Modine Manufacturing Company
Q4 2021 Earnings Call Transcript

Published: 27 May 2021

[Operator:]

Good morning, ladies and gentlemen and welcome to the Modine Manufacturing Company’s Fourth Quarter Fiscal 2021 Earnings Conference Call. As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Ms. Kathy Powers, Vice President, Treasury, Investor Relations and Tax. Please go ahead.

[Kathy Powers:]

Good morning and thank you for joining our conference call to discuss Modine’s fourth quarter and full year fiscal 2021 results. I am 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 in the Investor Relations section of our website, modine.com.

[Neil Brinker:]

Thank you, Kathy and good morning everyone. Before discussing the quarter and full year results, I would like to reflect on some of our accomplishments this past year and give a quick update on some of our other strategic initiatives. This has been a challenging year for Modine to say the least, but I am very proud of the resilience of this organization and the ability of this team to deliver on commitments under less than ideal circumstances. We started the year responding to the initial impacts of the pandemic, temporarily shutting down plants, sending employees home to shelter-in-place and taking actions to conserve cash. We implemented protocols to keep our employees safe and healthy and our infection rate, thankfully, stayed very low. At the same time, we were focusing on how to keep our automotive strategy moving forward. We found a way and we are able to reach agreements with two separate buyers. Last October, we announced the sale of our liquid cooled automotive business to Dana. And then in February, we announced that we had reached an agreement for the sale of our Austrian air-cooled automotive plant. We have previously stated that we expected both transactions to close in the first half of this year. I am pleased to announce that we closed on the sale of the Austrian facility at the end of April, completing that transaction. The sale of that facility drives significant value, allowing us to avoid operating losses, capital expenditures and future restructuring expenses. The regulatory process for the pending sale of the liquid-cooled automotive business is taking longer than we originally expected. We are currently working jointly with the buyer through this process. As a result, we aren’t able to provide any guarantees regarding the timing or outcome. Over the past few months, I have been able to visit most of our North American plants and facilities. I must say that I was impressed by the strength of our operational and technical know-how. We are experienced operators who drive on challenges presented by our customers and are ready and willing to overcome the obstacles inherent in being a global company, but I also see a great deal opportunity for change. First and foremost, we need to reduce complexity. To accomplish this, we will adjust our organizational structure to align around market verticals.

[Mick Lucareli:]

Thank you, Neil and good morning everyone. Please turn to Slide 8. I am happy to report that we maintained positive momentum throughout fiscal ‘21 and posted solid fourth quarter results despite various commodity and supply chain challenges. Our fourth quarter sales benefited from favorable foreign exchange rates, with sales up nearly 5% on a constant currency basis. As Neil reviewed, main revenue drivers were the HDE and Building HVAC segments. Gross profit was better than the prior year by $9 million with a margin improvement of 50 basis points. The current quarter benefited from reduced depreciation due to the classification of our liquids and air-cooled automotive businesses as held-for-sale. Material costs were significantly higher due to commodity metals, tariffs and logistics. Despite our price adjustment mechanisms, we absorbed approximately $8 million of higher material costs.

[Neil Brinker:]

Thanks, Mick. In conclusion, we have performed well under difficult conditions. Looking forward, we have the benefit of improving markets, but also have the challenges associated with this current global economy namely material, labor shortages logistic issues and cost inflation. We are working through those issues while addressing our bigger strategic priorities. We have the tools in place to make those strategic decisions and to continue to transform Modine. What’s truly exciting is that our technology enables our customers to meet their goals, especially around clean air and sustainability. Our products improve indoor air quality, heat and cool with greater energy efficiency and reduce toxic commissions. Our products make this world a better place, and that’s why I’m proud to work at Modine. With that, we will take your questions.

[Operator:]

Our first question comes from Michael Shlisky with Colliers Securities. Your line is open.

[Michael Shlisky:]

Hey, good morning, guys. Can you maybe comment first on a couple of growth end markets that you mentioned during your prepared comments, maybe can you talk first on electric vehicles? Can you give us some color as to the approximate number of how many platforms you’re on today? And can you tell us whether you’re involved in some of the hydrogen fuel cell platform, which also have batteries in them? Are you involved in any of those, those seem to be really strong candidates for long-haul trucking as well, a lot of foreign markets out U.S. like to have been testing hydrogen recently. Any comments there would be appreciated.

[Neil Brinker:]

Sure, Michael, how are you doing? This is Neil. Good. Sure. In terms of some of the programs and platforms around, we continue to gain traction in that arena. There is probably over two dozen different programs that we’re working through that are in various phases from inquiry to development. And they range from medium to heavy-duty trucks. So there is obviously demand there. We see more inquiries that are coming in, and we have the organization in place to support that. Relative to fuel cell and hydrogen based powertrains, as you know those require significant thermal management systems. There is a global consensus that feels that there is a growing need for this for the heavy-duty long-haul commercial vehicles. And Modine is engaged currently with major North America and European OEMs in this early phase of fuel cell work.

[Michael Shlisky:]

Got it. Can we then turn into some of your data center business, can you give us a little bit more color as to maybe some of the end markets driving that business? I know you’ve got the one big customer, we don’t have to discuss that one. But more broadly speaking, I mean, there is been a lot of interest recently in Crypto, which obviously can run very hot. And obviously, there is been some growth in e-commerce as well, which is – has some capacity issues. Have you seen any growth outside of your main customer, whichever company that is, has there any growth outside of that big customer in some of these growth in your data center sectors?

[Neil Brinker:]

Yes. We’re seeing – it’s a good question. We’re seeing strong growth in the co-location market, certainly. And if buying behaviors change and you start to see this with some of the larger hyperscalers, looking at different ways to go to market, we see that in co-locations and that’s driving a lot of our growth. So not only is it driving growth for the current product, but it is really starting to fill our funnel in terms of new product development and how we can continue to satisfy the growth in that arena.

[Michael Shlisky:]

Got it. Maybe I’ll just ask one quick one on HDE. It sounds like, just like we saw last time with the tariffs a couple of years back, you’ve got under control as far as your pricing and the mechanisms in your contracts, there is a lag where it does end up working out okay in the end. I am curious do you have to feel that the OEMs feel good about their entire supply chain being as solid as Modine’s right now? I’m just kind of curious if certain areas of the supply chain just can’t deliver and you can, they still want to not ask for a shipment from you, even if – right now, you’re currently ready to ship. If they can’t get a steering wheel or other parts, they are just not going to be able to actually build the truck. Have you gotten any feedback from the OEMs about any pushback in any build rates, thanks to other companies not being ready, even if Modine is?

[Neil Brinker:]

Yes, that’s a fair question. I think we’re all keeping a very close eye on semiconductor. I think that’s driving a lot of the plant shortages globally. A lot of the auto customers and heavy-duty truck customers are very public in terms of plants that they are having to shutter based on shortages with semiconductor. We haven’t felt many issues relative to our scheduling and our inventory, but we’re just-in-time, that potentially could happen. It’s a fair question. But at the moment, we’ve been able to time our inventory position, time our roll with are finished as well as with the schedules of our customers, and it hasn’t been a significant impact for us.

[Michael Shlisky:]

Excellent. Thanks so much, Neil. I will pass it on.

[Operator:]

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

[Matt Summerville:]

Thanks. A couple of questions. First, with respect to the air cool divestiture that just got completed a few weeks back, how much revenue and adjusted EBITDA goes away with that divestiture? And then what sort of EBITDA assumption are you guys using in the $170 million to $185 million for the Auto segment this year?

[Mick Lucareli:]

Yes. Good morning. It’s Mick talking. So the air cool businesses we had described it in the past was – it was in the $40 million to $50 million range in revenue-wise, slightly negative from an EBITDA perspective, mostly immaterial to the total company. So revenues down – will be down a little bit, lost revenue from that, Matt, the earnings slightly better, but right around breakeven to slightly negative on that business. From an Automotive standpoint, we’re assuming they are similar in that liquid-cool business. We had talked about it historically being in a $25 million run rate range, and that’s a good go-forward number for that business as well.

[Matt Summerville:]

Got it. Thank you. And then with respect to CIS and the data center business there, I want to make sure I’m clear on Slide 5. So I was anticipating stable run rate in fiscal ‘22, similar levels as ‘21, but then you have 30% to 40% growth also in the upper right-hand corner there. So can you sort of explain that and make sure I understand what the moving pieces may be there?

[Mick Lucareli:]

Yes. Yes, I’ll go first here, and then Neil can add any color. So as Neil talked about, Matt, one of the things that we’re in the process of doing is putting all of our commercial and – engineering and operational groups together under data centers. And we’re planning to make that change July 1. And so until that point, we still – for Q1, we will have some data center revenue in CIS as we have in the past, and we have some in Building HVAC. We are – if you recall, we are launching our Modine products. Think of it as – and Neil talked about our co-location, our chillers, our computer room air handlers in Spain and in the U.S., and we’re launching those in CIS facilities. So in total, we see 30% to 40% growth this year in our data center business. And in the Q1, that will be in both segments. And then we will come back and we will restate for you and help – we will do a restatement and then going beginning in Q2. The vast majority of all our data center business will show up in building HVAC, which will make the communication, the modeling a lot easier.

[Matt Summerville:]

Got it. That makes sense. Thank you.

[Mick Lucareli:]

Yes, okay. So what you’re seeing there is the launch of our – and the growth of our sales to non-outside of that one customer to the growth Neil was talking about in the first part of the year here, that will show up part of it in CIS and part of the HVAC.

[Matt Summerville:]

With respect to that large customer, I guess on some of the impressions coming out of last quarter, you thought that business was poised to potentially re-ramp, pretty significantly in fiscal ‘22 and maybe even more so in fiscal ‘23. Is that not – are you no longer thinking about it that way?

[Neil Brinker:]

Yes. It’s a good question, Matt. It’s just a matter of timing. And also, what I described in terms of some of the buying behavior, some of these larger hyperscalers continue to digest their capacity. A lot of – there is a shift and it’s driving some growth in the co-location market with why you’re seeing some of the growth in our colos at the rate that we’re growing at.

[Matt Summerville:]

Got it. And maybe one final one if I could. How do you feel the building HVAC business is positioned to benefit from these school retrofits? Are you able to size that opportunity, maybe talk about your relative market share in that space and what you’ve kind of factored into your Building HVAC outlook just as it pertains to that specific driver? Thank you.

[Neil Brinker:]

Yes, for sure. Thanks, Matt. I’ll let Mike comment on the numbers. But relative to where we’re at and where we’re positioned, we have strong positions regionally throughout the United States and Canada, we have strong partners as well in order to deploy our solutions into schools to help with improving air quality and it’s a selling cycle that takes a period of time, and it requires multiple decision-makers. So we partner with system integrators, we partner with engineers, we partner with builders and contractors in order to do that. So it’s a network that we’ve built. We’re strong in multiple regions throughout the United States. In the areas where we recognize we don’t have that position, we know what we need to do to win. We know how to sell. We know how to partner. And we are trying to replicate that model and scale it in other regions of the United States and Canada.

[Operator:]

Your next question comes from Brian Sponheimer with Gabelli. Your line is open.

[Brian Sponheimer:]

Hi, good morning Neil and good morning Mick, how are you doing?

[Neil Brinker:]

Great. Good morning.

[Brian Sponheimer:]

Just a question on the Dana business or the business you are selling to Dana rather. Can you talk a little bit about the approval process there and what the specific holdups are, what jurisdictions are potentially the hang-ups here?

[Mick Lucareli:]

Yes, sure, Brian. It’s Mick. So, we did 2 filings; one in China and one in Germany. When we looked across the markets, both parties felt like – and eventually, there will be one in Austria, but where the volume of the business that those were the 2 primary ones. The China one, we received approval on, and that went relatively quickly compared to what we thought could happen with relations between the U.S. and China. The German regulatory approval process entered a Phase 2, which takes a lot more time. There is a lot more paperwork. There’s a lot more analysis, meetings, filings, when you get into a Phase 2. I think we want to be clear, even though its take – we are taking longer than we expected. We have got purchase agreement with Dana. Both parties are working side by side. This isn’t one party or the other. And we are just going through the regulatory process in Germany right now.

[Brian Sponheimer:]

Would it be reasonable to assume that this can get done by midyear or are we looking further out?

[Mick Lucareli:]

Yes. Unfortunately, we are not able to comment on the timing. And it’s strictly a matter of it’s something that’s outside our control, Brian. We are going to push as fast as we can. And I wish we could give you more, but we just can’t – it’s not something we can control.

[Brian Sponheimer:]

Okay. I expect to understand it. Just going to the data center business, when this is all said and done, can you quantify what you expect the data center business will be on a run rate basis in total from a revenue perspective, just so I think it really takes – it’s an exciting part of the business for you just to understand the size of it, I think, is a quarter?

[Mick Lucareli:]

Yes. Thanks. So last fiscal year, the year we just ended, our run rate for Modine is around $100 million. And next year, we expect that to grow between 30% and 40%. And looking at our compound growth rate in the next few years, we have got targets to maintain a compound growth rate of a 30% plus rate.

[Brian Sponheimer:]

Great. That’s off of me. Good luck.

[Neil Brinker:]

Fantastic. Thank you.

[Operator:]

Your next question comes from Steve Ferazani with Sidoti & Company. Your line is open.

[Steve Ferazani:]

Thank you very much. I just wanted to dig a little bit into the Building HVAC guidance. Obviously, we came off of challenging weather this past winter. When you are putting together your guidance, particularly on the AC and building side, how are you thinking about weather when you put together that guidance?

[Mick Lucareli:]

Yes. Dave, it’s Mick. It’s probably the biggest challenge the team has, and I probably drive them crazy, and it drives them crazy. It’s a combination of – we don’t try to do anything obviously with weather. We look at patterns over the last few years. There is a fair amount of replacement business that happens regardless of weather. There is the pricing trend and the material costs in the market. And the last factor the team looked at is really how did the channel end, right. What amount of inventory do we close the winter with. Sometimes if you have a late cold spell, we can end the season with fairly lean inventories in the channel. So all of that put together, we try to build what we think would be a normal market growth and we look at some third-party data factor in where we think pricing is going to go. And then the weather pattern, we try to put as – unless it’s a super warm winner, we try to position it as any kind of colder winter is more good news than a surprise to us.

[Steve Ferazani:]

That’s helpful. In terms of the significantly rising material prices, certainly have heard from other suppliers to OEs, where given the dramatic rise and the fact there is huge demand for their products, efforts to renegotiate those contracts and the price reset time, and in some cases, successfully doing so. Has that been something you have pursued? What kind of response are you getting?

[Neil Brinker:]

Yes. Certainly, that is top of mind for us. We are at a point where we are weekly managing this through my staff meeting. But yes, we are looking at it not only with materials, we are looking at it with logistics. We are looking at it with pricing pass-throughs. We are doing it with surcharges. We are monitoring our supply chain in terms of expedited freight in order to get products to us in a timely fashion and how that’s – how those costs are controlled. So absolutely, we are looking at that across all regions, across all plants and globally. And for the most part, for at least in 2 of the segments, the pricing controls that we can put in place will absorb a considerable amount of this. However, we do have the lagging effect in the HDE segment. So, that will come to time.

[Steve Ferazani:]

Okay. That’s helpful. And then just a little bit on 80-20, when we talk to companies that are further along in the process. It really starts getting down to going SKU by SKU and figuring out, alright, these products make us money. We have been selling these products for years and they are not profitable. Where are you in sort of the process in terms of getting to that type of a level or are you still very early on?

[Neil Brinker:]

No, yes, it’s a good question, and you are right. So, where we are at in terms of the process is we have collected all the information and all the data and compiled it from our ERP systems. As you know, a company that’s been built on multiple acquisitions over time, there is a lot of different ERP systems, which require us to filter the data, fix the data together so that we can make sense of it. We went through that data cleanliness process and we are now at the point where we are actually pivoting the data in what we call our data, so that we can understand the intersection of profitable products by customer, by region and by plant. So, we are working through the data. We are sifting through the data, and we are actually – we actually have information as recently as the last couple of weeks that helps us understand exactly what you just described. So, we are in the – I would say we are in the analytical phase of that versus the decision-making phase.

[Steve Ferazani:]

Any data surprised you or was the – how useful was the process?

[Neil Brinker:]

Certainly, the process was useful. There are surprises for sure. But there is always ways to react to it, and there is a technique that we can address each one of these. But certainly, I would say 75% to 80% of it, the team had a hunch and the team understood this could potentially be an outcome. And then there was the things that are on the fringes outside of the standard deviation. So, it certainly was helpful, certainly was useful and it was necessary because as we go forward, and we build 80-20 inside of our systems and our processes, we are going to want to be able to collect the data in a common way so that we don’t have to go through the enormous lift to clean the data and fix the data together. We can just have it at our fingertips.

[Steve Ferazani:]

Great. Thanks a lot. Thanks everyone.

[Operator:]

Thank you. Your next question comes from Matt Summerville with D.A. Davidson. Your line is open.

[Matt Summerville:]

Maybe one or two follow-ups. Maybe you can talk about how the M&A funnel has evolved since the last conference call you guys held and whether or not you are starting to see the level of actionability there and improved meaningfully?

[Mick Lucareli:]

Yes, Matt, it’s Mick. We have – we mentioned last time, the big part is getting that engine going again. And I would say good news is inbound calls, and the market is opening up pass the pandemic. So, we are seeing more looks at businesses. The next step for Modine that Neil and I really do we want to do is to be more targeted and proactive versus the inbound call and tying to 80-20, as we complete our segmentation and have targeted market verticals. We are building our growth strategies around those, both in technology, channels, products that we want to fill in those growth areas. In data center, we have talked about is one of the first that we are targeting with 80-20. So, I am optimistic. What I am most excited about is the balance sheet, as you know, is in a great position. And there is – as we get the automotive divestiture behind us, which has been a huge amount of resource and effort, then having the targeted – very targeted acquisition strategy is where we will be able to accelerate, I would say, and be more aggressive on the acquisition side.

[Matt Summerville:]

And then just lastly, one clarification, I think it was in your prepared remarks, Mick, you mentioned that the impact of metals-related inflation, the unabsorbed headwind that you have incorporated into your guide, that is that $20 million number you shared? Do I have that correct?

[Mick Lucareli:]

Yes. The two big headwinds are materials, and it’s about $20 million. Most of that is HDE and Auto. So again, Auto part of it will depend on when the transaction were to close, but that’s the right number. The other one is the COVID cost, recovering salaries, wages and benefits and is about another $20 million, $21 million. A little less than half of that was up in cost of goods sold with furloughs and things of that and $8 million or so in the SG&A side.

[Matt Summerville:]

Got it. Thank you.

[Neil Brinker:]

And I think it was Matt asked, I was just – I don’t know they had closed to loop on schools. I want to make sure we address that. Last year, we estimate the school market for us is about $100 million. It should be growing exponentially. This was pre-COVID numbers and pre-government spending and our sales in that market last year were right around $20 million or so.

[Matt Summerville:]

Great. Thank you.

[Operator:]

There are no further questions at this time. I will now turn the call back to Kathy Powers.

[Kathy Powers:]

Thank you and thanks to everybody who joined us this morning. A replay of this call will be available through our website in about 2 hours. We hope you all have a great day. Thanks.

[Operator:]

This concludes today’s conference call. You may now disconnect.