REGAL-BELOIT's CEO Discusses Q3 2012 Results - Earnings Call Transcript

Oct.30.12 | About: Regal Beloit (RBC)

REGAL-BELOIT CORPORATION (NYSE:RBC)

Q3 2012 Earnings Call

October 30, 2012 10:00 a.m. ET

Executives

John Perino – Vice President, Investor Relations

Mark Gliebe – Chairman and Chief Executive Officer

Chuck Hinrichs – Vice President and Chief Financial Officer

Jonathan Schlemmer – Chief Operating Officer

Analysts

Michael Halloran – Robert W. Baird & Co. Inc.

Joshua Pokrzywinski – MKM Partners LLC

Jeff Hammond – KeyBanc Capital Markets

Jamie Sullivan – RBC Capital Markets

Mark Douglas – Longbow Research

Scott Graham – Jefferies & Company

Holden Lewis – BB&T Capital Markets

Bill Dezellem – Tieton Capital Management

Walter Liptak – Barrington Research Associates

Raymond Rund – Shaker Investments

Operator

Good morning everyone and welcome to the Regal-Beloit Third Quarter 2012 Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions)

Please also note that today’s event is being recorded. At this time I’d like to turn the conference call over to Mr. John Perino, Vice President of Investor Relations Mr. Perino, you may begin.

John Perino

Thank you, Jamie. Good morning and welcome to the Regal-Beloit Third Quarter 2012 Earnings Conference Call. Joining me today are Mark Gliebe, Chairman and CEO; Jon Schlemmer, COO; Chuck Hinrichs, Vice President and CFO.

Before turning the call over to Mark, I’d like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of those factors that could cause actual results to differ materially from projected results, please refer to today’s earnings release and our filings with the SEC.

On slide two, we mention that we’re presenting certain non-GAAP financial measures related to adjusted diluted earnings per share, adjusted gross profit, adjusted gross profit as a percentage of net sales and free cash flow. We believe that these are useful measures for providing you with additional insight into our operating performance. Please read this slide for information regarding these non-GAAP financial measures, and please see the appendix where you can find reconciliation of these measures to the most comparable measures in accordance with GAAP.

Now, I’ll turn the call over to Mark.

Mark Gliebe

Welcome and thank you for joining the call and for your interest in Regal-Beloit. Before we get started today, I just want to acknowledge all of our friends, families and business associates who are enduring the storm who are thinking about them and praying for them as I go through this difficult time.

Today, I will start up with opening comments, Chuck will give you a financial update, John will provide colors on the products markets and our operations and then I’ll come back and summarize before we move to Q&A.

Despite softening global economic conditions, Regal posted another quarter of record sales and record earnings in the third quarter. Market conditions weakened as we approached the end of the third quarter putting revenue pressure on most of our businesses. Our HVAC business performed as expected with slight growth in the quarter with a modest mix improvement.

At the end of the quarter, two of our businesses in China were awarded favorable high-tech status from the Chinese government. We have been working on this for some time and we were quite pleased with the outcome. The combination of these results allowed us to achieve the high end of our guidance for the quarter.

A key highlight for the quarter was our free cash flow at 102% of net income which represents the second consecutive quarter where free cash flow was either equal to or greater than net income. Other noteworthy topics from the quarter include first, solid progress on our synergy rationalization programs. Second, we celebrated two ribbon cutting ceremonies in China for our new hermetic motor factor and our new electric generator factory.

And finally, we are continuing our momentum on our simplification initiative. During the quarter we converted three more legacy ERP systems over to our main Oracle environment. We initiated further plant simplification moves and we further consolidated our supply base.

As we look forward, we see continued uncertainty in the macroeconomic environment, which we project will result in softer demand in most of our businesses. Fortunately, between our synergy programs and our simplification initiative and our proactive cost controls, we believe we are taking the right actions to best position our company to react to changing market conditions.

Further, we continue to invest in new products, new facilities and quality improvements that will allow us to continue the great strides we’ve made in customer care. With that, I will turn it over to Chuck.

Chuck Hinrichs

Thank you, Mark and good morning everyone. Our record third quarter results were inline with our earlier guidance. Net sales was $779.5 million, increased 5.8% over the prior year. Excluding the acquired businesses, consolidated sales declined 9.7% from the prior year. Sales in the third quarter reflected slight growth in our North American HVAC business and continued growth in our Unico business.

This growth helps to offset declining demand in our North American industrial markets and weaker economic conditions in our international markets. Also, international sales were negatively impacted by currency exchange rates which reduced sales by 1.7% in the third quarter.

Our third quarter results included $5.2 million or $0.08 per share of restructuring charges related to our synergy programs and simplification initiatives. Of these restructuring charges, $2.8 million were included in the cost of goods sold and $2.4 million were in operating expenses. Third quarter cost of goods sold included a $2.5 million LIFO expense compared to $0.4 million in the prior year.

The other adjustment to our third quarter 2012 earnings was the $0.05 per share tax adjustment. During the quarter, two of our China facilities qualified for the high-tech status which lowers their income tax rate. The $0.05 per share adjustment reflects the refund of taxes paid in the prior year.

In addition, this high-tech status will lower our future effective tax rate in China. As Mark mentioned, we are proud of our China team’s success and achieving this recognition and tax incentive.

In summary, our third quarter 2012 earnings per share of $0.29 were inline with our guidance for the quarter. To calculate our adjusted earnings per share, we add $0.08 per share for restructuring charges and subtract $0.05 per share for the prior year tax benefit. Our adjusted EPS was $1.32 for the third quarter.

This chart summarizes our third quarter sales growth of 6%, operating profit growth of 7%, and earnings per share growth of 14%, all presented on a GAAP basis. The next chart summarizes the same data but on an adjusted basis. Sales growth of 6%, adjusted operating profit increased 1% and adjusted earnings per share increased 1% as compared to the prior year.

The takeaway here is that, even with the uncertain economic environment and the slowing international markets we faced in the third quarter, we generated modest growth in our key operating metrics and substantially protected our profit margins. Let me provide some additional details on our financial performance.

In the upper left quadrant, we summarized data on our capital expenditures. In the third quarter, our capital spending of $21 million included the completion of the two new factories in China which we recently relocated. We also received $5 million of government grants during the quarter to assist in the relocation. We estimate spending approximately $20 million in capital this fourth quarter. For full year 2012 capital expenditures of $85 million.

In the upper right quadrant, we provide income tax information. Our effective tax rate in the third quarter was 24.5%. Our ETR in the quarter benefited from the high-tech status of our two China facilities and the lower ETR reflects the tax refund from the prior year and an expected lower tax provision in the current year.

We estimate our ETR to be approximately 26% in the fourth quarter 2012. In the lower left quadrant, we highlight our strong free cash flow in the third quarter of $55 million equal to 102% of net income for the quarter. This is the sixth consecutive quarter that we generated free cash flow at or greater than net income. On year-to-date basis, our 2012 free cash flow was $217 million, equal to 131% of net income. We are focused on generating free cash flow for debt reduction to improve shareholder value, pay dividends and fund our future growth.

In the lower right quadrant, we summarize our credit metrics. At the end of the third quarter, total debt was $866 million, a decrease of $45 million in the quarter. We continue to drive improvement in our credit metrics with our strong free cash flow, even with the higher level of capital expenditures in 2012. As we look to the fourth quarter, we expect earnings per share on a GAAP basis, to be $0.58 to $0.66 per share.

Our guidance includes $5.6 million or $0.09 per share of fourth quarter restructuring charges for cost of synergy program. Our adjusted earnings per share guidance of $0.67 to $0.75 per share adds back the $0.09 of restructuring charges to the GAAP guidance.

As we’ve previously discussed, our fourth quarter sales are seasonally our lowest sales, averaging 23% of our annual sales. Fourth quarter sales are normally 10% below the third quarter sales level. In this fourth quarter, we expect to see modest sales growth in our residential HVAC business while our other North American and international businesses are experiencing weaker demand. Sales in our international businesses are also expected to face currency translation losses, similar to what we experienced in the third quarter. Also our fourth quarter guidance includes approximately $4 million of projected LIFO expense.

Recall in the fourth quarter of 2011, we experienced a LIFO benefit of $5.4 million. To defend our profit margin, we are reducing our labor and variable costs and managing our SG&A expenses.

Now I will turn the presentation over to Jon Schlemmer.

Jonathan Schlemmer

Thanks, Chuck. Good morning everyone. The third quarter seemed to have two distinct faces. During the early part of the quarter most of our businesses were tracking to our forecast and order rates were consistent with our projections. Then, in the latter part of the quarter, many of our businesses including residential HVAC seem to soften rather quickly.

We believe much of this was related to the general uncertainty in the global markets. For the quarter, sales in our North American commercial and industrial motors business declined by 6.4%. Our North American mechanical businesses were also impacted by the same market conditions with sales declining nearly 1% for the quarter, compared to the same period prior year.

We saw order strengthen in areas such as commercial HVAC other than refrigerated transportation, packaging and conveying and also telecom. However, standby power generation, industrial pump, agriculture and oil and gas were all slow.

Overall distribution remained flat throughout most of the quarter. Our sales to regions outside the US declined by 9.4% compared to the third quarter of 2011. However foreign currency exchange rates represented about one-third of this decrease. Sales of industrial motors, hermitic motors and electric generators into the China domestic market was one of our bigger challenges in the quarter.

We are hopeful that the recent upturn in the China Flash PMI is a sign that the government stimulus is having a positive effect. Sales outside the US still represented approximately 31% of our total sales. The Unico business performed well with 32% sales growth. The strength is from oil and gas, particularly in Latin America as well as automotive. While orders have moderated somewhat, the Unico team continues to launch new versions of its popular LRP artificial lift system to help expand the product range. This allows Unico’s products to be used on deeper wells and in more applications.

And as we anticipated, our residential HVAC business improved with sales up 0.4% compared to the prior year. This improvement from the first half comparisons was the result of stronger demand early in the third quarter, most likely as a result of the warm weather and improved mix. We have a lot of momentum with our restructuring programs and our simplification initiatives to help us reduce our cost and put ourselves in a position to minimize the impact of weaker demand should it continue.

I want to give you an update on these programs. First is the restructuring of our Juarez manufacturing operations. Last quarter we talked about our plans to consolidate our operations in the Juarez region and closed four of our manufacturing facilities. We are making excellent progress and we are on track to complete these moves by mid-2013.

One of the four moves have already been completed. This is all about aligning the production of EPC products with legacy Regal products, putting light products into the same facilities and taking advantage of our combined footprint in Mexico. The moves will make us more efficient and improve the quality and delivery performance for our customers and also reduce overhead costs.

We also previously announced our plans to consolidate our North America warehouses allowing us to exit three warehouses. As of today, one of these warehouses has already been closed and the other two will be completed this quarter as planned and on schedule. Again this is part of the acquisition synergies.

In addition to the synergy programs and consistent with our simplification initiatives, we are making progress on further plant rationalization efforts. During the third quarter, we also announced plans for further rationalization of our manufacturing facilities in Mexico. We will be transferring some of our products from our facilities in Monterrey into our larger operations in Mexico.

This simplification move will help improve the quality and lead times of these products for our customers and as part of our ongoing efforts to simplify our operations. We will complete the transfer of these products in 2013. And as Mark mentioned, we converted three of our ERP systems during the quarter. We also made good progress on our 2012 goal to consolidate and reduce 120 suppliers from our global supply base.

And finally, our engineering team will be implementing a common engineering database in the next month. What this means is that all of our technical drawings and our standards will be on a single Regal database making the information accessible to all of our engineers in every location. This will help generate more ideas for cost reductions and speed up new product development.

Our simplification initiative is gaining real momentum. We’ll have more details to share on simplification during our Investor Day Meeting in December. While we are rationalizing our factories in Mexico and making them more efficient, we are relocating our factories in China while at the same time upgrading the facilities and improving efficiencies.

Here are pictures taken during the grand opening ceremonies last month at our two new China facilities. We took the opportunity to showcase these facilities to our customers, suppliers and our employees.

Mark actually attended both events and came back excited about our team and the lean improvements that we’re making. The commercial hermitic plant is shown on the left and the generator plant on the right. Both are now fully operational and we’ve completed the transitions. We implemented lean production concepts and process improvements to yield productivity and quality improvements supporting our long-term growth objectives.

We did received financial assistance from the China government to help fund a portion of these moves. Even though the current market conditions in China are challenging, we are confident that these are great investments for the company and when the China market comes back, we will be well positioned. While the restructuring and simplification efforts are critical to improving our operating performance, we haven’t let up on new product development efforts.

Sales of energy efficient products during the quarter represented approximately 22% of our net sales. We continue to see opportunities for energy efficiency in nearly every business and every part of the world. Today I want to show you two more of the new products recently developed by our teams; the first one is a great example of energy efficiency in a wide range of commercial and industrial applications.

Our commercial and industrial motor business teamed up with our mechanical team to introduce a high performance, energy efficient gear motor solution. This is a combination of our new High Efficiency Right Angle or HERA gear box from Hub City and our energy efficient Max series motors from Marathon.

The combination called HERA-MAX is the customer drop-in replacement for standard warm gear motor drives. The HERA-MAX can reduce energy cost by up to 35%. HERA-MAX was also designed to help our customers to reduce their inventory levels in some cases by up to 75% by making many features and options interchangeable such as shafts, brake kits, encoders and mountings.

The new design offers improved energy efficiency, weight and size reduction, increased reliability and flexibility to adapt to more applications. One of our national power transmission distributors is launching this new product and we’ve already seen the benefits as customers have begun utilizing HERA-MAX on their more demanding applications.

Shown in the picture on the lower right is an interesting application of HERA-MAX on one of Unico’s new oil and gas pump designs. This new pump has been piloted with one of our key growth customers in Mexico. It’s great to see Unico utilizing our latest gear drives and motor technology on their innovative systems.

Second, our Marathon team also launched another new product in the third quarter expanding our capability to provide large frame IEC motors to our customers in North America. While it mean that designed motors are commonly used by our customers in North America, many of our customers also design and build products for projects and export opportunities where IEC standards are required.

Our Marathon team works with our large motor team in China to co-develop this new product range for our customers in North America. This 450 frame IEC motor expands our Marathon IEC offerings to 1250 horsepower and the motors are up to 95% efficient. The motors can be used in a wide range of applications including water and waste water, steel mills, pulp and paper and oil and gas.

The team used our existing IEC designs and many of our IEC components supplied by our China operations to reduce the investment and to accelerate the product development cycle. We can now produce custom IEC motors with much shorter lead times for our customers in North America who require motors meeting these standards.

This is a great example of our engineering teams in the US and China working together to develop an entire new range of products for our commercial and industrial business. Our teams launched 13 new products in the third quarter. These were just two examples, but they hopefully give you an idea of what we are doing to bring new technologies to our customers and grow the business.

In summary, while the economic conditions are uncertain, you can be certain that our operating teams will continue to execute on the synergy programs, execute on the simplification plans and execute on the new product introductions that we’ve laid out. As the market turns up, we’ll be in a great position. If the markets don’t, we’ll be better prepared.

With that, I’ll turn it back over to Mark.

Mark Gliebe

Thanks, Jon. So to summarize, it was another record quarter of sales and earnings. We finished the quarter at the high end of our guidance and we are consistently generating solid free cash flow. The timing of our synergy programs and our simplification initiatives cannot be any better. We will begin to see a modest positive impact from this heavy lifting late this year and more significant benefits as we move into 2013.

With our fourth quarter guidance, we expected typical seasonal decline combined with the weak overall market conditions. The residential HVAC business is projected to experience modest growth while we expect continued soft conditions in our other North American and international businesses.

Finally, we expect the business to continue to generate strong free cash flows which we plan to use delever the balance sheet and to continue to seek out strategic acquisition opportunities. Our acquisition pipeline remains strong and we continue to actively seek candidates that meet our strategic objectives and financial criteria. We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mike Halloran from Robert Baird. Please go ahead with your question.

Michael Halloran – Robert W. Baird & Co. Inc

Morning guys.

Mark Gliebe

Good morning, Mike.

Michael Halloran – Robert W. Baird & Co. Inc.

So, first on the commercial and industrial side of the business, could you try to parse out what the components of the downside on the growth rates are, specifically? Maybe talk a little bit about whether you see some destocking with your customer base, how much of it is just end-market trends and if there is any sense if there is some share loss going on here. It doesn’t sound like it, but wouldn’t mind here in the components if you could?

Mark Gliebe

Well, relative to the C&I, certainly our biggest challenge within our commercial and industrial businesses was the power generation business. It was the business we struggled the most with during the quarter. I do want to remind you that last year at this time that business was getting the benefits of product that was being sent over to Japan during the nuclear issue that they had there and the Tsunami. That was certainly the biggest challenge for the quarter. If you look at, Jon talked about a number of end-markets that was struggling, certainly the general and industrial market he talked about, industrial farm he talked about parts of the oil and gas space and we saw kind of across the board downturns in terms of demand. Relative to inventory, in that particular space, it’s hard for us to say. I will give you a sense that people are just holding back until we get through some of the uncertainty in the US. Obviously, we are always looking very hard at making sure that there is no share loss and we have no indication of that at this time in that particular space.

Michael Halloran – Robert W. Baird & Co. Inc.

That makes sense and then kind of working through how you get from the third quarter number towards the fourth quarter guidance range, again, can we try to put this in buckets. It certainly sounds like the LIFO side gets a little bit worst and that’s a headwind here. You obviously have, I think Chuck mentioned about a 10% normal sequential decline from 4Q to 3Q, 4Q maybe it’s even a little bit bigger than that. How much of this is normal seasonality? How much of it is a little bit worsening trends when you hit the fourth quarter? Are there any businesses that you think are going to be a little bit worse than normal? Because certainly the margins should held up exceptionally well here and so I wouldn’t mind trying to get a little bit more delineation as you get from 3Q to 4Q?

Mark Gliebe

Sure, Mike. I’ll try to answer that for you. I think to start with, we have to start with the third quarter base which was lower than we had seen in our second quarter. So, and then apply the normal fourth quarter seasonality down. So that’s about a 10% down on average in the past. And then, and you filter in the market conditions that Mark and John had talked about the FX translation issues that we faced in the international business and so that kind of gets us to where we see the forecast for the top line in the fourth quarter.

Michael Halloran – Robert W. Baird & Co. Inc.

Okay.

Mark Gliebe

And then as you work down the P&L, the LIFO, particularly the year-over-year change is very significant as it impacts gross margin and operating profit margin.

Michael Halloran – Robert W. Baird & Co. Inc.

So from a top line perspective, it sounds like the growth rates aren’t going to be much different in the fourth quarter than the third quarter, it’s just the comparisons are lot easier for the fourth quarter. So that incremental decline here is going to see a little bit worse from an earnings perspective?

Mark Gliebe

I think that’s accurate, yes, Mike.

Michael Halloran – Robert W. Baird & Co. Inc.

Okay. And then on the margin line, tough top line environment, but the margins have held in there very, very well. Maybe a little discussion about what’s going on underneath from a standpoint of what are the levers you guys are pulling at this point? You certainly gave a lot of color on some of the consolidations and the underlying operational improvements, but maybe a little more color there as well as, any reason why relative to the revenue levels you are seeing now that this isn’t a good base to build off if not maybe even a little bit low as some of these synergy things start rolling through in 2013?

Mark Gliebe

Well, if you look back over time, we typically have lower revenues and lower margins in the fourth quarter and so that’s probably the starting point. But relative to the proactive things we’ve done, we didn’t start just to score, oh we started six months ago looking at the expenses and controlling both on the cost of goods sold side as well as our SG&A line. Relative to labor, we are adjusting labor to the market conditions and that’s point one and then point two, driving productivity improvements and efficiency improvements in our facilities. And so, we’ve been doing that all year and that’s kind of certainly supports our margin improvements. And on the SG&A lines, we are doing all the normal stuff that you would do when you have the kind of uncertainty we are facing. So, all the normal levers.

Michael Halloran – Robert W. Baird & Co. Inc.

Sounds good and then a last one housekeeping item, Chuck, you said 26% tax rate for the fourth quarter, is that fair for ‘13 or should we be thinking something more towards your normalized 28% 30% type range?

Chuck Hinrichs

It will be closer to that range, but we’ll provide some more information on our 2013 tax guidance at our Investor Day in December.

Michael Halloran – Robert W. Baird & Co. Inc.

Sounds good. Appreciate the time.

Operator

Our next question comes from Josh Joshua Pokrzywinski from MKM Partners. Please go ahead with your question.

Joshua Pokrzywinski – MKM Partners LLC

Good morning guys.

Mark Gliebe

Good morning Josh.

Joshua Pokrzywinski – MKM Partners LLC

Just wanted to dive in on C&I in the third quarter, what was the shortfall versus your plan and maybe I missed the answer before, but impact of destocking and cancellations?

Mark Gliebe

Yeah, Josh, the comment that I made earlier to Jeff is that the power generation space was certainly our biggest struggle for the third quarter. And I want to remind everybody that we did have a tough comp on the third quarter because last year we shipped a lot of products over to Japan as a result of the Tsunami. So that was a certainly a tough comparison, but the demand meaningfully declined in that particular product line throughout the quarter. So that was point one and then, whether or not our customers are destocking, I would just say everybody is gun shy right now and that ties to the uncertainty we are seeing in the North American market relative to all the things you already know about.

Joshua Pokrzywinski – MKM Partners LLC

I guess, while I was going with the question was you guys were probably aware of the tough comp going into the quarter and if I am recalling this tone right from the last conference call, you seemed pretty realistic or I guess maybe pessimistic on, particularly China, but North America in some respect as well. So I guess, I’m just wondering, if C&I missed your plan because of the power gen comp or was it North America just like your distribution business stepping down through the quarter? Or I guess if that is the case, how do we look into October here?

Jonathan Schlemmer

Josh, this is Jon. I’ll see if I can answer that. So, you are right, as – when we talked about the second quarter results we had mentioned that we were seeing order rates moderating in the C&I segment of our business. We certainly saw that but as I mentioned, the order strength deteriorated through the quarter. So the latter part of the quarter was tougher. We started off pretty much where we expect it to be and then we saw that deterioration through the quarter. I would say that, so it’s certainly a sharper downturn than what we had expected and anticipated and I would describe it as more of the end-markets impacted than what we had anticipated as we entered the third quarter and also distribution was pretty flat through the quarter. So, we didn’t have some of the strength in distribution that we had seen earlier in the year and certainly in the second quarter.

Joshua Pokrzywinski – MKM Partners LLC

Okay, and then October?

Jonathan Schlemmer

I would say that’s mixed right now in terms of – if you look at our business today, it’s mixed and choppy, if you look at our businesses today and what we are seeing for order strength, some businesses are up a little bit better than where we exited September, other business are running at similar order rates than what we saw in the September timeframe. And it’s a bit choppy, some week we’ll get a good report one week and then in the next week, we’ll see a drop off again in orders.

Joshua Pokrzywinski – MKM Partners LLC

Jon, that’s helpful and then maybe just thinking HVAC and thinking about some of the moving parts in the next year and I know you guys are really ready to talk annual guidance or annual demand guidance at this point. But thinking about the HVAC business, clearly new housing becomes a pretty nice tailwind for you guys, maybe 15% to 20% of that business on the HVAC side going into new housing up and on a 25% some of the consensus to work ups, thinking about, R22 becoming a probably a net tailwind going from the way some of the players in the states described it, 15% of the mix today to maybe less than 10% next year and a small replacement component on the volume side, you start to get this in pretty big numbers and I know you guys have been underperforming the market for a while and some of that is mixed with high efficiency. I have to imagine that in the next year, not really a drag anymore, it kind of ends up being in the comp and R22 shifting in your favor, you stat to think about a double-digit year with a pretty realistic view. I mean, is there anything else I need to keep in mind in terms of the moving pieces that I maybe missing here?

Mark Gliebe

I think you are saying about all the right items. The only one perhaps that you didn’t mention is, if in fact these regional efficiency standards go in place that would be further tailwind in that business. So, we are hearing and seeing all the same things you are and all of them seem to be directionally good for us. So, we are not ready to talk about 2013, but directionally that’s the way to think about it.

Joshua Pokrzywinski – MKM Partners LLC

So you guys think that the underperformance versus market is in the comp at this point and you guys kind of flushed all that out?

Mark Gliebe

It’s probably too soon to talk about it right now, but I think the items you mentioned are in our favor.

Joshua Pokrzywinski – MKM Partners LLC

Gotcha. And then just one last one on the balance sheet, obviously, you guys put up good free cash flow on the balance sheet starting to look pretty tidy again, especially if you look at over the next year, what is the management capacity to do kind of another sizable deal in ‘13? Will you guys be integrated enough on EPC to go that route or is that something you want to sit back and you maybe wait another year?

Mark Gliebe

From a management capacity, and obviously from a balance sheet perspective, I think we are in good shape. We now have 18 months passed since our largest acquisition. We feel great about the ways the integration of the business has gone. We obviously have some heavy lifting to do relative to facility rationalization that’s still in front of us. But, that would not stop us from moving forward. In our pipeline, we have small bolt-ons that we are looking at and we have larger transactions similar to the size of the EPC acquisitions that we are looking at.

Joshua Pokrzywinski – MKM Partners LLC

Gotcha, understood. Thanks much guys.

Mark Gliebe

Thanks, Josh.

Operator

Our next question comes from Christopher Glynn from Oppenheimer. Please go ahead with your question.

Christopher Glynn – Oppenheimer

Thanks, good morning.

Mark Gliebe

Good morning, Chris.

Christopher Glynn – Oppenheimer

Mark, I was looking for some of your thoughts on Asia. It sounds like that was the toughest market in the past several months. Just wondering if you are thinking that’s stabilizing and establishing a run rate and is there a different or rather characterizing the difference in competitive dynamics there versus domestically?

Mark Gliebe

Well, first of all, there are two questions there, what do we see happening there and two what are the competitive dynamics. The markets – we are still seeing a weakening in that particular part of the world and we saw the Flash PMI that came up early this week indicating that perhaps there is some response to the government stimulus. We are hopeful that that’s case, obviously we are positioned well when that business – when that part of the world comes back. But we haven’t seen a significant turnaround yet in that space. The competitive dynamics, it is a somewhat different space for us than the US. We don’t have a large exposure to residential HVAC over there. Our exposure is more on the commercial and industrial side. And so it’s a different set of competition.

Christopher Glynn – Oppenheimer

Okay and your relative ability to defend and grow market share there versus here?

Mark Gliebe

Yes, so, if you think about the China market, you have a number of the large competitors that you got on the commercial and industrial side such as ABB and Siemens and WEG. They would be on a global basis NIDEC as well. So positive same competition we have kind of all over the world, but additionally there are many, many smaller less sophisticated players the China market has not yet consolidated and there is an opportunity to win and to grow in – because we have relatively low share in that space and there is lots of fragmented competition over there.

Christopher Glynn – Oppenheimer

Sounds good. Thank you.

Mark Gliebe

Thanks, Chris.

Operator

Our next question comes from Jeff Hammond from KeyBanc Capital Markets. Please go ahead with your question.

Jeff Hammond – KeyBanc Capital Markets

Hey guys.

Mark Gliebe

Good morning Jeff.

Jeff Hammond – KeyBanc Capital Markets

I know you touched upon the power generation, but I’m struggling with the moving pieces to get to the down nine organic in electric as you said, commercial industrial down six, international down nine, HVAC flat, I mean, is it just that power gen was that – or maybe you can quantify what the power gen does decline as to help us bridge to the down nine?

Mark Gliebe

Well, the power gen number would have been in the North America down six.

Jeff Hammond – KeyBanc Capital Markets

Okay, so what’s worst than the down nine to get us to down nine, international, commercial and industrial?

Mark Gliebe

I just misspoke, the down six was motors only and in addition to that you have the impact of our power generation business.

Jeff Hammond – KeyBanc Capital Markets

Okay, so, versus the consensus, because you keep coming back to power gen which it seems like, we knew that there was a tough comp there. And I know you don’t give revenue guidance, but you missed the consensus number by $60 million and I am just wondering, again if you understood that the power gen was tough comp like where that big variance was or was just the street estimate is too high relative to your internal plan from the start?

Mark Gliebe

Yes, it’s the third time, we obviously knew going into the quarter what we did the prior year and we certainly expected the power gen space to be down year-over-year, it was down greater than we had expected.

Jeff Hammond – KeyBanc Capital Markets

But it was like, was HVAC a shortfall versus expectations?

Mark Gliebe

Well, I would say, yes. We would have expected slightly more growth than what we had. I think as we came out of the early part of the third quarter, we were benefiting rather significantly from the warm weather and so we came up strong and then it tailed off rather quickly. But we weren’t expecting that fast tail off in that particular area. We would have expected slightly higher growth rates, I think everybody did and everybody came in relatively low.

Jeff Hammond – KeyBanc Capital Markets

Okay and then just shifting gears to energy efficiency mix that number continues to go up and it just seems like your HVAC mix has been going against you and I just want to understand, how much of that is just what you acquired recently having a higher mix versus like where is really that increase coming from?

Jonathan Schlemmer

Jeff, I’ll try to add some color to that. So I’d say it’s a little bit of both. Certainly there is some good mix with some of the acquired businesses that are helping with that number. Milwaukee Gear is an example. There is a lot of high efficiency gearing. So, all of that counts us to high efficiency product mix as part of that metric. So, some would be impact from acquisitions. HVAC actually was a bit positive in the third quarter which is a nice improvement from what we’ve seen in the past with all the dynamics we’ve been talking about in the HVAC business. So that was good to see some improvement and product mix on the HVAC side in the third quarter. And then we have the ongoing penetration in the C&I business with higher efficiency motors. The change that took place in the US. We mentioned that that we had the change that took place in Canada, that’s now certainly the take effect and we had some improvement as well in energy efficient industrial motors being sold in the international businesses. So all of those are contributing to that gradual increase in percent of energy efficient products.

Jeff Hammond – KeyBanc Capital Markets

Okay that’s good. And then, I know you’ve updated us on EPC and some stuff is maybe running ahead and things are moving a little bit, but can you remind me how you are thinking about incremental cost savings from EPC in 2013 I know, if that’s taking you back to the original bridge or as that’s changed, what the new number is? I can make my own assumptions I guess into ‘13 on the macro, but I’m just looking for a little help on kind of how you are thinking about incremental integration savings from that into ‘13?

Chuck Hinrichs

Jeff, as we’ve talked about in the past, EPC is now integrated with our Regal business and so we are operating as one Regal. So the savings and the performance are really rolled up and reported through the synergy program and so we had updated that last quarter and so we’ll continue to provide guidance on that as we go into 2013. But EPC is really it doesn’t have a standalone P&L that we talk about publicly.

Jeff Hammond – KeyBanc Capital Markets

Okay, maybe then to ask it another way, you talked about, Jon went through some of the restructuring actions and update there. Can you talk about, if you take all your restructuring actions, EPC or otherwise how you are thinking about what the payback is and cost savings in the ‘13 is from those collective actions?

Chuck Hinrichs

We laid it out by a year in the last earnings call and we show that in 2020, that in the first year, we had $10 million of synergies. So that would have been August to August which just ended recently three or four months ago. In the second year, we’ll have $20 million and in the third year, we’ll have $30 million and what we did is we – I’m sorry, in the second year we’ll have $25 million, in the third year we’ll have $38 million. So we did two things, we pulled it in by a year when we increased it by $3 million in terms of what the savings were.

Jeff Hammond – KeyBanc Capital Markets

Okay, so the $25 million is August to August?

Chuck Hinrichs

August to August, that’s correct

Jeff Hammond – KeyBanc Capital Markets

Okay, perfect. I’ll go back and look at that. Thanks guys.

Jon Schlemmer

Thanks, Jeff.

Operator

Our next question comes from Jamie Sullivan from RBC Capital Markets. Please go ahead with your question.

Jamie Sullivan – RBC Capital Markets

Hi good morning.

Mark Gliebe

Good morning.

Jamie Sullivan – RBC Capital Markets

With some of the discussion about Asia, how much was Asia down in the quarter?

Mark Gliebe

The only number that we’ve talked about is that total international sales were down 9%. Now, I will tell you that most – relative to small exposure to Europe and the largest part of that would have been Asia.

Jonathan Schlemmer

And then Jamie, the currency translation loss obviously would impact some of the Asian business, particularly India and Australia.

Jamie Sullivan – RBC Capital Markets

Okay, thanks and does Asia, obviously on a year-over-year basis, the comps are tough, but does it continue to deteriorate sequentially as well?

Mark Gliebe

In the fourth quarter, the answer to that would be yes, now, we haven’t seen that all year. But again, there is a little bit of seasonality in that business but I would say yes in the fourth quarter.

Jamie Sullivan – RBC Capital Markets

Okay, great and moving to HVAC, it sounds like you had some mix benefit in the quarter, what was the volume trends that you experienced?

Mark Gliebe

Can you ask that again, Jamie, I missed that?

Jamie Sullivan – RBC Capital Markets

So you had some benefit of mix from high efficiency that you mentioned in HVAC where volume is still down year-over-year but you got the benefit of mix driving that business up?

Chuck Hinrichs

No, Jamie, volumes were down for the quarter. So I would say volumes were just slightly up and then we also had some mix improvement. So I would say, not real strong of either but both positive.

Jamie Sullivan – RBC Capital Markets

Right, okay. And then maybe just to follow on with the cost savings question, I guess maybe through the September quarter what were the synergies that you have achieved at this point or the cost savings?

Chuck Hinrichs

Well, if you look at what Mark was mentioning before, we had anticipated, actually our original estimate was $10 million for year one. We actually improved that to $12 million and that was exactly what we saw in the first year that August of ‘11 to August ‘12 with most of that – lot of that benefit coming in ‘12 this year. And so, then there will be of course a little bit additional for the month of September. But I view that number as a pretty close number for what we actually realized for our synergy savings.

Jamie Sullivan – RBC Capital Markets

Okay, great. Thank you very much.

Mark Gliebe

Thank you.

Operator

Our next question comes from Mark Douglas from Longbow Research. Please go ahead with your question.

Mark Douglas – Longbow Research

Good morning, gentlemen.

Mark Gliebe

Good morning, Mark.

Mark Douglas – Longbow Research

Back to the synergy, so the $5 million in restructuring and then further restructuring in 4Q, how much of that is part of the original plan you’ve been laying out here versus new actions because of the softer marketing conditions?

Mark Gliebe

It’s all related to the original EPC acquisition.

Mark Douglas – Longbow Research

Okay, so you done nothing separate or to accelerate or come up with new programs because of the softer marketing conditions.

Mark Gliebe

Then nothing that would have been put into that restructuring bucket.

Mark Douglas – Longbow Research

Okay, so what sorts you’ve been doing maybe would be on the – maybe variable cost line, the timing and shipping round of hours for labor and such?

Chuck Hinrichs

Yes, Mark it would be those typical tactical responses to some fall-off in demand and then trimming our SG&A expenses which typically don’t qualify for restructuring charges.

Mark Douglas – Longbow Research

I see, okay. And then, on the resi HVAC, can you talk about what it typically is in the fourth quarter on an annual basis your chart shows about 30%, in the fourth quarter does it typically decline to like 25% of sales? Can you give a little bit color as to how the seasonal trends workout through the year at least in resi HVAC?

Chuck Hinrichs

Mark, the guidance that we had given that the third quarter is usually around 26% and then declining to 23% in the fourth quarter would be for the consolidated business.

Mark Douglas – Longbow Research

Right.

Chuck Hinrichs

We haven’t provided any seasonal guidance on the HVAC business on a standalone basis.

Mark Douglas – Longbow Research

Okay, is it typically little worse than that?

Chuck Hinrichs

Yes, because a lot of our business would be cooling rather than heating, but we still have products that go into the heating part.

Mark Douglas – Longbow Research

Okay, thank you.

Mark Gliebe

Thanks, Mark.

Operator

Our next question comes from Scott Graham from Jefferies. Please go ahead with your question.

Scott Graham – Jefferies & Company

Hi, good morning. Most of my questions have been answered. The only one I really had was, this is the time that you guys talk to your OEMs about what HVAC looks like next year and then typically come back to you with a sales volume number. I was wondering if that’s something you can share with us at this point?

Mark Gliebe

Well, there is a lot of moving parts as we talked about earlier. And you are right, this is the time we are not yet ready to have that dialogue because of all the moving parts. We have couple of inputs Jon will share with you and we’ll probably share more at the Investor Day. Go ahead Jon.

Jon Schlemmer

Thanks, Mark. So, Scott I’d say it is a little early at this point that some of the early indication that we’ve received is OEMs looking at low single digits up next year versus 2012, but I would say the overall tone is pretty cautious right now.

Scott Graham – Jefferies & Company

Okay, so low-single, volume or sales?

Jon Schlemmer

It would be sales.

Scott Graham – Jefferies & Company

Okay, and are any of them talking about destocking going into the fourth quarter and if so, is that destocking impacting your fourth quarter guidance, I assume it would be?

Jon Schlemmer

I would say, none of the OEMs are actually talking about destocking. We work on a pretty quick cycle with them. But I can tell you that our historical experience with the large customers is that they tend to act rather aggressively to reduce inventory late in the fourth quarter. That has been our history and we have obviously baked that into our guidance.

Scott Graham – Jefferies & Company

Very good, that was my question. Thanks a lot.

Jon Schlemmer

Thank you.

Operator

Our next question comes from Holden Lewis from BB&T. Please go ahead with your question.

Holden Lewis – BB&T Capital Markets

Thanks, good morning.

Mark Gliebe

Good morning, Holden.

Holden Lewis – BB&T Capital Markets

Two things. Can you guys give us an update on your price cost outlook at this point, is that improving?

Chuck Hinrichs

On the price cost, I would say in the third quarter, we were modestly positive, in the fourth quarter we think it will be pretty much a wash. I am sorry, in the fourth quarter it would be pretty much a wash.

Mark Gliebe

Holden, just to add some color to that, we have a lot of our OEM business and HVAC under material price formula. So, those prices are catching up with some of the commodity deflation that we’ve seen in 2012.

Holden Lewis – BB&T Capital Markets

Gotcha, okay. That’s roughly usual. How about your expectations for production or under producing, it’s slowing that you are seeing is it causing you to rail back on your production and get inventories in line, is that having a drag on cost of goods at all or is it pretty much matching production with demand now?

Chuck Hinrichs

Well, I would say that, we are pretty well constantly adjusting our production rates to current demand. We do that on a fairly regular basis. So, as we look at we enter the fourth quarter, there is certainly some of that as we saw the decrease in the latter part of the third quarter, so we have – in some cases where we are reducing demand offset inventory levels to get inventories in line. But I’d say we’ll work that out probably through the quarter.

Holden Lewis – BB&T Capital Markets

Okay, but currently as we think about these going forward, at this point this is not being like the price cost or sort of the production schedule, this does not look like real sort of improving variables for you at this point, it’s pretty good balance?

Mark Gliebe

I would say generally speaking, we already mentioned the price cost what we have been looking at in the fourth quarter Jon discussed what’s happening to our manufacturing facilities responded inventory. We normally have lower margins going into the fourth quarter and if you look back over time and I think we’ll see that here in the fourth quarter.

Holden Lewis – BB&T Capital Markets

Okay, and then just last thing, kind of going back to the discussion about the relative growth of your two big businesses, it looks like going forward we’ll have a flip in sort of the recent trends where industrial maybe weak but HVAC be relatively strong. Can you talk about what that means to you from a market mix standpoint. Is there some reason whether the – sort of the HVAC market, it is the raw material differences, when you think about getting a dollar of HVAC instead the dollar of industrial, is there a reason that – is that positive, negative, during this rate, how should we view that that sort of a mix impact as we look forward to a shift in top trends?

Mark Gliebe

It’s a good question, Holden. I think you should think about it as, us being indifferent.

Holden Lewis – BB&T Capital Markets

Okay, so in terms of operating leverage, in terms of raw material usage, all those things, they are closed enough that you just – that it doesn’t matter for you at the – at sort of the gross margin or operating margin line?

Mark Gliebe

That’s correct.

Holden Lewis – BB&T Capital Markets Capital Markets

Okay. All right. Thanks, guys.

Mark Gliebe

Thanks, Holden.

Operator

Our next question comes from Bill Dezellem from Tieton Capital Management. Please go ahead with your question.

Bill Dezellem – Tieton Capital Management

Thank you. I’d like to ask a follow-up on couple or one of the questions before and that’s relative to the customer inventory reduction that you normally see in the fourth quarter. But you also mentioned earlier in the call that your customers in general are being more cautious with their inventory. So does that imply that they are going Interviewer: the quarter with less inventory and therefore there is a potential that you will have a more modest negative impact from your customers cutting their inventory. Or am I just not hearing that right?

Mark Gliebe

Well, we were talking about two different sets of customers there. The comment I made on our large HVAC OEMs, the comment I made is that, historically we have seen that our large OEMs tend to reduce their production in the fourth quarter do adjust their inventories and they do that quickly and aggressively and we’ve seen that enough that was kind of built that into our thinking. The other comment that was made is relative to our commercial and industrial customers that we thought they were being somewhat cautious. It’s a different set of customers. That helps answer your question, Bill?

Bill Dezellem – Tieton Capital Management

Yes. Thank you for your clarification and apologies for my confusion.

Mark Gliebe

No problem.

Bill Dezellem – Tieton Capital Management

Relative to your inventories, they increased sequentially, but were lower than a year ago. So that sequential increase in Regal’s inventories, is that a function of sales being softer than you anticipated and now you had some – of your own inventories to work off? What are the dynamics that we ought to be thinking about there?

Mark Gliebe

Well, there are two things to think about. The first one is the fact that as we go through these manufacturing transitions and these transitions, the ones we’ve talked about are both plant relocations, two in China, a number of them in Juarez and then also the ERP conversions that we are doing. You tend to build inventory going into those conversions to protect the customers. So that’s some of what you saw at the end of the third quarter and then also I would say that, yes there was a little bit of – demand was softer than we had expected late in the quarter. So, it’s not a significant number to work off, but there is a little bit there.

Bill Dezellem – Tieton Capital Management

The bigger component is your planning for these changes as you discussed on plant moves and ERP system?

Mark Gliebe

That’s correct.

Bill Dezellem – Tieton Capital Management

Great. Thank you for the time.

Mark Gliebe

Thank you, Bill.

Operator

Our next question comes from Walt Liptak from Barrington Research. Please go ahead with your question.

Walter Liptak – Barrington Research Associates

All right. Thanks, good morning guys.

Mark Gliebe

Good morning Walt.

Walter Liptak – Barrington Research Associates

I wanted to ask about the quarter relation to your long-term margin targets for 2015. I wonder if there is anyway that you can characterize kind of where we are – I think US turning a little bit different with international weakening and how that impacts your thoughts on getting to those targets?

Mark Gliebe

Well, we are never going to back off our targets that’s for sure in every business is marching to that and the fact that we are stepped our synergy targets to $38 million sounds that we were certainly on the march towards our targets. Certainly, if we get significant volume turn down, that makes it a lot tougher to get there. So, that would be my only thought right now, if these trends and volumes continue, that it will make it tougher to get there.

Walter Liptak – Barrington Research Associates

Okay, as we think about 2013, with a lot of heavy lifting done this year, even with a flatter down revenue, margins should start marching towards 2015, right?

Mark Gliebe

Well, if we get the volume hanging in there, we’ll continue to see the – we had nice improvement this year. We had talked about it earlier on this call that our margins were hanging in there, despite volume turning down. So all year long, we’ve seen improved margins and then as a result of the synergy savings and productivity efforts that the company have done and we expect that to continue assuming now that our volume hangs in there as well.

Walter Liptak – Barrington Research Associates

Okay, thanks.

Mark Gliebe

Thanks, Walt.

Operator

Our next question comes from Josh Pokrzywinski from MKM Partners. Please go ahead with your question.

Pokrzywinski – MKM Partners LLC

Hi, just one follow-up I want to be clear on because it seems like, we spent half of the call kind of going through some data items whether it’s continuing, on the synergies that you guys have talked about with the 12 year one 25 going to 38, it sounds pretty explicitly in the slide deck that that’s a one rate basis and obviously with year one, year two, that’s August to August, maybe just to make it clear for everybody so we don’t have anymore confusion, what is the 2013 versus 2012 synergy capture. So not run rate so much as incremental cost saving dollars, so one described it as restructuring or synergies or I guess the nomenclature is not so much important as it is the EBIT change from the actions that you are taking?

Chuck Hinrichs

Josh, I think we understand your question. We’ll try to provide some more details at our Investor Day in December. But I think we have described it correctly on a run rate basis and Jon Schlemmer mentioned today as he has in the past, that we would expect in the synergy program to complete the plant rationalizations in second quarter or mid-2013. So the savings would then start to build as we would exit the third quarter to stay on track with that run rate on synergies. But we’ll try to provide some additional detail at the investor day.

Pokrzywinski – MKM Partners LLC

Okay, but I guess it’s a working placeholder in the mean time, it sounds like what you are saying is that it’s unfair to think of 38 minus 25 as necessarily the incremental calendar year ‘13 number, just the way the year falls out versus the timing of the deal and the timing of integration, because, it seems like there in the call has walked us down the path that’s a fair placeholder, but it also seems like there are not moving parts. So that’s not necessarily the right way to think about it and I mean, to be fair, they are big numbers.

Chuck Hinrichs

Yeah, I think you are thinking about it correctly. It’s not as linear as you would think on a run rate basis given the level of activity in the first half of 2013.

Pokrzywinski – MKM Partners LLC

Okay, so you guys will have that in the P&L?

Chuck Hinrichs

Yes.

Pokrzywinski – MKM Partners LLC

Okay, thank you.

Mark Gliebe

Thanks, Josh.

Chuck Hinrichs

Thanks, Josh.

Operator

And our next question comes from Ray Rund from Shaker Investments. Please go ahead with your question.

Raymond Rund – Shaker Investments

Thank you. I had the exact same question that was just Josh asked. So unlike you care to say more about it I just say it satisfies me for now.

Mark Gliebe

Thanks, Ray. We’ll lay it out at Investor Day. We’ll put more clarity around it. We understand your concern and question.

Raymond Rund – Shaker Investments

Thank you very much.

Operator

And with that, we’ll conclude today’s question-and-answer session. I’d now like to turn the conference call back over to Mr. Mark Gliebe for any closing remarks.

Mark Gliebe

Thanks again and the first three quarters of 2012 were exciting for our real employees. We achieved record sales, record earnings, while successfully integrating the largest acquisition in our history. With that acquisition we not only executed on the synergy savings, but increased our synergy targets. We continue to simplify every aspect of our company while achieving another record year of new product launches. We successfully transitioned two new factories in China and we are now better positioned to serve the Chinese market when it rebounds.

We have been proved our performance around quality and delivery for most of our customers. In fact, our most recent customer survey reflects these improvements. We are proud of our achievements in spite of the global economic uncertainties we are excited about our future and we recognize that none of this will be possible without the dedication and commitment of our Regal employees. Thank you for joining the call and for your interest in Regal.

Operator

Ladies and gentlemen, that concludes today’s conference call. We do thank you for attending. You may now disconnect your telephone lines.

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