Good morning, and welcome to the Regal Rexnord Third Quarter 2021 Earnings Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Robert Barry, Vice President of Investor Relations. Please go ahead.

Great. Thank you, Anthony. Good morning, and welcome to Regal Rexnord's Third Quarter 2021 Earnings Conference Call. Joining me today are Louis Pinkham, our Chief Executive Officer; and Rob Rehard, our Vice President and Chief Financial Officer. Before turning the call over to Louis, I would like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our SEC filings. On Slide 3, we state that we are presenting certain non-GAAP financial measures in this presentation. We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods and in the same manner as management. Please read this slide for information regarding these non-GAAP financial measures, and please see the appendix for reconciliations of these measures to the most comparable measures in accordance with GAAP. Turning to Slide 4, let me briefly review the agenda for today's call. Louis will lead off with his opening comments. Rob Rehard will then provide our third quarter financial results in detail and discuss updates to our 2021 and 2022 guidance. Louis will then come back to discuss the acquisition of Arrowhead Systems, which we announced today. We will then move to Q&A, after which, Louis will have some closing remarks. And with that, I'll 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 the new Regal Rexnord. While unprecedented levels of inflation and severe supply chain disruptions are surely top of mind, as they have been for Regal Rexnord, on the whole, I'm feeling upbeat, especially given our team's strong performance in the third quarter, along with strong market demand, but also because of the tremendous progress we are making, transforming Regal, now Regal Rexnord, into a higher-margin, faster-growing, more cash-generative and higher-return enterprise. Despite many external headwinds in the quarter, Regal Rexnord posted record operating margins and record earnings on a robust 16% organic top line growth. Many factors drove this performance, but a couple highlights include being modestly price/cost positive and achieving market share gains across our portfolio. And with our third quarter's orders up 27% and up at a low 20s rate in October, we are confident we will have healthy top line momentum as we enter 2022. We also closed a transformational merger with Rexnord's Process & Motion Control business, synergies from which should add materially to our margins, free cash flow and organic growth profile over the next few years, particularly as we begin to deliver the benefits of selling our customers an integrated industrial powertrain solution, which, by the way, has already started to happen. I am also extremely excited to announce today our acquisition of Arrowhead, a highly strategic bolt-on that we expect to be accretive to adjusted EPS in year 1, to achieve an ROIC exceeding 10% before year 5 and which promises to open an array of growth vectors for our conveying business, both organic and inorganic. I will discuss Arrowhead in more…

Thanks, Louis, and good morning, everyone. As you just heard, Regal Rexnord had very strong results in Q3, and I'd also like to send my congrats to our global team for executing so well in the face of severe inflation and global supply chain disruptions. Now let's discuss our results by segment, and then I'll walk through our latest guidance, which incorporates us owning the Rexnord PMC business as of the merger close on October 4 and assumes we'll close Arrowhead by the end of this year. We'll start with our legacy Power Transmission Solutions, or PTS, segment. To be clear, these results only reflect legacy PTS. Beginning in the fourth quarter, legacy PTS plus the Rexnord PMC business forms our new Motion Control Solutions segment or MCS. Organic sales for PTS in the third quarter were up 23.7% from the prior year on broad-based strength across every market served, with particular strength in alternative energy, North America general industrial and the conveying business. In addition, the business had meaningful tailwinds from share gains, including from our industrial powertrain solutions offering. Pruning actions were approximately 290 basis points of top line headwind in the quarter. Operating margin in the quarter for PTS was 18.8%, up 600 basis points compared to the prior year. Very strong performance aided by volume, price and permanent restructuring actions. Orders in PTS for the quarter were up 40%, and orders for the new MCS segment are tracking up over 30% in October, both on a daily basis. Turning to Climate Solutions. Organic sales in the third quarter were up 14.2% from the prior year. The increase was driven by broad-based strength in all markets, with particular strength in North America residential HVAC markets, in EMEA and in North America general industrial markets. The business also…

Thanks, Rob. I am very excited about Arrowhead Systems becoming part of the new Regal Rexnord. As you can see on Slide 14, after sales growing at a high teens rate over the last few years, we believe the business is on track to generate roughly $100 million in sales in 2021, split about evenly between the conveyance subsystems and palletizers and depalletizers, which each represent about 40% of the total, and the remaining 20% of sales from aftermarket parts and services. For those who may be less familiar with palletizers, as the name suggests, they automatically load or unload products onto or off a pallet and often operate in conjunction with a conveyor system as products are conveyed to or from them. Regarding end markets, Arrowhead is focused on selling to food and beverage producers with a heavy weighting to makers of aluminum beverage cans, which represented nearly 60% of 2020 sales, with food, consumer staples and other beverage applications each representing roughly 15% of the remaining sales. These are very attractive end markets where we have been looking to gain more exposure. For perspective, our Regal Rexnord food and beverage exposure is about 9%, and we expect it to reach a low double-digit percent of total sales by adding Arrowhead. Within beverage, aluminum cans, in particular, are expected to rise in popularity from a strong secular shift away from single-use plastic bottles. Aluminum cans are lower cost for producers and are easy to recycle with extremely high recycling rates and yields, which drives meaningful environmental benefits, a big reason consumers increasingly prefer them. We see this shift from plastic to aluminum continuing for some time and also gaining traction with packaging formats for a variety of other products outside of beverage such as personal care and home cleaning…

[Operator Instructions] Our first question comes from Mike Halloran with Baird.

Congrats on managing through all of these moving pieces here, really impressive.

Thanks, Mike.

So first, let's start on the capital allocation side. Obviously, the positive Arrowhead announcement, which you guys just -- you spent a lot of great detail on. Also announced an uptick on the buyback plan here. So kind of a twofold question. One, how are you thinking about the buyback plan? And how aggressive are you willing to be? And then secondarily, what does the funnel look like beyond what was clearly a nice fit with this tuck-in here?

Sure, Mike. Thanks for the question. It's Rob. So as you know, we don't preannounce plans to do stock purchases, but certainly, we want to have the increased flexibility on this front. We -- for a while there, as you know, we were a bit limited on the buybacks that we could be involved with through the merger timing. And so therefore, we're a bit -- put on a bit of a pause there over the last 6 to 9 months. However, now going forward, we do expect to go back to a more balanced approach, which absolutely includes buybacks, and expect that to be part of our approach going forward. And then I think from the M&A standpoint and the funnel standpoint, I'll let Louis chime in.

Yes. Let me add on there, Mike. As we said and have continued to say, we're going to be very disciplined in our approach. Our funnels are strong. We are looking at assets that make us stronger. But they have to meet a strategic need, but also meet our financial metrics of being above 10% by year 5, EPS accretive year 1, and they need to make us stronger. And so I'd tell you, our funnels are in a very good position. Of course, we're very focused right now on the merger with PMC and achieving our integration synergies, and I couldn't be more excited and proud of our teams. We're well on our path. Arrowhead is another example of bringing on a great asset that's going to make us stronger. And I'm just going to emphasize Rob's comments about the buyback. The increase was stated because it shows how the Board and Rob and I feel, the high confidence we have in the value creation that we have at Regal Rexnord right now and the opportunities to buy back. So we'll be balanced, but we're really excited about where we are, the strength of our balance sheet and the opportunities coming forward.

Great answer. And then secondarily, kind of an open-ended question here. Obviously, the order trends remain very good through October. Based on the commentary, it seems like the inventory replenishment side is still ahead of you. But you also have a ton of challenges from an industry perspective, just managing through getting supply, getting things out the door, capacity constraints, logistics, everything, right? So how are you thinking about the demand cadence and the sustainability of the demand cadence as we move forward from here and what the sustainable health looks like of a lot of the markets you serve?

Yes. So there's quite a bit there, Mike. And honestly, it's what we deal with every day. There are lots of constraints in the supply chain. There's certainly inflation going on and logistic constraints as well. Demand is strong. Demand is strong across all of our markets, bluntly. Maybe Australia and Southeast Asia, which is a small part of Regal Rexnord, has been a bit more affected by COVID over the last 3 to 6 months. But everywhere else is strong. Europe has certainly rebounded. All of our North American markets are strong. Now from an inventory perspective and restocking, the supply chain constraints are challenging our ability to restock the HVAC market in particular. Pool has need for further restocking as well. But bluntly, there's been constraints in getting resources, contractors for new pool installations. And so we actually expect a little bit of a slowdown in pool demand in fourth quarter because of that, not because of the underlying demand, but because of the constraints. And then our industrial markets are still restocking. And so all of this tells us right now that we're going to go into 2022 with a strong tailwind demand-related. So we're feeling pretty bullish going into '22 as long as we can effectively manage the supply chain constraints. And I couldn't be more proud of our teams and what they're doing. Every one of our sites has a war room around supply chain issues. But it's the over management, the discipline over management that would ensure our success long term.

Our next question comes from Joe Ritchie with Goldman Sachs.

Kudos as well on executing the transaction and announcing another deal.

Thanks Joe.

So Louis, maybe just kind of trying to parse out the guide. I know there's a lot of moving pieces here. You guys gave us a sales number, this $5.1 billion for 2022. It seems to imply mid-single-digit-type organic growth, if I'm doing my math right. So can you just -- maybe just give us a little bit more color on what's embedded from an organic growth perspective and how you're thinking about pricing as well as a component to the full year guide.

Sure. Joe, honestly, the top line guide at this point is a little premature. The point of showing that summary was to say that we are being consistent in our communication of where we think we can go with the business. We're just starting our operating plans that we'll be meeting with all of our teams over the next 3 weeks, and we'll get more clarity. So perhaps a little conservative on the top line, to be blunt. And so I don't really want to elaborate on how we got to that number other than saying we said that we would be at $5 billion of revenue roughly in 2022. And then with the addition of Arrowhead, it takes us to $5.1 billion. So hopefully, that's a sufficient answer for you now. We'll certainly elaborate on that much more as we give fourth quarter results. But let me talk about price/cost for a second. Again, I couldn't be more proud of our teams on how they're managing price/cost. There is no question we're in an unprecedented inflationary period. And we're leveraging our 80/20 tools to ensure that we are pricing strategically but ensuring that we're passing on price and not absorbing the full impact of inflation. And in third quarter, we were price/cost positive, and we envision that continuing in fourth quarter and in 2022.

Got it. That's super helpful. Maybe my quick follow-on, just to clarify, on the synergies from the deal, are we still expecting $70 million to come through in 2022? Or is that more kind of like an annualized run rate number that you'll hit by the end of the year? I just want to make sure I've got that buttoned up.

Yes. $70 million is the annualized run rate that we're expecting at the end of '22, but what I can tell you is our teams are targeting above that, so that we are driving hard. We are -- couldn't be more excited about the cost synergies opportunities with the merger. And then again, I can't -- when we talk about synergies, I can't leave without saying we're thrilled as well around the cross-marketing synergies. The 2 teams have come together in the first 4 weeks and identified lots of opportunities of how we're going to take legacy PMC and legacy PTS products into multiple channels, how we're going to strengthen our industrial powertrain offering. And our objective is to outgrow our markets by 50% with all of the cross-marketing capabilities. So more to come with that again as we get into 2022 at fourth quarter results, but I couldn't be more excited around synergies for Regal Rexnord.

Our next question comes from Jeff Hammond with KeyBanc.

So just on supply chain and the pinch points. I guess, one, you had talked last quarter about being able to pick up market share. Is that still the case? And then outside of industrial, it didn't seem like there's really any things getting worse or impacting results. Maybe just level set us on that.

Yes. So I would agree with you. Our teams are doing a phenomenal job of managing the supply chain. I can tell you, though, that everyone is burning the midnight oils to be able to do that, and it's been an unprecedented time. So maybe this is my third or fourth time thanking my team, but the team -- without that team, we wouldn't be here, and the performance was solid. So thanks for that acknowledgment. I do believe we're gaining some share. On the margins, no question, but gaining some share. And that's all because of the hard work of those teams, whether that's some share in our HVAC and combustion side of our business, the move to more efficient, higher technology, variable speed motors and air-handling solutions, gaining some share in our climate distribution as well as our climate European business. On the Commercial Systems side, I couldn't be more excited about our digital customer capabilities and the share that we are driving with our small- and medium-sized customers and the new product that we launched to meet the pool regulations of 2021. It's highly differentiated, more compact, better performance and at a better cost position than anyone in the market today, and we are gaining share. And then lastly, our PTS business, now our MCS business, doing a fantastic job with their tiger team around the powertrain and seeing some nice wins in conveying as well. So all in all, yes, the team is hitting on all cylinders. So really excited about where we are.

Okay. Great. And then just on the '22, one, I appreciate the early color and I know it's early, but just can you give us a sense of what you think the pro forma free cash flow generation of the business looks like?

Yes. Sure, Jeff. This is Rob. We absolutely believe that the pro forma cash flow generation will be 100% conversion as we've had with our legacy business. We expect that to continue going forward. So that's where we are at this point. Of course, again, we'll restate that it is still early days, but we're working through that as we go through our annual planning process, which is upon us at this time. And we'll continue to update you as we get -- as we announce fourth quarter earnings and talk about guidance again.

Our next question comes from Nigel Coe with Wolfe Research.

You had us a bit worried last night with the delayed results. Some companies would do that to try and hide stuff, but it seems like the acquisition was probably the reason. So thanks for that. So again, the color on '22 is great. I want to just dig into Arrowhead a little bit more. The 18% [ start ] with CAGR without too much help from end markets, so I'm just wondering the confidence on the low double-digit-type growth rates in the next 3 years. Does this -- is this a business that carries much backlog, gives you confidence in that number? And then on the synergy side, $8 million seems like it might be leaning conservative. And I'm wondering, is there a component input cost synergy where legacy Regal is supplying components to Arrowhead? Just wondering if that's part of the synergy.

Yes. Sure. So a couple of things, Nigel. So you're absolutely right, the whole reason why we waited until this morning is we wanted to give the opportunity for the Arrowhead team to be communicated to before the announcement went out. So nothing bluntly nefarious beyond that. So not -- no concerns. Second, this is a business that has seen significant growth. And I would disagree with you slightly. The fact that the business leans highly to aluminum cans, that market, there's a secular trend away from plastics to aluminum. And actually, there's a capacity constraint in the United States today in aluminum cans, which will drive more demand for palletizers, depalletizers and conveying systems. And so that move towards more environmentally friendly solution is going to be a benefit for this business going forward. Add that to the fact that this business brings us improved knowledge around control systems and that we will be able to leverage our ModSort into their markets and segments and then conversely, leverage their products and solutions into our markets and segments, that's going to be win-win. And then the last win-win is exactly what you said, which is there are opportunities for us to leverage the -- our product portfolio in the power transmission space to sell to Arrowhead, but also then to sell to Arrowhead's customers. So all of this is a benefit. Now with regards to the synergies, you know how we like to work. We like to set objectives that we can drive to and run to hard and achieve and beat. So I'll certainly tell our team that we've got a little more to push there, but we feel good about the $8 million by year 3 and the $12 million by year 5.

Great. And then just digging a little bit more into price/cost. I agree with Joe's math, it looks like mid-single-digit core growth is sort of like what the $5 billion reflects. Just wondering how much of that, I guess, mechanically today could be price as we wrap into '22. And I'm just wondering if you could just bring us up to speed on where we are with the NPS within climate.

Yes. Sure, Nigel. Let me start with the last question with the NPS on climate. So we are now caught up and we caught up in the third quarter, late second, early third quarter on the 2-way material price formulas within the climate segment and other parts of our business as well are now largely caught up. Again, inflation continues to move in the wrong direction, and it's -- there's always a 3- to 4-month lag, but we're seeing the benefits of that as we exit the third and expect that to continue through the fourth, which should be a nice tailwind as we move into 2022.

And so I think, Nigel, for that reason, we're not quite ready to give you any more specificity for '22 on the impact of price or growth beyond what we've said.

Our next question comes from Walt Liptak with Seaport Research.

Congratulations, guys.

Thanks, Walt.

Just wanted to ask a couple of -- the comments about 80/20 sounded very positive. It sounds like everybody is speaking the same 80/20 languages. And so I guess, we knew that as you announce the deal, but what does that mean for some of the synergies and especially for the cost savings? I wonder if there's buckets of savings either around factories or procurement or other things that 80/20 is going to get a bigger lift.

Yes. Walt, I wouldn't say so, not yet. I mean we came into this with a very clear understanding that the former Rexnord PMC group and the legacy PTS group understood 80/20 well, and that was all modeled into our synergy planning. I will tell you, it drives everything we do. We talk about the Regal Rexnord business system as being a bus and 80/20 is the steering wheel. And it directs our -- all our efforts, whether it's new product development, operational synergies or purchasing synergies. So at this point, I wouldn't say it's really had any change in the way we're thinking about $120 million by year 3 and a nice buffer for upside.

Okay. Great. And just on the Arrowhead business, I want to see if I can get a clarification. Are you selling to the food and beverage customers or are you selling to systems integrators? And is there a point at which -- in conveyors where you may be in conflict with some of the installers, some of your existing customers?

Yes. So we're selling to both. And again, our -- the Arrowhead offering is the depalletizers and palletizers, there's 0 overlap there. There's slight overlap with conveying. But the reality is we're -- our customers are looking to us to provide more subsystems, and this is why our ModSort has seen significant growth over the last 2 years. Two years ago, it quadrupled in revenue. Last year, it doubled in revenue because our customers are looking for us to provide that subsystem, and Arrowhead just strengthens that. So we have modeled very little dyssynergy with this acquisition. We don't see that as a concern.

Our next question comes from Christopher Glynn with Oppenheimer.

Nice presentation today. Wanted to talk about the share gain comments around the industrial powertrain offering. Wondering if we could get into some examples of specifications, wins and what maybe changes you're implementing in terms of go-to-market there.

Yes. Sure, Chris. I'd be happy to. We purposely left an example out of this earnings call because we knew we were going to go long. But I'd encourage you to go back to the last 2 where we gave some very specific examples. But where we're seeing wins is anywhere where -- for example, a warehouse where there is a conveying system. There's an example that we've talked about historically around the customer was having challenges with their gearing failing. We went in with our application experience, and we were able to identify that they oversized the motor and they had the -- not the optimal gear solution. We gave them a solution that would save them money and has reduced their downtime significantly. And we can put numbers behind every single one of those claims that the customer will validate. And so it's those types of examples where we're seeing wins. Bluntly, our customers don't have the level of engineering expertise and capabilities that they've had in the past, but we do because we know those products and those solutions, and we know how best to put a motor with a gearing system, with a couplings and bearings and provide a full industrial powertrain, and that's where we're seeing some wins. So we'll make sure and we'll continue to emphasize those benefits as we go forward.

Okay. Great. And then a clarification on the positive price/cost comments. Is that for an actual margin rate or OP dollars?

That's on dollars. That's a dollar basis. It's actually dilutive to margins for us and to leverage if you -- just because we're not -- the price that we're getting does cover the inflation dollars. But again, as I said, it's certainly dilutive to the margin.

Yes. Chris, I'll just add on there. Historically, Regal has been very focused on price/cost neutral and being positive. We are now focused on price/cost positive because of that reason. And so I couldn't be more proud of the team and their efforts in getting us an improved price/cost position in the third quarter.

[Operator Instructions] Our next question comes from Chris Dankert with Loop Capital.

I guess the -- one of the very few areas of critique, I guess, how do we think about the cost actions going on in commercial and industrial? Obviously, very challenged from a cost and inflation perspective. Just kind of can you give us an update on some of the structural actions that are going on there and kind of what we can expect in the next 6 to 9 months here?

Yes. So let's take commercial and take them out very quickly because I'd say they're performing very well. And no question that there is some pressures, but the team is doing a great job of leveraging 80/20, of rationalizing our products and solutions and making sure that we're getting a sufficient price. So I think you will continue to see solid performance out of Commercial System. Industrial, it is our biggest challenge, no question. Now you also know it's our lowest gross margin business. And so when you have lower gross margins, that means you have a higher material cost as a percentage of sales and so, therefore, a higher impact of inflation. You add that with the fact that you've got global supply chain disruptions at a time when we launch a new product in a new manufacturing location in Mexico that still has a long supply chain right now. And those delays are being realized in tough margin performance. Now we still see value creation for this segment. We still see a path to 8% to 11% as we discussed at our Investor Day, but it's certainly delayed. And so I would not expect any grand improvement in the fourth quarter, but we will continue to improve through 2022. And again, our goal is to get this business to 8% to 11%. I'll make one last point about the industrial business. I realize that industrial's EBITDA is 5% of Regal and will be less than 4% of Regal Rexnord. So we talk about it because it's a segment, but the reality is it has a small impact on the overall strong performance of Regal Rexnord.

And then just to follow up, I guess, any update on the pruning actions? I mean it's -- you guys have been really taking a focused approach to some of the cuts here. I guess do we expect the pruning to kind of continue at the current rate for the foreseeable future? Or should they kind of start to taper as we get into the new year, would you expect?

Yes. No, I'd tell you, 80/20 is -- we -- that's the direction we drive all of our discussions. And so pruning will continue into 2022. It will moderate a bit. But we are focused on the quad and the quad analysis. And so the quads are looked at once a quarter. They are trended. And so a new quad is still going to show, for example, the fourth quad, which is B customers and B products, and we're going to still have to take action on them because they don't belong with Regal Rexnord. They need to be served. They can be served through distribution. We need to move those customers on to A products, and we need to grow with those customers or they don't belong. So I do think it will moderate a bit, Chris, but you'll continue to see us talk a lot about 80/20 and pruning going forward.

Congrats on the results on the deals here, guys.

Yes. Thanks so much, Chris.

Thanks.

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, and thanks to our investors and analysts for joining us today. I hope you got a better understanding of why, despite so many external pressures confronting our business, I am excited about and confident in the future of Regal Rexnord. These external pressures are real. We are battling them daily, but we're also being disciplined about our execution on our organic growth and restructuring programs, pursuing PMC merger synergies and vetting new capital deployment opportunities as we think about how best to leverage our clean balance sheet and strong cash flow to keep enhancing shareholder value. Thank you again for joining us today and for your interest in Regal Rexnord. Have a good day.

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