Regal Beloit Corporation (now Regal Rexnord) — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 29, 2019, compared with June 30, 2018. The filing identifies the registrant as Regal Beloit Corporation, not Regal Rexnord Corporation. Financial statements are unaudited and prepared under U.S. GAAP.
Business context
The company manufactures electric motors, electrical motion controls, power-generation products and power-transmission products through three segments: Commercial and Industrial Systems, Climate Solutions, and Power Transmission Solutions. Management cited positive order trends and continued to expect low-single-digit organic sales growth for full-year 2019.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $873.7 million | $959.7 million | $1,727.5 million | $1,838.5 million |
| Gross profit | $234.0 million | $247.4 million | $468.6 million | $482.3 million |
| Gross margin | 26.8% | 25.8% | 27.1% | 26.2% |
| Income from operations | $96.0 million | $99.6 million | $216.6 million | $187.8 million |
| Operating margin | 11.0% | 10.4% | 12.5% | 10.2% |
| Net income attributable to Regal Beloit | $66.6 million | $65.9 million | $152.5 million | $124.3 million |
| Diluted EPS | $1.55 | $1.50 | $3.54 | $2.81 |
| Operating cash flow | Not separately provided | Not separately provided | $130.6 million | $144.3 million |
Q2 sales declined 9.0%, while six-month sales declined 6.0%. Q2 net income attributable to the company increased modestly despite lower sales; six-month earnings benefited materially from divestiture gains and lower tax expense.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $291.3 million at June 29, 2019, compared with $248.6 million at December 29, 2018. Approximately $288.0 million was held by foreign subsidiaries.
- Working capital was $1,157.6 million and the current ratio was 2.8:1, versus $1,134.2 million and 2.7:1 at year-end 2018.
- Total debt was $1,223.3 million, including $786.0 million under the term facility, $400.0 million of senior notes and $38.0 million under the revolving facility. Debt declined from $1,307.1 million at December 29, 2018.
- The revolving facility had $461.6 million of available borrowing capacity, excluding $0.4 million of standby letters of credit. The company was in compliance with all debt covenants.
- Six-month financing cash flow was negative $172.3 million, including $84.6 million of net debt repayments, $24.0 million of dividends and $55.9 million of share repurchases.
- Capital expenditures were $56.2 million for the six months, compared with $40.5 million in the prior-year period.
Material changes versus the prior comparable period
- Sales and segment performance: Commercial and Industrial Systems sales fell 14.3% in Q2 and 11.4% for six months, primarily due to divestitures, foreign exchange and weakness in pool pump, China, commercial HVAC, power-generation and other end markets. Climate Solutions sales declined 3.4% in Q2 but gross profit increased 2.6%; six-month gross profit increased 6.5%. Power Transmission Solutions sales declined 4.4% in Q2 and 1.0% for six months.
- Sales bridge: Q2 sales reflected negative organic growth of 2.2%, negative foreign-currency translation of 1.5% and a 5.3% reduction from businesses divested or being exited. Six-month sales reflected negative organic growth of 1.6%, negative currency translation of 1.6%, a 4.6% divestiture/exit impact and a 1.8% contribution from the Nicotra Gebhardt acquisition.
- Margins: Consolidated gross margin improved to 26.8% in Q2 and 27.1% for six months, aided by productivity, simplification programs, pricing and mix. Operating margin improved for the six-month period despite lower revenue.
- Divestitures: Regal Drive Technologies was sold in January for proceeds of $119.4 million and a $39.4 million gain. Velvet Drive and CapCom were sold in April for combined proceeds of $18.8 million; the company recognized a $6.0 million net gain. Total six-month divestiture gains were $45.4 million.
- Cash flow comparison: Investing cash flow changed to positive $83.7 million from negative $201.1 million, primarily because of divestiture proceeds and the absence of the prior-year Nicotra Gebhardt acquisition. Operating cash flow declined $13.7 million despite higher net income.
- Lease accounting: Adoption of the new lease standard added $93.0 million of right-of-use assets and lease liabilities at December 30, 2018, without a material effect on net income or cash flow.
Guidance, outlook, risks and unusual items
- Management maintained expectations for low-single-digit organic sales growth for full-year 2019 and cited positive order trends. No specific revenue, EPS or cash-flow guidance range was provided.
- The Hermetic Climate business is being exited following a customer decision to wind down operations; completion was expected by the end of the third quarter of fiscal 2019. Six-month 2019 sales from the business were $18.4 million, versus $31.9 million in the prior-year period.
- Restructuring costs were $5.9 million for the six months, versus $3.2 million in the prior-year period. The company expected approximately $15.1 million of additional aggregate restructuring charges, including $6.5 million expected to be paid in fiscal 2019.
- The company recorded $10.0 million of impairment charges in the first quarter, largely related to businesses held for sale. These charges were partly offset by divestiture gains.
- Material risks include cyclical capital-goods demand, commodity and raw-material costs, tariffs and other trade policies, foreign exchange, global manufacturing and supply-chain disruptions, customer concentration, acquisition integration, debt repayment, product liability, warranty claims, litigation, cybersecurity, intellectual property and potential goodwill or intangible-asset impairments.
- A subsidiary faces numerous claims involving sub-fractional motors allegedly associated with fires in third-party ventilation units. The company has accrued for estimated incurred claims but stated that it cannot assure the claims or potential regulatory remedies will not materially affect the subsidiary.
- At June 29, 2019, fixed-rate debt was approximately $404.5 million and variable-rate debt was approximately $824.2 million. Management estimated that a hypothetical 10% change in the weighted-average borrowing rate would change annualized after-tax earnings by approximately $2.4 million.
Investor verification priorities
- Verify the company-name transition from Regal Beloit Corporation to Regal Rexnord and ensure comparisons use the correct legal entity and reporting period.
- Assess whether expected low-single-digit organic growth is achievable after separating organic performance from divestitures, exits, foreign exchange and acquisitions.
- Monitor Commercial and Industrial Systems demand, particularly power generation, commercial HVAC, pool pump, China and other weakened markets.
- Reconcile reported earnings and operating margin improvements for the $45.4 million of six-month divestiture gains and $10.0 million of impairments.
- Track restructuring spending, the Hermetic Climate exit and remaining businesses held for sale, including potential additional charges or lost revenue.
- Review debt amortization, floating-rate exposure, covenant headroom and the use of cash for debt repayment, dividends and repurchases.
- Evaluate the potential financial exposure from product-safety claims, litigation and regulatory actions involving the acquired subsidiary.