Regal Rexnord Corporation

Good morning and welcome to the Regal Rex Nord fourth quarter 2022 earnings conference 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 would now like to turn the conference over to Robert Berry, Vice President of Investor Relations. Please go ahead.

Great. Thank you, Andrea. Good morning and welcome to Regal Rexnord's fourth quarter 2022 earnings conference call. Joining me today are Louis Pinkham, our Chief Executive Officer, and Rob Rayhart, our Vice President and Chief Financial Officer. Before turning the call over to Louis, I'd like to remind you that the statements made in this conference call that are not historic 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 filing. 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 see 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 Rayhart will then provide our fourth quarter financial results in more detail and discuss our 2023 guidance. 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.

Great. Thanks, Rob. And good morning, everyone. Thanks for joining us to discuss our fourth quarter earnings and to get an update on our business. And thank you for your continued interest in Regal Rexnord. Last night, we reported strong results that evidence our transformation continues to gain traction. Organic sales growth of slightly over 4% for the enterprise reflects continued share gains and strong price discipline, even as some of our end markets slowed. The share we are gaining continues to be supported by our digital and e-commerce investments, new products, and competitive service levels. This fourth quarter was also the eighth in a row of being price-cost positive, which along with sizable M&A synergies, NPD mix-up, and our ongoing 80-20 and lean efforts, drove 300 basis points of adjusted EBITDA margin expansion versus the prior year period. I was also pleased to see our cash flow performance improve in the fourth quarter, resulting in cash flow conversion of 165 percent. Despite this strong finish, we did fall short of what arguably was an ambitious goal for the year. While the supply chain is improving, during the quarter, it did continue to contain us, while making it costlier to maintain high service levels for our most valuable Quad 1 customers. In aggregate, a very strong finish to 2022. I think it is also important to acknowledge the first full year of Regal Rexnords. as we continue to manage our portfolio and drive significant shareholder value. Sales were up 37% versus 2021, with organic sales up 9% year-over-year. Adjusted EBITDA reached more than $1.1 billion. We achieved 33% adjusted gross margins right on track to our plans, And adjusted EBITDA margins improved 230 basis points from 19% to 21.3%. Solid overall results. And for this strong execution, pursued with a sense of urgency, as well as continued adherence to our Regal Rexnord values, I want to say a sincere thank you to our Regal Rexnord associates around the world. Now, I do want to take a moment and comment a bit further on cash flow because I am increasingly optimistic about our cash flow outlook. In addition to the EBITDA growth we expect in 2023, plus strong gains over the forecast period, we also see a significant opportunity to reduce working capital and especially inventory, both as the supply chain continues to improve and as we further mature our 80-20 and lean efforts. Our teams are becoming more disciplined about how they manage working capital. Some of this is happening through IT and logistics investments, such as a new global freight scheduling software. Some is occurring through our M&A synergies. In addition, I am excited to announce that we added a new member to my leadership team, our Vice President of Strategic Sourcing, who is bringing over two decades of global sourcing and supply chain experience to Regal Rexnord, and who I am confident will help us improve our working capital performance, continue to expand our gross margins by lowering our input costs, and enhance the service level improvements that are helping us gain market share by reducing our lead times. In the spirit of what gets measured gets done, we are complementing this stepped-up focus on cash flow by making working capital performance and resulting free cash flow a larger component of our leadership's 2023 compensation, creating a stronger link between incentives and targeted performance. Cash flow is a critical driver of our values. But it becomes even more critical in the context of the leverage we've added to fund the Ultra transaction, and I can assure you that my team and I will be over-managing it. Turning to orders. We did see further pressure in the quarter, with daily organic orders down just over 10% on an FX neutral basis. This was not a surprise directionally, given softening macro indicators such as US and non-US PMIs, and what some of our large HVAC customers have been indicating on destocking. But it was weaker than we anticipated in terms of magnitude as we entered Q4, particularly in residential HVAC. We do expect order weakness to persist in early 2023, especially in the first quarter, when we face a tough compare. And with supply chain improvements plus heightened macro caution, our customers are likely reducing their stocking levels further. That said, we remain cautiously optimistic about our top line prospects. Not only do we have a diverse set of end markets with balanced early, mid, and late cycle exposures, But we continue to have an elevated backlog, still up nearly 50% versus early 2021 levels. And we expect significant tailwinds from new product launches in 2023. As a reminder, we aim to double our product vitality in the 2023 to 2025 time frame. We also have sizable self-help tailwinds from Rexnord PMC and Arrowhead synergies, both on cost and revenue, and then anticipate significant M&A synergy upside once we close Ultra. Rob will provide further detail on all the moving parts, plus our 2023 expectations for growth, margins, and earnings in his section. But the bottom line is that our focus in 2023 and beyond remains on controllable execution. Between our ample backlog, healthy new product pipeline, current and expected M&A synergies, and significant ongoing 80-20 and lean initiatives, we have a tremendous opportunity to create value for our key stakeholders, our customers, our associates, and our shareholders. and we believe this to be the case regardless of what the macro does. Shifting focus a bit, I'd like to provide an update on where we are with the Ultra transaction. Since announcing the acquisition on October 27th of last year, we secured financing for the transaction, saw approval of the deal by Ultra shareholders, and made nice progress on the regulatory front. We were very pleased with our early January financing activities, which involved raising $4.7 billion in three, five, seven, and 10-year unsecured notes. The offering was greater than four times oversubscribed, which helped us achieve interest rates that were over 100 basis points lower than assumed when we announced the transaction. On the regulatory front, The waiting period on our US HSR filing ended on January 12th, and a simplified regulatory review process was initiated in China in mid-January. China and other jurisdictional reviews remain in process, and we continue to expect that we will close the transaction in the first half of this year. We remain extremely excited about adding Altra to our Regal Rexnord team. We see tremendous opportunities to drive material cost and revenue synergies through this combination and create meaningful benefits for all of our key stakeholders. One of the many growth opportunities we envision with Altra is enhancing our industrial powertrain offering by adding certain capabilities that we lack such as clutches, and expanding narrower parts of the offering, such as in brakes. Meanwhile, our current powertrain team continues to see great momentum in the market. As a reminder, this cross-segment, cross-functional team is dedicated to selling integrated industrial powertrain solutions, and its focused efforts are driving strong momentum across selling these highly differentiated subsystems. Pictured on this slide is a recent powertrain win. In this case, our Regal Rexnord powertrains are running clarifying tanks that are critical components of a large municipal water treatment facility. Our content includes marathon motors, Rex and Hub City gearboxes, bulk couplings, and Rexnord bearings in addition to providing custom fabricated base plates and bearing pedestals. In aggregate, a seven-figure project win for the powertrain team. What the customer needed and we were able to provide is first, an integrated solution, and second, a solution that enhanced durability and energy efficiency. For our customer, This installation is over a $100 million project. So they were eager to lean on Regal Rexnord's application and powertrain expertise to provide these subsystems plus commissioning so they could free up time to focus on other aspects of the project. In other words, we made it easier for our customers. And at the same time, optimize the subsystem's efficiency and durability. On top of that, our team brought this highly customized solution together with best-in-class lead times, doing our part to help keep the broader project on schedule. What we love about these differentiated subsystem sales is that conversations with the customer are more strategic. more focused on our technical capabilities and on efficiency, making this powertrain subsystem an absolute win-win for the customer and for Regal Rush Nord. Plus, this win tees up other project opportunities and a strong MRO funnel for the future. And so, congratulations to our powertrain team for acting with urgency to deliver this great result. And with that, I'll now turn the call over to Rob to take you through our fourth quarter performance in more detail.

Thanks, Lewis, and good morning, everyone. I'll begin by also thanking our global team for their strong execution, including delivering a very strong finish to 2022 in what remains a challenging operating environment. Now, let's turn to our fourth quarter segment financial performance. Starting with our Motion Control Solutions segment, or MCS, organic sales in the fourth quarter were up 9.4% from the prior year. The result reflects broad-based growth, but with particular strength in the general industrial energy, metals and mining, and aerospace end markets, partially offset by weakness in alternative energy, including lapping project activity in the China wind market. Adjusted EBITDA margin in the quarter for MCS was 27.8%, up 300 basis points compared to the prior year, primarily due to merger synergies and volume growth, partially offset by non-material inflation, supply chain frictions, mix, and FX headwinds. Orders in MCS for the quarter were down 7% on a daily FX neutral basis. In January, book to bill tracked at roughly 1.2. Turning to climate solutions, organic sales in the fourth quarter were down 10.7% from the prior year. The decline was driven by global in-market volume headwinds, particularly in the North America residential HVAC market, as large HVAC OEMs took significant actions to reduce inventories. These market volume headwinds were partially offset by pockets of share gain. To put climate's fourth quarter top line result in context, the U.S. residential HVAC business faced tough comparisons, including 15% growth in the prior year quarter in a two-year stacked growth rate of nearly 40%. While some top-line pressure in the face of these difficult comparisons was anticipated, the headwinds in the quarter from OEM destocking activity were more severe than we expected. We believe a weaker macro outlook plus temporary near-term uncertainty around how the January 1st implementation of the new U.S. energy efficiency regulations would impact regional channel inventory levels prompted a more cautious stance from our HVAC OEM customers. This dynamic likely continues to weigh on the first quarter as well, but we are cautiously optimistic that we'll see improving conditions thereafter. The adjusted EBITDA margin in the quarter for climate was 18.5%. While there was pressure on climate's EBITDA margins in the fourth quarter due to lower volumes and headwinds related to material inflation, non-material inflation, supply chain disruptions, and currency, the segment did realize a benefit related to the capitalization of freight variances that will unwind in the first quarter of 2023. We continue to see a path back to margins in the high teens to low 20s during 2023. though most of the improvement is likely to occur after the first quarter. Expected drivers of the forecast improvement include, one, launching mixed positive new products, in particular our Frontier compressor drive, two, mixed tailwinds related to new U.S. minimum efficiency standards, or SEER ratings, which should drive greater demand for our electronic variable speed motors, and three, significant productivity and restructuring initiatives, many tied to maturing 80-20 and lean efforts. Turning to orders, orders in climate for the fourth quarter were down 22% on a daily FX neutral basis. Book to bill in January is tracking at roughly 1.2. Turning to commercial systems, organic sales in the fourth quarter were up 5.6% from the prior year. Growth in the quarter reflects strong performance in North America general industrial and the large commercial HVAC markets, partially offset by headwinds in China. The strength we are seeing in general industrial continues to reflect meaningful share gains tied to investments we are making in digital and the e-commerce channel initiative. The adjusted EBITDA margin in the fourth quarter for commercial systems was 17.6%, up 510 basis points compared to the prior year, reflecting some moderation in freight costs along with strong execution of our 80-20 and lean initiatives, partially offset by commodity and other non-material product cost inflation. Shifting to orders, segment orders for the fourth quarter were down 17% on a daily FX neutral basis, or down 10% excluding orders in pool, which continued to actively right-size inventories during the quarter. Looking to January, book-to-bill tracked at roughly 0.95%. In industrial systems, organic sales in the fourth quarter were up 9.7% versus the prior year. Principal drivers include volume growth, largely tied to share recapture stemming from improved operating performance and service levels, along with in-market strength in general industrial and data center. As expected, the business did see some weakening in China, which tempered the segment's growth. The adjusted EBITDA margin in the quarter for industrial was 12.2%. an increase of 650 basis points versus the prior year period. We continue to be extremely pleased with the performance at industrial, which we feel is on a sustainable path. Orders in industrial for the quarter were down 5% on a daily FX neutral basis. In January, book to bill was 1.0. 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, you'll see we ended the quarter with a net debt to adjusted EBITDA ratio of 1.2 times. Second, our free cash flow in the quarter was $169 million, which equates to a conversion rate of roughly 165%. Our team did a great job improving free cash flow performance in the quarter, and while the result left us shy of our full-year conversion target, we see significant opportunities to augment our cash flows in 2023, in particular by lowering inventories as the supply chain improves. As we stated previously, our focus will continue to be on paying down debt with the improving cash generation. Moving to the outlook. And please note that all of our adjusted earnings guidance excludes any impacts related to Altra. Let's start with the top line. We defined our top line forecast by considering several factors. One, a weakening demand environment evident in our order rates, our record backlog, three, pricing dynamics, and four, continued success with our outgrowth initiatives, including expected new product launches, service level improvement, and e-commerce and digital investments. To help illustrate how we're thinking about market impacts in 2023, we've included a table on this slide detailing our principal in-markets and our current views on how each is likely to grow this year. As noted in the table, the weighted average of our underlying in-market growth assumptions is a 3.5 percent decline in 2023. Beyond what in-markets may be doing, we expect to deliver outgrowth of roughly two points, which equates to outperforming these markets by a little better than 50%. Our top-line modeling also embeds a slightly positive impact from price, along with a modest headwind from currency, which brings our overall sales growth expectation to down roughly 1% at the midpoint of our range. At the EBITDA line, we anticipate delivering margin expansion of 50 to 70 basis points at the midpoint, Note that margin gains will likely be weighted to the back half of the year, with only modest improvements expected in the first half due to continued, albeit moderating, supply chain challenges. Before leaving margins, a word on commodity inflation. While we saw prices of our principal commodities, steel, copper, and aluminum, decline through the second half of last year, we are starting to see those prices moderate slightly higher coming out of January on a sequential basis. Our outlook assumes relatively neutral commodity costs in 2023 relative to the way we finished 2022. We also assume that we will remain at least price-cost neutral and likely slightly positive throughout 2023. Moving further down the income statement, we factor below the line items as detailed later in this presentation to arrive at a range for projected adjusted earnings per share of $10.05 to $10.85 or $10.45 at the midpoint. I will highlight that we have nearly 50 cents of incremental year-over-year net interest expense embedded in our estimates, which reflects higher benchmark interest rates. To be clear, our net interest expense guidance excludes any new acquisition-related financing costs and is aligned with the interest expense on our current business that we saw in the fourth quarter of 22. In summary, we are choosing to err on the side of caution here as we start the year, but our confidence in the business remains extremely strong. We have line of sight to additional margin upside through our M&A synergy efforts, disciplined cost savings initiatives, and a continued focus on 80-20 and liens. We're also gaining traction with our growth initiatives, especially our industrial powertrain cross-segment initiative, and we remain on track to double our new product vitality over the next three years, which is also expected to benefit our margins through higher mix. On this slide, as I referenced earlier, we provide some modeling items that should be helpful as you build out the income statement below the EBITDA line and model free cash flow. Our $105 million of guided interest expense is for our current business only and excludes all ultra-related impacts. I'll wrap up by saying that on the whole, we are very pleased with the Q4 results and our team's ability to execute in what remained a challenging environment. While the macro outlook remains uncertain, our outlook for the company remains very positive considering the tremendous amount of self-help we have in front of us on growth, margin, and cash flow. And now, I'd like to turn the call back to the operator so that we can take any 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 are 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 the roster. And our first question will come from Nigel Cole of Wolf Research. Please go ahead.

Thanks for the first question. Appreciate it. Good morning, everyone. So first of all, congratulations on the financing for the deal. Looks like good terms there. But in terms of, you know, the down 2% organic, I think that's the number you're keening on here, down 1.5%, 2%. How does that look through the year? And I'm just, obviously, we're cognizant of the challenges in one queue. So any help on that phasing of that, you know, downloads and widgets would be helpful.

Sure, Dido. Thanks for the question. Let me do it this way. Let me give you the full, I'll give you a guidance for the full company and the way that should work, but and kind of how we're expecting that to phase. But let me start by just giving you some segment guidance. And then what I'll do is I'm going to give you the full year, and then I'm going to give you a little bit of direction on Q1. The first half of the year we expect to be relatively slow or slower, especially in Q1, and then more of the improvement coming in the back half. So starting by segment, and I'll start with the top line. And I'll start by each side with climates first. And for each one of these, the way I would look at this is I'll give you the expectation that's embedded in our midpoint, and then just plus or minus 200 basis points in the range. So climate down mid-single digit. Commercial down mid-single digits. Industrial up high single digit. And MCS up low single digit. So overall down about 1%. at the midpoint. Again, plus or minus 200 basis points for the range. Now, before I get into Q1, let me also just finish this section up by giving you a bit on EBITDA margins. So, I'll use 22 as a jump-off point to full year 22. For climate, margins up half a point, give or take. Commercial, margins roughly flat to up slightly. Industrial, margins up as much as a half a point, and MCS margins up between 50 and 100 basis points. Now I'm going to skip back to Q1, because it is unique. Similar to last year, where we had an outsized benefit of the cost roll, which was positive to the first quarter, this year we're seeing the opposite effect. We're seeing deflation, so it's an expense versus income in the prior year. So with that being said, Let me first start with top line. And I'm going to give you these numbers or these expectations and think of this as more sequential to fourth quarter. For climate, flat. Commercial, roughly down high single digit. Industrial, up high single digit. And MCF, down low single digit. Again, sequential. And so overall, Regal Rexnor level down low single digits. So now let me move to, similar to what I did on the full year, let me give you the directional guidance on EBITDA margins. So for climate, and this is again sequential to be clear. Roughly down five points. Commercial, roughly down three points. Industrial, roughly down two and a half points, and MCF, roughly flat. So overall, we expect to be down roughly one and a half to two points. So again, first half, expect more pressure, especially in Q1, and more improvement in the back half. Hopefully that is fairly comprehensive.

Yeah, the answer was a lot better than my question, that's for sure, but we'll kind of process this and come back offline. My final question is on the Altra deal. The HSR waiting period over, is that equivalent to effectively getting sign-off from the regulators on that deal? And is there a possibility this deal could close this side of the quarter? Because I know you said first half, but does that lead up to the possibility of a one-key closure?

Yeah, so, Nigel, this is Louis. Good morning. You know, first of all, with regards to HSR, It's a review process, and the review process expired on January 12th. And so that's the process. Specific to could this close in first quarter? Potentially unlikely. We still have – and regulatory really is the only outstanding item at this point, of course, because we had good success in the financing phase. and USHSR should be behind us. But we also have behind us Turkey, UK, and Australia. However, still pending is EU and China. And as I said in my prepared remarks, China accepted a short form in mid-January. So there's typically a 30-day period from that. We also received FDI approvals from Czech Republic, Italy, and the U.K., and outstanding from Australia, Denmark, France, and Germany. So really still on track with what we expected, we believe, first half. And so certainly I'm giving you my thoughts that it's likely second quarter, but we'll see.

Great. Thanks, Lewis.

Sure.

The next question comes from Mike Halloran of Baird. Please go ahead.

Hey, good morning, everyone. Thanks for taking the questions. Good morning. So just a clarification on all that detail, Rob, you gave. When you think about the underlying dynamics from an end market perspective, what is the expectation for those end markets, front half versus back half, at a high level? you know, obviously appreciate all the finite detail in there, but just maybe bring it a little higher level and just talk about the broad-based expectations for the underlying dynamics as you work through the year and what's embedded in guidance that way.

Sure, Mike, and I'll take this one. You know, what we like about our portfolio is a very balanced early, mid, and late cycle exposure. No question we're seeing slowing in that early cycle. Anything consumer-related is seeing slowing. And so, you know, residential HVAC, we're thinking likely down high single, low double-digit for 2023 and more weighted to the first half. Pull down. Now, pull, you know, residential HVAC is about 15% of regal. Pool is only about 2% to 3%, but that's going to be about the same type of profile. You know, anything that's a little later cycle, though, we're seeing acceleration, bluntly. Aerospace is quite strong. We expect solar or alternative energy to be strong. And then kind of relatively flat would be the commercial space, hospitality, power gen, and we still feel pretty good about non-res construction. There's a little bit of noise in some of the indicators, but non-res construction should be pretty strong in this first half as well. I hope that helps, Mike.

Yeah, so basically, it seems like you're saying from a seasonal perspective, you're going to get a lot of variance by end market, but you're not expecting acceleration in any of kind of the shorter cycle, earlier cycle type things in the area where you might see a little bit of that extra strength or these longer cycle things. So not assuming some sort of recovery in the year in the areas where there's a little bit of stress that's being seen in the short term, correct?

I would tell you RESI, HVAC later happens. Fourth quarter of the year is we would expect it to see a little bit of a rebound. But otherwise, no, I think you're right on. We don't really see a lot of seasonality, though, Mike. I wouldn't reference it as seasonality. But when you think about it, you know, a couple of other things I'd just provide you. When you think about the strength of our backlog up 45%, when you think about the comps, you know, the – The stacking of orders for both our commercial and climate business has a 30% stack in fourth quarter, so we weren't so surprised about orders being down in fourth quarter in those two segments. Overall, though, we're forecasting. Our viewpoint is our backlog will likely drop as the year progresses. The first half of the year, orders will be down about you know, high single-digit, low double-digit levels, and starting to recover in third and fourth quarter.

That's very great context. And then follow-up is just on the success. You're having a new product side. Maybe talk about how the market is receiving some of the initiatives you're putting out there and, you know, you know, the confidence, I suppose, in that end market, our performance remains high. So any help on that side would be great.

Yeah, our confidence remains quite high. Really, the only thing that's going to slow us down is the supply chain. And whenever you launch a new product, it takes a little bit longer and, you know, it's a little tougher. Electronics continues to be a bit of a constraint for us. But You know, we have a partner OEM in our compressor drive, and so we can accelerate that as fast as I can produce it. We have a partner OEM in our global motor impeller solution, a COPRA solution, where our partner OEM would take more than I can capacity get out the door. It's a great product. It's a smaller footprint. It's more energy efficient than anything in the marketplace. This aligns very well with how we think about our subsystem solutions and driving differentiation to solve our customer's problem. We've come out with other products in the portfolio all around that approach. And so I feel our teams have done a great job over the last few years of developing a robust product roadmap. And we're seeing launches come out that should help us overachieve market, and that's why we're pretty confident in that, you know, 300, 250, 300 basis points of beat to market. Awesome.

Really appreciate it. Thanks for all the context.

Yeah, thanks, Mike.

The next question comes from Christopher Glynn of Oppenheimer. Please go ahead.

Thanks. Good morning, and appreciate all the detail. I'm curious about some of the book to bills in January with the 1.2s at MCS and climate. I think climate's just kind of wonky, you know, denominator moving around quite a bit there. But maybe the MCS there speaks to some particular strength. Curious if you could comment on that.

You know, we saw a little bit more strength in our order rates at MCS than we anticipated in January. You're spot on. You know, aerospace is strong. There's no question we get larger blanket orders there. We got a large order in January. We got a large order as well in solar in January. So I think if you take those out, Overall, it's not a big surprise, that book bill. The other, on climate, just clearly, you're right, it is a little wonky. The other wonkiness is that we did shut down the facility the first week of January, given the demand levels, and we thought the facilities, I should say, we thought that was the most efficient manner to manage the order rates, and so that's why it's a 1.2 book bill.

Okay, great. And then, Louis, you mentioned early in the pitch about significant upside to the synergies once closed. Altra, I think that comment ties to the relative progress towards the original 160 target.

No, it really ties to simply that once we close, we'll have access to that $160 million target. I wasn't referencing yet that we have line of sight to anything significantly more than that. Of course, we have not come out with growth synergies, which we are really bullish about with this transaction, and we won't come out with until probably six to nine months after we close. But that's the whole reason why we're doing Ultra, is to drive the accelerated growth for Regal. We're very pleased with our growth synergies out of the MCS PMC transaction of last year. They achieved north of $25 million, which was right on track of what we were looking for. So right now, though, nothing more to guide on synergies.

Okay, great. And then on the PMC transaction, Is it about $50 million plus incremental realized within the 2023 guide?

Yes, there's $50 million incremental. Some of that is carryover and then plus new. So it's about $20 million of carryover and $30 million of new.

Great. Thank you. Sure.

The next question comes from Julian Mitchell of Barclays. Please go ahead.

Hi, this is Matthew Schaefer on for Julian Mitchell. My first question would be on China. You guys cited some pressures in commercial and industrial in the quarter. Can you maybe flesh out your expectations for China in 2023?

Hey, good morning, Matthew. Yeah, happy to. Yeah, definitely, there was some pressure. I think our team performed extremely well, though, and you see it in the results of Q4. Even given the fact that we did have some operational pressure in Q4 and orders slowed. Now, we do not expect, and by the way, all of our operations are fully operational at this point in China. Supply chains are a little bit still constrained, but we expect a nice rebound coming out of Chinese New Year. And although we're not forecasting a lot of strength in China in 23, I think it could surprise. Right now it's relatively flat, year over year is our forecast. I think it could surprise China, always surprises me on the upside.

Okay, thank you. And then just what I'm pricing, you guys don't give much price disclosure, but are you still expecting to hold or grow price in 2023? And then what gives management the confidence that you guys will be able to do it potentially if there is more deflationary environment?

Yeah, Matthew, this is Rob, thanks. So absolutely, we do believe that we can be price-cost positive, slightly positive, and that's basically embedded in our guide and what we had assumed. You asked about what gives us confidence. Well, first of all, the fourth quarter was a 21st quarter of being at least price-cost neutral. And the eighth quarter, where we've been price cost positive, despite the challenging environment that we're in. So we've got a really strong track record of holding on to price. If you go back and historically, you'll see that we've been able to do that, especially in distribution and the aftermarket side. Remember, this is all net of MPF that I'm talking about here. We've got two-way material price formulas on about 20% of our business. So So that's working in the other direction on us right now, but rollover certainly, our carryover benefits from price moving into 23 is the other side that helps offset some of that impact. So hopefully that helps.

Great. Thank you, guys.

The next question comes from Jeff Hammond of KeyBank Capital Markets. Please go ahead.

Hey, guys. Good morning. Morning, Jeff. Good morning. Thanks for all the detail. That was really helpful. The one thing I wanted to zero in on is climate, because I know you had some noise in the margins this year. And I think you're saying for the full year, revenue down mid-single digits, margins up 50 bps. But your 1Q margin is down pretty substantially, sequentially in year on year. So I'm just trying to understand kind of in a decline market and the tough 1Q, kind of how you get you know, margins up, you know, on a full-year basis?

Yeah, so first of all, the margin drivers on a full-year basis are obviously you've got the volume piece going one direction, but then we've got new product development like the new Frontier product that I mentioned in my prepared remarks. And then we still anticipate we'll be price-cost positive despite the fact that the MPFs are moving in a downward direction. And so, you know, from a full year perspective, we absolutely have line of sight to see in those margins up that half a point, give or take. I mean, that is absolutely what we're modeling at this point. Remember also, Jeff, that, you know, we're going to start the year a bit conservative here. And so, you know, we think there could be additional opportunity here for climate as we move through the year.

You know, Jeff, I'll add a couple of more things. And Rob's spot on. You know, when you think about 22, we did a lot to service our customer in 22, and our supply chains are balancing out. And so we're not going to have as much of that headwind around spot buys and premium freight. And just bluntly, we're continuing to drive 80-20 and lean. That is helping us in being more productive and more efficient. And so overall, So the challenge of Q1 is really just to compare year over year in the cost role. We believe climate will strengthen as the year progresses.

And one more point, and I failed to mention this, is that when you're dealing with the NPS and they move in the downward direction, it does help your margin rate as you move through the year. So just one other point to make.

Okay. That's a great color. Maybe just sneak two quick ones in. One, appreciate the free cash flow comment and targets. Maybe just speak to what you think free cash flow conversion can be as you work on that working capital, what you think the source from all the working capital build was in 22 can be in 23. And then just any update on what you're thinking about ultra accretion for 2023, just given the much favorable interest costs that you got. Thanks.

Sure. So I'll take those in order. First, when it comes to free cash flow and trade working capital and where we expect to see a significant source of cash as we move into 23 is going to be in inventory. And that, as we said, is as the supply chain normalizes. And we estimate that in 2023, we estimate that somewhere in the range of $150 to $200 million as a source in 23. And then as we move forward into 2024, another $100 million, again, as we have this elevated inventory level and that supply chain starts to normalize. So $250 million, $300 million range over the next 18 to 24 months is how we're thinking about it. Hey, we know the timing is a bit out of our control, but those are the levels that we're talking about at this point and feel very confident in our ability to execute on that. based on the way that we manage the business, for sure. Let's talk about accretion now. So we see, based on the, you know, we had originally modeled, as we mentioned, rates, interest rates, you know, on an average of about 7.5% on the bonds, and we're now roughly at 6.2 on a weighted basis. So that 130 basis points certainly helps in terms of the interest expense that will be seen flow through the business, and that absolutely impacts accretion. And so we expect the next 12 months post-close, the accretion to be around 8%. And it's up from about 4% at announcement. And then certainly at 2024, estimate at this time somewhere in the mid-teens. So hopefully that helps.

Okay. Thanks, guys. Thanks, Jeff.

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

Hey, morning, guys. Thanks for taking the question for all the details so far this morning. I guess thinking about the sales comments, you brought some market commentaries, some organic commentary, I guess baked into that organic outlook. How should we be thinking about backlog burn, kind of what's baked in versus what could be upside, some of the risk of cancellations? Any comment on kind of how the backlog fits into that guidance outlook would be great.

Yeah, so good morning, Chris, and thanks for your comments. You know, we are expecting a burndown of our backlog in order to achieve those numbers. Now, I'll tell you, you know, orders were slightly stronger in January than what our modeling is for that burn down of backlog. Now, you know, it's one month. We're going to be measured in our approach here, but we can achieve our guidance with a mid-teens reduction in orders in the first half and an improvement in the second half, and we can and we can meet our guidance through the backlog. And so that's how we're modeling it right now. If orders are a little bit stronger, then that's going to give us a little bit more strength.

Got it. Understood. And then just to put a point on some of the destocking commentary, it seems like that was focused specifically on climate and HVAC. Again, given the order strength and demand, you know, backlog numbers for MCS. There's no destocking going on in industrial or the motion control businesses right now, correct? It just seems like, again, your major distributors were all kind of building inventory still. Just maybe some comments on how you see channel inventory on more of the industrial and MCS businesses would be great.

Yeah, I think that's probably about right. We see visibility through our distribution partners. Their sales out and they still seem to be fairly strong. We do not see a destocking. You know, the shorter cycle products, the early cycle products, you know, bearings is an indicator and perhaps that's a little bit slower. But overall, like I said, we were pretty pleased with our MCS order rates in January and And so I think you're spot on. We're not seeing destocking in industrial, nor are we seeing destocking in MCF. I would throw pool into your where we are absolutely seeing destocking. And, you know, we expected it, but it's significant. And then, like you said, residential HVAC.

Okay. Well, thanks so much for the comments and best of luck on 23 here.

Yeah, great. Thanks. Thanks much.

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. And thanks to our investors and analysts for joining us today. In summary, the Regal Rechner team is continuing to deliver very strong performance. While we are taking a measured approach to our 2023 guidance as we head into a period of weaker macro activity, I am confident that our Regal Rexnor team can continue to create value for our customers and shareholders and open up attractive new opportunities for our associates, all by focusing on our controllable execution. We are fortunate in having so many value-creating opportunities to pursue, a clear path to higher outgrowth, plus material margin and free cash flow upside. With the highly anticipated addition of Altra, our opportunity set becomes even wider. So much to be excited about at Regal Resnort. Thank you again for joining us today, and thank you for your interest in Regal. Have a good day.

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