Q2 2020 Regal Beloit Corp Earnings Call

Welcome to Regal Beloit second quarter 2020 earnings conference call all participants will be in listen only mode should you need assistance. Please say no with comfort specialist by pressing star key followed by zero.

After today's presentation they'll be an opportunity to ask questions. Please note that this event is being recorded I would now like to turn the conference. So work to Robert Barry Vice President of Investor Relations go ahead.

Great. Thanks, Kate Good morning, everybody welcome to Regal Beloit second quarter 2020 earnings Conference call. Joining me today, our Louis Pink on our Chief Executive Officer, and Rob Ray Howard, Our Chief Financial Officer.

Turning the call over to Lewis 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 forward looking statements.

Just a factors that could cause actual results to differ materially from projected results. Please refer to today's earnings release.

And our FCC 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 matter as management. Please.

Threed 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 gap.

Now let me briefly review the agenda for today's call Lewis will be leaving off with his opening comments. A then Rob Ray hard our CFO will provide our second quarter financial results in more detail and discuss how we're thinking about the remainder of the year. We will then move to Q and aim after which Louie.

We'll have some closing remarks are now I will turn the call over to Lewis.

Great. Thanks, Rob.

Good morning, everyone.

Thanks for joining us to discuss our second quarter earnings and get an update on our business and thank you for your interest in Regal.

To be direct this was a challenging quarter as the impact of this unprecedented global pandemic weighed heavily on our orders and sales constrain some of our key manufacturing operations and supply chain and presented an array of professional and personal challenges before our associates.

So before going further I wanted to take a moment to think all of my Regal colleagues around the world for their hard work no resourcefulness and their sense of duty as they work to service and support our customers where the central products. During this challenging Todd.

I also want to thank them for their sense of discipline, and then and in some cases I might even say sacrifice enduring pay cuts and hearing too strict safety measures, which maybe uncomfortable at times to ensure not only their own health, but also the health and safety of our entire Regal fan.

<unk> as well as our company's ability to be there for our customers.

Well second quarter was tough well I'm also extremely proud of all that we accomplished through a relentless focus on what we can control and by delivering very strong execution.

Indeed, controllable execution was our Montreign second quarter and will remain so for the foreseeable future.

And so despite having to navigate many challenges presented by Kobin 19.

The Regal team delivered on a wide range of targeted cost actions, resulting in a 15% de leverage right for the quarter.

We also made progress on working capital, which along with the low de leverage right and our Capex discipline drove just under $80 million a free cash flow in the quarter for cash conversion rate up 255%.

And even amidst a host of topline challenges the team managed to find pockets of opportunity to drive some share gains.

Before getting further into our second quarter financial results I'd like to update you on a few important operational items.

First is safety.

Do you run Regal guided by yes, Q D.C.G.

This principle is reverberating through the calls about our officers and down the lines of our production plants and frankly on the video conferencing calls that continue to support so many of our daily interactions.

Safety quality.

On time delivery and cost, which will drive G. Gross.

But safety always comes first.

On our last call I shared a host of measures we implemented to help our associates stay safe from Kobin 19, and I won't repeat them all today.

But what I do want to share is that we continued to refine and improve the safety protocols.

Through a regular cadence of format formal business best practice sharing which have included actions such as virtual gamble walks to get more eyes evaluating our safety measures in practice, we think many of our protocols have become best in class.

In fact as an example, we have on more than one occasion been approached by regional officials and the Mexican government, who want to learn about and share our co good related safety Pat practices.

We opened our plant to them and shared all we do.

And I think I speak for all of my colleagues that Regal when I say, we had been proud to step up as a good corporate citizen in this way.

I have to acknowledge that balancing the need to produce essential products. During a pandemic. While also keeping our associates safe has not always been easy back it's been hard.

Well, we think we're doing it in effective fair an appropriate manner.

That said despite our best efforts the pandemic has had some unavoidable negative impact on our operations.

Well all of our facilities around the world are currently operational our capacity levels in Mexico in India. In particular are not quite where we want them to be.

In Mexico for example through all of stuck in quarter, roughly 15% of our workforce was out with full pay on a government imposed medical degree.

Clearly a financial headwind, but a little less obvious nuances that many of those out a medical degree are generally are more experienced associates, who have more advanced training and skills, which has an outsized impact on the our throughput.

And as I shared with you on our last call one of our principal operations in Mexico was close for nearly three weeks in the quarter as we worked with local government authorities to navigate and evolving and sometimes the inconsistent body of regulations to clarify the essential nature of our products.

I believe however that is important to acknowledge that we're still managing through a precarious period in particular, while I'm proud of our actions to ensure the safety of our associates inside all of our facilities, we've increasingly been finding vulnerabilities to our operations stemming from.

From behaviors by our employees outside of the workplace.

Indeed in a couple of cases, where you have had employees contract the virus, which our tracing protocol determined likely resulted from non workplace interactions.

In such cases, we've had to multi day periods of downtime to properly clean the facilities.

Beyond Mexico, our operations in India were impacted by mandatory three week nationwide shut down during the quarter, followed by a gradual phased reopening based on each local state governments guidelines.

Some of our facilities were impacted for up to six weeks and also face material supply chain challenges as certain of our vendors experienced labor shortages during the initial reopening of their facilities.

In the face of these simultaneous multi continent constraints on our operations. The Regal team responded with a sense of urgency and started to shift production elsewhere in our global network.

This is a core differentiator for Regal, our global yeah local supply chain.

But even moving quickly the process of adjusting our supply change took longer due to the virus and instances where customers needed to certify a substitute product or a product made in a different facility or both the timeline for resuming production took longer.

And because as we made these footprint and just meant we retained strict adherence to Sq DCG safety. First then quality then delivery in a number of situations, we have incurred expedited freight cost to bolster our service levels.

And in other cases, which we believe are relatively isolated these disruptions have had an impact on our ability to fully service our customers. Although those situations have improved greatly.

The other consequence of these operational challenges is ending the quarter with a sizable backlog, particularly in our commercial motors business.

Shipping lots of our backlog weighed on our top line performance in second quarter on the flip side, we expect a benefit to sales and third quarter as we execute down our elevated backlog position.

All that said I firmly believe that by leveraging our global capabilities executing with urgency and adhering to our 80 20 principles.

Our teams to minimize the impact to Regal from these manufacturing disruptions.

And as we come through the pandemic, we see even greater value in our diverse global footprint.

As of today, our operations in India are running at roughly 90% capacity with our Mexico operations slightly below this level our teams in China in Southeast Asia I have also contributed meaningfully to expanding our capacity.

After executing with urgency to adjust supply chains and achieve what requisite customer certifications.

As a result, we expect to see Tailwinds in third quarter as we reduce our backlog.

Also on the operational front I'm happy to report that our absenteeism rates are at a normal level across our business.

Meanwhile, we sought pockets of disruptions among our supply chain in the quarter. These currently are very limited and not impacting our operations in a material way.

Shifting to orders I'd call this a bright spot.

They are tracking down 31% in April and down 27% in May orders improved to down 14% in June.

And were down only 7% in July.

Notably, we believe our bearings business and the Pts segment, a good barometer for a short cycle industrial demand bottomed in May and it has remained stable.

Our pulled pump in residential H.B.A.C. businesses also saw meaningful improvement in orders during the quarter, which continued in July.

That brings me to guidance our guiding principle here is trying to provide our investors and analysts with a meaningful view on how we think the business can perform without making too many assumptions, where we have limited visibility or no unique insights.

For this reason as a short cycle business without a sizable backlog operating against the backdrop of uncertainty tied to Kobin 19, we're not providing a 2020 outlook at this time.

However, we do feel comfortable sharing more detail on how we see the third quarter shaping up.

Based on our recent order rates our backlog the current state of our manufacturing operations and supply chain, we think our third quarter adjusted net sales will decline in a range of 8% to 12%.

From a margin perspective, we think we can de lever at a rate up 12% to 18% with the midpoint of that range Slim similar to the performance we delivered in second quarter.

Rob will provide further details on this topic in his remarks.

One point I do want to emphasize in advance we continue to have ample cash and a very secure balance sheet.

In fact, given our strong first half cash flow generation and improving orders, we did feel comfortable fully paying down our revolver in the second quarter. After drawing it down last quarter in an abundance of caution when we were in the earliest days of Kobin 19.

As business conditions started to show signs of bottoming, but with prospects are for full recovery tenuous and a path out of this recession likely protracted.

We decided to recalibrate our cost out actions as we executed executed the quarter.

As a result after careful consideration we made the difficult decision to implement a reduction in force and also to offer an early retirement program in late June, which together impacted roughly 4% of our solid salaried associates globally, and while we estimate will.

Result in permanent annualized cost savings of about $7 million.

On the flip side with our fighting team now in place and lots of hard work ahead of us on the cost and growth fronts, including executing on our backlog.

We thought it made sense to end the furloughs and pay reductions we had implemented in the second quarter.

As a reminder, those actions drove roughly $6 million a temporary savings in the quarter.

In addition to these actions we remain prepared to take additional measures if needed as impacts of the virus, including any second wave continue to develop.

Before turning it over to Rob I want to share a few operational highlights.

Our second quarter revenue was down 24.7% on inorganic basis, we distribute the vast majority of that declined two pressures related to covert 19, which impacted demand levels in North America in our European businesses.

And also contributed to the manufacturing disruptions and backlog increases I noted earlier.

To a lesser extent, our proactive 80 20 pruning efforts also created a 190 basis points were $16 million headwind to sales in second quarter as we continued to de prioritize our lowest margin accounts.

Despite this revenue pressure, we executed on our 80 20 initiatives another cost actions and posted a year over year adjusted gross margin improvement up 80 basis points and held our operating margin declined to 160 basis points.

That translated to a 15.5% de leverage rate in the quarter, well below historic levels and below the low end of the framework. We provided at Q1, owing largely to stronger execution on our cost out actions.

I remain very pleased with how our Regal team is driving 80, 20 lean productivity in supply chain improvements along with SGN, a reductions to simplify our business and provide more attractive do leverage rates.

Our strong controllable execution helped us deliver 95 cents of adjusted earnings per share in second quarter.

While that's down 36% from prior year, it's better than some of our more concerning scenarios had an implied during our early days of the penned up back.

Looking across our segments, both P.T. as an industrial pushed didnt meaningful year over year operating margin expansion with Pts operating margins up 120 basis points and industrial our operating margins improving 420 basis points women industrial also achieving.

Nice improvement in adjusted operating profit dollars in at $5.2 million for second quarter.

And all these gains were achieved while confronting severe topline headwinds with industrial sales down, 19.8% and Pts sales down 21.1 person on an organic basis.

These operating margin gains are being driven primarily by very strong execution on our cost out initiatives with some added boost from mix.

We're happy with the margin gains we've realized in industrial and see a clear path to significant further upside.

You'll remember that Regal was in the enviable position of having defined and extensive multi year margin enhancement program at the end of 2019. So our focus during Corona virus has been keeping our heads down and executing those well thought out plans.

Our commercial and climate business is also faced significant coated related challenges in the quarter. In addition to significant end market headwinds that weighed on these segments top lines, including North America, industrial and commercial HB AC markets in the commercial segment.

Along with factory disruptions and significant residential HBC, OEM destock and tough furnished prebuilt comps in climate.

Commercial saw an organic sales decline of 23.6%.

While climate sales were down 31.4% on an organic basis.

In this context I feel the commercial team delivered very strong controllable execution in particular on exit executing their cost out initiatives, which kept the de leverage rate in the segment to 20%.

Notably June was one of the strongest performing gross margin months for our commercial business in the last 18 months evidencing the positive margin momentum in that business.

I believe our climate team also did a solid job executing on what was under its control.

But candidly the degree of topline pressure that business experienced along with higher carrying costs due to government imposed capacity restrictions in Mexico, and India brought de leverage right in that 28.5%.

Well that's within the broader scenario framework, we outlined in Q1, it's still not quite where we won the segment to be.

The good news for both commercial and climate is that we saw orders start to rebound nicely as the quarter ended and in July.

For example, after a challenging first quarter in our pool pump business in commercial pull pump orders were up 49% year over year in June and tracked up about 30% in July.

Within our climate business Hvdc orders were up 9% sequentially in May up another 25% in June with July orders up an additional 26% to a level that is roughly flat in dollar terms versus the prior year.

In our distribution business within climate orders were down 26% for the quarter, but up 43% sequentially in July versus June.

So we're very encouraged about what we're seeing infield the resilience in end user demand that many of our customers are seeing and pull and hvdc is starting to benefit our business.

As a result based on what we see today, we are cautiously optimistic that we will see us substantial rise in our climate segment margins in the second half of this year.

Relative to the second quarter levels.

Before concluding I would like to take a moment to highlight a couple of recent positive developments.

One is that despite battling covered related sales and operational headwinds some of our teams were able to eke out some nice share gains in the quarter in particular in the datacenter market.

In alternative energy, both wind and solar.

And then the warehousing and distribution space.

On the ladder, our much sort high precision conveying system continues to exceed great traction in the market as warehouse operators look to advance social distancing objectives by automating what can typically be densely daft last mile package sorting operations.

As I have said previously Regal is no longer focused on big Bang R&D investments that have varying degrees of success.

But rather on more focused initiatives aimed at solving specific problems defined by the voice of the customer which tend to drive more reliable yet incremental growth gains.

Second I wanted to update you that we filled the last open position on my executive leadership team.

Our new head of the Regal business system join two weeks ago.

We see opportunities to run our business better from a supply chain and manufacturing perspective, and we look forward to moving more aggressively on this front in the coming quarters end years.

Well keep you updated as potential upside from our four walls lean in supply chain initiatives come into sharper focus.

And with that I'll turn it over to our CFO, Rob very hard.

Who will take you through the second quarter results in more detail and share our thoughts on third quarter.

Thanks, Louis and good morning, everyone.

I'll start by echoing Lewis's comments about second quarter, being particularly challenging on a number of fronts, but also that our Regal associates remained focused on purposefully executing what was under their control.

And were successful in do that in doing so achieving a 15.5% de leverage rate favourably below what we had reference coming out of our first quarter earnings call, especially given the co. It cost headwinds at our facilities and 77 million of free cash flow for our cash conversion rate of 255%.

The topline story was largely about first and second derivative impacts of the Corona virus.

In our first quarter geographic impacts of Covance were weighted to Asia in Europe, where we generate generate about 25% of our sales versus in the second quarter. When cobot 19 impacts weighed more heavily on the Americas, where we generate 75% of our sales.

In the second quarter, we saw some recovery in Asia, but Europe remained under pressure and North America was heavily impacted evident in our sales being down 24.7% on an organic basis.

The good news is that as the quarter progressed, our order rates improved with July coming and even stronger down 7%.

In our more consumer driven business, such as Reggie H. back and pool, we've seen a much more dramatic recovery in orders I'll provide more details as a walk you through our segment results.

Starting with commercial.

Organic sales in the second quarter were down 23.6% from the prior year.

The decline was largely volume driven with particular headwinds in our North America General industrial and commercial HVAC markets and in our Europe Air moving business. However, we did see an increase in our backlog in this business as we worked to best serve our customers while managing challenges at power.

Plants in in our supply chains.

We also saw more modest headwinds from our ongoing proactive pruning of low margin accounts as we continue to execute on our 80 20 initiatives and to a lesser extent from foreign exchange.

Our pruning activities accounted for roughly 150 basis points of the organic sales decline.

Let me also update you on our pool pump business, which you may recall was negatively impacted in first quarter by cobot related production delays at one of our facilities in China.

That facility resumed operations in April and is running normally.

We also have some pull pump production in Mexico, where we've been experiencing scattered coven related operating frictions.

From a demand perspective, our pool pump business saw increasingly positive momentum during the quarter.

While orders for the quarter were down 4% June orders were up 49% versus prior year end July orders were up 30% versus prior year.

With our manufacturing facility in China backup to full production levels, along with our facility in Mexico at near full production levels. We are confident in our ability to meet customer service levels throughout the pool season.

Also of note is that the commercial China market showed nice improvement in the quarter as we continue to execute on our 80 20 customer segmentation initiatives as discussed on our last earnings call.

The adjusted operating margin in the quarter for commercial systems was 6%.

Down 350 basis points compared to the prior year. This margin was primarily down due to the volume decline and to a lesser extent higher freight costs and increased burden from manufacturing plant inefficiencies due to carve it.

We were able to partially offset the impact of these headwinds with significant cost reductions. In addition to getting some benefit from favorable price cost.

Our de leverage in the quarter was 20.2% a nice result, given the headwinds in this business and far below historical de leverage rates.

Orders in commercial for the quarter were down approximately 23%.

Reflecting particular weakness in Europe, and then our North America General industrial market with Asia and pump as bright spots.

In July orders were down 1% with similar relative dynamics by end market that we saw in the quarter.

This is a solid recovery and we are optimistic that this rate will continue in the quarter.

In industrial organic sales in the second quarter were down 19.8% from the prior year.

The segment saw double digit largely cobot related declines in a general industrial nonresidential construction and oil and gas in market.

In particular in Europe.

This was partially offset by stronger sales into the data center market, where our products provide standby power.

The decline in sales was also impacted by our proactive approach to pruning low margin accounts, which accounted for approximately 180 basis points of the organic sales decline.

The adjusted operating margin in the quarter for industrial was 4.3% up 420 basis points compared to the prior year.

The margin improvement was driven by 80 20 continued cost reductions.

Positive price cost unfavorable mix, partially offset by the impact of lower volumes.

We still have a long path to raising our industrial operating margin to an acceptable level, but we were very happy to see such a meaningful improvement in the second quarter. Given this given severe covered related headwinds on the topline.

The industrial team has done a great job executing on whats under its control.

Orders and industrial for the quarter were down 18%, but would have been down further were it not for the strength and the datacenter business. The headwinds from Cobot 19 quickly became more pronounced as the second quarter began with April orders and industrial down 27%, but we started to see improvement as the quarter progressed and order.

There's for July or down 15%.

Turning to climate solutions.

Organic sales in the second quarter were down 31.4% from the prior year.

The decrease was primarily driven by de stocking at our HVAC Oems.

And in the residential HVAC channel along with pressure on our commercial refrigeration business, which is only 8% of the segment sales, but had a sizeable year over year decline given its exposure to the hospitality end market.

As a reminder, the climate segment also had a nice volume leverage tailwind in the prior year period related to OEM pre build activity ahead of a furnace energy efficiency regulatory change, creating a tough compare this year.

Last year, we communicated that we saw roughly $9 million of Fcr related pull ahead into the first half of 2019, most of which was in the second quarter.

Overall in Q2 sales of more energy efficient furnaces was a mix tailwind for us in the second quarter, but its impact was diminished by the end market headwinds discussed earlier.

It should also be noted that weather had a fairly neutral to modestly positive impact in the second quarter posing a headwind in April and May, but inflecting to a tailwind in June.

Whether in July was particularly favorable.

In addition, the declining sales was driven by our proactive approach to pruning, which impacted sales by 300 basis points.

The adjusted operating margin in the quarter for climate was 12.4% down 520 basis points compared to the prior year.

Continued cost reductions helped to partially offset volume and mix related pressures.

De leverage in this segment was 28.5% in the quarter inline with the scenario planning framework, we provided last quarter, but still slightly above where we wanted this segment to be.

We attribute the weaker de leverage to the combination of severe cold related topline declines and weak absorption at a couple of the segments principal manufacturing operations in Mexico, and India due primarily to the government and present medical restrictions and mandates in addition to fcr related mix headwinds.

On a more positive note orders in climate starting to show meaningful improvement in June and July and we are cautiously optimistic that we'll see significant improvement to the segment operating margin in the back half of this year starting in the third quarter.

Orders in the climate segment for the second quarter.

Were down 34% largely on the cover related headwinds and headwinds in the H. fat as well as commercial refrigeration, which makes up roughly 10% of this segment and where orders were down 40%.

Orders in July or down, 6% with Asia up nicely.

North America down modestly and our Europe business, which makes up 7% of this segment down meaningfully.

Our Europe business and climate is heavily weighted to the hospitality and market, which continued to see pressure is tied.

To cover 19.

Summarizing what we are seen on the order from within the climate segment.

Our significant sequential improvements in order rates in both May and June and now again in July.

Turning to power transmission solutions for Pts organic sales in the second quarter were down 21.1% from the prior year.

Reflecting significant pressure on the North America General industrial end market and to a lesser extent.

Headwinds and upstream oil and gas lumpiness in the alternative energy market.

Our proactive actions to prune lower margin business and foreign exchange.

In the second quarter, our pricing actions weighed on sales by roughly 100 basis points.

Partially offsetting these headwinds we saw growth in midstream oil and gas from preexisting project activity as well as modest growth in China and in the AG in the market.

While our exposure to oil and gas is only about 5% to 7% of the Pts segment and is weighted to mid stream.

The severity of declines we saw an upstream had an outsized impact on sales performance in the quarter for this segment.

The adjusted operating profit for Pts was down $3.6 million in the quarter. Despite the 45 million dollar year over year decline in sales representing de leverage of 8%.

Operating margin in the quarter for Pts was 13.6% up 120 basis points compared to the prior year.

Continued cost reductions and to a lesser extent favorable mix and slightly positive price cost more than offset volume related pressures.

Orders Npts for the quarter were down approximately 18% largely on headwinds in a general industrial and upstream oil and gas end markets.

Looking at July.

Year over year orders were down 10% on diminished, but still fairly broad based headwinds.

Notably our short cycle industrial focused bearings business stabilized during the second quarter.

May appears to have been the bottom for this business, though we have not.

And though we have seen limited improvement in June and July with customers, appearing to order act demand versus showing an appetite to restock. We do believe channel inventories and bearings are relatively lean and we would expect to see a nice tailwind in this business when end user confidence rises and restocking does start to.

Occur.

Now I will summarize a few key financial metrics for the second quarter for total Regal.

Our capital expenditures were $9.5 million in the quarter, we continue to be focused on ensuring that we deploy capital that drive share that drives returns above our weighted average cost of capital and ultimately improve shareholder value.

We continue to monitor capital expenditures very closely and continue to expect full year spending a $50 million.

The adjusted effective tax rate in the quarter was 22.4% we provided a table in the appendix of this presentation to reconcile the gap BTR to the adjusted DTR, our full year adjusted Trs still expected to be 21%.

Our simplification and footprint consolidation activities resulted in $10.9 million of restructuring and related costs in the quarter and we now expect $25 million have restructuring spend for the full year.

Also included on this page is a summary of the cost savings actions, we've taken both in that 2019 and now 2020.

We expect our 2020 restructuring actions to result in approximately $45 million in annualized savings.

As a reminder, during our first quarter earnings call. We estimated that we would realize $32 million of 80, 20 and restructuring related cost savings this year.

We now anticipate that we will realize $36 million of cost savings. This year, an increase of $4 million from our prior estimate due to the additional actions we took during Q2.

Of the $36 million in cost savings, we estimate that we realized approximately 8.5 million in Q2, and we'll realize an additional 23.5 million in the second half of this year.

We've provided on this slide the quarterly cadence of how we expect these cost savings to contribute three through the remainder of this year.

In the second quarter, we also realized $6 million of savings related to temporary pay reductions in furloughs.

During the quarter, we recalibrated our cost actions under the carefully considered assumptions that there will not be a V shaped macro recovery in the us or in Europe, and that any recovery could be bumpy and will likely be protracted.

As a result, we took the difficult decision of implementing at reduction in force and also offered a voluntary early retirement program. These two actions together impacted roughly 4% of our global workforce and are expected to generate $7 million in annualized savings with roughly $4 million of that amount record.

Nice in the back half of this year.

As Louis mentioned in his remarks post our headcount actions. We believe we now have our fighting team in place.

And with lots of opportunity ahead of us on the revenue cost in cash flow front, plus some positive data points on orders.

We thought it was appropriate to end the pay reductions and furloughs implemented for the second quarter.

Now, let's move onto our balance sheet.

Our total debt at the end of the second quarter was $1.126 billion and our net debt was $694 million. We ended the quarter with our net debt to adjusted EBITDA ratio at 1.6. The same is how we ended the first quarter and well within our comfort zone of 1.5 to 2.0.

We'll also reiterate what Louis highlighted in his opening remarks and that we fully paid down our revolver during the second quarter after dropping it down out of an abundance of caution in the early days of cover 19.

Our balance sheet remains very strong with a solid cash position along with relatively low debt.

Moving to free cash flow, we achieved $77.4 million a free cash flow in the quarter.

Our second quarter free cash flow resulted in a conversion rate of 255% of adjusted net income and speaks to that cash generation cash generating capability of the business.

Trade working capital was a source of cash in the second quarter and we continue to expect trade working capital to be a source of cash throughout 2020.

As we discussed during our first quarter earnings call. We did this we decided to partner stock purchases to preserve capital in response to cope unrelated uncertainties for.

For now our program remains pause, but we are open to reinstating. This program when we see sustained order rate patterns.

Moving onto the outlook.

Similar to last quarter, we're not providing guidance for the full year.

Unlike last quarter when we provided scenarios. We're now at a point, where our order rates are improving giving us more confidence to write a framework for the third quarter.

However, given where a short cycle business and there is still uncertainty in the market and potential uncontrolled cobot impacts on our operations, we're not providing and outlook beyond the third quarter.

We expect sales to decline in the range of 8% to 12% versus the third quarter of last year.

With Pts at the higher into the range and commercial near the lower end.

We expect de leverage to be in the range of 12% to 18%, which at the midpoint is consistent with the de leverage rate, we saw in Q2 with room to improve.

I remind you.

That we started realizing the cost actions implemented last year in Q3 of 2019.

Which provides a bit tougher comp however, the additional cost actions discussed earlier should help offset that year over year comp headwind.

Next I thought it made sense to remind you of comments, we made last quarter about how we believe that business can perform when our sales start to grow again.

Our thoughts here are unchanged, we feel very strongly that through our 80 20 initiatives our supply chain moves and our other restructuring actions. We are building a business that has found a fundamentally different cost structure versus recent cycles that means we expect a strong performance we've been executing on de leverage will also translate into stronger leverage rate.

Leverage rates versus history history, which we think can be above 30%.

At the bottom of this page Weve include some it included some additional assumptions that can be used when modeling the remainder of this year.

Before I conclude our prepared remarks I want to once again, thank all of our real associates for everything they are doing to navigate these difficult times.

Our result in Q2, despite severe pandemic related revenue headwinds and manufacturing disruptions showed very strong execution as demonstrated by low 15.5% de leverage rate and strong free cash flow.

And with that I'll turn it back over to the operator, operator, we're now ready to take questions.

We will now begin the question and answer session too.

Question. Please press Star then one on your Touchtone phone, if you're using a speakerphone. Please pick up your handset before pressing the key to withdraw your question. Please press Star then Tim.

This time, we will pause momentarily to assemble our roster.

Our first question is from Julian Mitchell from Barclays.

Go ahead.

Hey, Good morning, guys. This is attrition on for Chilean.

Good morning to rely on residential HVAC was just wondering if maybe you can talk a bit more about what you're seeing out of the commercial HVAC market, maybe order of magnitude there for what that doesn't fit in terms of orders and sales in the quarter and just kind of given what you're seeing resonates back do you think this segment could return to growth as a whole earned in the second huh.

Yes so.

Good morning Trust us as Louis I'll take those ones. So commercially track, which is actually in our commercial segment. It is not in our climate segment.

Commercially fact was orders were down pretty significantly in the quarter down down 38% now going into July we have seen a rebound, but still down. So overall I would say that side of our business is.

Not seen the recovery that we're seeing on the residential Atri AC side residential hvdc, we're getting the benefit of consumer demands stay at home demand and.

Also a warmer second quarter April may was slightly weak, but but June so certainly June and July have seen a strong rebound. So I would say from a commercial hvdc side.

We're still down.

Hi single low low double digit.

Got it hopefully that helps thank you.

Yet and then just maybe one follow up on the cost savings how should we be thinking about that by segment and then on it seems like it's been weighted more towards industrial given the incremental actions are there any team thats, how we should be thinking about incremental margin on the upturn.

And maybe you can industrial do 30, 35% incremental margins keybanc.

Hi, This is Rob I'll take that one so first of all on the split by segments. All segments have their share of the cost savings and of course, the industrial segment as we've communicated previously does have.

A good percentage of those cost savings and they're in their expectations certainly.

We've communicated how in industrial.

Most of the improvement plan is cost savings related as opposed to growth related on the topline so.

That's really the way to think about it in terms of.

Industrial coming out of this and working towards higher margins, we have as we showed and our Investor day, we have a plan to get industrial margins above our weight is weighted cost of capital over the term.

As we pointed out on that and that presentation. So that's really the way to be thinking about it should industrial.

Lever up.

35% or so.

I think just maybe around 30% maybe slightly just south of that that's kind of the way to think about it.

Hi, Thanks.

Great. Thanks Trish.

Next question is from Mike Halloran from Baird.

Go ahead.

Hey, good morning, gentlemen.

I'd like to so first on the on the on the climate side could you help put a lot of those moving pieces in the context for us we're certainly hearing that some pretty robust residential trends.

And that June July time period, you're certainly talking about some sequential improvement you've got other pieces in there.

Our comps.

In other than that some other pieces that are constrained, but maybe talk a little bit about that trend. If you keeping up with what you think the end markets are looking like right now in the commentary and what inventory looks like you to channel to help understand the comparative performance between what you're looking like and maybe what the sell out from the industry is looking like.

Yeah, Mike Good morning. This Lewis I am happy to happy to share you know, we provided a lot of information in our prepared remarks, and a lot of numbers and.

Hopefully not to confuse but to provide as much transparency in detail, but but to give you our perspective on.

Hvdc in our climate spec segment in particular.

Certainly weak demand in April and May we saw a significant destocking by our customers as well as in the channel in in early parts of second quarter certainly through early June.

In addition, when you look at the mix of that business roughly 10% of the sales are our commercial refrigeration.

Served the hospitality end market and those orders were down significantly in the quarter and we're not seeing them rebound and then to your point there was the tough compare of FBR.

Which we believe has probably about a three point impact in second quarter.

Now you're when you asked the question of how do you compare that may be too some of the Oems that have.

Provided results already you know clearly were upstream of those Oems those Oems or are we would say have taken their inventory levels down in second quarter, but we are starting to see them restock in so that justifies some of the upsides. We're seeing now now sales in Oh excuse me.

Orders.

In April were down 40, plus percent in that segment.

Year over year, and then we saw.

Consecutive improvement of nine in May and 25 in June and July.

Another 26.

And so overall, we're seeing for the month of July pretty much flat from year over year perspective.

I'm I'm bullish actually of what's going on in this segment I'm also very positive about the relationships, we have with our Oems and the partnering that we have going on we are in the middle of a couple of long term agreement negotiations that I would tell you are going positive Lee.

You know in the end our responsibility as a supplier to this segment is to provide good product technology, Great service, which we do and be cost competitive and I believe we're doing all of that well and partnering with our Oems to help them be successful in the future within.

New products and technology. So overall, a tough Q2 no question orders April may tough definitely rebounding and we feel good about a third quarter and beyond. This is why also in our prepared remarks, we made the comment that we feel our operating margin should improve.

Because of this the sales increases we expect in the second half.

So hopefully that that answer yes, I know that that does and so what I'm hearing is pretty stable on the share side.

Just a question of timing and inventory so from what we've seen from where we sit here today.

That's exactly right that's exactly right. Okay and then the second question is then.

When you think about the back half of the year in the framework that you put up for this third quarter.

Excluding the commentary we just had on the residential climate side in probably the pool side as well.

Are you embedding pretty normal sequential trends from what you saw on that kind of June July time periods from here or is there a different thought process internally for some of those core industrial.

Commercial markets.

Yes, so so.

A couple of comments there overall regals orders in a July were down 7% year over year, and we believe our sales will be down roughly 8% to 12% I will comment that our backlog did grow in second quarter and so from a.

Consecutive orders rates were not looking for a great improvement.

If anything maybe even a July was a little bit of fault on August we're not expecting August and September to be anything up a stronger at this point.

It's a pretty normal from numerous I appreciate it. Thank you sure. Thanks Bye.

Our next question is from Christopher Glynn from Oppenheimer go ahead.

Thank you good morning.

Good morning Trust, so nice milestone on the traction with the industrial.

Our gen.

We.

The term it's kind of interesting now is it just really a lot of the traction.

Hitting in risk clearly been working on for the past year two years or.

Were there any timing factors that helped the margin rate or do you expect to continue to build up the twoq you level for industrial margin.

Yeah really Chris.

No no one timers in the quarter, you know a slight impact because of the furloughs and pay reductions, but this is the outcome of the hard work that the industrial team has been putting into driving the performance of the business. This is all of our cost out initiatives. This is a.

We've talked on previous calls all about coming out with a new global Terramax industrial motors solution that had a much better cost position and we're actually I'd say in early days of reaping the benefits of that as well as well is taking significant cost out of our alternator in January.

Peter business. So we can be more cost competitive so I'd say very limited onetime impacts which should allow us to continue.

To improve on the operating margins in this segment as we proceed through the year.

Thanks for that and then just wanted to visit the accrued the pruning initiatives I'm just a brief overview of the state of play there types of accounts and in particular climate, where it's a little bit there.

Yes, I mean this is this is our 80 20. This is who we are.

This is understanding our customers understanding the value they placed in our our offering and providing the best solution now if we.

We can't do that competitively and we can't make appropriate margins then we'll make those tough decisions I would say historically as I've comment on other calls that perhaps regal hasn't done this in the level of analytical detail that we're doing it today, which is raising.

This need to do pruning, a where our focus does is around having 80 20 drive us. So we can focus on our highly valued customers and grow with them and will define those highly valued customers is those that value us as well. In addition, it allows us to focus on.

And what we define now is our perfect prospect customers and segment those customers again that value, our technology and our differentiation and are willing to pay for that appropriately and so.

I've talked about a couple of our segments in regions that are gaining some nice momentum here, our commercial motors business in China has gained some fantastic momentum Mark our hermetic business is gaining some momentum because we're focusing our teams on where we're going to getting the best returns and so.

I'm I'm not surprised by.

His we said before that we thought pruning would be between 1% to 2% for Regal. It was 1.9 in the quarter, a little bit higher in a climate, but again I'm, okay with it and because that's where we're putting our focus on quite places than where we need to go with the business long term.

Hopefully that helps scherfig.

Thanks, Chris.

Our next question is from Michael.

From Wells Fargo's go ahead.

Good morning, everybody.

Good morning.

Congrats mr. Barry on the new seat.

No. Thank you.

So if I could just jump into the incremental margin discussion. It seems like you've got some really good trends here within climate heading into July.

That's a large segment for you highly profitable.

So are there any considerations that would push that deleveraging to the high end of the range. It's it seems like.

Maybe a little conservative I mean is their currency or FX baked in that any color would be greatly appreciated.

Yes, I think that the de leverage rate that.

That we've highlighted on the on our third quarter here pretty consistent with what we would expect theres nothing that we see as as kind of a an outlier from that perspective.

Our climate business does tend to de lever.

No.

Around that 25% range, where we certainly see them delevering better than that as we go through this next quarter aligned with the framework that we've provided so no there really isn't anything that stands out as a as a big headwind to to offset that impact.

Okay.

And then I think you mentioned some repo considerations, maybe the back half of this year.

Shares have had a good really good run here I think you're trading above pre cobot levels. So can you just talked about what you're baking into what is more market considerations versus your own return on capital metrics, how you see that laying out the back half this year.

Right, so as as I talked to during the call.

No we are still.

Suspending the share repurchase program. However, the things that will cause us to actually open that backup and reinstate the program would be things like Hey, the continued stabilization of our order rates for example, as we go through the year, we saw really nice uptick sequentially.

In our orders as we commented on the call and so that continuation will certainly be one of the factors that we're looking to in order to reinstate that program. The other would be market as you said.

The demand side is a market you know.

We're starting to stabilize more going forward and is that our expectation is that sort of confidence that would trigger our decision to potentially open back up and reinstate the repurchase program.

Okay.

Very helpful. If I could just sneak one more in on the Pts because I don't think it's down a lot of color thus far.

Some other OEM, noting strengthen the center of the our grocery I know you have some conveying parcel food food exposure there any comment on the long term and market drivers that maybe you see as we get through these these choppy waters here.

Yes, so if you look at our Pts business and our conveying business. It's a it's a bit more focused on beverage and in a material unit handily. We are incredibly bullish on a material unit handling Mrs.

Even pre Covidien, which the driver now is around social distancing, but a pre co bid it was around safety.

And automating that last mile of package distribution and we have a great technology its differentiated.

With solid accuracy in the sorting process and so very very bullish there on the beverage side. We tell you were where Ah during 2019. It there was a bit of a law and it was really what's going on in the marketplace around plastics and what's going to be the replaced.

Packaging.

For plastic bottling et cetera that hasn't been worked out and we're in the middle co bid. So right now we are seeing some nice aftermarket business, but I would say once we get through coated and theres a clarity on the if the path forward for packaging I believe bed of is going to be strong as well but.

Our our where we're putting our 80 20 focus is material unit handling.

Thanks, I'll pass along.

Yes. Thanks. Our next question is from Nigel Coe from Wolfe Research go ahead.

Hey, good morning, everybody. This is Brian on for Nigel maybe just to start off.

Could you maybe recap some of the supply chain moves that you mentioned in your prepared remarks as far as moving some of that capacity to I think southeast Asia.

Yeah, no happy to.

Again as I emphasized in those remarks. This is a core capability of Regal is our global supply chain then show.

We have the ability to manufacture in multiple facilities and it really just comes down to a working with the customer to get there approvals in certifications from the manufacturing site and so we've actually transferred quite a bit of our production capacity into.

China in Southeast Asia facilities.

To be able to support the demand in the marketplace and the service levels. As we were no through Q2 did have challenges in Mexico in our supply chain and so again I think it to core differentiator for Regal and makes us as strong as we are in this in the market.

Great. Thanks for that and then maybe just any changes in how you look at the portfolio or any different pieces of it going forward, obviously really strong performance from industrial this quarter just any change there.

You know not really we.

Have a path with every one of our businesses to drive continuous improvement and performance improvements and so we have a I'd say compelling stories to.

Bring shareholder value creation in each of our segment. So nothing nothing changes for us at this time.

Great. Thanks look.

Our next question is from Jeff Hammond from Keybanc capital markets.

Go ahead.

Good morning.

Good morning, just back on so the guidance is eight to 12 down I think you said PT at the better and commercial at the at the lower end should we assume.

That the other two businesses are kind of square in the middle and why would climb or why would commercial be at the lower end given kind of order rates in the backlog build.

Yes, well I think thats the reason they would be at the lower end because.

On the.

They do have.

On the de leverage standpoint, we would expect them to to have a little bit.

Little bit of an uptick in terms of art improved de leverage as we move through the third quarter.

On the lower end on growth and that's good that's on revenues yeah. So.

The at the low end up our commercial is because we have that that backlog sitting there along with the improved order rate. So.

The the backlog that we said we built within the second quarter was largely in commercial so it provides that level of protection and Thats why you've got that maybe at a lower sales decline for commercial.

Okay. So so commercials that the better ended the decline and Pts at the worst send the decline and the other two or the window.

There are in that yeah within that range, yes, there within the metal.

Okay. So then just moving back to climate, because I'm still confused so.

I think you said July orders down six overall and resonates back, which I think it's 40% to 45% segment is up 26.

Can you just go through the piece because I understand refrigeration is weak you said that but that's only 10% can you go through these other pieces like general industry combustion aftermarket like it just seems like.

That other 60% is just you know really really bad still.

Right I mean, yes, so so just to just to be clear from a segment perspective.

We are combining our HPC and combustion and that overall roughly 55% to 60% of the segment. So not not the 40 that you reference Jeff. So it's a larger part of the second segment now distribution.

Okay distribution is also roughly about 10% to 15% of the segment.

The rest of the segment I remind you that we do have a small India business in India orders, where where we can in second quarter, and then general industrial and commercial refrigeration are the other two commercial refrigeration, absolutely doubt AWG and so to that point, we saw orders down.

40, plus percent in second quarter, and then general industrial down as well.

But but in the mid Twentys from an orders perspective, so that 40% ish.

Actually it's more like 30% are definitely down.

Yes, it just doesn't seem that up to down six for July you'd given that makes you talked about.

I can follow up offline so just focused on.

So I think clearly the Oems destocked.

And then they saw rapid demand. So it seems like channel inventories are very very lean.

And demand is very very high I mean are you is there any indication that there's not only some catch up in demand, but you know view that inventory levels needed to catch up as well and then you continue to see kind of this sharp.

Restocking recovery kind of continue into fourq, two or at least continue through the third quarter.

Yes, I mean definitely we expect a restocking to go on inventories were brought down.

You know I'll remind you are you know our perspective, the underlying demand the consumer underlying consumer demand.

We at least we heard this in our the Oems our earnings call are still down that that high single digit 10% rate. So it's not a full rebound there yet but.

So you you add that to the positive of some restocking, but then the negative of roughly 30% of the segment being in commercial refrigeration and general industrial all and I do think it comes as well as.

Because our numbers came out at 5.5% orders down in July.

We certainly expect a better third quarter.

But but we are planning for that roughly five to five day present down.

Okay, yes, because the I mean, the distributors in the distributor data, which would represent sell through indicates June and July were like closer to plus 20.

So where's the negative.

Underlying consumer demand.

Coming from.

Yeah, well April May award were significantly lower so if you look at April amazing results for for distribution of.

It was quite a bit lower than that so.

Down 47% in April down 29% in May for US. This is for US jot down 29 presented may down 3% in June up 24% in July.

So from a second quarter perspective orders were were very quite weak 20 down 26% overall in second quarter, but absolutely rebounding in July.

Okay. Thanks, so much guys.

Yeah got it thanks, Jeff. Our next question comes from Chris Dankert from Longbow Research go ahead.

Hi, Good morning, guys. Thanks for taking the question.

I guess, if we can update into my apologies if I missed that there was a a lot of of data of this morning.

Did you guys specify were there any actual plant closures in the quarter kind of driving those permanent savings and then maybe just in the path. We've talked a lot about automation driving some of these savings just any update on where we are with with the pace of automation the business would be great too.

Thanks, Chris This is Rob ill start and then let US can also add on the automation side, but when it comes to the the additional savings that we highlighted during the call. Those are really more around the reduction in force and the voluntary retirement program that we that we laid out.

You know and implement at the end of Q2, so thats the $7 million annualized with roughly 4 million at that time in the back half of this year, so that wasn't really plat related the plant related.

Restructuring actions that we've taken were already embedded in the the 30 38 million or the 32 million in the year that we talked about last quarter.

Yes, so I saw all add onto that as well.

Robs right on.

Reemphasize, though as we talked about at our Investor days that we have a clear path for footprint consolidation and were on we're on our plan that we communicated which was going to be a 23% reduction in our square footage over the next three years and so we did we did close a key.

Couple of facilities in second quarter specific to that question, but to to Rob's comment that's not part of the incremental 6 million of savings. It was already embedded in what we've communicated in the past, but we feel really bullish about the opportunities to drive 80, 20 at Regal and test.

Simplify our business, so a 23% reduction in footprint, we're driving a 42% reduction in product into a product rationalization. So S.K. you count we're improving our best value country sourcing significantly over this period all of these things are with our path of 300 basis points have been.

Approvement in three years, that's specific to your question on automation then you may recall in.

Earnings call, three or four or earnings calls ago, we changed our direction a bit here.

Regal was going down the path of large automation implementations and we've pulled that back and we said where it makes sense and we can put in a solution in that results like a co bought a little lesser cost investment, but a faster return.

We're going to do that and we've done that at many of our facilities and we continue to do that and many of our facilities and so.

Rob made the comment in.

In his prepared remarks around our capital investment you know in investment like that is going to pay back in less than a year and we're driving it in many of our facilities and so that's where our focus is not on a big Bang automation solution, but on tailored customized solutions and our manufacturing.

Signs that drive.

Safety quality.

And then costs.

Hopefully that helps grip no that's very helpful. Thank you.

And then just to follow up again, we've heard from a lot of company, so far with the downturn and volumes kind of revisiting. The go to market commercial excellence, just given the kind of air pocket here any thoughts from you guys in terms of shifting direct versus indirect growth strategy, just any comments more broadly on go to mark.

It would be great.

Yes, so no no changes in our approach to go to market other than 80, 20, and it's all about servicing our highly valued customers and providing them better service solutions, and then leveraging our digital customer experience.

Which we've invested significantly in the over the years that I've reinforced investment in since I've been CEO to make it easier to do business with Regal.

Oh, so beyond that.

No no changes in our go to market.

Plants Gabi I still similar distribution approach well perfect. Thanks much of the color guys.

Yeah, great. Thank you thanks, Chris.

This concludes our question and answer session I would now like to turn the conference back over to Louis pick them for closing remarks.

Thank you operator to summarize second quarter was tough as we expected it would be confronting the unique challenges posed by coven 19 across our business.

And as I mentioned in my opening remarks, the virus also impacted our associates personally in many ways.

But one but when it comes to factors under our control.

I'm pleased with how our Regal team executed in the quarter, achieving 15% de leverage very strong cash flow and even a few bright spots on the share gain front.

I think them again for all of their efforts.

With the challenges of second quarter, now hopefully largely behind us and some encouraging signs that our businesses inflecting towards the positive. The Regal team will continue executing on our near mid and long term goals guided by the priorities of Sq DCG.

The safety quality on time delivery and cost, which will achieve profitable growth for our associates for our customers and for our shareholders.

Thank you for joining our call and please stay safe.

The conference has now concluded.

Thank you for attending today's presentation you may now disconnect.