Good morning, and welcome to the Regal Rexnord Third Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would like now to turn the conference over to Robert Barry, Vice President, Investor Relations. Please go ahead.

Great. Thank you, Alan. Good morning, and welcome to Regal Rexnord’s third quarter 2023 earnings conference call. Joining me today are Louis Pinkham, our Chief Executive Officer; and Rob Rehard, our Chief Financial Officer. I’d like to remind you that during today’s call, you may hear forward-looking statements related to our future financial results, plans and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we described in greater detail in today’s press release and in our reports filed with the SEC which are available on the regalrexnord.com website. On Slide 3, we state that we are presenting certain non-GAAP financial measures that we believe are useful to our investors, and have included reconciliations between the non-GAAP financial information and the GAAP equivalent in the press release and in the presentation materials. Turning to Slide 4. Let me briefly review the agenda for today’s call. Louis will lead off with his opening comments and an overview of our 3Q performance. Rob Rehard will then provide our third quarter financial results in more detail and provide an update to our guidance. 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 to get an update on our business and for your continued interest in Regal Rexnord. Our third quarter can be characterized by strong controllable execution against an end market backdrop that became weaker than we expected in the quarter, causing us to fall short of our sales and earning expectations for the quarter and for the year. Our strong execution is most evident in our cash flow performance. We generated $162 million of free cash flow in the quarter, keeping us firmly on track to hit our target of at least $650 million for 2023, even with the lower sales and EBITDA expectations. What we generated in Q3, plus some cash on hand, allowed us to pay down $185 million of debt, which is further lowering our interest expense forecast. Our team also delivered roughly flat adjusted EBITDA margins, down 10 basis points versus prior year on a pro forma basis, as our top line fell by 8.5% on a pro forma organic basis, implying a deleverage rate of 22%. We also made significant progress rebalancing the portfolio towards our most profitable growth opportunities by reaching an agreement to sell our industrial motors and generators businesses for cash proceeds of $400 million, which is on track to close in the first half of 2024. Adjusting for this sale, our enterprise gross and EBITDA margin should rise by over a 100 basis points. And because we intend to deploy all net proceeds to debt reduction, we should be able to accelerate our balance sheet deleveraging. At the same time, we believe our associates in these businesses will benefit by joining an organization that is more aligned with the growth strategy in global industrial motors…

Thanks, Louis, and good morning, everyone. I’ll also begin by thanking our global team for their hard work and disciplined execution at a time when we are facing challenging end market headwinds. Now, let’s review our segment operating performance. Starting with Automation and Motion Control or AMC, organic sales in the third quarter, pro forma for the Altra acquisition, roughly flat to the prior year, reflecting strength [ph] in the data center, aerospace and medical markets, tempered by weakness in general industrial and global factory automation, particularly the short cycle booking ship business. I will also point out that year-to-date organic sales growth for the AMC segment is up 5.1% on a pro forma basis. Adjusted EBITDA margin in the quarter was 24%, in line with our expectation and up 130 basis points versus the prior year on a pro forma basis. The margin performance reflects pockets of strength in mix positive markets such as data center, aerospace, and medical, along with favorable price cost, strong operational synergy realization, and discretionary cost management. Orders in AMC, on a pro forma organic basis we're down roughly 20% in the third quarter on a daily basis with book-to-bill at 0.86. We expected orders to decline in the quarter versus prior year as supply chain lead times and inventory levels normalize. However, order intake was lighter than expected in our book ship business as more cautious general industrial end markets pushed out inventory replenishment orders. This was most pronounced in our businesses with factory automation exposure where blanket orders and inventory buildup had been more significant. In October, book-to-bill tracked at roughly 1.1, which we are pleased by, but the order mix is still weighted more towards new projects with longer shipment dates versus in-quarter book and turn. For perspective, AMC's third quarter…

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

Hey. Good morning, everyone.

Good morning.

Good morning, Mike.

Yes. Let's start on Slide 12 and kind of wrap what you're seeing today into why there's confidence in next year. You look at the year-over-year read on 2024, and it certainly reads more positive than some of the in-quarter trends that you were highlighting. So as we think about that picture you're painting for 2024, how much of that is just destock comps? How much of that is Regal's, in Regal's control with some synergy benefits on the revenue side or some drivers of outperformance versus fundamentally thinking the market is going to get better from an end market perspective? And any color you could give there would be great?

Yes. Great, Mike. Thanks for the question. We are feeling a little bit more bullish about 2024. And a big part of that is the destock and the destock especially in the consumer space. We're not expecting a significant rebound in the NAND, if any, for that matter from an end-user demand perspective. But because of the destock we lived through in 2023, we expect positive momentum going into 2024. A lot of our markets that are more secular-driven, aerospace, data center, medical, alternative energy. Those are going to continue to be strong into 2024 and our efforts to expand our servable [ph] market with new product in those markets is going to help us as well. And then when we look at a couple of other markets, for example, non-res construction, which I think could have some additional tailwinds around some of the stimulus in the United States as well as the investments in data center, we will – we're very well positioned there. On top of that, I would say we're bringing up new products, air handling products, products to support the heat pump market both in the United States and in Europe, as you probably know we do not have a strong residential HVAC positioning in Europe. And so this will be an opportunity for us next year. So overall, we're feeling that 2024 should be a bit stronger. Short-cycle industrial is a bit of a question mark for us right now. And we certainly saw more than we expected destocking in Q3 and a little bit more slowdown in demand. We expect that destocking though is ending. And certainly, IPS's orders being up in October year-over-year gave us some confidence, but hopefully that helps you understand how we're thinking about 2024 and we'll give much more guidance on this at the end of our Q4 earnings in July or excuse me, in January.

The only thing I would add, Mike, to that is that you also asked about synergies and how that might help benefit the business as well. And so I would add that we do expect to realize the $65 million in synergies here in 2023. And then there's another $90 million of synergies in 2024, which is about $45 million for PMC and carryover and then about another $45 million for Altra. So that's how you get to that extra $90 million that will certainly help on the bottom line as we move through2024.

That helps. Thanks. And then is there any way to quantify what the destocking impact was this year in dollar terms, percent terms, anything to help understand the magnitude?

You know what, Mike it would be a little bit of a guess for us. We're saying probably about two-thirds of the headwind in PES was likely due to destock this year. And then I would tell you the headwinds that we saw in IPS in Q3, I'd say two-thirds of the headwind specific to Q3. And the – on the factory automation side of AMC, I'd say about two-thirds as well was destock specific to Q3.

Okay. Thank you. Last one then; maybe just talk about the operational headwinds you saw in the quarter as you're going through these, I think it's natural to have quarters where everything doesn't go smoothly, and you have to make some adjustments. So I suspect I'm just more interested in understanding why you think this is not going to linger into next year? And if there's any remediation that's necessary here, I'm going to guess no because again I think you directionally have your hands around it. But anything that you've gotten from a lesson here that we can take forward, and comfort level that this is behind you once you exit the year?

Yes. So thanks, Mike. And we do think we have our arms around this. And we do not expect these inefficiencies to continue into next year. First of all, I want to emphasize that our goal is always to execute any of our restructuring actions with zero customer impact, and our track record has been pretty strong here. When you look back to our 303 plan a couple of years ago, we actually reduced in 23% of our manufacturing square footage and closed 21 facilities and had very little customer impact. And so that was the decision in Q3 is that there were actually four site consolidations going on at the same time. A couple of them were a little bit more complex than we anticipated. And so we took on more headcount and inefficiency at the receiving plants to ensure that we could have high quality and service levels to our customer. About half of that will reduce in Q4, and it will go away fully into next year. And so it gives us an ability to think about the planning of next year a little bit differently we still have every expectation to achieve our synergy objectives. But this learning gives us an opportunity to be better prepared because we'll be making moves next year as well. And so right now, we feel good about our approach. I'm proud of our team and the decision they made in Q3 and I feel confident that we'll have this behind us by the end of the year.

Thanks for that. Track record speaks for itself prior to the quarter. So really do appreciate the color. Thank you.

Yes. Thanks Mike.

The next question comes from Julian Mitchell from Barclays. Please go ahead.

Thanks and good morning. Maybe my first question was just trying to think about next year again. So it sounds like based on Slide 12 and some of the comments around synergies that are kind of a base assumption should be maybe flat to slightly up core sales. And then on the EBITDA front, we have the $90 million of synergy incremental and then maybe sort of, I don't know, $80-ish million maybe from sort of base EBITDA from the acquisition. And then on the rest of the sort of base business, should we get some operating leverage there? Are you accelerating any cost cutting or for now I think it's safer just too sort of assume the quarter of Altra year-on-year and then the synergies?

Yes. So I think the way you're outlining it here makes a lot of sense and is how we're thinking about 2024. Now to be clear, Julian, we go through our operating planning in the November timeframe. So we'll give a lot more guidance on this in January. But I think you are painting the appropriate picture. I would tell you that from a PES standpoint, those stronger margins that we saw over the last couple of quarters will continue into next year, we did consolidate one factory in PES. So we have lower fixed overheads. So there'll be, I would say continued nice leverage in our PES segment. And then really, the commentary around the synergies affects mostly IPS, but somewhat AMC as well. And as you can imagine, when things flow we tend to get very operationally focused and we tightened our belts. And so there will be some cost save that continues into next year also. So overall, the way you're describing it is a great starting point.

And maybe just my second follow-up would be around, in terms of – when you look at the history of Altra and your own history of the sort of some of the base motion control businesses, thinking about the sort of typical downturn, duration is maybe three, four quarters and you're obviously entering it now in the second half of this year, IPS, I think you're in the third quarter of that downturn now. AMC in the first one, it looks like. So are we assuming based on history and sort of your best guess it's maybe a sort of a four-ish quarter downturn again on core sales? Or is there something different about this downturn versus history?

Julian, I'm not the one who want to try to call the cycle here. I do think we're coming out on PES. There's a slight slow in IPS and parts of AMC, although other parts are very strong, medical, aerospace, data center up double digit for us and feels really good. We're going to stay very focused on what we can control, and we've got a lot of levers to pull. The only difference, I'd say, perhaps from the past is that the supply chain normalization that's going on and the incredibly strong backlog that we still have in IPS and AMC. AMC's backlog is probably 50-plus percent over normal AMC run rates and IPS is about 45% over normal run rates. And therefore, I don't – we're not forecasting it's going to be a large impact because of those strong backlogs where we stand today going into Q4 and next year.

Thanks very much.

Sure. Thanks Julian.

Our next question comes from Jeff Hammond from KeyBanc Capital Markets. Please go ahead.

Hey. Good morning guys.

Good morning, Jeff.

Can you hear me?

Yes. Good morning.

Just maybe to step back, I mean, I think after the Altra deal, you talked about $18 in earnings maybe $15, if the end markets were flattish. Leverage kind of 2.5% to 3%; I think exiting 2024 and then some margin targets. I'm just wondering with this reset, how maybe we snap the line a little bit differently on some of those long-term targets?

Yes, Jeff, I think the way you described it is its pretty spot on. What we came out with is that a statement of we have a path to 40% gross margins and 25% adjusted EBITDA margins. And with the divestiture of industrial, that path is even clearer and maybe a point above, as I shared in my prepared remarks, a plan to get to $1 billion plus of free cash flow. We feel good about that. There are still some levers to pull around trade working capital. And so then it comes down to the sales. Our original planning would have gotten 4% to 6% organic sales growth to get to $18. And I think you're right, it's slightly over $15 at flat sales. Now we expect through the next couple of years that the market will rebound and that we'll see some sales growth. What that is, I'm going to not opine upon right now. But we would expect markets to rebound. On top of that, significant investment at Regal going on right now, doubled our vitality in the last three years. We have an intention to double our vitality in the next three that will help us through expanding our serve market with new products, very focused on over servicing our A customers and our A products. And so that will help us accelerate growth. So right now we’re not ready to come out with an update on the top line. We would expect growth. It’s likely not the four to six that we were thinking a year ago it could be. But it’s going to depend on where market is. And then we’re going to definitely outgrow market is our expectation.

And I would just add, the other side of your question around the leverage as we kind of move through the cycle. We absolutely have a clear path to continue to reduce our debt and get our leverage rates down to that, that we talked about during the longer term, despite the reduction that we might see in EBITDA. So it’s very strong free cash flow generation expected going forward to do that.

Okay. And then just shifting gears to HVAC, it seems like most of the OEMs kind of didn’t really surprise anybody. I think they were all kind of claiming destocking has run its course, which is maybe good for you guys. But I’m just surprised by the magnitude of kind of the miss in trends. Just – I don’t know if that’s – did you not appreciate the magnitude of the destock, was it more aggressive? Are there some share dynamics? Is there more some product line simplification? Just what are the moving pieces on the miss there? And then just on this refrigerant change, some guidelines came out just are you kind of indifferent to that or how does that impact? And as people redesign, how are you feeling about share opportunities? So a lot of questions on HVAC, but thanks.

Yes. So first of all, I think it is important to remember that resi-HVAC is only about 30% of our PES segment where we saw – we do feel like the AC side has gone through its destock. We expect furnace to be to go through in Q4 and maybe a little continuation into Q1, but not significant. The bigger issue that we saw in surprise in Q3 was around the general commercial space and the slowdown in demand and the destock that we saw there. And so that was really more of the pressure in PES than it was a resi-HVAC pressure. Now the – with regards to the refrigerant change, this should be an opportunity for us. It is just all of our OEMs will need to redesign to meet that change. And we have the right product, whether it is our ECM motors, which tends to be a mix up. It is our air moving solution, which tends to be a mix up, or it’s our drive solution, which is a new technology that we brought to bear that’s going to help achieve that system – overall system requirement with the new regulations will be a mix up. So all in should be a positive. Now, the one piece that we’re not quite clear on is the EPA guidance around what the shipment allowance will be as of January 1, 2025. And could that cause some headwind in 2024 because the OEMs are further destocking, but they’re going to have to go to a new system, and our components and subsystems really fit well to support them in achieving those new system requirements. So hopefully, hopefully I answered all those questions Jeff, happy to follow up if you have anything else.

No, that’s great. Appreciate it, guys.

Okay, great. Thanks, Jeff.

The next question comes from Nigel Coe of Wolfe Research. Please go ahead.

Thanks. Good morning, guys.

Good morning.

Good morning, Nigel.

Good morning. So on the 4Q guidance, by the way [indiscernible] you have to give us the quarterly guidance from here on. But Rob, looks like you’ve taken the approach of assuming essentially flattish sequential sales and margin. And I’m just curious, just given that this is a very new portfolio, I mean, how do you expect versus normal seasonality, how would the three segments normally track? I mean, I think PES, we understand would normally be down. But how would the other two normally track?

Yes. I think – so first of all, on the sales side, slightly down sequentially, the way we would look at that. As it comes to the margin, we do expect to be a little bit better on fourth quarter margin versus the third quarter. When it comes to the seasonality, there isn’t a lot of seasonality based on what we’ve seen with the supply chain disruption. And so we’re not expecting a lot of seasonality. Our order rates support that conclusion and our backlog certainly support that. So that’s the way we’re thinking about it. There’s not a lot of seasonality in any of the businesses right now, and that’s the progression quarter-over-quarter.

And of course, with assuming flat sequential from a very depressed base with destocking. If you had to put a line in the sand and say, this is the quarter when we expect destocking to essentially be done, when do you say – would you say it’s 1Q next year, I mean and any thoughts there?

From a PES perspective, we would say – we would expect it to be likely done in the end of this year. What I like about our portfolio is the diversification of the portfolio. So it’s a little bit difficult, Julian to answer that question without doing it by segment and in some aspects, having to do it by division. But let me try to simplify. From an IPS perspective, we would actually expect much of that destocking, we’re getting through it. And again, it would be a Q4. The factory automation side of AMC we’re still honestly trying to get a little bit more clarity on that. Now we got some strong orders in October, but they were a bit more longer cycle that’s going to help us in 2024. So we’re getting our arms around the business. I think as the quarter’s progress, we’ll give you more clarity certainly on the factory automation piece of the business.

Okay. And then a quick follow-on. Just to be specific, in 4Q, what is the synergy capture modeling from PMC and Altra?

Sure, Nigel. The PMC, we’re expecting about $13 million in the fourth quarter and Altra about $10 million, about $23 million overall. Remember that for the PMC side, as we said, we do expect to get about $6 million or so of those additional costs to maintain our service levels and it may mask some of that benefit on the PMC side. But the synergies are still permanent and absolutely expected to be realized in the quarter. So a total of $23 million.

Great. Thank you.

Great. Thanks.

[Operator Instructions] Our next question comes from Christopher Glynn from Oppenheimer. Please go ahead.

Yes, thanks. Good morning. So Louis, realizing that the October pickup isn’t a trend yet. Just curious to dig a little deeper, what channels, what was the nature of the pickup, particularly, I’m curious if those channel partners that destocked in the most in the third quarter, where you see in the October pickup?

Yes. So – and the simple answer, Chris, and good morning, is yes. Those that we saw slowing down in Q3, we did see a start of the pickup in Q4. But you’re right, one month does not make a trend. And so we’d like to see that continuing. That’s partially why we also are forecasting this quarter to be modestly down sequentially from Q3.

Okay. And in terms of inventory rebalances, how would you compare what you’re seeing in distribution channel versus with OEMs? Because hoarding and gathering was systemic for a little while there, now that lead times are better. Obviously, we’re on the other end of that.

Yes. So I think there’s still some room in OEM. And whereas I think the distribution channel has more quickly tried to readjust.

Okay. And are there specific conversations with distributors? Or is it just too fast moving and contemporaneous to bring that to bear on your general comments that the distributors are moving through destock faster?

We have pretty clear visibility to our industrial distribution channel. We see their sales out, we see their inventory levels. We see their calls [ph]. Probably why I was a little more unclear around factory automation is we don’t have that level of clarity in factory automation. And although I can assure you with the Altra businesses that we now own as part of Regal, we will get that clarity in time. It’s just that we don’t have that quite yet. But from a IPS standpoint, in particular, we know what our distributors are holding for inventory or the majority of our distributors, we know where they stand with sales out and with their orders on us. So good clarity there.

Sure.

Thanks, Chris.

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

Thank you, operator. And thanks to our investors and analysts for joining us today. As you heard this morning, while we are facing more challenging end market headwinds in parts of our business, our Regal Rexnord team is effectively managing through them. But what keeps us excited is our ongoing transformation, executing our path to top quartile gross margins to generating over $1 billion in annual free cash flow over the next couple of years, to rapidly deleveraging our balance sheet. And to the outgrowth acceleration, we are confident we can deliver by raising our new product vitality and by executing our many 80/20 growth initiatives. In short, many levers we can pull to create tremendous value for our key stakeholders. Thank you again for joining us today, and thanks for your interest in Regal Rexnord.

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