Regal Rexnord Corp (RRX) 2013 Q3 法說會逐字稿

Good morning and welcome to the Regal Beloit third-quarter 2013 earnings conference call.

(Operator Instructions)

I would now like to turn the conference over to John Perino, Vice President of Investor Relations. Please go ahead.

Thank you, Andrew. Good morning, and welcome to the Regal Beloit third-quarter 2013 earnings conference call.

Joining me today are Mark Gliebe, Chairman and CEO; Jon Schlemmer, COO; and Chuck Hinrichs, Vice President and CFO. Before turning call over to Mark, 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 that 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.

On Slide 2, we mention that we are presenting non-GAAP financial measures related to adjusted diluted earnings per share, adjusted gross profit, adjusted gross profit percentage of net sales, adjusted income from operations, and free cash flow. We believe that these are useful financial measures for providing you with additional insight into our operating performance. Please read this slide for information regarding these non-GAAP financial measures. And please see the appendix, where you can find reconciliation of these measures to the most comparable measures in accordance with GAAP.

Now I'll turn the call over to Mark.

Good morning everyone, and thank you for joining our third-quarter call and for your interest in Regal.

We'll follow our normal agenda. I will make some opening comments; Chuck will give you a financial update; Jon will provide color on products, markets, and operations; and then I'll summarize, and we'll will move to Q&A. For the third quarter, Regal delivered operating performance that was within our guidance and earnings at the top end of our guidance. Chuck will get into the details, but we had a tax benefit in the quarter that improved our earnings. From an operating standpoint, revenues in our North American Commercial and Industrial Motor business were down slightly, offset by growth in our Power Generation business, where we experienced real strength in the data center and market.

Our business in China performed better than expected, with sales up high single-digits, while sales in India and Australia remained challenged. North America residential HVAC sales were down 3.6% and below the overall market performance. Our HVAC performance was driven mostly by the customer dynamics we discussed in Q1, but also impacted by modestly lower pricing from our two-way materials price formula. We did see strength in other residential markets outside of HVAC, due to improved end-market conditions and the new products we've introduced in the past few years.

Our mechanical business was down for the quarter, with most of the decline coming from our exposure to hydraulic fracturing. Our simplification program continues to move forward, and we are seeing the benefits. During the quarter we announced the closure of our Springfield, Missouri, facility and the relocation of that production to our facilities in McAllen, Texas, and Reynosa, Mexico. There is more to come from simplification, and John will discuss this further in his comments.

Margins were in line with our expectations, and we were pleased with our progress. Free cash flow for the quarter came in at 123% of net income. On a year-to-date basis, we are again achieving our goal of free cash flow to exceed net income. To spur growth, we launched 14 new products during the quarter, after launching 37 new products in the first half. We remain focused on continuous innovation around Energy Efficiency to help drive organic growth and improve our margins. And finally, as you may have seen from our press release earlier this morning, yesterday we signed an agreement to acquire Cemp, a $35 million European-based manufacturer of specialty hazardous-duty electric motors.

The Cemp products have achieved the ATEX certification, which makes them salable in segments such as oil and gas and chemicals that require flameproof protection. Roughly 85% of Cemp sales are in the oil and gas and marine space. The Cemp patterns are a nice addition to our existing motor product offering, and we expect to be able to market these products to our American and Asian sales teams. As far as other acquisitions go, we continue to have a full pipeline, and we intend to continue to be a consistent and successful acquirer.

As we look to the fourth quarter, our guidance reflects typical residential HVAC seasonality and end-market strength, somewhat offset by the customer dynamics that we have previously discussed. Further, we expect our North American Commercial and Industrial Motors business to be flat to slightly down for the quarter; however, we do expect continued strength in our Power Generation business. Internationally we anticipate sales in China will be up modestly but offset by continued weakness in India and Australia. The good news is that the C&I markets appear to have stabilized, and we expect the residential markets will be a continuing tailwind going into 2014.

Finally, we are forecasting a better-than-expected tax rate in the fourth quarter, and Chuck will provide you the details. With that, I will turn it over to Chuck Hinrichs.

Thank you, Mark. And good morning, everybody.

Our earnings in the third quarter 2013 were $1.16 per share on a GAAP basis. Restructuring charges in the quarter were $1.2 million, or $0.02 per share, related to our initial work on the 2014 closure of the Springfield plant, a key plant of our simplification initiative. Adding back the $0.02 of restructuring charges, our adjusted earnings per share were $1.18. As a reminder, the average number of our shares outstanding in the third quarter was 45.3 million shares, which accounted for $0.09 of the change in EPS as compared to the third quarter of the prior year.

Our third-quarter net sales were $768 million, a decline of 1.5% from the prior year. One of the major factors in the sales decline was the impact of foreign currency exchange rates, which reduced our total net sales by 1.1%. The foreign currency translation reduced our total international sales by 3.4% during the third quarter as compared to the prior year. Sales prices declined 0.8% from the prior year, impacted by the two-way material price formulas with our larger customers, reflecting the decrease in our commodity input costs from the prior periods. We were pleased with our gross margin of 25.6%, given the headwind of the foreign currency and price challenges.

In the third quarter, we recognized a $900,000 LIFO benefit, an accounting adjustment to estimate our year-end LIFO reserve. The $1.2 million of restructuring charges were charged of cost goods sold in the third quarter. Our gross margin continues to benefit from our synergy program and the simplification initiatives. Our SG&A expenses in the third quarter were $117.7 million, down $10.4 million from the second quarter of 2013. You will recall the prior quarter included $2.9 million of acquisition diligence costs and $1.4 million of net bad debt expense. On our last earnings call, we communicated that we expected a lower level of SG&A expenses in this third quarter, and we achieved that result.

Our free cash flow was a strong 123% of net income in the third quarter and 114% for our year-to-date 2013 results. On the next slide we provide summary data on other financial results in the third quarter. Our capital expenditures in the quarter were $18.2 million. For year-to-date 2013, our capital expenditures were $65.4 million, on pace for total capital spending of approximately $90 million for the full year. You will recall that we are investing in two large capital projects in 2013, the expansion of our Unico plant in Wisconsin and our industrial motor plant in China.

Our effective tax rate in the third quarter was 21.6%, which was below our earlier guidance of 26.5%. In the third quarter, we finalized our 2012 US federal income tax return and lowered the third quarter tax provision to reconcile our tax accounts. We expect our ETR to be approximately 18% in the fourth quarter of 2013. We plan to execute a strategy to declare foreign dividends that will repatriate cash and generate foreign tax credits. As a reminder, our ETR for the fourth quarter in the prior year was 15.6%, driven by the implementation of our EPC tax integration plan. Looking forward into 2014, our ETR should approximate 27% in the first half of the year. As I described on previous calls, we have executed tax strategies and integrated acquisitions to successfully reduce our ETR to a sustainably lower level.

In the lower-left section, we summarize our free cash flow in the third quarter. As I mentioned earlier, our free cash flow in the quarter was a strong $65 million or 123% of net income. On a year-to-date basis, our free cash flow was 114% of net income, a metric we are very proud of. Your in the lower-right quadrant we provided on our quarter-end balance sheet. Our total debt was $769 million, and our net debt decreased to $306 million. Our net interest expense in the third quarter was $9.3 million, a decline of $900,000 from the prior year. Our credit metrics are strong, as our debt to EBITDA was 1.9 times and our net debt to EBITDA was 0.7 times.

Our fourth-quarter 2013 earnings guidance is $0.77 to $0.85 per share on a GAAP basis. Adjusting for the expected $2.7 million, or $0.05 per share, of restructuring charges for our simplification initiative, our adjusted EPS guidance is $0.82 to $0.90 per share. Our fourth-quarter sales are expected to reflect the normal seasonal decline. This guidance reflects the expected lower ETR of 18%, which I explained on the previous slide.

Mark announced the signing of the agreement to acquire Cemp in this fourth quarter. Jon Schlemmer will provide more information on this acquisition. Our fourth-quarter guidance excludes the impact of this acquisition. The expensing of the purchase accounting adjustments and closing costs will be earnings per share dilutive by $0.01 to $0.02 per share in this fourth quarter. The Cemp acquisition will be EPS accretive beginning in 2014. Our fourth-quarter 2013 guidance is a solid improvement over our fourth-quarter 2012 earnings per share, of $0.70 per share.

Now I will turn the call over to Jon Schlemmer.

Thanks, Chuck. And good morning, everybody.

I will start by giving some color on the end markets and customer demand. Sales in our North America residential HVAC business decreased 3.6% compared to the prior year. Mark already provided the background, so I am going to spend my time telling you about the changes we are making in the business. You are already aware of the restructuring of our manufacturing footprint in this business, and those changes are well under way. In addition, we recently made organizational changes to our Leadership team to drive organic growth and to accelerate the acceptance of our new technologies.

Outside of HVAC, our residential sales increased approximately 4% compared to prior year, reflecting the impact of our new products and the improved residential market conditions. We experienced improvement on the international front, with sales outside of the US increasing 2.7% compared to the same period prior-year, in spite of currency, which impacted our international sales by 3.4%. The largest improvement was in China, where we saw high single-digit sales growth. The sales improvement in China was across several of our products, including Commercial and Industrial Motors and our generator businesses. We recently increased our resources in Latin America, and our efforts were rewarded with positive organic growth in the quarter. However, we do continue to experience challenging end markets in India and Australia.

The decline in our mechanical business was substantially driven by reduced demands in oil and gas, and in particular, hydraulic fracturing equipment. We also expressed a decline in demand of our mechanical products in Australia, driven by the weakness of that economy. Orders have improved on our standard power transmission products; however, we expect to continue see difficult year-over-year comparisons in the mechanical business through the first quarter of next year, driven primarily again by oil and gas.

Orders in our Commercial and Industrial business stabilized in the third quarter. We ended the quarter with revenues down less than 1%, compared to the same period prior-year, excluding the impact of the divested Pool and Spa Motor business. We experienced sales strength in a number of end markets, including industrial equipment and machinery, industrial pumps, and a slight improvement in distribution. We expect to see similar performance from this business in the fourth quarter.

Revenues and our global Power Generation businesses were up approximately 8% in the quarter compared to the same period prior-year. Here we are seeing stronger demand for our generators and switchgear equipment, used primarily in applications were standby power is critical. One end application where we see a lot of demand is data centers, where downtime is very critical. These data centers require high performing and very reliable equipment. Over the last few years, we have made investments in our generator and switchgear manufacturing capability in Mexico, and last year we invested to expand our generator capability and capacity in China.

We are using a more competitive footprint, along with investment in new technology, to go after new Power Generation business. Again we expect to see similar performance from this business in the fourth quarter. During the quarter, our teams launched another 14 new products. That makes 51 new products launched this year, on pace to exceed the number of new products launched in 2012.

Energy Efficient product sales represented 21.5% of total sales. There are several areas where Energy Efficient product have really made an impact this year, including commercial refrigeration and pool-pump motors. Year-to-date, we are experiencing double-digit sales growth of Energy Efficient products in both of these areas. We recently launched another high-efficiency pool pump motor, and I would like to spend a little time on this product and the impact on energy savings.

When we acquired the EPC business two years ago, we were very excited about a new product that had recently been launched in the business, the V-Green 270. V-Green uses permanent-magnet and variable-speed technology to increase the efficiency of pool pumps. We have been pleased with growing demand with that product over the last 2 years. This motor and control delivers 2.7 horsepower and is perfect for large residential inground pools, as well as commercial pool applications. The team quickly saw a need for a smaller version of the product for smaller-size residential pools, which are common in Florida and other areas of the country.

Adopting technology from our HVAC ECM products, the team just recently developed and launched the new V-Green 165. The motor is designed to be used in replacement and retrofit applications for these smaller-sized pools. Here is an actual example that illustrates how much energy these motors can save. The picture shows two V-Green pump motors, which were installed on a neighborhood pool, retrofitting two standard single-speed motors.

There were two pumps at the site, one that powered a larger pool and the other for a smaller pool. The standard single-speed motors were inefficient and not properly matched of the actual pumping requirements, which is typical of what we see in these applications. The graph shows daily energy usage and you can clearly see the impact when the new V-Green motors were installed. It is an 85% reduction in energy usage, saving over $300 a month in electricity, paying back the cost of the two motors and installation in just a matter of a few months.

Our key pool OEMs are very interested in both the V-Green 270 and the new smaller V-Green 165. We are seeing solid growth in our total North American pump motors sales this year, up nearly 6% in the third quarter, and much of this growth is driven by the sale of these Energy Efficient new products. Earlier I mentioned we saw 4% of than our non-HVAC residential businesses as quarter. New products like V-Green are helping to drive this growth.

I would like to give you a little more background now on our latest acquisition announcement. Founded in 1954, Cemp is a manufacturer of industrial motors designed specifically for hazardous-duty applications. Their headquarters are near Milan, Italy, with annual sales of approximately $35 million. They specialize in motors that are commonly referred to as flameproof or explosion-proof motors. These motors are often specified in hazardous areas, such as oil and gas, marine, mining, and chemical processing.

Approximately 85% of Cemp's products are used in oil and gas and marine applications. Certifications, such as ATEX, are required to meet these stringent requirements, and Cemp's entire line of products is fully certified. The majority of their sales are to customers in Europe, which helps to strengthen our Commercial and Industrial Motor business in Europe.

The Cemp team has tremendous knowledge of the products, applications, and certification requirements. While we have a good range of explosion-proof motors today, our level of global ATEX certification is limited. Cemp really does a nice job filling this gap for us. With our global sales footprint, we expect to deliver $10 million in sales synergies over the next three years. While we don't have a substantial European footprint, we do expect cost synergies by utilizing our global industrial manufacturing and supply-chain capabilities. We will provide more color on the sales and cost synergies at a later date. Expected impact from earnings in 2014 is accretive $0.03 to $0.05 per share and 2015, accretive $0.06 to $0.08 per share.

On our last call, I talked about our simplification initiative and the announcement to close our fractional motor facility located in Springfield, Missouri. We are consolidating the production into our existing Reynoso, Mexico, and McAllen, Texas, facilities. The transition has started on schedule and will be completed by the end of 2014 as planned. Restructuring costs and benefits are tracking consistent to what we previously communicated. We expect to announce further footprint consolidation with our factories around the world during the first half of 2014. And we continue to make good progress in all of our other simplification efforts across the entire company. This includes standardizing our design platforms, supplier consolidation efforts, and ERP consolidations. Simplification will make it easier for our customers to do business with us and improve our margins at the same time.

With that, I will turn it back over to Mark.

Thanks, Jon.

So, to summarize from an operating standpoint, our performance was in line with our guidance, and with the tax benefit, our results finished at the high end of our guidance. We are pleased with our progress on gross margins and with our free cash flow, which is at 114% of net income on a year-to-date basis. As John said, our simplification efforts are focused on footprint and platform consolidation, and we are moving forward aggressively. You should expect more in the future from these efforts.

We continue to launch new products to innovate our product offering and drive rose and margin improvement. We are excited to add Cemp to the Regal family. Our pipeline is healthy, and we continue to aggressively and yet prudently seek acquisition targets that meet our strategic objectives and financial criteria. As we look to the fourth quarter, our EPS guidance is up double-digit versus prior-year. While not all of our markets are behaving, the Regal teams are driving performance improvements that are showing up in our results.

So, in closing, we are pleased to have delivered performance within our guidance, and we continue to feel good about our Company. Our overall focus is on growing our Company both organically and through acquisitions, while improving our margins. We have proactively worked to reduce costs by driving simplification while still making prudent investments for the future on new technologies and on new facilities. Further, we continue to launch new products, we are consistently investing in our IT infrastructure, and we are continuing to develop our people through education and new experiences. We are proud of the progress we have made and certainly optimistic about the opportunities that lie ahead of us.

With that we will take your questions.

(Operator Instructions)

Josh Pokrzywinski from MKM Partners.

Hi. Good morning, guys.

Good morning, Josh.

Just hone in on the HVAC business for a second here. X the price givebacks on the two-way formula and the customer loss, what was volume in the quarter?

Let me just make sure I understand your question. Our overall volume was down 3.6% for the quarter, and the majority of that was related to both the customer dynamics we discussed as well as volume. And what you are asking is if we take those two things out, what happens to the volume?

Just volume, you mentioned price as well.

I think it was probably flat to slightly up on a year over year basis, if you adjust those two things out.

Okay. Then thinking about normal seasonality into the fourth quarter, I guess I am struggling to see what normal is with this business, given a couple of the ebbs and flows. But should we think about some of the share losses being smaller, just because the customer loss was in [hermetics] tends to be more of a cooling product, shouldn't really show up as much, or is that wrong way to think about it?

No, if you think back to Q1, we said that we thought there was $40 million to $45 million of headwind ahead of us, and we thought $15 million of it would show up in the second quarter, and then it would follow normal seasonality. So that number would decline as the season declined.

Okay. Then on the simplification program and the $15 million in annualized savings, is that a gross number or is that netted out for any kind of requalification that you had to do with your customers to get Reynosa up and running for the product transfers?

Yes, you know, $15 million is the gross number, and we believe that we will maintain substantially that amount. There are some givebacks here and there for specific situations, but the majority of it, we think we will hold on to.

Okay, that's helpful. Then just one question on Cemp. I recall some of your competitors in the past with explosion-proof businesses seemed to have pretty good margins in that. If I make some assumptions about deal amortization, it looks like those margins might be high single digits, maybe 10%, excluding the step-up and amortization. Is that, one, a good way to think about it, and two, would you say that that business is kind of under-earning now, and that structurally those margins should be higher?

The answer to the first question is that you should think about the Cemp market margins as above the Regal fleet average. And then relative to the second point, as John mentioned, while we do believe there are some cost synergies, we have yet to quantify it and we will try to comment on that at a later date.

Okay. Thanks guys.

Thanks Josh.

Scott Graham of Jeffries.

Hey, good morning. This is a question mostly for Jon. Jon, are you able to at this point give us an idea of what the new product contributions are to sales, not, obviously, the percentage--but are we talking about these new products, the last couple of years, this year, maybe impacting sales 1%, 2%? Have you been able to quantify that?

I would say, Scott, I don't have a number to quantify in terms of the impact on an annual year over year basis, and in fact this is clearly contributing to helping us on top-line performance. We typically look at our product vitality and look at how much of our business revenue is being generated from new products and product line extensions that have been done in the business over the past five years. And that is typically about a third of our revenue.

So we know the products are having an impact on our revenue. We also track business by business what the impact is in our growth plans from new products as well as other customer initiatives. So there is no question; it is having an impact. We have had difficulty seeing that, of course, with some of the other dynamics that we have experienced.

Thank you. This one is for Mark. You know the M&A pipeline finally spit something out, and this looks like a nice deal for you. I was just wondering kind of, if you were to look out over the latter part of the year, is it possible that we could see another one before the end of the year? And maybe also talk about within your funnel, some of the sizings of the deals that are out there that you guys maybe are looking at a little closer on? And just to make sure none of them are in resi-HVAC.

In terms of the pipeline, as I mentioned earlier, it is still a healthy pipeline. I think the way to think about it, Scott, is transactions that are similar to size to the Cemp transaction up to transactions that are similar in size to the EPC transaction that we did back in August of 2011. Timing is always difficult to tell. It is tough for me to comment on timing and when one of these would come across, but I can assure you that we are focused on it.

And you are not looking to enter residential HVAC and international markets, is that fair?

We have a small exposure today in resi-HVAC and international markets, and I think it would be fair to say that that is a not a primary focus for us.

Thank you very much.

You're welcome.

Christopher Glynn of Oppenheimer.

Thanks, good morning. Mark, wondering about the formula prices, are they either designed to be margin neutral, or is it more a situation where the customer gives you margin on the way up an taken it back on the way down?

No, I would say overall you should think about it as margin neutral, that is the goal overall. Now, there is a little bit of a timing lag that can come with these. Some of them will adjust within the quarter, some of them will adjust the next quarter, and some of them will adjust two quarters out. But you should think of it as margin neutral.

Okay. For electrical, it looks like profits declined a little bit more than core revenues. I am just wondering what else was going on there, if there is a mix impact or if it is just other, kind of, moving pieces?

So, you are looking specifically at the electrical segment and you're saying overall profitability is down slightly more, is that what your comment is?

Yes, the profit dollars down about the same amount as organic sales year over year.

Right. So Chris, this is Chuck. It would be impacted by volume and the price dynamic that we had talked about also.

Oh, okay. But in my comment the price was in the revenue dynamic.

Oh. Okay. So the margin improvement, for the most part, is going to be at the gross margin level will be in the electrical segment. You can see that improvement, and then the rest would just be how it allocate the SG&A expenses by the businesses. I don't think there is anything that we would call out on that subject.

Okay, thanks.

Jeff Hammond KeyBanc Capital Markets.

Good morning, guys. Maybe just a dovetail on the margin comment. You know, SG&A, I think you mentioned down sequentially, but it was down similarly last year. So I'm just wondering how much of that is seasonal, how much of structural? Clearly the last few quarters, you have been running 15.5% of sales in your operating expenses, I think you bottomed at 11%. Just talk about your SG&A line, what you're doing to address that, where you think long-term SG&A costs should be as a percentage of sales?

Well Joe, I will start with the fact that, again, we had reduced the SG&A in the third quarter down $10 million from the previous quarter, but the SG&A level was up on a year over year basis. And in the third quarter last year, we had a few favorable reductions in a few of our reserves, such as bad debt and inventory reserves that did not repeat in the third quarter of 2013. So in third quarter 2013, we experienced a modest increase in salaries and benefits, principally inflationary costs for our US health insurance. Then we also had a higher level of IT expenses, as we continue to invest in our ERP consolidation. So as you think about it, while the sales come down a little bit, the SG&A expenses are not necessarily variable to that. So the way to focus on it, as we do, on a dollar basis -- and I assure you we are focusing on taking out all of discretionary spending and managing our expenses across the company.

Okay. Can we talk longer-term on where this number should be, and maybe you can speak to what EPC did to the SG&A structure?

Jeff, our target is to have our SG&A expenses at 14.5% to 15% of sales on an ongoing basis.

Okay. Why is that materially different from the latter part of last cycle when you were 11.5%, 12%?

Well the company has gotten a lot bigger, obviously. Back then -- obviously, as you grow in size, the complexity of the business grows and the requirements of the business grows. So there has certainly been some of that, that has contributed. We did pick up the EPC business, and they would be slightly higher than the legacy company was at that time. So those were all contributors.

Okay. The 14.5% to 15% target, is that kind of in line with the 13.5% out margin targets by 15%?

Yes, that would be consistent with that same plan. I believe it would be certainly top quartile performance for Diversified Industrials, that we would see as our peers.

Okay. Then finally back on resi-HVAC. To Josh's question, there still seems to still be a gap between what you are putting up X the one customer loss and price and what the industry is putting up, and you mentioned res tailwind into 2014. What is a reasonable timeframe where you start to see your business more in line with that residential tailwind?

I believe it is after substantially the customer dynamic issues that we discussed back in Q1 is behind us, which we think is going to be late second quarter.

Okay. And what is your comfort level that if you look at all of the moving pieces that as we get into Q2, you do start to see something more in line with industry trends?

What we see in front of us today, that is our best view of the world. Obviously the world changes all the time, but as we look out today, that is our best view.

Okay. Thanks, guys.

Yep. Thanks, Jeff.

Mark Douglass of Longbow Research.

Good morning, gentlemen.

Good morning.

Chuck, what was the price paid for Cemp?

We have not disclosed that price, Mark, it was a private transaction.

Okay. I will wait for the queue. Okay. So, right now looking at the Resi- HVAC channel, you mentioned before trying to capture some share with lower price point motors, aluminum replacing copper, is there any update on the status of that endeavor? Do you think that could help you in 2014?

Mark, this is Jon. Absolutely feel good about that initiative. We did talk in earlier calls about putting more focus on value products, and in particular aluminum-wound motors, where we convert copper to aluminum to help reduce the cost of the product and also to utilize our global manufacturing footprint with manufacturing capability in India and now in China with the EPC acquisition. We are absolutely focused on that.

I mentioned some of the organization changes we have made in the business. Part of that is to continue to put a strong focus on those products. We actually just increased the capability and the capacity for aluminum winding capacity in our India facility because we wanted to match of that product capabilities with our best cost footprint. And we are continuing to take those products to customers. We have interest from customers, from a valuation standpoint. We have some of those products in production now, so I feel good about the longer-term prospects in that initiative.

So you have sales, then?

Yes we do.

For those products?

Yes, we do.

But not in volume at this point?

Clearly, none of us are happy with the 3.6% decrease in sales. We need and expect more from that effort, and that is part of our focus to improve our HVAC business and total.

Okay. Then on an organizational changes, help us understand with that really means.

We, as you think about our sales leadership, I think there is a change out in our sales leadership team, and secondly just another example of the kinds of things we do, we took a key leader of the business and asked him to just separate himself from the day-to-day transactions and focus on new technologies that we think could be potential game changers for us.

Okay. Thank you.

Yep.

Thanks, Mark.

Jamie Sullivan of RBC Capital Markets.

Hi, good morning.

Good morning. How are you doing?

Good, thanks. Quick question on the fourth quarter, is there any LIFO impact baked into the numbers that you're assuming there?

There'll be a modest benefit, based on our current view of year end in copper prices, but it would be comparable to what we had in the third quarter.

Okay. That's helpful, thanks. And then a follow-on to the long-term margin question, 12.5% to 13.5% to 15% -- with the HVAC cycle mix that you are seeing and feeling at the low end and sort of the growth numbers there, it looks like to hit the margin target about half of that comes from volume and new products. Can you still deliver on the 20% o 25% incrementals, with the mix of the HVAC industry right now and your exposure there? Does that make sense?

I will just trying to clarify, if it is okay, Jamie? Just trying to make sure I understand your question. We have communicated that by the end of 2015 we expect -- our goal on EBIT margins was to be in the 13.5% ZIP code on EBIT margins. And your question is, can we get there with our exposure in HVAC?

I think that is your question, and I will just comment that we are not focusing on volume to deliver. We had very modest volume assumptions, and our thinking was, we're going to have to have 2.5% GDP growth in order to be able to deliver on our margin commitments. Most of the benefits were coming from three or four buckets. The synergies that we were going to get from the EPC transactions, which those transactions are substantially behind us, the benefits we were going to get from our simplification program, those benefits are still out in front of us, and the benefits from new products. So that remains our focus and remains our target, top target, and our goal is to get there by the time we exit the fourth quarter of 2015.

Okay. Thanks. Then last question just on CapEx, Chuck, is there any way to quantify what sort of heavier this year that won't repeat next year in any magnitude?

Well, Jamie, I think the total number for 2014 is not finalized yet. But I would expect the Unico project to be complete this year, WADA, our plan in China, will have some spillover capital spend in 2014 in the first half. But there is no other new, big projects that we have, that we have communicated. So the level of capital investment should be down year over year and trending towards our normal rate of 2.5% to 2.75% of sales.

Great. Thanks very much.

You're welcome.

Julian Mitchell of Credit Suisse.

Hey guys, Charlie for Julian.

Good morning, Charlie.

How are you? Just after seven quarters of core growth declines in both businesses and just talking into next year for 2014, even just the first half in mechanical talking about tough comps in that business, that would put you ten quarters in a row, down ten core. Can you just talk about maybe where we will see an inflection point in organic growth, both in mechanical and electrical, and where we will see the core business stabilize?

If you think about some of our key markets, residential -- we have touched on residential HVAC and we have talked about what we thought was in front of it and what the timing of that was. The earlier question just one came after that, but we commented that by late, the end of second quarter, we expect a change in what was happening there. With our commercial and industrial markets, I can think back probably six or seven quarters ago, six quarters ago, and think back to prior to that point, we had seven quarters in a row of high single-digit, low double-digit sales growth quarter after quarter. Since that time, our commercial and industrial business has been down, and have been improving kind of quarter to quarter. This quarter down less than 1% on a year over year basis when you adjust for the domestic businesses. So I think it is improving there.

In China, third quarter 2011, we started to see deterioration in China, and this was the first quarter and some time that we saw growth in China, and we are expecting to see it again in, I mean in the fourth quarter. You know, I think the wildcards are going to be the rest of Asia, which is India and Australia, to a lesser degree Europe. So it appears to us that Europe is starting to stabilize and improve as well. So, when you take all those things into consideration, certainly the forward look looks better than what was in the rearview mirror.

Great, thanks.

You're welcome.

Samuel Eisner from Goldman Sachs.

Thanks. Good morning, everyone.

Good morning.

So on Cemp, you indicated that there is roughly $10 million or so of sales synergies you're expecting over the next few years. Is that factored into the accretion guidance you provided on today's press release.

Yes it is, Samuel.

Okay. Great. In terms of long-term goals for tax rate, Chuck was talking about moving down the tax rate over time. I'm just curious if you guys have a benchmark you are trying to reach in terms of the tax rate because obviously with the first half of next year thing around 27%, just trying to understand where all the moving pieces are there.

Sam, I think we successfully implemented the majority of the tax strategies to get us down to that 27%. To give an estimate beyond that, I would have to make a lot of assumptions about tax rates and possible tax changes around the globe, and that would be awfully difficult to do. But for the most part, we are down at a sustainable level, the effective tax rate of 27%, and that would be impacted in the future by distribution of global earnings and any other changes in the tax code around the world.

Got you. And on resi-HVAC, X the customer loss that happened in the first quarter, what was resi-HVAC in the quarter?

I'm sorry, can you add on?

In terms of the growth rate in resi-HVAC, you guys reported that you guys were down 3.6% year-on-year, but that was inclusive of the customer loss. I'm just curious what was that extra customer loss?

We answer that question including the impact of our two-way pricing formula. We said flat to slightly up.

Okay. Great. Appreciate that. Thanks so much.

Thank you.

Walt Liptak of Global Hunter Securities.

Hi, thanks, good morning. You made a comment about distribution improving slightly, and I wonder if it is possible to get some color around that? If there are any sectors that are getting better, large distributors, what you're thinking about in the fourth quarter and next year. I'm sorry, related to the C&I business.

Right, right. Walt, in the second quarter, the color I had given on end markets for C&I included distribution being one of the weaknesses that we saw in the second order in C&I. We actually saw a slight improvement, with a little bit of year over year growth overall in distribution in C&I in the third quarter. However, I would temper that by saying that if you look at from an order standpoint and what we're hearing from customers, especially some of the smaller distributors who tend to be just an ongoing tone of caution and concern and about being put in a position of holding too much inventory. We are not seeing a lot of strength, especially with the smaller distributors, but we did at least see some year over year improvement in the third quarter.

Okay. Got it. If I could switch over to the leadership change. Wonder if you could help us understand, it sounds like the head of HVAC was switched out, and I wonder if you could tell us why that happened? Who was put in his place? What kind of expectations should we have about the new leadership?

No, that is not exactly correct. We changed of our sales leader, and then we took a key leader of the business and had him focus on driving our new technologies, which we think can be game-changing technologies with our key HVAC and key industrial customers. So, we took someone that is well-respected out of the business and focused him on the future key technologies that we think are really meaningful in the space. So those are the changes. Those were the high-level changes that we've made.

Okay. Great. Thank you.

Rudy Hokanson of Barrington Research.

Thank you. I was wondering if you could just talk a little bit more about your international opportunities, especially China but also Latin America, and what kind of lead time or visibility you have on that activity right now? You just mentioned that this last quarter was the first time in some time that you started to see signs of life -- it was up, I think it was 4% -- and that you see positive comparisons in the fourth quarter. I was wondering, are most of those sales fairly short lead time, so you can't really go out beyond that quarter, or do you have a feel for what you're seeing or what you're hearing from customers for 2014?

Rudy, with regards to China, you should think of our lead times as typically in the three-month range, give or take a month. That is the way to think about that. So we can see of about that far, which gives us confidence about the fourth quarter. I would say it is certainly feels better today than it has over the last six quarters with regards to our commercial and industrial business in China.

What about, I believe you mentioned briefly Latin America was looking good or South America was looking good?

Yes, Rudy, this is Jon. I'd mentioned we put more focus here this year in organic growth in Latin America, and we have increased the presence of our sales team, and have been coordinating our efforts there as well as targeting some new products specifically for the markets in Latin America. And we did see organic growth, nice organic growth in the third quarter from those efforts. Now, we are starting a relatively small position, but it is nice to see the growth and the impact of those efforts. I'd mentioned on the last call, in particular, commercial refrigeration retrofits, and we some really nice progress on that front in the third quarter, and we will expect to see benefit from that, not only in the fourth quarter but into 2014.

Okay. Is that mostly Mexico?

It is Mexico, but it is also Central America, the Caribbean, and in South America. So, it is really throughout the entire region. We don't have a strong of a presence say in Brazil, Colombia, Venezuela. But we have teams there, and we're trying to grow that footprint.

Okay. Thank you. Then on the oil and gas side and the mechanical sales, you basically have said the first half of next year is going to be very difficult. I believe that was the time reference. Again in terms of lead times or the type of sales or what you're hearing, is this something that you get involved with a CapEx program of a company where they might be setting their budgets and you are negotiating with them? Or is this more of something -- are your items usually something more that'll be -- they see the need in the fields because they have completed a well, so they place an order and four weeks later you deliver?

I would say, Rudy, first of all, we mentioned that we are going to continue to see some fairly difficult comps through the first quarter, not the first half, so the first quarter of next year. The issue is predominantly on hydraulic fracturing equipment. So it's a case of where we're selling to an OEM, they're filling a need in the channel. In our view is that there has been a fair amount of inventory that has been built up over the past year or so, and we are essentially waiting to see that inventory decline. And we have recently seen a few orders, which has been a good sign. Something we haven't seen earlier in the year for some time. But, as I say, it is a little too early to call and celebrate.

Okay. So, it is something that is more -- it's more within a short period of time when you get the order to when delivery is expected?

Yes, I'd say that is a fair way to characterize it, Rudy.

Thank you very much. Those are my questions.

Liam Burke of Janney Capital Markets.

Thank you. Good morning, Mark, good morning, Chuck.

Good morning, Liam.

Can you give us some sense as to how the aftermarket business has been trending?

Yes, sure, hold on. Are you asking specifically about the commercial and industrial part of our business?

Yes, I'm sorry. Yes.

I would say overall the way I would describe it, Liam, this is Jon. Aftermarket or distribution side of our C&I business, I mentioned it had improved in the third quarter, I would say orders are stable at this point, going forward, and that's in particular with the larger distributors. Now, I think many of the large distributors would say that they have not had a great year this year overall in distribution, and we have definitely seen that as well. But our efforts to continue to grow our presence with those large distributors, we feel good about that in terms of long-term prospects.

Some of the feedback that we have gotten on the distribution side, you would hear the words cautious, customers being a little bit uncertain about the environment out there.

Okay. Thank you. And you said your non-HVAC residential business was strong, or was better year over year, excuse me. How big a business is that for you?

I think it represents roughly 5% to 7% of our total residential exposure. I don't have all the numbers in front of me, but I think they are laid out in one of our presentations. We will make sure that John Perino could shoot the data.

Great, thank you.

The last question for today comes from Bill Dezellem of Tieton Capital Management.

Thank you. A couple of questions. First of all, there has been a number of more specific questions about China, but would you talk more in general terms what it is that you're seeing there, and how you are viewing that market now after a few soft quarters?

We tend to sell into larger commercial, I'm sorry, larger commercial and industrial applications and you should think about infrastructure. Infrastructure growth, I think that would be the best way to think about it on one piece, and another piece would be the large commercial installations would the other piece. That is where we are seeing improvement in our orders.

And at this point are you feeling that there is some sustainability to that? Or does it appear that it is more of an inventory channel fill, how are you looking at that?

I wouldn't think about it as inventory, you don't have the same distribution dynamics in China that you have in the US. You're typically selling right to an OEM or an end user. You are not going to get an order unless they have orders. I don't think it is a channel fill. We feel good about the fourth quarter; beyond that, I have seen too many ups and downs in China to talk about sustainability yet. But certainly we feel okay about the fourth quarter.

A bit of positive news, I would say, Mark, our order rates have been more stable over the past three to four months, and we wouldn't have been able to say that earlier in the year.

And the PMI data has been sporting that, trending up.

That's helpful. One additional question. Relative to the mechanical business, your sales were down sequentially; however, your gross margin was up nicely. I apologize if I missed it before, but would you please discuss what you have been doing to move that gross margin up in spite of softer sales?

Well, it's the same initiative in that business as we have in any other businesses relative to all the key focus of the business which is going to be around simplification. We did do some restructuring last year that we paid for last year that will show up this year. Certainly that was a contributor as well.

Thank you both.

Thank you, Bill.

This concludes our question-and-answer session, I would like to turn the conference back to Mark Gliebe, Chairman and CEO, for any closing remarks.

Thank you all for your interest in the company, and thank you for joining the call. Have a great day.

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