Modine Manufacturing Co Q2 FY2026 Earnings Call

Good morning, everyone, and welcome to the Modine Second Quarter Fiscal 2026 Earnings Conference Call. This call is being recorded. I would now like to hand it over to your host, Ms. Kathy Powers, Vice President, Treasurer and Investor Relations. Please proceed.

Good morning, and welcome to our conference call to discuss Modine's second quarter fiscal 2026 results. I'm joined by Neil Brinker, our President and Chief Executive Officer; and Mick Lucareli, our Executive Vice President and Chief Financial Officer. The slides that we will be using for today's presentation are available on the Investor Relations section of our website, modine.com. On Slide 3 of that deck is our notice regarding forward-looking statements. This call will contain forward-looking statements as outlined in our earnings release as well as in our company's filings with the Securities and Exchange Commission. With that, I'll turn the call over to Neil.

Thank you, Kathy, and good morning, everyone. Last quarter, we announced plans to significantly expand our U.S. manufacturing capacity for data center products. We are continuing to invest in our fastest-growing businesses and are actively advancing the strategy. In fact, we are accelerating other planned investments to meet the unprecedented demand for our products. Our Climate Solutions segment continues to deliver, posting a 24% increase in revenue. This includes contributions from our three acquisitions earlier this year: AbsolutAire, L.B. White and Climate by Design International. As we integrate these businesses, we are applying 80-20 principles to drive value by improving margins, increasing capacity utilization and unlocking commercial opportunities to cross-sell into new markets. Bringing these respected brands into the Modine portfolio not only broadens our product offerings but also brings scale to HVAC Technologies. Excluding these acquisitions, organic sales increased 15% from the prior year, driven primarily by a 42% increase in data center sales. Over this past quarter, we've made substantial progress on our capacity expansion. I'm pleased to report that we have officially launched chiller production in our Grenada, Mississippi facility. In total, we plan to have five chiller lines in Grenada and are currently producing on two of these lines. We are working on getting the incremental production lines in place and are on schedule to launch full production by the end of this fiscal year. We've also made good progress in Franklin, Wisconsin and Jefferson City, Missouri. Franklin is scheduled to launch initial production of data center products this quarter, with volumes ramping through Q4. We will have four chiller lines in Jeff City, with the first two launching in the fourth quarter and the remainder planned for later next fiscal year. The final site for our expansion has been secured in Grand Prairie, Texas just outside of Dallas. This facility is planned to fully come online early next fiscal year and will have five chiller lines. Both the Franklin and the Dallas locations are being designed for flexible manufacturing with the ability to produce multiple products that can be flexed based on demand. Both facilities will be able to produce modular data centers, which we see as a great opportunity. We've made initial shipments to one customer and are currently working through some design modifications. In addition, we are in the early stages of discussions with others, including both hyperscaler and neocloud customers. We are excited to be able to support our strategic customers with innovative products that offer rapid deployment and scalability. We are making good progress overall, but current hurdles include the hiring and training of the workforce, which is a heavy lift for the organization. In total, we've hired 1,200 employees to support data centers so far this year, including temporary and contract workers, and talent we've strategically redeployed from our Performance Technologies segment. This added significant additional cost this quarter, with little incremental revenue, resulting in temporary margin erosion in Climate Solutions. We expect this to continue in Q3 and then improve in Q4 when volumes begin to ramp. We expect a significant jump in revenue between Q3 and Q4 driven by new capacity coming online. Outside the U.S., we successfully launched production of data center products at our new Chennai, India facility. This strengthens our ability to serve customers in the APAC region with locally manufactured product. Furthermore, we are planning to expand chiller capacity in the U.K. to support demand for both hyperscaler and colocation customers in Europe. This incremental capacity is anticipated to come online early next fiscal year. I currently see a path to deliver more than 60% revenue growth in data center this year, on our way to achieving over $2 billion in revenues in fiscal 2028. This year marks a period of major investment in our data center businesses, driven by strong market demand. This is hard work for our organization, and we are addressing challenges and making adjustments along the way. In addition, this represents a major transition for the business, evolving from a low-volume, high-mix manufacturing operation to a high-volume producer. This is not a shift in strategy as we remain committed to serving as a premium, highly customizable provider. However, we will now be able to deliver these specialized products at scale to meet the needs of our largest customers. This is important as large data centers, especially those specializing in AI applications, require our products to be delivered at a much greater rate than we have historically provided. Fortunately, Modine is highly capable of ramping scale production on highly engineered product designs. A competency we have honed over many years with our Performance Technologies business. This expertise is also why we have been successful in leveraging internal resources to support these critical projects. We have the right team in place, and we are hyper-focused on execution to deliver these innovative products our customers require. I want to stress again: this is a very heavy lift for the data center team, but I remain confident in our ability to execute, meeting our targets and customer commitments. Please turn to Page 5. Our end markets and Performance Technologies segment continue to be challenged, but actions we've taken in response to these conditions are having a positive impact. Although revenues this quarter were down 4% from the prior year, adjusted EBITDA was up 3%. The segment adjusted EBITDA margins increased by 90 basis points, primarily due to the cost control measures we've taken over the past few quarters, including actively reallocating resources to the Climate Solutions segment. We are monitoring market conditions closely, and we will continue to make adjustments as necessary. I'm pleased to announce that the segment is now being led by Jeremy Patten, who joined our team as the President of the Performance Technologies segment last month. Jeremy's previous experience with transformational change with an 80/20 mindset makes him uniquely qualified to take on the challenges and opportunities ahead. I'm happy to welcome Jeremy to the team and have confidence that he will continue the momentum created over these past quarters to drive margin improvement as we transform this portfolio. I'm extremely proud of the hard work being done in both segments to drive toward our vision of evolving our portfolio in pursuit of highly engineered mission-critical thermal solutions. This is creating a great deal of organizational change and a heightened level of complexity. This includes integrating three acquisitions, expanding capacity across multiple locations around the globe to support data center growth, and exploring strategic divestiture opportunities in Performance Technologies. We are moving people into new roles in support of these plans and are incurring temporary cost increases to support future growth. Although we will encounter obstacles along the way, this team is up for the challenge, giving me further confidence in our ability to reach our long-term targets. With that, I'll turn the call over to Mick.

Thanks, Neil, and good morning, everyone. Please turn to Slide 6 to begin reviewing the Q2 segment results. Climate Solutions delivered another quarter of strong revenue growth with a 24% increase in sales. Driving this growth was data centers, which grew $67 million or 42%. HVAC Technologies increased $17 million or 25%, driven by inorganic sales from our recent acquisitions. This was partially offset by lower indoor air quality sales and lighter preseason stocking orders for heating products. Heat Transfer Solutions grew 2% or $3 million due to higher volume with commercial refrigeration and coatings customers. Climate Solutions second quarter profit margins were lower than normal, and adjusted EBITDA declined 4%. I want to review a few temporary factors that contributed to the decline this quarter. The largest impact was due to significant investments relating to the data center capacity expansion, including direct and indirect labor and overhead expenses needed to build out new production lines and facilities. As Neil previously covered, we're expanding production lines at several existing locations while also preparing to launch a few new facilities. These actions are required to meet the growing customer demand for Modine products and more than double our revenue. While we expect to see sequential revenue growth in Q3, we won't begin to realize significant volumes in the new production facilities until Q4. We also had a lower margin in HVAC Technologies, which was mostly due to a negative mix impact. This was driven by lower preseason heating sales, combined with the early integration steps for the three most recent acquisitions. Heating represents some of our highest margin products, and the acquisitions are very early in the integration 80/20 phases. Within this product group, we anticipate a sequential margin improvement as we enter the heating season and begin to implement 80/20 across the acquisitions. And finally, in HTS, the prior year included several million dollars of commercial pricing settlements from heat pump customers. As we implement a major step function change in our data center production capabilities, we anticipated that there would be significant unabsorbed costs as we launch the expansion plans. Looking to the second half of the year, we currently expect sequential margin improvement in Q3, but the margin will remain below normal operating levels until Q4. Then in Q4, we should begin to see more significant volumes from our new production lines, which will allow us to more fully absorb the fixed incremental costs and exit the year at more normalized profit margins. Before moving on to Performance Technologies, I want to highlight that the demand for Modine data center solutions continues to grow, and we're increasing our revenue outlook for the current fiscal year. In order to support this growth and achieve our $2 billion goal, we need to make significant capacity investments while still delivering on our earnings targets. And this will set the stage for further revenue growth and margin improvement with the ability to move well above historical profit margins. Please turn to Slide 7. Performance Technologies revenue declined 4% from the prior year. Heavy-duty equipment revenue was relatively flat, with stronger sales to construction and mining customers offset by lower GenSet sales. On-highway applications decreased 3% or $7 million, driven by lower commercial vehicle demand, including specialty vehicle and bus customers. Despite the tough market conditions, adjusted EBITDA improved 3% from the prior year, and the adjusted EBITDA margin increased by 90 basis points to 14.7%. The margin increase was mostly driven by significant cost reductions and improved operating efficiencies. Tariffs remain a significant challenge for all market participants, but our team is working hard to recover these increases through surcharges, along with our normal pass-through mechanisms. In addition, we're reorganizing this business and reducing costs wherever possible, which resulted in a nearly $7 million reduction in SG&A expenses this quarter. The team remains focused on margin improvement despite ongoing challenges with the end market demand. As we look ahead, Q3 typically represents the lowest volume quarter due to seasonal patterns and holiday shutdowns by our OE customers. As a result, we expect that the Q3 margin will be down sequentially from Q2 but should be above the prior year, then stepping back up sequentially in Q4 as we've done in previous years. Until the markets turn around, we'll stay focused on costs and operating efficiencies, which will allow us to drive higher operating leverage and margins when volumes improve. Now let's review total company results. Please turn to Slide 8. Second quarter sales increased 12%, driven by the revenue growth in Climate Solutions. The gross margin declined 290 basis points to 22.3%, driven primarily by the factors I covered on the Climate Solutions slide. SG&A expenses declined in the quarter, driven by Performance Technologies cost savings initiatives, partially offset by incremental SG&A and the acquisitions in Climate Solutions. The net result was a 4% improvement in adjusted EBITDA from the prior year with a margin of 14%. With regards to EPS, the adjusted earnings per share was $1.06 or 9% higher than the prior year. I want to again summarize the key items that impacted the Q2 margin and how we currently see our consolidated results for the balance of the year. For Q2 consolidated results, the adjusted EBITDA margin benefited from the year-over-year improvement in Performance Technologies. This was offset by the lower margin in Climate Solutions, as I reviewed on that segment slide. As we look to Q3, we anticipate the adjusted EBITDA margin will remain below normal levels in this quarter. Then based on the sequential improvements by both segments in Q4, we expect a significant increase in the sequential margin, which should be more in line with the prior year. Based on this second half outlook, we would exit the fiscal year at the highest quarterly margin rate, and we would fully expect additional margin expansion in the new fiscal year, consistent with our fiscal '27 goals. Now moving on to cash flow metrics. Please turn to Slide 9. Free cash flow was a negative $31 million in the second quarter. We anticipated lower cash flow primarily due to higher inventory builds and CapEx in Climate Solutions. We continue building significant data center inventory to support customer demand and delivery schedules in the second half of the year. And second quarter free cash flow also included $9 million of cash payments, primarily related to restructuring and acquisition-related costs. Net debt of $498 million was $219 million higher than the prior fiscal year-end, directly related to the acquisitions of AbsolutAire, L.B. White and Climate by Design. With the investments in acquisitions and capital during the first half of the year and the associated earnings, our balance sheet remains quite strong with a leverage ratio of 1.2. Based on our earnings and cash flow outlook, we expect that the leverage ratio will decline further by fiscal year-end. Now let's turn to Slide 10 for our fiscal 2026 outlook. As we cross the midpoint of our fiscal year, we're raising our revenue outlook and reaffirming our earnings outlook. For fiscal '26, we now expect total company sales to grow in the range of 15% to 20%. For Climate Solutions, we're raising our outlook for the full year sales to grow 35% to 40%, with data center sales now expected to grow in excess of 60% this year. With regards to data center sales growth, we anticipate sequential increases in Q3 and in Q4, with the second half year-over-year sales growth exceeding 90%. During the next quarter, the team will be further preparing numerous production lines, both in existing and new facilities to support the strong orders. In Q4, we anticipate our first full quarter of significant production volume from these new production lines. For Performance Technologies, we're raising our sales outlook with revenue now anticipated to be flat to down 7%, improving from the prior range of down 2% to 12%. We expect that the end markets will remain depressed, with the ongoing trade conflicts and cautious market sentiment having a negative impact on market recoveries. However, last quarter, I explained that revenue was trending more favorably due to foreign exchange rates and the large amount of material cost recoveries. While the underlying market volumes have not recovered, we expect higher revenue as these trends have continued, and we're adjusting the outlook accordingly. I want to point out that while the large cost recoveries helped to protect our absolute level of earnings, they don't have a positive impact on our profit margins. With regards to our full year earnings, we're balancing the higher revenue outlook with margins running temporarily below normal levels. Based on this, we're holding our fiscal '26 adjusted EBITDA outlook to be in the range of $440 million to $470 million. For cash flow, we anticipate generating free cash flow in the second half of the year, but lower as a percentage of sales compared to the prior year. For the full year, we expect free cash flow to be in the range of 2.5% to 3% of sales. This is directly related to the significant investment in data center capacity that we're making this year, along with higher working capital to support this rapidly growing business. This also includes cash required to fully fund our U.S. pension plan prior to our planned annuitization in the third quarter. With the conclusion of this large project, we'll be able to remove a very large liability from the balance sheet along with the time and cost to manage it. And consistent with our previous outlook, we're not including any cash proceeds from potential divestitures this year. Looking ahead to next year, we anticipate that our free cash flow margin will return to previous levels and be in line with our fiscal '27 targets. To wrap up, we have a lot of moving pieces this quarter, including significant cost reductions in Performance Technologies combined with large investments in Climate Solutions for the three acquisitions and the data center expansion. This represents a lot of change, and the team will continue to execute as we've done throughout our transformation. These activities are critical elements of our strategic transformation and capital allocation strategy. We remain confident that these actions are setting the stage for long-term sustainable growth for Modine shareholders. With that, Neil and I will take your questions.

And our first question will come from Matt Summerville with D.A. Davidson.

Can you first break down the year-over-year margin contraction on the Climate side of the business, indicating what was driven by the data center and what was due to mix, as well as the specific headwinds, possibly providing a breakdown in basis points? Additionally, could you provide a clear plan on how you aim to return to what is considered 'normal' in the fiscal fourth quarter, which I would assume indicates around 21% at the segment level? Mick, in your prepared remarks, you mentioned that the Climate segment has the potential to exceed historical profitability in the future. Could you elaborate on that? I have a follow-up after this.

Yes, Neil, would you like me to go first? Thank you for the question, Matt. Starting with your inquiry about Q2, breaking down the margin in basis points, the largest portion of the margin in the quarter came from the data center expansion, contributing around 225 to 250 basis points. This translated to approximately $10 million to $12 million in increased costs, primarily related to labor and overhead, with some material costs included. Neil can provide further details on that. Regarding the HTS side, last year, we had significant heat pump settlements following the market downturn, amounting to around 125 basis points. For HVAC Technologies and others, it accounted for about 100 basis points, mainly due to mix issues and some start-up integration costs associated with acquisitions. That's the Q2 breakdown. As we approach Q3 and Q4, Neil and I can offer more insights. You mentioned future expectations, and as we outline our plans, we're building capacity not only to reach our goal of $2 billion but also to exceed it without operating every plant at maximum capacity. Once we achieve normal production levels and trend towards full capacity, the incremental margins will be considerably high. Therefore, I believe that as we reach normalized production levels, we can anticipate more standard EBITDA margins for CS, along with significantly high incremental contribution rates. Neil, I'll pass it back to you to discuss our outlook for Q3 and Q4.

Yes. I want to add that we anticipated some launch costs, which is expected. We brought in over 1,200 new employees in recent months. The costs were slightly higher than we anticipated, but we recognize the root cause of this, which we understand. We faced such high demand and expectations from our customers that we had to stretch our resources by launching multiple products simultaneously. We acknowledge the impact and costs associated with that. We have now returned to our standard launch process, which is more controlled, with the appropriate number of specialists managing the tasks. We are applying an 80/20 approach to scheduling and lead times, and we have improved alignment with our customers' expectations and schedules. We attempted a different approach to meet demand and launch more quickly to support our customers, which ended up being costly.

I appreciate that insight. Yes, I would like to continue.

Just to clarify, you inquired about the ramp-up as well. We mentioned some improvement in Q3, and I want to ensure we address your question about returning to a growth rate of over 20 percent in Q4. Our implied guidance indicates approximately 90 percent in the second half, and we do anticipate sequential growth, so the growth rate is expected to continue improving. To meet our Q3 targets, we likely need an additional $40 million to $50 million in incremental capacity coming online. If we have over two chiller lines, that should suffice. For Q4, we would need another $75 million to $100 million in revenue capacity, which would require at least five more chiller lines. We can discuss this further with you, either online or offline, as many of you are familiar with these plans. We are on track, and this doesn't factor in sales of other products like air handlers or modular units. In terms of the ramp-up, it involves fully operating at least two lines in Q3 and adding another five lines, focusing solely on chillers in Q4.

Super helpful, I appreciate all that detail. I want to stay inside the data center business for my follow-up, 90 days ago, you mentioned establishing a data center sort of goal approaching $2 billion in fiscal '28. Now you're talking about a number over $2 billion just 90 days later. Did something change with order activity, funnel, customer acquisition? And ultimately, as you get to the tail end of this capacitation journey, both in North America and now in the U.K., where will your capacity actually be? And should we be thinking about maybe something a bit materially higher than $2 billion in '28 based on what I'm describing there?

Yes, thanks, Matt. In the last 90 days, we've definitely seen a change in order and funnel rates. Demand has increased, and our relationships with customers are evolving positively. The scheduling and outlook have opened up, allowing us to perceive more opportunities and instilling greater confidence to continue with capital expenditures. We've experienced this with the expansion of our current product lines and the introduction of new offerings, such as our modular data centers. The market appears promising, and we believe we have the right technology and timelines to satisfy customer needs, which boosts our confidence in our current position.

So I just want to follow up on the margin commentary. Just what gives you the confidence that margins should normalize going into 4Q beyond just the accelerated capacity just given investments should continue? And I know it's further out, but how should we think about margins as it relates to the longer-term targets that you laid out as you accelerate the rate of production here? Is the 4Q implied run rate a sustainable way to think about kind of the longer-term margins?

Thank you, David. We are currently undertaking many new initiatives, including new products, processes, plants, and personnel. These launches often lack efficiency, and we are aware of that. However, with each product we release, we gain valuable insights that will ultimately enhance our performance. As we progress with the Grenada and Rockbridge launches in the data centers, we are learning key lessons that we can apply to the introduction of additional chiller and modular lines across various facilities. The focus is on learning, improving efficiency, and honing our expertise in design, manufacturability, and quality. This continual improvement gives us confidence that we will enhance our margins as the year progresses.

Yes, David, I would add that margin improvement has two aspects, building on what Neil mentioned. Our established data center regions and plants are operating at or above the segment margins. As we increase volume in these stable facilities, we can further enhance margins. However, launching new facilities involves fixed cost absorption challenges as we scale to cover additional fixed costs. Additionally, as Neil noted, in some cases we face inefficiencies due to extra labor or training. The key takeaway is that as we start new lines, we are also increasing volume to better utilize our fixed costs. While typical conversions can lead to inefficiencies, we are addressing this and enhancing our processes. Therefore, it's both a volume and lean initiative, if you view it that way.

I want to follow up on Matt's second question regarding the acceleration in investments. How are we approaching this in relation to the long-term growth needed to achieve over $2 billion in sales by fiscal 2028? I also want to clarify that this represents a slight increase from our previous expectations. If that is the case, what is the new sales capacity target based on the investments you are making?

Yes, we haven't provided a specific number yet. We usually give ranges. However, considering the order profiles, new product launches, ongoing product development, and the timely entry into new regions for launching our facilities and deploying capital expenditure, we have a lot of visibility. There is substantial interest and demand for our products due to the technologies we've developed. Over the past few years, we've positioned ourselves well by acquiring and developing the right technologies and building relationships with major hyperscale, neocloud, and colocation providers, all of which are experiencing solid growth. Our sales funnel continues to expand, which boosts our confidence to invest capital and hire staff for product launches.

Let's stay with data centers. So when you've talked about data centers in the past in terms of Modine's positioning, expected growth, one of the consistent themes has been you're focused on providing a relatively small subset of the market, exceptional products and services. So when you think about, just for example, the $2 billion data center target in fiscal '28, just trying to get a sense as to how you view the total addressable market in calendar '27. I mean, is $2 billion, is that 10% of the available HVAC market? Is it a bigger percentage of that? Just trying to understand kind of where that puts Modine in the overall kind of structure of the HVAC market on the data center side.

Sure. Thank you for that. Around $2 billion, and remember, the total addressable market is going to continue to grow as we've seen the amount of capital expenditure being deployed in the data center market across the board. So our total addressable market is expanding. Are we growing at a similar rate? We are growing above the market, and we are growing faster than the market. Therefore, we are gaining market share. We started with single-digit, low single-digit growth. Last year, we reached double-digit, low double-digit growth. If we reach the $2 billion range based on our assumptions about market size and the available market we can address, it likely places us between 15% and 20% at that point, Chris.

And maybe just my follow-up. Recognizing you don't necessarily look at your data center solutions discretely, air cooled versus liquid cooled. When you talk again about the $2 billion target, how do you view the relative contribution of air versus liquid at that level?

Well, you need both in this space today. It requires both. They complement one another. But where we're seeing a lot of the growth and where we're seeing a lot of the demand with our closest customers is with the deployment of AI. So it's going to require a great chiller product, which we have. It's going to require the air cooling products that we have to help augment it and CDUs as well. So we're seeing the growth, and a lot of the growth is coming from AI expansion.

And on the margin, there's a relatively consistent margin profile across the product suite. Obviously, service is at the highest end, and we get a lot of questions on that. That will grow as our installed base grows over time, but the contribution margin is relatively consistent across our product suite.

I mean so much focus today on these margins and the incrementals, certainly for good reason. I may want to ask a different way. Is the right way to think about what's going on here that you've largely front-loaded a lot of the investments associated with the multiyear capacity ramp, and that perhaps starting with Q4, we started to see more normal incrementals in CS and specifically in data center? If that's the case, even though you're opening more plants over the coming years, again, what gives you confidence that we can see that kind of level of normal incrementals based off of the specific products that you're making and the configuration of the lines that you're setting up?

Yes, it's Mick. A good example is from last year when we launched production of chillers in North America for the first time. Last year, we generated margins on the data center side that aligned with the rest of our data center business. I remember we had a few quarters with high margins thanks to that volume, and we saw a nice improvement last year. It's really about repeating what we've been doing with existing products in a disciplined way. The challenges arise when creating a new product in a new location. Essentially, it’s about replicating what we’ve done in the U.K. and North America. The main issue for the first six months will be setting up the building and equipment, bringing in staff, training them, and sourcing materials. There’s still a learning curve when launching. Once that’s established, we're confident because we’ve been doing this for 10 years and understand our expected profit margins.

Yes. So then to put a finer point on it, what should incrementals look like as we get into '27?

Early to say in '27, but what I would say on incrementals is typically at a gross profit line, we'd be looking at a 30% type incremental gross profit to each dollar of sales when we're running at existing facilities, and we're adding more volume.

And then just to ask one question on PT, bringing Jeremy and getting some traction on margin improvement. Maybe just talk a little bit about current focus areas for the business and any update on the divestiture process?

Yes, having Jeremy on board is a valuable asset, and he will continue to implement our existing strategy, focusing on stabilizing the business and operating as efficiently as possible. We will maintain close relationships with our customers and work on enhancing our order pipeline. When market recovery occurs, we will be well-positioned to execute on the platforms and programs we've developed through our innovation and technology. The approach will remain consistent, and he will help speed up our efforts and provide further structure.

And any update on the divestitures or we save that for another call?

Business as usual there. I mean, we're always looking strategically in terms of what our best options are. I think we've got a pretty good history and trend that through product line strategies that we can execute on those year-over-year. You've seen that over the last few years, and I'm pleased with where we're at in terms of the progress of that today.

We'll go next to Brian Drab with William Blair.

Just given that we just touched on the Performance Technologies there, what are you seeing, Neil, in those end markets, off-road, on-road, demand for your components in those end markets over the next 12 months?

Yes. We've been experiencing this cycle for about 1.5 years now. These cycles usually last between 1.5 and 2 years. We are closely monitoring the trends and announcements from the major OEMs to prepare for a market rebound. We are paying attention to their inventory levels and identifying how we can accelerate manufacturing in response to the needs we observe through our OEM partners.

Okay. And my sense there is that it's stabilizing. I mean, would you agree with that? Or do you think there's another way...

Yes. I think there's some recent reports, as of today that suggest there could be some stabilization and that the inventory levels are right. Those are early indicators. I'd like to see a trend first. But yes, that's fair.

I would like to ask a question about the data center. There are some large projects happening around the world, and I'm curious about the situation in the U.S. Specifically, are there any significant projects in regions where you currently lack manufacturing capacity or service capabilities nearby? Have any opportunities arisen recently that would require you to establish new capabilities near these major sites, similar to what you are doing in Texas?

Yes, it's a valid question. You're right that there are opportunities for global expansion. Our top priority is the United States, as it is home to our largest customers and constitutes half of the global market. We need to ensure that we are executing effectively and delivering the products that meet current industry demands, which enhance total cost of ownership, power usage effectiveness, and water usage effectiveness. This is a focus for us in the U.S., and we're committed to doing it well. We have also recently launched operations in India, where we conducted our first pilot project. This new facility will support our customers in India and Southeast Asia as they grow. Additionally, we are experiencing demand in Europe, where we already have facilities to support our operations. We are adding another chiller line and expanded a facility last year by an additional 400,000 square feet to facilitate growth in that region. Furthermore, we are seeing significant opportunities in the Middle East. We have secured some orders there and are servicing them from our facility in Spain. We may consider making additional investments in the Middle East in the future, but for now, our current capacity allows us to serve the region effectively from both India and Spain. We are indeed expanding globally, with the most substantial projects outside the U.S. and Europe being in the Middle East.

Okay. And then just one more on that topic. Inside the U.S., when you won this opportunity in Texas, it seemed to come suddenly and was an incredible opportunity. Have you experienced any other situations like that or, as a result of that one, have any other major projects come your way since we last spoke on the 1Q call?

Yes, we definitely see that. We're noticing these developments, and we're still in the early stages. This gives us greater opportunities to exert influence as well.

And we'll go next to Jeff Van Sinderen with B. Riley Securities.

Just since we're on the topic, in the data center area, can you provide any more details on how customer concentration is changing? You mentioned picking up some new customers. At one point, you spoke about a hyperscaler that you might not have had as a customer before. Has that turned into a customer? Are there still major new customers that could increase demand further? I'm also curious about how the demand for the modular product is progressing.

We have strong relationships with the major hyperscalers and are further developing these connections with some new ones. We are enhancing our products and engaging in discussions that give us confidence in our growth potential. Currently, out of the five major hyperscalers, two account for most of our business. There is significant opportunity for expansion now that we are connected to the other three and have proven our technical specifications and capabilities. We also see potential for growth outside of the hyperscalers with neocloud providers, where we have already seen success with one that has generated strong interest from others. Additionally, we have identified other geographic areas with large players where we can expand. This growth potential is primarily due to our robust product offerings and strong relationships with some of the largest data center providers worldwide.

And then I think you mentioned in some of your earlier comments about having a wider aperture and generally improving visibility for the data center product demand. How far out can you see in the data center business at this point? And I know sometimes maybe customers pull sooner than you think. I think you spoke to that a little bit. What does demand for the data center solutions look like if you go out a year or two years or as far as you can see?

You're correct. Some of these situations arise unexpectedly and require us to respond quickly to meet the needs of our customers, particularly our largest ones. We aim to react swiftly to produce and deliver products, even if the process isn't always efficient. This approach allows us to drive revenue growth and satisfy customer demand. However, when the situation is more strategic, and we engage with customers focused on their future plans and capital deployment, we can project our visibility out three to five years. For most of our largest customers, we have that insight, which is beneficial for ensuring we allocate capital strategically and establish facilities and factories in the appropriate regions. One example of that is what we did in India. We discussed this a year ago, and the main reason for establishing facilities and capacity in India was because our customers requested it. They specifically mentioned that they would be in the region in a couple of years and needed our support. They asked if we were willing to invest there. This illustrates the positive outcome of having these discussions well in advance, ensuring we can have the facility ready in time.

And that does conclude our question-and-answer session. I would now like to turn the conference back to Kathy Powers.

Thank you, and thanks to everybody for joining us this morning. The replay will be available through our website in about two hours. Thanks.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.