Modine Manufacturing Co (MOD) 2021 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Modine Manufacturing Company's Third Quarter Fiscal 2021 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Kathy Powers, Vice President, Treasury, Investor Relations and Tax.

Good morning, and thank you for joining our conference call to discuss Modine's third quarter fiscal 2021 results. I'm joined on this call by Neil Brinker, our President and Chief Executive Officer; and Mick Lucareli, our Vice President, Finance and Chief Financial Officer. I'd like to take a moment to introduce Neil, who joined Modine as President and CEO on December 1. Neil came to us from Advanced Energy Industries, where he most recently served as President and Chief Operating Officer; and prior to that, led global sales, marketing, engineering and operations for AE's semiconductor telecom and networking, data center, industrial and medical markets. Prior to joining AE, Neil spent 6 years with IDEX Corporation in a variety of senior leadership roles. We are very pleased to have Neil leading our team here at Modine.

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 on the Investor Relations section of our website, modine.com.

On Slide 2 is our notice regarding forward-looking statements. This call may 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. It's been a busy first 2 months with Modine, and I'm encouraged by what I see. I've spent much of my time connecting with the senior leadership team and getting to know the business. I'm honored to be part of a company with such a long and rich history. I would also like to share my appreciation for everyone in this organization that has gone above and beyond expectations during this past year to respond to the global pandemic. In addition to all of our employees, I would also like to thank members of our supply chain for keeping us running efficiently and for our customers who have continued to give us their business and their trust. This has been a difficult year to say the least, and we wouldn't have been able to deliver our financial results without the hard work from all these key stakeholders.

The team has also done a great deal of heavy lifting in preparing for the exit of the automotive business, and those plans are on track. As a reminder, last quarter, we announced the sale of our liquid-cooled business to Dana. Both teams are currently working through all pre-closing items, including the required regulatory approvals around the globe. This process has been initiated, and we anticipate a close sometime in the June quarter.

For the air-cooled business, which represents a much smaller portion of the Automotive segment, we are diligently working on multiple exit strategies. As previously discussed, we have talked with several interested parties and are getting closer to a definitive exit plan. The exit of the automotive business is an important step in our strategic transformation that will allow us to further focus on the future. As the teams work through the auto exit work streams, I'm personally focused on the next chapter for Modine. These are certainly exciting and challenging times for our company. And I see great opportunity for growth and for further improvement to our business model.

One of our key priorities is to expand our presence in the data center market. The data center market in North America and in EMEA are large growing sectors with strong underlying drivers. We expect this growth to continue for some time. Modine has full thermal system expertise, innovative product technology focused on lowering cost of ownership and a global footprint to support our customer locations.

And Modine has strong relations with growing colocation customers and our key hyperscale client, providing leverage for continued growth in Europe and in North America markets. We've talked about growing our share in the data center market for some time. And let me reiterate and be clear, this is one of the best opportunities for Modine to drive higher growth and profit margins.

Here's the immediate 4 step plan on what we'll do differently to win additional market share in data centers. One, organizationally, we're consolidating the leadership for data center solutions under one key leader here at Modine. We will align our organization around our customers and markets, which will remove internal barriers and increase our speed and accountability. Two, we are increasing our manufacturing capacity by leveraging our global footprint to deliver data center products at scale and in region. We are expanding capacity on our computer room air handlers by industrializing these product ranges in the U.S. and in Spain and are also investing to build and test chillers for the North America market. Three, we will continue to invest and scale our commercial and technical teams to better align with our customers. And finally, we will use the data center market as the pilot for our 80/20 initiative.

Many of you know my background and success with 80/20 companies, and Modine will adopt the same 80/20 principles, helping shape who we are in the future. As I mentioned, we will launch a pilot within the data center business, training our team in advance of a company-wide rollout. As you may know, a 80/20 is a systematic way of examining a business and focusing resources on the highest growth and best returning opportunities. Our opportunity is to focus both on improving margins and accelerating revenue growth. We will eventually work through all of our other key markets in a disciplined manner. The 80/20 process and methodology will take some time to fully implement across the company, and we will invest time and money, and it's a very important area. The result of this process have been successfully proven across many companies, and I am confident that Modine will be no different.

Finally, I want to mention that our focus includes both organic and inorganic growth. Mick and I will spend significant time wrapping up an aggressive and proactive acquisition program here at Modine, specifically designed to shore up our products, technologies and channels where it makes sense.

I'd like to cover our third quarter segment results on Page 4. CIS sales were down 13% from the prior year, primarily due to lower sales to our large data center customer, which were down approximately $19 million versus the prior year. Adjusted EBITDA was down $10 million. Similar to revenue, nearly all the earnings decline was due to the lower sales with one customer. I would like to take a minute and walk through the changing dynamics of this market while reiterating our confidence in our strategy. As you know, our largest customer in the CIS segment is a hyperscale data center customer. While the hyperscale market has grown at a good rate this past year, many hyperscale providers have chosen to scale back their large-scale capital expenditures for DC construction. In order to keep pace with the growth, many hyperscale providers have leveraged the rapid growth of colocation to expand our DC footprints.

During this period, we have collaboratively worked with our clients to design their next-generation of cooling technology for large-scale data center construction. We expect that we will see orders for these innovative and proprietary cooling products ramp again in fiscal 2022. In addition, I previously mentioned that we are consolidating leadership and focus on the data center markets to continue our growth with both hyperscale and colocation clients.

At the same time, we will evaluate different alternatives to better align the external reporting of our consolidated data center business since it currently resides in 2 business segments. Besides the drop in sales, CIS margins were also negatively impacted by expenses to complete the final phase of our plant consolidation in China. This is now behind us, and we expect those inefficiencies to improve going forward. Last, the team remains focused on improving the profit margins of our coils products and driving growth in coolers. I'm encouraged, and I look forward to utilizing our 80/20 process to accelerate this progress.

Please turn to Page 5. The Building HVAC segment had another strong quarter, with sales up 6% from the prior year and adjusted EBITDA up 15%. This was primarily driven by increased sales of heating products in North America, and of data center products in the U.K. It continues to be a strong heating season for us with strong growth and share gains in our gas unit heater products. There has been a strong demand for replacement unit heaters this year. We estimate that more than 70% of our heaters are sold as replacement units. We also gained market share, mostly due to our strong distribution partners and our superior product availability. As an example, our Hot Dawg brand of products, which are typically used in residential or light commercial applications are up 35% in the third quarter versus the prior year, whereas we believe the market to be up around 10% in this product category. We've been able to be successful keeping up with the increased demand, often providing next day shipping for these orders. The higher heating product sales also drove strong margin performance this quarter, with excellent conversion on the increased volume.

In data centers, our U.K. business is having an extremely good year with data center sales up 30% on a year-to-date basis. Third quarter sales were up slightly from the prior year, impacted by the timing of shipments with several orders pushed to the fourth quarter. Our focus within data centers for this business is on the colocation customers. These clients value and need our thermal expertise. As mentioned previously, we will leverage these relationships formed in the U.K. and the EU to establish our business in the North America market.

Please turn to Page 6. Sales in heavy-duty equipment, or HDE, were up 13% from the prior year, with higher sales to off-highway and truck customers in all regions as markets continue to stabilize. Adjusted EBITDA nearly doubled with a significant improvement in gross margin driven by volume increase, along with savings from procurement and other cost reduction initiatives. This was clearly a great quarter for our HDE segment, benefiting from a market improvement that was ahead of our expectations. We expect this trend to continue in the fourth quarter as many of our customers are building safety stock.

We continue to monitor a number of issues that may impact our raw material costs, including tariffs and the rollback of certain exclusions that we benefited from in the past. We are always working to improve our manufacturing and supply chain strategies, which have been complicated by geopolitical and economic trends, including tariffs. This will continue to be a focus as we analyze our risk and implement mitigation strategies. This is another excellent opportunity to use the 80/20 methodology to quickly drive improvement and focus in on our supply chain activities.

Please turn to Page 7, and I'll shift to the Automotive segment. Sales were down 3% on a constant currency basis, driven by lower market demand in North America, partially offset by higher sales in Asia. Adjusted EBITDA for the segment was $12.3 million, up significantly from the prior year, primarily due to the improved plant efficiency and the benefit of cost-saving measures. We expect further uncertainty in this market due to ongoing economic weakness. And in addition, we may be impacted by the current disruption to the auto industry, resulting from shortages of semiconductors.

We did not see a great deal of impact from this in the third quarter, but anticipate that it could start to impact volumes in Q4 as more and more automakers halt production due to chip shortages. As I mentioned before, we are diligently working on our exit strategy for this segment, including closing on the sale of liquid-cooled business that is still pending regulatory approval.

With that, I'll turn it over to Mick to review the total company financial results.

Thanks, Neil, and good morning, everyone. Please turn to Slide 8. I'm pleased to report a good third quarter and before walking through the underlying results, I'd like to review 2 large items that impacted our GAAP results this quarter. First, we recorded $134 million of impairment charges primarily related to the liquid-cooled Automotive business. As a result of our agreement to sell this business, we wrote down the associated assets. Upon closing, we would anticipate reporting a final and much smaller noncash loss on the sale. Also, connected to the third quarter impairment charges, we recorded valuation allowances on deferred tax assets in the U.S. and abroad. These were partially offset by tax benefits related to the impairment charges. The net tax impact of these items was $79 million.

In order to provide a true comparison, Slide 8 is focused on adjusted operating metrics. As usual, our appendix includes an itemized list of adjustments and a full reconciliation to our GAAP results. Third quarter adjustments totaled $139.1 million, mostly comprised of the noncash asset impairment I just reviewed. The remaining balance includes $3 million related to the automotive exit along with $1.7 million of restructuring activities, environmental charges and CEO transition costs.

Now shifting to the key metrics. Third quarter sales increased by $11 million or 2% as compared to the prior year. The increase was largely driven by favorable currency translation. I'm happy to report gross profit of $83 million, which was higher than the prior year by $9 million. Our gross margin once again exceeded 17% and improved 160 basis points. The higher margin was achieved through procurement, operational efficiencies and various spending reductions. As discussed last quarter, we ramped down our COVID savings during Q3, which is leading to more normalized costs and margins as we go forward. SG&A finished 12% or $7 million lower than the prior year. The largest reduction relates to lower automotive separation costs. We also benefited from permanent cost reductions executed late in the prior fiscal year, as well as temporary COVID-related cost savings. Despite the pandemic and challenging market conditions, adjusted EBITDA improved by $3 million, including a 40 basis point margin improvement. Our adjusted earnings per share of $0.41 was $0.04 or 11% higher than the prior year. Similar to the previous quarter, the improved Q3 financials reflect the hard work of all employees around the globe, lots of hard work, cost-cutting and dedication have resulted in higher earnings and margins during this very difficult operating environment.

Let's turn to Slide 9. In addition to the income statement improvements, I'm pleased to report year-to-date free cash flow of $123 million. This extraordinary performance was driven by a number of items, including operating cost reductions, reduced automotive exit spending, lower capital spending, CARES Act deferrals and effective working capital management. We continue to repay debt with excess cash, resulting in a leverage ratio of 1.9, which is our lowest level in 4 years. As we look to the full year, we expect free cash flow will be negative in Q4, due mostly to the timing of some large cash payments, including required pension contributions, higher capital spending and working capital. Again, I want to highlight that the cash flow and balance sheet position are key successes this year, allowing us to head into our strategic transformation with a strong and flexible financial position.

Now let's turn to Slide 10 with our fiscal 2021 outlook. After analyzing the incremental tailwinds and headwinds, we are maintaining our full year outlook. Our revenue guidance reflects a 7% to 12% decrease with adjusted EBITDA falling within a range of $155 million to $165 million. Although our markets are largely recovering from the pandemic, we continue to see pockets of softness as well as rising commodity metals prices and lingering tariff challenges. The recent trends in our Heavy Duty Equipment markets are very encouraging. With Automotive market, semiconductor shortages need to be closely monitored.

While holding the full year EBITDA guidance, we continue to see a dip in our Q4 margin due to a few transitory items, including tariffs and metal increases not yet passed through to our customers, a delayed ramp-up of CIS data center shipments to early fiscal '22, a complete phase out of COVID-recovery measures in Q4. Finally, our fiscal 2021 outlook includes the full scope of our Automotive business, including the liquid-cooled portion that is in the process of being sold. As discussed in the past, we'll continue to forecast and report the Auto segment results until the transaction closes or further actions trigger a change in the accounting treatment. Given that we're a March year-end company, the team is in the middle of annual planning. That said, I'd like to share some preliminary thoughts about the end markets and earnings drivers for the new year. First, we're encouraged about good market recoveries and tailwinds across nearly all of our business segments.

We anticipate very strong data center growth across the entire company. We also expect to benefit from the ongoing recovery in our commercial vehicle and off-highway markets. And for the broader CIS and Building HVAC markets, we see a slow, steady recovery through calendar '21. As we head into the new fiscal year, the volume increases will help to offset some economic headwinds that many companies are encountering. The largest impact will come from the rising commodity metals costs, plus new tariffs, and the resumption of employee-related costs to pre-COVID levels.

Last, and with regards to auto, we expect the transaction with Dana will close sometime in our fiscal first quarter. Like many companies, we've dealt with our fair share of COVID-related challenges. However, the results show the strong focus on cost savings and cash flow. We look forward to resuming and accelerating the growth opportunities that lie in front of us.

With that, Neil, I'll turn the call back to you.

Thanks, Mick. In conclusion, I would like to reiterate what an exciting time it is for Modine. With the introduction of the COVID-19 vaccine, we are on a road to recovery. But in the meantime, I'm so proud to be part of this organization that has been positively impacting people's lives during this difficult time. Since the pandemic began, our Building HVAC team has emphasized how important indoor ventilation is for school environments. Our school ventilation units can greatly improve indoor air quality, lower energy costs and help prevent the spread of pathogens in the air, clearly important objectives for our school districts around the country. Our HVAC systems clearly have a positive impact on people's lives from keeping schools safe to intelligent cooling and greener data centers. We will continue to invest in and grow these important product lines.

Lastly, I would like to say a final word about 80/20. As I mentioned, we are launching a pilot of the 80/20 process with our data center expansion and have developed goals and KPIs to allow us to track our progress. I believe that this pilot and future company-wide launches will have a positive impact on all of our key stakeholders and will become the future lifeblood of Modine. 80/20 will drive our decisions, and it will become part of who we are. Although we anticipate some early positive results, this is a journey that we'll be on for some time. And I'm even more confident than when I started that Modine has great potential. We will leverage the great legacy and culture to make this a truly great company. With that, we'll take your questions.

(Operator Instructions) Your first question is from Matt Summerville of D.A. Davidson.

Maybe just start with you mentioning tariffs a couple of times during the prepared remarks, rollbacks as well. Can you talk about how that's impacting Modine? What sort of financial impact we can expect in that regard? What the company can and will do to mitigate that? How much you ultimately feel you'll be able to recoup? And also that includes the recent escalation we've seen in input costs as well. So maybe just spend a few minutes parsing those things out, talking about how we should be thinking about that?

Yes. Matt, it's Mick. I'll give you some of the numbers behind it and what we're seeing, and then I'll let Neil wrap up with all the work he's been doing with the supply chain to address the mitigation efforts. So last year, as you know, we had some new tariffs come through. There were some tariffs put on stainless steel and products we had coming in from China. And we eventually were given exclusions on those, and those exclusions, some of those were expired and/or removed. And now we've got some exposure there on the stainless steel side.

Then late in the fall, there was a large anti-dumping tariff applied of 50-plus percent tariff on aluminum products coming in from Europe. And that's been another large impact to the company. In the quarter, we estimate that it's about a $2 million to $3 million impact in Q4. And through our mitigation efforts, we've got -- both on the supply chain and where we produce, where we import materials to and where we convert these materials to finished products, we have the mitigation efforts. We think next year that that's probably a $3 million type net headwind for us. Obviously, if you annualize the $2 million to $3 million in the quarter, that's a big annual number, but we've got a number of actions between switching suppliers. I mentioned bringing product into different Modine locations and also sharing relationships between our suppliers and our customers.

So I'll pause there and see, Neil, if you want to add anything from your side.

Yes. Good. Thanks, Mick. Matt, yes, that's a great question. This has certainly highlighted an area for us where we can improve our ability around our agility and flexibility with our operations footprint and our supply chain strategies. So we're actively looking at short-term and long-term countermeasures on how we're going to mitigate. And that ranges from shifting production to plants that aren't impacted by the tariffs to shipping equipment from plants based on demand as well as the impact of tariffs.

So this has really opened up an opportunity for us to look at our operations footprint, to look at our supply chain strategies and break that down by commodities. And come up with some very creative ways to mitigate this issue.

Got it. As a follow-up, maybe Neil, I'll spend a minute talking about kind of 80/20. And I know you've only been in place for about 2 months now, so it's still very early, but maybe just if you have some high-level observations in terms of maybe what you feel will be borne out of that effort in the near-term versus maybe the longer term? And what sort of external metrics you might be willing to provide us so we can sort of gauge your progress on the deployment of 80/20 and the segmentation process associated with it?

Yes. Very good question, Matt. 80/20 is a systematic way of examining the business and focusing its precious resources and I mean they're precious here. We run pretty lean on the highest growth opportunities while reducing complexity and improving the margins through product and market rationalization. And my early observations are we got to get a quick win. And I think our best opportunity -- I know our best opportunity after consulting with a leadership organization here is on the data center side. There's just some things that we can do right out of the gate that make a lot of sense, not only externally, but internally, so that we can get to drive accountability into the teams, and we can give them what they need to win, and they're very much commercial and focused with our customers. And it's pretty early in the process, to your point. We're working through what those KPIs will look like. I'm excited to say that we've got some consulting that's coming in next week that's going to help us with this journey to accelerate it. There's no need to move at a slow pace here with the data centers. I think we can accelerate that. And from that over the next, I'd say, 30 days when we get through the data analytics, we're going to be able to come up with some pretty strong KPIs in terms of what we expect to achieve.

Your next question is from Michael Shlisky of Colliers Securities.

Great job reducing the leverage over the last, well, couple of years really, but this quarter in particular. Give us a sense, like, what is the company's current kind of comfort level on what you'd like the leverage to be and how much would you leverage up for a decent-size M&A deal should 1 present itself?

Great question. And more fun questions. Yes. So we've been out for quite a while talking about keeping Modine, especially when we were 80% vehicular, a leverage ratio of 1.5 to 2.5x, my hope, by the way of one of our longer-term outcomes is being more diversified industrial, less capital intensive, that we might be able to look at debt in a slightly different way. But the good news is, if we've got market tailwinds, we exit auto, we're quickly going to have a leverage ratio that is already heading towards the low end of our range.

So I think, Mike, one thing Neil mentioned, he's quickly accelerated our focus and asked me to do a lot of work on acquisition funnels and target. So that's one thing into your question. We've got capability within our credit agreements to do 3, 3.25 leverage and no problems there. And we did that with Luvata, if you could recall. So I think every situation is different, but I would say we can do 3, 3.25x leverage. And as long as we've got a good integration synergy plan to quickly pay it down.

Got you. Maybe another question I can bring up quickly here is, I was wondering if you could give just a quick update on anything that you're doing in the EV world. We are seeing some EV truck platforms actually coming to market, small volumes, but they're starting in 2021. You've already mentioned buses. There's actually 1 bus company going public this year, at least 1 bus company going public. Just give us your sense as to what you maybe have won? And kind of how you feel about your chances of putting [not according] to technologies or other products on those kind of vehicles going forward?

Yes. Mike, I think I talked about this a little bit last quarter, and then Neil has completely jumped in with our HDE team. And as we think about 80/20 as well, the opportunities, as you know, on electrification in truck is growing quite quickly. The amount of inbound calls and the amount of development activities we have going on has really grown quite a bit. We're working with a number of mainstream companies, none of which we can really talk about in a public forum, as you can imagine, plus a number of emerging and start-up companies, and the big success we've seen there are in production, orders, development, production on specialty vehicle and bus. The truck development cycles are quickly right behind there. And then we're also doing a lot of evaluating of what other last mile vehicles, right, will be the quickest or most logical to implement from an EV status.

Neil, do you want to add anything from your view?

Yes. No, that's a great question, and this is a very exciting area, not only for Modine, but for myself. I've spent a little bit of time here in Racine, especially in the tech center. And as I go back into the tech center, I look at where we're at, and we're at an all-time high relative to EV, commercial vehicle and bus activity with our prototypes. And the team has generated some pretty substantial wins in terms of early development for programs.

And this EV activity is extremely exciting for me because it's just not component-related, it's system-related. And that's a new chapter for us at Modine in driving value and improving the value with our propositions to customers with a system-related response to solving thermal challenges in the EV section, especially with commercial vehicle and bus. So it's a great area. We're going to have some focus on that -- in that area. And the team has done a pretty good job in terms of getting out the prototypes in a timely way so that we can get some wins.

Your next question is from Brian Sponheimer of Gabelli Funds.

And welcome certainly to Neil. Neil, just a question for you. Taking a step back to when this courtship began. What was it about Modine that attracted you from the beginning and now 2 months in, anything that confirms or disconfirms to your additional impression of the company?

Only positive confirmations.

Good.

No doubt about it. Yes, no regrets at all. This has been great. My early observations in the journey, as I worked with Modine, particularly the leadership and the Board was it's an environment that's ready to evolve and change. And the best foot was put forward with the transaction and the divestiture that we're working through with Dana, and that speaks volumes in actions, right? There's a culture that's dedicated and motivated to turn the corner, and that's exciting to me. And there's very strong innovative product technologies. That was an absolute draw coming from highly engineered diversified background. That is something that in order to be successful, you have to be innovative and creative. And I see pockets of that in Modine that we just need to untap. It has a rich legacy and a strong brand. And we're going to continue to identify those target opportunities inside Modine to support the transformation. So to me, to be part of that change was pretty exciting, it drew me. Not only the team and the culture and the rich legacy of Modine and its brand, but that transformational piece, to be part of that, that was very enticing.

Yes. I guess, along the same lines, what do you think your mandate is from the Board and from the shareholders?

Drive the transformation of Modine, continue to do that and do that in a productive way while we maintain and respect the legacy of the company.

Great. Well, I look forward to eventually getting out to Racine to see you and maybe in the parking lot. But I will -- we wish you the best, and I look forward to seeing what the next few years bring.

Your next question comes from Steve Ferazani of Sidoti & Company.

You've talked about the adding of data center capacity in the U.S. and Spain on a previous call. Just trying to get a sense of the timing on that, where the -- where you are in expanding that capacity? And is that part of the higher CapEx in Q4?

Yes. Steve, it's Mick. No, I think Q4 will be just kind of across the board that's been with plant shutdowns, people working remote. There's just a general backlog of some things we need to get done as the world starts to open up.

And then with regards to the expansion for CIS in Spain, we'll be up and running in our Q4, which is great on computer room air handlers our [crawl] units.

And in the chiller side in the U.S., that will be second half of our fiscal year, where we'll be in production from that side. Total capital spending is another nice thing I like about this side of our business is -- relatively speaking, these are not large capital investments for us. Large capital, in total, these are probably kind of $5 million, give or take, compared to one automotive program, which can be $5 million to $10 million just to launch one -- with one customer.

So we're really excited about it. And the footprints there, by the way, again, these are 2 existing facilities with proven management team. So another reason why the capital isn't overly large as we're leveraging existing footprint in teams and employees that are quite capable to make these more complicated systems, as Neil pointed out. Neil, anything?

No. I think you added the fact that we're in North America as well expanding the footprint. Not only in Spain, but in North America as well. So that's great. Good question.

And I just wanted to follow-up on the expectation on higher metal prices and the impact. Did you -- and I just want to clarify this. Did you say that those higher metal prices didn't impact the P&L in the quarter you just reported. And then the flip side of the question would be what's the efforts to mitigate higher prices if we remain elevated for a while in terms of price resets with contracted customers or pass-throughs?

Yes, really good question and good clarifying for us. So my -- when I answered a little earlier, that was specific to tariffs. The other, I'd say, challenge inflationary issue is going to -- that's going on as the world looks past COVID is the rapid rise of commodity metals. Everybody has seen copper, aluminum, steel. And for us, we're heavy users of copper and aluminum, a little bit of steel. And in the quarter, we had a net year-over-year negative impact, pretty small for us. It's only about $2 million. The run really began in the metals since October. We've seen kind of almost a 20% increase. If you look at next year, average, if things hold or stay where the markets expect them to be with metals, we'll see about a 20% increase on average in raw materials.

In Q4, we expect to start to see the biggest impact the next couple of quarters. As a reminder, we have a lag. We do have pass-through. So on CIS, that business segment is much more real-time as we pass-through each bid spec program, we use current material costs. Building HVAC, much the same way, more real-time pricing to current market conditions.

So then we're down to HDE, which has the long-term agreements with the large OEs. Just about every customer has a pass-through agreement. And then the difference is really the -- how they work, the lag or the timing impact of that. And we tend to think about -- on average, it is about 6 months on the HDE side. So Q4 here for us, Q1, [too] will be catching up about $6 million. So I'm estimating impact in our Q4. And next year in total, probably -- again, if things stay, anything can happen in the metals markets, but at least probably a $10 million or $12 million metal headwind as we try to pass through these prices and eventually catch up to the metals market. That would be in addition to the tariff numbers I mentioned earlier. Neil?

Yes. And I think that's a great explanation in terms of how we're maintaining the margins with the increase in metals. But in order to maintain the material velocity, we've also added safety stock, and we've added safety lead times. We've executed on advanced bookings, and we're redirecting some sea freight to less congested ports to prevent disruption. So it's not only on the margin side, but we have a lot of activity in order to maintain on-time delivery and lead times across the facilities.

We have Matt Summerville from D.A. Davidson return to the queue.

Yes. In the past, you've talked about the revenue associated with this large data center customer. I'm sort of eyeballing a $30 million kind of revenue number from that customer in fiscal '21. First, is that accurate?

And then second, Mick, you've talked in the past about how you expect that to ramp in fiscal '22. What's your current read or current update on where you think that number goes next year?

Yes. A good question. The CIS has really 2 pieces. Again, for everybody making 1 step back to also Neil's comments earlier, we -- last year, we had about $40 million of data center business in Building HVAC. That is primarily U.K. systems, great margin business, right? We want to do more of that and that's what we're also expanding globally when we mentioned Spain and North America. When we acquired Luvata, there were 2 pieces. And probably, on average, about evenly mixed. There's about $40 million of coils that we sell heat exchangers into the data center market. And we had one major hyperscale customer of about kind of equal size. So we've run in data centers in CIS in that $60 million, $80 million kind of range.

This year, as we go forward and what you're picking up is mostly this year, our biggest sales will be that $30 million, $40 million worth of heat exchangers that we sell into the data center market to multiple customers. And the large hyperscale customer over the last year has really declined a pretty -- in this quarter, next quarter, very nominal level. They're in the middle of a technology transition. So much lower. I can't disclose exact numbers, Matt, for you. But again, about, think of it as $30 million to $40 million of heat exchangers, coil sold to multiple data center customers plus our 1 hyperscale customer. In this year in total, sales will be very, very small.

And then I think you asked about the ramp-up, and Neil talked about it. They have their building, their construction schedules, their site selected. We actually have completed all of our technology testing, and this is a very complicated new proprietary system for this customer. And we're very encouraged and optimistic and have a good line of sight to the ramp-up in '21 here for the new sites.

We would expect them to get back to a normal level this year as we start to ramp that up. One or 2 years into Luvata, after we acquired them, we saw really big growth. We almost kind of doubled in sales that's hard to stay beyond that point, I'd say. So short run, we see this customer getting back to an average, a normal run rate for them. And then beyond that, whether there's upside to hit a high water mark, too early to tell. But nonetheless, really good opportunity here for us in the new year to have the new launch starts. Neil, do you want to add anything?

No, I think you covered it really well, Mick. Like in any industry, when there's lots of capital deployment, there's a digestion period, right? And we're seeing some digestion periods. And looking at alternative spends, the alternative spends have been in the colos. And the good news for us in Modine is we have products and services and offerings in both either colocation or with hyperscale. So depending on where they spend and how they deploy their capital, we're in a good position to where we can win in both avenues.

Got it. And then just 1 follow-up on M&A. How long do you think it will take Modine to develop a pipeline to start to cultivate deals? And is there anything you would characterize as actionable in the pipeline currently? Or is this sort of still very early innings in that process? Is it going to take the better part of, say, the next 6 to 12 months to get anything done?

Well, I'd tell you, my new boss is pushing hard. So there is -- I would say, we do have a pipeline. We've been maintaining a good pipeline and there are actionable opportunities to me, and then I'll pause and let Neil answer. I think making sure we get through first digesting 80/20 to ensure we're not pursuing something just transactionally, but it's filling a strategic need is where we want to go. Once we start going, as everybody knows, it's the multi-month all-encompassing project plus the integration.

So personally, I'd like to make sure we go after the most important and what Neil is asking us to put together is think of it as a scorecard and a force ranking. What's in the pipeline was actionable, but then how do we force rank them.

Yes. And I think Mick and the team has done a really good job in terms of thinking through exactly that. And then we want to overlay that with a filter, right, a strategic filter in terms of where we want to go with our acquisition strategies. Does it fulfill a strategic initiative? Does it fulfill strategic need? Is it backwards, forward or sideways integration? What are the opportunities for us? As they hit a certain profile, we'll have a different type of profile for the -- for our targets. And then we'll monitor the milestone process as a check through the filters, and that's exactly the system, the rigor and the discipline behind that that Mick and his team are starting to put together. And then 80/20 will be a very good lens for us to start to introduce some potential candidates inside of that filter.

I am showing there's no further questions in the queue. I'd like to turn the call back to Neil for any closing remarks.

Yes. One last comment. I'd like to recognize Mick for his leadership as the interim CEO. Mick did a great job stabilizing the company and preparing the organization for change. His efforts have allowed for a very smooth onboarding and transition for me, and I thank Mick for his commitment to Modine.

Thank you, Neil. And thanks, everybody, on the line for joining us this morning. A replay of the call will be available from our website in about 2 hours. We hope everybody has a great day. Thanks.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.