MODINE MANUFACTURING COMPANY Overview
Founded in 1916,Modine Manufacturing Company is a global leader in thermal management systems and components, bringing heating and cooling technology and solutions to diversified global markets. We operate on five continents, in 17 countries, and employ approximately 11,300 persons worldwide. Our primary product groups include i) powertrain cooling and engine cooling; ii) coils, coolers, and coatings; and iii) heating, ventilation and air conditioning. Our products are used in on- and off-highway original-equipment vehicular applications. In addition, we provide our thermal management technology and solutions to a wide array of commercial, industrial, and building heating, ventilating, air conditioning, and refrigeration markets.
Company Strategy
Fiscal 2020 brought challenges, including market weakness in key vehicular end markets and the COVID-19 pandemic, which negatively impacted our businesses, beginning in the fourth quarter inAsia andEurope . In response to these challenges, we have rapidly implemented cost-savings measures to mitigate the impacts of lower customer demand. These measures have included, but are not limited to, production staffing adjustments, furloughs, shortened work weeks, and temporary salary reductions at all levels of our organization. We are reducing operating and administrative expenses, including travel and entertainment expenditures, and lowering the annual compensation paid to the Board of Directors. We have also taken steps specifically aimed to preserve cash and maximize our liquidity. In addition, we are focused on reducing capital expenditures by delaying certain projects and the purchase of some program-related equipment and tooling. Both the vehicular market weakness and the impacts of the COVID-19 pandemic during fiscal 2020 placed significant strain on our previously-announced evaluation of strategic alternatives for the automotive business. As a result, we have paused this process until economic conditions improve. We remain committed, however, to exiting the automotive business in a manner that is in the best interest of our shareholders. As we steer our business through these uncertain times in light of the COVID-19 pandemic, we are focused on leveraging the advantages we have. We have made significant strides in becoming an industrial thermal management company and possess superior technology that we can apply to targeted end markets. We are confident in our Company's strong foundation, comprised of our effective leadership team, committed workforce, and engaged board of directors. Through our strong foundation, we believe we can create and maintain shareholder value even in these times of unprecedented uncertainty.
Development of New Products and Technology
Our ability to develop new products and technologies based upon our building block strategy for new and emerging markets is one of our competitive strengths. Under this strategy, we focus on creating core technologies that form the basis for multiple products and product lines across multiple business segments. Each of our business segments have a strong heritage of new product development, and our entire global technology organization benefits from mutual strengths. We own four global, state-of-the-art technology centers, dedicated to the development and testing of products and technologies. The centers are located inRacine, Wisconsin ,Grenada, Mississippi , Pocenia,Italy and Bonlanden,Germany . Our reputation for providing high quality products and technologies has been a Company strength valued by our customers.
We continue to benefit from relationships with customers that recognize the value of having us participate directly in product design, development and validation processes. This has resulted, and we expect it to continue to result, in strong, long-term customer relationships with companies that value partnerships with their suppliers.
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.
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We devote significant resources to global strategic planning and development
activities to strengthen our competitive position. We expect to continue to
pursue organic- and external-growth opportunities, particularly to grow our
global, market leading positions in our industrial businesses. As an example,
we recently announced that we are changing how we will go to market to existing
and potential new data center customers and are expanding our data center
offerings into the North American market. We are bringing together the full
systems capability and established roots of our BHVAC segment in the data center
space with the global manufacturing expertise and customer relationships within
CIS. We expect strong growth opportunities in the North American data center
market as the industry is growing exponentially in order to keep up with the
ever-increasing reliance on digital technologies.
Operational and Financial Discipline
We operate in a dynamic, global marketplace; therefore, we manage our business with a disciplined focus on increasing productivity and reducing waste. The nature of the global marketplace requires us to move toward a greater manufacturing scale in order to create a more competitive cost base. In order to optimize our cost structure and improve efficiency of our operations, we have executed restructuring activities in our VTS and CIS segments during recent years. We have also developed a single focus approach to the data center market by combining the resources and capabilities of our BHVAC and CIS teams. In addition, as costs for materials and purchased parts may rise from time to time due to increases in commodity markets, we seek low-cost sourcing, when appropriate, and enter into contracts with some of our customers that provide for commodity price adjustments, on a lag basis. We follow a rigorous financial process for investment and returns, intended to enable increased profitability and cash flows over the long term. We place particular emphasis on working capital improvement and prioritization of our capital investments. Our executive management incentive compensation (annual cash incentive) plan for fiscal 2020 was based upon consolidated operating income growth and a cash flow margin metric. These performance goals drive alignment of management and shareholders' interests in both our earnings growth and cash flow targets. In addition, we provide a long-term incentive compensation plan for officers and certain key employees to attract, retain, and motivate employees who directly impact the long-term performance of our company. The plan is comprised of stock awards, stock options, and performance-based stock awards. The performance-based stock awards for the fiscal 2020 through 2022 performance period are based upon a target three-year average annual revenue growth and a target three-year average consolidated cash flow return on invested capital.
Segment Information - Strategy, Market Conditions and Trends
Each of our operating segments is managed by a vice president and has separate strategic and financial plans, and financial results, all of 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. EffectiveApril 1, 2020 , we began managing our automotive business separate from the VTS segment as we target the sale or eventual exit of the automotive business. We will report financial results for the automotive segment beginning in the first quarter of fiscal 2021.
Vehicular Thermal Solutions (58 percent of fiscal 2020 net sales)
Our VTS segment provides powertrain and engine cooling products, including, but not limited to, radiators, charge air coolers, condensers, oil coolers, EGR coolers, and fuel coolers, to OEMs in the automotive, commercial vehicle, and off-highway markets inNorth America ,South America ,Europe , andAsia . In addition, our VTS segment also servesBrazil's automotive and commercial vehicle aftermarkets. Sales volume in the VTS segment decreased during fiscal 2020, as compared with the prior year. In particular, sales to commercial vehicle and off-highway customers decreased significantly compared with the prior year, resulting from weakness in the global vehicular markets and the planned wind-down of certain commercial vehicle programs. In addition, to a lesser extent, sales volume decreased to automotive customers in fiscal 2020. During fiscal 2020, we recorded asset impairment charges totaling$8 million , primarily related to manufacturing facilities inAustria andGermany that are expected to be negatively impacted by planned wind downs of certain commercial vehicle and automotive programs. 25 -------------------------------------------------------------------------------- Table of Contents We previously announced our evaluation of strategic alternatives for the automotive business. As a result of the widespread economic impacts of the COVID-19 pandemic, we have paused this process, yet we remain committed to exiting this business in a manner that is in the best interest of our shareholders. We intend to resume this process once we determine that market conditions will support our effort to maximize the value of our business. It is possible that our exit strategy may ultimately include a combination of both selling and winding-down or closing portions of the automotive business. We remain committed to executing on the best strategic alternative for the automotive business in order to both optimize our VTS segment's financial performance and maximize shareholder value.
Commercial and Industrial Solutions (31 percent of fiscal 2020 net sales)
Our CIS segment provides a broad offering of thermal management products to the HVAC&R markets, including solutions tailored to indoor and mobile climates, food storage and transport-refrigeration, and industrial processes. CIS's primary product groups include coils, coolers, and coatings. Our coils products include custom-designed condensers, evaporators, round-tube solutions, as well as steam and water/fluid coils. Our coolers include commercial refrigeration units, which are used across the food supply chain, products for precision climate control for other applications such as data center cooling, carbon dioxide and ammonia unit coolers, remote condensers, transformer oil coolers, and brine coolers. In addition, we offer proprietary coating solutions for corrosion protection, prolonging the life of heat-transfer equipment. During fiscal 2020, CIS segment sales volume decreased to both commercial HVAC&R and data center customers. The lower sales volume to commercial HVAC&R customers was largely attributable to general market weakness. In particular, theU.S. refrigeration transport market declined compared with the prior year. The lower data center sales primarily resulted from a significant decline in sales to an individual data center customer in fiscal 2020. The lower sales to this customer primarily resulted from the customer's temporary lull in additional investment, after strong capacity expansion in the prior year. Looking ahead, while the duration and severity of the impacts of COVID-19 on the markets we serve are currently uncertain, our team is focused on improving financial results through manufacturing efficiencies, vertical integration projects and pricing strategies. We will continue to support our customers with innovative products, such as coils with smaller diameter tubing, to help them meet increasingly-stringent environmental requirements. Also, we have increased our product offerings that feature low Global Warming Potential refrigerants, which are more environmentally friendly than traditional refrigerants, and will continue to support the transition to natural refrigerants through our comprehensive line of commercial cooler products. We aim to capitalize on opportunities arising from energy and environmental regulations and believe we are well-positioned to be the partner of choice for our customers.
Building HVAC Systems (11 percent of fiscal 2020 net sales)
Our BHVAC segment manufactures and distributes a variety of original equipment and aftersales HVAC products, primarily for commercial buildings and related applications inNorth America , theU.K. , mainlandEurope , theMiddle East ,Asia , andAfrica . We sell and distribute our heating, ventilation and cooling products through wholesalers, distributors, consulting engineers, contractors and building owners for applications such as warehouses, repair garages, greenhouses, residential garages, schools, data centers, manufacturing facilities, hotels, hospitals, restaurants, stadiums, and retail stores. Our heating products include gas (natural and propane), electric, oil and hydronic unit heaters, low- and high-intensity infrared, and large roof-mounted direct- and indirect-fired makeup air units. Our ventilation products include single-packaged vertical units and unit ventilators used in school room applications, air-handling equipment, and rooftop packaged ventilation units used in a variety of commercial building applications. Our cooling products include precision air conditioning units used primarily for data center cooling applications, air- and water-cooled chillers, and ceiling cassettes, which are used in a variety of commercial building applications. Economic conditions, such as demand for new commercial construction, building renovations, including HVAC replacement, growth in data centers and school renovations, and higher efficiency requirements, are growth drivers for our building HVAC products. During fiscal 2020, sales increased inNorth America , primarily driven by increased sales of ventilation and heating products. These higher sales inNorth America were partially offset by lower sales in theU.K. , primarily due to lower sales of air conditioning and ventilation products. 26 -------------------------------------------------------------------------------- Table of Contents We are focused on being a leader in the development of sustainable HVAC solutions for our customers. As recently announced, we are targeting to expand our data center cooling business into the North American market. We have established roots in the data center space and plan to leverage our North American presence, including our manufacturing footprint and thermal management expertise, to deploy integrated data center cooling solutions to the U.S. market. We are seeing heightened demand in the data center markets, particularly in light of the increasing reliance on virtual capabilities resulting from stay-at-home edicts associated with the COVID-19 pandemic.
Consolidated Results of Operations
Fiscal 2020 net sales decreased$237 million , or 11 percent, from the prior year, primarily due to lower sales in our VTS and CIS operating segments, partially offset by higher sales in our BHVAC segment. Foreign currency exchange rate changes negatively impacted sales in fiscal 2020 by$46 million . Cost of sales decreased$179 million , or 10 percent, from last year, primarily due to lower sales volume. Gross profit decreased$58 million and gross margin declined 90 basis points to 15.6 percent. SG&A expenses increased$6 million , primarily due to separation and project costs associated with our review of strategic alternatives for the VTS segment's automotive business, which increased approximately$29 million compared with fiscal 2019. The higher separation and project costs were partially offset by lower-compensation related expenses. Operating income during fiscal 2020 decreased$72 million to$38 million , primarily due to lower gross profit and higher SG&A expenses. The COVID-19 pandemic began negatively impacting our business beginning with our Asian and European markets in the fourth quarter of fiscal 2020. Both weakness in key vehicular markets and the impacts of the COVID-19 pandemic placed significant strain on our previously-announced evaluation of strategic alternatives for the automotive business within the VTS segment. As a result, we paused this process until economic conditions improve. We remain committed, however, to exiting the automotive business in a manner that is in the best interest of our shareholders. Once we resume the process, it is possible that our exit strategy may ultimately include a combination of both selling and winding-down or closing portions of the automotive business. We have spent considerable time and money separating the automotive business and preparing for a potential sale. We have dedicated resources to physically separate the automotive manufacturing operations, including resources for IT systems and separate business processes, and have also established new legal entities. We believe these resource investments are critical to exiting the automotive business. We remain committed to our strategy of becoming a diversified industrial company and executing on the best strategic alternative for the automotive business in order to both optimize our VTS segment's financial performance and maximize shareholder value. As a result of the impacts of the COVID-19 pandemic, we suspended production at certain manufacturing facilities inChina ,India ,Italy ,Spain ,Germany ,the Netherlands ,Austria ,Hungary , theU.S. ,Mexico andBrazil due to local government requirements or customer shutdowns and are operating other facilities in theU.S. and abroad at reduced capacity levels. Although the temporarily-closed facilities have since reopened, many are operating at a significantly reduced volume because of low customer demand. Beginning largely inApril 2020 and in an effort to mitigate the negative impacts of COVID-19 on our financial results, we have taken actions, including, but not limited to, production staffing adjustments, furloughs, shortened work weeks, and temporary salary reductions at all levels of our organization. In addition, we are reducing operating and administrative expenses, including travel and entertainment expenditures, and lowering the annual compensation paid to the Board of Directors. We are also focused on reducing capital expenditures by delaying certain projects and the purchase of some program-related equipment and tooling. 27 -------------------------------------------------------------------------------- Table of Contents The following table presents our consolidated financial results on a comparative basis for fiscal years 2020 and 2019. A detailed comparison of our consolidated fiscal 2019 and 2018 financial results can be found in the Management's Discussion and Analysis of Financial Condition and Results of Operations section in the Company's 2019 Annual Report on Form 10-K filed with theSEC onMay 23, 2019 . Years ended March 31, 2020 2019 (in millions) $'s % of sales $'s % of sales Net sales$ 1,976 100.0 %$ 2,213 100.0 % Cost of sales 1,668 84.4 % 1,847 83.5 % Gross profit 308 15.6 % 366 16.5 % Selling, general and administrative expenses 250 12.6 % 244 11.0 % Restructuring expenses 12 0.6 % 10 0.4 % Impairment charges 9 0.4 % - - (Gain) loss on sale of assets (1 ) - 2 0.1 % Operating income 38 1.9 % 110 5.0 % Interest expense (23 ) -1.1 % (25 ) -1.1 % Other expense - net (5 ) -0.2 % (4 ) -0.2 % Earnings before income taxes 10 0.5 % 81 3.7 % (Provision) benefit for income taxes (12 ) -0.6 % 5 0.2 % Net (loss) earnings$ (2 ) -0.1 %$ 86 3.9 % Fiscal 2020 net sales of$1,976 million were$237 million , or 11 percent, lower than the prior year, primarily due to lower sales in our VTS and CIS segments and a$46 million unfavorable impact of foreign currency exchange rate changes, partially offset by higher sales in our BHVAC segment. Sales decreased$175 million and$84 million in our VTS and CIS segments, respectively. Sales increased$9 million in our BHVAC segment. Fiscal 2020 cost of sales of$1,668 million decreased$179 million , or 10 percent, primarily due to lower sales volume and a$39 million favorable impact of foreign currency exchange rate changes. As a percentage of sales, cost of sales increased 90 basis points to 84.4 percent and was negatively impacted by approximately 80 basis points due to higher labor and inflationary costs and, to a lesser extent, by sales mix. These negative impacts were partially offset by favorable material costs, which impacted costs of sales by approximately 30 basis points. The favorable material costs primarily resulted from lower commodity pricing, which more than offset the negative impacts of tariffs. In addition, we recorded$3 million of costs at Corporate for program and equipment transfers associated with the separation of the VTS segment's automotive business in preparation for a potential sale.
As a result of lower sales and higher cost of sales as a percentage of sales,
fiscal 2020 gross profit decreased
Fiscal 2020 SG&A expenses increased
Restructuring expenses totaled$12 million during fiscal 2020 and increased$2 million compared with the prior year. The fiscal 2020 restructuring expenses primarily consisted of severance expenses related to targeted headcount reductions in the VTS segment and equipment transfer and plant consolidation costs in the CIS segment. The fiscal 2020 headcount reductions were in response to lower market demand and in support of our objective to reduce operational and SG&A cost structures. During fiscal 2021, we approved headcount reductions in the VTS and CIS segments and, as a result, we expect to record approximately$4 million of severance expenses during the first quarter of fiscal 2021.
During fiscal 2020, we recorded impairment charges totaling
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Operating income of $38 million during fiscal 2020 decreased $72 million
compared with the prior year. This decrease was primarily due to an increase of
$32 million of separation and project costs associated with our review of
strategic alternatives for our automotive business and lower earnings in our VTS
and CIS segments, which decreased $37 million and $20 million , respectively,
partially offset by higher earnings in our BHVAC segment, which increased $9
million .
The provision for income taxes was $12 million in fiscal 2020, compared with a
benefit for income taxes of $5 million in fiscal 2019. The $17 million change
was primarily due to the absence of income tax benefits totaling $25 million
recorded in the prior year and income tax charges totaling $10 million in the
current year, partially offset by lower operating earnings in fiscal 2020. The
$25 million of income tax benefits recorded in fiscal 2019 related to the
recognition of tax assets for foreign tax credits and a manufacturing deduction
in the U.S. and our accounting for the Tax Act. The $10 million of income tax
charges in fiscal 2020 were comprised of net charges totaling $7 million
resulting from adjustments of valuation allowances on certain deferred tax
assets in the U.S. and in a foreign jurisdiction and $3 million associated with
legal entity restructuring in preparation for a potential sale of our automotive
business. See Note 7 of the Notes to Consolidated Financial Statements for
additional information.
Segment Results of Operations
A detailed comparison of our segment financial results for fiscal 2019 and 2018 can be found in the Management's Discussion and Analysis of Financial Condition and Results of Operations section in the Company's 2019 Annual Report on Form 10-K filed with theSEC onMay 23, 2019 . EffectiveApril 1, 2020 , we began managing our automotive business separate from the other businesses within the VTS segment. We are managing the automotive business as a separate segment as we target the sale or eventual exit of the automotive businesses. Beginning for fiscal 2021, we will report the financial results for the automotive business as the Automotive segment. The remaining portion of the previous VTS segment will be named the Heavy-Duty Equipment segment and will include the heavy-duty commercial vehicle and off-highway businesses. VTS Years ended March 31, 2020 2019 (in millions) $'s % of sales $'s % of sales Net sales$ 1,177 100.0 %$ 1,352 100.0 % Cost of sales 1,032 87.7 % 1,165 86.2 % Gross profit 145 12.3 % 187 13.8 % Selling, general and administrative expenses 100 8.5 % 113 8.3 % Restructuring expenses 10 0.8 % 9 0.7 % Impairment charges 8 0.7 % - - Gain on sale of assets (1 ) -0.1 % - - Operating income$ 28 2.3 %$ 65 4.8 % VTS net sales decreased$175 million , or 13 percent, in fiscal 2020 compared with the prior year, primarily due to lower sales volume, a$31 million unfavorable impact of foreign currency exchange rate changes, and, to a lesser extent, unfavorable customer pricing largely resulting from contractually-scheduled price-downs. Sales to commercial vehicle, off-highway, and automotive customers decreased$64 million ,$60 million , and$34 million , respectively. These sales declines largely result from weakness in global vehicular markets and the planned wind-down of certain commercial vehicle programs. VTS cost of sales decreased$133 million , or 11 percent, primarily due to lower sales volume and a$26 million favorable impact of foreign currency exchange rate changes. As a percentage of sales, cost of sales increased 150 basis points to 87.7 percent. Beyond the unfavorable impact of the lower sales volume, higher labor and inflationary costs and unfavorable customer pricing negatively impacted cost of sales by approximately 90 basis points and 70 basis points, respectively. Higher depreciation costs, primarily resulting from recent manufacturing capacity expansion inChina andHungary , also negatively impacted cost of sales to a lesser extent. These negative impacts were partially offset by favorable material costs, which impacted cost of sales by approximately 30 basis points, improved operating efficiencies and cost savings from procurement initiatives. The favorable material costs primarily resulted from lower commodity pricing, which more than offset the negative impacts of tariffs.
As a result of the lower sales and higher cost of sales as a percentage of
sales, gross profit decreased
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VTS SG&A expenses decreased $13 million compared with the prior year yet
increased 20 basis points as a percentage of sales. The decrease in SG&A
expenses was primarily due to lower compensation-related expenses, which
decreased approximately $9 million , lower environmental charges related to
previously-owned manufacturing facilities in the U.S , which decreased
approximately $3 million , and a $3 million favorable impact of foreign currency
exchange rate changes.
Restructuring expenses during fiscal 2020 increased $1 million , primarily due to
higher severance expenses resulting from targeted headcount reductions in Europe
and in the Americas .
During fiscal 2020, we recorded asset impairment charges totaling $8 million ,
primarily related to manufacturing facilities in Austria and Germany to write
down property and equipment assets to fair value. We anticipate future cash
flows at these facilities will be negatively impacted by planned wind downs of
certain commercial vehicle and automotive programs.
During fiscal 2020, we completed the sale of a previously-closed manufacturing
facility in
Operating income in fiscal 2020 decreased$37 million to$28 million , primarily due to lower gross profit and higher impairment charges, partially offset by lower SG&A expenses. CIS Years ended March 31, 2020 2019 (in millions) $'s % of sales $'s % of sales Net sales$ 624 100.0 %$ 708 100.0 % Cost of sales 531 85.1 % 593 83.8 % Gross profit 93 14.9 % 115 16.2 % Selling, general and administrative expenses 57 9.2 % 61 8.6 % Restructuring expenses 2 0.3 % - - Impairment charges 1 0.1 % - 0.1 % Operating income$ 33 5.3 %$ 53 7.5 % CIS net sales decreased$84 million , or 12 percent, in fiscal 2020 compared with the prior year, primarily due to lower sales volume and a$12 million unfavorable impact of foreign currency exchange rate changes. Sales to commercial HVAC&R and data center cooling customers decreased$43 million and$38 million , respectively. CIS cost of sales decreased$62 million , or 10 percent, primarily due to lower sales volume and an$11 million favorable foreign currency exchange rate impact. As a percentage of sales, cost of sales increased 130 basis points to 85.1 percent, primarily due to the unfavorable impact of lower sales volume and unfavorable sales mix.
As a result of the lower sales and higher cost of sales as a percentage of
sales, gross profit decreased
CIS SG&A expenses decreased
Restructuring expenses during fiscal 2020 increased$2 million , primarily due to higher equipment transfer and plant consolidation costs. We are currently transferring product lines to our manufacturing facility inMexico in order to achieve operational improvements and organizational efficiencies.
During fiscal 2020, we recorded a
Operating income in fiscal 2020 decreased
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BHVAC
Years ended March 31,
2020 2019
(in millions) $'s % of sales $'s % of sales
Net sales $ 221 100.0 % $ 212 100.0 %
Cost of sales 150 67.7 % 149 70.1 %
Gross profit 72 32.3 % 63 29.9 %
Selling, general and administrative expenses 35 15.8 % 35 16.4 %
Loss on sale of assets - - 2 0.8 %
Operating income $ 36 16.5 % $ 27 12.6 %
BHVAC net sales increased $9 million , or 4 percent, in fiscal 2020 compared with
the prior year, primarily due to higher sales in the U.S. , which increased $14
million , partially offset by lower sales in the U.K. , which decreased $5
million . The higher sales in the U.S. were primarily driven by the increased
sales of ventilation and heating products. The lower sales in the U.K. were
primarily due to lower sales of air conditioning and ventilation products and a
$3 million unfavorable impact of foreign currency exchange rate changes,
partially offset by higher data center sales.
BHVAC cost of sales increased
As a result of the higher sales and lower cost of sales as a percentage of
sales, gross profit increased
BHVAC SG&A expenses remained consistent with the prior year yet decreased 60 basis points as a percentage of sales.
During fiscal 2019, we sold our business in
Operating income in fiscal 2020 of
Liquidity and Capital Resources
Our primary sources of liquidity are cash flow from operating activities, our cash and cash equivalents as ofMarch 31, 2020 of$71 million , and an available borrowing capacity of$118 million under our revolving credit facility. Given our extensive international operations, approximately$31 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. In response to lower customer demand resulting from the COVID-19 pandemic, we have taken actions to reduce operating expenses, conserve cash and maximize liquidity. These actions have included, but are not limited to, production staffing adjustments, furloughs, shortened work weeks, and temporary salary reductions at all levels of our organization. In addition, we are reducing operating and administrative expenses. Further, as described below, we are focused on reducing our capital expenditures and have executed amendments to our primary credit agreements to help ensure liquidity through financial covenant flexibility during the next two fiscal years. Together with anticipated cash flow from operations, we currently believe we have sufficient available cash and access to both committed and uncommitted credit facilities to adequately cover our funding needs on both a short- and long-term basis. However, we are continuing to monitor the impacts of COVID-19 on our business and the credit and financial markets. The full extent of the impacts of COVID-19, which will largely depend on the length and severity of the pandemic, could have a material adverse effect on our business, results of operations, and cash flows and could adversely affect our access to capital and/or financing. 31 -------------------------------------------------------------------------------- Table of Contents Net Cash Provided by Operating Activities Net cash provided by operating activities in fiscal 2020 was$58 million , a decrease of$45 million from$103 million in the prior year. This decrease in operating cash flow was primarily due to lower operating earnings in the current year and payments for separation and project costs associated with our strategic review of alternatives for the VTS segment's automotive business, partially offset by favorable net changes in working capital. The favorable changes in working capital, as compared with the prior year, included lower employee benefit and incentive compensation payments. Net cash provided by operating activities in fiscal 2019 was$103 million , a decrease of$21 million from$124 million in fiscal 2018. This decrease in operating cash flow primarily resulted from unfavorable changes in working capital, partially offset by the favorable impact of stronger earnings. The unfavorable changes in working capital, as compared with the prior year, included higher incentive compensation and other employee benefit payments and higher inventory levels associated with higher sales levels.
Capital Expenditures
Capital expenditures of$71 million during fiscal 2020 decreased$3 million compared with fiscal 2019, primarily due to lower capital investments in our VTS segment compared with the prior year, particularly inChina andNorth America . Similar to prior years, our capital spending in fiscal 2020 primarily occurred in the VTS segment, which totaled$53 million , and included tooling and equipment purchases in conjunction with new and renewal programs with customers, as well as$7 million of capital investments associated with preparing our automotive business for a potential sale. In response to the economic impacts of the COVID-19 pandemic, we are taking steps to preserve our financial liquidity. As part of this initiative, we are focused on reducing our capital expenditures by delaying certain projects and the purchase of certain program-related equipment and tooling. AtMarch 31, 2020 , our capital expenditure commitments totaled$12 million and primarily consisted of commitments for tooling and equipment expenditures in support of new and renewal programs in the VTS segment. Debt Our total debt outstanding increased$33 million to$482 million atMarch 31, 2020 compared with the prior year, primarily due to additional borrowings during fiscal 2020. In response to the economic impacts of the COVID-19 pandemic, we executed amendments to our primary credit agreements inMay 2020 to provide additional covenant flexibility. The amendments temporarily raise the leverage coverage ratio limit during the next two fiscal years. Our credit agreements require us to maintain compliance with various covenants. As specified in the credit agreement, the term loans may require prepayments in the event of certain asset sales. In addition, at the time of each incremental borrowing under the revolving credit facility, we must represent to the lenders that there has been no material adverse effect, as defined in the credit agreement, on our business, property, or results of operations. Under our primary credit agreements in theU.S. , we are subject to a leverage ratio covenant, which requires us to limit our consolidated indebtedness, less a portion of our cash balance, both as defined by the credit agreements, in relation to our consolidated net earnings before interest, taxes, depreciation, amortization, and certain other adjustments ("Adjusted EBITDA"). The leverage ratio covenant limit was 3.25 to 1 through the fourth quarter of fiscal 2020. 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 ofMarch 31, 2020 , we were in compliance with our debt covenants; our leverage ratio and interest coverage ratio were 2.4 and 8.1, respectively. InMay 2020 , as noted above, we executed amendments to our primary credit agreements that provide additional financial covenant flexibility during the next two fiscal years in light of the risks and uncertainties associated with the COVID-19 pandemic. We believe this additional flexibility will enable us to be compliant with our debt covenants, even if the adverse effects of the COVID-19 pandemic on our business are more severe than we currently anticipate. However, failure to comply with the debt covenants could result in an event of default, which, if not cured or waived, could result in us being required to repay borrowings before their due date. Under the amended agreements, the leverage ratio covenant limit is temporarily raised. For fiscal 2021, the leverage ratio covenant limit is 4.00 to 1, 4.75 to 1, 5.25 to 1, and 5.75 to 1 for the first, second, third, and fourth quarters, respectively. In fiscal 2022, the leverage ratio covenant limit is 4.75 to 1, 3.75 to 1, and 3.50 to 1 for the first, second and third quarters, respectively, and subsequently returns to 3.25 to 1 for the fourth quarter of fiscal 2022. We expect to remain in compliance with our debt covenants during fiscal 2021 and beyond.
See Note 17 of the Notes to Consolidated Financial Statements for additional information regarding our credit agreements.
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Off-Balance Sheet Arrangements
None.
Contractual Obligations
March 31, 2020
Less than 1 More than 5
(in millions) Total year 1 - 3 years 4 - 5 years years
Long-term debt $ 468.9 $ 15.2 $ 42.6 $ 294.4 $ 116.7
Interest associated with
long-term debt 89.3 17.7 33.4 24.5 13.7
Operating lease obligations 71.8 12.8 20.7 12.1 26.2
Capital expenditure commitments 12.0 12.0 - - -
Other long-term obligations (a) 9.9 1.9 3.1 3.0 1.9
Total contractual obligations $ 651.9 $ 59.6 $ 99.8 $ 334.0 $ 158.5 (a) Includes finance lease obligations and other long-term obligations.
Our liabilities for pensions, postretirement benefits, and uncertain tax positions totaled$145 million as ofMarch 31, 2020 . We are unable to determine the ultimate timing of payments for these liabilities; therefore, we have excluded these amounts from the contractual obligations table above. We expect to contribute$20 million to ourU.S. pension plans during fiscal 2021.
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 significantly impact our financial statement are disclosed in Note 1 of the Notes to Consolidated Financial Statements.
Revenue Recognition
In fiscal 2019, we adopted new revenue recognition accounting guidance. In accordance with this new accounting guidance, 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 towards the satisfaction of the contract's performance obligations. We record an allowance for doubtful accounts for estimated uncollectible receivables and we accrue for estimated warranty costs at the time of sale. We base these estimates upon historical experience, current business trends, and current economic conditions.
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. When 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 to current
operations. 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.
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The most significant long-lived assets we evaluated for impairment indicators
were property, plant and equipment and intangible assets, which totaled $448
million and $106 million , respectively, at March 31, 2020 . 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 CIS 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 2020, we recorded asset impairment charges
totaling $8 million , primarily related manufacturing facilities in Austria and
Germany within the VTS segment. See Note 5 of the Notes to the Consolidated
Financial Statements for additional information.
Impairment of
We perform goodwill impairment tests annually, as ofMarch 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. Reporting units resulting from recent acquisitions generally represent 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 significant estimates and assumptions, which include assumptions regarding the revenue growth rates and operating profit margins used to calculate estimated future cash flows, risk-adjusted discount rates, business trends and market conditions. 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-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 the continued economic uncertainty and impacts associated with 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. AtMarch 31, 2020 , our goodwill totaled$166 million related to our CIS and BHVAC segments. Each of these segments is comprised of two reporting units. We conducted annual goodwill impairment tests during the fourth quarter of fiscal 2020 by applying a fair value-based test and determined the fair value of each of our reporting units exceeded the respective book value.
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.
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Warranty Costs
We estimate costs related to product warranties and accrue for such costs at the
time of the sale, within cost of sales. We estimate warranty costs based upon
the best information available, which includes statistical and analytical
analysis of both historical and current claim data. We adjust our warranty
accruals, which totaled $8 million at March 31, 2020 , if it is probable that
expected claims will differ from previous estimates.
Pension Obligations
Our calculation of the expense and liabilities of our pension plans is dependent upon various assumptions. AtMarch 31, 2020 , our pension liabilities totaled$134 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 withU.S. GAAP, actual results that differ from these assumptions are accumulated and amortized over future periods. These differences impact future pension expenses. Currently, participants in our domestic pension 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 large 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 both fiscal 2020 and 2019 was 7.5 percent. For fiscal 2021, we have also assumed a rate of 7.5 percent. A change of 25 basis points in the expected rate of return on assets would impact our fiscal 2021 pension expense by$0.4 million . The discount rate reflects rates available on long-term, high-quality fixed-income corporate bonds on the measurement date ofMarch 31 . For fiscal 2020 and 2019, for purposes of determining pension expense, we used a discount rate of 4.0 percent. We determined these rates based upon a yield curve that was created following an analysis of the projected cash flows from 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 2021 pension expense by less than$1 million .
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 jurisdiction-by-jurisdiction 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 7 of the Notes to Consolidated Financial Statements for additional information regarding income taxes.
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Other Loss Reserves
We maintain liabilities and reserves for a number of other loss exposures, such
as environmental remediation costs, self-insurance reserves, uncollectible
accounts receivable, 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
Note 20 of the Notes to Consolidated Financial Statements for additional
information regarding contingencies and litigation.
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 theU.S. Securities and Exchange Commission . Other risks and uncertainties include, but are not limited to, the following:
Market Risks:
• The impact of the COVID-19 pandemic on the national and global economy, our
business, suppliers, customers, and employees;
• 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, in particular, foreign currency
exchange rate fluctuations; tariffs (and any potential trade war resulting from
tariffs or retaliatory actions); inflation; changes in interest rates;
recession and recovery therefrom; restrictions and uncertainty associated with
cross-border trade, public health crises, such as pandemics and epidemics,
including the ongoing COVID-19 pandemic; and the general uncertainties about
the impact of regulatory and/or policy changes, including those related to tax
and trade, the COVID-19 pandemic and other matters, that have been or may be
implemented in
regarding the short- and long-term implications of "Brexit";
• The impact of potential 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
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, whether through our quotation process
or through contract provisions for prospective price adjustments, as well as
the inherent lag in timing of such contract provisions; 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 overall health and continually increasing price-down focus of our vehicular
customers in light of economic and market-specific factors, and the potential
impact on us from any deterioration in the stability or performance of any of
our major customers;
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• Unanticipated problems with suppliers meeting our time, quantity, quality and
price demands, and the overall health of our suppliers, including their ability
and willingness to supply our volume demands if their production capacity
becomes constrained;
• Our ability to maintain current customer programs and compete effectively for
new business, including our ability to offset or otherwise address increasing
pricing pressures from competitors and price reduction and overall service
pressures from customers, particularly in the face of macro-economic instability;
• Unanticipated product or manufacturing difficulties or operating
inefficiencies, including unanticipated program launch and product transfer
challenges and warranty claims and delays or inefficiencies resulting from
restrictions imposed in response to the COVID-19 pandemic;
• Unanticipated 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 reduce our cost structure in
response to sales volume declines 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; particularly 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 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 any 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
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 unanticipated litigation, claims, or other
obligations. Strategic Risks:
• Our ability to successfully exit the automotive business within our VTS segment
in a manner that is in the best interest of our shareholders in order to optimize the segment's future financial performance;
• Our ability to successfully realize anticipated benefits from our increased
"industrial" market presence, with our CIS and BHVAC businesses, while
maintaining appropriate focus on the market opportunities presented by our VTS
business;
• Our ability to identify and execute growth and diversification opportunities in
order to position us for long-term success; and
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• The potential impacts from unanticipated actions by activist shareholders,
including disruption of our business and related costs.
Financial Risks:
• Our ability to fund our global liquidity requirements efficiently for Modine's
current operations and meet our long-term commitments, particularly in light of
the significant volatility and negative pressure in the financial markets as a
result of the COVID-19 pandemic and in the event of disruption in or tightening
of the credit markets or extended recessionary conditions in the global economy;
• The impact of potential increases in interest rates, particularly in LIBOR and
the Euro Interbank Offered Rate ("EURIBOR") in relation to our variable-rate
debt obligations, and of the continued uncertainty around the utilization of
LIBOR or alternative reference rates;
• Our ability to comply with the financial covenants as amended 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
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 inBrazil ,China ,India ,Mexico , and throughoutEurope . We also have joint ventures inChina andSouth 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 2020, 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 intoU.S. dollars. These translation impacts are primarily affected by changes in exchange rates between theU.S. dollar and European currencies, primarily the euro, and changes between theU.S. dollar and the Brazilian real. In fiscal 2020, more than 50 percent of our sales were generated in countries outside theU.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 2020, changes in foreign currency exchange rates unfavorably impacted our sales by$46 million ; however, the impact on our operating income was less than$3 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 2020, there would not have been a material impact on our fiscal 2020 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. 38 -------------------------------------------------------------------------------- Table of Contents 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 is based upon a variable interest rate, primarily either LIBOR or EURIBOR, plus 137.5 to 250 basis points, depending on our leverage ratio. For purposes of calculating the variable interest rate under our current credit agreement, LIBOR cannot be less than one percent. As a result, we are subject to risk of fluctuations in LIBOR 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 ofMarch 31, 2020 , our outstanding borrowings on variable-rate term loans and the revolving credit facility totaled$189 million and$127 million , respectively. Based upon our outstanding debt with variable interest rates atMarch 31, 2020 , a 100-basis point increase in interest rates would increase our annual interest expense in fiscal 2021 by approximately$3 million .
Commodity and Supply Risks
We are dependent upon the supply of raw materials and supplies in our production processes and, from time to time, enter into firm purchase commitments for aluminum, copper, nickel, and natural gas. Commodity price risk is most prevalent to our vehicular businesses, which provide customized production and service parts to customers under multi-year programs. In order to mitigate commodity price risk specific to these long-term sales programs, we maintain contract provisions with certain customers that allow us to prospectively adjust prices based upon raw material price fluctuations. 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 theLondon Metal Exchange and exclude additional cost elements, such as related premiums and fabrication. For our industrial businesses, we predominantly seek to mitigate commodity price risk by adjusting product pricing in response to any applicable price increases. In an effort to manage and reduce our costs, we have been consolidating our supply base. As a result, we are 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 are exposed to the risk of suppliers of certain raw materials not being able or willing to meet strong customer demand (including the potential effects of trade laws and tariffs), as they may not increase their output capacity as quickly as customers increase their orders, and of increased prices being charged by raw material suppliers. In addition, we 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. AtMarch 31, 2020 , 34 percent of our trade accounts receivable balance was concentrated with our top ten customers. These customers operate primarily in the automotive, commercial vehicle, off-highway, data center cooling and commercial air conditioning 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 COVID-19 pandemic. 39 -------------------------------------------------------------------------------- Table of Contents 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
• 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 also exposed to risks associated with demands by our customers for decreases in the price of our products. We attempt to offset this risk with firm agreements with our customers whenever possible, but these agreements sometimes contain provisions for future price reductions.
Economic and Market Risk
Economic risk represents the possibility of loss resulting from economic instability in certain areas of the world or downturns in markets in which we operate. We sell a broad range of products that provide thermal solutions to customers operating in diverse markets, including the automotive, commercial vehicle, off-highway, and commercial, industrial, and building HVAC&R markets. The COVID-19 pandemic has negatively impacted these markets; the duration and severity of the impacts of COVID-19 on these markets are currently uncertain. We are monitoring economic conditions in theU.S. and abroad and the impacts associated with the COVID-19 pandemic. Considering our global presence, we also encounter risks imposed by potential trade restrictions, including tariffs, embargoes, and the like. We continue to pursue non-speculative opportunities to mitigate these economic risks, and capitalize, when possible, on changing market conditions. 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, coils and coolers in certain markets, and coatings. Our investment in these areas is 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. In fiscal 2020 and 2019, we designated certain commodity forward contracts as cash flow hedges for accounting purposes. Accordingly, 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 2020, 2019 and 2018, net gains and losses recognized in cost of sales related to commodity forward contracts were less than$1 million in each year. 40 -------------------------------------------------------------------------------- Table of Contents 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. We have designated certain hedges of forecasted transactions as cash flow hedges for accounting purposes. Accordingly, 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 2020, 2019, and 2018, net gains and losses recognized in sales and cost of sales related to foreign currency forward contracts were less than$1 million 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. AtMarch 31, 2020 , all counterparties had a sufficient long-term credit rating. 41
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