Good morning, and welcome to the Regal Rexnord Third Quarter 2022 Earnings Conference 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, operator. Good morning, and welcome to Regal Rexnord's Third Quarter 2022 Earnings Conference Call. Joining me this morning 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'd 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 more detail and discuss updates to our 2022 guidance. Louis will then share some brief comments about our recently announced acquisition of Altra. 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.

Great. Thanks, Rob. And good morning, everyone. Thanks for joining us to discuss our third quarter earnings and begin an update on our business, and thank you for your interest in Regal Rexnord. As you saw in our announcement last week regarding our planned acquisition of Altra, it is clear that our team is working on a number of fronts to continue advancing Regal Rexnord's transformation into our faster-growing, higher-margin, more cash generative and higher-return enterprise. I am excited to report that product of those efforts are also apparent in our strong third quarter results. Even in the face of persistent inflationary and supply chain headwinds and some incremental macro-related caution at our customers, our Regal Rexnord team delivered strong third quarter performance. That includes 8% organic top line growth, 120 basis points of adjusted EBITDA margin expansion and further evidence of share gains, supported by our digital and e-commerce investments, new products and competitive service levels. The margin gains we achieved were enabled by a host of factors. Chief among them, continued strong performance, realizing merger synergies, where we remain ahead of plan and continuing to achieve a positive price/cost position. Also notable, the team's disciplined approach to managing working capital improved our free cash flow performance in the quarter. And so as we forge ahead into the fourth quarter, we are firmly on track to meeting our earnings guidance commitment which we have revised to reflect a modestly higher midpoint in our targeted range for earnings per share. For this strong execution, pursued with a sense of urgency as well as continued adherence to our Regal Rexnord's values, I want to say a sincere thank you to our approximately 29,000 Regal Rexnord associates around the world. Turning to orders. We did see some moderation as expected. Daily organic…

Thanks, Louis, and good morning, everyone. I'd also like to send my thanks to our global team for their strong execution in what continues to be a challenging operating environment. Now let's turn to our third quarter segment financial performance. Starting with our Motion Control Solutions segment, or MCS, Organic sales in the third quarter were up 3.6% from the prior year. The result reflects broad-based growth, but with particular strength in the general industrial and aerospace end markets, partially offset by weakness in alternative energy, in particular, the China wind market. Adjusted EBITDA margin in the quarter for MCS was 27.2%, up 30 basis points compared to the prior year, factoring favorable price realization, merger synergies and volume, partially offset by mix, higher freight costs and FX headwinds. As expected, the segment posted a nice, sequential improvement in margin in the quarter. Orders in MCS for the quarter were flat on an organic FX-neutral basis. In October, book-to-bill tracked at roughly 1.0. Turning to Climate Solutions. Organic sales in the third quarter were up 4.9% from the prior year. The increase was driven by healthy price realization and modest volume gains in our North America resi HVAC OEM business, partially offset by modest volume declines elsewhere, particularly in Europe. We attribute our volume gains in HVAC to outgrowth since we believe in-market volumes moderated against a challenging prior year compare. The adjusted EBITDA margin in the quarter for Climate was 16.4%. Factors impacting margins in the quarter include commodity inflation, including plastics, unfavorable mix and higher freight costs, partially offset by strong price realization. We also had some carryover impacts from second quarter related to intentional decisions, the business made to overserve certain high-value customers, which resulted in lower past dues, but also higher freight and component costs. While…

Thanks, Rob. I am sure you are aware, last week, we announced our decision to acquire Altra Industrial Motion. The industrial logic for adding Altra to Regal Rexnord is crystal clear. It transforms our automation capabilities and enhances our industrial powertrain offering, creating clear benefits for our customers and a host of new opportunities for profitable growth. Expected financial returns are incredibly strong. Accretion in year 1, double-digit accretion thereafter. ROIC above 10% by year 5 and a path to a 40% enterprise gross margins supported by $160 million in cost synergies plus upside from substantial expected cross-marketing synergies. Notably, our expected 2025 free cash flow rises from about $1 billion as shared at our Investor Day to about $1.1 billion in 2025. And then to nearly $1.4 billion in 2026 as our interest cost and cash tax rate both decline significantly in '26 and beyond. We believe the valuation is compelling and reflects the quality of the Altra business, its synergies with our business and the transaction's timing. The acquisition is unique because it will deliver significant synergies and catalyze our growth while further enhancing our scale and diversification which improves our already strong credit profile. We have always managed Regal Rexnord as -- in a manner consistent with an investment-grade credit profile, low leverage, abundant liquidity, consistently strong free cash flow conversion and manageable debt maturities. We are larger, more diversified and lower levered than our investment-grade rated peers today, and the acquisition of Altra further enhances our scale, diversification and exposure to resilient end markets. We are adding leverage to fund the transaction, and we believe it will be manageable. We expect our enhanced credit profile will give us broad access to financing in both the bank loan and bond markets. We've designed a permanent debt structure…

[Operator Instructions] And our first question will come from Michael Halloran of Baird.

So can we talk a little bit about order trajectory as you said here and kind of end market thoughts into next year? Obviously, at the Analyst Day, you threw out a low single-digit kind of growth number. We're seeing some weakening in some of the markets, obviously, some nice offsets with what you're doing internally. SEER coming on some other things. So just maybe some commentary on that side and how we should be thinking about things as we track into next year.

Yes, sure, Mike. As a reminder, at Investor Day, we did say 3% to 4% growth, assuming no recession and end markets that are flat to up modestly. That paradigm is still relatively intact, but more uncertain around market. It reflects a 2% to 3% outgrowth tied to many of our growth initiatives and of course, our strong backlog. If investors have a different view on end markets, they can adjust the framework, but we feel very good about what's in our control especially around our digital and e-commerce initiatives, our new product and our superior service levels. We're going to provide more clarity on 2023 when we report fourth quarter. So for now, I think that's about where I want to end my commentary.

Fair. And then what about -- and that was helpful. What about on the channel inventory side, certainly some targeted areas where there seems to be some destocking happening at the customer level. But maybe some thoughts more broadly across the enterprise.

Yes. Some of the metrics are still strong, Mike, I'd say, ISM remains above 50. But as of September, new orders and employment contracts were coming down a bit. I'll tell you in the industrial distribution channel, they're still sounding quite positive. And as you know, we have clear visibility to their sales out and they're still strong. So given that, they are looking at some inventory adjustments, but we're feeling that the industrial channel is still really solid. Now pool is a very small part of Regal Rexnord, it's only about 2% to 3%, but that had a big reset, if you will, during Q3. The HVAC OEMs in their normal pattern they will take down their inventories going to the end of the year. So overall, a little bit more mixed. But I'll tell you, with 50% of our business being in more of that industrial space, we feel pretty good around the industrial distribution and continuing into next year. Now one other comment that I would make is when I look at our business and what we've done to change the portfolio over the last few years, we're about 1/3 early cycle, a third mid-cycle and about 1/3 late cycle. And we're seeing some momentum in that late cycle, non-res construction, aerospace, these are markets that are gaining some momentum, and we feel good about. So a little bit mixed bag. But hopefully, that helped.

No, that helps a lot.

Our next question comes from Julian Mitchell of Barclays.

Just wanted to talk back to the fourth quarter guide on a sort of firm-wide levels. So Rob, you laid out some segment-moving pieces. I just wanted to clarify, if we're thinking kind of enterprise-wide at Regal Rexnord, is the guide midpoint based on kind of mid-single-digit organic sales growth, sort of 21.5% EBITDA margins? Are those the right sort of rough ballpark figures for Q4? And then from your book-to-bill comments, do we assume that orders are probably down sort of high single digits in Q4?

So Julian, thank you for the question. First answer is yes. I assume about low to mid-single-digit growth in Q4, and your EBITDA comment on the margin side is tracking very closely to where our expectations are, maybe slightly below, but pretty close to that based on some of the comments that I made. The second part of your question was related to order expectations as we move into the fourth quarter. And again, we would expect orders to be down a bit in the fourth quarter, maybe low single digits in the fourth quarter.

Yes. And that would be on an FX-neutral perspective, Julian, just to be clear. And so that would probably translate more to down mid- to high single digit, but we do expect orders to be down in the fourth quarter.

That's helpful. And I suppose when -- you mentioned some areas of kind of specific softness, I think, around pool and HVAC destocking and then also China, a little bit softer in the industrial side going into fourth quarter. So maybe just kind of flesh out on the pool and HVAC side, how much sort of destock do you think is needed from this point from your channel partners and customers. And then maybe just flesh out sort of China and how you're thinking about that run rate into year-end.

Yes. I'm going to hit pool quickly because it's only 2% of our sales. And so we think that's leveled out and will continue in the fourth quarter. I would tell you that it doesn't have a big impact on us from an HVAC standpoint. A lot of this is simply the adjustment from order perspective on the fact that our lead times are coming down a little bit as well because of slightly improved supply chains. And therefore, it's really just an ERP demand creation perspective. But the OEMs typically do this in fourth quarter with a slight reduction. We don't see a huge impact, and Rob has already given you guidance on what we expect from a revenue perspective for fourth quarter. And then China, yes, China is under a little bit more pressured than we anticipated at the beginning of the third quarter. China was down 8% on sales year-over-year. It was actually down with a big wind order, 74%. So the total down of China for us was 34%, down 8% because of wind. That wind project is lumpy. I wouldn't take that into consideration in modeling. It's really the 8% down ex wind. And we would say that, that will likely continue into Q4. Now let me be clear, that wind project is an MCS-specific project, it only impacted the MCS business. So hopefully, that helps, Julian.

Next question comes from Jeff Hammond of KeyBanc.

So just on Climate margin, I thought that, that was going to get better, and it stepped down again and I think the trajectory is maybe a little bit less into 4Q than you thought. Maybe just what's changed there and maybe speak to the mix dynamic?

Yes. So I'll take this on, Jeff. Margins did come in modestly below our expectations, really largely due to factors outside our control, a weaker mix, and we saw incremental supply chain and inflationary headwinds, specifically around plastics, and that's a pretty big part of our supply there. Again, we believe the pressures on climate, though are temporary and expect improvement back to normal levels, especially going into 2023. Fourth quarter we'll see modest improvement just around improved mix and overall strong performance. So we're -- climate is a really strong business for us, has lots of room for upside into '23, especially with the SEER regulation and our new products that we're launching. And so we're confident that we'll get back into those high teens and low 20s in 2023.

Okay. And then as we look at the Altra deal and the combined businesses, just if we go back, clearly some concerns over the leverage. If you kind of run the stress test on recession for both businesses, where does that take you from a leverage at a high watermark? And just if you were to get into that situation, anything you can really do to kind of accelerate the debt pay down, whether it be noncore business, divestitures, et cetera?

Sure. This is Rob. So Jeff, I'd tell you that the stress testing that we did with those dramatic shifts in EBITDA that we might stress test for '23 and even '24 still provided -- it never provided a scenario where we couldn't service the debt, the leverage did get above 4%, but still always were able to service the debt. And if there was, and to your second part of the question, which was, would we look to accelerate anything? Hey, as we've commented previously, we are always evaluating our portfolio, but we have no plans at this time to do anything like that. And if we did make that determination, we'll certainly communicate that at the appropriate time.

The next question comes from Joe Ritchie of Goldman Sachs.

Louis, there is some concern around the timing of this Altra acquisition, trying to integrate 2 assets and the resourcing you have in place to do it successfully. Can you maybe just talk a little bit about the timing and then also your confidence in getting after the synergies associated with the Altra deal once it closes?

Yes, happy to. Yes. And I've thought about this a lot and got a pretty thoughtful response here that I'm going to take you through. And it really starts with certainty and actionability. So we maintain a short list of transformative targets that we see as providing a unique combination of an accretive margin growth and synergy that can provide a step change on our continued transformation journey. Altra was the crown jewel on that list for us. And put simply, we did not believe this deal would be available in the future. It wouldn't have been available for us a year ago, and we felt we needed to act. The biggest challenge is finding the opportunity where one of these targets is actionable and acquirable under highly attractive terms while we also have the readiness from an integration perspective and the balance sheet to transact. All of those elements lined up here, which we believe is very rare. The deal metrics are best in class as compared to our Rexnord PMC deal, as well as other recent deals in the PT and automation landscape. We are also ready with a proven integration team on this deal that will quickly synergize and have high visibility into taking out public costs quickly and then dovetailing once we are finished with the PMC footprint moves to be able to move quickly into the Altra moves. The one element of question is leverage, I would say. We did extensive sensitivity analyses on both EBITDA downside, as well as further interest rate increases, looking at past recessions, including multiyear downside scenarios. In all cases, we feel highly confident in our ability to navigate. We also worked with JPMorgan and met with the rating agencies prior to signing to ensure we felt confident in our path to securing the debt we need to close this transaction and maintain our commitment to an accelerated reduction in our leverage. Ultimately, we sat down and outlined pros and cons. We made a disciplined decision based on the facts and data. We debated this extensively, and there are external factors that we cannot yet get into, but we strongly believe this deal as it stands now would not be available in the future. I'm highly optimistic, as is our team, and there's a lot to process here. As more of our investors have time to better get their arms around what we're doing, I'm confident that they will be compelled and as excited as we are about this transaction. So hopefully, that helps.

Yes, that was comprehensive. I appreciate that. Maybe my one follow-up is, once you've got this debt lined up, and I know that you've turned out a lot of your current debt, I'm just curious, how are you thinking about the structure of both variable versus fixed debt going forward? And then secondly, is the #1 priority for you at this point once the deal gets executed to pay down debt?

Joe, 2 parts to this. The first is how are we going to structure this? So we're already out -- we're upsizing our revolver and our term loan. And that's going on right now as we speak over the next couple of weeks. Whatever is remaining, we will then go to the bond market and look to potentially 3, 5, 7, 10-year bonds to stagger the pay down so that we can continue to pay down quickly, and there's no concentration in any 1 year. So we'll minimize that, but at the same time, stagger that so that we can pay down very quickly, and we absolutely have a clear path to paying that down to 2.5x, 3x by the time we're through '24 and then below 2.5 in '25. So very clear path on that front given the very strong cash flow generation of this business. And our priority, and we've been running the company here as investment grade for many, many years as an investment grade profile, our priority will be to continue to pay down debt with the available cash that we have to get back down to that 2 to 2.5x leverage range that we're comfortable with.

The next question comes from Christopher Glynn of Oppenheimer.

I just wanted to go back to the comment on Climate margins, getting back to the high teens, low 20s in 2023. Was that comment meant to capture the full year or kind of a target rate by later in the year?

Yes. It really was to capture the full year. And honestly, when we get into the first quarter, we would expect to be very close to, if not right on that target and then progress through the year in that range. So hopefully, that helps.

Great. And then for industrial, just curious, margins kind of broke out last quarter with some onetime, but held in new target range here. Just curious how that overall pivot to Mexico, relocating the supply chain and staffing there. If anything interesting is going on there, if it's all going according to plan.

Yes. It's really all going according to plan, Chris. I'll remind you, given the size of the industrial business, and we broke out industrial to give more visibility, $1 million shift in performance can be magnified in the margins. The transition to Mexico is going -- we're in a very stable state, I feel really good about the supply chain. The Industrial business is seeing some headwinds around China. And if you look at our profile of our businesses, Industrial has still more presence in China than any of our businesses. China is about 8% of Regal Rexnord; for Industrial, it's 25%; APAC is 35%. So it's a bit more mixed there, and they are seeing some headwinds, and that's really the driver here.

The next question comes from Nigel Coe of Wolfe Research.

Thanks for the question. I wouldn't normally lead off with interest, but it's a big swing in the guide, and there's a big step-up from 3Q to 4Q; 2Q to 3Q to 4Q. Are you baking in future rate increases into that number? Or are you marking-to-market current rates? And given the swing, obviously, in interest, I think the big swing, you previously expressed confidence, Louis, in the high end. Are we now sort of more at the midpoint?

No, first of all, on the uptick in the interest. So certainly, there's 2 components to this. One is based on rate increases that we've seen. And so we're using the yield curves to determine what those -- what our interest rate should be now and going forward that we're plugging into our profile to see where that interest should come out. So there's that piece of it. And then there's a piece that as we've commented from a free cash flow cadence standpoint, we haven't generated as much cash in the first 3 quarters of the year as we normally would. And that's largely tied to inventory levels and what we're doing to kind of overserve our highly valued customers. And so we made great progress in the third quarter and that we're now over 90% and expect to finish the year still at a 95% range as we exit the year, which means tremendous cash flow in Q4. But in Q3, we didn't pay down as much debt as we had anticipated, which also drove some of the interest expense that you're referencing. So those are the 2 components to it that really impacted the number and the take-up. But again, the nice thing is, despite that, we're overperforming from an operational perspective and still able to raise guidance at the midpoint. So we feel really good that we're able to overcompensate for that as well as other FX headwinds that our business has been facing as most others have as well and still performing very well.

Yes. And so I would just add on to that, Nigel, exactly what Rob said. We did state the upper end, we reset the midpoint up $0.05. Operationally, we're performing at that upper end. But the 2 items of the interest rate and FX should not be missed here, bring us to, we feel confident at 10.55.

Okay. That's very clear. And then just a quick 1 for Rob. I think there's quite a big pickup in the accounts receivable allowances from 2Q to 3Q. I'm just wondering if where that landed and what caused that?

It really wasn't anything that went through the P&L. It's related to purchase accounting and the way we account for when we -- for allowances when we purchased the -- or when we merged with Rexnord. So there really wasn't a take-up in the allowance that would go through the P&L, it is more just balance sheet related and reestablishing that allowance here in the third quarter.

[Operator Instructions] And our next question will come from Chris Dankert of Loop Capital.

I guess, looking at the PMC business, organic growth, I understand there's some pretty hefty comp issues there, a lot of noise with the PMC deal. But 3.6% organic, a little bit light versus some of your major distributors and some of your peers here, I guess. Maybe I underappreciated it just the China wind component, but any comment on kind of the organic growth in MCS this quarter and kind of how we're going to trend forward a bit.

Yes. It was a really hard compare bluntly. And it was a hard compare on 2 fronts, winning projects in China, as well as solar projects in the U.S. If you would eliminate those, we would be at high single digits growth. We felt really good about the performance.

Got you. Thanks so much for breaking that out a bit. And then forgive if I missed it, on the PMC synergies, both the sales and the cost synergies, any update kind of on what was realized in the quarter here?

Yes, Chris. We did see about $14 million come through in the third quarter related to the synergies on the PMC deal. That brings us after the third quarter up to about $33 million on a realized year-to-date. And to be clear, we do expect that we should see fourth quarter about $17 million, right, which would get you about over $50 million for the full year and really just a bit ahead of our $70 million targeted exit rate from 2022.

And yes, sorry, go ahead.

That's good. I was going to circle back on with the sales side.

Yes. So Chris, we aren't in a position to give you a specific number here. We're still on our track to get $30 million of incremental sales synergies for this year, but we're not prepared to report on Q3.

The next question is a follow-up from Nigel Coe of Wolfe Research.

I couldn't resist one more. So thanks for the opportunity. Obviously, the leverage is sort of like, Joe, has already made that question. No doubt you'll take down leverage really quickly post the Altra deal. But I'm just wondering, could noncore-asset sales accelerate that process. Is that on the menu opportunities?

You know, and I apologize. Nigel, I didn't hear. Could what sales -- what.

Yes. Noncore asset sales, so to the extent that there are...

I'm sorry, I figured that's what you meant, but I'm sorry, I misunderstood. It could, but we're not in a position right now to comment on that. We are -- we did a full portfolio review, and we'll continue to do so on a very regular basis. But we're not -- we're -- we don't have a clear plan on anything at this time.

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. In summary, the Regal Rexnord team is continuing to deliver very strong performance. That gives me confidence that even if we head into a period of heightened macro uncertainty, our Regal Rexnord team can create value for our customers and shareholders and new opportunities for our associates by focusing on controllable execution, and we have so many value-creating opportunities to pursue. As we outlined at our September Investor Day, we have a path to accelerated organic growth and material margin and free cash flow upside. With the addition of Altra, our targets move even higher. Thank you again for joining us today, and thank you for your interest in Regal Rexnord.

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