Modine Manufacturing Company

Good morning, ladies and gentlemen, and welcome to Modine Manufacturing Company's second quarter fiscal 2020 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. If anyone should require assistance during the conference, please press star then zero on your touch-tone phone. 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, Treasurer, and Investor Relations. Please go ahead.

Good morning, and thank you for joining our conference call to discuss Modine's second quarter fiscal 2020 results. I am here with Modine's President and CEO, Tom Burke, and Mick Lucareli, our Vice President, Finance, and Chief Financial Officer. We'll 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. This morning, Tom and Mick will present our second quarter results for fiscal 20 and will provide an update to our outlook for the rest of the year. At the end of the call, there will be a question and answer session. On slide two is our notice regarding forward-looking statements. This call may contain forward-looking statements as outlined in our earnings release as well as in our company's filings with the Securities and Exchange Commission. With that, it's my pleasure to turn the call over to Tom Burke.

Thank you, Kathy, and good morning, everyone. In the past few months, we have seen a significant decline in many of the key end markets served by our VTS and CIS segments. In addition to the automotive slowdown mentioned last quarter, We are now projecting additional weakness in the commercial vehicle and off-highway markets that we expect to continue through the remainder of our fiscal year and into fiscal 2021. We are also seeing lower orders in our CIS segment, including both cooler sales to the data center market and coil sales to the HVAC and refrigeration markets. These conditions have led to our second quarter earnings being lower than we originally expected and to a significantly lower outlook for the remainder of the fiscal year. We have therefore lowered our sales and earnings guidance for Fiscal 20. MIP will provide additional details later in the call. Given the significant change in our order outlook and market conditions, we are rapidly implementing a number of aggressive cost containment measures. Some of these are immediate actions that will drive short-term cost savings and some are longer-term initiatives, designed to deliver between $25 and $30 million of annual savings over the next 18 months. These measures include operational and SG&A expense reductions resulting from accelerated procurement savings, structural changes, and headcount reductions with the immediate goal of improving our operating earnings and cash flows. It's important for our shareholders to know that we are experiencing a major correction in some of the markets we serve and are taking the appropriate actions now to ensure we stay on path to meet our performance goals. Before turning to the segment results for the quarter, I would like to provide an update on the potential divestiture of our automotive business. As most of you know, we entered into a formal sale process in the late spring, early summer timeframe, and we've been diligently working to prepare for the sale of the business over the past several months while managing through a challenging industry environment. Throughout the process, numerous companies expressed interest in the business, and we received bids from both strategic and financial buyers. Over the last several months, we narrowed the group and believed that we could reach an agreement with one particular buyer. Unfortunately, negotiations with the counterparty have recently been terminated. This is due to a combination of factors, including general market and economic conditions, deal complexity, and overall value. We have other interested parties and will continue with the sale process while continuing to analyze all strategic options. Clearly, the process has taken longer than anticipated due to the industry and economic uncertainty. but we will make the right decision for our shareholders. The team has worked extremely hard on the separation and the investment is significant, but we believe this is a prudent investment because it is a necessary step for Modine to exit the automotive business. We believe that becoming a more diversified industrial company is in the best short-term and long-term interest of our shareholders and will make Modine a stronger, more profitable business once complete. Now, turning to our second quarter results. Overall, second quarter sales decreased 9%. Our building HVAC segment had another strong quarter with sales up 12% on a constant currency basis versus the prior year. However, both our BTS and CIS businesses had year-over-year sales declines, primarily due to continued weakness in our end markets and unfavorable currency impacts. Our second quarter adjusted operating income was $20.2 million, down $6.3 million, or 24% from the prior year, primarily due to the lower sales volume in our BTS and CIS segments. Turning to page 4, sales for the BTS segment were down 11% from the prior year or 9% on a constant currency basis. Our key vehicular markets have slowed significantly. Overall sales to commercial vehicle customers were down 15% and off-highway sales were down 22%. We started seeing a decline late in the first quarter with only significant sales softening in our automotive markets. Early in our second quarter, commercial vehicle markets still appeared stable, but we began to hear early word of inventory adjustments from our off-highway customers. At this point, third-party market research estimates continued to signal year-over-year growth. By the end of the second quarter, we saw a significant drop in off-highway orders and started receiving mixed signals for the rest of the year. It wasn't until early October that third-party market data began reflecting a portion of these market declines and that we learned the full extent of the impact of the second half of our year for both off-highway and commercial vehicle sales. We continue to monitor published market data, but as we talk with our customers, we now understand that the volume declines in the fourth calendar quarter of 2019 and the first calendar quarter of 2020 may be significantly worse than the current data would indicate. In some cases, we expect year-over-year volumes to decline by as much as 20%. We base our forecasts both on market data and customer feedback. In the current environment, we are taking a more conservative approach and are preparing for volumes to continue to decline for the balance of our fiscal year. Within the off-highway space, the area most negatively impacted has been large engines and high horsepower equipment. This includes high-tonnage excavators, harvesters, and large tractors, where we have a higher mix of business. These impacts are generally in line with what we have seen and heard from the earnings commentary of our large OE customers in this quarter. Sales to customers in the Americas region were down 9% from the prior year, primarily driven by lower sales to automotive and off-highway customers. Sales in Europe were down 13% from the prior year, due primarily to a steep drop in commercial vehicle sales as programs continue to wind down. In Asia, sales were down 12% due to lower off-highway sales in China and Korea, This was partially offset by higher automotive sales in China. Adjusted operating income for the BTS segment was $9.3 million for the quarter, which is $6.7 million lower than the prior year. Adjusted operating margin was down 170 basis points to 3.1%. This volume-driven decline has lowered our segment returns to a level that is clearly below our targets. So far, we have rapidly adjusted our direct labor costs, but the BTS team is now focused on quickly reducing our fixed costs as well. Our operations team is aggressively rebalancing production schedules and adjusting labor requirements and overhead spending in line with our latest sales forecast. Please turn to page 5. Our CIS segment also had another down quarter, with sales decreasing 12% from the prior year. Sales to data center customers were down 26% from the prior year. Similar to last year, we knew that this quarter's sales would be down from the strong level in the second quarter of last year. We still have a strong relationship with our largest customers in this segment, and they are happy with our performance. We are actively working with them to find opportunities to grow this business. And even though they are still growing their data center capacity, the rate of this growth has slowed, which impacted both the second quarter and our forecast for the rest of the fiscal year. Part of our future initiatives for the data center piece of our CS segment is the diversification of our customer base. This market is fairly concentrated, which makes this effort difficult. but we believe the relationship and success we've had with our largest customers is a testament to our products and services and gives us confidence in our ability to obtain new customers. In addition to data centers, sales to other end markets in our CIS segment were down as well due to a tough industrial environment. This segment reported adjusted operating income of $8.9 million, down 31% from the prior year. This decrease is primarily due to lower gross profits driven by lower sales volumes and negative sales mix. We recently announced a leadership change over our CIS segment with Scott Bowser, our Chief Operations Officer, assuming responsibility for this segment. We will also be making further structural and leadership changes to ensure we drive improvement in both the commercial and operational sides of this business. We clearly have some work to do in this segment. I am confident in Scott's proven leadership that this team will execute on our growth and profit improvement plans. In particular, we're focused on profit improvement in our coils business where we're reviewing our profitability by product and by customer and believe there is room to strengthen our pricing structure and distribution channels. In addition, we're also examining the organizational structure of this business. Last year, our VTS business moved from a regionally managed business to a global structure. In CIS, the group is still managed regionally with different areas of focus, strengths, and weaknesses around the world. We're now looking to move to a global product structure that will help to improve profitability in our coils business and further strengthen our market presence in our coolers business. Please turn to page six. Turning to our bright spot in a quarter, sales for our building HVAC segment increased 10%, driven primarily by higher sales of school ventilation and heating products in North America and higher data center sales in the U.K., partially offset by lower non-data center product sales in the U.K. Adjusted operating income increased 35% from the prior year to $8.8 million, and adjusted operating margin increased 300 basis points to 15.8%. This increase was driven by higher sales volume and favorable sales mix. We continue to be encouraged by the strong performance and our competitive position in this segment. We recently announced that we entered into a supply agreement with Cirrus One, a global owner and manager of data center properties, to provide cooling solutions for the data center projects in Europe. Our Airedale Business Unit in the UK is in a great position to provide energy-efficient cooling solutions to this growing market. With that, I'd like to turn it over to Mick for an overview of our consolidated results and to update our outlook for fiscal 20.