Modine Manufacturing Company (NYSE:MOD) Q3 2024 Earnings Call Transcript

Modine Manufacturing Company (NYSE:MOD) Q3 2024 Earnings Call Transcript January 31, 2024

Modine Manufacturing Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, ladies and gentlemen, and welcome to Modine’s Third Quarter Fiscal 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Kathy Powers, Vice President, Treasurer, and Investor Relations.

Kathleen Powers: Good morning, and thank you for joining our conference call to discuss Modine’s third quarter fiscal 2024 results. I’m joined on this call by Neil Brinker, our President and Chief Executive Officer; and Mick Lucareli, 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 Neil.

Neil Brinker: Thank you, Kathy, and good morning, everyone. I’m pleased to report another successful quarter highlighted by very strong margin expansion and earnings growth. Our results this quarter further demonstrate our ability to improve our earnings profile as we shift towards faster-growing and higher-margin businesses. Despite all of our early success, I continue to believe that we are in the early stages of our transformation and are just beginning to realize the opportunities we’ve identified in each of our core market verticals. In many cases, we are recommitting our focus on operational excellence, adding additional resources for lean manufacturing and supply chain to improve productivity, quality, and cost realization.

Coupled with the success of our commercial team, this approach, enhanced by 80/20, will help to support our ongoing progress towards our goals. Overall, on the M&A front, we feel very good about the pipeline of opportunities available to us. We are not focusing on large transformational deals, but instead are looking for bolt-on acquisitions that bring complementary products and technologies to our key growth verticals. Our recent acquisitions of Napps Technology and the IP and select assets of TMGcore are perfect examples of this approach. We benefit from a very strong balance sheet, which will help support our inorganic growth targets as we remain vigilant in our search for attractive opportunities that fit our focus areas. Mick will go over our third quarter financial results and provide an update to our full year outlook, but first I’d like to provide some high-level updates on each segment.

Please turn to slide five. Starting with our Climate Solutions segment, we observed many of the same trends we saw in the second quarter. Our data center business remains very strong, with revenue up 34% compared to the prior year. Meanwhile, certain markets for our heat transfer products remain soft, and our revenues continue to be strategically impacted by the exit of low-margin businesses in connection with the 80/20 initiatives. Earlier this month, we shared some very exciting news about the purchase of the IP and select assets of TMGcore, a specialist in single-and two-phase liquid immersion cooling technology. This expands our global data center product offering, allowing us to support the future requirements of our customers as they manage the demands of high-density computing.

Our investment in immersion cooling technology, along with the internal development of a cooling distribution unit, or CDU, allows us to expand our product portfolio to address technology gaps while accelerating our ability to be prepared for the technology needs of the future. Further, this new technology will complement our existing high-performance products that maintain the temperature in the hall and add additional opportunities for the development and integration of a complete hybrid data center cooling system. We believe that the best strategy is to have multiple solutions with a complete suite of products that can be customized and optimized to the customer’s needs. I’m very excited for the data center team to begin working on commercializing this technology in support of our co-location and hyperscaler data center customers.

In further recognition of the expected growth in our data center business, we are transitioning our existing Grenada, Mississippi manufacturing plant to be a data center facility, similar to what we did in Europe at our Spain and UK facilities. Overall, I’m extremely pleased with the performance of the Climate Solutions segment. We are making the right investments to ensure that our data center business continues to grow and are delivering strong year-over-year earnings improvements, despite challenging markets for the heat transfer and heating products. Please turn to slide six. Turning to our PT segment, while our advanced solutions business continues to perform well, we have seen some leveling of the volumes in our air and liquid cooled businesses, which is in line with our expectations.

Despite flat revenues, our margins continue to benefit from 80/20 initiatives focused on commercial improvements and productivity enhancements. In addition, our PT segment also made some important announcements this quarter. First off, our EV systems business announced an important partnership for our Evantage thermal management systems with Bosch Rexroth, a recognized leader in drive and controls technologies. Given Bosch Rexroth’s strong market position, we are very excited about this opportunity to partner on electrified solutions for the off-highway market. This partnership is still in development phase, but is expected to provide additional growth opportunities in the future. At this point, the team has booked 31 program wins, including four additional wins since the end of last quarter, equating to a projected annual revenue run rate of over $160 million of program maturity.

And in addition, the team was also recently recognized by Frost & Sullivan with its 2023 North American Product Innovation Award. This award recognizes our commitment to quality, reliability, and customer service, while also helping our customers achieve their sustainability goals by accelerating decarbonization. I’m so proud of what this team has been able to accomplish, and with the previously announced capacity expansions in the US and Europe, we have ensured that we have the capacity to meet our commitments and future goals. Now, I’d like to pivot to another growth area in the PT segment, our GenSet business. Stationary power is a market ripe for growth with ever expanding needs for energy security for critical applications such as data centers and healthcare facilities.

As we recognize the growth potential of this market, we established a dedicated team devoted to understanding the market and building this business. We are very encouraged by our early progress and expect this to be a key growth area for Modine in the future. Last quarter, we announced that we had completed the divestitures of our German operations that supported the European light vehicle market. We have been transparent about our intentions to exit certain product lines that don’t meet our margin targets and these actions were in line with that strategy. We also mentioned that we would need to reduce certain overhead costs that have historically supported these markets. And we’re taking action to address these requirements by consolidating our technical services capabilities.

These actions are in line with our broader initiative of focusing resources on opportunities that carry higher growth profiles and more attractive returns through both divestitures and acquisitions. I’m very pleased with our progress and our performance this quarter. Our team is operating at a very high level and we are not only executing on our strategies, but are putting in the plans in place to reach our next set of goals. With that, I’ll turn the call over to Mick.

Michael Lucareli: Thanks Neil and good morning, everyone. Please turn to slide seven to review the segment results. Climate Solutions completed another excellent quarter, driven by a 29% improvement in adjusted EBITDA. Revenue was down slightly due to a decrease in heat transfer products and mostly offset by strong growth in data centers and a favorable FX impact. As discussed over the last two quarters, we’ve experienced some reductions in several markets served by heat transfer products. Based on these trends, we lowered our full year outlook for this product group. The adjustment is primarily due to lower demand within commercial and residential HVAC markets, including European heat pumps, along with 80/20 initiatives. Data center sales grew 34% or $15 million driven by strong demand from both hyperscale and co-location customers.

Our data center outlook remains quite strong while anticipating a very strong fourth quarter and full year growth in excess of 60%. HVAC&R sales were higher by 2% or $2 million driven by an increase in IAQ sales and the acquisition of Napps Technology that we completed last July, along with higher sales in power industrial coolers. Our heating sales were somewhat lower than expected as the overall market remains depressed from previous levels. We expect this softness to continue for at least another quarter, but the market data is indicating a potential bottom and we believe it will improve through calendar 2024. We’re very pleased with the Climate Solutions strong earnings conversion, resulting in a 470 basis point margin improvement to 18.9%.

Our 80/20 discipline is at the heart of these quarterly margin improvements. At a segment level, we continue to prioritize earnings and margins improvement over revenue growth. To wrap up on Climate Solutions, we remain cautious in a few markets for HVAC and heat transfer products businesses, but fully anticipate further year-over-year improvements next quarter to finish a great year. Please turn to slide eight. Performance Technologies also had a great quarter with a 52% increase in adjusted EBITDA. Revenue increased 2% driven by higher average selling prices and a favorable FX impact. Sales volume was down in the quarter, partly driven by the recent German divestitures, which negatively impacted revenue by $12 million. Excluding the impact of the divestitures, our sales would have improved by 6%.

Performance Technologies remains focused on driving rapid earnings growth, and that was very evident again this quarter. As I previously explained for Climate Solutions, the 80/20 efforts in Performance Technologies are focused on improving earnings and margins versus segment revenue growth. Advanced solutions sales were up 27% or $10 million with continued growth of EV systems and component sales, including higher sales to commercial and specialty vehicles along with higher coding sales. Liquid cooled application sales decreased 4% or $5 million, mainly due to the divestitures and lower automotive demand. Lastly, air-cooled application sales grew 2% or $3 million, primarily due to higher sales to off-highway and GenSet customers. The growth was partially offset by lower automotive sales, also related to the German divestitures.

Much like Climate Solutions, Performance Technologies’ earnings conversion was excellent, resulting in a 12% adjusted EBITDA margin and a 390 basis point improvement. For the balance of the year, we anticipate ongoing 80/20 progress and further year-over-year improvement, with a sequential earnings increase in Q4. Now let’s review the total company results. Please turn to slide nine. Third quarter sales were relatively flat as we continue to see rapid growth in our targeted growth areas, such as data centers and advanced solutions. These were somewhat offset by planned 80/20 activities and divestitures, along with temporary weakness in select HVAC markets. Excluding the impact of the divestitures in Germany, sales were up 3%. Our transformation initiatives are clearly benefiting the gross margin, which improved 530 basis points.

SG&A increased $10 million, driven primarily by higher employee compensation expenses, including incentive compensation. I’m happy to report that adjusted EBITDA was very strong again this quarter, with an increase of 39% or $21 million. This equates to an adjusted EBITDA margin of 13.2% or 370 basis point improvement from the prior year. And this now represents the eighth consecutive quarter of year-over-year margin improvement. In addition, adjusted earnings per share was $0.74, 54% higher than the prior year. We’re very pleased with another exceptional quarter, resulting in a year-to-date EBITDA margin that is above our targeted fiscal 2024 transformation range. Now moving to cash flow metrics, please turn to slide 10. We generated $47 million of free cash flow in the third quarter, which puts our year-to-date free cash flow at $131 million.

This represents a significant improvement compared to $33 million generated in the prior year. Net debt of $184 million was $102 million lower than the prior fiscal year-end, and $39 million lower from the last quarter. Also during the quarter, we repurchased 100,000 shares. For the fiscal year, we’re well on track to deliver our improved cash flow conversion targets, driven by higher earnings and a continued focus on working capital. We maintain a relatively low level of debt, supporting a strong balance sheet, and ready to support both organic growth and acquisition initiatives. Now let’s turn to slide 11 for our fiscal 2024 outlook. As announced in the press release, we’re raising our full year earnings outlook for fiscal 2024. While raising earnings, we’re also slightly lowered our full year sales outlook to recognize the impact of the European divestitures in Q3, along with lower expectations for our heating and HTP product sales.

In the Climate Solutions segment, we continue to expect data center revenue growth of 60% to 70%, with the forecast trending towards the high end of this range. Moving to HVAC&R, we expect revenue to be flat, slightly lowering the range from the low single digits last quarter. This is mostly due to a slower recovery in heating than originally anticipated. With regards to heat transfer products, we expect sales to decline in the range of 10% to 15%, which is a reduction from our previous guidance. This is primarily due to the ongoing weakness in a few end markets, especially the residential and commercial refrigeration applications and the European heat pump market. For Performance Technologies, we expect advanced solutions to grow in the 25% to 35% range, which did not change from the last quarter.

This growth is driven by program launches and continued demand for EV systems and components. We’re holding the outlook for liquid and air-cooled products, but we’ll be trending towards the lower end after adjusting for the recent divestitures. From an earnings perspective, I’m pleased to report that we’re once again raising our adjusted EBITDA outlook for the year. We now expect our fiscal 2024 adjusted EBITDA to be in the range of $305 million to $313 million, representing an increase of 44% to 48%. In addition, we anticipate good free cash flow this fiscal year, resulting in an improved ratio to sales, and capital expenditures are expected to be in the range of $70 million. Other assumptions, including interest, taxes, depreciation, and amortization are included in appendices attached to this presentation, and the press release.

To wrap up, we’re extremely pleased with the results from the third quarter, while we maintain momentum towards our interim and long-term financial targets. With that, Neil and I will take your questions.

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Q&A Session

Operator: Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Matt Summerville with D.A. Davidson. Please proceed with your question.

Matt Summerville: Thanks. Morning. A couple of questions. First, how much do you feel like you’re seeing incremental market weakness in the areas you highlighted in Climate versus more of a function of just 80/20 making its way into the business? And along these lines, if the market headwinds you see today are there — are going to be prevalent in 2025, is there any reason that shifts the momentum at all with respect to the massive amount of EBITDA margin and EBITDA dollar improvement you’re generating across Modine?

Michael Lucareli: Yeah. Good morning, Matt. It’s Mick. Let me give you a couple comments on revenue, and then I’ll turn it over to Neil to add some more color just around the 80/20 impact because I know there were some questions just around our revenue adjustments. First, I just want to be clear that our revenue adjustments aren’t solely tied to market softness. There’s clearly an 80/20 element in there. So, last quarter, we had the automotive divestitures closed right at our quarter end on the 31st, and as we analyzed that revenue impact at that point, we were estimating we’re running a little bit below the midpoint of the range last quarter. And as we announced last night, we’re raising the earnings outlook and adjusting the overall revenue range down a little bit.

That’s about that 2% adjustment to our sales outlook for the year, about $50 million. And then that’s in three areas, and we’ll get to your question, right? So, one of them is in heat transfer products, we lowered our outlook, and that’s a combination of market and 80/20 activities. And again, I’ll let Neil comment in a second. The second one, we talked about air and liquid in the divestitures. So, we’re running towards the lower end of our air and liquid range combined by adjusting and truing up the full year outlook for the closing of the deal, the divestitures. And we’ve seen some softness on the automotive side across the globe, especially on automotive EV, both ICE and EV vehicles. But that’s strategically okay with us and also tied to 80/20.

And then last, we talked about HVAC&R, and there I want to be clear, it’s really the heating market has been slower to recover. It was basically relatively flat. So, we’re not seeing it getting worse, and the industry data is showing that we seem to be turning a quarter, but we thought it would recover at a little bit faster rate. So, again, the way we sit today, Matt, we’re running about the middle of the revenue range, about the midpoint that we put out last night. And again, I just want to highlight it’s really a combination of the market adjustments and 80/20 activities. And that’s really what’s allowed us to drive the — a key driver to our rapid earnings growth and margin improvements. So, just maybe before we wrap it up, Neil, maybe a couple comments around the 80/20 impact.

Neil Brinker: Yeah. Matt, this is Neil. Thanks for the question. That’s a good summary for Mick in terms of how we’re thinking about it, especially when we think about heat transfer products. And we see some softening in some markets that we potentially would consider exiting. We accelerate those opportunities so we can continue to drive margin expansion and profitability in that business. HTP is a big business. Not all of it is ready for growth. It’s still going through 80/20 activity. We’ve isolated some areas in HTP where we’ve found favorable markets and trends in customers that — we’re preparing strategic initiatives to grow that business in the next fiscal year. But there’s still a lot of work to clean up with the tens of thousands of SKUs and customers that we serve. So, when we see an opportunity to accelerate that through 80/20 because of market softness, we react pretty quick.

Matt Summerville: Thanks for that, color. And then as my follow-up, just on the data center side of things, Neil, can you talk about kind of what the go-forward funnel looks like? How much visibility you have looking ahead into fiscal 2025 in that business? And when would you expect to start to see a little bit of liquid-related activity start to creep in?

Neil Brinker: Yeah. Great question, Matt. So, we’ve got visibility with some of our customers out as far as two years. I’d say on average, it’s between 12 and 18 months. Funnel continues to grow. It’s been growing at the rates that we’d assumed it would grow at, hence the revenue targets that we’ve been pretty public about, projections that we’ve been public about. So, we’re happy with where we’re at working with our customers in both North America as well as in Europe on co-locations and hyperscalers. Relative to liquid, we had the acquisition, a technology acquisition of assets, IP and assets, which is going to really help us with our product portfolio and making sure that we have the most current technologies in the liquid side, and that’s immersion.

And then we announced we were going to go into development with a couple customers around our cooling distribution unit, or CDU, which is direct-to-chip liquid cooling. And we expect to be into prototype in the next quarter or two on the CDU with a couple customers. And if their markets and their end customers have demand for high-performance computing, they’ll have a solution in place, assuming we pass the validation and testing with that customer. So, CDU’s direct-to-chip, I think, is closer to generating revenue than immersion cooling is at this time. But having the immersion cooling allows us to be part of conversations around next-generation data centers that we weren’t a part of prior to the acquisition of assets from TMGcore.

Matt Summerville: Understood. I’ll get back in queue. Thank you.

Operator: Our next question comes from the line of Chris Moore with CJS Securities. Please proceed with your question.

Chris Moore: Hey, good morning, guys. Thanks for taking a couple questions. Maybe we’ll just start with margins. It looks like fiscal 2024 operating margin will be in 10-plus range, Q4 being a little bit lower than the first three quarters were adjusted in that six, seven range. I realize you’re not giving guidance for 2025, but what are the puts and takes to Modine being able to match or perhaps improve on the 2024 margins in 2025?

Michael Lucareli: Yeah. Hi, Chris. It’s Mick here. So, I’ll just — I’ll talk EBITDA margin, but same drivers, right? And I’d say first, we’ll wrap up this year as a company of well above the target we set out. We wanted to be in the 10% to 12% range, and we’re clearly trending between the 12% and 13%. So, we’re ahead of schedule, but that doesn’t mean we’re not going — our plan is fully to drive further margin improvement next year. And to your question, where that comes from, a couple elements. On the growth side and mix, we still anticipate growth in those targeted areas that we’ve been through, whether that’s on the GenSet side in PT or data centers or IAQ, EV systems. We see growth, and that’s a good margin and earnings mix up for us.