MODINE MANUFACTURING CO 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. When we use the terms “Modine,” “we,” “us,” the “Company,” or “our” in this report, we are referring to Modine Manufacturing Company. Our fiscal year ends on March 31 and, accordingly, all references to quarters refer to our fiscal quarters. The quarter ended December 31, 2020 was the third quarter of fiscal 2021. Pending Disposition of Liquid-cooled Automotive Business On November 2, 2020, we entered into a definitive agreement to sell our liquid-cooled automotive business to Dana Incorporated. We expect this transaction will close during the first quarter of fiscal 2022, subject to regulatory approvals and other customary closing conditions. We do not expect significant net cash proceeds from this transaction based upon the selling price of one dollar and adjustments for cash, debt, and working capital, as defined within the definitive agreement. We report financial results of the liquid-cooled automotive business within the Automotive segment. We recorded a non-cash impairment charge of $132.7 million during the third quarter of fiscal 2021 related to the liquid-cooled automotive business’s long-lived assets. We expect to record an additional loss on sale of approximately $15.0 million to $25.0 million when the sale is completed. It is possible that the loss on sale could differ materially from this estimate. See Note 2 of the Notes to Condensed Consolidated Financial Statements for information regarding the accounting impacts of this pending sale. We are also evaluating strategic alternatives for the other businesses in the Automotive segment and are committed to exiting these businesses in a manner that is in the best interest of our shareholders. COVID-19 As the COVID-19 pandemic continues, both the health and overall well-being of our employees and delivering quality products and services to our customers remain our top priorities. The COVID-19 pandemic has broadly impacted the global economy and our key end markets, which were most severely impacted during the first quarter of fiscal 2021. Beginning largely in April 2020 and in an effort to mitigate the negative impacts of COVID-19 on our financial results, we implemented 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 reduced operating and administrative expenses, including travel and entertainment expenditures. We have also focused on limiting capital expenditures and, where possible, have delayed certain projects and the purchase of some program-related equipment and tooling. Our swift cost-saving actions, coupled with a slow but steady recovery in most of our key end markets, have favorably impacted our financial results. As production has generally returned to more normal levels, we reduced the extent of furloughs, shortened work weeks and salary reductions. As a result, the benefit of the cost-saving actions, primarily on selling, general and administrative (“SG&A”) expenses, was less significant during the third quarter of fiscal 2021 compared with the first and second quarters of fiscal 2021. 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. 26 Table of Contents Third Quarter Highlights Net sales in the third quarter of fiscal 2021 increased $10.9 million, or 2 percent, from the third quarter of fiscal 2020, primarily due to higher sales volume in the Heavy Duty Equipment (“HDE”) segment and a favorable impact of foreign currency exchange rate changes, partially offset by lower sales volume in our Commercial and Industrial Solutions (“CIS”) segment. Cost of sales increased $1.7 million compared with the third quarter of fiscal 2020. Gross profit increased $9.2 million and gross margin improved 160 basis points to 17.1 percent. SG&A expenses decreased $7.4 million, primarily due to lower project costs associated with our review of strategic alternatives for the automotive segment businesses and preparing the liquid-cooled automotive business for sale. We recorded $134.4 million of impairment charges during the third quarter in our Automotive segment, primarily related to the pending sale of the liquid-cooled automotive business. The operating loss of $108.7 million during the third quarter of fiscal 2021 represents a decline of $116.9 million from the prior-year operating income of $8.2 million, primarily due to the impairment charges in our Automotive segment and lower earnings in our CIS segment, partially offset by higher earnings in our HDE and Building HVAC Systems (“BHVAC”) segments. Year-to-date Highlights Net sales in the first nine months of fiscal 2021 decreased $209.1 million, or 14 percent, from the same period last year, primarily due to lower sales in our HDE, CIS and Automotive segments. Cost of sales decreased $186.1 million, or 15 percent, from the same period last year, primarily due to lower sales volume. Gross profit decreased $23.0 million and gross margin improved 70 basis points to 16.2 percent. SG&A expenses decreased $42.8 million, primarily due to lower project costs associated with our review of strategic alternatives for the automotive segment businesses and preparing the liquid-cooled automotive business for sale. In addition, SG&A expenses benefitted from cost-reduction initiatives implemented earlier in the fiscal year in response to the negative impacts of COVID-19. The operating loss of $83.4 million during the first nine months of fiscal 2021 represents a decline of $115.7 million from the prior-year operating income of $32.3 million, primarily due to the $134.4 million of impairment charges recorded during the third quarter of fiscal 2021, partially offset by lower SG&A expenses. CONSOLIDATED RESULTS OF OPERATIONS The following table presents our consolidated financial results on a comparative basis for the three and nine months ended December 31, 2020 and 2019: Three months ended December 31, Nine months ended December 31, 2020 2019 2020 2019 (in millions) $'s % of sales $'s % of sales $'s % of sales $'s % of sales Net sales $ 484.3 100.0 % $ 473.4 100.0 % $ 1,293.5 100.0 % $ 1,502.6 100.0 % Cost of sales 401.6 82.9 % 399.9 84.5 % 1,083.9 83.8 % 1,270.0 84.5 % Gross profit 82.7 17.1 % 73.5 15.5 % 209.6 16.2 % 232.6 15.5 % Selling, general and administrative expenses 56.1 11.6 % 63.5 13.4 % 151.6 11.7 % 194.4 12.9 % Restructuring expenses 0.9 0.2 % 2.6 0.6 % 7.0 0.5 % 6.7 0.4 % Impairment charges 134.4 27.8 % - - 134.4 10.4 % - - Gain on sale of assets - - (0.8 ) -0.2 % - - (0.8 ) - Operating (loss) income (108.7 ) -22.5 % 8.2 1.7 % (83.4 ) -6.5 % 32.3 2.1 % Interest expense (4.6 ) -0.9 % (5.6 ) -1.2 % (15.2 ) -1.2 % (17.3 ) -1.2 % Other (expense) income – net (0.5 ) -0.1 % 0.1 - (1.0 ) -0.1 % (2.3 ) -0.2 % (Loss) earnings before income taxes (113.8 ) -23.5 % 2.7 0.6 % (99.6 ) -7.7 % 12.7 0.8 % Provision for income taxes (81.6 ) -16.8 % (1.7 ) -0.4 % (95.3 ) -7.4 % (8.3 ) -0.5 % Net (loss) earnings $ (195.4 ) -40.3 % $ 1.0 0.2 % $ (194.9 ) -15.1 % $ 4.4 0.3 % Comparison of Three Months ended December 31, 2020 and 2019 Third quarter net sales of $484.3 million were $10.9 million, or 2 percent, higher than the third quarter of the prior year, primarily due to higher sales volume in the HDE and BHVAC segments and an $11.2 million favorable impact of foreign currency exchange rate changes, partially offset by lower sales volume in the CIS and Automotive segments. Sales in the HDE, BHVAC, and Automotive segments increased $20.7 million, $3.8 million, and $3.4 million, respectively. CIS segment sales decreased $18.5 million. 27 Table of Contents Third quarter cost of sales increased $1.7 million. As a percentage of sales, cost of sales decreased 160 basis points to 82.9 percent. The increase in cost of sales was primarily due to a $9.7 million unfavorable impact of foreign currency exchange rate changes, partially offset by the favorable impacts of procurement and other cost-reduction initiatives and a $3.0 million decrease in depreciation expense in the Automotive segment. In addition, program and equipment transfer costs to prepare the liquid-cooled automotive business for sale decreased approximately $1.0 million compared with the prior year. As a result of higher sales and lower cost of sales as a percentage of sales, third quarter gross profit increased $9.2 million and gross margin improved 160 basis points to 17.1 percent. Third quarter SG&A expenses decreased $7.4 million. The decrease in SG&A expenses was primarily due to lower costs recorded at Corporate associated with our review of strategic alternatives for the Automotive segment’s business operations, which decreased approximately $10.0 million. This favorable driver was partially offset by a $1.0 million unfavorable impact of foreign currency exchange rate changes and higher environmental charges in the HDE segment. Restructuring expenses of $0.9 million during the third quarter of fiscal 2021 decreased $1.7 million, primarily due to lower restructuring expenses in the HDE segment. Impairment charges of $134.4 million in the third quarter of fiscal 2021 primarily related to the write-down of the long-lived assets in the Automotive segment’s liquid-cooled automotive business in connection with the pending sale of that business. The operating loss of $108.7 million represents a $116.9 million decline from the prior-year operating income of $8.2 million. The decline was primarily due to the $134.4 million of impairment charges recorded in the Automotive segment and lower earnings in the CIS segment. These negative drivers were partially offset by higher earnings in our HDE and BHVAC segments. Interest expense decreased $1.0 million, or 18 percent, during the third quarter of fiscal 2021, primarily due to lower outstanding long-term debt and, to a lesser extent, favorable changes in interest rates. The provision for income taxes was $81.6 million and $1.7 million in the third quarter of fiscal 2021 and 2020, respectively. The $79.9 million increase was primarily due to income tax charges totaling $116.5 million recorded in the third quarter of fiscal 2021 to increase the valuation allowances on deferred tax assets in the U.S. and in certain foreign jurisdictions, partially offset by income tax benefits totaling $37.7 million related to the impairment charges recorded earlier in the third quarter of fiscal 2021. Comparison of Nine Months ended December 31, 2020 and 2019 Fiscal 2021 year-to-date net sales of $1,293.5 million were $209.1 million, or 14 percent, lower than the same period last year, primarily due to lower sales in our HDE, CIS and Automotive segments. Sales in these segments decreased $93.8 million, $87.4 million, and $53.9 million, respectively, and were significantly impacted by market-driven volume declines and temporary plant closures earlier in the fiscal year due to the COVID-19 pandemic. BHVAC segment sales increased $8.3 million. Fiscal 2021 year-to-date cost of sales of $1,083.9 million decreased $186.1 million, or 15 percent, primarily due to lower sales volume. As a percentage of sales, cost of sales improved 70 basis points to 83.8 percent. The unfavorable impact of lower sales volume was more than offset by the benefits of cost-reduction initiatives implemented earlier in the fiscal year in response to lower end market demand and procurement initiatives. 28 Table of Contents As a result of lower sales and lower cost of sales as a percentage of sales, fiscal 2021 year-to-date gross profit decreased $23.0 million and gross margin improved 70 basis points to 16.2 percent. Fiscal 2021 year-to-date SG&A expenses decreased $42.8 million. The decrease in SG&A expenses was primarily due to lower costs recorded at Corporate associated with our review of strategic alternatives for the Automotive segment’s business operations, which decreased approximately $29.0 million, and lower compensation-related expenses, which decreased approximately $18.0 million. These favorable drivers were partially offset by $5.9 million of costs recorded at Corporate in connection with Mr. Burke stepping down from his position as President and CEO and the search for his successor. Restructuring expenses of $7.0 million during the first nine months of fiscal 2021 increased $0.3 million compared with the same period last year, primarily due to higher restructuring expenses in the CIS segment, partially offset by lower restructuring expenses in the Automotive segment. The fiscal 2021 year-to-date operating loss of $83.4 million represents a $115.7 million decline from the prior-year operating income of $32.3 million. The decline was primarily due to the $134.4 million of impairment charges recorded in the Automotive segment and lower earnings in our CIS and HDE segments. These negative drivers were partially offset by lower SG&A expenses at Corporate and higher earnings in our BHVAC segment. Interest expense decreased $2.1 million, or 12 percent, during the first nine months of fiscal 2021, primarily due to lower outstanding long-term debt and favorable changes in interest rates. The provision for income taxes was $95.3 million and $8.3 million during the first nine months of fiscal 2021 and 2020, respectively. The $87.0 million increase was primarily due to income tax charges totaling $123.1 million recorded during the first nine months of fiscal 2021 to increase the valuation allowances on deferred tax assets in the U.S. and in certain foreign jurisdictions, partially offset by income tax benefits totaling $37.7 million related to the impairment charges recorded during fiscal 2021. SEGMENT RESULTS OF OPERATIONS Effective April 1, 2020, we began managing our global automotive business separate from the other businesses within the previously-reported Vehicular Thermal Solutions (“VTS”) segment. We have been managing the automotive business as the Automotive segment as we target the sale or eventual exit of its underlying automotive business operations. We are managing the other businesses of the VTS segment, including the commercial vehicle and off-highway businesses, as the Heavy Duty Equipment segment. We began reporting financial results for our new segment structure beginning for fiscal 2021. Segment financial information for fiscal 2020 has been recast to conform to the fiscal 2021 presentation. The segment realignment had no impact on the CIS and BHVAC segments. 29 Table of Contents The following is a discussion of our segment results of operations for the three and nine months ended December 31, 2020 and 2019: Commercial and Industrial Solutions Three months ended December 31, Nine months ended December 31, 2020 2019 2020 2019 (in millions) $'s % of sales $'s % of sales $'s % of sales $'s % of sales Net sales $ 129.0 100.0 % $ 147.5 100.0 % $ 385.6 100.0 % $ 473.0 100.0 % Cost of sales 116.4 90.2 % 124.8 84.6 % 338.2 87.7 % 403.1 85.2 % Gross profit 12.6 9.8 % 22.7 15.4 % 47.4 12.3 % 69.9 14.8 % Selling, general and administrative expenses 13.8 10.7 % 13.7 9.3 % 39.1 10.2 % 42.8 9.1 % Restructuring expenses 0.5 0.4 % 0.7 0.5 % 4.4 1.1 % 1.3 0.3 % Operating (loss) income $ (1.7 ) -1.3 % $ 8.3 5.6 % $ 3.9 1.0 % $ 25.8 5.4 % Comparison of Three Months ended December 31, 2020 and 2019 CIS net sales decreased $18.5 million, or 13 percent, from the third quarter of fiscal 2020 to the third quarter of fiscal 2021, primarily due to lower sales volume of data center cooling products, partially offset by a $4.5 million favorable impact of foreign currency exchange rate changes. Sales to data center cooling customers decreased $18.4 million, primarily due to lower sales to one individual customer. CIS cost of sales decreased $8.4 million, or 7 percent, from the third quarter of fiscal 2020 to the third quarter of fiscal 2021, primarily due to lower sales volume, partially offset by a $4.2 million unfavorable impact of foreign currency exchange rate changes. As a percentage of sales, cost of sales increased 560 basis points to 90.2 percent, primarily due to the impact of lower sales volume, unfavorable sales mix, and to a lesser extent, temporary operating inefficiencies associated with plant consolidation activities in China. These negative impacts were partially offset by benefits from procurement and other cost-reduction initiatives. As a result of the lower sales and higher cost of sales as a percentage of sales, gross profit decreased $10.1 million and gross margin declined 560 basis points to 9.8 percent. SG&A expenses increased $0.1 million, or 140 basis points as a percentage of sales, compared with the third quarter of the prior year. The increase in SG&A expenses was primarily due to a $0.5 million unfavorable impact of foreign currency exchange rate changes, partially offset by lower compensation-related expenses. Restructuring expenses during the third quarter of fiscal 2021 totaled $0.5 million, a decrease of $0.2 million compared with the third quarter of fiscal 2020, and primarily consisted of equipment transfer and plant consolidation costs in China. The CIS operating loss of $1.7 million represents a $10.0 million decline from the prior-year operating income of $8.3 million and was primarily due to lower gross profit. Comparison of Nine Months ended December 31, 2020 and 2019 CIS year-to-date net sales decreased $87.4 million, or 18 percent, from the same period last year, primarily due to lower sales volume associated with the impacts of the COVID-19 pandemic. In addition, sales in fiscal 2021 have been negatively impacted by lower sales to a significant data center customer. Sales to commercial HVAC&R and data center cooling customers decreased $48.1 million and $41.1 million, respectively. 30 Table of Contents CIS year-to-date cost of sales decreased $64.9 million, or 16 percent, from the same period last year, primarily due to lower sales volume. As a percentage of sales, cost of sales increased 250 basis points to 87.7 percent, primarily due to the impact of lower sales volume and unfavorable sales mix, partially offset by cost-reduction and procurement initiatives. As a result of the lower sales and higher cost of sales as a percentage of sales, gross profit decreased $22.5 million and gross margin declined 250 basis points to 12.3 percent. CIS year-to-date SG&A expenses decreased $3.7 million compared with the prior year. The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased approximately $5.0 million, partially offset by a $0.6 million unfavorable impact of foreign currency exchange rate changes. Restructuring expenses during the first nine months of fiscal 2021 increased $3.1 million compared with the prior year and primarily consisted of severance expenses and equipment transfer costs related to plant consolidation activities in China and targeted headcount reductions in North America. Operating income decreased $21.9 million to $3.9 million, primarily due to lower gross profit and higher restructuring expenses, partially offset by lower SG&A expenses. Building HVAC Systems Three months ended December 31, Nine months ended December 31, 2020 2019 2020 2019 (in millions) $'s % of sales $'s % of sales $'s % of sales $'s % of sales Net sales $ 68.7 100.0 % $ 64.9 100.0 % $ 178.2 100.0 % $ 169.9 100.0 % Cost of sales 43.0 62.7 % 41.8 64.5 % 116.3 65.3 % 115.4 67.9 % Gross profit 25.7 37.3 % 23.1 35.5 % 61.9 34.7 % 54.5 32.1 % Selling, general and administrative expenses 9.9 14.3 % 9.6 14.7 % 25.9 14.5 % 26.9 15.8 % Operating income $ 15.8 23.1 % $ 13.5 20.8 % $ 36.0 20.2 % $ 27.6 16.2 % Comparison of Three Months ended December 31, 2020 and 2019 BHVAC net sales increased $3.8 million, or 6 percent, from the third quarter of fiscal 2020 to the third quarter of fiscal 2021, primarily due to higher sales in the U.S. and the U.K., which both increased approximately $2.0 million. The higher sales in the U.S. were primarily due to higher sales of heating products, partially offset by lower sales of ventilation products. The higher sales in the U.K. were primarily due to higher sales of air conditioning and data center cooling products. BHVAC cost of sales increased $1.2 million, or 3 percent, from the third quarter of fiscal 2020 to the third quarter of fiscal 2021, primarily due to higher sales volume. As a percentage of sales, cost of sales decreased 180 basis points to 62.7 percent and was positively impacted by favorable customer pricing and sales mix. As a result of the higher sales and lower cost of sales as a percentage of sales, gross profit increased $2.6 million and gross margin improved 180 basis points to 37.3 percent. SG&A expenses increased $0.3 million from the prior year, yet decreased 40 basis points as a percentage of sales. The increase in SG&A expenses was primarily due to higher compensation-related expenses, including commission expenses. 31 Table of Contents Operating income of $15.8 million increased $2.3 million during the quarter, primarily due to higher gross profit. Comparison of Nine Months ended December 31, 2020 and 2019 BHVAC year-to-date net sales increased $8.3 million, or 5 percent, from the same period last year, primarily due to higher sales volume. Compared with the first nine months of the prior year, sales increased $9.2 million in the U.K. and decreased $0.9 million in the U.S. The higher sales in the U.K. were primarily due to higher sales of data center products. The lower sales in the U.S. resulted primarily from the negative impacts of the COVID-19 pandemic and decreased sales of ventilation products, partially offset by higher sales of heating products. BHVAC year-to-date cost of sales increased $0.9 million from the same period last year. As a percentage of sales, cost of sales decreased 260 basis points to 65.3 percent and was positively impacted by favorable customer pricing, sales mix and cost-reduction initiatives. As a result of higher sales and lower cost of sales as a percentage of sales, gross profit increased $7.4 million and gross margin improved 260 basis points to 34.7 percent. BHVAC year-to-date SG&A expenses decreased $1.0 million, or 130 basis points as a percentage of sales, from the prior year. The decrease in SG&A expenses was primary due to lower travel expenses. Operating income of $36.0 million increased $8.4 million compared with the same period last year, primarily due to higher gross profit and lower SG&A expenses. Heavy Duty Equipment Three months ended December 31, Nine months ended December 31, 2020 2019 2020 2019 (in millions) $'s % of sales $'s % of sales $'s % of sales $'s % of sales Net sales $ 185.6 100.0 % $ 164.9 100.0 % $ 474.7 100.0 % $ 568.5 100.0 % Cost of sales 159.6 86.0 % 148.1 89.8 % 413.8 87.2 % 496.8 87.4 % Gross profit 26.0 14.0 % 16.8 10.2 % 60.9 12.8 % 71.7 12.6 % Selling, general and administrative expenses 13.2 7.1 % 12.6 7.7 % 35.4 7.4 % 42.3 7.4 % Restructuring expenses - - 1.4 0.8 % 1.9 0.4 % 2.2 0.4 % Operating income $ 12.8 6.8 % $ 2.8 1.7 % $ 23.6 5.0 % $ 27.2 4.8 % Comparison of Three Months ended December 31, 2020 and 2019 HDE net sales increased $20.7 million, or 13 percent, from the third quarter of fiscal 2020 to the third quarter of fiscal 2021, primarily due to higher sales volume to global off-highway customers. Sales to off-highway and commercial vehicle customers increased $16.7 million and $3.8 million, respectively. Geographically, sales increased most significantly in Asia. HDE cost of sales increased $11.5 million, or 8 percent, from the third quarter of fiscal 2020 to the third quarter of fiscal 2021, primarily due to higher sales volume. As a percentage of sales, cost of sales decreased 380 basis points to 86.0 percent and was favorably impacted by the higher sales volume, cost savings from procurement and other cost-reduction initiatives, and, to a lesser extent, improved operating efficiencies. As a result of the higher sales and lower cost of sales as a percentage of sales, gross profit increased $9.2 million and gross margin improved 380 basis points to 14.0 percent. 32 Table of Contents SG&A expenses increased $0.6 million, yet decreased 60 basis points as a percentage of sales, compared with the third quarter of the prior year. The increase in SG&A expenses was primarily due to environmental charges related to a previously-owned U.S. manufacturing facility, which increased $0.4 million. Restructuring expenses decreased $1.4 million compared with the third quarter of fiscal 2020, primarily due to lower severance expenses related to targeted headcount reductions. Operating income of $12.8 million increased $10.0 million during the quarter, primarily due to higher gross profit and lower restructuring expenses. Comparison of Nine Months ended September 30, 2020 and 2019 HDE year-to-date net sales decreased $93.8 million, or 16 percent, from the same period last year, primarily due to lower sales volume resulting from the impacts of the COVID-19 pandemic, which were most severe in the Americas and Europe during the first half of the fiscal year. Sales to commercial vehicle and automotive and light vehicle customers decreased $57.2 million and $15.2 million, respectively. HDE year-to-date cost of sales decreased $83.0 million, or 17 percent, primarily due to lower sales volume. As a percentage of sales, cost of sales decreased 20 basis points to 87.2 percent. The significant unfavorable impact of the lower sales volume was more than offset by favorable impacts from improved operating efficiencies and cost savings from procurement and other cost-reduction initiatives. As a result of the lower sales and lower cost of sales as a percentage of sales, gross profit decreased $10.8 million and gross margin improved 20 basis points to 12.8 percent. HDE year-to-date SG&A expenses decreased $6.9 million from the prior year. The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased approximately $6.0 million, and cost-reduction initiatives, including lower travel expenses. Restructuring expenses during the first nine months of fiscal 2021 totaled $1.9 million, a decrease of $0.3 million compared with the same period last year, and primarily consisted of severance expenses resulting from targeted headcount reductions in North America. Operating income of $23.6 million decreased $3.6 million compared with the same period last year, primarily due to lower gross profit, partially offset by lower SG&A expenses. 33 Table of Contents Automotive Three months ended December 31, Nine months ended December 31, 2020 2019 2020 2019 (in millions) $'s % of sales $'s % of sales $'s % of sales $'s % of sales Net sales $ 113.9 100.0 % $ 110.5 100.0 % $ 285.9 100.0 % $ 339.8 100.0 % Cost of sales 95.5 83.9 % 98.3 89.0 % 246.1 86.1 % 302.1 88.9 % Gross profit 18.4 16.1 % 12.2 11.0 % 39.8 13.9 % 37.7 11.1 % Selling, general and administrative expenses 8.5 7.4 % 11.2 10.2 % 25.5 8.9 % 33.6 9.9 % Restructuring expenses 0.4 0.4 % 0.2 0.2 % 0.6 0.2 % 2.9 0.8 % Impairment charges 134.4 118.0 % - - 134.4 47.0 % - - Gain on sale of assets - - (0.8 ) -0.8 % - - (0.8 ) -0.2 % Operating (loss) income $ (124.9 ) -109.7 % $ 1.6 1.4 % $ (120.7 ) -42.2 % $ 2.0 0.6 % Comparison of Three Months ended December 31, 2020 and 2019 Automotive net sales increased $3.4 million, or 3 percent, from the third quarter of fiscal 2020 to the third quarter of fiscal 2021, primarily due to a $6.7 million favorable impact of foreign currency exchange rate changes, partially offset by lower sales volume. Compared with the prior year, sales increased $3.8 million and $2.0 million in Europe and Asia, respectively, and decreased $2.4 million in the Americas. Automotive cost of sales decreased $2.8 million, or 3 percent, from the third quarter of fiscal 2020 to the third quarter of fiscal 2021. As a percentage of sales, cost of sales decreased 510 basis points to 83.9 percent. Compared with the prior year, cost of sales was favorably impacted by lower depreciation expenses, which decreased approximately $3.0 million, cost savings from procurement and other cost-reduction initiatives, and improved operating efficiencies. The lower depreciation expenses resulted from the Company ceasing depreciation of the long-lived assets within the liquid-cooled automotive business when it was classified as held for sale in November 2020. Foreign currency exchange rate changes negatively impacted cost of sales by $5.7 million. As a result of the higher sales and lower cost of sales as a percentage of sales, gross profit increased $6.2 million and gross margin improved 510 basis points to 16.1 percent. SG&A expenses decreased $2.7 million compared with the third quarter of the prior year. The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased approximately $2.0 million. Restructuring expenses during the third quarter of fiscal 2021 totaled $0.4 million and primarily consisted of severance expenses resulting from targeted headcount reductions in Europe. Impairment charges during the third quarter of fiscal 2021 totaled $134.4 million and primarily related to assets in the liquid-cooled automotive business. Upon classifying this business as held for sale during the third quarter, we identified an implied loss in excess of the carrying value of its long-lived assets. Accordingly, we reduced the liquid-cooled automotive business’s long-lived assets, primarily property, plant and equipment, to zero. During the third quarter of fiscal 2020, we completed the sale of a previously-closed manufacturing facility in Germany and, as a result, recorded a gain of $0.8 million. The Automotive operating loss of $124.9 million in the third quarter of fiscal 2021, as compared with operating income of $1.6 million in the third quarter of the prior year, was significantly impacted by the large impairment charges associated with the liquid-cooled automotive business and, to a much lesser extent, higher gross profit and lower SG&A expenses. 34 Table of Contents Comparison of Nine Months ended December 31, 2020 and 2019 Automotive year-to-date net sales decreased $53.9 million, or 16 percent, from the same period last year, primarily due to lower sales volume largely resulting from the impacts of the COVID-19 pandemic, partially offset by a $9.7 million favorable impact of foreign currency exchange rate changes. Sales in Europe and North America decreased $46.8 million and $13.0 million, respectively. Sales in Asia increased $5.9 million. Automotive year-to-date cost of sales decreased $56.0 million, or 19 percent, from the prior year, primarily due to lower sales volume, partially offset by an $8.2 million unfavorable impact of foreign currency exchange rate changes. As a percentage of sales, cost of sales decreased 280 basis points to 86.1 percent and was favorably impacted by improved operating efficiencies, cost savings from procurement initiatives, and lower depreciation expenses of approximately $4.0 million, partially offset by the unfavorable impact of lower sales volume. As a result of the lower sales and lower cost of sales as a percentage of sales, gross profit increased $2.1 million and gross margin improved 280 basis points to 13.9 percent. Automotive year-to-date SG&A expenses decreased $8.1 million compared with the prior year. The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased approximately $8.0 million. Restructuring expenses during the first nine months of fiscal 2021 totaled $0.6 million, a decrease of $2.3 million compared with the same period in the prior year. The decrease was primarily driven by lower severance expenses in Europe resulting from fewer targeted headcount reductions. The Automotive operating loss of $120.7 million during the first nine months of fiscal 2021, as compared with operating income of $2.0 million during the same period last year, was significantly impacted by the large impairment charges associated with the liquid-cooled automotive business during the third quarter of fiscal 2021 and, to a much lesser extent, higher gross profit and lower SG&A expenses and restructuring charges. Liquidity and Capital Resources Our primary sources of liquidity are cash flow from operating activities, our cash and cash equivalents of $72.9 million as of December 31, 2020, and an available borrowing capacity of $213.6 million under our revolving credit facility. Given our extensive international operations, approximately $59.0 million of our cash and cash equivalents is 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 the COVID-19 pandemic, we have taken actions to reduce operating and administrative expenses, conserve cash and maximize liquidity. In addition, as described below, we have focused on reducing our capital expenditures and executed amendments to our primary credit agreements to provide financial covenant flexibility during fiscal 2021 and 2022. We believe our sources of liquidity, including cash flow from operations, our cash and cash equivalents, and access to both committed and uncommitted credit facilities, will provide sufficient cash flow to meet our obligations during the next twelve months and beyond. However, we are continuing to monitor the impacts of COVID-19 on our business and the credit and financial markets. 35 Table of Contents Net Cash Provided by Operating Activities Net cash provided by operating activities for the nine months ended December 31, 2020 was $146.5 million, which represents a $100.6 million increase compared with the same period in the prior year. This increase in operating cash flow was primarily due to favorable net changes in working capital and lower payments for separation and project costs associated with our review of strategic alternatives for the automotive businesses. The favorable changes in working capital during the first nine months of fiscal 2021, compared with the same period in the prior year, included lower inventory levels and lower payments for incentive compensation, employee benefits, income taxes and payroll taxes. In addition, we have deferred payments of U.S. payroll taxes, as permitted by the Coronavirus Aid, Relief and Economic Security Act. We plan to resume payment of these payroll taxes during the fourth quarter of fiscal 2021. Capital Expenditures In response to the economic impacts of the COVID-19 pandemic, we have been focused on reducing our capital expenditures and, where possible, have delayed certain projects and the purchase of certain program-related equipment and tooling in our vehicular businesses. Capital expenditures of $23.7 million during the first nine months of fiscal 2021 decreased $34.5 million compared with the same period in the prior year. Debt Our credit agreements require us to maintain compliance with various covenants, including a leverage ratio covenant and an interest expense coverage ratio covenant discussed further below. Also, 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. In May 2020, we executed amendments to our primary credit agreements in the U.S. to provide additional covenant flexibility in light of the risks and uncertainties associated with the COVID-19 pandemic. Under the amended agreements, the leverage ratio covenant limit has been temporarily raised. 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, in relation to our consolidated net earnings before interest, taxes, depreciation, amortization, and certain other adjustments (“Adjusted EBITDA”). The leverage ratio covenant limit is 5.75 to 1 for the fourth quarter of fiscal 2021. 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 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 December 31, 2020, we were in compliance with our debt covenants; our leverage ratio and interest coverage ratio were 1.9 and 8.7, respectively. We expect to remain in compliance with our debt covenants during fiscal 2021, fiscal 2022 and beyond. Share Repurchase Program On November 5, 2020, we announced our Board of Directors approved a two-year, $50.0 million share repurchase program, which allows us to repurchase shares of our common stock through solicited and unsolicited transactions in the open market or in privately-negotiated or other transactions, at such times and prices and upon such other terms as we deem appropriate. To date, we have not repurchased shares under this program. Our decision whether and to what extent to repurchase shares under this program will depend on a number of factors, including business conditions, other cash priorities, and stock price. 36 Table of Contents Forward-Looking Statements This report, including, but not limited to, the discussion under Item 2. 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 the Company’s Annual Report on Form 10-K for the year ended March 31, 2020. 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 the U.S. or abroad, as well as continuing uncertainty 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 components 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, 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, the concentration of sales within our CIS segment attributable to one customer, and the potential impact on us from any deterioration in the stability or performance of any of our major customers; 37 Table of Contents • The impact of any 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; • The impact of product or manufacturing difficulties or operating inefficiencies, including any program launch and product transfer challenges and warranty claims and delays or inefficiencies resulting from restrictions imposed in response to the COVID-19 pandemic; • The impact of any 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 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. 38 Table of Contents Strategic Risks: • Our ability to successfully complete the pending sale of our liquid-cooled automotive business, including the receipt of governmental and third-party approvals and satisfaction of other closing conditions, and our ability to successfully exit our other automotive businesses in a manner that is in the best interest of our shareholders; • 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 HDE and Automotive businesses; • Our ability to identify and execute growth and diversification opportunities in order to position us for long-term success; and • The potential impacts from any 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 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. 39 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk. The Company’s quantitative and qualitative disclosures about market risk are incorporated by reference from Part II, Item 7A. of the Company’s Annual Report on Form 10-K for the year ended March 31, 2020. The Company’s market risks have not materially changed since the fiscal 2020 Form 10-K was filed.