Regal Beloit Management Presents at 2011 Investors and Analysts Conference - Event Transcript

| About: Regal Beloit (RBC)

Regal Beloit Corporation (NYSE:RBC)

Company Conference Call

December 6, 2011 8:30 am ET


Mark Gliebe – President, Chief Executive Officer

Chuck Hinrichs – Chief Financial Officer

John Schlemmer – Chief Operating Officer

Scott Brown – Vice President, Manufacturing

Mike Wickiser – Vice President, Commercial and Industrial

Paul Goldman – Vice President, HVAC

Steve O’Brien – Vice President, Pump and General Industry

John Perino – Vice President, Investor Relations

John Perino

Good morning everyone. I’m John Perino, Vice President of Investor Relations, and thank you for joining us for the 2011 Regal Beloit Investor and Analyst Day. Before turning the presentation over to Mark, I just wanted to mention what was in your packets. Inside your packet is a small disc which contains the entire presentation on it. When you load the disc into your computer, if you could put logo up, it fits correctly that way. Also, if I could ask you to turn your cellphones off to avoid interruption or turn them on mute, please.

And before turning the conference over to Mark, I’d like to remind you that the statements made in this conference 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 those factors that could cause actual results to differ materially from projected results, please refer to our previous filings with the SEC.

During this conference, we will mention that we are presenting certain non-GAAP financial measures. We believe these are useful measures for providing you with additional insight into our operating performance. You can find a reconciliation of these measures to the most comparable measures in accordance with GAAP in the appendix to this presentation and on our website.

Now I’ll turn the call over to Mark. Thank you.

Mark Gliebe

Good morning everyone and thank you so much for being here and joining us this morning. It’s great to have you all here and we really genuinely appreciate your interest in the company. We have a great day set up for you today and a chance to expose our deep bench, our management team; and this year, a special added addition, we get to have some of the management team from the recent acquisition of A.O. Smith. Those folks are here with us today and you’ll get a chance to talk to them and hear yourself what the experience has been like joining the company.

So first I’ll start off with just a little discussion about our leadership team and who you’re going to be hearing from today. This is our organization at the top with my direct reports showing at the top, and then John Schlemmer, who is the COO of the Company, his team right below that. So today, Chuck Hinrichs, our CFO, will be speaking to you; John Schlemmer, our Chief Operating Officer. Sarah Sutton – Sarah, if you can raise your hand – Sarah is the former CFO of EPC and today she is Vice President of Financial Planning and Analysis. Scott Brown, Vice President of Manufacturing, and Scott is one of the two key leaders in the integration process. Mike Wickiser, Vice President of our commercial and industrial business; Paul Goldman, Vice President of our HVAC business, and Steve O’Brien, who is the Vice President of Pump and General Industry business. And again, Steve O’Brien also came from the EPC transaction and Steve was the other half to the two-part team that has been leading the integration process of EPC into the Company. So you’ll be able to get to hear from both of those individuals today and I think you’ll really enjoy the experience that we’ve all been going through.

For those of you that are not familiar with the Company, just very briefly as we go into next year on a pro forma basis, the Company will be 3 billion-plus in revenues – quite a change over the last number of years. We have roughly 25,800 employees and you see a comment up there that there’s four CEOs, and I have to apologize – somebody actually asked the question, do you mean you have four CEOs running the Company? So that’s not the case. The point is that the Company is roughly 56 years old and in that span of time, we’ve had four CEOs and I am the fourth CEO. Just last year, Henry Knueppel, as many of you know, was up here, and Henry has retired since May.

Over the last seven years, the Company has been growing at an average annual growth rate of 24%, and in that same seven-year period total shareholder return in that time frame was 142% - so pretty good and consistent performance throughout the past seven years.

In terms of the products that we sell, you can see we manufacture electric motors, the small motors that literally fit in the palm of your hand or would be the size of a large toaster; large motors that would be as tall as this room and the size of two of these tables put together. We manufacture blowers that use a motor but move air. Generators – and Mike will talk about the range of generators that generate power. Our mechanical gear drive business, our electronic drives business, and then a number of other electrical products.

In terms of our footprint and where we make our product, you can see we’re global in terms of our footprint. Over 75% of our product is made outside of the U.S. in places like Mexico and Asia. So today, if you just stop and say how would you describe the company, we’re a solid, midcap diversified industrial, truly a global manufacturer. We do use Lean Six Sigma as our continuous improvement platform, and for those of you that have had a chance to go our Wausau facility on a recent visit, I’ve gotten some of the feedback and it’s the same experience that I’ve had, which is as you walk into the facility, you just don’t recognize it from what it looked like just a few years ago. And that’s true about many of our facilities – we’re on the Lean journey and it makes a significant difference in the performance of our manufacturing facilities, so we’re very excited about the direction there.

We’re a company innovating around energy efficiency. We continue to see even through the short-term blips with R22 and some of the stuff going on there, we still see long-term energy efficiency as a long-term secular trend that plays well for our company. We are a leader in energy efficiency technology and electric motors continue to consume a big portion of the power that is generated on this earth, so to the extent that you have that technology, no matter where you’re at in the world, it plays well for us.

We have been and will continue to be a consistent and successful acquirer. Obviously the EPC transaction that we closed back in August, the largest acquisition in the Company’s history. And as you acquire, you get the opportunity to get great talent, and you’re going to get a chance today to meet some of that great talent. They’ll be up here talking to you.

Here is another just quick view of the pictures of the products that we manufacture – again, the range of electric motors on the left, the range of electric generators in the second column, our custom electronic drives, and then our power transmission or mechanical products.

If you look at the Company from just an overall model perspective, we’re well balanced, we’re well diversified, and we’re performing quite well when you compare us to peers. I showed you earlier our production by geography. Here’s a look at our revenues by geography – roughly 68% of our sales in the U.S., the rest outside of the U.S. Our goal over time, as we’ll talk about later, is to make it 50/50 – 50 in the U.S., 50 outside of the U.S. In terms of where we sell our product, we’re pretty diversified in our footprint which allows us to get through the kind of difficult times we’re seeing in the housing industry and still perform well. We have a pretty good split between commercial, industrial and residential.

Similarly, we have a good mixture of businesses that are either in early, mid or late cycle businesses. Obviously the residential-related businesses would be in the early cycle. Our commercial and industrial businesses tend to be mid cycle; our mechanical and then very large motor businesses tend to be late cycle.

And then over on the far right if you take a look at just our five-year EPS kegger and we compare ourselves to some pretty respected companies there, you can see that we kind of hang right in there from a growth rate around earnings per share. Similarly as you look at the next slide, again we’re comparing ourselves here where the dark blue and the light blue is a very respected peer group, including Danaher, Roper, AmoTech and three or four others, but we have performed well over the last seven years as you look at total shareholder return. So we like to say that we’re keeping up with some very good talent there.

Our third quarter, just as a snapshot, was a very good quarter. We exceeded our own expectations. We felt good about the way the quarter closed on virtually all key metrics, whether it be EPS, revenue growth, our operating margins on an adjusted basis were up and our free cash flow has been performing quite well, so it was a great quarter. We felt good about it as we head into the end of the year.

As we look back at 2011, it was a great year in terms of the Company’s performance. We’ll close the year with record sales of 2.8 billion-plus. From an adjusted earnings perspective, our operating profit will be 290 million-plus, and our EPS given our last guidance will be somewhere between $4.31 and $4.37, again a record for the Company. Our price capture throughout the year exceeded inflation. We felt very good about that. We had some catch-up to do as we left 2010. In 2010, we had given up more on the inflation side than we captured on price. In 2011, we gained some of that back and we had two price increases, one in late 2010, one in first quarter 2011, and felt very good on the fact that those price increases stuck and we were able to, like I said, outpace the inflation.

We closed the EPC acquisition finally after 259 days of trying to get through that process. That closed in late August and, like I said, it’s the largest acquisition in the Company’s history, and rather than stealing the other team’s thunder, they’re going to talk all about it and explain how it’s going.

We’ll launch 50 new products this year and you saw a flavor of those in the product showcase room. If you didn’t go back there, either on your break or at lunch, please feel free to go back and the team will answer any questions you have. But some great new products and some exciting ones that I think you’ll share our excitement over them.

We restructured our debt, locking in long-term attractive interest rates. The cash flow of the Company is doing quite well. It’s going to allow us to pay down the debt for our EPC acquisition and in very short order and allow us to continue to fund other acquisitions. That cash flow is again expected to be greater than 100%. That is our internal target to always have cash flow greater than 100% of net income, and we believe we’ll do that this year.

If you think about a year ago, for those of you that were here, we talked to you about a refreshed set of initiatives for the Company and we talked in great detail on how we were going to try to focus on improving our customer care scores. We made that the number one initiative in the Company and we actually hold ourselves accountable to our Board on our performance around quality delivery and net promoter score. For those of you that aren’t familiar with that concept, net promoter score is a commonly known surveying tool to measure how a customer feels about you, and so we’ve been using that now for five or six years and I’m proud to say that we improved our net promoter scores this year and it’s going in the right direction. So the team is very rallied around customer care all throughout the Company.

So for today, just a quick look at our agenda, Scott Brown is going to come up and talk to you about the RBC EPC integration, and just a very short story – as soon as we had made the decision and as soon as A.O. Smith had accepted our final offer to acquire EPC business, Scott Brown, who you’ll meet, came to me and said, I want to lead the integration. So when you have a guy like that step up, you just can’t help but feel very excited about having that kind of talent on your team and that kind of initiative. Similarly, Steve O’Brien made the same comment to Chris Mapes, who was the former leader of the EPC business. So two great talents here who you’re going to hear from. These two guys met each other for the first time about a year ago and they’ve just been knocking it out of the park in terms of our integration. Sarah Sutton is also here and I encourage you to ask Sarah your own questions about how the integration is going overall. She’ll give you an interesting view on the whole experience.

Paul Goldman is going to talk about our HVAC business and our air moving business. Mike Wickiser is going to touch on our global commercial and industrial business. He’s going to give you a global perspective that is a business that while we have it broken up internally, we act globally from that perspective. Chuck’s going to talk about the financials, and then John Schlemmer is going to come back and give you an overall wrap-up and talk a little bit about the operations.

We’ll have Q&A at the end but we’ll also have time for Q&A—about five minutes of Q&A after every presentation, so if you have questions right at the end of each presentation, we’ll have about five minutes and we’ll take your questions then. And then at the end, we’ll come back and have another opportunity.

There will be the opportunity for those of you that would like to stay for lunch, you’re welcome to. Management will be here to have lunch with you if you’d like to just sit down and do that. So get ready for a great day. We’re excited to be here and, again, thanks for your interest.

Now, I’d like to introduce Scott Brown.

Scott Brown

Thank you, Mark. Good morning everyone. It’s a pleasure to be here. As Mark said, the EPC acquisition is the biggest acquisition that Regal Beloit has ever made and really critical to our success. And part of why I volunteered to be part of it, I wanted to be right in the middle of the action there. I knew there was going to be a lot of parts to it related to manufacturing, so naturally I was going to be there because it’s so important for the Company. I wanted to make sure that it was a success, and I’ve really enjoyed working with Steve O’Brien from EPC. He’s got a lot of experience and he ran some businesses inside EPC, and a very successful leader there. We’re having lots of fun and we’ll take you through how things are going so far.

True to our Lean Six Sigma kind of headset, we decided that we have to measure success in the integration in measurable ways, so we developed these three areas. We call them the Key Performance Indicators – KPIs – and it starts first with customer retention. So we had a goal to not lose a single EPC customer account. As well, we wanted to retain 100% of the EPC business. Now, we’re trying to grow the business as well and we have growth opportunities all over, and later on I’ll talk about some synergy targets and synergy goals that we’re driving for. I did not include those growth initiatives. We’re looking at the growth initiatives as on top of all of this, and we do have a healthy deck of growth initiatives, but our goal here is to net out have zero lost business from EPC as a result of the integration.

On the talent front, we’re measuring—we have an HR team that is very focused on looking if we lose anybody in the company from Regal Beloit or EPC, whether we lost that talent due to the integration, and we go through a pretty rigorous exercise of staying close to that and our goal is to not lose anybody through the integration in Regal Beloit or with EPC. And then we have, of course, the synergies that we want to capture that we committed at the time of the deal. So I’ll take you through how we’re doing on these three fronts.

To avoid becoming internally focused, the first thing we thought we should do is actually go out and see what’s on our customer’s minds about the integration. So we did that two ways, and we also thought that was great way to introduce actually customer care, which is a strategic initiative with Regal Beloit to all these new EPC employees. So we did it two ways – one at a kind of personal level at our largest accounts. We have over 30 very large accounts that we had executive one-on-one meetings to see what their thoughts are and what they would like to see come out of the integration, and then we used an established Regal Beloit customer survey tool that we’d been using for years to reach out to over 4,000 of EPC’s customer contacts and get their feedback. Overall, it was encouraging, the feedback. There are some things for us absolutely to work on. In general, a couple of comments – for the distribution customers, they told us that they liked the EPC model. They thought it was working well and would like us to figure out how to continue to spread that, and then with the larger OEMs, Regal Beloit has got much more experience. The larger OEMs, we’re hoping that Regal Beloit could share some of our best practices with the EPC teams.

So armed with that feedback from customer, we molded that into how we looked at any organization changes that we were going to make and also how we looked at the integration plans; and I’m happy to say that we have not lost a single customer count. We have retained 100% of the business. I know it’s very early right now, so we’re not claiming victory, but we’re very focused in this area. In many integrations, if you don’t keep a focus here as you go after the synergies and other things, this could be very damaging and you don’t get the net gain out of the acquisition. So this is priority number one for us moving forward.

When we make an acquisition, one of the biggest things we’re acquiring is the talent and the people that actually run the company. And so we made a big deal of making sure that the EPC employees and teams really felt good about coming to Regal Beloit, and we sent a strong message that we loved to have them come to the company and we were really looking forward to it. So we made Day 1 to be a very big, special day, and we called it the Welcome Celebrations. And what did is all throughout the world – so in Mexico and China and the United States – we had all-employee meetings. We posted Regal Beloit leaders at all those different sites and played a DVD video for everybody through the all-employee meetings that have various locations all throughout Regal Beloit welcoming the EPC employees to the Company. There was a little bit of discussion by the leaders about what it’s like to work for Regal Beloit. We actually didn’t make a canned script for this. We let the Regal Beloit leaders just talk off the top of their heads about how they were feeling. There was a celebratory luncheon at the sites and just a good chance for everyone to try to get to know each other.

Many of us in Regal Beloit have come from acquisitions, so we know that at this stage, this early stage right after close, there’s a lot of basic things going through employees’ minds, and it’s stuff like will my payroll benefits change, is my job going to change, who I report to, will that change? So we made a point of spending a lot of time—Steve and I worked very closely through the pre-close period to try to clarify the organizations as much as possible. Now, we couldn’t do everything right at Day 1 because there were certain things that we weren’t allowed to talk and work on while the anti-trust evaluation was going on, but we ended up getting enough information that we could start launching organization charts by Day 2. And they started cascading every day after that, and we just feel that we brought this period of uncertainty that’s on everybody’s mind down to be a very small window, and we got an awful lot for that.

Then our IT and HR teams came through and just made an outstanding transfer of the payroll and benefits. This was one of our big and more complicated ones to do, and if anyone’s ever been part of one of these, they know all the detail that’s behind this. That just built a lot of trust and confidence with the EPC teams with the type of company that they were coming to. That picture you see right there is the EPC headquarters in Tipp City, Ohio, so that’s not Regal Beloit even though you see the Regal Beloit logo behind all the employees. They had taken down all of the A.O. Smith logos all throughout all their facilities worldwide –literally by Day 2, I would say they were all gone. And you have to understand, through our pre-close period, we weren’t exactly sure when close day was going to be, whether it was a very short period of lead time to notification of that, and so all this had to happen in three to four days. And while we encouraged the thought of doing that, the A.O. Smith employees took that upon themselves—the EPC employees, and had that all changed over to Regal Beloit. And that was very moving for us at Regal Beloit. It made us feel like a very warm welcome and we had not seen that in any of our other acquisitions to that extent, to happen that quickly. So that was very exciting for us, the teams that we were coming to work with.

Literally by Day 2, 3 and 4, we had all of the senior leadership at EPC and at Regal Beloit come to the headquarters in Beloit, Wisconsin, and we had a leadership orientation. We’ve done this before in acquisitions. We get better at it every single acquisitions as we go, and this was our best one. At that session, we taught the Regal Beloit compass operating system. Each of the P&L leaders gets to come up and talk about their businesses from EPC and from Regal Beloit, and talk about their plans, their business models, field questions from people. That helps get everybody kind of grounded. During pre-close, we couldn’t talk about that kind of information so we spent quite a bit of time on that.

We spent a lot of time being candid about our cultures, and we had a fairly long pre-close time, as Mark alluded to there earlier, so we got to know each other a little bit. We were very open talking about where our cultures are similar, where are we different, and where could be some pitfalls as we move forward, and how should we think about those in the integration plans. So it was an awesome three days. There were EPC leaders making testimonials at the end of those three days saying that they were now feeling part of being a Regal Beloit employee. So were talking Day 3 after close, people were having this feeling that I kind of feel more like a Regal Beloit employee at this point, so that made us feel very, very good that we were on the right road.

I’m happy to report that we only lost one EPC employee post-close, so that’s over thousands and thousands of employees. We know we can’t rest here, though. This is something that we’ve got to keep a focus on and we’ve got all of our teams very focused on it with the human resources teams.

The synergies are being captured on these three fronts, and this should not be a surprise that these are the main areas that we’re actually getting the savings. The sourcing team has a very, very strong deck and they’re executing on these opportunities as we speak, and the negotiations with our steel, copper, bearing –some of those larger commodities – are progressing just as we had hoped and are going well. The logistics teams came out of the blocks very, very strong and secured reduced transportation rates for us right away for all the different modes of transportation. That’s hitting the bottom line now. We’re also leveraging the Regal Beloit fleet. We have a fleet of trucks that covers about 20% of our shipments in North America where we feel that was a cost saving to keep our own fleet of trucks for that small segment of the transportation. And we’re leveraging that to in-source some of the partial shipment loads that EPC had, and we’re seeing some great savings there. And then the logistics team’s got a really exciting optimization of the footprint in North America when they look at the different transportation routes and they look at the warehouse layouts in North America that has promise to get us savings at the bottom line, also to serve our customers better. And so we’re very excited about that, and that’s coming soon for that to be launched.

In manufacturing, all about consolidating rooftops. We had some overlapping operations that we started focusing on, and some of these are kind of complex, some of these moves, but we sorted it out and we understand what we’ve got to get done in 2012, and we have project teams being launched focused on that. Besides these big moves, though, we actually have some great interactions happening between our plants. An example of that came up just the other day that I heard about is in China. Two of our plants in China – a Regal Beloit plant and an EPC plant – we had a technique in Regal Beloit where we could cut lamination steel and save a lot of scrap when we do that, but we had trouble in our plant with the skills and capabilities to be able to run that process consistently. EPC plant in China, they didn’t know about that process but they had people who know how to actually run the presses and things that were needed to run the process and get the savings, so the two plants got together. They saw this opportunity and they started working together, and now we’re actually running that new process where before we didn’t have it running, and that’s getting savings for us. So we’re getting savings that are smaller from plant to plant, and then we’re getting the consolidation of the plants that I mentioned.

As well, we’re finding a way to simplify as we go, so there is some rationalization of SKUs that’s starting to happen and that just creates more value for us and for our customers, and it’s going to smooth out some of the transitions. So we’re feeling very good where we’re at. We’re going to meet or exceed what we committed at the time of the deal.

Right away at due diligence, we started to see the talent at EPC that was going to come into Regal Beloit, and we were very, very excited about that. I could put up a chart here and show you all of the key roles that the EPC leadership now have at Regal Beloit and they’re making a difference today. We’re lucky, as Mark said, to have Sarah here who is Vice President of FP&A and Steve O’Brien who is the Vice President of Pump and General Purpose here with us today, and we couldn’t be happier to have them as part of the team.

So Steve now is going to take you through and talk about how we’ve integrated the EPC businesses in fitting them strategically with the Regal Beloit businesses. Thank you.

Steve O’Brien

Thanks, Scott. Again, my name is Steve O’Brien. I’m Vice President and business leader for EPC’s pump and general purpose business, and I’ll explain that as a standalone business as I go throughout my presentation. I’m very happy to be here with you all today and extremely happy to be part of this great company in talking to you all about it today.

I’m going to provide you an overview of the EPC business. I’m going to discuss the strategy EPC was working on prior to the acquisition and then I’m going to give you my perspective of the benefits of joining Regal Beloit at this point in the Company’s history.

A.O. Smith Electrical Products Company has a very long and rich history in the electrical motor business. A.O. Smith entered the motor business in 1950 with the acquisition of Whirlaway Motors, which made pump motors for a customer who is still with us today. That business was located in Tipp City, Ohio where EPC has been headquartered ever since. With the entrance into HVAC motors and hermetic motors, the company enjoyed steady growth throughout the 60s, 70s and 80s as the HVAC industry expanded during that period.

After divesting the automotive frame business in 1997, A.O. Smith became a consolidator in the electric motor industry and made eight acquisitions in eight years, including Magnetech’s global motor operations in 1999 and then more recently for investments in China. As a result of these acquisitions and other investments, EPC’s product portfolio is diverse with products including small, sub-fractional C-frame motors commonly used in applications like range hoods and bath fans, to fractional and integral horsepower motors used in a wide variety of HVAC pump and general industries applications, and an extensive portfolio of hermetic motors which are actually the motors inside the compressor in a refrigeration or air conditioning system.

Traditionally, EPC has gone to market by strategic business units. Our HVAC and our hermetic businesses each have about half residential and half commercial content. Our sales to distributors, including HVAC pump and commercial industrial distributors, accounts for about one-fourth of revenue while our OEM pump and general industries businesses make up another one-fourth. Our pump customers are those customers who make pumps for pools, spas, water systems, sump pumps – those kind of applications – and general industry customers are basically customers who are not directly involved in the pump or HVAC industry, so a wide variety of applications including applications like garage door openers, commercial restaurant equipment, agriculture equipment, and those kinds of applications.

EPC’s manufacturing footprint is focused in low-cost regions in Mexico and China. In general, EPC has been operating with a two-pole strategy, meaning we can make most of our major product lines in Mexico and in China and we have approvals with most of our major OEMS to make motors for them in both regions. This gives us the flexibility as costs change from one region to another and it also gives us the opportunity to catch our customers’ business as they locate their production in those low-cost regions.

EPC also has a small operation in the U.K. which has already been consolidated and integrated with the rest of the Regal Beloit European business, and we have sales offices and warehouses in Dubai and Singapore where a few of our major customers are located.

In 2006, EPC embarked on a strategy to fix the underlying business, then grow once the foundation had been stabilized. While the business wasn’t in dire financial condition by most measures, it had too many redundant plants, too much fixed cost, too many standard motor product lines and too much unprofitable business. Our strategy to address all of these issues and position the company for growth was to close 11 of our high-cost plants, implement pricing discipline to rationalize some unprofitable product lines and unprofitable customers, and really refocus our engineering and marketing efforts on high value, energy efficient products. As a result of this, our margins have improved by over 400 basis points since that period of time, and we see a significant opportunity for future improvement.

We knew back then to implement this strategy and stay ahead of our global multinational customer base, we needed to globalize the company. To accomplish this in addition to significantly reducing our fixed costs in implementing the two-pole strategy, we knew we had to get on to one modern MRP system, create global world-class procurement offices in Mexico and China, and supplement our engineering and sales talent in both of these regions. As a result of that effort, we have positioned the business to be able to design, sample, test, procure and manufacture of our major product lines in both regions.

The company now has three main operations in China with two of them focused on commercial hermetic motor production for customers in Asia, Europe and North and South America. The third operation pictured in the middle is in Changzhou and that’s one of the most diverse and cost-efficient motor plants in the world. In Changzhou, we basically make nearly every non-hermetic product platform in the company. Many of those motors are exported back to the U.S. but many also stay in China for our customers who produce there and some of those who participate in the local market. As many of you probably know, Regal Beloit has a similar operation located near the EPC Changzhou facility, so we see a fairly significant opportunity for synergy as we look as these two operations.

EPC’s Mexico operations are focused on three regions – Acuna, pictured on the right, is the hermetic center of excellence; Monterrey on the left is where we make sub-fractional and fractional HVAC motors, and Juarez, consisting of nine plants spread over five campuses, makes a wide variety of AC and DC fractional and IHP motors. Regal Beloit also has about seven facilities in Mexico, so the opportunity for consolidation of our operations in Mexico is significant also.

Although EPC was well behind Regal Beloit in terms of HVAC ECM motor development, EPC did recognize this trend in the HVAC application and most other major applications several years ago, and as a result began to invest quite heavily in electronics engineers and permanent magnet and variable speed motor technologies. We focused on an important segment to EPC – the pump segment – and we released one of the first ECM motors for pool and spa applications, which is on display here and now in its second generation and designed into three of the four major OEM pool pump platforms.

Without losing focus on our core applications, we also began the process of developing higher efficient motors for most of our other major product platforms, and as a result the current pipeline is full of projects in various stages of development and commercialization.

In the pool industry, the payback of switching to a variable speed, permanent magnet motor is fairly quick because the savings can be quite significant. The largest pool market states – California, Florida and Arizona – have all recognized the potential for significant energy reductions and as a result have implemented legislation requiring multi-speed or variable speed motors on all pump systems greater than one horsepower. EPC is very well positioned to capitalize on this trend due to our pump ECM motor and also our premium efficient two-speed motor that now also has a built-in timer.

Our pump ECM is called the V-Green and the latest feature comes with some very exciting new features. Most importantly, the motor is fully variable in terms of the speeds and it’s extremely efficient over the entire range of speeds. The latest generation has an optional controller so the motor can be field programmed to the discrete speeds and the on-off times, and as a result an additional controller is not necessary. Basically what that means is a user can simply take off a single speed motor, replace it with this variable speed motor, program the speeds and the on-off times, and begin saving energy immediately. The motor also comes with a few other features. It has freeze protection, a battery back-up, and an auxiliary connection which allows pool owners to connect other items such as a pool heater or a salt chlorinator and program the on-off times for those as well.

An example of a sales synergy that we have and are working on is in the ag market, an currently EPC provides traction motors for center-pivot irrigation systems, and Durst, another EPC company, provides the gear boxes to this industry. We envision a potential scenario in the future where Regal Beloit can provide the entire motor and gearing system to this industry, adding value to our customers’ business and to Regal Beloit.

As we have integrated with Regal Beloit, you can see that EPC has a lean operating model and a focus on high value, energy efficient motor development. 2011 was basically the year we were going to begin our transition to the growth phase once we had fixed the underlying business, so in my view, the merger with Regal Beloit could not have come at a better time. I say this not only because Regal Beloit is focused on growth but because many of the tools and initiatives that Regal Beloit has put in place I think are really going to help the EPC businesses take the next steps toward global growth.

The first one I wanted to talk about is the Regal Beloit operating cycle, and I think the operating cycle or the compass is not only going to help EPC ensure a smooth and disciplined transition into Regal Beloit but it’s also going to help the EPC businesses ensure we’re focused on the right things throughout the course of the year, everything from ensuring we have robust long-term growth plans established to the process for fostering high potential people through the organization to continually seeking feedback from our customers and our employees.

The Lean Six Sigma model is another example. I think that’s a great fit for EPC at this time because it builds on the continuous improvement culture that EPC had implemented. And then finally, the focus on customer care as evidenced by the fact that customer care is the number one initiative throughout the company, and the opportunity to accelerate our energy efficient platforms now as part of the world-leading ECM motor company are very significant.

I’m happy to report, as Scott alluded to and consistent with the RBC operating cycle and our customer care initiative, that we have already completed the first EPC customer survey. As we had hoped and Scott mentioned, we found validation of some of the initiatives we’re working on, and we also got clear and candid feedback for where we can make some improvements. Our distribution customers validated that the distribution model that EPC has in place works fairly well, while our OEM customers told us that they’d like to have us adopt a few of the Regal Beloit best practices in order to service their businesses better.

As far as the integration of our organizations goes, as we reviewed the various options for integrating our organizations, we made the decision consistent with the feedback we’ve gotten to leverage and expand the EPC distribution model by combining all three major Regal Beloit HVAC brands under the EPC distribution leadership team, ultimately reporting to Paul Goldman. The global competitiveness in the OEM HVAC industry also led us to consolidate that business quickly, also underneath Paul, with additional opportunities to consolidate our ECM platforms. And then finally, the pump and general purpose business that I manage as well as the global hermetic businesses, we left as standalone businesses primarily because of the less significant overlap in those businesses.

To summarize, the EPC business was steadily improving at the time it was acquired with, I think, significant opportunity for continued improvement. The timing to become part of Regal Beloit couldn’t be better because it’s a perfect fit with EPC’s strategy to fix and now grow. As an added benefit, EPC offers Regal Beloit a lean operations footprint poised for expansion, and the energy efficient platforms are off to a great start with a significant acceleration opportunity as part of the industry-leading ECM company.

The integration is off to a great start by nearly any measure, including the excitement level that Sarah and I and our coworkers feel as we become important contributors to one of the leading motor control and mechanical equipment companies in the world. Thank you.

Okay, sure. Yes.?

[question inaudible]

Yes, I think in most of our major applications—oh, sure. The question is where do we see the combination with Regal Beloit giving us the opportunity to accelerate the adoption of energy efficient motors? I think the pool market is one very good example. EPC was working hard on developing the pool motor that we have shown here, but we’ve already realized fairly significant benefits of taking advantage of the ECM expertise that Regal Beloit has in terms of not only the development but also the scale and procurement of electronics and permanent magnets, and all of the other unique components that go along with ECM motors. From there, we see the opportunity to adopt variable speed permanent magnet motors in nearly all of our applications. There’s almost no application that wouldn’t benefit, in my view, from the adoption of a permanent magnet variable speed motor.


[question inaudible]

Which product development? Yeah, okay. So the question is why are we doing product development in two different companies? And I think the answer is we’re really not. We are one company. We have separate business units and separate business leaders for some of the major breaks in our business, like the difference between pump, HVAC and commercial industrial; but we very clearly leverage and utilize our engineering and development talent across the organization. We don’t keep it siloed.

[question inaudible]

Yes, absolutely. Yes. Okay, any other questions?

[question inaudible]

Yes, you’re talking commercial buildings? Okay. So the question is about the adoption of energy efficient products in commercial and residential buildings, and I actually think Paul is going to talk quite extensively about the adoption of ECM motors in commercial buildings, so I think you’ll get a little more background there. And then Mike is going to talk about the adoption of some energy efficient motors in commercial industrial applications. So maybe hold that question – I think you’re going to get some pretty good answers as we go throughout the presentation.

And now, I’d like to introduce Paul Goldman, Vice President and business leader of our HVAC business.

Paul Goldman

Good morning everybody. Welcome ladies and gentlemen. It’s a pleasure to be here for the second year in a row. Thanks for coming back, and seeing a lot of your faces again. I had the pleasure of talking with a few of you this morning and I’m glad to be able to talk about our HVAC and refrigeration focus this morning. I’ll predominantly focus on our North American business. I certainly want you to understand the diversity of the applications and the product offerings that we provide.

We have nearly 5,000 discrete customer applications that we provide into this industry, and we provide a range of products all the way down from motors like Mark and Steve have talked about that can fit in the palm of your hand, and into the HVAC space motors that you wouldn’t be comfortable carrying.

We do have a global manufacturing business. We’re located in North America. We still have some U.S. manufacturing. We’re predominantly in Mexico. We’re still in India – that was a large-scale facility for us for a number of years. We’re in China, and we’re now even more so in China with the recent acquisition of EPC. We’re leveraging the integration of those HVAC facilities in China, so we are a nice global manufacturing footprint.

I will spend a little bit of time about strategic initiatives. The HVAC market is a little dynamic right now. The last couple of years have been pretty exciting. I’ll give a little update on the effect of the stimulus tax incentives that we’ve had the last couple years. I had a couple conversations this morning about dry ship, and I’ll give a little bit deeper explanation than maybe I thought about this morning around that area, so I’ll spend a little bit of time on dry ship (inaudible) later.

It has changed the industry. The industry is going through a reset. The good news for us – for you – is that we are coming through it. The outlook that we have that I want to share with you is very positive. It’s bee a good industry for us and it will continue to be a very good industry for us, and it only got better with the things that we did in the recent acquisition. It is changing our direction, though. Our customers are asking us to do things a little bit differently. They certainly want us to continue to be a leader in high efficiency and variable speed. We have been the innovator in that industry, but they’re all now also asking us to help them on cost, on entry level, on (inaudible) dynamic. Our strategy I believe appropriately provides for that. And then lastly I want to finish, just as Steve did, in giving you a little bit of an update on some cool new innovative products that we’ve just launched. A few of them are here in the product showcase, and I appreciate the opportunity to show them. They do mean things to us. They mean to your—just like pool pump motors, if you have one. If you have an old pool, you need to buy one of our new motors. If you have an HVAC system, you need to buy one of our high efficiency motors. It doesn’t matter – you don’t have to buy a new system, we can retrofit what you have. And in building, to the gentleman’s question in the back, we have products that are designed and we are retrofitting the installed base of North America, both in HVAC and refrigeration. So we’re creating market demand that wasn’t necessarily there, just based on the benefit and payback of efficiency.

So a little bit more about our business. I’ll talk about a couple large segments and then a little bit about a couple niches. Clearly residential, commercial HVAC is the largest part of the business that I represent, and we have a very broad and deep focus in that industry. Our teams are very focused on the applications. We work very closely with our customers. My objective of my team is you need to know your customer as well as they do, and that’s what drives innovation. That’s what allows us to understand where they’re going and that’s what lets us lead our technology team to be ahead of maybe where our customers think they need to be, and certainly where our competition is. Those products range from bath vent fans to certainly the split air conditioning systems that are the predominant configuration in North America to small commercial HVAC systems that you’d see on strip malls to a very large, multi-motor like in the upper right-hand corner there that you’d see on the roof of a building like this.

Commercial refrigeration has been a very attractive space to us. We specifically targeted it about five years ago. We saw that the dynamics of high efficiency, future legislation, penetration of motors similar to what we saw in the HVAC space was going to come to commercial refrigeration. It has been a lagging industry, a slow adopter on high efficiency. It’s been a first cost type of equipment construction that was presented to end users, grocery stores, very large installations. We knew that that was not going to be that way forever. We’ve literally gone around and in some cases our customers that were unwilling to sell high efficiency, going to that end user, talking to them about what they could do if they installed high efficiency motors. I gave an example this morning, and there’s a product in the display case, the second generation of it, where three to seven years ago – I may have referenced this last year – we retrofitted 5,000 stores, over 450,000 motors. We went into those stores over a three-year period, took out perfectly good operating motors, threw them away and put in high efficiency motors simply for the payback that in most cases was less than two years. There’s just too much energy still being wasted, so independent of what the economy is doing from a new equipment standpoint or the failure rate of motors, we’re creating what I call a third cycle which is the proactive replacement of motors based on energy efficiency payback.

And we’re seeing that across the board on refrigeration. We’re focused not only on the point of manufacturing of refrigerated goods, large factories that would have that lower middle picture of a multi-unit package refrigeration system, but now with EPC very strong discipline and penetration and success in transport refrigeration, so that’s an over-the-road air conditioning system that would go on a tractor trailer. And then we’ve got products that are going on sea containers – very tough duty but certainly very high value perishable goods over the water, a lot of performance and efficiency required in that application. So we’re in the transport and then we’re certainly in the point of retail, point of display – those are bottle coolers and display cases.

I also wanted to highlight a couple of niche applications that are not as large but they’re certainly attractive to us. HART – alternate heating, we are making motors for combustion flue gas dilution and air circulation, and then lastly hot water heating. Hot water, there’s a large installed base. It’s kind of a 50/50 electrical – which doesn’t take a flue gas motor – and then there’s gas. Most of the gas hot water heaters in North America are gravity vent. That means that the flue gas is so hot that it will rise by natural convection. So there’s a lot of heat, there’s a lot of energy and there’s a lot of waste going out the stack. We’re focused on this now because of recent Energy Star qualifying products and the attempt to improve that hot water efficiency and then going in and replacing an existing system, but now the gas is so cold it won’t leave on its own. So creating products—we actually have a patented product that’s over in the showcase where we’re going in and having an opportunity to install, retrofit that installed base, get that poisonous gas out of the house that’s now too cool to rise on its own, and we’re providing the products. We’re in the market with a customer right now and we’re encouraged about that going forward.

This is kind of the range of the products – classified them in combustion, comfort and cooling. On the combustion side, it’s about dilution, gas efficiency. We’re focused on not only hot water heating as I just described, certainly flue gases in residential gas furnaces, but also the emergence of premix where you’re actually mixing the gas and air together and injecting it into a burner. This is a technology that’s widespread in Europe, so we’re developing products and making progress in what is now a common practice in Europe but will eventually come to the States. We’ll have a nice portfolio of products on a global basis on combustion.

On comfort cooling, as I said earlier, we have been the industry innovator. We were the first to bring ECM technology now nearly over 20 years ago. When SEER 13 came in 2005 to ’06, it was initially thought that it was going to be 13 and then it was turned back to 12, and then last minute it was a 13 SEER regulation. And that last change, that last one minute change that happened in the Bush—Clinton administration, that one SEER change resulted in us having the largest launch and most successful product in the history of the company, and that was our X13 motor. The reason I’m highlighting that one SEER change and the need for high efficiency, I’ll get to it a little bit later when I talk about the regional efficiency and consensus agreements, and there are similar one SEER changes that are pending—or not pending but are in the future, and what that just means to high efficiency motors.

And then lastly with Fasco and just a couple years ago, we launched a high efficiency blower, so we’re not only just designing and extending what we’ve done in (inaudible) ECM but now we’re working on the air mover, the efficiency of that wheel, and of the housing. That scroll, which while it looks common, is a patented design. We have patented the scroll angle and the way the air exits the opening, and it’s resulting in significant efficiency versus what is the standard in the industry, in some cases 10 to up to 30% more efficient as an air mover than what’s currently out there. So we’re expanding our space and not just in motors but into air moving systems, and that’s an important progression in the company.

And then on cooling, again that small motor on the bottom right, I’ll highlight it a little bit later. There could be 3 to 500 of those in a large grocery store, so very large penetration opportunity in a single-store standpoint. There’s also evaporator cooler motors in the back room where the eggs and the milk are stored, and then that dark black motor there I’m highlighting is an extremely robust, durable, high reliability product. That specifically came from A.O. Smith, and that’s part of the container transport refrigeration application.

I wanted to spend a little bit of time on the diversity now of the segments that we play in, and we know a lot about residential HVAC and some of the current issues about the decline and the reset that we’re having there. Commercial HVAC is a nice offset. It’s more of a mid-term business cycle, and then refrigeration, the installed base there continues to grow and the retrofit opportunities are what continue to make that very attractive. So in this portfolio here, I see short cycle, medium cycle, and then energy retrofit cycle. It’s an attempt to balance out our whole view of how we approach the HVACAR industry. Clearly, we’re still predominantly residential but we have a nice growing complement of non-residential and commercial and refrigeration.

As I mentioned earlier in my opening comments, our customers are asking us to help them differently on our investment, so I’ll talk in a minute about how much CAPEX that we’re now moving into to be more cost effective across the board on everything we do in response to what’s going on in the industry. I do think that we’re extremely well positioned for the rebound. We’ve got the right headset around our manufacturing, our focus on our customers, where they’re going, where the industry is heading; so as this industry rebounds, we’re going to be in a very nice position. On commercial, the efficiency drivers that we’ve learned and are now leveraging from small residential applications—Steve talked about the learnings and the marriage of products and sourcing and design into the pool. We’re taking that same thing into commercial HVAC, so as we get into larger motors outside the 48 frames, and Mike has a nice example of one in the display case in the showroom area, we’re just leveraging that technology. I share Steve’s enthusiasm – there’s not a single application of spinning motors that are used in North America, or the world from that standpoint, that can’t benefit from a significant step-up in efficiency. It’s all about can you get the right form factor and you get the right price point, the right economic payback. Certainly stimulus, and other things like that, and efficiency regulations help, but eventually it all comes, and we intend to continue to be the leader in that.

I talked a little bit about large property retrofits, and I’ve got a neat example about something that’s happening right here in our neighborhood; and then last year I talked a little bit about Elco. Elco was an acquisition in the refrigeration space that we made in Europe last year – nice global player, good focus around the globe, good manufacturing footprint. Now a year later, a quick update – it’s part of this larger team. We’re leveraging their manufacturing strategies. They had some really nice automation and designs for global construction. They’re taking advantage of some of our, again, ECM products, so together Elco and what was our moral brand in refrigeration here in North America are really leveraging together.

And then lastly, high efficiency legislation in the commercial refrigeration space is coming and it will continue to get more aggressive, so what we’ve seen in the more obviously residential HVAC legislation is moving into commercial—now moving into commercial refrigeration and creating a very nice, positive view forward.

Our manufacturing footprint – predominantly Mexico, still a little bit in the U.S., and then the rest made up in India and China. And this is a very natural progression of what we’ve gone through for a number of years. Our customers are in the U.S.; our manufacturing was predominantly U.S. We had customers that started moving to Mexico; we moved to Mexico. We’re in a good position to catch them. They continue to come down there. Mexico provides a very nice cost position for us. Customers say we need you to continue to migrate that strategy, so a number of years ago we went to India and we went to China, and now as Steve talked about, two-pole manufacturing that EPC had, we also have multi-pole manufacturing, in this case in this greater HVAC space. It provides a lot of benefits. It provides a nice complement of cost and speed and sprint.

This industry is very hard to predict. Our customers are continually taking working capital out. They’re continuing to reduce their finished goods, and the volatility of the signals of what happens in the market, they come on a lot faster than they ever did, and our customers expect us to serve a lot quicker. So having a well-balanced portfolio around the globe on how to serve that has served us well, and I believe it will continue to in the future.

But we do have opportunities, and we’ve got a lot of opportunity to simplify capabilities. With the acquisition, the great acquisition of EPC, we have more manufacturing space. We have more designs. We have more supply chain. So as we work through that, it’s going to be part of the synergies that Scott talked about and it’s going to be part of the efficiencies and the benefits that our customers feel as a result of it. It’s so important – we’ve got an aggressive strategy to get on one ERP system. This is what links everything together. This is what links our customer demands into our supply chain, into our manufacturing, and into our sales, and we’ve had large investments in IT and we will continue to because to really capitalize on all those synergies, we have to make that move, and we are.

I want to spend a little bit of time about what’s regional efficiency standards and what has been referenced to as the consensus agreement. And this is where the government, industry and advocacy groups came together and pinned what was going to be—what is now the next phase of efficiency regulations that will be in the HVAC space. And to set this up, what was in the past – today- is you have one standard efficiency level across North America, it doesn’t matter where you live. What we’ll have in the future is we’ll have two or three standards. If you’re in the north, you’re more concerned about heating – that’s where most of your comfort expense is going – so what was an 80% AFUE or 80% of the gas going into a furnace was coming out as usable heat, it’s now going to move to 90 and that’s going to happen on May 1, 2013. So all the northern half of the United States is going to have an 80 to 90 AFUE step-up, and when that happens those furnaces require more sophisticated inducer motors, which supports penetration of more high efficiency motors – not just standard motors but variable speed motors into flue gas induction, so we’re looking forward to that change.

In the south, it’s about cooling – you’re more concerned about what happens in the summer and that’s where most of your energy expenses go. Currently that’s a 13 SEER, changed in 2005 and ’06, went from to 10 to 13. That was 30%, a pretty big step-up. It’s going to go up now another point to 14. I talked earlier about the largest launch in the history of the company being the response to what was thought to be a 12 but went to 13. The importance there is now we’re going from a 13 to a 14, so very bullish about what’s going to happen in the industry as our customers respond to now 14 SEER equipment across the bottom half of the country.

And we’ll see that – we’ll see the change in efficiency in early ’13, so that will be a positive mix pickup, and then again in late ’14 as we get into the air conditioning cycle. The history behind this, or why I want to give a little more credibility to this, I’ll start to talk about in this chart. And there’s a fair amount in here, so I’ll spend a minute or two on this. So this is what’s happened in the past and maybe a little bit of a view of what we might expect going forward in the future. The left-hand side is cooling; the right-hand side is heating. The bars are industry shipments, so these are our customers’ reported shipments into the industry. This is AHRI data, and it’s in thousands of units, and then the go-forward data from ’12 to ’15 is JP Morgan Chase estimates on the rebound of the industry. The black line I drew on top of this is the mandated efficiency levels in the past, what we’re going to see in the future, except for the dotted line. The dotted line is the impact of the 30% tax credit up to $1,500 stimulus rebate that we had in ’09 and ’10.

So a couple things on this chart, then. On the blue one, you can see, for instance, 2005 to ’09, we had four years of steady decline of industry shipments – not a positive trend for the industry in total. During that same time – I don’t have the data in there, we don’t share the data – our variable speed mix and sales grew year-over-year 10 to 15% every year. So even in the midst of declining overall top units, we continued to grow our business nicely in the face of that.

Talked about the big step-up from ’05 to ’06 of three SEER points, and then when we approached ’09 and ’10 we were stimulated to go out and buy 15 or 16 SEER AC heat pump systems, and that was the pick-up there. And then I’ve shown in ’14 and ’15, what’s going to happen on the regional requirements.

Similarly on furnaces, the federal minimum across the country is 80%, and I just told you in the north it’s going to go to 90 in 2013, and also gas furnaces had a 30% $1,500 tax credit to go to a 95% AFUE for those two years.

Now, I also want to talk about—so that’s—my positive view here is that the next four years, furnaces and ACs we’re at a low, we’re at an industry reset. The indicators are that this industry is going to continue to grow. The efficiency regulations are in place to continue to drive higher efficiency. Net of what you see at the top line, we’re going to continue to see a positive mix shift of high efficiency within our customers’ sales units.

It’s probably appropriate that I also spend a little bit of time on dry ship. I had a couple conversations this morning with a couple gentlemen, so I’ll spend a minute or two on that. Dry ship is the phenomenon where beginning in 2010, we were—our customers were legally no longer allowed to ship a condenser with R22 refrigerant inside of the condensing unit, and the result of that was is that now its in our 410A world, and you in 2010 as a consumer have an air conditioner that needs to be replaced You could no longer buy an old R22-charged condenser to replace that outdoor unit. You were faced with having to buy an R410A. The thermodynamics of R410A are such that the air conditioner needed to be larger, not only larger on the outdoor but larger on the indoor. The refrigerant is pumped in through tubing into your house. There’s an evaporator coil that sits on top of the furnace. That evaporator coil needed to be larger. It didn’t fit well with the furnace – it may be oversized for the furnace, so now the furnace needs to be replaced. So what was maybe a $1,000 repair bill to replace the outdoor condenser may now have become a $5,000 to $8,000 whole new system to replace them all to have them all compatible on the same refrigerant. That was presented with a lot of resistance. Fortunately, we have a $1,500 tax credit during that period, so a consumer may be encouraged to step up in efficiency. At the same time they were stepping up to R410A, they were getting a little tax incentive. We enjoyed a nice mix shift. We were selling an outdoor motor, we were selling an indoor motor. It was a matched set. They were all going together. It was a very wonderful thing.

Then later in ’10, we had some customers that realized that there’s a caveat to the regulation, and that is that the components that are uncharged, do not have refrigerant in them, can still be sold into the industry. And the purpose was that if you had a little valve or some other device that the air conditioner needed replaced, that we weren’t going to disallow an R22 system to have a valve serviced. It was uncharged; there was no refrigerant. That was the classification. So what people figured out is we’ll just make R22 condensers and we won’t put any refrigerant in them. So now you have an old air conditioner that doesn’t work anymore. Rather than having to replace the whole thing, the contractor would say I can now replace just that condenser – go back to the way it was – and I’ll bring my tank of refrigerant and I’ll charge it on site and get you back in business. It’s been a pretty hotly debated issue in the industry, with the government, the Department of Energy, by our customers. It doesn’t appear that it’s going to get closed, so now we’re waiting for it to play out. From our standpoint, it was unfavorable in the second half of this year, so we’ll continue to see some negative comparables through, I’d say, April-May-June of next year.

You probably have your own estimates. I’d size it at a 1.2 million to 1.4 million units a year that are being dry shipped. I think it will probably hold at that level and start to go down towards a more dramatic phase-out in the 2015-type time frame. It needs for refrigerant to get more expensive. I mean, there is going to be—there is an end of life here, and we’re somewhat kidding ourselves – R22 is going to go away and the cost is going to be quite high. But in the current economic conditions, there was incentive to do it the way it was done. It will not say with us, though, and we’ll work through that dynamic.

Last point on this chart maybe—also from JP Morgan analysis based on studying the industry, and what’s happened now for the last four or five years of many fewer units going into an expanding marketplace, we’ve got a very aged install base. Our customers’ customers’ customer had gone through many iterations of repairing compressors, repairing outdoor systems, and limping along. So there is an estimate of nearly the size of a whole annual year’s worth of volume – 5 million units – of just pent-up demand that’s overdue to be replaced. So this is going to work its way through the industry and it’s going to, again, provide a nice forward view on growth.

But it has changed the focus of what our customers have worked on, and it’s therefore changing some of the focus that we’re working on. We’ve got to respond to those price points and those dynamics in the marketplace, and we’ll continue to lead the industry on high efficiency but we’re also going to spend more of our investment on cost, cost across the board, not only on high performance products but on entry level.

A moment or two on customer care – upper left is delivery performance. I talked a little bit about why that’s important and what’s going on in the industry. I estimate that our customers have taken out nearly half a billion dollars worth of finished goods out of the industry in the last five years. Their attention to working capital and how they’re running their businesses is more finely tuned than ever. It’s a very difficult industry to forecast. When the demand comes on, it comes on very aggressively. Our customers can ramp up extremely fast, so what we’ve had to do in response to that is to transform our operations. As an example, we have one facility that in 23 hours can go from raw materials to a finished good. That’s no work in process, no (inaudible) or sub-assemblies. They go from raw to a finished motor in 23 hours, and they can ramp their production 40% in the same day. That’s all in response to how dramatic and how aggressive our customers are moving their business. We’ve had to be a chameleon and respond to it in a similar fashion, and we’re doing that on a global basis, and we still have a lot of opportunity. We’ll create a lot of productivity and a lot of benefit in our industry by continuing to drive down that type of flexibility and sprint capability.

We’ve spent a little time this morning already on net promoter score. It’s a measurement of our customers’ satisfaction, whether or not they would promote us for somebody else to do business with us. It’s been a great tool. We’ve had five years’ worth of survey inputs. I’m happy to say the HVAC business has had four years of steady improvement year-over-year. We learn a lot from this. We learn a lot of candid feedback. We survey over 500 customers in various roles and disciplines. You don’t just get—the sourcing perspective may be somewhat biased. You get the whole organizations’ perspective, and we’ve learned a lot about where we need to be on e-tools, on responsiveness, on productivity, and it’s been a very great source of information for us.

And then lastly on delivered quality, there’s a tale of two cities here. First is that we have had a nice track record of world-class PPM or delivered quality performance over the last several years. We did, however, have a major excursion that happened earlier this year. This was part of the announcement of a $28 million accrual. I can tell you two things about it – one, it feels better than what it was at the time. I can’t give you an update on it now. The leadership will give you an update at the end of the quarter. And the other is it’s helped transform us into where we need to be from a process certification and change management process. So a company that had done this well, had this kind of world-class performance, has an issue – what are you going to do about that differently?

It also did something for us that I think you as stakeholders might appreciate, and that’s the response from our customers. Our customers said, people have problems. Everybody has problems; it’s how you deal with it, and we really stepped up. We stepped up in a big way. We accrued quite a bit of funds to be able to do that. We effectively assumed that we were going to have to go out and replace everything that we had made during that period at a very expensive rate. Our customers were very impressed and it’s created loyalty that we’ll have for a long time, because everybody has problems – it’s how you deal with them that makes the difference.

Going to shift now to our strategy on innovation. It’s two pieces – we’ll continue to have leadership in performance. We are the industry leader on how to drive reliability. We launched black box flight data recording in our high efficiency programmable motors so we know what’s going on in the field, and when these motors come back why they were replaced. It’s an ability to make a breakthrough in reliability performance. We’re making nice investments in alternative materials. We’ve made acquisitions that are helping us with variable speed. We’ve got an acquisition recently made that allows us to design motors that do not have magnets, so we’ll continue to bring that type of benefit to our customers. We’re launching air moving systems. We’ve got the industry’s leading (inaudible) communicating protocol with our Air-Kom system; and as I said earlier, we’re going after a large scale property retrofit, so we still have a lot of runway on the high end performance, high reliability, programmability systems of our products.

At the same time, we’re moving a lot more of our investment to cost leadership. Fully 77% of our CAPEX in 2012 is going to be on driving out cost across the board. We’re targeting a 70% product simplification as part of the acquisition. We have a lot more product platforms with big opportunities around our supply base, products for our customers to drive simplification, and it will create a lot of benefit as part of the synergies that Scott talked about earlier, and result in also consolidated supply base and a lot more flexibility. And we’re driving aluminum – aluminum wires. Most wires are still made out of copper. Copper continues to be at all-time highs, so we’re bringing productivity to our customers in the form of alternate materials. And we’re also working on a still-secretive step function cost breakthrough in ECM technology for our customers, so they’ll be very appreciative when this comes through.

Now I want to spend very time – very quickly, I’m starting to run out of time – on four product overviews, and a couple of them are in the showcase, so if you want to learn a little bit more about them, come by. So this is the latest inducer that we developed as part of the response to the Energy Star phase 2, and why this is important is probably half the install base in North America are these gravity vent hot water heaters. The problem is having new hot water go in and plumbed the same way results in a similar low efficiency hot water heater. So here’s a breakthrough in technology, and this is patented. It allows a new hot water heater – we developed this, it’s already in the market – where it can go into that same footprint, it’s a 30-gallon hot water heater that operates at 90 gallon performance, and it’s all about recovery rates so you have big hot water tanks because when your girls take a shower, they drain them out and they take a long time to recover. So this recovers in half the amount of time and a third of the size, and it plumbs right into the existing footprint. And there is about 4 million old-style water heaters that are sold into the industry every year. If they were all converted, it would be a $4 million benefit let alone going back and retrofitting everything that’s already out in the marketplace. So a nice opportunity with that product.

Next one I want to talk about is commercial refrigeration. That continues to be very favorable for us. I couldn’t be more bullish about the long-term view of this industry for a couple reasons. Most recently, federal regulations were released beginning in 2012, display cases – that’s in the upper right there – now have a federal energy minimum mandate. It doesn’t mandate an ECM motor; it mandates the maximum watts that the case can consume. But in a lot of cases when our customers are coming to us, we’re expecting a significant step function in ECM product going into this to help our customers. Just like when I talked about residential HVAC going from 10 to 13 and the broad adoption of ECM, that regulation in the case here is going to drive similar.

Also what’s happening in this industry is hydrocarbon refrigerants. In the European community, hydrocarbon refrigerants, they’re always ahead of us – they’re starting to mandate them, so this is a replacement of ozone-depleting, high global warming potential, conventional refrigerants with hydrocarbon refrigerants like propane and others. And the quantity of refrigerant is dramatically smaller. The problem is that they’re explosive, and they want to use these in these standalone bottle coolers, vending machines all over Europe. You can just imagine the millions of bottle cases, but all of those are point sources for leaking and environmental degradation. So going to a flammable refrigerant, very small quantity that doesn’t have ozone depletion, global warming potential is a big breakthrough – the problem is that they’re flammable, so you can’t have a motor that creates a spark.

So we just launched this motor, it’s in production. It’s being used by display case and bottle cooler manufacturers today. It’s IP65 – Ingress Protection 65 – means it’s impervious to dust and almost submersible and cannot have a spark. It’s being displayed over there – we’re splashing water on it to demonstrate that – so it’s meant to be able to serve that. And in addition, we still think that although we’ve retrofitted thousands of stores in North America, we still think there’s nearly 45,000 stores that have not had large scale motor retrofits, so as we continue to launch products like this that are wash-down duty, that’s very important in a display case because they have to be cleaned. The back rooms, the rooftops, we’re going to continue to have a nice forward entitlement on variable speed into these applications. Somebody said this morning $36 doesn’t seem like a lot. That’s $36 in savings for a very small motor that may have 400 in a store, so it adds up very dramatically.

Next one is right here in New York. This is the beautiful Chrysler building, and we were just awarded the retrofit of all the occupancy motors in the room, so this is nearly 5,000 motors that will be retrofitted in this building in the next couple months. This is the latest ECM product that specifically is a drop-in. The problem about going back and retrofitting the install base is you don’t have a factory line, you don’t have a production operation that can take a product that wasn’t designed or needs some slight modification. It has to fit in exactly as the product that was in there before. If it requires any bracketing, much work at all, the labor cost to do it, the disruption to the space will preclude the effort being done. So we designed this motor to be slightly smaller, double shaft, which is not unique for what we’d normally do, to fit into this space and we’re starting the operation right now. The beauty of it is it can run at lower speeds, which is lower noise and improves the occupancy comfort. It can be programmable. It works with building automation. It can improve dehumidification. It can deal with some of the temperature issues that we’re feeling right now. This is the type of building control that moves forward and allows a wonderful payback. We estimate 2 million kilowatt hours of electricity served, a quarter million dollars on their energy bill just to retrofit these motors.

And that leverage really came out of our success that we saw in the residential HVAC retrofit. So last year, I think I highlighted our Evergreen motor. This was the industry’s first variable speed motor specifically designed to go into your home if you had a non-variable speed system and wanted some of the efficiency benefits, some of the performance benefits. We could take out that standard induction motor and put in this Evergreen. It’s been very successful and it’s part of what you just saw on the prior page in our broader retrofit strategy. What I wanted to highlight today is we’ve now taken it to applications. We’ve launched Android, iPad, iPhone apps. There’s an example in the product display case. This is to help that contractor get in front of you as a consumer and talk about what the payback benefits of this product would be and how to properly configure it, program it if necessary to improve the sale. And this is still a little bit of a technical sale. We’re still trying to bring technology to a contractor base that is not steeped in electronics, so tools that we can make that are three levels removed – this is OEM distributor contractors – we’re providing tools for the contractor to talk to you, the consumer, is where we’re continuing to make a lot of investment and see the nice payback.

So I’ll just wrap up. I’ve enjoyed spending the time with you this morning and giving you an update. We have had a very nice run with the HVAC business. We are going through an industry reset right now, but all the dynamics appear to be very favorable going forward. The industry regulation absolutely is favorable to higher mix and higher efficiency motors. Our customers are asking for our help, so we’re modifying our CAPEX strategy and bringing out lower cost solutions to help them going forward, but I continue to be very positive about the future, not only from the new equipment which will come back but the service of the installed base. We’ve talked at length about our distribution strategy – it works very effectively as part of EPC. We’ve got a very nice distribution business with a wonderful footprint, so we have even more touch to now service the install base. And then finally for this last business cycle, which is the proactive retrofit replacement and how much that benefit that brings to our customers.

And that’s it for me. Thank you very much. With that, I’d like to introduce Mike Wickiser. Mike is the Senior VP of the commercial motors business.

Mike Wickiser

Good morning everyone. I’m Mike Wickiser, as Paul said, and I am the business leader for our commercial and industrial motor and generator business. It’s my pleasure to be here to speak with you this morning. First of all, I would like to add my very warm welcome to all of you that are here and thank you for coming. I know that you all have very busy schedules and many other things that you could have done this morning, and it’s just wonderful that you chose to be here with us so that we could talk to you about our favorite subject and my favorite subject in particular, and that is our business.

To help frame my comments this morning, Mark mentioned it earlier but I want to say it again, last year when I spoke to you I spoke about the commercial and industrial motor and generator business from a North American perspective, and then later John Schlemmer got up and he spoke to you about the Asia Pacific business in total, which has a C&I component in it. Today, I’m going to talk to you about the commercial and industrial motor and generator business on a global basis. I think it will help you understand it better.

You might have noticed there that I said C&I a couple times. That’s what we affectionately refer to it as, so if I say those two terms, I’m using them interchangeably.

There’s four key messages that I’d like to get across this morning if I can. I’d like to give you the sense for how global this business is and the growth trajectory that we’ve been on, and the strategy that we’ve used to get there. I want to be sure that I explain that to you. I want to dimension the business as best I can and talk about the products that we have and how broad and diverse they are in the applications and customer base that we sell those into. I want to talk about our multi-pole manufacturing strategy over the last five years. We have acquired a lot of businesses that are outside of the United States that have improved our manufacturing footprint in the products that we offer, and I want to focus on that for a bit. And then finally, I want to talk to you about our new product development strategy and how we continually bring a stream of innovative and energy-efficient products into our customer base.

So let’s get right into it here if we can. To help you understand the business a bit more, I’ve kind of broken it into three groups, if you will. This past spring, we re-did our mission vision and strategy, and we created a company purpose. Our company purpose says we convert power into motion to help the world run more efficiently. So at our core, we are a power conversion company, and I like to think of it in three different steps, if you will, and it is the power generation business, the power transmission business, and the power conversion business.

If I take the power generation business first, that is our generator business, it came to us with the acquisition of Marathon business in the mid to late 90s. We build generators and sell them under the Marathon brand name around the world. They range in size from about 5 kilowatts, which might be used to run a light tower when you see them working on the roads at night. They’ve got the light tower running, so that’s about how much energy is being generated and used there; to a very large unit which might be a 4 megawatt unit which might be used as a backup power supply for a small building, or a building the size of this they might have multiples of those.

I also want to point out that we build the generator and we sell to customers that we refer to as gen-set builders. That means they buy a generator and they buy an internal combustion engine. Typically, it’s powered by diesel. It could be a gasoline engine or it could run on natural gas, methane, propane; but more than likely, it is a diesel engine and they couple those two things together and that’s what’s used to either provide standby or prime power to the customers that they sell it to, and I’ll talk about those in just a moment.

The second part – so now that you have the electricity, you have to be able to transmit it to wherever you’re going to use it. We don’t sell the lines that transmit it or the distribution switch gear that’s used to distribute the power, but we do have a business called Thomson Technology that builds automatic transfer switches and paralleling switch gear, which is what’s required when you have this power to be able to safely and effectively use it. So think of that as the switch that switches it off and on. And there’s hardware and software that’s used to safely and effectively do that, and that’s what Thomson does.

And then finally, the majority of this portion of the business, the power conversion business refers to the motor business, and we sell motors around the world under the Marathon brand and we also have regional brands we use. For instance, in North America we sell under the Leeson brand; in Europe, we use the Rotor brand and a couple others regionally throughout the world. The motors that we build, as Mark has referred to earlier, many of them are small enough that you could hold them in your hand. Then there’s a midrange, as you can see, that you wouldn’t want to try to pick up but they would fit right in front of you; and then the very large motors that are built in our Wuxi facility in China and our Calcutta facility in India, and those range in the 7,000 or 8,000 horsepower and they may be as big as a couple of these tables, or I like to think of it as a small car, maybe, a smart car – that physical size. So hopefully you can see that we have a broad portfolio of custom and general purpose products that range a very wide range.

So let’s spend a few moments and talk about who are the customers? What are the important industries that drive this particular piece of the business? I’m going to go in the same order that I just went in. So from our generator business or the power generation portion of the business, I have three noted here; and you’ll recall that I mentioned there is something called standby power and prime power. Standby power is typically used where the facility is connected onto the electrical grid and it’s only run in the event that the electrical grid fails. The prime power is more like I’m showing here where it’s meant to run 24/7. It’s used as the primary source of power. The first one there is the marine industry, and I’m going to talk to you a little bit later about a new product we have within the marine industry. The one in the middle is the ag business. If you drive out through the Midwestern portion of the country, you’ll see a lot of these systems that are watering the fields. A lot of times, there is not utility power local there; you have to generate your own. And then finally is drilling – that could be for either oil or gas. Many, many times there is not power there local and you have to provide your own. These are applications where our units would be used.

From a Thomson Technology perspective on the power transmission side, we have a new product for the residential use that’s called a residential automatic transfer switch. For those of you that live in this area and have gone through the weather of the past few months with the storms, and many of you—or some of you may have lost power in your homes. I know the State of Connecticut had half a million people that did not have power for over a week. If you were able to generate in your own home, you would use one of these devices to kick in whenever the power from the grid was lost.

Two of the major industries driving this business currently though are data centers and water and wastewater treatment. Data centers continue to grow as the Internet is used more and more, either for data centers like a bank would use or the government would use for billing and those sorts of things, or just the simple build-out of the Internet as we continue to use it more. Data centers would be used for social networking where the switches are being used, or video streaming is also driving that use. And then finally, the world has an insatiable need for water and once that water is used, you need to deal with it, so there are many large projects around the world today in that specific space.

Now from the power conversion or motor portion of our business, I’d like to break that into two – commercial on one side, industrial on the other. The commercial tends to be perhaps lower horsepower, perhaps less robust motors that are used into these spaces because the applications are not quite as severe. They are typically coupled to fans, pumps, compressors or any kind of mechanical equipment that requires motion in order for it to work. I’ve given you a few examples here. You’ll see the fans on the rooftop of the building, the material handling in the middle, and then the agriculture in the final slide there, the final picture.

On the industrial side, we’re very steeped in the basic industries of metal, mining, paper, forest products. The one in the middle is light manufacturing as well as heavy, and then oil and gas and refining. So from this, you’ll see that the space we sell into is very, very broad and diverse.

So now, I’d like to—remember again, I’m talking about our global business. I’d like to try to dimension it for you if I can. I want to talk about the revenues by geography, and I want to characterize it by looking at 2006 and then what it is today. So if you look at 2006, you’ll see that the U.S. was the vast majority of where our sales occurred. China was a small portion of that and that was for the most part our generator business, which we have the facility in China that sells within China, and then a small sliver for the rest of the world.

Our strategy that we came out with in 2005 was to become more global as a business, and so as we look at it today as we close out this year, 2011, our sales inside the United States will be roughly 63%. The rest of the world will be 37%. That will be led by China at 15, the remainder of southeast Asia and Pacific region at 10, India at 5 and the rest of the world around 7. So we made wonderful progress in that period of time and we’re moving towards 50/50 as we go forward.

I want to dig a little deeper here and I want to talk about the motor business specifically, and I want you to think about them in terms of size. We could say small, medium and large, or we could say fractional, integral, and large. That’s the terms typically used in the industry, and you’ll see that the fractional piece, roughly 40% of the business; integral piece, roughly 40% of the business, and then large 20. If we had looked at this five years ago also, we would have been heavily into the fractional side, we would have had some integral. There would have been almost zero large. We have acquired businesses that have allowed us to get into those spaces also, and we’ve grown that large piece significantly. We’ve grown the integral piece, too. As we go forward, we believe there is a lot of room to continue to grow in those areas while maintaining the fractional space.

Now if we look at the middle portion specifically, that’s the integral piece of it, you want to think about that for just a moment. There are two standards that that product is built to in the world. NEMA is the North American manufacturer’s association. That’s the standard that’s set for the Americas, if you will; and then the IEC, that’s the international standard. That’s the rest of the world. That’s Europe and the rest of Asia. We think about the world in terms of the opportunity as a third in North America, a third in Europe, and a third in Asia. So if you look at this chart and if our business reflected the opportunity in the world, it would actually be two-thirds IEC and one-third NEMA. If you have looked at this five years ago, that pie chart would have been almost entirely NEMA as almost all of our sales would have been in the North America or NEMA standard, and just a sliver of IEC which would represent the rest of the world. So again, we’ve made great progress in expanding into the standard used by the remainder of the world, and where we want to be is two-thirds IEC, one-third NEMA, and we’re going to continue on the strategy and the track that we’re on over the next five years to get there.

This next chart talks about motor efficiency, specifically the integral piece again that we just have talked about in the last two slides. This was a big topic this time last year because the U.S. ISO 2007 law was coming into effect in December of 2010, which was increasing the minimum required efficiency of integral motors, and that’s what occurred to make that very steep bar right there between 2010 and 2011. I can tell you that what we thought would happen, what we predicted would happen is pretty much what we’ve experienced – a little jostling or whatever term you want to use, perhaps, in the first quarter but it all smoothed out, and that transition has been made.

It’s interesting to note that 2007 to 2010, you’ll see that our percent of high efficiency product sales actually declined. That wasn’t a decline in the high efficiency products we were selling. That was the addition of our (inaudible) facility, our dutchy facility, our rotor facility and CMG al outside of North America where they did not have as many high efficiency motors being sold, so it reduced the overall percentage as those motors came into the total. As we go forward, our friends to the north in Canada will have the same legislation be enforced in April of 2012. Smaller market, so it will be a little smaller change there, and then we’ll have the normal growth we would expect to see as we go forward. And then in 2015, the European Union already has a law on the books that they will increase the efficiency standard there similar to the U.S. NEMA premium, except it’s called IE3. So that’s kind of the profile we see as we go forward from an efficiency perspective.

It’s also interesting to note that we believe this is going to be a tailwind for us as energy costs continue to rise, as businesses become more and more concerned about that energy cost and how to reduce it. They’ll be looking for more energy efficient solutions. In faster growing regions like India and China, it’s voluntary at this point; however, it is a discussion which we feel is healthy and China has recently given financial incentives to go ahead and put in energy efficient products. It’s not required but there is a financial incentive there, and we feel that will be beneficial to us also.

Okay, we’ve talked a bit about the business in total. Let’s move on to the manufacturing segment and think about where are we manufacturing our products around the world. You’ll see that a full two-thirds of the manufacturing is in what we’d call a low cost region – Mexico, China, southeast Asia Pacific, India – and the remainder being in what we would refer to as a higher cost region – Europe, the U.S.A., and Canada. So again, if you looked at that six years ago, it would be dramatically different than it is today. We’re continually moving into the low cost regions to take advantage of two things – number one, we’re in Asia for Asia. Those are the faster growing regions of the world. We want to be there to participate in that faster growth. Secondly, we also want to be there to help serve the higher cost regions, so we’re able to go there with more standard product and bring that back and either customize it in the U.S. or Europe, or sell it directly where need be. We also believe that there continually be a need for manufacturing within the high cost regions because many of our customers require highly engineered product, and we build those in our higher cost regions and then deliver them quickly. That speed to getting them to the customer has proven to be very valuable. We refer to this as our multi-pole manufacturing strategy. So with the two of these combined, we feel like we have a very competitive cost base and gives us flexibility to provide solutions for our customers.

Just a little more color on what I’m talking about. I want to give you two examples of how we use the multi-pole manufacturing. Wuxi, China is a facility that makes the range of motors that would be the medium to large, or integral to large if you want to think of it like that – the pictures are shown there. They make both of the standards. They make IEC standard as well as NEMA, so they’re prepared to sell in Europe, in Asia as well as the U.S. They augment the manufacturing that we have – let’s go with the U.S. first. Let’s go with Wausau, Wisconsin, which is one of our factories that builds large motors for us. They do the highly engineered product. Roughly 60% of what’s built there is highly engineered product that’s then shipped quickly to the customer base. But where it’s more standard product, we use our Wuxi facility to support those same customers.

Likewise in Europe, we do essentially the same thing there. In the Netherlands, we have our rotor facility which serves the marine industry – again, a very customized product – but they also have a significant need for a more standard product, and Wuxi has been able to supply them for a long period of time. We feel like this is a way that we can provide our customers with the cost effectiveness that they’re looking for as well as the sophisticated product and speed.

Another key thing we needed was we needed the footprint around the world to be able to not only have the product, to manufacture within the region, but we needed to serve those customers there. This is a characterization of where we’re located around the world. Mark has shown this before in different presentations, and it’s all of the company, if you will. What I’ve done to it is carve out those places, those locations within countries that support the C&I business on a global basis. If you characterize this the way it would have looked maybe five years ago, clearly we would have been in the U.S. and Canada, a facility or so in Mexico, and we would have had a facility or two in China, and that would have been pretty much it. In the five years that ensued, we have really expanded our footprint. It’s given us a lot of capacity in order to build product. We’ve also gotten those products that are used in those portions of the world, and we feel like we are positioned well to continue to grow around the world as I showed you earlier.

We’ll switch now to our new product development or the new products that we’ve come out with. This is kind of an intro slide. I’m going to show you three specifically new ones that we’re coming out with or have just recently come out with. I want to give you a flavor for how we think about it. What is depicted on the left-hand side of the screen here, the bar chart, these are our new product introductions. In 2008, we did around nine of them; in 2011, we’re going to finish 11 of them, so we’ve done maybe on average 10 over the last three or four years, and that’s how we think about it.

Many of these start off maybe in the first year of sale around $1 million or so, second year sales 3, third year sales 5; so 1,3, 5 kind of thing. So after a few years of doing this, we feel like we’re introducing 10 or 11 new products a year, average revenues around $5 million. So that’s kind of a conservative view of it. Some are more; not many of them are less than that. We have a long pipeline of opportunities that we’re looking at. We always have our sales and marketing teams out listening to customers, and we’ve trained them that any time they hear a customer say I need, that’s the time to really start listening. We bring all those needs back in and as we begin to see the patterns come from those needs, we start to think of the products that could fulfill those needs. When we put them through a screen that ranks them, we often go back out and do specific voice of the customer and then bring that information back, and finally that’s how we select among the opportunities that are available to us which ones we will pursue, obviously trying to maximize the return.

I’ll give you an example of one here. John spoke last year about this specific product. This is an Energy Star integral motor that was designed and built specifically in India for that particular space. It was designed in the year 2009. Manufacturing began in late 2009. It was sold in 2010. We sold roughly $3 million of the product in 2010, all within the India space. 2011, we’re going to do around 6 million and we’re targeting 12 to 14 for 2012. So that one’s a little more than the average that I spoke about earlier, and of course there will be those; but that gives you a feel for what I’m talking about.

Now let me go on and show you three more that we’re excited about. I particularly am excited about this one. You’ll see a brochure in the showcase in there. This is our diesel electric propulsion marine generator. We have been in the marine business for many, many years for smaller units, if you will, that are used to run the lights and heating and things like that, but not the propulsion system. This is actually running the propulsion system. These are used in work boats, which that’s a work boat that you’re looking at there, and this boat is used on offshore drilling rigs. There’s a lot of equipment that has to be taken from the shore out to the rig and that’s what this boat does. For a long time, these were diesel mechanical, but in the last six or eight years or so, they’re converting them over to diesel electric, so it’s actually much more efficient for the operator to use. It reduces the maintenance cost whenever you take the mechanical equipment out, and it gives them much more precise control. The offshore platforms, as we all learned a summer or so ago, are 5,000 feet deep, 10,000 feet deep of water, so you can’t just toss down an anchor. You have to have some way to hold the boat stable there, and they use a sophisticated GPS to do that.

Our customers came to us and said we need – and we listen closely – and we were strongly encouraged by them to get into this business. We developed it over the last 18 months. We’ve sold over a million dollars of them this year. I just came back from the work boat show. There was tremendous excitement there. We expect to do a couple million dollars next and probably three or four the year after that. It’s a very exciting product for us.

This next one is maybe a product that only a company like Regal Beloit could actually put this system together. We call this the Hera-max drive system. HERA stands for High Efficiency Right Angle gear, and that’s the yellow piece you see on the right-hand side of the screen. We have coupled that with a high efficiency 48-frame motor. It’s about a one horse motor, if you will. The gear itself is about 40% more efficient than the gear it replaces. It’s just a different type of gearing in there that gives you tremendous savings. We’ve gone ahead and made a NEMA premium version of that motor, even though it’s not required by the DOE today. We’ve gone ahead and done it. There’s a lot of discussion going on right now about raising that efficiency to NEMA premium for that particular style of motor, so we’ll be ready with that. What you end up getting is something that’s half the size and half the weight. What you’re looking at in this picture, the grey part on the outside, that’s the unit that it replaces. The yellow part on the inside, that’s the new product that we’re speaking about, so you can see that it’s literally half the size and half the weight.

The important part where it bolts on, though, is exactly like literally hundreds of thousands of units just like this that are out there in service today, so it’s interchangeable with all of the existing—most of the existing product that’s out there. The uses of it are on any kind of driven mechanical equipment. One of the applications I like to think about is the conveying system, so in all the distribution centers around the country, many products just like this are running the conveyers; but of course, any type of mechanical equipment would be a place where you would find this.

We’ve sold a million dollars’ worth of the gears this past year, the gearing alone. We’re going to come out with the gear and the motor together next year, which we expect to sell a million or two, and probably double that the following year.

Then finally, not to leave out our friends in Europe here, Rotor, as I mentioned before, they’re a company that does a lot of business within the marine industry, but by coupling their technology with that of the rest of our company, we’re looking at other applications that we might be able to collaborate on, and there are many, many on offshore platforms that have to do with jacking systems. Jacking systems are things like cranes and winches. It’s how they move things within that platform. It’s all run by an electric motor; however, it’s a very special motor. It has to be built specifically for the oil and gas industry, so we’re working hard to come out with those in the coming year also.

So those are just three new products that we’re coming out with. There will be more, and we’ll continue to tell you those as we come out with them.

In summary, I’d like to kind of just go over things again. Hopefully, I’ve given you a good feel for how the global commercial and industrial motor and generator business is positioned to continue our rapid growth throughout the world. Hopefully, you see that the applications, the customer base we sell to are very, very broad and the products that we have fit into that broad space. The third thing is the multi-pole manufacturing that we have. We’ve increased our footprint. There is a lot of work yet to do as we continue to simplify our product and streamline the manufacturing. There is still a lot of work we can do there, but it gives us a very good footprint with which to work from. And then finally, in a business where you wouldn’t think there’s a lot of change going on, there’s actually a tremendous amount of change going on, much of it driven by the need for more energy efficient products, and we are doing our best to fulfill all of those needs.

So with that, that ends my comments. We have a couple minutes maybe for a few questions. Yes, sir?

[question inaudible]

Yeah. The question is I mentioned the ISO 2007 law in this country, in the U.S. that pertains to the minimum efficiencies required for those motors. Those motors are the integral motors. We call them the three digit NEMA frame sizes, if you will. He’s referring to the two-digit frame sizes or the fractional motors. What do we see—what’s the chatter about what might happen from a legislated efficiency with those frame sizes?

There is actually a lot of work going on. They refer to that as the two-digit frame sizes the 48 and 56 frame. They refer to them as fractional, but they actually break the one horsepower so it’s kind of confusing to talk about; but the DOE has had a small motor rule making that is out there now, and the comment period has been going on. The comment period is passed. They actually have a ruling that’s out there that’s being discussed broadly now.

So having said all that, I don’t want to predict where anything is going, but it’s always good when the discussion is happening. We would be proponents of higher efficiency. Obviously, it’s the right thing to do and I think that there will be considerable discussion and ultimately legislation around that coming.

Yes, sir?

[question inaudible]

Good question. Here’s his question, if I understand it correctly. There is really two ways to get at energy efficiency when it comes to a motor. You can make the motor itself more efficient, so the difference between—if I use integrals, that’s where a lot of the discussion has been. If I use that as an example, a standard efficient motor might have been around 82, 84%, something like that. A NEMA premium – and there’s a step in the middle, the EPAct in the middle – then the NEMA premium might have been 90% or something like that, depending on the horsepower. So you could view it just as that, or there is another way to get at energy savings that kind of works with a different idea, if you will, and that is can we run it with a variable speed drive. I believe your question is how should a user look at those two things and make a comparison – do I just want to buy a more efficient motor or do I want to apply a drive to it, right?

I would say this – to kind of clarify for everyone, on especially fans and maybe fans and pumps, which is a very large percentage of what integral motors are used on – of course, they’re used on many things – typically you don’t need all of the air movement or all the fluid movement that running it at it’s maximum speed requires. There’s normally some kind of dampening – think of it as a throttling valve or closing the vent a little bit – to reduce that flow. That’s not very efficient at all. You’re actually using all the energy and then you’re bleeding part of it away, so that’s why typically people have used drives. If you can slow it down, you actually save that energy. You get rid of the throttling or the dampening equipment and that sort of thing.

It does require more to buy the drive. You’ve bought the motor, and now you need to buy the drive portion of it. If you’re just going to run it and you do have a process that operates with it running as fast as it will run, and you want all that flow and you want all that air or water or whatever it is, then it may well be that you want to have just a higher efficient motor. So it’s a trade-off that requires an engineering analysis, actually, to figure out which one’s the best for you, and actually I would say the world is doing both now. In either case, it requires a motor.

Yes, sir?

[question inaudible]

The total revenues are 40%--can we go with that? Yeah, 40% of the Company revenue.

[question inaudible]

I’ll clarify. Those facilities don’t necessarily mean manufacturing facilities. Those could be warehouses, distribution centers, offices, things of that nature; so it’s not pure—

[question inaudible]

I don’t have that number.

[question inaudible]

Yeah, yeah. If I can repeat the question just for those that may be listening. Your question is do we have a figure that would be an average revenue dollar per manufacturing facility that we feel is a reasonable number?

Chuck Hinrichs

Yeah. Probably it’s about half, so the number of facilities that’s shown there, you’re right – probably about half are manufacturing facilities. So you have to balance between very large facilities, getting too monolithic, and it all depends on a lot of the location that you’re in. So we do have a size that we like to get to try to get to when we look at our overhead rates and look at those relative to the volumes that are going through the plants, and try to size up there. So typically, we try to get to some sort of plant that’s 300 to 400,000 square feet. But to our acquisitions, that’s not the size of plants necessarily, so over time that’s what we try to do – consolidate to that size of plant.

[question inaudible]

Mike Wickiser

Without giving you a firm number on that, I will answer the question. The question he’s asked is how big an opportunity do we have within the C&I business to rationalize the footprint of manufacturing? Essentially that’s what you’re asking, right? There has been some work done, I would say, in that regard over the last five years. We will continue to do work there. There is significant work—I showed you where we produce our motors. I believe the number was greater than 30% that’s still within the U.S. I believe there will always be a need for U.S. manufacturing and manufacturing in higher cost regions. There will always be those customers that are requiring highly engineered product that needs to be delivered in a very short period of time. You’d asked me during the session this morning what we had done to lean out our new product development process. We have a process that we call the Lean Engineered Order Sell, where we can put highly engineered orders through very rapidly, and we’ve used the Lean principles in order to do that.

So there will always be a need for those facilities; however, for more standard product, there’s a lot of work to be done to consolidate and to move to low cost regions, and we have been doing that and we will continue to do that in the future.

We’ve got time for one more.

[question inaudible]

The question is what are some of the tailwinds driving the C&I business as we go into 2012? I’ll take the power generation transmission piece first, kind of the ones I highlighted across there. Many of those have been strong. We feel good about what’s happened in the first three quarters of this year, and largely those have been drivers. There was the marine business there, there was the data centers driving that part of the business, there was oil and gas and that was continually driving that.

From a power conversion or the motor piece of it, it’s really an industrial business; so as industrial production goes, which it still seems to be relatively strong, that’s the way we view that. So we’re still looking positive, I would say. That was my final comments around there, I would say.

[question inaudible]

Paul looks good.

[question inaudible]

Raw materials – that’s fairly public what’s happening there. We had a lot of inflation this past year and we had price increases at the end of last year, the beginning of this year to offset that. I would say that we have still not captured enough, that it was a difficult year in 2010. Prices in copper – I don’t know what they are today, $3.60, $3.50, whatever the number is – moderated slightly, but there is still inflation out there, so.

Okay, thank you very much. It’s been a lot of fun for me and I appreciate it. We’re going to go to a 15-minute break. We’re a bit behind the schedule. My clock says it’s 25 ‘til, so to give you 15 minutes, if you’d be back here at 10 ‘til the hour, that would be great. Thank you.


Chuck Hinrichs

Okay, well thank you for coming back to the room so promptly. I’m Chuck Hinrichs, the CFO of Regal Beloit. I know some of you were frustrated and maybe had some questions for Paul Goldman or Mike Wickiser and didn’t get a chance to those. We do have more time for general Q&A at the end, so you’ll have those opportunities. We wanted to stay on schedule to get to the break and also to respect those people that have a hard stop later in the morning. So we’re a little bit behind, but we will continue to provide some information and time for you to ask some questions after the presentations.

So my presentation has four key messages – number one, I want to talk with you about our strong record of growth in sales and profitability; number two, our favorable comparisons to our peer group, and I’ll give you some data on that; number three, our focus on free cash flow; and fourth, the effective use of our balance sheet in order to drive growth of the Company, and then I’ve got some other information on the sales breakdown to respond to some questions that we’ve had in the past.

So let’s talk about our growth record of sales and profitability. This chart measures our sales growth over the last six years. Mark started off the presentation with talking about our 24% compounded annual growth rate over seven years. This really starts six years after the GE motor acquisition and we still have a compounded growth rate of 11.9% during this period of time. Our 2011 estimated sales – $2.8 billion – there we go, and this sales growth is driven by a combination of organic growth and acquisitions of businesses.

In addition, we have a great record on growth in profitability. The blue line is our operating profit in dollars, and we’re estimating our 2011 estimated adjusted operating profit of some $290 million, which would be an increase of 21% over the 2010 actual results, and our gross profit—I’m sorry, our operating profit margin at approximately 10.3% on an adjusted operating profit margin basis. Our goal is to increase our operating profit margin, as you know, to the mid-teen level, and John Schlemmer will review our plan to do that later in the presentation.

This next slide tracks our earnings per share and dividends over this period of time. The blue line, our earnings per share for 2011, and here we’re using the midpoint of our guidance for the fourth quarter in order to calculate our adjusted earnings per share of the full year of $4.34. Our dividend shown here over the six-year period, this year to be at $0.71 per share. I would remind you that we have a 51-year record of continuous quarterly dividends at Regal Beloit and we have a record of having increased our dividend on an annual basis for each of the last seven years. So again, this demonstrates a consistent record of earnings and dividend growth for the Company.

I’ve got a couple slides on comparisons against our peer group. Now, this peer group is 46 companies that we have tracked for almost 10 years – U.S. based, diversified industrials with revenue sizes of a billion to up to $7 billion. This is the peer group that we have been measuring ourselves and reporting to our Board of Directors for some period of time. The blue line is the Regal Beloit sales percentage growth, and the red line is the peer group; so you’ll see that in 2008 – 2009 during the recession, our sales you might conclude declined more than the peer group. Actually, we were coming off a very strong growth rate in 2008 where the peer group was already starting to show some impact of the recession. Our sales on a percentage basis did decline from a much higher level, and then in 2010 – the recovery year – our sales were more than twice the percentage growth of the peer group.

This next chart measures our operating profit versus our peer group. Again, the blue line is Regal Beloit on a percentage basis. Two important points here – number one, the Regal Beloit operating profit margin did not decrease as much as the peer group during the recession 2008 – 2009. We call that a leverage down effect, so the peer group had more leverage down during the recession than did Regal Beloit. And then the second key message is that our operating profit margin is consistent but below our peer group, so our goal is to drive that operating profit margin, as I mentioned before, to the mid-teens level; and again, John Schlemmer will give you our program for doing that later in the presentation.

Our third message is our focus on free cash flow at Regal Beloit. This chart is from 2005 to our estimated level in 2011, a key metric. Free cash flow – we measure it as a percentage of net income. That’s how we compare our performance over a multi-year period and how we compare our performance against our peer group. On a seven-year basis, we show it here, our average is free cash flow as a percentage of net income, 111%. Our target is to always exceed 100% of net income. And on a 20-year average basis, our free cash flow as a percentage of net income is 102%.

Continuing our focus on free cash flow, tactically you achieve that in three ways. Number one, you drive your operating profit higher; number two, you focus on your working capital as a percentage of net sales – we measure it here; and then third, you manage your use of capital investment. So on the left side here, we compare Regal Beloit’s working capital as a percentage of sale on the blue line against the same peer group that we had talked about before in the red line. So over this four-year period of time, our working capital as a percentage of sales was 20.1%. Now, you can’t help but notice the sharp decrease in 2008. That was caused by when the recession hit, many of our businesses at Regal Beloit in the fourth quarter of 2008, the sales fell quickly in that fourth quarter, therefore accounts receivables were also at lower levels. Measured against the full-year performance, that showed a very sharp reduction in the DSO, and then inventories were also brought down as a reaction to the decline in demand. So our working capital fell very quickly that year, but again, over this four-year period we’ve consistently outperformed our peer group.

On the right side, we show two ways to measure our capital expenditure levels. The first, the blue line, is our reinvestment rate, the percentage of capital expenditures as a percentage of depreciation – not DNA, but just depreciation. And you see that over the last couple of years, it’s been well below the level of depreciation. Another way to measure capital spending is as a percentage of sales, so the red line at the bottom of the chart shows that capital spending is about 2% of sales over the last four years.

Now, lest you be concerned that we are under-spending or under-investing in our business, keep in mind that as Regal Beloit acquires companies, we’re picking up production capacity during those acquisitions, so we have a balance of investing in our existing plant and equipment and looking for opportunities to reduce costs, and then our acquisitions can add to that capacity and grow the total capacity of the business without going through the capital expenditure line.

Also, I would remind you that in 2011 and 2012, we’ll be completing two very significant plant relocations in our China factory system, and those will drive our capital spending in 2011 and 2012 to higher levels than we’ve historically shown, and they’ll be closer to the total amount of depreciation during those years.

The fourth message we wanted to talk about was the effective use of our balance sheet to drive growth at Regal Beloit. This tracks the period from 2004 to 2011 where we highlight some of the acquisitions we’ve made over this period of time. On the left axis, we track our total debt to total capital to show that periodically we will add a moderate amount of debt in order to finance an acquisition, and then quickly drive that debt down through the free cash flow ability of the business and bring our debt to cap down to a more normal level. You can see as we closed on the EPC acquisition from A.O. Smith, our debt to cap went up to some 38% at the end of the third quarter; and again, we’ll use our free cash flow ability from the businesses to drive down that debt in the future. Generally, we target a total debt to cap of 20 to 30% at Regal Beloit to continue to maintain a strong financial condition and yet execute our growth strategy.

This chart gives another example of that. Going back to the founding of our company in 1955 and over the 56-year history, you see the sales growth monitored on the right side of the chart. There was a dip during the 2008 – 2009 recession, and then growth continued again very quickly, and we would expect the 2012 revenues to exceed a $3 billion number. We’ve achieved that growth with organic growth and acquisitions, and we’ve picked up real momentum in 2010 and ’11 as we closed 10 acquisitions during that period of time. We continue to view the trend towards energy efficiency as a tailwind for the business growth and we continue to look for opportunities to globalize and simplify our operations worldwide. As Scott Brown mentioned, we use our continuous improvement and Lean Six Sigma tools as a headset to continue to drive operating efficiencies at the Company.

We’ve had a number of requests to give some information on the sales breakdown on a quarterly basis, and this shows looking historically and then including the pro forma results of EPC as to how our quarterly sales would be expected to continue in the future. You can see a pretty good balance between the quarters with the exception of the fourth quarter where seasonal sales are lower, averaging about 22% of the total year sales.

So just to review the messages that I tried to communicate to you today, four key messages – strong growth record of sales and profitability at Regal Beloit, favorable comparisons to our peer group, a focus on free cash flow at Regal Beloit, and then we’ve effectively used our balance sheet to drive growth and then use free cash flow to de-lever that and return the balance sheet to a strong financial condition.

With that, I’ll open it up for a few questions. Cliff?

[question inaudible]

I’m not sure our business can achieve that given the worldwide distribution and the needs of our customer for us to quickly respond to their requirements for their business. We focus it on a days of cash cycle, and so we generally try to get our receivables to the 40-day turnover. Inventories would be 60 to 70 days, and then payables would be that same 40 to 50 days. The net result would be in the kind of 70-day average, which we would consider to be top quartile, not just against our peer group but to a world-class kind of performance. Ten percent of sales, perhaps with a lot of different industries might be possible; but in a diversified manufacturing platform, I’m not sure that that’s as achievable.

[question inaudible]

Yeah, I think 2008 was kind of an outlier given the fact that the business fell off so dramatically in the fourth quarter. Our sales fell, collection of receivables, and then inventories. So I’m not sure that that’s an achievable target. I think we’re very pleased with where we have been operating the last couple of years against our peer group, and we’ll continue to try to drive further improvements from that level.

Yes, Jeff?

[question inaudible]

Yeah, I think to the question of guidance in our fourth quarter, we’re not really updating it but we’re using our earlier guidance to give kind of a full-year look on the businesses’ performance in 2011. So we’re not updating that number. With respect to the sales, that’s an indication of how seasonality would impact the sales number. The operating profit could be much different depending upon, as you said, the mix as it relates to the HVAC business, price increase initiatives, increases or changes in commodity prices. In the fourth quarter, we typically see a fall-off in operating profit margins as a result of lower sales and then less absorption of some of our manufacturing costs as the volume is lower at our factories. So you would expect to see a decrease in operating profit margins in the fourth quarter as revenues, but we’d have to come up with a lot more data and cover a lot more variables to try to predict what those operating profit margins would be on a quarterly basis.

Yes, Scott?

[question inaudible]

Well, we continue to be actively involved in the acquisition market. You can’t predict when those opportunities will become available. We want to be out there, and the pipeline continues to be quite active. Our focus is on the small or medium-sized one as we continue to drive the integration of EPC; but again, the timing of those larger opportunities just can’t be controlled or predicted.

[question inaudible]

No, there is nothing on the balance sheet that projects it, particularly given our confidence in our ability to generate free cash flow.

One more question?

[question inaudible]

Well, if you look at that business, it’s about 10% of our total sales. Operating profit margins are excellent. Sales growth has been good as most of those businesses are kind of late cycle end markets, and we’ve looked at many opportunities to grow that business from an acquisition perspective and have just not been successful. It’s not for lack of trying. It continues to be an important part of our business and one that we’d like to continue to grow, both organically and through acquisitions.

Okay, thank you. I will turn it over to John Schlemmer, our Chief Operating Officer.

John Schlemmer

Thanks, Chuck. Good morning. Well, before I start, I just want to share with you – I just got back from a trip from China, just arrived back in the States and had a great week last week. I had a chance to review many of our operations there and visit with our teams there, and I have to share with you that I came back from China feeling better than ever about our combined business in China. Steve shared with you the facilities that EPC has in China, and when you combine that with the facilities and the team that Regal Beloit has in China, I feel terrific about our combined capabilities, our manufacturing scale in China, and the talent on the team. Paul talked about retrofit opportunities in commercial refrigeration as one example. One of our teams there shared with me that our plans to retrofit our very first supermarket in China with energy efficient motors, and I feel terrific about that. The growing opportunity there is tremendous.

I had a chance to review our progress on the construction of the three new manufacturing facilities, which Chuck just mentioned. Two of those are well underway right now and the other third is moving along well in the planning stage. Those facilities are going to help us grow those businesses and also improve our quality and delivery performance in each of those operations. And then last but not least, I had the chance to see many of the synergies that Scott talked about between the EPC and the Regal Beloit manufacturing facilities and a couple projects that just 90 days into the integration are already in full-speed production, and just how proud the teams were to point out what they’d done working together to improve our business there. It just made me feel terrific, so coming back—just getting back from China, I should be a little tired but I feel pretty great right now after seeing what we have in place over in China and the platform that we have to grow on.

At last year’s meeting, Mark shared with you our vision for 2015 and details on our strategy to help achieve that vision. Today, I’m going to give you an update on our progress in 2011 towards achieving those goals. I’ll give you an update on how we’re driving both organic and acquisition growth to achieve our long-term revenue goal, and then I’m going to touch on each of the strategic initiatives and how our teams are driving improvements in performance across all aspects of our business. We’re still firmly committed to delivering mid-teens operating profit, and as Chuck mentioned, I’ll share with you our views of the important drivers to help accomplish this. And then finally, I’ll share views on both the headwinds and the tailwinds as we look forward to 2012.

This chart shows our long-term revenue projection, and it’s the same chart that we presented in last year’s meeting. Our growth strategy hinges on two fronts – organic growth and acquisition growth. Organic growth is driven by several important factors. First is our innovation strategy to deliver innovative new products for our customers across the entire company. Second, we’re growing our geographic footprint. We now have the advantage of participating in the high growth emerging markets, especially in Asia; and third, we’ve been persistent on our quest to develop energy efficient products across all segments of the company. I think you got a good flavor for that from Steve and Mike and Paul as they talked about their businesses.

While we’re driving organic growth in the existing business, we’ll continue to focus on acquisitions. Our acquisition goals are very clear. First is technology in the area of energy efficiency; second is helping to expand our geographic footprint as we look to continue to diversify our business; and third, our businesses that bring significant synergy opportunities to help improve our overall margins. You’ve heard some examples with the A.O. Smith EPC business, and that’s a great example of what we’ve tried to do with our acquisition focus to help grow the business. Both organic and acquisition growth combined, our goal is to drive an average growth rate of 14% over this six-year period.

Now here is an update based on what we’ve achieved in just the year 2011. The bars in blue are exactly what I just showed you – that’s our 14% growth projection. The bars in green show our current projections. You can see that a little bit in ’10 but especially in 2011, and our projection for 2012 we’re off to a great start and actually exceeding our 14% growth target. Our C&I and mechanical in Asia businesses delivered solid organic growth in 2011. The growth is helping offset the difficult comps that Paul talked about that we’re facing in the North American HVAC business, and that’s really the strength of our business where you look at the diversity we have in the end markets that we serve as well as the diversity in the geography where our business is based.

Clearly we’re off to a great start with the acquisitions. The six acquisitions in 2010 and the four in 2011 are driving significant growth in the Company with over 1 billion of annualized incremental sales. You have to think about how good this could be if we experience some benefit from the pent-up HVAC demand that Paul mentioned.

Our objectives are clear – we’re striving to become the preferred choice for our customers, for our employees, and for our shareholders. To deliver these objectives, we’re focusing on these five strategic initiatives. We don’t change initiatives very often in the Company. The first that you see here in fact were put in place in 2005 when we set our first five-year strategy, and they continue to be critical for our strategy over the next five years. Sustainability and simplification were added last year when we refreshed the strategy to help us achieve our vision for 2015.

I’m going to give you a flavor on what we’re focused on and how our teams are driving improvements on each of the initiatives. Customer care is all about performing for our most important stakeholder, our customers. We know that our future depends on their success and our job is to listen to their needs and respond with a sense of urgency. Our customers made it clear to us in their feedback that we have to deliver world-class performance in regards to on-time delivery and quality of our products.

We measure every business, every plant and every product when it comes to on-time delivery and quality. The top two charts show our performance on these two metrics over the past four years for the combined company. We’re not showing the detailed data because I’m not trying to make the point about the absolute value, but more importantly is our focus on continuous improvement, year-over-year improvement in both delivery and quality. The improvements that are shown here are real and they are significant for our customers. Both metrics have been improving every year with just one exception, which Paul mentioned, which is the quality issue that we experienced earlier in the year and clearly impacted our quality performance during that time period. But you can see the trend over the long period of time that we’re on the right track.

As Paul mentioned, we’ve learned a lot from this experience. We’re making improvements and we’re going to be a better company as a result. As Paul also talked about, we’re going to be updating the quality reserve that we took at the end of the quarter.

Every year, we also survey thousands of our customers and ask for their direct feedback. One of the questions helps us achieve a net promoter score. You can see the results in the lower left-hand corner of this chart that shows our improvement in 2011. This improvement mirrors the long-term improvements that we’re making in both delivery and quality and other aspects of our performance. The feedback that we get from customers is excellent. They tell us exactly what we’re doing that they appreciate and how we’re improving, and they point out areas that we need to make continuous improvement.

We want to be global for three reasons. First, we want to be in those regions that have high growth around the world. Second, our customers are global and we have to be global to meet their needs; and third, we want to seek out the best talent that helps us remain globally competitive. Those are the three reasons why we want to be global. The charts here show our revenue based on regions around the world where we sell our products. Our sales outside the U.S. have grown from just 14% in 2005 to 32% in 2011 on a pro forma basis. Based on our run rate, we now have nearly a $1 billion business outside the U.S., and that’s a fivefold increase over just this six-year period, so we’re clearly growing our global space. We remain committed to delivering our vision in 2015 of having a balanced business both inside the U.S. and outside the U.S.

Innovation is critical to our future as we build the future of the Company on new products. We’re committing to investing in new products and technologies that benefit our customers. Energy efficiency continues to be an important mega-trend, as you’ve heard already today. Electric motors consume a significant percentage of the total electricity that’s generated in the world, so we can make a significant impact with our products. The chart in the upper left shows the sales of our energy efficient products since 2003. You can see we’ve experienced excellent growth every year. Even in 2009 during the period of the global financial crisis, our energy efficient sales grew on a year-over-year basis.

We’re stepping our efforts up to do more. The chart on the lower left shows the number of new product introductions our engineering teams are delivering. 2011 will be a record year. We’ll introduce 50 new products and we continue to invest in innovation and utilize the talent from the acquisitions as well.

Energy efficient products help our customers at every step in the supply chain, and Steve and Paul and Mike gave you some great examples of that with all their products. End users and consumers see the benefit with reduced energy costs, and many times our products can provide a direct payback in two years or less, often less than one year. Whether you’re running a manufacturing facility or you’re the owner of a supermarket, or just a consumer paying your monthly utility bill, it absolutely matters and the customer directly cares about the energy efficiency and the savings that they can achieve with our products.

For distributors and contractors, it gives them ability to provide an up-sell because they can provide more value with their products to their customers; and for our OEMs, they are having to chase the ever-changing and ever-increasing energy efficiency regulations. What we’re able to do is help them meet these energy efficiency demands by providing them products and components that operate at higher efficiency levels, and they’re always looking for the best design solutions to get to that efficiency point based on cost and reliability.

The good news is you can see we have a lot of runway in this area. While we now provide nearly half a billion of revenue of energy efficient products, that means over 80% of our products still have the opportunity to be improved. That’s good news for the planet in terms of energy efficiency. It’s good news for our customers for all the reasons listed on the chart, and it’s good news for our business.

Sustainability – we know that long-term sustainability of our company depends not just on growth and profitability but also that we take personal impact on the planet and for the fair treatment of people that we employ. That’s the three Ps of sustainability – planet, people, and profit. The charts on the left show just three of our sustainability metrics, to give you an idea of how we’re tracking progress. These three all focus on planet. It’s measuring energy usage, fresh water usage, and total waste disposed of all of our facilities worldwide. We measure this on a regular basis among many other sustainability metrics, and you can see in the first year of the initiative we’ve made some very nice progress in this area. We see sustainability as helping lower our costs and at the same time meeting customer requirements. Many of our customers, especially the large multinational customers, demand that we made these improvements. It’s certainly consistent with our Lean way of thinking and our continuous improvement headset, and it’s attractive for our employees. People want to work for a company that cares about sustainability, and we feel we’re just getting ramped up and there’s much more to come in this area.

Finally, we recognize that complexity is a serious disadvantage for any company and it makes it difficult for customers to do business with us. Simplification is all about eliminating complexities across every aspect of our business. Our acquisitions strategy certainly has increased complexity in our business, and we have the opportunity to help simplify our business in every area, whether it’s reducing the number of ERP systems, the number of factories, warehouses, design platforms, legal entities, suppliers, brands. I could go on and on with the opportunity to simplify our business.

Simplifying our business helps us reduce costs and it makes it easier for our customers to do business with us. Let me give you just a couple of examples. On ERP, we’ve been on a path every year to eliminate two to three ERP systems in our company every year. We’ve done that for the past three years. We’ll do that for the next three years, and in three years we’ll have roughly 80 to 90% of our revenue on just two ERP systems, so we won’t be at one yet but we’ll have the vast majority of the Company on two. That’s tremendous progress from where we’ve come from.

On plants, there was some great questions about opportunity to consolidate manufacturing facilities. What we’re showing here is that we’ve eliminated two this year and we see six in the coming three years. I’d view that as the minimum opportunity that we have for manufacturing consolidation, and these are all large facilities.

On suppliers, you might want to make a note – the chart here should actually be ten times what’s shown here. We’ve eliminated approximately 50 suppliers in 2011 and our team is committed to eliminating another 500 suppliers from our supply chain over the next three years. That’s just the opportunity we have given the makeup of our business and the acquisition strategy that we’ve had and continue to have as we move forward.

During last year’s meeting, Scott explained how our teams are driving continuous improvement across the Company. Lean Six Sigma and variable cost productivity are really embedded now in the culture of our continuous improvement headset. We know we can’t stand still and continuous improvement is vital to our long-term success. The chart on the left shows the number of kaizens executed by our employees around the world. Every kaizen is focused on making rapid improvements in our operations. Some are very small, some are very large. It’s really amazing when you see what all of our employees, one when they’re empowered, and two when they’re given the tools and training of Lean Six Sigma. I mentioned that I was in China last week. I had a chance to see firsthand many of these improvements that are being made by our teams. It’s just really powerful to see the impact and how our manufacturing and operations are transforming, really not just in manufacturing but also in the office.

The chart on the right shows the impact of variable cost productivity efforts in the Company. We measure this as a percentage of our total variable cost, so every project that’s done that eliminates a penny, a dime or a dollar from a product counts toward the variable cost productivity efforts. Scott explained last year about how it’s ledger-based. It only counts if the cost truly comes out. We reserve a large percentage of our capital investment for these projects, and you can see that in 2011 we didn’t achieve our VCP goal. That’s simply because of the incremental warranty expense we took earlier in the year. We took this right out of our variable cost productivity because that’s real cost that was added to the business to cover that quality issue, and we can’t take credit for the other cost reductions when we have that added cost. But even with this, if you look over the average of these five years, we have averaged 4.5% variable cost productivity and that’s very consistent with our year-over-year focus on cost reduction. The variable cost productivity helps us improve our margins; it also helps us deal with other issues such as commodity inflation.

I mentioned earlier that our acquisition strategy continues to be a key focus in three areas – technology, geographic footprint, and driving synergies. The acquisitions that we’ve made over the past years are all shown on the right, and it’s interesting to point out that of the 10 acquisitions that we made in just the past two years, five bring what we view as significant new energy efficient technology. Seven of these companies are actually located outside of the U.S. with significant sales in their businesses, of course outside the U.S. that’s helping us in our second point of our strategy. Nearly every one of the 10 acquisitions are bringing opportunities for synergies. All of those we’re working on on a very rigorous basis, like Scott explained with the EPC acquisition. As we sit here today, our acquisition pipeline is full, as Chuck mentioned, and we have the cash flow we need to continue to grow.

I know there’s certainly interest in this page, so I’ll spend a little bit of time on it. We’re committed to our goal of achieving mid-teens operating profit performance. Chuck showed that in 2010 and 2011 our operating profit has been slightly above 10%, short of our mid-teens goal. We have, though, all the levers that we feel are needed to improve over the next few years to achieve the objective, and I’ll touch on each of these. First is the variable cost productivity and the Lean Six Sigma efforts that I just talked about. We will continue to drive improvements in the coming years just like we’ve done in the past. It’s ingrained in what we do; it’s part of our operating cycle. We also have the incremental synergies that will come from the EPC integration, which Scott walked you through earlier – the $35 million over four years, and we’ll be able to leverage SG&A as the Company continues to grow as well.

The focus on innovation and energy efficiency will help us improve the mix of our products. As I mentioned, there’s tremendous runway for energy efficiency in the Company. Finally, we have the non-recurring items that of course won’t repeat, such as the higher than normal acquisition-related costs that we had this year with the EPC business as well as the incremental warranty expense that we took in the second quarter.

So all these improvements combined will allow us to reach our long-term objective of mid-teens operating profit. It takes a lot of hard work but we have everything in place to do it.

I want to wrap up today by giving you a look into 2012 and overall as we look across the Company at what we view as both headwinds and tailwinds for the year. I’ll start with HVAC – while some of the recent data indicates that we could see growth in HVAC, we’re just really not quite sure as we sit here today; and so we still view this as a potential risk in terms of the weak market conditions in HVAC. We do have the negative impact of the R22 dry ship issue that Paul spent some time on. That will impact our business as a headwind certainly in the first half, less so in the second half of 2012. And of course, there is a risk of a global economic slowdown. We’ve continued to take the necessary measures, though, so we can react in the event there is a slowdown. We’ve been running the company being prepared if there is a slowdown in terms of economic conditions.

The good news is the tailwinds certainly out-measure the headwinds. I’ll touch on each of these. The C&I and the mechanical sales are still growing due to the mid and late-cycle nature of those businesses. Mike touched on that certainly for the commercial and industrial business. We’ll have the full-year impact of the price increases that Mark mentioned, the one that went into place essentially at the first of 2011 and the other that went into place towards the end of the first quarter. We’ll have the full-year of the EPC results, of course; and as we’ve said before, we’re on track to get the synergies. We’re actually running to meet or exceed the synergies target, and we’ll see the step-up of new product introductions—the 50 new product introductions and also the improved sales mix from the energy efficient products that we’ve been introducing in all segments of the company.

We should see some benefit if commodity costs continue to decline. While we could face headwinds in HVAC, there will be a tailwind for the 2013 consensus agreement that Paul explained, if not in 2012 certainly in early 2013. We’ll experience the release of pent-up HVAC demand, and again, hard for anyone to tell when we’ll see that released; but we will see it, if not in 2012 in the coming years.

Besides the EPC business, we’ll see the full-year profit contribution from the six acquisitions in 2010, and additional acquisitions are likely as well. And last, we can’t forget that 2011 included $16 million of EPC acquisition-related expenses, and of course that will not repeat in 2012.

So as I wrap up, I can’t help but feel very good about what the team accomplished in a very challenging year in 2011. We’ve achieved a lot and there’s a lot more to come.

Thank you very much for your interest in the company and for attending the conference this morning. With that, I’d like to open it up just for general Q&A.

Question and Answer Session

Unidentified Analyst

When you think about the longer term target still in that 14% range tracking ahead of that, could you maybe talk about the mix of inorganic versus organic that you’re seeing within there, if there’s any deviation on the organic side specifically, particularly because you’ve done a pretty fair job on the acquisition side rolling some of the bigger ones in with EPC.

John Schlemmer

Yeah, I think everybody could hear the question since Mike had the microphone. You know, the mix on organic and inorganic growth or the acquisition-related growth, clearly we’ve done very well with the acquisitions, the 10 acquisitions and especially the EPC acquisition, the size of that business but also the strength of many of the acquisitions in 2010. We’ve been off to a great start for our 14% year-over-year growth target. Mark mentioned in last year’s meeting that we had set ourselves internally some very aggressive organic growth targets. We want to constantly focus our teams on how to grow organically in our business, and you’ve heard a lot of great examples about how we can do that, either based on geography or based on energy efficient products, for example.

It’s been a tough year for us. We’ve had really tough comps in HVAC with the stimulus that was in place in 2009 and 2010, the refrigerant change that came on in 2010, and then the issue with dry ship this year. So that really set us back this year in terms of organic growth, but as I mentioned, with the diversity in our business, while we were experiencing that, we had really solid organic growth in Mike’s business, in the commercial and industrial business. Several of our international businesses had very good organic growth this year, and our mechanical business was growing for much of the year at double digits, and that was all organic growth. So I’d say it’s a bit mixed. When you combine it up, yes, we’re falling a bit short of our own internal target; but we feel like when we see some of the improvements that Paul mentioned in HVAC, all the right processes are in place to see us continue to grow organically in the Company.

Unidentified Analyst

And then switching gears, just to the margin real quick, I was surprised with your mid-teen goal that volumes aren’t playing a bigger part in that progression pattern. Could you maybe just talk about volumes fit into this scheme, if that gives you a little bit more upside potential as the resi market comes back a little bit and as absorption levels improve some, or is that already embedded in how you look at the variable cost side and some of the other factors?

John Schlemmer

Yeah, my view—so the question is on volumes and how it helps our march to mid-teens operating profit. It’s somewhat embedded, I would say, in the numbers in two ways. I talked about the leverage on SG&A. Clearly that’s about volume and growing the top line, growing revenue in the Company. That’s a must for us to achieve our goal. Number two, it’s very important for our VCP target. If we don’t have volume in our operations, while we can continue to take costs out of the products and costs out of the processes in the Company, the volume helps us also achieve from an absorption standpoint and we measure that directly in variable cost productivity. So it’s in there in both of those categories, Mike.

Unidentified Analyst

Hi. With the dry ship still being a headwind, you talked about implementing cost savings measures to get lower price point motors in there. How quickly can you ramp that? Is that really going to be driver in 2012 or are those not really going to roll through until 2013? Can you just talk about how you’re addressing that, how you see that roll through?

John Schlemmer

Yeah, great question, and I think I’ll let Paul talk about it because I think you’re referring to the HVAC products that Paul talked about, and the higher investment in the value products versus just the high performing products and improving our mix, how fast can we realize.

Paul Goldman

So I want to make two comments real quickly. One is I think—I don’t want to over-sensitize the negative (inaudible), so when you go back and study Chart 45, you’ll see that outdoor shipments has always been two to one versus indoor, so we’ve always had a complement of outdoor condensers sold by themselves. Now the fact that they are uncharged just changes the complexion of them, but they already had a motor in it and we participate highly in that segment already. So going forward, sure, our customers are sensitized to the economic conditions and what their end consumers are looking for is sensitized. The question is how quickly can we move? Well, we’re already in there and many of the things that we’re doing right now, like the transition to aluminum wire, EPC had very nice leverage into that space already. One of the major OEMs, several hundred thousand motors a year, so we’re providing that cost productivity, lower entry level point for them. We’re going to expand that across our other brands and positions, and then some of the other moves that I references, we’ll start to feel those next year. But we’re already in there, and I think I maybe left a view—or some of the people think that dry ship is just a complete extraction of volume. No, it was already there, just in a different construction.

Unidentified Analyst

No, but do you not have a lower share of the lower efficiency products versus higher efficiency, and how does that roll through also to margins? I mean, will cost productivity initiatives keep margins where they’re at as you increase sales of—

Paul Goldman

Well, dry ship doesn’t necessarily mean lower efficient; it just means it was an R22 construction without refrigerant. It could have been a higher SEER performing unit with a respectable product in that we provided. There is pressure in that area, but it doesn’t mean a complete shift of what was being made in the past. Does that help?

John Schlemmer

But I think in general though, Paul, the question on competitiveness, there certainly is more competition in the—for those dry ship units that were, say, at the standard efficiency level, we’ve always said we have more competition in that space than we do in the high efficiency products. It’s very true. And as Paul mentioned, though, not all the dry ship would be just at the standard efficiency point. You would guess a fairly high percentage of it is, but not all.

Unidentified Analyst

Yeah, just a couple here. First, you’re somewhat underrepresented in Europe relative to the market opportunity, which is a good thing right now; but what are you seeing recently in terms of European M&A activity and multiples, given the macro issues there?

John Schlemmer

About M&A activity?

Unidentified Analyst

Yeah, just specific to Europe.

John Schlemmer

I’ll let Mark or Chuck comment about the multiples. In terms of M&A activity and opportunity, we continue to look at opportunities, as we mentioned, to acquire businesses and grow the Company. We have looked in the past at several opportunities in Europe. The two businesses that we have there today were acquisitions that we’ve made in just the past few years, so—actually, it’s the three acquisitions. The three businesses we have there today have all been acquired in the last three years, so we’ve had clearly a focus, because we do view that as underrepresented in our business today, Europe in terms of just general market opportunity. In terms of going forward, maybe Mark can add some color.

Mark Gliebe

Yeah, it’s a good time to be looking in Europe given what’s going on, and there certainly is pressure on the multiples on a good side from our perspective, in terms of us being on the buy side. So we’ve seen some of that. In fact, I’ll be in Europe next week for that exact purpose. So we are looking at it and we think it’s the right time from a buy side. The question is—you know, it makes you a little bit nervous of what’s happening in Europe in general, so just got to make sure we—you know, we’re not going to make a huge bet over there. If we do something, it will be relatively small.

Unidentified Analyst

Okay. And then the second question is maybe the last five years are not representative in terms of the typical commodity environment, but I’m assuming – and I think you said this last year – your mid-teens EBIT goal assumes price cost parity.

Mark Gliebe

That’s right.

Unidentified Analyst

How realistic is that given the mix, and particularly on the HVAC side and your increased presence in some of the emerging markets where margins and pricing pressure may be a little more severe?

Mark Gliebe

Well, yeah, okay. You have the situation going on in HVAC. I just don’t think it’s going to be forever. You know, I don’t think the pressure that we’re seeing right now on the HVAC side is going to be there forever. You saw Paul’s charts talking about what others are saying about the growth rate in HVAC over a period of time, number one. Number two, you saw the impact both of the consensus agreement – that’s going to be moving in the right direction over time, and so I think HVAC in the end is going to be a good place to be. Yeah, okay, it’s tough right now; but the thing’s going to bounce back at some point in time and we’re going to be in a great position. We’re still going to have the leading edge product, and when it does turn around it’s going to be favorable from an energy efficiency standpoint, again.

The other point to answer your question is you saw what’s happening in both the pump business with now—you know, Steve O’Brien bringing ECM-type variable speed motors to the pump space, specifically in pool, and as he does that there’s going to be a margin trade-up there, and you’ve got the same thing happening with Mike. So I do believe mix is going to be a good thing for our company over time because we have the backing of the secular trend of energy efficiency and I don’t think it’s going away.

Unidentified Analyst


Mark Gliebe

You know, our emerging market businesses when we first get are typically below our fleet average, and it takes time to turn them around. We had a very nice improvement in the first year in our CMG business in Australia. Margin grew by probably 100 basis points in the first year, so it takes time to get there but we march forward in every business and get the margins up over time. You saw what Steve O’Brien talked about—you know, that was a business that didn’t have an energy efficiency play, and over a three-year period a 400 basis point improvement. So we can get there.

John Schlemmer

I would add just also in terms of the emerging markets that when it comes to our focus on price capture versus inflation, we look at that closely for every business regardless of where those businesses are operating in the world. We review every business four times a quarter and that’s one of the key metrics that we look at. So when I’m looking at the China businesses and talking to our operating teams there, our India businesses and talking to the operating teams there, it’s as much of a discussion about what we’re doing to manage price versus what we’re seeing with inflation as it is with our North America businesses. Certainly some of the dynamics are a bit tougher, but we have the same discipline in terms of how we’re running those businesses and the expectations.

Unidentified Analyst

John, first of all congratulations on your presentation style – to deliberately put that order of magnitude typo in there on the number of suppliers so that we would remember it. Very effective!

John Schlemmer

That’s a good style.

Unidentified Analyst

How would you respond if I were to ask you if your—I keep hearing Lean Six Sigma in your company being put in the same sentence with the phrase cost cutting. To me, cost cutting is about the seventh reason to do Lean Six Sigma. Do you think that observation on my part is fair or not fair, and how would you respond to it?

John Schlemmer

The observation is probably fair. We often talk about the cost benefits of our Lean Six Sigma initiative. I can tell you that we look at the customer performance, for example, on-time delivery and quality. There’s no way to get there without our Lean Six Sigma initiative, and I firmly believe that. Our teams believe that. So I don’t think it is the number one goal. We do track direct benefits from our Lean Six Sigma initiatives in terms of cost savings. It’s a little bit harder to put dollar figures on what it means to reduced cycle time, improved inventory levels, certainly when you look at the cash side of that, improving deliveries to our customers and quality. But those are all important metrics to us. We measure those—as Mark said, we report out to our Board every quarter. The first thing we talk about is delivery performance to customers and quality performance to customers, and Lean Six Sigma is right behind that. It’s the way we’re getting those improvements, so. But I can see the observation, though, because often when we talk about it, we try to quantify the results. We talk about the direct dollar benefit of the initiative.

Unidentified Analyst

I think we’ll be—when you change your delivery metric from promise date to customer request date, we’ll be heartened by that. Second question is can you talk a little bit about how you’ve applied your Lean Six Sigma process in the transactional world, i.e. Carpetland, thinking about accounting or HR, SI&OP, warranty, any of that, new product development? Can you just give us a bit of narrative on that? You touched around it, but maybe we could get a little more detail.

John Schlemmer

Sure, I can share; and if anybody else has an example you want to share. (Inaudible) actually mentioned probably the best example in the company, Cliff. Our engineering leader for the Company today, Mike Logsdon, was on the org chart that Mike showed earlier. Mike was one of our global master black belts, so he’s spent a good part of his career in Lean Six Sigma. When he went back into the engineering function, the first thing he did was he put in a Lean engineered order cell, and he looked at what was going on—and you think about the engineered order cell, Mike talked about how his business is highly customized, so a lot of the orders he takes are on products we’ve never built before, so you just can’t pull an existing built material and put it in the supply chain and the plant. It has to be engineered before we can put it into manufacturing, and it has to be done with speed and with quality. Mike came back into engineering and looked at that process and said, this is just like a manufacturing facility, what we’re doing here, but we’re not running it anything like our manufacturing facility and certainly aren’t applying any of the Lean principals. If you walked into that Lean engineered order cell today, it looks more like a manufacturing process. There is visual management, he has a hospital for orders that are in trouble that are right out in the center of the cell. There’s a more logical flow of the work. They talked about the paper flow, if you will, even though it’s not all paper but just where the work goes. Cross-training of people doing the work so they aren’t dependent on one person putting a bottleneck in the process. All the things that Scott talked about in manufacturing is what Mike applied in that cell.

That’s one example. It’s probably one of the better examples we have in the company because Mike put tremendous focus on it, but I could talk about a team last year in our leasing business that worked on the credit collection process and doing something very similar in that process. So probably a lot more work to do in that area because I think we’ve put more of our focus in manufacturing, but we have some nice examples we can point to where we’ve seen the direct benefit of applying Lean outside of the manufacturing environment.

Unidentified Analyst

Have you seen any material change in the competitive environment with your traditional competitors, and I guess I would ask if you’ve seen any particular change at Baldor given the change in ownership.

Mark Gliebe

I don’t think. Mike or Steve, if you guys have any color to it. I would say not really. There’s lot of rumblings out there specifically related to Baldor, and there will be a circumstance here or there where we have seen a direct benefit of a result of the merger between ABB and Baldor. I’m not going to make a big deal about that because I think over time there will be offsets to that; but I don’t think there’s been any significant change in their behavior so far.

Mike, anything, or Steve? Okay. Go ahead.

Unidentified Analyst

Yeah, just to kind of walk through a couple of headwinds, tailwinds, and take the top line first. Just clarification on res HVAC – do you expect that to—you know, it’s weak already, it’s continuing to be weak so kind of flattish. What are maybe the OEMs telling you to think about for growth or no growth in ’12? And then just on the C&I comment, I think the mention was kind of full steam ahead and things look good, but I just want to understand how you guys think about Europe as a risk, global slowdown as a risk, China, and just tougher compares?

Mark Gliebe

I’ll give Paul a chance to think and I’ll just talk about the second question first. We talked a little bit about our concern around China during our last call, and we were starting to see some slowdown in China. So that is a concern for us. I mean, if China were to really slow down, obviously everybody would be struggling; and we see the impact on both their domestic business a little less so than their export business, more pressure on the export business out of China. So that is something we’re keeping our eye on and keeping a close watch on. I don’t think it’s sustainable, what we’re seeing right now, because I do believe the country will continue to have high single digit GDP. And if you believe that, then you could say well, it’s just going to be a temporary catch-up and pause in the supply chain, which is what we think is happening right now. So that’s my view on things to be watchful for.

Paul, you want to talk about what the customers are telling you?

Paul Goldman

Yeah, so Jeff, on residential HVAC, I think our customers have a fairly conservative view right now. I’d characterize a mix of flat to slightly up with low single digits kind of across the board, is how I’d summarize it today.

Unidentified Analyst

And then just on the cost side, and maybe this is another one for Paul, but how should we think of—is the magnitude of mix-down from R22 greater in ’11 than ’12, and how should we think about price—price cost was a benefit in ’11. Is it a bigger benefit in ’12, comparable, smaller?

Mark Gliebe

So I’ll cover the price cost thing here. You know, we have one quarter of overlap before we anniversary our second price increase, and then you could also say that, hey, some of your first price increase, it takes time to get it through. So we announced it in November of ’10. Some of it doesn’t actually happen. So we have some overlap in the year of price that we’re going to get.

Keep in mind from a commodity perspective, we are hedged and our hedging process is very well understood. You know, we hedge out five quarters, and so in terms of our copper prices and steel prices, we don’t expect a significant change other than the overlap of the price increase.

Unidentified Analyst

And the R22 mix?

Paul Goldman

Yeah, so it started second quarter of this year, so we didn’t feel the full year impact of it. In my discussions, I’d estimate now that next year would be slightly higher than this year, the impact of dry ship, those units shipped with that refrigerant. However, I’d take it out of the units that the 6 million—roughly 6 million units that were already going to be produced, and again, I still feel that we grew—furnaces in ’11 were greater than ’09, so ’09 was a stimulus year. Furnaces this year will still be greater than that, and forecast right now is ’12 will be greater than ’11. So we spent a lot of time on dry ship. I see that mix changing within outdoor condensers but I don’t see that holding down indoor units right now.

Unidentified Analyst

Just thinking about the C&I business, I know you kind of cited that as a tailwind into next year, that mid and late cycle markets are still strong. Maybe backing out ISO, and I know it’s permanently in the numbers, but what is underlying volume growing at today, and should we think about that comment as kind of an extension of current run rates?

Mark Gliebe

What is the underlying volume—what kind of growth rate are we seeing in C&I—

Unidentified Analyst

Right, because I would imagine ISO is providing a lot of price mix this year.

Mark Gliebe

It is—if you recall, there is definitely a sales mix positive, not necessarily a significant margin mix positive when we do the ISO, because your material cost is going up. So I don’t know the exact growth rate, you know, when you take out the ISO. In fact, I don’t know that exact number. So anybody have any color on it?

Mike Wickiser

You’re taking the motor business out of the C&I business in your question, or you’re looking at the C&I business across the generator business, the power transmission, the entire piece of that?

Unidentified Analyst

Whichever way you want to present it. I mean, I guess I’m just trying to size the ISO benefit this year and get at what is the underlying volume growth. Is that a tough comp in the next year, or is it even that strong? Is volume growing 2 to 3% and that’s something you can actually lever off of if the world doesn’t fall apart in Europe and China?

Mike Wickiser

Well, I think the ISO impact affected this year for sure, and we won’t have a continued impact like that next year. I mean, there was a step function that occurred that I showed in the chart there.

Mark Gliebe

You’ll get the carryover.

Mike Wickiser

You will get the carryover effect because it didn’t happen instantaneously. As I mentioned, there was—we talked at the end of 2010, there was a bit of a buy ahead of the EPAct and standard product that then, I believe, flushed itself through in the first quarter of this year. So there will be a little bit of that as we go into 2012.

Unidentified Analyst

And just thinking about the EPC business, clearly there wasn’t a lot of chunky overhead there, and the plant structure is pretty lean versus some businesses you’ve bought in the past where there’s been more consolidation opportunity. When you talk about the longer term footprint consolidation, which I think was brought up earlier, does that require a lengthier process to free up floor space and look at that over a longer period of time, as opposed to being able to pull a lot of levers in ’12 or I guess even early ’13?

Mark Gliebe

Well, I think if you can recall back to Steve’s presentation, he talked about how we picked up three manufacturing facilities in China, one of them in Changzhou. We have a facility in Changzhou. We picked up – I think the number, Steve, is 14 facilities in Mexico, add them to the seven that we already have, so we have 21 facilities in Mexico, something like that. That’s too many. We don’t need all that floor space, and you saw a comment right on someone’s chart about we’re going to be going after rooftops, and you’re going to see it starting to happen in 2012.

Now it will be—for the next three years, you’re going to see that happening, and John mentioned that there will be at least six facilities – at least, at a minimum – over the next three years.

Unidentified Analyst


Mark Gliebe

The question is, is there a timing issue and where do the plants go? I mean, we have—because there is overlap on some of the products, we have a home for them already.

John Schlemmer

Yeah, I think it’s a consolidation opportunity. As Mark mentioned, there’s nothing stopping us from going after it. Those projects are a bit longer cycle time than the sourcing opportunities and the logistics opportunities that Scott explained, so we’re absolutely—those are projects that are being implemented today as well as some of the manufacturing synergies between plant support that we talked about. Those are being put in place today. The plans are being established for what we want to do with the footprint, so we’re aggressively working on the plans; and as Scott mentioned, the projects will start up next year. So nothing’s stopping us; they just take a little bit longer because obviously with OEM customers, it’s very critical we get hooked in very closely with our customers on terms of approvals and work like that that has to be done.

Mark Gliebe

We’ll take two more questions and then the management team will be available to sit with anybody during lunch if you’d like to stay.

Unidentified Analyst

Two questions – one for Chuck and one for you, John. Chuck, I assume—John mentioned the possibility of a fourth quarter adjustment to the warranty reserve to update what we did a couple quarters back. I assume that any adjustment up or down is away from the guidance?

Chuck Hinrichs

Yes, yes. It’s not included in any guidance, and as we continue to work through that, as Paul said, our experience has been favorable. But we’ll do another analysis at the end of this fourth quarter.

Unidentified Analyst

Right, okay. Secondly, when you bought EPC, you got a really good hermetic motors business from them, and that’s a business that over the years kind of stuck to HVAC, and really I had always thought that that was a business that could be moved into harsher environments, into more C&I applications. Do you have plans for the EPC hermetics business, which is a pretty big business within EPC, to take it into new applications?

John Schlemmer

Actually it’s a great question. You know, one of the points that Steve was showing on his chart was that with the acquisition of the two businesses in China, EPC has grown a really nice commercial hermetic compressor business and moving those products into larger systems, more commercial and light industrial applications. And that’s a very, very good business for us and it’s a business that’s a global business. You look at the footprint, not in terms of just where we manufacture the product but where we sell the product, it’s a very global business. I had a chance just last week when I was in China to visit one of those facilities that also was one of the new manufacturing plants we’re putting up in China. And we had talked about also I think in one of our calls the opportunity to integrate that business with our custom electronic drives business because some of those systems are going variable speed now as well to get at energy efficiency for the large AC systems. And our Unico business has been working on variable speed drive applications for that same segment. We haven’t gone after it together yet, but the teams are now working together to figure out how we can do that and develop not just the motors but the motors and control systems.

So—and we absolutely have that as a growth area and a focus for the Company for the reasons you mentioned – it’s a great fit. It moved from the residential into the larger commercial systems.

Unidentified Analyst

You have about (inaudible) in energy efficient products today. How big do you think that can be over the next five years in light of all the pending energy efficiency legislation coming on board?

John Schlemmer

Yeah, we don’t have an exact target on where we want—it’s a great question. We don’t have an exact target on where we want the energy efficiency mix to be, say, in five years. As I showed, it’s clearly part of our strategy to get to mid-teens operating profit. We measure it in every business where we are today in terms of percent of energy efficient revenue versus total revenue in the Company. I don’t have a great feel for exactly where we want it to be. Certainly we’re focused on growing that every year. You can see that with some of the acquisitions we’ve made, that percentage has come down, not the revenue dollars but the percentage has come down; but that’s a wonderful opportunity because just like in the EPC business, now the question is how do we put that technology into those businesses and help grow those businesses and improve the mix? So I just can’t give you an exact number, only that’s it clearly a focus area for us to continue to grow that space.

Unidentified Analyst

Thanks. Just to circle back on the HVAC downstream initiatives, just wondering when we might start seeing some of those play out, when those will take effect?

Mark Gliebe

You’re talking about some of the new product—

Unidentified Analyst

Some of the new—yeah, as you go downstream, you talked about some cost initiatives, and—

Mark Gliebe

Okay Paul, I think it would be also helpful if you kind of talk about the fact that some of your cost efforts are also focused on energy efficient products, not just standard products.

Paul Goldman

Yeah, so it is broad-based. We’re applying the benefits on two fronts, so we talked a lot about facilities and rationalization, and purposely I’m a little bit vague because we’re talking about facilities and people’s jobs and careers and livelihood, and we’re at the aggressive stage but not completely divulging. So please bear with us that it’s not just as crystal clear as you’d like it to be because it’s not fully communicated within our organization.

But there’s a big component of facility rationalization that is going to take a step function in cost, and it will be across the board. So it will be entry level products, mid, premium, et cetera. It’s broad based across all we do in HVAC.

And the in addition that, the other piece, the 77% of our CAPEX that’s being applied next year to the cost, that is cost from design, so it’s design around aluminum lining, it’s design around alternate materials, it’s design around—I said a secret step function in ECM costs, a new platform that we’re working on that I can’t share yet. So in order to continue to lead the industry across the bases, we’re applying our design smarts to cost in addition to our factory rationalization and base costs.

Unidentified Analyst

So does that help in the low end portion? Does that help your margins in that business, assuming that you maintain share, or do you think you can go after business at a good margin that you’re currently not able to go after?

Paul Goldman

Well, we’re always sensitive to—I mean, we are the price leader in the industry and you may be able to go after it, but it’s do you want to go after it? So it certainly—it helps and enables us to continue to do that. We expect to keep some and we expect to share some with our customers. We’re trying to respond very favorably to our customers – that’s our obligation, but at the same time we see it improving our margins at the same time.

Unidentified Analyst

Thanks. And then, Chuck, if I can sneak one in – with all the moving parts, do you still believe in the 20 to 25% incremental margins?

Chuck Hinrichs

The 20 to 25%?

Unidentified Analyst

You’ve talked in the past—I think last year you talked about achieving with the margin goals that you have, getting 20 to 25% incremental operating margins on—you know, when you’re growing. Is that still a good number that we should think about?

Chuck Hinrichs

Well, I guess at the highest level, yes. I mean, if you think about our gross profit margin at roughly 25%, that would contribute towards it. But then as John talked about, we’ve got the path to expand in the VCP area and improve our product mix, so there’s a number of other variables that we’re focusing on driving that overall profit margin higher.

Mark Gliebe

So I’m going to go ahead and close. First of all, I just want to—John mentioned a number of times that he was just in China, so I want to tell you a little funny story. Six months ago he was in China having a discussion with the team over there, and John’s a runner and they’re talking about running, and they said hey, the Shanghai marathon is coming up. And John says if just one employee tells me that they’ll run the marathon, I’ll come over and run the marathon with them in Shanghai. Well, as it turns out, 27 employees in China signed up to run the marathon, so John comes to me and says, this is really kind of exciting. Here’s the bad news – it’s the Sunday before our analyst day event. So John has been in China for the last week, and on Sunday he ran the Shanghai marathon with 27 other employees, finished it in four hours and—

John Schlemmer

Too long!

Mark Gliebe

Too long? But the real excitement is we are in the midst of changing our brand in China from Hwada to Marathon, so what better time to do a little commercial about the Marathon brand. They had 400 employees show up for the marathon, and they had our banners and it was really kind of an exciting thing. It was great to have John lead the effort there, so.

Anyway, thanks so much for your attention and for coming out this morning. We really appreciate your interest in the company. Hopefully you saw the talent that we have on this team, just people that really get it and you can sense their passion and the energy for the business. We’re optimistic about the future and we really appreciate your support of our company.

There will be lunch outside. There’s a lunchroom in the back. You’re welcome to sit down there. A number of us will be here to sit and talk. If you want to go in the showcase, that’s good as well. So thank you very much.

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