Good morning, and welcome to the Regal Beloit Second Quarter 2019 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Rob Cherry, Vice President of Investor Relations. Please go ahead.

Thank you, Operator. Good morning, and welcome to Regal Beloit's Second Quarter 2019 Earnings Conference Call. Joining me today are Louis Pinkham, our 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 Louis, I would like 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 to differ materially from those expressed or implied in forward-looking statements. For a list of factors that could cause the actual results to differ materially from projected results, please refer to today's earnings release in 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 a reconciliation of these measures to the most comparable measures in accordance with GAAP. Now let me briefly review the agenda for today's call. Louis will lead off with his opening comments and an overview of the quarter. Rob will then review our second quarter financial results in detail and provide an update on our 2019 outlook. We will then move to Q&A, after which, Louis will have some closing remarks. Now I will turn the call over to Louis.

Thanks, Rob, and good morning, everyone. Thank you for joining Regal's second quarter earnings conference call and thank you for your interest in Regal. As Rob mentioned, our COO, Jon Schlemmer, is joining us today. And although he will not be making prepared remarks, he will be available on this call to help answer questions. I would like to take this opportunity to thank all of the investors and analysts that I have had the pleasure of meeting with over the 4 months since I started at Regal. I look forward to meeting even more of you in the future. In these past four months, I have visited many of our facilities, met with many of our associates and visited with a number of our customers. The talent in our organization is strong, and we have deep application knowledge in our served markets. Our products are differentiated, push the boundaries of energy efficiency and are increasingly IoT-oriented. Our customer relationships are strong and deep. In all, we have a great organization. Turning to the current period, we had tough macro conditions in the quarter. Our second quarter financial results reflected lower-than-expected demand due to abnormally wet and mild weather, the ongoing global trade uncertainties, including the June Mexico tariff concerns; efforts by distribution partners to reduce channel inventories, along with an overall continued economic malaise in Asia Pacific and Europe. Regal posted negative 2.2% organic growth in the quarter with overall orders down mid-single-digit year-over-year against tough comps. Despite the challenging sales environment, we delivered an adjusted earnings per share of $1.52, which was flat to the prior year. We had strong margin expansion in our Climate segment of 110 basis points and solid expansion in the PTS segment up 40 basis points. In the C&I segment, we continued to…

Thank you, Louis, and good morning, everyone. As Louis mentioned, we had a tough quarter that saw weakness in several end markets and regions, which was made more challenging by difficult prior year comparisons. Despite these headwinds, Regal delevered at 16%, far below our normal rate. Sales in the second quarter for the total company were down 9% from the prior year. After the impact from businesses divested or to be exited and foreign currency, the organic sales in the quarter decreased 2.2% from the prior year. I will start by providing comments on the segments and end with more detail on the total company and our guidance. Starting with Commercial and Industrial Systems. Sales in the second quarter were down 14.3% from the prior year. After adjusting for the impact from businesses divested or to be exited and foreign currency, organic sales in the quarter decreased 5.5% from the prior year. The segment saw double-digit declines in pool pump, China, and parts of our commercial HVAC business, partially offset with gains in distribution. The adjusted operating margin in the quarter for C&I was 6%, down 160 basis points compared to the prior year. This margin was down mainly due to an unfavorable inventory adjustment, year-over-year FX headwinds and to a lesser extent, reduced volume. In the quarter, Regal conducted a manufacturing facility move in the power generation business within the C&I segment. This facility is part of an engineered-to-order business. As part of the move, a full physical inventory was conducted, which resulted in an unfavorable adjustment of $3.4 million of inventory on a pretax basis, or approximately $0.06 on a diluted earnings per share basis. In addition, we had a $2.9 million year-over-year headwind in translational FX for the segment. These 2 items drove most of the decrease…

[Operator Instructions]. And our first question comes from Jeff Hammond of KeyBanc Capital Markets.

This is Trish on for Jeff. So maybe if we could start with just talking about C&I profitability looking at second half. Is the second quarter, is that margin run rate something we should be looking at for the second half and kind of what's within that?

Trish, this is Rob. I can take that. From a C&I perspective, second half versus first half margins, we would expect C&I to be slightly up. But the third quarter should be flat to down.

Okay. Great. And then just kind of within your updated guidance, which end markets are incrementally weaker than when you issued guidance last three months ago, kind of where you've seen that fundamental weakness? Is there anything that's getting any better than you're expecting?

Yes, Trish. Maybe I'll take this one. If you look at incrementally weaker, definitely in second quarter, the weather was a challenge, and that had an impact on certainly our pool pump market as well as our HVAC market. Lesser in HVAC, but certainly in pool pump. In addition, slightly worse, although we're seeing challenges in the China market in particular in our industrial business. It's not getting better, and we're not forecasting it to get better. We are seeing some strength however in our commercial industrial distribution segment, and so we believe that, that will continue into the second half of the year. Another what we would say, an incremental change for us was the industrial distribution market, especially for our PTS business. We saw absolutely an approach in the quarter, a slowdown because of the current market uncertainties, a slowdown in demand. And therefore, our distribution partners bringing down their inventory levels. One area we are seeing some strength, however, is in renewable energy, quite a bit stronger than we anticipated in second quarter going into the second half. So hopefully that gives you a perspective of how we're thinking about some of the changes that we saw through Q2.

Our next question comes from Mike Halloran of Baird.

So just continuing on the question there, just trying to understand. From a guidance perspective, obviously there is inventory headwinds that are going to change with the core demand for you, looks like. But what is the assumption from the end-market perspective relative to the first half? Is this sequential stability from the run rate exiting 2Q, slight deterioration? How should we think about that end-market normalizing for inventory, normalizing for FER, pre-buy and all those things across the three segments?

Mike, this is Rob. I'll take that one. Let me answer your question in terms of what we're seeing from an order rate perspective. So overall, our orders in July were down from the prior year. But let me give you some color by segment. Climate orders in July were slightly above the prior year as they were in Q2 as well. And from a sequential basis, Climate orders are down mid- to high single digits, which is normal seasonality. FER pre-buy is contributing to this decline. In PTS, orders in July were below prior year by double-digit, which we believe is a continuation of the inventory correction in the channel as well as slightly lower industrial demand. Q2 orders were down mid-single digit, and sequentially, as compared to Q2, July orders were down double-digit. However, we do expect this will partially correct as we move through the third quarter. C&I orders in July were also below the prior year and slightly below second quarter. However, this is a lumpy business, which is highly impacted by project orders. As Louis mentioned, we're adding a level of fidelity to our orders in backlog management, which will improve our forecasting capability. You asked a little bit about what does this mean in terms of the inventory headwinds and others. As I mentioned from a margin standpoint, overall, we would expect to be relatively flat to the first half for overall Regal. C&I should be slightly up with pressure still in the third. Climate should be slightly down based on normal seasonality, and PTS should be relatively flat. So hopefully, that gets to most of your question there, Mike.

No. That's really helpful. Great. And then just a question on the reorganization, the focus on 80/20, the decentralized approach. Maybe just talk a little bit about what steps you're taking now to implement that through the organization, receptivity. How long do you think it's going to take for the organization to stay on those principles and start really executing on it? And then in the context of the savings, when do those savings start ramping up?

Yes, Mike. I'll take this one. So we actually announced the reorganization in early June. And I believe the organization was very receptive. And we've now gone through -- a tough part of a reorganization, of course, is restructuring and reduction in force. We've announced that -- the majority of that already, and so we'll start seeing benefit -- some benefits in the third quarter, mostly fourth and then full year next year. Now from a timing perspective, Regal had already started down the path around 80/20 product plant rationalization, which we believe is a big part of that for us. All we're doing is we're accelerating it. And so it's understood by our organization. We're certainly ensuring that it's a big part of our culture and a way of doing that is setting clear objectives and then having a cadence of review of those objectives. And so part of this reorganization is a strong cadence of follow-up and follow-through that each one of our businesses have. So I feel good. I think -- again, like I said, you'll start to see some benefit in '19, more benefit in 2020. Hopefully that answers your question.

Our next question comes from Joe Ritchie of Goldman Sachs.

So maybe just touching on C&I for a second. Just the commentary around the, call it, flattish, maybe slightly better margins in the fourth quarter at a time and like the growth rate is probably going to remain down, call it, mid-single digits. Can you maybe just discuss a little bit the puts and takes that could keep this to flattish type margin in the second half of the year?

Yes. I think it's fairly simple. It's on the cost side, Joe. So the restructuring will help. We are laser focused on accelerating our productivity initiatives, and that's going to help with the margin improvement for Q4.

And Joe, this is Jon. One other that I would add is the mitigation actions that both Louis and Rob talked about earlier around the tariffs and what we're doing to stabilize in that area, and help us win back some of the share that we've -- experienced share loss that we experienced in the first half.

Got it. Okay. That's helpful. And then maybe my follow-on here. You guys cited a few different areas in C&I again that obviously deteriorated. We're down double digits in the quarter. Some of it was weather-related. I'm just wondering if -- does that just basically become lost revenue for the year? Or is there an opportunity, let's say, this quarter to pick up some of that revenue if weather normalizes?

Yes, Joe. I'll take that one. It could, especially if we see a heat wave come through and Regal likes heat. We also like really cold in the winter as I'm learning, but we're not seeing it. Not to the extent that we'd recover the decline of Q2.

Our next question comes from Julian Mitchell of Barclays.

Maybe firstly just clarify in PTS, should we assume there a pretty similar rate of revenue decline in Q3 and Q4 when you're looking at the order intake? Or are you assuming a big dip in Q3 and then a less bad decline exiting the year?

So I can tell you, Julian, this is Rob, that we do expect -- on PTS, as I said in July, the order rates in July that we saw versus the prior year were down double digits and sequentially versus Q2 were also down double digits. As we said, we do expect this to partially correct throughout the third quarter, but certainly continue to see pressure based on those order rates as we go through the remainder of the year.

The way I'd answer it, Julian, is that -- just to expand on what Rob just said is we are going to see in the PTS segment a slight reduction in orders -- sorry, in sales in Q3 to prior year as well as a slight reduction in Q4 to prior year.

Understood. And then just my follow-up would be looking at the second half adjusted operating margin. I think based on what Rob had said about the second half margin versus the first half, it looks like you're assuming maybe a decremental margin year-on-year in the low teens against 16% in Q2. Just wanted to check if that math is roughly right. And then what impact, if any, price net of cost is having on the margins in the second half?

So Julian, this is Rob. So first of all, yes, you are directionally correct in your calculation there. Price, we do expect price to be -- price/cost to be positive for the remainder of the year as we've seen in the first half of the year. So yes. So I think you have your math correct from that perspective.

Our next question comes from Christopher Glynn of Oppenheimer.

So looking at your North America where the HVAC sales up slightly, just curious what your best gauge of what the end market did in the quarter.

Yes. Chris, this is Louis. I would say the end market in North American resi was up mid-single digits in the quarter. We were up slightly below that. I would say for -- although we saw the FER pre-buy, we had done some -- taken some pruning actions in that business that had a positive impact on margins. But of course, some headwind on sales.

Makes sense. And then C&I distribution gains, wondering just what's enabling that, where you are on the curve. What's the runway from the gains that started in the second quarter? And then putting that into the context of what you think you can do with the distribution channel over a longer horizon.

Chris, this is Jon. I'll take that. So distribution for C&I certainly was one of the positives in the quarter in terms of top line strength. And we do believe there is share gain through that channel. We would attribute that to the investments that we've been making in the sales force as well as on the digital side of the business. We put a lot more focus on the distribution channel in general. And we've seen year-to-date growth in that part of the business and again, we believe that a good part of that is definitely gaining some share in the channel. We expect that to continue through the second half. We continue to place investments in that area and feel good about the progress that we're making there.

Okay. Last one from me is, you're looking at the inventory reduction. Is there any material impacts from under absorption of manufacturing overhead contemplated in the third quarter?

So this is Rob. The quick answer is no. We have -- this inventory adjustment, as I said, was really an engineered-to-order project business, and we've been discussing this over the past 3 quarters, and this...

I'm sorry. I meant the reduction in the overall Regal inventory.

Oh, okay. I'm sorry. Yes. Okay. Sorry. So the answer is no, we wouldn't expect it to have a material impact in the third quarter.

Our next question comes from Robert McCarthy of Stephens.

I promise not to get quite as riled up about inventory. I guess the first question I have is, maybe stepping back, Louis, just talking about what you've been impressed with in this kind of managing a more chaotic -- not chaotic, more volatile environment and the downturn and how your organization has responded. Where have you seen kind of the bright points? And where do you see really the need to improve upon as you manage a more cyclically volatile environment?

Yes. Happy to share perspective here, Rob. I believe that the reorganization that we talked about earlier is really going to get our team very focused on the markets that they serve and how to bring value to our customers. I think that's going to be a significant benefit for us. The team's already been working on 80/20, and we're accelerating that activity and driving it deeper into the organization and a focus on P&L management at every manufacturing site and every business unit is helping to ensure that we're driving gross margin improvements. I believe there's opportunity, as I said before in my remarks, to evaluate our margin situation especially, if you will, in that fourth quartile of 80/20. And that's something the team is working on. And then lastly, opportunities, there is no question that the Regal team has done a fantastic job in time of looking at our footprint, but there's more opportunities around plant consolidation and product rationalization that we are evaluating. All of these things as well as the portfolio that I talked to you about earlier and our approach to evaluating our portfolio, we are discussing with my leadership team and we're considering options with the board and we'll be in a better position towards the end of this year to come out with a clear path forward.

Okay. Fair enough. And then your current guidance, does it include some concern or some additional debit in association with the most recent tariffs announced? In other words, did you bake it before the tariffs announcement or after?

Yes. Actually, interestingly enough, the latest tariff announcement has very little impact on Regal. We have less than $500,000 in spend that was already excluded in the first 3 tariff lists. So it's going to have very little impact directly. However, the impact is clearly going to be felt from further market uncertainty due to the ongoing trade tensions. That's where we're going to see the impact, and we believe we've put that -- we've considered that in our guidance.

No. That's very helpful. And then finally, in terms of the cadence of exposure in terms of your contemplated plan, we're going to get a lot more detail presumably on the fourth quarter call, which will be in early January, then followed up by a clear articulation in the March timeframe at the Analyst Day?

That's exactly the way it's dated. Thank you.

And then last question then is, what have you done in terms of thinking about your cost base and your geographic base for sourcing and production, particularly Mexico, elsewhere, in light of what we've seen these global trade concerns? Do you think you have to have more investments to change your footprint there or alter your footprint in any way? How are you thinking about that?

One of the benefits of Regal is our scale and our global footprint. I do not believe there's going to be a need for any significant capital -- further capital investment to be able to best leverage and manage our footprint. Where I do believe there will be opportunity is consolidation of footprint in the multiple regions where we produce, and that is something that we're evaluating as part of our strategy.

[Operator Instructions]. And our next question will come from Nigel Coe of Wolfe Research.

I wanted to dig into C&I. You called out the weakness in China. No surprise there, but you also called out weakness in commercial HVAC. And sorry if I missed your commentary around that market, but maybe just dig into where you've seen weakness there and how you see that developing.

Nigel, this is Jon. So I'd say that it was a bit mixed for commercial HVAC. There were parts of the commercial HVAC business where we actually saw some strength in the quarter; in other parts where we saw weakness. We anticipate on, what I'll call, kind of light commercial through heavy commercial kind of the applied value as well -- and both in Asia and in North America. So some of that was geographic -- based geographically in terms of where we saw weakness in particular in Asia. And then also on the transport refrigeration side is another aspect of our commercial HVAC business so it was -- parts of that vertical were up for us in the quarter while parts were down, and I would put it around the larger applied side, the Asia side of the business and also on the transport refrigeration side.

Being down.

Being down. Correct.

Down.

So a lot of clients down. Okay. That's a little bit different to what we're hearing from the OEMs. They call it applied's being up, but we can certainly dig in off-line on that. And then understand the comments about List 4 not being a major direct impact. But List 3, 10%, 25%, how is that impacting the cost side of the equation of the price/cost? And then how is it impacting your competitors that are importing from Asia? Are they facing more tariff headwinds? Any comment on that would be helpful.

So I'll take that one also, Nigel. So I think that, first of all, on the List 3 going from 10% to 25%, the important thing to remember for us is, we had assumed the increase to 25% in terms of the mitigation actions we were taking, which was the combination of footprint and price as we entered the year. So -- well, there is some incremental headwind for us clearly because with the tariffs increasing to 25%, we have pretty much planned for that and have that embedded in our guidance. In terms of competition, I think that we would see that as a bit of a larger impact on our competition. In our C&I business, that was more of a List 1, List 2 challenge for us. List 3, I think, is a little bit less of an impact for us and we believe a bit more of an impact for some of our global competition.

Okay. Then finally -- well, maybe one for Louis here. When you [indiscernible], you talked about maybe a more meaningful C&I restructuring potentially. How -- kind of where are we in that process? And could that be a 2020 event?

Nigel, I'll take that. As I've said before, we're evaluating different options. I certainly think that the reorganization, our approach to portfolio review, the comments I made in my prepared remarks around looking at it from a shareholder value creation perspective of ROIC and EBITDA, as well as our focus on 80/20, that's going to be our drive for our strategy moving forward. Now giving you much more clarity on that around product rationalization, plant rationalizations and portfolio management, I'm not able to do that at this time. We're evaluating options. We're talking with our board, discuss a path forward and we'll be better prepared in the January and March timeframe to come out with clarity.

This concludes our question-and-answer session. I would like to turn the conference back over to Louis Pinkham for any closing remarks.

Thank you, operator. To summarize, it was a tougher quarter where we faced difficult comparisons and challenging end markets. We feel that we met those challenges and delevered far below our normal delevered rate. Regal continues to make our customer the priority of everything we do. In Q2, we conducted a survey on customer satisfaction using the Net Promoter methodology. Our overall score improved 15% from the prior year, and we saw improvement in all performance factor categories. Looking forward, we are energized about leveraging our reorganization and driving a P&L focus deeper into the business. We will further deploy our 80/20 approach throughout the organization and drive improvement in product stability, while staying laser focused on exceeding customer needs and driving profitable organic growth. And of course later this year, I will be providing more clarity on our strategy and portfolio management. Thank you for joining the call and your interest in Regal.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.