Modine Manufacturing : Q4 2024 Transcript

Modine Manufacturing

Fourth Quarter and Fiscal Year 2024 Earnings Conference Call

May 22, 2024

Presenters

Kathy Powers, Vice President, Treasurer and Investor Relations

Neil Brinker, President and Chief Executive Officer

Mick Lucareli, Executive Vice President and Chief Financial Officer

Q&A Participants

Chris Moore - CJS Securities

Noah Kaye - Oppenheimer & Company

Matt Summerville - D.A. Davidson

Brian Sponheimer - Gabelli Funds

Operator

Good morning, ladies and gentlemen, and welcome to Modine's Fourth Quarter and Fiscal Year 2024 Earnings Conference Call.

At this time all participants are in a listen-only mode. Later, we will conduct a question-and- answer session. Instructions will follow, at that time. If anyone should require operator assistance during the conference, please press "*" then "0" on your telephone keypad.

As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Ms. Kathy Powers, Vice President, Treasurer and Investor Relations. Please go ahead.

Kathy Powers

Hello, and good morning. Welcome to our conference call to discuss Modine's Fourth Quarter and Full Year Fiscal 2024 Results.

I'm joined by Neil Brinker, our President and Chief Executive Officer and Mick Lucareli, our Executive Vice President and Chief Financial Officer.

The slides that we will be using for today's presentation are available on the Investor Relations section of our website, modine.com. On Slide 3 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 will turn the call over to Neil.

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Neil Brinker

Thank you, Kathy, and good morning, everyone. This was an important year in our transformation where our plans became actions, and we delivered results. Our strong fourth quarter performance closed out another record year for Modine, with the highest reported sales and adjusted EBITDA in our history for the second year in a row.

Our sales were up 5% to $2.4 billion and more importantly, adjusted EBITDA increased by 48% to $314 million. This equates to a 13.1% adjusted EBITDA margin for the full fiscal year and underscores the step change in profitability that our commitment to 80/20 has produced.

We have shifted our business mix to targeted markets with strong growth drivers, where our products and solutions are well positioned and carry sustainable margins. This was demonstrated through both acquisitions and divestitures during the year, including two acquisitions completed in the fourth quarter, the assets of TMGcore, a liquid immersion cooling technology for Data Centers that we discussed last quarter, and Scott Springfield, a manufacturer of air handling units for Data Centers and other strategic applications.

We also executed two important divestitures during fiscal 2024, including the sale of three automotive businesses in Germany that manufactured parts, principally used by the internal combustion engine in the European market, as well as two coatings aftermarket businesses here in the U.S.

These actions fit squarely within our strategy of focusing on innovative engineering solutions and investing in our most attractive end markets to help us achieve our long-term margin targets.

Mick will cover our fourth quarter financial results and provide our outlook for fiscal '25. But first, I'd like to reflect on some of our accomplishments over the past year.

Please turn to Slide 5. Climate Solutions reported another outstanding year. The segment delivered a 31% increase in adjusted EBITDA on a 4% increase in sales, resulting in a 370 basis point improvement in adjusted EBITDA margin to 18.3%.

Sales growth in the segment was driven by Data Centers, which were up 69% to $294 million, at the top end of our expected range. We have made several investments in this market this year, including TMGcore and Scott Springfield.

Scott Springfield is a great strategic fit for Modine and our Climate Solutions segment. Their manufacturing operations are in Calgary with two locations, one dedicated to Data Center products, which we are integrating into our Data Center vertical, and the other supporting custom air handling units for other end markets such as health care, which we are integrating into our HVAC&R vertical.

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Perhaps most importantly for our Data Center business, Scott Springfield brought us a complementary cooling technology and a strong customer base. In addition, it also brought a strategic relationship with a new hyperscaler customer, accelerating our ability to broaden and diversify our customer base.

We have secured additional manufacturing capacity in Calgary to support our expected growth of this business, more than doubling the output potential.

In addition, we recently announced that we secured a new manufacturing site for Data Center cooling products in Bradford U.K., which will also include a new state-of-the-art R&D test center. This brings our total number of Data Center manufacturing locations to nine and represents a doubling of our potential capacity from where we were at the beginning of the past fiscal year.

Given the current level of our backlog and active pipeline, this additional capacity will ensure we will be able to meet our customers' commitments and future growth projections.

Our other businesses within the Climate Solutions segment also performed well this past year. Despite a 15% revenue decline, our Heat Transfer products business significantly improved EBITDA margins through 80/20 actions, contributing to the overall improvement of the segment.

Looking forward, Climate Solutions is focused on executing organic growth opportunities, while integrating and building synergies with their acquired businesses.

In addition, we will continue to target smaller inorganic growth opportunities to fill product and technology gaps. This team is executing at a high level, and I have confidence that they will continue to meet and exceed their targets.

Please turn to Page 6. The Performance Technologies segment also had a fantastic year, reporting a 67% increase in adjusted EBITDA on a 5% increase in sales, resulting in 450 basis point improvement and adjusted EBITDA margin to 12.1%.

This performance was largely a product of advancing 80/20 throughout the organization, from high-level commercial activities down to the factory floor. We have improved our sales mix by focusing resources on strategic product lines and deemphasizing and divesting lower-margin business.

The transformation of this portfolio is still underway, but we have a greater understanding of the profit drivers and have identified and are supporting those markets where we have strong customer relationships, technology superiority and a clear strategic advantage.

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Our Advanced Solutions business continues to perform well with our advanced Thermal Systems Group having added 16 new programs, representing over $40 million of incremental peak annual revenue, this year. Overall revenues grew 25%.

Our Air and Liquid cooling verticals were relatively flat on the top line, largely due to the divestitures of the German automotive plants in Q3. We are making progress consolidating our technical services, testing and tooling operations, and we expect this to be mostly completed by the end of this quarter.

The PT segment made significant strides against their strategic objectives, this year, but still have much work ahead. The segment will remain focused on driving favorable changes to their sales mix, as they explore new applications for their products in support of energy transition and promote further attrition of the portfolio through product exits and divestitures.

I'm very pleased with how the business performed this year, and I'm equally encouraged about what lies ahead.

We are leaders in thermal management solutions, and we are finding newer and better ways to apply our technology. We are investing for the future, while leveraging our strengths in using 80/20 to guide our decisions. This is leading to improved customer relationships and new opportunities to build a stronger Modine.

With that, I will turn the call over to Mick.

Mick Lucareli

Thanks, Neil, and good morning, everyone. Please turn to Slide 7 to review the segment results.

Climate Solutions finished the year with another excellent quarter, resulting in a 14% adjusted EBITDA improvement. Our focus and resource shift to the Data Center market continues to pay off, driving strong revenue growth and higher segment earnings. Data center sales grew 40%, or $25 million, driven by strong demand for both hyperscale and colocation customers.

Heat Transfer product sales were down 20%, or $24 million. The decline was generally in line with our expectations, continuing the trend from the past few quarters. The lower revenue was driven by a combination of 80/20 activities, along with lower demand in certain commercial and residential markets, including a soft European heat pump market.

HVAC&R sales increased 1%, or $1 million, including revenue from our acquired businesses. Heating revenues were slightly up from prior year, offset by a decline in commercial refrigeration coolers.

We're very pleased with Climate Solutions strong earnings conversion, resulting in a 210 basis point margin improvement in adjusted EBITDA to 18%.

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Despite relatively flat sales, our 80/20 discipline remains at the heart of these quarterly margin improvements, including a positive mix impact with Data Center sales driving a meaningful margin increase.

This quarter wrapped up another great year for Climate Solutions. We anticipate more revenue and earnings growth ahead, including the positive impact from the businesses we acquired this past fiscal year.

Please turn to Slide 8. Performance Technologies also had another great quarter with a 38% increase in adjusted EBITDA. Revenue decreased 5%, driven by the recent German divestitures and lower sales of automotive products, partially offset by higher sales to off-highway and specialty vehicle customers.

The negative sales impact due to divestitures in the quarter was $24 million, and organic sales grew 2%. Performance Technologies remains very focused on improving earnings and margins versus revenue growth, which came through clearly again this quarter.

Advanced Solutions sales were up 15%, or $6 million, with growth of the EVantage product, including higher sales to commercial and specialty vehicle customers.

Liquid cool application sales decreased 13%, or $18, million mainly due to the divestitures and lower auto sales in Europe and Asia.

Lastly, Air Cooled application sales decreased 2%, or $4 million, also primarily due to the divestitures and ongoing 80/20 activities.

As we've discussed strategically in the past, Performance Technologies will continue reducing and exiting targeted areas to drive higher earnings, while redeploying resources to future growth businesses. As a result, their earnings conversion was excellent to finish the year, resulting in a 13.4% adjusted EBITDA margin, a 430 basis point improvement.

To wrap up the year, we achieved significant earnings improvement and anticipated 80/20 actions will result in continued improvement in the upcoming fiscal year.

Now let's review total company results. Please turn to Slide 9. As we move on to the total company results, I think it's important that I review how the numbers align with our transformation and the 80/20 journey.

A key element of 80/20 is to focus on and prioritize those areas that drive the majority of the value, while deemphasizing other areas. As investors know, we've been actively reallocating human and financial resources to the highest returning businesses. This also means that we're not focused on driving total revenue growth. Instead, we're targeting revenue growth in certain areas, while deemphasizing others.

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It's in this 80/20 methodology that's allowed us to increase adjusted EBITDA by 48% on a relatively small increase in total revenue in fiscal '24. This is why we remain focused on margins and earnings, over top line revenue.

With that said, fourth quarter sales declined 2%, driven by planned 80/20 activities and divestitures, with $24 million of the decline tied to the divestitures.

Our gross margin improved 420 basis points, benefiting from the 80/20 initiatives and actions, along with lower commodity costs.

SG&A increased $15 million, driven by higher employee compensation expenses, including $2.5 million tied to recent acquisitions and transaction-related costs.

Adjusted EBITDA was strong again this quarter with an increase of 20%, or $13 million. The adjusted EBITDA margin was 13.1%, a 250 basis point improvement from the prior year. This now represents the 9th consecutive quarter of year-over-year margin improvement.

In addition, adjusted earnings per share was $0.77, 15% higher than the prior year. Please note, earnings per share on a GAAP basis was $0.48,, which was $1.21 lower than the prior year. The decrease was due to the reversal of a tax valuation allowance, which resulted in an income tax benefit of $57 million in the prior year's fourth quarter.

We're pleased with another exceptional quarter resulting in a full year EBITDA margin that ended above our targeted transformation range that we established more than two years ago.

Now, moving to cash flow metrics, please turn to Slide 10. We generated $127 million of free cash flow during fiscal '24. This represents 5.3% of sales and an improvement of $70 million, compared to the prior year. CapEx was higher than we previously anticipated, primarily due to the recent purchase of the new U.K. manufacturing facility to support additional Data Center growth.

Net debt of $372 million was $86 million higher than the prior fiscal year and $188 million higher than last quarter. This was largely due to our acquisition of Scott Springfield manufacturing, during the quarter.

Our leverage ratio increased from 0.7 to 1.2 during the quarter, due to the acquisition. We funded a large number of growth initiatives and acquisitions during fiscal '24, but ended the year with a lower leverage ratio than when we started. As a result, we remain in a great position to support more organic growth and acquisition initiatives.

Now, let's turn to Slide 11 for our fiscal 2025 outlook. I'm pleased to share our current fiscal '25 outlook, which shows further progress towards our long-term financial targets. We're expecting a recovery in some of our key HVAC&R markets and continued strong growth in Data Centers.

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We're expecting slightly lower sales in Performance Technologies, due to the divestitures, and 80/20 related product rationalization in the areas we've chosen to deemphasize.

Overall, we expect total company sales to grow in the range of 5% to 10%.

In the Climate Solutions segment, we expect Data Center sales to grow 60% to 70%. This includes both organic growth and the positive impact from our recent acquisitions.

Moving to HVAC&R, we expect sales to improve this fiscal year, growing 20% to 25%, following a relatively flat year. This will be driven by growth in indoor air quality, which also benefits from our recent acquisitions, along with the further recovery in heating and refrigeration cooler markets.

For Heat Transfer products, we expect sales growth in the range of 3% to 5%, following a down year.

For Performance Technologies, we expect Advanced Solutions growth in the 20% to 30% range, driven by new program launches. We expect a decline in sales in Liquid Cooled products, driven by the remaining impact of the German divestitures and further attrition of nonstrategic business.

Our Air Cool business will also be impacted by the divestitures, but that will be offset by targeted growth in strategic off-highway and power generation markets.

Overall, we're planning on slightly lower sales in Performance Technologies, but this is consistent with our long-term strategy and expect significant improvement in EBITDA dollars and margin.

Before moving to the earnings outlook, I'd like to announce an organizational change that will impact our product group sales reporting's going forward. Effective April 1, we moved our Coatings Products to Climate Solutions, and we'll report Coating sales within Heat Transfer products, going forward.

Previously, the Coatings was managed by Performance Technologies and reported within Advanced Solutions. The financial impact will be minimal to the segment results. In terms of revenue for fiscal '24, sales in our Coatings business were $53 million.

Now, moving to our earnings outlook. We expect fiscal '25 adjusted EBITDA to be in the range of $365 million to $385 million. Using the midpoint of the range would result in a nearly 20% increase and another year of rapid earnings growth.

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In addition, we anticipate another year of good cash flow and expect we'll generate a similar level of free cash flow in fiscal '25. As part of our cash flow outlook, we anticipate fiscal '25 capital spending to be in line with the prior year.

Given the relatively complex purchase accounting for our acquisitions, we would like to provide some EPS guidance.

As part of the accounting treatment for the Scott Springfield acquisition, we're doing a typical adjustment for all asset values, which will result in a higher noncash depreciation and amortization expense.

Based on our current outlook and the purchase accounting items, we're expecting adjusted EPS to be in the range of $3.55 to $3.85. This reflects the key assumptions for interest expense, taxes and amortization and depreciation expense, including impacts from the acquisition of Scott Springfield.

Please note that these assumptions are summarized in the appendices attached to this presentation and our press release.

To wrap up, we're extremely pleased with the results from the fourth quarter and the fiscal year. We've clearly demonstrated momentum towards our longer-term financial targets and look forward to the upcoming fiscal year. We plan to hold an Analyst and Investor Day event later this year at our headquarters and additional information on that event will be available, soon.

With that, Neil and I will take your questions.

Operator

Thank you. If you would like to ask a question, at this time, please press "*", then the "1" key on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press "*" and then the "2" if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up the handset, before pressing the keys.

Our first question is from Chris Moore with CJS Securities. Please proceed.

Chris Moore

Hey, good morning, guys. Thanks for taking a couple questions. Maybe we can start to talk a little bit on Data Centers. As you guys--I think to discuss at this point in time, all of current revenue is on the Air Cooled side. On the liquid cooling front, you have the ongoing development efforts, both directed chip cooling and immersion cooling. Can you talk a little bit about the critical milestones over the next, say, 12 to 18 months, where that would put you some time in calendar '25?

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Neil Brinker

Yeah, good question, Chris. Thanks for that. This is Neil. Certainly, we have seen growth in the markets and Data Center around direct cooling, and now with the addition of Scott Springfield that adds a new technology with evaporative cooling that has been in the industry for some time, that may or may not support or augment liquid cooling, but certainly for standard Data Centers, you need that product line.

And we're getting market capture there. So, that's significant. That's where we're seeing the expansion in the United States and some of the expansions that we've done in Europe, are to support the growth on market capture, driven by or not by liquid cooling. So that's--that has been a milestone for us, building out the capacity so that we can continue to gain share.

The other milestone is where we know it's tied directly to liquid cooling, whether that's direct to chip, single phase or two phase, liquid cooling immersion. And we--the acquisition of the TMG assets will help us be at the table having conversations with our Data Center customers for future Data Center generations that may adopt those technologies. So that's a milestone to be able to have those products and technologies to have conversations about the future.

And then our CDU development, which I believe is right around the corner for direct to chip with adoption in the market, we're in the process of developing that product. And when we launch that with a select few customers by the end of the fiscal year, that would be a milestone.

So capacity expansion, setting ourselves up for success, continuing to win with our customers, over serving our customers and providing them with the products and services that we provide and then having the technologies in terms of direct to chip and full immersion cooling so that we can have conversations about future Data Centers with our most important customers.

Chris Moore

Got it. Very helpful. And maybe just another way to look at it. From the Air Cooling perspective, I'm just trying to get a sense for the runway there. Obviously, we're talking about huge growth here. I mean, is there any reason to think growth slows, Data Center-wise, in three or four years from now? I'm just trying to understand if everything is shifting towards liquid or air growth is going to be there, significantly, and liquids coming, as well.

Neil Brinker

We believe, Chris, it's a matter of both. You don't necessarily need liquid cooling for everything. And we also see, in most cases, we're working with our customers and watching the trends in the industry that air often augments liquids. So there's a desire for both technologies.

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Chris Moore

Got it. Very helpful. Maybe just my last one. I know at Investor Day, that was--it feels like a long time ago. We're talking about $400 million to $600 million in M&A between '24 and '26. Obviously, what you guys have done already on the M&A side and also in terms of kind of the more organic growth, aren't going to need to get to that level.

Can you talk a little bit more about M&A thoughts? And is there a revenue target moving forward? Or just kind of how you're looking at it at this stage.

Mick Lucareli

Yeah, hey, Chris, it's Mick. Yeah, I think from the original targets we laid out two and a half years ago, you're right. Clearly, we didn't--we don't see the need to have as large of an M&A funnel versus where we thought we need to be to maybe address some of the planned product line down. So through a lot of good work and margin improvement and other growth areas, organically, we found that's definitely come down.

I think we don't have a firm target. We will try to provide updated guidance for you on that in the fall. But Neil and I have been pretty consistent with that. I think now the sweet spot we're looking at are kind of the smaller to midsized transactions, probably more in the Scott Springfield size that we think are right down the middle of the road for us.

But no, we don't need a lot of M&A. We don't need large M&A to hit our financial targets. So we're being pretty selective here about what we choose to bolt on.

Chris Moore

Got it, very helpful. I'll jump back in line. Thanks, everybody.

Operator

Our next question is from Noah Kaye with Oppenheimer & Company. Please proceed.

Noah Kaye

Hey, good morning. Thanks for taking the questions. Maybe we can start with margins. Certainly, margin improvement happening faster than consensus across both segments. Can we maybe understand the margin expectations embedded in the '25 guide at a segment level, if possible and any considerations around cadence. And is it also possible to ballpark the magnitude of divestitures embedded in the guide?

Mick Lucareli

Yeah, sure. It's Mick. So, if you look at our guidance in the range where, if you kind of go to the midpoint, that's kind of putting that around, say, a 14.5% or so tight EBITDA margin. And clearly, we're continuing to expect another sizable increase as we really talked about that all year, we would expect fiscal '25 for Performance Technologies to have a nice lift, call it another 200 basis points or so goal there.

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