Regal Rexnord Corp (RRX) 2010 Q3 法說會逐字稿

Good morning, and welcome to the Regal Beloit third quarter 2010 earnings conference call. (Operator Instructions). I would now like to turn the conference over to John Perino. Please go ahead.

Thank you, Amy and good morning. And welcome to the Regal Beloit third quarter 2010 earnings conference call. Joining me today are Henry Knueppel, Chairman and CEO; Mark Gliebe, President and COO; and Chuck Hinrichs, Vice President and CFO. Before turning the call over 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 there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of those factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our filings with the SEC. Also, I would like to remind all investors that we have scheduled our first annual investor and analyst day on December 7 in New York. If anyone has any questions or would like to make a reservation, feel free to contact me off line.

Now I will turn the call over to Henry.

Thanks, John. Welcome, everyone and thank you for joining the call and for your interest in Regal Beloit. We will follow our normal agenda today. I will make a few opening comments, Chuck Hinrichs will give you a financial update, Mark Gliebe will give you some color on the products markets and operations, and I will talk a little bit about the fourth quarter and then we'll open it up for Q&A.

Overall, we are pleased to report strong earnings for the third quarter despite some significant, unexpected head winds that developed during the quarter along with head winds that were expected and were reported to you during the last quarterly call. The expected head winds included expedite and premium freight costs associated with supplier shortages due to the rapid ramp in business in the second quarter, Hurricane Alex clean up costs and copper and steel cost increases not offset by price. On the unexpected side, copper costs increased significantly above our expectations and as usual there was a portion of our buy not covered by hedges during the quarter. We also experienced a normal, but faster than expected, seasonal drop in our HVAC business.

The highlights for the quarter included solid growth in nearly all of our other businesses. Another solid cash flow quarter, the acquisition of Rotor in the Netherlands, continued execution of our technology strategy and particularly good news for me, the filling of both our CFO and General Counsel roles with outstanding people who will add real value in the years to come. You have all read the press release about Chuck Hinrichs, our new CFO. Chuck brings a wealth of experience in both commercial banking and as a large public company CFO. You've also read the release on Pete Underwood, our new VP and General Counsel. Pete brings a wealth of corporate legal and M&A experience. We are extremely pleased to have Henry and Chuck onboard and already contributing.

Finally, it is a pleasure to announce the purchase, effective yesterday, of a 55% share of Elco BV, based in Milan, Italy, with manufacturing locations in Milan, China and Brazil. Elco is the perfect fit for our growing commercial refrigeration business and gives us a global presence in that business. We will be the majority owner with the former owners as partners. We have great confidence in the management team and we are pleased that they will continue to run the business. All things considered it was another good quarter. With that I will turn it over to Chuck Hinrichs.

Thank you, Henry, and good morning, everyone. We are pleased with our results for the third quarter as we posted strong sales and earnings growth and solid cash flow from operations. Sales for the third quarter of 2010 were $590.8 million, an increase of 27% over the third quarter of 2009. The year over year sales growth benefited from the impact of our 2010 acquisitions of CMG and Rotor, but the principal drivers were the market strength in nearly all our businesses and the demand for our energy efficient products.

The third quarter 2010 sales growth was 19.8% without the acquired businesses. Our gross profit percentage for the third quarter of 2010 was 24.5%, unchanged from both the second quarter of 2010 and the third quarter of 2009. As Henry stated in his introductory comments, we experienced higher costs in two areas that require further discussion. As we discussed on last quarter's call, during the second quarter we experienced product outages from supplier shortages and incurred $4.2 million in additional expediting and freight costs and expected to incur a similar level of these costs in the third quarter of 2010. In the third quarter of 2010, we incurred $4.4 million of these additional costs.

The other area of higher costs continued to be in the area of commodity inputs such as copper, steel, aluminum and zinc. Let me give you some data on one of these commodities as an example. Average spot copper prices ended the second quarter of 2010 at $2.94 per pound, and increased to $3.52 per pound at the end of the third quarter of 2010, a 16.5% increase in the third quarter. For the fourth quarter of 2010, copper prices are forecasted to be $3.87 per pound based on the COMEX forward curve, an additional 10% increase in this fourth quarter. As we have communicated in the past, we have an active and successful commodity hedging program that mitigates some of these price spikes. But in a rapidly increasing environment like the one we have experienced, the timing of price action versus costs can impact our results.

In a moment, Mark will touch on the price increases we announced last week. Despite these cost pressures in the third quarter of 2010, we maintained our gross profit margin as compared to the prior year through the hard work of our operating teams in leveraging the higher production volumes. Operating expenses in the third quarter of 2010 were higher by $9.2 million over the prior year primarily due to including the SG&A expenses of the acquired companies. Net income was $44.6 million or $1.14 per diluted share which is in line with the guidance we provided last quarter. Our cash flow from operations for the quarter was $46.9 million which exceeded net income, but was reduced by an increased investment in working capital assets.

Our quarter end cash position remained strong at $328 million. During the third quarter, we funded the Rotor acquisition and the increased level of networking capital. For the fourth quarter of 2010, we expect earnings to be in the range of $0.69 to $0.75 per share. The fourth quarter will be seasonally slower than the third quarter, reducing gross profits due to lower sales and the lower absorption of fixed manufacturing costs. We anticipate additional cost inflation from commodities and input costs not offset by price actions will be over $6 million in the fourth quarter. This increase in the cost of goods sold is net of the benefit from our commodity hedging program.

As mentioned in our press release and in our fourth quarter 2009 earnings call, the fourth quarter of 2009 benefited from a $15 million reduction in our LIFO reserve versus a LIFO expense and inflationary costs in the fourth quarter of this year. Certainly the combination of the seasonal downturn and spiking input costs will create a challenging fourth quarter. Beyond the quarter we expect seasonal improvements, which along with the pricing actions we are implementing, should improve results. Now I will turn the call over to Mark Gliebe.

Thanks Chuck, and good morning everyone. During the third quarter of 2010 we experienced year over year double-digit sales growth in almost every business and in every region. Our mechanical business, for example, which competes in later cycle segments had a strong rebound in the quarter with sales up 24%. Sales in our Asia-based businesses were up double-digit when compared to prior year, driven by robust economies in China, India and Australia. The strength that we saw in the first and second quarters in our North American commercial and industrial businesses continued throughout the third quarter with our OEM sales channel up 28% and our distribution sales channel up 13%.

In general, all North American commercial and industrial vertical markets showed year over year improvements. In the HVAC segment we finished the quarter with sales up 5.3% as compared to the same period last year. We carried an $11 million backlog into the third quarter as a result of material shortages created by stronger than expected demand in the second quarter. The supply chain issues that we faced in the late second and early third quarters are now behind us, but we did incur, as Chuck mentioned, roughly $4.4 million of expedite cost in the quarter. As you know, we continue to focus our new product development efforts on energy efficient products. During the last call we previewed our readiness for the 2010 Federally legislated EISA law which takes effect this coming December, and we also discussed a new product launch for the commercial refrigeration segment.

Today we would like to talk about more progress on the energy efficiency front. First is our new Eon ECM product for the HVAC segment. We have been working on this new product for two years. It replaces our existing HVAC ECM 2.3 platform which has been in place for a number of years. This will be our seventh generation of the HVAC ECM motor, and this product will offer our customers even higher efficiency than our current product as well as improved reliability, black box diagnostics, and improved feature set and a more compact design. Eon will be backward compatible with our existing ECM 2.3 products. We believe Eon sets a new and even higher standard in the industry, with a complete solution combining size, efficiency, reliability, quality and breadth of application.

Next is our new draft inducer product for the 80+ furnaces. This new draft inducer lowers sound levels and comes in a more compact footprint, thereby freeing up valuable space in the furnace. The additional space then allows OEM's to modify their equipment to improve efficiency. We have one customer who has already decided to take advantage of this new offering and two others who are currently testing. .

With regards to the EISA law, our businesses are ready with a full line of products that meet the EISA requirements. Our belief is that some competitors may not yet have a full line of products that meet the more stringent requirement and that there could be an advantage to those companies like Regal-Beloit who are ready. While there have been a few customers building inventory of the standard lower cost products, we don't think it is significant and we expect it to sell through by the end of the first quarter.

The integration of our new Netherlands-based Rotor business into Regal-Beloit progressed very well throughout the third quarter. We recently announced to our Netherlands-based employees the consolidation of our management teams and our facilities. We are very pleased with the new management team. The business is performing as we had hoped and we are beginning to mine the synergies. We are also excited about the acquisition of Elco. Elco is an Italian-based supplier of motor and air-moving systems, selling primarily into the commercial refrigeration segment. 55% of Elco sales are in Europe and the rest are in China, Brazil and other countries. We believe the long-term opportunity to sell energy efficient systems in Europe is as great as the opportunity in North America. We expect to combine the best of the energy-efficient technologies in our existing Morrill branded commercial refrigeration segment with Elco's technologies.

We believe we were able to enhance our capabilities and our reach to deliver customers value with better energy-efficient alternatives. Overall we were very pleased with our third quarter results. As we look forward to the fourth quarter of 2010, we see continued order strength in our mechanical, commercial, industrial, and our Asian businesses. While in the HVAC segment we see more normal seasonality. The key head wind for the quarter will be material inflation. We have already announced price increases up to 8% depending on the business and the products. We expect to begin to see the impact of those increases late in the fourth quarter. With that I will turn it back over to Henry.

Thanks, Mark. As we look to the fourth quarter we have a lot of moving parts to communicate, and they include the full range of great, good, bad and ugly. In a nutshell, the ugly is commodity costs. In this case they are truly ugly. We have announced pricing actions to keep pace with the current commodity prices, but those actions are unlikely to help significantly in the quarter. The bad is that, unlike last year, we are seeing normal fourth quarter seasonal downturn in our HVAC business. I say bad only in relationship to last year.

This year is the norm and in some respects a return to the norm is probably a good thing. The good is, that without considering nonrecurring benefits in last year's fourth quarter, nonrecurring charges expected in the coming quarter and the effect of acquisitions, our base business is actually showing solid year over year improvement for the quarter. The great is that with new product introductions at record levels, recent acquisitions beginning to add value, a full team, and a strong balance sheet, we are well positioned for the future. With that, we will open it up for questions.

(Operator Instructions). The first question is from Christopher Glynn at Oppenheimer.

Thanks, good morning. On the residential HVAC, just wondering how your initial expectations for next year are coming together relative to the comparisons, the channel inventories you see and what your thoughts are around the tax credit expansion.

I will cover that. Let's start with the tax credit and the stimulus. We try to stay close to what's happening in Washington and the feelings of our legislators. Obviously nothing is going to happen until after the elections today. But the current feeling that we are hearing is there is a chance that stimulus will get renewed. The reason is there is support in both Democratic and Republican sides, and it is a jobs-creating type of activity. So there is a positive feeling there that we have noticed an increase in over the last 30 or 45 days. So we have to stay tuned and see what happens there. The other general feeling that we are picking up on the part of our customers is more confidence in 2011 than I have heard in say the last three months. Predictions in terms of residential HVAC to be up anywhere from 3% to 5% next year. So that's the feedback we are getting.

Thank you. And then on the -- thinking about the price costs in the first half, and relative to the gap you are looking at in the fourth quarter, how would you expect that to trend directionally with hedges rolling off versus realizing some incremental price?

The wild card, of course, is what happens to commodity prices from where we are currently. Some of that has to do with the expectations for the dollar, and some of it has to do with inventories. But in general as we look at it right now, if things stay steady, we would expect our pricing actions to bring us back to the position that we have been in for most of this year.

Thanks a lot.

Next question comes from Steve Sanders at Stevens Inc.

Good morning, guys.

Hi, Steve.

I just wanted to come back to the fourth quarter versus the third quarter. I think you have given us several of the pieces here, but can you provide a little more color on the composition of the earnings decline 3Q to 4Q. Volume, [class] absorption, commodities mix, et cetera, just to make sure I understand it correctly.

I will take a stab at it and let Mark or Chuck add in. First of all as you go from 3Q to 4Q the number one issue is volume. And we've talked before about the seasonality of our business. Last year that didn't exist. We were coming out of a slow time, and things continued to pick up as we went Q3 to Q4. This year we are seeing what we would consider other than 2008 and 2009, normal seasonal pattern. As we communicated to you in the past, that typically looks like the fourth quarter being the low for us for the year at about 22% of our business. The third quarter is the high, somewhere in the vicinity of 26% of our business. So while that doesn't sound like that's a big swing, if you do the math, that means from the third quarter to the fourth quarter there is nearly a 10% drop quarter to quarter. And of course a lot of that hits in one particular segment of the business. So it is a pretty significant drop. That's why our seasonal patterns over the years have traditionally produced earnings curves that you have seen. Now, add this year the change in commodities and to just give you some color on that as Chuck said, ending the second quarter, so only four months ago, the price of copper was $2.94. Today we are up in the $3.80s and as little as 30 days ago it was $3.50. So that is a significant change and it provides -- it has a hit in the fourth quarter that is pretty significant along with the fact that that trips LIFO in the quarter. So, as opposed to last year, when we had a big benefit in the fourth quarter, this year we've got a hit.

Can you quantify the LIFO portion of it?

Well, a combination of LIFO and the cost inflation on a sequential basis would be about $7 million, around $0.13 cents a share.

Okay, great. And then, Henry, I think you said in your remarks that maybe the HVAC business was a little weaker in the quarter than you expected. Can you just talk a little more about that?

Well, as we came across the quarter, as you remember, we were fighting shortages, and we had a backlog. So we expected the quarter to play out sort of normal and the backlog to be additional. And of course some of it was, but it just slowed down faster I think in the end of July and August than we would have expected. Our checks with customers and so on, we don't think there is some big overhang problem. We think that they were adjusting relatively quickly to what they were seeing in demand. It is what it is. It was just faster than we expected it to be, but not wildly different.

Okay. Okay. And the last question on Elco, I think you gave the 55% Europe. I was wondering if you could talk about how their business performed in 2009 and 2010. Was it similar to broadly what we saw in industrial? Or did they have some secular drivers and some technology drivers that maybe mitigated some of the weakness and/or some of the strength?

Yes, I would say in 2009 the business performed similar to the rest of, I would say, businesses in the commercial HVAC segment. Europe was in a significant recession as was the rest of the world. So that business performed similarly. In 2010, however, the business came back quite strong, and we were pleased with the sales growth that the business was seeing.

Okay, thank you very much.

Just add to that, Steve, that they do have some very interesting technology both from a standpoint of manufacturing technology as well as product technology that we think will create some nice bridges, if you will. As well as the fact that their strengths are where we do not have as good of coverage yet, and so it really makes a nice global pattern if you will of product sales and product capabilities.

Okay. Thanks, Henry.

The next question comes from Mike Halloran at Robert Baird.

Good morning.

Hi, Mike.

When you take the $6 million incremental head wind in the fourth quarter from the commodity costs, what did that look like in the third quarter?

It is added on top of the roughly $13 million or $14 million that we had in the third quarter that we reported to you at the last quarterly call. I think we said it was going to be roughly $13 million. And it was. Well, it was slightly over that, actually. And this is added to that.

Looking at $19 million or so head winds fourth quarter. Now with the price increases you guys put into place, are you expecting that to normalize back towards a zero-type number, or is this a things where it's going to normalize and offset that $6 million or so that is incremental to just the fourth quarter?

Yes, the price increase we put in place, plus our productivity actions combined we believe will protect us going forward.

Maybe a better way to ask it then is, let's say you are successful in pushing the price increases through. What kind of incremental margins are you going to be looking at in your electrical segment next year? Are you expecting to get towards that normalized rate of 20% or 25%?

Yes I believe we will return back to that rate as we go forward. That is the rate that we were running at in the second quarter. Now, obviously, Mike, you have the seasonality quarter by quarter. (inaudible - overlapping speakers)

Absolutely, absolutely.

But other than that, I think yes, That's what we should expect.

And then maybe you can give a little color on the price increases by HVAC and then versus industrial and commercial. Are they pretty comparable within those categories, or is one a little bit heavier than the other?

I would say it differs by both business and product, and if it is okay, I prefer not to get into that discussion.

That's fair. That's fair. I appreciate the time. Thank you.

Thanks, Mike.

The next question comes from Holden Lewis at BB&T.

Good morning, thank you.

Good morning.

I think in terms of supply chain issues and the deferred revenues, I think you had identified about $11 million in Q2. Did you ship that entire $11 million, and assuming you did, what impact did that have on sort of productivity and margin? And I guess I'm thinking particularly about as we go into Q4, and maybe we don't have that $11 million repeating. Does that mean that production has to come down a fair bit? How should we be looking at that impact of that deferred revenue?

Holden, we believe that we shipped the majority of that $11 million in the quarter like we had predicted. Probably didn't get 100% of it, but we got the majority of it. And more than anything in the fourth quarter, what we are seeing as Henry had mentioned is a return to more normal seasonality. The HVAC business, if you go back and look at 2006 and 2007 as an example, normally has a rather sharp fall off in the fourth quarter, and that is -- if you go back even further, that is what the business has typically seen. It was a little different in 2008, in 2009, because of the recession in 2008 and coming out of it in 2009. The dynamics were somewhat different. But as we look at 2010 we are in a more normal seasonal pattern.

Okay, I guess what I was trying to get is, in Q3 you suffered I guess expedite expenses in the neighborhood of $4.4 million, but I assume at the same time if you shipped $11 million in extra revenues that there was probably some absorption that would have eaten into some or all of that $4.4 million so that the net number would be smaller. But I guess I'm wondering if you go into Q4, does that $4.4 million in expedited cost, does that just go to zero at this point, and do we need to cut production more than normal to consider the absence of that deferred revenue?

Certainly the $4.4 million goes to zero. I think you should certainly think about it that way, that's for sure. And we have adjusted our manufacturing lines to be in line with our demand for the quarter.

Okay. That $4.4 million does go away?

Yes, that's correct.

And then just the number I missed, I guess you said the question regarding the raw materials and LIFO impact. I thought I heard you say raw materials were an incremental $6 million but that raw materials and LIFO together were an incremental $7 million? Or was the LIFO alone an incremental $7 million?

It is a combined number, Holden, of $7 million.

Okay, so LIFO benefit plus incremental raw materials is a $7 million incremental negative in fourth quarter.

That's correct. And again, that's our estimate. And as we have seen there has been a lot of volatility in some of our input costs. But that's our estimate today.

Okay. Last thing and I will jump in. How do you feel about the inventory at this point? It was up about 31% I think year over year.

Yes, that was principally driven by our HVAC segment. Given the fact that in the second and third quarter, were having supply issues, component shortages. Obviously our inventory was lower than we would have wanted. So the inventory that we have now built back up is our more normal inventory. And you also have the addition of the Rotor acquisition showing up in that number.

Okay, thank you.

The next question comes from Jeff Hammond at KeyBanc Capital markets.

Hi, good morning, guys.

Hi, Jeff.

Just on the de-stock, what feedback are you getting? Are inventories getting pretty low, or does that de-stock continue beyond the fourth quarter? If I recall, if we are getting back to normal seasonality, I think the first quarter felt better than normal last year, so does that issue persist into first quarter?

The feedback, Jeff, we get from our customers is that the product is flowing through very quickly which means that inventory from our OEM to their distribution is thin to appropriate. I don't see it as a concern right now in the HVAC space. In the industrial space you have the dynamic going on of the Federal legislation going through, the EISA law. And I touched on that briefly just to say that if there are a few customers that we see building inventory, we don't think it is a significant build. To the extent that there is any, we would see it coming right out in the first quarter, but we don't think it is big.

Okay, and then just to clarify, Mark, you mentioned some optimism by the customers and 3% to 5% growth in residential HVAC. I just wanted to understand that a little bit better in light of what seems to be weaker results and a more aggressive de-stock out of your OEM customers. I mean, where is the optimism coming from?

Well, I'm just feeding back to you what we are hearing from our key customers. There are only seven of them. If you get three or four data points in the same direction you start to think that that is how they are all thinking. So we have a couple data points that are consistent with what I just said. They believe next year's resi market we ought to think about it up 3% to 5%.

Okay and then just kind of asking the same question as I asked last quarter. If you take the EISA standard coming in and then you assume the stimulus tax credit doesn't get extended. What does that 18% of sales efficiency look like?

First of all, I'll comment on, in the event that the stimulus does not get renewed. I just commented earlier that we have some favorable comments that perhaps it could go through. But in the event it doesn't go through, I would make two comments. One, prior to the stimulus law being in place, our energy efficient products were growing at the rate of 22% on a compound annual growth rate five years back. So that's point one. Point two is we have had a couple customers comment that they believe that the behavior at the contractor level where the decision is met --where the decision is influenced in terms of what product to purchase by the homeowner, that they believe that the contractor's behavior could have permanently changed. They have been taught to up sell. We are hopeful that is true.

And just to fall into that, as you look at the de-stock, are you getting -- as these guys go through their back-to-normal de-stock, are you getting -- are you seeing a mix down reverting back to2008 or 2009 mix, or are people going into a bigger mix -- or being more aggressive in terms of destocking higher efficiency equipment?

We don't see any pattern that would say it is going one way or the other at this point in time.

Great. And then just a final question on Elco, is there any prearrangement that you would be able to buy the remaining portion down the road or --

We do have an arrangement that would say that we would have the preference to take additional share over the next several years.

Okay. Great, thanks, guys.

The next question comes from Nigel Coe at Deutsche Bank.

Thanks, good morning.

Hi, Nigel.

Just wanted to just make sure I was clear on the 4Q road map. So, Henry, I think you mentioned, expect a normal 10% Q to Q revenue decline?

Yes.

And it looks like the bulk of the (inaudible) inflation from 3Q to 4Q, that $7 million has been offset primarily by -- well, the bulk of that has been offset by the $4.4 million which goes away. So I am just trying to understand, because it looks like your operating margin is going to come in somewhere in the 9% range. That's a two and a half point step down from 3Q .So I'm just trying to understand, is this just volumes? And if this is volumes with a bit of (inaudible) inflation, why is margin stepping down so much?

First of all, again, a 10% drop relates to a much more significant drop in those segments where that real seasonality occurs, or the bulk of the seasonality occurs. You can go back and take a look I think at most any company that has a very significant drop in a short period of time, and it has a pretty negative impact on that particular business. In terms of the inflation, it is not just offset by the $4.4 million. There's a lot more than that, that adds up to net-net, even if you take the $4 million out, it's $0.06 or $0.07 cents. So it is not inconsequential.

Sure. So just to kind of take that -- I think the point is made. So the decline in the higher margin businesses will be greater which accentuates the margin pressure Q over Q?

I wouldn't -- no, I wouldn't go that far. I mean, HVAC is certainly a very important business to us, but I wouldn't make the extrapolation that that's our highest margin business.

Okay. And then on the price increases, obviously you mentioned price increases up to 8%, but I'm sure there is a wide variation by product line. Can you maybe give us a sense on what kind of blended price increase you expect for next year?

Actually I think, Nigel, in this case, we don't really want to do that.

Okay. What about going back in the past, can you just remind us some of what kind of price increases you managed to achieve back in 2006 or 2007?

Well, we have announced, as you know, a number of price increases throughout the years as copper has been volatile. The range of those price increases at that point in time depended on the volatility in copper, but they ranged anywhere from 3% to say 8% over the years.

And then just finally, can you just throw out data points of what your average hedge price was for copper, where you expect it to be for 2010?

Nigel, we don't release that information for competitive reasons.

Okay. I'm doing well here, aren't I? Okay, thanks a lot guys.

Thanks, Nigel.

The next question comes from Mark Douglass at Longbow Research. Mr. Douglass? Okay, we will go on to Walt Liptak at Barrington Research.

Thanks, good morning, guys.

Hi, Walt.

I wanted to ask about the price increase as well. It just seems like we are -- you are chasing price in the second quarter, and then again going into the fourth quarter. Can you explain to us a little bit more about the industry dynamics, are you leading here, are you lagging, why does it take the back part of the quarter to get the price realized?

I am not going to try to get into whether we are leading or lagging and some of that kind of discussion, Walt, but what happens in any given situation, you have to evaluate whether or not there is staying power on a cost increase. This came up pretty much like a rocket ship. When you consider it is up almost a dollar in four months period of time, that's a pretty fast, significant move. As a viable company in this market place, we have to evaluate that for long enough to understand is it something that is going to bounce back down or is it for real? And so that doesn't happen in a five-day period of time. You have to look at that, and you look at it in relation to other materials and how they are moving and what you expect. Because legitimately, when we talk with customers, we have to talk from a basis fundamentally of solid business people with solid intentions. And we do that. In this case, they continue to escalate. Inventories are continuing to actually drop slightly. So there is every reason to believe that this is here to stay for at least for a long enough period of time that we can't sit still. So that's the reason for the lag. That's the reason that those are the kind of things we take into account as we look. We are not going to be in business for one quarter. We are going to be in business for the long-term and we have to be able to legitimately understand the nature and the duration of cost increases as we pass those along to our customers.

If you look into 2011, and I know you don't want to comment too much about the price costs, but the weak dollar is expected to continue. Is there a way that you can get in front of these price increases finally, or is there too much of a risk to market share?

Obviously we want to protect our ability to leverage, if you will, productivity efforts that our people work on every day, and the strength of our growth, which is these days pretty significant growth. You always want to do that as much in advance as you can. It is a delicate issue that we work on all the time. I don't see us getting wildly ahead or even ahead at this point in the near term. And I would say over my tenure at least I don't remember too many times -- I don't remember any times right off the top of my head where we were ever really ahead of this issue.

Okay. And just going back to the fourth quarter numbers, have you given a number or can you give us an expectation for the gross margin? Is this going to be the weakest gross margin for the year?

Well, that would be the same thing. I'm not sure I have that here. We haven't calculated that, Walt, but we tried to give you some of the key drivers in order to get to the bottom line.

Okay, thanks very much, guys.

You're welcome.

The next question comes from Bill Develum at Keaton Capital Management.

Thank you. We had a couple of questions here. The first one is following up on the price increase front. Where have your competitors been in terms of what they have or have not done on the price increase front?

I think over the last few years, generally speaking the industry has moved, but it really varies considerably by company, and given the individual situation and how fast things ramp, I don't think we really want to get into trying to say what competitors are doing. We really should stick to our own knitting and tell you what we are doing.

And second question is relative to the Elco purchase. We don't recall the last time that you did a partial purchase rather than an out right. Would you please discuss the dynamics that led to your 55% interest in Elco rather than a 100%?

Yes, there are always two parties to any transaction. So obviously we were interested in the entire business. The owners felt very comfortable with their direction. We realized that together we were going to be a stronger force, and it was a one plus one equals something significantly better than two. So it made sense to get together and work that out, which we have. But in our view in this situation, and we have had other situations like this, not many, but we have had other joint ventures that eventually got converted and we still have a joint venture where we are a 55% owner in China. And it has worked very, very well. I think our view was that making the move to this kind of a situation is certainly better than not doing it and there is a long-term path for a higher percentage ownership.

So the existing owner, they see the one plus one equals something more than two and wanted to benefit from that, but longer term were willing to step aside, and as you have discussed you have that opportunity in the future?

Yes.

Thank you.

Thank you.

The next question comes from Christopher Glynn at Oppenheimer.

Yes, just on the SG&A costs, pretty remarkable looking nearly flat, excluding the acquisitions, on 20% organic growth. Is that the sort of leverage you expect on that going forward?

I think they may have been flat on a quarter over quarter basis because of some things that happened last year. Overall we are up on a year over year basis if you exclude acquisitions. We have done a pretty good job at leveraging it. However, clearly we are having a very good year compared to the previous year. So there are costs including selling costs and bonuses et cetera that put us up over a year ago. But we are pretty pleased, frankly, with the leverage we are getting.

Okay, and last one, just a little book keeping on the tax rate outlook.

Yes, I think for the fourth quarter, Chris, we are looking at something about 28%.

Okay, thank you, Chuck.

You're welcome.

Our next question comes from Holden Lewis at BB&T.

Thanks. Can you talk about what the accretion from the acquisitions that you made this quarter was? And then just to make sure, the $0.08 you talking about on Elco, that's your percentage, right? That's not the whole transaction?

Yes, the Elco communication is correct. It is our 55% interest. In terms of dilution -- or accretion for the acquired companies, Rotor, which we acquired in September, has the purchase accounting adjustments that we typically have in the first and into the second quarter of an acquired company. So there is no real contribution for Rotor. CMG is contributing sales and a modest amount of operating profit, but we expect the accretion that we had earlier communicated to be in 2011 for CMG.

And on Elco, you are going to -- the entire business will be consolidated and then you'll just split out the minority interest, right?

That's correct.

Can you give some progress in Europe? I know last quarter you were talking about that business being a little bit slower because it's a bit more CapEx oriented, but you saw activity picking up. Was Europe still negative in the quarter? Did it turn positive? What kind of progress are we seeing there?

It is a mixed bag, but for the most part it has turned positive for us. Our mechanical businesses had a strong return, and in terms of our motor-based business, we are in the midst of combining our management teams with the Dutchi and Rotor management teams and starting to mine synergies between those two businesses which are located in the Netherlands.

Okay. Thank you.

The next question comes from Mark Douglass at Longbow Research.

Try this again? Can you hear me?

Hi, Mark.

Okay, sorry about that. Pretty much most of my questions have been asked and answered. Just something again on the pricing, if I think about EISA legislation. You said you expect that in general a 15% to 20% price premium for an efficient motor. Is that going to -- how is that going to stick given there is going to be another price increase at the same time people have to buy those motors. Do you think it's going to be sticky, or they just have to pay it because everybody else is doing it?

Hi, this is Mark. I will just comment on that. As you know, when you build -- as we have said in the past, when you go to a EISA-approved motor, we refer to is as a NEMA premium product. We have been selling those products prior to the legislation as have others, and the price for those products has historically been up 15% to 20% versus the product that it replaces. And the principal driver behind that is that there is more material in the product, both copper, aluminum and steel. And so those prices will have to be increased on top of that 15% to 20%.

Okay. And then just finally, you mentioned the new product for HVAC, your new ECM motor. And that is getting released now or when?

That product is already at our customers. We are in the process of communicating to each and every customer the availability of that product and our intention is to convert our entire fleet of ECM 2.3 motors over the next 12 months. So it will be a conversion from one product to the other.

Okay, and then I suppose you haven't heard any of the competitors being taken up yet? On ECM? (inaudible - background noise.) This mitigates new entrants?

Well, as we have mentioned in the past, we have always expected competition in that space. There are potential competitors in that space. What we are trying to do is set the bar even higher and offer our customers value beyond what our product had offered in the past. And this particular new product Eon product will have higher efficiency than our historical motor. It will have a more compact design and better reliability than even the product we had supplied in the past.

Okay, thank you.

Our next question comes from Steve Sanders at Stephens, Inc.

Just a follow-up. I think you made a comment that you typically see a 10% plus kind of decline 3Q to 4Q in your more seasonal businesses. Obviously HVAC is in there. What else is in there? In other words, should we think about 35% to 50% of the business feeling that sort of 10% plus kind of sequential decline? And the rest flattish? Or can you help us a little bit with that dynamic.

Yes, let me see if I can help. First of all what we said is that if you take a look at our typical seasonal pattern, third quarter is the highest, typically at 26% to 27% of our total sales for the year, and the fourth quarter is the lowest, and it is typically 22% to 23% of our sales. In order to make that move, well it only sounds like a 2% decline. If you do the math you are going to see that your actual total sales drop somewhere in the area of 9% or 10% fourth quarter versus third quarter. Then when you take that down to where does that come from, it comes predominantly from the HVAC segment of our business. So it's a much higher percentage decline during that quarter for that particular business.

Okay. All right. Thank you.

The next question comes from Jeff Hammond at KeyBanc Capital Markets.

I know you guys don't guide on a forward basis or give a look into 2011, I just wanted to walk through, just given some of the confusion and moving pieces in the fourth quarter and see if these make sense. So you have kind of signed up for $0.24 to $0.29 cents accretion from the three acquisitions? Is that unchanged, one. The EISA standard I imagine you get some benefit. Industrial motors, and PT, seem to have pretty good momentum. The supply chain issue of $9 million over two quarters kind of goes away. What are some of the head winds that maybe I am not thinking about? Or is price cost an issue that pushes into next year even if we get pricing? Maybe just fill in some of the blanks.

Yes, I think you did a pretty nice job there, Jeff, of talking about some of the changes in the drivers. The big issue is always going to be for us market strength overall and materials. We don't get into trying to predict what they are going to do exactly. Typically in a hotter economy they go up and in a slow economy they go down. So there is some natural hedge I guess that takes place there. But I think you got the key points. I think the only other point I would add to it is that we still have a very strong balance sheet and we are very aggressive on the acquisition front. So I would hope that we continue to find some opportunities like those we have found this year to add to the overall growth story.

Okay thanks, guys.

The next question comes from Nigel Coe at Deutsche Bank.

Thanks for the follow up there. So I guess just following up on your last comment, Henry, on the M&A, you didn't really talk about the backlog opportunity you see there. Will you expect in the next six, nine months for the flow to be similar to what we have seen in the last two pr three quarters or do you see a potential for that pick up?

As you know, these things are always hard to predict. We have several opportunities that we are really excited about and think that have real value. And we're at various stages with those, so I would hope that you'll see at least the pace that we've been on, and I would say there is some chance that it could pick up.

Okay. Any opportunities for larger deals?

I'm sorry, what?

Any opportunities for larger deals?

Yes. Yes, there are some there, there are some opportunities that we think will be available over the next six months, and again those are always interesting to say the least, but we'll certainly be a participant.

Okay. And then just a follow on to Jeff's question. I mean, he walked through a lot of the tail winds you've got. But based on what you see now, I mean, the key question we're getting from a lot of investors is, can Regal grow earnings in 2011. Would you care to address that? It sounds to me like the answer is yes, but would you care to answer that question?

Yes. Frankly, it's very difficult to report the fourth quarter and then talk like you're really pretty positive about the future. But the reality is, I am. I am very positive for several reason. We've talked about those repeatedly, but we've now got a core business in Asia that is growing pretty rapidly, and it's going to continue to grow pretty rapidly. The acquisitions we've done this year have really strengthened our global position, particularly in those markets that are growing faster. So I think by itself that's pretty significant. Second, and big significant thing to us, is new products. We've ramped up over the last few years. We've more than doubled the number of new product introductions that we bring out per year. These are significant new product introductions, not paint color changes. And we're very pleased with those, and it takes a lot for them to gain traction, but they do gain traction as we've proven. And so I'm very very positive about that. We think that those are great growth stories, not just average, number one. Number two is, the acquisition opportunities based on our balance sheet. So, no, I'm not happy with what we're talking about for the fourth quarter, but I'm very positive about what the future holds for Regal Beloit.

Okay, thanks Henry.

(Operator Instructions.) This concludes our question and answer session. I would like to turn the conference back over to Henry Kneuppel for any closing remarks.

Okay, again we want to thank everyone for listening in to our earnings call. I think the takeaways for us are pretty straightforward. We believe it was a very solid third quarter. Our fourth quarter is challenged, but at its core, when you look at it down to the basics, it's actually not a bad story, it's a pretty good story. Our new products and 2010 acquisition are beginning to contribute. A strong balance sheet positions us for growth. And we really believe that we have a Company that's built for the future. Wanted to just reinforce what John said earlier, we are going to be hosting an analyst day on December 7 in New York, and we hope to see all of you there. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.