Modine Manufacturing Company — Form 10-Q
Reporting period: Quarter ended December 31, 2016, the third quarter of Modine’s fiscal 2017; year-to-date figures cover the nine months ended that date. Unless otherwise stated, amounts are in millions of U.S. dollars. The financial statements are unaudited.
Business context and reporting period
Modine manufactures thermal management products and reports Americas, Europe, Asia, Building HVAC (BHVAC), and Commercial and Industrial Solutions (CIS) segments. On November 30, 2016, it acquired Luvata Heat Transfer Solutions (Luvata HTS), a global HVAC&R supplier, for $415.6 million including 2.2 million Modine shares ($388.2 million net of cash acquired). Luvata contributed one month of results: $34.7 million of sales and a $0.3 million operating loss. CIS is the segment for Luvata HTS.
Financial performance
| Metric | Three months ended Dec. 31, 2016 | Prior-year quarter | Nine months ended Dec. 31, 2016 | Prior-year period |
|---|---|---|---|---|
| Net sales | $349.8 | $328.7 | $1,014.7 | $1,008.8 |
| Gross profit / margin | $58.7 / 16.8% | $58.6 / 17.8% | $168.4 / 16.6% | $161.3 / 16.0% |
| Operating income (loss) | $6.0 | $13.7 | $19.2 | $(6.8) |
| Net earnings (loss) | $1.9 | $8.2 | $6.8 | $(8.8) |
| Net earnings (loss) attributable to Modine | $1.7; $0.04 per diluted share | $8.2; $0.17 per diluted share | $6.2; $0.13 per diluted share | $(9.2); $(0.19) per diluted share |
- Quarter: Sales rose 6%, primarily from $34.7 million of Luvata sales and higher automotive volume, partly offset by softer commercial vehicle and off-highway demand and a $4.2 million unfavorable currency impact. Gross margin fell 100 basis points. SG&A rose $7.8 million, mainly due to Luvata acquisition and integration costs. Operating income declined $7.7 million year over year; interest expense increased $1.8 million to $4.5 million following acquisition financing.
- Nine months: Sales rose 1%. Operating income improved $26.0 million and Modine-attributable earnings improved $15.4 million. Comparisons benefited substantially from the prior-year $40.3 million pension settlement loss; the current period also included $11.6 million of Luvata acquisition and integration costs and $2.9 million of inventory purchase-accounting expense in the quarter.
- Cash flow: Nine-month operating cash flow was $35.0 million, down from $65.4 million. Investing cash outflow was $405.2 million, including $363.9 million for Luvata net of cash acquired and $46.0 million of capital expenditures. Financing cash inflow was $353.4 million. Cash decreased by $18.9 million to $50.0 million.
- Liquidity and debt: At December 31, cash was $50.0 million and total available credit lines were $155.5 million. Balance-sheet debt carrying amounts were $70.6 million short-term, $30.0 million current portion of long-term debt, and $413.2 million long-term debt. The company reported a 2.8 leverage ratio and 7.2 interest coverage ratio; it was in compliance with covenants. The $175 million revolving facility expires in November 2021; $37.5 million was drawn and $135.5 million remained available under it.
- Other metrics: Total assets increased to $1,392.9 million from $920.9 million at March 31, 2016, primarily reflecting the acquisition. Nine-month capital expenditures were $46.0 million. Foreign currency translation contributed a $17.7 million loss to other comprehensive income for the nine-month period.
Material changes and segment trends
- Americas nine-month sales fell 12% to $389.4 million and operating income fell to $13.3 million from $24.8 million, principally on lower commercial vehicle and off-highway volume and production inefficiencies.
- Europe nine-month sales increased 1% to $389.7 million; operating income rose to $30.0 million from $18.3 million, supported by procurement savings, mix, and production efficiencies.
- Asia nine-month sales increased 39% to $78.2 million and operating income improved to $4.9 million from a $0.9 million loss, reflecting higher China automotive and off-highway sales and joint-venture contribution.
- BHVAC nine-month sales declined 6% to $132.8 million and operating income declined to $10.3 million from $12.7 million; margin pressure included unfavorable mix and materials, currency effects, and higher depreciation on Airedale fire replacement assets.
- Luvata acquisition accounting is preliminary and subject to change. The preliminary allocation includes $159.8 million of goodwill and $105.9 million of identifiable intangible assets; the company expects goodwill to be nondeductible for tax purposes.
Outlook, commentary, and risks
- No full-year revenue or earnings guidance is provided in the filing. Management expected the inventory purchase-accounting adjustment to reduce fourth-quarter fiscal 2017 cost of sales by approximately $1.4 million. It expected to remain in compliance with debt covenants and stated a target leverage range of 1.5–2.5x after the acquisition.
- Management’s strategy is to strengthen, diversify, and grow the business. It expects Luvata to broaden the industrial portfolio and customer base and reduce cyclicality; realization of integration benefits and synergies remains uncertain.
- Debt carries variable interest rates, primarily LIBOR or EURIBOR plus a spread; the filing identifies incremental interest-rate risk from acquisition borrowing. The leverage covenant ceiling was temporarily raised to 3.75x through fiscal Q2 2018 and then to 3.5x through fiscal Q1 2019.
- Other highlighted risks include volatile metals prices and delayed customer pass-throughs, foreign exchange movements, demand and pricing pressures, product-launch and production challenges, customer and supplier health, China and Brazil market conditions, Brexit and trade-policy uncertainty, and integration and acquired-business liabilities.
- Modine settled a Brazilian antitrust matter for $4.6 million and expected payment in early fiscal 2018. Environmental accruals were $5.1 million; management did not expect the disclosed environmental matters to materially affect financial position, while noting inherent uncertainty and possible unfavorable outcomes.
- Tax valuation allowances included $42.4 million against certain foreign deferred tax assets and $5.4 million against certain U.S. deferred tax assets. Management said approximately $6.0 million of a foreign valuation allowance might be released in late fiscal 2017 or fiscal 2018, subject to realization assessments.
Important facts for investors to verify
- Whether Luvata’s integration, acquired-business performance, and expected synergies develop as management anticipates; the acquisition allocation remains preliminary.
- Whether margins recover from materials inflation, purchase-accounting charges, and production inefficiencies, and how much demand weakness persists in commercial vehicle and off-highway markets.
- Debt reduction, variable-rate exposure, covenant headroom, and progress toward the stated 1.5–2.5x target leverage range.
- Operating cash generation and working-capital needs after the acquisition, given lower year-to-date operating cash flow and increased debt.
- Potential changes in tax valuation allowances, environmental and acquired contingencies, and the timing and payment of the Brazilian settlement.