Modine Manufacturing Company

Good morning, and thank you for joining our conference call to discuss Modine's first quarter fiscal 2024 results. And 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'll be using slides with today's presentation, which can be accessed either through the webcast link or by accessing the PDF file posted in the investor relations section of our website, Modine.com. 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's my pleasure to turn the call over to Neal.

Thank you, Kathy, and good morning, everyone. This has been an exciting quarter for Modine. First, we delivered another record quarter with 15% top-line growth and adjusted EBITDA of $80.4 million, an increase of 91% from the prior year. Second, we completed our first acquisition since announcing our transformation strategy with the addition of NAPCS Technology and the Jetson brand to our product portfolio in early July. NAPCS has a small chiller range that fits nicely within our indoor air quality business, providing an additional product line for our target schools market. I'm excited to welcome NAPCS President Sam Neill and his team to Modine and look forward to continuing to manufacture this great product at their facility in Longview, Texas. This acquisition is directly in line with our growth strategy, which is focused on differentiated technologies and systems that address real-world needs. Most importantly, this acquisition demonstrates our commitment to responsibly investing in key verticals where our objective is to grow faster than the market. As a result, we're making great progress towards our financial targets and planning the seats for future growth. But this doesn't mean that we're reaching the end of the journey. In fact, I would say we're still in the early stages of this transformation. There's an additional opportunity for incremental revenue and margin growth as a greater percentage of our business portfolio shifts to the growth column and as we further simplify and rationalize low margin products. Please turn to slide five. The climate solution segment delivered another strong performance this quarter with revenue up 11% from the prior year and an adjusted EBITDA margin of 18.3%, about 500 basis points from the prior year. In Climate Solutions, we are well along in our 80-20 journey and have proved out the effectiveness of this approach. We stabilize the business by providing the leadership, resources, and strategies necessary to improve our operating margins and accelerate top-line growth. I've often said that data centers is the tip of the spear, and it's leading the way in both revenue growth and margin improvement. In the first quarter, data center sales more than doubled from the prior year at margins above our segment targets. This is the result of a dedicated focus and strategy to grow, investing capital and resources as we've never done before. Mick will provide more detail in a minute, but we're raising our outlook for data center revenue growth this year, now targeting a 60% to 70% increase, which would equate to over $270 million in data center revenue this fiscal year, up from $174 last year. This large change in our forecast is primarily due to higher than expected orders in Q1, which will positively impact the back half of the year. We have a strong backlog, including both hyperscale and co-location customers. In addition, we have a pipeline of new products and new customers that we are confident will fuel above market growth in the future. I often get questions about the next generation of technology in data center and arena, particularly as it relates to high performance computing, supporting AI, machine learning and other applications that require more advanced cooling technologies to deal with a higher heat load. This technology is still developing and it's an area that we're very interested in and we've done some R&D here in the past. We will continue to develop this technology organically, inorganically or both and are actively monitoring and assessing the landscape. We see this as a great opportunity for us to add to our portfolio of data center cooling products. As data center products become a bigger portion of our portfolio, this revenue stream provides a level of diversification away from our traditional heating and HVAC markets, both in the HVAC and HTP verticals. In fact, our heating sales were down nearly 40% in the quarter due to weak market conditions, and the sales of heat transfer products were down 7% from the prior year. Despite this decline, margins actually improved due to lower material and freight costs and greater labor efficiency. When demand started to change, we quickly shifted our efforts to operational improvements leading to solid performance. Please turn to slide six. The performance technology segment also delivered strong results this quarter with revenue of 18% from the prior year and an adjusted EBITDA margin of 11.2%, an improvement of 560 basis points. In fact, the margin is exactly double the prior year. Much of this gain is due to the hard work the team has put into improving commercial terms and our long-term contracts, helping to recapture margin loss to material, labor, and overhead inflation over the past several years. In many cases, we've benefited from these adjustments earlier than expected, leading to our quarterly performance exceeding our expectation. The important thing to understand is that our teams are focused on the value that we deliver to our customers and they're negotiating agreements that are fair to both parties. In addition, we're winning incremental business in targeted markets with accretive margins. Much of this is due to the 80-20 work that we've done so far in the PT segment. We are evaluating our business using a data-driven approach and are simplifying improving wherever possible. For example, in our liquid pooling applications business, we've eliminated 73 skews representing over 20 million of annual revenue that was at negative gross margins. In some cases, we're getting favorable commercial terms as we negotiate exits on non-strategic product lines. As the business wind down, we plan to replace it with higher margin opportunities. An example of this is the GENSEP business, which I've mentioned before. We have been in this business for a long time, but it was never a strategic focus. Now we are working with existing and new potential customers to support the conversion from copper brass to aluminum heat exchangers, similar to what the vehicular OEs did decades ago. Aluminum has both a cost and performance advantage, and we have the technology and global footprint to deliver in region. There are great drivers for the growth in this business as data centers, hospitals, and other critical applications secure backup power to guarantee continuity of energy supply. This was about a $50 million business for us last year, and we expect this business to have a 30% tagger over the next three years, definitely in the growth column. Another business in the growth column is our EV systems business. We have a number of important launches this year, but some are being delayed due to supply chain constraints, but the demand is there. As for the commercial funnel, we are up to 25 program wins, including two wins for our fuel cell product. This pushes our awarded revenue at peak annual production to over $150 million. Again, I'd like to reiterate that we are just getting going on 80-20 in the PT business, but are seeing remarkable early results. We are investing in those businesses that have the right growth drivers and addressing low margin business in different ways throughout the segment. We've simplified our product offering and are negotiating favorable exits while also working to improve commercial terms to recapture the value that we provide to our customers. all while further investing in the technology of the future. I'm very proud of the work being done in both segments and the results we have delivered this quarter. Now, I'd like to turn the call over to Nick, who will review our results for the quarter and provide segment financial updates.

Thanks, Neil, and good morning, everyone. Please turn to slide seven to review the segment results. Climate Solutions had another great quarter with improved earnings on higher sales. Segment revenue was up 11%, driven by our data center vertical, with sales up 124% for $38 million. The data center increase is fantastic, given it supports one of our most attractive markets and is quickly becoming a very large portion of Modine's total revenue. A significant piece of the increase is related to North American chiller sales as we ramp up production at our new plant in Virginia. We entered the year with a strong backlog and realized some of the sales much earlier in the year than originally planned, which added to a stronger than anticipated first quarter. HVAC and our sales were down a modest 2% or 1 million, driven by lower sales of heating products. partially offset by higher indoor air quality sales, which were up 40%. The heating market remains down, largely due to higher field inventories and lower pre-season stocking sales. Sales of heat transfer products decreased 7% or 9 million. As anticipated, there was some market softness with commercial refrigeration customers and in various residential-related markets. and we are also continuing 80-20 product rationalization activities. We're pleased with the very strong earnings conversion as adjusted EBITDA increased 53%, resulting in a 500 basis point margin improvement to 18.3%. The earnings and margin improvements were primarily driven by higher sales volume and benefits from 80-20 initiatives. The climate solution segment continues to perform very well and is off to a strong start to the year. The growth in data center sales is driven by a robust backlog, which is continuing to grow. With regards to heating and heat transfer products, we're maintaining a cautious outlook for the second half of the year, which has been incorporated into our revised guidance. Given these factors, we believe we're likely to see more level-loaded quarters or less seasonality than in previous years. Please turn to slide eight. Performance Technologies also had another great quarter with sales up a very strong 18% or $55 million. Revenue benefited from both volume and commercial improvements, many of which were realized earlier than expected. Sales volume accounted for 37 million or 12% revenue growth. Advanced solution sales were up 31% or 10 million with continued growth of our EV systems and component sales. Liquid cooled application sales increased 21% or 24 million due to higher sales across all end markets. Lastly, air cooled application sales increased 13% or 20 million primarily due to continued strong demand from off-highway customers with a higher sales in genset or stationary power applications, which we see as a significant growth area. Performance technologies converted the higher revenue to an extremely high level of earnings. Adjusted EBITDA was up 135 percent, resulting in an 11.2 percent margin and a 560 basis point improvement. As Neil mentioned, the performance technology segment has worked hard at modifying long-term contracts. And in some cases, we benefited from these adjustments earlier than expected. While we're making great progress towards our margin targets, I want to point out that it will be difficult to sequentially match this Q1 result. As we entered the year, the team had a long list of projects to execute, and we believed the results would ramp over the year. consistent with most of last year. As I just mentioned, we're pleased that some of our commercial negotiations were completed earlier than expected and were also able to capture some retroactive commercial benefits during the quarter. Lastly, as previously discussed, the team is pursuing multiple 80-20 product rationalization strategies, which could result in some reduced revenue I want to be clear that these are planned actions and relate to business that cannot meet our margin objectives. Based on all these factors and as we look to the balance of the year, our full year outlook for the segment has improved and we now see more even results over each of the four quarters. Now let's review the total company results. Please turn to slide nine. First quarter sales were up 15% or $81 million. Higher sales volume drove approximately 62 million of incremental sales, or 11% growth. Commercial pricing added another 19 million to the top line. The gross margin improved 520 basis points, primarily driven by the factors I reviewed for climate solutions and performance technologies. SG&A increased 5 million, primarily due to higher employee and incentive compensation expenses, However, SG&A as a percentage of sales was 50 basis points lower than the prior year. I'm happy to report that adjusted EBITDA was very strong in the quarter with an increase of 91% or 38 million. This equates to an adjusted EBITDA margin of 12.9% or a 510 basis point improvement from the prior year. This also represents the sixth consecutive quarter of year-over-year margin improvement. Adjusted earnings per share was 85 cents, an increase of 53 cents, or 166 percent from the prior year. Before moving to the balance sheet, I'd like to reiterate that the quarter was clearly stronger than expected. We now see a more level-loaded year for several reasons. First, Q1 revenue was higher than initially expected in our plan, including a faster ramp than anticipated in some areas, such as data centers. Second, Performance Technologies is achieving 80-20 benefits earlier than expected, including the settlement of new commercial agreements and some retroactive adjustments that will not carry through to future quarters. Third, raw material costs have been below our previous projections, which is favorable to Modine, until we pass on the lower costs through our material pass-through agreements over the next few quarters. As a result, a portion of the strong Q1 earnings was due to timing and the accelerated benefit from some of these items. In a few minutes, I'll further discuss how we're rolling these impacts and the strong operating performance into our full-year outlook. Now moving to the cash flow metrics, please turn to slide 10. We generated $27 million of free cash flow in the quarter, which is a significant improvement over the first quarter of fiscal 23. This was primarily driven by higher operating earnings, partially offset by higher working capital and higher payments for incentive compensation. Net debt of $265 million decreased $20 million this quarter, Net debt coupled with strong earnings resulted in a leverage ratio of 1.1. This fiscal year, we expect continued growth in free cash flow driven by higher earnings and a continued focus on working capital. We anticipate the full-year free cash flow will fall in our target range of 3 to 5 percent of sales. Modine's balance sheet remains quite strong, ready to support both organic growth and acquisition initiatives as was demonstrated by the acquisition of NAPCS technology that we announced in early July. Now let's turn to our Fiscal 24 outlook on slide 11. As announced in the press release, we're raising our sales and earnings outlook for Fiscal 24. Before I discuss the updated guidance, I want to review some modifications to how we report product group sales. We've refined reporting of revenue by product group within the climate solution segment in order to be more consistent with how we manage by general manager and manufacturing location. As part of 80-20, we're continuing to align our product groups and manufacturing with each of our general managers. As a result, we've recast revenue for fiscal 23 to be consistent with how the product groups are now reported in fiscal 24. There are no changes within performance technologies, but we made some minor revenue changes between data centers, HVAC and R, and heat transfer products within climate solutions. We provided a summary table of the recast numbers in the appendix to this slide presentation. For the prior fiscal year, the recast resulted in a $20 million increase in data center revenue, a $5 million increase in HVAC and R, offset by a reduction in revenue for heat transfer products. To be clear, there is no change to total climate solutions revenue, rather just minor classification changes between the three product groups. As I previously mentioned, our first quarter exceeded our expectations for several reasons, and this was certainly a factor leading to our improved outlook for the year. In the climate solution segment, we now expect data center revenue to grow 60 to 70%, a significant increase from our previous guidance. And we now anticipate data center revenue to be more than $270 million. Moving to HVAC and R, we expect revenues to grow in the low single digits and have lowered the top end of this range as we remain cautious about ongoing weakness in the heating market. However, we anticipate this should be offset by very strong sales growth in school ventilation products. With regards to heat transfer products, we now anticipate a sales decline in the low 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. Also within heat transfer products, we're adjusting our projected ramp up for sales to heat pump customers in Europe due to changes in regulations and incentives. We still anticipate this to be a high growth market for us, but at a somewhat slower ramp rate. Moving to performance technologies, we expect continued momentum from relatively stable markets and benefits from our 80-20 rollout. We expect advanced solutions growth to be in the 25% to 35% range, which did not change from last quarter. This growth is driven by program launches and continued demand for EV systems and components. Lower growth for liquid and air-cooled products as we roll out 80-20 throughout the segment. Market growth is expected to be somewhat offset by product rationalization as we continue to de-emphasize lower margin business. The product rationalization associated lower revenue could result from negotiated program exits or from select divestitures. Let's move to adjusted EBITDA. Again, the first quarter was much stronger than we anticipated based on many factors, including sales volume, material margins, and operational improvements. Based on the recent results and market trends, we're raising our adjusted EBITDA outlook for the year. We now expect our fiscal 24 adjusted EBITDA to be in the range of 280 to 295 million, up from 240 to 260 million. and representing an increase of 32 to 39% versus the prior year. Also, when looking at the midpoints of the earnings ranges, our new outlook represents a nearly 38 million increase. Again, much of this change is due to the performance in the first quarter. and some of the Q1 benefits won't necessarily repeat in subsequent quarters, including the realization of retroactive commercial adjustments. Based on this and our higher full-year outlook, we now anticipate that the next three quarters will hover around $70 million versus the previous plan for a more back-end loaded year. The second and third quarters could be somewhat below the 70 million quarterly average, with Q4 potentially above the average. Now that I've covered the very strong Q1 and associated sequential trends, I want to reiterate that our outlook assumes ongoing and very strong year-over-year improvement for the balance of the year. We anticipate that free cash flow will improve with the higher earnings outlook, with capital expenditures expected to be around 70 million. Our assumptions, including interest expense, taxes, depreciation, amortization, are all included in the appendices attached to this presentation and our press release. To wrap up, we're extremely pleased with the first quarter results and how we've started fiscal 24. Our outlook remains strong. We're making progress towards our financial targets. And in many cases, we're trending well ahead of our initial transformation timeline and goals. I'm pleased to say that we're firmly on track with our transformation. But as Neil said, we're still in the early stages. This was a great quarter, but we still have plenty of work ahead of us. And we're quite confident in the entire Modine team. With that, Neil and I'll take your questions.