Item 7A. Quantitative and Qualitative Disclosures About Market Risk
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 in Brazil, Canada, China, India, Mexico, and throughout Europe. We also have joint ventures in
China and South Korea. We sell and distribute products throughout the world and also purchase raw materials from suppliers in foreign countries. As a result, our financial results are affected by changes in foreign currency exchange rates and
economic conditions in the foreign markets in which we do business. Whenever possible, we attempt to mitigate foreign currency risks on transactions with customers and suppliers in foreign countries by entering into contracts that are denominated in
the functional currency of the entity engaging in the transaction. In addition, for certain transactions that are denominated in a currency other than the engaging entity’s functional currency, we may enter into
foreign currency derivative contracts to further manage our foreign currency risk. In fiscal 2024, we recorded a net gain of less than $1 million within our statement of operations related to foreign currency derivative contracts. In
addition, our consolidated financial results are impacted by the translation of revenue and expenses in foreign currencies into U.S. dollars. These translation impacts are primarily affected by changes in exchange rates between the U.S. dollar and
European currencies, primarily the euro and the British pound sterling, the Brazilian real, and the Chinese yuan. In fiscal 2024, approximately 49 percent of our sales were generated in countries outside the U.S. A change in foreign currency exchange
rates will positively or negatively affect our sales; however, this impact will be offset, usually to a large degree, with a corresponding effect on our cost of sales and other expenses. In fiscal 2024, changes in foreign currency exchange rates
favorably impacted our sales by $28 million; however, the impact on our operating income was only $4 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 2024, there would not have been a material impact on our fiscal 2024 earnings.
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We maintain foreign currency-denominated debt obligations and intercompany loans that are subject to foreign currency exchange risk. We seek to mitigate this risk through maintaining offsetting positions between external and intercompany loans;
however, from time to time, we also enter into foreign currency derivative contracts to manage the currency exchange rate exposure. These derivative instruments are typically not accounted for as hedges, and
accordingly, gains or losses on the derivatives are recorded in other income and expense in the consolidated statements of operations and typically offset the foreign currency changes on the outstanding loans.
Interest Rate Risk
We seek to reduce the potential volatility of earnings that could arise from changes in interest rates. We generally utilize a mixture of debt maturities and both fixed-rate and variable-rate debt to manage exposure to changes in interest rates.
Interest on both our term loans and borrowings under our multi-currency revolving credit facility, including swingline borrowings, is variable and is currently based on either SOFR or EURIBOR, plus 137.5 to 175 basis points, depending on our leverage
ratio. As a result, we are subject to risk of fluctuations in SOFR and EURIBOR and changes in our leverage ratio, which would affect the variable interest rate on our term loans and revolving credit facility and could create variability in interest
expense.
As of March 31, 2024, our outstanding borrowings on variable-rate term loans and the revolving credit facility totaled $205 million and $92 million, respectively. Based upon our outstanding debt with variable interest rates at March 31, 2024, a
100-basis point increase in interest rates would increase our annual interest expense in fiscal 2025 by approximately $3 million.
Commodity Price and Supply Risk
To produce the products we sell, we purchase raw materials and supplies including aluminum, copper, steel and stainless steel (nickel), brass, refrigerants, and gases such as natural gas, helium, and nitrogen. In addition, we also purchase
components and parts that are integrated into our end products.
We seek to mitigate commodity price risk primarily by adjusting product pricing in response to applicable price increases. Our contracts with certain customers contain provisions that provide for prospective price adjustments based upon changes in
raw material prices. These prospective price adjustments generally lag behind the actual raw material price fluctuations by three months or longer, and the contract provisions are limited to the underlying material cost based upon a relevant pricing
source, such as the London Metal Exchange, American Metal Market, or Platts index, and typically exclude additional cost elements, such as related metals premiums and fabrication. In instances where the risk is not
covered contractually, we seek to adjust product pricing in response to price increases, including through our quotation process and through price list increases. Nevertheless, we are still subject to the risk of price increases on commodities,
components, and other goods and services that we purchase.
We regularly engage with our suppliers to ensure availability of purchased commodities and components. While the global supply chain challenges that were widespread in fiscal 2023 have largely eased and we do not currently
anticipate significant shortages or delays from our key suppliers, we are subject to supply risk. We use a limited number of supply sources for certain components, including aluminum, copper, steel and stainless steel (nickel) and are exposed to the
risk that our suppliers may not be able or willing to meet our supply requirements due to strong customer demand, as they may not be able to increase their output capacity as quickly as customers increase their orders, or the potential effects of trade
laws and tariffs, capacity constraints, financial instability, or other circumstances.
We also purchase parts from suppliers that use our tooling to create the parts. In most instances, and for financial reasons, we do not have duplicate tooling for the manufacture of the purchased parts. As a result, we are exposed to the risk of a
supplier being unable to provide the quantity or quality of parts that we require. Even in situations where suppliers are manufacturing parts without the use of our tooling, we face the challenge of obtaining consistently high-quality parts from
suppliers that are financially stable. We manage supplier risk by leveraging internal and third-party tools to identify and mitigate higher-risk supplier situations.
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Credit Risk
Credit risk represents the possibility of loss from a customer failing to make payment according to contract terms. Our principal credit risk consists of outstanding trade accounts receivable. At March 31, 2024, 35 percent of our trade accounts
receivable was concentrated with our top ten customers. These customers operate primarily in the commercial vehicle, off-highway, automotive and light vehicle, data center cooling, and commercial air conditioning and refrigeration markets and are
influenced by similar market and general economic factors. In the past, credit losses from our customers have not been significant, nor have we experienced a significant increase in credit losses in connection with the current inflationary market
conditions.
We manage credit risk through a focus on the following:
•
Cash and investments – We review cash deposits and short-term investments to ensure banks have acceptable credit ratings, and short-term investments are maintained in secured or guaranteed
instruments. We consider our holdings in cash and investments to be stable and secure at March 31, 2024;
•
Trade accounts receivable – Prior to granting credit, we evaluate each customer, taking into consideration the customer’s financial condition, payment experience and credit information. After credit
is granted, we actively monitor the customer’s financial condition and applicable business news;
•
Pension assets – We have retained outside advisors to assist in the management of the assets in our pension plans. In making investment decisions, we utilize an established risk management protocol
that focuses on protection of the plan assets against downside risk. We ensure that investments within these plans provide appropriate diversification, the investments are monitored by investment teams, and portfolio managers adhere to the
established investment policies. We believe the plan assets are subject to appropriate investment policies and controls; and
•
Insurance – We monitor our insurance providers to ensure they maintain financial ratings that are acceptable to us. We have not identified any concerns in this regard based upon our reviews.
In addition, we are exposed to risks associated with price reduction pressure applied by OEM customers. If contractual price downs are unavoidable, we contemplate them in our overall strategy and adjust pricing as necessary to provide profit
margins that are acceptable to us.
Economic and Market Risk
Economic risk represents the possibility of loss resulting from economic instability in certain areas of the world, such as that caused by geopolitical uncertainly or pandemics, or downturns in markets in which we operate. We sell a broad range of
thermal solution systems to customers operating in diverse markets, including the commercial, industrial, and building HVAC&R, data center cooling and commercial vehicle, off-highway, and automotive and light vehicle markets.
Considering our global presence, we also encounter risks imposed by potential trade restrictions, including tariffs, embargoes, sanctions, and the like. We continue to pursue non-speculative opportunities to mitigate these economic risks, and
capitalize, when possible, on changing market conditions. We pursue new market opportunities after careful consideration of the potential associated risks and benefits. Successes in new markets are dependent upon our ability to commercialize our
investments. Current examples of new and emerging markets for us include those related to electric vehicles, data centers, indoor air quality, and Gensets. Our investments in these areas are subject to the risks associated with technological success,
customer and market acceptance, and our ability to meet the demands of our customers as these markets grow.
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