Q2 2019 Earnings Call
Good morning, and welcome to the Regal Beloit second quarter 2019 earnings Conference call.
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I would now like to turn the conference over to Rob Cherry Vice President of Investor Relations. Please go ahead.
Thank you operator, good morning, and welcome to Regal Beloit second quarter 2019 earnings Conference call.
Joining me today are Louis Pinkham, our Chief Executive Officer, Jon Schlemmer, our Chief operating officer, and robbery, Hart, Our Vice President and Chief Financial Officer.
Before turning the call over to Louis I would like to remind you that.
The statements made in this conference call that are not historical in nature are forward looking statements.
Forward looking statements are not guarantees. So there are inherent difficulties in predicting future results and actual results could differ materially from those expressed or implied in forward looking statements.
Well a list of factors that could cause actual results to differ materially from projected results. Please refer to today's earnings release, and our FCC filing.
[noise] slide three we state that we are presenting certain non-GAAP financial measures in this presentation.
We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods and in the same manner as management.
Please read this slide for information regarding these non-GAAP financial measures.
Please see the appendix for a reconciliation of these measures to the most comparable measures in accordance with GAAP.
Now let me briefly review the agenda for today's call.
Louis will lead off with his opening comments and an overview of the quarter.
Rob will then review our second quarter financial results in detail and provide an update on our 2019 outlook.
We will then move to queuing day, after which Louis will have some closing remarks, now I will turn the call over to Louis.
Thanks, Rob and good morning, everyone.
Thank you for joining Regal second quarter earnings conference call and thank you for your interest in Regal.
As Rob mentioned, our COO, Jon Schlemmer is joining us today and although he will not be making prepared remarks. He will be available on this call to help answer questions.
I would like to take this opportunity to thank all of the investors and analysts that I have had the pleasure of meeting with over the four months since I started at Regal.
I look forward to meeting even more view in the future.
In these past four months I have visited many of our facilities met with many of our associates and visited with a number of our customers.
The talent in our organization is strong and we have deep application knowledge in our served markets.
Our products are differentiated push the boundaries of energy efficiency and are increasingly Iraqi oriented.
Our customer relationships are strong and deep.
You know we have a great organization.
Turning to the current period, we had a tough macro conditions in the quarter.
Our second quarter financial results reflected lower than expected demand.
Do do abnormally wet and mild weather.
The ongoing global trade uncertainties, including the June Mexico tariff concerns.
Efforts by distribution partners to reduce channel inventories.
Along with an overall continued economic malaise in Asia Pacific and Europe .
Regal posted negative 2.2% organic growth in the quarter.
With overall orders down mid single digit year over year against tough comps.
Despite the challenging sales environment, we delivered an adjusted earnings per share of $1.52, which was flat to the prior year.
We had strong margin expansion in our climate segment up 110 basis points and solid expansion in the Pts segment up 40 basis points.
In the sea an ice segment, we continued to experience significant weakness in some key end markets with operating margins down 160 basis points.
This led to overall organic growth being down, 2.2% and adjusted operating margin being down 20 basis points.
De leveraging as far below our normal rate.
Year to date, our adjusted operating margin is up 20 basis points.
In particular I want to highlight two significant impacts on our second quarter adjusted earnings per share.
The first was an unfavorable inventory adjustment in the scene ice segment and that was the result of a full physical inventory performed during a facility move.
This adjustment had a six cents negative impact.
The second was a year over year translational headwind in FX for the total company with the majority of the impact in the sand segment.
This FX headwind had a seven cents negative impact.
Rob we'll give more clarity on both later in the call.
Before going into more detail on the performance of the segments I want to share with you a reorganization that we have undertaken which my leadership team and I believe will improve the alignment and accountability.
Increased speed of decision making.
Improved financial performance.
And better position Regal for talent development.
Simply this reorganization takes us from a centralized model, which was appropriate at the time of its implementation to a decentralized model.
This will result in greater visibility and focus on piano tiles at the business level and manufacturing site level, rather than just at the segment level.
These business units have clear leaders with dedicated teams that are fully responsible and accountable for the business units profitable growth.
We have implemented a monthly cadence of operating reviews with these business units, which allows us to quickly identify and address issues and spot opportunities on which to capitalize in a more timely fashion.
Another key benefit of this reorganization into decentralized business units is that it enables our teams to leverage their deeply rooted vertical knowledge and experience in order to drive our product innovation roadmaps organic growth and customer relationships.
Ideas will be fostered and nurtured by these teams that had the expertise and the business and the incentive to drive them.
Through this reorganization, we will incur some short term restructuring costs, but the changes will improve performance turn into cost savings and pay long term dividends in the execution of the business.
We estimate that the annual savings of this reorganization will be at least a $15 million and we should see the full benefit in 2020.
As we start to leverage this reorganization it will enable us to deploy our version of an 80 20 approach across Regal focused on improving margins.
Executing on our remaining footprint synergies and driving further product rationalization and consolidation.
In my first few months at Regal. It is clear that there are value creation opportunities around accelerated simplification.
But also around customer margin management.
I am a believer that if a customer values the product technology or service that you offer it is clear in the margins you earn from that customer.
At Regal, we have an opportunity to more effectively manage the lower margin mix with some of our customers.
However, if we don't earn a reasonable margin there are three choices.
Regal becomes more market competitive.
We work with our customer to raise prices in a partnering fashion.
Or we exit the business and address our cost position.
All of our segments have opportunities to better manage our product and customer margin mix.
This will be a focus and priority over the next few quarters.
In the quarter. We also continued to execute on our portfolio management as we divested a non core vapor recovery business that was focused on the oil and gas market.
The business had annualized sales of approximately $50 million, which brings the total annual sales that we have either exited or divested to approximately $270 million over the last 12 months.
Again as part of my review of the business.
I am taking a non biased approach at evaluating our portfolio.
Comparing and plotting our businesses against to shareholder value creation metrics.
Oh, I see and EBITDA.
For those businesses that lie in the bottom quartile. It is very simple, we will need to fix or exit.
I am in the process of working with my leadership team and discussing options with our board.
These learnings will influence our strategy that we will begin to share with you in the fourth quarter and then later with a full roll out at our investment day Investor Day in March.
Returning to the quarter and the segment's performance in climate, we continue to see a benefit from the pre buy of standard Motors that ahead of the July implementation of the fan energy rating regular like regulation for furnaces.
North America residential HPC was up low to mid single digit.
But without FDR it would have been up only slightly due to the cold weather in the quarter.
Weakness in the commercial refrigeration along with our ongoing 80 20 account pruning efforts were partial offsets and dampened our organic growth to 2.3% in the segment.
The 80 20 account pruning efforts in climate, which was which we are deploying across Regal have a near term negative impact on our sales, but will improve our profitability over time.
These pruning efforts along with the mix due to the divestitures as well as positive price cost resulted in a 110 basis point year over year improvement in adjusted operating margin.
In Pts we faced a tough comparison, having grown over 10% organically in the prior year.
Approximately 70% of our sales in Pts go through the industrial distribution channel.
This channel has been experiencing a slowdown in North America as industrial markets cool and trade in Turkey certainty weighs on the end market.
While we do not see much of a direct impact from the tariffs in this segment, we do feel the indirect impact on the markets we serve.
Altogether. We believe this is that this has led to higher inventory levels in the channel and is resulting in destocking.
Also hampering Pts deals are challenging end markets in upstream oil and gas.
Agriculture and beverage equipment.
Together these markets represent approximately 25% of the segment sales.
The overall net impact drove organic growth down 1% in segment.
Despite the sales headwinds our productivity positive price cost and deployment of cost controls delivered a 40 basis point year over year improvement in adjusted operating margin.
And see and I, we saw significant slowing in several of our end markets.
The cool and wet weather had a double digit negative impact on our pool pump business.
In Asia Pacific, we saw single and in some markets double digit declines.
We are also continuing to be negatively impacted by project delays in the power generation market as we highlighted in the first quarter.
There is also a broader weakness in the generator rental market driven in part by the decline in upstream oil and gas activity and milder weather.
And finally, we experienced minimal share loss in North America related to tariffs that we are in the process of mitigating as we discussed on our last call by establishing production capability and capacity within the region.
This program is well on track our service levels have improved along with our cost position as we mitigate the China tariffs.
We expect order improvement in Q3 and Q4 from these actions.
However, all together these sales headwinds contributed to organic sales growth being down 5.5% in the segment.
The adjusted operating margin is seen I was down to 160 basis points from the prior year.
The inventory adjustment and FX headwinds that I previously mentioned along with the volume headwinds drove the entire decrease.
Our de leverage rate was 28%, which would have improved to 9% without the inventory and FX headwinds.
From a total company perspective, our free cash flow was 122% of adjusted net income.
Our accelerated focus on working capital resulted in a 39 million dollar inventory reduction in the quarter.
We remain confident that we will generate free cash flow greater than adjusted net income for the full year.
In addition, we continue to do that but we continued to deliver on our balanced capital allocation approach.
We raised our dividend by 7%.
And we repurchased 731000 shares for $56 million.
While maintaining our net debt to adjusted EBITDA ratio at 1.8.
Finally, we are reducing our adjusted earnings outlook for the year from a range of $6.15 to $6.55.
To a range of $6.50 to.
Excuse me $5.50 to $5.80.
The reduction is driven in part by the divestiture that we announced this quarter, which has a 12 cents impact on full year performance.
But also due to the ongoing weak end market conditions and the continuing global trade uncertainties.
As evidence of these conditions Regals orders were down mid single digit in the second quarter.
Consequently, we are laser focused on accelerating our mitigation efforts given these market conditions.
The reorganization that I discussed earlier will hold by reducing SDMA costs.
But we are also further reducing discretionary expenses accelerating productivity improvements and aggressively managing price cost.
We will also be leveraging our reorganization by driving a PML focus deeper into the business.
With the business unit structure, we are further deploying our 80 20 approach into the organization, which we expect will improve margins.
The PML focus is also improving our order and backlog management, which then in turn is driving forecasting accuracy throughout the company.
In summary, poor weather weaker macroeconomic trends and trade tariffs.
Impacts have decreased our 2019 guidance expectations.
But the fact remains that we have good products good people and good technology that form a solid business, which is focused on profitable growth for the long term.
I remain very excited about our our our prospects.
I will now turn the call over to Rob who will provide more details on our financial performance.
Thank you Lewis and good morning, everyone.
As Louis mentioned, we had a tough quarter that saw weakness in several end markets and regions.
Which was made more challenging by difficult prior year comparisons. Despite these headwinds Regal de levered at 16% far below our normal rate.
Sales in the second quarter for the total company were down 9% from the prior year.
After the impact from businesses divested or to be exited and foreign currency the organic sales in the quarter decreased 2.2% from the prior year.
I will start by providing comments on the segments and end with more detail on the total company and our guidance.
Starting with commercial and industrial systems sales in the second quarter were down 14.3% from the prior year.
After adjusting for the impact from businesses divested or to be exited and foreign currency organic sales in the quarter decreased 5.5% from the prior year.
The segment saw double digit declines in pool pump, China and parts of our commercial HVAC business, partially lot, partially offset with gains in distribution.
The adjusted operating margin in the quarter for Cnine was 6% down 160 basis points compared to the prior year.
This margin was down mainly due to an unfavorable inventory adjustment year over year, FX headwinds and to a lesser extent reduced volume.
In the quarter Regal conducted a manufacturing facility move in the power generation business within the Cnine segment.
This facility is part of an engineered to order business as part of the move a full physical inventory was conducted which resulted in an unfavorable adjustment of $3.4 million of inventory on a pre tax basis or approximately six cents on a diluted earnings per share basis.
In addition, we had a $2.9 million year over year headwind in translational FX for the segment.
These two items drove most of the decrease in operating margin otherwise margin would have been roughly flat to the prior year and we would have de levered and only 9%.
Orders in Cnf for the quarter were down approximately 10%, reflecting weakness in a number of our end markets the cool and wet weather in the quarter along with high inventory in the channel has softened our pool pump market.
In China, we are seeing weakness in several of our commercial and industrial businesses as Louis mentioned due to the China tariff the commercial industrial business was impacted by some share loss in North America.
But with our localization efforts, we have stabilized the situation and are working to regain our position over the next couple of quarters.
We continued to see the impact from project delays in our power generation business that we previously shared in the first quarter.
Lastly, we gained some share in distribution.
Turning to climate solutions sales in the second quarter were down 3.4% from the prior year.
After adjusting for the impact from businesses divested or to be exited and foreign currency the organic sales in the quarter increased 2.3% from the prior year.
The increase was primarily driven by the impact of the FBR prebuy along with moderate growth in the North American residential HVAC business, which was dampened by the poor weather in the quarter.
The headwinds in the quarter, primarily came from commercial refrigeration and the impacts from pruning accounts as we further deploy 80 20.
The adjusted operating margin in the quarter for climate was a record, 17.6% up 110 basis points compared to the prior year.
The margin expansion was driven by productivity improvements positive price cost favorable mix from recent divestitures and our 80 20 pruning efforts.
Orders in climate for the quarter were up slightly.
As previously mentioned the cool quarter dampened our residential HVAC demand, we saw improvement in the distribution in Asia Pacific end markets, but they were more than offset by weakness in water heater and commercial refrigeration.
Okay.
Turning to power transmission solutions sales in the second quarter were down 4.4% from the prior year.
After adjusting for the impact from businesses divested or to be exited and foreign currency organic sales in the quarter decreased 8.8% from the prior year.
Our main challenge in this segment was a slowdown in North American industrial markets, which impacted our distribution sales due to the de stocking of inventory in the channel.
We did see positive growth from our gearing sales in the renewable energy end market.
The adjusted operating margin in the quarter for Pts was 12.4% up 40 basis points compared to the prior year.
The margin benefited from positive price cost and other actions, we took to improve productivity.
Orders in EPS for the quarter were down mid single digit again. The main driver for this was a slowdown in the industrial distribution channel, but we also saw significant weakness in the upstream oil and gas mainly fracking agriculture, commercial HVAC and beverage end markets.
Now I will summarize a few key financial metrics for the second quarter.
Our capital expenditures were $36 million in the quarter, we now expect capital expenditures of $85 million for the full year 2019, a reduction of $5 million from our prior guidance.
We are focused on ensuring we deploy capital that drive shareholder value.
Our simplification activities resulted in $3.6 million of restructuring and related costs in the quarter.
With our reorganization effort underway, we now expect $13 million of restructuring and related costs for the full year 2019, an increase of $3 million from our prior guidance most of which is due to the recent reorganization actions.
We expect the reorganization will lead to annual savings of at least $15 million.
The adjusted effective tax rate in the quarter was 20.4%.
We're adjusting both the second quarter and the full year EMR for the tax effect of the businesses divested and assets to be exited.
We have provided a table in the appendix of this presentation to reconcile to GAAP EPS to the adjusted each year.
We continue to expect our adjusted EBITDAR to be approximately 21% for the full year 2019.
Our total debt was $1.223 billion and our net debt was $932 million.
We ended the quarter with our net debt to adjusted EBITDA ratio unchanged at 1.8.
We achieved $76.3 million of free cash flow in the quarter and our free cash flow as a percentage of net income was 121.9%.
We continue to expect to be above 100% for the full year 2019.
Also in the second quarter, we repurchased just over 731000 of our shares for $55.9 million.
We continue to execute on our balanced capital allocation strategy.
And lastly on July 2nd 2019, we divested a non core vapor recovery business, which was previously part of our CNS segment.
Annualized sales in this business were approximately $50 million.
Given the timing of the sale closing after the quarter end. The results of this business are included in our second quarter results.
But they are previously expected full year results of 12 cents have been removed from our 2019 guidance.
Consistent with the way we have previously presented this information additional details related to all divestitures are included in the appendix of this presentation.
In these tables, we've included net sales and adjusted income from operations for each segment by quarter and for the full year as well as the impact on adjusted diluted earnings per share for the full year and by quarter.
So you can clearly see the impact of these divestitures on our ongoing business for comparison purposes.
Now I will provide an update on our full year guidance for 2019, our guidance now assumes organic sales growth to be down low to mid single digit for the full year due to the ongoing impacts from unseasonal weather conditions, the global trade uncertainties excess channel inventories along with the continued overall economic slowdown in Asia and Europe .
Specifically on a segment basis and see an eye in the second half, we expect to see additional destocking and pool pump.
Further erosion in China in additional account pruning.
Due primarily to the Lumpiness in our engineered to order businesses and visibility to related backlog coupled with the soft demand observed in July we expect to see the majority of the headwinds within this segment in the third quarter.
Partially offsetting this impact will be the benefits from our recent restructuring actions localization efforts and improved service levels.
In climate in the second half, we expect to see an overhang from the FBR Prebuy, which will start to reverse in the fourth quarter.
Pressure on margin from Mexican labor wage increases and additional account pruning. We will also start to see benefits from new innovations in commercial refrigeration market penetration in Europe , and our recent restructuring actions.
In Pts in the second half, we expect to see continued destocking pressure from the industrial distribution channel.
We also expect to see as we often do variability in margin by quarter due to mix shift between OEM and distribution demand. However, we expect continued tailwinds in the renewable energy end market and expect to see benefits from our recent restructuring actions.
We are lowering our full year 2019, GAAP EPS guidance to a range of $6 to $6.30.
On an adjusted EPS basis, we are lowering our full year 2019 guidance to a range of $5.50 to $5.80.
The reduction is driven in part by the divestitures divestiture that we announced this quarter and by the volume deleverage, which we look to partially offset with productivity positive price cost and our 80 20 efforts.
Although we are not anticipating the slowdown to be dramatic to better align our cost structure with the near term dynamics, we are accelerating SGN a cost reductions.
We will also see benefits from our reorganization to a more decentralized model, which will allow us to operate more efficiently and help offset some of our headwinds.
In summary at the midpoint of our guidance our full year adjusted EPS is expected to be flat to the prior year on a comparable basis after accounting for the impact that impact of the divestitures and exits included in the appendix of this presentation.
Operator, we're now ready to take questions.
We will now begin the question and answer session.
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At this time, we will pause momentarily to assemble our roster.
Thanks.
And our first question comes from Jeff Hammond of Keybanc capital markets. Please go ahead.
Hey, this is Jason on for Jeff.
And so maybe if you could start just talking about senile profitability looking at second half.
Is the second quarter is that margin run rate something we should be looking out for the second half and kind of what maybe not.
Hi, Tricia. This is Rob I can take that from a C and I perspective second half versus first half margins, we would expect to see United to be slightly up but the third quarter should be flat to down.
Okay, Great and then just kind of within your updated guidance.
Which end markets are incrementally weaker than when you issued guidance last three months ago I'm kind of where are you seeing that fundamental weakness and is there anything that's getting any better than you were expecting.
[noise], Yeah, Trish good morning, maybe I'll take this one.
If you look at incrementally weaker definitely in second quarter. The weather was a challenge and that had an impact on certainly our pool pump markets as well as our hvdc market lesser in entries city, but certainly in pool Paul.
In addition.
Slightly worse, although we were seeing.
Joe images in the China market in particular in our industrial business, it's not getting better and we're not forecasting it to get better.
We are seeing some strength however in our commercial industrial distribution segment and so we're we believe that that will continue into the second half of the year.
Another what we would say the incremental.
Changed for US was the the industrial distribution markets, especially for our Pts business.
We saw absolutely a an approach in the quarter, a slow down because of the current market uncertainties, a slowdown in demand and therefore, our distribution partners are bringing down their inventory levels.
One area, we are seeing some strength however, as in renewable energy a quite a bit stronger than we anticipated in second quarter going into the second half. So hopefully that gives you a.
A perspective of how we're thinking about some of the changes that we saw through Q2.
Yes, that's great. Thank you.
Our next question comes from Mike Halloran of Baird. Please go ahead.
Hey, good morning, everyone.
Good morning Bill.
So just continuing on the question there just to make sure I understand from a guidance perspective.
And obviously there is inventory headwinds that are that are going to change what the core demand for you looks like but what is the assumption from an end market perspective relative to the first half its a sequential stability from the run rate exiting Twoq you had slight deterioration how should we think about that end market.
Normalizing for inventory normalizing for Fcr, Prebuy and all those things across the three segments.
Hey, Mike This is Rob I'll take that one so let me let me answer your question in terms of what we're seeing from an order rate perspective. So overall our orders in July were down.
From the prior year, but let me give you some color by segment.
Climate orders in July were slightly above the prior year as they were in Q2 as well from a sequential basis climate orders are down.
Mid to high single digits, which is which is normal seasonality FBR prebuy is contributing to this decline in Pts orders in July were below prior year by double digit, which we believe is a continuation of the inventory correction in the channel as well as slightly lower industrial demand Q2 orders were down mid single digit and sequentially as compared to Twoq July orders were down double digit. However, we do expect this will partially correct as we move through the third quarter.
See an i. orders in July or also below the prior year and slightly below second quarter. However, this is our lumpy business, which is highly impacted by project orders as Louis mentioned, we're adding in a level of fidelity to our orders and backlog management, which will improve our forecasting capability.
You asked a little bit about.
What does this mean in terms of the inventory headwinds and others.
As I mentioned from a from a margin standpoint overall, we would expect to be relatively flat.
To the first half for our overall Regal.
I see and I should be slightly up with pressure still in the third a climate should be slightly down based on normal seasonality and pts should be relatively flat.
So hopefully that gets to most of your question there Mike.
No that was great really helpful. Great and then just a question on the reorganization the focus on 80 20, the decentralized approach.
Maybe just talk a little about what steps, you're taking now to implement that through the organization receptivity. How long do you think it's going to take for the organization understand those principles and start really executing on it.
And then in the context of the savings when did those savings start ramping.
Ramping up.
Yes, Mike I'll take this one.
So we actually announced the reorganization in early June .
And I believe the organization was.
Very receptive and we've now gone through.
A tough part of a reorganization of course is restructuring and reduction in force.
We've we've announced that the majority of that already.
So we'll start seeing benefit some benefits in third quarter, mostly fourth and then four year next year.
Now from a timing perspective, you know Regal had already started down the path of around 80 20.
Product plant rationalization, which we believe is a a big part of that for us.
All we're doing is we're accelerating it and so it's understood by our organization, we're certainly ensuring that it's a big part of our culture in a way of doing that is setting clear objectives.
And then having a cadence of review of those objectives and so part of this reorganization is a strong cadence of follow up and follow through with that each one of our businesses have so.
I feel good I think again like I said, you'll start seeing some benefit in 19 more benefit in 2020.
Hopefully that answers your question.
No Thats Super helpful. I appreciate it.
Sure.
Our next question comes from Joe Ritchie of Goldman Sachs. Please go ahead.
Thanks, Good morning.
Good morning.
So maybe just touching on.
See NIE for for a second just the commentary around the call. It flattish maybe slightly better margins in the fourth quarter at a time when like the growth rate is probably going to remain.
Down call. It mid single digits can you, maybe just discuss a little bit of the puts and takes that keep us too.
Flattish type margin in the second half of the year.
Yeah, I think it's fairly simple it's on the cost side, Joe. So it's you the restructuring will help.
We are laser focused on accelerating our productivity initiatives and.
That's going to help with the margin improvement for Q4.
And want Joe This is John one other that I would add is the mitigation actions that both Lewis and Rob talked about earlier around the tariffs and what we're doing to stabilize in that area and help us win back some of the share that weve experienced share loss that we experienced in the first half.
Got it Okay. That's helpful. And then maybe my follow on here you guys cited a few different areas.
In CNS again that that obviously deteriorated if were down double digits in the quarter. Some of it was weather related I'm just wondering if.
Does that does that just basically become lost revenue for the year or you know is there an opportunity, let's say this quarter to pick up some of that revenue if weather.
Normalizes.
Yes, Joe I'll take that one.
It could.
Oh, especially if we see a heat wave come through and Regal likes heat. We also like really cold in the winter as I'm learning.
But we're not we're not seeing it not not to the extent that would recover the decline of Q2.
Okay got it thank you very much.
Our next question comes from Julian Mitchell of Barclays. Please go ahead.
Hi, good morning.
Good morning, maybe morning, maybe first can you just clarify in Pts.
Should we assume they're pretty similar rate of revenue decline in Q3 in Q4, when you're looking at the order intake or are you assuming a big dip in Q3, and then less bad decline exiting the year.
[noise] so.
I can tell you Julien this is rob that.
We do expect that.
Pts as I said in July the order rates.
In July that we saw versus the prior year were down double digits and sequentially versus Q2 were also down double digits digits.
As we said we do expect this to the partially correct throughout the third quarter, but certainly continue to see pressure.
Based on those order rates as we go through the remainder of the of the year.
I think thats.
Yes.
Okay fair enough if it was taken hub.
Yeah.
Yes, the way I'd answer it Julian is that just to expand on what Rob. Just said is we are going to see in the Pts segment, a slight reduction in orders sorry, and sales in Q3 to prior year as well as a slight reduction in Q4 deployed prior year.
Understood. Thank you and then just my follow up would be.
Looking at the second half.
Adjusted operating margin.
I think based on what Robert said about the second half margin versus the first half it looks like you're assuming.
Maybe a decremental margin year on year in the low teens against 16% in Q2, just wanted to check if that math is roughly right.
And then what impact if any price net of cost is having on the margins in the second half.
So Julien this is Rob so first of all yes, you are directionally correct in your in your calculation there.
On price, we do expect price to be price cost to be positive for the remainder of the year.
As we've seen in the first half of the year. So yes. So I think you have you have your math correct on that from that perspective.
Great. Thank you very much.
You got it.
Thanks Julien.
Our next question comes from Christopher Glynn of Oppenheimer. Please go ahead.
Thank you good morning.
And so looking at your North America Resi HVAC sales up slightly just curious what your.
Best gauge of what the end market did in the quarter.
Yeah, Hey, Chris This is Louis good morning.
I would say the end market in North American revenue was up mid single digits in the quarter, we were up slightly below that to I would say for us. Although we saw the FDR pre buy 'em, we have done some taken some pruning actions in that business.
The positive impact on margins, but of course, some headwind on a sales.
Makes sense and then seeing distribution gains.
I'm wondering just what's enabling that where you are on the curve, what's the runway from the gains that started in the.
Second quarter, and then putting that into the context of.
What you think you can do with the distribution channel over a longer horizon.
Chris This is John I'll take that so.
Distribution for CN I, certainly was one of the positives in the quarter in terms of topline strength than we do believe there is share gain through that channel.
We would we would.
Attribute that to the investments that we've been making in the salesforce as well as on the digital side of the business. We put a lot more focus on the distribution channel in general and we've seen year to date growth in that part of the business and and again, we believe that a good part of that is definitely take a gaining some share in that channel. We would expect that to continue through the second half we continue to place investments in that area.
And feel good about the progress that we're making there.
Okay last one from me is.
Looking at the inventory reduction.
Is there any material impacts from.
Under absorption of manufacturing overhead contemplated in the third quarter.
So the answer is quite good. This is Rob a quick answer is no.
We have.
Yes. This inventory adjustment as I said was related to an engineered order project business and Weve.
And weve been discussing this over the past few quarters and this expense this but im sorry, I meant the reduction in the overall Regal in RK I am sorry, yes, okay sorry.
So the answer is no we wouldn't expect it to have a material impact in the in the third quarter.
Okay. Thank you.
Our next question comes from Robert Mccarthy of Stephens. Please go ahead.
Hi, good morning, everyone, I I promise not to get quite as Rollup of other inventory.
Good morning, Rob.
I guess the first question I would have is you know.
Maybe stepping back Lewis just talking about what you've been impressed with in this kind of managing a more chaotic day on ipi more volatile environment and the downturn and how your organization has responded.
Where have you seen kind of a bright points and where do you see really the need to approve upon as you manage.
Or simply volatile environment.
Yes.
Happy to share perspective here, Rob you know I I believe that the reorganization that we talked about earlier is really going to get our team very focused on.
The markets that they serve and how to bring value to our customers I think thats going to be a significant benefit for us. The teams already been working on 80, 20, and we're accelerating that activity and driving deeper into the organization and a focus on a piano management at every manufacturing site. In every business unit is helping to ensure that were driving gross margin improvement.
I believe there's opportunity as I said before in my my remarks too.
Evaluated our margins situation, especially if you will in that fourth quartile of 80 20.
And that's something the team is working on and then lastly opportunities. There. There's no question that the Regal team has done a fantastic job in time of looking at our our footprint, but theres more opportunities around plant consolidation and product rationalization that we are evaluating.
All of these things as well as the portfolio that I talked about earlier in our approach to evaluating our portfolio. We are discussing with my leadership team and were considering options with the board and we will be in a better position towards the end of this year to come out with a clear path forward.
Okay Fair enough and then your current guidance does it include some concern or some additional.
Debit in association with the most recent terrorist announced in other words did you bake in for those that terrorists announcement or after.
Yeah actually you know interestingly enough. The latest tariff announcement has very little impact on Regal, we have less than 500000 spend that was already excluded in the first three tariff west So it's and I have very little impact directly.
However, the impact is clearly going to be felt from further market uncertainty due to the ongoing trade tensions and thats where were going to see the impact and we believe we've put that we've considered that in our guidance.
No. That's very helpful. And then finally in terms of the cadence of of.
Disclosure in terms of your contemplated plan, we're going to get a lot more detail, presumably on the fourth quarter call, which will be in early January then followed up by a clear articulation in the March timeframe at the analyst day.
That's exactly the way to state it. Thank you.
And last question then is what have you done in terms of thinking about your cost base and your geographic.
A base for sourcing and production, particularly Mexico and elsewhere.
In light of what Weve seen these global trade concerns do you think you have to have more investments to change your footprint, there or alter your footprint any way how are you thinking about that.
Yes, you know one of the benefits of Regal is our scale and our global footprint I do not believe there is going to be a need for any significant capital further capital investment to be able to best leverage and manage our footprint.
Where I do believe there will be opportunity is consolidation of footprint in the multiple regions, where we produce and that is something that we're evaluating as part of our strategy.
Thank you for your time.
Sure. Thank you.
Again, if you would like to ask a question. Please press Star then one.
And our next question will come from Nigel Coe of Wolfe Research. Please go ahead.
Thanks, Good morning.
Good morning to dig into.
Good morning, once again to see and I know you called out so we didn't in China, no surprise, there, but it was called out weakness in.
Commercially Tracy and I'm, sorry, if I missed.
Kind of your commentary around that market, but maybe just dig into why you seen weakness there and how you see that developing.
Nigel This is John so I'd say that it was a bit mixed for commercial HVAC. There were parts of the commercial HVAC business, we actually saw some strength in the quarter and other parts of we saw weakness we participate.
On what I'll call kind of light commercial through heavy commercial kind of the applied side as well and both in Asia and in North America. So some of that was geographic Jeep.
Based geographically in terms of where we saw weakness.
In particular in Asia, and then also on the transport refrigeration side is another aspect of our commercial HVAC business. So.
It was parts of the parts of the <unk>.
That vertical were up for us in the quarter, while parts were down and I would put it around the larger applied side, the Asia side of the business and also on the transport refrigeration side.
Being down being down correct.
It's a lot of upside down okay, that's a little bit different to what we hear from the Oems who they want to apply its being up but we can make and so do you think in offline on that and then.
I understand the comments about list for not being a.
Major direct impact, but list three and between 5% how is that.
Impacting your cost the cost side of the equation, though the price cost.
And then how is it impacting your competitors are important from Asia are they facing more tariff headwinds and any color on that would be helpful.
So I'll take that one also.
Nigel So I think that.
First of all on the list three going from 10% to 25% the important thing to remember for US as we had assumed the increase to 25%. We in terms of the mitigation actions, we were taking which was a combination of footprint in price as we entered the year. So.
While there is some incremental headwind for us clearly because with the terror tariffs increase into 25% we have pretty much planned for that and have that have that embedded in our guidance.
In terms of.
Competition.
I think that we would see that as a bit of a larger impact on our competition.
In our in our scene I business that was more of a list one list to challenge for US list. Three I think is a little bit less of an impact for us and we would believe a bit more of an impact for some of our global competition.
Okay, and then finally, maybe by everyone from Lewis here you know when when you hosted that south at breakfast.
You talked about.
You talked about maybe a more meaningful see an eye of restructuring proposed restructuring potentially.
How you know kind of where are we in that process and could that be a train 20 events.
[noise].
Yes Nigel.
I'll take that you know as I've said before we're evaluating different options I, certainly think that the reorganization.
Our approach to portfolio review the comments I made in my my prepared remarks around.
Looking at it from a shareholder value creation perspective of ROI see and EBITDA.
As well is our focus on 80 20 that that's going to be our drive for our strategy moving forward now, giving you much more clarity on that around.
Product rationalizations plant rationalizations and portfolio management, I am not able to do that at that time at this time, we're evaluating options, we're talking with our board to.
Discuss path forward and we'll be better prepared in the January and March timeframe to come out with clarity.
Okay. Thank goodness.
Sure. Thanks Nigel.
This concludes our question and answer session I would like to turn the conference back over to Louis Pinkham for any closing remarks.
Thank you operator.
To summarize it was a tougher quarter, where we faced difficult comparisons and challenging end markets.
We feel that we met those challenges and de Levered far below our normal de leverage rate.
Regal continues to make our customer the priority of everything we do.
In Q2, we conducted a survey on customer satisfaction using the net promoter methodology.
Our overall score improved 15% from the prior year and we saw improvement in all performance factor categories.
Looking forward, we are energized about leveraging our reorganization and driving a PML focus deeper into the business.
We will further deploy our 80 20 approach throughout the organization and drive improvement in profitability, while staying laser focused on exceeding customer needs and driving profitable organic growth.
And of course later this year I will be providing more clarity on our strategy and portfolio management.
Thank you for joining the call and your interest in Regal.
The conference is now concluded. Thank you for attending today's presentation you may now disconnect.