Regal Rexnord Corp (RRX) 2013 Q4 法說會逐字稿

Good morning and welcome to the Regal Beloit Corporation fourth quarter 2013 earnings conference call. All participants will be in listen only mode.

(Operator Instructions)

Please note this event is being recorded. 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 fourth 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 the call over to Mark I'd like to remind you that the statements made in this 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.

On slide 2 we mention that we're presenting certain non-GAAP financial measures related to adjusted diluted earnings per share, adjusted gross profit, adjusted gross profit as a percentage of sales, adjusted income from operations and free cash flow.

We believe that these are useful financial measures for providing you with additional insight into your operating -- into our operating performance. Please read this slide for more information regarding these non-GAAP financial measures, and please see the appendix where you can find reconciliation of these measures with the most comparable measures in accordance with GAAP.

Now I'll turn the call over to Mark.

Thank you, John. Welcome and thank you for joining our fourth quarter call and for your interest in Regal. As usual I'll follow the normal schedule. I'll make some opening comments, Chuck will give you a financial update. John will give you color on products, markets, recent acquisitions and operations, and then I'll summarize before we move to Q&A.

Before I get into the details, as you may have read in our press release, Regal took a non-cash impairment charge in the fourth quarter primarily related to businesses competing in difficult economic or market environments. Chuck will discuss this topic in greater detail. To better address our operating performance I will discuss our results on an adjusted basis.

From an operating standpoint revenues were up slightly year-over-year in the quarter. Sales in our HVAC business were up approximately 5% in spite of the previously disclosed headwinds. As expected sales into China experienced strong growth while revenues in India and Australia remained challenged.

Again, as expected 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 end market.

Our North American mechanical business was down 7% for the quarter, with the decline coming primarily from our exposure to hydraulic fracturing in our Milwaukee Gear business.

We were pleased with our two point improvement in gross margins, which were in line with our expectations, and driven by EPC synergies, our simplification programs, our new products, and stronger sales of high efficiency products.

For the fourth quarter Regal's adjusted EPS was up 46% on a year-over-year basis and while our operating performance was within our guidance, our adjusted earnings were well ahead of our guidance. Chuck will get into the details, but unanticipated tax benefits in the quarter resulted in adjusted earnings exceeding our guidance.

On an adjusted basis free cash flow for the quarter came in at 118% of net income and for the year we finished at 115% of net income, achieving our goal of free cash flow greater than net income for the third year in a row.

Our simplification program continues to move forward. The relocation of our Springfield facility to McAllen, Texas and Reynosa, Mexico is on schedule to be substantially completed by the end of 2014.

Recently, we announced to our employees the combination of our two Acuna, Mexico facilities. This restructuring move will be completed by year end and will right size the facility given their current conditions while providing an attractive payback. There is more to come from our simplification efforts and John will discuss this in more detail.

To spur growth we launched 20 new products during the quarter, making it 71 new products for all of 2013. We are focused on continuous innovation around energy efficiency to help drive organic growth and improve our margins.

Recall that we acquired Cemp at the beginning of the fourth quarter. The integration is going as planned and we are excited to have Cemp part of the Regal family. As expected the acquisition was $0.02 dilutive in the quarter due to normal purchase accounting practices. Consistent with our earlier guidance we expect Cemp to be accretive in 2014, $0.03 to $0.05 with minimal contribution in the first quarter.

And finally, as you may have seen from our press release this past Friday we signed and closed on the acquisition of Hy-Bon, a $57 million US-based manufacturer of Vapor Recovery Units, or VRUs, in the oil and gas space. VRUs capture gases from storage tanks that would otherwise be vented or flared and transfers them to nearby pipelines.

Hy-Bon is an excellent bolt-on addition to our Unico business and we expect two way sales synergies as well as modest cost synergies. We like the oil and gas end market and we like the fact that Hy-Bon's products recapture lost energy that benefits the customers and meets both state and EPA regulations.

As far as other acquisitions go we continue to have a solid pipeline, and we intend to be a consistent and successful acquirer.

Speaking of Unico, we have substantially completed our expansion of our Franksville, Wisconsin facility. The final relocation of the production lines is underway, and we expect continued growth in this business in 2014.

And speaking of plant relocations, we began the relocation of our facility in Wuxi, China into their new home. This will be our third and final major China plant relocation in the last three years. We expect the relocation to be complete by the end of the year.

In the fourth quarter the Board reauthorized the repurchase of up to 3 million shares. With our consistent strong free cash flow and our strong balance sheet, we are in a position to continue our growth through acquisition strategy and repurchase shares should, in our evaluation, the market conditions warrant. Our bias will be to continue to pursue acquisitions as we believe it creates the greatest long-term shareholder value.

As we look to the first quarter our guidance reflects typical residential HVAC seasonality as well as low single digit residential market growth offset, however, by the customer dynamics we've previously discussed. Further, we expect our North American commercial and industrial motors business to grow slightly for the quarter and we expect continued strength in our power generation business.

Internationally, we anticipate sales in China will be up as well but offset by continued weakness in India and Australia. We are expecting a 1 percentage point margin rate headwind in the first quarter driven by a number of factors.

First, our two recent acquisitions will contribute roughly $15 million of incremental revenue on a year-over-year basis, with minimal margin contribution due to normal purchase accounting. We expect both businesses to begin to contribute in the second quarter.

Next, while Unico had another good year with revenues up 20% and we expect Unico to have growth in 2014, the first quarter of 2013 was particularly strong, so the year-over-year comparisons are difficult.

Also, as we mentioned earlier, our Milwaukee Gear business has one more quarter of difficult comparisons in front of us. The good news is that Milwaukee Gear is beginning to see more customer inquiries and quote activity is up higher than we've seen throughout 2013.

Next, we are expecting operational inefficiencies related to our Springfield HVAC plant consolidation efforts. The program is on track. We expect to complete the transition by year end and begin realizing the benefits in the second half of 2014.

Finally, we are expecting modest price cost gap in Q1. In early December we did announce a 3.4% general price increase to our North American customers. While we expect this price increase to begin to have an impact in Q1, the full impact won't be realized until Q2 and beyond.

With that I will turn it over to Chuck Hinrichs.

Thank you Mark, and good morning everyone.

I will start with the reconciliation of our fourth quarter 2013 results on a GAAP EPS basis to adjusted EPS. Earnings in the fourth quarter 2013 on a GAAP basis were a loss of $0.74 per share. We add back the impairment expense of $1.65 per share adjusted for taxes.

The next adjustment in the fourth quarter was purchase accounting adjustments and closing costs for Cemp totaling $0.02 per share. Restructuring charges in the quarter were $2.7 million or $0.04 per share related to our continuing work on our simplification initiative. Adding back these adjustments results in adjusted earnings per share for the fourth quarter 2013 of $0.97 up 46% from the prior year.

Our fourth quarter sales were $727 million, an increase of 1.6% from the prior year. The impact of foreign currency translation in the fourth quarter was a negative 0.9% on total sales and a negative 2.5% on international sales as compared to the prior year.

Sales in the quarter increased 1.3% from the Cemp and RAM acquisition as compared to the prior year. In the fourth quarter of 2013, our gross margin of 24.5% represents a solid improvement over the prior-year gross margin of 22.5%.

In the fourth quarter 2013, we had LIFO expense of $3.1 million, an increase of $3.4 million over the prior year, and $2.7 million of restructuring expenses, a net decrease of $800,000 from the prior year.

The gross margin improvement resulted from the benefits of the EPC synergy program and sales of new products at higher margins. Our SG&A expenses in the fourth quarter 2013 were $125 million. This was an increase from the prior year and previous quarter, impacted by the SG&A expenses and closing costs from Cemp, higher health care, IT, and audit related costs.

In the fourth quarter 2013, we performed our annual goodwill impairment analysis. We concluded that an $81 million impairment expense for goodwill and tangible and related items was required. Net of the tax benefit, the after tax impact is $75 million or $1.65 per share.

This write down was primarily due to the difficult economic market conditions in the India, Europe and Australia markets and in the natural gas fracturing market in the US. The impairment expense is a non-cash expense and does not impact future sales, margins or liquidity.

Our income tax provision in the fourth quarter 2013 was a $3.7 million tax benefit, substantially lower than our earlier guidance of an 18% ETR. The tax benefits resulted from two adjustments.

The first adjustment was related to the impairment expense as the write downs of the intangibles and related items were deductible for tax purposes.

Second adjustment recognized was the December 2013 change in the Mexican tax law, which required an adjustment to our deferred tax account and a reduction in the tax provision for the quarter.

Also, there were changes in the global distribution of earnings which impacted our tax provision. This resulted in a $0.12 per share benefit versus our guidance for the quarter.

This slide provides some key financial metrics for the fourth quarter and year end 2013. Our capital expenditures in the quarter were $17.3 million and $81.1 million for the full year 2013. For 2014 we estimate capital expenditures will be $80 million to $85 million as we complete our Wuxi China motor plant and invest capital for the simplification projects.

Our effective tax rate in the fourth quarter was a 10.3% benefit, which was below our earlier guidance of 18% as I explained earlier. We estimate our 2014 ETR to be 27% consistent with our guidance from last quarter.

In the lower left section we summarize our adjusted free cash flow. We posted another strong quarter and full year in our adjusted free cash flow performance. 2013 was the third year in a row with free cash flow greater than 100% of adjusted net income.

In the lower right quadrant, we provide data on our quarter-end balance sheet. Our total debt was $767 million and our net debt decreased to $301 million. Our credit metrics are strong as our debt to EBITDA was 1.8 times and our net debt to EBITDA was 0.7 times.

Now I'd like to discuss our priorities for capital allocation. Our first priority is the continued investment in our current businesses to enable organic growth and investments in new capital projects with the favorable return on invested capital.

To supplement our organic growth, we continue to pursue acquisitions that meet our strategic and financial criteria. The third priority is our consistent dividend strategy to return a portion of our free cash flow to our investors. We have increased our dividend eight out of the last nine years.

And finally, we will consider opportunistic repurchases of our stock. As Mark mentioned our Board reauthorized the 3 million share repurchase program. All our decisions on capital allocation are focused on driving long-term shareholder value.

Our first quarter 2014 earnings guidance is for GAAP EPS of $0.90 to $0.98 per share. On an adjusted basis that is $0.99 to $1.07 per share, after adding back the estimated $0.07 per share of restructuring charges, and $0.02 per share of purchase accounting adjustments for both Cemp and Hy-Bon.

Excluding these purchase accounting adjustments Cemp and Hy-Bon's results will be neutral to first quarter's results but will be accretive to future earnings.

As Mark mentioned, we expect to see headwind on our first quarter gross margin of approximately 1%. There are a couple of factors driving this margin pressure.

Two of our businesses, Unico and Milwaukee Gear, have difficult prior-year comparisons. Secondly, we are experiencing some operational inefficiencies as we execute our plant closures and production transfers. These will abate in the second half of 2014.

And lastly, we are experiencing some pressure on our price-cost margin. Copper prices have been volatile, and steel prices and other input costs are increasing. This margin pressure is being addressed with our price increase, which will be fully realized in the second quarter of 2014.

We will hold our SG&A expenses flat in the first quarter of 2014 excluding the impact of the acquired businesses. And finally, we expect our effective tax rate to be 27% in the first quarter of 2014 and for the full year 2014.

Now I will turn the call over to Jon Schlemmer.

Thanks, Chuck. Good morning, everyone. I'll start by giving some color on the end markets and customer demand.

We saw improved performance in our North America residential HVAC businesses with sales up approximately 5% compared to the same period prior year. The sales strength was in both the OEMs and the aftermarket side of our business.

The cold weather across much of the country in the fourth quarter drove an increase in furnace related motor demand that improved our sales and our mix. The customer dynamics that we communicated back in early 2013 negatively impacted our sales in the quarter, as expected. However, I would remind everyone that the seasonality of our residential HVAC businesses results in less of an impact for the fourth quarter versus other periods throughout the year.

Sales in our North America commercial and industrial motor businesses decreased approximately 2% excluding the impact of the divested pool and spa motor business. Overall order performance was stable throughout the quarter.

We experienced strength in a number of end markets including commercial and industrial pump and commercial ventilation. Commercial and industrial equipment and machinery sales declined in the quarter. It seemed that a number of small OEMs were reducing their year-end inventory levels. Sales through distributors were slightly down in the quarter.

We had another good quarter in our global power generation businesses with sales up strong double digits compared to the same period prior year. The strength in both generators and switch gear equipment resulted from a combination of new customer wins, new products, and strong demand in the data center segment.

The decline in our North American mechanical business was driven by the reduced demand for hydraulic fracturing equipment in our Milwaukee Gear business. Excluding Milwaukee Gear, we experienced slight growth in the rest of our North American mechanical business.

As we mentioned on our last call we have one more quarter of difficult year-over-year comparisons in the mechanical business, driven by the demand for hydraulic fracturing equipment. While we have not seen an increase in our order rates our fracking customers are somewhat more optimistic and we have seen an increase in inquiries and quote activity.

Unico had a very good quarter with sales up approximately 20% driven by increased demand for Unico's oil and gas products. We experienced growth in North America, South America and Europe.

We've substantially completed the expansion of Unico's manufacturing facility in Franksville, Wisconsin and have made a lot of progress increasing both the production output as well as the efficiency of the operations. I'll talk more about Unico later when we discuss our recent acquisition.

On the international front, sales outside the US increased approximately 1% compared to the same period prior year in spite of currency, which impacted our international sales by 2.5%. For the quarter, sales outside the US represented approximately 36% of our total sales.

We experienced continued growth in Latin America and solid growth in our China businesses. Conditions in Europe seem to be improving where we experienced much better order rates as we exited the quarter. The India and Australia markets continue to be very challenging.

During the quarter our teams launched another 20 new products. That makes 71 new products launched in 2013, another record year for new products. High efficiency sales increased approximately 7% compared to the same period prior year and represented 22% of total sales. The increase in high efficiency sales was partially driven by greater demand for energy efficient gas furnaces as well as an increase in demand for new products.

Last month we showed our latest residential and commercial HVAC products at the AHR Expo in New York City. There was tremendous interest in the new DEC Star blower system and the SyMAX-I 56 Frame ECM motor and control.

DEC Star is the latest innovation for efficient air movement and residential HVAC applications. DEC stands for dual efficiency configuration, the axial permanent magnet motor combined with a high efficiency blower. The new diagnosis is more efficient, lighter, more compact and quieter, all features that are important to our customers. We have a number of launch customers and even more are evaluating DEC Star in their labs.

The SyMAX-I 56 Frame ECM motor and control brings our proven ECM technology to larger motors for higher horsepower, air conditioning, refrigeration and ventilation applications. The new motor and control can reach nearly 4 horsepower while today's HVAC ECM motors are limited to approximately 1 horsepower.

The I in SyMAX-I stands for integrated where the motor and control are integrated into one system for reliable, efficient, compact and cost effective performance. This opens up the door for a wide variety of new and larger applications such as commercial air conditioning and commercial refrigeration.

Like DEC Star, we have a lot of customers evaluating the new product and we've launched the product with several of these customers. Both of these new products are examples where we're offering a system solution, the integration of a motor and electronic control in the case of SyMAX-I and even the addition of the blower wheel and housing in the case of DEC Star.

In the fourth quarter we announced the acquisition of Cemp, a manufacturer of industrial motors designed specifically for hazardous duty applications with revenues of approximately $35 million. Approximately 85% of Cemp's products are used in oil and gas and marine applications.

In the fourth quarter we started the integration process and put in a growth plan behind the $10 million of sales synergies that we have targeted for this business. The expectation is to realize the sales synergies over the next three years and the team is off to a great start.

The idea is to use our sales footprint to expand Cemp's customer reach in North America, Latin America, the Middle East and Asia. We also kicked off a lean event at Cemp to streamline the operation to help increase capacity, reduce lead times, and improve costs.

On our last call we projected $0.03 to $0.05 EPS accretion in 2014 and $0.06 to $0.08 impact in 2015. We're off to a great start and we continue to feel confident about these estimates.

Today we're pleased to talk about our latest acquisition, Hy-Bon. The Hy-Bon business is a manufacturer of Vapor Recovery Units based in Midland, Texas with sales of approximately $57 million. The majority of the sales are in the oil and gas segment.

Hy-Bon's products are used to capture and convert gas vapor emissions that come from oil field storage tanks. Not only are there ever-increasing environmental regulations to deal with the vapor emissions but there's also an attractive payback equation that helps to drive demand for Hy-Bon's products and services. We're excited about the team, the products and their knowledge of the oil and gas space.

This is a great fit with our Unico business and we see sales synergies with Hy-Bon service centers to help sell and service our Unico products in North America as well as using Unico's sales footprint outside of the US to help expand Hy-Bon's customer reach.

Here's a picture of one of Hy-Bon's larger systems installed in the field. Hy-Bon systems range in size and complexity depending on the size of the storage tanks and the overall demand on the system. Expected impact from earnings in 2014 is accretive $0.03 to $0.06 per share, and 2015 accretive $0.08 to $0.12 per share. In the first quarter, as a result of normal purchase accounting, we expect no EPS contribution from Hy-Bon.

I'd like to wrap up with an update on our simplification efforts. Last year we announced our plans to close our Springfield, Missouri motor and parts operation consolidating the production into our existing Reynosa, Mexico and McAllen, Texas facilities.

This decision was all about simplifying our manufacturing footprint to drive efficiencies and improve lead times. A portion of the product has already been transferred and we're on plan to be completed by the end of 2014.

While we're on schedule, the Springfield restructuring is creating manufacturing efficiencies -- inefficiencies that will impact us in the first half. Once completed we expect savings of roughly $15 million.

We recently announced to our employees the decision to consolidate our residential hermetic motor operations located in Acuna, Mexico. We currently have two production facilities in Acuna and will be consolidating the operations into one facility and closing the other. These facilities supply residential hermetic motors to a number of our customers, primarily in North America.

The consolidation will require approximately $1.6 million of restructuring expenses with an estimated $1 million of restructuring in the first quarter and the remainder in the second quarter. We expect the consolidation to be completed by year end.

This simplification effort will better align our capacity and our overhead structure with our current level of demand in this business. We've updated the estimated restructuring expenses to show the impact on 2014. This includes both the Springfield and Acuna restructuring programs.

Our engineering teams are making excellent progress on our design platform simplification programs. We've identified five major product lines where we will consolidate our existing design platforms to simplify our product offerings.

These are major programs. They involve literally thousands of designs and hundreds of customers. When completed these programs will not only simplify our designs but will also help to further consolidate and simplify our supply base and our manufacturing footprint.

The benefits include improved quality, shorter lead times, lower inventory levels, and ultimately a more competitive cost structure. We are now finalizing the new platform designs and we're targeting to be substantially complete with the conversions by the end of 2015.

One of the five platform simplification programs is our high efficiency IEC industrial motor product line called [Mark 3]. In this case we're developing a common IEC product line that will be used to serve customers and markets that offer us an opportunity such as Europe, Asia, and the rest of the world.

Here we're taking the best of our current product offerings and combining those features and capabilities into one common platform. We're actually consolidating four of our existing IEC products into one common platform. Initially the platform will be produced in our new Wuxi, China industrial motor facility.

This new facility will produce industrial motors ranging in size from 1 kilowatt to 5,000 kilowatts for both the China market as well as for export. All of the products currently produced in our Wuxi, China business will be relocated to this new facility.

The Wuxi facility was previously a state owned enterprise with multiple rooftops. The move allows us to put all of our operations under one rooftop and establish a lean production flow. We're actually able to decrease the overall square footage with this move yet still make significant improvements in the efficiency and capacity of the operation.

The new facility is nearly complete, and we've started the relocation of the manufacturing processes. The relocation will be completed by year end.

As you can see our teams are making excellent progress on both our innovation and simplification initiatives, I'm confident these efforts will make a significant impact.

With that I'll turn it back over to Mark.

Thanks, Jon.

So to summarize, our top line grew in the fourth quarter, and our adjusted earnings per share were up 46% year over year. While our performance was in line with our guidance, with the added tax benefits our results finished well ahead of our expectations.

We had a 2 percentage point improvement in the fourth quarter margins driven by our key initiatives and we are pleased with our continued progress on free cash flow, which finished the year at 115% of adjusted net income.

As Jon mentioned, our simplification efforts are focused on footprint and design platform consolidation, and we are moving forward aggressively.

In addition to the recently announced Springfield and Acuna consolidations you should expect more in the future from these restructuring efforts. We continue to launch new products to innovate our product offering and drive growth in margin improvement.

The fourth quarter Cemp acquisition is going well and will contribute to EPS growth beginning in the second quarter. We are very excited to welcome Hy-Bon to the Regal family.

Hy-Bon will be a nice tuck-in with Unico and we like the Hy-Bon product platform in the oil and gas space. Our acquisition pipeline is healthy and we continue to aggressively and yet prudently seek acquisition candidates that meet both our strategic objectives and financial criteria.

We are fortunate to be in the position with a balance sheet where we can pursue acquisitions and make appropriate share repurchases should the opportunity present itself.

As we look to the first quarter, we are expecting modest growth in our commercial and industrial markets both in North America and China, and we expect the HVAC business to be flat to slightly up. Further we project more challenges -- more challenging conditions in India, Australia and with Milwaukee Gear.

On margin, as we explained, will have a 1 percentage point headwind in the Q1, but we do expect these challenges to be mostly behind us by the end of the second quarter.

And finally, we expect SG&A as a percentage of sales to improve in the first quarter compared to prior year.

Now before we go to questions, we understand there are a lot of moving parts here in both the fourth and first quarters. But we are convinced that we are on the right path. We will anniversary the HVAC customer losses we had in 2013. We believe our simplification efforts will pay off, and we expect that our new products will drive organic growth. All these efforts point to margin improvement, and we expect to continue to acquire businesses both in current and adjacent product platforms.

We will now take your questions.

(Operator Instructions)

First question comes from Mike Halloran of Robert Baird.

Good morning, guys.

Good morning, Mike.

I just want to dig in on the margin comments and how you guys except those to lay out through the year assuming the revenue expectations come in largely as you guys expect.

So obviously the purchase accounting stuff, that will be behind you when you get past the first quarter here as will the Unico Milwaukee Gear commentary.

So when do you expect the operational efficiencies to start turning into a benefit for you guys? In other words the operational efficiencies go away, and then the gains from the restructuring efforts start layering in. Is that a 3Q event or does that start happening a little bit in 2Q?

I think that, you know, I think you mentioned, Mike, 3Q is probably the way to think about it. It could happen a little earlier but right now we're going to say it looks like 3Q we'll start to see the -- you know, the shift over during the quarter from getting the inefficiencies behind us and starting to realize the savings.

And then the -- the price-cost gap, obviously with the price increase you're expecting to normalize on that. What about things you haven't talked about? For instance, the IT side, I know you guys have had a little bit of spend increase there, maybe on the R&D engineering side. How do those costs look as we flex through the year as well there?

Well, you know, we are -- we have been and will continue to invest in IT, certainly through the end of 2015. We had some catch-up to do and in fact, we just -- we had a conversion just this past weekend, a pretty major one that went quite well so far so good, and we have a few more ahead of us, so we'll continue to do that.

You know, our goal by the end of 2015 is to have 75% of the revenues in the company on two IT platforms and we're heading towards that goal. You know, in -- as I had mentioned earlier, as we look at Q1, our SG&A on a quarter-to-quarter basis will be flat and as we look at it as a percentage basis we expect it to actually have been improved in the first quarter.

And when you think about the opportunities in the SG&A line to chip away from that as you work through the year, is that the type of thing where that $125 million-ish kind of -- or the flattish year-over-year $123 million, $125 million kind of range, is that the thought process through the year or is there an expectation that as you start anniversaring some of these things and as some of the efficiency -- not efficiency, but as some of the restructuring initiatives come through maybe you can start chipping away at that, a little bit lower?

Well we certainly don't expect to be increasing that's for sure, but you know, in terms -- you know, I would say through 2014, you know, probably be flat with our first quarter.

Okay. That makes sense and then lastly, just on the 1% gross margin headwind, if I think about that in dollar terms, it sounds based on the prepared remarks that if I look at that 1% dollar gross margin headwind pressure that substantially all of that will go away by the end of the second quarter. Is that one way to think about it?

Yes, that's correct, Mike.

All right. Great, guys. Appreciate the time.

Thank you, Mike.

The next question comes from Christopher Glynn of Oppenheimer. Please go ahead.

Thanks. Good morning.

Good morning, Chris.

Hey, just wondering if you could give us some more color on the improvement you're seeing in the gas fracking outlook, just kind of parse that and any detail.

Well, you know, as we mentioned on the call, you know, it hasn't shown up in our orders yet, but there are a lot more activity -- quoting activity and inquiries but like I said nothing -- no substantial change in our order base.

Now, our Milwaukee Gear business has seen a little bit of improvement on the industrial side on a year-over-year basis but not yet on the fracking side. But we have a little bit of, you know, optimism there given the, you know, change in natural gas prices and some of the activity that's occurring in that space, but too soon to tell.

Okay. And then on the $0.12 tax benefit, it looks like, you know, some of the part to do with Mexico we'd call one time but the part related to the mix of profits is kind of a core organic thing, I think. Am I looking at that correctly?

Yes, Chris, that's really just a forecasting issue as we set our tax provision, but that's a smaller amount relative to the change in the Mexican tax code, which was the principal driver for that -- the change from the guidance.

Okay. And then in terms of the North American, really the HVAC markets from some of the other reports it looks like maybe low to double digits for the end market. Just wondering if we could just bridge from the five with formula pricing, lost customer, any other pieces?

I would say -- Chris, this is Jon. I would say that if you look at our fourth quarter performance, you know we pretty much saw I think what most others would expect to see from the market with mid- to high- single digit market growth.

We had the share dynamics -- the customer dynamics that we talked about with our second quarter earnings call last year that did impact our results in the fourth quarter, but as I mentioned to a lesser degree just because of the seasonality of the business.

And then the price versus cost pressure that we saw overall in the business certainly did impact HVAC as well for the quarter. So those would be the three -- the three main factors.

Okay. Great. Thank you.

Thank you.

Next question comes from Josh Pokrzywinski of MKM Partners. Please go ahead.

Hi, good morning, guys.

Good morning, Josh.

If I could just follow up on the on the 1Q guidance. Any issue from weather adversely impacting the business, due to shutdowns or any, you know, any branch closures on the distribution side?

Josh, good morning, this is Jon. I would say that certainly the first week of January, -- I'd say the first one to two weeks of January the weather probably had an impact on our business probably three to four days in terms of just overall shipment performance to customers.

Some of that you would say will come -- you know, comes back over time. Some of it could be -- could be a loss, you know, depending on the -- you know, the particular business that we're talking about.

I think our business has recovered pretty well though, coming through the month of January, clearly not out of it completely yet because we've continued to have harsh weather across the Midwest. But that's how I would characterize it in terms of impact to us.

Some benefit on the aftermarket side of the heating side of the business, but, you know, otherwise some challenges with customers' operations and transportation logistics.

I just saw an update on that this morning, Jon, and I do know that our transportation suppliers are about three days behind, and -- even now, and given some of the weather that they're facing and they're digging out, so I don't believe it's had an impact on our revenues but it certainly has had an impact on some of our deliveries.

Okay. That's helpful.

And then, I guess on the other side of weather some of the OEMs in HVAC talked about perhaps a little bit of a pull forward in 4Q. Anything you guys saw on your end? Did that help the quarter at all, and are you seeing, you know, the back side of that in 1Q?

Josh, I would say that we did hear some of that from the -- from the industry about, you know, questioning whether there was a pull forward or not. Hard for me really to say we saw that in our business. We had some mixed reports from customers about the hearty performance versus the OEM shipments, so we don't really feel like there was much of a pull forward in Q4 that will have an adverse impact in Q1.

As we come into the first quarter, most of our customers are talking about low- to mid-single digit market growth in resi-HVAC. As I mentioned we're seeing some nice strength in furnaces especially in the aftermarket side of our business related to the cold weather, so that's how I would summarize it.

Okay. That's helpful. And then just one last question on -- on the capital allocation. You guys mentioned buyback as a possibility, and I understand that, you know, it's a holistic comment that you're making and maybe not overemphasizing buyback over anything else.

But how should we interpret that in terms of your guys' view on the landscape, and maybe kind of doing a Monday morning quarterback on the capital raise in 2012 and the ability to identify -- identify properties?

Well, Josh this is Chuck. As Mark said, the acquisition pipeline is still strong, and we believe that that can create stronger long term shareholder value than a share repurchase, but we continue to evaluate that. And as we communicated, the Board reauthorized the 3 million share commitment. So it's just one of the four ways that we intend to deploy our capital going forward to drive improved shareholder value.

But I guess where I'm going with this is, is there -- is there a time frame at which, you know, you guys say, okay, we haven't gotten enough done and look more seriously at buyback, or is it just kind of always on the table as an option and, you know, you'll continue to prosecute deals first.

Yes, I think it's always on the table as an option and you know, our bias will be to continue to put the money to work. And you know, our pipeline is healthy, and obviously we just closed on two acquisitions in the last, you know, three and a half months so you kind of know where our head's at. So it's always -- we're always going to evaluate it on a month-to-month basis.

All right. That's helpful. Thank you.

Thank you, Josh.

Thank you, Josh.

The next question comes from Jeff Hammond of KeyBanc Capital Markets. Please go ahead.

Hey, guys.

Good morning, Jeff.

Chuck, I'm wondering if you could bucket the three head winds that, you know, that come up with the point of gross margin headwind and I guess most particularly the inefficiencies?

Jeff, we don't have that kind of detail to discuss today. I think the best way to say it is that the comps against prior year would not be as significant as the operational inefficiencies and the pressure on price versus cost.

But as we said, we're working every day on that. We're implementing the price increase, and we would expect the operating inefficiencies to abate in the second half.

Okay. So maybe just to go through you know, some of the cost -- so can we talk about what your incremental savings are in 2014 from EPC and what you actually capture from simplification in 2014?

Sure, Jeff. Going back to the -- the original EPC synergy benefits, there was a final incremental $8 million of savings in 2014, and that was certainly a contributor to our fourth quarter gross margin performance relative to the prior year.

Savings on the simplification, you know, we're kind of netting them against some of the -- the costs that we're experiencing in 2014, a total amount as it goes through 2015 would be $28 million. The current initiatives we're working on would be the closure of the Springfield plant which will generate $15 million in savings beginning in 2015.

Right, so I guess what I'm asking is of this $28 million identified, what -- what -- how much do you get in 2014 and how much do you get in 2015?

The -- as Chuck mentioned, you know, you have the $8 million in synergy savings from the EPC synergies and then some portion -- we don't have the $28 million broken down by year but some portion of the $28 million from the simplification benefit is going to hit in the back half of the year.

The biggest chunk of that is going to be some portion of the $15 million savings from the Springfield, but I don't have the exact amount here, Jeff. We can go work on that and try to come up with a better answer.

Okay.

And then I guess it sounds like there's more to go on simplification. So is there anything you can do, you know, as you take these additional steps to prevent some of these operational efficiencies? Because it seems like you were talking to us about -- a lot about the savings and now we're kind of surprised with these -- you know, with these inefficiencies.

I mean should we expect some of these inefficiencies as we do other, you know, other activities or do we see better execution?

Well, you know, in the case of, you know, Springfield, I mean the -- that's a pretty difficult and tough move, and you know, for something like that, you know, we typically, you know, we'll experience something like that. We had a similar experience in the Juarez move where we were moving five different facilities, so it's not unusual in my experience to have some of that.

You know, in the Acuna situation, you know these two facilities are located right next to each other. We're going to employ the same people. We're going to use the same equipment. We wouldn't expect, you know the same degree of operational inefficiencies in that move. It's going to be different on a case by case basis depending on the complexity and size of the move.

Okay.

And then just final thing, you know back to buyback you mentioned it still seems like it's much lower on the list, but if you look at your peer group and a significant number of your peers have seen significant multiple expansion it feels like deals out in the space are running at much higher multiples. So why is now not the time, you know, to be more opportunistic with buyback?

Well, Jeff, I think it gets to our evaluation of the acquisition pipeline and the opportunities that we see, and we still believe that the best utilization of our capital is going to be in that area. That would be our preference as Mark said.

If the dynamics and the valuations and the acquisition market and the pipeline slows down, then I think we would, as we said, consider the share repurchase opportunities.

It just seems like if you take your free cash flow this year, your free cash flow last year, the capital raise, you have room for both and your stock here has been a big underperformer. So I don't understand why you don't have room for both.

Well, I think we did say we do have room for both. We're pursuing both of those initiatives.

Okay.

It's really not a binary decision.

That's helpful. Thanks, guys.

Thank you, Jeff.

The next question comes from Mark Douglass of Longbow Research. Please go ahead.

Hi. Good morning, gentlemen.

Good morning, Mark.

Mark, you've mentioned the price increase is 3.4%?

Yes.

So I assume that's a blended average. Is it going to be a little higher in commercial industrial, lower HVAC, or can you parse that out a little bit more?

Well, it's different in different parts of the world, but I would say generally in North America 3.4% was, you know, kind of the number we went with in North America.

Oh, that is just the North American number?

Yes. I mean, there's different things happening in different economies. With the currency fluctuation for instance, in one account or the other -- I'm sorry one country or the other -- you may, you know, you may have different price increases, but in North America it's 3.4%.

And the other thing I'll mention is you may recall that roughly 30% of our revenues are to customers that participate in two-way material price formulas with us. We're -- you know, their pricing is dependent on commodities and so those customers are obviously -- would not be impacted by this price increase.

Right, right. Okay. And then price -- pricing in your international sales, assume it's relatively stable?

No, I -- you know, in India, as an example, is experiencing inflation. South Africa, as an example, is experiencing big inflation. Those price increases could be substantial. It all depends on the different economies we're participating in.

So is it fair to say that you expect by 2Q to be price cost, neutral, is that fair?

Yes, that's fair.

Okay. Okay. Helpful.

And then on Hy-Bon, first, how much was paid? And then, and secondly when the big jump in EPS accretion from 2014 to 2015, is that integration costs in 2014 rolling off or is that savings generated in 2015 or can you discuss that a little bit?

We won't be disclosing the price that we paid for Hy-Bon relative to the change in earnings year to year. A big chunk of that is going to be related to purchase accounting. The first rollover and the second piece of it is going to be related to the growth that the business is seeing.

Okay. But that purchase accounting, I think you said it's what $0.02 next quarter all in? Is the majority Hy-Bon?

Yes. Yes, Mark, the majority of it's Hy-Bon. There's still a little bit will have Cemp that will flow through in the first quarter.

Okay. The $0.03 to $0.06 on Hy-Bon includes the purchase accounting costs? So we're talking --.

Yes.

-- closer to $0.05 to $0.07 x or maybe --?

Yes, probably more $0.04 to $0.06. There's almost a penny of it from Cemp and the rest would be Hy-Bon. And the EPS accretion numbers that we refer to would be net of those costs for the full year 2014.

Okay.

And final question on Milwaukee Gear, you mention it still faces tough comps. But I remember in 1Q 2013 with a double digit decline in mechanical, part of that was justified as a slow down in fracking that you had already been seeing in 1Q. Was it just beginning then or can you discuss why it's still a tough year-over-year comp?

Mark this is Jon, what you said is correct. It was beginning but it was just beginning in Q1, so it had some impact on our mechanical performance, not to the same degree we saw then through the second quarter and on through 2013 and we will see now in Q1 of 2014. And then we expect those more difficult comps to be behind us as we exit the first quarter.

Okay. Thank you.

Thanks, Mark.

The next question comes from Walter Liptak of Global Hunter Securities. Please go ahead.

Hi. Thanks. Just wanted to ask a quick one on the pricing. When was the price increase announced and any color on, you know, like the effective date or, you know, how it's been accepted by customers?

It was announced in December of this past year at the early part of December, and it's to take effect in -- you know, typically January, February time frame of the first quarter. And it's, you know, probably too soon to comment on, you know, how it's being accepted or anything like that at this point.

Okay. Okay. Fair enough.

And then, you know, your commentary on the C&I business being, you know, stable, you know, and kind of the outlook I think is -- sounds, you know, pretty decent, you know, going into 2014. You know, I wonder if you could just comment or provide a little bit more color. I know you said distributors were down, machinery was down. Are you seeing indications that those might be picking up as the year goes on?

Well, you know, we are seeing a little bit of improvement and a little stronger improvement on the commercial side versus the industrial side overall. And, you know, the -- we -- as we came out of the fourth quarter, you know, orders appeared slightly better than they were going into the first quarter than they were going into the fourth quarter.

And while I would add that the comment on the stable order performance, you know, we held it at a decent level all through the quarter. We didn't see a drop, you know, that maybe would be related to -- other than distribution falling a little bit but that was a pretty small drop on a year-over-year basis. And then as we entered into the first quarter, that kind of stable order performance just continued.

Okay. Got it.

And if we can move over to China, you know, we're getting mixed data points out of there, but it sounds like your business is pretty strong. I wonder if you could talk a little bit about the sectors or you know what you're seeing out of China in more detail.

We saw -- we saw -- we have seen two quarters now of good year-over-year performance in our China business, and fourth quarter was, as we mentioned on the call, mentioned earlier a strong quarter for our China businesses.

I would say in terms of the products both commercial and industrial motors as well as power generation, similar to what we saw in the third quarter performance. As you said there is -- there is a lot of news out right now on China. So far we're -- our business is looking okay from an order standpoint. But as you know it changes -- it can change very quickly in China.

Okay. Great. Okay thank you.

Thanks, Walt.

The next question comes from Julian Mitchell from Credit Suisse.

Hi, it's John [Schweiz] for Julian.

Good morning, John.

I was just wondering if you could give a little more color just around kind of North American HVAC. It seems like the trend is significantly improving. You had about 5% growth this quarter and that's also kind of excluding, you know not concerning the customer impact.

You know, if you kind of add that back in it seems like you're probably growing in that area around high single digit. Should we expect that kind of strength in residential to continue into 2014?

Well, I'd say, John, a couple of things. You know, what we saw in the fourth quarter certainly we felt like the overall market did perform well in the fourth quarter for resi-HVAC.

In addition that, we did see pretty good strength on the furnace side of the business, likely related to the extreme cold weather throughout much of the country. We had a little bit of headwinds on price. Mix was probably slightly positive but not a strong contributor to our performance in the quarter, and again, that mix was likely driven by the cold weather and the demand for furnaces, especially high efficiency gas furnaces.

So -- and then the share dynamics that we had -- had previously talked about, no surprise there from our view in the fourth quarter other than the fact it's the seasonal low for HVAC So, you know, we expect to see that kind of impact in Q -- you know, with the same expectation that we've been talking about before through Q1 and Q2. No change there.

Now, the market, how will the market perform in 2014 compared to what we saw in the fourth quarter, you know, the projections from our customers would not be as -- quite as robust as what we saw in the fourth quarter but most are saying low- to mid-single digit growth in the market.

So that should be a positive tailwind in that business, and we've got to get through the first half of the customer dynamics. And as we've consistently said, we expect to be operating with the market in the third quarter and on.

That's very helpful.

And then just on the -- on the high efficiency side, as a percentage of sales it seems like that's, you know, continuing to improve. Should we expect further improvement kind of in the share of sales from high efficiency? And then just as a second part to that, you know, will that contribute positively to margin overall?

That clearly has been our goal to drive high efficiency sales. Some of the fourth quarter performance, again, was related to a stronger mix HVAC that Jon mentioned related to our furnace -- related to furnace demand in the quarter. But clearly that is what we're driving to. That's, you know, a 75% of all of our new products are high efficiency kinds of products and so that is -- that is the goal.

Thanks a lot.

Thanks, John.

The next question comes from Nigel Coe of Morgan Stanley. Please go ahead.

This is Drew in for Nigel.

Just a quick question. You had mentioned a little bit on the raw materials, seeing a little bit of volatility in copper and I think you said some headwinds in steel Just wondering if you could give your outlook for 2014 and then what you're hedged?

First of all, obviously copper is pretty volatile lately. It was up a little bit there in the last few months and then kind of came down a little bit. And then steel, we did see -- we are seeing some headwinds on steel going into 2014.

Relative to hedge, we do hedge copper and aluminum, and we're typically hedged out five quarters on a declining stair step basis.

Okay. Great. Thanks.

Yep.

And due to time constraints the last question for today will come from Liam Burke of Janney Capital Markets. Please go ahead.

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

Good morning, Liam.

Mark, could we get a little more color on the commercial market? It looks like there was some lift there, orders were pretty consistent throughout the quarter. Is that retrofit? Are you seeing any lift in the new build side of that market?

Well, I mean certainly retrofit continues to be an area of excitement for us. You know, the -- to have the opportunity to supply both our small fans and blower systems into the commercial refrigeration side and now more recently our kind of -- our larger HVAC residential motors and pool motors into the residential side.

We get the opportunity to go into facilities. We just had one in L.A. where we're going to retrofit a Hilton hotel in L.A. with our residential HVAC motors and we're seeing more and more of that, so that's pretty exciting.

We, you know, often don't really know where the product ends up, so it's tough for us to say whether it went into new build or retrofit, but there is certainly a loft excitement out there for us on retro fit.

Great. Thank you.

Chuck, working capital, specifically receivables in inventory were up a tick from a year ago. Is there timing? Is it the mix of international business or --?

I think it's probably a combination of those two Liam, and typically with the plant move we're building some inventory buffer, safety stock, and I think that would account for some of the increase in inventory.

Great. Thank you.

Thank you, Liam.

Thanks for your continued interest in the company, we appreciate all the questions. Have a good day.

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