Regal Rexnord Corporation (RRX) Earnings Call Transcript & Summary

Everybody, My name is Mike Halloran, industry analyst here with Baird, and we're pleased to welcome the Regal Rexnord team with us today. Joining us today, Louis Pinkham, CEO; Rob Rehard, CFO. There's absolutely nothing to talk about -- so we're going to take our time -- no. We've got a lot to go through. He's going to give some remarks to start out with. If you have any questions, raise your hand or look at the cards in front of you, send an e-mail, and we'll make sure to weave the questions in as we go along. With that, Louis, floor is yours.

Great. Good morning, everyone. Happy to be here with you this morning. Thank you for your interest in Regal Rexnord. Some perfunctory slides, of course, an ugly slide and we jump right in. Hey, I'd like to start with a brief overview of Regal Rexnord for those in the room who are not as familiar or those on the webcast that are not as familiar. Over $5 billion in sales. We'll have 33% gross margins this year and 21% EBITDA. We have 4 segments, and we serve a diverse array of end markets, which are roughly evenly weighted between markets with early, mid- and late cycle exposures. By application, we're about 40% power transmission, 40% electronic motors and are moving, about 15% niche engineered products. And then we have a small but soon to be expanded automation portfolio. We compete on technology, often tied to improving energy efficiency, product quality, channel strength and service levels. The portfolio is also characterized by strong long-standing brands, a large installed base and a healthy degree of brake fix replacement sales. In the last few years, we have been on a transformation journey. Our success is, I believe, best summarized by our gross margin performance, up over 500 basis points in the last 3 years with a clear path to 37% by 2025. And now with the acquisition of Altra, which we announced last week, a clear path to 40%. A similar story is playing out with EBITDA. There are many drivers of this performance but a disciplined application of 80/20 and Lean are top of the list along with infusion of new talent, a more decentralized operating structure, more data-driven decision-making and the consistent cadence of performance reviews. Our transformation also extends into the realm of capital deployment, particularly M&A. We've executed a transformational merger with Rexnord's Process & Motion control business and a strategic bolt-on in the automation space with Arrowhead. For both deals, integration and synergy actions are ahead of schedule and above plan, which brings me to acquiring Altra, which we announced last week. My goal today is to drill down into the significant strategic relevance of this asset to Regal Rexnord, in particular, how it will help us grow. Altra is roughly $2 billion in sales, mid-30s gross margins, nearly 20% EBITDA, a solid business, roughly split 50-50 between power transmission and automation and specialty at a high level, adding PTT presents significant cost synergy opportunities plus sizable opportunities from cross-selling and enhancing our industrial power trade. A key growth driver for us. Adding A&S is less about cost synergies. Gross margins here are already nicely in the 40s. But about transforming our automation business in a way that opens up many new growth factors. We believe the revenue synergies with A&S will be substantial. As a reminder, we see $160 million of cost synergies from the transaction weighted to PTT and certain corporate costs. cross marketing sales synergies are expected to be substantial. And as we did with our merger with PMC, we plan to quantify them at an appropriate time after close. That said, let me give you a better sense of the revenue opportunity qualitatively. On this slide, we picture one of our key growth initiatives, selling the industrial powertrain. That is motors plus related power transmission components. These subsystems sit inside tens of thousands of industrial products and we can optimize them from an energy efficiency and performance while allowing our customers to pass the engineering responsibility on to Regal Rexnord. The merger with PMC gave us the critical mass to offer a highly value-added powertrain across a broader array of end markets. The addition of Altra, further enhances the offering, in particular, by adding brakes and clutches. We have a capability today in brakes, but it's quite narrow and this expands our offering as well as the other Altra power transmission products. But an even larger step change in growth potential for Regal Rexnord comes from adding A&S. So let me jump in here. The businesses comprise primarily of highly engineered products with proprietary technology and gross margins consistent with the description. There are 3 primary brands: Kollmorgen, Thomson and Portescap. Kollmorgen sells high-precision motion solutions, including server motors, electronic drives, motor controllers, precision linear actuators and related software. These products are used in advanced material handling, aerospace and electronics, factory automation, medical, semiconductor and robotic applications among others. Thomson provides bearings, guides, linear actuators and other highly engineered components that enable to support the transition of rotary motion to linear motion. These products are used in factory automation, medical material handling, food processing and other niche application. Portescap offers high efficiency miniature motors and motion control products used in medical, industrial power tool and general industrial equipment. What's critical is that A&S products often sit next to and interact with existing Regal Rexnord products, which tees up a range of new opportunities for us to drive growth. What you're looking at here is a bottling-rinsing line, which can be found inside a typical beverage manufacturing facility. And what is notable from the numerous product call-outs are a couple of things: first of all, a lot of Regal Rexnord content is sitting adjacent to Altra A&S content on the line. In this case, Portescap Precision Motors, Kollmorgen Motion Control servo motors and drives, and an automation suite and then Thomson Linear Motion subsystem. Second, is that the combination of Regal Rexnord and A&S gives us a critical mass of value-added content, making us much more relevant to our customers. The relevance leads to a different kind of relationship, one that gets us involved earlier in the design phase of the equipment or the line, a more collaborative relationship. We become a trusted adviser. That makes discussions with our customers more strategic. For example, how to improve quality and reliability, how to improve energy efficiency and OEE, how to advance productivity and lean initiatives. By raising the value we provide our customer relationships more stickier and ultimately allows us to drive further growth. And when I refer to the customer in this case, I'm talking about equipment or systems integrators who is designing the -- installing the line at a plant, the end customer or in this case, the beverage OEM who owns the equipment. So we're also broadening our customer relationships. Success with an end user can lead to component and subsystem specifications at other facilities. Success with machine OEMs and integrators can lead to a preferred standard for us on future projects. Of course, quality, reliability, service levels all still matter. But I hope this gives you a better sense of how the combination with Altra is not only compelling on the cost side, but it's truly 1 plus 1 equals 3, both from an organic growth perspective and from the higher gross margins that a company being a trusted adviser versus a component supplier. I'll conclude here, sharing some key metrics of where we think the enterprise can be in 2025 before and after Altra. Looking across the industrial space, I believe these are strong metrics, and I think when combined with our track record from the operational execution improvements and our M&A integration, it implies a highly attractive opportunity for our shareholders. Thanks.

Thanks for that, Louis. As a reminder, if you have any questions, just let me know, and we'll make sure we weave them into the conversation here. So let's start with the question I'm getting by far the most or at least the first question I get every call that we've had on this, and it's been a lot of interest, right? You're a smart guy. You've had a really good track record of building the company right. The Rexnord deal is a very strong deal. Why now? Why did this deal make sense now? What did you see that the market isn't necessarily understanding in the short term that required you to go out and be proactive on putting this transaction together today.

Yes, great, Mike, and I'm sure it's on a lot of individuals mind. We think about things from the standpoint of certainty and actionability. So certainty for us is, does it make sense? Does it make financial sense and strategic sense? The industrial logic is incredibly sound. Financially, 10% ROIC by year 5; accretive, year 1; double-digit accretive, year 2 and going forward; strong free cash flow generation opportunities. So the financial metrics make sense. We also did lots of sensitivity analyses. What happens if we do go into a slowdown, what happens if interest rates go higher. All of these things, the financial metrics still made sense for us. And then it goes to actionability. Bluntly, we wouldn't have been able to transact the deal a year ago. We wouldn't have been able to afford this deal a year ago. We knew that others were looking at this asset, we've been looking at this asset. We felt we have others that have called us and said, you take this half, and we'll take this half. I wanted the whole thing. I think it's going to make us stronger from a long-term strategy perspective, which is really why we decided to move when we did. The question is, could this be there at this price 6 months from now? I don't know. But what I can tell you is that financial metrics made sense today, and we felt we needed to move today.

So before we go on to the strategy side, maybe just talk about what that stress test was if you could give some people comfort on what that buffer looks like even if we do get some downside?

Do you want me take it?

Yes. Okay. So a couple of different stress tests that we did. We looked at it from both a rate perspective, as Louis mentioned, and the EBITDA perspective. We put a downside scenario of about 20% down EBITDA in next year or a year in the year following the close as well as moving the rates down 200, 300 basis points. And so 20% down EBITDA, ranging from 5% to 20%. And then the following year, another 5% to 20% on the EBITDA side, and there was never a scenario in which we modeled in which we could not service the debt. Certainly, some of the metrics are a little slower to realize when that happens. But given the strong cash flows of the business and that we still felt very comfortable that we could take this on. And even under those very extreme scenarios, of which we've never seen -- to that extent, that would be an Armageddon scenario, basically, but wanted to push the scenarios to that level to feel comfortable going into this.

So just to clarify, when you say bring rates down, you actually mean have rates expand?

That's what I mean.

Just making sure. Yes. So if we think about this strategically, if I'm going to be really simple about it, it's -- PTT is about what you can do with the existing portfolio as a group. A&S is about what you guys can do longer term and opens up new doors, right?

Yes.

So let's start for the first piece. Maybe talk about some of the structural things that you think you're going to be able to accomplish as a combined entity with these 3 scaled assets now and some subscale stuff, right, smaller stuff, like an Arrowhead, that you weren't going to be able to do before? So to talk about that revenue and then we'll dig into the cost a little bit.

Yes, a couple of things. First of all, I'll remind everyone that when we came out with the merger with PMC, we didn't provide any cross-sell synergies, but we came out at our Investor Day and said $30 million this year, $125 million year 4. We absolutely know that our go-to-market with our $2.5 billion MCS business that soon becomes $3.5 billion gives us the exposure to more OEMs, more end users and our success in year 1 around $30 million has been a cross-sell success. We believe on top of that, will become the industrial powertrain and being able to take a greater subsystem and solve our customers' problems. And so we feel really good that, that will lend very well with the PTT side. Let me add on top that the PTT side today has a 33% gross margin. The PTS of our -- side of our business, for those that you know us, PTS was the original power transmission business was 33% three years ago gross margin. We moved it to 38% when we merge with PMC over a 2-year period. Now it's over 40%. That's -- we know that playbook. We know how to make that happen. Then you bring automation and specialty products and those solutions. And you saw from that slide I showed earlier, and that was just one example of a process line that -- those -- the Kollmorgen in particular, the Kollmorgen and Thomson products are on the line with the Regal Rexnord product. And so we will be able to leverage our go-to-market because today, Altra goes to market with 6 divisions. I go to market with some scale that we believe will open the aperture for opportunities for them in a significant way. And like I said, their products tend to be more relevant to customers than ours. I love my industrial powertrain, but the linear actuator, the servomotors, that product set garners more interest from our customer base.

No, that makes sense. The cross-selling piece certainly understand and part of this actually dovetails with what we would have talked about at the Analyst Day with the sub-solution approach, the industrial drivetrain being maybe the biggest example you're giving. But -- this is a fragmented industry, right? You're going to be, by far, the most scaled asset player in this business. Maybe talk to how much of an opportunity set that is or how much that came into the calculus to be able to combine all these assets.

Yes. So it really didn't enter the calculus because we don't like to justify an acquisition on sales synergies. So the financial metrics wouldn't try that, but absolutely, we think it's a huge part of the opportunity here. And again, I think we've seen it this year and the momentum we're seeing around cross-selling, a component cross-sell -- but we have the hypothesis that we will do more and more partnering with design, with our customer base. And the A&S side will pull us into that more. And so yes, that -- this was not a decision made for today or even the next year. This is a decision for what Regal Rexnord can be in the future in 3 to 5 years, and we're really excited about that future.

So maybe break down some of the cost opportunities here. Obviously, Altra, publicly traded company, you're going to be able to remove the corporate side of things. But I don't know if everyone understands the network and how Altra runs and how that's different from how you run your network and what some of those opportunity sets might look like?

Sure. So you're spot on. There's about $30 million of corporate costs, and so that comes out pretty quickly. We did not model any cost synergies on the A&S side. Their gross margins are solid. That's not what we're looking to do. We're looking to drive growth there. The only across Altra synergies are indirect spend, which is a small part of the overall $160 million. And so the focus was on the PTT side. Absolutely, go to market. We go to market today as a one face to the marketplace. And we sell a portfolio of incredibly strong brand. Altra, on the other hand, goes with 6 independent divisions, less scale, less exposure. They may go into 1 OEM with 3 different sales leaders. And that's okay. We will learn this in time of how do we leverage our scale to help give them more exposure and to take advantage of this now $3.5 billion plus because when you add A&S on top of that, that sells to the same customers -- it's a pretty powerful sale.

That makes sense. And so just from a regulatory perspective, how much risk do you see -- how much overlap is there in the existing products might be worthwhile talking about how fragmented the industry is as a gating point just so people understand as well.

Yes. And that's exactly where I'm going to go. It's a highly fragmented marketplace. We will be a scale player, but we're not going to be a scale player in any 1 vertical or product offering. And so we feel pretty good about the regulatory approach, but we'll let the regulators make that full evaluation. We actually submitted our HSR filing this week. And so we'll let that go through in the normal practice. But yes, we're pretty comfortable.

So the functional overlap is well below 50%.

Yes.

Like 15% kind of range?

Yes, it's definitely well below.

Yes. So talk about bandwidth. That's obviously a concern that comes up. We've talked about it. I think -- we've given a very thoughtful answer about it, but I think the management bandwidth piece and ability to execute on 2 transformational acquisitions in 1.5 year span.

Yes. We really thought about this a lot. And the nice part about the PMC transaction is we had 6 months to plan and then we execute it. By December 31, 2021, we had our go-to-market defined, we merged that sales force and the marketing teams and the product management teams. We'll do the same thing here, by the way. And so my point is we can plan. Now 2023 for us, for Regal is very focused on the PMC footprint rationalization. We won't start any footprint rationalization with Altra until 2024. And that's a big part of the saving. So what happens is, I've got this very solid team. I have the leader of the team who reports to me was the President of the PTS business. He has a team of roughly 15 very capable, knowledgeable team members who've gone through an integration. So we're going to use the jokingly PMC 2.0 to approach PTT and that will be through '23, we will complete the footprint rationalization activity in PMC. And into '24, we'll start with the Altra events.

Does any of that overlap, right? I mean there's enough complementary products amongst those that does it change some of the footprint decisions you might do on the PMC side as you layer the Altra pieces in?

It's a great question. We have some thoughts on that. We haven't locked it down. We do not believe, though, that it will delay us in being able to drive PMC. If anything, it will accelerate us to be able to start PTT. But we don't think there's going to be a significant impact.

And just for clarification sake, the $160 million of Regal Rexnord merger synergies, the Altra $160 million is on top of that, correct?

That's right. So we raised our merger synergy to $150 to be clear, and then $160 million is the Altra and we like to set objectives that we can beat -- So our goal is to beat that $160 million.

Absolutely. So let's shift gears slightly and just talk about what the playbook looks like from your perspective, if we do see some slowing from an environment perspective. Now before the acquisition, there were a lot of levers you could pull. Legacy Regal, merged Regal, now you're laying on Altra, where there's other levers to pull. Is this a case where things slow, you're going to be able to accelerate this internally from your perspective? Or is the cadence going to be what it is because of the complexity of all the transactions?

Yes. I don't think there will be much of an acceleration opportunity. I do think we'll diverge from the macro just simply because of all those powerful levers. When you look at the business today though, from what it was 3 years ago, I mean it's completely different. And so we believe that we're about 1/3, 1/3, 1/3, early, mid, late cycle -- we expect early slowing or we don't expect -- we're starting to see early slow. Late is actually accelerating in some instances, aerospace and defense, alternative energy, power gen, these are markets that we like data centers. They're still quite strong. So we feel that we'll be able to weather that storm, but we'll run our normal playbook. We'll leverage our direct labor and indirect labor to the sales levels. We'll look to reduce our inventories. And in 2020, we delevered at about 2%. And on down sales of 10. And so I think we know how to operate, and we'll follow that same playbook.

And I think you talked about it in terms of the end markets of what they are, but we see 2, 3 points of relative outperformance because of all these growth initiatives.

Yes. Yes, that's a great question. We've been changing our business, and we've got 18 business units. Every business unit has a product in that technology road map. We are launching new products. Our vitality has doubled in the last 3 years, and we have a path to double it in the next 3 years. And so absolutely, we have already 2 fairly large program that give us confidence in saying next year, we'll be up 2% to 3% without market. Because of those and then add on all the other program. We talk about today, we want every business unit to have at least 1 single. If I have every business unit with 1 single, I'll have 5 or 6 home runs every year.

And that's a change, right? I mean if you -- before you took over -- there was a good R&D function, but I think it was a little more swing for defense mentality. I think you've repurposed it, add more voice of customer demand generation type thematics and you're starting to see that correct output.

Absolutely. Arguably, we have outgrown our markets in 2021 and 2022. No question. And with the decentralization of the organization, we're making decisions closer to the customer your point, voice of the customer, understanding their needs and solving their problems instead of doing it at a center of a $3 billion business. We're doing it at the customer in the $5-plus billion business and soon $7-plus billion.

So let's talk a couple of portfolio type things and cash generation. On the portfolio side, you've brought a segmentation, 80-20 approach, you're going to bring the Altra assets in, I guarantee you're going to take the same hard look at those assets. So a twofold question. When you look at your existing portfolio and you look at the future portfolio, what are the puts and takes you're thinking of what belongs with belongs with Altra -- I mean, Regal at long term versus maybe what's there today?

We've been pretty open about industrial -- is a tough segment. I think the team has done a phenomenal job, and I'm very proud of our team, and we've improved the performance there significantly, but we're a 5 or 6 player. Are we the best owner? I'm not sure. We're constantly looking at that portfolio. But now from an 80/20 perspective, and to the point of Altra, Altra doesn't drive with an 80/20 view. Altra drives with a similar view, and not -- I'm not being negative with this comment, but that all customers and all products are important. 80/20 is my A customers and my A products are important. This is something we brought to Regal Beloit, something we'll bring to Altra and feel really good about the impact it will have on their performance.

So should we think about cash flows here. Obviously, there's a lot of puts and takes on the $1.1 billion target in 2025 and the $1.4 billion in '26. Debt repayments can be the priority. Talk about how that cash generation, why that accelerates so much?

Yes. So the reason it accelerates so much over the -- we were already at $1 billion when we came out with -- at Investor Day. So just to be clear. And then there's another, hey, you'd say, well, that's only another $100 million that you're throwing on there. Well, there's a couple of reasons for that. One of the main reasons is because the cash tax rate because of the interest deduction limitation creates an environment where we're just not pulling as much cash. You're investing more CapEx to get some of the synergies pulled through that you'd like to see. But then the next year, things turn around for us, and we start to see significantly more cash generation coming through the business. There's also a real opportunity for us from the standpoint of trade working capital. We didn't model this in because of the supply chain environment that we're in at this time. But over the next 12 to 18 months, if the supply chain helps us out a little bit, we absolutely see a really nice source of cash coming in '23 and maybe '24, depending on when that kind of loosens up a little bit for us. So we have a nice opportunity there to -- that will help us certainly from a cash perspective and also get down -- pull our debt down below where we are currently modeling at the 3.9 at close. So that's kind of the way it progresses going forward.

Great. Well, unfortunately, we're out of time. Please join me in thanking the Regal team for their time today.