# Modine Manufacturing Co: Form 10-Q for the period ended Dec 31, 2010

- Company: [Modine Manufacturing Co](/companies/mod.md) (CIK 67347)
- Form: 10-Q
- Filed: 2011-02-09
- Accepted by EDGAR: Feb 9, 2011, 22:17 ET
- Period: 2010-12-31
- Accession: 0001140361-11-007575
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/67347/000114036111007575/form10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/67347/000114036111007575/

## Management's discussion and analysis

As filed, 45,456 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, 2010 is the third quarter of fiscal 2011.

*Third Quarter Overview:* Net sales in the third quarter of fiscal 2011 improved significantly from the third 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 and commercial vehicle markets, as these markets are showing signs of recovery from the global recession. Gross profit improved with these increased sales volumes. Gross margin was consistent with the prior year. As anticipated, selling, general and administrative (SG&A) expenses increased from the third quarter of fiscal 2010 to the third quarter of fiscal 2011 due to higher employee benefits, higher engineering and development costs and an investment in growth in Asia. Income from operations improved during the third quarter of fiscal 2011, as the incremental benefit from the sales growth during the quarter more than offset the increase in SG&A expenses. During the third quarter of fiscal 2011, we reported earnings from continuing operations of approximately $6 million largely due to the increased sales volumes.

*Year-To-Date Highlights:* Net sales in the first nine months of fiscal 2011 increased substantially compared with the first nine months of fiscal 2010 due to an overall sales volume increase, particularly within the commercial vehicle and off-highway markets. Gross margin improved as a result of better fixed cost absorption on the higher sales volumes. SG&A expenses increased year-over-year, primarily resulting from reinvestment in the business, including higher compensation benefits and higher engineering and development costs. However, SG&A expenses as a percentage of sales decreased as our rate of growth in sales exceeded the rate of growth in SG&A costs. Income from operations improved as a result of the sales growth and gross margin improvement partially offset by the increase in SG&A expenses. Interest expense includes costs related to the long-term debt refinancing completed during the second quarter of fiscal 2011. Our results for the first nine months of fiscal 2011 were income from continuing operations before taxes versus a loss from continuing operations before taxes for the first nine months of fiscal 2010.

#### CONSOLIDATED RESULTS OF OPERATIONS – CONTINUING OPERATIONS

The following table presents consolidated results from continuing operations on a comparative basis for the three and nine months ended December 31, 2010 and 2009:

#### Index

*(dollars in millions)*

|  | Three months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales | Nine months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **360.0** | **100.0%** | 302.4 | 100.0% | **1,051.1** | **100.0%** | 838.3 | 100.0% |
| Cost of sales | **302.9** | **84.1%** | 254.7 | 84.2% | **877.7** | **83.5%** | 712.4 | 85.0% |
| Gross profit | **57.1** | **15.9%** | 47.7 | 15.8% | **173.4** | **16.5%** | 125.9 | 15.0% |
| Selling, general and administrative expenses | **46.0** | **12.8%** | 40.7 | 13.5% | **133.0** | **12.7%** | 116.2 | 13.9% |
| Restructuring expense (income) | **-** | **0.0%** | 1.1 | 0.4% | **-** | **0.0%** | (0.9) | -0.1% |
| Impairment of goodwill and long-lived assets | **1.3** | **0.4%** | 0.3 | 0.1% | **2.5** | **0.2%** | 5.1 | 0.6% |
| Income from operations | **9.9** | **2.7%** | 5.7 | 1.9% | **37.9** | **3.6%** | 5.5 | 0.7% |
| Interest expense | **2.6** | **0.7%** | 3.8 | 1.3% | **30.2** | **2.9%** | 18.9 | 2.3% |
| Other income – net | **(0.2)** | **0.0%** | (0.4) | -0.1% | **(2.2)** | **-0.2%** | (7.1) | -0.8% |
| Earnings (loss) from continuing operations before income taxes | **7.5** | **2.1%** | 2.4 | 0.8% | **9.8** | **0.9%** | (6.3) | -0.8% |
| Provision for income taxes | **1.4** | **0.4%** | 0.2 | 0.1% | **10.2** | **1.0%** | 2.1 | 0.3% |
| Earnings (loss) from continuing operations | **6.0** | **1.7%** | 2.1 | 0.7% | **(0.3)** | **0.0%** | (8.4) | -1.0% |

#### Comparison of Three Months Ended December 31, 2010 and 2009

Third quarter net sales of $360.0 million were 19.0 percent higher than the $302.4 million reported in the third quarter of fiscal 2010 driven by increases in overall sales volumes as certain end markets are recovering from the recent global recession, partially offset by a $10.9 million unfavorable impact of foreign currency exchange rate changes. Commercial vehicle and off-highway sales improved approximately 21 percent and 62 percent, respectively, compared to the third quarter of fiscal 2010.

Gross profit increased $9.4 million, or 19.7 percent from the third quarter of fiscal 2010 to the third quarter of fiscal 2011 on the increased sales volumes. Gross margin of 15.9 percent during the third quarter of fiscal 2011 is comparable to the same period last year as the benefits from higher sales volumes were offset by incremental costs of program launches and increased metals prices. In addition, the majority of the sales volume increases were within lower margin segments.

SG&A expenses increased $5.3 million from the third quarter of fiscal 2010 to the third quarter of fiscal 2011, yet decreased as a percentage of sales. The increase in SG&A is due primarily to higher employee benefits, higher engineering and development costs and $1.5 million to support growth in Asia.

Restructuring expense 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 closure of our Harrodsburg, Kentucky facility.

During the third quarter of fiscal 2011, we recorded impairment charges of $1.3 million primarily related to facilities held for sale within the Original Equipment – North America segment due to a continued decline in the real estate market for commercial property.

Income from operations improved $4.2 million from $5.7 million in the third quarter of fiscal 2010 to $9.9 million in the third quarter of fiscal 2011 primarily as a result of the higher sales volumes and resulting improvement in gross profit.

Interest expense decreased $1.2 million from the same period last year, due to the lower interest rates as a result of the debt refinancing completed during the second quarter of fiscal 2011.

Other income decreased $0.2 million from the same period last year, primarily related to foreign currency transaction losses recorded in the third quarter of fiscal 2011 on inter-company loans denominated in foreign currencies versus gains recorded in the third quarter of fiscal 2010.

During the third quarter of fiscal 2011, we recorded a $1.4 million provision for income taxes, which represents an effective tax rate of 19.2 percent. This compares to a $0.2 million provision for income taxes recorded during the third quarter of fiscal 2010, which represents an effective tax rate of 10.1 percent. We record a provision for income taxes primarily in foreign jurisdictions where we are generating pre-tax profits, such as Brazil, United Kingdom, the Netherlands and Hungary. The provision for income taxes increased from the prior year as we generated more pre-tax profits in these foreign tax jurisdictions. During the third quarter of fiscal 2011, we recorded an increase to the valuation allowance of $0.1 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.

Earnings from continuing operations of $6.0 million in the third quarter of fiscal 2011 was an improvement of $3.9 million from the earnings from continuing operations of $2.1 million in the third quarter of fiscal 2010. In addition, diluted earnings per share from continuing operations of $0.13 for the third quarter of fiscal 2011 was an improvement from diluted earnings per share from continuing operations of $0.05 in the third quarter of fiscal 2010. These improvements are primarily related to the higher sales volumes.

Fiscal 2011 year-to-date net sales of $1,051.1 million were $212.8 million higher than the $838.3 million reported in the same period last year driven by overall sales volume improvements. Commercial vehicle and off-highway sales increased approximately 24 percent and 65 percent, respectively, compared to the first nine months of fiscal 2010. This was partially offset by an unfavorable impact of foreign currency exchange rate changes of $27.2 million.

Fiscal 2011 year-to-date gross profit increased $47.5 million from the same period last year. Gross margin improved 150 basis points from 15.0 percent in the first nine months of fiscal 2010 to 16.5 percent in the first nine months of fiscal 2011. The gross margin improvement is the result of better fixed cost absorption on the higher sales volumes.

Fiscal 2011 year-to-date SG&A expenses increased $16.8 million from the same period last year, primarily due to our reinvestment in the business, including higher employee benefits and higher engineering and development costs. SG&A expenses decreased 120 basis points as a percentage of sales.

Restructuring income of $0.9 million was recorded during the first nine months of fiscal 2010 related to the reversal of severance liabilities of $3.3 million within our European business as the result of favorable benefits negotiations partially offset by restructuring charges related to the closure of our Harrodsburg, Kentucky facility.

During the first nine months of fiscal 2011, we recorded impairment charges of $2.5 million within the Original Equipment – Europe and Original Equipment – Asia segments due to a program cancellation and the Original Equipment – North America segment on facilities held for sale due to a continued decline in the real estate market for commercial property. Asset impairment charges of $5.1 million were recorded during the first nine months of fiscal 2010 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.

Fiscal 2011 year-to-date interest expense increased $11.3 million over the same period last year, largely due to the $20.0 million of costs related to the debt refinancing completed during the second quarter of fiscal 2011. Interest expense for the first nine months of fiscal 2010 includes $4.2 million of costs related to the mandatory prepayment of debt with a portion of the cash proceeds from the common stock offering on September 30, 2009.

Fiscal 2011 year-to-date other income decreased $4.9 million from the same period last year. The decrease was due to a reduction in foreign currency exchange gains on inter-company loans denominated in a foreign currency. Other income for the first nine months of fiscal 2010 also includes a gain of $1.5 million related to the sale of our 50 percent ownership of Anhui Jianghaui Mando Climate Control Co. Ltd.

During the first nine months of fiscal 2011, we recorded a $10.2 million provision for income taxes, which represents an effective tax rate of 103.3 percent. This compares to a $2.1 million provision for income taxes recorded during the first nine months of fiscal 2010, which represented an effective tax rate of 33.8 percent. The increase in the provision for income taxes is primarily related to growth in pre-tax earnings in our foreign jurisdictions. During the first nine months of fiscal 2011, we recorded an increase to the valuation allowance of $10.7 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 2010, we recorded valuation allowance charges of $6.2 million primarily against the net deferred tax assets in the U.S.

Loss from continuing operations improved $8.1 million from the first nine months of fiscal 2010 to the first nine months of fiscal 2011. In addition, diluted loss per share from continuing operations improved from a $0.23 loss per share in the prior year to a loss of $0.01 per share in the current year. The increased sales volumes and gross margin improvement were the primary drivers of this improvement.

#### DISCONTINUED OPERATIONS

During the second quarter of fiscal 2011, we recorded $2.9 million of environmental cleanup and remediation expenses as a component of loss from discontinued operations related to a facility in the Netherlands that was sold as part of the spin off of our Aftermarket business on July 22, 2005.

During the third quarter of fiscal 2010, we sold 100 percent of the shares of our South Korea-based vehicular HVAC business for net cash proceeds of $11.2 million and recognized a loss on sale, net of taxes, of $0.4 million.

#### OUT OF PERIOD ADJUSTMENTS

During the second quarter of fiscal 2011, we identified a $3.3 million postretirement curtailment gain related to the closure of the Harrodsburg, Kentucky manufacturing facility, of which $2.9 million related to prior periods and $0.4 million related to the second quarter. We recorded $1.2 million in the Original Equipment – North America segment during the second quarter for the portion of the postretirement curtailment gain that should have been recorded in the fourth quarter of fiscal 2010. We performed a quantitative analysis of the impact of this adjustment on previously issued financial statements, and further considered qualitative factors including the impact of this adjustment on recent and historical earnings trends and that there was no impact on compensation or covenant compliance. After considering both qualitative and quantitative factors, we determined this adjustment was not material to the fiscal 2010 financial statements or the second quarter fiscal 2011 financial statements. As a result of these adjustments, cost of sales decreased $1.2 million, pre-tax and post-tax results increased $1.2 million and diluted loss per share from continuing operations decreased $0.03 for the first nine months of fiscal 2011.

In addition, we determined that $1.7 million of the previously mentioned postretirement curtailment gain should have been recorded in the first quarter of fiscal 2011 and identified a $1.0 million gain from a commercial settlement in the Original Equipment – Europe segment that should have been recorded in the first quarter of fiscal 2011 as well. After considering similar qualitative and quantitative factors to those previously discussed, we determined these first quarter adjustments totaling $2.7 million were not material to the previously issued first quarter fiscal 2011 financial statements. Accordingly, we revised our year-to-date results in the quarterly report for the second quarter of fiscal 2011 and will revise the first quarter fiscal 2011 results prospectively in future filings. The revised first quarter fiscal 2011 results (which are reflected in the fiscal 2011 year to date results) reflect decreased cost of sales of $2.7 million, increased provision for income taxes of $0.4 million, increased income from continuing operations of $2.3 million and increased diluted earnings per share from continuing operations of $0.05.

#### SEGMENT RESULTS OF OPERATIONS

The following is a discussion of our segment results of operations for the three and nine months ended December 31, 2010 and 2009:

*(dollars in millions)*

| Original Equipment - Asia | Three months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales | Nine months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **16.9** | **100.0%** | 8.9 | 100.0% | **41.6** | **100.0%** | 22.4 | 100.0% |
| Cost of sales | **15.6** | **92.3%** | 8.7 | 97.8% | **38.5** | **92.5%** | 22.6 | 100.9% |
| Gross profit | **1.3** | **7.6%** | 0.2 | 2.7% | **3.1** | **7.5%** | (0.2) | -1.0% |
| Selling, general and administrative expenses | **2.2** | **13.0%** | 0.7 | 7.9% | **5.3** | **12.7%** | 3.2 | 14.3% |
| Impairment of long-lived assets | **-** | **0.0%** | 0.2 | 2.2% | **0.3** | **0.7%** | 0.2 | 0.9% |
| Loss from continuing operations | **(0.9)** | **-5.3%** | (0.7) | -7.9% | **(2.5)** | **-6.0%** | (3.6) | -16.1% |

#### Comparison of Three Months Ended December 31, 2010 and 2009

The Original Equipment – Asia segment continues to operate in a growth phase. Net sales increased $8.0 million from the third quarter of fiscal 2010 to the third quarter of fiscal 2011 primarily due to increased program launch activity within the Chinese off-highway markets. Gross margin improved from 2.7 percent during the third quarter of fiscal 2010 to 7.6 percent during the third quarter of fiscal 2011. SG&A expenses increased $1.5 million from the third quarter of fiscal 2010 to the third quarter of fiscal 2011 due to our investment in growth in this segment. The loss from continuing operations increased $0.2 million over the periods presented due to the increase in SG&A costs.

Original Equipment – Asia fiscal 2011 year-to-date net sales increased $19.2 million from the same period last year as a result of continued launch activities and ramp-up of business within this segment. Gross margin improved to 7.5 percent for the first nine months of fiscal 2011 from a gross margin of negative 1.0 percent during the first nine months of fiscal 2010. SG&A expenses increased $2.1 million from the first nine months of fiscal 2010 to the first nine months of fiscal 2011 as a result of our investment in growth in this segment. The loss from continuing operations decreased $1.1 million over the periods presented based on the gross margin improvement.

*(dollars in millions)*

| Original Equipment - Europe | Three months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales | Nine months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **139.9** | **100.0%** | 127.0 | 100.0% | **397.0** | **100.0%** | 344.6 | 100.0% |
| Cost of sales | **122.6** | **87.6%** | 109.3 | 86.1% | **342.6** | **86.3%** | 299.5 | 86.9% |
| Gross profit | **17.3** | **12.4%** | 17.7 | 13.9% | **54.4** | **13.7%** | 45.1 | 13.1% |
| Selling, general and administrative expenses | **9.7** | **6.9%** | 11.5 | 9.1% | **32.0** | **8.1%** | 32.6 | 9.5% |
| Restructuring (income) expense | **-** | **0.0%** | (0.2) | -0.2% | **0.1** | **0.0%** | (3.5) | -1.0% |
| Impairment of goodwill and long-lived assets | **0.3** | **0.2%** | - | 0.0% | **1.2** | **0.3%** | 0.2 | 0.1% |
| Income from continuing operations | **7.3** | **5.2%** | 6.4 | 5.0% | **21.1** | **5.3%** | 15.8 | 4.6% |

31

#### Comparison of Three Months Ended December 31, 2010 and 2009

Original Equipment – Europe net sales increased $12.9 million from the third quarter of fiscal 2010 to the third quarter of fiscal 2011, driven by a $24.9 million increase in sales to vehicular customers, partially offset by a $12.0 unfavorable impact of foreign currency exchange rate changes. Gross margin decreased from 13.9 percent during the third quarter of fiscal 2010 to 12.4 percent during the third quarter of fiscal 2011 due to increased commodity prices and the incremental costs of program launches. During the third quarter of fiscal 2011, the Tubingen, Germany facility was sold for a gain of $2.2 million, which is included in SG&A expense. Income from continuing operations improved $0.9 million over the periods presented due to the sale of the Tubingen, Germany facility.

Original Equipment – Europe fiscal 2011 year-to-date net sales increased $52.4 million from the same period last year, based primarily on an increase in sales to the premium automotive and commercial vehicle markets, partially offset by a $35.0 million unfavorable impact of foreign currency exchange rate changes. Gross margin improved 60 basis points to 13.7 percent during the first nine months of fiscal 2011 due to improved operating leverage on higher sales volumes, which was partially offset by the incremental costs of program launches. SG&A expenses are comparable, yet decreased as a percentage of sales. During the third quarter of fiscal 2011, the Tubingen, Germany facility was sold for a gain of $2.2 million, which is included in SG&A expense. 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. A long-lived asset impairment charge of $1.2 million was recorded during the first nine months of fiscal 2011 related to a program cancellation and for assets no longer in use. Income from continuing operations of $21.1 million during the first nine months of fiscal 2011 was an improvement of $5.3 million from same period in the prior year due to the improved sales and gross margin.

*(dollars in millions)*

| Original Equipment - North America | Three months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales | Nine months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **124.5** | **100.0%** | 101.3 | 100.0% | **379.9** | **100.0%** | 293.6 | 100.0% |
| Cost of sales | **108.0** | **86.7%** | 92.2 | 91.0% | **327.3** | **86.2%** | 261.0 | 88.9% |
| Gross profit | **16.5** | **13.3%** | 9.1 | 9.0% | **52.6** | **13.8%** | 32.6 | 11.1% |
| Selling, general and administrative expenses | **10.0** | **8.0%** | 8.2 | 8.1% | **30.0** | **7.9%** | 22.9 | 7.8% |
| Restructuring expense | **-** | **0.0%** | 1.3 | 1.3% | **-** | **0.0%** | 1.4 | 0.5% |
| Impairment of long-lived assets | **1.0** | **0.8%** | 0.1 | 0.1% | **1.0** | **0.3%** | 4.7 | 1.6% |
| Income (loss) from continuing operations | **5.5** | **4.4%** | (0.5) | -0.5% | **21.6** | **5.7%** | 3.6 | 1.2% |

#### Comparison of Three Months Ended December 31, 2010 and 2009

Original Equipment – North America net sales increased $23.2 million from the third quarter of fiscal 2010 to the third quarter of fiscal 2011, primarily driven by the continued recovery within the off-highway and Class 8 commercial vehicle markets. Gross margin improved 430 basis points from 9.0 percent during the third quarter of fiscal 2010 to 13.3 percent during the third quarter of fiscal 2011 as a result of better fixed cost absorption due to the higher sales volumes. SG&A expenses increased $1.8 million year-over-year, yet was comparable as a percentage of sales. The increase is primarily due to higher employee benefits and higher engineering and development costs. Restructuring charges recorded during the third quarter of fiscal 2010 relate to the closure of our Harrodsburg, Kentucky facility. Asset impairment charges of $1.0 million recorded during the third quarter of fiscal 2011 related to a decline in the market value for facilities held for sale. The income from continuing operations of $5.5 million during the third quarter of fiscal 2011 was an improvement of $6.0 million from the loss from continuing operations of $0.5 million incurred in the third quarter of fiscal 2010, based on the sales increase and gross margin improvement.

Original Equipment – North America fiscal 2011 year-to-date net sales increased $86.3 million, or 29 percent, from the same period last year primarily driven by the continued recovery within the off-highway and Class 8 commercial vehicle markets. Gross margin improved from 11.1 percent during the first nine months of fiscal 2010 to 13.8 percent during the first nine months of fiscal 2011, primarily attributable to improved operating leverage on higher sales volumes and a $3.3 million postretirement curtailment gain related to the closure of the Harrodsburg, Kentucky manufacturing facility. SG&A expenses increased $7.1 million year-over-year due to higher employee benefits and higher engineering and development costs. Restructuring charges recorded in fiscal 2010 relate to the closure of our Harrodsburg, Kentucky facility. Asset impairment charges of $4.7 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, that had a net book value which exceeded its fair value. The income from continuing operations of $21.6 million during the first nine months of fiscal 2011 was an $18.0 million improvement from the income from continuing operations of $3.6 million reported during the first nine months of fiscal 2010 due to the increased sales volumes and improved gross margin.

*(dollars in millions)*

| South America | Three months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales | Nine months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **36.4** | **100.0%** | 32.3 | 100.0% | **114.5** | **100.0%** | 82.9 | 100.0% |
| Cost of sales | **29.5** | **81.0%** | 26.2 | 81.1% | **91.1** | **79.6%** | 66.3 | 80.0% |
| Gross profit | **7.0** | **19.1%** | **6.1** | 19.0% | **23.4** | **20.4%** | 16.6 | 20.0% |
| Selling, general and administrative expenses | **5.7** | **15.7%** | 3.3 | 10.2% | **13.4** | **11.7%** | 9.5 | 11.5% |
| Restructuring expense | **-** | **0.0%** | - | 0.0% | **-** | **0.0%** | 0.8 | 1.0% |
| Income from continuing operations | **1.2** | **3.3%** | 2.8 | 8.7% | **10.0** | **8.7%** | 6.3 | 7.6% |

#### Comparison of Three Months Ended December 31, 2010 and 2009

South America net sales increased $4.1 million from the third quarter of fiscal 2010 to the third quarter of fiscal 2011, due to increased sales volumes within the commercial vehicle and off-highway markets, as well as within the Aftermarket business and a $0.9 million favorable impact of foreign currency exchange rate changes. Gross margin of 19.1 percent during the third quarter of fiscal 2011 was a slight improvement from 19.0 percent during the third quarter of fiscal 2010 due to improved operating leverage on higher sales volumes, partially offset by increased materials costs. SG&A expenses increased $2.4 million largely due to an environmental cleanup and remediation charge of $1.8 million related to a pre-acquisition groundwater contamination issue the company has been addressing. Income from continuing operations decreased $1.6 million over the periods presented due to the increased SG&A costs.

South America fiscal 2011 year-to-date net sales increased $31.6 million from the same period last year, due to increased sales volumes within the commercial vehicle and off-highway markets and in the Aftermarket business and a favorable impact of foreign currency exchange rate changes of $8.4 million. Gross margin improved from 20.0 percent during the first nine months of fiscal 2010 to 20.4 percent during the first nine months of fiscal 2011 due to improved operating leverage on higher sales volumes partially offset by year-over-year increased materials pricing. SG&A expenses increased $3.9 million as a result of reinvestment in the business, including higher employee benefits, and a $1.8 million environmental cleanup and remediation charge. 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 increased $3.7 million to $10.0 million from the first nine months of fiscal 2010 to the first nine months of fiscal 2011 based on the significant increase in sales volumes and gross margin improvement.

#### Index

*(dollars in millions)*

| Commercial Products | Three months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales | Nine months ended December 31 2010 $'s | % of sales | 2009 $'s | % of sales |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Net sales | **48.4** | **100.0%** | 48.4 | 100.0% | **134.8** | **100.0%** | 128.0 | 100.0% |
| Cost of sales | **33.8** | **69.8%** | 33.1 | 68.4% | **96.1** | **71.3%** | 92.1 | 72.0% |
| Gross profit | **14.6** | **30.2%** | 15.2 | 31.5% | **38.7** | **28.7%** | 35.9 | 28.1% |
| Selling, general and administrative expenses | **7.6** | **15.7%** | 7.4 | 15.3% | **21.4** | **15.9%** | 19.5 | 15.2% |
| Restructuring expense | **-** | **0.0%** | - | 0.0% | **-** | **0.0%** | 0.3 | 0.2% |
| Income from continuing operations | **7.0** | **14.5%** | 7.9 | 16.3% | **17.3** | **12.8%** | 16.1 | 12.6% |

#### Comparison of Three Months Ended December 31, 2010 and 2009

Commercial Products net sales were comparable for the third quarter of fiscal 2010 and the third quarter of fiscal 2011. Gross margin decreased from 31.5 percent during the third quarter of fiscal 2010 to 30.2 percent during the third quarter of fiscal 2011, primarily due to materials cost increases. Income from continuing operations of $7.0 million during the third quarter of fiscal 2011 decreased $0.9 million from the third quarter of fiscal 2010 as a result of the decline in gross margin.

Commercial Products fiscal 2011 year-to-date net sales increased $6.8 million from the same period last year, due to higher market penetration with new product introductions, partially offset by a $1.3 million unfavorable impact of foreign currency exchange rate changes. Gross margin improved from 28.1 percent during the first nine months of fiscal 2010 to 28.7 percent during the first nine months of fiscal 2011, primarily due to the increased sales volumes and performance improvements. SG&A expenses increased $1.9 million from the first nine months of fiscal 2010 to the first nine months of fiscal 2011 due to an investment in additional resources within the segment and higher engineering and development costs. Income from continuing operations increased $1.2 million from the first nine months of fiscal 2010 to the first nine months of fiscal 2011 as a result of 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. See Note 14, “Indebtedness” to our condensed consolidated financial statements for further information regarding our debt agreements.

#### Debt Covenants

Our debt agreements require us to maintain compliance with various covenants. The Company is 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 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 $40.0 million of cash restructuring and repositioning charges, not to exceed $20.0 million in any fiscal year, and further adjusted to add back depreciation and amortization. Adjusted EBITDA does not represent, and should not be considered, an alternative to 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 Company is required to maintain the interest expense coverage ratio and leverage ratio covenants based on the following ratios:

|  |  |  |
| --- | --- | --- |
|  | Interest Expense Coverage Ratio Covenant (Not Permitted to Be Less Than): | Leverage Ratio Covenant (Not Permitted to Be Greater Than): |
| Fiscal quarter ending on or after June 30, 2010 but on or before August 12, 2014 | 3.00 to 1.0 | 3.25 to 1.0 |
| All fiscal quarters ending thereafter | 3.00 to 1.0 | 3.00 to 1.0 |

Our adjusted EBITDA for the four consecutive quarters ended December 31, 2010 was $107.5 million. The following table presents a calculation of adjusted EBITDA:

(dollars in thousands)

|  | Quarter Ended March 31, 2010 | Quarter Ended June 30, 2010 | Quarter Ended September 30, 2010 | Quarter Ended December 31, 2010 | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| (Loss) earnings from continuing operations | $(11,895) | $5,404 | $(11,762) | $6,024 | $(12,229) |
| Consolidated interest expense | 3,993 | 4,108 | 23,529 | 2,602 | 34,232 |
| Provision for income taxes | 7,707 | 3,715 | 5,012 | 1,431 | 17,865 |
| Depreciation and amortization expense (a) | 15,329 | 14,578 | 13,747 | 14,168 | 57,822 |
| Non-cash charges (b) | 4,662 | 3,460 | (5,279) | 1,819 | 4,662 |
| Restructuring and repositioning charges (income) (c) | 1,557 | 1,714 | 1,319 | 537 | 5,127 |
| Adjusted EBITDA | $21,353 | $32,979 | $26,566 | $26,581 | $107,479 |

(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, 2010 | Quarter Ended June 30, 2010 | Quarter Ended September 30, 2010 | Quarter Ended December 31, 2010 | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| Long-lived asset impairments | $1,432 | - | $1,226 | $1,274 | $3,932 |
| Non-cash restructuring and repositioning charges | 1,006 | (1,727) | (1,565) | - | (2,286) |
| Exchange losses (gains) on intercompany loans | 1,939 | 5,187 | (4,940) | 545 | 2,731 |
| Provision for uncollectible notes receivable | (214) | - | - | - | (214) |
| Supplemental executive retirement plan settlement | 499 | - | - | - | 499 |
| Non-cash charges | $4,662 | $3,460 | $(5,279) | $1,819 | $4,662 |

(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.

Our interest expense coverage ratio for the four fiscal quarters ended December 31, 2010 was 6.04, which exceeded the minimum requirement of 3.00. The following table presents a calculation of our interest expense coverage ratio:

#### Index

|  | Four Quarters Ended December 31, 2010 |
| --- | ---: |
| Consolidated interest expense | $34,232 |
| Less: Prepayment penalty classified as interest | (16,570) |
| Plus: Other items (a) | 129 |
| Total consolidated interest expense | $17,791 |
| Adjusted EBITDA | $107,479 |
| Interest expense coverage ratio | 6.04 |

(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 December 31, 2010 was 1.62, which was below the maximum ratio of 3.25. The following table presents a calculation of our leverage ratio:

|  | Four Quarters Ended December 31, 2010 |
| --- | ---: |
| Debt per balance sheet | $151,620 |
| Plus: Indebtedness attributed to sales of accounts receivable | 16,878 |
| Net commodity derivative liability | 567 |
| Standby letters of credit | 4,777 |
| Total consolidated debt | $173,842 |
| Adjusted EBITDA | $107,479 |
| Leverage ratio | 1.62 |

We expect to remain in compliance with the interest expense coverage ratio covenant and leverage ratio covenant for the remainder of fiscal 2011 and beyond.

Cash used for operating activities for the nine months ended December 31, 2010 was $1.4 million as compared to cash provided by operating activities of $49.9 million for the nine months ended December 31, 2010. This decline in cash flow from operations is primarily due to a $14.6 million contribution to our U.S. pension plans, the $16.6 million prepayment penalty related to the pay-off of our then existing senior notes in the first half of fiscal 2011 and the investment in working capital balances.

At December 31, 2010, we had capital expenditure commitments of $17.6 million. Significant commitments include tooling and equipment expenditures for new and renewal platforms with new and current customers in Europe and North America.

Outstanding indebtedness increased $12.4 million to $151.6 million at December 31, 2010 from the March 31, 2010 balance of $139.2 million, as a result of the refinancing of our debt, our investment in working capital and the contribution to our domestic pension plan. Our cash balance of $40.4 million at December 31, 2010 is lower than the $43.7 million balance at March 31, 2010.

#### Off-Balance Sheet Arrangements

None.

#### New Accounting Pronouncements

*Accounting standards changes and 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 From 10-K for the fiscal year ended March 31, 2010, with the exception of those relating to the refinancing of our revolving credit facility and the simultaneous repayment and replacement of our senior notes. The following is an updated summary of contractual obligations for the long-term debt and interest associated with long-term debt:

*(in thousands)*

|  | December 31, 2010 Total | Less than 1 year | 1 - 3 years | 4 - 5 years | More than 5 years |
| --- | ---: | ---: | ---: | ---: | ---: |
| Long-term debt | $145,487 | $60 | $567 | $14,096 | $130,764 |
| Interest associated with long-term debt | 76,696 | 2,244 | 17,956 | 17,736 | 38,760 |
| Total long-term debt and interest | $222,183 | $2,304 | $18,523 | $31,832 | $169,524 |

Interest for the revolving credit facility was calculated using a weighted average interest rate of 3.26 percent. Interest for the 2020 Notes was calculated using the contractual interest rate of 6.83 percent.

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 $5.0 million as of December 31, 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 and commercial vehicle markets 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 fiscal 2011 gross margin to be positively impacted by the sales volume improvements, given our improved operating leverage. We anticipate SG&A expenses to increase when compared with fiscal 2010 as a result of reinvestment in the business to capitalize on long-term growth drivers, higher pension expense, increased employee total compensation and higher engineering and development expense as sales volumes increase. However, we expect SG&A costs as a percentage of sales to decrease over time as sales volumes grow at a faster pace than the growth in SG&A costs.

#### 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 this Report and 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 current global economic uncertainty is having on Modine, its customers and its suppliers and any worsening of such economic conditions leading to declining sales volumes;
- The impact on Modine of increases in commodity prices, particularly Modine’s exposure to the changing prices of aluminum, copper and steel;
- 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 and increased gross margins as a result;
- The impact of operational inefficiencies as a result of program launches and product transfers;
- 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;
- Costs and other effects of the remediation of environmental contamination;
- Modine’s ability to obtain profitable business at its facilities in the low cost countries of China, Hungary, Mexico and India and to meet quality standards with products produced at these facilities;
- Unanticipated problems with suppliers meeting Modine’s time, quality 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 launch challenges and warranty claims;
- Work stoppages or interference at Modine’s facilities or those of its major customers and/or suppliers; 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 renewed disruption in the credit markets;
- Modine’s ability 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, 19,461 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 December 31, 2010, the Company experienced a strengthening of the U.S. dollar to these foreign currencies, which resulted in an unfavorable currency translation adjustment of $3.1 million. For the nine months ended December 31, 2010, the Company experienced a general weakening of the U.S. dollar to these foreign currencies, which resulted in a favorable currency translation adjustment of $0.6 million. At December 31, 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 $97.8 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 $9.8 million and $8.9 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, 2010 there were no third party foreign-denominated, long-term debt obligations. The Company had inter-company loans outstanding at December 31, 2010 as follows:

- $14.4 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;
- $1.1 million loan to its wholly owned subsidiary, Modine U.K. Dollar Limited, that matures on November 30, 2011;
- $26.2 million loan to its wholly owned subsidiary, Modine Holding GmbH, that matures on January 31, 2020;
- $5.7 million receivable with its wholly owned subsidiary, Modine do Brazil Sistemas Terminos Ltda. (Modine Brazil) related to the interest on equity tax planning action; and
- $0.3 million loan to its wholly owned subsidiary, Modine Thermal Systems Korea, that matures on April 23, 2011.

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 250 to 375 basis points depending upon the Company’s Consolidated Total Debt to Consolidated Adjusted Earnings before Interest, Taxes, Depreciation and Amortization ratio (leverage ratio) for the four preceding fiscal quarters. As of December 31, 2010, the Company’s variable interest rate was LIBOR plus 300 basis points or 3.26 percent. The Company is subject to future fluctuations in LIBOR and changes in its leverage ratio, 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 $0.1 million for the fiscal year based on the December 31, 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 were reflected as a component of accumulated other comprehensive income (loss), and were being amortized to interest expense over the respective lives of the borrowings. During the nine months ended December 31, 2010, $1.8 million of expense was recorded in the consolidated statements of operations related to the amortization of interest rate derivative losses, which includes the remaining unamortized balance of these interest rate derivatives of $1.6 million in conjunction with the repayment of the 2015 and 2017 Notes on August 12, 2010. 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 the nine months includes $0.5 million of amortization in proportion with the mandatory prepayment of the senior notes on September 30, 2009. There were no remaining net unrealized losses deferred in accumulated other comprehensive income (loss) at December 31, 2010.

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 $125.0 million fixed rate notes, which have a fair value of approximately $121.1 million at December 31, 2010.

As of December 31, 2010, long-term debt matures as follows:

#### Index

| Long-term debt in ($000's) | Expected Maturity Date F2011 | F2012 | F2013 | F2014 | F2015 | Thereafter | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Fixed rate (U.S. dollars) | - | - | - | - | - | $125,000 | $125,000 |
| Average interest rate | - | - | - | - | - | 6.83% | 6.83% |
| Variable rate (U.S. dollars) | - | - | - | - | $13,500 | - | $13,500 |
| Average interest rate | - | - | - | - | 5.04% | - | 5.04% |

#### 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 48 percent of the trade receivables balance at December 31, 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 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 adverse events in the global financial markets in recent years also increased credit risks for 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, 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 to aggressively grow the plan assets while minimizing downside risk. The Company monitors investments in its pension plans to ensure that these plans provide good 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 do fluctuate with changing 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 economy over the last two years 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 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.

The Company expects that continued recovery from the global recession and continued economic growth in China will 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 as suppliers may not increase their output capacity as quickly as customers increased their orders and of increased prices being charged by raw material suppliers.

In addition, the Company purchases parts from suppliers that use the Company's tooling to create the part. In most instances, and for financial reasons, 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 inside and third-party tools 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 often carry price-down provisions.

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 and started to hedge copper during the third quarter 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 selectively uses derivative financial instruments 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 copper. 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 copper impact earnings. During the three and nine months ended December 31, 2010, $0.1 million of income and $0.1 million of expense, respectively, was recorded in the consolidated statement of operations related to the settlement of certain futures contracts. 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, 2010, $0.6 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 54 months.

The Company has entered into futures contracts from time to time related to certain of the Company’s forecasted purchases of nickel. The Company’s strategy in entering into these contracts was to reduce its exposure to changing purchase prices for future purchases of this commodity. 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. 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, 2010, the Company had no outstanding forward foreign exchange contracts. The Company believes that njon-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 entities 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, 2010, all counterparties had a sufficient long-term credit rating.

## Controls and procedures

As filed, 1,130 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 December 31, 2010.

#### Changes In Internal Control Over Financial Reporting

During the third 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.

## Risk factors

As filed, 897 characters.

*Our business involves risks. The following information about these risks should be considered carefully together with the other information contained in this report and in conjunction with Part I. Item 1A. “Risk Factors” included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2010. The risk described below and those in the Form 10-K are not the only risks we face. Additional risks not currently known or deemed immaterial may also result in adverse results for our business.*

***The Company may incur significant costs in the remediation of environmental contamination.***

We are working with our environmental consultants to determine the appropriate means of remediating groundwater contamination at our facility in Brazil that has, over a period of years, migrated to neighboring properties. This remediation could result in potentially significant expenditures.

Filed Feb 9, 2011.
Source: SEC EDGAR, the filing index for accession 0001140361-11-007575. Last ingested by Listed: Nov 4, 2026, 20:14 ET. No prices; not investment advice.