Regal Rexnord Corp (RRX) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the Regal-Beloit third quarter 2005 earnings conference call. (OPERATOR INSTRUCTIONS). Please note that this conference is being recorded. I would now like to turn the call over to Mr. Ken Kaplan, Vice President and Treasurer and Secretary. Mr. Kaplan, you may begin.

Good afternoon everyone, and welcome to Regal-Beloit's third quarter 2005 earnings conference call. With me here today are Henry Knueppel, our President and CEO, Dave Barta, our Vice President and CFO, and Mark Gliebe, Vice President and President of our Electric Motors Group.

But first I would like to remind everyone 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 list of a factors that could cause actual results to differ materially from those projected, please refer to our 2005 filings with the SEC.

If you have not had an opportunity to review this morning's earnings release, it is up on our website at Regal-Beloit.com. Now I will turn the call right over to Henry.

Thanks all of you for joining us. We appreciate your interest in Regal-Beloit. The agenda we're going to -- I'm going to spend a few minutes here and give you if you headline comments, and then turn the program over to Dave Barta who will talk about the financial results from the quarter. We're going to ask Mark Gliebe to cover the HVAC marketplace, and answer some of the questions that we anticipate that you're interested in. And then I will finish up with a little color on other markets, materials and our thoughts on the fourth quarter. And then we will open it up for questions.

Let me start out with the top headline. We are extremely pleased with the quarter. It was obviously a very good quarter. And certainly on a seasonal basis, much better than we would normally expect. Sales were buoyed overall by the record heat that we experienced in June, July and August, and excellent organic growth in our Marathon Electric Motors division and our Hub City division. These strengths were somewhat offset by slowness in the Power Generation business overseas, particularly in China, where we had early and more severe wet season than normal, and also by the effects of the sale of Illinois Gear in the Mechanical Group. I would also say that we have seen very little impact from the hurricanes to date. There are some pluses and minuses, but overall we would be overall net neutral.

Profits were also extremely solid in all regards as we saw improvement in our Mechanical Group, as we projected last quarter, improvements in our legacy Electrical Group, and of course the impact of volume on our HVAC business. We were particularly pleased considering the continued hikes in copper costs, the severe increase in energy costs, and the still significant costs involved in moving out of Taylor Street and the Tell City facility, two facilities that were not purchased as a part of the GE acquisition. Overall it was a very positive quarter, and certainly better than what we would normally expect for the third quarter given the seasonal patterns of our HVAC business.

We were also extremely pleased with our secondary offering. During the quarter our stock traded up during that offering as opposed to the more typical down draft experienced by most offerings during that same time frame. We were oversubscribed, which allowed us to sell literally all of the GE holdings and the primary stock that we wanted to sell on top of that. The successful culmination of that offering, settling up purchase agreement matters with GE, and our strong operational cash flow for the quarter allowed us to reduce our debt by $88 million, which was another milestone.

With that I'm going to turn it over to Dave Barta, our Chief Financial Officer.

As Henry mentioned, starting with the first line of the P&L, we saw strength throughout our financial results. Sales for the quarter were 345.9 million, which was a 78.4% increase over the third quarter of 2004. Included in our sales results are 145 million of incremental sales from the CAC and HVAC businesses that we acquired from General Electric last year. I will remind you that we did book our close on the CAC business at the end of August, so we had one month of the CAC business in our 2004 results.

This performance really reflects strong results in our Electrical segment where sales increased 106.3%, including the sales from the acquired businesses. On an organic basis, the segment sales increased 5.4, but two real distinct stories here. Motor sales for the quarter on an organic internal growth basis increased 9.1%, therefore the remainder of these segment sales were down. The decrease is really coming from one factor, and that was out of our generator business, the sales in Asia and in China. Third quarter in 2004 generator sales were extremely strong. And that was related to the shortages of hydro generated power and government investment incentives that were in effect. Those two factors were not going in our favor this year. And then on top of that with the cost of diesel fuel, generator sales were soft in Asia. Those three factors really drove the generator sales down from last year and pulled the segment down.

Sales in our mechanical business decreased 1.6%. But as Henry mentioned, the first factor there was the sales of the Illinois Gear business, again, recall that we did sell that business in May. And it impacted sales for the quarter by 1.5 to $2 million. Excluding that factor, sales would have increased 1.4%. And again within this segment we really did see two extremes as well. Several of our divisions had extremely strong sales performance, double digits in two cases,, and then that was offset by softness in that several of our divisions, one of those being continued softness we have been saying in the cutting tools business where sales were down double digits.

On a year-to-date basis, sales are now 1.1 billion. And I think it is the first time that certainly we've got to use that term to talk about our sales line, which is a milestone for us as well. That is an increase of 97%, so almost double where we were a year ago. Included in the year-to-date sales are 477.6 million of incremental sales from the acquired businesses. On an organic basis year-to-date sales have increased 8.1%. Sales in our Electrical segment are 903 million, which is an increase of 133.7%. And on an organic basis year-to-date sales in the Electrical segment are up 10%. Mechanical segment sales year-to-date are 149.5 million, which is slightly ahead of last year.

Another bright spot, and something we have been working hard on, and talked about I think now for the last five or six quarters is gross margin. We were very pleased that gross margins were 22.1%, which is an improvement over the 21.6 for the second quarter. And I think the first time again in a year and a half we would have been able to report gross margins flat with the prior year. And again, this material cost, as Henry mentioned, continued to pressure margins heavily. But our folks are working very diligently on pricing, productivity and mix to offset those pressures and were successful this quarter in doing that.

Year-to-date gross margins are 21.3 versus 22.8 for the same period last year. So we still obviously have a hole here that we have not caught up on a year-to-date basis. The gross margin of our legacy business increased nicely the third quarter of this year over third quarter of last year, again reflecting the price and the productivity actions being taken.

Operating expenses where 12.1% of sales versus 14.1% in the third quarter of last year. That really reflects again the volume leveraging of our fixed costs, and the impact of the cost structure, particularly the HVAC business, has a lower SG&A structure. I should also mention that last year in the third quarter we did have a onetime event. We had sold a property in the UK. It was about $1 million gain on that property, and that was reflected as a reduction of operating expenses last year.

Year to date operating expenses are 12.2% of sales compared to 14.9 last year. Income from operations, another bright spot, was 34.6 million versus 15.6 million in the third quarter of last year, an increase of 122%. And on a percent of sales basis, income from operations was 10% versus 8% in the prior year. And again recalling that the prior year was boosted by the sale of the UK property. Again this is all reflective of the pricing actions, the productivity, and the contribution from the acquisitions. Year to date income from operations is 96.3 million versus 42.2 million in the same period of 2004.

The tax rate for the quarter is 33.5%. And again in that we did receive a onetime benefit, a tax refund at one of our Chinese joint ventures. And that -- our portion of that refund is about $600,000. Net income for the quarter was 18.5 million, an increase of 107.4% versus the 8.9 million reported last year. And fully diluted earnings per share were $0.59 compared to $0.36 in the third quarter of 2004. The average number of diluted shares was 31,234,000, and that compares to 24,725,000 last year. And again this difference was due to the shares we issued as part of the HVAC acquisition, as well as the primary shares we issued in our most recent offerings. Year to date net income is 49.2 million versus 23.4 million for the first nine months of 2004. And year-to-date EPS is $1.62 versus $0.94 for the same period of last year.

A few balance sheet highlights, and then Henry touched on these. Total debt was 448.9 million, which is an $88 million decrease from the second quarter, and about $100 million decrease from the beginning of the year. And we remain really confident that we will continue to pay the debt down even further. Within the components of cash flow inventories were reduced 5.5 million. CapEx for the quarter was 6.2 million, so again slightly below the pace that we had guided. And we will talk a bit more about that. That brings our year-to-date capital spending to 21.7 million. And depreciation and amortization was 9 million for the quarter and year to date is 27.8.

Turning to the fourth quarter. We expect to see continued strength in HVAC sales. And Mark will certainly address that. And again, I think something else I will mention is we had previously provided some of the seasonality flavor for our sales and indicated that the second quarter would be the strongest quarter for us, followed by the third, and with the first and forth being at similar levels. This is really based on the historic HVAC sales distribution and its impact on our total Regal-Beloit sales. And I think we still believe that that certainly is going to be the order of this quarter's lineup this year. There's certainly has been change to the way that curve looks. And again Mark will talk more about that.

We provided EPS guidance of $0.48 to $0.52 per share. And this is reflective of what we see as a fairly strong sales environment between the HVAC arena and our latest assumptions on material cost, our inventory reduction plans, and our plant operating plans. And again, we're continuing to aggressively address inventory levels through the fourth quarter. In arriving at this guidance we used a tax rate of 35.5%. And again I will comment here that we have several projects going on in our Company to reduce our effective tax rate.

One more bit of guidance we're expecting capital spending in the area of 7 to 10 million in the fourth quarter, which coupled with the year-to-date spending is below our prior guidance. We have had a couple of projects that, while those projects are ongoing and underway, the spending will probably flip in the next year, and namely one of those being our IT area where we had planned to spend about $6 million, and some of that spending will carry over into next year. So with that I will turn it over to Mark.

Good afternoon everyone. I'm sure a number of you have questions on the HVAC segment of our Motors business, so we will try to anticipate a view of those questions and tackle them right up front. The HVAC segment of our Motors business had a stronger than anticipated quarter. As we were closing the second quarter and providing our third quarter guidance, our customers were feeling the negative effects of cool temperatures in May and the early part of June. As we look back at the summer we know it was a warm one. Cooling degree days, as published by the National Weather Service, were up 23% year-over-year and through the month of September. The effect of that heat that had on our customers orders can be seen in the ARI data where OEM inventories declined 31% through the end of September. The increase in cooling degree days and the decline in OEM inventories translated into stronger orders for our HVAC motors in the third quarter. As we look at our sales over a two quarter period and compare it to ARI data, we believe our sales were in line with what happened in the marketplace.

Now we can take a quick look at the fourth quarter. As you all know, our HVAC business is quite seasonal. And normally our HVAC sales would fall off dramatically in the fourth quarter. For this year we have increased our fourth quarter sales slightly from a more normal year, and that is to reflect orders from our HVAC customers. We believe that the fourth quarter HVAC order strength is a combination of rebuilding of the OEM inventories that were depleted in the third quarter, and a 13 SEER prebuy. We really do not know how much of the order strength can be attributed to each dynamic, but we do believe both dynamics are coming into play. These dynamics and the impact of our sales are very fluid right now, and they're changing daily. If the impact of these dynamics were to have a more materially positive effect on our business, we might need to update our guidance later in the quarter.

We are currently in the middle of our 2006 planning process. As we look at next year it is difficult to sort out exactly what the impact might be. We do believe that any prebuy will come out of the market next year, but there are many variables that include the prebuy itself, the inventory rebuild, our customers' changeover to new designs, and the weather that make it difficult to pinpoint the future. We will know, however, when the prebuy and the inventory rebuild ends because there will be a mix shift in our demand. So far that has not occurred.

The other area that we would like to touch on today is the lunch of our new X13 motor. We are now in a ramp up production of this new product out of our Reynosa facility. And so far we are quite pleased with our product. The interest in the product on the part of our customers has recently strengthened. And all seven major HVAC manufacturers will be using the X13 motor for some portion of their 13 SEER HVAC application.

We do believe, however, that the 13 SEER prebuy is having the effect of lowering our near-term demand for this new product. Our customers continue to build the older 10 to 12 SEER units that will not utilize our new motor. One thing we are confident about, however, that is even with the noise of the prebuy and inventory rebuild, the X13 motor launch is very positive for Regal-Beloit. With that I will turn it back over to Henry.

Just a little bit of color on the markets for the quarter. The markets that were hot continued to be oil and related, telecommunication, mining, and HVAC. Still improving and growing in strength are commercial construction and industrial construction, material handling, paper. And we did see some gains in pumps because of the hurricane events. The markets that we're still pretty cool were irrigation, marine pleasure craft, and power generation in China, as I mentioned earlier.

A little extra color on the materials. We did see some further improvement reduction in cost in steel during the course of the quarter. But we would have to say that it is a very volatile market. Surcharges and scrap prices are rising again as we speak. Those gains were unfortunately more than offset by the increased cost of copper, which is hitting historic highs, and the increase in energy costs, and of course oil-based components such as plastics.

While we have a solid hedging program, we can tell you that there's simply no way to offset the three-year run-up of prices in copper, given the size and strength of that run up. And we expect to see further inflation in those costs next year. We have, as a result of that, announced additional price increases that are set for the end of this quarter and the beginning of '06. Even with those price increases, however, it is a no-win game for us and for our customers. And we will continue to be in a lagging position as we move through the quarter.

While that is not good news, it further illustrates the strength of our earnings initiatives. And we are very pleased with those. The leveraging of our buys, given the size of our Company now, our global sourcing efforts, the plant consolidations that we have talked about, and certainly our lean Six Sigma effort, which is very significant in our Company. We do have over 150 green and black belts operating in the Company, with nearly 200 projects being tracked on a monthly basis. And we expect this process to continue to deliver and deliver more in the future a financial benefit to the Company. We also have several very strong IT initiatives that are designed to make us faster, more cost-effective, and give us a better and faster flow of information as well as allow us to be more customer centric.

We're also extremely pleased with the progress on new product and growth initiatives. We really believe in our products, and the new products that we are bringing out, and the innovation that we are bringing to market. We have talked before about this four trends that we believe we can capitalize on. The first being high efficiency. And certainly the X13 motor is an example of a great success there, as well as our high-efficiency power transmission drives that were introduced in the last year.

We have talked about variable speed as a key trend. The ECM motor is a good example, as are inverter duty motors. And we believe that we're the leaders in technology in both of those cases. We have talked about the trend toward embedded intelligence, and certainly our 2400 Series switchgear, our PhD motors and other products are good examples of the gains that we're making there. And we have talked about the value of working on discrete applications where we can add unique value to the market, such as our spa motors. We are very pleased with those efforts.

We also are pleased with the growth that we are experiencing in China and Southeast Asia in general. However, I would have to say that we need to accelerate those efforts even further.

As we look at the fourth quarter, we expect a very good quarter. It will be outside of what we consider to be the seasonal norms for fourth quarter, and has the potential, as Mark said, to even expand further. Obviously it is due to the HVAC inventory rebuild and build. Growth in large motors continues to be a real engine, and particularly because of oil and gas and industrial construction. And finally, we would say that we expect continued good results from the initiatives we have in earnings and growth.

With that we will stop our presentation and as for questions.

(OPERATOR INSTRUCTIONS). Michael Schneider from Robert W. Baird.

Henry, maybe you could first continue with materials and pricing. Do you have a quantity or an estimate on basis points -- what had hit gross margins during the quarter? And then maybe where, with the pricing you had put in place, where you actually make it up? Is it out in the first quarter yet, or do you actually see some benefit flowing already in the fourth quarter?

For the third quarter it was actually reasonably flat because of the pricing actions that we had taken. Catching up, however, as the quarter progressed toward the end of the quarter we started to see copper take off again. And so of course we responded with some additional price increases. But it is going to be sometime in the first quarter before those will catch.

You don't think it actually had a negative impact on margins during the third quarter?

Very little. There is a small amount, but very little.

And then on the inventory reduction efforts, again, were you actually bleeding inventory during the quarter, such that I guess you had some under absorption?

Actually, I think some of the inventory reduction was because of the hot weather and the historic kind of shipments that we saw in the HVAC. We will see some reduction in absorption in the fourth quarter because of some of the efforts there. But I would say that it was more a case of the demand driving the inventories down during the quarter.

And then, Mark, you used the phrase a couple of times, the 13 SEER prebuy. To be clear, you are saying though that the prebuy is actually a 10 SEER product in front of the 13 SEER transition?

That is what I'm saying, yes.

Just on the IT projects during the quarter and what is going on, I guess, with the CapEx spending. Can you give us a sense of where you are? Are you on target? What has been the shortfalls so far in the IT integration and the GE businesses? And then just how the separation is going from the back office functions of GE corporate?

I might find some wood to knock on here, because so far it has gone fabulous. We were on schedule with financial package change over, and we have stayed on schedule with the hardware side of the transition. There is another large transition that will happen early in the year. But so far, we're right on schedule with where we expected to be, and minimal issues as a result of that.

Would you describe -- as of today have you actually executed some major transitions or has this all been in preparation for what is going to occur in the first half?

No, there has been -- there is probably five significant steps. And we are two out of the five now that were significant that went very, very well.

And why is spending spilling in to '06 versus getting done yet in '05?

There is no specific reason, just a number of things. By the time we got them ordered or by the time we decided what we needed, it is going to spill over a little bit.

Or in some cases, payment terms -- I think everything is going to the plan that we initially laid out, our internal plan, almost, as Henry said, almost too perfect. We have converted over accounts payable, general ledger, a lot of our engineering and building materials systems. And we will have some spending in the fourth quarter related to some of the onetime fees and costs that results from those. And then we have a more -- another one of five that Henry mentioned that will be right after the first of the year, which will be another round of some of that spending.

Where we had originally planned our schedule of conversion and kind of matched the cost of that, the costs are shifted out a little bit, which we view as a good thing.

And then on global sourcing, maybe you could address who's heading the project now? And if you look at your building materials across the two combined companies, how much you have addressed, maybe what you have actually realized in savings, and then what you both view as left in that project?

The person who heads up our sourcing effort is a fellow by the name of Mike Dahm. I don't know -- I don't have a specific percentage that I can give you. What I would say is that we're hitting the low hanging fruit currently. There's a lot of data mining that will come out of when we finish these conversions, and get all of the Company over on one system that will help us gain more. And that will expand into next year, so there is going to be continued opportunities. But We haven't been sitting still waiting for that. We have certainly been making progress over the last couple of quarters, in particular. I don't know -- as a roundabout way of saying that maybe 40% of the way there.

But obvious ones, steel and copper, you have already taken a hit?

Yes.

You feel like those savings are hitting the P&L today or yet to come?

They have started.

And then final question. Just gave on the tax rate, it is bouncing around. What should we use in the fourth quarter? And then what is the run rate in '06?

On the fourth quarter the number we used for our guidance, and I say this way for a good reason -- was 35.5%. I mentioned that is what we used in our guidance, because we are working on quite a few projects. We have a new Tax Director on board here that has signed up to our thinking when it comes to Six Sigma and lean. And tax doesn't get to escape those projects either. He is working on quite a few things, some of which are baked into the number, but over and above it, we're working on some other projects.

As far as next year, we are in the process of rolling up our plan. And until I have that complete and can see the breakdowns by country, and also get a sense of all of his efforts and when those will deliver, I really can't give you anything yet. I will have to defer that one.

Any reason to expect though that the rate goes up in '06 from 35.5?

No, there shouldn't be any reason why it would go up.

Great quarter guys. Thanks again.

Holden Lewis from BB&T.

Can you comment about where we are -- the Mechanical segment margins obviously stepped up pretty sharply. I know that we were talking about winding down restructuring activities there. But the sharpness of the pot makes me think maybe some of that wasn't necessarily wound down but maybe completed a little bit early. Can you sort just give some progress of where we are on mechanical activities, and perhaps what the cost delta was sequentially, or year-over-year, in terms of what you incurred?

I will let Dave think a little bit about the cost delta question. But we are very pleased with the progress that we made over the last two quarters. The Electra-Gear move is essentially complete. There is still some opportunity I think for us to improve our efficiencies a little further on that move. But we are certainly back up to a good operating rate and a lot of the costs are behind us.

The Illinois Gear move was also complete. So we did wind those up and I think we're glad that is behind us. There are a few more things that we want to complete in the Mechanical Group, but overall we are pleased with the results. And I think we would say that there is more room for expansion. We want to do some work there in inventories which could create some of absorption issues for us in the short run, but there is plenty of overrun in that for the upside.

I guess just on the year-over-year I would actually have to go back and dig through it a little bit. I don't have a good answer for you. I think the other piece is that we have in our restructuring in the UK while there is still some going on there, that also I think is trying to tail off. Really is a tail off of some of the projects we had this year, coupled with the benefits that we had been hoping for.

Frankly, we have one issue there, and the cutting tool business has been very slow. And otherwise I think the results, frankly, would look even a little bit better. And Dave mentioned that in his (multiple speakers).

Did you have any substantial costs incurred for these activities in Q3, or they were essentially largely out in Q3 completely?

Nothing substantial. There were some trial out cost, but it was not substantial.

Right. In Q2 they were running more full bore.

Yes.

And was that a little bit more accelerated that result than you thought? Because I thought we were kind of looking for it to tail off through the Q4, and it sounds like maybe that got accelerated there. Is that accurate or no?

I think that is fair.

Secondly, can you comment a bit on the year to year organic or legacy business change? It looks like your rate of growth is up 3.5% if you strip out the acquired revenues. I noticed that is partly impacted by the sale of the business, but it was in Q2 as well. It just looks like you had a deceleration against some lately slightly easier comp, which might otherwise suggest maybe some softening in the market. Can you comment to how that number might differ from your commentary about the markets at all?

There are a number of pieces in that puzzle. As Dave commented, our legacy motor business was up I believe 9.1% year-over-year. The Power Generation business was, particularly in Asia, was down quite a bit this year over last year. Last year we saw a slow down at the very end of the year. This year it started much sooner and there were a whole combination of factors. We have grown fairly substantially in Southeast Asia in the generator business. It is no longer an insignificant thing.

And then as I just mentioned, the cutting tool business has been a very difficult year for us overall. And as you mentioned, the Illinois Gear comparison comes out. Certainly it is not the robust kind of growth that we saw a year ago, but certainly it was not -- nothing that we're concerned about. It is still very solid growth overall.

Would you expect as we go forward -- I know you don't give revenue guidance per se, but would you expect that the -- that rate of growth, particularly with a very tough Q4 might decelerate a bit further here or --?

As you said, we don't give guidance going forward. So I'm going to stay away from that one.

Richard Rossi from Morgan Joseph.

Just a couple of things. One, your new X13 motor, what kind of a price comparison are your customers seeing versus the motors that comply with 10 SEER?

I will give Mark just a minute on that one. But as an overview so we don't just try to dance around that answer very much, as you can appreciate it is a very, very competitive market. And so while we can give you some indication --.

That is all I am looking for.

That there is higher value in it than there is on a standard motor. We probably can't get a lot more specific than that. Mark, any --?

I think what we said is that as we go from our standard motor to our X13 motor to our ECM motor, from both the revenue perspective and the margin perspective they are increasing, which is a good thing for us. Good thing for customers because the value gets passed down in the chain all the way to the consumer.

Understanding that copper prices at these levels is already a major issue, and it is difficult to compensate for it short term, have you thought about changing your buying strategies, changing how you hedge, how much inventory you carry? I know given these record prices maybe it is not the best time to make that bet? But is there much thought about making some changes in that regard?

Not really. We have a pretty disciplined process. There is no process in the world that would make up for what has happened in the last three years. There just isn't any way to overcome that. It has been a steadily increasing cost. And we think -- we certainly have done much better than buying just at spot level all the way through this. We think that we're approaching the top. Unfortunately I have got to tell you, I told you that last quarter too. But the market continues to be in a backwardation, which says that a lot of people believe that it is approaching the top. We may not be as long as we typically would be in this scenario, but we stay pretty disciplined. We're not trying to do market timing and speculation. We are trying to have definitive cost structure that we can run our business from.

Alexander Paris from Barrington Research.

We're kind of flabbergasted because normally you're the first question.

Well, I thought I would think a little bit first. But most of my questions were answered. Could you just us a general idea -- and now you just had something like 4 to close to $500 million of incremental sales from GE. Can you just give us a rough idea of what the margins are on that kind of business relative to your legacy electrical business? And if there is a gap between the two will there be closing or just --?

Particularly with the HVAC -- and you really have two different business profiles, the CAC versus the HVAC. The HVAC is generally a lower gross margin business than our legacy. But a -- we call it fleet average are slightly above operating margin. And again when you are selling the volume that you are to OEMs, that really drives both of those factors.

The CAC business is a little more I would say in line with our legacy motors business. But in this first year somewhat penalized by the fact that we were buying products out of the two GE facilities that we are in a process of moving out of. That definitely has impacted both our gross and operating margins for a quarter of the first year.

Under an ideal environment, which would be continued, modest economic growth, what do you target for in your legacy electrical business? And how close can you get to that with your -- with this incremental business that you've got? Looking, for example, I think your operating margins have been going up very nicely, by my calculation just a little over 20%. And more and more of that is coming from the electrical business, obviously. In the past you've gotten up to 27 to 28%. Is the different enough that you'll get volume, but you're not going to get back up to those operating margins in the best of times?

I think from a gross margin basis, we are going to look quite a bit different. I think we have commented before that the business today versus what it was even eight years ago, and it is quite a different profile. Gross margins probably will not get back to that level. But we do think that operating margins, and we have said this several times and are very committed, and we have our entire Company, every employee, focused on operating margin improvement -- that operating margins in the mid teens out into three, four years from now. And that is definitely something that we think is achievable. It is not easy. There are a lot of efforts, and it is impossible on a conference call to convey all those efforts that are going on. But there is a tremendous amount of work going on with the plant moves and the Six Sigma and lean and new products, and just every area of the Company. Even our tax guy, I got him involved in that. We do think mid teens are something that is achievable.

Operating margins?

Operating margins.

You are well over that now aren't you?

No, this quarter we were 10% operating margin.

We have moved up nicely this year. And as Dave said, there are a lot of efforts going on, so we're optimistic.

Nigel Coe from Deutsche Bank.

A very nice quarter, if I may. Phil Smith, one of your competitors in the HVAC motor business, talked a lot about tough market inventory workouts. Obviously you didn't feel the same trends. Why not talk about a little bit about your market share, and how you see market share trends changing? And what do you think is driving those changes?

I will let Mark comment on it. But overall we feel very comfortable with our market position, certainly. And I think Mark already said that he felt comfortable that we have held our share through the course of this year. We are very confident of our new products and the opportunities to take additional share in the years ahead, because we believe they bring technology and add value in the channel. Mark, do you want to comment any further than that?

I would say over the last two years we had some success in taking some share away from our competitors. And we have been penetrating our existing customer base with a number of our both existing products and new products. And I would also comment that there is a different -- we tend to have a stronger position in the OEMs segment and some of our competitors have a stronger -- not a stronger position, but have more of their business in the after market. So you wouldn't expect the same kind of performance.

Secondly, could you give me some sense on how your X13 and ECM motors are tracking maybe order-wise perhaps for the prior year?

X13 is a product we are just launching this quarter. So it is a very large new product launch for us. And as I had mentioned earlier, it is everything -- we are very, very pleased with it. Just recently we have had an increase in interest from our customers. And as we see it now all seven of the largest HVAC manufacturers will use the X13 in some portion of their SEER 13 product applications.

In terms of our ECM offering, which is a premium product, more of a premium product than our X13 motor, that product has been doing well for the last 10 years. We had another good year this year. And with natural gas prices doing what they're doing, we see another good year next year for that product.

I have an interest in your guidance for fourth quarter what sort of year-on-year increase are you building in to OEMs HVAC shipments?

We don't give revenue guidance per se. Certainly we're expecting to see -- we are saying with the earnings guidance that it will be a little above normal on a seasonal basis. There is -- and as Mark commented, there is some possibility -- we're really looking now to see what is going to happen in the last six weeks of the year. There are a lot of, as Mark said, a lot of variables going on. Customers are changing over their lines. Typically we would see December drop substantially. They're trying to determine how much they need to rebuild their inventories due to the heat. How much they want to build in advance of the SEER 13 legislation. When they want to actually make the shutdown for their factories. So there are a lot of factors that make it difficult to see what the concluding six weeks or so of the year are going to be. It will all become clear pretty quickly. So there is some swing possibilities, but right now in our guidance we have baked in the fact that it is going to be seasonally better than it would be in a normal year.

Finally come if I may, it has been eleven months since your last deal. You've getting a bit stale actually. What is your appetite and capacity to do further deals going forward?

Did you say we are a little bit stale?

Well, yes, it has been eleven months since your last deal really, and the deal finger must be itching by now, I would have thought.

I think that is a fair statement. Certainly we have the capacity. We talked about the debt reduction during the quarter. And if you take a look at debt to cap and you take a look at the debt to EBITDA ratios, we certainly are in our comfort range now. And as you know, we are acquisitive by nature. There's certainly a lot of opportunities in the marketplace. There is no shortage of those. However, the pricing in the market is somewhat astounding. And so we're going to keep a very disciplined view. We have never been a debt to farm company, and we have never been a go do it at any price type of company. When we do acquisitions we do them with the eye toward being accretive out of the box, and adding long-term value, and being strategic to our future business.

I can assure you the pipeline is full. I can assure you that we're having a lot of discussions and looking at a lot of opportunities. But I can't give you anymore color than that. And I can't promise you that there's something that is going to happen in the next six weeks or six months for that matter. It is going to be when we find the right thing.

And looking at the multiples, is it nontrade buys that is probably actually pushing up the prices?

I'm sorry. I couldn't understand what you are asking.

You talked about the pricing. The multiples are getting too high. Is that because we've got a nontrade bias for financial investors?

Yes, the financial buyers are certainly in a kind of an historic positive position with a lot of money to use, and good rates, and so on and so they have pushed the multiples up substantially.

Michael Schneider from Robert W. Baird.

Mark, your comment is intriguing about seven of the largest OEMs are using the X13 at least in some portion. Can you give us just attacking that at a different angle I guess -- if you look at what you were forecasting for unit volumes and what you're guessing you would speced on or specified on for the coming year, are you ahead of that rate, behind that rate, how would you characterize it?

In the fourth quarter I would say we're behind the rate. But I attribute that to the fact that they're doing the prebuys right now. There's some portion either doing prebuy or inventory rebuild. And so at least I understand exactly why this has happened. In terms of looking forward, I would say we are -- that the interest in our product has strengthened recently. And so we feel better than we -- we feel even more pleased. We were very pleased before. We feel even more pleased then we did perhaps six weeks ago.

But if you look back at your plan, I presume at some point you had to guess how many platforms or SKUs you would be used on, and what that meant for unit volumes for X13, post 13 SEER. Given the order book you have today, or the spec book you have today, are you above or below that number?

Speaker: We're above that number.

And then generator sales in the U.S., Dave, I think you mentioned the China sales were off. Can you give us a sense of what the U.S. generator sales are actually doing?

Those are actually -- have been on the increase.

So it is all China that explains the decline?

Yes.

And then I guess just the plant down in Reynosa, can you give us a sense what is going on there? I'm headed down there in December, but I guess I am curious as to what I'm going to see and what has been done and what is going on maybe in '06?

In my opinion, you're going to see the best motor plant on the face of the earth. It is a great plant. We have great people. Obviously business levels are strong, as we have said. It was stronger than normal for the third quarter, and we expect the same for the fourth quarter. You're going to see a very productive work force.

The move out of the two GE plans to other facilities, I guess how much is done and how much has yet to be done?

There is two facilities. The first one was our Taylor Street facility in Indiana. Again these were both facilities that were held by GE. We were 80% of the volume completed in July of this year. And we will be 100% completed by December 1 of this year. And then the second facility is Tell City, Indiana and we will be 100% out of that facility by the end of the year.

Mark, are you happy with the ramp that has occurred in the receiving facilities?

Yes, I am, very much so. The first facility was -- our Taylor Street facility most of that volume -- the largest piece of it went into our Juarez, Mexico facility. Some of the volume went to other U.S. facilities. But it has gone quite well.

(OPERATOR INSTRUCTIONS).

If there are no further questions, I will just make a couple of concluding comments. Again, I want to thank all of you. We really do appreciate your interest in Regal-Beloit. We feel great about the quarter. I don't know how else we can say it. We have improved margins. We're doing it again some fairly significant headwinds. Certainly we were helped by the heat, but it was a good quarter even without the heat. And we continue to make progress on our strategic initiatives. We expect in the fourth quarter to continue to see year-over-year performance improvement. And we're very optimistic about what the future holds for Regal-Beloit.

Again, thank all of you. Have a great day.

This does conclude today's conference. Thank you for participating. You may now disconnect.