Business context and reporting period
Modine Manufacturing Company filed this unaudited Form 10-Q for the first quarter of fiscal 2017, the three months ended June 30, 2016, compared with the three months ended June 30, 2015. The company manufactures thermal management products and reports four segments: Americas, Europe, Asia, and Building HVAC. Management’s “Strengthen, Diversify and Grow” strategy targets procurement savings, operating-footprint optimization, lower personnel costs, and growth opportunities.
Financial results and liquidity
| Metric | Q1 FY2017 | Q1 FY2016 |
|---|---|---|
| Net sales | $347.2 million | $346.1 million |
| Gross profit / margin | $62.0 million / 17.8% | $57.0 million / 16.5% |
| Operating income / margin | $15.1 million / 4.3% | $11.6 million / 3.4% |
| Net earnings | $8.9 million | $5.5 million |
| Net earnings attributable to Modine | $8.6 million | $5.1 million |
| Diluted EPS | $0.18 | $0.11 |
| Operating cash flow | $1.6 million | $(0.1) million |
| Capital expenditures | $14.5 million | $16.0 million |
Sales were nearly flat, up less than 1%. Gross margin rose 130 basis points, primarily from lower material costs, procurement savings, and improved production efficiencies. SG&A rose $1.8 million to $44.6 million, including higher business-development professional fees and employee benefit and incentive compensation costs. Restructuring expense was $2.3 million versus $2.6 million.
Segment sales and operating income: Americas $140.0 million and $9.3 million; Europe $146.0 million and $15.0 million; Asia $24.9 million and $1.5 million; Building HVAC $39.9 million and $0.9 million. Europe and Asia sales grew, while Americas sales fell 12% and Building HVAC sales declined 3%.
At June 30, 2016, cash was $64.1 million, down from $68.9 million at March 31. Total assets were $925.4 million; current assets were $417.4 million and current liabilities $280.3 million. Debt totaled approximately $171.3 million, comprising $37.5 million short-term debt, $12.5 million current long-term debt, and $121.3 million long-term debt. The company had $198.0 million of available credit lines and was in compliance with debt covenants. Approximately $50.0 million of cash was held by foreign subsidiaries and would be subject to U.S. tax if repatriated.
Operating cash flow improved year over year, largely due to working-capital changes, including lower incentive-compensation payments. Investing cash outflow was $13.4 million and financing cash inflow was $8.2 million. Cash declined by $4.8 million during the quarter.
Material changes and management commentary
- Americas sales fell $19.1 million, mainly from lower commercial-vehicle and off-highway volumes and weak Brazilian conditions; automotive sales partly offset the decline. Operating income was unchanged at $9.3 million.
- Europe sales increased $14.8 million and operating income rose to $15.0 million from $5.7 million. Higher volume, lower material costs, procurement savings, and improved production efficiencies lifted gross margin to 17.2% from 11.5%.
- Asia sales increased $5.6 million, including higher China automotive and off-highway volume and incremental joint-venture sales; operating income rose to $1.5 million.
- Building HVAC operating income declined to $0.9 million from $2.1 million. Management cited UK competitive pricing pressure, higher depreciation on Airedale fire replacement assets, and UK production inefficiencies.
- Corporate operating costs included $4.2 million of professional services related to procurement initiatives and business development, contributing to higher corporate and elimination costs.
Outlook, risks, and unusual items
The filing provides no specific revenue, earnings, or margin guidance. Management said it expects to remain in compliance with debt covenants through the rest of fiscal 2017 and beyond and reported no expected difficulty meeting global liquidity needs. Results for the quarter are not necessarily indicative of full-year results.
Key risks include weak or unstable markets, particularly Brazil, China, and North America; uncertainty following the Brexit vote; foreign-exchange movements; commodity-cost increases and delays in passing them through to customers; customer pricing pressure and program changes; supplier and manufacturing disruption; and the company’s ability to deliver strategic cost savings, complete restructuring, and execute growth opportunities.
Restructuring included a U.S. voluntary retirement program, targeted headcount reductions, and continuing plant transfers and European restructuring. The Washington, Iowa production transfer was expected to be completed in the second half of fiscal 2017. The Airedale facility reconstruction was completed in fiscal 2016; cumulative insurance proceeds since the 2013 fire were $99.0 million.
Contingencies include environmental matters, with recorded environmental accruals of $4.5 million, and a Brazilian antitrust investigation, for which the company accrued $3.1 million. Management did not expect the environmental matters or other ordinary-course litigation to have a material adverse effect, but noted uncertainty and the possibility of unfavorable outcomes. The company also retained valuation allowances against certain foreign and U.S. deferred tax assets and said it might release approximately $6.0 million of a foreign valuation allowance in fiscal 2017 or 2018 if realization becomes more likely than not.
The $50.0 million share-repurchase authorization expires in November 2016; approximately $43.1 million remained at quarter-end. Management said it made no program repurchases during the quarter; the shares reported as purchased were employee and director shares surrendered for tax withholding.
Important facts for investors to verify
- Whether Europe’s sharp improvement and the companywide gross-margin gains are sustainable, particularly given ongoing Americas weakness and Building HVAC pricing and production pressures.
- Whether procurement savings and restructuring deliver expected benefits, and the costs and timing of the Washington facility transfer and other initiatives.
- Working-capital needs, capital spending, foreign cash accessibility, and debt maturities, including Senior Note principal repayments beginning in the third quarter of fiscal 2017.
- Potential developments in the Brazilian antitrust investigation, environmental matters, and deferred-tax valuation allowances.
- The effect of foreign exchange, customer demand and price-down pressure, commodity costs, and Brexit-related uncertainty on future results.