Regal Rexnord Corp (RRX) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Third Quarter 2006 Earnings Conference Call. [OPERATORS INSTRUCTIONS] I will now turn the call over to Mr. Dave Barta. Mr Barta you may begin.

Thank you and everyone welcome to the Regal-Beloit Third Quarter Earnings Conference Call. Joining me today are Henry Knueppel, Chairman and CEO, Mark Gliebe , President and COO.

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

Now I'll turn over the call to Henry.

Thank you, Dave. Hello, everyone. We want to thank you for joining the call. We certainly appreciate your interest in Regal-Beloit. We will follow a similar agenda as we have in recent calls. I will make a few overview comments and Dave Barta our Chief Financial Officer will cover the financial aspects of the quarter. Mark Gliebe our Chief Operating Officer will then give you some color in the markets, materials and other operating highlights, and then I will finish with a little discussion, a review of the quarter and talk about the fourth quarter.

So from an overview standpoint, it was another great quarter. We are very pleased with the quarter and we achieved record third quarter sales, driven by continued strong, commercial, and industrial markets. Power generation was strong globally. We had some slightly down unit volume in the residential HVAC market. And we had another very strong quarter in commercial HVAC sales but it was offset by mix and share gains and we had another very strong quarter in commercial HVAC sales. We also achieved record third quarter profits with strong leverage due to strong productivity improvements across the Company.

Also improvements in mix with growth and higher tech products and larger motors and generators. Continued progress on our strategic initiatives. Once again, however, our efforts were restrained by materials cost increases. With that, I'm going to turn it over to Dave Barta.

Just to recap the financial highlights from the quarter, which were included in the press release we issued this morning and if you haven't seen that, that is available on our website.

Sales for the quarter were $419.3 million which is a 21.2% increase over the third quarter of 2005. And breaking down that into some finer detail, that performance reflected the strong results in our electrical segment where sales increased 24.9%. Sales in the electrical segment were strong in almost all product lines, but specifically in HVAC motor business, the industrial motor business, and the power generation businesses.

The [Sina] business that we purchased in May of this year reported sales of 11.7 million for the quarter. And then on the negative side, we also saw the continued impact of the transition away from the GE supply agreements that we talked about last quarter and sales were reduced by about 3.2 million because of the transitioning of that business.

So after adjusting for those factors, sales increased 22% on an organic basis. Reported sales in mechanical segment increased 0.8% and results of the mechanical segment were negatively impacted by the sale of the Regal Cutting Tool business that we sold in the second quarter of this year and that amounted to about a $3.9 million reduction in sales.

So excluding the impact of the sale of the business, sales increased about 8%. And as we had mentioned in the prior quarter as we saw particular strength in our later cycle mechanical businesses. The gross margins for the quarter were 24.6% as compared to the prior year third quarter gross margin of 22.1. And as Henry mentioned material costs, particularly copper and aluminum continued to have an impact on margins.

However, the impact and of new products, productivity, pricing actions and the positive mix across our entire business did offset significant portion of the inflationary pressures that we saw in the quarter. Operating expenses were 11.9% of sales verses 12.1 in the third quarter of 2005, included in this year's results was approximately $900,000 of expense related to equity compensation and that compares to about 100,000 in the prior year.

Income from operations was 53 million verses 34.6 million in the third quarter of 2005, which is an increase of 53.2%. As a percent of sales the income from operations was 12.7 verses 10% in the prior year. And again really reflects the contribution from new products from the pricing, productivity, and a leveraging of SG&A. Tax rate for the quarter was 36.6%, rate was impacted again by the distribution of income, which was weighted to the higher tax rate country such as the United States.

And net income for the quarter was 29.7, which is 60.5% increase as compared to the 18.5 million reported in the third quarter of 2005. And fully diluted earnings per share of 89, which is compared to 59 reported for last year. I'll turn to a few balance sheet highlights, total debt was 410.8 million, which was an increase of 17.6 million from the second quarter, but a reduction of 38 million from a year ago.

And the increase in debt from the second quarter was driven by positive strong income performance, however, it was more than offset by a net investment working capital and a higher level of capital spending. And thing is the one area that we all agree we're not pleased with our cash performance in the third quarter, and we're taking aggressive steps to improve our performance moving forward. CapEx for the quarter as we had forecast was heavier than our run rate. It was 19.8 million. And depreciation was 7.2 million and amortization was 2 million for the quarter.

Now, turning our attention to the fourth quarter of '06 and the guidance we provided this morning, we provided EPS guidance of $0.64 to $0.71 per share, the guidance is a function of what we see as a return to what we would classify as a more normal seasonal sales pattern, and continued positive mix contributions and continued positive contributions for our Lean Six Sigma, productivity in another key initiatives for the Company. Tax rate we used to arrive at this guidance of 36% and I guess the last bit of housekeeping on the fourth quarter we expect capital spending of 8 to 12 million in the fourth quarter.

So now I'll turn it over to Mark to provide a little more insight and color into the results quarter and a look forward.

Thank you and good afternoon everyone. During the third quarter, we again achieved strong top line growth. The strongest growth rates we're seeing in our power generation and motors businesses while the growth rates in our mechanical businesses were a bit more uneven.

Revenue strength can be attributed to general economic conditions, share gain, and the continued success of our new products. In terms of our third quarter on the electrical side of the business, sales from our motor is segments excluding acquisitions grew roughly 20% with double-digit sales growth across almost all of our brands and business segments.

Additionally sales in our generator division were up 20 plus percent for the second quarter in a row. In our HVAC business, our sales continued strong despite weaker shipments throughout the quarter from our customers to their own customers. In terms of our own performance, we have continued to benefit from the strong demand for both our new X13 motor and our ECM motors. The ECM motors, some of our growth has been driven by consumers of HVAC systems where taking advantage of both federal and utility energy rebates offered on the more energy efficient HVAC systems. As we look forward, our key challenge continues to be inflation. Copper prices peaked back in early May and we have seen only small corrections from that peak.

Aluminum prices have reacted similarly. As we move through the rest of the year, our effective prices for copper and aluminum will gradually increase as our hedges are replaced with higher priced hedges.

While we will relentlessly work at driving productivity improvements both in our business and for our customers, we have been unable to completely offset the continued increases in these commodities. As you can imagine, customers would prefer no price increases. And we are looking at all alternatives to offset our higher costs.

But unfortunately we've been forced to look at our customers to offset some portion of these increases. We did announce price increases in a number of our motor brands in late September.

The second key issue for the fourth quarter is the year-over-year comparisons to the fourth quarter of 2005 when the HVAC industry experienced unprecedented strength as a result of 13 sere energy legislation that went into effect at the end of January of 2006. Thirteen Sere had the effect of pulling forward revenue into the fourth quarter of 2005 out of 2006. We have been saying all year long that we do expect a significant unit decline in the fourth quarter, but that we thought we would fair well in the fourth quarter, overall. I think our guidance this morning reinforces what we've been saying all year.

Overall, we are seeing a return to more normal seasonal ordering patterns. In the past two years we have experienced somewhat vigorous ordering activity driven by very strong economic conditions. Moving forward, we expect a return to more normal seasonal order patterns. Further, we do believe the housing market is having some impact on our HVAC orders, however this is somewhat blurred by the 13 sere pull a head last year. Changing gears a bit, I would like to spend a little time talking about two of our key initiatives.

Lean Six Sigma and innovation. As you may already know, the Company launched the Lean Six Sigma initiative in the middle part of 2005. Our view all along has been that Lean Six Sigma would be a culture-changing journey for the Company. We knew from the start that in order to make the investment pay off, we had to support the effort from the top and we had to take a longer-term view. Since the inception of the initiative, we have trained over 340 employees from 5 different companies.

Today we have over 400 active Lean Six Sigma projects all focussed on continuously improving our products, or processes, and our cost position. As an example of the power of Lean, we launched Lean in our Juarez, Mexico facility in January of this year. As you may recall the Juarez facility was a site where we had increased the demand on the plant by over 40% as a result of plant rationalizations and a few key customer wins. Late in 2005 and into 2006, the plant was struggling to keep up with the higher volumes and the increase complexity of the added demand. We went right at the problem with Lean.

We completely restructured the plant floor and employed Lean tools such as standardized work, pound bonds, visual controls and work cells. The implementation of these tools allowed us to achieve a better, faster, flow of higher quality products through the plant. Along the way we trained over 171 employees in the use of Lean tools to resolve problems on the floor. Since the implementation of Lean in Juarez, we have increased our line rates 33%, lowered our overtime by 40%, reduced our defects by 43%, and shipped on our pass due significantly.

More importantly, what we found along the way on our Lean Six Sigma journey is that the initive in both uniting and energizing the Company. Being an acquisitive company we need to be good at integration. With many different businesses and brands, the Lean Six Sigma initive has given us a common language, common problem solving tools and a platform to share best practices. We couldn't be happier with our results so far and we see more opportunity in the future.

With regards to our innovation initiative, we view innovation as a key to our long-term success. Our focus is to launch new products or processes that allow our customers to become more profitable either by adding features to their products or by reducing the overall cost of their systems. In our long range planning process we ask each business to look out three years at the new products that they would like to launch. From that planning process, we see a continued stream of new products in the years to come. As an example, this quarter we are launching our ECM3.0 in the HVAC market. This is our six generation ECM motor and the latest in our plug and play offering.

Through design and software enhancements, we will bring more features to our HVAC customers while improving overall system reliability. Our goal is to remain in the technology leadership position in the years ahead. In summary, we feel great about the third quarter. It was great to see the broad base contributions from almost every business unit.

Given the tough year-over-year comparisons, we feel good about the fourth quarter and we are optimistic given the initiatives, energy, and enthusiasm throughout the Company. Back to Henry.

Thank you, Mark. Not to rehash all of the third quarter because I think Mark and Dave have done a great job of it, but we were particularly pleased with our organic growth. It's very significant in our business. We're very pleased with the operating leverage, despite materials. And certainly we're pleased with the continued progress we're making on initiatives.

We recorded record production in Mexico, China, and India. Global sourcing has now touched all of our businesses and is growing. And certainly our new product rollouts are gaining pace and enhancing the value we provide to customers. And finally we would say that the acquisition pipeline is very solid, always long shot to complete any acquisition, but we have a very solid pipeline. As we look at the fourth quarter and as Mark said, we expect to return to more normal seasonal trends, but we look at that as a good thing.

Markets are still solid except for the residential HVAC market, which has lagged now for two quarters. However, our share gains and mix have allowed us to offset the unit volumes and we expect the same in the fourth quarter. Our initiatives are continuing to create leverage, materials will continue to be a drag as we look into next year, at least through if first half of next year as we see it now. Hopefully no longer than that. But that's the amount of sight line we have at this point. The great news is that we're expecting a record fourth quarter, profit contribution, against a very difficult 2005 comp, which is no small feat.

And for that we credit our people across the Company, they are just doing a terrific job. With that, we're going to open it up for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Alexander Paris from Barrington Research Associates. Please go ahead.

Afternoon, great quarter.

Thank you, Alex.

Getting bored hearing that yet?

Well, you know, it never gets old. I hope we can continue to say it every quarter.

I just have a couple of questions. One in the near-term. You hear a lot of talk lately of slowing, maybe momentum in the U.S. manufacturing sector and maybe more business caution in inventory strategy and spending. You hear any signs of that at all among your customers?

I think our entire customer base, I mean all of us are concerned about that because you cannot pick up any periodical without reading about it. So I think we're all looking for it and perhaps looking too hard for it. So every time, we have a slow day, everybody's engaged in that discussion. But as we've said, we don't really see it yet. We believe that we are seeing a normal seasonal trend, which up until last year would have been normal. Last year we pushed right on through it because the economy was definitely in hot mode. But we haven't seen those signs that at this point would say it's weakening other than the seasonal kind of things that we typically see. Again with the exception of the residential HVAC market, which we've talked about.

Just looking forward then. Let's just assume that 2007 you continue to see 3% or so, reasonable growth. That would be good growth for the economy. But I'm just wondering what you would do for an encore. You've been doubling that. Do you see more gains from international? Gains from -- are there more margin gains from integrating the acquisitions you've already made? That is can you see more in that kind of environment? Can you see gross and operating margins moving up?

Are there anymore facilities to rationalize? You can step in any place here. There's a lot of questions. Where would you expect it? If you're going to do say double what a modest growth would do on the top line. Where would it come from from what you see in some of those things I've mentioned?

I think from a top line standpoint, Alex, we would expect to do a little bit better than the economy based on our new product initiatives and based on growth in Asia, specifically, but although elsewhere around the world. Even if North America slows a little bit, the bulk of our business is in North America so we can't be immune to what goes on here, but we don't look at North America as being a bad market next year. Even if it slows, it's still going to be a growth market, we believe. Those initiatives hopefully help the top line. On the bottom line side we still have a lot of room for improvement. Mark talked about our Lean efforts and our Six Sigma efforts. And that doesn't even get into some of our productivity that we have around the Company. You touched on continue rationalization toward low cost regions. We have some of that going on current live.

So there is no end in sight from our point of view from the thing that is are out there to go do. And hopefully at some point, materials continue -- discontinue being a drag. Just having material stopping the dragging motion would be a big help, would really showcase our productivity efforts. We're very optimistic. We're optimistic about what the year ahead holds short of some global event that none of us can foresee. We have a clear line of sight. We've said before, publicly that we believe we can get into the mid teens operating margins. We've made great progress on that in the last two years, specifically this year very good progress. And we still have what we consider to be a pretty clean line of sight to get there.

Thank you very much.

Thank you.

Our next question comes from Michael Schneider from Robert W. Baird. Please go a head.

Good afternoon, guys.

Hi, Mike.

First, I guess maybe we can address on that materials issue, what pricing is contributing. You mentioned the 20% motor growth this quarter organically. Any idea how that breaks down between units and price?

Well, certainly I think high single-digits is in the cards for price, but we think that, you know, we've -- it's been a double-digit year on units.

Okay. And then, unit volumes in HVAC, understandably down this quarter a bit. When you say substantial declines in the fourth quarter in HVAC volumes, unit volumes that is, I've been modeling say 35% declines, is that the order of magnitude you guys are expecting?

I don't think we are expecting that much. The market is going to be somewhere close to that overall, but we're not expecting it to be quite that dramatic.

Okay. And in HVAC alone in Q4, Henry, do you actually expect with mix and price in HVAC to be flat or up in sales in just the HVAC motors?

Slightly up.

Okay. And can you give us an update now on X13 and ECM you guys are the market leader, which unfortunately means everybody's gunning for you. What has changed now a year into 13 sere and a year into the renewed focus on energy efficiency? Have you seen competitive products introduced? Have you had any major customers that were single source looking to go dual sourced? Any update would be helpful.

Well, certainly it is one of those mixed blessings to be the leader in a given area. As Mark said, we are not, we are not sitting back saying gee, we're there. We are working on our sixth generation of products and doing creative things that will hopefully keep us in the lead in terms of the value we offer our customers. There is always pressure from customers, as there should be to make sure that we're doing our job for them. And there are always some puts and takes. And certainly all those things come into play every day. But you can see from our fourth quarter guidance and I think our overall optimism that we view those things as being very real, but we view ourselves as doing the job we need to do to continue to earn customers' loyalty.

And presumably now, you've gone through the bidding or the spec season for the '07 HVAC season. Are you aware of any meaningful gains or meaningful losses in the HVAC share?

I think there will be some -- there will be some puts and takes. There's no question about that. I don't think we have all of the answers to the puzzle, yet. But, you know, we don't expect there to be huge swings.

Okay. And capacity for both ECM and X13 production. Mark talked about the lien efforts and the process improvements. Do you have to add bricks and mortar though in the coming 12 months to deal with growth in the HVAC market?

Not in the overall sense. There are -- there's always, maybe there's some projects where we are adding not brick and mortar but equipment but generally speaking there is not going to be a lot of capacity addition.

Okay. And I guess when you look into early next year in the pricing contribution, what do you believe -- where do we start to lap these price increases I guess is the cleanest way to put it? Because we've been enjoying high single-digit pricing and you mentioned the September price increases. Presumably you've got built in growth heading through the first half of next year just on the pricing.

Yes, when will that stop? When materials stop forcing it. I mean, that's the answer. The materials are a global phenomena. It's not something that's just happening in North America,Europe, or Asia, as stands right now as you know, just based on the way most companies in our business hedge, the prices are going to be up year-over-year for at least the next quarter or two and then we'll see what happens with the pricing in those commodities, you know between now and then.

Maybe a different way to attack, Henry is when, what are the anniversary dates of the big increases that went in '06?

July was the one before this one, Mike.

Okay. I'll get back in line. Thanks again, and congratulations.

Thank you.

Our next question comes from Wendy Caplan from Wachovia. Please go ahead.

Hi. Dave, could you talk a little more about the working capital issues in terms of your being, I think you mentioned sort of unhappy with the increase? Looks like it's mostly receivables. Can you talk about that?

Certainly. There was one primary driver and it was in the receivables area. We had timing of customer payments that actually, we got the payments after the end of the quarter. And that was a fairly large number, about $30 million delta in what we were expecting in the quarter verses what happened in the quarter. So that certainly drove the receivables piece of it. And I think beyond that, we feel like we've got a lot of opportunity -- we are taking Lean type concepts to all of our business disciplines. That's receivables, inventory, where we've made progress. We still aren't happy with the level of inventory turns that we think there is more. And we've proven it certainly the example Mark gave that we have a lot of opportunity there and I think finally in the payables area, we have some opportunities there and have begun to work very very diligently on increasing our days payable.

Okay, that's helpful, thank you. And you know, not to beat a dead horse, but the issue of material costs, aside from pricing and cutting costs elsewhere, are there other initiatives you're looking at? I'm not sure I can think of any, but I thought I'd ask you.

Well, I'm going to let Mark answer that.

Yes, Wendy, to the extent that we can find ways to either take copper out of our own products or copper out of our customers' products, that's a good thing to do. And we, in some cases have found ways to do that, not across the board and don't have the capability to do it across the board in every case, but that's just one example of ways to get at it and replace it with another material.

That's helpful, thank you. And also, anything in field inventories in terms of HVAC motors that we should know about going into the fourth quarter?

Well, you know, they -- as you probably know ARI stop publishing that data because it was not dependable and we don't get a look at it anymore so it's hard for us to answer that question.

Thanks very much.

Thank you, Wendy.

Our next question comes from Chris Fremont from Morgan Joseph. Please go ahead.

Actually, my questions were answered, thank you.

Thank you, Chris.

Our next question comes from Michael Schneider, from Robert W.Baird Please go ahead.

Henry, maybe you can just talk about your appetite for acquisitions at this point in the wake of digesting the two GE deals and some of the international deals and obviously there's some significant properties on the market today. Can you talk about where you believe the Company's ability is to digest something large and what your appetite is?

Sure. First of all, I would say that our appetite is good and solid, strong, however you'd like to look at that. We're down in the debt to total cap in a range where we typically are starting to look pretty aggressively at what the opportunities are in the market. We feel we need to be appropriately leveraged to create shareholder value. It is a difficult market. There aren't properties available, but trying to find the right property with the right strategic values and final values to add on. But and I won't comment obviously on any specific property. We are very active. And it's like fishing, you have to throw a lot of lines in the water to hope you catch the right fish.

But we are active in Southeast Asia and we are active in North America and some activity in Europe. And I would hope that we will find a property that can deliver the kind of value that previous acquisitions have delivered. Certainly we feel that we are ready from a -- an internal standpoint with our initiatives in position and we've put to bed all but one final now extraction that we have to do from the GE side and that's a smaller, smaller situation that we have to deal with and that will be done by the end of the first quarter next year. So we feel that we are also from a time standpoint ready to move forward again.

Okay. And Dave, maybe just in the guidance on fourth quarter. It's a fairly wide range of $0.07, can you give us a sense of what the swing factors are from top to bottom? Is it your HVAC assumption or is it margin assumptions?

I think we're pretty zeroed in on margins. So I think there is an environment that Henry mentioned. We've been in an abnormal sales environment, I would say, at least certainly last year and maybe even arguably in the fourth quarter. I think there's still a lot of noise as we try to sort through, last year was obviously impacted by the hot weather. We got a little bit of our ranging around the sales assumptions. More so than other assumptions.

Do you model or can you give us some sense of what you expect for incremental margins going forward? And I ask because the mix has changed significantly with the GE deals and obviously now with the new product contribution. Can you guide us as to what you expect or what you look for in the business in terms of motor incremental margins?

Well, going forward, you talking about fourth quarter and beyond?

Yes, just generally speaking.

We, a year ago, we said we saw a path to the mid teens margins and this year obviously will make quite a significant jump on that going from in the range, around 12 or a little bit above. And I think the margins that you see in our segments we, I think see both businesses, both mechanical and electrical remain opportunities. So good news is a lot of the noise is out of those. The mechanical business, there's not any significant restructuring going on, for example, right now.

So we're going to make continued progress towards that goal of mid teens and mechanical and electrical side as well as a little bit of movement right now with the some of the facility, one facility movements that Henry mentioned. But again, I think we see kind of a steady move towards the mid teens, as well. So I wouldn't say that there's any, step out there where we're going to take a big step forward. I think this year was obviously one of the big steps.

Well, to look at it a different way, the incremental margins in motors have been running basically between 25 and 30% just in electrical, are those rates sustainable or is that skewed because of the HVAC's mix improving so much this year?

Probably a little bit of a positive influence through the mix, but that's probably still in the zone of what we would expect.

Okay. Thank you again.

Mike, I I guess I just need to make one correction. When you asked the question about HVAC residential volume in the fourth quarter, I thought I said one thing and Mark tells me I said another. Let me correct that for everyone. Our volume in the fourth quarter will be slightly down.

But only slightly, Henry?

Yes.

Given that the market isn't --

Yes.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from Alexander Paris from Barrington Research Associates Please go ahead.

Couple quick questions. That Sina 11to 12 million sales, is that a good run rate or is that a seasonal quarter?

It's -- it's good for this time of the year. They are a bit seasonal. They are typically in the same kind of seasonality strong third quarter -- third quarter -- second third quarter strong, fourth quarter let off, first quarter buildup.

And your tax rate for next year, is that going to stay close to 36%?

We're still working on our plan for next year, so I would say at this point 36 is a good number.

And just one other question, international, what is that up to now in terms of the percentage of your total sales?

Last year we finished about 92% of our sales were North America, that would include U.S. and Canada. That number is going to drip down. We'll probably see 8 or 9% of our sales in Asia by the end of this year. And then obviously with a full-year next year and our plans that continue to grow in Asia, I think you'll see the North America piece, you know, drift down towards 85% and Asia and the rest of the world being a bigger part of that.

Thanks, again.

[OPERATOR INSTRUCTIONS]

Okay. If we have no further questions, I'll just finish off, I guess our final thoughts. Certainly, again, we would say it was a great quarter. It exceeded our expectations and we are looking for a great fourth quarter by comparison to previous fourth quarters in the Company's history. And we're very pleased with the progress we've been making on initiatives and we continue to be very optimistic about the future and very pleased with the contribution our employees are making across the Company. So thank you all of you for your interest in Regal-Beloit, and we hope to talk to you again.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, you may all disconnect.