Modine Manufacturing Co Q4 FY2023 Earnings Call

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 a 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 segment this past fall where we are reducing complexity and prioritizing our best opportunities. Overall, we are proud of what we have achieved through our 80/20 journey thus far and expect incremental benefits in the next fiscal year from the actions already taken. For the full year, our sales were up 12% and our adjusted EBITDA was up 34% to a record-breaking $212 million. This equates to a 9.2% EBITDA margin, up 150 basis points from the prior year. We generated $57 million of free cash flow and reported adjusted EPS of $1.95. I'm so proud of the company's remarkable accomplishments and look forward to the year ahead. Please turn to Slide 5. The Climate Solutions segment had a fantastic year and I would like to highlight some of their accomplishments. Full year revenue increased 11% from the prior year, well above the 6% to 8% goal for fiscal 2024 presented at our Investor Day. Annual sales increased across the product groups, with the largest gains in data centers, which was up 60% from the prior year. A good portion of this gain is related to North America, including sales from our new chiller plant. As I mentioned last quarter, bringing the chiller product to North America makes us a full systems supplier to the data center market allowing us to better serve our co-location customers. The chiller product has been very well received and we are expecting further double-digit data center sales gains in fiscal 2024. Another success in the Climate Solutions segment this past year was margin expansion. For the full year, the segment reported adjusted EBITDA margin of 14.6%, up 370 basis points from the prior year. This already meets our target margins for this segment of 13% to 15% by the end of fiscal 2024, one year earlier than previously planned. A large part of this gain resulted from the improvements in our heat transfer products group, who embraced 80/20 early on, helping them achieve improvements in many aspects of their operations. Last quarter, I mentioned the growth in sales of heat transfer products to heat pump customers and that we are looking at increasing capacity. We recently announced that we will be expanding our manufacturing campus in Serbia to allow us to meet the demand we are seeing in this market. Over the next three years, we are expecting these sales to more than double. Looking ahead, this segment's strong momentum is being fueled by a healthy backlog, strong markets and from all the hard work this past year. The leadership team is shifting focus from improving commercial processes to more operational targets to further improve gross margin. This includes enhancing cost control and productivity as we work to simplify and improve our supply chain and production process. Our growth focus is on new product development as we use 80/20 to make decisions on where to invest when developing our technology roadmaps. In addition, our business development team is building its acquisition pipeline with a focus on supporting product and technology strategies. I'm very proud of this team. They reached their initial margin target a year early and are gearing up to make further improvements as they look ahead towards the next goal. Please turn to Slide 6. The Performance Technologies segment also delivered strong performance this year, with full year revenue up 12% from the prior year. Sales increased in all product groups with the largest gains coming from sales of air cooled products to the genset market. The PT segment reported an adjusted EBITDA margin of 7.6% for the full year, an improvement of 140 basis points. The segment reported fourth quarter adjusted EBITDA margin of 9.1%, 220 basis points higher than the prior year. The momentum in this segment is clearly building. Since the first quarter of this year, the PT segment has shown sequential margin improvement each quarter. Our team is on track to reach our Investor Day margin targets due in large part to strong volumes and improved product mix. Our markets in the PT segment continue to be steady with ongoing backlogs due to underproduction and supply chain challenges over the last few years. We expect continued market growth in gensets, construction equipment and commercial vehicles, although we are seeing softening in certain sectors. We continue to focus on market development for zero-emission vehicles with strong government incentives and regulations driving the transition from internal combustion engines to EV. We have recently made several new product introductions, including a new BTMS, with a liquid-cooled condenser for heavy-duty applications and a fuel cell stack cooling package for the fuel cell market. The team has made great progress this year, adding nine new programs, including one incremental program in the fourth quarter. This brings our total EV systems program wins to 21 with over $140 million of projected revenue at mature production volume. This new product is a plug-and-play system for rapid integration into fuel cell vehicle chassis, allowing our customers to accelerate the timeline from bringing these products to markets. This is just another example of how Modine is engineering a cleaner, healthier world. To sum up, fiscal 2023 was a milestone year and I believe an inflection point for Modine. We set aggressive goals and either hit them or surpassed them. Over the last few years, we've radically changed our business while significantly expanding our long-term commercial opportunities. We have a clear line of sight to reach the 2027 goals we presented to you last year. We enter fiscal 2024 with excitement and a unified vision as we continue to reposition around the greatest potential. We look forward to sharing this journey with all of you. Now, I'd like to turn the call over to Mick, who will review our results for the quarter and provide segment financial updates.

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 2024. 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 to commercial vehicle and automotive customers. Lastly, air-cooled application sales increased 13% or $21 million, primarily due to strong demand from off-highway customers with higher sales in genset or stationary power applications. The Performance Technology team is deep into 80/20 activities and the early results are clear with strong earnings growth this quarter. Adjusted EBITDA was up 51%, resulting in a 9.1% margin and a 220 basis point improvement. As Neil discussed, the Performance Technologies segment is clearly building momentum with sequential margin improvement during the fiscal year. We are tracking towards our Investor Day margin targets and expect the improvements to continue as we see additional benefits from the ongoing rollout of 80/20 throughout the segment. Now, let's review total company results. Please turn to Slide 9. Fourth quarter sales were up 8% or $44 million, driven by gains in both Performance Technologies and Climate Solutions. Revenue was up 11%, excluding a negative FX impact of $18 million. Growth was driven primarily by $51 million of higher volume, resulting in a 9% growth rate. Commercial and materials pricing added another $9 million. Our gross margin improved 160 basis points, primarily driven by higher volume and pricing. SG&A increased by $7 million from the prior year, primarily due to higher employee compensation-related expenses. I'm very pleased to report that adjusted EBITDA was higher than we anticipated in the quarter with an increase of 16% or $9 million. This represents a 70 basis point improvement and the fifth consecutive quarter of year-over-year margin improvement. Please note that earnings per share on a GAAP basis was $1.69, which was $1.53 higher than the prior year. This was mostly due to the reversal of a valuation allowance on certain U.S. deferred tax assets, which resulted in an income tax benefit of $57 million. This is additional good news and reflects the improved earnings outlook in the U.S. Excluding the valuation allowance impact and the impact of restructuring and environmental charges, adjusted earnings per share for the fourth quarter was $0.67, an increase of $0.10 or 18% from the prior year. These adjustments can be found in our non-GAAP reconciliations in the appendix of this presentation. Now, moving to cash flow metrics. Please turn to Slide 10. We generated $24 million of free cash flow in the fourth quarter, resulting in $57 million of free cash flow for the fiscal year. The full-year cash flow includes the negative impact of $18 million of cash payments, primarily for restructuring activities, including the European headcount reductions announced last year. Net debt of $286 million improved by $22 million during the quarter, resulting in a leverage ratio of 1.4x. During the quarter, we repurchased another 100,000 shares for a total of 400,000 shares for the fiscal year. As we look to the next fiscal year, we expect continued growth in free cash flow, driven by higher earnings and a continued focus on working capital. Modine's balance sheet remains quite strong, ready to support our growth and acquisition initiatives. Now, let's turn to Slide 11 for our fiscal '24 outlook. First, fiscal '24 is fully aligned with our financial targets presented at the Investor Day last June. We are expecting most end markets to remain relatively stable with strong backlogs in Climate Solutions. We're also anticipating strong revenue growth in targeted markets, data centers, indoor air quality for schools, and electric vehicles. Last, we are proceeding with product rationalization through 80/20 activities and expect volume decreases in certain areas that we've chosen to deemphasize. As a result, we believe total company revenue will grow in the range of 4% to 10%. In the Climate Solutions segment, we expect data center revenue to grow 15% to 25%. As previously mentioned, we have a strong backlog going into the year, especially in North America. We anticipate HVAC&R revenues to grow in the mid-single digits as we expect some ongoing market softness, particularly in the residential heating market. However, this should be more than offset by the growth in school products, commercial refrigeration and commercial heaters. We also expect modest heat transfer product growth, as strong growth to the heat pump market will be somewhat offset by ongoing weakness in residential applications and product rationalization from 80/20 actions. Moving to Performance Technologies. We expect continued momentum from relatively stable markets and benefits from our 80/20 rollout in this segment. We expect advanced solutions to have a growth rate in the 25% to 35% range, driven by program launches and continued demand for EV systems and components. We expect lower growth for liquid- and air-cooled products as we roll out 80/20 throughout the segment. Market growth and additional pricing benefits will be partially offset by product rationalization as we continue to deemphasize low-margin business. From an earnings standpoint, we anticipate another strong year in terms of earnings growth and margin improvement. We expect fiscal '24 adjusted EBITDA to be in the range of $240 million to $260 million, representing an increase of 13% to 23%. As we look to the quarterly run rate, we anticipate some ongoing seasonality with Q1 being the lowest quarter, then increasing sequentially through the year. That said, we fully expect the first quarter to show strong year-over-year earnings and margin improvement. With regards to cash flow, we anticipate further improvement in free cash flow with capital spending to be approximately $70 million. Other assumptions, including interest expense, taxes, and depreciation and amortization are included in the appendices attached to this presentation and our press release. To wrap up, we are very pleased with the fourth quarter and fiscal year results, including record results in fiscal '23. We're on track with our transformation, and we're working towards the long-term margin and revenue targets presented in our Investor Day last June. As a result, we look forward to another year of improvement in fiscal '24. With that, Neil and I will take your questions.

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. Given the analytical segmentation process you've now completed, how does that inform your go-forward strategy with respect to that business? You 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, it's still 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 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. A 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 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 the 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.

I appreciate the clarification. You mentioned that you're about a year ahead of your margin targets for Climate Solutions. Does this indicate that you are simply ahead of your plans, or do you see potential for even greater profitability in this business?

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, 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 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.

That's great to hear, and it appears to be a strong example of effective capital allocation. You mentioned that the first quarter of this fiscal year had the lowest sales figure, followed by sequential growth. I'm curious about the extent of gross margin expansion. Should we expect it to improve each quarter? Also, is there a chance that the June quarter could show a lower gross margin than the one you just reported for March? I'm interested in your thoughts on that.

Yes, that's a great question. I'm happy you brought it up. We do experience some seasonality at Modine, with Q4 usually being very strong. Q1 tends to be the weakest quarter, primarily due to business on the Climate side ramping up in HVAC in schools and being the slowest period of the heating year. After a strong Q4, it's expected that Q1 will be lower than Q4 in terms of margin and earnings. However, compared to the previous year, we anticipate significant increases in revenue, gross margin, and earnings for Q1. We can't directly compare Q4 to Q1, but we expect Q1 to align with our guidance on a year-over-year basis. I hope that clarifies things.

That's exactly what I was looking for and what I anticipated might happen. This is very positive, and investors are aware of the seasonality. My final question pertains to the data centers chilling business in the U.S. and North America. It seems you have a clear outlook on revenue from co-location, hyperscale businesses, and orders. Please correct me if I'm mistaken, but do I remember correctly that you expect around $100 million in sales from North America this fiscal year? Additionally, as you consider the upcoming years, what does your growth trajectory look like for the next fiscal year? If you expect $100 million this year, could it be around $150 million next year, eventually reaching $300 million in a few years?

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 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 and Mick, I appreciate the insights this morning. I wanted to follow up on the heat pump market in Europe, which has been very strong, supported by government incentives. You're discussing the potential to double it, but I was surprised to see that your heat transfer products were down, especially since some trade association data and reports from smaller Scandinavian heat pump providers showed substantial increases this quarter. Are you currently facing capacity constraints there, or is this just a smaller part of the overall heat transfer products?

Yes, you're correct, Steve. Currently, it's smaller, but the trends indicate that it will become significant. That's precisely why we have invested in the additional plant and the required production lines. We're beginning to ramp that up and are operating continuously with our existing capacity as we work on expanding it in Serbia.

Yes, we're expecting that doubling within three years.

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.

Thank you for your insights. I would like to discuss school retrofits in light of the current conversations in Washington regarding the reallocation of unused funds. Are there any risks associated with how that market is developing? Additionally, what are your expectations for that market over the next two to three years, keeping in mind that predictions about government decision-making can be challenging?

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 like to add that due to the success we are experiencing from the changes and growth we are achieving, we are ahead of our expectations from a year ago in New York with Climate Solutions, and we're launching it in PT. We have good control over this growth. When considering mergers and acquisitions, we are focused on identifying where we can fill technological gaps. We do not need to pursue larger acquisitions to meet our goals but rather assess where we want to grow and ensure we have advanced technologies to support our verticals, especially in Climate Solutions.

When considering these aspects, the focus shouldn't be solely on whether they're accretive or not; instead, it should be about addressing gaps that could lead to better long-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 concentrate on smaller acquisitions. In our pipeline, we consistently monitor a few larger targets, though we cannot dictate when opportunities arise. Ideally, we will maintain our focus on midsized acquisitions that align with our technology and product strategy.

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. Thank you for taking my question. I would like to know how the acceleration in AI rollout and development affects your business. I assume it's more relevant to the data center side. What opportunities does this create, and how do you plan to invest in that area moving forward? Thank you.

Hey, Flo, it’s great to hear from you. This is Neil. That's a very pertinent question. As we witness shifts in technology, it's crucial for us as a key supplier in data centers to provide up-to-date technologies to support this evolution. We're collaborating with our customers as they transition from traditional computing to high-performance computing, which is essential for AI and many market drivers such as AV, IoT, and 5G — all of which necessitate higher-performance computing. With high-performance computing comes the challenge of power density, leading to heat generation, which requires innovative solutions for heat removal. Eventually, the existing mechanical heating solutions will reach their limits, prompting a shift. We're working closely with our teams and clients to foster innovation in this area. We're also exploring various approaches to acquiring the necessary technology, both inorganic and organic. Given that this is crucial for our growth in data centers, we embrace this change, the new technologies, and the engineering challenges that come with them.

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?

Yes. Mick and I closely monitor the margin to ensure efficiency. A year ago, with a transient workforce, we spent a lot of time on training and overtime, which reduced our productivity. Once we established stability, we noticed improvements in margins over time, as well as reductions in labor hours and expedited freight costs, because we now have the right people in the right roles.

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.