Modine Manufacturing Co (MOD) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Modine Manufacturing Company earnings conference call. At this time, all participants are in listen-only mode and 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 Ms. Susan Fisher, Director of Investor Relations and Corporate Communications. Please proceed.

Thank you and good morning, everyone. Welcome to Modine's second quarter and first half fiscal 2008 earnings conference call and webcast or the period ending September 26, 2007. Joining me on today's call are Modine's CEO, David Rayburn, and our Chief Financial Officer, Brad Richardson. Dave will provide comments on the quarter and year-to-date and some of our current activity. Brad will review the financial performance. And following their remarks, we will open up the call to your questions.

Before we begin, I'd like to remind you that this morning's call may contain forward-looking statements such as forecast of business performance and Company results, and expectations about the Company's plans and future initiatives. Actual results may differ materially from those projected. For an in-depth discussion of risk factors, please refer to today's press release and our Company's filings with the Securities and Exchange Commission.

If you have not received today's earnings release, it's available on the Investor Relations portion of our corporate website, along with presentation slides to be used in today's discussion, at www.modine.com.

With that, I'll now turn this call over to Dave Rayburn. Dave?

Thank you, Susan, and welcome to the Modine team. Brad will review the financial details of the quarter and the specifics in regards to our outlook for fiscal '08. But first, I would like to discuss the key takeaways from this morning's call.

We continue to be encouraged by the internal and external results and response from our actions to date in changing our business model. I will provide an update regarding some of our implementation efforts.

I am also pleased with the strong sales in Europe, Asia, and South America, which reinforces the value of our diversification strategy. Our international growth has been substantially offset by the continued weakness in the North America heavy-duty and medium truck markets. The rebound is much slower than anticipated, and based on this continued weakness, we are lowering our guidance range, which Brad will review later.

As we significantly realign our manufacturing, there has been near-term impact related to our efforts. These changes will provide significant benefits to our long-term results. I will review today the inefficiencies that we have been experiencing, primarily in North America, around our plant closures, consolidation, new product launches, and our plans to combat these emerging issues.

In the second quarter, we recorded net positive results and pricing recovery of past material cost increases. As we have discussed, there is a lag in recovering from our customers. This is the first time in three years we are finally catching up and we are pleased that the material costs continue to stabilize.

We are working to further reduce cost while supporting our long-term business growth. We executed on several initiatives this quarter to reduce our long-term cost. This will continue to be a priority. And finally, we will discuss the announcements we made on some leadership changes in the organization.

As you refer to slide four, it summarizes the North America past and projected annual heavy-duty truck build rates, which does have a significant impact on our earnings. We have seen reports throughout the quarter decreasing build rates estimates for the calendar year. You will note included in the chart that a pre-buy volume spiked prior to the January emissions standards changes, with nearly 372,000 units billed in 2006 compared to the expected calendar year billed at 2007 of nearly 218,000 units.

While the data presented from the awards indicates an increase in 2008, our sales show that this rebound is much lower level than we had anticipated in our earlier discussions. Based on the weakness in this market, we are increasing our fiscal 2008 estimate truck build. As a result of this softness coupled with other factors, we are also reducing our guidance. One positive sign is that the truck build is expected to increase in 2008 and 2009 in anticipation of the 2010 environmental changes.

Page five summarizes how we will profitably drive Modine forward. We introduced a year ago our plans to change the Modine business model. We have made great strides this year, but it is a journey. As noted in this slide, the four priorities, the categories, are summarized in four areas. And these are important four areas that will drive our new business model.

Organizational change, organizational excellence is a priority. Manufacturing realignment, which we will talk some today about. Rationalization of market and customers and products. And finally, technology acceleration, which we spent significant time discussing at our annual Board meeting.

Our implementation plans are organized around each of these drivers and a new business model is the structure that guides our actions. It is also through these drivers that we will achieve the metrics that are summarized at the bottom of this page that we are focused on to reach by the end of 2010.

Slide six. The manufacturing realignment is a cornerstone of our current actions. We are closing four North American plants and consolidating operations to create scale. As a result, we are qualifying and launching multiple product launches in our facilities. We are reducing our North America vehicular plant footprint by 20%. With changes of this magnitude, as evidenced in the quarter results, come temporary inefficiencies. We are working to continually identify emerging issues, develop and implement focused action plans, ensure appropriate resources are allocated or reallocated to manage our integration efforts, and improve our operation efficiencies.

In addition, we are currently building two plants in China -- one in India and one in Mexico -- and recently broke ground for a new facility in Northeast Hungary. The new capacity and low cost countries is a benefit for both regional growth and source cost reduction for our high cost regions.

The Mexican plant is under roof and we expect to begin production in July of 2008. Brad and I had the opportunity to visit our new construction site in Chennai, India last month. And they are on track with production slated to begin in April of 2008. We also visited our two plants in China. One is complete and the second is under construction and expected to start production in February 2008.

In addition to our realignment activities, we continue to focus on reducing our cost structure to ensure we remain competitive while also supporting our long-term growth. In this quarter, the gain related to the amendment for freezing our salary portion of our pension plan in the sale of the corporate aircraft are examples that had positive impact on our earnings, both for short-term and long-term. We are committed to reducing our cost structure that will bring our SG&A down to 11.5% by the end of 2010.

We announced our new organization structure in November, which is having positive results with our customers. It has five global product platforms. This restructuring is a key element of our business. The announcement this morning in regards to some leadership changes included we have a new leader in North American, Jim Rulseh. Jim will be replacing Chuck Katzfey, who has announced his retirement. Jim will be shifting his efforts in growing our Asian region to leading the North American activities -- the America activities, which include South America. This is a very challenging environment, but Jim has very strong business and operational background. With this change, Tom Marry will now lead Asia and will be relocating to Shanghai. Paul Byrne will fill Tom's role in the Global Products Global Group. And Scott Wollenberg will replace Paul in the Global Engine Product Group.

We have significant bench strength internally, and the breadth and depth of the experiences each of the individuals bring to their new assignments is a confidence builder for me. The organization structure put in place around new product introductions ensuring that we have focus on regional and operational accountability is a key element of our growth.

Turning to slide seven. From a product and market standpoint, we can continue to strengthen our customer relations and review our product offerings and rationalize as appropriate. It is a matter of making choices and driving our diversification model and our technology, and as I mentioned, we highlighted in our annual meeting. To this point, we have grown our market presence as demonstrated by our strong sales in Europe, Asia and South America. In our results, the growth helps offset the weakness in the North America truck business that I have discussed.

A diversification model, both by markets and by product lines, is a key strength of your company and we're going to continue to drive this diversification strategy. Mitsubishi, Peugeot and Hyundai heavy-duty industry are two programs that we recently announced that illustrate how we are building new business in Asia, leveraging our commitment and our capability in the region to have it to be a principal part of our Company.

The Airedale product line of new, energy efficient chillers is another example of our diversification strategy and bringing new technology that will not allow our products to be treated as commodities. Diversification in the Electronics Cooling business, which is under way, is also part of this rationalization strategy.

Environmental-related initiatives will also drive further growth as we support our customers to beat new requirements, such as further emission reductions; the move to carbon dioxide refrigerant for technologies -- an area that Modine is a leader; continued changes in SER ratings related to greenhouse gas reductions; oil prices with technology enhancements to reduce costs; and mileage standards and noise reduction expectations -- all of which Modine can address and grow our business appropriately. In our business, we continue to develop new opportunities to ensure growth. The next generation powertrain cooling and heat transfer technology we recently announces is very exciting. Our fuel cell activities are prime examples of the importance of new products for our long-term growth.

So I'll now turn it over to Brad to talk about some financials for the quarter and the year, and our full year outlook.

Thank you very much, Dave, and good morning to everyone. And I just want to reiterate Dave's welcome of Susan as Director of Investor Relations and Corporate Communications, and also thank Beth Coronelli, who served as the interim Director of Investor Relations and Corporate Communications. She did an outstanding job and I want to thank her for that.

Turning to slide eight, certainly we saw strong sales across most segments, as Dave mentioned, with the exception of North America. Net earnings of $9.9 million increased from $5.8 million driven by the strong performance outside of North America. The gains were also related to the decision made to freeze the benefits under the Company's salary portion of its US defined benefit pension plan and the sale of a corporate aircraft.

Further legislation passed in Germany was very favorable to the Company. It reduced the overall tax rate in Germany by 10 percentage points. This change resulted in a reduction in our deferred tax liability balance with the offsetting being a favorable contribution to earnings of about $2.5 million, thereby reducing our overall effective tax rate.

Further, the effect of tax rate benefited from a significant change in the earnings mix as we incurred losses here in the United States -- our highest tax rate jurisdiction -- and generated improved profits outside of North America in jurisdictions that have a lower tax rate. The earnings return on capital employed and margins were significantly impacted by the cyclical down turn in the relatively high margin North American truck market and operating efficiencies, which Dave outlined.

I will talk more to our margins and our targets going forward and how we plan to get there in a moment. But I would like to talk for just a minute about the balance sheet. We do remain conservatively financed with a debt ratio of 28.9% at the end of the quarter. The debt increased versus the previous year with incremental borrowings to support the construction of new plants and higher levels of working capital. The increase in working capital was primarily related to higher inventory levels, supporting the realignment activity here in the U.S. and higher sales in Europe. Further, the inventory levels also grew in Asia as we increased inventories to prepare for potential strikes in Korea, which did not occur.

As you may recall -- and Dave mentioned this last quarter -- the Electronics Cooling business is excluded from these results and is treated as a discontinued operations. We are in the process of marketing this business for sale and are very, very encouraged by the level of interest in purchasing this business.

So turning to the next slide, is a reconciliation -- I call it the earnings per share profit factor analysis -- which walks you from the $0.18 per share that we had in fiscal 2007 to $0.31 per share from continuing operations that we reported in our second quarter. Certainly on the operating side, the volume, the global strength that we had outside of North America was more than offset by a decline in North American truck build rates. On the commodity price side which, as Dave mentioned, has been a net negative to corporation for the last three years. It was actually positive in the quarter as commodity prices stabilized; a very encouraging trend for the Company.

And certainly the North American operating efficiencies that we incurred as a result of plant closures, consolidation, and new product launches adversely impacted the overall earnings comparison. There were a number of special factors, including the pension plan freeze, the sale of the corporate aircraft, and a change in the effective tax rate which, again, I mentioned was primarily a result of the German legislation and the mix impact on our income profile.

If you look at the next slide, that is slide 10, which shows our year-to-date performance, again, the factors impacting the overall comparison of the two periods are the same as we saw in the second quarter, with the North American volumes being down but strong performance outside of North America. And you can see the rest of the factors listed here on the slide.

If we can go to slide 11, I'd like to talk briefly about our segment results. And again, as just a reminder, these segments were introduced in our last quarter. And what we've tried to do is to show on this slide not only the actual reported sales and a change in those reported sales, but also the change in sales excluding the impact of foreign exchange benefits, which has had a very favorable impact on the overall sales comparison.

So let's briefly walk through each of the segments. The original equipment North America segment, again, was impacted by what I would call recessionary level declines in the build rates for the North American truck business. We also had the temporary manufacturing inefficiencies driven by plant closures, specifically the pending closure of our Jackson, Mississippi plant and the consolidation of our Richland plant, which has been closed, into our McHenry, Illinois plant. We also incurred inefficiencies associated with the launch of several new product lines.

Our Europe original equipment segment continued to show strength with sales reaching a record for the second quarter, primarily driven by exhaust gas recirculation coolers and the launch of new condenser programs.

In Asia, we had significant improvement, albeit the business is still operating in a loss position, driven by new business wins and the continued strength of the commercial vehicle and bus markets in Korea. We were very encouraged the labor negotiations in Korea are complete and we did not have strike activity this year. I would note that on an absolute basis, the Korea business has been profitable this year, with the offset being the costs that we are incurring in support of growth in this region and costs associated with launching the two plants that are under construction in this region that Dave spoke to.

South America also performed very well in the quarter with sales up over 50%. This reflected the strength of the agricultural and commercial vehicle markets where we have significant marketshare. I would note I had the opportunity to spend time in Brazil this quarter and am very, very encouraged about the opportunity that we have on a go-forward basis with this business.

In the commercial products segment, which consists of our specialty heating and air conditioning business, it continues to improve, as our earnings doubled in this segment, reflecting tight cost control and the absence of manufacturing inefficiencies that we incurred in the prior year quarter caused by facility consolidation following the Airedale acquisition. And as we've said previously, this is a business that we plan to further grow through synergistic and product extension type acquisitions.

So let's turn to slide 12 and look at our fiscal 2008 guidance. Certainly, our guidance has been impacted, as Dave mentioned, due to a revision in our assumptions on the North American truck build rate, which we've decreased from 205,000 units on the heavy-duty market to 190,000 units that's implied in the guidance that you see before you. The decrease in the EPS and the gross margin guidance assumption is due to significant weakness, again, in this North American truck market coupled with the operating inefficiencies that we've spoken to. The EPS guidance does reflect a significant reduction in the overall effective tax rate for the Corporation, again driven by the German tax law change previously mentioned and the change in our profit mix which, again, as we're generating large losses in North America -- our highest tax regime -- being offset by greater than anticipated income outside of North America where the tax rate are materially lower.

Finally, I would just note that we have adjusted our commodity price assumptions as material costs continue to stabilize.

Turning to slide 13, I think given the overall gross margin performance and expectations for this year, I think it's very important that we show you a partial pathway to our intermediate gross margin goal or target of 18% to 20%. To show this, we have taken the gross margin at the low end of the guidance range for this year, that is 15%, and normalized for certain items.

So starting first with volume absorption. For the volume, we assume a recovery in the heavy-duty truck market with a more normalized build rate of 280,000 units, which will improve fixed costs absorption, which we estimate would add 1.3 percentage points to our overall gross margin.

The North American operations, as we work through the inefficiencies that we've had with plant closures and the transfer of products and new product launches, again, we would expect that the margins would improve and we estimate the impact of that to be about 0.7%.

And as for the facility consolidation benefits, we expect to eliminate duplicate overhead costs as a result of these closures, adding another 0.6% onto the overall gross margin. And certainly there were some special factors that positively impacted the gross margin, which we're not expecting to repeat, certainly in the area of the pension curtailment benefit that we've spoken to and as exchange rates stabilize.

So with this view, we would assume a more normalized margin for the Company to be about 17.2%, which certainly implies that we have more work to do around implementing the business model that Dave spoke to and specifically looking at our manufacturing footprint as well as looking at our product lines for potential rationalization.

Turning to slide 14, I would just note, again, we remain very, very committed to the targets that we have previously communicated. Return on capital employed, which we believe is the key metric for measuring our overall financial success, is certainly a function of the overall capital turns and margins that we have in the business. Given that we are investing capital to support the new facilities -- as this slide indicates -- we're not expecting a meaningful increase in our asset turns. Again, as I've outlined previously, therefore, we must focus on the margin improvement.

As stated previously, our financial framework is for gross margins to be in the 18% to 20% range and the SG&A at 11.5%, yielding an operating margin in the range of 6.5% to 8.5%. This range, coupled with capital turns at 2.5 times, will drive the return on capital up to the targeted 11% to 12% range.

We certainly face a challenging marketplace and the margin expansion that we see assumes that the North American truck market will recover. The significant change in our business model is critical and it is how we will deliver the results consistent with these targets.

And finally, I would note, again, we are very much focused on execution and reaping the benefits associated with the actions we are taking to close and consolidate facilities and launch new products.

So to recap our fiscal 2008 second quarter, certainly, again, strong international performance. I think we're very pleased with the operations outside of North America. The North American truck market has been very, very challenging. And as we've mentioned, the manufacturing realignments here in North America as well as product launches has driven near-term inefficiencies. But we are focused on implementation of the business model. We're focused on continuing to diversify our product platform. And we're focused on ongoing cost savings such as the sale of the corporate airplane and such as the freeze of our defined benefit pension plan for our U.S. salaried employees. And finally, we're very, very encouraged and welcome the new leadership to support us in, not only the ongoing operations but in supporting us as we continue to develop and launch new products.

So with that, Dave, I think we'll open up for questions.

Great.

(OPERATOR INSTRUCTIONS). David Leiker, Robert W. Baird.

A handful of number-related questions here to start with. Brad, if you took the pension and the plane out of the numbers, where would your tax rate have been?

Well, I think what I would say is -- I would prefer to answer that -- the primary driver here is the change in the tax rate associated with Germany. So let me just kind of walk through the change in that tax rate to show you what I think would have been a more normalized tax rate for the quarter.

And certainly if you take the minus -- again, 124% effective tax rate, that is, negative rate -- we had $2.5 million benefit of simply the change in our deferred tax liability; albeit the liability has now been reduced so there was a $2.5 million pickup to our earnings.

There also associated with this was a further $2.5 million pickup as we recalculated, if you will, our effective tax rate and brought it up to current for the impact on the quarterly results post the change in this tax rate change. So, those two factors would bring the effective tax rate down to, quite frankly, in the quarter at about a minus 12%.

As we look at -- and that, again, David, is a function of the large losses that we've incurred in the high tax jurisdiction here in the United States -- as we look forward for the rest of the year, we would expect the incremental earnings to be taxed at about a 19% rate. Which again, I think factors in to the overall tax rate guidance of between 5% and 9%.

So 19% for the second half of the year?

Correct.

Okay. And then -- that you go out to this 2010 number, obviously a big part of that's North America doing better -- does that tax rate get back up to that 35% to 40% rate by then?

No, it doesn't because, again, I think we're seeing that the profits clearly are being shifted towards the international side of the business where the tax rate is kind of in what you'd call the 25% range. So, we would continue to evolve our thinking on this. And every time, David, you ask that question, we kind of lower it as the mix of profits continue to change. But my best guess at this point is that the overall effective tax rate is going to migrate up to kind of the 25% to 30% range. I don't anticipate we're going to be up in the mid-'30s as we go forward.

I have a hard time getting you back to a 7.5% margin out in 2010 without the North American profits meaningfully recovering. I mean, Europe is already above that level. So I mean your incremental profits are going to come from these high tax areas.

Correct. And I'm talking about just on a weighted average basis. So certainly this year if we operate in the 5% to 9% range for the full year -- and, again, there are some special factors, albeit that the German -- you're absolutely right, that the profit improvement is going to come from the recovery in North America, which will be higher tax rate. But when all is said and done, also we're going to see further growth out of Brazil and certainly further growth out of Asia. Stay tuned on the Europe growth, which again, I think is -- you weight all that together and I think, again, you're going to have disapportionment amount of your earnings still earned outside of the United States.

Okay. Is there any savings from the pension freeze?

There certainly are. And again, because -- and that's, I think, a message that we're trying to really be -- to drive home from the standpoint of certainly there was the impact in the quarter. But as we go forward, there is about a $2.5 million annual savings from the freeze that we have made.

And I would note, David, just you probably haven't dissected the balance sheet, but what we're very encouraged about is the result of this change and also the result of the performance of our pension assets that the pension plan has actually moved into a net positive funded status here in the United States.

Okay. And then one other number of question and I'll come back in after that. The gain on the plane and the pension, both are at the SG&A line, correct?

Well, the plane certainly is at the SG&A line. And the pension is split between -- it's majority SG&A but there is some impact on the gross margin. And again, that's why we showed it as one of the reconciling factor as we tried to get to a more normalized gross margin.

Okay. And then on the segment reporting, where does it fall? Where do those two items fall?

Okay, so, again, it will be in the original equipment Americas and it will also be in the overall corporate SG&A. And we could certainly break that out for you if that would be helpful.

Yes, we can follow-up on that. That's all I need right now. I'll come back with some other ones, thanks.

(OPERATOR INSTRUCTIONS). Your next question is a follow-up question from the line of David Leiker with Robert W. Baird. Please proceed.

I guess it's just the two of us.

I'm feeling left out.

David, you're going to ask Dave some questions, please.

If you look at -- is there a way -- I know this is kind of a tough number to get to but is there a way you could break out for us the impact on the revenue line of the North America Class A truck market?

Well, I think, certainly the North American Class A and medium duty market -- I mean I think that, as you know, we have a very good position in that marketplace. And --

Was that a $30 million number in the quarter?

No, I mean, I think it's probably -- I mean, you can look at our overall revenues in that segment as being down about one-third -- about $60 million. And I would say a vast majority of that -- there's some automotive, but a vast majority of that is actually the variance from the previous year is due to the truck market. Because our ag market where we have again a good business, and the off-highway markets have been fairly stable, albeit [at] a strong level. So majority of that variance is driven by a decline in the North American medium and heavy-duty truck market.

Now, that's a lot worse, though, than we saw in this last quarter, yet the build rates weren't quite as bad, were they?

Yes. You're talking about in the first quarter?

Yes. It seems like it's incrementally getting worse.

Well, we've talked in the past also about the new business launch that Freightliner has been slower. And they have gone through some specific things in regards to export mix versus North American mix. And the export has some legacy product. So that will stabilize. But it has more of an adverse expect that's startup volume than we had originally anticipated despite the market.

Do you have any of this new volume from Freightliner in your estimates?

Well, we certainly, as we go forward, absolutely. The impact --

Through the March quarter -- through your fiscal year?

I'm sorry?

Through the end of your fiscal year.

Correct. We're expecting, as Dave mentioned, I mean, just back up -- the decline that we saw in the original equipment Americas was down about $45 million in the first quarter and it's down about $60 million or $59 million I think in the second quarter. And again, I think it is a function of the Freightliner business, where we have -- obviously we're on the '07 programs, but the Freightliner certainly -- their volumes largely are for export at this point, which are using the '06 modules, which we're on -- excuse me, platforms that we're not on.

The exports will change because the emission law changes in Mexico and in other export locations will be changing at the end of the calendar year. So that will put it back into '07 product. And I don't want to get into a heavy-duty Freightliner discussion, but they are very, very strong in fleets, and that's where the market has been hit the hardest in regards to a slow recovery.

What about your European truck number? That had to be better -- volume seemed better there.

Yes, I mean the European, we're certainly not seeing the cycle and we continue to see the growth out of Europe. I mean, that's a much more stable, if you will, and growing market. And certainly we're very, very encouraged about the upcoming emission law changes where we will be obviously working to get on incremental platforms and gain marketshare in Europe as we go forward. So it's post the new emission law changes in the 2011 timeframe.

The increased volume that we've seen, though, in Europe right now is related to new business in the EGR areas, which is truck related as well as new condenser business that we'd launched in the quarter. We are very encouraged by how we are being received in the region in regards to the decisions that will be made over the next 12 months in regards to both engine and powertrain cooling decisions for that next emission law change in Europe.

Okay. Another item I want to dig through here are these manufacturing inefficiencies. Are you doing more plant realignments than what you thought you were going to? Is it taking longer? Is it more disruptive? Just kind of fill in some color there of what's going on, if that's worse than what we've been seeing.

And let's separate the two from what I would call realignment and launch. The launch issues are in two facilities. I don't want to get real granular but in both cases it's been absolutely invisible to the customer, which is the first priority. We have had some equipment issues in one specific that we are addressing very aggressively. And then we have some -- managing some what I call in the launch design changes as well as some learning curves in regards to dealing with some material and bracing materials, et cetera.

There's a lot of detail in the new product launches. Always our priority is the customer. Is there some disappointment in a couple of these new product launches? I would say yes, but Burke and company are on point on those.

What market are those for?

Truck.

Okay.

In the consolidation area -- and that's where we've had I would say a larger part of the inefficiencies, is we did expect some of this. You don't do what we're doing without having expectations. I would break it into there's some controllable and non-controllable. And oftentimes the non-controllable you can control by adding good insight. In the non-controllable we, in one facility, we have had difficulty in finding actually quality employees. We found employees but not people that would stay or have the skill sets. And so we've responded by reevaluating hiring rates and how long there before they get benefits, et cetera.

But unfortunately, that was one that maybe could have been anticipated better. We've also had, in the midst of transfers, we've had some spike volumes from one particular customer that was not anticipated. The customer has been served well, but that created some significant variances. Again, how quickly you can respond to emerging issues is key.

And then the last one that I would say is just managing the detail. And managing the detail means that you have to have the right people in the right jobs. We've had some turnover or some performance issues in a couple situations that we have dealt with and are behind us. And Tom and his team have made sure that we're not going to rationalize this for an extended period but make sure that we're on top of that. So, we've actually put some incremental resources, management resources, on making sure that we understand root causes, you know, for things like scrap rates or things like premium [paid] freight, et cetera.

So, am I disappointed in the quarter in the manufacturing performance? Yes. Do I have confidence that we know the issues? Yes. Are we putting the right resources in place? But I'm not being naive to say that the balance of the year, you can't do this much without having things that come out of the woodwork. And the key is keeping the customer insulated and minimizing the impact.

Any of these consolidation -- are these on the truck side or auto also?

It's construction, ag, and truck. They're very limited in the automotive side. I mean, the automotive piece now with the Toledo shut down is done. We do have some startup activities. I didn't mentioned this; we do have startup costs in Mexico. Those are not out of line. Those are under control but they are something incremental to the year. And that's basically automotive business.

Okay. I have some other ones but I'll hop off and see if there's anyone else around.

I'm sure, they're just waiting to talk to us.

Well, I'll be right back if there isn't.

[David Thax], Huffy Capital.

Sorry to break up the party. I have a couple of questions. One -- this should be the easiest of them -- on the slide where you had provided your estimate of builds, there weren't numbers, they were just bars, so could you just fill in the blanks there? It was 190,000 you're saying for 2008?

Yes, this actually comes out of reports but the numbers across -- I'll start with '05 -- is 335; '06 is 372; I believe 217, if I can read my writing --

218.

218; 270; 357; and 216 for 2010.

I'm sorry -- 218, 270 --

357 and 216. I want to qualify -- this is a very dynamic environment right now. And in regards to what the numbers in '08, I hear a lot of discussion right now that '08 will probably be softer than that. And '09, which is a pre to an emission law change, how big that pre-buy will be will be dependent on really a couple of different things. One, what will be the expectation of the performance and the vehicle costs with the new vehicles after the emission law change. And that's a dynamic that I think the industry is still learning about. Two, where will the economy be? The ton miles are down right now and how long that will extend or will that recover prior to the pre-buy is certainly a very key element there.

So there are a lot of moving parts, not only within the short term but I think -- and in fact, David Leiker reports about this about every month -- is that there's just a lot of moving parts in this truck assumption between -- over the next three years and it will be important that we stay on top of that.

In the 190 that you're using, that's just because it's a fiscal year as opposed to a calendar year? That's (multiple speakers) --

Correct. That just says that our fourth quarter will be softer than the first quarter calendar.

Okay. Next question. One of the slides you talked about your longer-term opportunity of 4% or so organic growth rate and then supplementing that with acquisitions. So can you just talk about whether some of the drivers to that quote/unquote organic growth rate and then what you might be looking for in terms of acquisitions, how you're looking at building onto this existing business mix?

Yes, the organic has several parts. One, obviously increased content on vehicles that have diesel engines. With increased content what I mean is that there's more components, heat transfer components, that get attached to an engine. Like exhaust gas recirculation coolers and fuel coolers, wheel coolers, et cetera. So there is a content opportunity that is taking place in our mature North America and European market.

There's also penetration opportunity, where we feel confident we are going to have incremental wins in marketplace, not just in truck but also in our ag and construction markets.

The other piece, an important piece of organic growth is new technology. We had a number of I think significant opportunities in new products that could actually have a significant [more] a larger impact than the organic number that we're talking about. Those relate to -- I mentioned the new powertrain cooling technology that we had a release on about a quarter ago, as well as some technology we're working on in regards to improving mileage, in regards to taking energy from exhaust and putting it back to the wheels.

The other piece on organic is the new economies. We're building plants in China, India and Hungary. And we certainly think there's great opportunity in incremental participation in one, penetration, but two, those economies are growing a lot faster than Western and Eastern Europe. And then finally, we've got Brazil. So, I'm feeling personally very good about the organic consumption that we have. And we're going to continue to monitor that to make sure that that may be -- maybe understated, who knows -- until we get more clarity on the decisions that are going to be made over the next 18 months, specifically in North America and Europe and on the truck and construction side.

On the acquisition side, we have made four acquisitions in the last three years. And we have a process in place. We continue to put a lot of things through our funnel; a lot of things don't make it through the funnel. But it's an active area. It's an active area where we want to grow in our core business, so we will continue to look in acquisitions and where we're strong in regions. We will look certainly -- and have looked -- in the areas that we're doing greenfields. We have looked very hard at acquisition and joint ventures in China and India. And thus far we have determined that greenfields are better, but that will continue to be an evaluation.

And then the other piece -- and we've been very open about -- we would like to further expand our commercial business, our non-vehicular business. That's where we made one acquisition, the Airedale business. And we think there's further opportunity here in North America and certainly in Europe because of the consolidation opportunity in that marketplace.

So it's a long-winded answer, but I think there's a lot of key elements to growth. The key in maintaining margin with growth is technology, is that we absolutely have to have differentiating technology in order to be able to have what I would say a premium position or have the customers that value technology appropriately compensate us for it.

And back to more of a (multiple speakers) --

But I'd just add certainly everything that Dave said I absolutely support. And I think on the organic growth side, certainly we've been very, very open around the area of the fuel cells and that that could make up towards the end of our five year planning horizon about 10% or up $200 million worth of revenue based upon the programs that we can see in the two companies that we're partnering with, Bloom Energy and Ceres Power. So that could certainly provide a substantial growth over that five year period for the Company.

Okay. And then as far as -- while I'm on that -- the fuel cell target margin opportunity, have you disclosed or have you talked at all about where you think that business at $200 million could be in terms of level of profitability?

We certainly haven't talked about that. But given the significant investment that we've made in the R&D side of this business in support of the fuel cell and the technology that we've developed, the proprietary technology, you would expect that we would be certainly above our overall average margins for the Corporation. Again, based upon obviously the fact that we've got to get a return on the R&D investments. And we certainly think that we have leading-edge technology in that space.

We also are very sensitive for these customers [that] he mentioned specifically, but others we have in fuel cells is that they also have to be competitive. And so part of the chemistry of having success here is having product that works but also is competitive to alternative energy sources. So we understand their needs. And I think they also respect our needs in regards to, as Brad said, there's a significant investment that we made in this business and will continue.

Switching gears to the European and the rest of world truck market, what are your thoughts there in terms of the sustainability of the growth we've been experiencing? '07 has turned out to be a far better year in Europe. What do you feel is causing that and how sustainable do you feel that trend will be?

Well, yes, I mean certainly as you look at Modine, and I just divert away from Europe for a minute, but as Dave stressed, as we look outside of the traditional North American Western Europe, there we're really looking at market penetration as we enter those markets. And so we should experience obviously very healthy Modine growth rates again, as we bring technology to those markets on both the engine side but also the powertrain cooling.

I think as it relates to Europe, the Europe economy -- European region economy, if you will, continues to be very, very strong. Stay tuned on whether or not there is a cycle that they may incur as a result of the upcoming emission changes; albeit that business has been less cyclical than what we've seen here in North America. But we continue to be very encouraged with the growth.

But again, I think as you look at specifically Modine, as we go through this five year planning cycle as I mentioned and then Dave mentioned, we are really encouraged about some of the new programs and our ability to grow our marketshare in Europe in the medium and heavy-duty truck market.

It's an interesting phenomenon. As you watch Europe, they have trailed the North America emission law changes by a year or two, but they traditionally have never had the kind of volatility that we have seen in the Class A market. And even our mediums have had lesser volatility but some historical. But with these changes they've been very dramatic in pre-buy. And looking at Europe, the amount of pre-buy and the traditional volatility has just not been there. The market just operates from a different set of values.

So the strength we're seeing in Europe -- I'm trying to read between some of your comments -- we should be essentially seeing that perpetuating or continuing into '08; there's no reason to think that we'll see a reduction in activity levels?

I would agree with that.

Okay. And then last question and I'll get back in line. As you look at incremental leverage to changes in the build rates in North America -- I think the questioner before talked about how the fall off in profitability -- I didn't do the incremental analysis -- but the fall off in profitability in the second quarter based on volume shortfall is far bigger than the first quarter. You have got costs or programs in place to take costs out, so in theory we should be more leveraged to a volume pickup next year or in two years. How do you think about that in terms of units and what are you setting your breakeven level to be? So we can try to model operating leverages as the business turns?

Well, I think that's what we tried to do on slide 13, was to say in North America, given that we're operating at 190,000 unit Class A truck market, if we're able to operate the Company at 280,000 unit, which is a more normalized build rate for North America, on our margins there's a 1.3 percentage point margin enhancement, simply from the fixed cost absorption, if you will, that we get from operating our plants at higher levels.

Okay. So that's the -- on a 90,000 unit change, we pick up 130 basis points of margin?

Correct.

And then the other aspects of that slide just talked about improving efficiencies and that's just a plain consolidation in lower cost manufacturing potential?

I am surprised that volume absorption number is not dramatically higher than that.

Correct. And as I mentioned, you know --

I'm surprised that that volume absorption number is not dramatically higher than that.

I'm sorry?

I'm surprised that that volume absorption number wouldn't be much higher than that.

Well, I mean, you can kind of do your own --

I'm just looking at the degradation in profit on the way down. I would think it would be a much quicker recovery on the way up, especially with a more efficient cost structure.

Yes, I mean you can do your -- again, the fixed cost structure -- the more efficient cost structure comes through the other two bullet points, the North American operating improvement and getting the fixed cost out of the plants that are being closed. So if you want to look at an aggregate the kind of leverage that we have here in North America, you can add those bars up, if you will.

I guess my point would be is if you look at the environment to get to 280 or probably directionally through that, we'll have Europe and rest of world doing much better, theoretically profitable in Asia and North America going from a loss to (multiple speakers) --

Let me correct that in that what we've tried to do here, we're not going to give kind of -- we've shown you our target, which is 18% to 20%. And what we have done is we've taken the current guidance for the year, the low end of that guidance at 15%, and we've said there are some unusual things in the year around the state of the truck market and the state of our operations here in North America and the fact that we're in the process of closing facilities.

So we've simply normalized for the North America effect. As we go forward and how Europe performs, how Asia performs, et cetera, that's part of that journey, if you will, from 17.2%; again, a normalized 2008 margin up to the 2010, 18% to 20%.

With one other element of costs that actually that we're not spending any time on today, one I'm tickled we're not spending time on, and that's the lag in the material recovery, commodity costs. But the other very important piece of that journey from 17% to 19% is the new organization structure we have in purchasing. We've got very good traction and very good leadership in that area. And that will also be a key element in that incremental step, as Brad said, that we've got more work to do. And that organization is maturing very well, in my opinion.

And that's just leveraging global purchasing scale of the first auctions or --

I would say leverage is certainly part of it. I think a bigger part of it was within our control is have global designs. I hate to say, the old organization we had regional designs. We had regional optimized, we had customer optimized design. So having global designs and global purchase where you could call that leverage, but that's not just leverage; that's bringing incremental volume to that, other than just adding the regions up.

The other piece is standardization. This is a harder piece but a piece that we're working on and that's on the legacy product. Because many of our products have very long life cycles. And in order to be able to create purchasing opportunities, you have to reach back and work with these new platforms that we've talked about, and with those new platforms we can do it. We can design design-cost of production into the legacy product. Obviously. in those cases you typically have to have it tested. You have to have the customer involved. And we'll probably share some of that with the customers in order to be able to drive that through, so you don't get all of that in your pocket. But it's good news for us and it will be good news for the customer. And I think we have the structure now that we cannot just talk about, we can actual do it.

I'll get back in queue, thanks.

David Leiker, Robert W. Baird.

I think this is the last go around for me.

Yes, you've said that before.

I won't hold myself to it. If you pulled out the plane costs out and the pension gain out, you have an SG&A number that isn't consistent with the strategy of reducing SG&A. I mean it ends up being [as a] percent of revenues one of the highest numbers that you've had ever. And up pretty meaningfully from last year when you've been able to pull those numbers down. Is there anything else running through that line?

Well certainly, and you're right. The overall target of 11.5%, clearly the overall revenue line, if you will, is certainly down dramatically. So our ability to absorb the SG&A, if you will, has been impacted by just the North American truck market. I would say -- so, if you look at the change in the SG&A from $112 million on a year-to-date basis to $108 million, certainly you're right that the plane sale of [4] and the pension impact that's in the SG&A in the first six months is about $4 million. So what's kind of offsetting that clearly I think I would say the big area is $3 million to $4 million of exchange benefit -- [that is an] adverse exchange in this case as we translate foreign SG&A at higher exchange rates, if you will.

Even adjusting that and trying to gross up the number to a $2 billion revenue run rate, you still end up with something that's over 13%. Is that -- [I'd apply] a 150 basis point gap from where you are to where you want to be, is that a consistent number?

Yes, we've been operating in that kind of just below 13%. So you're right. I mean that's part of the next couple of years journey; as the Company grows, clearly we have to take steps to control the SG&A. And again, that's why, for example, one of the things that we've talked about -- or the two things here, which, again, you could call those one-off -- I would like to say no, they are not one-off is because they're part of the strategy to get to 11.5%, the corporate airplane sale and the pension.

And let me just embellish on that, is that we still have an airplane in North America. But there is an operating cost reduction in going to one versus two. We're not going to compromise our support when we have fewer plants, but there are also different technologies to support.

And Brad has already mentioned that there's an ongoing savings in the pension area. There's many pieces to the -- and we're very focused on the SG&A. A couple of those, for example, it's not significant, but it's part of the pile of nickels, is that with the new plant launches that we have in place right now, until they are in production, those flow through SG&A.

We also have a North American SAP launch going on right now. And when that's completed that certainly those resources will be redeployed and reduced. And we have more work to do in a number of regions, specifically in Europe. We also think there's some opportunity in Brazil. And so this whole SG&A thing is very important to us and it only is going to happen with detailed action plans. And Dave, we've got a lot of activity working.

How much of that SG&A is what you would call research and development, product development?

Well, our total SG&A -- I can do the math here -- about $80 million on a run rate. So, our R&D expenditures are about just a little under 5% of our total revenues. So you get about $80 million in our total SG&A as you're doing the math is in kind of the 220 to 230 range.

On the capacity numbers. Dave, it seems like I ask you this all the time. Part of the idea (multiple speakers) [three] years ago of the book of new business is they're all going to launch in existing facilities and be a big driver of margins. And here today, we're looking at a cap spending budget that's well above depreciation and new plants going up and plants being closed. And those two seem to be contradictory.

Well, when we talked about new plant -- new business that we had booked -- the booked business that we had talked about in the past is primarily and North America and in Europe. And those statements were being put into existing facilities.

The rationalization that has taken place in North America, specifically closing one plant that we have in Tennessee, building one in Texas, is a cost reduction opportunity versus saying you have available capacity. There was capacity there, but it was not as cost-effective capacity.

And then we are certainly spending a lot of money in new regions. But that new region capacity was not included in that net new business number that we talked in the past, because those new businesses are just emerging on our radar. When we talked about those in the past, they weren't

But are the capacity closings because the new business number is not as big as you thought it was? Is it because you have walked away from business that's not there? I would have expected that capacity to be filled with new business as opposed to being closed and consolidated.

I would say that the answer is, at least in North America, is one, you are aware, we have walked away from some business out of Toledo, [contract] decision.

The balance of that is there is some rationalization of some business that just doesn't make sense that we should continue. So part of the reducing the footprint is walking away from some unprofitable, low volume mix customers that aren't strategically important.

But the other thing is that -- and maybe we haven't said this in a while -- we have a small plant philosophy, Dave. But with the technologies that we have in the plants, with systems that we have in the plants, we have raised the upper limit of our small plant philosophy to about 350 people. And then with automation in high cost countries you have to do, we are actually creating more scale facilities in our North American facilities. And we're doing that without adding footprint in those plants. We're doing that by doing that kind of things a lot of people that we talk -- about lean manufacturing.

So places like Joplin, Missouri; places like Pemberville, Ohio; places like McHenry, Illinois -- all three of those plants -- Camdenton, Missouri -- all four of those plants are getting incremental business via consolidation without footprint. And that is only happening because of the activities in lien.

(multiple speakers) capital spending and you put a number out there for March of '08, does that start to come down in 2009, 2010? Or is that a number that we are going to continue to see run at a pretty high rate?

It's going to come down starting in 2010. Clearly, as we go into the next fiscal year, we will be gearing up for again for some of the 2010 programs, as well as starting to capacitize for some of the fuel cell activities.

So I think 2009 will be another decent year as we, again, also complete the facilities that are under construction. And then in 2010, you should see the capital drop back down.

I just want to again reiterate this journey on the gross margin, which is I think again what you were pushing on on the capacity, and certainly from where we are on a normalized basis, that 17% to 18% to 20%. As Dave mentioned, we certainly have the purchasing initiatives that we have. We do also over this period clearly have ongoing pricedowns, which we have to offset.

And so clearly, to get to this journey, as I mentioned in my prepared remarks, is -- we have to continue to look at the manufacturing footprint, and we do have to continue to look at the overall product line and the product line profitability, which is, again, all part of implementing the business model.

And something Dave, a little bit more granular detail, but I think you'll like it -- as we have gone to the new organization structure and accountability for these product lines, Brad has brought out some very good tools internally for us to better understand specific product line profitability and customer profitability. And that -- and having better information, we can make better either rationalization decisions or pricing decisions with our customers. (multiple speakers) So there are lots of pieces to the puzzle.

(multiple speakers) Brad, the special items that are in there -- just what we have seen here in Q1 and Q2 -- the pension, the plane, and the currency gain in Q1?

Yes.

There is nothing else that you are anticipating through the rest of the year that's embedded in there?

Certainly, we don't have as we go forward --

(multiple speakers) You're not anticipating there's anything --

(multiple speakers) unusual items -- and certainly I would say this, that in the guidance -- it is a guidance, David, from continuing operations. So any impact of the divestment of the electronic business certainly is not in these numbers.

And it looks like with the changing commodity assumptions that that should have been an incremental -- I don't know -- $0.10, $0.15, maybe $0.20 in earnings?

Yes, based upon our sensitivities that we have provided, I don't think it is quite that high, only because we do have some of our aluminum locked at this point, which would have been locked at a slightly higher price. And certainly some of our nickel is locked also.

Okay, so if we net out all of those items, it looks like about a $0.50 or $0.60 reduction in earnings. Is there a way you can split that between the second quarter being below what you expected and the balance of the year? How that is weighted between what you experience here in Q2 versus what your outlook is for the balance? Whether that number is right or not, but just -- I mean, your guidance revision here -- how that gets weighted?

Certainly in the guidance -- I am a little uncomfortable in answering that, because in the previous guidance, clearly we had had the assumption of, for example, the corporate airplane sale. We had been anticipating that as part of our SG&A reduction initiatives.

That was in your guidance.

(multiple speakers) that was part of our previous guidance. And the pension plan -- certainly, again, we were looking at that, and had some estimate of the pension plan, albeit the pension plan benefit has turned out to be more favorable than what we had had in the previous guidance.

So I wouldn't think that you should be saying that those were one-off -- not in the previous guidance, and therefore there is a huge underlying decline here, because in our previous guidance, again, we had aircraft, and we had most of the pension -- albeit again, there has been some upside.

But those wouldn't have been numbers that would have been in our estimates, though.

Well, I don't know what was in your estimates. But they certainly were in our estimates.

It is a disclosure thing -- I don't think people were aware of that. But go ahead.

I don't have anything else to say, David.

And then the last thing here is when you look at your 2010 targets, you seem to be implying there's like a $2 billion revenue base that those are based off of.

If you take 4% to 6%, correct.

And are you using a normalized build rate for [cost save] of this 280,000 number, or what you have shown in your slides of 216,000?

I am sorry, the 280, again, is on the bridge.

Yes, kind of a normalized number.

Right, as a more normalized build rate.

So that's 2010 based on a normalized build rate, or is it built on that $210,000 that you are showing in your slides for 2010?

Oh, you're getting off the [awards] data -- I am sorry, I was just puzzled where you were getting your -- that is calendar 2010, right? And we are on a fiscal 2010. So that clearly would be -- we would be running in 2010 at a higher -- our fiscal year would be running at a higher rate, because it would have the April 1, 2009 to March 31, 2010 --

(multiple speakers) It's built on what you think build is during that fiscal year? Or is it built on this normalized volume?

The 18% to 20% is a normalized volume, 280. Sorry.

(multiple speakers) At this time, there are no further questions in the queue.

Well, as I opened, changing the business model -- I had a lot of confidence in. I think the organization has embraced it. The customers have seen better clarity on what we provide them. There is a lot of work to do. There is a lot of work to do, and we shut some facilities down. We moved product around.

And as we launch these new facilities in various parts of the world, the key comes to leadership. And I am pleased with the leadership that we have in place in a number of locations, some of the new leadership that I announced. I am very confident in those people.

But this is a continuum. And this changing the business model will continue to evolve. And so the actions that we have announced, there will be probably more coming. But we're not going to make those decisions until we clearly understand what it takes, what the impact, and what the opportunity is.

So we look forward to seeing some of you on some of our visits. And those that we don't, we will see you, hopefully talk with you at the next quarterly call. Thank you.

Thank you.

Thank you for your participation in today's conference, ladies and gentlemen. All parties may now disconnect. Have a great day.