Modine Manufacturing Co (MOD) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Modine Manufacturing fourth-quarter fiscal 2015 earnings conference call.

(Operator Instructions)

As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Kathy Powers, Vice President, Treasurer and Investor Relations. You may begin.

Thank you for joining us today for Modine's fourth-quarter fiscal 2015 earnings conference call. With me today are Modine's President and CEO Tom Burke, and Mick Lucareli, our Vice President Finance and Chief Financial Officer.

We will be using slides for today's presentation. Those links are available through both the webcast links as well as the PDF file posted on the Investor Relations section of our Company website, modine.com. Also should you need to exit the call prior to its conclusion, a replay will be available through our website beginning approximately two hours after the call concludes.

On slide 2 is an outline for today's call. Tom and Mick will provide comments on our fourth-quarter results and provide our revenue and earnings guidance for fiscal 2016. At the end of the call, there will be a question-and-answer session.

On slide 3 is our notice regarding forward-looking statements. I want to remind you that this call may contain forward-looking statements as outlined in today's earnings release as well as in our Company's filings with the Securities and Exchange Commission.

With that, it is my pleasure to turn the call over to Tom Burke.

Thank you Kathy and good morning everyone. I'm pleased to report that we ended our fiscal year with a strong fourth quarter.

Our fourth-quarter sales of $363 million were up 2% from the prior year on a constant currency basis with sales growth in each of our segments except South America, where markets remained weak. Adjusted operating income of $17 million, up 27% from the prior year, largely driven by improved gross margin in North America and building HVAC segments.

We reported adjusted earnings per share of $0.12 compared to $0.15 in the prior year. Despite the significant increase in operating income, EPS declined due to higher income tax expense in the current year resulting from the reversal of US tax valuation allowances in the fourth quarter of last year.

I'm pleased to report that for the full fiscal year, sales were up 4%, excluding currency, and reported adjusted operating income of $65 million, which is up 6% from the prior year. We were able to grow earnings despite unfavorable currency impact and weaker than expected conditions in some of our key end markets.

Our earnings benefited from a 40 basis point improvement in gross margin driven by higher sales volume and lower warranty cost. Adjusted earnings per share of $0.63 was down from the prior year, again, due to the expected increase in income tax expense.

Mick will go through the consolidated results in greater detail. First, I will review the segment performance and provide an initial view on the end market expectations for fiscal 2016.

Turning to page 6, our North America segment finished the year on a strong note. Sales increased 1%, with higher sales to commercial vehicle and automotive customers more than offsetting a decrease in sales to off-highway customers as both the agricultural and mining equipment markets remained weak.

Adjusted operating income was up $5.6 million to $15.4 million, an increase of 57% compared to the prior year. This was driven by a 310 basis point improvement in gross margin, to 19%, and a decrease in SG&A expense.

The gross margin improvement was primarily driven by lower warranty cost in the current year. Both gross margin and SG&A benefited from lower incentive compensation expenses as compared to last year.

We're nearing the completion of our transfer of production from our McHenry, Illinois manufacturing facility to other Modine locations. In addition, we recently announced our intention to close our Washington, Iowa facility over the next two to three years. This was not an easy decision but was the right one as we continue to improve our manufacturing footprint by operating scale production facilities.

As with the McHenry closure, this does not represent a decrease in overall manufacturing capacity, but instead, a commitment to world-class, cost-effective manufacturing operations to better serve our customers and deliver increased value to our shareholders. We will move production from Washington to our Joplin, Jefferson City, and Nuevo Laredo facilities.

We expect to incur total closure costs of approximately $5 million over the entire Washington closure period with $2 million of that being reported in the first quarter of fiscal 2016 relating to anticipated severance cost. There will also be temporary inefficiencies that we typically see with closing a plant and moving production. We anticipate that these actions will generate annual savings of at least $9 million, once the closure is completed.

Our outlook for the fiscal 2016 North America heavy duty truck market is for growth of 5% to 10% over fiscal 2015. While we expect mediums to be flat as compared to the prior year, we may realize lower overall growth in North America commercial vehicle market due to our particular mix of business. Our outlook for the automotive market is for sales to remain steady, possibly increasing 5%.

For off-highway markets, we expect continued weakness in the agriculture equipment market with sales projected to be down an additional 20% to 25%, versus fiscal 2015. We expect the construction market to be flat with gains in light construction, most likely offsetting continued weakness in heavy construction and mining.

Turning to page 7, sales for our Europe segment increased 5% in the fourth quarter excluding currency impact. In US dollar terms, sales decreased 14% in the quarter, driven by the impact of the stronger US dollar versus the Euro.

Sales to automotive customers was up 11%, driven by strong oil cooler and condenser sales. Sales to commercial vehicle customers were up 8%, driven by higher volumes of components for Euro 6 vehicles, including radiators and EGRs. These increases were partially offset by lower off-highway and tuning sales which were down from the prior year.

Gross margin decreased 80 basis points from the prior year. The positive impacts from higher volume were more than offset by unfavorable material costs, unfavorable sales mix and lower profits on tooling sales.

With respect to material costs, currency can have a major influence on total cost to each of our foreign operations, as has been the case lately, since the underlying commodity prices are typically fixed in US dollars. When the US dollar strengthens, these foreign locations including Modine Europe pay higher prices for materials purchased in the local currency.

I am pleased to report that the German plant consolidation remains on track. We're in the final stages of removing all remaining equipment from our Kirchentellinsfurt facility and are actively marketing the facility for sale.

The building is in a desirable location. We already have strong interest in the property. Operationally, we're focused on optimizing the cost structure of the newly consolidated facility in Pliezhausen including consolidating workforce and normalizing the two labor contracts.

Our 2016 market outlook for Europe is improving with a continued demand of premium automotive components where Modine has a strong presence. We expect the automotive market to be flat to up 5%, the commercial vehicle market to be up 3% to 7%, and our off-highway markets to be flat to up 5%.

Moving to South America on page 8, sales were down 31% or 17% excluding currency impact with decreases in commercial vehicle, off-highway and aftermarket sales. Unfortunately, the economy in Brazil remains weak and continues to impact our customers and us. Gross margin was 14%, down 120 basis points on lower sales volume, partially offset by performance and the favorable impact of restructuring actions taken to date.

The increase in SG&A was primarily due to a $3.2 million accrual reported in the quarter, related to a legal matter in Brazil. Because this is considered to be a one-time item relating to a prior period, the amount has been excluded from adjusted operating income in the current period.

Excluding this legal reserve, SG&A was down 16% from the prior year, primarily due to the measures we took to cut costs in the region this year and the impact of currency translation. Adjusted operating income was down $1.1 million, primarily due to the decrease in sales volume. As discussed in previous quarters, we diligently cut cost in South America segment early in fiscal 2015, when volumes began to decline.

In addition, we recently made a decision to combine the management of our North America and South America operations so that they are now functioning as one operating segment. The objective of this change is to streamline our operations, to gain synergies, and improve our cost structure. Given this change in reporting structure, effective for the first quarter of fiscal 2016, we will report the combined North and South American operations externally as the Americas segment.

We believe that the weak Brazilian market conditions will continue into fiscal 2016. Specifically, we expect the commercial vehicle market to be down 20% to 30%, the ag equipment market to be down 20% to 25%.

We expect the aftermarket business to remain steady as we expect this market to be flat. With our reduced cost base and our significant market presence, we are in an excellent position to take advantage when the Brazilian economy begins to recover.

Turning to page 9, I am pleased to report that our Asia segment reported positive operating income for the quarter and for the full fiscal year. Sales increased 7% in the quarter.

In China, we continue to see significant year-over-year increases in sales of oil coolers to automotive customers. This increase was partially offset by a decline in sales to off-highway customers, as the excavator markets in China and Korea remained weak.

We also saw a year-over-year revenue increase in India, with sales increases in automotive, commercial vehicle and off-highway customers. Gross margin improved 20 basis points to 14.5% from the prior year on higher sales volumes, partially offset by lower profits on tooling sales.

I am very pleased with the performance of the Asia segment this year. They generated an operating profit and positive cash flow for the fiscal year with $81 million in sales. This beats our previous estimate of their breakeven point of $85 million in sales.

We would have reached this point much sooner, had it not been for the downturn of the construction markets in China and Korea. However, the launch of the oil cooler business in China and the growth of our business in India have returned the segment to growth and we expect this trend to continue in fiscal 2016.

Our outlook for the automotive market in China is for continued strength up 5% to 10%. We also expect the commercial vehicle market in India to remain strong with growth similarly up 5% to 10%. The Asia excavator market remained weak, down 15% to 20%.

Turning to page 10, sales in our building HVAC segment increased 7% in the quarter on a constant currency basis. This increase was largely driven by continued strength in North America with increases in heating, ventilation and cooling. Our UK data center cooling business was down slightly from the prior year.

The fourth quarter of last year was our last quarter of full production after the fire and included catching up on a backlog of orders. This was offset by higher sales of Barkell, which only had one month of sales in the prior year.

Gross margin for the segment increased 180 basis points on the higher sales volume during the quarter. In addition, gross margin benefited from insurance recovery related to the fire that included the offset of additional expenses from throughout the fiscal year. SG&A was up slightly, on higher sales.

Our outlook for the building HVAC markets is for continued strength in each of our served markets. We expect the North America heating market to be up 3% to 5%, and both the North America ventilation and UK data center markets to be up 5% to 7%. This year, the building HVAC segment clearly benefited from strong markets in North America and from the investments made to expand our product offerings.

During the quarter, we saw significant progress in construction of the new Airedale facility, and we expect to move in later this calendar year. I am very pleased with how this segment has contributed to Modine's results this year and continue to view it as a key source of diversification from our vehicular business.

With that, I would like to turn it over to Mick for an overview of our consolidated financial results and guidance.

Thanks, Tom. Good morning. Please turn to slide 12.

Modine's fourth-quarter sales were down 7%, primarily due to the strengthening of the US dollar. As Tom mentioned, sales increased 2% on a constant currency basis.

In the quarter, our gross profit increased $400,000. Excluding an unfavorable exchange rate impact of $4.4 million, gross profit increased $4.8 million, or nearly 8%. I am happy to report a gross margin improvement of 140 basis points, to 17.3%.

The gross profit was negatively impacted by the cost of raw material. In total, aluminum increased around 20%, year-over-year. This includes an increase in the spot price along with an increase in the transaction premium.

Offsetting that was the benefit of lower warranty expenses in the North America and Europe segments. We also experienced good cost control in other manufacturing overhead areas.

Moving onto SG&A, I have said before that we are closely managing and reducing our costs wherever possible. In total, SG&A cost decreased slightly from the prior year.

The exchange rate impact was favorable at $3.1 million in the quarter. This was offset by a $3.2 million legal reserve relating to our South America segment.

We also reported $1 million of restructuring expenses in the quarter. This was fairly evenly spread among Europe, North America and South America.

In addition, we recorded a $7.8 million goodwill impairment in our South America segment. Each year we perform a global assessment of our goodwill. This year, the assessment led us to fully impair the goodwill related to our acquisition in Brazil.

The impairment was primarily due to the weak economic environment, and a significant increase in the associated discount rate used to do that analysis. This does not diminish our long-term commitment to the markets in Brazil where we have an excellent competitive position. And I am pleased with the cost-cutting measures that our team has taken so far.

Looking at operating income, I would like to point out that Modine's operating income was negatively impacted by approximately $1 million, relating to foreign currency. Q4's adjusted operating income of $17.2 million represents a 27% increase over the prior year.

This figure represents adjustments for the restructuring costs along with a legal reserve and goodwill impairment in South America. As usual, we have included reconciliations in our press release and slides.

When comparing year-over-year income tax, it is important to remember that we came out of our US tax valuation status at the end of last year. We are now recording US tax expense, and this impacted our tax provision in the fourth quarter by more than $4 million. Also, given our current mix of earnings, primarily in the various tax jurisdictions in Europe, you will notice that our income tax provision actually exceeded our pretax earnings.

And last, adjusted earnings per share of $0.12 was down slightly versus the prior year. Given the increase in operating income, you can see the EPS change was due to the higher income tax expense. The negative impact of higher US taxes on EPS was $0.09 per share.

Turning to slide 13, I am happy to report that we generated positive free cash flow again this fiscal year. For the full year, our free cash flow was $16 million. This very closely matched our projections.

We knew that heading into the year, we would see some builds in working capital to support our plant closures and operations in the UK after the fire. Our capital expenditures of $58 million were up slightly from the prior year, but are still well below the historical levels.

In addition to the free cash flow of $16 million, we generated another $7.6 million of cash inflows from various asset sales. We remain focused on a strong balance sheet and ended the quarter with a net debt to capital ratio of 18%.

Now let's turn to our fiscal 2016 full-year guidance on slide 14. As Tom walked you through, we are expecting limited growth in many of our end markets. In particular, we expect continued weakness in Brazil and in the global agricultural and mining markets.

We also anticipate significant headwinds on our projections, due to the exchange rate environment. We estimate the exchange rate impact to be approximately $100 million on revenue.

On the positive side, our diversification strategy in Asia is working. And we expect to see continued sales improvement as we launch new programs in China and India. Our building HVAC segment has delivered strong results and we expect those markets to continue to grow.

Finally, the Company is benefiting from the restructuring in Germany, McHenry, Illinois, and Brazil. We expect to continue to experience benefits throughout fiscal 2016.

Also, on the restructuring front, our North America segment recently announced plans to close a plant in Washington, Iowa. The work will begin this year and be completed in 2018.

Given all of this, our full-year outlook is as follows. Sales flat to down 5% from the prior year. On a constant currency basis, we expect sales to be up 1% to 6%.

Adjusted operating income in the range of $65 million to $70 million. The range is flat to up 7%. And on a constant currency basis, this would equate to adjusted operating income of $68 million to $73 million, which is up 5% to 12%.

Adjusted earnings per share of $0.75 to $0.82, up significantly from $0.63 reported this year. From a quarterly run rate perspective, we anticipate the second half will be significantly stronger than the first half, both in terms of the absolute numbers and year-over-year comparables.

If you recall, we got off to a very strong start last fiscal year including a sizable business interruption insurance recovery. In addition, material prices and foreign exchange rates were much more favorable during the first half of last year. As the new year progresses, we expect sequential revenue growth along with easier comparables.

So to wrap things up, I am very pleased that we are able to report operating income growth in the past fiscal year, given the exchange rate environment we face, and the weaker than expected market conditions. We anticipate the new year will have its share of obstacles. We will continue to adjust and manage to the changing conditions.

Tom, I will turn it back to you.

Thanks, Mick. Our focus at Modine this past year continues to be on positioning the Company for meaningful growth.

Our balance sheet is strong. We have proven we can generate positive operating income and free cash flow at our current level of business.

We delivered on the earnings guidance provided at the beginning of the fiscal year despite significant currency impacts and an economic downturn in Brazil that was significantly worse than anticipated. Although it is good to be able to weather these storms, we are focused on putting our cash to work in significant ways and assessing investment opportunities that allow us to grow profitably and sustainably while further diversifying our business. We are equally focused on operational efficiency, as we continue to work to improve our cost structure, to remain competitive in the marketplace.

Our employees are working very hard to ensure we have a market-leading product portfolio and a world-class manufacturing base, both in terms of location and scale. Given this combination, we are in excellent competitive position. The significant amount of new business quoting activity and new business wins at Modine confirms that we're heading in the right direction and have a very bright future.

With that, we will take your questions.

(Operator Instructions)

Mike Shlisky, Global Hunter.

Good morning, guys.

Good morning.

A bunch of questions, but I will keep it brief here. First touching on the Midwest transaction premium, it sounds like that probably was a headwind here in the most recent quarter. But it did fall off pretty dramatically at the end of March. I was wondering when you might start to see that improvement hit your P&L. Will it be this current quarter or possibly we will have wait until the back half of the year there?

Mike, good question. This is Mick. Yes, good news is we have seen that come back quite a bit from the spike that we saw last year.

It will take probably about -- we factored that into our projections and our guidance. But we will start to see the benefit of that later in our Q1 and then continue through. So we should capture most of our fiscal year, the benefit of that.

Okay, great. And then moving on to South America. Perhaps I missed it.

But can you just explain about -- is your reserve in the quarter for legal? Can you give us more color as to what was going on there? I might have missed it, sorry.

I will take that one. We received notice from Brazil's administrative authority on some alleged antitrust violations by Modine Brazil and a few of its employees, many years ago. Based upon our investigation, we made a decision to establish a $3.2 million reserve at year-end that represents an amount that we may incur to resolve the matter.

I appreciate that you have the question and you may have follow-up questions on this. But I hope you understand, given the current status of the investigation, I can't provide additional details at this time.

However, I will note that the allegations are limited in nature, unrelated to any other Modine segment. And I am very comfortable with the effectiveness of our internal controls and training to focus on our behavior around the world.

Got it. Got it. Touching on Europe briefly, you had mentioned that you're actively looking to sell the old facility in Germany.

Could you remind us -- or update us, is there guidance around the -- showing a gain or a loss there in the coming fiscal year? Or is that -- exclude any one-time items on the sale of your facility?

Mike, it is Mick. We haven't included, in our outlook, any -- the sale both in cash projections -- also, we wouldn't include the gain -- or any gain on the sale in there.

So in fact, hopefully we will sell at a gain, we would adjust our earnings frankly for that anyway. So it's not in the numbers we provided to you.

All right. If I could just squeeze in one last one here about North America trucks.

You mentioned -- in your comments here -- you said that your growth rate may not mirror exactly the market growth rate in fiscal 2016. That is a little bit surprising because I have always heard of -- basically your prowess in almost every single truck out there. So what would be behind the reasons why you might lag the overall market here going forward?

If you look at our particular mix, Mike, the customer base we have, the share changes that may happen -- that are occurring, we don't think will be at the maximum end of that growth projection. We're going to grow. But we don't think we will see maybe the full growth potential because of the particular mix of business.

Okay, great. I will leave it there, guys. Thanks very much.

David Leiker, Robert W. Baird.

This is Joe Vruwink for David.

Hello Joe.

Two questions on profitability in Europe this quarter. Is it possible to quantify the tooling impact? And then given it wasn't called out as impacting gross margin, can we think about the plant consolidation and the related inefficiencies as being neutral, let's say, to profitability in the quarter?

Joe, it is Mick. Tooling -- I will see if I can grab the number while we are on. But tooling wasn't the major driver in the gross margin in the quarter.

The largest driver, frankly, was the material cost. We had a double hit between the transaction premium that we talked about, and it really peaked there in the fourth quarter, combined with the exchange rate impact and the fact that Modine Europe metals are indexed and priced off the US dollar.

So there is about a $2 million to $3 million materials impact in the quarter in Europe. That was the biggest impact.

I will let Tom add any thoughts on the consolidation. Clearly the complexity of that -- the move from Kirchentellinsfurt to Pliezhausen and managing through that with the origami line and the dual workforces, it was very complicated in the quarter as well.

Clearly, as Mick said, this ended our major restructuring movement actions and relocation of workforce and equipment. So with that behind us, we feel that we are going to be moving forward in a much stronger position.

There was some impact with that. But clearly not as much as the materials impacted that Mick mentioned.

It sounds like -- on a sequential basis, maybe additional improvement as we work in the next year. Obviously on a year-over-year basis, just given the index -- saying that is still going to be a headwind. So from a transactional standpoint, does that sound fair?

Yes. We would expect improvement ongoing in our operations, Joe -- with the materials piece. It will take a while to work through, including the FX, is frankly out of our control. We don't have commercial agreements that will allow us to adjust for changes in exchange on materials.

Okay. Given it is the end of the fiscal year, can you maybe provide an update on your bookings during this past fiscal year? And obviously, given the end market forecast that most of the organic growth -- or really all of the organic growth is coming from new awards or the backlog. So maybe, if you look over the three-year horizon, what type of growth you would expect to come from your new business backlog.

As we do each year -- we go through our long-range planning cycle, Joe, I am happy to report we still have a really solid three-year backlog. About $200 million, consistent with prior years.

And as you know, frankly, the challenge we have had each year is just trying to analyze the impact of economic changes, whether that is Brazil or in Asia or in the off-highway markets with anything getting delayed or pushed out. But, the actual order intake and the solid book of new business and launches is intact. And we feel really good about that over the next few years.

I will add to that, Joe. At a macro level, the megatrends on things that are driving fuel efficiency, CO2 emissions we are very well positioned for and very pleased as I mentioned with the product portfolio and the work the teams have done to get the products right.

We're seeing just a lot of activity with engagement in quoting and, again, the win rates as Mick said, we are very pleased with. And really expanding these opportunities that are developing on the next level of efficiency requirements in vehicles and also in our stationery business with building HVAC in our coils business.

Okay. That is certainly a very good number.

My last question -- when you see thermal assets in the space -- there was a big transaction earlier this year, going for close to 10 times EBITDA. How does that influence strategically how you view your business?

And does it make things much more difficult from an M&A standpoint for you? Are you still considering assets that are out there? Maybe any update there?

Joe, it is Mick. We said before and we will continue to say it, we are actively out in the market looking for strategic ways for us to expand our market and our product portfolio.

We know -- and frankly we have known this for a while, as you do, that multiples can be very high. I think the good news for Modine is, anything we have looked at and we are looking at, is going to be highly strategic. So the way we will be able to generate a high ROI in that type investment, will only be in the case where we see it as highly core to us and highly synergistic.

I think it is really good news that the world of thermal is really in demand. And everybody is seeing the trends and the need for Modine type products. So on the positive side, despite that driving multiple is up, I think that is good for our future business.

I will add to that, Joe. We have added some significant resource to our business development focus, with dedicated individuals that are not just looking for direct acquisition opportunities but relationships and business partners. We may be expanding in that success in the sport utility business, electric vehicle business and also through some tier ones on supporting some of the needs on these new engine developments that are coming.

So, we're looking at all levels of business -- not just the straight up acquisition by itself. So it is pretty exciting for us right now. I think we have the right focus on it.

Okay, great. Just need all thermal assets to trade at 10, and you guys will be in good shape.

We agree.

We like that theory.

All right. I will leave it there. Thank you.

At this time, I am showing no further questions. I would like to turn the call back over to Kathy Powers for any closing remarks.

Thank you. This concludes today's call.

Thank you for joining us this morning and thank you for your interest in Modine. Goodbye.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.