Good morning and welcome to the Regal Rexnord Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. And now, I would 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 fourth 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 describe 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 we have included reconciliations between the non-GAAP financial information and the GAAP equivalent in the press release and in these 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 4Q performance, Rob Rehard will then provide our fourth quarter financial results in more detail and lay out our 2024 guidance. We’ll 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 fourth quarter earnings to get an update on our business and for your continued interest in Regal Rexnord. Our team ended 2023 on a high note achieving fourth quarter adjusted diluted earnings per share of $2.28, in line with our guidance midpoint. We also delivered very strong adjusted free cash flow of $171 million, which exceeded our expectations and we realized 40 basis points of adjusted EBITDA margin expansion on a pro forma basis despite continuing to confront destocking and end market headwinds that weighed on our sales. For the year, the Regal Rexnord team delivered $683 million of adjusted free cash flow, firmly above our $650 million plus commitment and nearly double 2022. This allowed us to make significant progress paying down debt and lowering our interest costs, truly outstanding performance much of it due to the team’s disciplined execution on working capital. We also made significant progress on margins with adjusted gross margins up 150 basis points versus prior year. And adjusted EBITDA margins on a pro forma basis were down 10 basis points versus prior year, even while facing market headwinds. There were many drivers of this strong margin performance, but a key contributor was our IPS and AMC teams achieving $65 million of cost synergies in 2023. They are on track to deliver another $90 million in 2024. The past year has also been one of transformational portfolio change for Regal Rexnord. We added Altra, while also reaching an agreement to sell the motors and generators businesses that comprise the majority of our Industrial Systems segment. We now have line of sight to the portfolio we plan to grow with going forward. It is one where our IPS segment, which will represent roughly…

Thanks Louis and good morning everyone. I’d also like to thank our global team for their hard work right up to year-end to deliver a strong close to 2023, while continuing to drive the many initiatives we have underway to accelerate profitable growth. Now let’s review our operating performance by segment. Starting with Automation and Motion Control, or AMC, organic sales in the fourth quarter, pro forma for the Altra acquisition were down 3% to the prior year, reflecting strength in the aerospace, data center and medical markets, tempered by weakness in the global discrete automation and food and beverage markets. Notably, for the full year 2023, organic sales growth for the AMC segment is up 3.1% on a pro forma basis. Adjusted EBITDA margin in the quarter was 24.8%, in line with our expectations and up 90 basis points versus the prior year period on a comparable pro forma basis. The margin performance reflects favorable price/cost, pockets of strength in mixed positive markets such as data center, aerospace and medical, along with synergy realization and good discretionary cost management. Orders in AMC on a pro forma organic basis were down just under 5% in the fourth quarter on a daily basis, a significant improvement versus recent quarters. For perspective, we expected orders to decline in the quarter versus prior year, driven by a couple of factors. One, as supply chain and lead times normalize we have been addressing customer demand by working down an elevated AMC backlog. We made good progress on this front in the fourth quarter. Though AMC’s backlog still remains roughly 35% above normal, a factor we think bodes well for top line improvement as 2024 unfolds. Second, as anticipated when we reported third quarter, we continue to see softness in our short-cycle discrete factory automation…

Thank you very much. [Operator Instructions] And our first question is coming from Mike Halloran from Baird. Mike, please go ahead.

Thanks. Good morning, everyone.

Good morning, Mike.

So first, just on the expectations laid out in the guidance and kind of what’s changed here. If I listen to the comments, it sounds like a conservative approach makes sense. Has anything really changed in your thought process over the last 3 months or so? It doesn’t seem like it. I mean if anything, you’ve seen a little better order start to the year, which you’re just hesitant to roll through too quickly. And then related, how do you think about the sequential for the year? Is there a fundamental improvement embedded in the guide as you get to the back half of the year or is this just comps easier, destock goes away and kind of relatively normal sequentials from here?

Yes, Mike. Great questions. Thank you. So first, what has changed. I’d say, in fourth quarter, our teams performed extremely well. IPS in particular, executed very nicely. The margin lift is exactly what we expected, really solid performance, AMC as well. A bit more headwinds, though, for PES. And really it was the residential HVAC, but the destock furnace that is extending beyond what we anticipated. And we believe that, that will continue into ‘24 with resi HVAC, which is about 30% of that segment being down high double digits, so 15% to 20% in first quarter and then improving through the year, but down overall for the year. So that would be the main surprise for us. And then as we think about the planning for ‘24, we expect our first half and second half sales levels to be weighted about 49%, 51% first half, second half, about a 2.5 point spread. Now the driver of that is we expect destocking to end in the first half, both in residential HVAC and in factory automation. And so then a slide up split in the second half. We’re not banking on a significant uplift in the second half, but that could be a catalyst for us if that changes. But right now, it’s, like I said, 49/51-ish, of course, that would mean for us, first half sales growth would be down year-over-year and second half growth would be up year-over-year. Hopefully, that helps.

No, it did. And then maybe stick to that factory automation piece, that’s one where you look back last quarter, the shorter cycle side was softer but your project, at least, the front log of opportunity is still really strong. Maybe you could talk about what you’re seeing there and then what gives you the confidence in how you think about the back half of the year?

Yes. So you kind of hit on the nail in the head of that with the way you described. Sequentially, we saw orders improve in that factory automation business. A lot of the longer cycle, though, orders are strong, so it gives us confidence in the second half, although the shorter cycle did improve quarter-over-quarter, but not yet to a year-over-year improvement. And so we see destocking continuing into the first half and then slightly rebounding in the second half, and that’s really, again, the longer cycle orders and the destocking strengthening H2 for us.

Great, really appreciate it. Thanks, guys.

Thanks, Mike.

And our next question comes from Nigel Coe from Wolfe Research. Nigel, you may proceed.

Thanks, good morning, everyone.

Good morning.

Very good color, thanks. And Rob, now you’ve given the quarterly guidance, so there’s no going back to. So – just want to pick up on your assumptions around resi HVAC. I know it’s a subset of PES, which is a subset of your business. But – the down for the full year, down volumes for the full year. I understand 1Q is driving that. But – that seems a lot more conservative than perhaps your customers’ outlook. And for example, carriers, I think guidance for mid-to digit volume growth in 2024. So I would have thought that you would outperform the OEMs given the inventory destock you’re lapping in 2023. So maybe just talk about what’s informed in your opinion on that outlook for ‘23 – ‘24? And are you seeing any benefits from the transition to 454B [ph], anything like that?

Yes. So Nigel, it’s a great question. And I’d tell you the markets are still murky here. When you think about how we entered Q4, we were expecting even more strength than we saw and furnace destock extended beyond Q4, and now we’re saying first half. Until we see some good trends that would support volume growth in ‘24, we’re not going to model that. We’re going to take a prudent approach and plan for what we’re seeing in the market today. Even what we’re seeing in the today though, given what we’re – the first quarter forecast for us, we’re going to need an uplift in the second half of about 6 points. So could it be more? Maybe. So that would be upside for us. And when we see that trend, we’ll certainly guide to it. But for now, we’re not confident enough, and so we’re not guiding beyond what I’ve already stated. And then specific to your question – sorry, sorry, Nigel. Specific to your question on the GWP implementation, really, we’re not factoring in any impact to that transition at this time. We’re not seeing any upside or benefit from it yet. And as you probably know, the final rule would require that you can’t install anything manufactured after January 1, 2025 – after January 1, 2025. That’s going to put a lot of pressure on the supply chain. And so our guess is that the final rule will be modified so that you can install through January 1, 2026, what’s manufactured through January 1, 2025. So right now, we’re not expecting any major implications from the GWP implementation.

Okay. That’s good color, thanks, Louis. And then on the 4Q restructuring, pretty heavy sort of restructuring investment in 4Q. Is that all M&A integration related? Or is there additional restructuring actions over and above the PMC and Altra integrations? Just wondering if there’s anything dialed in for over and above that $90 million of integration savings?

Yes. So the restructuring and related in the quarter was really mostly around the integration type work that we’re doing for IPS and AMC. There was some in PES as we have done some product line setups associated with some scoffer that we’re doing there that were also embedded in the quarter. But aside from that, it’s really all around integration activities.

Okay, that’s clear. Thank you.

Thanks, Nigel.

And we have a question now from James Picariello from KeyBanc. James, please go ahead.

This is actually Jeff Hammond. I know what happened there. Can you hear me?

Good morning.

Just – the EBITDA margins, I think you’re guiding to ‘22. I think at a conference in the fall, you said, hey, we can get to 25% by ‘25, so big leap. But I understand industrial comes out. So I’m just wondering if you could level set us on. One, you’re confident in that 25% by ‘25. And two, what ‘24 would look like if you kind of took out industrial for the full year?

Yes. So Jeff, thanks for the question. The comment that was made in the fall was exiting ‘25. But nevertheless, we feel very confident in our ability to get to that 25% EBITDA margin. So the way to just do dramatically is 22% in ‘24. Industrial will actually help about 100 basis points of uplift. And so call it, 23% in ‘24. We will expect another $65 million of synergies in ‘25 and then assume some growth because we would expect ‘25 to start to rebound as our markets start to return, and then we’ll continue to do what we do. We’ll drive 80/20. We will drive lean. I feel really good about our new product development and the mix positive gross margins. As a reminder, we expect to double our mortality coming out of ‘25 and showed all of those things plus a normalization of markets, in particular, short-cycle industrial, resi HVAC, all of that gives us confidence in our ability to execute to a 25% EBITDA margin.

Okay. That’s really helpful, Louis. Last quarter, you called out some challenges with plant moves, and I’m just wondering, one, what the impact was in 4Q? And two, if you feel confident that’s all behind you?

Yes. We did indicate that we had some costs that we expected about $6 million at the time. We actually track closer to $4 million in the quarter, so below our initial expectations. And yes, those costs are now behind us, and we don’t expect that to repeat as we move through 2024.

Okay. And then just last one on free cash. I think you were saying earlier, maybe $800 million of free cash flow for this year, I think you said $700 million. Is that just timing around working capital or maybe just speak to the upside around continuing to pull working capital out of the business? Thanks.

Sure. First of all, similar to way we are approaching earnings guide in ‘24, we are being a bit conservative in our free cash flow guidance as we start the year. But adding to that, some of the decline is due to the outperformance we saw in 2023 around inventory reduction. If you recall, we said we would – expect about $200 million to $225 million in cash from inventory in 2023, and we actually ended the year with inventory related inflows of $255 million, so significant improvement there from what we had originally thought. Again, we still expect another $50 million in ‘24, but that is a bit of a year-over-year headwind. The other side of this is just our guidance is aligned now to the $700 million in addition to what I have just talked about. I mean when you – when we think about cash here at that level, we are also thinking about free cash flow per share, and that’s about $10 and our free cash flow yield is now over 7%. And so where cash is incredibly important to us, we are going to continue to drive that every year and pay down our debt. And – but really, from the standpoint of looking to drive an investment opportunity for us, as we look at our business, we think that this is a compelling investment opportunity for RRX. And based on what I just talked about, over $10 a share and a yield of over 7%.

Alright. Thanks guys.

Yes. Thanks.

We have a question now from Deepak Mathivanan from Barclays. Deepak, please go ahead.

Hi. It’s Julian here. Just a quick question. First off, around maybe earnings seasonality, you have talked about the revenue progression earlier in this call. But I guess if I am thinking about the first quarter, it looks like maybe flattish EBITDA sequentially sort of $3.45 to $3.50 or something company-wide. And then just trying to understand sort of how do we think about the second quarter? You classically get that nice sequential lift from PES, maybe that’s more muted this year for the well-rehearsed resi HVAC headwinds. So, maybe just any help around how much of the year are we getting in the first half on EBITDA and anything moving around below the line aside from interest expense reduction through the year?

Yes. First of all, in our first quarter, I think – you think about it maybe a little bit less on the sequential side. It may be on a year-over-year pro forma flat from an EBITDA perspective, with margins roughly in line with maybe 100 basis points on a pro forma basis versus prior year. So, think about first quarter like that. And then progression as we move through the year, so to your point, would we expect to see nice progression as we move into the second quarter. Yes, we would off of that first quarter, but we still expect growth rates to be down in the second quarter and not move to positive until we get to the back half. But we would absolutely expect to see progression from Q1 to Q2.

That’s helpful. Thank you. And then just my second question would be around – if we are trying to think about sort of IPS, what’s happening there? You have talked about that mix headwind on the slides a bit, so maybe go into some detail there. And I guess when you are thinking about that sort of margin progression through the year, you are sort of, I think flattish guide for Q1 on margins, decent increase for the year. So, is that kind of assuming that the mix headwinds dissipate through the year as it goes? Maybe just any help around that.

Yes. So, Julian, there is some mix headwinds that dissipate, but a big driver is the synergies and the benefits from the synergies on the gross margin. That’s where we are seeing 75%, 80% of all of our synergies in the IPS segment. Teams are executing incredibly well on the footprint rationalization and the product line simplification. And that’s really the majority of the driver of the margin uplift in IPS in ‘24.

That’s great. Thank you.

Our next question comes from Vivek Sri from Goldman Sachs. Vivek, please go ahead.

Hey guys. Congrats. You got Joe from Goldman. How are you doing?

Hey. Good Joe. Good to have you here.

Yes. Thanks guys. So, hey, I just want to – I think that there is some confusion around the 1Q guys, so I am just going to try to clarify it here. When you talk through pro forma Q4 margins, and you baseline it in both the IP/IPS segment as well as the AMC segment. We are base lining off of an IPS margin of 24.6% and we’re base lining off of an AMC margin of 22.4%, is that correct?

Yes. If you go back to the 8-K filed September 8, ‘23, yes, those would be the margins on a pro forma basis.

Got it. Alright. Crystal. And then really, just my only other question, again, just more around like the guidance for the year, I was a little confused on the commentary around industrial. It sounds like industrial is in for the year, but then there is a debt pay down associated with the proceeds from the industrial sales. So, I just want to – I want to make sure that I have clarified that. Is industrial in for the full year? And then are you assuming that the financing from the deal is also going to help pay down debt?

Okay. Great. And thanks for the question. We do assume motor generators business that comprises the majority of the Industrial Systems segment, contributes about $500 million on the top line in the year fully embedded in our guidance as well as about $40 million to $45 million of adjusted EBITDA in 2024. That is fully embedded on a full year basis in our guide. Now, while that is embedded in the guide, when we close the transaction, there will be proceeds from that transaction expected of approximately $360 million net of interest – sorry, taxes and fees. And so if you assume that you lose the $40 million or $45 million or so of EBITDA and offset that by an equivalent maybe $26 million on an annualized basis of interest savings, the net impact to our guidance is a negative $0.10 or so. So, depending on when the transaction closes, you can work from that back.

Okay. Wonderful. Great. Thank you very much.

Great. Thank you.

And we now have a question from Christopher Glynn from Oppenheimer. Christopher, please proceed.

Thank you. Correctly identified, nice to say. I was curious, guys, just from end market perspective, what do you think the biggest kind of variables and opportunities as you go from 1Q into 2Q for demand and revenue? I don’t know what the exact January orders comps. The year-over-year sounds nice, but we can’t correlate that to revenue. So, yes, just kind of some of the subtleties that might be particularly interesting and key variables into the second quarter end markets.

Yes. I mean I think the drivers of our business by market that could see some implication quarter-to-quarter, Chris, would be general industrial with – right now, we are seeing some sluggish in machinery, some destock. If that improves faster, that would see a bit of an uplift from Q1, Q2. Really, the same commentary around resi HVAC, that could show a nice uplift from Q1, Q2. Of course, we have got some really strong markets right now that we think are going to continue great momentum. Medical, data center, aerospace are really strong. I would tell you, alternative energy, the incentives get fully figured out and the projects released, perhaps that could show a nice uplift Q1, Q2. That’s how I would think about it between those two quarters.

Okay. Great. Thanks. And as you are driving the organization hard, what do you do when signs a strain pop up? You get large organizations and you are doing a lot of work. The pro forma EBITDA margin growth was great. And yes, just curious about the strain risk as you drive the organization?

Hey Chris. I think it’s a great question. Thank you. It’s all about living by Regal Rexnord’s values. We have a set of values and 35,000 associates worldwide that know them and live by them and that’s how we represent every day. We also over-communicate. We did an employee survey in the second half of 2023, and there is opportunities for us to improve, and there is opportunities that we are going to further leverage. And it’s over-communicating what our goals and objectives are and what it’s going to take to achieve them and working with our teams to when there are challenges and headwinds to put forward mitigating plans. And so we are a very planned do check at culture. And we do that with our culture as well. And so we have a plan to improve, and we will work with our organization worldwide to ensure that we are executing on that plan and partnering with everyone for great success.

Great. Thanks for that color.

Yes. Thank you.

Okay. We have one more question from Walter Liptak from Seaport. Walter, you many now proceed.

Hey. Good morning Walt. You will have to un-mute.

Oh, sorry about that. Yes. So, very clear today. So, thank you very much for that. But a couple of things just to clarify, so the timing you are still saying for the industrial business is in the first half. What’s the volatility around the calendar and when you close it?

Walter, the process is proceeding nicely and as we expected. And we guided the first half previously. And so we are on that path. We have most of our approvals at this point, but there are still a couple of few outstanding. And so as those approvals come in, then we will be able to close. So, again, right on our expectations of the first half close.

Okay. And then another little thing, just you talked about how January was a little bit better, but mid-single digit declines. I didn’t quite catch. If January is starting to get a little bit better, is it tough comps, or is it things started turning down in February, why is it going to be down mid-single digit for orders?

Yes. It’s really visibility at this point, Walt. I would say, one month does not make a trend. And if you recall, we were – we started October a little strong. And then in the end, we ended fourth quarter down mid-single digits. So, we believe it’s a prudent approach to plan for orders down. And if they do turn, of course that will be a benefit for Regal. But right now, that’s not what we are modeling.

Okay. Alright. Great. Thank you.

Sure. Thank you.

And this concludes our question-and-answer session. Thank you very much. I would like to turn the conference over to Louis Pinkham, CEO, for any closing remarks. Please go ahead.

Great. Thank you, operator and thanks to our investors and analysts for joining us today. As we embark on 2024, our team remains excited about the value creation opportunities in front of us. Even as certain of our end markets remain choppy, we will be focused on three key things. One, achieving our targeted $90 million of synergies. Two, delivering at least $700 million of free cash flow, which we expect to use in combination with the industrial motors and generators sale proceeds to reduce our debt and meaningfully shift the mix of our capital structure towards equity. And three, continuing to mature our many growth initiatives, driving 80/20, better leveraging our scale and scope, especially in IPS, and executing on our multiyear pipeline of differentiated new product launches. In short, tremendous opportunities for our associates, our customers and shareholders. Thank you again for joining us today and thank you for your interest in Regal Rexnord.

And the conference has now concluded. Thank you for attending today’s presentation. You may now disconnect. Enjoy the rest of your day.