Good day, and welcome to the Regal Fourth Quarter 2020 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would like now to turn the conference over to Robert Barry, VP of Investor Relations. Please go ahead.

Great. Thank you, operator. Good morning, everybody. Welcome to Regal Beloit's fourth quarter 2020 earnings conference call. Thanks to everyone who is joining us again. As a reminder, today's earnings call is replacing our previously scheduled earnings call on February 18 of this year. With 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 the 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 three, we state that we are presenting certain non-GAAP financial measures in this presentation. We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods and in the same manner as management. Please read this slide for information regarding these non-GAAP financial measures and please see the appendix for reconciliations of these measures to the most comparable measures in accordance with GAAP. Now let me briefly review the agenda for today's call. Louis will lead off with his opening comments. Rob Rehard, our CFO, will then provide our fourth quarter financial results in more detail and discuss our guidance, and then we will move into Q&A. After which, Louis will have some closing remarks. And with that, I will now turn the call over to Louis.

Great. Thanks, Rob. And good morning, everyone. Thanks for joining us to discuss our fourth quarter earnings, and thanks for your interest in Regal. I'm sure many of you saw the news this morning announcing our plans to merge with Rexnord's Process & Motion Control segment through a Reverse Morris Trust transaction. I hope that all of you listened to our call earlier this morning discussing that transaction. If not, I encourage you to listen to the replay. We are extremely excited about this transaction and what it means for Regal. But to set expectations, the subject of this call will be our fourth quarter results and initial 2021 outlook. Before turning to our results, I want to begin by thanking all my Regal colleagues around the world for their hard work and resourcefulness, and for staying focused on serving our customers, while remaining disciplined about keeping our workplace safe as COVID-19 persists. We had a great fourth quarter, which capped a strong and truly transformational 2020 for Regal. And I can't thank our nearly 20,000 associates enough for a full year of very strong execution at a time when the pandemic was presenting a host of personal and professional challenges. Some highlights of our strong fourth quarter performance include a return to top line growth, leveraging that growth at 54%, well ahead of our 30% plus target, achieving another quarter of adjusted gross and operating margin expansion, posting free cash flow conversion of 175% and delivering year-over-year adjusted EPS growth of 42%. And despite the challenges of COVID in a global recession, achieving 5% EPS growth and 190% free cash flow conversion for the full year. Regarding fourth quarter, after several very challenging quarters, it was great to see Regal return to positive top line growth with our fourth…

Thanks, Louis. And good morning, everyone. I'll start by echoing Louis' comment about how good it feels to be reporting positive top line growth rates again, which tracked at nearly 5% on an organic basis in the fourth quarter. And with January orders strong, we're starting 2021 with great top line momentum. While COVID-related pressures remain, especially in parts of our Mexico operations, we think we're seeing light at the end of the tunnel. Beyond the top line, the team continued to execute on a variety of margin expansion initiatives, delivering 240 basis points of adjusted operating margin improvement in the quarter, supported by a 54% leverage rate, handily exceeding our target of 13% plus when growth resumed. Finally, the fourth quarter was another quarter of excellent cash flow conversion, which tracked at a 175%, and for the year, our conversion rate was 190%. Now let's dive into the segment results. Starting with Commercial Systems. Organic sales in the fourth quarter were up 10.1% from the prior year. The result was driven largely by strength in our pool pump business, which was up almost 30% in the quarter, in addition to ongoing gains in China and to a lesser extent, growth in North America, general industrial and commercial HVAC end markets. Momentum in pool remains strong, with Q4 orders up roughly 12% on a daily basis. An area of weakness in the quarter was our [Technical Difficulty] business, where second wave COVID impacts were a headwind. We also continue to confront isolated production challenges in our Mexico operations, but we feel we're making progress there. And despite these frictions, the business was able to deliver very strong growth. Finally, we show a roughly two point headwind from our ongoing proactive pruning of low margin accounts as we continue to execute…

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

Hey. Good morning, guys. Busy day.

Yeah.

So a couple of things here. One, a lot of content there, a lot of content today in general. So could you just kind of clarify the channel trends and the inventory trends as you look through your four pieces? I know the industrial - sorry, the PTS piece, you thought there might be a little pre-buying, maybe in little industrial. But could you just kind of go through all of those pieces? And how you think the channel fits, what inventory levels look like?

Yeah, I'm happy to do that, Mike. First of all, the PTS business, we're starting to gain and see some momentum in the channel. And so as Rob said, our January orders in PTS were 30%. And so after a relatively okay fourth quarter where orders were 2%, it was a nice highlight for us going into the year. Climate, I would tell you, there's still strength, and they're still filling the channel. And so the work from home phenomenon and the investments that are being made there are still pretty solid. On the pool side, so I didn't go to the commercial space, and pool is a pretty big space for us there. The OEMs are still pretty strong. This is seasonally though, a pretty quiet time, although pool in 2020 was very strong marketplace. And so we're down a little bit there, but as expected. And then, of course, as Rob commented, we've got the new pool regulation coming out in July and partner very closely with our OEMs, and that's why there's a bit more strength there, and we have a new product launching. On general industrial, still relatively sluggish, although, I would say that the prospects seem to be brightening. The ISM is greater than 50%, and we expect that, as I said with PTS, there's some short cycle restocking in the bearing business as well. And then industrial, the larger capital investments are still swamped. And so for our industrial business, orders being down in the quarter really because that longer cycle industrial market has not rebounded yet. So hopefully, that helps give the perspective on both the channels considering the market.

Yeah. So if I summarize that, though, the couple of areas where you pointed, there was some channel restocking going on, it doesn't sound like you think there's excess inventory in the channel that, that's more getting you back towards parity. Is that a fair characterization?

I would say, absolutely. We do not think there's excess inventory in the channel at this point and that - there's opportunity there.

And then on the price cost side, price cost positive in the fourth quarter. Maybe some thoughts on how you're thinking about it here moving forward. You've got some indexing relationships. You're putting in pricing in other areas. So just thoughts on how that works through the year, just at a high level. And if there's any lag impacts anywhere? Or this is a price cost positive thought process moving forward?

Sure, Mike, this is Rob. So we do think that we'll be neutral to slightly better. We could see climate remain modestly negative in Q1 and turned to positive Q2. That's where you're going to see the two way material price formulas and that lag that you're referring to which is generally about three to four months. But the good news is NPS far kicking in and - but commodity prices are also continue to be up side [ph]. So it's a bit of a moving target. And we do see that catching up very soon. Pricing elsewhere is better and in our non-contracted business and we also have some traction on some of our pricing initiatives. So overall, I'd characterize it as, we're expecting neutral to slightly positive, and that's the way we're entering the year.

And Mike, I'd just emphasize, 80/20 is helping us out a lot here. So - and so when we say that it's slightly beneficial in those other segments, it's really 80/20 in the way we're approaching product management at Regal today. We're managing price very closely.

That's super helpful. Last one here. With the transaction announcement earlier today, my suspicion is, the balance sheet usage over the course of the year is going to be pretty measured, given you have to figure out what the dividend looks like and just all the machinations there. Is that a fair thought process? Or should I be thinking about it differently?

No, Mike, I think that's the way to think about it. In terms of - we will continue - I will say we continue to be balanced in our capital allocation. We are still going to look for a disciplined approach here through organic investments, CapEx, R&D, dividend, opportunistic share purchases. And of course, we're still looking at potential bolt-on M&A from an inorganic standpoint. So we do see that we will continue to be balanced as we go through '21. And that's the way you should be thinking about it.

And so…

Go ahead. Go ahead. Sorry, go ahead.

The strength of our balance sheet, I think, gives us still some optionality even during this year. And so to just reinforcing Rob's comments, a one-time net EBITDA, it gives us that optionality that we will consider through the year, even knowing that we have a big transaction that will occur later in the year.

I appreciate it, everyone. That was what I was looking for. Congrats again on the announcement in the quarter.

Thanks, Mike.

[Operator Instructions] Our next question comes from Jeff Hammond with KeyBanc. Please go ahead.

Hey. Good morning, guys.

Morning, Jeff.

Just on the guide and the incremental. So I think fourth quarter, you had 54% incrementals on some growth. I think, that even includes the inventory charge. I'm just wondering why we're still thinking about kind of only 30% plus, and I know there's a plus on there, incrementals as we flip to growth in 2021?

Yes, Jeff. Rob here, again. I think the way to think about this is, we really did have some nice benefits as we exited the fourth quarter, especially from a mix perspective in the HVAC space in the pool space. Those are some of the really nice benefits that we saw. And they do tend to be a bit lumpy from that perspective and we wouldn't expect that same level mix going forward, especially in the first quarter. Not at this time at least. The other side of that is, we also have some nice price cost. And as you know, we are - we do say that we're going to be price cost favorable as we enter the first quarter or exit the first quarter. But not the same level that we saw in the fourth quarter. So just a couple of points there and why we may not see the same level of leverage going forward. But I will remind you that the range that we've provided has leverage up into the 35% range at the high end of the range. So still on the upper end from what we've guided to previously.

And Jeff, I'll just - couldn't agree more with Rob, and I'll just add the point that we like to set objectives that we're confident that we're going to hit. And then hopefully, we exceed a little bit as well.

And any aberrations in the PT margins, which were particularly strong on the good side that would normalize?

Again, our PT business has done a fantastic job in 2020 of driving 80/20, and accelerating their consolidation, their SKU rationalization and transforming the cost structure of that business. And so I would say, no, nothing in particular sticks out with regards to margins for the PTS business.

Okay. And just a clarification on the deal structure. Can you just talk about the range of shares that are going to be issued associated with the deal? I don't know, like just the split and then the dividend dynamic, I think you'd be issuing some additional shares, depending on the dividend, is that right?

Yeah, that's right. You know, let me give a little bit more detail. I mean it's a good question. In a typical RMT, there would be the 50-plus percent for Rexnord shareholders, 49.9% for Regal. In our case, we currently have a good, solid overlap of shareholders. And what this means - and currently, that overlap is roughly 25%. This means that we can meet the RMT threshold, a 50% plus for shareholders, including the overlap, while still having an economic ownership split of 61.4% for Regal and 38.6% for Rexnord shareholders pre-dividend. Plus a potential rightsizing dividend to Regal shareholders and a corresponding post-dividend ownership adjustment, which we're calling the adjustment mechanism, which is predefined and covers all circumstances in this deal. So I'll get into that in a little detail. The pre-dividend ownership is 61.4% for Regal, 38.6% for Rexnord, that is fixed. It does not change. What the adjustment mechanism does is to ensure that we meet the RMT threshold at closing, even as shareholder overlap may change between signing and closing. For IRS purposes, the overlap and the RMT threshold of Rexnord shareholders owning 50-plus-percent, including that overlap, is measured at closing. We do expect there to be a private letter ruling from the IRS. We will, of course, follow that as we measure the overlap at closing. So looking at all this. Considering Regal shareholder base and having had detailed discussion with our tax and financial advisers, we believe that the likely range of special dividend to Regal shareholders is between $100 million and $500 million at closing. And as you know, in the deck we presented that we picked the mid-point of $300 million to model. And so that's how we're approaching this. The mechanism is clear. It tells us how we define the dividend based on direction from the private letter ruling from the IRS. So hopefully, that gives you a little bit more clarity, Jeff, of how this will work.

Okay. So just to clarify, so the base split is the 61.4% to 38.6%, so you'd be - there'd be 26 million shares issued to, or so to the Rexnord shareholders?

Yes. That's right.

Okay. And then it will adjust based on the dividend structure. Okay. Thanks. I’ll get back in queue.

Thanks, Jeff.

Our next question will come from Chris Dankert with Longbow Research. Please go ahead.

Hey, morning.

Hey, Chris.

I guess as we head into 2021 here, are there any additional divestitures we should be thinking about? Or do we kind of work through a lot of the pruning actions as we think about the core portfolio here?

You know, and Chris, as you know, we really don't talk about divestitures until they - if and when they occur. We talked about the small motor service center in Cairns, Australia that we divested in Q4. I mean, we're talking a couple of million dollars of revenue, and it was losing money. There's not a lot of that in our portfolio anymore. We have taken good action on 80/20 over the last two years. We will continue on that path. But to have done actually divesting anything at this time, there's nothing specific in our planning. Of course, we're always evaluating our portfolio and what makes then best sense and where Regal is best as an owner. And of course, we'll keep you updated as well, Chris.

Understood. Understood. And then thank you for the color on the first quarter and then particularly on the margins. I guess it is because there's such a swing and a lot of moving pieces going on. How should we think about kind of Industrial Systems margin for 2021. Can we get to mid single, 6%, 7% margin in '21? Or is it really too early to kind of set goals that high?

Hey, Chris. This is Rob. Good question. We did spend a little bit of time on this during the call, but let me give you a bit of a perspective here. We do see some continued near term choppiness on project mix in the first quarter for industrial. And we're also seeing some lingering, near term COVID-related pressures in industrial into the first quarter. If you exclude the inventory charge, the operating margin industrial was closer to 5%, 6% in the fourth quarter. So that 2% is not - certainly not indicative of how we're tracking. For the first quarter, as I touched on the call, a range of 2% to 4% probably does make sense. And while we're not really providing any guidance outside of the first quarter, we do expect to improve from these levels, certainly as we move through the year. I'll tell you, Chris, that we feel that the framework we laid out at our Investor Day for 8% to 11%, still makes a lot of sense and remains independent of volumes. And we did say today that we would look to deliver on the 303 ahead of schedule. And so that acceleration of the margin progress also includes industrial. So we're very confident in our ability to bring this business to the level that we've articulated at Investor Day, and we've got a great path to get there.

Got it. Thanks so much.

Okay. Thanks, Chris.

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. To summarize, our fourth quarter results capped off what has been a challenging but also a transformational year for Regal, with margins and earnings up, strong free cash flow, and lots of groundwork laid to deliver stronger above market top line growth, all despite sizable COVID-related pressures. We're also starting 2021 with great momentum, both on an organic and inorganic basis. Organically, orders are strong. Our new product pipeline is healthy and expanding. Our restructuring plans are proceeding in our 80/20 and lean initiatives continue to ramp. We're extremely excited about the transaction we announced earlier today, which will meaningfully rebalance our portfolio towards the PT business, deliver top quartile cost synergies, and give the post-merger Regal an ability to deliver stronger above-market growth. We look forward to discussing our integration plans with you all in the future and providing more detail. I want to thank you for your interest in Regal, and have a good day.

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