Business Context and Reporting Period
Regal Beloit Corporation, now Regal Rexnord, manufactures electric motors, electrical motion controls, power generation and power transmission products through four segments: Commercial Systems, Industrial Systems, Climate Solutions and Power Transmission Solutions. This unaudited Form 10-Q covers the three months ended March 28, 2020, compared with March 30, 2019.
COVID-19 began affecting operations in China early in the quarter and increasingly affected global demand, manufacturing and supply chains. The company classified itself as an essential business but reported certain facility closures and reduced production rates.
Key Financial Metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $734.2 million | $853.8 million | Down 14.0% |
| Gross profit | $203.3 million | $234.6 million | Down 13.3% |
| Gross margin | 27.7% | 27.5% | Up 20 basis points |
| Income from operations | $70.0 million | $120.6 million | Down 42.0% |
| Operating margin | 9.5% | 14.1% | Down 460 basis points |
| Net income | $46.7 million | $86.8 million | Down 46.2% |
| Net income attributable to Regal | $45.8 million | $85.9 million | Down 46.7% |
| Diluted EPS | $1.12 | $1.99 | Down 43.7% |
| Operating cash flow | $102.7 million | $18.3 million | Up $84.4 million |
| Capital expenditures | $10.9 million | $20.2 million | Down $9.3 million |
Reported operating income in Q1 2019 included a $41.2 million gain on divestiture of businesses. Q1 2020 included $1.5 million of asset impairments and $5.1 million of restructuring costs. The effective tax rate increased to 22.9% from 19.6%, primarily because China Hi-Technology incentives expired in 2019.
Segment Sales and Operating Results
| Segment | Q1 2020 Sales | Year-over-year sales change | Q1 2020 operating margin |
|---|---|---|---|
| Commercial Systems | $199.4 million | Down 17.7% | 6.3% |
| Industrial Systems | $129.6 million | Down 6.2% | (0.4)% |
| Climate Solutions | $210.1 million | Down 20.2% | 14.0% |
| Power Transmission Solutions | $195.1 million | Down 7.2% | 14.6% |
Management attributed the consolidated sales decline to negative organic sales of 9.8%, unfavorable foreign currency translation of 0.7% and a 3.5% decline from businesses divested or being exited. Lower volumes were partly offset by productivity improvements, cost savings and simplification programs.
Liquidity, Debt and Balance Sheet
- Cash and cash equivalents were $604.5 million at March 28, 2020, compared with $331.4 million at December 28, 2019. Approximately $427.4 million was held by foreign subsidiaries.
- Working capital was $1.254 billion and the current ratio was 3.2 to 1, compared with $1.047 billion and 2.9 to 1 at year-end 2019.
- Total debt was $1.365 billion at March 28, 2020, up from $1.138 billion at December 28, 2019. Debt consisted primarily of a $720.0 million term facility, $244.8 million drawn under the revolving facility and $400.0 million of senior notes.
- The company had $254.8 million of remaining revolver capacity at quarter-end and was in compliance with all debt covenants.
- On April 1, 2020, after quarter-end, the company borrowed the remaining $254.8 million, fully drawing the $500.0 million revolver. Management stated that cash and cash investments were approximately $862.0 million immediately after the draw.
- Senior notes include $230.0 million maturing July 14, 2021 and $170.0 million maturing July 14, 2023, with fixed rates ranging from approximately 4.8% to 5.1%.
Material Changes Versus the Prior Comparable Period
- Sales, operating income, net income and diluted EPS declined materially, principally because of COVID-19-related demand and production impacts and the absence of the prior-year divestiture gain.
- Gross margin modestly improved despite lower volume, reflecting productivity and simplification benefits.
- Operating cash flow increased substantially, primarily because inventory declined in Q1 2020 compared with an inventory build in Q1 2019.
- Financing cash flow changed from a $106.0 million use in Q1 2019 to a $188.7 million source in Q1 2020, reflecting increased borrowings. The company also repurchased $25.0 million of stock and paid $12.2 million of dividends.
- The company repurchased 315,072 shares at an average price of $79.38 during the quarter. The repurchase program was suspended after quarter-end.
- Accumulated other comprehensive loss increased to $326.1 million from $237.8 million, primarily due to foreign currency translation and hedge losses.
- Restructuring provisions increased to $5.1 million from $2.3 million. The company expects approximately $16.8 million of additional restructuring charges, including $5.9 million of employee termination costs and $10.9 million of facility-related costs.
Outlook, Commentary, Risks and Unusual Items
Management withdrew detailed near- and mid-term outlook guidance because COVID-19 created substantial uncertainty around demand, manufacturing capacity, supply chains and end markets. The company will resume providing a more detailed outlook as recovery trends become clearer.
- COVID-19 may reduce customer demand, disrupt suppliers and carriers, limit employee availability, delay collections and constrain manufacturing operations.
- Management implemented discretionary spending reductions, hiring deferrals, compensation reductions and global furloughs, and may make further permanent cost-structure changes.
- Goodwill at the global industrial motors reporting unit remained at risk of impairment; its excess fair value over carrying value was less than 10%. Further deterioration in market conditions or performance could result in material impairment charges.
- The company had $23.6 million of net hedging losses in accumulated other comprehensive income, including $19.2 million expected to be realized in earnings during the following 12 months.
- Variable-rate debt and LIBOR exposure create interest-rate and benchmark-transition risk. A hypothetical 10% change in the weighted average borrowing rate would change after-tax annualized earnings by approximately $2.2 million.
- Product-liability claims involving motors manufactured through 2004 remain outstanding. The company has accrued for incurred claims but cannot predict the outcome, potential regulatory actions or total costs, which could be significant.
- The CARES Act may provide payroll-tax deferral and employee-retention benefits; the company was still evaluating the Act’s full impact.
Important Facts for Investors to Verify
- Whether COVID-19-related demand, supply-chain and facility disruptions continued or worsened after March 28, 2020.
- The company’s ability to reduce debt after fully drawing the $500.0 million revolver and the impact of higher leverage and floating interest rates.
- Progress toward the expected $16.8 million of additional restructuring charges and associated savings.
- Potential goodwill impairment at the global industrial motors reporting unit and other reporting units sensitive to economic assumptions.
- The status and ultimate cost of legacy product-liability and regulatory claims.
- Whether and when the company resumes share repurchases, and how capital allocation priorities change under continued uncertainty.
- Future segment demand, particularly in commercial HVAC, climate solutions, oil and gas, power generation and other COVID-19-sensitive markets.