Feb 7, 2017
Executives
Kathy Powers - Vice President, Treasurer and Investor Relations Tom Burke - President and Chief Executive Officer Mick Lucareli - Vice President, Finance and Chief Financial Officer
Analysts
Matthew Paige - Gabelli & Company David Liker - Baird Mike Shlisky - Seaport Global
Operator
Good morning, ladies and gentlemen, and welcome to the Modine Manufacturing Company's Third Quarter Fiscal 2017 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. [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.
Ma’am, go ahead.
Kathy Powers
Thank you. And thank you for joining us today for Modine's third quarter fiscal 2017 earnings call.
With me today are Modine's President and CEO, Tom Burke; and Mick Lucareli, our Vice President, Finance and Chief Financial Officer. We will be using slides for today's presentation.
Those links are available through both the webcast link as well as the PDF file posted on the Investor Relations section of our company website modine.com. Also should you need to exit the call prior to its conclusion, a replay will be available through our website 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 third quarter results and update on our Strengthen, Diversify & Grow strategic initiative including the Luvata HTS acquisition and providing update to our revenue and earnings guidance for fiscal 2017.
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 is my pleasure to turn the call over to Tom Burke.
Tom Burke
Thank you, Kathy and good morning everyone. On today's call I will discuss our third quarter results and provide an update on our Strengthen, Diversify & Grow strategic transformation including the acquisition of Luvata HTS business.
After that, Mick will provide a more detailed review of our consolidated financial results and will update our revenue and earnings guidance for fiscal 2017. I will then provide a few closing remarks prior to opening the call for questions.
As you know we completed Luvata HTS acquisition on November 30. We now operating this business as our commercial and industrial solution segment.
We will refer to this as CIS going forward. Completing this acquisition was a key component in achieving our objectives of our SDG strategic framework introduced over 15 months ago.
In addition to completing the acquisition, we have also continued to identify savings from other components of our SDG initiative, and I will provide an update on where we stand, what is our targets in a few minutes. Moving onto our third quarter results sales were up on a constant currency basis including $35 million of sales from our CIS business in the month of December.
Our non-CIS or base business was down 3% on a constant currency basis primarily due to lower sales in the Americas and Europe segments partially offset by strong sales in the Asia’s segment. Our adjusted operating income was $17.7 million up 3% from the prior year.
As I mentioned in our last call, I was very disappointed with our Q2 performance due to several operating inefficiencies in the Americas and building BHVAC segments. We have fully and appropriately addressed the large majority of the issues resulting in significant improvements sequentially in the third quarter.
A few remaining items have already been or will be corrected in Q4. In addition, I am very pleased with the strong performances in our Asia and Europe segments which also contributed to the improved earnings performance this quarter.
Our adjusted earnings per share were $0.21 for the quarter down a penny from the prior year, primarily due to an increase in interest expense [Indiscernible] taken on to finance the acquisition. Of note, December is seasonally one of the slowest months for CIS business so it’s contribution to our operating income was not material.
As I review each segment, I will update our market outlook for calendar 2017. We are currently in the middle of our fiscal 2018 planning process, but we are able to provide a market outlook for fiscal 2018 with our fourth quarter results.
Now I would like to briefly review the segment results. Turning to page six, sales for the Americas segment were down roughly 10% to $123.4 million and were significantly impacted by lower sales to heavy duty truck customers which were down 42% in the prior year.
We do not expect to see significant improvement in the North American markets this year, however, the markets have declined more than our initial expectations and we expect these conditions to continue into our fourth fiscal quarter. Markets in Brazil continue to be weak across the board with the exception of the agriculture equipment markets where we are seeing some improvements.
While this is offset by a significant decline in our aftermarket sales which continue to be lower than our expectation. The automotive aftermarket in Brazil tends to be a stable market even during recession.
In the past couple of quarters we have seen a 20% year-over-year decline in this market, evidence of just how deep the Brazilian recession is reaching. We are the heat transfer market leader in the Brazilian automotive aftermarket and are maintaining this position despite the dip of sales caused by the market decline.
The drop in sales volume negatively impacted our third quarter gross margin which was down 170 basis points while the markets have not been entirely kind, we recognize that many things are within our control and we have continued to do some significant work in this segment to improve our cost basis of our operation. This includes completing new Washington, Iowa plant closure and accelerating significant procurement savings.
We are also able to offset much of the drop in gross profit with a $2.1 million year-over-year reduction in SG&A expense. During the third quarter we had a higher recovery of development cost and savings from headcount reductions in conjunction with our SDG initiatives.
Taking all those pushes and pose [ph] together, adjusted operating income for the Americas segment was $6.8 [ph] million down $2.8 million from the prior year but significantly up from the second quarter. Next quarter we will update our outlook for 2018 fiscal year, but given the state of the markets we do not expect improvement in our North America market in calendar 2017 and unfortunately we are planning for additional declines of commercial vehicles in off-highway equipments.
We expect the automotive market to be flat which is a small but -- component of our North America business. We also expect to see some improvement in the markets in Brazil and as I mentioned we have already started to see some volume increases in the agricultural markets, where a ramp or significant declines we have seen in the past couple of years these increases are of low base.
Please turn to page seven. As anticipated, sales for our Europe segment were down 4% in the third quarter on a constant currency basis as a result of planned program wind-downs and lower sales to off-highway customers.
The planned program wind-downs included $5 million of commercial vehicles and $2 million with BMW. This was partially offset by higher automotive sales.
Gross margin improved by 170 basis points from the prior year despite the decrease in sales. Similar to last quarter, we achieved a higher gross margin of lower sales due to favorable operating performance and sales mix.
We continue to see better operating performance due to our purchasing initiatives and labor and overhead improvement. Operationally, we continue to transfer production of certain products to Hungary and have broken ground on expansion at our largest facility in Hungary.
This was an important step ensuring that we have capacity to absorb all the newly awarded the transfer business so that we can continue to realize gross margin improvements that we have for the past five quarters. Adjusted operating income was up 12% to $8.4 million due primary to the higher gross profit.
We expect the European automotive market to remain stable, the commercial vehicle to be down about 1% Off-Highway market to be down about 5% in calendar 2017. We expect that we will continue to see growth in our automotive programs as we launch new business and this will be offset by plant wind-downs in the low margin commercial vehicle programs that began last quarter.
We are continuing to focus on supporting our European automotive customers as they intensify the development of the electrification strategy. As I mentioned last quarter, this is a major area of investment for our European customers which expect major growth in these product offerings in the near future.
Please turn to page eight; sales for our Asia segment were up 60% compared to the prior year on a constant currency basis. This significant improvement related primarily to higher sales to automotive and off-highway customers in China, and incremental sales from our new joint venture.
The sales growth we have seen over the past two years have been largely driven by significant volume of layered core oil coolers for programs that we were awarded beginning in 2012. At that time, we mentioned that we expected significant volume increases over the next several years as we launched this critically in [Indiscernible] product.
We continue to aggressively ramp up production towards our mature volumes on these programs and expect double digit growth, sales growth to continue in this segment as new programs continue to launch. I am also encouraged by the continued improved in the Off-highway markets in China and Korea, which have also contributed to our sales growth over the past two quarters.
Higher sales volume led to $2.4 million improvement in gross profit nearly doubliong from the prior year. Gross margin improved by 370 basis points to 17.6%, delivering the highest gross margin of our vehicular segments.
Adjusted operating income for the Asia segment increased $2.4 million in the third quarter compared to the prior year primarily due to higher sales volumes and lower SG&A expenses. We expect the growth trends to continue in Asia with continued improvement in construction markets in China and Korea.
We will continue to benefit from higher volumes of automotive oil coolers as our programs continue to launch. We also expect both the automotive and commercial vehicle market in India to grow 5% which is great news for our high performing India operations.
Turning to page nine, sales for our building HVAC segment was flat compared to the prior year on a constant currency basis. Lower sales of heating and ventilation products in North America were partially offset by higher precision air conditioning sales in the U.K.
North American heating and sales, heating sales were below our expectations due to the mild weather except for a short spike during the cold snap in December. Our gross margin fell 160 basis points to 32.4% but was significantly higher than the 25.8% reported in the second quarter.
The improvement from the second quarter was due to the seasonally higher heating sales in North America and the benefits from cost reduction efforts. We remain focused on improving our cost structure particularly in the U.K.
business. We are seeing the benefit of our past actions including early retirements and other work force reduction and will continue to see ongoing improvements.
In addition we are reviewing all of our business practises for this segment in detail with a goal of bringing our gross margins back to historical levels. The year-over-year decrease in gross margin was mainly due to unfavourable product mix in the U.K.
as we sold higher volume with lower margin product. We have seen a shift in our U.K.
businesses that Brexit has caused a decline in overall investment in our core markets. In response, we have instituted across the board price increase in September and are attacking our cost structure from top to bottom.
Our goal is to significantly improve our gross margin while maintaining a competitive position in the market place. Adjusted operating income was down slightly from the prior year but improved as a percentage of sales.
This decline in gross profit was offset by lower SG&A expense resulting from cost saving initiatives. I am encouraged by the improvement in this segment since the second quarter, but there is still additional work to do particularly in the U.K.
business. As I mentioned last quarter, we have made significant leadership changes that are focused on making improvements to our U.K.
business. As expected, we started seeing results this quarter and should see continued improvements in the fourth quarter.
However, we are lowering our overall expectations for this segment for the remainder of the fiscal year as the warm weather of January most likely resulted in fourth quarter heating sales that are below our original forecast. Please turn to page 10, before turning over to Mick, I’d like to give you an update on our Strengthen, Diversify & Grow objectives including some initial thoughts on our acquisition of Luvata HTS.
I have personally visited seven of the CIS locations have been met with genuine enthusiasm about joining of our two businesses. Both the CIS management team and the general workforce around the world are excited to be part of the Modine family.
We are actively working on the integration of this business and we see many opportunities, great future valuing together. Our dedicated, integration management office has been tasked with driving synergy savings throughout the organization and we have identified actions to reach our initial target of $50 million of cost synergies over the next three or four years.
The significant amount of savings will come from procurement optimization, operational improvements and organizational efficiencies. We also have challenges to address in our new CIS segment, particularly related to a temporary change in product mix with a large data center customer.
This change has resulted in lower year-over-year volumes and margins which we knew prior to completing the acquisition. We will continue to work closely with this important customer to ensure that we have sufficient and timely information to support our planning and production processes.
At Modine, we pride ourselves on our focus on continuous improvement through a methodology we called Modine operating system or MOS. Through MOS we strive to improve every process everyday to create a culture of mentoring, if all is well with the organization.
The administrative offices to the shop floor, we are looking forward to bringing the benefits of MOS to our new CIS business. This acquisition clearly brings together all of the key attributes of our strengthen, diversify and growth strategy, providing us with significant commercial and industrial revenue in transforming our business into a more thermal management company.
The transaction effectively completed all of our diversification and growth transformation goals associated with the SDG strategy. In terms of our core operational goals, our actions during the past 15 months have significantly strengthened our business, leading to over $50 million of annual run rate savings exceeding our original target.
We have achieved a portion of these savings this year and have already seen the positive impact of our results. We estimate that we will achieve an additional $20 million of savings next year including the full benefit of the closure of the Washington Iowa plant and incremental procurement savings.
These savings are critically important to offset the increased cost related to wage inflation, higher material cost and contractual price to our commitments. This along with volume improvements from the eventual recovery in some of our key markets will allow us to reach our 7% to 8% operating margin target.
And with that, I would like to turn it over to Mick for an overview of our consolidated financial results including review of the results of our CIS business for the month of December and to provide an update for our fiscal 2017 guidance.
Mick Lucareli
Thanks, Tom. Please turn to Slide 12.
I’d like to start by saying I am pleased with the significant improvement over the prior quarter and effort of our employees to drive earngins which dealing with the volume challenges. As anticipated, we were able to improve earnings significantly after a difficult Q2 but not able to fully offset additional volume drops in North America, South America and heating.
Beginning with the top line, our third quarter sales increased $21.1 million including $34.7 million of sales from the Luvata HTS acquisition. Excluding CIS, constant currency sales were down $9.5 million or 3% year-over-year.
Reported gross profit of $58.7 million was up slightly for the quarter, however this includes a negative 2.9 million purchase accounting adjustment related to inventory. As a result, gross margin had a negative 80 basis point impact from the inventory step up estimated fair value.
Excluding CIS and its adjustment, gross margin on the base business improved 30 basis points over the prior year to 18.1% and this is on lower sale. Moving on at SG&A where we are keeping a relentless focus on cost control, SG&A of 51.1 million includes two significant items worth noting.
First, we incurred professional fees of $7.2 million per transaction and integration costs related to the acquisition, second, the CIS segment included $4.7 million of us SG&A. Excluding these items, core SG&A was down $4.1 million or 9% lower than the prior year.
Also during the quarter, we recorded $1.6 million of restructuring expenses, these primarily relate to equipment transfers in plant consolidation in the Americas. Interest expense was up $1.8 million over the prior year primarily due to the additional acquisition related debt.
Third quarter adjusted operating income of $17.7 million was up $0.5 million or 3%, and our adjusted earnings per share was $0.21 down $0.02 compared to last year. Given only one month of results the CIS impact was not material to adjusted operating income.
Our EPS was negatively impacted by approximately $0.02 from the incremental interest expense due to the acquisition. The lower table shows the walk of our adjusted operating income.
As usual, we've included a full reconciliation between our reported results and adjusted operating results in the appendix. Our U.S.
GAAP income statement is included in the appendix of this presentation and in our earnings release. Turning to slide 13, in the quarter adjusted free cash flow was $16.6 million, and much improved from last quarter.
Year-to-date operating cash flow has been temporarily impacted by cash restructuring and acquisition related cost. Adjusted free cash flow year-to-date is $10.8 million, which is down from last year.
This is due to the combination of several items, these include slightly lower cash earning, tooling payments, higher working capital and the timing of capital expenditures. Consistent with the past few years we expect our full-year capital spending will remain in the $60 million to $65 million range, including CIS.
The adjustments include restructuring payments to $12.1 million which are related to plant consolidation and severance with the remaining items mainly related to acquisition activities. Turning to slide 14, I want to review Modine’s capital structure which changed significantly as a result of the acquisition.
The table on the upper left breakdown current capital structure including total debt of $514 million. This includes $71 million, a short-term debt and $443 million, a long-term debt.
In conjunction with the acquisition, we entered into and amended and extended credit agreement with the syndicated bank. This includes a renewed $175 million, five-year revolving credit facility and a new $275 million five-year term loan facility.
We also entered into a new $50 million 10-year private placement. The table on the right shows our net debt position along with our current leverage ratio.
Modine currently has $464 million a net debt, up $370 million from the prior year end. Our leverage ratio is now 2.8, up from 1.2 at the prior year end.
We have previously communicated our steady takeover to keep Modine’s leverage ratio between 1.5 and 2.5 and plan to reduce our overall leverage during the next year. For added cushion, I'd like to point out that our debt agreement allow for our leverage ratio to be temporarily raised after the acquisition.
Currently, our max leverage ratio covenant is 3.75 through the second quarter of fiscal 2018 then it drops to 3.5 to the first quarter of fiscal 2019, and finally reversed to 3.25 thereafter. Turing to slide 15, I want to take a few minutes to review the financial implications of the CIS acquisition and potential earnings profile.
We are early in the integration process, but so far things have been going smoothly. We have a dedicated integration team in place that is helping to facilitate a smooth transition and they are now quickly shifting their focus to synergy execution.
As most of you know purchase accounting can be complex and we’re currently in the middle of our analysis. With the December closed, we have included our best estimate of the opening balance sheet and associated increase in non-cash fixed cost which will show up as depreciation and amortization.
Our goal is to complete all purchase accounting adjustments in Q4, even though a few topics may continue in the fiscal 2018 at the various items are fully evaluated. As I mentioned earlier our Q3 included only one month of CIS sales and the adjusted operating income impact with a material.
Based on initial estimates CIS incurred $1 million of additional intangible amortization and fixed asset depreciation expense created through the acquisition. As we look ahead for fourth quarter forecast for CIS, I want to highlight that the numbers are in line with our pre-closed expectation.
We anticipate CIS sales in the $125 million to $135million range and adjusted operating income of $4 million to $5 million. Keep in mind that this includes at least $3 million of increased amortization and depreciation expense due to the purchase accounting impact.
Now switching gears to full year expectations, our detailed fiscal 2018 guidance will be provided in next quarter, but we expect CIS to be accretive in the first full fiscal year. To put things in perspective, prior to the acquisition Luvata HTS annual sales were approximately $500 million with an operating margin of 8% to 9%.
Going forward, we will have to adjust for purchase accounting which we estimate will have an annual impact of $13 million to $14 million through increase non-cash depreciation and amortization expenses. We also anticipate an incremental annual interest expense of $14 million to $15 million.
On a pro forma basis, this clearly leads to significant earnings accretion both on operating income and EPS. In addition, our goal is offset incremental depreciation, amortization and improve earnings through cost synergies.
I'll provide more information on those cost benefits and timing next quarter. Even though we’re only about 60 days into the acquisition, I continue to be optimistic about the financial impact from CIS.
Now, let’s turned our fiscal 2017 guidance on slide 16. We are updating our fiscal 2017 guidance following the CIS acquisition and other market factors in our base business including the recent rise in metal prices, the change in exchange rate and a declining market outlook in Americas to building HVAC since we last updated in October.
We now expect sales to be up 9% to 11% from the prior year. This includes four months of sales from CIS of approximately $160 million to $170 million.
This also reflects the strengthening of the U.S. dollar which just had a negative impact on our sales.
The increased from CIS is partially offset by the lower sales outlook in our base business which we estimate will be down 1% to 3%. We expect adjusted operating income to remain in the same range of $65 million to $71 million based on the moving parts I just described.
This equates to an increase of 3% to 12% over the prior year, in addition to the lower sales outlook we have considered the rapid increase in commodity metal prices since September both for aluminium and copper. Improvements in Europe and Asia along with further SG&A cost reductionS have helped to offset the economic challenges.
Last but not least, the addition of CIS is also offsetting these headwinds. We expect adjusted EPS to be between $0.74 and $0.80 down from the prior range of $0.77 to $0.87.
This change is primarily driven by $5 million of incremental interest resulting from the acquisition. So to wrap up, we made a lot of progress in achieving our second half target and a lot of hard work remains.
As Tom noted we are seeing the operational improvements in all regions with further opportunity in the fourth quarter. We are clearly facing some market headwinds in the Americas in HVAC segments, but were glad to have CIS on board and lead the way into fiscal 2018.
Integration plans are well underway and we are pleased with the opportunities that are being presented. So with that Tom, I turn it back to you.
Tom Burke
Thank, Mick. And as Mick mentioned last quarter we mentioned that we expected that our second half performance would improve significantly from the first half of the year and we have delivered with our third quarter results.
I am pleased with the excellent progress being made on addressing the majority of the second quarter operational issues and can confirm that we continue to remediate remaining issues that impacted our third quarter results and expected continued and sustained improvements in Q4. However, as we look forward we see continued market-driven volume challenges in the Americas building HVAC segments.
In addition, we expect higher metal prices and foreign exchange will continue to pressure our earnings. I’m pleased that earnings accretion from the addition of the CIS business will offset some of the challenges and although it is still early, we are very confident this acquisition will deliver to Modine and it shareholders a value we anticipated.
That being said, there’s plenty of hard work being done around this organization to build strong stronger, more diversified industrial company. We will deliver cost savings objectives of our SDG strategy and continue to benefit from our actions into the fiscal 2018 and beyond.
The worker and our cost structure allow us to continue to provide our customers with superior products at competitive prices. In addition, the creation of the commercial and industrial solutions business -- the creation of the commercial and industrial solutions business build through the acquisition of Luvata HTS allows us to expand our presence in familiar markets with products and technologies are squarely in our wheelhouse.
We’re actively working on the integration of this business in Modine and look forward to providing updates along the way. With that, we’ll take your questions.
Operator
[Operator Instructions] Our first question comes from Matthew Paige from Gabelli & Company. Your line is now open.
Matthew Paige
Hey, good morning everybody.
Tom Burke
Good morning.
Mick Lucareli
Good morning.
Matthew Paige
Just wanted to start off the first question with about the recent proposals that we’ve seen regarding tax policies, I guess given your diverse geographic end market how much benefit do you think you could even get from a lower corporate tax rate and along those lines could also speak to the impacts that you see from a potential water adjustments tax?
Mick Lucareli
Yes. We’re getting a lot of questions on that and I think the short answer is we really need to wait to see how all policies shakeout before we can assess the impact to Modine.
I think if there's any type of tax changed, there’s clearly going to be a short term non-cash impacted as we adjust our balance sheet, our company has a lot to adjust tax -- adjust for tax assets and liabilities. And then going forward from a cash basis, really have to assess, hopefully that will only be positive news from the cash tax basis going forward.
Matthew Paige
All right. And then, you also mentioned earlier special benefits from electric vehicles, could you speak to some of the products that serve those and how you view that potential growth in that market?
Tom Burke
Sure. Obviously, this market is really eating up.
We’ve had the initial success in North America with North American base companies providing whether we call chillers which is part of the overall system of cooling batteries in the passenger compartment, that’s expand into higher content and into other what we called powertrain cooling products with the overall system and then looking at battery plates. So that’s been our basis from the last couple of years for North America, but this is picking up globally now.
So as I mentioned the Europe customers really in last year have accelerated the electrification strategies. We’re very involved in those products.
So think of battery plate coolers, think of chillers have managed overall system performance and specific components have managed the overall what we call powertrain that is the balance between heating and cooling of drive train and passenger thermal management compartments. So, a lot of potential content, lot of acceleration going into this market with big -- that are going on in the world, we’re saying that they expect to see significant increase restarting in electric vehicles over the next five years.
Matthew Paige
Great. And then last one from me, this is a little housekeeping question.
Do you have that share count at the end of the quarter?
Mick Lucareli
Yes. I’ll grab that for you.
So in the quarter, $47.3 million – at the end of the quarter a $47.3 and then in the press release is still the weighted average shares use in the quarter 48.5.
Matthew Paige
Got it. Okay.
Appreciate it.
Mick Lucareli
Thank you.
Operator
And our next question comes from David Liker from Baird. Your line is now open.
David Liker
Good morning, everyone.
Tom Burke
Hi, David.
David Liker
Just first on CIS, I guess this is the housekeeping item to start with. Is CIS is all over Luvata in CIS and is CIS only Luvata or there are some moving pieces between the other segments?
Tom Burke
CIS is Luvata plus the coils business that we develop, that we have established in North America, so think about that $50 million to $60 million worth of coils business in North America that we’ve had or something that is being fallen into that business as well as we speak.
David Liker
But that's not in the numbers for the quarter, but I could see….
Tom Burke
I would say it’s a big picture, that’s where we’re going, so for the quarter Mick go ahead.
Mick Lucareli
Yes. Now, for the quarter and then for -- the really the plan will be for the next fiscal year, while we’re integrating Luvata, the business Tom reference will stay in the Americas section and we have plans to operationally that will be run and lead out immediately by our new leadership team at CIS.
But from the accounting standpoint we’ll go through as part of our integration, how to move that from an accounting standpoint from the Americas into the CIS segment. That would probably take most of into fiscal 2018, David.
David Liker
Okay. And then on the – Tom, I know you talk about the datacenter, I know you talk this a little bit, but to new frame that first in terms of size and timing and what needs to happen there on CIS or Luvata?
Tom Burke
Okay. The impact I mentioned, the large customer…
David Liker
The large datacenter customer…
Tom Burke
Yes. So yes, there is a – we saw in due-diligence and discovered and of course confirmed that that there is a transition of product mix going on with the large customer in the datacenter market.
That’s again being confirmed both internally and with the customers, they transition from one product platform to another, so its kind of – think about it as a low, okay, as I make that transition to just temporary position to a new just call it product platform, I guess the best way to call it, the significant product platform of content. But – so again everything is – we’re please with the customer relationship and the opportunity as we transition, think of it from one product platform to another there this transition phase that we’re going through and that leaves a lower margin product that’s from earlier, the product platform transition to the new ones.
So that's the mix story going on. So, I can’t give you any timing focus on that, but that transition we will inform of course our shareholders and investors at [Indiscernible] but again it’s as we saw and as right as we plan for and we’ll see that transition over the next several quarters.
David Liker
Okay. And then on China, the Asian business, that nice to see in those volumes up at these levels, so I’m not sure that's exciting for you folks?
Tom Burke
Very exciting.
David Liker
Yes, guys, you continue to ramp that contract that you have there. I mean you’re pushing out 30 million a quarter run rate there.
How much more upside is there on the volume out of Asia?
Tom Burke
Well, we have not hit a mature level yet, so we do have upside to where we’re running right now, and especially we’re really encouraged just to see that as we gain share in automotive side which even really targeting is that we’re seeing some strengthening in the construction business as well which is encouraging. So, all in all I’d say we feel very positive and as I mentioned we continue – expect to see double-digit growth in that segment.
David Liker
Yes. And if we look at what the mix of that revenue is today between the automotive and the construction side, what would you think it is?
Tom Burke
Yes. It’s approaching 50% automotive now, where it used be about 80% construction, so it's about a 50/50 automotive, 35% construction, probably then the rest commercial vehicle.
David Liker
Okay, great. And then what about the profitability there, a nice margins there.
What’s your longer-term target, so what you think that’s up little bit?
Mick Lucareli
Yes. It’s been a wild data and I’m not sure we’d I’d see a day where we talk about a quarter where Asia had the highest operating margin of all of our segments.
I think from here on now its going to be – I think its really going to be – we’re going to reach a normalization year, I think in the 17% to 18% tight gross margin, SG&A has been tightly managed, so more inflationary levels. So, I think from here it’s all going to be about a volume story with fairly stable margins.
David Liker
Okay. And then one last item on China, what the tax there on the automotive side and some free [ph] activity in December, I know that folks are just coming it back from the New Year's, but do you have any sense of what the bill rates are you currently running as we settle into the new taxes regime there?
Tom Burke
It don’t. I don’t have that, but we can get back on that [Indiscernible].
David Liker
No one seems to have it. Okay.
Thanks.
Tom Burke
Thank you, David.
Operator
[Operator Instructions] Next question comes from Mike Shlisky from Seaport Global. Your line is now open.
Mike Shlisky
Hey, guys, good morning.
Tom Burke
Good morning.
Mick Lucareli
Hi, Mike.
Mike Shlisky
I wanted to touch on the few things here. First on Luvata and CIS, the annual interest expense of $14 million to $15 million you put in your slides and comments, does that assume no repayment from today onward, and can you maybe comment for us a little bit on the cadence of when some of the debt might be paid down either in Calendar 2017 or in fiscal 2018?
Mick Lucareli
Yes. So that is full year annualized interest rate, interest payment, Mike assuming that that debt does stay on for the full year.
Really its fairly we’ve model there and looking at even though we’re in a planning as fairly evenly spread quarter-to-quarter, partly depend on our final cash flows next year, that will be the main driver of it. We do have plans to pay down the debt.
So I think we’d like to say the $14 million to $15 million is worth case, but I can't comment on the opportunity for us to go lower until we really complete our plan and the timing of cash flow.
Mike Shlisky
Okay. All right.
Got it. And also wanted to ask about your outlook for North America both heavy-duty and medium-duty, is it fair to say on heavy duty that perhaps the worst part of it as far as declines year-over-year could be in your fiscal fourth quarter or the calendar first quarter here.
And might not be quite as negative as we go through fiscal 2018?
Tom Burke
We certainly hope its not. That’s fore sure, but yes, its been a really drop last two quarters means on Q3 and what we anticipate this quarter, is that when even out more that would be great.
Mick Lucareli
We’re not so far, Mike, we’re not just to ask to that looking at it really any differently than other market data sources if they are correct and that there is a stabilization or even start to improve in the second half of calendar 2017, to your question that could be good for us as we come out at 2017 and even though our Q4 which would be early 2018 obviously.
Mike Shlisky
Okay. Got it.
And then kind of following up on that question on medium-duty, I see outlook here is little about decline of 5% in calendar 2017, but some of the forecasters are saying, up 5% or 6% on the positive side. So I was just wondering what you’re seeing differently between the big forecasters and what your business is?
Tom Burke
Well, I just really anticipate obviously with the planning process of 2018. We will look at that going forward and in the next quarter we can give higher outlook.
But right now that’s kind of what are -- we’ve kind of triangulated with the information both from the external sources and internally what our people are thinking. So, it has not been affected as much clearly.
We have a proposition on medium duty, and that's we feel great about that, so we’ll get back to you next quarter when we see that outlook going forward.
Mike Shlisky
Okay. And one last one from me.
I just want to clarify. Do you say that mix is going to be a benefit for you in calendar 2017 in Europe, as we saw the business in fiscal 2017?
Tom Burke
Yes. The mix of commercial truck volume going down, you’re talking about.
Mike Shlisky
It sounds to me as you were just kind of just talking your overall margin mix with exiting some stuff in calendar 2016 and improve your outlook for margins in Europe in Calendar 2017, is that what you were referring to, I just want to clarify?
Mick Lucareli
Yes. I believe as Tom was describing as we will continue is what you have seen in the last few quarters as we continue to launch the automotive engine program, that’s offsetting the – has been offsetting the wind-down of the commercial vehicle radiator program, we would expect that to be a positive mix shift.
Mike Shlisky
Okay. I think that clears it up.
Thank you very much guys.
Operator
At this time, I’m showing no further questions. I would now like to turn the conference back to Kathy Powers.
Mick Lucareli
Yeah, this Mick. One comment Kathy before I turn it back.
Here just wanted to correct on the first question on the shares outstanding as of December 31, $50.1 million and then as of March 31, 2016 $47.4 million. So March 31, 2016 $47.4 and December 31, 2016 $50.1 million.
Thank you.
Kathy Powers
All right. Thank you Mick.
This concludes today’s call. Thank you for joining us this morning and thanks again for your interest in Modine.
Operator
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program.
You may now all disconnect. Everyone have a great day.