Modine Manufacturing Company (MOD) Q2 2008 Earnings Report, Transcript and Summary

Good day Ladies and Gentlemen, and welcome to the SecondQuarter, 2008, Modine Manufacturing Company Earnings Conference Call. My nameis Maria, and I would be your audio coordinator for today. At this time, all participants are in listen-only mode andwill be facilitating a question-and-answer session towards the end of today’sconference. [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 Maria and good morning everyone; welcome toModine’s Second Quarter and First Half Fiscal 2008 Earnings Conference Call andWebcast for the period ending September 26, 2007. Joining me on today’s call are Modine’s CEO, David Rayburnand our Chief Financial Officer, Brad Richardson. Dave will provide comments onthe quarter and year-to-date and some of our current activities. Brad willreview the financial performance, and following their remarks, we will open upthe call for your questions. Before we begin, I would like to remind you that thismorning’s call may contain forward-looking statements, such as forecasts ofbusiness performance and company results and expectations about the company'splans and future initiatives. Actual results may differ materially from those projected.For an in-depth discussion of risk factors, please refer to today’s pressrelease and our company’s filings with the Securities and Exchange Commission. If you have not received today’s earnings release, itsavailable on the Investor Relations portion of our Corporate Website along withpresentation slides that we used in today’s discussion at www.modine.com. With that I will now turn this call over to David Rayburn.Dave?

Thank you Susan, and welcome to the Modine team. Brad willreview the financial details of the quarter and the specifics in regards to ouroutlook for fiscal '08. But first, I would like to discuss the key takeawaysfrom this morning’s call. We continue to be encouraged by the internal and externalresults and response from our actions today in changing our business model. Iwill provide an update regarding some of our implementation efforts. I am alsopleased with the strong sales in Europe, Asia, South America, which reinforces the value of our diversificationstrategy. Our international growth has been substantially offset bythe continued weakness in the North America heavy duty and medium truck markets. The reboundis much slower than anticipated, and based on this continued weakness, we arelowering our guidance range, which Brad will review later. As we significantly realign our manufacturing, there hasbeen near-term impact related to our efforts. These changes will providesignificant benefits to our long-term results. I will review today theinefficiencies that we have been experiencing, primarily North America around our plant closures,consolidation, new product launches and our plans to combat these emergingissues. In the Second Quarter, we recorded net positive resultsand pricing recovery are 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 finallycatching up, and we are pleased that the material cost continues to stabilize.We are working to further reduce costs while supporting our long-term businessgrowth. We executed on several initiatives this quarter to reduceour long-term costs, and this will continue to be a priority. And finally wewill discuss the announcements we made on some leadership changes in theorganization. As you refer to slide four, it summarizes the North America past or projected annualheavy-duty truck build rates, which does have a significant impact on ourearnings. We have seen reports throughout the quarter decreasing build ratesestimates for the calendar year. You will note included in the chart that apre-buy volume spiked prior to the January emissions standards changes, withnearly 372,000 units billed in 2006 compared to the expected calendar yearbilled at 2007 of nearly 218,000 units. While the data presented from the awards indicates anincrease in 2008, our sales show that this rebound is at a much lower levelthan we had anticipated in our earlier discussions. Based on the weakness inthis market, we are increasing our fiscal 2008 estimate truck build. As aresult of this softness coupled with other factors, we are also reducing ourguidance. One positive sign is that the truck build is expected to increase in2008 and 2009 in anticipation of the 2010 environmental changes. Page five summarizes how we will profitably drive Modineforward. We introduced a year ago our plans to change the Modine businessmodel. We have made great strides this year, but it is a journey. As noted inthe 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 apriority. Manufacturing realignment, which we will talk some today about;rationalization of market and customers and products, and finally, TechnologyAcceleration, which we spent significant time discussing at our Annual Boardmeeting. Our implementation plans are organized around each of these drivers,and a new business model is the structure that guides our actions. It is alsothrough these drivers that we will achieve the metrics that are summarized atthe bottom of this page that we are focused on to reach by the end of 2010. Slide six. The Manufacturing Realignment is a cornerstoneof our current actions. We are closing four North American plants andconsolidating operations to create scale. As a result, we are qualifying andlaunching 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, cometemporary inefficiencies. We are working to continually identify emergingissues, develop and implement focused action plans, ensure appropriateresources are allocated or reallocated to manage our integration efforts, andimprove 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 anew facility in Northeast Hungary. The new capacity in low cost countries is a benefit forboth regional growth and source cost reduction for our high cost regions. The Mexican plant is under roof and we expect to beginproduction in July of 2008. Brad and I had the opportunity to visit our newconstruction site in Chennai, India last month, and they are on trackwith production slated to begin in April of 2008. We also visited our twoplants in China; one is complete and the secondis under construction and expected to start production in February of 2008. In addition to our realignment activities, we continue tofocus on reducing our cost structure to ensure we remain competitive along withsupporting our long-term growth. In this quarter, the gain related to the amendment toappraising our salary portion of our pension plan and the sale of the corporateaircraft are examples that had positive impact on our earnings both forshort-term and long-term. We are committed to reducing our cost structure thatwill 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 productplatforms. This new restructuring is a key element of our business. Theannouncement this morning in regards with some leadership changes include -- wehave a new leader in North America, Jim Rulseh. Jim will be replacing Chuck Katzfeywho has announced his retirement. Jim will be shifting his efforts in growing our Asianregion to leading the American activities, which includes South America. This is a very challengingenvironment. 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 rollin the Global Products, Global group, and Scott Wollenberg will replace Paul inthe Global Engine Product Group. We have significant bench strength internally, and thebreadth and depth of experiences each of the individuals bring to their newassignments, to the confidence (inaudible) build it for me. The organizationstructure put in place around new product introductions, ensuring that we havefocused on regional and operational accountability is a key element of ourgrowth. Turning to slide 7, from a Product and Market standpoint,we continue to strengthen our customer relations and review our productofferings and rationalize as appropriate. It is a matter of making choices anddriving diversification -- our diversification model in our technology, and asI mentioned, we highlighted in our annual meeting. To this point, we have grown our market presence asdemonstrated by our strong sales in Europe, Asia and South America. In our results, the growth helps to offset theweakness in the North American truck business that I have discussed. And diversification model, both by its markets and byproduct lines is a key strength of your company, and we’re going to continue todrive this diversification strategy. Mitsubishi Fuso and Hyundai heavy-dutyindustry are two programs that we regionally announced that illustrate how weare building new business in Asia, leveraging our commitment and our capability in theregion, so they have it to be a principal part of our company. The aerial product line of new energy efficient chillersis another example of our diversification strategy and bringing new technologythat will not allow our products to be treated as commodities. Diversificationof electronics cooling business, which is underway. is also part of thisrationalization strategy. Environmental related initiatives will also drive furthergrowth as we support our customers to do [ph] new requirements. So (Inaudible)further emission reductions, the move to carbon dioxide refrigerant with [ph]technologies, an area that Modine is a leader; continued changes in steelratings related to greenhouse gas reductions, oil prices with technologyenhancements to reduce cost and milling standards and noise reductionexpectations, all of which Modine can address and grow our businessappropriately. In our business we continue to develop new opportunitiesto ensure growth. The next generation powertrain cooling and heat transfertechnology we recently announced is very exciting. Our fuel cell activities areprime examples of the importance of new products for our long-term growth. So, I’ll now turn it over to Brad to talk about somefinancials for the quarter in 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 InvestorRelations and Corporate Communications and also thank Beth Coronelli who servedas the Interim Director of Investor Relations and Corporate Communications. Shedid an outstanding job and I want to thank her for that. Turning to slide eight, certainly we saw strong salesacross most segments as Dave mentioned, with the exception of North America. Net earning’s up $9.9 million,increase from $5.8 million driven by the strong performance outside of North America. The gains were also related tothe decisions made to freeze the benefits under the company’s salary portion ofits U.S defined benefit pension plan and the sale of a corporate aircraft. Further, a legislation passed in Germany was very favorable to the company;it reduced the overall tax rate in Germany by 10 percentage points. Thischange resulted in a reduction in our deferred tax liability, balance with theoffsetting being a favorable contribution to earnings of about $2.5 million,thereby reducing our overall effective tax rate. Further, the effective tax rate benefited from asignificant change in the earnings mix, as we incurred losses here in the United States, our highest tax ratejurisdiction, and generated improved profits outside of North America in jurisdictions that have alower tax rate. The earnings, return on capital, employed, and margins,were significantly impacted by the cyclical downturn in the relatively highmargin North American truck market and operating efficiencies, which David outlined. I will talk more to our margins and our targets goingforward and how we plan to get there in a moment. But I would like to talk forjust a minute about the balance sheet. We do remain conservatively financedwith a debt ratio of 28.9% at the end of the quarter. The debt increased,versus the previous year, with incremental borrowings to support theconstruction of new plants and higher levels of working capital. The increase in working capital was primarily related tohigher inventory levels supporting the realignment activity here in the U.S. and higher sales in Europe. Further, the inventory levelsalso grew in Asia as we increased inventories toprepare 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 treatedas a discontinued operations. We are in the process of marketing this businessfor sale and are very, very encouraged by the level of interest in purchasingthis business. So turning to the next slide is a reconciliation, I callit 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 continuingoperations that we reported in our Second Quarter. Certainly, on the operatingside, the volume -- the global strength that we had outside of North America was more than offset by a declinein North American truck build rates. On the commodity price side, which as Dave mentioned, hasbeen a net negative of the corporation for the last three years, it wasactually positive in the quarter as commodity prices stabilized, a veryencouraging trend for the company. And certainly, the North American operatinginefficiencies 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 thepension plan freeze, the sale of the corporate aircraft and a change in the effectivetax rate, which again I mentioned was primarily a result of the Germanlegislation and the mixed impact on our income profile. If you look at the nextslide, that is, slide 10, which shows our year-to-date performance, again thefactors impacting the overall comparison of the two periods are the same as wesaw in the Second Quarter with the North American volumes being down, butstrong performance outside of North America, and you can see the rest of thefactors listed here on the slide. If we can go to slide 11, I’d like to talk briefly aboutour segment results. And again, as just a reminder, these segments wereintroduced in our last quarter, and what we've tried to do is to show on thisslide, 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. TheOriginal Equipment North America segment again was impacted by, what I wouldcall, recessionary level declines in the build rates for the North Americantruck business. We also had the temporary manufacturing inefficiencies drivenby plant closures, specifically the pending closure of our Jackson, Mississippi plant and the consolidation ofour Richmond plant, which has been closed intoour McHenry, Illinois plant. We also incurredinefficiencies associated with the launch of several product lines. Our Europe Original Equipment segment continued to showstrength with sales reaching a record for the Second Quarter, primarily drivenby exhaust gas recirculation coolers and the launch of new condenser programs.In Asia, we had significant improvementalbeit the business is still operating in a loss position, driven by newbusiness wins and the continued strength of the commercial vehicle and busmarkets in Korea. We were very encouraged. The labor negotiations in Korea are complete, and we did not havestrike activity this year. I would note that on an absolute basis, the Korea business has been profitable thisyear with the offset being the cost that we are incurring in support of growthin this region and costs associated with launching the two plants that areunder construction in this region that Dave spoke to. South America also performed very well in thequarter with sales up over 50%. This reflected the strength of the agriculturaland commercial vehicle markets where we have significant market share. I wouldnote, I had the opportunity to spend time in Brazil this quarter, and I'm very, veryencouraged about the opportunity that we have on a go-forward basis with thisbusiness. In the Commercial Product segment, which consists of ourspecialty Heating and Air Conditioning business, it continues to improve as ourearnings doubled in this segment reflecting tight cost control, and the absenceof manufacturing inefficiencies that we incurred in the prior year quartercaused by facility consolidation following the Airedale acquisition. And as wesaid previously, this is a business that we plan to further grow throughSynergistic and Product Extension type acquisitions. So let’s turn to slide 12 and look at our fiscal 2008guidance. Certainly our guidance has been impacted as Dave mentioned due to arevision in our assumptions on the North American truck build rate, which we'vedecreased from 205,000 units on the heavy duty market to a 190,000 units that’simplied in the guidance that you see before you. The decrease in the EPS and thegross margin guidance assumption is due to significant weakness, again, in itsNorth American truck market coupled with the operating inefficiencies thatwe’ve spoken to. The EPS guidance does reflect a significant reduction inthe overall effective tax rate for the Corporation, again, driven by the Germantax law change previously mentioned, and the change in our profit mix, whichagain, as we're generating large losses in North America, our highest taxregime being offset by greater than anticipated income outside of NorthAmerica, where the tax rates are materially lower. Finally, I would just notethat we have adjusted our commodity price assumptions, as material costscontinue to stabilize. Turning to slide 13, I think, given the overall grossmargin performance and expectations for this year, I think it’s very importantthat we show you a partial pathway to our immediate, intermediate gross margingoal, a target of 18% to 20%. To show this, we have taken the gross margin atthe low end of the guidance range for this year, that is 15%, and normalizedfor certain items. So starting first with Volume Absorption, for the volume,we assume a recovery in the heavy duty truck market with a more normalizedbuild rate of 280,000 units, which will improve fixed cost absorption, which weestimate would add 1.3 percentage points to our overall gross margin. The NorthAmerican operations, as we work through the inefficiencies that we've had withplant closures and the transfer of products and new product launches, again, wewould expect there that the margins would improve, and we estimate the impactof that to be about 0.7%. And as for the facility consolidation benefits, we expectto duplicate Overhead Cost as a result of these closures, adding another 0.6%onto the overall gross margin. And certainly, there were some special factorsthat positively impacted the gross margin, which we are not expecting torepeat, certainly in the area of the pension curtailment benefit that we havespoken to, and as exchange rates stabilize. So with this view, we would assume a more normalizedmargin for the company to be about 17.2%, which certainly implies that we havemore work to do around implementing the business model that Dave spoke to, andspecifically looking at our manufacturing footprint, as well as looking at ourproduct lines for potential rationalization. Turning to slide 14 I would just note again; we remainvery, very committed to the targets that we have previously communicated.Return on Capital Employed, which we believe is the key metric for measuringour overall financial success - it's certainly a function of the overallCapital Returns and Margins that we have in the business. Given that we areinvesting capital to support the new facilities -- as this slide indicates, weare not expecting a meaningful increase in our asset returns. Again, as outlined previously, therefore, we must focus onthe margin improvement. As stated previously, our financial framework is forgross 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, coupledwith Capital Returns of 2.5 times will drive the Return on Capital up to thetargeted 11% to 12% range. We certainly face a challenging marketplace, and theexpansion that we see assumes that the North American truck market willrecover. The significant change in our business model is critical, and it ishow we will deliver the results consistent with these targets. And finally I would note; again, we are very much focusedon execution and reaping the benefits associated with the actions we are takingto close and consolidate facilities and launch new products. So to recap our fiscal 2008 Second Quarter, certainlyagain, strong international performance; I think we're very pleased with theoperations outside of North America. The North American truck market has been very, verychallenging, and as we’ve mentioned, the manufacturing realignment here in North America as well as product launches hasdriven near-term inefficiencies. But we are focused on implementation of the businessmodel; we are focused on continuing to diversify our product platform, and weare focused on ongoing cost savings such as the sale of the corporate airplaneand such as the freeze of our defined benefit pension plan for our U.S. salaried employees. And finally, we are very, very encouraged and welcome thenew leadership to support us in not only the ongoing operations, but insupporting us, as we continue to develop and launch new products. So with that Dave, I think we’ll open up for questions.

Right.

(Operator Instructions) Your first question comes from theline of David Leiker with Robert W. Baird. Please proceed.

Good morning.

Good morning.

Good morning.

I had a handful of number related questions here to startwith. Brad, if you take out pension and the claim out of those numbers, wherewould your tax rate have been?

Well, I think what I would say is, I would prefer toanswer that the primary driver here is the change in the tax rate associatedwith Germany. So, let me just kind of walkthrough the change in that tax rate to kind of show you what I think would havebeen a more normalized tax rate for the quarter. And certainly, if you take theminus -- again a 124% effective tax rate that is negative rate, we had $2.5million benefit of simply the change in our deferred tax liability albeit --the liabilities now have been reduced, so there was a $2.5 million pick up toour earnings. Also associated with this was a further $2.5 million pick up aswe recalculated if you will, our effective tax rate and brought it up tocurrent for the impact on the quarterly results post the change in this taxrate change.

Okay

So, those two factors would bring the effective tax ratedown to - quite frankly in the quarter at about minus 12%. As we look at -- andthat again David is a function of the large losses that we’ve incurred in thehigh tax jurisdiction here in the United States. As we look forward for the rest of the year, we wouldexpect the incremental earnings to kind of -- tax that about a 19% rate, whichagain I think factors in to the overall tax rate of guidance set between 5% and9%.

So 19% for the second half of the year?

Correct.

Okay. And then as you go out to the 2010 number, andobviously a big part of that’s North America doing better, that tax rate gets back up to a 35%to 40% rate by then?

No, it doesn’t. Because again, I think we’re seeing thatthe profits clearly are being shifted towards the international side of thebusiness where the tax rate’s kind of in what you’d call the 25% range. So we continue to evolve our thinking on this, and everytime David, you ask that question we kind of lower it, as the mix of profitscontinue to change. But my best guess at this point is that the overalleffective tax rate is going to migrate up to kind of the 25% to 30% range. Idon’t anticipate we’re going to be up in the mid 30’s as we go forward.

I have a hard time getting you back to a 7.5% margin on2010 without the North American profits meaningfully recovering, and Europe is already above that level. So I mean your incremental profits are going to come fromthese high tech areas.

Correct, and I’m talking about just on a weighted averagebasis, so, certainly this year we operate in the 5% to 9% range for the fullyear, and again there are some special factors albeit the German -- you’reabsolutely right that the profit improvement is going to come from the recoveryin 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 furthergrowth out of Asia, stay tuned on the Europe growth, which again I think is --you weight all of that together and I think, again, you're going to have adisproportionate amount of your earnings still earned outside of the UnitedStates.

Okay. Is there any savings from the pension freeze?

There certainly are, again because -- and that’s I think amessage that we are trying to drive home from the standpoint of, certainlythere was the impact in the quarter, but as we go forward, there is about a $2.5million annual savings from the freeze that we have made. And I would note David, just you probably haven’tdissected the balance sheet, but what we are very encouraged about as theresult of this change and also as the result of the performance of our pensionassets that the pension plan has actually moved into a net positive fundedstatus here in the United States.

Okay. And one other number question, I’ll come back inafter that. The gain on the plan and at the pension, both are at the SG&Aline, correct?

Well, the plan certainly is at the SG&A line, and thepension is split between -- it’s majority SG&A but there is some impact onthe gross margin, and again that’s why we showed it as one of the reconcilingfactor as we try to get to a more normalized gross margin.

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

Okay. So, again it will be in the Original EquipmentAmericas and it will also be in the Overall Corporate SG&A. And we couldcertainly break that out for you if that would be helpful.

Yeah. We can follow-up on that. That’s all I need rightnow. I’ll come back with some other ones. Thanks.

Thank you, David. Operator (Operator Instructions) Your next question is a follow-upquestion from the line of David Leiker with Robert W. Baird. Please proceed.

I guess it’s just the two of us.

We are feeling left out.

David, you got to ask David some questions, please.

If you look at -- is there a way -- I know its kind of atough number to get to, but is there a way you could break up for us the impacton the revenue line of the North America Class A truck market?

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

Is that a $30 million number in the quarter?

No. I mean I think, its probably -- I mean, you can lookat our overall revenues in that segment as being down about a third, of about60 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 yearis due to the truck market, as our ag market where we have again a goodbusiness and the off-highway markets have been fairly stable, albeit at astrong level, so a majority of that variance is driven by the decline in theNorth American Medium and Heavy Duty truck market.

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

Yeah, you’re talking about in the First Quarter?

Yes.

It seems I guess incrementally getting worse.

We’ll we talked also about the new business launch thatFreightliner has been slower and they have gone through some specific things inregards to export mix versus North American mix, and the export has some legacyproduct. So, that will stabilize the effect -- will have an adverse effect ofthat startup volume than we had originally anticipated despite the market.

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

Well, we certainly as we go forward, absolutely. Theimpact…

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, Iwould just back up -- the decline that we saw on the Original EquipmentAmericas was down about 45 million in the First Quarter and is down about $60million or $59 million I think in the Second Quarter. And again, I think it is the function of the Freightlinerbusiness where we have -- obviously we’re on the 2007 programs, but theFreightliner certainly -- their volumes largely are for export at this point,which are using the '06 modules which were not on, it’s using platforms that weare not on.

Probably your exports will change because the emission lawchanges in Mexico and in other export locations will be changing again to thecalendar year, so that will put it back as a’07 product. And I don’t want toget into a heavy duty Freightliner discussion, but they are very, very strongand pleased and that’s where the market has been hit the hardest in regards toslow recovery.

What about your European truck number? That had to be better-- volumes seem better there?

I mean, the European, we’re certainly not seeing thecycles and we continue to see the growth out of Europe - I mean, that’s muchmore stable if you will, and growing market. And certainly, we’re very, veryencouraged about the upcoming emission law changes where we will be obviouslyworking to get on incremental platforms and gain market share in Europe as we go forward post the newemission law changes in the 2011 timeframe.

Dave, the increased volume that we’ve seen though in Europe right now is related to newbusiness in the EGR areas, which is truck related, as well as a new condenserbusiness that we’ve launched in the quarter. We are very encouraged by how weare being received in the region in regards to the decisions that will be madeover the next 12 months in regards to both engine and powertrain coolingdecisions for that next emission law change in Europe.

Okay. Another item I want to dig through here are thesemanufacturing inefficiencies. Are you doing more plant realignments than whatyou thought you were going to, or is it taking longer, or is it moredisruptive? Can you fill in some color there on what’s going on if that’s theworst thing what we’ve been seeing?

And let’s separate the two from what I would callRe-alignment and the Launch. The Launch issues are in two facilities -- I don’twant to get real granular, but in both cases, it’s been absolutely invisible tothe customer, which is the first priority. We have had some equipment issues inone specific that we are addressing very aggressively. And then we have some, managing some, what I call design-- in the Launch, design changes, as well as some learning curves in regards todealing with some material, embracing materials, etcetera. There is lot ofdetail in the new product launches. Always our priority is the customer. Yes, there are some disappointments in a couple of thesenew product launches. I would say yes, but work and company are on point onthose.

But what market are those for?

Truck.

Truck. Okay.

In the consolidation area -- and that’s where we’ve had, Iwould say, a larger part of the inefficiencies is, we did expect some of this.You don’t do what we are doing without having expectations. I would break it into Controllable and Non-controllable.And oftentimes, the Non-controllable, you can control by having good insight.In the Non-controllable, we in -- in one facility, we have had difficulty infinding actually quality employees. We found employees but not people thatwould stay or have the skills sets, and so we’ve responded by revaluatinghiring rates and how long there -- before they get benefits, etcetera, butunfortunately that was one that maybe could have been anticipated better. We’ve also had, in the midst of transfers we have had someslight volumes from one particular customer that was not anticipated. Thecustomer has been served well, but that created some significant variances.Again, how quickly you can respond to emerging issues is key. And on the last one that I would say is just managing thedetail. And managing the detail means that you to have to have the right peoplein the right jobs. We’ve had some turnover or some performance issues and acouple of situations that we have dealt with and are behind us. And Tom and histeam have made sure that we’re not going to rationalize this for an extendedperiod, but make sure that we’re on top of it. So, we had actually put some incremental resources --management resources on making sure that we understand the root causes, youknow, for things like scrap rates or things like premium trade freight,etcetera. So, am I disappointed in the quarter in the manufacturingperformance? Yes. Do I have confidence that we know the issues? Yes. Are weputting the right resources in place? But I’m not yet -- and I need to say thatthe balance of the year, you can’t do this much without having things to comeout of the wood-work, and the key is keeping the customer insulated andminimizing the impact.

And these consolidation issues -- are these on the Truckside or Auto also?

It’s Construction, Ag and Truck, although very limited inthe Automotive side, that means the automotive piece (inaudible) shutdown andits done. We do have some startup activities -- I didn’t mention this, we dohave startup costs in Mexico, those are not out of line, thoseare under control but they are something incremental to the year, and that’sbasically automotive business.

Okay. I have some other ones but I will pass it if there’sanyone else around.

I am sure they’re just waiting to talk to us.

I will be right back, if there isn’t.

Your next question comes from the line of David Saks withHuffy Capital. Please proceed.

Sorry to breakup the party. I had a couple of questions;one, this should be the easiest of them. At the slide where you had providedyour estimate of bills, they weren’t numbers, they were just bars. So could youjust fill in the blanks there with a 190,000 you are saying for…

Yes, this just actually comes out of words, but thenumbers across -- I will start with ’05, is 335, ‘06 is 372, I believe 217 if Ican read my writing, 218, 270, 357 and 216 for 2010.

I am sorry 218, 270?

357 and 216. I would -- I want to quantify -- this is avery dynamic environment right now. And in regards to what -- the numbers in’08, I hear a lot of discussion right now, but ’08 will probably be softer thanthat. And '09, which is a pre to an emission law change, how bigthat 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 cost withthe new vehicles after the emission law change, and that’s a dynamic that Ithink the industry is still learning about. Two, where will the economy be? The (inaudible) miles aredown right now and how well that will -- how long that will extend or will thatrecover prior to the pre-buy is certainly a very key element there. So, there are a lot of moving parts, not only within theshort term but I think -- and in fact, David Leiker reports about this everymonth is that there's just a lot of moving parts in this truck assumptionbetween -- over the next three years, and it will be important that we stay ontop of that.

In the 190 that you're using, that's just because it's aFiscal Year as opposed to a calendar year? That's…

Correct. That just says that our Fourth Quarter will besofter than the First Quarter calendar.

Okay. Next question. One of the slides you talked aboutyour longer-term opportunity of 4% or so organic growth rate and thensupplementing that with acquisitions. So can you just talk about what are someof the drivers to that “organic growth” rate and then what you might be lookingfor in terms of acquisitions, how you're looking at building onto this existingbusiness mix?

Yes, the organic has several parts; one, obviouslyincreased content on vehicles that have diesel engines. With increased content,what I mean is that there's more components, heat transfer components that getattached to an engine, like exhaust gas recirculation coolers and fuel coolers,wheel coolers, etcetera. So there is a content opportunity that is taking placein our mature North Americaand European markets. There's also penetration opportunity, where we feelconfident we are going to have incremental wins in marketplace, not just inTruck but also in our Ag and Construction markets. The other piece, animportant piece of organic growth is new technology. We had a number of I thinksignificant opportunities in new products that could actually have a significant-- a larger impact than the organic number that we're talking about. Those relate to, I mentioned the new powertrain coolingtechnology that we had released on about a quarter ago, as well as sometechnology we're working on in regards to improving mileage, in regards totaking energy from exhaust and putting it back to the wheels. The other piece on organic is the new economies. We'rebuilding plants in China, India and Hungary. and we certainly think there'sgreat 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 organicconsumption that we have, and we're going to continue to monitor that to makesure that that maybe understated, who knows, until we get more clarity on thedecisions that are going to be made over the next 18 months, specifically inNorth America and Europe and on the truck and construction side. On the acquisition side, we have made four acquisitions inthe last three years, and we have a process in place. We continue to put a lotof things through our funnel - a lot of things don't make it through thefunnel, but it's an active area. It's an active area where we want to grow inour core business, so we will continue to look at acquisitions and where we'restrong in regions. We will look certainly, and have looked in the areas thatwe're doing Greenfields, we have looked very hard at acquisition and jointventures in China and India, and thus far we have determined that Greenfieldsare 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-vehicularbusiness, and that's where we made one acquisition, the Airedale business, andwe think there's further opportunity here in North America and certainly inEurope because of the consolidation opportunity in that marketplace. So it's a long-winded answer, but I think there's a lot ofkey elements to growth. The key in maintaining margin with growth istechnology; is that we absolutely have to have differentiating technology inorder to be able to have what I would say a premium position or has a customerthat value technology appropriately compensate us for it.

And back to more of a…

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

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

We certainly haven’t talked about that. But given thesignificant investment that we’ve made in the R&D side of this business insupport of the fuel cell, and kind of the technology that we’ve developed, theproprietary technology, you would expect that we would be certainly above ouroverall average margins for the Corporation. Again, based upon, obviously thefact that we've got to get a return on the R&D investments and we certainlythink that we have kind of leading edge technology in that space.

We also are very sensitive for these customers that hementioned specifically, but others, we have in fuel cells is that they alsohave to be competitive. And so, part of the chemistry, or the kind of chemistryof having success here is having a product that works, but also is competitiveto alternative energy sources. So, we understand their needs and I think theyalso respect our needs in regards to -- as Brad said, there's a significantinvestment that we’ve made in this business and we’ll continue.

And switching gears to the European and the rest of theworld Truck market, what are your thoughts there in terms of the sustainabilityof the growth we've been experiencing? '07 has turned out to be a far betteryear in Europe. What do you feel is causing thatand how sustainable do you feel that trend will be?

Well, yeah, I mean certainly, as you look at Modine, and Ijust divert away from Europe for a minute, but as Dave stressed, as we look outside ofthe traditional North American Western Europe, there we're really looking atmarket penetration as we enter those markets. And so, we should experienceobviously very healthy Modine growth rates, again, as we bring technology tothose markets on both the engine side but also the powertrain cooling. I think as it relates to Europe, the Europe economy -- European regioneconomy, if you will, continues to be very, very strong. Stay tuned on whetheror not there is a cycle that they may incur as a result of the upcomingemission changes albeit that business has been less cyclical than what we'veseen here in North America,but we continue to be very encouraged with the growth. But again, I think as you look at specifically Modine, aswe go through this five-year planning cycle as I mentioned and then Davementioned, we are really encouraged about some of the new programs and ourability to kind of, grow our market share in Europe in the Medium andHeavy-duty truck market.

It's an interesting phenomena as you watch Europe, andthey have trailed the North America emission law changes by a year or two, butthey traditionally have never had the kind of volatility that we have seen inthe Class A market. And even our mediums have had lesser volatility, but somehistorical, but with these changes they've been very dramatic in pre-buy. Andlooking at Europe, the amount of pre-buy and thetraditional volatility has just not been there. The market just operates from adifferent set of values.

Okay. So the strength that we are seeing in Europe -- I’m kind of reading between someof your comments, we should be essentially seeing that perpetuating orcontinuing into '08. There's no reason to think that we’ll see a reduction inthe activity levels.

I would agree with that.

Okay. And then last question and I'll get back in line.Just the -- as you look at incremental leverage to changes in the build ratesin North America, I think the questioner before talked about how the falloff inprofitability -- I didn’t do the incremental analysis -- the falloff inprofitability in the Second Quarter based on volume short fall is far biggerthan the First Quarter. You’ve got cost programs in place to take costs out, so intheory 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 sort of what are you settingyour breakeven level to be, so we can try to model our operating leverages,it’s a business (inaudible)?

Well, I think that’s what we tried to do on slide 13, wasto say, in North America, given that we’re operating at a 190,000 unit class-Atruck market, if we’re able to operate the company at 280,000 units, which is amore normalized build rate for North America, on our margins there is 1.3percentage point margin enhancement simply from the fixed cost absorption ifyou will that we get from operating our plants at higher levels.

Okay. So that's the -- on 90,000 unit change, we pick up a130 Basis Points of margin?

Correct.

And then the other aspects of that slide just talked aboutimproving efficiencies, and not just a plain consolidation in the lower costmanufacturing potential?

I am surprised that that volume absorption number is notdramatically higher than that.

I am sorry?

I am surprised that volume absorption number wouldn’t bemuch higher than that.

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

I'm just looking at the degradation in profit on the waydown. 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 --the more efficient cost structure comes through the other two bullet points,the North American operating improvement, and getting the fixed cost out of theplants that are being closed. So if you want to look at an aggregate the, kind ofleverage that we have here in North America, you can add those bars up if you will.

And I guess my point would be, is if you look at theenvironment to get to 280 or probably directionally through that, we'll haveEurope and the rest of the world doing much better, theoretically profitable inAsia and North America going from a loss to...

Let me correct that in that what we've tried to do here,what we're not going to give -- kind of, we've shown you our target, which is18% to 20%. And what we have done is, we've taken the current guidance for theyear, the low end of that guidance at 15% and we've said there are some unusualthings in the year around the state of the Truck market and the state of ouroperations here in North America and the fact that we're in the process ofclosing facilities. So, we've simply normalized for the North American effect.As we go forward and how Europe performs, how Asia performs, etcetera, that'spart of that journey if you will, from 17.2% - again, a normalized 2008 marginup to the 2010 18 to 20%.

There is one other element of cost that actually thatwe're not spending any time on today, one I'm tickled we're not spending timeon, and that's the lag in the material recovery, commodity cost. But the other very important piece of that journey from17% to 19% is the new organization structure we have in purchasing. We've gotvery good traction and very good leadership in that area. And that will also bea key element in that incremental step as Brad said, that we've got more workto do, and that organization is maturing very well in my opinion.

And that's just leveraging global purchasing scale at thefirst auctions or…

I would say, leverage is certainly part of it. I think abigger part of it, what’s within our control is have global designs. I hate tosay, the old organization we had Regional Designs; we had Regional Optimized,we had Customer Optimized Design. So having Global Designs and Global Purchase where youcould call that leverage, but that's not just leverage; that's bringingincremental volume to that, other than just adding the regions up. The other piece is standardization. This is a harderpiece, but a piece that we're working on and that's on the legacy productbecause many of our products have very long life cycles. And in order to beable to create purchasing opportunities, you have to reach back and work withthese new platforms that we've talked about, and with those new platforms wecan do it. We can design design-cost of production into the Legacyproduct. Obviously in those cases, you typically have to have it tested, youhave to have the customer involved, and we'll probably share some of that withthe customers in order to be able to drive that through, so you don't get toput all of that in your pocket. But it's good news for us and it will be good news for acustomer and I think we have the structure now that we cannot just talk aboutit, we can actually do it.

I’ll get back in queue. Thanks.

Your next question is a follow up from the line of DavidLeiker with Robert W. Baird. Please proceed.

I think this is the last go around for me.

You've said that before.

I won't hold myself to it. If you pulled the plain costsout and the pension gain out, you have an SG&A number that isn't consistentwith the strategy of reducing SG&A. It ends up being as a percent ofrevenues, one of the highest numbers that you've had ever. And up prettymeaningfully 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 of11.5%, clearly the overall revenue line if you will, is certainly downdramatically. So, our ability to absorb the SG&A if you will, has beenimpacted by just the North American truck market. I would say -- so, if youlook at the change in the SG&A from 112 million on a year-to-date basis to108 million, certainly you're right that the plain sale of four -- and thepension impact that's in the SG&A in the first six months is about 4million. So what's kind of offsetting that clearly I think I wouldsay, the big area is 3 to $4 million of exchange benefit -- adverse exchange inthis case, as we translate foreign SG&A at higher exchange rates if youwill.

Even adjusting that and trying to gross up the numbertowards $2 billion revenue run rate, you still end up with something that'sover 13%; is that, playing a 150 Basis Point gap from where you are to whereyou want to be, is that a consistent number?

Yeah, I mean we've been operating in that kind of justbelow 13%.

Okay.

So you're right, I mean that's part of the next couple ofyears journey; as the company grows, clearly we have to take steps to control theSG&A. And again, that's why for example, one of the things we've talkedabout -- or the two things here, which again, you could call those one-off. Iwould like to say, no, they are not one-off, it’s because they're part of thestrategy to get to 11.5%, the corporate airplane sale and the pension.

And let me just embellish on that, is that we still havean airplane in North America but there is that cost -- an operating costreduction in going to one versus two. We're not going to compromise our supportwhen we have fewer plants, but there are also different technologies tosupport. And Brad has already mentioned that there's an ongoing savings in thepension area. There's many pieces to the -- and we're very focused onthe SG&A. A couple of those for example, it's not significant but it's partof a pile of nickels, is that with the new plant launches that we have in placeright now, until they are in production, those flow through SG&A. We alsohave a North American SAP launch going on right now. And when that's completedthat 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 thingis very important to us and it only is going to happen with detailed actionplans. And Dave, we've got a lot of activity working.

How much of that SG&A is what you would call Researchand Development, Product Development?

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

On the capacity numbers.

Yeah.

Dave, it seems like I ask you this all the time. Part ofthe idea three years ago of booking new business is -- or going to launch atexisting facilities and be a big driver of margins. And here today we'relooking at a cap-spending budget that's well above depreciation and new plantsgoing up or plants being closed - and those two seem to be contradictory.

Well, when we talked about new plants -- I mean newbusiness that we had booked, the booked business that we had talked about inthe past is primarily in North America and in Europe, and those statements were being put into existingfacilities. The rationalization that’s taken place in North America,specifically closing one plant that we have in Tennessee and building one inTexas is a cost reduction opportunity versus saying you have availablecapacity. There was capacity there, but it was not as cost-effective capacity. And then we are certainly spending a lot of money in newregions. But that new region capacity was not included in that net new businessnumbers that we talked in the past, because those new businesses are justemerging on our radar. When we talked about those in the past, they weren't…

But are they capacity closings, because the new businessnumber is not as big as you thought it was? Is it because you’ve walked awayfrom business that's not there? I would have expected a capacity to be filledwith new business as opposed to being closed and consolidated.

I would say that the answer is, at least in North America,one, you are aware we walked away from some business out of Toledo contractdecision. The balance of that is, there is some rationalization of somebusiness that just doesn't make sense that we should continue. So, part of the reducing the footprint is walking awayfrom some unprofitable, low volume, mixed customers that aren't strategicallyimportant. But the other thing is that -- and maybe we haven't said this in awhile, we have a small plant philosophy Dave, but with the technologies that wehave in the plants, with systems that we have in the plants, we have raised theupper limit of our small plant philosophy to about 350 people And then, with automation in high cost countries you haveto do, we are actually creating more scaled facilities in our North Americanfacilities. And we're doing that without adding footprint in those plants;we're doing that by doing the kind of things a lot of people that we talk aboutlean 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 viaconsolidation without footprint. And that’s only happening because of theactivities in lien.

Capital spending, and you put a number out there for Marchof '08. Does that start to come down in 2009, 2010, or is that a number thatwe’re going to continue to see run at a pretty high rate?

It's going to come down starting at 2010. Clearly, as wego into the next Fiscal Year, we will be gearing up for again, some of the 2010programs, as well as starting to capacitize for some of the fuel cellactivities. So I think 2009 will be another decent year as we -- again, alsocomplete the facilities that are under construction. And then in 2010, you should see the capital drop backdown. I just want to kind of again just reiterate this journey on the grossmargin, which is I think again what you were pushing on, on the capacity, andcertainly from where we are on a normalized basis of 17% to 18% to 20%. As Dave mentioned, we certainly have the purchasinginitiatives that we have. We do also over this period clearly have ongoingprice downs, which we have to offset. And so clearly, to get to this journey, as I mentioned inmy prepared remarks, is -- we have to continue to look at the manufacturingfootprint, and we do have to continue to look at the overall product line andthe product line profitability, which is again all part of implementing thebusiness model.

And something Dave, a little bit more granular detail, butI think you like it -- as we have gone to the new organization structure andaccountability for these product lines, Brad has brought out some very goodtools internally for us to better understand specific product lineprofitability and customer profitability. And that’s -- and having betterinformation and we can make better -- either rationalization decisions orpricing decisions with our customers. So there are lots of pieces to thepuzzle.

Brad, the special items that are in there -- just what wehave seen here in Q1 and Q2 -- the pension, the plain, and the currency gain inQ1?

Yeah.

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

Yeah. Certainly, we don't have as we go forward…

You're not anticipating there's anything…

Unusual items -- and certainly I would say this that inthe guidance -- it is a guidance David, from continuing operations. So anyimpact of the divestment of electronic business certainly is not in thesenumbers.

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

Yeah. Based upon our sensitivities that we’ve provided, Idon't think it’s quite that high, only because we do have some of our aluminumlocked 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 likeabout a $0.50 or $0.60 reduction in earnings. Is there a way you can split thatbetween the Second Quarter being below what you expected and the balance of theyear? How that’s weighted between what you experience here in Q2 versus whatyour 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’m a little uncomfortablein answering that, because in the previous guidance, clearly, we had had theassumption of, for example, the corporate airplane sale. We had beenanticipating that as part of our SG&A reduction initiatives.

That was in your guidance.

That was part of our previous guidance. And the pensionplan -- certainly, again, we were looking at that, and had some estimate of thepension plan, albeit the pension plan benefit has turned out to be morefavorable than what we had had in the previous guidance. So I wouldn't think that you should be saying that thosewere one-off -- not in the previous guidance, and therefore there is a hugeunderlying decline here, because in our previous guidance, again, we hadaircraft, and we had most of the pension -- albeit again, there has been someupside.

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

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

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

No. I don't have anything else to say, David.

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

If you take 4% to 6%, correct.

And are you using a normalized build rate for Class A ofthis 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 itbuilt on that $210,000 that you are showing in your slides for 2010?

You're getting off the awards [ph] data -- I am sorry, Iwas just puzzled where you were getting your -- that’s calendar 2010, right?And we are on a fiscal 2010. So that clearly would be -- we would be running in2010 at a higher -- our Fiscal Year would be running at a higher rate, becauseit would have the April 1, 2009 to March 31, 2010.

It's built on what you think Build is during that FiscalYear or is it built on this normalized volume?

The 18% to 20%.

Right.

Is a normalized volume - 280, sorry.

Okay. That’s all I need. Thanks.

Operator, any other questions?

No. At this time, there are no further questions in thequeue.

Well, as I opened, changing the business model, I have alot of confidence in. I think the organization has embraced it. The customershave seen better clarity on what we provide them. There is a lot of work to do.There is a lot of work to do as we shut some facilities down. We move product aroundand as we launch these new facilities in various parts of the world, the keycomes down to leadership, and I am pleased with the leadership that we have inplace in a number of locations, some of the new leadership that I announced. Iam very confident in those people. But this is a continuum. And this Changing the BusinessModel will continue to evolve. And so the actions that we have announced, therewill be probably more coming. But we're not going to make those decisions untilwe clearly understand what it takes, what the impact, and what the opportunityis. So we look forward to seeing some of you on some of ourvisits. And those that we don't, we will see you, hopefully talk with you atthe 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.