Modine Manufacturing 2027 Q1 Earnings Call

Hello and good morning. Welcome to our conference call to discuss Modine's first quarter fiscal 2027 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 with today's presentation are available on the investor relations section of our website, modine.com. On slide three of that deck is our notice regarding forward-looking statements. This call will contain forward-looking statements as outlined in our earnings release, as well as in our company's filings with the Securities and Exchange Commission. I'll turn the call over to Neil.

Thank you, Kathy, and good morning everyone. Before covering the quarterly results, I'd like to share a couple of personnel updates. As we've recently announced, Michael Mahan has joined Modine as the new president of our Commercial HVAC segment, reporting to me. We are very excited to have Michael join our team, bringing extensive experience managing global P&Ls, executing portfolio transformations, and driving product development and technical innovation. The priorities of this segment have not changed. We are focused on improving margins throughout the segment while driving organic growth and pursuing inorganic growth opportunities. We expect to create significant value in this segment through our ongoing 80/20 work and through the integration of our last three acquisitions. Michael's the right leader to help us achieve these goals.

Secondly, Art Laszlo, who has been leading our global data center business, has resigned from his role at Modine for unexpected personal reasons and will be leaving at the end of July. We are grateful for his contributions over these four years and wish him the best for his next chapter. We have initiated a search for his replacement. In the interim, I will step in to lead this organization. Given the level of growth and complexity of this business, I will be spending a great deal of my time and focus on making sure that we are executing on all of our many priorities in this segment. This includes launching and ramping production in North America to support our strategic customers and their growth targets, including ensuring that we are ready to perform on our long-term capacity commitments starting in 2027.

This is a heavy lift, but I have confidence in our global team and our ability to delight our customers while staying at the forefront of technology. Please turn to slide four. This is the first quarter that we are reporting under our new three-segment structure: Data Centers, Commercial HVAC, and Performance Technologies. Starting with the Data Center segment, revenues increased 90% from the prior year, but were down sequentially from the previous quarter as expected. As we discussed last quarter, we began experiencing supply chain shortages of certain key components that impacted production volumes in the quarter. In response, we started taking decisive action to secure supply. Our existing suppliers are expanding capacity to meet market demand, and we are negotiating commitments to secure the volume of components we need for fiscal 2027 and beyond.

While we regularly assess our supply chain risks, recent component shortages materialized even earlier than anticipated. We quickly activated our contingency plans, which included dynamically resequencing our capacity rollouts. Because we are actively staffing and preparing our broader network for significantly higher volume, these sudden part shortages caused temporary downtime and lower than planned capacity utilization across our expansion sites. As a result, both labor efficiency and overhead absorption were below our normal levels, which negatively impacted our margins in the quarter. The key takeaway here is that these margin pressures are a transitional timing issue, not a structural one. While these supply chain realities expand the timeline to reach full operating efficiency across our network, they do not impact our ability to meet our recently announced long-term capacity agreements or our financial targets for this year. Most importantly, the underlying demand for our products is unprecedented.

We just logged our third consecutive quarter of record order intake, driving another significant increase in our backlog. We remain firmly focused on executing our expansion and securing critical components so that as our supply chain normalizes, our facilities are primed to effectively deliver on this massive demand. Commercially, we continue to focus on our strategic customers and perfect prospects, which include high-quality hyperscalers, neoclouds, and co-location customers, and our new product launches have been a commercial success. I spent time last week visiting our Data Center plants in North America, and I just want to reiterate my confidence in this team. As I jump in to lead this business over these next few months, my focus is ensuring that we are executing on our capacity expansion to support our strategic growth plan. I anticipate that we will have periodic challenges and setbacks with this exponential growth business.

Over the last three years, we have grown revenue at a compound annual growth rate of more than 80%. Even with temporary cost or margin headwinds, very few companies can grow earnings at these exceptionally high double-digit rates. Our visibility and confidence in revenue and earnings growth over the next two to three years remains as high as it's ever been. Please turn to slide five. Our Commercial HVAC business delivered a strong quarter with revenues up 22%. This was largely driven by our acquisition last year and higher coil sales to our Data Center customers. As I previously mentioned, Michael Mahan will be leading this next phase of the 80/20, including a renewed vertical segmentation, which will help to accelerate our acquisition integration, along with very specific targets and actions for each of our general managers.

We are taking strategic actions to optimize our manufacturing footprint in the segment in support of our 80/20 focus and to improve our overall cost structure. Product lines are being consolidated into our Owatonna, Minnesota facility, which was part of the CDI acquisition last year. In addition, we have consolidated coils production in Grenada and Juarez in order to allow for the capacity expansion for the chiller lines of Grenada while preserving capacity for growth and coils to support our Data Center customers. Commercially, we are also taking decisive pricing actions to offset inflationary cost increases, including materials and tariffs. This, along with ongoing 80/20 focus, will help improve margins through simplification and efficiency. Please turn to page six. The Performance Technologies team continues to focus on preparations for the planned spin-off and merger with Gentherm and was able to hit several significant milestones since our last update.

Gentherm completed its S-4 submission to the SEC. Once it becomes effective, they will request approval for the transaction from their shareholders. We have also completed the filing required for an IRS determination letter on the tax treatment of the Reverse Morris Trust transaction and expect to receive a favorable ruling prior to close. Internally, we have been working on the IT separation and legal entity reorganization to allow us to deliver a standalone operating business to Gentherm. Overall, these processes remain on track, and we are still expecting to close the transaction before the end of the calendar year, presuming that all the necessary approvals are received and closing conditions are met. With that, I will turn the call over to Mick.

Thanks, Neil. Good morning, everyone. Please turn to slide seven to review the Q1 segment results. As Neil mentioned, this is the first quarter reporting results under the new operating segments, Data Centers, Commercial HVAC, and Performance Technologies. Please refer to the 8-K filed last week for the historic recast of our results under this new structure. Beginning with Data Centers, this segment continues to grow in an exponential rate with a 90% increase in sales. Americas sales grew 112%, and EMEA sales increased 18%, mainly from growth with strategic hyperscale and colocation customers. As we discussed last quarter, we anticipated that Q1 revenue would be up significantly year-over-year, but down sequentially from Q4. This was due to a significant impact from supply chain shortages that limited our production volume in the quarter, which ended up lasting longer than we originally anticipated.

In addition, we also had a customer program delay and a few delayed shipments at the end of the quarter. The entire industry is continually adjusting to supply and demand changes. Despite a few challenges this quarter, the segment was able to deliver well above average earnings growth. Adjusted EBITDA grew 27%, resulting in an adjusted EBITDA margin of 14.8%. As expected, the adjusted EBITDA margin was down versus the prior year. This decline was due to a few temporary factors. First, there was 150 basis point warranty variance year-over-year, which was due to a large warranty settlement in the prior year. Also, as part of our production ramp to meet future customer volumes, we have added significant labor and overhead costs. The supply chain shortages caused significant inefficiencies in our plants as we ramped our labor and manufacturing capacity to handle higher volumes.

The excess labor, along with unfavorable overhead absorption on the lower volumes, had a 450-550 basis point impact on margins during the quarter. We experienced unfavorable product mix combined with some higher material costs, partially related to supply chain shortages. These will be addressed through our commercial agreements, and we expect this will contribute to sequential margin improvement next quarter. With regards to the operating income and adjusted EBITDA margins, our rate of revenue growth is far exceeding the increase in SG&A spending, which had a positive impact on our margins. SG&A was down nearly 400 basis points as a percentage of sales. As supply chain catches up, capacity comes online, and revenue grows, we expect adjusted EBITDA margin to improve. We fully expect the segment margin will improve in Q2 and continue that trend in the second half of fiscal 2027.

Despite some periodic growing pains, we're excited about the overall momentum in the segment. Based on our revenue and margin outlook, we anticipate that the Data Center segment will generate earnings growth in excess of 85% this year. Please turn to slide eight to review the Commercial HVAC segment. Commercial HVAC also delivered strong revenue growth with a 22% increase in sales. HVAC Technologies sales increased $24 million or 45%, with acquisitions contributing $20 million of revenue in the quarter. Heat Transfer Solutions sales improved 7% or $11 million, with strong volume in North America Coils supporting data center customers. Adjusted EBITDA increased 7%, while the margin was down 220 basis points versus the prior year. Similar to the Data Center segment, we anticipated a negative margin comparison for Q1, mostly due to a temporary business mix.