Modine Manufacturing Company - Q2 2020

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to Modine Manufacturing Company's second quarter fiscal 2020 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone phone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Kathy Powers, Vice President, Treasurer, and Investor Relations. Please go ahead.

Kathy Powers (VP of Treasurer and Investor Relations)

Good morning, and thank you for joining our conference call to discuss Modine's second quarter fiscal 2020 results. I am here with Modine's President and CEO, Tom Burke, and Mick Lucarelli, our Vice President, Finance and Chief Financial Officer. We'll be using slides for today's presentation, which can be accessed either through the webcast link or by accessing the PDF file posted on the investor relations section of our website, modine.com. This morning, Tom and Mick will present our second quarter results for fiscal 2020 and will provide an update to our outlook for the rest of the year. 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.

Tom Burke (CEO)

Thank you, Kathy, and good morning, everyone. In the past few months, we have seen a significant decline in many of the key end markets served by our VTS and CIS segments. In addition to the automotive slowdown mentioned last quarter, we are now projecting additional weakness in the commercial vehicle and off-highway markets that we expect to continue through the remainder of our fiscal year and into fiscal 2021. We are also seeing lower orders in our CIS segment, including both cooler sales to the data center market and coil sales to the HVAC and refrigeration markets. These conditions have led to our second quarter earnings being lower than we originally expected and to a significantly lower outlook for the remainder of the fiscal year. We have therefore lowered our sales and earnings guidance for fiscal 2020. Mick will provide additional details later in the call.

Given the significant change in our order outlook and market conditions, we are rapidly implementing a number of aggressive cost containment measures. Some of these are immediate actions that will drive short-term cost savings, and some are longer-term initiatives designed to deliver between $25 million-$30 million of annual savings over the next 18 months. These measures include operational and SG&A expense reductions, resulting from accelerated procurement savings, structural changes, and headcount reductions, with the immediate goal of improving our operating earnings and cash flows. It's important for our shareholders to know that we are experiencing a major correction in some of the markets we serve and are taking the appropriate actions now to ensure we stay on path to meet our performance goals. Before turning to the segment results for the quarter, I would like to provide an update on the potential divestiture of our automotive business.

As most of you know, we entered into a formal sale process in the late spring, early summer time frame, and we've been diligently working to prepare for the sale of the business over the past several months while managing through a challenging industry environment. Throughout the process, numerous companies expressed interest in the business, and we received bids from both strategic and financial buyers. Over the last several months, we narrowed the group and believed that we could reach an agreement with one particular buyer. Unfortunately, negotiations with the counterparty have recently been terminated. This is due to a combination of factors, including general market and economic conditions, deal complexity, and overall value. We have other interested parties and will continue with the sale process while continuing to analyze all strategic options.

Further, the process has taken longer than anticipated due to the industry and economic uncertainty, but we will make the right decision for our shareholders. The team has worked extremely hard on the separation and the investment is significant, but we believe this is a prudent investment because it is a necessary step for Modine to exit the automotive business. We believe that becoming a more diversified industrial company is in the best short-term and long-term interest of our shareholders and will make Modine a stronger, more profitable business once complete. Now, turning to our second quarter results. Overall, second quarter sales decreased 9%. Our Building HVAC segment had another strong quarter, with sales up 12% on a constant currency basis versus the prior year.

However, both our VTS and CIS businesses had year-over-year sales declines, primarily due to continued weakness in our end markets and unfavorable currency impacts. Our second quarter adjusted operating income was $20.2 million, down $6.3 million, or 24% from the prior year, primarily due to the lower sales volume in our VTS and CIS segments. Turning to page four. Sales for the VTS segment were down 11% from the prior year, or 9% on a constant currency basis. Our key vehicular markets have slowed significantly. Overall sales to commercial vehicle customers were down 15%, and off-highway sales were down 22%. We started seeing a decline late in the first quarter, with only significant sales softening in our automotive markets.

Early in our second quarter, commercial vehicle markets still appeared stable, but we began to hear early word of inventory adjustments from our off-highway customers. At this point, third-party market research estimates continued to signal year-over-year growth. By the end of the second quarter, we saw a significant drop in off-highway orders and started receiving mixed signals for the rest of the year. It wasn't until early October that third-party market data began reflecting a portion of these market declines, and that we learned the full extent of the impact of the second half of our year for both off-highway and commercial vehicle sales.

We continue to monitor published market data, but as we talk with our customers, we now understand that the volume declines in the fourth calendar quarter of 2019 and the first calendar quarter of 2020 may be significantly worse than the current data would indicate. In some cases, we expect year-over-year volumes to decline by as much as 20%.... We base our forecast both on market data and customer feedback. In the current environment, we are taking a more conservative approach and are preparing for volumes to continue to decline for the balance of our fiscal year. Within the off-highway space, the area most negatively impacted has been large engines and high horsepower equipment. This includes high-tonnage excavators, harvesters, and large tractors, where we have a higher mix of business.

These impacts are generally in line with what we have seen and heard from the earnings commentary of our large OE customers in this quarter. Sales to customers in the Americas region were down 9% from the prior year, primarily driven by lower sales to automotive and off-highway customers. Sales in Europe were down 13% from the prior year, due primarily to a steep drop in commercial vehicle sales as programs continue to wind down. In Asia, sales were down 12% due to lower off-highway sales in China and Korea. This was partially offset by higher automotive sales in China. Adjusted operating income for the VTS segment was $9.3 million for the quarter, which is $6.7 million lower than the prior year. Adjusted operating margin was down 170 basis points to 3.1%.

This volume-driven decline has lowered our segment returns to a level that is clearly below our targets. So far, we have rapidly adjusted our direct labor costs, but the VTS team is now focused on quickly reducing our fixed costs as well. Our operations team is aggressively rebalancing production schedules and adjusting labor requirements and overhead spending in line with our latest sales forecast. Please turn to page 5. Our CIS segment also had another down quarter, with sales decreasing 12% from the prior year. Sales to data center customers were down 26% from the prior year. During the last year, we knew this quarter's sales would be down from the strong level in the second quarter of last year. We still have a strong relationship with our largest customers in this segment, and they are happy with our performance.

We are actively working with them to find opportunities to grow this business. Even though they're still growing their data center capacity, the rate of this growth has slowed, which impacted both the second quarter and our forecast for the rest of the fiscal year. Part of our future initiatives for the data center piece of our CIS segment is the diversification of our customer base. This market is fairly concentrated, which makes this effort difficult, but we believe the relationship and success we've had with our largest customers is a testament to our products and services and gives us confidence in our ability to obtain new customers. In addition to data centers, sales to other end markets in our CIS segment were down as well due to a tough industrial environment.

This segment reported adjusted operating income of $8.9 million, down 31% from the prior year. This decrease is primarily due to lower gross profits, driven by lower sales volumes and negative sales mix. We recently announced a leadership change over our CIS segment, with Scott Bowser, our Chief Operating Officer, assuming responsibility for this segment. We'll also be making further structural and leadership changes to ensure we drive improvement in both the commercial and operational sides of this business. We clearly have some work to do in this segment. I'm confident in Scott's proven leadership that this team will execute on our growth and profit improvement plans. In particular, we're focused on profit improvement in our coils business, where we're reviewing our profitability by product and by customer, and believe there is room to strengthen our pricing structure and distribution channels.

In addition, we're also examining the organizational structure of this business. Last year, our VTS business moved from a regionally managed business to a global structure. In CIS, the group is still managed regionally, with different areas of focus, strengths, and weaknesses around the world. We're now looking to move to a global product structure that will help to improve profitability in our coils business and further strengthen our market presence in our coolers business. Please turn to page 6. Turning to our bright spot in the quarter, sales for our Building HVAC segment increased 10%, driven primarily by higher sales of school ventilation and heating products in North America and higher data center sales in the U.K., partially offset by lower non-data center product sales in the U.K.

Adjusted operating income increased 35% from the prior year to $8.8 million, and adjusted operating margin increased 300 basis points to 15.8%. This increase was driven by higher sales volume and favorable sales mix. We continue to be encouraged by the strong performance and our competitive position in this segment. We recently announced that we entered into a supply agreement with CyrusOne, a global owner and manager of data center properties, to provide cooling solutions for the data center projects in Europe. Our Airedale business unit in the U.K. is in a great position to provide energy-efficient cooling solutions to this growing market. With that, I'd like to turn it over to Mick for an overview of our consolidated results and to update our outlook for fiscal 2020.

Mick Lucarelli (CFO)

Good morning, everyone. Please turn to slide 7. As I reviewed last quarter, we anticipated a challenging Q2, but things were even more difficult than we expected. Both VTS and CIS had lower year-over-year sales due to negative trends in their key end markets. On the VTS side, we experienced particular weakness with global off-highway and commercial vehicle customers. With regards to CIS, we saw lower orders from data center, commercial HVAC, and refrigeration customers. As a result, second quarter sales decreased $49 million or 9%. Excluding the negative FX impact of $11 million, sales were down 7%. As Tom covered, Building HVAC segment sales increased 10%, continuing their positive momentum. Gross profit of $76 million was lower by 14%, resulting in a gross margin of 15.1%.

Downside conversion was generally in line with our expectations based on current fixed and variable cost structures. In addition, foreign exchange had a negative impact on our gross profit compared to the prior year. VTS and CIS segments were the primary drivers of our gross margin decline. Within VTS, the gross margin declined primarily due to lower volumes. CIS margins also declined as a result of decreased volumes and unfavorable product mix. The drop in cooler sales to data center customers had a negative impact on segment margins. In addition, we are focused on reversing a negative coils margin trend. As Tom mentioned, improving coils profitability is a top priority of the new segment leadership team. Building HVAC remains a bright spot, with gross margin improving 220 basis points. SG&A for the quarter was $67 million.

As we face market headwinds, we remain focused on controllable costs to offset lower revenue. Also, please note that $12 million of SG&A was related to preparing the automotive business for sale. These costs have been excluded from our adjusted operating income, and you can see the details in the appendix. The remaining SG&A expenses decreased by $8 million. Adjusted operating income of $20 million was down $6 million from the prior year. As previously reviewed, the earnings growth in Building HVAC was offset by the decline in VTS and CIS. Lower SG&A helped offset the volume declines and the negative foreign currency impact. As usual, our appendix includes an itemized list of adjustments and a full reconciliation of our U.S. GAAP results. These adjustments totaled $14.2 million. As previously mentioned, $11.9 million relates to the automotive divestiture.

The other $2.3 million relates primarily to VTS severance costs as we separate the automotive business and restructure the balance of VTS. We unfortunately see a large and unexpected swing in our tax rate, which has impacted the adjusted and GAAP results. First, we recorded valuation allowances against certain U.S. tax attributes that had a significant impact on the quarterly tax rate. Second, our projected pre-tax loss position in the U.S. resulted in losing the 50% deduction of our GILTI inclusion, which is one of the new U.S. tax provisions introduced under the Tax Act. The loss of this deduction actually results in more tax being expensed when companies enter a loss position in the U.S. Adjusted earnings per share in the quarter was $0.13, which is down $0.22 from the prior year.

As I just reviewed, the decline is due primarily to lower sales, combined with the higher tax rate. Turning to Slide 8. Our year-to-date cash flow is down due to lower cash earnings and large costs related to the anticipated automotive divestiture. Year-to-date, free cash flow is negative $24 million. However, this includes $20 million of payments related to strategy and restructuring costs. Capital expenditures were slightly higher than prior year, and that's partially due to the separation of our automotive business. As I mentioned last quarter, full-year capital spending is expected to be slightly higher, largely due to these additional costs. In addition to the cash expenditures, the operations teams have been carrying higher inventory to support our automotive plant separation. Despite the high level of cash spending on the automotive separation, we anticipate slightly positive free cash flow in the second half of our fiscal year.

Finally, our net debt increased $25 million year-to-date, and our leverage ratio is 2.3. Now, let's turn to our fiscal 2020 guidance on Slide 9. Based on recent results, sales trends, and customer feedback, we are reducing our guidance to reflect additional market weakness in the second half of our fiscal year. As Tom reviewed, we anticipate further softening across our VTS markets, especially with commercial vehicle and off-highway customers. In addition, we are expecting ongoing weakness in our CIS markets, including a key data center customer. Many companies have not released their 2020 outlook, but given that we have a March fiscal year-end, we have tried to extrapolate the current trends. To summarize our updated fiscal 2020 guidance, we now project sales to be down 7%-12%.

This represents about $150 million move based on the midpoint of our range, with the majority of this reduction coming from the second half of our fiscal year. In Building HVAC, we are expecting the sales growth to continue, although slower in the second half. With regards to CIS, we are expecting negative sales growth in the second half of the year, primarily due to slowing global markets, along with a negative foreign exchange impact. We also anticipate a significant decline in our VTS segment sales in the second half versus the prior year. The largest decline is in the Americas, where all end markets are projected to be down. We continue to have a challenge in Europe with a weakening automotive and off-highway markets and the continued wind down of certain commercial vehicle programs.

We have also reduced our Asia market forecast substantially and expect a small sales decline for the year, offsetting continued market share gains. As Tom mentioned, we are taking immediate cost-cutting actions and targeting significant savings. However, we will need time to fully implement the reductions and achieve the full effect. Adjusted operating income is now expected to be in the range of $85 million-$95 million. The change in our earnings outlook represents a downside conversion of approximately 20% based on the corresponding sales change. In addition to the unusual tax items I previously mentioned, our estimated full-year tax rate is now projected to be higher due to our mix of earnings and specifically foreign business tax regulations. For example, in some jurisdictions, we will have income tax expense despite pre-tax losses.

Based on the expected tax rate of approximately 34%, we anticipate adjusted earnings per share will be between $0.75 and $0.90. By separating the automotive business and reducing our cost structure, we are protecting Modine from further market downturns and aggressively positioning the company for significant margin improvements. We remain focused on the areas that we can control and executing on the strategic plan. Tom, I'll turn it back to you.

Tom Burke (CEO)

Thanks, Mick. Four years ago, we announced our Strengthen, Diversify and Grow strategic platform that enabled us to become a more diversified thermal management company. This platform has served as a framework for our decision-making and risk management efforts as a company. We executed on that plan and have continued to execute on this strategy, which led us to the decision to exit the automotive business. This is an important step for us. It will allow us to better focus our capital and management time on continuing to strengthen, diversify, and grow our business going forward, with a new set of strategies that will help us reach our financial and operating targets in the future. This process has taken longer than originally anticipated, but we remain committed to moving towards a structure and valuation that will be in the best interest of our shareholders.

However, the recent downturn in end markets is forcing us to take additional, more immediate actions, which includes a cost savings plan. We're targeting $25 million-$30 million in annual savings over the next 18 months. As I mentioned, these savings will come from a variety of sources, including headcount reductions, procurement savings, plant consolidations, and other SG&A and overhead reductions. We have started to take the initial steps and will continue to take the actions necessary to meet this target and timeline. We've been through this before and have not only executed, but have met our goals. We have a proven track record of responding quickly to market downturns, and this time will be no different. As a matter of fact, we're in a much better position than we've been in the past when the markets have moved against us.

In our CIS segment, we have made a significant leadership change and will make additional changes to how this segment is managed. I am confident that these actions will get this segment back on track. Meanwhile, our Building HVAC segment continues to generate strong margins and earnings, and we are optimistic about the segment's future growth prospects as it continues to contribute more and more to our total company results. We are well positioned in our key end markets with leading shares in our non-automotive businesses. We will focus our investment and growth on these industrial markets with strong long-term mega trends where we have a right to win. We will prioritize capital investment businesses that will improve our margins and cash flows. With that, we'll take your questions.

Operator (participant)

If you have a question at this time, please press star then one on your touch tone phone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from the line of Mike Shlisky, Dougherty & Company. Your line is open.

Mike Shlisky (MD and Senior Equity Research Analyst)

Good morning, everybody.

Tom Burke (CEO)

Good morning, Mike.

Mick Lucarelli (CFO)

Mike.

Mike Shlisky (MD and Senior Equity Research Analyst)

Okay, so I wanted to just briefly touch on some of the one-time costs surrounding the auto parts divestiture. When I go back over the last bunch of quarters, it looks like when you add it up, it's, you've spent at least $27 million, so far, I think. If I'm wrong, correct me there. Can I ask a little color as to kind of what those costs are? I'm not really sure why it would cost so much to sell something that, you know, is relatively small from an EBITDA perspective. You might have actually already spent the whole segment EBITDA on these fees. So I'm just kind of curious as to some more detail there.

If you don't end up selling it for some reason, I was just kind of curious, is there any contractual provision that you get some of that cash back from your vendors?

Mick Lucarelli (CFO)

Yeah. Hey, Mike, it's Mick. I'll, I'll take the first shot, and then Tom can comment on the non-financial side. Yeah, we knew heading into the process, and we've talked about the cost to prepare the business for divestiture would be significant. And the primary reasons are, the biggest driver is we need to stand this up as a separate business, otherwise we can't carve it out. And having that been integrated into multiple business units over the past, and then most recently, three or four regions, all part of the VTS segment, there's a significant amount of accounting and financial work to be able to separate out the financials, not only on a historical basis, but on a monthly and go forward.

The second big piece of that is from an IT standpoint, we have to duplicate and stand up the IT systems in order for us to be able to separate the business. The challenge with that, and your question about, you know, kind of cost benefit, is the alternatives is, as you know, the footprint of the business and the alternatives of thinking about a wind down are really a significant cost to Modine and the shareholders. So Tom and I continue to believe that spending the investment to separate the business gives us the most flexibility to determine what to do with it going forward. But that's the main drivers of the costs we've spent.

We anticipate probably another quarter or two of investment, and then we'll be ready to stand this business up as a separate entity, and that'll help us going forward quite a bit from both a visibility and you know, a full separate entity. Tom, anything to add?

Tom Burke (CEO)

Yeah, no, and I think maybe just a general statement overall. I mean, this remains a strategic priority for the company, the divestiture of auto. We went through a process, a very thorough process. This narrowed down. We had, you know, quite a big interest at the beginning. That narrowed down to a smaller number. Then we selected one potential buyer to go into final negotiation with, and that just completed and decided not to go forward in this last week's time frame, simply because of quite frankly, valuation from our standpoint, and also, I think, concerns on the market conditions that had a factor on that. But this remains a top priority, where this will happen.

We're gonna get back. We are getting back into the flow of second round of alternatives here to what we can consider, and that's we'll keep you posted on the timeline. But frankly, we want to make sure it's a good deal for the company, for shareholders, and we can... So we're gonna, you know, our focus was to get it done in this quarter, but we decided not to pursue that because of the reasons I just said. So it remains a priority. This will happen, and it's just a matter of time of finding the right arrangement with the right buyer.

Mike Shlisky (MD and Senior Equity Research Analyst)

Okay. And just to as a housekeeping item on this, in your comments about looking to save $25 million-$30 million over the next 12 to 18 months, that's not just simply not repeating some of these one-time costs for the auto parts divestiture, right? That's a whole other set of expenses you're gonna be cutting down.

Mick Lucarelli (CFO)

Yeah. Yeah, great, great question. Good clarification. No, the $25 million-$30 million Tom talked about are operating costs within the company. It's completely separate, separate from the one-time costs we're spending now to separate the auto business.

Mike Shlisky (MD and Senior Equity Research Analyst)

Okay. Thanks for that. Can I move on just to CIS quickly here? Maybe a two-part question. One, can you give us a little color or some commentary as to how easy is it to move to a global structure for that business, given some of the changes in, you know, regulations between countries or other issues, as far as shipping and facilities and how you acquire raw materials? And also, do you think any additional one-time costs there or footprint changes that have to happen? And then maybe secondly, on CIS, given what's been going on and where your forecast is headed and what's happened now for a few quarters here in data centers, is there any risk of a goodwill write-down in that business?

Tom Burke (CEO)

What was the last question, Mike? I didn't quite-

Mike Shlisky (MD and Senior Equity Research Analyst)

I was just curious if, given what's happened with your forecast over the last couple of quarters, in data centers and, and elsewhere in that business, I'm curious if there is a risk of a, you know, goodwill write-down, from the Luvata deal.

Tom Burke (CEO)

I'll take the first part and then swing it back to Mick on the second part of the question then. As far as, we, we've just made the announcement on the leadership change. We're making an assessment. We've been globalizing, the functions within, CIS for some time now with the integration. So things like procurement, that are over, you know, involved with optimizing the buys, on a global basis are already done. Now, this is a matter of really aligning the product strategies. We have, for instance, obviously the largest, share of coils on the open market position globally.

That varies, though, by market in different regions, and we haven't really addressed the optimization of how we run commercially, you know, as both, you know, how we go to market in our selling proposition and also operationally. So there's a lot. There's things on both ends of this that we can really optimize by making sure we have oversight on a global basis. Yes, it comes down to running regionally from an operations and sales standpoint, but this overall strategy of the product, whether it be coils, which is really what the concentration is, and also coolers, where we have a very strong position in Europe, of bringing that focus to North America and other regions as well. So it's really bringing the strategy to a global level, operational and commercial consistency around the globe.

That's what we're focused on and feel very confident with what that's gonna bring.

Mick Lucarelli (CFO)

Yeah, Mike, I'll just jump in on the goodwill question, any impairments. The short answer is no, but we always go through, we always look at impairment indicators, and we do a heavy look each fiscal year-end, and as part of our planning process. As you know, coming out after the acquisition, we had actually had one or two years of really strong earnings growth. So we're coming off of what is... You know, we're not happy with it, but the dip is coming off of some really good growth base, higher than where we bought the business. The other thing is, on the technical accounting side, a lot of that goodwill is applied to different areas of the business, and some of those areas within CIS are doing quite well, have strong margins that support some of that, those intangibles on the balance sheet.

So yes, we'll keep looking at it, and, you know, next review will be as part of our planning process.

Tom Burke (CEO)

Mike, if I could go back to your first question. This is Tom. One of the things, you were talking about CIS, but as we globalize the strategies and the performance prioritization and drive that, you know that we have a data center business in CIS that really focuses on, say, on the cloud computing side, and we have a computer data center focus in the U.K. out of our Building HVAC group. We're really looking at how we can link those two together to have one strong face to the market. That's early days, but that's something we're concentrating on as well, to make sure that we can take advantage of both those channels to market in a smarter way to grow that business is a priority.

Mike Shlisky (MD and Senior Equity Research Analyst)

Okay. Just want to ask a question also on the upcoming cost savings. Will all the cost savings be in just VTS and CIS, or will any of it be in the auto business that's being carved out here? And also, is any of it going to be in the HVAC business, or is it all going to be in those two main segments?

Tom Burke (CEO)

Well, clearly, the focus and priority is on the VTS and CIS side, but we're going to look at all flows of workflows and where we can have opportunities. You know, on the growth side of Building HVAC, we want to make sure we're leveraging everything possible there. So as I mentioned, the data center business, we've had a recent announcement of success with CyrusOne recently on co-location across Europe opportunities, and so we're going to be careful on that front. But we want to support that and deliver it fully and be able to grow that even further. But the main focus is VTS and CIS, and then, of course, we're mentioning using procurement savings, accelerating opportunities there, so and others. We'll be targeted in spots, but mostly be VTS and CIS.

Mick, you add anything to that?

Mick Lucarelli (CFO)

Yeah, just, yeah, it's a balancing act we'll have to do with regards to your question on the automotive side versus the rest of VTS. Clearly, automotive is down as well as part of VTS. So, but at the same time, we're, as Tom's indicated, we're talking to buyers, and so you have to be very careful about the level of adjustments, reductions we would take in the middle of a sale process. I think it'd be a much, you know, heavier look. Obviously, our $25 million-$30 million is... Tom and I are focused on the remaining company. So, you know, your question about it coming out of the one-time separation costs or Dakota, if we lean and put all these costs into business things that aren't going to stay with us, it won't help us in the long run.

So most of the focus is going to be on the remaining part of Modine.

Mike Shlisky (MD and Senior Equity Research Analyst)

Okay. Okay. And I just maybe squeeze in one more here before I pass it along. I just want to confirm, in the quarter, there were no major impacts to your numbers due to the auto strike at one of the big OEMs? And maybe as a secondary to that question, one of their plants, or I think actually a few of them are not far from your facilities. Maybe that's by coincidence or from old relationships. I'm curious if you've seen any good hiring trends for I guess folks who are either fed up or to try and find something new from the auto business recently.

Tom Burke (CEO)

The first part of that question is we've worked had some impact, okay, but not material, okay, to, to, mention here, with this, with supplying, engine products to, to, the GM, in North America, specifically. And as far as personnel, I can't answer that. I don't know. I don't know that in the side of where we have our operations, we're probably going through, some levels of reductions across the, you know, the plant operations as far as rebalancing loads, so, don't know the answer to that one, but, but the first part is clearly, impacted, but not materially.

Mike Shlisky (MD and Senior Equity Research Analyst)

Okay, guys. I appreciate the color. Thanks so much.

Tom Burke (CEO)

Thank you, Mike.

Operator (participant)

Our next question comes from the line of David Leiker, Baird. Your line is open.

David Leiker (Research Analyst)

Good morning, everyone.

Tom Burke (CEO)

Morning, David.

Mick Lucarelli (CFO)

Hey, David.

David Leiker (Research Analyst)

On Building HVAC, you know, doing well there. When you look on the horizon, are there any signs that, you know, there's some issues that are popping up there, some weakness in the end markets or anything along those lines that, you know, could come up in the next couple of quarters?

Tom Burke (CEO)

If you look, and I mentioned, the non-data center sales in the UK are down some, okay? So offset by significant growth, the data center. So I think that's a Brexit issue, with things slowing down in England. But right now, it's, that's what we see at this point. I can't say in North America, the sales are great. We have a great heating sales season going on right now. I mentioned school product sales are going strong, so not really seeing any indication in North America.

David Leiker (Research Analyst)

And then on the data center side, I know you've been working and trying to broaden that, but, you know, are there any actions or, you know, any signs that you're able to break into some other customers in that data center to help smooth out the flows there?

Tom Burke (CEO)

Yeah, we're putting a lot of time into that, Dave, as we talked last quarter with some questions, and we've got a team of people that we're pulling together. And I mentioned it earlier in a follow-up question of the earlier caller, that of bringing together with this change we made in leadership in CIS, you know, bringing together a team is one face to the market that we can leverage relationships that we're building in both segments now, but leverage that into one voice to the market. For instance, in the UK, I'm repeating the CyrusOne order that we received, that's significant going there. That is a North America-based company. They clearly are interested in us supplying them in this region, okay?

And we're really looking the best way to do that. That also means that, you deal through engineering firms and contractors, so the specifier relationships are very important. We've got a very strong specifier relationship arrangement set up based on, on both sides of both channels to market that we're putting in place to leverage. So, we're putting on the time, putting on the right resources, and again, addressing our approach to market that we should be able to talk a lot more about that in the next earnings call.

David Leiker (Research Analyst)

Okay, great. Just one more item on CIS. Are there any targets you can share in terms of, you know, what you hope to accomplish to reposition that in terms of future profitability, growth rates, along the way, or any parts of that business you may not want to be in that just don't offer the opportunity you want?

Tom Burke (CEO)

Yeah, we clearly have some targets out there. I'll let Mick get into those in detail, but we want to get, you know, I'm thinking 200-300 basis points worth of improvement going in, really driving the changes that Scott is leading right now. But Mick, you want to go into further color with that?

Mick Lucarelli (CFO)

Yeah, I mean, we were frankly on a really good roll. We got the good execution of our initial synergies. We had some good momentum behind us with you know, the large data center customer. And last year, we finished, David, about 9.5% EBITDA. We think that business should be running more in 12%-13% in the next one to two years here, year and a half. We've got a good path forward. I think we know your question about businesses we need to exit. No, the big-- everybody knows the largest piece of that business is in coils, and Tom talked about that. That's just getting back to blocking and tackling with regards to how we build cost and price that product.

We see significant margin improvement. This year will probably be down a little bit, more like a 9% EBITDA, but our goal and the team's target is 12% or 13% EBITDA in the next 18 months.

David Leiker (Research Analyst)

Okay. Thank you.

Operator (participant)

Our next question comes from the line of Matt Summerville, D.A. Davidson. Your line is open.

Matt Summerville (MD and Senior Equity Research Analyst)

Thanks. A couple questions. First, can you give us some sort of feel for what your book-to-bill look like in the commercial vehicle and off-highway portions of VTS? And then whether or not, you know, the results we're seeing in your coils business are indeed indicative of market share loss?

Tom Burke (CEO)

Okay. So book business and commercial vehicle, I mean, obviously, we, you know, we don't project, we don't give out that data publicly. We're very pleased with our business wins around the globe on commercial vehicle. You know, we spent time recently with several of our commercial vehicle customers and really understanding their strategies, but more importantly, what they see coming up in the next 12-18 months in their outlook, which is one of the reasons we adjusted our sales down. But we're winning our business. We're well positioned as a top three position in North America and Europe, smaller in China, of course, but growing with both multinationals and domestic customers there.

We did see some push out with delayed launches due to China VI in China, with one or two specific customers there that were part of that delay. So, but I saw a very, very strong position, very well good product platforms that we offer, that we're able to leverage in a smart manner. And then, of course, going into specialty bus and truck, a little bit deeper into the commercial vehicle segment, great position in North America and growing in Europe, especially with electrification opportunities that we're seeing there, that we're involved with all the major bus companies and specialty truck companies as well. So, I'm very, very positive on our position on commercial vehicle in that perspective.

Now, on the second part of your question was getting back to CIS, I think it was-

Matt Summerville (MD and Senior Equity Research Analyst)

Coil share.

Tom Burke (CEO)

-coil share. And from that standpoint, we believe our coil share is, again, as I mentioned, the largest independent position. We think that we're approaching, you know, 25%-30% market share in that globally, and that we supply and leveraging that is very important. Thousands of customers, the visibility there is, you know, far less as far as lead time sales and that type of thing, which is one of the strengths we have, is responding to the orders in a fast way, in matter of weeks.

And so we've really need to focus on how we manage that commercially, making sure we're getting all the value from a value proposition and pricing standpoint, and then really working on the investments necessary to, you know, have fast response and be able to respond to those customers' needs to get out the door, and also vertical integration, which helps us on the cost side, too. So, you know, it's share-wise, we feel that we're a leading position, which we need to leverage that better to take advantage of that position.

Matt Summerville (MD and Senior Equity Research Analyst)

With respect to the $25 million-$30 million of anticipated restructuring related savings, Mick, what is the cash cost out the door to accomplish that? And can you give us some sort of sense... in terms of the cadence of realization as we look out through the balance of fiscal 2020 and into your early part of fiscal 2021, please?

Mick Lucarelli (CFO)

Yeah, yeah, great question, Matt. So we estimate right now, it's early, but most likely, the cash cost to achieve that savings will probably be between $3 million and $5 million total. With regards to annualizing the savings, we feel confident we can get $4 million-$5 million in this fiscal year, and then the balance of it, 90% of it, hitting in next fiscal year. And, we've got -- obviously, we're targeting other ideas above and beyond. There may be a little bit that carries over, but our goal here is to get the full 25-30 within the next 18 months. Again, with 4-5 hitting here in the next, you know, 4-5 months.

Matt Summerville (MD and Senior Equity Research Analyst)

Is there a way maybe to parse out? If you look at the EPS guide takedown, parse out, you know, how much of that is being driven by the dynamics you talked about in commercial vehicle off-highway in VTS, how much is being driven by CIS? And then, you know what the, I, I could calculate after the call, but what the impact is on the tax rate change, if you have it.

Mick Lucarelli (CFO)

Yeah. So, when we think about the change in the guidance going back to last quarter, from an operating income standpoint, it's really pretty evenly split, a little bit more on the VTS side, but it's been a heavy mix here of VTS and CIS. And the tax side, I haven't quantified it, but we could do that with you offline. We've, you know, clearly moved up on the tax side from a 26% rate to a 34% rate. So, the downturn has been really then split on the VTS and CIS side.

Matt Summerville (MD and Senior Equity Research Analyst)

Got it. With respect to Building HVAC, I just want to make sure I heard you guys correctly. You anticipate that business still growing organically in the back half of the year. Maybe help me understand some of the drivers there, given you're up against a +16 organic comp in Q3 and a +25 organic comp in Q4. Talk through that a little bit.

Tom Burke (CEO)

Yeah. Well, clearly, in Q3, we'll be finishing out our heater sales, which is, you know, our strength of the North American side of that business, coming off the strong school season, which was more of a Q1, Q2 type of phenomena for retrofitting schools. The big focus on the back end of the year is in the UK as well, with the data center orders that we've landed, the CyrusOne deliveries that I've talked about. So, you know, we feel very, very positive about the organic side of that growth opportunity and expanding on it.

Matt Summerville (MD and Senior Equity Research Analyst)

Got it. Thank you, guys.

Tom Burke (CEO)

Thank you, Matt.

Operator (participant)

Our next question comes from the line of Brian Sponheimer, Gabelli Funds. Your line is open.

Brian Sponheimer (Research Analyst)

Hey, good morning, guys.

Tom Burke (CEO)

Hi, Brian.

Mick Lucarelli (CFO)

Hey.

Brian Sponheimer (Research Analyst)

Couple of different questions here. You know, just going back to the comment that the cash costs out the door to save $25 million-$30 million on an annual basis is $3 million-$5 million. I guess the question then becomes: why wasn't that done sooner? I guess we'll start there.

Tom Burke (CEO)

Yeah. Well, you know, clearly, the timing of this drop, Mick mentioned that the majority of the drop, is in the second half of the year, which is still in front of us. We are, you know, working on, you know, driving, the sales and, and, focus that. And so this is, this is kind of a, a recessionary, let's, let's get ready, okay? As I talked about in my early comments, that, we're in better shape now, responding early to what I think is gonna be a pretty deep and, and broader potential, contraction in our markets anyway. I, I, but so with that in mind, we've really focused on making sure that we, we, are, being as aggressive as we need to be.

Okay, so yeah, we're gonna take some risk here with some changes we're gonna manage, but we're thinking we're doing that in a smart way. We wanna come out of this thing with we're not taking our eye off those targets on our margins that Mick mentioned, as far as what we're striving for the company to be, and this is a necessary change to adjust for that contraction.

So, on the procurement side, those savings that we've, you know, put a lot of investment into our procurement team over the last couple of years and starting to deliver, and now we're broadening even more, not only just through straight, you know, the direct buy, but indirect buy, logistics savings, and those type of things, I think is a natural maturity level of where we are with our whole supply chain management focus. So I think that's just right in line with the timing of building out a fully functional and, I would say, operational excellence within supply chain. And then, the rest is contracting on the variable side, and then I think we're structurally gonna have to make some changes to get through this contraction. So, good question.

Mick, you wanna add to that?

Mick Lucarelli (CFO)

Yeah, just a little more color on the forecast question and pulling levers sooner. As we were on the call last time and we talked in July, we knew there was some softness, and also back to the automotive discussion, we have been pulling levers this year on cost reductions, also planning for the separation of auto. So year to date, we had already pulled cost reduction, headcount levers in the tune of $5 million-$6 million annualized. And then, the second quarter came in a little bit lighter on the top line than we expected as that was closing out. September forecast, we saw a significant drop in CIS and VTS. And then in October, we took a really hard look again.

Tom talked about some mixed signals we were getting from EDI order rates from customers versus what we were seeing or actual pulls out of that. So we went back, and we did another really deep scrub in October, rolled that up, and, you know, as we come to you today, obviously, we immediately went into, okay, based on the current forecast and concerns Tom laid out about, you know, everybody looking into 2020, that's when we said, we're going to set a bigger target and go get it right now. That's how we, you know, where we ended up today, Brian.

Brian Sponheimer (Research Analyst)

Okay. So just, I just wanna be clear on this because, I mean, it's a 6x payment—it's a 6x recovery on this in a two-year timeframe, which seems like an amazing return. This is more loss prevention. So it stands to reason that when things do get better, that some of that $25 million-$30 million is clearly going to have to come back into the business.

Tom Burke (CEO)

Well, I mean, I think, you know, this $25 million-$30 million includes some investments we're going to make, okay? I mentioned data center focus. You know, there we know we need to add some key resources and talent that we're planning on. So, so it's not just, you know, throw the cargo off the side of the ship here. We are making sure that we're focused and ready for the future when it's, you know, grow. So, the procurement savings, again, it's more of an investment of resource and processes. You know, so that if you look at the target we have set in there, which we haven't publicly split that out yet, but it's a significant portion.

It's a matter of more effective and efficient, you know, focus on driving not only direct sales, but technical, direct, excuse me, direct buy, but also, you know, technical changes to help optimize the buy, getting deeper into indirect buy, using data analytics and smart things we can do there, as well as I mentioned, the whole supply chain. So there it's just natural progression where we're going on our supply chain management. And on the sales side, adjusting down, it's really a focus on getting ready for what I'm saying is a pretty deep and broad drop in some key markets that we need to be prepared for and are not gonna be, you know, caught standing flat-footed. So combination.

Brian Sponheimer (Research Analyst)

Okay. All right, so let's go over to the missed opportunity on the sale of the business. How far apart were the two groups? Well, I wanna be clear. So the $20 million or $27 million that's been spent so far in separating the light vehicle business, how much of that is consulting fees and banker fees?

Mick Lucarelli (CFO)

Yeah. There's been no banking fees, Brian, in that amount, so the majority of it is not consulting per se. It's third-party accounting work to do the separation and legal work. So most of it is accounting, some IT and legal in there. No banking fees.

Brian Sponheimer (Research Analyst)

Okay. And could you help contextualize how far apart buyer and seller were in this from a price perspective?

Tom Burke (CEO)

No, probably not. But at the same time, I can tell you that, we, you know, had a, a valuation that we felt comfortable with starting off with, that quite frankly, weren't comfortable when we got done through the, exclusivity period. So, again, it's doing the best thing we can for the company, position ourselves for our strategy and also for shareholders. So, we decided that we needed to step out of that. Yes, we really targeted a second quarter close. It was important to us. That's what our commitment was, but we found ourselves in a position where this is not the right thing to do for those reasons I just said. But saying that, we are focused on moving forward with the strategy.

You know, the investment to carve it out and set it up as a separate entity within a company, that's gonna allow us to do that in a smarter way. Leadership team, I want to give a lot of credit to our automotive leadership team that's going through that transition and a lot of people supporting them, but it's, as you can imagine, it's emotional. This has been a long-term part of our company, okay? And it's, you know, going back to the Model T and more. And so, you know, making that change was not an easy emotional decision. It was an easy financial decision when you looked at the factors.

With that, we're gonna continue down this path and complete this key tactic in our strategy of we wanna take the company as far as becoming a more industrial-like company.

Brian Sponheimer (Research Analyst)

Yeah, no, and I respect the emotion that's involved here. Last one for me, though, on this. Now that the sale of just the light vehicle, it doesn't appear to be something that you can do in the near term, is there any thought to adding the entirety of the vehicle business as something that would be put up for sale, given you see the cyclicality that takes place within the, the commercial vehicle and off-highway markets?

Tom Burke (CEO)

Yeah.

Brian Sponheimer (Research Analyst)

Any thought to that?

Tom Burke (CEO)

So, yeah, the answer is no, okay? We have put a lot of work into Matador, both organizationally and product strategy-wise, and focused on making sure that we have a position where we can maintain our strong positions that are out there and grow that globally. Yes, one of the challenges of that is cyclicality nature of those businesses, and we're going to see that for the next, whatever number of quarters. But we feel very strong that, again, I mentioned relationships that are strong, business wins that we're pleased with, and that we can drive this business forward. And quite frankly, the cash flow return profile is very good. Taking that all into account, yes, the cyclicality standpoint makes it a challenge at times.

But rebalancing that with more diversified industrial business opportunities, whether it's data center and growth we have directly in front of us or other inorganic opportunities that we'll be more freed up to be able to do without the cash constraints given by automotive business, is gonna be a lot more flexibility, strategically, that we're gonna be able to move on.

Brian Sponheimer (Research Analyst)

Okay. Thank you for entertaining my questions.

Tom Burke (CEO)

Thank you, Brian.

Operator (participant)

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

Kathy Powers (VP of Treasurer and Investor Relations)

Thank you. Thank you all for joining us this morning. A replay of the call will be available through our website in about two hours. We hope you have a great day and a great weekend as well. Thanks.

Operator (participant)

This concludes today's conference call. You may now disconnect. Have a great day.