Modine Manufacturing Company

Good morning and thank you for joining our conference call.

Nine percent or eight million driven by lower sales of heating products versus a strong quarter last year, partially offset by higher cooler sales. The heating market decline was mostly driven by a reversion to normal pre-COVID levels, along with a relatively mild winter. Sales of heat transfer products decreased six percent or eight million from the prior year, As discussed last quarter, we anticipated some market softness around residential applications combined with 80-20 rationalization and difficult comparisons to an exceptionally strong quarter last year. We are pleased with the very strong earnings conversion as adjusted EBITDA increased 8% resulting in 100 basis point margin improvement to 15.9%. The earnings and margin improvements were primarily driven by commercial pricing, positive sales mix, and benefits from our 80-20 initiative. As Neil previously explained, the climate solution segment is performing well and is about a year ahead of schedule in meeting their margin objectives. We expect these improvements to continue in fiscal 24. Please turn to slide 8. Performance Technologies also had a great quarter with sales up 13% or $42 million. Revenue was up 16% on a constant currency basis, benefiting from both volume and pricing improvements. Advanced Solutions sales were up 25% or $8 million with continued growth in our electric vehicle product sales in both North America and Europe. Liquid cooled application sales increased 9% or $11 million due to higher sales to commercial vehicle and automotive customers. Lastly, air-cooled application sales increased 13% or 21 million, primarily due to strong demand from off-highway customers with higher sales in genset or stationary power applications. The performance technology team is deep into 80-20 activities, and the early results are clear, with strong earnings growth this quarter. Adjusted EBITDA was up 51%, resulting in a 9.1% margin and a 220 basis point improvement. As Neil discussed, the performance technology segment is clearly building momentum with sequential margin improvement during the fiscal year. We are tracking towards our investor day margin targets and expect the improvements to continue as we see additional benefits from the ongoing rollout of 80-20 throughout the segment. Now let's review total company results. Please turn to slide nine. Fourth quarter sales were up 8% or $44 million driven by gains in both performance technologies and climate solutions. Revenue was up 11%, excluding a negative FX impact of $18 million. Growth was driven primarily by $51 million of higher volume, resulting in a 9% growth rate. Commercial and materials pricing added another $9 million. Our gross margin improved 160 basis points, primarily driven by higher volume and pricing. SG&A increased $7 million from the prior year, primarily due to higher employee compensation related expenses. I'm very pleased to report that adjusted EBITDA was higher than we anticipated in the quarter, with an increase of 16% or $9 million. This represents a 70 basis point improvement and the fifth consecutive quarter of year-over-year margin improvement. Please note that earnings per share on a GAAP basis was $1.69, which was $1.53 higher than the prior year. This was mostly due to the reversal of evaluation allowance on certain U.S. deferred tax assets, which resulted in income tax benefit of $57 million. This is additional good news and reflects the improved earnings outlook in the U.S. Excluding the valuation allowance impact and the impact of restructuring and environmental charges, adjusted earnings per share for the fourth quarter was 67 cents, an increase of 10 cents or 18% from the prior year. These adjustments can be found in our non-GAAP reconciliations in the appendix of this presentation. Now moving to cash flow metrics, please turn to slide 10. We generated 24 million of free cash flow in the fourth quarter, resulting in 57 million of free cash flow for the fiscal year. The full year cash flow includes the negative impact of 18 million of cash payments, primarily for restructuring activities, including the European headcount reductions announced last year. Net debt of $286 million improved by $22 million during the quarter, resulting in a leverage ratio of 1.4 times. During the quarter, we repurchased another 100,000 shares for a total of 400,000 shares for the fiscal year. As we look to the next fiscal year, we expect continued growth in free cash flow driven by higher earnings and a continued focus on working capital. Modine's balance sheet remains quite strong. ready to support our growth and acquisition initiatives. Now let's turn to slide 11 for our fiscal 24 outlook. First, fiscal 24 is fully aligned with our financial targets presented at the Investor Day last June. We are expecting most end markets to remain relatively stable with strong backlogs and climate solutions. We're also anticipating strong revenue growth in targeted markets, data centers, indoor air quality for schools, and electric vehicles. Last, we are proceeding with product rationalization through 80-20 activities and expect volume decreases in certain areas that we've chosen to de-emphasize. As a result, we believe total company revenue will grow in the range of 4% to 10%. In the climate solutions segment, we expect data center revenue to grow 15% to 25%. As previously mentioned, we have a strong backlog going into the year, especially in North America. We anticipate HVAC and R revenues to grow in the mid-single digits as we expect some ongoing market softness, particularly in the residential heating market. However, this should be more than offset by the growth in school products, commercial refrigeration, and commercial heaters. We also expect modest heat transfer product growth as strong growth to the heat pump market will be somewhat offset by ongoing weakness in residential applications and product rationalization from 80-20 actions. Moving to performance technologies, we expect continued momentum from relatively stable markets and benefits from our 80-20 rollout in this segment. We expect advanced solutions to have a growth rate in the 25% to 35% range driven by program launches and continued demand for EV systems and components. We expect lower growth for liquid and air-cooled products as we roll out 80-20 throughout the segment. Market growth and additional pricing benefits will be partially offset by product rationalization as we continue to de-emphasize low margin business. From an earnings standpoint, we anticipate another strong year in terms of earnings growth and margin improvement. We expect fiscal 24 adjusted EBITDA to be in the range of 240 to 260 million, representing an increase of 13 to 23%. As we look to the quarterly run rate, we anticipate some ongoing seasonality, with Q1 being the lowest quarter, then increasing sequentially through the year. That said, we fully expect the first quarter to show strong year-over-year earnings and margin improvement. With regards to cash flow, we anticipate further improvement in free cash flow with capital spending to be approximately $70 million. Other assumptions, including interest expense, taxes, and depreciation amortization are included in the appendices attached to this presentation and our press release. To wrap up, we are very pleased with the fourth quarter and fiscal year results, including record results in fiscal 23. We're on track with our transformation and we're working towards the long-term margin and revenue targets presented in our investor day last June. As a result, we look forward to another year of improvement in fiscal 24. With that, Neil and I will take your questions.

If you have a question at this time, please press the star then one key on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star then two. if you would like to remove any questions from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for any questions. And our first question comes from the line of Matt Somerville with DA Davidson. Please proceed with your question.

Thanks. Excuse me. Morning. Wanted to first talk about 80-20 specifically as it pertains to performance tech here. Given kind of the analytical segmentation process you've now completed, how does that inform your kind of go-forward strategy with respect to that business? And you kind of touched on the fact that we should start to expect some deliberate revenue attrition. From rationalization, I think you're calling it. How much revenue attrition should we be looking at this year and next based on what you're thinking today as it pertains to both businesses? And then I will follow up.

Got it, Matt. Thanks for the question. This is Neil. Yes. So six months into it with the performance technology side of the business and as they continue to get more intelligence and information that they're learning how they want to continue to what I'll say sub-segment further into the business so that we can have our organizational line behind those very specific verticals. So we have some ideas, we have some concepts that we're working through, and I would expect to be able to line up on some firmer ranges probably within the next couple months.

Got it. Maybe I'll pivot over to data centers.

Can you talk about How much of that business is in North America versus Europe? What kind of relative growth rates you're seeing in those geographies versus the guidance? If you can also speak to both the hyperscale and co-location markets as an overlay to that. Thank you.

Yes, this is Neil again. Thanks for the question, Matt. Certainly, the majority of the revenue that we're seeing is from Europe. That's where the core of the business is as we continue to ramp up our facility in Virginia that supports the data center market. We're gaining share. We're winning business in the North American market. That continues to be a growth area for us. That area is growing at a much faster rate than it is in Europe, albeit they're both growing They're both growing. So we have that focus. We've partnered with the right customers. We have the right technology. And we're excited about the products that we have. The products that we have help our customers meet their sustainability targets, and we're seeing that pull through in both Europe and North America. So growth in both, but it's faster in the North America side. Relative to the co-location market still is strong. especially with the customers that we've aligned behind where we're providing the unique solutions that they're looking for. Our focus and through 80-20 in terms of making sure that we have our best opportunities in front of us with our customers to help them essentially grow in the market space that they're in is actually starting to pay dividends. So that focus and that energy on the critical few is why we're seeing the growth in Europe and North America as well. On the hyperscaler side, we're not seeing any slowdown there as well. We're still connected with a large hyperscaler customer. We're working with new product development with the next generation data centers, and we're pretty far along in that process.

Thanks, and then maybe if I could just sneak one more in. If you look at the plus 4% to 10% sales guidance, can you maybe talk about where the two businesses, where you expect them to fall relative to that range, and then if you can maybe talk about incremental cost savings you expect in 24 over 23 from the European restructuring. Thank you.

Yeah. Hey, Matt. It's Mick. I'll take the first part of that. I think within the range itself, we've got that, you know, the lower end and the high range. So, just first broader speaking to your first question, I think planned product rationalization as you know in the past in early phases of 80 20 it's hard to predict which customers or business will drop off and sometimes it stays much longer than we expect and with the higher profit margin on it we're quite comfortable with that so first i would say i think the big difference between our low end and high end is really just trying to have a crystal ball about exactly which business will wind off or not. And then within your question for climate and for performance technologies, both are really going to be kind of within that range, not really too far off. I guess I'd probably expect slightly higher revenue growth across climate than performance technologies. But that said, we've got a lot of good program launches in performance technologies around power generation gen sets and significant commercial pricing initiatives kicking in this year, which will both help the top line for performance technologies. And then at the end, you had a question. If you could just repeat. I think it had to do with restructuring.

Yeah, how much incremental cost savings should hit the PML in 24 versus 23 from that European restructuring that you've completed?

Yeah, we've got rolled through most of it. I think net, Matt, I would expect about a 5 million net just in that German European headquarters region as far as net savings in the new year.

Great. Thank you, guys.

And the next question comes from the line of Brian Sponheimer with Gabelli Funds. Please proceed with your question.

Hi. Good morning, everyone, and congratulations.

Thanks, Brian.

A couple questions. One, on just the balance sheet, we saw, you know, good cash flow performance, but also on a year-over-year basis, you've got an extra $30 million or so of receivables. 40 million of inventory. Can you just talk about the working capital needs of the business as you kind of transition in 80-20 and whether there's any sort of collection that you're thinking about as you work through the year?

Yeah. Hey, Brian. It's Nick. You're right. Really kind of beginning with the post-COVID supply chain, we've seen inventory rise in the last 12 to 18 months. And the plan is to continue to work that down as really availability of parts is much improved. So there's some improvement we have there. Accounts receivable, too, a little bit higher than we normally have and expect. I think part of that has been a lot of the 80-20 initiatives, too, as you can imagine, as we are talking to customers and negotiating and renegotiating prices at times that can get caught up in AR. But short answer is generally speaking, we see kind of a flat level of working capital. So we're going to hold working capital while continuing to grow revenue. And then that should convert nicely from a free cash flow standpoint.

Okay, appreciate the color there. And then, you know, you had mentioned that you're about a year ahead of where you wanted to be in into margin targets for performance tech, I'm sorry, for climate solutions rather. Does this mean that you are just simply ahead of plan or is this potentially that you see greater possibilities as to where the profitability of this business can go?

Yeah, I'll go first, Brian, to Mick again, then Neil can jump on. Yeah, good question. We should be clear that we were really happy about how fast that team, I think it was about 370 basis points this year, first year out, drove the margin improvement. From there, when we were in our analyst day, we had goals from years two to five to push that margin higher. Yeah, short answer is we expect to drive further margin improvement. We don't see it peaking out here, but really that almost 400 basis points was faster than we thought in year one. We won't do that every year, but we expect to drive it higher each year. You know anything to add?

No, that's a great summary.

Well, great. Congratulations. Look forward to seeing what you all do next.

Thank you.

Thanks, Brian. And the next question comes from the line of Tim Moore with EF Hutton. Please proceed with your question.

Thanks, and congratulations on the strong EBITDA growth against a year ago high growth comparable. You know, just maybe shifting gears for your internal combustion engines auto business, not the EVs that you're ramping up on, but, you know, it seems like the ICE business is still maybe a little bit misconceived or biased by some investors. Isn't that just only maybe a $300 million sales business or 13% of your sales and you possibly might have stopped taking new orders on that and those margins are probably going up because of pricing hikes you've done?

Yeah, it's a relatively small portion of the business overall. In PT, the revenue has declined year over year, certainly. We're still actively working with our customers there. We're serving some products. We have certain thresholds and filters that we put in place through our 80-20 analytics. And if we can provide a solution that meets those margin targets and those thresholds because we have the technology and there's value there, that's what we're looking for. And we're going to continue to shift our focus more on the system size as well.

Great. That's helpful, Collar. I can't imagine the margins going up there compared to a couple years ago. Maybe just switching gears to your European production capacity expansion for the heat transfer pumps at your Serbia plant. Did I hear correctly earlier on the call that you mentioned you expect those sales to double? And I'm just kind of curious over what timeframe are you expected, given kind of the credit subsidy for houses in Europe?

Yeah, so I'll let Mick give you the timeline on that. But we're excited about that space and that market. So we have expanded our facilities there on our campus in Serbia. We're in the process of buying capital equipment, getting that equipment into the plant so we can start up the first of several lines that we need to put in place because the order book is so healthy. It's a highly regulated market and we certainly see that market as multiple years in terms of growth. So the team is in place. The team is putting in the capital and the infrastructure and we've got a pretty healthy order book.

Yeah. Neil, we've talked about that doubling within three years on the heat pump side. Currently, a little bit more than $50 million, but growing really rapidly over the next few years.

Great. That's terrific to hear and seems like a terrific use of capital allocation. You gave some color around the first quarter of this fiscal year, being the lowest sales figure and then sequentially growing. I'm just trying to think about the gross margin expansion magnitude cadence. Should that also improve sequentially each quarter? And I'm just wondering, will the June quarter possibly be a lower gross margin than this quarter you just reported, March? Just kind of curious about that.

Yeah, a really good question. I'm glad you followed up on that. We do have, we still have a little bit of seasonality at modine where q4 tends to be really strong q1 can be a typically the last few years has been the weakest quarter of the year and that has to do with some of the business on the climate side ramping up in hvac and schools it's also the the slowest part of the heating year but um so coming off of a really strong q4 that's we want to be sure we see Q1 being lower than Q4, both in probably margin a little bit and in earnings. But if you look at it year over year, Q1 we fully expect to be up significantly in revenue, up in gross margin, and up in earnings. Can't really roll forward Q4 to Q1, but Q1 on a year-over-year basis, we expect to be fully in line with our guidance. Hopefully that helps.

That's exactly what I was looking for and kind of what I thought might happen. So that's really good that investors know that for seasonality. My last question is around the data center's chilling business. In the U.S. and North America, it obviously appears you have a strong line of sight on revenues there, the co-location and hyperscale businesses and orders. Feel free to correct me if I'm wrong, but did I recall correctly you expect maybe $100 million in sales from North America this fiscal year? And I'm just wondering maybe as you think out the next few years, how does your growth trajectory look for maybe next fiscal year? I mean, maybe you could do this year something like $150 next year and eventually $300 million a few years down the road. That's what we're doing.

Yeah, that's a great question. Because it's such a focus for us, you're right. You know, when you think about those growth rates, we're building the capacity in today. I think we've been really clever in terms of how we're utilizing our manufacturing footprint and where we're making investments for manufacturing space as well as labs to support this growth. But we have visibility in the market. We see where we fill a gap with our technology, and we're building our capacity expansion model to fit those type of growth rates.

Well, thanks, Neil and Mick.

Yeah, I was just going to add, coming off of this year, we'll have wrapped up a little bit north of 150 million of data center sales globally. And we should expect to grow over the next three years. Similar rate, probably in the 15% to 20% range over a three- to five-year window. Obviously, this year, we've got the next fiscal year much higher growth rate, a lot more visibility in our guidance there, 15 to 25. But if you want to roll it forward, I think that 15 to 20% over a long term is a good current target for us.

That's terrific color and granularity. Thanks, Neil and Mick. That's it for my questions.

Thank you. Thank you. And as a reminder, if you have any questions, please press star then 1 on your telephone keypad. A confirmation tone will indicate that your line is in the queue. You may press star 2 to remove any questions from the queue. For any participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. And our next question comes from the line of Steve Ferrazani with Sidoti and Company. Please proceed with your question.

Good morning, Neal, Nick. Appreciate all the color this morning. I wanted to follow up on the heat pump market in Europe, which we know has been very, very strong, supported by government incentives. You're talking about the potential to double it, but we saw some of the trade association data and some of the reporting from some smaller Scandinavian heat pump providers this quarter were up substantially. So I'm a little bit surprised your heat transfer products was down. Are you capacity constrained there right now, or is that just a much smaller part of the overall HTP.

Yeah, it is. You're right, Steve. For the moment, it's smaller, but the trends and where we're headed with it, it'll be substantial. But yeah, that's exactly right. That's why we've invested in that additional plant. We've invested in the lines that are necessary for that. So we're starting to ramp that up. We're running 24-7 with the capacity that we have as we start to expand that capacity in Serbia.

Excellent. Okay. And I may have missed that we covered so much ground this morning, I know. Did you provide a fiscal 24 CapEx range?

Yeah, we expect that to be around 70 million or below.

Seventy million?

Yeah, 70 million.

And then we also provided in the appendix, it's important to point out with the valuation allowance coming off the U.S., we'll go back to being a taxpayer in the U.S., which is a good situation, but we're guiding to about a 26% effective tax rate in the new year. And then with rates up a little bit, we had guided to interest expense, being in 23 to 25 million range fees.

Okay, that's helpful. Thank you. I wanted to touch on school retrofits with all the discussions in Washington right now in terms of pulling back some unused funds. Any risks right now to how that market is playing out and you still expect, and I don't want to obviously can't predict government decision makers, but how are you thinking about that market playing out over the next two or three years as it currently stands?

Yeah, it's a good question. I literally just got off the phone with the general manager of that business yesterday asking that very question. And we're comfortable with where we're at in terms of the orders. We're comfortable with the production rates that we're running to. We have visibility beyond a year in terms of what the order intake looks like. So in the short term, even over the next, say, 18 months, we're comfortable with what our position's been.

And just on capital allocation, starting to develop any kind of plan for M&A now that you're starting to become a more significant cash flow generator and balance sheets in great shape?

Yeah. Hey, Steve. It's Mick. Yeah. Neil and I have talked for a few quarters. I think we went back a year ago where our message was head down, implementing 80-20, starting to generate cash. The last few quarters was we've really rebuilt uh and added some really strong skills on the business development side trying to refill the funnel as we look today i think neil and i are a lot more encouraged and optimistic that we're now starting to see some potential targets in the funnel that can be actionable in the next year or so so really good progress from the the whole business development team yeah i would just add one thing to that steve is that

Because of the success that we're having organically, with the changes that we're making organically, with the businesses that we're growing organically, we're ahead of what we planned to be a year ago in New York with Climate Solutions, and we're kicking it off in PT. Organically, we have pretty good control around it. So when we're thinking about M&A, we're thinking about technology. Where do we fill technology gaps? It's not as if we need to do large acquisitions to catch up with the goals that we put in place, but really, where do we want to grow Where do we want to make sure that we have leading-edge technologies so that we can continue to support our growth verticals, particularly those in climate solutions?

And when we think about those as not net, you wouldn't be focused on it as being accretive or not accretive. You would be thinking about trying to fill a hole that maybe provides better longer-term growth?

Correct.

Yeah. And anything bigger on the radar screen, or would you be focused more on the bolt-on type size?

Yeah, we continue to focus on the bolt-ons. And then within our pipeline, we've been pretty consistent that there are always going to be a few targets that we keep our eye on that are larger. And you can't control when things come to market. But if we had our way, we'll continue to focus on some of those midsize ones that we can tuck in under the technology and product roadmap.

Great. Thanks, Neil. Thanks, Mick.

And the next question comes from the line of Florence Daisy with DC Capital Advisors. Please proceed with your question.

Hi, good morning, Neil and Mick. Thanks for taking the question. I have a question. How does the acceleration in AI rollout and development impact your business? I'm guessing it's more on the data center side, what sort of opportunities does that present and how are you thinking about investing in that area going forward? Thanks.

Hey, Flo. Good to hear from you. This is Neil. Great question. That's a very relevant question. As we start to see these technologies shift, it's really important that we as a supplier, a critical supplier in this space and data centers provide current technologies to support that. So we're working with our customers as they start to evolve in the data center space, moving away from the traditional computing to high-performance computing, which supports AI. It supports a lot of the market drivers. It supports AI. It supports AV. It supports IoT. It supports 5G. All these things that require high-performance computing. And when you have high-performance computing, you have a power density issue. And when you have a power density issue, you get heat. from that heat you have to have more creative ways to remove it and at some point in time we'll hit a Threshold with the mechanical heating solutions that are currently in the market today and things will start to shift So we are working closely with our teams and our customers to make sure that we're being very innovative in that space and it's also an area that we are very curious and where we have a pretty big net cast to make sure that you know we can There's other ways to potentially acquire that technology. So there's the inorganic inorganic path So we're looking at both and because it's at the tip of the spear for us with data centers And that's where we want to grow. We welcome this change.

We welcome this new technology and we welcome the engineering challenge Thanks and on a different Topic what are you seeing on the human capital side? You know, it wasn't that long ago that

number of companies we're talking about higher turnover difficulty hiring what are you seeing on that front yeah it's it's different regionally but for the most part what we're seeing is much more stability than where we were at a year ago and and that's based on the fact that we've had some pretty good talents inside of our plants today that are making sure that we have the the right workforce in place and then we've got our policies here on the salary side that we can recruit and retain very talented individuals across multiple industries. That's how we've been able to absolutely move in this rate that we're moving and transform the company at the rate we have.

Is there any way for you to quantify the benefit to you all just cost-wise from that?

I didn't catch the full question. So is there any way to quantify?

I guess in terms of reduced costs from lower turnover or less need to use recruiters for hiring.

Yes. Yes. So where Vic and I watch that closely is in the margin and making sure that we're efficient. You go back a year ago and when you have a workforce that is transient There's a lot of time training. There's a lot of overtime that's used. You're not efficient. You're not productive. So, once you get some stability in place, you start to see the margins improve relative to overtime, relative to labor hours, and relative to things like expedited freight because we don't have people in the right place at the right time.

Thanks. Sure.

I'm showing no further questions at this time, and I would now like to turn the conference back over to Kathy Powers.

Thank you, and thanks to everybody for joining us this morning. You'll be able to access the replay of this call through our website in about two hours. We hope everybody has a great day.