Good morning, ladies and gentlemen. And welcome to Modine Manufacturing Company's First Quarter Fiscal 2021 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Kathy Powers, Vice President, Treasury, Investor Relations and Tax. Please go ahead, madam.

Good morning. And thank you for joining our conference call to discuss Modine's first quarter fiscal 2021 results. I am here with Vice President, Finance and Chief Financial Officer, Mick Lucareli. Last night, we issued a press release announcing a CEO transition plan which included the announcement that Mick has also been named Interim President and Chief Executive Officer effective immediately, while the Board conducts a search for a permanent CEO. The Board is very thankful for the more than 12 years that Tom Burke served as President and CEO, and he will remain with the company in an advisory role until August 28, 2020, to ensure a smooth transition. The Board decided that this was the right time to make a leadership change and is committed to finding the right leader that will execute our industrial strategy and accelerate Modine's future growth. We remain committed to our current strategy, including the exit of the automotive business. The Board is confident that Mick and the rest of our senior leadership team will continue to execute against our strategic vision until that leader is in place. We will not provide any further details about the transition on this call but we will certainly provide updates as the search progresses. Now moving on to the quarter. We will be using slides for today's presentation, which can be accessed either through the webcast link or by accessing the PDF file posted on the Investor Relations section of our website, modine.com. On slide two is our notice regarding forward-looking statements. This call may contain forward-looking statements as outlined in our earnings release as well as in our company's filings with the Securities and Exchange Commission. With that, it is my pleasure to turn the call over to Mick Lucareli.

Thank you, Kathy. And good morning, everyone. Although it was a challenging quarter, Q1 revenue and earnings were in line with our expectations, and the positive free cash flow was better than anticipated. From an operational standpoint, all plants have been opened since late May, but most are running at reduced capacity. All locations are following strict measures to protect our employees' health and safety including social distancing, wearing face masks and following enhanced sanitation protocols. Also during this downturn, we're evaluating ways to improve our manufacturing efficiency. As a result, we made progress on several important operational initiatives during the quarter, the most important of which was the consolidation of the CIS manufacturing footprint in China. We expect this to be complete in September and provide immediate cost savings while still providing sufficient capacity for growth in the region. Another priority is tightly managing our CapEx spend as part of efforts to maintain positive cash flow. Capital spending was relatively low this quarter, and we continue to target a 25% reduction overall in CapEx spending from the prior year. Strategically, we are moving forward with the automotive exit. We've spent a significant amount of time and money separating the automotive business last year in support of this strategy. Our automotive business is now successfully carved out as a separate reporting segment from what we are now calling our Heavy Duty Equipment segment, or HDE. As a reminder, HDE will focus on several heavy duty markets, including medium and heavy truck, bus and specialty vehicle, agriculture and construction equipment and power generation. Unfortunately, the automotive exit has taken longer than expected and was further delayed by the onset of COVID-19. I am encouraged as we have successfully reengaged with interested parties and we are progressing with a number of productive…

[Operator Instructions] Our first question is from Mike Shlisky of Colliers Securities. Your line is open.

Good morning, guys.

Hey. Good morning, Mike.

And I'll dedicate my questions to David, who I also knew was a great guy as well. So just starting off with your outlook for the vehicular markets for the year. You had mentioned that it will be kind of a slow recovery in the back half of the year. Does that kind of imply that the second fiscal quarter here will be not much better than the first?

Yeah. Mike, we're expecting second quarter to be sequentially better than Q1. And versus a 34%, 35% revenue decline in Q1, we think Q2 will be sequentially better, but revenue will be down. It could be, as I said, between 15% and 20% down versus the 35%. And then we expect, as we continue, Q3 and Q4 will sequentially be better as we go through the year.

Okay. Switching to the search for a new CEO. Can you tell us if you're looking at mostly internal candidates? Or do you know if the Board has engaged with an outside recruiter to find somebody in there?

Yes. So Mike, as you could imagine that the Board got a search committee. I'm not involved with the Board discussions, but I can share with you what we've issued in the press release and what the Board has shared, and that is they have engaged with a search firm, that is well underway. And that they're going to consider both external and internal candidates in the process.

Okay. Turning to your auto - to the auto - potential auto sale of that business. Are you engaging with the same buyer that you were looking at before? Or have you basically started a whole revenue process at this point?

Yeah. As we talked last in our Q4 and Tom was talking coming a little - I'd say, coming out of the pandemic, but as things were starting to stabilize, we reengaged with both, parties that had been active pre COVID and those that hadn't really fully engaged. So there's been a combination of buyers jumping right back in and then new ones becoming more engaged.

Okay. I wanted to also ask, it's been a bit of a hot topic these days, that is alternatively-fueled trucks. I guess, can you share with us a little bit more detail about what does Modine have to offer to a hydrogen fuel cell system compared to, let's say, a regular battery-powered or diesel-powered vehicle? Is this - is there similar content per vehicle? I guess - I'll start out there, but maybe I should also ask you the same question, it seems [ph] that you guys have developed a full portfolio of products to meet these truck makers' needs in this area. Do you have any feel for whether your competitors have gone as far as you have to work with the OEMs and get a full product line-up going?

Yeah. So a few questions. I mean there's a lot in there, Mike. I think - so on the specialty bus, specialty vehicle side, we have a leading position there. And from a leading share position, we feel very confident based on our book of business and the trends we see moving very rapidly there towards, especially on the electric side, that we've got a competitive advantage. The truck side is picking up pace as well. The number of inbound calls and development projects has been increasing. And as you mentioned, there's a full slate of product offerings, including the battery thermal management systems that we've been actively working on with several key customers. That, like the rest of the truck, my assumption is our competitors are working as hard as we are. I can't comment whether we're ahead of them? Or I think all parties are pushing hard on that regard on the truck side. We're excited because I think my estimation is the dollar value of content and the opportunity for us on a profit margin standpoint is improved anytime there's a technology change. So we're excited about the opportunity. As the truck - we see truck going that way. Also, good progress. I think the team was talking about in Germany, there was a large stimulus package release like $7 billion worth for transit and commercial vehicle incentives to electrification and hydrogen-based vehicles. So we see things picking up, Mike, and anytime there's a technology change, that's a good opportunity for us.

I want to throw one last one in there. And just can you give us your thoughts on the aluminum and general raw material market, both in the quarter and maybe in the current second quarter so far?

Yeah. It's been favorable for us this year coming down. We see it - it's been holding stable, which is good. We do have some expectations in the second half of the year that we may see a slight rise in aluminum. But generally, this has been something that's been in our favor this year, and we don't see as a major obstacle going forward.

Okay, got it. Thanks so much. I will hop back in the queue.

Yeah. Thanks, Mike.

Your next question is from Joseph Mondillo of Sidoti & Co. Your line is open.

Hi. Good morning, Mick, Kathy.

Good morning.

Hope you are doing well. I wanted to start with on the cost side, just wondering how significant is that consolidation in China, the CIS segment? And then maybe just broadly if you've been able to take out any costs on a permanent basis?

Yeah. So the - on the China project, that's a plant consolidation and we estimate about $2 million of annualized savings. Those savings will start to kick in, in the September quarter. And there's also a little bit of government incentives built in. So that, I think, total charge and cost to consolidate those plants is around $2 million or a little under and the first year savings on that will be $2 million. There's a quick payback. And then with regards to our cost-cutting actions this year, part of our SDG actions that started last year, we estimate about $10 million of permanent cost reduction actions this year. And then as part of COVID activities that are more temporary in nature, there's about $14 million or $15 million worth of temporary actions, cost-cutting measures that are in our outlook for this year that won't be permanent. At some point, those will return.

Okay. And so a couple of follow-ups there. The $2 million related to the China footprint, is that baked into the $10 million that you're originally expecting or is that incremental to the $10 million?

Yes. That's incremental as part of our cost of goods sold reduction.

Okay. And the 14 to 15, that's mainly savings that you see this year? Although I'm sure volume dependent. So at this time, you expect to see those savings this year and start to return in '21 barring a stronger recovery in volumes?

Yeah, correct. We're - the run rate we're at this year, our SG&A will probably - the run rate we're on probably between $195 million and $200 million. I would say, normalized, when people are still - employees are still under wage reductions and that type of activity, a normal SG&A run rate is probably about $15 million higher than that.

Okay. Perfect. The CIS segment, I thought - I have in my notes that you stated that you were sort of anticipating maybe a 20% decline at that data center customer. And in the presentation, you noted that you anticipate flat to up this year. So have things shifted maybe with stay-at-home and cloud activity? Could you just update us what your thoughts on that particular revenue stream?

Yeah. No. I think I confused you on that message. We expect the market to be flat to up. We still see growth in the data center market. In CIS, we're clearly expecting our data center revenue to be down this year, and that's because so much of CIS is driven by one customer. And then - but I do - what I do want to be clear about is we are - we need - we know we need to diversify our customer base on data center, and we are the Building HVAC that the data center growth outside of the 1 customer this quarter was north of 50%, and we're anticipating 40% to 50% type data center growth this year for Modine out - excluding the one customer.

Okay. And are you still looking for - I mean the sort of backing in, it's - I'm calculating that potentially, you could see, at that CIS data center customer, potentially a 50% increase in fiscal '22. Is that the kind of visibility that you have into fiscal '22?

Yeah. We typically, with regards to good orders and firm commitments and guidance from the customer, it typically goes three to six months out, but we have regular conversations with them and for several months now, the indication from them is that there's a heavy ramp that they're planning for our next fiscal year. It should begin later this fiscal year, early calendar '21, but calendar '21, this customer is anticipating a ramp-up in their build rates, and that's been consistent.

Okay. And as far as your market outlook, I guess I got a little confused with market outlook and what you guys are anticipating, I can see that in the presentation now. Could you just decipher why the market outlook is different at commercial HVAC at CIS and the ventilation and AC market outlook at BHVAC segment? And then related to this, could you comment on what your thoughts are with non-residential construction? People are a little - maybe a little concerned with the non-residential construction starts in the second quarter and maybe we see a downturn towards the end of this year into early next calendar year.

Yeah, for sure. So let me first talk about the difference between Building HVAC&R and CIS. Their Building HVAC segment has a much heavier mix. Their products in there are ventilation equipment, products that go into commercial AC. And on the CIS side, it's a heavy - most of that are replacement coils that go into - across the HVAC industry, including residential and refrigeration. So we're able to narrow down our markets a lot more in the Building HVAC side and we expect that commercial ventilation air conditioning, and we also are seeing good orders. We help sell products into the school market, so that's why we expect a slightly better market outlook in Building HVAC. And then CIS, you can think about it, that's a pretty broad brush across the entire HVAC industry. And I said it's including residential and a lot of replacement business as well. And to your question, Matt, as we look about construction and that, we - on the Building HVAC side, both heating and AC and air conditioning side, there's a lot of replacement business. It's a heavy replacement and high commercial applications. So when we think about the rest of the year, we are expecting kind of a flat heating market, but also weather plays a major component. And then we are seeing a real strong order book in Building HVAC that's giving us a lot of confidence as we head into the second half of the year, and those are custom solutions for either new or replacement applications. And then back to CIS, so much of that is short order replacement. We saw in that first quarter, the HVAC side was down about 24%, refrigeration down about 35%. It's much broader, really tied to just general economic conditions from the CIS side than any one indicator. One bright spot I pointed out is we do sell products that go into the recreational vehicle market. And with - everybody seems to be taking travel vacations instead of flying, and we're seeing a good uptick in products in CIS, coils that go into the recreational vehicle market.

Okay. And lastly, and I'll jump back in queue. Regarding the HDE segment, could you give us an idea of how your bookings trended from April, July? I'm guessing it was a pretty big fluctuation when you look at that on a monthly basis, just from what I've heard from some of the OEMs, but could you tell us what you've seen in your business there?

Yes. So a couple of big changes we've seen. One across the board seems to be the most strength in recovery coming out of China. And I believe the month of June, excavator sales, not Modine, but the market was up like 60%. There is a lot of government incentives going on all the way across auto to trucking and off-highway equipment. So across the board, we're seeing, both in auto and HDE, probably the best recovery coming out of China. And then with regards to Europe and North America HDE, Europe seems to be strengthening a little bit quicker. Now in our HDE segment, Europe is a relatively small piece. We're a heavy North America base. And what we're seeing in North America from our last one, when we talked at the end of May, was very little customer communication. This may be what you're hearing. The customer communication and guidance with regards to order input, order entry was very limited. That's been firmed up. And what we've seen in the past month is a lot more stability. What the customers are ordering, they're taking for delivery. So we feel good about that, and that bodes well for the improvement in Q2. Though what's still an open question, even I think among the OEMs, is just how the second half - our second half of the year will look, this September, December quarter and heading into early '21.

Okay, great. Well, I'll hop back in queue. Thanks a lot.

All right. Thanks.

Your next question is from Matt Summerville of D.A. Davidson. Your line is open.

Thanks. Good morning. Mick, what's a realistic free cash flow conversion rate for Modine this year? And how should we - around net income? And then how should we be thinking about decremental margins across the businesses going forward?

Yes. So we had a good decremental. We think of it as a gross margin conversion. I commented about our SG&A run rate for the first part of the - for the full year. Our Q1 downside conversion was just a little over 20%. And as we go through the year, I think we're targeting to hold it about that. If we are just converting at a variable rate and not taking out any fixed cost, our conversion rate would be 25% or 30% down on a gross profit line. So we're trying to pull that down and also manage fixed costs the best we can. So short answer, trying to hold it around a 20% downside conversion at the gross profit line. We don't necessarily look at free cash flow to a net income level, but we are targeting about $50 million of free cash flow this year. And so I think based on what we do, ratio to our EBITDA, I think - probably do ratios to EBITDA, I think, anywhere between 30% to 50% of EBITDA would be what we'd be targeting.

Got it. And then you mentioned in your prepared remarks that you accessed government support programs. Was there any sort of P&L benefit from that in the quarter?

Yes. So on the gross profit side, it's really awash. For mostly across the globe, we have people on layoffs or temporary work, and then they collect unemployment. And then on the - in Europe, it's a slightly different situation where they have the companies continue to pay for the workers' salary even though they're not working and then you get reimbursed or the worker gets reimbursed. So the short answer is on the cost of goods, really awash. In Europe, we do have what we call short workweek programs that are government-sponsored. That's about a $5 million benefit of savings this year. And when I talked about $14 million or $15 million of cost savings that are really going to be temporary this year, that's part of it. About $5 million of it would be based on government programs.

Got it. And then you mentioned to a prior question, kind of talking through the HDE business and how things trended over the course of the last few months. Can you maybe just spend a minute talking about the other three segments? Maybe how far down incoming order rates fell on a year-over-year basis in April? And then maybe how those are trending now in July? Just to get a feel for the cadence you've been experiencing. Thank you.

Yeah. The best way to answer it is when we headed into April and May, the amount of visibility and order intake almost completely stalled. At one point, we had 60% of our factories were either closed or running at single shift. And May - starting in May, we started to see some firming up of late May orders. And June was really the first month we saw some stability where orders coming in and taking delivery. We also had some situations where customers weren't adjusting the order and they weren't taking the orders that were in the system, and we were trying to adjust to that as well. So I can't give you a firm sales numbers by month. But what I can tell you is we've seen a nice trend from April to May to June, and it seems to be continuing in July of what people are placing, are they taking, and the orders seem to be improving at the rate we've been projecting and planning on.

Got it. Thanks, Mike.

Yeah. I just wanted to clarify when I mentioned the cash flow, I was referencing adjusted free cash flow for the year. That's what we're targeting.

Great. Thank you.

Yes.

[Operator Instructions] Your next question is from Joseph Mondillo of Sidoti & Co. Your line is open.

Hey. Mick, just two quick follow-up questions. As far as the, I guess, BHVAC and CIS, one of the concerns, I guess, within the HVAC space, just in general, is probably more so new construction, but construction of retail, hotels, office. As you can imagine, those end markets potentially could see more of a multiyear hit to the market there, just related to COVID. I'm wondering what your exposure is to those construction markets specifically?

Yeah. Relatively small. We have a small and growing ventilation business. When you break that down, the ventilation and air conditioning business is about 40% of a $200 million segment. And then that's split between the commercial applications and school - the school business as I mentioned as well. Right now, we've got really good order intake, so we're feeling good. And a lot of that is - don't - as I mentioned, a fair amount of that is replacement. The only - the one caution the team has said we're watching is making sure, on the school side, projects are fully funded. Sometimes we've seen where we've been awarded a project and then funding can get delayed. So based on us having kind of a small growing business and the mix that we have. And in the UK, we have a lot of ventilation business that kind of goes into hospital settings. I forgot to mention that. There is been some positive trends, obviously, with COVID, where we're getting orders and inquiries for equipment that go into hospital settings. So I think pretty balanced. I understand your concerns but it seems to be pretty balanced with regards to our HVAC business.

Okay. And then at CIS, specifically, I know for a little while, it's been a focus of trying to improve the margins at that business. Just wondering, could you remind us, I can't remember if you had financial goals out there or targets, but where you think the margins at this business could be and how long of a time line that would take?

Yes. Tom has mentioned in the past, and I still firmly believe that our CIS segment should be operating at 12% to 13% EBITDA margins. We have been operating in the 10%, 11% range. A couple of things going on that over the last year, that's been a lot of noise. After fiscal '19, so last fiscal year, we saw a significant drop, 30% plus type, with our data center business, which is - impacts our mix and our margins. And then as we head into this year, there was another planned drop. So that's one thing happening behind the scenes. And then COVID as well, from a pure volume impact, has impacted our business. We do have a team isolating - the biggest opportunity for us is our coils business, which is the largest business within CIS, $300 million to $400 million business. And we have a team focused on that, and we do see improvement when you isolate the mix issue, data center, the volume issues and the last report, for example, when we looked at the trends through last fiscal year, we saw an 80 basis point improvement through the work the team had done on costing and pricing. It's going to take a little while to work through there. And then there's also going to be some customers that we have to address pricing list that we may not retain. But obviously, when we do that, we feel strongly that it's the right decision for the company if we do not - if we happen to lose a piece of business over low margin. I hope that answers your question.

Yeah. No, it does. And just a quick follow-up related to that though. So more so related to the outlook at CIS. I don't - I may have missed this in your prepared commentary, but data center is obviously expected to be down for a lot - much of the year. And then refrigeration, I'm guessing is probably the other big headwind in that segment. Relative to the decline that you saw in the first quarter, how do you think about the rest of the year as far as that 27% decline in the first quarter?

Yes. Great question. It's very similar to how we see the rest of the company. And we see Q2 for CIS, and I'll just talk revenue will be sequentially better, not only in dollars but that percentage decline. And then we see Q3 better than Q2, and we're optimistic as we get to our Q4. And remember that's next calendar year. We start to see things starting to rebound and even start heading into a revenue growth territory. So we see sequential improvement each quarter.

Okay. Appreciate that. Thanks for taking my follow-up questions and good luck for the year.

Thank you.

I am showing no further questions at this time. I would now like to turn the conference back to Kathy Powers.

Thank you. Thank you for joining us this morning. A replay of this call will be available through our website in about two hours. We hope you have a great day. Bye.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.