Regal Rexnord Corp: Form 10-Q for the period ended Mar 31, 2023

(Dollars In Millions Except Per Share Data, Unless Otherwise Noted)

Overview

Regal Rexnord Corporation (NYSE: RRX) (“we,” “us,” “our” or the “Company”) is a global leader in the engineering and manufacturing of factory automation sub-systems, industrial powertrain solutions, automation and mechanical power transmission components, electric motors and electronic controls, air moving products, and specialty electrical components and systems, serving customers around the world. Through longstanding technology leadership and an intentional focus on producing more energy-efficient products and systems, we help create a better tomorrow – for our customers and for the planet. We are headquartered in Beloit, Wisconsin and have manufacturing, sales and service facilities worldwide.

Our company is comprised of four operating segments: Industrial Powertrain Solutions (IPS), Power Efficiency Solutions (PES), Automation & Motion Control (AMC) and Industrial Systems. Effective during the first quarter of 2023, in conjunction with the Altra Transaction (as defined in Note 3 - Acquisitions and Divestitures), we realigned our four operating segments with the change to our management structure and operating model. See Note 6 - Segment Information of the Notes to the Condensed Consolidated Financial Statements for further information.

A description of our four operating segments is as follows:

• IPS consists of the majority of our previous Motion Control Solutions (MCS) segment, excluding the conveying and aerospace business units, plus Altra's Power Transmission Technologies segment. The IPS segment designs, produces and services mounted and unmounted bearings, couplings, mechanical power transmission drives and components, gearboxes and gear motors, clutches, brakes, 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, agriculture machinery, turf & garden and general industrial.
• PES consists of our previous Climate Solutions and Commercial Systems segments. The PES segment designs and produces fractional to approximately 5 horsepower AC and DC motors, electronic variable speed controls, fans, and blowers for commercial applications and small motors, electronic variable speed controls and air moving solutions serving markets including residential and light commercial HVAC, water heaters, commercial refrigeration, commercial building ventilation, pool and spa, irrigation, dewatering, agriculture, and general commercial equipment
• AMC consists of our previous MCS aerospace and conveying business units, Altra's Automation & Specialty segment and the Thomson Power Systems business that was previously in our Industrial Systems segment. The AMC segment designs, produces and services conveyor products, conveying automation subsystems, aerospace components, rotary precision motion solutions, high-efficiency miniature motors and motion control products, automatic transfer switches, switchgear for industrial applications and automation systems that enable and control the transition of rotary motion to linear motion. These products are used in advanced material handling, aerospace and defense, factory automation, data centers, medical device, packaging, printing, semiconductor, robotic, industrial power tool, mobile off-highway, food & beverage processing and other applications.
• Industrial Systems consists of our previous Industrial Systems segment excluding the Thomson Power Systems business. The Industrial Systems segment designs and produces integral motors, alternators 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, prime and standby power, and general industrial equipment.

As previously disclosed, we are considering a full range of strategic alternatives for the Industrial Systems operating segment. Our ongoing strategic review may or may not lead to a decision to divest this business.

Components of Profit and Loss

Net Sales. We sell our products to a variety of manufacturers, distributors and end users. Our customers consist of a large cross-section of businesses, ranging from Fortune 100 companies to small businesses. A number of our products are sold to Original Equipment Manufacturers ("OEMs"), who incorporate our products, such as electric motors, into products they manufacture, and many of our products are built to the requirements of our customers. The majority of our sales derive from direct sales to customers by sales personnel employed by the Company, however, a significant portion of our sales are derived from sales made by manufacturer’s representatives, who are paid exclusively on commission. Our product sales are made via purchase order, long-term contract, and, in some instances, one-time purchases. Many of our products have broad customer bases, with levels of revenue concentration by customer varying widely across our business units.

Our level of net sales for any given period is dependent upon a number of factors, including (i) the demand for our products and for the products in which our products are components; (ii) the strength of the economy generally and the end markets in which we compete; (iii) our customers’ perceptions of our product quality at any given time; (iv) our quote, lead and delivery times; (v) the selling price of our products; (vi) inventory levels in the channels through which our products are sold; and (vii) the weather. As a result, our total revenue has tended to experience quarterly variations and our total revenue for any particular quarter may not be indicative of future results.

We use the term “organic sales" to refer to sales from existing operations excluding (i) sales from acquired businesses recorded prior to the first anniversary of the acquisition (“Acquisition Sales”), (ii) less the amount of sales attributable to any businesses divested/to be exited, and (iii) the impact of foreign currency translation. The impact of foreign currency translation is determined by translating the respective period’s organic sales using the same currency exchange rates that were in effect during the prior year periods. We use the term “organic sales growth” to refer to the increase in our sales between periods that is attributable to organic sales. We use the term “acquisition growth” to refer to the increase in our sales between periods that is attributable to Acquisition Sales. Organic sales, organic sales growth and acquisition growth are non-GAAP measures. See reconciliation for these measures to GAAP net sales in Non-GAAP Measures below.

Gross Profit. Our gross profit is impacted by our levels of net sales and cost of sales. Our cost of sales consists of costs for, among other things (i) raw materials, including copper, steel and aluminum; (ii) components such as castings, bars, tools, bearings and electronics; (iii) wages and related personnel expenses for fabrication, assembly and logistics personnel; (iv) manufacturing facilities, including depreciation on our manufacturing facilities and equipment, insurance and utilities; and (v) shipping. The majority of our cost of sales consists of raw materials and components. The price we pay for commodities and components can be subject to commodity price fluctuations. We attempt to mitigate this through fixed-price agreements with suppliers and our hedging strategies. When we experience commodity price increases, we have tended to announce price increase to our customers who purchase via purchase order, with such increases generally taking effect a period of time after the public announcements. For those sales we make under long-term contracts, we tend to include material price formulas that specify quarterly or semi-annual price adjustments based on a variety of factors, including commodity prices.

Outside of general economic cyclicality, our business units experience different levels of variation in gross profit from quarter to quarter based on factors specific to each business. For example, a portion of our PES segment manufactures products that are used in air conditioning applications. As a result, our sales for that business tend to be lower in the first and fourth quarters and higher in the second and third quarters. In contrast, a portion of our PES segment, IPS segment, AMC segment and Industrial Systems segment and have a broad customer base and a variety of applications, thereby helping to mitigate large quarter-to-quarter fluctuations outside of general economic conditions.

Operating Expenses. Our operating expenses consist primarily of (i) general and administrative expenses; (ii) sales and marketing expenses; (iii) general engineering and research and development expenses; and (iv) handling costs incurred in conjunction with distribution activities. Personnel related costs are our largest operating expense.

Our general and administrative expenses consist primarily of costs for (i) salaries, benefits and other personnel expenses related to our executive, finance, human resource, information technology, legal and operations functions; (ii) occupancy expenses; (iii) technology related costs; (iv) depreciation and amortization; and (v) corporate-related travel. The majority of our general and administrative costs are for salaries and related personnel expenses. These costs can vary by business given the location of our different manufacturing operations.

Our sales and marketing expenses consist primarily of costs for (i) salaries, benefits and other personnel expenses related to our sales and marketing function; (ii) internal and external sales commissions and bonuses; (iii) travel, lodging and other out-of-pocket expenses associated with our selling efforts; and (iv) other related overhead.

Our general engineering and research and development expenses consist primarily of costs for (i) salaries, benefits and other personnel expenses; (ii) the design and development of new energy efficiency products and enhancements; (iii) quality assurance and testing; and (iv) other related overhead. Our research and development efforts tend to be targeted toward developing new products that would allow us to maintain or gain additional market share, whether in new or existing applications. In particular, a large driver of our research and development efforts in those three segments is energy efficiency, which generally means using less electrical power to produce more mechanical power.

Income from Operations. Our income from operations consists of the segment gross profit less the segment operating expenses. In addition, there are shared operating costs that cover corporate, engineering and IT expenses that are consistently allocated to the operating segments and are included in the segment operating expenses. Income from operations is a key metric used to measure year-over-year improvement of the segments.

Altra Transaction

On March 27, 2023, in accordance with the terms and conditions of the Altra Merger Agreement, by and among us, Altra, and Merger Sub, pursuant to the satisfaction of specified conditions, Merger Sub merged with and into Altra, with Altra surviving the Altra Merger as our wholly owned subsidiary. See Note 3 - Acquisitions and Divestitures of the Notes to the Condensed Consolidated Financial Statements for further information regarding the Altra Transaction.

In connection with the Altra Transaction, we entered into certain financing arrangements, which are described below under “Liquidity and Capital Resources”.

2023 Outlook

We continue to expect a low single digit percentage decline in organic sales and earnings per share. We expect benefits from merger and acquisition synergies, improving new product mix, ongoing 80/20 initiatives and various productivity initiatives to be more than offset by headwinds from lower volumes, material and non-material inflation, strategic growth investments, a higher tax rate and higher net interest expense.

Results of Operations

Three Months Ended March 31, 2023 Compared to March 31, 2022

Net sales decreased $74.4 million or 5.7% for the first quarter 2023 compared to the first quarter 2022. The decrease consisted of negative organic sales of 4.1% and negative foreign currency translation of 1.6%. The decrease was primarily driven by sales decreases in North American markets, partially offset by price realization. Gross profit decreased $23.8 million or 5.6% for the first quarter 2023 as compared to the first quarter 2022. The decrease in gross profit was driven by lower volumes and increased material costs partially offset by lower freight costs and lower restructuring costs. Total operating expenses for the first quarter

2023 increased $77.2 million or 30.6% as compared to the first quarter 2022. The increase was primarily driven by higher acquisition costs from the Altra Transaction and employee compensation costs, partially offset by lower restructuring costs.

Industrial Powertrain Solutions segment net sales for the first quarter 2023 were $414.4 million, a decrease of $1.9 million or 0.5% as compared to the first quarter 2022. The decrease consisted of negative foreign currency translation of 1.8% offset by positive organic sales of 1.3%. The decrease was primarily driven by the North America general industrial market. Gross profit increased $23.1 million or 15.0% as compared to the first quarter 2022. The increased gross profit was primarily driven by lower freight and material costs and lower restructuring expense. Total operating expenses for the first quarter 2023 were $151.5 million compared to $108.0 million in the first quarter 2022. The $43.5 million or 40.3% increase was primarily driven by higher acquisition costs from the Altra Transaction and increased employee compensation costs partially offset by lower restructuring costs.

Power Efficiency Solutions segment net sales for the first quarter 2023 were $469.5 million, a decrease of $97.7 million or 17.2% as compared to the first quarter 2022. The decrease consisted of negative organic sales of 15.9% and negative foreign currency translation of 1.3%. The decrease was primarily driven by lower volumes resulting from slowing market demand in the North America pool pump and residential and light commercial HVAC markets and general industrial markets. Gross profit decreased $59.8 million or 33.7% as compared to the first quarter 2022. The decrease in gross profit was primarily driven by material inflation and lower volumes partially offset by lower freight costs. Total operating expenses for the first quarter 2023 and 2022 were $72.3 million and $73.1 million, respectively. The decrease in operating expenses was primarily driven by cost cutting measures.

Automation & Motion Control segment net sales were $203.2 million, an increase of $18.9 million or 10.3% as compared to the first quarter 2022. The increase consisted of positive organic sales of 11.7% offset by negative foreign currency translation of 1.4%. The increase was primarily due to price increases in conveying and share gains in aerospace. Gross profit increased $12.4 million or 19.7% compared to the first quarter 2022. The increase in gross profit was primarily driven by higher price realization. Total operating expenses for the first quarter 2023 were $80.6 million compared to $50.7 million in the first quarter 2022. The increase was primarily due to higher acquisition costs from the Altra Transaction and employee compensation costs.

Industrial Systems segment net sales for the first quarter 2023 were $137.0 million, an increase of $6.3 million or 4.8% compared to first quarter 2022 net sales of $130.7 million. The increase consisted of positive organic sales of 8.0% partially offset by negative foreign currency translation of 3.2%. The increase was primarily driven by strength in demand for generators in North America and global industrial motors. Gross profit for the first quarter 2023 increased $0.5 million or 1.8%. The increase was driven by the increase in volume and price realization, partially offset by foreign exchange losses. Total operating expenses for the first quarter 2023 increased $4.6 million as compared to the first quarter 2022, primarily due to increased employee compensation, commissions and foreign exchange losses.

The effective tax rate for the three months ended March 31, 2023 was 180.9% versus 22.2% for the three months ended March 31, 2022. The effective tax rate for the three months ended March 31, 2023 was higher than the same period in the prior fiscal year primarily driven by non-deductible transaction costs associated with the Altra Transaction, and withholding tax costs resulting from the cash repatriation of foreign earnings.

Non-GAAP Measures

We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP"). As noted above, in this Quarterly Report on Form 10-K, we also disclose organic sales, organic sales growth and acquisition growth, which are considered non-GAAP financial measures. We use the term "organic sales growth" to refer to its increase in sales between periods that is attributable to sales. "Organic sales" refers to GAAP sales from existing operations excluding any sales from acquired businesses recorded prior to the first anniversary of the acquisition and excluding any sales from business divested/to be exited recorded prior to the first anniversary of the exit and excluding the impact of foreign currency translation. The impact of foreign currency translation is determined by translating the respective period's organic sales using the currency exchange rates that were in effect during the prior year periods. We reconcile these non-GAAP measures in the table below to GAAP net sales. We believe that these non-GAAP financial measures are useful measures for providing investors with additional information regarding our results of operations and for helping investors understand and compare our operating results across accounting periods and compared to our peers. This additional non-GAAP information is not meant to be considered in isolation or as a substitute for the Company's results of operations prepared and presented in accordance with GAAP.

Liquidity and Capital Resources

General

Our principal source of liquidity is cash flow provided by operating activities. In addition to operating income, other significant factors affecting our cash flow include working capital levels, capital expenditures, dividends, share repurchases, acquisitions and divestitures, availability of debt financing and the ability to attract long-term capital at acceptable terms.

Cash flow provided by operating activities was $106.2 million for the three months ended March 31, 2023, a $112.1 million increase from the three months ended March 31, 2022. This increase was driven primarily by improvements in cash flows related to working capital, partially offset by payments for certain acquisition costs and lower net income excluding the impact of non-cash adjustments.

Cash flow used in investing activities was $4,865.5 million for the three months ended March 31, 2023 as compared to cash flow used in investing activities of $47.0 million for the three months ended March 31, 2022. The change was driven primarily by the Altra Acquisitions in the current year.

In fiscal 2023, we anticipate capital spending for property, plant and equipment to be approximately $150 million. We believe that our present manufacturing facilities will be sufficient to provide adequate capacity for our operations in fiscal 2023. We anticipate funding fiscal 2023 capital spending with operating cash flows.

Cash flow provided by financing activities was $5,203.6 million for the three months ended March 31, 2023, compared to $3.7 million provided by financing activities for the three months ended March 31, 2022. We had net debt borrowings of $5,284.1 million during the three months ended March 31, 2023, compared to net debt borrowings of $145.7 million during the three months ended March 31, 2022. The increase was primarily driven by the $4.7 billion of Senior Notes issued in January 2023 and $840.0 million upsize of the unsecured term loan facility in March 2023, partially offset by the repayment of the $500.0 million of Private Placement Notes in January 2023. There were no share repurchases for the three months ended March 31, 2023, compared to $114.2 million shares repurchases for the three months ended March 31, 2022. There were $23.2 million of dividends paid for the three months ended March 31, 2023, compared to $22.3 million of dividends in the prior year. There were $50.0 million in financing fees paid for the three months ended March 31, 2023, compared to $4.5 million of fees in the prior year. There were no distributions paid to noncontrolling interests for the three months ended March 31, 2023 and March 31, 2022.

Our working capital was $2,703.3 million (inclusive of assets and liabilities assumed from the Altra Transaction) as of March 31, 2023, compared to $1,998.3 million as of December 31, 2022. As of March 31, 2023 and December 31, 2022, our current ratio (which is the ratio of our current assets to current liabilities) was 2.9:1 and 3.0:1, respectively. Our working capital increased primarily as a result of assets and liabilities assumed as part of the Altra Transaction.

The following table presents selected financial information and statistics as of March 31, 2023 and December 31, 2022:

As of March 31, 2023, $668.2 million of our cash was held by foreign subsidiaries and could be used in our domestic operations if necessary. We anticipate being able to support our liquidity and operating needs largely through cash generated from operations and the available capacity under the revolver. We regularly assess our cash needs and the available sources to fund these needs which includes repatriation of foreign earnings which may be subject to withholding taxes. Under current law, we do not expect restrictions or taxes on repatriation of cash held outside of the United States to have a material effect on our overall liquidity, financial condition or the results of operations for the foreseeable future. As of March 31, 2023, we have repatriated approximately $420 million of foreign cash in fiscal 2023 to support the repayment of debt. We are continuing to evaluate opportunities to repatriate additional foreign cash in fiscal 2023.

We will, from time to time, maintain excess cash balances which may be used to (i) fund operations, (ii) repay outstanding debt, (iii) fund acquisitions, (iv) pay dividends, (v) make investments in new product development programs, (vi) repurchase our common stock, or (vii) fund other corporate objectives.

Financing Agreement

During the three months ended March 31, 2023, the Company made the following updates to its financing agreements primarily in connection with the Altra Transaction:

• Issued Senior Notes on January 24, 2023 and received $4,647.0 million in net proceeds
• Incurred additional term loans under the Term Facility of $840.0 million on March 27, 2023
• Increased the commitments under the Multicurrency Revolving Facility by $570.0 million on March 27, 2023
• Assumed the Altra Notes of $18.1 million
• Repaid in full the Private Placement Notes of $500.0 million

The Company will incur significant incremental interest expense as a result of the debt issuances above. The Company plans to use cash generated from operations to fund its interest obligations and reduce the principal balance of its debt over time.

As of March 31, 2023, the Company had no standby letters of credit issued under the Multicurrency Revolver Facility, and $870.0 million of available borrowing capacity. For the three months ended March 31, 2023 and March 31, 2022 under the Multicurrency Revolving Facility, the average daily balance in borrowings was $580.6 million and $773.7 million, respectively, and the weighted average interest rate was 5.8% and 1.7%, 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.

See Note 7 - Debt and Bank Credit Facilities and Note 3 – Acquisitions and Divestitures for more information.

Critical Accounting Estimates

Our critical accounting policies and estimates, which are discussed in our Annual Report on Form 10-K for the year ended December 31, 2022, have not materially changed since that report was filed.

We are exposed to market risk relating to our operations due to changes in interest rates, foreign currency exchange rates and commodity prices of purchased raw materials. We manage the exposure to these risks through a combination of normal operating and financing activities and derivative financial instruments such as interest rate swaps, commodity cash flow hedges and foreign currency forward exchange contracts. All hedging transactions are authorized and executed pursuant to clearly defined policies and procedures, which prohibit the use of financial instruments for speculative purposes.

Generally, hedges are recorded on the balance sheet at fair value and are accounted for as cash flow hedges, with changes in fair value recorded in Accumulated Other comprehensive Income (Loss) (“AOCI”) in each accounting period. An ineffective portion of the hedges change in fair value, if any, is recorded in earnings in the period of change.

Interest Rate Risk

We are exposed to interest rate risk on certain of our outstanding debt obligations used to finance our operations and acquisitions. Loans under the Credit Agreement bear interest at variable rates plus a margin, based on our consolidated net leverage ratio. As of March 31, 2023, excluding the impact of interest rate swaps, we had $4,800.3 million of fixed rate debt and $2,545.8 million of variable rate debt. We utilize interest rate swaps to manage fluctuations in cash flows resulting from exposure to interest rate risk on forecasted variable rate interest payments.

We have floating rate borrowings, which expose us to variability in interest payments due to changes in interest rates. A hypothetical 10% change in our weighted average borrowing rate on outstanding variable rate debt as of March 31, 2023 would result in a $14.7 million change in after-tax annualized earnings. We entered into two forward starting pay fixed/receive floating non-amortizing interest rate swaps in June 2020, with a total notional amount of $250.0 million to manage fluctuations in cash flows from interest rate risk related to floating rate interest. These swaps were terminated in March 2022 upon closing the Credit Agreement. The cash proceeds of $16.2 million received to settle the terminated swaps is being recognized into interest expense via the effective interest rate method through July 2025 when the terminated swaps were scheduled to expire. We also entered into two forward starting pay fixed/receive floating non-amortizing interest rate swaps in May 2022, with a total notional amount of $250.0 million to manage fluctuations in cash flows from interest rate risk related to floating rate interest. Upon inception, the swaps were designated as a cash flow hedges against forecasted interest payments with gains and losses, net of tax, measured on an ongoing basis, recorded in AOCI.

Details regarding the instruments as of March 31, 2023 are as follows:

As of March 31, 2023 and December 31, 2022, a $4.3 million and $7.9 million interest rate swap asset was included in Other Noncurrent Assets, respectively. There was an unrealized gain of $13.2 million (a $10.0 million gain on the terminated swaps and a $3.2 million gain on the active swaps) and $17.0 million, net of tax, as of March 31, 2023 and December 31, 2022, respectively, that was recorded in AOCI for the effective portion of the hedges.

Foreign Currency Risk

We are exposed to foreign currency risks that arise from normal business operations. These risks include the translation of local currency balances of foreign subsidiaries, intercompany loans with foreign subsidiaries and transactions denominated in foreign currencies. Our objective is to minimize our exposure to these risks through a combination of normal operating activities and the utilization of foreign currency exchange contracts to manage our exposure on the forecasted transactions denominated in currencies other than the applicable functional currency. Contracts are executed with credit worthy banks and are denominated in currencies of major industrial countries. We do not hedge our exposure to the translation of reported results of foreign subsidiaries from local currency to United States dollars.

As of March 31, 2023, derivative currency assets (liabilities) of $22.8 million, $2.0 million, $(2.5) million and $(0.1) million are recorded in Prepaid Expenses and Other Current Assets, Other Noncurrent Assets, Other Accrued Expenses and Other Noncurrent Liabilities, respectively. As of December 31, 2022, derivative currency assets (liabilities) of $13.0 million, $0.9 million and $(4.8) million, are recorded in Prepaid Expenses and Other Current Assets, Other Noncurrent Assets and Other Accrued Expenses, respectively. The unrealized gains on the effective portions of the hedges of $16.4 million net of tax, and $6.3 million net of tax, as of March 31, 2023 and December 31, 2022 respectively, were recorded in AOCI. As of March 31, 2023 and December 31, 2022, we had $9.1 million and $5.3 million, respectively, net of tax, of currency gains on closed hedge instruments in AOCI that will be realized in earnings when the hedged items impact earnings.

The following table quantifies the outstanding foreign exchange contracts intended to hedge non-US dollar denominated receivables and payables and the corresponding impact on the value of these instruments assuming a hypothetical 10% appreciation/depreciation of their counter currency on March 31, 2023:

Gains and losses indicated in the sensitivity analysis would be offset by gains and losses on the underlying forecasted non-US dollar denominated cash flows.

Commodity Price Risk

We periodically enter into commodity hedging transactions to reduce the impact of changing prices for certain commodities such as copper and aluminum based upon forecasted purchases of such commodities. The contract terms of commodity hedge instruments generally mirror those of the hedged item, providing a high degree of risk reduction and correlation.

Derivative commodity assets (liabilities) of $2.3 million, $0.4 million, $(3.4) million and $(0.1) million were recorded in Prepaid Expenses and Other Current Assets, Other Noncurrent Assets, Other Accrued Expenses and Other Noncurrent Liabilities as of March 31, 2023. Derivative commodity assets (liabilities) of $0.9 million, $0.3 million and $(10.6) million were recorded in Prepaid Expenses and Other Current Assets, Other Noncurrent Assets and Other Accrued Expenses, respectively as of December 31, 2022. The unrealized loss on the effective portion of the hedges of $0.6 million net of tax and the unrealized loss on the effective portion of the hedges of $6.9 million net of tax, as of March 31, 2023 and December 31, 2022, respectively, was recorded in AOCI. As of March 31, 2023, we had $2.7 million, net of tax, of derivative commodity losses on closed hedge instruments in AOCI that will be realized in earnings when the hedged items impact earnings. As of December 31, 2022, there was an additional $4.4 million, net of tax, derivative commodity loss on closed hedge instruments in AOCI that were realized in earnings when the hedged items impacted earnings.

The following table quantifies the outstanding commodity contracts intended to hedge raw material commodity prices and the corresponding impact on the value of these instruments assuming a hypothetical 10% appreciation/depreciation of their prices on March 31, 2023:

Gains and losses indicated in the sensitivity analysis would be offset by the actual prices of the commodities.

The net AOCI hedging component balance of $35.4 million of gains as of March 31, 2023 includes $24.2 million of net current deferred gains that are expected to be realized in the next twelve months. The gain/loss reclassified from AOCI into earnings on such derivatives will be recognized in the same period in which the related item affects earnings.

Counterparty Risk

We are exposed to credit losses in the event of non-performance by the counterparties to various financial agreements, including our interest rate swap agreements, foreign currency exchange contracts and commodity hedging transactions. We manage exposure to counterparty credit risk by limiting our counterparties to major international banks and financial institutions meeting established credit guidelines and continually monitoring their compliance with the credit guidelines. We do not obtain collateral or other security to support financial instruments subject to credit risk. We do not anticipate non-performance by our counterparties, but cannot provide assurances.

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective to ensure that (a) information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and (b) information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

As discusssed above, on March 27, 2023, we completed the Altra Transaction. As part of our ongoing integration of Altra, we continue to incorporate our controls and procedures into Altra operations and to expand our company-wide controls to reflect the risks inherent in an acquisition of this size and complexity.

Our business and financial results are subject to numerous risks and uncertainties. These risks and uncertainties have not changed materially from those reported in Part I, Item 1A - Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2022, which is incorporated herein by reference. For additional information regarding risks and uncertainties facing the Company, please also see the information provided under the header "Cautionary Statement" contained in this Quarterly Report on Form 10-Q.