Modine Manufacturing Company - Q1 2024

Transcript

Kathy Powers (VP, Treasurer and Investor Relations.)

Good morning, thank you for joining our conference call to discuss Modine's First Quarter fiscal 2024 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'll be using slides for today's presentation, which can be accessed either through the webcast link or by accessing the PDF file posted in the Investor Relations section of our website, modine.com. On slide three is our notice regarding forward-looking statements. This call will contain forward-looking statements as outlined in our earnings release, as well as in our company's filings with the Securities and Exchange Commission. With that, it's my pleasure to turn the call over to Neil.

Neil Brinker (President and CEO)

Thank you, Kathy, and good morning, everyone. This has been an exciting quarter for Modine. First, we delivered another record quarter with 15% top line growth and adjusted EBITDA of $80.4 million, an increase of 91% from the prior year. Second, we completed our first acquisition since announcing our transformation strategy with the addition of Napps Technology and the Jetson brand to our product portfolio in early July. Napps has a small chiller range that fits nicely within our indoor air quality business, providing an additional product line for our target schools market. I'm excited to welcome Napps President, Sam Neale, and his team to Modine, and look forward to continuing to manufacture this great product at their facility in Longview, Texas. This acquisition is directly in line with our growth strategy, which is focused on differentiated technologies and systems that address real-world needs.

Most importantly, this acquisition demonstrates our commitment to responsibly investing in key verticals, where our objective is to grow faster than the market. As a result, we're making great progress towards our financial targets and planting the seeds for future growth. This doesn't mean that we're reaching the end of the journey. In fact, I would say we're still in the early stages of this transformation. There's an additional opportunity for incremental revenue and margin growth as a greater percentage of our business portfolio shifts to the growth column, and as we further simplify and rationalize the low-margin products. Please turn to slide five. The Climate Solutions segment delivered another strong performance this quarter, with revenue up 11% from the prior year, and an adjusted EBITDA margin of 18.3%, up 500 basis points from the prior year.

In Climate Solutions, we are well along in our 80/20 journey and have proved out the effectiveness of this approach. We stabilized the business by providing the leadership, resources, and strategies necessary to improve our operating margins and accelerate top-line growth. I've often said that data centers is the tip of the spear, and it's leading the way in both revenue growth and margin improvement. In the first quarter, data center sales more than doubled from the prior year at margins above our segment targets. This is the result of a dedicated focus and strategy to grow, investing capital and resources as we've never done before.

Mick will provide more detail in a minute, we're raising our outlook for data center revenue growth this year, now targeting a 60%-70% increase, which would equate to over $270 million in data center revenue this fiscal year, up from $174 last year. This large change in our forecast is primarily due to higher-than-expected orders in Q1, which will positively impact the back half of the year. We have a strong backlog, including both hyperscale and colocation customers. In addition, we have a pipeline of new products and new customers that we are confident will fuel above-market growth in the future. I often get questions about our next-generation technology in data center arena, particularly as it relates to high-performance computing, supporting AI, machine learning, and other applications that require more advanced cooling technologies to deal with a higher heat load.

This technology is still developing, it's an area that we're very interested in, and we've done some R&D here in the past. We will continue to develop this technology organically, inorganically, or both, and are actively monitoring and assessing the landscape. We see this as a great opportunity for us to add to our portfolio of data center cooling products. As data center products become a bigger portion of our portfolio, this revenue stream provides a level of diversification away from our traditional heating and HVAC markets, both in the HVAC and HTP verticals. In fact, our heating sales were down nearly 40% in the quarter due to weak market conditions, and the sales of heat transfer products were down 7% from the prior year. Despite this decline, margins actually improved due to lower material and freight costs and greater labor efficiency.

When demand started to change, we quickly shifted our efforts to operational improvements, leading to this solid performance. Please turn to slide six. The Performance Technologies segment also delivered strong results this quarter, with revenue up 18% from the prior year, and an adjusted EBITDA margin of 11.2%, an improvement of 560 basis points. In fact, the margin is exactly double the prior year. Much of this gain is due to the hard work the team has put into improving commercial terms and our long-term contracts, helping to recapture margin lost to material, labor, and overhead inflation over the past several years. In many cases, we benefited from these adjustments earlier than expected, leading to our quarterly performance exceeding our expectation.

The important thing to understand is that our teams are focused on the value that we deliver to our customers, and they're negotiating agreements that are fair to both parties. In addition, we're winning incremental business in targeted markets with accretive margins. Much of this is due to the 80/20 work that we've done so far in the PT segment. We are evaluating our business using a data-driven approach and are simplifying, improving wherever possible. For example, in our liquid cooling applications business, we've eliminated 73 SKUs, representing over $20 million of annual revenue that was at negative gross margins. In some cases, we're getting favorable commercial terms as we negotiate exits on non-strategic product lines. As the business wind down, we plan to replace it with higher-margin opportunities. An example of this is the genset business, which I've mentioned before.

We have been in this business for a long time, but it was never a strategic focus. Now we are working with existing and new potential customers to support the conversion from copper brass to aluminum heat exchangers, similar to what the vehicular OEs did decades ago. Aluminum has both a cost and performance advantage, and we have the technology and global footprint to deliver in region. There are great drivers for the growth in this business as data centers, hospitals, and other critical applications secure backup power to guarantee continuity of energy supply. This was about a $50 million business for us last year, and we expect this business to have a 30% CAGR over the next three years. Definitely in the growth column. Another business in the growth column is our EV Systems business.

We have a number of important launches this year, some are being delayed due to supply chain constraints, the demand is there. As for the commercial funnel, we are up to 25 program wins, including two wins for our fuel cell product. This pushes our awarded revenue at peak annual production to over $150 million. Again, I'd like to reiterate that we are just getting going on 80/20 in the PT business, are seeing remarkable early results. We are investing in those businesses that have the right growth drivers and addressing low-margin business in different ways throughout the segment. We've simplified our product offering and are negotiating favorable exits, while also working to improve commercial terms to recapture the value that we provide to our customers, all while further investing in the technology of the future.

I'm very proud of the work being done in both segments and the results we have delivered this quarter. Now, I'd like to turn the call over to Mick, who will review our results for the quarter and provide segment financial updates.

Mick Lucareli (EVP and CFO)

Thanks, Neil, and good morning, everyone. Please turn to slide seven to review the segment results. Climate Solutions had another great quarter with improved earnings on higher sales. Segment revenue was up 11%, driven by our data center vertical, with sales up 124%, or $38 million. The data center increase is fantastic, given it supports one of our most attractive markets and is quickly becoming a very large portion of Modine's total revenue. A significant piece of the increase is related to North American chiller sales as we ramp up production at our new plant in Virginia. We entered the year with a strong backlog and realized some of the sales much earlier in the year than originally planned, which added to a stronger than anticipated first quarter.

HVAC and R sales were down a modest 2%, or $1 million, driven by lower sales of heating products, partially offset by higher indoor air quality sales, which were up 40%. The heating market remains down, largely due to higher field inventories and lower preseason stocking sales. Sales of heat transfer products decreased 7%, or $9 million. As anticipated, there was some market softness with commercial refrigeration customers and in various residential-related markets. We are also continuing 80/20 product rationalization activities. We're pleased with the very strong earnings conversion, as adjusted EBITDA increased 53%, resulting in a 500 basis point margin improvement to 18.3%. The earnings and margin improvements were primarily driven by higher sales volume and benefits from 80/20 initiatives. The Climate Solution segment continues to perform very well and is off to a strong start to the year.

The growth in data center sales is driven by a robust backlog, which is continuing to grow. With regards to heating and heat transfer products, we're maintaining a cautious outlook for the second half of the year, which has been incorporated into our revised guidance. Given these factors, we believe we're likely to see more level-loaded quarters or less seasonality than in previous years. Please turn to slide eight. Performance Technologies also had another great quarter, with sales up a very strong 18%, or $55 million. Revenue benefited from both volume and commercial improvements, many of which were realized earlier than expected. Sales volume accounted for $37 million, or 12% revenue growth. Advanced Solutions sales were up 31%, or $10 million, with continued growth of our EV Systems and component sales. Liquid-cooled application sales increased 21%, or $24 million, due to higher sales across all end markets.

Lastly, air-cooled application sales increased 13%, or $20 million, primarily due to continued strong demand from off-highway customers with a higher sales in genset or stationary power applications, which we see as a significant growth area. Performance Technologies converted the higher revenue to an extremely high level of earnings. Adjusted EBITDA was up 135%, resulting in an 11.2% margin and a 560 basis point improvement. As Neil mentioned, the Performance Technologies segment has worked hard at modifying long-term contracts, and in some cases, we've benefited from these adjustments earlier than expected. While we're making great progress towards our margin targets, I want to point out that it will be difficult to sequentially match this Q1 result....

As we entered the year, the team had a long list of projects to execute, and we believed the results would ramp over the year, consistent with most of last year. As I just mentioned, we're pleased that some of our commercial negotiations were completed earlier than expected, and we're also able to capture some retroactive commercial benefits during the quarter. Lastly, as previously discussed, the team is pursuing multiple 80/20 product rationalization strategies, which could result in some reduced revenue. I want to be clear that these are planned actions and relate to business that cannot meet our margin objectives. Based on all these factors, and as we look to the balance of the year, our full year outlook for the segment has improved, and we now see more even results over each of the four quarters. Let's review the total company results. Please turn to slide nine.

First quarter sales were up 15%, or $81 million. Higher sales volume drove approximately $62 million of incremental sales, or 11% growth. Commercial pricing added another $19 million to the top line. The gross margin improved 520 basis points, primarily driven by the factors I reviewed for Climate Solutions and Performance Technologies. SG&A increased $5 million, primarily due to higher employee and incentive compensation expenses. SG&A as a percentage of sales, was 50 basis points lower than the prior year. I'm happy to report that adjusted EBITDA was very strong in the quarter, with an increase of 91% or $38 million. This equates to an adjusted EBITDA margin of 12.9%, or a 510 basis point improvement from the prior year. This also represents the sixth consecutive quarter of year-over-year margin improvement.

Adjusted earnings per share was $0.85, an increase of 0.53 or 166% from the prior year. Before moving to the balance sheet, I'd like to reiterate that the quarter was clearly stronger than expected. We now see a more level-loaded year for several reasons. First, Q1 revenue was higher than initially expected in our plan, including a faster ramp than anticipated in some areas, such as data centers. Second, Performance Technologies is achieving 80/20 benefits earlier than expected, including the settlement of new commercial agreements and some retroactive adjustments that will not carry through to future quarters. Third, raw material costs have been below our previous projections, which is favorable to Modine, until we pass on the lower costs through our material pass-through agreements over the next few quarters.

As a result, a portion of the strong Q1 earnings was due to timing and the accelerated benefit from some of these items. In a few minutes, I'll further discuss how we're rolling these impacts and the strong operating performance into our full year outlook. Moving to the cash flow metrics. Please turn to slide 10. We generated $27 million of free cash flow in the quarter, which is a significant improvement over the first quarter of fiscal 2023. This was primarily driven by higher operating earnings, partially offset by higher working capital and higher payments for incentive compensation. Net debt of $265 million decreased 20 million this quarter. Net debt, coupled with strong earnings, resulted in a leverage ratio of 1.1. This fiscal year, we expect continued growth in free cash flow, driven by higher earnings and a continued focus on working capital.

We anticipate the full-year free cash flow will fall in our target range of 3%-5% of sales. Modine's balance sheet remains quite strong, ready to support both organic growth and acquisition initiatives, as was demonstrated by the acquisition of Napps Technology that we announced in early July. Let's turn to our fiscal 24 outlook on slide 11. As announced in the press release, we're raising our sales and earnings outlook for fiscal 24. Before I discuss the updated guidance, I want to review some modifications to how we report product group sales. First, we've refined reporting of revenue by product group within the Climate Solutions segment in order to be more consistent with how we manage by general manager and manufacturing location. As part of 80/20, we're continuing to align our product groups in manufacturing with each of our general managers.

As a result, we've recast revenue for fiscal 2023 to be consistent with how the product groups are now reported in fiscal 2024. There are no changes within Performance Technologies, but we made some minor revenue changes between data centers, HVAC and R, and heat transfer products within Climate Solutions. We provided a summary table of the recast numbers in the appendix to this slide presentation. For the prior fiscal year, the recast resulted in a $20 million increase in data center revenue, a $5 million increase in HVAC and R, offset by a reduction in revenue for heat transfer products. To be clear, there is no change to total Climate Solutions revenue, rather just minor classification changes between the three product groups.

As I previously mentioned, our first quarter exceeded our expectations for several reasons, and this was certainly a factor leading to our improved outlook for the year. In the Climate Solutions segment, we now expect data center revenue to grow 60%-70%, a significant increase from our previous guidance, and we now anticipate data center revenue to be more than $270 million. Moving to HVAC&R, we expect revenues to grow in the low single digits and have lowered the top end of this range as we remain cautious about ongoing weakness in the heating market. However, we anticipate this should be offset by very strong sales growth in school ventilation products. With regards to heat transfer products, we now anticipate a sales decline in the low single digits, which is a reduction from our previous guidance.

This is primarily due to concerns over a general economic slowdown, especially in residential and commercial refrigeration applications. Also, within heat transfer products, we're adjusting our projected ramp-up for sales to heat pump customers in Europe due to changes in regulations and incentives. We still anticipate this to be a high-growth market for us, but at a somewhat slower ramp rate. Moving to Performance Technologies, we expect continued momentum from relatively stable markets and benefits from our 80/20 rollout. We expect Advanced Solutions growth to be in the 25%-35% range, which did not change from last quarter. This growth is 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 is expected to be somewhat offset by product rationalization as we continue to de-emphasize lower-margin business. The product rationalization and associated lower revenue could result from negotiated program exits or from select divestitures. Let's move to adjusted EBITDA. Again, the first quarter was much stronger than we anticipated, based on many factors, including sales volume, material margins, and operational improvements. Based on the recent results and market trends, we're raising our adjusted EBITDA outlook for the year. We now expect our fiscal 2024 adjusted EBITDA to be in the range of $280 million-295 million, up from $240 million-260 million, and representing an increase of 32%-39% versus the prior year. When looking at the midpoints of the earnings ranges, our new outlook represents a nearly $38 million increase.

Again, much of this change is due to the performance in the first quarter, and some of the Q1 benefits won't necessarily repeat in subsequent quarters, including the realization of retroactive commercial adjustments. Based on this and our higher full-year outlook, we now anticipate that the next three quarters will hover around $70 million, versus the previous plan for a more back-end-loaded year. The second and third quarters could be somewhat below the $70 million quarterly average, with Q4 potentially above the average. Now that I've covered the very strong Q1 and associated sequential trends, I want to reiterate that our outlook assumes ongoing and very strong year-over-year improvement for the balance of the year. We anticipate that free cash flow will improve with the higher earnings outlook, with capital expenditures expected to be around $70 million.

Our assumptions, including interest expense, taxes, depreciation, and amortization, are all included in the appendices attached to this presentation and our press release. To wrap up, we're extremely pleased with the first quarter results and how we've started fiscal 2024. Our outlook remains strong. We're making progress towards our financial targets, and in many cases, we're trending well ahead of our initial transformation timeline and goals. I'm pleased to say that we're firmly on track with our transformation, but as Neil said, we're still in the early stages. This was a great quarter, but we still have plenty of work ahead of us, and we're quite confident in the entire Modine team. With that, Neil, and I'll take your questions.

Operator (participant)

If you have a question at this time, please press the star, then one key on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star, then two, if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from the line of Matt Summerville with D.A. Davidson. Please proceed with your question.

Matt Summerville (Managing Director and Senior Research Analyst)

Thanks. Morning. Obviously, great quarter. Couple, couple thoughts. Just with respect to Performance Tech, can you maybe quantify, to the extent you can, how much retroactive benefit that would be kind of more one-time in nature that you saw in the quarter, that you would not, expect, to repeat necessarily looking forward?

Mick Lucareli (EVP and CFO)

Hey, Matt, it's Mick here. Good morning. In, in total, total company, we estimate there was at least, you know, $10 million in the quarter of pull ahead, things we got earlier than we thought would happen, plus, you know, some retroactive adjustments for the, and that's for the total company. As I look at it between PT and CS, I'd probably estimate that it's about two-thirds, one-third, about two-thirds of that coming in PT and a third of that in Climate Solutions.

Matt Summerville (Managing Director and Senior Research Analyst)

Okay. Follow-up. Data center business, obviously, you had a pretty amazing first quarter here. Neil, I want to understand a little bit more about how you're approaching the high-performance computing market, the liquid cooling strategy, realizing you may have concurrent development paths going on here. I guess from, from a timing standpoint, when should we expect Modine to be able to address that, that cross-section of the market head-on? Could you give a little bit more granularity around what incoming orders and backlog might look like, specifically to data center, either year-on-year, sequentially, just whatever color you're willing to provide? Thank you.

Neil Brinker (President and CEO)

Yeah, good question, Matt. Thank you. This is Neil. Sure. We've, we've seen, a, a very healthy pipeline within data centers, right? When we continue to build out our, our customer base and broaden our customer base, particularly around the co-location side, these, these orders, potential orders that are in the pipeline, when they break, they make large swings, right? We don't-- we typically don't predict, you know, some of these larger orders until they actually cut over to POs, and that's where you're starting to see some of that adjustment is, is this-- as this funnel continues to grow, more and more is, is transitioning through the tollgate process into purchase orders.

we like that, we enjoy that, and we appreciate the work that we're doing with our customers there to, to help support them and meet their sustainability targets. Relative to liquid cooling, we've been close to this. We're gonna remain close to this. This has been something that, you know, Modine has participated in for over a decade. We understand the shift in the technology, but we also understand that there isn't a clear technology winner, whether that is gonna be immersion cooling or liquid on-chip cooling. We want to understand where the market will continue to evolve, and as, as this market becomes more dynamic around liquid cooling, we're gonna continue to observe to see where the greatest opportunity is for Modine to penetrate.

Again, that can be, you know, through agreements or, or inorganic growth or organic growth. We are in a good position to do either. And we'll move at the rate as the, as the market adopts. As the market adopts, we'll, we'll make those adjustments accordingly. We're very keen to the market. We understand it, our customers understand it, our customers look to Modine for these solutions, and we'll make the adjustments appropriately.

Matt Summerville (Managing Director and Senior Research Analyst)

Thanks, Neil. Then maybe I'll just sneak maybe one more. Just to kind of use a baseball analogy, how would you characterize what inning we're in within the two business segments with respect to generating the 80/20 benefits you fully intend to, to achieve, within climate and performance? Thank you.

Neil Brinker (President and CEO)

Yeah, good question, Matt. This is Neil. In Climate Solutions, we're, you know, we're halfway through the first game of a 5-game series. In Performance Technologies, we're just getting started. The teams are they're organized appropriately. They have they've picked the markets that they wanna grow in, they understand the strategic initiatives and objectives, and we've put in the right leadership team in order to execute on those objectives. As you know, we started Climate Solutions a year ahead of, of Performance Technologies deliberately, they're tracking right in line with what our expectations were with the financial targets that we put in place in New York last year.

Matt Summerville (Managing Director and Senior Research Analyst)

Got it. Thanks, guys.

Operator (participant)

Our next question comes from the line of Chris Moore with CJS Securities. Please proceed with your question.

Chris Moore (Senior Research Analyst)

Hey, good morning, guys. Thanks for taking a couple questions. Maybe just big picture on, on pricing. I know that you guys have raised prices aggressively over the past year or so, up until at least recently, you talked about still being underpriced in, in many areas. Just wondering, is that still the case? You know, is there specific areas that, that you could talk to there?

Neil Brinker (President and CEO)

Hey, Chris, this is Neil. Good question. Yeah, we, we continually go out and evaluate the marketplace in terms of where we're positioned with price. As you know, with in, in, in this inflationary environment, and increases in metals and, and other commodities, we're all often and, and regularly reassessing that, and then, you know, having conversations with not only our customers, but our supply chain as well, to improve those positions. This is part of our business cycle, part of our business system, and it's, it's how we operate so frequently would be the answer to that question.

Chris Moore (Senior Research Analyst)

Got it. Helpful. Thank you. My understanding is that, you know, auto OEMs have multiple vendor relationships with suppliers like Modine. However, you know, they often sole source a given platform. Assuming that's accurate, do, do you see situations where the OEM is, you know, might be reluctant to allocate the internal engineering resources necessary to get another vendor spec'd in, even though your, your pricing, you know, is, is going up significantly?

Neil Brinker (President and CEO)

That's a good question, Chris. I think, you know, OEMs have, all OEMs have different strategies. They could have dual supply chain, single supply chain, triple. That depends on how they wanna balance the strategic or supply chain risk, if there is any, whether that's an issue with factory output production, or it's an issue with logistics, or maybe even price. I think they all have their own unique strategy, but I, you know, there's a, there's, there's that element that you just described, and there's also an element of we've seen a conversion over to EV.

As we look at opportunities on the internal combustion engine side, and maybe there's adjustments there commercially that are made, I think you also have to consider whether or not it, it's, it's worth the time and effort and energy, in order to maybe find additional suppliers to, to provide that product, knowing that the platform's gonna end and it's gonna convert to EV anyway.

Chris Moore (Senior Research Analyst)

Got it. Very helpful. Just last one for me on... It sounds like this 25 EV program wins $150 million. I'm just trying to understand, over what timeframe are you kinda looking at that?

Mick Lucareli (EVP and CFO)

Yes, it's Mick. It's gonna be a significant ramp, so, and we, last year was about $50 million or so in EV business, and we estimate that that'll grow at a 40%-50% compound growth rate. If you kinda extend that out, you get a feel for when you think, when we think we'll be hitting that, that run rate.

Chris Moore (Senior Research Analyst)

Got it. Very helpful. I'll leave it there, guys.

Operator (participant)

Our next question comes from the line of Jeff Van Sinderen with B. Riley Securities. Please proceed with your question.

Jeff Van Sinderen (Senior Analyst)

Good morning, everyone, and let me add my congratulations on the strong metrics and overall progress. If we could circle back to the data center segment for a minute, just wondering how fast that segment could grow? In other words, how much capacity do you have to meet demand if it happens to exceed your internal plan, kind of ahead of expectations?

Neil Brinker (President and CEO)

Hey, Jeff, good question. This is Neil. Thanks for that. You know, we're, we're evaluating our capacity, and we're looking at redundancy, and we're making investments there. As you know, two years ago, we primarily, most of the data center output and revenue came from the U.K., out of one facility. Since then, we've expanded to two facilities in the U.K. We've retooled an existing manufacturing facility in Spain to support data center growth for continental Europe. We've modified a facility in Virginia to produce our chillers for North America, so we added additional capacity there, and then we're adding capacity in Mississippi as well. We're across five different footprints, and we have the capacity to continue to grow at the rates.

We have more capacity than the actual stated percentage of growth year-over-year. I'm not concerned about capacity. It's just a matter of being able to transition the conversations that we have with our customers and provide the products and the engineering solutions. The capacity in terms of the factory, we're in a good position.

Jeff Van Sinderen (Senior Analyst)

Okay, great to hear. Maybe if you could delve a little bit more into what you're seeing in the, in the school market for indoor air quality. Just a little bit of update there.

Neil Brinker (President and CEO)

Yeah, that's a great business for us. We continue to, we continue to, you know, gain share there in that space. We've, we're working on the process of actually dedicating a facility to that. There's enough volume now that we can, we can dedicate an entire facility to that, so we're, we're getting that positioned and ready to grow. We see this outlook of growth at this rate for, you know, the next couple of years as well. It's the funding is continuing to flow through into the schools. They're making the decisions, they're upgrading the infrastructure, and, you know, we put ourselves in some pretty good positions with our reps and distributors to fulfill the needs of the customers.

Jeff Van Sinderen (Senior Analyst)

Okay, great. I had sort of a, a P&L question on the gross margin that came in substantially better than we expected, which we know has been a focus during the current phase of transformation. Can you maybe speak to whether you believe the level of gross margin we saw in Q1 is sustainable? I know that you, you mentioned some of the maybe a little bit of a non-linear progression over the next few quarters and the revenues. Just wondering how we should think about gross margin over the, the remainder of the year.

Mick Lucareli (EVP and CFO)

Yeah. Hey, Jeff, it's Mick. The, I, I mentioned to Matt's question, we estimate at least about $10 million in Q1 of, of good things that are more, that were pull ahead. If we look at having a, an average the next few quarters around $70 million ±, it's about, probably about one point of margin. I think for sure the gross margin is driving the earnings. We talked about that. 80/20 is gonna come through at the gross profit line. It wasn't an SG&A story, and we expect that to remain elevated. Going, like, from Q1 forward, I would say it'll remain elevated, but probably about one point or so below, where we were in Q1.

Matt Summerville (Managing Director and Senior Research Analyst)

Obviously, in all my comments, I think ramping towards the latter part of the year, as Neil said, we're still early phases of 80/20. So, super hard to repeat all the, the one-timers, benefits we've got in Q1, but then, ramping again later in the year, and I'd say about a, about a point probably lower for the next couple quarters.

Jeff Van Sinderen (Senior Analyst)

Okay, that's helpful. Thanks for taking my questions. I'll take the rest offline, and please keep up the fantastic work.

Neil Brinker (President and CEO)

Thanks, Jeff.

Mick Lucareli (EVP and CFO)

Thanks.

Operator (participant)

As a reminder, if anyone has any questions, you may press star one on your telephone keypad to join the question and answer queue. Our next question comes from the line of Tim Moore with EF Hutton. Please proceed with your question.

Tim Moore (Senior Equity Research Analyst)

Thanks, reiterating the very impressive beat and raise for the quarter. I was gonna drill into data centers, and two other analysts beat me to it, and most of my questions. Just maybe following up one more question on data centers, given the increased guidance and the sales growth coming in, you know, maybe, you know, four times what you expected. Just, just back there on the capacity, you explained that, you know, I plan to visit the Virginia site next week for your plant tour. Are you getting enough labor there? For the co-location center projects, I mean, how much lead time do you need on that?

I'm also just wondering, given the rapid growth of it this year, do you think that pulls in a little bit of the sales growth from next year, or is this incremental market share wins, do you think?

Neil Brinker (President and CEO)

Yeah, good questions. Thanks for that, Tim. You know, we have a, we have a pretty broad labor force in, in BV, as you know, the Rockbridge facility, where we produce the chillers. We, we've been able to secure the amount of good work and assembly workers there, and pipefitters to help us with that. We also have a facility and a factory that employs several hundred people that's 10 miles away, and we can flex labor back and forth. If heating volumes were down, you could arguably flex the workforce in, in, in Rockbridge as well, since we have multiple facilities in that campus and in that county. Labor, labor isn't a concern for us at the moment. The second question was?

Mick Lucareli (EVP and CFO)

With regards to the, the visibility and-

Neil Brinker (President and CEO)

Visibility, yes.

Mick Lucareli (EVP and CFO)

Potential pull ahead from next year.

Neil Brinker (President and CEO)

Relative to visibility, you know, typically we see these. We start engagements with our customers, and we start to move them through our pipeline, and it could take anywhere from the initial conversation to the point where we actually get an order of six to 12 months.

Tim Moore (Senior Equity Research Analyst)

Great. No, that's helpful. You already hit air quality, and I was gonna, I know I've been talking to Kathy about that with all the wildfires and the smoke pollution, but maybe I'll just switch gears. I mean, given air quality was up so strong, and we know you probably have orders for the schools, but just my other question is really around acquisitions. You know, given that you've kind of given that, you know, sales acquisition goal, have you seen for your Climate Solutions acquisition pipeline, you know, the asking prices become more reasonable over the last few months, or are they still pretty lofty by the sellers?

Neil Brinker (President and CEO)

No, that's a, that's a good question. It depends on the technology. It depends in terms of what the technology does it have to offer, and at what level of adoption rate it is, or if it's specified or spec'd into the, the product that's being, consumed today by the end users. Certainly there's some hot markets as we grow out our, our inorganic pipeline. I, and I'll tell you, I'm really pleased with what the team's been able to do there. It's, we've got, you know, multiple opportunities at different levels and different gates. We're, we're, we're gonna be cautious, and we're gonna do the right things for the business as long as it aligns with strategy. Certainly, we're starting to see some, some areas like you just described in indoor air quality, where you see some of those elevated rates.

Tim Moore (Senior Equity Research Analyst)

Great. No, that's helpful, and that's it for my questions. Thank you.

Operator (participant)

Our next question comes from the line of Matt Summerville with D.A. Davidson. Please proceed with your question.

Matt Summerville (Managing Director and Senior Research Analyst)

I apologize if you touched on this, just back to the data center side of things, are you seeing pretty similar growth in both co-location and hyperscale markets? Are you still on the hyperscale side, just doing business with the one large player? Do you think doors may be opening to some of the other hyperscalers?

Neil Brinker (President and CEO)

100%, yes, doors will be opening to other hyperscalers. The business mix is healthy on both sides. We're seeing the growth in co-location, and we're seeing the, the, the growth with our, with our hyperscale customers as well. That, that, that combination of the two is, is why we're, we're increasing our, our, our year-over-year objectives and targets in data centers.

Matt Summerville (Managing Director and Senior Research Analyst)

Then I think, I can't remember which one of you guys mentioned it, but I thought I heard that out of the 5 growth opportunities, right, you guys talk about a lot, it's EV battery, it's data center, it's indoor air, it's gensets, and then European heat pump. It sounded like the, the growth rate on the latter might be decelerating a bit, whereas in some of the others, it sounds like it may be accelerating. What's driving the, the pace of the, the rate of change on the European heat pump side of things? Does that give you pause with some of the capacitization you've been undertaking there?

Neil Brinker (President and CEO)

No, we're gonna continue to grow our Serbia facility and factory with CapEx, and we're gonna continue to install machines and dedicate lines to the heat pump growth targets that we expect. We're gonna continue to invest in Serbia and build out that facility. The thing that gives us a little bit of a pause is the turmoil in the European market relative to what the priority is on regulation. As you know, there was a strong movement, and there was a lot of followership behind moving away from natural gas in Europe. There was regulations and incentives that were deployed to do just that. Recently, we've seen a different priority that's got some traction in Europe around reducing GWP.

In order to do that, you have to use a different refrigerant, and a lot of the heat pump manufacturers aren't there yet to move at the same rate. It's almost like we, we slam the accelerator to move forward to deploy heat pumps in the European market, and then we hit the brake at the same time relative to regulations around GWP. We know that the European Commission will be getting together after the summer recess sometime likely in September. I think as soon as they work that out, we'll get back to the, the levels of heat pump adoption that we had predicted. For now, because there seems to be a little bit of conflict between the two agencies there, we're, we're watching this and observing.

Matt Summerville (Managing Director and Senior Research Analyst)

Got it. Thanks, Neil.

Operator (participant)

Okay, I am showing no further questions at this time. I would now like to turn the conference back to Kathy Powers for closing remarks.

Kathy Powers (VP, Treasurer and Investor Relations.)

Thank you. Thanks to everybody for joining us this morning. The replay will be available through our website in about two hours. We hope everybody has a great day. Thanks.