Regal Rexnord Corp (RRX) 2003 Q4 法說會逐字稿

Welcome to the Regal-Beloit fourth quarter earnings conference 2003. (OPERATOR INSTRUCTIONS). As a reminder, today's call is being recorded. I would now like to turn the conference over to Mr. Ken Kaplan.

Good morning, everyone. This is Ken, and along with me are Jim Packard, our Chairman and CEO, and Henry Knueppel, our President and Chief Operating Officer. This call is in reference to Regal-Beloit's fourth quarter 2003 and year 2003 earnings announcement, released earlier this morning. If you have not had the opportunity to read it, the news releases 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 would like to make a few comments. But first, John, would you please provide the participants with instructions for asking questions?

(OPERATOR INSTRUCTIONS).

Before I make my brief financial comments, please keep in mind that with the exception of historical facts, other statements we may make during this conference call may be forward-looking statements. Investors are directed to the Company's filings with the SEC.

Overall, given that we expected a decrease in Electrical Group sales in the fourth quarter, we were very pleased with our financial results for the quarter. We were able to hold our company operating margin and net margin about even with the third quarter, despite our lower sales. Compared to fourth quarter 2002, our net sales of $152 million improved a little over four percent. Our fourth quarter net income of 6.1 million and 24 cents per share were about 15 percent higher than a year ago, excluding the plant consolidation charge we took last year in our Mechanical Group.

For the full year we had sales of $619 million, a 2.3 increase over last year, and net income of $25.2 million, which was three percent better than the prior year. As we have reported previously, sales of our power generator products were the most significant factor in our 2003 sales growth.

Our operating cash flow was again strong in the fourth quarter, at $16.8 million. Our 2003 total of 56.8 million of operating cash flow was up four percent over 2002. After funding our dividends and investing $18 million in capital expenditures during 2003, we were able to reduce our outstanding debt by $27 million to a $196 million balance at December 31st. Our capitalization ratio at year end was 33 percent and we reduced our debt to EBITDA ratio to 2.88 to 1.

Now, Henry has a few comments to make.

Good morning, everyone. Just to give you a little bit of the mortar between the bricks here. As we went through the quarter, the good news is that there were no surprises. It developed as we expected it to. We continued to see, looking at some of the markets, power generation stay very strong. I think last quarter we talked about the combination of factors -- weak dollar making some of our gen sets that go over from this country more competitive elsewhere in the world; we talked about the hurricane and the blackout, and the impact that those were having, and we thought would continue, even after the initial demand was satisfied; and of course, the military demands are fairly steady and stronger than they were a few years ago. Those factors have kept power generation strong throughout the quarter, which we expected, and we think it is an industry that is gathering momentum for the future.

Other markets that exhibited strength were material handling; distribution, both industrial and electrical, are gaining strength, and we see some signs of them beginning to put some inventory back in, although that is early in the cycle for that. They do see a need to start doing that and they are optimistic enough to do so; food machinery was strong for the quarter; machine tools is developing very nicely; and in general, pump applications are developing very nicely.

The markets that are still soft are pulp and paper, oil and gas, and commercial construction. And then we have some normal seasonal swings that are slow in the fourth quarter -- you cannot read the market that way; it's just a normal seasonal swing, such as pleasure craft marine, high-performance automotive aftermarket, and HVAC aftermarket.

Overall, we're very pleased with the way the quarter developed. Our quota activity was strong, our bookings improved. Customers are significantly, and I would say, broad-based -- in a broad-based fashion, more positive than we have seen for some period of time. And we finished the year with a backlog that was stronger than -- by three or four percent than we finished last year.

We are continuing to have some very good success with new products. Our high-efficiency drives which we have added over the last few years are gaining traction in the marketplace. And our stainless steel food solutions products, including motors and gear drives, were up nicely for the quarter and for the year. We finished the year, frankly, in the food industry up about 10 percent over the previous year. And we think that there is lots of growth opportunity left there.

We have a number of new products in the pipeline that we are pretty excited about, such as driveline components for SUVs and off-highway vehicles, and through our Richmond gear division and several more -- I would be boring you if I went through the entire list, but I think it is important to note that we have a very strong pipeline.

We are also pleased with the progress that we made this year at our joint ventures in China. We have two joint ventures there, as you know, and both of those had very strong years, and we believe will continue to grow rapidly. And we are continuing to increase the resources that we place -- that we have in place to add to those joint ventures, as well as do other sourcing things globally.

So overall, our feel is that the economy is definitely strengthening. The negative side of the strengthening economy is materials, and we are seeing materials cost increases as we speak. I think the really good news is that for the first time in three years we sense -- we have the ability in the marketplace, and we're taking advantage of that to at least offset those, and in some cases perhaps even gain a little bit with pricing.

So I think overall, we are poised, as we have said before, for good upside leverage with any growth, and we anticipate the growth.

Okay. Is that it, Henry?

Yes.

Okay, thank you. John, I guess we are ready to begin our question-and-answer session.

(OPERATOR INSTRUCTIONS). Alexander Paris, Barrington Research.

I have two questions. Speaking of Asia-Pacific, could you give us an idea of just what the dollar sales are in that region for you in the fourth quarter and year?

I didn't add it up for the fourth quarter, Alex, per se.

For the year?

Overall we're doing somewhere in the vicinity of $20 million a year in China specifically. And then outside of that, we actually have a fair amount sales of generators and motors. But -- I apologize, but I don't have a number for you. I am going to say it's several million dollars.

I ask that question because I get more questions with all the outsourcing going there, than --

What I was talking about was what we sell there.

Right, what you sell there. But people keep coming up with the question, are U.S. manufacturers like you threatened or vulnerable to what is going on? My feeling is it is mostly in electronics. But do you -- are there some areas there where outsourcing by competitors to that region are forcing you to expand? For example, in China. Are you expanding there to take advantage of that market, or to compete with other companies that are doing that?

Frankly, both. We have said for some time that -- we have sourced there since 1987. So we have been there a long time. We have been very experienced at sourcing there, but as we added the joint ventures -- and of course, our thought process is that it is a growing region and we need to be a key player there with our products. And while the numbers don't look big, they were up substantially this year from the previous year. And as I said before, we are gaining a lot of traction with where we're going there. So we expect that to grow very rapidly.

Just a couple of accounting questions. Capital spending you said was 18 million in 2003. What was your depreciation and amortization?

Depreciation was 20.9 and amortization 1.1 for the year. So that would be 22, combined.

And your tax rate for 2004? What is a good number to use?

We ended the year at about 36.2, and I think we are going to be -- I think to start out the year I think something in that same range, maybe slightly higher; 36.5 points would be a good place to look now.

Okay. And looking at your guidance for the first quarter, I sense a lot more enthusiasm coming in now, and yet it is your bottom part of your range in the earnings, you would be unchanged with a year ago, which was a difficult period. Do you see still quite a few reasons to be -- what is your sales assumption, for example?

Just a couple of points I would make. One is that materials are changing pretty rapidly right now. And as I said, we think that there are opportunities to do pricing, but sometimes those don't always time together -- number one. Number two is there are some things that happen in the first quarter every year for a lot of companies that are restarts, such as unemployment compensation, costs that run until an employee hits $12,000, for example, in most states. And so, some of those things hit you in the first quarter. The cost of heating our facilities in the first quarter is typically a little higher. So there are some structural things that impede a little bit what the first quarter looks like.

Are there some higher pension contributions in the quarter?

Yes, the pension expense is going to be higher this year than it has been in 2003. That is correct.

But it is not a significant -- that is not a significant thing for the year. We are pretty optimistic about where the year's going to go. We've had two years in a row of false starts. This one feels better than either of those, and there's certainly all of the fundamentals, as you know, because of the articles you've written. The fundamentals are there to drive this thing further. So we are pretty positive.

What about your sales assumption for the first quarter? Are you assuming that it is going to be up to get these earnings?

Yes. We are assuming the first quarter will be up over the fourth quarter. But again, there are some things that will hold us back a little bit in the first quarter that we don't expect to see in the second, third and fourth.

One other question. I noticed your gross margin was up from a year ago, but you're operating expense as a percent of sales -- unless I figured wrong -- was 19 percent, and that was up from 16.3 percent a year ago.

I don't know. I have 17 percent even for the operating expenses. They were up a little, but --

Oh, for this year?

Yes.

Okay, maybe it is my calculator.

You're talking for the quarter or the year?

For the quarter.

Yes, for the quarter it was 17 percent.

So it's 17, (indiscernible) still up just from 16.3 percent.

There are a lot of factors that get involved in that, as well, from one year to the next as you go through. There are adjustments that you make in one year that maybe aren't able to be made in the next year; nothing that describes any kind of a problem that we see going forward, Alex.

Are you still being cautious enough to try to hold that level in the face of rising sales?

Yes. In fact, we expect to leverage our operating expenses as we go forward now.

Holden Lewis, BB&T Capital Markets.

I guess I need a little bit more hand holding with regards to the SG&A. And the reason I say that is because I noticed -- even though your revenues for seasonal reasons were at their lowest level of the year, your SG&A was actually at the highest level of the year. And when I sort of go into your segment groups, I look at electrical -- which as expected had a little bit of an uptick in the margins despite the reduced volumes -- but then I look at the mechanical group, where volumes were essentially flat, and then you had the operating margin drop sharply. I assume that the SG&A increases are specifically in mechanical. I guess I am kind of curious as to what's behind that?

What is interesting about it is -- and this is something we don't get into a lot of detail of, so I won't give specific numbers -- but in the fourth quarter this year, our mechanical was lower in terms of operating expenses as a percentage of sale, and it was the electrical that was slightly up in the fourth quarter.

I was going to say (indiscernible) mechanical group margins actually improved as we went through the year, and we finished the rationalizations that we talked about a year ago. So I am a little bit confused by what you are saying.

Fourth quarter mechanical put up 3.158 in income from operations, right? And 44.74 for sales --

Right. Which was 7.1 percent.

Wasn't it 8.2 percent in Q3 and 8.3 percent in Q2, and --?

I suspect you're right. I have the numbers here, just bear with me a second and I'll confirm that for you.

Essentially your revenues were flat but your mechanical group margins -- your revenues are essentially flat, for much of the year essentially. It just seems like relative to earlier in the year when you guys were incurring certain expenses and costs for restructuring which are now out of the mix, it seems like you took a big step back here given flat revenues. And coupled with the observation that your SG&A is at it's highest level of the year in Q4, I'm just curious what is behind all of those moving pieces?

Just from an operational standpoint, there were no operational problems of any major kind. We do have some significant swings in where our volumes from in the fourth quarter. As I said earlier when we talked about market segments, pleasure craft marine and our drive line components for automotive high-performance aftermarket fell off substantially in the fourth quarter. That is primarily late first quarter, second quarter and third quarter business. And those are -- that has some impact on that, but not significant.

I guess more broadly, I know in '99, 2000, 2001 -- you know, fourth quarter was not especially seasonally week. I guess more broadly can you comment to the fact that your revenues were sort of at their lowest level again seasonally, but the SG&A was at the highest level. You see, I would've thought that the drop-off in revenues would have had some impact on SG&A. It looks like those costs were higher than I would've expected given where the revenues were, and given a good strong performance in the gross margin.

(indiscernible)

Holden, I think you're going into an area, in terms of that -- we're talking about relatively small amounts of dollars overall. I will look into it and try to get back with you with some response, but I don't think we are going to be able to analyze that here this morning. I just think that overall, when you go from one quarter to another --- understand this too, that in years past before we had gotten into the way accounting is monitor these days, companies could do things between quarters. And now they expect every quarter to be like a separate year when the auditors come in. So where you might be able to have certain expenses that -- you may get a big expense in a quarter for an advertising bill or for repairs or things. And these things, you know, can swing it one way or the other. I really think that when we look year to year, obviously you get, you take that out of it. And then if there is a problem there with percentages rising, then we can talk about that and address that more.

This much I would say, Holden, structurally there is no reason for concern. The Mechanical Group is -- we have had a number of issues because of the shrinkage of the marketplace and so on over the last few years, but I think that they are stabilized and we see the signs now of bookings coming back. And I have zero concerns, frankly, about how you're going to feel about that as the year progresses.

Okay, that's fine. I wish I had a better explanation, I guess, for why the costs are up. But maybe we can go into it further off-line or something. But can you also give some sense -- obviously, in '04 -- you don't give us specific numbers -- but in '03, you had a number of charges that you took for the restructuring of the various groups. I assume that all those issues were done and that there was no impact from that in Q4. (indiscernible). Can you also give a sense of what is the swing factor as we going into '04? Those costs that aren't going to repeat, and then the benefits that we expect to get -- what is the earnings swings factor just from those things alone?

I think a year ago when we talked about those restructuring costs, we said that that there was a three cent charge, as I recall, at the end of last year. And we said that those costs would be recoupable within a year. And some of the moves took a little longer than we expected, and I think we chronicled that as we went through the year. Overall, those are complete. You can see by our sales volume we have not had any break yet, although our bookings now are up and our backlog is up as we go into the new year. But we were till decelerating in sales as we went through the year in Mechanical Group. And so overall, I think that we have tried to answer that question before, what we thought those changes would be worth.

But you believe that this year you recoup the three cent charge that you took for the mechanical business? And then you incurred, I think, additional charges through Q3 to do similar types of activities in electrical --

Yes, they actually in the Electrical Group, Holden, went into the Q4. We were -- that move took longer than we expected it to take. But those are essentially complete.

But much like you did with the three cent piece for mechanical, can you give a sense of what the swing is in '04 from the electrical activities now that they are completed?

No, the only things we have ever said about that was that the changes that we were doing in the electrical group were part of the 12 to 15 million of initial savings that we had identified literally three years ago now, on the (indiscernible). And that these were the final pieces that were coming in. But we have never talked about that specifically, and we're not going to.

So from that -- did you recognize the 12 to 15 in your three year time frame, or these steps mean that you will actually get there finally in '04, as opposed to out there in '03?

Originally we said it was going to take 3 years to complete that work. So we were within three months, literally, of what we said 3 years ago. And the full effect would be going forward. However, most of that has been in effect. What you saw offsetting it was a decline in sales value. And when we made all those projections originally, we were expecting not a dropping economy.

Michael Schneider, Robert W. Baird.

First maybe you can give us a sense of where you are in the restructuring now? Henry, you mentioned you're essentially complete, but I guess I was under the impression you were essentially complete last quarter. What's specifically left now in terms of moves, plant closures, production ramps, etc., in the first quarter?

Nothing from what we have announced in the past. We are always assessing what it is we need to do, and if there are things that make sense. But we are complete with those projects that we have announced.

Where are you in the learning curve at the receiving facilities, as best as you can measure it?

Probably 90 to 95 percent.

Okay. So you're really -- as you exit the year and enter this year, you feel like you are, from an efficiency standpoint, where you need to be?

We'd like to be at 100 percent, but we are very close now, and we made a lot of progress in the fourth quarter.

So along the same line of questioning as the previous caller, I guess I'm still miffed why we have not seen more leverage. The Electrical Group, for example, up $6 million organically from last year, and yet margins are still down 40 basis points. Which would imply actually (indiscernible) margins, even on organic growth. And the same thing goes on mechanical. Mechanical down 2 percent but margins down sequentially by 110 basis points. Where's it falling out? There has got to be something missing. Either that, or the expenses that are lingering on from restructuring are greater than we can appreciate.

A couple of things, Mike. First of all, while you say Electrical Group is up that amount, remember that some of that came as the result of a joint venture, so it is not sheer unit value, or as they would talk in the big box area, same-store sales. So you don't get the same leverage on that that you get -- particularly in the first year of a new joint venture, you don't get the same leverage that you would get if it was growth at the current platform at a current plant. Just to start with.

Secondly, there have been some fairly significant structural cost changes over the last few years with energy costs and materials costs that have escalated as we went through this year rather rapidly in the last quarter. And up until now, we didn't feel that there was the opportunity to offset those with price. We are starting -- we do believe there is that opportunity moving forward. So there was a drag and a time lag on that end of the set. And I guess the final piece of that is that -- while I think all of the restructuring stuff is behind us, we have not had the benefit yet from the volume just stabilizing. It stabilized in the Electrical Group; it did not stabilize in the Mechanical Group.

Along those lines in mechanical, I guess we have -- this year marks the six straight year of organic declines in that business. Where are you losing share, what product lines are you re-assessing? There has got to be a structural decision that needs to be made in this business, because even as -- for example for the last three quarter, you've seen organic growth in the electrical business; the mechanical business continues to slide. What are just kind of your macro thoughts on that business?

First of all, don't make the assumption that we have lost share. That would be incorrect. Frankly, we think we have gained share in most of our markets. And cutting tools might be a slight difference, although that market itself is down. We did choose to exit a couple of areas of the business that we did not think were any longer appropriate for us to be in. But otherwise, if you take a look at enclosed worm gear -- enclosed drives, the American Gear Manufacturer Association information would indicate that we have gained share in each of those years. It has been a market that has had some secular decline. There is a piece of that market that has been moved over from speed reducers to motors, for example, variable speed drives. We think most of that has taken place now, and that it is a pretty stable market. But we did not lose share. So -- and secondly, I would say that we did do some fairly substantial restructuring over the last couple of years to try to get into position. And at the same time, we believe now that we will see some uptick finally in the levels of business that are going to exist. It is hard to describe accurately, but I think -- and unfortunately we don't have too many people who publicly report that are in the same products. But the reality is that with capacity utilization in the country at somewhere around 70 percent for a few years, the kinds of products that we make in mechanical gear drives are not going to be needed. They are needed when you're building capacity. And now as we see capacity utilizations going up at 74 percent, 75 percent, the fact of the matter is people are starting to get back into the game.

Let's make the assumption that your gaining share on the margin, the business is still off 39 percent from its peak in '95. And the global economies, North American economies, nobody is off 40 percent in production. So there must be a systemic change in that market that is actually just contracting that market, even though you're gaining share in a declining market. What's changed there and what do you see for the next couple of years, because there must be something systemically different about that business?

Mike, this is Jim Packard. We analyzed this pretty closely, I think, six years ago, when we realized that -- first of all, when we talk about the mechanical market, we talk about everything from boat transmissions to race car transmissions to farm ag gearboxes to irrigation drives, to x-ray machine drives -- I mean, this a very fragmented market that we are in, and it is very niche-oriented. That is why when it rocks-and-rolls you make a lot of money at it, and when it slows down you lose pretty significantly. (indiscernible) six years ago we recognized it as a company. This was not a growth market. This was not something that we could -- we were going to continue to struggle at GDP if we didn't acquire businesses in it. That is when we made the decision to get into the electric motor business, and now that represents substantially the largest part of the company. So I think we knew that, and maybe we have not done a good job of telling people like you that this is an area that was going to be constantly confronted with the difficulties of growth. And in addition to that, we recognize that the areas, that many of them were going to be affected by not only technology changes, but were going to be affected by pricing. And so we, in a number of cases, and pricing is an example -- whether it's in irrigation drives or farm ag equipment or construction equipment -- we just chose to get out of the market. So some of it is just a natural disappearance, a business decision to say let's just don't do that; we're not going to do it anymore. So it is not like we hold on to it and then it didn't grow, it's like we got out of the market. We made a decision to get out of it, and put our money and our capital, at least momentarily, into the electrical business. So there is not a good answer that would give the traditional thinking what they are looking for when it comes to the mechanical side of business. We just don't have one, other than we chose to redefine ourself in that market, stick to the niches we could make money in, and let the rest of the business go elsewhere. And put our time and effort into some other items, which is what I think we have done. And I think we have been a bad job of articulating that process to the marketplace. Subsequently, we get into these discussions where you're saying I don't understand why it is decreasing.

Jim and Henry, you guys deserve a lot of credit, you're right, for transitioning the business, because you did recognize it. Is this is a case that it is almost the last man standing wins here? That this business has been difficult, and if you stay the course that there's a number of smaller competitors or European competitors that are at a cost disadvantage to you, that ultimately you could turn this into an increasingly profitable business?

I think we will definitely see (indiscernible) very profitable business. I'm extremely confident of that. I do think we're going to be challenged from a growth standpoint and that we're going to have to get some of our growth -- and this might seem like a funny thing to say -- but we're going to have to get some of our growth through acquisitions and the mechanical side of the business, because there's still worldwide way too many people in this market, like there are even in the electric motor business. That is our goal in life, is to be a consolidator, and to be able to buy these businesses and get rid of the junk that is in them and focus on the things that are profitable. Unfortunately, that doesn't always play well to the growth people who want to say -- well, you're growing, (indiscernible) you lost market share this quarter. You know? It's just the way we go about doing things. We bought Leeson, we bought Marathon; certainly in those businesses we went in and got rid of certain volumes of business that, let's just say the owners didn't do for whatever reason -- we don't know. I think we're going to -- yes, we have got a challenge -- I think the last man standing might be -- I don't like that phrase -- but it is probably descriptive of some of what we are confronted with.

One other piece of that, Mike, I would bring up is that up until six months ago, you will recall that the dollar was higher against the euro. We have talked in the past about equipment coming in with other peoples reducers on it because the equipment -- we didn't see the foreign competition as tough directly here, but the equipment that our customers used to make was coming in from other locations in the world. That has changed, and that is one of the reasons why I'm pretty optimistic about some of the change we're seeing now in bookings and so on. It takes a while before that runs its way through to our level, but it is reversed now, and I expect to get some gain out of that.

And I would say the mechanical side of the business is even more than the electrical, dependent upon building capacity as opposed to just fix and replace. We have not been building a lot of capital expansion in this country, so it's down, I think, probably more than a lot of things. Not all great answers, Mike, and maybe we should --

No, I appreciate it. It is a difficult market. I don't mean to be confrontational about this. I'm trying to figure out structurally what is different.

Here's what we do know. Some of these things are very hard to get your hands on. We can tell you you replace three motors per gearbox, so in a slowdown you see more consistent motor sales. And we can go on and on about that kind of stuff, but there's a fair amount that's speculation. But we do track very carefully who our competitors are and what the information is. So one more time I'll just say, we have not lost share, we have gained.

Jim and Henry, again, on the electric motor business. You guys have built the co-leader in this market along with Baldor (ph). It seems like there's a lot more sellers now than buyers; arguably, Reliance, GE and Emerson all went out of this industrial business. Are you guys willing, interested in taking this kind of stair-step increase by acquiring one of these larger competitors?

Let me responded to that first and give Henry some time to think about it. That is what we do, Mike. We're only constrained by the amount of debt that we're willing to take on and our ability to rationalize these things. It is a very difficult task to buy these kinds of manufacturing operations, and to transfer the skills of three plants into one. And it costs you a lot of money to do that. You build that into your model when you do it, but you pay hell from the marketplace while you're trying to get it done, as evident by a number of the questions that we had today. But certainly, if we could financially do that without betting the farm, we would be taking a whack at some of these really big deals. We will continue to look at some of the smaller ones and look at ways to add product lines and/or other motor companies. Absolutely we'll do that.

Richard Rossi, Morgan Joseph.

You have covered most of the ground. You've mentioned obvious cost pressures on the materials side. Could you give us some examples on where you are seeing the most pressure, what kind of increases and what you're kind of building in for '04 in your own internal modeling?

Copper is a significant material cost to, and if you take a look at the run-up in copper over the last -- I'm going to say five months or so -- it has been from a range of somewhere in the vicinity of 85 cents to $1.10 per pound. Another key item is steel. Steel is being increased about $30 a ton around the world. A lot of it is being driven by the Chinese machine; their purchase of scrap metal (indiscernible) metal up. Their capital utilization now on copper wire, or copper in total, has driven the markets. So those things -- that is what's driving it. There's reason to believe that over the next year it is probably going to continue here for a little while longer this coming year, in '04. But there's a lot of capacity coming online also that will probably start to change that toward the end of the year beginning the following year. So it's not a permanent thing but it is going to be there for a while. I think we mentioned last quarter that based on the changes that we were seeing, that it could have as much as a penny a share cost per quarter, of it continued to go where it was going. The difference I would say today is that we believe that because of the cost increases also bringing in things from China, the change of the dollar and the euro, that we can probably offset that with pricing.

One other question, if you could just give us a picture of what the European markets look like for you?

We don't participate in a big way in Europe. We do sell products, but it's not been a major marketplace for us in the past. They seem to be -- we are, right now, of course, beginning to have some advantage in selling there, so we are seeing some growth in the products that we sell there. But it is not, it's not a momentum-changer overall in our company.

And you don't see the currency change having enough of an impact to make it more important?

It certainly has that potential if it stays there for very long. But you know, like people in this country, the people we would compete with over there are also sourcing things from all over the world. So it is not a huge change that is going to take place.

We do have a follow-up from Alexander Paris.

Just a quick one. I think you answered most of my questions. Going back to the electrical. You did the acquisitions, you did the integration, you made more sense out of the brand names that you are showing or selling, organized changes in the organization. If you made no more acquisitions there, would you be in a reasonable position -- that is, having most of the price points and products covered in that industry?

We have a very good broad product offering right now in the industrial arena. We are doing product additions all the time, we are adding new products. I think in the new catalog we're just getting ready to publish for one of our brands, we're adding over 250 new items in it right now. So we are broadening the band as we go. We don't necessarily need acquisitions, although there are some things that will -- either are or will be available that would allow us to move on one end or the other of our current product range, that we would be potentially be interested in.

So in industrial motors you would rank yourself a close second?

In terms of range, I wouldn't even rate us second. I would say we're there.

I would say in range, there is nobody out there who has as much as we do.

How about in just size?

I guess that's kind of what I'm talking about, size and/or types in terms of industrial motors. There are some we don't have, and somebody else can say we've got it, but we would be back saying we've got this and you don't have that. But in the overall scheme of things --

Did you mean dollar size?

Yes. In terms of, say, relative to the Baldor I guess would be number one. Are you right -- somebody (multiple speakers)

Yes, we're still -- in motors, we are still a little smaller than they are.

Okay. How about generators?

There is no comparing us hardly with anybody else on generators, because we are easily the largest generator manufacturer in the United States, when it comes to producing large kilowatt generators, all of which we sell to somebody else to build gen sets (indiscernible). In Baldor's case, they're making a smaller range of generators, usually I would say more apt for construction sites and homes and so on. And they build the build the whole generator set, so they can't sell really to anybody who makes big generators. As an example, they can't sell to CAT or Cummings or some of the other people we sell to.

Just one other question. The last time you did financing with your bank line it got you to a point where I think you said you didn't have to ask their permission on acquisitions anymore. So you have a free hand there, and your debt to capital at 33 percent is probably about optimal, or at least comfortable, for you. So there's some room even at the current level to make at least some bolt-on acquisitions?

Yes, that is correct.

How far would you take the debt to capital back up again if you saw something good?

I think the way we would answer that is if the opportunity is right and it was something that was a significant acquisition, of course we would go to our banks and wherever we needed to finance it to do it properly. And then we would be willing to go back up significantly. If you recall -- just to give a little perspective -- on a capitalization ratio, when we bought Marathon, our capitalization ratio was in the 55 percent range. When we finished Leeson it was also in the '50s. So going there with the ability to generate the kind of cash flow that we do to reduce our debt over a period of a few years, we would go there again for the right acquisition. Obviously, if we have our choice and we can do it in a way that allows us to stay in the 40s, sure, we would prefer that.

We have a follow-up from Holden Lewis.

A couple of things. On the gross margin, you had a nice little rebound from Q3 to Q4. Is that just a function of your inventories having gone up and getting some absorption from that? What's sort of the elements of it?

There are probably two or three elements of it. Some of that is certainly the case. We did do a little bit of building in the fourth quarter that we did not do in the first quarter -- or third quarter, I mean. Some of it is the elements of improving performance, but it's probably bits and pieces as opposed to one thing that really overrode the others.

Henry, if I can add -- if you recall, Holden, in the third quarter our gross margin of 22.9 percent was depressed, because of a lot of the efficiency problems we were having with our electrical moves. As we've gotten those things corrected, the margin popped up back to the 24 range which is where we were pretty much in the first half of the year as well.

Thank you. Can you give a little bit more guidance in terms of what was the contribution from the generator business on the electrical growth? I guess that was up about 7 percent or so year-over-year. To what extent was the generator business up, and what was the growth absent generator?

I don't think we actually break that out, Holden. But I can tell you that the motors were up in their own right, slightly. Certainly there was more growth in the generator side of the business. But I don't think --

No, you're correct, Henry. We don't break that out per se. And what you said was correct.

But you do get a little bit of growth out of the motor business just the same?

Yes.

Any sense -- you've been selling mostly smaller motors and relatively stronger than larger motors. Do you see any change where larger motors are coming back in vogue a bit?

Not substantially. When I made my statements early on, I mentioned that a couple of the industries that are still slow are pulp and paper, and oil and gas, and commercial construction. Unfortunately those are better markets for larger motors. We have seen some slight improvement, but mostly the improvement that we're seeing so far has still been in the smaller end of the business.

Just clarify one other thing. The Asia sales question that was earlier -- you said that you sell 20 million in China plus several million elsewhere, so call it 25 for arguments sake. That's not what flows through your P&L, right? Because those are all joint ventures?

Some of the sales that we sell there are not through the joint ventures, but most of it is.

So how much -- but you're not flowing 20 million-plus of sales through your P&L from Asia?

No, you should be aware that we consolidate -- the way the accounting works, we consolidate all the sale of the joint ventures that are external to the Company. Obviously, the product we buy from our joint ventures is not in those numbers, because it is inter-Company. And then, one of the ventures is 50 percent owned and the other is 55 percent, so you're seeing 100 percent of it, but when we come down to the profits, then the profits are only our share of it.

Thank you.

A follow-up from Michael Schneider.

Ken, in the guidance for the first quarter, have you assumed taking more inventory out which would ultimately pressure the margin, at least temporarily?

From the standpoint of production schedules, no. That's correct, Henry isn't it? We're not in a mode of reducing production, are we?

No.

What is your outlook for the inventory as you enter '04, then? Ken, do you anticipate it being a source of cash in the '04 or in the first half only?

A modest source of cash over the whole year. We do expect to pull some dollars out of inventory, even with growth. But nothing -- because of the growth it would not be anything like we have seen in past years, when sales were contracting.

One other question. Henry, in the price increases you have put through, I have learned at least Leeson and Marathon have gone out with what I am told are three percent increases. What has the initial reaction been? Because you've obviously got raw material costs to blame, and hopefully even offset. What has been the initial reaction, if any?

We've had a couple of competitors follow quickly and a couple more that we think well. I think the market will -- nobody says okay, well that's fine. It would be nice, but that does not happen. But we are not seeing pushback that we can't deal with.

Mr. Kaplan, there are no further questions in queue.

Any final comments, Jim or Henry?

Henry, do you have anything else?

I would day one more time, this broad base bookings improvement, as well as the optimism we see in the market -- and the things that we've done to create leverage for the future -- we are very optimistic -- at least I personally am very optimistic about what the year ahead is going to bring. And I am looking forward to being able to have these kinds of calls, and talk about not just what lies ahead but what a great quarter it was.

I will only add to that with these comments. It is good to get a bunch of this stuff behind us, and I always like to -- at least to our board and to the investment community -- remind them that even with all the work we're doing and all the rationalizations we've gone through, that our margins still look pretty doggone good when compared to some companies who haven't done any of these types of things, and basically have maintained their margins. So when we have margins that are equal to some of our competitors in doing the things that we're doing, I am really encouraged by what I think we might be able to do as we move forward.

The other comment I want to make is that we are not just sitting still on this rationalization issue. I think one of the things that we have learned through this whole process -- there's always some good things that come out of these kinds of periods of time -- that there is a lot more that we can do to improve our efficiency, not only in the plants we've got but in terms of not having as many facilities as we have been accustomed to having. (indiscernible) we had a better marketplace could afford to do it. So I expect that we are going to probably see some additional rationalization projects surface in the Company in the next year, even if we have a good economy, just because of some of the improvements that we know we can make and have been forced to make during this past recession. All that considered, I am pretty optimistic about where we are going, and we're going to continue to look at acquisitions, and its good to see the sun coming up on the horizon. I don't have anything else to say.

Okay, then. I will say a final thank you to all the participants. And if you have follow-ups, you know how to get hold of me. We'll look forward to talking with you. Thank you very much.

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