Modine Manufacturing Company

Welcome to Modine Manufacturing Company's 3rd 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 touchstone telephone. 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, Investor Relations, and Tax.

Good morning, and thank you for joining our conference call to discuss Modine's third quarter fiscal 2020 results. I am here with Modine's President and CEO, Tom Burke, and Michael Lucareli, our Vice President, Finance, 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. This morning, Tom and Nick will present our third quarter results for fiscal 2020. and we'll 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 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. Overall, third quarter sales were down $67.6 million or 12% from the prior year. These results were in line with our previous guidance. Third quarter adjusted operating income was $24 million, down $10.8 million, or 31% from the prior year, primarily due to lower sales volume in our VTS and CIS segments. As reported last quarter, several of our end markets slowed significantly in the past few months, but conditions appear to be stabilizing. As for other highlights during the quarter, I'm pleased to report that our free cash flow improved to $11.6 million this quarter, including auto separation and restructuring costs. We have also strengthened our balance sheet by terming out a portion of our short-term debt. Nick will cover this in more detail during his section. Our new CIS leadership team is keenly focused on identifying opportunities to enhance our margins and improve operational efficiencies. As mentioned last quarter, margins in this segment have fallen below our targets. We have plans in place to strengthen our coils business and grow our coolers business. In addition, we are making organizational and structural changes to how we manage our data center business. The volatility of our data center sales has created short-term challenges due to significant concentration with one customer, but the team is making good progress in diversifying our data center portfolio. I will cover more on this and another strategic priorities during my segment review. Before diving into our quarterly segment results, I would like to provide an update on our automotive exit strategy. We spent considerable time and investment separating the automotive business from the VTS segment and plan to start managing and reporting a separate auto segment in the first quarter of fiscal 21. While this has been time consuming and costly, I believe it was a good and necessary investment and is now largely complete. Reporting this new segment will provide improved transparency going forward as we transition away from the automotive market. This work included physically separating manufacturing operations, We have named a seasoned leader and management team that is committed to the successful separation and dedicated support of our automotive customers. The separation of the automotive business will allow us to showcase the new Modine, which we anticipate will generate higher margins, returns on capital, and cash flows. I want to be clear, our primary strategy remains to exit Modine's automotive business as quickly and efficiently as possible. Through our previous efforts to sell the auto business, we determined that it would be more beneficial to divide the existing business to better align and appeal to strategic buyers. Specifically, we are marketing two separate components of our automotive business to different potential buyers. With this revised approach, we have been actively engaged with numerous interested parties. We're encouraged with the revised process so far. As we assess our options and their related timelines, there may be some remaining products locations that we will have to address. In these scenarios, our goal would be to complete the exit as quickly as possible when meeting or exceeding our customer commitments as we transition or phase out of certain product lines. Our objectives are clear. Separate the automotive business and run it to optimize earnings and cash flow. Maximize the cash value by divesting the most valuable assets and exit the remaining business as rapidly as possible on a cash-neutral basis. Beginning in the first quarter of fiscal 21, we plan to report the financial results of the new auto segment separately from the remainder of the VTF segment, which will include our heavy-duty equipment business. We continue to believe that pursuing this path is the right long-term decision for the company and for our shareholders. It will lower our capital intensity, better focus management's attention on higher-margin, higher-growth businesses, and improve our cash flows, opening up new opportunities for organic and inorganic investment. Now turning to our third quarter results on page four. As expected, we experienced a decline in sales across our vehicular markets. Sales for the VTS segment were down 16% from the prior year. As I previously mentioned, our T vehicular markets have slowed significantly in the recent months and continue to be soft. Overall sales to our commercial vehicle and off-highway customers were each down 26%, and automotive sales were down 3%. These market declines have not been isolated in any particular region, as we have seen volume weakness across the globe. Sales to customers in the Americas region were down 18% from the prior year, with lower sales to automotive, commercial vehicle, and off-highway customers. Sales in Europe were also down 18% from the prior year, due primarily to a steep drop in commercial vehicle sales as certain programs wind down. In Asia, sales were down 4% due to lower off-highway sales in China, Korea, and India. This was partially offset by higher automotive sales in China. Adjusted operating income for the BTS segment was $5.1 million in a quarter, which is $9.9 million lower than the prior year. Adjusted operating margin was down 270 basis points to 1.9%. We have quickly responded to the downturn in our markets by cutting structural costs in our business to align our operating plans with changing customer demand. In addition, we are highly focused on other factors we can control, such as SG&A reductions, Improved Operating Efficiencies, and Accelerating Procurement Initiatives. This drives near-term margin improvements and increases our confidence for improved operating leverage when the markets pull out of a down cycle. Our customer relationships are strong as we continue to deliver leading performance and critical elements like quality delivery and cutting-edge technology such as EV solutions for the bus and truck markets. And as we discussed last quarter, in talking with our key customers, we felt that industry volume declines could prove to be more substantial and many industry forecasts we're expecting. So while these year-over-year declines were steep, they were largely in line with our projections. The silver lining to the market weakening is that the rate of decline in these markets seems to have stabilized. We are not expecting any meaningful recovery in calendar 2020. There are some reasons to be optimistic with regards to the longer-term market outlook. We believe the off-highway and truck markets will be challenged for the next several quarters and then to begin to recover. Many are predicting an improvement beginning later in calendar 2020. On the auto side, we anticipate relatively stable volumes, which is key to our investiture process. Please turn to page 5. The largest challenge in our CIS segment was the decline in sales to one large data center customer. This accounted for more than half the revenue decline. Overall, CIS segment sales declined 12% from the prior year. Sales to data center customers were down 25% from the prior year. Within our served market in this segment, The strong growth in cooler sales that we saw last year was a result of strong capacity expansion in excessive market demand. The drop in sales this year is due to a temporary lull in customer investment and further capacity that is expected to continue into our next fiscal year. We are currently expecting very low volumes for this business in fiscal 21 with a strong recovery in fiscal 22. Sales to our commercial HVAC and refrigeration end markets were down as well. The majority of the sales decline was related to refrigeration customers driven by market decline in refrigerated transport in the U.S. The segment reported adjusted operating income of $9 million, down 34% from the prior year. This decrease was primarily due to lower gross profit driven by lower sales volume and negative sales mix. The new leadership team for this segment has been in place for over a quarter now, and the strategic priorities and related actions have been set. As I mentioned last quarter, we are keenly focused on improving the profitability of our coils business. We've initiated an aggressive cost reduction program to vertically integrate certain high-cost components and to strengthen our manufacturing operations and business processes. We're also reviewing our product costing and pricing practices to make sure that our quotes have sufficient margin, particularly on low-volume releases. The team is working hard to take advantage of our data center growth opportunities and to diversify our customer base. This is being done in conjunction with our building HVAC team, and I have decided to consolidate these efforts under one leader. I will cover this more in detail as part of the building HVAC update. We are also leveraging new technology to reduce energy consumption and total cost of ownership in our cooler and coatings business, and are adding resources to our North American team in order to grow market share. In the upcoming year, we expect the market supporting our coils and coolers products to be relatively flat, with some continued weakness in our industrial markets. With regard to our largest data center customer, we are planning on very limited sales for the next several quarters based on recent communications with them. However, long-term demand and projections are very encouraging, with projected sales in calendar 21 potentially reaching new highs. Please turn to page 6. Sales for our building HVAC segment increased 1%, driven primarily by higher sales of school ventilation and heating products in North America, partially offset by lower ventilation and air conditioning sales in the U.K., Operating income increased 4% from the prior year to $13.5 million, and operating margin increased 50 basis points to 20.8%. This increase was largely driven by favorable sales mix and customer pricing. We continue to be encouraged by the strong performance and our competitive position in this segment. We expect the favorable growth trends in our market to continue and remain focused on growing our data center business. In order to better capture opportunities in the scoring market, we are developing a new single-focus approach to the data center market by combining the resources and capabilities of Building HVAC and CIS teams. This new structure will allow us to leverage the products across both CIS and Building HVAC, providing a more seamless customer experience, along with a more comprehensive solution offering. The end goal is to have greater customer diversification by reaching a broader segment of these markets by introducing new, highly regarded products across new geographic regions. This change in strategy is showing early indications of success as we are growing and winning new business with other data center customers. For example, in the quarter, we secured our first order with a major cloud computing customer in Europe for shipment at fiscal 21. This is a key component of our growth strategy moving forward. Looking ahead, we see our markets starting to pull back a little bit, but they will remain generally positive throughout the calendar year. Within that, we expect to see stronger growth in key markets as macro trends should remain strong. For data centers, strong growth continues in the co-location and cloud data center space. Given our strong presence in the U.K. markets, the increased certainty around Brexit should provide some stability into the general HVAC market. We anticipate U.K. banks to release capital funding for construction, opening the door to growth again. As I mentioned earlier, our newly engaged global data center team has solid plans to grow and diversify this business with new customers at fiscal 21. With that, I would like to turn it over to Mick for an overview of our consolidated results. and an update to our outlook for fiscal 2020.