Good morning, and welcome to the Regal Rexnord 2022 Second Quarter Earnings Conference 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 now like to turn the conference over to VP of Investor Relations, Rob Barry. Please go ahead.

Great. Thank you, operator. Good morning, and welcome to Regal Rexnord’s second quarter 2022 earnings conference call. Joining me today are Louis Pinkham, our Chief Executive Officer; and Rob Rehard, our Vice President and Chief Financial Officer. Before turning the call over to Louis, I’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 second quarter financial results in more detail and discuss updates to our 2022 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.

Great. Thanks, Rob, and good morning, everyone. Thanks for joining us to discuss our second quarter earnings and to get an update on our business, and thank you for your interest in Regal Rexnord. I am proud to report that despite a host of challenges related to various forms of inflation in the global supply chain, our Regal Rexnord team remained focused on factors under their control, resulting in strong second quarter performance, plus continued progress on many of our strategic growth and margin enhancement initiatives. The team’s disciplined thinking and actions are apparent in our record results this quarter, which include 12% organic top line growth, 280 basis points of gross margin expansion and 230 basis points of EBITDA margin expansion. These margin gains were enabled in part by continuing to achieve a positive price cost position. The results put us firmly on track to meet our earnings guidance commitment for the year, which, by the way, we have revised modestly higher. Also contributing to the strong performance in a meaningful way are our M&A synergies that continue to track favorably and on our current trajectory, suggests material upside versus our original target on revenue and margin. This is a topic that we’ll discuss in greater detail at our September 13 Investor Day. The quarter also continued to evidence clearly identifiable share gains, supported by our digital investments, new products and competitive service levels. Regal Rexnord is winning in the market, a result of the team’s hard work and the many changes we have made in how we run this business. And on these fronts, there’s much more to come. For this strong execution pursued with a sense of urgency as well as continued adherence to our Regal Rexnord values, I want to say a sincere thank you to…

Thanks, Louis, and good morning, everyone. I’d also like to send my thanks to our global team for continuing to execute with discipline in what remains a very challenging environment. So now let’s turn to our second quarter segment financial performance. Starting with our Motion Control Solutions segment, or MCS, organic sales in the second quarter were up 6.4% from the prior year. The results reflect broad-based growth, but with particular strength in the general and industrial marine and metals and mining end markets partially offset by lapping prior year large project activity in alternative energy. As in recent quarters, supply chain disruptions continued to impact our ability to deliver, resulting in increased backlog and posing a headwind to the top line, a dynamic that continues to impact all of our segments. Adjusted EBITDA margin in the quarter for MCS was 26.4%, down 70 basis points compared to the prior year factoring updated corporate cost allocations, higher freight costs, commodity inflation, FX headwinds and mix largely offset by tailwinds related to favorable price realization, synergies, restructuring actions and higher volumes. As expected, the segment posted a nice sequential improvement in margin, and we see this trend continuing in each of the remaining quarters of 2022, driven in large part by accruing synergies. Orders in MCS for the quarter were down approximately 3%. However, book-to-bill in the second quarter was slightly above 1.0. Turning to Climate Solutions. Organic sales in the second quarter were up 14.8% from the prior year. The increase was driven by strength in North America residential HVAC and North America general industrial markets by positive price realization and by continued share gains in the quarter. The adjusted EBITDA margin in the quarter for Climate was 17.1%, down 390 basis points versus the prior year period. Factors impacting…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Mike Halloran from Baird. Please go ahead.

Hey, good morning, everyone.

Good morning, Mike.

First, Rob, could you clarify your Industrial margin comments. Sounds like – basically, maybe a little more detail on why they’re elevated here? And if I have it right, sequentially a little lower from where we are in 3Q, probably even a little lower in 4Q. But what you’re trying to say is the margin trajectory into next year, we should be thinking about a low teens kind of EBITDA base is what we build off. Is that the right messaging?

Yes, that’s exactly the way to think about it. We did get a bit of a benefit that’s a little longer trending for the Industrial segment versus other segments. And so we’ll see that benefit continue through the third and then really taper off in the fourth. So the way you sized it up is exactly the way you should. We’ll see that come down a bit in the third quarter and then down to that low teens level in the fourth. And that’s kind of the go-forward expectation. Of course, we plan to continue to work on the underlying performance of the business and have great plans in place to improve upon that. But that should be from a modeling standpoint where you start.

Great. Thanks for that, Rob. And then – maybe you guys could talk a little bit about the channel inventory as you see it across the segments? And then correlated, how is backlog tracking? Have you been able to work that down at all as we sit here? Or is there still some build that’s happening sequentially?

Yes. Hey, Mike. This is Louis. Let me try to cover both of those. I’ll take backlog first. Yes, backlog did not come down in Q2. And as I commented, our book bill has been positive for seven quarters. And so that gives us some confidence in the strength of our growth and revenue, especially going into the second half, even in light of the macro uncertainties. Specific to channel inventory. We’re still seeing opportunities for restock in industrial distribution. There seems to still be strength there, no question. We have direct visibility to our distributors sell through, and there’s definite strength. In resi, HVAC, this is more of a question of our supply constraints, especially driven by the electronic supply chain challenges that we have seen. And bluntly got a little bit worse in Q2 because of the fire at one of our suppliers. And so there’s definitely restock opportunity there. So those are the main two I would comment on and say we still have restocking that will go on through the end of this year.

Thanks, Louis. Thanks, Rob. Appreciate it.

Sure. Thanks, Mike.

The next question comes from Jeff Hammond of KeyBanc. Please go ahead.

Hey, good morning, guys.

Good morning, Jeff.

Great color and progress on Industrial. That’s good to hear. My question is on Commercial because you seem similarly upbeat about that and just kind of maybe level set us on kind of how you think margins are trending there and what you think entitlement is for the Commercial margins?

Sure, Jeff, this is Rob. Let me first give you the first part of that, which is kind of the margin trending, if you will. So we would expect coming out – so great performance on the margin side coming out of the second quarter in Commercial. We’d expect to see that same level of margin performance for the Commercial segment in both the third and the fourth quarters. And so we’ll expect that – them to end about mid-teens as you – for the year, but continue about the same trend that you saw in the second quarter.

And Jeff – and I’ll add on. Commercial, I’ve been saying for a number of quarters, Commercial is our diamond in the rough. And I think we’re proving that out, and they’re doing a fantastic job. Clearly an 80-20 mindset, driving digital customer experience to grow share. And I am really, really excited about the product and technology road maps that we’re going to be emphasizing at our Investor Day on September 13. This is a segment that I would say has been undervalued historically. And yet I think there’s so much opportunity, and we’re proving it out with the results so far this year. So thanks for that question.

Okay. And then just on MCS. Can you just talk about how you’re thinking about sequential margin progression given what sounds like synergies kind of running ahead? Thanks.

Sure, Jeff. So for MCS, we would expect that margins continue to improve sequentially. So from jumping off of the Q2 end point, we would expect to see margin improvement in Q3 and then once again in Q4. Again, as you stated, mostly due to the strong execution by the team, but then synergies really kicking in, getting back to that $70 million exit rate we discussed as we first announced the business transaction.

Okay, great. I’ll get back in queue.

Thanks, Jeff.

Our next question comes from Joe Ritchie of Goldman Sachs. Please go ahead.

Thanks. Good morning, everyone.

Good morning, Joe.

Thank you. I kind of want to parse out this margin bridge for Industrial a little bit better. So as I look at it, I – let’s assume that you would have had kind of like low teens EBITDA margins, right, if not for kind of like the – what you called out on the cost roll impact. So I don’t know. So maybe that impacts like $4 million to $5 million. You got a little bit more volume leverage. G&A was a little bit lower. But you still also have like operational improvement that came through. So is that the kind of right framework, first of all, to kind of think about the bridge year-over-year? And then secondly, maybe talk a little bit about the structural cost improvements that you’re making in the business?

Sure. So first of all, on the framework that you laid out, yes, that is the way to think about it. Think about it as about $5 million of cost roll benefit. That would take you down to kind of that low teens, which we say is more of the run rate, if you will, operationally for this business, as we move through the remainder of the year. Now don’t forget, we’re going to continue to get some of that cost roll benefit in the third quarter. So we would expect that we would see the elevated margins in the third quarter and then taper down to that low teens by the time we get to the fourth.

And then let me add on, Joe, specific to the performance improvement. And I would say it’s absolutely structural, and it’s a great example of what the Regal Rexnord business system is driving at Regal. And we haven’t talked a lot about this, but it first starts with having the right, disciplined talent driving disciplined planning and thought that then drives disciplined action. Bluntly, we have made significant changes in the leadership of this organization over the last two years. And they are driving with 80/20, focusing on our Quad 1 customers and products to overserve. And then we’ve done significant actions to improve the operational performance. As you know, this was the business that was most impacted by the China tariffs. We had to stand up operational capabilities in Mexico. This was also where Regal Rexnord is highly differentiated because of our global manufacturing footprint. This was the business that was really still very China-centric. And so we stood up a facility in Mexico. That facility is being leaned out, and we’re driving our tool sets to improve performance. There’s still more room to improve. And so I’ll end again with emphasizing this is a great example of the Regal Rexnord business system at work, and I couldn’t be more proud of our RBS leadership in the Industrial Systems team.

Yes. That’s awesome to hear, Louis. And look, and I know that you also had a retirement announcement in the Climate business. I’m just curious – like I know that – been pressured a little bit. Do you expect it to kind of come right back in the fourth quarter? Maybe just talk a little bit about – you mentioned the fire like obviously out of your control. How much of the pressure that you’ve seen so far has been exogenous versus maybe things internally that you think you could have done a little bit better?

Yes. I’d say the majority of it was external. When you think of what we were trying to do, we saw some significant impacts on spot buys in the quarter. COVID shutdown our Climate plant in China for six weeks. And so we had to transfer some production to Mexico, but not as efficient. And so therefore, cost headwinds there as well. And then the supplier fire, which both hurt on mix, but also on expedited freight. And so it was a tougher quarter, but we opted to overserve our customers. And so we took on some costs to be able to support their needs. I think that conscious decision in the end is strengthening our relationship with our customers. And the good news is that we’ve been able to course correct. We are getting some early receptivity on incremental price from our OEMs. And we expect to be in a stronger position by the end of the year and really have a very good plan to get there. So I’d say, again, back to the question, it was a tough, externally impacted quarter for the Climate business, but they’re turning it around quickly.

That’s great. Thank you.

Our next question comes from Julian Mitchell of Barclays. Please go ahead. Julian, is your line muted.

We can go to the next question, operator, and circle back.

Thank you. Our next question is from Nigel Coe of Wolfe Research. Please go ahead.

Good morning, everyone. So on this cost roll benefit for Industrial, obviously, very bullish commentary on the run rate margins. Is this the same impact that we had in Commercial last quarter? And I’m just wondering if you could give us a quick sort of idiots guide to cost roll accounting 101, Rob, if you can give a chance. But I just wanted to confirm that, that’s the same impact?

Yes, it is the same impact. And it impacts all of our businesses or you’re marking up your inventory, and you get the benefit of that flowing through your P&L essentially. I mean, in theory, until you have your prices get back to where they should be to cover off of an inflation. And it depends the time in which it takes to run through that impact is dependent upon how fast your inventories turn. And so with the industrial segment, different from our others, the inventory turns slower, and therefore, that impact is more delayed or last longer through the year. That’s why it goes through the third quarter and a bit into the fourth before it finally burns off. So that’s the way the cost roll works. But by the end of the year, it’s all burned off in industrial. And as we said, we would expect our margins to reflect that as we exit the year in the fourth quarter at – in the low teens.

Understood. And then on the Climate side, you mentioned the chip supply issue with the fire. If I’ve got this correct. I think that impact – I think that fire was at the end of March, if I’m not mistaken. So that was an impact you’ve been dealing with for the whole quarter. Is that correct?

Yes, it was actually early second quarter. So yes, that was an impact that we felt all quarter.

Okay. That’s great. And then just my final question is really around this SEER change. Can you just remind us, as we step up from 14 to 15 SEER, how does that impact Regal specifically in terms of the kind of motors and fan systems you are supplying to the OEMs?

There’s no question that these requirements drives to more energy-efficient solution. And so therefore, we’ll continue the mix-up benefit of moving from induction motors. As you well know, we’ve been moving away from to more of our higher technology variable speed motors, which make up more than 50% of our mix today. In addition to that, we launched earlier this year our Frontier product solution, which is a solution that helps with compressor controls. That is a product expansion. And so this goes back to – the new Regal Rexnord very focused on singles and doubles of expanding our served markets with new product. And this new product is an intelligent drive that helps to solve the higher sear levels, and we’ve already signed on with one large OEM and are in talks with others, which will benefit us as well going into 2023. Quantifying that? I’m not ready to do yet. But what I can tell you is that SEER 2023 will definitely be a benefit for us, and you’ll hear more about this from us at Investor Day.

Great. Thank you.

Sure. Thank you.

Our next question is from Walt Liptak of Seaport. Please go ahead.

Hi, thanks. Good morning.

Good morning, Walt.

I want to ask two questions. You called out the macro. And clearly, things are showing some signs of slowing. And I want to understand if you saw anything in sort of the cadence of orders during the quarter in July or anything that would be a tell about any macro slowing in your business canceled orders, et cetera?

Yes. Nothing at this point that’s material from a specific order perspective. No question from a year-over-year perspective, orders were slightly down. Book bill rates slightly down in second quarter from first quarter, but still more greater than 1. Overall, we’re still seeing pretty healthy demand. But no question, it’s understandable of everything we read in the papers every day that there’s increased caution. And so by the way, that’s part of the reason why we guided the way we did is increased caution for the second half.

Okay. Sounds good. Are there benefits that we can think of for the second half or into 2023? And I’m thinking of some of the copper prices, industrial metals prices have been coming down. Is that going to help at all with the price cost?

Yes. Well, 20% of the company is on material price formulas. And so that will map pretty closely. There’s usually a three to four-month offset that should bring a little bit of benefit. We’re 19 quarters in now of price cost positive or neutral. Positive, certainly for the last many quarters. And Regal has a history of being able to hold price. Now we’ll manage that and talk to customers one by one as we see commodity deflation. But our intent – because there’s lots of other inflation we’re dealing with, including labor, including freight, et cetera, is that we’re going to drive to hold our price in the marketplace.

Okay. That sounds great. And maybe just a last one for me on the Industrial, yes, it was absolutely great to see those margins move up. And we can tell the enthusiasm that you now have over – the renewed enthusiasm for this business. As they gain momentum, could there be another step-up that we see going into 2023?

Yes. I mean how I would think about this is we’re continuing to perform and drive 80/20 and Lean, which is our Regal Rexnord business system. And pretty much every quarter, we’ve had a little bit better, a little bit better, a little bit better. And I bluntly expect that into 2023. Add to that, that this tends to be a longer cycle market. And as Rob commented, our book bill was 1.2 in the quarter, and there will be leverage with that strength of volume, too. So yes, I believe, start with that baseline of low-teens and then keep building from there.

Okay. Sounds great. Thank you.

Sure.

The next question today comes from Chris Dankert of Loop Capital. Please go ahead.

Hey, good morning. Thank you for taking the question. I guess kind of to circle back that impressive book-to-bill in Industrial, is that just the underlying strength in the market? Or is there a significant cross-selling pull-through with the MCS you seem to allude to with the contract win that was highlighted earlier in the presentation? And if so, is there a way to kind of quantify that cross-selling benefit?

Yes, it’s a great question. So there’s definitely cross-selling benefit. That Industrial business is really our 3 to 5-horsepower or greater, and that fits on the industrial powertrain. We’ve said that that cross-selling and the industrial powertrain would bring us a minimum of $10 million this year in revenue. And so a certain percentage of that will come from Industrial, lesser from Commercial. So yes, absolutely a benefit. But I would say what’s the real driver of those – that growth; or two, service improvement and regaining some share that we lost when we transferred production to Mexico two years ago. And secondly, we’ve got a really nice business in the data center market there both with our generator business, but also our paralleling switchgear and automatic transfer switch business. And we are absolutely seeing solid growth in data center, and that’s a secular market we want to continue to grow in. So yes, really overall pretty pleased with Industrial Systems, and we’ll continue to drive performance there.

That’s very helpful color, Louis. Thank you. And then just any update on Arrowhead or maybe automation market trends more broadly and how those are benefiting Regal here?

Yes. So we’re really pleased with Arrowhead, and we call that business now Automation Solutions business unit. It’s part of MCS. We definitely acquired that business because of its position in food and beverage. We want to drive growth with that business. I commented in my prepared remarks that we are on the path to hit double-digit growth in 2022. So I feel really good about that. In addition, we are building out our product and technology road map there and feel like there’s lots of opportunity to increase our served market. With of course, we’ll be talking about at Investor Day and then also talking about the sales synergies of being part of a much larger organization like MCS. So overall, feeling good. Now the food and beverage market again a good secular market that we feel will continue long-term growth. Certainly, a big piece of Arrowhead as well as in the global beverage can market with the palletizers and depalletizers. And when you look globally, pretty much every region is under capacity constraint with cans. And so that was part of the thesis of Arrowhead that was going to drive growth. So feeling – it’s only 4% of MCS, but it’s an important 4% of MCS, and it’s part of a Regal restructuring our portfolio and moving more to growth.

Got you. Well, thank you so much for that color. I’m looking forward to September here.

Yes. Great. Thank you.

Our next question is from Julian Mitchell of Barclays. Please go ahead.

Hi, thanks. Good morning.

Good morning, Julian.

Good morning. Just wanted Louis or Rob to kind of circle back to the orders color and so forth because your bookings, as you said, they were down modestly in Q2. You’ve raised the organic sales guide for the year. And so feeling pretty good about the second half on sales. Does that tell us that sort of your bookings growth year-on-year in the second half, it shouldn’t be much worse than what you just saw in Q2? And I don’t know if there’s any color you could give on July trends, in particular around that bookings rate.

Yes, Julian. Happy to give a little bit more color here. So I think you’re spot on, on the way to think about the second half, in particular, as compared to Q2, relatively flat – on orders relatively flat. But we have a very big backlog, and we’re working through that backlog. And so therefore, with the strong execution now that Q2 and continued solid price attainment in our segments, we felt comfortable with increasing the guidance by $0.10. And as both Rob and I said in our prepared comments, if everything stays the same and supply chain, perhaps there might be a little bit of a beat to that midpoint. But right now, we’re going to be cautiously conservative and going with the guidance we’ve given.

Thank you. And then just looking at the second half, I know you don’t guide quarterly, but is the right way to sort of think about it, you’ve got roughly 21% EBITDA margins dialed in for the year as a whole. It’s a similar sort of 21% number for both Q3 and Q4, and then you just have that usual sort of seasonal revenue step down a little bit in Q3, a little bit more in Q4. Is that the right way to think about the sort of Q3, Q4 earnings? And any other items you’d call out for the back half?

Yes, Julian, this is Rob. The way I think about it is like you said on the top line, certainly, you get a bit of seasonality as you go from 3% to 4%. On the margin profile, absolutely, we should see in that 21%-plus range as we go through the third quarter. And then maybe a bit of improvement as we enter the fourth because that’s when we’ll realize more of the synergies that we have good line of sight to that will come through the MCS segment. So very good cadence, Q3 to Q4 for MCS is expected, which will drive a lot of that EBITDA margin performance as we exit the year.

That’s very helpful. Thank you.

Got it.

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

Hey guys, just a quick follow-up on free cash flow. I think you said 100% conversion, you’re running a little bit behind. Just wondering how long of a put that is to kind of get to that conversion that’s pretty impressive in this environment?

Yes. Jeff, it is a bit of a long put. But the good news is, is that we’ve got pretty good indication right now as we evaluate our inventories and have worked through the modeling in terms of how that inventory should become a source of cash in the back half of the year for us to get us to that 100%-plus. And so I feel really good about the modeling at this point, given everything that we see it as today. So it will likely mostly come from inventory reduction, just to be clear. And most of it will come late Q3 and then into Q4.

And Jeff, I’ll just add on. From an operational perspective, hopefully, we’re gaining some credibility about being a plan-do-check-act company, and we have plans, and we’re executing on them, every one of our businesses. Certainly, customer service – servicing our customer is a priority, but we are driving those plans on inventory and feel like we have a clear path to like Rob said, achieve the free cash flow goal in 2022.

That’s great. Thanks, guys.

Got it.

Great. Thank you.

This concludes our question-and-answer session. I would now like to turn the conference over to CEO, Louis Pinkham for final comments.

Thank you, operator. And thanks to our investors and analysts for joining us today. Rest assured that our high performing Regal Rexnord team is acting with discipline and urgency and in accordance with our Regal Rexnord values, to bring value to our customers and deliver on our financial commitments. More broadly, we’ll continue to execute on the many opportunities before us, new product development, digital, RBS, 80/20, making Lean pervasive, sizable M&A synergies and a tremendous opportunity tied to capital deployment to name just a few. These keep me confident that the best days for Regal Rexnord remains firmly ahead of us. And I look forward to sharing this vision of what lies ahead in greater detail at our September 13 Investor Day at the New York Stock Exchange. I hope to see many of you there. Thank you again for joining us today, and thank you for your interest in Regal Rexnord.