Good morning, ladies and gentlemen, and welcome to Modine's Fourth Quarter and Full Year Fiscal 2023 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. As a reminder, this conference call is being recorded. And I would now like to turn the conference over to your host, Ms. Kathy Powers, Vice President, Treasurer and Investor Relations. Thank you, Ms. Powers, you may begin.

Good morning, and thank you for joining our conference call to discuss Modine's fourth quarter and full year fiscal 2023 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 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.com. On Slide 3 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. We clearly surpassed our expectations this quarter and delivered record results with sales of $618 million, up 8% and up 11% on constant currency basis. We reported adjusted EBITDA of $66 million, up 16% from the prior year. We generated $24 million of free cash flow and $0.67 of adjusted EPS. This strong performance resulted in a record year that saw the highest sales and adjusted EBITDA in our history. What is especially remarkable is that these gains were not the result of particularly strong economic conditions, but instead were driven by the internal actions that we've taken over the past two years to transform the company. It is a testament to the value we've unlocked across our business, an example of how a sound focused 80/20 approach can drive higher returns and better margins. Taking a step back, we accomplished a great deal in fiscal 2023. We started the year by announcing a change in our segments, streamlining reporting structures and establishing an infrastructure with focused market-based product groups. We held our first Analyst and Investor Day this past June, where we introduced our purpose statement, engineering a cleaner, healthier world. Our senior leadership team presented their strategies and shared their financial targets for both revenue growth and margin improvement, setting a clear path on how we plan to meet those targets over the next five years. I'm happy to say that we made outstanding progress towards these goals this past year and are even running ahead of many of them. We also established an 80/20 mindset, which has created a culture shift within our organization. We started this journey with the Climate Solutions segment last year, and immediately started seeing improved results. We began rolling out 80/20 in the Performance Technologies…

Thanks, Neil, and good morning, everyone. Please turn to Slide 7 to review the segment results. Climate Solutions had another stellar quarter with improved earnings and slightly higher sales. Revenue was up 1% from the prior year and improved 5% on a constant currency basis. Data center sales were up 55% or $20 million, including the benefit of the North American chiller expansion. As anticipated, HVAC&R sales were down 9% or $8 million, driven by lower sales of heating products versus a strong quarter last year, partially offset by higher cooler sales. The heating market decline was mostly driven by a reversion to normal pre-COVID levels, along with a relatively mild winter. Sales of heat transfer products decreased 6% or $8 million from the prior year. As discussed last quarter, we anticipated some market softness around residential applications, combined with 80/20 rationalization and difficult comparisons to an exceptionally strong quarter last year. We are pleased with the very strong earnings conversion as adjusted EBITDA increased 8%, resulting in a 100 basis point margin improvement to 15.9%. The earnings and margin improvements were primarily driven by commercial pricing, positive sales mix and benefits from our 80/20 initiative. As Neil previously explained, the Climate Solutions segment is performing well and is about a year ahead of schedule in meeting their margin objectives. We expect these improvements to continue in fiscal '24. Please turn to Slide 8. Performance Technologies also had a great quarter with sales up 13% or $42 million. Revenue was up 16% on a constant currency basis, benefiting from both volume and pricing improvements. Advanced solutions sales were up 25% or $8 million with continued growth in our electric vehicle product sales in both North America and Europe. Liquid-cooled application sales increased 9% or $11 million due to higher sales…

And our first question comes from the line of Matt Summerville with D.A. Davidson. Please proceed with your question.

Thanks. Excuse me, good morning. Wanted to first talk about 80/20, specifically as it pertains to Performance Tech here. What -- given kind of the analytical segmentation process you've now completed, how does that inform your kind of go-forward strategy with respect to that business? And you kind of touched on the fact that we should start to expect some deliberate revenue attrition from rationalization, I think you're calling it. How much revenue attrition should we be looking at this year and next based on what you're thinking today as it pertains to both businesses? And then I have a follow-up.

Got it, Matt. Thanks for the question. This is Neil. Yes, so six months into it with the Performance Technologies side of the business and as they continue to get more intelligence and information that they're learning, how they want to continue to, what I'll say, subsegment further into the business, so that we can have our organization aligned behind those very specific verticals. So, we have some ideas. We have some concepts that we're working through, and I would expect to be able to line up on some firmer ranges probably within the next couple of months.

Got it. Maybe I'll pivot over to data centers. Can you talk about how much of that business is in North America versus Europe? What kind of relative growth rates you're seeing in those geographies versus the guidance? And if you could also speak to both the hyperscale and co-location markets as an overlay to that? Thank you.

Yes, this is Neil again. Thanks for the question, Matt. Certainly, the majority of the revenue that we're seeing is from Europe, that's where the core of the business is as we continue to ramp up our facility in Virginia that supports the data center market. We're gaining share. We're winning business in the North America market. That continues to be a growth area for us. That area is growing at a much faster rate than it is in Europe, albeit they're both growing. So we have that focus. We've partnered with the right customers. We have the right technology, and we're excited about the products that we have. The products that we have are to help our customers meet their sustainability targets, and we're seeing that pull-through in both Europe and North America. So growth in both, but it's faster in the North America side. Relative to the co-location market, still is strong, especially with the customers that we've aligned behind, where we're providing the unique solutions that they're looking for. Our focus and through 80/20 in terms of making sure that we have our best opportunities in front of us with our customers to help them essentially grow in the market space that they're in is actually starting to pay dividends. So that focus and that energy on the critical field is why we're seeing the growth in Europe and North America as well. On the hyperscaler side, we're not seeing any slowdown there as well. We're still connected with a large hyperscaler customer. We're working with new product development with the next-generation data centers, and we're pretty far along in that process.

Thanks. And then maybe if I can just sneak one more in. If you look at the plus 4% to 10% sales guidance, can you maybe talk about where the two businesses, where you expect them to fall relative to that range? And then, if you can maybe talk about incremental cost savings you expect in '24 over '23 from the European restructuring? Thank you.

Yes. Hey, Matt, it's Mick. I'll take the first part of that. I think within the range itself, we've got that the lower end and the higher range. So just first, broader speaking to your first question, I think planned product rationalization, as you know, in the past in early phases of 80/20, it's hard to predict which customers or business will drop off. And sometimes it stays much longer than we expect. And with the higher profit margin on it, we're quite comfortable with that. So first, I would say, I think the big difference between our low end and high end is really just trying to have a crystal ball about exactly which business will wind off or not. And then within your question for Climate and for Performance Technologies, both are really going to be kind of within that range, not really too far off. I guess, I probably expect slightly higher revenue growth across Climate than Performance Technologies. But that said, we've got a lot of good program launches in Performance Technologies around power generation and gensets and significant commercial pricing initiatives kicking in this year, which will both help the top-line for Performance Technologies. And then, at the end, you had a question, if you could just repeat? I think it had to do with restructuring.

Yes, how much incremental cost savings should hit the P&L in '24 versus '23 from that European restructuring that you've completed?

Yes. We've got rolled through most of it. I think net-net, I would expect about a $5 million net just in that German, European headquarters region as far as net savings in the new year.

Great. Thank you, guys.

And the next question comes from the line of Brian Sponheimer with Gabelli Funds. Please proceed with your question.

Hi. Good morning, everyone and congratulations. Couple of questions. One, just the balance sheet, we saw good cash flow performance, but also on a year-over-year basis, you've got an extra $30 million or so of receivables and $40 million of inventory. Can you just talk about the working capital needs of the business as you kind of transition in 80/20 and whether there's any sort of collection that you're thinking about as you work through the year?

Yes. Hey, Brian, it's Mick. You're right, really kind of beginning with the post-COVID supply chain, we've seen inventory rise in the last 12 to 18 months. And the plan is to continue to work that down as really availability of parts is much improved. So there's some improvement we have there. Accounts receivable too a little bit higher than we normally have and expect. I think part of that has been a lot of the 80/20 initiatives too, as you can imagine, as we are talking to customers and negotiating and renegotiating prices, at times, that can get caught up in AR. But short answer is, generally speaking, we see kind of a flat level of working capital. So we're going to hold working capital while continuing to grow revenue and then that should convert nicely from a free cash flow standpoint.

Okay. Appreciate the color there. And then, you had mentioned that you're about a year ahead of where you wanted to be into margin targets for Performance Tech -- I'm sorry, for Climate Solutions rather. Does this mean that you are just simply ahead of plan? Or is this potentially that you see greater possibilities as to where the profitability of this business can go?

Yes. I'll go first, Brian, it's Mick again, and Neil can jump on. Yes, good question. We should be clear that we are really happy about how fast that team, I think it was about 370 basis points this year, first year out drove the margin improvement. From there, when we were in our Analyst Day, we had goals from years two to five to push that margin higher. So yes, short answer is we expect to drive further margin improvement. We don't see it peaking out here, but really that almost 400 basis points was faster than we thought in year one. We won't do that every year, but we expect to drive it higher each year. Neil, anything to add?

No, that's a great summary.

Great. Congratulations. I look forward to seeing what you all do next.

Thank you.

Thanks, Brian.

And the next question comes from the line of Tim Moore with EF Hutton. Please proceed with your question.

Thanks, and congratulations on the strong EBITDA growth against a year ago, high-growth comparable. Just maybe shifting gears for your internal combustion engines auto business, not the EVs that you're ramping up on, but it seems like the ICE business is still maybe a little bit misconceived or biased by some investors. Isn't that just only maybe a $300 million sales business or 13% of your sales and you possibly might have stopped taking new orders on that, and those margins are probably going up because of the pricing hikes you've done?

Yes, it's a relatively small portion of the business overall. In PT, we've -- the revenue has declined year-over-year, certainly. We're still actively working with our customers there. We're serving some products. We have certain thresholds and filters that we put in place through our 80/20 analytics. And if we can provide a solution that meets those margin targets and those thresholds because we have the technology, and there's value there, that's what we're looking for. And we're going to continue to shift our focus more on the systems side as well.

Great. That's helpful color. Because I can imagine the margin is going up there compared to a couple of years ago. Maybe just switching gears to your European production capacity expansion for the heat transfer pumps at your Serbia plant. Did I hear correctly earlier on the call that you mentioned you expect those sales to double. And I'm just kind of curious over what timeframe you expect it given kind of the credit subsidy for houses in Europe?

Yes. So, I'll let Mick give you the timeline on that, but we're excited about that space in that market. So, we have expanded our facilities there on our campus in Serbia. We're in the process of buying capital equipment, getting that equipment into the plant, so we can start up the first of several lines that we need to put in place because the order book is so healthy. It's a highly regulated market, and we certainly see that market as multiple years in terms of growth. So the team is in place. The team is putting in the capital and the infrastructure and we've got a pretty healthy order book.

Yes, Neil, just we've talked about that doubling within three years on the heat pump side, currently a little bit more than $50 million, but growing really rapidly over the next few years.

Great. That's terrific to hear, and it seems like a terrific use of capital allocation. You gave some color around the first quarter of this fiscal year, being the lowest sales figure and then sequentially growing. I'm just trying to think about the gross margin expansion magnitude cadence. Should that also improve sequentially each quarter? And I'm just wondering, will the March -- will the June quarter possibly be a lower gross margin than this quarter you just reported in March? Just kind of curious about that.

Yes, a really good question. I'm glad you followed up on that. We do have -- we still have a little bit of seasonality at Modine where Q4 tends to be really strong. Q1 can be -- typically, the last few years has been the weakest quarter of the year, and that has to do with some of the business on the Climate side ramping up in HVAC in schools. It's also the slowest part of the heating year. But -- so coming off of a really strong Q4, that's the one to be sure. We don't -- we see Q1 being lower than Q4, both in probably margin a little bit and in earnings. But if you look at it year-over-year, Q1, we fully expect to be up significantly in revenue, up in gross margin, and up in earnings. So, can't really roll forward Q4 to Q1, but Q1 on a year-over-year basis, we expect to be fully in line with our guidance. Hopefully, that helps.

That's exactly what I was looking for and kind of what I thought might happen. So that's really good and investors know that for seasonality. My last question is around the data centers chilling business in the U.S. and North America. It obviously appears you have a strong line of sight on revenue there, the co-location and hyperscale businesses and orders. Feel free to correct me if I'm wrong, but did I -- do I recall correctly, you expect maybe $100 million in sales from North America this fiscal year? And I'm just wondering maybe as you think out the next few years, how does your growth trajectory look for maybe next fiscal year. I mean, maybe you could do $100 million this year, is it something like $150 million next year and eventually $300 million a few years down the road?

Yes, that's a great question. Because it's such a focus for us, you're right. When you think about those growth rates, we're building the capacity in today. I think we've been really clever in terms of how we're utilizing our manufacturing footprint and where we're making investments for manufacturing space as well as labs to support this growth. But we have visibility in the market. We see where we fill a gap with our technology, and we're building our capacity expansion model to fit those type of growth rates.

Yes, I was just going to add coming off of this year, we'll have wrapped up a little bit north of $150 million of data center sales and -- globally. And we should expect to grow over the next three years similar rate, probably in the 15% to 20% range over a three- to five-year window. Obviously, this year, we've got the next fiscal year, much higher growth rate, a lot more visibility in our guidance there, 15% to 25%. But if you want to roll it forward, I think that 15% to 20% over a long term is a good current target for us.

That's terrific color and granularity. Thanks, Neil and Mick. That's it for my questions.

Thank you.

Thank you.

And our next question comes from the line of Steve Ferazani with Sidoti & Company. Please proceed with your question.

Good morning, Neil, Mick, appreciate all the color this morning. I wanted to follow up on the heat pump market in Europe, which we know has been very, very strong, supported by government incentives. You're talking about the potential to double it, but we saw -- I mean some of the trade association data and some of the reporting from some smaller Scandinavian heat pump providers this quarter were up substantially. So, I'm a little bit surprised your heat transfer products was down. Are you capacity constrained there right now? Or is that just a much smaller part of the overall HTP?

Yes, it is -- you're right, Steve. For the moment, it's smaller, but the trends and where we're headed with it is it will be substantial. But yes, that's exactly right. That's why we've invested in that additional plant. We've invested in the lines that are necessary for that. So, we're starting to ramp that up. We're running 24/7 with the capacity that we have as we start to expand that capacity in Serbia.

Excellent. Okay. And I may have missed that. We covered so much ground this morning, I know. Did you provide a fiscal '24 CapEx range?

Yes, we expect that to be around $70 million or below.

$70 million?

Yes, $70 million. And then, we also provided in the appendix. It's important to point out, with the valuation allowance coming off U.S., we'll go back to being a taxpayer in the U.S., which is a good situation. But we're guiding to about a 26% effective tax rate in the new year. And then with rates up a little bit, we had guided to interest expense being in the $23 million to $25 million range, Steve.

Okay. That's helpful. Thank you. I wanted to touch on school retrofits with all the discussions in Washington right now in terms of pulling back some unused funds. Any risks right now to how that market is playing out? And you still expect -- and I don't want you -- obviously, you can't predict government decision makers. But how are you thinking about that market playing out over the next two or three years as it currently stands?

Yes, it's a good question. I literally just got off the phone with the general manager of that business yesterday, asking that very question. And we're comfortable with where we're at in terms of the orders. We're comfortable with the production rates that we're running to. We have visibility beyond a year in terms of what the order intake looks like. So, in the short term, even over the next, say, 18 months, we're comfortable with what our position has been.

And just on capital allocation, starting to develop any kind of plan for M&A now that you're starting to become a more significant cash flow generator and the balance sheet is in great shape?

Yes. Hey, Steve, it's Mick. Yes, Neil and I talked for a few quarters. I think if we went back a year ago, our message was head down, implementing 80/20, starting to generate cash. The last few quarters was we've really rebuilt and added some really strong skills on the business development side trying to refill the funnel. As we look today, I think, Neil and I are a lot more encouraged and optimistic that we're now starting to see some potential targets in the funnel that can be actionable in the next year or so. So, really good progress from the whole business development team.

Yes. I would just add one thing to that, Steve, is that because of the success that we're having organically with the changes that we're making organically, with the businesses that we're growing organically, we're ahead of where we plan to be a year ago in New York with Climate Solutions, and we're kicking it off in PT. Organically, we have this -- we have pretty good control around it. So, when we're thinking about M&A, we're thinking about technology, where do we fill technology gaps? It's not as if we need to do larger acquisitions to catch up with the goals that we put in place. But really, where do we want to grow? Where do we want to make sure that we have leading-edge technologies, so that we can continue to support our growth verticals, particularly those in Climate Solutions.

And when we think about those as not -- you wouldn't be focused on it as being accretive or not accretive, you would be thinking about trying to fill a hole that maybe provides better longer-term growth?

Correct.

Yes. And anything bigger on the radar screen, or would you be focused more on the bolt-on type size?

Yes. We continue to focus on the bolt-ons. And then within our pipeline, we've been pretty consistent that there are always going to be a few targets that we keep our eye on that are larger, but -- and you can't control when things come to market. But if we had our way, we'll continue to focus on some of those midsized ones that we can tuck in under the technology and product road map.

Right. Thanks, Neil. Thanks, Mick.

And the next question comes from the line of Florence Dethy with D.C. Capital Advisors. Please proceed with your question.

Hi. Good morning, Neil and Mick. Thanks for taking the question. I have a question on the -- how does the acceleration in AI rollout and development impact your business? I'm guessing it's more on the data center side. What sort of opportunities does that present? And how are you thinking about investing in that area going forward? Thanks.

Hey, Flo, good to hear from you. This is Neil. Great question. That's a very relevant question. As we start to see these technologies shift, it's really important that we, as a supplier, critical supplier in this space and data centers provide current technologies to support that. So, we're working with our customers as they start to evolve in the data center space, moving away from the traditional computing to high-performance computing, which supports AI. It supports a lot of the market drivers, it supports AI, it supports AV, it supports IoT, it's supports 5G, all these things that require higher-performance computing. And when you have high-performance computing, you have a power density issue. And when you have a power density issue, you get heat. And from that heat, you have to have more creative ways to remove it. And at some point in time, we'll hit a threshold with the mechanical heating solutions that are currently in the market today and things will start to shift. So, we are working closely with our teams and our customers to make sure that we're being very innovative in that space. And it's also an area that we are very curious, and we have a pretty big backcast to make sure that we can -- there's other ways to potentially acquire that technology. So there's the inorganic and organic path. So we're looking at both. And because it's at the tip of the spear for us with data centers and that's where we want to grow, we welcome this change. We welcome this new technology, and we welcome the engineering challenge.

Thanks. And on a different topic, what are you seeing on the human capital side? It wasn't that long ago, a number of companies were talking about higher turnover, difficulty hiring. What are you seeing on that front?

Yes, it's different regionally. But for the most part, what we're seeing is much more stability than where we were at a year ago. And that's based on the fact that we've had some pretty good talents inside of our plants today that are making sure that we have the right workforce in place. And then, we've got our policies here on the salary side that we can recruit and retain very talented individuals across multiple industries. That's how we've been able to absolutely move in this rate that we're moving and transform the company at the rate we have.

Is there any way for you to quantify the benefit to you all just cost-wise from that?

I didn't catch the full question, Flo. Is there any way to quantify...

I guess, in terms of reduced costs from lower turnover or less need to use recruiters for hiring?

Yes. So, we're -- Mick and I watch that closely as in the margin and making sure that we're efficient. You go back a year ago and when you have a workforce that is transient, there's a lot of time training, there's a lot of overtime that's used, you're not efficient, you're not as productive. So once you get some stability in place, you start to see the margins improve relative to over time, relative to labor hours and relative to things like expedited freight, because we don't have people in the right place at the right time.

Thanks.

Sure.

I'm showing no further questions at this time. And I would now like to turn the conference back over to Kathy Powers.

Thank you, and thanks to everybody for joining us this morning. You'll be able to access the replay of this call through our website in about two hours. We hope everybody has a great day.

That concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.