Modine Manufacturing Company (MOD) Q2 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Modine Manufacturing Company's Second Quarter Fiscal 2018 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and information will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Kathy Powers, Vice President, Treasurer, Investor Relations and Tax.

Thank you. Thank you for joining us today for Modine's Second Quarter Fiscal 2018 Earnings Call. With me today are Modine's President and CEO, Tom Burke; and Mick Lucareli, our Vice President of Finance and Chief Financial Officer. We will be using slides with today's presentation. Those links are available through both the webcast link as well as the PDF file posted on both the webcast link as well as a PDF file posted on the Investor Relations section of our company Web site, modine.com. Also should you need to exit the call prior to its conclusion, a replay will be available through our Web site beginning approximately two hours after the call concludes. On Slide 2 is an outline for today's call. Tom and Mick will provide comments on our second quarter results and review our revenue and earnings guidance for fiscal '18. At the end of the call, there will be a question-and-answer session. On Slide 3 is our notice regarding forward-looking statements. I want to remind you that 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's my pleasure to turn the call over to Tom Burke.

Thank you, Kathy, and good morning, everyone. On today’s call, I will discuss our second quarter results including an update on our business segments and strategic initiatives. After that, Mick will provide a more detailed review of our consolidated financial results and will update our revenue and earnings guidance for fiscal '18. I will then provide a few closing remarks prior to opening up the call for questions. I’m pleased to report another strong quarter with significant sales and earnings improvements driven by growth across all of our business segments, including a significant contribution from the CIS segment that we acquired last year. In addition to significant sales growth, each business segment observed gross margin expansion in the second quarter led by higher volumes and operating performance. Overall, sales increased 60% including $149 million of sales from our CIS business in the quarter. Our non-CIS business grew 11% on a constant currency basis with increases reported in each of our segments. This growth was fueled by improvements in many of our key end markets along with continued launch activity for automotive programs in the Americas and Asia segments. Our adjusted operating income was $26.8 million, up $22.4 million from the prior year. Each segment reported year-over-year improvements in earnings and the CIS business contributed $8.1 million of operating income during the quarter. Our adjusted earnings per share were $0.36 for the quarter, a $0.37 improvement from the prior year primarily due to higher operating earnings partially offset by higher interest expense from the debt taken on to finance the Luvata acquisition. Now I would like to briefly review the segment results for the second quarter. Turn to Page 6. Sales for the Americas segment increased 12% on a constant currency basis to $141.9 million, driven by in-market improvements in both North America and Brazil. In North America, we saw sales increases across all end markets with substantial increases in off-highway and specialty vehicle sales. We’re also benefitting from ramp-up volumes on new automotive programs. In Brazil, we are seeing continued improvements in our markets with the recovery in our aftermarket business and higher commercial vehicle sales. Gross margin improved 260 basis points to 15.2%. This is driven by the higher sales volumes and improved performance, partially offset by the impact of higher material costs. Adjusted operating income for the Americas segment was $8.6 million, an increase of $6.5 million from the prior year driven by the higher sales volume and lower SG&A expense. We continue to be very encouraged by the improving markets in North America and Brazil. In addition, I am particularly pleased with our strong sales conversion this quarter as higher volume and production efficiency improvements led to a considerable gross margin expansion. However, as I mentioned last quarter, the global commercial vehicle powertrain cooling business has become increasingly competitive, and in some cases the investment required to launch these programs did not meet our return on capital expectations. Our capital allocation discipline, which has been further honed by our strengthen, diversify and grow strategic initiatives, is driving our focus for improved returns in our new business pursuits. As a result, we do expect to see some lower volumes in our North America commercial vehicle business during the second half of the fiscal year as certain powertrain cooling and service programs begin to wind down. With our new diversified business structure, we will continue to be selective with our choices supporting programs and markets provide an acceptable return on the use of our capital. This improved discipline in our capital allocation strategy is aimed directly at yielding the highest possible return for our shareholders. Please turn to Page 7. Sales for our Europe segment increased 3% on a constant currency basis to $134.5 million, primarily driven by higher sales to automotive and off-highway customers. This was partially offset by lower sales to commercial vehicle customers as certain programs continue to wind down as we’ve announced in prior calls. Gross margin increased 130 basis points to 14.5%. The increase in margin is due to improved plant performance, procurement savings and higher sales volume. Higher gross profit led to a $3.1 million increase in adjusted operating income which was $8.9 million in the quarter. Additionally, the construction of our new production facility in Hungary is nearly complete. We have begun equipment installation and will commence process validation and production next month. The additional capacity in Hungary is an important step in our growth strategy and will further enhance our already competitive global footprint. We continue to see a great deal of quote activity for our electric vehicle programs in Europe with the significant number of RFQs in process with several European manufacturers. Please turn to Page 8. Our Asia segment continued to lead our vehicular segments in both sales growth and gross margin. Overall, Asia sales grew 60% compared to the prior year. This significant improvement was driven by stronger sales to off-highway customers in China, India and Korea along with higher automotive and commercial vehicle sales in China and India. Higher sales volume led to a 400-basis point improvement in gross margin which at 18.9% leads our vehicular segments. This resulted in doubling of our gross profit from $3.7 million last year to $7.4 million this year. Operating income for the Asia segment increased $3.4 million to 4.2 million, due to the higher sales volume. As I mentioned in the past, our strong growth in Asia over the past year has challenged our capacity in the region. This has been a direct result of the growth of our automotive oil cooler business which has seen growing market share as well as recovery of excavator market sales across Asia. We will need additional capacity in China to meet the demands of our current order book and the needs of our incremental business and growth strategies. We’re planning a fourth manufacturing facility to support our vehicular segment in China. This is a great example of how we are strategically allocating our capital to where we expect to deliver the highest return for our shareholders. Turning to Page 9. The CIS segment reported $149.2 million in sales. Gross profit was $22.5 million, which resulted in the gross margin of 15.1%. This segment reported operating income of $8.1 million. As a reminder, this includes $3.2 million in depreciation and amortization expense recorded as a result of purchase accounting split equally between cost of sales and SG&A. We are confident that our synergy savings will offset these costs and bring the segment back to historical operating margins. The markets we serve in our CIS segment are generally stable with positive growth projected for the rest of the fiscal year. There are some opportunities for additional growth in the precision cooling market as demand for new data center capacity in the U.S. continues to grow with one of our major customers. In addition, the recent major weather events in the South have increased demand for mobile air conditioning and dehumidification, which could drive additional demand for our products. In China, the transformer oil cooler growth market remains robust driven by increased infrastructure investment. In addition, we are well on our way to achieving our synergy goals ahead of our initial timeline. Our current focus is on our global manufacturing footprint where we are evaluating expansion with current low cost country presence. Please turn to Page 10. Sales for our building HVAC segment increased 7% compared with the prior year with improvements in heating and ventilation partially offset by lower air conditioning sales. We continue to see strong sales of school products which nearly doubled from the prior year. Gross profit increased 26% and gross margin improved by 470 basis points to 30.5%. This along with a slight decrease in SG&A resulted in adjusted operating income of 6.3 million, more than double that of the prior year. This improvement is largely due to improved pricing and better performance in the UK. As you may recall, our UK business struggled last year with sales mixed issues and operational inefficiencies. We took several actions to correct these issues and now seeing the positive results. This is the second consecutive quarter where operating earnings have more than doubled resulting from the cost saving and operational improvements made last year. In addition, our order book remains strong. We have seen good demand for our ventilation products in North America and are encouraged to see pre-seasonal stocking orders for the heating products up over the prior year. In the UK, we are seeing solid demand for precision air conditioning and air handlers and expect growth in these markets in the second half of this year. Please turn to Page 11. It’s been two years since we first announced our strengthen, diversify and grow strategy along with our initial objectives and I am very pleased with the results. Modine is now a more diversified business that has seen significant top line growth along with improved earnings and cash flow. Although the initial goals of that program have largely been met, our strategic focus has not changed. We are continuing to look for ways to strengthen, diversify and grow now and in the future. As I’ve shared in the past, our main operational focus for this year is to resolve our remaining operational inefficiencies in North America and UK, complete the integration of the CIS business, meet or exceed our synergy targets and generate cash to repay the acquisition debt. I’m pleased to report that we are well on our way to achieving all of these goals. In addition to these operational goals, we have also set some strategic goals for ourselves to make sure that we are thinking ahead and determine how we can best continue to provide profitable growth. This review is focused on creating a disciplined framework to analyze our business portfolio and to better understand how to prioritize our capital resources in order to continue to create value for our shareholders. Some examples of this strategy include the investments in additional capacity in China and our focus on electric vehicles. We know that our customers are making electric vehicles as a development priority. We understand these vehicles have different thermal management needs than internal combustion engines. Some of these needs can be met with products that are very similar to those we’ve already produced, particularly with our plate-type or engine-based products. In addition, there is also the opportunity for us to add adjacencies for our product offering such as battery-plate cooling. This new product platform from Modine – this would be a new product platform from Modine and would take a balanced prudent approach to our investments around this technology as the market continues to develop. We consider this our next phase of our strengthen, diversify and grow strategic initiative which will guide our actions over the coming years. This is a great opportunity for Modine as our stronger profitability in market diversification makes us truly a diversified industrial company. With that, I'd like to turn it over to Mick for an overview of our consolidated financial results. Mick will also update our revenue and earnings guidance for fiscal '18.

Thanks, Tom. Good morning, everyone. Please turn to Slide 13. We are extremely pleased with the results this quarter with year-over-year sales and earnings improvement in each segment. In particular, we benefitted from favorable volumes on the vehicular side and strong margin improvement in building HVAC. Beginning with the top line, sales increased 183 million or 58% on a constant currency basis. Sales in our new CIS segment totaled 149 million. Excluding CIS, constant currency sales were up 34 million or 11% year-over-year. Gross profit of 86.1 million was up 38 million or nearly 80%. This includes 22.5 million from CIS. Excluding CIS, gross profit was up 15.6 million or 32%. As Tom mentioned, this improvement was driven by all of our segments from higher sales volume and operational improvements. SG&A of 62.2 million was up 14 million. The year-over-year increase is primarily due to the addition of CIS. Please note that at the bottom of the page, we’ve included a table with adjustments to operating income. In total, adjustments were 3.3 million for the quarter. We added back 2.2 million of acquisition-related items. The remaining 1.1 million is for restructuring and environmental expenses relating to plant closures. Second quarter adjusted operating income of 26.8 million was up 22.4 million and our adjusted earnings per share was $0.36, an improvement of $0.37 compared to last year. As discussed last quarter, EPS was positively impacted by the tax benefit from the development credit in Hungary. As a reminder, our U.S. GAAP income statement is included in the appendix of this presentation and in our earnings release. In addition, we provide a full reconciliation between our reported results and our adjusted operating results. So let’s turn to Slide 14. Year-to-date, operating cash flow was 71.1 million, which is 57.5 million higher than the prior year. The year-over-year increase was due to the combination of several items including favorable changes in working capital, the inclusion of CIS this year and higher earnings in all our segments. Capital expenditures were above the prior year by 4.8 million and we expect CapEx for the full year to be 65 million to 70 million. This is slightly higher than the last year and primarily due to foreign exchange rate changes and capital spending in our new CIS segment. We reported year-to-date free cash flow of 34.3 million which was better than the prior year by 52.7 million. Please note that this does include 15.5 million of cash payments for restructuring activities, legal and environmental charges along with acquisition and integration costs. For the second quarter, free cash flow was 37.2 million, an increase of 42.7 million over the prior year, and this includes 3.6 million of cash payments for the areas I just described. Finally, our debt leverage ratio is currently 2.6, down from 2.9 at the end of fiscal '17. This is well below our current covenant ratio requirement of 3.75. With the addition to CIS in the strong first half performance, we continue to anticipate much improved cash flow in fiscal '18. We remain focused on paying down our debt and getting our leverage ratio below 2.5 by the end of this fiscal year. Now let’s turn to fiscal '18 guidance on Slide 15. We are happy with our second quarter results and excited to report we are raising our fiscal 2018 sales and earnings guidance. To summarize, we project sales to be up 32% to 36% from the prior year, an increase from the previous range of 25% to 30%. We expect our top line will continue to benefit from automotive growth in Asia and improvements in the global off-highway markets. We also anticipate more favorable exchange rates than last quarter as the euro and British pound is strengthened against the U.S. dollar. We expect adjusted operating income to be in the range of 107 million to 117 million, an increase from the previous guidance of 100 million to 110 million. We currently expect an increase of 48% to 62% compared to the prior year. We anticipate adjusted EBITDA to be in the range of 182 million to 192 million, up from 175 million to 185 million. Our current expectation equates to an increase of more than 46% over the prior year. As usual, I want to briefly review some of our key assumptions. First, our guidance includes planned wind downs with certain commercial vehicle programs in Europe and North America. As a result, forecasted sales may not fully align with the overall commercial vehicle market growth. Next, we anticipate that copper and aluminum will hold at current levels which are about 20% and 25% higher than last year. With the additional increases over the last few months, we are watching and managing this area closely. Third, we expect the U.S. dollar will hold at current levels versus most major currencies. Lastly, we assume annual interest expense of approximately 26 million. Moving on, we expect our adjusted EPS to be between $1.30 and $1.45, which is up from $1.20 to $1.35 and up significantly from $0.78 in fiscal 2017. This includes the impact of the Hungarian development tax credit and a resulting adjusted tax rate of approximately 12% to 14% in fiscal 2018. Finally, I would like to cover several important factors with regards to our increase in guidance and the second half run rate. First, the significant portion of our additional revenue relates to currency translation and materials pricing adjustments which have minimal conversion. The volume portion of our revenue increase does include normal profit conversion and we have increased our outlook accordingly. Offsetting a portion of the volume is the additional increase in metals, up approximately 15% since last quarter and a significant mix effect relating to the loss of some commercial vehicle service business. In addition, given the strengthening of our business, we expect some limited SG&A increases. Consistent with last quarter’s comments, we expect the next two quarters to proceed at a similar run rate to our second quarter. And lastly, our year-over-year comparables will become more normalized in the fourth quarter as CIS results will be included in both years. So just to summarize, we have adjusted for the positive impact of exchange rates and volume in certain markets while also factoring the additional metals increase and reduction in commercial vehicle service business. Our employees have made excellent progress during the first six months while taking advantage of the market tailwinds and we’re excited about the opportunities ahead and look forward to further improvements in our business. Tom?

Thanks, Mick. As Mick outlined, our performance this year is clearly exceeding our initial expectations. This is in large part due to improving markets but is equally the result of the actions taken in the past to ensure our future success. As we near the one-year anniversary of the Luvata acquisition, I would like to look back on some of the actions we have taken that positively impacted our quarter and fiscal year so far. Clearly, the addition of the CIS business has been an incredible success with significant accretion to our bottom line. In our vehicular business, the investments made in China have led to tremendous growth, so much so that we’re running out of capacity and eyeing opportunities for expansion. In our building HVAC segment, I am pleased that we have returned to growth and are seeing margins that are closer to historical levels. This is a direct result of the actions taken to improve this business, particularly in UK. Over the past few years, Mick and I have often discussed the earnings potential of this business if only we’d see some improvements across our markets. We’re now seeing the strength of that potential in our results, while positioning ourselves as a more diversified industry company. This is truly an exciting time to be a shareholder at Modine and I’m thankful for your ongoing support and excited for our future. With that, we’ll take your questions.

[Operator Instructions]. Our first question comes from Mike Shlisky from Seaport Global. Mike, your line is now open.

Good morning, everybody. Can you hear me okay?

We hear you fine, Mike. Good morning.

Okay, great. Want to start off with a question about Asia; interesting quarter here. It looks like that’s really gone from kind of last place to first place over the last 12 to 18 months. I guess I’m kind of curious about the potential for expansion of capacity in Asia. And the new business that could be on the way for you guys, I guess I’m curious as to kind of what’s your benchmark operating margin rate for that business or gross margin rate. Are you looking at trying to keep the EBITDA at double digits here going forward? And what’s the timeframe for any of kind of CapEx or spending that you might have taken in Asia over the next couple of years here?

Mike, it’s Mick. I’ll go first and then Tom can add his comments. But yes, we’re very, very pleased with both the gross profit margin and operating margin in Asia. I think as we go forward, what we’re modeling and we would hold ourselves to is holding at similar margins somewhere between the 18% and 20% gross margin range and we’d be quite happy with a 10% operating margin. And with regards to capital spending and CapEx, the majority of that will just continue to be on equipment and tooling to support the new business. The expansion that Tom referenced is really within – we’re looking to be within an existing campus and looking at more to leasing the square footage than major greenfield plant expansion.

Mike, I just came back from China. I was there last week. I visited each of our VTS businesses and one of our new CIS businesses and I can tell you I’m very excited with what’s happening there. The team has matured extremely well. This has been well groomed over the years to get to this position of getting the rate not only products there but talent in place, leadership in place and it’s clicking on all cylinders right now with the expansion for growth both with multinationals and domestic OEs looking very strong. And on the CIS business, which is kind of new to us as far as China, I’m very pleased with what we have done there as far as really supporting infrastructure gains that are focused on China specifically and elsewhere. So I expect the Asia segment in both the VTS and the CIS business to be very big contributors going forward.

Okay, got it. Wanted to turn quickly to building HVAC as well, again, also very strong margin growth there obviously year-over-year and I’m kind of curious can you achieve the double-digit range going into the next couple of quarters here, or can you give us some sense with all the cost reductions and changes in strategy and changes in facility kind of what – is there a different seasonality now than you’ve had in the past to kind of near to mid-term outlook there as well? Thanks.

Okay, great question. First up, it starts with the leadership changes we made in the UK specifically really getting to understand the market connection as far as channels to market and getting the order book set up the right way, which is strong insight to business. They made all the right decisions on streamlining, as necessary, to get the cost in line and that’s starting to pay off as well. Looking forward to growth, they’re all great segments that we’re participating in, whether it’s precision, ventilation, heating, air conditioning and we added ventilation product line that we’re adding to North America with the [indiscernible] product line. We’re launching the new D cabinet as we speak this month which we really think will broaden that out. So I see, again, the opportunity for growth in this segment and making sure that this segment gets its fair share of capital to take advantage of that in a market that’s something I’m really excited about as well.

Great. And finally I want to turn to the Americas segment and the changes you’ve made in your portfolio business because of the truck market. It looks like you walked away from some business and that’s in line with what you’ve been talking about for a couple of years now which just doesn’t meet your goals, you’re just going to kind of walk away here. I’m curious about two things. One, did somebody else win this business and that might have been smaller than you. They just wanted to kind of get the bookings. And do you stand ready to kind of step in if they can’t deliver? And then kind of secondly, is this one of the first of what could be several different program wind downs but there are other market share gains as other new platforms kind of ramp up in 2018, 2019?

Well, first, let me say we are not walking away from the commercial vehicle business, okay? One element of that business being a powertrain cooling segment is in the heavy-duty section or market sub-segment is kind of the challenging moment and I just want to say the VTS growth opportunities across all of our products end markets I’m very pleased with, this happens to be the one challenging element in the heavy-duty PTC area. I’ll remind you that that’s about 7% of our total sales and if I take the engine product out of that, that’s about half that. And again, we’re about a 30% global market share on the engine product inside of the commercial vehicle program. So again, commercial vehicle very important to Modine. Specifically on PTC, with diversification and growth plans that we laid with the acquisition of CIS and with the focus we’ve had on BTS in building HVAC, we have lots of options as far as making sure we invest our capital in a disciplined manner to return rates that meet our expectations. And that’s kind of the key point. We aren’t going to chase market share for the sake of market share. Let me just be clear about that. We’re going to make sure that investment is growing to accrete our business accordingly to our expectations. So again, we’re not walking away from commercial vehicle. We are reprioritizing our portfolio inside of that specifically heavy-duty PTC. As far as new entrants or whatever, I don’t really have a comment on that. I think that clearly there’s competitors we know well that are focused on that area and quite frankly we made decisions on where we’re going to stop at our quoting thresholds and we’re going to hold that discipline for the benefit of our shareholders.

That’s great color, Tom. Thank you so much. I’ll pass it on.

Your next question comes from the line of Matthew Paige from Gabelli. Matthew, your line is now open.

Good morning and congratulations on another solid quarter.

Thank you, Matthew.

We had spoken in the past about your view on leverage and you mentioned it today. I guess just given the strong stock performance of late, I just wanted to ask for your thoughts on alternative sources to finance what you had perceived to be a lack of margin of safety in your finances?

Yes, can you repeat the first part of your question? You said “the one.”

No. I just thought given where we had been in the stock price and the strong movement lately, I was just curious what your thoughts were on financing options?

Yes, great. It’s Mick. So we are quite pleased to see the stock moving up and reflecting, as Tom said, all the hard work we did. We’ve been so focused on since the Luvata acquisition about driving cash flow and ensuring we get our leverage ratio back to that 2.5x range. So the strong cash flow this quarter, the strong results and the raise in the guidance and the current ratio sitting about 2.6, we feel really good about our capital structure. I think especially on the debt side, we got favorable borrowing rates and we feel really good about the leverage ratio and cash flow. With regards to any type of equity raise, Tom and I talked a lot about that. I think that would have to be tied to something very specific and a very large project before we would think about any type of equity raise.

All right, great. That’s all the questions I have for this morning. Thank you.

[Operator Instructions]. Our next question comes from the line of David Leiker from Baird. David, your line is now open.

Hi. Good morning. This is Joe Vruwink for David.

Hi, Joe.

Hi, Joe.

I wanted to start, can you maybe size the magnitude of the program exits in North America in the second half, and then if you could maybe the profit implication?

Joe, It’s Mick. I’ll kind of ballpark the volume size, but will prefer not to comment on the – I’ll give you some color potentially on margins. So we said through the year on European, just to be clear on that, we have been talking about somewhere between €25 million and €30 million of the commercial vehicle related there to the Origami radiator business. In the North American side we’re looking at approximately $10 million this year. That’s a combination of heavy-duty OE business and service and there’s oaks [ph] in there. As Tom mentioned on the OE production business, clearly more challenged from a returns standpoint. Service business historically has always been across the market, across the distribution channel a relatively higher margin, less capital intensive profile.

Okay. And it sounds like 10 million beginning in the second half, so presumably – focusing in on North America for now, so presumably is first half of next fiscal year you probably grandfather that?

Yes, there’s – still a little early but looking into next year, it’s probably a similar level for fiscal '19.

Okay. On the materials side, what is the headwind now contemplated in guidance? And can you maybe just update us on where that number stood in June when you first issued guidance for the fiscal year?

Yes, we were – when we talked earlier in the year and last quarter, we were estimating 15 million to 20 million of material cost increases. I think that range still holds but we’ve moved from that low end to the high end. Incrementally, Joe, I think from last quarter to this quarter we’re looking at, at least 3 million to 4 million I would say of increased metals and that’s really due to the timing with the spike in the last quarter, again will catch it up, but we’ll start to catch that next fiscal year or late in our Q4.

So where I’m going was I think at the midpoint, revenue guidance moved up round numbers, about $100 million at the midpoint, EBIT moved up I think about $7 million. Maybe I can add back material headwinds that sounds like, maybe that’s 5 million. There’s obviously some volume implication to consider. But when Modine thinks about “normal” contribution margins for the organic piece of the business, is that more like a 15% to 20% number at the EBIT line? And as you think into next year given you have some plan actions in place, [indiscernible] continues to contribute savings. Is 15 to 20 kind of the new status quo going forward or could you actually operate above that when thinking about Luvata synergies and things like that?

Yes, great question, Joe, and a lot of questions in there.

Sorry.

No, this is important that we are clear in the communication. When we target volume conversions, we still stand behind 25% gross margin conversions while we expect to see all else equal. One of the challenges we see – and again, if you just do the midpoint, clearly our business – we try to give you guys ranges [indiscernible] point. We don’t at all – line numbers don’t line up right now the midpoint but I get your question. If you take the increase in revenue and the operating income of 7 million at the midpoint, at least 40% or so of that revenue increase is, as you mentioned, FX and metals that isn’t volume. So we’re not going to convert on that. But even taking a 25% conversion then on a smaller number, we would expect and we did see the gross profit come through. The offsets to that are the metals and the service business on the commercial vehicle side which was – both of those were second half impacts to us. So that took a significant – a negative impact on the volume. Then your question or your bigger question is, is there a different conversion rate running from Modine going forward? And I would say no. On volume, we still see 25% plus conversions and you’ve seen a lot of quarters like that. This quarter, this half, we have some of those headwinds and we’ve had quarters where our conversions 60%. The positive as we look to next year is we will start to recoup the metals increases. And you also mentioned synergies, so not to get too far out in front of us but we’re not setting a new low conversion rate for Modine. There’s some unique factors here on the second half. But more importantly, as we stated, those become recoveries or tailwinds and synergies, you can see a conversion rate that looks by the time you get to EBIT more favorable. Hopefully, I’m making sense to you, Joe. I’ll just pause.

Yes, that’s exactly what I was looking for. That’s great detail. I wanted to finish up on just recalibrating around Luvata; one more quarter in, so just maybe an update on how the business continues to operate relative to your expectations? And I want to be sure I’m thinking about the business correctly into the December quarter. Obviously we got a one-month look at a year ago of what Luvata can do in the month of December and it’s seasonally weak. And so with the expectation into the December quarter this year, probably a sequential step down in EBIT margin just given seasonality. And then Q4 kind of jumps back up and potentially the strongest margin quarter of the year?

You answered your question very well, Joe. That’s exactly right. First off, I’m very pleased with the performance of CIS obviously on how they’re contributing and more importantly really excited about the synergy opportunities that are developing U.S. last quarter about how we’re seeing the synergies between CIS and building HVAC and those are coming together well through procurement, through some other make versus buy things that we’re looking at. So again, very positive with that outlook. So a great performing business, brings the diversification we wanted and obviously cash flow. But the Q3 is – fiscal Q3 is its weak quarter going into December. Obviously their short order lead time falls into the holiday period, so things kind of shutdown, if you will, for a couple of weeks in there. So we’ll see that. But it comes back strong in the fourth quarter next year which we anticipate. I did mention that we see the precision air conditioning business that they’d have a very significant position in, specifically with one customer that we see that outlook brightening. We think that can have some additional impact potentially in Q4 this fiscal year and going forward. So again, they really bring exactly what we wanted to the company and very pleased with what their contributing. And again, some major steps we’re considering forward on synergy when we add to that. So that’s my quick summary on that.

Okay, that’s great. That’s all I have. Congrats on the quarter, it’s great to see.

Thanks, Joe.

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

Thank you. And that concludes today's call. Thank you for joining us this morning. And thank you for your continued interest in Modine.