MODINE MANUFACTURING COMPANY
|
PART I
|
|||
|
ITEM 1.
|
1
|
||
|
ITEM 1A.
|
11 | ||
|
ITEM 1B.
|
19 | ||
|
ITEM 2.
|
19 | ||
|
ITEM 3.
|
19 | ||
|
ITEM 4.
|
20 | ||
| 20 | |||
|
PART II
|
|||
|
ITEM 5.
|
21 | ||
|
ITEM 6.
|
22 | ||
|
ITEM 7.
|
22 | ||
|
ITEM 7A.
|
38 | ||
|
ITEM 8.
|
42 | ||
|
ITEM 9.
|
84 | ||
|
ITEM 9A.
|
84 | ||
|
ITEM 9B.
|
84 | ||
|
ITEM 9C.
|
84 | ||
|
PART III
|
|||
|
ITEM 10.
|
85 | ||
|
ITEM 11.
|
85 | ||
| ITEM 12. | 85 | ||
| ITEM 13. | 86 | ||
| ITEM 14. | 86 | ||
|
PART IV
|
|||
| ITEM 15. | 86 | ||
| ITEM 16. | 86 | ||
| 87 | |||
| 88 | |||
| 92 |
|||
(This page intentionally left blank.)
PART I
At Modine Manufacturing Company, we are Engineering a Cleaner, Healthier World ™. Building on more than 100 years of excellence in thermal management, we provide trusted products and
technologies that help improve our world. Our broad portfolio of systems and solutions support our mission of improving indoor air quality, conserving natural resources, lowering harmful emissions, enabling cleaner running vehicles, and using
environmentally friendly refrigerants.
We sell innovative and environmentally responsible thermal management products and solutions to diversified customers in a wide array of commercial, industrial, and building heating, ventilating, air conditioning, and refrigeration
(“HVAC&R”) markets. In addition, we are a leading provider of engineered heat transfer systems and high-quality heat transfer components for use in on- and off-highway original equipment manufacturer (“OEM”) vehicular applications. Our
primary customers across the globe include:
| − |
Heating, ventilation and cooling OEMs;
|
| − |
Construction architects and contractors;
|
| − |
Wholesalers of heating equipment;
|
| − |
Agricultural, industrial and construction equipment OEMs;
|
| − |
Commercial and industrial equipment OEMs; and
|
| − |
Automobile, truck, bus, and specialty vehicle OEMs.
|
We partner with our customers across industries to provide sustainable components, systems, and services and solve complex heat transfer challenges to ensure their climate solutions and performance technologies work more efficiently, last longer
and add comfort to people’s lives. We work to provide the best possible thermal solutions to our customers by first assessing their entire systems to make sure our products integrate seamlessly with other components. We also focus on product
design, from raw materials to end-of-life recyclability, to optimize total cost of ownership and reduce negative environmental impacts across the product life cycle. We anticipate and prepare for change, keeping pace with new and emerging
regulations and fulfilling the demand for sustainable technologies in response to increasingly stringent emissions, fuel economy, and energy efficiency standards.
History
Modine was incorporated under the laws of the State of Wisconsin on June 23, 1916 by its founder, Arthur B. Modine. Mr. Modine’s “Turbotube” radiators became standard equipment on the famous Ford Motor Company Model T. When he died at the age
of 95, A.B. Modine had personally been granted more than 120 U.S. patents for his heat transfer innovations. The standard of innovation exemplified by A.B. Modine remains the cornerstone of Modine today.
Our heritage provides a depth and breadth of expertise in thermal management, which, when combined with our global manufacturing presence, standardized processes, and state-of-the-art technical resources, enables us to rapidly bring
highly-valued, customized solutions to our customers.
Terms and Year References
When we use the terms “Modine,” “we,” “us,” the “Company,” or “our” in this report, unless the context otherwise requires, we are referring to Modine Manufacturing Company. Our fiscal year ends on March 31 and, accordingly, all references to a
particular year mean the fiscal year ended March 31 of that year, unless indicated otherwise.
Business Strategy and Results
Our purpose is to engineer a cleaner, healthier world by providing products and services that improve indoor air quality, reduce water and energy consumption, lower harmful emissions, enable cleaner running vehicles, and use environmentally
friendly refrigerants.
In fiscal 2023, we made significant progress toward transforming Modine. We originally announced our vision for a “new” Modine in late fiscal 2021. In fiscal 2022, we onboarded seasoned leaders with the requisite experience to drive
transformative change, including new segment presidents for our Climate Solutions and Performance Technologies segments. Since that time, we have simplified and segmented our organization, aligning teams, led by general managers, around specific
strategies and market-based verticals within our company. Our new leadership teams have embraced 80/20 principles, which focus on the rule that 80 percent of outputs result from 20 percent of inputs. By applying 80/20 principles through data
analytics to identify these valuable inputs, and instilling the mindset of prioritizing the factors that drive the best results, our teams created a high-performance culture that focuses resources on products and markets with the highest
sustainable growth opportunities and best return profiles, while simplifying and improving our processes. For example, we have been focused on growth opportunities in the data center market. In response to identified opportunities, we
strategically expanded our product offerings in this business and are manufacturing and selling more data center cooling products in North America. We have also improved our commercial acumen and have strengthened our business relationships with
our best customers. In addition, by applying 80/20 principles and improving our commercial pricing methodologies, we have improved our profit margins in fiscal 2023, in spite of significant supply chain challenges and inflationary market
conditions.
Looking ahead, our teams remain focused on executing our transformational strategy. We are applying 80/20 principles throughout our organization, including within our manufacturing facilities to improve efficiencies and further simplify our
businesses. We are also taking steps toward maximizing our share in targeted markets, including data centers, electric vehicles, and HVAC&R, where we see the best opportunities for profitable growth.
During fiscal 2023, our consolidated net sales were $2.3 billion, a 12 percent increase from $2.1 billion in fiscal 2022. This increase was primarily due to higher sales in both our Performance Technologies and Climate Solutions segments. Our
operating income of $150 million in fiscal 2023 increased $31 million from the prior year, primarily due to higher gross profit, partially offset by the absence of a $56 million net impairment reversal recorded in the prior year that primarily
related to the liquid-cooled automotive business, which reverted back to held and used classification upon the termination of a sale agreement with the prospective buyer during fiscal 2022.
Our top five customers are in the commercial vehicle, off-highway and automotive and light vehicle markets and our ten largest customers accounted for 39 percent of our fiscal 2023 sales. In fiscal 2023, 56 percent of our total sales were
generated from customers outside of the U.S., with 49 percent of total sales generated by foreign operations and 7 percent generated by exports from the U.S. In fiscal 2022, 60 percent of our total sales were generated from customers outside of
the U.S., with 53 percent of total sales generated by foreign operations and 7 percent generated by exports from the U.S. In fiscal 2021, 63 percent of our total sales were generated from customers outside of the U.S., with 56 percent of total
sales generated by foreign operations and 7 percent generated by exports from the U.S.
Product Groups
We partner with our customers across multiple industries to provide sustainable solutions for a wide range of applications. The following is a summary of our primary product groups, categorized as a percentage of our net sales:
|
Fiscal 2023
|
|
Fiscal 2022
|
|
|
Air-cooled
|
28%
|
|
28%
|
|
Heat transfer
|
23%
|
|
23%
|
|
Liquid-cooled
|
21%
|
|
22%
|
|
HVAC & refrigeration
|
15%
|
|
16%
|
|
Data center cooling
|
7%
|
|
5%
|
|
Advanced solutions
|
6%
|
|
6%
|
Competitive Position
We compete with many manufacturers of heat transfer and HVAC&R products, some of which are divisions of larger companies. The markets for our products continue to be very dynamic. For example, the expansion of electric vehicle demand has
created opportunities to work with our existing OEM customers, as well as emergent customers focused on zero-emission products. Our OEM customers are faced with significant international competition and maintain global manufacturing footprints to
compete in local markets. In addition, consolidation within the supply base and vertical integration have introduced new or restructured competitors to our markets. Some of these market changes have caused us to experience competition from
suppliers in other parts of the world that enjoy economic advantages such as lower labor costs, lower healthcare costs, and lower tax rates. Many of our customers also continue to ask us, as well as their other primary suppliers, to provide
research and development (“R&D”), design, and validation support for new potential projects. This combined work effort often results in stronger customer relationships and more partnership opportunities for us.
Business Segments
Our chief operating decision maker reviews the separate financial results for each of our operating segments. These results are used to evaluate the performance of each business segment and for making decisions on the allocation of resources.
Financial information for our operating segments is included in Note 22 of the Notes to Consolidated Financial Statements.
Effective April 1, 2022, we began managing the Company under two operating segments, Climate Solutions and Performance Technologies. Our new segment structure aligns businesses serving similar or complimentary end markets, products and
technologies under common segment management. This simplified segment structure allows us to better focus resources on targeted growth opportunities and better enables an efficient application of 80/20 principles across all product lines to
optimize profit margins and cash flow.
The Climate Solutions segment includes the previously-reported Building HVAC Systems (“BHVAC”) and the Commercial and Industrial Solutions (“CIS”) segments, with the exception of CIS Coatings. The Performance Technologies segment includes the
previously-reported Heavy Duty Equipment and Automotive segments and the CIS Coatings business.
Climate Solutions Segment
The Climate Solutions segment provides energy-efficient, climate-controlled solutions and components for a wide array of applications. The Climate Solutions segment sells heat transfer products, heating, ventilating, air conditioning and
refrigeration (“HVAC & refrigeration”) products, and data center cooling solutions.
The Climate Solutions segment has strategically aligned its teams around three primary market-based verticals: i) heat transfer products; ii) HVAC & refrigeration; and iii) data center cooling.
Heat Transfer Products
The heat transfer products business provides heat transfer coils, including heat recovery and round tube plate fin coils, to the HVAC&R markets in North America, Europe, and Asia. Its customers include commercial and industrial equipment
manufacturers, distributors, contractors, and end users in a variety of commercial and industrial applications, including commercial and residential HVAC, mobile air conditioning, refrigeration, data center management, and precision and industrial
cooling.
In fiscal 2023, the primary HVAC&R markets served by the heat transfer products business experienced modest growth. We expect strong growth in the residential heat pump and data center markets in fiscal 2024, while the commercial and
residential markets are expected to be relatively flat. Trends influencing our primary markets include refrigerant substitution and energy efficiency requirements, both of which are expected to benefit the commercial HVAC&R markets. Demand
for more efficient HVAC&R systems in buildings and processes is driven by more stringent energy efficiency regulations. In addition, the adoption of heat pump technology in Europe is expected to contribute to market growth.
HVAC & Refrigeration
The HVAC & refrigeration business provides a wide array of solutions to heating; indoor air quality; commercial and industrial refrigeration; and industrial power generation, conversion, and transmission and industrial process markets in
North America, Europe, the Middle East and Africa (“EMEA”), and China.
Heating products, primarily sold to the North American residential and commercial heating markets, include unit heaters (gas-fired, hydronic, electric and oil-fired); duct furnaces (indoor and outdoor); infrared units (high- and low-intensity);
and perimeter heating products (cabinet unit heaters and convectors). The primary customers for these heating products are HVAC wholesalers, installers, and end users in a variety of residential, commercial and industrial applications, including
residential garages, warehousing, manufacturing, and greenhouses. In fiscal 2023, the North American heating market experienced a modest decline, primarily driven by weakness in the residential heating market and the impact of the relatively mild
winter weather this past year. Overall, we expect the North American heating market will be stable in fiscal 2024. Longer term, we anticipate that increasing demands for energy efficiency as well as decarbonization and lower emission initiatives
and regulations will benefit the North American heating market.
Indoor air quality products, primarily sold to the North American school and commercial HVAC markets, include roof-mounted direct- and indirect-fired makeup air units; unit ventilators; single packaged vertical units; and ceiling cassettes.
Customers for these indoor air quality products include mechanical contractors, HVAC wholesalers, installers, and end users in a variety of commercial and industrial applications, primarily connected to the North American education system. In
fiscal 2023, the North American school and commercial HVAC markets experienced strong growth, largely driven by available federal and local government funding for ventilation improvements for schools. We expect the federal funds available for
schools to upgrade facilities, including their HVAC systems, will drive continued strong market growth in fiscal 2024.
Refrigeration products, primarily sold to the commercial and industrial refrigeration markets in EMEA, China, and North America, include evaporator unit coolers, remote condensers, fluid coolers, gas coolers, and dry and brine coolers.
Customers for these coolers and refrigeration products primarily include wholesalers, distributors and resellers, commercial and industrial OEMs, as well as contractors and end users in a variety of commercial and industrial applications, including
supermarkets, refrigerated warehouses, logistic centers, cold rooms, precision and industrial cooling, hospitality, hotels, and restaurants. In fiscal 2023, the commercial and industrial refrigeration markets experienced modest growth. We expect
moderate growth in the global refrigeration markets in fiscal 2024, driven by improving standards of living in emerging countries as well as more stringent energy efficiency regulations, partially offset by investment delays in connection with
general market and economic uncertainties. Regulations focused on eliminating fluorinated gases, which are man-made gases that contribute to the global greenhouse effect, are shifting investments from synthetic to natural gas, including carbon
dioxide cooling solutions, and are driving growth in mature markets in Europe and North America.
Power generation and conversion products, primarily sold to the industrial power generation, conversion, and transmission and industrial process markets in EMEA, China, and North America, include motor and generator cooling coils, transformer
oil coolers, radiators, dryers and industrial heat exchangers. Customers for these products primarily include industrial OEMs as well as contractors and end users in industrial applications and for capital projects within the pulp and paper
industry, including industrial cooling and industrial power conversion, production, and transmission. In fiscal 2023, the pulp and paper sector within the industrial power and process market experienced strong growth, however this growth was
tempered by the overall weakness in demand for power transmission products due to delays in capital investments associated with the impacts of the COVID-19 pandemic, including the shortage of certain components. We expect these markets overall
will be stable in fiscal 2024, with an increase in demand for transformer oil cooler products, driven by higher electricity demands, offset by a softening demand in the pulp and paper sector after a strong year of capital investments.
Data Center Cooling
The data center cooling business provides sustainable cooling solutions for data center markets in North America, EMEA, and Asia, including complete system design, controls, maintenance and monitoring. We provide data center cooling solutions
that feature low global warming potential refrigerants, free cooling technology, and lower water consumption, enabling our customers and end-users to meet their environmental and sustainability goals. Data center products consist of IT cooling
solutions, including precision air conditioning units for data center applications; computer room air conditioning (“CRAC”) and computer room air handler (“CRAH”) units; hybrid fan coils; fan walls; chillers; condensers; and condensing units. In
addition, our data center business sells replacement parts, maintenance service and control solutions for existing equipment and new building management controls and systems. This business serves data center management customers, including large
colocation, cloud service providers and hyperscalers, as well as customers in the commercial and industrial sectors such as telecommunications, healthcare and commercial real estate.
In fiscal 2023, the data center markets that we serve experienced strong growth. We expect continued strong growth in these markets in fiscal 2024, driven by the increasing reliance on digital technologies, specifically colocation and cloud
usage. Market demand for data usage and storage continues to rise, driven by the increased use of IoT (Internet of Things) technology, which connects various devices through the internet, artificial intelligence and machine learning, smart phones,
and digital transformation trends. Digital transformation trends driving market demand include employers offering remote work arrangements, an increased focus on the digital customer experience, as more transactions and customer interactions are
taking place virtually through websites and mobile applications, and the increasing use of 5G technology and its application across global enterprise opportunities, particularly in the healthcare, manufacturing, and energy sectors.
Performance Technologies Segment
The Performance Technologies segment provides products and solutions that enhance the performance of customer applications and develops solutions that increase fuel economy and lower emissions in light of increasingly stringent government
regulations. The Performance Technologies segment designs and manufactures air- and liquid-cooled technology for vehicular, stationary power, and industrial applications. In addition, the Performance Technologies segment provides advanced thermal
solutions to zero-emission and hybrid commercial vehicle and automotive customers and coating products and application services.
The Performance Technologies segment has strategically aligned its teams around three primary market-based verticals: i) air-cooled applications; ii) liquid-cooled applications, and iii) advanced solutions.
Air-Cooled Applications
The air-cooled applications business provides air-cooled heat exchangers and modules for vehicular, stationary power, and industrial applications. This business primarily serves the commercial vehicle, off-highway and power generation markets
in North America, Brazil, Europe, China, India and South Korea. It primarily sells powertrain cooling products, such as radiators, condensers, engine cooling modules, charge air coolers, fan shrouds, and surge tanks. Its customers include
commercial, medium- and heavy-duty truck and engine manufacturers; construction, agricultural, and mining equipment and engine manufacturers; and industrial manufacturers of material handling equipment, generator sets and compressors.
During fiscal 2023, the commercial vehicle and off-highway markets in North America and Brazil experienced moderate to strong growth. The European commercial vehicle and off-highway markets remained relatively flat during fiscal 2023, as
compared with fiscal 2022, despite market disruptions from the military conflict between Russia and Ukraine. The off-highway markets in Asia experienced modest declines resulting from cyclical market weakness in fiscal 2023. The commercial
vehicle market in India experienced strong growth during fiscal 2023. Lastly, the power generation market in North America experienced moderate growth. Global supply chain challenges and rising inflation pressures also continued in fiscal 2023
and negatively impacted each of these markets.
In fiscal 2024, we expect stability in the North American and European commercial vehicle markets and moderate growth in the commercial vehicle markets in Brazil and India. Longer term, we expect the continued need by commercial vehicle
manufacturers to meet increasingly stringent emissions and fuel consumption requirements to be a market growth driver. We expect growth in off-highway markets in fiscal 2024. Specifically for the North American agriculture market, we believe that
elevated commodity prices will drive strong demand, particularly for larger agricultural equipment. In addition, our OEM order backlogs remain strong as customers look to replenish large equipment inventory. We also expect growth in the European
and Brazilian agriculture markets, but to a lesser extent than in North America. With regard to construction markets, we expect modest market growth in North America and stable markets in Europe and Asia. Specific to Asia, we anticipate the
construction market will remain relatively weak, however, we expect it to benefit from increasing export sale opportunities. In addition, construction markets may benefit from government infrastructure investments in the U.S., China, and India.
Finally, in regard to the power generation market, we expect strong market growth in North America to be driven by demand for backup power for data centers, power grids, and critical infrastructure, such as hospitals and airports.
Liquid-Cooled Applications
The liquid-cooled applications business provides liquid-cooled heat exchangers for engine, stationary power, and industrial applications. This business primarily serves the automotive, commercial vehicle and off-highway markets in North
America, Brazil, Europe, China, and India. Its products and solutions include aluminum and stainless steel engine oil coolers, exhaust gas recirculation (“EGR”) coolers, liquid charge air coolers, transmission and retarder oil coolers, fuel
coolers, and condensers. Its customers include automobile and light truck OEMs; commercial, medium- and heavy-duty truck and engine manufacturers; Tier-1 filter and front-end module manufacturers and assemblers; and construction and agricultural
equipment manufacturers.
During fiscal 2023, the global commercial vehicle and off-highway markets experienced moderate growth, with the largest gains in the medium- and heavy-duty truck markets. We expect these markets will be stable in fiscal 2024 based upon strong
OEM order backlogs driven by the need to replace aging truck fleets. In addition, compared with fiscal 2023, we expect the raw material markets will stabilize as supply chain challenges begin to ease.
During fiscal 2023, the global automotive market experienced further declines, as semiconductor chip shortages continued to negatively impact the automotive markets, particularly in Europe and North America. In addition, the automotive market
in China was negatively impacted by increased COVID-19 cases and the related lock-downs and supply chain challenges. In fiscal 2024, we expect the automotive markets in Europe and North America will experience modest to moderate growth as
customers look to replenish inventory levels. While we expect the semiconductor chip shortages will persist in fiscal 2024, we expect that the limitations associated with the shortages will ease compared with fiscal 2023. We expect the automotive
market in China, however, will decline slightly in fiscal 2024, as we expect the termination of automotive purchasing incentives by the Chinese government and economic uncertainty will outweigh the favorable impacts of customers replenishing their
inventory levels. Overall, we expect that longer-term growth of the global automotive market will be supported by government tightening of emissions standards for internal combustion engines, in-vehicle technology enhancements and growth in
emerging markets.
Advanced Solutions
The advanced solutions business provides thermal management systems and components for electric vehicles, and factory-applied and aftermarket coating products and application services.
Products and solutions for zero-emission and hybrid vehicles, primary sold to the commercial vehicle, bus and specialty vehicle, off-highway and automotive markets in North America and Europe, include complete battery thermal management systems,
electronics cooling packages, battery chillers, battery cooling plates, coolers and casings for electronics cooling, and coolers for electric axles (“e-axles”). Customers for these products include commercial vehicle, bus and specialty vehicle,
off-highway, and automotive OEMs, e-axle producers, power electronics providers, and electric vehicle startup companies. In fiscal 2023, the primary vehicular markets served by the advanced solutions business experienced strong growth. We expect
continued strong growth in fiscal 2024, as government policies in the U.S. and Europe are driving investments in electric vehicles, as well as the infrastructure necessary for wide-scale adoption of alternative powertrains.
Our advanced solutions business also provides coatings products and application services to the HVAC&R markets in North America and Europe. Our coatings products are designed to extend the life of equipment and components by protecting
against corrosion and foreign matter. Customers for these products and services include manufacturers of commercial and residential HVAC and refrigeration systems, and distributors, contractors, and end users of HVAC&R equipment. In fiscal
2023, the primary HVAC&R markets served by the advanced solutions business experienced modest growth. We expect continued modest growth in these commercial and residential HVAC&R markets in fiscal 2024.
Geographic Areas
We maintain administrative organizations in all key geographic regions to facilitate customer support, development and testing, and other administrative functions. We operate in four continents and within the following countries:
|
North America
|
South America
|
Europe
|
Asia
|
|
|
|
|
|
|
United States
Mexico
|
Brazil
|
Germany
Hungary
Italy
Netherlands
Serbia
Spain
Sweden
United Kingdom
|
China
India
South Korea
United Arab Emirates
|
Our non-U.S. subsidiaries and affiliates manufacture and sell a number of commercial, industrial and building HVAC&R and vehicular products similar to those produced in the U.S.
Exports
Export sales from the U.S. to foreign countries, as a percentage of consolidated net sales, were 7 percent in fiscal 2023, 2022, and 2021.
We believe our international presence positions us to benefit from the anticipated long-term growth of the global commercial, industrial and building HVAC&R and vehicular markets. We are committed to increasing our involvement and
investment in these international markets in the years ahead.
Customer Dependence
Our ten largest customers, some of which are conglomerates or otherwise affiliated with one another, accounted for 39 percent of our consolidated net sales in fiscal 2023. In fiscal 2023 and 2022, our largest customer accounted for less than 10
percent of our sales. In fiscal 2021, Daimler AG, which included Mercedes-Benz Group AG and Daimler Truck AG prior to the spin-off of Daimler Truck AG in fiscal 2022, accounted for more than 10 percent of our sales.
Our top customers operate primarily in the commercial vehicle, off-highway, automotive and light vehicle, data center cooling, and commercial air conditioning and refrigeration markets. Our top customers, listed alphabetically, include:
Carrier; Caterpillar; Daimler Truck AG (including Detroit Diesel, Freightliner, Thomas Built Buses, and Western Star Trucks); Deere & Company; Mercedes-Benz Group AG (including AMG, Athlon, and Maybach); Stellantis (including Chrysler, Fiat,
PSA-Peugeot-Citroen, and VM Motori); Trane Technologies; Volkswagen AG (including Audi, MAN, Porsche, Scania, and Navistar); and Volvo Group (including Mack Trucks and Renault Trucks). In addition, our Climate Solutions segment includes
significant sales to a single global technology customer with which we are party to confidentiality agreements. Generally, we supply products to our customers on the basis of individual purchase orders received from them. When it is in the mutual
interest of Modine and our customers, we utilize long-term sales agreements to minimize investment risks and provide the customer with a proven source of competitively-priced products. These contracts are typically three to five years in duration.
Backlog of Orders
Our operating segments maintain their own inventories and production schedules. We believe that our current production capacity is capable of handling our expected sales volume in fiscal 2024 and beyond.
Raw Materials
We purchase aluminum, nickel and steel from several domestic and foreign suppliers. In general, we do not rely on any one supplier for these materials, which are, for the most part, available from numerous sources in quantities required by us.
The supply of copper and brass material is concentrated between two global suppliers, with other suppliers qualified and supplying lesser amounts to mitigate risk. While our suppliers may become constrained due to global demand, we typically do
not experience raw material shortages and believe that our suppliers’ production of these metals will be adequate throughout the next fiscal year. We typically adjust metals pricing with our raw material suppliers on a monthly basis and our major
fabricated component suppliers on a quarterly basis. When possible, we have included provisions within our long-term customer contracts which provide for adjustments to customer prices, on a prospective basis, based upon increases and decreases in
the cost of key raw materials. When applicable, however, these contract provisions are typically limited to the underlying cost of the material based upon the London Metal Exchange, and do not include related premiums or fabrication costs. In
addition, there can often be a three-month to one-year lag until the time that the price adjustments take effect.
Patents and Other Intellectual Property
We protect our intellectual property through patents, trademarks, trade secrets and copyrights. As a part of our ongoing R&D activities, we routinely seek patents on new products and processes. Our Patent Review Committee manages our
intellectual property strategy and portfolio. We own or license numerous patents worldwide related to our products and operations. Also, because we have many product lines, we believe that our business as a whole is not materially dependent upon
any particular patent or license, or any particular group of patents or licenses. We consider each of our patents, trademarks, and licenses to be of value and aggressively defend our rights throughout the world against infringement.
Research and Development
We are committed to building better products that will, in turn, help create a better world. We focus our engineering and R&D efforts on innovative solutions to meet the challenging thermal management needs of OEMs and other customers
within the commercial, industrial, building HVAC&R, commercial vehicle, construction, agricultural, powersports, and automotive and light vehicle markets. Our products and systems are often aimed at solving difficult and complex heat transfer
challenges requiring advanced thermal management, while meeting the demand for being more efficient, lighter weight, more compact, and more durable to ensure compliance with increasingly stringent energy efficiency, fuel economy and emissions
requirements. Our heritage includes a depth and breadth of expertise in thermal management that, combined with our global manufacturing presence, standardized processes, and state-of-the-art technical resources, enables us to rapidly bring
customized solutions to our customers.
R&D expenditures, including certain application engineering costs for specific customer solutions, totaled $44 million, $50 million, and $46 million in fiscal 2023, 2022, and 2021, respectively. As a percentage of our consolidated net
sales, we spent approximately 2 percent on R&D in fiscal 2023 and 2022, and approximately 3 percent in fiscal 2021. As our key markets continue to change, we are committed to meaningful R&D investment in the years to come. To achieve
efficiencies and lower development costs, our R&D groups work closely with our customers on special projects and system designs. These development projects for the HVAC&R markets primarily focus on sustainable solutions that optimize
thermal efficiency and manufacturing, to support decarbonization efforts and the use of next generation refrigerants, to help minimize global warming potential. Within our data center markets, development projects focus on product advancements to
reduce water and energy consumption. Our vehicular market projects are aimed at providing advanced thermal solutions for electric vehicles that improve fuel efficiency and reduce overall energy consumption. Most of our current R&D activities
are focused on internal development in the areas of building HVAC, commercial and industrial thermal management products, data center cooling, and vehicular and equipment cooling including electric vehicle, powertrain and engine cooling. We also
collaborate with industry, university, and government-sponsored research organizations that conduct research and provide data on practical applications in the markets we serve. We continue to identify, evaluate and engage in external research
projects that complement our strategic internal research initiatives in order to further leverage our significant thermal technology expertise and capabilities.
Quality Improvement
Globally, we drive quality improvement by maintaining the Global Modine Management System and executing the Modine Quality Strategy.
Our actions and decisions are driven by our purpose: Engineering a Cleaner, Healthier World™. Our strategic journey requires a uniting culture that grounds us, inspires us and
energizes us as we address the world’s most important challenges through innovative products and services with superior quality.
Through our integrated and process-oriented Global Modine Management System, the majority of our manufacturing facilities and administrative offices are registered to ISO 9001:20015 or IATF 16949:2016 standards, helping to ensure that our
customers receive high quality products and services. We regularly monitor our process performance to meet or exceed rising customer expectations for products, services and quality.
Our Global Modine Management System supports our mission and values by applying well-defined improvement principles and leadership behaviors, all based on our 80/20 mindset to facilitate rapid improvements. We drive sustainable and systematic
continuous improvement throughout our company by utilizing the principles, processes and behaviors of the Global Modine Management System.
To ensure future quality, we continue to execute the Modine Quality Strategy, which focuses on people, process, performance, quality engineering and the Global Modine Management System.
Environmental Matters
We are committed to Engineering a Cleaner, Healthier World™ and are working every day to deliver systems and solutions that improve air quality and conserve natural resources. We
concentrate on the benefits our products deliver, including reducing water and energy consumption, lowering harmful emissions, and enabling our customers to use environmentally friendly refrigerants. In addition, we are committed to conducting
business at our global locations in an environmentally conscious manner, specifically by preventing pollution, eliminating waste and reducing environmental risks. We employ waste management programs to advance our environmental stewardship and
minimize our environmental footprint. The majority of our facilities maintain Environmental Management System (“EMS”) certification to the international ISO14001 standard through independent third-party audits.
In regard to providing innovative, climate-resilient solutions that enable our customers to meet their sustainability goals, we are continuously driving energy efficiency across our product portfolio. Our Climate Solutions segment continues to
develop high-efficiency heating and indoor air quality products and data center cooling solutions that reduce both electrical and water usage. Our Lodronic™ Low-Temperature Hydronic Heater, for example, was designed for use with high-efficiency
boilers, geothermal or air-to-water heat pump systems to maximize efficiency and uses 50 percent less electricity than the typical hydronic heater. We are also shifting our product portfolios toward lower-emission propellants and refrigerants
which greatly reduce the environmental impact and enhance energy efficiency for our customers’ heating and cooling systems. Our Performance Technologies segment offerings focus on fuel efficiency and lower emissions. Our oil, charge-air, and EGR
coolers, radiators, air conditioning condensers, and battery thermal management systems for cars, trucks, buses, specialty vehicles, and off-highway equipment allow both electric vehicle and internal combustion systems to run at optimal
temperatures, which promotes better fuel efficiency, lower emissions, and improved vehicle lifespans, while still providing the vehicle performance that our customers expect.
In regard to our global business operations, we are working to reduce both our energy and water usage and have empowered each of our global facilities to create and carry out action plans that contribute to our company-wide reduction goals.
Examples of steps we are taking to meet these goals include the installation of more efficient LED lighting systems, the replacement of inefficient boilers and air compressors, improved building HVAC management systems, increased industrial water
recycling, and the installation of water-saving faucets.
Obligations for remedial activities may arise at our facilities due to past practices, or as a result of a property purchase or sale. These obligations most often relate to sites where past operations followed practices that were considered
acceptable under then-existing regulations, but now require investigative and/or remedial work to ensure appropriate environmental protection or where we are a successor to the obligations of prior owners and current laws and regulations require
investigative and/or remedial work to ensure sufficient environmental compliance. We have recorded liabilities for environmental investigative and remediation work at sites in the U.S. and abroad totaling $18 million at March 31, 2023.
Seasonal Nature of Business
Our overall operating performance is generally not subject to a significant degree of seasonality. The Climate Solutions segment experiences some seasonality, as demand for HVAC & refrigeration products can be affected by heating and
cooling seasons, weather patterns, construction, and other factors. Sales volume for our Climate Solutions heating products is generally stronger in our second and third fiscal quarters, corresponding with demand for these products. We generally
expect sales volume for our Climate Solutions refrigeration, power generation and conversion, and heat transfer products to be higher during our first and second fiscal quarters due to the construction seasons in the northern hemisphere. Sales to
Performance Technologies vehicular OEM customers are dependent upon market demand for new vehicles. However, our second fiscal quarter production schedules are typically impacted by customer summer shutdowns and our third fiscal quarter is
affected by holiday schedules.
Working Capital
We manufacture products for the majority of customers on an as-ordered basis, which makes large inventories of finished products unnecessary, with the exception of certain products in our Climate Solutions segment. Within our Climate Solutions
segment, we maintain varying levels of finished goods inventory, primarily related to our heating, indoor air quality, and data center products, due to seasonal demand and the timing of sales programs. In Brazil, within our Performance
Technologies segment, we maintain aftermarket product inventory in order to timely meet customer needs in the Brazilian automotive and commercial vehicle aftermarkets. We have not experienced a significant number of returned products within any of
our businesses.
Human Capital Resource Management
As of March 31, 2023, we employed approximately 11,300 persons worldwide.
We recognize that our continued success is a direct result of the quality of our people. As such, we strive to be an employer of choice in every community in which we operate. We do this by fostering a fair, respectful, and safe work
environment for our people in alignment with our core values.
We have identified priorities that we believe are essential to attract, develop and retain highly-qualified talent. These include, among others, i) providing career development programs; ii) promoting health and safety; iii) fostering diversity
and inclusion in the workplace; and iv) providing competitive compensation and benefits.
Workforce Development
Our operations require expertise across a wide range of disciplines, from engineering and manufacturing to accounting and finance to information technology. Our human resources team at our corporate headquarters and our local facility managers
work to hire talented individuals who align with our values.
All of our new employees go through a comprehensive onboarding program with their managers to ensure proper training is provided to succeed in their respective roles. We also encourage our employees to further develop their skills through both
internal and external training programs.
We are committed to growing our employees’ capabilities. Through our annual Performance and Development Process (“PDP”), we provide all salaried employees with a consistent, structured development and performance review experience. The PDP
provides employees with a development pathway that focuses on both annual performance goals and longer-term career development. In addition, we perform strategic talent reviews and succession planning on a regular cadence.
Health and Safety
The health and safety of our employees is paramount to us. We are committed to conducting our business operations in a safe and healthy manner. We employ a behavior-based safety program which proactively seeks to correct at-risk behaviors
while positively reinforcing safe behaviors. We educate and train employees on safe practices and promote personal accountability and responsibility for safety at all levels of our organization.
We have consistently out-performed the private-industry Recordable Incident Rate (“RIR” as defined by the Occupational Safety and Health Administration) average for the manufacturing sector, which was 3.3 in 2021, the most recent year for which
data is available. During fiscal 2023, we recorded an RIR of 1.06, well below the manufacturing sector average.
Diversity and Inclusion
We are committed to a diverse workforce, founded on respect and value for people of different backgrounds, experiences, and perspectives. Incorporating diverse talent and fostering an inclusive workforce is a key focus of our talent management
strategy. We track and focus on indicators of diversity and inclusion across our global operations, including the number of women in supervisory roles and minority new hires in the U.S.
Competitive Compensation and Benefits
We offer our employees competitive compensation and comprehensive benefit packages. We regularly benchmark our compensation practices and benefits programs against those of comparable industries and in the geographic areas where our facilities
are located. We believe that our compensation and employee benefits are competitive and allow us to attract and retain talent throughout our organization.
Available Information
Through our website, www.modine.com (Investors link), we make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, other Securities Exchange Act reports and
all amendments to those reports as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). Our reports are also available free of charge on the SEC’s
website, www.sec.gov. Also available free of charge on our website are the following corporate governance documents, among others:
| − |
Code of Conduct, which is applicable to all Modine directors and employees, including our executive officers;
|
| − |
Guidelines on Corporate Governance;
|
| − |
Audit Committee Charter;
|
| − |
Human Capital and Compensation Committee Charter;
|
| − |
Corporate Governance and Nominating Committee Charter; and
|
| − |
Technology Committee Charter.
|
All of the reports and corporate governance documents referenced above and other materials relating to corporate governance may also be obtained without charge by contacting Corporate Secretary, Modine Manufacturing Company, 1500 DeKoven Avenue,
Racine, Wisconsin 53403-2552. We do not intend to incorporate our internet website and the information contained therein or incorporated therein into this Annual Report on Form 10-K.
| ITEM 1A. |
RISK FACTORS.
|
In the ordinary course of our business, we face various market, operational, strategic, financial and general risks. These risks could have a material impact on our business, financial condition, results of operations
and cash flows. Please consider each of the risks described below, along with other information contained in this Annual Report on Form 10-K, when making any investment decisions with respect to our securities.
Our Enterprise Risk Management process seeks to identify and address material risks. We believe that risk-taking is an inherent aspect of operating a global business and, in particular, one focused on growth and
cost-competitiveness. Our goal is to proactively manage risks in a structured approach in conjunction with strategic planning, while preserving and enhancing shareholder value. However, the risks set forth below and elsewhere in this report, as
well as other risks currently unknown or deemed immaterial at the date of this report, could adversely affect us and cause our financial results to vary materially from recent or anticipated future results.
| A. |
MARKET RISKS
|
Economic Uncertainties
A downturn or recessionary conditions in the global economy could adversely affect our business, financial position, results of operations and cash flows.
We operate in 15 countries in four continents and serve customers in a wide array of HVAC&R and vehicular markets, including commercial vehicle, off-highway, automotive and light vehicle. As such, our business is impacted by general
economic and industry conditions globally as well as in the regions and countries in which we conduct business. An economic downturn or recession in the global economy could have a material adverse effect on our business, financial position,
results of operations and cash flows. Customer demand for our products and system solutions is impacted by the overall strength of the economy, employment levels, consumer confidence levels, the availability and cost of credit, and the cost of
fuel. For example, rising interest rates associated with inflationary market conditions may drive a higher cost of capital for our customers, which may have a deteriorating impact on overall economic activity and the financial condition of our
customers which could negatively impact the demand for our products. Prolonged recessionary or adverse economic conditions, such as disruptions in the global financial system, could result in our customers or suppliers experiencing significant
economic constraints, including potential bankruptcies.
Supply chain disruptions and inflationary market conditions could adversely affect our business, financial position, results of operations and cash flows.
Market and economic dynamics, including the impacts of the military conflict between Russia and Ukraine and the COVID-19 pandemic, have contributed to global supply chain challenges and inflationary market conditions. Further disruptions or
significant deterioration in market conditions could have a material adverse effect on our business, financial position, results of operations and cash flows.
In February 2022, Russian troops invaded Ukraine and the military conflict is ongoing. In response to the military conflict, governments in the U.S. and abroad have imposed sanctions against Russia and Belarus, which could adversely affect the
global economy and financial markets in which we operate. We do not have manufacturing operations in Ukraine or Russia nor any significant business relationships with Ukraine- or Russian-based customers or suppliers. To date, the military
conflict has not materially impacted our business or operations. An expansion of the military conflict, geographically or politically, could result in further market disruptions, including volatility in raw material prices and credit and capital
markets, supply chain challenges, and an increase in the threat of cyberattacks on the global supply chain, which could adversely affect our business, financial position, results or operations and cash flows.
Since its onset, the COVID-19 pandemic has broadly impacted the global economy and our key end markets. The direct effects on our company in fiscal 2023 from the COVID-19 pandemic were relatively limited. However, the pandemic, along with
other market and economic dynamics, have contributed to global supply chain challenges, labor shortages and inflationary market conditions. Raw material and logistic prices have increased and we, like many companies, have experienced delays and
shortages in certain purchased commodities and components. In addition, our Performance Technologies segment has been impacted by lower order volume associated with semiconductor shortages.
At this time, we cannot reasonably estimate the full impact of the ongoing supply chain challenges or inflationary market conditions. If we, our suppliers, or our customers continue to experience prolonged shutdowns or
other significant business disruptions, it is possible that our ability to conduct business in the manner and on the timelines presently planned could be materially and negatively impacted, which could have a material adverse effect on our
business, financial position, results of operations and cash flows.
A future widespread outbreak of an illness or other public health threat could adversely affect our business, financial position, results of operations and cash flows.
An outbreak of a disease or public health threat, including a significant resurgence of COVID-19, in the future could create economic and financial disruptions and adversely affect our businesses around the world.
Potential impacts of epidemics, pandemics, or other health crises include, but are not limited to, (i) staffing shortages if portions of our workforce are unable to work effectively due to illness, quarantines, government actions, facility
closures, or other restrictions; (ii) short- or long-term disruptions in our supply chain and our ability to deliver products to our customers; (iii) deterioration in the markets that we or our customers operate in, which may result in lower sales
or a lack in the ability of our customers to pay us; and (iv) significant volatility or negative pressure in the financial markets, which could adversely affect our access to capital and/or financing.
Customer and Supplier Matters
Increases in costs of materials, including aluminum, copper, steel and stainless steel (nickel), other raw materials and purchased components, could place significant pressure on our results of
operations.
Further potential increases in the costs of raw materials and other purchased components, which may be impacted by a variety of factors, including changes in trade laws, tariffs, sanctions, inflation, the behavior of our suppliers and
significant fluctuations in demand, could have a significant adverse effect on our results of operations. In the shorter-term, our ability to adjust for cost increases is limited when prices are fixed for current orders. In these cases, if we are
not able to recover such cost increases through price increases to our customers, such cost increases will have an adverse effect on our results of operations. With regard to our longer-term sales programs, we have sought to reduce the risk of
cost increases by including provisions within our customer contracts, where possible, which provide for prospective price adjustments based upon increases and decreases in the cost of key raw materials. However, where these contract provisions are
applicable, there can often be a three-month to one-year lag until the time of the price adjustment. To further mitigate our exposure, from time to time we enter into forward contracts to hedge a portion of our forecasted aluminum and copper
purchases. However, these hedges may only partially offset increases in material costs, and significant increases could have an adverse effect on our results of operations.
We could be adversely affected if we experience shortages of components or materials from our suppliers.
In an effort to manage and reduce our costs while balancing supply risk, we have added key suppliers to our supply base during the last year. We are, however, still dependent upon limited sources of supply for certain components used in the
manufacture of our products, including aluminum, copper, steel and stainless steel (nickel). We select our suppliers based upon total value (including price, delivery and quality), taking into consideration their production capacities, financial
condition and willingness and ability to meet our demand. In some cases, it can take several months or longer to identify and accept a new supplier due to qualification requirements.
Strong demand, the potential effects of trade laws and tariffs, capacity constraints, financial instability, public health crises, such as pandemics and epidemics, or other circumstances experienced by our suppliers could result in shortages or
delays in their supply of product to us, or a significant price increase resulting in our need to resource to a different supplier. If we experience significant or prolonged shortages of any critical
components or materials from our suppliers and could not procure the components or materials from other sources, we may be unable to meet our production schedules and could miss product delivery dates, which would adversely affect our sales,
results of operations and customer relationships.
Our results of operations could be adversely affected by price reduction pressures from OEMs.
Although we have negotiated price increases for certain customer contracts in response to the current inflationary market conditions, we have historically faced price-reduction pressure from our vehicular OEM customers and expect to face price
reduction pressure from them in the future. We have taken, and will continue to take, steps to reduce our operating costs to offset both inflationary pressures and contractual price reductions in order to achieve profit margins that are acceptable
to us. For existing contractual price reductions, if we are unable to offset price reductions through improved operating efficiencies and manufacturing processes, sourcing alternatives, technology enhancements and other cost reduction initiatives,
or through price negotiations, our results of operations could be adversely affected.
As part of our application of the 80/20 principles, we have improved our commercial acumen, including our pricing methodology, and have clear, strategic targets in terms of profit margins for new sales programs. To the extent contractual price
reductions are unavoidable for new sales programs, we contemplate them in our overall strategy and adjust pricing as necessary to provide satisfactory profit margins throughout the duration of the sales programs. While we believe that this pricing
strategy will strengthen our business and allow us to focus our resources on higher margin sales programs, it is possible that it may result in a lower overall win rate for new business in the shorter-term. If our pricing strategy results in
winning less new business, our results of operations could be adversely affected.
Our net sales and profitability could be adversely affected from business losses or declines with major customers.
Deterioration of a business relationship with a major customer could cause our sales and profitability to suffer. In certain areas of our businesses, a large portion of sales are attributable to a relatively small number of customers. In our
vehicular businesses, the failure to obtain new business on new models or to retain or increase business on redesigned existing models could adversely affect our business and financial results. In addition, as a result of the relatively long lead
times required for many of our complex components, it may be difficult in the short term for us to obtain new sales to replace any unexpected decline in sales of existing products. The loss of a major customer in any of our businesses, the loss of
business with respect to one or more of the vehicle models that use our vehicular products, or a significant decline in the production levels of such vehicles could have an adverse effect on our business, results of operations and cash flows.
Customer pressure to absorb costs adversely affects our profitability.
Vehicular customers often request that we pay for design, engineering and tooling costs that are incurred prior to the start of production and recover these costs through amortization in the piece price of the product. Some of these costs
cannot be capitalized, which adversely affects our profitability until the programs for which they have been incurred are launched. If a given program is not launched, or is launched with significantly lower volumes than planned, we may not be
able to recover the design, engineering and tooling costs from our customers, further adversely affecting our results of operations.
Climate Change and ESG-Related Risks
Global climate change and related emphasis on ESG matters by various stakeholders could negatively affect our business.
Increased public awareness and concern regarding global climate change may result in more regional and/or federal requirements to reduce or mitigate the effects of greenhouse gas emissions. There continues to be a lack of consistent climate
legislation, which creates economic and regulatory uncertainty. Such regulatory uncertainty extends to our product portfolio and overall costs of compliance, which may impact the demand for our products and/ or require us to make increased capital
expenditures to meet new standards and regulations. Further, our customers or other market participants may impose emissions or other environmental standards upon us through regulation, market-based emissions policies or consumer preference that
we may not be able to timely meet, or which may not be economically feasible for us, due to the required level of capital investment or technological advancement.
There is a growing consensus that greenhouse gas emissions are linked to global climate changes. Climate changes, such as extreme weather conditions, create financial risk to our business. For example, the demand for our products and services
may be affected by unseasonable weather conditions. Climate changes could also disrupt our operations by impacting the availability and cost of materials needed for manufacturing and could increase insurance and other operating costs. We could
also face indirect financial risks passed through the supply chain, and process disruptions due to climate changes could result in price modifications for our products and the resources needed to produce them.
Furthermore, customer, investor, and employee expectations in areas such as the environment, social matters and corporate governance (ESG) have been rapidly evolving and increasing. Specifically, certain customers are requiring information on
our environmental sustainability goals and commitments, which we have not yet released publicly. There can be no assurance of the extent to which any of our future plans will be achieved, or that any investments we make in furtherance of achieving
any such plans, targets, goals or other commitments will meet customer, investor, employee or other stakeholder expectations and desires or any regulatory or legal standards regarding sustainability performance.
Additionally, the enhanced stakeholder focus on ESG matters requires the continuous monitoring of various and evolving standards and the associated reporting requirements. A failure to adequately meet stakeholder expectations may result in the
loss of business, diluted market valuation, an inability to attract and retain customers or an inability to attract and retain top talent.
Competitive Environment
Continued and increased competition could adversely affect our business and our results of operations.
The global competitive environment continues to be dynamic as many of our customers, faced with intense international competition, have expanded their sourcing of components. As a result, we experience competition from suppliers in other parts
of the world that enjoy economic advantages, such as lower labor costs, lower health care costs, lower tax rates, lower costs associated with legal compliance, and, in some cases, export or raw materials subsidies. In addition, consolidation and
vertical integration within the supply base have introduced new or restructured competitors to our markets. Increased competition could adversely affect our business and our results of operations.
| B. |
OPERATIONAL RISKS
|
Complexities of Global Presence
We are subject to risks related to our international operations and global customer base.
We have manufacturing and technical facilities located in North America, South America, Europe, and Asia. In fiscal 2023, 56 percent of our sales were generated from customers outside the U.S., with 49 percent of these sales generated by our
non-U.S. operations. Our global operations are subject to complex international laws and regulations and numerous risks and uncertainties, including changes in monetary and fiscal policies, including those related to tax and trade, cross-border
trade restrictions or prohibitions, import or other charges or taxes, fluctuations in foreign currency exchange and interest rates, inflation, changing economic conditions, public health crises, including COVID-19, unreliable intellectual property
protection and legal systems, insufficient infrastructures, social unrest, political instability and disputes (including, for example, impacts of the military conflict in Ukraine), incompatible business practices, and international terrorism.
Changes in policies or laws governing the terms of foreign trade, and in particular increased trade restrictions, tariffs or taxes on imports from countries where we either manufacture products, such as Mexico, or buy raw materials, such as China,
could have a material adverse effect on our results of operations. In addition, compliance with multiple and often conflicting laws and regulations of various countries can be challenging and expensive.
Embargoes or sanctions imposed by the U.S. government or those abroad that restrict or prohibit sales to or purchases from specific persons or countries or based upon product classification may expose us to potential criminal and civil sanctions
to the extent that we are alleged or found to be in violation, whether intentional or unintentional. Governments in the U.S. and abroad have imposed sanctions on Russia in connection with the military conflict in Ukraine. While we do not have
manufacturing operations in Ukraine or Russia nor any significant business relationships with Ukraine- or Russian-based customers or suppliers, we are actively monitoring the sanctions requirements and reacting as necessary to ensure compliance.
We cannot predict future regulatory requirements to which our business operations may be subject or the manner in which existing laws might be administered or interpreted.
In addition, the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and other similar anti-corruption laws generally prohibit companies and their intermediaries from making payments to improperly influence foreign government officials or
other persons for the purpose of obtaining or retaining business. In recent years, there has been a substantial increase in the global enforcement of anti-corruption laws. In the event that we believe our employees or agents may have violated
applicable anti-corruption laws, or if we are subject to allegations of any such violations, we may have to expend significant time and financial resources toward the investigation and remediation of the matter, which could disrupt our business and
result in a material adverse effect on our financial condition, results of operations and reputation.
Challenges of Maintaining a Competitive Cost Structure
We may be unable to maintain competitive cost structures within our business.
In recent years, we have engaged in various restructuring activities in order to optimize our manufacturing footprint and cost structure. These restructuring activities have included targeted headcount reductions that support our objective of
reducing operational and SG&A cost structures and the consolidation and/or closure of manufacturing facilities in North America, Europe and Asia. In addition, we continue to focus on reducing costs for materials and services through targeted
adjustments and negotiations with our supply base. Our successful execution of these initiatives, and our ability to identify and execute future opportunities to optimize our cost structures, is critical to enable us to establish a cost structure
that will improve and sustain our long-term competitiveness. Any failure to do so could, in turn, adversely affect our results of operations and financial condition.
Challenges of Program Launches
We launch a significant number of new programs at our facilities across the world. The success of these launches is critical to our business.
We design technologically advanced products, and the processes required to produce these products can be difficult and complex. We spend significant time and financial resources to ensure the successful launch of new products and programs. Due
to our high level of launch activity, particularly within our Performance Technologies segment, we must appropriately manage these launches and deploy our operational and administrative resources to take advantage of the resulting increase in our
business. If we do not successfully launch new products and programs, we may lose market share or damage relationships with our customers, which could negatively affect our business. In addition, any failure in our manufacturing strategy for
these new products or programs could result in operating inefficiencies or asset impairment charges, which could adversely affect our results of operations.
Information Technology (IT) Systems
We may be adversely affected by a substantial disruption in, or material breach of, our IT systems.
We are dependent upon our IT infrastructure, including network, hardware, and software systems, to conduct our business. Despite network and other cybersecurity measures we have in place, our IT systems could be compromised or we could
experience a cybersecurity breach from computer viruses, ransomware, phishing, break-ins or similar disruptions. A substantial disruption in our IT systems for a prolonged time period, or a material breach of our IT systems, could result in delays
in receiving inventory and supplies or filling customer orders, and/or the release of otherwise confidential information, including personal information that is protected by the General Data Protection Regulation, adversely affecting our customer
service and relationships as well as our reputation, and could lead to significant remediation expenses and litigation risks. Our systems, and the systems of our service providers or others, could be breached, damaged or interrupted by
cyber-attacks or other intentional or unintentional events, or by natural disasters or occurrences, many of which may, despite our best efforts, be beyond our ability to effectively detect, anticipate or control. This impact may be heightened by
the increased prevalence of hybrid and/or remote work arrangements that were first offered in connection with mitigating the spread of COVID-19. Further, the military conflict in Ukraine and the associated political uncertainty may increase the
threat of cyberattacks on the global supply chain, which could directly or indirectly impact our operations. Any such events and the related delays, problems or costs could have a material adverse effect on our business, financial condition,
results of operations and reputation.
Environmental, Health and Safety Regulations
We could be adversely impacted by the costs of environmental, health and safety regulations.
Our operations are subject to various federal, state, local and foreign laws and regulations governing, among other things, emissions to air, discharge to waters and the generation, handling, storage, transportation, treatment and disposal of
waste and other materials. The operation of our manufacturing facilities entails risks in these areas and there can be no assurance we will avoid material costs or liabilities relating to such matters. Our financial responsibility to clean up
contaminated property may extend to previously-owned or used property, properties owned by unrelated companies, as well as properties we currently own and use, regardless of whether the contamination is attributable to prior owners. In addition,
potentially material expenditures could be required in order for our products and operations to comply with evolving environmental, health and safety laws, regulations (including those developed as a concern to climate control), or other
requirements that may be adopted or imposed in the future. Future costs to remediate contamination or to comply with environmental, health and safety laws and regulations could adversely affect our business, results of operations and financial
condition.
Claims and Litigation
We may incur material losses and costs as a result of warranty and product liability claims and litigation or other legal proceedings.
In the event our products fail to perform as expected, we are exposed to warranty and product liability claims and may be required to participate in a recall or other field campaign of such products. Many of our vehicular customers offer
extended warranty protection for their vehicles and require their supply base to extend warranty coverage as well. If our customers demand higher warranty-related cost recoveries, or if our products fail to perform as expected, it could have a
material adverse impact on our results of operations and financial condition. We are also involved in various legal proceedings from time to time incidental to our business. If any such proceeding has a negative result, it could adversely affect
our business, results of operations, financial condition and reputation.
| C. |
STRATEGIC RISKS
|
Business Optimization and Growth Strategies
Inability to execute on our strategic initiatives may adversely impact our business and operating results.
We are well on our way in our strategic transformation. We onboarded seasoned leaders and segmented our organization, aligning teams led by general managers around specific strategies and market-based verticals. Our leadership teams have
created a high-performance culture and are prioritizing resources on products and markets with the highest growth opportunities and best return profiles. We plan to continue to employ an 80/20 mindset across our businesses, including within our
manufacturing facilities, to optimize profit margins and cash flow. However, if we are unable to successfully execute on our strategic initiatives, we may not achieve the financial or operational successes anticipated.
In addition, we will continue to review our business portfolio and pursue acquisitions to accelerate growth. There can be no assurance we will be able to identify attractive acquisition targets. If we are unable to successfully execute on
organic growth opportunities or complete acquisitions in the future, our growth may be limited. In addition, future acquisitions will require integration of operations, sales and marketing, information technology, finance, and administrative
functions. If we are unable to successfully integrate future acquisitions and operate these businesses profitably, we may not achieve the financial or operational success expected from the acquisitions.
| D. |
FINANCIAL RISKS
|
Liquidity and Access to Cash
Our indebtedness may limit our use of cash flow to support operating, development and investment activities, and failure to comply with our debt covenants could adversely affect our liquidity and
financial results.
As of March 31, 2023, we had total outstanding indebtedness of $353 million. Our indebtedness and related debt service obligations (i) require that significant cash flow from operations be used for principal and interest payments, which reduces
the funds we have available for other business purposes; (ii) limit our flexibility in planning for or reacting to changes in our business and market conditions; and (iii) expose us to interest rate risk, since the majority of our debt obligations
carry variable interest rates.
Our credit agreements contain financial covenants that, among other things, require us to maintain a minimum interest coverage ratio and impose a maximum leverage ratio. Failure to comply with debt covenants could result in an event of default,
which, if not cured or waived, could result in us being required to repay these borrowings before their due date. If we are forced to refinance these borrowings on less favorable terms, our results of operations and financial condition could be
adversely affected by increased costs and interest rates.
Market trends and regulatory requirements may require additional funding for our pension plans.
Our defined benefit pension plans in the U.S. are frozen to new participants. Our funding policy is to contribute annually, at a minimum, the amount necessary on an actuarial basis to provide for benefits in accordance with applicable laws and
regulations. Our domestic plans have an unfunded liability totaling $20 million as of March 31, 2023. As a result of funding relief provisions within the American Rescue Plan Act of 2021, we do not expect to make cash contributions to our U.S.
plans during fiscal 2024. Funding requirements for our defined benefit plans are dependent upon, among other things, interest rates, underlying asset returns, mortality rate assumptions, and the impact of legislative or regulatory changes. Should
changes in actuarial assumptions or other factors result in the requirement of significant additional funding contributions, our cash flows and financial condition could be adversely affected.
Goodwill and Intangible Assets
Our balance sheet includes significant amounts of goodwill and intangible assets. An impairment of a significant portion of these assets would adversely affect our financial results.
Our balance sheet includes goodwill and intangible assets totaling $247 million at March 31, 2023. We perform goodwill impairment tests annually, as of March 31, or more frequently if business events or other conditions exist that require a
more frequent evaluation. In addition, we review intangible assets for impairment whenever business conditions or other events indicate that the assets may be impaired. If we determine the carrying value of an asset is impaired, we write down the
asset to fair value and record an impairment charge to current operations.
We use judgment in determining if an indication of impairment exists. For our annual goodwill impairment tests, we use estimates and assumptions, including revenue growth rates and operating profit margins
to calculate estimated future cash flows and risk-adjusted discount rates. We cannot predict the occurrence of future events or circumstances, including lower than forecasted revenues, market trends that fall below our current expectations,
actions of key customers, increases in discount rates, and the continued general economic uncertainties, which could adversely affect the carrying value of goodwill and intangible assets. An impairment of a significant portion of goodwill or
intangible assets could have a material adverse effect on our financial results.
Income Taxes
We may be subject to additional income tax expense or become subject to additional tax exposure.
The subjectivity of or changes in tax laws and regulations in jurisdictions where we have significant operations could materially affect our results of operations and financial condition. We are also subject to tax audits in each jurisdiction
in which we operate. Unfavorable or unexpected outcomes from one or more tax audits could adversely affect our results of operations and financial condition.
In addition, as of March 31, 2023, our net deferred tax assets totaled $79 million. Each quarter, we evaluate the probability that our deferred tax assets will be realized and determine whether valuation allowances or adjustments thereto are
needed. This determination involves judgement and the use of significant estimates and assumptions, including expectations of future taxable income and tax planning strategies. Future events or circumstances, such as lower taxable income or
unfavorable changes in the financial outlook of our operations in certain jurisdictions, could require us to establish further valuation allowances, which could have a material adverse effect on our results of operations and financial condition.
| E. |
GENERAL RISKS
|
Customers and Markets
We are dependent upon the health of the customers and markets we serve.
We are highly susceptible to unfavorable trends or disruptions in the markets we serve, as our customers’ financial condition and performance are affected by general economic conditions, including supply chain challenges, access to credit, the
price of fuel and electricity, employment levels and trends, interest rates, labor relations issues, regulatory requirements, government-imposed restrictions relating to health crises or other unusual events, trade agreements and other market
factors, as well as by customer-specific issues. Any significant decline in demand for our products and solutions, including those driven by customer production levels, by current and future customers could result in asset impairment charges and a
reduction in our sales, thereby adversely impacting our results of operations, cash flows and financial condition.
Exposure to Foreign Currencies
As a global company, we are subject to foreign currency rate fluctuations, which affect our financial results.
Although our financial results are reported in U.S. dollars, a significant portion of our sales and operating costs are realized in foreign currencies. Our sales and profitability are affected by movements of the U.S. dollar against foreign
currencies in which we generate sales and incur expenses. To the extent that we are unable to match sales in foreign currencies with costs paid in the same currency, exchange rate fluctuations in any such currency could have an adverse effect on
our financial results. During times of a strengthening U.S. dollar, our reported sales and earnings from our international operations will be lower because the applicable local currency will be translated into fewer U.S. dollars. In certain
instances, currency rate fluctuations may create pricing pressure relative to competitors quoting in different currencies, which could result in our products becoming less competitive. Significant long-term fluctuations in relative currency values
could have an adverse effect on our results of operations and financial condition.
Reliance upon Technology Advantage
If we cannot differentiate ourselves from our competitors with our technology, our existing and potential customers may seek lower prices and our sales and earnings may be adversely affected.
Price, quality, delivery, technological innovation, and application engineering development are the primary elements of competition in our markets. If we fail to keep pace with technological changes and cannot differentiate ourselves from our
competitors with our technology or fail to provide high quality, innovative products and services that both meet or exceed customer expectations and address their ever-evolving needs, we may experience price erosion, lower sales, and lower profit
margins. Significant technological developments by our competitors or others also could adversely affect our business and results of operations.
Developments or assertions by or against us relating to intellectual property rights could adversely affect our business.
We own and license significant intellectual property, including a large number of patents, trademarks, copyrights and trade secrets. Our intellectual property plays an important role in maintaining our competitive position in a number of the
markets we serve. As we maintain or expand our operations in jurisdictions where the enforcement of intellectual property rights is less robust, the risk of others duplicating our proprietary technologies increases, despite our efforts to protect
them. Developments or assertions by or against us relating to intellectual property rights could adversely affect our business and results of operations.
Attracting and Retaining Talent
Our continued success is dependent on being able to attract, develop and retain qualified personnel.
Our ability to sustain and grow our business requires us to hire, develop, and retain skilled and diverse personnel throughout our organization. We depend significantly on the engagement of our employees and their skills, experience and
industry knowledge to support our objectives and initiatives. We have observed tightening and increased competitiveness in the labor markets and have experienced labor shortages at certain of our manufacturing locations. Any prolonged labor
shortages or significant employee turnover could negatively impact productivity and result in increased labor costs, such as increased overtime to meet demand or increased wage rates necessary to attract and retain employees. Overall, difficulty in
attracting, developing, and retaining qualified personnel could adversely affect our business and results of operations.
None.
| ITEM 2. |
PROPERTIES.
|
We operate manufacturing facilities in the U.S. and in multiple foreign countries. Our world headquarters, including general offices and laboratory, experimental and tooling facilities, is located in Racine, Wisconsin. We have additional
technical support functions located in Grenada, Mississippi; Leeds, United Kingdom; Pocenia, Italy; Guadalajara, Spain; Söderköping, Sweden; Bonlanden, Germany; Sao Paulo, Brazil; Changzhou, China; and Chennai, India.
The table below summarizes the number of manufacturing facilities within each of our operating segments as of March 31, 2023. Sixteen of these facilities include leased manufacturing space.
|
|
|
Americas
|
|
Europe
|
|
Asia
|
|
Total
|
|
Climate Solutions
|
|
6
|
|
9
|
|
1
|
|
16
|
|
Performance Technologies
|
|
7
|
|
7
|
|
6
|
|
20
|
|
Total manufacturing facilities
|
|
13
|
|
16
|
|
7
|
|
36
|
In addition to the manufacturing facilities summarized in the table above, we also operate six coatings facilities in the U.S. and Europe, which primarily enhance customer-owned products with coatings solutions and operate at a smaller scale
than our other manufacturing facilities.
We consider all of our facilities and equipment to be well maintained and suitable for their purposes. We review our manufacturing capacity regularly and make the determination as to our need to expand or, conversely, rationalize our facilities
as necessary to meet changing market conditions and our operating needs.
| ITEM 3. |
LEGAL PROCEEDINGS.
|
The information required hereunder is incorporated by reference from Note 20 of the Notes to Consolidated Financial Statements.
| ITEM 4. |
MINE SAFETY DISCLOSURES.
|
Not applicable.
The following sets forth the name, age (as of March 31, 2023), business experience during at least the last five years, and certain other information relative to each executive officer of the Company.
|
Name
|
Age
|
Position
|
||
|
Brian J. Agen
|
54
|
Vice President, Human Resources (October 2012 – Present).
|
||
|
Neil D. Brinker
|
47
|
President and Chief Executive Officer (December 2020 – Present). Prior to joining Modine, Mr. Brinker served as President and Chief Operating Officer of Advanced Energy Industries, Inc. after serving as its Executive Vice President and
Chief Operating Officer. Prior to joining Advanced Energy Industries, Inc, Mr. Brinker served as a Group President at IDEX Corporation.
|
||
|
Michael B. Lucareli
|
54
|
Executive Vice President, Chief Financial Officer (May 2021 – Present); previously Vice President, Finance and Chief Financial Officer for the Company.
|
||
|
Eric S. McGinnis
|
52
|
President, Climate Solutions (April 2022 – Present); previously Vice President, Building HVAC upon joining Modine in August 2021. Prior to joining Modine, Mr. McGinnis served as President, Industrial Systems at Regal Beloit.
|
||
|
Adrian I. Peace
|
55
|
President, Performance Technologies (April 2022 – Present); previously Vice President, Commercial & Industrial Solutions upon joining Modine in August 2021. Prior to joining Modine, Mr. Peace served as a Strategy Advisor for AIP
LLC. Prior to AIP LLC, Mr. Peace served as Senior Vice President, Emerging Business Operations for Republic Services.
|
||
|
Sylvia A. Stein
|
56
|
Vice President, General Counsel, Corporate Secretary and Chief Compliance Officer (February 2020 – Present); previously Vice President, General Counsel and Corporate Secretary for the Company.
|
Executive officer positions are designated in our Bylaws and the persons holding these positions are elected annually by the Board. In addition, the Human Capital and Compensation Committee of the Board may recommend and the Board of Directors
may approve promotions and other actions with regard to executive officers at any time during the fiscal year.
There are no family relationships among the executive officers and directors. There are no arrangements or understandings between any of the executive officers and any other person pursuant to which he or she was elected an officer of Modine.
PART II
| ITEM 5. |
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
|
Our common stock is listed on the New York Stock Exchange. Our trading symbol is MOD. As of March 31, 2023, shareholders of record numbered 2,071.
We did not pay dividends during fiscal 2023 or 2022. Under our credit agreements, we are permitted to pay dividends on our common stock, subject to certain restrictions based upon the calculation of debt covenants, as defined in our credit
agreements. We currently do not intend to pay dividends in fiscal 2024.
The following describes the Company’s purchases of common stock during the fourth quarter of fiscal 2023:
|
Period
|
Total Number of
Shares Purchased
|
Average
Price Paid
Per Share
|
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
|
Maximum Number (or
Approximate Dollar
Value) of Shares
that May Yet Be Purchased
Under the Plans or Programs (a)
|
|
January 1 – January 31, 2023
|
_______
|
_______
|
_______
|
$47,909,372
|
|
February 1 – February 28, 2023
|
3,562 (b)
|
$24.64
|
_______
|
$47,909,372
|
|
March 1 – March 31, 2023
|
110,750 (b) (c)
|
$25.48
|
100,000
|
$45,372,391
|
|
Total
|
114,312 (b) (c)
|
$25.46
|
100,000
|
| (a) |
Effective November 5, 2022, the Company’s Board of Directors authorized the Company to repurchase up to $50.0 million of Modine common stock at such times and prices that it deems to be appropriate. This authorization expires in
November 2024.
|
| (b) |
Includes shares delivered back to the Company by employees and/or directors to satisfy tax withholding obligations that arise upon the vesting of stock awards. The Company, pursuant to its equity compensation plans, gives participants
the opportunity to turn back to the Company the number of shares from the award sufficient to satisfy tax withholding obligations that arise upon the termination of restrictions. These shares are held as treasury shares.
|
| (c) |
Includes shares acquired pursuant to the repurchase program described in (a) above.
|
PERFORMANCE GRAPH
The following graph compares the cumulative five-year total return on our common stock with similar returns on the Russell 2000 Index and the Standard & Poor’s (S&P) SmallCap 600 Industrials Index. The graph assumes a $100 investment
and reinvestment of dividends. The return shown on the graph is not necessarily indicative of future performance.
|
Indexed Returns
|
||||||||||||||||||||||||
|
Initial Investment
|
Years ended March 31,
|
|||||||||||||||||||||||
|
Company / Index
|
March 31, 2018
|
2019
|
2020
|
2021
|
2022
|
2023
|
||||||||||||||||||
|
Modine Manufacturing Company
|
$
|
100
|
$
|
65.58
|
$
|
15.37
|
$
|
69.83
|
$
|
42.60
|
$
|
108.98
|
||||||||||||
|
Russell 2000 Index
|
100
|
102.05
|
77.57
|
151.14
|
142.39
|
125.87
|
||||||||||||||||||
|
S&P SmallCap 600 Industrials Index
|
100
|
98.85
|
76.59
|
149.62
|
149.63
|
156.62
|
||||||||||||||||||
| ITEM 6. |
RESERVED
|
| ITEM 7. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
|
Overview
At Modine, we are Engineering a Cleaner, Healthier World ™. We provide trusted products and technologies that help improve our world. Our broad portfolio of systems and solutions
support our mission of improving indoor air quality, conserving natural resources, lowering harmful emissions, enabling cleaner running vehicles, and using environmentally friendly refrigerants. We operate in
four continents, in 15 countries, and employ approximately 11,300 persons worldwide.
We sell innovative and environmentally responsible thermal management products and solutions to diversified customers in a wide array of commercial, industrial, and building HVAC&R markets. In addition, we are a leading provider of
engineered heat transfer systems and high-quality heat transfer components for use in on- and off-highway OEM vehicular applications. Our primary product groups include i) heat transfer; ii) HVAC & refrigeration; iii) data center cooling; iv)
air-cooled; v) liquid-cooled; and vi) advanced solutions.
Company Strategy
Our purpose is to engineer a cleaner, healthier world by providing products and services that improve indoor air quality, reduce water and energy consumption, lower harmful emissions, enable cleaner running vehicles, and use environmentally
friendly refrigerants.
In fiscal 2023, we made significant progress toward transforming Modine. We originally announced our vision for a “new” Modine in late fiscal 2021. In fiscal 2022, we onboarded seasoned leaders to drive transformative change, including new
segment presidents for our Climate Solutions and Performance Technologies segments. Since that time, we have simplified and segmented our organization, aligning teams, led by general managers, around specific strategies and market-based verticals
within our company. Our new leadership teams have created a high-performance culture and are prioritizing resources on products and markets with the highest growth opportunities and best return profiles. We have been focused on growth
opportunities in the data center market and have strategically expanded our product offerings in this business. We are now manufacturing and selling more data center cooling products in North America. We have also improved our commercial acumen
and have strengthened our business relationships with our best customers. In addition, by applying 80/20 principles and improving our commercial pricing methodologies, we have improved our profit margins in fiscal 2023, in spite of significant
supply chain challenges and inflationary market conditions.
Entering fiscal 2024, while a level of uncertainty and the possibility of recessionary conditions exist in the global marketplace, we are focused on organic and inorganic growth opportunities in the key markets we
serve and the incremental value we believe we can unlock in Modine by applying 80/20 principles across our businesses. We are strengthening key customer relationships and pursing strategic growth opportunities, particularly in the data
center, electric vehicles, and HVAC&R markets where we see the best opportunities for profitable growth. In addition, we are utilizing an 80/20 mindset within our manufacturing facilities and expect to achieve
production efficiency improvements as a result.
Our ultimate objective for our transformational strategy is to accelerate profitable growth. We expect to change our mix of business, as we grow certain areas and strategically deemphasize others. We expect these changes will fuel improvements
in both earnings and cash flow, all while supporting our customers with innovative and environmentally responsible thermal management solutions to succeed in the ever-changing global marketplace.
Development of New Products and Technology
Every day, we leverage our technical expertise, building on more than 100 years of excellence in thermal management, to advance our purpose. We are dedicated to utilizing technology and solutions with sustainable
impacts. Our ability to provide customizable solutions to meet the ever-evolving needs of our customers is one of our greatest competitive strengths.
We partner with our customers and use a systems-based approach to ensure our solutions work seamlessly with their other components. Our thermal solutions enable our customers to stay ahead of new and emerging
regulations, particularly those involving increasingly stringent emissions, fuel economy, and energy efficiency standards.
We maintain numerous state-of-the-art technology centers, dedicated to the development and testing of products and technologies. The centers are located in Racine, Wisconsin; Leeds, United Kingdom; Grenada, Mississippi;
Pocenia, Italy; and Bonlanden, Germany. Customers know our reputation for innovation and rely on Modine to provide high quality products and technologies.
Strategic Planning and Corporate Development
We employ both short-term (one-to-three year) and longer-term (five-to-seven year) strategic planning processes, which enable us to continually assess our opportunities, competitive threats, and economic market
challenges.
We devote significant resources to global strategic planning and development activities to strengthen our competitive position. We will continue to pursue organic- and external-growth opportunities,
particularly to grow our global, market leading positions in the HVAC&R and data center markets. In addition, we have a dedicated team focused on products and solutions for electric vehicles, supporting demands for climate-friendly alternative
powertrains. We have provided our general managers with the tools that they need to be successful, including dedicated resources to create an entrepreneurial environment and to challenge the status quo.
Operational and Financial Discipline
We are using 80/20 principles to guide our path forward toward commercial excellence. Through closely analyzing our customer and product data with our 80/20 mindset, we
focus our commercial and operational actions in areas that drive our profitability and also in areas requiring improvement. Our Climate Solutions and Performance Technologies segments have strategically aligned their teams around their
primary market-based verticals and are driving transformative change. The general manager for each vertical is working toward strategic objectives specifically tailored to his or her business and we expect these strategies will continue to
generate earnings and cash flow improvements.
While executing on our strategic initiatives, we have faced obstacles including supply chain disruptions and inflationary market conditions. We have and will continue to address these challenges head-on through
commercial actions and close engagement with our suppliers.
Our fiscal 2023 annual cash incentive plan for our management team was based upon two performance metrics: growth in net earnings before interest, taxes, depreciation, amortization, and certain other
adjustments (“Adjusted EBITDA”) and Adjusted EBITDA margin as a percentage of net sales. The incentive plan’s performance goals were established for each operating segment as well for the consolidated company. In
addition, we provide a long-term incentive compensation plan for officers and certain key leaders throughout our organization to attract, retain, and motivate these employees who are responsible for driving the long-term success of our company.
The plan is comprised of stock awards, stock options, and performance-based awards. The performance-based awards for the fiscal 2023 through 2025 performance period are based upon a target three-year average
growth in Adjusted EBITDA and a target three-year average cash flow return on invested capital.
Segment Information – Strategy, Market Conditions and Trends
Each of our operating segments is managed by a segment president and has separate strategic and financial plans and financial results which are reviewed by our chief operating decision maker. These plans and results are used by management to
evaluate the performance of each segment and to make decisions on the allocation of resources.
Effective April 1, 2022, we began managing the Company under two operating segments, Climate Solutions and Performance Technologies. Our segment structure aligns businesses serving similar or complimentary end markets, products and technologies
under common segment management. This simplified segment structure allows us to better focus resources on targeted growth opportunities and better enables an efficient application of 80/20 principles across all product lines to optimize profit
margins and cash flow.
The Climate Solutions segment includes the previously-reported BHVAC and CIS segments, with the exception of CIS Coatings. The Performance Technologies segment includes the previously-reported Heavy Duty Equipment and Automotive segments and
the CIS Coatings business.
Climate Solutions (43 percent of fiscal 2023 net sales)
Our Climate Solutions segment provides energy-efficient, climate-controlled solutions and components for a wide array of applications. The Climate Solutions segment sells heat transfer, HVAC & refrigeration, and data
center cooling solutions to customers in North America, EMEA, and Asia. Heat transfer products include heat transfer coils used in commercial and residential HVAC and refrigeration applications. HVAC & refrigeration products include
commercial and residential unit heaters, vertical and horizontal unit ventilators, air conditioning chillers, low global warming potential unit coolers, air-cooled condensers, and dry coolers. Data center cooling solutions, which are integrated
with system controls, include air- and liquid-cooled chillers, CRAC and CRAH units, and fan walls. We sell our products and solutions both directly to commercial and industrial OEM and end user customers and through wholesalers, distributors,
consulting engineers, contractors and data center operators for applications such as data centers, schools, greenhouses, healthcare systems, warehouses, residential garages, manufacturing facilities, and other commercial and industrial
applications.
During fiscal 2023, Climate Solutions segment sales increased compared with the prior year, primarily driven by increased sales of data center cooling, heat transfer, and HVAC & refrigeration products. We applied
80/20 principles to each of our businesses within the Climate Solutions segment during fiscal 2023. For example, we simplified our heat transfer products business by reducing SKUs and have refined our pricing discipline. Through these efforts, we
achieved improvements in the Climate Solutions segment’s profit margins. In addition, as part of our strategic growth initiatives, we have expanded our data center business and are manufacturing and selling more data center cooling products in
North America.
Looking ahead, while a level of uncertainty and the possibility of recessionary conditions exist in the global marketplace, we expect growth across the HVAC&R and data center markets we serve during fiscal 2024.
These markets are heavily impacted by construction activity, building regulations, owner/occupant comfort requirements, and the increasing reliance on digital technologies. We expect particularly strong growth in the data center markets as the
need for digital infrastructure expands. We also expect the North American school and commercial HVAC markets, to which we sell our indoor air quality products, will experience strong growth during fiscal 2024, driven by federal and local funding
for ventilation improvements for schools. In addition, we expect the rapid adoption of heat pump technology in Europe to be a market growth driver and are increasing our manufacturing capacity in response.
In fiscal 2024, we will continue to utilize an 80/20 mindset across our Climate Solutions businesses. We are focused on engaging with key customers to further develop our relationships with them and are pursuing
strategic growth opportunities, particularly for our data center, heating, and indoor air quality products. We are also focused on growing our refrigeration sales and believe we can become a market leader in more environmentally friendly carbon
dioxide gas coolers and adiabatic solutions in North America and Europe. In addition to these organic growth opportunities, we plan to pursue acquisitions to further accelerate growth and complement our existing product portfolio. Finally, we are
also focused on applying the 80/20 principles within our manufacturing facilities and expect to achieve production efficiency improvements as a result.
Performance Technologies (57 percent of fiscal 2023 net sales)
The Performance Technologies segment provides products and solutions that enhance the performance of customer applications and develops solutions that increase fuel economy and lower emissions in light of increasingly stringent government
regulations. The Performance Technologies segment designs and manufactures air- and liquid-cooled technology for vehicular, stationary power, and industrial applications. Air-cooled products consist primarily of powertrain cooling products, such
as radiators, condensers, engine cooling modules, charge air coolers, fan shrouds, and surge tanks. Liquid-cooled products include engine oil coolers, EGR coolers, liquid charge air coolers, transmission and retarder oil coolers, fuel coolers, and
condensers. In addition, the Performance Technologies segment provides advanced solutions, designed to improve battery range and vehicle life, to zero-emission and hybrid commercial vehicle and automotive customers. These solutions include
battery thermal management systems, electronics cooling packages, and battery chillers. The advanced solutions provided by the segment also include coating products and application services that extend the life of equipment and components by
protecting against corrosion.
During fiscal 2023, Performance Technologies segment sales increased compared with the prior year, primarily driven by higher sales volume and favorable commercial pricing, including adjustments in response to material price increases. Compared
with the prior year, sales of air-cooled, liquid-cooled, and advanced solutions products each increased. In fiscal 2023, we focused on training our employees on 80/20 principles and began applying them to our businesses.
Looking ahead, while a level of uncertainty and the possibility of recessionary conditions exist in the global marketplace, we are excited about the growth potential in our key markets and the benefits we
expect to achieve as we roll out 80/20 principles across all of our businesses. Our Advanced Solutions team is focused on growing sales of its thermal management systems and components for electric vehicles and is engaged with numerous
current and prospective customers. We believe government policies in the U.S. and Europe will drive customer investments in electric and alternative powertrains and will support market growth in this area. In addition, we expect the global
automotive markets to experience moderate growth, as customers look to replenish inventory levels in light of the semiconductor chip shortage and other supply chain challenges. We are also working to apply our 80/20 mindset to achieve
manufacturing efficiencies and to improve our business mix, focusing on higher profit margin products, applying quoting filters for new customer programs and reducing complexity across our businesses.
Consolidated Results of Operations
Supply Chain Disruptions and Inflationary Market Conditions
Market and economic dynamics, including the impacts of the military conflict between Russia and Ukraine and the COVID-19 pandemic, have contributed to global supply chain challenges and inflationary market conditions. We are focused on
mitigating the negative impacts of labor shortages, supply chain challenges and inflationary market conditions, including changes in raw material, energy, logistic, and interest costs, as well as delays and shortages in certain purchased
commodities and components. We have implemented selling price increases for many of our products in response to raw material and other cost increases and are engaged with suppliers to ensure availability of key raw materials. We cannot reasonably
estimate the full impact that economic and market dynamics will have on our business, results of operations, or cash flows in the future.
Fiscal 2023 Highlights
Fiscal 2023 net sales increased $248 million, or 12 percent, from the prior year, primarily due to higher sales in our Performance Technologies and Climate Solutions segments. Cost of sales increased $168 million, or 10 percent, primarily due
to higher sales volume and higher raw material costs, including underlying metal prices and related premiums, fabrication, freight, and packaging costs. Gross profit increased $80 million and gross margin improved 180 basis points to 16.9
percent. SG&A expenses increased $19 million, primarily due to higher compensation-related expenses. Operating income of $150 million during fiscal 2023 increased $31 million from the prior year, primarily due to higher gross profit,
partially offset by the absence of a $56 million net impairment reversal recorded in the prior year that primarily related to the liquid-cooled automotive business. Upon the termination of a sale agreement with the prospective buyer during the
third quarter of fiscal 2022, the liquid-cooled automotive business reverted back to held and used classification. See Note 2 of the Notes to Consolidated Financial Statements for further information regarding the liquid-cooled automotive
business, which was classified as held for sale during the first seven months of fiscal 2022.
Fiscal 2022 Highlights
Fiscal 2022 net sales increased $242 million, or 13 percent, from the prior year, primarily due to higher sales in our Climate Solutions and Performance Technologies segments. Cost of sales increased $226 million, or 15 percent, from the prior
year primarily due to higher raw material prices and higher sales volume. Gross profit increased $16 million and gross margin declined 110 basis points to 15.1 percent. SG&A expenses increased $4 million, primarily due to higher
compensation-related expenses, as the prior-year benefitted from cost-saving actions implemented in response to the COVID-19 pandemic. Operating income of $119 million during fiscal 2022 represents a $217 million improvement from the prior-year
operating loss of $98 million. The operating income and operating loss during fiscal 2022 and 2021 include a $56 million net impairment reversal and $167 million of impairment charges, respectively, primarily related to the automotive businesses
that were held for sale.
The following table presents our consolidated financial results on a comparative basis for fiscal years 2023, 2022 and 2021.
|
Years ended March 31,
|
||||||||||||||||||||||||
|
2023
|
2022
|
2021
|
||||||||||||||||||||||
|
(in millions)
|
$’s
|
% of sales
|
$’s
|
% of sales
|
$’s
|
% of sales
|
||||||||||||||||||
|
Net sales
|
$
|
2,298
|
100.0
|
%
|
$
|
2,050
|
100.0
|
%
|
$
|
1,808
|
100.0
|
%
|
||||||||||||
|
Cost of sales
|
1,909
|
83.1
|
%
|
1,741
|
84.9
|
%
|
1,515
|
83.8
|
%
|
|||||||||||||||
|
Gross profit
|
389
|
16.9
|
%
|
309
|
15.1
|
%
|
293
|
16.2
|
%
|
|||||||||||||||
|
Selling, general and administrative expenses
|
234
|
10.2
|
%
|
215
|
10.5
|
%
|
211
|
11.7
|
%
|
|||||||||||||||
|
Restructuring expenses
|
5
|
0.2
|
%
|
24
|
1.2
|
%
|
13
|
0.7
|
%
|
|||||||||||||||
|
Impairment charges (reversals) - net
|
-
|
-
|
(56
|
)
|
-2.7
|
%
|
167
|
9.2
|
%
|
|||||||||||||||
|
Loss on sale of assets
|
-
|
-
|
7
|
0.3
|
%
|
-
|
-
|
|||||||||||||||||
|
Operating income (loss)
|
150
|
6.5
|
%
|
119
|
5.8
|
%
|
(98
|
)
|
-5.4
|
%
|
||||||||||||||
|
Interest expense
|
(21
|
)
|
-0.9
|
%
|
(16
|
)
|
-0.8
|
%
|
(19
|
)
|
-1.1
|
%
|
||||||||||||
|
Other expense – net
|
(4
|
)
|
-0.2
|
%
|
(2
|
)
|
-0.1
|
%
|
(2
|
)
|
-0.1
|
%
|
||||||||||||
|
Earnings (loss) before income taxes
|
125
|
5.5
|
%
|
101
|
5.0
|
%
|
(119
|
)
|
-6.6
|
%
|
||||||||||||||
|
Benefit (provision) for income taxes
|
28
|
1.2
|
%
|
(15
|
)
|
-0.7
|
%
|
(90
|
)
|
-5.0
|
%
|
|||||||||||||
|
Net earnings (loss)
|
$
|
154
|
6.7
|
%
|
$
|
86
|
4.2
|
%
|
$
|
(209
|
)
|
-11.6
|
%
|
|||||||||||
Year Ended March 31, 2023 Compared with Year Ended March 31, 2022
Fiscal 2023 net sales of $2,298 million were $248 million, or 12 percent, higher than the prior year, primarily due to higher sales volume in both of our segments and favorable commercial pricing, including adjustments in response to raw
material price increases. These increases were partially offset by a $111 million unfavorable impact of foreign currency exchange rates. Sales in the Performance Technologies and Climate Solutions segments increased $144 million and $101 million,
respectively.
Fiscal 2023 cost of sales of $1,909 million increased $168 million, or 10 percent, primarily due to higher sales volume and higher raw material prices, which increased $34 million. These increases were partially offset by a $95 million
favorable impact of foreign currency exchange rates. As a percentage of sales, cost of sales decreased 180 basis points to 83.1 percent, primarily due to the favorable impact of higher sales volume and favorable commercial pricing, partially
offset by higher material, labor and other inflationary costs.
As a result of higher sales and lower cost of sales as a percentage of sales, fiscal 2023 gross profit increased $80 million and gross margin improved 180 basis points to 16.9 percent.
Fiscal 2023 SG&A expenses increased $19 million, yet decreased 30 basis points as a percentage of sales. The higher SG&A expenses were primarily driven by higher compensation-related expenses, which increased $20 million and included
higher incentive compensation and commission-related expenses, and, to a lesser extent, increases in other general and administrative expenses that have been impacted by inflationary market conditions. These increases were partially offset by an
$8 million favorable impact of foreign currency exchange rates. In addition, strategic reorganization costs, costs associated with our review of strategic alternatives for our automotive businesses, and environmental charges related to a
previously-closed manufacturing facility in the U.S., which are each recorded at Corporate, decreased $3 million, $2 million, and $2 million, respectively, during fiscal 2023 compared with the prior year.
Restructuring expenses of $5 million in fiscal 2023 decreased $19 million compared with the prior year, primarily due to lower severance-related expenses in the Performance Technologies segment.
The net impairment reversal of $56 million during fiscal 2022 primarily related to the liquid-cooled automotive business. In connection with the termination of the agreement to sell this business in the third quarter of fiscal 2022, we
reversed a significant amount of previously-recorded impairment charges within the Performance Technologies segment.
We sold our Austrian air-cooled automotive business on April 30, 2021. As a result of the sale, we recorded a $7 million loss on sale at Corporate during fiscal 2022.
Operating income of $150 million during fiscal 2023 increased $31 million from the prior year, primarily due to an $80 million increase in gross profit, a $19 million decrease in restructuring expenses, and the absence of the $7 million loss on
the sale of the Austrian air-cooled automotive business in the prior year. These drivers, which favorably impacted operating income in fiscal 2023, were partially offset by the absence of the $56 million net impairment reversal recorded in the
prior year and higher SG&A expenses.
Interest expense in fiscal 2023 increased $5 million compared with the prior year, primarily due to unfavorable changes in interest rates. In addition, we amended and extended our U.S. credit agreement that provides for a multi-currency
revolving credit facility and U.S. dollar- and euro- denominated term loans maturing in October 2027, along with shorter-duration swingline loans. In connection with this credit agreement modification, we recorded $1 million of costs as interest
expense during fiscal 2023.
The benefit for income taxes was $28 million in fiscal 2023, compared with a provision for income taxes of $15 million in fiscal 2022. The $43 million change was primarily due to a $57 million income tax benefit recorded in the current year
related to the reversal of the valuation allowance on certain deferred tax assets in the U.S., partially offset by the absence of a net $11 million income tax benefit related to valuation allowances on deferred tax assets in foreign jurisdictions
in the prior year.
Year Ended March 31, 2022 Compared with Year Ended March 31, 2021
Fiscal 2022 net sales of $2,050 million were $242 million, or 13 percent, higher than the prior year, primarily due to higher sales volume in each of our segments, and favorable commercial pricing, including adjustments in response to raw
material price increases. Sales in the Climate Solutions and Performance Technologies segments increased $180 million and $63 million, respectively.
Fiscal 2022 cost of sales of $1,741 million increased $226 million, or 15 percent, primarily due to higher raw material prices, which increased $148 million, and higher sales volume. In addition, cost of sales in fiscal 2021 was favorably
impacted by cost-saving actions taken in response to the COVID-19 pandemic. These factors, which caused an increase in cost of sales compared with the prior year, were partially offset by lower depreciation expense in the Performance Technologies
segment and improved operating efficiencies. As a percentage of sales, cost of sales increased 110 basis points to 84.9 percent.
As a result of higher sales and higher cost of sales as a percentage of sales, fiscal 2022 gross profit increased $16 million and gross margin declined 110 basis points to 15.1 percent.
Fiscal 2022 SG&A expenses increased $4 million. The increase in SG&A expenses was primarily due to higher compensation-related expenses, as the prior year was favorably impacted by cost-saving actions implemented to mitigate the
negative impacts of COVID-19. In addition, environmental charges related to a previously-owned manufacturing facility in the U.S. increased $3 million. These increases were partially offset by lower costs related to our review of strategic
alternatives for the automotive businesses and lower strategic reorganization costs, which decreased $4 million and $3 million, respectively. The lower strategic reorganization costs primarily resulted from lower severance expenses for executive
management positions.
Restructuring expenses of $24 million in fiscal 2022 increased $11 million compared with the prior year, primarily due to higher severance-related expenses in the Performance Technologies segment, partially offset by lower severance-related
expenses in the Climate Solutions segment.
In fiscal 2021, we recorded $167 million of impairment charges to write down the long-lived assets in the liquid-cooled and Austrian air-cooled automotive businesses when they were classified as held for sale. In fiscal 2022, we adjusted the
long-lived assets in the liquid-cooled automotive business to the lower of carrying or fair value once they no longer met the held for sale classification criteria and, as a result, recorded a net impairment reversal of $56 million.
We sold our Austrian air-cooled automotive business on April 30, 2021. As a result of the sale, we recorded a $7 million loss on sale at Corporate during fiscal 2022.
Operating income of $119 million during fiscal 2022 represents an improvement of $217 million from the prior-year operating loss of $98 million. The operating income and operating loss during fiscal 2022 and 2021 included the significant
impairment reversal and impairment charges within the Performance Technologies segment. In addition, as compared with the prior year, the fiscal 2022 operating income was favorably impacted by higher gross profit. Operating income was negatively
impacted by higher restructuring expenses, the loss on sale of the Austrian air-cooled automotive business, and higher SG&A expenses.
The provision for income taxes was $15 million and $90 million in fiscal 2022 and 2021, respectively. The $75 million decrease was primarily due to the absence of $117 million of income tax charges recorded in fiscal 2021 to increase the
valuation allowances on deferred tax assets in the U.S. and in certain foreign jurisdictions and a net $11 million income tax benefit recorded in fiscal 2022 related to valuation allowances on deferred tax assets in foreign jurisdictions. These
drivers, which decreased the provision for income taxes, were partially offset by the absence of income tax benefits totaling $47 million recorded in the prior year, including $38 million related to the impairment charges recorded for the held for
sale automotive businesses and $9 million resulting from the allocation of the income tax provision between net earnings and other comprehensive income.
Segment Results of Operations
Effective April 1, 2022, we began managing the Company under two operating segments, Climate Solutions and Performance Technologies. Our new segment structure aligns businesses serving similar or complimentary end markets, products and
technologies under common segment management. This simplified segment structure allows us to better focus resources on targeted growth opportunities and better enables an efficient application of 80/20 principles across all product lines to
optimize profit margins and cash flow.
The Climate Solutions segment includes the previously-reported BHVAC and CIS segments, with the exception of CIS Coatings. The Performance Technologies segment includes the previously-reported Heavy Duty Equipment and Automotive segments and
the CIS Coatings business.
The segment realignment had no impact on our consolidated financial position, results of operations, and cash flows. We have recast the segment financial information for fiscal 2022 and 2021 to conform to the fiscal 2023 presentation.
Climate Solutions
|
Years ended March 31,
|
||||||||||||||||||||||||
|
2023
|
2022
|
2021
|
||||||||||||||||||||||
|
(in millions)
|
$’s
|
% of sales
|
$’s
|
% of sales
|
$’s
|
% of sales
|
||||||||||||||||||
|
Net sales
|
$
|
1,012
|
100.0
|
%
|
$
|
911
|
100.0
|
%
|
$
|
731
|
100.0
|
%
|
||||||||||||
|
Cost of sales
|
788
|
77.9
|
%
|
744
|
81.7
|
%
|
595
|
81.3
|
%
|
|||||||||||||||
|
Gross profit
|
224
|
22.1
|
%
|
166
|
18.3
|
%
|
137
|
18.7
|
%
|
|||||||||||||||
|
Selling, general and administrative expenses
|
97
|
9.6
|
%
|
90
|
9.9
|
%
|
82
|
11.2
|
%
|
|||||||||||||||
|
Restructuring expenses
|
2
|
0.2
|
%
|
2
|
0.2
|
%
|
5
|
0.7
|
%
|
|||||||||||||||
|
Operating income
|
$
|
124
|
12.3
|
%
|
$
|
73
|
8.1
|
%
|
$
|
50
|
6.8
|
%
|
||||||||||||
Year Ended March 31, 2023 Compared with Year Ended March 31, 2022
Climate Solutions net sales increased $101 million, or 11 percent, in fiscal 2023 compared with the prior year, primarily due to higher sales volume and favorable commercial pricing. These increases were partially offset by a $52 million
unfavorable impact of foreign currency exchange rates. Compared with the prior year, sales of data center cooling, heat transfer, and HVAC & refrigeration products increased $58 million, $33 million, and $11 million, respectively.
Climate Solutions cost of sales increased $44 million, or 6 percent, in fiscal 2023, primarily due to higher sales volume, partially offset by a $44 million favorable impact of foreign currency exchange rates. As a percentage of sales, cost of
sales decreased 380 basis points to 77.9 percent, primarily due to the favorable impact of higher sales volume, favorable commercial pricing, and improved operating efficiencies, partially offset by higher labor and inflationary costs.
As a result of higher sales and lower cost of sales as a percentage of sales, gross profit increased $58 million and gross margin improved 380 basis points to 22.1 percent.
Climate Solutions SG&A expenses increased $7 million compared with the prior year, yet decreased 30 basis points as a percentage of sales. The increase in SG&A expenses was primarily due to a $5 million increase in compensation-related
expenses, including commission expenses, and increases in other general and administrative expenses that have been impacted by inflationary market conditions. These increases were partially offset by a $4 million favorable impact of foreign
currency exchange rate changes.
Restructuring expenses totaling $2 million during fiscal 2023 were consistent with the prior year and primarily consisted of severance-related expenses.
Operating income in fiscal 2023 increased $51 million to $124 million, primarily due to higher gross profit, partially offset by higher SG&A expenses.
Year Ended March 31, 2022 Compared with Year Ended March 31, 2021
Climate Solutions net sales increased $180 million, or 25 percent, in fiscal 2022 compared with the prior year, primarily due to higher sales volume and, to a lesser extent, favorable commercial pricing, including adjustments in response to raw
material price increases. Sales of heat transfer, HVAC & refrigeration, and data center cooling products increased $101 million, $46 million, and $32 million, respectively.
Climate Solutions cost of sales increased $149 million, or 25 percent, in fiscal 2022, primarily due to higher sales volume and higher raw material prices, which increased $67 million. As a percentage of sales, cost of sales increased 40 basis
points to 81.7 percent, primarily due to higher material costs, partially offset by favorable impacts of higher sales volume and improved operating efficiencies.
As a result of higher sales and higher cost of sales as a percentage of sales, gross profit increased $29 million and gross margin declined 40 basis points to 18.3 percent.
Climate Solutions SG&A expenses increased $8 million compared with the prior year, yet decreased 130 basis points as a percentage of sales. The increase in SG&A expenses was primarily due to higher compensation-related expenses, which
increased $6 million and included higher commission expenses.
Restructuring expenses during fiscal 2022 decreased $3 million, primarily due to lower severance expenses. The fiscal 2022 severance expenses primarily related to targeted headcount reductions in Europe and China. The fiscal 2021 severance
expenses primarily related to plant consolidation activities in China and targeted headcount reductions in North America.
Operating income in fiscal 2022 of $73 million increased $23 million, primarily due to higher gross profit, partially offset by higher SG&A expenses.
Performance Technologies
|
Years ended March 31,
|
||||||||||||||||||||||||
|
2023
|
2022
|
2021
|
||||||||||||||||||||||
|
(in millions)
|
$’s
|
% of sales
|
$’s
|
% of sales
|
$’s
|
% of sales
|
||||||||||||||||||
|
Net sales
|
$
|
1,316
|
100.0
|
%
|
$
|
1,172
|
100.0
|
%
|
$
|
1,109
|
100.0
|
%
|
||||||||||||
|
Cost of sales
|
1,150
|
87.4
|
%
|
1,030
|
87.9
|
%
|
952
|
85.8
|
%
|
|||||||||||||||
|
Gross profit
|
166
|
12.6
|
%
|
142
|
12.1
|
%
|
157
|
14.2
|
%
|
|||||||||||||||
|
Selling, general and administrative expenses
|
98
|
7.4
|
%
|
99
|
8.4
|
%
|
93
|
8.4
|
%
|
|||||||||||||||
|
Restructuring expenses
|
3
|
0.2
|
%
|
22
|
1.9
|
%
|
7
|
0.6
|
%
|
|||||||||||||||
|
Impairment charges (reversals) - net
|
-
|
-
|
(56
|
)
|
-4.8
|
%
|
167
|
15.0
|
%
|
|||||||||||||||
|
Operating income (loss)
|
$
|
66
|
5.0
|
%
|
$
|
77
|
6.6
|
%
|
$
|
(109
|
)
|
-9.8
|
%
|
|||||||||||
Year Ended March 31, 2023 Compared with Year Ended March 31, 2022
Performance Technologies net sales increased $144 million, or 12 percent, in fiscal 2023 compared with the prior year, primarily due to higher sales volume and favorable commercial pricing, including adjustments in response to raw material price
increases. These increases were partially offset by a $59 million unfavorable impact of foreign currency exchange rates and, to a lesser extent, the absence of sales from the Austrian air-cooled automotive business, which we sold on April 30,
2021. Sales of air-cooled, liquid-cooled, and advanced solutions products increased $86 million, $36 million, and $25 million, respectively.
Performance Technologies cost of sales increased $120 million, or 12 percent, primarily due to higher sales volume and higher raw material prices, which increased $29 million. In addition, to a lesser extent, higher labor costs and higher
depreciation expenses negatively impacted cost of sales. During fiscal 2022, we did not depreciate the held for sale property, plant and equipment assets within the liquid-cooled automotive business until they reverted back to held and used
classification during the third quarter of fiscal 2022. These increases were partially offset by a $52 million favorable impact of foreign currency exchange rates. As a percentage of sales, cost of sales decreased 50 basis points to 87.4 percent,
primarily due to the favorable impact of higher sales volume and commercial pricing, partially offset by higher material, labor and inflationary costs.
As a result of higher sales and lower cost of sales as a percentage of sales, gross profit increased $24 million and gross margin improved 50 basis points to 12.6 percent.
Performance Technologies SG&A expenses decreased $1 million compared with the prior year. As a percentage of sales, SG&A expenses decreased by 100 basis points. The decrease in SG&A expenses was primarily due to a $4 million
favorable impact of foreign currency exchange rate changes and, to a lesser extent, lower compensation-related expenses, partially offset by higher general and administrative expenses that have been impacted by inflationary market conditions.
Restructuring expenses during fiscal 2023 totaled $3 million, a decrease of $19 million compared with the prior year. This decrease was primarily driven by lower severance expenses in Europe for targeted headcount reductions.
The net impairment reversal of $56 million in fiscal 2022 primarily related to assets in our liquid-cooled automotive business. See Note 2 of the Notes to Consolidated Financial Statements for further information.
Operating income in fiscal 2023 decreased $11 million to $66 million, primarily due to the absence of the significant net impairment reversal recorded in the prior year, partially offset by higher gross profit and lower restructuring expenses.
Year Ended March 31, 2022 Compared with Year Ended March 31, 2021
Performance Technologies net sales increased $63 million, or 6 percent, in fiscal 2022 compared with the prior year, primarily due to favorable commercial pricing, including adjustments in response to raw material price increases, and to a
lesser extent, higher sales volume. In regard to the higher sales volume, sales in the prior year were negatively impacted by the COVID-19 pandemic in fiscal 2021. Sales increased in fiscal 2022 to off-highway and commercial vehicle customers, as
those underlying markets recovered. Sales to automotive customers, however, decreased in fiscal 2022, primarily due to $58 million of lower sales from our Austrian air-cooled automotive business, which we sold in the first quarter of fiscal 2022,
and the negative impacts of the semiconductor chip shortage on the global automotive market. Compared with the prior year, sales of air-cooled and advanced solutions products increased $52 million and $21 million, respectively. Sales of
liquid-cooled products decreased $11 million.
Performance Technologies cost of sales increased $78 million, or 8 percent, primarily due to higher raw material prices, which increased $81 million, and to a lesser extent, higher sales volume. These drivers, which increased cost of sales, were
partially offset by lower depreciation expenses in the segment’s automotive businesses, which decreased $9 million. We ceased depreciating the property, plant and equipment assets within the liquid-cooled and Austrian air-cooled automotive
businesses when they were classified as held for sale during the second half of fiscal 2021. Upon reverting back to held and used classification during the third quarter of fiscal 2022, we resumed depreciating the property, plant and equipment
assets in the liquid-cooled automotive business. As a percentage of sales, cost of sales increased 210 basis points to 87.9 percent, primarily due to the higher material prices.
As a result of higher sales and higher cost of sales as a percentage of sales, gross profit decreased $15 million and gross margin declined 210 basis points to 12.1 percent.
Performance Technologies SG&A expenses increased $6 million compared with the prior year. The increase in SG&A expenses was primarily due to higher compensation-related expenses, which increased approximately $7 million, partially
offset by lower development and other administrative costs.
Restructuring expenses during fiscal 2022 totaled $22 million, an increase of $15 million compared with the prior year. The increase was primarily driven by higher severance expenses in Europe related to targeted headcount reductions.
The fiscal 2022 net impairment reversal of $56 million primarily related to assets in our liquid-cooled automotive business. We remeasured the previously impaired long-lived assets within the liquid-cooled automotive business to the lower of
their carrying or fair value once they were no longer held for sale. The fiscal 2021 impairment charges totaling $167 million related to assets in the liquid-cooled and Austrian air-cooled automotive businesses, which were first classified as held
for sale in fiscal 2021. See Note 2 of the Notes to Consolidated Financial Statements for further information.
Operating income of $77 million during fiscal 2022 represents a $186 million improvement from the prior-year operating loss of $109 million. The operating income and operating loss during fiscal 2022 and 2021 were largely driven by the
significant net impairment reversal and impairment charges, respectively. In addition, as compared with the prior year, operating income was unfavorably impacted by lower gross profit and higher restructuring expenses.
Liquidity and Capital Resources
Our primary sources of liquidity are cash flow from operating activities, our cash and cash equivalents as of March 31, 2023 of $67 million, and an available borrowing capacity of $270 million under our revolving credit facility. Given our
extensive international operations, approximately $63 million of our cash and cash equivalents are held by our non-U.S. subsidiaries. Amounts held by non-U.S. subsidiaries are available for general corporate use; however, these funds may be
subject to foreign withholding taxes if repatriated. We believe our sources of liquidity will provide sufficient cash flow to adequately cover our funding needs on both a short-term and long-term basis.
Our primary contractual obligations include pension obligations, debt and related interest payments, lease obligations, and obligations for capital expenditures. Our pension liabilities totaled $42 million as of March 31, 2023. As a result of
funding relief provisions within the American Rescue Plan Act of 2021, we do not expect to make cash contributions to our U.S. pension plans during fiscal 2024.
Net Cash Provided by Operating Activities
Net cash provided by operating activities in fiscal 2023 was $108 million, an increase of $96 million from $12 million in the prior year. This increase in operating cash flow was primarily due to the favorable impact of higher earnings and
favorable net changes in working capital, as compared with the prior year. While inventories have increased $44 million from the prior year, the increase has been less significant than the increase in the prior year. In fiscal 2023, the Company
increased its inventory levels, particularly in the Climate Solutions segment, to meet planned production increases. In fiscal 2022, the higher inventory levels largely resulted from increased raw material prices and impacts from global supply
constraints and challenges, which continued to impact our businesses in fiscal 2023. In addition, the favorable changes in working capital include lower payments for incentive compensation and lower pension plan contributions in fiscal 2023, as
compared with the prior year.
Net cash provided by operating activities in fiscal 2022 was $12 million, a decrease of $138 million from $150 million in the prior year. This decrease in operating cash flow was primarily due to unfavorable net changes in working capital,
including higher inventory and accounts receivable levels and higher payments for incentive compensation and employee benefits as compared with the prior year. Inventory increased $61 million from March 31, 2021 to March 31, 2022.
Capital Expenditures
Capital expenditures of $51 million during fiscal 2023 increased $11 million compared with fiscal 2022. Our capital spending in fiscal 2023 in the Performance Technologies and Climate Solutions segments totaled $25 million and $24 million,
respectively. Capital expenditures in the Performance Technologies segment include tooling and equipment purchases in conjunction with new and renewal programs with customers. Capital spending in the Climate Solutions segment include investments
supporting our strategic growth initiatives, including expanding our data center business.
Debt
In October 2022, we executed an amended and restated credit agreement with a syndicate of banks that provides for a multi-currency $275 million revolving credit facility and term loan facilities maturing in October 2027. This credit agreement
modified our then existing $250 million revolver and term loan facilities, which would have matured in June 2024.
Our total debt outstanding decreased $25 million to $353 million at March 31, 2023 compared with the prior year, primarily due to repayments during fiscal 2023.
Our credit agreements require us to maintain compliance with various covenants, including a leverage ratio covenant and an interest expense coverage ratio covenant, which are discussed further below. Indebtedness under our credit agreements is
secured by liens on substantially all domestic assets. These agreements further require compliance with various covenants that may limit our ability to incur additional indebtedness; grant liens; make investments, loans, or guarantees; engage in
certain transactions with affiliates; or make restricted payments including dividends. Also, the credit agreements may require prepayments in the event of certain asset sales.
The leverage ratio covenant within our primary credit agreements requires us to limit our consolidated indebtedness, less a portion of our cash balance, both as defined by the credit agreements, to no more than three and one-quarter times
consolidated net earnings before interest, taxes, depreciation, amortization, and certain other adjustments (“Adjusted EBITDA”). We are also subject to an interest expense coverage ratio covenant, which requires us to maintain Adjusted EBITDA of
at least three times consolidated interest expense. As of March 31, 2023, we were in compliance with our debt covenants. We expect to remain in compliance with our debt covenants during fiscal 2024 and beyond.
See Note 17 of the Notes to Consolidated Financial Statements for additional information regarding our credit agreements.
Share Repurchase Program
During fiscal 2023, we repurchased $7 million of our common stock. As of March 31, 2023, we had $45 million of authorized share repurchases remaining under our current repurchase program, which expires in November 2024. Our decision whether
and to what extent to repurchase additional shares depends on a number of factors, including business conditions, other cash priorities, and stock price.
Critical Accounting Policies
The following critical accounting policies reflect the more significant judgments and estimates used in preparing our consolidated financial statements. Application of these policies results in accounting estimates that have the greatest
potential for a significant impact on our financial statements. The following discussion of these judgments and estimates is intended to supplement the significant accounting policies presented in Note 1 of the Notes to Consolidated Financial
Statements. In addition, recently issued accounting pronouncements that either have or could materially impact our financial statements are disclosed in Note 1 of the Notes to Consolidated Financial Statements.
Revenue Recognition
We recognize revenue based upon consideration specified in a contract and as we satisfy performance obligations by transferring control over our products to our customers, which may be at a point in time or over time. The majority of our
revenue is recognized at a point in time, based upon shipment terms. A limited number of our customer contracts provide an enforceable right to payment for performance completed to date. For these contracts, we recognize revenue over time based
upon our estimated progress toward the satisfaction of the contract’s performance obligations. We record an allowance for credit losses and we accrue for estimated warranty costs at the time of sale. We base these estimates upon historical
experience, current business trends and economic conditions, and risks specific to the underlying accounts receivable or warranty claims.
Impairment of Long-Lived Assets
We perform impairment evaluations of long-lived assets, including property, plant and equipment and intangible assets, whenever business conditions or events indicate that those assets may be impaired. We consider factors such as operating
losses, declining financial outlooks and market conditions when evaluating the necessity for an impairment analysis. In the event the net asset values exceed undiscounted cash flows expected to be generated by the assets, we write down the assets
to fair value and record an impairment charge. We estimate fair value in various ways depending on the nature of the underlying assets. Fair value is generally based upon appraised value, estimated salvage value, or selling prices under
negotiation, as applicable.
The most significant long-lived assets we evaluated for impairment indicators were property, plant and equipment and intangible assets, which totaled $315 million and $81 million, respectively, at March 31, 2023. Within property, plant and
equipment, the most significant assets evaluated are buildings and improvements and machinery and equipment. Our most significant intangible assets evaluated are customer relationships, trade names, and acquired technology, the majority of which
are related to our Climate Solutions segment. We evaluate impairment at the lowest level of separately identifiable cash flows, which is generally at the manufacturing plant level. We monitor manufacturing plant financial performance to determine
whether indicators exist that would require an impairment evaluation for the facility. This includes significant adverse changes in plant profitability metrics; substantial changes in the mix of customer products manufactured in the plant; changes
in manufacturing strategy; and the shifting of programs to other facilities under a manufacturing realignment strategy. When such indicators are present, we perform an impairment evaluation.
During fiscal 2022, we recorded a net impairment reversal of $56 million, primarily related to assets that were held for sale in the Performance Technologies segment. In fiscal 2021, we recorded $167 million of impairment charges to write down
the long-lived assets in the liquid- and air-cooled automotive businesses when they were classified as held for sale. In fiscal 2022, we adjusted the long-lived assets in the liquid-cooled automotive business to the lower of carrying or fair value
when they no longer met the held for sale classification criteria. See Note 2 of the Notes to the Consolidated Financial Statements for additional information.
Impairment of Goodwill
We perform goodwill impairment tests annually, as of March 31, unless business events or other conditions exist that require a more frequent evaluation. We consider factors such as operating losses, declining financial and market outlooks, and
market capitalization when evaluating the necessity for an interim impairment analysis. We test goodwill for impairment at a reporting unit level. Goodwill resulting from recent acquisitions generally represents the highest risk of impairment,
which typically decreases as the businesses are integrated into the Company and positioned for future operating and financial performance. We test goodwill for impairment by comparing the fair value of each reporting unit with its carrying value.
We determine the fair value of a reporting unit based upon the present value of estimated future cash flows. If the fair value of a reporting unit exceeds the carrying value of the reporting unit’s net assets, goodwill is not impaired. However,
if the carrying value of the reporting unit’s net assets exceeds its fair value, we would conclude goodwill is impaired and would record an impairment charge equal to the amount that the reporting unit’s carrying value exceeds its fair value.
Determining the fair value of a reporting unit involves judgment and the use of estimates and assumptions, which include assumptions regarding the revenue growth rates and operating profit margins used to calculate estimated future cash flows
and risk-adjusted discount rates. We determine the expected future revenue growth rates and operating profit margins after consideration of our historical revenue growth rates and earnings levels, our assessment of future market potential and our
expectations of future business performance. The discount rates used in determining discounted cash flows are rates corresponding to our cost of capital, adjusted for country- and business-specific risks where appropriate. While we believe the
assumptions used in our goodwill impairment tests are appropriate and result in a reasonable estimate of the fair value of each reporting unit, future events or circumstances could have a potential negative effect on the estimated fair value of our
reporting units. These events or circumstances include lower than forecasted revenues, market trends that fall below our current expectations, actions of key customers, increases in discount rates, and continued inflationary market conditions,
including the impacts associated with the military conflict in Ukraine and the COVID-19 pandemic. We cannot predict the occurrence of certain events or changes in circumstances that might adversely affect the carrying value of goodwill.
At March 31, 2023, our goodwill totaled $166 million related to our Climate Solutions and Performance Technologies segments. We conducted goodwill impairment tests as of March 31, 2023 by applying a fair value-based test and determined the fair
value of the reporting units in each of our operating segments exceeded their respective book value. A 10 percent decrease in the estimated fair value of each reporting unit would not have resulted in a different conclusion.
Acquisitions
From time to time, we make strategic acquisitions that have a material impact on our consolidated results of operations or financial position. We allocate the purchase price of acquired businesses to the identifiable tangible and intangible
assets acquired and liabilities assumed in the transaction based upon their estimated fair values as of the acquisition date. We determine the estimated fair values using information available to us and engage third-party valuation specialists
when necessary. The estimates we use to determine the fair value of long-lived assets, such as intangible assets, can be complex and require significant judgments. While we use our best estimates and assumptions, our estimates are inherently
uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to
goodwill. Upon conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statement of operations. We
also estimate the useful lives of intangible assets to determine the amount of amortization expense to record in future periods. We periodically review the estimated useful lives assigned to our intangible assets to determine whether such
estimated useful lives continue to be appropriate.
Pension Obligations
Our calculation of the expense and liabilities of our pension plans is dependent upon various assumptions. At March 31, 2023, our pension liabilities totaled $42 million. The most significant assumptions include the discount rate, long-term
expected return on plan assets, and mortality rates. We base our selection of assumptions on historical trends and economic and market conditions at the time of valuation. In accordance with U.S. GAAP, actual results that differ from these
assumptions are accumulated and amortized over future periods. These differences impact future benefit cost. Our domestic pension plans are closed to new participants; therefore, participants in these plans are not accruing benefits based upon
their current service as the plans do not include increases in annual earnings or for future service in calculating the average annual earnings and years of credited service under the pension plan formula.
For the following discussion regarding sensitivity of assumptions, all amounts presented are in reference to our domestic pension plans, since our domestic plans comprise all of our pension plan assets and the majority of our pension plan
expense.
To determine the expected rate of return on pension plan assets, we consider such factors as (a) the actual return earned on plan assets, (b) historical rates of return on the various asset classes in the plan portfolio, (c) projections of
returns on those asset classes, (d) the amount of active management of the assets, (e) capital market conditions and economic forecasts, and (f) administrative expenses paid with the plan assets. The long-term rate of return utilized in fiscal
2023 and 2022 was 7.0 percent and 7.5 percent, respectively. For fiscal 2024, we have assumed a rate of 6.5 percent. A change of 25 basis points in the expected rate of return on assets would impact our fiscal 2024 pension expense by less than $1
million.
The discount rate reflects rates available on long-term, high-quality fixed-income corporate bonds on the measurement date of March 31. For fiscal 2023 and 2022, for purposes of determining pension expense, we used a discount rate of 3.9 and
3.2 percent, respectively. We determined these rates based upon a yield curve that was created following an analysis of the projected cash flows for our plans. See Note 18 of the Notes to Consolidated Financial Statements for additional
information. A change in the assumed discount rate of 25 basis points would impact our fiscal 2024 pension expense and projected benefit obligation by less than $1 million and approximately $4 million, respectively.
Income Taxes
We operate in numerous taxing jurisdictions; therefore, we are subject to regular examinations by federal, state and non-U.S. taxing authorities. Due to the application of complex and sometimes ambiguous tax laws and rulings in the
jurisdictions in which we do business, there is an inherent level of uncertainty within our worldwide tax provisions. Despite our belief that our tax return positions are consistent with applicable tax laws, it is possible that taxing authorities
could challenge certain positions.
Our deferred tax assets and liabilities reflect temporary differences between the amount of assets and liabilities for financial and tax reporting purposes. We adjust these amounts to reflect changes in tax rates expected to be in effect when
the temporary differences reverse. We record a valuation allowance if we determine it is more likely than not that the net deferred tax assets in a particular jurisdiction will not be realized. This determination, which is made on a legal
entity-by-legal entity basis, involves judgment and the use of significant estimates and assumptions, including expectations of future taxable income and tax planning strategies. We believe the assumptions that we used are appropriate and result
in a reasonable determination regarding the future realizability of deferred tax assets. However, future events or circumstances, such as lower-than-expected taxable income or unfavorable changes in the financial outlook of our operations in
certain jurisdictions, could cause us to record additional valuation allowances.
See Note 8 of the Notes to Consolidated Financial Statements for additional information regarding income taxes.
Loss Reserves
We maintain liabilities and reserves for a number of loss exposures, including environmental remediation costs, product warranties, self-insurance costs, estimated credit losses associated with trade receivables, regulatory compliance matters,
and litigation. Establishing loss reserves for these exposures requires the use of estimates and judgment to determine the risk exposure and ultimate potential liability. We estimate these reserve requirements by using consistent and suitable
methodologies for the particular type of loss reserve being calculated. See Notes 15 and 20 of the Notes to Consolidated Financial Statements for additional information regarding product warranties and contingencies and litigation, respectively.
Forward-Looking Statements
This report, including, but not limited to, the discussion under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains statements, including information about future financial performance,
accompanied by phrases such as “believes,” “estimates,” “expects,” “plans,” “anticipates,” “intends,” and other similar “forward-looking” statements, as defined in the Private Securities Litigation Reform Act of 1995. Modine’s actual results,
performance or achievements may differ materially from those expressed or implied in these statements, because of certain risks and uncertainties, including, but not limited to, those described under “Risk Factors” in Item 1A. in Part I. of this
report and identified in our other public filings with the U.S. Securities and Exchange Commission. Other risks and uncertainties include, but are not limited to, the following:
Market Risks:
| • |
The impact of potential adverse developments or disruptions in the global economy and financial markets, including impacts related to inflation, including rising energy costs, along with supply chain challenges, tariffs, sanctions and
other trade issues or cross-border trade restrictions (and any potential resulting trade war), and including impacts associated with the military conflict between Russia and Ukraine;
|
| • |
The impact of other economic, social and political conditions, changes, challenges and unrest, particularly in the geographic, product and financial markets where we and our customers operate and compete, including foreign currency
exchange rate fluctuations; increases in interest rates; recession and recovery therefrom; and the general uncertainties about the impact of regulatory and/or policy changes, including those related to tax and trade that have been or may be
implemented in the U.S. or abroad;
|
| • |
The impact of potential further price increases associated with raw materials, including aluminum, copper, steel and stainless steel (nickel), and other purchased component inventory including, but not limited to, increases in the
underlying material cost based upon the London Metal Exchange and related premiums or fabrication costs. These prices may be impacted by a variety of factors, including changes in trade laws and tariffs, the behavior of our suppliers and
significant fluctuations in demand. This risk includes our ability to successfully manage our exposure and our ability to adjust product pricing in response to price increases, including through our quotation process or through contract
provisions for prospective price adjustments, as well as the inherent lag in timing of such contract provisions;
|
| • |
Our ability to mitigate increased labor costs and labor shortages;
|
| • |
The impact of public health threats, such as COVID-19, on the national and global economy, our business, suppliers (and the supply chain), customers, and employees; and
|
| • |
The impact of current and future environmental laws and regulations on our business and the businesses of our customers, including our ability to take advantage of opportunities to supply alternative new technologies to meet
environmental and/or energy standards and objectives.
|
Operational Risks:
| • |
The impact of problems, including logistic and transportation challenges, associated with suppliers meeting our quantity, quality, price and timing demands, and the overall health of our suppliers, including their ability and willingness
to supply our volume demands if their production capacity becomes constrained;
|
| • |
The overall health of and price-reduction pressure from our vehicular customers in light of economic and market-specific factors, the potential lower overall win rate for sales programs with contractual price reductions as a result of
pricing strategies to ensure satisfactory profit margins for the duration of the programs, and the potential impact on us from any deterioration in the stability or performance of any of our major customers;
|
| • |
Our ability to maintain current customer relationships and compete effectively for new business, including our ability to achieve profit margins acceptable to us by offsetting or otherwise addressing any cost increases associated with
supply chain challenges and inflationary market conditions;
|
| • |
The impact of product or manufacturing difficulties or operating inefficiencies, including any program launch and product transfer challenges and warranty claims;
|
| • |
The impact of delays or modifications initiated by major customers with respect to program launches, product applications or requirements;
|
| • |
Our ability to consistently structure our operations in order to develop and maintain a competitive cost base with appropriately skilled and stable labor, while also positioning ourselves geographically, so that we can continue to
support our customers with the technical expertise and market-leading products they demand and expect from Modine;
|
| • |
Our ability to effectively and efficiently manage our cost structure in response to sales volume increases or decreases and to complete restructuring activities and realize the anticipated benefits of those activities;
|
| • |
Costs and other effects of the investigation and remediation of environmental contamination; including when related to the actions or inactions of others and/or facilities over which we have no control;
|
| • |
Our ability to recruit and maintain talent, including personnel in managerial, leadership, operational and administrative functions, in light of tight global labor markets;
|
| • |
Our ability to protect our proprietary information and intellectual property from theft or attack by internal or external sources;
|
| • |
The impact of a substantial disruption or material breach of our information technology systems, and any related delays, problems or costs;
|
| • |
Increasingly complex and restrictive laws and regulations, including those associated with being a U.S. public company and others present in various jurisdictions in which we operate, and the costs associated with compliance therewith;
|
| • |
Work stoppages or interference at our facilities or those of our major customers and/or suppliers;
|
| • |
The constant and increasing pressures associated with healthcare and associated insurance costs; and
|
| • |
Costs and other effects of litigation, claims, or other obligations.
|
Strategic Risks:
| • |
Our ability to successfully realize anticipated benefits from strategic initiatives and our continued application of 80/20 principles to our business, through which we are focused on reducing complexity and growing businesses with strong
market drivers;
|
| • |
Our ability to identify and execute on organic growth opportunities and acquisitions, and to efficiently and successfully integrate acquired businesses;
|
| • |
Our ability to successfully execute strategies to reduce costs and improve operating margins; and
|
| • |
The potential impacts from actions by activist shareholders, including disruption of our business and related costs.
|
Financial Risks:
| • |
Our ability to fund our global liquidity requirements efficiently for our current operations and meet our long-term commitments in the event of disruption in or tightening of the credit markets
or extended recessionary conditions in the global economy;
|
| • |
The impact of increases in interest rates in relation to our variable-rate debt obligations;
|
| • |
The impact of changes in federal, state or local taxes that could have the effect of increasing our income tax expense;
|
| • |
Our ability to comply with the financial covenants in our credit agreements, including our leverage ratio (net debt divided by Adjusted EBITDA, as defined in our credit agreements) and our interest coverage ratio (Adjusted EBITDA divided
by interest expense, as defined in our credit agreements);
|
| • |
The potential unfavorable impact of foreign currency exchange rate fluctuations on our financial results; and
|
| • |
Our ability to effectively realize the benefits of deferred tax assets in various jurisdictions in which we operate.
|
Forward-looking statements are as of the date of this report; we do not assume any obligation to update any forward-looking statements.
In the normal course of business, we are subject to market exposure from changes in foreign currency exchange rates, interest rates, commodity prices, credit risk and other market changes.
Foreign Currency Risk
We are subject to the risk of changes in foreign currency exchange rates due to our operations in foreign countries. We have manufacturing facilities in Brazil, China, India, Mexico, and throughout Europe. We also have joint ventures in China
and South Korea. We sell and distribute products throughout the world and also purchase raw materials from suppliers in foreign countries. As a result, our financial results are affected by changes in foreign currency exchange rates and economic
conditions in the foreign markets in which we do business. Whenever possible, we attempt to mitigate foreign currency risks on transactions with customers and suppliers in foreign countries by entering into contracts that are denominated in the
functional currency of the entity engaging in the transaction. In addition, for certain transactions that are denominated in a currency other than the engaging entity’s functional currency, we may enter into
foreign currency derivative contracts to further manage our foreign currency risk. In fiscal 2023, we recorded a net gain of less than $1 million within our statement of operations related to foreign currency derivative contracts. In
addition, our consolidated financial results are impacted by the translation of revenue and expenses in foreign currencies into U.S. dollars. These translation impacts are primarily affected by changes in exchange rates between the U.S. dollar and
European currencies, primarily the euro, and changes between the U.S. dollar and the Brazilian real. In fiscal 2023, approximately 50 percent of our sales were generated in countries outside the U.S. A change in foreign currency exchange rates
will positively or negatively affect our sales; however, this impact will be offset, usually to a large degree, with a corresponding effect on our cost of sales and other expenses. In fiscal 2023, changes in foreign currency exchange rates
unfavorably impacted our sales by $111 million; however, the impact on our operating income was only $7 million. Foreign currency exchange rate risk can be estimated by measuring the impact of a near-term adverse movement of 10 percent in foreign
currency exchange rates. If these rates were 10 percent higher or lower during fiscal 2023, there would not have been a material impact on our fiscal 2023 earnings.
We maintain foreign currency-denominated debt obligations and intercompany loans that are subject to foreign currency exchange risk. We seek to mitigate this risk through maintaining offsetting positions between external and intercompany loans;
however, from time to time, we also enter into foreign currency derivative contracts to manage the currency exchange rate exposure. These derivative instruments are typically not accounted for as hedges, and
accordingly, gains or losses on the derivatives are recorded in other income and expense in the consolidated statements of operations and typically offset the foreign currency changes on the outstanding loans.
Interest Rate Risk
We seek to reduce the potential volatility of earnings that could arise from changes in interest rates. We generally utilize a mixture of debt maturities and both fixed-rate and variable-rate debt to manage exposure to changes in interest
rates. Interest on both our term loans and borrowings under our primary multi-currency revolving credit facility, including swingline borrowings, is variable and is currently based primarily on either SOFR or EURIBOR, plus 137.5 to 175 basis
points, depending on our leverage ratio. As a result, we are subject to risk of fluctuations in SOFR and EURIBOR and changes in our leverage ratio, which would affect the variable interest rate on our term loans and revolving credit facility and
could create variability in interest expense.
As of March 31, 2023, our outstanding borrowings on variable-rate term loans totaled $216 million. There were no outstanding borrowings on our revolving credit facility as of March 31, 2023. Based upon our outstanding debt with variable
interest rates at March 31, 2023, a 100-basis point increase in interest rates would increase our annual interest expense in fiscal 2024 by approximately $2 million.
Commodity Price and Supply Risk
To produce the products we sell, we purchase raw materials and supplies including aluminum, copper, steel and stainless steel (nickel), refrigerants, and gases such as natural gas, helium, and nitrogen. In addition, we also purchase components
and parts that are integrated into our end products.
We seek to mitigate commodity price risk primarily by adjusting product pricing in response to applicable price increases. Our contracts with certain vehicular customers contain provisions that provide for prospective price adjustments based
upon changes in raw material prices. These prospective price adjustments generally lag behind the actual raw material price fluctuations by three months or longer, and typically the contract provisions are limited to the underlying material cost
based upon the London Metal Exchange and exclude additional cost elements, such as related premiums and fabrication. In instances where the risk is not covered contractually, we seek to adjust product pricing in
response to price increases, including through our quotation process and through price list increases.
In fiscal 2023, we continued to experience a significant increase in raw material prices and price increases on other goods and services in connection with global supply chain challenges and inflationary market
conditions. In response, we implemented selling price increases for our products. Nevertheless, we are still subject to the risk of further price increases on commodities, components, and other goods and services that we purchase.
Regarding supply risk in light of current supply chain challenges, we are engaged with our suppliers to ensure availability of purchased commodities and components and we have added key suppliers to our
supply base during the last year. However, we are still dependent upon limited sources of supply for certain components used in the manufacture of our products, including aluminum, copper, steel and stainless steel (nickel). Even with this
expanded supply base, we are exposed to the risk of suppliers of certain raw materials not being able or willing to meet strong customer demand, as they may not increase their output capacity as quickly as customers increase their orders, the
impact of trade laws and tariffs, and increased prices being charged by raw material suppliers.
We also purchase parts from suppliers that use our tooling to create the parts. In most instances, and for financial reasons, we do not have duplicate tooling for the manufacture of the purchased parts. As a result, we are exposed to the risk
of a supplier being unable to provide the quantity or quality of parts that we require. Even in situations where suppliers are manufacturing parts without the use of our tooling, we face the challenge of obtaining consistently high-quality parts
from suppliers that are financially stable. We utilize a supplier risk management program that leverages internal and third-party tools to identify and mitigate higher-risk supplier situations.
Credit Risk
Credit risk represents the possibility of loss from a customer failing to make payment according to contract terms. Our principal credit risk consists of outstanding trade accounts receivable. At March 31, 2023, 37 percent of our trade
accounts receivable was concentrated with our top ten customers. These customers operate primarily in the commercial vehicle, off-highway, automotive and light vehicle, data center cooling, and commercial air conditioning and refrigeration markets
and are influenced by similar market and general economic factors. In the past, credit losses from our customers have not been significant, nor have we experienced a significant increase in credit losses in connection with the current inflationary
market conditions.
We manage credit risk through a focus on the following:
| • |
Cash and investments – We review cash deposits and short-term investments to ensure banks have acceptable credit ratings, and short-term investments are maintained in secured or guaranteed
instruments. We consider our holdings in cash and investments to be stable and secure at March 31, 2023;
|
| • |
Trade accounts receivable – Prior to granting credit, we evaluate each customer, taking into consideration the customer’s financial condition, payment experience and credit information. After
credit is granted, we actively monitor the customer’s financial condition and applicable business news;
|
| • |
Pension assets – We have retained outside advisors to assist in the management of the assets in our pension plans. In making investment decisions, we utilize an established risk management
protocol that focuses on protection of the plan assets against downside risk. We ensure that investments within these plans provide appropriate diversification, the investments are monitored by investment teams, and portfolio managers
adhere to the established investment policies. We believe the plan assets are subject to appropriate investment policies and controls; and
|
| • |
Insurance – We monitor our insurance providers to ensure they maintain financial ratings that are acceptable to us. We have not identified any concerns in this regard based upon our reviews.
|
In addition, we are exposed to risks associated with price reduction pressure applied by OEM customers. If contractual price downs are unavoidable, we contemplate them in our overall strategy and adjust pricing as necessary to provide profit
margins that are acceptable to us.
Economic and Market Risk
Economic risk represents the possibility of loss resulting from economic instability in certain areas of the world, such as that caused by geopolitical uncertainly or pandemics, or downturns in markets in which we operate. We sell a broad range
of thermal solution systems to customers operating in diverse markets, including the commercial, industrial, and building HVAC&R and commercial vehicle, off-highway, and automotive and light vehicle markets.
Considering our global presence, we also encounter risks imposed by potential trade restrictions, including tariffs, embargoes, sanctions, and the like. We continue to pursue non-speculative opportunities to mitigate these economic risks, and
capitalize, when possible, on changing market conditions. We pursue new market opportunities after careful consideration of the potential associated risks and benefits. Successes in new markets are dependent upon our ability to commercialize our
investments. Current examples of new and emerging markets for us include those related to electric vehicles, data centers, indoor air quality, and aftermarket coatings. Our investments in these areas are subject to the risks associated with
technological success, customer and market acceptance, and our ability to meet the demands of our customers as these markets grow.
Hedging and Foreign Currency Forward Contracts
We use derivative financial instruments as a tool to manage certain financial risks. We prohibit the use of leveraged derivatives.
Commodity Derivatives
From time to time, we enter into over-the-counter forward contracts related to forecasted purchases of aluminum and copper. Our strategy is to reduce our exposure to changing market prices of these commodities. We periodically designate
certain commodity forward contracts as cash flow hedges for accounting purposes. For these designated hedges, we record unrealized gains and losses related to the change in the fair value of the contracts in other comprehensive income (loss)
within shareholders’ equity and subsequently recognize the gains and losses within cost of sales as the underlying inventory is sold. In fiscal 2023, 2022, and 2021, net gains and losses recognized in cost of sales related to commodity forward
contracts were approximately $1 million or less in each year.
Foreign Currency Forward Contracts
We use derivative financial instruments in a limited way to mitigate foreign currency exchange risk. We periodically enter into foreign currency forward contracts to hedge specific foreign currency-denominated assets and liabilities as well as
forecasted transactions and designate certain hedges of forecasted transactions as cash flow hedges for accounting purposes. For these designated hedges, we record unrealized gains and losses related to the change in the fair value of the
contracts in other comprehensive income (loss) within shareholders’ equity and subsequently recognize the gains and losses as a component of earnings at the same time and in the same financial statement line that the underlying transactions impact
earnings. In fiscal 2023, 2022, and 2021, net gains and losses recognized in sales and cost of sales related to foreign currency forward contracts were $1 million or less in each year. We have not designated forward contracts related to foreign
currency-denominated assets and liabilities as hedges. Accordingly, for these non-designated contracts, we record unrealized gains and losses related to the change in the fair value of the contracts in other income and expense. Gains and losses
on these non-designated foreign currency forward contracts are offset by foreign currency gains and losses associated with the related assets and liabilities.
Counterparty Risks
We manage counterparty risks by ensuring that counterparties to derivative instruments maintain credit ratings acceptable to us. At March 31, 2023, all counterparties had a sufficient long-term credit rating.