Good morning, and welcome to the Regal Beloit Fourth Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. 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 fourth quarter 2019 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 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. Now, let me briefly review the agenda for today’s call. Louis will lead off with his opening comments and an overview on the quarter. Rob will then provide our fourth quarter financial results in detail and provide an outlook for 2020. 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 our fourth quarter earnings conference call and thank you for your interest in Regal. We continue to experience tough macro conditions in the quarter. Our fourth quarter financial results reflected the ongoing slowdown in industrial markets, particularly in the U.S. and China due to the ongoing global trade uncertainties, weakness in the industrial distribution channel and inventory destocking in the HVAC and pool pump markets. Regal posted negative 9.3% organic growth in the quarter, of which approximately 1.7% was from our 80/20 account pruning efforts. Overall, orders were down 2.8% in the quarter. Excluding a one-time blanket project order, orders were down 5.7% for the company. This compares to down 10% in Q3. Orders were relatively flat in the quarter for the industrial business, but down mid to high single-digit for the other three segments, excluding the unusual blanket order. Despite this challenging sales environment, we generated an adjusted EPS of $1.25 and delevered well below our normal rate at 12.2%. I’m proud of our Regal teams that have been driving 80/20 lean productivity and supply chain improvements, along with SG&A reductions, to simplify our business. We are still in the early stages of executing on these tools and efforts, but the benefits are already showing in our results. Our full-year deleverage rate was 15.5%. You can see this improvement in our sales per employee metric, which was up approximately 7% over 2018. As is clear from our earnings release, we made a strategic decision to reorganize into four reporting segments. Climate and PTS will remain unchanged. C&I has been split into two segments: Commercial Systems and Industrial Systems. All four segments currently have a President, who reports directly to me with the previously disclosed retirement of the Regal COO.…

Thank you, Louis, and good morning, everyone. As Louis mentioned, we had some significant top line headwinds in the quarter that saw weakness in several end markets and regions. Despite these sales headwinds, Regal delevered at 12.2%, well below our normal rate, helping to minimize the volume impact to our operating profit. I will start by providing comments on the segments and end with more detail on the total company and our guidance. As Louis mentioned, the company has realigned into four business segments effective December 28, 2019. Those segments are Commercial Systems, Industrial Systems, Climate Solutions and Power Transmission Solutions. For the recast financial results related to this resegmentation, please see the tables in the appendix of our earnings release or this presentation. Starting with Commercial. Organic sales in the fourth quarter were down 10.4% from the prior year. The segment saw double-digit declines in North American pool pump and in general industry, along with low single-digit declines in the China market. The decline in sales was also driven by our proactive approach to pruning low-margin accounts, as we continue to execute on our 80/20 initiative. The impact of this pruning initiative was approximately 200 basis points over the organic sales decline. The adjusted operating margin in the quarter for Commercial was 7.5%, down 290 basis points compared to the prior year. This margin was largely down due to the volume decline, along with the impact of unfavorable mix, primarily in the pool pump distribution market. However, margins were also impacted by the fact that we allocated corporate expenses to Nicotra Gebhardt business within this segment in 2019, but did not allocate corporate expenses to this business in 2018, the year of acquisition. Despite these headwinds, we were able to partially offset the impact with favorable price cost and…

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mike Halloran with Baird.

Hey, good morning, everyone.

Good morning, Mike.

So why don’t we just start with the guidance side and talk about a couple of things here. One, the sequential trends into the first quarter seems like they’re stable, if not improving in specific areas. Maybe just touch a little bit on that? And then also, how much of an improvement are you embedding in guidance? Is this slight improvement, something more significant? And how would you compare it to normal seasonality? Thank you.

Sure. Mike, this is Rob. I’ll take that one. So first of all, from a cadence standpoint, going into the first quarter, let’s talk about top line first. We certainly are seeing some headwinds, especially in our Climate segment. We talked about that a little bit as we talked about order rates entering the quarter. All of our segments are certainly seeing some pressure as we enter the first quarter. The first-half of the year, we do expect to be pressured from a top line perspective and from a bottom line perspective. From a margin – switching down to margins now. We see that, on a year-over-year basis, we’d expect that Commercial would be down slightly, Industrial up slightly, along with Climate and PTS relatively flat, but again, the top line headwinds in the first quarter are certainly fairly significant. And in light of everything that’s going on in the economy right now, we do see that pressure continuing, at least, pressure continuing the first quarter, if not through the first-half.

Was that – I was more referring kind of a sequential trend first – fourth to first, Rob. Do you think there’s stability on that side, but I do certainly appreciate the incremental color?

Yes. There is certainly, I think that from a fourth to first standpoint, we will continue to see pressure on the top line, again, especially in the Climate segment. But from a margin perspective, we would expect the margins to be relatively flat for most of our segments from a fourth to first perspective. Although we don’t provide, as you know, guidance from a quarterly perspective, that’s just a little bit of color on how they – it should work sequentially.

And then the embedded back-half recovery, just some comments on that?

Yes. So, we’ve got savings that we’ve talked about throughout 2019 to the tune of $32 million. Part of that is related to the reorganization at $15 million on an annualized basis, plant rationalization at about $17 million, and then we just announced another benefit as a result of restructuring of about $6 million. We have about $30 million – $38 million of annualized benefit. The – we do expect that we would see a fair amount of that coming into 2020, more back –half weighted. The reorg, the $15 million we would expect to see throughout the year and at the full run rate of the $15 million. However, the plant simplification activities we talked about it in third quarter – second and third quarter, we would expect to see that more back-half weighted as we go into 2020. And we’d expect the other restriction we just announced a $6 million to be more back-half weighted, with about half of that coming in 2020. So most of the benefit of the savings that we’re talking about is coming through the second-half, with the exception of the original $815 million we talked as a result of the reorg.

And then just a comment on demand assumptions front-half versus second-half and why there’s confidence in the acceleration? And how – what kind of magnitude are you talking about contextually?

Yes, Mike. So this is Louis. Good morning. Let me take this one. So, we’re certainly coming out of the fourth quarter. Orders were down as much in Q3, but certainly down. The expectation going into the first-half is that, first quarter is going to be light, a year-over-year perspective and then recovery through the year with the second-half being stronger. That second-half stronger is really driven by three things: one is a little bit better comps to compare against; plus, as I talked about in my commentary, we’ve got some really solid commercial initiatives that we’re driving, in particular, in the Climate and PTS business that we’re gaining some momentum on; and then we just expect an overall improvement in –a slight improvement in markets that’s going to make the second-half stronger than the first-half.

Great. Thank you. I appreciate the time.

Yes. Thanks, Mike.

Our next question comes from Julian Mitchell with Barclays.

Thanks.

Hi, Julian.

Hi. Lucky to get a question in after that barrage. Maybe just the first question around the inventory levels, maybe if you could just characterize how you see those at your channel partners and customers across the different segments, particularly, I guess, the progress in Industrial?

Yes. So I’m happy to – I’ll take that one, Julian. Good morning. So – but I’m going to start with PTS and tell you and we see the channel inventories. I would tell you we worked through those inventories in Q4 from a PTS perspective. So we did not see destock a significant – we do not expect a significant change from a destocking perspective in Q1 of this year. However, we still see destocking in both the Commercial and Industrial, into that matter in Climate, especially with OEMs going through this quarter. We’ve seen the inventory levels come down from Q3 to Q4, but we still expect to have to work through that through this quarter. We expect to be through destocking by the end of Q1.

That’s helpful. Thank you. And then my follow-up, maybe focused on the Industrial Systems segment. So in Q4, you had that 1.5 points sales impact from 80/20 pruning. Should we expect that number to get larger in 2020, as you sort of get your arms around the business? And maybe any color at all you could give on the sort of margin range of the assets inside the segment? There are some that are very high-margin and then a massive sort of break-even-ish profits or losses, maybe give some broad brush comments on that?

Yes, sure. Happy to, Julian. So you’re absolutely right. At 80/20, we saw pruning in fourth quarter of about 1.5%. We’re open to sharing that we expect around 2% for total Regal in 2020 of further pruning. Now, I would expect more in the Industrial Systems business, but we’re not really ready to give that guidance. We are digging deep. This is what 80/20 helps you with as it allows you to segment the data, understand your highly-valued customers, your valued customers, your A products, your B products and then determine what’s the best path forward. For Industrial Systems, we do expect to continue to see pruning in 2020. From a margin perspective, Julian, we don’t really give specific gross margins within a segment. What I can tell you is that, we have clear path to improve the performance of margins in that segment. 80/20 is going to help. SKU reduction is going to be significant. We’re launching a new line of motors and generators for the North American market that are much more cost competitive. So, again, our view is this is a segment that there’s real value creation opportunities through cost reduction that don’t need to occur with volume either. So we’re pretty bullish of our ability to improve margins in this segment.

Very helpful. Thank you.

Sure. Thanks, Julian.

Our next question comes from Christopher Glynn with Oppenheimer.

Thank you. Good morning.

Good morning.

So I was just curious on the restructuring savings coming through in 2020. Broad stroke way to think about the geography of that among the segments?

Yes. So this is Rob, Chris, I’ll take that one on. So certainly, as you’ve seen in the past, we have put a lot of our restructuring dollars towards C&I. That was because we had readily actionable projects. And as a result, Commercial delevered well in 2019 and held margins around 9%. Now we’re actively taking the same approach with Industrial, but there are clear restructuring activities in each of our segments and all of our segments have opportunities. So although we are shifting some of the focus now towards Industrial to get that margin profile up to what we would – what we’d like it to be, there are certainly opportunities in all segments. And so it’s fairly evenly weighted with the exception of Climate, you don’t need as much in Climate, the margin profile. We’ve done a lot of restructuring in our path in the Climate segment. And so it’s not as much restructuring dollars allocated to Climate in 2020.

Okay. And on the $17 million savings annualized related to the plants that second-half weighted, should we anticipate kind of full annualized run rate in the back-half?

You would expect something close to an annualized run rate in the second-half of the year, with the full run rate coming in 2021. But certainly, yes, on an annualized basis, that would be your second-half assumption.

Okay. And then on Industrial Solutions, is relative scale serving those markets a competitive issue at all with channels and end customers?

Yes, I’ll take that. Our position is not as strong in the Industrial Systems business as it is in some of our other segments. But we have differentiated products and solutions that have strong – our associates and our leaders in those businesses have strong application knowledge of how they get deployed in those markets. And so there are parts of that business that we’re very bullish on that can still grow. I’d say, in – so again, they’re – those niche segments that we like a lot. And then the other part of that business is standard motors that we need to be more cost competitive. And that’s exactly why we’re coming out with the new line of motors and generators to be more cost competitive in the segment.

Okay. And did you give a free cash flow guidance?

We didn’t on the page, but we’d expect free cash flows to exceed 100% of adjusted net income in the year.

That’s a good follow-on for last year. Thank you.

You’ve got it?

Yes. Thanks, Julian – or it’s Chris, excuse me.

Our next question comes from Chris Dankert with Longbow Research.

Hi. Good morning, guys.

Good morning.

I guess to pull the thread a little bit more on Julian’s question. Historically, the big focus was get C&I to 10% EBIT margin, and maybe we have to wait till March, but I’m going to try here anyway. Is it fair to assume Industrial EBIT margin is significantly higher, but probably less than 10% and maybe Commercial is above 10%? Can we kind of get that bigger than a breadbasket sort of quantification?

Here’s what I’ll tell you, Chris, and this is Louis. We see an absolute path to get in our Industrial business, return on invested capital over our weighted average cost of capital for Regal, and that’s our focus. Now, this is not going to be an overnight activity, it’s going to take time. But with the approach that we’re taking to this business around driving cost competitiveness, 80/20, we’re very confident in our ability to improve shareholder value through that effort. Now, Commercial is further along, and we’re excited about doing even more with Commercial and it will come quicker. So I think for now, that’s how I’d like to summarize the response in C&I.

Got it. Thank you for the additional color there. That’s helpful. And again, the new restructuring very exciting not to get greedy, but it seems like you guys are moving quick. So is there more to be announced yet from a restructuring or a plant footprint perspective? And I’m not looking at quantification there, but just can we expect there is still work to be done from a big picture perspective there?

Yes. So I’ll take that one as well, Chris. Absolutely. There is a path. Our – and honestly, our square footage utilization is not where it needs to be and we’ve got some more work to do there. I don’t know that we’ll be providing a lot more guidance in March. But we’ll be giving an overview over the next few years and our thought process around capacity and utilization, but there is certainly a path to further simplification.

Yes, thanks very much I’ll leave it there.

Great. Thank you, Chris.

Our next question comes from Jeff Hammond with KeyBanc Capital Markets.

Hey, good morning.

Good morning.

Hey, good morning, Jeff.

Hey, just to kind of comment the C&I in a different way. So, I think, Louis, when you came in, you had talked about there being some non-core businesses. And just wondering if that inform kind of how you split the two businesses here? And just kind of how you balance kind of getting the margins up versus saying, hey, some of these businesses are non-core and we should just move on?

Yes, it’s a good question, Jeff. I’m actually – and I hope I didn’t say it this way. I’m not a believer necessarily in core versus non-core. I’m a believer in businesses that I think can be positioned well for future success and have good returns and shareholder value creation. So it is not, I’d say, that’s a bit of a strategic change for Regal, honestly, since I’ve started. So, no, I don’t – the split of Commercial and Industrial wasn’t because of core, non-core. It really was all about getting a higher level of visibility, providing a greater sense of transparency and major focus on what we need to do to drive improvement in the performance of the business. So I wouldn’t actually read into core versus non-core with this action.

Okay. And then, yes, I think you mentioned a couple of times the Climate weakness in the order rates. Do you have a sense of what’s going on there? Is it just a milder weather, or is it – there’s some heavy destocking going on? Just maybe speak. And then, as you look at that FER opportunity, like are we done kind of through the pre-buy and we just get the full $35 million, or is there an offset with destocking?

Yes. No, I think you kind of hit the nail on the head with the first two parts of your answer, which is, certainly, mild weather has had an impact on average, the cooling days are down 6% to norm and that has certainly had an impact. And we are also seeing inventory adjustments at our OEMs that are having an impact. But we’re not – we don’t expect this to continue beyond the first quarter. Now there is the FER overhang, which – a $9 million pre-buy in the first-half of the year that we’re still working through. But we – barring any significant changes from a macro economic perspective, we still expect incremental $35 million of sales of the FER solution in 2020.

Okay. And then just one final one. The pool pump destocking, do you think that’s done or is there more to go there?

Through this quarter is our expectation.

Okay. Thanks, guys.

Yes.

Thank you.

Thanks, Jeff.

[Operator Instructions] Our next question will come from Joe Ritchie with Goldman Sachs.

Good morning, Joe.

Hi, good morning, everyone.

Hey, Joe.

Maybe just following on that thread and just to make sure I understand it. On FER for Q1, is Q1 going to have less of an impact or more of an impact than 4Q had in terms of pre-buy?

In terms of pre-buy. So the pre-buy ended at the end of Q2 of last year. And what you’re asking us is, how we work through that full pre-buy, and are we back to normal demand levels for Q1? And I would say not quite yet.

Right. I would add on that, the overhang will linger into the first quarter, certainly not to what we experienced in the fourth quarter, but we are seeing the mix up to higher efficiency motors.

Got it. Okay, that’s clear. And then I know there has been obviously a lot of discussion on the margin opportunity within Commercial and Industrial. But the performance this quarter in both Climate and in PTS just given the volume declines, I thought was pretty impressive. And so how do you think about the longer-term margin entitlement for those two businesses, given that we’re basically sitting here at record margins for both of those businesses today?

Yes, let me take that on. First of all, and I agree and just incredibly proud of our teams, Climate and PTS had a really solid Q4, and for that matter, solid in 2019, even given the tough sales impacts of macro conditions. These are both very well performing businesses and we’re actively looking to invest in driving growth. Now, how do I think about the business? Climate, I think, margin potential is roughly where it is, and so we’re looking to grow. PTS still has some room to improve our bottom line performance, but we’re also looking to grow there. So, when I compare that to Commercial and Industrial, we are strictly focused on margin improvement in Commercial and Industrial. And so from a strategic approach, our emphasis is, 2020 is at climate and PTS will grow. And we’ve also weighted that our team’s incentive plans to growth, while Commercial and Industrial are weighted to margin improvement. All of our incentives at Regal are aligned to the strategic imperatives of the segment. So hopefully, that gives you a sense of how we’re thinking about the four segments.

Yes. That’s helpful. Thank you.

Sure.

Thank you.

Thanks, Joe.

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, in the quarter, we faced some difficult and challenging end market conditions. We feel that we met those challenges and delevered well as we improved performance in consecutive quarters. Looking forward, we are providing adjusted earnings guidance for 2020 in the range of $5.65 to $6.05. This approximate 7% increase at the midpoint over 2019 will mainly be driven by our ongoing 80/20 and cost-out initiatives. We are not forecasting a strong rebound of markets in 2020 and expect the first-half of the year to continue to be challenged, but we will see some recovery in the second-half. Overall, we are forecasting flat to slightly negative sales growth in 2020. We are energized about our reorganization and resegmentation, executing 80/20 and driving improvement in profitability through cost-out and supply chain efficiencies, while staying laser-focused on exceeding customer needs with differentiated products, solutions and services, while ultimately driving profitable organic growth. I hope to see you all at our Investor Day in New York City on March 3. 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.