Day and welcome to the Regal Rexnord Corporation fourth quarter 2021 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Robert Barry, Vice President of Investor Relations. Please go ahead.
Great. Thank you, operator. Good morning and welcome to Regal Rexnord's fourth quarter 2021 earnings conference call. Joining me today are Louis Pinkham, our Chief Executive Officer, and Rob Rehard, our Vice President and Chief Financial Officer. Before turning the call over to Louis, I would like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees, since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our SEC filings. On Slide 3, we state that we are presenting certain non-GAAP financial measures in this presentation.
We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods and in the same manner as management. Please read this slide for information regarding these non-GAAP financial measures, and please see the appendix for reconciliations of these measures to the most comparable measures in accordance with GAAP. Turning to Slide 4, let me briefly review the agenda for today's call. Louis Pinkham will lead off with his opening comments. Rob Rehard will then provide our fourth quarter financial results in detail and discuss updates to our 2022 guidance. We will then move to Q&A, after which Louis Pinkham will have some closing remarks. With that, I'll turn the call over to Louis Pinkham.
Great. Thanks, Rob, and good morning, everyone. Thanks for joining us to discuss our fourth quarter earnings and to get an update on our business. Thank you for your interest in Regal Rexnord. While the fourth quarter continued to present many challenges, in particular around inflation and supply chain disruptions, our Regal Rexnord team met these challenges head on and delivered solid results. In the quarter, Regal Rexnord posted robust 11% organic top-line growth, achieved positive price cost for the enterprise, exceeded the midpoint of our earnings per share target range, and delivered strong free cash flow. We closed the year with a balance sheet that is 1.3 times levered on a pro forma basis, which gives us lots of optionality around capital deployment.
Furthermore, with our fourth quarter orders up about 30% and up mid-20s% in January, we ended 2021 with a record backlog and as a result have a very healthy top-line potential in 2022. These strong results are the product of disciplined execution, strong adherence to 80/20 principles, price discipline, and targeted overmanagement of our toughest challenges, in particular supply chain consistency, logistics, and inflationary pressures. In one sign of our team's success navigating these challenges, I am extremely proud to share that Regal Rexnord was recently named Supplier of the Year by one of our large OEM customers. I believe the award reflects our strong service during a challenging time, which is fantastic.
What made me even more excited was our customer citing alignment on our values and in particular on our value of diversity, engagement, and inclusion, and on our value of innovation with purpose, creating products and solutions that are purposeful for our customer and through a consistent focus on improving energy efficiency, products and solutions that are purposeful for our planet. This news and our fourth quarter performance mark a consistent close to a year characterized by tremendous progress, transforming our business into a stronger performing, higher margin, faster growing, more cash generative, and higher return global enterprise. Before going any further, I wanna thank all of our Regal Rexnord associates around the world.
Our strong performance at its core is about our nearly 30,000 talented associates, their disciplined execution, leveraging their individual skills and diverse perspectives, always guided by our Regal Rexnord values to act with urgency to serve our customers and meet our financial commitments. Let's also not forget that during fourth quarter we closed a transformational merger with Rexnord's Process and Motion Controls business and completed the acquisition of Arrowhead Systems. While we are only one quarter in working jointly with PMC, now the Motion Control Solutions segment, and have owned Arrowhead for only a couple of months. I'm extremely pleased with the positive momentum we're already seeing behind our integration and synergy activities. In fact, as we've conducted monthly operating reviews with our new associates from PMC and Arrowhead, many have remarked that it feels like we've been operating as one Regal Rexnord team for many years.
This great cultural fit is the main reason I remain confident that synergies from these transactions can add materially to our future margin, free cash flow, and organic growth profile. As we have discussed before, the cornerstone of our MCS sales synergies are the significant benefits we see from being able to offer our customers an integrated industrial powertrain solution. That is, our motors plus the critical power transmission components that connect the motor to whatever it is powering. We believe this value proposition will become even more compelling as we leverage data collected from all the key powertrain components and use that data to optimize the system's performance through Perceptiv Intelligence. I'd like to provide a brief update on our continued progress pursuing powertrain opportunities.
Our engineering teams have been hard at work on how to optimize performance of the greatly expanded scope of powertrain solutions we are now able to provide by leveraging the legacy PTS and PMC portfolios in conjunction with our motors. This clearly will be a multi-year journey, but even so, we have already seen some accelerated advances. In parallel, our sales teams have been actively speaking with our customers about the benefits of procuring integrated powertrain solutions, and I'm excited about the number and quality of these conversations. To shed some light on what I'm referring to, this slide provides examples of powertrain solutions we are working on. All of these are active projects with actual customers and are in the development or quoting phase.
In each example, we have noted the principal components included in the solution, as well as some of the key benefits each can provide to our customer. You'll notice a diverse array of benefits, including energy efficiency, greater reliability, and optimized performance. As our powertrain efforts continue to advance, we'll keep you updated on our progress, including quantifying the revenue impact we expect to see from selling these solutions. Now, where we have been seeing more immediate merger-related benefits on the top line is in cross-selling activities, which are just getting started and are expected to ramp meaningfully as 2022 unfolds. We'll look to quantify these benefits as our efforts mature, but I think it's fair to say that from cross-selling alone, we'd expect sales of at least $10 million in the first year and at gross margins that are accretive to the enterprise.
Before I share some thoughts on our 2022 outlook, I'd like to make a couple high-level comments about the operating environment. As you know, we and many others have been confronting a host of inflation and supply chain challenges through most of 2021. On the whole, I believe we've been navigating through them as well as, and in some cases, a little better than our peers, which has helped us gain some share and likely also boosted our ability to manage price. However, as we close 2021, I would say these challenges intensified. Freight congestion at the ports was particularly acute in the fourth quarter. Freight inflation has stepped up meaningfully as well. Labor availability has become more of a challenge for some of our businesses, especially in the United States.
We believe a resurgence in COVID-19 cases with the highly transmissible Omicron variant has been a factor intensifying all of these headwinds. Now, the good news is an incredibly healthy demand environment, which you can see in our order rates and a healthy backlog. We feel good about top-line prospects. Very good, actually. In the last couple of months, our visibility has diminished around how quickly we'll be able to work down the backlog and around certain costs associated with serving this demand, most notably freight and labor, although we believe these peaked in fourth quarter of 2021. As a result, we decided to take a slightly more conservative approach when updating our 2022 guidance. At a high level, we're adjusting the top line to reflect our strong orders and record backlog while retaining some caution around supply chain constraints.
From a margin perspective, we're factoring some incremental pressure related to non-commodity inflation, in particular, labor and freight. With that, I'll turn it over to Rob.
Thanks, Louis, and good morning, everyone. As you heard, Regal Rexnord had very strong results in Q4, but the team is also navigating headwinds on a number of fronts. I'd also like to send my congrats to our global team for executing so well in this challenging environment. Now, let's discuss our results by segment, and then I'll discuss our guidance. As a reminder, having closed the merger with Rexnord PMC, we are now discussing segment operating performance on an adjusted EBITDA basis. We'll start with our Motion Control Solutions segment, or MCS, which beginning in the fourth quarter of 2021 reflects the combination of our legacy Power Transmission Solutions segment, or PTS, our newly acquired Arrowhead business, plus Rexnord PMC.
Organic sales for MCS in the fourth quarter were up 4.9% from the prior year on strength across most of our end markets, but with particularly healthy demand in the food and beverage, general industrial, and agriculture markets. In addition, the business had nice tailwinds from share gains. Partially offsetting these tailwinds was pressure from lapping large prior year project activity in the China wind energy market. Furthermore, and this can be said for all of our businesses, supply chain disruptions continue to impact our ability to deliver, resulting in increased backlog, but posing an additional headwind to the top line. Lastly, our 80/20-related pruning actions were approximately 130 basis points of top-line headwind in the quarter.
Adjusted EBITDA margin in the quarter for MCS was 24.5%, up 10 basis points compared to the prior year, with benefits from volume, price, and permanent restructuring actions largely offset by impacts from supply chain disruptions and inflation, including freight, labor, and materials. Orders in MCS for the quarter were up approximately 30% and were up at a mid-40s% rate in January, both on a daily basis. Turning now to Climate Solutions. Organic sales in the fourth quarter were up 18.4% from the prior year. The increase was driven by broad-based strength in almost all markets and with particular strength in North America residential HVAC markets, North America general industrial markets, and in EMEA. The business also continued to achieve nice market share gains.
In addition, price was a meaningful contributor to Climate top-line performance in the quarter, reflecting what is generally heightened price discipline for all Regal Rexnord, but also more specific, segment-specific tailwinds related to catching up on price under our two way material price formulas or MPS. As you may remember, dynamics related to MPS are most significant in our Climate segment. Finally, pruning actions were approximately 70 basis points of top line headwind in the quarter. The adjusted EBITDA margin in the quarter for Climate was 19.8%, down 130 basis points versus the prior year period. Factors impacting this margin include higher inflation, including freight, supply chain-related frictions, and negative mix.
While price cost was favorable in the quarter and helped to offset the continued impact of inflation, this dynamic was a drag on margins in Q4 and similar to what we've seen throughout the year. Orders in Climate for the fourth quarter were up high twenties% and up roughly 7% in January, both on a daily basis. We continue to have healthy backlog in Climate and messaging from our HVAC OEM customers remains very positive, with tailwinds from residential restock activity likely still mostly ahead of us. Turning to Commercial Systems. Organic sales in the fourth quarter were up 13% from the prior year. Growth in the quarter reflects strong performance in large commercial HVAC, and North America general industrial markets. We're also confident that our commercial business is achieving share gains in North America general industrial market, aided by some of our digital investments.
Notably, pricing was a meaningful contributor to top-line performance in the quarter. While volumes were impacted by supply chain disruptions, specifically logistics challenges that intensified as the quarter progressed and ended up being worse than we expected. These pressures have bled into the first quarter, but we're continuing to work with urgency to identify and implement countermeasures. To close out our top-line discussion for Commercial, 80/20 related pruning was a 180 basis point sales headwind in the quarter. The adjusted EBITDA margin in the fourth quarter for Commercial Systems was 11.1%, down 320 basis points compared to the prior year. Despite a healthy top line, headwinds from inflation, mix, and supply chain disruptions drove a net year-over-year margin decline.
When assessing Commercial's margin performance this quarter, it's important to understand that our Commercial segment has experienced a disproportionate negative impact from supply chain and logistics headwinds. This is due partly to the segment's above-average exposure to seaborne freight compared to our other segments. Not only has seaborne container inflation become particularly acute, but mounting disruptions across our Commercial segment supply chain have led us to book containers with shorter lead times at elevated spot rates, which has further raised our costs. If there's a silver lining here, it's that much of this margin pressure is timing related, and we believe this dynamic should become less severe as supply chain frictions ease, enabling backlog reduction and shorter lead times between when products are shipped and when they are delivered, which will likely occur over the next couple of quarters.
Actually, we're already seeing some improvement in January. Shifting to orders, the demand environment for commercial remains very healthy, with segment orders for the fourth quarter up mid-20s and January orders up approximately 8%, both on a daily basis. In industrial systems, organic sales in the fourth quarter were up 4.5% versus the prior year. Pruning actions during the quarter were approximately 320 basis points of top-line headwind. The adjusted EBITDA margin in the quarter for industrial was 8.9%, up 230 basis points versus the prior year period. Although we feel good about improved performance in industrial systems, especially due to the supply chain logistics challenges, it is important to note that this business will see some quarter-over-quarter lumpiness.
Orders in industrial for the quarter were up mid-20s% and were up at a low-teens percent rate in January, both on a daily basis. On the following slide, we highlight some key financial metrics for your review. A couple notable highlights. First, on the right side of this page, you'll see we ended the year with a net debt to EBITDA ratio of 1.8x, or 1.3x on a pro forma basis, and consistent with our prior expectations. Second, our free cash flow of $82.6 million, which resulted in a cash flow conversion rate of 289% or 118.1% for the full year 2021. Finally, we purchased 20 million of our shares in the fourth quarter.
We have $434 million remaining on our $500 million share purchase authorization. Now moving to the outlook. We are raising our expectation for adjusted earnings per share to a range of $10-$10.60 from our prior range of $9.95-$10.35. The range assumes a mid- to high single-digit revenue growth rate, including a headwind from roughly two points of pruning. Currency is expected to be a very modest headwind to sales. In thinking about where to set our top line growth forecast, we tried to balance the competing dynamics of a very strong demand environment, evident in our strong order rates and a record backlog with supply chain frictions that remain severe and in some cases have worsened, plus labor availability challenges at some of our U.S. locations.
In addition, some of our plants and certain facilities at our suppliers have seen significant spikes in absenteeism that we believe are related to the latest COVID-19 variant, which has weighed on our output. While we are cautiously optimistic that conditions related to COVID in the supply chain will improve as the year unfolds, current conditions make us believe it is prudent to err on the side of conservatism as we start the year. As a result, our outlook assumes we make only limited progress in 2022 towards working down our backlog. From a margin perspective, our revised outlook factors some incremental pressure on margins compared to our prior expectations. The principal drivers of this heightened pressure are significant non-commodity inflation, in particular in labor and freight, in addition to weaker absorption related to supply chain frictions.
We model these dynamics being particularly challenging in the first quarter, with moderate improvements assumed in subsequent quarters. Regarding commodity inflation, we have started to see some leveling in the prices of our principal commodities, steel, copper, and aluminum. While this is encouraging, we are not yet seeing prices decline, and our outlook assumes only modest tailwinds from lower commodities in 2022. At the bottom of this page, we are providing modeling items that should help investors bridge from EBITDA down to net income and our adjusted earnings per share. While we are choosing to err on the side of caution here as we start the year, our confidence in this business remains extremely strong. We have line of sight to additional margin upside through our synergy efforts, disciplined cost-saving initiatives, and continued focus on 80/20 and lean.
We're gaining traction with our growth initiatives, especially our industrial powertrain cross-segment initiative. Our clean balance sheet plus strong cash flows create material upside from capital deployment. The future is certainly bright. With that, operator, we are now ready to take questions.
We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the key. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Mike Halloran with Baird. Please go ahead.
Good morning, gentlemen.
Good morning, Mike.
Let's talk about the guidance a little bit, just make sure I understand the moving pieces here. Obviously, the components of what are creating some sloping in the trajectory through the year make a lot of sense. Could you help frame how much pressure we're seeing in the first quarter or give some sort of sense for what the earnings cadence should look like this year versus a normal year? Also maybe give some context for how you're thinking about sequential revenue trends through the year versus a normal year.
Sure, Mike, this is Rob. First of all, we should see improving revenues, EBITDA, and margins in the first quarter. Absolutely. But to provide some more directional guidance, it might be best to look at how we see Q1 shaping up relative to the way we ended Q4, or maybe more of a sequential view. From a top-line perspective, we would expect some slight improvement in Q1 relative to Q4, and this applies to all of our segments. From an EBITDA margin perspective, I think it's best to actually talk to that by segment. First in Commercial, we'd expect margins to return to rates that we saw maybe in the first three quarters of 2021 or just north of 15%.
This is partially tied to some slight improvement in supply chain logistics, especially at the ports, as well as the timing we discussed during the call. Now moving to industrial, we'd expect margins to approximate those that we saw in Q4, but possibly get a little closer to our full year exit rate for industrial. In climate, we would expect margins to move up slightly relative to Q4 as we address some of the electronic supply chain constraints that we talked about. Finally in MCS, we'd expect margins to improve also a bit from Q4 as we start to realize more of the synergy savings anticipated as the year progresses. When it comes to the sequential on the revenue side, certainly we'll see revenues progress as we move through the year.
Normally we're fairly flat in terms of revenues and that cadence as we go through the year. In this year in particular, the first quarter as some of those logistics and supply chain challenges start to ease, it'll be a little lower in the first than we may have seen historically, and then start to move up as we move through the subsequent quarters. Hopefully that helps.
No, no, that does help. On the HVAC side, in the pool side, a couple areas where maybe you have some tougher comps as you work through the year. Maybe just some thoughts on how you think about the stability or sustainability of the underlying demand there. It sounds like backlog orders are good. Sounds like the customer conversations are good. How do you think about sustainability of that and when you get to the back half of the year, are there volume pressures that could potentially materialize or are the indications consistent, positive growth there?
Yeah. Hey, Mike Halloran, this is Louis Pinkham. I'm gonna break that into the two pieces and first HVAC and you know realizing that residential HVAC makes up about 15% of Regal Rexnord and commercial about 10%. So let's talk about residential. You know all the near-term growth drivers are positive. And you certainly have probably tracked the OEMs as well that have come out and felt that end market demand is strong. We see it as well. Pricing is certainly gonna help also, especially as our material price formulas have caught up. And then lastly, I would say you know as we think about the restocking. We absolutely have felt some challenges in fourth quarter and even third quarter, especially with the electronic supply chain.
Some of the pressure we saw due to mix in Q4 should relieve itself over the next few quarters as that electronic supply chain balances out. I'll tell you, electronics is gonna continue to be a headwind all year long. With that said, you know, longer term for residential, you talked about the back half. We believe that there will continue to be strength. Strength in res and new construction will help here, as well as this just the reality that with COVID, there's still significant work from home activity.
Then lastly, I remind you that 2023 will see a new SEER rating uplift, which will be a benefit for Regal Rexnord, especially as we're the leader in variable frequency and variable speed drive motor technology. That's how I think about HVAC. We think HVAC 2022 is gonna be pretty solid. You know, pool, same for the most part. End user demand remains quite strong. However, we did see in fourth quarter, and we absolutely expected it as well, a bit of a slowdown, mostly because of supply chain disruptions and contractor availability. In fourth quarter of 2021, there was tough compares. Now longer term for 2022, we believe the demand profile is strong.
As you know, the 2021 July 2021 regulation that requires all 1.1 horsepower and above motors to be variable speed is a benefit to Regal Rexnord, if for no other reason than our pricing levels on those products are quite a bit higher than our standard motor offerings. All in all, we feel good about both HVAC and pool. I will make one other point on pool, though. Pool is only 3% of our sales. So you know, it doesn't have as much influence. Clearly, HVAC is a big part of our business.
Louis, could you just also touch on the commercial piece in there.
Yeah, sorry, I missed that. Thanks. Yeah, no, we see the commercial HVAC market strong this year, gaining momentum through the year. It definitely will be a tailwind for us, and we've seen it in the order rates as well, Mike, so it should be a strong commercial HVAC year for us.
Really helpful. Thanks for the color.
Sure.
The next question comes from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.
Hey, good morning, guys.
Good morning.
Good morning, Jeff.
Hey, you talked about the revenue, some of the early revenue synergies. That's great to hear. I think your comment seemed to suggest that the synergies were on track or ahead. I'm just trying to get a better sense. Is the part about it being ahead really just around these sales synergies coming faster, or is there anything, you know, from a cost standpoint that's different or better?
Jeff, this is Louis. I'll take that one. From a cost synergy standpoint, Jeff, I feel really confident that we're on track. It will be as we expected to exit year one at about a $70 million run rate. We feel good about all areas. The team is performing as expected. From a cross-selling synergies perspective, you know, we never came out with any guidance here, and we're not ready. We will likely, you know, towards later in the year to come out with a more specific objective. What I am seeing is really twofold. I'm really excited about the industrial powertrain and our early discussions with OEM in identifying opportunities.
This is where, you know, I really believe that the fact that we are really the only North American supplier of that total solution, and that we can optimize the operating capabilities of the individual components together because we, in some cases, better understand the application than our customers, and we certainly better know our product. Bringing it together allows for improved optimization, reliability, and energy efficiency, and that's a big driver. What I think the upside for us is the cross-selling opportunity. That has been a little bit more positive than we anticipated, certainly so early as well in the process.
This is simply, Jeff, the reality that, you know, there's significant overlap in distribution for the PTS and PMC, the former legacy businesses, but not on the OEM side, which was a big premise for this merger. It's absolutely a reality that we're now able to identify pull-through opportunities of the individual legacy business components to the others' customer base. That's where I'd say we're seeing a little bit of upside that I'm excited about.
Okay. That's great. I just wanted, you know, the order rate pretty helpful by segment. I thought what stood out is the MCS, you know, kind of acceleration into January, where the other ones may be normalized. I didn't know if that's, you know, has to do with comps or what's, you know, different about kind of that acceleration and the huge really order rates in January for MCS.
Yeah. I mean, this one's a pretty simple one. It's all around aerospace. We are seeing that market start to return. We're certainly getting orders. It's highly influencing the overall numbers, which, you know, we feel good about. We like the aerospace market. We think long term, it's a growth market. It certainly has been challenged with COVID over the last few years, but we think it's a good market to be in.
Okay. Thanks so much, guys.
You got it.
The next question comes from Nigel Coe with Wolfe Research. Please go ahead.
Thanks. Good morning, everyone.
Morning.
Good morning, Nigel.
Good morning. Just as an FYI, I dropped by your booth at AHR earlier this week, and the systems integration emphasis really came through, you know, the integration of the motors and powertrain really came through. That's what we're seeing.
Awesome.
Just wanted to touch a little bit, you know, on sort of the price cost dynamics here and in particular on the MPS within the climate business. I'm just wondering, are we still, you know, below water on those MPS and does that start to significantly improve through the first half of the year? Any more color on the improvements you expect to see in commercial from 4Q - 1Q? That's quite a big jump. Just curious what's driving that.
Yes. Nigel, let me take that. You know, from a climate perspective, you know, the MPS have basically caught up. Where we've had opportunities though is, we did see some mixed pressure in fourth quarter, and that's strictly from the standpoint of the electronic supply chain being fairly constrained. We absolutely left business on the table in the production lines that we could have shipped if the semiconductor supply chain was a bit more robust. We're feeling good going into Q1 that margins will improve slightly because of the supply chain kind of working itself out. Bluntly, it's going to take many quarters to work itself out, but better than fourth quarter.
From a commercial side, it's really as simple as saying that the log jam in the ports and the freight constraints had the impact on the margins. The inflation in freight was significant. If you pull out that inflation from freight out of Q4, we would have leveraged as we would have expected in Q4 in our commercial business in the mid-20s%. That's what we're expecting going into Q1 of 2022. We have absolute line of sight in that margin improvement in 2022.
Okay. That's great. My follow-on is, you know, you alluded to the mixed benefits from the SEER change at the end of this year. As we go to 15 SEER in the Southern states, can you maybe just, like, give us a bit more color in terms of what that does for your opportunity set, you know, in the residential markets? Is there a significant uplift in mix from that one SEER change?
Nigel, I apologize. It's my hearing, clearly. I'm not quite sure I understood your question. Could you please repeat it? Apologies.
Yeah. You mentioned, you know, the SEER change in residential HVAC is good news for Regal. Just looking for a bit more color there. You know, what does this, you know, kind of offer you in terms of mix, price point, et cetera?
Oh, okay. Sorry. I didn't hear SEER. That was the issue. You know, we're already starting working with the OEMs. Clearly, that development starts significantly in advance. We actually have a new product that's gonna be launched with one OEM in particular that will provide a nice margin step up to that 35% gross margin level that we like to see. You know, the SEER requirements one SEER level step up is expected in 2023. That drives more variable speed motor requirements. You know, from a margin mix perspective, that's a benefit for us. We aren't quite ready to quantify what all of that means for us yet, Nigel, but all in all, it should be positive tailwind.
That's great color. Thanks very much.
Thanks.
Sure.
Thank you.
The next question comes from Christopher Glynn with Oppenheimer. Please go ahead.
Thanks. Good morning.
Morning, Chris.
One clarification on backlog. I think your guidance said just partial backlog reduction expected this year. To what extent does that assume trend line orders are pretty sticky versus, you know, some correction against maybe some early loading of orders, in recent quarters?
You know, it's a great question, Chris, actually. We expect the trend line of orders to be pretty consistent through the year. Why? Because the supply chain will continue to be stressed, and the demand continues to be strong. You know, do I think the backlog is elevated a bit because our lead times have extended and therefore, I mean, simply MRP is just driving more order rates? I do, but we also believe that our lead times have started to see some decline in our lead time, and yet our order rates continue to be strong. Our expectation is order rates are strong throughout the year.
Okay, thanks. On the mid-40s January orders boost at MCS, is that pure pro forma organic orders period over period, or is there some acquired backlog aspect to that?
No, we try to do an apples-to-apples comparison on that. It is strength in orders and demand. You know, as I commented earlier, it's highly influenced by aerospace, but overall, we feel the demand profile in MCS continues to be strong. Although restocking did occur through 2021, we're still in the process of restocking in that market space. The January orders are solid for MCS.
Okay. That's organic pro forma of the three combined businesses?
Yes, that's correct.
Gotcha. Great. Just a clarification on free cash flow. You know, you historically have guided free cash flow to adjusted net income conversion. You've switched to GAAP net income for the conversion metric. There's a wide divergence between your GAAP and your ANI, obviously here. Just curious about that transition and guiding free cash flow.
Yeah. We're still expecting free cash flow, even if you were to make the adjustment on the free cash flow side, to exceed 100% for the year. You know, our calculation on that front, you know, of course, it, you know, we're excluding some of the one-time items there, and we're not adding back that amortization or SBC or stock-based comp like we would on the earnings side, still be above 100%.
Of adjusted net income?
Yes. That's right.
Great. Thank you.
You got it.
Great. Thank you.
The next question comes from Julian Mitchell with Barclays. Please go ahead.
Hi. Good morning.
Morning.
Morning. Maybe just the first question around that adjusted EBITDA margin. You know, just sort of explain kind of the main sort of puts and takes relative to that prior, you know, 21% comment. Where do you think we're looking at now for 2022 and the slope to get there? You know, it sounds like your Q1 EBITDA margins are up slightly perhaps year-on-year. Just wondered about the pace of that slope kind of picking up in terms of margin expansion over the balance of 2022?
Yeah. It's a great question. You know, the expectation is as you pointed out, certainly we're gonna see an uptick in margin in the first quarter, which I talked about here in the beginning. We would expect that to continue to pace as we largely tied to the synergy savings, along with the improvement in the supply chain that we're expecting as we go through the year. Now, supply chain improvement, we're not expecting much on that, quite frankly, through at least the first half of the year and maybe even third, fourth quarter. The synergy savings will absolutely be a pace change throughout the year from that first quarter and then pretty evenly paced as we march through the subsequent quarters.
Got it. Thank you. Then, when we're thinking about, you know, the sort of organic sales trajectory, and you talked about the mid-high single digit growth this year dialed in, maybe help us understand a couple of different factors in it. One is just, you know, how much of a sort of price tailwind there is in the revenue this year guided relative to what you'd seen in 2021, and then any particular segment by segment dispersion in terms of that revenue growth rate in 2022.
Let me take that. This is Louis. Good morning. You know, the way I would think about it is this way, for 2022, you know, we don't disclose price. From a perspective of start with expectation of growth, you know, 6%-9%, and go back and say, "Okay, we're still on an 80/20 journey." We do expect about 2% pruning in 2022. We're excited about the new products we've been working on, the industrial powertrain, as well as the cross-selling initiatives. We believe that that's a point, maybe a little even more. That would tell you that market price is about 7%-9%.
Of that, price is definitely a meaningful part of that 7%-9%, but again, we won't disclose a specific number at this point. I think the other thing I'd keep in mind is when you look at our backlog, there's probably even a little bit more upside to that. As Rob said earlier, in the way we're thinking about the supply chain, there's still pretty significant uncertainty. We don't expect significant improvement, certainly not through the first half, perhaps a little towards the end of the year. That's putting pressure on our ability to do even more. I believe the demand profile is strong and we're doing a nice job. Our teams are doing a very nice job of identifying new opportunities and growing through share as well as new product and commercial initiatives.
Great. The sort of segment, any sort of segment fleshing out maybe for sort of MCS.
By segment. Yeah. Good question. You know, I tell you the legacy Regal Beloit businesses other than MCS are all about the same, you know, mid-high single digits. Then MCS on a pro forma apples to apples basis, a little bit higher with the cross-selling initiatives that we're driving.
Great. Thank you.
The next question comes from Walter Liptak with Seaport Research Partners. Please go ahead.
Hey, guys. Thanks. Good morning.
Good morning.
wanted to ask about the synergies, and if you could just refresh us on the $70 million and, you know, what you still have to go get this year to get to that $70 million and then in 2023, the synergies.
$70 million run rate coming out of 2022. What do we have to go get to achieve that? At this point, you know, we talked about this broken down into three categories. The first category is the organizational changes. Coming out of 2021, we had executed on most of those. That's got going into Q1, starting a nice run rate. Indirect material savings is on track, and we feel good about that. Negotiating with suppliers feel good there. Direct material, yes, there's some customer approvals, supply chain negotiations still ongoing, but on track. The footprint rationalization is more weighted towards the end of next year in 2023, but all the planning is as we expected at this point.
We feel good about that $70 million coming out of 2022. Coming out of 2023, we're expecting $100 million. Much more weighted to the supply chain. Excuse me, much more weighted to the footprint rationalization activities. That's where those really start to accelerate in 2023. Planning feels really good though, Walt, so we're pretty confident on the cost side.
All right. Yeah, that sounds great. Thank you. As you're working on these synergies, the cash flow's gonna be coming through. I wonder if you could talk a little bit about the Arrowhead acquisition and how that integration is going and how is your appetite for doing other deals in 2022?
Sure. Arrowhead is going well. We've owned the business for a couple of months now. This was an opportunity for us to acquire into a space that's a growing space, probably at quite an accelerated rate. 18% CAGR over the last three years. We're forecasting 10%+ for us over the next few years in that business. It also gives us quite a few vectors for us to look at additional acceleration of growth. As we've talked about historically, our ModSort offering, which is well suited for the e-commerce space, which has grown significantly under our ownership over the last three years, will accelerate because of Arrowhead's competency in providing a subsystem and their control engineering competency. Synergistically, really just a nice fit for us.
From a disciplined capital allocation perspective, I can tell you our funnel's strong. I like what I see. I think there's opportunity. I'll tell you though, we will be disciplined. As we've talked about in the past, we will not overpay. It needs to be a business in a market that's growing above GDP, that has good gross margins, 35% + or a path to get there. Accretive first year. ROIC of 10% year three. Year five is highly strategic. We'll be disciplined financially, but it needs to strengthen our position. Like I said, I think the funnel's strong. We're actively talking about a number of opportunities. We won't shy away from an acquisition in 2022, but what I'll tell you is, my guess is, you won't see anything in the short run, but perhaps later in the year into 2023.
Okay, great. Thanks for all that color.
Sure.
The next question comes from Chris Dankert with Loop Capital. Please go ahead.
Hey, morning, guys. Thanks for taking the questions.
Good morning.
I guess fully appreciate you know taking a somewhat conservative tack at the guide here. Just trying to think out loud, if input and freight costs don't you know kind of ease as expected here, how quickly can we course correct and readjust and pass that pricing through? Is there a way to get ahead of it a little bit more quickly than in the past? Any comments on just the speed there?
Yeah. We are using in some instances, Chris, surcharges. Surcharges allows us to move faster than a normal, price list price increase. That has helped. I would tell you that the pressure we saw in fourth quarter, the inflation for sure was partially due to our supply chain constraints and the need to go to the spot market to confirm containers. By the way, the inflation in the spot market was up 125% in fourth quarter. A lot of which was driven by the big retail component of the end of the year and the Christmas holidays and even the Chinese New Year holiday.
We are better able to manage through that because of the reduction in supply chain constraints we're seeing coming into Q1. We feel better around the cost profile, but it's still inflated over 2021. Then, like I said, to be able to go for price, we definitely have used surcharges to help us address this accelerated inflation.
Got it. That's helpful. Very excited to hear more about the cross-selling synergies over time here. Is there also kind of a margin opportunity tied to that cross-selling since, you know, by definition, a lot of these are gonna be more system-based sales? Is that too optimistic a way to frame it?
The industrial powertrain, I would say absolutely, there's gonna be some margin opportunities, especially with the OEM, right? We typically have a little bit lower margins with OEMs and then have a little bit higher margins in the aftermarket. Because we're able to provide an optimal solution, it should be a mix up. From a cross-selling perspective, I would tell you it's not about the optimization piece, it's just simply about selling legacy Regal components into the PMC channel and the legacy PMC components into the Regal OEM channel. I don't believe there's a margin uplift there. There is for overall Regal Rexnord though, because of course, the MCS segment margins are about, you know, 500-600 basis points above our fleet average. From a mix perspective, that's a benefit for sure.
Got it. Thanks so much for that, and best of luck to you guys.
Thank you.
As a reminder, if you have a question, please press star then one to be joined into the queue. The next question comes from Joe Ritchie of Goldman Sachs. Please go ahead.
Thanks. Good morning, everyone.
Morning, Joe.
I guess my first question, you guys touched on the M&A, you know, piece of the capital allocation bucket for this year. I'm just curious, doesn't seem like you have much dialed in for buyback. I know you raised your authorization last quarter. How are you thinking about that toggle for 2022?
Yeah, Joe, this is Rob. Absolutely, we intend to remain balanced in our capital allocation, and that does absolutely include the optionality around buying back our shares, which we've done in the fourth quarter and is an option for us going forward. However, it isn't in any way embedded in our guidance at this time, but is absolutely an option for us, and that's the way we're thinking about it.
Got it. Okay, that's clear. I guess the question I know that you guys historically and you know have been reticent to give you know your pricing that's gonna come through this year, but I'm curious, when you think about all the puts and takes on price cost and you know the margins that you've given us for the first quarter and through the year, how do you see that relationship you know trending throughout most of 2022?
Yeah, Joe, this is Rob again. Hey, absolutely, price cost. We expect that to be positive as we move into 2022. It will be a carryover, at least a couple points there, into 2022. You know, we've been getting better at getting leverage on that price as we move through the year. We've been price cost at least neutral over 17 quarters now. We keep improving our ability to capture more price to cover off on that margin drag that we've seen in many of our businesses. Some businesses it's a little easier than others. We're absolutely seeing that improve, and we expect to see that improve throughout the year.
Therefore, you know, it's the cadence of that improvement will continue, and we'll see that in our margins each quarter moving forward. That would be the expectation. I'd also want to remind you that, you know, price cost is certainly one that we see as a positive. But we still have a lot of other inflation that's impacting our business, you know, such as labor and freight that we talked about today. Those are other areas where we do have surcharges, as Louis discussed just a few minutes ago, that are helping to offset some of that impact. Again, that is impacting our business and can drag a little bit on some of the improvements you might naturally expect with the carryover and additional price coming through this next year.
Hey, Joe, I'm gonna add one other comment and completely agree with everything Rob just said. The other piece to keep in mind, we are getting more mature every day around how we drive 80/20. 80/20 helps us know where we should be driving price versus where we should be driving more customers to A products to drive mix efficiency in our manufacturing facilities. On top of all of what Rob shared, 80/20 should continue to give us momentum through 2022.
Great. Thank you.
Great.
This concludes our question and answer session. I would like to turn the conference back over to Louis Pinkham, CEO, for any closing remarks.
Thank you, operator. Thanks to our investors and analysts for joining us today. As I consider 2022, there's a lot to be excited about, even with a challenging operating environment. We're starting the year with a record backlog. Our team is executing at a very high level, and we see growing revenue and margin tailwinds from our M&A synergies from further capitalizing on the benefits of 80/20 and as our lean initiatives keep maturing. All of which, in the coming years, are expected to drive significantly higher gross margins. This operating performance supports strong free cash flow and, along with our clean balance sheet, means sizable value creation upside from capital deployment. Frankly, as much progress as we've already made, I believe we're still in early innings of transforming our business. I look forward to sharing further updates in the future.
Thank you again for joining us today, and thank you for your interest in Regal Rexnord.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.