What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-08-05 compared with 2020-02-05 · 156 added, 185 removed, 68 unchanged (83% of the section changed)

2 unchanged sentences

Our fiscal year ends on March 31 and, accordingly, all references to quarters refer to our fiscal quarters.

The quarter ended December 31, 2019 was the third quarter of fiscal 2020.

Third Quarter Highlights

Net sales in the third quarter of fiscal 2020 decreased $67.6 million, or 12 percent, from the third quarter of fiscal 2019, primarily due to lower sales in our Vehicular Thermal Solutions (“VTS”) and Commercial and Industrial Solutions (“CIS”) operating segments, largely driven by weakness in key end markets.

Foreign currency exchange rate changes negatively impacted sales in third quarter of fiscal 2020 by $7.1 million.

Cost of sales decreased $49.4 million, or 11 percent, from the third quarter of fiscal 2019, primarily due to lower sales volume.

Gross profit decreased $18.2 million and gross margin declined 140 basis points to 15.5 percent.

Selling, general and administrative (“SG&A”) expenses increased $6.3 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 $11.0 million compared with the third quarter of fiscal 2019.

Operating income during the third quarter of fiscal 2020 decreased $25.4 million to $8.2 million, primarily due to lower gross profit and higher SG&A expenses.

Year-to-date Highlights

Net sales in the first nine months of fiscal 2020 decreased $153.4 million, or 9 percent, from the same period last year, primarily due to lower sales in our VTS and CIS operating segments, partially offset by higher sales in our Building HVAC Systems (“BHVAC”) segment.

Foreign currency exchange rate changes negatively impacted sales in the first nine months of fiscal 2020 by $35.8 million.

Cost of sales decreased $112.1 million, or 8 percent, from the same period last year, primarily due to lower sales volume.

The quarter ended June 30, 2020 was the first quarter of fiscal 2021.

As the COVID-19 pandemic continues, the health and overall well-being of our employees continues to be our top priority.

We have implemented strict measures to mitigate risk in our manufacturing operations and administrative offices, including face masks, social distancing, and enhanced sanitation protocols.

We are also committed to meeting our customers’ needs and will work to overcome any obstacles that may arise to deliver quality products and services to our customers in a timely manner.

The COVID-19 pandemic and the resulting broad economic impacts on our key end markets negatively impacted our business operations and financial results during the first quarter of fiscal 2021.

In March and April 2020, we suspended production at many manufacturing facilities around the world due to local government requirements or customer shutdowns.

Although we have since reopened all of the temporarily-closed facilities, we are currently operating approximately half of our facilities at reduced production levels based upon customer demand.

In an effort to mitigate the negative impacts of COVID-19 on our financial results, we have taken actions that are yielding significant cost savings, including, but not limited to, production staffing adjustments, furloughs, shortened work weeks, and temporary salary reductions at all levels of our organization.

We have also taken advantage of government assistance programs, primarily offered in European countries, to offset idle labor costs and to avoid employee layoffs to the extent possible.

In addition, we have reduced operating and administrative expenses, including travel and entertainment expenditures, and lowered the annual compensation paid to the Board of Directors.

We are also focused on reducing capital expenditures and, where possible, have delayed certain projects and the purchase of some program-related equipment and tooling.

First Quarter Highlights

Net sales in the first quarter of fiscal 2021 decreased $181.2 million, or 34 percent, from the first quarter of fiscal 2020, primarily due to lower sales in our Heavy Duty Equipment (“HDE”), Automotive, and Commercial and Industrial Solutions (“CIS”) segments.

Sales in each of these segments were significantly impacted by market-driven volume declines and the temporary plant closures described above related to the COVID-19 pandemic.

Cost of sales decreased $143.9 million, or 32 percent, from the first quarter of fiscal 2020, primarily due to lower sales volume.

Gross profit decreased $37.3 million and gross margin declined 250 basis points to 13.3 percent.

SG&A expenses increased $14.5 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 $32.0 million compared with the first nine months of fiscal 2019.

Operating income during the first nine months of fiscal 2020 decreased $58.9 million to $32.3 million, primarily due to lower gross profit and higher SG&A expenses.

We previously announced our evaluation of strategic alternatives for the automotive business within our VTS segment.

We are committed to exiting this business in a manner that is in the best interest of our shareholders and are evaluating all alternatives.

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 working towards the separation of 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.

Selling, general and administrative (“SG&A”) expenses decreased $18.8 million, primarily due to cost-reduction initiatives in response to the negative impacts of COVID-19 and lower project costs associated with our review of strategic alternatives for the automotive business, which decreased approximately $8.0 million compared with the first quarter of fiscal 2020.

The operating loss during the first quarter of fiscal 2021 of $3.2 million represents a $21.3 million decline from the prior-year operating income of $18.1 million and was primarily due to lower earnings in our HDE, Automotive, and CIS segments, partially offset by increased earnings in our Building HVAC Systems (“BHVAC”) segment.

We previously reported that we had paused our evaluation of strategic alternatives for the automotive business in light of the impacts of the COVID-19 pandemic and vehicular market weakness.

We resumed this process during the first quarter of fiscal 2021 and are committed to exiting the automotive business in a manner that is in the best interest of our shareholders.

Recent Announcement

On August 4, 2020, we announced that Thomas A.

Burke stepped down from his position as President and Chief Executive Officer ( “CEO” ) and as a member of Modine ’s Board of Directors, effective immediately.

The Board of Directors has launched a search for Mr.

Burke ’s successor and has named Michael B.

Lucareli, our Vice President, Finance and Chief Financial Officer, as Interim President and CEO.

As a result of Mr.

Burke ’s departure and based upon the terms of his employment agreement, we expect to record severance expense during the second quarter of fiscal 2021 of approximately $5.0 million, to be paid on a bi-weekly basis over the next three years.

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, 2019 and 2018:

Three months ended December 31,

Nine months ended December 31,

The following table presents our consolidated financial results on a comparative basis for the three months ended June 30, 2020 and 2019:

Three months ended June 30,

(in millions)

2 unchanged sentences

Restructuring expenses

Impairment charge

(Gain) loss on sale of assets

Operating income

Operating (loss) income

Interest expense

Other income (expense) – net

Earnings before income taxes

(Provision) benefit for income taxes

Comparison of Three Months Ended December 31, 2019 and 2018

Third quarter net sales of $473.4 million were $67.6 million, or 12 percent, lower than the third quarter of the prior year, primarily due to lower sales in our VTS and CIS segments and a $7.1 million unfavorable impact of foreign currency exchange rate changes.

Sales decreased $51.4 million and $19.5 million in our VTS and CIS segments, respectively.

Sales increased $0.7 million in our BHVAC segment.

Third quarter cost of sales decreased $49.4 million, or 11 percent, primarily due to lower sales volume and a $6.3 million favorable impact of foreign currency exchange rate changes.

As a percentage of sales, cost of sales increased 140 basis points to 84.5 percent and was negatively impacted by approximately 100 basis points due to higher labor and inflationary costs.

In addition, we recorded approximately $2.0 million of costs at Corporate for program and equipment transfers associated with the separation of the VTS segment’s automotive business in preparation of a potential sale.

As a result of lower sales and higher cost of sales as a percentage of sales, third quarter gross profit decreased $18.2 million and gross margin declined 140 basis points to 15.5 percent.

Third quarter SG&A expenses increased $6.3 million.

The increase in SG&A expenses was primarily due to separation and project costs recorded at Corporate associated with our review of strategic alternatives for the VTS segment’s automotive business, which increased approximately $11.0 million.

These costs primarily related to accounting, legal, and IT professional services, including costs associated with the separation of the automotive business from the VTS segment’s other businesses and preparation for a potential sale.

This increase was partially offset by lower compensation-related expenses, including incentive compensation, which decreased approximately $3.0 million.

Restructuring expenses totaled $2.6 million in the third quarter of fiscal 2020 and primarily consisted of severance expenses related to targeted headcount reductions in support of our objective to reduce operational and SG&A cost structures.

In January 2020, we approved additional headcount reductions in Europe and North America within the VTS segment and, as a result, expect to record approximately $4.0 million of severance expenses during the fourth quarter of fiscal 2020.

During the third quarter of fiscal 2019, we recorded a $0.4 million asset impairment charge within the CIS segment related to a previously-closed manufacturing facility in Austria.

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 within the VTS segment.

Operating income of $8.2 million in the third quarter of fiscal 2020 decreased $25.4 million compared with the third quarter of fiscal 2019.

This decrease was primarily due to an increase of approximately $13.0 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 $11.2 million and $4.8 million, respectively.

The provision for income taxes was $1.7 million and $8.6 million in the third quarter of fiscal 2020 and 2019, respectively.

The $6.9 million decrease was primarily due to lower operating earnings, the absence of a $3.1 million income tax charge recorded in the prior year related to the Tax Cuts and Jobs Act (the “Tax Act”), and an income tax benefit recognized in the current year for a tax incentive in Italy.

These factors, which lowered our tax provision compared with the prior year, were partially offset by a $3.0 million income tax charge for a valuation allowance on certain U.S.

deferred tax assets, a net income tax charge of $2.7 million resulting from legal entity restructuring in preparation for a potential sale of our automotive business, and the absence of income tax benefits recorded in the prior year related to foreign tax credits and a manufacturing deduction in the U.S.

Comparison of Nine Months Ended December 31, 2019 and 2018

Fiscal 2020 year-to-date net sales of $1,502.6 million were $153.4 million, or 9 percent, lower than the same period last year, primarily due to lower sales in our VTS and CIS segments and a $35.8 million unfavorable impact of foreign currency exchange rate changes, partially offset by higher sales in our BHVAC segment.

Sales decreased $114.0 million and $56.1 million in our VTS and CIS segments, respectively.

Sales increased $10.0 million in our BHVAC segment.

Fiscal 2020 year-to-date cost of sales of $1,270.0 million decreased $112.1 million, or 8 percent, primarily due to lower sales volume and a $30.8 million favorable impact of foreign currency exchange rate changes.

As a percentage of sales, cost of sales increased 100 basis points to 84.5 percent and was negatively impacted by approximately 90 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 20 basis points.

The favorable material costs primarily resulted from lower commodity pricing, which more than offset the negative impacts of tariffs.

As a result of lower sales and higher cost of sales as a percentage of sales, fiscal 2020 year-to-date gross profit decreased $41.3 million and gross margin declined 100 basis points to 15.5 percent.

Fiscal 2020 year-to-date SG&A expenses increased $14.5 million.

The increase in SG&A was primarily due to separation and project costs recorded at Corporate associated with our review of strategic alternatives for the VTS segment’s automotive business, which increased approximately $32.0 million.

This increase was partially offset by lower compensation-related expenses, which decreased approximately $9.0 million, lower environmental charges related to previously-owned manufacturing facilities in the U.S., which decreased approximately $2.0 million, and a $3.2 million favorable impact from foreign currency exchange rate changes.

Restructuring expenses of $6.7 million during the first nine months of fiscal 2020 increased $6.0 million compared with the same period last year, primarily due to higher severance expenses related to targeted headcount reductions.

Operating income of $32.3 million during the first nine months of fiscal 2020 decreased $58.9 million compared with the same period last year.

This decrease was primarily due to an increase of approximately $32.0 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 $26.1 million and $13.4 million, respectively, partially offset by higher earnings in our BHVAC segment, which increased $6.6 million.

The provision for income taxes was $8.3 million during the first nine months of fiscal 2020, compared with a benefit for income taxes of $9.3 million during the same period in the prior year.

The $17.6 million change was primarily due to the absence of income tax benefits totaling $24.7 million recorded in the prior year and income tax charges totaling $5.7 million in the current year, partially offset by lower operating earnings in the first nine months of fiscal 2020.

The $24.7 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 $5.7 million of income tax charges in fiscal 2020 were comprised of a $3.0 million charge to establish a valuation allowance on certain U.S.

deferred tax assets and a net $2.7 million charge associated with legal entity restructuring.

Other expense – net

(Loss) earnings before income taxes

Benefit (provision) for income taxes

Net (loss) earnings

First quarter net sales of $347.8 million were $181.2 million, or 34 percent, lower than the first quarter of the prior year, primarily due to lower sales volume in our HDE, Automotive, and CIS segments.

Sales in these segments decreased $92.9 million, $51.5 million, and $46.3 million, respectively, and were significantly impacted by market-driven volume declines and temporary plant closures due to the COVID-19 pandemic.

First quarter cost of sales decreased $143.9 million, or 32 percent, primarily due to lower sales volume.

Cost of sales was favorably impacted by the benefits of cost-reduction initiatives in response to lower end market demand and procurement initiatives.

As a percentage of sales, cost of sales increased 250 basis points to 86.7 percent, primarily due to the unfavorable impact of the lower sales volume.

As a result of lower sales and higher cost of sales as a percentage of sales, first quarter gross profit decreased $37.3 million and gross margin declined 250 basis points to 13.3 percent.

First quarter SG&A expenses decreased $18.8 million.

The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased approximately $10.0 million, and lower costs recorded at Corporate associated with our review of strategic alternatives for the Automotive segment’s business operations, which decreased approximately $8.0 million.

The lower compensation-related expenses resulted primarily from our cost-reduction initiatives aimed to mitigate the negative impacts of COVID-19.

Restructuring expenses totaled $4.6 million in the first quarter of fiscal 2021 and primarily consisted of severance expenses in the CIS and HDE segments.

The severance expenses related to targeted headcount reductions in support of our objective to reduce operational and SG&A cost structures and plant consolidation activities.

The operating loss of $3.2 million represents a $21.3 million decline from the prior-year operating income of $18.1 million and was primarily due to lower earnings in our HDE, CIS, and Automotive segments, partially offset by increased earnings in our BHVAC segment.

The benefit for income taxes was $0.2 million during the first quarter of fiscal 2021, compared with a provision for income taxes of $2.9 million during the first quarter of the prior year.

The $3.1 million change was primarily due to lower earnings and changes in the mix of foreign and U.S.

SEGMENT RESULTS OF OPERATIONS

The following is a discussion of our segment results of operations for the three and nine months ended December 31, 2019 and 2018:

Vehicular Thermal Solutions

Three months ended December 31,

Nine months ended December 31,

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 are 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.

The following is a discussion of our segment results of operations for the three months ended June 30, 2020 and 2019:

Commercial and Industrial Solutions

Three months ended June 30,

(in millions)

2 unchanged sentences

Restructuring expenses

Gain on sale of assets

Operating income

Comparison of Three Months Ended December 31, 2019 and 2018

VTS net sales decreased $51.4 million, or 16 percent, from the third quarter of fiscal 2019 to the third quarter of fiscal 2020, primarily due to lower sales volume, a $4.9 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 and off-highway customers decreased $23.7 million and $19.1 million, respectively.

These sales declines largely resulted from weakness in global vehicular markets and the planned wind-down of certain commercial vehicle programs.

VTS cost of sales decreased $38.9 million, or 14 percent, from the third quarter of fiscal 2019 to the third quarter of fiscal 2020, primarily due to lower sales volume and a $4.3 million favorable impact of foreign currency exchange rate changes.

As a percentage of sales, cost of sales increased 220 basis points to 89.4 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 110 basis points and 80 basis points, respectively.

Higher depreciation costs, primarily resulting from recent manufacturing capacity expansion in China and Hungary, also negatively impacted cost of sales to a lesser extent.

These negative impacts were partially offset by improved operating efficiencies and cost savings from procurement initiatives.

As a result of the lower sales and higher cost of sales as a percentage of sales, gross profit decreased $12.5 million and gross margin declined 220 basis points to 10.6 percent.

SG&A expenses decreased $1.7 million compared with the prior year yet increased 80 basis points as a percentage of sales.

The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased approximately $2.0 million, and a $0.5 million favorable impact of foreign currency exchange rate changes, partially offset by the absence of a $1.1 million recovery of environmental investigation costs from a prior property owner received in the prior year.

Restructuring expenses during the third quarter of fiscal 2020 totaled $1.6 million and primarily consisted of severance expenses resulting from targeted headcount reductions in North America.

In January 2020, we approved additional headcount reductions in Europe and North America and, as a result, expect to record approximately $4.0 million of severance expenses during the fourth quarter of fiscal 2020.

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.

Operating income decreased $11.2 million to $4.3 million during the third quarter, primarily due to lower gross profit and higher restructuring expenses, partially offset by lower SG&A expenses and the $0.8 million gain on sale of the closed manufacturing facility in Germany.

Comparison of Nine Months Ended December 31, 2019 and 2018

VTS year-to-date net sales decreased $114.0 million, or 11 percent, from the same period last year, primarily due to lower sales volume, a $23.6 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 customers in Europe decreased $60.6 million and sales to off-highway customers in Asia and North America decreased $21.4 million and $14.4 million, respectively.

VTS year-to-date cost of sales decreased $83.2 million, or 10 percent, primarily due to lower sales volume and a $20.4 million favorable impact of foreign currency exchange rate changes.

As a percentage of sales, cost of sales increased 160 basis points to 87.8 percent.

Higher depreciation costs, primarily resulting from recent manufacturing capacity expansion in China and Hungary, 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.

CIS net sales decreased $46.3 million, or 27 percent, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021, primarily due to lower sales volume resulting from the impacts of the COVID-19 pandemic.

Sales to commercial HVAC&R and data center cooling customers decreased $37.0 million and $10.4 million, respectively.

CIS cost of sales decreased $37.5 million, or 26 percent, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021, primarily due to lower sales volume.

As a percentage of sales, cost of sales increased 180 basis points to 87.4 percent, primarily due to the unfavorable impact of lower sales volume, partially offset by cost-reduction initiatives and favorable sales mix.

As a result of the lower sales and higher cost of sales as a percentage of sales, gross profit decreased $8.8 million and gross margin declined 180 basis points to 12.6 percent.

VTS year-to-date SG&A expenses decreased $8.5 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 $6.0 million, lower environmental charges related to previously-owned manufacturing facilities in the U.S, which decreased approximately $2.0 million, and a $2.0 million favorable impact of foreign currency exchange rate changes.

Restructuring expenses during the first nine months of fiscal 2020 increased $4.6 million, primarily due to higher severance expenses resulting from targeted headcount reductions in Europe and in the Americas.

Operating income decreased $26.1 million to $29.0 million, primarily due to lower gross profit and higher restructuring expenses, partially offset by lower SG&A expenses and the $0.8 million gain on sale of the closed manufacturing facility in Germany.

Commercial and Industrial Solutions

Three months ended December 31,

Nine months ended December 31,

SG&A expenses decreased $2.0 million compared with the first 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 first quarter of fiscal 2021 totaled $2.4 million and primarily consisted of severance expenses related to plant consolidation activities in China and targeted headcount reductions in North America.

Operating income decreased $9.0 million, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021, primarily due to lower gross profit and higher restructuring expenses, partially offset by lower SG&A expenses.

Building HVAC Systems

Three months ended June 30,

(in millions)

1 unchanged sentence

Selling, general and administrative expenses

Restructuring expenses

Impairment charge

Operating income

Comparison of Three Months Ended December 31, 2019 and 2018

CIS net sales decreased $19.5 million, or 12 percent, from the third quarter of fiscal 2019 to the third quarter of fiscal 2020, primarily due to lower sales volume and a $2.3 million unfavorable impact of foreign currency exchange rate changes.

Sales to commercial HVAC&R and data center cooling customers decreased $10.3 million and $10.0 million, respectively.

CIS cost of sales decreased $14.0 million, or 10 percent, from the third quarter of fiscal 2019 to the third quarter of fiscal 2020, primarily due to lower sales volume and a $1.9 million favorable impact of foreign currency exchange rate changes.

As a percentage of sales, cost of sales increased 150 basis points to 84.6 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 $5.5 million and gross margin declined 150 basis points to 15.4 percent.

SG&A expenses decreased $0.9 million compared with the prior year yet increased 50 basis points as a percentage of sales.

The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased $0.6 million, and cost-control initiatives.

Restructuring expenses during the third quarter of fiscal 2020 totaled $0.7 million and primarily consisted of severance expenses resulting from targeted headcount reductions and equipment transfer and plant consolidation costs.

During the third quarter of fiscal 2019, we recorded a $0.4 million asset impairment charge related to a previously-closed manufacturing facility in Austria.

Operating income decreased $4.8 million to $8.3 million during the third quarter, primarily due to lower gross profit, partially offset by lower SG&A expenses.

Comparison of Nine Months Ended December 31, 2019 and 2018

CIS year-to-date net sales decreased $56.1 million, or 11 percent, from the same period last year, primarily due to lower sales volume and a $10.2 million unfavorable impact of foreign currency exchange rate changes.

Sales to data center cooling and commercial HVAC&R customers decreased $29.2 million and $26.4 million, respectively.

CIS year-to-date cost of sales decreased $40.9 million, or 9 percent, primarily due to lower sales volume and an $8.7 million favorable foreign currency exchange rate impact.

As a percentage of sales, cost of sales increased 130 basis points to 85.2 percent, primarily due to the unfavorable impact of lower sales volume and unfavorable sales mix.

BHVAC net sales decreased $1.4 million, or 3 percent, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021 and were negatively impacted by the COVID-19 pandemic.

Compared with the first quarter of the prior year, BHVAC sales decreased $3.1 million in the U.S.

and increased $1.7 million in the U.K.

The lower sales in the U.S.

were primarily driven by decreased sales of heating and ventilation products.

The higher sales in the U.K.

were primarily due to higher sales of data center products, partially offset by lower sales of air conditioning products.

BHVAC cost of sales decreased $2.2 million, or 6 percent, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021.

As a percentage of sales, cost of sales decreased 260 basis points to 69.5 percent and was positively impacted by favorable customer pricing, cost-reduction initiatives and lower material costs.

As a result of the lower sales and lower cost of sales as a percentage of sales, gross profit increased $0.8 million and gross margin improved 260 basis points to 30.5 percent.

SG&A expenses decreased $1.0 million, or 170 basis points as a percentage of sales, from the prior year.

The decrease in SG&A expenses was primarily due to lower compensation-related expenses and lower travel expenses.

Operating income of $7.1 million increased $1.8 million during the quarter, primarily due to higher gross profit and lower SG&A expenses.

Heavy Duty Equipment

Three months ended June 30,

(in millions)

Cost of sales

Selling, general and administrative expenses

Restructuring expenses

Operating (loss) income

HDE net sales decreased $92.9 million, or 43 percent, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021, primarily due to lower sales volume resulting from the impacts of the COVID-19 pandemic.

Sales to commercial vehicle, off-highway, and automotive customers decreased $46.4 million, $16.8 million, and $13.8 million, respectively.

These sales declines, which were most significant in the Americas and Europe, largely resulted from weakness in the global vehicular markets.

In addition, the planned wind-down of certain programs contributed, to a lesser extent, to the lower sales to commercial vehicle customers.

HDE cost of sales decreased $71.7 million, or 39 percent, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021, primarily due to lower sales volume.

As a percentage of sales, cost of sales increased 580 basis points to 90.8 percent.

The significant unfavorable impact of the lower sales volume was partially offset by improved operating efficiencies and cost savings 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 $21.2 million and gross margin declined 580 basis points to 9.2 percent.

CIS year-to-date SG&A expenses decreased $2.5 million compared with the prior year yet increased 50 basis points as a percentage of sales.

The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased approximately $1.0 million, a $0.9 million favorable impact of foreign currency exchange rate changes, and cost-control initiatives.

Restructuring expenses during the first nine months of fiscal 2020 increased $1.1 million, primarily due to higher equipment transfer and plant consolidation costs.

Operating income decreased $13.4 million to $25.8 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,

SG&A expenses decreased $2.9 million compared with the first 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, and lower travel expenses.

Restructuring expenses during the first quarter of fiscal 2021 totaled $1.9 million and primarily consisted of severance expenses resulting from targeted headcount reductions in North America.

The operating loss of $2.5 million represents a $19.8 million decline from the prior-year operating income of $17.3 million and was primarily due to lower gross profit, partially offset by lower SG&A expenses.

Three months ended June 30,

(in millions)

1 unchanged sentence

Selling, general and administrative expenses

Loss on sale of assets

Operating income

Comparison of Three Months Ended December 31, 2019 and 2018

BHVAC net sales increased $0.7 million, or 1 percent, from the third quarter of fiscal 2019 to the third quarter of fiscal 2020, primarily due to higher sales in the U.S., which increased $2.3 million, partially offset by lower sales in the U.K., which decreased $1.6 million.

The higher sales in the U.S.

were primarily driven by increased sales of heating and ventilation products.

The lower sales in the U.K.

were primarily due to lower sales of air conditioning and ventilation products.

BHVAC cost of sales decreased $0.4 million, or 1 percent, from the third quarter of fiscal 2019 to the third quarter of fiscal 2020.

As a percentage of sales, cost of sales decreased 120 basis points to 64.5 percent and was positively impacted by favorable sales mix and customer pricing.

As a result of the higher sales and lower cost of sales as a percentage of sales, gross profit increased $1.1 million and gross margin improved 120 basis points to 35.5 percent.

SG&A expenses increased $0.6 million, or 70 basis points as a percentage of sales, from the prior year.

The increase in SG&A expenses was primarily due to higher compensation-related expenses, including commission expenses resulting from the increased sales in the U.S.

Operating income of $13.5 million increased $0.5 million, primarily due to higher gross profit, partially offset by higher SG&A expenses.

Comparison of Nine Months Ended December 31, 2019 and 2018

BHVAC year-to-date net sales increased $10.0 million, or 6 percent, from the same period last year, primarily due to higher sales volume, partially offset by a $2.2 million unfavorable impact of foreign currency exchange rate changes.

Sales of ventilation and heating products in the U.S.

increased $7.6 million and $5.5 million, respectively.

BHVAC year-to-date cost of sales increased $4.1 million, or 4 percent, from the same period last year, primarily due to higher sales volume, partially offset by a $1.8 million favorable impact of foreign currency exchange rate changes.

As a percentage of sales, cost of sales decreased 170 basis points to 67.9 percent, primarily due to favorable sales mix and customer pricing.

As a result of the higher sales and lower cost of sales as a percentage of sales, gross profit increased $5.9 million and gross margin improved 170 basis points to 32.1 percent.

BHVAC year-to-date SG&A expenses increased $1.0 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 resulting from the increased sales.

During the second quarter of fiscal 2019, we sold our business in South Africa and, as a result, recorded a loss of $1.7 million.

Operating income of $27.6 million increased $6.6 million, primarily due to higher gross profit and the loss on sale of our South African business in the prior year.

Restructuring expenses

Operating (loss) income

Automotive net sales decreased $51.5 million, or 45 percent, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021, primarily due to lower sales volume resulting from the impacts of the COVID-19 pandemic.

Sales in Europe and North America decreased $43.4 million and $9.9 million, respectively.

Automotive cost of sales decreased $43.8 million, or 43 percent, from the first quarter of fiscal 2020 to the first quarter of fiscal 2021, primarily due to lower sales volume.

As a percentage of sales, cost of sales increased 330 basis points to 92.3 percent.

The significant unfavorable impact of the lower sales volume was partially offset by improved operating efficiencies and favorable raw material costs.

As a result of the lower sales and higher cost of sales as a percentage of sales, gross profit decreased $7.7 million and gross margin declined 330 basis points to 7.7 percent.

SG&A expenses decreased $2.9 million compared with the first quarter of the prior year.

The decrease in SG&A expenses was primarily due to lower compensation-related expenses, which decreased approximately $3.0 million.

Restructuring expenses during the first quarter of fiscal 2021 totaled $0.2 million and primarily consisted of severance expenses resulting from targeted headcount reductions in Europe.

The operating loss of $3.8 million represents a $3.8 million decline from the prior-year operating income of less than $0.1 million and was primarily due to lower gross profit, partially offset by lower SG&A and restructuring expenses.

Liquidity and Capital Resources

Our primary sources of liquidity are cash flow from operating activities, our cash and cash equivalents as of December 31, 2019 of $36.2 million, and an available borrowing capacity of $135.4 million under our revolving credit facility.

Our primary sources of liquidity are cash flow from operating activities, our cash and cash equivalents as of June 30, 2020 of $77.2 million, and an available borrowing capacity of $118.4 million under our revolving credit facility.

Given our extensive international operations, approximately $57.0 million of our cash and cash equivalents are held by our non-U.S.

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however, these funds may be subject to foreign withholding taxes if repatriated.

We have not encountered, and do not expect to encounter, any difficulty meeting the liquidity requirements of our global operations.

Net cash provided by operating activities for the nine months ended December 31, 2019 was $45.9 million, which represents a $21.5 million decrease compared with $67.4 million of net cash provided by operating activities during the same period 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 during the first nine months of fiscal 2020, compared with the same period in the prior year, included lower employee benefit and incentive compensation payments.

Capital expenditures of $58.2 million during the first nine months of fiscal 2020 decreased $0.5 million compared with the same period in the prior year and included approximately $4.0 million of capital investments associated with preparing for the potential sale of our automotive business.

On January 31, 2020, we issued $100.0 million of 5.9 percent Senior Notes with repayments ending in fiscal 2029.

We used the proceeds from the new notes to prepay the $73.0 million principal balance of the 6.8 percent Senior Notes, which were scheduled to mature in August 2020, and to repay a portion of the borrowings on our revolving credit facility.

Our debt 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, under our primary debt agreements in the U.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, to no more than three and one-quarter times consolidated net earnings before interest, taxes, depreciation, amortization, and certain other adjustments (“Adjusted EBITDA”).

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 have reduced operating and administrative expenses.

Further, as described below, we are focused on reducing our capital expenditures and executed amendments to our primary credit agreements to help ensure liquidity through 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 uncommittted 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.

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.

Net Cash Provided by Operating Activities

Net cash provided by operating activities for the three months ended June 30, 2020 was $12.3 million, which represents an $11.8 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 business, partially offset by lower operating earnings in the current year.

The favorable changes in working capital during the first three months of fiscal 2021, compared with the same period in the prior year, included lower payments for incentive compensation, employee benefits, income taxes and payroll taxes.

We have deferred, and expect to continue to defer, payments of payroll taxes, as permitted by the Coronavirus Aid, Relief and Economic Security Act.

Capital Expenditures

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 and, where possible, have delayed certain projects and the purchase of certain program-related equipment and tooling in our vehicular businesses.

Capital expenditures of $9.1 million during the first three months of fiscal 2021 decreased $11.2 million compared with the same period in the prior year.

Our credit agreements require us to maintain compliance with various covenants, including a leverage ratio covenant and an interest expense coverage ratio covenant further discussed 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.

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.

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”).

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 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, 2019, our leverage ratio and interest coverage ratio were 2.3 and 8.4, respectively.

We were in compliance with our debt covenants as of December 31, 2019 and expect to remain in compliance during the balance of fiscal 2020 and beyond.

As of June 30, 2020, we were in compliance with our debt covenants;

our leverage ratio and interest coverage ratio were 2.9 and 7.0, respectively.

We expect to remain in compliance with our debt covenants during fiscal 2021 and beyond.

Forward-Looking Statements

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Market Risks:

Economic, social and political conditions, changes, challenges and unrest, particularly in the geographic, product and financial markets where we and our customers and suppliers operate and compete, including, in particular, foreign currency exchange rate fluctuations, tariffs (and potential trade war impacts 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, and the general uncertainties about the impact of regulatory and/or policy changes, including those related to tax and trade, that have been or may be implemented in the United States or by its trade partners, as well as continuing uncertainty regarding the short- and long-term implications of “Brexit”;

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);

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 component inventory including, but not limited to, increases in the underlying material cost based upon the London Metal Exchange and related premiums or fabrication costs.

These prices may be impacted by a variety of factors, including changes in trade laws and tariffs and the behavior of our suppliers.

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;

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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;

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;

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Strategic Risks:

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 successfully separate and sell our automotive business within our VTS segment at a price that is sufficient to maximize the value of the business, and in order to optimize the segment’s future financial performance;

Our ability to successfully exit the automotive business 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 identify and execute growth and diversification opportunities in order to position us for long-term success;

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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 an unexpected disruption in or tightening of the credit markets or extended recessionary conditions in the global economy;

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 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 maintain our leverage ratio (net debt divided by Adjusted EBITDA, as defined in our credit agreements) in our target range of 1.5 to 2.5 in an efficient manner;

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;

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we do not assume any obligation to update any forward-looking statements.

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, 2019.

The Company’s market risks have not materially changed since the fiscal 2019 Form 10-K was filed.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis