Modine Manufacturing - 10-Q quarterly report FY2013 Q1

 

 

 

For the quarterly period ended June 30, 2012

or

For the transition period from ____________ to ____________

Commission file number 1-1373

(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code (262) 636-1200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

The number of shares outstanding of the registrant's common stock, $0.625 par value, was 47,111,744 at August 1, 2012.

MODINE MANUFACTURING COMPANY

INDEX

MODINE MANUFACTURING COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the three months ended June 30, 2012 and 2011

(In thousands, except per share amounts)

(Unaudited)

 

The notes to unaudited condensed consolidated financial statements are an integral part of these statements.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the three months ended June 30, 2012 and 2011

(In thousands)

(Unaudited)

 

The notes to unaudited condensed consolidated financial statements are an integral part of these statements.

MODINE MANUFACTURING COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

June 30, 2012 and March 31, 2012

(In thousands, except per share amounts)

(Unaudited)

 

The notes to unaudited condensed consolidated financial statements are an integral part of these statements.

MODINE MANUFACTURING COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the three months ended June 30, 2012 and 2011

(In thousands)

(Unaudited)

 

The notes to unaudited condensed consolidated financial statements are an integral part of these statements.

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

Note 1: General

The accompanying condensed consolidated financial statements were prepared in conformity with generally accepted accounting principles (GAAP) in the United States applied on a basis consistent with those principles used in the preparation of the annual consolidated financial statements by Modine Manufacturing Company (Modine or the Company) for the year ended March 31, 2012.  The financial statements include all normal recurring adjustments that are, in the opinion of management, necessary for a fair statement of results for the interim periods.  Results for the first three months of fiscal 2013 are not necessarily indicative of the results to be expected for the full year.

These financial statements should be read in conjunction with the consolidated financial statements and related notes in Modine's Annual Report on Form 10-K for the year ended March 31, 2012.

Note 2: Significant Accounting Policies

Restricted cash:  At June 30, 2012 and March 31, 2012, the Company had long-term restricted cash of $3,457 and $3,721, respectively, included in other noncurrent assets, consisting of $1,107 and $1,371, respectively, to secure long-term employee compensation arrangements for certain employees in Europe and $2,350 to collateralize insurance liabilities with an insurance carrier in North America.

Revision of prior period financial statements:  As described in Note 1 and Note 26 of the Notes to Consolidated Financial Statements in Modine’s Annual Report on Form 10-K for the year ended March 31, 2012, the quarterly results for fiscal 2012 have been revised as a result of errors identified during fiscal 2012 that were not considered material individually or in the aggregate to previously issued financial statements but were considered significant to the quarters in which they were identified.  For the three months ended June 30, 2011, cost of goods sold decreased $371, gross profit increased $371, selling, general and administrative expenses increased $106, other income– net increased $197, provision for income taxes increased $1,012 and earnings from continuing operations decreased $550 as a result of the revisions.  Diluted earnings per share from continuing operations and diluted net earnings per share decreased $0.01 for the three months ended June 30, 2011 as a result of these revisions.

Out of period adjustments:  During the three months ended June 30, 2012, the Company identified an error related to certain commodity hedges that should have been deemed ineffective in the fourth quarter of fiscal 2012, which understated pre-tax earnings by approximately $542 in the fourth quarter of fiscal 2012, and overstated pre-tax earnings by this same amount in the first quarter of fiscal 2013.  This amount was not considered material to the financial statements of either the fourth quarter of fiscal 2012 or the first quarter of fiscal 2013.

Accounting standards changes and new accounting pronouncements:  In June 2011, the FASB issued an amendment to the accounting guidance for the presentation of comprehensive income. This amendment removes one of the three presentation options for presenting the components of other comprehensive income as part of the statement of changes in shareholders’ equity and requires either a single continuous statement of net income and other comprehensive income or a two consecutive statement approach.  This amendment shall be applied retrospectively and is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011.  This amendment was adopted for the first quarter of fiscal 2013 in the separate condensed consolidated statements of comprehensive income (two consecutive statement approach).

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

In September 2011, the FASB issued an amendment to the accounting guidance for testing goodwill for impairment.  The amendment provides an option for companies to first use a qualitative approach to test goodwill for impairment if certain conditions are met.  If it is determined to be more likely than not that the fair value of the reporting unit is less than its carrying amount, entities must perform the quantitative analysis of the goodwill impairment test.  The amendments are effective for goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  The Company is assessing this new guidance and currently does not anticipate any impact on the consolidated financial statements from the adoption of this amendment.

Note 3: Employee Benefit Plans

During the three months ended June 30, 2012 and 2011, the Company recorded compensation expense of $1,629 and $1,229, respectively, related to its defined contribution employee benefit plans.

During the three months ended June 30, 2012 and 2011, the Company elected to contribute $2,150 and $5,050, respectively, to its U.S. pension plans.  The Company anticipates making additional contributions of $8,350 for the remainder of fiscal 2013.

Costs for Modine's pension and postretirement benefit plans for the three months ended June 30, 2012 and 2011 include the following components:

Note 4: Stock-Based Compensation

Stock-based compensation consists of stock options, restricted stock granted for retention and performance and discretionary unrestricted stock.  Compensation cost 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.  Modine recognized stock-based compensation cost of $893 and $843 for the three months ended June 30, 2012 and 2011, respectively.  The performance component of awards granted under the long-term incentive plan during the first quarter of fiscal 2013 is based on consolidated target return on average capital employed (ROACE) (weighted at 50 percent), cumulative revenue over the three year performance period (weighted at 25 percent), and a target European ROACE at the end of the three year performance period (weighted at 25 percent).  The Company currently considers the attainment of the consolidated ROACE and European ROACE to be probable.  ROACE is defined as operating income adjusted to exclude unusual, non-recurring or extraordinary non-cash charges and cash restructuring and repositioning charges, multiplied by 70 percent to account for an assumed 30 percent income tax rate, and further adjusted to exclude earnings (or losses) attributable to minority shareholders; divided by total debt plus shareholders’ equity.  Cumulative revenue is the Company’s total revenue over the performance period.  European ROACE is defined as the Original Equipment – Europe segment  (Europe Segment) operating income, less research and development charges to the Company’s corporate and administrative expenses, adjusted to exclude all unusual, non-recurring or extraordinary non-cash charges and cash restructuring and repositioning charges, multiplied by 70 percent to account for an assumed 30 percent income tax rate; divided by Europe Segment total assets, less cash and cash equivalents and Europe Segment total liabilities, excluding debt.

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

The following table presents, by type, the fair market value of stock-based compensation awards granted during the three months ended June 30, 2012:

The accompanying table sets forth the assumptions used in determining the fair value for the options granted during the three months ended June 30, 2012:

As of June 30, 2012, the total remaining unrecognized compensation cost related to the non-vested stock-based compensation awards, which will be amortized over the weighted average remaining service periods, is as follows:

 

Note 5: Other Income – Net

Other income – net was comprised of the following:

Foreign currency transactions for the three months ended June 30, 2012 and 2011 were primarily comprised of foreign currency transaction (losses) gains on the re-measurement or settlement of foreign currency-denominated assets and liabilities, including inter-company loans and transactions denominated in a foreign currency.

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

Note 6: Income Taxes

For the three months ended June 30, 2012 and 2011, the Company’s effective income tax rate attributable to earnings from continuing operations before income taxes was 205.8 percent and 28.6 percent, respectively.

The most significant factors impacting changes in the effective tax rate for the three months ended June 30, 2012 as compared to prior periods were changes in the valuation allowance for certain foreign losses for which no benefit is recognized.  During the three months ended June 30, 2012, the Company continued to record a full valuation allowance against its net deferred tax assets located in the U.S. and certain foreign jurisdictions as it is more likely than not that these assets will not be realized based on historical performance.  The Company will continue to provide a valuation allowance against its net deferred tax assets in each of the applicable jurisdictions going forward until the need for a valuation allowance is eliminated.  The need for a valuation allowance will be eliminated when the Company determines it is more likely than not that the deferred tax assets will be realized.  It is possible that by the end of fiscal 2013, the U.S. taxing jurisdiction will no longer be in a cumulative three year loss position thereby removing significant negative evidence concerning valuation allowance.  Throughout the remainder of fiscal 2013, all positive and negative evidence will be further analyzed in order to determine the propriety of the valuation allowance against the net deferred tax assets of this jurisdiction.

Accounting policies for interim reporting require the Company to adjust its effective tax rate each quarter to be consistent with the estimated annual effective tax rate.  Under this effective tax rate methodology, the Company applies an estimated annual income tax rate to its year-to-date ordinary earnings to derive its income tax provision each quarter.  The tax impact of certain significant, unusual or infrequently occurring items must be recorded in the interim period in which they occur. For the three months ended June 30, 2012, the U.S. taxing jurisdiction had pre-tax earnings and is forecasting pre-tax earnings for the full fiscal year.  As a result, the U.S. taxing jurisdiction is no longer considered on a discrete basis but is included in the overall annual effective tax rate methodology.  The impact of the Company’s operations in Germany, Austria and certain other foreign locations continue to be excluded from the overall effective tax rate methodology and recorded discretely based upon year-to-date results as these operations anticipate net operating losses for the year for which no tax benefit can be recognized.  The income taxes for the Company’s other foreign operations continue to be estimated under the overall effective tax rate methodology.

The Company does not anticipate the gross liability for unrecognized tax benefits to significantly change in the next twelve months other than that which will result from the expiration of the applicable statutes of limitation.  The Company files income tax returns in multiple jurisdictions and is subject to examination by taxing authorities throughout the world.  The tax audit in Germany covering fiscal years 2006 through 2010 commenced during the first quarter of fiscal 2013 and is in its early stages.  The Company has not been notified of any other tax examinations covering open periods.

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

For the three months ended June 30, 2012, the total number of potential dilutive securities was 336.  However, these securities were not included in the computation of diluted net loss per common share for the three months ended June 30, 2012, since to do so would decrease the loss per share.  In addition, for the three months ended June 30, 2012, 1,330 of common shares issuable upon the exercise of stock options and 149 restricted stock awards were anti-dilutive and were also excluded from the calculation of diluted earnings per share.  For the three months ended June 30, 2011, 1,165 of common shares issuable upon the exercise of stock options and 152 restricted stock awards were anti-dilutive and were excluded from the calculation of diluted earnings per share.

Note 8: Inventories

Inventories consisted of the following:

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

Assets held for sale of $2,450 at June 30, 2012 and March 31, 2012, respectively, included in noncurrent assets, consist of two facilities that the Company has closed within the Original Equipment – North America segment.  The Company is currently marketing the facilities held for sale.

Note 10: Restructuring, Plant Closures and Other Related Costs

During fiscal 2013, the Company announced its intention to restructure its Original Equipment – Europe segment.  The Company expects actions will include exiting certain non-core product lines based on our global product strategy, reducing manufacturing costs, implementing headcount reductions, and disposing of or selling certain fixed assets.  The restructuring plan is designed to align the cost structure of the segment with the strategic focus on the commercial vehicle market, while improving gross margin and return on average capital employed.

Since the commencement of the Original Equipment – Europe segment restructuring plan, the Company has incurred $4,502 of termination charges and $59 of other closure costs, in the aggregate.  The Company anticipates incurring additional costs of approximately $12,500 through fiscal 2017 (with the majority being incurred through fiscal 2014), consisting of additional headcount reductions and equipment moving costs.  Total future cash expenditures of approximately $17,000 are anticipated to be incurred related to this restructuring plan.

Prior to fiscal 2013, the Company had been executing a restructuring plan in the U.S. and its Tubingen, Germany facility.  The final plant closure under this restructuring plan was completed in the fourth quarter of fiscal 2012.

Changes in the accrued restructuring liability for the three months ended June 30, 2012 and 2011 were comprised of the following, related to the above-described restructuring activities:

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

Total restructuring and other repositioning costs were recorded in the consolidated statement of operations for the three months ended June 30, 2012 as follows: $271 was recorded as a component of cost of sales and $4,490 was recorded as restructuring expense.  Total restructuring and other repositioning costs were recorded in the consolidated statement of operations for the three months ended June 30, 2011 as follows: $135 was recorded as a component of cost of sales and $57 was recorded as restructuring income.  The Company accrues severance in accordance with its policies and relevant statutory requirements.  Restructuring income relates to reversals of severance liabilities due to employee terminations prior to completion of required retention periods.

Note 11: Goodwill and Intangible Assets

Changes in the carrying amount of goodwill during the first three months of fiscal 2013, by segment and in the aggregate, are summarized in the following table:

Intangible assets are comprised of the following:

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

Note 12: Indebtedness

The Company has $125,000 outstanding on 6.83 percent Senior Notes, maturing on August 12, 2020.  As of June 30, 2012, the Company also had $29,000 outstanding under its $145,000 domestic revolving credit facility which expires in August 2014.  At March 31, 2012, the Company had $9,000 outstanding on this domestic revolving credit facility.

Provisions contained in the Company’s revolving credit facility and Senior Note agreements require the Company to maintain compliance with various covenants.  The Company was in compliance with its covenants as of June 30, 2012.

Modine also maintained credit agreements with foreign banks with outstanding short term borrowings at June 30, 2012 and March 31, 2012 of $21,545 and $21,296, respectively.  The foreign unused lines of credit in Europe, Brazil, and China at June 30, 2012 were approximately $33,098.  Domestic unused lines of credit at June 30, 2012 were $116,000.  In aggregate, the Company had total available lines of credit of $149,098 at June 30, 2012.

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.  At June 30, 2012 and March 31, 2012, the carrying value of Modine’s long-term debt approximated fair value, with the exception of the Senior Notes, which had a fair value of approximately $136,452 and $139,234 at June 30, 2012 and March 31, 2012, respectively.  The fair value of the Senior Notes is categorized within Level 2 of the hierarchy.  Refer to Note 15 for the definition of a Level 2 fair value measurement.

Note 13: Financial Instruments

Concentrations of Credit Risk: The Company invests excess cash in investment quality short-term liquid debt instruments.  Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of accounts receivable.  The Company sells a broad range of products that provide thermal solutions to a diverse group of customers operating throughout the world.  At June 30, 2012 and March 31, 2012, approximately 52 percent and 54 percent, respectively, of the Company's trade accounts receivables were from the Company's top ten individual customers.  These customers operate primarily in the automotive, truck and heavy equipment markets and are all influenced by many of the same market and general economic factors.  To reduce credit risk, the Company performs periodic customer credit evaluations and actively monitors their financial condition and developing business news.  The Company does not generally require collateral or advanced payments from its customers, but does so in those cases where a substantial credit risk is identified.  Credit losses to customers operating in the markets served by the Company have not been material.  Total bad debt write-offs have been well below one percent of outstanding trade receivable balances for the presented periods.  See Note 18 for further discussion on market, credit and counterparty risks.

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

Inter-Company Loans Denominated in Foreign Currencies:  The Company has certain foreign-denominated inter-company loans that are sensitive to foreign exchange rates.  At June 30, 2012, the Company has inter-company loans outstanding of $12,000 between two loans to its wholly owned subsidiary, Modine Thermal Systems (Changzhou) Co. Ltd. (Changzhou, China), with various maturity dates through July 2013.   These inter-company loans are sensitive to movement in foreign exchange rates, and the Company does not have any derivative instruments to hedge this exposure at June 30, 2012.

Note 14: Derivatives/Hedges

Modine uses derivative financial instruments from time to time as a tool to manage certain financial risks.  Leveraged derivatives are prohibited by Company policy.

Accounting for derivatives and hedging activities requires derivative financial instruments to be measured at fair value and recognized as assets or liabilities in the consolidated balance sheets.  Accounting for the gain or loss resulting from the change in the fair value of the derivative financial instruments depends on whether it has been designated, and is effective, as a hedge and, if so, on the nature of the hedging activity.

Commodity Derivatives:  The Company enters into futures contracts related to certain of the Company’s forecasted purchases of aluminum and copper.  The Company’s strategy in entering into these contracts is to reduce its exposure to changing market prices for future purchases of these commodities.  Until the fourth quarter of fiscal 2012, these contracts were designated as cash flow hedges by the Company.  Accordingly, unrealized gains and losses on these contracts were deferred as a component of accumulated other comprehensive (loss) income (AOCI), and recognized as a component of earnings at the same time that the underlying purchases of aluminum and copper impact earnings.  During the fourth quarter of fiscal 2012, the future contracts used for aluminum and copper hedging became ineffective.  Accordingly, the Company de-designated the hedges and began recording the unrealized gains and losses within cost of goods sold (see “Out of period adjustments” within Note 2).  The amounts recorded in AOCI prior to the de-designation will remain in AOCI until the underlying purchases of aluminum and copper impact earnings.

Foreign exchange contracts:  The Company’s foreign exchange risk management strategy uses derivative financial instruments in a limited way to mitigate foreign currency exchange risk.  The Company periodically enters into foreign currency exchange contracts to hedge specific foreign currency-denominated assets and liabilities.  The Company has not designated its forward contracts as hedges.  Accordingly, unrealized gains and losses related to the change in fair value are recorded in other income – net.  Gains and losses on these foreign currency forward contracts are offset by gains and losses recorded on the underlying assets and liabilities.

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

 

The amounts recorded in AOCI and in the consolidated statement of operations for the three months ended June 30, 2012 are as follows:

Fair value measurements are classified under the following hierarchy:

When available, the Company uses quoted market prices to determine fair value and classified such measurements within Level 1.  In some cases, where market prices are not available, the Company makes use of observable market-based inputs to calculate fair value, in which case the measurements are classified within Level 2.  If quoted or observable market prices are not available, fair value is based upon internally developed models that use, where possible, current market-based parameters such as interest rates, yield curves, currency rates, etc.  These measurements are classified within Level 3.

Fair value measurements are classified according to the lowest level input or value-driver that is significant to the valuation.  A measurement may therefore be classified within Level 3 even though there may be significant inputs that are readily observable.

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

The Company’s trading securities are a mix of various investments maintained in a deferred compensation trust to fund future obligations under Modine’s non-qualified deferred compensation plan.  The securities’ fair values are the market values from active markets (such as New York Stock Exchange (NYSE)) and are classified within Level 1 of the valuation hierarchy.  The fair values of money market investments have been determined to approximate their net asset values, with no discounts for credit quality or liquidity restrictions and are classified within Level 2 of the valuation hierarchy.

As part of the Company’s risk management strategy, Modine enters into derivative transactions to mitigate certain identified exposures.  The derivative instruments include currency options and commodity derivatives.  These are not exchange traded and are customized over-the-counter derivative transactions.  These derivative exposures are with counterparties that have long-term credit ratings of BBB – or better.

The Company measures fair values assuming that the unit of account is an individual derivative transaction and those derivatives are sold or transferred on a stand-alone basis.  Therefore, derivative assets and liabilities are presented on a gross basis without consideration of master netting arrangements.  The Company estimates the fair value of these derivative instruments based on dealer quotes as the dealer is willing to settle at the quoted prices.  These derivative instruments are classified within Level 2 of the valuation hierarchy.

The fair value of the deferred compensation obligation is recorded at the fair value of the investments held by the deferred compensation trust.  As noted above, the fair values for the securities are the market values directly from active markets (such as NYSE) and are classified within Level 1 of the valuation hierarchy.  The fair values of money market investments have been determined to approximate their net asset values, with no discounts for credit quality or liquidity restrictions and are classified within Level 2 of the valuation hierarchy.

The carrying values of cash and cash equivalents, trade receivables, and accounts payable, approximate fair value, without being discounted as of June 30, 2012 and March 31, 2012 due to the short-term nature of these instruments.

At June 30, 2012, the assets and liabilities that are measured at fair value on a recurring basis are classified as follows:

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

Commitments: At June 30, 2012, the Company had capital expenditure commitments of $13,613.  Significant commitments include tooling and equipment expenditures for new and renewal platforms with new and current customers in Europe and North America along with new program launches in Asia.

Note 17: Segment Information

The following is a summary of net sales, gross profit, earnings from continuing operations before income taxes and total assets by segment:

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

 

Credit risk:  The Company manages credit risks through its focus on the following:

Counterparty risks:  The Company manages counterparty risks through its focus on the following:

European value added tax:  During fiscal 2012, the Company determined that it was not properly applying value added tax (VAT) to various cross border transactions within the Original Equipment – Europe segment.  At June 30, 2012 and March 31, 2012, the Company had recorded an estimated liability for the VAT exposures of $10,683, which consists of unpaid VAT and estimated interest and penalties that may be levied against the Company by taxing authorities.  The Company is in the process of reporting this matter to the applicable taxing authorities, and cannot provide assurance about the ultimate resolution at this time.

Environmental: At present, the United States Environmental Protection Agency (“USEPA”) has designated the Company as a potentially responsible party (“PRP”) for remediation of six sites with which the Company had involvement.  These sites include: Auburn Incinerator, Inc./Lake Calumet Cluster (Illinois), Cam-Or (Indiana), a scrap metal site known as Chemetco (Illinois), Circle Environmental of Dawson (two sites: Dawson, GA and Terrell County, GA), and LWD, Inc. (Kentucky).  In addition, Modine is voluntarily participating in the care of an inactive landfill owned by the City of Trenton (Missouri).  These sites are not Company-owned and allegedly contain materials attributable to Modine from past operations.  The percentage of material allegedly attributable to Modine is relatively low.  Remediation of these sites is in various stages of administrative or judicial proceedings and includes recovery of past governmental costs and the costs of future investigations and remedial actions.  The Company accrues for costs anticipated for the remedial settlement of the sites listed above if they are probable and can be reasonably determined.  Costs anticipated for the remedial settlement of the sites listed above that are not probable or cannot be reasonably determined at this time have not been accrued; however, the Company does not believe any potential costs are material due to Modine’s relatively small portion of contributed materials.

MODINE MANUFACTURING COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(unaudited)

The Company actively monitors and addresses environmental issues and has recorded environmental investigation and remediation expense accruals for groundwater contamination at its manufacturing facility in Brazil and subsurface contamination at its former manufacturing facility in the Netherlands, along with other lesser issues at certain facilities located in the United States.  These expenditures generally relate to facilities where past operations followed practices and procedures that were considered acceptable under then existing regulations, or where the Company is a successor to the obligations of prior owners and current laws and regulations require investigative and/or remedial work to ensure sufficient environmental compliance.  The reserves for these environmental matters totaled $6,102 and $6,946 at June 30, 2012 and March 31, 2012, respectively.  During the three months ended June 30, 2012 and June 30, 2011, additional reserves of $20 and $70, respectively, were recorded as a component of continuing operations.  During the three months ended June 30, 2012 reductions to the reserves of $177 were recorded as a component of discontinued operations.  As additional information becomes available, any potential liability related to these matters is assessed and the estimates are revised, if necessary.  Based on currently available information, Modine believes that the ultimate outcome of these matters, individually and in the aggregate, will not have a material adverse effect on the financial position or overall trends in results of operations.  However, these matters are subject to inherent uncertainties, and unfavorable outcomes could occur, including significant monetary damages.  During fiscal 2011, one of the adjacent businesses to the operation in Brazil filed suit against Modine’s Brazilian subsidiary seeking remediation and certain other damages as a result of the contamination.  The Company is defending this suit and believes that the ultimate outcome of this matter will not be material.

Other litigation:  In the normal course of business, the Company and its subsidiaries are named as defendants in various other lawsuits and enforcement proceedings by private parties, the Occupational Safety and Health Administration, the USEPA, other governmental agencies and others in which claims are asserted against the Company.  At June 30, 2012 and March 31, 2012, the Company did not have an accrual related to any such matter that was not deemed probable.

 

When we use the terms “Modine,” “we,” “us,” “Company,” or “our” in this report, unless the context otherwise requires, we are referring to Modine Manufacturing Company.  Our fiscal year ends on March 31 and, accordingly, all references to quarters refer to our fiscal quarters.  The quarter ended June 30, 2012 is the first quarter of fiscal 2013.

First Quarter Highlights:  Net sales in the first quarter of fiscal 2013 decreased from the first quarter of fiscal 2012, as anticipated, driven by weakening end market demand and unfavorable foreign currency exchange rate changes.  Gross margin decreased mostly due to the overall sales volume declines.  Selling, general and administrative (SG&A) expenses decreased from the first quarter of fiscal 2012 to the first quarter of fiscal 2013, primarily due to lower compensation-related expense and favorable foreign currency exchange rate changes.  European restructuring expense of $4.5 million negatively impacted the first quarter of fiscal 2013 results.  The European restructuring plan is aimed at aligning the cost structure of the segment with the strategic focus on the commercial vehicle market, while improving gross margin and return on average capital employed.  During the first quarter of fiscal 2013, we recorded a loss from continuing operations of approximately $1 million.

The results for the three months ended June 30, 2011 have been revised to reflect the correction of errors relating to that period.  In addition, the first quarter of fiscal 2013 results include an out-of-period adjustment related to certain commodity hedges.  See Note 2 to the Notes to Condensed Consolidated Financial Statements for further discussion.  The following table presents consolidated results from continuing operations on a comparative basis for the three months ended June 30, 2012 and 2011:

First quarter net sales of $350.4 million were 16.2 percent lower than the $417.9 million reported in the first quarter of last year driven by decreases in overall sales volumes, along with a $23.5 million unfavorable impact of foreign currency exchange rate changes.  Automotive market sales declined 32.1 percent compared to the first quarter of fiscal 2012, as we continue the strategic exit of the automotive module business.

During the first quarter of fiscal 2013, gross profit decreased $18.2 million from the first quarter of fiscal 2012 on the decreased sales volumes and a $2.9 million unfavorable impact of foreign currency exchange rate changes.  Gross margin decreased 200 basis points from 16.7 percent in the first quarter of fiscal 2012 to 14.7 percent in the first quarter of fiscal 2013 largely due to lower sales volume.

SG&A expenses decreased $6.4 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013, yet increased as a percentage of sales to 12.3 percent.  The decrease in SG&A expenses is primarily the result of lower compensation-related expense and favorable foreign currency exchange rate changes.

Income from operations declined $16.4 million from $20.3 million in the first quarter of fiscal 2012 to $3.9 million in the first quarter of fiscal 2013.  The lower sales volumes, unfavorable impact of foreign currency exchange rate changes and $4.5 million of restructuring expense related to the Original Equipment – Europe segment were the primary factors contributing to this decline in results from operations.

 

Restructuring expense increased $4.6 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 due to the initiation of the European restructuring plan in the first quarter of fiscal 2013.  The restructuring expense was for severance costs related to reductions in headcount within the Original Equipment – Europe segment.

During the first quarter of fiscal 2013, we recorded a $2.1 million provision for income taxes, which represents an effective tax rate of 205.8 percent.  This compares to a provision for income taxes of $5.0 million recorded during the first quarter of fiscal 2012, which represented a 28.6 percent effective tax rate.  This increase in the effective income tax rate is primarily due to changes in the valuation allowance for certain foreign losses for which no benefit is recognized.  During the first quarter of fiscal 2013, the Company continued to record a full valuation allowance against its net deferred tax assets located in the U.S. and certain foreign jurisdictions as it is more likely than not that these assets will not be realized based on historical performance.  It is possible that by the end of fiscal 2013, the U.S. taxing jurisdiction will no longer be in a cumulative three year loss position thereby removing significant negative evidence concerning valuation allowance.  Throughout the remainder of fiscal 2013, all positive and negative evidence will be further analyzed in order to determine the propriety of the valuation allowance against the net deferred tax assets of this jurisdiction.

Loss from continuing operations of $1.1 million for the first quarter of fiscal 2013 represents a $13.7 million decline from the earnings from continuing operations of $12.6 million recorded for the first quarter of fiscal 2012.  In addition, diluted loss per share from continuing operations of $0.03 decreased $0.30 from diluted earnings per share from continuing operations of $0.27 for this same period last year.  The decrease in sales volumes and the European restructuring expense were the primary drivers of this decrease.

SEGMENT RESULTS OF OPERATIONS

Original Equipment – Asia

The Original Equipment – Asia segment is still in a growth phase and is currently launching numerous programs.  Net sales decreased $5.5 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 due to an expected decrease in automotive sales as we continue the strategic exit of the automotive module business and a decline in the off-highway vehicular market due to weak economic conditions in China.  Gross margin declined from 14.5 percent during the first quarter of fiscal 2012 to 2.6 percent during the first quarter of fiscal 2013 due to the sales volume decrease.  Loss from continuing operations of $2.3 million for the first quarter of fiscal 2013 represents a $3.1 million decline from the income from operations of $0.8 million for the first quarter of fiscal 2012 due to the decrease in gross profit from the lower sales volumes.

Original Equipment – Europe

Original Equipment – Europe net sales decreased $41.4 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013, driven by a $28.6 million decrease in premium automotive sales volumes as we continue to wind down the automotive module business, a delay in launches of commercial vehicle programs due to the slowdown in demand in the European commercial vehicle market, and a $15.3 million unfavorable impact of foreign currency exchange rate changes.  Gross profit decreased $10.7 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 including a $1.8 million unfavorable impact of foreign currency exchange rate changes, and gross margin decreased 350 basis points to 11.7 percent from 15.2 percent over this same period.  The decline in gross margin is primarily attributable to the lower sales volumes.  SG&A expenses decreased $3.4 million to $10.4 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013 due to lower compensation-related expenses and a $1.8 million favorable impact of foreign currency exchange rate changes.   Loss from continuing operations of $0.2 million during the first quarter of fiscal 2013 represents a decline of $11.8 million from income from continuing operations of $11.6 million during the first quarter of fiscal 2012.  The (loss) income from continuing operations decline is a result of lower gross profit on lower sales volume and $4.5 million of restructuring expense recorded in the first quarter of fiscal 2013.

During the first quarter of fiscal 2013, we began implementing a restructuring plan in the Original Equipment – Europe segment.  This plan includes exiting certain non-core product lines, reducing manufacturing costs, implementing headcount reductions, and disposing of or selling certain fixed assets.  We recorded restructuring expense of $4.5 million in the quarter due to headcount reductions under this plan.  The restructuring plan is designed to align the cost structure of the segment with the strategic focus on the commercial vehicle market.  The long-term objectives of the restructuring plan for this segment are to achieve a gross margin in a range of 15 percent to 17 percent, annual SG&A savings of approximately $6.0 million to $9.0 million, operating margin in a range of 8 percent to 10 percent, and return on average capital employed of 15 percent.

Original Equipment - North America

Original Equipment – North America net sales decreased $3.0 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013, primarily driven by the wind down of automotive programs, partially offset by increases in commercial vehicle and off highway sales.  Gross margin increased 100 basis points to 15.4 percent during the first quarter of fiscal 2013 from 14.4 percent during the first quarter of fiscal 2012 driven primarily by lower material costs and improved plant performance.  SG&A expenses decreased $2.1 million primarily due to lower pension and warranty costs and higher prototype and testing recoveries.  Income from continuing operations increased $3.0 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013, due to higher gross profit and lower SG&A expenses.

South America

South America net sales decreased $16.7 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013, due to the continued weakness in the commercial vehicle market following the pre-buy ahead of the January 1, 2012 change in emission standards, aftermarket sales declines due to local economic conditions and an unfavorable impact of foreign currency exchange rate changes of $7.1 million.  Gross margin decreased from 18.8 percent during the first quarter of fiscal 2012 to 15.2 percent in the first quarter of fiscal 2013, due to the lower sales volume.  SG&A expenses decreased $1.8 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013, partially due to a favorable impact of foreign currency exchange rate changes of $0.9 million.  Income from continuing operations decreased $2.5 million, based on the lower gross profit from lower sales volume, partially offset by the decrease in SG&A expenses.

Commercial Products

Commercial Products net sales decreased $4.0 million from the first quarter of fiscal 2012 to the first quarter of fiscal 2013, primarily due to weak overall economic conditions in the United Kingdom, a slowdown in construction activity ahead of the Olympics in London and a $0.4 million unfavorable impact of foreign currency exchange rate changes.  Gross margin decreased 170 basis points to 26.2 percent during the first quarter of fiscal 2013 from 27.9 percent during the first quarter of fiscal 2012, from the lower sales volume.  SG&A expenses increased $0.8 million due to investment in new products and future growth.  Income from continuing operations declined $2.4 million to $1.0 million in the first quarter of fiscal 2013 from $3.4 million in the first quarter of fiscal 2012, due to the lower gross profit on the lower sales volume.

Our primary sources of liquidity are cash flow from operating activities and borrowings under lines of credit provided by banks in the United States and abroad.  See Note 12 of the Notes to the Condensed Consolidated Financial Statements for further information regarding our debt agreements.

Our debt agreements require us to maintain compliance with various covenants.  Under its primary U.S.-based debt agreements the Company is subject to an adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) to interest expense (interest expense coverage ratio) covenant and a debt to adjusted EBITDA (leverage ratio) covenant.  Adjusted EBITDA is defined as earnings from continuing operations before interest expense and provision for income taxes, adjusted to exclude unusual, non-recurring or extraordinary non-cash charges and up to $40.0 million of cash restructuring and repositioning charges, not to exceed $20.0 million in any fiscal year, and further adjusted to add back depreciation and amortization.  Adjusted EBITDA does not represent, and should not be considered, an alternative to earnings from continuing operations as determined by generally accepted accounting principles (GAAP), and our calculation may not be comparable to similarly titled measures reported by other companies.

The Company is required to maintain the interest expense coverage ratio and leverage ratio covenants based on the following ratios:

(dollars in thousands)

(dollars in thousands)

Our interest expense coverage ratio for the four fiscal quarters ended June 30, 2012 was 8.77, which exceeded the minimum requirement of 3.00.  The following table presents a calculation of our interest expense coverage ratio:

(a)  Other items include costs associated with the sale of receivables.

We expect to remain in compliance with the interest expense coverage ratio and leverage ratio covenants through the remainder of fiscal 2013 and beyond.

None.

In June 2011, the FASB issued an amendment to the accounting guidance for the presentation of comprehensive income. This amendment removes one of the three presentation options for presenting the components of other comprehensive income as part of the statement of changes in shareholders’ equity and requires either a single continuous statement of net income and other comprehensive income or a two consecutive statement approach.  This amendment shall be applied retrospectively and is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011.  This amendment was adopted for the first quarter of fiscal 2013 in the separate condensed consolidated statements of comprehensive income (two consecutive statement approach).

In September 2011, the FASB issued an amendment to the accounting guidance for testing goodwill for impairment.  The amendment provides an option for companies to first use a qualitative approach to test goodwill for impairment if certain conditions are met.  If it is determined to be more likely than not that the fair value of the reporting unit is less than its carrying amount, entities must perform the quantitative analysis of the goodwill impairment test.  The amendments are effective for goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  We are assessing this new guidance and currently do not anticipate any impact on the consolidated financial statements from the adoption of this amendment.

There have been no material changes to our contractual obligations outside the ordinary course of business from those disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012.  We are currently unable to determine the impact on our contractual obligations from the ultimate timing of settlement of the gross liability for uncertain tax positions, which was $3.2 million as of June 30, 2012.

For the remainder of fiscal 2013, we expect weak economic conditions in several key geographic markets, including Europe, South America, and Asia.  Also, we expect approximately $80 million of planned program reductions due to the wind down of our BMW business in Europe and Asia, and of certain automotive and military programs in North America. These factors, as well as unfavorable foreign exchange impacts, result in an outlook of a 5 to 10 percent year-over-year decrease in net sales compared with our fiscal 2012 results.  We began to implement a restructuring program designed to align the cost structure and manufacturing base in Europe with a strategic focus on the commercial vehicle market.  We expect the impact of the sales volume declines in fiscal 2013 will result in operating income in a range of 3.5 to 4.0 percent of sales, excluding the impact of the European restructuring.  Further, we expect diluted earnings per share to be in the range of $0.60 to $0.70, excluding the impact of the European restructuring.  This outlook is unchanged from that reported at the end of fiscal 2012.

This report contains statements, including information about future financial performance, accompanied by phrases such as “believes,” “estimates,” “expects,” “plans,” “anticipates,” “intends,” and other similar “forward-looking” statements, as defined in the Private Securities Litigation Reform Act of 1995. Modine’s actual results, performance or achievements may differ materially from those expressed or implied in these statements, because of certain risks and uncertainties, including, but not limited to, those described under “Risk Factors” in Item 1A. in Part I. of the Company’s Annual Report on Form 10-K for the year ended March 31, 2012.  Other risks and uncertainties include, but are not limited to, the following:

 

In addition to the risks set forth above, Modine is subject to other risks and uncertainties identified by the Company in public filings with the U.S. Securities and Exchange Commission.  Modine does not assume any obligation to update any forward-looking statements.

The Company’s market risk disclosures have not materially changed since the 2012 Form 10-K was filed.  The Company’s quantitative and qualitative disclosures about market risk are incorporated by reference from Part II, Item 7A of the Company’s Annual Report on Form 10-K for the year ended March 31, 2012.

 

 

As of the end of the period covered by this quarterly report on Form 10-Q, the Company carried out an evaluation, at the direction of the General Counsel and under the supervision of the Company’s President and Chief Executive Officer and Vice President, Finance and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e), with the participation of the Company’s management. Based upon that evaluation and the identification of a material weakness in the Company’s internal control over financial reporting as described in Part II, Item 9A of the Company’s fiscal 2012 Form 10-K, the President and Chief Executive Officer and Vice President, Finance and Chief Financial Officer concluded that the design and operation of the Company’s disclosure controls and procedures are not effective as of June 30, 2012.

 

During the first quarter of fiscal 2013 there was no change in the Company’s internal control over financial reporting that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II.  OTHER INFORMATION

ISSUER OF PURCHASES OF EQUITY SECURITIES

The following describes the Company’s purchases of Common Stock during the first quarter of fiscal 2013:

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.