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Executives

Susan Fisher – Director of IR and Corporation Communications

Tom Burke – President, CEO and Chief Technology Officer

Brad Richardson – EVP of Corporate Strategy and CFO

Analysts

Andrew DeAngelis – KeyBanc Capital Markets

David Leiker – Robert W. Baird

Modine Manufacturing Company (MOD) F2Q09 (Qtr End 09/30/08) Earnings Call Transcript October 30, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Modine Q2 2009 earnings conference. My name is Kim, and I'll be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator instructions) I would now like to turn the presentation over to your host for today's conference, Ms. Susan Fisher, Director of Investor Relations and Corporate Communications. Please proceed, ma'am.

Susan Fisher

Thank you, everyone, for joining us today for Modine’s second quarter fiscal year 2009 earnings call. With me today are Modine’s President and Chief Executive Officer, Tom Burke, as well as our Executive VP, Corporate Strategy, and Chief Financial Officer, Brad Richardson. Tom will lead us off today with an overview on the quarter and our market outlook amid challenging business conditions. Brad will then review our financial performance and then we’ll be happy to take your questions. We will be using slides with today’s presentation. Those slides are available through both the webcast link as well as a PDF of the slides posted on our Investor Relations sections of our company website, modine.com.

If you should need to exit the call for any reason, a replay will be available beginning approximately two hours after this call concludes at toll free 888-286-8010 with the passcode of 75653515. Before we begin, a brief reminder that our call today may contain forward-looking statements, as outlined in today’s earnings release as well as in our company’s filings with the Securities and Exchange Commission.

And with that, it’s my pleasure to turn this call over to Tom Burke. Tom?

Tom Burke

Thank you, Susan. Clearly the world has changed a great deal since our last quarterly earnings call. During a period of heavy restructuring and launching within Modine, our business, like most within our industry segment, has felt the full impact of the credit market crisis, which has fueled both macroeconomic and end-market uncertainty. Within this environment, our second quarter results were clearly a disappointment.

Pretax earnings reflected a loss of nearly $17 million on net sales of $433 million. Absent the one-time items, which Brad will detail for you in a few moments, our pretax results for the quarter would reflect a loss of $5.3 million compared to a loss of $3.1 million in the prior year quarter, resulting in an underlying decline of about $2 million.

Looking within our segments, first within Original Equipment – North America, the results were disappointing. Due to a combination of planned plant closures, program launch-related operating inefficiencies, and sluggish North American Class 8 and medium truck volumes, we’ve seen these difficulties continue. The Original Equipment – Europe segment experienced a noticeable decline in automotive production volumes combined with a mix shift to a lower margin product in a specific customer application. Original Equipment – Asia segment results reflected a significant volume decline due to a strike-related activity at a major customer, which has since been resolved. I would like to note two bright spots in the quarter. And that’s the Commercial Products group and our Brazilian operations where performance continued to be strong and the outlook looks positive.

On slide five, you can see the historical and projected sales for our two largest markets; the North American Class 8 truck and the Western European automotive markets. In the North American truck market, you can see the dramatic drop since 2007 pre-buy, driven by the ’07 emission regulations. We anticipated a healthy return to the 2009 calendar year North American truck market. But with the market uncertainty and the prolonged impact of the economy, we are projecting another difficult year in 2009. The ranges for the remaining 2008 and 2009 calendar year are from the AMRC participants. The darkened 200,000 point is our estimate for both calendar year 2008 and 2009. We are preparing ourselves to live within these projections.

In Europe, the automotive market has dropped drastically. The projections shown are based on J.D. Power’s forecast for automotive sales in Western Europe. We are using these projections in our forecast for the balance of our 2009 fiscal year and in preparation for fiscal 2010. Again, we are preparing our operations to live within these assumptions.

Continue with our market outlook on slide six. With the market uncertainty and its impact on the global economy, we are adjusting our guidance downward. Our focus is prepare for a worst-case scenario to ensure we navigate the next 18 to 24 months successfully. We will be closely evaluating and aggressively managing our businesses to ensure we meet our debt coverage commitments.

I would like to talk about our outlook past the challenge of the next 18 to 24 months. We remain very positive about the future. Our few facilities in India, China, Hungary, and Mexico are all proving to be prudent investments, each is landing new higher margin business with our core products. Our new technologies have been well received in the market. Our new exhaust-gas-recirculation cooler or EGR technology is ramping nicely as we hope our customers prepare for the 2010 and EURO 6 emission law changes.

Our Origami technology is meeting with an excellent response from our targeted OE customers. The Commercial Product group has introduced a high-efficiency chiller into the market has already surpassed our annual sales projections. Simply put, our order book is strong. The product focus organization structure we put in place is yielding the expected benefits, which is a strong product technology pipeline that we know will provide high value to our customers and higher returns to the customer and our shareholders.

On slide seven, we have a slide on focus on the fundamentals. We call it blocking and tackling. Our four-point plan is our game plan. It brings together actions in an orchestrated manner to ensure we are effectively executing towards our goal of returning the company to top quartile performance and shareholder return. The proactive steps, which began in the fall of 2006, are continuing and in fact accelerating. Last week we announced the intended sales of our Korean vehicular HVAC business.

In the last month, we have realignment our North American corporate organization structure with clear accountability for the leadership and delivery of results within our North American OE segment. This resulted in about a 15% management reduction at our Racine headquarters. We also announced recently the elimination of post-retirement medical coverage for Medicare eligible participants. These are difficult decisions, but ones that we must make and will continue to make to ensure the future viability of the company as well as to keep Modine a leader in the thermal management technology and innovation.

With that, I’d like to turn the call over to Brad to review our financials and liquidity situation.

Brad Richardson

Thanks so much, Tom. And good morning to everyone. On slide eight is the outline for the financial review here this morning. And so we can turn first to slide nine. As Tom pointed out, there is no doubt that Modine’s second quarter was quite challenged on an absolute basis, but also relative to the comparable 2008 period. As you can note, the overall pretax earnings and EBITDA declined by $22 million. Negatively impacting the results was a decline in the overall gross margin as we experienced decline in revenues in the higher margin European business as well as a negative mix issue in Europe. The operating inefficiencies in North America albeit at a lower level than the first quarter of this year.

The SG&A expenses were up $6.8 million. But if you exclude the impact of last year of the gain on the sale of the corporate aircraft and the favorable impact of last year’s pension freeze, SG&A expense was actually down over $2 million. Despite the challenging income results, the overall cash flow from operations was down only about $4 million and our net debt position was unchanged at $193 million, as we continue to tightly manage working capital ultimately with the goal of running the company on a free cash flow neutral basis this year.

The objective of slide ten is to share you the underlying results of the company, excluding unusual items. In the current quarter, the company was impacted by the repositioning related charges, which included cost associated with plant closures announced in February of this year as well as severance related costs resulting from the downsizing here at the corporate headquarters in Racine. In the prior year’s second quarter, we experienced special factors, as indicated on the slide, with the most significant being, once again, the gain on the sale of the corporate aircraft and the favorable impact of the freeze Modine’s US-defined benefit plan.

Absent the unusual items, you can see that the pretax results for the quarter would be a loss of $5.3 million compared to a loss of $3.1 million in the prior year quarter. EBITDA of $16.9 million on an adjusted basis compares to $19.1 million in the previous quarter. Net-net, the underlying results are down about $2 million.

Turning to slide 11, the left side of table shows in change in sales by segment on an absolute basis and without the benefit of foreign exchange. Most notable is the decline in sales in Asia due to labor strikes at a key customer and in Europe due to decreasing volumes in the automotive segment. We continued to enjoy sales growth in South America and further the sales strength in Commercial Product segment reflects the impact of new product introductions here in North America and in the UK, leading to market share growth.

From a segment operating income standpoint, I would draw your attention to the far right column, which shows the change in profitability excluding the impact of exchange and other unusual items. The change in Asia profitability was related directly to the volume decline. For Europe, the $8.8 million drop reflected the impact of volume declines and an adverse mix as we are phasing out a high margin EGR product.

The North American relative improvement was still disappointing as the business continued to run in an absolute loss position and experienced operating performance issues due to plant closures and launch-related inefficiencies. On the positive side, the performance and the profit conversion on the incremental sales in South America and Commercial Product sets a standard for the rest of our businesses.

Turning our attention to slide 12, as we have indicated previously, none of us are satisfied with the performance of the company over the last two years. And the current decline in the end market, particularly in Europe, has heightened the need to take significant action for the ultimate turnaround of the company. We started the restructuring efforts in 2006 and established the four-point plan long before the credit-drive economic downturn.

Over the 2006 to 2008 period, we closed four original equipment plants here in North America while opening new facilities in Mexico and emerging markets. At the same time, we completed the divestment of our electronics cooling business and completed two workforce reduction programs, taking approximately 100 positions out of the Racine headquarters in 2006 and approximately 15% of the management staff last month.

We have also frozen the US-defined benefit plan and eliminated the post-retirement medical benefits for our US Medicare eligible population, reducing our OPEB liability by approximately $15 million. As it relates to capital allocation, we have put in a clear process and framework for allocation of capital to advantage product lines with a financial hurdle rate consistent with our gross margin and return on capital employed framework. We have also made a tough decision in the fuel cell area, choosing to license our technology versus investing approximately $85 million in capital to support a program that did not need Modine’s financial hurdle rates.

We have accomplished a lot and have a number of actions in progress, including the closure of four plants that were announced in February. When closed, we expect to reduce our cost structure by approximately $16 million $20 million, which is down approximately $4 million from our previous estimates. In addition, last week we announced our intention to divest our Korean vehicular HVAC business.

In response to the current environment, though, we must once again look at further actions to ensure the company weathers the significant contraction in the global economy. Actions under consideration include additional plant closures, the evaluation of our vehicular HVAC assembly businesses outside of Korea, and additional SG&A related actions. We have a very good track record of follow-through on the critical elements of the four-point plan, which are designed to return the company to profitability and achieve Modine’s long-term return on capital employed framework of 11% to 12%. At the same time, as Tom mentioned, we are very excited about the new program wins and market share capture opportunities on which the company continues to execute.

Turning to slide 13, today, and as Tom mentioned, in light of a significant change in the world economic outlook, we are reducing Modine’s guidance for fiscal 2009 reflecting the impact of an assumed stagnant North American truck market, where Modine has a significant market share and the sharp drop-off in automotive production in Europe. The sales volume impact coupled with the strength of the US dollar has contributed to an approximate $200 million drop in top line revenue. The significantly lower revenue is converting at the gross profit line on the downside at about a 20% rate versus the previous guidance, resulting in the new projection of a loss – a pretax loss in a range of $5 million to $25 million. I would note that the guidance does include approximately $17 million in restructuring actions and $12 million in the one-time licensing payment from Bloom Energy.

Let me close off this slide with a big qualifier. There is a high degree of uncertainty on how the steep the markets are going to decline resulting in a wide range of variability around how the company is going to perform for the rest of the fiscal year.

On slide 14, in light of the projected loss position, we wanted to provide you with an update on Modine’s liquidity situation. Under the three primary debt instruments of the company, that is the $175 million revolving credit facility and two private placement notes, Modine is required to maintain a debt-to-EBITDA of less than 3 and an EBIT interest coverage ratio of greater than 1.75 adjusting to 2.25 at the end of Modine’s fourth quarter.

As you can see, Modine is in full compliance with its covenants at the end of the second quarter. At this point, given the income impact of the Bloom Energy payment primarily impacting the third quarter, we would expect to remain in compliance at the end of the third quarter. Given the guidance discussed though on the previous slide, we would anticipate needing to work with the bank group and note holders to execute amendments or waivers to the EBIT-to-interest coverage ratio yet this fiscal year.

Through preliminary discussions we have had with the bank group, we do expect our creditors will work with us. In the event that we are unable to reach agreement, we have developed a series of actions that could be executed on to ensure that the company remains in compliance. Obviously, these actions are quite strategic in nature or we would have already executed on these alternatives.

With that, I’ll turn it back to Tom for a wrap-up.

Tom Burke

Thank you, Brad. And as Brad said, we are preparing for the challenging period that we anticipate in fiscal ’09 and ’10. Modine leadership team has and will continue to be aggressive in executing on our four-point plan. Again repeating those. The manufacturing realignment that is achieving greater scale expanding our low-cost country footprint, we are well on our way. The portfolio rationalization, we're clearly defining our advantage products and fixing our problem product segments is well in place. SG&A expense reduction, which is focused on lean administrative processes and affordable structure targets that we'll drive to is in place. And finally, the capital allocation discipline, which is using our precious capital wisely in making sure we make the smart bets going forward, again is in place.

Our approach of blocking and tackling is having an impact. The focus on our underperforming North American business is intense. I’m encouraged with the initial results of the team, but we have a significant challenge that must and will be overcome. Our decision on Korea, while difficult, is the right long-term decision for the company, so we can focus our resources and capital on advantage products and to provide higher value to customers and higher returns to company and our shareholders.

We have a 92-year old heritage as a leading thermal management technology company and are fully intent on managing our company to these near-term challenges as we have in the past to ensure a bright future.

And with that, Brad and I will be happy to take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Andrew DeAngelis of KeyBanc Capital Markets. Please proceed.

Andrew DeAngelis – KeyBanc Capital Markets

Good morning, guys.

Tom Burke

Good morning, Andy.

Andrew DeAngelis – KeyBanc Capital Markets

I guess first question here. Just wanted to get I guess your thoughts on the specific actions that you are taking to frame the company within your revised market outlook in addition to the restructuring actions you already have in place.

Tom Burke

Andrew, at a high level, we have clearly a clear list of levers and actions that we have in place and ready to take on that we have high confidence in. And we’re prepared to do what it takes to move that forward and getting the assumptions right. And paying attention to those is clearly going to be where our focus needs to be, and again we have that in place. The actions that Brad highlighted in a couple of his points moving forward (inaudible) under the four-point plan are clearly the actions we need to make sure we remain focused on.

Andrew DeAngelis – KeyBanc Capital Markets

But do you need to take any major additional restructuring move, specifically within Europe, to address your current market outlook?

Brad Richardson

Andrew, I mean, certainly and just to delve on Tom’s point, what we identified clearly is additional things that are under evaluation. Clearly our additional closures, plant closures, and that could involve Europe. As you know, we have one plant being closed in Europe and there is the potential for an additional closure in Europe. So that’s certainly, as Tom mentioned, is part of what we’re looking at in light of the downturn that we are seeing. We also – on the portfolio side, as I mentioned, we have announced the exit of the vehicular HVAC assembly business in Korea and we are looking at our other businesses that are dedicated to that form of product and market. And then the SG&A side, clearly that’s something that we’ve got to really continue to focus on and are focused on to control that element of our business globally.

Andrew DeAngelis – KeyBanc Capital Markets

Okay. I guess strategically within Europe, are you guys happy with your current footprint, just I guess the way it lays out your cost intensiveness? Obviously, the market conditions weigh in on how tactically that’s implemented, but I’m just wondering if something similar to what you guys have done in North America to scale the operations a little bit more perhaps needs to be done in Europe.

Tom Burke

Clearly, we are taking the first step with the first plant in Germany, of the four plants that we have. And our mix is rich in Western Europe, but we are – one of the things that we’ve really leveraged is running at very high utilization rates in our plants. So we get every bit of absorption that we can through the operations has been successful. The Hungarian plant that we're launching right now in Gyongyos is really going to help that. Okay? So that's the first step. Again that investment that’s fueling up with charge air cooler business and other heat exchanger component to feed back into Western Europe to help us secure EURO 6 truck market share is also a key play in that. So, yes, we have a rich mix. So I would say is high cost country. We are effectively improving that with the Hungarian footprint, and we will take whatever further actions going from there to make sure we have a competitive focus that we can hit the cost targets and yield those margins. And additionally, this hasn’t been announced as widely, but we are expanding our Austrian footprint as well with the condenser business where we have a very advantage position both from at technical standpoint and manufacturing scale in Austria. And we looked at the options of how to move that forward with new business opportunities. We’ll be expanding that operation with actually a new facility to allow us become even more scale-efficient and more effective delivering product into that advantage product segment. So we have the right look at it, Andrew, and again we are moving with the right steps, but we will accelerate again if we find that’s necessary.

Andrew DeAngelis – KeyBanc Capital Markets

Great. And I guess just staying with Europe, could you give me some color on the production environment that you guys are seeing there in recent weeks? How far it’s gone down? And how far – given the market outlook that you’ve given us today, how far it further needs to go to hit I guess the run rates?

Tom Burke

Well, you saw – in the slide, you saw the J.D. Power’s projection of how we are going to – how they're projecting, which is going to I think a $13.7 million type market as far as sales in Western Europe (inaudible) on that. There's a lot of variation within OE customers in Europe. Some are holding in better than others. Some are losing it. So, you see anything from a 10% to 15% at some of the premium car suppliers or maybe some of the mid-segment suppliers are holding in with normalized volumes at this point. So I think it’s going to be a mix situation depending on how long this prolonged economic impact stays on with in Europe. But clearly we are focused to get underneath it, to use my term, and make sure we have an equation, an operating position that can live within our projection.

Andrew DeAngelis – KeyBanc Capital Markets

But I guess my question was, the production rates that you are currently experiencing in Europe fit to that I guess 12.4 number that you see for production in Europe next year. I mean, have you gotten all the way down there? How much further do we need to go to get to that 12.4 number versus where we are currently at?

Tom Burke

We have not gotten to that 12.4 number yet. Okay? I would say we are running more at the 13.7, 13.5 kind of range right now with probably an average 10% drop at the mix right now. So – but we are prepared to go lower, and we are prepared – obviously taking costs out of Europe is always challenging. And because we’ve been running over rates, our plans have been running at six-plus days usually for the last couple of years. So we can actually come down in volume and stay within our five-day window to match customer needs in a lot of cases. Where we can’t, we will be looking at short work weeks. Clearly, the temporary employees that we have in each of our plants, which is also a tool we've used to manage the upward volume. So, I think we have the levers in place to be able to match up well to the demand that we see in front of us. And if it should drop further, we are going to anticipate that and make the changes accordingly.

Andrew DeAngelis – KeyBanc Capital Markets

Okay, all right. Just one more question from me before I hop back in. The pricing actions that you guys announced within your North American replacement oriented business, I believe that press release came out in the last month, month and a half or so. Just wondering how that is going in terms of implementation? And then maybe just some color on what you expect commodity costs for you guys to do going forward?

Brad Richardson

Yes. Andrew, I mean, the – I would say that as it relates to the pricing action, we certainly didn’t see much of that in the second quarter because that was clearly announced late in the second quarter, so there is not much of an impact in the second quarter. I would say this that the pricing action – because clearly we’re in front of the major customers here in North America right now literally as we speak and the pricing action is going to start to affect the business and is incorporated in our guidance in the third – but more significantly in the fourth quarter. And I think overall, I think there has been a respectable response to what we're proposing to the customers. So I think that’s kind of a status report as to where we stand on pricing.

Andrew DeAngelis – KeyBanc Capital Markets

Okay. And then I guess on the commodities cost?

Brad Richardson

Yes. The commodities, certainly that’s a great tailwind for the company. You’ve seen copper come off significantly and aluminum and nickel. As you know, there is a lag effect just as it’s on the way up and there is a lag effect on the way down simply because right now we are still taking delivery of copper that was priced in the late summer timeframe when copper was still up over $3 and aluminum was up over $1.20. So again, I think the tailwind from the commodities and the favorable benefit will start to impact the company in our fourth quarter – so, the first calendar quarter of the year.

Andrew DeAngelis – KeyBanc Capital Markets

And to the extent that you’ve implemented pricing actions with your OEs that contemplate higher levels for commodities, do you anticipate I guess being able to hold that pricing somewhat given I guess the gross margin degradation that you saw on the way up to some extent?

Brad Richardson

Absolutely. I mean, our intent – and we have no choice, right, given the condition of the company, but to ensure that we enforce the contracts that we have. And fortunately, with just the timing of the adjustments of those and the way they are calculated, again that should give us a decent tailwind as we go into fiscal 2010. Now, is that going to offset again the discussion you were having with Tom on the volumes, that’s certainly going to be a challenge. But that is a positive in terms of the commodity prices and how that works through in terms of price adjustments back to the customers.

Andrew DeAngelis – KeyBanc Capital Markets

Okay. Thanks for the color.

Brad Richardson

Okay, very good.

Operator

Your next question comes from the line of David Leiker of Robert W. Baird. Please proceed, sir.

David Leiker – Robert W. Baird

Hi, good morning.

Tom Burke

Good morning, David.

Susan Fisher

Hi.

David Leiker – Robert W. Baird

Can you give us some sort of perspective on the currency side, what the impact is on the operating income or EPS line for you guys?

Brad Richardson

Well, you are talking about in the quarter?

David Leiker – Robert W. Baird

Yes, in the quarter and then just on a general basis going forward, given the significant move in the dollar.

Brad Richardson

Yes. I mean, the currency in the quarter was about a $13 million favorable impact on the top line. And again, that’s primarily out of Europe and South America. In fact, out of Asia went the other way. So, net $13 million. And on the contribution in the quarter was a favorable $1.3 million. As we look at the guidance – I mean, you’ve seen the overall reduction in revenues of $200 million versus the previous guidance. About $80 million of that $200 million drop is our assumption that the dollar will stay strong, stay in the relative trading range that it is right now. So you can see that – again, the strength of the dollar, David, has made a significant impact, about $80 million on that change in guidance. So the balance of the $200 million drop-off then would be market-related both here in North America as it relates to the Class 8 truck market and in Europe as it relates to automotive volumes.

David Leiker – Robert W. Baird

And then could we imply that that's an $8 million negative impact on profit as well?

Brad Richardson

It’s in that range.

David Leiker – Robert W. Baird

Is that an operating income line or gross profit? Where are you entering that number?

Brad Richardson

Pretax.

David Leiker – Robert W. Baird

Pretax?

Brad Richardson

Yes.

David Leiker – Robert W. Baird

Okay. Given what’s going on in these end markets, your South American business has rapidly become a major profit contributor. Just give us some perspective on what’s happening there? Those markets seem to be weakening and you’ve got negative currency moves down there as well. Just give us a better understanding on what’s happening in that market as it relates to you, guys?

Tom Burke

I’ll go through the operating so that Brad talk about currency, but clearly the Brazilian market remains strong. We have a leading market share position both in our target markets of commercial vehicle and off-highway. The forecast through the end of our fiscal year are on target. We just had a forecast review with the team this week. And the order books remain strong as well. There is some softening around the edges, if you will, with Argentina that we are seeing some impact with ag sales going into Argentina with certain OEM customers. But again, with that offset versus other growth, we are seeing no impact to our forecast as initially estimated. So it appears that the Brazilian market remains strong, yet we do see some adjacent issues maybe in Argentina, but yet no net impact to the business because of the growth in Brazil.

Brad Richardson

Yes, David. I mean, just – we did continue to see quarter-over-quarter revenue growth out of South America that the reais strength – again it’s weakened lately, but in the quarter had a $5.8 million favorable currency effect. So – but even absent that, you can see that there was real underlying growth. It has, as you know – and in the factor analysis that we showed is the position of the reais has caused losses on a US dollar denominated loan down there, which has adversely impacted the profit by a little over $3 million in the quarter. So this currency is not only affecting – potentially affecting the outlook for the export market there, but it’s also had an impact on the specific income as it relates to that specific debt instrument.

David Leiker – Robert W. Baird

And the accounting for that is showing up in the segment profit or in the corporate?

Brad Richardson

Corporate, down in the other income.

David Leiker – Robert W. Baird

Okay. And then remind me please, your end market there is focused on the OE or after-market?

Tom Burke

We have both. I mean, on a commercial and off-highway side, it clearly is an OE perspective and then we have an after-market (inaudible). But it’s 70% OE focus, which is commercial truck and off-highway.

David Leiker – Robert W. Baird

Okay. Just a clarification here on South Korea. In terms of the extent that you look at exiting, selling that business, how much of it would you end up retaining? I mean, my sense is most of what you are looking at disposing here would be the bulk of your Korean business, correct?

Brad Richardson

That’s correct.

David Leiker – Robert W. Baird

Would your retain anything at all?

Brad Richardson

There is some power train cooling business and very little bit of engine products business that again fits right within our core product lines that we would look to somehow structure to be able to retain that.

David Leiker – Robert W. Baird

And we didn’t include the assets that are in China. If I remember correctly, you’ve had a –

Brad Richardson

You are talking about the JV, the JMCC, that’s an asset that’s under evaluation at this point. The sale itself did not include the joint venture in China.

David Leiker – Robert W. Baird

It does not. Okay. The fuel cell business, the accounting for that is going to be what? You got $12 million of license revenue with no expenses, is that correct?

Brad Richardson

Yes, that’s correct.

David Leiker – Robert W. Baird

And you said a bulk of that will show up in Q3?

Brad Richardson

That’s correct.

David Leiker – Robert W. Baird

And is this the solution to find the way to fund the growth in that business? Is that how we should look at this?

Brad Richardson

I think – I’ll say and then Tom – we’re both trying to chime in here. This is a difficult decision. But as we looked, clearly we had some – the fact that we got a $12 million payment says that our intellectual property and our know-how is quite valuable. But when we looked at actually commercializing this business, the amount of capital that was going to be required to commercialize, it certainly didn't meet our hurdle rate. And therefore, we entered to an arrangement with Bloom Energy to license our technology and receive this one-time payment, which I think again speaks very highly to the IP technology of the company. We continue, though, to be active in the fuel cell space and continue to support the customers in that space. But in this case, the commercialization did not meet our financial hurdle rate. So we chose a license strategy.

Tom Burke

And this fits right inside of our capital allocation discipline of our four-point plan, David, and we look very, very closely at this and clearly there is a real appeal because of the alternative energy space, but we did not see a business equation that would satisfy our hurdle rates going forward. So we as a team focused on the next right thing to do is capture all the value possible from the IP we’ve established.

David Leiker – Robert W. Baird

Yes. Are there any residual payments that can come out of this that are tied to performance on their part, or is this the end of the revenue stream from that for you?

Brad Richardson

It’s essentially the end of the revenue stream other than the fact that we have agreed to provide Bloom Energy hot boxes for their calendar 2009 requirements. But in terms of overall profit contribution from that is it will not be significant.

David Leiker – Robert W. Baird

And then do you – what do you retain in terms of rights for the technology that you can use to sell to other people, or is this an exclusive license agreement with them?

Tom Burke

We retain full rights and access we own it to the intellectual property. We will not be licensing that to others, but we have the ability to have full right access and use that technology with other customers.

David Leiker – Robert W. Baird

There are no prohibition on you licensing the technology or supplying other people?

Tom Burke

No, we can supply other people, we cannot license it to other people.

David Leiker – Robert W. Baird

Okay. I understand, thank you. And then the last thing here. You made a comment on the tax rate. Is there any – I realize this is a very difficult moving target to attack, but what would you suggest we use as kind of a base number to – going forward on your taxes?

Brad Richardson

I only wish I had you here right now, David, I could walk you through the tax calculation. It is very, very difficult. I mean, I think for the rest of the calendar year, I think you are still looking at 100% tax rate. And in the intermediate term, when the North American business returns to profitability, then we are back down to the historic 30% to 35% range. But I would use over 100% for at least the remainder of this calendar year.

David Leiker – Robert W. Baird

But a particular quarter, you're in a loss position, we should use taxes that are –?

Brad Richardson

In a normal quarter, you should still use – even in a loss position, you should use over 100%. It was the tax accounting for the post-retirement medical change is very unusual. And that resulted in an actual tax benefit being recorded in this quarter that was an unusual treatment.

David Leiker – Robert W. Baird

Okay. All right. Thank you.

Brad Richardson

Okay.

Tom Burke

Thank you.

Operator

You have a follow-up question from the line of Andrew DeAngelis of KeyBanc Capital Markets. Please proceed.

Andrew DeAngelis – KeyBanc Capital Markets

Hi, guys. Just wanted possibly a comment on your backlog, where it stands right now versus the year-ago period?

Tom Burke

But we don’t report officially a backlog or net new business number, Andrew, but I’ll give you a kind of a qualitative assessment. We have a healthy backlog. We are very satisfied with the discipline of last 18 months of hurdle rates and the profitability targets we’ve put in place and focusing on our target markets with our advantage products. So again, the commercial vehicle and off-highway business continues to look very strong. Our new plants, China, India, Hungary, some reference to I made before, but the China and India plants that are just launching with literally dozens of product launches in the next 12 to 18 months with products that again we’re very happy with the quality of that business. It’s coming forward. The technologies that I mentioned briefly again from engine products, EGR, for the EPA ’10 and EURO 6 markets are showing very good business wins. Going forward, again it targeted profits levels are above. And even the newer technology that’s coming out, we’ve introduced the Origami technology. We were recently at the German Truck Show and had the opportunity to really target critical customers that technology to demonstrate the opportunity and a lot of excitement that hasn't yielded necessarily orders yet, but a lot of excitement about what the value that brings to them. And we think even more confidence to fill that backlog. So the outlook passed this window. That’s what – which makes this even, let’s say, kind of a dichotomy of battling through the challenging times, but seeing what's waiting for us both in orders and launches we’ll be going through during that period of time, in bids that we are going through right now that are very exciting. We clearly have what we call a battle worth fighting for, and it’s our focus to attain that.

Andrew DeAngelis – KeyBanc Capital Markets

Great. And then just one last one from me. Your working capital, it looked like your inventories came down sequentially. I was just wondering if you guys are under-producing yourselves right now and how much longer you anticipate that would be the case and the kind of the under-absorption that results from that right now?

Brad Richardson

Yes. I mean, I think the inventory levels though, if you look at the turns, actually aren’t where we want them to be. I was pleased about the work that we’ve done on DSO and on the payables, but the inventory turns, you just look at them in the quarter. We were turning in fiscal 2008 at 13 times, in fiscal ’07 at 13 times. We turned 11 times in the second quarter. And clearly what’s happening is operationally there are a couple of things happening. One was strike-related banks that we had in Korea, which caused us to carry actually more inventory that we would expect. And clearly the closure activity here in North America, there are inventory buffers. And third is clearly in light of some volatility in customer schedules. But the organization, this is something that Tom and I are very, very focused on is to bring the turns back up to where we have been operating in the 13 range and by the end of the fiscal quarter. So there is more room on the inventory.

Andrew DeAngelis – KeyBanc Capital Markets

Okay, okay. Thanks for that color.

Brad Richardson

Yes.

Operator

There are no further questions in the queue.

Tom Burke

We would like to thank everybody for participating and we will be focused on the plans we laid out here and look forward to next quarter’s call to give you an update on where the company stands. Thank you very much.

Brad Richardson

Thank you.

Susan Fisher

Thanks.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: Modine Manufacturing Company F2Q09 (Qtr End 09/30/08) Earnings Call Transcript
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