Q2 2021 Modine Manufacturing Co Earnings Call
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Good morning, ladies and gentlemen, and welcome to Modine manufacturing company second quarter fiscal 2021 earnings conference call. At this time all participants are in a listen only mode made every well conduct a question and answer session and instructions will follow at that time, if anyone should require us to.
Since during the conference. Please press Star then Joe on your Touchtone phone as a reminder, this conference call is being recorded I would now like turn the conference over to your host Ms., Kathy powers, Vice President of Treasury and Investor Relations and tax. Please go ahead.
Good morning, and thank you for joining our conference call to discuss know during the second quarter fiscal 2021 result.
I am joined on this call I misspoke earlier, our interim President and Chief Executive Officer.
We'll be using five 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 owning dot com.
I would like to is our notice regarding forward looking statements. This.
This call may contain forward looking statements as outlined in our earnings release as well as in our Companys filings with the Securities and Exchange Commission.
With that it's my pleasure to turn the call over to Mikkel growing.
Thank you Kathy and good morning, everyone. We have a lot of good news to report 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 and giving our improved liquidity position and provides additional flexibility to manage our future cash flows.
And finally.
I would 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 announcement 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 to higher returning industrial businesses, especially those within our building HVAC segment.
Eliminating significant liabilities relating to future restructuring along with the pension costs and additional cash investments.
And finally, the 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 liabilities associated with these locations.
While not expecting significant proceeds we are foregoing significant future cash investments, including ongoing capital spending and future liabilities, along with pension and other employee related costs.
Also I want to highlight that this is a leverage neutral transaction from a covenant standpoint, consistent with the provisions in our credit agreement.
And last we expect the transaction to close in the first half of calendar 2021.
Subject to regulatory approvals and customary closing conditions.
Please turn to slide five.
I would like to provide some additional details on both the liquid cooled business that we're selling and the air cooled business, though we are planning to address next as part of our overall auto strategy.
Starting with the liquid cooled business.
It's averaged about 300 million in revenues over the last several years and has been recently running below that level due to general economic conditions.
As we have discussed in the past this has historically been a negative cash flow business with annual capital spending offsetting cash earnings.
In addition, this business has required significant restructuring and would require additional investments going forward.
Given the large amount of historical investment the liquid cooled business carries a significant amount of net assets.
Based on the transaction, we anticipate the large non cash impairment charge in Q3.
Our view is then that this business is best in the hands of the strategic owner that has the size scale and desire to make the required investments.
Now moving on to the air cooled business, which is the remaining business than our automotive segment and includes a plant in Austria and Germany.
This business represents approximately $100 million of revenue and is currently running at a lower rate due to the global pandemic.
The majority of this business is comprised of automotive condensers, which are produced in Austria.
Again as previously discussed this business runs much closer to breakeven on an adjusted EBITDA basis.
We will require minimal capital going forward.
We are actively exploring alternatives for portions of this business and are currently engaged in discussions with interested strategic buyers.
For the right partner this business has value due to our relatively new facility.
Industry, leading products and intellectual property, along with a solid order book.
We have some more work to do but much of the heavy lifting is complete with the automotive separation done and the recent sale announcement.
Optimistic about addressing the small amount of remaining business and further reducing future liabilities and cash needs.
Now lets cover our second quarter segment results on page six.
Yes sales were down 14% from the prior year, primarily due to covered related declines in our commercial HPC and refrigeration markets along with lower datacenter sales.
Approximately half of the decline relates to lower sales to our largest datacenter customer.
As we've previously discussed.
The pullback is due to loan customers reduction in construction.
And is expected to continue through Q4 after.
After which we will begin to see the recovery.
We're actively working on the testing of their next generation product and are encouraged by the recent order outlook for next year.
We continue to invest in our coating business, where we're receiving positive feedback from our OEM customers on a new coating process.
Adjusted EBITDA was down 7% on lower sales, but I'm pleased to report the margin improved 70 basis points, despite lower revenue.
Good downside conversion was due to cost savings initiatives, taking earlier in the year and.
And a good trend with regard to coils margin improvement.
In fact, if.
If we adjust for the negative effect of lower data center sales the margin would have improved by approximately 300 basis points versus the prior year on lower sales.
Please turn to slide seven.
The building HVAC segment had another great quarter with sales up 11% from the prior year. This was primarily driven by a significant increase in data center sales due.
Due to our aggressive growth plans.
Looking forward, we expect continued growth in our datacenter sales in the coming quarters and project will finish the fiscal year up more than 50%.
In addition, we also had a strong pre season orders of heating products.
Which was partially offset by lower sales of ventilation and air conditioning products.
On the ventilation side sales to the hospitality market have been higher debt by cold and 19, causing us to shift focus to both the school and healthcare markets.
We see future growth opportunities with our ventilation products given the growing focused on the benefits of proper ventilation.
I want to highlight that adjusted EBITDA increased 42% from the prior year, primarily due to higher sales volume and favorable product mix.
This resulted in a 500 basis point improvement in EBITDA.
The recent performance of this segment.
Also demonstrates the potential for modine after we complete the exit of the auto business and continue to reallocate capital.
For example, we are leveraging our success in brand in the UK to produce datacenter products in mainland Europe.
An equally exciting are the increasing opportunities in the us.
We're industrializing computer room air handlers, and Chillers in our existing us manufacturing site.
And are planning to be in production next fiscal year.
Please turn to slide eight.
Sales and the HD or heavy duty equipment were down 12% from the prior year, but a significant improvement from Q1.
As markets continue to stabilize.
Although sales decreased the most of our major end markets, we actually had higher sales to commercial vehicle and off highway customers in Asia Harsha.
Partially offsetting the declines in North America.
Adjusted EBITDA was up 42%.
On a 460 basis point margin improvement despite lower sales.
HD significantly benefited from temporary cost reductions along with permanent actions, including head count reductions taken earlier in the year procurement savings.
And improved operational performance.
We are cautiously optimistic about further market recoveries in this segment.
While balancing the impact of higher material costs, and recently announced here.
Please turn to slide nine.
And I'll shift to the automotive segment.
Sales were down 5% from the prior year, which also represents a large sequential improvement from the first quarter.
Auto sales recovered faster than most people anticipated as we saw lower sales in North America, and Europe, partially offset by higher sales in Asia.
Adjusted EBITDA improved significantly up $5.7 million from the prior year, primarily due to cost reductions.
And other temporary code related savings action.
Given the large amount of temporary cost reductions, we expect that the auto segment margins will return to more normal levels in the second half of the year.
I want to point out that we do not anticipate that the recent announcement will change how we report our earnings in this segment.
Obviously things can change.
But for now we expect to report segments sales and earnings in a consistent manner until the transaction closes.
Please turn to slide 10.
As I mentioned at the beginning.
Our team adjusted to the challenging economic environment earlier in the year by quickly implementing significant cost reductions we prepared for the worst case, while we were pleased to see sales rebounded somewhat more quickly than expected.
Second quarter sales declined by $39 million or 8% as compared to the prior year, driven mostly by the global pandemic and associated economic condition.
Overall, our results benefited from a combination of markets recovering better than we anticipated and aggressive cost cutting measures, resulting in both temporary and permanent savings.
I'm very pleased to report our gross profit was $81 million, which was higher than the prior year by $5 million on lower sales.
And the gross margin increased by 240 basis points.
To 17.5%.
SDMA was $17 million or 25% lower than the prior year.
Given the significant uncertainties surrounding the pandemic, we maintained strict cost controls over spending and benefited from previous SDG saving.
Some of the reductions should be viewed as largely temporary.
Representing about a third of the SGN any savings this quarter.
Another driver of lower SGN and was a significant reduction in auto separation costs.
Adjusted EBITDA of $55 million was better than the prior year by $16 million or 40%.
Please see our appendix for.
Itemized list of adjustments and a full reconciliation to our us GAAP results.
Our second quarter adjustments totaled $7.6 million, including $5.5 million from CEO transition costs, mostly related to severance and benefit related expenses owed to the previous CEO. Most of these will be paid over multiple years.
We also incurred $1.5 million of restructuring expenses related to plant consolidation activities.
And our adjusted earnings per share was 43 cents higher than the prior year by over 200%.
Let's turn to cash flow and debt on slide 11.
I'm pleased to report our free cash flow for the first six months of fiscal 21 was $73 million, which represents the $97 million improvement over the prior year.
The positive cash flow is driven by numerous items, including lower spending on the automotive exit strategy favorable working capital and nominal capital spending.
We used cash in the quarter to repay debt increasing our available liquidity.
And I'm very pleased to report that our resulting leverage ratio was 2.2 back to pre pandemic levels and within our target range.
We expect slightly positive cash flow for the remainder of the year, resulting in full year free cash flow of $70 million to $80 million.
Anticipated lower second half cash is due to a number of timing factors, including the deferral of certain cash items.
As for example, we have approximately $20 million in pension contributions along with the phase out of payroll tax deferrals under the care that.
We also expect higher capital at capital spending in the second half of the fiscal year, along with some working capital growth in line with the recovery.
Overall, the cash and debt position is a great story for modine, especially given the current economic environment.
Now, let's turn to slide 12, and our fiscal 20 on outlook.
Like many companies we are hesitant to provide full year guidance, especially given the ever changing dynamics tied to Colin.
Based on the recent results our full year outlook has clearly improved but we want to be careful not to extrapolate all of the Q2 upside through the balance of the year.
We have a reasonable amount of visibility into our third fiscal quarter ending December 31.
Our Q4 is more uncertain, especially as it expands into calendar 2021.
We expect our net sales to be down between seven and 12% from the prior year.
And for adjusted EBITDA to be in a range of 155 to 165 million.
While the markets are changing continuously we expect sequential revenue improvement in the third and fourth quarters.
Positives include good momentum as we enter the heating season, and a solid datacenter order book.
Plus strong vehicular market trends in Asia.
We also see some higher costs in the second half, particularly related to employee compensation expenses as we reverse some of the temporary cost control measures taken earlier in the year as.
As well as higher metals prices, including the negative impact of the newly announced tariffs in the EU.
I also want to point out that our outlook includes the automotive business.
That is subject to the recent sale announcement, our full year results could be different this or another transaction is completed before fiscal year end.
And finally I want to thank our employees, who have made numerous sacrifices this year and to the many shareholders who are fully supported our transformation.
With that we'll now take your questions.
If you have questions at this time, please press star and the number one key on your Touchtone phone.
If your question has been answered or you wish to 2% from key please press the pound key.
Our first question comes from Matt Summerville D.A. Davidson Your line is open.
Thanks, Good morning.
Couple of questions first with respect to your large data center customer within CIO can.
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.
Yes, good morning, Matt Good question so.
We then on as you know the last few quarters have unfortunately been year over year decline than Weve been.
Entering a period here where in the quarter.
We had very little in the way of actual sales to that customer and Q4 as well, we'll have very little in the way of cost in sales in total.
And then.
As I mentioned, we're working now on the testing and development of what they're going to use than the next generation.
For the next generation product.
We're starting to see those purchase orders and construction plans come into play.
With a ramp in our Q4 will actually start building products in our March quarter, as well a little hard to forget the actual.
Timing of shipments and revenue, but we see that being the inflection point.
And then for.
From where we've come from we're running significantly below.
This year, where we were two years ago last year was cut in half and this year again tutton half so without.
Without going into too much detail in detail I can't provide enough in a public setting what I can tell you is next year next fiscal year would be a significant.
The 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 it's often 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 flow of sales and then the activity is really ramped up.
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 with them 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 to be as it pertains to steel.
Steel prices moving higher as well so.
You mentioned, some sort of Terra faction, 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 more granular about what that impact is going to look like thank you, yes, yes for sure. So two things as we think about the second half of the year and try to quantify it for you want as we see.
Seen recently, a rise in raw material prices as you referenced.
We estimate from the second half versus first half that those metal prices will be up.
Four to 5 million net cost increase impact to us again second half and then a.
A few weeks ago, maybe just a couple of weeks ago, the new set of tariffs that announced.
On a little bit on products.
And one of the highest tariffs was products coming out of Germany at almost 50% tariff rate we.
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 that's about another $3 million cost impact to us.
Asked for that one we think we have a path forward to.
Between different logistics, and procurement strategies of eliminating or reducing that cost, but for now in the second half of FY about $3 million from tariff.
In four to five from.
Net metal.
Thank you ill get back in queue.
Your next question comes from Michael scheme with Cowen Securities. Your line is open.
Hey, good morning, everybody.
Yeah.
So can we first start with with the auto.
So that was announced.
Can you hear me give us I was just kind of a of a full.
Full view on what sort of a avoided cash costs that are part of the deal in total.
Just to kind of failure that was it for the true value of what you're assuming for the for this for this division.
Yes, Mike so.
A couple of things that many as we know it and made it more of a complex story since the day one.
We know and as part of our automotive exit strategy that this businesses than a low EBITDA business.
A four 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 in the last few years, we've had.
Almost $25 million of restructuring costs and tens of millions of dollars of impairments as we aim fully know well.
300 million ish type business, the liquid cooled that we announced the sale of.
Thats than historically.
Neutral and negative free cash flow business.
Depends on the year and exactly in all the different calcs going into it that.
As I said on the and on the beginning generally the lower margin and low level of EBITDA. 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 struggled 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 a company that will make the investments required.
To improve that margin profile reduced the cost profile.
So to your question a big part of.
Liabilities in costs in future costs 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 that is a liquid cooled have been averaging around 25 million a year.
Sales 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 up a profile that drives value for our shareholders.
Yes, it's that plus the Petchem and you also discussed.
Yes, so yes with it part of it came with dementia itself $15 million of pension and then.
On top of that I mentioned, if all along we've always talked about since we first announced that if we don't see that engine the amount of potential social costs and social liabilities that could come our way our enormous so we view it as a huge step forward for us and I, even mentioned in non management.
And the last year.
The amount of management time and money. We spent also on separating in running this business has been enormous.
Okay.
Can you also maybe give us a broad outline of whether to go forward capex.
For Modine and in the next few quarters prior to the auto so closing will that have any capex associated with it in the very near term.
Yes, so good question.
We mentioned that bad.
Balance of 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 all assume that those are stay with no gain.
There is always a chance that the transaction closes before our fiscal year.
And the other issue is we clearly have a run.
Responsibility to run that business between the signing of the deal and closing in a normal course normal course of business for us.
I would say the next two quarters.
For us.
Average about $15 million.
Quarter of capital spending that may be a little bit high.
We'll just see how the next few months shakeout into year end and Im talking total company.
After the automotive divestiture, we see low.
Modine running more in US 50 million ish type capital spending run rate annually, we've been 70 to 80.
So very well could be a little bit running a little below 50, maybe a little bit ahead, just depending on the year, but in totality going from a company spending 70 to 80 and again I'm excluding restructuring.
Which would make it even higher to more like a 50 run rate mine.
And does that.
Got 50 run rate to include or exclude the liquid parts of still left to sell the air Air side ill.
I'll, let me billion, yes, we anticipate.
Very little future capital spending meant net.
Basically the majority that volume has run out of one plant that.
Fully capitalized, though I would say an immaterial amount of capital spending tied to air cooled.
Okay.
Also I want to turn to some suitable the XTRAC business you had mentioned some good heating.
Just this in your slides.
But also we cost holiday I was curious whether the heating business strength was able to do with our.
Outdoor heating or areas for outdoor dining or anything or have you gotten any kind of positive.
Orders or sales from people shifting to downing outdoors.
Yes, we've seen a lot of those opportunities, we we don't make a product that the standard state.
Staying in the meeting unit that you would think of we do make some infrared products that you'd see hanging.
Mop beyond you enter a hotel or something we have seen a nice increase in the heating market in our side as well.
But we think thats a lot tied to.
With going across on across the market in general on home construction and home repair remodeling factor hotdog units.
I've 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 on.
And so I mentioned on the call lots of opportunity we are doing some additional product development and we're getting inbound calls and.
As you can imagine for our ventilation side of equipment.
Additional applications and school applications for improve ventilation and filtration, we think could be a good opportunity for us going forward.
Got it.
And also I wish you all give us kind of a one pinpoint number for the quarter obviously.
So it was great performance or EBITDA level, I'm, just kind of curious if you'd give us some sense of how much of that was in total would you attribute to temporary stuff going on around covert.
Yeah. That's a good question I would say when we look at.
The corridor.
There was about.
By $11 million or so of benefit between cost of goods and SGN, a <unk> that I would classify as temporary in nature. They are you know things.
Everything from salaries to short work weeks and furloughs.
So I view it as call it normalized.
EBITDA margin more than 9.5% rate.
Quarter, Mike clearly well above.
What we did last year at just under eight and on lower volumes. So kind of like you said I view it as.
The 12% really good but we actually had volumes better than we were we were planning for the worst and we got a little bit better on the volumes and we had all the cost savings. 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 metric just throw one last one in there and that is that is a question on the outlook.
Yes, we'll get a sense as to what triggers are kind of working on immediately world. Some of these wells coming fashion.
Fashion are expected in the second half to 21 summer 22, and 23 launches but I.
I was curious.
One more deep seated at that table.
And some of your development projects and some of the outlook for that in Europe business.
Yes so.
The answer is probably twofold on the commercial vehicle side I can tell you that modine continues to have a seat at the table with all of those disc.
Discussions in development work there is a lot of requests for development time and resources to.
The work on electrification projects on truck.
There is.
Some concern we have are I'd say, we're monitoring and along with some of our customers that we talk to about the actual timing and it may be a longer run rate.
To see significant volumes and commercial truck.
The other side, which has been really exciting is on the bus and specialty vehicle side, where we've had a tremendous quarter or two here and it's continuing to grow with the rate that it looks like.
Losses are converting to.
Fully the hybrid even thinking about fuel cell type vehicles and those are not only development activity. Those are those are real.
In production orders and so thats exciting we see boss specialty vehicle coming first and then in the next.
The near term us a year or two Mike. This is more developmental work on the truck side.
Okay, well, thanks, very much I'll leave it there.
Yes. Thanks.
Again to ask a question. Please press Star then the number one on your telephone keypad. Your next question comes from Chris Mooney with capital. Your line is open.
Hi, good morning.
Good morning.
I just wanted to ask where we have a couple of questions around it but this is such a focus on air quality currently given the health crisis.
Right.
This may catalyze this longer term thinking about the need to have cleaner indoor air.
As you're looking at your age back segment, it's not your biggest revenue source, but it's it's a good profit source.
How do you see a big focus you are talking about shifting the ventilation for schools and health care market.
Can you give us a sense of how.
Large that business is in this segment now and where 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 what where the interest is and how you think thats going to develop over the next couple of years.
Yes, great I appreciate the question.
The.
For Modine right now ventilation is about four or 5% of sales of the company and you're right. It historically hasn't gotten as much attention. Obviously is the vehicular side I can tell you in Atlanta.
Starting with the announcement to exit auto, but even ramping up the last six months, even creek hole that we see this area and it's a big area I think its the way we would define it and products, we sell in market and channel $900 billion to $1 billion market.
And then on top of that you add in Cove is related concern and we think this is a great opportunity again, we're focused on commercial applications.
Previous to this we've been having a big part of our growth plan. This year was in the hospitality side and we've been making a lot of inroads but.
Slide from a product development side, but what the team is mostly focused on now is.
So there's a combination of alternatives and the base out there is it how much of that is putting more air into a building or a room and how much of it than is recirculating or Phil Phil trading air in that same space and we have.
Product.
That can kind of fill both avenues. So we're super excited about this is that becoming a bigger deal for schools.
Weve Jeff.
Will you won some significant business in a large community in the referendum was just passed so we're excited about that theme.
Seeing those orders come through and then secondly in office spaces, you lined up I think I'd, just say over the top of that as the exciting part for us that I mentioned with Mike in the call that a while ago. There's been so much effort spent in the last year.
Monumental effort the company too.
Take a.
Million dollars segment of the secular segment and split it into two pieces.
Between automotive and heavy duty and then.
Go through a year sales process.
The more we can continue to focus our resources and our capital on these opportunities I think is a huge opportunity for the company.
Great. Thank you.
I'm showing no further questions at this time I would now like to turn the conference call back to Kathy powers.
Thank you and thank you to everybody for joining us. This morning, a replay of the call will be available through our web site in about two hours.
We hope you all have a great day.
Hi.
This concludes today's conference call you may now disconnect.
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Hello.
Okay.
Good morning.
Yes.
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Okay.
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Thanks.