Notes to the Consolidated Financial Statements
(Dollars In Millions Except Per Share Data, Unless Otherwise Noted)
(1) Nature of Operations
Regal Rexnord Corporation (the “Company”) is a United States-based multi-national corporation. The Company is comprised of four operating segments: the 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; the 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; the Climate Solutions segment designs and produces small motors, electronic variable speed controls and air moving solutions; and the 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.
(2) Basis of Presentation
Effective for fiscal year 2022, the Company changed its 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. The fiscal year ended December 31, 2022 was 52 weeks, the fiscal year ended January 1, 2022 was 52 weeks and the fiscal year ended January 2, 2021 was 53 weeks.
(3) Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned and majority-owned subsidiaries. In addition, the Company has joint ventures that are consolidated in accordance with consolidation accounting guidance. All intercompany accounts and transactions are eliminated.
Use of Estimates
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”), which require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the 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 credit losses; 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; 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.
Acquisitions
The Company recognizes assets acquired, liabilities assumed, contractual contingencies and contingent consideration at their fair value on the acquisition date. The operating results of the acquired companies are included in the Company’s consolidated financial statements from the date of acquisition.
Acquisition-related costs are expensed as incurred, restructuring costs are recognized as post-acquisition expense and changes in deferred tax asset valuation allowances and income tax uncertainties after the measurement period are recorded in Provision for Income Taxes. See Note 4 - Acquisitions for more information.
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.
For a limited number of contracts, the Company recognizes revenue over time in proportion to costs incurred. The pricing of products sold is generally supported by customer purchase orders, and accounts receivable collection is reasonably assured. Estimated discounts and rebates are recorded as a reduction of gross sales in the same period revenue is recognized. Product returns and credits are estimated and recorded at the time of shipment based upon historical experience. Shipping and handling costs are recorded as revenue when billed to the customers. The costs incurred from shipping are recorded in Cost of Sales and handling costs incurred in connection with selling and distribution activities are recorded in Operating Expenses.
The Company derives a significant portion of its revenues from several original equipment manufacturing customers. Despite this relative concentration, there were no customers that accounted for more than 10% of consolidated net sales in fiscal 2022, fiscal 2021 or fiscal 2020.
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 – Segment Information 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 systems/solutions.
Product:
The nature of products varies from segment to segment but across all segments, individual products are generally not integrated and represent separate performance obligations.
Customized systems/solutions:
The Company provides customized systems/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 contract asset or contract liability position and classified as such on the Consolidated Balance Sheet.
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. See Note 12 - Contingencies for more information.
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, it is 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 table presents the Company’s revenues disaggregated by geographical region for the fiscal years ended December 31, 2022, January 1, 2022 and January 2, 2021, respectively:
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December 31, 2022 | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Total |
North America | $ | 813.3 | | | $ | 361.6 | | | $ | 953.6 | | | $ | 1,728.1 | | | $ | 3,856.6 | |
Asia | 156.8 | | | 159.1 | | | 31.3 | | | 157.6 | | | 504.8 | |
Europe | 134.1 | | | 50.7 | | | 48.1 | | | 394.2 | | | 627.1 | |
Rest-of-World | 41.2 | | | 44.6 | | | 48.8 | | | 94.8 | | | 229.4 | |
Total | $ | 1,145.4 | | | $ | 616.0 | | | $ | 1,081.8 | | | $ | 2,374.7 | | | $ | 5,217.9 | |
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January 1, 2022 | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Total |
North America | $ | 696.0 | | | $ | 296.2 | | | $ | 905.9 | | | $ | 877.0 | | | $ | 2,775.1 | |
Asia | 182.3 | | | 186.7 | | | 33.7 | | | 60.3 | | | 463.0 | |
Europe | 102.7 | | | 46.4 | | | 43.6 | | | 168.8 | | | 361.5 | |
Rest-of-World | 51.1 | | | 47.0 | | | 47.4 | | | 65.2 | | | 210.7 | |
Total | $ | 1,032.1 | | | $ | 576.3 | | | $ | 1,030.6 | | | $ | 1,171.3 | | | $ | 3,810.3 | |
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January 2, 2021 | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Total |
North America | $ | 566.9 | | | $ | 291.4 | | | $ | 752.7 | | | $ | 572.4 | | | $ | 2,183.4 | |
Asia | 124.9 | | | 150.9 | | | 27.7 | | | 27.5 | | | 331.0 | |
Europe | 86.1 | | | 44.8 | | | 30.3 | | | 86.4 | | | 247.6 | |
Rest-of-World | 42.3 | | | 41.7 | | | 36.1 | | | 24.9 | | | 145.0 | |
Total | $ | 820.2 | | | $ | 528.8 | | | $ | 846.8 | | | $ | 711.2 | | | $ | 2,907.0 | |
Practical Expedients and Exemptions
The Company typically expenses incremental direct costs of obtaining a contract, primarily sales commissions, as incurred because the amortization period is expected to be 12 months or less. Contract costs are included in Operating Expenses in the accompanying Consolidated Statements of Income.
Due to the short nature of the Company’s contracts, the Company has adopted a practical expedient to not disclose revenue allocated to remaining performance obligations as substantially all of its contracts have original terms of 12 months or less.
The Company typically does not include in its transaction price any amounts collected from customers for sales taxes.
Research, Development and Engineering
The Company performs research, development and engineering activities relating to new product development and the improvement of current products. The Company's research, development and engineering expenses consist primarily of costs for: (i) salaries and related personnel expenses; (ii) the design and development of new energy efficient products and enhancements; (iii) quality assurance and testing; and (iv) other related overhead. The Company's research, development and engineering efforts tend to be targeted toward developing new products that would allow it to gain additional market share, whether in new or existing segments.
Research, development and engineering costs are expensed as incurred. The costs are recorded in Operating Expenses in the fiscal year as follows as noted in the table below:
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| | December 31, 2022 | | January 1, 2022 | | January 2, 2021 |
Research, Development and Engineering Costs | | $ | 106.6 | | | $ | 74.5 | | | $ | 67.0 | |
Cash and Cash Equivalents
Cash equivalents consist of highly liquid investments which are readily convertible to cash, present insignificant risk of changes in value due to interest rate fluctuations and have original or purchased maturities of three months or less.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents. The Company has material deposits with global financial institutions. The Company performs periodic evaluations of the relative credit standing of its financial institutions and monitors the amount of exposure.
Concentration of credit risk with respect to trade accounts receivable is limited due to the large number of customers and their dispersion across many geographic areas. The Company monitors credit risk associated with its trade receivables.
Trade Receivables
The Company's policy for estimating the allowance for credit losses on trade receivables considers several factors including historical write-off experience, overall customer credit quality in relation to general economic and market conditions, and specific customer account analyses to estimate expected credit losses. The specific customer account analysis considers such items as, credit worthiness, payment history, and historical bad debt experience. Trade receivables are written off after exhaustive collection efforts occur and the receivable is deemed uncollectible. Adjustments to the allowance for credit losses are recorded in Operating Expenses. Trade receivables acquired in the Rexnord Transaction (see Note 4 - Acquisitions and Divestitures) were recorded at fair value at the acquisition date in an amount that reflected expected credit losses, and accordingly, an allowance for credit losses was not separately presented and disclosed. The allowance for credit losses has increased by approximately $11.0 million at December 31, 2022 when compared to January 1, 2022 primarily due to the presentation of post-merger trade receivables at carrying value, with an allowance for credit losses presented separately. There has not been a significant change in the amount of expected credit losses from the acquisition date to December 31, 2022.
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 Consolidated Statements of Operations and Consolidated Statements of Comprehensive Income for the years ended January 1, 2022 and January 2, 2021, Consolidated Statements of Cash Flows for the years ended January 1, 2022 and January 2, 2021 and our Consolidated Balance Sheet as of January 1, 2022, were adjusted as follows:
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| | As Originally Reported | | Effect of Change | | As Adjusted |
Consolidated Statement of Operations for the year ended January 1, 2022 | | | | | | |
Cost of Sales | | $ | 2,724.6 | | | $ | (25.9) | | | $ | 2,698.7 | |
Provision for Income Taxes | | $ | 68.5 | | | $ | 6.2 | | | $ | 74.7 | |
Net income attributable to Regal Rexnord Corporation | | $ | 209.9 | | | $ | 19.7 | | | $ | 229.6 | |
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Earnings Per Share Attributable to Regal Rexnord Corporation: | | | | | | |
Basic | | $ | 4.44 | | | $ | 0.41 | | | $ | 4.85 | |
Assuming Dilution | | $ | 4.40 | | | $ | 0.41 | | | $ | 4.81 | |
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Consolidated Statement of Operations for the year ended January 2, 2021 | | | | | | |
Cost of Sales | | $ | 2,098.3 | | | $ | 2.1 | | | $ | 2,100.4 | |
Provision for Income Taxes | | $ | 56.8 | | | $ | (0.5) | | | $ | 56.3 | |
Net income attributable to Regal Rexnord Corporation | | $ | 189.3 | | | $ | (1.6) | | | $ | 187.7 | |
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Earnings Per Share Attributable to Regal Rexnord Corporation: | | | | | | |
Basic | | $ | 4.66 | | | $ | (0.04) | | | $ | 4.62 | |
Assuming Dilution | | $ | 4.64 | | | $ | (0.04) | | | $ | 4.60 | |
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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 | |
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Consolidated Statement of Cash Flows for the year ended January 1, 2022 | | | | | | |
Net Income | | $ | 216.1 | | | $ | 19.7 | | | $ | 235.8 | |
Change in Inventories | | $ | (148.5) | | | $ | (25.9) | | | $ | (174.4) | |
Benefit from Deferred Income Taxes | | $ | (14.9) | | | $ | 6.2 | | | $ | (8.7) | |
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Consolidated Statement of Cash Flows for the year ended January 2, 2021 | | | | | | |
Net Income | | $ | 193.8 | | | $ | (1.6) | | | $ | 192.2 | |
Change in Inventories | | $ | (3.7) | | | $ | 2.1 | | | $ | (1.6) | |
Benefit from Deferred Income Taxes | | $ | (16.5) | | | $ | (0.5) | | | $ | (17.0) | |
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Consolidated Statement of Comprehensive Income for the year ended January 1, 2022 | | | | | | |
Comprehensive income attributable to Regal Rexnord Corporation | | $ | 178.1 | | | $ | 19.7 | | | $ | 197.8 | |
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Consolidated Statement of Comprehensive Income for the year ended January 2, 2021 | | | | | | |
Comprehensive income attributable to Regal Rexnord Corporation | | $ | 263.8 | | | $ | (1.6) | | | $ | 262.2 | |
The following table compares amounts that would have been reported under the LIFO method with amounts reported under the FIFO method in our Consolidated Statement of Operations, Consolidated Statement of Comprehensive Income and Consolidated Statement of Cash Flows for the year ended December 31, 2022 and our Consolidated Balance Sheet as of December 31, 2022:
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| | As Computed under LIFO | | Effect of Change | | As Reported under FIFO |
Consolidated Statement of Operations for the year ended December 31, 2022 | | | | | | |
Cost of Sales | | $ | 3,616.4 | | | $ | (68.2) | | | $ | 3,548.2 | |
Provision for Income Taxes | | $ | 102.6 | | | $ | 16.3 | | | $ | 118.9 | |
Net income attributable to Regal Rexnord Corporation | | $ | 437.0 | | | $ | 51.9 | | | $ | 488.9 | |
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Earnings Per Share Attributable to Regal Rexnord Corporation: | | | | | | |
Basic | | $ | 6.55 | | | $ | 0.78 | | | $ | 7.33 | |
Assuming Dilution | | $ | 6.51 | | | $ | 0.78 | | | $ | 7.29 | |
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Consolidated Balance Sheet as of December 31, 2022 | | | | | | |
Inventories | | $ | 1,182.9 | | | $ | 154.0 | | | $ | 1,336.9 | |
Deferred Income Taxes | | $ | 547.9 | | | $ | 44.0 | | | $ | 591.9 | |
Retained Earnings | | $ | 2,020.0 | | | $ | 110.0 | | | $ | 2,130.0 | |
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Consolidated Statement of Cash Flows for the year ended December 31, 2022 | | | | | | |
Net Income | | $ | 443.0 | | | $ | 51.9 | | | $ | 494.9 | |
Change in Inventories | | $ | (106.2) | | | $ | (68.2) | | | $ | (174.4) | |
Benefit from Deferred Income Taxes | | $ | (96.4) | | | $ | 16.3 | | | $ | (80.1) | |
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Consolidated Statement of Comprehensive Income for the year ended December 31, 2022 | | | | | | |
Comprehensive income attributable to Regal Rexnord Corporation | | $ | 280.0 | | | $ | 51.9 | | | $ | 331.9 | |
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The major classes of inventory at year end are as follows:
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| December 31, 2022 | | January 1, 2022 |
Raw Material and Work in Process | 57.0% | | 43.4% |
Finished Goods and Purchased Parts | 43.0% | | 56.6% |
Inventories are stated at the lower of cost or net realizable value. Material, labor and factory overhead costs are included in the inventories.
The Company reviews inventories for excess and obsolete products or components. Based on an analysis of historical usage and management's evaluation of estimated future demand, market conditions and alternative uses for possible excess or obsolete parts, the Company records an excess and obsolete reserve.
Property, Plant and Equipment
Property, Plant and Equipment are stated at cost. Depreciation of plant and equipment is provided principally on a straight-line basis over the estimated useful lives (3 to 50 years) of the depreciable assets. Accelerated methods are used for income tax purposes.
Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures which extend the useful lives of existing equipment are capitalized and depreciated.
Upon retirement or disposition of property and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized. Leasehold improvements are capitalized and amortized over the lesser of the life of the lease or the estimated useful life of the asset.
Property, plant and equipment by major classification was as follows:
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| Useful Life (In Years) | | December 31, 2022 | | January 1, 2022 |
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Land and Improvements | | | $ | 103.4 | | | $ | 109.1 | |
Buildings and Improvements | 3-50 | | 401.7 | | | 449.6 | |
Machinery and Equipment | 3-15 | | 1,111.3 | | | 1,164.8 | |
Property, Plant and Equipment | | | 1,616.4 | | | 1,723.5 | |
Less: Accumulated Depreciation | | | (809.4) | | | (815.0) | |
Net Property, Plant and Equipment | | | $ | 807.0 | | | $ | 908.5 | |
As of December 31, 2022 and January 1, 2022, $47.1 million and $50.3 million of ROU assets (as defined in Note 9 - Leases) were included in Net Property, Plant and Equipment, respectively.
Goodwill
The Company evaluates the carrying amount of goodwill annually or more frequently if events or circumstances indicate that the goodwill might be impaired. Factors that could trigger an impairment review include significant underperformance relative to historical or forecasted operating results, a significant decrease in the market value of an asset or significant negative industry or economic trends. For goodwill, the Company may perform a qualitative test to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the quantitative goodwill impairment test. The Company performed quantitative impairment testing for all reporting units in fiscal 2022. The Company performs the required annual goodwill impairment testing as of the end of the October fiscal month.
The Company uses a weighting of the market approach and the income approach (discounted cash flow method) in testing goodwill for impairment. In the market approach, the Company applies performance multiples from comparable public companies, adjusted for relative risk, profitability, and growth considerations, to the reporting units to estimate fair value. The key assumptions used in the discounted cash flow method used to estimate fair value include discount rates, revenue and EBITDA margin projections and terminal value rates because such assumptions are the most sensitive and susceptible to change as they require significant management judgment. Discount rates are determined by using market and industry data as well as Company-specific risk factors for each reporting unit. The discount rate utilized for each reporting unit is indicative of the return an investor would expect to receive for investing in such a business. Terminal value rate determination follows common methodology of capturing the present value of perpetual cash flow estimates beyond the last projected period assuming a constant discount rate and long-term growth rates.
The Company did not record any goodwill impairments in fiscal 2022. The Company recorded goodwill impairments of $33.0 million and $10.5 million for its global industrial motors reporting unit in fiscal 2021 and 2020, respectively. Some of the key considerations used in the Company's impairment testing included (i) market pricing of guideline publicly traded companies (ii) cost of capital, including the risk-free interest rate, and (iii) recent historical and projected operating results of the subject reporting unit. There is inherent uncertainty included in the assumptions used in goodwill impairment testing. A change to any of the assumptions could lead to a future impairment that could be material. See Note 5 - Goodwill and Intangible Assets for more information.
Intangible Assets
Intangible assets with finite lives are amortized over their estimated useful lives using the straight line method. The Company evaluates amortizing intangibles whenever events or circumstances have occurred that indicate carrying values may not be recoverable. If an indicator is present, the Company uses an estimate of the related undiscounted cash flows over the remaining life of the primary asset to estimate recoverability of the asset group. If such estimated future cash flows are less than carrying value, an impairment would be recognized. There was no impairment of intangible assets during fiscal 2022, 2021 or 2020.
The Company's indefinite-lived intangible assets previously consisted of a trade name associated with the acquisition of the Power Transmission Solutions business from Emerson Electric Co. During fiscal 2021, following the Rexnord Transaction (as defined in Note 4 – Acquisitions and Divestitures), which included the acquisition of additional trade names that impacted on
the Company's long-term branding strategy, the Company determined that the indefinite-lived intangible asset associated with the Power Transmission Solutions trade name had a finite life and began amortizing it over a remaining estimated useful life using the straight line method. Following this change, this asset has been evaluated for impairment under guidance applicable to long-lived assets. Previously, the Company determined the fair value of this asset using a royalty relief methodology similar to the methodology used when the associated asset was acquired, but used updated assumptions and estimates of future sales and profitability. For fiscal 2021 and fiscal 2020, the fair value of the indefinite-lived intangible asset exceeded its respective carrying value. Some of the key considerations used in the Company's impairment testing included (i) cost of capital, including the risk-free interest rate, (ii) royalty rate and (iii) recent historical and projected operating performance. See Note 5 - Goodwill and Intangible Assets for more information.
Long-Lived Assets Impairment
The Company evaluates the recoverability of the carrying amount of property, plant and equipment assets (collectively, "long-lived assets") whenever events or changes in circumstance indicate that the carrying amount of an asset may not be fully recoverable through future cash flows. Factors that could trigger an impairment review include a significant decrease in the market value of an asset or significant negative economic trends. For long-lived assets, the Company uses an estimate of the related undiscounted cash flows over the remaining life of the primary asset to estimate recoverability of the asset group. If the asset is not recoverable, the asset is written down to fair value. In fiscal 2022, the Company concluded it had asset impairments related to assets to held for sale of $0.9 million. The Company concluded it had an impairment of $5.6 million in long-lived assets in fiscal 2021 due to the transfer of assets to held for sale.
Earnings Per Share
Diluted earnings per share is computed 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 dilutive securities. Share based compensation awards for common shares where the exercise price was above the market price have been excluded from the calculation of the effect of dilutive securities shown below; the amount of these shares were 0.2 million in fiscal 2022, 0.1 million in fiscal 2021 and 0.4 million in fiscal 2020. The following table reconciles the basic and diluted shares used in earnings per share calculations for the fiscal years ended:
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| 2022 | | 2021 | | 2020 |
Denominator for Basic Earnings Per Share | 66.7 | | | 47.3 | | | 40.6 | |
Effect of Dilutive Securities | 0.4 | | | 0.4 | | | 0.2 | |
Denominator for Diluted Earnings Per Share | 67.1 | | | 47.7 | | | 40.8 | |
Defined Benefit Pension Plans
The majority of the defined benefit pension plans covering the Company's domestic associates have been closed to new associates and frozen for existing associates. Most of the Company's foreign associates are covered by government sponsored plans in the countries in which they are employed. The Company's obligations under its defined benefit pension are determined with the assistance of actuarial firms. The actuaries, under management's direction, make certain assumptions regarding such factors as withdrawal rates and mortality rates. The actuaries also provide information and recommendations from which management makes further assumptions on such factors as the long-term expected rate of return on plan assets, the discount rate on benefit obligations and where applicable and the rate of annual compensation increases.
Based upon the assumptions made, the investments made by the plans, overall conditions and movement in financial markets, life-spans of benefit recipients and other factors, annual expenses and recorded assets or liabilities of these defined benefit pension plans may change significantly from year to year.
The service cost component of the Company's net periodic benefit cost is included in Cost of Sales and Operating Expenses. All other components of net periodic benefit costs are included in Other (Income) Expenses, net on the Company's Consolidated Statements of Income. See Note 8 – Retirement Plans for more information.
Derivative Financial Instruments
Derivative instruments are recorded on the Consolidated Balance Sheets at fair value. Any fair value changes are recorded in Net Income or Accumulated Other Comprehensive Loss ("AOCI") as determined under accounting guidance that establishes criteria for designation and effectiveness of the hedging relationships.
The Company uses derivative instruments to manage its exposure to fluctuations in certain raw material commodity pricing, fluctuations in the cost of forecasted foreign currency transactions, and variability in interest rate exposure on floating rate borrowings. The majority of derivative instruments have been designated as cash flow hedges. See Note 13 – Derivative Financial Instruments for more information.
Income Taxes
The Company accounts for income taxes in accordance with ASC 740, Accounting for Income Taxes (“ASC 740”). Deferred tax assets and liabilities arise from temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and consideration of operating loss and tax credit carryforwards. Deferred income taxes are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. The impact on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Valuation allowances are provided to reduce deferred tax assets to the amount that will more likely than not be realized. This requires management to make judgments and estimates regarding the amount and timing of the reversal of taxable temporary differences, expected future taxable income, and the impact of tax planning strategies.
Uncertainty exists regarding tax positions taken in previously filed tax returns which remain subject to examination, along with positions expected to be taken in future returns. The Company provides for unrecognized tax benefits, based on the technical merits, when it is more likely than not that an uncertain tax position will not be sustained upon examination. Adjustments are made to the uncertain tax positions when facts and circumstances change, such as the closing of a tax audit; changes in applicable tax laws, including tax case rulings and legislative guidance; or expiration of the applicable statute of limitations. See Note 11 – Income Taxes for more information.
Foreign Currency Translation
For those operations using a functional currency other than the US dollar, assets and liabilities are translated into US dollars at year-end exchange rates, and revenues and expenses are translated at weighted-average exchange rates. The resulting translation adjustments are recorded as a separate component of Shareholders' Equity.
Product Warranty Reserves
The Company maintains reserves for product warranty to cover the stated warranty periods for its products. Such reserves are established based on an evaluation of historical warranty experience and specific significant warranty matters when they become known and can reasonably be estimated. See Note 12 – Contingencies for more information.
Accumulated Other Comprehensive Loss
Foreign currency translation adjustments, unrealized gains and losses on derivative instruments designated as hedges and pension and post retirement liability adjustments are included in Shareholders' Equity under AOCI.
The components of the ending balances of AOCI are as follows:
| | | | | | | | | | | |
| 2022 | | 2021 |
Foreign Currency Translation Adjustments | $ | (356.1) | | | $ | (201.8) | |
Hedging Activities, Net of Tax of $5.1 in 2022 and $6.6 in 2021 | 17.3 | | | 21.0 | |
Pension and Post-Retirement Benefits, Net of Tax of $(4.1) in 2022 and $(4.2) in 2021 | (13.3) | | | (14.3) | |
Total | $ | (352.1) | | | $ | (195.1) | |
Legal Claims and Contingent Liabilities
The Company is subject to various legal proceedings, claims and regulatory matters, the outcomes of which are subject to significant uncertainty and 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. The Company records expenses and liabilities when the Company believes that an obligation of the Company or a subsidiary on a specific matter is probable and there is a basis to reasonably estimate the value of the obligation, and such assessment inherently involves an exercise in judgment. This methodology is used for legal claims that are filed against the Company or a subsidiary from time to time. The uncertainty that is associated with such matters frequently requires adjustments to the liabilities previously recorded. See Note 12 – Contingencies for more information.
Fair Values of Financial Instruments
The fair values of cash equivalents, term deposits, trade receivables and accounts payable approximate their carrying values due to the short period of time to maturity. The fair value of debt is estimated using discounted cash flows based on rates for instruments with comparable maturities and credit ratings as further described in Note 7 – Debt and Credit Facilities. The fair value of pension assets and derivative instruments is determined based on the methods disclosed in Note 8 - Retirement and Post-Retirement Medical and Note 13 – Derivative Financial Instruments.
New Accounting Standards
New Accounting Standards Adopted as of January 1, 2023
In September 2022, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2022-04, Liabilities - Supplier Finance Programs (Subtopic 405-50) Disclosure of Supplier Finance Program Obligations. The ASU requires that a buyer in a supplier finance program disclose sufficient information about the program to allow a user of financial statements to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude. This ASU was effective January 1, 2023. The Company has evaluated the effect of adopting this accounting guidance and will include the new required disclosures in future filings as needed.
(4) Acquisitions and Divestitures
Altra Transaction
On October 26, 2022, the Company entered into an Agreement and Plan of Merger (the “Altra Merger Agreement”) by and among the Company, Altra Industrial Motion Corp., a Delaware corporation (“Altra”), and Aspen Sub, Inc., a Delaware corporation and a wholly owned subsidiary of the Company (“Merger Sub”), pursuant to which, among other things and subject to the satisfaction or waiver of specified conditions, Merger Sub will merge (the “Altra Merger”) with and into Altra, with Altra surviving the Altra Merger as a wholly owned subsidiary of the Company (the “Altra Transaction”).
Pursuant to the Altra Merger Agreement, at the effective time of the Altra Merger (the “Effective Time”), each of Altra’s issued and outstanding shares of common stock, par value $0.001 per share (“Altra Common Stock”) (other than (i) any shares held by either the Company, Altra or Merger Sub, (ii) shares owned by any direct or indirect wholly owned subsidiary of Altra or the Company, (iii) shares for which appraisal rights have been properly demanded according to Section 262 of the Delaware General Corporation Law and (iv) restricted shares of Altra Common Stock granted under Altra’s 2014 Omnibus Incentive Plan and subject to forfeiture conditions) will be converted into the right to receive $62.00 in cash, without interest (the “Altra Merger Consideration”). The Altra Merger Agreement generally provides that (1) each vested Altra stock option outstanding immediately prior to the Effective Time will be canceled and converted into a cash payment equal to the intrinsic value of such option based on the Altra Merger Consideration, (2) each unvested Altra stock option outstanding, immediately prior to the Effective Time, will be converted into an award of stock options with respect to Common Stock with an intrinsic value equivalent to the intrinsic value of the Altra stock option based on the Altra Merger Consideration, (3) each unvested Altra restricted stock unit outstanding, as of the Effective Time, that is subject solely to time-based vesting conditions will be converted into an award of restricted stock units with respect to Common Stock with an equivalent value based on the Altra Merger Consideration on substantially similar terms and conditions, (4) each unvested award of Altra restricted shares will be converted into an award of restricted cash of equivalent value based on the Altra Merger Consideration on substantially similar terms and conditions and (5) each unvested Altra restricted stock unit outstanding, as of the Effective Time, that is subject to performance-based vesting conditions will be converted into an award of time-based restricted stock with an equivalent value based on the Altra Merger Consideration on substantially similar terms and conditions (with performance goals being deemed satisfied at specified levels).
Consummation of the Altra Transaction is subject to customary closing conditions under the Altra Merger Agreement including, among others: the absence of any order issued by any court of competent jurisdiction or governmental entity, or any applicable law, enjoining or otherwise prohibiting consummation of the Altra Transaction; the receipt of certain specified regulatory consents, approvals and clearances under competition laws and laws governing foreign investments; accuracy of representations and warranties and compliance with covenants, subject to certain customary qualifications and exceptions; and the absence of any law or judgment resulting in the imposition of or requiring a Burdensome Condition (as defined in the Altra Merger Agreement).
The Company incurred transaction-related costs of approximately $14.7 million during fiscal 2022. These costs were associated with legal and professional services and were recognized as Operating expenses in the Company's Consolidated Statements of Income. In connection with the Altra Transaction, the Company has entered into certain financing arrangements, which are described in Note 7 – Debt and Bank Credit Facilities.
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 “Rexnord Merger Agreement”), the Company completed its combination with the Rexnord Process & Motion Control business (“Rexnord PMC business”) of Zurn Elkay Water Solutions Corporation (formerly known as Rexnord 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 merged with and into Land (the “Rexnord Merger”) and all shares of Land common stock (other than those held by Zurn, Land, the Company, the Company's merger subsidiary or their respective subsidiaries) were converted as of the effective time of the Rexnord 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 Rexnord 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 Rexnord 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 Rexnord Transaction (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 has entered into certain financing arrangements, which are described in Note 7 – Debt and Bank Credit Facilities.
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 in connection with the Rexnord Transaction was approximately $4.0 billion. The total assets and liabilities assumed were based on the final balances per the terms included within the Separation and Distribution Agreement.
The final purchase price of the Rexnord PMC business consisted of the following:
| | | | | | | | | | | | | | | | | | | | |
| | As Reported as of January 1, 2022 | | Measurement period adjustments | | As Reported as of December 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) | |
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 Rexnord Merger.
(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 that was negotiated in connection with the Rexnord Transaction 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.
As of December 31, 2022, the valuation process to determine the fair values of the net assets acquired during the measurement period was complete. The Company estimated the fair value of net assets acquired based on information available during the measurement period.
| | | | | | | | | | | | | | | | | | | | |
| | As Reported as of January 1, 2022 | | Measurement period adjustments | | As Reported as of December 31, 2022 |
| | | | | | |
Cash and Cash Equivalents | | $ | 192.8 | | | $ | — | | | $ | 192.8 | |
Trade Receivables | | 186.9 | | | (4.4) | | | 182.5 | |
Inventories | | 262.5 | | | (10.8) | | | 251.7 | |
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 | | | 12.3 | | | 24.6 | |
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) | | | 13.2 | | | (495.0) | |
Pension and Other Post Retirement Benefits | | (75.1) | | | — | | | (75.1) | |
Noncurrent Operating Lease Liabilities | | (38.0) | | | — | | | (38.0) | |
Other Noncurrent Liabilities | | (17.0) | | | (8.6) | | | (25.6) | |
Total Identifiable Net Assets | | 1,547.5 | | | (22.8) | | | 1,524.7 | |
Goodwill | | 2,433.2 | | | 26.9 | | | 2,460.1 | |
Noncontrolling Interests | | (3.3) | | | — | | | (3.3) | |
Purchase price | | $ | 3,977.4 | | | $ | 4.1 | | | $ | 3,981.5 | |
During the twelve months ended December 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 twelve months ended December 31, 2022 resulted in $26.9 million of additional goodwill.
Summary of Significant Fair Value Methods
The methods used to determine the fair value of significant identifiable assets and liabilities included in the allocation of purchase price are discussed below.
Inventories
Acquired inventory was comprised of finished goods, work in process and raw materials. The fair value of finished goods was calculated as the estimated selling price, adjusted for costs of the selling effort and a reasonable profit allowance relating to the selling effort. The fair value of work in process inventory was primarily calculated as the estimated selling price, adjusted for estimated costs to complete the manufacturing, estimated costs of the selling effort, as well as a reasonable profit margin on the remaining manufacturing and selling effort. The fair value of raw materials and supplies was determined based on replacement cost which approximates historical carrying value.
Property, Plant and Equipment
The preliminary fair value of Property, Plant, and Equipment was determined based on assumptions that market participants would use in pricing an asset.
Identifiable Intangible Assets
The fair value and weighted average useful life of the identifiable intangible assets are as follows:
| | | | | | | | | | | | | | |
| | Fair Value | | Weighted Average Useful Life (Years) |
Trademarks(1) | | $ | 225.0 | | | 10 |
Customer Relationships(2) | | 1,519.0 | | | 17 |
Technology(3) | | 87.0 | | | 12 |
Total Identifiable Intangible Assets | | $ | 1,831.0 | | | |
The fair value estimates for identifiable intangible assets are preliminary and are based upon assumptions that market participants would use in pricing an asset.
(1) The Rexnord PMC business Trademarks were valued using the relief from royalty method, which considers both the market approach and the income approach.
(2) The fair value of Customer Relationships was valued using a multi-period excess earnings method, a form of the income approach, which incorporates the estimated future cash flows to be generated from the Rexnord PMC business's existing customer base.
(3) The Rexnord PMC business Technology were valued using the relief from royalty method, which considers both the market approach and the income approach.
The intangible assets related to definite-lived customer relationships, trademarks and technology are amortized over their estimated useful lives, which had estimated weighted-average useful lives of 17 years, 10 years and 12 years, respectively, at acquisition.
The Company believes that the amounts of purchased intangible assets recorded represent the preliminary fair values and approximates the amounts a market participant would pay for these intangible assets as of the acquisition date.
Leases, including right-of-use ("ROU") assets and lease liabilities
Lease liabilities were measured as of the acquisition date at the present value of future minimum lease payments over the remaining lease term and the incremental borrowing rate of the Company as if the acquired leases were new leases as of the acquisition date. ROU assets recorded within “Operating Lease Assets” are equal to the amount of the lease liability at the acquisition date adjusted for any off-market terms of the lease. The remaining lease term was based on the remaining term at the acquisition date plus any renewal or extension options that the Company is reasonably certain will be exercised.
Pension and Other Post Retirement Benefits
The Rexnord PMC business recognized a pretax net liability representing the net funded status of the Rexnord PMC business’s defined-benefit pension and other postretirement benefit (“OPEB”) plans. See Note 8 for further information on the pension and OPEB arrangements.
Long-Term Debt
In connection with the Rexnord Transaction, the Company entered into certain financing arrangements as indicated in Note 7.
The fair value for long term debt was determined based on the total indebtedness as the debt consummated at the time of closing of the acquisition.
Deferred Income Tax Assets and Liabilities
The acquisition was structured as a merger and therefore, the Company assumed the historical tax basis of the Rexnord PMC business’s assets and liabilities. The deferred income tax assets and liabilities include the expected future federal, state, and foreign tax consequences associated with temporary differences between the fair values of the assets acquired and liabilities assumed and the respective tax bases. Tax rates utilized in calculating deferred income taxes generally represent the enacted statutory tax rates at the effective date of the acquisition in the jurisdictions in which legal title of the underlying asset or liability resides. See Note 11 - Income Taxes for further information related to income taxes.
Noncontrolling Interests
As of the date of acquisition, the Company assumed the noncontrolling interest in two subsidiaries. The carrying values of the noncontrolling interests approximates the fair value of as of the acquisition date.
Other Assets Acquired and Liabilities Assumed (excluding Goodwill)
The Company utilized the carrying values, net of allowances, to value accounts receivable and accounts payable as well as other current assets and liabilities as it was determined that carrying values represented the fair value of those items at the acquisition date. With the exception of the receivable allowance to align Rexnord PMC business's reserve policy to the Company's policy, to reflect the best estimate at the acquisition date of the contractual cash flows expected to be collected
Goodwill
The excess of the consideration for the acquisition over the fair value of net assets acquired was recorded as goodwill. The goodwill is attributable to expected synergies and expanded market opportunities from combining the Company’s operations with those of the Rexnord PMC business. The goodwill created in the acquisition is not expected to be deductible for tax purposes.
Transaction Costs
The Company incurred transaction-related costs of approximately $4.3 million and $64.4 million during fiscal 2022 and 2021, respectively. These costs were associated with legal and professional services and were recognized as Operating expenses in the Company's Consolidated Statements of Income.
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.
Unaudited Pro Forma Information
The following unaudited supplemental pro forma financial information presents the financial results for the fiscal years 2021 and 2020 as if the Rexnord Transaction had occurred on December 29, 2019. The pro forma financial information includes, where applicable, adjustments for: (i) additional amortization expense that would have been recognized related to the acquired intangible assets, (ii) additional interest expense on transaction related borrowings, (iii) additional depreciation expense that would have been recognized related to the acquired property, plant, and equipment, (iv) transaction costs and other one-time non-recurring costs which reduced expenses by $64.4 million for the year ended January 1, 2022 and increased expenses by $64.4 million for the year ended January 2, 2021, (v) additional cost of sales related to the inventory valuation adjustment which reduced expenses by $24.1 million for the year ended January 1, 2022 and increased expenses by $26.9 million for the year ended January 2, 2021, and (vi) the estimated income tax effect on the pro forma adjustments. The pro forma financial information excludes adjustments for estimated cost synergies or other effects of the integration of the Rexnord Transaction and the retrospective effect of changing accounting methods for valuing certain inventories to the FIFO cost method from the LIFO cost method.
The pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have been achieved had the Rexnord Transaction been completed as of the date indicated or the results that may be obtained in the future.
Unaudited Supplemental Pro Forma Financial Information
| | | | | | | | | | | | | | |
| | For the Year Ended January 1, 2022 | | For the Year Ended January 2, 2021 |
Net Sales | | $ | 4,780.7 | | | $ | 4,136.8 | |
Net Income Attributable to Regal Rexnord Corporation | | $ | 347.3 | | | $ | 84.8 | |
Earnings Per Share Attributable to Regal Rexnord Corporation: | | | | |
Basic | | $ | 5.13 | | | $ | 1.25 | |
Assuming Dilution | | $ | 5.09 | | | $ | 1.25 | |
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 known as the Automation Solutions business unit, which is a part of the Conveying 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.
As of December 31, 2022, the valuation process to determine the fair values of the net assets acquired during the measurement period was complete. The Company estimated the fair value of net assets acquired based on information available during the measurement period.
The final fair value of the assets acquired and liabilities assumed were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | As Reported as of January 1, 2022 | | Measurement period adjustments | | As Reported as of December 31, 2022 |
| | | | | | |
Cash and Cash Equivalents | | $ | 1.1 | | | $ | — | | | $ | 1.1 | |
Trade Receivables | | 19.1 | | | (0.3) | | | 18.8 | |
Inventories | | 12.8 | | | — | | | 12.8 | |
Prepaid Expenses and Other Current Assets | | 7.6 | | | — | | | 7.6 | |
| | | | | | |
| | | | | | |
Property, Plant and Equipment | | 3.7 | | | — | | | 3.7 | |
| | | | | | |
| | | | | | |
Intangible Assets(1) | | 160.0 | | | — | | | 160.0 | |
| | | | | | |
Accounts Payable | | (4.7) | | | — | | | (4.7) | |
Accrued Compensation and Benefits | | (2.6) | | | — | | | (2.6) | |
Other Accrued Expenses | | (25.0) | | | — | | | (25.0) | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
Total Identifiable Net Assets | | 172.0 | | | (0.3) | | | 171.7 | |
Goodwill | | 143.6 | | | 0.3 | | | 143.9 | |
Purchase price | | $ | 315.6 | | | $ | — | | | $ | 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 cumulative impact of the adjustments during the year ended December 31, 2022 resulted in $0.3 million of additional goodwill.
(5) Goodwill and Intangible Assets
Goodwill
The following information presents changes to goodwill during the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions |
Balance as of January 2, 2021 | $ | 1,518.2 | | | $ | 433.3 | | | $ | 163.7 | | | $ | 330.8 | | | $ | 590.4 | |
| | | | | | | | | |
Less: Impairment Charges | (33.0) | | | — | | | (33.0) | | | — | | | — | |
Acquisitions | 2,576.8 | | | — | | | — | | | — | | | 2,576.8 | |
| | | | | | | | | |
Translation and Other | (22.8) | | | (4.4) | | | (1.9) | | | (0.3) | | | (16.2) | |
Balance as of January 1, 2022 | $ | 4,039.2 | | | $ | 428.9 | | | $ | 128.8 | | | $ | 330.5 | | | $ | 3,151.0 | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
Acquisitions | 27.2 | | | — | | | — | | | — | | | 27.2 | |
| | | | | | | | | |
Translation and Other | (47.6) | | | (6.4) | | | (2.0) | | | (0.7) | | | (38.5) | |
Balance as of December 31, 2022 | $ | 4,018.8 | | | $ | 422.5 | | | $ | 126.8 | | | $ | 329.8 | | | $ | 3,139.7 | |
Cumulative Goodwill Impairment Charges | $ | 328.7 | | | $ | 183.2 | | | $ | 105.1 | | | $ | 17.2 | | | $ | 23.2 | |
Intangible Assets
Intangible assets consist of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2022 | | January 1, 2022 |
| Weighted Average Amortization Period (Years) | | Gross Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Amount | | Accumulated Amortization | | Net Carrying Amount |
Customer Relationships | 16 | | $ | 2,321.4 | | | $ | 532.0 | | | $ | 1,789.4 | | | $ | 2,335.4 | | | $ | 405.0 | | | $ | 1,930.4 | |
Technology | 13 | | 246.2 | | | 125.0 | | | 121.2 | | | 250.1 | | | 114.1 | | | 136.0 | |
Trademarks | 10 | | 392.7 | | | 73.4 | | | 319.3 | | | 400.0 | | | 37.2 | | | 362.8 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Total Intangibles | | | $ | 2,960.3 | | | $ | 730.4 | | | $ | 2,229.9 | | | $ | 2,985.5 | | | $ | 556.3 | | | $ | 2,429.2 | |
While the Company believes its customer relationships are long-term in nature, the Company's contractual customer relationships are generally short-term. Useful lives are established at acquisition based on historical attrition rates.
Amortization expense was $185.5 million in fiscal 2022, $77.4 million in fiscal 2021 and $47.3 million in fiscal 2020.
The following table presents estimated future amortization expense:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Estimated Amortization |
Year | | |
2023 | | | $ | 187.5 | |
2024 | | | 186.9 | |
2025 | | | 184.9 | |
2026 | | | 181.4 | |
2027 | | | 146.9 | |
(6) Segment Information
The Company's four operating segments are: 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 fiscal 2022, fiscal 2021 and fiscal 2020, respectively:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Eliminations | | Total |
Fiscal 2022 | | | | | | | | | | | | |
External Sales | | $ | 1,145.4 | | | $ | 616.0 | | | $ | 1,081.8 | | | $ | 2,374.7 | | | $ | — | | | $ | 5,217.9 | |
Intersegment Sales | | 23.0 | | | 1.0 | | | 4.3 | | | 5.3 | | | (33.6) | | | — | |
Total Sales | | 1,168.4 | | | 617.0 | | | 1,086.1 | | | 2,380.0 | | | (33.6) | | | 5,217.9 | |
Gross Profit | | 328.2 | | | 152.7 | | | 282.9 | | | 905.9 | | | — | | | 1,669.7 | |
Operating Expenses | | 162.5 | | | 97.7 | | | 121.7 | | | 596.5 | | | — | | | 978.4 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Asset Impairments | | — | | | — | | | — | | | 0.9 | | | — | | | 0.9 | |
Income from Operations | | 165.7 | | | 55.0 | | | 161.2 | | | 308.5 | | | — | | | 690.4 | |
Depreciation and Amortization | | 29.3 | | | 13.8 | | | 17.6 | | | 246.7 | | | — | | | 307.4 | |
Capital Expenditures | | 20.7 | | | 10.4 | | | 21.2 | | | 31.5 | | | — | | | 83.8 | |
Fiscal 2021 | | | | | | | | | | | | |
External Sales | | $ | 1,032.1 | | | $ | 576.3 | | | $ | 1,030.6 | | | $ | 1,171.3 | | | $ | — | | | $ | 3,810.3 | |
Intersegment Sales | | 88.7 | | | 26.6 | | | 19.1 | | | 4.1 | | | (138.5) | | | — | |
Total Sales | | 1,120.8 | | | 602.9 | | | 1,049.7 | | | 1,175.4 | | | (138.5) | | | 3,810.3 | |
Gross Profit* | | 274.2 | | | 107.6 | | | 312.3 | | | 417.5 | | | — | | | 1,111.6 | |
Operating Expenses | | 161.1 | | | 88.0 | | | 115.5 | | | 350.1 | | | — | | | 714.7 | |
Goodwill Impairment | | — | | | 33.0 | | | — | | | — | | | — | | | 33.0 | |
Asset Impairments | | 1.8 | | | — | | | 0.5 | | | 3.3 | | | — | | | 5.6 | |
Income (Loss) from Operations* | | 111.3 | | | (13.4) | | | 196.3 | | | 64.1 | | | — | | | 358.3 | |
Depreciation and Amortization | | 29.9 | | | 23.2 | | | 16.5 | | | 101.0 | | | — | | | 170.6 | |
Capital Expenditures | | 17.8 | | | 9.5 | | | 11.7 | | | 15.5 | | | — | | | 54.5 | |
Fiscal 2020 | | | | | | | | | | | | |
External Sales | | $ | 820.2 | | | $ | 528.8 | | | $ | 846.8 | | | $ | 711.2 | | | $ | — | | | $ | 2,907.0 | |
Intersegment Sales | | 62.5 | | | 27.7 | | | 18.8 | | | 2.5 | | | (111.5) | | | — | |
Total Sales | | 882.7 | | | 556.5 | | | 865.6 | | | 713.7 | | | (111.5) | | | 2,907.0 | |
Gross Profit* | | 212.8 | | | 94.6 | | | 246.9 | | | 252.3 | | | — | | | 806.6 | |
Operating Expenses | | 144.9 | | | 91.6 | | | 115.5 | | | 160.9 | | | — | | | 512.9 | |
Goodwill Impairment | | — | | | 10.5 | | | — | | | — | | | — | | | 10.5 | |
Asset Impairments | | 2.8 | | | 0.2 | | | 1.3 | | | 1.0 | | | — | | | 5.3 | |
Gain on Sale of Business | | (0.1) | | | — | | | — | | | — | | | — | | | (0.1) | |
Income (Loss) from Operations* | | 65.2 | | | (7.7) | | | 130.1 | | | 90.4 | | | — | | | 278.0 | |
Depreciation and Amortization | | 32.6 | | | 23.9 | | | 19.6 | | | 55.3 | | | — | | | 131.4 | |
Capital Expenditures | | 15.3 | | | 8.1 | | | 12.1 | | | 12.0 | | | — | | | 47.5 | |
The following table presents total identifiable assets attributable to the Company's operating segments as of December 31, 2022 and January 1, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions | | Total |
Identifiable Assets as of December 31, 2022 | $ | 1,253.5 | | | $ | 886.0 | | | $ | 980.6 | | | $ | 7,148.8 | | | $ | 10,268.9 | |
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 3 for additional information.
The following sets forth net sales by country in which the Company operates for fiscal 2022, fiscal 2021 and fiscal 2020, respectively:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Net Sales |
| | 2022 | | 2021 | | 2020 |
United States | | $ | 3,332.5 | | | $ | 2,364.7 | | | $ | 1,885.1 | |
Rest of the World | | 1,885.4 | | | 1,445.6 | | | 1,021.9 | |
Total | | | | $ | 5,217.9 | | | $ | 3,810.3 | | | $ | 2,907.0 | |
U.S. net sales for fiscal 2022, fiscal 2021 and fiscal 2020 represented 63.9%, 62.1% and 64.8% of total net sales, respectively. No individual foreign country represented a material portion of total net sales for any of the years presented.
The following sets forth net property, plant and equipment by country in which the Company operates for fiscal 2022 and fiscal 2021, respectively:
| | | | | | | | | | | |
| Long-lived Assets |
| 2022 | | 2021 |
United States | $ | 307.8 | | | $ | 363.6 | |
Mexico | 200.4 | | | 204.6 | |
China | 79.4 | | | 91.2 | |
| | | |
| | | |
Rest of the World | 219.4 | | | 249.1 | |
Total | $ | 807.0 | | | $ | 908.5 | |
No other individual foreign country represented a material portion of net property, plant and equipment for any of the years presented.
(7) Debt and Bank Credit Facilities
The Company's indebtedness as of December 31, 2022 and January 1, 2022 was as follows:
| | | | | | | | | | | |
| December 31, 2022 | | January 1, 2022 |
|
Term Facility | $ | 536.3 | | | $ | 620.0 | |
Private Placement Notes | 500.0 | | | — | |
Land Term Facility | 486.8 | | | 486.8 | |
| | | |
Multicurrency Revolving Facility | 429.0 | | | 736.7 | |
| | | |
| | | |
Other | 76.7 | | | 78.7 | |
Less: Debt Issuance Costs | (5.3) | | | (3.7) | |
Total | 2,023.5 | | | 1,918.5 | |
Less: Current Maturities | 33.8 | | | 4.9 | |
Non-Current Portion | $ | 1,989.7 | | | $ | 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) replaced 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) amended and restated 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. Prior to the First Amendment (as defined below), the credit facilities extended under the Credit Agreement consisted of (i) an unsecured term loan facility in the initial principal amount of up to $550.0 million, maturing on March 28, 2027 (the "Term Facility"); (ii) an unsecured term loan facility in the initial principal amount of $486.8 million, 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 $1,000.0 million, maturing on March 28, 2027 (the "Multicurrency Revolving Facility"), including a $50.0 million letter of credit sub facility, available for general corporate purposes. Borrowings under the Credit Agreement bear interest at floating rates based upon indices determined by the currency of the borrowing (SOFR for US Dollar borrowings), plus an applicable margin determined by reference to our consolidated funded debt to consolidated EBITDA ratio or at an alternative base rate. 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 Agreements 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.
On November 17, 2022, the Company entered into an amendment (the “First Amendment”) with certain of the Company’s lenders under the Credit Agreement. Among other things, the First Amendment (i) permits the consummation of the Altra Transaction and the incurrence of indebtedness and liens in an aggregate principal amount not to exceed $4,900.0 million in connection with the Altra Transaction; (ii) establishes incremental term loan commitments of $600.0 million under the Term Facility, to be funded upon consummation of the Altra Transaction; and (iii) provides an increase of $500.0 million in the aggregate principal amount of the Multicurrency Revolving Facility upon consummation of the Altra Transaction.
On November 30, 2022, the Company entered into an incremental assumption agreement (the “Assumption Agreement”) with JPMorgan Chase Bank, N.A., as Administrative Agent and the lenders named therein. Among other things, the Assumption Agreement (i) establishes incremental term loan commitments of $240.0 million under the Term Facility, to be funded upon consummation of the Altra Transaction and (ii) provides an increase of $70.0 million in the aggregate principal amount of the Multicurrency Revolving Facility upon consummation of the Altra Transaction.
The weighted average interest rate on the Term Facility for the fiscal years ended December 31, 2022 and January 1, 2022 was 2.9% and 1.2%, 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. We repaid $13.7 million under the Term Facility in fiscal 2022.
As of December 31, 2022 the Company had $429.0 million of borrowings under the Multicurrency Revolving Facility, and $571.0 million of available borrowing capacity. No standby letters of credit were issued under the Multicurrency Revolving Facility. The average daily balance in borrowings under the Multicurrency Revolving Facility was $675.4 million and $163.6 million, and the weighted average interest rate on the Multicurrency Revolving Facility was 2.8% and 1.2% for the fiscal years ended December 31, 2022 and January 1, 2022, 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. In connection with the issuance of the Senior Notes in January 2023, further discussed below, the outstanding borrowings under the Multicurrency Revolving Facility were fully repaid.
As of December 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 was 3.0% and 1.3% for the fiscal years ended December 31, 2022 and January 1, 2022, respectively.
Private Placement Notes
On April 7, 2022, the Company entered into a Note Purchase Agreement with certain institutional accredited investors (the "Private Placement Notes Purchase Agreement") for the issuance and sale of $500.0 million aggregate principal amount of 3.90% notes due April 7, 2032 (the "Private Placement Notes"), in an offering exempt from the registration requirements of the Securities Act of 1933, as amended. The Company used the net proceeds from the offering for general corporate purposes.
On December 21, 2022, the Company entered into an amendment to the Private Placement Notes Purchase Agreement with certain holders of the Private Placement Notes, which would have, among other things, (i) permitted the consummation of the Altra Transaction, and (ii) added a maintenance fee of 2.50% per annum on the unpaid principal amount of the Private Placement Notes upon consummation of the Altra Transaction. Following the issuance of the Senior Notes discussed below, on January 27, 2023, the Company used a portion of the proceeds from that transaction to repay the Private Placement Notes in full with no make-whole payments.
Bridge Facility
In connection with the Altra Transaction, on October 26, 2022, the Company entered into a commitment letter (the “Commitment Letter”), and related fee letters, with JPMorgan Chase Bank, N.A. pursuant to which JPMorgan Chase Bank, N.A. (i) committed to provide the Company approximately $5,500.0 million in aggregate principal amount of senior bridge loans under a 364-day senior unsecured bridge term loan facility (the “Bridge Facility”) for the purpose of funding, in part, the Altra Transaction, repaying certain outstanding indebtedness of Altra, and for general corporate purposes and (ii) agreed to use commercially reasonable efforts to arrange financing (through the issuance of notes and/or the incurrence of term loans) in an aggregate principal amount of up to approximately $5,500.0 million for the purpose of replacing the Bridge Facility. There were $4,160.0 million in Bridge Facility commitments remaining at December 31, 2022. Upon issuance of the Senior Notes in January 2023, as further discussed below, the Bridge Facility was terminated.
In connection with the Bridge Facility, the Company paid $27.5 million in fees in the fourth quarter of 2022, of which $10.5 million were recognized in Interest Expense during the year ended December 31, 2022 and $17.0 million was deferred on the Consolidated Balance Sheet as of December 31, 2022 and was recognized in Interest Expense in the first quarter of 2023 when the Bridge Facility was terminated.
Backstop Facility
In connection with the Altra Transaction, on October 26, 2022, the Company entered into a backstop credit facility with JPMorgan Chase Bank, N.A. in an aggregate principal amount of up to $2,030.0 million, consisting of a $1,000.0 million backstop revolving credit facility and $1,030.0 million backstop term loan facility (collectively, the “Backstop Facility”). The Backstop Facility was terminated on November 17, 2022 when the Company entered into the First Amendment to the Credit Agreement further discussed above. In connection with the Backstop Facility, the Company paid $5.1 million in fees which were recognized in Interest Expense during the year ended December 31, 2022.
Senior Notes
On January 24, 2023, the Company entered into an Indenture (the “Indenture”) with U.S. Bank Trust Company, National Association, as trustee (the “Trustee”), relating to the issuance by the Company of $1,100.0 million aggregate principal amount of its 6.05% senior notes due 2026 (the “2026 Senior Notes”), $1,250.0 million aggregate principal amount of its 6.05% senior notes due 2028 (the “2028 Senior Notes”), $1,100.0 million aggregate principal amount of its 6.30% senior notes due 2030 (the “2030 Senior Notes”) and $1,250.0 million aggregate principal amount of its 6.40% senior notes due 2033 (the “2033 Senior Notes” and, together with the 2026 Senior Notes, 2028 Senior Notes and 2030 Senior Notes, collectively, the “Senior Notes”).
The Senior Notes were issued and sold in a private offering to persons reasonably believed to be qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933 and persons outside the United States in accordance with Regulation S under the Securities Act. Pursuant to a registration rights agreement, the Company will exchange the Senior Notes with registered notes with terms substantially identical to the Senior Notes within 540 days from the date of issuance.
The Company received $4,647.0 million in net proceeds from the sale of the Senior Notes, after deducting the initial purchasers’ discounts and estimated offering expenses. The Company used a portion of the net proceeds to repay the Company’s outstanding Private Placement Notes, as further discussed above, and intends to use the remaining net proceeds, together with the incremental term loan commitments under the Term Facility and cash on hand, to fund the consideration for the Altra Transaction, repay certain of Altra’s outstanding indebtedness, and pay certain fees and expenses. Prior to the consummation of the Altra Transaction, the Company used a portion of the proceeds to repay the outstanding borrowings under the Multicurrency Revolving Facility in January 2023 and invested the remaining net proceeds of approximately $3.6 billion in interest bearing accounts.
The rate of interest on each series of the Senior Notes is subject to an increase of up to 2.00% in the event of certain downgrades in the debt rating of the Senior Notes. Interest on the 2026 Senior Notes and the 2030 Senior Notes will be payable semi-annually on February 15 and August 15 of each year, beginning on August 15, 2023. Interest on the 2028 Senior Notes and the 2033 Senior Notes will be payable semi-annually on April 15 and October 15 of each year, beginning on April 15, 2023. The 2026 Senior Notes are scheduled to mature on February 15, 2026, the 2028 Senior Notes are scheduled to mature on April 15, 2028, the 2030 Senior Notes are scheduled to mature on February 15, 2030, and the 2033 Senior Notes are scheduled to mature on April 15, 2033.
Compliance with Financial Covenants
The Credit Agreement requires the Company to meet specified financial ratios and to satisfy certain financial condition tests. The Note Purchase Agreement contains financial covenants consistent with the financial covenants in the Credit Agreement. The Company was in compliance with all financial covenants contained in the Credit Agreement and Note Purchase Agreement as of December 31, 2022.
Other Notes Payable
As of December 31, 2022, other notes payable of $76.7 million were outstanding with a weighted average interest rate of 5.1%. As of January 1, 2022, other notes payable of $78.7 million were outstanding with a weighted average interest rate of 5.2%. These amounts consist primarily of finance leases. See Note 9 – Leases for more information.
Other Disclosures
Based on rates for instruments with comparable maturities and credit quality, which are classified as Level 2 inputs (see also Note 14 – Fair Value), the approximate fair value of the Company's total debt was $1,926.6 million and $1,918.5 million as of December 31, 2022 and January 1, 2022, respectively.
Maturities of long-term debt outstanding as of December 31, 2022, excluding debt issuance costs, are as follows:
| | | | | | | | | | | | | | | | | | | | |
Year | | | | | | Amount of Maturity |
2023 | | | | | | $ | 33.8 | |
2024 | | | | | | 31.1 | |
2025 | | | | | | 31.4 | |
2026 | | | | | | 31.5 | |
2027 | | | | | | 1,346.3 | |
Thereafter | | | | | | 554.7 | |
Total | | | | | | $ | 2,028.8 | |
(8) Retirement Plans
Retirement Plans
The Company sponsors pension and other post-retirement benefit plans for certain associates. Most of the Company's associates are accumulating retirement income benefits through defined contribution plans. The majority of Company's defined benefit pension plans covering the Company's domestic associates have been closed to new associates and frozen for existing associates, however certain employees represented by collective bargaining continue to earn benefits. Certain foreign associates are covered by government sponsored plans in the countries in which they are employed. The defined contribution plans provide for Company contributions based, depending on the plan, upon one or more of participant contributions, service and profits. Company contributions to domestic defined contribution plans totaled $16.2 million, $9.8 million and $7.6 million in fiscal 2022, fiscal 2021 and fiscal 2020, respectively. Company contributions to non-US defined contribution plans were $7.8 million, $5.7 million and $5.5 million in fiscal 2022, fiscal 2021 and fiscal 2020, respectively.
Benefits provided under defined benefit pension plans are based, depending on the plan, on associates' average earnings and years of credited service, or a benefit multiplier times years of service. Funding of these qualified defined benefit pension plans is in accordance with federal laws and regulations. The actuarial valuation measurement date for pension plans is the calendar year end of each year.
The Company's target allocation, target return and actual weighted-average asset allocation by asset category are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Target | | Actual Allocation |
| Allocation | | Return | | 2022 | | 2021 |
Equity Investments | 47.7% | | 7.3 - 8.9% | | 41.1% | | 35.7% |
Fixed Income | 38.1% | | 2.9 - 7.0% | | 44.7% | | 55.0% |
Other | 14.2% | | 0.5% - 7.0% | | 14.2% | | 9.3% |
Total | 100.0% | | 6.6% | | 100.0% | | 100.0% |
During 2022, the Company maintained its dynamic de-risking investment strategy implemented during 2021 designed to allow the plans to attain and/or maintain fully funded status levels while reducing volatility. Accordingly, allocation targets have been established to fit this strategy in response to increased funded ratio thresholds along a glidepath. The overall fixed income portfolio will increase to meet the allocation targets in such a manner that its interest rate sensitivity correlates highly with that of the liabilities of the plans, and other assets classes are intended to provide additional return with associated higher levels of risk. The long-term rate of return assumptions consider historic returns and volatilities adjusted for changes in overall economic conditions that may affect future returns and a weighting of each investment class. During 2022, the Company transitioned legacy Rexnord PMC’s pension plan to align with the Company’s other pension plan’s derisking strategy at similar funded status levels, which is expected to result in improved funding levels and less required contributions over time.
The following table presents a reconciliation of the funded status of the defined benefit pension plans:
| | | | | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | |
Change in Projected Benefit Obligation: | | | | |
Obligation at Beginning of Period | $ | 587.2 | | | $ | 298.4 | | |
Service Cost | 1.4 | | | 1.2 | | |
Interest Cost | 14.0 | | | 7.5 | | |
Actuarial Gain | (123.9) | | | (1.2) | | |
| | | | |
Less: Benefits Paid | 32.5 | | | 19.7 | | |
Settlements | (0.2) | | | (1.9) | | |
| | | | |
Foreign Currency Translation | (5.7) | | | (3.0) | | |
Acquisitions | — | | | 305.9 | | |
Obligation at End of Period | $ | 440.3 | | | $ | 587.2 | | |
Change in Fair Value of Plan Assets: | | | | |
Fair Value of Plan Assets at Beginning of Period | $ | 478.9 | | | $ | 230.2 | | |
Actual Return on Plan Assets | (104.5) | | | 33.7 | | |
Employer Contributions | 8.3 | | | 5.7 | | |
Less: Benefits Paid | 32.5 | | | 19.7 | | |
Settlements | (0.2) | | | (1.9) | | |
Foreign Currency Translation | (3.8) | | | (1.3) | | |
Acquisitions | — | | | 232.2 | | |
Fair Value of Plan Assets at End of Period | $ | 346.2 | | | $ | 478.9 | | |
Funded Status | $ | (94.1) | | | $ | (108.3) | | |
| | | |
The actuarial gains for fiscal 2022 and 2021 were primarily due to an increase in discount rates, partially offset by losses due to demographic experience.
The funded status as of December 31, 2022 included domestic plans of $(64.6) million and international plans of $(29.5) million. The funded status as of January 1, 2022 included domestic plans of $(61.6) million and international plans of $(46.7) million.
Pension Assets
The Company classifies its investments into Level 1, which refers to securities valued using quoted prices from active markets for identical assets, Level 2, which refers to securities not traded on an active market but for which observable market inputs are readily available, and Level 3, which refers to securities valued based on significant unobservable inputs. Mutual funds are valued at the unadjusted quoted market prices for the securities. Real estate interest values are determined using model-based techniques that include relative value analysis and discounted cash flow techniques. Common collective trust funds are valued based on the net asset value (“NAV”) provided by the administrator of the fund as a practical expedient to estimate fair value. The NAV is based on the value of the underlying assets owned by the fund, minus its liabilities, and then divided by the number of shares outstanding. Investments in units of collective trust funds and short-term investment funds, comprised of cash and money market funds, are valued at their respective published market prices as reported by the funds daily. Certain international plans hold insurance contracts. The fair value of these contracts is calculated by projecting expected future cash flows from the contract and discounting them to present value based on current market rates. The contracts are included within Level 3 of the hierarchy as the assumptions used to project expected future cash flows are based on actuarial estimates and are unobservable.
Pension assets by type and level are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
| Total | | Level 1 | | Level 2 | | Level 3 |
Cash and Cash Equivalents | $ | 4.3 | | | $ | 4.3 | | | $ | — | | | $ | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Mutual Funds: | | | | | | | |
US Equity Funds | 1.5 | | | 1.5 | | | — | | | — | |
International Equity Funds | 3.1 | | | 3.1 | | | — | | | — | |
| | | | | | | |
Fixed Income Funds | 2.3 | | | 2.3 | | | — | | | — | |
Other | 1.6 | | | 1.6 | | | — | | | — | |
Insurance Contracts | 20.9 | | | — | | | — | | | 20.9 | |
| | | | | | | |
| | | | | | | |
| $ | 33.7 | | | $ | 12.8 | | | $ | — | | | $ | 20.9 | |
Investments Measured at Net Asset Value | 312.5 | | | | | | | |
Total | $ | 346.2 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| January 1, 2022 |
| Total | | Level 1 | | Level 2 | | Level 3 |
Cash and Cash Equivalents | $ | 5.3 | | | $ | 5.3 | | | $ | — | | | $ | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
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Mutual Funds: | | | | | | | |
US Equity Funds | 1.9 | | | 1.9 | | | — | | | — | |
International Equity Funds | 3.9 | | | 3.9 | | | — | | | — | |
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Fixed Income Funds | 2.9 | | | 2.9 | | | — | | | — | |
Other | 2.0 | | | 2.0 | | | — | | | — | |
Insurance Contracts | 34.0 | | | — | | | — | | | 34.0 | |
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| $ | 50.0 | | | $ | 16.0 | | | $ | — | | | $ | 34.0 | |
Investments Measured at Net Asset Value | 428.9 | | | | | | | |
Total | $ | 478.9 | | | | | | | |
The following table sets forth additional disclosures for the fair value measurement of the fair value of pension plan assets that calculate fair value based on NAV per share practical expedient as of December 31, 2022 and January 1, 2022:
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| 2022 | | 2021 | |
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Common Collective Trust Funds | $ | 312.5 | | | $ | 428.9 | | |
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The 2022 common collective trust funds are investments in the Mercer US Small/Midcap Equity Portfolio, the Mercer Non-US Core Equity Portfolio, the Mercer Global Low Volatility Equity Portfolio, the Mercer US Large Cap Passive Equity Portfolio, the Mercer Emerging Markets Equity Portfolio, the Mercer Active Long Corporate Fixed Income Portfolio, the Mercer Opportunistic Fixed Income Portfolio, the Mercer Long Strips Fixed Income Portfolio, and the Mercer Core Real Estate Portfolio. The Mercer US Small/Midcap Equity Portfolio seeks to provide long term total returns comprised primarily of capital appreciation by investing in equity securities issued by small to medium capitalization US companies. The Mercer Non-US Core Equity Portfolio seeks to provide long term total return, which includes capital appreciation and income, by investing in equity securities of non-US companies. The Mercer Global Low Volatility Equity Portfolio seeks to provide long term total return, which includes capital appreciation and income, by investing in equity securities of US and foreign issuers. The Mercer US Large Cap Passive Equity Portfolio seeks to approximate, as closely as possible, the performance of the S&P 500 Index over the long term by investing in the equity securities comprising the index in approximately the same proportions as they are represented in the index. The Mercer Emerging Markets Equity Portfolio seeks to provide long term total return, which includes capital appreciation and income, by investing equity securities of companies that are located in emerging markets, other investments that are tied economically to emerging markets, as well as in American, European and Global Depository Receipts. The Mercer Active Long Corporate Fixed Income Portfolio seeks to maximize long term total return by investing on high quality US corporate bonds. The Mercer Opportunistic Fixed Income Portfolio seeks to provide long term total return, which includes capital appreciation and income, by investing in high yield bonds and emerging markets debt. The Mercer Long Strips Fixed Income Portfolio seeks to extend the duration of plan assets by investing in US Treasury STRIPS with a maturity of greater than 20 years. The Mercer Core Real Estate Portfolio seeks to earn attractive risk-adjusted returns on a diversified portfolio of private real estate, by systematically favoring the market segments and opportunities believed to offer the most attractive relative value at a given point in time. The 2022 common collective trust funds are available for immediate redemption.
The 2021 common collective trust funds are investments in the Mercer US Small/Midcap Equity Portfolio, the Mercer Non-US Core Equity Portfolio, the Mercer Global Low Volatility Equity Portfolio, the Mercer US Large Cap Passive Equity Portfolio, the Mercer Long Duration Passive Fixed Income Portfolio, the Mercer Emerging Markets Equity Portfolio, the Mercer Active Long Corporate Fixed Income Portfolio, the Mercer Opportunistic Fixed Income Portfolio, the Mercer Long Strips Fixed Income Portfolio, the Mercer Active Intermediate Credit Portfolio, and the Mercer Core Real Estate Portfolio. The Mercer US Small/Midcap Equity Portfolio seeks to provide long term total returns comprised primarily of capital appreciation by investing in equity securities issued by small to medium capitalization US companies. The Mercer Non-US Core Equity Portfolio seeks to provide long term total return, which includes capital appreciation and income, by investing in equity securities of non-US companies. The Mercer Global Low Volatility Equity Portfolio seeks to provide long term total return, which includes capital appreciation and income, by investing in equity securities of US and foreign issuers. The Mercer US Large Cap Passive Equity Portfolio seeks to approximate, as closely as possible, the performance of the S&P 500 Index over the long term by investing in the equity securities comprising the index in approximately the same proportions as they are represented in the index. The Mercer Long Duration Passive Fixed Income Portfolio seeks to approximate as closely as practicable, before expenses, the performance of the Bloomberg Barclays Capital US Long Government Bond Index over the long term by investing in securities that comprise the index in the same proportions as they are represented in the index. The Mercer Emerging Markets Equity Portfolio seeks to provide long term total return, which includes capital appreciation and income, by investing equity securities of companies that are located in emerging markets, other investments that are tied economically to emerging markets, as well as in American, European and Global Depository Receipts. The Mercer Active Long Corporate Fixed Income Portfolio seeks to maximize long term total return by investing on high quality US corporate bonds. The Mercer Opportunistic Fixed Income Portfolio seeks to provide long term total return, which includes capital appreciation and income, by investing in high yield bonds and emerging markets debt. The Mercer Long Strips Fixed Income Portfolio seeks to extend the duration of plan assets by investing in US Treasury STRIPS with a maturity of greater than 20 years. The Mercer Active Intermediate Credit Portfolio seeks to maximize long-term total return. The Mercer Core Real Estate Portfolio seeks to earn attractive risk-adjusted returns on a diversified portfolio of private real estate, by systematically favoring the market segments and opportunities believed to offer the most attractive relative value at a given point in time. The 2021 common collective trust funds are available for immediate redemption.
The table below sets forth a summary of changes in the Company's Level 3 assets in its pension plan investments as of December 31, 2022 and January 1, 2022:
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| | | | 2022 | | 2021 | | |
| | | | Insurance Contracts | | Total | | Real Estate Fund | | Insurance Contracts | | Total |
Beginning Balance | | | | $ | 34.0 | | | $ | 34.0 | | | $ | 10.0 | | | $ | — | | | $ | 10.0 | |
Acquisition | | | | — | | | — | | | — | | | 33.6 | | | 33.6 | |
Net Sales | | | | (0.2) | | | (0.2) | | | (11.6) | | | — | | | (11.6) | |
Net (Losses) Gains | | | | (10.7) | | | (10.7) | | | 1.6 | | | 1.4 | | | 3.0 | |
Translation | | | | (2.2) | | | (2.2) | | | — | | | (1.0) | | | (1.0) | |
Ending Balance | | | | $ | 20.9 | | | $ | 20.9 | | | $ | — | | | $ | 34.0 | | | $ | 34.0 | |
Funded Status and Expense
The Company recognized the funded status of its defined benefit pension plans on the Consolidated Balance Sheets as follows:
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| | 2022 | | 2021 |
Other Noncurrent Assets | | $ | 2.1 | | | $ | 0.8 | |
Accrued Compensation and Benefits | | (4.4) | | | (4.9) | |
Pension and Other Post Retirement Benefits | | (91.8) | | | (104.2) | |
Total | | $ | (94.1) | | | $ | (108.3) | |
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Amounts Recognized in Accumulated Other Comprehensive Loss | | | | |
Net Actuarial Gain | | $ | 21.2 | | | $ | 20.5 | |
Prior Service Cost | | 0.4 | | | 0.7 | |
Total | | $ | 21.6 | | | $ | 21.2 | |
The accumulated benefit obligation for all defined benefit pension plans was $434.8 million and $580.9 million as of December 31, 2022 and January 1, 2022, respectively.
Defined pension plans with accumulated benefit obligations in excess of plan assets as of December 31, 2022 and January 1, 2022 were as follows:
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| | 2022 | | 2021 |
Projected Benefit Obligation | | $ | 407.0 | | | $ | 554.9 | |
Accumulated Benefit Obligation | | 405.1 | | | 548.6 | |
Fair Value of Plan Assets | | 310.9 | | | 445.8 | |
Defined pension plans with projected benefit obligations in excess of plan assets as of December 31, 2022 and January 1, 2022 were as follows:
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| | 2022 | | 2021 |
Projected Benefit Obligation | | $ | 408.6 | | | $ | 554.9 | |
Accumulated Benefit Obligation | | 406.4 | | | 548.6 | |
Fair Value of Plan Assets | | 312.3 | | | 445.8 | |
The following weighted average assumptions were used to determine the projected benefit obligation as of December 31, 2022 and January 1, 2022, respectively:
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| 2022 | | 2021 |
Discount Rate | 5.2% | | 2.7% |
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The objective of the discount rate assumption is to reflect the rate at which the pension benefits could be effectively settled. In making the determination, the Company takes into account the timing and amount of benefits that would be available under the plans. The methodology for selecting the discount rate was to match the plan's cash flows to that of a theoretical bond portfolio yield curve.
Certain of the Company's defined benefit pension plan obligations are based on years of service rather than on projected compensation percentage increases. For those plans that use compensation increases in the calculation of benefit obligations and net periodic pension cost, the Company used an assumed rate of compensation increase of 2.8% and 3.0% for the fiscal years ended December 31, 2022 and January 1, 2022, respectively.
Net periodic pension benefit costs and the net actuarial loss and prior service cost recognized in OCI for the defined benefit pension plans were as follows:
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| | 2022 | | 2021 | | 2020 |
Service Cost | | $ | 1.4 | | | $ | 1.2 | | | $ | 2.0 | |
Interest Cost | | 14.0 | | | 7.5 | | | 8.0 | |
Expected Return on Plan Assets | | (20.3) | | | (14.5) | | | (13.3) | |
Amortization of Net Actuarial Loss | | 1.0 | | | 3.0 | | | 1.9 | |
Amortization of Prior Service Cost | | 0.1 | | | 0.2 | | | 0.3 | |
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Net Periodic Benefit Cost | | $ | (3.8) | | | $ | (2.6) | | | $ | (1.1) | |
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Change in Obligations Recognized in OCI, Net of Tax | | | | | | |
Prior Service Cost | | $ | 0.1 | | | $ | 0.1 | | | $ | 0.2 | |
Net Actuarial Loss | | 0.7 | | | 2.4 | | | 1.5 | |
Total Recognized in OCI | | $ | 0.8 | | | $ | 2.5 | | | $ | 1.7 | |
The amortization of any prior service cost is determined using a straight-line amortization of the cost over the average remaining service period of associates expected to receive benefits under the plans. The amortization of the net actuarial loss is determined using a straight-line amortization of the loss over the average remaining life expectancy of the associates expected to receive benefits under the plans.
The following weighted average assumptions were used to determine net periodic pension cost for fiscal years 2022, 2021 and 2020, respectively.
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| | 2022 | | 2021 | | 2020 |
Discount Rate | | 2.7% | | 2.6% | | 3.3% |
Expected Long-Term Rate of Return on Assets | | 4.6% | | 6.2% | | 7.0% |
The Company made contributions to its defined benefit plan of $8.3 million and $5.7 million for the fiscal years ended December 31, 2022 and January 1, 2022, respectively.
The Company estimates that in fiscal 2023 it will make contributions in the amount of $6.5 million to fund its defined benefit pension plans.
The following pension benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
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Year | | Expected Payments |
2023 | | $ | 35.0 | |
2024 | | 33.9 | |
2025 | | 34.2 | |
2026 | | 34.7 | |
2027 | | 33.6 | |
2028-2032 | | 163.3 | |
Post-Retirement Health Care Plan
The Company's other post-retirement health care plans were not significant during fiscal 2022 and fiscal 2021.
(9) Leases
The Company leases certain manufacturing facilities, warehouses/distribution centers, office space, machinery, equipment, IT assets, and vehicles. If the contract provides the Company the right to substantially all of the economic benefits from the use of the identified asset and the right to direct the use of the identified asset, it is considered to be or contain a lease. Right-of-use ("ROU") assets and lease liabilities are recognized at lease commencement date based on the present value of the future lease payments over the expected lease term.
As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The incremental borrowing rate is estimated based upon the sovereign treasury rate for the currency in which the lease liability is denominated when the Company takes possession of the leased asset, adjusted for various factors, such as term and internal credit spread. The ROU asset also includes any lease payments made and excludes lease incentive and initial direct costs incurred.
Leases entered into may include one or more options to renew. The renewal terms can extend the lease term from one to twenty-five years. The exercise of lease renewal options is at the Company's sole discretion. Renewal option periods are included in the measurement of the ROU asset and lease liability when the exercise is reasonably certain to occur. Some leases include options to terminate the lease upon breach of contract and are remeasured at that point in time.
The depreciable life of leased assets and leasehold improvements are limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain of exercise.
Some of the Company's lease agreements include rental payments adjusted periodically for inflation or are based on an index rate. These increases are reflected as variable lease payments and are included in the measurement of the ROU asset and lease liability. The Company's lease agreements do not contain any material residual value guarantees or material restrictive covenants.
Operating leases are included in the following asset and liability accounts on the Company's Consolidated Balance Sheet: Operating Lease Assets, Current Operating Lease Liabilities and Noncurrent Operating Lease Liabilities. ROU assets and liabilities arising from finance leases are included in the following asset and liability accounts on the Company's Consolidated Balance Sheet: Net Property, Plant and Equipment, Current Maturities of Long-Term Debt and Long-Term Debt.
Short-term and variable lease expense was immaterial. The components of lease expense were as follows:
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| 2022 | | 2021 | | 2020 |
Operating Lease Cost | $ | 40.7 | | | $ | 33.7 | | | $ | 30.9 | |
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Finance Lease Cost: | | | | | |
Amortization of ROU Assets | 3.2 | | | 1.3 | | | 0.3 | |
Interest on Lease Liabilities | 3.8 | | | 1.1 | | | 0.2 | |
Total Lease Expense | $ | 47.7 | | | $ | 36.1 | | | $ | 31.4 | |
Maturity of lease liabilities as of December 31, 2022 were as follows:
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| Operating Leases | | Finance Leases | | Total |
2023 | $ | 34.0 | | | $ | 6.9 | | | $ | 40.9 | |
2024 | 27.1 | | | 7.0 | | | 34.1 | |
2025 | 22.1 | | | 7.1 | | | 29.2 | |
2026 | 18.5 | | | 7.0 | | | 25.5 | |
2027 | 14.2 | | | 7.1 | | | 21.3 | |
Thereafter | 26.6 | | | 75.8 | | | 102.4 | |
Total Lease Payments | $ | 142.5 | | | $ | 110.9 | | | $ | 253.4 | |
Less: Interest | (28.0) | | | (37.7) | | | (65.7) | |
Present Value of Lease Liabilities | $ | 114.5 | | | $ | 73.2 | | | $ | 187.7 | |
Other information related to leases was as follows:
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Supplemental Cash Flows Information | 2022 | | 2021 | | 2020 |
Cash Paid for Amounts Included in the Measurement of Lease Liabilities: | | | | | |
Operating Cash Flows from Operating Leases | $ | 38.4 | | | $ | 32.6 | | | $ | 29.7 | |
Operating Cash Flows from Finance Leases | 3.8 | | | 1.1 | | | 0.3 | |
Financing Cash Flows from Finance Leases | 2.9 | | | 1.0 | | | 0.2 | |
Leased Assets Obtained in Exchange for New Finance Lease Liabilities | — | | | 73.8 | | | — | |
Leased Assets Obtained in Exchange for New Operating Lease Liabilities | 31.4 | | | 65.4 | | | 24.3 | |
Weighted Average Remaining Lease Term | | | | | |
Operating Leases | 5.5 years | | 6.0 years | | 5.2 years |
Finance Leases | 17.0 years | | 17.8 years | | 7.3 years |
Weighted Average Discount Rate | | | | | |
Operating Leases | 8.0 | % | | 7.9 | % | | 8.2 | % |
Finance Leases | 5.2 | % | | 5.2 | % | | 5.9 | % |
The Company had no significant operating or finance leases that had not yet commenced nor entered into as of December 31, 2022.
(10) Shareholders' Equity
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 under the Company's share repurchase program. The authorization has no expiration date. In fiscal 2022, the Company acquired and retired 1,698,227 shares of its common stock at an average cost of $140.89 per share for a total cost of $239.2 million. In fiscal 2021, the Company acquired and retired 156,184 shares of its common stock at an average cost of $165.05 per share for a total cost of $25.8 million. In fiscal 2020, the Company acquired and retired 315,072 shares of its common stock at an average cost of $79.38 per share for a total cost of $25.0 million under its previous share repurchase program.
The existing share repurchase program remains authorized by the Company's Board of Directors. There is approximately $195.0 million in common stock available for repurchase under the October 26, 2021 repurchase authorization as of December 31, 2022.
Share-Based Compensation
The Company recognized approximately $22.5 million, $24.9 million and $9.2 million in share-based compensation expense in fiscal years 2022, 2021 and 2020, respectively. The total income tax benefit recognized in the Consolidated Statements of Income for share-based compensation expense was $5.4 million, $6.0 million and $2.2 million in fiscal years 2022, 2021 and 2020, 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. The total fair value of shares and options vested was $25.6 million, $26.1 million and $7.7 million in fiscal years 2022, 2021 and 2020, respectively.
Total unrecognized compensation cost related to share-based compensation awards was approximately $27.4 million, net of estimated forfeitures, which the Company expects to recognize over a weighted average period of approximately 1.8 years as of December 31, 2022.
During 2018, the Company's shareholders approved the 2018 Equity Incentive Plan ("2018 Plan"). The 2018 Plan authorized the issuance of 2.1 million shares of common stock, plus 1.5 million of shares reserved under the prior 2013 Equity Incentive Plan that were not the subject of outstanding awards for equity-based awards and terminated any further grants under prior equity plans. Approximately 2.3 million shares were available for future grant or payment under the 2018 Plans as of December 31, 2022.
Options and Stock Appreciation Rights
The Company uses several forms of share-based incentive awards including non-qualified stock options and stock settled stock appreciation rights (“SARs”). SARs are the right to receive stock in an amount equal to the appreciation in value of a share of stock over the base price per share. Shares granted prior to fiscal 2020 generally vest over five years on the anniversary date while shares granted in fiscal 2020 and after generally vest over three years on the anniversary date of the grant date. Generally all grants expire 10 years from the grant date. All grants are made at prices equal to the fair market value of the stock on the grant date. For fiscal years ended December 31, 2022, January 1, 2022 and January 2, 2021, expired and canceled shares were immaterial.
The table below presents share-based compensation activity for the fiscal years ended 2022, 2021 and 2020:
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| | 2022 | | 2021 | | 2020 |
Total Intrinsic Value of Share-Based Incentive Awards Exercised | | $7.8 | | $11.3 | | $6.7 |
Cash Received from Stock Option Exercises | | 3.5 | | 2.6 | | 0.2 |
Income Tax Benefit from the Exercise of Stock Options | | 6.1 | | 2.7 | | — |
Total Fair Value of Share-Based Incentive Awards Vested | | 8.2 | | 4.5 | | 2.1 |
The weighted average assumptions used in the Company's Black-Scholes valuation related to grants for options and SARs were as follows:
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| 2022 | | 2021 | | 2020 |
Per Share Weighted Average Fair Value of Grants | $42.21 | | $25.97 | | $21.23 |
Risk-Free Interest Rate | 1.8% | | 0.7% | | 1.5% |
Expected Life (Years) | 4.0 | | 4.2 | | 7.0 |
Expected Volatility | 35.3% | | 34.1% | | 25.2% |
Expected Dividend Yield | 0.9% | | 0.9% | | 1.4% |
The average risk-free interest rate is based on US Treasury security rates in effect as of the grant date. The expected dividend yield is based on the projected annual dividend as a percentage of the estimated market value of the Company's common stock as of the grant date. The Company estimated the expected volatility using a weighted average of daily historical volatility of the Company's stock price over the expected term of the award. The Company estimated the expected term using historical data.
Following is a summary of share-based incentive plan activity (options and SARs) for fiscal 2022:
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Number of Shares Under Options and SARs | Shares | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Term (years) | | Aggregate Intrinsic Value (in millions) |
Outstanding as of January 1, 2022 | 811,906 | | $ | 81.50 | | | | | |
Granted | 135,634 | | 150.23 | | | | | |
Exercised | (108,609) | | 64.98 | | | | | |
Forfeited | (27,797) | | 149.24 | | | | | |
Expired | (2,994) | | 76.86 | | | | | |
Outstanding as of December 31, 2022 | 808,140 | | $ | 92.94 | | | 6.3 | | $ | 27.1 | |
Exercisable as of December 31, 2022 | 475,123 | | $ | 74.93 | | | 5.1 | | $ | 22.0 | |
Compensation expense recognized related to options and SARs was $6.1 million, $5.6 million and $2.8 million for fiscal years 2022, 2021 and 2020, respectively.
As of December 31, 2022, there was $6.9 million of unrecognized compensation cost related to non-vested options and SARs that is expected to be recognized as a charge to earnings over a weighted average period of 1.7 years.
The amount of options and SARs expected to vest is materially consistent with those outstanding and not yet exercisable.
Restricted Stock Awards and Restricted Stock Units
Restricted stock awards ("RSAs") and restricted stock units ("RSUs") consist of shares or the rights to shares of the Company's stock. The awards are restricted such that they are subject to substantial risk of forfeiture and to restrictions on their sale or other transfer. As defined in the individual grant agreements, acceleration of vesting may occur under a change in control, or death, disability or normal retirement of the grantee.
Following is the summary of RSAs activity for fiscal 2022:
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| | Shares | | Weighted Average Fair Value at Grant Date | | Weighted Average Remaining Contractual Term (years) |
Unvested RSAs as of January 1, 2022 | | 9,018 | | $ | 144.73 | | | 0.5 |
Granted | | 10,287 | | 131.27 | | | |
Vested | | (9,018) | | 144.73 | | | |
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Unvested RSAs as of December 31, 2022 | | 10,287 | | $ | 131.27 | | | 0.4 |
The weighted average grant date fair value of awards granted was $131.27, $144.73 and $70.05 in fiscal years 2022, 2021 and 2020, respectively.
RSAs vest on the one year anniversary of the grant date, provided the holder of the shares is continuously employed by or in the service of the Company until the vesting date. Compensation expense recognized related to the RSAs was $1.4 million for fiscal 2022 and $1.2 million for fiscal 2021 and 2020, respectively.
As of December 31, 2022, there was $0.5 million of unrecognized compensation cost related to non-vested RSAs that is expected to be recognized as a charge to earnings over a weighted average period of 0.4 years.
Following is the summary of RSUs activity for fiscal 2022:
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| | | Shares | | Weighted Average Fair Value at Grant Date | | Weighted Average Remaining Contractual Term (years) |
Unvested RSUs as of January 1, 2022 | | 220,898 | | $ | 119.59 | | | 1.8 |
Granted | | 94,791 | | 147.70 | | | |
Vested | | (128,166) | | 114.90 | | | |
Forfeited | | (31,110) | | 137.27 | | | |
Unvested RSUs as of December 31, 2022 | | 156,413 | | $ | 136.95 | | | 1.9 |
The weighted average grant date fair value of awards granted was $147.70, $143.44 and $86.70 in fiscal years 2022, 2021 and 2020, respectively.
RSUs granted prior to fiscal 2020 vest on the third anniversary of the grant date while RSUs granted in fiscal 2020 vest one third each year on the anniversary of the grant date, provided the holder of the shares is continuously employed by the Company until the vesting date. Compensation expense recognized related to the RSUs was $10.3 million, $9.7 million and $3.8 million for fiscal 2022, 2021 and 2020, respectively.
As of December 31, 2022, there was $13.3 million of unrecognized compensation cost related to non-vested RSUs that is expected to be recognized as a charge to earnings over a weighted average period of 1.9 years.
Performance Share Units
Performance share unit awards ("PSUs") consist of shares or the rights to shares of the Company's stock which are awarded to associates of the Company. These shares are payable upon the determination that the Company achieved certain established performance targets and can range from 0% to 200% of the targeted payout based on the actual results. PSUs have a performance period of 3 years, vest three years from the grant date and are issued at a performance target of 100%. The PSUs have performance criteria based on a return on invested capital metric or they have performance criteria using returns relative to the Company's peer group. As set forth in the individual grant agreements, acceleration of vesting may occur under a change in control, death or disability. There are no voting rights with these instruments until vesting occurs and a share of stock is issued. Some of the PSU awards are valued using a Monte Carlo simulation method as of the grant date while others are valued using the closing market price less net present value of dividends as of the grant date depending on the performance criteria for the award.
The assumptions used in the Company's Monte Carlo simulation related to grants for performance share units were as follows:
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| December 31, 2022 | | January 1, 2022 | | January 2, 2021 |
Risk-free interest rate | 1.8% | | 0.2% | | 1.4% |
Expected life (years) | 3.0 | | 3.0 | | 3.0 |
Expected volatility | 38.0% | | 37.0% | | 24.0% |
Expected dividend yield | —% | | 0.9% | | 1.4% |
Following is the summary of PSUs activity for fiscal 2022:
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Shares | | Weighted Average Fair Value at Grant Date | | Weighted Average Remaining Contractual Term (years) |
Unvested PSUs as of January 1, 2022 | | 99,867 | | $ | 108.28 | | | 1.6 |
Granted | | 41,078 | | 151.27 | | | |
Vested | | (28,653) | | 78.09 | | | |
Forfeited | | (4,627) | | 146.61 | | | |
Unvested PSUs as of December 31, 2022 | | 107,665 | | $ | 131.07 | | | 1.8 |
The weighted average grant date fair value of awards granted was $151.27, $120.19 and $117.63 in fiscal years 2022, 2021 and 2020, respectively.
Compensation expense for awards granted are recognized based on the Monte Carlo simulation value or the expected payout ratio depending upon the performance criterion for the award, net of estimated forfeitures. Compensation expense recognized related to PSUs was $4.7 million, $8.4 million and $1.4 million for fiscal 2022, 2021 and 2021, respectively. $4.3 million of compensation expense recognized in fiscal 2021 related to PSUs vesting upon consummation of the Rexnord Transaction. Total unrecognized compensation expense for all PSUs granted as of December 31, 2022 was $6.7 million and it is expected to be recognized as a charge to earnings over a weighted average period of 1.8 years.
(11) Income Taxes
Income before taxes consisted of the following:
| | | | | | | | | | | | | | | | | | | | |
| | 2022 | | 2021 | | 2020 |
United States | | $ | 221.2 | | | $ | 61.7 | | | $ | 78.1 | |
Foreign | | 392.6 | | | 248.8 | | | 170.4 | |
Total | | $ | 613.8 | | | $ | 310.5 | | | $ | 248.5 | |
The provision for income taxes is summarized as follows:
| | | | | | | | | | | | | | | | | | | | |
| | 2022 | | 2021 | | 2020 |
Current | | | | | | |
Federal | | $ | 101.6 | | | $ | 18.2 | | | $ | 7.1 | |
State | | 10.2 | | | 10.6 | | | 2.7 | |
Foreign | | 87.2 | | | 54.6 | | | 63.5 | |
| | $ | 199.0 | | | $ | 83.4 | | | $ | 73.3 | |
Deferred | | | | | | |
Federal | | $ | (50.7) | | | $ | 6.7 | | | $ | (2.5) | |
State | | (12.1) | | | (2.0) | | | (0.3) | |
Foreign | | (17.3) | | | (13.4) | | | (14.2) | |
| | (80.1) | | | (8.7) | | | (17.0) | |
Total | | $ | 118.9 | | | $ | 74.7 | | | $ | 56.3 | |
A reconciliation of the statutory federal income tax rate and the effective tax rate reflected in the consolidated statements of income follows:
| | | | | | | | | | | | | | | | | | | | |
| | 2022 | | 2021 | | 2020 |
Federal Statutory Rate | | 21.0% | | 21.0% | | 21.0% |
State Income Taxes, Net of Federal Benefit | | 0.5% | | 0.6% | | 0.8% |
| | | | | | |
| | | | | | |
Effect of Impairment Charges | | —% | | 2.7% | | 0.9% |
Foreign Rate Differential | | (0.2)% | | 0.4% | | 0.8% |
Research and Development Credit | | (1.6)% | | (2.7)% | | (3.0)% |
| | | | | | |
| | | | | | |
Valuation Allowance | | —% | | (0.4)% | | (0.1)% |
| | | | | | |
Tax on Repatriation | | 1.2% | | 0.3% | | 1.2% |
Transaction Costs | | —% | | 2.0% | | —% |
| | | | | | |
| | | | | | |
Deferred Tax Remeasurement | | (0.4)% | | 0.2% | | (0.4)% |
Other | | (1.1)% | | —% | | 1.5% |
Effective Tax Rate | | 19.4% | | 24.1% | | 22.7% |
Deferred taxes arise primarily from differences in amounts reported for tax and financial statement purposes. The Company's net deferred tax liability was $547.9 million as of December 31, 2022, classified on the consolidated Balance Sheet as a net non-current deferred income tax asset of $44.0 million and a net non-current deferred income tax liability of $591.9 million. As of January 1, 2022, the Company's net deferred tax liability was $644.0 million classified on the consolidated Balance Sheet as a net non-current deferred income tax asset of $35.7 million and a net non-current deferred income tax liability of $679.7 million.
The components of this net deferred tax liability are as follows:
| | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | January 1, 2022 |
Accrued Benefits | | $ | 52.1 | | | $ | 55.7 | |
Bad Debt Allowances | | 7.2 | | | 6.9 | |
Warranty Accruals | | 6.2 | | | 4.6 | |
| | | | |
| | | | |
Tax Loss Carryforward | | 7.6 | | | 8.8 | |
| | | | |
Operating Lease Liability | | 47.1 | | | 49.8 | |
Other | | 42.2 | | | 44.4 | |
Deferred Tax Assets before Valuation Allowance | | 162.4 | | | 170.2 | |
Valuation Allowance | | (5.2) | | | (5.3) | |
Total Deferred Tax Assets | | 157.2 | | | 164.9 | |
Property Related | | (57.9) | | | (77.0) | |
Intangible Items | | (585.5) | | | (636.2) | |
Accrued Liabilities | | (11.6) | | | (15.8) | |
Derivative Instruments | | (5.6) | | | (7.4) | |
Inventory | | (5.4) | | | (29.7) | |
Operating Lease Asset | | (39.1) | | | (42.8) | |
Deferred Tax Liabilities | | (705.1) | | | (808.9) | |
Net Deferred Tax Liability | | $ | (547.9) | | | $ | (644.0) | |
Following is a reconciliation of the beginning and ending amount of unrecognized tax benefits:
| | | | | | | | | | | | | | | | | | | | |
Unrecognized Tax Benefits, December 28, 2019 | | $ | 6.9 | |
| | |
Gross Increases from Current Period Tax Positions | | 0.2 | |
| | |
Lapse of Statute of Limitations | | (0.3) | |
Unrecognized Tax Benefits, January 2, 2021 | | $ | 6.8 | |
Gross Increases from Prior Period Tax Positions | | 0.1 | |
Gross Increases from Current Period Tax Positions | | 0.6 | |
Gross Increases from Acquisitions | | 5.3 | |
| | |
Lapse of Statute of Limitations | | (4.0) | |
Unrecognized Tax Benefits, January 1, 2022 | | $ | 8.8 | |
| | |
Gross Increases from Current Period Tax Positions | | 0.6 | |
| | |
Settlements with Taxing Authorities | | (2.0) | |
Lapse of Statute of Limitations | | (1.7) | |
Unrecognized Tax Benefits, December 31, 2022 | | $ | 5.7 | |
Unrecognized tax benefits as of December 31, 2022 amount to $5.7 million, 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. During fiscal years 2022, 2021 and 2020, the Company recognized approximately $(0.1) million, $(1.4) million and $0.4 million in net interest (income) expense, respectively. The Company had approximately $1.2 million, $1.3 million and $2.7 million of accrued interest as of December 31, 2022, January 1, 2022 and January 2, 2021, respectively.
Due to statute expirations, approximately $1.4 million of the unrecognized tax benefits, including accrued interest, could reasonably change in the coming year.
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 2019, and the Company is no longer subject to non-US income tax examinations by tax authorities for years prior to 2017.
As of December 31, 2022, the Company had approximately $7.6 million of tax effected net operating losses in various jurisdictions with a portion expiring over a period of up to 15 years and the remaining without expiration. As of January 1, 2022, the Company had approximately $8.8 million of tax effected net operating losses in various jurisdictions with a portion expiring over a period up to 15 years and the remaining without expiration.
Valuation allowances totaling $5.2 million and $5.3 million as of December 31, 2022 and January 1, 2022, respectively, have been established for deferred income tax assets primarily related to certain subsidiary loss carryforwards that may not be realized. Realization of the net deferred income tax assets is dependent on generating sufficient taxable income prior to their expiration. Although realization is not assured, management believes it is more-likely-than-not that the net deferred income tax assets will be realized. The amount of the net deferred income tax assets considered realizable, however, could change in the near term if future taxable income during the carryforward period fluctuates.
The Company has been granted tax holidays for some of its Chinese subsidiaries. The majority of these tax holidays expired at the end of 2022. All tax holidays will be renewed subject to certain conditions with which the Company expects to comply. In 2022, these holidays decreased the Provision for Income Taxes by $4.3 million.
The Company continues to treat approximately $261.1 million of earnings from certain foreign entities as permanently reinvested and has not recorded a deferred tax liability for the local withholding taxes of approximately $25.5 million on those earnings.
(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 $900.0 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. The soil excavation work and transporting and disposing of the excavated material was completed in October 2020. An AS/SVE system construction was completed in February 2022 and is anticipated to operate for three years. 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 350 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 is a reconciliation of the changes in accrued warranty costs for fiscal 2022 and fiscal 2021:
| | | | | | | | | | | | | | |
| | December 31, 2022 | | January 1, 2022 |
Beginning Balance | | $ | 23.0 | | | $ | 15.5 | |
Less: Payments | | 24.6 | | | 19.2 | |
Provisions | | 30.8 | | | 20.5 | |
Acquisitions | | — | | | 6.3 | |
| | | | |
Translation Adjustments | | (0.4) | | | (0.1) | |
Ending Balance | | $ | 28.8 | | | $ | 23.0 | |
These liabilities are included in Other Accrued Expenses and Other Noncurrent Liabilities on the 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 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 December 31, 2022 or January 1, 2022.
Cash flow hedges
The effective portion of the gain or loss on the derivative is reported as a component of AOCI and reclassified into earnings 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.
As of December 31, 2022 and January 1, 2022, the Company had $11.9 million and $5.6 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.
The Company had the following commodity forward contracts outstanding (with maturities extending through May 2024) to hedge forecasted purchases of commodities (notional amounts expressed in terms of the dollar value of the hedged item:
| | | | | | | | | | | | | | |
| | December 31, 2022 | | January 1, 2022 |
| | |
Copper | | $ | 89.4 | | | $ | 154.6 | |
Aluminum | | 4.0 | | | 9.5 | |
| | | | |
The Company had the following currency forward contracts outstanding (with maturities extending through June 2024) to hedge forecasted foreign currency cash flows:
| | | | | | | | | | | | | | |
| | December 31, 2022 | | January 1, 2022 |
| | |
Mexican Peso | | $ | 215.2 | | | $ | 194.8 | |
Chinese Renminbi | | 173.8 | | | 263.8 | |
Indian Rupee | | 33.1 | | | 64.0 | |
Euro | | 159.6 | | | 208.4 | |
Canadian Dollar | | — | | | 0.3 | |
Australian Dollar | | — | | | 17.6 | |
Thai Baht | | — | | | 2.8 | |
| | | | |
British Pound | | 2.1 | | | 1.3 | |
| | | | |
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 which were subsequently terminated in March 2022. The cash proceeds of $16.2 million received to settle the terminated swaps 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 Company entered into two additional receive variable/pay-fixed forward starting non-amortizing interest rate swaps in May 2022, with a total notional amount of $250.0 million to hedge the floating rate interest of the Term Facility. These swaps will expire in March 2027.
Fair values of derivative instruments as of December 31, 2022 and January 1, 2022 were:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 |
| | Prepaid Expenses and Other Current Assets | | Other Noncurrent Assets | | Other Accrued Expenses | | Other Noncurrent Liabilities |
Designated as Hedging Instruments: | | | | | | | | |
Interest Rate Swap Contracts | | $ | — | | | $ | 7.9 | | | $ | — | | | $ | — | |
Currency Contracts | | 12.3 | | | 0.9 | | | 4.8 | | | — | |
Commodity Contracts | | 0.9 | | | 0.3 | | | 10.2 | | | — | |
Not Designated as Hedging Instruments: | | | | | | | | |
Currency Contracts | | 0.7 | | | — | | | — | | | — | |
Commodity Contracts | | — | | | — | | | 0.4 | | | — | |
Total Derivatives | | $ | 13.9 | | | $ | 9.1 | | | $ | 15.4 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 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 | |
Derivatives Designated as Cash Flow Hedging Instruments
The effect of derivative instruments designated as cash flow hedges on the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income for fiscal years 2022, 2021 and 2020 were:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Fiscal 2022 |
| | | | | | Interest | | |
| | Commodity | | Currency | | Rate | | |
| | Forwards | | Forwards | | Swaps | | Total |
(Loss) Gain Recognized in Other Comprehensive Income | | $ | (23.5) | | | $ | 11.4 | | | $ | 18.2 | | | $ | 6.1 | |
Amounts Reclassified from Other Comprehensive Income (Loss): | | | | | | | | |
Gain Recognized in Net Sales | | — | | | 0.1 | | | — | | | 0.1 | |
Gain Recognized in Cost of Sales | | 3.5 | | | 6.1 | | | — | | | 9.6 | |
Gain Recognized in Operating Expense | | — | | | — | | | — | | | — | |
Gain Recognized in Interest Expense | | — | | | — | | | 1.3 | | | 1.3 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Fiscal 2021 |
| | | | | | Interest | | |
| | Commodity | | Currency | | Rate | | |
| | Forwards | | Forwards | | Swaps | | Total |
Gain Recognized in Other Comprehensive Income | | $ | 29.9 | | | $ | 11.4 | | | $ | 7.0 | | | $ | 48.3 | |
Amounts Reclassified from Other Comprehensive Income (Loss): | | | | | | | | |
Gain Recognized in Net Sales | | — | | | 0.3 | | | — | | | 0.3 | |
Gain Recognized in Cost of Sales | | 32.6 | | | 16.9 | | | — | | | 49.5 | |
Gain Recognized in Operating Expense | | — | | | 2.2 | | | — | | | 2.2 | |
Loss Recognized in Interest Expense | | — | | | — | | | (0.4) | | | (0.4) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Fiscal 2020 |
| | | | | | Interest | | |
| | Commodity | | Currency | | Rate | | |
| | Forwards | | Forwards | | Swaps | | Total |
Gain (Loss) Recognized in Other Comprehensive Loss | | $ | 14.8 | | | $ | (3.2) | | | $ | (0.2) | | | $ | 11.4 | |
Amounts Reclassified from Other Comprehensive Income (Loss): | | | | | | | | |
| | | | | | | | |
Gain (Loss) Recognized in Cost of Sales | | 1.2 | | | (2.9) | | | — | | | (1.7) | |
Loss Recognized in Operating Expense | | — | | | (8.3) | | | — | | | (8.3) | |
Gain Recognized in Interest Expense | | — | | | — | | | 0.9 | | | 0.9 | |
The ineffective portion of hedging instruments recognized was immaterial for all periods presented.
Derivatives Not Designated as Cash Flow Hedging Instruments
The effect of derivative instruments not designated as cash flow hedges on the Consolidated Statements of Income for fiscal years 2022, 2021 and 2020 were:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fiscal 2022 |
| | | | Commodity Forwards | | Currency Forwards | | Total |
Loss Recognized in Cost of Sales | | $ | (0.6) | | | $ | — | | | $ | (0.6) | |
Gain Recognized in Operating Expenses | | — | | | 10.2 | | | 10.2 | |
| | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fiscal 2021 | | |
| | | | Commodity Forwards | | Currency Forwards | | Total | | |
Gain Recognized in Cost of Sales | | $ | 0.2 | | | $ | — | | | $ | 0.2 | | | |
Gain Recognized in Operating Expenses | | — | | | 7.2 | | | 7.2 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fiscal 2020 |
| | | | Commodity Forwards | | Currency Forwards | | Total |
Gain Recognized in Cost of Sales | | | | $ | 0.2 | | | $ | — | | | $ | 0.2 | |
Loss Recognized in Operating Expenses | | — | | | (8.6) | | | (8.6) | |
The AOCI balance related to hedging activities of a $17.3 million gain net of tax as of December 31, 2022 includes $3.7 million of net deferred gains expected to be reclassified to the Consolidated Statement of Comprehensive Income in the next twelve months. There were no gains or losses reclassified from AOCI to earnings based on the probability that the forecasted transaction would not occur.
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 Consolidated Balance Sheets on a gross basis for the periods ended December 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:
| | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 |
| | Gross Amounts as Presented in the 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 | | $ | 13.0 | | | $ | (2.5) | | | $ | 10.5 | |
Derivative Commodity Contracts | | 0.9 | | | (0.9) | | | — | |
Other Noncurrent Assets: | | | | | | |
Derivative Currency Contracts | | 0.9 | | | — | | | 0.9 | |
Derivative Commodity Contracts | | 0.3 | | | — | | | 0.3 | |
Other Accrued Expenses: | | | | | | |
Derivative Currency Contracts | | 4.8 | | | (2.5) | | | 2.3 | |
Derivative Commodity Contracts | | 10.6 | | | (0.9) | | | 9.7 | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | January 1, 2022 |
| | Gross Amounts as Presented in the 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: | | | | | | |
| | | | | | |
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:
| | | | | | | | | | | | | | | | | | | | |
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 following table sets forth the Company's financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2022 and January 1, 2022, respectively:
| | | | | | | | | | | | | | | | | |
| December 31, 2022 | | January 1, 2022 | | |
| | | Classification |
Assets: | | | | | |
Prepaid Expenses and Other Current Assets: | | | | | |
| | | | | |
Derivative Currency Contracts | $ | 13.0 | | | $ | 8.6 | | | Level 2 |
Derivative Commodity Contracts | 0.9 | | | 9.3 | | | Level 2 |
| | | | | |
Other Noncurrent Assets: | | | | | |
Interest Rate Swap | 7.9 | | | 5.3 | | | Level 2 |
Assets Held in Rabbi Trust | 6.4 | | | 6.8 | | | Level 1 |
Derivative Currency Contracts | 0.9 | | | 0.7 | | | Level 2 |
Derivative Commodity Contracts | 0.3 | | | 0.1 | | | Level 2 |
Liabilities: | | | | | |
| | | | | |
| | | | | |
Other Accrued Expenses: | | | | | |
| | | | | |
Derivative Currency Contracts | 4.8 | | | 1.7 | | | Level 2 |
Derivative Commodity Contracts | 10.6 | | | 1.2 | | | Level 2 |
Other Noncurrent Liabilities: | | | | | |
| | | | | |
| | | | | |
Derivative Commodity Contracts | — | | | 0.6 | | | Level 2 |
| | | | | |
| | | | | |
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 using the SOFR forward yield curve for an instrument 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. Debt instruments are valued based on quoted prices in active markets for instruments with similar contractual terms.
The Company did not change its valuation techniques during fiscal 2022.
(15) Restructuring Activities
The Company incurred restructuring and restructuring-related costs on projects during fiscal 2022, 2021 and 2020. Restructuring costs include associate termination and plant relocation costs. Restructuring-related costs 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 associate termination expenses are generally required to be accrued over the associate's remaining service period while restructuring costs for plant relocation costs and restructuring-related costs are generally required to be expensed as incurred.
The following is a reconciliation of provisions and payments for the restructuring projects for fiscal 2022 and fiscal 2021:
| | | | | | | | | | | | | | |
| | December 31, 2022 | | January 1, 2022 |
Beginning Balance | | $ | 5.0 | | | $ | 2.0 | |
Acquisition | | — | | | 2.2 | |
Provision | | 46.8 | | | 14.0 | |
Less: Payments | | 36.7 | | | 13.2 | |
Ending Balance | | $ | 15.1 | | | $ | 5.0 | |
The following is a reconciliation of expenses by type for the restructuring projects in fiscal years 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | |
| 2022 | | 2021 | | 2020 |
Restructuring Costs: | Cost of Sales | Operating Expenses | Total | | Cost of Sales | Operating Expenses | Total | | Cost of Sales | Operating Expenses | Total |
Severance Expense | $ | 25.1 | | $ | 6.4 | | $ | 31.5 | | | $ | 6.4 | | $ | 1.2 | | $ | 7.6 | | | $ | 6.2 | | $ | 5.6 | | $ | 11.8 | |
Facility Related Costs | 13.5 | | 1.1 | | 14.6 | | | 4.2 | | 0.3 | | 4.5 | | | 11.7 | | 3.1 | | 14.8 | |
Other Expenses | 0.3 | | 0.4 | | 0.7 | | | 1.6 | | 0.3 | | 1.9 | | | 0.3 | | (0.3) | | — | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Total Restructuring and Restructuring-Related Costs | $ | 38.9 | | $ | 7.9 | | $ | 46.8 | | | $ | 12.2 | | $ | 1.8 | | $ | 14.0 | | | $ | 18.2 | | $ | 8.4 | | $ | 26.6 | |
The following table shows the allocation of Restructuring Expenses by segment for fiscal years 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | Commercial Systems | | Industrial Systems | | Climate Solutions | | Motion Control Solutions |
Restructuring Expenses - 2022 | $ | 46.8 | | | $ | 7.3 | | | $ | 1.6 | | | $ | 12.1 | | | $ | 25.8 | |
Restructuring Expenses - 2021 | $ | 14.0 | | | $ | 1.9 | | | $ | 1.9 | | | $ | 0.8 | | | $ | 9.4 | |
Restructuring Expenses - 2020 | $ | 26.6 | | | $ | 6.3 | | | $ | 8.7 | | | $ | 3.7 | | | $ | 7.9 | |
The Company expects to record aggregate future charges of approximately $26.8 million in 2023. The Company continues to evaluate operating efficiencies and anticipates incurring additional costs in future periods in connection with these activities.
(16) Subsequent Events
See Note 7 - Debt and Bank Credit Facilities for information on the Senior Notes issued in January 2023, including use of proceeds and termination of the Bridge Facility.