Regal Rexnord Corporation — Q3 2022 Form 10-Q Summary
Business context and reporting period
Regal Rexnord is a global manufacturer of industrial powertrain solutions, power transmission components, electric motors, electronic controls, air-moving products and specialty electrical systems. The company reports four segments: Commercial Systems, Industrial Systems, Climate Solutions and Motion Control Solutions.
This unaudited Form 10-Q covers the three and nine months ended September 30, 2022, compared primarily with the three and nine months ended October 2, 2021. Beginning in 2022, the company changed to a December 31 calendar year-end and retrospectively changed certain inventory valuation from LIFO to FIFO.
Financial performance and key metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Net sales | $1,325.3 million | $892.7 million | $3,973.2 million | $2,593.7 million |
| Gross profit | $407.7 million | $268.1 million | $1,263.1 million | $775.6 million |
| Gross margin | 30.8% | 30.0% | 31.8% | 29.9% |
| Income from operations | $173.9 million | $120.9 million | $538.7 million | $337.6 million |
| Operating margin | 13.1% | 13.5% | 13.6% | 13.0% |
| Net income attributable to Regal Rexnord | $119.8 million | $79.8 million | $387.4 million | $233.1 million |
| Diluted EPS | $1.80 | $1.95 | $5.76 | $5.69 |
| Operating cash flow | Not separately provided | Not separately provided | $238.0 million | $258.1 million |
Q3 sales increased 48.5%, including 42.8% from acquisitions, 8.2% organic growth and a 2.5% foreign-currency headwind. Nine-month sales increased 53.2%, including 43.3% from acquisitions, 11.6% organic growth and a 1.8% foreign-currency headwind.
Gross profit benefited from acquisitions, pricing and cost-reduction actions, but was partly offset by material, freight and restructuring costs. Operating expenses increased substantially because of acquired businesses, higher wages and benefits, and increased intangible amortization.
- Liquidity: Cash and equivalents were $723.6 million at September 30, 2022, compared with $672.8 million at January 1, 2022. Working capital was $1,993.3 million and the current ratio was 2.9:1.
- Debt: Total debt was $2,195.9 million, including $600.0 million drawn on the revolving facility, $543.1 million under the Term Facility, $486.8 million under the Land Term Facility and $500.0 million of senior notes. Available revolving capacity was $399.8 million, net of $0.2 million of standby letters of credit.
- Cash flow and capital allocation: Nine-month operating cash flow was $238.0 million; capital expenditures were $54.6 million; acquisition spending was $35.0 million; dividends paid were $67.9 million; and share repurchases were $239.2 million.
- Taxes: The effective tax rate was 21.4% in Q3 and 21.9% for the nine-month period, versus 20.5% and 20.9%, respectively, in the comparable prior-year periods.
Material changes versus the prior comparable period
- The Rexnord Process & Motion Control business, acquired October 4, 2021, and Arrowhead Systems, acquired November 23, 2021, materially increased reported sales and earnings, particularly in Motion Control Solutions. Motion Control sales increased 185.5% in Q3 and 184.9% for the nine-month period.
- Organic growth was positive across all four segments in Q3, led by Industrial Systems at 14.7% and Commercial Systems at 11.5%. Climate Solutions growth slowed as market demand weakened.
- Climate Solutions gross profit declined 27.7% in Q3 and 7.0% for the nine-month period because of material and freight inflation, lower volumes and restructuring costs.
- Q3 gross margin improved to 30.8% from 30.0%, while operating margin declined to 13.1% from 13.5% because of higher operating expenses and acquisition-related amortization.
- Diluted Q3 EPS declined despite higher net income attributable to the company, primarily reflecting the substantially higher share count following the Rexnord transaction.
- Foreign currency translation generated an after-tax other comprehensive loss of $182.5 million in Q3 and $303.7 million for the nine-month period, materially reducing comprehensive income.
- Restructuring costs increased to $20.9 million in Q3 and $36.7 million for the nine-month period, compared with $2.2 million and $5.4 million, respectively, in the prior-year periods.
Guidance, outlook, commentary, risks and unusual items
Management continued to expect high-single-digit organic sales growth for 2022. The outlook included benefits from the Rexnord and Arrowhead acquisitions, price realization, new products and growth initiatives, partly offset by inflation, supply-chain disruption and foreign-currency headwinds.
Management expected cost inflation affecting labor, energy, freight, logistics and supplier components to continue throughout 2022. Current restructuring activities were expected to continue through 2023; the company expected approximately $12.0 million of additional restructuring charges during 2022 and anticipated further costs in future periods.
On October 26, 2022, after the reporting date, the company agreed to acquire Altra Industrial Motion Corp. for $62.00 per share, implying an enterprise value of approximately $4.95 billion. Financing commitments included approximately $5.5 billion of senior bridge loans and a potential backstop facility of approximately $2.03 billion. The company expects substantial additional debt, fees and financing costs and stated that it expects to seek permanent financing through bank debt and bonds.
The Altra transaction remains subject to shareholder, regulatory and other closing conditions. The company disclosed risks involving financing availability and terms, increased leverage, integration, realization of synergies, customer and employee retention, supply-chain disruption, commodity prices, interest rates, foreign exchange, cyclical markets, product liability, environmental and asbestos claims, cybersecurity and potential impairment of goodwill.
Contingencies include product-safety claims involving sub-fractional motors, environmental remediation at the Ellsworth Industrial Park Site, and asbestos-related litigation. The company has recorded estimated liabilities and expects applicable insurance and third-party indemnities to cover certain exposures, but stated that some outcomes and potential costs cannot be predicted and could be significant.
Important facts for investors to verify
- Whether the Altra transaction receives required shareholder and regulatory approvals and closes on the expected terms and timeline.
- The final financing structure, permanent debt terms, leverage, interest expense and covenant capacity following any Altra acquisition.
- Whether management achieves the stated high-single-digit organic growth outlook despite inflation, supply constraints, weakening demand and foreign-exchange pressure.
- The sustainability of pricing actions and gross margins, particularly in Climate Solutions.
- The amount and timing of restructuring, integration and transaction costs, including costs continuing through 2023.
- Cash conversion and working-capital trends, given the $428.5 million unfavorable change in operating assets and liabilities during the nine-month period.
- The ultimate exposure from product-safety, environmental and asbestos matters and the availability of related indemnification and insurance.
- The impact of acquisition-related amortization, foreign-currency losses and the increased share count on future EPS and comprehensive income.