Modine Manufacturing Company

Hello and good morning. Welcome to our conference call to discuss Modine's second quarter fiscal 2025 results. I'm joined by Neil Brinker, our President and Chief Executive Officer, and Mick Luccarelli, our Executive Vice President and Chief Financial Officer. The slides that we'll be using for today's presentation are available on the investor relations section of our website at modine.com. On slide three of that deck 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, I'll turn the call over to Neal.

Thank you, Kathy, and good morning, everyone. As most of you know, we held an Investor Day last month at our corporate headquarters. I'd like to thank everyone who attended in person, participated in the live webcast, or watched the replay online. This was a very important event for us, so before going over our quarterly results, I'd like to review some of the key messages. Throughout the presentation, we highlighted five strategic pillars that we believe are key value drivers that form the foundation of our strategy to drive growth and margin expansion for years to come. First, at our core, we create value through our deep expertise in thermal management technology, allowing us to provide highly engineered, mission-critical thermal solutions for our customers. In fact, we've been doing it for over 100 years. Second, through 8020, we have leveraged our product portfolio to segment and resegment the business, focusing resources where we can drive the most value. 8020 is an ongoing process, and as part of it, we announced that we will realign our six product groups in our next fiscal year to improve our product and market focus. The third pillar relates to megatrends and how they are fueling our growth. For example, we are currently focused on supporting trends like high-performance computing, as the rapid expansion of AI and machine learning fuels demand for data center capacity and more advanced cooling solutions. Although these trends can change over time, we believe that the need to meet ever-increasing regulations and reduce the impact of fossil fuels on our environment are currently driving multi-year growth cycles. This will provide a constant need for new and advanced thermal solutions. Next, we have the benefit derived from our 80-20 discipline. which drives everything from our decentralized organization to our strategic resource allocation. By pushing decision-making down in the organization, we create a more focused product development cycle, stronger customer relationships, and an entrepreneurial spirit to fuel profitable growth. We consider 80-20 to be a competitive advantage, helping us improve efficiency, drive strategy, and ultimately to evolve our business portfolio. That brings us to the final pillar. evolving our portfolio to compound shareholder value. This process does not have a beginning or an end, but is a repeatable cycle to continually drive shareholder value and is expressed through our recently introduced vision statement, always evolving our portfolio products in pursuit of highly engineered, mission-critical thermal solutions. In addition to sharing this new vision statement, we also introduced new three-year financial targets. We expect compound annual revenue growth of 10% to 13%, for the three-year period off of fiscal 24 base and expect adjusted EBITDA margins in the range of 16 to 18% by fiscal 27. Overall, the feedback from the event has been overwhelmingly positive. We delivered on our commitments shared during our first investor day back in 2022, and we've now raised the bar even further. The team has accepted this challenge and have the plans in place to deliver once again. Now, shifting back to the quarter, I'd like to review the segment results. Please turn to slide five. Our climate solutions segment had another outstanding quarter, driven primarily by growth in our data center business. Revenues more than doubled as compared to the prior year, with about half of the increase driven organically and the balance from the Scott Springfield acquisition. This business continues to exceed our expectations. In addition, we officially announced the launch of our one megawatt coolant distribution unit, or CDU, which is a critical component for liquid and hybrid cooling systems, for high density applications. Demonstrating the benefits of 80-20 in product development decision making, our CDU was developed with voice of customer at the forefront and is designed to seamlessly integrate with Modine systems and controls to improve energy efficiency in the data centers. Interest in this product has escalated, with inquiries now coming from both co-location and hyperscaler customers. We still anticipate our first shipments of this product in the fourth fiscal quarter of the year. As mentioned during our Investor Day presentation, growth with hyperscaler customers continue to accelerate. In addition to our two current hyperscaler customers, we are now building a relationship with a third and expect to get our first order this quarter. We are also observing the evolving needs of these customers. Currently, we design and manufacture custom air handlers for our hyperscaler customers, and this will continue to be a significant component of our business. However, these customers have been increasingly interested in our high-performance chillers, especially now that we have production in both the US and the UK. In fact, we have received our first purchase order for chillers from a hyperscaler customer this past quarter, with expected shipment in our fourth fiscal quarter. This is an exciting expansion of our product offering to strategic hyperscaler customers, and another exciting growth prospect for our data center business. Last quarter, I mentioned that we are expanding capacity for our data center products, and I'm pleased to report that our UK expansion has been completed ahead of schedule, with the first units off the production line last week. We are also up and running at our expansion in Calgary, supporting the growth of data center products from SSM. I'm also excited to announce our next capacity expansion for data center products will be in India at a new facility in Chennai to support our customers in Asia and the Middle East. This new facility is near our existing manufacturing location and can be leveraged in the future for growth in both segments. This will bring the number of data center manufacturing locations to 10 and provide us with the capacity for continued growth around the globe. I'm very excited about this opportunity as we continue to organically invest in the data center market. Please turn to slide six. The performance technology segment also had a strong quarter with earnings and margin growth despite a drop in top line revenue driven by the decline in our vehicular markets. However, we are still seeing solid growth in the Genset module business. This is being bolstered by our global footprint, high quality, and on-time delivery. In fact, our capacity expansion in India for data centers will also allow for future growth in Genset production in that region. Sales in our advanced solution group also posted positive sales growth in the quarter. Last week, we announced our partnership with Gillick, a leading manufacturer of transit buses, specializing in low and zero emission solutions for public transportation. This longstanding supply relationship includes collaboration on their hybrid vehicles, which use our advantage battery thermal management system and inverter cooling modules. We also introduced our smart electric component portfolio, which is receiving positive feedback from the market. Our funnel of customer engagement and our advanced solutions group continues to be strong, including a number of opportunities in Europe. All in all, we are experiencing some short-term volume challenges in certain markets and are implementing countermeasures to reduce costs. but we are also seeing long-term opportunities with positive implications for our product mix in this segment. Overall, a good quarter, and our 80-20 culture and approach continues to help us mitigate legacy business wind-downs and some economic sensitivity in a few product categories. I'll turn the call over to Mick, who will provide some further updates on what we expect for the balance of the year.

Thanks, Neil, and good morning, everyone. Please turn to slide 7 to review the segment results. Climate Solutions continues to deliver outstanding results, hosting a 47% improvement in just the EBITDA and a margin above 21%. Data center sales grew 102%, or 80 million, driven by strong demand from North American hyperscale and co-location customers, along with the sales from the acquired Scott Springfield business. Modine's data center business continues to exceed our projections, and we're once again raising the revenue forecast for this product group. HVAC and R sales increased 14%, or $13 million, including revenue from Scott Springfield, along with higher sales of refrigeration coolers. Heat transfer product sales were down 13%, or $16 million, with lower sales to European Heat Pump, and commercial and residential HVAC customers. However, we were able to finalize some commercial settlements this quarter to help offset the lower volumes versus what was originally agreed to with certain customers. The team had been working towards the settlements, and we originally expected to see most of the benefit beginning in our Q3. Overall, we're pleased with the climate solution's strong earnings conversion. which resulted in a 300 basis point adjusted EBITDA margin improvement to 21.5%. As discussed at the investor day, our 80-20 discipline continues to be at the heart of the segment's quarterly margin improvements. And the team will continue to focus on accelerating organic growth, with organic sales improving 7% this quarter after adjusting for 53 million of revenue from the Scott Springfield acquisition. As we look at the last half of the year, we expect the positive momentum for revenue and earnings to continue for climate solutions. Please turn to slide eight. Performance technologies continues to evolve the portfolio and improve profitability, including a 5% increase in adjusted EBITDA and a 230 basis point improvement in the margin. The earnings growth and strong margin improvement were due to a lot of hard 80-20 work, including labor, material, and overhead improvements. In addition to the operational improvements, we were able to secure sales tax credits in Brazil, which had a positive impact on revenue and adjusted EBITDA in the quarter. As anticipated, performance technologies revenue was down in the quarter. This was driven by the prior year automotive divestitures, along with lower sales to automotive, commercial vehicle, and off-highway customers. Excluding the negative 22 million impact of divestitures, organic sales decreased 5%. Advanced solution sales were higher by 18% or 6 million, driven by increased sales of EV systems to specialty vehicle and bus customers. Liquid-cooled application sales decreased 22% or $27 million due to the prior year divestiture along with lower end market demand across auto, commercial vehicle, and off-highway markets. Lastly, air-cooled application sales were lower by 10% or $18 million, also driven by the divestitures and lower market demand from agriculture and construction equipment and commercial vehicle customers. However, as we've highlighted as a strategic focus, sales to GENSEC customers increased in the quarter by 29%. In addition to the planned portfolio rationalization, this segment is quickly addressing the broader market softness, which is well publicized across the agriculture, construction, and commercial vehicle markets. Despite temporary volume headwinds, we're pleased with the level of earnings conversion further validating the benefit of our 80-20 discipline. After a historically and seasonally soft fiscal Q3, we anticipate a step up in Q4. Now let's review total company results. Please turn to slide nine. Second quarter sales increased 6% driven by the Scott Springfield acquisition and organic growth in climate solutions. Climate Solutions' growth was partially offset by 22 million of divestitures and market-related volume declines in performance technologies. Our gross margin improved 340 basis points to 25.2%, driven primarily by an improved business mix, including the benefit of the Scott Springfield acquisition and numerous 80-20 initiatives. As noted during my comments and the segments, The quarter also benefited from a few items, including the commercial settlements and climate solutions and a sales tax credit recovery in Brazil. We estimate that the net impact of these items, along with a few others, was approximately $5 million. These items were previously included in our full-year outlook, but we anticipated that they would land in the second half of the fiscal year. That said, we are pleased to secure the benefits earlier than expected. As noted last quarter, year-over-year SG&A includes SG&A of the acquired Scott Springfield business and incremental amortization expense related to the acquired intangible assets. In addition, we recorded higher salary and incentive compensation expenses in line with our improved performance. Adjusted EBITDA was strong again this quarter with an increase of 23% or 19 million. The adjusted EBITDA margin was 15.2%, representing a 210 basis point improvement from the prior year. Each quarter, I provide a margin trend update, and this now represents the 11th consecutive quarter of year-over-year margin improvement. Adjusted earnings per share was 97 cents, 9% higher than the prior year. We're very pleased with another exceptional quarter resulting in great adjusted EBITDA growth as momentum in some key end markets allowed us to overcome challenges in others. The management team continues to implement 80-20 and remains laser focused on the things we can control. Now moving to the cash flow metrics, please turn to slide 10. We generated 44 million of free cash flow in the second quarter. which was an improvement from the first quarter. Please note that the quarterly cash flow included nearly $6 million of cash restructuring payments. This puts our year-to-date pre-cash flow at $58 million, which is on track with our full-year outlook. Net debt of $327 million was $45 million lower than the prior fiscal year and $36 million lower than last quarter. This resulted in a leverage ratio of 0.9. Consistent with the previous quarter, the balance sheet remained strong, and we anticipate another year of good free cash flow. Now let's turn to slide 11 for our fiscal 25 outlook. With half the year behind us, we announced in the press release that we're holding our fiscal 25 outlook. While the Q2 earnings were somewhat higher than we anticipated, The quarter included an estimated $5 million in net benefits, as I reviewed in the quarterly results. We had previously anticipated these benefits would settle in the second half of the year, with the majority of the benefit coming in our Q3. From a revenue standpoint, we'll continue to update each quarter the revenue outlook for Modine's product groups. The net impact of product group revenue adjustments is relatively neutral for the total company this quarter. In the climate solution segment, we're making a large increase to the data center outlook, along with an increase to HVAC and R, while lowering our outlook for heat transfer products. We now expect data center sales to grow 100% to 110%, a significant increase driven by their strong performance in the first half of the year and a growing order book. For performance technologies, We've adjusted for customer trends and ongoing weakness in the global commercial vehicle, off-highway, and auto markets. With regards to earnings, we expect fiscal 25 adjusted EBITDA to be in the range of $375 to $395 million. Consistent with our previous guidance, we expect Q3 will be sequentially lower than Q2 based on normal seasonal trends, along with some ongoing weakness in our vehicular markets. We then expect a sequential ramp in Q4 consistent with previous years and driven by specific markets and product launches. In addition, our view of cash flow remains consistent as we anticipate another year of good cash flow. Based on the current outlook, we anticipate that free cash flow this year will be in line or above the prior fiscal year. Last, we expect adjusted EPS to remain in the range of $3.65 to $3.95. Our income tax expense is trending a bit higher, and we expect the effective tax rate to be in the range of 26% to 28%. Other assumptions for interest expense, taxes, and amortization depreciation expense are summarized in the appendix attached to this presentation. To wrap up, we're pleased with the results from the second quarter and the first half of the year. Thanks again to those who attended or viewed the webcast of our Investor Day event. I encourage anyone who may have missed it to view the replay available on our Investor Relations website. With that, Neil and I'll take your questions.