Good morning, ladies and gentlemen, and welcome to Modine Manufacturing Company's Third Quarter Fiscal 2019 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, Treasurer, Investor Relations and Tax.

Good morning, and thank you for joining our conference call to discuss Modine's third quarter fiscal 2019 results. I'm here with Modine's President and CEO, Tom Burke; and Mick Lucareli, our Vice President, Finance, and Chief Financial Officer. We will be using slides with 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. This morning, Tom and Mick will present our third quarter results and update our outlook for the remainder of fiscal '19. At the end of the call, there will be a question-and-answer session. 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's my pleasure to turn the call over to Tom Burke.

Thank you, Kathy. Good morning, everyone. We recorded another strong quarter with significant increases in both sales and earnings. Sales increased 6% or 8% on a constant currency basis. Each of our segments recorded higher sales this quarter as compared to the prior year, led by the off-highway, data center and commercial HVAC markets. Third quarter adjusted operating income was $34.8 million, up 29% to prior year. Similar to last quarter, strong performances from CIS and Building HVAC segments were partially offset by lower earnings from the VTS segment. Mick and I will provide more details, but we continue to be negatively impacted by the direct and indirect impact of tariffs on raw material purchases within the VTS segment. After reviewing the segment results for the third quarter, Mick will provide an update on our consolidated results and our outlook for the rest of fiscal 2019. I will then provide an update on our strategic initiatives, including our review of the strategic alternatives for the automotive business that was announced earlier this week. Please turn to Page 5. Sales for the VTS segment increased 3% or 6% on a constant currency basis, driven primarily by increase in the Americas and Asia, partially offset by lower sales in Europe. Growth in the Americas region was across all end markets, while growth in Asia was primarily driven by higher off-highway sales. Adjusted operating income for the VTS segment is $15 million for the quarter or $5 million lower than the prior year. And adjusted operating margin was down 180 basis points to 4.6%. Over the past couple of quarters, we have mentioned the direct and indirect impact that tariffs continue to have on our raw material cost at VTS. Although we source much of our raw material domestically, our raw material suppliers…

Good morning. Please turn to Slide 9. First, I want to say that we're pleased with the quarterly sales and earnings growth within our 2 primary industrial segments. Total company sales increased $28 million or 6%, including a negative foreign currency impact. Revenue improved in all business segments this quarter, with the highest rate of growth in the off-highway, data center and commercial HVAC markets. Gross profit of $92 million was up 7%, and our margin was up 20 basis points. The Building HVAC gross margin was higher than the prior year, and CIS showed a significant improvement as well. On the VTS side, we had positive impacts from higher sales volume and ongoing purchasing initiatives. However, this was more than offset by higher tariff and tariff-related costs. As Tom described, these costs relate to tariffs on imported materials and large price increases from certain domestic suppliers that are leveraging their current position. We're working hard to recover these cost increases from our VTS customers, but this is proving more difficult than we anticipated. With regards to CIS and Building HVAC, we are generally able to pass through these cost increases in the normal course of business. In addition to the material costs, we incurred a number of incremental costs related to rapid volume increases, program launches and a facility expansion. To help offset the material challenges, we continue to tightly manage SG&A. At $57 million, SG&A improved 130 basis points as a percentage of sales. The 6% decrease in SG&A includes a $1.1 million recovery of environmental costs. Adjusted operating income was $34.8 million, up 29%, due primarily to the gross margin improvement in CIS and Building HVAC segments. The appendix includes an itemized list of adjustments and a full reconciliation to our U.S. GAAP results. These adjustments totaled…

Thanks, Mick. Please turn to Slide 12. As we've been discussing over the past several quarters, our strengthened, diversified and growth strategy is driving our focus on areas targeted for improved organic and inorganic growth and on the areas of our business that we plan to deemphasize. Soon after completing the Luvata acquisition, we began a strategic analysis of our portfolio of businesses, including our major end-market drivers and the performance of our current product portfolio in those markets. You may have already seen us take some strategic action by selling our South African business and exiting the geothermal product line. What has been clear, however, is that even though some of our highest growth rates are within our automotive engine products, there are significant and persistent competitive forces in the industry that we believe will limit our long-term return on capital, given the high capital intensity and ever-increasing competitive pressures in this business. Last quarter, we specifically mentioned that we had identified approximately $200 million of sales to automotive markets that were undergoing a strategic review. As we further evaluated this business, we widened the scope of the review to include our entire automotive business, which accounts for approximately 25% of our total company revenues. As discussed in a separate press release we distributed earlier this week, we are now exploring strategic alternatives to find the most successful path for this whole business in order to best serve our customers and provide the greatest return for our shareholders. Let me be clear: we have great products, technology, customer relationships and a very talented team that service this market. Further, we have been producing products for the automotive customers for nearly 100 years. This is an incredible legacy, but at this point, we need to determine what it will take…

[Operator Instructions] Our first question comes from David Leiker with Baird.

This is Joe Vruwink for David. I wanted to start on the topic of tariffs. Could you maybe just walk through what got worse relative to your thinking a quarter ago? I'm wondering, is it the inflationary pressures from your suppliers that worsened? Or did some of the Modine mitigation actions maybe just take a little bit longer to go into effect, and so there's maybe a benefit still to come on the horizon?

Let me give you a couple of points, then I'll let Mick chime in. The indirect impact of tariffs has been much greater than we anticipated, okay? As I highlighted in my comments, that the domestic suppliers have been very aggressive in using the opportunity for rising cost and higher demand to leverage their capacity against us. That's been very significant and forcing us to then -- and one example, as I mentioned, I mentioned it's up over 20% in one case. And that's pretty much -- it varies across the board, but just about everybody that is impacted by this [ supply growth ] is taking advantage of that. One supplier has actually said, "Hey, look, I'm going to send my capacity someplace else other than heat exchanger raw material." So that has then had a knock-on effect of having to bring on new suppliers that are from outside the country, quite frankly, that has then a tariff impact potentially, still better than what -- the price gouging that we were going through, and then having to go through the cost of running that material and testing it and getting it approved through the system. That is a full-court press, okay? So you're flying in materials, you're spending overtime, you're [ bidding ] parts, you're getting tests done, working with customers to keep our customers in product. So that's been very -- something that we didn't quite anticipate last quarter. The rest of the kind of planned tariffs, okay, is going along as planned. And clearly, as Mick mentioned, negotiation with our customers, which, again, with the contract terms we have, have to be kind of walked back in and discussed, okay? And they have the ability to kind of say, do they support a negotiation or not? That has been a little more difficult as well. And -- but I will say that overall, we -- from a procurement standpoint, the contracts we had, we've got those, for the first round of the tariffs, besides negotiations, had things long-handed, this indirect impact has been worse. Mick, do you want to add anything to that?

Two other things to add with regards to the sharing that we've talked about. We assumed there would be a sharing, and that's proving out to be the case, so that -- no surprise there. But I mean Tom was on the road in January personally, and what's taking a long time is to get the agreements in writing. So we actually had one customer that we're able to get everything buttoned up for Q3, and we've got a lot of progress with other customers. Those contracts or legal agreements do have to be buttoned up. Obviously, they want to protect themselves if these go away. The second point would be the exclusions. The government shutdown didn't help us at all. We had comment periods expiring. And so we believe strongly, we have valid exclusions from certain tariffs, and that was taking a longer progress -- or process than we expected, Joe.

So that's helpful. So a quarter ago, you kind of tweaked the fiscal year guidance by $5 million. This quarter, you're tweaking it by $6 million, so let's call it an $11 million EBIT adjustment the last 2 quarters. And over that period of time, I would imagine that the contribution from the industrial business has been a lot better than you would have originally assumed as well. So are we talking about something that's maybe $15 million, plus or minus, adversely impacting you relative to 6 months ago? And then how much of that, if I'm right, $15 million, give or take, can maybe be mitigated into fiscal 2020?

Yes. I'll take a stab at it first, Joe. It's Mick. So I'm not going to comment specifically on your math. It's probably just -- I can help you with the direction. From -- the magnitude that you're laying out is much -- is higher than we have seen. But from a material standpoint, we talked about, in fiscal '19, about a $6 million to $7 million challenge, cost increase this fiscal year. And on top of it, at the time, we were talking about potential risks of domestic suppliers. If you roll in the indirect or the domestic price increases, a lot of those came, Joe, late in the calendar year in a lot of frantic moving over the holidays, frankly, with price increases coming January 1, another $4 million to $6 million. So somewhere between $10 million and $13 million, $14 million, just price increases. And then it gets to the sharing that I've talked about. The $4 million to $6 million that has come in from domestic suppliers, there is no sharing there. That's a renegotiation or resourcing that Tom walked you through, and we'll find a way through that. I'll let Tom comment. But we will -- we are vetting, evaluating and resourcing where appropriate on those, and we are getting sharing agreements even though it's slower. So I think probably $10 million to $13 million in total tariff-related headwinds. And absolutely, we should be able to make progress on closing that gap as we head into fiscal '20. The other challenge in there, if you think, in the last 6 months, Tom talked about some of the program launches and inefficiencies. We are seeing improvements, but honestly, they've been, frankly, a little bit slower than we anticipated. And again, when we look to fiscal '20, we -- these are things, both on the material and the launch costs, that we should be able to work through. Tom?

No, I think you hit that squarely. I'll just add, on the performance, as far as launch performance and inefficiencies, we are improving. I'm not satisfied with the rate of improvement. I noted we've made some leadership changes as a result, and I expect that to significantly improve at a higher rate. So that's the other portion that we're getting through. But Joe, they're great questions. We -- from a quarter, this thing got much more complicated quickly with the indirect impact. We are managing the direct impact, as we talked about before, in a very structured way. But this -- kind of the dam broke loose a little bit here with the challenges with our domestic suppliers. Very unfortunate and, quite frankly, not acceptable on how -- we've had long-term relationships with a lot of these suppliers that we're talking about. And to see them react this way has been very disturbing, but we are managing through that, focused on making sure, number one, we keep our customers in supply, which we're confident we will; and then making sure that we get the best deals possible. But it's been a full-court press from nearly every function in the VTS world.

Okay. So focusing on the good news now. CIS profitability was pretty remarkable this quarter. And I seem to remember that seasonally, the December quarter should actually be the weakest of the quarters for CIS, so even more remarkable in that regard. Maybe walk through some of the things that surprised you on the upside. And then in thinking about upcoming quarters, does this become a new high watermark where you kind of build from here? Or are there certain things to contemplate where maybe there's a bit of moderation in upcoming quarters?

Well, as mentioned in my comments, Joe, we were benefiting from several factors in CIS. First off, we were a focused leadership team on building levers in their strategy that are important to improve operating performance, manage opportunities with the restructuring that we did in Europe last year that we invested in with the plant in Austria to give them a better performance there. And clearly, the data center market has been -- the surge in orders there has been very positive for us, both in the market and in gaining share, okay, that we feel across different -- throughout the different channels in the data center market. So I can only say that I'm very pleased. The cash flow predictability in this segment is great. The ability to not be in hammerlock because of tariffs because of our ability to price and pass through is very refreshing. So overall, I'm just very pleased. Mick, you want to quantify anything more to that?

Yes, Joe. I think as much as we love it, I think this business will regress to what we talked about when we bought it. I think we should all be thinking about this as a low single-digit top line grower, and the margins are just going to plateau here and stabilize. We've got a lot of benefit from everything from the synergies fully coming through, operational improvements, mix. But I think we -- this is going to start to level off, which is fine because it's also a very nice cash generator. And we want to build off of it, both organically and inorganically. But booyah, there -- this is a -- several good things have gone our way, favorable from a market standpoint. And I think we still think of this business, long term, as a low single-digit top line and a nice margin, cash flow generator going forward. And then we can supplement that growth through other strategic and acquisition kind of measures.

And then my last question, and I'll turn it over. The growth in Building HVAC was also very remarkable this quarter. Do you have a sense -- this would, I guess, apply only to your U.K. business, but a sense of stocking ahead of some uncertainties in Q1, thinking about Brexit primarily? But anything that would indicate that not only was end demand strong but stocking as well, so there's some moderation due into coming quarters?

Yes. Well, as far as orders, we're right now in very good shape as far as the order book. I mentioned the real focus on data center business there with the expansion of data center -- colo centers in Ireland, England, the Netherlands and Germany, which we're receiving nice orders and really gaining share. So the order book looks fine -- not fine, it looks great. So I'm really pleased with that. And the performance -- operating performance of our U.K. business, as you recall from a couple of years ago, has really improved as well with focused leadership and really driving improvement. As far as the -- what was the second part? Oh, Brexit. As far as Brexit is concerned, it's -- clearly, we're preparing. We have about 40% of our parts that we supply, that we get, comes from the mainland in Europe. So we -- what we're doing to counter that a little bit is we've built some inventory, banked up on those parts just to have some flexibility there, okay, depending on what happens here. But we're staying really close, but that's really the one countermeasure we put in place right now as well as staying close to what the latest developments are. But very good question.

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

Thank you for joining us this morning. A replay of this call will be available through our website in about 2 hours. We hope you have a great day. Goodbye.

This concludes today's conference call. You may now disconnect.