Q3 2023 Modine Manufacturing Co Earnings Call
Turn the conference over to your host Ms. Kathy powers, Vice President Treasurer, Treasurer, and Investor Relations. Please go ahead.
Good morning, and thank you for joining our conference call to discuss <unk> third quarter fiscal 2023 results I'm joined on this call by Neil Brinker, Our President and Chief Executive Officer, and Nic Lucarelli, Our executive Vice President and Chief Financial Officer, we will be using slides for 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 Dot 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 is my pleasure to turn the call over to Neil.
Thank you Kathy and good morning, everyone.
I am pleased to announce another strong quarter with sales up 12% and adjusted EBITDA up 36% from the prior year.
Mick will go through our financial results in more detail, but before that I would like to provide an update on our transformation focusing specifically on our 80 20 activities as we make progress towards our strategic goals.
It was actually on this call two years ago. My first with a company that we began outline our vision for the new Modine and the role of the 80 20 with play.
The initial steps towards a simplified and segment the organization and align the teams around specific strategies for each market vertical.
Once those steps were complete our leaders began creating a high performance culture, driven by prioritizing and focusing our resources on our best returning opportunities.
All of these activities were done in preparation for driving focused and sustainable growth.
As I mentioned last quarter. The climate solutions segment was the first to launch a 'twenty and is well along in its journey.
Best example of this is in data centers, which was the initial pilot for our 80 20 initiatives.
Fast forward to where we are today and we couldnt be happier with our progress.
We stood up the data center organization and immediately began expanding our manufacturing capability to bring our existing products to new markets.
Our new Chiller plant, Virginia is now up and running and we have shipped our first products off the production line early last quarter. This.
This is an important step for us as it allows us to be a full system supplier of data center products in North America with local production capabilities.
In addition throughout the climate solutions segment, we are sharpening, our commercial acumen by identifying and developing relationships with our top sales prospects.
And by providing our best customers with exceptional service in order to strengthen existing relationships and drive brand loyalty.
We are strengthening our distribution model and simplifying our product offerings through SKU reduction for better focus.
All of this is leading to improvements across our business.
Our segment adjusted EBITDA margin this quarter of 14, 2% is more than 300 basis points better than last year.
And its run rate is tracking well towards the two year target range set at our Investor Day. This past June .
Our heat transfer products group was a large contributor to this improvement this.
This team has simplified our business by reducing Skus and fine tuning their pricing model.
Even the level of improvement in this business. They are now focusing on growth in key markets, particularly within the European heat pump market, where we will be increasing manufacturing capability.
The rapid adoption of heat pump technology in Europe is providing a clear tailwind for this business.
This glimpse at areas of the business, where 80 20 is furthest along demonstrates the effectiveness of our initiatives and the impact they are having.
It is also a positive indicator for areas of the business that are in early innings of the 80 20 process.
While I'm very pleased with the traction and the rate of improvement within our climate solutions segment. We are far from done we will continue to drive 80 20 throughout the organization beyond the commercial team through the supply chain and to the factory floor in order to improve our efficiency and further simplify our business.
We are creating focus factories with incremental capability and capacity created by eliminating low margin product lines and.
In addition, we are also returning to new product development fueling our gaps are improving technologies where warranted.
Please turn to slide five.
And our performance technologies segment, we formally launched 80 20 in the latter part of 2022, and we are well along the way and training the workforce.
We have our leadership team in place and we are working through the segmentation process.
Although most of our contracts and the performance technologies segment allow us to pass through metal prices. We have generally not been allowed to pass through increases in other costs, which have hurt our margins over the past several quarters.
We have started to make major gains in this area. However, and have reached agreements with several key customers. This has led to incremental improvements in EBITDA margins over the past two quarters.
Our product groups in this segment have a clear understanding of their priorities.
In our advanced solution group, which includes our <unk> systems business, we continue to build our order book with one additional production order during the quarter and the last mile delivery space.
Increasing our peak annual revenue estimate to nearly $140 million.
And our liquid cooled business, we are moving in the right direction identifying the strategic initiatives with a keen focus on improving the efficiency of operations and those plants that are not currently meeting our expectations.
Our <unk> business has the heaviest lift ahead and has a number of key initiatives underway.
One major area of focus has been the Gen set market, where we are building a strong book of business that will help us reach our financial targets.
The key here is prioritization using 80 20 to capture the greatest opportunities.
I have tremendous faith in this team.
They have negotiated key commercial improvements they are rationalizing product lines and reducing complexity. They are improving their cost structure by relentlessly focusing on supply chain optimization and they are introducing quoting filters to ensure that new programs meet our financial criteria.
We are already seeing improvements in our results and expect to see incremental benefits from our 80 20 actions in fiscal year 'twenty four.
None of this is easy.
In fact, it's quite difficult.
But it is a critical step in our transformation of our business and hitting our financial targets.
I am optimistic.
And then we will finish our fiscal year on a strong note.
Now I'd like to turn the call over to Nick who will review our results for the quarter and provide segment financial updates.
Thanks, Neal and good morning, everyone.
Please turn to slide six to review the segment results.
Climate solutions had another exceptional quarter with higher sales volume and excellent earnings growth.
Revenue was up 9% over the prior year and up 15% on a constant currency basis.
Data center sales were up 68% or $16 million and strong demand from our north American customers.
As Neil mentioned, we shipped our first chillers in the North American market this quarter.
HVAC and our sales were up 3% or $2 million driven by higher sales of indoor air quality products to the school market and increased sales of commercial refrigeration coolers.
This was partially offset by some weakness in the heating market in 2020 product rationalization.
Sales of heat transfer products increased 2% or $3 million from the prior year.
There was a modest growth across our global markets for coil products, but we're seeing some softening in demand from residential HVAC customers.
Adjusted EBITDA increased 48%, including a 370 basis point margin improvement to 14, 2%.
Earnings and margin improvements were primarily driven by higher sales volume and benefits from our 80 20 initiatives.
The climate solutions segment, it's far along in its 80 20 journey and we are clearly seeing the anticipated margin improvement.
In Q4, we expect data center and HVAC in our markets to remain strong, but anticipate ongoing weakness in the heating market and lower sales of heat transfer products.
Please turn to slide seven.
Performance technologies also had a strong quarter with sales up 13% or $36 million.
Revenue was up 19% on a constant currency basis.
Benefiting from volume growth in all product groups, along with improved commercial pricing.
Advanced solution sales were up 17%.
Our $5 million with continued growth in our electric vehicle product sales.
Liquid cooled product sales increased 10%.
Our $11 million due to solid growth in North American and European commercial vehicle sales, partially offset by softness in Asia tied to Covid related shutdowns in China.
Lastly, air cooled product sales increased 15% or $21 million, primarily due to strong demand in the off highway and commercial vehicle markets.
Adjusted EBITDA increased 48%.
<unk> in our eight 1% margin and a 200 basis point improvement.
As anticipated we experienced a small positive net impact of material costs this quarter <unk>.
Aluminum and copper had been trending lower however, stainless steel prices have been increasing to partially offset that favorability.
SG&A was higher than the prior year, but declined 30 basis points as a percentage of sales.
As Neil discussed the performance technology segment is still in the early stages of its 80 20 journey, but progressing very well.
Adjusting our commercial agreements to better recover cost is key to margin improvement and the team's progress is evident in our results this quarter.
We continue to see strength in most of our end markets and expect further gains in both revenue and earnings in our fourth quarter.
Now let's review the total company results, please turn to slide eight.
Third quarter sales were up 12% or $58 million driven by gains in both performance technologies and climate solutions.
Revenue was up 18%, excluding a negative FX impact of $30 million.
In the quarter. The main revenue driver was higher volume of approximately $74 million, resulting in a volume growth rate of 15%.
Gross margin improved 250 basis points due to the higher volume and pricing.
Really offset by the net impact of other inflationary cost increases.
SG&A increased $8 million from the prior year, primarily due to higher employee compensation related expenses professional fees and certain variable costs.
As a reminder, last year's operating income was higher due to large reversal of previous asset impairment charges related to auto divestiture activities in prior years.
I'm happy to report that adjusted EBITDA increased 36% or $14 million. This represents a 170 basis point improvement in the fourth consecutive quarter of year over year margin improvement.
Adjusted earnings per share of <unk> 48.
Was 17 or 55% above the prior year.
Now moving to cash flow metrics.
Please turn to slide nine.
Free cash flow was relatively flat in the third quarter.
Working capital remained somewhat elevated as we are working through global supply chain challenges year to date free cash flow is at $33 million. This includes the negative impact of $13 million of cash payments, primarily for restructuring activities, including the European head count reductions announced last year.
During the quarter, we repurchased 100000 shares for a total of 300000 shares on a year to date basis.
Net debt of $308 million was slightly higher than the last quarter and partially due to a negative FX impact.
Our cash balance was $82 million with a leverage ratio of one six which improved slightly from last quarter.
As we look to Q4, we expect stronger free cash flow, mostly due to reduced working capital.
Now, let's turn to slide 10 for our fiscal 'twenty three outlook.
We are confirming our outlook for fiscal 'twenty three revenue growth at 6% to 12%. Despite the negative impact of foreign exchange has had this year.
We have slightly reduced the sales outlook in HVA, CNR and tightened the range for heat transfer products, mostly due to some weakness and heating products and coils that are sold into the residential market.
In addition, we slightly lowered the high end of the ranges for sales of liquid and air cooled products.
We're also holding our outlook for fiscal 'twenty three adjusted EBITDA to be in the range of 190 to 200 million, representing an increase of 20% to 26% versus the prior year.
As we look to Q4, we will have difficult comparable and climate solutions in particular, the year ago period had extremely high sales and margins in heating and coil products.
Given that we raised our guidance last quarter and the current economic uncertainty we're taken a relatively conservative stance on the next quarter that said and based on our year to date results. We are clearly trending towards the high end of our guidance range.
To wrap up we're pleased with our third quarter results and our business leaders continue to execute on planned improvements we remain on track with our transformation and progress towards our long term margin targets presented in our Investor Day last June with that Neil and I will take your questions.
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One moment, please while we poll for questions.
Our first question comes from Matt Summerville with D. A Davidson. Please proceed with your question.
Good morning. This is willa jealousy from that some of those today.
I wanted to start out by asking you about the data center business as we head into your fiscal year 2024.
And what's your observations are with respect to both Hyperscale and Colocation markets in North America, as well as Europe , and whether or not you still feel comfortable with the level of growth that you've expected from these businesses.
Now.
Hi, Good morning. This is Neil thanks for the question.
Yes in short I do feel comfortable with where we're at.
I, particularly feel comfortable because of the position that we have with our expansion of factories.
Not only.
In the UK, but in.
Continental Europe as well as in North America. So we're seeing a lot of opportunity as we've expanded our products product line, we've seen a lot of opportunity as we've taken very specific strategic customers that we want to grow with and over serving those customers. So.
Sure, Yes, I am still confident with where we're at and where we're trending in the data center side.
Okay.
Alright, and then on the performance technology side.
It sounds like you had one incremental customer win within last mile delivery, but I'm wondering if we could get a broader picture about.
The go forward funnel of interested customers.
And any other notable wins you've had in the EV thermal management space.
Yes, that's a great question will certainly an area of focus for us and where we see tremendous amounts of opportunity for growth considering where we were two years ago.
We're on our engagements.
<unk> increased from 100 engagements in September to a roughly 120 last month, we have gone from 18 wins to 19 wins are prototypes of increase from 56 to 58, Our peak award last quarter. When we made this announcement was $95 million were up to $140 million today.
So we're continuing to solve critical applications in terms of battery thermal management for our customers we've.
We've looked at specialty vehicles in a meaningful way and we've also pivoted towards some wins on the last mile delivery van So we've expanded our commercial base and we've also.
<unk> expanded our product portfolio as well, we've recently put out a press release with our El Con, which is another version of battery thermal management system. That's for harsh applications in tough environments that gets us into additional specialty vehicles. So.
The group continues to grow we continue to invest we're adding more resources more capital.
We're pleased with where we're at with the funnel today.
That's great. Thank you Neil.
Welcome all.
Our next question comes from Stephen <unk> with CJS Securities. Please proceed with your question.
Hey, good morning, Neil next thanks for taking my questions.
Good morning, Steph I, just wanted to touch on the implied guidance for Q4.
At the high end, it's applying about $53 million of EBITDA can you just remind us of the Q4 last year and just the year over year comparison, and how to think about that I know you touched on it on the call, but maybe just a little more detail there.
Yeah, Hey, Nik, let me give you a little bit more color because there's a lot of moving pieces. So.
As you already mentioned, we're holding guidance, but we're very confident in our ability to hit that top end of our range with.
With regards to PT of performance technologies, we expect that they will have another good quarter with both sequential and year over year growth.
So.
Really good continued progress from performance technology.
We're anticipating that climate solutions.
Earnings will be up slightly from Q3, but they do have some pockets of difficult comps and last year, we had a really strong heating season and heating results from both volume and pricing. We also had a record I talked about last year in the coil.
Also heat transfer products area.
A volume price and the 80 20 activities.
So as we flip ahead to this year, we see a little bit of softness in for the coils are http areas, where products are going into residential applications.
Plus some of our OE customers are leaning out their inventory a little bit.
And then this winter Hasnt really cooperated from the heating season. So the general heating market is down a little bit from last year.
And then last but not least in Q4, we're planning on a little bit higher SG&A, mostly tied to incentive comp and last year. The incentive compensation was very very low. So as we look forward, we're really trying to take a cautious view.
We think we have an opportunity to exceed our guidance if volumes hold in Q4, and then even looking out into the next fiscal year. Neil just covered our climate solutions order books are quite strong we feel really good about the upcoming year and we're still holding to our fiscal 'twenty four targets we laid.
Out on our Investor day, So I hope all of that kind of helps address that let me know if you have more questions.
No that's great color. Thank you so much.
And I just want to move on to free cash flow can.
Can you just talk us.
Just about working capital in particular inventory levels and how you view those closing out 'twenty three and then going into next year.
Yes for most of the year and probably like a lot of other companies you follow we had higher working capital most of that is <unk>.
Primarily due as you mentioned inventory.
It's taking us some time to lean that out and the supply base is slowly.
<unk>, improving neill talked on previous calls about some components that.
In the peak were 52 week lead time, so it'll take us a little bit of time.
Would say for sure we've been carrying at least.
$20 million to $30 million excess in inventory.
And we're still up quite a bit over that from pre COVID-19 levels. So in Q4, we expect I mentioned to have positive cash flow a much improved mostly driven by the working capital improvements and as we go into next year I think we're good from a working capital standpoint, a little too early to give you.
<unk> on that side, but we would expect as revenue and earnings grow we will do our best here to continue to manage working capital down to where we were for for quite a long time pre COVID-19.
Sounds good thank you for taking my questions.
Our next question comes from Brian spot Hymer with Gabelli <unk> Company. Please proceed with your question.
Hi, Good morning, everyone I guess I want to go back to just the outlook.
Seems from your commentary and the numbers really bare it out.
It is really positive momentum everywhere in the business to you and your team are doing a fantastic job.
And pursuant to a question that was asked before fourth quarter guidance at the high end implies basically a similar quarter to the one that you just had.
It seems to me that Theres, just so much momentum.
And I know you've spoken to being at the high end is that basically you take the low end of the guidance is completely out of the picture.
Yes, Hi, Brian .
I mean.
We feel very confident that.
Based on where we are nine months to date as you point out and where we see the year that we're going to come in at the.
The very high end of our guidance.
The opportunities to <unk>.
Exceed it really if.
Our <unk>, our order rates remain solid in Q4 on our vehicular customers.
The data center business is going to have one of its strongest quarters of the year in Q4, and those can be a little bit lumpy as far as when actual shipments go out of those but those will be a couple of the drivers that we would see that allow us to actually overdrive our forecast.
Yes.
Okay.
That makes sense to me.
I wanted to.
Okay.
Just in regards of.
As regards to your balance sheet.
I think the reaction today probably has some.
Some algo.
Aspect to it given the headline EPS in the year over year comparison.
Balance sheet is at one six times Levered youre going to take another $20 million out eventually and working cap and all you're really doing is.
Really positive momentum perspective.
We're down.
On the line would you start to consider something like is it like a buyback.
Where you can really be opportunistic on a day like today.
Where would that start to enter your thinking Neal.
Yeah, Hey, Brian it's Nick although first if Neil wants to add anything I think.
Back to the previous question, where are we then on cash flow, we've been a little bit lumpy. This year, primarily driven by working capital.
Yes.
As things stabilize here and we expect to see that working capital has stabilized in Q4 and next year, we would anticipate.
Based on the targets, we set to have even better cash flow.
At that point I think Bryan when we've got the relatively stable quarter to quarter free cash flow and as you pointed out.
We wanted to really work our leverage ratio down this year I think a full point.
We're at a point then when we enter.
24 here 23 calendar 'twenty three our fiscal 'twenty four is the point, where we can look at.
Both acquisition opportunities, but also in between there opportunistically look at buybacks when when needed.
I appreciate that just one more anecdotal really quickly if I could.
G and H.
I had a pretty significant strike at one of their facilities and were seeing were you able to do any hiring from from workers that may have gotten.
Tired of being on strike and any opportunity. There that you were able to take advantage of from a labor perspective.
Yes, that's a good question Brian This is neill.
Not that I'm aware of we do very little manufacturing and we are seeing is primarily our R&D center.
And testing and development most of our manufacturing footprint is in the United States is.
As in Tennessee.
Rhode Island.
It's in Missouri, so locations.
Locations outside of the Wisconsin area, but that's a fair point.
Understood.
Best of luck.
Thank you.
Our next question comes from Steve Frenzy with Sidoti <unk> Company. Please proceed with your question.
Good morning, Neil Good morning, Mick.
I do want to run through a couple of more specific questions on guidance.
So I'm trying to match up your previous presentation, just to see the shifts on revenue.
When I look at climate solutions, the only real change I see Harris http. Youre actually you raised the lower end HVAC and refrigeration down very modestly but.
I'm in New York, and we Havent had winter was skipped it I know the Groundhogs said six more weeks.
How much of an impact is that when parts of the country are just skipping winter this year.
Yes, I think <unk>.
Neil Correct me, if I'm wrong, our market data says pockets of the heating market 20, or 30% down where we're gaining share we're nowhere near that but the magnitude of what you are describing from really a lack of a cold snap of winter, it's really impacted.
Heating both commercial and then Youll see a little bit decline to where people have heaters on a residential application in new home starts.
And I'd also add Steve that we're also believe that there is a distribution with little overweight in terms of inventory and we're going to start to see some of that work itself out.
Certainly colder temperatures would help that work it out faster, but again at the rate, where we see the industry and where we're at we know that we're gaining market share in the heating side of the business.
Great.
When I think about just that if we ended up with a really warm winter does that carryover into.
Stronger next year.
Or is it weather dependent because if you didn't replace stuff. This year, although I guess, new home starts will impact that as well right.
As well as market capture as we continue to build out our distribution.
Yes, Steve we've had years where.
It said Neil said the channel so.
The good and the bad of Adobe is based on the winter if a lot of distributors stopped restocking they will sell remainder of the year, what they have on and we will we'll address that as we head into next season heating season, but youre right. Some years the answer of winter with a really lean inventory channel and that can help quite a bit regardless.
Actual weather.
Got you that's helpful and then on HCP, where argue with the I believe it was Serbia, where you're building the pump facility.
Facility.
Yes, that's correct. So we're still working through the final negotiations there with the landholder.
We've we've recently started to work the process to secure equipment.
And as you know Steve we currently do manufacture there in Serbia and in <unk>.
Two plants. This is a third additional plant to continue to build out the capacity to support the European heat pump market.
So would it be fair to say that that number could have been different.
Just on the timing that you or your demand.
Overwhelming supply scale is that fair.
So we're going to continue yes, we're continue to win orders. Our order book is building quite healthy in regards to that very specific technology, hence the need for that additional factory we can do.
I don't have in front of me exactly which quarter. It is next year that were back online, but we will have production of that and that third facility.
Okay, and then just just briefly touching on liquid cooled and air cools, we know that automotive production is starting to pick up.
China, starting to reopen I was a little bit surprised that you've reduced right now on those and we know from hearing from AG and construction is supply chain constraints put the mark to your order books are still really strong in that area. So I'm, just a little bit surprised on the modest reduction there.
Yes, our commercial vehicle and off highway order book is healthy.
We're confident in terms of the Adi and the messaging that we're getting back on the auto side of the business itself.
It's been more unpredictable, hence, where we hedged a little bit there on the automotive side.
But you haven't seen any major shift from where we were last quarter.
No.
Okay.
And just a quick question on that so you're saying $140 million of peak production with EV. The last number I had written down was $90 million have you picked up that one order wasn't 50 million was it and then just in general how you think that production ramp might work.
As component shortages CES.
Yeah, So that's incremental.
If you combine all of the wins to today in addition to that.
Other order that we won we're seeing those forecast increase as well so it's an aggregate of.
The trends that we see in that space.
The team has done a really good job in terms of managing its inventory and managing our supply chain. So that we can hit those targets and so much so that they have launched this new product.
We put a press release out for the Alcon, <unk>, which actually has a different technology.
And we're able to source the components, where we need to source not only locally but we also do some of our own manufacturing for those components.
Great. Thanks, Neil Thanks, Mike you got it thank you Sir.
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Our next question comes from Tim Moore with <unk> Suisse.
Please proceed with your question.
Thanks, and congratulations on the impressive EPS growth in the quarter and the continued execution of the <unk> strategy.
My first question is related to.
The evolution to full systems offerings with aftermarket aftermarket maintenance packages for data centers getting into air quality and Evs.
After a ramp up hiring there and open any additional service locations near our major customers.
Yes, absolutely and thanks for the question Tim This is Neil certainly Thats, an area, where we want to expand in North America. We have a very good service organization that supports our business and the U K as well as our partnerships that we use in.
Continental Europe , that's an area, where we're starting to.
Put together plans on the service side.
Help support some of our largest customers, particularly in the Virginia, Northern Virginia area.
Okay.
Great. That's helpful and then maybe just one.
On the Virginia topic.
For your facility for the data centers, the pre cooling Chillers for North America.
When do you think you might be.
<unk> ramped up to generate $100 million in.
Sales run rate.
I take.
Another three or six months or youre going to cluster.
So yes, we produced our first Chillers off net production line less last quarter, we're ramping up our capacity there.
Added some additional capacity at the same time, so we believe.
We have the ability to hit triple digits.
And we put that out in the most recent press release that I believe it was two years was what $1 50.
Yes.
$100 million $100 million.
Sure.
Data center production. So that would include Chillers plus the other products that we produce and that would be in fiscal 'twenty four.
Does that help Tim.
That does now it seems like you're on track for that and I just want to make sure that was going well and just switching gears you mentioned.
The Serbia, the third facility for heat pumps production.
What's your initial read for.
Calendar 2023 for the demand for heat pumps from Europe , and those incentives there are those still holding up.
Do you think 2023 could be maybe as good of a year as 2021.
I do we are seeing that demand and we're picking up more customers.
And that's the reason why its driven the capital strategy that we have in Serbia to continue to advance and build out the capacity there.
The incentives are there the motivation is there.
With the traditional products that we sell into that space today, we have seen increase in sales and orders and then as we continue to win new customers.
Oems to be honest that are really helping us pull it through.
Team has been very successful successful commercially in that space.
Great It seems like.
Enduring trend for the next few years and then just my last question is around free cash flow and I know.
John into this already.
Just trying to wrap my head maybe around this march quarter fee castle, the positive free cash flow guidance.
I just want to make sure that the working capital reduction benefit as you unwind some buffer inventories.
That should more than offset yes.
Structuring and head count cash cost it sounds like you've already paid out 13.
$13 million in cash payments for the European head count reduction.
Wondering about the timing of maybe how much of a.
Final payment you would have to do in Europe .
Yes.
I would expect probably a few million dollars of cash restructuring costs in Q4 nothing unlike.
We have seen for the full year will probably be a little bit more than $15 million in cash restructuring.
So yes, we would expect similar.
We've talked a lot about the EBITDA in Q4, and then we have.
The favorable working capital as the main driver of it.
Great. Thanks, Neil that's it for my questions. Thank.
Thank you.
I am showing no further questions at this time I would now like to turn the conference back over to Kathy powers.
Thank you and thanks to everyone for joining us this morning.
And be able to access the replay of this call through our website in about two hours. We hope that you all have a great day.
This concludes today's conference. Thank you for your participation you may disconnect your lines at this time.
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