Regal Rexnord Corporation (RRX) Earnings Call Transcript & Summary

Welcome, everybody, to the second day of the Barclays Industrial Select Conference. My name is Trish Gorman. I work with Julian Mitchell on the U.S. multis team. With us today, we have Rob Cherry and Rob Rehard from Regal Beloit. Welcome, guys.

Thank you.

Thanks for inviting us.

Of course. So I guess to kick things off, if we could start with talking about Mr. Pinkham and his transition in as CEO. Maybe his initial assessments of the businesses and where they are within their 80/20 journey.

Sure. So first of all, thank you for having us out. We're pleased to be here. It's always a nice conference, so thank you. Louis has been very upfront about the 80/20 initiatives and where we want to go. We talked a lot about 80/20 over the past couple of quarters as we've rolled this out to our organization. The 80/20 initiative obviously takes different forms. There's the 80/20 side of rationalizing your customer base and ensuring that you're really focusing on those -- that top 20 of your customers and really treating them well. And then you're looking at the bottom right-hand quadrant and you're saying, "Hey, well, what are -- where are those customers where we're not making the margins that we should?" And you have choices on those customers in that lower quadrant, some of which could be that you're going to raise prices, you're going to look to work on your costs to ensure that you can get them to an acceptable margin level, or you can take those customers out of your mix. So that's part of 80/20. The other part of 80/20 is really on footprint rationalization and product rationalization, so -- or plant rationalization, if you will, rather than footprint. So Louis has really taken an active approach to consolidating plants, as we've talked about. We talked about that really in the third quarter -- second and third quarter calls, where we talked about 5 different plant closures that we were working through from a restructuring standpoint, a simplification standpoint. And that has resulted in about $17 million of savings as a result of those plant closures. The $17 million will come about -- 2/3 of that will come in the back half of 2020. And we'll probably get more into like the savings opportunities that we have and we've identified as we go through this -- today's discussion. But that's another side of simplification and 80/20 that Louis is really focused on. Now you asked about how we're viewing the businesses. So we really see that we have -- we've now re-segmented, as you know, into 4 segments. We -- essentially, what that means is that we split our Commercial and Industrial segment. The reason that we did that is because we really wanted to focus on each of the segments and drive accountability through our organization. And by splitting C&I, it really improves the transparency and the accountability throughout the organization. We decentralized the organization back in June time frame, and we talked about that a lot in the second and third quarter calls. But by re-segmenting and having Industrial and Commercial separate, with separate teams, separate P&Ls, there's really a true focus on driving that profitability and accountability through the organization. And it's something that we're very focused on. And we are really seeing the benefits of running the business in this decentralized model.

And I guess, as we think about that now, the Commercial versus Industrial, and Mr. Pinkham identified the bottom quartile as either fix or exit, I believe. So kind of how do you think about what businesses you choose to fix versus exit?

Well, at this time, we're not -- we did -- first of all, we did divest approximately $270 million of our sales over the last 18 months or so. We're not going to -- we're not ready at this time to put out a new target on divestitures, but we do have an upcoming Investor Day, which is really in about 10 days, March 3, in New York. So that's something that we will be talking about, and we'll be providing more color on at that time. But we really have a clear path on Commercial and Industrial in terms of improving those margins in those businesses. We talked about the fact that we have a path of 200 to 300 basis points of improvement in Industrial alone. And it's not coming from the top line. We're not relying on top line. In fact, 80/20 is something that's going to -- actually the pruning impact of 80/20 on the top line, will impact as we go forward in that business. It's really all about cost out. And we have a very good plan, a clear road map to getting that basis point improvement. So that's something that Louis is -- we've been very focused on. And there's other opportunities within the Industrial segment as well. We've got a very big initiative on product rationalization in terms of how we are simplifying our products to -- in the platform that we use. And so let me give you a little example there. So we have a -- we had motors within our Industrial segment that were very similar in nature, large motors that go down our production lines, and let's say, there were 4 different motors, it went down 4 lines or very close, but not quite exact. And they're going to have 4 different lines within a particular facility or a manufacturing production line, 4 different production lines. What we've done is we've consolidated that product line now through engineering to create one platform that runs through one line. So on the back end, you're getting the benefit of doing that because when you don't have to run 4 lines, you don't have a changeover, you don't have -- you can run one line. And on the front end, the branding side, all we have to do is paint that motor a different color, put a different label on it. And I mean it's amazing, the savings opportunity that we have there in that one initiative, which is a platform change for us on a very large industrial motor platform that we have. The other areas that we are focusing on are our supply chain. We use a term, best value country, or it's where our supply chain -- we have examples that we've talk about on calls, where we've moved the product line from, let's say, the U.S. into a facility in Mexico. And we're producing that product in Mexico. And when we go back and we do kind of a postmortem analysis on, well, how did everything go. We find that, "Well, wait, we didn't move all of the supply chain." We're still sourcing some of those materials from the U.S. as opposed to Mexico. And we weren't taking advantage of a lot of those opportunities that were still there, and we're now focusing on a lot of those as well. That's going to help drive some of that margin improvement. So there are many different pieces to this that provide that cost road map -- cost-out road map that's going to deliver that 200 to 300 basis point improvement over the next 12 to 18 months in Industrial alone.

That's awesome. And I guess so then just switching more to top line. In the fourth quarter, we had some challenging order trends. Industrial flat, and the other 2 were down, I believe, mid- to high single digits.

That's right.

So kind of from that, how should we be thinking about trends into the first quarter in terms of organic growth for the -- between the segments?

Well, one of the things we talked about in order rates as we exited the fourth and going into January, so we had visibility to January order rates. So we said that Climate was down in the low teens. We said that Industrial was down about 20%. And we said that Commercial was down slightly, and Industrial was relatively flat. So those are the order trends we saw coming into the first quarter in January, and we talked about that in our last call. The first quarter for Regal, as we talked about, will be challenged. One of the main reasons it's challenged is because of our Climate segment. We had a very -- it's like a record warm winter here -- not here but across primarily North America. And that warm weather is definitely having an impact on us in terms of -- in our Climate segment. In addition, we still have the FER pre-buy -- or the FER hangover coming into the first quarter from the fourth quarter. Now that's going -- that will end in the first quarter, but that certainly impacted us as well. So the first quarter, in particular, for Climate will be challenged. We do expect to see pressure there as we go through the first quarter, and then it should -- we also work against some pretty tough comps in the prior year. But that should go away as we go into the second quarter.

And then I guess thinking about the rest of the year, kind of where do you see growth coming from, what end markets? Or anywhere you can go see some volumes?

Yes. We do -- we're starting to see some traction in our power generation space within the Industrial segment. That is largely standby power. Data centers, if you will, are a large part of that piece of the business, that there was overcapacity for a while in that space. We're starting to see that end, and we're seeing some order rates pick up in power generation. Oil and gas will continue to be -- we don't see a real path to that trending up quite yet. But pool pump is starting to come back for us. That's pool pump in Commercial is roughly 20% or so of the Commercial segment. We're starting to see that pick back up for us a bit. It will still be challenged in the first quarter for Commercial but -- in the first half, but we're starting to see that activity pick up. Destocking in our Power Transmission segment has largely ended. We don't see destocking continuing in PTS, so we feel that we're at the bottom there. Now I told you that as we entered January, the PTS orders were down about 20% or so. It's not that there isn't a year-over-year headwind, but the destocking has ended. There are still challenges in that space, but we're starting to see that ramp up as well as we enter the year, and we should see that continue through the back half. Now FER will also be a pickup for us in the back half of the year. So we have certainly headwinds in the first half, but we'll see the FER trail off, and we'll get that benefit in the second half. That's a mix-up for us because you're going from standard motors to high-efficiency motors, which are higher-margin products. So that's another nice tailwind for us going into the second half of 2020.

Great. That's very helpful. And then I guess also on the fourth quarter call, you guys talked about some of the longer-term growth drivers, maybe efficiency trends within each of the segments. Can you just elaborate a little bit on those?

Sure. So the -- as we talked about the FER initiative, that longer-term trend towards higher-efficiency motors is one where we will continue see that benefit us as we go forward. But that's across the board. We're starting to see a shift toward this electrification, shift towards electrification, high energy -- sorry, high-efficiency motors is something that we're seeing in each of our motor businesses. We're -- we have new technology that we're introducing, that we've been talking about. For example, in our Climate segment, we have what we call -- it's a -- Snowy Owl, it's commercial refrigeration technology, where we are installing motors with IoT capabilities that are in the commercial refrigeration space in a grocery store, for example. And this technology has sensing capabilities where it can determine whether a motor goes down, if there's usually maybe 4 motors or so within a case -- a refrigeration case. And we are now starting to work with fairly large grocery store chains to install this technology within their grocery stores. And if a motor fails, then we have the capability to detect that through telemetry, and we monitor that, and we can replace it before it becomes a problem. Grocery stores operate on razor-thin margins. And so if they lose a case of a product in a refrigeration case, it's a big deal for them obviously when you're dealing with those kinds, types of margins. And therefore, we have a technology that can predict that. We can get ahead of it. If one motor fails, another one can pick up the refrigeration capabilities to make up for the other motor, that I said there were about 4 in a case. These are the types of things that we're doing, and these are the trends that we're seeing. And we have similar technologies in our other motor capabilities as well as our PTS space, where we can measure vibration and other things and be able to do more predictive analytics for our customers.

And then I guess, in terms of regulatory drivers, is there one in 2021 within pool efficiency?

There is. There is a new regulation in the pool pump space where all motors going forward will have to be energy-efficient, variable speed motors as opposed to single speed, so just higher-efficiency motor requirements in the pool pump space in 2021. And that's one of the nice regulations that's just coming out here, as you said. It's June of this year.

Next year.

Sorry, next year. Yes.

Okay. I guess kind of switching gears, as we think about free cash flow, you guys have been one of the few companies that we cover at least that's had consistently over 100% conversion in recent years. How sustainable is this? Kind of what's the right run rate you guys think about both in terms of free cash flow conversion and free cash flow margin?

So we've definitely had a great run rate. We have, over the last 7 years, consistently generated over 100% of adjusted net income, free cash flow. And so do we see -- think it's sustainable? Absolutely. We still have quite a bit of runway, by the way, on our trade working capital. We've made some great improvements in 2019 in trade working capital. We think we have at least 12 to 18 months left of runway. And when I say that, what I'm talking about is primarily inventory. 80/20, by the way, drives a lot of inventory benefit, SKU reductions, things like that, drive a lot of 80/20 benefit. Increased focus on inventory management is one where we've really taken a very -- we've renewed the entire organization in terms of their focus on inventory management and working capital in general. We're also looking at terms are -- in terms of DSO and DPO or AR and AP terms. And we've made some nice changes there as well. But inventory is a primary driver of a lot of that trade working capital improvement. Do I think it's sustainable going forward? Absolutely. We have a track record of it, and I don't think it's going anywhere.