Good morning, ladies and gentlemen, and welcome to Modine Manufacturing Company's Second 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 second 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 second quarter results, I would like to provide an update on our recent announcement regarding the Automotive divestiture. As announced, we mutually terminated the agreement with Dana for the sale of our liquid-cooled Automotive business. After spending months going through the regulatory approval process in Germany, it became apparent that we could not reach an agreement that would receive the required regulatory approval. Because of the agreement in place, we are prohibited from taking any substantial actions on the portion of the business despite the declining volumes created by the semiconductor shortage. Now that we are back in control, we can take a different approach. Over the past few months, we have been planning for this possibility and I'm excited because we have a real opportunity to run the business differently by applying 80-20 principles. Using 80-20 is a key tool and one that we didn't have when we made our initial decision to exit the Automotive business, our goal is to optimize profit margins and cash flows while focusing resources on the products where we have sustainable competitive position and where we can provide value to our key customers, while still meeting our return targets. We will initiate restructuring actions to reduce SG&A, and we will limit capital expenditures, especially in low margin areas where we don't have a competitive position. We will also analyze and segment our business portfolio to identify those portions that are accretive to our margins and take actions where possible to improve commercial terms. When we started this process, our Automotive business was around $500 million of revenue, but with wind downs and the earlier divestiture of the Austrian air-cooled business, we now have an annual run rate of about $300 million to $350…

Thanks, Neil. And good morning, everyone. Please turn to Slide 6. Second quarter sales were up 4% or $18 million with double digit increases in our building HVAC, CIS and HDE segments. Included in the sales increase was $25 million of pricing to help recover rising material and other supply chain costs. Excluding pricing and foreign exchange sales volume was down 3% as increases in HVAC, CIS and HDE were more than offset by a significant decline in automotive. Adjusted EBITDA declined $26 million driven by the significant rise of material costs. The quarter included nearly $45 million increase in commodity metals, freight, packaging and tariffs. In particular prices for aluminum, copper and steel were significantly higher than the prior year. As I mentioned as an element of revenue, we adjusted prices by $25 million to offset the significant cost increases. Despite the large amount of pricing this quarter had a $20 million net negative material impact. In addition to materials, the quarter had a difficult comparison from temporary COVID saving, which peaked during Q2 of last year. Compared to the prior year the absence of COVID savings resulted in an $11 million cost increase. Adjusted earnings per share of $0.15 with $0.28 below the prior year. As we look back at the quarter, revenue was somewhat lower than we originally expected and materials have increased beyond what we anticipated. In particular the auto segment sales were well below our expectations as customers failed to meet their target. Before moving on, I like to summarize the $5.9 million of adjustments incurred during Q2. First, we recorded $3.3 million of impairment charges related to automotive assets held for sale during the quarter. Next, we incurred $1.6 million of costs related to our 80/20 transformation with the majority relating to recruiting and…

Thank you. [Operator Instructions] Our first question is from Matt Summerville with D.A. Davidson. Your line is open.

Thanks. A couple of questions. You had a $20 million sort of GAAP if you will between the 45 and the 25 in fiscal Q2? [Indiscernible]

So, operator that we weren't able to hear that question. I don't know if it was just our end.

Mr. Summerville is having some audio issues.

You guys can hear me?

We got you now, Matt.

Okay. Sorry. [Indiscernible] I don't know what the deal was. Let me just ask you, so if a $20 million CapEx if you will, the 15 to 25 in the input cost versus price coverage. What do those numbers look like in Q3 and Q4 is here today? And assuming that input costs, stay where they are at when will that gap fully closed for the company?

Yes. We've got you, Matt. It's Mick here. So, the GAAP narrows each quarter as we go forward assuming the material stabilized where they're at the GAAP gets smaller in Q3 will be a little bit negative on a year-over-year basis. But maybe about half of this quarter, maybe a little more than $10 million or so GAAP in Q3, and then in Q4 we're anticipating a net positive material pass through. So again, or starting to recoup more in price than in cost on a year-over-year basis. So, then this year we would end this year with about $40 million of a GAAP. It would – I anticipate we'd be another quarter or two of positive gains before we fully caught up. But again, I would expect one more negative quarter and the December quarter, but less, and then having a net positive beginning in Q4, which is good news for us. And obviously the last 10 days or so, it's been a really large change in the material aluminum and copper costs. If that were to continue or to stay there's even opportunity for us on the positive side, but we haven't factored that in at this point.

Got it. With respect to building HVAC as I look at the end-market slide towards the end of the presentation. I just add up those numbers and sort of average them, I guess not add them up, average them somewhere in the range of 25% to 35% type growth in the business, yet year-to-date you were only up 18%. You think you're gaining market share in that business. So, help me square that up. I know you mentioned you had a shipment on the data center side pushed to the right a little bit at the customer's request. So maybe quantify that, if possible, but kind of square up the growth you've seen in building HVAC versus the numbers indicated on that slide.

Yes. I'll go first. Matt from the financials and Neil can add a little more color commercially and competitively on the market space. But yes, in building HVAC Q2, the biggest driver there was between $5 million and $10 million of product that we produced completed and customers didn't pull or take shipment at the end of the month or at the end of the quarter that in itself would have had a big impact in the quarter from a data center revenue growth and from a margin and an earning standpoint. So, we're expecting a very strong second half of the year. When you do the math heating the ventilation side have being pretty consistent and strong growth for the first half of the year. We knew Q1 data center growth was a little bit lower and then this quarter data center growth at 10% is below, what we're projecting for the year, but a portion of that is just a timing by days. And then there's a large backlog, I'll let Neil comment too. So, the biggest driver in the second half to get to the full year guidance will be data centers.

Yes. Thanks Mick. Hi Matt here. Yes, definitely a data center story. As you can see from the press release last night, we brought a new data center, general manager and internal promotions. So, we're excited there. And he's going to help us with this transition, but overall BHVAC, we're seeing heating increase. We've got a very healthy order book on the heating side, a rolling 12 month through September orders are up over 25% from the previous year. And into our air quality we continue to get traction and momentum, especially in the areas where we have high concentration. That's a 300% year-over-year growth on the indoor air quality side. And then of course with data centers, the key there was timing those large orders that we have with our two key customers and in terms of their build out of the data center. So, our product was ready to go and ready to ship, but the data center wasn't ready to receive it relative to the supply chain constraints and the data center build out. So, we've got the orders, we have the opportunities and it's just a matter of getting them shipped to the end user; just the timing issue there.

Got it. And just is a follow-up and then I can get back in queue. What sort of timeline are we looking at for us to be able to external those externally outside Modine to start to see tangible improvements in both the auto and non-auto businesses from the 80/20 process, the segmentation approach you're taking to the business?

Yes. That's a good question. So, this quarter, we're this – this current quarter we're working with new team members. We've got a new GM that is leading the HD portion of business and the new GM that we've hired to lead the EV portion of the business. We're working with our consultants as well as the new leadership team to analyze the data of combined automotive and HDE. And what does that look like? So, as we filter that information, similar to what we did roughly 10 months ago with data center, it takes typically three months to get through the data analytics. So, we can start to divide the action plan, and then there's some immediate actions that we can take, even as we go through and look at the consolidated data. There's some restructuring efforts that we can do, and there's some other areas that we can address considering the semiconductor shortage that are just actions that are must do versus 80/20 strategy.

Got it. Thank you.

Our next question is from Steve Ferazani with Sidoti and Company. Your line is open.

Good morning, Neil. Good morning, Mick. In terms of your guidance and I guess this sort of follows up previous questions, certainly as we've gone through this earning season, there's been a lot of indications that supply chain issues not getting better, potentially getting a lot worse and the duration longer. So, when you're thinking about guidance, even in terms of your data center product being ready, but your customer not being able to take it and certainly we know on the auto parts side, the supply chain issues there, HDE perhaps extending theirs. I'm just trying to think about how the shift in supply chain issues is affecting your thoughts on guidance for the remainder of the year?

Hey, Steve, it's Neil. Good to hear from you. I'll comment on that first and I'll turn it over to Mick. Fortunately for us, when we're thinking about supply chain, we have two isolated areas that we're thinking about this is primarily in the HDE side of the business in North America and then auto with semiconductors. So, it isn't as if we're managing this throughout the world globally. There's two primary areas that we can focus in on and that's essentially where we've got the management team focused currently. Mick?

Yes. From – with the new guidance and the balance of the year, Steve, I think so two elements; one is volume and I think you're getting there from that regard, we did an element on the adjustment was in volume. So, we're really looking at – we've pulled down auto for the balance of the year. And so, we feel good about that projection now. We've really level set and come under customers. And then secondly, there was an element of HDE as well, where we lowered that. The biggest driver and you can see it right in the first half, its materials in short of a rapid rise further. What I feel good about is these are contractual agreements. They can be painful and long, but we know what we're going to get, and we know how the mechanism works. So, I've got good confidence in that element coming through. So yeah, we've got some backlog to work through some operational challenges by far. The biggest challenge for us in the first tab obviously has been metals and materials. And we will begin to flip that and get a bigger piece of the recovery in the second half of the year.

And I think it's sort of step back and look at bigger picture, you're almost up to a year and probably more challenging year than maybe you thought when you stepped into the role. And now you have this additional challenge of automotive staying. How you're thinking about big picture, these mixes of these four segments, whether they make sense going forward and how you're thinking big picture of Modine over the next year or two?

Yes. That's a great question, Steve. Well, big picture for me 11 months in we've progressed considerably with the leadership team. So, we have the full leadership team in place. We're taking back control of the auto business. We're managing through the supply chain disruption. We continue to advance our 80/20 principles and further segment the company, certainly excited about the future and the strategies that we're developing currently. And then, to back it, we've got a really good order book, that's healthy. And we've got some commercial wins in this – in the focused areas that we wanted to focus in. So those are the things that set the stage for us to think big picture. Now with a new team, as we go through our strategic planning cycle, we should come out of that by the end of this calendar year. From that we'll be able to look at big picture how we want to continue to segment the organization. So certainly, you're right in terms of keeping our focus and having less distraction, we want to make sure that we have it segmented properly. We have the right leaders in place and they have the right goals and we're treating these businesses differently. And that's part of who we are and where we're going to be. But I would suspect within the next 90 days, we'll be able to have something after our strategic planning cycle and our leaders – our new leaders have time to digest their business.

I guess what I'm getting at is you tried to get rid of automotive, you couldn't. As you look at these four businesses as all-encompassing Modine, does this mix make sense to you?

Yes Steve, so we're a diverse company, right. We have lots of different products in lots of different markets and that brings stability at times. So, I'm very accustomed and familiar with working in diversified industrials and that's the space we're in today. So, we have a mix of HVAC, and auto and data centers, and we manage these differently. As we continue to evolve, we're always going to assess the market and we'll make the determination of where is it that we want to be, where do we want to play. We'll put together some financial targets, we'll look at what businesses are accretive and what businesses are dilutive. Well regardless of the space, if it's diluted to the overall target, we're going to address that and we'll decide whether or not we want to be in that space.

All right. Thanks for the time, Neil and Mick.

Sure.

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

Thanks. I'll ask you a couple of follow-ups. Just for modeling purposes, make what is the revenue headwind that we should be expecting in Q3 and Q4 associated with the air-cooled divestiture? And then you mentioned from a free cast standpoint being positive for the year, can you frame that up a little bit, does positive mean $5 million, does it mean $50 million? Obviously, that can mean a lot of different things. So maybe just put a finer point on your free cash expectations.

Yes, sure thing. So, I think first you had a question, it's about auto. I think the easiest way to look at that Matt would be, we see the auto segment down last year. I believe it's like $398 million, $400 million down 20% to 30%, absent the air-cooled portion that would be down approximately 10%. And then with regards to, fair question on free cash flow, we're expecting Q3 obviously to flip to be positive free cash and the same with Q4. So right now, we see positive cashflow for the year, most likely between I’d say $15 million and $25 million or so from a free cashflow standpoint.

Got it. And then you mentioned coming in the second half of your fiscal year with a materially elevated backlog, can you put that in the context, talk about absolute backlog levels, how much backlog has maybe increased in the last six to twelve months with everything sort of with tightness and supply around the world, et cetera. Is there a way that you can frame that up for us?

You want me to go for it? Yes, so it really depends as we go around business to business, the shortest windows, right, is in our CIS and building HVAC space as Neil walked you through. So there really good visibility, I would say, for the second half of the year and building HVAC and CIS, well north of a $20 million in data center backlog. And Neil talked about heating as well. From a CIS standpoint, generally speaking, I believe, we've got really strong visibility in orders filled or booked through the first couple of months of 2022. Obviously beyond longer and Neil can talk about the order book and the opportunities and the quotes we're doing for data centers and the like, well into calendar 2022. And then from the HDE auto EV side, I think, when we think about the transition there a good order book on EV and across the Board and bought some specialty vehicle as well. So there, we typically have – we haven't quantified yet. I'll take that away from a vehicular standpoint, but we generally have short of this chip crisis that we've been going through, we generally have a really good visibility over a two- or three-year window. And across auto EV, truck EV, specialty bus and truck, we've got good visibility here to double digit compound growth rates over the next several years. Neil, did you want to add any other to that question?

Yes, that's good. And I think of it like this, Matt, when we're looking at HVAC, we're looking at CIS the backlog that we continue to build is we're winning in markets that we're focused in. And we continue to gain share, and that's very positive. The backlog that we've built in HDE and then automotive has been because of some issues that are outside of our major customers that go on strike or customers that closed plants for short one-, two-week periods in order to stabilize their supply chain. So, backlogs built a couple of different ways, but we're really positive and excited about the backlog in MBH back in CIS.

Got it. And then you mentioned that you're initiating a restructuring program in auto. Is it too early to frame-up what we should anticipate the cash cost of that looking like and what the savings we should be anticipating in over what timeframe? And then separately – that's question number one. Separately, you also are kind of hinting to a broader manufacturing realignment potentially born out of 80-20. And I guess, I'm also wondering sort of the same question on that, when will we get more detail?

You want to take the first one? I'll take this.

Yes. Well within this quarter, or as we approach quarter end, Matt will be able to give you more details on the level of restructuring that we'll have with regards to the automotive business. As you we've got legal, social obligations that flowing processes follow there, which we will. But I think any cash impacts to that just from a timing standpoint, will likely be into the new fiscal year, and we can lay out for you both the immediate savings and the timing of that cash flow. So, we'll be able to give you more information within the quarter or in here stay tuned.

Yes, relative to the second question, Matt, it's a good question. We're looking at all of our operations’ split principle. One of the benefits of being a global company is that we have facilities, factories, capabilities, and supply chain capabilities globally. And we want to leverage that and potentially repurpose some of those facilities towards our greatest growth opportunities. And data centers, we've focused a lot in terms of our facilities in the UK and how we can optimize the facilities and get plants dedicated to specific products. Removing the complexity and allowing for growth. So, there's a series of different maneuvers that are taking place in the UK to set these facilities up with dedicated product lines, to support data centers. We're doing the same in Virginia on the HVAC side of the business, where we see opportunities with indoor air quality and we see opportunities for heat. Our biggest obstacle to growth there right now is a manufacturing capability. So, we're really focused on making sure we can repurpose some of these plants and get dedicated product lines out and making sure we're manufacturing the right things. So, we're making make buy decisions based on the opportunities and the growth potential. And then obviously within HDE and auto there are some areas of consolidation that we can continue to look at as we've split those apart. With the previous Dakota deal, now we're looking at how we can bring some of that together where we have some offers, obvious synergies, particularly where we want to grow in EV.

Got it. Thank you, guys.

The next question is from Steve Ferazani with Sidoti and Company. Your line is open.

Yes. Just want to follow-up on a couple of things just as you can imagine, all of these conference calls this quarter are so focused on trying to piece through the supply chain and labor issues. And I just want to clarify in terms of backlog, it sounds like you are indicating the issues are purely on the customer side. And I just want to get a better sense. You've indicated the material price issues, but what you are seeing in terms of component shortages, and are you just not having those issues when the backlog growth is purely on the customer side?

No. So we do have some supply chain constraints for sure, as we have that in the data center side of the business. So, it’s both ends, right, Steve. So, you have it where customers aren't able to take the finished goods because their sites or their facilities aren't prepared. And then we also have it on the front end of the business with – it’s roughly five specific suppliers that we're really focused on in the HVAC side of the business. On the HDE side and the automotive side, we're seeing some constraints there. But I would suggest it's more labor and managing the factories and getting the factories output has been a challenge. Supply chain, primarily focused in HVAC is where we have a lot of our energy and efforts and then labor on the HDE and auto automotive side of the business.

As my second when I ask about labor, are you seeing, and how are you managing wage inflation to get people through the door? And how are you handling retention? Because I know that those have been two separate issues for a lot of companies.

Yes, we're staying competitive. We have to stay competitive in this market. We have increased our wages. And we've gone through some very creative ways in order to attract and retain people in our facilities. So certainly, that's a focus and it's primarily been a North America play for us, Steve, where we have to continue to make sure that we have our facilities up and running and we have them properly staffed. But it's a lot overtime, it’s shifts, three shifts, six, seven days a week in order to maintain production output certainly would like to have more labor so that we could dial back the overtime.

Do you think you have enough labor as, particularly on the automotive and HDE side, you start seeing some of this pent-up demand, turn to production? Certainly, on the automotive side, how far off do you think you are, where you need to be on the labor front? And I know particularly with automotive, you were kind of hands-off for the last four quarters. As we see some of this come back, how [indiscernible] are you on the labor side?

Yes, we're roughly a couple of hundred people behind schedule where we want to be. We've got the team looking at the stop gap measures in order to close that. We've been running that way for multiple months now. We've been able to figure out a way to get to the levels that where we're at. We can continue to maintain at these levels, but certainly we would want to increase our labor pool especially in North America.

I know you've had a lot of questions. Thanks both of you for time.

Thank you.

I'm showing no further questions at this time. I'd like to turn the conference back to Kathy Powers.

Thank you. And thanks to everybody for joining us this morning. You'll be able to access the replay of this call through our website in about two hours. We hope you all have a great day. Thanks.

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