Regal Rexnord Corp (RRX) 2016 Q4 法說會逐字稿

Good morning and welcome to the Regal Beloit fourth-quarter 2016 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Rob Cherry, Vice President of Investor Relations. Please go ahead.

Thank you operator. Good welcome to Regal Beloit's fourth-quarter 2016 earnings conference call. Joining me today are: Mark Gliebe, Chairman and Chief Executive Officer; Jon Schlemmer, Chief Operating Officer; and Chuck Hinrichs, Vice President and Chief Financial Officer. Before turning the 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 there are inherent difficulties in predicting future results and actual results could differ material through from those expressed or implied in forward-looking statements. For a list of factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our SEC filings.

On slide 3 we state that we are presenting certain non-GAAP financial measures in this presentation. We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors to understand and compare our operating results across accounting periods and in the same manner as management. Please read this side for information regarding these non-GAAP financial measures and please see the appendix for reconciliations of these measures to the most comparable measures in accordance with GAAP. Now I will turn the call over to Mark.

Thanks, Rob. Welcome everyone and thank you for joining our fourth-quarter call and thank for your interest in Regal. We will follow our typical agenda. I'll make a few opening comments, Chuck will give a financial update, Jon will provide color on markets, operations and the performance of our three segments, and then after that I'll summarize and we'll move to Q&A.

Our fourth-quarter results were generally in line with our expectations. We expected that organic growth would be flat to slightly down and we would improve sequentially. Organic growth overall was negative 7/10 of a percent for the quarter and we did improve sequentially for the fourth quarter in a row. At a segment level, organic growth in the climate segment was up 3% with strong sales in residential HVAC, partially offset by weakness in the Middle East.

In the C&I segment, overall organic growth was slightly positive with weaker sales in oil and gas offset by organic growth in most other end-markets. Finally, in the PTS segment, organic sales were down 7.1% for the quarter driven mostly by renewable energy demand patterns and weakness in oil and gas end-markets.

From an operating profit perspective, it was a better quarter than it appeared. As you may recall at the time of our fourth-quarter guidance, we specifically excluded any LIFO impact. Soon after, following the election, copper and steel prices spiked. The actual LIFO expense in the fourth quarter was $14.5 million. We were able to offset the impact of the LIFO expense with operational improvements and cost controls.

Focusing just on adjusted operating margin, adjusted margins would have been 11.4% in the fourth quarter, excluding the LIFO expense. Overall with sales essentially flat, we felt pretty good about our margin performance in the quarter.

We had another good quarter in free cash flow with free cash flow coming in at 202% of net income. Part of the way we accomplished these results was by reducing working capital. For the quarter, we again improved cash-cycle days with inventory reductions of an additional $25 million. With the strong free cash flow, we paid down a healthy $100 million of debt in the quarter.

As we look forward to 2017, we expect that a number of the top-line headwinds that held us back in 2016 will ease as we move through the year. First, given the recent commodity inflation, we expect the two-way material price formulas to be a tailwind to sales. Next, we expect to anniversary last year's declines in the Middle East as we enter the second quarter and in oil and gas as we enter the third quarter. Further, our residential and commercial HVAC customers are predicting mid single-digit growth rates for 2017.

The biggest top-line headwind we expect for 2017 will be the strong dollar, which will continue to be a drag on our customers' ability to export. Overall for the year, we're expecting slight positive organic growth.

Given the success of our simplification efforts, we expect that the increase in revenues will deliver strong incremental margins. We are expecting price cost pressures driven by materials inflation, especially in the first half as the two-way material price formulas take full effect as we enter the third quarter. Overall our 2017 guidance reflects total year adjusted EPS of $4.50 to $4.90, up 6% at the midpoint over 2016. I will now turn it over to Chuck.

Thank you, Mark and good morning, everyone. Sales in the fourth quarter, 2016 were $758.1 million, down 2% from the prior year. Foreign currency translation in the quarter was a negative 0.7%. The divestiture of the Mastergear business reduced sales by $4.7 million or 0.6%. Therefore, organic sales declined 0.7% from the prior year, in line with our earlier guidance for the fourth quarter.

Our adjusted operating profit margin in the fourth quarter was 9.5%. But both this quarter and the prior-year quarter had significant LIFO impacts. The fourth quarter of 2016 had a LIFO expense of $14.5 million and the prior year quarter had a $15.3 million LIFO benefit. Excluding the LIFO impact from both periods, the adjusted operating margin for the fourth quarter of 2016 was 11.4%, which compares favorably to the 8.3% in the prior year. The higher-than-expected LIFO expense was offset by operational improvements and cost control actions, which reduced both cost of goods sold and SG&A expenses in the quarter.

Let me explain the LIFO expense in the fourth quarter of 2016. Our earlier guidance did not include any LIFO impact, which was not forecasted to be a material amount. Following the US election, commodity prices spiked up, with steel prices increasing 13% and copper prices increasing 20%. This spike in commodity prices drove the higher LIFO expense.

Our fourth-quarter 2016 earnings per share reported on a GAAP basis were $1.01. There were two adjustments to the GAAP EPS in the fourth quarter; the first adjustment was $2.6 million or $0.04 per share of restructuring and related costs for projects in all three reporting segments. The second adjustment was the $500,000 after-tax gain or $0.01 per share from the gain on the sale of assets. Net of these adjustments, the adjusted EPS for the fourth quarter was $1.04 per share, in line with our earlier guidance for the quarter.

Now I will summarize a few key financial metrics. Our capital expenditures were $19 million in the fourth quarter and $65 million for the full-year 2016. From a restructuring standpoint, restructuring expenses were $2.6 million in the fourth quarter and $6.8 million for the full-year 2016.

In the upper right quadrant we show our effective tax rate information. The ETR in the fourth quarter was 17%. The lower ETR was driven by the LIFO expense in the US, which impacted our mix of earnings and lowered the ETR in the quarter.

In the lower left quadrant, we provide data on our fourth-quarter 2016 balance sheet. Our total debt was $1.4 billion and our net debt was $1.1 billion. In the fourth quarter, we achieved strong debt reduction, repaying $100 million of debt. For the full-year 2016, we reduced our total debt by $315 million. Our strong debt reduction in 2016 reduced our total debt-to-EBITDA ratio to 3.0 at year end.

In the lower right quadrant, we present information on our free cash flow. We generated $92 million of free cash flow in the fourth quarter, representing 202% of net income for the quarter. For the full-year 2016, we generated $374 million of free cash flow, representing 184% of net income. We had a very strong quarter and a record year for cash flow generation. The full-year 2017 free cash flow benefited from the $114 million of inventory reduction.

Now I will review our full-year 2017 earnings guidance. Our guidance for 2017 reflects our expectation that organic sales will grow slightly with momentum improving in the second half of 2017. We expect FX translation to continue to be a headwind to our total sales of 1% to 1.5% in 2017.

Our adjusted operating margin is expected to improve in 2017 as we benefit from the success of our simplification initiative and the increase in sales. Our full-year 2017 GAAP EPS guidance is $4.35 to $4.75. On an adjusted-EPS basis, our 2017 guidance is $4.50 to $4.90. The adjustments to convert the GAAP EPS to the adjusted EPS are restructuring costs of $9 million or $0.15 per share.

I'll comment on the key assumptions in our 2017 guidance. We expect our capital expenditures to be approximately $75 million. Regarding our free cash flow in 2017, as always, we target our free cash flow to be greater than 100% of net income and we expect to again be successful in 2017. We will continue to use a portion of our free cash flow to reduce our debt and expect our debt reduction in 2017 to be greater than $200 million.

As we reduce our debt in 2017, our interest expense will also decrease. We estimate our net interest expense in 2017 to be approximately $47 million.

And our last assumption is that we expect our tax ETR to be 23% in 2017, excluding any discrete tax items that may occur. Obviously this does not include any changes in the US tax code in 2017. Now I'll turn the call over to Jon Schlemmer.

Thanks Chuck and good morning, everyone. Let's first walk through each of the segments.

In commercial and industrial systems, sales were $369 million. Organic sales turned positive and were up slightly from prior year. This was in line with our expectations and represents the third consecutive quarter of improving organic growth rates.

In the quarter, we experienced strength in Asia and Europe as well as strength in data centers and the North America pump end-market. These strengths were partially offset by weakness in the oil and gas and power generation end-markets. Price was slightly negative in the quarter, however, prices did increase sequentially due to the two-way material price formulas.

Adjusted operating margin was 5.8% of sales, down from prior year due to the impact of the $8.4 million LIFO expense. Excluding the impact of LIFO from both periods, adjusted operating margins increased by approximately 50 basis points in the quarter.

Last week, Regal participated in the AHR Expo in Las Vegas. On the slide you can see one of the highlights at the show for us was the launch of our UlteMAX product, an axial industrial motor and a Regal-designed fully integrated electronic control. As you can see from the picture, the exciting part of this new technology is the form factor. The UlteMAX motor is only about five inches wide, while a standard motor with the same horsepower is approximately 15 inches wide. That's a tremendous difference.

The key benefits are a smaller, more compact footprint, much lower weight, and higher efficiency. We had tremendous interest at the show and created many new leads. We're just now launching the product and we're excited about the organic growth we will see from this new platform.

In climate solutions, sales were $215 million, organic sales turned and were up 3% from prior year. This represents the fourth consecutive quarter of improving organic growth rates.

We had low double-digit sales strength in our North America residential HVAC business, partially offset by continued headwinds in the Middle East and the non-HVAC North America end-markets. Similar to C&I, price from the two-way material price formulas remained a headwind in the quarter, but improved sequentially from the third quarter.

Adjusted operating margin was 12.8% of sales. Down 40 basis points from prior year, but up substantially excluding the impact of LIFO. The underlying business performed well benefiting from the increased sales volume, slightly improved mix and the simplification efforts in cost controls.

At the AHR Expo, for those of you who attended, you saw our new expanded lineup of DEC Star blower products designed to help our HVAC customers meet the increasing efficiency targets. DEC Star is a high efficiency system, integrating an axial motor, a Regal-designed electronic control and our latest high efficiency air moving technology. We are bringing a full suite of energy efficient products to our customers as they work to meet the upcoming fan energy rating, or FER requirements for 2019. It was nice to see that five of our customers were displaying new products using our new DEC Star platform.

The picture on the far right shows one of our customer's air handling units where they were highlighting the DEC Star system. These customers are using our new technology to help solve problems related to noise, space and energy efficiency.

Sales in power transmission solutions were approximately $174 million with organic sales down 7% versus prior year. The decline was driven primarily by lower demand in the renewable energy and the oil and gas end-markets.

The organic growth rate, while still down mid single digits, improved as compared to organic growth rates of the second and third quarters. Further, the order rates in this segment continued to improve and we expect another quarter of sequential organic growth rate movement as we move into 2017.

Adjusted operating margins were 13.3% of sales, benefiting from the cost controls, synergies and favorable timing of some SG&A expenses.

On the right side of the slide, you will see the Browning Toolbox Technician app that we rolled out at the AHR Expo last week with a number of new features. One of the new features is a motor cross-reference tool that allows the contractor to search and find one of our Marathon motors. This app is utilized by thousands of HVAC contractors to select the appropriate Browning products. By adding the motor cross-reference capability, we're leveraging our Browning brand to cross-sell Marathon motors.

We continued our focus on simplification in the fourth quarter with three new announcements. First, we announced the consolidation and closure of our smaller, Monterey, Mexico HVAC facility into our existing HVAC manufacturing footprint. Second, we announced the consolidation of two of our China-based small motor factors and finally we announced the consolidation of two India large motor facilities.

The combined restructuring cost for these three programs are expected to be approximately $7 million. $800,000 was expensed in the fourth quarter and the remainder will be spent in 2017. All three of these programs are underway and we expect all of the programs to be completed by the end of the fourth quarter of 2017. We'll begin to realize the savings from these projects in the second half of 2017 with the majority of the benefits impacting 2018. Pay back on these programs will be less than two years.

We're convinced that our Performance Excellence program is having a significant impact on our ability to exceed the customers' expectations. Performance Excellence is part of Regal's business system and is the underlying framework that drives our operations to continuously improve. In 2016, across the Company, we increased on-time deliveries by two full percentage points and improved deliver quality by 38%.

We received more good news from our customers during the quarter. We've received two more awards from customers recognizing our performance around quality, delivery and innovation. That makes five awards that we have received in the last six months from some of our largest customers. The picture on the right shows our team receiving a continuous improvement award just a few weeks ago from one of our largest and most demanding customers at their Annual Supplier Event.

At the event, our customer recognized our team for improvements in service, engaging in joint problem solving efforts, bringing them innovation, and our commitment to their team at all levels in the organization. Performance Excellence is building a growth foundation by helping us to grow with existing customers and to win new customers. I'll now turn the call back over to Mark.

Thanks Jon, now before we go to Q&A, I would like to do three things; first I'll address the proposed border adjustability tax. Second I will briefly summarize our fourth-quarter performance and third, I'll summarize our total-year performance.

With regards to the border adjustability tax under consideration, as you all know this is a dynamic situation and there is still a lot unknown. However, we thought we would explain our view at this time.

We believe there are three key considerations. The first consideration is the fact that Regal's production based in Mexico is 35% to 40% of our total production and we ship those products to customers in the US, Mexico, Canada, Europe, the Middle East, and other countries. Second, a significant portion, greater than 50%, of the material used in that production is US based. It's not clear how domestic content will be handled in the regulations.

And finally, we believe the critical question in all of this, is competitiveness. We have looked at the manufacturing footprint of our electric motor competitors and most of our competitors produce their products outside of the United States. There are still many unknowns related to this potential legislation and we will share more with you as we learn.

Now, onto the fourth quarter review. Our performance was in line with our expectations. Sales were down slightly with organic growth in climate and C&I offset by slower markets in PTS. Margins were relatively strong in the quarter, however they were masked by a $14 million LIFO expense. We were able to offset the LIFO impact with stronger operational performance. Our cash flow to net income was 202% and we used the free cash flow to pay down $100 million in debt.

Now I'll summarize our 2016 full-year performance. There is no question, we faced difficult market headwinds all year long. Oil and gas markets, the Middle East and two-way material price formulas were a drag on our top line for most of the year. The good news is that our organic growth rates improved for four sequential quarters and the organic growth rates in climate and C&I turned positive in the fourth quarter.

As you can see from the slide, the highlights for the year were: a 17-day reduction in cash cycle days; free cash flow of 148% to net income; a $350 million reduction of our debt; and total shareholder return of 20%. Behind this performance was an incredible amount of operational change that gives us momentum as we enter 2017. We continued to simplify the Company with 13 additional plant and product line transitions, three more warehouse consolidations and three more ERP conversions.

The well-timed simplification investments helped us through a year when we had top-line headwinds and promises to further pay back as our organic growth improves. And as we continued to simplify the Company, we also continued our investments in exciting new energy efficiency technology such as DEC Star and UlteMAX that we believe will pay dividends in the near future.

We also continued to invest in our performance for our customers, we again improved both our deliveries and quality. Our customers recognized our improvement performance with the highest ever customer survey scores and by rewarding us with five more quality and performance awards. The customer recognition is encouraging to us and bodes well for our future.

Before I close, please note Regal will host an Investor Day on March 10 in New York City. We will forward to seeing you all there.

We will now take your questions.

Our first question comes from Julian Mitchell with Credit Suisse. Please go ahead.

My first question would just be about you talk about price cost on the margins of the first half of this year. Give us a sense of how severe those are and what LIFO headwind are you dialing in for the first quarter?

I'll walk you through that and then perhaps Chuck or Jon want to add in. So you got to go back to the third quarter when we were starting to see a turn in our material price formulas, as a result of the fact that steel had been starting to inflate in the third quarter. And so we had been predicting and forecasting that our material price formulas would start to turn and as Jon mentioned, they had. And then coming into, prior to the election, we announced one day before the election, we had all that baked into our view and we had commented that we were excluding any impact of LIFO in our views from that point on.

But copper and steel jumped as Chuck said 13% and 20% on copper and steel right after the election. So that was the $14.5 million LIFO expense that we saw in the quarter.

Now, we'll start to see that impact our costs in the first half. But there's a lag to the timing of the material price formulas kicking in, so we'll start to see the full benefit of the material price formulas on that inflation occur in the third, beginning in the third quarter. And then carrying on for some time after that.

So that addresses a third of the Company in terms of the rest of the Company that's not impacted by material price formulas. We have a history of being able to offset inflation with appropriate pricing and we believe we'll be able to do that. So Chuck, do you have anything else you want to add to that?

Julian, just specifically about the LIFO impact in 2017, we have that in our guidance. We don't have any specific LIFO impact, but the higher inflation that we are entering the year is built into our guidance.

Understood. And thank you and then just my follow up would be around operating expenses. You had a very, very big reduction in OpEx year on year in the fourth quarter, a decent reduction in OpEx for 2016 as a whole. Should we expect that OpEx or SG&A line again to come down quite a bit in 2017? And were there any one-time factors in that SG&A drop in Q4?

Good question, Julian. In the fourth quarter of the prior year, you would adjust out the Venezuelan write off and the gain in asset sales that we had. So comparing that total of a $9.1 million reduction, year over year we've got about a $22 million reduction in SG&A. $10 million of that was lower compensation and benefits, but $5 million of that was foreign currency translation on some of our balance sheet and P&L items that run through SG&A.

So you wouldn't necessarily count on that. When you look at the full-year number, again, you've got to adjust out some of the larger entries in the prior year, and the base would then be reduced by, again, good control over compensation and benefits. And I think you would expect to see going forward that we would see some increase in SG&A year over year, but you know our history, we've got a good control of controlling our SG&A and that's factored into our guidance for the year.

Great, thanks for the answers.

Thanks Julian.

The next question comes from Christopher Glenn from Oppenheimer. Please go ahead.

Thank you, good morning.

Good morning, Chris.

Hey, Mark, I appreciate the complexion, particularly on finished goods versus value add with respect to Mexico. Have you gained any perspective on what's gaining favor in terms of phase-in periods?

We are really are not hearing anything about that at this point, but as you know, it literally changes every single day, so we're going to stay quite close to it. We're analyzing all the different potential ways this could be implemented and we'll be ready. But like I said, I do think regardless of when it gets implemented or if it gets implemented it really does come down to a discussion of competitiveness for us. And so most, not all, but most of our competitors make the product outside the United States.

That makes sense. Just want to dive into the C&I segment, the trend you're seeing there in terms of first the oil and gas, how you describe your mix of early cycle sensitivity versus later lagging cycle? And then for power gen, if there are any indications there of that coming back and where that's landed from peak to trough?

I'll take a pass at it. If Jon wants to add any color he can. First on the oil and gas, I'll start off by saying two years ago, oil and gas was 8% of our revenues. Today it's as we exited 2016, it was roughly 4% of our revenues so -- and two-thirds of that being upstream for us.

So we have seen an increase in both inquiries and orders, so we have started to see some green shoots so that gives us a little bit of confidence about that market. But too soon to call it a dead trend, so, but we have seen a little bit of improvement there.

On the power gen side, we saw the market was down in the fourth quarter for us, and I don't know, Jon, you want to comment on --?

On power gen, we haven't seen the same thing we have seen in oil and gas. I would call it slightly up as we went through January, if we compare the January orders in power gen to the fourth quarter order rates but not a material change at this point. And we really haven't baked in any real market strength into our guidance for power gen for the year.

Okay. And any way to characterize -- oil and gas went 8% to 4%, can we take a similar look at power gen?

Over that period of time, I don't know. Roughly, I think we've characterized power gen to be $130 million business for the Company in total.

Okay. And we would have been down, Chris, double digits throughout the year in 2016 in that business.

Got it.

Thanks, Chris.

Thank you.

The next question comes from Mike Halloran with Baird. Please go ahead.

Good morning, guys.

Good morning, Mike.

So let's start on the PTS margins, could you just help talk about a run rate there that you think looks appropriate? Margins have jumped around 2Q through 4Q a little bit. How do you think about the margins as we go through the year here?

I understand your question. I think the way to think about it is take the third and fourth quarter and combine them, so look at the second half, and I think it will be a normalized rate of about 10% percent, so I think that's the way to think about it going forward.

At that sales level.

At that sales level right.

If you look at the sales level in our second half and look at the combined margins that's probably the way to think about our starting point as we enter 2017.

Yes, this particular business leverages hard on the way down and leverages nicely on the way up.

Okay. And second question on the inventory side what's your view on channel inventory as we enter the year?

So if you recall our comments back in the third quarter we thought the destocking was going to end in our PT distribution channel. As it turned out there was some late activity by a few of our customers who were destocking as they exited the year. So that actually has helped the front end of the start of 2017; customers are putting inventory back in place.

And I would say in climate our view is that inventory levels are not high at this point and especially through the distribution channel we would feel that if anything, inventory is probably a little light this the channel.

Great. Appreciate the time.

Thanks, Mike.

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

Thanks, good morning guys. I just want to dig in a few points already covered. The Mexican color is really helpful. Just wondering how much of production in Mexico is destined for the US directly and maybe any color on, in terms of how much goes into the Mexican supply chains of the OEMs and then how much of that is exported, ex-US?

Good questions. I would say the majority of our production out of Mexico is headed towards the US. We do supply as I had mentioned a number of other companies but the majority would go to the US. And I think your second question was how much of the product is actually going to OEMs.

Right.

Who are right in Mexico. I would say a sizable chunk of it. I don't have the answer off the top of my head. That's one I'll have to get for it you. It is a good question, but it is a sizable piece of the business that is, it goes right to our customers with operations in Mexico.

Okay. Great. You mentioned, I think Chuck mentioned, that comp was a $10 million piece of good news, 2016 versus 2015 on G&A and I think you also had a benefit in 2015 as well. I'm just wondering what's dialed into for 2017 in terms of comp maybe coming back in 2017 over 2016? And then perhaps given that you seem to be chasing more materials on the way up through the first half of the year, should we expect margins to be flat or even down in the first half of the year?

Well, this is Chuck, I'll start with the comp question. I think in terms of total SG&A, which is included in our guidance, I think the year-over-year decreases in comp and benefits have really been achieved in 2015 and 2016. And as we move in to 2017 where we expect to see some organic growth, I think the stability or stability with some slight inflation would be the trend. But again, we're still very good at controlling our SG&A.

Right, but my question was should we get a step up as you still have some bonuses in 2017.

It would not be a material amount.

Okay. And then just finally on the question on the raw material inflation and the impact on margins in the first half of the year.

Oh, no question, Nigel it's going to be a headwind in the first half of the year, and then our material price formula as we expect, there's a three to six month delay, it will start to get feathered in late second, early third quarter.

Okay. Thanks for the color.

Thanks, Nigel.

The next question comes from Scott Graham with BMO Capital Markets, please go ahead.

Good morning. Nice quarter, nice guidance, good job. The one thing I did want to ask, and again, the same question that several have asked on the raw materials inflation. Pricing is obviously going to be two-thirds of the hope is that we offset two-thirds of the business through pricing the inflation.

And with the spike that you saw, assuming that your people are hard at work formulating price strategies and increases and what have you, and I was just hoping you could give us, this is probably more a question for you Jon, some type of an indication as to how that's going, have any price increases been implemented, are they sticking? What's the game plan there and any type of traction data points would be helpful?

Yes, Scott, good morning, this is Jon. I'll give you my view on that, and certainly Mark or Chuck can add in. So I'm going to go back to 2016, if you look at 2016, we had a price-cost headwind for the full year and when we were in the other environment with deflation and a lot of that is due to the timing of some of the MPFs and also the impact that we had in price cost as we entered the year last year. We talked about that throughout last year.

What's built into our guidance for this year is we do expect a headwind as we have been talking about in price cost for 2017. Having more of an impact in the first half than in the second half because of the timing of the MPFs. For the non-MPF business, as Mark said, we have a history of being able to manage pricing to offset commodity inflation. I feel good about that entering 2017.

As Chuck mentioned earlier, we did take the latest inflation in copper and steel in the commodities as we exited 2016, factor that into our guidance for 2017 and we also factored in what we believe we can achieve on the pricing side. And I would say so far there's been no surprises there. We have been able to manage that well across a number of our businesses.

And you're right, Scott, that if the people are working real hard at it, it was probably too soon to say directly how it's going. It's a little early yet but you're right, everybody is working real hard at it.

I'm sure. Does this change the seasonality of earnings for 2017 a little bit more back-half oriented?

I would say it's not a big impact overall. You know, we have a lot of other things that we have some nice carryover in simplification that helps us in the first half as well that helps us offset challenges on price cost. As you think about the earnings profile, not a significant change.

Okay. Last question, on the end-markets, I know you touched on a number of different ones relative to the, each of the segments, could you re-sketch that for us. You are in a ton of different end-markets, which of the best ones right now, which are still the [laggers] and any charge at the margin? Just on your larger end-markets, if you can just sketch that out.

I'll start off and Jon will help me out. So again, we commented on resi and commercial HVAC, Jon talked about low double-digit growth in residential HVAC, and that was a help to us as we exited the fourth quarter. Commercial was positive. Commercial HVAC was positive, low-to-mid single digits.

China was improving in the quarter, in the fourth quarter and we're seeing improved ore rates out of China. On some small markets our pool distribution market was positive in the quarter, our pump market was positive in the quarter, however we were still feeling the effects of the Middle East on the top line, and still feeling the effects of oil and gas on the top line. Anything else I missed?

And those are the key ones.

Yes.

Well, one of your larger markets is that factory market, general industrial things that go through distribution, could you give us an idea of what you're seeing there?

Well, the good news is I would say we saw the third or fourth consecutive quarter of improved organic growth. And as we had commented overall, our C&I business was positive organic growth in the fourth quarter, but that general equipment market through the fourth quarter was relatively flat on a year-over-year basis. Order rates did show some improvement as we exited the year.

Very good. Thanks.

Thanks, Scott.

The next question comes from Jeffrey Hammond from KeyBanc. Please go ahead.

Good morning, guys.

Good morning, Jeff.

So just on climate, I just want to understand the margins a little bit better, 4Q to 4Q because if you pull out LIFO both years it seems like you have a 500, 600 basis point improvement in margins, versus the rest of the year where it seemed fairly stable. So what was really going on there ex-LIFO, how sustainable is that?

Jeff, this is Jon, I would say that one of the things -- two things that really benefited our margins in climate in the fourth quarter, one was that we mentioned that North America residential HVAC was up low double-digit sales growth. We had a lot of volume improvement in the business certainly in the quarter. We also had some pretty significant help from the simplification efforts that we have been working on over the last two years, and that starting to show up and help improve our margins in that business. So to me those would be two of the real big drivers in the quarter.

Okay. So simplification, that stuff should sustain, and then it really depends on the volume and the North America resi volume, is that really the market or is this a lot of the Dec Star starting to kick in?

I would say it's mostly market. We are getting revenue from DEC Star in some of the new products but the improvement we saw in the top line in the fourth quarter was more the market.

Okay. Great. And then Mark, again, good color on Mexico, can you just talk about should this border adjustability tax go in as discussed, what are you thinking about in terms of contingency plans or what changes or doesn't change?

Well the good thing is that we have this unique footprint that we're making our products. We have 14, I'm sorry, we have 21 factories in the United States still in this Company, so it's our home market. And so we're pretty good at making whatever we need to make right here in the US if we need to.

But we have a substantial footprint in Mexico with 15 factories and so we also make product in India, and China. We have a relative to our competition, we have a unique footprint and we have proven we can make the product anywhere we need to make it and serve our customer base. So we're going to need to be agile when it becomes clearer of which direction this is all going and we'll be ready.

And if I could just sneak one final one on oil and gas? Clearly smaller piece of the business now given the market, but two-thirds upstream, we're seeing some good things on land-base upstream, just -- and it sounds like your business is still weak, so what's the underlying tone, quoting activity, how close do you see us to being of at an inflection? Thanks.

So as I commented earlier, certainly our top line was weak in the fourth quarter. And we expect to have still a top-line pressures until we exit the second quarter. However, I did comment that we are starting to see better orders and better inquiry, better backlog of entries than we have. So that's encouraging to us in what has been a very tough market.

Thanks, Mark.

Thanks, Jeff.

The next question comes from Joshua Pokrzywinski with Buckingham Research Group. Please go ahead.

Hi, good morning, guys.

Good morning, Josh.

Just a follow up on some of the oil and gas commentary. Mark, what do you have in guidance for oil and gas, do you see that starting to rebound here maybe in the second half and could you just remind us what some of the lead times are for that? Upstream land-based product that led on the way down.

Josh, good morning, this is Jon. So we do have in our guidance growth expected in the latter half of the year. We're looking at the year, and I think the way you could size up oil and gas for us is we have in our forecast call it mid single-digit growth in the oil and gas end-markets for the Company; so off a pretty low base, so growth, that's the good news but off a pretty low base as we exited 2016.

If you think about some of our business, we have some business that is, I'd call it mid cycle. Those are the businesses where we're seeing the increase in inquiries and the increase in order activity right now.

Now, we have some other longer cycle businesses that we've yet to see the increase in order rates. And so we haven't really factored in for those businesses much strength even in the latter half, but in our -- the part of the business I would consider to be more mid cycle in nature we have definitely seen an increase in order activity and that's where the mid single-digit growth expectation is coming from.

And then just on the lead times for those? For what you have? Like could it come in the first half if order trends persist or is it really no chance of a turn before the second half?

I would say that we should think about a second-half impact. There could be some latter second-quarter activity if you think about lead times in some of these products if the order rates continue to look positive, but I think in general we should think about it as a second-half impact.

Got you. And just turning to the balance sheet, is there any plan to re-examine some of that bank debt for the PTS deal with interest rates moving up here?

Josh, this is Chuck, not really. We have increasing confidence in our ability to continue to generate strong cash flow, so I think we're comfortable with the variable-rate debt, particularly given the progress we made in 2016 in debt reduction. So no current refinancing plans on the table.

Got you. And then just one final one on the broader simplification or productivity initiatives. Can you remind us if you had to sum up everything that you got in 2016, what would that look like in the rear view mirror? And then how should we think about that same line item into 2017 as being similar or accelerating, so not a price cost discussion not a, not like a mix discussion?

Well, I think, if you look at the year clearly, we had margin rates down on a year-over-year basis for a full year. If, for a moment, if you exclude the LIFO impact in prior year and in 2016 and look at what happened to the underlying margins in the business with organic sales down 8% we would have been down something like 20 basis points on operating profit -- on adjusted op profit for the year.

And I think we would say that the major reason for those decrementals being much lighter than normal is the simplification and productivity efforts we have been working on the past several years in the Company. I don't have an impact number, Josh, for the dollar impact in the year, but clearly we are seeing those benefits in the underlying performance of the business.

Got you. All right, thanks for the color, guys.

Thanks, Josh.

The next question comes from Bhupender Bohra from Jefferies. Please go ahead.

Good morning, guys.

Good morning, Bhupender.

Hey, could you talk about the vitality index? I don't know if you have that internally, but I think Jon talked about the new products you introduced over the last few years. Give us a sense of like how is that contributing and if there's a number on the vitality index, I would like to know that, thank you.

Yes, so we haven't calculated it for a while. We do -- we are paying attention to it here and will be taking a closer look at it in 2017, and we'll look at it as new products that are five years older or less. But we don't have a number here for you right now, Bhupender. It could be something we could share in the future with you.

Thank you. Sorry, go ahead.

I was just going to say, Bhupender, in terms of the products that we talked about today and have talked about in our past calls, UlteMAX, we don't have revenue in the fourth quarter from UlteMAX. We're just now launching that product, but the lead creation that we had at AHR just last week for example, we are very excited about the level of customer interest on that product. We have a number of launch customers that we will sell the product to this year.

Now, it won't have a material impact on our revenue in 2017 for the C&I segment, but we do believe that product will have a material impact over the three- to five-year period. And DEC Star we're selling the product today. We have a number of customers, a number of customers that showed the product in their products at AHR.

We have a revenue stream today. It's not a, as I answered the question earlier, it's not the key driver on why our revenue was up in the fourth quarter. It is contributing though and it will contribute at a higher rate as we move through 2017 into 2018, especially with the FER requirements coming in 2019.

Got it. Now, just moving onto the next question here from the end-market perspective, I think you did mention power gen was weak and has been weak in 2016. Any color on why this market, you haven't seen much pick-up like in January sequentially from fourth quarter?

I don't know why we haven't seen a pick-up in January. I just know that looking at our order rates, they're up, I would call it up mid single digits from the order rates that we had in the fourth quarter. So while that's an improvement, it's only one month and this business is -- typically when I look at the business we have to look at it over more like a three month order period to really see a trend.

Okay. Is that business mostly US or international, any other color like whether the underlying factors within power gen are weak as we go into 2017 as some of the peer groups have been talking about?

Yes, most of the business we serve is we consider it to be -by power requirements so most of our products go into some stand-by power application; a hospital, for example, a little bit with data centers. And it is an international business so we have sales in Asia, for example, that is a significant -- a substantial portion of the business. So it's North America, Europe and Asia is the way to think about the revenue split.

All right. Got it. And lastly, just on the climate solution, if you remember in 2016, I think there was a revenue shift just because of the weather changes from second and third quarter. How should we think about climate solution in terms of sales in the first half versus the second half this year; will it be second quarter should be a bigger quarter in terms of climate solution this year?

Yes, so what happened in 2016 is interesting, both the cooling season and heating season had a similar dynamic. We started the cooling season rather weak, finished the cooling season rather strong and in fact some of the demand carried over into the third quarter that we would have typically seen in Q2 and we even had some of that carry into the early part of Q4. So I do think that is something that we'll see that in our comparisons in 2017.

Now, the heating season started off rather weak. If you recall on our last call, we talked about that the start of the heating season was pretty poor from a weather standpoint. Now it ended very strong in December. When you go back and look at January in terms of heating degree days, January hasn't been anything to celebrate, so our demand has been okay, has been solid, I would say, as we entered the year for climate in 2017. But when you think about the cooling season last year, we'll see that; we'll see some of that in our comparisons in the second and third quarter.

Got it. Thank you.

Thank you, Bhupender.

The next question comes from Sam Eisner with Goldman Sachs, please go ahead.

Thanks very much, and good morning, everyone.

Good morning, Sam.

Just a couple follow ups on the power transmission business you called out the Mastergear divestiture of about 2.5% and then also some synergies that were aiding the margin, any way to put some dollar numbers behind how much the divestiture as well as the synergies benefited that segment on an EBIT basis?

Sam, this is Chuck, in terms of the Mastergear we had given earlier a guidance that the sales were about $22 million and the OP profit was $4 million for a full year. So the amount that we're adjusting top line is pretty much along those same lines and in terms of achieving the synergies, we are on track to hitting our third year of the PTS synergies. You'll recall originally our timeline was four years. We brought that up and we have every confidence that we'll achieve that in 2017.

Got it. That's helpful. And then maybe on going through the simplification again, I recognize that you aren't giving any numbers here, but can you talk about the cadence of simplification throughout the course of the year? Was fourth quarter the strongest, just help us understand the phasing and then ultimately how that's going to impact 2017 as well.

I would say that in terms of the cadence, we had more impact in the second half than we did the first half in terms of some of the key programs and the timing of those programs. We have some nice carryover benefit that will come into 2017. That will help. That is the key in helping us offset the headwind on price cost.

And then you mentioned we have these other three programs that will help late in the year.

They'll kick in late. I think as we think about it, we're set up pretty nicely, I think, to see solid impact from simplification throughout the year in 2017.

Got it. And then maybe just lastly on free cash flow, obviously a very good job on inventory reduction with about $115 million, $114 million or so; what is the expectation entering next year regarding working capital and how that ultimately affects your greater than 100% free cash of net income?

Yes, so as Chuck mentioned, we certainly expect greater than 100% going into next year. No question about that. We got a little bit of help right at the end of the year to our $114 million number from the LIFO benefit, so -- then as we look at next year, we still expect to improve our total cash-cycle days as we go into the year. Certainly not at the same rate from an inventory perspective that we did in 2016.

Got it. Thanks so much.

Thanks, Sam.

The next question comes from Chris Dankert with Longbow Research. Please go ahead.

Good morning, guys, thanks for taking my question.

Good morning, Chris.

First off, you commented on some of the renewable energy impact on 4Q, could you just remind us how big is that business and have you seen any risk to that business just from maybe less federal regulation on energy efficiency and where the energy comes from?

So the renewable energy business we have been talking about for the last couple of years. In 2015 and 2016 was great new organic growth for us. We were selling into the solar panel space. And you know what, we've been working through the over the last couple of years and into 2017 is the choppiness of the order patterns.

This business is dependent on large projects and so one quarter you'll hear us talk about strength in that space and the next quarter you'll hear us talk about weakness in that space. But it has to do more overall with the big projects that our customers get in that space. So we feel great about it. It's been good for us and we think it will continue to grow. It's not clear to me from anything I have heard of so far whether or not that business will be impacted by any proposed legislation. I just don't know.

Got it. Yes, that's fair enough. And then looking at 2017 on the whole, were you calling out any additional program pruning just from lower margin stuff in 2017 at all?

Well, we're always looking, analyzing our businesses, and our SKUs, and our portfolio for appropriate pruning, so, yes, I would say that's always a potential.

But nothing explicit to call out at this point.

Not at this point.

Got you. And one last one if I could sneak it in here, as far as capital deployment you articulated what plan 2017 is, exiting the year looks like you will be below the 2.5-times leverage ratio you have been aiming for. Does that put M&A back on the table for 2018 then?

Chuck made the comment that we expect to pay down $200 million more in debt using a portion of our free cash flow to pay down debt, and as we enter the 2.5 debt-to-EBITDA ratios, we'll be analyzing other forms of capital deployment including share repurchases and M&A.

Got it. Thanks so much.

(Operator Instructions)

The next question comes from Robert McCarthy with Stifel, please go ahead.

Good morning, everyone.

Good morning, Rob.

Congratulations on a great quarter and solid free cash flow.

Thank you.

With that preamble, I'm going to go back to running the gauntlet of the border adjustability tax questions. In terms of your net importing exposure, I apologize I was switching between conference calls, but have you quantified the size of that? And just as a follow up is there certain end-markets or product lines or SKUs where you just think pricing could be an issue in terms of getting price if we get in a situation where border adjustability becomes a real issue in terms of passing along through price the inherent cost of tax or the tariff? Could you comment on that?

Yes, so from a US perspective, we are a net importer. We have not quantified it. It's probably in the range of 2-to-1. That's probably the way to think about it right now.

Imports versus exports.

Imports versus export. So in terms of pricing, it's way too soon to be thinking about that. I think our perspective is just to say will we be able to be competitive? And like I mentioned before most but not all, most of our competition makes the product outside the United States in our key markets, so that to us is the key thought.

And then the last question is just extending the line of questioning on M&A, obviously the focus in (inaudible) is debt pay down and restructuring, not restructuring but improving the core business that is you do have. But do you think this amount of legislative uncertainty or tax uncertainty, how do you think about managing that down the road in terms of trying to do the right deals on the M&A side; do you think that makes selection, strategic selection of assets more difficult?

Well, I think you're bringing up a good question. Certainly we're going to have to be analyzing what could the potential impacts be of any of this proposed legislation on anything that we might be interested in. So I think it's a fair question, and one that throw our diligence processes we'll be certainly taking a hard look at when we get to that point.

Thanks for taking my question. Appreciate it.

Thanks Rob.

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

Thanks for your interest in Regal and have a great day.

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