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Edited Transcript of MOD earnings conference call or presentation 1-Aug-19 1:00pm GMT

Q1 2020 Modine Manufacturing Co Earnings Call

Racine Aug 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Modine Manufacturing Co earnings conference call or presentation Thursday, August 1, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kathleen T. Powers

Modine Manufacturing Company - VP of IR & Tax and Treasurer

* Michael B. Lucareli

Modine Manufacturing Company - CFO & VP of Finance

* Thomas A. Burke

Modine Manufacturing Company - President, CEO & Director

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Conference Call Participants

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* David Jon Leiker

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Modine Manufacturing Company's First Quarter Fiscal 2020 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Kathy Powers, Vice President, Treasurer, Investor Relations and Tax.

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Kathleen T. Powers, Modine Manufacturing Company - VP of IR & Tax and Treasurer [2]

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Good morning, and thank you for joining our conference call to discuss Modine's First Quarter Fiscal 2020 Results. I am here with 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, which can be accessed either through the webcast link or by accessing the PDF file posted on the Investor Relations section of our website, modine.com.

 

This morning, Tom and Mick will present our first quarter results for fiscal '20 and will provide an update to our outlook for the rest of the year. At the end of the call, there will be a question-and-answer session.

 

On Slide 2 is our notice regarding forward-looking statements. This call may contain forward-looking statements as outlined in our 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.

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [3]

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Thank you, Kathy, and good morning, everyone. Overall, first quarter sales decreased 7% or 3% on a constant currency basis. Our Building HVAC segment had another strong quarter with sales up 11% on a constant currency basis versus the prior year. However, both our VTS and CIS businesses had year-over-year sales declines, primarily due to currency impacts and softening end markets. Our first quarter adjusted operating income was $28.4 million, down $7.6 million or 21% from the prior year.

 

Operating margins in our VTS and CIS segments were negatively impacted by lower sales volumes. While our performance this quarter wasn't too far off our internal expectations, we did see some recent softness that caused us to adjust our expectations for the rest of fiscal 2020. This has been driven by a number of trends and macroeconomic factors.

 

First, the stronger U.S. dollar is having a significant impact on our year-over-year revenue comparisons. Second, in recent weeks, we've experienced a significant slowdown in some of our key vehicular end markets, including the global automotive and off-highway markets. In addition, we're now expecting slower growth in our served data center markets, particularly related to the timing of sales to our large data center customer in the CIS segment. Finally, we are benefiting from lower commodity prices. They continue to be somewhat offset by the negative impact of tariffs on our earnings. As a result, we're taking a number of actions to reduce this negative impact in the fiscal 2020, and I'll highlight those in a few minutes.

 

We are focused on improving what we can control, and I'm pleased with the improvements within our operations group, and the procurement team is currently exceeding our cost savings targets.

 

Before reviewing the segment results, I would like to provide a brief update on the potential sale of our automotive business. As I previously communicated, we have launched a formal sale process to further evaluate the best strategic alternative for Modine's automotive business. This process is well underway, including a lot of work to prepare for a separation while engaging with all interested parties.

 

As you can appreciate, I can't provide any more information at the current time given that we're in the middle of a process. We will be able to provide a more in-depth update once the process is completed or we reach a definitive agreement. In the meantime, I can assure you that we will move forward with the best option to maximize long-term shareholder value.

 

Turning to Page 5. Sales for the VTS segment were down 7% from the prior year, were down 4% on a constant currency basis. The most significant driver of the lower sales in this segment was in Europe, where sales were down 15% from the prior year. A large component of this decrease was currency, driven by the stronger U.S. dollar versus the euro as compared to the prior year. In addition, sales were down across all end markets, with an 11% drop in automotive sales as global light vehicle production volumes have fallen significantly.

 

This is the first quarter in a long time that we've experienced a sales decline in Asia. Sales in Asia were down 12%, driven primarily by lower off-highway sales in China and Korea. Auto and commercial vehicle sales in India were down slightly, while sales to these end markets were slightly up in China year-over-year.

 

Vehicular sales in the Americas region were up 2% from the prior year, primarily due to higher commercial vehicle sales. After a long period of stable or growing vehicular markets, we're starting to see some significant softening. As I mentioned, automotive markets are slowing globally, and sales of this end market were down 11% versus the prior year. We expect the automotive market to be down 3% in the Americas region, 5% in Europe, and 7% in Asia in fiscal 2020. We have recently revised this market outlook and have updated our forecast to reflect these weakening conditions.

 

In addition, we're expecting the off-highway market to slow considerably this year. Off-highway sales were down 12% as compared to the prior year. We're expecting off-highway market to be down 6% in the Americas, 2% in Europe and 4% in Asia in fiscal 2020. We are also clearly seeing the results of this market slowdown this quarter in Asia and have also updated our expectations for the balance of the year.

 

Adjusted operating income for the VTS segment was $19 million for the quarter, which is $7.5 million lower than the prior year. Adjusted operating margin was down 170 basis points to 5.8%. This decrease was primarily due to lower sales volume, currency and higher labor costs. We also had costs related to tariffs this quarter, but this was offset by lower commodity metal costs.

 

We spoke a great deal about the impact that tariffs had on the business this last year. So I'd like to give an update on some of the actions that we have taken to mitigate these costs.

 

First, in certain situations, we have been able to partially offset the direct costs of tariffs by negotiating cost-sharing agreements with our key customers. We began to see some of the initial benefits of these agreements in the fourth quarter of last year. Second, we've applied for exclusions. In certain cases, we have seen progress with the government granting these exclusions and are working with our suppliers to recover the cost of the tariffs that have previously been paid. Last, our procurement team is continuing to work on strategic sourcing initiatives. We have been able to resource much of our raw material supply to lower cost overseas suppliers. As previously mentioned, we are focusing on improving what we can control. And this group, in particular, is doing a great job. Although these actions won't allow us to fully recover our costs, they have clearly led to lower tariff-related costs this quarter, and we'll continue to drive improvements in subsequent quarters.

 

Turning to Page 6. As we anticipated and as Mick discussed last quarter, we had some revenue challenges within our CIS segment in Q1.

 

Sales decreased 8% from the prior year or 6% on a constant currency basis. Data center sales were down 29% from the prior year, driven by both lower sales to a large cloud computing customer and by lower sales of coils to other customers that sell into the data center end market.

 

Last year, we saw a growth of cooler sales to the data center end market in excess of market growth. And this quarter, we're going to see the opposite. It is often difficult to forecast these sales more than 3 to 6 months out. And as we have mentioned many times, project-based sales in this market tend to change drastically quarter-to-quarter.

 

Last year, we had record-breaking sales to this market. And this year, there's been a pullback, driven primarily by a slowdown in data center expansion by our major customer. Overall, we expect our data center revenue to be down this year, even though we expect the market to be generally flat.

 

This segment reported adjusted operating income of $9.2 million, down 31% from the prior year. This decrease was primarily due to lower margins, driven by negative sales mix and higher labor costs, particularly in Mexico. The adjusted operating margin was down 170 basis points year-over-year to 5.5%, primarily due to lower gross profit on sales.

 

Please turn to Page 7. Sales for our Building HVAC segment increased 9% or 11% on a constant currency basis, driven primarily by higher sales of school, ventilation products and heating products in North America and higher data center sales in the U.K., partially offset by lower nondata center air conditioning-related product sales in the U.K. Operating income increased 66% from the prior year to $5.3 million, and operating margin increased 360 basis points to 10.7%. This increase was driven by higher sales volume and favorable sales mix.

 

We continue to be encouraged by strong performance and our competitive position in this segment. With that, I'd like to turn it over to Mick for an overview of our consolidated results and an update for our outlook for fiscal 2020.

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Michael B. Lucareli, Modine Manufacturing Company - CFO & VP of Finance [4]

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Good morning, everyone. Please turn to Slide 9. As Tom previously mentioned, we anticipate a difficult first quarter comparisons based on year-over-year volume and cost variances. First quarter sales decreased $37 million or 7%. As covered in previous slides, this was mostly due to weakness across our vehicular markets, a difficult year-over-year data center comparison and negative foreign currency impact. On a constant currency basis, sales were down 3%. Gross profit of $83 million was lower by 12%, resulting in a gross margin of 15.8%. The downside conversion was generally in line with our expectations based on typical fixed-cost absorption.

 

In addition, foreign exchange had a negative impact on our gross profit compared to the prior year. Within VTS and CIS, gross margins were down due primarily to lower volumes, combined with the doubling of our Mexican labor rate and negative tariff impacts. Building HVAC had strong gross margin improvement, up 200 basis points on higher sales and volume and favorable pricing.

 

I want to take a moment to review our reported SG&A cost of $63.5 million. Please note, this includes $8.4 million of consulting and advisory fees related to the potential automotive business sale. In order to help offset the volume and tariff challenges, we are reducing other SG&A costs. As an example, excluding the unique costs related to our automotive business sale, SG&A would be down significantly from the prior year.

 

Last, please note these items have been excluded from our adjusted operating income, and you can see the detail in our appendix. Adjusted operating income was $28.4 million, which is down $7.6 million from the prior year. As Tom reviewed the earnings growth in Building HVAC was offset by the decline in VTS and CIS.

 

In addition to the volume decline in tariffs, operating income was negatively impacted by the change in foreign exchange rates.

 

As usual, the appendix includes an itemized list of adjustments and a full reconciliation to our U.S. GAAP results. These adjustments totaled $10.3 million. As I previously mentioned, there was $8.4 million relating to the potential sale of our automotive business, another $1.8 million was primarily employee severance costs in Europe and the Americas within the VTS segment. Our adjusted earnings per share was $0.31, which is down $0.10 from the prior year.

 

Turning to Slide 10. As anticipated, in customary, our first quarter free cash flow was negative. Operating cash flow was minimal but was $4.6 million higher as compared to last year. Capital expenditures were slightly lower than the prior year. Full year capital spending is expected to be slightly higher, largely due to the costs related to the anticipated sale of our auto business. Some additional capital spending will be necessary to prepare for a potential separation.

 

I want to point out that first quarter cash flow includes $13 million of payments related to consulting, advisory, restructuring and environmental costs. With regards to our outlook for the balance of the fiscal year, we do expect positive full year free cash flow with an improvement over fiscal 2019.

 

Finally, our net debt increased $20 million during the quarter, and our leverage ratio is 2.2.

 

Now let's turn to our fiscal 2020 guidance on Slide 11. Based on the latest trends and customer feedback, we are reducing our guidance to reflect additional market weakness, primarily in the second half of the year. In particular, we are seeing further softening in the global automotive and off-highway markets, along with some slowing in data center sales.

 

To summarize our updated fiscal '20 guidance, we now project sales to be down 5% to flat, which was previously flat to up 5%. In Building HVAC, we're expecting the sales growth to continue although somewhat slower in the second half.

 

With regards to CIS, we're now expecting sales to be slightly down this year, primarily due to a negative foreign exchange impact, combined with slowing data center sales. We also anticipate a decline in our VTS segment sales versus the prior year. The largest challenge remains in Europe with the weakening of the automotive market and the continued wind down of certain commercial vehicle programs. We have also reduced our Asia market forecast but expect modest sales growth for the year. And finally, we expect sales in the Americas region to decrease due to lower automotive and off-highway markets.

 

The updated adjusted operating income is expected to be in the range of $120 million to $130 million compared to our previous guidance of $135 million to $145 million. Based on the expected tax rate of approximately 26%, we anticipate our adjusted earnings per share will be between $1.35 and $1.50.

 

And before turning the call back over to Tom, I want to reiterate my outlook for the overall run rate of quarterly earnings this year. As I reviewed in May, we expected significant challenges in the first quarter, and our results were generally in line with these expectations.

 

We also discussed challenges in Q2 due to difficult VTS and CIS comparisons. In the CIS segment, we continue to expect lower revenue year-over-year in the first half, primarily due to robust data center sales in fiscal 2019. The second half of fiscal '20 should be more favorable with projections for orders ramping up later this year. For VTS, we anticipate a reduced volume impact and more favorable cost comparisons in the second half of the year.

 

Lastly, I want to point out that our current outlook includes the full year results for our automotive business. If a transaction is completed this fiscal year, it will obviously have an impact on our fiscal 2020 financial results. Once we have certainty regarding deal details, timing and outcome, we will address this further.

 

With that, Tom, I'll turn it back to you.

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [5]

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Thanks, Mick. And with that, we will take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from David Leiker from Baird.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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A couple of things. On the data center business, we're hearing mixed things. Some people talk about it being really strong. Other people talk about it being a little bit weaker. Can you talk a little bit about what you're seeing in particular? And is this something that's just a soft spot we're going through? Or is there something more structural there?

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [3]

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Yes. I think it's -- as we've said all along, David, we kind of use the word lumpy to describe data center sales. If you look at it, when we closed the deal with the acquisition of Nevada, the sales have increased significantly from a lower point initial year to the record high of last year was capacity buildout with the -- with one customer and others that we supply through components growing significantly.

 

The drop is really kind of focused on the capacity needs. So there's no -- as we have communication with -- through the customer, we had a team out there just in the last couple, couple of weeks, said that everything appears to be normal. Just as they look at their capacity, their capacity needs, they drop projects or add projects. And right now, they just said there was this thing that they're going to drop their capacity needs a little bit in the near term, but that could change. But we don't see anything from a general market standpoint that's driving, let's say, a macroeconomic change and it just happens to be timing right now based on all the feedback we received.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

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So I mean we have some other companies with exposure into that segment, and they seem -- they don't seem to be experiencing the same thing. So is this a customer mix issue that's more of a concentration as opposed to the whole space?

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [5]

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No doubt. It's a way that we're concentrated. We have a high mix with a certain customer. And that's driving what the change is near term right now.

 

There is some a little bit on the other side with the general components that we supply into engineering firms and contractors to supply that. But that's not as significant making...

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [6]

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And then on the guidance on the end markets, what are you -- you directionally gave some comments in terms of those end markets. But the big swing factor, as we've been going through things right now, has been China. So what are your assumptions there as you look at the vehicular markets there and kind of (inaudible)

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [7]

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Yes. For the balance of our year, we see China, automotive, Asia automotive. Let's just talk about China specifically right now, about 7% down for the balance of the year. I think that pretty much ties in with your estimate. I think you're at 8% down.

 

We're also seeing a pretty significant drop in India, okay, which isn't as big as the China market, obviously, but we have a pretty good concentration there with a large customer that we actually export from India with, and they're seeing a significant drop in India, about 9%, which is really kind of tied to some of the banking changes they're making or financing availability, that type of thing is what we think. So -- but overall, a pretty high single-digit number across Asia on the automotive side.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [8]

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And then some of the regular -- regulatory things going on in China that's disrupting some of the end markets. Is that having any ripple effect in terms of your product and launches? And new technologies you bring to market for China 6?

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [9]

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Well, not new technologies, but you're talking -- regulatory changes in China you're talking about or in India? I didn't...

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [10]

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China has gone from -- to essentially Euro 6 emission standards right now. And there are some -- there looks like a little bit of stutter step in terms of how that's getting implemented.

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [11]

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Yes. No. So we're seeing some push out on launches because of that. So with Europe, with China 6 being delayed a little bit, we had some planned launches, specifically on commercial vehicle programs that are being delayed. So yes, we're -- there's an impact there. On the technology, no, just a delay.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [12]

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And then the last item here and this -- I guess the strategic review process that you're going through. Sometimes when companies announce a strategic review for a certain part of their business, customers become reluctant of bidding new contracts or awarding new business. Is any of that happening with you in that business right now?

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [13]

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That's a great question and that was, of course, one of the concerns we had upfront publicly announcing that. We've actually won business, okay, since the announcement. And can't give more specifics but a significant global supplier -- a customer, excuse me, that sourced us with a significant program and even a second opportunity. So right now, I think what I'd like to think is because of our transparency in getting out there and really forming a strong automotive team that's clear to the marketplace, and they've been engaged with our current customers and current pursuits,

 

I think there's kind of a confidence that is being built that this transaction will be successful. So knock on wood, right now, we're not seeing any negative impact.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [14]

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Okay. I was on another call, so I missed the very beginning part of it. But did you give any update on the process, timing or anything along those lines?

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Thomas A. Burke, Modine Manufacturing Company - President, CEO & Director [15]

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No, just generally that we're in process. Can't give any updates. We're moving along as planned. And as soon as we can give something, we will. So -- but nothing new to report.

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Operator [16]

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(Operator Instructions) I am showing no further questions at this time. I would now like to turn the conference back to Kathy Powers.

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Kathleen T. Powers, Modine Manufacturing Company - VP of IR & Tax and Treasurer [17]

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Thank you, and thank you for joining us this morning. A replay of the call will be available through our website in about 2 hours. We hope you have a great day. Goodbye.