Q3 2022 Modine Manufacturing Co Earnings Call
To win.
These strategic plans are helping us develop long range targets that will better measure and drive our success as we continue to transform the company.
We're also beginning to make changes to our automotive business.
As previously discussed we are thinking about our vehicular business as differently.
Focusing more on technology, rather than end markets.
This means re prioritizing resources and capital away from legacy internal combustion solutions and towards system focused platforms.
Along those lines, our new EV organization is focused on providing smart thermal system technologies to specialty and commercial vehicle customers. This.
This technology is advancing rapidly and we are providing significant resources to those applications, where we can provide a value added system solution.
Our strategy for this business is to leverage our thermal and mechanical expertise to provide a turnkey solution that fast growing niche markets.
These markets include the last mile delivery School and transit bus and specialty vehicles.
Our goal is to design and manufacture a complete thermal solution for any EV chassis.
By controlling the temperature of the vehicles key components, we can improve the batteries range in life.
We are making good progress with staffing this function and have a great deal of inbound activity engagement, including refrigerated trucks specialty vehicles and rail applications as.
As we increase our investment in products and technologies that will fuel profitable revenue growth. We're also taking actions to improve the profitability of other parts of our business.
Our objective is to optimize profit margins and cash flows while focusing resources on the products, where we have technical competitive position and where we can provide value to our key customers.
In order to meet our return targets, we will reduce SG&A expense and limit capital expenditures and low margin areas, where we do not have a competitive position.
As I mentioned last quarter, we are working on restructuring plans to improve profit margins across all business units.
Particularly within our automotive business.
For the full company, we are targeting approximately $20 million in annualized savings with these actions.
We're too early in the process to precisely estimate the associated costs, we expect to record approximately 20% to $25 million of restructuring expenses for these plants.
We expect most of these costs will be severance related for head count reductions.
We will finalize our plans in the fourth quarter.
And we will provide more details in terms of timing levels of cost savings and related charges at that time.
Please turn to slide five.
Now I would like to provide some business highlights for the quarter.
While we continue to manage through a challenging business environment commercial actions taken earlier in the year are beginning to have a positive impact.
We are aggressively managing our supply chain and adding resources to address specific challenges and decentralized decision, making structure where possible.
Our most significant supply chain challenges are being felt in our North America business to.
To address this we have instituted a critical supplier management process, which includes designating a dedicated point of contact for critical suppliers, taking a project management approach. This includes daily communication site visits and escalation protocol.
We are building recovery plans to meet our requirements and implementing dual or resourcing strategies where appropriate.
From a labor standpoint, we have been dealing with both an increase in COVID-19 cases, and the ongoing impact of the labor shortage.
I'm happy to report that at the current time numbers seem to be improving.
At the peak, we had over 350 employees in North America, and Europe out of work with positive Covid cases are due to quarantine requirements. We are currently seeing these numbers decline, but that could change as new variance emergent spreads. We therefore continue to maintain strict protocols to mitigate the risk of internal spread of the virus in our facilities.
In addition, we had over 300 open positions at our peak vacancy rates in 2021, however, creative recruiting solutions enhanced benefit offerings modifications to our wage structures and hiring incentives have allowed us to make significant progress in filling our open positions.
Now moving on to the segments.
In building HVAC demand remains strong for our heating indoor air quality and data center businesses.
That said as of the third quarter, we were not able to fully offset inflationary pressures with price increases, causing margins to decline year over year.
The team is aggressively working through corrective actions regarding both cost and pricing as evidenced by the strong sequential earnings improvement, we anticipate that the HVAC will be back to historical margin levels in the next few months and.
In addition production volumes have been constrained by the lack of labor, but this does appear to be improving.
In December our heating planned Virginia produced 20% more units been at previous single month record.
This was possible in part due to employees that traveled to Virginia from our Racine, Wisconsin headquarters and our Lawrenceburg, Tennessee plant. So that we would have sufficient labor resources to meet demand.
And data centers, we continue to make progress on our Rockbridge, Virginia facility.
While we are repurposing, an existing warehouse into a dedicated chiller manufacturing and testing facility.
I am pleased to report that we've received our first purchase order for Chillers in North America. During the quarter. In addition to the orders for computer room Air handlers and fan walls produced at our Grenada, Mississippi facility.
This investment in capacity expansion will allow us to meet our aggressive revenue growth targets in the future.
Moving to our <unk> segment, our focus during the quarter was primarily on pricing and supply chain management.
This included expediting raw material purchases, which impacted our freight costs that being said, we had less overtime during the quarter as the labor situation improve.
This allowed us to reduce our order backlog while market demand has held steady we.
We saw significant improvement in the margins this quarter versus the prior year due.
Due to higher sales volume despite the supply chain challenges. In addition, we're using 80 20 in our coils business to take targeted pricing actions.
<unk>, our product offering and improve operations efficiency by maximizing setups to eliminate bottlenecks on the plant floor.
And our HDD and automotive segments, our focus has shifted to improving profitability utilizing 80 20 deep within our processes. This includes strict quoting guidelines for new programs, including Capex and payback limits.
The improvements made in this business a critical component to the transformation of Modine.
The EV transition is enabling a new play promoting with thermal systems. The thermal system technology can be leveraged into new market spaces promoting that are opening up with EV market inflection.
As we think about our business there is a common thread.
We provide trusted systems and solutions that improve air quality and conserve natural resources, we do this by reducing water and energy consumption in data centers.
Improving air quality in schools and businesses as we continue to battle a global pandemic.
Lowering harmful emissions and enabling more efficient electric vehicles as internal combustion engine transitions to alternative powertrains.
All while innovating more environmentally friendly refrigerants that will meet future regulatory requirements.
It is clear that all of our key growth areas support our purpose of engineering, a cleaner healthier world.
This is the cornerstone of unlocking the value in modine, driving our decisions as we invest in our future.
Now I'd like to turn the call over to Nick who will review our results for the quarter and provide segment financial updates.
Thanks, Neal and good morning, everyone. Please turn to slide six.
I am pleased to report good sequential performance from the previous quarter as we continue to work through the supply chain challenges.
<unk> input costs and labor shortages.
The organization is hard work is beginning to pay off and we expect the trends to continue.
Third quarter sales were up 4% or $18 million as building HVAC and Cif experienced significant gain.
It's important to point out that our revenue increase was positively impacted by approximately $31 million of material pass throughs and other price increases.
While this is positive from a material cost recovery standpoint, it does not drive higher unit volume.
Sales volume, excluding the impact of price increases and foreign exchange was down $8 million.
The lower volume was primarily driven by the auto segment with declines due to the semi conductor shortage and the Austrian divestiture earlier this year.
Adjusted EBITDA declined 16% or $7 million year over year that showed significant improvement from the previous quarter.
A portion of the decline was due to the lower volumes that.
But that was offset with higher plant productivity.
The main driver of the earnings decline relates to the current inflationary environment, especially around material costs.
During the quarter, we experienced approximately $39 million and commodity metals freight and packaging increases.
However, we were able to recover $29 million of the cost increases, which resulted in a net negative EBITDA impact of $10 million.
Like many companies we have been battling significant cost increases throughout 2021 and now into 2022.
As previously discussed we expect the cost recovery gap to narrow with time and Im pleased to report that the negative materials impact was reduced by 50% as compared to the prior quarter.
Last we are closely managing our SG&A costs, which favorably impacted adjusted EBITDA by $3 million.
Although adjusted EBITDA margin was below the prior year, we're seeing positive momentum from our recovery actions, which resulted in sequential margin improvement from Q2.
Adjusted earnings per share of <unk>, 31, <unk> with <unk> <unk> above the prior year.
Before moving on I'd like to point out that we had a few earnings adjustments that occurred during Q3.
The largest was in connection with the termination of the automotive divestiture as we reclassified those assets held and used.
This resulted in a reversal of held for sale and impairment charges of $57 2 million.
Balance of smaller adjustments can be found in our press release and appendix, which includes additional information U S. GAAP result, and complete reconciliations.
Now, let's review the segment results.
Please turn to slide seven.
Building HVAC reported sales growth of 23% from the prior year.
This includes approximately $5 million related to pricing actions, mainly in our heating business. The main driver of the volume growth was a strong increase in data center sales.
Heating product sales were up 9% over the prior year, while indoor air quality finished 8% higher.
As anticipated we experienced strong sequential margin improvement that our EBITDA margin remains below prior year levels due to several factors.
First results were negatively impacted by the higher material and freight cost as it's taking us a little longer than anticipated to fully offset the rising costs.
Second our heating products carry shorter lead times and the extremely tight labor market resulted in higher labor costs.
This is important because maintaining and protecting lead times is one of several key competitive differentiators in this market.
Finally, we've made some temporary investments in SG&A to support aggressive growth plans return on this investment will begin to show along with the higher revenue and the eventual recovery of raw material costs.
Before I move on I'd like to point out that we're excited about the growth opportunities with building HVAC. Despite the recent headwinds our gross margin was over 30%, which is a large improvement from the first half of the year.
Please turn to slide eight.
<unk> reported a good quarter with strong revenue growth and year over year margin improvement.
Early signs of 80 20 progress are evident within this segment.
Third quarter sales for <unk> were up 19% or 24 million with $13 million of the increase coming from pricing.
Revenue was up double digits in most markets, including 30% in commercial HVAC, 14% in refrigeration and 10% in coatings.
Adjusted EBITDA was $10 1 million or <unk>, 87% higher than the prior year.
Most importantly, the adjusted EBITDA margin improved 250 basis points.
The earnings and margin increases were driven by several factors, including increased volume realization of key pricing initiatives and a focus on operational improvements.
Given the steady market demand our reduced backlog in our 80 20 work, we anticipate finishing the fiscal year with further margin improvement in Q4.
Please turn to slide nine.
Sales in the HD segment were up 8% or $15 million.
Similar to building HVAC and Cif the sales increase was partially driven by increased pricing.
Pricing and foreign exchange resulted in a $9 million increase while sales volume was up $6 million or 3%.
With regards to our markets, we experienced strong revenue growth in the bus and specialty vehicle market, particularly in the Americas region.
In addition, the off highway market experienced double digit increases.
Adjusted EBITDA declined $4 million driven by a reduction in gross profit that was partially offset by lower SG&A.
As is typical for this segment commodity costs have a large impact on bottom line results.
Net material cost increased by $9 million as we were able to pass through of approximately $10 million of a $19 million increase.
On a more positive note SG&A was $2 million lower than the prior year.
As I mentioned last quarter, we implemented additional pricing adjustments in January which should result in further margin improvements.
Supply chain remains highly uncertain, including the metals markets, but we are benefiting from market demand and new program launches.
Given all of these activities were pleased to deliver the sequential margin improvement in Q3 and expect a further increase in Q4.
Please turn to slide 10.
As expected our auto segment was heavily impacted by volume declines tied to semiconductor shortages and other supply chain issues within the auto industry.
In addition, we sold our Austrian business earlier, this year, which also contributed to the year over year decline.
As a result third quarter sales declined $42 million, including an $18 million impact from our Austrian sale.
Adjusted EBITDA was significantly lower largely from the sales decline.
Lower volume accounted for nearly all of the $13 million EBITDA decline along with the material cost increases.
SG&A was up with general inflationary pressures.
We are moving swiftly to improve the automotive business through pricing initiatives restructuring activities and optimizing our plants.
As Neil previously discussed we began taking aggressive profit improvement actions through commercial negotiations and SG&A cost reductions.
We generated some sequential improvement in Q3 and believe we are past the low watermark for this business.
Based on the 2022 market outlook.
And our restructuring plan, we anticipate further improvements in Q4, and even larger steps in the new fiscal year.
Now moving to the balance sheet, please turn to slide 11.
As anticipated our Q3 free cash flow was a positive $16 million.
On a year to date basis free cash flow remains negative but is improving.
As I mentioned earlier this year the first half of fiscal 'twenty two would be challenged in terms of cash flow with improvements in the second half.
Over the last three months, we focused on improving our working capital.
Inventory levels continue to be a challenge as material cost has gone up and supply chain issues that forced us to maintain safety stock.
We're also working hard to reduce backlog, which will help us further reduce inventory in the fourth quarter.
Our net debt of $330 million is slightly lower than the prior quarter.
And our leverage ratio was two five times, which is within our targeted range and we expect a further decline by fiscal year end.
Now, let's turn to slide 12, and our fiscal 2022 outlook.
I am pleased to report that after analyzing the current economic conditions and the actions, we're taking as a company we're maintaining the fiscal 2022 outlook.
We anticipate the final quarter, we will build on third quarter's momentum with sales and adjusted EBITDA to increase sequentially in all segments.
Material costs continue to be our largest headwinds and volatility over the last several weeks has made the outlook even more uncertain.
Our plants have been very aggressive driving favorable performance to offset the tight labor and difficult labor markets.
End market demand continues to be a tailwind in the growth outlook is relatively consistent with the prior quarter's projections.
While year over year comparisons have been challenging Disney economic climate I'm very encouraged by the sequential improvement in trends heading into our new fiscal year.
With that ill now take your questions.
If you have a question at this time. Please press Star then one on your Touchtone telephone. If your question has been answered or you wish to remove yourself from the queue. Please press Star then one again, our first question comes from Keith.
<unk> with Sidoti <unk> Company. Your line is open.
Good morning, everyone nice job with the cost cuts in the quarter.
I'm trying to get a sense, Jonathan particularly acute in the U S.
G&A was heavy duty equipment in automotive I'm trying to think of so you are talking about $20 million of cost cuts in the future I'm trying to think about near term what <unk> can do on the SG&A line and how much of that.
Related to the weakness in those segments margin wise recently or more is this part of your long term 80, 20 initiatives or a combination.
Yes, Hey, Steve Good morning, it's Nick.
<unk>.
So the target that Neil laid out the $20 million savings target.
We'll be in a heavy heavy piece in the automotive segment.
And then a smaller portion in hte and a little bit across some other areas of the company.
Short term nature long term nature of it.
It's going to take us probably the next quarter to finalize all of those plans.
And then still a little early but I think it's a fair target to capture about half at least half of that in the new year.
And then the balance after that.
That helps me out at all.
As clients.
And then when I think about how.
How we should think about pricing clearly it was.
You seem to have an easier time of it than necessarily the building HVAC and I'm just trying to get a sense of is that based on the products you're selling the customers you're selling to the contractual terms why it was that much easier to get the margins back up on Gis and then also whether we would see greater pass throughs just contractually with.
<unk> automotive in this current quarter, although you've got quite a bit this quarter.
Yes, no thats a good question Hey, Steve This is Neil here regarding the difference there is.
<unk> had.
Implemented those price increases pretty early on on a backlog there wasn't as strong or robust as on the HVAC side. So we needed to get through some of the backlog on the HVAC side of the business in order for the price increases to be realized.
<unk>.
We just recently announced our fourth price increase in HVAC. So we've done more incremental price increases on the HVAC side.
While we are burning through their largest backlog that mcis.
On the CNS backlog so.
So we should see more of that more of it on the building HVAC.
Over the next couple of quarters, that's fair Jim.
If I can get one more in the 92% growth on data center sales will sort of one large order there was there something in terms of timing, we shouldnt expect that every quarter.
Yes, I think.
Last year was a little bit of a dip.
Chip.
It wasn't one large order. These are in theories. These are all generally big orders and.
Sometimes they are they can be lumpy, depending on just the timing of the actual shipment or when the customer is ready to receive it but.
We are on track this year still too.
We're still targeting that $100 million range of data center revenue.
On a full year basis.
Great.
Now, let me turn it over I'll get back in queue. Thank you.
And your next question comes from the line of Matt Summerville with D. A Davidson your line is open.
Thanks, Kevin.
Questions first.
With the guide.
Kind of.
That's a pretty wide range with two months to go so help me understand what kind of define the low end versus the high end and.
How derisked do you feel that bottom end would be at this point again, given that we have just two months left.
Yes.
I think thats a good question.
We decided and typically we loan.
<unk> guidance with a quarter to go even though we could have thought about may be narrowing that band a little bit.
But as we went through the.
The segment by segment results, Matt I think we.
Clearly feel really good about where we sit in that range very hard too.
If we deliver on our sequential improvement really the lower where we are well outside of the low end of the range right. So I would say as I went through it we expect sequential improvement in earnings and in margins in Q4.
And if you just take that from the $102 million, we've done year to date.
I'll leave it at that but.
Yes, we feel secure within that range.
We are proud that the math would simply say we'd have to go backwards to get at the low end.
Yes.
Okay. So I wanted to talk a little bit about price and first I want to talk about the price capture you experienced in Q3, how much of that was structural versus formulaic pass through.
And how we should be thinking about structural pricing.
Looking forward.
Yes, and you and you talked about structural I think.
It's really margin improvement.
Longer term margin capture right Matt.
Yes, that's exactly right.
Yes, maybe I will go through segment by segment, a little bit and Neil can add I'll, let neel add color over the top.
Clearly.
Across the total company in the quarter. This the same as last quarter, our largest gap is in the HVA segment tends to have longer lags. The auto side frankly is more tied to quarterly.
But we have a lot more large module lot more components, we passed through as well on the heavy duty equipment side.
All of that is.
Pass through there we have more of a catch up from a lag and a lot more commercially.
Go back to the customers with there so that is and we passed through.
The amount of pricing in those vehicular spaces.
That is drives revenue right, but it also doesn't attach margin to it so it can actually be a little margin dilutive. So.
So we have a lot of work to do.
Commercially strategically using $80 1 million.
Only recoup.
Those cost increases on the vehicular side, but then think about even different ways to manage that business going forward to get structural improvements on the Cif and HVAC side as you can imagine a lot.
Cleaner I won't say easier and Neil was just talking about Cif.
They were able to jump out in front of that very quickly.
<unk>.
You could see that in the numbers a lot of the Cif improvements Iot answer your question I would say is in that structural category.
And then on the building HVAC side and Neil is talking about that.
The first.
Three quarters of this year there was a day.
<unk> did a series of price increases, 2% to three to catch up on material pass through level, what we see beginning in Q4 and beyond we will be more pricing on a structural level.
Building HVAC.
Let me pause Neil if you want to add anything.
Yes, the only other thing I would add to that hi, Matt This is Neil.
We have more liberty on the HVAC side as well as on the <unk> side.
We're not.
Were not hindered with some of the contractual obligations that we have across other parts of the business.
Got it.
And then just.
A follow up if you look at.
The data center piece of the business $100 million platform for you guys. This year do you have any thoughts, albeit early.
That business does in fiscal 'twenty, three and if you can speak to both.
The hyper as well as the Colo market, there and that would be great. Thank you.
Yes, Matt I think Thats a good question, we are in the process of developing our strategic plan we should.
Expect to see some of the outputs relative to our our outlook relative to hyperscale as well as co location.
We're also in the throes of our planning and we should start to see some of that forecasting come to fruition soon.
And then the only thing I would add is.
Yes, I think the target for us is to continue to grow greater than the market and it can be hard.
Have another to continue obviously at a 50% clip.
But if the market is still going to be up another 15 or 20% next year. Our goal is to outpace that market growth.
As Neil said once we wrap up our plan and provide updates to you in Q4, we can be a little more specific.
Got it thank you guys.
Your next question comes from Steve with Arizona with Sidoti and company. Your line is open.
Okay.
A couple of questions there wasn't able to get to the first time around really about the automotive and plans on restructuring I think you've touched on a couple of couple of the points in your presentation, but I'm trying to think about in terms of and we certainly know some of the larger Ottoman automakers over the last one or two weeks.
Assumption with the chip shortage could be alleviated.
Significantly this year more food more backend loaded for automotive business does can do well in a growing market.
Youre thinking about how that affects your thinking about shrinking lab business potential divestitures and just longer term how that might affect your sort of restructuring plans with automotive.
Yes, Steve Thats a good question. So as we think about automotive we're looking at it in terms of technologies, where we have a competitive position where we see now.
Evolution in the market towards EV products, where we have good strong customer relations. Those are the areas that we're going to continue to rally around other areas, where we don't have a competitive advantage.
<unk>.
The vehicle recovery, if there is margin compression in margin issues and challenges those are going to be areas that we're going to continue to.
Have conversations commercially as well as looking at other options.
So you should have some news how much of it is controlled by the market itself.
Can you just repeat that Steve one more thing.
Whats your timetable for some of the bigger plans in terms of maybe individual facilities when the automotive market in terms of what you might do with them and how much of it's controlled by the market itself is it easier to potentially divest in a recovering market and it would be when the market still remains weak.
Yes is the go back to the restructuring plans in the savings Niels targeted buys.
<unk>, so first and foremost those numbers are nearly all tied to SG&A cost reductions really refocusing on the areas as Neil said that we think.
Drive value for us so not plant restructurings in there.
And then we talked a little bit about this last quarter out of the.
The automotive business and Neil talked about looking at it as a technology.
<unk>.
A smaller piece of that now is the last couple of years, we shrunk it we exit we executed the sale in Austria.
A third or so of that that is non strategic it isn't tied to the technologies.
The emissions changes fuel economy economy, EV that Neil is describing.
And that.
We'll probably have a long tail to it.
And then the balance of it is the core stuff that Neil is covering we think.
Already today has good margin our margin potential and the leads to the EV transformation.
Great. Thanks, Thanks for let me have the follow ups.
I am showing no further questions at this time.
I would now like to turn the conference back to Kathy powers.
Thank you and thanks to everyone for joining us on the call. This morning, you'll be able to access the replay of the call through our website in about two hours. We hope you have a great day.
This concludes today's conference call you may now disconnect.
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