Business context and reporting period
Modine Manufacturing Company’s unaudited Form 10-Q covers the second quarter and first six months of fiscal 2012, ended September 30, 2011. The fiscal year ends March 31. The company supplies thermal-management products across original equipment, commercial products, and regional markets. Comparative fiscal 2011 figures were revised for previously identified errors.
Key financial results
Amounts are in millions of dollars, except per-share data. Figures may not sum due to rounding.
| Metric | Q2 FY2012 | Q2 FY2011 | First six months FY2012 | First six months FY2011 |
|---|---|---|---|---|
| Net sales | $397.3 | $345.9 | $815.2 | $691.4 |
| Gross profit / margin | $62.0 / 15.6% | $55.8 / 16.1% | $131.5 / 16.1% | $114.7 / 16.6% |
| Operating income / margin | $11.9 / 3.0% | $9.1 / 2.6% | $31.9 / 3.9% | $25.8 / 3.7% |
| Continuing-operations earnings (loss) | $0.6 | $(13.7) | $13.7 | $(8.7) |
| Net earnings (loss) attributable to Modine | $1.0 | $(16.7) | $14.1 | $(11.7) |
| Diluted EPS from continuing operations | $0.01 | $(0.30) | $0.29 | $(0.19) |
| Diluted net EPS | $0.02 | $(0.36) | $0.30 | $(0.25) |
- Q2 sales rose 15%, including a $17.5 million favorable foreign-exchange effect. Commercial-vehicle sales increased approximately 25% year over year. Six-month sales rose 18%, including a $45.1 million favorable currency effect.
- Gross profit increased with higher volumes, but gross margin declined 50 basis points in Q2 and 50 basis points year to date. Management cited higher material costs; product mix also weighed on Q2 margin.
- Q2 SG&A rose $3.4 million to $50.1 million, but fell to 12.6% of sales from 13.5%. Six-month SG&A rose $10.6 million to $99.5 million but declined as a share of sales.
- Q2 other expense was $6.0 million, versus $5.6 million of other income in the prior-year quarter, primarily reflecting $6.2 million of foreign-currency transaction losses. Six-month other expense was $5.9 million versus $2.0 million of income.
- Interest expense fell sharply year over year because the prior-year period included approximately $20.0 million of debt-refinancing costs. Q2 tax expense was $2.0 million, with a 76.1% effective rate; the filing cites valuation allowances and the mix of domestic and foreign earnings as key rate factors.
Cash flow, liquidity, and debt
- Six-month operating cash flow was $3.2 million, compared with cash use of $15.9 million in the prior-year period. Working-capital and other operating asset/liability changes used $47.0 million.
- Capital expenditures were $32.5 million, versus $20.2 million a year earlier. Investing cash use was $30.7 million; financing provided $26.3 million. Cash declined $2.7 million to $30.2 million from March 31, 2011.
- At September 30, balance-sheet debt totaled $171.3 million: $10.9 million short-term debt, $1.0 million current long-term debt, and $159.4 million long-term debt. The company had $125.0 million outstanding on 6.83% Senior Notes due 2020, $20.0 million drawn on its $145.0 million domestic revolver, and $6.6 million under foreign bank facilities.
- Modine reported $125.0 million available under the domestic revolver and $35.1 million in unused foreign credit lines, subject to covenants. It was covenant-compliant. Its four-quarter interest-coverage ratio was 8.53 against a 3.00 minimum, and leverage ratio was 1.83 against a 3.25 maximum. Management expected continued compliance.
- Current assets were $433.9 million and current liabilities $300.5 million. Inventories rose to $135.2 million from $122.6 million at March 31.
Material changes and segment performance
- Revenue increased across all segments. Europe had the largest sales increase, with Q2 sales up $27.1 million and six-month sales up $61.8 million, partly reflecting favorable currency effects. North America original-equipment sales also grew, supported by commercial-vehicle and off-highway demand.
- Asia sales increased with program launches in China and India; the segment remained loss-making in Q2, though its results improved year over year. South America and Commercial Products had higher sales but lower margins and lower Q2 segment earnings, primarily from input costs, mix, currency effects, and higher expenses.
- Six-month continuing-operations earnings improved by $22.4 million. The improvement reflected higher volume and the absence of prior-year refinancing costs, partly offset by foreign-currency losses and lower gross margin.
- Discontinued operations contributed $0.4 million of income in Q2 and year to date, mainly from a reduction in an environmental reserve for a former Netherlands facility. The comparable prior-year periods included approximately $2.9 million of remediation expense.
Outlook, risks, and unusual items
- Fiscal 2012 outlook: net sales growth of 12%–16% versus fiscal 2011; operating income of 4.1%–4.7% of sales; diluted EPS of $0.95–$1.05; and capital spending of $70–$75 million. Management cited anticipated recovery in commercial vehicles and growth in selected off-highway and regional markets.
- Risks highlighted include market and currency volatility, commodity-price increases and delays in passing costs to customers, execution of program launches and product transfers, supplier and customer pressures, warranty claims, environmental remediation, and the ability to fund liquidity needs if credit markets deteriorate.
- Trade-compliance matters involving the Laredo, Texas warehouse and Nuevo Laredo, Mexico plant remained unresolved in part. After a $2.1 million voluntary payment and agency closure of that matter, Modine retained a $2.4 million reserve for remaining issues; the filing says the ultimate outcome is uncertain.
- Environmental reserves were $7.1 million at September 30. The company also reported a neighbor’s lawsuit related to contamination at its Brazilian operation; management believed the outcome would not be material, while acknowledging uncertainty in environmental matters.
- Management concluded disclosure controls and procedures were not effective at September 30 because of material weaknesses in internal control identified at March 31, including inventory-management and trade-compliance deficiencies. Remediation steps were underway, but additional work was expected.
- The quarter included an approximately $0.8 million South America environmental-remediation charge and a $1.2 million prior-year asset impairment is absent from the current-year comparison. The company also corrected two prior-quarter items in Q2; the adjustments had overstated Q1 FY2012 net income by approximately $0.4 million and were deemed immaterial to both quarters.
- Fiscal 2011 comparative results were revised for prior-period errors. The filing reports that these revisions reduced continuing-operations earnings by $1.9 million for Q2 and $2.3 million for the first six months of fiscal 2011.
Important facts for investors to verify
- Whether sales growth and the stated fiscal 2012 outlook are sustained, particularly across commercial-vehicle and off-highway markets.
- Whether Modine can recover gross margin as commodity costs, product mix, and customer pricing pressures evolve.
- Cash conversion and working-capital demands, given low six-month operating cash flow relative to capital spending.
- Debt availability and covenant headroom, including the conditions attached to domestic and foreign credit lines.
- Resolution and potential cost of trade-compliance and environmental matters, and progress in remediating internal-control weaknesses.
- The effects of foreign-exchange movements, tax valuation allowances, and the revised prior-period financial information.