Regal Rexnord Corp (RRX) 2003 Q3 法說會逐字稿

Thank you for standing by and welcome to the REGAL-BELOIT third quarter earnings conference call. At this time phone participants are in a listen-only mode. Later, we will conduct a question and answer session, instructions will be given at that time. If you should require assistance during the conference, just press star then zero. As a reminder, today's conference is being recorded. I would like to turn the conference over to Chief Financial Officer Ken Kaplan. Please go ahead sir.

Thank you Kim, good morning everyone. This is Ken Kaplan, and with me today is Henry Knueppel, our President and Chief Operating Officer. Jim Packard, our CEO is unable to be with us today. Today's call is in reference to REGAL-BELOIT's third quarter 2003 earnings announcement released earlier this morning. If you haven't had the opportunity to read it, the news release has been on our website at regal-beloit.com since about 8:30 this morning. Before we move into our question and answer session we first like to make a few comments. But before that, Kim, would you be so kind as to provide the participants with the instructions for asking questions? Kim?

Yes. If you wish to ask a question, please press star then one on your phone. You will hear a tone indicating you've been placed in queue and you can remove yourself from queue at anytime by pressing the pound key. Remember if you are using a speakerphone do pick up handset before pressing the number.

Thanks Kim. Before I briefly comment on our financial results, please keep in mind that with the exception of historical facts, other statements we make during the conference call may be forward-looking statements. And we encourage investors to go to the company's filings with the Securities and Exchange Commission. Okay. Our third quarter financial performance was for the most part in line with our expectations three months ago. Our $6.5m of net income and $0.26 per share were the same as we earned in the second quarter. We did have a 3% sequential increase in sales lead by a strong showing in our power generator products. But as we - as we have been sailing all year, we needed to reduce our inventories further and we were successful at it, decreasing them by $6.6m in the quarter and $10.6m in the last 6 months. Whenever you reduce inventories in a weak demand environment, you pay a price, in volume variances and overhead absorption. In previous conference calls, we've commented on the relationship between achieving our plant consolidation program cost savings, and the market demand for our products. It's always difficult to transfer production into new locations and move down the learning curve, while at the same time restricting production levels to bring about lower inventories. Yet we feel good about meeting our expectations for the quarter despite this situation. Lastly, we paid down $12.5m of debt to end the quarter at just under $207m outstanding. This gave us the capitalization ratio of 34% and reduced our debt to EBITDA ratio nicely down to 3.11 to 1 at September 30th. Capital spending was $4.5m in the quarter, bringing our year-to-date spending to 14.4m. On pace to finish the year as we have previously indicated in the $18m to $20m range. Now, I will turn it over to Henry for his comments.

Thanks Ken. Good morning everyone. I am going to try to add a little bit of color to what Ken has already told you. First of all, as Ken said from a matter of point of view, there were few surprises during the quarter from what we expected. I would say the only significant surprise was a positive one and that was the short-term demand for power generation. Primarily, that was driven by some projects for rebuilding in Iraq and the Middle East; the blackout in New England or the North East in general, certainly provided a lot of short-term demand, as did the Hurricane. Now, all three of those were you know, short-term drivers that probably won't be repeated in the fourth quarter. However, some longer-term things are evident. One is that the blackout has created knowledge now that there are problems with the infrastructure or electricity and so that's going to lead to longer-term positive cycle for the kind of products that we make and we believe that you know, that is to some degree started and will continue to grow. We also because of the weakening of the dollar have become more competitive now overseas and our overseas business was up nicely during the third quarter. We would expect that to repeat and continue and then finally, the Telecom industry, which has been dormant for two plus years, has started to show some signs of life. A long way to go to get anywhere close to where they were, but certainly it's better than it has been for some period of time. Now, those three factors we believe were little bit longer-term in nature.

we are also pleased to say that we had sequential improvement in motors in general. We think that's the counter to the industry and other people who are making motors. The drivers there were distribution. We don't believe that they were building inventory yet, but certainly more short-term demand, air moving was very positive, the HVAC after market due to the hot summer. We saw a good improvement or improvement in pumps and some improvement in machine tools towards the end of the quarter. Oil and gas, pulp and paper, material handling and ags continue to be flat. In the mechanical power transmission group, we saw that we were sequentially down and that was driven by mainly seasonal kinds of impact in marine, both less in automotive high-performance which traditionally are down in the last part of the year as the season start to come to a close. We did see some strength in food, petrochemical and again in distribution in the mechanical group as well. Overall, we feel like we did I guess, at the beginning of the year and beginning of 2002, quote activity is better than it has been. Customers appeared to us to be more positive about '04 than they have been and I am not talking about light year type of changes here, but certainly more positive and we are continuing to have very good success with new customers and new products, which we have been talking about all year has been one of the differences for us this year. Looking at our earnings, they were okay. We are certainly not writing home about them, it was a solid quarter overall. The product moves that we made in the Electrical Group that were in full bloom in the third quarter and finished frankly in the third quarter, it took longer than we expected and were a little more expensive than we expected, they were not easy moves, we knew that going in, it just took a little longer than we hoped for and we still have some work off to do there, but we expect to see steady improvement from where we are. As Ken mentioned, the inventory reduction certainly played against us in the third quarter and we did see an unfavorable mix and as I had mentioned before one of the drivers was small generators and small motors and those are a little less margin mix give us a little bit of a mix issue. As we look at the fourth quarter, as we said in our news release from our discussions we've had with our customers we are expecting the normal cycle. That's little bit disappointing. We had hoped by now, we would see some inventory build and we will be more confident, but it is not a negative sign overall, I mean we are hearing the positive things for '04 but we believe that they are going to continue work on balance sheet issues for the remainder of '03. It is also a shorter quarter for us by three days and that has some impact on our projections moving forward and we are seeing some increase in commodity cost, particularly copper, that will have - I think a relatively minor, but an impact nevertheless in the fourth quarter. Countering that we expect to see continued improvement in the plants where we made the moves and we continue to be very positive - reasonably positive I should say about '04. As I said before, the signals are certainly there for improvement, albeit not huge, but steady. With that I will turn back to Kenneth.

Okay, in that case - Kim I'd say we are ready to entertain questions. So if you would start us out, that will be great.

Sure, we do have a question from Richard Rossi with Morgan Joseph. Please go ahead

Good morning

Good morning Rich.

I know this is probably going to be tough, but Ken could you give us some sense of what the overall margins would have looked like, had you not addressed the inventory issue in the quarter and what did that cost you in terms of basis points. Give some sense of that? -

In the past, when we have had time to really think about it, I didn't come prepared with that today. Now you heard us talk about taking down inventory $6.5m. I can make a calculation like that - Rich and I can - I don't - I wouldn't say providing that would be a material piece of information, but we could - I could do that separately or may be -

I will get back to you.

Yeah I guess I just don't have that information with me obviously would have been a little better, but I just don't know how much.

Are we looking at more inventory trim in the fourth quarter?

We've all, we are going to probably continue at about the rates that we're producing right now, however with our projections for sales being down a little in the fourth quarter, that will not be as big a reduction.

Okay. All right. And again most of these - the comment about the material of the commodity cost that's mostly copper.

Yes.

Some sense of what kind of cost increase in terms of percentage and what's the copper content for your cost-base?

Well, I don't have the exact percent and -

I am just looking at the expenses. Yes.

- That is in terms of - that the increase we've gone from being in the $0.70, the high 70s in the first and second quarter to the 80s in the third quarter and it has bounced up to the high 80s as we start the fourth quarter.

Okay.

And we can't forward contract a fair amount of our copper, but there is a significant percentage that we buy in the spot market, so that we are properly balancing forward contracting with spot with current needs.

So, it will have - if high 80s remain the price structure as we go out, I mean it will have some impact on the fourth quarter profitability as well.

Yes.

Okay. All right, done. In terms of overall operating leverage, we haven't seen the turn yet and, obviously this question relates to a much more robust market, but, given what you've done internally to get the structure right sized for the current level of demand. Is operating leverage even on - let's say a more modest improvement in topline than historically we've seen in recoveries? Is that going to allow you get back to the kind of margins you saw, let's say in 99 and 2000, in 204/205? I mean do you think, is that an achievable goal?

I'll give an opinion, and my opinion would be yes, the 99-2000 kind of margins are very possible. Certainly there is, in the market place over the last two years has been a lot of price pressure and with a little bit of build back we would expect to see that dissipate and that's been, I think the opportunity is based on what we have done, certainly give us that kind of leverage.

Okay. Then I have just one more and - I am sorry - can you hear me?

Yeah.

Okay.

Go ahead.

Just one more and then I'll get back in the queue and that's, looking at what you've done in plant consolidation this year, some sense of what that might save you in '04? Let's put it this way, is it meaningful enough to have a legitimate impact on the bottom line?

It's definitely meaningful enough to have a legitimate impact and we - when we bought leasing in the year 2000 we had projected forward the synergies from all of that and

Right.

The final leg of that - in the mean time the market has obviously reduced as opposed to held level or increased. These moves are certainly, they are significant, there is not question about that. I think we had said that we were right on schedule with the three-year plan at 12m to 15m in sales since we started the year, and this was kind of the third leg of that.

And I think we had indicated that we felt that - there is still a third of that 12m to 15m to go as we were, coming through 2003. So, I think that kind of gives you some impression of that -

Okay, you'll still hold with those numbers then? [Inaudible]

The only issue Richard there is the volumes, I mean [Inaudible]

Right, I got from [Inaudible]

We are checking at a higher volume than we are today, so you have to discount that.

Okay. All right very good, thanks very much.

Thanks Rich.

And our next question is from Mike Schneider with Robert W. Baird. Please go ahead.

Hi. Good morning guys.

Good morning Mike.

Maybe you can just spend a minute on the restructuring and the plant closures etcetera. I presume although the lights are off in the closed facilities, the product lines are actually moved into the receiving plants is that a correct assumption?

Yes.

Okay. And with all that shaking out now, could you give us a sense of where you are in utilization, you mentioned that the market has dropped since you bought Leeson and certainly we have seen that across the industry. But, is it a case now where you still kind of had the same capacity utilization level you've would been on had you -- at the time you bought Leeson given that the market is stepped back a few points each of the last few years?

Yeah. We've not reduced our capacity to any measurable degree in the course of these moves. We've reduced our costs because we are in lower cost facilities and we've reduced tools where footage of use. But, in terms of few capability based on some of the things that we've done with capital expenditures and so and I don't think that our absolute capacity has changed.

Okay. And again with the backdrop that the market has deteriorated several points a year now. Is there another plan underway or do you think again about the structure as you look into '04 and '05?

Well. We never stopped looking. We never stopped looking, as you know we are doing a lot of searching work around the world and we are constantly evaluating what makes sense to do there. We are continuing to evaluate product line moves but I think the big one that we talked about in our plans are certainly complete. And as we said, we are optimistic about '04 and so hopefully other than normal sourcing and some other more minor changes than what we had to make over the last year, we'll be moving forward on that basis.

And Ken I am curious looking into the fourth quarter, it is seasonally weaker and you probably won't have the recurrence of the PowerGen boost this quarter. Yet with the full run rate of savings in place with these product line moves having been completed, I am surprised that you aren't some what more confident on the earnings line that you could at least hold flat how relative to Q3?

Well. Obviously, you've heard what Henry had to say, while we won't give specific sales guidance. Obviously you know that we do expect sales to come down and when you bring the sales down that has the biggest impact. Now, obviously if we can make some more progress with coming down the learning curve in some of our start-ups in where we move the grafting and softfill production to. Sure, we would hope that maybe we could have some good news at the end of the quarter, but from where we sit now we are trying to provide the guidance we feel is our most likely scenario.

Well, on those lines Ken the inefficiencies, I know it's almost impossible to quantify but may be one thing that you could quantify is may be what you spent on overtime in the receiving plans this quarter that presumably would fade away?

I can't quantify that in dollars, I don't have the number in front of me Mike, but we rolled that into what we are expecting for the fourth quarter, I mean, certainly there is improvement in efficiencies that will take place every month. And there are reductions in overtime to get the same amount out and so on. But I don't have a dollar on just the overtime alone, what that would mean.

Okay. And then Ken, just a specific question on the interest rate step down now at 3.1 times that EBITDA, did you guys enjoy another step down this quarter, or does that come in..?

Yeah, We remember we stepped up 25 basis points in August. On November 15th, that comes back out so we'll down 25 basis points effective November 15th. And that and the next breakpoint is February 29th, so that means based on where we are at year end, you know that will determine what the interest rate markup will be from March 1st on.

And final question just more qualitatively on your Asian sourcing strategy, could you give us an update as to what is being done over the last quarter and maybe what's ahead in the next quarter or two?

Well, to that we haven't we have not yet announced any new joint ventures or partnerships. However, we continue to press forward with the joint ventures we have, we are having great success with our generator joint venture. We are having good success with our motor joint venture. We are continuing to work with it and we have strengthened our sourcing team here internally and I mean it is a continual change. There is never time when we aren't moving along that - down the curve. But there weren't any significant new changes.

Okay. Thanks again.

Okay, thanks.

And we have a question from Robert Schenosky with CIBC World Markets, please go ahead.

Yeah. Good morning Bob. Bob?

Hello. This is Kerry Kathy (ph) sorry I go up this way.

It's all right. That's what we figured.

Could you please expand upon the inefficiencies that occurred due to the plant moves, was that just that it took longer than expected?

Yeah. There was a little about the just the length of time it took to move but the bigger part is just the learning curve. The more time it took to get people up to speed. We were moving products that were higher specification products to plants that they were used to little bit lower specification products, that took us little longer to get some of the things done that we need to do to get our production levels up. That's a learning curve issue more than it is any physical move.

Okay, and you have mentioned pricing pressures previously, are there any changes or will that continue into the balance of this year and '04 potentially?

Well, there's no let up yet on the pricing pressures, however anyhow there are number of signs that would say that that could start to ease off, I mean there are steps been taken China, in China for example to reduce some of the exporting that they're doing where they can. There are some commodity changes that are worldwide in nature that probably will start to change the way people look at that, and certainly with the dollar down, we have some benefits other than in China, in Europe and South America and so on. Now we would hope that the pressure would reduce as we go through the remainder of the year and in '04 would be at least neutral.

Okay, and with the apparent lackluster demand in 4Q, is there any sense from customers that as we move into 2004, it will look similar to 4Q or any specific indications that there will be improvement?

Well, the fourth quarter for us is typically been, I don't know what's typically more, but typically has been a slower quarter, and first quarter has been a better quarter.

Right

We're certainly expecting that, and the signs that we're getting is as I mentioned before, the signs that we're getting are, that our customers increasingly expect next year to above this year. Certainly quoting activity would be indicative of growth as opposed to shrinkage so we're expecting things to improve.

I would like to try to make sure we're seeing this in the right perspective. As I think most of our analysts knows and the sell side people and the buy side people too, the fourth quarter when we say sales have typically historically been a little lower that's really been more of a motor phenomenon in dealing with our OEMs and how they like to get their balance sheets in order by the end of the year and just they typically will take more in the first quarter than they do in the fourth quarter. But for the rest of our business the mechanical business, that's not a scenario and we don't necessarily see that for the fourth quarter. Our power generation business, and so when you take out the seasonality, we're not looking at a negative scenario here, and I want to make sure everyone understands that, what we're looking at is a fourth quarter historical typical phenomenon primarily because of the way our motors business is. Okay.

Okay, thank you.

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

Yes. Good morning. Thank you. According to -- first on the generator business. I mean, I guess, I am trying to get a sense of how much of the increase that you saw sequentially over you, what have you relates to specifically generator. So, to get a better feel for the underlying motor business. How much incremental revenue do you think that you saw in generators, specifically from this quarter?

Well, you know, in terms -- we try not to break out as you know, those businesses and we haven't and we have been consistent about that over the years, Holden. I will say this, we had double-digit increase sequentially in the area of our generators and we had a modest single-digit increase in the area of our motors during the third quarter, but I think that's about as far as we'll go if we are going to maintain this consistency.

Okay. But generators are about 10% of your business and then the other reason to think that a lot of those revenues you saw this quarter kind of fade out as of fourth quarter? Is the strength that you saw in generators in the third quarter, you don't expect that there is going to be much follow through on that because it was all event driven?

No, no. As I have said before there are two or three forces that are longer-term that are going to continue to play out but there was certainly a short burst of things you know, when a Hurricane hits, a lot of inventories disappear quickly and the same thing is true on the blackout. So, those are short bursts that you know, aren't going to be repeated necessarily but the -- it's certainly isn't going to go back to where it was. There is no question that that demand was strengthening before this quarter we had a burst it's strengthening through the next quarter. So, we expect the power generation to continue to be a pretty hot market.

Yeah. We have got in some real benefits in our JV too in China, in terms of growing and a very substantial increase in their sales, of course, you know, that's where we are a 55% owner of that joint venture. One other thing I would like to add Holden, too. You know, we look as you do versus our competition and everything and even though you know, from what was going in the motors. Our motor increase as everything we could sell was definitely nicely in excess of any of our competitors during the third quarter on a sequential basis.

Okay. Can you comment on the tax rate? It look's like tax rate was down relative to Q1 and Q2. Is that just sort of squaring up for the full year number?

A part of it was that, but a part of it is that we have you know, in reanalyzing our tax rate and where we have things. We expect that we are going to see a rate that is lower than the 37.5 that we have been operating early on as much as the point better and we expect that to probably continue into '04.

Okay, and that's, so that's all sustainable based on the internal initiatives you outlined to getting that done.

Yes, but when you saw a rate of 35.3% this quarter, that had some one-time phenomenon in that, okay.

Fair enough. And then lastly, I guess I am just trying to get a better feel. You know, there's a tone about expecting '04 to look better than '03, it isn't a lot different from what we saw a year ago when you said you would expect '03 look lot better than '02. I mean, kind of compare and contrast for me that period that's high. You're optimistic then and you are optimistic now, how do they feel different or do they feel largely the same - why would you be more confident in that comment this time around than you were last time around?

Well, there's a lot in that question. The fundamentals in the economy certainly with the liquidity that exists, the dollar being down, the inventory levels being low, and so on, are good. A year ago, they were pretty good. But it's been there for a long period of time now, and it's just a sense from our customers growing our confidence and also a level of coding on projects that we have not seen for a while. Very honestly, though, if you went back to the first quarter of last year, we did feel that way, we were very confident. When the war started, I should say this year -- this year when the war started, it cooled off and didn't come back. So, there are no guarantees, certainly there are no guarantees, but I believe that it's going to get better now.

I am just little curious whether in you conversations with management, we have heard from every company that there is a lot of optimism now, that's not different. I didn't begin to put any scale in the gain till I actually say, these are our expectations for next year. This is what they need from you, is there anything concrete, which might always change at least points to real evidence that they are planning to buy more or they're still pretty speculative?

We have conversations with our customers all the time, and we are -- we do have some people who are telling us they definitely expected to be better next year. Is that across the board or 100%? No. But, we don't have anyone saying that they think it's going to get worse. So, that the top end is better, the bottom end is certainly no worse, and that would lead us to be, I would say, optimistic about what the year will be. Again, we are not thinking this is a double-digit increase next year, but we do expect it to be improvement.

Okay, thank you. Then, I guess lastly, I'd like sort of revisit, there's a drop in the operating margin in the quarter. You barely you don't really want to give dollar amounts in terms of the impact of inefficiencies, the impact of the under-absorption from the inventory reduction, but from the 7.8% operating margin in Q2 to the 7.3% in Q3, can you sort of say what percentage of the drop can be related to inefficiencies versus the absorption issue, but obviously it's relevant as we try to model forward understand these things tend to come, go, reverse, understanding the magnitude and where they derive from I think is important for us.

You know, I think it's -- I know what you would like and the reason it's difficult is this. There are so many things that happen in a quarter for any operating company, obviously their inefficiencies, but then you have your absorptions, you have your volume variances, you have one-time expenses that come through that can some times cut into it, it could be a $100,000 item, and then you have the positives data coming through the same way. So, a portion of that drop clearly was in the inefficiencies, and it was probably the leading part of it now. I will leave it up to you really and everybody else to try to guesstimate. Obviously, it's not all of it and it's not nothing of it, but it is a meaningful portion. Now, we go into the fourth quarter and you start asking us dollar earnings and everything, and there are still inefficiencies. Now, we certainly hope that those inefficiencies are going to be less, so that has a positive impact compared to the prior quarter, but then there all sorts of other things that come into play because of the lower sales volumes, what happens in terms of our inventory reduction, how are we going to manage our production schedules, if none of those, we are going to try to predict for you, but they are all factors.

But, certainly, all of the moving -- I mean the activity is done now, it's just acclaiming the learning curve issue?

Yes.

All right, thank you.

We have a question from Brad Evans with High Rock Capital (ph).

Good morning Ken.

Yeah, Hi Brad, good to hear from you.

Good to hear, congrats on the quarter looks like a reasonable one. I guess -- I have a couple of questions. One was, can you just -- as you look out for the end of the year debt, where do you think that will be? Can you give us a year ending debt target?

Yeah, we have been - we had a good quarter at $12.5m. I don't see that repeating in the fourth quarter, but we certainly want to be in the range of 200, maybe a little bit below that, and we are certainly going to work towards that. Obviously, how the market demand is during the quarter will play on that because when you get with in a few million dollars, you can't predict that that closely.

That's helpful, I guess the -- just I know you haven't given guidance for '04 at this point, but as you look at the $90m in Capex at the mid-point for '03, is that a number that likely rises in '04 or how should we think about Capex directionally in '04?

I don't expect that there will be a much of change. I think it's probably a reasonable level. We are working through all of these plans right now, but I think that the level we are at this year is a pretty healthy level, and we would see normal to meet for next year.

And, I am just curious in terms of maybe recently, have you seen anything in the way of mix shift on the motor side to larger motors recently?

No. We have not.

And I was just curious also just, generally speaking across the two businesses, can you just discuss the linearity in the quarter, how the business developed over the three months of the quarter?

Yeah, July was a relatively slow month, and we saw a nice improvement in orders as we went through the end of August and into September. And so, I would say backend loaded.

And would you characterize -- I know it's early days here in October, but would you characterize the pace of this in October. How would you characterize it versus sequentially maybe year-over-year at this point?

I would say we are up a little bit from a year ago and we are holding at levels that are pretty similar to what we did at the end of September.

And are you -- when you talk about the seasonality on the electrical group side, the motor side, is that mostly in December would you say?

Yeah.

You start to see that in December.

November, late November and early December has been when we have seen that happen.

This is probably a stupid question, I am going to ask it anyway. You are talking about, and I imagine I know the answer, but I'll throw it out to you you're talking about copper prices increasing here, at the same time taking about demand being fairly soft, I guess how do you -- is it just the supply of copper in terms of the predecessor rationally [Inaudible] any supply or is there something else going on there?

There are two things. One is copper supply has reduced over the last two or three years as mines were closed down because of the pricing, but world demand for copper is not necessarily slow. Demand in North America is certainly slower than it is in Asia and South America.

All right. Thank you very much.

You're welcome.

And if there is any additional questions, please press star one. We do have a follow up from Richard Rossi with Morgan Joseph, please go ahead.

Just one thing, I may have missed this, but did you quantify what currency, how currency impacted the quarter?

No, and primarily because currency doesn't have much of an impact to us, okay. We have some transactions that go in other currencies, but I would say it is immaterial.

All right, thank you.

We have no additional questions.

Well, then we'd say thank you very much for everyone who called in today, and you know I am available for follow-up questions at any time. Other than that, everyone have a good fall and we will talk to you soon. Thanks for listening us.

Thank you.

And this conference will be available for replay starting today at 1:30 PM and lasting until October 31st, at midnight. You may access the AT&T Executive Playback Service by dialing 800-475-6701,and entering the access code 702502. Again the dial in number is 800-475-6701 and the access code is 702502. That does conclude our conference for today. Thanks again for your participation.

And thank you Ken very much.

Thank you.

Okay goodbye.

Goodbye.