MODINE MANUFACTURING CO annual report, FY2017

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Modine Manufacturing Company — FY2017 Form 10-K

Business context and reporting period. Modine provides thermal-management products and systems for vehicle, commercial, industrial, and building HVAC&R markets. This annual report covers the fiscal year ended March 31, 2017; it is not a calendar-year 2016 fourth-quarter filing. The fourth fiscal quarter ended March 31, 2017.

Financial results and key metrics

  • Revenue: FY2017 net sales were $1.503 billion, up 11% from $1.353 billion in FY2016. The increase primarily reflected $177.7 million of sales from acquired Luvata HTS, reported as the CIS segment from November 30, 2016, and higher Asia sales.
  • Profit and margins: Gross profit was $253.3 million and gross margin was 16.9%, up 40 basis points. Operating income was $39.4 million (2.6% of sales), versus an operating loss of $7.5 million in FY2016. Net earnings were $14.9 million; earnings attributable to Modine were $14.2 million, or $0.29 per diluted share.
  • Cash flow and investment: Operating cash flow was $41.6 million, down from $72.4 million. Capital expenditures were $64.4 million. Net cash used in investing activities was $422.2 million, including $364.2 million for acquisitions, net of cash acquired.
  • Debt and liquidity: Total debt was approximately $511 million at year-end, compared with approximately $163 million a year earlier. Cash and cash equivalents were $34.2 million, and available lines of credit totaled $152.6 million. The company reported leverage of 2.9 against a temporarily increased maximum covenant of 3.75, and interest coverage of 7.0 against a minimum of 3.0; it reported covenant compliance.
  • Other metrics: ROACE was 6.9%, down from 8.4%; management cited higher capital employed following the acquisition. The company paid no common dividends and said it did not intend to pay one in FY2018.
  • Fourth quarter: Net sales were $488.3 million, gross profit was $84.9 million, earnings from continuing operations were $8.1 million, and diluted EPS was $0.16. The filing attributes the annual and quarterly comparison in part to the newly acquired CIS business.

Material changes versus FY2016

  • Modine acquired Luvata HTS for $415.6 million of total consideration ($388.2 million net of cash acquired), financed substantially with new debt. The acquisition added $177.7 million of FY2017 sales and $7.5 million of operating income for four months of ownership; 2.2 million Modine shares formed part of the consideration.
  • FY2017 operating results benefited from the absence of $42.1 million of FY2016 pension settlement losses and a $9.9 million FY2016 impairment charge. FY2016 also included a $9.5 million insurance recovery gain in other income.
  • FY2017 included $14.8 million of acquisition and integration costs, a $4.3 million inventory purchase-accounting charge, and $10.9 million of restructuring expenses. Modine also recorded $2.0 million of net gains on facility sales.
  • Segment results were mixed: Europe operating income increased to $37.1 million from $13.3 million, and Asia increased to $7.7 million from $0.8 million. Americas declined to $26.7 million from $36.2 million; BHVAC declined to $13.1 million from $13.9 million.

Outlook, commentary, risks, and contingencies

  • Management gave qualitative FY2018 market expectations, not quantified consolidated revenue or earnings guidance. It expected modest or varied growth across many HVAC&R markets, moderate Asia growth, and generally flat North American commercial-vehicle and several other vehicular markets; U.S. agriculture and some markets remained challenged.
  • Management targeted at least $15 million of CIS cost synergies over three to four years, with additional potential revenue synergies. Integration and realization of those benefits are uncertain; purchase-price allocation remained preliminary, including acquired tax reserves and contingent liabilities.
  • Key risks include customer price reductions and concentration (the ten largest customers generated 54% of sales; Daimler and Volkswagen each represented at least 10%), cyclical end markets, foreign exchange, commodity costs and pass-through delays, supplier constraints, product launches, and acquisition integration.
  • Debt is predominantly exposed to variable rates; a 100-basis-point rate increase was estimated to add about $3 million to annual FY2018 interest expense. Management’s stated leverage target range was 1.5–2.5, above which it was at year-end.
  • Environmental accruals were $16.8 million, including obligations assumed with Luvata HTS. The company also disclosed a $4.7 million settlement of a Brazil antitrust matter, expected to be paid in early FY2018, and a $119.4 million pension liability on the balance sheet. It anticipated $13.1 million of U.S. pension contributions in FY2018.
  • The auditor issued an unqualified opinion on the financial statements and internal control. Management and the auditor excluded acquired Luvata HTS from the FY2017 internal-control assessment; integration and harmonization of its controls were ongoing.

Important facts for investors to verify

  • Whether CIS integration delivers the targeted cost savings and anticipated revenue benefits, and how the final purchase-price allocation changes acquired liabilities, amortization, or goodwill.
  • Debt repayment capacity, variable-rate exposure, covenant headroom, and progress toward management’s leverage target, especially given operating cash flow below capital expenditures in FY2017.
  • Whether sales and margin trends improve in Americas and BHVAC and whether the FY2017 recovery in Europe and Asia is sustainable.
  • Exposure to major customers and the CIS segment’s undisclosed global technology customer, which represented 7% of CIS segment sales and had historically fluctuating demand.
  • Potential changes in environmental, pension, tax, and other contingent liabilities, including the preliminary liabilities assumed in the Luvata HTS acquisition.