Business Strategy and Results
Modine focuses on thermal management leadership and highly engineered product and service innovations for diversified, global markets and customers. We are committed to enhancing our presence around the world and serving our customers where they are located. We create value by focusing on customer partnerships and providing innovative solutions for our customers' thermal problems.
Modine’s strategy for improved profitability is grounded in diversifying our markets and customer base, differentiating our products and services, and partnering with customers on global OEM platforms. Modine’s top five customers are in three different markets -– automotive, truck and off-highway -– and its ten largest customers accounted for approximately 6857 percent of the Company’s fiscal 20072008 sales, as compared to 6064 percent in fiscal 2006.2007. In fiscal 2007, 592008, 70 percent of total revenues were generated from sales to customers outside of the U.S., 5465 percent of which were generated by Modine’s international operations and 5 percent of which were generated by exports from the U.S. In fiscal 2006, 562007, 59 percent of total revenues were generated from sales to customers outside of the U.S., comprised of 49with 54 percent generated by Modine’s international operations and 75 percent generated by exports from the U.S.
During fiscal 2007,2008, the Company achieved record revenue from continuing operations of $1.76$1.85 billion, an 8a 7 percent improvement from $1.63$1.72 billion in fiscal 2006.2007. Sales volumes were positively affected by strengthstrong foreign volumes in the truckEurope and heavy-duty and industrial markets,Brazil, as well as incremental revenues from Radiadores Visconde Ltda. (“Modine Brazil”)steady growth in which we increased our ownership from 50 percent to 100 percent in May 2006. EarningsCommercial Products business. The loss from continuing operations of $42.3$65.5 million, or $1.31a loss of $2.05 per fully diluted share in fiscal 2008, was down from earnings from continuing operations of $60.8$38.9 million, or $1.78earnings of $1.21 per fully diluted share in fiscal 2006.2007. The decrease in earnings from continuing operations was primarily driven by a decreasedecline in gross margins related to higher raw material prices (primarily copper, aluminumweak North American truck volumes, manufacturing inefficiencies experienced as part of plant closures and nickel)consolidations and pricing pressure from customers. In addition, the reductionimpairment charges of $47.4 million were recorded primarily in earnings from continuing operations relates to an 8 percent increase in selling, generalNorth America and administrative (“SG&A”) expenses. The increase in SG&A expense is primarily related to an increase in expenditures necessary to support growing business volume, added costs in conjunction with the acquisition of the remaining 50 percent of Modine Brazil and repositioning costs related to our global competitiveness program and repositioning of our manufacturing footprint. Partially offsetting these decreases in net earnings was an improvement in Modine’s effective income tax rate from a provision of 32.9 percent in fiscal 2006 to a benefit of 7.6 percent in fiscal 2007. The improvement in the effective income tax rate was primarilySouth Korea due to a $4.1 million tax benefit related to net operating losses in Brazil that were previously unavailable, $2.5 million of research and development credits recorded from passage of legislation which extended this credit and an $8.0 million tax benefit related to the worthlessness of the stock of the Modine’s Taiwan business upon the closure of this Electronics Cooling facility.
Operating cash flow for fiscal 20072008 was $67.4 million which represents a 34.1 percent decrease from the prior year of $102.4 million due largely to reduced operating results in the 7th consecutive year above $100Original Equipment – North America segment. The reduced operating cash flows were not sufficient to fully finance capital expenditures and working capital needs for the business during fiscal 2008, therefore requiring additional borrowings on the Company’s revolving credit facility during the year. Total debt at the end of fiscal 2008 was $226.5 million compared with $179.3 million at the end of fiscal 2007. Additional net borrowings were made primarily to finance $87.0 million of capital expenditures, the purchase of Company stock of $7.7 million through the anti-dilutive portion of the stock repurchase program announced in fiscal 2006 and purchases of stock to satisfy tax withholding obligations upon the vesting of stock awards and a $37.9 million increase in working capital. This significant increase in working capital is primarily due to the growing business volumes. Modine’s days sales outstanding of 51 days at the end of fiscal 2008 has improved from the 53 days at the end of fiscal 2007 and is consistent with the 51 days at the end of fiscal 2006. Modine’s inventory turns of 13.2 at the end of fiscal 2008 has improved from the end of fiscal 2007 of 12.9, but has decreased from 15.4 at the end of fiscal 2006.
During fiscal 2008, the Company recognized a 21 percent decrease versusdecline in future growth prospects within the prior year. TheOriginal Equipment – North America business from previous management projections, including a lower margin outlook, which resulted in a goodwill impairment charge of $23.8 million within this segment. Also during fiscal 2008, the South Korean business, which is included in the Original Equipment – Asia segment, continued to underperform expectations due to customer pricing pressures and a reduced outlook for this business, which resulted in a long-lived asset impairment charge of $12.1 million. In addition to these charges, long-lived asset impairment charges of $11.6 million were recorded during fiscal 2008 consisting of $3.4 million in Original Equipment – North America, where a program was identified as being unable to support its asset base, $4.7 million in Original Equipment – Europe for the Tübingen, Germany manufacturing facility which will be closed, and $3.5 million in the Commercial Products segment for the cancellation of a product in its development stage. A deferred tax valuation allowance of $64.6 million was recorded primarily against the net U.S. and South Korean deferred tax assets related to the existence of projected losses, which resulted in the determination that it was more likely than not that these deferred taxes would not be realized. In response to these business and market conditions, the Company targetsimplemented a number of cost and operational efficiency measures that are designed to improve our longer term competitiveness:
| · | Manufacturing realignment – The Company announced the closure of the Camdenton, Missouri; Pemberville, Ohio; and Logansport, Indiana facilities within the Original Equipment – North America segment and the Tübingen, Germany manufacturing facility within the Original Equipment – Europe segment. These closures are in addition to the previously announced four plant closures in North America, of which the Jackson, Mississippi and Clinton, Tennessee facility closures are still in process. |
| · | Portfolio rationalization – The Company has a new organizational structure which has been in place for a little over a year. The new structure is organized around global product lines and a regional operating model. The Company is looking at product lines within and across the regions to assess them relative to Modine’s competitive position and the overall business attractiveness in order to identify those lower margin product lines which should be divested or exited. Through these rationalization efforts, the Company completed the sale of its Electronics Cooling business on May 1, 2008. |
| · | Capital allocation – The Company introduced an enhanced capital allocation process which is designed to allocate capital spending to the segments and programs that will provide the highest return on investment. The Company anticipates capital spending in the intermediate term to be near deprecation levels. |
| · | Selling, general and administrative (SG&A) cost containment – The Company has a target of driving SG&A levels down to 11.5 percent of sales by fiscal 2011. Progress was made toward this goal during fiscal 2008, with SG&A as a percentage of sales declining from 13.4 percent in the prior year to 12.7 percent in the current year. |
These initiatives are intended to support the Company’s focus on increasing return on average capital employed (“ROACE”)* of 11 percent to 12 percent through the cycle and we achieved a 7.2 percent ROACE in fiscal 2007 as compared to 9.7 percent in fiscal 2006.
| Net earnings | $ | 42,332 | ||
| Plus interest expense, net of tax benefit at total Company effective tax rate | 7,947 | |||
| Net return | $ | 50,279 | ||
| Divided by: | ||||
| Average capital (debt + equity, last five quarter ends / divided by 5) | $ | 697,391 | ||
| Return on average capital employed | 7.2 | % | ||
| Interest expense | $ | 10,163 | ||
| Total company effective tax rate | 21.8 | % | ||
| Tax benefit | 2,216 | |||
| Interest expense net of tax benefit | $ | 7,947 |
We focus our development efforts on the most promising new markets and new products. Our investment in research and development (“R&D”) has increased approximately 413 percent from fiscal 20062007 to fiscal 2007.2008. R&D is an investment in our future that pays off withreturns new technologies for our core markets, such as exhaust gas recirculation (“EGR”) coolers. It is also an investment in our future, as our work with CO22 as a refrigerant,fuel cell technologies and next generation aluminum radiators demonstrates. U.S., European and Asian emissions regulations are tightening fastcontinuing to become more restrictive which require that we react quickly.requires new technologies and products in order to meet these emissions standards. Modine is a leader in EGRexhaust gas recirculation (“EGR”) cooler technology and we have developed solutions that allow our customers to meet tighter government standards efficiently. Forthcoming regulationsEGR coolers recirculate “cooled” exhaust back into a diesel engine at a lower temperature thus reducing emissions of nitrous oxides (NOx), a key pollutant that is being regulated. As the emissions standards tighten in the future, much higher amounts of recirculation is planned, possibly greater than 40 percent of the engine’s exhaust, which will requireput even moregreater emphasis on advanced technology, but throughEGR cooler technology. Through our proactive R&D, we are developing new technologies designed to keep our customers within federal and international guidelines and regulations well into the future.
We have made substantial investments in new, highly efficient plants and equipment along with state-of-the-art technical centers. All of theseThese are critical to our strategy of generating growth through technological leadership. Our wind tunnels, technical centers and administration buildings in Racine, Wisconsin and Bonlanden, Germany, and wind tunnel and technical center in Asan City, South Korea ensure better ongoing service for our global customers.
On May 4, 2006, we purchased1, 2007, the remaining 50 percent of Modine Brazil, our Brazilian joint venture,Company announced it would explore strategic alternatives for its Electronics Cooling business and presented it as held for sale and as a net purchase price of $13.1 million, with $2.0 million of this price payable 24 months after the acquisition. The purchase agreement also provides for payment of an additional $4.0 million based on certain future performance goals. This business, which was established in 1963 and is based in Sao Paulo, Brazil, provides thermal management solutions to the automotive, truck, agricultural and construction equipment, and industrial application markets, as well as the automotive and heavy duty aftermarket for export and for distribution throughout South America. It manufactures a wide array of modules and heat exchangers for OEMs including radiators, charge air coolers, and oil coolers.
Products
The Company offers a broad line of products that can be categorized generally as a percentage of net sales as follows:
| Fiscal 2007 | Fiscal 2006 | ||||||
| Modules/Packages* | 27 | % | 28 | % | |||
| Oil Coolers | 13 | % | 14 | % | |||
| Vehicular Air Conditioning | 13 | % | 14 | % | |||
| Radiators | 14 | % | 11 | % | |||
| Charge-Air Coolers | 11 | % | 12 | % | |||
| Building HVAC | 9 | % | 9 | % | |||
| EGR Coolers | 8 | % | 9 | % | |||
| Miscellaneous | 3 | % | 1 | % | |||
| Electronics | 2 | % | 2 | % | |||
3
| Fiscal 2008 | Fiscal 2007 | |||||||
| Modules/Packages* | 27 | % | 28 | % | ||||
| Oil Coolers | 15 | % | 13 | % | ||||
| Radiators | 14 | % | 14 | % | ||||
| Vehicular Air Conditioning | 14 | % | 14 | % | ||||
| Charge-Air Coolers | 9 | % | 11 | % | ||||
| Building HVAC | 9 | % | 9 | % | ||||
| EGR Coolers | 9 | % | 8 | % | ||||
| Miscellaneous | 3 | % | 3 | % | ||||
*Typically include components such as radiators, oil coolers, charge air coolers, condensers and other purchased components.
Competitive Position
The Company competes with several manufacturers of heat transfer products, some of which are divisions of larger companies and some of which are independent companies. The markets for the Company's products are increasingly competitive and have changed significantly in the past few years. The Company's traditional OEM customers in the U.S. are faced with dramatically increased international competition and have expanded their worldwide sourcing of parts to compete more effectively with lower cost imports. These market changes have caused the Company to experience competition from suppliers in other parts of the world that enjoy economic advantages such as lower labor costs, lower health care costs, and lower tax rates. In addition, our customers continue to ask the Company, as well as their other primary suppliers, to participate in research and development, design, and validation responsibilities. This should result in stronger customer relationships and more partnership opportunities for the Company.
The competitive landscape for Modine's core heat transfer products continues to change. We face increasing challenges from existing competitors and the threat of new, low cost competitors (specifically from China) continues to exist.
Business Segments
The Company has assigned specific businesses to a segment based principally on defined markets and geographical locations. Each Modine segment is managed at the regional vice president or managing director level and has separate financial results reviewed by its chief operating decision makers. These results are used by management in evaluating the performance of each business segment, and in making decisions on the allocation of resources among our various businesses. Our chief operating decision makers evaluate segment performance with an emphasis on gross margin, and secondarily based on operating income of each segment, which includes certain allocations of Corporate SG&A expenses. Additional information about Modine’s business segments, including sales and assets by geography, is set forth in Note 25 of the Notes to Consolidated Financial Statements.
In the first quarter of fiscal 2008, the Company implemented certain management reporting changes which resulted in the Brazilian operation being reported in a newly established South America segment; the Original Equipment -– Americas segment being renamed Original Equipment – North America; certain supporting departments previously included within Corporate and administrative being realigned into the Original Equipment – North America segment; the Commercial HVAC&R segment renamed Commercial Products; and the Other segment renamed to Fuel Cell since the Electronics Cooling business is presented as a discontinued operation. The Original Equipment – Asia and Original Equipment – Europe segment have no changes. The segment information for fiscal 2007 and 2006 has been revised to reflect these changes on a comparable basis.
Original Equipment – Asia, Europe and AsiaNorth America Segments
The continuing globalization of the Company's OEM customer base has led to the necessity of viewing ourModine’s strategic approach, product offerings and competitors on a global basis. In addition, the Company's customers are putting more and morecontinue to pressure on their suppliers to lower prices continuously over the life of a program, or platform, increasing emphasis on priceemphasizing transparency in the quoting process, and are requestingin some cases have requested up front payments in return for the award of future business.
The Company's traditionalmain competitors, Behr GmbH & Co. K.G., Dana Corporation, Visteon Corporation, Denso Corporation, Delphi Corporation, T.Rad Co. Ltd., Honeywell Thermal Div, Tokyo Radiator Co., Ltd (Calsonic) and Valeo SA and ex Valeo Heavy Duty group now owned by EQT, have a worldwide presence. Increasingly, the Company faces a new form of competition as these companiescompetitors expand their product offering and manufacturing footprint through low cost country sourcing which depresses overall market price levels. This also includes migrating from suppliers of components to suppliers of complete integrated modules/packages. Some OEMs have embraced this move, and award contracts based on the ability to provide integrated modules/packages.packages capable of meeting request for quote conditions directed by customers.
Specifically, the Original Equipment - Americas,– North America, Europe and Asia segments offerserve the following product types:markets:
Commercial Vehicle
Customers - – Commercial, medium and heavy duty truck;truck and engine manufacturers; bus; and specialty vehicle manufacturers
Market Overview- – We have witnessed strong growthexperienced weaker than anticipated post-2007 emission mandate sales in the U.S., and Canada. This dynamic is material to our fiscal 2008 results as the new post-2007 heavy truck business we were awarded has had a slow start due to pre-buy activity in advance of the 2007 emission law changes as well as overall market weakness. Strong growth existed in Europe Asia, and South America with broad customer and market consolidation, which we expect to continue.consolidation. Other trends influencing the market include system suppliers becoming more vertically integrated,the consolidation of major customers into global entities emphasizing the development of global vehicle platforms in order to leverage and reduce development costs increasing, and distribution methods and dynamics changing. This market demonstrates cyclical demand patterns as global emissions standards continue to be more tightly controlled.methods. The most recent example of this cyclical pattern is the 2006 pre-build of U.S. trucks in anticipation of higher emission standards required for diesel engine vehicles built after January 1, 2007. Significant growth in truck volumes existed prior to January 1, 2007, but these volumes are anticipated to be much lower subsequent to the emission change as trade manufacturers utilize the supply of 2006 pre-built inventories. These fixed emissions regulations and timelines are driving the advancement of product development worldwide.worldwide and creating demand for incremental thermal transfer products. At the same time, OEMs expect greater supplier support at lower prices and requireseek high tech/technology/low cost solutions for their thermal management needs. In general, the customers havethis drives a deflationary price approach.environment.
The Company also participates in the vehicular air conditioning business with specific strengths in HVAC modules for the truck markets in North America. Market demand for higher efficiency, lower weight, alternative “green” refrigerants, and truck “off-idle” regulations are creating new opportunities for Modine. Commercial vehicle customers are looking for more sophisticated HVAC systems with “car-like” performance and low cost.
Primary Competitors- – Behr GmbH & Co. K.G., Bergstrom, Inc., Delphi Corporation, Denso Corporation, Red Dot Corporation,T. Rad Co. Ltd.; Valeo HD (EQT), Tokyo Radiator Co., Ltd. (Calsonic), Honeywell Thermal Div., Dayco Ensa SA Visteon Corporation
Automotive
Products- – Powertrain cooling (engine cooling modules; radiators; condensers; charge-air-coolers;modules, radiators, condensers, charge-air-coolers, auxiliary cooling (power steering coolers and transmission oil coolers)); and on-engine cooling (EGR coolers;coolers, engine oil coolers;coolers, fuel coolers;coolers, charge-air-coolers and intake air coolers); HVAC system modules
Customers- – Automobile, and light truck and engine manufacturers
Market Overview- – Modine is a niche player in North America, Europe and Asia with sales moderately diversified from a global perspective but dependent on a few major customers. North American growth is relatively flat with several factors (overcapacity byMost auto market analysts have lowered their U.S. sales expectations to just under 15 million units while early in 2008, the Big 3 and under capacity by foreign automakers with manufacturing facilitiesU.S. auto manufacturers were predicting sales in the U.S.) leadingupper 15 to 16 million units. This market consolidationis experiencing a shift in sales from light-duty truck to smaller, more fuel-efficient vehicles as automakers plan to build more light-vehicles with turbochargers or superchargers to increase fuel economy and price pressures.reduce weight. With each of these vehicles, Modine has the opportunity for incremental business that will complement our endeavors on the Next Generation Heat Transfer Technology announced last year. This technology uses less materials resulting in lighter products which contribute to higher fuel economy. OEMs are shifting more development and commercial responsibilities to Tier 1 suppliers with a unique North American trend toward front-end modules and cockpit modules. Production in Europe is expected to grow two percent over the next four years with the majority of growth coming from Asian automakers with manufacturing facilities in Europe investing in local production. The European OEMs are experiencing market share losses, thus creating further cost pressure. Incremental or replacement business is awarded based upon price reductions on current business.
Primary Competitors - – Behr GmbH & Co. K.G., Dana Corporation, Delphi Corporation, Denso Corporation, Doowon Climate Control Company Ltd., The Halla Group (Visteon Corporation)T. Rad., Toyo Radiator Co., Ltd., Samsung Corporation Ltd., Showa Corporation, Valeo SA, (Calsonic) and Visteon Corporation
Off-Highway
Market overview – The slowing of the North American economy driven by the steep decline in housing starts, tight credit and rising energy costs has depressed related off-highway equipment orders. This has been offset by increased funding of highway projects driving demand growth for construction and paving equipment. In addition, agricultural equipment manufacturers have forecasted 25-30 percent increases in production over the next 12-18 months due to bio-fuel production and the 2008 Economic Stimulus Package that will provide incentive for small business (farmers) to purchase new equipment. This may now be tempered by recent indications that government bio-fuel mandates may be modified due to the concern over higher food prices.- Market
Overall market trends in North America and Europe include a migration toward global machine platforms driving the multi-region assembly of a common design platform with an emphasis on low cost country sourcing for certain components. Additionally, fixed emissions regulations and timelines are driving the advancement of product development in both of these markets. OEMs are rapidly expanding into Asia and have a strong desire for suppliers to follow and localize production. Modine is recognized as having strong technical support, product breadth, and the ability to support global standard designs of its customers. Customer expectations are increasing, especially for year-over-year cost reductions and more sophisticated warranty recovery programs.
Primary Competitors – Adams Thermal Systems Inc., AKG, Delphi Corporation, Denso Corporation, Honeywell Inc., Zhejiang Yinlun Machinery Co., Ltd, ThermaSys Corp., T. Rad Co., Ltd., Tokyo Radiator Co., Ltd. (Calsonic), Doowon and Donghwan
South America
Products – Construction and agricultural applications, automotive OEM and industrial applications, aftermarket radiators, charge-air-coolers, oil coolers, auxiliary coolers (transmission, hydraulic and power steering), engine cooling modules and HVAC system modules
Customers - Commercial, medium and heavy duty truck and engine manufacturers; bus; and specialty vehicle manufacturers, automobile, light truck vehicle and engine manufacturers, construction and agricultural equipment, engine manufacturers and industrial manufacturers of material handling equipment, generator sets and compressors
Market Overview – South America provides heat exchanger products to a variety of markets in the domestic Brazilian market as well as for exports to North America and Europe for both on-highway and off-highway markets, automotive OEMs and industrial applications. South America also provides products to the Brazilian, North American and European aftermarkets for both automotive and commercial applications.
Primary Competitors - – Behr GmbH & Co. K.G., Valeo SA, Denso Corporation and Delphi Corporation Visteon Corporation, Bergstrom, Red Dot
Commercial HVAC&R SegmentProducts
Products - – Unit heaters (gas-fired; hydronic; electric and oil-fired); duct furnaces (indoor and outdoor); infrared units (high intensity and low intensity and vacuum systems)intensity); hydronic products (commercial fin-tube radiation;radiation, cabinet unit heaters, and convectors); roof mounted direct and indirect fired makeup air units; unit ventilators; close control units for precise temperature and humidity control applications; chiller units; ceiling cassettes; condensing units and coils for heating, refrigeration, air conditioning and vehicular applications
Customers - – Heating and cooling equipment manufacturers; construction contractors; wholesalers of plumbing and heating equipment; installers; and end users in a variety of commercial and industrial applications, including banking and finance, education, transportation, telecommunications, pharmaceuticals, electronics, hospitals, defense, petrochemicals, and food and beverage processing
Market Overview- – Commercial HVAC&RProducts has strong sales in gas unit heaters, coil products and room heating and cooling units. There are relatively few competitors in the North American market, but those that exist are relatively strong. Efficiency legislation, lower noise requirements, and higher energy costs are driving market opportunities.
Primary Competitors- – Lennox International Inc. (ADP); Luvata (Heatcraft)(Heatcraft / ECO); ECO; Thomas & Betts Corp. (Reznor); Mestek Inc. (Sterling); Emerson Electric Company (Liebert Hiross); United Technologies Corporation (Carrier); Johnson Controls, Inc. (York); and McQuay International
Customers - – The fuel cell group works with targeted customers in the fuel cell or fuel processing industries where close collaborative relationships are formed. Our customers are developing fuel cell, hydrogen generation and hydrogen infrastructure products that are dependent on thermodynamic and catalytic processes and require Modine’s expertise to provide optimal solutions to their unique thermal management challenges. One of these customers is Bloom Energy, with whom we have partnered to provide heat exchange components for their early stage prototype stationary power units that should be commercially available in the next few years.
Market Overview - – Markets served by our customers consist of stationary distributed power generation markets (primary back-up and combinedpower applications); micro-CHP (combined heat and power applications)power); mobile power (passengers(passenger cars, fleet vehicles and industrial vehicles); portable power (man-portable and auxiliary power units for on-board supplementary vehicle power); fuel processing; and the hydrogen infrastructure (refueling stations and on-site hydrogen generation). Modine has a global presence in these markets and is perceived by our customers as the innovation and technology leader.
Primary Competitors - – Behr GmbH & Co. K.G., Dana Corporation, Delphi Corporation and Toyo Radiator Co., Ltd.
We maintain administrative organizations in three regions - North America, Europe and Asia - to facilitate financial and statutory reporting and tax compliance on a worldwide basis and to support the business units. We have manufacturing facilities and joint ventures located in the following countries:
| North America | Europe | South America | Africa | Asia/Pacific | ||||
| Mexico | Austria | Brazil | South Africa | China | ||||
| United States | Germany | Japan | ||||||
| Hungary | South Korea | |||||||
| Italy | ||||||||
| France | ||||||||
| The Netherlands | ||||||||
| United Kingdom |
Our non-U.S. subsidiaries and affiliates manufacture and sell a number of vehicular and industrial products similar to those produced in the U.S. In addition to normal business risks, operations outside the U.S. are subject to other risks such as changing political, economic and social environments, changing governmental laws and regulations, currency revaluations and volatility and market fluctuations.
Information about business segments, geographic regions, principal products, principal markets, methods of distribution, net sales, operating profit and assets is included in Note 25 of the Notes to Consolidated Financial Statements.
Exports
The Company exports from North America to foreign countries and receives royalties from foreign licensees. Export sales as a percentage of net sales were 5 percent for fiscal 2008 and 2007, respectively, and 7 percent for fiscal 2006. Royalties from foreign licenses were 5 percent of total loss from continuing operations in fiscal 2008, and were 9 percent and 4 percent of total earnings from continuing operations for fiscal 2007 and 2006, respectively.
Modine believes its international presence has positioned the Company to share profitably in the anticipated long-term growth of the global vehicular and industrial markets. Modine is committed to increasing its involvement and investment in international markets in the years ahead.
Foreign and Domestic Operations
Financial information relating to the Company's foreign and domestic operations is included in Note 25 of the Notes to Consolidated Financial Statements.
Customer Dependence
Ten customers accounted for approximately 6857 percent of the Company's sales in the fiscal year ended March 31, 2007.2008. These customers, listed alphabetically, were: BMW, Caterpillar Inc., DaimlerChryslerDaimler AG; Deere & Company; Halla Climate Control; Hyundai; International Truck and Engine Corporation;Navistar; MAN Truck & Bus; PACCAR Inc.; and Volkswagen AG; and Volvo AB.AG. Goods are supplied to these customers on the basis of individual purchase orders received from them. When it is in the customer's and the Company's best interests, the Company utilizes long-term sales agreements with customers to minimize investment risks and also to provide the customer with a proven source of competitively priced products. These contracts can be up toare on average three years in duration and may include built-in pricing adjustments. In certain cases, our customers have requested additional pricing adjustments beyond those built-in to these long-term contracts.
Raw Materials
Aluminum, copper, nickel, brass, steel, and solder, all essential to the business, are purchased regularly from several domestic and foreign producers. In general, the Company does not rely on any one supplier for these materials, which are for the most part available from numerous sources in quantities required by the Company. The supply of fabricated copper products is highly concentrated between two global suppliers. Presently, all purchases of fabricated copper are from one supplier. The Company normally does not experience material shortages within its operations and believes that our suppliers’ production of these materials will be adequate throughout fiscal 2008.2009. In addition, when possible, Modine has made material pass-through arrangements with its key customers. Under these arrangements, the Company can pass material cost increases and decreases to its customers. However, where these pass-through arrangements are utilized, there is a time lag between the time of the material increase or decrease and the time of the pass-through, and the customers are increasingly not paying the full material cost increases. To further mitigate the Company’s exposure to fluctuating material prices, we adopted a commodity hedging program in fiscal 2007.2007 which has been continued into fiscal 2008. The Company entered into forward contracts to hedge a portion of our forecasted aluminum purchases, our single largest purchased commodity. In addition, the Company entered into fixed price contracts to hedge against changes in natural gas over the winter months. At March 31, 2007,2008, the Company has forward contracts outstanding which hedge approximately 60 percent of our globalNorth American aluminum requirements anticipated to be purchased over the next sixnine months. The Company expects to continue to use a commodity hedging program in fiscal 2008.2009. During fiscal 2008, the Company started utilizing collars for certain forecasted copper purchases, and also entered into forward contracts for certain forecasted nickel purchases.
Patents
The Company and certain of its wholly owned subsidiaries, ownowns outright or areis licensed to produce products under a number of patents and licenses. These patents and licenses, which have been obtained over a period of years, will expire at various times. Because the Company is involved with many product lines, the Company believes that its business as a whole is not materially dependent upon any particular patent or license, or any particular group of patents or licenses. Modine considers each of its patents, trademarks and licenses to be of value and aggressively defends its rights throughout the world against infringement. By the end of fiscal 2007, Modine hadhas been granted more than 2,300 patents worldwide.worldwide over the life of the Company.
Research and Development
The Company remains committed to its vision of creating value through technology. Company-sponsored research activities relate to the development of new products, processes and services, and the improvement of existing products, processes, and services. Research expenditures were $93.2 million, $82.3 million and $79.4 million in fiscal 2008, 2007 were $82.5 million; in fiscaland 2006, were $79.6 million; and in fiscal 2005 were $68.8 million.respectively. There were no material expenditures on research activities that were customer-sponsored. Over the course of the last few years, the Company has become involved in a number of industry-, university- and government-sponsored research organizations, who conduct research and provide data on technical topics deemed to be of interest to the Company for practical applications in the markets the Company serves. The research and data developed is generally shared among the member companies. In addition, toTo achieve efficiencies and lower developmental costs, Modine's research and engineering groups work closely with Modine'sour customers on special projects and systems designs. In addition, the Company is participating in U.S. government-funded projects, including dual purpose programs in which the Company retains commercial intellectual property rights in technology it develops for the government, such as a contract with the United States Army for the use of CO22 technology in the Mobility Multi-purpose Wheeled Vehicle (HMMWV) cooling system.
Quality Improvement
Modine’s Quality Management System has been evolving steadily since its inception in 1996. As customer requirements and international quality standards have changed, the Modine quality management system has changed with them. Quality expectations have risen continuously and Modine is actively pursuing ways to continue to meet those expectations. For example, ongoing Modine Presidential Initiatives for scrap reduction and improvement of first pass yield continue to provide positive results. In the past year, fourfive manufacturing plants have met the 40 percent improvement goal for first pass yield. Since inception, a total of 18 different plants (including seventen repeat winners) have met this first pass yield goal. In addition, sevensix plants have met the goal for a 30 percent reduction in scrap in the past year. Since inception, a total of 20 different plants (including sevennine repeat winners) have met this scrap reduction goal. Overall, performance on first pass yield and scrap as a percentage of material used have continued a positive trend of improvement over the past 8ten years.
The value of the Modine Quality Management System is also evidenced by the improving results of our Company’s 10ten quality indicators -– metrics that reflect the various aspects of the quality system, such as customer rejects, warranty costs and product test failures. Collectively, these indicators have shown a significant improvement since the end of fiscal 2001. Implementing the Modine Quality Management System at all sites globally helps ensure that customers receive the same high-quality products and services from any Modine facility.
Environmental, Health and Safety Matters
Modine built on its successful history of environmental stewardship in fiscal 20072008 by establishing corporate-wide objectives for the reduction of waste, air emissions and water use. Although not all of these objectives were achieved within the past year, the Company made substantial progress. Modine facilities used 8.1achieved its annual goal by using 5.2 million cubic feet less of water in fiscal 2008, a 2620 percent reduction globally.reduction. Hazardous and solid wastes were reduced by 324,000548,000 pounds and volatile organic compound air emissions were reduced by 56,00064,000 pounds, decreases of 3approximately 4 percent and 6 percent, respectively. For fiscal 2008, Modine has again established company-wide environmental objectives and is increasing its focus at specific locations to achieve these goals.
In fiscal 2005, Modine introduced its Energy Conservation Initiative which challenged its facilities worldwide to reduce energy consumption by 12 percent over the fiscal 2004 baseline. In fiscal 2006, Modine surpassed that goal and achieved a 17 percent reduction in energy consumption (normalized for sales). This past year was marked by a rapidly growing momentum of energy awareness and cultural changes within Modine. The Company’s energy conservation effort was bolstered by the formation of a Global Energy Management Team, the establishment of Global Energy Best Management Practices, and the creation of a $1 million Energy Conservation Fund which provided financial resources for all Modine locations to invest in energy conscious programs, equipment and infrastructure. With 60 projects enabled byCompany continued this fund, the Company built upon its early successsuccessful Initiative and in fiscal 20072008 further reduced energy use by 75 percent year-over-year (normalized for sales).
In terms of sales, Modine consumed 26 percent less energy in fiscal 2008 than it did at the onset of the Energy Conservation program in fiscal 2005. Modine’s sustained energy conservation improvements over the past threefour years avoided the emissions of greater than 122,000205,000 tons of carbon dioxide, significantly reducing its dependence on fossil fuels and shrinking its global carbon footprint. These improvements are equivalent to saving 12.621.2 million gallons of gasoline. Additionally, Modine’s shareholders benefited from energy conservation savings which were in excess of $1 million in fiscal 2007.
An obligation for remedial activities may also arise at Modine-owned facilities due to past practices or as a result of a property purchase or sale. These expenditures most often relate to sites where past operations followed practices and procedures that were considered acceptable under then-existing regulations, but now require investigative and/or remedial work to ensure appropriate environmental protection. TwoThree of the Company's currently owned manufacturing facilities and twoone formerly owned propertiesproperty have been identified as requiring soil and/or groundwater remediation. Environmental liabilities recorded as of March 31, 2008, 2007, 2006, and 20052006 to cover the investigative work and remediation for sites in the United States, Brazil, and The Netherlands were $2.1 million, $1.2 million, $1.1 million, and $1.2$1.1 million, respectively. These liabilities are recorded in the consolidated balance sheet in "accrued expenses and other current liabilities" and "other noncurrent liabilities." It is unlikely these remediation efforts will have a material effect on the Company's results of operations.
Environmental expenses charged to current operations, including remediation costs, solid waste disposal, and operating and maintenance costs totaled $2.7$2.9 million in fiscal 2007.2008. Operating expenses of some facilities may increase during fiscal year 20082009 because of environmental matters but the competitive position of the Company is not expected to change materially.
Modine’s health and safety performance made very positive improvementscontinued to show improvement in fiscal 2007. New in fiscal 2007, the Company began consolidating safety performance into a global reporting format instead of the regional reporting structure used in the past. This reporting format was modified to more accurately represent the expanded global footprint the Company has established in recent years.2008. Modine ended the 2006 calendarfiscal year with a global Recordable Incident Rate (“RIR“) of 2.51,2.42, according to U.S. recordkeeping requirements. This yielded a 236 percent improvement in recordable injuries over calendar 2005 and exceeded the company’s 20 percent RIR improvement goal. The ability of Modine to achieve this goal was largely aided by the European facilities who improved their recordable incident rate by 46 percent compared to calendar 2005. In the European region, 8 of the 12 facilities ended the year with a 40 percent improvementfiscal 2007. Seven company-owned or greater. Of further significance, the Ashington, U.K., Kirchentellinsfurt, Germany, and Uden, Netherlands facilitiesjoint venture locations ended the year with no recordable injuries in calendar 2006.fiscal 2008. Complementing this achievement were 13 American15 facilities worldwide which also met or exceeded the zero injury or 20 percent RIR improvement goal. Leading the improvement in North America were the Harrodsburg, Kentucky and Toledo, Ohio facilities who ended the year with no recordable injuries along with the Jefferson City, Joplin, and Trenton, Missouri facilities who improved their RIR by 65 percent or more.
The Company is focused on meeting Modine’s Global Commitment for Responsible Relationships by providing a safe working environment for all Modine employees worldwide. In order to achieve this, Modine is pursuingfiscal year 2009, a global health and safety programsystem in line with OHSAS 18001 will be applied worldwide to ensure safety is a fundamental element of every culture in which Modine operates.
Employees
The number of persons employed by the Company as of March 31, 20072008 was approximately 7,700.8,100.
Seasonal Nature of Business
The Company generally is not subject to a significant degree of seasonality as sales to OEMs and electronics manufacturers are dependent upon the demand for new vehicles and equipment, respectively.vehicles. Our Commercial HVAC&RProducts business may experience a degree of seasonality since the demand for HVAC products is affected by weather patterns, construction, and other factors. However, no significant seasonality differences are experienced related to this business.
Working Capital Items
The Company manufactures products for the Original Equipmentoriginal equipment segments on an as-ordered basis, which makes large inventories of such products unnecessary. In addition, the Company does not experience a significant amount of returned products. In the Commercial HVAC&RProducts segment, the Company maintains varying levels of finished goods inventory due to certain sales programs. In these areas, the industry and the Company generally make use of extended terms of payment for customers on a limited basis.
Available Information
We make available free of charge through our website, www.modine.com (Investor Relations Link), our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, other Securities Exchange Act reports and all amendments to those reports as soon as reasonably practicable after such material is electronically filed, or furnished, with the Securities and Exchange Commission (“SEC”). These documents were available on our website during the entire year covered by this report. Our reports are also available free of charge on the SEC’s website, www.sec.gov. Also available free of charge on our website (Investor Relations Link) are the following corporate governance documents:
| - | Modine Manufacturing Company Guideline for Business Conduct, which is applicable to all Modine employees, including the principal executive officer, the principal financial officer, |
| - | Modine Manufacturing Company Corporate Governance Guidelines; |
| - | Audit Committee Charter; |
| - | Officer Nomination & Compensation Committee Charter; |
| - | Pension Committee Charter; |
| - | Corporate Governance and Nominating Committee Charter; and |
| - | Technology Committee Charter. |
All of the reports and corporate governance documents referred to above may also be obtained without charge by contacting Investor Relations, Modine Manufacturing Company, 1500 DeKoven Avenue, Racine, Wisconsin 53403-2552. We do not intend to incorporate our internet
website and the information contained therein or incorporated therein into this Report on Form 10-K.
ITEM 1A. RISK FACTORS.
Our business involves risk. The following information about these risks should be considered carefully together with the other information contained in this report. The risks described below are not the only risks we face. Additional risks not currently known or deemed immaterial may also result in adverse results for our business.
We may be unable to complete and successfully implement our restructuring plan to reduce costs and increase efficiencies in our business and, therefore, we may not achieve costs savings.
We are implementing a number of cost savings programs, such as the recently announced plant closures in North America and Europe. Successful implementation of these and other initiatives, including the expansion in low cost countries, is critical to our future competitiveness and our ability to improve our profitability. However, there can be no assurances that these efforts will allow us to achieve cost reductions.
We may need to undertake further restructuring actions.
As we recently announced, we have initiated certain restructuring actions to realign and resize our production capacity and cost structure to meet current and projected operational and market requirements. We may need to take further actions to reduce costs and the charges related to these actions may have a material adverse effect on our results of operations and financial condition.
If we do not execute on our current business plan, we may violate our bank and note holder covenants.
We have amended our existing credit agreement and agreements with holders of $150 million of the Company’s debt to enable the Company to continue to remain in compliance with its financial covenants. The covenants contained in the amended agreements are based upon achievement of the Company’s plans for fiscal years 2009 and 2010, in particular. If the strength in our Original Equipment – Europe, South America and Commercial Products segments does not continue, if the Original Equipment – North America or Original Equipment – Asia results do not improve, or if the recently announced restructuring actions are not executed successfully, we could fail to perform in accordance with our business plan. If this were to occur, the Company could violate its bank and note holder covenants. If we default under our credit agreement and agreements with the note holders, either through failing to meet financial covenants or in some other way, and are unable to reach suitable accommodations with our lenders, our lenders could elect to stop making the advances we need to fund daily operations and could declare all the debt we owe them immediately due and payable.
Events beyond our control may impair our operations and financial condition.
As of March 31, 2008, our total consolidated debt was $226.5 million. This debt level could have important consequences for the Company, including increasing our vulnerability to general adverse economic, credit market and industry conditions; requiring a substantial portion of our cash flows from operations to be used for the payment of interest rather than to fund working capital, capital expenditures, acquisitions and general corporate requirements; limiting our ability to obtain additional financing or refinance our existing debt agreements; and limiting our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate.
The agreements governing our debt include covenants that restrict, among other things, our ability to incur additional debt; pay dividends on or repurchase our equity; make investments; and consolidate, merge or transfer all or substantially all of our assets. Our ability to comply with these covenants may be adversely affected by events beyond our control, including prevailing economic, financial and industry conditions. These covenants may also require that we take action to reduce our debt or to act in a manner contrary to our short-term or long-term business objectives. There can be no assurance that we will meet our covenants in the future or that the lenders will waive a failure to meet those tests.
We may experience negative or unforeseen tax consequences.
We periodically review, as we did in fiscal 2008 with regard to our North American and South Korean operations, the probability of the realization of our deferred tax assets based on forecasts of taxable income in both the U.S. and numerous foreign jurisdictions. In our review, we use historical results, projected future operating results based upon approved business plans, eligible carryforward periods, tax planning opportunities and other relevant considerations. Adverse changes in the profitability and financial outlook in both the U.S. and numerous foreign jurisdictions may require changes in the valuation allowances to reduce our deferred tax assets or increase tax accruals. Such changes could result in material non-cash expenses in the period in which the changes are made and could have a material adverse impact on our results of operations or financial condition.
The Company is currently under examination in the U.S. and in certain foreign countries by the local taxing authorities. Based on the outcome of these examinations, a risk exists that the taxing authorities may disallow certain tax positions taken on previously filed tax returns. Any disallowed tax positions may be in excess of the liability for uncertain tax positions which we have currently recorded in our consolidated financial statements, which could have a material adverse impact on our results of operations or financial condition.
We may be unable to improve the performance of our South Korean business within the targeted timeframe.
Our South Korean business continues to underperform expectations and financial targets due largely to combination of ongoing customer pricing pressures, deteriorating product mix, lack of customer base diversification, and our unfavorable manufacturing cost structure. If we are unable to offset these pricing pressures through continued operating efficiencies and a lower-cost manufacturing profile, we will be unable to meet our financial targets. The workforce within this business is unionized and the annual collective bargaining process has historically resulted in strike-related activities. If we are unable to secure cooperation from the union to help improve cost efficiency, we may be unable to achieve operating efficiencies required and furthermore, could be subject to the risk of future strikes. Any prolonged disputes with the union could lead to program disruption and cancellation which could impact our customer relationships. These events could have a material adverse effect on our results of operations and the future of our South Korean business.
Our OEM business, which accounts for approximately 90 percent of our business currently, is dependent upon the health of the OEM markets we serve. A decline in vehicle sales would reduce our sales and harm our operations.
Our customers’ sales and production levels are affected by general economic conditions, such asincluding the price of fuel, employment levels and trends, fuel prices and interest rates, labor relations issues, regulatory requirements, trade agreements and other factors. The vehicular industry in North and South America, Europe and Asia is extremely challenging. In North America, the domestic automotive industry is characterized by significant overcapacity, fierce competition, high fixed cost structures and significant employee pension and health care obligations. Domestic automakers are losing market share which is creating a vicious circle of lower annual production volumes, overcapacity, fewer vehicles over which to spread high fixed costs and the resulting squeeze of suppliers. Any significant decline in automotive production levels for its current and future customers would reduce the Company’sour sales and harm itsour results of operations and financial condition. We are highly susceptible to downward trends in the markets we serve.
The slowdown in the U.S. economy and increased fuel prices have reduced the demand for commercial trucks. We are also experiencing program cancellations from our customers because the increase in fuel prices is changing consumer demand for vehicles. The global truck markets are subject to tightening emission standards that drive cyclical demand patterns. Any extended cyclical declines in truck market volumes could have an adverse effect on our business. The global construction, agriculture and industrial markets are also impacted by emission regulations and timelines driving the need for advanced product development. These markets are experiencing rapid global expansion into low-cost countries. Significant declines in any of these evolving markets could have an adverse effect on our business.
If we were to lose business with a major OEM customer, our business wouldrevenue and profit could be adversely affected. Even though no one customer accounts for more than 10 percent of our revenue, deterioration
Deterioration of a business relationship with a major OEM customer wouldcould cause the Company’s revenue and profitability to suffer. The loss of a major OEM customer, the loss of business with respect to one or more of theirthe vehicle models that use our products, or a significant decline in the production levels of such vehicles could have an adverse effect on our business, results of operations and financial condition.
The sales of our products are dependent on the success of the particular platform in which our products are placed.
We are awarded business by an OEM customer generally two to three years prior to the launch of a vehicle platform. Although the Company has purchase orders from many of its customers, these purchase orders generally provide for the supply of a customer’s requirements for a particular model and assembly plant and are renewable on a year-to-year basis, rather than for the purchase of a specific quantity of products. We incur significant costs to produce our products for a platform in the form of tooling, plant capacity expansion, research and development, and product testing and evaluation, among others. If the actual sales volumes for those platforms are not what we anticipate, our results of operations wouldcould be adversely affected. Weaffected because the tooling to produce the products is generally cannot recover those expenses from our customers. Therefore, thespecific to a particular program. The discontinuation, loss of business with respect to, or a lack of commercial success of, a particular vehicle model for which the Company is a significant supplier would reduce the Company’s sales and could adversely affect our financial condition.
Our OEM customers continually seek and obtain price reductions from us. These price reductions adversely affect our results of operations and financial condition, even in the face of increased revenue.
A challenge that we and other suppliers to vehicular OEMs face is continued price reduction pressure from our customers. Downward pricing pressure has been a characteristic of the automotive industry in recent years and it is migrating to all our vehicular OEM markets. Virtually all such OEMs have aggressive price reduction initiatives that they impose upon their suppliers, and such actions are expected to continue in the future. In the face of lower prices to customers, the Company must reduce its operating costs in order to maintain profitability. The Company has taken and continues to take steps to reduce its operating costs to offset customer price reductions; however, price reductions are adversely affecting our profit margins and are expected to do so in the future. If the Company is unable to offset customer price reductions through improved operating efficiencies, new manufacturing processes, sourcing alternatives, technology enhancements and other cost reduction initiatives, our results of operations and financial condition could be adversely affected.
We continue to face high commodity costs (including steel, copper, aluminum, nickel, other raw materials and energy) that we increasingly cannot recoup in our product pricing.
Increasing commodity costs continue to have a significant effect on our results, and those of others in our industry. We have sought to alleviate the impact of increasing costs by including a materials pass-through provision in our contracts with our customers. However, certain of our customers are challenging these contractual provisions and are not paying the full cost of the materials increases. The continuation of this practice could adversely affect our profitability. We have also sought to mitigate the risk of changing commodity costs through a commodity hedging program. Under this program, the Company enters into forward contracts to hedge approximately 60 percent of its forecasted U.S. purchases of aluminum. However, this policy would only partially offset increases in material costs, and significant increases could continue to have an adverse effect on our results of operations.
The continual pressure to absorb costs adversely affects our profitability.
We continue to be pressured to absorb costs related to product design, engineering and tooling, as well as other items previously paid for directly by OEMs. In particular, some OEMs have requested that we pay to obtain new business. In addition, they are also requesting that we pay for design, engineering and tooling costs that are incurred prior to the start of production and recover these costs through amortization in the piece price of the applicable component. Some of these costs cannot be capitalized, which adversely affects our profitability until the programs for which they have been incurred are launched.
13
Our lack of manufacturing facilities in low cost countries adversely affects our profitability.
The competitive environment in the OEM markets we serve has been intensifying as our customers seek to take advantage of lower operating costs in China, other countries in Asia and parts of Eastern Europe. As a result, we are facing increased competition from suppliers that have manufacturing operations in low cost countries. While we continue to expand our manufacturing footprint with a view to taking advantage of manufacturing opportunities in low cost countries, we cannot guarantee that we will be able to fully realize such opportunities. Additionally, the establishment of manufacturing operations in emerging market countries carries its own risks, including those relating to political and economic instability; trade, customs and tax risks; currency exchange rates; currency controls; insufficient infrastructure; and other risks associated with conducting business internationally. The loss of any significant production contract to a competitorcompetitors in low cost countries or significant costs and risks incurred to enter and carry on business in these countries wouldcould have an adverse affecteffect on our profitability.
Additional automotive supplier bankruptcies and related labor unrest may disrupt the supply of components to our OEM customers, adversely affecting their demand for our products.
Many automotive suppliers are already in bankruptcy. The bankruptcy courts handling these cases could invalidate or seek to amend existing agreements between the bankrupt companies and their labor unions. The bankruptcy or insolvency of other vehicular suppliers or work stoppages or slowdowns due to labor unrest that may affect these suppliers or our OEM customers could lead to supply disruptions that could have an adverse effect on our business.
As a global company, we are subject to currency fluctuations and any significant movement between the U.S. dollar, the euro, South Korean won and Brazilian real, in particular, could have an adverse affecteffect on our profitability.
Although our financial results are reported in U.S. dollars, a significant portion of our sales and operating costs are realized in euros, the South Korean won, the Brazilian real and other currencies. Our profitability is affected by movements of the U.S. dollar against the euro and the won and other currencies in which we generate revenues and incur expenses. Significant long-term fluctuations in relative currency values, in particular a significant change in the relative values of the U.S. dollar, euro, won or real, could have an adverse affecteffect on our profitability and financial condition.condition or our ongoing ability to remain in compliance with our bank and note holder covenants.
We receive new business and keep the business we have because of our technological innovation.
If we were to compete only on cost, our sales would decline substantially. We compete on vehicle platforms that are small- to medium-sized in the industry where our technology is valued. For instance, in the automotive market we do not bid on large vehicle platforms with commoditized products because the margins are too small. If we cannot differentiate ourselves from our competitors with our technology, our products may become commodities and our sales and earnings would be adversely affected.
Developments or assertions by or against the Company relating to intellectual property rights could adversely affect our business.
The Company owns significant intellectual property, including a large number of patents, trademarks, copyrights and trade secrets, and is involved in numerous licensing arrangements. The Company’s intellectual property plays an important role in maintaining our competitive position in a number of the markets we serve. Developments or assertions by or against the Company relating to intellectual property rights could adversely affect the business. Significant technological developments by others also could adversely affect our business and results of operations.
We may incur material losses and costs as a result of product liability and warranty claims and litigation.
We are exposed to warranty and product liability claims in the event that our products fail to perform as expected, and we may be required to participate in a recall of such products. Our largest customers have recently extended their warranty protection for their vehicles. Other OEMs have also similarly extended their warranty programs. This trend will put additional pressure on the supply base to improve quality systems. This trend may also result in higher cost recovery claims by OEMs from suppliers whose products incur a higher rate of warranty claims. Historically, we have experienced relatively low warranty charges from our customers due to our contractual arrangements and improvements in the quality, warranty, reliability and durability performance of our products. If our customers demand higher warranty-related cost recoveries, or if our products fail to perform as expected, it could have a material adverse impact on our results of operations or financial condition.
We are also involved in various legal proceedings incidental to our business. Although we believe that none of these matters are likely to have a material adverse effect on our results of operations or financial condition, there can be no assurance as to the ultimate outcome of any such legal proceeding or any future legal proceedings.
Our business is subject to costs associated with environmental, health and safety regulations.
Our operations are subject to various federal, state, local and foreign laws and regulations governing, among other things, emissions to air, discharge to waters and the generation, handling, storage, transportation, treatment and disposal of waste and other materials. We believe that our operations and facilities have been and are being operated in compliance, in all material respects, with such laws and regulations, many of which provide for substantial fines and sanctions for violations. The operation of our manufacturing facilities entails risks in these areas, however, and there can be no assurance that we will not incur material costs or liabilities. In addition, potentially significant expenditures could be required in order to comply with evolving environmental, health and safety laws, regulations or other pertinent requirements that may be adopted or imposed in the future.
We are also expanding our business in China and India where environmental, health and safety regulations are in their infancy. As a result, we cannot determine how these laws will be implemented and the impact of such regulation on the Company.
The Company could be adversely affected if we experience shortages of components from our suppliers.
In an effort to manage and reduce the cost of purchased goods and services, the Company, like many suppliers and automakers, has been consolidating its supply base. As a result, the Company is dependent on limited sources of supply for certain components used in the manufacture of our products. The Company selects its suppliers based on total value (including price, delivery and quality), taking into consideration their production capacities, and financial condition and we expect that they will be ableability to support our needs.meet demand. However, there can be no assurance that strong demand, capacity limitations or other problems experienced by the Company’s suppliers will not result in occasional shortages or delays in their supply of components to us. If we were to experience a significant or prolonged shortage of critical components from any of our suppliers and could not procure the components from other sources, the Company would be unable to meets its production schedules for some of its key products and would miss product delivery dates which would adversely affect our sales, margins and customer relations.
We believe that the bankrupt companies and their labor unions. The bankruptcy or insolvency of other automotive suppliers or work stoppages or slowdowns due to labor unrest that may affect these suppliers or our OEM customers could lead to supply disruptions that could have an adverse affect on our business.
Risks related to internal control deficiencies.
Management has identified a material weakness in our internal control over financial reporting during fiscal 2008. Effective internal control is necessary for appropriate financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process, under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our customers, which would adversely affect our salesfinancial statements for external reporting purposes in accordance with generally accepted accounting principles. As disclosed in Item 9A. “Controls and earnings.Procedures”, in this Annual Report on Form 10-K, management identified a material weakness in reconciliations within the Original Equipment – Europe segment. We are currently implementing remediation plans to correct this material weakness, and a risk exists that financial reporting errors could occur before we are able to fully remediate this material weakness or if we experience other internal control deficiencies.
We operate manufacturing facilities in the United States and certain foreign countries. The Company's world headquarters, including general offices, and laboratory, experimental and tooling facilities are maintained in Racine, Wisconsin. Additional technical support functions are located in Bonlanden, Germany and Asan City, South Korea.
The following table sets forth information regarding our principal properties by business segment as of March 31, 2007.2008. Properties with less than 20,000 square feet of building space have been omitted from this table.
Location of Facility | Building Space and Primary Use | Owned or Leased | ||
| Sao Paulo, Brazil | 336,000 sq. ft./manufacturing | Owned | ||
| Original Equipment – North America Segment | ||||
| Harrodsburg, KY | 263,500 sq. ft./manufacturing | Owned | ||
| Clinton, TN | 194,100 sq. ft./manufacturing | Owned | ||
| Pemberville, OH | 186,900 sq. ft./manufacturing | Owned | ||
| McHenry, IL | 164,700 sq. ft./manufacturing | Owned | ||
| Jefferson City, MO | 162,000 sq. ft./manufacturing | Owned | ||
| Trenton, MO | 159,900 sq. ft./manufacturing | Owned | ||
| Washington, IA | 148,800 sq. ft./manufacturing | Owned | ||
| Lawrenceburg, TN | 143,800 sq. ft./manufacturing | Owned | ||
| Joplin, MO | 142,300 sq. ft./manufacturing | Owned | ||
| Logansport, IN | 141,600 sq. ft./manufacturing | Owned | ||
| Jackson, MS | 138,900 sq. ft./manufacturing | Owned | ||
| Camdenton, MO | 128,000 sq. ft./manufacturing | |||
| Owned | ||||
| 90,000 sq. ft./ | Owned | |||
Original Equipment - Asia Segment | ||||
| Asan City, South Korea | 559,100 sq. ft./manufacturing & technical center | Owned | ||
| Chennai, India | 118,100 sq. ft./manufacturing (under construction) | Owned | ||
| Changzhou, China | 107,600 sq. ft./manufacturing | Owned | ||
| Shanghai, China | 64,600 sq. ft./manufacturing | Leased | ||
Original Equipment - Europe Segment | ||||
| Wackersdorf, Germany | 344,400 sq. ft./assembly | Owned | ||
| Bonlanden, Germany | 262,200 sq. ft./corporate & technology center | Owned | ||
| Pontevico, Italy | 153,000 sq. ft./manufacturing | Owned | ||
| Berndorf, Austria | 145,700 sq. ft./manufacturing | Leased | ||
| Tübingen, Germany | 126,400 sq. ft./manufacturing | Owned | ||
| Pliezhausen, Germany | 122,400 sq. ft./manufacturing | 49,800 Owned; | ||
| Kirchentellinsfurt, Germany | 107,600 sq. ft./manufacturing | Owned | ||
| Mezökövesd, Hungary | 90,500 sq. ft./manufacturing | Owned | ||
| Neuenkirchen, Germany | 76,400 sq. ft./manufacturing | Owned | ||
| Uden, Netherlands | 61,900 sq. ft./manufacturing | Owned | ||
| Gyöngyös, Hungary | 57,000 sq. ft./ manufacturing (under construction) | Leased | ||
Commercial | ||||
| Leeds, United Kingdom | 269,100 sq. ft./corporate & manufacturing | Leased | ||
| Nuevo Laredo, Mexico (Plant I) | 198,500 sq. ft./manufacturing | Owned | ||
| Buena Vista, VA | 197,000 sq. ft./manufacturing | |||
| Owned | ||||
| Lexington, VA | 104,000 sq. ft./warehouse | Owned | ||
| West Kingston, RI | 92,800 sq. ft./manufacturing | Owned | ||
| Laredo, TX | 22,000 sq. ft./warehouse | Leased | ||
Corporate Headquarters | ||||
| Racine, WI | 458,000 sq. ft./headquarters & technical center | Owned | ||
| Discontinued Operations | ||||
| Lancaster, PA | 60,000 sq. ft./corporate & manufacturing | Leased | ||
| Ashington, United Kingdom | 22,000 sq. ft./manufacturing | Leased |
We consider our plants and equipment to be well maintained and suitable for their purposes. We review our manufacturing capacity periodically and make the determination as to our need to expand or, conversely, rationalize our facilities as necessary to meet changing market conditions and Company needs.
Certain information required hereunder is incorporated by reference from Note 2526 of the Notes to Consolidated Financial Statements.
Omitted as not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT.
Current Executive Officers of Registrant | |||
Name | Age | Position | Officer Since |
| David B. Rayburn | 59 | President and Chief Executive Officer; Director | 1991 |
| Thomas A. Burke | 50 | Executive Vice President and Chief Operating Officer | 2005 |
| Bradley C. Richardson | 48 | Executive Vice President, Finance and Chief Financial Officer | 2003 |
| Charles R. Katzfey | 60 | Regional Vice President - Americas | 2000 |
| Klaus A. Feldmann | 53 | Regional Vice President - Europe | 2000 |
| James R. Rulseh | 52 | Regional Vice President - Asia | 2001 |
| Dean R. Zakos | 53 | Vice President, General Counsel and Secretary | 1985 |
| Anthony C. DeVuono | 58 | Vice President and Chief Technology Officer | 1996 |
Current Executive Officers of Registrant
Name | Age | Position | Officer Since | |||
| Thomas A. Burke | 51 | President and Chief Executive Officer | 2005 | |||
| Bradley C. Richardson | 49 | Executive Vice President – Corporate Strategy and Chief Financial Officer | 2003 | |||
| Klaus A. Feldmann | 54 | Regional Vice President – Europe | 2000 | |||
| James R. Rulseh | 53 | Regional Vice President – Americas | 2001 | |||
| Thomas F. Marry | 47 | Regional Vice President - Asia | 2007 | |||
| Dean R. Zakos | 54 | Vice President, General Counsel and Secretary | 1985 | |||
| Anthony C. DeVuono | 59 | Vice President and Chief Technology Officer | 1996 |
Officer positions are designated in Modine's By-LawsBylaws and the persons holding these positions are elected annually by the Board generally at its first meeting after the annual meeting of shareholders in July of each year.
There are no family relationships among the executive officers and directors. All of the above officers have been employed by Modine in various capacities during the last five years, except Bradley C. Richardson and Thomas A. Burke.
Mr. Burke was appointed President and Chief Executive Officer in April 2008. Mr. Burke joined Modine on May 31, 2005 as Executive Vice President, and was subsequently promoted to Executive Vice President and Chief Operating Officer in July 2006. Prior to joining the Company, Mr. Burke joined Modine fromworked over a period of nine years in various management positions with Visteon Corporation in Detroit, Michigan, a leading supplier of parts and systems to automobileautomotive manufacturers, in Dearborn, Michigan, where he held various positions over nine years including as Vice President of North American Operations (2002 -– May 2005) and Vice President, European and South American Operations (2001 -– 2002). Prior to working at Visteon, Mr. Burke’s experience also includes 13 years withBurke worked in positions of increasing responsibility at Ford Motor Company.
Mr. Richardson joined Modine on May 12, 2003 asMarry was elected an executive officer of the Company in November 2007 when he became Regional Vice President Finance– Asia. Mr. Marry joined the Company in 1998 and Chief Financial Officer,prior to serving in his current capacity served as Managing Director – Powertrain Cooling Products (November 2006 through October 2007); General Manager, Truck Division (January 2004 through October 2006); Director, Engine Product Group (March 2002 to January 2004); and was subsequently promotedvarious sales and marketing positions from 1998 through 2003. Prior to Executive Vice President, Financejoining the Company, Mr. Marry worked with General Motors Company, Robert Bosch GmbH and Chief Financial Officer in January 2006. Mr. Richardson came to Modine from BP Amoco, now known as BP, where he spent over 20 years in various positions including Chief Financial Officer and Vice President of Performance Management and Control for BP's Worldwide Exploration and Production division (2000-May 2003) and President of BP Venezuela (1999-2000).Milwaukee Electric Tool Corporation.
There are no arrangements or understandings between any of the above officers and any other person pursuant to which he or she was elected an officer of Modine.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's Common Stock is listed on the New York Stock Exchange. The Company's trading symbol is "MOD." The table below shows the range of high and low sales prices for the Company's Common Stock for fiscal 20072008 and 2006.2007. As of March 31, 2007,2008, shareholders of record numbered 3,690; it is estimated that beneficial owners numbered approximately 19,000.3,496.
| 2007 | 2006 | 2008 | 2007 | ||||||||||||||||||||||||||||
| Quarter | High | Low | Dividends | High | Low | Dividends | High | Low | Dividends | High | Low | Dividends | |||||||||||||||||||
| First | $29.99 | $21.90 | $ .1750 | $33.53 | $26.45 | $ .1750 | $ | 24.47 | $ | 21.50 | $ | 0.1750 | $ | 29.99 | $ | 21.90 | $ | 0.1750 | |||||||||||||
| Second | 24.98 | 20.68 | .1750 | 37.38 | 31.93 | .1750 | 29.95 | 22.79 | 0.1750 | 24.98 | 20.68 | 0.1750 | |||||||||||||||||||
| Third | 25.29 | 22.62 | .1750 | 37.98 | 31.44 | .1750 | 28.96 | 15.82 | 0.1750 | 25.29 | 22.62 | 0.1750 | |||||||||||||||||||
| Fourth | 28.00 | 22.65 | .1750 | 34.10 | 25.20 | .1750 | 17.06 | 11.62 | 0.1750 | 28.00 | 22.65 | 0.1750 | |||||||||||||||||||
TOTAL | $ .7000 | $ .7000 | $ | 0.7000 | $ | 0.7000 | |||||||||||||||||||||||||
Certain of the Company's financing agreements require it to maintain specific financial ratios and place certain limitations on the use of retained earnings for the payment of cash dividends and the net acquisition of Company stock (restricted payments). Under our predominant borrowing facility, restricted payments related to dividends may not exceed $150 million on a cumulative basis over the life of the agreement, which runs through October 2009. Cumulative dividend payments made and subject to this restrictive covenant totaled $57.8$80.4 million as of March 31, 2007.2008. Under that same agreement, restricted payments related to share repurchases may not exceed $150 million on a cumulative basis over the life of the agreement. Cumulative payments made to repurchase shares and subject to this restrictive covenant totaled $98.4$103.8 million as of March 31, 2007.2008. The Company was in compliance with these restrictive covenants at March 31, 2007.2008.
The Board of Directors authorized a reduction in the Company’s quarterly cash dividend on its common stock to a rate of 10 cents per share beginning in fiscal 2009.
ISSUER PURCHASES OF EQUITY SECURITIES
During fiscal 2006, the Company announced two common share repurchase programs approved by the Board of Directors. The first program, announced on May 18, 2005, was a dual purpose program authorizing the repurchase of five percent of the Company’s outstanding common stock, as well as the indefinite buy-back of additional shares to offset dilution from Modine’s incentive stock plans. The five percent portion of this program was completed in fiscal 2006, while the anti-dilution portion of this program continues to be available to the Company. During fiscal 2008, 250,000 shares were purchased under the anti-dilution portion of this program at an average cost of $27.48 per share, or a total of approximately $6.9 million. No shares were repurchased under the anti-dilution portion of this program during fiscal 2007. The second program announced on January 26, 2006 authorized the repurchase of up to 10 percent of the Company’s outstanding stock over the next 18 months, incremental to the first buyback program.an 18-month period of time, which expired on July 26, 2007. No share repurchases were made under this program during fiscal 2008. During fiscal 2007, the Company purchased 502,600 shares of common stock at an average price of $26.38 for a total of approximately $13.3 million. As previously announced, any purchases will beThe repurchases were made from time to time at current prices through solicited and unsolicited transactions in the open market, in privately negotiated transactions, or other transactions. Purchases are atThe Company has retired shares acquired pursuant to the discretionprograms, and the retired shares have been returned to the status of the Company and depend on business and market conditions, regulatory considerations and other factors.authorized but un-issued shares.
The following describes our purchases of Common Stock during the Company's 4th fourth quarter of fiscal 2007:2008:
| Period | (a) Total Number of Shares (or Units) Purchased | (b) AveragePrice PaidPer Share(or Unit) | (c)Total Number of Shares (or Units) Purchased as Part of PubliclyAnnounced Plans or Programs | (d)MaximumNumber (orApproximate DollarValue) of Shares(or Units) that May Yet Be Purchased Under the Plans or Programs | |||||||||||
| December 27, 2007 – January 26, 2008 | 20,626 | (1) | $ | 14.91 | (2) | — | — | (3) | |||||||
| January 27 – February 26, 2008 | 324 | (1) | $ | 13.04 | (2) | — | — | (3) | |||||||
| February 27 – March 31, 2008 | 78 | (1) | $ | 12.00 | (2) | — | — | (3) | |||||||
| Total | 21,028 | (1) | $ | 14.87 | (2) | — | — | (3) | |||||||
| (1) | Consists of shares delivered back to the Company by employees and/or directors to satisfy tax withholding obligations that arise upon the vesting of the stock awards. The Company, pursuant to its equity compensation plans, gives participants the opportunity to turn back to the Company the number of shares from the award sufficient to satisfy the person’s tax withholding obligations that arise upon the termination of restrictions. These shares are held as treasury shares. |
| The stated price does not include any commission paid. |
| (3) | There are no shares remaining that may be repurchased under the two publicly announced share repurchase programs, described in Note 22 of the Notes to Consolidated Financial Statements in Item 8. of Part II. of this report, which description is incorporated herein by reference, other than pursuant to the indefinite buy-back authority under the anti-dilution portion of the first program. The Company does not know at this time the number of shares that will be purchased under this portion of the program. In addition, the Company cannot determine the number of shares that will be turned back to the Company by holders of restricted awards or by the directors upon award of unrestricted shares. The participants also have the option of paying the tax-withholding obligation described above by cash or check, or by selling shares on the open market. The number of shares subject to outstanding restricted stock awards is290,039 with a value of $4,202,665 at March 31, 2008. Generally, the tax withholding obligation on such shares is approximately 40 percent of the value of the shares when they vest. The restrictions applicable to the stock awards generally lapse 20 percent per year over five years for stock awards granted prior to April 1, 2005 and generally lapse 25 percent per year over four years for stock awards granted after April 1, 2005; provided, however, that certain stock awards vest immediately upon grant. |
PERFORMANCE GRAPH
The following graph compares the cumulative five-year total return on the Company’s common stock with similar returns on the Russell 2000 Index and the Standard & Poor’s (S&P) MidCap 400 Industrials Index. The graph assumes a $100 investment and reinvestment of dividends.
| INDEXED RETURNS | ||||||||||||||||||||||||||||||
| Base | Years Ending | |||||||||||||||||||||||||||||
| March 31, | Initial Investment | Indexed Returns | ||||||||||||||||||||||||||||
| Period | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | ||||||||||||||||||||||||
| Company / Index | 3/31/02 | 3/31/03 | 3/31/04 | 3/31/05 | 3/31/06 | 3/31/07 | ||||||||||||||||||||||||
| Modine | 100 | 56.95 | 101.22 | 116.24 | 124.60 | 99.57 | ||||||||||||||||||||||||
| Modine Manufacturing Company | $ | 100 | $ | 177.73 | $ | 204.10 | $ | 218.77 | $ | 174.83 | $ | 114.70 | ||||||||||||||||||
| Russell 2000 Index | 100 | 73.04 | 119.66 | 126.13 | 158.73 | 168.11 | 100 | 163.83 | 172.70 | 217.34 | 230.18 | 200.25 | ||||||||||||||||||
| S&P Midcap 400 Industrials Index | 100 | 75.90 | 109.40 | 122.29 | 162.91 | 171.92 | ||||||||||||||||||||||||
| S&P MidCap 400 Industrials Index | 100 | 144.15 | 161.12 | 214.65 | 226.52 | 230.12 | ||||||||||||||||||||||||
The following selected financial data has been presented on a continuing operations basis, and excludes the discontinued operating results of the Electronics Cooling business and the Aftermarket business and the loss on the July 22, 2005 spin off of thisthe Aftermarket business in fiscal 2006.
| (in thousands, except per share amounts) | Fiscal Year ended March 31 | |||||||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
| Net sales | $ | 1,849,373 | $ | 1,722,281 | $ | 1,595,622 | $ | 1,306,822 | $ | 943,622 | ||||||||||
| (Loss) earnings from continuing operations | (65,511 | ) | 38,921 | 73,025 | 69,967 | 46,130 | ||||||||||||||
| Total assets | 1,149,858 | 1,101,573 | 1,052,095 | 1,152,155 | 976,523 | |||||||||||||||
| Long-term debt - excluding current portion | 226,198 | 175,856 | 151,706 | 40,724 | 84,885 | |||||||||||||||
| Dividends per share | 0.70 | 0.70 | 0.70 | 0.63 | 0.55 | |||||||||||||||
| Net (loss) earnings from continuing operations per share of common stock - basic | (2.05 | ) | 1.21 | 2.17 | 2.05 | 1.36 | ||||||||||||||
| Net (loss) earnings from continuing operations per share of common stock - diluted | (2.05 | ) | 1.21 | 2.14 | 2.03 | 1.35 | ||||||||||||||
| (in thousands, except per share amounts) | Fiscal Year ended March 31 | |||||||||||||||
2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||||
| Net sales | $ | 1,757,472 | $ | 1,628,900 | $ | 1,342,416 | $ | 980,675 | $ | 862,989 | ||||||
| Earnings from continuing operations | 42,262 | 60,752 | 61,686 | 35,493 | 33,388 | |||||||||||
| Total assets | 1,101,573 | 1,052,095 | 1,152,155 | 976,523 | 907,221 | |||||||||||
| Long-term debt - excluding current portion | 175,856 | 151,706 | 40,724 | 84,885 | 98,556 | |||||||||||
| Dividends per share | 0.70 | 0.70 | 0.63 | 0.55 | 0.50 | |||||||||||
| Net earnings from continuing operations per share of common stock - basic: | 1.32 | 1.80 | 1.81 | 1.05 | 0.99 | |||||||||||
| Net earnings from continuing operations per share of common stock - diluted: | 1.31 | 1.78 | 1.79 | 1.04 | 0.99 | |||||||||||
The following factors impact the comparability of the selected financial data presented above:
| · | During fiscal |
| · | During fiscal 2008, the Company recorded long-lived asset impairment charges of $23.6 million. Refer to Note 11 of the Notes to Consolidated Financial Statements for additional discussion of these |
| · | During fiscal 2008, the Company’s effective tax rate was a negative 210.1 percent due to a valuation allowance of $64.6 million recorded primarily against the net U.S. and South Korean deferred tax assets. During fiscal 2007, the Company’s effective tax rate was |
| · | During fiscal 2008 and 2007, the Company incurred |
| · | During fiscal 2007, the Company acquired the remaining 50 percent of Radiadores Visconde Ltda. (“Modine Brazil”). During fiscal 2006, the Company acquired Airedale International Air Conditioning Limited. Refer to Note 13 of the Notes to Consolidated Financial Statements for additional discussion of these acquisitions. During fiscal 2005, the Company acquired the South Korean and Chinese assets of the Automotive Climate Control Division of WiniaMando Inc. and the heavy-duty original equipment business of Transpro, Inc. |
| · | During fiscal 2007, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 123(R), “Share-Based |
| · | During fiscal 2007, the Company adopted SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statement Nos. 87, 88, 106 and 132(R)”. Refer to Note |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview and Strategic Plan
Founded in 1916, Modine Manufacturing Company is a worldwide leader in thermal management systems and components, bringing heating and cooling technology and solutions to diversified global markets. Founded in 1916, the Company is in its 91st year of operation with a long history of profitability. We operate on 5 continents, in 15 countries, with approximately 7,7008,100 employees worldwide.
Our products are in automobiles, light-, medium- and heavy-duty vehicles, commercial heating, ventilation and air conditioning (HVAC) equipment, refrigeration systems, off-highway and industrial equipment. Our products are also inequipment, and fuel cell applications and electronic equipment.applications. Our broad product offerings include heat transfer modules and packages, radiators, oil coolers, charge air coolers, vehicular air conditioning, building HVAC equipment, and exhaust gas recirculation (“EGR”) coolers, and electronics cooling solutions.coolers.
Consolidated Strategy
Our goal is to grow profitably as a leading global provider of thermal management technology to a broad range of niche highway, off-highway and industrial end markets. We willexpect to achieve this goal over the long termlong-term through both organic growth and through selective acquisitions. In order to reach our goal, our strategy is diversification by geography and by end market. We focus on:
| · | Development of new products and technologies for diverse end markets; |
| · | A rigorous strategic planning and corporate development process; and |
| · | Operational and financial discipline for improved profitability and long-term stability. |
Effective execution of these strategies will assist us in meeting our long-term financial goals of: (1) ROACEreturn on average capital employed of 11 percent to 12 percent; (2) organic revenue growth of 94 percent to 136 percent; (3) total debt to capital ratio below 40 percent; and (4) gross margins of 18 percent to 20 percent.percent; and (5) selling, general and administrative (SG&A) costs less than 11.5 percent of sales.
Development of New Products and Technologies for Increasingly Diverse End Markets
Our heritage and a current competitive strength is our ability to develop new products and technologies for current and potential customers and for new, emerging markets. We own three global, state-of-the-art technology centers, dedicated to the development and testing of products and technologies. The centers are located in Racine, Wisconsin in the United States,U.S., in Bonlanden, Germany, and in Asan City, South Korea. Our reputation for providing quality products and technologies has been a company strength valued by customers, and has led to a history with few product warranty issues. In fiscal 2008 we spent $93.2 million (representing approximately 40 percent of SG&A expenses) on our product and technology research and development efforts.
We continue to benefit from relationships with customers who recognize the value of having us participate directly in product design, development and validation. This has resulted and should continue to result in strong, longer-term customer relationships with companies that value partnerships with their suppliers. In the past several years, our product lines have been under price pressure from increased global competition, primarily from Asia and other low cost areas. At the same time, many of our products containing higher technology have helped us better manage demands from customers for lower prices. Many of our technologies are proprietary, difficult to replicate and are patent protected. We holdhave been granted over 2,300 patents on our technologies over the life of the Company and work diligently to protect our intellectual property.
Strategic Planning and Corporate Development
We employ both a short-term and longer-term (five(three to five year) strategic planning process enabling us to continually assess our opportunities, competitive threats, and economic market challenges.
We focus on strengthening our competitive position through strategic, global business development activities. We continuously look for and take advantage of opportunities to advance our position as a global leader, both by expanding our geographic footprint and by expanding into new end markets -– all with a focus on thermal management technologies. For the most part, we generate our ideas for potential acquisitions internally. This process allows us to identify product gaps in the marketplace, develop new products and make additional investments to fill those gaps. An example of our success from this process has been our expansion activities into niche HVAC and refrigeration markets.
Operational and Financial Discipline
We operate in an increasingly competitive global marketplace; therefore, we must manage our business with a disciplined focus on increasing productivity and reducing waste. To support this focus we operate our plants using various continuous improvement tools such as Kaizen, lean manufacturing, Six Sigma and others. We operatehistorically operated with a “small plant” philosophy enablingprior to our recent repositioning activities, but the competitiveness of the global market place requires us to move toward a greater flexibilitymanufacturing scale in order to manage our asset base, our capacity, and relationships with employees. We also seek low-cost sourcing when and where appropriate. We are accelerating our efforts in this area ascreate a more competitive cost base. As costs for materials and purchased parts rose dramatically in the past 18 months, primarilyrise due to global increases in the metals commodity markets. To counter these rising materials prices,markets, we have enteredseek low-cost country sourcing when appropriate and enter into contracts with some of our customers which provide for these rising costs to be passed through to them on a lag basis. In addition, in April 2006, we entered into a hedging strategyhave been utilizing futures contracts related to mitigatevarious forecasted commodity purchases to reduce our exposure to changing aluminum prices, which is our largest materials component. We are currently hedging 60 percent of our aluminum needs over the next six months.changes in these commodity prices.
We follow a rigorous financial process for investment and returns, enablingintended to enable increased profitability and cash flows over the long term. We employ a value-based management financial focus,long-term with particular emphasis on working capital improvement and prioritization of capital for investment and disposals -– driving past and current improvement in global cash management,and debt reductionmanagement and access to sufficient credit. This focus has given us the flexibility to capitalize on acquisition opportunities, other investments and joint ventures, research and development, stock buy-backs, and pay dividends. It also helps us identify and take action on underperforming assets in our portfolio, such as our recent announcement of our intention to explore strategic alternatives for the Electronics Cooling business.business, which was recently sold.
Our executive management incentive compensation is based on a return on net assets calculation that drives our singular focus for alignment with shareholders’ interests when it comes to our capital allocation and asset management decisions. In addition, we maintain a long-term incentive compensation plan for officers and certain key employees which is used to attract, retain and motivate key employees who directly impact the performance of the companyCompany over a time-frame greater than a year. This plan is comprised of stock options, retention restricted stock awards and performance stock awards which are based on a mix of earnings per share growth and growth in our stock price. price relative to the market.
Consolidated Market Conditions and Trends
in combination with annual price decreases. At the same time, we are experiencing dramatic increases in the costs of our purchased parts and raw materials -– particularly aluminum, copper, steel, and stainless steel (nickel). Raw materials and purchased components represent approximately 60 percentThe combination of these factors impacts our cost of goods sold. Approximately 60 percent of base materialprofitability. Material increases are subject to pass-through to our customers on a lag basis. This lag period can average up to a year, based on the agreements we have with an individual customer, and some of our customers are pushing back on our attempts to pass these costs on. In addition to our negotiations to pass material costs on to our customers, our strategy to mitigate growing cost pressures is to accelerate new product development and geographic expansion into new and existing niche markets. As well, weWe continue to focus on developing new and expanded proprietary technology that is of more value in the marketplace -– such as our early stage development of fuel cell technology for energy, vehicular and other applications.
Our Response to Current Market Conditions
In response to the unprecedented near-term conditions facing the Company, we have implemented severalthe following strategies over the year to mitigate the effects these pressures have on our margins and our goals for profitable growth and return targets.targets:
| o |
| o | Portfolio rationalization. During fiscal 2007, |
| o |
| o | Selling, general and administrative cost containment. The Company has a target of driving SG&A levels down to 11.5 percent of sales. Progress was made toward this goal during fiscal 2008, with SG&A as a percentage of sales declining from 13.4 percent in fiscal 2007 to 12.7 percent in the current year. Our goal is to achieve the 11.5 percent of sales by fiscal 2011 through continued revenue growth in combination with diligent SG&A cost containment. |
Segment Information -– Strategy, Market Conditions and Trends
Each of these segments is managed at the regional vice president or managing director level and has separate financial results reviewed by our chief operating decision makers. These results are used in evaluating the performance of each business segment, and in making decisions on the allocation of resources among our various businesses. Our chief operating decision makers evaluate segment performance with an emphasis on gross margin, and secondarily based on operating income of each segment, which includes certain allocations of Corporate selling, general and administrativeSG&A expenses.
Original Equipment - Americas (43– Asia (14 percent of fiscal 20072008 revenues)
Our Asian operation is primarily engaged in providing vehicular climate control systems, powertrain cooling systems and engine products to various industrial end markets, with the greatest percentage for commercial light truck applications. These products are sold primarily to South Korean OEMs who export a significant portion of Korean-made vehicles to other countries. Our largest customers are Hyundai Motor Company and Kia Motors Corporation. Competitors include The Halla group of Visteon Corporation, Doowon Climate Control Company Ltd., Samsung Electronics, and others.
A significant trend in our Asian business is our customers’ relative emphasis on lower price over better technology, evidenced by significant price reduction demands from Hyundai Motor and Kia Motors, two of our key customers. On the upside, many partsMany of our products are becoming commoditized because of local suppliers’ ability to compete head-on with pricing. This pricing environment requires a low-cost manufacturing profile and continued operating efficiencies in order to maintain a profitable business environment. This is particularly applicable in our South Korean business, where we have historically been unable to offset customer price reductions with additional operating improvements.
Many components that we have supplied as separate componentsin this region are becoming part of a module, which increases the amount of our content on an engine. Our strategy and focus in this business is to control and reduce costs, secure new business, further diversify our product offering and customer base, and focus on building manufacturing capabilities in China and India to serve the region in a more cost competitive manner. Construction is currently underway on our new manufacturing facilitiesfacility in Changzhou, ChinaChennai, India, and Chennai, India. Both facilitiesit should be ready for production in late fiscal 2008.2009. Construction of the manufacturing facility in Changzhou, China is complete and we are currently shipping low volumes of production from this location. Several new products are scheduled to begin production in this new facility over the next fiscal year.
Original Equipment -– Europe (33(40 percent of fiscal 20072008 revenues)
Our European operation is primarily engaged in providing powertrain and engine cooling systems as well as vehicular climate control components to various industrial end markets, including automotive, heavy duty and industrial, commercial vehicle, bus and off-highway OEMs. These systems include cooling modules, radiators, charge air coolers, oil cooling products, heavy duty exhaust gas recyclingEGR products, retarder and transmission cooling components, and HVAC condensers. Competitors include Behr GmbH & Co. K.G., Valeo, Denso Corporation, AKG, and a variety of other companies.
The business experienced strong growth with the general expansion of the European market in fiscal 2007 and fiscal 2008. Our European operation was able to benefit from the growth of its medium to heavy truck customers, andits construction machinery customers.customers and its automotive customers alike. At the same time the business has been successful in winning additional program awards that will start production beginning in the 2010 time frame. Going forward, we expect to see a further consolidation of the customer base as well as a continuously developingadditional emission legislation that will cause the need for more cooling products and other new products and systems.
Trends affecting our European automotive business include significant price-down demands from our European-based customers, price competition from low-cost country manufacturing locations, and material cost increases for aluminum, stainless steel and energy which have not been offset entirely by pass-through agreements with our customers. At the same time customer service expectations have increased.
To offset these difficult market conditions in the short term,short-term, we continue our focus on various lean manufacturing initiatives, low-cost country sourcing and a critical review of all SG&A related activities. For mid- and long-term improvement, we have recently initiated a program to assessare in the process of adjusting our manufacturing footprint, withand have begun construction of a new facility in Hungary. At the announcement of adding capacitysame time we have started to phase-out our existing facility in Hungary, where we already have one plant.Tübingen, Germany. We believe there is an opportunity to be more cost competitive and grow our business at a higher rate if we expand our operations ininto lower-cost geographic areas.areas like Eastern Europe. In addition, we expect our European business to benefit from the output of our technology initiatives, which will contribute to establishing technological differentiation in the market place and thus provide leverage for new customer agreements.
The continued profitability of this business is dependent upon a further strengthening of our high technologycustomer relationships, on the continued growth of our employee capabilities, on the strengthening of our advanced product development capabilities, and automatedon the automation and reduced cost base in our manufacturing environment, and therefore a lower manufacturing cost base.environment. In the interim, management is focused on process improvement in all areas and the implementation of favorable longer-term customer agreements.
Our Original Equipment – North America segment includes products and technologies that are found on vehicles made by commercial vehicle OEMs, including Class 3-8 trucks, school buses, transit buses, motor homes and motor coaches. It also serves the automotive, heavy duty, and industrial markets, including agricultural, construction and industrial markets; i.e. lift trucks, compressors and power generation.
The majority of our North American business is derived from commercial vehicle customers. The Environmental Protection Agency emissions mandates (January 1, 2007 and the upcoming January 1, 2010) create cyclicality in the Class 8 heavy-truck commercial vehicle build rates due to pre-buy activity which occurs prior to these emission law changes. The expected cyclical downturn in this market after the January 1, 2007 emissions law change has been adversely impacted by the current economic concerns (credit crisis, high oil and diesel prices, and depressed housing market) which has reduced the demand for Class 8 trucks used to haul freight. As a result, truck build rates in fiscal 2008 were 50 percent below the prior year levels. While the January 1, 2007 emissions change and economic concerns created a downturn in build rates, the change did provide an opportunity for us, as more of our components are required on each vehicle to meet the new standards. Additionally, we have increased our share in this market as a result of new business wins.
Our North American automotive business has experienced considerable deflationary price pressure from OEMs, while at the same time the cost of raw materials and purchased parts has increased. Many of our U.S. competitors continue to be financially challenged. As a result, we have experienced increased opportunities to bid on business that was previously not available to us.
A positive trend in our North American heavy duty and industrial businesses is increased emission standards for agricultural and construction equipment, which is driving increased demand for our components such as EGR coolers.
The overall strategy for this business segment includes the following components:
| · | First, our strategy is to reposition the segment, including reassessing our manufacturing footprint, improving sourcing of raw materials and purchased parts, and other programs intended to increase efficiency and right-size capacity. During fiscal 2008, we announced the closure of three North American manufacturing facilities within this segment, consolidating the business into other existing locations. In addition, construction of our new facility in Nuevo Laredo, Mexico, was completed during fiscal 2008. |
| · | Second, we are focused on reducing lead times to bring new products to market and offering a wider product breadth, while at the same time rationalizing the existing product lines that do not meet required financial metrics. |
| · | Third, we are focused on pursuing only selected new business opportunities that meet our minimum targeted rates of return which will enable profitable growth to the Company. |
South America (7 percent of fiscal 2008 revenues)
Our South America segment provides heat exchanger products to a variety of markets in the domestic Brazilian market as well as for export to North America and Europe. This business provides products to the on-highway commercial vehicle markets, off-highway markets including construction and agricultural applications, automotive OEMs and industrial applications, primarily for power generation systems. This business also provides products to the Brazilian, North American and European aftermarkets for both automotive and commercial applications. We manufacture radiators, charge-air-coolers, oil coolers, auxiliary coolers (transmission, hydraulic, and power steering), engine cooling modules and HVAC system modules.
We have benefited from strong revenue growth in the Brazilian market related to strong economic conditions in Brazil and increased business awards from our OEM customers. The aftermarket sales under the Radiadores Visconde brand have continued to improve while export sales have been negatively affected by the weakening of the U.S. dollar at the same time that the real has strengthened against global currencies. We made capital investments in bar/plate technology for our Brazilian operations in fiscal 2008 that will continue to help fuel growth in the region as well as support operations in North America and Europe.
Competitors in the OEM sector include Behr GmbH & Co. K.G., Valeo SA, Denso Corporation and Delphi Corporation. Our aftermarket competitors also include these same major competitors as well as some regional competitors that focus specifically on the Brazilian aftermarket.
Commercial Products (11 percent of fiscal 2008 revenues)
Our Commercial HVAC&RProducts business provides a variety of niche products in North America, Europe, Asia and South Africa that are used by engineers, contractors and building owners in applications such as warehouses, repair garages, greenhouses, residential garages, schools, computer rooms, manufacturing facilities, banks, pharmaceutical companies, stadiums and retail stores. We manufacture coils (copper tube aluminum fin coils and all aluminum microchannel coils) for heating, refrigeration, air conditioning and vehicular applications. We also manufacture heating products for commercial applications, including gas, electric, oil and hydronic unit heaters, high and low intensity infrared and large roof mounted direct and indirect fired makeup air units. Our cooling products for commercial applications include single packaged vertical units and vertical unit ventilators used in school room applications, computer room air conditioning units, air and water cooled chillers, ceiling cassettes, and roof top cooling units used in a variety of commercial building applications.
Competitors include Lennox International Inc. (ADP), Luvata (Heatcraft Refrigeration Products)/ ECO), ECO, Thomas & Betts (Reznor), Mestek Inc. (Sterling), Emerson Electric Company (Liebert/Hiross), United Technologies Corporation (Carrier) and Johnson Controls, Inc. (York). Revenues have increased primarily due to the acquisition of Airedale in fiscal 2006. However, the segment has grown organically as well, due to growth in coil sales.sales and unit heater sales in North America. Margins in this business have been negatively affected by increased commodity costs -– a trend which is expected to continue. Economic conditions, such as demand for new commercial construction, are drivers of demand for the heating and cooling products.
As macro economic trends have shifted causing increased development of alternatives to oil-based fuel, we have intensified our activity in this business. During fiscal 20072008, we workedcontinued to work with our partner, Bloom Energy to provide components for their early stage prototype stationery power units that should be commercially available in the next severalfew years. We view our thermal solutions for stationery power units as a potentially significant long termlong-term growth driver for the companyCompany due to increased global demand for fuel cell technology, driven by demand for a sustainable, environmentally sound and independent means of power.
In the past year we have increased our solid oxide fuel cell activities and have begun developing products in support of the micro-CHP (combined heat and power) market. These fuel cell based systems are expected to emerge, primarily in Europe, over the next several years as a direct replacement for the small boilers found in homes using hydronic heating systems. In addition to efficient production of hot water for heat, the device is designed to produce electricity to supplement the electrical needs of the home. We have been working with Ceres Power, a UK based developer of these systems, to expand the Company’s presence in this residential market. We are not aware of any competitor of ours that has the same level of focus on this market.
Challenging market worldwide. On May 1, 2007, we announced our intention to explore strategic alternatives for this business. The business includes facilities located in North America and the United Kingdom. We offer customers global design and manufacturing support. Our broad product offering includes heat pipes (round, flat/bent, and vapor chambers), heat pipe assemblies (embedded and remote), heat sinks, cold plates, heat exchangers (liquid-to-air and air-to-air), liquid cooling systems, and advanced technologies such as loop heat pipes. We serve a diversified set of markets and industries that include high performance computing (server/storage/embedded), communications, power, military/aerospace, medical, automotive, and transportation. The markets we servefactors are expected to grow at a mid-single digit compounded annual growth rate. These trends are favorable because the thermal requirements of the end product continue to drive greater demand for heat pipes, heat pipe assemblies, and other advanced solutions.
In fiscal 20082009 and beyond, we intend to remain focused on our strategies of developing new productsrealigning our manufacturing footprint and technologies, expanding into new markets and geographies and reducingrationalization of our costs. Theseportfolio. When completed over the next two years, these strategies and actions will make us a more cost competitive, innovative and efficient technology provider to our current and future customers. We believe these actions will continuehelp us to achieve our repositioning efforts withlong-term goals of 11 percent to 12 percent return on average capital employed, 18 percent to 20 percent gross margin, 11.5 percent SG&A as a goalpercentage of making the Company more efficient. We are implementing programs to changesales, and asset turnover of 2.5 times our manufacturing footprint, reduce our fixed and variable cost structure and standardize our manufacturing processes and global product offering.annual sales.
Consolidated Results of Operations - Continuing Operations
Fiscal 20072008 revenues were a record $1.8 billion, representing an increase of $128$127 million, or 87.4 percent, from fiscal 2006.2007. The growth in revenues was primarily related to acquired revenues from the May 2006 Modine Brazil acquisition.strong volumes in Europe, South America, and Commercial Products. In addition to acquired revenues, the fiscal 2007 growth in revenues was driven by strength in global truck and off-highway markets. Earnings2008 we reported a loss from continuing operations decreasedof $66 million compared to $42earnings from continuing operations of $39 million in fiscal 2007 from $61 million in fiscal 2006.2007. The increase in revenues was primarilymore than offset by higher commodity prices, additional customera reduction in gross margins related to lower than anticipated North America truck volumes, manufacturing inefficiencies experienced as part of plant closures and consolidations, and pricing pressures and increased selling, general and administrative (“SG&A”) expenses including repositioning and restructuring charges. Partially offsetting these increased costsfrom customers. During fiscal 2008, the following significant charges were recorded by the Company:
| · | Goodwill impairment charge – A goodwill impairment charge of $24 million was recorded in our Original Equipment – North America business. During the fiscal year, the Company’s outlook for this business was reduced, which resulted in the book value of assets employed in this business exceeding the fair value of this business. Several factors contributed to this reduced outlook for the Original Equipment – North America business: |
| o | Our future growth prospects within this business have declined from previous management projections. The recent decline in the North American truck market has caused us to reexamine our assumptions around future emissions law changes, specifically the upcoming change in fiscal 2010. In addition, we are estimating reduced prospects for future business, as our customers have shifted programs outside of North America. |
| o | Our future outlook includes lower margins than our previous expectations for this business. Plant closures and inefficiencies related to new product launches are having a near-term impact on our margins, and continued industry-wide customer pricing pressures are anticipated to adversely affect the North American vehicular market. Our products have an increasing material content, which makes offsetting these pricing pressures through manufacturing improvements more difficult. |
| · | Long-lived asset impairment charges – We recorded impairment charges of $23 million against certain long-lived assets. Included in this amount is a $12 million charge related to an impairment review of our South Korean business, as this business continues to underperform our expectations and financial targets. A charge of $3 million was related to an impairment review of our long-lived assets in Original Equipment – North America, where a program was identified as being unable to support its asset base. An additional $3 million charge was related to an impairment of long-lived assets in the Commercial Products segment for the cancellation of a product in its development stage. The remaining $5 million impairment charge was recorded for our Tübingen, Germany manufacturing facility in Europe, which will be closed. |
| · | Repositioning charges – We recorded repositioning charges of $10 million related to our manufacturing realignment activities including the completed closure of our Toledo, Ohio and Richland, South Carolina facilities within the Original Equipment – North America segment. Included in this amount is $4 million of restructuring charges and $6 million of other related costs. |
During fiscal 2008, the Company recorded a decreasevaluation allowance of $65 million primarily against the net deferred tax assets in the effective incomeU.S. and South Korean tax rate based on favorable tax planning strategies completed duringjurisdictions. This valuation allowance contributed to the year.
The following table presents consolidated results from continuing operations on a comparative basis for the years ended March 31, 2008, 2007 2006 and 2005:2006:
| Years ended March 31 | 2008 | 2007 | 2006 | |||||||||||||||||||||
| (dollars in millions) | $'s | % of sales | $'s | % of sales | $'s | % of sales | ||||||||||||||||||
| Net sales | $ | 1,849 | 100.0 | % | $ | 1,722 | 100.0 | % | $ | 1,596 | 100.0 | % | ||||||||||||
| Cost of sales | 1,580 | 85.5 | % | 1,441 | 83.7 | % | 1,284 | 80.5 | % | |||||||||||||||
| Gross profit | 270 | 14.6 | % | 281 | 16.3 | % | 312 | 19.5 | % | |||||||||||||||
| Selling, general and administrative expenses | 235 | 12.7 | % | 232 | 13.5 | % | 211 | 13.2 | % | |||||||||||||||
| Restructuring charges | 4 | 0.2 | % | 4 | 0.2 | % | - | 0.0 | % | |||||||||||||||
| Impairment of goodwill and long-lived assets | 47 | 2.5 | % | - | 0.0 | % | - | 0.0 | % | |||||||||||||||
| (Loss) income from operations | (17 | ) | -0.9 | % | 45 | 2.6 | % | 101 | 6.3 | % | ||||||||||||||
| Interest expense | 13 | 0.7 | % | 10 | 0.6 | % | 7 | 0.4 | % | |||||||||||||||
| Other income - net | (9 | ) | -0.5 | % | (10 | ) | -0.6 | % | (9 | ) | -0.6 | % | ||||||||||||
| (Loss) earnings from continuing operations before income taxes | (21 | ) | -1.1 | % | 45 | 2.6 | % | 103 | 6.5 | % | ||||||||||||||
| Provision for income taxes | 44 | 2.4 | % | 6 | 0.3 | % | 30 | 1.9 | % | |||||||||||||||
| (Loss) earnings from continuing operations | $ | (66 | ) | -3.6 | % | $ | 39 | 2.3 | % | $ | 73 | 4.6 | % | |||||||||||
Year Ended March 31, 2008 Compared to Year Ended March 31, 2007:
Net sales increased $127 million, or 7.4 percent, to $1.8 billion in fiscal 2008 from $1.7 billion in fiscal 2007. The increase in revenues consisted of $96 million related to favorable impact of changing foreign currency exchange rates and $31 million of organic growth. Revenues were driven by strong foreign volumes in the Original Equipment – Europe, South America and Commercial Products segments, which were offset by declines in the Original Equipment – North America segment primarily in the truck market.
Gross profit decreased $11 million, or 3.9 percent, to $270 million in fiscal 2008 from $281 million in fiscal 2007. In addition, gross margin decreased from 16.3 percent in fiscal 2007 to 14.6 percent in fiscal 2008. The decrease in gross profit and gross margin is primarily driven by the impact of the decrease in North American truck volumes, manufacturing inefficiencies experienced as part of plant closures and consolidations, and pricing pressures from customers. In addition, repositioning costs of $5 million were recorded in gross profit during fiscal 2008, as the Company continued to reposition its global manufacturing footprint.
SG&A expenses increased $3 million, or 1.3 percent, to $235 million in fiscal 2008 from $232 million in fiscal 2007, but decreased as a percentage of sales to 12.7 percent from 13.5 percent. The net increase is primarily due to ongoing expansion in the Original Equipment – Asia segment. Restructuring charges were consistent from fiscal 2007 to fiscal 2008, and related primarily to severance costs incurred under our announced restructuring plans. During fiscal 2008, asset impairment charges of $47 million were recorded including a goodwill impairment charge of $24 million and a long-lived asset impairment charge of $3 million recorded in the Original Equipment – North America segment, a long-lived asset impairment charge of $5 million recorded in the Original Equipment – Europe segment, a long-lived asset impairment charge of $12 recorded in the Original Equipment – Asia segment, and a long-lived asset impairment charge of $3 million recorded in the Commercial Products segment. The decrease in gross profit combined with the impairment charges contributed to the $62 million decrease in operating income from fiscal 2007 to fiscal 2008.
| Years ended March 31 | 2007 | 2006 | 2005 | ||||||||||||||||
| (dollars in millions) | $ | 's | % of sales | $ | 's | % of sales | $ | 's | % of sales | ||||||||||
| Net sales | $ | 1,757 | 100.0 | % | $ | 1,629 | 100.0 | % | $ | 1,342 | 100.0 | % | |||||||
| Cost of sales | 1,476 | 84.0 | % | 1,319 | 81.0 | % | 1,063 | 79.2 | % | ||||||||||
| Gross profit | 282 | 16.0 | % | 310 | 19.0 | % | 279 | 20.8 | % | ||||||||||
Selling, general and administrative expenses and restructuring charges | 242 | 13.8 | % | 220 | 13.5 | % | 184 | 13.7 | % | ||||||||||
| Income from operations | 40 | 2.3 | % | 90 | 5.5 | % | 95 | 7.1 | % | ||||||||||
| Interest expense | (10 | ) | -0.6 | % | (7 | ) | -0.4 | % | (6 | ) | -0.4 | % | |||||||
| Other income - net | 9 | 0.5 | % | 8 | 0.5 | % | 9 | 0.7 | % | ||||||||||
Earnings from continuing operations before income taxes | 39 | 2.2 | % | 91 | 5.6 | % | 98 | 7.3 | % | ||||||||||
(Benefit from) provision for income taxes | (3 | ) | -0.2 | % | 30 | 1.8 | % | 36 | 2.7 | % | |||||||||
| Earnings from continuing operations | $ | 42 | 2.4 | % | $ | 61 | 3.7 | % | $ | 62 | 4.6 | % | |||||||
28
Interest expense increased $3 million from fiscal 2007 to fiscal 2008 related to an increase in outstanding debt during the year. Borrowings increased during fiscal 2008 to finance capital expenditures of $87 million and a $38 million increase in working capital.
The provision for income taxes increased $38 million, or 633 percent, to $44 million in fiscal 2008 from $6 million in fiscal 2007. The increase in the provision for income taxes was due to a valuation allowance of $65 million recorded against net deferred tax assets in the U.S. and South Korean tax jurisdictions. Due to the current market conditions and future projections in these tax jurisdictions, the Company determined that it was more likely than not that the U.S. and South Korean deferred tax assets will not be realized. The effective income tax rate differed from the U.S. statutory income tax rate of 35 percent primarily due to the impact of the valuation allowance recorded during the year.
Year Ended March 31, 2007 Compared to Year Ended March 31, 2006:
Net sales increased $128$126 million, or 87.9 percent, to $1.8$1.7 billion in fiscal 2007 from $1.6 billion in fiscal 2006. The increase in revenues was driven by $77 million of acquired revenues related to the May 2006 acquisition of Modine Brazil, $36 million related to favorable impact of changing foreign currency exchange rates and $15 million of organic growth. Organic revenues were driven by strength in truck and heavy-duty and industrial markets. Strong sales in the European automotive, North American truck and global heavy duty markets were offset by moderate declines in the North American automotive market, based on continued softness experienced in the market and overall price down pressures reducing sales prices per unit.
Gross profit decreased $28$31 million, or 99.9 percent, to $282$281 million in fiscal 2007 from $310$312 million in fiscal 2006. The decrease in gross profit is primarily driven by higher global commodity pricing and customer price decreases experienced during the fiscal year. Gross margin decreased 300320 basis points to 1616.3 percent in fiscal 2007 from 1919.5 percent in fiscal 2006. The primary contributing factor to the decline in gross margin has been the steady increase in raw material prices experienced which started during the third and fourth quarter of fiscal 2006 and continued through fiscal 2007. The most significant commodities used in our manufacturing process are aluminum, copper and nickel. Aluminum prices increased 27 percent on average from fiscal 2006 to fiscal 2007, and copper prices increased 67 percent on average from fiscal 2006 to fiscal 2007. Nickel has experienced a 112 percent increase on average from fiscal 2006 to fiscal 2007 which resulted in considerably more cost to the Company. We have agreements with certain customers to pass-through these higher commodity prices to them in our sales price; however, these pass-through agreements can lag up to one year behind the actual price increases, or may not provide us the ability to recover the entire material price increase. These commodity price increases were the primary factor contributing to the decrease in gross margin, as the material component of cost of sales increased from 49 percent of net sales in fiscal 2006 to 53 percent of net sales in fiscal 2007. In addition, repositioning costs of $6$4 million were recorded in gross profit during the fiscal year as the Company continuescontinued to reposition its manufacturing footprint.
SG&A expenses and restructuring charges increased $22$25 million, or 1011.8 percent, to $242$236 million in fiscal 2007 from $220$211 million in fiscal 2006. Approximately $11 million of the increase in SG&A was related to the acquisition of Modine Brazil in May 2006. The remaining increase in SG&A was primarily driven by $7$3 million of repositioning costs recorded during fiscal 2007. The decrease in gross profit combined with the increase in SG&A expenses contributed to the $50$56 million decrease in operating income from $90$101 million in fiscal 2006 to $40$45 million in fiscal 2007.
Interest expense increased $3 million from fiscal 2006 to fiscal 2007 related to an increase in outstanding debt during the year, partially offset by a reduction in the effective interest rate achieved in conjunction with refinancing activities completed during the fiscal year. Borrowings increased during fiscal 2007 to finance the Modine Brazil acquisition of $11 million and the share repurchase program of $13 million.
Other income increased $1 million from fiscal 2006 to fiscal 2007. This increase is primarily due to a purchase price settlement of $3 million received during fiscal 2007 relating to the fiscal 2005 acquisition of WiniaMando’s Automotive Climate Control Division. This is partially offset by the reduction in equity earnings of non-consolidated joint ventures due to the May 2006 acquisition of the remaining 50 percent of Modine Brazil.
The provision for income taxes decreased $33$24 million, or 11080.0 percent, to a benefit of $3$6 million in fiscal 2007 from a provision of $30 million in fiscal 2006. In addition, the effective income tax rate decreased to a benefit of 7.613.8 percent in fiscal 2007 from a provision of 32.929.0 percent in fiscal 2006. The decrease in the effective income tax rate was related to a $4.1 million benefit from net operating losses in Brazil that were previously unavailable prior to the acquisition of Modine Brazil, a $8.0 million benefit from the determination that our investment in the Taiwan business had become worthless and a tax benefit of $2.5 million from a research and development tax credit which was extended. The effective income tax rate differed from the U.S. statutory income tax rate of 35 percent primarily due to the impact of the Brazil net operating loss benefit, worthless stock benefit andthe research and development credit discussed above, as well as the impact of various state and foreign income taxes.
sale. On July 22, 2005, the Company completed the spin off of its Aftermarket business on a debt-free and tax-free basis to its shareholders and the immediate merger of the spun off business into Transpro.Proliance International, Inc. (formerly known as Transpro, Inc.). The Aftermarket business which was a part of the former Distributed Products segment, has been presented as a discontinued operation in the consolidated financial statements. In fiscal 2006, the Company recorded as a result of the spin off transaction, a non-cash charge to earnings of $53.5 million representingto reflect the difference between the value that Modine shareholders received in the new company of $51.3 million,Proliance, a function of the stock price of TransproProliance. at the time of the closing of the spin off, and the $101.4 million in asset carrying value of Modine’s Aftermarket business; and $3.4 million of foreign currency translation loss recognized at the date of the transaction. The net assets spun off in the transaction were primarily comprised of inventory, accounts receivable and property, plant and equipment. As a result of the discontinued operations presentation, the net earnings (loss) related to the discontinued operations of $351,000 and ($24,000) for fiscal years 2006 and 2005, respectively, has been separately presented in the consolidated statements of earnings as a component ofbusiness. After earnings (loss) from discontinued operations (netand loss on spin off of income taxes).discontinued operations, a net loss of $65.6 million was reported in fiscal 2008, and net earnings of $42.3 million and $7.6 million were reported in fiscal 2007 and fiscal 2006, respectively. This resulted in a loss per fully diluted share of $2.05 in fiscal 2008, and earnings per fully diluted share of $1.31 and $0.22 in fiscal 2007 and fiscal 2006, respectively.
Segment Results of Operations
Original Equipment – Asia | ||||||||||||||||||||||||
| Years ended March 31 | 2008 | 2007 | 2006 | |||||||||||||||||||||
| (dollars in millions) | $'s | % of sales | $'s | % of sales | $'s | % of sales | ||||||||||||||||||
| Net sales | $ | 268 | 100.0 | % | $ | 219 | 100.0 | % | $ | 207 | 100.0 | % | ||||||||||||
| Cost of sales | 243 | 90.7 | % | 201 | 91.8 | % | 188 | 90.8 | % | |||||||||||||||
| Gross profit | 25 | 9.3 | % | 18 | 8.2 | % | 19 | 9.2 | % | |||||||||||||||
| Selling, general and administrative expenses | 27 | 10.1 | % | 19 | 8.7 | % | 20 | 9.7 | % | |||||||||||||||
| Impairment of goodwill and long-lived assets | 12 | 4.5 | % | - | 0.0 | % | - | 0.0 | % | |||||||||||||||
| Loss from continuing operations | $ | (14 | ) | -5.2 | % | $ | (1 | ) | -0.5 | % | $ | (1 | ) | -0.5 | % | |||||||||
Original Equipment – Americas | |||||||||||||||||||
| Years ended March 31 | 2007 | 2006 | 2005 | ||||||||||||||||
| (dollars in millions) | $ | 's | % of sales | $ | 's | % of sales | $ | 's | % of sales | ||||||||||
| Net sales | $ | 743 | 100.0 | % | $ | 682 | 100.0 | % | $ | 590 | 100.0 | % | |||||||
| Cost of sales | 639 | 86.0 | % | 559 | 82.0 | % | 471 | 79.8 | % | ||||||||||
| Gross profit | 104 | 14.0 | % | 123 | 18.0 | % | 119 | 20.2 | % | ||||||||||
Selling, general and administrative expenses and restructuring charges | 50 | 6.7 | % | 41 | 6.0 | % | 35 | 5.9 | % | ||||||||||
| Income from operations | $ | 54 | 7.3 | % | $ | 82 | 12.0 | % | $ | 84 | 14.3 | % | |||||||
Net sales within the Original Equipment - Americas– Asia segment increased $92$12 million, or 165.8 percent from fiscal 2005 to fiscal 2006, and increased $61 million, or 9 percent, from fiscal 2006 to fiscal 2007. Continued sales growth experienced in truck and heavy duty and industrial markets over the years presented contributed to this growth. These strong volumes are attributable to strength in the truck, agriculture and construction markets, as well as high pre-buy activity in anticipation of the January 1, 2007 emission regulations primarily within the truck market. In addition, the March 2005 Modine Jackson acquisition contributed $59 million toward the fiscal 2006 growth in net sales, and the May 2006 Modine Brazil acquisition contributed $77 million toward the fiscal 2007 growth in sales. These increased volumes were partially offset in fiscal 2006 and more than offset in fiscal 2007 by reduced sales in the automotive market, as several automakers have gone through inventory corrections, in part triggered by higher gas prices and a consumer shift from light trucks and full SUV’s to cars and small SUV’s.
Original Equipment – Asia | |||||||||||||||||||
| Years ended March 31 | 2007 | 2006 | 2005 | ||||||||||||||||
| (dollars in millions) | $ | 's | % of sales | $ | 's | % of sales | $ | 's | % of sales | ||||||||||
| Net sales | $ | 219 | 100.0 | % | $ | 207 | 100.0 | % | $ | 116 | 100.0 | % | |||||||
| Cost of sales | 201 | 91.8 | % | 188 | 90.8 | % | 104 | 89.7 | % | ||||||||||
| Gross profit | 18 | 8.2 | % | 19 | 9.2 | % | 12 | 10.3 | % | ||||||||||
Selling, general and administrative expenses | 19 | 8.7 | % | 20 | 9.7 | % | 10 | 8.6 | % | ||||||||||
| (Loss) income from operations | $ | (1 | ) | -0.5 | % | $ | (1 | ) | -0.5 | % | $ | 2 | 1.7 | % | |||||
Gross margin has decreased from 10.3 percent in fiscal 2005, to 9.2 percent in fiscal 2006 to 8.2 percent in fiscal 2007. Weak sales volumes resulting from the strike at a customer facility, as well as customer pricing pressures, are the primary factors drivingdrove this decrease. SG&A expenses were relatively consistent as a percentage of sales for fiscal 2005 anddecrease in fiscal 2007. The increase to 9.7Gross margin increased from 8.2 percent in fiscal 2007 to 9.3 percent in fiscal 2008 due to purchasing savings and higher sales volumes which offset customer price downs. SG&A expenses remained consistent in fiscal 2006 and fiscal 2007 and increased $8 million in fiscal 2008. This increase is due to ongoing expansion in this region with the construction of new manufacturing facilities in China and India, as well as the establishment of a corporate office in China. The new manufacturing facility in Changzhou, China began production in the third quarter of fiscal 2008, and the Chennai, India facility is scheduled to being production in the second quarter of fiscal 2009. Long-lived asset impairment charges of $12 million were recorded during fiscal 2008 related to an early retirement programimpairment review of the South Korean business which resulted in a $2.5has historically underperformed our expectations, and is projected to continue to underperform into the future. Improved financial performance for this business is dependent on significant commercial concessions by the primary customers, as well as labor cost reductions.
Original Equipment – Europe | ||||||||||||||||||||||||
| Years ended March 31 | 2008 | 2007 | 2006 | |||||||||||||||||||||
| (dollars in millions) | $'s | % of sales | $'s | % of sales | $'s | % of sales | ||||||||||||||||||
| Net sales | $ | 751 | 100.0 | % | $ | 589 | 100.0 | % | $ | 539 | 100.0 | % | ||||||||||||
| Cost of sales | 611 | 81.4 | % | 477 | 81.0 | % | 417 | 77.4 | % | |||||||||||||||
| Gross profit | 140 | 18.6 | % | 112 | 19.0 | % | 122 | 22.6 | % | |||||||||||||||
| Selling, general and administrative expenses | 48 | 6.4 | % | 50 | 8.5 | % | 50 | 9.3 | % | |||||||||||||||
| Impairment of long-lived assets | 5 | 0.7 | % | - | 0.0 | % | - | 0.0 | % | |||||||||||||||
| Income from continuing operations | $ | 87 | 11.6 | % | $ | 62 | 10.5 | % | $ | 72 | 13.4 | % | ||||||||||||
Net sales within the Original Equipment – Europe segment increased $50 million, charge recorded during the year. This early retirement charge contributed to the reduction in income from operations from fiscal 2005 to fiscal 2006. Loss from operations is consistentor 9.3 percent, from fiscal 2006 to fiscal 2007 primarily due to the customer pricing pressures and strike activity discussed above.
Original Equipment – Europe | |||||||||||||||||||
| Years ended March 31 | 2007 | 2006 | 2005 | ||||||||||||||||
| (dollars in millions) | $ | 's | % of sales | $ | 's | % of sales | $ | 's | % of sales | ||||||||||
| Net sales | $ | 589 | 100.0 | % | $ | 539 | 100.0 | % | $ | 496 | 100.0 | % | |||||||
| Cost of sales | 477 | 81.0 | % | 417 | 77.4 | % | 384 | 77.4 | % | ||||||||||
| Gross profit | 112 | 19.0 | % | 122 | 22.6 | % | 112 | 22.6 | % | ||||||||||
Selling, general and administrative expenses | 50 | 8.5 | % | 50 | 9.3 | % | 50 | 10.1 | % | ||||||||||
| Income from operations | $ | 62 | 10.5 | % | $ | 72 | 13.4 | % | $ | 62 | 12.5 | % | |||||||
Gross profit increased correspondingly tomargin has gradually declined over the increasepast few years from 22.6 percent in net sales from fiscal 2005 to fiscal 2006 but declinedto 18.6 percent in fiscal 2008. The decrease from fiscal 2006 to fiscal 2007. Gross margin held consistent at 22.6 percent in fiscal 2005 and 2006 and decreased2007 was primarily due to 19.0 percent in fiscal 2007. This reduced gross profit and margin in fiscal 2007 is related to the highhigher commodity prices and certain warranty issues experienced during fiscal 2007, as well as customer pricing pressures by the OEM’s. These pricing pressures started duringOEMs. The decrease from fiscal 20062007 to fiscal 2008 was due to a change in mix of sales towards lower margin products, as well as customer price downs which we were not entirely able to offset with purchasing savings and acceleratedperformance improvements in fiscal 2007. The gross margin decrease was partially offset by operating efficiencies that focused on plant performance and cost reductions.our manufacturing facilities. SG&A expenses were consistent over the past three years on a larger sales base, resulting in a reduction in SG&A expensesan improvement as a percentage of sales within this segment. This improvementAn impairment charge of $5 million was recorded in fiscal 2008 at the Tübingen, Germany manufacturing facility in conjunction with the announced closure of this facility within the next 18 to 24 months. Income from continuing operations decreased $10 million in fiscal 2007 due to the reduction in gross margin. Income from continuing operations improved $25 million in fiscal 2008 based on the contribution impact of the increased sales volumes. Construction is currently underway for our new Gyöngyös, Hungary facility within this region, with production scheduled to begin in fiscal 2009.
During the fourth quarter of fiscal 2008, adjustments of $2.1 million were recorded within this segment to correct errors that related to prior quarters and annual periods consisting of $1.4 million related to an understatement of accounts payable and $0.7 million related to the understatement of a value added tax liability. These adjustments were made in the fourth quarter of fiscal 2008 as they were deemed immaterial to previously issued financial statements and full year fiscal 2008 results. Based on these adjustments, we identified a material weakness in our internal control over financial reporting due to ineffective controls over reconciliations within this segment. We are developing and implementing remediation plans to address this material weakness including the creation of a standardized workplan for account reconciliations and trial balance reviews which will be accompanied by appropriate monitoring procedures.
Original Equipment – North America | ||||||||||||||||||||||||
| Years ended March 31 | 2008 | 2007 | 2006 | |||||||||||||||||||||
| (dollars in millions) | $'s | % of sales | $'s | % of sales | $'s | % of sales | ||||||||||||||||||
| Net sales | $ | 521 | 100.0 | % | $ | 667 | 100.0 | % | $ | 682 | 100.0 | % | ||||||||||||
| Cost of sales | 492 | 94.4 | % | 577 | 86.5 | % | 559 | 82.0 | % | |||||||||||||||
| Gross profit | 29 | 5.6 | % | 90 | 13.5 | % | 123 | 18.0 | % | |||||||||||||||
| Selling, general and administrative expenses | 43 | 8.3 | % | 42 | 6.3 | % | 44 | 6.5 | % | |||||||||||||||
| Restructuring charges | 4 | 0.8 | % | 4 | 0.6 | % | - | 0.0 | % | |||||||||||||||
| Impairment of goodwill and long-lived assets | 27 | 5.2 | % | - | 0.0 | % | - | 0.0 | % | |||||||||||||||
| (Loss) income from continuing operations | $ | (45 | ) | -8.6 | % | $ | 44 | 6.6 | % | $ | 79 | 11.6 | % | |||||||||||
Net sales within the Original Equipment – North America segment decreased $15 million, or 2.2 percent, from fiscal 2006 to fiscal 2007, and decreased $146 million, or 21.9 percent, from fiscal 2007 to fiscal 2008. The sales decline is largely due to the downturn in the North American truck market following the January 1, 2007 emission regulations. In addition, sales in the automotive market are down due to higher gas prices and a consumer shift from light trucks and full SUVs to cars and small SUVs.
Gross margin decreased from 18.0 percent in fiscal 2006, to 13.5 percent in fiscal 2007, and decreased further to 5.6 percent in fiscal 2008. The deterioration in gross margin from fiscal 2007 to fiscal 2008 has been driven by the following two factors: (1) The significant reduction in sales volumes has resulted in a decline in gross profit, an underabsorption of fixed overhead costs and a lower gross margin as we have excess capacity in many of our North American facilities: and (2) the manufacturing realignment currently in progress in North America, including the process of closing operating facilities, transferring and consolidating product lines and launching new product lines has caused operating inefficiencies which have impacted the gross margin. SG&A expenses have held relatively consistent yet increased as a percentage of sales iswithin this segment from fiscal 2007 to fiscal 2008. A goodwill impairment charge of $24 million was recorded during fiscal 2008 as a result of a declining outlook for this segment. These reduced expectations were based on declining sales volumes and lower gross margin related to plant closures, product-line transfers and continued customer pricing pressures which are impacting the North American vehicular industry. In addition, a long-lived asset impairment charge of $3 million was recorded during fiscal 2008 as the result of on going reduction efforts.a program line which was not able to support its asset base. Income from continuing operations decreased $35 million in fiscal 2007 primarily driven by the decline in gross margin related to commodity price increases and customer pricing pressures. Income from continuing operations decreased $89 million in fiscal 2008 to a loss from continuing operations of $45 million primarily due to the significant decrease in sales and gross margin coupled with the asset impairment charges recorded during the year.
| South America | ||||||||||||||||||||||||
| Years ended March 31 | 2008 | 2007 | 2006 | |||||||||||||||||||||
| (dollars in millions) | $'s | % of sales | $'s | % of sales | $'s | % of sales | ||||||||||||||||||
| Net sales | $ | 133 | 100.0 | % | $ | 77 | 100.0 | % | - | - | ||||||||||||||
| Cost of sales | 106 | 79.7 | % | 61 | 79.2 | % | - | - | ||||||||||||||||
| Gross profit | 27 | 20.3 | % | 16 | 20.8 | % | - | - | ||||||||||||||||
| Selling, general and administrative expenses | 16 | 12.0 | % | 11 | 14.3 | % | - | - | ||||||||||||||||
| Income from continuing operations | $ | 11 | 8.3 | % | $ | 5 | 6.5 | % | - | - | ||||||||||||||
South America is comprised of our Brazilian operation which was acquired in May 2007 through a purchase of the remaining 50 percent of the Radiadores Visconde Ltda. (Modine Brazil) joint venture. Prior to this, the operating activity of Modine Brazil was reported in the consolidated financial statements through equity earnings from non-consolidated affiliates. South America’s operations for fiscal 2007 represent ten months of results after the May 2006 acquisition of the remaining 50 percent of this business.
Commercial HVAC&R | |||||||||||||||||||
| Years ended March 31 | 2007 | 2006 | 2005 | ||||||||||||||||
| (dollars in millions) | $ | 's | % of sales | $ | 's | % of sales | $ | 's | % of sales | ||||||||||
| Net sales | $ | 179 | 100.0 | % | $ | 171 | 100.0 | % | $ | 103 | 100.0 | % | |||||||
| Cost of sales | 140 | 78.2 | % | 127 | 74.3 | % | 74 | 71.8 | % | ||||||||||
| Gross profit | 39 | 21.8 | % | 44 | 25.7 | % | 29 | 28.2 | % | ||||||||||
Selling, general and administrative expenses | 31 | 17.3 | % | 29 | 17.0 | % | 16 | 15.5 | % | ||||||||||
| Income from operations | $ | 8 | 4.5 | % | $ | 15 | 8.7 | % | $ | 13 | 12.7 | % | |||||||
32
Net sales within South America increased $56 million, or 72.7 percent from fiscal 2007 to fiscal 2008, based on continued strength in the Brazilian agricultural and commercial vehicle markets, along with strength in the overall Brazilian economy. In addition, foreign currency exchange rate changes favorably impacted sales by $17 million.
Gross margin decreased slightly from 20.8 percent during fiscal 2007 to 20.3 percent in fiscal 2008, driven by higher material procurement costs and incremental costs related to the launch of bar/plate oil cooler production in Brazil during fiscal 2008. SG&A expenses increased $5 million primarily due to the impact of foreign currency rate changes. In addition, fiscal 2007 SG&A represented ten months of results while fiscal 2008 represented twelve months of results, contributing to this increase. Income from continuing operations improved $6 million based largely on the increased sales volumes.
| Commercial Products | ||||||||||||||||||||||||
| Years ended March 31 | 2008 | 2007 | 2006 | |||||||||||||||||||||
| (dollars in millions) | $'s | % of sales | $'s | % of sales | $'s | % of sales | ||||||||||||||||||
| Net sales | $ | 199 | 100.0 | % | $ | 179 | 100.0 | % | $ | 171 | 100.0 | % | ||||||||||||
| Cost of sales | 154 | 77.4 | % | 140 | 78.2 | % | 127 | 74.3 | % | |||||||||||||||
| Gross profit | 45 | 22.6 | % | 39 | 21.8 | % | 44 | 25.7 | % | |||||||||||||||
| Selling, general and administrative expenses | 32 | 16.1 | % | 31 | 17.3 | % | 29 | 17.0 | % | |||||||||||||||
| Impairment of long-lived assets | 3 | 1.5 | % | - | 0.0 | % | - | 0.0 | % | |||||||||||||||
| Income from continuing operations | $ | 10 | 5.0 | % | $ | 8 | 4.5 | % | $ | 15 | 8.8 | % | ||||||||||||
Net sales within the Commercial HVAC&RProducts segment increased $68 million, or 66 percent, from fiscal 2005 to fiscal 2006, and increased $8 million, or 54.7 percent, from fiscal 2006 to fiscal 2007. The majority of the2007, and increased $20 million, or 11.2 percent, from fiscal 2006 increase was related2007 to the Airedale acquisition that contributed $57 million of incremental sales. In addition, strong coil and condenser sales, especially in southeastern portions of the U.S. related to Hurricane Katrina, also contributed to the fiscal 2006 increase in net sales.2008. The fiscal 2007 increase in net sales is primarily related to growing air conditioning sales in the U.S. as the Airedale product was further expanded into this market during fiscal 2007. The fiscal 2008 increase is driven by strong air conditioning sales in the United Kingdom and increased heating and air conditioning product sales in North America. In addition, foreign currency exchange rate changes favorably impacted sales by $4 million.
Gross margin decreased over the past few years from 28.225.7 percent in fiscal 2005,2006 to 21.8 percent in fiscal 2007. Lower gross margin earned2007, and showed slight improvement to 22.6 percent in the newly acquired Airedale operations was the primary factor leading to the decline in the gross margin from fiscal 2005 to fiscal 2006.2008. The decrease from fiscal 2006 to fiscal 2007 is primarily due to the changing mix of products within this segment toward lower margin air conditioning products. Modest commodity pricing pressures for certain component products have alsoPerformance improvements within the manufacturing operations contributed to the reductiongross margin increase in gross marginfiscal 2008. SG&A expenses have remained relatively consistent over the past two years. SG&A expenses increased $13 million from fiscal 2005 to fiscal 2006, primarily driven by incremental SG&A expenditures absorbed in the Airedale acquisition. The slight increase in SG&A in fiscal 2007 is related to integration inefficiencies, as the U.S. Airedale business was transferred into the existing North American facilities during the year. SG&A expenses are relatively consistent in fiscal 2006 and fiscal 2007few years but have improved as a percentage of sales.
Other | |||||||||||||||||||
| Years ended March 31 | 2007 | 2006 | 2005 | ||||||||||||||||
| (dollars in millions) | $ | 's | % of sales | $ | 's | % of sales | $ | 's | % of sales | ||||||||||
| Net sales | $ | 40 | 100.0 | % | $ | 35 | 100.0 | % | $ | 38 | 100.0 | % | |||||||
| Cost of sales | 38 | 95.0 | % | 37 | 105.7 | % | 35 | 92.1 | % | ||||||||||
| Gross profit (loss) | 2 | 5.0 | % | (2 | ) | -5.7 | % | 3 | 7.9 | % | |||||||||
Selling, general and administrative expenses | 10 | 25.0 | % | 13 | 37.1 | % | 14 | 36.8 | % | ||||||||||
| Loss from operations | $ | (8 | ) | -20.0 | % | $ | (15 | ) | -42.8 | % | $ | (11 | ) | -28.9 | % | ||||
| Fuel Cell | ||||||||||||||||||||||||
| Years ended March 31 | 2008 | 2007 | 2006 | |||||||||||||||||||||
| (dollars in millions) | $'s | % of sales | $'s | % of sales | $'s | % of sales | ||||||||||||||||||
| Net sales | $ | 3 | 100.0 | % | $ | 5 | 100.0 | % | $ | 2 | 100.0 | % | ||||||||||||
| Cost of sales | 2 | 66.7 | % | 3 | 60.0 | % | 2 | 100.0 | % | |||||||||||||||
| Gross profit | 1 | 33.3 | % | 2 | 40.0 | % | - | 0.0 | % | |||||||||||||||
| Selling, general and administrative expenses | 3 | 100.0 | % | 3 | 60.0 | % | 2 | 100.0 | % | |||||||||||||||
| Loss from continuing operations | $ | (2 | ) | -66.7 | % | $ | (1 | ) | -20.0 | % | $ | (2 | ) | -100.0 | % | |||||||||
Fuel cell is in the Taiwan facility,start-up phase. We continue to partner with customers such as this businessBloom Energy and Ceres Power to provide, in the near future, clean, continuous power applying fuel cell technology to stand-alone power systems. We believe that fuel cell technology has historically operated with losses. On May 1, 2007, we announced that we will explore strategic alternatives for our Electronics Cooling business. This review could result in several scenarios, including the salelong-term potential to contribute up to 10 percent of the business at a price andCompany’s consolidated revenues toward the end of the five year planning period based on terms that would represent a better value for Modine’s shareholders than having the business continue to operate as a Modine subsidiary.customer estimates of volumes.
Liquidity and Capital Resources
The 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. The Company expects to meet its future operating, capital expenditure and strategic acquisition costs primarily through these sources.
13.2 turns. Cash decreased $9.6increased $17.1 million to $21.2$38.3 million at fiscal 2007 year end.March 31, 2008. The ratio of Modine’s total debt to capital was 32.6 percent at the end of fiscal 2008 compared to 26.7 percent at the end of fiscal 2007 compared to 23.8 percent at the end of fiscal 2006. Total debt increased $21.5 million to $179.3 million, due in large part to the $11.1 million Modine Brazil acquisition and the $14.5 million the Company spent on repurchasing its stock, which is comprised of $13.3 million acquired through stock repurchase programs and $1.2 million of treasury stock acquisitions. Other key programs funded during the fiscal year were dividends totaling $22.6 million and capital expenditures of $82.8 million. These programs were financed by a drawdown of surplus cash and the use of existing lines of credit.2007.
Worldwide, Modine had approximately $229.5$177.3 million in unused lines of credit at March 31, 2007,2008, compared with $194.4$229.5 million at March 31, 2006.2007. An additional $75.0 million is available on the credit line revolver, subject to lenders’ approval, bringing the total available to $304.5$252.3 million in fiscal 2007.2008. The revolving credit agreement matures in October 2009 and the Company has begun the renegotiation process to refinance this debt.
Certain of the Company’s debt agreements require it to maintain specific financial ratios and place certain limitations on dividend payments and the acquisition of our common stock. At December 26, 2007, we would have been in violation of certain debt agreements due to the goodwill impairment charge of $23.8 million recorded during the third quarter of fiscal 2008 absent amendments to certain financial covenants. On February 1, 2008, we reached an agreement with our primary lenders to amend our debt agreements. The primary purpose of the amendments was to secure prospective relief under the earnings before interest and taxes (EBIT) to interest expense ratio (interest coverage ratio), and to permit the add-back of certain cash and non-cash charges. The cash charges relate to Modine’s recently announced restructuring program, where we are permitted to add back future cash-related charges up to a basket limit of $25 million through fiscal 2010. We were in compliance with all amended financial ratios effective December 26, 2007 and March 31, 2008. In connection with these amendments, interest costs increased 35 basis points on the $150 million of private placement notes for the period of April 1, 2008 through June 30, 2009. In addition, we incurred $0.4 million of amendment fees.
The amended covenants allow the add-back of certain non-cash charges including the third quarter goodwill impairment charge and the fourth quarter long-lived asset impairment charge for our South Korean business, and thus to be in compliance with the financial covenants as of December 26, 2007 and March 31, 2008. The amendment to allow the add-back of certain cash charges was completed so that the Company may conduct the recently announced restructuring actions within the bounds of the financial covenants.
The prospective relief to the interest coverage ratio provided in the amended agreement was necessary in order for the Company to continue to comply with this covenant on a quarterly basis over the next two fiscal years. We assess our ability to meet the amended interest coverage ratio based on an analysis of the Company’s fiscal 2009 and 2010 plans. We conducted a sensitivity analysis of our fiscal 2009 plan against our financial covenants, with particular focus on a quarterly review of the anticipated fiscal 2009 results. This sensitivity analysis identified that we have approximately $6 million to $15 million of quarterly EBIT “cushion” under the interest coverage ratio beginning with the first quarter of fiscal 2009 and ending with the fourth quarter of fiscal 2009. This quarterly EBIT “cushion” has increased slightly from the $5 million to $9 million cushion projected at the end of the third quarter of fiscal 2008. The ongoing achievement of our plan is critical to remaining in compliance with the financial covenants, and we believe that the plan is achievable. Therefore management anticipates that we will remain in compliance with the interest coverage ratio through fiscal 2009, with ongoing compliance thereafter. The other significant financial covenant included within our debt agreements is a debt-to-earnings before interest, taxes, depreciation and amortization (EBITDA) ratio (leverage ratio). Our EBITDA “cushion” within the leverage ratio is substantially greater than our EBIT “cushion”.
Our ongoing ability to remain in compliance with the amended financial covenants assumes a debt level relatively consistent with the March 31, 2008 balance of $226.5 million. The Company believes that this is an achievable assumption based on the availability of cash provided by operating activities, as well as additional sources of cash. These additional sources include the $10.8 million of cash proceeds from the May 1, 2008 sale of our Electronics Cooling business, as well as potential proceeds to be generated by our portfolio rationalization efforts. We will continue to tightly manage our anticipated capital spending in fiscal 2009 and fiscal 2010, and anticipate this spending, net of potential dispositions, to be near our current depreciation levels. To the extent that these sources of cash are not sufficient to fully fund our cash requirements, we currently estimate that we could incur additional borrowings averaging approximately $107 million under our domestic unused lines of credit without violating a financial covenant, although this level of borrowing would nearly eliminate our EBIT “cushion”.
On December 7, 2006, the Company issued $50.0 million of 5.68 percent Series A Senior notes due in 2017 and $25.0 million of 5.68 percent Series B Senior notes due in 2018. The proceeds from the notes are beingwere used for general corporate purposes, including repayment of borrowings on existingexisting domestic credit lines. For further details, see Note 1718 of the Notes to Consolidated Financial Statements.
Off-Balance Sheet Arrangements
None.
Contractual Obligations
| (in thousands) | March 31, 2008 | |||||||||||||||||||
| Total | Less than 1 year | 1 - 3 years | 4 - 5 years | More than 5 years | ||||||||||||||||
| Long-term debt (including interest) | $ | 298,823 | $ | 11,044 | $ | 86,613 | $ | 15,997 | $ | 185,169 | ||||||||||
| Capital lease obligations | 8,806 | 260 | 649 | 649 | 7,248 | |||||||||||||||
| Operating lease obligations | 18,680 | 4,603 | 5,073 | 3,371 | 5,633 | |||||||||||||||
| Capital expenditure commitments | 44,085 | 44,085 | - | - | - | |||||||||||||||
| Other long-term obligations | 6,192 | 824 | 139 | 120 | 5,109 | |||||||||||||||
| Total contractual obligations | $ | 376,586 | $ | 60,816 | $ | 92,474 | $ | 20,137 | $ | 203,159 | ||||||||||
| (in thousands) | March 31, 2007 | |||||||||||||||
| Total | Less than 1 year | 1 - 3 years | 4 - 5 years | More than 5 years | ||||||||||||
| Long-term debt (including interest) | $ | 263,092 | $ | 12,656 | $ | 41,724 | $ | 16,462 | $ | 192,250 | ||||||
| Operating lease obligations | 19,397 | 4,510 | 5,614 | 3,754 | 5,519 | |||||||||||
| Capital expenditure commitments | 30,594 | 29,797 | 797 | - | - | |||||||||||
| Other long-term obligations | 5,002 | 55 | 129 | 110 | 4,708 | |||||||||||
| Total contractual obligations | $ | 318,085 | $ | 47,018 | $ | 48,264 | $ | 20,326 | $ | 202,477 |
The capital expenditure commitments are primarily comprised of tooling and equipment expenditures for new and renewal platforms with new and current customers in both Europe and North America.on a global basis.
Net Cash Provided by Operating Activities
Net cash provided by operating activities in fiscal 2008 was $67.4 million, down $35.0 million from the prior year of $102.4 million, driven by a reduction in earnings and growth in working capital. Major changes in operating assets and liabilities contributing to the overall decrease in cash provided by operating activities were a $21.6 million increase in accounts receivable based on higher sales volumes, a $16.1 million decrease in accounts payable due to timing of payments, and a $5.4 million year-over-year reduction to cash from an increase in inventories to support the growing business volumes. These decreases were partially offset by favorable changes including a $7.7 million increase from income taxes and a $20.3 million increase in accrued expenses and other current liabilities.
Net cash provided by operating activities in fiscal 2007 was $102.4 million, down $27.0 million from the prior year of $129.4 million. Major changes in operating assets and liabilities contributing to the overall decrease in cash provided by operating activities were a $36.3 million decrease in accounts payable due to timing of payments, a $17.8 million reduction in income taxes, a $15.7 million decrease in cash due to other current assets, and a $4.5 million year-over-year reduction to cash from an increase in inventories to support the growing business volumes. These decreases were partially offset by favorable changes including a $57.8 million increase in cash from accounts receivable due to better collection efforts and a $6.9 million increase in accrued expenses and other current liabilities.
Capital expenditures were $87.0 million for fiscal 20062008, which was $129.4$4.3 million down $24.8 million fromhigher than the prior year of $154.2 million. Major changesyear. The primary spending occurred in operating assetsthe Original Equipment – North America segment which totaled $23.1 million, the Original Equipment – Europe segment which totaled $32.8 million and liabilities contributing to the overall decreaseOriginal Equipment – Asia segment which accounted for $19.3 million in cash provided by operating activities were a $23.2 million decrease in cash from accounts receivable, a reflection of increased sales, and a $31.7 millioncapital spending. The increase in accounts payable which grewcapital expenditures primarily relates to tooling and equipment purchases in response to working capital initiativesconjunction with new global program launches with new and current customers in Europe, Asia and North America, along with the timingconstruction of payments. Other decreases include a $7.7 million year-over-year reduction to cash from a changenew facilities in inventories, a $5.5 million decrease due to accrued compensationAsia, Europe and employee benefits, a $7.2 million reduction due to a change in income taxes, a $9.1 million reduction due to accrued expenses and other current liabilities and a $3.3 million decline from other non-current assets and liabilities. A favorable change in other current assets impacted cash flow by $2.4 million.
Capital expenditures were $82.8 million for fiscal 2007, which were $2.9 million higher than the prior year.fiscal 2006. The primary spending occurred in the Original Equipment - Americas– North America segment which totaled $28.8$25.5 million, the Original Equipment -– Europe segment which totaled $22.1 million, the Original Equipment -– Asia segment which totaled $8.7 million and Corporate which accounted for $15.1 million in capital spending. The increase in capital expenditures primarily relates to tooling and equipment purchases in conjunction with new global program launches of new truck programs in North America which incorporatesincorporated the new emission restrictions subsequent to the January 1, 2007 change.
Capital expenditures were $79.9 million for fiscal 2006, which were $11.3 million higher than the prior year.2006. The primary spending occurred in the Original Equipment - Americas– North America segment which recorded $19.9 million in additions,spending, the EuropeanOriginal Equipment - Europe segment which totaled $28.1 million and Corporate which accounted for $18.3 million in capital spending. Spending on truck programs in North America and Europe, together with spending on programs for BMW in Europe and Commercial HVAC&R’s PF2 programs in North America, accounted for some of the more significant equipment and tooling expenditures. The implementation of new manufacturing and financial systems in North America also contributed to the growth in expenditures in the current year.fiscal 2006.
Acquisitions and Investments in Affiliates
Modine spent $11.1 million, net of cash acquired, on the acquisition of Modine Brazil in May of fiscal 2007. Modine spent $38.0 million, net of cash acquired, on the acquisition of Airedale in May of fiscal 2006. During fiscal 2005, Modine spent $102.2 million on acquisitions, including $16.6 million on the purchase of a 100 percent interest in Transpro’s heavy-duty original equipment facility in Jackson, Mississippi, and $85.6 million on a three-tiered acquisition of WiniaMando’s Korea- and China-based operations. The acquisition of the WiniaMando operations resulted in two wholly owned facilities in Asan City, South Korea and Shanghai, China, as well as a 50 percent interest in a joint venture in Hefei, China. Refer to Note 1213 of the Notes to Consolidated Financial Statements for further discussion of these acquisitions.
Spin off of Aftermarket Business
During fiscal 2006 the Company completed the spin off of its Aftermarket business as discussed in Note 1314 of the Notes to Consolidated Financial Statements. Included in the assets that were spun off was $6.3 million of cash. As part of the spin off, Modine shareholders received $51.3 million of Proliance stock which is shown as non-cash activity in the accompanying consolidated statementsstatement of cash flows.
Proceeds from the Disposition of Assets
In fiscal 2008, the Company received proceeds from the disposition of assets of $10.0 million, including approximately $5.0 million from the sale of a corporate aircraft, $3.2 million from the sale of the Richland, South Carolina facility which closed in fiscal 2007, and $1.8 million from the sale of other equipment.
In fiscal 2007 and fiscal 2006, the Company received proceeds from the disposition of assets of $0.9 million, respectively. These dispositions were spread across operating segments and consisted primarily of insignificant dispositions of machinery and equipment of insignificant amounts.
Changes in Debt: Short- and Long-Term
In fiscal 2008, overall debt increased $47.2 million primarily from new borrowings in North America. Domestically, debt grew by $43.0 million with borrowings on the revolving credit facility used primarily to fund capital expenditures. International debt increased $4.2 million during fiscal 2008.
In fiscal 2007, overall debt increased $21.5 million primarily from new borrowings in North America. Domestically, debt grew by $64.0 million with borrowings of $75.0 million through private placement of notes used to finance the Modine Brazil acquisition and the share repurchase program. Outstanding debt in Europe of 41 million euro ($52.3 million U.S. equivalent) was paid in full during fiscal 2007.
In fiscal 2006, overall debt increased $52.2 million primarily from new borrowings in Europe and North America. Domestically, debt grew by $13.4 million as $75.0 million was borrowed through a private placement of notes while $60.6 million was repaid on a loan that matured in September 2005. The remaining $1.0 million decrease resulted from a repayment under the revolving credit agreement. In Europe, a new 71.0 million euro ($84.2 million U.S. equivalent) loan was taken out in December 2005 with the proceeds being used to purchase a portion of the shares in Modine’s Austrian operating subsidiary, Modine Austria GmbH, for the purpose of repatriation of cash from Modine subsidiaries in Europe. At March 31, 2006, 30 million euro ($35.6 million U.S. equivalent) was paid. Short-term loans outstanding of $6.0 representmillion represented overdrafts at the Company’s European subsidiaries.
Common Stock and Treasury Stock
During fiscal 2008, the Company repurchased and retired 250,000 shares of the Company’s common stock for $6.9 million under the anti-dilution portion of one of the common share repurchase programs. In addition, the Company repurchased approximately 42,000 common shares for treasury at a cost of $0.8 million in fiscal 2008. A second share repurchase program expired on July 26, 2007. No share repurchases were made under this program in fiscal 2008. In fiscal 2007, the Company continued with two common stock share repurchase programs that were approved by the Board of Directors. Under these programs, the Company repurchased and retired 502,600 shares of the Company’s common stock for $13.3 million for the year ended March 31, 2007. The programs were undertaken to offset dilution created by shares issued for stock option and award plans, as well as to repurchase shares when the Company believes market conditions are favorable. In addition to these repurchases, the Company also repurchased 49,000 common shares for treasury at a cost of $1.3 million.million in fiscal 2007. These repurchases were mainly to satisfy tax withholdings requirements for restricted stock awards that vested and stock option exercises. Common stock and treasury stock activity is further detailed in Note 2122 of the Notes to Consolidated Financial Statements.
Dividends Paid
Dividends for fiscal 2007, 2006, and 2005 were $22.6 million for fiscal 2008 and 2007, and $23.9 million and $21.6 million, respectively.for fiscal 2006. The effective dividend rates paid were 70 cents per share for fiscal 2008, 2007 and fiscal 2006 and 632006. The Board of Directors authorized a reduction in the Company’s quarterly cash dividend on its common stock to a rate of 10 cents per share beginning in fiscal 2009. The primary purpose in reducing the dividend is to provide additional financial flexibility and support reinvestment for fiscal 2005.growth during the Company’s restructuring period. On May 16, 2007,21, 2008, the Board of Directors declared a quarterly dividend of 17.510 cents per share payable on June 8, 200720, 2008 to shareholders of record on May 25, 2007. The dividend rate remained unchanged from the prior quarter.June 6, 2008.
Settlement of Derivative Contracts
In fiscal 2008, the Company entered into future contracts related to forecasted purchases of aluminum and natural gas which were treated as cash flow hedges. Unrealized gains and losses on these contracts are deferred as a component of accumulated other comprehensive income (loss), and recognized as a component of earnings at the same time that the underlying purchases of aluminum and natural gas impact earnings. During fiscal 2008, $2.0 million of expense was recorded in cost of sales related to the settlement of certain futures contracts. At March 31, 2008, $1.4 million of unrealized gains remain deferred in other comprehensive income, and will be realized as a component of cost of sales over the next nine months. The Company also entered into future contracts related to forecasted purchases of copper and nickel which were not designated as cash flow hedges. Therefore, gains and losses on these contracts are recorded directly in the consolidated statement of operations. During fiscal 2008, $0.2 million of income was recorded in cost of sales related to these future contracts. The Company also entered into zero cost collars to offset the foreign exchange exposure on intercompany loans. These contracts were not designated as hedges, accordingly transaction gains and losses on the derivatives are recorded in other income – net in the consolidated statement of operations. During fiscal 2008, $1.6 million of expense was recorded to other income – net in the consolidated statement of operations related to these zero cost collars.
In fiscal 2007, the Company entered into two forward starting swaps in anticipation of a $75.0 million private placement debt offering that occurred on December 7, 2006. These swaps were settled during fiscal 2007 with a loss of $1.8 million being recorded. This loss was reflected as a component of accumulated other comprehensive income (loss) and is being amortized to interest expense over the respective eleven and twelve year lives of the debt offerings. During fiscal 2008 and 2007, $0.2 million and $0.04 million of this loss, respectively, was recognized as interest expense. At March 31, 2007, $1.82008, $1.0 million of the loss is deferred in accumulated other comprehensive income (loss), net of income taxes of $0.6 million.taxes. In fiscal 2007, the Company also entered into future contracts related to forecasted purchases of aluminum and natural gas which were treated as cash flow hedges. Unrealized gains and losses on these contracts are deferred as a component of accumulated other comprehensive income (loss), and recognized as a component of earnings at the same time that the underlying purchases of aluminum and natural gas impact earnings. During fiscal 2007, $0.4 million of income was recorded as a component of earnings related to the settlement of certain futures contracts. At March 31, 2007, $0.5 million of unrealized gains remain deferred in other comprehensive income, and will be realized as a component of cost of sales over the next three months.
In fiscal 2006, the Company entered into a derivative forward contract which was used to mitigate cash flow losses for maturing foreign denominated debt. This contract was settled during fiscal 2006 with a loss of $0.4 million recorded within the consolidated statement of earnings.operations. In fiscal 2006, the Company also entered into a cash flow hedge of a benchmark interest rate in anticipation of a private placement borrowing. This contract was settled during fiscal 2006 with a loss of $1.8 million being recorded. This loss was reflected as a component of accumulated other comprehensive income (loss) and is being amortized to interest expense over the ten-year life of the private placement borrowing. During fiscal 2008, 2007 and 2006, $0.1 million of this loss, respectively, was recognized as interest expense and the remaining loss of $1.5$0.8 million is deferred in accumulated other comprehensive income (loss) at March 31, 2007,2008, net of income taxes of $0.6 million.taxes.
Research and Development
In fiscal 2007,2008, Modine increased its research and development (R&D) spending by 3.613.2 percent to $82.5$93.2 million from $79.6$82.3 million one year ago. Investment in R&D has increased at an average annual rate of approximately 9.59.0 percent since fiscal 2005.2006. The Company’s R&D efforts have been focused on new products and technologies to respond to market trends due to environmental legislation as well as to enhance energy efficiency and fuel economy. These key market drivers are shaping and influencing our customers’ future thermal management needs. Legislation on NOx and particulate emissions for diesel engines continues to provide market opportunities for Modine through products such as EGR’s. Many new heat exchanger and cooling module platforms have been developed in order to help our customers comply with this legislation. Likewise, concern over global warming is continuing to cause the industry to consider replacing current refrigerants such as R-134a with new, environmentally friendly refrigerants such as CO2.CO2. A newly formed vehicular HVAC group has grown out of the R&D area. Knowledge developed from R&D activities will be used to develop improved HVAC product platforms, including products to comply with potential anti-idling legislation for heavy duty vehicles. Energy efficiency legislation is also driving opportunities for high performance, lightweight heat exchangers in commercial markets. Modine continues to refine the product development process for all of its markets, including the use of virtual simulation to increase efficiency and reduce time to market with new designs.
Modine ended the year with 2,347has been granted 2,355 worldwide patents, an increase of 143 patents over the prior year.life of the Company. Modine is focused on the long-term commercialization of our intellectual property and research, and believes that these investments will result in new and next generation products and technologies.
Critical Accounting Policies
The following critical accounting policies reflect the more significant judgments and estimates used in preparing the financial statements. Application of these policies results in accounting estimates that have the greatest potential for a significant impact on Modine's financial statements. The following discussion of these judgments and estimates is intended to supplement the Summary of Significant Accounting Policies presented in Note 12 of the Notes to Consolidated Financial Statements.
Revenue Recognition
The Company recognizes revenue, including agreed upon commodity price increases, as products are shipped to customers and the risks and rewards of ownership are transferred to our customers. The revenue is recorded net of applicable provisions for sales rebates, volume incentives, and returns and allowances. At the time of revenue recognition, the Company also provides an estimate of potential bad debts and warranty expense. The Company bases these estimates on historical experience, current business trends and current economic conditions. The Company recognizes revenue from various licensing agreements when earned except in those cases where collection is uncertain, or the amount cannot reasonably be estimated until formal accounting reports are received from the licensee.
Contractual commodity price increases may also be included in revenue. Price increases agreed-upon in advance are recognized as revenue when the products are shipped to our customers. In certain situations, the price increases are recognized as revenue at the time products are shipped in accordance with the contractual arrangements with our customer,customers, but are offset by appropriate provisions for estimated commodity price increases which may ultimately not be collected. These provisions are established based on historical experience, current business trends and current economic conditions. There was no provision for estimated commodity price increases at March 31, 2008. At March 31, 2007, we had established $0.4 million of provisions for estimated commodity price increases which may ultimately not be collected as the likelihood of collection iswas uncertain.
Impairment of Long-Lived and Amortized Intangible Assets
The Company performs impairment evaluations of its long-lived assets, including amortized intangibles,property, plant and equipment and intangible assets with finite lives, whenever business conditions or events indicate that those assets may be impaired. When the estimated future undiscounted cash flows to be generated by the assets are less than the carrying value of the long-lived assets, the assets are written down to fair market value based on a discounted cash flow approach and a charge is recorded to current operations.
Impairment of Goodwill and Intangible Assets
Impairment tests are conducted at least annually unless business events or other factors indicate a need to perform the testing more often. The Company conducts its annual review of goodwill and other intangible assets with indefinite lives for impairment in the third quarter. The recoverability of goodwill and other intangible assets with indefinite lives was determined by estimating the future discounted cash flows of the businessesreporting unit to which the goodwill and other intangible assets with indefinite lives relates. The rate used in determining discounted cash flows is a rate corresponding to our cost of capital, adjusted for risk where appropriate. In determining the estimated future cash flows, current and future levels of income wereare considered as well as business trends and market conditions. The estimated cash flows assume an improvement in future years. To the extent that future cash flows do not improve, certain portions of our goodwill balance could become impaired.book value exceeds the fair value, an impairment is recognized.
Warranty
Estimated costs related to product warranties are accrued at the time of the sale and recorded in cost of sales. Estimated costs are based on the best information available, which includes using statistical and analytical analysis of both historical and current claim data. Original estimates, accrued at the time of sale, are adjusted when it becomes probable that expected claims will differ materially from these initial estimates.
ToolingCosts
Pre-production tooling costs incurred by the Company in manufacturing products under various customer programs are capitalized as a component of property, plant and equipment, net of any customer reimbursements, when the Company retains title to the tooling. These costs are amortized over the program life or three years, whichever is shorter, and recorded in cost of sales in the consolidated statements of earnings.operations. For customer-owned tooling costs incurred by the Company, a receivable is recorded when the customer has guaranteed reimbursement to the Company. The reimbursement period may vary by program and customer. No significant arrangements existed during the years ended March 31, 20072008 and 20062007 where customer-owned tooling costs were not accompanied by guaranteed reimbursements.
Pensions and Postretirement Benefits Other Than PensionsPlans
The calculation of the expense and liabilities of Modine's pension and postretirement plans are dependent upon various assumptions. The most significant assumptions include the discount rate, rate of compensation increase, long-term expected return on plan assets, and future trends in health care costs. The selection of assumptions is based on historical trends and known economic and market conditions at the time of valuation. In accordance with generally accepted accounting principles, actual results that differ from these assumptions are accumulated and amortized over future periods. These differences may impact future pension or postretirement benefit expenses and liabilities. The Company replaced the existing defined benefit pension plan with a defined contribution plan for salaried-paid employees hired on or after January 1, 2004. In addition, theThe Modine Salaried Employee Pension Plan was modified so that no service performed after March 31, 2006 will be counted when calculating an employee’s years of credited service under the pension plan formula. During fiscal 2008, the plan was modified so that no increases in annual earnings after December 31, 2007 will be included in calculating the average annual portion under the pension plan formula. At the current pension assumption rates, we would expect pension expense to decline steadily going forward. We believe the defined contribution plan will, in general, allow the Company a greater degree of flexibility in managing retirement benefit costs on a long-term basis.
For the following discussion regarding sensitivity of assumptions, all amounts presented are in reference to the domestic pension plans since the domestic plans comprise 100 percent of the Company’s total benefit plan assets and the large majority of the Company’s pension plan expense.
To determine the expected rate of return, Modine considers such factors as (a) the actual return earned on plan assets, (b) historical rates of returns on the various asset classes in the plan portfolio, (c) projections of returns on those asset classes, (d) the amount of active management of the assets, (e) capital market conditions and economic forecasts, and (f) administrative expenses covered by the plan assets. The long-term rate of return utilized in fiscal 20062008 and fiscal 2007 was 8.25 percent and 8.50 percent.percent, respectively. For fiscal 2008,2009, the Company has assumed a rate of 8.218.25 percent. The impact of a 25 basis point decrease in the expected rate of return on assets would result in a $0.5 million increase in fiscal 20082009 pension expense.
The discount rate reflects rates available on long-term, high quality fixed-income corporate bonds, reset annually on the measurement date of DecemberMarch 31. For fiscal 2008,2009, the Company will use a discount rate of 5.926.62 percent, reflecting an increase from 5.755.92 percent in fiscal 2007.2008. The Company based this decision on a yield curve that was created following an analysis of the projected cash flows from the affected plans. See Note 34 of the Notes to Consolidated Financial Statements for additional information. Changing Modine’s discount rate by 25 basis points would impact the fiscal 20082009 domestic pension expense by approximately $0.7 million.
A key determinant in the amount of the postretirement benefit obligation and expense is the health care cost trend rate. The health care trend rate for fiscal year 20072008 was 9 percent, and the Company expects this to decline to 8remain at 9 percent for fiscal 2008.2009. This rate is projected to decline gradually to 5 percent in fiscal year 20112014 and remain at that level thereafter. An annual "cap" that was established for most retiree health care and life insurance plans between fiscal 1994 and 1996 limits Modine’s liability. Furthermore, beginning in February 2002, the Company discontinued providing postretirement benefits for salaried and non-union employees hired on or after that date. A one percent increase in the health care trend rate would result in an increase in postretirement expense of approximately $72,000 and an increase in postretirement benefit obligations of approximately $1.1 million. A 25 basis point decrease in the postretirement discount rate would result in an increase in benefit expense of approximately $60,000.
Other Loss Reserves
The Company has a number of other loss exposures, such as environmental and product liability claims, litigation, self-insurance reserves, recoverability of deferred income tax benefits, and accounts receivable loss reserves. Establishing loss reserves for these matters requires the use of estimates and judgment to determine the risk exposure and ultimate potential liability. The Company estimates these reserve requirements by using consistent and suitable methodologies for the particular type of loss reserve being calculated. See Note 2526 of the Notes to Consolidated Financial Statements for additional details of certain contingencies and litigation.
Accounting Pronouncements
In JuneSeptember 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) which clarifies the accounting for uncertainty in income taxes recognized in accordance with Statement of Financial Accounting Standard (SFAS) No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Under FIN 48, if a tax position does not meet a “more-likely-than-not” recognition threshold, the benefit of that position is not recognized in the financial statements. The Company is required to adopt FIN 48 on April 1, 2007, and is currently finalizing its assessment of its global tax positions. The Company’s anticipated impact of adopting this standard will result in an increase in long-term liabilities in a range of $2.0 million to $3.0 million, with an offset to beginning retained earnings to reflect the cumulative effect of this change in accounting principle.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities —– including an Amendment of SFAS No. 115” (SFAS No. 159), which permits an entity to measure many financial assets and financial liabilities at fair value that are not currently required to be measured at fair value. Entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with a few exceptions. SFAS No. 159 amends previous guidance to extend the use of the fair value option to available-for-sale and held-to-maturity securities. The Statement also establishes presentation and disclosure requirements to help financial statement users understand the effect of the election. SFAS No. 159 is effective as of the beginning of the first quarter of fiscal 2009. Management is currently assessing the potential impact of this standard on the Company’s consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS No. 141(R)) which replaces SFAS No. 141, “Business Combination”. SFAS No. 141(R) retained the underlying concepts of SFAS No. 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but SFAS No. 141(R) changed the method of applying the acquisition method in a number of significant aspects. For all business combinations, the entity that acquires the business will record 100 percent of all assets and liabilities of the acquired business, including goodwill, generally at their fair values. Certain contingent assets and liabilities acquired will be recognized at their fair values on the acquisition date and changes in fair value of certain arrangements will be recognized in earnings until settled. Acquisition-related transactions and restructuring costs will be expensed rather than treated as an acquisition cost and included in the amount recorded for assets acquired. SFAS No. 141(R) is effective for the Company on a prospective basis for all business combinations for which the acquisition date is on or after April 1, 2009, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. SFAS No. 141(R) amends SFAS No. 109, “Accounting for Income Taxes,” such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that close prior to the effective date of SFAS No. 141(R) would also apply the provisions of SFAS No. 141(R). Early adoption is not allowed. Management is currently assessing the potential impact of this standard on the Company’s consolidated financial statements; however, the Company does not anticipate the adoption to have a material impact on previous acquisitions.
In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB 51.” SFAS No. 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to establish new standards that will govern the accounting for and reporting of (1) non-controlling interest in partially owned consolidated subsidiaries and (2) the loss of control of subsidiaries. The Company’s consolidated subsidiaries are wholly-owned and as such no minority interests are currently reported in the consolidated financial statements. Other current ownership interests are reported under the equity method of accounting under investments in affiliates. SFAS No. 160 is effective for the Company on a prospective basis on or after April 1, 2009 except for the presentation and disclosure requirements, which will be applied retrospectively. Early adoption is not allowed. Based upon the Company’s current portfolio of investments in affiliates, the Company does not anticipate that adoption of this standard will have a material impact on the consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities an Amendment of FASB Statement No. 133.” SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. SFAS No. 161 is effective for the Company during the fourth quarter of fiscal 2009. Early adoption is encouraged. SFAS No. 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The Company is currently evaluating the impact this statement will have on the Company’s financial statement disclosures.
Forward-Looking Statements
This report contains statements, including information about future financial performance, accompanied by phrases such as “believes,” “estimates,” “expects,” “plans,” “anticipates,” “will,” “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 11A of this report. Other risks and uncertainties disclosed herein include, but are not limited to, the following:
| • | Modine’s ability to successfully implement its current and impending restructuring plans so that we achieve the targeted cost reductions desired; |
| • | Modine’s ability to maintain adequate liquidity to carry out restructuring programs while investing for future growth; |
| • | Modine’s ability to refinance its existing revolving credit facility as it matures; |
| • | Modine’s ability to satisfactorily service its customers during the implementation and execution of the restructuring plans and the Company’s ability to avoid inefficiencies in the transitioning of products from production facilities to be closed to other existing or new production facilities; |
| • | Modine’s ability to remain in compliance with its existing debt agreements; |
| • | Modine’s ability to meet or exceed its long-term financial plan; |
| • | Modine’s ability to obtain commercial concessions and improved profitability in its South Korean business; |
| • | Modine’s ability to further cut costs to increase its gross margin and to maintain and grow its business; |
| • | Impairment of assets resulting from business downturns; |
| • | Modine’s ability to realize future tax benefits; |
| • | Modine’s ability to maintain its market share when its customers are experience pricing pressures and excess capacity issues; |
| • | Modine’s ability to increase its gross margin by producing products in low cost countries; |
| • | Modine’s ability to maintain customer relationships while rationalizing business because Modine must ensure increased revenues are accompanied by increasing margins; |
| • | 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 cost-downs from its customers; |
| • | Modine’s ability to obtain profitable business at its new facilities in China, Hungary, Mexico and India and to produce quality products at these facilities from business obtained; |
| • | Modine’s ability to react to increasing commodities pricing including its ability to pass increasing costs on to customers in a timely manner; |
| • | The effect of the weather on the Commercial Products business, which directly impacts sales; |
| • | Unanticipated problems with suppliers meeting Modine’s time and price demands; |
| • | Customers’ actual production demand for new products and technologies, including market acceptance of a particular vehicle model or engine; |
| • | The impact of environmental laws and regulations on Modine’s business and the business of Modine’s customers, including Modine’s ability to take advantage of opportunities to supply alternative new technologies to meet environmental emissions standards; |
| • | Economic, social and political conditions, changes and challenges in the markets where Modine operates and competes (including currency exchange rate fluctuations, tariffs, inflation, changes in interest rates, recession, and restrictions associated with importing and exporting and foreign ownership); |
| • | The cyclical nature of the vehicular industry; |
| • | Changes in the anticipated sales mix; |
| • | Modine’s association with a particular industry, such as the automobile industry, which could have an adverse effect on Modine’s stock price; |
| • | Work stoppages or interference at Modine or Modine’s major customers; |
| • | Unanticipated product or manufacturing difficulties, including unanticipated warranty claims; |
| • | Unanticipated delays or modifications initiated by major customers with respect to product applications or requirements; |
| • | Costs and other effects of unanticipated litigation or claims, and the increasing pressures associated with rising health care and insurance costs and reductions in pension credit; and |
| • | Other risks and uncertainties identified by the Company in public filings with the U.S. Securities and Exchange Commission. |
Modine does not assume any obligation to update any of these forward-looking statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
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, South Korea, India and throughout Europe. It also has equity investments in companies located in France, Japan, and China. 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 itits products. The Company's operating results are principally exposed to changes in exchange rates between the dollar and the European currencies, primarily the euro, changes between the dollar and the South Korean won 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. The Company's favorable/(unfavorable)favorable currency translation adjustments recorded in fiscal 20072008 and fiscal 20062007 were $24.3$48.0 million and ($19.1 million),$24.3 million, respectively. As of March 31, 20072008 and 2006,2007, the Company's foreign subsidiaries had net current assets (defined as current assets less current liabilities) subject to foreign currency translation risk of $74.7$149.2 million and $57.3$74.7 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 $7.5$14.9 million. 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 certain foreign-denominated, long-term debt obligations that are sensitive to foreign currency exchange rates. The following table presents the future principal cash flows and weighted average interest rates by expected maturity dates. The fair value of 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 carrying value of the debt approximates fair value. As of March 31, 20072008 the foreign-denominated, long-term debt matures as follows:
| Years ending March 31 | Years ending March 31 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Expected Maturity Date | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Expected Maturity Date | ||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | F2008 | F2009 | F2010 | F2011 | F2012 | Thereafter | Total | F2009 | F2010 | F2011 | F2012 | F2013 | Thereafter | Total | ||||||||||||||||||||||||||||||||||||
| Fixed rate (won) | $ | 149 | $ | 203 | $ | 194 | $ | 216 | $ | 239 | $ | 1,920 | $ | 2,921 | $ | 245 | $ | 193 | $ | 215 | $ | 238 | $ | 261 | $ | 1,728 | $ | 2,880 | ||||||||||||||||||||||
| Average interest rate | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | - | |||||||||||||||||||||||||
In addition to the external borrowing, the Company has from time to time had foreign-denominated, long-term inter-company loans that are sensitive to foreign exchange rates. At March 31, 2007,2008, the Company has a 28.924.1 billion won, ($30.724.3 million U.S. equivalent), 8-year loan to its wholly owned subsidiary, Modine Korea, LLC, that matures on August 31, 2012. On April 6, 2005, the Company entered into a zero cost collar to hedge the foreign exchange exposure on the entire outstanding amount of this loan. This collar was settled on August 29, 2006 for a loss of $1.1 million. On August 29, 2006, the Company entered into a new zero cost collar to hedge the foreign exchange exposure on the entire outstanding amount of the Modine Korea, LLC loan. This collar was settled on February 29, 2008 at no cost. On February 29, 2008, the Company entered into a new zero cost collar that expired on March 31, 2008 to hedge the foreign exchange exposure on the entire outstanding amount of the Modine Korea, LLC loan. This collar was settled on March 28, 2008 for a gain of $0.6 million. On March 28, 2008, the Company entered into a purchased option contract that expires March 31, 2009 to hedge the foreign exchange exposure on the entire outstanding amount of the Modine Korea, LLC loan. The derivative instrument is beinginstruments are not treated as a fair value hedge,hedges, and accordingly, transaction gains or losses on the derivativederivatives are being recorded in other income -– net in the consolidated statement of earningsoperations and acts to offset any currency movement outside of the collar on the outstanding loan receivable. This derivative instrument expires on February 29, 2008. During fiscal 2006,2008, Modine Korea, LLC paid 9.44.8 billion won ($9.35.1 million U.S. equivalent) on this intercompanyinter-company loan and the Company correspondingly adjusted the zero cost collar to reflect these payments. Priorthe payment.
At March 31, 2008, the Company also had two inter-company loans totaling $20.0 million to December 15, 2005, the Company’s wholly owned German subsidiary, Modine Holding GmbH had a 11.1 million euro ($14.7 million U.S. equivalent) on-demand loan from its wholly owned subsidiary, Modine Hungaria Kft. For fiscal 2006,Brazil with various maturity dates through May 2011. On June 21, 2007, the Company entered into a zero cost collar that expired on March 31, 2008 to hedge the foreign exchange exposure on the principal amount of the loans. This collar was settled on March 31, 2008 for a loss of 3.9 million reais ($2.3 million U.S. equivalent). On March 31, 2008, the Company entered into a purchased option contract that expires on April 1, 2009 to hedge the foreign exchange exposure on the larger ($15.0 million) of the two inter-company loans. The smaller inter-company loan ($5.0 million) will be repaid by February 2009 and its foreign exchange exposure will be managed by natural hedges and offsets that exist in the Company’s operations. The derivative instruments are not treated as hedges, and accordingly, transaction gains or losses on the derivatives are being recorded in "other income/(expense)" transaction gainsother income – net in the consolidated statement of $0.6 million.operations and acts to offset any currency movement on the outstanding loan receivable.
The Company also has other inter-company loans outstanding at March 31, 2008 as follows:
| · | $0.9 million loan to its wholly-owned subsidiary, Modine Thermal Systems India, that matures on April 30, 2013; |
| · | $6.0 million loan to its wholly-owned subsidiary, Modine Thermal Systems Co (Changzhou, China), that matures on February 1, 2009; and |
| · | $1.1 million loan to its wholly-owned subsidiary, Modine Thermal Systems Shanghai, that matures on January 19, 2009. |
These inter-company loans are sensitive to movement in foreign exchange rates, and the Company does not have any derivative instruments which hedges 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. On October 25, 2006, theThe Company has, from time-to-time, entered into two forward starting swaps in anticipation of the $75 million private placement debt offering which occurred on December 7, 2006. These swaps were entered intointerest rate derivates to eliminate themanage variability in interest rates prior to locking the fixedrates. These interest rate forderivatives 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 private placement offering. On November 14, 2006,respective lives of the fixedborrowings. During the years ended March 31, 2008 and 2007, $0.3 million and $0.1 million of expense, respectively, was recorded in the consolidated statement of operations related to the amortization of interest rate derivative losses. At March 31, 2008, $1.8 million of the private placement borrowing was locked and, accordingly, the swaps were settled at a loss of $1.8 million.net unrealized losses remain deferred in accumulated other comprehensive income (loss). The following table presents the future principal cash flows and weighted average interest rates by expected maturity dates (including the foreign denominated long-term obligations included in the previous table). 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 fairbook value of the debt approximates fair value, with the exception of the $150$150.0 million fixed rate notes, which have a fair value of approximately $145.4$159.2 million at March 31, 2007. 2008.
As of March 31, 2007,2008, long-term debt matures as follows:
| Years ending March 31 | ||||||||||||||||||||||||||||
| Expected Maturity Date | ||||||||||||||||||||||||||||
| (dollars in thousands) | F2009 | F2010 | F2011 | F2012 | F2013 | Thereafter | Total | |||||||||||||||||||||
| Fixed rate (won) | $ | 245 | $ | 193 | $ | 215 | $ | 238 | $ | 261 | $ | 1,728 | $ | 2,880 | ||||||||||||||
| Average interest rate | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | ||||||||||||||||
| Fixed rate (U.S. dollars) | - | - | - | - | - | $ | 150,000 | $ | 150,000 | |||||||||||||||||||
| Average interest rate | - | - | - | - | - | 5.30 | % | |||||||||||||||||||||
| Variable rate (U.S. dollars) | - | - | $ | 69,000 | - | - | - | $ | 69,000 | |||||||||||||||||||
| Average interest rate | - | - | 3.98 | % | - | - | - | |||||||||||||||||||||
| Years ending March 31 | ||||||||||||||||||||||
| Expected Maturity Date | ||||||||||||||||||||||
| (dollars in thousands) | F2008 | F2009 | F2010 | F2011 | F2012 | Thereafter | Total | |||||||||||||||
| Fixed rate (won) | $ | 149 | $ | 203 | $ | 194 | $ | 216 | $ | 239 | $ | 1,920 | $ | 2,921 | ||||||||
| Average interest rate | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | 3.00 | % | - | |||||||||
| Fixed rate (U.S. dollars) | - | - | - | - | - | $ | 150,000 | $ | 150,000 | |||||||||||||
| Average interest rate | - | - | - | - | - | 5.30 | % | - | ||||||||||||||
| Variable rate (U.S. dollars) | $ | 3,000 | - | $ | 23,000 | - | - | - | $ | 26,000 | ||||||||||||
| Average interest rate | 3.68 | % | - | 5.56 | % | - | - | - | - | |||||||||||||
Credit Risk
Credit risk is the possibility of loss from a customer's failure to make payment according to contract terms. The Company's principal credit risk consists of outstanding trade receivables. Prior to granting credit, each customer is evaluated, taking into consideration the borrower's financial condition, past payment experience and credit information. After credit is granted the Company actively monitors the customer's financial condition and developing business news. Approximately 5251 percent of the trade receivables balance at March 31, 20072008 was concentrated in the Company's top 10ten customers. Modine's history of incurring credit losses from customers has not been material, and the Company does not expect that trend to change.
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. For example, traditionally, significant increasesA sustained economic downturn in oil pricesany of these markets could have had ana material adverse effect on many markets the Company serves. Continued high oil prices may negatively impact the Company’s earnings, particularlyfuture results of operations and potentially result in the truck and off-highway markets.impairment of related assets.
With respect to international instability, the Company continues to monitor economic conditions in the U.S. and elsewhere. During fiscal 20072008 there was an overallcontinued weakening of the U.S. dollar. The euro and wonBrazilian real strengthened against the dollar by 1115 percent and 325 percent, respectively. The Brazilian realwon remained essentially unchanged in fiscal 2007,2008, but strengthened by 223 percent in fiscal 2006.2007. The Chinese renminbi strengthened almost 49 percent against the U.S. dollar in fiscal 20072008 and was rather flatalmost 4 percent in fiscal 2006.2007. As Modine expands its global presence, we also encounter risks imposed by potential trade restrictions, including tariffs, embargoes and the like. We continue 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, CO22 and fuel cell technology. 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 upturn in the economy and continued economic growth in China are putting 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 serving a more robust market. As a result, some suppliers are allocating product among customers, extending lead times or holding supply to the prior year's level. 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. Historically high commodity pricing, which includes aluminum, copper, nickel and nickel,steel is making it increasingly difficult to pass along the full amount of these increases to our customers as our contracts have provided for in the past.customers.
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 offsets 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, or a reduction in the Company's participation in any one or more markets. However, the risks associated with any market downturn or reduction are still substantial.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, and aluminum, alloy,nickel, and natural gas. In fiscal 2007, theThe Company enteredutilizes an aluminum hedging strategy by entering into fixed price contracts to hedge against changes in aluminumhelp offset changing commodity prices. The Company utilizes collars for certain forecasted copper purchases, and natural gas. In fiscal 2008, the Company is evaluating its other heavily used commodities and expects to adopt hedging strategies, where prudent,also enters into forward contracts for these commodities to assist in protecting the Company from continued gross margin erosion.certain forecasted nickel purchases. The Company does maintain agreements with certain OEM 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. Because of the historic highs reached in some commodities, the Company is dealing with increasing challenges from OEM customers to abide by these agreements and pay the full amount of the price increases.
Hedging and Foreign Currency Exchange Contracts
The Company uses derivative financial instruments in a limited way as a tool to manage certain financial risks. Their use is restricted primarily to hedging assets and obligations already held by Modine, and they are used to protect cash flows rather than generate income or engage in speculative activity. Leveraged derivatives are prohibited by Company policy.
Commodity Derivatives: During fiscal 2007,2008, the Company entered into futures contracts related to certain of the Company’s forecasted purchases of aluminum and natural gas. The Company’s strategy in entering into these contracts is to reduce its exposure to changing purchase prices for future purchase 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, and recognized as a component of earnings at the same time that the underlying purchases of aluminum and natural gas impact earnings. During the year ended March 31, 2007, $0.42008, $2.0 million of incomeexpense was recorded in the consolidated statement of earningsoperations related to the settlement of certain futures contracts. At March 31, 2007, $0.52008, $1.4 million of unrealized gains remain deferred in accumulated other comprehensive income, and will be realized as a component of cost of sales over the next threenine months.
During fiscal 2008, the Company entered into futures contracts related to certain of the Company’s forecasted purchases of copper and nickel. The Company’s strategy in entering into these contracts is 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 are recorded directly in the consolidated statements of operations. At March 31, 2008, $0.2 million of income, was recorded in cost of sales related to these futures contracts.
Foreign exchange contracts: Modine maintains a foreign exchange risk management strategy that uses derivative financial instruments in a limited way to mitigate foreign currency exchange risk. Modine periodically enters into foreign currency exchange contracts to hedge specific foreign currency denominated transactions. Generally, these contracts have terms of 90 or fewer days. The effect of this practice is to minimize the impact of foreign exchange rate movements on Modine’s earnings. Modine’s foreign currency exchange contracts do not subject it to significant risk due to exchange rate movements because gains and losses on these contracts offset gains and losses on the assets and liabilities being hedged.
As of March 31, 2007,2008, the Company had no outstanding forward foreign exchange contracts, with the exception of the zero cost collarpurchased option contracts to hedge the foreign exchange exposure on the entire amount of the Modine Korea, LLC loan and the $15.0 million intercompany loan with Modine Brazil, which isare discussed above under the section entitled “Foreign Currency Risk”. Non-U.S. dollar financing transactions through intercompany loans or local borrowings in the corresponding currency generally are effective as hedges of long-term investments.
The Company has a number of investments in wholly owned foreign subsidiaries and non-consolidated foreign joint ventures. The net assets of these subsidiaries are exposed to currency exchange rate volatility. In certain instances,From time to time, the Company uses non-derivative financial instruments to hedge, or offset, this exposure. The currency exposure related to the net assets of Modine's European subsidiaries has been managed partially through euro-denominated debt agreements entered into by the parent. As of March 31, 2007, there were no outstanding euro-denominated borrowings.
Interest rate derivative: derivatives: As further noted above under the section entitled “Interest Rate Risk”, the Company has, from time to time, entered into a two forward starting swapsinterest rate derivates to manage the variability in anticipation of the $75.0 million private placement debt offering that occurred on December 7, 2006. The forward starting swaps wereinterest rates. These interest rate derivatives have been treated as cash flow hedges of forecasted transactions. On November 14, 2006, the fixed interest rate of the private placement borrowing was lockedtransactions and, accordingly, the Company terminated and settled the forward starting swaps at a loss of $1.8 million. The $1.8 million loss isderivative gains or losses are reflected as a component of accumulated other comprehensive income (loss), net of income taxes of $0.6 million, and is beingare amortized to interest expense over the respective eleven and twelve year lives of the debt offerings.borrowings.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. MODINE MANUFACTURING COMPANY | ||||||||||
| CONSOLIDATED STATEMENTS OF EARNINGS | ||||||||||
| For the years ended March 31, 2007, 2006 and 2005 | ||||||||||
| (In thousands, except per share amounts) | ||||||||||
2007 | 2006 | 2005 | ||||||||
| Net sales | $ | 1,757,472 | $ | 1,628,900 | $ | 1,342,416 | ||||
| Cost of sales | 1,475,620 | 1,319,294 | 1,062,576 | |||||||
Gross profit | 281,852 | 309,606 | 279,840 | |||||||
| Selling, general, and administrative expenses | 237,837 | 220,090 | 183,391 | |||||||
| Restructuring charges | 4,292 | - | 1,031 | |||||||
Income from operations | 39,723 | 89,516 | 95,418 | |||||||
| Interest expense | (10,163 | ) | (7,247 | ) | (6,329 | ) | ||||
| Other income – net | 9,727 | 8,271 | 8,828 | |||||||
Earnings from continuing operations before income taxes | 39,287 | 90,540 | 97,917 | |||||||
| (Benefit from) provision for income taxes | (2,975 | ) | 29,788 | 36,231 | ||||||
Earnings from continuing operations | 42,262 | 60,752 | 61,686 | |||||||
| Earnings (loss) from discontinued operations (net of income taxes) | - | 351 | (24 | ) | ||||||
| Loss on spin off of discontinued operations | - | (53,462 | ) | - | ||||||
| Cumulative effect of accounting change (net of income taxes) | 70 | - | - | |||||||
Net earnings | $ | 42,332 | $ | 7,641 | $ | 61,662 | ||||
| Earnings per share of common stock – basic: | ||||||||||
| Continuing operations | $ | 1.32 | $ | 1.80 | $ | 1.81 | ||||
| Earnings from discontinued operations | - | 0.01 | - | |||||||
| Loss on spin off of discontinued operations | - | (1.58 | ) | - | ||||||
| Cumulative effect of accounting change | - | - | - | |||||||
| Net earnings – basic | $ | 1.32 | $ | 0.23 | $ | 1.81 | ||||
| Earnings per share of common stock – diluted: | ||||||||||
Continuing operations | $ | 1.31 | $ | 1.78 | $ | 1.79 | ||||
| Earnings from discontinued operations | - | 0.01 | - | |||||||
| Loss on spin off of discontinued operations | - | (1.57 | ) | - | ||||||
| Cumulative effect of accounting change | - | - | - | |||||||
| Net earnings – diluted | $ | 1.31 | $ | 0.22 | $ | 1.79 | ||||
| The notes to consolidated financial statements are an integral part of these statements. | ||||||||||
| MODINE MANUFACTURING COMPANY | |||||||
| CONSOLIDATED BALANCE SHEETS | |||||||
| March 31, 2007 and 2006 | |||||||
| (In thousands, except per share amounts) | |||||||
2007 | 2006 | ||||||
ASSETS | |||||||
Current assets: | |||||||
| Cash and cash equivalents | $ | 21,227 | $ | 30,798 | |||
| Short term investments | 3,001 | - | |||||
| Trade receivables, less allowance for doubtful accounts of $1,679 and $1,511 | 252,359 | 254,681 | |||||
| Inventories | 111,912 | 90,227 | |||||
| Deferred income taxes and other current assets | 68,358 | 36,489 | |||||
Total current assets | 456,857 | 412,195 | |||||
Noncurrent assets: | |||||||
| Property, plant and equipment – net | 517,349 | 467,600 | |||||
| Investment in affiliates | 18,794 | 41,728 | |||||
| Goodwill | 67,029 | 52,256 | |||||
| Intangible assets – net | 11,137 | 12,735 | |||||
| Prepaid pension costs | - | 59,894 | |||||
| Other noncurrent assets | 27,092 | 5,687 | |||||
| Assets held for sale | 3,315 | - | |||||
Total noncurrent assets | 644,716 | 639,900 | |||||
Total assets | $ | 1,101,573 | $ | 1,052,095 | |||
LIABILITIES AND SHAREHOLDERS' EQUITY | |||||||
Current liabilities: | |||||||
| Short-term debt | $ | 344 | $ | 5,983 | |||
| Long-term debt – current portion | 3,149 | 125 | |||||
| Accounts payable | 196,330 | 187,048 | |||||
| Accrued compensation and employee benefits | 59,801 | 56,835 | |||||
| Income taxes | 14,600 | 13,169 | |||||
| Accrued expenses and other current liabilities | 33,729 | 31,789 | |||||
Total current liabilities | 307,953 | 294,949 | |||||
Noncurrent liabilities: | |||||||
| Long-term debt | 175,856 | 151,706 | |||||
| Deferred income taxes | 18,385 | 38,424 | |||||
| Pensions | 48,847 | 28,933 | |||||
| Postretirement benefits | 27,960 | 20,085 | |||||
| Other noncurrent liabilities | 29,305 | 12,573 | |||||
Total noncurrent liabilities | 300,353 | 251,721 | |||||
Total liabilities | 608,306 | 546,670 | |||||
Commitments and contingencies (See Note 25) | |||||||
Shareholders' equity: | |||||||
| Preferred stock, $0.025 par value, authorized 16,000 shares, issued - none | - | - | |||||
| Common stock, $0.625 par value, authorized | |||||||
| 80,000 shares, issued 32,872 and 33,210 shares | 20,545 | 20,756 | |||||
| Additional paid-in capital | 61,240 | 52,459 | |||||
| Retained earnings | 439,318 | 433,405 | |||||
| Accumulated other comprehensive (loss) income | (14,779 | ) | 10,017 | ||||
| Treasury stock at cost: 453 and 404 shares | (12,468 | ) | (11,212 | ) | |||
| Deferred compensation trust | (589 | ) | - | ||||
Total shareholders' equity | 493,267 | 505,425 | |||||
Total liabilities and shareholders' equity | $ | 1,101,573 | $ | 1,052,095 | |||
| The notes to consolidated financial statements are an integral part of these statements. | |||||||
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
MODINE MANUFACTURING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended March 31, 2008, 2007 and 2006
(In thousands, except per share amounts)
| 2008 | 2007 | 2006 | ||||||||||
| Net sales | $ | 1,849,373 | $ | 1,722,281 | $ | 1,595,622 | ||||||
| Cost of sales | 1,579,778 | 1,441,241 | 1,283,703 | |||||||||
| Gross profit | 269,595 | 281,040 | 311,919 | |||||||||
| Selling, general and administrative expenses | 235,258 | 231,639 | 210,969 | |||||||||
| Restructuring charges | 3,565 | 3,618 | - | |||||||||
| Impairment of goodwill and long-lived assets | 47,420 | - | - | |||||||||
| (Loss) income from operations | (16,648 | ) | 45,783 | 100,950 | ||||||||
| Interest expense | 13,198 | 10,144 | 7,247 | |||||||||
| Other income – net | (8,721 | ) | (9,518 | ) | (9,124 | ) | ||||||
| (Loss) earnings from continuing operations before income taxes | (21,125 | ) | 45,157 | 102,827 | ||||||||
| Provision for income taxes | 44,386 | 6,236 | 29,802 | |||||||||
| (Loss) earnings from continuing operations | (65,511 | ) | 38,921 | 73,025 | ||||||||
| (Loss) earnings from discontinued operations (net of income taxes) | (85 | ) | 3,341 | (11,922 | ) | |||||||
| Loss on spin off of discontinued operations | - | - | (53,462 | ) | ||||||||
| Cumulative effect of accounting change (net of income taxes) | - | 70 | - | |||||||||
| Net (loss) earnings | $ | (65,596 | ) | $ | 42,332 | $ | 7,641 | |||||
| (Loss) earnings per share of common stock – basic: | ||||||||||||
| Continuing operations | $ | (2.05 | ) | $ | 1.21 | $ | 2.17 | |||||
| Earnings (loss) from discontinued operations | - | 0.10 | (0.35 | ) | ||||||||
| Loss on spin off of discontinued operations | - | - | (1.59 | ) | ||||||||
| Cumulative effect of accounting change | - | - | - | |||||||||
| Net (loss) earnings – basic | $ | (2.05 | ) | $ | 1.31 | $ | 0.23 | |||||
| (Loss) earnings per share of common stock – diluted: | ||||||||||||
| Continuing operations | $ | (2.05 | ) | $ | 1.21 | $ | 2.14 | |||||
| Earnings (loss) from discontinued operations | - | 0.10 | (0.35 | ) | ||||||||
| Loss on spin off of discontinued operations | - | - | (1.57 | ) | ||||||||
| Cumulative effect of accounting change | - | - | - | |||||||||
| Net (loss) earnings – diluted | $ | (2.05 | ) | $ | 1.31 | $ | 0.22 | |||||
The notes to consolidated financial statements are an integral part of these statements.
| MODINE MANUFACTURING COMPANY | ||||||||||
| CONSOLIDATED STATEMENTS OF CASH FLOWS | ||||||||||
| For the years ended March 31, 2007, 2006 and 2005 | ||||||||||
| (In thousands) | ||||||||||
2007 | 2006 | 2005 | ||||||||
Cash flows from operating activities: | ||||||||||
Net earnings | $ | 42,332 | $ | 7,641 | $ | 61,662 | ||||
| Adjustments to reconcile net earnings with net cash provided by operating activities: | ||||||||||
| Depreciation and amortization | 71,104 | 68,181 | 66,176 | |||||||
| Loss on spin off of Aftermarket business | - | 53,462 | - | |||||||
| Pensions and postretirement expense | 6,233 | 8,755 | 6,096 | |||||||
| Loss from impairment or disposition of property, plant and equipment | 2,033 | 4,109 | 1,072 | |||||||
| Deferred income taxes | (9,028 | ) | (6,695 | ) | 8,582 | |||||
| Provision for doubtful accounts | 250 | (60 | ) | 1,332 | ||||||
| Undistributed earnings of affiliates, net of dividends received | (2,707 | ) | (1,455 | ) | (4,139 | ) | ||||
| Stock-based compensation expense | 6,644 | 3,910 | 1,856 | |||||||
| Other – net | (4,006 | ) | (2,186 | ) | (4,153 | ) | ||||
| Changes in operating assets and liabilities, excluding acquisitions and dispositions: | ||||||||||
| Trade receivables | 27,888 | (29,891 | ) | (6,708 | ) | |||||
| Inventories | (3,082 | ) | 1,423 | 9,168 | ||||||
| Other current assets | (7,421 | ) | 8,247 | 5,891 | ||||||
| Accounts payable | (5,979 | ) | 30,313 | (1,395 | ) | |||||
| Accrued compensation and employee benefits | 980 | (2,622 | ) | 2,909 | ||||||
| Income taxes | (19,190 | ) | (1,440 | ) | 5,787 | |||||
| Accrued expenses and other current liabilities | (1,834 | ) | (8,761 | ) | 371 | |||||
| Other noncurrent assets and liabilities | (1,807 | ) | (3,574 | ) | (284 | ) | ||||
Net cash provided by operating activities | 102,410 | 129,357 | 154,223 | |||||||
Cash flows from investing activities: | ||||||||||
| Expenditures for property, plant and equipment | (82,752 | ) | (79,870 | ) | (68,567 | ) | ||||
| Acquisitions, net of cash acquired | (11,096 | ) | (37,991 | ) | (100,026 | ) | ||||
| Spin off of Aftermarket business | - | (6,300 | ) | - | ||||||
| Proceeds from purchase price settlement | 2,900 | 2,500 | - | |||||||
| Proceeds from dispositions of assets | 931 | 863 | 2,022 | |||||||
| Investments in affiliates | - | - | (2,246 | ) | ||||||
| Other – net | 181 | 1,082 | 9 | |||||||
Net cash used for investing activities | (89,836 | ) | (119,716 | ) | (168,808 | ) | ||||
Cash flows from financing activities: | ||||||||||
| Short-term debt, net | (6,118 | ) | 5,992 | - | ||||||
| Additions to long-term debt | 209,629 | 318,233 | 115,000 | |||||||
| Reductions of long-term debt | (187,386 | ) | (267,767 | ) | (104,754 | ) | ||||
| Bank overdrafts | (2,069 | ) | 7,993 | (1,289 | ) | |||||
| Proceeds from exercise of stock options | 2,914 | 12,500 | 9,971 | |||||||
| Repurchase of common stock, treasury and retirement | (14,519 | ) | (82,811 | ) | (1,591 | ) | ||||
| Cash dividends paid | (22,642 | ) | (23,878 | ) | (21,610 | ) | ||||
| Settlement of derivative contracts | (1,412 | ) | (2,238 | ) | - | |||||
| Excess tax benefits from stock-based compensation | 382 | - | - | |||||||
| Other – net | 5 | (281 | ) | 4 | ||||||
Net cash used for financing activities | (21,216 | ) | (32,257 | ) | (4,269 | ) | ||||
Effect of exchange rate changes on cash | (929 | ) | (1,677 | ) | 4,187 | |||||
| Net decrease in cash and cash equivalents | (9,571 | ) | (24,293 | ) | (14,667 | ) | ||||
Cash and cash equivalents at beginning of year | 30,798 | 55,091 | 69,758 | |||||||
Cash and cash equivalents at end of year | $ | 21,227 | $ | 30,798 | $ | 55,091 | ||||
Cash paid during the year for: | ||||||||||
| Interest, net of amounts capitalized | $ | 8,648 | $ | 7,094 | $ | 6,428 | ||||
| Income taxes | $ | 22,845 | $ | 38,206 | $ | 18,742 | ||||
Non-cash activity: | ||||||||||
| Shareholder dividend related to spin-off of Aftermarket business | $ | - | $ | (51,319 | ) | $ | - | |||
| The notes to consolidated financial statements are an integral part of these statements. | ||||||||||
MODINE MANUFACTURING COMPANY
CONSOLIDATED BALANCE SHEETS
March 31, 2008 and 2007
(In thousands, except per share amounts)
| 2008 | 2007 | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 38,313 | $ | 21,227 | ||||
| Short-term investments | 2,909 | 3,001 | ||||||
| Trade receivables, less allowance for doubtful accounts of $2,166 and $1,511 | 287,383 | 248,493 | ||||||
| Inventories | 123,395 | 108,217 | ||||||
| Assets held for sale | 6,871 | 9,256 | ||||||
| Deferred income taxes and other current assets | 63,281 | 66,663 | ||||||
| Total current assets | 522,152 | 456,857 | ||||||
| Noncurrent assets: | ||||||||
| Property, plant and equipment – net | 533,807 | 514,949 | ||||||
| Investment in affiliates | 23,150 | 18,794 | ||||||
| Goodwill | 44,935 | 64,284 | ||||||
| Intangible assets – net | 10,605 | 11,137 | ||||||
| Assets held for sale | 5,522 | 9,281 | ||||||
| Other noncurrent assets | 9,687 | 26,271 | ||||||
| Total noncurrent assets | 627,706 | 644,716 | ||||||
| Total assets | $ | 1,149,858 | $ | 1,101,573 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Current liabilities: | ||||||||
| Short-term debt | $ | 11 | $ | 344 | ||||
| Long-term debt – current portion | 292 | 3,149 | ||||||
| Accounts payable | 199,593 | 194,734 | ||||||
| Accrued compensation and employee benefits | 65,167 | 58,977 | ||||||
| Income taxes | 11,583 | 14,358 | ||||||
| Liabilities of business held for sale | 3,093 | 3,478 | ||||||
| Accrued expenses and other current liabilities | 55,661 | 32,913 | ||||||
| Total current liabilities | 335,400 | 307,953 | ||||||
| Noncurrent liabilities: | ||||||||
| Long-term debt | 226,198 | 175,856 | ||||||
| Deferred income taxes | 22,843 | 18,291 | ||||||
| Pensions | 35,095 | 48,129 | ||||||
| Postretirement benefits | 26,669 | 27,960 | ||||||
| Liabilities of business held for sale | 166 | 94 | ||||||
| Other noncurrent liabilities | 35,579 | 30,023 | ||||||
| Total noncurrent liabilities | 346,550 | 300,353 | ||||||
| Total liabilities | 681,950 | 608,306 | ||||||
| Commitments and contingencies (See Note 26) | ||||||||
| Shareholders' equity: | ||||||||
| Preferred stock, $0.025 par value, authorized 16,000 shares, issued - none | - | - | ||||||
| Common stock, $0.625 par value, authorized | ||||||||
| 80,000 shares, issued 32,788 and 32,872 shares | 20,492 | 20,545 | ||||||
| Additional paid-in capital | 69,346 | 61,240 | ||||||
| Retained earnings | 342,490 | 439,318 | ||||||
| Accumulated other comprehensive income (loss) | 49,324 | (14,779 | ) | |||||
| Treasury stock at cost: 495 and 453 shares | (13,303 | ) | (12,468 | ) | ||||
| Deferred compensation trust | (441 | ) | (589 | ) | ||||
| Total shareholders' equity | 467,908 | 493,267 | ||||||
| Total liabilities and shareholders' equity | $ | 1,149,858 | $ | 1,101,573 | ||||
The notes to consolidated financial statements are an integral part of these statements.
MODINE MANUFACTURING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended March 31, 2008, 2007 and 2006
(In thousands)
| 2008 | 2007 | 2006 | ||||||||||
| Cash flows from operating activities: | ||||||||||||
| Net (loss) earnings | $ | (65,596 | ) | $ | 42,332 | $ | 7,641 | |||||
| Adjustments to reconcile net (loss) earnings with net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 80,951 | 71,104 | 68,181 | |||||||||
| Loss on spin off of Aftermarket business | - | - | 53,462 | |||||||||
| Pensions and postretirement expense | 4,372 | 6,233 | 8,755 | |||||||||
| (Gain) loss from disposition of property, plant and equipment | (3,297 | ) | 2,033 | 4,109 | ||||||||
| Loss from impairment of goodwill and long-lived assets | 47,420 | - | - | |||||||||
| Deferred income taxes | 21,541 | (9,028 | ) | (6,695 | ) | |||||||
| Provision for doubtful accounts | 940 | 250 | (60 | ) | ||||||||
| Undistributed earnings of affiliates, net of dividends received | (1,831 | ) | (2,707 | ) | (1,455 | ) | ||||||
| Stock-based compensation expense | 8,129 | 6,644 | 3,910 | |||||||||
| Other – net | (4,880 | ) | (4,006 | ) | (2,186 | ) | ||||||
| Changes in operating assets and liabilities, excluding acquisitions and dispositions: | ||||||||||||
| Trade receivables | (21,676 | ) | 27,888 | (29,891 | ) | |||||||
| Inventories | (5,482 | ) | (3,082 | ) | 1,423 | |||||||
| Other current assets | (2,033 | ) | (7,421 | ) | 8,247 | |||||||
| Accounts payable | (16,169 | ) | (5,979 | ) | 30,313 | |||||||
| Accrued compensation and employee benefits | 2,464 | 980 | (2,622 | ) | ||||||||
| Income taxes | 7,760 | (19,190 | ) | (1,440 | ) | |||||||
| Accrued expenses and other current liabilities | 20,334 | (1,834 | ) | (8,761 | ) | |||||||
| Other noncurrent assets and liabilities | (5,593 | ) | (1,807 | ) | (3,574 | ) | ||||||
| Net cash provided by operating activities | 67,354 | 102,410 | 129,357 | |||||||||
| Cash flows from investing activities: | ||||||||||||
| Expenditures for property, plant and equipment | (87,013 | ) | (82,752 | ) | (79,870 | ) | ||||||
| Acquisitions, net of cash acquired | - | (11,096 | ) | (37,991 | ) | |||||||
| Spin off of Aftermarket business | - | - | (6,300 | ) | ||||||||
| Proceeds from purchase price settlement | - | 2,900 | 2,500 | |||||||||
| Proceeds from dispositions of assets | 10,020 | 931 | 863 | |||||||||
| Settlement of derivative contracts | (1,974 | ) | (1,412 | ) | (2,238 | ) | ||||||
| Other – net | 85 | 181 | 1,082 | |||||||||
| Net cash used for investing activities | (78,882 | ) | (91,248 | ) | (121,954 | ) | ||||||
| Cash flows from financing activities: | ||||||||||||
| Short-term debt, net | (487 | ) | (6,118 | ) | 5,992 | |||||||
| Borrowings of long-term debt | 144,428 | 209,629 | 318,233 | |||||||||
| Repayments of long-term debt | (96,828 | ) | (187,386 | ) | (267,767 | ) | ||||||
| Book overdrafts | 8,687 | (2,069 | ) | 7,993 | ||||||||
| Proceeds from exercise of stock options | 701 | 2,914 | 12,500 | |||||||||
| Repurchase of common stock, treasury and retirement | (7,710 | ) | (14,519 | ) | (82,811 | ) | ||||||
| Cash dividends paid | (22,633 | ) | (22,642 | ) | (23,878 | ) | ||||||
| Excess tax benefits from stock-based compensation | (124 | ) | 382 | - | ||||||||
| Other – net | 11 | 5 | (281 | ) | ||||||||
| Net cash provided by (used for) financing activities | 26,045 | (19,804 | ) | (30,019 | ) | |||||||
| Effect of exchange rate changes on cash | 2,569 | (929 | ) | (1,677 | ) | |||||||
| Net increase (decrease) in cash and cash equivalents | 17,086 | (9,571 | ) | (24,293 | ) | |||||||
| Cash and cash equivalents at beginning of year | 21,227 | 30,798 | 55,091 | |||||||||
| Cash and cash equivalents at end of year | $ | 38,313 | $ | 21,227 | $ | 30,798 | ||||||
| Cash paid during the year for: | ||||||||||||
| Interest, net of amounts capitalized | $ | 13,782 | $ | 8,648 | $ | 7,094 | ||||||
| Income taxes | $ | 12,383 | $ | 22,845 | $ | 38,206 | ||||||
| Non-cash activity: | ||||||||||||
| Shareholder dividend related to spin-off of Aftermarket business | $ | - | $ | - | $ | (51,319 | ) | |||||
| MODINE MANUFACTURING COMPANY | |||||||||||||||||||||||||
| CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) | |||||||||||||||||||||||||
| For the years ended March 31, 2007, 2006 and 2005 | |||||||||||||||||||||||||
| (In thousands, except per share amounts) | |||||||||||||||||||||||||
| Preferred stock | Common stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive income (loss | ) | Treasury stock | Deferred compensation trust | Total | |||||||||||||||||
| Balance, March 31, 2004 | $ | - | $ | 21,478 | $ | 26,696 | $ | 535,885 | $ | 9,974 | $ | (7,492 | ) | $ | - | $ | 586,541 | ||||||||
| Comprehensive income: | |||||||||||||||||||||||||
| Net earnings | - | - | - | 61,662 | - | - | - | 61,662 | |||||||||||||||||
| Foreign-currency translation | - | - | - | - | 23,342 | - | - | 23,342 | |||||||||||||||||
Minimum pension liability (net of taxes of $828) | - | - | - | - | (1,325 | ) | - | - | (1,325 | ) | |||||||||||||||
| Total comprehensive income | 83,679 | ||||||||||||||||||||||||
| Cash dividends, $0.63 per share | - | - | - | (21,610 | ) | - | - | - | (21,610 | ) | |||||||||||||||
| Purchase of treasury stock | - | - | - | - | - | (1,591 | ) | - | (1,591 | ) | |||||||||||||||
Stock options and awards including related tax benefits | - | 316 | 10,585 | - | - | - | - | 10,901 | |||||||||||||||||
Amortization of deferred compensation under restricted stock plans | - | - | 1,860 | - | - | - | - | 1,860 | |||||||||||||||||
| Balance, March 31, 2005 | - | 21,794 | 39,141 | 575,937 | 31,991 | (9,083 | ) | - | 659,780 | ||||||||||||||||
| Comprehensive income (loss): | |||||||||||||||||||||||||
| Net earnings | - | - | - | 7,641 | - | - | - | 7,641 | |||||||||||||||||
| Foreign-currency translation | - | - | - | - | (19,109 | ) | - | - | (19,109 | ) | |||||||||||||||
| Cash flow hedge (net of taxes of $663) | - | - | - | - | (1,042 | ) | - | - | (1,042 | ) | |||||||||||||||
Minimum pension liability (net of taxes of $1,119) | - | - | - | - | (1,823 | ) | - | - | (1,823 | ) | |||||||||||||||
| Total comprehensive income loss | (14,333 | ) | |||||||||||||||||||||||
| Cash dividends, $0.70 per share | - | - | - | (23,878 | ) | - | - | - | (23,878 | ) | |||||||||||||||
| Shareholder dividend related to spin off | - | - | - | (51,319 | ) | - | - | - | (51,319 | ) | |||||||||||||||
| Stock repurchase program | - | (1,525 | ) | (4,182 | ) | (74,976 | ) | - | - | - | (80,683 | ) | |||||||||||||
| Purchase of treasury stock | - | - | - | - | - | (2,129 | ) | - | (2,129 | ) | |||||||||||||||
Stock options and awards including related tax benefits | - | 487 | 13,995 | - | - | - | - | 14,482 | |||||||||||||||||
Amortization of deferred compensation under restricted stock plans | - | - | 3,505 | - | - | - | - | 3,505 | |||||||||||||||||
| Balance, March 31, 2006 | - | 20,756 | 52,459 | 433,405 | 10,017 | (11,212 | ) | - | 505,425 | ||||||||||||||||
| Comprehensive income: | |||||||||||||||||||||||||
| Net earnings | - | - | - | 42,332 | - | - | - | 42,332 | |||||||||||||||||
| Foreign-currency translation | - | - | - | - | 24,895 | - | - | 24,895 | |||||||||||||||||
| Cash flow hedges (net of taxes of $272) | (525 | ) | - | (525 | ) | ||||||||||||||||||||
Minimum pension liability (net of taxes of $1,383) | - | - | - | - | 2,275 | - | - | 2,275 | |||||||||||||||||
| Total comprehensive income | 68,977 | ||||||||||||||||||||||||
| Adjustment for SAB No. 108 | - | - | - | (1,775 | ) | - | - | - | (1,775 | ) | |||||||||||||||
| Adjustment to adopt SFAS No. 158 | - | - | (51,441 | ) | - | - | (51,441 | ) | |||||||||||||||||
| Cash dividends, $0.70 per share | - | - | - | (22,642 | ) | - | - | - | (22,642 | ) | |||||||||||||||
| Stock repurchase program | - | (314 | ) | (947 | ) | (12,002 | ) | - | - | - | (13,263 | ) | |||||||||||||
| Purchase of treasury stock | - | - | - | - | - | (1,256 | ) | - | (1,256 | ) | |||||||||||||||
Stock options and awards including related tax benefits | - | 103 | 6,173 | - | - | - | - | 6,276 | |||||||||||||||||
Amortization of deferred compensation under restricted stock plans | - | - | 3,555 | - | - | - | - | 3,555 | |||||||||||||||||
| Investment in deferred compensation trust | - | - | - | - | - | (589 | ) | (589 | ) | ||||||||||||||||
Balance, March 31, 2007 | $ | - | $ | 20,545 | $ | 61,240 | $ | 439,318 | $ | (14,779 | ) | $ | (12,468 | ) | $ | (589 | ) | $ | 493,267 | ||||||
| The notes to consolidated financial statements are an integral part of these statements. | |||||||||||||||||||||||||
MODINE MANUFACTURING COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
For the years ended March 31, 2008, 2007 and 2006
(In thousands, except per share amounts)
| Preferred stock | Common stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive income (loss) | Treasury stock | Deferred compensation trust | Total | |||||||||||||||||||||||||
| Balance, March 31, 2005 | $ | - | $ | 21,794 | $ | 39,141 | $ | 575,937 | $ | 31,991 | $ | (9,083 | ) | $ | - | $ | 659,780 | |||||||||||||||
| Comprehensive income (loss): | ||||||||||||||||||||||||||||||||
| Net earnings | - | - | - | 7,641 | - | - | - | 7,641 | ||||||||||||||||||||||||
| Foreign-currency translation | - | - | - | - | (19,109 | ) | - | - | (19,109 | ) | ||||||||||||||||||||||
| Cash flow hedge (net of taxes of $663) | - | - | - | - | (1,042 | ) | - | - | (1,042 | ) | ||||||||||||||||||||||
| Minimum pension liability (net of taxes of $1,119) | - | - | - | - | (1,823 | ) | - | - | (1,823 | ) | ||||||||||||||||||||||
| Total comprehensive loss | (14,333 | ) | ||||||||||||||||||||||||||||||
| Cash dividends, $0.70 per share | - | - | - | (23,878 | ) | - | - | - | (23,878 | ) | ||||||||||||||||||||||
| Shareholder dividend related to spin off | - | - | - | (51,319 | ) | - | - | - | (51,319 | ) | ||||||||||||||||||||||
| Stock repurchase program | - | (1,525 | ) | (4,182 | ) | (74,976 | ) | - | - | - | (80,683 | ) | ||||||||||||||||||||
| Purchase of treasury stock | - | - | - | - | - | (2,129 | ) | - | (2,129 | ) | ||||||||||||||||||||||
| Stock options and awards including related tax benefits | - | 487 | 13,995 | - | - | - | - | 14,482 | ||||||||||||||||||||||||
| Amortization of deferred compensation under restricted stock plans | - | - | 3,505 | - | - | - | - | 3,505 | ||||||||||||||||||||||||
| Balance, March 31, 2006 | - | 20,756 | 52,459 | 433,405 | 10,017 | (11,212 | ) | - | 505,425 | |||||||||||||||||||||||
| Comprehensive income (loss): | ||||||||||||||||||||||||||||||||
| Net earnings | - | - | - | 42,332 | - | - | - | 42,332 | ||||||||||||||||||||||||
| Foreign-currency translation | - | - | - | - | 24,895 | - | - | 24,895 | ||||||||||||||||||||||||
| Cash flow hedges (net of taxes of $272) | - | - | - | - | (525 | ) | - | - | (525 | ) | ||||||||||||||||||||||
| Minimum pension liability (net of taxes of $1,383) | - | - | - | - | 2,275 | - | - | 2,275 | ||||||||||||||||||||||||
| Total comprehensive income | 68,977 | |||||||||||||||||||||||||||||||
| Adjustment for SAB No. 108 | - | - | - | (1,775 | ) | - | - | - | (1,775 | ) | ||||||||||||||||||||||
| Adjustment to adopt SFAS No. 158 | - | - | - | - | (51,441 | ) | - | - | (51,441 | ) | ||||||||||||||||||||||
| Cash dividends, $0.70 per share | - | - | - | (22,642 | ) | - | - | - | (22,642 | ) | ||||||||||||||||||||||
| Stock repurchase program | - | (314 | ) | (947 | ) | (12,002 | ) | - | - | - | (13,263 | ) | ||||||||||||||||||||
| Purchase of treasury stock | - | - | - | - | - | (1,256 | ) | - | (1,256 | ) | ||||||||||||||||||||||
| Stock options and awards including related tax benefits | - | 103 | 6,173 | - | - | - | - | 6,276 | ||||||||||||||||||||||||
| Amortization of deferred compensation under restricted stock plans | - | - | 3,555 | - | - | - | - | 3,555 | ||||||||||||||||||||||||
| Investment in deferred compensation trust | - | - | - | - | - | - | (589 | ) | (589 | ) | ||||||||||||||||||||||
| Balance, March 31, 2007 | - | 20,545 | 61,240 | 439,318 | (14,779 | ) | (12,468 | ) | (589 | ) | 493,267 | |||||||||||||||||||||
| Comprehensive income (loss): | ||||||||||||||||||||||||||||||||
| Net loss | - | - | - | (65,596 | ) | - | - | - | (65,596 | ) | ||||||||||||||||||||||
| Foreign-currency translation | - | - | - | - | 47,918 | - | - | 47,918 | ||||||||||||||||||||||||
| Net investment hedge adjustment | - | - | - | - | 5,626 | - | - | 5,626 | ||||||||||||||||||||||||
| Cash flow hedges (net of taxes of $565) | - | - | - | - | 1,194 | - | - | 1,194 | ||||||||||||||||||||||||
| Changes in benefit plans: | ||||||||||||||||||||||||||||||||
| Net actuarial gains (net of taxes of $7,163) | - | - | - | - | 9,928 | - | - | 9,928 | ||||||||||||||||||||||||
| Net prior service costs (net of taxes of $886) | - | - | - | - | (1,379 | ) | - | - | (1,379 | ) | ||||||||||||||||||||||
| Transition obligations (net of taxes of $8) | - | - | - | - | (12 | ) | - | - | (12 | ) | ||||||||||||||||||||||
| Total comprehensive loss | (2,321 | ) | ||||||||||||||||||||||||||||||
| Effects of changing the benefit plan measurement dates pursuant to SFAS No. 158 | - | - | - | (839 | ) | 828 | - | - | (11 | ) | ||||||||||||||||||||||
| Adoption of FIN 48 effective April 1, 2007 | - | - | - | (1,579 | ) | - | - | - | (1,579 | ) | ||||||||||||||||||||||
| Cash dividends, $0.70 per share | - | - | - | (22,633 | ) | - | - | - | (22,633 | ) | ||||||||||||||||||||||
| Stock repurchase program | - | (156 | ) | (538 | ) | (6,181 | ) | - | - | - | (6,875 | ) | ||||||||||||||||||||
| Purchase of treasury stock | - | - | - | - | - | (835 | ) | - | (835 | ) | ||||||||||||||||||||||
| Stock options and awards including related tax benefits | - | 103 | 3,966 | - | - | - | - | 4,069 | ||||||||||||||||||||||||
| Amortization of deferred compensation under restricted stock plans | - | - | 4,678 | - | - | - | - | 4,678 | ||||||||||||||||||||||||
| Investment in deferred compensation trust | - | - | - | - | - | - | 148 | 148 | ||||||||||||||||||||||||
| Balance, March 31, 2008 | $ | - | $ | 20,492 | $ | 69,346 | �� | $ | 342,490 | $ | 49,324 | $ | (13,303 | ) | $ | (441 | ) | $ | 467,908 | |||||||||||||
The notes to consolidated financial statements are an integral part of these statements.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Note 1: Significant accounting policiesOverview
Nature of operations: Modine Manufacturing Company (Modine or the Company) specializes in thermal management systems and components, bringing heating and cooling technology and solutions to diversified global markets. The Company is a leading global developer, manufacturer and marketer of heat exchangers and systems for use in on-highway and off-highway original equipment manufacturer (OEM) vehicular applications, and to a wide array of building, industrial, refrigeration and fuel cell electronics and telecommunications markets. Product lines include radiators and radiator cores, vehicular air conditioning, oil coolers, charge air coolers, heat-transfer packages and modules, building heating, ventilating and air conditioning (HVAC) equipment and exhaust gas recirculation (EGR) coolers and electronics cooling solutions.coolers.
Basis of presentation: The consolidated financial statements are prepared in conformity with generally accepted accounting principles in the United States. These principles require management to make certain estimates and assumptions in determining Modine’s assets, liabilities, revenue, expenses and related disclosures. Actual amounts could differ from those estimates.
Significant charges contributing to loss from continuing operations: For the year ended March 31, 2008, the Company reported a loss from continuing operations of $65,511 which represents a significant reduction from the earnings from continuing operations of $38,921 and $73,025 reported for the years ended March 31, 2007 and 2006, respectively. During fiscal 2008, the Company recorded asset impairment charges of $47,420 and a deferred tax valuation allowance of $64,571. These charges were the primary factors contributing to the loss from continuing operations for the year ended March 31, 2008.
A significant portion of these charges related to the Company’s Original Equipment – North America segment, which has reported a significant decline in its current fiscal year results as compared to the prior year. Original Equipment – North America’s net sales decreased $146,778, or 22.0 percent from the year ended March 31, 2007 to the year ended March 31, 2008. In addition, Original Equipment – North America reported a loss from operations of $44,817 for the year ended March 31, 2008 as compared to earnings from operations of $44,708 for the year ended March 31, 2007. The decline in net sales was primarily driven by an ongoing downturn in the North American truck market as a result of pre-buy activity in advance of the January 1, 2007 emission requirement changes in North America and a slowdown in the North American economy. This decline in net sales has been more severe and is extending for a longer period of time than originally anticipated by the Company. This significant decline in sales volumes has contributed to a declining gross profit and an underabsorption of fixed overhead costs as excess capacity exists in many of the Original Equipment – North America facilities during fiscal 2008. Manufacturing inefficiencies incurred during fiscal 2008 in the Original Equipment – North America production facilities also contributed to the declining performance within this business. These inefficiencies were primarily related to new program launches and product line transfers in conjunction with our previously announced global competitiveness program.
In addition to the current fiscal year reduction in performance in the Original Equipment – North America segment, the Company reduced its outlook for this business during fiscal 2008. The future growth prospects within this business were reduced based on, among other factors, trends experienced with the January 1, 2007 emissions law change and a shift by customers in future vehicular programs to countries outside of North America. The reduced outlook also included a reduction in expected future gross margins based on the near-term impact of plant inefficiencies related to new program launches and product transfers. The reduced outlook for future gross margins was also based on continued industry-wide cost and customer pricing pressures.
As a result of the decrease in the fiscal 2008 net sales and profitability in the Original Equipment – North America segment, combined with the reduced future outlook for this business, the Company recognized a goodwill impairment charge of $23,769 during fiscal 2008. This represented an impairment of the full amount of goodwill recorded within the Original Equipment – North America segment. In addition, the Company performed an impairment review of the Original Equipment – North America long-lived assets during fiscal 2008, which resulted in an impairment charge of $3,407 for a program which was not able to support its asset base.
Also during fiscal 2008, the South Korean business, which is included in the Original Equipment – Asia segment, continued to underperform expectations and financial targets due largely to ongoing customer pricing pressures. These pricing pressures require a low-cost manufacturing profile and continued operating efficiencies in order to maintain a profitable business environment. The Company has historically been unable to offset customer price reductions with additional operating improvements. As a result of the continued underperformance and reduced future outlook for the South Korean business, the Company recognized a long-lived asset impairment of $12,077 related to assets at the Asan City, South Korea manufacturing facility.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The current year losses generated within the Original Equipment – North America and Original Equipment – Asia segment and the reduced future outlook for these businesses significantly contributed to a projection of future losses in the United States and South Korea. Based on this projection, the Company made a determination during fiscal 2008 that it was more likely than not that the U.S. and South Korean deferred tax assets will not be realized. Accordingly, a valuation allowance of $58,024 and $6,655 was recorded against the net U.S. and Korean deferred tax assets, respectively, for the year ended March 31, 2008.
In response to these conditions, the Company is implementing a number of cost and operational efficiency measures that will be designed to improve the Company’s longer term competitiveness. The following actions have been identified:
| · | Manufacturing realignment – The Company announced the closure of the Camdenton, Missouri; Pemberville, Ohio; and Logansport, Indiana facility within the Original Equipment – North America segment and the Tübingen, Germany manufacturing plant within the Original Equipment – Europe segment. These closures are in addition to the previously announced four plant closures in North America, of which the Jackson, Mississippi and Clinton, Tennessee facility closures are still in process. |
| · | Portfolio rationalization – The Company has a new organizational structure which has been in place for a little over a year. The new structure is organized around global product lines and a regional operating model. The Company is looking at product lines within and across the regions to assess them relative to Modine’s competitive position and the overall business attractiveness in order to identify those lower margin product lines which should be divested or exited. Through these rationalization efforts, the Company completed the sale of its Electronics Cooling business on May 1, 2008. |
| · | Capital allocation – The Company introduced an enhanced capital allocation process which is designed to allocate capital spending to the segments and programs that will provide the highest return on investment. The Company anticipates capital spending, net of potential dispositions, in the intermediate term to be near deprecation levels. |
| · | Selling, general and administrative (SG&A) cost containment – The Company has a target of driving SG&A levels down as a percent of sales by fiscal 2011. Progress was made toward this goal during fiscal 2008, with SG&A as a percentage of sales declining from 13.4 percent in the prior year to 12.7 percent in the current year. |
Collectively, management anticipates the actions described will provide increased discipline around gross margins, working capital levels and asset utilization.
Liquidity: For the year ended March 31, 2008 and 2007, the Company reported net cash provided by operating activities of $67,354 and $102,410, respectively, which represents a decrease of $35,056. The fiscal 2008 decline in Original Equipment – North America’s results was a significant factor contributing to this decrease in net cash provided by operating activities. In addition, the Company’s outstanding debt increased from $179,349 at March 31, 2007 to $226,501 at March 31, 2008. The reduced cash flows from operating activities were not sufficient to fully finance capital expenditures and working capital needs of the business during fiscal 2008, therefore requiring additional borrowings on the Company’s revolving credit facility during the current year.
The Company’s debt agreements require it to comply with certain limitations and to maintain specified financial ratios. The Company would have been in violation of a financial ratio as of December 26, 2007, had the agreements not been amended, due to the goodwill impairment charge recorded during the third quarter of fiscal 2008. On February, 1, 2008, the Company amended these debt agreements to allow the add-back of the asset impairment charges. At December 26, 2007 and March 31, 2008, the Company was in compliance with the amended agreements. In addition, certain amendments were made to the covenants on a prospective basis to allow the add-back of certain anticipated cash and non-cash charges and to reduce the ratio of earnings before interest and taxes to interest expense (interest coverage ratio). The Company anticipates remaining in compliance on a prospective basis with the limitations and financial ratios based on its current business projections. In addition, the Company believes that its internally generated operating cash flow and existing cash balances, together with access to available external borrowings, will be sufficient to satisfy future operating, capital expenditure and strategic business opportunity costs. If the Company is unable to meet the financial covenants and reach suitable resolution of such defaults with the lenders, it could have a material adverse effect on the future results of operations, financial position and liquidity of the Company. See Note 18 for further discussion.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Note 2: Significant accounting policies
Discontinued operations:operations and assets held for sale: The Company considers businesses to be held for sale when management approves and commits to a formal plan to actively market a business for sale. Upon designation as held for sale, the carrying value of the assets of the business are recorded at the lower of their carrying value or their estimated fair value, less costs to sell. The Company ceases to record depreciation expense at the time of designation as held for sale. Results of operations of a business classified as held for sale are reported as discontinued operations when (a) the operations and cash flows of the business will be eliminated from ongoing operations as a result of the sale and (b) the Company will not have any significant continuing involvement in the operations of the business after the sale. The Company currently classifies the Electronics Cooling business as held for sale and as a discontinued operation.
On July 22, 2005, the Company spun off its Aftermarket business on a tax-free basis and merged it with Transpro, Inc. (“Transpro”). As a result of this spin-off, the consolidated financial statements and related notes have been restated to present the results of the Aftermarket business as a discontinued operation. Accordingly, the operating results of the Aftermarket business have been included in earnings (loss) from discontinued operations, (net of income taxes) in the consolidated statements of earningsoperations for the periods presented. In addition, the loss on the spin-off of $53,462 was included in the consolidated statement of earningsoperations in fiscal 2006. Also seeSee Note 13.14 for further discussion.
Consolidation principles: The consolidated financial statements include the accounts of Modine Manufacturing Company and its majority-owned or Modine-controlled subsidiaries. Material intercompany transactions and balances are eliminated in consolidation. Operations of subsidiaries outside the United States are predominately included for periods ending one month prior to Modine’s year end in order to ensure timely preparation of the consolidated financial statements. Investments in non-consolidated affiliated companies in which ownership is 20 percent or more are accounted for by the equity method. The investments are stated at cost plus or minus a proportionate share of the undistributed net income (loss). Modine’s share of the affiliates’ net income (loss) is reflected in other income—income – net. Also seeSee Note 11.12 for further discussion.
Revenue recognition: Sales revenue, including agreed upon commodity price increases, is recognized at the time of product shipment to customers when title and risk of loss pass to customers, selling prices are fixed or determinable and collectibility from the customer is reasonably assured. Appropriate provisions are made for uncollectible accounts based on historical data or specific customer economic data, and for estimated commodity price increases which may ultimately not be collected.
Sales discounts: Sales discounts, which are allowed for prompt payment of invoices by customers, are recorded as a reduction to net sales.
Tooling costs: Modine accounts for pre-production tooling costs as a component of property, plant and equipment—equipment – net when the Company owns title to the tooling, and amortizes the capitalized cost to cost of sales over the life of the related program. At March 31, 20072008 and 2006,2007, the Company-owned tooling totaled $22,538$25,756 and $14,378,$22,572, respectively. In certain instances, the Company makes an upfront payment for customer-owned tooling costs, and subsequently receives a reimbursement from the customer for the upfront payment. The Company accounts for unbilled customer-owned tooling costs as a receivable when the customer has guaranteed reimbursement to the Company. No significant arrangements exist where customer-owned tooling costs were not accompanied by guaranteed reimbursement. At March 31, 20072008 and 2006,2007, the cost reimbursement receivable related to customer-owned tooling totaled $10,646$8,484 and $2,329,$9,101, respectively.
Warranty: Modine provides product warranties for specific product lines and accrues for estimated future warranty costs in the period in which the sale is recorded. Warranty expense is generally provided based upon historical and current claim data. Accrual balances are monitored and adjusted when it becomes probable that expected claims will differ from existing estimates. Accruals are recorded as current liabilities under the caption accrued expenses and other current liabilities. Also seeSee Note 20.21 for further discussion.
Shipping and handling costs: Shipping costs for inbound freight are treated as product cost. Shipping and handling costs incurred upon the shipment of products to our OEM customers are recorded as a component of cost of sales, and related amounts billed to these customers are recorded as a component of net sales. Shipping and handling costs incurred upon the shipment of products to our HVAC customers are recorded as a component of selling, general and administrative (SG&A) expenses. For the years ended March 31, 2008, 2007 2006 and 2005,2006, these shipping and handling costs recorded as a component of SG&A expenses were $3,653, $3,100 $3,094 and $2,200,$3,094, respectively.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Revenue recognition under licensing arrangements (royalty payments): Revenues under various licensing agreements are recognized when earned except in those cases where collection is uncertain, or the amount cannot reasonably be estimated until formal accounting reports are received from the licensee as provided for under the provisions of the licensing agreement. For the years ended March 31, 2008, 2007 2006 and 2005,2006, licensing revenue totaled $4,785, $5,166 $4,132 and $4,085,$4,132, respectively, and are recorded in the statement of earningsoperations under the caption net sales.
Translation of foreign currencies: Assets and liabilities of foreign subsidiaries and equity investments are translated into U.S. dollars at the period-end exchange rates, and income and expense items are translated at the monthly average exchange rate for the period in which the items occur. Resulting translation adjustments are reported as a component of accumulated other comprehensive income included in shareholders' equity. Foreign currency transaction gains or losses are included in the statement of earningsoperations under the caption other income—income – net.
Derivative instruments: The Company enters into derivative financial instruments from time to time to manage certain financial risks. Futures contracts are entered into by the Company to reduce exposure to changing future purchase prices for aluminum and natural gas. Foreign exchange options and forward contracts on foreign currencies are entered into by Modine as hedges against the impact of currency fluctuations on certain sales and purchase transactions. Interest rate locks and swaps are entered into to lock in fixed interest rates for variable-rate borrowings. These instruments are used to protect cash flows and are not speculative. The Company generally designates its derivative instruments as cash flow hedges. Accordingly, unrealized gains and losses on these contracts are deferred as a component of accumulated other comprehensive income and recognized as a component of earnings at the same time that the underlying transactions impact earnings. In instances whereStarting in fiscal 2008, the derivative instrument doesCompany entered into future contracts related to certain of its forecasted purchases of copper and nickel. The Company has not qualifydesignated these contracts as a cash flow hedge, unrealizedhedges, therefore gains and losses are recorded as a component of earnings when incurred. Also seeSee Note 19.20 for further discussion.
Income taxes:Deferred tax assets and liabilities are determined based on the difference between the amounts reported in the financial statements and the tax bases of assets and liabilities, using enacted tax rates in effect in the years in which the differences are expected to reverse. A valuation allowance is established if it is more likely than not that some portion or all of a deferred tax asset will not be realized. Also seeA valuation allowance of $64,679 was recorded during fiscal 2008 against net U.S. and South Korean deferred tax assets. See Note 6.7 for further discussion.
Earnings per share: Basic earnings per share is calculated based on the weighted average number of common shares outstanding during the year, while diluted earnings per share is calculated based on the dilutive effect of common shares that could be issued. Also seeDuring fiscal 2008, the calculation of diluted earnings per share excludes all potentially dilutive shares in which their inclusion would have the effect of decreasing the loss per share amount. See Note 7.8 for further discussion.
Cash equivalents: Modine considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
Deferred compensation trust: The Company maintains a deferred compensation trust to fund future obligations under its non-qualified deferred compensation plan. The trust’s investments in third-party debt and equity securities are reflected as short termshort-term investments in the consolidated balance sheet and are treated as trading securities with changes in fair value reflected as a component of earnings. The trust’s investment in Modine stock is reflected as a reduction of shareholder’s equity in the consolidated balance sheet at its original stock cost. A deferred compensation obligation is recorded within the liabilities at the fair value of the investments held by the deferred compensation trust. Any differences between the recorded value of the shortshort- term investments and Modine stock and the fair value of the deferred compensation obligation are reflected as adjustments to earnings.
Trade receivables and allowance for doubtful accounts: Trade receivables are recorded at the invoiced amount and do not bear interest if paid according to the original terms. The allowance for doubtful accounts is Modine’s best estimate of the uncollectible amount contained in the existing trade receivables balance. The allowance is based on historical write-off experience and specific customer economic data. The allowance for doubtful accounts is reviewed periodically and adjusted as necessary. Utilizing age and size based criteria, certain individual accounts are reviewed for ability to collect,collectibility, while all other accounts are reviewed on a pooled basis. Receivables are charged off against the allowance when it is probable and to the extent that funds will not be collected. There was no off-balance sheet credit exposure related to Modine’s trade receivables at March 31, 2007.2008.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Inventories: Inventories are valued at the lower of cost on a first-in, first-out basis, or market value.
Property, plant and equipment: Property, plant and equipment are stated at cost. For financial reporting purposes, depreciation is principally computed using the straight-line method over the expected useful life of the asset. Maintenance and repair costs are charged to operations as incurred. Costs of improvements are capitalized. Upon the sale or other disposition of an asset, the cost and related accumulated depreciation are removed from the accounts and the gain or loss is included in the statement of earnings.operations. The Company capitalizes direct costs of materials and services used in the development and purchase of internal-use software. Amounts capitalized are amortized on a straight-line basis over a period of three to six years and are reported as a component of office equipment within property, plant and equipment.
Goodwill and intangible assets:The Company accounts for purchased goodwill and intangible assets in accordance with Statement of Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangible Assets”. Under SFAS No. 142, purchased goodwill and other intangible assets with indefinite lives, primarily tradenames, are not amortized; rather they are tested for impairment annually unless conditions exist which would require a more frequent evaluation. An assessment of the fair value of the Company’s reporting units for its goodwill valuation, and its other intangible assets with indefinite lives is required and is based upon, among other things, the present value of the expected future cash flows. An impairment loss is recognized when the book value of goodwill exceeds the fair value. A goodwill impairment charge of $23,769 was recorded during fiscal 2008. See Note 16 for further discussion.
Impairment of long-lived assets:Long-lived assets, including property, plant and equipment and intangible assets with finite lives, are reviewed for impairment and written down to fair value when facts and circumstances indicate that the carrying value of long-lived assets may not be recoverable through estimated future undiscounted cash flows. If impairment has occurred, a write-down to market value or the discounted cash flowestimated fair value is made and the impairment loss is recognized as a charge against current operations.Fair value is estimated using a variety of valuation techniques including discounted cash flows, market values and comparison to values for similar assets. Long-lived asset impairment charges of $23,651 were recorded during fiscal 2008. See Note 11 for further discussion.
Environmental expenditures: Environmental expenditures related to current operations that qualify as property, plant and equipment or substantially increase the economic value or extend the useful life of an asset are capitalized. All other expenditures are expensed as incurred. Environmental expenditures that relate to an existing condition caused by past operations are expensed. Liabilities are recorded on an undiscounted basis when environmental assessments and/or remediation efforts are probable and the costs can be reasonably estimated.
Self-insurance reserves: The Company retains much of the financial risk for insuring property, general liability, worker’s compensation and employee group health claims. Operations are charged with the cost of claims reported and an estimate of claims incurred but not recorded. Self-insurance accruals include estimated settlements for known claims, as well as accruals of estimates, some of which are actuarially determined, of incurred but not reported claims. The determination of insurance claims and the appropriateness of the related liability accruals are reviewed and updated at regular intervals.
Stock-based compensation: Stock-based compensation is recognized by the Company using the fair-value-based method prescribed by SFAS No. 123(R), “Share-Based Payments.” Accordingly, compensation cost for stock options, stock awards and restricted stock is calculated based on the fair value of the instrument at the time of grant, and is recognized as expense over the vesting period of the stock-based instrument. Also seeSee Note 23.24 for further discussion.
Reclassifications:A $2,500$1,412 and $2,238 reclassification was made on the consolidated statement of cash flows for fiscal 2007 and 2006, respectively, from cash flows from operatingfinancing activities to cash flows from investing activities to present proceeds from a purchase pricethe settlement of derivative contracts on a consistent basis with the fiscal 20072008 presentation.
Accounting standards changes and new pronouncements: In November 2004,June 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, “Inventory Costs - An Amendment of Accounting Research Bulletin (ARB) No. 43, Chapter 4,” which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). The Company adopted the provisions of SFAS No. 151 effective for inventory costs incurred during the first quarter of fiscal 2007. The adoption of this statement did not have a material impact on the Company’s financial condition or results of operations.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In September 2006, the FASB’s Emerging Issues Task Force (EITF) issued EITF Issue No. 06-3, “How Sales Tax Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation),” that requires that a company disclose its accounting policy for the statement of earnings presentation of taxes assessed by a governmental authority on a revenue-producing transaction between a seller and a customer. In addition, for any taxes reported on a gross basis (included in revenues and costs), disclosure of the amount of taxes recorded within these categories is required. The Company’s accounting policy is to present the taxes within the scope of this EITF on a net basis. The adoption of EITF 06-3 in the fourth quarter of fiscal 2007 did not result in a change to the Company’s accounting policy and, accordingly, does not have a material effect on the Company’s consolidated financial statements.thousands, except per share amounts)
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which addresses how companies should measure fair value when required to use a fair value measure for recognition or disclosure purposes under GAAP. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and establishes a hierarchy that categorizes and prioritizes the sources to be used to estimate fair value. SFAS No. 157 also expands thefinancial statement disclosures onabout fair value measurements. On February 12, 2008, the FASB issued FASB Staff Position (FSP) 157-2 which delays the effective date of SFAS No. 157 for one year, for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company is required to adopt SFAS No. 157 and FSP 157-2 in the first quarter of fiscal 2009, and is currently assessing the impact of adopting this pronouncement.
In September 2006, the FASB issued SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans,” an amendment of FASB Statement Nos. 87, 88, 106 and 132(R). SFAS No. 158 requires companies to recognize a net asset or liability to report the funded status of defined benefit pension and other postretirement plans on the balance sheet and recognize changes in that funded status in the year in which the changes occur through other comprehensive income in shareholders’ equity. The Company adopted the recognition and disclosure requirements of SFAS No. 158 as of March 31, 2007. Also see Note 3. The adoption of this statement did not have an adverse impact on existing loan covenants. SFAS No. 158 also requires that employers measure plan assets and the Company’s obligations as of the date of their year-end financial statements beginning with the Company’s fiscal year ending March 31, 2009. The Company currently uses December 31 asadopted the year-end measurement date for its pension and postretirement plans. The Company is currently assessingplans in fiscal 2008 using the impactprospective method, which resulted in an increase in accumulated other comprehensive income (loss) of the change$828 and a reduction in measurement date on the Company’s financial statements but does not believe the adoptionretained earnings of this provision of SFAS No. 158 will have a material impact on the Company’s consolidated financial statements.$839.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities —– including an Amendment of SFAS No. 115” (SFAS No. 159), which permits an entity to measure many financial assets and financial liabilities at fair value that are not currently required to be measured at fair value. Entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with a few exceptions. SFAS No. 159 amends previous guidance to extend the use of the fair value option to available-for-sale and held-to-maturity securities. The Statement also establishes presentation and disclosure requirements to help financial statement users understand the effect of the election. SFAS No. 159 is effective as of the beginning of the first quarter of fiscal 2009. Management is currently assessing the potential impact of this standard on the Company’s consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS No. 141(R)) which replaces SFAS No. 141, “Business Combination”. SFAS No. 141(R) retained the underlying concepts of SFAS No. 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but SFAS No. 141(R) changed the method of applying the acquisition method in a number of significant aspects. For all business combinations, the entity that acquires the business will record 100 percent of all assets and liabilities of the acquired business, including goodwill, generally at their fair values. Certain contingent assets and liabilities acquired will be recognized at their fair values on the acquisition date and changes in fair value of certain arrangements will be recognized in earnings until settled. Acquisition-related transactions and restructuring costs will be expensed rather than treated as an acquisition cost and included in the amount recorded for assets acquired. SFAS No. 141(R) is effective for the Company on a prospective basis for all business combinations for which the acquisition date is on or after April 1, 2009, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. SFAS No. 141(R) amends SFAS No. 109, “Accounting for Income Taxes,” such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that close prior to the effective date of SFAS No. 141(R) would also apply the provisions of SFAS No. 141(R). Early adoption is not allowed. Management is currently assessing the potential impact of this standard on the Company’s consolidated financial statements; however, the Company does not anticipate the adoption to have a material impact on previous acquisitions.
In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB 51.” SFAS No. 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to establish new standards that will govern the accounting for and reporting of (1) non-controlling interest in partially owned consolidated subsidiaries and (2) the loss of control of subsidiaries. The Company’s consolidated subsidiaries are wholly-owned and as such no minority interests are currently reported in its consolidated financial statements. Other current ownership interests are reported under the equity method of accounting under investments in affiliates. SFAS No. 160 is effective for the Company on a prospective basis on or after April 1, 2009 except for the presentation and disclosure requirements, which will be applied retrospectively. Early adoption is not allowed. Based upon the Company’s current portfolio of investments in affiliates, the Company does not anticipate that adoption of this standard will have a material impact on the consolidated financial statements.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities an Amendment of FASB Statement No. 133.” SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. SFAS No. 161 is effective for the Company during the fourth quarter of fiscal 2009. Early adoption is encouraged. SFAS No. 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The Company is currently evaluating the impact this statement will have on the Company’s financial statement disclosures.
In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, that provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 iswas effective for the Company’s fiscal year endingended March 31, 2007. The Company elected early application of the provisions of SAB No. 108 during the second quarter of fiscal 2007. SAB No. 108 established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the Company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods. SAB No. 108 permits initial application of its provisions either by (i) restating prior financial statements as if the “dual approach” had always been applied; or (ii) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of assets and liabilities as of April 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. We elected to record the effects of applying SAB No. 108 using the cumulative effect transition method. The following table summarizes the effects up to April 1, 2006 of applying the guidance in SAB No. 108:
| Period in which the | ||||||||||||||||
| Misstatement Originated (1) | ||||||||||||||||
| Cumulative | Adjustment | |||||||||||||||
| Prior to | Year Ended March 31, | Recorded as of | ||||||||||||||
| April 1, 2004 | 2005 | 2006 | April 1, 2006 | |||||||||||||
| Fixed assets (2) | $ | 482 | $ | 324 | $ | 732 | $ | 1,538 | ||||||||
| Vacation (3) | - | - | 510 | 510 | ||||||||||||
| Inventory (4) | - | - | 456 | 456 | ||||||||||||
| Administrative expenses (5) | - | - | 124 | 124 | ||||||||||||
| Deferred income taxes (6) | (166 | ) | (112 | ) | (575 | ) | (853 | ) | ||||||||
| Impact on net income (7) | $ | 316 | $ | 212 | $ | 1,247 | ||||||||||
| Retained earnings (8) | $ | 1,775 | ||||||||||||||
(1) The Company has concluded that these errors were immaterial, individually and in the aggregate, to all periods prior to April 1, 2006.
(2) The Company was not properly accounting for the disposal of fixed assets within the Original Equipment – Europe segment. As a result of this error, net income was overstated by $482 (cumulatively) in fiscal years prior to 2005, by $324 in fiscal 2005 and by $732 in fiscal 2006. The Company recorded a $1,538 reduction of fixed assets for disposals not previously recognized as of April 1, 2006 with a corresponding reduction in retained earnings to correct these misstatements.
(3) The Company was not properly recording its vacation accrual within the Original Equipment – Asia segment. As a result of this error, pretax income was overstated by $510 in fiscal 2006. The Company recorded a $510 increase in the vacation liability as of April 1, 2006 with a corresponding reduction in retained earnings to correct this misstatement. This includes $125 which was previously recorded in the first quarter of fiscal 2007.
| Period in which the | |||||||||||||
| Misstatement Originated (1) | |||||||||||||
| Cumulative | Adjustment | ||||||||||||
| Prior to | Year Ended March 31, | Recorded as of | |||||||||||
| April 1, 2004 | 2005 | 2006 | April 1, 2006 | ||||||||||
| Fixed assets (2) | $ | 482 | $ | 324 | $ | 732 | $ | 1,538 | |||||
| Vacation (3) | - | - | 510 | 510 | |||||||||
| Inventory (4) | - | - | 456 | 456 | |||||||||
| Administrative expenses (5) | - | - | 124 | 124 | |||||||||
| Deferred income taxes (6) | (166 | ) | (112 | ) | (575 | ) | (853 | ) | |||||
| Impact on net income (7) | $ | 316 | $ | 212 | $ | 1,247 | |||||||
| Retained earnings (8) | $ | 1,775 | |||||||||||
58
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
(4) The Company did not properly recognize a $456 reduction in inventory at one operating location within the Original Equipment – Americas segment which was identified as a result of a physical inventory performed on September 26, 2006. As a result of this error, pretax income was overstated by $456 in fiscal 2006. The Company recorded a $456 reduction in the inventory balance as of April 1, 2006 with a corresponding reduction in retained earnings to correct this misstatement.
(5) As a result of a clerical error, the Company improperly capitalized certain corporate administrative charges, consisting primarily of salaries and miscellaneous office expenses, within accounts receivable at March 31, 2006. As a result of this error, pretax income was overstated by $124 in fiscal 2006. The Company recorded a $124 reduction in the accounts receivable balance as of April 1, 2006 with a corresponding reduction in retained earnings to correct this misstatement.
(6) As a result of the misstatements previously described, the provision for income taxes was overstated by $166 (cumulatively) in fiscal years prior to 2005, by $112 in fiscal 2005 and by $575 in fiscal 2006. The Company recorded an increase in the deferred income tax assets in the amount of $853 as of April 1, 2006 with a corresponding increase in retained earnings to correct these misstatements.
(7) Represents the net overstatement of net income for the indicated periods resulting from these misstatements.
(8) Represents the net reduction to retained earnings recorded as of April 1, 2006 to reflect the initial application of SAB No. 108.
While the amounts above are considered immaterial to prior periods, they have been corrected through the cumulative effect adjustment upon adoption of SAB No. 108 as recording these amounts in fiscal 2007 as an out-of-period adjustment would have had a material effect on the results of operations for fiscal 2007.
Certain of the adjustments ((4) & (5)) included above also resulted in an error in the first quarter of fiscal 2007. This error represented an overstatement of net income for the first quarter of fiscal 2007 totaling approximately $600, which was corrected in the second quarter of fiscal 2007.
Note 2:3: Research and development costs
Research and development costs charged to operations totaled $82,497$93,191 in fiscal 2008, $82,315 in fiscal 2007, $79,628and $79,400 in fiscal 2006, and $68,784 in fiscal 2005. During fiscal 2007, the Company identified that the research and development costs previously disclosed for fiscal 2006 and fiscal 2005 improperly excluded certain costs incurred at three foreign locations. This omission was corrected in fiscal 2007 by increasing the research and development costs from the previously disclosed amounts in this footnote of $48,542 in fiscal 2006 and $40,610 in fiscal 2005 to the revised amounts shown above. This omission had no impact on the consolidated statements of earnings as all research and development costs incurred in prior fiscal years were properly recorded as a component of selling, general and administrative expenses when incurred.2006.
Note 3:4: Employee benefit plans
Defined Contribution Employee Benefit Plans:
401(k) plans: The Company maintains domestic 401(k) plans which allow employees to choose among various investment alternatives, including Modine stock. The Company currently matches 60%50 percent of the employees’ contribution up to 6%6 percent of employee compensation. Company contributions have an initial three year vesting period.
Defined contribution plan: The Company maintains a domestic defined contribution plan which was established in January 1, 2004 and initially covered all eligible salaried employees hired after January 1, 2004. Effective April 1, 2006, all salaried employees previously covered under the Modine Salaried Employee Pension Plan were eligible to participate in this plan. Modine makes annual contributions based on a percentage of compensation, which is determined by management. Employees can choose among various investment alternatives including Modine stock.
Deferred compensation plan: The Company maintains a non-qualified deferred compensation plan for eligible employees. The plan is funded and allows qualified employees to choose among various investment alternatives including Modine stock. The Company matching contributions are participant directed similar to the 401(k) plans.
Activity in the defined contribution employee benefit plans, including the employee stock ownership plan discussed in Note 23,24, for fiscal 2008, 2007 2006 and 20052006 resulted in the purchase of 247, 4 113 and 177113 shares of Modine common stock, respectively. These purchases were made from the open market. It is currently anticipated that future purchases will also be made from the open market or other available sources at the discretion of the plans’ administrative committees. Costs of Modine’s contributions to the defined contribution employee benefit plans for fiscal 2008, 2007 and 2006 were $7,746, $8,104 and 2005 were $8,105, $5,252 and $3,931,$5,050, respectively.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
In addition, various Modine foreign subsidiaries have in place government required defined contribution plans under which Modine contributes a percentage of employee earnings into accounts, consistent with local laws.
Statutory Termination Plans:
Our South Korean business is required to offer a statutory employee termination plan that covers employees with at least one year of service. Eligible employees are entitled to receive a lump-sum payment upon termination of employment, based on their length of service and rate of pay at the time of termination. Accrued termination benefits are estimated assuming all eligible employees were to terminate their employment at the end of fiscal 2007.2008. The Company is permitted, but not required to make contributions to the plan, and such contributions are held in South Korean insurance companies. These contributions are deducted from the accrued termination benefit liability. At March 31, 20072008 and 2006,2007, the Company maintained an accrued termination liability of $10,573$13,359 and $8,397,$10,573, respectively, for this termination plan.
Certain of Modine’s other foreign subsidiaries also have statutory termination indemnity plans covering all of their eligible employees. The benefits under these plans are based on years of service and final average compensation levels or a monthly retirement benefit amount. These programs are all substantially unfunded in accordance with local laws, but are often covered by national obligatory umbrella insurance programs that protect employees from losses in the event that an employer defaults on its obligations.
Defined Benefit Employee Benefit Plans:
Pension plans: Modine has several non-contributory defined benefit pension plans that cover most of its domestic employees hired on or before December 31, 2003. The benefits provided are based primarily on years of service and average compensation for the salaried plans and some hourly plans. Other hourly plans are based on a monthly retirement benefit amount. Domestic salaried employees hired after December 31, 2003 are not covered under any defined benefit plan. Certain of Modine’s foreign subsidiaries also have legacy defined benefit plans covering a small number of active employees.
In February 2008, the Company announced the closure of its facilities in Logansport, Indiana, and Pemberville, Ohio. The Company recorded pension curtailment charges of $485 and $1,378 during fiscal 2008 to reflect the impact of these upcoming closures on the Logansport Hourly-Paid Employees Retirement Plan and the Pemberville Hourly-Paid Employees Retirement Plan, respectively.
In September 2007, the Company announced that effective January 1, 2008, the Modine Manufacturing Company Pension Plan for Non-Union Hourly-Paid Factory and Salaried Employees (Salaried Employee Component) and the Modine Manufacturing Company Supplemental Executive Retirement Plan was modified so that no increases in annual earnings after December 31, 2007 would be included in calculating the average annual earnings portion under the pension plan formula. The Company recorded a pension curtailment gain of $4,214 and a reduction in the pension benefit obligation of $15,501 during the second quarter of fiscal 2008 to reflect this modification.
In July 2006, the Company announced the closure of its facility in Clinton, Tennessee. The Company recorded a pension curtailment charge of $650 during fiscal 2007 to reflect the impact of this upcoming closure ofon the Clinton Hourly-Paid Employees Retirement Plan.
In May 2006, the Company offered a voluntary enhanced early retirement program to certain U.S. employees. This program generally included an enhanced pension benefit of five years of credited service for those employees who accepted the early retirement program. The Company recorded a charge of $738 during fiscal 2007 to reflect this enhanced pension benefit.
Postretirement plans: Modine and certain of its domestic subsidiaries provide selected healthcare and life-insurance benefits for retired employees. Designated employees may become eligible for those benefits when they retire. These plans are unfunded. Modine periodically amends the plans, changing the contribution rate of retirees and the amounts and forms of coverage. An annual limit on Modine’s liability (a “cap”) was established for most plans between fiscal 1994 and fiscal 1996 after original recognition of the liability in fiscal 1993. It maximizes future costs at 200%200 percent of Modine’s then-current cost. These changes reduced the accrued obligation, and the reduction is being amortized as a component of the benefit cost.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
In December 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the “Act”) was signed into law. The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retirement medical plans with prescription drug coverage when the benefit is at least actuarially equivalent to Medicare Part D. In May 2004, the FASB issued FASB Staff Position (FSP) No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and Modernization Act of 2003.” FSP No. 106-2 provides authoritative guidance on the accounting for the federal subsidy and specifies the disclosure requirements for employers who have adopted FSP No. 106-2, including those who are unable to determine whether benefits provided under its plan are actuarially equivalent to Medicare Part D.
Certain of Modine’s postretirement benefit plans covering U.S. retirees currently provide prescription benefits to eligible participants. The Company’s actuaries have determined that several of the prescription drug plans for retirees and their dependents provide a benefit that is at least actuarially equivalent to Medicare Part D under the Medicare Prescription Drug Improvement and Modernization Act. Modine adopted FSP No. 106-2 during the second quarter of fiscal 2005, which reduced the fiscal 2005 accumulated postretirement benefit cost obligation by $2,237. For fiscal 20072008 and 2006,2007, the Company recorded reductions to the net periodic postretirement medical benefit cost of $805$413 and $855,$805, respectively, due to the effect of the federal subsidy.
Measurement Date: Modine uses DecemberMarch 31 as the measurement date for its U.S. pension and postretirement plans.
The Company adopted the recognition and disclosure requirements of SFAS No. 158 as of March 31, 2007. SFAS No. 158 requires companies to recognize a net asset or liability to report the funded status of defined benefit pension and other postretirement plans on the balance sheet and recognize changes in that funded status in the year in which the changes occur through other comprehensive income in shareholders’ equity. SFAS No. 158 does not change the amounts recognized in the income statement as net periodic benefit costs. The incremental effect of applying SFAS No. 158 on individual line items in the consolidated balance sheet at March 31, 2007 is as follows:
| Prior to SFAS No. 158 adoption | SFAS No. 158 adoption adjustments | After SFAS No. 158 adoption | ||||||||||
| Deferred income taxes and other current assets | $ | 33,401 | $ | 34,957 | $ | 68,358 | ||||||
| Intangible assets - net | 14,205 | (3,068 | ) | 11,137 | ||||||||
| Prepaid pension costs | 57,310 | (57,310 | ) | - | ||||||||
| Total assets | 1,126,994 | (25,421 | ) | 1,101,573 | ||||||||
| Pensions | 29,727 | 18,400 | 48,127 | |||||||||
| Postretirement benefits | 20,340 | 7,620 | 27,960 | |||||||||
| Total liabilities | 582,286 | 26,020 | 608,306 | |||||||||
| Accumulated other comprehensive income (loss) | 36,662 | (51,441 | ) | (14,779 | ) | |||||||
| Total shareholders' equity | 544,708 | (51,441 | ) | 493,267 | ||||||||
| Total liabilities and shareholders' equity | 1,126,994 | (25,421 | ) | 1,101,573 | ||||||||
Prior to SFAS No. 158 adoption | SFAS No. 158 adoption adjustments | After SFAS No. 158 adoption | ||||||||
| Deferred income taxes and other current assets | $ | 33,401 | $ | 34,957 | $ | 68,358 | ||||
| Intangible assets - net | 14,205 | (3,068 | ) | 11,137 | ||||||
| Prepaid pension costs | 57,310 | (57,310 | ) | - | ||||||
| Total assets | 1,126,994 | (25,421 | ) | 1,101,573 | ||||||
| Pensions | 30,447 | 18,400 | 48,847 | |||||||
| Postretirement benefits | (20,340 | ) | 7,620 | 27,960 | ||||||
| Total liabilities | 582,286 | 26,020 | 608,306 | |||||||
| Accumulated other comprehensive income (loss) | 36,662 | (51,441 | ) | (14,779 | ) | |||||
| Total shareholders' equity | 544,708 | (51,441 | ) | 493,267 | ||||||
| Total liabilities and shareholders' equity | 1,126,994 | (25,421 | ) | 1,101,573 | ||||||
61
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The change in benefit obligations and plan assets as well as the funded status of Modine's pension and postretirement plans were as follows:
Pensions Plans | Postretirement Plans | Pensions Plans | Postretirement Plans | ||||||||||||||||||||||||||
Years ended March 31 | 2007 | 2006 | 2007 | 2006 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||||||||
| Change in benefit obligation: | |||||||||||||||||||||||||||||
| Benefit obligation at beginning of year | $ | 269,851 | $ | 248,994 | $ | 33,310 | $ | 42,038 | $ | 264,255 | $ | 269,851 | $ | 30,704 | $ | 33,310 | |||||||||||||
| Service cost | 4,371 | 8,571 | 361 | 383 | 3,388 | 4,371 | 344 | 361 | |||||||||||||||||||||
| Interest cost | 15,003 | 13,980 | 1,748 | 1,883 | 17,633 | 15,003 | 2,257 | 1,748 | |||||||||||||||||||||
| Plan amendments | 1,636 | 2,192 | - | - | 317 | 1,636 | - | - | |||||||||||||||||||||
| Actuarial (gain) loss | (15,465 | ) | 14,778 | (1,554 | ) | (6,325 | ) | (24,602 | ) | (15,465 | ) | (1,016 | ) | (1,554 | ) | ||||||||||||||
| Benefits paid | (13,966 | ) | (12,522 | ) | (5,123 | ) | (5,722 | ) | (21,343 | ) | (13,966 | ) | (5,054 | ) | (5,123 | ) | |||||||||||||
| Special termination benefits | 738 | - | - | - | - | 738 | - | - | |||||||||||||||||||||
| Curtailment loss | (127 | ) | - | - | - | ||||||||||||||||||||||||
| Curtailment adjustment | (15,501 | ) | (127 | ) | - | - | |||||||||||||||||||||||
| Contributions by plan participants | - | - | 1,488 | 1,053 | - | - | 1,826 | 1,488 | |||||||||||||||||||||
| Medicare subsidy | - | - | 474 | - | - | - | 373 | 474 | |||||||||||||||||||||
| Currency translation adjustment | 2,214 | (2,050 | ) | - | - | 3,110 | 2,214 | - | - | ||||||||||||||||||||
| Aftermarket spin off | - | (4,092 | ) | - | - | ||||||||||||||||||||||||
| Benefit obligation at end of year | $ | 264,255 | $ | 269,851 | $ | 30,704 | $ | 33,310 | $ | 227,257 | $ | 264,255 | $ | 29,434 | $ | 30,704 | |||||||||||||
| Change in plan assets: | |||||||||||||||||||||||||||||
| Fair value of plan assets at beginning of year | $ | 210,632 | $ | 213,716 | $ | - | $ | - | $ | 215,364 | $ | 210,632 | $ | - | $ | - | |||||||||||||
| Actual return on plan assets | 15,663 | 7,773 | - | - | (4,608 | ) | 15,663 | - | - | ||||||||||||||||||||
| Benefits paid | (13,966 | ) | (12,522 | ) | (5,123 | ) | (5,722 | ) | (21,343 | ) | (13,966 | ) | (5,054 | ) | (5,123 | ) | |||||||||||||
| Employer contributions | 3,035 | 3,683 | 3,161 | 4,669 | 1,419 | 3,035 | 2,855 | 3,161 | |||||||||||||||||||||
| Contributions by plan participants | - | - | 1,488 | 1,053 | - | - | 1,826 | 1,488 | |||||||||||||||||||||
| Medicare subsidy | - | - | 474 | - | - | - | 373 | 474 | |||||||||||||||||||||
| Aftermarket spin off | - | (2,018 | ) | - | - | ||||||||||||||||||||||||
| Fair value of plan assets at end of year | $ | 215,364 | $ | 210,632 | $ | - | $ | - | $ | 190,832 | $ | 215,364 | $ | - | $ | - | |||||||||||||
| Funded status at end of year | $ | (48,891 | ) | $ | (59,219 | ) | $ | (30,704 | ) | $ | (33,310 | ) | $ | (36,425 | ) | $ | (48,891 | ) | $ | (29,434 | ) | $ | (30,704 | ) | |||||
| Unrecognized actuarial loss | - | 108,124 | - | 9,226 | |||||||||||||||||||||||||
| Unrecognized prior service costs | - | (593 | ) | - | 293 | ||||||||||||||||||||||||
| Unrecognzied net transition obligation | - | (54 | ) | - | - | ||||||||||||||||||||||||
| Net amount recognized | $ | (48,891 | ) | $ | 48,258 | $ | (30,704 | ) | $ | (23,791 | ) | ||||||||||||||||||
| Amounts recongized in the consolidated balance sheet consist of: | |||||||||||||||||||||||||||||
| Prepaid benefit costs | $ | 59,894 | $ | - | |||||||||||||||||||||||||
| Accrued benefit liability | (30,056 | ) | (23,791 | ) | |||||||||||||||||||||||||
| Intangible asset | 2,832 | - | |||||||||||||||||||||||||||
| Accumulated other comprehensive income | 15,588 | - | |||||||||||||||||||||||||||
| Net amount recognized | $ | 48,258 | $ | (23,791 | ) | ||||||||||||||||||||||||
| Amounts recognized in the consolidated balance sheet consist of: | |||||||||||||||||||||||||||||
| Current liability | $ | (44 | ) | $ | (2,744 | ) | $ | (1,330 | ) | $ | (762 | ) | $ | (2,765 | ) | $ | (2,744 | ) | |||||||||||
| Noncurrent liability | (48,847 | ) | (27,960 | ) | (35,095 | ) | (48,129 | ) | (26,669 | ) | (27,960 | ) | |||||||||||||||||
| $ | (48,891 | ) | $ | (30,704 | ) | $ | (36,425 | ) | $ | (48,891 | ) | $ | (29,434 | ) | $ | (30,704 | ) | ||||||||||||
Amounts recongized in accumulated other comprehensive income (loss) consist of: | |||||||||||||||||||||||||||||
| Amounts recognized in accumulated other comprehensive income (loss) consist of: | |||||||||||||||||||||||||||||
| Net actuarial loss | $ | 90,585 | $ | 7,349 | $ | 74,068 | $ | 90,585 | $ | 5,722 | $ | 7,349 | |||||||||||||||||
| Prior service cost | 241 | 271 | 2,534 | 241 | 243 | 271 | |||||||||||||||||||||||
| Net transition asset | (27 | ) | - | - | (27 | ) | - | - | |||||||||||||||||||||
| $ | 90,799 | $ | 7,620 | $ | 76,602 | $ | 90,799 | $ | 5,965 | $ | 7,620 | ||||||||||||||||||
The accumulated benefit obligation for all defined benefit pension plans was $237,531$225,556 and $208,846$237,531 as of March 31, 20072008 and 2006,2007, respectively.
Pension plans with accumulated benefit obligations in excess of plan assets consist of the following:
| Years ended March 31 | 2008 | 2007 | ||||||
| Projected benefit obligation | $ | 64,735 | $ | 66,911 | ||||
| Accumulated benefit obligation | 63,035 | 61,701 | ||||||
| Fair value of the plan assets | 29,207 | 31,634 | ||||||
Years ended March 31 | 2007 | 2006 | |||||
| Projected benefit obligation | $ | 66,911 | $ | 57,767 | |||
| Accumulated benefit obligations | 61,701 | 56,393 | |||||
| Fair value of the plan assets | 31,634 | 28,907 | |||||
62
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
Costs for Modine’s pension and postretirement benefit plans include the following components:
| Pension Plans | Postretirement Plans | |||||||||||||||||||||||
| Years ended March 31 | 2008 | 2007 | 2006 | 2008 | 2007 | 2006 | ||||||||||||||||||
| Components of net periodic benefit costs: | ||||||||||||||||||||||||
| Service cost | $ | 2,814 | $ | 4,371 | $ | 8,335 | $ | 276 | $ | 361 | $ | 383 | ||||||||||||
| Interest cost | 14,188 | 15,003 | 13,528 | 1,806 | 1,748 | 1,842 | ||||||||||||||||||
| Expected return on plan assets | (18,208 | ) | (18,959 | ) | (18,396 | ) | - | - | - | |||||||||||||||
| Amortization of: | ||||||||||||||||||||||||
| Unrecognized net loss | 2,625 | 5,578 | 4,637 | 488 | 323 | 415 | ||||||||||||||||||
| Unrecognized prior service cost | 380 | 14 | 65 | 23 | 22 | 21 | ||||||||||||||||||
| Unrecognized net asset | (20 | ) | (27 | ) | (27 | ) | - | - | - | |||||||||||||||
| Adjustment for curtailment | (2,351 | ) | 663 | - | - | - | - | |||||||||||||||||
| Adjustment for special termination benefits | - | 738 | - | - | - | - | ||||||||||||||||||
| Net periodic benefit (income) cost | $ | (572 | ) | $ | 7,381 | $ | 8,142 | $ | 2,593 | $ | 2,454 | $ | 2,661 | |||||||||||
| Other changes in plan assets and benefit obligation recognized in other comprehensive income: | ||||||||||||||||||||||||
| Net actuarial gain | $ | (12,831 | ) | $ | (1,017 | ) | ||||||||||||||||||
| Prior service costs | 317 | - | ||||||||||||||||||||||
| Reversal of amortization items: | ||||||||||||||||||||||||
| Net actuarial gain | (2,625 | ) | (488 | ) | ||||||||||||||||||||
| Prior service costs (credit) | 1,971 | (23 | ) | |||||||||||||||||||||
| Transition asset | 20 | - | ||||||||||||||||||||||
| Total recognized in other comprehensive income | $ | (13,148 | ) | $ | (1,528 | ) | ||||||||||||||||||
| Total recognized in net periodic benefit costs and other comprehensive income | $ | (13,720 | ) | $ | 1,065 | |||||||||||||||||||
Pension Plans | Postretirement Plans | ||||||||||||||||||
Years ended March 31 | 2007 | 2006 | 2005 | 2007 | 2006 | 2005 | |||||||||||||
| Components of net periodic benefit costs: | |||||||||||||||||||
| Service cost | $ | 4,371 | $ | 8,335 | $ | 7,458 | $ | 361 | $ | 383 | $ | 397 | |||||||
| Interest cost | 15,003 | 13,528 | 13,762 | 1,748 | 1,842 | 2,116 | |||||||||||||
| Expected return on plan assets | (18,959 | ) | (18,396 | ) | (19,367 | ) | - | - | - | ||||||||||
| Amortization of: | |||||||||||||||||||
| Unrecognized net loss | 5,578 | 4,637 | 2,432 | 323 | 415 | 476 | |||||||||||||
| Unrecognized prior service cost | 14 | 65 | 497 | 22 | 21 | (7 | ) | ||||||||||||
| Unrecognized net asset | (27 | ) | (27 | ) | (27 | ) | - | - | - | ||||||||||
| Adjustment for curtailment | 663 | - | 1,081 | - | - | - | |||||||||||||
| Adjustment for special termination benefits | 738 | - | - | - | - | - | |||||||||||||
| Net periodic benefit cost | $ | 7,381 | $ | 8,142 | $ | 5,836 | $ | 2,454 | $ | 2,661 | $ | 2,982 | |||||||
The estimated net actuarial loss and prior service cost and net transition asset for the pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $4,921, $132$5,574 and $(27),$366, respectively. The estimated net actuarial loss and prior service cost for the postretirement plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $466$388 and $22, respectively.
The weighted-averageweighted–average assumptions used to determine Modine’s benefit obligation under the plans are detailed as follows:
| Years ended March 31 | 2008 | 2007 | ||||||||||||||
| U.S. Plans | Foreign Plans | U.S. Plans | Foreign Plans | |||||||||||||
| Pension plans: | ||||||||||||||||
| Discount rate | 6.62 | % | 5.53 | % | 5.92 | % | 4.70 | % | ||||||||
| Rate of compensation increase | N/A | 2.00 | % | 4.00 | % | 1.75 | % | |||||||||
| Postretirement plans: | ||||||||||||||||
| Discount rate | 6.62 | % | 5.92 | % | ||||||||||||
Years ended March 31 | 2007 | 2006 | |||||||||||
U.S. Plans | Foreign Plans | U.S. Plans | Foreign Plans | ||||||||||
| Pension plans: | |||||||||||||
| Discount rate | 5.92 | % | 4.70 | % | 5.75 | % | 4.25 | % | |||||
| Rate of compensation increase | 4.00 | % | 1.75 | % | 4.00 | % | 2.00 | % | |||||
| Postretirement plans: | |||||||||||||
| Discount rate | 5.92 | % | 5.75 | % | |||||||||
| Rate of compensation increase | 4.00 | % | 4.00 | % | |||||||||
63
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
The weighted-average assumptions used to determine Modine's costs under the plans are detailed as follows:
| Years ended March 31 | 2008 | 2007 | 2006 | |||||||||||||||||||||
| U.S. Plans | Foreign Plans | U.S. Plans | Foreign Plans | U.S. Plans | Foreign Plans | |||||||||||||||||||
| Pension plans: | ||||||||||||||||||||||||
| Discount rate | 5.92 | % | 4.70 | % | 5.75 | % | 4.25 | % | 5.75 | % | 4.25 | % | ||||||||||||
| Expected return on plan assets | 8.25 | % | N/A | 8.50 | % | N/A | 8.50 | % | N/A | |||||||||||||||
| Rate of compensation increase | N/A | 2.00 | % | 4.00 | % | 1.50 | % | 4.00 | % | 2.00 | % | |||||||||||||
| Postretirement plans: | ||||||||||||||||||||||||
| Discount rate | 5.92 | % | 5.75 | % | 5.75 | % | ||||||||||||||||||
Years ended March 31 | 2007 | 2006 | 2005 | ||||||||||||||||
U.S. Plans | Foreign Plans | U.S. Plans | Foreign Plans | U.S. Plans | Foreign Plans | ||||||||||||||
| Pension plans: | |||||||||||||||||||
| Discount rate | 5.75 | % | 4.25 | % | 5.75 | % | 4.25 | % | 6.25 | % | 5.89 | % | |||||||
| Expected return on plan assets | 8.50 | % | N/A | 8.50 | % | N/A | 8.75 | % | N/A | ||||||||||
| Rate of compensation increase | 4.00 | % | 1.50 | % | 4.00 | % | 2.00 | % | 4.00 | % | 3.52 | % | |||||||
| Postretirement plans: | �� | ||||||||||||||||||
| Discount rate | 5.75 | % | 5.75 | % | 6.25 | % | |||||||||||||
| Rate of compensation increase | 4.00 | % | 4.00 | % | 4.00 | % | |||||||||||||
The discount rate used to determine the present value of the Company's future foreign pension obligations as of the measurement date is based upon the yield for zero coupon bonds plus a yield margin measured as the difference between corporate bonds (AA or higher) in Europe and government bonds.
Plan assets in the U.S. defined benefit plans comprise 100 percent of the Company’s world-wide benefit plan assets. Modine's U.S. pension plan weighted-average asset allocations at the measurement dates of March 31, 2008 and December 31, 2006 and 2005 by category, and the target allocation for the years ended March 31, 20072008 and 20062007 are summarized below:
| Target allocation | Plan assets | |||||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||||
| Equity securities | 55 | % | 60 | % | 58 | % | 65 | % | ||||||||
| Debt securities | 38 | % | 38 | % | 39 | % | 33 | % | ||||||||
| Alternative assets | 5 | % | 0 | % | 0 | % | 0 | % | ||||||||
| Cash | 2 | % | 2 | % | 3 | % | 2 | % | ||||||||
| 100 | % | 100 | % | 100 | % | 100 | % | |||||||||
Target allocation | Plan assets | ||||||||||||
2007 | 2006 | 2007 | 2006 | ||||||||||
| Equity securiites | 60 | % | 55 | % | 65 | % | 56 | % | |||||
| Debt securities | 38 | % | 40 | % | 33 | % | 39 | % | |||||
| Cash | 2 | % | 5 | % | 2 | % | 5 | % | |||||
100 | % | 100 | % | 100 | % | 100 | % | ||||||
Due to market conditions and other factors including timing of benefit payments, actual asset allocation may vary from the target allocation outlined above. The assets are periodically rebalanced to the target allocations. Included in the plan assets for fiscal 20072008 are 482373 shares of Modine common stock with a market value of $12,070 (5.6$5,399 (2.8 percent of total plan assets). For 2006,2007, the plan held 482 shares of Modine common stock with a market value of $15,720 (7.5$12,070 (5.6 percent of total plan assets).
Modine employs a total return investment approach, whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets while avoiding excessive risk. Pension plan guidelines have been established based upon an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements and periodic asset/liability studies.
The expected rate of return on U.S. plan assets is based upon historical return experience and forward-looking return expectations for major asset class categories. For fiscal 2007,2008, Modine assumed a rate of return of 8.508.25 percent for purposes of determining the U.S. pension plan expense. For fiscal year 20082009 U.S pension plan expense, Modine has assumed a rate of 8.218.25 percent, net of administrative expenses.
MODINE MANUFACTURING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
With respect to the postretirement plans, for measurement purposes, the assumed healthcare cost trend rates were as follows:
| Years ended March 31 | 2008 | 2007 | ||||||
| Healthcare costs trend rate assumed for next year (pre-65) | 9.0 | % | 9.0 | % | ||||
| Healthcare costs trend rate assumed for next year (post-65) | 8.3 | % | 8.5 | % | ||||
| Ultimate trend rate | 5.0 | % | 5.0 | % | ||||
| Year the rate reaches the ultimate trend rate | 2014 | 2011 | ||||||
Assumed healthcare cost trend rates affect the amounts reported for the postretirement plans. A one percentage point change in assumed healthcare cost trend rates would have the following effects:
| One percentage point | ||||||||
| Year ended March 31, 2008 | Increase | Decrease | ||||||
| Effect on total of service and interest cost | $ | 72 | $ | (65 | ) | |||
| Effect on postretirement benefit obligation | 1,073 | (971 | ) | |||||
One percentage point | |||||||
| Year ended March 31, 2007 | Increase | Decrease | |||||
| Effect on total of service and interest cost | $ | 72 | $ | (64 | ) | ||
| Effect on postretirement benefit obligation | 1,123 | (996 | ) | ||||
The funding policy for domestic qualified pension plans is to contribute annually at a minimum, the amount necessary on an actuarial basis to provide for benefits in accordance with applicable law and regulation. Modine anticipatesdoes not anticipate that it will contribute a total of approximately $914make any contributions to these plans during fiscal 2008 due to minimum funding requirements and discretionary determinations. In addition,2009. Modine expectsdoes expect to contribute $3,262$2,779 to its postretirement benefit plans in fiscal 2008.2009.
The estimated benefits, which reflect future service, as appropriate, for the next ten fiscal years are as follows:
| Years ended March 31 | ||||||||
| Pension | ||||||||
| Pension | ||||||||
| 2008 | $ | 12,129 | ||||||
| 2009 | 12,459 | $ | 12,198 | |||||
| 2010 | 13,538 | 13,306 | ||||||
| 2011 | 14,266 | 13,212 | ||||||
| 2012 | 14,240 | 13,438 | ||||||
| 2013 - 2017 | 78,832 | |||||||
| 2013 | 13,378 | |||||||
| 2014 - 2018 | 77,955 | |||||||