Good morning, ladies and gentlemen and welcome to Modine Manufacturing Company's Second Quarter Fiscal 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a 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. Kathleen Powers, Vice President, Treasury, Investor Relations and Tax. Please go ahead.

Good morning and thank you for joining our conference call to discuss Modine's second quarter fiscal 2021 results. I'm joined on this call by Michael Lucareli, Interim President and Chief Executive Officer. We'll be using five of 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 2 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 Michael Lucareli.

Thank you Kathy and good morning everyone. We have a lot of good news to reward. So I'll start with a brief summary of the highlights. Q2 results were significantly ahead of our expectations, including higher earnings, margins and cash flow. Better market conditions combined with significant cost control resulted in a 40% adjusted EBITDA increase. In addition, we generated $73 million of year-to-date free cash flow, bringing our leverage ratio back to pre-pandemic levels. Next, we made significant progress on our strategic initiatives this quarter, including an agreement to sell our liquid-cooled automotive business, which makes up the majority of our automotive segment. Our Board authorized a $50 million share repurchase program. This is timely, given our improved liquidity position and provides additional flexibility to manage our future cash flows. And finally, I'd like to make a quick comment on the CEO search. The process has been going very well, with very good outside candidates. We are in the final stages of the search and anticipate completing the process within the coming weeks. Now before turning to the quarterly results, I would like to provide some more details about our automotive announced on page four. Earlier this week we announced an agreement to sell the majority of our automotive business, which is a significant step in our strategic transformation. This transaction provides our company with a number of benefits including reallocating capital and resources, the higher-returning industrial businesses, especially those within our building HVAC segment, eliminating significant liabilities relating to future restructuring along with pension costs and additional cash investments. And finally, this transaction will lower our future capital spending, improving our cash profile. The transaction includes seven manufacturing locations around the globe, including several in Western Europe and our headquarters in Germany. It also includes the assets and…

[Operator Instructions] Our first question comes from Matt Summerville with DA Davidson.

Thanks, good morning. Couple of questions, first, with respect to your large data center customer within any CIS, can you talk about how you expect that revenue to ramp up during fiscal '22 and what you think the overall potential book of business could look like on an annual basis for that customer compared to prior peak levels.

Yeah, good morning, Matt. Good question. So we've been on, as you know, the last few quarters have unfortunately been year-over-year decline than we've been entering a period here where in the quarter, we had very little in the way of actual sales to the customer. And Q4 as well will have very little in the way of sales in total. And then, as I mentioned, we're working now on the testing and development of what they're going to use in next generation for the next generation product. We're starting to see those purchase orders and construction plans come in place. With a ramp in our Q4, we'll actually start building products in our March quarter as well, little hard to forget the actual timing of shipments and revenue. But we see that being the inflection point. And then from where we come from we're running significantly below this year, where we were two years ago. Last year was cut in half and this year was again cut in half. So without going into too much in detail, I can't provide in a public setting, what I can tell you is next year -- next fiscal year would be a significant increase in planned volumes in production, at almost about like a double run-rate. So a real significant rebuild. And even at that run-rate, next year would be well below our high watermark. So we're optimistic, we're talking to that customer about an opportunity. From there, about another significant increase to get back to where we peaked out probably more than a year year and a half ago. So again, probably another quarter here of slow sales and then the activity is really ramped up. And production beginning in our Q4, next year we see a significant jump in sales. And at that point, we're still well below where we kind of peaked out and an opportunity to go significantly higher from there.

Got it. And then just as a follow-up, can you talk about what you anticipate the impact will be as it pertains to steel prices moving higher as well as you mentioned some sort of tariff action, maybe if you could provide a little bit more detail on that. But if you could sort of parse that out and be a little bit more granular about what that impact is going to look like. Thank you.

Yeah, yeah, for sure. So two things as we think about the second half of the year and I'll try to quantify it for you. One, as we've seen recently arrived in raw material prices that you referenced, we estimate for the second half versus first half that those metal prices will be $4 million to $5 million net cost increase impact to us, again second half. And then a few weeks ago, maybe just a couple of weeks ago, the news that of tariffs announced on aluminum products, and one of the highest tariffs was products coming out in Germany at almost 50% tariff rate. We do have some material coming out of Germany and we've got plans in place now to adjust for that. But we anticipate in the second half of the year. That's about another $3 million cost impact to us. For that one, we think we have a path forward to go between different logistics and procurement strategies of eliminating or reducing that cost. But for now in the second half, it would be about $3 million from tariffs and $4 million to $5 million from net metal.

Your next question comes from Michael Shlisky with Colliers Securities. Your line is open.

Hi, good morning, everybody. So can we first start with the auto sale that was announced. Can you give us just kind of a full view on what are the avoided cash costs that are part of the deal in total, just to kind of, was it to put the true value of what you're receiving for this division?

Yes, Mike. So a couple of things that as we know has made it more of a complex story since the day one. We know in a part of our automotive exit strategy that this business is down a low EBITDA business of 4% or 5% type in total margin business and very high capital spending. We spent an average of $40 million a year just on capital expenditures in auto as a segment, not to mention other restructuring costs. And the last few years, we've had almost $25 million of restructuring costs and tens of millions of dollars of impairments as we painfully know well. The $300 million-ish-type business, the liquid-cooled that we announced the sale of, that has been historically, neutral'd the negative free cash flow business, depends on the year and exactly and all the different, going into it. As I said, at the beginning, generally the lower margin and low level of EBITDA that this business has been throwing out has been all consumed by a large amount of capital spending. So just as an ongoing basis, we've had struggles to generate positive cash flow. And then, our biggest strategy going forward and belief on this business, as I also mentioned, is that we think the right owner, the right place for this business is for a strategic buyer or company that will make the investments required to improve that margin profile, reduce the cost profile. So to your question, a big part of liabilities in costs, in future cost investments we're avoiding all relate to what we would view as additional plant moves, plant expansion, severance charges and ongoing capital investments that in this business is a liquid-cooled has been averaging around $25 million a year. So that's the biggest value driver of the business, if you want to think about it that way, or challenge in selling it. But also the opportunity for Modine as we go forward is avoiding all the additional cash investments we would need to put this into a profile that drives value for our shareholders.

Yes. And is that plus the pension that you also discussed?

Yes. So, yes. You know, part of that came with, I mentioned it's about $15 million of pension and then on top of that I mentioned, all along we've always talked about since we had first announced this, if we don't feel that engine the amount of potential social costs and social liabilities that could come our way are enormous. So, we view it as a huge step forward for us. And I even mentioned management. The last year, the amount of management time and money we spent also on separating and running this business has been enormous.

Can you also just maybe give us the broad outline of was it a go-forward CapEx for Modine, and in the next few quarters prior to the oil sale closing, will that area have any CapEx associated with it in the very near terms.

Yeah, so good question. We mentioned that balance in the year for Modine, two things where our guidance. Our outlook is based on the assumption that we still have the liquid-cooled automotive business and the air-cooled even though we're looking at alternatives there. And so earnings and cash flow, I will assume that those stay with Modine. There is always a chance that transaction closes before our fiscal year. And the other issue is we clearly have a responsibility to run that business between the signing of a deal and closing in a normal course of business for us. I would say the next two quarters for us average about $15 million a quarter of capital spending. That may be a little bit high. We'll just see how, you know in the next few months shake out and through year-end. I'm talking total company. After the automotive divestiture, we see Modine running more in a $15 million'ish-type capital spending run rate annually, we've been 70-80 so very well could be running a little below 50, maybe a little bit ahead depending on the year. But in totality, going from a company spending 70-80, and again I'm excluding restructuring, which will make it even higher to more like a 50 run rate point.

And does that 50 run rate include or exclude the liquid part that's still left to sell?

Yes. The air side, we anticipate very little future capital spending. Basically the majority of that volume has run out of one plan that fully capitalized. So it's been a material amount of capital spending tied to air-cooled.

Okay. I also wanted to turn to some of the Building HVAC business, you had mentioned some good heating business in your slides and also --. I was curious whether the heating business, technically they do with outdoor heating or areas for outdoor dining or anything. If you got any kind of positive orders or sales from people shifting to dining outdoors.

Yes. We've seen a lot of those opportunities. We don't make a product that's the standard standing heating unit that you would think of. We do make some infrared products that you see hanging often as you enter a hotel or something. We have seen a nice increase in the heating market on our side as well. But we think that's a lot of time to what's going across the market in general, home construction and home repair/remodeling. In fact, our Hot Dawg units have been selling quite nicely. We're also optimistic about our win rate on school products. There's been some good news coming out recently there. So I mentioned on the call lots of opportunities. We're doing some additional product development and we're getting in-inbound calls as you can imagine for our ventilation side of equipment. Commercial applications and school applications for improved ventilation and filtration we think could be a good opportunity for us going forward.

Got it. And also will you give us kind of one pin point number for the quarter. Obviously, it was a great performance on EBITDA level. I'm just kind of curious if you give us some sense of how much of that in total would you attribute to some temporary stuff going on around COVID.

Yeah. That's a good question. I would say when we look at the quarter there was about $11 million or so of benefit between cost of goods and SG&A. That I would classify as temporary in nature, there are things -- everything from salaries to short work weeks and furloughs. So I view it, I call it normalized EBITDA margin more and 9.5% rate for the quarter, Mike. Clearly well above what we did last year, just under eight and on lower volumes, so kind of like you said, I view it as 12% really good. But we actually had volumes better than we were planning for the worst and we got a little bit better on the volumes and we had all the cost saving. So we won't be able to continue that at least in the next couple of quarters until we see a significant rebound in revenue.

Okay. Thanks for that Mike. Maybe I could just throw one last one in there and that is the question on the EV outlook. Can you give us a little bit of sense as to what your engineers are kind of working on in the EV world. Are some of these miles coming faster than expected in the second half of '21, somewhere in '22 and '23 launches. But I was curious what Modine seated at that table and some of your development projects and some of the outlook for that in your business.

Yeah. The answer is probably two fold. On the commercial vehicle side, I can tell you that Modine continues to have a seat at the table with all of those discussions in development work. There is a lot of request for development time and resources to work on electrification projects on truck. There is some concern we have or I'd say we're monitoring and along with some of our customers that we talked to about the actual timing and it may be a longer run-rate to see significant volumes and commercial trucks. The other side, which has been really exciting is on the bus and specialty vehicle side, where we'd a tremendous quarter to here and it's continuing to grow with the rate that it looks like boxes that are converting to full EV hybrid. Even thinking about fuel cell-type vehicles. And those are not only development activities, those are real in-production orders. And so that's exciting. We see soft specialty vehicle coming first, and then in the near term. I'd say in a year or two Mike, this is more development work on the truck side.

Okay, well thanks very much. I'll leave it there.

Yes, Thanks.

[Operator Instructions]. Your next question comes from Chris Hillary with Roubaix Capital. Your line is open.

I just wanted to ask we'd a couple of questions around it, but there is such a focus on air quality currently given the health crisis, but this may catalyse as longer term thinking about the need to have cleaner indoor air as you're looking at your HVAC segment, it's not your biggest revenue source but it's a good profit source. How do you see this focus you're talking about shifting the ventilation for school and the healthcare market. Can you give us any sense of how large that business is in this segment now and where do you think it might be able to go in the medium term. And as you mentioned, you're getting some inbound calls, can you just maybe share some color about the products that you're selling and where the interest is and how you think that's going to develop over the next couple of years.

Yes, great. I appreciate the question. For Modine, right now ventilation is about 4% or 5% sales of the company. And you're right, it historically hasn't gotten as much attention obviously as the vehicular side, I can tell you in the last, starting with the announcement to exit auto but even ramping up the last six months, even pre-COVID. We see this area and it's a big area. I think it, the way we would define it and products we sell and market and channels, $900 million to a $1 billion market. And then on top of that, you add in COVID-related concern and we think this is a great opportunity. Again, we're focused on commercial application. Previous to this, a big part of our growth plan this year was in the hospitality side and we've been making a lot of inroads. But from a product development side, what the team is mostly focused on now is that there is a combination of alternatives and based out there and how much of it is putting more air into a building or a room and how much of it then is recirculating or filterating air in that same space. And we have products that can kind of fill both avenues. So we're super excited that this is becoming a bigger deal for schools. We want some significant business in a large community and the referendum was just passed, so we're excited about seeing those orders come through. And then secondly in the office space you lined up, I think I'll just say over the top of that is the exciting part for us and I mentioned with Mike in the call a little while ago, there's been so much effort spent in the last year of monumental effort for the company to take a billion dollar segment of vehicular segment and split it into two pieces, between automotive and heavy duty and then go through a year sale process. The more we can continue to focus our resources and our capital on these opportunities, I think it is a huge opportunity for the company.

I'm showing no further question at this time. I would now like to turn the conference call back to Kathy Powers.

Thank you to everybody for joining us this morning. Replay of the call will be available through our website in about two hours. We hope you all have a great day. Bye.

This concludes today's conference call. You may now disconnect.