Modine Manufacturing Company

Good morning, and thank you for joining our conference call to discuss Modine's third quarter fiscal 2023 results. I'm joined on this call by Neil Brinker, our President and Chief Executive Officer, and Mick Luccarelli, 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 on the Investor Relations section of our website, modine.com. On slide three 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 is my pleasure to turn the call over to Neil.

Thank you, Kathy, and good morning, everyone. I'm pleased to announce another strong quarter with sales up 12% and adjusted EBITDA up 36% from the prior year. Mick will go through our financial results in more detail, but before that, I would like to provide an update on our transformation, focusing specifically on our 80-20 activities as we make progress towards our strategic goals. It was actually on this call two years ago, my first with a company, that we began outlining our vision for the new Modine and the role that 80-20 would play. The initial steps were to simplify and segment the organization and align the teams around specific strategies for each market vertical. Once those steps were complete, our leaders began creating a high performance culture driven by prioritizing and focusing our resources on our best returning opportunities. All of these activities were done in preparation for driving focused and sustainable growth. As I mentioned last quarter, the climate solution segment was the first to launch 8020 and is well along in its journey. The best example of this is in data centers, which was the initial pilot for our 8020 initiatives. Fast forward to where we are today, and we couldn't be happier with our progress. We stood up the data center organization and immediately began expanding our manufacturing capability to bring our existing products to new markets. Our new chiller plant in Virginia is now up and running, and we have shipped our first products off the production line early last quarter. This is an important step for us, as it allows us to be a full system supplier of data center products in North America with local production capabilities. In addition, throughout the climate solutions segment, We are sharpening our commercial acumen by identifying and developing relationships with our top sales prospects and by providing our best customers with exceptional service in order to strengthen existing relationships and drive brand loyalty. We are strengthening our distribution model and simplifying our product offerings through SKU reduction for better focus. All this is leading to improvements across our business. Our segment adjusted EBITDA margin this quarter of 14.2% as more than 300 basis points better than last year. And its run rate is tracking well towards the two-year target range set at our investor day this past June. Our heat transfer products group was a large contributor to this improvement. This team has simplified their business by reducing SKUs and fine-tuning their pricing model. Given the level of improvement in this business, they are now focusing on growth in key markets, particularly within the European heat pump market, where we will be increasing manufacturing capability. The rapid adoption of heat pump technology in Europe is providing a clear tailwind for this business. This glimpse at areas of the business where 80-20 is furthest along demonstrates the effectiveness of our initiatives and the impact they're having. It is also a positive indicator for areas of the business that are in early innings of the 80-20 process. While I'm very pleased with the traction and the rate of improvement within our climate solution segment, we are far from done. We will continue to drive 80-20 throughout the organization beyond the commercial team. through the supply chain and to the factory floor in order to improve our efficiency and further simplify our business. We are creating focus factories with incremental capability and capacity created by eliminating low margin product lines. In addition, we are also returning to new product development, filling our gaps or improving technologies where warranted. Please turn to slide five. In our performance technology segment, We formally launched 80-20 in the latter part of 2022, and we are well along the way in training the workforce. We have our leadership team in place, and we are working through the segmentation process. Although most of our contracts in the performance technology segment allow us to pass through metal prices, we have generally not been allowed to pass through increases in other costs, which have hurt our margins over the past several quarters. We have started to make major gains in this area, however, and have reached agreements with several key customers, This has led to incremental improvements in EBITDA margins over the past two quarters. Our product groups in this segment have a clear understanding of their priorities. In our advanced solution group, which includes our EV systems business, we continue to build our order book with one additional production order during the quarter in the last mile delivery space, increasing our peak annual revenue estimate to nearly $140 million. In our liquid cooled business, we are moving in the right direction. identifying the strategic initiatives with a keen focus on improving the efficiency of operations and those plants that are not currently meeting our expectations. Our air-cooled business has the heaviest lift ahead and has a number of key initiatives underway. One major area of focus has been the genset market, where we are building a strong book of business that will help us reach our financial targets. The key here is prioritization, using 80-20 to capture the greatest opportunities. I have tremendous faith in this team. They have negotiated key commercial improvements. They are rationalizing product lines and reducing complexity. They are proving their cost structure by relentlessly focusing on supply chain optimization. And they are introducing quoting filters to ensure that new programs meet our financial criteria. We are already seeing the improvements in their results and expect to see incremental benefits from our 80-20 actions in fiscal year 24. None of this is easy. In fact, it's quite difficult. but is a critical step in our transformation of our business and hitting our financial targets. I'm optimistic that we will finish our fiscal year on a strong note. Now, I'd like to turn the call over to Mick, who will review our results for the quarter and provide segment financial updates.

Thanks, Neil, and good morning, everyone. Please turn to slide six to review the segment results. Climate Solutions had another exceptional quarter. with higher sales volume and excellent earnings growth. Revenue was up 9% over the prior year and up 15% on a constant currency basis. Data center sales were up 68% or 16 million on strong demand from our North American customers. As Neil mentioned, we shipped our first chillers in the North American market this quarter. HVAC and R sales were up 3% or 2 million, driven by higher sales of indoor air quality products to the school market and increased sales of commercial refrigeration coolers. This was partially offset by some weakness in the heating market and 80-20 product rationalization. Sales of heat transfer products increased 2% or 3 million from the prior year. There was a modest growth across our global markets for COIL products, but we're seeing some softening in demand from residential HVAC customers. Adjusted EBITDA increased 48%, including a 370 basis point margin improvement to 14.2%. Earnings and margin improvements were primarily driven by higher sales volume and benefits from our 80-20 initiatives. The climate solution segment is far along on its 80-20 journey, and we are clearly seeing the anticipated margin improvement. In Q4, we expect data center and HVAC in our markets to remain strong, but anticipate ongoing weakness in the heating market and lower sales of heat transfer products. Please turn to slide seven. Performance technologies also had a strong quarter, with sales up 13 percent, or 36 million. Revenue was up 19% on a constant currency basis, benefiting from volume growth in all product groups, along with improved commercial pricing. Advanced solution sales were up 17%, or 5 million, with continued growth in our electric vehicle product sales. Liquid cooled product sales increased 10%, or 11 million due to solid growth in North American and European commercial vehicle sales, partially offset by softness in Asia tied to COVID-related shutdowns in China. Lastly, air-cooled product sales increased 15% or 21 million, primarily due to strong demand in the off-highway and commercial vehicle markets. Adjusted EBITDA increased 48%, resulting in an 8.1% margin and a 200 basis point improvement. As anticipated, we experienced a small positive net impact of material costs this quarter. Aluminum and copper have been trending lower. However, stainless steel prices have been increasing to partially offset that favorability. SG&A was higher than the prior year, but declined 30 basis points as a percentage of sales. As Neil discussed, the performance technology segment is still in the early stages of its 80-20 journey, but progressing very well. Adjusting our commercial agreements to better recover costs is key to margin improvement, and the team's progress is evident in our results this quarter. We continue to see strength in most of our end markets and expect further gains in both revenue and earnings in our fourth quarter. Now let's review The total company results, please turn to slide eight. Third quarter sales were up 12% or 58 million, driven by gains in both performance technologies and climate solutions. Revenue was up 18%, excluding a negative FX impact of 30 million. In the quarter, the main revenue driver was higher volume of approximately 74 million, resulting in a volume growth rate of 15%. Gross margin improved 250 basis points due to the higher volume and pricing, partially offset by the net impact of other inflationary cost increases. SG&A increased $8 million from the prior year, primarily due to higher employee compensation-related expenses, professional fees, and certain variable costs. As a reminder, last year's operating income was higher due to a large reversal of previous asset impairment charges related to auto divestiture activities in prior years. I'm happy to report that adjusted EBITDA increased 36% or 14 million. This represents 170 basis point improvement in the fourth consecutive quarter of year-over-year margin improvement. Adjusted earnings per share of 48 cents was 17 cents or 55% above the prior year. Now moving to cash flow metrics. Please turn to slide nine. Free cash flow was relatively flat in the third quarter. Working capital remains somewhat elevated as we are working through global supply chain challenges. Year-to-date free cash flow is at 33 million, This includes the negative impact of $13 million of cash payments primarily for restructuring activities, including the European headcount reductions announced last year. During the quarter, we repurchased 100,000 shares for a total of 300,000 shares on a year-to-date basis. Net debt of $308 million was slightly higher than the last quarter end, partially due to a negative FX impact. Our cash balance was $82 million, with a leverage ratio of 1.6, which improved slightly from last quarter. As we look to Q4, we expect stronger free cash flow, mostly due to reduced working capital. Now let's turn to slide 10 for our fiscal 23 outlook. We are confirming our outlook for fiscal 23 revenue growth at 6 to 12%, despite the negative impact of foreign exchange has had this year. We have slightly reduced the sales outlook in HVAC and R and tightened the range for heat transfer products, mostly due to some weakness in heating products and coils that are sold into the residential market. In addition, we slightly lowered the high end of the ranges for sales of liquid and air-cooled products. We are also holding our outlook for fiscal 23 adjusted EBITDA to be in the range of $190 to $200 million, representing an increase of 20% to 26% versus the prior year. As we look to Q4, we'll have difficult comparables in climate solutions. In particular, the year-ago period had extremely high sales and margins in heating and coil products. Given that we raised our guidance last quarter and the current economic uncertainty, we're taking a relatively conservative stance on the next quarter. That said, and based on our year-to-date results, we are clearly trending towards the high end of our guidance range. To wrap up, we're pleased with the third quarter results and our business leaders continue to execute on planned improvements. We remain on track with our transformation and progress towards our long-term margin targets presented in our investor day last June. With that, Neil and I will take your questions.