# Modine Manufacturing Co: Form 10-Q for the period ended Dec 31, 2009

- Company: [Modine Manufacturing Co](/companies/mod.md) (CIK 67347)
- Form: 10-Q
- Filed: 2010-02-08
- Accepted by EDGAR: Feb 8, 2010, 22:21 ET
- Period: 2009-12-31
- Accession: 0001140361-10-004720
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/67347/000114036110004720/form10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/67347/000114036110004720/

## Management's discussion and analysis

As filed, 66,917 characters.

When we use the terms “Modine,” “we,” “us,” the “Company,” or “our” in this report, unless the context otherwise requires, we are referring to Modine Manufacturing Company. Our fiscal year ends on March 31 and, accordingly, all references to quarters refer to our fiscal quarters. The quarter ended December 31, 2009 is the third quarter of fiscal 2010.

*Third Quarter Overview:* Net sales in the third quarter of fiscal 2010 declined from the third quarter of fiscal 2009 as a result of the weak global economy. Significant reductions in direct and indirect costs in our manufacturing facilities as a result of our manufacturing realignment activities under our four-point plan resulted in a 420 basis point improvement in gross margin from the third quarter of fiscal 2009 to the third quarter of fiscal 2010. This four-point plan includes manufacturing realignment, portfolio rationalization, SG&A expense reduction and capital allocation discipline. During the third quarter of fiscal 2010, we announced the closure of our Harrodsburg, Kentucky facility, which reflects our continued focus on realigning our manufacturing footprint to achieve greater efficiencies in scale. We recognized income from continuing operations of $2.1 million for the third quarter of fiscal 2010, which represents an improvement of $58.6 million from the loss from continuing operations of $56.5 million in the third quarter of fiscal 2009 due to the favorable impact of recent cost reduction activities. The third quarter of fiscal 2009 included significant restructuring charges primarily for substantial workforce reductions in North America and Europe as part of our cost reduction efforts. In addition, goodwill and long-lived asset impairment charges were recorded in the third quarter of fiscal 2009 within our Original Equipment – Europe and Original Equipment – North America segments.

On December 23, 2009, we sold 100 percent of the shares of our South Korea-based vehicular heating, ventilation and air conditioning (HVAC) business as a result of our portfolio rationalization focus. We received net cash proceeds of $11.2 million and recognized a loss on sale, net of taxes, of $0.4 million for the three months ended December 31, 2009. The entire cash proceeds were used to further reduce our indebtedness. Our reduced capital spending and strong operating results during the quarter allowed us to reduce our indebtedness to a total debt balance of $131.7 million at December 31, 2009 as compared to $249.2 million at March 31, 2009.

*Year-To-Date Overview:* Net sales in the first nine months of fiscal 2010 decreased 27.4 percent from the first nine months of fiscal 2009 driven by overall sales volume declines as a result of the weak global economy particularly within the automotive, medium/heavy duty truck and agriculture and construction markets. Sales volumes decreased across most of the segments of our business. In addition, the unfavorable impact of foreign currency exchange rate changes contributed to approximately 4.5 percent of this decline in sales. Gross margin improved 80 basis points from the first nine months of fiscal 2009 to the first nine months of fiscal 2010 due to the reduction in direct and indirect costs in the manufacturing facilities due to cost reduction actions taken during fiscal 2009 and the impact of favorable materials pricing. SG&A expenses for fiscal 2010 year-to-date decreased 27.1 percent from the same period in fiscal 2009 reflecting our intense focus on lowering our administrative cost structure and executing on our portfolio rationalization strategy. Our loss from continuing operations for the first nine months of fiscal 2010 decreased $54.4 million from the first nine months of fiscal 2009 as a result of the reduction in SG&A costs year over year and significant restructuring and asset impairment charges recorded during the first nine months of fiscal 2009.

On September 30, 2009, we completed a public offering of 13.8 million shares of our common stock for proceeds of $93.0 million after deducting underwriting discounts and commissions of $5.1 million and legal, accounting and printing fees of $0.6 million. We initially used the proceeds to reduce our outstanding indebtedness.

#### CONSOLIDATED RESULTS OF OPERATIONS – CONTINUING OPERATIONS

The following table presents highlights of the consolidated results from continuing operations on a sequential basis from the second quarter of fiscal 2010 to the third quarter of fiscal 2010:

*(dollars in millions)*

| For the three months ended | December 31, 2009 $'s | September 30, 2009 $'s |
| --- | ---: | ---: |
| Net sales | **$302.4** | $282.3 |
| Gross margin | **15.8%** | 15.0% |
| Selling, general and administrative expenses | **$40.7** | $37.0 |
| Earnings (loss) from continuing operations before income taxes | **$2.4** | $(4.0) |
| Adjusted EBITDA | **$25.2** | $22.7 |

Net sales improved 7.1 percent from the second quarter of fiscal 2010 to the third quarter of fiscal 2010, which we believe provides a good indication of stabilization and selective, modest improvements in the markets we serve. Gross margin increased 80 basis points from the second quarter of fiscal 2010 to the third quarter of fiscal 2010, which is primarily attributable to the higher quarter-over-quarter sales volumes and a significant reduction in direct and indirect costs in our manufacturing facilities as a result of actions taken during fiscal 2009. SG&A expenses have been relatively consistent throughout fiscal 2010 due to our intense focus on lowering our cost structuring, which started in fiscal 2009. During the third quarter of fiscal 2010, we recorded earnings from continuing operations before income taxes of $2.4 million, which improved slightly from the second quarter of fiscal 2010 due to the favorable gross margin performance and decreased interest costs. The second quarter of fiscal 2010 included a $3.4 million prepayment penalty incurred in conjunction with the debt paydown from the proceeds of our common stock offering. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) improved based on the favorable impact of our cost reduction efforts and increase in sales volumes. See Liquidity and Capital Resources in this item for further discussion and the calculation of adjusted EBITDA.

The following table presents consolidated results from continuing operations on a comparative basis for the three and nine months ended December 31, 2009 and 2008:

*(dollars in millions)*

|  | Three months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales | Nine months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **302.4** | **100.0%** | 325.6 | 100.0% | **838.3** | **100.0%** | 1,153.9 | 100.0% |
| Cost of sales | **254.7** | **84.2%** | 287.7 | 88.4% | **712.4** | **85.0%** | 990.6 | 85.8% |
| Gross profit | **47.7** | **15.8%** | 37.9 | 11.6% | **125.9** | **15.0%** | 163.4 | 14.2% |
| Selling, general and administrative expenses | **40.7** | **13.5%** | 43.3 | 13.3% | **116.2** | **13.9%** | 159.3 | 13.8% |
| Restructuring expense (income) | **1.1** | **0.3%** | 25.3 | 7.8% | **(0.9)** | **-0.1%** | 28.1 | 2.4% |
| Impairment of goodwill and long-lived assets | **0.3** | **0.1%** | 27.3 | 8.4% | **5.1** | **0.6%** | 30.5 | 2.6% |
| Income (loss) from operations | **5.7** | **1.9%** | (58.0) | -17.8% | **5.5** | **0.7%** | (54.5) | -4.7% |
| Interest expense | **3.8** | **1.3%** | 4.0 | 1.2% | **18.9** | **2.3%** | 9.6 | 0.8% |
| Other (income) expense – net | **(0.4)** | **-0.1%** | 1.7 | 0.5% | **(7.1)** | **-0.8%** | 1.4 | 0.1% |
| Earnings (loss) from continuing operations before income taxes | **2.4** | **0.8%** | (63.8) | -19.6% | **(6.3)** | **-0.8%** | (65.5) | -5.7% |
| Provision for (benefit from) income taxes | **0.2** | **0.1%** | (7.3) | -2.2% | **2.1** | **0.3%** | (2.7) | -0.2% |
| Earnings (loss) from continuing operations | **2.1** | **0.7%** | (56.5) | -17.4% | **(8.4)** | **-1.0%** | (62.8) | -5.4% |

#### Comparison of Three Months Ended December 31, 2009 and 2008

Third quarter net sales of $302.4 million were 7.1 percent lower than the $325.6 million reported in the third quarter of fiscal 2009. The decrease in revenues was driven by overall sales volume declines as a result of the weak global economy partially offset by $22.2 million of favorable foreign currency exchange rate changes. The most significant sales volume decreases were experienced within our Original Equipment – North America segment.

During the third quarter of fiscal 2010, gross margin improved 420 basis points from 11.6 percent in the third quarter of fiscal 2009 to 15.8 percent in the third quarter of fiscal 2010. The improvement in gross margin is the result of the reduction in direct and indirect costs in the manufacturing facilities as a result of cost reduction actions taken during fiscal 2009.

SG&A expenses decreased $2.6 million from the third quarter of fiscal 2009 to the third quarter of fiscal 2010 due to the impact of fiscal 2009 cost reduction actions, which include a workforce reduction at the Corporate headquarters in Racine, Wisconsin and throughout the European facilities, including the European headquarters in Bonlanden, Germany.

Restructuring expense (income) is primarily comprised of severance costs incurred as a result of actions taken under our four-point plan. During the third quarter of fiscal 2010, we recorded $1.2 million of restructuring charges as the result of the announced closure of our Harrodsburg, Kentucky facility. During the third quarter of fiscal 2009, we recorded restructuring expenses of $25.3 million, which represents severance charges primarily related to a workforce reduction in our Racine, Wisconsin headquarters and a planned workforce reduction throughout our European facilities including the European headquarters in Bonlanden, Germany.

During the third quarter of fiscal 2009, we recorded impairment charges of $27.3 million. This includes a goodwill impairment charge of $9.0 million and a long-lived asset impairment charge of $10.6 million, both recorded in our Original Equipment – Europe segment, and a long-lived asset impairment charge of $7.8 million recorded in our Original Equipment – North America segment.

Results from operations improved $63.7 million from the reported loss from operations of $58.0 million in the third quarter of fiscal 2009 to the reported income from operations of $5.7 million in the third quarter of fiscal 2010. The improvement in gross margin and absence of significant restructuring and asset impairment charges were the primary factors contributing to this improvement in results from operations.

Interest expense is comparable quarter over quarter. Interest expense incurred during the third quarter of fiscal 2010 related to a lower debt balance than during the third quarter of fiscal 2009 yet at a substantially higher interest rate.

Other (income) expense increased $2.1 million from $1.7 million of expense recorded in the third quarter of fiscal 2009 to $0.4 million of income recorded in the third quarter of fiscal 2010. The increase in other (income) expense was primarily related to foreign currency transaction gains recorded in the third quarter of fiscal 2010 on inter-company loans denominated in a foreign currency.

During the third quarter of fiscal 2010, we recorded a $0.2 million provision for income taxes, which represents an effective tax rate of 10.1 percent. This compares to a $7.3 million benefit from income taxes recorded during the third quarter of fiscal 2009, which represents an effective tax rate of -11.4 percent. During the second quarter of fiscal 2010, we recorded a valuation allowance of $3.8 million predominantly against the net deferred tax assets in the U.S. as we continue to assess that it is more likely than not that these assets will not be realized in the future.

Income from continuing operations of $2.1 million in the third quarter of fiscal 2010 was an improvement of $58.6 million from the loss from continuing operations of $56.5 million in the third quarter of fiscal 2009. In addition, diluted earnings per share from continuing operations of $0.05 for the third quarter of fiscal 2010 was an improvement from diluted loss per share from continuing operations of $1.76. These improvements are primarily related to the improved gross margin and the absence of significant restructuring and asset impairment charges in the third quarter of fiscal 2010.

Fiscal 2010 year-to-date net sales of $838.3 million were $315.6 million lower than the $1,153.9 million reported in the same period last year. The decrease in revenues was driven by overall sales volume declines as a result of the weak global economy. Automotive and medium/heavy duty truck sales declined approximately 10.6 percent and 29.1 percent, respectively compared to the first nine months of fiscal 2009. In addition, unfavorable foreign currency exchange rate changes contributed to $14.3 million of the decrease. Significant sales volume declines were experienced throughout most of the segments of our business.

Fiscal 2010 year-to-date gross profit decreased $37.5 million from the same period last year. The year over year reduction in net sales of $315.6 million and the resulting underabsorption of fixed costs in our manufacturing facilities was the most significant factor contributing to the reduction in gross profit. Partially offsetting this decline are improvements related to the substantial reduction in direct and indirect costs in the manufacturing facilities as a result of cost reduction actions taken during fiscal 2009 and the impact of favorable materials pricing. These two improvements were largely equal factors which contributed to the year over year improvement in gross margin from 14.2 percent in the first nine months of fiscal 2009 to 15.0 percent in the first nine months of fiscal 2010.

Fiscal 2010 year-to-date SG&A expenses decreased $43.1 million from the same period last year, reflecting our intense focus on lowering our administrative cost structure and executing on our portfolio rationalization strategy. Incremental consulting fees of $3.2 million were incurred during the first nine months of fiscal 2009 related to the ongoing restructuring activities in North America, which also contributed to the year-over-year decrease in SG&A expenses.

Restructuring income of $0.9 million was recorded during the first nine months of fiscal 2010 related to the reversal of severance liabilities within our European business as the result of favorable benefits negotiations partially offset by restructuring charges related to the announced closure of our Harrodsburg, Kentucky facility. We recorded restructuring charges of $28.1 million during the first nine months of fiscal 2009 related to a workforce reduction in our Racine, Wisconsin headquarters and a planned workforce reduction throughout our European facilities including the European headquarters in Bonlanden, Germany under our four-point plan.

During the first nine months of fiscal 2010, we recorded impairment charges of $5.1 million primarily related to long-lived assets in our North American business for certain program assets that were not able to support their asset bases and for the Harrodsburg, Kentucky manufacturing facility based on our intentions to close this facility. During the first nine months of fiscal 2009, we recorded impairment charges of $30.5 million including a goodwill impairment charge of $9.0 million in our Original Equipment – Europe segment and a long-lived asset impairment charge of $21.5 million against certain long-lived assets in our European, North American and Commercial Products businesses. These charges were related to certain manufacturing facilities with projected cash flows not able to support their asset bases, program assets that were not able to support their asset bases and assets no longer in use, as well assets related to cancelled programs.

Fiscal 2010 year-to-date interest expense increased $9.3 million over the same period last year, based on increased borrowings early in fiscal 2010 with increased interest rates along with the $3.4 million prepayment penalty to the holders of our senior notes in connection with the mandatory prepayments of debt with a portion of the cash proceeds from the common stock offering on September 30, 2009. Also included in interest expense was the amortization of $0.8 million of capitalized debt issuance costs and interest rate derivatives in proportion with the mandatory prepayment of the senior notes.

Fiscal 2010 year-to-date other income increased $8.5 million over the same period last year. The increase was partially related to foreign currency exchange gains on inter-company loans denominated in a foreign currency. In addition, we sold our 50 percent ownership of Anhui Jianghaui Mando Climate Control Co. Ltd. resulting in a gain of $1.5 million during the first quarter of fiscal 2010.

During the first nine months of fiscal 2010, we recorded a $2.1 million provision for income taxes, which represents an effective tax rate of 33.8 percent. This compares to a $2.7 million benefit from income taxes recorded during the first nine months of fiscal 2009, which represented an effective tax rate of -4.1 percent. During the first nine months of fiscal 2010, we recorded a valuation allowance of $6.2 million predominantly against the net deferred tax assets in the U.S. as we continue to assess that it is more likely than not that these assets will not be realized in the future. During the first nine months of fiscal 2009, we recorded valuation allowance charges of $17.8 million primarily against the net deferred tax assets in the U.S.

Loss from continuing operations improved $54.4 million from the first nine months of fiscal 2009 to the first nine months of fiscal 2010. In addition, diluted loss per share from continuing operations improved from a $1.96 loss per share in the prior year to a loss of $0.23 per share in the current year. The significant decline in SG&A costs and the absences of significant restructuring and asset impairment charges from fiscal 2009 were the primary drivers of this improvement.

#### DISCONTINUED OPERATIONS

During fiscal 2009, we announced the intended divestiture of our South Korea-based heating, ventilating and air conditioning (HVAC) business. We determined during the fourth quarter of fiscal 2009 that this business should be presented as held for sale and as a discontinued operation in the consolidated financial statements.

The following table presents the quarterly results of the South Korea HVAC business reported through the third quarter of fiscal 2009, which were separately presented as a component of earnings (loss) from discontinued operations in subsequent filings (amounts in thousands):

|  | Fiscal 2009 Quarter Ended June 30 | Sept. 30 | Dec. 31 |
| --- | ---: | ---: | ---: |
| Net sales | $61,847 | $42,776 | $39,622 |
| Cost of sales and other expenses | 60,814 | 44,292 | 39,489 |
| Earnings (loss) before income taxes | 1,033 | (1,516) | 133 |
| Provision for (benefit from) income taxes | 854 | (359) | 100 |
| Earnings (loss) from discontinued operations - South Korea | $179 | $(1,157) | $33 |

As a result of separately classifying the South Korea HVAC business as a discontinued operation, our previously reported earnings (loss) from continuing operations is revised as follows:

|  | Fiscal 2009 Quarter Ended June 30 | Sept. 30 | Dec. 31 |
| --- | ---: | ---: | ---: |
| Earnings (loss) from continuing operations as previously reported | $6,763 | $(14,064) | $(56,478) |
| Earnings (loss) from discontinued operations - South Korea | 179 | (1,157) | 33 |
| Earnings (loss) from continuing operations - revised | $6,584 | $(12,907) | $(56,511) |

On December 23, 2009, we sold 100 percent of the shares of our South Korea-based HVAC business for net cash proceeds of $11.2 million and recognized a loss on sale, net of taxes, of $0.4 million for the three months ended December 31, 2009.

#### SEGMENT RESULTS OF OPERATIONS

The following is a discussion of our segment results of operations for the three and nine months ended December 31, 2009 and 2008:

### Original Equipment - Asia

*(dollars in millions)*

|  | Three months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales | Nine months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **8.9** | **100.0%** | 4.2 | 100.0% | **22.4** | **100.0%** | 13.2 | 100.0% |
| Cost of sales | **8.7** | **97.8%** | 4.4 | 104.8% | **22.6** | **100.9%** | 13.1 | 99.2% |
| Gross profit | **0.2** | **2.2%** | (0.2) | -4.8% | **(0.2)** | **-0.9%** | 0.1 | 0.8% |
| Selling, general and administrative expenses | **0.7** | **7.9%** | 2.0 | 47.6% | **3.2** | **14.3%** | 6.4 | 48.5% |
| Impairment of long-lived assets | **0.2** | **2.2%** | - | 0.0% | **0.2** | **0.9%** | - | 0.0% |
| Loss from continuing operations | **(0.7)** | **-7.9%** | (2.2) | -52.4% | **(3.6)** | **-16.1%** | (6.3) | -47.7% |

#### Comparison of Three Months Ended December 31, 2009 and 2008

The Original Equipment – Asia segment is currently in the expansion phase. Net sales increased $4.7 million from the third quarter of fiscal 2009 to the third quarter of fiscal 2010 due to our growing presence in the region and the completion of construction on a new facility in Chennai, India. This facility began production in the second quarter of fiscal 2009 and is currently in low volume production. Gross margin improved 700 basis points from the third quarter of fiscal 2009 to the third quarter of fiscal 2010 due to manufacturing efficiencies with the increased sales volumes. SG&A expenses decreased $1.3 million from the third quarter of fiscal 2009 to the third quarter of fiscal 2010 due to cost reduction efforts within this region. The loss from continuing operations decreased $1.5 million over the periods presented due to the improved gross margin and the decrease in SG&A costs.

Original Equipment – Asia fiscal 2010 year-to-date net sales increased $9.0 million from the same period last year due to expansion in the Asia region and incremental sales from a new manufacturing facility completed during the second quarter of fiscal 2009. The negative margin for the first nine months of fiscal 2010 is related to the start-up activities at this facility. SG&A expenses decreased $3.2 million as a result of positive cost reduction efforts within the region. The loss from continuing operations decreased $2.7 million over the periods presented based on the cost reduction efforts in SG&A.

### Original Equipment - Europe

*(dollars in millions)*

|  | Three months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales | Nine months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **127.0** | **100.0%** | 112.9 | 100.0% | **344.6** | **100.0%** | 499.9 | 100.0% |
| Cost of sales | **109.3** | **86.1%** | 104.0 | 92.1% | **299.5** | **86.9%** | 426.0 | 85.2% |
| Gross profit | **17.7** | **13.9%** | 8.9 | 7.9% | **45.1** | **13.1%** | 73.9 | 14.8% |
| Selling, general and administrative expenses | **11.5** | **9.1%** | 11.3 | 10.0% | **32.6** | **9.5%** | 39.8 | 8.0% |
| Restructuring (income) expense | **(0.2)** | **-0.2%** | 21.4 | 19.0% | **(3.5)** | **-1.0%** | 21.4 | 4.3% |
| Impairment of goodwill and long-lived assets | **-** | **0.0%** | 19.6 | 17.4% | **0.2** | **0.1%** | 19.6 | 3.9% |
| Income (loss) from continuing operations | **6.4** | **5.0%** | (43.4) | -38.4% | **15.8** | **4.6%** | (6.9) | -1.4% |

#### Comparison of Three Months Ended December 31, 2009 and 2008

Original Equipment – Europe net sales increased $14.1 million from the third quarter of fiscal 2009 to the third quarter of fiscal 2010, driven by the favorable impact of foreign currency exchange rate changes. Gross margin improved from 7..9 percent during the third quarter of fiscal 2009 to 13.9 percent during the third quarter of fiscal 2010 primarily as a result of the reduction of indirect costs in the manufacturing facilities. Restructuring income of $0.2 million was recorded during the third quarter of fiscal 2010 related to the reversal of severance liabilities as the result of favorable benefits negotiations. Restructuring charges of $21.4 million were recorded during the third quarter of fiscal 2009 as the result of a plan to reduce the workforce throughout the European facilities including at the European Headquarters in Bonlanden, Germany. A goodwill impairment charge of $9.0 million was recorded during the third quarter of fiscal 2009 based on a declining outlook for this segment. In addition, a long-lived asset impairment charge of $10.6 million was recorded during the third quarter of fiscal 2009 related to certain manufacturing facilities with projected cash flows unable to support their asset bases. The income from continuing operations of $6.4 million during the third quarter of fiscal 2010 was an improvement of $49.8 million from the loss from continuing operations of $43.4 million incurred in the third quarter of fiscal 2009 primarily due to the restructuring and impairment charges recorded during the prior year third quarter.

Original Equipment – Europe fiscal 2010 year-to-date net sales decreased $155.3 million from the same period last year, based primarily on a decline in vehicular sales volumes as a result of the weak global economy and a $6.2 million unfavorable impact of foreign currency exchange rate changes. Gross margin decreased from 14.8 percent during the first nine months of fiscal 2009 to 13.1 percent during the first nine months of fiscal 2010, which was largely due to the underabsorption of fixed manufacturing costs as a result of the substantial decrease in sales volumes partially offset by the reduction of indirect costs in the manufacturing facilities and the impact of favorable materials pricing. SG&A expenses decreased $7.2 million, primarily due to the positive impact of SG&A cost reduction efforts. Restructuring income of $3.5 million was recorded during the first nine months of fiscal 2010 related to the reversal of severance liabilities as the result of favorable benefits negotiations. Restructuring charges of $21.4 million were recorded during the third quarter of fiscal 2009 as the result of a plan to reduce the workforce throughout the European facilities including at the European Headquarters in Bonlanden, Germany. A goodwill impairment charge of $9.0 million was recorded during the third quarter of fiscal 2009 based on a declining outlook for this segment. In addition, a long-lived asset impairment charge of $10.6 million was recorded during the third quarter of fiscal 2009 related to certain manufacturing facilities with projected cash flows unable to support their asset bases. The income from continuing operations of $15.8 million during the first nine months of fiscal 2010 was an improvement of $22.7 million from the loss from continuing operations of $6.9 million incurred in the first nine months of fiscal 2009 primarily due to the restructuring and impairment charges recorded during the prior year.

### Original Equipment - North America

*(dollars in millions)*

|  | Three months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales | Nine months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **101.3** | **100.0%** | 137.7 | 100.0% | **293.6** | **100.0%** | 399.6 | 100.0% |
| Cost of sales | **92.2** | **91.0%** | 122.2 | 88.7% | **261.0** | **88.9%** | 370.3 | 92.7% |
| Gross profit | **9.1** | **9.0%** | 15.5 | 11.3% | **32.6** | **11.1%** | 29.3 | 7.3% |
| Selling, general and administrative expenses | **8.2** | **8.1%** | 14.2 | 10.3% | **22.9** | **7.8%** | 49.7 | 12.4% |
| Restructuring expense | **1.3** | **1.3%** | 2.2 | 1.6% | **1.4** | **0.5%** | 2.0 | 0.5% |
| Impairment of long-lived assets | **0.1** | **0.1%** | 7.8 | 5.7% | **4.7** | **1.6%** | 10.6 | 2.7% |
| (Loss) income from continuing operations | **(0.5)** | **-0.5%** | (8.7) | -6.3% | **3.6** | **1.2%** | (33.0) | -8.3% |

#### Comparison of Three Months Ended December 31, 2009 and 2008

Original Equipment – North America net sales decreased $36.4 million from the third quarter of fiscal 2009 to the third quarter of fiscal 2010, primarily driven by depressed North American truck and off-highway markets. Also included in the third quarter of fiscal 2009 is revenue of $8.7 million related to a license agreement entered into with Bloom Energy, a leading developer of fuel cell-based distributed energy systems, under which Bloom Energy licensed our thermal management technology for an up-front fee of $12.0 million. In addition to licensing this technology, we were also providing certain transition services to Bloom Energy, including the sale of products through December 2009. We received an advance payment of $0.7 million for these transition services, and received additional compensation for the supply of products to Bloom Energy over this time. The total up-front compensation received of $12.7 million was recognized as revenue over the 15-month term of these agreements. Gross margin decreased from 11.3 percent during the third quarter of fiscal 2009 to 9.0 percent during the third quarter of fiscal 2010 due to the revenue from the Bloom Energy transaction in the third quarter of fiscal 2009 partially offset by the benefits realized as a result of manufacturing realignment efforts initiated during fiscal 2009. SG&A expenses decreased $6.0 million year-over-year, primarily due to the flow-through impact of fiscal 2009 cost reduction actions. Restructuring charges recorded during the third quarter of fiscal 2010 relate to the announced closure of our Harrodsburg, Kentucky facility. The majority of the restructuring charges recorded during the third quarter of fiscal 2009 related to a workforce reduction at the Racine, Wisconsin Headquarters which was completed during January 2009. Asset impairment charges of $7.8 million recorded during the third quarter of fiscal 2009 related to assets of a facility which projected cash flows unable to support its asset base, a program which was unable to support its asset base, as well as assets related to a cancelled program. The loss from continuing operations of $0.5 million during the third quarter of fiscal 2010 was an improvement of $8.2 million from the loss from continuing operations of $8.7 million incurred in the third quarter of fiscal 2009, based on the manufacturing and SG&A cost reduction activities and absence of significant impairment charges.

Original Equipment – North America fiscal 2010 year-to-date net sales decreased $106.0 million from the same period last year. The sales volumes continued to be depressed on a year-over-year basis due to depressed North American truck and off-highway markets. Gross margin improved from 7.3 percent during the first nine months of fiscal 2009 to 11.1 percent during the first nine months of fiscal 2010, primarily attributable to a significant reduction in direct and indirect costs in the North American manufacturing facilities and the positive impact of materials pricing. SG&A expenses decreased $26.8 million year-over-year due to the positive impact of cost reduction actions within the region and the absence of consulting fees incurred in fiscal 2009 in connection with the manufacturing realignment. Restructuring charges recorded in fiscal 2010 year-to-date relate to the announced closure of our Harrodsburg, Kentucky facility. The majority of the restructuring charges recorded during fiscal 2009 year-to-date related to a workforce reduction at the Racine, Wisconsin Headquarters which was completed during January 2009. Asset impairment charges of $4.6 million recorded during the first nine months of fiscal 2010 related to a program that was not able to support its asset base and the Harrodsburg, Kentucky manufacturing facility, which had a net book value which exceeded its fair value. The majority of the long-lived asset impairment charges recorded during the first nine months of fiscal 2009 relate to assets within this segment for a program, which was unable to support its asset base, as well as for assets which are no longer in use. During the first nine months of fiscal 2010, this segment reported income from continuing operations of $3.6 million, which has improved $36.6 million from the loss from continuing operations of $33.0 million incurred in the first nine months of fiscal 2009, based primarily on the improved gross margin, reduction in SG&A costs and reduced impairment charges.

### South America

*(dollars in millions)*

|  | Three months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales | Nine months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **32.3** | **100.0%** | 28.7 | 100.0% | **82.9** | **100.0%** | 114.8 | 100.0% |
| Cost of sales | **26.2** | **81.1%** | 23.7 | 82.6% | **66.3** | **80.0%** | 89.9 | 78.3% |
| Gross profit | **6.1** | **18.9%** | 4.9 | 17.1% | **16.6** | **20.0%** | 24.9 | 21.7% |
| Selling, general and administrative expenses | **3.3** | **10.2%** | 3.9 | 13.6% | **9.5** | **11.5%** | 13.2 | 11.5% |
| Restructuring expense | **-** | **0.0%** | - | 0.0% | **0.8** | **1.0%** | - | 0.0% |
| Income from continuing operations | **2.8** | **8.7%** | 1.0 | 3.5% | **6.3** | **7.6%** | 11.6 | 10.1% |

#### Comparison of Three Months Ended December 31, 2009 and 2008

South America net sales increased $3.6 million from the third quarter of fiscal 2009 to the third quarter of fiscal 2010 due to a $7.6 million favorable impact of foreign currency exchange rate changes partially offset by reduced sales volumes within their commercial vehicle and agricultural markets as a result of the global recession. Gross margin improved from 17.1 percent during the third quarter of fiscal 2009 to 18.9 percent during the third quarter of fiscal 2010 as a result of manufacturing realignment efforts initiated during fiscal 2009. Income from continuing operations increased $1.8 million over the periods presented based on the improved gross margin.

South America fiscal 2010 year-to-date net sales decreased $31.9 million from the same period last year, based on reduced sales volumes within their commercial vehicle markets, along with an unfavorable impact of foreign currency exchange rate changes of $1.5 million. Gross margin decreased from 21.7 percent during the first nine months of fiscal 2009 to 20.0 percent during the first nine months of fiscal 2010 due to the underabsorption of fixed costs with the reduced sales volumes. SG&A expenses decreased $3.7 million due to the positive impact of SG&A reduction efforts within this region. Restructuring expense of $0.8 million was recorded during the first nine months of fiscal 2010 related to a workforce reduction within the Brazilian operations. Income from continuing operations decreased $5.3 million from the first nine months of fiscal 2009 to the first nine months of fiscal 2010 based on the significantly reduced sales volumes and gross margin decline.

### Commercial Products

*(dollars in millions)*

|  | Three months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales | Nine months ended December 31 2009 $'s | % of sales | 2008 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **48.4** | **100.0%** | 48.8 | 100.0% | **128.0** | **100.0%** | 150.9 | 100.0% |
| Cost of sales | **33.1** | **68.4%** | 36.5 | 74.8% | **92.1** | **72.0%** | 114.9 | 76.1% |
| Gross profit | **15.3** | **31.6%** | 12.3 | 25.2% | **35.9** | **28.0%** | 36.0 | 23.9% |
| Selling, general and administrative expenses | **7.4** | **15.3%** | 7.1 | 14.5% | **19.5** | **15.2%** | 21.7 | 14.4% |
| Restructuring expense | **-** | **0.0%** | - | 0.0% | **0.3** | **0.2%** | - | 0.0% |
| Impairment of long-lived assets | **-** | **0.0%** | - | 0.0% | **-** | **0.0%** | 0.4 | 0.3% |
| Income from continuing operations | **7.9** | **16.3%** | 5.2 | 10.7% | **16.1** | **12.6%** | 13.9 | 9.2% |

#### Comparison of Three Months Ended December 31, 2009 and 2008

Commercial Products net sales were comparable for the third quarter of fiscal 2009 and the third quarter of fiscal 2010. Gross margin improved from 25.2 percent during the third quarter of fiscal 2009 to 31.6 percent during the third quarter of fiscal 2010, primarily related to sales price increases, lower material costs and manufacturing cost improvements. Income from continuing operations improved $2.7 million over the periods presented with the significant improvement in gross margin.

#### Comparison of Nine Months Ended December 31, 2009 and 2008

Commercial Products fiscal 2010 year-to-date net sales decreased $22.9 million from the same period last year, based primarily on an overall reduction in sales volume with the deterioration in the global economy and a $6.3 million unfavorable impact of foreign currency exchange rate changes. Gross margin improved from 23.9 percent during the first nine months of fiscal 2009 to 28.0 percent during the first nine months of fiscal 2010, based on lower material costs, manufacturing cost improvements and productivity initiatives. SG&A expenses decreased $2.2 million from the first nine months of fiscal 2009 to the first nine months of fiscal 2010 due to cost reduction efforts. Income from continuing operations increased $2.2 million from the first nine months of fiscal 2009 to the first nine months of fiscal 2010 as a result of the gross margin improvements and SG&A cost reduction efforts.

#### Liquidity and Capital Resources

Our primary sources of liquidity are cash flow from operating activities and borrowings under lines of credit provided by banks in the United States and abroad. On September 30, 2009, we completed a public offering of 13.8 million shares of our common stock, including 1.8 million shares issued pursuant to the fully exercised underwriters’ option to purchase additional shares, at a price of $7.15 per share. The proceeds of the common stock offering were $93.0 million, after deducting underwriting discounts, commissions, legal, accounting and printing fees of $5.6 million. On December 23, 2009, we sold 100 percent of the shares of our South Korea-based HVAC business for net cash proceeds of $11.2 million.

Cash provided by operating activities for the nine months ended December 31, 2009 was $49.9 million as compared to $80.3 million for the nine months ended December 31, 2008. During the first nine months of fiscal 2009, we were able to generate positive cash flow through working capital improvement initiatives. During the first nine months of fiscal 2010, we held our working capital balances relatively consistent, while increasing our cash flows from improved operating results. The changes in working capital balances over the first nine months of fiscal 2009 as compared to the same period of fiscal 2010, partially offset by the improved operating results on the first nine months of fiscal 2010, were the most significant factors contributing to the reduction in operating cash flows.

At December 31, 2009, the Company had capital expenditure commitments of $32.8 million. Significant commitments include tooling and equipment expenditures for new and renewal platforms with new and current customers in Europe and North America. During the first nine months of fiscal 2010, we incurred capital expenditures of $41.4 million. Our capital spending is limited under our amended credit agreements to $70.0 million for fiscal 2010 and for all fiscal years thereafter.

Outstanding indebtedness decreased $117.5 million to $131.7 million at December 31, 2009 from the March 31, 2009 balance of $249.2 million, primarily as a result of the debt repayments with the proceeds from the common stock offering and the sale of our South Korea-based HVAC business.

At December 31, 2009, we had $136.1 million available for future borrowings under the revolving credit facility. In addition to this revolving credit facility, we have unused lines of credit in Asia, Europe and Brazil totaling $38.8 million at December 31, 2009. In the aggregate, we have total available lines of credit of $174.9 million at December 31, 2009. On May 15, 2009, Modine Holding GmbH and Modine Europe GmbH, each a subsidiary of the Company, entered into a Credit Facility Agreement with an available line of 15.0 million euro ($21.5 million U.S. equivalent). This credit facility is available until May 14, 2010.

We believe that our internally generated operating cash flows and existing cash balances, together with access to available external borrowings, will be sufficient to satisfy future operating costs, capital expenditures, working capital needs of the business as our end markets recover from the global recession and restructuring costs incurred under the four-point plan.

#### Intercreditor Agreement

During the third quarter of fiscal 2010, we generated positive cash flow from operations. We used this cash, plus the proceeds from the sale of our South Korea-based HVAC business during the third quarter, to voluntarily repay our revolving credit facility. At December 31, 2009, there was $2.0 million outstanding under the revolving credit facility, which represents a significant reduction from the $50.0 million outstanding balance at September 30, 2009. In addition, at December 31, 2009, we had $121.5 million outstanding on the senior notes.

In conjunction with the First Amendment to Credit Agreement and Waiver with our primary lenders and Waiver and Second Amendment to the Note Purchase Agreements with the senior note holders each dated as of February 17, 2009, the primary lenders and senior note holders entered into a Collateral Agency and Intercreditor Agreement, to which we consented. This agreement provides for the sharing of payments received in respect of the collateral and the guarantees provided by the Company to the primary lenders and senior note holders. On September 18, 2009, the primary lenders and senior note holders entered into a First Amendment to Collateral Agency and Intercreditor Agreement (“Intercreditor Agreement”), to which we consented. Under the terms of the Intercreditor Agreement, 90 days after the expiration of our revolving credit facility in July 2011, certain actions may be required in order to preserve a stated ratio relative to the Company’s indebtedness to the primary lenders on the one hand and the senior note holders on the other. This portion of the Intercreditor Agreement, if triggered, would require the primary lenders to pay the senior note holders to preserve the relative position of those two groups that existed when the Intercreditor Agreement was executed. If the outstanding balance on the revolving credit facility at that time is the same as it was as of December 31, 2009, the primary lenders would be required to pay approximately $46 million to the senior note holders in October 2011.

We currently plan to refinance our revolving credit facility prior to its expiration in July 2011. In the unlikely event that we were unable to complete this refinancing prior to October 2010 (one year prior to the potential rebalancing described above), and if the Intercreditor Agreement terms remain in their current state, we may be required to classify the above-described payment from the primary lenders to the senior note holders as a current liability in our Consolidated Balance Sheet. This current liability classification may be required as we may need to reimburse the primary lender for the rebalancing payment made to the senior note holders. If that were to occur, we believe that our existing cash balances and internally generated operating cash flows would be sufficient to fund this required payment and any potential associated obligations.

#### Debt Covenants

Our debt agreements require us to maintain compliance with various covenants. The most restrictive limitation at present is a minimum adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) covenant. Adjusted EBITDA is defined as our (loss) earnings from continuing operations before interest expense and provision for income taxes, adjusted to exclude unusual, non-recurring or extraordinary non-cash charges and up to $34.0 million of cash restructuring and repositioning charges and further adjusted to add back depreciation and amortization expense. Adjusted EBITDA does not represent, and should not be considered, an alternative to (loss) earnings from continuing operations as determined by generally accepted accounting principles (GAAP), and our calculation may not be comparable to similarly titled measures reported by other companies.

The following presents the minimum adjusted EBITDA level requirements with which we are required to comply through the fourth quarter of fiscal 2010:

|  |  |
| --- | --- |
| For the four consecutive quarters ended December 31, 2009 | $ 1.8 million |
| For the four consecutive quarters ending March 31, 2010 | 35.0 million |

Our adjusted EBITDA for the four consecutive quarters ended December 31, 2009 was $66.5 million, which exceeded the minimum adjusted EBITDA requirement by $64.8 million. We expect to remain in compliance with this covenant throughout the remainder of fiscal 2010 based on the adjusted EBITDA recorded during the first three quarters of fiscal 2010 and the projected financial results for the remainder of fiscal 2010. The following table presents a calculation of adjusted EBITDA:

(dollars in thousands)

|  | Quarter Ended March 31, 2009 | Quarter Ended June 30, 2009 | Quarter Ended September 30, 2009 | Quarter Ended December 31, 2009 | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| Earnings (loss) from continuing operations | $(40,763) | $(5,642) | $(4,886) | $2,125 | $(49,166) |
| Consolidated interest expense | 4,182 | 5,459 | 9,643 | 3,793 | 23,077 |
| Provision for income taxes | 3,346 | 1,016 | 871 | 238 | 5,471 |
| Depreciation and amortization expense (a) | 15,827 | 15,755 | 16,183 | 16,045 | 63,810 |
| Non-cash charges (b) | 15,610 | (2,036) | 3,264 | 583 | 17,421 |
| Restructuring and repositioning charges (income) (c) | 3,515 | 2,263 | (2,334) | 2,463 | 5,907 |
| Adjusted EBITDA | $1,717 | $16,815 | $22,741 | $25,247 | $66,520 |

(a) Depreciation and amortization expense represents total depreciation and amortization from continuing operations less accelerated depreciation which has been included in non-cash charges described in footnote (b) below.

(b) Non-cash charges are comprised of long-lived asset impairments, non-cash restructuring and repositioning charges, exchange gains or losses on inter-company loans and non-cash charges which are unusual, non-recurring or extraordinary, as follows:

(dollars in thousands)

|  | Quarter Ended March 31, 2009 | Quarter Ended June 30, 2009 | Quarter Ended September 30, 2009 | Quarter Ended December 31, 2009 | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| Long-lived asset impairments | $13,228 | $994 | $3,849 | $273 | $18,344 |
| Non-cash restructuring and repositioning charges | 894 | 820 | 767 | 718 | 3,199 |
| Exchange losses (gains) on intercompany loans | 968 | (3,871) | (1,226) | (412) | (4,541) |
| Provision for uncollectible notes receivable | (404) | (59) | (327) | 4 | (786) |
| Supplemental executive retirement plan settlement | 924 | 80 | 201 | - | 1,205 |
| Non-cash charges | $15,610 | $(2,036) | $3,264 | $583 | $17,421 |

(c) Restructuring and repositioning charges (income) represent cash restructuring and repositioning costs incurred in conjunction with the restructuring activities announced on or after January 31, 2008. See Note 11 of the Notes to Condensed Consolidated Financial Statements for further discussion on these activities.

In addition to the minimum adjusted EBITDA covenant, we are not permitted to incur capital expenditures greater than $70.0 million for fiscal year 2010 and for all fiscal years thereafter. We expect to remain in compliance with this covenant for the remainder of fiscal 2010 and beyond.

Beginning with the fourth quarter of fiscal 2010, we are subject to an adjusted EBITDA to interest expense (interest expense coverage ratio) covenant and a debt to adjusted EBITDA (leverage ratio) covenant as follows:

|  |  |  |
| --- | --- | --- |
|  | Interest Expense Coverage Ratio Covenant (Not Permitted to Be Less Than): | Leverage Ratio Covenant (Not Permitted to Be Greater Than): |
| Fiscal quarter ending March 31, 2010 | 1.50 to 1.0 | 7.25 to 1.0 |
| Fiscal quarter ending June 30, 2010 | 2.00 to 1.0 | 5.50 to 1.0 |
| Fiscal quarter ending September 30, 2010 | 2.50 to 1.0 | 4.75 to 1.0 |
| Fiscal quarter ending December 31, 2010 | 3.00 to 1.0 | 3.75 to 1.0 |
| Fiscal quarters ending March 31, 2011and June 30, 2011 | 3.00 to 1.0 | 3.50 to 1.0 |
| All fiscal quarters ending thereafter | 3.00 to 1.0 | 3.00 to 1.0 |

We expect to remain in compliance with the interest expense coverage ratio covenant and leverage ratio covenant in the fourth quarter of fiscal 2010 and through the term of the revolving credit facility based on the adjusted EBITDA recorded during the first three quarters of fiscal 2010, our projected financial results for the remainder of fiscal 2010 and the significant reduction in the debt balance as a result of the common stock offering and proceeds from the sale of our South Korea-based HVAC business.

#### Off-Balance Sheet Arrangements

None.

#### Critical Accounting Policies

*Impairment of Goodwill and Indefinite-Lived Intangible Assets:* Impairment tests are conducted at least annually unless business events or other conditions exist that would require a more frequent evaluation. The Company considers factors such as operating losses, declining outlooks and market capitalization when evaluating the necessity for an impairment analysis. We conduct the annual review of goodwill and other intangible assets with indefinite lives for impairment in the third quarter. The recoverability of goodwill and other intangible assets with indefinite lives is determined by estimating the future discounted cash flows of the reporting unit to which the goodwill and other intangible assets with indefinite lives relates. The rate used in determining discounted cash flows is a rate corresponding to our cost of capital, adjusted for risk where appropriate. In determining the estimated future cash flows, current and future levels of income are considered as well as business trends and market conditions. To the extent that book value exceeds the fair value, an impairment is recognized. At December 31, 2009, the Company had goodwill of $30.8 million recorded, consisting primarily of $14.2 million within the South America segment and $16.1 million within the Commercial Products segment. The South America and Commercial Products segments continue to report operating income and forecast strong financial results. The future discounted cash flows of these segments continue to exceed their carrying value indicating that the goodwill recorded in these segments is fully realizable at December 31, 2009. If, in future periods, these segments experience a significant unanticipated economic downturn in the markets in which they operate, this would require an impairment review.

*Impairment of Long-Lived and Amortized Intangible Assets:* The Company performs impairment evaluations of its long-lived assets, including property, plant and equipment, intangible assets with finite lives and equity investments, whenever business conditions or events indicate that those assets may be impaired. The Company considers factors such as operating losses, declining outlooks and market capitalization when evaluating the necessity for an impairment analysis. When the estimated future undiscounted cash flows to be generated by the assets are less than the carrying value of the long-lived assets, or the decline in value is considered to be “other than temporary,” the assets are written down to fair market value and a charge is recorded to current operations. Fair market value is estimated in various ways depending on the nature of the assets under review. This value can be based on appraised value, estimated salvage value, sales price under negotiation or estimated cancellation charges, as applicable. The Company recorded long-lived asset impairment charges of $0.3 million and $27.3 million for the three months ended December 31, 2009 and 2008, respectively. The Company recorded long-lived asset impairment charges of $5.1 million and $30.5 million for the nine months ended December 31, 2009 and 2008, respectively.

The most significant long-lived assets that have been subject to impairment evaluations during the nine months ended December 31, 2009 and 2008 are the Company’s net property, plant and equipment, which totaled $443.0 million at December 31, 2009. Within property, plant and equipment, the most significant assets evaluated are buildings and improvements, and machinery and equipment. The Company evaluates impairment at the lowest level of separately identifiable cash flows, which is generally at the manufacturing plant level. The Company monitors its manufacturing plant performance to determine whether indicators exist that would require an impairment evaluation for the facility. This includes significant adverse changes in plant profitability metrics; substantial changes in the mix of customer programs manufactured in the plant, consisting of new program launches, reductions, and phase-outs; and shifting of programs to other facilities under the Company’s manufacturing realignment strategy. When such indicators are present, the Company performs an impairment evaluation by comparing the estimated future undiscounted cash flows expected to be generated in the manufacturing facility to the net book value of the long-lived assets within that facility. The undiscounted cash flows are estimated based on the expected future cash flows to be generated by the manufacturing facility over the remaining useful life of the machinery and equipment within that facility. When the estimated future undiscounted cash flows are less than the net book value of the long-lived assets, such assets are written down to fair market value, which is generally estimated based on appraisals or estimated salvage value.

The Company’s four-point plan is designed to attain a more competitive cost base and improve the Company’s longer term competitiveness, and this plan is intended to reduce the risk of potential long-lived asset impairment charges in the future once the accelerated restructuring under the four-point plan is completed. The manufacturing realignment strategy of this plan is designed to improve the utilization of the Company’s facilities, with fewer facilities, but operating at higher capacities. The portfolio rationalization strategy of this plan is designed to identify and retain products for which the Company can earn a sufficient return on its investment, and divest or exit products that do not meet required financial metrics. These strategies have the goal of creating better facility utilization and greater profitability in product mix, which are designed to allow the manufacturing facilities to withstand more significant adverse changes before an impairment charge is necessary.

#### New Accounting Pronouncements

*Accounting standards changes and new accounting pronouncements:* In December 2007, the Financial Accounting Standards Board (FASB) issued updated guidance on business combinations which retained the underlying concepts that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but changed the method of applying the acquisition method in a number of significant aspects. For all business combinations, the entity that acquires the business will record 100 percent of all assets and liabilities of the acquired business, including goodwill, generally at their fair values. Certain contingent assets and liabilities acquired will be recognized at their fair values on the acquisition date and changes in fair value of certain arrangements will be recognized in earnings until settled. Acquisition-related transaction and restructuring costs will be expensed rather than treated as an acquisition cost and included in the amount recorded for assets acquired. Additionally, this new guidance amended the goodwill disclosure requirements to require a roll-forward of the gross amount of goodwill and accumulated impairment losses. This new guidance is effective on a prospective basis for all business combinations for which the acquisition date is on or after April 1, 2009, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. The segments for which we currently have goodwill have not had any historical impairment charges. This guidance also amends accounting for income taxes such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that close prior to the effective date of the new guidance would also apply the provisions of that guidance. Early adoption was not allowed. The adoption of this standard did not have an impact on previous acquisitions.

In December 2007, the FASB issued new accounting guidance on consolidations which established new standards that will govern the accounting for and reporting of (1) non-controlling interests in partially owned consolidated subsidiaries and (2) the loss of control of subsidiaries. Our consolidated subsidiaries are wholly owned and, as such, no non-controlling interests are currently reported in the consolidated financial statements. Other current ownership interests are reported under the equity method of accounting under investments in affiliates. This new guidance is effective on a prospective basis on or after April 1, 2009 except for the presentation and disclosure requirements, which will be applied retrospectively. Early adoption was not allowed. The adoption of this standard did not have an impact on the consolidated financial statements.

In April 2009, the FASB issued new accounting guidance which requires the disclosure about fair value of financial instruments in interim reporting periods of publicly traded companies similar to the disclosures that were previously only required in annual financial statements. The provisions of this new guidance were effective April 1, 2009 and amend only the disclosure requirements about fair value of financial instruments in interim periods. Therefore, the adoption of this guidance had no impact on our consolidated financial statements.

In May 2009, the FASB issued new accounting guidance on subsequent events that addresses the types and timing of events that should be reported in the financial statements for events occurring between the balance sheet date and the date the financial statements are issued or available to be issued. This guidance was effective on June 30, 2009. We reviewed events for inclusion in the financial statements through February 8, 2010, the date that the accompanying financial statements were issued. The adoption of this guidance did not impact the financial position or results of operations.

In August 2009, the FASB issued a new accounting standards update on fair value measurements and disclosures that applies to the fair value measurement of liabilities. This update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, companies are required to measure the fair value of the liability using one or both of the following techniques: (i) the quoted price of an identical liability when traded as an asset or quoted prices for similar liabilities or similar liabilities when traded as assets or (ii) another valuation technique (e.g., a market approach or income approach) including a technique based on the amount an entity would pay to transfer the identical liability, or a technique based on the amount an entity would receive to enter into an identical liability. This update was effective during the third quarter of fiscal 2010, and had no impact on our consolidated financial statements.

#### Contractual Obligations

There have been no material changes to our contractual obligations outside the ordinary course of business from those disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2009, with the exception of the mandatory prepayment of long-term debt of $46.4 million from the proceeds of the common stock offering on September 30, 2009. The majority of these payments reduce our contractual obligations for long-term debt (including interest) in the period greater than five years. A voluntary repayment of long-term debt of $46.6 million was also made from the proceeds of the common stock offering on September 30, 2009. In addition, as further discussed under “Liquidity and Capital Resources,” under the terms of the Intercreditor Agreement, as amended, the primary lenders may be required to pay approximately $46 million to the senior note holders in October 2011 if a rebalancing of the Company’s indebtedness to the primary lenders and the senior note holders is required. We are currently unable to determine the impact on our contractual obligations from the ultimate timing of settlement of the gross liability for uncertain tax positions which was $6.2 million as of December 31, 2009.

#### Forward-Looking Statements

This report contains statements, including information about future financial performance, accompanied by phrases such as “believes,” “estimates,” “expects,” “plans,” “anticipates,” “intends,” and other similar “forward-looking” statements, as defined in the Private Securities Litigation Reform Act of 1995. Modine’s actual results, performance or achievements may differ materially from those expressed or implied in these statements, because of certain risks and uncertainties, including, but not limited to, those described under “Risk Factors” in Item 1A. in Part I. of the Company’s Annual Report on Form 10-K for the year ended March 31, 2009. Other risks and uncertainties include, but are not limited to, the following:

- The impact on Modine of increases in commodities prices, particularly aluminum and copper;
- Modine’s ability or inability to pass increasing commodities prices on to customers as well as the inherent lag in timing of such pass-through pricing;
- Changes in sales mix to products with lower margins;
- Modine’s ability to remain in compliance with its debt agreements and financial covenants going forward;
- The impact the weak global economy is having on Modine, its customers and its suppliers and any worsening of such economic conditions;
- The secondary effects on Modine’s future cash flows and liquidity that may result from the manner in which Modine’s customers and lenders deal with the economic crisis and its consequences;
- Modine’s ability to limit capital spending;
- Modine’s ability to successfully implement restructuring plans and drive cost reductions as a result;
- Modine’s ability to satisfactorily service its customers during the implementation and execution of any restructuring plans and/or new product launches;
- Modine’s ability to avoid or limit inefficiencies in the transitioning of products from production facilities to be closed to other existing or new production facilities;
- Modine’s ability to successfully execute its four-point plan;
- Modine’s ability to further cut costs to increase its gross margin and to maintain and grow its business;
- Modine’s impairment of assets resulting from business downturns;
- Modine’s ability to realize future tax benefits;
- Customers’ actual production demand for new products and technologies, including market acceptance of a particular vehicle model or engine;
- Modine’s ability to increase its gross margin, including its ability to produce products in low cost countries;
- Modine’s ability to maintain customer relationships while rationalizing its business;
- Modine’s ability to maintain current programs and compete effectively for new business, including its ability to offset or otherwise address increasing pricing pressures from its competitors and price reductions from its customers;
- Modine’s ability to obtain profitable business at its new facilities in China, Hungary, Mexico and India and to produce quality products at these facilities from business obtained;
- The effect of the weather on the Commercial Products business, which directly impacts sales;
- Unanticipated problems with suppliers meeting Modine’s time and price demands;
- The impact of environmental laws and regulations on Modine’s business and the business of Modine’s customers, including Modine’s ability to take advantage of opportunities to supply alternative new technologies to meet environmental emissions standards;
- Economic, social and political conditions, changes and challenges in the markets where Modine operates and competes (including currency exchange rate fluctuations, tariffs, inflation, changes in interest rates, recession, and restrictions associated with importing and exporting and foreign ownership);
- Modine’s association with a particular industry, such as the automobile industry, which could have an adverse effect on Modine’s stock price;
- The nature of the vehicular industry, including the failure of build rates to return to pre-recessionary levels and the dependence of these markets on the health of the economy;
- Work stoppages or interference at Modine or Modine’s major customers;
- Unanticipated product or manufacturing difficulties, including unanticipated warranty claims;
- Unanticipated delays or modifications initiated by major customers with respect to product applications or requirements;
- Costs and other effects of unanticipated litigation or claims, and the increasing pressures associated with rising health care and insurance costs; and
- Other risks and uncertainties identified by the Company in public filings with the U.S. Securities and Exchange Commission.

Modine does not assume any obligation to update any forward-looking statements.

## Market risk

As filed, 19,579 characters.

In the normal course of business, Modine is subject to market exposure from changes in foreign exchange rates, interest rates, credit risk, economic risk and commodity price risk.

#### Foreign Currency Risk

Modine is subject to the risk of changes in foreign currency exchange rates due to its operations in foreign countries. Modine has manufacturing facilities in Brazil, China, Mexico, South Africa, India and throughout Europe. It also has an equity investment in a company located in Japan. Modine sells and distributes its products throughout the world. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company manufactures, distributes and sells its products. The Company attempts to mitigate foreign currency risks on transactions with customers and suppliers in foreign countries by entering into contracts that are denominated in the functional currency of the Modine entity engaging in the contract. The Company's operating results are principally exposed to changes in exchange rates between the dollar and the European currencies, primarily the euro, and changes between the dollar and the Brazilian real. Changes in foreign currency exchange rates for the Company's foreign subsidiaries reporting in local currencies are generally reported as a component of shareholders' equity. For the three months ended December 31, 2009, the Company experienced a strengthening of the U.S. dollar to these foreign currencies, which resulted in an unfavorable currency translation adjustment of $4.8 million. For the nine months ended December 31, 2009, the Company experienced a general weakening of the U.S. dollar to these foreign currencies, which resulted in a favorable currency translation adjustment of $36.4 million. At December 31, 2009 and March 31, 2009, the Company's foreign subsidiaries had net current assets (defined as current assets less current liabilities) subject to foreign currency translation risk of $95.9 million and $71.8 million, respectively. The potential decrease in the net current assets from a hypothetical 10 percent adverse change in quoted foreign currency exchange rates would be approximately $9.6 million and $7.2 million, respectively. This sensitivity analysis presented assumes a parallel shift in foreign currency exchange rates. Exchange rates rarely move in the same direction relative to the dollar. This assumption may overstate the impact of changing exchange rates on individual assets and liabilities denominated in a foreign currency.

The Company has, from time to time, certain foreign-denominated, long-term debt obligations and long-term inter-company loans that are sensitive to foreign currency exchange rates. As of December 31, 2009 there were no third party foreign-denominated, long-term debt obligations.

At December 31, 2009, Modine, Inc., a subsidiary of the Company, had an inter-company loan totaling $6.9 million with its wholly owned subsidiary, Modine Brazil, that matures on May 8, 2011. Modine Brazil paid $2.0 million and $8.0 million on this inter-company loan during the three and nine months ended December 31, 2009, respectively.

The Company also had other inter-company loans outstanding at December 31, 2009 as follows:

- $11.9 million loan to its wholly owned subsidiary, Modine Thermal Systems Private Limited (Modine India), that matures on April 30, 2013; and
- $12.0 million between two loans to its wholly owned subsidiary, Modine Thermal Systems (Changzhou) Co. Ltd. (Changzhou, China), with various maturity dates through June 2012.

These inter-company loans are sensitive to movement in foreign exchange rates, and the Company does not have any derivative instruments that hedge this exposure.

#### Interest Rate Risk

Modine's interest rate risk policies are designed to reduce the potential volatility of earnings that could arise from changes in interest rates. The Company generally utilizes a mixture of debt maturities together with both fixed-rate and floating-rate debt to manage its exposure to interest rate variations related to its borrowings. The domestic revolving credit facility is based on a variable interest rate of London Interbank Offered Rate (LIBOR) plus 475 basis points. The Company is subject to future fluctuations in LIBOR which would affect the variable interest rate on the revolving credit facility and create variability in interest expense. A 100 basis point increase in LIBOR would increase interest expense by less than $0.1 million for the fiscal year based on the December 31, 2009 revolving credit facility balance. The Company has, from time to time, entered into interest rate derivatives to manage variability in interest rates. These interest rate derivatives were treated as cash flow hedges of forecasted transactions. Accordingly, the losses are reflected as a component of accumulated other comprehensive income (loss), and are being amortized to interest expense over the respective lives of the borrowings. During the three and nine months ended December 31, 2009, $0.1 million and $0.7 million of expense, respectively, was recorded in the consolidated statements of operations related to the amortization of interest rate derivative losses. The expense for nine months includes $0.5 million of amortization in proportion with the mandatory prepayment of the senior notes on September 30, 2009. At December 31, 2009, $0.7 million of net unrealized losses remain deferred in accumulated other comprehensive income (loss).

The following table presents the future principal cash flows and weighted average interest rates by expected maturity dates for our long-term debt. The fair value of the long-term debt is estimated by discounting the future cash flows at rates offered to the Company for similar debt instruments of comparable maturities. The book value of the debt approximates fair value, with the exception of the $121.5 million fixed rate notes which has a fair value of approximately $128.9 million at December 31, 2009.

As of December 31, 2009, long-term debt matures as follows:

| Long-term debt in ($000's) | Expected Maturity Date F2010 | F2011 | F2012 | F2013 | F2014 | Thereafter | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Fixed rate (U.S. dollars) | - | - | $9,375 | $18,750 | $23,438 | $69,889 | $121,452 |
| Average interest rate |  |  | 10.38% | 10.38% | 10.38% | 10.38% | 10.38% |
| Variable rate (U.S. dollars) | - | - | $2,000 | - | - | - | $2,000 |
| Average interest rate |  |  | 7.82% |  |  |  | 7.82% |

As further discussed under “Liquidity and Capital Resources,” under the terms of the Intercreditor Agreement, as amended, the primary lenders may be required to pay approximately $46 million to the senior note holders in October 2011 if a rebalancing of the Company’s indebtedness to the primary lenders and the senior note holders is required. If this rebalancing becomes necessary, it would reduce the debt maturity in the thereafter column.

#### Credit Risk

Credit risk is the possibility of loss from a customer's failure to make payment according to contract terms. The Company's principal credit risk consists of outstanding trade receivables. Prior to granting credit, each customer is evaluated, taking into consideration the borrower's financial condition, past payment experience and credit information. After credit is granted the Company actively monitors the customer's financial condition and developing business news. Approximately 43 percent of the trade receivables balance at December 31, 2009 was concentrated in the Company's top ten customers. Modine's history of incurring credit losses from customers has not been material, and the Company does not expect that trend to change. However, the current economic uncertainty, especially within the global automotive and commercial vehicle markets, makes it difficult to predict future financial conditions of significant customers within these markets. Deterioration in the financial condition of a significant customer could have a material adverse effect on the Company’s results of operations and liquidity.

The recent adverse events in the global financial markets have also increased credit risks on investments to which Modine is exposed or where Modine has an interest. The Company manages these credit risks through its focus on the following:

- Cash and investments – Cash deposits and short-term investments are reviewed to ensure banks have credit ratings acceptable to the Company and that all short-term investments are maintained in secured or guaranteed instruments. The Company’s holdings in cash and investments were considered stable and secure at December 31, 2009;
- Pension assets – The Company has retained outside advisors to assist in the management of the assets in the Company’s defined benefit plans. In making investment decisions, the Company has been guided by an established risk management protocol under which the focus is on protection of the plan assets against downside risk. The Company monitors investments in its pension plans to help ensure that these plans provide good diversification, investment teams and portfolio managers are adhering to the Company’s investment policies and directives, and exposure to high risk securities and other similar assets is limited. The Company believes it has good investment policies and controls and proactive investment advisors. Despite our efforts to protect against downside risk, the assets within these plans do fluctuate with changing market valuations and volatility; and
- Insurance – The Company monitors its insurance providers to ensure that they have acceptable financial ratings, and no concerns have been identified through this review.

#### Economic Risk

Economic risk is the possibility of loss resulting from economic instability in certain areas of the world or significant downturns in markets that the Company supplies. The Company sells a broad range of products that provide thermal solutions to a diverse group of customers operating primarily in the truck, heavy equipment, automotive and commercial heating and air conditioning markets. The recent adverse events in the global economy have created a significant downturn in the Company’s vehicular markets and to a lesser extent in its commercial heating and air conditioning markets. The weak global economy makes it difficult to predict future conditions within these markets. A sustained economic downturn in any of these markets could have a material adverse effect on the future results of operations or the Company’s liquidity and potentially result in the impairment of related assets.

The Company is responding to these market conditions through its continued implementation of its four-point plan as follows:

- Manufacturing realignment – aligning the manufacturing footprint to maximize asset utilization and improve the Company’s cost competitive position;
- Portfolio rationalization – identifying products or businesses which should be divested or exited as they do not meet required financial metrics;
- SG&A expense reduction – reducing SG&A expenses and SG&A expenses as a percentage of sales through diligent cost containment actions; and
- Capital allocation discipline – allocating capital spending to operating segments and business programs that will provide the highest return on investment.

The Company continues to monitor economic conditions in the U.S. and elsewhere. As Modine expands its global presence, it also encounters risks imposed by potential trade restrictions, including tariffs, embargoes and the like.

The Company pursues new market opportunities after careful consideration of the potential associated risks and benefits. Successes in new markets are dependent upon the Company's ability to commercialize its investments. Current examples of new and emerging markets for Modine include those related to exhaust gas recirculation, waste heat recovery and residential fuel cells. Modine's investment in these areas is subject to the risks associated with business integration, technological success, customers' and market acceptance, and Modine's ability to meet the demands of its customers as these markets emerge.

Future recovery from the global recession or continued economic growth in China is expected to put production pressure on certain of the Company's suppliers of raw materials. In particular, there are a limited number of suppliers of copper, steel and aluminum fin stock. The Company is exposed to the risk of supply of certain raw materials not being able to meet customer demand and of increased prices being charged by raw material suppliers.

In addition to the purchase of raw materials, the Company purchases parts from suppliers that use the Company's tooling to create the part. In most instances, the Company does not have duplicate tooling for the manufacture of its purchased parts. As a result, the Company is exposed to the risk of a supplier of such parts being unable to provide the quantity or quality of parts that the Company requires. Even in situations where suppliers are manufacturing parts without the use of Company tooling, the Company faces the challenge of obtaining high-quality parts from suppliers. The Company has implemented a supplier risk management program that utilizes industry sources to identify and mitigate high risk supplier situations.

In addition to the above risks on the supply side, the Company is also exposed to risks associated with demands by its customers for decreases in the price of the Company's products. The Company attempts to offset this risk with firm agreements with its customers whenever possible but these agreements generally carry annual price down provisions as well.

The Company operates in diversified markets as a strategy for offsetting the risk associated with a downturn in any one or more of the markets it serves. However, the risks associated with any market downturn, including the current global recession, are still present.

#### Commodity Price Risk

The Company is dependent upon the supply of certain raw materials and supplies in the production process and has, from time to time, entered into firm purchase commitments for copper, aluminum, nickel, and natural gas. The Company has utilized an aluminum hedging strategy from time to time by entering into fixed price contracts to help offset changing commodity prices. The Company does maintain agreements with certain customers to pass through certain material price fluctuations in order to mitigate the commodity price risk. The majority of these agreements contain provisions in which the pass through of the price fluctuations can lag behind the actual fluctuations by a quarter or longer. The Company anticipates that recent commodity price increases, especially with copper and aluminum, combined with the lagging impact of material pass-through agreements with several customers, will put pressure on the gross margin for the fourth quarter of fiscal 2010.

#### Hedging and Foreign Currency Exchange Contracts

The Company uses derivative financial instruments from time to time as a tool to manage certain financial risks. Their use has been restricted primarily to hedging assets and obligations already held by Modine, and they have been used to protect cash flows rather than generate income or engage in speculative activity. Leveraged derivatives are prohibited by Company policy.

*Commodity Derivatives:* The Company enters into futures contracts from time to time related to certain of the Company’s forecasted purchases of aluminum and natural gas. The Company’s strategy in entering into these contracts is to reduce its exposure to changing purchase prices for future purchases of these commodities. These contracts have been designated as cash flow hedges by the Company. Accordingly, unrealized gains and losses on these contracts are deferred as a component of accumulated other comprehensive income (loss), and recognized as a component of earnings at the same time that the underlying purchases of aluminum and natural gas impact earnings. During the three and nine months ended December 31, 2009, $1.1 million and $5.9 million of expense, respectively, was recorded in the consolidated statement of operations related to the settlement of certain futures contracts. At December 31, 2009, $2.1 million of unrealized losses remain deferred in accumulated other comprehensive income (loss), and will be realized as a component of cost of sales over the next 66 months. During the first nine months of fiscal 2010, the Company did not enter into any new futures contracts for commodities.

The Company has entered into futures contracts from time to time related to certain of the Company’s forecasted purchases of copper and nickel. The Company’s strategy in entering into these contracts was to reduce its exposure to changing purchase prices for future purchases of these commodities. The Company did not designate these contracts as hedges, therefore gains and losses on these contracts were recorded directly in the consolidated statement of operations. There were no future contracts entered into for fiscal 2010. During the three and nine months ended December 31, 2008, $2.6 million and $4.5 million of expense, respectively, was recorded in cost of sales related to these futures contracts.

*Foreign exchange contracts:* Modine maintains a foreign exchange risk management strategy that uses derivative financial instruments in a limited way to mitigate foreign currency exchange risk. Modine periodically enters into foreign currency exchange contracts to hedge specific foreign currency denominated transactions. Generally, these contracts have terms of 90 or fewer days. The effect of this practice is to minimize the impact of foreign exchange rate movements on Modine’s earnings. Modine’s foreign currency exchange contracts do not subject it to significant risk due to exchange rate movements because gains and losses on these contracts offset gains and losses on the assets and liabilities being hedged.

As of December 31, 2009, the Company had no outstanding forward foreign exchange contracts. Non-U.S. dollar financing transactions through inter-company loans or local borrowings in the corresponding currency generally are effective as hedges of long-term investments.

The Company has a number of investments in wholly owned foreign subsidiaries and non-consolidated foreign joint ventures. The net assets of these subsidiaries are exposed to currency exchange rate volatility. From time to time, the Company uses non-derivative financial instruments to hedge, or offset, this exposure.

*Interest rate derivatives:* As further noted above under the section entitled “Interest Rate Risk,” the Company has, from time to time, entered into interest rate derivatives to manage the variability in interest rates. These interest rate derivatives have been treated as cash flow hedges of forecasted transactions and, accordingly, derivative gains or losses are reflected as a component of accumulated other comprehensive income (loss) and are amortized to interest expense over the respective lives of the borrowings.

*Counterparty risks:* The Company manages counterparty risks by ensuring that counterparties to derivative instruments have credit rating acceptable to the Company. At December 31, 2009, all counterparties had a sufficient long-term credit rating.

## Controls and procedures

As filed, 1,136 characters.

#### Evaluation Regarding Disclosure Controls and Procedures

As of the end of the period covered by this quarterly report on Form 10-Q, the Company carried out an evaluation, at the direction of the General Counsel and under the supervision of the Company’s President and Chief Executive Officer and Vice President, Corporate Controller and Chief Accounting Officer, of the effectiveness of the Company’s disclosure controls and procedures as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e), with the participation of the Company’s management. Based upon that evaluation, the President and Chief Executive Officer and Vice President, Corporate Controller and Chief Accounting Officer concluded that the design and operation of the Company’s disclosure controls and procedures are effective as of December 31, 2009.

#### Changes In Internal Control Over Financial Reporting

During the third quarter of fiscal 2010 there was no change in the Company’s internal control over financial reporting that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Filed Feb 8, 2010.
Source: SEC EDGAR, the filing index for accession 0001140361-10-004720. Last ingested by Listed: Nov 4, 2026, 20:14 ET. No prices; not investment advice.