Modine Manufacturing Company (MOD) Q4 2015 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the Modine Manufacturing Fourth Quarter Fiscal 2015 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded.\ I’d 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 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 with today’s presentation. Those links are available through both the webcast link as well as the PDF file posted on the Investor Relations section of our company Web site modine.com. Also, should you need to exit the call prior to its conclusion; a replay will be available through our Web site 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 revenue and earnings guidance for fiscal ’16. 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 was up 27% from the prior year largely driven by improved gross margin on North America in building HVAC segments. 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 U.S 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 are able to grow earnings despite unfavorable currency impacts and weaker than expected conditions in some of our key end market. Our earnings benefited from a 40 basis point improvement in gross margin driven by higher sales volume and lower warranty costs. 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, but first I’ll 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 costs in the current year. Both gross margin and SG&A benefited from lower incentive compensation expenses as compared to last year. We are nearing the completion of our transfer of production from our McHenry, Illinois manufacturing facility to other Modine locations. In addition, we recently announced our intension 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 of that being recorded in the first quarter of fiscal ’16 relating to anticipated severance costs. There will also be a temporary inefficiencies that we typically see when 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 with growth of 5% to 10% over fiscal ’15, while we expect mediums to be flat as compared to the prior year, we may realize lower overall growth in North America commercial market -- vehicle market due to our particular mix of business. Our outlook for the automotive market is for sales to remain steady, with possibly increasing 5%. For our off-highway markets, we expect continued weakness in the agricultural equipment market, with sales projected to be down an additional 20% to 25% versus fiscal ’15. 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 impacts. In U.S. dollar term, sales decreased 14% in the quarter driven by the impact of the stronger U.S 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 tooling sales which were down from the prior year. Gross margin decreased 80 basis points from the prior year. The positive impacts from higher volumes 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 in total cost to each of our foreign operations as it has been the case lately. Since the underlying commodity prices are typically fixed in U.S dollars. When U.S dollars strengthens, these foreign locations including Modine Europe pay higher prices for materials when purchased in the local currency. I’m pleased to report that the German plant consolidation remains on track. We are 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 consolidated work force and normalizing the two labor contracts. Our 2016 market outlook for Europe is improving with the 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 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 impacts, with decreases in commercial vehicle, off-highway and aftermarket sales. Unfortunately the economy in Brazil [ph] 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 a 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 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 costs in South America segment early in fiscal 2015 when volumes began to decline. In addition, we’ve recently made a decision to combine the management of our North America and South America operations, so they’re 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’m 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 remain weak. We also saw 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 volume, partially offset by lower profits on tooling sales. I’m 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 reach this point much sooner, had it not been for the downturn in 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 to segment to grow and we expect this trend to continue in fiscal ’16. Our outlook for the automotive market in China is for continued strength of 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 remains 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 U.K. 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 an 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 American heating market to be up 3% to 5% and both the North American ventilation and U.K. 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 investments made to expand our product offering. During the quarter, we saw significant progress in the construction of our new Airedale facility and we expect to move in later this calendar year. I’m very pleased with how the segment has contributed to Modine’s results this year and continue to view it as a key source of diversification from a vehicular business. With that, I’d 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 strengthening of the U.S 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’m 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 materials. 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 on to SG&A, I’ve said before that we’re closely managing and reducing our costs wherever possible. In total, SG&A costs 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 recorded $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 not 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’ve an excellent competitive position. And I’m pleased with the cost cutting measures our team is taking so far. Looking at operating income, I’d 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 the legal reserve and goodwill impairment in South America. As usual, we’ve included reconciliations in our press release and slide. When comparing year-over-year income tax, it is important to remember that we came out of our U.S tax valuation status at the end of last year. We are now recording U.S 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 pre-tax earnings. In 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 U.S taxes on EPS was $0.09 per share. Turning to Slide 13, I’m 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’d see some builds in working capital to support our plant closures and operations in the U.K. 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 walk you through, we’re 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 a $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 ’16. Also on the restructuring front our North America segment recently announced plans to close the plant in Washington, Iowa. The work will begin this year and be completed in 2018. Given all 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 at 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’m very pleased that we’re 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 believe we will continue to adjust and manage to the changing conditions. Tom, I’ll turn it back to you.

Thanks, Mick. Our focus in Modine this past year continues to be on positioning the company for meaningful growth. The balance sheet is strong and we approve that we can generate positive operating income and free cash flow at our current business -- 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’s good to be able to weather these storms, we’re focused on putting our cash to work in significant ways and assessing investment opportunities that will allow us to grow profitably and sustainably while further diversifying our business. We’re equally focused on operational efficiency as we continue to work to improve our cost structure to remain competitive in a market place. 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’re 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’ll take your questions.

Thank you. [Operator Instructions] And our first question comes from the line of Mike Shlisky of Global Hunter. Your line is open. Please go ahead.

Good morning, guys.

Good morning.

Hi, Mike.

A bunch of questions, but I’ll just keep it brief here. Anyway, first touching on the mid-west transaction premium, it sounds like that probably was a headwind here in the most recent quarter, but it did kind of fall off pretty dramatically at the end of March. I was wondering, when you might start to see that kind of improvement picture of P&L, will it be this current quarter or possibly we’ll have to wait into the back half of the year there?

Mike, good question. It’s Mick. Yes, good news is we’ve 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 in our guidance, but we’ll 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 this. But can you just explain about your, is you reserve in the quarter for legalities. Give us little more color as to what was going on there? I might have missed it, sorry.

Yes, Mike I’ll take that one. We received notice from Brazil’s administrative authority on some of the alleged anti-trust 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 yearend to represent the 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 that 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 that I’m very comfortable with the effect of this, our internal controls of trading and focus on our behavior around the world.

Got it. And then touching on Europe quickly, you had -- [indiscernible] that you’re actively looking to sell the old facility in Germany. Could you remind us or just update us, is there -- is your guidance currently showing a gain or a loss there in the coming fiscal year or did that exclude any kind of one time items on the sale of your facility?

Yes, Mike, it’s Mick. We haven’t included in our outlook any, the sale of both in our cash projections also; we wouldn’t include the gain or any gain on the sale in there. So, in fact we would hopefully we’ll 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. I’d just kind of squeeze in one last one here, about North America trucks. Obviously I had mentioned here in your comments here that you said that, that your growth rate may not mirror exactly the market growth rate in fiscal 2016. That’s a little bit surprising because I’ve always heard of basically you’re [indiscernible] truck out there. So, kind of what would be behind the reasons why you might lag the overall market here going forward?

Yes, it could have been our particular mix Mike that, the customer base we have, the share changes that may happen, that are occurring we don’t think we’ll be at maximum end of that growth projection. We’re going to grow, but we just don’t think we’ll see maybe the full growth potential because of the customer particular mix of business.

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

Thank you. Our next question comes from the line of David Leiker of Robert W. Baird. Your line is open. Please go ahead.

Hi, good morning. This is Joe Vruwink for David.

Hi, Joe.

Hi, 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 those kind of being neutral lets say the profitability in the quarter?

Yes. Joe, its Mick. Tooling, I’ll see if I can grab the number while we’re on. But tooling is -- wasn’t the major driver in the gross margin line in the quarter. The largest driver frankly was the material cost that we had a double hit between the transaction premium that we talked about and it really peaked there in this fourth quarter combined with the exchange rate impact and the fact that Modine Europe metals have indexed and priced off the U.S. dollar. So there’s about a $2 million to $3 million materials impact in the quarter in Europe that was the biggest impact. I’ll let Tom; add any thoughts on the consolidation. Clearly the complexity of that the move from [indiscernible] and managing through that with the Origami line and the dual workforces, it was very complicated in the quarter as well.

Yes, now clearly as Mick said, this kind of ended our quarter, our major restructuring movement actions and relocation of workforce and equipment. So with that behind us, we feel that we’re going to be moving forward in a much stronger position, and so there was some impact for that. But clearly not as much as a materials impact that Mick mentioned.

So it sounds like on a sequential basis, maybe additional improvement as we work into next year, obviously on a year-over-year basis just given the indexing that’s still going to be a headwind, at least from a transactional standpoint. Does that sound fair?

Yes, we would expect improvements ongoing in our operations Joe with -- the materials piece is going to 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 material.

Okay. Given it’s 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 was coming from kind of 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?

So as we do each year, we go through our long range planning cycle Joe. I’m happy to report we still have a really solid three year backlog, about $200 million consistent with prior years. And as you know that frankly the challenge we had each year is just trying to analyze the impact of economic changes whether that’s 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.

Yes, I’ll add to that Joe. I mean at the macro level the mega trends on things that are driving fuel efficiency, CO2 emissions and we’re very well positioned for, very pleased as I mentioned with the product portfolio, the work your teams have done to get the products right and we’re seeing just a lot of activity with engagement and coding and again the win rates is Mick said, we’re very pleased with and really expanding some of these opportunities that are developing on next level of efficiency requirements and vehicles and also in our stationary business with building HVAC in our coils business.

Okay. Yes, that’s certainly a very good number. My last question, when you see thermal assets in the space, there is 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 a standpoint for you? Are you still considering assets that are out there or maybe any update there?

Yes, Joe its Mick. Well we said before and we’re continuing to say that 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’ve known this for a while as you do that multiples can be very high. I think the good news for Modine is, anything we’ve looked at and we are looking at is going to be highly strategic. So, the way we’ll be able to generate a high ROI and that type of investment will only be in a case where we see it as highly core to us and highly synergistic. I think its really good news that the world of thermal is really in demand and everybody is seeing the trends and the needs for Modine type products. So on the positive side despite that driving multiples up, I think that’s good for our future business.

Yes, I’ll add to that Joe. We’ve 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 maybe expanding to add success and sport-utility business, [indiscernible] vehicle business and also through some Tier 1s 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’s pretty exciting for us right now and I think we have the right focus on it.

Okay, great. Just need all thermal assets for trade [indiscernible] you guys will be in good shape.

We agree.

We like this. Yes.

Yes. All right. I’ll leave it there. Thank you. End of Q&A

Thank you. At this time, I’m showing no further questions. I’d 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.