NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2022
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying (a) Condensed Consolidated Balance Sheet of Regal Rexnord Corporation (the “Company”), as of January 1, 2022, which has been derived from audited Consolidated Financial Statements, and (b) unaudited interim Condensed Consolidated Financial Statements as of March 31, 2022 and for the three months ended March 31, 2022 and April 3, 2021, have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading.
It is suggested that these Condensed Consolidated Financial Statements be read in conjunction with the Consolidated Financial Statements and the Notes thereto included in the Company’s 2021 Annual Report on Form 10-K filed on March 2, 2022.
In the opinion of management, all adjustments considered necessary for a fair presentation of financial results have been made. Except as otherwise discussed, such adjustments consist of only those of a normal recurring nature. Operating results for the three months ended March 31, 2022 are not necessarily indicative of the results that may be expected for the entire fiscal year ending December 31, 2022.
The Condensed Consolidated Financial Statements have been prepared in accordance with GAAP, which requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the Condensed Consolidated Financial Statements and revenues and expenses during the periods reported. Actual results could differ from those estimates. The Company uses estimates in accounting for, among other items, allowance for doubtful accounts; excess and obsolete inventory; share-based compensation; acquisitions; product warranty obligations; pension and post retirement assets and liabilities; derivative fair values; goodwill and other asset impairments; health care reserves; retirement benefits; rebates and incentives; litigation claims and contingencies, including environmental matters; and income taxes. The Company accounts for changes to estimates and assumptions when warranted by factually based experience.
Effective for fiscal year 2022, the Company approved a change in the fiscal year end from a 52-53 week year ending on the Saturday closest to December 31 to a calendar year ending on December 31. The Company made the fiscal year change on a prospective basis and did not adjust operating results for prior periods. While this change will impact the comparability of future results with each of the fiscal quarters and the annual fiscal period in 2022, the impact is not expected to be material to our quarterly or annual results.
Change in Accounting Principle
As of January 2, 2022, the Company changed its methodology for valuing certain inventories to the first-in, first-out ("FIFO") cost method from the last-in, first-out ("LIFO") cost method. The effects of this change have been retrospectively applied to all periods presented. See Note 2 for additional information.
Recently Issued Accounting Standards
In October 2021, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") ASU 2021-08, Business Combinations (Topic 805) Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The ASU improves the accounting for acquired revenue contracts with customers in a business combination. This ASU becomes effective for fiscal years beginning after December 31, 2022, with early adoption permitted. The Company is evaluating the effect of adopting this new accounting guidance.
2. OTHER FINANCIAL INFORMATION
Inventories
As of January 2, 2022, the Company changed its method for valuing certain inventories to the FIFO cost method from the LIFO cost method. The Company believes that this change in accounting is preferable as it provides a better matching of costs and revenues, more closely resembles the physical flow of inventory, better reflects acquisition cost of inventory on the balance sheet, conforms the Company's method of inventory valuation to a single method, results in improved comparability with industry peers and reduces the administrative burden of determining the LIFO valuation.
The effects of this change have been retrospectively applied to all periods presented. This change resulted in an increase to retained earnings of $38.4 million as of January 2, 2021.
In addition, certain financial statement line items in our Condensed Consolidated Statements of Operations and Condensed Consolidated Statements of Cash Flows for the three months ended April 3, 2021 and our Condensed Consolidated Balance Sheet as of January 1, 2022, were adjusted as follows (dollars in millions):
| | | | | | | | | | | | | | | | | | | | |
| | As Originally Reported | | Effect of Change | | As Adjusted |
| Condensed Consolidated Statement of Operations for the three months ended April 3, 2021 | | | | | | |
| Cost of Sales | | $ | 568.7 | | | $ | (4.4) | | | $ | 564.3 | |
| Provision for Income Taxes | | $ | 20.2 | | | $ | 1.1 | | | $ | 21.3 | |
| Net income attributable to Regal Rexnord Corporation | | $ | 65.6 | | | $ | 3.3 | | | $ | 68.9 | |
| | | | | | |
| Earnings Per Share Attributable to Regal Rexnord Corporation: | | | | | | |
| Basic | | $ | 1.62 | | | $ | 0.08 | | | $ | 1.70 | |
| Assuming Dilution | | $ | 1.60 | | | $ | 0.08 | | | $ | 1.68 | |
| | | | | | |
| Condensed Consolidated Balance Sheet as of January 1, 2022 | | | | | | |
| Inventories | | $ | 1,106.6 | | | $ | 85.8 | | | $ | 1,192.4 | |
| Deferred Income Taxes | | $ | 652.0 | | | $ | 27.7 | | | $ | 679.7 | |
| Retained Earnings | | $ | 1,854.5 | | | $ | 58.1 | | | $ | 1,912.6 | |
| | | | | | |
| Condensed Consolidated Statement of Cash Flows for the three months ended April 3, 2021 | | | | | | |
| Net Income | | $ | 67.0 | | | $ | 3.3 | | | $ | 70.3 | |
| Change in Operating Assets and Liabilities | | $ | (64.1) | | | $ | (3.3) | | | $ | (67.4) | |
| | | | | | |
| Condensed Consolidated Statement of Comprehensive Income for the three months ended April 3, 2021 | | | | | | |
| Comprehensive income attributable to Regal Rexnord Corporation | | $ | 50.4 | | | $ | 3.3 | | | $ | 53.7 | |
The following table presents approximate percentage distribution between major classes of inventories inclusive of the accounting method change discussed above:
| | | | | | | | | | | |
| March 31, 2022 | | January 1, 2022 |
| Raw Material and Work in Process | 47.8% | | 43.4% |
| Finished Goods and Purchased Parts | 52.2% | | 56.6% |
Inventories are stated at cost, which is not in excess of market. All inventory is valued using the FIFO cost method.
Property, Plant, and Equipment
The following table presents property, plant, and equipment by major classification (dollars in millions):
| | | | | | | | | | | | | | | | | |
| Useful Life in Years | | March 31, 2022 | | January 1, 2022 |
| Land and Improvements | | | $ | 108.7 | | | $ | 109.1 | |
| Buildings and Improvements | 3 - 50 | | 420.9 | | | 449.6 | |
| Machinery and Equipment | 3 - 15 | | 1,162.9 | | | 1,164.8 | |
| Property, Plant and Equipment | | | 1,692.5 | | | 1,723.5 | |
| Less: Accumulated Depreciation | | | (839.8) | | | (815.0) | |
| Net Property, Plant and Equipment | | | $ | 852.7 | | | $ | 908.5 | |
For the three months ended March 31, 2022 and April 3, 2021, the Company recognized no material asset impairments.
Revenue Recognition
The Company recognizes revenue from the sale of electric motors, electrical motion controls, power generation and power transmission products. The Company recognizes revenue when control of the product passes to the customer or the service is provided and is recognized at an amount that reflects the consideration expected to be received in exchange for such goods or services.
Nature of Goods and Services
The Company sells products with multiple applications as well as customized products that have a single application such as those manufactured for its OEM customers. The Company reports in four operating segments: Commercial Systems, Industrial Systems, Climate Solutions and Motion Control Solutions. See Note 6 for a description of the different segments.
Nature of Performance Obligations
The Company’s contracts with customers typically consist of purchase orders, invoices and master supply agreements. At contract inception, across all four segments, the Company assesses the goods and services promised in its sales arrangements with customers and identifies a performance obligation for each promise to transfer to the customer a good or service that is distinct. The Company’s primary performance obligations consist of product sales and customized system/solutions.
Product:
The nature of products varies from segment to segment but across all segments, individual products are not integrated and represent separate performance obligations.
Customized system/solutions:
The Company provides customized system/solutions which consist of multiple products engineered and designed to specific customer specification, combined or integrated into one combined solution for a specific customer application. The goods are transferred to the customer and revenue is typically recognized over time as the performance obligations are satisfied.
When Performance Obligations are Satisfied
For performance obligations related to substantially all of the Company's product sales, the Company determines that the customer obtains control upon shipment and recognizes revenue accordingly. Once a product has shipped, the customer is able to direct the use of, and obtain substantially all of the remaining benefits from the asset. The Company considers control to have transferred upon shipment because the Company has a present right to payment at that time, the customer has legal title to the asset, the Company has transferred physical possession of the asset, and the customer has significant risks and rewards of ownership of the asset.
For a limited number of contracts, the Company transfers control and recognizes revenue over time. The Company satisfies its performance obligations over time and the Company uses a cost-based input method to measure progress. In applying the cost-based method of revenue recognition, the Company uses actual costs incurred to date relative to the total estimated costs for the contract in conjunction with the customer's commitment to perform in determining the amount of revenue and cost to recognize. The Company has determined that the cost-based input method provides a faithful depiction of the transfer of goods to the customer.
Payment Terms
The arrangement with the customer states the final terms of the sale, including the description, quantity, and price of each product or service purchased. Payment terms vary by customer but typically range from due upon delivery to 120 days after delivery. For contracts recognized at a point in time, revenue and billing typically occur simultaneously. The Company generally has payment terms with its customers of one year or less and has elected the practical expedient applicable to such contracts not to consider the time value of money. For contracts recognized using the cost-based input method, revenue recognized in excess of customer billings and billings in excess of revenue recognized are reviewed to determine the net asset or net liability position and classified as such on the Condensed Consolidated Balance Sheets.
Returns, Refunds, and Warranties
The Company’s contracts do not explicitly offer a “general” right of return to its customers (e.g., customers ordered excess products and return unused items). Warranties are classified as either assurance type or service type warranties. A warranty is considered an assurance type warranty if it provides the customer with assurance that the product will function as intended. A warranty that goes above and beyond ensuring basic functionality is considered a service type warranty. The Company generally only offers limited warranties which are considered to be assurance type warranties and are not accounted for as separate performance obligations. Customers generally receive repair or replacement on products that do not function to specification. Estimated product warranties are provided for specific product groups and the Company accrues for estimated future warranty cost in the period in which the sale is recognized. The Company estimates the accrual requirements based on historical warranty loss experience and the cost is included in Cost of Sales.
Volume Rebates
In some cases, the nature of the Company’s contract may give rise to variable consideration including volume based sales incentives. If the customer achieves specific sales targets, they are entitled to rebates. The Company estimates the projected amount of the rebates that will be achieved and recognizes the estimated costs as a reduction to Net Sales as revenue is recognized.
Disaggregation of Revenue
The following tables presents the Company’s revenues disaggregated by geographical region (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended |
| March 31, 2022 | | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Total |
| North America | | $ | 205.9 | | | $ | 82.4 | | | $ | 238.5 | | | $ | 408.5 | | | $ | 935.3 | |
| Asia | | 42.2 | | | 39.4 | | | 8.2 | | | 34.4 | | | 124.2 | |
| Europe | | 32.7 | | | 12.3 | | | 13.6 | | | 98.1 | | | 156.7 | |
| Rest-of-World | | 12.5 | | | 10.6 | | | 13.6 | | | 45.6 | | | 82.3 | |
| Total | | $ | 293.3 | | | $ | 144.7 | | | $ | 273.9 | | | $ | 586.6 | | | $ | 1,298.5 | |
| | | | | | | | | | |
| April 3, 2021 | | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Total |
| North America | | $ | 154.1 | | | $ | 71.1 | | | $ | 209.7 | | | $ | 163.8 | | | $ | 598.7 | |
| Asia | | 46.0 | | | 43.2 | | | 9.3 | | | 6.9 | | | 105.4 | |
| Europe | | 24.7 | | | 11.6 | | | 9.5 | | | 23.5 | | | 69.3 | |
| Rest-of-World | | 12.2 | | | 10.5 | | | 10.6 | | | 7.4 | | | 40.7 | |
| Total | | $ | 237.0 | | | $ | 136.4 | | | $ | 239.1 | | | $ | 201.6 | | | $ | 814.1 | |
3. HELD FOR SALE, DIVESTITURES AND ACQUISITIONS
Assets Held for Sale
The balances that were classified as Assets Held for Sale as of March 31, 2022 and January 1, 2022 were $11.7 million and $12.5 million, respectively.
2021 Acquisitions
Rexnord Transaction
On October 4, 2021, in accordance with the terms and conditions of the Agreement and Plan of Merger, dated as of February 15, 2021 (the “Merger Agreement”), the Company completed its combination with the Rexnord Process & Motion Control business (“Rexnord PMC business”) of Rexnord Corporation (which changed its name on October 4, 2021 to Zurn Water Solutions Corporation) (“Zurn”) in a Reverse Morris Trust transaction (the “Rexnord Transaction”). Pursuant to the Rexnord Transaction, (i) Zurn transferred to its then-subsidiary Land Newco, Inc. (“Land”) substantially all of the assets, and Land assumed substantially all of the liabilities, of the Rexnord PMC business (the “Reorganization”), (ii) after which all of the issued and outstanding shares of common stock, $0.01 par value per share, of Land (“Land common stock”) held by a subsidiary of Zurn were distributed in a series of distributions to Zurn’s stockholders (the “Distributions”, and the final distribution of Land common stock from Zurn to Zurn’s stockholders, which was made pro rata for no consideration, the “Spin-Off”) and (iii) immediately after the Spin-Off, a subsidiary of the Company (“Merger Sub”) merged with and into Land (the “Merger”) and all shares of Land common stock (other than those held by Zurn, Land, the Company, Merger Sub or their respective subsidiaries) were converted as of the effective time of the Merger (the “Effective Time”) into the right to receive 0.22296103 shares of common stock, $0.01 par value per share, of the Company (“Company common stock”), as calculated in the Merger Agreement.
As of the Effective Time, Land, which held the Rexnord PMC business, became a wholly owned subsidiary of the Company.
Pursuant to the Merger, the Company issued approximately 27,055,945 shares of Company common stock to holders of Land common stock, which represents approximately 39.9% of the approximately 67,756,732 outstanding shares of Company common stock immediately following the Effective Time. In addition, holders of record of Company common stock as of October 1, 2021 received $6.99 per share of Company common stock pursuant to a previously announced special dividend in connection with the Transactions (the “Special Dividend”).
In connection with the Rexnord Transaction, two directors designated by Zurn were appointed to the Company's Board of Directors. The current chief executive officer of the Company continued as the chief executive officer of the combined company after the Rexnord Transaction and a majority of the senior management of the Company immediately prior the consummation of the Rexnord Transaction remained executive officers of the Company immediately after the Rexnord Transaction. The Company's management determined that the Company is the accounting acquirer in the Rexnord Transaction based on the facts and circumstances noted within this section and other relevant factors. As such, the Company applied the acquisition method of accounting to the identifiable assets and liabilities of Rexnord PMC business, which have been measured at estimated fair value as of the date of the business combination.
In connection with the Rexnord Transaction, the Company entered into certain financing arrangements, which are described in Note 7.
The tax matters agreement the Company entered into in connection with the Rexnord Transaction imposes certain restrictions on the Company, Land and Zurn during the two-year period following the Spin-Off, subject to certain exceptions, with respect to actions that could cause the Reorganization and the Distributions to fail to qualify for the intended tax treatment. As a result of these restrictions, the Company's and Land’s ability to engage in certain transactions, such as the issuance or purchase of stock or certain business combinations, may be limited.
The total consideration transferred for the acquisition of Land was approximately $4.0 billion subject to finalization of purchase accounting adjustments. The total assets and liabilities assumed will be adjusted, based on the final balances per the terms included within the Separation and Distribution Agreement.
The preliminary purchase price of the Rexnord PMC business consisted of the following (in millions):
| | | | | | | | | | | | | | | | | | | | |
| | As Reported as of January 1, 2022 | | Measurement period adjustments | | As Reported as of March 31, 2022 |
| | | | | | |
| Fair value of Company common stock issued to Zurn (a) | | $ | 3,896.3 | | | $ | — | | | $ | 3,896.3 | |
| Stock based compensation (b) | | 47.1 | | | — | | | 47.1 | |
| Adjustment amount (c) | | 30.9 | | | 4.1 | | | 35.0 | |
| Land Financing Fees paid by the Company (d) | | 3.9 | | | — | | | 3.9 | |
| Preexisting Relationships (e) | | (0.8) | | | — | | | (0.8) | |
| Preliminary purchase price | | $ | 3,977.4 | | | $ | 4.1 | | | $ | 3,981.5 | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
(a) Represents approximately 27 million new shares of Company common stock issued to Zurn stockholders in the exchange offer, based on the Company's October 4, 2021, closing share price of $151.00, less the Special Dividend amount of $6.99, which the Zurn stockholders were not entitled to receive.
(b) Represents fair value of replacement equity-based awards and Company common stock issued in settlement of other Zurn share based awards. The portion of the fair value attributable to pre-Merger service was recorded as part of the consideration transferred in the Merger - see Note 10.
(c) Represents working capital adjustment pursuant to the terms of the purchase agreement. The entire amount was settled and paid in cash by the Company as of March 31, 2022.
(d) Represents financing fees paid by the Company for the Bridge Facility and Land Term Facility (as defined in Note 7) that were determined to be costs of Zurn.
(e) Represents effective settlement of outstanding payables and receivables between the Company and the Rexnord PMC business. No gain or loss was recognized on this settlement.
Purchase Price Allocation
The Rexnord PMC business’s assets and liabilities were measured at estimated fair values at October 4, 2021, primarily using Level 3 inputs. Estimates of fair value represent management’s best estimate of assumptions about future events and uncertainties, including significant judgments related to future cash flows, discount rates, competitive trends, margin and revenue growth assumptions including royalty rates and customer attrition rates and others. Inputs used were generally obtained from historical data supplemented by current and anticipated market conditions and growth rates expected as of the acquisition date.
Due to the timing of the business combination and the nature of the net assets acquired, at March 31, 2022, the valuation process to determine the fair values is not complete and further adjustments are expected during the measurement period. The Company has estimated the preliminary fair value of net assets acquired based on information currently available and will continue to adjust those estimates as additional information becomes available, including the refinement of market participant assumptions. As the Company finalizes the fair value of assets acquired and liabilities assumed, additional purchase price allocation adjustments will be recorded during the measurement period, but no later than one year from the date of the acquisition. The Company will reflect measurement period adjustments in the period in which the adjustments are determined.
The preliminary fair value and subsequent measurement period adjustments of the assets acquired and liabilities and noncontrolling interests assumed were as follows (in millions):
| | | | | | | | | | | | | | | | | | | | |
| | As Reported as of January 1, 2022 | | Measurement period adjustments | | As Reported as of March 31, 2022 |
| | | | | | |
| Cash and Cash Equivalents | | $ | 192.8 | | | $ | — | | | $ | 192.8 | |
| Trade Receivables | | 186.9 | | | (3.5) | | | 183.4 | |
| Inventories | | 262.5 | | | (1.0) | | | 261.5 | |
| Prepaid Expenses and Other Current Assets | | 21.0 | | | — | | | 21.0 | |
| Assets Held for Sale | | 1.4 | | | — | | | 1.4 | |
| Deferred Income Tax Benefits | | 8.8 | | | (7.7) | | | 1.1 | |
| Property, Plant and Equipment | | 412.3 | | | (38.4) | | | 373.9 | |
| Operating Lease Assets | | 46.4 | | | — | | | 46.4 | |
| | | | | | |
| Intangible Assets | | 1,831.0 | | | 23.0 | | | 1,854.0 | |
| Other Noncurrent Assets | | 12.3 | | | 3.7 | | | 16.0 | |
| Accounts Payable | | (121.1) | | | — | | | (121.1) | |
| Accrued Compensation and Benefits | | (44.0) | | | 2.6 | | | (41.4) | |
| Other Accrued Expenses | | (55.7) | | | (4.0) | | | (59.7) | |
| Current Operating Lease Liabilities | | (8.1) | | | — | | | (8.1) | |
| Current Maturities of Long-Term Debt | | (2.5) | | | — | | | (2.5) | |
| Long-Term Debt | | (558.2) | | | — | | | (558.2) | |
| Deferred Income Taxes | | (508.2) | | | 12.1 | | | (496.1) | |
| Pension and Other Post Retirement Benefits | | (75.1) | | | — | | | (75.1) | |
| Noncurrent Operating Lease Liabilities | | (38.0) | | | — | | | (38.0) | |
| Other Noncurrent Liabilities | | (17.0) | | | — | | | (17.0) | |
| Total Identifiable Net Assets | | 1,547.5 | | | (13.2) | | | 1,534.3 | |
| Goodwill | | 2,433.2 | | | 17.3 | | | 2,450.5 | |
| Noncontrolling Interests | | (3.3) | | | — | | | (3.3) | |
| Preliminary purchase price | | $ | 3,977.4 | | | $ | 4.1 | | | $ | 3,981.5 | |
During three months ended March 31, 2022, the Company made a cash payment of $35.0 million to Zurn in connection with finalizing the acquisition date trade working capital. The preliminary purchase price allocations were also adjusted by the refinement of the estimated fair value of the assets received and liabilities assumed. The cumulative impact of the adjustments during the three months ended March 31, 2022 resulted in $17.3 million of additional goodwill.
Results of the Rexnord PMC business Subsequent to the Acquisition
The financial results of the Rexnord PMC business have been included in the Company's Motion Control Solutions segment from the date of acquisition.
Arrowhead Transaction
On November 23, 2021, the Company acquired all of the outstanding equity interests of Arrowhead Systems, LLC, ("Arrowhead") (the "Arrowhead Transaction"), for $315.6 million in cash, net of $1.1 million of cash acquired. Arrowhead is a global leader in providing industrial process automation solutions including conveyors and (de)palletizers to the food & beverage, aluminum can, and consumer staples end markets, among others. Arrowhead is now part of the Automation Solutions division of the Company's Motion Control Solutions segment.
The Consolidated Statements of Income include the results of operations of Arrowhead since the date of acquisition, and such results are reflected in the Motion Control Solutions segment.
Purchase Price Allocation
Arrowhead's assets and liabilities were measured at estimated fair values at November 23, 2021. Estimates of fair value represent management’s best estimate of assumptions about future events and uncertainties, including significant judgments related to future cash flows, discount rates, competitive trends, margin and revenue growth assumptions including royalty rates
and customer attrition rates and others. Inputs used were generally obtained from historical data supplemented by current and anticipated market conditions and growth rates expected as of the acquisition date.
The preliminary fair value of the assets acquired and liabilities assumed were as follows (in millions):
| | | | | | | | | | | | |
| | As Reported as of January 1, 2022 | | | | |
| | | | | | |
| Cash and Cash Equivalents | | $ | 1.1 | | | | | |
| Trade Receivables | | 19.1 | | | | | |
| Inventories | | 12.8 | | | | | |
| Prepaid Expenses and Other Current Assets | | 7.6 | | | | | |
| | | | | | |
| | | | | | |
| Property, Plant and Equipment | | 3.7 | | | | | |
| | | | | | |
| | | | | | |
Intangible Assets(1) | | 160.0 | | | | | |
| | | | | | |
| Accounts Payable | | (4.7) | | | | | |
| Accrued Compensation and Benefits | | (2.6) | | | | | |
| Other Accrued Expenses | | (25.0) | | | | | |
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| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| Total Identifiable Net Assets | | 172.0 | | | | | |
| Goodwill | | 143.6 | | | | | |
| Preliminary purchase price | | $ | 315.6 | | | | | |
(1) Includes $124.0 million related to Customer Relationships, $18.0 million related to Trademarks and $18.0 million related to Technology.
The allocation of purchase price is subject to finalization during a period not to exceed one year from the acquisition date. Adjustments to the preliminary allocation of purchase price may occur related to finalization of the working capital adjustment, finalization of the valuation of intangibles and other long-lived assets, adjustment to income tax assets and liabilities and other changes related to the valuation of assets acquired and liabilities assumed. No adjustments to the preliminary allocation of purchase price were made during the three months ended March 31, 2022.
4. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Foreign currency translation adjustments, hedging activities and pension and post-retirement benefit adjustments are included in Accumulated Other Comprehensive Income (Loss) ("AOCI") a component of Total Equity.
The following tables present changes in AOCI by component for the three months ended March 31, 2022 and April 3, 2021 (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended |
| March 31, 2022 | | Hedging Activities | | Pension and Post Retirement Benefit Adjustments | | Foreign Currency Translation Adjustments | | Total |
| Beginning Balance | | $ | 21.0 | | | $ | (14.3) | | | $ | (201.8) | | | $ | (195.1) | |
| Other Comprehensive Income (Loss) before Reclassifications | | 34.4 | | | 0.2 | | | (1.0) | | | 33.6 | |
| Tax Impact | | (8.3) | | | — | | | — | | | (8.3) | |
| Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) | | (8.0) | | | 0.2 | | | — | | | (7.8) | |
| Tax Impact | | 2.0 | | | — | | | — | | | 2.0 | |
| Net Current Period Other Comprehensive Income (Loss) | | 20.1 | | | 0.4 | | | (1.0) | | | 19.5 | |
| | | | | | | | |
| Ending Balance | | $ | 41.1 | | | $ | (13.9) | | | $ | (202.8) | | | $ | (175.6) | |
| | | | | | | | |
| April 3, 2021 | | Hedging Activities | | Pension and Post Retirement Benefit Adjustments | | Foreign Currency Translation Adjustments | | Total |
| Beginning Balance | | $ | 23.5 | | | $ | (31.1) | | | $ | (155.7) | | | $ | (163.3) | |
| Other Comprehensive Income (Loss) before Reclassifications | | 19.2 | | | — | | | (21.4) | | | (2.2) | |
| Tax Impact | | (4.6) | | | — | | | — | | | (4.6) | |
| Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) | | (11.5) | | | 0.4 | | | — | | | (11.1) | |
| Tax Impact | | 2.8 | | | (0.1) | | | — | | | 2.7 | |
| | | | | | | | |
| Net Current Period Other Comprehensive Income (Loss) | | 5.9 | | | 0.3 | | | (21.4) | | | (15.2) | |
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| Ending Balance | | $ | 29.4 | | | $ | (30.8) | | | $ | (177.1) | | | $ | (178.5) | |
| | | | | | | | |
The Condensed Consolidated Statements of Income line items affected by the hedging activities reclassified from AOCI in the tables above are disclosed in Note 13.
The reclassification amounts for pension and post-retirement benefit adjustments in the tables above are part of net periodic benefit costs recorded in Other Income, Net (see also Note 8).
5. GOODWILL AND INTANGIBLE ASSETS
Goodwill
As required, the Company performs an annual impairment test of goodwill as of the end of the October fiscal month or more frequently if events or circumstances change that would more likely than not reduce the fair value of its reporting units below their carrying value.
The following table presents changes to goodwill during the three months ended March 31, 2022 (in millions):
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| Total | | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions |
| Balance as of January 1, 2022 | $ | 4,039.2 | | | $ | 428.9 | | | $ | 128.8 | | | $ | 330.5 | | | $ | 3,151.0 | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| Acquisition and Valuation Adjustments | 17.3 | | | — | | | — | | | — | | | 17.3 | |
| | | | | | | | | |
| Translation Adjustments | (5.2) | | | — | | | (0.1) | | | (0.1) | | | (5.0) | |
| Balance as of March 31, 2022 | $ | 4,051.3 | | | $ | 428.9 | | | $ | 128.7 | | | $ | 330.4 | | | $ | 3,163.3 | |
| | | | | | | | | |
| Cumulative Goodwill Impairment Charges | $ | 328.7 | | | $ | 183.2 | | | $ | 105.1 | | | $ | 17.2 | | | $ | 23.2 | |
Intangible Assets
The following table presents intangible assets (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | March 31, 2022 | | | | January 1, 2022 |
| | | Weighted Average Amortization Period (Years) | | Gross Value | | Accumulated Amortization | | | | Gross Value | | Accumulated Amortization |
| Amortizable Intangible Assets: | | | | | | | | | | | | |
| Customer Relationships | | 16 | | $ | 2,355.6 | | | $ | 438.6 | | | | | $ | 2,335.4 | | | $ | 405.0 | |
| Technology | | 13 | | 250.1 | | | 117.3 | | | | | 250.1 | | | 114.1 | |
| Trademarks | | 10 | | 399.6 | | | 46.7 | | | | | 400.0 | | | 37.2 | |
| Patent and Engineering Drawings | | 5 | | 16.6 | | | 16.6 | | | | | 16.6 | | | 16.6 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | $ | 3,021.9 | | | $ | 619.2 | | | | | $ | 3,002.1 | | | $ | 572.9 | |
| | | | | | | | | | | | |
| Intangible Assets, Net of Amortization | | | | $ | 2,402.7 | | | | | | | $ | 2,429.2 | | | |
Amortization expense recorded for the three months ended March 31, 2022 was $47.3 million. Amortization expense recorded for the three months ended April 3, 2021 was $11.2 million. Amortization expense for fiscal year 2022 is estimated to be $187.0 million. There were no intangible asset impairments during the three months ended March 31, 2022 and April 3, 2021, respectively.
The following table presents future estimated annual amortization for intangible assets (in millions):
| | | | | | | | |
| Year | | Estimated Amortization |
| 2023 | | $ | 187.0 | |
| 2024 | | 186.3 | |
| 2025 | | 184.2 | |
| 2026 | | 180.7 | |
| 2027 | | 145.8 | |
| | |
| | |
| | |
6. SEGMENT INFORMATION
The Company is comprised of four operating segments: Commercial Systems, Industrial Systems, Climate Solutions and Motion Control Solutions.
Commercial Systems segment designs and produces fractional to approximately 5 horsepower AC and DC motors, electronic variable speed controls, fans, and blowers for commercial applications. These products serve markets including commercial building ventilation and HVAC, pool and spa, irrigation, dewatering, agriculture, and general commercial equipment.
Industrial Systems segment designs and produces integral motors, automatic transfer switches, alternators and switchgear for industrial applications, along with aftermarket parts and kits to support such products. These products serve markets including agriculture, marine, mining, oil and gas, food and beverage, data centers, healthcare, prime and standby power, and general industrial equipment.
Climate Solutions segment designs and produces small motors, electronic variable speed controls and air moving solutions serving markets including residential and light commercial HVAC, water heaters and commercial refrigeration.
Motion Control Solutions segment designs, produces and services mounted and unmounted bearings, conveyor products, conveying automation solutions, couplings, mechanical power transmission drives and components, gearboxes and gear motors, aerospace components, special components products and industrial powertrain components and solutions serving a broad range of markets including food and beverage, bulk handling, eCommerce/warehouse distribution, energy, aerospace and general industrial.
The Company evaluates performance based on the segment's income from operations. Corporate costs have been allocated to each segment based on the net sales of each segment. The reported external net sales of each segment are from external customers.
The following sets forth certain financial information attributable to the Company's operating segments for the three months ended March 31, 2022 and April 3, 2021 (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| March 31, 2022 | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Eliminations | | Total |
| External Sales | $ | 293.3 | | | $ | 144.7 | | | $ | 273.9 | | | $ | 586.6 | | | $ | — | | | $ | 1,298.5 | |
| Intersegment Sales | 28.2 | | | 7.3 | | | 4.8 | | | 1.9 | | | (42.2) | | | — | |
| Total Sales | 321.5 | | | 152.0 | | | 278.7 | | | 588.5 | | | (42.2) | | | 1,298.5 | |
| Gross Profit | 94.3 | | | 31.3 | | | 83.2 | | | 213.1 | | | — | | | 421.9 | |
| Operating Expenses | 41.4 | | | 23.4 | | | 31.7 | | | 155.5 | | | — | | | 252.0 | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Total Operating Expenses | 41.4 | | | 23.4 | | | 31.7 | | | 155.5 | | | — | | | 252.0 | |
| Income from Operations | 52.9 | | | 7.9 | | | 51.5 | | | 57.6 | | | — | | | 169.9 | |
| Depreciation and Amortization | 7.7 | | | 3.6 | | | 4.4 | | | 62.2 | | | — | | | 77.9 | |
| Capital Expenditures | 3.6 | | | 1.5 | | | 4.3 | | | 4.0 | | | — | | | 13.4 | |
| | | | | | | | | | | |
| April 3, 2021 | | | | | | | | | | | |
| External Sales | $ | 237.0 | | | $ | 136.4 | | | $ | 239.1 | | | $ | 201.6 | | | $ | — | | | $ | 814.1 | |
| Intersegment Sales | 17.5 | | | 3.7 | | | 4.3 | | | 0.7 | | | (26.2) | | | — | |
| Total Sales | 254.5 | | | 140.1 | | | 243.4 | | | 202.3 | | | (26.2) | | | 814.1 | |
| Gross Profit* | 66.8 | | | 28.0 | | | 75.4 | | | 79.6 | | | — | | | 249.8 | |
| Operating Expenses | 38.0 | | | 23.1 | | | 30.7 | | | 56.5 | | | — | | | 148.3 | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Total Operating Expenses | 38.0 | | | 23.1 | | | 30.7 | | | 56.5 | | | — | | | 148.3 | |
| Income from Operations* | 28.8 | | | 4.9 | | | 44.7 | | | 23.1 | | | — | | | 101.5 | |
| Depreciation and Amortization | 7.8 | | | 5.9 | | | 4.5 | | | 13.6 | | | — | | | 31.8 | |
| Capital Expenditures | 3.3 | | | 2.4 | | | 3.2 | | | 1.8 | | | — | | | 10.7 | |
The following table presents identifiable assets information attributable to the Company's operating segments as of March 31, 2022 and January 1, 2022 (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Total |
| Identifiable Assets as of March 31, 2022 | $ | 1,306.1 | | | $ | 874.1 | | | $ | 1,006.0 | | | $ | 7,284.9 | | | $ | 10,471.1 | |
| Identifiable Assets as of January 1, 2022* | 1,264.0 | | | 859.9 | | | 982.7 | | | 7,260.8 | | | 10,367.4 | |
*Includes the retrospective effect of changing accounting methods for valuing certain inventories to the FIFO cost method from the LIFO cost method. See Note 2 for additional information.
7. DEBT AND BANK CREDIT FACILITIES
The following table presents the Company’s indebtedness as of March 31, 2022 and January 1, 2022 (in millions):
| | | | | | | | | | | |
| March 31, 2022 | | January 1, 2022 |
| Term Facility | $ | 550.0 | | | $ | 620.0 | |
| | | |
| Land Term Facility | 486.8 | | | 486.8 | |
| Multicurrency Revolving Facility | 955.0 | | | 736.7 | |
| | | |
| | | |
| | | |
| Other | 76.2 | | | 78.7 | |
| Less: Debt Issuance Costs | (7.4) | | | (3.7) | |
| Total | 2,060.6 | | | 1,918.5 | |
| Less: Current Maturities | 3.2 | | | 4.9 | |
| Long-Term Debt | $ | 2,057.4 | | | $ | 1,913.6 | |
Credit Agreement
On March 28, 2022, the Company entered into a Second Amended and Restated Credit Agreement with the Company's lenders (the “Credit Agreement”) with JPMorgan Chase Bank, N.A., as Administrative Agent and the lenders named therein. The Credit Agreement (i) replaces in its entirety the Amended and Restated Credit Agreement, dated as of August 27, 2018, as amended by that First Amendment, dated March 17, 2021, among the Company and other parties thereto and (ii) amends and restates in its entirety the Amended and Restated Credit Agreement, dated as of October 4, 2021, among Land and the other parties thereto (collectively, the “Former Credit Agreements”).
The Credit Agreement provides for, among other things, an extension of the maturity date of the revolving credit facility and term loans provided under the Former Credit Agreements. The credit facilities extended under the Credit Agreement consist of (i) an unsecured term loan facility in the initial principal amount of up to $550,000,000, maturing on March 28, 2027 (the "Term Facility"); (ii) an unsecured term loan facility in the initial principal amount of $486,827,669, under which Land remains the sole borrower, maturing on March 28, 2027 (the "Land Term Facility"); and (iii) an unsecured revolving loan in the initial principal amount of up to $1,000,000,000, maturing on March 28, 2027 (the "Multicurrency Revolving Facility"). Interest for benchmark rate loans is calculated based on a SOFR benchmark rate, plus a margin spread to be adjusted quarterly based on the Company’s funded debt to EBITDA ratio. The Credit Agreement is subject to customary and market provisions. The subsidiaries of the Company that provided a guaranty of the Company's and Land's obligations under the Former Credit Agreement also entered into subsidiary guaranty agreements with respect to the obligations under the Credit Agreement.
The Term Facility was drawn in full on March 28, 2022 to refinance the Former Credit Agreements, pay fees, costs, and other expenses incurred therewith, to fund working capital needs and for general corporate purposes of the Company and its subsidiaries. The Term Facility requires quarterly amortization at 5.0% per annum, unless previously prepaid. Per the terms of the Credit Agreement, prepayments can be made without penalty and be applied to the next payment due. After the prepayment is considered, the next payment in the amortization schedule is not due within one year and therefore no current maturities of debt will be recognized for this agreement.
The weighted average interest rate on the Term Facility for the three months ended March 31, 2022 and April 3, 2021 was 2.0% and 1.5%, respectively. The Credit Agreement requires that the Company prepay the loans under the Term Facility with 100% of the net cash proceeds received from specified asset sales and borrowed money indebtedness, subject to certain exceptions.
At March 31, 2022, the Company had $955.0 million of borrowings under the Multicurrency Revolving Facility, $0.1 million of standby letters of credit issued under the facility, and $44.9 million of available borrowing capacity. For the three months ended March 31, 2022 and April 3, 2021 under the Multicurrency Revolving Facility, the average daily balance in borrowings
was $773.7 million and $7.4 million, respectively, and the weighted average interest rate was 1.7% and 1.4%, respectively. The Company pays a non-use fee on the aggregate unused amount of the Multicurrency Revolving Facility at a rate determined by reference to its consolidated funded debt to consolidated EBITDA ratio.
As of March 31, 2022, the Company had $486.8 million of borrowings under the Land Term Facility. The Land Term Facility has no required amortization. The weighted average interest rate on the Land Term Facility for three months ended March 31, 2022 was 1.7%.
In connection with the Rexnord Transaction, on February 15, 2021, the Company entered into a debt commitment letter (the “Bridge Commitment Letter”) and related fee letters with Barclays Bank PLC (“Barclays”), pursuant to which, and subject to the terms and conditions set forth therein, Barclays committed to provide approximately $2.1 billion in an aggregate principal amount of senior bridge loans under a 364-day senior bridge loan credit facility (the “Bridge Facility”). As the Rexnord Transaction was consummated and the payments of amounts in connection therewith occurred without the use of the Bridge Facility, the commitments under the Bridge Commitment Letter were terminated in connection with the closing of the Rexnord Transaction.
Compliance with Financial Covenants
The Credit Agreement requires the Company to meet specified financial ratios and to satisfy certain financial condition tests. The Company was in compliance with all financial covenants contained in the Credit Agreement as of March 31, 2022.
Other Notes Payable
At March 31, 2022, other notes payable of approximately $76.2 million were outstanding with a weighted average interest rate of 5.1%. At January 1, 2022, other notes payable of approximately $78.7 million were outstanding with a weighted average rate of 5.2%.
Other Disclosures
Based on rates for instruments with comparable maturities and credit quality, which are classified as Level 2 inputs (see also Note 14), the approximate fair value of the Company's total debt was $2,060.6 million and $1,918.5 million as of March 31, 2022 and January 1, 2022, respectively.
8. RETIREMENT AND POST RETIREMENT HEALTH CARE PLANS
The following table presents the Company’s net periodic benefit cost (income) components (in millions):
| | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, 2022 | | April 3, 2021 | | | | |
| Service Cost | $ | 0.3 | | | $ | 0.3 | | | | | |
| Interest Cost | 3.6 | | | 1.5 | | | | | |
| Expected Return on Plan Assets | (5.1) | | | (3.1) | | | | | |
| Amortization of Prior Service Cost and Net Actuarial Loss | 0.2 | | | 0.4 | | | | | |
| Net Periodic Benefit Income | $ | (1.0) | | | $ | (0.9) | | | | | |
The service cost component is included in Cost of Sales and Operating Expenses. All other components of net periodic benefit costs are included in Other Income, Net on the Company's Condensed Consolidated Statements of Income.
For the three months ended March 31, 2022 and April 3, 2021, the Company contributed $1.7 million and $1.2 million, respectively, to post retirement plans. The Company expects to make total contributions of $7.6 million in 2022. The Company contributed a total of $6.0 million in fiscal 2021.
9. SHAREHOLDERS’ EQUITY
Repurchase of Common Stock
At a meeting of the Board of Directors on October 26, 2021, the Company's Board of Directors approved the authorization to purchase up to $500.0 million of shares. During the three months ended March 31, 2022, the Company purchased 731,194 shares or $114.2 million of common stock. The Company did not repurchase and retire any common stock during the three months ended April 3, 2021.
As of March 31, 2022, there was approximately $320.0 million in common stock available for repurchase under the October 2019 program.
Share-Based Compensation
The Company recognized approximately $6.3 million and $3.3 million in share-based compensation expense for the three months ended March 31, 2022 and April 3, 2021, respectively. The total income tax benefit recognized in the Condensed Consolidated Statements of Income for share-based compensation expense was $1.5 million and $0.6 million for the three months ended March 31, 2022 and April 3, 2021, respectively. The Company recognizes compensation expense on grants of share-based compensation awards on a straight-line basis over the vesting period of each award.
During the three months ended March 31, 2022, the Company granted the following share-based incentive awards:
| | | | | | | | | | | | | | |
| Award Type | | Number of Awards | | Weighted Average Grant-Date Fair Value |
| Options and SARs | | 135,816 | | | $ | 42.21 | |
| | | | |
| Restricted Stock Units | | 76,962 | | | $ | 151.36 | |
| Performance Share Units | | 40,763 | | | $ | 174.91 | |
See Note 9, Shareholders' Equity, to the audited consolidated financial statements in the Company's Annual Report on Form 10-K for the year ended January 1, 2022, for further information regarding share-based compensation.
10. INCOME TAXES
The effective tax rate for the three months ended March 31, 2022 was 22.2% versus 23.3% for the three months ended April 3, 2021. The effective tax rate for the three months ended March 31, 2022 was lower than the same period in the prior year due to additional tax reserves in the three months ended April 3, 2021 for the repatriation of foreign earnings. The reduction in the effective rate for the three months ended March 31, 2022 was partially offset by the impacts of the Rexnord Transaction in fiscal 2021.
As of March 31, 2022 and January 1, 2022, the Company had approximately $9.1 million and $8.8 million of unrecognized tax benefits, all of which would impact the effective income tax rate if recognized. Potential interest and penalties related to unrecognized tax benefits are recorded in income tax expense. The Company had approximately $1.4 million and $1.3 million of accrued interest as of March 31, 2022 and January 1, 2022, respectively.
With few exceptions, the Company is no longer subject to US Federal and state/local income tax examinations by tax authorities for years prior to 2018, and the Company is no longer subject to non-US income tax examinations by tax authorities for years prior to 2015.
11. EARNINGS PER SHARE
Diluted earnings per share is calculated based upon earnings applicable to common shares divided by the weighted-average number of common shares outstanding during the period adjusted for the effect of other dilutive securities. The amount of the anti-dilutive shares were 0.1 million and zero for the three months ended March 31, 2022 and April 3, 2021, respectively. The following table reconciles the basic and diluted shares used in earnings per share calculations for the three months ended March 31, 2022 and April 3, 2021 (in millions):
| | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, 2022 | | April 3, 2021 | | | | |
| Denominator for Basic Earnings Per Share | 67.4 | | | 40.6 | | | | | |
| Effect of Dilutive Securities | 0.5 | | | 0.4 | | | | | |
| Denominator for Diluted Earnings Per Share | 67.9 | | | 41.0 | | | | | |
12. CONTINGENCIES
One of the Company's subsidiaries that it acquired in 2007 is subject to numerous claims filed in various jurisdictions relating to certain sub-fractional motors that were primarily manufactured through 2004 and that were included as components of residential and commercial ventilation units manufactured and sold in high volumes by a third party. These ventilation units are subject to product safety requirements and other potential regulation of their performance by government agencies such as the US Consumer Product Safety Commission (“CPSC”). The claims generally allege that the ventilation units were the cause of fires. The Company has recorded an estimated liability for incurred claims. Based on the current facts, the Company cannot assure that these claims, individually or in the aggregate, will not have a material adverse effect on its subsidiary's financial condition. The Company's subsidiary cannot reasonably predict the outcome of these claims, the nature or extent of any CPSC or other remedial actions, if any, that the Company's subsidiary may need to undertake with respect to motors that remain in the field, or the costs that may be incurred, some of which could be significant.
As a result of the Company's acquisition of the Rexnord PMC business, it is entitled to indemnification from third parties to agreements with the Rexnord PMC business against certain contingent liabilities of the Rexnord PMC business, including certain pre-closing environmental liabilities.
The Company believes that, pursuant to the transaction documents related to the Rexnord PMC business' acquisition of the Stearns business from Invensys plc ("Invensys"), Invensys (now known as Schneider Electric) is obligated to defend and indemnify us with respect to the matters described below relating to the Ellsworth Industrial Park Site and to various asbestos claims. The indemnity obligations relating to the matters described below are subject, together with indemnity obligations relating to other matters, to an overall dollar cap equal to the purchase price, which is an amount in excess of $900 million. In the event that the Company is unable to recover from Invensys with respect to the matters below, it may be entitled to indemnification from Zurn, subject to certain limitations. The following paragraphs summarize the most significant actions and proceedings:
•In 2002, the Company's subsidiary, Rexnord Industries, LLC ("Rexnord Industries") was named as a potentially responsible party ("PRP"), together with at least ten other companies, at the Ellsworth Industrial Park Site, Downers Grove, DuPage County, Illinois (the "Site"), by the United States Environmental Protection Agency ("USEPA"), and the Illinois Environmental Protection Agency ("IEPA"). Rexnord Industries' Downers Grove property is situated within the Ellsworth Industrial Complex. The USEPA and IEPA allege there have been one or more releases or threatened releases of chlorinated solvents and other hazardous substances, pollutants or contaminants at the Site, allegedly including but not limited to a release or threatened release on or from Rexnord Industries' property. The relief sought by the USEPA and IEPA includes further investigation and potential remediation of the Site and reimbursement of USEPA's past costs. In early 2020, Rexnord Industries entered into an administrative order with the USEPA to do remediation work on its Downers Grove property. Rexnord Industries' allocated share of past and future costs related to the Site, including for investigation and/or remediation, could be significant. All previously pending property damage and personal injury lawsuits against Rexnord Industries related to the Site have been settled or dismissed. Pursuant to its indemnity obligation, Invensys continues to defend Rexnord Industries in known matters related to the Site, including the costs of the remediation work pursuant to the 2020 administrative order, and has paid 100% of the costs to date. This indemnification right would not protect Rexnord Industries against liabilities related to environmental conditions that were unknown to Invensys at the time of the acquisition of the Stearns business from Invensys.
•Multiple lawsuits (with approximately 300 claimants) are pending in state or federal court in numerous jurisdictions relating to alleged personal injuries due to the alleged presence of asbestos in certain brakes and clutches previously manufactured by the Rexnord PMC business' Stearns brand of brakes and clutches and/or its predecessor owners. Invensys and FMC, prior owners of the Stearns business, have paid 100% of the costs to date related to the Stearns lawsuits. Similarly, the Rexnord PMC business' Prager subsidiary is the subject of claims by multiple claimants alleging personal injuries due to the alleged presence of asbestos in a product allegedly manufactured by Prager. However, all these claims are currently on the Texas Multi-district Litigation inactive docket, and the Company does not believe that they will become active in the future. To date, the Rexnord PMC business' insurance providers have paid 100% of the costs related to the Prager asbestos matters. We believe that the combination of the Company's insurance coverage and the Invensys indemnity obligations will cover any future costs of these matters.
In connection with the Company's acquisition of the Rexnord PMC business, transaction documents related to the Rexnord PMC business’ acquisition of The Falk Corporation from Hamilton Sundstrand Corporation were assigned to Rexnord Industries, and provide Rexnord Industries with indemnification against certain products related asbestos exposure liabilities. The Company believes that, pursuant to such indemnity obligations, Hamilton Sundstrand is obligated to defend and indemnify Rexnord Industries with respect to asbestos claims described below, and that, with respect to these claims, such indemnity obligations are not subject to any time or dollar limitations.
The following paragraph summarizes the most significant actions and proceedings for which Hamilton Sundstrand has accepted responsibility:
•Rexnord Industries is a defendant in multiple lawsuits pending in state or federal court in numerous jurisdictions relating to alleged personal injuries due to the alleged presence of asbestos in certain clutches and drives previously manufactured by The Falk Corporation. The ultimate outcome of these lawsuits cannot presently be determined. Hamilton Sundstrand is defending Rexnord Industries in these lawsuits pursuant to its indemnity obligations and has paid 100% of the costs to date.
The Company is, from time to time, party to litigation and other legal or regulatory proceedings that arise in the normal course of its business operations and the outcomes of which are subject to significant uncertainty, including product warranty and liability claims, contract disputes and environmental, asbestos, intellectual property, employment and other litigation matters. The Company's products are used in a variety of industrial, commercial and residential applications that subject the Company to claims that the use of its products is alleged to have resulted in injury or other damage. Many of these matters will only be resolved when one or more future events occur or fail to occur. Management conducts regular reviews, including updates from legal counsel, to assess the need for accounting recognition or disclosure of these contingencies, and such assessment inherently involves an exercise in judgment. The Company accrues for exposures in amounts that it believes are adequate, and the Company does not believe that the outcome of any such lawsuit individually or collectively will have a material effect on the Company's financial position, its results of operations or its cash flows.
The Company recognizes the cost associated with its standard warranty on its products at the time of sale. The amount recognized is based on historical experience. The following table presents a reconciliation of the changes in accrued warranty costs for the three months ended March 31, 2022 and April 3, 2021 (in millions):
| | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, 2022 | | April 3, 2021 | | | | |
| Beginning Balance | $ | 23.0 | | | $ | 15.5 | | | | | |
| Less: Payments | (5.6) | | | (4.5) | | | | | |
| Provisions | 6.0 | | | 5.4 | | | | | |
| | | | | | | |
| | | | | | | |
| Translation Adjustments | — | | | (0.1) | | | | | |
| Ending Balance | $ | 23.4 | | | $ | 16.3 | | | | | |
These liabilities are included in Other Accrued Expenses and Other Noncurrent Liabilities on the Condensed Consolidated Balance Sheets.
13. DERIVATIVE FINANCIAL INSTRUMENTS
The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed using derivative instruments are commodity price risk, currency exchange risk, and interest rate risk. Forward contracts on certain commodities are entered into to manage the price risk associated with forecasted purchases of materials used in the Company's manufacturing process. Forward contracts on certain currencies are entered into to manage forecasted cash flows in certain foreign currencies. Interest rate swaps are utilized to manage interest rate risk associated with the Company's floating rate borrowings.
The Company is exposed to credit losses in the event of non-performance by the counterparties to various financial agreements, including its commodity hedging transactions, foreign currency exchange contracts and interest rate swap agreements. Exposure to counterparty credit risk is managed by limiting counterparties to major international banks and financial institutions meeting established credit guidelines and continually monitoring their compliance with the credit guidelines. The Company does not obtain collateral or other security to support financial instruments subject to credit risk. The Company does not anticipate non-performance by its counterparties, but cannot provide assurances.
The Company recognizes all derivative instruments as either assets or liabilities at fair value in the Condensed Consolidated Balance Sheets. The Company designates commodity forward contracts as cash flow hedges of forecasted purchases of commodities, currency forward contracts as cash flow hedges of forecasted foreign currency cash flows and interest rate swaps as cash flow hedges of forecasted SOFR-based interest payments. There were no significant collateral deposits on derivative financial instruments as of March 31, 2022 or April 3, 2021.
Cash Flow Hedges
The effective portion of the gain or loss on the derivative is reported as a component of AOCI and reclassified into the same line within the Condensed Consolidated Statement of Income as the earnings effect of the hedged item in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or changes in market value of derivatives not designated as hedges are recognized in current earnings.
At March 31, 2022, the Company had $18.2 million, net of tax, of derivative gains on closed hedge instruments in AOCI that will be realized in earnings when the hedged items impact earnings. At January 1, 2022, the Company had $5.6 million, net of tax, of derivative gains on closed hedge instruments in AOCI that was subsequently realized in earnings when the hedged items impacted earnings.
As of March 31, 2022, the Company had the following currency forward contracts outstanding (with maturities extending through December 2022) to hedge forecasted foreign currency cash flows (in millions):
| | | | | |
| | Notional Amount (in US Dollars) |
| Chinese Renminbi | $ | 264.0 | |
| Mexican Peso | 210.4 | |
| Euro | 209.3 | |
| Indian Rupee | 59.7 | |
| Canadian Dollar | 0.1 | |
| Australian Dollar | 16.4 | |
| |
| British Pound | 2.0 | |
| Thai Baht | 1.5 | |
As of March 31, 2022, the Company had the following commodity forward contracts outstanding (with maturities extending through December 2022) to hedge forecasted purchases of commodities (notional amounts expressed in terms of the dollar value of the hedged item (in millions)):
| | | | | |
| | Notional Amount |
| Copper | $ | 158.6 | |
| Aluminum | 7.9 | |
The Company entered into two receive variable/pay-fixed forward starting non-amortizing interest rate swaps in June 2020, with a total notional amount of $250.0 million. The cash proceeds of $16.2 million received to settle the terminated swaps in
March 2022 will be recognized as a reduction of interest expense via the effective interest rate method through July 2025 when the terminated swaps were scheduled to expire.
The following table presents the fair values of derivative instruments as of March 31, 2022 and January 1, 2022 (in millions):
| | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2022 |
| | Prepaid Expenses and Other Current Assets | | Other Noncurrent Assets | | Other Accrued Expenses | | Other Noncurrent Liabilities |
| Designated as Hedging Instruments: | | | | | | | |
| | | | | | | |
| Currency Contracts | $ | 13.5 | | | $ | 1.7 | | | $ | 0.5 | | | $ | — | |
| Commodity Contracts | 13.8 | | | 1.7 | | | 0.1 | | | 0.1 | |
| Not Designated as Hedging Instruments: | | | | | | | |
| Currency Contracts | 0.6 | | | — | | | 0.2 | | | — | |
| Commodity Contracts | 0.8 | | | 0.1 | | | — | | | — | |
| Total Derivatives | $ | 28.7 | | | $ | 3.5 | | | $ | 0.8 | | | $ | 0.1 | |
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| | January 1, 2022 |
| | Prepaid Expenses and Other Current Assets | | Other Noncurrent Assets | | Other Accrued Expenses | | Other Noncurrent Liabilities |
| Designated as Hedging Instruments: | | | | | | | |
| Interest Rate Swap Contracts | $ | — | | | $ | 5.3 | | | $ | — | | | $ | — | |
| Currency Contracts | 8.3 | | | 0.7 | | | 1.3 | | | — | |
| Commodity Contracts | 8.9 | | | 0.1 | | | 1.2 | | | 0.5 | |
| Not Designated as Hedging Instruments: | | | | | | | |
| Currency Contracts | 0.3 | | | — | | | 0.4 | | | — | |
| Commodity Contracts | 0.4 | | | — | | | — | | | 0.1 | |
| Total Derivatives | $ | 17.9 | | | $ | 6.1 | | | $ | 2.9 | | | $ | 0.6 | |
The following table presents the effect of derivative instruments on the Condensed Consolidated Statements of Income and Condensed Consolidated Statement of Comprehensive Income (pre-tax) (in millions):
Derivatives Designated as Cash Flow Hedging Instruments
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| Three Months Ended |
| March 31, 2022 | | April 3, 2021 |
| Commodity Forwards | | Currency Forwards | | Interest Rate Swaps | | Total | | Commodity Forwards | | Currency Forwards | | Interest Rate Swaps | | Total |
| Gain Recognized in Other Comprehensive Income (Loss) | $ | 13.4 | | | $ | 10.4 | | | $ | 10.6 | | | $ | 34.4 | | | $ | 14.1 | | | $ | 0.2 | | | $ | 4.9 | | | $ | 19.2 | |
| Amounts Reclassified from Other Comprehensive Income (Loss): | | | | | | | | | | | | | | | |
| Gain recognized in Net Sales | — | | | 0.1 | | | — | | | 0.1 | | | — | | | 0.1 | | | — | | | 0.1 | |
| Gain Recognized in Cost of Sales | 5.2 | | | 3.0 | | | — | | | 8.2 | | | 5.2 | | | 2.6 | | | — | | | 7.8 | |
| Gain Recognized in Operating Expenses | — | | | — | | | — | | | — | | | — | | | 3.5 | | | — | | | 3.5 | |
| (Loss) Gain Recognized in Interest Expense | — | | | — | | | (0.3) | | | (0.3) | | | — | | | — | | | 0.1 | | | 0.1 | |
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Derivatives Not Designated as Cash Flow Hedging Instruments (in millions):
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| Three Months Ended |
| March 31, 2022 | | April 3, 2021 |
| Commodity Forwards | | Currency Forwards | | Commodity Forwards | | Currency Forwards |
| Gain recognized in Cost of Sales | $ | 0.6 | | | $ | — | | | $ | 0.2 | | | $ | — | |
| Gain recognized in Operating Expenses | — | | | 1.5 | | | — | | | 5.8 | |
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The net AOCI hedging component balance of a $41.1 million gain at March 31, 2022 includes $28.6 million of net current deferred gain expected to be realized in the next twelve months. The gain/loss reclassified from AOCI into earnings on such derivatives will be recognized in the same period in which the related item affects earnings.
The Company's commodity and currency derivative contracts are subject to master netting agreements with the respective counterparties which allow the Company to net settle transactions with a single net amount payable by one party to another party. The Company has elected to present the derivative assets and derivative liabilities on the Condensed Consolidated Balance Sheets on a gross basis for the periods ended March 31, 2022 and January 1, 2022.
The following table presents the derivative assets and derivative liabilities presented on a net basis under enforceable master netting agreements (in millions):
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| March 31, 2022 |
| Gross Amounts as Presented in the Condensed Consolidated Balance Sheet | | Derivative Contract Amounts Subject to Right of Offset | | Derivative Contracts as Presented on a Net Basis |
| Prepaid Expenses and Other Current Assets: | | | | | |
| Derivative Currency Contracts | $ | 14.1 | | | $ | (0.7) | | | $ | 13.4 | |
| Derivative Commodity Contracts | 14.6 | | | (0.1) | | | 14.5 | |
| Other Noncurrent Assets: | | | | | |
| Derivative Currency Contracts | 1.7 | | | — | | | 1.7 | |
| Derivative Commodity Contracts | 1.8 | | | (0.1) | | | 1.7 | |
| Other Accrued Expenses: | | | | | |
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| Derivative Currency Contracts | 0.7 | | | (0.7) | | | — | |
| Derivative Commodity Contracts | 0.1 | | | (0.1) | | | — | |
| Other Noncurrent Liabilities: | | | | | |
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| Derivative Commodity Contracts | 0.1 | | | (0.1) | | | — | |
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| January 1, 2022 |
| Gross Amounts as Presented in the Condensed Consolidated Balance Sheet | | Derivative Contract Amounts Subject to Right of Offset | | Derivative Contracts as Presented on a Net Basis |
| Prepaid Expenses and Other Current Assets: | | | | | |
| Derivative Currency Contracts | $ | 8.6 | | | $ | (1.7) | | | $ | 6.9 | |
| Derivative Commodity Contracts | 9.3 | | | (1.2) | | | 8.1 | |
| Other Noncurrent Assets: | | | | | |
| Derivative Currency Contracts | 0.7 | | | — | | | 0.7 | |
| Derivative Commodity Contracts | 0.1 | | | (0.1) | | | — | |
| Other Accrued Expenses: | | | | | |
| Derivative Currency Contracts | 1.7 | | | (1.7) | | | — | |
| Derivative Commodity Contracts | 1.2 | | | (1.2) | | | — | |
| Other Noncurrent Liabilities: | | | | | |
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| Derivative Commodity Contracts | 0.6 | | | (0.1) | | | 0.5 | |
14. FAIR VALUE
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The inputs used to measure fair value are classified into the following hierarchy:
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| Level 1 | Unadjusted quoted prices in active markets for identical assets or liabilities |
| Level 2 | Unadjusted quoted prices in active markets for similar assets or liabilities, or |
| Unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or |
| Inputs other than quoted prices that are observable for the asset or liability |
| Level 3 | Unobservable inputs for the asset or liability |
The Company uses the best available information in measuring fair value. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
The fair values of cash equivalents and short-term deposits approximate their carrying values as of March 31, 2022 and January 1, 2022, due to the short period of time to maturity and are classified using Level 1 inputs. The fair values of trade receivables and accounts payable approximate the carrying values due to the short period of time to maturity. See Note 7 for disclosure of the approximate fair value of the Company's debt at March 31, 2022 and January 1, 2022.
The following table sets forth the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2022 and January 1, 2022 (in millions):
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| March 31, 2022 | | January 1, 2022 | | Classification |
| Assets: | | | | | |
| Prepaid Expenses and Other Current Assets: | | | | | |
| Derivative Currency Contracts | $ | 14.1 | | | $ | 8.6 | | | Level 2 |
| Derivative Commodity Contracts | 14.6 | | | 9.3 | | | Level 2 |
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| Other Noncurrent Assets: | | | | | |
| Assets Held in Rabbi Trust | 6.7 | | | 6.8 | | | Level 1 |
| Derivative Currency Contracts | 1.7 | | | 0.7 | | | Level 2 |
| Derivative Commodity Contracts | 1.8 | | | 0.1 | | | Level 2 |
| Interest Rate Swap | — | | | 5.3 | | | Level 2 |
| Liabilities: | | | | | |
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| Other Accrued Expenses: | | | | | |
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| Derivative Currency Contracts | 0.7 | | | 1.7 | | | Level 2 |
| Derivative Commodity Contracts | 0.1 | | | 1.2 | | | Level 2 |
| Other Noncurrent Liabilities: | | | | | |
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| Derivative Commodity Contracts | 0.1 | | | 0.6 | | | Level 2 |
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Level 1 fair value measurements for assets held in a Rabbi Trust are unadjusted quoted prices.
Level 2 fair value measurements for derivative assets and liabilities are measured using quoted prices in active markets for similar assets and liabilities. Interest rate swaps are valued based on the discounted cash flows for the LIBOR forward yield curve for a swap with similar contractual terms. Foreign currency forwards are valued based on exchange rates quoted by domestic and foreign banks for similar instruments. Commodity forwards are valued based on observable market transactions of forward commodity prices.
15. RESTRUCTURING ACTIVITIES
The Company incurred restructuring and restructuring-related costs on projects during fiscal 2022 and 2021. In conjunction with the Rexnord Transaction, the Company initiated a restructuring plan to achieve cost synergies from procurement, distribution efficiencies, footprint rationalization and other general cost savings measures. Restructuring costs include employee termination and plant relocation costs. Restructuring-related costs also include costs directly associated with actions resulting from the Company's simplification initiatives, such as asset write-downs or accelerated depreciation due to shortened useful lives in connection with site closures, discretionary employment benefit costs and other facility rationalization costs. Restructuring costs for employee termination expenses are generally recognized when the severance liability is determined to be probable of being paid and reasonably estimable while plant relocation costs and related costs are generally required to be expensed as incurred.
The following table presents a reconciliation of provisions and payments for the restructuring projects for the three months ended March 31, 2022 and April 3, 2021 (in millions):
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| Three Months Ended | | |
| March 31, 2022 | | April 3, 2021 | | | | |
| Beginning Balance | $ | 5.0 | | | $ | 2.0 | | | | | |
| Provision | 16.8 | | | 1.7 | | | | | |
| Less: Payments/ Other | 7.3 | | | 1.0 | | | | | |
| Ending Balance | $ | 14.5 | | | $ | 2.7 | | | | | |
The following table presents a reconciliation of restructuring and restructuring-related costs for restructuring projects for the three months ended March 31, 2022 and April 3, 2021, respectively (in millions):
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| Three Months Ended |
| March 31, 2022 | | April 3, 2021 |
| Restructuring Costs: | Cost of Sales | | Operating Expenses | | Total | | Cost of Sales | | Operating Expenses | | Total |
| Employee Termination Expenses | $ | 4.8 | | | $ | 3.6 | | | $ | 8.4 | | | $ | 0.2 | | | $ | 0.4 | | | $ | 0.6 | |
| Facility Related Costs | 8.0 | | | 0.4 | | | 8.4 | | | 0.8 | | | 0.2 | | | 1.0 | |
| Other Expenses | — | | | — | | | — | | | 0.1 | | | — | | | 0.1 | |
| Total Restructuring Costs | $ | 12.8 | | | $ | 4.0 | | | $ | 16.8 | | | $ | 1.1 | | | $ | 0.6 | | | $ | 1.7 | |
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The following table presents the allocation of restructuring and restructuring-related costs by segment for the three months ended March 31, 2022 and April 3, 2021 (in millions):
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| Restructuring Costs - Three Months Ended | Total | | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions |
| March 31, 2022 | $ | 16.8 | | | $ | 0.7 | | | $ | — | | | $ | 0.3 | | | $ | 15.8 | |
| April 3, 2021 | $ | 1.7 | | | $ | 0.2 | | | $ | 0.5 | | | $ | 0.3 | | | $ | 0.7 | |
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The Company's current restructuring activities are expected to continue through 2023. The Company expects to record aggregate future charges of approximately $43.3 million in 2022. The Company continues to evaluate operating efficiencies and anticipates incurring additional costs in future periods in connection with these activities.
16. SUBSEQUENT EVENT
The Company has evaluated subsequent events since March 31, 2022, the date of these financial statements, and is aware of the following event to disclose.
On April 7, 2022, the Company entered into a Note Purchase Agreement with certain institutional accredited investors (the “Note Purchase Agreement”) governing the issuance and sale of $500,000,000 aggregate principal amount of 3.90% senior notes due April 7, 2032 (the “Senior Notes”), in an offering exempt from the registration requirements of the Securities Act of 1933, as amended. The Company expects to use the net proceeds from the offering for general corporate purposes. The Note Purchase Agreement contains customary representations, warranties and covenants of the Company. The Company may, at its option, prepay at any time all, or from time to time any part of, the Senior Notes, in an amount not less than 5% of the aggregate principal amount of the Senior Notes then outstanding in the case of a partial prepayment, at 100% of the principal amount so prepaid, and a make-whole amount determined as provided in the Note Purchase Agreement for the prepayment date with respect to such principal amount. The Company's obligations under the Note Purchase Agreement and Senior Notes are unconditionally guaranteed by certain subsidiary guarantors.