Regal Rexnord Corporation

Morning, and welcome to the Regal Rex Nord 3rd Quarter 2021 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 today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I'd now like to turn the conference over to Robert Berry, Vice President of Investor Relations. Please go ahead.

Great. Thank you, Anthony. Good morning and welcome to Regal Rexnord's third quarter 2021 earnings conference call. Joining me today are Louis Pinkham, our chief executive officer, and Rob Reihard, our vice president and chief financial officer. Before turning the call over to Louis, I would like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our SEC filings. On slide three, we state that we are presenting certain non-GAAP financial measures in this presentation. We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods, and in the same manner as management. Please read this slide for information regarding these non-GAAP financial measures, and please see the appendix for reconciliations of these measures to the most comparable measures in accordance with GAAP. Turning to slide four, let me briefly review the agenda for today's call. Louis will lead off with his opening comments. Rob Rahard will then provide our third quarter financial results in detail and discuss updates to our 2021 and 2022 guidance. Louis will then come back to discuss the acquisition of Arrowhead Systems, which we announced today. We will then move to Q&A, after which Louis will have some closing remarks. And with that, I'll turn the call over to Louis.

Thanks, Rob. And good morning, everyone. Thanks for joining us to discuss our third quarter earnings and to get an update on our business. And thank you for your interest in the new Regal Rexnord. While unprecedented levels of inflation and severe supply chain disruptions are surely top of mind, as they have been for Regal Rexnord, on the whole, I'm feeling upbeat, especially given our team's strong performance in the third quarter, along with strong market demand, but also because of the tremendous progress we are making transforming Regal, now Regal Rexnord, into a higher margin, faster growing, more cash generative, and higher return enterprise. Despite many external headwinds in the quarter, Regal Rexnord posted record operating margins and record earnings on robust 16% organic top line growth. Many factors drove this performance, But a couple highlights include being modestly price cost positive and achieving market share gains across our portfolio. And with our third quarter's orders up 27% and up at a low 20s rate in October, we are confident we will have healthy top line momentum as we enter 2022. We also closed a transformational merger with Rexnord's process and motion control business, synergies from which should add materially to our margins, free cash flow, and organic growth profile over the next few years, particularly as we begin to deliver the benefits of selling our customers an integrated industrial powertrain solution, which, by the way, has already started to happen. I am also extremely excited to announce today our acquisition of Arrowhead, a highly strategic bolt-on that we expect to be accretive to adjusted EPS in year one, to achieve an ROIC exceeding 10% before year five, and which promises to open an array of growth vectors for our conveying business, both organic and inorganic. I will discuss Arrowhead in more detail later on this call. I'll note, however, that even after adding PMC and Arrowhead, our balance sheet remains very healthy at about one times levered, and combined with our strong free cash flow, gives us lots of flexibility to create more shareholder value from various capital deployment initiatives going forward. Before turning it over to Rob, I want to spend a minute saying thank you to all our Regal Rexnord associates around the world. Our strong performance at its core is about talent. It's about our nearly 30,000 Regal Rexnord associates and their disciplined execution, leveraging their individual skills and diverse perspective, exhibiting dedication and hard work, and acting with urgency for our customers. always guided by our Regal Rexnord values. On October 5th, the day after we closed the PMC merger, I and many Regal associates spent the day at the PMC headquarters in Milwaukee, now the headquarters of our combined PMC and PTS business, Motion Control Solutions, or MCS. We spent significant time walking every floor of our 10-story building meeting with hundreds of associates along the way. That was a great experience on so many levels. But one of the things that excited me most was all the talk of 80-20, of customer segmentation, of lean principles, of SKU rationalization, of the importance of diversity engagement and inclusion, and of using data to make decisions. Bluntly, I was thrilled because this is the language of legacy Regal and of the new Regal REST Nord. I think so many of our management tools, 80, 20 prime among them, are helping us navigate these choppy times just a little bit better than our competition. But it is the disciplined execution of our associates using these tools that is helping us succeed. So again, a sincere thank you to all our associates. Another welcome to our PMC associates. And I look forward to being able to welcome the approximately 300 Arrowhead associates to the Regal Rexnor team later this quarter. And now I'll turn the call over to Rob, who will take you through the financials in more detail and discuss our guidance, after which I'll be back to discuss Arrowhead.

Thanks, Louis, and good morning, everyone. As you just heard, Regal Rexnord had very strong results in Q3, and I'd also like to send my congrats to our global team for executing so well in the face of severe inflation and global supply chain disruptions. Now, let's discuss our results by segment, and then I'll walk through our latest guidance, which incorporates us owning the Rexnord PMC business as of the merger close on October 4th, and assumes we'll close Arrowhead by the end of this year. We'll start with our Legacy Power Transmission Solutions, or PTS, segment. To be clear, these results only reflect Legacy PTS. Beginning in the fourth quarter, Legacy PTS plus the Rexnord PMC business forms our new Motion Control Solutions segment, or MCS. Organic sales for PTS in the third quarter were up 23.7% from the prior year on broad-based strength across every market served, with particular strength in alternative energy, North America General Industrial, and the conveying business. In addition, the business had meaningful tailwinds from share gains, including from our industrial powertrain solutions offering. Pruning actions were approximately 290 basis points of top-line headwind in the quarter. Operating margin in the quarter for PTS was 18.8%, up 600 basis points compared to the prior year. Very strong performance, aided by volume, price, and permanent restructuring actions. Orders in PTS for the quarter were up 40%, and orders for the new MCS segment are tracking up over 30% in October, both on a daily basis. Turning to climate solutions, organic sales in the third quarter were up 14.2% from the prior year. The increase was driven by broad-based strength in all markets, with particular strength in North America residential HVAC markets, in EMEA, and in North America general industrial markets. The business also achieved nice market share gains, mostly in the North America HVAC distribution business, in Europe, and in Asia. Pruning actions were approximately 180 basis points of top line headwind in the quarter. The adjusted operating margin in the quarter for climate was 19.4%, up 230 basis points versus the prior year period. A number of factors contributed to this strong performance, including the drivers I mentioned a minute ago, along with a continued shift to more energy efficient variable speed motors. Permanent cost reductions and achieving modestly positive price costs also benefited climate's margin in the quarter. Orders in climate for the third quarter were up nearly 20% on a daily basis and are tracking at nearly the same pace in October, both on fairly broad-based strength, but with particularly healthy momentum in the EMEA and commercial refrigeration verticals. Based on our current backlog, and what we're hearing from our HVAC OEM customers, our assessment is that end-user demand remains healthy and that significant restock activity is still ahead of us and likely to occur in the first half of 2022. Turning to commercial systems. Organic sales in the third quarter were up 20.9% from the prior year. Growth in the quarter reflects strength in North America general industrial markets and strong performance in large commercial HVAC products, especially in China. We're also confident our commercial business is achieving some nice share gains, especially in the North America general industrial market. 80-20 related pruning was a 220 basis point sales headwind in the quarter. The adjusted operating margin in the quarter for commercial systems was 11.5%, down slightly compared to the prior year. Continued headwinds from inflation along with supply chain disruptions contributed to the year-over-year results. Furthermore, while overall price cost was slightly favorable in the quarter, this had a dilutive impact on margins. Orders in commercial for the third quarter were up 35% on a daily basis and are tracking up almost 20% in October. In industrial systems, Organic sales in the third quarter were up 3.6% versus the prior year. Principal drivers included strength in China and improving momentum in the North America non-residential construction and general industrial end markets, partially offset by lapping prior year large project activity in the data center market. Pruning actions during the quarter were approximately 210 basis points of top-line headwinds. The adjusted operating margin in the quarter for industrial was 3.4%. Keep in mind that this segment's margins are highly sensitive to small dollar value shifts in operating performance. Orders in industrial for the quarter were up approximately 14% on a daily basis. Order rates in October are up at a low teens rate when excluding some large prior period project orders in the data center market. On the following slide, we highlight some key financial metrics for your review. A couple notable highlights. First, on the right side of this page, we further delivered the balance sheet and ended the quarter with net debt to adjusted EBITDA of 0.5 times. However, after factoring the impacts of closing the merger with Rexnord PMC, along with the Arrowhead transaction announced today, which we anticipate closing during the fourth quarter, our net debt to adjusted EBITDA is expected to be roughly 1.1 times as we exit this year, affording us lots of optionality. Second, our free cash flow of 108 million or 133% of adjusted net income is a strong result and we continue to expect cash conversion above 100% for the year. Moving to the outlook. Lots of moving pieces here, but we've attempted to provide as much clarity as possible. We're providing guidance for the fourth quarter of 2021 and initial annual adjusted EPS guidance for 2022. Our outlook incorporates five factors. One, our latest expectations for performance at our legacy Regal business. Two, expected results for the Rexnord PMC business beginning in the fourth quarter. Three, PMC merger-related impacts, including additional shares, interest, depreciation and amortization, and our expected post-merger tax rate. Four, impacts in 2022 related to the Arrowhead transaction that we announced today. And five, a new definition of adjusted earnings per share, which beginning with the fourth quarter of 2021 will be calculated, adding back all amortization and stock-based compensation expense both on an after-tax basis, in addition to the adjustments we have made historically. We believe our new definition of adjusted EPS is consistent with what investors sometimes refer to as cash EPS, and going forward, we will be providing guidance and earnings commentary using this new definition of adjusted EPS. It is also what we would expect to define the non-GAAP consensus value for our EPS beginning with the fourth quarter. Please also note that going forward, our discussions of operational performance will focus on adjusted EBITDA instead of adjusted operating income, and our definition of adjusted EBITDA will now include adding back stock-based compensation expense. To help investors update their models for our new approach, we are providing historic details by quarter on depreciation, amortization, and stock-based compensation for Total Regal Rexnord and buy segments. in the appendix to our third quarter press release and slide deck. Now, turning to the outlooks. For the fourth quarter of 2021, we expect total Regal Rexnord sales to grow at a mid-teens rate versus prior year. And we expect to deliver adjusted earnings per share in a range of $1.97 to $2.27. For reference, the outlook we're providing for the fourth quarter is consistent with our prior outlook for legacy Regal along with the prior outlook for legacy PMC provided by Rexnorth. To this, we layer on PMC merger-related impacts, including higher shares, interest, depreciation and amortization, and a mostly higher tax rate. And we now present the outlook according to our updated definition of adjusted earnings per share. For 2022, we now expect revenue of approximately $5.1 billion, adjusted EBITDA, of approximately $1.1 billion, and adjusted EPS in a range of $9.95 to $10.35. Our outlook for 2022 is consistent with what we said previously regarding our expectations for revenue and adjusted EBITDA, which we expected to be approximately $5 billion and at least $1 billion, respectively, but now adds the impact of Arrowhead. note that while we expect arrowhead to close sometime during the fourth quarter of this year from a guidance perspective we do not add it to our p l until january january 1st 2022 so if we end up closing earlier than that as we expect there could be a modest upward impact to our 4q outlook lastly i'd like to reiterate that after giving effect to the merger With PMC and the acquisition of Arrowhead, we anticipate having a very healthy balance sheet with net debt to adjusted EBITDA, anticipated approximately 1.1 times at the end of 2021. Shifting focus to the table on the right-hand side of this slide, you will see that we provided a summary of our key guidance points for 4Q and for 2022, including the incremental impacts related to Arrowhead. At the bottom of this table, we also provide a number of modeling details. Given all the merger-related fluctuations to income statement items below EBITDA, we wanted to help investors align around how adjusted EBITDA bridges to an adjusted EPS value under our new definition for that metric. And with that, I will now turn the call back over to Louis to discuss Arrowhead.

Thanks, Rob. I am very excited about Arrowhead Systems becoming part of the new Regal Restaurant. As you can see on slide 14, after sales growing at a high team's rate over the last few years, we believe the business is on track to generate roughly $100 million in sales in 2021, split about evenly between the conveyance subsystems and palletizers and depalletizers, which each represent about 40% of the total, and the remaining 20% of sales from aftermarket parts and services. For those who may be less familiar with palletizers, as the name suggests, they automatically load or unload products onto or off a pallet and often operate in conjunction with a conveyor system as products are conveyed to or from them. Regarding end markets, Arrowhead is focused on selling to food and beverage producers with a heavy weighting to makers of aluminum beverage cans, which represented nearly 60% of 2020 sales, with food, consumer staples, and other beverage applications each representing roughly 15% of the remaining sales. These are very attractive end markets where we have been looking to gain more exposure for perspective Our Regal Rechnort food and beverage exposure is about 9%, and we expect it to reach a low double-digit percent of total sales by adding Arrowhead. Within beverage, aluminum cans in particular are expected to rise in popularity from a strong secular shift away from single-use plastic bottles. Aluminum cans are lower cost for producers and are easy to recycle with extremely high recycling rates and yields, which drives meaningful environmental benefits, a big reason consumers increasingly prefer them. We see this shift from plastic to aluminum continuing for some time and also gaining traction with packaging formats for a variety of other products outside of beverage such as personal care and home cleaning products. Other defining features of Arrowhead are strong research, development, and engineering capabilities in its core conveyance and palletizer products, plus deep domain expertise in the food and beverage and consumer staples industry. Its products are differentiated and highly valued by its customers, which include many leading blue chip food, beverage, and personal care producers that have highly recognizable brands. The unique value add of Arrowhead's products and services is evident in its long-term customer relationships, the top 10 averaging more than 20 years, as well as its attractive gross margins, which have been running in the 33% to 34% range very consistently over time. Arrowhead's adjusted EBITDA margins have been in the high teens. As many of you know, the conveying space is one that has interested Regal Rexnord for some time. In addition to attractive secular growth drivers in many relevant verticals, including food and beverage, e-commerce, warehousing, and metals and mining, we also see lots of opportunities to build on Regal Rexnord's current capability selling conveying components and our very successful ModSort transfer and diverter modules to serve customers in a more robust way by providing value-added solutions and related aftermarket services. By adding Arrowhead, our sales from conveying and related products, services, and solutions are expected to rise from about 19% of our motion control solution segment to roughly 26% in 2022. Turning to slide 15, I'll provide a little more color on the strategic rationale underpinning the transaction. We've already discussed many of the end market secular trends and product and solution capabilities that support point one, a strong growth outlook. We expect sales to grow at an organic low double digit rate or greater, at least over our planning period. The product portfolio is also very attractive. Products are highly engineered, differentiated, valued by customers, and create lots of opportunity for high margin aftermarket sales and services. Notably, the Arrowhead team launched a robust digitization effort several years ago that has added IoT and predictive maintenance capabilities that are a perfect fit with things we have been doing under our perceptive data collection and analytics platform. Arrowhead's products are also highly complementary with our Regal Rexnord portfolio and will help us build on our offering of components and modules to serve customers with more value-added solutions. From a financial perspective, the transaction metrics are attractive and consistent with our strict M&A criteria. We are paying $297 million for Arrowhead, which does not include a separate tax benefit related to an asset step-up that is worth a net $30 million in cash on a net present value basis. We anticipate delivering at least $8 million in cost and revenue synergies by year three, plus have line of sight to an additional $4 million of cross-marketing synergies looking a couple years further out. Adding Arrowhead is expected to be accretive to our adjusted EPS in year one, and to achieve an ROIC exceeding 10% at least by year five, and likely sooner. Finally, the conveying industry is highly fragmented, so adding Arrowhead should help Regal Rechnorn build a platform for future organic and inorganic growth. On slide 16, you can see our current Regal Rexnord offering on the left-hand side, which includes a series of highly engineered components, including gear motors, a highly efficient integrated motor and gear solution tailored for conveying applications that is another example of our powertrain offering. Also pictured are Regal Rexnord's ModSort transfer and diverter stations, which I'll discuss in more detail in the next slide. On the right-hand side is a sample of Arrowhead's products, which include palletizers, depalletizers, a wide variety of conveyance subsystems, as well as aftermarket services. While being able to assemble an entire production line is not our play here. I believe the product illustrations make clear that Arrowhead will move us up the value chain into a more complex subsystem, which along with our existing offering should allow Regal Rexnord to offer more value-added solutions, as well as more sophisticated aftermarket services, including predictive maintenance. One area where we see particularly attractive opportunities is around energy efficiency. After HVAC systems and pumps, conveying systems tend to be the largest users of electricities and facilities that have them. And increasingly, end user customers are committing publicly to making their footprints more energy efficient, often with a goal of net zero. We envision being able to play a significant role on this front by leveraging our capabilities, creating industrial powertrain solutions comprised of our motors and the relevant power transmission components that connect them to what the motors are powering. In this case, conveying subsystems and systems. With our domain expertise in the conveying space now greatly enhanced with Arrowhead, we expect to create more energy-efficient solutions designed to address the specific needs of our conveying customers. Layering on the data collection and analysis we do on our perceptive platform, also enhanced by Arrowhead's own aftermarket and service capabilities in this area, should allow these solutions to become even more robust over time. Moving to slide 17, I'd like to provide a little more detail about the particular opportunities we see leveraging Arrowhead along with our mod sort modules. because this is where we see significant potential cross-marketing synergies. These modules can be easily integrated into an existing conveyor line or system to steer whatever is being conveyed. For example, packages come down a central conveyor line in an e-commerce warehouse. Upon reaching the ModSort module, can be steered off at whatever angle the application requires. into a sortation bin, or perhaps down another conveyor line in the facility. The ModSort module is easy to integrate, highly reliable, quiet, and safer than many conventional applications, and conveys light items as light as a credit card with precision, which is invaluable to many customers as polybags and lighter packaging in general is the trend. Our ModSort modules and Arrowhead are highly complementary. From an end market perspective, the ModSort offering is strong in the e-commerce and warehousing vertical, where Arrowhead has limited exposure. On the flip side, ModSort has some but rather limited exposure in the food and beverage market. But as we have discussed, other very attractive verticals across food and beverage and personal care are areas where Arrowhead has strong domain expertise and customer relationships. While the end markets have limited overlap, we believe the product and services of Arrowhead and ModSort are highly relevant in each other's markets. We also see opportunities to pull through our current Regal Rechner conveyor and conveyor-related offerings through these channels. So I hope this gives you some perspective on why we are so excited to be bringing Arrowhead and Regal Rexnord together. Arrowhead is another step in Regal Rexnord's ongoing transformation. It mixes us up into higher growth and markets with differentiated, highly valued products and gross margins consistent with these attributes. Arrowhead is also a great example of innovation with purpose. one of our Regal Rexnord values, creating products and solutions that are purposeful for our customers and purposeful for our planet. Its growth and margins show Arrowhead's products are clearly purposeful for its customers. And because many of its products support strong secular trends to more environmentally friendly packaging, Arrowhead's offering is clearly also purposeful for our planet. In short, Arrowhead is an example of where we are looking to take our business overall. So I couldn't be more excited. And with that, I'll turn the call back over to the operator so Rob and I can take your questions. Operator?

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. 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. You may go ahead.

Hey, good morning, everyone, and congrats on managing through all these moving pieces here. Really impressive.

Thanks, Mike. Good morning.

Yeah, good morning. Thanks. So, first, let's start on the capital allocation side. Obviously, the positive Arrowhead announcement, which you guys just spent a lot of great detail on, also announced an uptick on the buyback plan here. So kind of a two-fold question. One, how are you thinking about the buyback plan and how aggressive are you willing to be? And then secondarily, what does the funnel look like beyond what was clearly a nice fit with this tuck-in here?

Sure, Mike. Thanks for the question. This is Rob. So as you know, we don't pre-announce plans to do stock stock purchases, but certainly we want to have the increased flexibility on this front. For a while there, as you know, we were a bit limited on the buybacks that we could be involved with through the merger timing, and so therefore we put on a bit of a pause there over the last six to nine months. However, now going forward, we do expect to go back to a more balanced approach, which absolutely includes buybacks, and expect that to be part of our approach going forward. And then I think from the M&A standpoint and the funnel standpoint, I'll let Louis chime in.

Yeah, let me add on there, Mike. You know, as we said and have continued to say, we're going to be very disciplined in our approach. Our funnels are strong. we are looking at assets that make us stronger. But they have to meet a strategic need, but also meet our financial metrics of being above 10% by year five, EPS accretive, year one. And they need to make us stronger. And so I'd tell you our funnels are in a very good position. Of course, we're very focused right now on the merger with PMC and achieving our integration synergies, and I couldn't be more excited and proud of our teams. We're well on our path. Arrowhead is another example of bringing on a great asset that's going to make us stronger. And I'm just going to emphasize Rob's comments about the buyback. The increase was stated because it shows how the board and Rob and I feel the high confidence we have in the value creation that we have at Regal Rexnord right now and the opportunities to buy back. So we'll be balanced, but we're really excited about where we are, the strength of our balance sheet, and the opportunities coming forward.

Great answer. And then secondarily, kind of an open-ended question here. Obviously, the order trends remain very good through October. Based on the commentary, it seems like the inventory replenishment side is still ahead of you. But you also have a ton of challenges from an industry perspective, just managing through getting supply, getting things out the door, capacity constraints, logistics, everything, right? So how are you thinking about the demand cadence and the sustainability of demand cadence as we move forward from here and what the sustainable health looks like of a lot of the markets you serve?

Yeah, so there was quite a bit there, Mike, and honestly, it's what we deal with every day. There are lots of constraints in the supply chain. There's certainly inflation going on and logistic constraints as well. Demand is strong. Demand is strong across all of our markets, bluntly. Maybe Australia and Southeast Asia, which is a small part of Regal Rechner, has been a bit more affected by COVID over the last three to six months. But everywhere else is strong. Europe has certainly rebounded. All of our North American markets are strong. Now, from an inventory perspective and restocking, the supply chain constraints are challenging our ability to restock the HVAC markets in particular. Pool has a need for further restocking as well, but bluntly there's been constraints in getting resources, contractors for new pool installations, and so we actually expect a little bit of a slowdown in full demand in fourth quarter because of that. Not because of the underlying demand, but because of the constraints. And then our industrial markets are still restocking. And so all of this tells us right now that we're going to go into 2022 with a strong tailwind demand-related. So we're feeling pretty bullish going into 22, as long as we can effectively manage the supply chain constraints. And I couldn't be more proud of our teams and what they're doing. Every one of our sites has a war room around supply chain issues, but it's the over-management, the discipline over-management that would ensure our success long-term.

Thank you. Appreciate it.

Sure. Thanks, Mike.

Our next question comes from Joe Ritchie with Goldman Sachs. You may go ahead.

Thanks. Good morning, everybody, and kudos as well on executing the transaction and announcing another deal.

Thanks, Joe. Good morning.

So, Lewis, maybe just kind of trying to parse out the guide. I know there's a lot of moving pieces here. You guys gave us a sales number of $5.1 billion for 2022. It seems to imply, you know, mid single digit type organic growth, if I'm doing my math right. So can you just maybe just give us a little bit more color on what's embedded from an organic growth perspective and how you're thinking about pricing as well as a component to the full year guide?

Sure. You know, Joe, honestly, the top line guide at this point is a little premature. The point of showing that summary was to say that we are being consistent in our communication of where we think we can go with the business. We're just starting our operating plans that we'll be meeting with all of our teams over the next three weeks, and we'll get more clarity. So perhaps a little conservative on the top line, to be blunt. And so I don't really want to elaborate on how we got to that number, other than saying we said that we would be at $5 billion of revenue roughly in 2022. And then with the addition of Arrowhead, it takes us to 5.1%. So hopefully that's a sufficient answer for you now. We'll certainly elaborate on that much more as we give fourth quarter results. But let me talk about price costs for a second. Again, I couldn't be more proud of our teams on how they're managing price costs. There is no question we're in an unprecedented inflationary period. And we're leveraging our 80-20 tools to ensure that we are pricing strategically but ensuring that we're passing on price and not absorbing the full impact of inflation. And in third quarter, we were price-cost positive, and we envision that continuing in fourth quarter and in 2022.

Got it. That's super helpful. Maybe my quick follow on just to just to clarify on the on the synergies from the from the deal. Are we still expecting, you know, 70 million to come through in 2022? Or is that more of kind of like a annualized run rate number that you'll hit by the end of the year? Just want to make sure I've got that buttoned up.

Yeah, 70 million is the annualized run rate that we're expecting at the end of 22. But what I can tell you is our teams are targeting above that so that we are driving hard. We couldn't be more excited about the cost synergies opportunities with the merger. And then, again, when we talk about synergies, I can't leave without saying we're thrilled as well around the cross marketing synergies. The two teams have come together in the first four weeks and identified lots of opportunities of how we're going to take legacy PMC and legacy PTS products into multiple channels, how we're going to strengthen our industrial powertrain offering. And our objective is to outgrow our markets by 50% with all the cross-marketing capabilities. So more to come with that again as we get into 2022 at fourth quarter results. But I couldn't be more excited around synergies for Regal Rational.

Great. Thank you. Great, thanks.

Our next question comes from Jeff Hammond with KeyBank. You may go ahead.

Hey, good morning, guys. Morning, Jeff. So just on supply chain and the pinch points, I guess, one, you know, you had talked last quarter about, you know, being able to pick up market shares. That's still the case. And then, you know, outside of industrial, it didn't seem like there's really any, you know, things getting worse or impacting results. Maybe just level set us on that.

Yeah, so I would agree with you. Our teams are doing a phenomenal job of managing the supply chain. I can tell you, though, that everyone's burning the midnight oils to be able to do that. And it's been an unprecedented time. So maybe this is my third or fourth time thanking my team. But the team, without that team, we wouldn't be here. And the performance was solid. So thanks for that acknowledgment. I do believe we're gaining some share. On the margins, no question, but gaining some share. And that's all because of the hard work of those teams. Whether that's some share in our HVAC and combustion side of our business, the move to more efficient, higher technology variable speed motors and air handling solutions, gaining some share in our climate distribution as well as our climate and European business. On the commercial system side, I couldn't be more excited about our digital customer capabilities and the share that we are driving with our small and medium-sized customers. And the new product that we launched to meet the pool regulations of 2021, it's highly differentiated, more compact. better performance and at a better cost position than anyone in the market today, and we are gaining share. And then lastly, our PTS business, now our MCS business, doing a fantastic job with their Tiger team around the powertrain and seeing some nice wins in conveying as well. So all in all, yeah, the team's hitting on all cylinders. So I'm really excited about where we are.

Okay, great. And then just on the 22-1, I appreciate the early color, and I know it's early, but just can you give us a sense of what you think the pro forma free cash flow generation of the business looks like?

Yeah, sure, Jeff. This is Rob. Hey, we absolutely believe that the pro forma cash flow generation will be 100% conversion as we've had with our legacy business. We expect that to continue going forward. So that's where we are at this point. Of course, again, we'll restate that it is still early days, but we're working through that as we go through our annual planning process, which is upon us at this time. And we'll continue to update you as we announce fourth quarter earnings and talk about guidance again.

Okay. Thanks, guys. Appreciate all the color. Yes, I got it.

Our next question comes from Nigel Coe with Wolf Research. You may go ahead.

Thanks. Good morning. Good morning, Nigel. You had us a bit worried last night you would be delayed the results. Some companies would do that to try and hide stuff, but it seems like the acquisition was probably the reason, so thanks for that. So again, the color on 22 is great. I wanted to dig into Arrowhead a little bit more. The 18% stock of CAGR without too much help from end markets. So I'm just wondering the confidence on the low double-digit type growth rates in the next three years. Is this a business that carries much backlog, gives you confidence in that number? And then on the Synergy side, $8 million seems like it might be lean and conservative. And I'm wondering, is there a component input cost, Synergy, where legacy companies regal supplying components to Arrowhead. Just wondering if that's part of the synergy.

Yeah, sure. So a couple of things, Nigel. So you're absolutely right. The whole reason why we waited until this morning is we wanted to give the opportunity for the Arrowhead team to be communicated to before the announcement went out. So nothing bluntly nefarious beyond that. So no concerns. Second, You know, this is a business that has seen significant growth. And I would disagree with you slightly. The fact that the business leans highly to aluminum cans, that market, there's a secular trend away from plastics to aluminum. And actually, there's a capacity constraint in the United States today in aluminum cans, which will drive more demand for palletizers depalatizers and conveying systems. And so that move towards more environmentally friendly solution is going to be a benefit for this business going forward. Add that to the fact that this business brings us improved knowledge around control systems and that we will be able to leverage our mod sort into their markets and segments and then conversely leverage their products and solutions into our markets and segments, that's going to be win-win. And then the last win-win is exactly what you said, which is there are opportunities for us to leverage our product portfolio in the power transmission space to sell to Arrowhead, but also then to sell to Arrowhead's customers. So all of this is a benefit. Now, with regards to the synergies, You know how we like to work. We like to set objectives that we can drive to and run to hard and achieve and beat. So I'll certainly tell our team that we've got a little more to push there, but we feel good about the $8 million by year three and the $12 million by year five.

Great. Thanks, Lewis. And then just digging a little bit more into price-cost, I agree with Joe's math. It looks like mid-scale digit core growth is sort of like what the $5 billion reflects. Just wondering how much of that just mechanically today could be priced as we wrap into 2022? And I'm just wondering if you'd just bring us up to speed on where we are with the NPFs within climate. Thanks.

Yeah, sure, Nigel. Let me start with the last question with the MPS on climate. So we are now caught up in the, we caught up in the third quarter, late second, early third quarter on the two-way material price formulas within the climate segment and other parts of our business as well are now largely caught up. Again, inflation continues to move in the wrong direction and there's always a three to four month lag, but we're seeing the benefits of that as we exit the third and expect that to continue through the fourth, which should be a nice tailwind as we move into 2022.

And so I think, Nigel, for that reason, we're not quite ready to give you any more specificity for 22 on the impact of price or growth beyond what we've said.

Okay. Thanks, guys.

Thanks.

Our next question comes from Walt Liptak with Seaport Research. You may go ahead.

Hey, good morning. Congratulations, guys.

Thanks, Walt.

I just wanted to ask a couple of them. You know, the comments about 80-20 sounded very positive. It sounds like, you know, everybody's speaking the same 80-20 languages. And so, you know, I guess we knew that, you know, as you announced the deal. But what does that mean for some of the synergies and especially for the cost savings? I wonder if there's buckets of savings either around factories or procurement or other things that 80-20 is going to get a bigger lift. Thanks.

Yeah, you know, Walt, I wouldn't say so. Not yet. I mean, we came into this with a very clear understanding that the former Rexnord PMC group and the legacy PTS group understood 80-20 well. And that was all modeled into our synergy planning. I will tell you, it drives everything we do. We talk about the Regal Rexnord business system as being a bust. And 80-20 is the steering wheel. It directs all our efforts, whether it's new product development, operational synergies, or purchasing synergies. So at this point, I wouldn't say it's really had any change in the way we're thinking about $120 million by year three and a nice buffer for upside.

Okay, great. And just on the Arrowhead business, I want to see if I can get a clarification. Are you selling to the food and beverage customers or are you selling to systems integrators? And, you know, is there a point at which, you know, in conveyors where you may be in conflict with some of the installers, some of your existing customers? Thanks.

Yeah, so we're selling to both. And, you know, again, the Arrowhead offering is the depalatizers and palatizers. There's zero overlap there. There's slight overlap with conveying, but the reality is our customers are looking to us to provide more subsystems, and this is why our mod sort has seen significant growth over the last two years. Two years ago, it quadrupled in revenue. Last year, it doubled in revenue because our customers are looking for us to provide that subsystem, and Arrowhead just strengthens that. So we have modeled very little dissynergy with this acquisition. We don't see that as a concern. Okay, great. Thank you for that. Thanks, Will. Thanks, Will.

Our next question comes from Christopher Glynn with Oppenheimer. You may go ahead.

Thanks. Good morning. Nice presentation today. Thanks, Chris. Yeah, I wanted to talk about the share gain comments around the industrial powertrain offering. I wondered if we could get into, you know, some examples of specifications, wins, and what maybe changes you're implementing in terms of go-to-market there.

Yeah, sure, Chris, I'd be happy to. You know, we purposely left an example out of this earnings call because we knew we were going to go long. But I'd encourage you to go back to the last two where we gave some very specific examples. But where we're seeing wins is anywhere where, you know, for example, a warehouse where there is a conveying system. There's an example that we've talked about historically around the customer was having challenges with their gearing failing. We went in with our application experience and we were able to identify that they oversized the motor and they had not the optimal gear solution. We gave them a solution that would save them money and has reduced their downtime significantly. And we can put numbers behind every single one of those claims that the customer will validate. And so it's those types of examples where we're seeing wins. Bluntly, our customers don't have the level of engineering expertise and capabilities that they've had in the past, but we do. because we know those products and those solutions. And we know how best to put a motor with a gearing system with couplings and bearings and provide a full industrial powertrain. And that's where we're seeing some wins. So we'll make sure and we'll continue to emphasize those benefits as we go forward.

OK, great. And then a clarification on the positive price-cost comments. For an actual margin rate or OP dollars?

That's on dollars. That's a dollar basis. It's actually dilutive to margins for us and to leverage if you, you know, just because we're not, the price that we're getting does cover the inflation dollars. But again, as I said, you know, is certainly dilutive to the margin.

Yeah, Chris, I'll just add on there. Historically, Regal has been very focused on price-cost neutral and being positive. We are now focused on price-cost positive because of that reason. And so I couldn't be more proud of the team and their efforts in getting us an improved price-cost position in third quarter.

Indeed. Thank you.

Sure. Thanks, Chris.

Again, if you have a question, please press star then 1. Our next question comes from Chris Danker with Loop Capital. You may go ahead.

Hey, morning, everyone. I guess, Kaz, one of the very few areas of critique, I guess, how do we think about the cost actions going on in commercial and industrial? Obviously, very challenged from a cost and inflation perspective. Just kind of, can you give us an update on some of the structural actions that are going on there and kind of what we can expect in the next six to nine months here?

Yeah, you know, so let's hit commercial and take them out very quickly because I'd say they're performing very well. And no question that there is some pressures, but the team is doing a great job of leveraging 80-20, of rationalizing our products and solutions, and making sure that we're getting sufficient price. So I think you will continue to see solid performance at a commercial system. You know, industrial, it is our biggest challenge, no question. Now, you also know it's our lowest gross margin business. And so when you have lower gross margins, that means you have a higher material cost as a percentage of sales. And so therefore, a higher impact of inflation. You add that with the fact that you've got global supply chain disruptions at a time when we launch a new product in a new manufacturing location in Mexico that still has a long supply chain right now. And those delays are being realized in tough margin performance. We still see value creation for this segment. We still see a path to 8% to 11% as we discussed at our investor day, but it's certainly delayed. And so, you know, I would not expect any grand improvement in the fourth quarter, but we will continue to improve through 2022. And again, our goal is to get this business to 8% to 11%. I'll make one last point about the industrial business. I realize that industrials EBITDA is 5% of Regal and will be less than 4% of Regal Rexnord. So, you know, we talk about it because it's a segment, but the reality is it has a small impact on the overall strong performance of Regal Rexnord.

Yep. Thanks so much for the color there. Much appreciated. And then just to follow up, I guess, any update on the pruning actions? I mean, it's... You guys have been really taking a focused approach to some of the cuts here, I guess. Do we expect the pruning to kind of continue at the current rate for the foreseeable future, or should they kind of start to taper as we get into the new year, would you expect?

Yeah, no, I'd tell you 80-20 is we – that's the direction we drive all of our discussions. And so pruning will continue into 2022. It will moderate a bit. But, you know, we are focused on the quad and the quad analysis. And so the quads are looked at once a quarter. They are trended. And so a new quad is still going to show, for example, the fourth quad, which is B customers and B products. And we're going to still have to take action on them because they don't belong with Regal Rexnord. They need to be served. They can be served through distribution. We need to move those customers onto A products. We need to grow with those customers or they don't belong. So, you know, I do think it will moderate a bit, Chris, but you'll continue to see us talk a lot about 80-20 and pruning going forward.

Understood. Well, be sure to send a fresh pallet of 5-Hour Energy over to that biz dev team of yours, and congrats on the results of the deals here, guys.

Yeah, thanks so much, Chris. Thanks, Chris. Thanks.

This concludes our question and answer session. I'd like to turn the conference back over to Louis Pinkham for any closing remarks.

Thank you, Operator. And thanks to our investors and analysts for joining us today. I hope you got a better understanding of why, despite so many external pressures confronting our business, I am excited about and confident in the future of Regal Resnores. These external pressures are real. We are battling them daily. but we're also being disciplined about our execution on our organic growth and restructuring programs, pursuing PMC merger synergies, and vetting new capital deployment opportunities as we think about how best to leverage our clean balance sheet and strong cash flow to keep enhancing shareholder value. Thank you again for joining us today and for your interest in Regal Rechnort. Have a good day.

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