Modine Manufacturing Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2023

There are 8 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to Modine's Second Quarter Fiscal 20 24 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. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms.

Operator

Kathy Powers, Vice President, Treasurer and Investor Relations. Please go ahead.

Speaker 1

Good morning, and thank you for joining our conference call to discuss Modine's 2nd Quarter Fiscal twenty twenty four Results. I'm joined on this call by Neil Brinker, our President and Chief Executive Officer and Mick Lucarelli, our Executive Vice President and Chief we'll be using slides with 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. On Slide 3 is our notice regarding forward looking statements. This call will 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 Neil.

Speaker 2

Thank you, Kathy, and good morning, everyone. I'm pleased to report another strong quarter with both solid revenue growth and earnings improvements that came in ahead of our expectations. Sales increased 7% from the prior year, Driven by increases in both the Climate Solutions and Performance Technologies segment. In addition, we reported adjusted EBITDA of 81,200,000 an increase of 59% from the prior year. EBITDA margin was 13.1%, a 4 30 basis point improvement from the prior year.

Speaker 2

As a reminder, last year, we set a goal to significantly improve our EBITDA margins, targeting a range of 10% to 12% by the end of the fiscal year and reaching 13% to 15% range by the end of fiscal 20 27. We are clearly ahead of these targets driven by a combination of key factors including using eightytwenty principles to guide decision making throughout the organization, allocating additional resources to targeted higher margin businesses And focusing on the value we bring to our customers and leveraging that to drive margin improvement and profitable growth. I'm very proud of what the organization has been able to accomplish and a short period of time, I continue to believe that we remain in the early stages of our transformation as we see medium to long term opportunities for sustainable growth we'll continue to improve our financial profile. Please turn to slide 5. The Climate Solutions segment delivered an excellent quarter With revenue up 8% from the prior year, we're benefiting from the planned diversification of our businesses as strong growth in the data center vertical helping offset some weaknesses in the other HVAC markets.

Speaker 2

The segment reported adjusted EBITDA of $50,400,000 a 31% increase from the prior year. This resulted in an adjusted EBITDA margin of 18.3%, up 3.30 basis points from the prior year. Revenues in our data center business were $79,000,000 more than double the prior year. Our order intake continues to grow. That said, this business can be quite lumpy due to the timing of product shipments on large data center projects, so we're not expecting growth to continue at a linear rate.

Speaker 2

We have projected a dip in the 3rd quarter data center volume since the beginning of the year and then expect volumes to pick up again in Q4. We have significant backlog to work through over the next 12 to 18 months, we should provide some stability in the business despite the quarter to quarter fluctuation in revenues. Our commercial team continues to win orders with key relation we will be able to achieve our expectations and add new opportunities to the sales funnel as we evaluate and develop high quality prospects. Our goal

Operator

is not to be

Speaker 2

a high volume product supplier to the data center market. Instead, we're focusing on relationships with key customers, supporting them with system solutions and ongoing services As they grow globally, this includes new and existing customers that value our engineering and service model. We have great products in the space and the expertise to advance the technology to address the higher heat loads that will be required in the future. For example, we are internally developing a cooling distribution unit or CDU. A CDU is integral to liquid cooling, providing critical cooling capacity and heat removal for high density data center environments.

Speaker 2

The CDU offers controlled contaminant free coolant for heat exchangers, direct to chip and immersion cooling devices, integrating between the server and the external heat rejection. The CDU will further strengthen our global data center systems offering as we'll be able to offer hybrid liquid and air cooled systems, our CDU is being developed with the full voice of the customer and is planned to be commercialized early next year. This marks our 1st dedicated development into liquid cooling systems. In addition, we are also working on other advanced technologies and our product roadmaps, so we can continue to provide our data center customers with efficient connected systems, elevating their performance, we're helping them meet their sustainability targets around power and water usage. Moving to our HVAC and our businesses.

Speaker 2

We recently announced the expansion of our electrical heating line with 2 new product launches. Our new electric infrared line provides a low emissions heating product that can be used in a wide variety of commercial and residential applications. In addition, our new AmpDOG is the electric version of our popular HotDOG line Residential Garage and Workshop Heaters. This line provides an electric alternative with the same quality and performance that Modine is known for. These are just a few examples of our product development efforts and there are more to come.

Speaker 2

Regarding heat pumps, earlier this year, we announced our plans to expand capacity at our plant in Serbia Growth expectations for the heat pump market have been fueled by regulations driving a conversion from natural gas to electric to increase the use of renewable energy. Recently, the enforcement date of these regulations has been delayed, specifically in the German market, where the adoption date was pushed from 2027 to 2029. This has resulted in a reduction of our forecast based on the latest information from our customers. We're still planning on growth, but expect lower growth in the near term, while we adjust our overall production ramp. We still believe that this is an important market for Modi and are nearing completion of the 1st phase of our Serbian plant expansion, we had planned the investment in phases so that we could bring on the necessary production capacity as needed.

Speaker 2

This is providing us with the flexibility to respond to regulatory changes like these and allows us to take a more measured approach to our investment. We will continue to monitor this market along with regulatory drivers that are creating this volatility. And our Climate Solutions business is having an incredible year, And I'm very proud of what we've been able to accomplish. We are investing in new products and technologies now to make sure we can continue to have profitable growth in the future. Please turn to slide 6.

Speaker 2

The Performance Technologies segment also delivered excellent results this quarter with revenue up 7% from the prior year, Driven by Off Highway Commercial Vehicle and Specialty Vehicle customers, adjusted EBITDA increased 73% to $42,000,000 Resulting in an adjusted EBITDA margin of 11.9%, an improvement of 4.50 basis points. Similar to last quarter, much of the increase was due to improving commercial terms in our long term contracts, including some additional retroactive recovery. The PT business made a couple of important announcements this quarter that I would like to highlight as a prime example of our eightytwenty work. First, we announced the divestiture of 3 businesses in Germany they produce products for internal combustion diesel and gasoline engines for the European automotive market. I'm pleased to report that this transaction closed on October 31.

Speaker 2

We have been very clear with our intention to exit non strategic businesses and these divestitures are firm actions towards that goal. We will continue to pivot our resources towards strategic high growth businesses and will quickly exit or wind down business that is not meeting our margin targets. Many of these actions have already been identified and are underway. As a reminder, exiting lower margin businesses it's a critical element of eightytwenty as we remain focused on the earnings growth over revenue growth. We have anticipated this as part of our transformation strategy in the PT segment, understanding that could initially result in lower revenue.

Speaker 2

However, we also have plans for growth in our EV Systems and genset businesses that will replace the businesses we are exiting with product profiles aligned with our long term goals. This is all part of the Eightytwenty process. In addition, as we exit certain businesses, we need to examine our cost structure to make sure that it's appropriate for the size of the business. There could be some additional costs as we realign our manufacturing footprint. 1 of the businesses where we're investing is our EV Systems business.

Speaker 2

Last month, we announced our plans to expand production of our eVantage Thermal Management System to Europe. Beginning next year, we will produce battery thermal management systems and electronic cooling packages for our European customers at our plant in Pontevico, Italy. This is in addition to our existing product lines in Lawrenceburg, Tennessee, where we are in the process of adding additional capacity to accommodate increased volumes as we launch more programs. Overall, our Performance Technologies segment is firmly on track and I'm proud of the work being done by this team. Material costs continue to be favorable we have had significant success negotiating contractual improvements.

Speaker 2

We're making great progress on the Eightytwenty journey in the segment, focusing the organization on both capitalizing on growth opportunities and optimizing non strategic product lines. Now, I'd like to turn the call over to Mick, we'll review our results for the quarter and provide segment financial updates.

Speaker 3

Thanks, Neil, and good morning, everyone. Please turn to Slide 7 to review the segment results. Climate Solutions had another excellent quarter with a 31% increase in adjusted EBITDA, revenue grew 8%, including a $7,000,000 favorable FX impact. The growth was driven by data center sales increasing 117% or 43,000,000 we continue to see strong demand for our products in North America and Europe, including those supporting both hyperscale and colocation customers. As Neil mentioned, the timing of these sales can be somewhat unpredictable and shipments in the quarter once again exceeded our based on the timing of our current customer schedules, we anticipate lower shipments in Q3 we have been ramping significantly in Q4.

Speaker 3

I want to highlight that while the timing can be hard to predict between quarters, our full year outlook has not changed with growth expected to exceed 60%. HVAC C and R sales were down 2% or $2,000,000 The heating market remains soft, but has improved sequentially from Q1. We expect to see further rebound as we enter the heating season, but the weather will ultimately factor into the strength of our sales for the balance of the year. Sales of heat transfer products decreased 16% or $21,000,000 As discussed in previous quarters, we've experienced a decline in market demand with commercial refrigeration along with commercial and residential HVAC and RV customers. We believe many customers are continuing to work down excess inventory that was created during the previous supply chain shortage.

Speaker 3

Additionally, we've continued eightytwenty product rationalization activities to drive further margin improvements. We're pleased with the strong earnings conversion as adjusted EBITDA increased 31% with a 330 basis point margin improvement to 18.3%. The earnings and margin improvements were driven by higher sales volume and benefits from ongoing Eightytwenty initiatives. Climate Solutions clearly had a very strong first half of the year. The growth in data center sales was driven by a favorable market along with the investments we've made to grow this business.

Speaker 3

With regards to HVAC and R and heat transfer products, we're still maintaining a cautious outlook for the second half of the year. Given our assumptions on the heating market and the lighter data center shipments in Q3, we would expect sequentially lower earnings in Q3 we'll then close out the year with a strong Q4. To wrap up on Climate Solutions, we're remaining cautious we are in a few key markets, but fully anticipate further year over year improvements in the next two quarters to wrap up another great year. Please turn to Slide 8. Performance Technologies also had a great quarter with 7% sales growth including an $8,000,000 favorable FX impact.

Speaker 3

Revenue benefited from eightytwenty initiatives as we we continue to focus on higher margin businesses. While underlying sales volume declined by $5,000,000 or 2%, the average selling price per unit was higher. As a reminder, eightytwenty efforts in Performance analogies are focused on driving rapid earnings growth and not revenue growth. Therefore, we expect to see earnings growth at a more rapid rate than overall sales volume Advanced Solutions sales were up 30% or $10,000,000 with continued growth of our EV Systems and Components sales, along with higher sales to specialty vehicle and coatings customers, liquid cooled application sales increased 6% or $7,000,000 due to higher demand from our commercial vehicle customers along with benefits from eightytwenty initiatives. Lastly, air cooled application sales increased 2 or $4,000,000 primarily due to higher sales to off highway and genset customers along with gains from eightytwenty initiatives.

Speaker 3

Performance Technologies earnings conversion was excellent with adjusted EBITDA of 73%, resulting in 11.9% margin And a 4 50 basis point improvement. Similar to the previous quarter, earnings temporarily benefited from several 1,000,000 we have received some of the initial orders of retroactive payments that may not repeat in future quarters. As Neil mentioned, we're pleased to report that the divestiture of 3 businesses in Germany was completed on October 31. As previously disclosed, the annual revenue impact from these businesses is approximately $80,000,000 to $90,000,000 and will result in a revenue reduction in the second half of this fiscal year. While these divestitures represent lower margin and non strategic business, we're reviewing action plans to further align our cost structure to the lower revenue.

Speaker 3

We anticipate that these plans will be launched in Q3 with savings to begin in Q4. We did not experience any material impact from the UAW strike, we expect that some of our major OE customers may take extended holiday shutdowns this year. Based on all of these factors for the balance of the year, we anticipate ongoing eightytwenty progress and further year over year improvements With a sequential dip in earnings in Q3 and a step up again in Q4. And on a full year basis, we expect Performance Technologies we will report another excellent year and be within our targeted margin range. Now let's review the total company results.

Speaker 3

Please turn to Slide 9. 1st quarter sales were up 7% or 42 $18,000,000 favorable FX impact. As previously discussed, the higher revenue was driven by growth in both business segments. The gross margin improved 5 20 basis points, primarily driven by increases in volume, higher average selling prices and numerous other improvements tied to our eightytwenty initiatives. SG and A increased $10,000,000 driven primarily by higher employee compensation expenses, including incentive comp and higher product development costs.

Speaker 3

I'm happy to report that adjusted EBITDA was very strong in the quarter with an increase of 59% or 30,000,000 this equates to an adjusted EBITDA margin of 13.1% and a 4 30 basis point improvement from the prior year. This also represents the 7th consecutive quarter of year over year margin improvement. In addition, adjusted earnings per share was $0.89 And 85% higher than the prior year. Before moving to the balance sheet, I'd like to reiterate that we're pleased with performance in the quarter and there were a few areas that were better than expected. First, our shipments of data center products were somewhat stronger than we had some additional benefits in the quarter for Performance Technologies, including favorable material ratios and product mix.

Speaker 3

And as I mentioned on the previous slide, we also benefited from some commercial negotiations and settlements. While maintaining a cautious view for the second half, we're again raising our earnings outlook based on some of the first half progress. In a few minutes, I will further review how all this will impact our sequential results in the full year guidance. Now moving to cash flow metrics, please turn to Slide 10. We generated $58,000,000 of free cash flow in the 2nd quarter, which it's a nice improvement from our Q1.

Speaker 3

This puts year to date free cash flow at $85,000,000 which compares very favorably to $33,000,000 generated in the prior year. Net debt of $222,000,000 was $63,000,000 lower than the prior year end and $43,000,000 lower than the last quarter. Net debt coupled with strong earnings resulted in a leverage ratio of During the quarter, we restarted our share repurchase program and purchased 200,000 shares. As a reminder, our program is currently focused on offsetting the dilutive impact of our share based incentive compensation program. This fiscal year, we expect continued growth in free cash flow driven by higher earnings and a continued focus on working capital.

Speaker 3

We continue to anticipate full year free cash flow will fall in our targeted range of 3% to 5% of sales. Modine's balance sheet remains quite strong, which we plan to maintain in the current economic climate and stand ready to support both organic growth and acquisition initiatives. Now let's turn to Slide 11 for our fiscal 2024 outlook. As announced in the press release, we're raising our full year earnings outlook for fiscal 2024. The Q2 exceeded our expectations, leading to another increase in our profitability outlook for the fiscal year.

Speaker 3

In the Climate Solutions segment, we continue to expect data center revenue growth of 60% to 70%. Moving to HVAC and R, we expect modest revenue growth in the low single digits, maintaining the range from last quarter as we remain cautious and approach the prime heating season. With regards to heat transfer products, we now anticipate a sales decline in the mid single digits, which is a reduction from our previous guidance. This is primarily due to concerns over a general economic slowdown, especially in residential and commercial refrigeration applications And a slower ramp schedule for the heat pump market. Moving to Performance Technologies, we expect continued benefits from our eightytwenty rollout.

Speaker 3

And now that we've completed the German divestitures, we're adjusting the second half revenue outlook accordingly. We expect Advanced Solutions to grow in the 25% to 35% range, which did not change from last quarter. This growth is driven by program launches, continued demand for EV Systems and Components. We anticipate modest growth for liquid and air cooled products as we implement eightytwenty across the segment, including the impact of the divestitures. From an SG and A perspective, we're anticipating that we'll finish the full year between $260,000,000 $270,000,000 including higher incentive and compensation expenses.

Speaker 3

Let's move to adjusted EBITDA. Based on the recent results and market trends, we're raising our adjusted EBITDA outlook for the year, while maintaining a somewhat cautious position with half of the fiscal year left in front of us, we now expect our adjusted fiscal 2024 EBITDA to be in the range of $285,000,000 to $300,000,000 up from $280,000,000 to 295,000,000 And representing an increase of 34% to 41% versus the prior year. Consistent with our previous update, we anticipate that the second half will average approximately $70,000,000 of a quarterly adjusted EBITDA. We expect that Q3 will be sequentially lower based on my previous comments on the business segments with a step up in Q4. The sequential lift in Q4 will be driven by typical seasonal patterns and a strong order book in data centers, advanced thermal solutions and other key growth businesses.

Speaker 3

Shifting back to the full year, I want to reaffirm that our full year outlook is well aligned with our we expect to deliver another year of record results at Modine. In addition, we anticipate that free cash flow will further improve with the higher earnings outlook with capital expenditures expected to be around $70,000,000 Other assumptions including interest expense, taxes, depreciation and amortization are included in appendices attached to this presentation and our press release. To wrap up, we're extremely pleased with the results from the Q2 and our ability to maintain momentum towards our interim and long term financial targets. As Neil said, we're in the early stages of our transformation, but the progress has been tremendous. And we have a lot of hard work and opportunity in front of us.

Speaker 3

With that, Neil and I will take your questions.

Operator

Thank you. A confirmation tone will indicate your line is in the question for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question comes from Matt Summerville with D. A.

Operator

Davidson. Please go ahead.

Speaker 4

Excuse me, thanks. Good morning. I wanted to maybe start with a question on the data center business. The growth cycle you're in, in fiscal 2024, what does that suggest about fiscal 2025 in the context of the backlog and order comments you made and what were in the slides here. And then I'm curious if you have any update on customer diversification initiatives within the hyperscale market and any early feedback on the CDU?

Speaker 4

And then I

Speaker 5

have a follow-up. Thank you.

Speaker 3

You You want to go first on CDU?

Speaker 2

Yes, Matt. Thank you for the question. Yes, so as you know, we continue to experience growth and we continue to grow the backlog in data centers. A lot of that was driven by the fact that we've expanded our ability to manufacture globally. The CapEx investment that we made in our labs and our factories in the United States as well as in Europe to support this growth is to allow us To build the capacity to keep up with this demand that we're seeing.

Speaker 2

And we've been able to expand our product portfolio on the air cooling side as well. An integral piece of this growth was being able to develop and manufacture a chiller in the United States and North American market. So we will continue to expand our product portfolio in data centers and the next evolution of that is with the CDUs. So these CDUs are going to get us into a different area of the data center to allow us to provide liquid cooling. And that's the VOC that we've collected from both our hyperscaler and colos that as they pivot into more of a liquid cooling approach for areas where they have high heat density and heat loads, they're leaning on us in order to help them provide that solution.

Speaker 2

And this isn't new to us, Matt. We've recognized this and we've realized this. We actually Produced a CDU back in 2016. And this was before there was a market. And now that we see that there's favorable trends where we can complement our current product portfolio of cooling products and data centers, adding the CDU piece just makes a lot of sense.

Speaker 3

Yes. And Matt, on your question about next year, we're in the middle of our planning process, so a little bit early to give a definitive number for you, but I think the way we thought about it for quite a while is ability obviously to grow 60%, 70% a year is not going to be sustainable over the long term as the business gets much bigger. But we've talked about longer term growth rates in the 20%, 30% level, maybe even a little bit higher. So still really high. We'd expect very high revenue growth next year, but it won't continue at a 60%, 70% pace.

Speaker 4

And then I'd ask about any progress on hyperscale customer diversification?

Speaker 2

Yes, we continue to have conversations and advance our conversations there. It takes time. We started the process about 18 months ago and we're much further along in line with where we would expect to be. Again, adding our capacity across the globe, having the global manufacturing footprint, increasing our product portfolio with liquid cooling technologies, all is in favor of us We're able to continue to advance those conversations with the hypers.

Speaker 4

Got it. And then just as a follow-up, as I kind of think about the guidance framework you gave coming out of Q1, thinking about Q2, pretty much everything you just delivered bucked all of that guidance In a good way. And I'm just curious about the go forward guidance. Have you really seen a step function change in the demand environment? Are you looking at this saying, macro is a little choppy, there's a few nits here and there in the business, geopolitical environment is Unfortunately, it is what it is, so to speak.

Speaker 4

So maybe some conservatism here is understandable, but I'm just trying to Sort of more dig at kind of your guidance philosophy as we think about the second half and the setup given how you performed in 1H? Yes.

Speaker 3

Hey Matt, it's Mick. I think really fair question. And I think it's much more of the latter. We're not seeing a step function change in the business or any level of profitability levels, the latter which you went through that list of the uncertainties kind of across the market, geopolitical environment, a number of things in a few markets like the heating season coming up. So, I know we had thought Q2 would be a little bit of a step down from Q1 and we had another strong quarter.

Speaker 3

In there is, the other thing I guess I'd add and Neil could add any color, but as we continue to go through this transformation, the amount of complexity that we have in the organization, we're asking the leaders to manage through businesses that we are divesting, product lines we're exiting, pricing adjustments we're pushing through, growth volumes and timing, it's turned out for us in a positive way, the momentum is great, but our ability to predict with one quarter to the next with that level of accuracy, there's a large amount of complexity in the company right now. Let's just make it we're trying to be cautious of how we project for the next 6 months. Neil, do you want to add any other color around it?

Speaker 2

Yes, I mean, when you think about how difficult it is to predict change in a stable environment when we destabilize it through a lot of our eightytwenty activities intentionally for the right thing to do, we're transforming the company. When you're in The stabilized mode, we're changing many, many things all at once. It does become a little bit more difficult to predict. So we're continuing to manage it the way we do, and we want to make sure that we keep consistent with our approach in terms of how we guide.

Speaker 4

Great. Thanks, guys.

Operator

Thank you. Our next question is from Chris Moore with CJS Securities. Please go ahead.

Speaker 6

Hey, good morning guys. Thanks for taking a couple of questions. Yes, maybe I'll just start with just a quick follow-up on the data center side. So The current backlog, is that all year from air cooling technology?

Speaker 2

Correct.

Speaker 6

Got you. And what the timeframe on the CDU development, is that a couple of years? What does that look like?

Speaker 2

Yes, great question, Chris. Yes, we expect to have the ability to commercialize that in the beginning of next year. And it will grow at the rate that we see or we potentially could predict the market adoption of this. So It's a nice complement in terms of what we're doing on the air cooling side. We've got multiple technologies here with the CDU.

Speaker 2

We can do liquid to liquid, we can do air to liquid. There's just different ways to solve for the challenges that our customers see. So we're going to be able to move and deploy product at the rate that They see that growth inside of the data centers that support high density helos.

Speaker 6

Got it. Very helpful. Does the competitive landscape change much as you move on to the liquid cooling side?

Speaker 2

It's a natural extension of what we do. The competitive landscape is similar. The technologies are different. Some of our competitors have partnered with some companies that have this technology and they position themselves well with joint ventures and other things, but it's a similar space. We're familiar with it.

Speaker 2

We've been waiting for the time to make this investment when we actually start to see this market Start to stabilize and has the potential to grow. Like I said earlier, we've developed CDUs in the past. We did this 6 years ago. There just wasn't a market for it. So we believe the time is right.

Speaker 6

Perfect. That's helpful. Let me switch gears here. So Ford is postponing a $12,000,000,000 EV factory. The reasons given were unwillingness of customers to pay extra for its electric vehicles.

Speaker 6

Just wondering kind of how you look at that, any impact you potentially on ICE Auto Business or EV Business in general, just kind of your thoughts there.

Speaker 2

Yes, it's an interesting question, right? We don't focus on EV automotive. Our EV in areas that we focus in terms of the electrification is on specialty vehicles. We really look at larger EV applications that require our systems and solutions. And we've moved away from any EV related to automotive that's component related.

Speaker 2

So where we see growth and where we see the demand, we're partnered with we're on 119 different engagements with customers in the areas that we target for EV. We see 27 orders or platform wins that we're very pleased to have won. We're expanding our EV product group. We're expanding capacity in our plants in Tennessee. We just recently put out a press release that we're expanding into Europe.

Speaker 2

We're going to be producing in Italy. So we see growth in the areas that we've defined that is target for us in the EV. And again, that's in systems And in vehicles like specialty vehicles, municipal buses, school buses, last mile delivery vehicles, that's the space that we're focused on.

Speaker 6

No, I got that. I understand it wasn't on the auto side. I was just curious if you had if you're getting any Pushback from a pricing perspective. Sounds like so far so good on that front. So, I will leave it there.

Speaker 6

Appreciate it. Thank you.

Operator

Thank you. Our next question is from Jeff Van Sinderen with B. Riley Securities. Please go ahead.

Speaker 5

Hi, good morning, everyone. I know you mentioned lumpiness, I think, and a pull forward, I believe you said, into Q2 in the data Center segment, maybe you can if I caught that right, maybe you can just help us understand the dynamics there.

Speaker 3

Yes, hey, it's Mick. So definitely, we from a forecast standpoint, probably the last 3 or 4 months based on schedules from our customers, we knew the lowest quarter of the year would likely be our Q3. Those data center, what we've talked about in the past is they can be lumpy. These are we had a photo in the presentation, really large construction projects. And so we were required to have product ready to be But when they're pulled, it depends on the customer and the completion.

Speaker 3

They only want it on time, ready to go. So in Q2, we had a little bit higher revenue than we thought that was really going to be we thought would be coming in Q3. And then in Q3, we expect to have a lower amount of revenue in Q3 and a big ramp in Q4, again, just based on just consistent with our order book, but it's based on the timing of where we see the customers pulling and asking for those shipments.

Speaker 5

Okay, fair enough. And then I just wanted to follow-up on the CDU, I guess, latest thoughts on how you're approaching high performance and AI data centers. And then does the CDU address that given that it's liquid cooling or not for that market?

Speaker 2

No, that's a good question. Yes, it does address that. So anywhere where you need to augment your cooling capacity in a data center where you have the traditional air cooling mechanisms And if you as a data center or co location want to expand into higher performance, higher computing speeds because of AI or AV or ML machine learning, you would need a more efficient cooling technique and liquid cooling It's a more efficient cooling technique. So this is liquid cooling that supports direct to chip, for example, cooling to allow for the removal of heat on those heat loads on those silver racks. So yes, it is part of that those market drivers.

Speaker 2

This helps Support and solve for that problem.

Speaker 5

Okay. And I think you said that's actually going to be available in the 1st part of calendar 2024 What did you mean? I wasn't clear on that.

Speaker 2

Yes. We're looking at the 1st part of next year, correct.

Speaker 5

Okay, great. And then just one quick one if I could squeeze it in. Any update or any updated thoughts, I guess, on what you're seeing in terms of M and A, potential targets, pipeline, any more color to add there?

Speaker 3

Yes, it's ebb and flowed a little bit, but we talked maybe a quarter or 2 ago with rate hikes and Nervousness around the economy. We saw some deal flow and opportunities kind of slow down. People were hesitant to come to the market. I would say the last few months, it's been picking up a little bit for us. In addition with as Neil and I have talked about, we're continuing to have more people on the Modine side being aggressive with dialogues, discussions, knocking on doors.

Speaker 3

So we'll continue to report back, but it's 100% effort going forward and I think it we're feeling good about the pipeline with opportunity we're building.

Speaker 5

Okay, great. Thanks for taking my questions and continued success.

Speaker 2

Thanks, Jeff.

Operator

Thank you. Our next question is from Tim Moore with E. F. Sutton. Please go ahead.

Speaker 7

Thanks and congratulations on the gross margin expansion and the data centers growth. For overall Modine, I mean, it seems like you've harnessed the quickest and easier way to grow sales is through your current customers, That helps the margin profile quicker. There may be a new customer that has new engineering design cost drag. As you look out over the next 12 months, I mean do you expect to take on some more new customers outside of the EV platforms that you've been signing up? And do you think that might weigh a little bit on Gross margin expansion or do you think the eightytwenty would offset that if you're having new customers?

Speaker 2

Yes. Well, this is a good question, Certainly, we're looking at new customers in new geographies where the we've identified market facing verticals that are growth. So if you think about the genset market, you think about what we're doing in EV, with data centers, indoor air quality, absolutely. And through eightytwenty as we identify those customers, we have filters just to be Direct. We've got filters in place to make sure that we don't have erosion in terms of all the hard work that we're doing.

Speaker 7

That's great. That's helpful color. I definitely enjoyed visiting your data center manufacturing facility in Virginia 3 months ago and got a really good appreciation of the uniqueness of the offering there. That was a great Investor Day. But we really want to get to I know the opening remarks you mentioned 12 to 18 month backlog range for that.

Speaker 7

I'm just trying to get a sense If there is a shadow backlog behind that, as you talk to your customers and they plan finding more power sources of electricity to run their To location and hyperscales and you kind of think about maybe what CDU can do in calendar 2025. Do you think that your backlog is a lot bigger than maybe the 12 months to 18 months based on kind of the plans of your customers for their growth?

Speaker 2

Yes, it's a good question. Certainly, if we think about it in terms of our percent confidence, when we get to the point of backlog, we run it all the way through a funnel, Right. So when you're looking at backlog, this is a high degree, high visibility, high likelihood that the order is going to be placed or the order has already been placed. And even before that, we look at our commercial funnel and we say that it's 50% visibility and it's larger than the current backlog. And then there's A precursor to that, which is 25%, assuming that you have 25% visibility of it that that order is larger and bigger.

Speaker 2

As you get out in the out years, 3, 4, 5 years, it's much more difficult to predict. But certainly we're having conversations with our customers because as you go along that cycle, whether it's a 25%, 50% or 75%, you have to start triggering supply chain, manufacturing, operations and there's an entire process. So, yes, we have those conversations. Yes, we see and we do have visibility of it. But we don't declare victory until we have the order in hand.

Speaker 7

That's helpful. Thanks, Neil. I just have 2 more questions. Your gross margin is beat several quarters in a row versus maybe some of the commentary or what Any sense if Mick wants to take a stab at this, any chance to maybe parse out how much of the gross margin expansion maybe this quarter or recently roughly is from kind of the cost savingsefficiencies bucket Versus catch up pricing taken, we're I cover a lot of industrial stocks and a lot of them have had terrific price increases the last 12 to 16 months, but they're starting to see it slow in October November. So I'm just trying to get a sense, is the ED-twenty still a Pretty big driver as it gets rolled out more to Performance Technologies.

Speaker 7

And are you kind of tapping out on maybe the pricing catch up?

Speaker 3

Yes, yes, that's a fair question. I would answer it 2 different ways or Two ways that we break it down by climate and by Performance Technologies. Climate Solutions and very intentionally as part of the transformation, the strategy has shifted towards a heavy lean on growth. And so most of the margin improvement we've been seeing in Climate solutions over the last two quarters, I would say is driven by growth. And yes, there's mix in there, but we're growing the businesses that we want to grow have high margins and margins where we want them to be and data centers is a good example.

Speaker 3

Performance Technologies, again, and Neil has talked about this for a couple of quarters, we specifically pace that. They are deep into the early phases of Eightytwenty. So for Performance Technologies over the last couple of quarters, they've had a much bigger margin drive based on I would combine it, it's not just pricing, but Product line simplification and with that is cost reduction and throughput and productivity. So, yes, we continue to thank Performance Technologies for a bit. It's going to be cleaning simplifying their business focused on margin improvement with a heavy dose of growth in EV and then we would expect probably a year out, Performance Technologies will continue to then identify those pockets where they see above market growth rates.

Speaker 3

So hope that answers the question for you.

Speaker 7

Nick, that definitely did. That was really good granularity and gives me more optimism about the runway for margin expansion from this technology and even climate, Unlike some other industrial companies, you're seeing their pricing power halves this quarter. But my last question is around your SG and A expense. I know it ran a bit high, 11% this quarter, and it seemed like the implied guidance you gave for this year is about 2.4% or so 10.4% So sales, I know you guys have been focused obviously on the operation side and for a good point, the gross margin expansion has been phenomenal. But Do you think maybe next year there's some opportunity to maybe get some more SG and A leverage out and get that down to 10% instead of maybe 10.4?

Speaker 3

Yes, the way I think about it, I'll give you my view and if Neil wants to add any color. There was if we go back again to when we announced the transformation And Neil coming in a 5 or 10 years of really leaning out Modine and focused on SG and A. Over the last year, we have reinvested in some key areas to support growth and people it's everything from procurement to product development and I think everybody sees the amount of earnings growth coming from those. But we will plateau, I call it kind of maybe reloading where we needed we had some gaps in SG and A, so I would expect we'll have SG and A dollars growing to that range I provided. And then, at that point, I think from a percentage of sales, that's a fair question.

Speaker 3

I think we'll peak out or even start to leverage a little bit as a percentage of sales, the SG and A.

Operator

Our next question is from Matt Summerville with D. A. Davidson. Please go ahead.

Speaker 4

Thanks. Couple of questions. First, talk through data center expectations a bit. You talked through the heat pump side of things. There's 3 other high growth verticals that you guys have talked about in the past.

Speaker 4

Could you maybe more directly address kind of what you're seeing there, what expectations may look like for revenue this year, where are the pluses And minuses in those remaining 3? And then I have

Speaker 5

a couple of quick follow ups.

Speaker 3

Do you want to talk genset?

Speaker 2

Yes. So we continue to develop in the genset market some advanced products that we believe we're going to be able to move into to expanding our customer So certainly, we still believe in the numbers behind genset. We still believe in the market. We see the tailwinds behind it and it's favorable to the work that we're doing. So genset market is on path.

Speaker 2

I'll let Mick give the numbers when I finish on the other 2. EV, we continue to develop new product. As we mentioned, the that we're moving into in Europe because of the potential demand in the out years. We're winning on platforms and we've launched additional new product. In indoor air quality, we're starting to continue to see the impact and effect of the CARES Act and the ESSER funds, we're seeing tailwinds out to 2026 with our school unit ventilators.

Speaker 2

So Again, we're standing behind our indoor air quality growth relative to the numbers. Yes.

Speaker 3

For the most part, those long term growth rates, especially in the growth businesses, Neil just went Drew, Matt, we still feel good about those. We'll, I think with the strong data center year, we'll probably be adjusting data center long term growth rates up to reflect this really strong year we're in. And then we still expect Similar growth rates, high double digit growth rates across all of those. And then on the heat pump side, that growth rate we think will based on what Neil said will take it down a little bit, still be double digit growth rate, but we See that being a slower ramp and taking a little bit longer to get to peak volume.

Speaker 4

Got it. And just to be clear from a modeling standpoint, embedded in the reiterated Line guide is how much headwind from either divestitures, product line exit or otherwise, I'll call it, deliberate revenue attrition?

Speaker 3

Yes. I would estimate that $40,000,000 to $50,000,000 Matt of Product, for sure the divestitures, those 3 German businesses were $80,000,000 to $90,000,000 annualized. And then we do track all of our 80 20 product line simplification efforts. And just In context for you, we just updated that. And since we started, we're over $300,000,000 Now that includes the divestitures, But over $300,000,000 of business that we've specifically targeted from a product line simplification.

Speaker 4

Okay. And then just lastly, early read on the heating season here in North America, I know that's an important business for you. Obviously, we had a really mild winter last year. But What does early selling look like into the channel? And what's your assessment of inventory levels as they sit here today?

Speaker 2

Yes. The last couple of quarters, we are looking at anticipating that we hit a bottom there relative to the amount of inventory that was in the channel and starting to see a recovery. This month, October, will be a very important month for us We track the order rates as well as November. And we're going to track those on a day to day basis To see exactly when we start to see the recovery and rebound. So I think we're near where we thought we would be.

Speaker 2

And we're going to know a lot more in the next 4 weeks how strong the recovery will be, Matt.

Speaker 4

Got it. Thanks guys.

Operator

Thank you. As there are no further questions at this time, I would now turn the conference over to Kathy Powers. Please go ahead.

Speaker 1

Thank you, and thanks to everybody for joining us on call this morning. The replay will be available through our website in about 2 hours. We hope everyone has a great day.

Operator

Thank you. The conference of Modine Manufacturing has now concluded. Thank you for your participation. You may now disconnect your line.

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Key Takeaways

  • Overall performance: Sales rose 7% year-over-year and adjusted EBITDA jumped 59% to $81.2 million, lifting the EBITDA margin to 13.1% and adjusted EPS to $0.89 (up 85%).
  • Climate Solutions growth: Revenue grew 8% as data center sales more than doubled to $79 million, driving adjusted EBITDA margin to 18.3%; the unit is developing a liquid-cooling CDU product for early next year.
  • Performance Technologies turnaround: Segment revenue increased 7% and adjusted EBITDA surged 73% to $42 million (11.9% margin) thanks to favorable contract renegotiations and 80/20 divestitures of non-strategic German engine businesses, refocusing on EV systems and gensets.
  • Strong cash flow & balance sheet: Generated $58 million of free cash flow in Q2, reduced net debt to $222 million, and resumed share repurchases to offset incentive dilution, with full-year free cash flow expected at 3–5% of sales.
  • Raised guidance: Full-year adjusted EBITDA outlook was boosted to $285–300 million (up 34–41%), with a modest Q3 dip forecasted before a stronger Q4 and segment growth targets maintained for data centers (60–70%) and Advanced Solutions (25–35%).
A.I. generated. May contain errors.
Earnings Conference Call
Modine Manufacturing Q2 2024
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