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Executives

David C. Calusdian - Executive Vice President and Partner

Brian J. Lipke - Chairman, Chief Executive Officer and Chief Executive Officer of Gibraltar New York

Henning N. Kornbrekke - President and Chief Operating Officer

Kenneth W. Smith - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Robert J. Kelly - Sidoti & Company, LLC

Matthew Dodson

Gibraltar Industries (ROCK) Q3 2013 Earnings Call October 31, 2013 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Gibraltar Industries Third Quarter 2013 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. David Calusdian from the Investor Relations firm, Sharon Merrill. Please proceed.

David C. Calusdian

Good morning, everyone, and thank you for joining us. If you have not received a copy of the earnings press release that was issued this morning, you can find it in the Investor Info section of the Gibraltar website, gibraltar1.com. During the prepared remarks today, management will be referring to presentation slides that summarize the company's third quarter performance. These slides also are posted to the website. Please turn to Slide #2 in the presentation.

Gibraltar's earnings release and this morning's slide presentation both contain non-GAAP financial measures. Reconciliations of GAAP to adjusted measures have been appended to the earnings release. Additionally, the company's remarks contain forward-looking statements about future financial results.

The company's actual results may differ materially from the anticipated events, performance or results expressed or implied by these forward-looking statements. Gibraltar advises you to read the risk factors detailed in its SEC filings, which can also be accessed through the company's website.

On our call this morning are Gibraltar's Chairman and CEO, Brian Lipke; recently retired President and Chief Operating Officer, Henning Kornbrekke; and CFO, Ken Smith.

At this point, I will turn the call over to Brian.

Brian J. Lipke

Thanks, David. Good morning, everyone, and thanks for joining us on our call today. I'm going to start off with some highlights on our business this quarter and then turn the call over to Henning and Ken for more detailed comments on our results. And then I'll close our prepared remarks with some thoughts on the outlook for Q4 and 2014. And at that point, we'll open the call to any questions that any of you may have.

Before I move into that part of our discussion this morning, I'd like to make a special note. As most of you know, Henning Kornbrekke retired from Gibraltar at the close of our third quarter and has agreed to continue on as a consultant for an interim period. And since we're reviewing the third quarter results, which he was part of, he's also participating in today's earning call. I want to publicly extend a note of thanks to Henning for his many contributions to Gibraltar during his more than a decade with the company, which included some very challenging times for our industry and for Gibraltar over the last 5 years or so.

Henning, your support and efforts have helped to position Gibraltar for significantly improving performance as our end markets continue to rebound. Thanks for your many contributions over the years.

With that, I'll turn -- I'll ask you to turn to Slide #3 in our presentation titled Q3 Overview.

Gibraltar overperformed this quarter on both the top and bottom lines compared to last year. Net sales were up 6%. Adjusted EPS increased nearly 30% from Q3 last year and also exceeded our EPS guidance for the quarter. The revenue growth came from our recent acquisitions, which continued to perform as expected with sales improvements by some of our operating units, which were offset by lower sales from our industrial business.

On the bottom line, our adjusted EPS of $0.31 came in higher than last year's $0.24, mainly driven by lower than expected operating costs, the earnings from recent acquisitions and improvements from some of our operating units, which again were partially offset by reduced profitability in our industrial business.

Weakness in the industrial and infrastructure markets continues to weigh on our organic sales, which were nearly flat with Q3 last year. Residential repair and remodeling activity remains well below historic levels but appears to be firming. We did, however, see continued improvement in the residential new construction market.

Our strong balance sheet, positive cash position and strong operational cash flow provides Gibraltar the financial wherewithal to seek opportunities to grow our sales, earnings and improve our operating performance characteristics through participation in the acquisition arena.

During the quarter, we announced the purchase of a small but innovative and growing solar powered ventilation product line. The acquired product line complements and expands our roof ventilation product offerings sold into the residential housing market. We expect these products to strengthen our position within the growing residential market for energy conservation products, and we plan to apply the technology of some of these existing products to help their sales.

As we begin to look into 2014, overall, the macroeconomic trends that we see suggest a strengthening of some of our end markets along with growing signs that other of our end markets could begin to improve during 2014.

In addition, the many internal operating initiatives currently underway will drive continued operating performance improvements as we move into 2014. As a result, we have a growing confidence that 2014 will be a stronger year for Gibraltar.

With that, I'll turn the call over to Henning.

Henning N. Kornbrekke

Thank you, Brian. Good morning, everyone. Let's turn now to Slide #4 titled Revenue Exposures, which illustrates our 2013 revenue exposure by end markets served.

As the center pie chart shows the residential and low-rise commercial building market represents about 50% of our current sales. Of that 50%, 1/5 comes from the low-rise commercial building market, which consists of structures such as professional buildings, hotels and retail centers. The other 4/5 of this half of the overall business is residential and most of that is driven by repair and remodeling activity.

The other half of our consolidated sales is split roughly 40% and 10%, coming from the industrial and transportation infrastructure markets, respectively. And repair and remodel activity is a meaningful driver of demand from these 2 market categories.

So with this context, let's move to Slide #4 titled Revenue Dynamics. As Brian cited, we had solid sales growth this quarter led by recent acquisitions. And for businesses owned in both periods, we had strong growth from residential new construction. Our third quarter sales to the homebuilding sector were up 10% year-over-year driven by continued demand for our storage and security products.

Regarding residential repair and remodeling demand, on our last call -- last quarter, we dialed down our previous guidance for consolidated revenues in 2013, in part due to lower second quarter volume and moderate market activity but we expected improvement in quarter 3 versus quarter 3 of 2012.

Quarter 3's actual sales were nearly consistent with this expectation. Overall, residential repair and remodeling sales, including roofing, were flat with our quarter 3 of 2012, which included a negative comparison for our ventilation products.

Although we don't sell roofing shingles, we do sell roof and attic ventilation products along with trims, flashings, metal roofing and rain dispersion products. Our products generally correlate with the shingles as part of a reroofing project and they comprise about 25% of our consolidated sales.

Our reroofing projects for the first 9 months of 2013 were down 3% year-over-year, a function of a 20% decline in the market driven by unfavorable weather in some parts of the country, and we believe the lingering effect of the recession on consumer confidence and consumers' willingness to commit to big-ticket home remodeling projects.

Let's turn now to our Transportation Infrastructure business, which contributes 10% of our consolidated revenues. Our quarter 3 sales in this business were weaker, declining 5% organically this quarter versus quarter 3 of last year. The 2-year federal transportation bill that was enacted 1 year ago is driving the demand for infrastructure products that we expected and quarter 3 sales related to smaller projects were in line with those forecasts.

The shortfall this quarter was associated with larger size projects. Many states remain cautious with investments in large projects due to the uncertainty of federal funding after the expiration of the current federal transportation appropriation.

The industrial markets are still facing challenges, 40% of our consolidated revenues are generated from sales of industrial products. This market remains soft with slow improvement expected in the year ahead as an improvement in the economy or a pickup in capital projects begins to accelerate. Overall our industrial sales, including sales by industrial businesses we acquired in Q4 of 2012 increased 2% this quarter versus quarter 3 of last year. Unit volume was equivalent in the majority of industrial markets, however, relatively weak demand continues to foster a competitive and price-sensitive market environment, in which we experienced reduced pricing compared to last year's third quarter.

Excluding the acquisition, total industrial sales decreased 6% from Q3 last year, including European industrial sales, which were down 14%. The economic weakness in Europe is continuing to press on demand for our security products, as well as our precision expanded metals sold in European OEMs with filtration applications in automobiles and off-road heavy equipment.

Let's turn now to Slide #6 titled Q3 Margin Increase. Overall, Gibraltar's operational performance improved compared to expectation for the quarter. Adjusted gross margin was up 20 basis points year-over-year to 19.9%. The increase was driven by residential and low-rise building construction, which approximated a 10% growth rate, plus the contributions from our recently acquired businesses. These contributions are partly offset by lower pricing and volume in our industrial business.

With the improvement in SG&A as a percent of sales noted on Slide 6, which was the result of lower operating expense, the adjusted operating margin also increased, rising 60 basis points versus Q3 of 2012. To sum up, our business fundamentals continue to be solid and we're poised to deliver better performance if the macroeconomic conditions improve in the periods ahead.

With that, I'll turn the call over to Ken.

Kenneth W. Smith

Thanks, Henning, and good morning. Before I comment on Slide 7, I want to provide some color to the noncash asset impairment charge we recorded in our GAAP results this quarter. The charge primarily relates to our sole European business that sells fabricated expanded metal products into a variety of industrial markets across Europe. The European recession, accelerated by sovereign debt issues and governmental austerity measures, has contracted economies there and has diminished the sales and cash flows generated by our European business. After updating the fair value of our European industrial business based on expected future cash flows, we wrote down that business intangibles this quarter.

Now let's turn to Slide #7 titled Year-over-year Performance. First I'll detail the third quarter results and comparisons. For the third quarter, revenues increased on acquisition-related growth while businesses we owned in both quarters experienced a 1% decrease in revenues. Company-wide, the 1% organic decrease was comprised of a 3% decrease in pricing, partially offset by a 2% increase in volume. The pricing pressure is primarily related to sales of our industrial products, as Henning noted. Sales of industrial -- of residential products increased 6% organically compared to Q3 of last year, net of volume gains from residential new construction and residential repair and remodeling volume that was equivalent to last year.

Regarding the factors affecting margins and earnings as cited by Brian and Henning, the following reconciles our nearly 30% EPS improvement from last year's adjusted EPS of $0.24 to $0.31 this quarter, with the key differences being a $0.04 increase from lower operating cost; plus a $0.02 increase from the recent acquisitions; plus a $0.01 increase from residential new construction volume; plus $0.02 improvement on lower interest expense resulting from our successful refinancing of notes in January of 2013; and a $0.01 increase from the lower income tax rate. And these 5 increases we're partially offset by 1 factor, that being a $0.03 decline on industrial products pricing and corresponding margin.

Compared to our August 1 guidance for Q3, the unexpected earnings improvement that resulted in the higher $0.31 of adjusted EPS came from lower operating expenses for health claims and compensation costs, and the lower income tax rate due to discrete tax events this quarter.

Now I'll describe the first 9 months results and comparisons on Slide 7. Revenues for the first 9 months were up 3%, with again acquisition-related growth providing 7 percentage points. Businesses we owned in both periods experienced a 4% decrease, which was comprised primarily of decreased pricing and sales of our industrial products. However, sales of residential products increased slightly the net effective growth in residential new construction, more than offsetting a small decline in residential repair and remodeling.

Regarding the factors affecting margins and earnings for the first 9 months, the following reconciles last year's $0.61 per share to the $0.61 this year with the key differences being, an $0.11 increase by our more efficient West Coast residential business; plus a $0.06 increase from the recent acquisitions; plus a $0.02 net increase from residential and low-rise buildings and new construction; and a $0.05 increase on lower interest expense resulting from the refinancing of notes earlier this year.

And these 4 improvements were offset primarily by the following 3 factors: an $0.11 -- I'm sorry, a $0.17 decline from industrial pricing and corresponding margin; a $0.06 per share decrease on higher equity-based compensation tied to our average higher stock price this year; and a $0.01 decrease from a small change in the year-to-date income tax rate.

I'll now turn to Slide #8 titled Free Cash Flow. We generated cash in the first 9 months of 2013 and there was an improvement over last year, which came from higher cash earnings plus less paydown on liabilities. Our free cash flow for the first 9 months of 2013 was nearly 5% of net sales, in my opinion, a strong performance that we anticipate will continue through the fourth quarter as we enter our slowest period of seasonality and reduce our working capital investment accordingly. In addition to the strong free cash flow generated so far this year, we also received this quarter an additional $12 million from cash -- of cash from the sale of one of our larger manufacturing plants located in California. This transaction was a result of the restructuring efforts put in place by our team on the West Coast over the past years and will allow us to further reduce our cost going forward. Days of net working capital for the third quarter 2013 continue to be low at 64 days and this compares favorably to 65 days of net working capital in the third quarter last year. And we believe this shortened cash conversion time is sustainable in periods of higher economic growth, which lies ahead.

Now Slide #9 titled Guidance. The fourth quarter is historically the slowest sales volume during the year, as colder weather reduces construction activity. Regarding the fourth quarter 2013, we expect revenue to rise approximately 8% compared to last year with the majority of that increase coming from recent acquisitions while organic revenues are expected to increase on higher residential construction activity compared to last year. Concerning the fourth quarter adjusted EPS from continuing operations, we expect it will be equivalent to last year's $0.05 per share as continued improvement in residential and new construction and lower interest expense are expected to be counterbalanced by continued weakness and demand along with competitive pressures in our Industrial business. Concerning our guidance for the full year 2013 listed on Slide 9, we now expect that Gibraltar will deliver modest sales growth in 2013 with equivalent margins of earnings compared to last year, bringing us to full year 2013 revenue growth approximating 4.5%. We expect adjusted gross margin for the full year to approximately 19%, unchanged from our prior guidance.

Regarding our SG&A expense for the full year, we expect it to approximate 13.3% of revenues. And while not shown on Slide 10, we continue to expect adjusted net interest expense to approximate $15.5 million for this year and the adjusted effective income tax rate to approximate 37%. With that detail, we expect adjusted earnings per share from continuing ops this year to be in the range of $0.63 to $0.66, which is equivalent to the $0.65 generated during the full year of 2012.

Now on Slide 10 titled EPS Guidance. Our now expected adjusted EPS for 2013 brackets the upper end of the range we provided you on our last earnings call of August 1. The most significant change in our improved expectations relates to our third quarter overperformance, which raised our year-to-date results.

Regarding end markets, we expect residential, repair and remodeling demand to have modest growth in the fourth quarter, complementing continuing strength in residential new construction. Longer-term, when we see a more broad-based end market rebound, as we believe we will, Gibraltar is well positioned to deliver more significant improvement on both the top and bottom lines.

With that, I'll turn the call back to Brian for his concluding remarks.

Brian J. Lipke

Think you, Ken. Before we open the call to your questions, I wanted to talk about the outlook for Q4 and the quarters ahead. We continue to focus on organic growth opportunities, which will consume some of our approximate $200 million to $300 million of available manufacturing capacity as a key to our growth. We're continuing to be aggressive at driving organic growth and we feel good about our prospects in this area. In the residential repair and remodeling sector, we're not expecting significant improvement in Q4, but 2014 is shaping up to be a stronger year than 2013. Although the recovery and big-ticket remodeling has taken longer to materialize than we had anticipated, the latest published reports suggest that conditions may finally be improving. Harvard's Joint Center for Housing Studies index, leading indicator of remodeling activity, is dramatically up from where it was a year ago. The joint center's economists said in September that remodeling contractors have been reporting improving market conditions and are seeing strength in the future market indicators.

Pent-up demand is 1 factor. It's been 6 years since the housing collapse and the home maintenance projects can only be deferred for so long. In addition, recent homebuyers are traditionally the most active home remodelers and this year's strength in existing home sales is beginning to translate into stronger sales of home improvement products.

Given these dynamics, the LIRA index is projecting continued strengthening of the repair and remodeling market through the end of 2013 and into the first half of 2014. We remain optimistic about the outlook for new residential construction. Housing appears to be in the midst of a long-term recovery. The current reports on permits, seasonally adjusted starts and new home sales suggest that residential new build has lost some momentum recently. We believe this is in large part due to the rise in home prices and mortgage interest rates this past summer.

The industry and its observers see this as a temporary slowdown, however, and our order flow for residential products suggest that they're right. After a slow start to the year, we are now seeing more new home building projects annually, actually being started, and our distributors also are gaining confidence in the recovery. We expect this trend to continue into the fourth quarter and into next years.

The outlook in commercial new construction also appears to be favorable. The American Institute of Architects' Architectural Building (sic) [Billings] Index or ABI for the month of September was 54.3, up from 53.8 in August. Accordingly, this means that business conditions at architectural firms have been steadily improving over the past year. This improvement signals an impending [indiscernible] in nonresidential construction activity.

In light of these dynamics, for 2014, we anticipate 10% to 15% year-over-year growth in the residential and low-rise commercial new construction sector.

We're leveraging the momentum in both the new construction and the repair and remodeling markets, residential, as well as commercial, by aggressively launching new and modified products for the building industry. Products that we developed organically, as well as by acquisition.

Last quarter, I talked about the growth of package deliveries as consumers continue to order more and more over the Internet. Gibraltar is focused on providing solutions to this growing need. One example of our efforts in this area include a new secured delivery solution we've introduced for apartments and condominiums that eliminates the need to have someone at the front desk to handle parcel deliveries. This is one of a long line of new product initiatives being undertaken.

Parallel with that, we're developing a suite of new products that align with the U.S. Postal Service strategy to take costs out of their business, which creates numerous growth opportunities for Gibraltar.

In the residential and low-rise commercial sector, we introduced one of the most innovative products in years during the third quarter, a product that's gaining traction for us. It's a new type of roof jack. A roof jack is the metal device that prevents rainwater from leaking around the plumbing and heating vent pipes that protrude up through a shingled roof. The difference between this new roof jack and conventional products is that ours is articulating, meaning that a single design can be installed regardless of what the pitch of the roof is. This makes it easier for builders and contractors to manage their inventories and it's been extremely well received in both of these communities as a result.

In our construction products business, despite the slowdown in Q3, we're continuing to anticipate solid performance going forward and the Infrastructure business we acquired in Q4 last year is making a solid contribution.

Most importantly, the underlying need to repair and upgrade the nation's aging bridges and highways is as compelling as ever. This is a crucial responsibility for the states, as well as Washington, D.C. State governments are recognizing the transportation infrastructure problems that they're facing are becoming more acute. As a result, we're seeing a growing number of them beginning to focus on ways to generate new tax revenue at the state level, specifically for infrastructure projects over and above funds coming from the federal government, which bodes well for this part of our business.

In our industrial markets, we're anticipating a continuation of near-term challenges. While volume is flat compared to 2012, we expect our industrial sales to be down 6% organically for the full year 2013 versus 2012, which takes into account the 7% organic sales contraction in the first 9 months of 2013 compared with the first 9 months of 2012.

Including acquisitions, we now continue to expect our company-wide industrial sales for 2013 to increase 2% year-over-year. Longer-term, we're well positioned for eventual recovery in industrial demand and prospects for that recovery appear to be improving. The Institute for Supply Management Purchasing Managers Index or PMI for September marked its highest reading for the year, with 11 of 18 manufacturing industries reporting growth.

Comments from the supply executive survey were generally positive and optimistic about increasing demand and improving business conditions.

We're seeing similar optimism anecdotally in discussions with our major customers, which is another positive indicator for 2014.

Our sales growth for the first 9 months of 2013 have been driven to a large extent by our recent acquisitions, so I want to comment on our position relative to acquisitions. Acquisitions will continue to be a factor in our growth initiatives. With our strong balance sheet, positive cash position, improved liquidity and positive cash flow generation, we're in a good position to participate in the acquisition arena. We're continuing to look for acquisitions that meet the disciplined criteria that we've developed. Key to these criteria are to improve our return on invested capital, improving our margins while providing new organic growth opportunities.

Our focus is to acquire companies that build on our existing product leadership positions where possible or companies that allow us to establish new product leadership positions in new product areas.

In the case of the 4 most recent acquisitions, each, while smaller in size, have all met our key acquisition criteria. We feel good about our ability to identify, assess and integrate new businesses to drive return improvement, margin expansion and provide organic growth opportunities.

Summing up, looking across all of our markets, we believe the prospects today are better than they were a year ago. With the operational improvement we've made this past year, we have stronger capabilities to capitalize on the improvement in end market activity that we expect we will see unfolding. We look forward to finishing 2013 as strong as possible and improving on this record in 2014.

At this point, we'll open the call to any questions that any of you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Peter Lisnic from Robert W. Baird.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

This is Josh Chan filling in for Pete. I have a question on the industrial pricing pressure that you noted. If we just focus on the industrial side, could you tell us how much pricing was down in that particular vertical? And then also, did it get worse compared to just the second quarter?

Kenneth W. Smith

It was down approximately 4% in the third quarter, I'm sorry, on the third quarter. And it was largely eased on the second quarter.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

I'm sorry, did you say it was down a little bit from the second quarter as well?

Kenneth W. Smith

Yes.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then -- so how are you thinking about industrial pricing heading into the fourth quarter and next year? I mean, steel prices have bounced off the bottom a little bit, so is that going to be a benefit in terms of firming up the price or how are you thinking about industrial pricing going forward?

Brian J. Lipke

As I noted in my prepared remarks, we believe that for the near term, that we will continue to face pricing pressure. However, more importantly, the decline in sales and operating margins in that part of our business is simply not acceptable, and we have worked very hard with the managers of that business to come up with a significant series of internal operating initiatives that we hope and believe will counter the downward margin pressures that we've experienced this year to a very large extent. So in short, let me say that in a positive sense, we're expecting that even with continued pricing pressure in the industrial market that our internal activities are going to offset a significant part of that as we move into 2014.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Okay, that's encouraging to hear. On the -- and the repair and remodel market being flat for you, how are you thinking about that comparison versus the market, I guess, many building products manufacturers have been seeing somewhat accelerating growth in recent quarters and, obviously, your products aren't comparable to the broader market in general, but could you help us sort of understand that gap between this accelerating growth that some are seeing in a relatively flat comparison still here?

Brian J. Lipke

Sure can. When we talk about repair and remodeling, we include in that, our roofing products because a substantial amount of those are used in reroofing activity, which we consider to be repair and remodeling activity. If you follow the roofing industry stats this year, you'll note, as Henning mentioned, that they are -- that part of the remodeling industry is experiencing a downturn compared to where it was in 2012. More -- far more significant, though, than the downturn that we're experiencing in those products. So that has been an offset to some of the other business areas that we're involved in, which have actually seen improvements in their sales of products that go to the residential repair and remodeling marketplace other than roofing related.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Okay. I guess, if you take out sort of the ventilation business, is there a way that you can ballpark for us, maybe how fast the rest of the repair and remodel business is growing so we can sort of see the...

Henning N. Kornbrekke

We think the repair and remodel is going to grow probably at high single-digit rates as we go into '14 and we think that will accelerate as you move through '14. As Brian indicated, agrees with the data we're getting from LIRA. I think LIRA is looking at double-digit growth and certainly you would correlate to high single-digit into low double-digit growth.

Operator

[Operator Instructions] Our next question comes from Robert Kelly from Sidoti & Company.

Robert J. Kelly - Sidoti & Company, LLC

Just a point of clarification on the previous caller's question. I think you answered his question that pricing for industrial was down sequentially from 2Q? Is that correct?

Kenneth W. Smith

Yes, I did.

Robert J. Kelly - Sidoti & Company, LLC

So selling prices were down sequentially. So...

Kenneth W. Smith

No, no. The effect of pricing being down lessened in the third quarter.

Brian J. Lipke

[indiscernible] stabilize.

Robert J. Kelly - Sidoti & Company, LLC

Yes, that's what I wanted to kind of reconcile because in your Q2 transcript, you said that there was an $0.08 year-over-year drag from industrial pricing in margins, and this quarter it's a $0.03 drag. So is the comp just easier or you're just seeing some stability in the demand trend and the pricing trend?

Henning N. Kornbrekke

There is some stability going forward, and the fact that, I think we indicated -- I think all of us did, that there's some upward momentum as we move through the fourth quarter into the first quarter. So we're starting to see signs that are encouraging.

Robert J. Kelly - Sidoti & Company, LLC

Upward momentum with respect to volume or pricing for industrial?

Henning N. Kornbrekke

Both. Both.

Robert J. Kelly - Sidoti & Company, LLC

Okay. As far as the steps that you're taking internally to kind of offset...

Brian J. Lipke

One last, one last comment on top of that. I'm a believer that because the demand is so low that we're seeing more price competition, as demand increases, I think we'll see that abate -- diminish as demand increases. I think also tied to that is as demand increases that should provide greater stability and upward mobility for steel prices, which also help us raise our selling prices.

Robert J. Kelly - Sidoti & Company, LLC

Sure. Sure. So a self-reinforcing sort of scenario.

Brian J. Lipke

Exactly. Exactly.

Robert J. Kelly - Sidoti & Company, LLC

As far as the steps that you're taking to address what could be -- I mean, assuming that pricing and demand remains weak into '14, you talked about internal steps that you take. What are those exactly? Have they been taken or do you plan on taking them in 4Q?

Henning N. Kornbrekke

Well, it's an ongoing project. We're looking very closely at the business, we're restructuring the business so that it can be competitive in the environment that exists today, and as we complete that restructuring, the business will improve its output as we go into 2014. So we expect the operating characteristics to get stronger, that's where we're positioning the company going forward.

Brian J. Lipke

A little more color on that is that we have been involved in consolidation activities in that part of our business and a couple of the steps that we've taken actually resulted in disruptions in the yields that we were getting from raw material. We are aggressively working on that. We think we have the majority of that behind us and that should contribute in a meaningful way to better returns in that business.

Robert J. Kelly - Sidoti & Company, LLC

Okay, all right. So in the slide that you've given us for 3Q, you talked about industrial being a 40 basis point drag on operating margins in 3Q, right?

Henning N. Kornbrekke

Right.

Robert J. Kelly - Sidoti & Company, LLC

So as we hit 4Q, given the steps you've taken and given the stability in pricing, should that number decline, should it be less than 40 basis points in 4Q? And at what point does it become kind of a neutral drag just given the steps you're taking internally?

Henning N. Kornbrekke

I think it's going to be neutral in the fourth quarter and I think it will improve as we go into the front part of 2014, because don't forget, we're moving into a slower period. It's a seasonally slower period and as we move out of that and you get the natural pickup through the first 2 quarters of the year, the improvements that Brian just described will continue to have more of an impact -- a meaningful impact that will eventually correlate to improvements you'll see on the P&L.

Robert J. Kelly - Sidoti & Company, LLC

Okay. So just tying that back to the fact that you see res remodel and new construction fundamentals improving, the mix of acquisitions getting better and Industrial being neutral to EBIT in 4Q, why do you see flat earnings year-over-year in 4Q?

Brian J. Lipke

The fourth quarter is always a wildcard. Different companies make year-end determinations on inventory levels, and as a result, it's always difficult for us to project what's going on there.

Robert J. Kelly - Sidoti & Company, LLC

Okay. So just kind of tend to be conservative.

Kenneth W. Smith

We also have in our transportation infrastructure business, some of the large projects that get shipped in the second half of 2012, are not in our backlog currently to the degree they were last year. So we'll have a bit lower earnings coming out of our infrastructure business in the fourth quarter compared to the prior year's quarter, as one example.

Henning N. Kornbrekke

Yes, the timing becomes a big issue, particularly with some of our businesses. If things go the right way, they might all close in the fourth quarter, in which case they will overproduce and if not they'll get shifted into the first quarter. It's hard -- as Brian said, it's harder to predict at this point.

Robert J. Kelly - Sidoti & Company, LLC

No, understood. There's a lot of moving pieces but it just seems like a trend for -- 90% of your business is moving up, just given the commentary.

Henning N. Kornbrekke

Yes.

Robert J. Kelly - Sidoti & Company, LLC

So having said all that, running out into 2014 a similar scenario, would 2014 be the year we start to see the incremental operating leverage you talked about in the past, 30% being your bogey for incremental operating margins? Should we start to see that show up in 2014, based on what you're seeing here in 3Q into 4Q?

Henning N. Kornbrekke

Yes. We believe we'll see improved -- based on everything we've told you so far, our expectation is improved gross margins as we go into 2014. We think that will correlate with the improvements we just discussed in the Industrial business. We continue to see the improvements that we had said that we hoped to see in the West Coast business, that's continued to perform just about as expected and we think that will continue into 2014. So I think when you put all of the pieces together, you'll start to see the expected improved operating characteristics that we've been describing for the last, probably 2 years.

Kenneth W. Smith

And most of the revenue growth being from the increased volume that we'll take across the cost structure that we have. So I -- just to supplement in agreement with what Henning just said.

Robert J. Kelly - Sidoti & Company, LLC

Okay, fair enough. And then just as far as the Industrial market, I'm sorry, the infrastructure market, it seems like the reauthorization of the highway bill, the changes to the federal credit program, that seems to be a pretty big catalyst for state-level spending at least in the next 2 years. I mean, are you hearing -- I know it's not showing up in your backlog just yet, but are you hearing that commentary and sentiment from the infrastructure customers that you're dealing with?

Henning N. Kornbrekke

It is. And I think it varies by state. I think when we look at different [ph] analysis, we have a different mix of products this year than we had the previous year. And Ken had described, we have more smaller projects and fewer bigger projects. I think that based on, I think, what we're looking at, I think we would expect a more leveling of the project activity. We'll have a greater portion of larger projects. We continue to do well in the smaller varying projects that we've been involved with.

Brian J. Lipke

I'd back up 1 step from what Henning just said and mention that the need for bridge and highway repairs and maintenance is more acute than ever. I'd also mention that the states now are recognizing that they have to come up with ways to raise revenue to augment what they're getting from the federal government to catch up with the needed repairs to bridges in various and different states. I've personally seen a number of bridges -- older bridges where -- in more rural areas, where they've actually reduced the traffic flow to 1 lane at a time because of the structural deficiencies on some of those bridges. So the states are recognizing that the need is getting increasingly more acute and our -- we've read several articles recently about states looking at different ways to raise additional revenue to fund bridge and road repairs. So the need is clearly there, and I think the recognition, particularly at the state level, that money needs to be spent is registering and they're looking for ways to come up with [indiscernible] increase tax revenues.

Henning N. Kornbrekke

I think a lot of [indiscernible] -- a lot of them have set up agencies to pay for those, if you look at the Verrazano Bridge, that's really funded by the port authority, and the port authority also funds the Whitestone Bridge [indiscernible] the Tappan Zee Bridge is funded by the New York State Thruway Authority, which is also self-funded and we're seeing more of those types of situations just across the nation.

Brian J. Lipke

We're very positive on that business on a long-term perspective.

Henning N. Kornbrekke

Yes.

Operator

Our next question comes from Matthew Dodson from JWest LLC.

Matthew Dodson

Kind of hit on your infrastructure again. Can you talk about, if you're seeing an increase in biddings? And then if the TIFIA really comes through, when would you see that orders come to you in 2014?

Brian J. Lipke

It's a good question. Generally from the start of the bidding process to the time that we begin shipping orders, can be up -- for major projects, can be well in excess of a year or more. In fact, I'm trying to think which major bridge project, we actually -- we shipped products over a 3-year period of time, the Golden Gate Bridge. But -- so there's a delay from when funding becomes available and when actual products get shipped. So it's all moving in a positive direction but there is a timing delay in all of that. Actually it was the Oakland Bay Bridge that we shipped products over 3 years, sorry. As far as bidding activity goes, we've seen a steady rate...

Henning N. Kornbrekke

There's actually only a few select suppliers for the types of products that we make, and so the bidding activity has been fairly normal and we wouldn't expect that to change. I mean, it's a small segment of the market that we participate in and we are well represented in that segment of the market.

Brian J. Lipke

I'd like to add too, we didn't mention this in our prepared remarks, but we have a joint venture that we've established with a Chinese manufacturer to produce some of our products in their facility and we recently shipped our first projects through that joint venture to Mexico, just about a month ago. This -- having a facility in China is going to put us closer to the Chinese markets and the fact that we're in a joint venture with a Chinese company, we expect will help us penetrate to a greater extent, not only the Chinese market but also the market overall in that part of the world.

Henning N. Kornbrekke

Yes. The Asian market is growing. And now that we've got presence there, we expect to grow with that market.

Brian J. Lipke

And actually just a little more color on that. In 2012, I don't have the numbers for 2013 yet. We shipped infrastructure projects to 16 different countries around the world. So clearly, our technology, our designs and our competitive position allow us to go far afield from the United States.

Matthew Dodson

To frame that up, would you expect you would start delivering more on these projects in 2014 or do you expect to bid on more projects in the United States in 2014 or is it a combination of both?

Brian J. Lipke

Both.

Operator

At this time, we have no further questions. I would like to turn the call back over to Brian Lipke for closing comments.

Brian J. Lipke

Thank you, operator, and thanks to everyone for listening in our call today. We're going to be out on the road attending conferences and doing non-deal roadshows over the course of the year, so we look forward to seeing many of you during those trips. And we'll be speaking with you about our fourth quarter earnings results on February 20 of 2014. We look forward to speaking with you then. Thank you.

Operator

Ladies and gentlemen, thank you very much for your participation in today's conference call. You may disconnect. Have a wonderful day.

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