Regal Rexnord Corporation (NYSE:RRX) Q4 2023 Earnings Call Transcript
Regal Rexnord Corporation (NYSE:RRX) Q4 2023 Earnings Call Transcript February 8, 2024
Regal Rexnord Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning and welcome to the Regal Rexnord Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. And now, I would like to turn the conference over to Robert Barry, Vice President of Investor Relations. Please go ahead.
Robert Barry: Great. Thank you operator. Good morning and welcome to Regal Rexnord’s fourth quarter 2023 earnings conference call. Joining me today are Louis Pinkham, our Chief Executive Officer and Rob Rehard, our Chief Financial Officer. I’d like to remind you that during today’s call, you may hear forward-looking statements related to our future financial results, plans and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today’s press release and in our reports filed with the SEC, which are available on the regalrexnord.com website. On Slide 3, we state that we are presenting certain non-GAAP financial measures that we believe are useful to our investors and we have included reconciliations between the non-GAAP financial information and the GAAP equivalent in the press release and in these presentation materials.
Turning to Slide 4. Let me briefly review the agenda for today’s call. Louis will lead off with his opening comments and an overview of our 4Q performance, Rob Rehard will then provide our fourth quarter financial results in more detail and lay out our 2024 guidance. We’ll then move to Q&A, after which, Louis will have some closing remarks. And with that, I’ll turn the call over to Louis.
Louis Pinkham: Thanks Rob and good morning everyone. Thanks for joining us to discuss our fourth quarter earnings to get an update on our business and for your continued interest in Regal Rexnord. Our team ended 2023 on a high note achieving fourth quarter adjusted diluted earnings per share of $2.28, in line with our guidance midpoint. We also delivered very strong adjusted free cash flow of $171 million, which exceeded our expectations and we realized 40 basis points of adjusted EBITDA margin expansion on a pro forma basis despite continuing to confront destocking and end market headwinds that weighed on our sales. For the year, the Regal Rexnord team delivered $683 million of adjusted free cash flow, firmly above our $650 million plus commitment and nearly double 2022.
This allowed us to make significant progress paying down debt and lowering our interest costs, truly outstanding performance much of it due to the team’s disciplined execution on working capital. We also made significant progress on margins with adjusted gross margins up 150 basis points versus prior year. And adjusted EBITDA margins on a pro forma basis were down 10 basis points versus prior year, even while facing market headwinds. There were many drivers of this strong margin performance, but a key contributor was our IPS and AMC teams achieving $65 million of cost synergies in 2023. They are on track to deliver another $90 million in 2024. The past year has also been one of transformational portfolio change for Regal Rexnord. We added Altra, while also reaching an agreement to sell the motors and generators businesses that comprise the majority of our Industrial Systems segment.
We now have line of sight to the portfolio we plan to grow with going forward. It is one where our IPS segment, which will represent roughly 40% of our pro forma sales has unrivaled scale and scope across the industrial powertrain market, a powerful advantage that should allow us to provide a differentiated offering and service levels to our customers, helping us grow. In 2023, we saw approximately $70 million of incremental sales from cross-marketing and the industrial powertrain subsystem solution which beat our expectations by roughly 10%. We also now have a meaningful presence in motion control with our AMC segment representing roughly 25% of our pro forma sales which has highly attractive secular growth characteristics, exceptional product and technology differentiation and provides a platform to support strong organic and inorganic growth opportunities.
In short, we are proud of all that we have achieved in the past year, but more importantly, extremely excited about our future prospects. Helping drive this progress and poised to execute so much value creation in 2024 and beyond is our dedicated global team of Regal Rexnord Associates. For their hard work and disciplined execution, I want to thank them for a strong fourth quarter, which capped off a very positive 2023. Turning back to our fourth quarter performance. Sales in the quarter were up 29.2%, but down 6.9% on a pro forma organic basis as we continue to see destock headwinds and weaker end market demand, particularly in our PES segment and in our factory automation business within AMC. Orders in the quarter were down 6% on an organic daily basis.
And while January was off to a somewhat stronger start, we expect first quarter orders to be down at a mid-single-digit rate versus prior year. Despite fourth quarter top margins in the quarter were strong. Our adjusted gross margin came in at 35.7%, reflecting synergy gains, 80/20 lean actions as well as some favorable segment mix. Our adjusted EBITDA came in at $346.5 million. This translates to roughly a $1.4 billion annual run rate and highlights how we have built scale and scope into what we believe is a sustainable competitive advantage. Adjusted EBITDA margin of 21.5% was up 40 basis points versus the prior year on a pro forma basis. That translates to a deleverage rate of 14.6% solid performance by our team. Lastly, what I believe was the key highlight of the quarter we delivered $171 million of free cash flow resulting in $683 million for the year, aided by overdriving working capital improvements, in addition to the strong operational execution sharing.
We paid down $117 million of debt in the quarter, and our net debt fell by over $153 million. We remain laser-focused on paying down our debt, and I believe we can be close to 3x levered at the end of 2024. Strong free cash flow is a fundamental attribute of our Regal Rexnord portfolio. It long has been, and we are accelerating it. With this strong free cash flow, we anticipate substantial value creation tied to capital deployment for many years to come. Shifting focus, you may recall that each quarter, I’ve been spending a few minutes introducing our principal AMC businesses to help investors better appreciate how we are well positioned to accelerate profitable growth. This quarter, I would like to spend a couple of minutes discussing Micro Motion, where we make small, ultra high-performance motors, controllers and encoders primarily for the medical, aerospace and industrial markets.
Our Micro Motion division grew 22% in 2023, and roughly 15 points of that growth can be directly tied to share gains supported by a robust pipeline of new products and improved service levels. This is important because it reinforces the success that comes from being part of Regal Rexnord. This division had relatively flat sales for more than 5 years, mainly due to operational obstacles. We rigorously applied the Regal Rexnord business system, address capacity constraints and improve service levels since the acquisition, which allowed the Micro Motion team to work down a significant backlog. Service levels that had once restrained growth have now become a competitive advantage and are helping the business take share. In addition, as part of our Regal Rexnord business system, we have been investing in this business.
And in one – only a few quarters, we accelerated key product launches and built a solid organic growth funnel to drive long-term growth. The division’s markets are also well positioned to benefit from strong secular growth tailwinds tied to increased access to medical care, transition to battery-powered equipment and making air travel more sustainable. In addition to leveraging our Micro Motion division’s long-standing technology leadership and deep application expertise, we have been making meaningful investments in R&D to significantly raise our new product vitality as our growth in outgrowth metrics demonstrate, we have solid momentum. Some examples of the innovations driving these results are pictured along the bottom of this slide.
Starting on the left, our products for new medical injector pens, devices used for injecting medication under the skin. We have started providing customers with a complete drive subsystem solution, which includes a micro motor encoder, gearing and lead screw. Providing this solution makes assembling these pins easier for our customers while also helping to optimize their performance. Arthroscopic shavers are highly engineered surgical tools used to perform arthroscopic surgeries by cleaning and removing soft tissues between bone joints. Our durable high precision motor at the heart of this device has doubled the product life as compared to competing products. The Bone Mill application contains our micro motor developed for a customer that wanted to shift from a manual to an automated advice.
This required a precisely controlled power output range and an ability to withstand autoclaving, a combination of attic that our competitors were not able to provide. This is a great example where our application expertise, plus our broader high-precision motor and controls technology resulted in a highly value-add and differentiated product. Lastly, battery torque wrenches are used in industrial applications where a precise application of torque is critical. Our next-generation solution is a micro motor that meets all standard performance criteria, but is also 50% faster, 15% lighter, 5% smaller and 20% more energy efficient than the next leading competitor. So stepping back, when I consider this division’s robust new product pipeline and the progress we have made on operational excellence and service levels, I see a business well positioned for strong and accelerating our growth with confidence that we will grow at high single digits or better for the next few years.
With that said, I will now turn the call over to Rob to take you through our fourth quarter segment financial performance and discuss our 2024 guidance.
Rob Rehard: Thanks Louis and good morning everyone. I’d also like to thank our global team for their hard work right up to year-end to deliver a strong close to 2023, while continuing to drive the many initiatives we have underway to accelerate profitable growth. Now let’s review our operating performance by segment. Starting with Automation and Motion Control, or AMC, organic sales in the fourth quarter, pro forma for the Altra acquisition were down 3% to the prior year, reflecting strength in the aerospace, data center and medical markets, tempered by weakness in the global discrete automation and food and beverage markets. Notably, for the full year 2023, organic sales growth for the AMC segment is up 3.1% on a pro forma basis.
Adjusted EBITDA margin in the quarter was 24.8%, in line with our expectations and up 90 basis points versus the prior year period on a comparable pro forma basis. The margin performance reflects favorable price/cost, pockets of strength in mixed positive markets such as data center, aerospace and medical, along with synergy realization and good discretionary cost management. Orders in AMC on a pro forma organic basis were down just under 5% in the fourth quarter on a daily basis, a significant improvement versus recent quarters. For perspective, we expected orders to decline in the quarter versus prior year, driven by a couple of factors. One, as supply chain and lead times normalize we have been addressing customer demand by working down an elevated AMC backlog.
We made good progress on this front in the fourth quarter. Though AMC’s backlog still remains roughly 35% above normal, a factor we think bodes well for top line improvement as 2024 unfolds. Second, as anticipated when we reported third quarter, we continue to see softness in our short-cycle discrete factory automation business. While short-cycle automation orders stabilized in the quarter, which helped overall segment order rates, short cycle orders are still not growing, and we do not expect to see growth in short-cycle automation until later in 2024, consistent with our prior expectations. In January, book-to-bill tracked at roughly 1.14, with orders down approximately 5%. Turning to Industrial Powertrain Solutions or IPS. Pro forma organic sales in the fourth quarter were down 1.5% versus the prior year and slightly above our expectations.
Growth in the quarter mainly reflects strength in the aerospace energy markets, partly offset by weakness in alternative energy and the food and beverage markets. Adjusted EBITDA margin in the quarter for IPS was 24%, in line with our expectation and up 20 basis points versus the prior year on a pro forma basis. We are very pleased to see a nice sequential improvement, IPS’s adjusted EBITDA margins. Margin performance in the quarter reflects tailwinds from synergies, along with continued discretionary cost management. Net of headwinds from lower volumes, weaker mix and as anticipated last quarter, cost to maintain quality and service levels for our customers during a period of peak synergy-related footprint moves. Pro forma organic orders in IPS were down 1.9% in the fourth quarter on a daily basis.
In January, book-to-bill tracked at 1.16 and orders were up just over 1%. Turning to Power Efficiency Solutions or PES, organic sales in the fourth quarter were down 16% from the prior year, below our expectations. The shortfall in performance was driven almost entirely by continued channel destocking activity and weaker demand in the North America residential furnace market, which we attribute to warmer weather, higher-than-estimated channel inventories and weaker underlying demand. We expect furnish to remain a headwind in the first quarter. While weather appeared to have tracked more favorably in January, we think furnace destock pressure will remain, given channel inventories were quite elevated entering this year. The adjusted EBITDA margin in the quarter for PES was 18.1%, up 10 basis points versus the prior year period and in line with our expectations.
Key contributors to the PES margin performance were improved operational efficiencies net of lower volumes. We also continue to selectively deploy 80/20 across the business to move away from lower-margin business and focus the majority of resources on growing our most attractive Quad 1 business. As we reflect on 2023, we are very pleased with the disciplined execution of our PES team, which achieved relatively stable margins at a healthy high teens level despite sizable top line headwinds. Shifting to orders. Orders of PES for the fourth quarter were down just under 10% on a daily basis. Book-to-bill tracked at 1.2 in January and orders were up just over 3%. While it is encouraging to see this inflection in PES orders, it is still early, and therefore, we will remain conservative in our expectations until we see that the improved rates are sustainable.
On the following slide, we highlight some additional financial updates for your reference. Notably, on the right side of this page, you’ll see we ended the quarter with total debt of $6.38 billion, down $117 million and net debt of $5.7 billion down $153 million versus the end of the third quarter. Net debt to pro forma adjusted EBITDA, including synergies, is now 3.8, and our interest coverage ratio is approximately 3.4. Adjusted free cash flow in the quarter was very strong, coming in at $170.9 million and nicely above our expectations. For the year, we generated adjusted free cash flow of $683.1 million, nearly double the prior year level. Throughout the year, the teams continue to do a great job driving strong free cash flow performance, in particular, by lowering inventories, performance that has allowed us to make significant progress paying down our debt.
Moving to outlook. Since markets and destock dynamics remain volatile, and we are a fairly short cycle business, we set our initial 2024 outlook with incremental conservatism and so biased our 2024 growth rate assumptions towards reflecting current end market initiatives. As you can see on this slide, we are introducing guidance for 2024 adjusted earnings per share to be in a range of $9.75 to $10.55, which implies a midpoint value of $10.15. Underpinning the guidance midpoint is an assumption that revenue is down slightly to prior year to approximately $6.65 billion, and adjusted EBITDA margin is up just over 100 basis points versus the prior year to approximately 22%. Note that this guidance factors a full year of performance for the industrial motors and generators businesses, which we announced late last year that we are selling a transaction still on track to close in the first half of this year.
The table on the right hand side of this slide outlines these key guidance points, as well as the sales growth assumptions at the low and high end of our EPS range. Note that the primary difference between the low and high ends of our adjusted earnings guidance range is the assumption for top line performance which is also noted on this slide. For 2024, we also expect to generate at least $700 million of free cash flow. The combination of the cash flow we expect to generate this year plus anticipated net cash proceeds from selling the industrial businesses should also pay down most of our variable rate debt in 2024, which in turn, would lower our net debt to adjusted EBITDA ratio from 3.8 at the end of 2023 to approximately at the end of 2024.
Finally, at the bottom of the table, includes assumptions to help investors model below the line items. Once again, all of the modeling items factor a full year performance for the industrial motors and generators businesses. On this slide, we provide more specific expectations for our first quarter and full year performance by segment, on revenue and adjusted EBITDA margin. Note that the performance indicated for these metrics is on a year-over-year pro forma basis. For AMC, we anticipate a low to mid-single-digit sales decline in the first quarter, with margins up modestly. We expect modest growth in sales and margins for the year, implying incremental strength in the second half, mainly as our results in discrete automation are expected to improve.
Overall, we see continued strength in the data center, aerospace and medical markets within AMC, net of headwinds in factory automation and food and beverage. For IPS, we also expect a low to mid-single-digit sales decline in the first quarter and roughly flat margins. For the year, we expect sales to be down low single digits and for adjusted EBITDA margins to be up roughly 200 basis points. Broadly sluggish end markets, especially food and beverage and general industrial are expected to weigh on top line performance, while tailwinds from synergies, net of anticipated mix pressure and select growth investments should drive nice margin gains. For PES, we anticipate a low double-digit to low teens top line decline in the first quarter, largely tied to furnace destocking and weak underlying HVAC end markets.
Margins are expected to be up roughly 300 basis points versus the prior year to a level in the mid-teens, which is slightly below recent segment performance, mostly due to mix. For the year, we assume sales are flat and margins are up roughly 50 basis points. Within PES, we assume a low single-digit decline in the resi HVAC portion of the business on furnace destock and weak underlying end market demand, with first quarter down, second quarter up slightly and the back half up mid-single digits on the absence of destocking headwinds. We assume the commercial HVAC business is up slightly for the year, with growth in North America, but declines in Europe. Lastly, for Industrial, we expect a low double-digit top line decline in first quarter, but stable margins versus the comparable prior year period.
For the year, we expect low to mid-single-digit top line declines, However, we expect margins to be up slightly in the year. We assume ongoing cost actions and operational improvements will help improve margins, despite top line headwinds tied to destocking and weak global industrial end markets. Before turning the call over to the operator for questions, I’d like to acknowledge that while 2023 challenged us with often significant in market and destocking headwinds, I think our teams did a great job executing many permanent structural improvements to our business, ranging from significantly enhancing our cost structure by executing synergies, 80/20 and lean actions to managing the significant portfolio transformation we achieved by closing the Altra acquisition and announcing the sale of our industrial business.
As we look ahead to 2024, our teams remain excited about the opportunities in front of us, controllable opportunities to drive significant margin upside to meaningfully lower our leverage and to advance our organic growth initiatives, many of which are tied to a healthy pipeline of differentiated and often more environmentally friendly new products. And with that, operator, we are ready to take questions.
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