# Modine Manufacturing Co: Form 10-Q for the period ended Jun 30, 2010

- Company: [Modine Manufacturing Co](/companies/mod.md) (CIK 67347)
- Form: 10-Q
- Filed: 2010-08-03
- Accepted by EDGAR: Aug 3, 2010, 19:33 ET
- Period: 2010-06-30
- Accession: 0001140361-10-031244
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/67347/000114036110031244/form10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/67347/000114036110031244/

## Management's discussion and analysis

As filed, 32,919 characters.

When we use the terms “Modine,” “we,” “us,” “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 June 30, 2010 is the first quarter of fiscal 2011.

*First Quarter Highlights:* Net sales in the first quarter of fiscal 2011 improved significantly from the first quarter of fiscal 2010, driven by an overall increase in sales volumes, primarily within the commercial vehicle and off-highway markets in North America and South America, as well as within the European automotive market. Gross margin improved with these increased sales volumes, reflecting the operating leverage generated through our reduced fixed cost structure. Selling, general and administrative (SG&A) expenses increased from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, as anticipated, due to our reinvestment in the business, increased pension costs and higher employee compensation. Our first quarter fiscal 2011 results included foreign currency exchange losses on inter-company loans denominated in foreign currency.

#### CONSOLIDATED RESULTS OF OPERATIONS – CONTINUING OPERATIONS

The following table presents consolidated results from continuing operations on a comparative basis for the three months ended June 30, 2010 and 2009:

*(dollars in millions)*

| For the three months ended June 30 | 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: |
| Net sales | **345.2** | **100.0%** | 253.6 | 100.0% |
| Cost of sales | **289.2** | **83.8%** | 217.8 | 85.9% |
| Gross profit | **56.0** | **16.2%** | 35.9 | 14.1% |
| Selling, general and administrative expenses | **41.8** | **12.1%** | 38.5 | 15.2% |
| Restructuring expense | **0.1** | **0.0%** | 1.2 | 0.5% |
| Impairment of long-lived assets | **-** | **0.0%** | 1.0 | 0.4% |
| Income (loss) from operations | **14.1** | **4.1%** | (4.9) | -1.9% |
| Interest expense | **4.1** | **1.2%** | 5.5 | 2.2% |
| Other expense (income) - net | **3.6** | **1.0%** | (5.7) | -2.2% |
| Earnings (loss) from continuing operations before income taxes | **6.4** | **1.9%** | (4.6) | -1.8% |
| Provision for income taxes | **3.3** | **1.0%** | 1.0 | 0.4% |
| Earnings (loss) from continuing operations | **3.1** | **0.9%** | (5.6) | -2.2% |

First quarter net sales of $345.2 million were 36.1 percent higher than the $253.6 million reported in the first quarter of last year driven by increases in overall sales volumes, partially offset by a $5.0 unfavorable impact of foreign currency exchange rate changes. Automotive and medium/heavy duty truck sales improved 25.4 percent and 27.2 percent, respectively, compared to the first quarter of fiscal 2010.

During the first quarter of fiscal 2011, gross margin improved 210 basis points from 14.1 percent in the first quarter of fiscal 2010 to 16.2 percent in the first quarter of fiscal 2011. The improvement in gross margin is the result of previous reductions in direct and indirect costs in the manufacturing facilities and increased sales volumes.

SG&A expenses increased $3.3 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, yet decreased 310 basis points as a percentage of sales. The increase in SG&A expenses is primarily the result of reinvestment in the business, including higher compensation expense, and higher pension costs.

Results from operations improved $19.0 million from the loss from operations of $4.9 million in the first quarter of fiscal 2010 to income from operations of $14.1 million in the first quarter of fiscal 2011. The higher sales volumes and improvement in gross margin were the primary factors contributing to this improvement in results from operations.

Interest expense decreased $1.4 million over the comparable quarter, primarily driven by the decreased outstanding borrowings.

Other expense of $3.6 million in the first quarter of fiscal 2011 represents a $9.3 million change from other income of $5.7 million reported during the first quarter of fiscal 2010. Other expense in the first quarter of fiscal 2011 consisted primarily of foreign currency exchange losses on inter-company loans denominated in a foreign currency while other income in the first quarter of fiscal 2010 consisted primarily of foreign currency exchange gains on inter-company loans denominated in a foreign currency. In addition, we sold our 50 percent ownership interest in 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 quarter of fiscal 2011, we recorded a $3.3 million provision for income taxes, which represents an effective tax rate of 51.4 percent. This compares to a provision for income taxes of $1.0 million recorded during the first quarter of fiscal 2010, which represented a 22.0 percent effective tax rate. During the first quarter of fiscal 2011, we recorded a valuation allowance of $2.7 million predominately 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.

Earnings from continuing operations of $3.1 million for the first quarter of fiscal 2011 represent a $8.7 million improvement from the loss from continuing operations of $5.6 million for the first quarter of fiscal 2010. In addition, diluted earnings per share from continuing operations of $0.07 increased $0.25 from diluted loss per share from continuing operations of $0.18 for this same period last year. The increase in sales volumes and improved gross margin were the primary drivers of this increase.

SEGMENT RESULTS OF OPERATIONS

### Original Equipment - Asia

*(dollars in millions)*

| For the three months ended June 30 | 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: |
| Net sales | **12.0** | **100.0%** | 6.3 | 100.0% |
| Cost of sales | **10.9** | **90.8%** | 6.6 | 104.8% |
| Gross profit | **1.1** | **9.2%** | (0.3) | -4.8% |
| Selling, general and administrative expenses | **1.5** | **12.5%** | 1.3 | 20.6% |
| Loss from continuing operations | **(0.4)** | **-3.3%** | (1.6) | -25.4% |

The Original Equipment – Asia segment continues to operate in an expansion phase. Net sales increased $5.7 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 due to new program launches within this segment. Gross profit and loss from continuing operations improved from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 due to increased sales.

### Original Equipment - Europe

*(dollars in millions)*

| For the three months ended June 30 | 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: |
| Net sales | **132.2** | **100.0%** | 105.3 | 100.0% |
| Cost of sales | **111.7** | **84.5%** | 91.8 | 87.2% |
| Gross profit | **20.5** | **15.5%** | 13.5 | 12.8% |
| Selling, general and administrative expenses | **10.5** | **7.9%** | 10.9 | 10.4% |
| Restructuring expense | **0.1** | **0.1%** | 0.2 | 0.2% |
| Impairment of long-lived assets | **-** | **0.0%** | 0.2 | 0.2% |
| Income from continuing operations | **9.9** | **7.5%** | 2.2 | 2.1% |

Original Equipment – Europe net sales increased $26.9 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, driven by a $36.6 million increase in underlying vehicular sales volumes partially offset by a $9.7 million unfavorable impact of foreign currency exchange rate changes. Gross profit increased $7.0 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 and gross margin improved 270 basis points to 15.5 percent from 12.8 percent over this same period. The improvement in gross margin is primarily attributable to a significant reduction in direct and indirect costs in the European manufacturing facilities and the increased sales volumes. SG&A expenses are comparable from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 yet decreased as a percentage of sales due to the positive impact of SG&A cost containment efforts. A long-lived asset impairment charge of $0.2 million was recorded in the first quarter of fiscal 2010 related to an investment in an affiliate with an “other than temporary” decline in value. Income from operations increased $7.7 million, primarily due to the improved gross margin and significant increase in sales volumes.

*(dollars in millions)*

| Original Equipment - North America For the three months ended June 30 | 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: |
| Net sales | **130.0** | **100.0%** | 91.5 | 100.0% |
| Cost of sales | **113.7** | **87.5%** | 79.4 | 86.8% |
| Gross profit | **16.3** | **12.5%** | 12.1 | 13.2% |
| Selling, general and administrative expenses | **9.4** | **7.2%** | 8.5 | 9.3% |
| Restructuring expense | **-** | **0.0%** | 0.1 | 0.1% |
| Impairment of long-lived assets | **-** | **0.0%** | 0.8 | 0.9% |
| Income from continuing operations | **6.9** | **5.3%** | 2.7 | 3.0% |

Original Equipment – North America net sales increased $38.5 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, primarily driven by improvements in the North American truck and off-highway markets. Gross margin decreased 70 basis points to 12.5 percent during the first quarter of fiscal 2011 from 13.2 percent during the first quarter of fiscal 2010 due to higher year-over-year commodity costs which more than offset improved operating leverage on higher sales volume. SG&A expenses increased $0.9 million primarily due to higher engineering and development costs and higher pension costs partially offset by a $1.0 million gain on the sale of two manufacturing facilities previously recorded as assets held for sale. Despite the increase in SG&A expenses, as a percentage of sales SG&A expenses decreased 210 basis points from the first quarter of fiscal 2010 to the first quarter of fiscal 2011 as the increase in sales volumes was greater than the increase in SG&A costs. A long-lived asset impairment charge of $0.8 million was recorded during the first quarter of fiscal 2010 for a program that was not able to support its asset base. Income from continuing operations increased $4.2 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, primarily due to the increased sales volumes.

### Index

*(dollars in millions)*

| South America For the three months ended June 30 | 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: |
| Net sales | **36.8** | **100.0%** | 22.6 | 100.0% |
| Cost of sales | **29.4** | **79.9%** | 17.8 | 78.8% |
| Gross profit | **7.4** | **20.1%** | 4.8 | 21.2% |
| Selling, general and administrative expenses | **3.6** | **9.8%** | 3.0 | 13.3% |
| Restructuring expense | **-** | **0.0%** | 0.6 | 2.7% |
| Income from continuing operations | **3.8** | **10.3%** | 1.2 | 5.3% |

South America net sales increased $14.2 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, due to increased sales volumes within their off-highway and commercial vehicle markets and a favorable impact on foreign currency exchange rate changes of $5.0 million. Gross margin decreased from 21.2 percent during the first quarter of fiscal 2010 to 20.1 percent in the first quarter of fiscal 2011, due to year-over-year increased materials pricing which more than offset improved operating leverage on higher sales volume. SG&A expenses increased $0.6 million largely due to an unfavorable impact of foreign currency exchange rate changes. Restructuring expense of $0.6 million was recorded during the first quarter of fiscal 2010 related to a workforce reduction within the Brazilian operation. Income from continuing operations improved $2.6 million, based on the increased sales volumes and the absence of restructuring charges.

*(dollars in millions)*

| Commercial Products For the three months ended June 30 | 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: |
| Net sales | **39.8** | **100.0%** | 34.3 | 100.0% |
| Cost of sales | **29.5** | **74.1%** | 26.1 | 76.1% |
| Gross profit | **10.3** | **25.9%** | 8.2 | 23.9% |
| Selling, general and administrative expenses | **6.7** | **16.8%** | 5.5 | 16.0% |
| Restructuring expense | **-** | **0.0%** | 0.3 | 0.9% |
| Income from continuing operations | **3.6** | **9.0%** | 2.4 | 7.0% |

Commercial Products net sales increased $5.5 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, due to higher market penetration iwht new product introductions. Gross margin increased 200 basis points to 25.9 percent during the first quarter of fiscal 2011 from 23.9 percent during the first quarter of fiscal 2010, with the increased sales volumes and performance improvements. SG&A expenses increased $1.2 million from the first quarter of fiscal 2010 to the first quarter of fiscal 2011, due to an investment in additional resources within the segment and higher commission costs due to increased sales. Income from continuing operations improved $1.2 million to $3.6 million in the first quarter of fiscal 2011 from $2.4 million in the first quarter of fiscal 2010 largely related to the increased sales volumes.

#### 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.

Cash used for operating activities was $21.4 million for the three months ended June 30, 2010 as compared to cash provided by operating activities of $8.0 million for the three months ended June 30, 2009. While operating results improved year-over-year, this increase was more than offset by an investment in working capital balances. The most significant working capital increase was in accounts receivable, which reduced operating cash flows by $26.2 million as we invested in accounts receivable to support an increase in net sales. Days sales outstanding increased 4 days to 47 days during the first quarter of fiscal 2011 as we return to more traditional payment terms with certain of our customers. In addition, we elected to make a $10.5 million contribution to our U.S. pension plan in the first quarter of fiscal 2011 which contributed to the decline in cash flow from operations.

At June 30, 2010, we had capital expenditure commitments of $25.4 million. Significant commitments include tooling and equipment expenditures for new and renewal platforms with new and current customers in Europe and North America. Our capital spending is limited under our amended credit agreements to $75.0 million for fiscal year 2011 and $70.0 million for all fiscal years thereafter.

Outstanding indebtedness increased $18.8 million to $158.0 million at June 30, 2010 from the March 31, 2010 balance of $139.2 million, as a result of our investment in working capital and the contribution to our domestic pension plan. Our cash balances decreased $9.4 million from $43.7 million at March 31, 2010 to $34.3 million at June 30, 2010.

At June 30, 2010, we had $112.6 million available for future borrowings under the domestic revolving credit facility. In addition to this revolving credit facility, unused lines of credit also exist in Europe, Brazil and China totaling $33.6 million at June 30, 2010. In the aggregate, total available lines of credit of $146.2 million existed at June 30, 2010. On May 10, 2010, Modine Holding GmbH and Modine Europe GmbH, subsidiaries of the Company, entered into a 15.0 million euro ($18.3 million U.S. equivalent) Credit Facility Agreement to replace an existing 15.0 million euro credit facility. The availability of funds under the credit facilities is subject to our ability to remain in compliance with the financial covenants and limitations in our respective debt agreements.

We believe that our internally generated operating cash flows, working capital management efforts and existing cash balances, together with access to available external borrowings, will be sufficient to satisfy operating costs and capital expenditures in the foreseeable future.

#### Intercreditor Agreement

At June 30, 2010, there was $25.6 million outstanding under the revolving credit facility, which represented an increase from the $7.5 million outstanding balance at March 31, 2010. In addition, at June 30, 2010, we had $121.5 million, in aggregate, 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 secured in accordance with the above-mentioned agreements 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 October 2011 is the same as it was as of June 30, 2010, the primary lenders would be required to pay approximately $31 million to the senior note holders at that time.

We currently anticipate refinancing our revolving credit facility in the second quarter of fiscal 2011, well before its expiration in July 2011. In the unlikely event that we are unable to complete the refinancing of the revolving credit facility 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 would 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, internally generated operating cash flows and availability on our revolving credit facilities would be sufficient to fund this required payment and any potential associated obligations. In addition to the referenced intention to refinance our revolving credit facility, we are also considering the simultaneous repayment and replacement of the senior notes. If completed, we anticipate that this initiative would include an amendment to and/or restatement of the Intercreditor Agreement to eliminate the above-described rebalancing payment. In addition, upon completion of the repayment and replacement of the senior notes, we would be required to pay a prepayment penalty of approximately $14 million to $18 million to the holders of the senior notes.

#### Debt Covenants

Our debt agreements require us to maintain compliance with various covenants. We are subject to an adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) to interest expense (interest expense coverage ratio) covenant and a debt to adjusted EBITDA (leverage ratio) covenant. Adjusted EBITDA is defined as our earnings (loss) 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 earnings (loss) 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.

Our adjusted EBITDA for the four consecutive quarters ended June 30, 2010 was $101.3 million. The following table presents a calculation of adjusted EBITDA:

(dollars in thousands)

|  | Quarter Ended September 30, 2009 | Quarter Ended December 31, 2009 | Quarter Ended March 31, 2010 | Quarter Ended June 30, 2010 | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| (Loss) earnings from continuing operations | $(4,886) | $2,125 | $(11,895) | $3,119 | $(11,537) |
| Consolidated interest expense | 9,643 | 3,793 | 3,993 | 4,108 | 21,537 |
| Provision for income taxes | 871 | 238 | 7,707 | 3,301 | 12,117 |
| Depreciation and amortization expense (a) | 16,183 | 16,045 | 15,329 | 14,578 | 62,135 |
| Non-cash charges (b) | 3,264 | 583 | 4,662 | 5,187 | 13,696 |
| Restructuring and repositioning (income) charges (c) | (2,334) | 2,463 | 1,557 | 1,714 | 3,400 |
| Adjusted EBITDA | $22,741 | $25,247 | $21,353 | $32,007 | $101,348 |

(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 September 30, 2009 | Quarter Ended December 31, 2009 | Quarter Ended March 31, 2010 | Quarter Ended June 30, 2010 | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| Long-lived asset impairments | $3,849 | $273 | $1,432 | $- | $5,554 |
| Non-cash restructuring and repositioning charges | 767 | 718 | 1,006 | - | 2,491 |
| Exchange (gains) losses on intercompany loans | (1,226) | (412) | 1,939 | 5,187 | 5,488 |
| Provision for uncollectible notes receivable | (327) | 4 | (214) | - | (537) |
| Supplemental executive retirement plan settlement | 201 | - | 499 | - | 700 |
| Non-cash charges | $3,264 | $583 | $4,662 | $5,187 | $13,696 |

(c) Restructuring and repositioning charges 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.

Our interest expense coverage ratio for the four fiscal quarters ended June 30, 2010 was 5.55, which exceeded the minimum requirement of 2.00. The following table presents a calculation of our interest expense coverage ratio:

|  | Four Quarters Ended June 30, 2010 |
| --- | ---: |
| Consolidated interest expense | $21,537 |
| Less: Prepayment penalty classified as interest | (3,449) |
| Plus: Other items (a) | 172 |
| Total consolidated interest expense | $18,260 |
| Adjusted EBITDA | $101,348 |
| Interest expense coverage ratio | 5.55 |

(a) Other items include line of credit fees and costs associated with the sale of receivables.

Our leverage ratio for the four fiscal quarters ended June 30, 2010 was 1.63, which was below the maximum ratio of 5.50 allowed in our debt agreements. The following table presents a calculation of our leverage ratio:

|  | Four Quarters Ended June 30, 2010 |
| --- | ---: |
| Debt per balance sheet | $157,998 |
| Less: Cash collateral on commodity derivatives | (3,000) |
| Plus: Indebtedness attributed to sales of accounts receivable | 2,925 |
| Commodity derivative liability | 1,820 |
| Standby letters of credit | 5,677 |
| Total consolidated debt | $165,420 |
| Adjusted EBITDA | $101,348 |
| Leverage ratio | 1.63 |

We expect to remain in compliance with the interest expense coverage ratio and leverage ratio covenants through the remainder of fiscal 2011 and through the term of the revolving credit facility, based on our projected financial results.

In addition to the interest expense coverage ratio and leverage ratio covenants, we are not permitted to incur capital expenditures greater than $75.0 million for fiscal year 2011 and greater than $70.0 million for all fiscal years thereafter. We expect to remain in compliance with this covenant for the remainder of fiscal 2011 and beyond.

#### Off-Balance Sheet Arrangements

None.

#### New Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (FASB) issued guidance on accounting for transfers of financial assets which requires entities to provide more information regarding sales of securitized financial assets and similar transactions, particularly if the entity has continuing exposure to the risks related to transferred financial assets. The guidance eliminates the concept of a “qualifying special –purpose entity,”changes the requirements for derecognizing financial assets and requires additional disclosures. This guidance is effective for us on a prospective basis on or after April 1, 2010 and had no impact on the consolidated financial statements.

In October 2009, the FASB issued updated guidance on revenue arrangements with multiple deliverables, which addresses the unit of accounting for multiple-deliverable arrangements and revises the method by which consideration is allocated among the units of accounting. The overall consideration is allocated to each deliverable by establishing a selling price for individual deliverables based on a hierarchy of evidence, including vendor-specific objective evidence, other third party evidence of the selling price, or the reporting entity’s best estimate of the selling price of individual deliverables in the arrangement. This guidance is effective for us on a prospective basis on or after April 1, 2011.

#### 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, 2010. As further discussed under “Liquidity and Capital Resources,” under the terms of the Intercreditor Agreement, the primary lenders may be required to pay approximately $31 million to the senior note holders in October 2011 if a rebalancing of our indebtedness to the primary lenders and the senior note holders is required. If this rebalancing becomes necessary, it would increase the debt maturities in the 1-3 years column. 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 $4.1 million as of June 30, 2010.

#### Outlook

We expect the Company’s results for fiscal 2011 to be better than those in fiscal 2010 as a result of improving trends in the markets the Company serves, the recent strengthening in sales volumes and improved operating leverage. Compared with the prior fiscal year, we anticipate improved sales across all of our segments, particularly in the commercial vehicle and off-highway markets in North America and the premium automotive market in Europe. We believe that this increase in revenue will be partially offset by the wind-down of certain automotive, passenger thermal management and commercial vehicle business within the Original Equipment – North America segment. We expect gross margin to be positively impacted by the sales volume improvements given our improved operating leverage. We project that commodity prices and currency rates will remain relatively stable for the remainder of fiscal 2011. We anticipate SG&A expenses to increase as a result of reinvestment in the business to capitalize on long-term growth drivers, higher pension expense, increased employee total compensation and engineering and development expense as sales volumes increase.

We anticipate refinancing our domestic revolving credit facility and are also considering the simultaneous repayment and replacement of the Company’s senior notes. If the Company repays and replaces the senior notes, the Company would be required to pay a prepayment penalty of approximately $14 million to $18 million to the holders of the senior notes. In addition, interest expense in fiscal 2011 may also include the recognition of capitalized debt issuance costs and interest rate derivatives related to these senior notes.

#### 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, 2010. Other risks and uncertainties include, but are not limited to, the following:

Market Risks:

- Economic, social and political conditions, changes and challenges in the markets where Modine operates and competes (including currency exchange rate fluctuations (particularly the value of the euro relative to the U.S. dollar), tariffs, inflation, changes in interest rates, recession, and restrictions associated with importing and exporting and foreign ownership);
- The impact the weak global economy is having on Modine, its customers and its suppliers and any worsening of such economic conditions;
- 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;
- The impact on Modine of increases in commodity prices, particularly Modine’s exposure to the changing prices of aluminum and copper;
- Modine’s ability or inability to pass increasing commodity prices on to customers as well as the inherent lag in timing of such pass-through pricing; and
- 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.

Operational Risks:

- Modine’s ability to successfully execute its four-point plan, including its ability to successfully implement restructuring plans and drive cost reductions as a result;
- 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 reduction pressures 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;
- Unanticipated problems with suppliers meeting Modine’s time and price demands;
- Unanticipated delays or modifications initiated by major customers with respect to product applications or requirements;
- Unanticipated product or manufacturing difficulties, including unanticipated warranty claims;
- Work stoppages or interference at Modine’s facilities or those of its major customers; and
- Costs and other effects of unanticipated litigation or claims, and the increasing pressures associated with rising healthcare and insurance costs.

Financial Risks:

- Modine’s ability to fund its liquidity requirements and meet its long-term commitments in the event of any continued decline and disruption in the credit markets;
- Modine’s ability to refinance its revolving credit facility and senior notes in a timely and favorable manner and to remain in compliance with its debt agreements and financial covenants going forward; and
- Modine’s ability to realize future tax benefits.

In addition to the risks set forth above, Modine is subject to 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, 18,449 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 Japanese company. 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 June 30, 2010, the Company experienced a general strengthening of the U.S. dollar to these foreign currencies, which resulted in an unfavorable translation adjustment of $22.9 million. For the three months ended June 30, 2009, the Company experienced a general weakening of the U.S. dollar to these foreign currencies, particularly the euro, which resulted in a favorable currency translation adjustment of $26.8 million. At June 30, 2010 and March 31, 2010, the Company's foreign subsidiaries had net current assets (defined as current assets less current liabilities) subject to foreign currency translation risk of $94.5 million and $88.5 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 $9.5 million and $8.9 million, respectively. This sensitivity analysis 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-currency-denominated, long-term debt obligations and long-term inter-company loans that are sensitive to foreign currency exchange rates. As of June 30, 2010, there were no third party foreign-denominated, long-term debt obligations. The Company had inter-company loans outstanding at June 30, 2010 as follows:

- $2.3 million loan to its wholly owned subsidiary, Modine do Brasil Sistemas Termicos Ltda. (Modine Brazil), that matures on May 8, 2011;
- $13.3 million loan to its wholly owned subsidiary, Modine Thermal Systems Private Limited (Modine India), that matures on April 30, 2013;
- $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;
- $1.8 million loan to its wholly owned subsidiary, Modine U.K. Dollar Limited, that matures on November 30, 2011; and
- $41.1 million between two loans to its wholly owned subsidiary, Modine Holding GmbH, with various maturity dates through January 31, 2020.

These inter-company loans are sensitive to movements in foreign exchange rates, and the Company does not have any derivative instruments which 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, that 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 $0.3 million for the fiscal year based on the June 30, 2010 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 (loss) income, and are being amortized to interest expense over the respective lives of the borrowings. During the three months ended June 30, 2010 and 2009, $0.1 million of expense was recorded in the consolidated statement of operations related to the amortization of interest rate derivative losses. At June 30, 2010, $0.5 million of net unrealized losses remained deferred in accumulated other comprehensive (loss) income. The following table presents the future principal cash flows and weighted average interest rates by expected maturity dates. 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 with comparable maturities. The book value of the debt approximates fair value, with the exception of the $121.5 million fixed rate notes, which have a fair value of approximately $129.2 million at June 30, 2010.

As of June 30, 2010, long-term debt matures as follows:

### Index

| Years ending March 31, Long-term debt in ($000's) | Expected Maturity Date 2011 | 2012 | 2013 | 2014 | 2015 | Thereafter | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Fixed rate (U.S. dollars) | - | $9,375 | $18,750 | $23,438 | $32,601 | $37,288 | $121,452 |
| Average interest rate | - | 9.56% | 9.56% | 9.56% | 9.56% | 9.56% | 9.56% |
| Variable rate (U.S. dollars) | - | $25,600 |  |  |  |  | $25,600 |
| Average interest rate | - | 5.87% |  |  |  |  | 5.87% |

As further discussed under “Liquidity and Capital Resources,” under the terms of the Intercreditor Agreement the primary lenders may be required to pay approximately $31 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 accelerate the debt maturities from 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, payment experience and credit information. After credit is granted, the Company actively monitors the customer's financial condition and developing business news. Approximately 47 percent of the trade receivables balance at June 30, 2010 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 the future financial condition 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 adverse events in the global financial markets over the past two years have 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 June 30, 2010;
- 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 ensure that these plans provide reasonable diversification, ensure that portfolio managers and investment consultants are adhering to the Company’s investment policies and directives, and ensure limited exposure to high risk securities and other similar assets. The Company believes it has good investment policies and controls and proactive, responsible investment advisors. Despite our efforts to protect against downside risk, the assets within these plans have decreased based upon declining market valuations and volatility; and
- Insurance – The Company monitors its insurance providers to ensure that they have acceptable financial ratings. The Company has not identified any concerns in this regard through its 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 adverse events in the global financial markets 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 current economic uncertainty 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, which includes manufacturing realignment, portfolio rationalization, SG&A expense reduction and capital allocation discipline.

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 continues to pursue non-speculative opportunities to mitigate these economic risks, and capitalize, when possible, on changing market conditions.

The Company pursues new market opportunities after careful consideration of the foreseeable associated risks and benefits. Success in new markets is 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 are 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 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.

#### 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. 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 (loss) income, and recognized as a component of earnings at the same time that the underlying purchases of aluminum earnings. During the three months ended June 30, 2010 and 2009, $0.1 million and $3.1 million of expense, respectively, was recorded in the consolidated statement of operations related to the settlement of certain futures contracts. At June 30, 2010, $2.6 million of unrealized losses remain deferred in accumulated other comprehensive (loss) income, and will be realized as a component of cost of sales over the next 60 months.

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 has not designated these contracts as hedges, therefore gains and losses on these contracts were recorded directly in the consolidated statement of operations.

*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 June 30, 2010, 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 a non-consolidated foreign joint venture. 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 (loss) income 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 June 30, 2010, all counterparties had a sufficient long-term credit rating.

## Controls and procedures

As filed, 1,126 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, Finance, Chief Financial Officer and Treasurer, 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, Finance, Chief Financial Officer and Treasurer concluded that the design and operation of the Company’s disclosure controls and procedures are effective as of June 30, 2010.

#### Changes In Internal Control Over Financial Reporting

During the first quarter of fiscal 2011 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 Aug 3, 2010.
Source: SEC EDGAR, the filing index for accession 0001140361-10-031244. Last ingested by Listed: Nov 4, 2026, 20:14 ET. No prices; not investment advice.