Q3 2023 Regal Rexnord Corp Earnings Call
Good morning, and welcome to the Regal Rexnord third quarter 2023 earnings call. All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the star key followed by zero.
After todays presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on your Touchtone phone. Please note. This event is being recorded I would like now to turn the conference over to Robert Berry, Vice President Investor Relations. Please go ahead.
Great. Thank you al and good morning, and welcome to Regal Rexnord third quarter 2023 earnings Conference call. Joining me today are Louis Pinkham, our Chief Executive Officer, and Rob <unk>, Our Chief Financial Officer.
I'd like to remind you that during today's call you may hear forward looking statements related to our future financial results plans and business operations. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today's press release and in the Hell of a report filed with the SEC, which are available on the <unk>.
Next door Dot com website.
On slide three we state that we are presenting certain non-GAAP financial measures that we believe are useful to our investors and have included reconciliations between the non-GAAP financial information and the GAAP equivalent in the press release and in the presentation materials.
Turning to slide four let me briefly review the agenda for today's call Lewis will lead off with his opening comments and an overview of our three key performance. Robert hard will then provide our third quarter financial results in more detail and provide an update to our guidance. We will then move to Q&A after which Louis will have some closing remarks.
That I will turn the call over to Lynn.
Great. Thanks, Rob and good morning, everyone.
Thanks for joining us to discuss our third quarter earnings to get an update on our business and for your continued interest in Regal Rexnord.
Our third quarter can be characterized by strong controllable execution against an end market backdrop that became weaker than we expected in the quarter.
Causing us to fall short of our sales and earning expectations for the quarter and for the year.
Our strong execution is most evident in our cash flow performance.
We generated $162 million of free cash flow in the quarter, keeping us firmly on track to hit our target of at least $650 million for 2023.
Even with the lower sales and EBITDA expectations.
What we generated in Q3, plus some cash on hand allowed us to pay down $185 million of debt.
As further lowering our interest expense forecast.
Our team also delivered roughly flat adjusted EBITDA margins.
Down 10 basis points versus prior year on a pro forma basis.
As our top line fell by eight 5%.
On a pro forma organic basis, implying a deleverage rate of 22%.
We also made significant progress rebalancing the portfolio towards our most profitable growth opportunities by reaching an agreement to sell our industrial motors and generators businesses for cash proceeds of $400 million, which is on track <unk>.
Lows in the first half of 2024.
Adjusting for this sale.
Our enterprise gross and EBITDA margins should rise by over 100 basis points.
And because we intend to deploy all net proceeds to debt reduction, we should be able to accelerate our balance sheet deleveraging.
At the same time, we believe our associates in these businesses will benefit by joining an organization that is more aligned with our growth strategy and global industrial motors and generators, which should allow them to excel in the future.
We have clearly transformed our portfolio.
With gross margins for years ago in the mid twenties.
To achieving mid Thirty's gross margins today.
And a clear path to 40% gross margins.
Which will be helped by the industrial sale.
As much as I am pleased with our controllable execution in the third quarter I am disappointed that our financial performance is falling short of prior expectations.
A dynamic largely explained by weaker end markets.
Our sales in third quarter were up 24, 5% all in but down eight 5% on a pro forma organic basis.
Four of our top five end markets, representing roughly 50% of our sales were.
Were weaker than expected.
This weakness was also apparent in our order rates, which on a daily pro forma basis were down 10% in the quarter.
We did face a fairly challenging 24% two year stack compare on orders, but performance was below our expected mid single digit decline.
Normalizing global supply chains continue to impact orders.
But a more cautious channel and in some cases weaker end user demand were also factors.
Our orders and sales performance resulted in a quarter end backlog that remains up above our normal levels in Ips and AMC with P. S levels now close to what we would consider normal.
Book to Bill was <unk> 94 in the quarter.
In October we did start to see early signs of improvement in our order rates.
Particularly in Ips, which saw a modest year over year growth.
And sequential growth in PFS and AMC.
This makes us cautiously optimistic that we may be approaching an inflection point.
Though an improvement versus what we saw in the third quarter. Our current guidance assumes fourth quarter orders are flattish to slightly down versus prior year.
Despite third quarter topline pressures margins in the quarter were strong.
Our adjusted gross margins came in at 34%.
The third quarter adjusted EBITDA margin was 26% down 10 basis points versus the prior year on a pro forma basis.
Two of our segments also achieved nice year over year adjusted EBITDA margin expansion.
P. S was up 310 basis points to 19, 7%.
And pro forma margins at AMC rose 130 basis points to 24%.
Drivers include price cost improved operational efficiencies, various 80, 20 initiatives and disciplined cost management by our teams.
Where we struggled in the quarter with Ips, which saw margins fall 330 basis points versus prior year.
The principal driver was mixed pressure much of it tied to short cycle weakness in the higher margin aftermarket channel.
But another factor also emerged during the quarter, which relates to PMC footprint synergy realization.
Those who have followed us for some time know that we like to set ambitious operational targets and then work with discipline and urgency to achieve that.
I think our track record on margins in particular demonstrates our ability to execute in this manner.
However, during the quarter, we decided to incur higher cost to minimize customer disruptions related to our footprint actions.
This decision is resulting in some temporary pressure to Ips margins.
But to be clear there is no change to the permanent reductions to our cost structure that our PMC or for that matter, our ultra footprint synergy actions are expected to bring.
Rob will elaborate on this topic a bit further and discussing segment performance and our updated outlook.
However in total I am pleased with our team's performance in the quarter and I want to thank all of our associates for their disciplined execution in a tougher end market environment and for their hard work and dedication to making Regal rexnord stronger everyday.
Shifting focus you may recall that each quarter I had been spending a few minutes introducing our principal AMC business is to help investors better appreciate how we are well positioned to accelerate profitable growth for many years to come.
This quarter I'd like to spend a couple of minutes discussing aerospace and defense.
Our A&D Division, which grew 27% in Q3 sales highly engineered components used in commercial aerospace air and land based defense helicopter and space exploration applications.
These markets are positioned to benefit from strong secular growth tailwind tied to making air travel more sustainable two countries addressing rising geopolitical risk into our OEM customers prioritizing suppliers with lower risk supply chain.
In the realm of aircrafts sustainability, we see greater electrification of commercial and military aircraft. The introduction of alternative fuels and increased use of hybrid propulsion systems.
As global geopolitical tensions rise countries are enhancing their domestic defense capabilities, which is driving demand for our defense products.
And in the wake of recent periods of global supply chain disruption customers are shifting their business to supplier partners with better managed lower risk supply chains. All of these trends play to Regal ration of its strength.
We had been making meaningful investments.
In R&D in engineering and in talent to significantly raise our new product vitality and production capacity and thereby ensure we are well positioned to continue addressing our customers' needs.
Effectively.
I am pleased to share that we have solid momentum as you can see on this slide our aerospace business.
Sales are tracking up 20% in 2023.
And roughly one quarter of this growth reflects outgrows tied to the new product investments the business has been making.
Through the combination of our legacy Regal aerospace business with that of Rexnord, and PMC and now ultra's aerospace businesses, we have a more comprehensive product portfolio and a scalable go global platform and footprint to expand from selling components to all.
Also providing vertically integrated electromechanical motion control solutions.
Today after only a couple of quarters since the transaction closed the combined Regal rexnord A&D businesses have a robust funnel of synergistic bid opportunities.
When it comes to our ability to provide differentiated service levels to our customers our manufacturing footprint and supply chain are increasingly a competitive advantage at a time when such reliability is critically relevant to customers.
To this end, we recently completed construction of a state of the art manufacturing facility in Chihuahua, Mexico.
We're tapping into highly skilled local labor pools in a region that has become an aerospace center of excellence for many of our customers.
Expanding our capacity to address rising demand, while improving our service levels and increasing the value we can offer to our customers.
I should add the facility also incorporates a range of state of the art energy and water efficiency features in its design supporting our commitment to be good corporate stewards of the environment.
So when we step back and connect the dots on the power of our A&D portfolio differentiated highly engineered products deep domain expertise long standing customer relationships and opportunities to leverage the combined capability of Regal.
Rexnord total portfolio.
We see a business position for strong outgrowth into the foreseeable future.
And with that I will now turn the call over to Rob to take you through our third quarter segment financial performance and discuss our latest guidance.
Thanks, Louis and good morning, everyone.
I will also begin by thanking our global team for their hard work and disciplined execution at a time when we are facing challenging end market headwinds.
Now, let's review our segment operating performance.
Starting with automation and motion control, our AMC organic sales in the third quarter pro forma for the ultra acquisition roughly flat to the prior year.
Reflecting strength in the data center aerospace and medical markets tempered by weakness in general industrial and global factory automation.
Particularly the short cycle book and ship business.
I will also point out that year to date organic sales growth for the AMC segment is up five 1% on a pro forma basis.
Adjusted EBITDA margin in the quarter was 24%.
In line with our expectations and up 130 basis points versus the prior year on a pro forma basis.
The margin performance reflects pockets of strength and mix positive markets, such as data center aerospace and medical along with favorable price cost strong operational synergy realization and discretionary cost management.
Orders in AMC on a pro forma organic basis, we're down roughly 20% in the third quarter on a daily basis with book to Bill at <unk> 86.
We expected orders to decline in the quarter versus prior year as supply chain lead times and inventory levels normalize. However, order intake was lighter than expected in our book ship business as more cautious general industrial end market pushed out inventory replenishment orders.
This was most pronounced in our businesses with factory automation exposure, where blanket orders and inventory buildup had been more significant.
In October book to Bill tracked at roughly 1.1, which we're pleased by but the order mix is still weighted more towards new projects with longer shipment date versus in quarter book in turn.
Our perspective.
Amc's third quarter order decline is against a two year stack, just above 40% and the segments backlog at the end of the third quarter remains the most elevated of all our segments.
<unk>, 50% above normal.
While this level of backlog gives us optimism, it's longer cycle waiting will likely benefit AMC in 2024.
In fact, the dynamic of weak short cycle orders.
Mainly in automation exposed businesses versus stronger long cycle orders and backlog in automation Aero Medical and data Center was a key driver of Amc's flat third quarter sales.
We expect this dynamic largely to continue in fourth quarter as well before starting to improve in early 2024.
Turning to industrial powertrain solutions or Ips pro forma organic sales in the third quarter were down three 7% versus the prior year.
Growth in the quarter, mainly reflects weakness in the global industrial and AG markets, partially offset by strength in energy.
Long with metals and mining.
In particular, our book shift business was down more in the third quarter than anticipated, which was driven mostly by destocking.
Adjusted EBITDA margin in the quarter for Ips was 21, 7% below our expectations due to a weaker mix and volumes net favorable price cost and synergies.
Mix in particular came in much weaker than our original expectations and presented a significant headwind to margins in the quarter.
The weakness in short cycle industrial has a disproportionately large impact on our standard products, which are often sold through distribution and tend to carry well above average margins.
At the same time some of the Ips market has seen strong growth such as metals and mining tend to drive demand for certain low mixed products.
The good news is that the channel for standard product is destocking and when it rebounds should lever at very attractive rates.
As Louis mentioned, we made a decision during the quarter to incur higher costs in Ips aimed at maintaining quality and service levels for our customers during a period of peak manufacturing footprint actions related to our P&C merger synergies.
We are currently in the process of rationalizing multiple manufacturing facilities and during the quarter, we encountered lower than anticipated labor productivity in the cats plants that is at the site into which we are consolidating production lines.
We estimate these higher customer service assurance costs are impacting Ips by approximately $16 million in the second half of this year.
Weighted roughly 60 40 between the third and fourth quarter.
While these costs are masking some of the synergy benefits they are temporary and in no way impact the permanent level of synergy savings that we ultimately expect to realize from the P&C and ultra transactions.
Pro forma organic orders and Ips were down 4% in the third quarter on a daily basis and book to Bill of just above one point out.
In October.
To Bill once again track at one point up and orders were up low single digits.
For perspective, I P. S. As third quarter order decline is against a two year stack of nearly 30% in the segments backlog at the end of the third quarter remained well above normal.
Turning to power efficiency solutions or P E S.
<unk> sales in the third quarter were down 19, 1% from the prior year.
The decline was driven by significant channel destocking activity and weaker demand in the North America residential HVAC market weakness in China, and Europe, and destock pressure in the U S General commercial market.
These destock pressures were anticipated and P. S. As sales performance is directionally consistent, albeit bought modestly more severe versus the expectations, we outlined on our last earnings call.
The good news is that we now believe destocking in residential AC is mostly behind us although at the heating season begins we believe there is still likely still too much furnace inventory in the channel.
The adjusted EBITDA margin in the quarter for P. S was 19, 7% up 310 basis points versus the prior year period.
And modestly ahead of our expectation.
Key contributors to the P. S margin performance were favorable price cost improved operational efficiency, lower freight and favorable mix, partially offset by lower volume volumes.
We also continued to selectively deploy 80 20 across the business to move away from lower margin quite for business and focus on growing our quad one business to better serve our most valued customers.
Overall strong margin performance, despite sizable top line headwinds achieved through disciplined execution by our P. S T.
Shifting to orders orders and P. S for the third quarter were down 9% on a daily basis book to Bill in the third quarter was one point out and track that point 97 in October.
Yeah.
On the following slide we highlight some additional financial updates for your reference.
Notably on the right side of this page you'll see we ended the quarter with total debt of $6 $5 billion down $185 million and net debt of $5 9 billion down $124 million versus the end of the second quarter.
Net debt to adjusted EBITDA is 3.86, and our interest coverage ratio is three to four times.
Free cash flow in the quarter was very strong coming in at $161 $5 million.
Up from $111 $1 million in the prior year period.
The teams continue to do a great job improving free cash flow performance aided by improving working capital and in particular by lowering inventories, where we continue to see lots of additional opportunity.
Yeah.
Moving to the outlook.
I'd like to start by providing an update on how our principal end markets are tracking versus our expectations earlier this year.
The table on this slide shows our end markets the percentage of our sales each represents from largest to smallest and then the third column.
Our growth expectations for each end market as of the first quarter, which also guided our second quarter expectations.
The fourth column indicate how the market was tracking as of the third quarter indicated a stronger weaker or as expected versus our prior expectation.
You can see that four of our top five end markets, specifically general industrial consumer food and beverage and commercial are tracking weaker versus our prior expectation the fourth of the top five nonresidential construction is tracking largely as expected.
These end market developments development are the reason, we now expect 2023 organic sales be down roughly 6% on a pro forma basis versus 2022 and versus our prior expectation of being down slightly.
Finally in the last column to the right. We are providing an early look on how we are thinking about end market growth rates in 2020 for which we will update again, when we report fourth quarter and provide our complete 2024 outlook.
You can see that we expect generally more favorable end market conditions next year, a few things in this column that I would highlight.
The consumer market, which largely reflects our residential HVAC business moves from red to green, implying an inflection to low to mid single digit growth.
The non res construction market, which largely reflects our commercial HVAC business is forecast to be flat to slightly up.
The significant declines we are experiencing this year in food and beverage are expected to subside.
The commercial market, which was expected to be flattish in 2023, but has been much weaker mostly due to destocking is expected to slightly improve in 2024, and finally, we expect to see continued healthy end market growth in a number of our secular markets, including aerospace medical.
Alternative energy alternative energy and data center.
As you can see on this slide we are revising our guidance for adjusted earnings per share to a range of $9 five to $9 25 versus a prior range of $10 20 to $10 60.
The change primarily reflects weaker end market as outlined on the prior slide mix and to a lesser extent the decisions we made to minimize customer impact as we move through the peak period of PMC synergy related footprint moves in I P. S.
Revenue for 2023 is now expected to be approximately $6 billion to $5 billion versus $6 5 billion previously.
On a pro forma basis 2023 revenue is expected to be approximately $6 7 billion versus $6 95 billion previously.
Adjusted EBITDA margin is now expected to be approximately 21% versus roughly 22% previously or equivalent to the to the pro forma 2022, adjusted EBITDA margins. Despite the top line pressures we are seeing.
This.
Presents an approximately 8% reduction on an EBIT dollar basis, a smaller decline versus an EPS due to our temporarily elevated interest expense.
Lastly.
We are reiterating our expectation for generating at least $650 million of free cash flow. This year. Despite the reduction in EBITDA guidance.
As a reminder, our capital deployment will remain heavily weighted to debt reduction.
Finally at the bottom of this slide we present, our standard below the line modeling items, some of which have changed slightly since our last update.
Okay.
On this slide.
We provide more specific expectations for our fourth quarter performance by segment to make it easier for the investment community to understand our near term financial expectations for the business.
While we do not plan to provide this level of detail going forward, we thought it would be useful given the newness of the reset mentation along with the segment specific headwinds we experienced in the third quarter.
Notably we assume revenues for the enterprise are down slightly versus third quarter, mainly as we continue to experience headwinds in short cycle, industrial and factory automation and in China, and Europe, partially offset by strength in data center aerospace medical and energy along with metals and mining markets.
We expect adjusted EBITDA margins to be up modestly versus third quarter.
Aided by line of sight in our backlog to modestly improve mix improved plant efficiencies cost actions implemented late in third quarter in response to weaker end markets and lower customer service assurance costs in Ips versus in third quarter.
In summary.
We are disappointed to be lowering our guidance, but we are pleased with the way. Our teams are managing what is under their control in particular around cash flow and P&L deleverage rates.
As we look ahead to the next couple of years, we remain motivated by the tremendous opportunities for value creation before us from Delevering the balance sheet to progressing to approximately 40% gross margins and 25% adjusted EBITDA margins and to work and to working the many strategies underway to improve.
Our outgrowth.
Before we conclude.
I'd like to connect a few dots on our cash flow expectations and the associated value creation opportunity we envision.
If you look at the strong momentum we have on cash flow generation this year.
And how that level can grow next year on further sizable progress lowering our inventory.
Picking up an extra quarter of ultra cash flows since we only owned altra for three quarters in 2023.
Plus stepped up synergy benefits not to mentioned using the proceeds from the industrial transaction to further pay down debt. It really does start to create a nice picture.
Using the majority of this cash flow to reduce our debt and lower our interest cost has a couple of key implications.
One is a nice boost to EPS growth, even before considering any help from end markets or our many growth initiatives.
The second is a nice potential benefit to our equity as that becomes a smaller portion of our capital structure.
At a time when in market noises running high I would urge investors to also keep these value creation levers in mind.
And with that I would now like to turn the call back to the operator, so we can take questions operator.
We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone, if you're using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
Our first question comes from Mike Halloran with Baird. Please go ahead.
Hey, good morning, everyone.
Hey, good morning.
Yeah, let's start on slide 12, and kind of ramp what what youre seeing today.
Into why there's confidence in next year, you know you look at the the year over year read on 2024, and you know it certainly reads more positives than some of the in quarter trends that you were highlighting.
So as we think about that picture you're painting for 2024, how much of that is just the stock comps how much of that is Regal Regal is control some synergy benefits on the revenue side.
Or some drivers of outperformance versus fundamentally thinking the market is going to get better from an end market perspective, and any color you could give there would be great.
Yeah, Great Mike Thanks for the question.
We are feeling a little bit more bullish about 24, and a big part of that is the destock and the destock, especially in the consumer space, where we're not expecting a significant rebound in demand if any for that matter from a end user demand perspective, but because of the day.
Stock what we lived through in 'twenty, three we expect a positive momentum going into 'twenty four.
A lot of our markets that are more secular driven aerospace datacenter medical alternative energy.
Those are are going to continue to be strong into 24, and our efforts to expand our server bull market with new product in those markets is going to help us as well.
And then when we look at a couple of other markets. For example, non res construction, which I think could have some additional tailwind is around some of the stimulus in the United States as well as the investments in data Center, we will we're very well positioned there.
On top of that I would say, we're bringing out new products on air handling products, our products to support the heat pump market, both in the United States and in Europe, and as you probably know we do not have a strong residential HVAC positioning in Europe and so this will be.
Our opportunity for US next year. So overall, we're feeling that 'twenty four should be a bit stronger on short cycle industrial is a bit of a question Mark for US right now and we certainly saw more than we expected. These docking in Q3.
Three and a little bit more slowdown in demand, we expect that destocking, though is ending and certainly ips's orders being up in October year over year gave us some confidence, but hopefully that helps you understand how we're thinking about 'twenty four.
And.
Giving much more guidance on this at the end of our Q4 earnings in July or excuse me in January the only thing I would add.
My T that is that you also asked about synergies and how that might help benefit the business as well and so I would add that we do expect to realize the $65 million in synergies here in 'twenty three and then there's another $90 million of synergies.
In 2024, which is about $45 million for P. M C and carrier or and then about another $45 million for altra. So that's how you get to that extra 90 million that will certainly help on the bottom line as we move through 'twenty four.
No that helps thanks for that and then is there any way to quantify what the Destocking impact was this year.
[laughter] terms percent terms any anything to help understand the magnitude.
You know what Mike.
It would be a little bit of a guess for us where we're saying probably about two thirds of that headwind in P. S.
Likely due to destock.
This year and then I would tell you you know what are the.
The headwinds that we saw in Ips and in Q3, I'd say two thirds of the headwind specific to Q3.
And the AR on the factory automation side of AMC, I'd say about two thirds as well was destock specific to Q3.
Okay. Thank you last one and then maybe just talk about the operational headwinds you saw in the quarter.
You know as you're going through these and I think it's natural to have quarters, where everything doesn't go smoothly and you have to make some adjustments so.
I suspect that.
I'm just more interested in understanding why you think this is not going to linger into next year and if theres any remediation that's necessary here I'm going to guess know because again I think.
Directionally have your hands around it but.
Anything that you've gotten from a lesson here that we can take some comfort level that this is behind you once you exit the year.
Yeah. So thanks, Thanks, Mike and we do think we have our arms around this.
And we do not expect these inefficiencies to continue into next year first of all I want to emphasize that our goal is always to execute any of our restructuring actions with zero customer impact and our track record has been pretty strong here you know when you when you look back.
To or 303, a play on a couple of years ago, we actually reduced 23% of our manufacturing square footage and closed 21 facilities and had very little customer impact.
And so that was the decision in Q3 is that.
There were.
Actually for site consolidations going on at the same time, a couple of them were a little bit more complex than we anticipated and so we took on more head count and inefficiency at the receiving plants to ensure.
That we could have high quality and service levels to our customer.
About half of that will reduce in Q4 and it will go away fully met our into next year and so it gives us an ability to think about the planning of next year, a little bit differently. We still have every expectation to achieve our synergy objectives, but this law.
<unk> gives us an opportunity to be better prepared because we will be making moves next year as well and so right now we.
Feel good about our approach Ah I I'm I'm proud of our team and the decision. They made in Q3 and feel confident that we'll have this behind us by the end of the year.
Thanks for that track record speaks for itself part of the quarter. So really do appreciate the color. Thank you.
Thanks, Mike.
The next question comes from Julian Mitchell from Barclays. Please go ahead.
Thanks, and good morning.
Maybe my first question was just trying to think about next.
Next year again so.
So it sounds like based on slide 12, and in some of the coinsurance synergies.
That had kind of a base assumption should be may be.
Flat to slightly up core sales.
And then on the EBIT front, we have the $90 million of synergy incremental.
And then maybe sort of I don't know.
T a familiar and may be some sort of base EBITDA from the acquisition.
And then on.
The rest of the sort of base business.
Should we get some operating leverage there where you are accelerating any cost cutting or for now you think it's it's safer just to sort of assume the quarter of ultra year on year and then the synergies.
Yeah, you know so I think the way you are outlining here. It makes a lot of sense and that's how we're thinking about 24 now to be clear Julien. We go through our operating planning are in the November timeframe. So we'll give a lot more guidance on this in January but I think you are.
Painting, the appropriate picture I would tell you that.
That from a P. S standpoint, those are stronger margins that we saw over the last couple of quarters will continue into next year. We did consolidate one factory in P. S. So we have a lower a.
Fixed overheads.
So there'll be a I would say continued nice leverage in our P. S segment, and then really the the the commentary around the synergies if that's mostly Ips, but somewhat AMC as well and as you can imagine when when things slow we tend to get very.
Sorry, operationally focused and we tightened our belts and so there will be some cost saves that continues into next year also so overall, though the way you're describing it.
He is a great starting point.
Thanks, very much and maybe just my.
Second.
The follow up would be around it in terms of you know when you look at the history of ultra and in your own history.
Some of the base motion control businesses.
You know thinking about that sort of typical downturn generation is maybe you know there's three full quarters.
Obviously.
Entering it now in the second half of this year Ah Ips with you in the third quarter of that downturn now.
M C.
First one.
Looks like so are we assuming based on history and sort of your best guess, it's maybe a sort of a four ish quarter downturn again on on core sales or is there something different about this downturn versus history.
Yeah.
You didn't Julien I'm not.
Not sure we want to try to call the cycle here.
I do think we're coming out on P. S. Theres, a slight slow in Ips in parts of the AMC. Although other parts are very strong medical aerospace datacenter up double digit for us and feels really good.
We're going to stay very focused on what we can control and we've got a lot of levers to pull the only difference I would say perhaps from the past is that the supply chain normalization, that's going on in the incredibly strong backlog that we still have in Ips.
And AMC Amc's backlog is probably 50 plus percent over.
Our normal AMC run rates and Ips is about 45% over normal run rates and therefore, I don't we're not forecasting it is gonna be a.
A large impact because of those strong our backlogs are where we stand today going into Q4 and next year.
Thanks very much.
Sure. Thanks Julien.
Our next question comes from Jeff Hammond from Keybanc capital markets. Please go ahead.
Hey, good morning, guys good.
Good morning, Jeff can you hear me.
Yeah good morning.
Just maybe to step back I mean, I think I think after the Altra deal you talked about.
Buxton earnings maybe 15, if the end markets were flattish.
Leverage kind of two and a half to three and I think exiting 2024.
And and then some margin targets I'm just wondering you know with this reset you know how may be we snapped the line a little bit differently on some of those long term targets.
Yeah, Jeff I, you know what I think the way you described it as a pretty spot on you know what we came out with is that a statement of we have a path to 40% gross margins and 25% adjusted EBITDA margins in and with the divestiture of industrial you know that path is even.
Clearer and maybe a point above it as like a shared in my prepared remarks.
Our plan to get to a billion plus of free cash flow. We feel good about that there are still some levers to pull around our trade working capital and so then it comes down to.
Sales, our original planning would've gotten a 46% organic sales growth to get to $18 and I think you're right. It's it's a slightly over 15 at flat sales.
No. We expect through the next couple of years that the market will rebound and that we'll see some sales growth what that is I'm going to not opine upon right now, but we would expect markets to rebound on top of that significant investment at Regal going on right now.
Doubled our vitality in the last three years, we have an intention to double our vitality in the next three that will help us through expanding our served market with new products.
<unk> focus on over servicing our customers and our a products and so that will help us accelerate growth and so right now we're not ready to come out with an update on the top line, we would expect growth its likely not the four to six.
We were thinking a year ago could be but it you know what's in it depending on where market is and then we're going to definitely outgrow market is our expectation and I would just add that you know the other side of your question around the leverage as we kind of move through the cycle, we absolutely have a clear path to to continue.
To reduce our debt and get our leverage rates down to that that we talked about during the longer time. Despite the reduction that we might see and in EBITDA. So it's very strong free cash flow generation expected going forward to do that.
Okay.
And then just shifting gears to track well it seems like most of the Oems kind of.
You know it didn't really surprise anybody I think they were all kind of claiming Destocking has run its course, which is may be good for you guys, but.
Hmm.
I'm just surprised by the magnitude of kind of a mess and trends just.
Don't know if that's did you not appreciate the magnitude of the destock.
Was it was it more aggressive or are there some share dynamics.
Is there more.
You know some product line simplification just what are the what are the moving pieces on the Miss there and then just.
This refrigerant change.
Some guidelines came out just.
Are you kind of indifferent to that or how does that impact then.
As people redesign.
You know how you how you feel about your opportunities so a lot of questions on HVAC, but thanks.
Yeah. So you know first of all I think it's important to remember that our residue H back is only about 30% of our P. S segment.
Where we were down we saw we do feel like the AC side has gone through its destock, we expect furnace to be to go through in Q4, and maybe a little continuation into Q1, but but not significant.
The bigger issue that we saw in surprise in Q3 was around the general commercial space and be a slowdown in demand and the destock that we saw there and so that was really more of the pressure in our P. Us than it was a red the atria.
Fee pressure.
No the with regards to the refrigerant trains this should be an opportunity for us. It's just a you know all of our Oems will need to re design to meet that change and.
We have the right product, whether it's our ECM motors, which tends to be a mix up it's our air moving solution, which tends to be a mix up or it's our drive solution, which is a new technology that we brought to bear that's going to help achieve that system overall system requirement with the new.
Regulations will be a mix up so all in should be a positive note. The one piece that we're not quite clear on is the EPA guidance around.
What the a shipment allowance will be as of January one 2025, and could that caused some headwind in 'twenty four because the Oems are further destocking, but theyre going to have to go to a new system in our components and sub systems really fit well to <unk>.
Support them in achieving those new system requirement. So hopefully hopefully I answered all those questions Jeff happy to follow up if you have anything else.
No that's great I appreciate it guys.
Okay, great. Thanks, Jeff.
The next question comes from Nigel Coe of Wolfe Research. Please go ahead.
Thanks, Good morning, guys.
Good morning Nigel.
So on the full Q guide and by the way nice out doing this there's no going back you know you have to give us a call. It guidance from here on I'll bet, but Rob it looks like you've taken the approach of assuming essentially flattish.
<unk> sales and margin and.
I'm just I'm just curious you know just given that this is a very new portfolio I mean, how do you expect this is normal seasonality.
I would you know the the three segments normally track I mean, I think P. S. We understand would normally be down, but but how would you.
The other two are normally track.
Yeah, I think so first of all on the on the sales side slightly down sequentially as the way we look at that.
If it goes comes to the margins, we do expect to be a little bit better on fourth quarter margin versus the third quarter. You know when it comes it the seasonality there isn't a lot of seasonality based on what we've seen with the supply chain disruption and and so we're not expecting a lot of seasonality, our our order rates support that conclusion.
And our backlog certainly support that so that's why we're thinking about it there's not a lot of seasonality in any of the businesses right now and and that's the progression quarter over quarter.
And of course with assuming a flat sequential from a very depressed base with the Destocking. If you had to put a aligning the fans you know and say this is the quarter. When we expect destocking to essentially be done well when when do you say what do you say, it's <unk> next year I mean any thoughts there.
You know from a PFS perspective, we would say we would expect it to be likely done at the end of this year you know what I like about our portfolio is the diversification of the portfolio. So it's a little bit difficult Julian to answer that question without doing it by segment and then some aspects having to do it by division, but let me let me try to.
Simplified.
From an Ips perspective, we would actually expect much of that Destocking, it where we're getting through it and again it would be a Q4.
The factory automation side of AMC, we're still you know honestly trying to get a little bit more clarity on that now we got some strong orders in October, but there were a bit more longer cycle, that's going to help us in 2020 for so you know we're getting our.
Arms around the business.
I think that as the quarters progress, we'll give you more clarity certainly on the factory automation piece of the business.
Okay, and then a quick follow on.
Just to be specific and full Q, what what is synergy capture your modeling.
From <unk> P M C and and Altra.
Sure Nigel.
PMC, we're expecting about $13 million in the fourth quarter and altra about $10 million of about 23 overall remember that for the P&C side. As we said you know, we do expect to get about $6 million or sell of those.
Additional cost to maintain our service levels. It may it may mask some of that benefit on.
On the PMC side, but but the synergies are still permanent and absolutely are expected to be realized in the quarter. So a total of 23.
Great. Thank you.
Great. Thanks.
As a reminder, if you would like to ask a question. Please press Star then one to enter the queue.
Our next question comes from Christopher Glynn from Oppenheimer. Please go ahead.
Yes.
Yeah. Thanks, good morning.
So Lewis realizing that the October picked up isn't it.
A trend yet.
Curious to dig a little deeper what what channels what was the nature of the pick up, particularly I'm curious if those channel partners destock and the most the most in the third quarter or where are you seeing the October pick up.
Yeah, so and the simple answer Chris and good morning is.
Yes, those that we saw slowing down in Q3, we did see a start of a pick up in Q4, but you are right. One one month does not make a trend and so we'd like to see that continuing that's partially why we also are forecasting this quarter to be modestly.
Down sequentially from Q3.
Okay.
Okay and in terms of inventory rebalancing is how would you compare what you're seeing in distribution channel versus.
With Oems because you.
You know you know hoarding and gathering was.
Systemic for a little while there are no that lead times are better.
Obviously, we're on the other end of that.
Yeah, So I think there's still some room and OEM.
And whereas I think the distribution channel has more quickly tried to readjust.
Okay and are there specific conversations with distributors.
Or is it just too fast moving and contemporaneous to.
Bring that to bear on your general comments that.
The distributors are moving through destock faster.
You know, we we have pretty clear visibility to our industrial distribution channel, we see their sales out we see their inventory levels, we see their their call probably why I was a little more unclear around factory automation as we don't have that level of clarity in.
Factory automation and although I can assure you with the ultra businesses that we now own as part of Regal, We will get that clarity in time. It's just we don't have that quite yet but from a Ah Ips standpoint in particular, we know what our our distributors are.
Holding for inventory or that the majority of our distributors, we know where they stand with sales out and with their orders on us.
So good cleric staff sure. Thanks, Chris.
Yeah.
This concludes our question and answer session I would like to turn the conference back over to Mr. Louis Pinkham for any closing remarks.
Thank you operator, and thanks to our investors and analysts for joining us today.
As you heard this morning, while we are facing more challenging end market headwinds in parts of our business. Our Regal rexnord team is effectively managing through them.
But what keeps US excited is our ongoing transformation.
Executing our path to top quartile gross margins to generating over $1 billion in annual free cash flow over the next couple of years to rapidly deleveraging our balance sheet.
Into the outgrowth acceleration, we are confident we can deliver by raising our new product vitality and by executing our many 80 20 growth initiatives in <unk>.
Short many levers we can pull to create create tremendous value for our key stakeholders.
Thank you again for joining us today and thanks for your interest in ring of Rexnord.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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Okay.
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