Hello and welcome to Regal Beloit’s Third Quarter 2020 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to your host today Robert Barry. Mr. Barry, please go ahead.

Great. Thank you, Keith. Good morning, everybody. Welcome to Regal Beloit’s third quarter 2020 earnings conference call. Joining me today are Louis Pinkham, our Chief Executive Officer; and Rob Rehard, our Chief Financial Officer. Before turning the call over to Louis, I would like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of factors that could cause actual results to differ materially from projected results, please refer to today’s earnings release and our SEC filings. On Slide 3, we state that we are presenting certain non-GAAP financial measures in this presentation. We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods and in the same manner as management. Please read this slide for information regarding these non-GAAP financial measures, and please see the appendix for reconciliations of these measures to the most comparable measures in accordance with GAAP. Now, let me briefly review the agenda for today’s call. Louis will be leading off with his opening comments. Then Rob Rehard, will provide our third quarter financial results in more detail. Discuss our fourth quarter guidance as well as share some high level thoughts on 2021 and on potential election impacts. 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. Thanks for joining us to discuss our third quarter earnings and to get an update on our business, and thank you for your interest in Regal. For the second quarter in a row, this unprecedented global pandemic weighed on our orders and sales, impacted some of our key manufacturing operations and supply chain and further tested the endurance of our associates. So before getting started, I’d like to thank all my Regal colleagues around the world for their hard work and resourcefulness as they remain focused on serving our customers while remaining disciplined about keeping our workplace safe. While many of our end markets remain challenged in the third quarter, I am encouraged that a number of bright spots also started to emerge, which we hope will prove sustainable. Order rates for the company turned positive in August and have remained so through October with notable material improvements in our North America residential HVAC business, which saw orders up 27% in September and tracking up 22% in October. While orders in our pool pump business rose 32% in the third quarter and are tracking up nearly 38% to date in October. In addition, two of our businesses, Climate and Commercial returned to positive top line growth in the quarter, nicely exceeding our expectations. While Industrial was nearly flat and PTS narrowed its year-over-year rate of decline materially versus last quarter. With the recovery in North America short-cycle industrial showing early signs of momentum, but upside on that front still ahead of us. We also made significant further progress on our 80/20 initiatives and on executing our multiyear restructuring program, which, as you may remember, we defined before the pandemic arose. Our cost-out plans are firmly on track. Indeed, despite seeing our top line decline…

Thanks, Louis, and good morning, everyone. While the third quarter continued to be impacted by COVID-related pressures, our team turned in very strong performance on growth, margin expansion and free cash flow, including 230 basis points of adjusted operating margin improvement and 171% cash flow conversion. In addition, with our order rates now in positive territory and showing some signs of stabilization, we feel comfortable providing guidance for the fourth quarter and also ending the pause on our stock purchase program. Before diving into our results by segment, I do want to preface that we won’t be speaking about our profitability improvements in terms of leverage or deleverage rates on today’s call, simply because they’re not as meaningful this quarter when we’re generating higher profit dollars despite lower sales. I will note, however, that our cost-out and productivity actions have been significant needle movers this year, resulting in 9% deleverage on a year-to-date basis. Starting with Commercial Systems. Organic sales in the third quarter were up 1.3% from the prior year. The result was driven largely by strength in our pool pump business, which was up almost 20% in the quarter in addition to ongoing share gains in China and to a lesser extent, growth in our North America large commercial applied HVAC business. As we enter October, momentum in pool remains strong with month-to-date orders tracking up almost 38%. Limiting the degree of growth we saw in the quarter were ongoing COVID-related operational disruptions in our Mexico operations, which prevented us from executing on as much of our backlog as we had hoped. But we’re optimistic and expect to see greater progress on this front in the fourth quarter, which should provide a nice tailwind to Commercial’s top line performance. In addition, We saw a roughly two-point headwind from…

Yes, thank you. [Operator Instructions] And the first question comes from Mike Halloran with Baird.

Hey, good morning everybody. Excellent quarter. Great to see the progress.

Thank you so much, Mike.

So first question, lots of information there really appreciated. Just want to make sure I understand how you guys are thinking about the trajectory by the various business units going into next year. Hoping you could weave in what you think is sustainable based on what we’re seeing today, where you think you have maybe a little excess in the short term with restocking versus where you’ve got more restocking that’s on the come. I know you gave a lot of that content in the prepared remarks. But if you wouldn’t mind just going piece by piece and how you’re thinking about the momentum of each of the businesses heading into next year? Just on the top line side.

Just on the top line, yes, sure. This is Louis. I’ll take it and then Rob will likely jump in as well. But I’ll do it by business and then I’ll do it a little bit by market. So, we’re cautiously optimistic. We still see in the PTS segment, it’s early days, and there would need to be a rebuild of inventory in the channel. Climate, it’s – that’s a consumer-driven market for us. We – certainly, our OEMs have reported some nice momentum. We’re seeing that momentum in our order rates. They continue to be strong. Right now, we would also say that there’s a need for restocking in that space where our OEMs are just meeting demand levels, but there’s a need to restock as well. Commercial pool, stay-at-home markets are certainly on the upswing. You’ve seen that reported with some of our peers as well. We feel very good there. We’re even more excited there because of the regulation that comes out in the middle of next year that drives further energy efficiency, which is perfect for our product and our technology. But then I would tell you, Industrial, a little bit more conservative. And not in the data center space, which we’re definitely gaining share. But in anything that has a significant capital investment and whether it’s metals, paper, the large motor applications, we’re just not seeing that kind of rebound. And so I’ll go in too quickly in the market. General industrial broadly under pressure mostly from COVID, but we definitely see with ISM being above 50, some momentum, and we would expect 2021 stronger. Industrial distribution, certainly, there was plenty of channel destocking until mid-June. We’re seeing some modest signs of restocking at this point and expect some upside. As I said, pool pump, anything work-from-home is strong and so strong demand. Residential HVAC, with the warm weather of the summer as well, that certainly helped. And there’s certainly consumer strength and restocking activity. Oil and gas, both midstream and upstream is very weak. And so that again impacts our industrial business and a bit of our PTS business. And then other verticals that we would highlight, data center, material handling bright spots. Some bright spots in agriculture, China, commercial and Australia. Asia Pacific weak construction markets for us right now. And then EMEA – EMEA is still slow. And I certainly think COVID is having an impact there, some market uncertainties and then where we play as well. Our business there is in hospitality with our Commercial Refrigeration space, oil and gas and marine all markets there are under pressure, and we would expect to continue under pressure into 2021. So hopefully, Mike, that gives you a perspective and helps you understand how we’re thinking about it.

No, no, it does. And then on the cost-out side, obviously, really good progress here. Maybe, give some context on what’s next and what you’re seeing that provides the incremental confidence to pull forward the 300 basis points of improvement? And what are the steps that you need to take from here to drive to that goal at a sooner date?

Mike, I think we were a bit in an enviable position because we outlined a three-year cost reduction program as we put together our strategies for 2020. And so we were in again an enviable position that we had started some momentum. And so, to answer your question, why we see the opportunity to perhaps pull this forward is, we still have room to improve here. Manufacturing plant consolidations as we aligned in our Investor Day, would take us two to three years. 80/20 is a driver of everything we’re doing. We have significant simplification around product rationalization that’s going to help us. And we’re continuing to work on, again, a two- to three-year plan. And then our focus on best value country sourcing is really paying off, and we believe will benefit our segments going forward. The last that we really haven’t baked in, in any significant way, but we’re spinning up with is our focus on lean. So, my first 18 months with Regal, 80/20 was absolutely the right place to focus. Decentralizing the organization, getting more accountability and ownership of the P&L, right place to refocus. We are now ready to really emphasize driving lean, focused on process, removing waste, variation and overburden. I commented on the last earnings call that we hired an individual who is a subject matter expert in this space, who now reports directly to me. This is an initiative that we are driving from the executive leadership team. And I think will provide – it’s a marathon. It’s not a sprint. It’s not a – we get it done tomorrow. But over the next three to five years, it will further help us transform our manufacturing and capabilities. So all of these things, Mike, on the cost side, give us confidence that we’re transforming this business. And hey, our fighting team is doing an excellent job.

Last one from me. Really strong cash generation is always really good cash position. You’ve taken the buybacks – the buyback pause off the table. You’re now going to be back in the market potentially. How are you balancing the opportunity set to buy back your own shares versus what’s available in the marketplace? What’s the thought process today? And then how aggressive do you think you could be with either of those external capital allocation decisions?

Yes, Mike. This is Rob. I’ll take that one. So as you know, right now, we’re talking about – we’re going to revert back to our strategy of being balanced in our capital allocation approach. Obviously, including dividends and CapEx on projects that have short paybacks. And as you said, opportunistically buying back shares and also looking for inorganic at the same time. We’re – we can be and will be at the right opportunity aggressive in our approach to organic investment that meets our acquisition target metrics. It’s a disciplined approach. We talked about it at Investor Day, we want to see opportunities with gross margins at 35% range. We want a differentiated product offerings. We want leading market positions. And we’re going to look for opportunities to give us an opportunity to see ROIC above 200 basis points above our WACC by three to five years depending on the asset. So that’s kind of how we’re looking at it, and we will absolutely be balanced, and we can be aggressive at the same time. And both of the – in all of those categories, quite frankly, but in share buybacks and as well as M&A, which was specific to your question.

Let me add on to the M&A theme there too, Mike. Hey, I’m very conscious that this will be my first acquisition, anything that we do in this space. And that valuations must make sense, that there needs to be significant synergies and a clear strategic fit. We’ve seen many opportunities. The funnel is strong. We’ve invested in working a more structured program around the funnel, and we feel good about our funnel. Valuations are elevated, and we’re not going to overpay. But I am sure there are options out there for us. And so to Rob’s point, we will be balanced in our deployment of capital, and I think there will be opportunities in the future.

Hey, thanks a lot for your time. Appreciate it.

Thanks, Mike.

Thanks, Mike.

And the next question comes from Julian Mitchell with Barclays.

Hi. Good morning.

Good morning, Julian.

Good morning, Julian.

Good morning. Maybe, just trying to keep the questions a little brief, see, I guess, on the portfolio, Louis, I think you’d mentioned a fresh look. So that was somewhat intriguing, I suppose. I mean, I had thought that perhaps you might try and push the margins up across the board before perhaps looking to divest some businesses. I wondered if anything had changed in your mind on that front? Or is it simply that the macro environment today is more conducive to assets changing hands and that sort of thing? And how broad or substantive that portfolio of fresh look might be?

Yes. So really, the point of bringing it up, Julian, was that it was brought up at our Investor Day. We just came out of a strategy review with our Board. We are constantly evaluating the position of our businesses, the performance of our businesses. And so I just wanted to emphasize that this is something that is top of mind for me and my leadership team as we think about strategy. I couldn’t agree with you more that there is still significant value creation, shareholder value creation in our ability to run margins up and especially in a couple of our less-performing businesses, certainly industrial. And I couldn’t be more proud of what our industrial business has done to date and believe that there’s more runway there. But at the same time, I think it’s healthy for us to constantly challenge ourselves and say, is the best business – is it – are our businesses best suited with us at Regal or perhaps elsewhere. So it was, yes, perhaps a little intriguing to put that paragraph into my prepared remarks, but it was done in just simply intentionally to reinforce to the investment community that we are focused on portfolio management, we are looking for growth, earnings growth as well as good return on our invested capital, which I think is our responsibilities for shareholders. And so that was the point. Hopefully, that’s clear.

Thank you, Louis. Yes. And then maybe, my second question, just circling back to margins. You mentioned restructuring charges this year of $29 million. Is that kind of the peak year and that drifts down next year? And then on the Industrial business, you mentioned some tailwinds specific to Q3. So what do you think the real sort of baseline margin is today in that segment?

Yes, Julian. This is Rob. Hey, so first of all, you asked about the restructuring, is it a peak. We’re still working through our plans for next year, but this year was certainly one that’s higher than what we may normally experience. Again, it’s certainly tied into some great cost actions that we’ve taken, and we’re reaping those benefits. I wouldn’t expect it to continue at a pace above where we are today, just to answer your question. But certainly, we will continue to have restructuring as we enter 2021. Now, how do we think about industrial margins and progression from here? Hey, we had a – we did have particularly good project levels in the third quarter as we talked about. And a lot of that’s in our data center business, which also helped our mix. And we still see further margin improvements year-over-year in the fourth quarter, but as we said, maybe not sequentially, you may not see that level of improvement. And we will talk more about this on the fourth quarter call. But we laid out a framework at Investor Day that called for 8% to 11% margins for the industrial business. And we absolutely believe that’s the right range to think about industrial margins going forward. We’re tracking as we talked about, ahead of that pace. So maybe, see the higher side of that range. But that’s the range that we laid out, and we’re still tied into that at this point.

Great, thank you.

Thanks, Julian.

And the next question comes from Nigel Coe with Wolfe Research.

Thanks. Good morning. Yes. Nice quarter, absolutely. So, you mentioned there’s a lot of noise around IAQ and you talked about the need for more sort of larger and more efficient motors in that kind of scenario. And Carrier laid out a pretty aggressive sort of opportunity set for that. But I’m just wondering, are you seeing any signs at all that perhaps 2021, we might see a mix up around that issue? And then the second part of that question is a second-part question is as we go from 14 to 15 SEER in a couple of years’ time, does that have any implications for the motor system within the equipment to achieve that?

Yes. So Nigel, I’ll take that. So first of all, are we seeing any indications that there will be a significant upside in 2021 from IAQ? I’d say it’s fairly early days. Now we are in discussions with OEMs. We do think our product and technology positions us very well to help solve the energy consumption and efficiency issues that will come along with IAQ, we’ve already – I talked a little bit about this of having what we think are some plug-and-play solutions that will position us well with OEMs, and we’ve already got one on the market today with an OEM. But I think it’s early days. So I’m not quite ready to comment on, do we think that we’ll have a significant uptick for 2021. With regards to the SEER regulation, absolutely. The next SEER regulation just drives another level of energy efficiency requirements. And again, this is where our technology is, and we’re a technology leader in our variable speed motors and solutions. And so we think we’re going to be well suited to benefit from that. So we see that as a positive tailwind for us.

Great. And then quick follow-on with free cash flow. You’ve been sort of seeing trade working capital tailwinds now for about six quarters. As we sort of turn the corner on volumes, do we need to rebuild working capital into 2021? Or do you think you are steady here?

Hey, I will tell you, Nigel that free cash flow has been very strong, as you’ve seen. Trade working capital has been a source of cash through most of the year. In the third quarter, it was a use of cash, but we do expect it to be a source of cash for the year as we exit the year. And we have more runway to go here, especially in the area of inventory, and we’ve made that point very clear in the way we’ve talked about trade working capital in the past. And so, we are not taking our foot off the gas. We have plenty of runway, and we expect it to be a source of cash as we move forward. Now obviously, that depends on volumes. You always have to build back for volumes, but we would expect steady state – that inventory and trade working capital will be a nice source moving forward.

I think we’ve gained some momentum here. Just to add on. I agree with Rob’s comments. It’s all about now measuring days on hand. And we’ve put a lot more discipline in our organization around inventory management, but there’s still opportunity there. So, I couldn’t agree more this will be – should be a benefit for us.

Great. Thanks.

Thanks, Nigel.

Thank you. And the next question comes from Jeff Hammond with KeyBanc.

Hey, good morning, guys.

Good morning.

Good morning, Jeff.

Just on fourth quarter, good color on the orders and certainly the guide. But just trying to pinpoint how you’re thinking about sales into 4Q, either kind of all in? Do we grow organically? Or it looks like maybe two of the four segments would see growth and maybe two of the four would still be down? Any help there would be great.

Sure, yes. First of all, we would expect further progress on industrial on a year-over-year basis, maybe not a quarter – not necessarily quarter-over-quarter sequentially after the third quarter saw such nice tailwinds from project activity and that sort of thing. But all of our segments are expecting tailwinds in fourth quarter related to the bottom line, cost actions, productivity, 80/20. But volumes are a little bit uncertain and so could pose some degrees of offset. One consideration for Climate is the strong momentum we’ve seen with the large HVAC OEMs and to the lesser – and to the extent that, that continues through the quarter, especially on the AC side, that would benefit volume leverage. It could be a mix headwind for us because OEMs are lower on the margin side. But from a top line perspective, we would still expect to see some nice momentum going forward into the fourth quarter on a year-over-year basis, where we will see pressure is certainly we would expect pressure in both our Industrial and PTS segments to be clear and on a year-over-year basis.

Okay. That’s real helpful, Rob. Just on the long-term margin targets, I mean, we would have thought maybe with the pandemic in between that those get pushed out, but it just seems like you’ve made a ton of progress this year. So just maybe, level set us on more broadly? I know you touched on industrial more broadly, how you’re thinking about progress on hitting those?

Yes. So Jeff, I’ll take that. It’s – again, it’s – we believe we are driving the transformation of the business. And 80/20 was the starting point to help us do so and really have dug into a quad perspective of ensuring that we’re providing the maximum value to our highly valued customers that buy a product, serving them better, providing better solutions in that space. So that has gained momentum across the board, a little bit faster than we anticipated. Plus as we said, we outlined a three-year program to transform, which included plant consolidation, product rationalization and now we’re accelerating our lean efforts. We outlined those at Investor Day, except for lean and lean has now added additional tailwind. So, we are feeling more confident and notice most of that is cost centric opportunities. And then with growth, we believe that the margin potential is there, the potential is there to pull forward the $303 million because that 80/20 is driving us to value the right segments and to put our focus of our sales force on those segments. And then as we talked about in Investor Day, our investment in additional R&D, 100 basis points over the next three years is allowing us to produce – to better understand our customer needs and help solve their problems and develop products that position us for accelerated growth. So, all of these things are giving us more and more confidence that we should be able to pull forward the $303 million.

Okay. And then just to sneak one more in there on the 80/20. Certainly, that’s a top-line headwind and additive to margins. But as we look into 2021, do you still think that 80/20 top line headwind continues? Or is that maturing?

Yes. I’d say, it’s – it will continue, but it will not continue at the extent that we saw in 2020. So it will temper a bit, and then 2022 will temper even a little bit further. We modeled the 80/20 pruning effect to be stronger in year one, but then decline over that period. Again, as I’ve said to the investment community, as I said, say to every one of our associates, we need to provide differentiated products and solutions that solve our customers’ challenging problems cost competitively. And so that’s our focus at Regal.

And the next question comes from Walter Liptak with Seaport.

Hi, thanks. Good morning, guys and great quarter especially, on the margin.

Yes. Thank you.

And the – just a follow-on from Jeff’s question with the 80/20 pruning that was nicely aggressive, I guess, it was a little bit more, I think, than we thought. But why – in the PTS segment, it didn’t look like there was as much, are they just better? They don’t have as many pruning situations they have to go through? Why was the pruning less in that segment?

Yes. I’d say that’s fair, very simple assessment. Our gross margins, and we’ve been pretty clear on this. Our gross margins in our power transmission business are stronger than the rest of the portfolio. And so that likely gives you a first indication that they should have less pruning. And we sell more through distribution in the power transmission business. So of course, that helps the uplift in the margins there. And so I think that’s really the main driver.

Okay, great. Switching over to the comments about climate with the HVAC OEMs. Considering that a lot of the manufacturing is done down in Mexico, and you’ve got the strong residential market going on, is it there a chance for a change in the seasonality, where you see more of that inventory build in the fourth quarter and first quarter, just kind of safety stock building in the channel?

It’s really hard to say right now, because there are quite a few variables out there. One variable is weather. And if weather – if we have a cold winter, there’s going to be a turn pretty quickly to furnace build. Another variable is COVID and the ability for the OEMs as well as us that matter to ramp up the production to be able to meet the demand as well as meet the inventory levels. So, I’m not quite ready to give a clear picture of that there could be a change here. What I can say is that we’ve got some nice momentum. The trailing three-month order rate in the HVAC space is 20% for us, and that’s going to propel us strongly, we believe, through Q4 and should into next year.

Okay, great. And then the last one from me is just on the restructuring from plant consolidation. Has that started yet? Are you – are there are plants – or is that something that happens in 2021, 2022?

No, no. Absolutely, it has started. We’ve communicated that there would be five manufacturing plants that would be announced or closed through 2020. We have not yet communicated the impacts for 2021. So Walter, it has definitely started.

Okay, great. Thank you.

Thanks, Walter.

And the next question comes from Joe Ritchie with Goldman Sachs.

Thanks. Good morning, everyone.

Hey, Joe.

Just a couple of quick ones from me. As you think about the 30%-plus incrementals in 2021. Is there a certain amount of volume that you need to come through the system in order to achieve that? And then secondly, as you kind of think about those margin targets as 300 basis points by 2022, again, similar comment in terms of what you already have within your own control to drive strong margins if the volume doesn’t come back?

Yes. The significant part of the 303 basis points was a cost focus. And so Joe, we feel pretty good about keeping that moment. Of course, we do need some volume to return, but we think the markets are going to provide that kind of tailwind. You asked are we doing – do we need a certain amount of volume to get the leverage going forward? And I’d say it shouldn’t be, I – able to see volume leverage year-over-year going into by segment. Now, we’d tell you that we’d probably lever a little bit stronger in PTS. We’d lever less in Climate, a little less in Industrial, a little stronger in Commercial. But overall, no, I don’t think it’s going to be highly tied to a minimum level of volume that comes with it.

Okay, great. That’s good to hear, Louis. And then maybe my quick follow-on question. You talked a lot about the work that you’re doing on the products that you have for data centers and the share gains that you’re experiencing. Maybe talk a little bit more about what you think is allowing you to gain share in the data center market?

Yes. I’m excited about this business, and I believe that we have further growth opportunities. I’ve got a team that understands the application that is able to easily and with speed customize solutions to better meet the requirements of their customer. This is where we want to drive more at Regal. Deeper understanding of the application and being able to provide solutions that differentiate us and do it with speed and cost competitively. And that team is doing it very well for us. And so I believe there’s runway for us to gain further share in this space.

That’s great to hear. Nice talk everybody.

Thank you.

Yes. Thank you.

Thank you. And as there are no more questions, I would like to return the floor to management for any closing comments.

Thank you, operator. To summarize, while our third quarter results continued to be impacted by COVID-19, a number of bright spots also emerged on orders and sales performance. And I feel extremely good about how the Regal team is executing on our restructuring actions, leveraging 80/20, managing our working capital and selectively pursuing share gain opportunities. We continue to transform this business, and I believe it’s increasingly evident in our results. Most notably, we drove year-over-year operating profit improvement on down sales with 300 basis points of adjusted gross margin improvement and we see a path to material further upside. While we’re still not out of the woods on COVID-19, we’re remaining focused on keeping everyone at Regal safe and on executing what’s under our control to keep moving down the path towards our longer-term gross margin and ROIC goals. Thank you again for your interest in Regal.

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