Regal Rexnord Corporation (RRX) Q4 2018 Earnings Report, Transcript and Summary

Good day and welcome to the Regal Beloit fourth quarter 2018 earnings conference call and webcast. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded. I will now like to turn the conference call over to Mr. Rob Cherry, Vice President of Business Development and Investor Relations. Mr. Cherry, the floor is yours, sir.

Thank you operator. Good morning and welcome to Regal Beloit's fourth quarter 2018 earnings conference call. Joining me today are Mark Gliebe, our Chairman and Chief Executive Officer, Jon Schlemmer, our Chief Operating Officer and Rob Rehard, our Vice President and Chief Financial Officer. Before turning the call over to Mark, 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 three, 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. Now, I will turn the call over to Mark.

Thanks Rob. Welcome everyone. Thank you for joining our fourth quarter call and thank you for your interest in Regal. We will follow our normal agenda. I will make a few opening comments, Rob Rehard will provide a financial update, Jon Schlemmer will provide color on markets, operations and the performance of our three segments. After that, I will reflect on our total year 2018 performance highlights and then we will move to Q&A. Regal delivered another solid performance in the fourth quarter with organic sales up 5.2%, adjusted operating margin up 80 basis points and adjusted earnings per share up 23%. At a segment level, in commercial & industrial, organic sales were up 1.3% with strength in a number of end-markets including power generation, oil and gas and commercial HVAC, offsetting weakness in Asia, particularly China. In the climate segment, organic sales were up a strong 9.4% with strength in North American residential HVAC, both OEM and aftermarket as well as commercial refrigeration, partially offset by weakness in international markets. Finally in the PTS segment, organic sales were up a strong 9% for this quarter with robust growth in distribution and oil and gas. From an operating profit perspective, the adjusted operating margin improved 80 basis points year-over-year. The operating margin benefited from volume, incremental price and variable cost productivity, but was held back by commodity inflation and tariffs. The resulted adjusted earnings per share was up 23% and was based on strong operational performance with no benefit coming from the 2018 tax reform. For the quarter, free cash flow to net income was 169%. In the quarter, we repurchased $49.5 million of our shares. The fourth quarter was the sixth quarter out of the last seven that we have repurchased shares. Additionally, we also announced the divestiture of a non-core engineered drives business which we closed down in January. Overall, it was a strong close to a record year with strong organic sales growth and further progress on our march to improve operating margins. Looking forward, as we enter the new year, overall we expect continued growth in 2019 despite the tougher year-over-year comparisons. For 2019, our guidance assumes total year organic growth to be up low to mid single digits. We expect to carry the price benefits from our 2018 increases into 2019. We expect our topline to benefit from continued growth in residential and light commercial HVAC end-markets and we expect to benefit from the upcoming FER energy efficiency regulation. We are planning for modest growth in North American commercial and industrial markets and we are planning for market headwinds in China and Europe. On margin performance, our manufacturing facilities are performing well and we continue to realize the benefits of our simplification initiative. Further, we are making the needed investments in our tariff mitigation programs to help offset the impact of tariffs. With these mitigation programs and the benefits of the pricing carryover, we expect to continue to offset tariffs and commodity inflation in 2019. Our total year adjusted earnings per share guidance for 2019 has been set at $6.15 to $6.55, up 6% at the midpoint of our guidance. When you account for the impact of our recent divestitures and exits, our earnings per share guidance for our ongoing business would result in a 10% increase in adjusted earnings per share at the midpoint. I will now turn it over to Rob.

Thank you Mark and good morning everyone. Sales in the fourth quarter 2018 were $881.7 million, up 7.4% from the prior year. Acquisitions contributed 3.9%. The business to be exited was a negative 0.4% and foreign currency was a negative 1.4% in the quarter. Therefore, organic sales increased a solid 5.2% from the prior year with all three segments contributing. Our adjusted operating margin in the fourth quarter was 10.7%. Our margin was up 80 basis points compared to prior year. Margins benefited from both volume growth and productivity improvements. Price cost was slightly positive in the quarter. Additionally, we incurred $10.8 million in LIFO expense, which impacted all three segments. For your reference, I have included a table at the bottom of the slide showing the LIFO expense or benefit by segment for the fourth quarter of 2018 and the fourth quarter of 2017. Overall, it was a solid quarter with strong organic sales growth and continued operating margin improvement. Our fourth quarter 2018 earnings per share reported on a GAAP basis were $1.28. There were a number of adjustments to GAAP EPS in the fourth quarter. The first adjustment was restructuring and related costs of $2.2 million or $0.04 per share. The second adjustment was a gain on the sale of assets of $2.2 million or $0.04 per share. The third adjustment was related to the business to be exited of $800,000 or $0.1 per share. The fourth adjustment was related to CEO transition costs of $3.8 million or $0.07 per share and the final adjustment was related to the impact of the new U.S. tax legislation of $3 million or $0.07 per share. Net of these adjustments, the adjusted earnings per share for the fourth quarter were $1.41, representing a 22.6% increase from the prior year. Now, I will summarize a few key financial metrics. Our capital expenditures were $18.4 million in the fourth quarter capital expenditures were $77.6 million for the full year 2018. Our simplification activities resulted in $2.2 million of restructuring and related costs in the fourth quarter. Restructuring and related costs were $7.7 million for the full year 2018. In the upper right quadrant, we show our effective tax rate information. The adjusted ETR in the fourth quarter was 21%. We are adjusting the ETR for the effect of the impact of the new U.S. tax legislation I mentioned on the prior slide. We have provided a table in the appendix of this presentation to reconcile the GAAP ETR to the adjusted ETR. Our adjusted ETR was 20.8% for the full year 2018. In the lower left quadrant, we present information on our fourth quarter 2018 balance sheet. Our total debt was $1,307 million and our net debt was $1,059 million. We finished the year with a net debt to adjusted EBITDA ratio of 2.0. In the lower right quadrant, we present information on our free cash flow. We generated $94 million of free cash flow in the fourth quarter, representing 169% of net income for the quarter. And lastly, we repurchased just over 645,000 of our shares for $49.5 million in the fourth quarter. Throughout 2018, we repurchased over 1.6 million of our shares for $127.8 million. Before I cover 2019 guidance, I would like to spend some time talking about a number of businesses we either have or will be divesting or exiting. You may have seen this reference in yesterday's earnings release. On the top half of this page, I have provided the five different non-core businesses that have been or expect to be divested or exited. The first is the residential hermetic motor parts business we disclosed in the second quarter of 2018. The second business is the engineered drives and controls business we announced at the end of 2018 and divested at the beginning of 2019. The final three businesses are other small non-core businesses that we have already or will be divesting or exiting early in 2019. On the bottom half of this page, I have provided a summary of the impact of these businesses to be divested and exited by segment. The results of these businesses are not included in our 2019 guidance. I would like to point out to all of our investors that additional details relates to these divestitures and exits are included in the appendix of this presentation. In these tables, we have included net sales and adjusted income from operations for each segment by quarter and for the full year as well as the impact on adjusted diluted earnings per share for the year, so you can clearly see the impact of these divestitures and exits on our ongoing business. Divesting or exiting non-core businesses is consistent with one of the key elements of our enterprise strategy, which is focusing on the core. Now, I will provide information on our full-year guidance for 2019. Our guidance assumes low to mid single digit organic sales growth for the full year. We are expecting continued improvement in our adjusted operating margin for the full-year 2019, making this the third consecutive year of improvement. We are expecting to see improvements in all three segments from volume leverage, continued simplification efforts and price. We are expecting free cash flow to exceed net income for the full year. Our full year 2019 GAAP EPS guidance is $6.59 to $6.99. On an adjusted EPS basis, our full year 2019 guidance is $6.15 to $6.55. The expected adjustments to convert the GAAP EPS to the adjusted EPS total $0.44 per share. The adjustments are restructuring and related costs of $10 million or $0.18 per share, a gain on the sale of assets related to the recent divestiture of the engineered drives and controls business of $40 million or $0.70 per share and CEO transition costs of $4.5 million or $0.08 per share. Also shown on this slide for your reference, are some key assumptions included in our 2019 guidance. In summary, at the midpoint of our guidance, our full-year adjusted EPS is expected to be up 6% over the prior year or 10% on a comparable basis after accounting for the impact of divestitures and exits included in the appendix of this presentation. Now, I will turn the call over to Jon.

Thanks Rob. Good morning everyone. Before I cover the normal updates on the segments, I would like to talk about the recent AHR Expo in Atlanta and the upcoming FER regulation. At the tradeshow, we had the opportunity to highlight our latest HVAC and refrigeration technologies to both our existing customers and potential new customers. Consistent with our enterprise strategy, there were three key innovation themes to our booth. The first theme of energy efficiency is all about the new products we have introduced to help our customers meet upcoming regulations. The most significant is the upcoming FER regulation for gas furnaces, which goes into effect in July of this year. We showcased an entire lineup of new products developed to help our customers meet the new rule. We continue to expect $40 million in annual incremental sales in our climate solutions segment as a result of the FER regulation. We are forecasting a meaningful impact in the second half of 2019. By 2020, we would expect to see the full impact of the incremental sales. The second theme is around IoT capabilities of our new products. We had many examples in our booth to show our customers. A great example is the Ensite motor and control, our entry-level product targeted for FER. This new product features near field communication which allows our OEM customers to easily program the product on their production lines reducing inventory and improving productivity. We also believe that this IoT feature can simplify the commissioning and troubleshooting of HVAC systems. We were excited that our new Ensite motor and control was recognized at the show by receiving the 2019 AHR Innovation Award. And finally, the third theme was all about our disruptive axial technology. This technology delivers improvements in reduced size, weight, noise and increased energy efficiency. Many of the new products displayed in our booth are utilizing axial technology. Last year, we experienced solid growth across the HVAC markets and we are excited about the growth our innovation efforts will deliver in 2019. Now, I will walk through each of the segments and give more details on organic sales and operating margin performance. In commercial and industrial systems, sales were $437 million with organic sales increasing 1.3% from prior year. We were facing a relatively difficult comparison in C&I as organic sales were up 8.8% in the fourth quarter of 2017. In the fourth quarter 2018, we experienced sales strength in oil and gas, power generation and commercial HVAC. Sales and distribution were relatively flat to the prior year. The strength was partially offset by weakness across Asia, particularly in China. Price improved sequentially and was up over prior year. Price cost continued to be slightly favorable in the fourth quarter, similar to our performance in the second and third quarter. We were pleased with the favorable price cost performance given additional cost headwinds we experienced from the tariffs and LIFO expense. Adjusted operating margin was 7.8% of sales, up 170 basis points from prior year. Productivity from our simplification programs and price had a positive impact on our margins. LIFO expense was a drag to margin in the quarter, but did help the year-over-year comparison. Inflation and tariff expense were headwinds. For the full year, organic sales grew 4.7% in our C&I segment and adjusted operating margin increased 80 basis points over prior year. Our margin improvement efforts for the C&I segment are on track and we expect to deliver another year of meaningful margin improvement in 2019. In climate solutions, adjusted sales were $223 million with organic sales increasing a strong 9.4% from prior year. In North America, sales in residential HVAC were up low double digits to prior year with strength with both our OEM and distribution customers. We also experienced sales strength in commercial refrigeration and water heating. Sales in Europe were up slightly over the prior year. The strength in North America was partially offset by headwinds in Asia and the Middle East. Price improved sequentially and was up over prior year. Price cost continued to be slightly favorable in the fourth quarter, similar to our performance in the second and third quarter. Adjusted operating margin was 15% of adjusted sales, down 30 basis points from prior year. Volume, productivity in our manufacturing operations, mix and price all had a positive impact on margins. The LIFO expense in the quarter, compared with the large LIFO benefit in the prior year, was a margin headwind and offset these benefits. For the full year in the climate segment, organic sales grew by 4.6% and in spite of the year-over-year increase in LIFO expense, adjusted operating margin was a strong 15.5%. We enter 2019 encouraged by the overall end-market demand and our ability to drive organic sales growth with our innovation efforts. Sales in power transmission solutions were $213 million with organic sales increasing a strong 9% from prior year. In the quarter, we experienced strength across a number of end-markets including distribution, oil and gas, marine and commercial HVAC. Similar to the third quarter, we saw weaker demand in agriculture. Price improved sequentially and was up over prior year. Price cost was favorable in the quarter. Adjusted operating margin was 11.9% of sales, down 30 basis points from the prior year. The higher volume, price and productivity in our manufacturing operations had a positive impact on margins. And similar to our climate business, the LIFO expense in the quarter, compared with a large LIFO benefit in the prior year, was a margin headwind and offset these benefits. For the full year, organic sales grew by 9.1% in the PTS segment and adjusted operating margin was 12.6%, up 120 basis points from the prior year. It was great progress in 2018 and we are expecting another year of sales growth and margin improvement in our PTS business in 2019. Before I turn the call back over to Mark, I would like to reflect on the three-year financial commitments that we made at our Investor Day meeting in March of 2017. The metrics in purple are the targets that we committed to deliver by 2019. In green, we show the progress that we have made through the first two years of 2017 and 2018. In the first two years, we delivered an organic sales compound annual growth rate of 5.2%, higher than our target. We have experienced strength in many of the end-markets and the investments we are making to grow organic sales are paying off. Over the past two years, we have increased adjusted operating margin by 130 basis points and return on invested capital by 180 basis points. During this time period, we were faced with significant inflation from both the commodities and freight and we also had to deal with the increased tariff expenses in 2018. We were able to overcome these headwinds and deliver meaningful improvement in profitability. And finally, free cash flow to net income exceeded 100% in each of the past two years coming in at 112% through the two year period. We have made significant progress on all four metrics through the first two years. We expect further progress in 2019 and the targets remain in sight. We are confident that the three elements of our enterprise strategy are key to delivering these results, focus on the core, innovate to grow and simplification. I will now turn the call back over to Mark.

Thanks Jon. Now before we go to Q&A, I would like to briefly reflect on our 2018 total year results. 2018 was a record year in both sales and adjusted earnings. Organic sales were up 5.7% and adjusted operating margins increased 60 basis points versus the prior year in spite of the significant commodity and tariff headwinds. Adjusted earnings per share increased 23% with most of the benefit coming from operations versus tax reform. And for the eighth consecutive year, we finished with free cash flow to net income greater than 100%. This year's free cash flow to net income was 116%. In 2018, we made a strategic acquisition of Nicotra Gebhardt to strengthen our position in the commercial air moving space. We repurchased roughly $128 million of our shares. And we reduced our net debt to adjusted EBITDA to 2.0. Over the last six months, we have put plans in place to exit or divested five non-core businesses with annual revenues totaling roughly $200 million. This will allow our management team to focus on and reinvest back in our core operations. Further, we have a healthy pipeline of potential core-related acquisition targets. Finally, Jon laid out the three-year performance targets we communicated at the March 2017 Investor Day, organic growth, operating margin, return on invested capital and free cash flow to net income. We are pleased that in both 2017 and 2018, we made meaningful progress on all four metrics and we believe that with our expected 2019 performance, the target range is still in sight. As we close 2018, we expect that the 2018 momentum will continue into 2019. Our 2019 guidance reflects low to mid single digit organic growth, a third consecutive year of margin improvement and a resulting 6% increase in adjusted earnings per share at the center point of our guidance. When you account for the impact of our recent divestitures and exits, our EPS guidance for our ongoing business would result in a 10% increase in adjusted earnings per share at the midpoint. To cap off a great year, Regal recently published its first-ever sustainability report. You can find it on a website. A few years ago, we restated our Regal purpose to recreate a better tomorrow by efficiently converting power into motion. Today, our Regal employees live this purpose and our sustainability report tells our story. We talk about Regal handprint, which represents the products we make and the positive impact they have on our environment by saving enormous amounts of energy. And we talk about the Regal footprint, which represent our efforts to reduce the waste we leave behind as well as the natural resources we consume to produce our products. Every year, we strive to increase the impact of our handprint and decrease the impact of our footprint. From the products we make the way we make them, our purpose is to create a better tomorrow for everyone. We believe sustainability is yet another element of the long-term value we deliver to shareholders. And finally, before we go to Q&A, I would like to briefly update you on our CEO transition. Our original transition plan remains intact. I will be retiring and stepping down as Regal's CEO once the new CEO is onboard. A committee comprised of members of Regal's Board of Directors is leading the search and we expect the new CEO to be in place sometime in the second quarter. I will continue to lead the company until that time and I will remain as an advisor for a short period after the new CEO is in place to assure an orderly transition. The Regal organization has responded very well to this transition and all of our energy is focused on delivering for our stakeholders. We will now take your questions.

[Operator Instructions]. The first question we will have will come from Joe Ritchie of Goldman Sachs. Please go ahead.

Hi. Good morning guys. This is Ashish Gupta, on for Joe.

Good morning.

So nice quarter and your guidance seems very reasonable. I guess just to start off, could you maybe talk about the differences in outlook between the three segments as we head into 2019? And maybe specifically also address the performance in climate in the quarter and whether there was some pre-buy associated with the regulation change?

Okay. I will take a pass at those questions and I am sure Jon will jump in. In terms of our guidance between the three segments, when we think about the commercial and industrial segment and the PTS segment, kind of serving many of the same end-markets and we are expecting low to mid single digit growth across those markets. The commercial and industrial business will have more of a headwind out of China and out of Europe. And then when it comes our climate segment, as we commented, we are expecting some lift in the back half of the year as a result of the FER law. As that law changes over, we expect some improvement there. And then relative to whether or not we saw any lift in the quarter as a result of FER, I think that was your second question, we don't believe there was any impact from FER as a pre-build in the fourth quarter. Jon, did I miss anything?

No. I would just add though that while we don't think there was an impact in the fourth quarter from FER, our customers are actively now talking about their needs for any potential pre-build. We are still pulling that all together. Our current assumption is that there will be a nominal pre-build in 2019 impacting the first half in the range of $3 million to $5 million and that's been factored into our guidance.

Topline, $3 million to $5 million on the topline.

Got it. Thank you. And maybe as a follow-up, I noticed that your guidance for 2019 doesn't include any impact of buybacks. So just curious on how you are thinking about capital allocation next year given the strong free cash and the cash that you will get from the asset sales?

Thanks Joe. Yes, you are right. We do not include any buyback assumption in our 2019 guidance. So as we think about capital allocation, we will continue to have a balanced approach. Looking at buybacks as an alternative. Obviously M&A, as I mentioned, we do have a healthy pipeline of targets that we are considering. And we will also look at debt paydown.

Got it. Thanks guys. Congrats on a good quarter.

Thank you.

And next we will have Scott Graham of BMO Capital Markets.

Yes. Hi. Good morning and very nice quarter, gents.

Thank you.

The couple of questions I have were really very end-market specific because I know, for example, you have a lot of your oil and gas in the upstream. And I am just kind of wondering what you are hearing, seeing order rate wise in that market, given some of the disruptive forces on the price of oil and some of these large upstream guys cutting back a little bit 2019? Can you just sketch that for us a little bit?

Sure Scott. This is Jon. I will add some comments there. So we called out, we did see sales strength in the fourth quarter from oil and gas in both the PTS segment and the C&I segment. We had overall good orders performance in 2018 in oil and gas. And you are right, more of our exposure is upstream. I will comment that, in the fourth quarter, we saw a little bit more choppiness in the order rates in oil and gas, but we were coming off some pretty strong orders in the first half of 2018. Coming into 2019, we still see order strength in oil and gas, but we are now coming up on some pretty difficult comparisons as we look at the orders there. Also I would say that overall for the company about 5% of our sales are in oil and gas. We have exposure in both upstream and midstream. And the divestiture of our engineered drives and control business will reduce this exposure a little bit, especially in the upstream demand.

By about 80 basis points or so.

Correct.

Got it. Thank you. And then on your HVAC markets, what are your OE customer saying on both the resi and the commercial sides for what they are expecting in 2019? And may be specify, if are going to respond, in sales dollars or sales volumes?

So I think what we would say, we are hearing from most of our customers for 2019 demand in HVAC is in the range of low to mid single digits is the expectation. That's pretty much what's built into our guidance. We will have a little bit of this dynamic of this nominal pre-build we talked about in our first half performance that will come out of the second half and that will then, of course, have a little bit of a delay in the timing of the FER transition just because of the pre-build that will be in the channel. But we don't think that will be a large amount.

Jon, are you saying low to mid single across both resi and commercial?

Yes. I would say that's a fair assessment of what we built into our guidance this year.

Okay. And then let my last question is about distribution, where C&I looked flat whereas I think PTS you said was strong. Could you kind of connect those dots for us?

Yes. So you are right. C&I was more flattish in the fourth quarter. PTS was strong. And climate was also strong in distribution in the fourth quarter. We think that for distribution in C&I, we had pretty healthy demand and distribution, but we had some pretty difficult comparisons in the C&I segment to prior year. Fourth quarter prior year was a strong quarter for C&I and in particular, distribution contributed nicely to that performance. So we think it was a bit more of a comparison issue in the fourth quarter for C&I.

So nothing changed the tone there. We had a couple of distributors saying that because of the timing of the holidays there was a little disruption but overall you would say that your distribution channel remains healthy for you?

Yes. I think that's how we would characterize it, Scott. And similar to the other comments on organic sales, we are going to have more difficult comparisons in 2019. But we still feel good about the performance of the market.

Got it. Thank you. Good job.

Thanks Scott.

And next, we have Mike Halloran of Baird.

Hi. Morning everyone.

Good morning Mike

So just kind of following up on that last point there. Maybe just talk a little bit about the underlying trajectory on the core industrial businesses as you look through the fourth quarter? Any real change in the trajectory from normal seasonality or from customer cadence that they talk about? And any change to start 2019 so far?

I would say that we are not seeing any big change, again, related to those kind of dynamics. I would say that, from an inventory standpoint, we would say that there is probably a slight increase in both industrial and HVAC in the distribution channels, but it's kind of difficult to understand what the difference is there or what the impact is given the variables on tariffs and price increase and whether this is a little bit of a normal inventory build or just some buying ahead of the tariffs. So that's a little bit of noise that would be in the inventory numbers right now.

Makes sense. And obviously some moving pieces on the price cost side with the two-way pricing formulas, the changes in the commodity pricing and some of the price actions you had last year. Maybe just help a little bit on how you think price cost cadence is as you work through the year? Slightly positive pre-ubiquitously through the year? Or are there some variances that we should look for?

I will comment and then Mark can add any anything he would like to add. So I will go back to 2018. We felt good about the performance in 2018 on price cost. We turned neutral in the first quarter and then we remained slightly favorable for the second, third and fourth quarter on price cost. We exited the year with a number of price increases that we implemented across all three segments either in the late third quarter or early to mid fourth quarter. So we are expecting to carryover from those price actions to carry over into 2019. That's what's in our guidance in our assumption around price cost. I think our expectation is that we will remain neutral to slightly favorable on price cost throughout the year.

I will just also add, copper started to turn somewhat deflationary in around the June timeframe and it's enough that we are seeing some of our two-way material price formulas cause a price reduction. Now it's still positive for us on a year-over-year basis. But it was enough to flip a few of those of formulas over in the first quarter.

Correct.

I appreciate the color. Thank you.

Thank you Mike.

Thanks Mike.

The next question we will have will come from Julian Mitchell of Barclays. Please go ahead.

Hi. Good morning.

Good morning Julian.

Good morning. Maybe a first question, maybe I had missed it, but it sounded like you talked about pretty healthy margin expansion at C&I and power transmission this year in 2019. I just wondered, in climate solutions, what the expectations on margins is relative to that 15.5% base figure? And what are sort of some of the main moving parts within that?

Julian, you are right. In 2018, we had nice margin expansions in both our PTS and our C&I segments on the full-year. And in climate, we finished the year at 15.5%. And I mentioned in my comments that the year-over-year change in LIFO expense, the LIFO expense versus the LIFO benefit, in 2017 was the headwind to margin expansion in our climate business for 2018. We are expecting margin expansion in climate in 2019. Our expectation would be that we will see margin expansion in all three segments. Climate will contribute to 2019. I would say, the key points there will be leverage on volume, some of the same themes we have talked about in 2018 benefits from productivity in our simplification efforts, neutral to slightly favorable price cost and then we will see a positive impact from mix, especially with the high efficiency products in 2019.

And I will just comment there to add in that if there is a pull ahead that's meaningful beyond what Jon already commented on, there could be a negative impact to mix in the front half the year and then a flip to a more positive impact in the back half of the year.

Thanks. And then maybe just my follow-up question around commercial and industrial systems. Are you expecting the first quarter growth rate to be roughly similar to what you saw in Q4, given what you have talked about in terms of flattish distribution and Asia weakness? Or do we see a bit of a pickup just because of the easier comp and maybe some of that inventory being flushed through?

I think we would be looking at a quarter that's probably more similar to the fourth quarter of 2018, Julian, as we look to the first quarter here.

Thank you very much.

Thanks Julian.

Next, we have Robert McCarthy of Stephens.

Good morning. Can you hear me?

Good morning. How are you doing Rob?

Good. Doing well. Mark, congratulations on a great run.

Thank you.

Yes. So you know what the next question is. So I guess I don't want to be impolitic in terms of the first question and it's not my intention to be. But in the context of this external CEO search, right, you have a very strong and talented deep management team. But going external seems to send a signal that there must be some concern among the Board around the portfolio or the position, not in terms of the cost position because you guys do a great job in terms of that and managing it but in terms of maybe the strategic vision of the businesses you need to be is. Can you expand upon what the Board is looking for in that CEO? And what that could mean for your portfolio to the extent you can?

I understand your question. I would say, we have great alignment between the management team and the Board around our enterprise strategy as we laid it out in 2017 and Jon talked about it today, focus, innovate, simplify. It's working for us, no question. You are always looking at the portfolio. I mean, obviously, we commented on that back in 2017 when we said we would divest roughly $200 million, which we did in that timeframe. And while we are not ready to set a new target, certainly you are always looking at the portfolio in terms of things that no longer are core or things that you would like to add that are core. So that's the headset that both management and the Board is looking at the business.

Okay. Thank you for taking my question by the way. And then I guess a couple of follow-ups. I guess in terms of thinking about the environment, it looks like definitely from what you are seeing now, pretty decent environment. But if you do see pricings under further pressure, volumes decelerate or we go into a bit of a slowdown here, remind us the counter-cyclical nature of the free cash flow, the net income conversion and what we should see given history and what you could maintain in terms of free cash flow to net income conversion, if we go into a bit of a meaningful downturn here?

I can take that one. So Rob, this is Rob Rehard. So I think you would expect to see free cash flow conversion through the quarters to be somewhat consistent with our historical trend in terms of how it trends relative to prior quarters. We do start out a little slower and then ramp up as we go through the year. I will remind you, we do have eight years over 100% on free cash flow conversion. In a downturn, we would still expect to see strong free cash flow conversion as we did during the downturn a few years back where we still converted over 100% despite the downturn and a lot of that came through trade working capital improvements as we moved through the year. So I think that would be how you would look at it.

I guess the final question would be just around price cost and obviously tariffs. And I apologize, I did have to miss a little bit of this call in the beginning. So I might have missed some of your commentary. So I apologize for that. But just talk about kind of ring-fencing the risks around, I mean you already alluded to the price cost being neutral to positive, right, but around the tariffs and how you are going to manage that impact? And could that drive you to the low end of your guidance? How do we think about, aside from revenue what drives you to the low end of your guidance range in terms of your cost structure and the pricing environment?

Rob, this is Jon. I will talk about the tariffs. So in the fourth quarter, we commented that price cost remained slightly favorable and that included the additional expense of the tariffs. So we were pleased with the price cost performance given those additional expenses. If you recall in our third quarter call, I talked about the two main actions we are taking to deal with the tariffs. The first is around our footprint, leveraging our global footprint and a number of product moves that we either have made or are making that will help us mitigate the impact of the tariffs. And then for the remaining products where we either don't have those options or it's not cost justified to do that, we have and will look at raising price. So we have been able to offset the tariffs. Our expectation in 2019 is that we will continue to offset the tariffs?

I will just add, you asked Robert, what would take us to the low end of the guidance? We are assuming low to mid single digit growth rates, a chunk of that coming from the markets we participate in. So certainly that could be a driver. Now I will also remind you that we talked about $10 million of restructuring for the year. So we are continuing our self-help efforts to get at margin improvement or offset the impact of a downturn.

Thanks for your time.

Thank you.

And next we have Jeffrey Hammond of KeyBanc.

Hi. Good morning guys.

Good morning Jeff.

So just on the long-term targets or I guess going into 2019, it looks like revenues running ahead. Do you think you can get into that zip code of 200 to 250? Or is that a stretch at this point, just given the last year?

No. I think we still have our eyes set on those targets on the low end. Obviously, on the low end of the target, but we still think there is a shot there. A lot has to go our way, but it's still in sight.

Okay. And then just any update on timing for the CEO search announcement?

Well, as I commented, we still believe it will be sometime in the second quarter.

And then just on the M&A side, can you just update us on the Nicotra integration? How it's going? And if you are seeing any change in valuation with some of the choppiness and macro worries? Thanks.

So first on Nicotra, the business is performing kind of the way we had thought it would when we acquired it. From an integration perspective, it just confirms that the business integrating into the company, I would declare victory there. We feel good about the integration. Still work to do on our synergies and there's still more to get there. So that will take us another couple of years and that's included in our guidance. But we feel good overall about what that business has brought to the company in the air moving space. And then finally on valuations, we would say that there's probably been a full turn down in valuations and targets and we see that both on what we are selling and in what we are considering as potential targets.

Okay. Thanks a lot.

Thanks Jeff.

God bless you, sir. The next question we have comes from Chris Dankert of Longbow Research.

Hi. Morning guys.

Good morning Chris.

Forgive me if I missed it, but any update as far as some of the manufacturing transition out of China into other lower production cost regions? Just kind of any progress there?

So Chris, this is Jon. We didn't really talk about it specifically, but we feel good about the progress we are making. We had commented on the third quarter call about one example of product that we were transitioning from one of our facilities in China to one of our existing facilities in Mexico. That transition has gone well. We are in production today on that product in Mexico and serving our customers in the US. So we feel good about that particular example. There is a couple of others that we are working on implementing in the first half of 2019. It's very similar to the one in Mexico, utilizing either existing footprint in Asia outside of China or footprint that we have in Mexico. So good progress and we feel good about the positive impact that could have to mitigate a portion of the tariff expense.

Got it. That's helpful. And I guess I assume a lot of your customers are trying to look at similar moves. Has that proven to be a net benefit for you guys? Or is it kind of a net neutral overall?

I would say today it's a net neutral. However, we have commented and we continue to believe that over time we would see this as slightly net positive for the company. We still feel that way today.

Got it. And one last one if I could, quick. Just any comment on labor cost into 2019? Is just similar growth from what we have seen? Just any kind of reminders on variable comp, any kind of impacts that might be out of the norm?

Are you talking about for our production workforce or is that what you are referring to, Chris.

Yes. Exactly, overall and then for 2019 for guidance. Sorry.

Yes. So I would say that in 2018 with pretty much a strong demand in the markets, labor availability and labor inflation has been and will continue to be an impact on the business. However in 2018, I would say we didn't see necessarily any meaningful increase in inflation. Kind of the normal inflationary pressures that we would see in the business. Going into 2019, one change that we are dealing with, it's in our guidance, but one change we are dealing with is the doubling of the minimum wage in Mexico in the cities along the border. So that's been a change that has been implemented in January, is impacting us and anyone else manufacturing in that region and we are looking at a number of actions to mitigate that, but that's some additional inflation that we are going to have to deal with in 2019.

Got it. Thanks so much and congrats on the results, guys.

Thanks Chris.

And the next question we have will come from Walter Liptak of Seaport Global. Please go ahead.

Hi. Thanks and congratulations on the quarter, guys.

Thanks Walt.

I wanted to ask about the C&I business in Asia and just maybe you could refresh us on the percentage of revenue for C&I that's Asia, how much of that is China? And then can you provide us with any other color, just kind of the tone of the market, pricing, et cetera, maybe how it trended during the quarter?

So I will start off and then Jon can jump in. So revenue overall for Asia is probably, I am going to say, 10% to 12% of total revenue and then the C&I piece of that is probably three quarters of that 10% to 12% is in the C&I segment. So yes, there is some headwind there, particularly in the China area. We are seeing nice growth, continued growth in India. But China, Middle East, Europe are headwinds for us. And then, the second part of your question again, Walt.

Just how it's trending? I mean do they come down and then stabilize? What are you hearing from your customers? I guess what are you expecting for 2019?

I think Walt, when we look at our China demand what we saw in the second half of 2018 was a step down in demand. If you look at our order rates, we had pretty strong orders in the first half. We saw a decrease in demand in the second half and it's been stable at that lower level. So if you looked at order since that drop in demand, it's been pretty stable. So we are going to see a difficult comparison in the first half of 2019 and then we will see a little bit of, certainly in the orders, we will see a better comparison in the second half, because we really haven't seen any further deterioration, but there was a step down in demand.

Okay. Good. That helps. And then just going back to the capital allocation question and M&A. With potentially a new CEO coming in, you are a little bit more careful about M&A and maybe size of the M&A or number of deals. And then you mentioned there's no buyback that's in your guidance. I wonder if you could refresh us on how much share repurchase authorization you have left, the timeframe remaining on it and buyback versus M&A, given the upcoming CEO change.

Thanks Walt. We will have Rob Rehard address the buyback first.

Yes. So Walt, we have about $200 million on our buyback authorized on authorization at this time. So that's what was remaining. We had a new authorization in place in 2018 at $250 million. We moved that down to about $200 million at the end of the year.

In terms of any M&A transactions, we have, as you know over the years, this organization, this company has done a lot of M&A and there is a core group of people here that know how to do it. So that wouldn't be the reason we wouldn't do M&A just because of the CEO transition. So we are operating like there's just every other day. So hope that answers your question, Walt.

Well, thank you, sir. At this time, we will go ahead and conclude our question-and-answer session. I would now like to turn the conference call back over to Mr. Mark Gliebe, CEO, for any closing remarks. Sir?

Thank you Michael. Just one last quick comment from me. In the event this turns out to be my last earnings call, it's been my honor to serve as Regal's Chairman and CEO and I appreciate the confidence and support of our investors and analysts. I have got to know many of you personally and I have enjoyed working with you and learning from you. I wish you all the best. Thank you for your questions and for your interest in Regal. Have a great day.

And thank you, sir, also for your time and to the rest of the management team. Again, the conference call has now ended. We thank you all for your participation. At this time, you may disconnect your lines. Thank you. Take care and have a great day, everyone.