Modine Manufacturing Company is a worldwide leader in thermal management, providing highly engineered heating and cooling solutions to a diversified customer base. Modine's products can be found in cars and light trucks, medium and heavy-duty vehicles, commercial heating, ventilation, and air conditioning (HVAC) equipment, refrigeration systems, off-highway and industrial equipment, as well as fuel cell applications and electronics. Our broad product offerings include heat transfer modules and packages, radiators, oil coolers, charge air coolers, vehicular air conditioning, building HVAC equipment, exhaust gas recirculation (EGR) coolers, and electronics cooling solutions.

Modine's vision is to pursue market leadership by being an innovative, customer-focused, global company that delivers exceptional quality and value. We will grow our core business, thermal transfer, by providing superior technical solutions in our systems, products, and services. We are committed to further increase our overall profitability and returns on capital through continued operational improvements and active cost management. We expect margins and returns to benefit from leveraging our current capital base in support of new business programs and recoveries in our markets, and by following a very disciplined approach when investing in our business and addressing underperforming parts of our operations. We continue to focus on the four strategic initiatives introduced two years ago -- Improving Profitability, Financial Stability, New Products and Technologies, and Strategic Planning and Business Development.

Modine is focused on strengthening our competitive position through strategic business development activities as the markets for our products continue to evolve. We continue to face competition from suppliers in other parts of the world, which enjoy economic advantages such as lower labor and health care costs. We are addressing these issues by reducing design and manufacturing costs, improving our operational performance and efficiency, and by seeking low cost sourcing as appropriate. While evaluating our cost structure and making changes, we also continue to follow our globalization and customer diversification strategies. Another developing trend is that customers are increasingly requesting Modine to participate directly in product design, development, and validation responsibilities, which has resulted and should continue to result in stronger, longer-term customer relationships.

Although the overall operating environment for Modine did not improve significantly in fiscal 2004, we began to see the start of recovery in our North American truck and heavy-duty markets in our fiscal fourth quarter. Combining this with the positive contribution from new business programs and continued operational improvements, Modine delivered a stronger performance in fiscal 2004 and achieved an increase in both sales and earnings for the full year. Sales for the full year increased 10% to $1,199.8 million from $1,092.1 million one year ago, setting a new record for the Company.

Effective with the first quarter of fiscal 2003, Modine adopted Statement of Financial Accounting Standard (SFAS) No. 142, "Goodwill and Other Intangible Assets," and recorded a related goodwill impairment charge of $21.7 million (net of $1.1 million income tax benefit), resulting in net earnings of $12.7 million, or $0.38 per fully diluted share for last year. Net earnings for this year more than tripled to $40.4 million or $1.19 per fully diluted share, while earnings before the cumulative effect of accounting change increased 18% from $34.4 million last year to $40.4 million. Both Modine's current year and previous fiscal year financial results contain a number of significant items. Please refer to the Net Earnings section of Management's Discussion and Analysis and the Notes to Consolidated Financial Statements for a detailed description of these items and the impact on Modine's financial results.

In fiscal 2004, including exports from domestic businesses, 47% of total revenues were generated from sales to customers outside of the United States. Net sales generated by Modine's international operations were 40% of total revenues, and exports from the United States were 7% of revenues.

For fiscal 2004, Modine's list of top ten customers remained unchanged in composition from fiscal 2003. Revenues from Modine's top ten customers accounted for approximately 55% of our total sales in fiscal 2004. Modine's largest customer (our second-largest customer in fiscal 2003) accounted for slightly more than 11% of this year's total sales. Sales to no other single customer exceeded 10% of total sales and Modine continues to have a well-diversified customer base overall.

Modine operates in three business segments, which are organized on the basis of market categories or geographical responsibility. They are as follows: 1) Original Equipment segment, which provides heat-transfer products, generally from business units in North America, to original equipment manufacturers (OEMs) of on-highway and off-highway vehicles, as well as to industrial- and commercial-equipment manufacturers, located primarily in North America; 2) Distributed Products segment, which provides heat-transfer products primarily for the North American and European vehicular replacement market and the North American commercial HVAC and refrigeration market from business units located in North America and Europe, as well as electronics cooling products for the computer and telecommunications equipment markets in North America, Europe, and Asia from business units in those three areas; and 3) European Operations segment, which provides heat-transfer products, primarily to European OEMs of on-highway and off-highway vehicles and industrial equipment manufacturers. Modine has assigned specific business units to a segment based principally on these defined markets and their geographical location. Each of Modine's segments is individually managed and has separate financial results reviewed by its chief operating decision maker. These results are used by management in evaluating the performance of each business segment, and in making decisions on the allocation of resources among Modine's various businesses. Modine evaluates segment performance based on operating income and the return on capital employed. The significant accounting policies of the segments are the same as those of Modine as a whole (see Critical Accounting Policies section of Management's Discussion and Analysis).

Original Equipment segment: Original Equipment segment sales increased 7% to $502.2 million from $469.4 million one year ago. Operating income rose 6% to $81.1 million from $76.4 million in the previous year.
Modine's North American OEM passenger car and light truck market increased its sales from the previous year and had a positive impact on this segment's operating income. New business programs, including one with the Chrysler Group to supply engine cooling and air conditioning modules for the all-new 2004 Dodge Durango, played a major role in increasing sales. During Modine's 2004 fiscal year, the overall North American automotive market remained generally flat compared to the previous year based on a number of industry statistics, including SAAR (seasonally adjusted annual sales rates). This market has proven resistant to the soft economy as long as automakers continue to provide incentives and rebates to boost sales. Market share competitiveness among manufacturers and continued pricing pressure placed on suppliers by OEMs to boost their profits are the most significant market concerns. While gaining a full year of production for the vehicle programs launched this past year and additional market penetration will have a positive impact on this market's sales, we also face maturing programs and ongoing pricing pressure. Our primary risks in this industry include pricing pressure, competition from foreign suppliers, and low cost sourcing. Modine is addressing these issues in a variety of ways. We continue to analyze design to minimize component costs, when practical, while increasing the sourcing of components from low cost producing countries. We are increasing efficiency at our existing plants through continuous improvement, and are utilizing benchmarking to incorporate best practice production methods. We are also enhancing our product offerings to cover the entire breadth of customer needs for engine cooling, which we believe will bring future business opportunities in this market.

Modine's North American OEM heavy-duty and medium-duty truck market also experienced sales growth in this past fiscal year. However, a program scope change and launch costs related to certain new products had a negative impact on this segment's operating income. We expect growth opportunities in this market as the heavy-duty truck industry continues to strengthen this year. Current production projections for class 8 commercial trucks point to a 2004 market of about 240,000 units, up from approximately 180,000 in 2003. Gaining a full year of production for certain EGR and engine cooling-related programs will also be a major driver of the growth of this market. While there is potential upside for the heavy-duty truck market, the medium-duty market has not shown a significant increase. However, the overall strengthening of the truck market may drive additional engine product sales, including EGR and oil coolers. We also expect cost and pricing pressure to continue, and are taking a proactive approach in managing design and manufacturing costs and material expenses. Modine's truck division is focusing on winning new business programs, executing new product launches, and improving profitability of existing products. We are well into the implementation of each of these goals.

Modine's OEM off-highway and OEM industrial markets reported increased sales in fiscal year 2004, after recording a decrease in the previous year. The closure of two OEM off-highway manufacturing facilities as part of the Company's restructuring plan initiated in the third quarter of fiscal 2002, and ongoing efforts to reduce costs and increase operating efficiency contributed to the increase in operating income for the Original Equipment segment. We expect further growth opportunities in these markets in the new fiscal year. The North American construction market in 2003 was up 5% after two down years, while projections for 2004 point to an even greater improvement. The North American agriculture and farm equipment market in 2003 was up 1% after a one-year decline in 2002 and 2004 projections indicate a more significant increase. To date, all indications point to the fact that the projections noted above are happening and could strengthen even further. The primary risks, beyond geopolitical and general economic factors, include the recent tightness of supply and higher pricing on key base metals such as steel, as well as the ability of the overall supply chain to support this significant market uptick. We are being proactive in working with customers and suppliers to address these issues. Various initiatives are also underway to improve internal processes and optimize the production for a significant new business program that will contribute to this division's financial performance.

Distributed Products segment: Sales for the Distributed Products segment showed a slight increase to $351.6 million from $348.8 million one year ago. Operating income declined 5% to $3.3 million from $3.4 million in the previous year.

Modine's sales of replacement parts to the automotive aftermarket accounted for approximately 18% of total Company sales versus 21% in the prior year. Factors contributing to this decline include: a decision to end the supply agreement with Advance Auto Parts in 2002, with full impact in 2003; pricing pressures from both larger and regional competitors; and unfavorable weather conditions. The U.S. aftermarket business remains very competitive with overall volumes being flat. However, market pricing declined due to increased competition and changes in distribution channels. Fiscal 2004 also saw continued shift from copper-brass radiators to aluminum radiators. We expect that competitor pricing strategies and evolving distribution channel conflicts will continue to force pressure on a generally flat aftermarket business. Modine's aftermarket division responded to these challenging market conditions by implementing a number of initiatives to reduce costs in the supply and distribution areas and by offering complementary product lines, which had a positive impact on this segment's operating income. We continue to introduce new models to maintain coverage for replacement parts. During fiscal 2004, 97 new radiator models and 18 new condenser models were launched. We also continue to improve our technical systems expertise and product coverage in air conditioning replacement parts. Aggressive cost reduction efforts are being planned and implemented in sourcing, warranty, and logistics to drive profitability improvements.

Modine's sales to the commercial heating, ventilating, air conditioning and refrigeration (HVAC&R) market increased in fiscal 2004, while accounting for approximately 6% of total Company revenues. This year-over-year growth resulted in part from the general economic recovery and winter weather patterns returning to more normal conditions. We experienced continued sales growth of residential garage heaters and commercial unit heaters. In the HVAC&R coil market, a number of OEMs have decided to outsource their coil manufacturing. Modine is capitalizing on this change and has begun to ship coils to these new OEM customers late in fiscal year 2004. Coil sales with existing customers also remained strong. We expect continued sales growth in fiscal 2005 as the market continues to grow with the improving economy. The efforts in customer training, product development, and continued expansion of the BreezeTM Accuspec software tool, which enables us to match customer needs with the right Modine product, should continue to provide additional growth of heating products. In addition, we expect existing customers to expand their HVAC&R coil purchases, resulting in Modine receiving the full year benefits of the new coil business. Continued low-cost competition and ongoing outsourcing efforts from some of the major HVAC&R OEMs could have an impact on our outlook for this market. Modine continues to put in place more flexible and responsive manufacturing capabilities to address short-term opportunities for growth during the coming year and place emphasis on cost reductions to meet competitive challenges.

Modine's electronics business recorded a nearly 20% increase in sales during fiscal 2004, while accounting for just over 3% of total Company revenues. The increase in sales is split among three geographic areas: North America, Europe, and Asia. However, lower margins related to a product mix shift had a negative impact on this segment's operating income. The electronics cooling market remained challenging in the past year. Computer unit volumes were strong, but profit pressure was intense with increased migration of the supply chain to Asia, specifically China. Without any significant investments in new technology, the telecom market also continued to be soft, but it is expected to begin a slow recovery this year after a three-year decline. Despite these challenges, our electronics cooling business expects growth opportunities in fiscal 2005. The most significant new market development to impact this business in the new fiscal year is the expected application of heat pipe thermal solutions to desktop computers. Unit volumes of desktop computers are the largest of all the computer segments and we expect that the application of heat pipe thermal solutions to desktops will drive rapid growth in heat pipe demand. In order to fully capitalize on this developing market trend, Modine's electronics cooling group has significantly expanded the capability at its Hsinchu, Taiwan facility to more than double the production of its high performance heat pipes.

European Operations segment: Sales for the European Operations segment increased 18% to $393.0 million from $333.0 million one year ago, primarily as a result of favorable currency exchange rates. Operating income increased 13% to $42.3 million from $37.4 million in the previous year. Sales for Modine's European passenger car and light truck market were positively impacted by favorable currency exchange rates and incremental business, such as the BMW X3 and EGR programs with Volkswagen. Offsetting factors included model and program phase out as well as volume reductions in certain cooling modules. In fiscal 2004, vehicular production in Europe was down approximately 5% versus fiscal 2003. European brands suffered more than the Asian carmakers, which caught up with Europe's domestic players in the last year by embracing diesel technology and introducing cars that appeal to European tastes at competitive prices. European car sales are generally expected to improve slowly in fiscal 2005. However, the expectation is that the success of the Asian carmakers will continue and they will further increase market shares at the expense of the European brands. Our European automotive division expects growth opportunities in the next year on the strength of gaining a full year production of the new programs launched this past year. While we continue to face pricing pressure in this market, upside volume potential on several programs could have a positive impact on sales in the coming year.

Modine's European Heavy Duty business was impacted positively by favorable currency exchange rates and increased volumes. Process and operational improvements at the plant level contributed positively to this segment's operating income, while the product performance issue reported in the third quarter of fiscal 2004 had a negative impact. The improved profitability was achieved despite a flat European truck market and a slightly down European off-highway market. We currently do not expect any significant market improvement in the coming year, but do see growth opportunities on the strength of a number of new business programs to be launched in fiscal 2005. Factors that could have an impact on sales include production volumes of certain programs and the potential threat from low-cost suppliers we will be facing in our plate oil cooler programs. Consistent with our view in the North American truck and off-highway businesses, engine-related programs, especially EGR coolers, represent a significant growth opportunity which we fully intend to capitalize on with advanced product design and competitive value. In fiscal 2005, our European Heavy Duty division will be focusing on executing new program launches and continuing the ongoing process improvements.

As indicated in Modine's fiscal 2004 fourth quarter and year-end press release, we are focused on increasing shareholder value through well executed new business programs and strategic business development activities. We expect to generate additional growth from our strategic investments, such as the recently announced proposed acquisition in Asia, our three-phase investment in Europe for the new European headquarters, Technical Center, and wind tunnel, and our new and expanded plants in Wackersdorf, Germany and Hsinchu, Taiwan. The stronger results in the second half of fiscal 2004 established a positive momentum for Modine, and we fully expect this positive momentum to accelerate in the new fiscal year. We expect to deliver a similar improvement in both sales and earnings in fiscal 2005 versus fiscal 2004 improvements, before considering the accounting change in fiscal 2003.

The following critical accounting policies reflect the more significant judgments and estimates used in preparing the financial statements. Application of these policies results in accounting estimates that have the greatest potential for a significant impact on Modine's financial statements. The following discussion of these judgments and estimates is intended to supplement the Summary of Significant Accounting Policies presented in Note 1 to the fiscal 2004 consolidated financial statements.

Revenue Recognition. The Company recognizes revenue as products are shipped to customers. The revenue is recorded net of applicable provisions for sales rebates, volume incentives, and returns and allowances. At the time of revenue recognition, the Company also provides an estimate of potential bad debts and warranty expense as well as an amount to be granted to customers under applicable advertising and marketing programs. The Company bases these estimates on historical experience, current business trends and current economic conditions. The Company recognizes revenue from various licensing agreements when earned except in those cases where collection is uncertain, or the amount cannot reasonably be estimated until formal accounting reports are received from the licensee.

Inventories. Inventories are valued at the lower of cost, on a first-in, first-out basis, or market value. Inventories are reviewed on a continuing basis to identify inventory on hand that may be obsolete or in excess of current and projected market demand. When inventory is identified under either of these criteria, a provision is recorded to bring the inventory to the appropriate value.

Impairment of Long-Lived and Amortized Intangible Assets. The Company performs impairment evaluations of its long-lived assets, including amortized intangibles, whenever business conditions or events indicate that those assets may be impaired. When the estimated future undiscounted cash flows to be generated by the assets are less than the carrying value of the assets, the assets are written down to fair market value or discounted cash flow and a charge is recorded to current operations.
Impairment of Goodwill. On April 1, 2002, the Company adopted SFAS No. 142 and simultaneously discontinued the amortization of goodwill as called for under the new regulations. Under the previous accounting policy for goodwill, goodwill was amortized on a straight-line basis, primarily over a fifteen-year period.

After the Company adopted SFAS No. 142, we tested for impairment of goodwill in all business units in accordance with the new standard. The initial impairment test indicated that carrying amounts in the aftermarket business unit exceeded the corresponding fair values, which were determined based on the discounted estimated future cash flows for the unit. As a result, an after-tax impairment charge of $21.7 million was recorded as the cumulative effect of an accounting change in fiscal 2003. Impairment tests are conducted at least annually unless business events or other factors indicate a need to perform the testing more often.

In the third quarter of fiscal 2004, the Company conducted its annual review of goodwill for impairment. The recoverability of goodwill was determined by estimating the future discounted cash flows of the businesses to which the goodwill relates. The rate used in determining discounted cash flows is a rate corresponding to our cost of capital, adjusted for risk where appropriate. Estimated cash flows are then determined by disaggregating our business segments to a level for which meaningful identifiable cash flows can be determined. In determining the estimated future cash flows, current and future levels of income were considered as well as business trends and market conditions. Based upon the review, the fair value of each reporting unit exceeded its book value and accordingly, no impairment recognition was required.

Warranty. Estimated costs related to product warranties are accrued at the time of the sale. These costs are included in cost of sales for our manufacturing operations and in selling, general, and administrative expenses for our aftermarket operations. Estimated costs are based on the best information available, which includes using statistical and analytical analysis of both historical and current claim data on each particular operation. Original estimates, accrued at the time of sale, are adjusted when it becomes probable that expected claims will differ materially from these initial estimates.

Pensions and Post-retirement Benefits Other than Pensions. The calculation of the cost and obligations of Modine's pension and post-retirement plans are dependent on various assumptions. The most significant assumptions include the discount rate, rate of compensation increase, long-term expected return on plan assets and future trends in health costs. The selection of assumptions is based on historical trends and known economic and market conditions at the time of valuation. In accordance with generally accepted accounting principles, actual results that differ from these assumptions are accumulated and amortized over future periods. These differences may impact future pension or post-retirement benefit expenses and obligations. In addition, the Company replaced the existing defined-benefit pension plan with a defined-contribution plan for salaried-paid employees hired on or after January 1, 2004. We believe the new defined contribution plan will enhance employees' understanding of their retirement benefits and will allow the Company a greater degree of flexibility in managing retirement benefit costs. The change was cost neutral in fiscal 2004. At the current pension assumption rates, we expect the change will be cost neutral in fiscal 2005, with cost reductions occurring in fiscal 2006 and thereafter.

For the following discussion regarding sensitivity of assumptions, all amounts presented are in reference to the domestic pension plans since the domestic plans comprise 99% of the total benefit plan assets and 95% of the pension plan expense.

To determine the expected rate of return, Modine considers such factors as (a) the actual return earned on plan assets, (b) historical rates of returns on the various asset classes in the plan portfolio, (c) projections of returns on those asset classes and (d) capital market conditions and economic forecasts. For fiscal 2004, Modine reduced the expected return on plan assets from 9% to 8.75%, which increased pension expense by $0.6 million. We anticipate the long-term rate of return to remain at 8.75% in fiscal 2005. The estimated impact of a 25 basis point decrease in the expected rate of return on assets is an increase of approximately $0.55 million on 2005 pension expense.

The discount rate reflects rates available on long-term high quality fixed-income corporate bonds, reset annually on the measurement date, December 31. We lowered the discount rate in 2004 to 6.75% from 7.50% in 2003. The anticipated discount rate for 2005 will be 6.25%, which will increase expense by $2.5 million. The change in the discount rate reflects the decrease in interest rates during these periods. Lowering Modine's discount rate by 25 basis points would increase 2005 domestic pension expense by approximately $1.25 million, or conversely, raising the discount rate by 25 basis points would decrease 2005 domestic pension expense by a similar amount.

A key determinant in the amount of the post-retirement benefit obligation and expense is the health care cost trend rate. In fiscal 2004, the rate remained at 9%. This rate is projected to decline gradually to 5% in fiscal year 2008 and remain at that level thereafter. An annual "cap" that was established for most retiree healthcare and life insurance plans between fiscal 1994 and 1996 limits Modine's liability. Beginning in February 2002, the Company discontinued providing post-retirement benefits for salaried and non-union employees hired on or after that date. In December 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003 was signed into law. The Act provides a federal subsidy to sponsors of post-retirement medical plans that provide prescription coverage when the benefit is at least actuarially equivalent to Medicare Part D. Modine has elected to defer recognition of the potential impact of the Act until accounting guidance is provided by the Financial Accounting Standards Board. Accordingly, the impact on the post-retirement benefit obligation and related cost is not reflected in the financial statements. A sensitivity analysis using a one-percentage point increase assumed healthcare cost trend rates would result in an increase in expense of $108,000 and an increase in benefit obligations of $1.6 million. A 25 basis point increase in the post-retirement discount rate would result in a decrease in benefit expense of $25,000.

Other Loss Reserves. The Company has a number of other loss exposures, such as environmental and product liability claims, litigation, self-insurance reserves, recoverability of deferred income tax benefits and accounts receivable loss reserves. Establishing loss reserves for these matters requires the use of estimates and judgment to determine the risk exposure and ultimate potential liability. The Company estimates these reserve requirements by using consistent and suitable methodologies for the particular type of loss reserve being calculated. See Note 28 to the fiscal 2004 consolidated financial statements for additional details of certain contingencies and litigation.

In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except for certain hedging relationships designated after June 30, 2003. The adoption of this statement by the Company did not have a material impact on the Company's net earnings or financial position.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement by the Company did not have a material impact on the Company's net earnings or financial position.

On December 24, 2003, the FASB issued a revision to staff Interpretation (FIN) No. 46 (revised 2003), which clarified some of the provisions of the original Interpretation No. 46, "Consolidation of Variable Interest Entities," and to exempt certain entities from its requirements. The application of revised FIN 46 is required in financial statements of public entities that have interests in variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities, other than small business entities, for all other types of entities is required in financial statements for periods ending after March 15, 2004. The adoption of this statement by the Company did not have a material impact on the Company's net earnings or financial position.

On December 23, 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132 retains the disclosures required by the original Statement No. 132, which standardized the disclosure requirements for pensions and other post-retirement benefits to the extent practicable and required additional information on changes in the benefit obligations and fair values of plan assets. Additional disclosures have been added in response to concerns expressed by users of financial statements. Those disclosures include information describing the types of plan assets, investment strategy, measurement date(s), plan obligations, cash flows, and components of net periodic benefit cost recognized during interim periods. See Note 3 for the related pension and post-retirement disclosures.

On January 12, 2004, the FASB issued a Staff Position (FSP) No. FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003." FSP No. FAS 106-1 permits a sponsor of a post-retirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act"). Until final guidance is issued by the FASB, the Company has elected to defer accounting for the effects of the Act. As a result, the accompanying financial statements and notes do not reflect the effects of the Act. However, upon final issuance of the accounting guidance, the Company could be required to change previously reported information.

On December 17, 2003, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of Emerging Issues Task Force (EITF) 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Financial Statements Frequently Asked Questions and Answers issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. The adoption of this statement by the Company did not have a material impact on the Company's net earnings or financial position.

Capital expenditures of $72.5 million in fiscal 2004 were 44% higher than the prior year. Significant expenditures included: a new assembly plant in Wackersdorf, Germany, continuing expenditures on the European administrative and Technical Center facilities in Bonlanden, Germany, tooling and equipment for new customer programs and process improvements at a number of facilities worldwide. Capital expenditures were primarily financed through internally generated cash. Outstanding commitments for capital expenditures on March 31, 2004 were approximately $34.6 million. Approximately $25 million of the commitments relate to expenditures by our European operations. On March 31, 2003 outstanding commitments were $37.0 million.

In fiscal 2004, Modine increased its research and development (R&D) spending by 13% to $31.4 million from $27.9 million one year ago. This increase related primarily to projects such as aluminum radiators for the heavy-duty market, as well as activities on EGR, CO2, and fuel cell technologies. Investment on R&D has increased at an average annual rate of over 10% since fiscal 2000. We ended the year with 1,663 worldwide patents, an increase of 102 patents worldwide over last year. Modine is focused on the long-term commercialization of our intellectual property and research, and believes that these investments will result in new and next generation products and new technologies.

The Modine quality management system has been evolving steadily since its inception in 1996. As customer requirements and international quality standards have changed, the Modine quality management system has changed with them. Quality expectations have risen continuously and Modine is actively pursuing ways to meet those expectations. The establishment of Presidential Initiatives for scrap reduction, improvement of first pass yield, and awards for process improvements at manufacturing plants and corporate offices are ways to help meet those expectations. In the past year, five manufacturing plants have met the 40% improvement goal for first pass yield, bringing the total to ten; and three additional plants have met the goal for a 30% reduction in scrap, bringing the total on that initiative to eleven plants. Quality system registration is another area where customer expectations are increasing. International quality standards such as ISO 9000 and TS 16949 have been revised in recent years, and Modine is on target to have all facilities worldwide upgraded and registered to the newer standards by December 2004.

The value of the quality management system is evidenced by the improving results of the Company's ten quality indicators -- metrics which reflect the various aspects of the quality system, such as customer rejects, warranty costs, and product test failures. Collectively, these indicators have shown a 28% improvement since the end of fiscal year 2001.

We have implemented the Modine quality management system at all sites globally to help ensure that customers receive the same high quality products and services from any Modine facility worldwide.

Modine continues the implementation of its Environmental Management System (EMS) with fifteen manufacturing facilities attaining certification to the internationally recognized ISO14001 standard. We are pursuing EMS implementation at our Original Equipment locations worldwide and expect certification to the ISO14001 standard at all those locations by the end of fiscal 2005. Our EMS has identified a number of opportunities for improving our environmental performance, and specific targets for improvement have been established at each certified location.

In fiscal 2004, Modine began a worldwide program for monitoring its environmental performance. This program tracks waste, air emissions and our consumption of electricity, water and fuels such as natural gas and propane. These standardized metrics were established to provide a baseline for the continued reduction of wastes, generation of fewer greenhouse gasses, and the introduction of more environmentally friendly production materials. Over the past year, Modine's North American locations recorded: a 10% decrease in fuel use; a 2% decrease in electricity use; and a 6% decrease in water use (all metrics normalized for sales). In addition, Modine has achieved a substantial 30% year-over-year reduction in the use of chemicals it has voluntarily targeted for elimination due to their potential environmental risks. These chemicals include certain solvents and lead compounds.

Modine's commitment to protecting the environment extends to reducing chemical releases as monitored by the United States Environmental Protection Agency's (USEPA's) Toxic Chemical Release Inventory program. The Company's U.S. locations decreased their reported chemical releases in five of the past six years, and recorded a 66% decrease from 2001 to 2002. Modine achieved a noteworthy 90% decline in reported chemical releases from 1996 to 2002, and has consistently performed better than the national average. Modine expects its 2003 results, which will be reported shortly, will reveal continued success in these areas.

Modine accrues for environmental remediation activities relating to past operations -- including those under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), often referred to as "Superfund", and under the Resource Conservation and Recovery Act (RCRA) - when it is probable that a liability has been incurred and reasonable estimates can be made. Although there are currently no known liabilities that might have a material effect on the Company's consolidated net assets, the USEPA has designated Modine as a potentially responsible party (PRP) for remediation of five waste disposal sites. These sites are as follows: Elgin Salvage (Illinois); N.L./Taracorp (Illinois); Interstate Lead (Alabama); H.O.D. Landfill (Illinois): and Alburn Incinerator/Lake Calumet Cluster (Illinois). These sites are not company-owned and allegedly contain wastes attributable to Modine from past operations. The Company's potential liability at these five sites is significantly less than the total site remediation costs because the percentage of material attributable to Modine is relatively low. These claims are in various stages of administrative or judicial proceedings and include recovery of past governmental costs and for future investigations and remedial actions. In three instances, Modine has not received, and may never receive, documentation verifying its involvement and/or its share of waste contributions to the sites. Additionally, the dollar amounts of the claims have not been specified.

At the N.L./Taracorp site, a settlement agreement was signed in January 2002 which included a $119,000 settlement assessment. On January 16, 2004, the USEPA published its notice of proposed settlement with the de minimis PRPs, including Modine.

In 1986, Modine executed a Consent Decree involving other PRPs and the Illinois EPA and paid $1,029 for its allocated share (0.1%) of the Alburn Incinerator, Inc. remediation costs. USEPA signed a Covenant Not to Sue in conjunction with the Consent Decree, but reserved its right to "seek additional relief" for any additional costs incurred by the United States at the site. On November 6, 2003, Modine received a General Notice of Liability from the USEPA requesting Modine's participation as a PRP for the performance of additional activities that the USEPA has determined, or will determine, required to restore the Alburn Incinerator Inc./Lake Calumet Cluster site. Modine responded to USEPA's letter stating that it would be willing to participate in settlement of the site remedial costs as a "micro de minimis PRP."

The Company accrues costs associated with environmental matters, on an undiscounted basis, when they become probable and reasonably estimable. As of March 31, 2004, 2003 and 2002, the Company had $119,000 accrued for all respective periods, in "accrued expenses and other current liabilities" on the consolidated balance sheet to cover cleanup activities, including remediation and legal costs at the N.L./Taracorp site. This accrual does not reflect any possible insurance recoveries but does reflect a reasonable estimate of cost sharing at multi-party sites. The Company expects to remit payment early in fiscal 2005. Costs anticipated for settlement of the Alburn Incinerator/Lake Calumet Cluster site cannot be reasonably defined at this time and have not been accrued. The costs to Modine, however, are not expected to be material at this site based upon Modine's relatively small portion of waste at just one of the three properties comprising the Lake Calumet Cluster.

An obligation for remedial activities may also arise at a Modine-owned facility due to past practices or as a result of a property purchase or sale. These expenditures most often relate to sites where past operations followed practices and procedures that were considered acceptable under then-existing regulations, but now require investigative and/or remedial work to ensure appropriate environmental protection. Three of the Company's manufacturing facilities currently have been identified as requiring soil and/or groundwater remediation. Environmental liabilities recorded as of March 31, 2004, 2003 and 2002 to cover the investigative work and remediation for sites in the United States and The Netherlands were $1.2 million, $1.0 million, and $0.8 million, respectively. These liabilities are recorded in the consolidated balance sheet in "accrued expenses and other current liabilities" and "other noncurrent liabilities." It is unlikely these remediation efforts will have a material effect on the Company's results of operations.

Emerging environmental regulations, as well as the Company's policy to continuously improve upon its environmental management programs, will require capital equipment expenditures over the coming years. For the fiscal year ending March 31, 2004, capital expenditures related to environmental projects were $0.5 million. Modine currently expects expenditures for environmentally related capital projects to be about $0.7 million in fiscal 2005.

Environmental expenses charged to current operations, including remediation costs, solid waste disposal, and operating and maintenance costs totaled approximately $2.5 million for the fiscal year ending March 31, 2004. Operating expenses of some facilities may increase during fiscal year 2005 because of environmental matters but the competitive position of the Company is not expected to change materially. Although some environmental costs may be substantial, the Company has no reason to believe such costs vary significantly from costs incurred by other companies engaged in similar businesses.

In terms of health and safety performance, the past year proved to be very successful for Modine. In fiscal 2003, our North American and European locations achieved a 41% and a 39% Recordable Incidence Rate (RIR) improvement, respectively. At calendar year-end 2003, 31 of 43 facilities finished below the General Industry RIR of 5.7, which includes not only manufacturing, but retail and commercial industries as well. Lost Time and Restricted Duty Incident Rates (LWDII) also improved by 48% throughout North America. Every operating division attained its annual corporate goal of a 20% reduction in RIR. Leading the way for the Company in incident rate improvement was the Harrodsburg, KY facility, which had an entire year without an OSHA recordable injury.

Another major accomplishment for the organization was the certification of the Harrodsburg, KY facility as a KY OSHA Voluntary Protection Program (VPP) site. The plant was only the ninth to be certified as a VPP site in that state and one of only two VPP sites to be certified in the U.S. for its particular SIC code. We continue to challenge our North American facilities to become Modine Safety STAR sites, which is a program modeled after Federal OSHA's VPP. In 2003, the Toledo, OH facility met the Modine STAR challenge and the West Kingston, RI facility was recognized with a Safety Merit Award for their excellent health and safety efforts. We expect more facilities to reach for the Safety STAR in 2004.

The Company continues to enhance its Health and Safety efforts through further program development. In fiscal 2005, a Corporate Ergonomics program will be implemented to focus the efforts of the Body Mechanics programs that began in 1998 at many of the North American facilities. The Ergonomics program is designed to eliminate musculoskeletal disorder-related injuries, often caused by repetitive motion activities or workstations that have been inadequately adapted to the employee. The new program will provide a consistent approach as well as the tools needed to take proactive measures to eliminate musculoskeletal disease hazards from the work environment. It will also encourage employee involvement as well as continue to use physical/occupational therapists from the local communities.

To further improve employee access to important health and safety information, computer kiosks are being installed in many of the North American locations to provide valuable training resources and key chemical information. The new Internet-based training will encourage learning and teach best safety practices to keep our employees safe and healthy. In addition, key chemical information will be provided through an electronic library of Material Safety Data Sheets that will offer details on all the chemicals used in the work environment. In conjunction with the electronic library, a safety call center will be provided to answer any chemical questions an employee may have.

In the normal course of business, Modine is subject to exposure from changes in foreign exchange rates, interest rates, credit risk, economic risk and commodity price risk.

Foreign Currency Risk: Modine is subject to the risk of changes in foreign currency exchange rates due to its operations in foreign countries. Modine has manufacturing facilities in Mexico, Taiwan, and throughout Europe. It also has equity investments in companies located in France, Japan and Brazil. In addition, with the recently announced proposed acquisition of the Automotive Climate Control Division of WiniaMando Inc., expected to be completed by mid-summer 2004, Modine will also have foreign currency risk at facilities located in South Korea and China. Modine sells and distributes its products throughout the world. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company manufactures, distributes and sells its products. The Company's operating results are primarily exposed to changes in exchange rates between the U.S. dollar and the European currencies, primarily the euro. Changes in foreign currency exchange rates for the Company's foreign subsidiaries reporting in local currencies are reported as a component of shareholders' equity. The Company's favorable foreign currency translation adjustments recorded in fiscal 2004 and 2003 were $28.5 million and $20.5 million, respectively. As of March 31, 2004 and 2003, the Company's foreign subsidiaries had net current assets (defined as current assets less current liabilities) subject to foreign currency translation risk of $73.7 million and $79.2 million, respectively. The potential decrease in the net current assets from a hypothetical 10% adverse change in quoted foreign currency exchange rates would be approximately $7.4 million and $7.9 million, respectively. This sensitivity analysis presented assumes a parallel shift in foreign currency exchange rates. Exchange rates rarely all move in the same direction relative to the U.S. dollar. This assumption may overstate the impact of changing exchange rates on individual assets and liabilities denominated in a foreign currency.

The Company has certain foreign denominated long-term debt obligations that are sensitive to foreign currency exchange rates. The following table presents the future principal cash flows and weighted average interest rates by expected maturity dates. The fair value of long-term debt is estimated by discounting the future cash flows at rates offered to the Company for similar debt instruments of comparable maturities. The carrying value of the debt approximates fair value. As of March 31, 2004, the foreign denominated long-term debt matures as follows:

Interest Rate Risk: Modine's interest rate risk policies are designed to reduce the potential volatility of earnings that could arise from changes in interest rates. The Company utilizes a mixture of debt maturities together with both fixed-rate and floating-rate debt to manage its exposure to interest rate variations related to its borrowings. The Company has not entered into any interest rate derivative instruments. The following table presents the future principal cash flows and weighted average interest rates by expected maturity dates. The fair value of long-term debt is estimated by discounting the future cash flows at rates offered to the Company for similar debt instruments of comparable maturities. The carrying value of the debt approximates fair value. As of March 31, 2004, long-term debt matures as follows:

Credit Risk: Credit risk is the possibility of loss from a customer's failure to make payment according to contract terms. The Company's principal credit risk consists of outstanding trade receivables. Prior to granting credit, each customer is evaluated, taking into consideration the borrower's financial condition, past payment experience and credit information. After credit is granted, the Company actively monitors the customer's financial condition and developing business news. Approximately 54% and 52% of the trade receivables balance as of March 31, 2004 and 2003, respectively, were concentrated in the Company's top ten customers. Modine's history of incurring credit losses from customers has not been material, and the Company does not expect that trend to change.

Economic Risk: Economic risk is the possibility of loss resulting from economic instability in certain areas of the world or significant downturns in markets that the Company supplies. For example, traditionally, significant rises in oil prices have had an adverse effect on many markets the Company serves. If oil prices continue to rise and remain at high levels, they may negatively impact the economic recovery that the Company is currently experiencing, particularly in the truck and off-highway markets.

With respect to international instability, the Company continues to monitor economic conditions in the United States and elsewhere. In particular, the Company monitors conditions in Brazil and the effect on the Company's $15.9 million net investment in its 50 percent-owned affiliate. During fiscal 2004, the Brazilian real has strengthened against the U.S. dollar by approximately 20%. Going forward, the Company will focus more intently on conditions in Asia as we complete the announced, planned acquisition of the ACC Division of WiniaMando Inc., which has operations in South Korea and China. As Modine expands its global presence, we also encounter risks imposed by potential trade restrictions, including tariffs, embargoes and the like. We continue to pursue non-speculative opportunities to mitigate these economic risks, and capitalize, when possible, on changing market conditions.

The Company pursues new market opportunities after careful consideration of the potential associated risks and benefits. Successes in new markets are dependent upon the Company's ability to commercialize its investments. Current examples of new and emerging markets for Modine include those related to EGR, CO2, and fuel cell technology. Modine's investment in these areas is subject to the risks associated with business integration, technological success and market acceptance.

Commodity Price Risk: The Company is dependent upon the supply of certain raw materials and supplies in the production process and has, from time to time, entered into firm purchase commitments for copper, aluminum alloy, and natural gas. The Company does not generally use forward contracts to hedge against changes in certain specific commodity prices of the purchase commitments outstanding. The Company does maintain agreements with certain original equipment customers to pass through certain material price fluctuations in order to mitigate the commodity price risk.

On a limited basis, Modine enters into foreign exchange options and forward contracts on foreign currencies as hedges against the impact of currency fluctuations. See Note 20 of the 2004 consolidated financial statements for additional details.

Sales of $1.2 billion, for the fiscal year ended March 31, 2004, including a favorable foreign currency exchange impact of $70.3 million, are discussed in detail in the Segment Results section of Management's Discussion and Analysis.

For the fiscal year ended March 31, 2003, sales were $1.09 billion, up $22.9 million or 2% from fiscal 2002. Foreign currency translation had a favorable impact of $34.3 million, primarily due to a stronger euro-to-U.S. dollar relationship from the previous year. Without the currency impact, worldwide sales declined in fiscal 2003 by $11.4 million. Sales to U.S. customers accounted for 53% of the total sales, while exports from the U.S. and sales from Modine's foreign locations accounted for the other 47%. Sales to Modine's top ten customers accounted for 54% of the Company's total sales. Sales in the Original Equipment markets grew by $12.4 million, or 3%. Higher sales in the automotive market and light, medium and heavy-duty truck markets were offset in part by lower sales in the original equipment off-highway and industrial markets. In the Distributed Products segment, sales declined by $28.5 million, or 8%, due primarily to lower sales to the automotive aftermarket and a continuing decline in sales to the semi-conductor and telecommunication markets. The European Operations segment grew by $32.2 million, or 11% from the prior year. Positive foreign currency translation accounted for $29.7 million of this increase with volume increases in the passenger car and light truck markets being partially offset by a volume decline in the heavy-duty markets.

For the fiscal year ended March 31, 2002, sales were $1.07 billion, down $45.9 million or 4% from the prior year. Foreign currency translation had an unfavorable impact of $9.6 million, primarily due to a stronger euro-to-U.S. dollar relationship when compared to the prior year. Without the currency exchange impact, total worldwide sales declined by $36.3 million in fiscal 2002. Sales to U.S. customers were 53% of the total sales, while exports from the U.S. and sales from Modine's international locations accounted for the other 47%. Sales to Modine's top ten customers accounted for 51% of the Company's total sales. Sales in the Original Equipment markets fell $10.3 million or 2%. Lower sales in several markets, including the heavy-duty truck, construction, and industrial markets were partially offset by higher sales to the automotive market. Distributed Products segment sales were down $43.5 million or 10%, due to lower automotive aftermarket sales and a significant decline in sales to the electronics markets due to a dramatic fall-off in the semi-conductor and telecommunications equipment industries. The European Operations segment registered less than a 1% decline in overall sales. Lower volumes in the off-highway market and unfavorable currency translation effects offset improved sales volume, in local currency, recorded by the OEM-automotive market.

The current year gross profit of $293.1 million declined to 24% of sales from $272.7 million or 25% of sales in the previous year. Higher material costs as a percent of sales were a large factor in accounting for the year over year overall decline in gross profit margin while labor and manufacturing overhead declined as a percent of sales. The growth in material costs as a percent of sales can be attributed to an increase in the metal market prices, which occurred in the latter part of the year, continuing pricing pressures from customers, and greater purchased component content in products being sold. Start-up costs incurred in developing new business programs and product launches contributed as well to the lower gross profit margins. Also affecting gross profit were $4.3 million in warranty costs associated with product performance issues with two customers, one in Europe and one in North America. Certain product scope change costs of $2.4 million with the same North American customer also played a part in contributing to the gross profit margin reduction. Gross profit in dollars, similar to last year, grew in the Original Equipment and European Operations segments while continuing to decline in the Distributed Products segment.

In fiscal 2003, gross profit of $272.7 million increased to 25% of sales from $258.9 million or 24% of sales in fiscal 2002. Higher sales volumes, better asset utilization and cost reductions, many generated by the restructuring actions initiated the previous year, were the most significant factors contributing to the improvement in fiscal 2003. Gross profit, in absolute dollars, was up in both the Original Equipment and European Operations segments while the Distributed Products segment showed a decline for the year.

In fiscal 2002, gross profit of $258.9 million declined to 24% of sales from $291.8 million or 26% of sales in the preceding year. Lower sales volumes, significant pricing pressures, increasing purchased component content, and closure costs outside of the restructuring all contributed to the lower return. Included in gross profit was a $4.2 million benefit from a reduction in workers' compensation insurance reserves as a result of the Company's improving experience. Gross profit, in dollars, was down all across the Company, reflecting the weakened worldwide economies, except for the North American automotive market, where the Company was able to gain additional business.

In fiscal 2004, selling, general and administrative (SG&A) expenses rose by $22.0 million to $243.2 million. As a percentage of sales, SG&A remained at 20% when compared to the prior year. Higher compensation and related benefit costs, increased research and development costs, and higher depreciation were some of the larger factors contributing to the overall increase shown. The significant strengthening of the euro against the U.S. dollar in the current fiscal year also unfavorably impacted SG&A.

In fiscal 2003, SG&A expenses grew by $0.7 million to $221.2 million. As a percentage of sales, SG&A declined to 20% from 21% in the prior year. Higher compensation and related benefit costs together with increased research and development costs were partially offset by the elimination of goodwill amortization as prescribed under SFAS No. 142, lower advertising and sales promotion costs, and a reduction in the provision for doubtful accounts.

For fiscal 2002, SG&A expenses dropped $7.7 million to $220.5 million, but increased to 21% of sales from 20% in the prior year. Reductions in compensation and related benefit costs, along with lower sales promotion and distribution costs, more than offset the $3.4 million in Thermacore acquisition costs and increases in depreciation and amortization, research and development expenditures, and a higher bad debt expense level.

In fiscal 2004, Modine recorded $0.1 million in income as the Company's restructuring activities initiated in 2002 were completed. The positive adjustments to restructuring costs were the result of certain lease payments that were forgiven and other personnel costs for which the estimates varied marginally from the final amounts paid.

In fiscal 2003, Modine recorded $1.6 million in income from adjustments made to the initial restructuring estimates to reflect lower than anticipated post-closing and other miscellaneous expenses. These changes were due in part to two of the facilities identified in the restructuring plan being sold or rented earlier than originally anticipated.

n the third quarter of fiscal 2002, the Company initiated a restructuring plan to reduce costs and increase future operating efficiency. Charges of $7.5 million were recognized for plans to close manufacturing facilities in North America and Europe and for other personnel reductions in both areas.

Income from operations in fiscal 2004 of $50.1 million decreased by $3.0 million from the prior year. Improved volume and the favorable effect of $7.3 million from currency changes, primarily the stronger euro to U.S. dollar, was more than offset by $13.4 million in higher SG&A costs, excluding currency effects of $8.6 million, during the year.

Income from operations in fiscal 2003 of $53.1 million increased $22.2 million from the previous year. Higher gross profit together with the $9.1 million favorable change in year-over-year restructuring costs were the main factors leading to the improvement shown for the year.

Income from operations in fiscal 2002 of $30.9 million declined $32.7 million from the preceding year. The reduction in gross profit discussed above carried down to operating income as the $7.7 million reduction in SG&A expense was offset by the $7.5 million restructuring charge.

Interest expense of $5.4 million for 2004 was down $0.6 million from last year. Continuing favorable interest rates and lower average debt outstanding during the year were the main reasons for the reduction.

Interest expense of $6.0 million for 2003 was down $1.8 million from fiscal 2002. Lower borrowing levels and more favorable interest rates were the primary reasons for the decline.

For fiscal 2002, interest expense of $7.8 million was down $1.0 million from the preceding year. Reduced levels of short-term borrowing and lower interest rates provided the benefit, which was partially offset by a $1.5 million reduction in the amount of interest capitalized.

Other income in the current year increased by $11.1 million. A year-over-year increase of $6.0 million in income recorded from the sale of property, plant, equipment and business was the largest factor influencing the change. The increase was mainly the result of three plant sales in the current year, two of which were closed pursuant to the restructuring that was announced in 2002. This was in contrast to the $1.7 million loss recorded on the sale of the Company's Canadian subsidiary in 2003. In addition, royalty income increased by $3.4 million primarily due to higher royalty payments received from licensees of the Company's heat transfer technology for the power generation industry, a portion of which represented payments for royalties in arrears. The Company has now completed all activities associated with the restructuring announced in 2002.

In fiscal 2003, other income decreased by $9.1 million. A year-over-year reduction of $7.7 million in gains recorded from the sale of property, equipment and business was the main factor leading to the decrease shown. In addition, a $1.7 million loss on the sale of the Company's Canadian subsidiary was recognized in fiscal 2003. A reduction in royalty income from licensees was also responsible for a $2.2 million reduction in other income. Approximately $1.9 million of the reduction was from three Japanese companies that previously had been making royalty payments for the use of the Company's PF technology.

In fiscal 2002, other income increased by $4.5 million to $12.7 million. The increase was primarily the result of a $3.5 million gain on the sale of one of the Company's aircraft and the disposal of some excess real estate.

The effective tax rate from continuing operations for fiscal 2004 declined by 1.1 percentage points to 36.5%. This percentage decrease over the preceding year relates to favorable foreign-tax-rate differentials with respect to foreign tax rates, and the related income mix in those foreign jurisdictions, and a reduction in state income taxes, offset by an increase in the valuation allowance related to certain foreign tax loss carryforwards.

The effective tax rate for fiscal 2003 attributable to earnings before income taxes and the cumulative effect of accounting change decreased by 4.2 percentage points to 37.6%. The lower rate is the result of year-over-year changes with respect to non-deductible costs associated with goodwill amortization and non-deductible costs incurred in the acquisition of Thermacore in fiscal 2002.

The effective tax rate for fiscal 2002 rose by 2.7 percentage points to 41.8%. This percentage increase over the preceding year was influenced by upward pressure from nondeductible costs associated with the acquisition of Thermacore and increased nondeductible goodwill amortization, offset by downward pressure from foreign tax rate differentials.

Earnings before the cumulative effect of the accounting change in the current year of $40.4 million, or $1.19 per diluted share, were $6.0 million higher than 2003 earnings of $34.4 million, or $1.02 per diluted share. Improved earnings in the Original Equipment and European Operations segments, together with higher non-operating income, were offset in part by higher administrative and research and development expenses.

Earnings before the cumulative effect of the accounting change in fiscal 2003 of $34.4 million were $11.1 million higher than reported fiscal 2002 earnings of $23.3 million. On a per-share basis before the cumulative effect of the accounting change, diluted earnings per share were $1.02 per share in fiscal 2003, a $0.32 increase over the fiscal 2002 diluted earnings per share of $0.70. Cost improvements from the restructuring initiative started in November 2001, improved gross margins in two business segments, discontinuance of goodwill amortization, lower restructuring charges, no acquisition costs in the current year, and lower interest expense were all items contributing to the earnings improvement before the accounting change.

In fiscal 2003, the Company recorded a $21.7 million after-tax goodwill impairment charge to earnings for its aftermarket business unit. This charge resulted from the transitional impairment testing required under SFAS No. 142 "Goodwill and Other Intangible Assets."

Net earnings for the current year grew to $40.4 million ($1.19 per diluted share) from $12.7 million ($0.38 per diluted share) in the prior year. Earnings as a percent of sales rose to 3.4% of sales from 1.2% last year. In fiscal 2003, an after-tax goodwill impairment charge of $21.7 million was recorded and negatively affected net earnings. Impacting current year earnings, on an after-tax basis, were favorable currency exchange rates, primarily the euro-to-U.S. dollar, that contributed $4.7 million to net earnings and non-operating after-tax gains of $1.5 million recorded from three plant sales, and $2.2 million in higher after-tax royalty income. Among the items adversely affecting net earnings were higher after-tax pension and post-retirement costs of $1.8 million and $1.3 million in accelerated pension and other compensation costs associated with the retirement of the Company's former Chairman in fiscal 2004. Program scope change costs, after tax, of $1.5 million with a large customer in North America and higher after-tax warranty costs of $2.6 million incurred as a result of some product performance issues with two customers, one in Europe and one in North America, negatively impacted net earnings as well. Return on average shareholders' equity (ROE) increased almost 5% for the year.

Net earnings in fiscal 2003 declined to $12.7 million ($0.38 per diluted share) from $23.3 million ($0.70 per diluted share) in the previous year. Net earnings also declined to 1.2% as a percent of sales. ROE dropped to 2% for the year. The major factor influencing the decrease in reported earnings was the $21.7 million, net of taxes, goodwill impairment charge recorded by the Company's aftermarket business unit. Continued competitive pressures in the aftermarket and depressed conditions in the electronics market diminished the improved results in markets served by the Original Equipment and European Operations business segments.

Net earnings in fiscal 2003 included the after-tax impact of the $21.7 million cumulative effect of the accounting change, $0.8 million in restructuring and other closure costs and $1.0 million of losses generated from the sale of the Company's Canadian subsidiary and Knoxville, Tennessee manufacturing plant. Similarly, net income in fiscal 2002 included $8.7 million in restructuring charges and plant closure costs, $4.0 million in favorable accrual adjustments to workers' compensation, $3.1 million in Thermacore acquisition costs, $4.6 million in goodwill amortization and a $1.9 million gain from the sale of a Company aircraft.

Net earnings declined 55% in fiscal 2002 to $23.3 million ($0.70 per diluted share) from $51.8 million ($1.58 per diluted share) in the prior year. ROE slipped to 5% and net earnings as a percent of sales to 2%. Reductions in SG&A expense, additional North American automotive business and the favorable impact on the workers' compensation liabilities and the aircraft sale were more than offset by the lower sales volumes, pricing pressures, increased purchased component content, and the restructuring and other closure costs.

Net earnings in fiscal 2002 included the after-tax effects of $8.7 million of restructuring and other closure costs, $3.1 million in Thermacore acquisition costs, the reduction in the workers' compensation accrual of $4.0 million and the $1.9 million gain on the aircraft sale.

Cash and cash equivalents decreased by $4.8 million to $72.4 million. Details of the sources and uses of funds can be found in the Net Cash Provided by Operating Activities section of Management's Discussion and Analysis.

Trade receivables, net of allowances for doubtful accounts, at $180.2 million, were up $18.8 million from one year ago. The primary reason for the increase was related to the year-over-year fourth quarter sales growth of $48.4 million coming primarily from the European Operations and Original Equipment (North America) segments. Also contributing to the increase was the stronger euro in relation to the U.S. dollar, accounting for $9.2 million in the current year. Days sales outstanding were reduced by three days from the previous year as management continued to focus its efforts on improving working capital utilization.

Inventory levels grew by $5.6 million in the current fiscal year to $136.4 million. The stronger euro in relation to the U.S. dollar was the main reason for $4.9 million of the increase over the prior year. Higher inventory levels in the Original Equipment segment were offset in part by reductions in the Distributed Products segment. Inventory turns increased to 7.2 from 6.4 the prior year-end even though overall U.S. dollar levels increased for the year.

Deferred income taxes and other current assets grew by $5.3 million to $53.3 million. The largest item contributing to the change was the addition of a $4.3 million insurance claim relating to a warranty matter with a customer in Europe. In addition, increases occurred in unbilled customer tooling, value added tax receivables, and royalty receivables. These items were offset in part by the reduction of income tax prepayments.

The current ratio of 2.1-to-1 decreased from last year's 2.2-to-1. Net working capital increased $5.0 million to $229.1 million. Major items influencing the change were higher trade receivables, inventories, and other current assets, together with a reduction in the current portion of long-term debt. These were offset in part by lower cash, together with an increase in accounts payable, accrued compensation and employee benefits, income taxes payable, and other current liabilities.

Net property, plant, and equipment of $397.7 million increased by $36.1 million in fiscal 2004. Capital spending of $72.5 million exceeded depreciation expense by $13.1 million. Foreign currency translation during the year contributed the majority of the remaining increase. Major additions during the year included continued expenditures related to a new assembly facility opened November 21, 2003 in Wackersdorf, Germany to service new and existing programs with BMW, and continued work on the three-phase investment in Bonlanden, Germany for the new European headquarters, Technical Center, and wind tunnel facilities. Also included in the capital expenditure total were tooling and other new equipment purchases primarily supporting the North American truck and automotive markets.

Equity investments in affiliates of $28.1 million increased $5.7 million in the current year. A $2.7 million foreign-currency translation increase recorded by the Company on its 50% equity investment in Radiadores Visconde, Ltda., in Brazil was the major factor leading to the overall increase for the year. Also contributing to the increase was a $0.9 million favorable foreign-currency translation recorded by the Company on its 41% equity investment in Constructions Mechaniques Mota, S.A., in France. An item reducing the overall investment balance was an annual dividend from Nikkei Heat Exchanger Co., Ltd. (NEX), in Japan in the current year, which was offset by the favorable foreign-currency translation recorded related to the NEX equity investment. Positively impacting the investment balance were equity earnings of $2.4 million recorded in fiscal 2004.

Goodwill at $32.6 million was $1.0 million higher than the previous year. The change for the year resulted from foreign currency translation.

Other intangible assets of $3.8 million were $0.7 million lower than last year, as a result of a decrease in the intangible pension asset of $0.4 million and amortization expense for the year of $0.3 million.

Deferred charges and other noncurrent assets of $74.6 million increased $1.3 million over the prior period. The net increase was primarily the result of continued recognition of the change in deferred pension assets of $1.5 million. In addition, a decrease in deferred tax assets of $0.8 million was offset in part by an increase in long-term note receivables of $0.5 million.

The current portion of long-term debt, totaling $3.0 million, decreased by $9.7 million from the prior year. The primary reason for the reduction was a $9.8 million payment of the remaining balance due on the Radiadores Visconde, Ltda. equity investment. The remaining changes resulted from scheduled repayments, offset by reclassifications from long-term debt to debt due within a year and foreign currency translation.

Accounts payable increased by $14.9 million to $108.4 million. Variations in the timing of purchasing activities and the related payments were the main contributors to the overall increase. The stronger euro in relation to the U.S. dollar also contributed $4.3 million of the change compared to the prior year.

Accrued compensation and other employee benefits increased by $5.3 million to $52.9 million. The main reasons for the increase include the stronger euro in relation to the U.S. dollar of $2.7 million and timing of payments for accrued compensation.

Accrued income taxes increased by $4.8 million to $12.2 million. The major reason for the increase is timing differences in making estimated payments. In addition, the stronger euro in relation to the U.S. dollar contributed $1.1 million to the increase.

Accrued expenses and other current liabilities grew by $4.7 million to $36.7 million. Warranty accruals increased by $7.8 million and was the main factor influencing the increase. The principal reason for the increase was an agreement reached during the year with a European original equipment customer concerning a product performance issue. Interest payable decreased by $2.3 million, primarily related to interest that became due in conjunction with the final debt payment for the Radiadores Visconde, Ltda. equity investment.

Long-term debt decreased by $13.7 million to $84.9 million at year-end. The net reduction in long-term debt consists of discretionary payments of $18.0 million in the United States and $2.3 million in Europe, the reclassification of certain debt due within twelve months, and offsetting foreign currency translation as the euro strengthened against the U.S. dollar during the fiscal year, thereby increasing the U.S. dollar value of euro-denominated borrowings.

As a percent of shareholders' equity, long-term debt was 14.5% at year-end. Total debt-to-capital was 13.0%, down 4.3 percentage points from the end of fiscal 2003.

Other non-current liabilities at $51.7 million were $0.5 million higher than last year. The change is primarily the result of an increase in recorded pension liabilities of $1.6 million for the year. In addition, $0.9 million was reclassified to other current liabilities for items that will be paid within the next fiscal year.

Total shareholders' equity of $586.5 million increased $56.2 million over the prior period. The major changes were in retained earnings, accumulated other comprehensive income/(loss), and common stock and additional paid-in-capital as a result of stock transactions. Retained earnings increased by $21.8 million from the prior year. Net earnings added $40.4 million during the year while dividend payments reduced retained earnings by $18.7 million. Common stock and related paid-in-capital increases for the year totaled $6.8 million. This increase resulted from common shares issued to satisfy stock options exercises and stock awards granted during the year.

Accumulated other comprehensive income of $10.0 million increased $28.7 million over the prior year. The most significant component was the foreign currency translation adjustment, which increased by $28.5 million. Gains from the euro strengthening against the U.S. dollar during the year and translation gains recorded on the Company's equity investment in its Brazilian affiliate were partially offset by the unfavorable foreign currency effects on the Company's foreign-denominated borrowings.

In fiscal 2004, the treasury stock activity consisted of purchases and stock award forfeitures, totaling $0.4 million or 17,000 shares. In addition, 321,000 new shares of common stock were issued to satisfy stock option exercises and stock awards granted. The Company is not currently utilizing treasury shares for employee stock-purchase plans. The number of shares of common stock outstanding at year-end increased to 34,077,000 shares.

In fiscal 2003, the treasury stock activity consisted of offsetting purchases and uses, each totaling $1.1 million or 45,000 shares. As in the past, treasury shares were used to satisfy requirements for stock option exercises. In addition, 302,000 new shares of common stock were issued to satisfy stock option exercises, stock awards granted, and employee stock-purchase plans. The number of shares of common stock outstanding at year-end increased to 33,773,000 shares.

During fiscal 2002, $1.3 million was expended to acquire 46,000 treasury shares while $17.9 million of treasury stock (586,000 shares) was used to satisfy requirements for stock options and employee stock-purchase plans. In addition, 80,000 new shares of common stock were issued to satisfy stock option exercises and employee stock-purchase plans. In April 2001, 3,327,000 common shares were issued in conjunction with the pooling transaction with Thermacore International, Inc. The number of shares of common stock outstanding at March 31, 2002 increased to 33,471,000 shares.

Book value per share increased 10%, or $1.51, during fiscal 2004 to $17.21.

Net cash provided by operating activities in fiscal 2004 was $107.2 million, down $6.1 million from the prior year of $113.3 million. Major positive influences contributing to the overall change were higher net earnings of $27.8 million, an increase in depreciation and amortization of $6.6 million and a reduction in inventory, year-over-year, of $4.0 million. These changes were more than offset by a year-over-year increase in accounts receivable of $19.2 million this year as a result of higher sales volumes, a $22.8 million goodwill impairment non-cash charge taken last year as a result of the cumulative effect of an accounting change, and a $5.5 million year-over-year change in (gains)/losses from the disposition of property, plant and equipment and the sale of a business in the prior year.

Net cash provided by operating activities in fiscal 2003 was $113.3 million, down $18.1 million from the prior year record of $131.4 million. Major items contributing to the overall change were lower earnings after the cumulative effect of the accounting change, increased inventories compared to a significant reduction in the prior year and lower non-cash restructuring charges. These items were offset in part by the non-cash expense of $22.8 million from the cumulative effect of an accounting change upon adoption of SFAS No. 142, increases in deferred income taxes and non-cash losses reported on the disposition of property, plant, and equipment.

Net cash provided by operating activities in fiscal 2002 was a record $131.4 million, up $5.6 million from the prior year. Major items contributing to the overall change were the reduced working-capital requirements as a result of the Company's continued programs in this area, higher non-cash depreciation and amortization adjustments, that were partially offset by lower earnings. Working-capital requirements included a non-cash restructuring charge of $5.6 million. Further details regarding restructuring charges recorded in fiscal 2002 can be found in Note 14 to the fiscal 2004 consolidated financial statements.

Capital expenditures for fiscal 2004 were $72.5 million, $22.0 million higher than the prior year. Major areas of capital spending included: continued spending on a new assembly plant in Wackersdorf, Germany to supply BMW programs; on-going expenditures for the wind tunnel, new Technical Center and administration building in Bonlanden, Germany; and costs associated with the purchase of new equipment and tooling for new customer programs and process improvements at Company facilities around the globe. North American additions were $25.7 million and European additions totaled $46.8 million. The Company anticipates completing the expenditures relating to the new assembly plant in Wackersdorf, Germany and the ongoing expenditures described above in Bonlanden and does not anticipate the need for additional capital expenditures for other newly constructed facilities during fiscal 2005. The Company anticipates that it will continue to incur capital expenditures for new equipment, supplier-specific tooling and process improvements at existing facilities throughout the world. These expenditures are expected to be in line with depreciation expense for fiscal 2005.

Capital expenditures for fiscal 2003 were $50.5 million, $14.7 million higher than the prior year. Major areas of capital spending included: a new assembly plant under construction in Europe to supply BMW programs; continued expenditures for the new Technical Center and administration building in Europe; and costs associated with the purchase of new equipment and process improvements throughout the world.
Capital expenditures for fiscal 2002 were $35.8 million, $37.1 million lower than the prior year, a direct result of management's initiative to reduce capital spending. Major areas of capital spending included: on-going construction and equipment costs of a new Technical Center in Europe; continued production and administrative facility expansion in Europe; and costs associated with the purchase of equipment and tooling for new customer programs.

During fiscal 2004, Modine received $ 4.8 million in proceeds from the disposition of assets that included the sales of its facilities located in St. Paul, Minnesota for $2.0 million, LaPorte, Indiana for $1.3 million, Strongsville, Ohio for $0.8 million, and $0.7 million on the sales of other equipment.

During fiscal 2003, Modine received proceeds of $2.0 million from the sale of its wholly owned Canadian aftermarket subsidiary, Modine of Canada, Ltd. In addition, the Company received $3.1 million in proceeds from the disposition of other assets that included the sale of its facility located in Knoxville, Tennessee for $2.3 million and various equipment related to the restructuring plan announced in fiscal 2002.

In fiscal 2004, Company debt decreased $33.9 million, due to repayments of long-term debt consisting of $18.0 million on the existing bank revolver and $0.5 million related to the fiscal 1999 acquisition of Core Holdings, Inc., $9.8 million representing the Company's final payment for its 50% share purchase, in fiscal 1999, of Radiadores Visconde Ltda. in Brazil, and $5.6 million in scheduled payments and early repayments of European debt. Improved operating efficiencies resulting in higher net earnings allowed for the reduction of outstanding debt. During fiscal 2005, the Company expects to finance the acquisition of the ACC Division of WiniaMando Inc. through a draw down of excess cash and utilization of existing credit lines.

In fiscal 2003, Company debt decreased $55.8 million, due to repayments of $55.0 million of long-term debt and all outstanding short-term debt. Improved working capital and closely monitored capital-expenditure requirements allowed for the reduction of outstanding debt. In April 2002, Modine entered into a new $150.0 million multi-currency, revolving credit facility. Initially, $64.0 million was borrowed against this new facility and used to pay down existing debt. See Note 18 to the fiscal 2004 consolidated financial statements for further detail.

In fiscal 2002, Company debt decreased $29.2 million, primarily due to discretionary repayments of $26.5 million of short-term debt and $2.7 million of long-term debt. Lower working capital and capital-expenditure requirements allowed for the reduction of outstanding debt. Total debt assumed as part of the Thermacore acquisition was $14.0 million. The majority of the debt assumed was refinanced with available lines of credit at more favorable interest rates.

Treasury stock activity is detailed in the Shareholders' Equity section of Management's Discussion and Analysis, with additional detail provided in Note 23 to the fiscal 2004 consolidated financial statements.

Dividends for fiscal 2004 totaled $18.7 million, or 55 cents per share. This is an increase of 5 cents per share over the previous year and includes a full year at the 13.75 cents quarterly rate, which was effective in the first quarter of fiscal 2004. Dividends for fiscal 2003 totaled $16.8 million, or 50 cents per share. This is a decrease of 37.5 cents per share over the previous year and includes a full year at the 12.5 cents quarterly rate, which was effective in the fourth quarter of fiscal 2002. Dividends for fiscal 2002 totaled $29.0 million, or 87.5 cents per share. This is a decrease of 12.5 cents per share over the previous year and includes one quarterly dividend at the reduced rate of 12.5 cents per quarter.

The Shareholder Rights Plan ("Poison Pill") was terminated during fiscal 2003 by redeeming the rights through a cash payment of $.0125 per share, or $0.4 million. See Note 24 to the 2004 consolidated financial statements for further detail.

The primary sources of liquidity are cash flow from operating activities and borrowings under committed and uncommitted lines of credit provided by banks in the United States and abroad. The Company expects to meet its future operating, capital expenditure and strategic business opportunity costs primarily through a combination of these sources.

Over the past four years, cash flows from operating activities have exceeded $100 million. As a result, the balance sheet and financial position continues to strengthen, providing the Company with the ability to pursue growth opportunities while preserving financial flexibility. The Company expects cash flows to remain strong in fiscal 2005. Working capital continues to be a key management focus. Compared with the prior year, days sales outstanding decreased three days to 49 days and inventory turns increased from 6.4 to 7.2.

Cash decreased $4.8 million to $72.4 million at fiscal 2004 year-end. At the same time, total debt decreased $23.3 million to $87.9 million. The Company expects to make scheduled debt repayments in fiscal 2005 with internally generated funds.

The ratio of Modine's total debt to capital was 13% at the end of 2004 compared to 17% at the end of 2003. The improvement reflects the decrease in debt levels in excess of the increase in shareholders equity in fiscal 2004.
In April 2002, Modine entered into a $150 million multi-currency, revolving credit facility. Upon request to the agent bank, an additional $50 million is available on this revolver. Worldwide, Modine had approximately $213 million in unused lines of credit at March 31, 2004. See Note 18 to the fiscal 2004 consolidated financial statements for further detail.

The pending acquisition of the ACC Division of WiniaMando Inc. in South Korea, scheduled to close mid-summer 2004, will be financed through a draw down of excess cash and utilization of existing credit lines. The estimated purchase price is $88 million, including $83 million in cash plus the assumption of certain long-term liabilities. Management believes it is positioned to provide the necessary financial resources to take advantage of additional potential strategic business opportunities in fiscal 2005.

The following tables represent our obligations and commitments to make future payments under contracts, such as debt and lease agreements, and under contingent commitments, such as debt guarantees, as of March 31, 2004.

This report contains statements, including information about future financial performance, accompanied by phrases such as "believes," "estimates," "expects," "plans," "anticipates," "will," "intends," and other similar "forward-looking" statements, as defined in the Private Securities Litigation Reform Act of 1995. Modine's actual results, performance or achievements may differ materially from those expressed or implied in these statements, because of certain risks and uncertainties, including, but not limited to, the following: Customers' abilities to maintain their market shares and achieve anticipated growth rates for new products, particularly as they experience pricing pressures and excess capacity issues. Modine's ability to maintain current programs and compete effectively for new business, including our ability to offset or otherwise address increasing pricing pressures from our customers and competitors. Modine's ability to consummate and successfully integrate proposed business development opportunities. The effect of the weather on market demand, which directly impacts sales. Unanticipated problems with suppliers' abilities to meet Modine's demands. Customers' actual production demand for new products and technologies, including market acceptance of a particular vehicle model or engine The impact of environmental laws and regulations on Modine's business and the business of Modine's customers, including Modine's ability to take advantage of opportunities to supply alternative new technologies to meet environmental emissions standards. Economic, social and political conditions, changes and challenges in the markets where Modine operates and competes (including currency exchange rates, tariffs, inflation, recession, and restrictions associated with importing and exporting and foreign ownership). Increases in production or material costs that cannot be recouped in product pricing. The cyclical nature of the vehicular industry. Work stoppages or interference at Modine or Modine's major customers. Unanticipated product or manufacturing difficulties, including unanticipated warranty claims. Unanticipated delays or modifications initiated by major customers with respect to product applications or requirements. Costs and other effects of unanticipated litigation or claims, and the increasing pressures associated with rising health care and insurance costs and reductions in pension credit. Other risks and uncertainties identified by the Company in public filings with the Securities and Exchange Commission.

Modine does not assume any obligation to update any of these forward-looking statements.