Good morning, ladies and gentlemen, and welcome to Modine Manufacturing Company's First Quarter Fiscal 2022 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. Kathy Powers, Vice President, Treasury, Investor Relations and Tax.

Good morning, and thank you for joining our conference call to discuss Modine's first quarter fiscal 2022 results. I'm joined on this call by Neil Brinker, our President and Chief Executive Officer; and Mick Lucareli, our Executive Vice President and Chief Financial Officer. 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 2 is our notice regarding forward-looking statements. This call will 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's my pleasure to turn the call over to Neil.

Thank you, Kathy, and good morning, everyone. Before reviewing our first quarter results, I would like to provide an update on our most important strategic initiatives and provide some additional information on our recently announced leadership changes. To start off, I would like to provide an update on our automotive exit strategy and the current status of the sale of our liquid-cooled automotive business to Dana. As I mentioned last quarter, the regulatory process in Germany has taken longer than originally expected. In response to concerns raised by the authorities, we voluntarily withdrew our regulatory filing in May. We then worked with Dana to revise the transaction and have resubmitted the filing in Germany, reflecting the new transaction. We will continue to work through this regulatory process, but cannot provide an estimated date of completion or guarantee any outcome. Both companies are committed to completing the sale, but at this point, it remains subject to approval by the German regulatory authorities. Now I would like to move on to the state of our markets. In general, we continue to enjoy a robust business environment, which is positive for revenue, but it's creating inflationary challenges. A number of items negatively impacting the first quarter, including incremental material and supply chain costs along with continued impact of the tight labor markets. Metals costs have continued to rise with aluminum, copper, and steel prices up substantially from the prior year. In addition, we are working through mill capacity constraints which impact both our direct spend and supply availability. We are relying on alternative sourcing when necessary and are recovering inbound premium freight costs wherever possible. From a logistics standpoint, we are dealing with the shortages of sea containers out of China, which is also driving up costs and are routing international inbound shipments…

Thanks, Neil, and good morning, everyone. Please turn to Slide 5. To help understand the underlying trends and results, I'll focus today on adjusted earnings. Our press release and appendix include additional information, U.S. GAAP results, and complete reconciliations. During the quarter, we included $11.1 million of adjustments which are comprised of three main categories. First, we incurred a $6.6 million loss on the sale of the air-cooled automotive business in Austria, which was completed during the quarter. Also as part of our auto exit plan, we had a number of items that netted to nearly zero, including other divestiture costs and a net impairment reversal. Next, we recorded $3.5 million of environmental charges related to a previously owned U.S. manufacturing facility. Third, we incurred $900,000 of reorganization and restructuring costs. First quarter sales and earnings were quite strong as expected, despite a number of obstacles within the supply chain, mostly relating to tight labor markets and material prices and shortages. Like many companies, our first quarter sales growth was quite strong due to significant impacts from the pandemic last year and favorable foreign exchange rates. Sales were up 42% and over 35% on a constant currency basis, as all segments reported significant improvement. Modine's adjusted EBITDA was up 62%, driven mainly by the higher sales volume. On the right side of the slide, we show the major components of the $12.8 million increase in adjusted EBITDA. Our gross profit margin showed a 150 basis point improvement. Partially offsetting the strong volume, the quarter is impacted by material inflation along with higher supply chain costs. Despite our price adjustment mechanism, we absorbed approximately $13 million of higher material costs. As Neil mentioned, we are experiencing very tight labor markets and other cost increases, but our plants are working hard to…

Thank you. [Operator Instructions] Our first question is from Matt Summerville of D.A. Davidson.

Thanks. Mick, to get back to the $25 million you just referenced, is that a gross or a net number in terms of offsets? And is it possible to try and split that out a little bit across the businesses just to give us a feel for how that impacts the vehicular side versus the other pieces?

Yes, good morning, Matt. When we go through the details of that $25 million I gave you, the vast majority of it sits within our vehicular businesses, probably about $20 million or more of that will sit within HDE and Automotive, and that's primarily based on the lag effect based on our pass-through arrangements and agreements with those customers. It is the net number, so we are clearly, there is a significant number I talked last time about based on the amount of material we buy in pounds, millions of pounds of aluminum, copper, steel, the gross cost increases are well greater that the gross costs are probably in the $50 million to $100 million range. And that net number, it isn't a loss number, it's going to be a catch-up. So when we look through the fiscal year, assuming once metals eventually level out, we will catch up to that, but we are anticipating now that there will be that lag. So it's a -- $25 million is a net number and vast majority of it sits in HDE and Auto.

Got it. And then as a follow-up, Neil, I was hoping you could just do a little bit more of a deeper dive now that you've been here for a couple of quarters on what you've been doing with 80/20, specifically in data center, but across the company more broadly. So looking for a deeper dive there, and then, Mick, if you can also comment on free cash in terms of what should be a realistic conversion rate this year? Thank you.

Sure. Hi, Matt, good morning. As you know, we piloted and started 80/20 in data center deliberately. That is an area where we have the highest potential of growth. We have a strong market position, a good customer base, and products that differentiate. And as we've evolved over the last couple of quarters, we've reorganized and we're starting the consolidation of our engineering efforts, our commercial efforts and most recently, as we announced today, on the operations side, where we've moved the Spain plant from CIS into the Building HVAC group to help increase our overall capacity globally. Also through our 80/20 work, we're dialed in with some of our customers, particularly in the co-location market and especially the ones that are thinking about single tenant usage. And we're doing this through further capacity expansion, not only in Europe, but in North America as well, in Virginia, particularly where we're utilizing our HVAC plant to expand capacity. So a lot of effort and energy at the beginning of 80/20 has been focused on data centers because that's where the growth is and we're doing quite well. And we're -- to the point now, it's around capacity expansion because we have a strategy in place that supports our 80/20 initiatives and we're moving forward. Now with that said, we with the success of this so far, we are now starting to roll into other areas of the organization where we've started to segment around our market-based verticals. And in order to do that we needed to get some leaders in place that have strong P&L experience and that's where Adrian and Eric come into play that are going to be extremely important. The next level is bringing in general managers and additional P&L support, so that we can roll out the data center type 80/20 approach with other parts of the business. So we collected the data, we are well with on our way, we've seen the success with data centers and we're going to continue to cascade that throughout the organization.

Matt, I'll jump in on too. You had asked the question just about cash flow. So as we look full-year, the CapEx we talked about being higher this year and part of that will depend on where we end up with timing of the automotive divestiture. But we're planning on higher CapEx this year in that $60 million to $70 million range and then with the volume coming back, higher working capital as well from a -- as the year progresses, we're anticipating each quarter will get sequentially better from a cash flow standpoint, improving in Q2 over Q1. And then a much stronger second half of the year based on two things. As you can imagine though, the working capital will level out plus as we work through a lot of the supply chain logistics challenges, we're planning to work down some excess working capital. And then from a conversion standpoint, we'll -- we're going to be positive free cash flow this year below last year. Last year was just an awesome year based on the combination of the COVID cash preservation and some other items going on. But probably the way to think about it would be the ratio to sales will probably be in the 2.5% to 3% range is a good target for us to shoot for this year.

Got it. Thank you, guys.

Thank you. Our next question is from Steve Ferazani from Sidoti and Company.

Congrats again for sharing all the color on the call. I do want to ask about the guidance because certainly it's worth the latter stages of earnings season. I think there's been an acknowledgment that materials costs and supply chain issues are less transitory than were expected three months ago and everyone is sort of adjusting their outlook for the year based on acknowledging that maybe there is more pressure there in the back half of the year than were expected. I'm trying to think, one, if you agree with that? And then two, if you do, are there other things you've seen that are more positive in the last three months that enables you to maintain that guidance?

Yes. Hey, good morning, Steve. It's Mick. I'll go first and kind of give you some quantitative view from the forecast standpoint and then Neil has got a lot more color around the operations side of it and from the business side. So a couple of things we see going on and as we talked about in our guidance was we see sequential improvement. One is, as I talked about at the beginning, we have a significant amount of contractual price-throughs to manage and put through in our process on the vehicular side, which is customary as part of our LTAs. That's one positive element of it. The second one is, we frankly in our mix of business, we start moving into a much heavier mix in our Building HVAC business and CIS. So some of the issues we're seeing around copper, aluminum, steel are heavily impacting the vehicular business. We talked about the chip shortage on the Auto side. On the data center growth, the HVAC growth, there are challenges there, but what we see there is a much better ability for us to manage the costs real-time and also manage the supply chain. It isn't that there isn't a global headwind, and I'll let Neil comment on that, but I think from our side, we see a combination of passing through prices and our mix of business changes through the year, which would be favorable or help us manage through them. Neil, you want to add more?

Yes, no, that's a good answer, and good morning. Yes, we're seeing this as well with the supply chain and primarily with the logistics. Logistics have been extremely challenging for us and we put together a tactical team in order to manage this and monitor it on a daily basis. So that is part of our daily management process in terms of making sure that we have the right parts in the right place and the right plan at the right time. And then on the supply chain side, their lead times are extending. We thought we would see improvement previously, but with the labor constraints, not only that we're experiencing, we're seeing that with our supply chain as well. And with these expanded lead times, we're having to do -- we're having to do unique things in terms of managing our pipeline with the inventory and sometimes that includes increasing our inventory levels for safety stocks. So it is a bit of a challenge, it's extremely tactical right now, and it's something that's at the forefront of us, how we're managing daily and weekly.

That's helpful. Thank you. I did want to -- I'm not sure what you can add for detail in terms of the resubmitted divestiture proposal. Is there anything -- color you can add in terms of the changes you made and why you think that was necessary and why you think -- any color probably on that?

Yes, sure, this is Mick. I'll give the best update I can. So the -- we can't give details now. I'll give you a little color around it, and as it links to our previous announcements that, as we looked at concerns with the German regulatory authorities, we got together with Dana and agreed on some changes on the perimeter and the perimeter is what's basically included and non-included in the transaction. And we think based on discussions and feedbacks from the regulatory authorities that's why both parties thought it was the right approach given how far we were in the process. We're not going to give more detail than that right now for two reasons. One is, we're clearly in a regulatory review process. And two, we're working through those details with Dana as well in parallel. As you can imagine prior to this, there is a lot of work and effort into a lot of agreements between the parties, and then with the change in that, it takes time to flow those completely through. So as soon as we get feedback on the regulatory process and/or a updated definitive agreement with the two parties, then we'll provide a more detailed update.

Great. That's helpful. And then just wanted to ask about, you announced leadership changes and just thinking about the 80/20 process and bringing in additional leaders, is it reasonable to think that there is additional costs before you start seeing the margin improvement that can be driven by 80/20?

So additional costs, can you elaborate on the question?

Sure. You just announced two pretty senior level executives.

Of course, understood. Well, maybe temporarily right, but at the end of the day what we can do with strong P&L ownership, individuals that are driving strategy and helping us win on a day-to-day basis, it will pay for itself multiple times over. So maybe in the temporary, you're correct, but the long-term payback in this investment is exactly where we want to be.

And then I guess adding to that would just be, if we back out those environmental costs in that SG&A line, Mick, would that SG&A be a reasonable run rate for the year?

Yes, that's a good point. The only items in there -- yes, that's the right run rate to use, Steve.

Okay, great. Thanks, everyone. Appreciate all these responses.

Sure. Thank you.

Thank you. I'm showing no further questions at this time. I would now like to turn the conference back to Ms. Kathy Powers.

Thanks for joining us this morning. A replay of the call will be available through our website in about two hours. We hope everyone has a great day. Thanks.

This concludes today's conference call. Thank you for participating. You may now disconnect.