Modine Manufacturing Company

Good morning, ladies and gentlemen, and welcome to Modine Manufacturing Company's third quarter fiscal 2021 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 touchtone 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, Treasury, Investor Relations, and Tax.

Good morning, and thank you for joining our conference call to discuss Modine's third quarter fiscal 2021 results. I'm joined on this call by Neil Brinker, our President and Chief Executive Officer, and Mick Luccarelli, our Vice President, Finance, and Chief Financial Officer. I'd like to take a moment to introduce Neil, who joined Modine as President and CEO on December 1st. Neil came to us from Advanced Energy Industries, where he most recently served as President and Chief Operating Officer, and prior to that, led global sales, marketing, engineering, and operations for AE Semiconductor, Telecom and Networking, Data Center, Industrial, and Medical Markets. Prior to joining AE, Neil spent six years with IDEX Corporation in a variety of senior leadership roles. We are very pleased to have Neil leading our team here at Modine. 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. 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 is my pleasure to turn the call over to Neal.

Thank you, Kathy, and good morning, everyone. It's been a busy first two months of Modine, and I'm encouraged by what I see. I've spent much of my time connecting with the senior leadership team and getting to know the business. I'm honored to be part of a company with such a long and rich history. I would also like to share my appreciation for everyone in this organization that has gone above and beyond expectation during this past year to respond to the global pandemic. In addition to all of our employees, I would also like to thank members of our supply chain for keeping us running efficiently and for our customers who have continued to give us their business and their trust. This has been a difficult year, to say the least, and we wouldn't have been able to deliver our financial results without the hard work from all these key stakeholders. The team has also done a great deal of heavy lifting in preparing for the exit of the automotive business, and those plans are on track. As a reminder, last quarter, we announced the sale of our liquid-cooled business to Dana. Both teams are currently working through all pre-closing items, including the required regulatory approvals around the globe. This process has been initiated and we anticipate a close sometime in the June quarter. For the air-cooled business, which represents a much smaller portion of the automotive segment, we are diligently working on multiple exit strategies. As previously discussed, we have talked with several interested parties and are getting closer to a definitive exit plan. The exit of the automotive business is an important step in our strategic transformation that will allow us to further focus on the future. As the teams work through the auto exit work streams, I'm personally focused on the next chapter for Modine. These are certainly exciting and challenging times for our company, and I see great opportunity for growth and for further improvement to our business models. One of our key priorities is to expand our presence in the data center markets. The data center market in North America and in EMEA are large growing sectors with strong underlying drivers. We expect this growth to continue for some time. Modene has full thermal system expertise, innovative product technology focused on lowering cost of ownership, and a global footprint to support our customer locations. And Modene has strong relations with growing co-location customers and our key hyperscale client, providing leverage for continued growth in Europe and in North America markets. We've talked about growing our share in the data center market for some time, and let me reiterate and be clear, this is one of the best opportunities for Medin to drive higher growth and profit margins. Here's the immediate four-step plan on what we'll do differently to win additional market share in data centers. One, Organizationally, we're consolidating the leadership for data center solutions under one key leader here at Modine. We will align our organization around our customers and markets, which will remove internal barriers and increase our speed and accountability. Two, we are increasing our manufacturing capacity by leveraging our global footprint to deliver data center products at scale and in region. We are expanding capacity on our computer room air handlers by industrializing these product ranges in the U.S. and in Spain, and are also investing to build and test chillers for the North America market. Three, we will continue to invest and scale our commercial and technical team to better align with our customers. And finally, we will use the data center market as the pilot for our 80-20 initiative. Many of you know my background and success with 8020 companies, and Modine will adopt the same 8020 principles, helping shape who we are in the future. As I mentioned, we will launch a pilot within the data center business, training our team in advance of a company-wide rollout. As you may know, 8020 is a systematic way of examining a business and focusing resources on the highest growth and best returning opportunities. Our opportunity is to focus both on improving margins and accelerating revenue growth. We will eventually work through all of our other key markets in a disciplined manner. The 80-20 process and methodology will take some time to fully implement across the company, and we will invest time and money in this very important area. The results of this process have been successfully proven across many companies, and I am confident that Modine will be no different. Finally, I want to mention that our focus includes both organic and inorganic growth. Nick and I will spend significant time wrapping up an aggressive and proactive acquisition program here at Modine, specifically designed to shore up our products, technologies, and channels where it makes sense. Now let's cover our third quarter segment results on page four. CIS sales were down 13% from the prior year, primarily due to lower sales to our large status center customer, which were down approximately 19 million versus the prior year. Adjusted EBITDA was down $10 million. Similar to revenue, nearly all the earnings declined was due to the lower sales with one customer. I would like to take a minute and walk through the changing dynamics of this market while reiterating our competence in our strategy. As you know, our largest customer in the CIS segment is a hyperscale data center customer. While the hyperscale market has grown at a good rate this past year, many hyperscale providers have chosen to scale back their large-scale capital expenditures for DC construction. In order to keep pace with the growth, many hyperscale providers have leveraged the rapid growth of co-location to expand their DC footprints. During this period, we have collaboratively worked with our clients to design their next generation of Kuhn technology for large-scale data center construction. We expect that we'll see orders for these innovative and proprietary cooling products ramp again in fiscal 2022. In addition, I previously mentioned that we are consolidating leadership and focus on the data center markets to continue our growth with both hyperscale and colocation clients. At the same time, we will evaluate different alternatives to better align the external reporting of our consolidated data center business since it currently resides in two business segments, Besides the drop in sales, CIS margins were also negatively impacted by expenses to complete the final phase of our client consolidation in China. This is now behind us, and we expect those inefficiencies to improve going forward. Last, the team remains focused on improving the profit margins of our coils products and driving growth in coolers. I'm encouraged, and I look forward to utilizing our 80-20 process to accelerate this progress. Please turn to page five. The building HVAC segment had another strong quarter with sales up 6% from the prior year and adjusted EBITDA up 15%. This was primarily driven by increased sales of heating products in North America and of data center products in the UK. It continues to be a strong heating season for us with strong growth and share gains in our gas unit heater products. There has been a strong demand for replacement unit heaters this year. that more than 70% of our heaters are sold as replacement units. We also gain market share, mostly due to our strong distribution partners and our superior product availability. As an example, our hot dog brand of products, which are typically used in residential or light commercial applications, are up 35% in the third quarter versus the prior year, whereas we believe the market to be up around 10% in this product category. We've been able to be successful keeping up with the increased demand, often providing next-day shipping for these orders. The higher heating product sales also drove strong margin performance this quarter, with excellent conversion on the increased volume. In data centers, our UK business is having an extremely good year, with data center sales up 30% on a year-to-date basis. Third quarter sales were up slightly from the prior year, impacted by the timing of shipments, with several orders pushed to the fourth quarter. Our focus within data centers for this business is on the co-location customers. These clients value and need our thermal expertise. As mentioned previously, we will leverage these relationships formed in the UK and the EU to establish our business in the North America market. Please turn to page six. Sales in heavy-duty equipment, or HDE, were up 13% from the prior year, with higher sales to off-highway and truck customers in all regions as markets continued to stabilize. Adjusted EBITDA nearly doubled, with a significant improvement in gross margin driven by volume increase, along with savings from procurement and other cost reduction initiatives. This was clearly a great quarter for our HDE segment, benefiting from a market improvement that was ahead of our expectations. We expect this trend to continue in the fourth quarter as many of our customers are building safety stock. We continue to monitor a number of issues that may impact our raw material costs, including tariffs and the rollback of certain exclusions that we've benefited from in the past. We're always working to improve our manufacturing and supply chain strategies, which have been complicated by geopolitical and economic trends, including tariffs. This will continue to be a focus as we analyze our risk and implement mitigation strategies. This is another excellent opportunity to use the 80-20 methodology to quickly drive improvement and focus in on our supply chain activities. Please turn to page seven, and I'll shift to the automotive segment. Sales are down 3% on a constant currency basis, driven by lower market demand in North America, partially offset by higher sales in Asia. Adjusted EBITDA for the segment was $12.3 million, up significantly from the prior year, primarily due to the improved plant efficiency and the benefit of cost-saving measures. We expect further uncertainty in this market due to ongoing economic weakness, and in addition, we may be impacted by the current disruption to the auto industry resulting from shortages of semiconductors. We did not see a great deal of impact from this in the third quarter, but anticipate that it could start to impact volumes in Q4 as more and more automakers halt production due to chip shortages. As I mentioned before, we are diligently working on our exit strategy for this segment, including closing on the sale of liquid-cooled business that is still pending regulatory approval. With that, I'll turn it over to Mick to review the total company financial results.

Thanks, Neil. And good morning, everyone. Please turn to slide eight. I'm pleased to report a good third quarter, and before walking through the underlying results, I'd like to review two large items that impacted our GAAP results this quarter. First, we recorded $134 million of impairment charges primarily related to the liquid-cooled automotive business. As a result of our agreement to sell this business, we wrote down the associated assets. Upon closing, we would anticipate reporting a final and much smaller non-cash loss on the sale. Also, connected to the third quarter impairment charges, we recorded valuation allowances on deferred tax assets in the U.S. and abroad. These were partially offset by tax benefits related to the impairment charges. The net tax impact of these items was $79 million. In order to provide a true comparison, slide 8 is focused on adjusted operating metrics. As usual, our appendix includes an itemized list of adjustments and a full reconciliation to our GAAP results. Third quarter adjustments totaled $139.1 million, mostly comprised of the non-cash asset impairment I just reviewed. The remaining balance includes $3 million related to the automotive exit, along with $1.7 million of restructuring activities, environmental charges, and CEO transition costs. Now, shifting to the key metrics, third quarter sales increased by $11 million or 2% as compared to the prior year. The increase was largely driven by favorable currency translation. I'm happy to report gross profit of $83 million which was higher than the prior year by $9 million. Our gross margin once again exceeded 17% and improved 160 basis points. The higher margin was achieved through procurement, operational efficiencies, and various spending reductions. As discussed last quarter, we ramped down our COVID savings during Q3, which is leading to more normalized costs and margins as we go forward. SG&A finished 12% or $7 million lower than the prior year. The largest reduction relates to lower automotive separation costs. We also benefited from permanent cost reductions executed late in the prior fiscal year, as well as temporary COVID-related cost savings. Despite the pandemic and challenging market conditions, adjusted EBITDA improved by 3 million, including a 40 basis point margin improvement. Our adjusted earnings per share of 41 cents was 4 cents, or 11% higher than the prior year. Similar to the previous quarter, the improved Q3 financials reflect the hard work of all employees around the globe. Loss of hard work, cost cutting, and dedication have resulted in higher earnings and margins during this very difficult operating environment. Let's turn to slide nine. In addition to the income statement improvements, I'm pleased to report year-to-date free cash flow of $123 million. This extraordinary performance was driven by a number of items, including operating cost reductions, reduced automotive exit spending, lower capital spending, CARES Act deferrals, and effective working capital management. We continue to repay debt with excess cash, resulting in a leverage ratio of 1.9, which is our lowest level in four years. As we look to the full year, we expect free cash flow will be negative in Q4 and due mostly to the timing of some large cash payments, including required pension contributions, higher capital spending, and working capital. Again, I want to highlight that the cash flow and balance sheet position are key successes this year, allowing us to head into our strategic transformation with a strong and flexible financial position. Now let's turn to slide 10 with our fiscal 2021 outlook. After analyzing the incremental tailwinds and headwinds, we are maintaining our full-year outlook. Our revenue guidance reflects a 7% to 12% decrease, with adjusted EBITDA falling within a range of $155 to $165 million. Although our markets are largely recovering from the pandemic, we continue to see pockets of softness, as well as rising commodity metals prices and lingering tariff challenges the recent trends in our heavy duty equipment markets are very encouraging with automotive markets semiconductor shortages need to be closely monitored while holding the full year ebitda guidance we continue to see a dip in our q4 margin due to a few transitory items including Tariffs and metal increases not yet passed through to our customers. A delayed ramp up of CIS data center shipments to early fiscal 22. A complete phase out of COVID recovery measures in Q4. Finally, our fiscal 2021 outlook includes the full scope of our automotive business, including the liquid cooled portion that is in the process of being sold. As discussed in the past, we'll continue to forecast and report the auto segment results until the transaction closes or further actions trigger a change in the accounting treatment. Given that we're a March year-end company, the team is in the middle of annual planning. That said, I'd like to share some preliminary thoughts about the end markets and earnings drivers for the new year. First, we're encouraged about good market recoveries and tailwinds across nearly all of our business segments. We anticipate very strong data center growth across the entire company. We also expect to benefit from the ongoing recovery in our commercial vehicle and off-highway markets. And for the broader CIS and building HVAC markets, we see a slow, steady recovery through calendar 21. As we head into the new fiscal year, the volume increases will help to offset some economic headwinds that many companies are encountering. The largest impacts will come from the rising commodity metals costs plus new tariffs and the resumption of employee-related costs to pre-COVID levels. Last, and with regards to auto, we expect the transaction with Dana will close sometime in our fiscal first quarter. Like many companies, we've dealt with our fair share of COVID-related challenges. However, the results show the strong focus on cost savings and cash flow. We look forward to resuming and accelerating the growth opportunities that lie in front of us. With that, Neil, I'll turn the call back to you.

Thanks, Nick. In conclusion, I would like to reiterate what an exciting time it is for Modine. With the introduction of the COVID-19 vaccine, we are on a road to recovery. But in the meantime, I'm so proud to be part of this organization that has been positively impacting people's lives during this difficult time. Since the pandemic began, our building HVAC team has emphasized how important indoor ventilation is for school environments. Our school ventilation units can greatly improve indoor air quality, lower energy costs, and help prevent the spread of pathogens in the air. clearly important objectives for our school districts around the country. Our HVAC systems clearly have a positive impact on people's lives, from keeping schools safe to intelligent cooling and greener data centers. We will continue to invest in and grow these important product lines. Lastly, I would like to say a final word about 8020. As I mentioned, we are launching a pilot of the 8020 process with our data center expansion. and have developed goals and KPIs to allow us to track our progress. I believe that this pilot and future company-wide launches will have a positive impact on all of our key stakeholders and will become the future lifeblood of Modine. 80-20 will drive our decisions, and it will become part of who we are. Although we anticipate some early positive results, this is a journey that we'll be on for some time. I'm even more confident than when I started that Modine has great potential. We will leverage the great legacy and culture to make this a truly great company. With that, we'll take your questions.

If you have a question at this time, please press the star key then the number one on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your first question is from Matt Somerville of DA Davidson.

Thanks. Good morning. Maybe just start with mentioning tariffs a couple times during the prepared remarks, rollbacks as well. Can you talk about how that's impacting Modine? What sort of financial impact we can expect in that regard, what the company can and will do to mitigate that, how much you ultimately feel you'll be able to recoup, and also that includes the recent escalation we've seen in input costs as well. So maybe just spend a few minutes parsing those things out, talking about how we should be thinking about that.

Yeah, good morning, Matt. It's Mick. I'll give you some of the numbers behind it and what we're seeing, and then I'll let Neil wrap up with all the work he's been doing with the supply chain to address the mitigation effort. So Last year, as you know, we had some new tariffs come through. There were some tariffs put on stainless steel and products we had coming in from China, and we eventually were given exclusions on those. And those exclusions, some of those were expired or removed. And now we've got some exposure there on the stainless steel side. Then late in the fall, there was a large anti-dumping tariff applied, a 50-plus percent tariff on aluminum products coming in from Europe. And that's been another large impact to the company. In the quarter, we estimate that it's about a $2 million to $3 million impact in Q4. And through our mitigation efforts, we've got both on the supply chain and where we produce, where we import materials to, and where we convert these materials to finished products. We have some mitigation efforts. We think next year that that's probably a $3 million-type net headwind for us. Obviously, if you annualize a $2 million to $3 million in the quarter, that's a big annual number. But we've got a number of actions between, you know, switching suppliers. I mentioned bringing products into different loading locations and also, you know, sharing relationships between our suppliers and our customers. So I'll pause there and see, Neal, if you want to add anything from your side. Yeah, good. Thanks, Mick.

Hi, Matt. Yeah, that's a great question. You know, this has certainly highlighted an area for us where we can improve our ability around our agility and flexibility with our operations footprint and our supply chain strategies. So we're actively looking at short-term and long-term countermeasures, on how we're going to mitigate. And that ranges from shifting production to plants that aren't impacted by the tariffs to shipping equipment from plants based on demand as well as the impact of tariffs. So this has really opened up an opportunity for us to look at our operations footprint, to look at our supply chain strategies, and break that down by commodities and come up with some very creative ways to mitigate this issue.

Got it. As a follow-up, maybe, Neil, spend a minute talking about kind of 80-20. And I know you've only been in place for about two months now, so it's still very early. But maybe just if you have some high-level observations in terms of maybe what you feel will be born out of that effort in the near term versus maybe the longer term and what sort of external metrics you might be willing to provide us so we can sort of gauge your progress there. on the deployment of 80-20 and the segmentation process associated with it?

Yeah, very good question, Matt. You know, 80-20 is a systematic way of examining the business and focusing its precious resources. And I mean they're precious here. You know, we run pretty lean on the highest growth opportunities while reducing complexity and improving the margins through product and market rationalization. And, you know, my early observations are it's we've got to get a quick win. And I think our best opportunity, I know our best opportunity after, you know, consulting with a leadership organization here is on the data center side. There's just some things that we can do right out of the gate that make a lot of sense, not only externally but internally, so that we can get a drive accountability into the teams and we can give them what they need to win. And they're very much commercial and focused with our customers. And, you know, it's pretty early in the process, to your point. We're working through what those KPIs will look like. I'm excited to say that we've got some consulting that's coming in next week that's going to help us with this journey to accelerate it. There's no need to move at a slow pace here with the data centers. I think we can accelerate that. And from that, over the next, I'd say, 30 days when we get through the data analytics, we're going to be able to come up with some pretty strong KPIs in terms of what we expect to achieve.

Great. Thank you, guys. I'll get back to you.

Your next question is for Michael Shilsky of Collier Securities.

Hey there. Good morning, everybody.

Good morning.

Great job reducing the leverage over the last, well, couple of years, really, but this quarter in particular. Give us a sense, Mick, what is the company's current kind of comfort level on what you'd like the leverage to be, and how much would you lever up for a decent-sized M&A deal should it 1% itself?

Great question, and more fun questions. We've been out for quite a while talking about keeping Modine, especially when we were 80% vehicular, a leverage ratio of 1.5 to 2.5 times. My hope, by the way, one of our longer-term outcomes is being more diversified, industrial, less capital-intensive, that we might be able to look at debt in a slightly different way But the good news is if we've got market tailwinds, we exit auto, we're quickly going to have a leverage ratio that it's already heading towards the low end of our range. So I think, Mike, one thing Neil mentioned, He's quickly accelerated our focus and asked me to do a lot of work on acquisition funnels and targets. So that's one thing. And to your question, we've got capability within our credit agreements to do three, three and a quarter leverage and no problems there. And we did that with Louvada, if you recall. So I think every situation is different, but I would say, you know, we can do three, three and a quarter times leverage, and as long as we've got a good integration synergy plan to quickly pay it down.

Gotcha. Maybe another question I can bring up quickly here is, you know, I was wondering if you could give us a quick update on anything that you're doing in the EV world. We are seeing some EV truck platforms actually come to market, small volumes, but they're starting in 2021. You've already mentioned buses. There's actually one bus company going public this year. It's one bus company going public, but just give us your sense as to what you maybe have won and kind of how you feel about your chances of putting battery-cooling technologies or other products on those kind of vehicles going forward.

Yeah. Mike, I think I talked about this a little bit, you know, last quarter and then Neil has completely jumped in with our HDE team. And as we think about 80-20 as well, the opportunities, as you know, on electrification in truck is growing quite quickly. The amount of inbound calls and the amount of development activities we have going on has really grown quite a bit. We're working with a number of mainstream companies, none of which we can really talk about in a public forum, as you can imagine, plus a number of emerging and startup companies. And the biggest success we've seen that is in production, you know, orders, development, production on specialty vehicle and bus. The truck development cycles are quickly right behind there. And then we're also doing a lot of evaluating of, you know, what other last-mile vehicles, right, will be the quickest or most logical to implement from an EV status. Neil, do you want to add anything from your view?

Yeah, no, that's a great question, and this is a very exciting area, not only for Modine but for myself. You know, I've spent a little bit of time here in Racine, especially in the tech center, and as I go back into the tech center, I look at – where we're at, and we're at an all-time high relative to EV commercial vehicle and bus activity with our prototypes. And the team has generated some pretty substantial wins in terms of early development for programs. And this EV activity is extremely exciting for me because it's just not component related. It's system related. And, you know, that's a new chapter for us at Modena in driving value and improving the value with our propositions to customers with a system-related response to solving thermal challenges in the EV section, especially with commercial vehicle and bus. So it's a great area. We're going to have some focus in that area, and the team has done a pretty good job in terms of getting out the prototypes in a timely way so that we can get some wins.

Excellent. I'll leave it there. Thanks so much, you guys.

Your next question is from Brian Sponheimer of Gabelli Funds.

Hi, good morning, everyone. Vic, good morning, and a welcome, certainly, to Neil. Neil, just a question for you, you know, taking a step back to when this courtship began. What was it about Modine that attracted you from the beginning and now, two months in, Anything that confirms or disconfirms your initial impression of the company?

Only positive confirmation. No doubt about it. No regrets at all. I mean, this has been great. My early observations in the journey as I worked with Modine, particularly the leadership and the board, was it's an environment that's ready to evolve and change. And, you know, the best foot was put forward with the transaction and and the divestiture that we're working through with Dana, and that speaks volumes in actions, right? There's a culture that's dedicated and motivated to turn the corner, and that's exciting to me. And there's very strong innovative product technologies. That was an absolute draw coming from highly engineered, diversified background. That is something that in order to be successful, you have to be innovative and creative, and I see pockets of that in Modine that we just need to untap. It has a rich legacy and a strong brand. And, you know, we're going to continue to identify those target opportunities inside Modine to support the transformation. So, to me, to be part of that change was pretty exciting. Drew me not only the team and the culture and the rich legacy of Modine and its brand, but that transformational piece. To be part of that, that was very enticing.

Yeah, I guess along the same lines, what do you think your mandate is from the board and from the shareholders?

Drive the transformation of Modine. Continue to do that and do that in a productive way while we maintain and respect the legacy of the company.

Great. Well, I look forward to eventually getting out to the scene to see you and maybe in the parking lot, but I will... We wish you the best and... I look forward to seeing what the next few years bring. Thanks, Brian. Pleasure.

Your next question comes from Steve Ferronzi of Sidodian Company.

Good morning, everyone. You've talked about the adding the data center capacity in the U.S. and Spain. On a previous call, just trying to get a sense of the timing on that, where you are in expanding that capacity. And is that part of the higher cap action Q4?

Yeah. Hi, Steve. It's Nick. No, I think Q4 will be just kind of across the board. There's been with plant shutdowns. People working remote, there's just a general backlog of some things we need to get done as the world starts to open up. And then with regards to the expansion for CIS, in Spain, we'll be up and running in our Q4, which is great on computer room air handlers, our CRAW units. And in the chiller side in the U.S., that'll be second half of our fiscal year where we'll be in production from that side. Total capital spending is another nice thing I like about this side of our business is, relatively speaking, these are not large capital investments for us. You know, large capital, you know, in total, these are probably, you know, kind of $5 million, give or take, compared to one automotive program, which can be $5 to $10 million just to launch with one customer. So we're really excited about it. And the footprints there, by the way, again, these are two existing facilities with, proven management teams. So another reason why the capital isn't overly large is we're leveraging an existing footprint in teams and employees that are quite capable to make these more complicated systems, as Neil pointed out.

Neil, did I miss anything? No, I think you added the fact that we're in North America as well expanding the footprint, not only in Spain but in North America as well. So that's great. Good question, Steve.

I just wanted to follow up on the expectation on higher metal prices and the impact. And I just want to clarify this. Did you say that those higher metal prices didn't impact the P&L in the quarter you just reported? And then the flip side of the question would be, what's the efforts to mitigate higher prices if we remain elevated for a while in terms of price resets with contracted customers or pass-throughs?

Yeah, really good question and good clarifying for us. So when I answered a little earlier, that was specific to tariffs. The other, I'd say, challenge, you know, inflationary issue that's going on as the world looks past COVID is the rapid rise of commodity metals. Everybody is seeing copper, aluminum, steel. And for us, we're heavy users of copper and aluminum, a little bit of steel. And in the quarter, we had a net year-over-year negative impact, pretty small for us, only about $2 million. The run really began in the metals since October. We've seen kind of almost a 20% increase. If you look at next year average, you know, things – hold or stay where the markets expect them to be with metals, we'll see about a 20% increase on average in raw materials. In Q4, we expect to start to see the biggest impact. The next couple quarters, as a reminder, we have a lag. We do a pass-through. So on CIS, that business segment, much more real-time as we pass through. You know, each bid spec program we use current material costs, building HVAC much the same way, more real-time pricing to current market conditions. But then we're down to HDE, which has the long-term agreements with the large OEs. Just about every customer has a pass-through agreement, and then the difference is really how they work, the lag or the timing impact of that. And we tend to think about on average is about six months. on the hde side so q you know q4 here for us q12 will be catching up uh about a six million dollars so i'm estimating impact in our q4 and next year in total probably uh again uh things stay anything can happen to metals markets but at least probably a 10 or 12 million dollar metal headwind as we try to pass through these prices and eventually catch up to the metals market that would be in addition to the tariff numbers i mentioned earlier neil yeah and i think you know that's a that's a great explanation in terms of how we we're maintaining the margins with uh with the increase in metals but in order to

maintain the material velocity, we've also added safety stock and we've added safety lead times. We've executed on advanced bookings, and we're redirecting some sea freight to less congested ports to prevent disruption. So it's not only in the margin side, but we have a lot of activity in order to maintain on-time delivery and lead times across the facilities.

It's really helpful. Thanks, everyone.

We had Matt Summerville from D.A. Davidson return to the queue.

Yeah, in the past, you've talked about, you know, the revenue associated with this large data center customer. I'm sort of eyeballing a $30 million kind of revenue number from that customer in fiscal 21. First, is that accurate? And then second, Mick, you've talked in the past about how you expect that to ramp in fiscal 22. What's your current read or current update on where you think that number goes next year?

Yeah, good question. The CIS has really two pieces. Again, for everybody, making one step back to also Neil's comments earlier, last year we had about $40 million of data center business in building HVAC. That is primarily UK systems, great margin business, right? We want to do more of that. and that's what we're also expanding globally when we mention Spain and North America. When we acquired Luvada, there were two pieces, and probably, you know, on average about evenly mixed. There's about 40 million of coils that we sell heat exchangers into the data center market, and we had one major hyperscale customer of about kind of equal size So, you know, we've run in data centers in CIS, you know, in that $60, $80 million kind of range. This year, as we go forward and what you're picking up is mostly this year, our biggest sales will be that $30, $40 million worth of heat exchangers that we sell into the data center market to multiple customers. And the large hyperscale customer over the last year has really declined in this quarter and next quarter, very nominal levels. They're in the middle of a technology transition, so much lower. I can't disclose exact numbers, math for you, but, again, think of it as 30 to 40 million of heat exchangers, coils sold to multiple data center customers. plus our one hyperscale customer. And this year in total, sales will be very, very small. And then I think you asked about the ramp up and Neil talked about it. They have, they're building their construction schedules, their site selected. We actually have completed all of our technology testing. And this is a very complicated, you know, new proprietary system for this customer. And we're very encouraged and optimistic and have a good line of sight to the ramp up in 21 here for the new sites. We would expect them to get back to a normal level this year as we start to ramp that up. One or two years into Levada, after we acquired them, we saw a really big growth. We almost kind of doubled in sales. That's hard to say beyond that point. I'd say so. Short run, we see this customer getting back to an average, a normal run rate for them. And, you know, and then beyond that, whether there's upside to hit a high watermark, too early to tell. But nonetheless, really good opportunity here for us in the new year as that new launch starts. Do you know that?

Sorry. No, I think you covered it really well, Mick. You know what? Like in any industry, when there's lots of capital deployment, there's a digestion period, right? And we're seeing some digestion periods and looking at alternative spends. The alternative spends have been in the co-locs. And the good news for us in Odin is we have products and services and offerings in both, either co-location or with hyperscale. So depending on where they spend and how they deploy their capital, we're in a good position to where we can that win both avenues.

Got it. And then just one follow up on M&A. You know, how long do you think it will take to develop a pipeline to start to cultivate deals? And is there anything you would characterize as actionable in the pipeline currently? Or is this sort of, you know, still very early innings in that process? Is it going to take, you know, the better part of, say, the next six to 12 months to get anything done?

Well, I tell you, my new boss is pushing hard. I would say we do have a pipeline. We've been maintaining a good pipeline, and there are actionable opportunities to me. And then I'll pause and let Neil answer. I think making sure we get through a first digestion of 80-20 is to ensure we're not pursuing something just transactionally, but it's filling a strategic need is where we want to get. Once we start going, as everybody knows, it's a multi-month, all-encompassing project, plus the integration. So personally, I like to make sure we go after the most important. And what Neil's asking us to put together is think of it as a scorecard and a force ranking. What's in the pipeline with actionable? But then how do we force rank them?

Yeah, and I think, you know, Mick and the team has done a really good job in terms of thinking through exactly that. And then we want to overlay that with a filter, right, a strategic filter in terms of where we want to go with our acquisition strategies. Does it fulfill a strategic initiative? Does it fulfill a strategic need? Is it backwards, forward, or sideways integration? What are the opportunities for us? If they hit a certain profile, we'll have a different type of profile for our targets. And then we'll monitor the milestone processes that check through the filters, and that's exactly the system, the rigor and the discipline behind that that Mick and his team are starting to put together. And then an 80-20 will be a very good lens for us to start to introduce some potential candidates inside of that filter.

Great. Thank you, guys.

I'm showing there's no further questions in the queue. I'd like to turn the call back to Neil for any closing remarks.

Yeah, one last comment. I'd like to recognize Mick for his leadership as the interim CEO. Mick did a great job stabilizing the company and preparing the organization for change. His efforts have allowed for a very smooth onboarding and transition for me, and I thank Mick for his commitment to Modine.

Thank you, Neil. And thanks, everybody on the line for joining us this morning. A replay of the call will be available from our website in about two hours. We hope everybody has a great day. Thanks.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.