Modine Manufacturing Company — Form 10-Q
Reporting period: Third quarter of fiscal 2018, three months ended December 31, 2017; year-to-date figures cover the nine months ended December 31, 2017. Comparisons are with the corresponding prior-year periods. Amounts are in millions except per-share data.
Business context and period comparability
Modine manufactures thermal management products and reports Americas, Europe, Asia, Commercial and Industrial Solutions (CIS), and Building HVAC segments. CIS consists primarily of Luvata HTS, acquired November 30, 2016. The prior-year quarter included only one month of CIS results, so reported sales growth is substantially acquisition-related and not directly comparable as organic growth.
Key financial results
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $512.7 | $349.8 | $1,536.5 | $1,014.7 |
| Gross profit / margin | $85.4 / 16.7% | $59.0 / 16.9% | $260.0 / 16.9% | $169.3 / 16.7% |
| Operating income | $13.9 | $6.7 | $65.0 | $21.4 |
| Net income (loss) attributable to Modine | $(28.3) | $1.7 | $4.6 | $6.2 |
| Diluted EPS | $(0.57) | $0.04 | $0.09 | $0.13 |
| Interest expense | $6.3 | $4.5 | $19.5 | $10.5 |
Quarterly sales increased 47%; management attributed the increase primarily to $110.2 of additional CIS sales (CIS was consolidated for just one month in the comparison period), higher sales in other segments, and favorable foreign exchange. Nine-month sales increased 51%, including $416.9 of additional CIS sales. Gross margin was nearly flat for the quarter, down 20 basis points, and up 20 basis points year to date. Quarterly operating income improved $7.2; year-to-date operating income improved $43.6.
The quarterly net loss primarily reflects $35.7 of provisional U.S. tax-reform charges. The income-tax provision was $35.2 for the quarter and $37.4 year to date. The quarter’s effective tax rate was 482.2%, which is distorted by the discrete tax charges and should not be viewed as a normalized rate. Tax-reform charges comprised a $20.7 reduction to deferred tax assets following the U.S. federal corporate-rate reduction and a $15.0 estimated transition-tax charge. Modine expects to pay the estimated transition tax over eight years, beginning with approximately $1.0 in fiscal 2019; the accounting remains provisional.
Cash flow, balance sheet and liquidity
- Cash flow, nine months: Operating cash flow was $105.6, up from $35.0, reflecting higher operating earnings, lower restructuring and acquisition-integration cash costs, and favorable working-capital changes. Investing cash outflow was $55.8, including $55.0 of capital expenditure. Financing cash outflow was $39.2. Cash increased $13.6 to $47.8.
- Liquidity: At December 31, 2017, cash was $47.8 and reported available credit lines were $168.8. Approximately $46.0 of cash was held outside the U.S. and could be subject to withholding taxes if repatriated. Current assets were $583.6 and current liabilities $469.0; the resulting current ratio was approximately 1.24.
- Debt: Short-term debt was $53.5, current long-term debt $37.9, and long-term debt $394.5, totaling approximately $485.9. Modine reported leverage and interest-coverage ratios of 2.5 and 7.9, respectively, and compliance with debt covenants. The company stated it expected to remain compliant.
- Other balance-sheet items: Total assets were $1,502.2 versus $1,449.5 at March 31, 2017; total equity was $471.6 versus $421.2. Pension liabilities were $105.7, and environmental accruals were $17.0.
Material changes, outlook and risks
- Modine closed its Gailtal, Austria manufacturing facility to reduce excess capacity and European manufacturing costs. The quarter included $9.4 of restructuring expense, primarily severance, and a $1.3 impairment charge; the company also recorded a $0.3 pension curtailment gain. Accrued severance was $11.2 at quarter end.
- Segment performance was mixed. Year-to-date Europe operating income declined to $22.8 from $30.9, amid lower gross margin and increased restructuring costs. Americas, Asia, and Building HVAC operating income improved. CIS contributed $14.3 of operating income year to date, but reported a $4.6 operating loss in Q3, including costs associated with the Austrian closure.
- Management provided no specific earnings or revenue guidance in the supplied filing text. It cited an expected approximately $11.0 fiscal-2018 benefit from Hungary’s development tax credit, which it does not expect to be significant in fiscal 2019, and said a roughly $3.0 foreign valuation allowance might be released in Q4 FY2018 or fiscal 2019.
- Management identified risks including Luvata HTS integration and synergy realization, vehicle-market and customer pricing pressures, commodity costs and pass-through timing, customer program changes, supply and manufacturing disruptions, foreign exchange and interest-rate movements, global liquidity, environmental remediation, litigation, and uncertain effects of U.S. tax reform. It was still assessing several tax-law provisions and expected to complete its analysis in Q4 FY2018 or early fiscal 2019.
- Environmental matters include several remediation sites and acquired or legacy facility obligations. Management said recorded accruals and currently assessed outcomes were not expected to have a material adverse effect, while noting inherent uncertainty and the possibility of unfavorable outcomes. The Brazil antitrust matter was settled and the $4.7 accrual paid during Q1 FY2018.
- Disclosure controls were concluded effective as of December 31, 2017. The company reported that Luvata integration activities had materially affected, or were reasonably likely to materially affect, internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported sales growth reflects acquired CIS revenue versus organic growth, and whether CIS integration and expected synergies are progressing.
- Whether the $35.7 provisional tax-reform charge, transition-tax estimate, deferred-tax remeasurement, and potential valuation-allowance release change as Modine completes its accounting.
- Whether CIS restructuring costs, particularly for the Austrian closure, remain within expectations and deliver the stated capacity and cost benefits.
- Whether margin pressure in Europe, material-cost inflation, and pricing dynamics persist, and how effectively other segments sustain operating improvements.
- Debt covenant headroom, cash availability and repatriation costs, and the company’s ability to manage variable-rate debt and maintain its target leverage range of 1.5 to 2.5.
- Potential changes in environmental, warranty, litigation, and other contingency exposures, including the uncertainties identified in the filing.