Modine Manufacturing Company

Good morning and thank you for joining our conference call to discuss Modine's second quarter fiscal 2024 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'll be using slides with today's presentation, which can be accessed either through the webcast link or by accessing the PDF file posted on the Investor Relations section of our website, Modine.com. On slide 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. I'm pleased to report another strong quarter with both solid revenue growth and earnings improvements that came in ahead of our expectations. Sales increased 7% from the prior year, driven by increases in both the climate solutions and performance technology segment. In addition, we reported adjusted EBITDA of 81.2 million, an increase of 59% from the prior year. EBITDA margin was 13.1%, a 430 basis point improvement from the prior year. As a reminder, last year we set a goal to significantly improve our EBITDA margins, targeting a range of 10 to 12% by the end of the fiscal year and reaching 13% to 15% range by the end of fiscal 27. We are clearly ahead of these targets, driven by a combination of key factors, including using 80-20 principles to guide decision-making throughout the organization, allocating additional resources to targeted higher-margin businesses, and focusing on the value we bring to our customers and leveraging that to drive margin improvement and profitable growth. I'm very proud of what the organization has been able to accomplish in a short period of time. I continue to believe that we remain in the early stages of our transformation as we see medium to long term opportunities for sustainable growth that will continue to improve our financial profile. Please turn to slide five. The climate solution segment delivered an excellent quarter with revenue of 8% from the prior year. We're benefiting from the planned diversification of our businesses as strong growth in the data center vertical is helping offset some weaknesses in the other HVAC markets. The segment reported adjusted EBITDA of $50.4 million, a 31% increase from the prior year. This resulted in an adjusted EBITDA margin of 18.3%, up 330 basis points from the prior year. Revenues in our data center business were $79 million, more than double the prior year. Our order intake continues to grow. That said, this business can be quite lumpy due to the timing of product shipments on large data center projects, so we're not expecting growth to continue at a linear rate. We have projected a dip in the third quarter data center volume since the beginning of the year and then expect volumes to pick up again in Q4. We have significant backlog to work through over the next 12 to 18 months, which should provide some stability in the business despite the quarter to quarter fluctuation in revenues. Our commercial team continues to win orders with key relationships in our pipeline and add new opportunities to the sales funnel as we evaluate and develop high quality prospects. Our goal is not to be a high-volume product supplier to the data center market. Instead, we're focusing on relationships with key customers, supporting them with system solutions and ongoing services as they grow globally. This includes new and existing customers that value our engineering and service model. We have great products in the space and the expertise to advance the technology to address the higher heat loads that will be required in the future. For example, we are internally developing a cooling distribution unit, or CDU, A CDU is integral to liquid cooling, providing critical cooling capacity and heat removal for high-density data center environments. The CDU offers controlled, contaminant-free coolant for heat exchangers, direct-to-chip, and immersion cooling devices, integrating between the server and the external heat rejection. The CDU will further strengthen our global data center systems offering, as we'll be able to offer hybrid, liquid, and air-cooled systems. Our CDU is being developed with the full voice of the customer and is planned to be commercialized early next year. This marks our first dedicated development into the liquid cooling systems. In addition, we are also working on other advanced technologies and our product roadmaps so we can continue to provide our data center customers with efficient, connected systems, elevating their performance while helping them meet their sustainability targets around power and water usage. Moving to our HVAC and our businesses, we recently announced the expansion of our electrical heating line with two new product launches. Our new electric infrared line provides a low emissions heating product that can be used in a wide variety of commercial and residential applications. In addition, our new amp dog is the electric version of our popular hot dog line of residential garage and workshop heaters. This line provides an electric alternative with the same quality and performance that Modine is known for. These are just a few examples of our product development efforts, and there are more to come. Regarding heat pumps, earlier this year, we announced our plans to expand capacity at our plant in Serbia in response to the strong order intake from heat pump customers. Growth expectations for the heat pump market have been fueled by regulations driving a conversion from natural gas to electric to increase the use of renewable energy. Recently, the enforcement date of these regulations has been delayed, specifically in the German market, where the adoption date was pushed from 2027 to 2029. This has resulted in a reduction of our forecast based on the latest information from our customers. We're still planning on growth but expect lower growth in the near term while we adjust our overall production ramp. We still believe that this is an important market for Modine and are nearing completion of the first phase of our Serbian plant expansion. We had planned the investment in phases so that we could bring on the necessary production capacity as needed. This is providing us with the flexibility to respond to regulatory changes like these and allows us to take more measured approach to our investment. We will continue to monitor this market along with regulatory drivers that are creating this volatility. And our climate solutions business is having an incredible year, and I'm very proud of what we've been able to accomplish. We are investing in new products and technologies now to make sure we can continue to have profitable growth in the future. Please turn to slide six. The performance technology segment also delivered excellent results this quarter, with revenue up 7% from the prior year, driven by off-highway commercial vehicle and specialty vehicle customers. Adjusted EBITDA increased 73% to 42 million, resulting in an adjusted EBITDA margin of 11.9%, an improvement of 450 basis points. Similar to last quarter, much of the increase was due to improving commercial terms in our long-term contracts, including some additional retroactive recovery. The PT business made a couple of important announcements this quarter that I would like to highlight as a prime example of our 80-20 work. First, we announced the divestiture of three businesses in Germany, that produce products for internal combustion diesel and gasoline engines for the European automotive market. I'm pleased to report that this transaction closed on October 31st. We have been very clear with our intention to exit non-strategic businesses, and these divestitures are firm actions towards that goal. We will continue to pivot our resources towards strategic, high-growth businesses and will quickly exit or wind down business that is not meeting our margin targets. Many of these actions have already been identified and are underway. As a reminder, exiting lower margin businesses is a critical element of 80-20 as we remain focused on the earnings growth over revenue growth. We have anticipated this as part of our transformation strategy in the PT segment, understanding that it could initially result in lower revenue. However, we also have plans for growth in our EV systems and Genset businesses that will replace the businesses we are exiting with product profiles aligned with our long-term goals. This is all part of the 80-20 process. In addition, As we exit certain businesses, we need to examine our cost structure to make sure that it's appropriate for the size of the business. There could be some additional costs as we realign our manufacturing footprint. One of the businesses where we're investing is our EV systems business. Last month, we announced our plans to expand production of our EVantage thermal management system to Europe. Beginning next year, we will produce battery thermal management systems and electronic cooling packages for our European customers at our plant in Ponte Vico, Italy. This is in addition to our existing product lines in Lawrenceburg, Tennessee, where we are in the process of adding additional capacity to accommodate increased volumes as we launch more programs. Overall, our performance technology segment is firmly on track, and I'm proud of the work being done by this team. Material costs continue to be favorable, and we have had significant success negotiating contractual improvements. We're making great progress on the 80-20 journey in the segment, focusing the organization on both capitalizing on growth opportunities, and optimizing non-strategic product lines. Now, I'd like to turn the call over to Mick, 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 excellent quarter with a 31% increase in adjusted EBITDA. Revenue grew 8%, including a $7 million favorable FX impact. The growth was driven by data center sales increasing 117% or $43 million. We continue to see strong demand for our products in North America and Europe, including those supporting both hyperscale and colocation customers. As Neil mentioned, the timing of these sales can be somewhat unpredictable and shipments in the quarter once again exceeded our expectations. Based on the timing of our current customer schedules, we anticipate lower shipments in Q3 than ramping significantly in Q4. I want to highlight that while the timing can be hard to predict between quarters, our full year outlook has not changed with growth expected to exceed 60%. HVAC and our sales were down 2% or 2 million. The heating market remains soft but has improved sequentially from Q1. We expect to see further rebound as we enter the heating season, but the weather will ultimately factor into the strength of our sales for the balance of the year. Sales of heat transfer products decreased 16% or 21 million. As discussed in previous quarters, we've experienced a decline in market demand with commercial refrigeration, along with commercial and residential HVAC and RV customers. We believe many customers are continuing to work down excess inventory that was created during the previous supply chain shortage. Additionally, we've continued 80-20 product rationalization activities to drive further margin improvements. We're pleased with the strong earnings conversion as adjusted EBITDA increased 31% with a 330 basis point margin improvement to 18.3%. The earnings and margin improvements were driven by higher sales volume and benefits from ongoing 80-20 initiatives. Climate solutions clearly had a very strong first half of the year. The growth in data center sales was driven by a favorable market along with the investments we've made to grow this business. With regards to HVAC and R and heat transfer products, we're still maintaining a cautious outlook for the second half of the year. Given our assumptions on the heating market and the lighter data center shipments in Q3, we would expect sequentially lower earnings in Q3, then close out the year with a strong Q4. To wrap up on climate solutions, we're remaining cautious in a few key markets, but fully anticipate further year-over-year improvements in the next two quarters to wrap up another great year. Please turn to slide eight. Performance Technologies also had a great quarter with 7% sales growth, including an $8 million favorable FX impact. Revenue benefited from 80-20 initiatives as we continue to focus on higher margin businesses While underlying sales volume declined by 5 million or 2%, the average selling price per unit was higher. As a reminder, 80-20 efforts in performance technologies are focused on driving rapid earnings growth and not revenue growth. Therefore, we expect to see earnings growth at a more rapid rate than overall sales volume. Advanced solution sales were up 30% or 10 million. with continued growth of our EV systems and component sales, along with higher sales to specialty vehicle and coatings customers. Liquid-cooled application sales increased 6% or 7 million due to higher demand from our commercial vehicle customers, along with benefits from AD20 initiatives. Lastly, air-cooled application sales increased 2% or 4 million, primarily due to higher sales to off-highway and genset customers. along with gains from 80-20 initiatives. Performance Technologies' earnings conversion was excellent, with adjusted EBITDA up 73%, resulting in 11.9% margin and a 450 basis point improvement. Similar to the previous quarter, earnings temporarily benefited from several million dollars of retroactive payments that may not repeat in future quarters. As Neil mentioned, we're pleased to report that the divestiture of three businesses in Germany was completed on October 31st. As previously disclosed, the annual revenue impact from these businesses is approximately 80 to 90 million and will result in a revenue reduction the second half of this fiscal year. While these divestitures represent lower margin and non-strategic business, we're reviewing action plans to further align our cost structure to the lower revenue. We anticipate that these plans will be launched in Q3 with savings to begin in Q4. We did not experience any material impact from the UAW strike, but expect that some of our major OE customers may take extended holiday shutdowns this year. Based on all of these factors for the balance of the year, we anticipate ongoing 80-20 progress and further year-over-year improvements. with a sequential dip in earnings in Q3 and a step up again in Q4. And on a full year basis, we expect performance technologies will report another excellent year and be within our targeted margin range. Now let's review the total company results. Please turn to slide nine. First quarter sales were up 7% or 42 million, including a 15 million favorable FX impact As previously discussed, the higher revenue was driven by growth in both business segments. The gross margin improved 520 basis points, primarily driven by increases in volume, higher average selling prices, and numerous other improvements tied to our 80-20 initiatives. SG&A increased 10 million, driven primarily by higher employee compensation expenses, including incentive comp and higher product development costs. I'm happy to report that adjusted EBITDA was very strong in the quarter with an increase of 59% or 30 million. This equates to an adjusted EBITDA margin of 13.1% and a 430 basis point improvement from the prior year. This also represents the seventh consecutive quarter of year-over-year margin improvement. In addition, adjusted earnings per share was 89 cents and 85% higher than the prior year. Before moving to the balance sheet, I'd like to reiterate that we're pleased with the exceptional performance in the quarter. And there were a few areas that were better than expected. First, our shipments of data center products were somewhat stronger than expected with a little pull forward from Q3. Second, we had some additional benefits in the quarter for performance technologies including favorable material ratios and product mix. And as I mentioned on the previous slide, we also benefited from some commercial negotiations and settlements. While maintaining a cautious view for the second half, we're again raising our earnings outlook based on some of the first half progress. In a few minutes, I'll further review how all this will impact our sequential results in the full year guidance. Now moving to cash flow metrics, please turn to slide 10. We generated 58 million of free cash flow in the second quarter, which is a nice improvement from our first quarter. This puts year-to-date free cash flow at 85 million, which compares very favorably to 33 million generated in the prior year. Net debt of 222 million was 63 million lower than the prior fiscal year end. and $43 million lower than the last quarter. Net debt coupled with strong earnings resulted in a leverage ratio of 0.8. During the quarter, we restarted our share repurchase program and purchased 200,000 shares. As a reminder, our program is currently focused on offsetting the dilutive impact of our share-based incentive compensation program. This fiscal year, we expect continued growth in free cash flow driven by higher earnings and a continued focus on working capital. We continue to anticipate full year free cash flow will fall in our targeted range of 3% to 5% of sales. Modine's balance sheet remains quite strong, which we plan to maintain in the current economic climate and stand ready to support both organic growth and acquisition initiatives. Now let's turn to slide 11 for our fiscal 24 outlook. As announced in the press release, we're raising our full year earnings outlook for fiscal 24. The second quarter exceeded our expectations, leading to another increase in our profitability outlook for the fiscal year. In the climate solution segment, we continue to expect data center revenue growth of 60 to 70 percent. Moving to HVAC and R, We expect modest revenue growth in the low single digits, maintaining the range from last quarter as we remain cautious and approach the prime heating season. With regards to heat transfer products, we now anticipate a sales decline in the mid-single digits, which is a reduction from our previous guidance. This is primarily due to concerns over a general economic slowdown, especially in residential and commercial refrigeration applications. and a slower ramp schedule for the heat pump market. Moving to performance technologies, we expect continued benefits from our 80-20 rollout. And now that we've completed the German divestitures, we're adjusting the second half revenue outlook accordingly. We expect advanced solutions to grow in the 25 to 35 percent range, which did not change from last quarter. This growth is driven by program launches, continued demand for EV systems and components. We anticipate modest growth for liquid and air-cooled products as we implement 80-20 across the segment, including the impact of divestitures. From an SG&A perspective, we're anticipating that we'll finish the full year between 260 and 270 million. including higher incentive and compensation expenses. Let's move to adjusted EBITDA. Based on the recent results and market trends, we're raising our adjusted EBITDA outlook for the year while maintaining a somewhat cautious position with half of the fiscal year left in front of us. We now expect our adjusted fiscal 24 EBITDA to be in the range of 285 to 300 million. up from 280 million to 295 million and representing an increase of 34 to 41% versus the prior year. Consistent with our previous update, we anticipate that the second half will average approximately 70 million of a quarterly adjusted EBITDA. We expect that Q3 will be sequentially lower based on my previous comments on the business segments with a step up in Q4. The sequential lift in Q4 will be driven by typical seasonal patterns and a strong order book in data centers, advanced thermal solutions, and other key growth businesses. Shifting back to the full year, I want to reaffirm that our full year outlook is well aligned with our transformational earnings and margin targets, and we expect to deliver another year of record results at Modine. In addition, We anticipate that free cash flow will further improve with the higher earnings outlook with capital expenditures expected to be around 70 million. Other assumptions including interest expense, taxes, depreciation, amortization are included in appendices attached to this presentation and our press release. To wrap up, we're extremely pleased with the results from the second quarter and our ability to maintain momentum towards our interim and long-term financial targets. As Neil said, we're in the early stages of our transformation, but the progress has been tremendous. And we have a lot of hard work and opportunity in front of us. With that, Neil and I will take your questions.

Thank you. Thank you. Ladies and gentlemen, if you have a question at this time, please press star then 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star then 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question comes from Matt Summerville with DA Davidson. Please go ahead.

Excuse me. Thanks, Morning. I wanted to maybe start with a question on the data center business. The growth cycle you're in in fiscal 24, what does that suggest about fiscal 25 in the context of the backlog and order comments you made and what were in the slides here? And then I'm curious if you have any updates

on customer diversification initiatives within the hyperscale market and any early feedback on the cdu and then have a follow-up thank you you want to go first on cdu yeah matt thank you for the question uh yeah so as you know we continue to experience growth and we continue to grow the backlog in data centers a lot of that was driven by the fact that we've expanded our ability to manufacture globally The CapEx investment that we made in our labs and our factories in the United States as well as in Europe to support this growth is allow us to build the capacity to keep up with this demand that we're seeing. And, you know, we've been able to expand our product portfolio on the air cooling side as well. An integral piece of this growth was being able to develop and manufacture a chiller in the United States and North American market. So we will continue to expand our product portfolio and data centers. And the next evolution of that is with the CDUs. So these CDUs are going to get us into a different area of the data center to allow us to provide liquid cooling. And that's the VOC that we've collected from both our hyperscaler and colos that as they pivot into more of a liquid cooling approach for areas where they have high heat density and heat loads, they're leaning on us in order to help them provide that solution. And this isn't new to us, Matt. We've recognized this and we realized this. We actually produced a CDU back in 2016. And this was before there was a market. And now that we see that there's favorable trends where we can complement our current product portfolio of cooling products and data centers, adding the CDU piece just makes a lot of sense.

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

Mike asked about any progress on hyperscale customer diversification.

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

Got it. And then just as a follow-up, as I kind of think about The guidance framework you gave coming out of Q1, thinking about Q2, pretty much everything you just delivered bucked all of that guidance in a good way. And I'm just curious about the go-forward guidance. Have you really seen a step function change in the demand environment? Or are you looking at this saying, you know, macro is a little choppy. There's a few nits here and there in the business. Geopolitical environment is as unfortunate as it is. It is what it is, so to speak. So maybe some conservatism here is understandable. But I'm just trying to sort of more dig at kind of your guidance philosophy as we think about the second half in the setup, given how you performed in 1H.

Yeah. Hey, Matt, Nick, I think a really fair question. And I think it's much more of the ladder where we're not seeing a step function change in the business or, you know, any level of pro the profitability levels, the ladder, which you went through that list of the uncertainties kind of across the market, geopolitical environment, a number of things in a few markets like the heating season coming up. So I know we had thought Q2 would be a little bit of a step down from Q1, and we had another strong quarter. In there is the other thing I guess I'd add, and Neil could add any color, but as we continue to go through this transformation, the amount of complexity that We have in the organization, we're asking the leaders to manage through businesses that we are divesting, product lines we're exiting, pricing adjustments we're pushing through, growth volumes and timing. It's turned out for us in a positive way, the momentum's great, but our ability to predict with one quarter to the next with that level of accuracy, there's a large amount of complexity in the company right now. It's just making it, we're trying to be cautious of how we project for the next six months. Neil, do you want to add any other color on it?

Yeah, I mean, when you think about how difficult it is to predict change in a stable environment, when we destabilize it, you know, through a lot of our 80-20 activities intentionally for the right thing to do, we're transforming the company. When you're in a destabilized mode where we're changing many, many things all at once, it does become a little bit more difficult to predict. So we're continuing to manage it the way we do, and we want to make sure that we keep consistent with our approach in terms of how we guide. Great. Thanks, guys.

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

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

Correct.

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

Great question, Chris. Yeah, we expect to have the ability to commercialize that in the beginning of next year. it'll grow at the rate that we see, or we potentially could predict the market adoption of this. So it's a nice compliment in terms of what we're doing on the air cooling side. You know, we've got multiple technologies here with the CDU. We can do liquid to liquid, we can do air to liquid. There's just different ways to solve for the challenges that our customers see. So, you know, we're going to be able to move and deploy product at the rate that they, they see that, you know, growth inside of the data centers that support high density heat loads.

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

You know, it's a natural extension of what we do. You know, the competitive landscape is similar. The technologies are different. Some of our competitors have partnered with some, you know, companies that have this technology and they, you know, position themselves well with joint ventures and other things. But it's a similar space. We're familiar with it. We've been waiting for the time to make this investment when we actually start to see this market start to stabilize and has the potential to grow. Like I said earlier, we've developed CDUs in the past. We did this six years ago. There just wasn't a market for it. So we believe the time is right. Perfect. That's helpful.

Let me switch gears here. So Ford is postponing a $12 billion EV factory. The reasons given were, you know, unwillingness of customers to pay extra for its electric vehicles. Just wondering, you know, kind of how you look at that, any impact you potentially, you know, on, on the ice auto business or EV business in general, just, you know, kind of your thoughts there.

Yeah, it's a, it's a, it's an interesting question, right? Um, We don't focus on EV automotive. Our EV and areas that we focus in terms of the electrification is on specialty vehicles. We really look at larger EV applications that require our systems and solutions. And we've moved away from any EV related to automotive that's component related. So where we see growth and where we see the demand, We're on 119 different engagements with customers in the areas that we target for EV. We see 27 orders or platform wins that we're very pleased to have won. We're expanding our EV product group. We're expanding capacity in our plants in Tennessee. We just recently put out a press release that we're expanding into Europe. We're going to be producing in Italy. So we see growth in the areas that we've defined that is target for us in the EV, and again, that's in systems and in vehicles like specialty vehicles, municipal buses, school buses, last mile delivery vehicles. That's the space that we're focused on.

Got it. No, I got that. I understand it wasn't on the auto side. I was just curious if you were getting any pushback from a pricing perspective. Sounds like so far so good on that front. I will leave it there. I appreciate it. Thank you.

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

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

Yeah. Hey, it's Nick. Uh, so definitely we, uh, from a forecast standpoint, probably the last, you know, three or four months or not based on, uh, schedules from our customers, we knew the, the lowest quarter of the year would likely be our Q3. Uh, those data center, what we've talked about in the past is they can be lumpy. These are, we had a photo in the, in the presentation. really large construction projects. And so we're required to have product ready to be shipped, but when they're pulled, it depends on the customer and the completion and they only want it, you know, on time, ready to go. So in Q2, we had a little bit higher revenue than we thought that was really going to be, we thought would be coming in Q3. And then in Q3, we expect to have a lower amount of revenue in Q3 and a big ramp in Q4. Again, just based on, it's consistent with our order book, but it's based on the timing of where we see the customers pulling and asking for those shipments.

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

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

Okay, and I think you said that's actually going to be available in the first part of calendar 24, or did you mean, I wasn't quite on that.

Yeah, we're looking at the first part of next year, correct.

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

Yeah, it's ebbed and flowed a little bit, but we talked maybe a quarter or two ago with rate hikes and nervousness around the economy. We saw some deal flow and opportunities kind of slow down. People were hesitant to come to the market. I would say the last few months, It's been picking up a little bit for us. In addition with, as Neil and I have talked about, we're continuing to have more people on the Modine side being aggressive with dialogues, discussions, knocking on doors. So we'll continue to report back, but it's 100% effort going forward. And I think we're feeling good about the pipeline with opportunity we're building.

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

Thanks, Jeff.

Thank you. Ladies and gentlemen, if you wish to ask a question, please press star and 1. Our next question is from Tim Moore with EF Hutton. Please go ahead.

Thanks, and congratulations on the gross margin expansion and the data center's growth. For overall Modine, it seems like you've harnessed the quickest and easier way to grow sales is through your current customers, because that helps the margin profile quicker than maybe a new customer that has new engineering design cost drag. As you look out over the next 12 months, do you expect to take on some more new customers outside of the EV platforms that you've been signing up? And do you think that might weigh a little bit on gross margin expansion, or do you think the 80-20 would offset that if you're adding new customers?

Yeah, well, it's a good question, Tim. Certainly, we're looking at new customers and new geographies where we've identified market-facing verticals that are growth. So if you think about the genset market, you think about what we're doing in EV, data centers, indoor air quality, absolutely. And through 8020, as we identify those customers, we have filters, just to be direct. We've got filters in place to make sure that we don't have erosion in terms of all the hard work that we're doing.

That's great. That's helpful, Collar. I definitely enjoyed visiting your data center manufacturing facility in Virginia three months ago. I got a really good appreciation of the uniqueness of the offering there. That was a great investor day. But what I really want to get to, I know the opening remarks you mentioned, 12 to 18 months backlog range for that. I'm just trying to get a sense if there's a shadow backlog behind that you know, as you talk to your customers and they plan finding more power sources of electricity to run their co-location and hyperscales, and you kind of think about maybe what CDU can do, you know, the calendar 2025. Do you think that, you know, your backlog is a lot bigger than maybe the 12 to 18 months based on kind of the plans of your customers for their growth?

Yeah, it's a good question. Certainly, you know, if we think about it in terms of our percent confidence, When we get to the point of backlog, we run it all the way through a funnel. So when you're looking at backlog, this is a high degree, high visibility, high likelihood that the order is going to be placed or the order has already been placed. And even before that, we look at our commercial funnel and we say that it's 50% visibility and it's larger than the current backlog. And then there's a precursor to that, which is 25%, assuming that you have 25% visibility of it that you know that that order is larger and bigger as you get out in the out years three four five years it's much more difficult to predict but certainly we're having conversations with our customers because as you go along that cycle whether it's a 25 50 or 75 you have to start triggering supply chain manufacturing operations and there's an entire process so Yes, we have those conversations. Yes, we see and we do have visibility of it. But we don't declare victory until we have the order in hand.

That's helpful. Thanks, Neil. I just have two more questions. Your gross margin has beat several quarters in a row versus maybe from the commentary or what the consensus number was. Any sense, if Mick wants to take a stab at this, any chance to maybe parse out how much of the gross margin expansion maybe this quarter or recently you know roughly you know is from kind of the cost savings slash efficiencies bucket versus catch-up pricing taken you know we're you know i cover a lot of industrial stocks and you know a lot of them have had terrific price increases the last 12 to 16 months but they're starting to see it slow in october november so i'm just trying to get a sense you know is the ed20 still a pretty big driver as it gets rolled out more to performance technologies And are you kind of tapping out on maybe the pricing catch up?

Yeah, yeah, that's a fair question. I would answer it two different ways or two ways. If we break it down by climate and by performance technologies, climate solutions and very intentionally as part of the transformation, the strategy has shifted towards a heavy lean on growth. And so most of the margin improvement we've been seeing in climate solutions over the last two quarters, I would say is driven by growth. And yes, there's mix in there, but we're growing the businesses that we want to grow have high margins and margins where we want them to be. And data centers is a good example. George Malavasic, Performance technologies again and neil's talked about this for a couple quarters we specifically paste that. George Malavasic, They are deep into the early phases of at 20 so for performance technologies over the last couple quarters they've had a much bigger margin drive based on I would I would combine it it's not just pricing but. product line simplification. And with that is cost reduction and throughput and productivity. So yeah, we continue to think performance technologies for a bit is gonna be cleaning, simplifying their business focused on margin improvement with a heavy dose of growth and EV. And then we would expect probably a year out performance technologies will continue to then identify those pockets where they see above market growth rates. So hope that answers the question for you.

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

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

Terrific, Mick and Neil. Thanks a lot. And that's it for my questions. Thank you.

Thank you. Our next question is from Matt Summerville with DA Davidson. Please go ahead.

Thanks. Couple questions. First, talk through data center expectations a bit. You talked through the heat pump side of things. There's three other high growth verticals that you guys have talked about in the past. Could you maybe more directly address what you're seeing there, what expectations may look like for revenue this year? Where are the pluses and minuses in those remaining three? And then I have a couple quick follow-ups. Do you want to talk Genset?

Yeah, so we continue to develop in the Genset market some advanced products that we believe we're going to be able to move into expanding our customer base. So certainly, we still believe in the numbers behind Genset. We still believe in the market. We see the tailwinds behind it. And it's favorable to the work that we're doing. So Genset market's on path. give the numbers when I finish on the other two. EB, we continue to develop new product. We mentioned the expansion that we're moving into in Europe because of the potential demand in the out years. We're winning on platforms and programs and we've launched additional new product. In indoor air quality, we're starting to continue to see the impact and effect of the CARES Act and the ESSER funds. We're seeing tailwinds out to 2026 with our school unit ventilators. Again, we're standing behind our indoor air quality growth relative to the numbers.

Yeah, for the most part, those long-term growth rates, especially in the growth businesses Neil just went through, Matt, we still feel.

Feel good about those.

I think with the strong data center year, we'll probably be adjusting data center long-term growth rates up to reflect this

really strong year we're in.

And then we still expect similar growth rates, high double digit growth rates across all of those.

And then on a heat pump side, that growth rate, we think, based on what Neil said, will take it down a little bit, still be double-digit growth rate.

But we see that being a slower ramp and taking a little bit longer to get to peak volume.

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

Yeah, I would estimate that 40 to 50 million mat of product, you know, for sure the divestitures, those three German businesses were 80 to 90 million annualized. And then we do track all of our 80, 20 product line simplification efforts. And just in context for you, we just updated that. And since we started, we're over 300 million. Now that includes the divestitures, but over 300 million of business that we've specifically targeted from a product line simplification.

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

Yeah, you know, the last couple quarters, we were looking at anticipating that we hit a bottom there relative to the amount of inventory that was in the channel and starting to see a recovery. This month, October, will be a very important month for us as we track the order rates as well as November. And, you know, we're going to track those on a day-to-day basis to see exactly when we start to see the recovery and rebound. So I think we're near where we thought we would be. And, you know, we're going to know a lot more in the next four weeks how strong the recovery will be met.

Got it. Thanks, guys.

Thank you. Has there been no further questions at this time? I would now turn the conference over to Kathy Powers. Please go ahead.

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