RBC Bearings Incorporated
Q3 2013 Earnings Call Transcript

Published: 29 Oct 2013

[Operator:]

Good morning, and welcome to the Regal Beloit Third Quarter 2013 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to John Perino, Vice President, Investor Relations. Please go ahead.

[John M. Perino:]

Thank you, Andrew. Good morning, and welcome to the Regal Beloit Third Quarter 2013 Earnings Conference Call. Joining me today are

[Mark J. Gliebe:]

Good morning, everyone, and thank you for joining our third quarter call and for your interest in Regal. We'll follow our normal agenda. I will make some opening comments. Chuck will give you a financial update. John will provide color on products, markets and operations. And then I'll summarize and we'll move to Q&A. For the third quarter, Regal delivered operating performance that was within our guidance and earnings at the top end of our guidance. Chuck will get into the details, but we had a tax benefit in the quarter that improved our earnings. From an operating standpoint, revenues in our North American commercial and industrial motor business were down slightly, offset by growth in our power generation business, where we experienced real strength in the data center end market. Our business in China performed better than expected with sales up high single-digit, while sales in India and Australia remain challenged. North American residential HVAC sales were down 3.6% and below the overall market performance. Our HVAC performance was driven mostly by the customer dynamics we discussed in Q1 but was also impacted by modestly lower pricing from our 2-way materials price formula. We did see strength in other residential markets outside of HVAC due to improved end market conditions and the new products we've introduced in the past few years. Our Mechanical business was down for the quarter with most of the decline coming from our exposure to hydraulic fracturing. Our simplification program continues to move forward, and we are seeing the benefits. During the quarter, we announced the closure of our Springfield, Missouri facility and the relocation of that production to our facilities in McAllen, Texas and Reynosa, Mexico. There's more to come from simplification, and John will discuss this during his comments. Margins were in line with our expectations, and we were pleased with our progress. Free cash flow for the quarter came in at 123% of net income. On a year-to-date basis, we are again achieving our goal of free cash flow to exceed net income. To spur growth, we launched 14 new products during the quarter after launching 37 new products in the first half. We remain focused on continuous innovation around energy efficiency to help drive organic growth and improve our margins. And finally, as you may have seen from our press release earlier this morning, yesterday we signed an agreement to acquire Cemp, a $35 million European-based manufacturer of specialty hazardous duty electric motors. The Cemp products have achieved the ATEX certification, which makes them salable in segments such as oil and gas and chemicals that require flameproof protection. Roughly 85% of Cemp sales are in the oil and gas and marine space. The Cemp products are a nice addition to our existing motor product offering. And we expect to be able to market these products through our American and Asian sales teams. As far as other acquisitions go, we continue to have a full pipeline, and we intend to continue to be a consistent and successful acquirer. As we look to the fourth quarter, our guidance reflects typical residential HVAC seasonality and end-market strength, somewhat offset by the customer dynamics we previously discussed. Further, we expect our North American commercial and industrial motors business to be flat to slightly down for quarter. However, we do expect continued strength in our power generation business. Internationally, we anticipate sales in China will be up modestly but offset by continued weakness in India and Australia. The good news is that the C&I markets appear to have stabilized, and we expect the residential markets will be a continuing tailwind going into 2014. Finally, we are forecasting a better-than-expected tax rate in the fourth quarter, and Chuck will provide you the details. With that, I will turn it over to Chuck Hinrichs.

[Charles A. Hinrichs:]

Thank you, Mark, and good morning, everyone. Our earnings in the third quarter 2013 were $1.16 per share on a GAAP basis. Restructuring charges in the quarter were $1.2 million or $0.02 per share related to our initial work on the 2014 closure of the Springfield plant, a key part of our simplification initiative. Adding back the $0.02 of restructuring charges, our adjusted earnings per share were $1.18. As a reminder, the average number of our shares outstanding in the quarter was 45.3 million shares, which accounted for $0.09 of the change in EPS as compared to the third quarter of the prior year. Our third quarter net sales were $768 million, a decline of 1.5% from the prior year. One of the major factors in the sales decline was the impact of foreign currency exchange rates, which reduced our total net sales by 1.1%. The foreign currency translation reduced our total international sales by 3.4% during the third quarter as compared to the prior year. Sales prices declined 0.8% from the prior year, impacted by the 2-way material price formulas with our larger customers, reflecting the decrease in our commodity input costs from the prior periods. We were pleased with our gross margin of 25.6% given the headwind of the foreign currency and price challenges. In the third quarter, we recognized a $900,000 LIFO benefit, an accounting adjustment to estimate our year-end LIFO reserve. The $1.2 million of restructuring charges were charged to cost of goods sold in the quarter. Our gross margin continues to benefit from our synergy program and the simplification initiatives. Our SG&A expenses in the third quarter were $117.7 million, down $10.4 million from the second quarter of 2013. You will recall the prior quarter included $2.9 million of acquisition diligence costs and $1.4 million of net bad debt expense. On our last earnings call, we communicated that we expected a lower level of SG&A expenses in this third quarter, and we achieved that result. Our free cash flow was a strong 123% of net income in the third quarter and 114% for our year-to-date 2013 results. On the next slide, we provide summary data on other financial results in the third quarter. Our capital expenditures in the quarter were $18.2 million. For year-to-date 2013, our capital expenditures were $65.4 million, on pace for total capital spending of approximately $90 million for the full year. You will recall that we are investing in 2 large capital projects in 2013, the expansion of our Unico plant in Wisconsin and our industrial motor plant in China. Our effective tax rate in the third quarter was 21.6%, which was below our earlier guidance of 26.5%. In the third quarter, we finalized our 2012 U.S. federal income tax return and lowered the third quarter tax provision to reconcile our tax accounts. We expect our ETR to be approximately 18% in the fourth quarter of 2013. We plan to execute a strategy to declare foreign dividends that will repatriate cash and generate foreign tax credits. As a reminder, our ETR for the fourth quarter in the prior year foreign was 15.6%, driven by the implementation of our EPC tax integration plan. Looking forward into 2014, our ETR should approximate 28 -- 27% in the first half of the year. As I described on previous calls, we have executed tax strategies and integrated acquisitions to successfully reduce our ETR to a sustainably lower level. In the lower left section, we summarize our free cash flow in the third quarter. As I mentioned, earlier, our free cash flow in the quarter was a strong $65 million or 123% of net income. On a year-to-date basis, our free cash flow was 114% of net income, a metric we are very proud of. In the lower right quadrant, we provide data on our quarter-end balance sheet. Our total debt was $769 million and our net debt decreased to $306 million. Our net interest expense in the third quarter was $9.3 million, a decline of $900,000 from the prior year. Our credit metrics are strong as our debt-to-EBITDA was 1.9x and our net debt-to-EBITDA was 0.7x. Our fourth quarter 2013 earnings guidance is $0.77 to $0.85 per share on a GAAP basis. Adjusting for the expected $2.7 million or $0.05 per share of restructuring charges for our simplification initiative, our adjusted EPS guidance is $0.82 to $0.90 per share. Our fourth quarter sales are expected to reflect the normal seasonal decline. This guidance reflects the expected lower ETR of 18%, which I explained on the previous slide. Mark announced the signing of the agreement to acquire Cemp in this fourth quarter. Jon Schlemmer will provide more information on this acquisition. Our fourth quarter guidance excludes the impact of this acquisition. The expensing of the purchase accounting adjustments and closing costs will be earnings per share dilutive by $0.01 to $0.02 per share in this fourth quarter. The Cemp acquisition will be EPS-accretive beginning in 2014. Our fourth quarter 2013 guidance is a solid improvement over our fourth quarter 2012 earnings per share of $0.70 per share. Now I'll turn the call over to Jon Schlemmer.

[Jonathan J. Schlemmer:]

Thanks, Chuck, and good morning, everyone. I'll start by giving some color on the end markets and customer demand. Sales in our North America residential HVAC business decreased 3.6% compared to the prior year. Mark already provided the background, so I'm going to spend my time telling you about the changes we're making in the business. You're already aware of the restructuring of our manufacturing footprint in this business, and those changes are well underway. In addition, we recently made organizational changes to our leadership team to drive organic growth and to accelerate the acceptance of our new technologies. Outside of HVAC, our residential sales increased approximately 4% compared to prior year, reflecting the impact of our new products and the improved residential market conditions. We experienced improvement on the international front with sales outside of the U.S. increasing 2.7% compared to the same period prior year in spite of currency, which impacted our international sales by 3.4%. The largest improvement was in China, where we saw high single-digit sales growth. The sales improvement in China was across several of our products, including commercial and industrial motors and our generator businesses. We recently increased our resources in Latin America, and our efforts were rewarded with positive organic growth in the quarter. However, we do continue to experience challenging end markets in India and Australia. The decline in our Mechanical business was substantially driven by reduced demand in oil and gas and, in particular, hydraulic fracturing equipment. We also experienced a decline in demand of our Mechanical products in Australia, driven by the weakness of that economy. Orders have improved on our standard power transmission products, however. However, we expect to continue to see difficult year-over-year comparisons in the Mechanical business through the first quarter of next year, driven primarily again by oil and gas. Orders in our commercial and industrial business stabilized in the third quarter. We ended the quarter with revenues down less than 1% compared to the same period prior year, excluding the impact of the divested pool and spa motor business. We experienced sales strength in a number of end markets, including industrial equipment and machinery, industrial pump and a slight improvement in distribution. We expect to see similar performance from this business in the fourth quarter. Revenues in our global power generation businesses were up approximately 8% in the quarter compared to the same period prior year. Here, we're seeing stronger demand for our generators and switchgear equipment used primarily in applications where standby power is critical. One end application where we've seen a lot of demand is data centers, where downtime is very critical. These data centers require high-performing and very reliable equipment. Over the last few years, we've made investments in our generator and switchgear manufacturing capability in Mexico. And last year, we invested to expand our generator capability and capacity in China. We're using this more competitive footprint along with investments in new technology to go after new power generation business. Again, we expect to see similar performance from this business in the fourth quarter. During the quarter, our teams launched another 14 new products. That makes 51 new products launched this year, on pace to exceed the number of new products launched in 2012. Energy efficient product sales represented 21.5% of total sales. There are several areas where our energy efficient products have really made an impact this year, including commercial refrigeration and pool pump motors. Year-to-date, we're experiencing double-digit sales growth of energy efficient products in both of these areas. We recently launched another high-efficiency pool pump motor. And I'd like to spend a little time on this product and the impact on energy savings. When we acquired the EPC business 2 years ago, we were very excited about a new product that had recently been launched in the business, the V-Green 270. V-Green uses permanent magnet and variable-speed technology to increase the efficiency of pool pumps. We've been pleased with the growing demand for that product over the past 2 years. This motor and control delivers 2.7-horsepower and is perfect for large residential in-ground pools, as well as commercial pool applications. The team quickly saw a need for a smaller version of the product for smaller-sized residential pools, which are common in Florida and other areas of the country. Adopting technology from our HVAC ECM products, the team just recently developed and launched the new V-Green 165. The motor is designed to be used in replacement and retrofit applications for these smaller-sized pools. Here's an actual example that illustrates how much energy these motors can save. The picture shows 2 V-Green pump motors, which were installed on a neighborhood pool, retrofitting 2 standard single-speed motors. There were 2 pumps at this site, one that powered a larger pool and the other for a smaller pool. The standard single-speed motors were inefficient and not properly matched to the actual pumping requirements, which is typical of what we see in these applications. The graph shows daily energy usage, and you can clearly see the impact when the new V-Green motors were installed. It's an 85% reduction in energy usage, saving over $300 a month in electricity, paying back the cost of the 2 motors and installation in just a matter of a few months. Our key pool OEMs are very interested in both the V-Green 270 and the new smaller V-Green 165. We're seeing solid growth in our total North America pump motor sales this year, up nearly 6% in the third quarter. And much of this growth is driven by the sales of these energy efficient new products. Earlier, I mentioned that we saw a 4% in our non-HVAC residential businesses this quarter. New products like V-Green are helping to drive this growth. I'd like to give you a little more background now on our latest acquisition announcement. Founded in 1954, Cemp is a manufacturer of industrial motors designed specifically for hazardous duty applications. Their headquarters are near Milan, Italy with annual sales of approximately $35 million. They specialize in motors that are commonly referred to as flameproof or explosion-proof motors. These motors are often specified in hazardous areas such as oil and gas, marine, mining and chemical processing. Approximately 85% of Cemp's products are used in oil and gas and marine applications. Certifications such as ATEX are required to meet these stringent requirements, and Cemp's entire line of products is fully certified. The majority of their sales are to customers in Europe, which helps to strengthen our commercial and industrial motor business in Europe. The Cemp team has tremendous knowledge of the products, applications and certification requirements. While we have a good range of explosion-proof motors today, our level of global ATEX certification is limited. Cemp really does a nice job filling this gap for us. With our global sales footprint, we expect to deliver $10 million in sales synergies over the next 3 years. While we don't have a substantial European manufacturing footprint, we do expect cost synergies by utilizing our global industrial manufacturing and supply chain capabilities. We'll provide more color on both the sales and cost synergies at a later date. Expected impact from earnings in 2014 is accretive $0.03 to $0.05 per share and 2015, accretive $0.06 to $0.08 per share. On our last call, I talked about our simplification initiative and the announcement to close our fractional motor facility located in Springfield, Missouri. We are consolidating the production into our existing Reynosa, Mexico and McAllen, Texas facilities. The transition has started on schedule and will be completed by the end of 2014 as planned. Restructuring costs and benefits are tracking consistent to what we previously communicated. We expect to announce further footprint consolidation with our factories around the world during the first half of 2014. And we continue to make good progress on all of our other simplification efforts across the entire company. This includes standardizing our design platforms, supplier consolidation efforts and ERP consolidation. Simplification will make it easier for our customers do business with us and improve our margins at the same time. With that, I'll turn it back over to Mark.

[Mark J. Gliebe:]

Thanks, Jon. So to summarize from an operating standpoint, our performance was in line with our guidance. And with a tax benefit, our results finished at the high end of our guidance. We are pleased with our progress on gross margins and with our free cash flow, which is at 114% of net income on a year-to-date basis. As Jon said, our simplification efforts are focused on footprint and platform consolidation, and we are moving forward aggressively. You should expect more in the future from these efforts. We continue to launch new products to innovate our product offering and drive growth and margin improvement. We are excited to add Cemp to the Regal family. Our pipeline is healthy, and we continue to aggressively and yet prudently seek acquisition targets that meet our strategic objectives and financial criteria. As we look to the fourth quarter, our EPS guidance is up double-digit versus prior year. While not all of our markets are behaving, the Regal teams are driving performance improvements that are showing up in our results. So in closing, we're pleased to have delivered performance within our guidance, and we continue to feel good about our company. Our overall focus is on growing our company both organically and through acquisitions while improving our margins. We have proactively worked to reduce cost by driving simplification while still making prudent investments for the future on new technologies and on new facilities. Further, we continue to launch new products, we are consistently investing in our IT infrastructure and we are continuing to develop our people through education and new experiences. We're proud of the progress we've made and certainly optimistic about the opportunities that lie ahead of us. With that, we will take your questions.

[Operator:]

[Operator Instructions] The first question comes from Josh Pokrzywinski of MKM Partners.

[Joshua C. Pokrzywinski:]

Just to hone in on the HVAC business for a second here. X the price givebacks on the 2-way formula and the customer loss, what was volume in the quarter?

[Mark J. Gliebe:]

Let's see. Let me just make sure I understand your question. So our overall volume was down 3.6% for the quarter, and the majority of that was related to both our -- the customer dynamics we discussed, as well as volume. And what you're asking is if we take those 2 things out, what happens to volume. I think it was...

[Joshua C. Pokrzywinski:]

Yes, just volume because you mentioned price as well.

[Mark J. Gliebe:]

Yes, I think it was probably flat to slightly up on a year-over-year basis if you adjust those 2 things out.

[Joshua C. Pokrzywinski:]

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

[Mark J. Gliebe:]

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

[Joshua C. Pokrzywinski:]

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

[Mark J. Gliebe:]

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

[Joshua C. Pokrzywinski:]

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

[Mark J. Gliebe:]

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

[Operator:]

The next question comes from Scott Graham of Jefferies.

[R. Scott Graham:]

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

[Jonathan J. Schlemmer:]

I'd say, Scott, I don't have a number to quantify in terms of the impact on an annual year-over-year basis -- an impact. They're clearly contributing to helping us on top line performance. And we typically look at our product vitality and look at how much of our business is revenues being generated from new products and product line extensions that have been done in the business over the past 5 years. And that's typically about 1/3 of our revenue. So we know the products are having an impact on our revenue. We also track business-by-business what the impact is on our growth plans from new products, as well as other customer initiatives. So there's no question it's having an impact, and we've had difficulty seeing that, of course, with some of the other dynamics that we've experienced.

[R. Scott Graham:]

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

[Mark J. Gliebe:]

So in terms of the pipeline, as I've mentioned earlier, it is still a healthy pipeline. And I think the way to think about it, Scott, is transactions that are similar in size to the Cemp transaction up to transactions that are similar in size to the EPC transaction that we did back in August of 2011. Timing is always difficult to tell, so it's tough for me to comment on timing on when one of these would come across. But I could assure you we're focused on it.

[R. Scott Graham:]

And you're not looking to enter resi HVAC in international markets. Is that fair?

[Mark J. Gliebe:]

We have a small exposure today to resi in HVAC in international markets, and I think it would be fair to say that, that's not a prime area of focus for us.

[Operator:]

The next question comes from Christopher Glynn of Oppenheimer.

[Christopher Glynn:]

Mark, I'm wondering about the formula prices. Are they either designed to be margin-neutral? Or is it more a situation where the customers give you margin on the way up and take it back on the way down?

[Mark J. Gliebe:]

No, I would say overall, you should think about it as margin-neutral. That's the goal overall. And now there's is a little bit of a timing lag that can come with these. And some of them will adjust within the quarter, some of them will adjust the next quarter and some of them will adjust 2 quarters out. But you should think of it as margin-neutral.

[Christopher Glynn:]

Okay. And then for Electrical, it looks like profits declined a little bit more than core revenues. I'm just wondering what else is going on there, if there's a mix impact or if it's just other kind of moving pieces.

[Mark J. Gliebe:]

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

[Christopher Glynn:]

Yes, the profit dollar is down to about the same amount as organic sales year-over-year.

[Charles A. Hinrichs:]

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

[Christopher Glynn:]

Okay. But in my comment, the price was in the revenue dynamic and...

[Charles A. Hinrichs:]

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

[Operator:]

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

[Jeffrey D. Hammond:]

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

[Charles A. Hinrichs:]

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

[Jeffrey D. Hammond:]

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

[Charles A. Hinrichs:]

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

[Jeffrey D. Hammond:]

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

[Mark J. Gliebe:]

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

[Jeffrey D. Hammond:]

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

[Mark J. Gliebe:]

Yes, that would be consistent with that same plan. And I believe it would be certainly top-quartile performance for diversified industrials that we would see as our peers.

[Jeffrey D. Hammond:]

Okay. And then just finally back on resi HVAC. I mean, to Josh's question, I mean, there seems to still be a gap between what you're putting up x kind of the one customer loss and price and what the industry is putting up. And you mentioned resi tailwind into '14. I mean, what's the reasonable timeframe where you start to see your business more aligned with that residential tailwind?

[Mark J. Gliebe:]

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

[Jeffrey D. Hammond:]

Okay. And what's your comfort level that if you look at all the moving pieces that as we get into 2Q, you do start to see something more in line with industry trends?

[Mark J. Gliebe:]

Well, what we see in front of us today, that's our best view of the world. Obviously, the world changes all the time. But as we look out today, that's our best view.

[Operator:]

The next question comes from Mark Douglass of Longbow Research.

[Mark Douglass:]

Chuck, what was the price paid for Cemp?

[Charles A. Hinrichs:]

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

[Mark Douglass:]

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

[Jonathan J. Schlemmer:]

Mark, this is Jon. Absolutely feel good about that initiative. We did talk in earlier calls about putting more focus on value products and, in particular, aluminum-wound motors, where we convert copper to aluminum to help reduce the cost of the product and also to utilize our global manufacturing footprint with manufacturing capability in India and now in China with the EPC acquisition. We're absolutely focused on that. I mentioned some of the organization changes we've made in the business. Part of that is to continue to put a strong focus on those products. We just -- we actually just increased the capability and the capacity for aluminum wire or aluminum winding capacity in our India facility because we wanted to match up that product capability with our best cost footprint. And we're continuing to take those products to customers. We have interest from customers from an evaluation standpoint. We have some of those products in production now. So I feel good about the longer-term prospects from that initiative.

[Mark Douglass:]

So you have sales then of the products?

[Jonathan J. Schlemmer:]

Yes, we do.

[Mark Douglass:]

Okay. But not in volume at this point?

[Jonathan J. Schlemmer:]

Well, clearly, none of us are happy with the 3.6% decrease in sales. So we need and we expect more from that effort. And that's part of our focus to improve our HVAC business in total.

[Mark Douglass:]

Okay. And then on organizational changes, can you help us understand what that really means?

[Mark J. Gliebe:]

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

[Operator:]

The next question comes from Jamie Sullivan of RBC Capital Markets.

[Jamie Sullivan:]

A quick question, on the fourth quarter, is there any LIFO impact baked into the numbers that you're assuming there?

[Charles A. Hinrichs:]

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

[Jamie Sullivan:]

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

[Mark J. Gliebe:]

Well, I'll just try to clarify if it's okay, Jamie, and I'll just try to make sure I understand your question. So we've communicated that by the end of 2015, we expect our goal on EBIT margins was to be in the 13.5% zip code on EBIT margins. And your question is can we get there with our exposure in HVAC? And so I think that's your question. And I'll just comment that we're not focusing on volume to deliver. We had very modest volume assumptions. And our thinking it was like we kind of have 2.5% GDP growth in order to be able to deliver on our margin commitments. Most of the benefit was coming from 3 or 4 buckets

[Jamie Sullivan:]

Okay. And then last question just on CapEx. Chuck, is there any way to maybe quantify what's sort of heavier this year that won't repeat next year at any magnitude?

[Charles A. Hinrichs:]

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

[Operator:]

The next question comes from Julian Mitchell of Crédit Suisse.

[Charles Clarke:]

It's Charlie for Julian. Just after 7 quarters of core growth declines in both the businesses and just talking to you into next year for '14, just even the first half in Mechanical, just talking about tough comps in that business, I mean, that would put you kind of 10 quarters in a row down core. Can you just talk about maybe where we'll see an inflection point in organic growth both in Mechanical and Electrical and where we'll see the core business stabilize?

[Mark J. Gliebe:]

So we've been -- if you think about some of our key markets, residential, we've touched on residential HVAC, and we talked about what we thought was in front of us and what the timing of that was. To an earlier question, just one kind of came after that, where we commented that by the end of the second quarter, we expected a change in what was happening there. And then with our commercial and industrial markets, I could think back probably 6 or 7 quarters ago, 6 quarters ago, and think back to prior to that point, we had 7 quarters in a row of high single-digit, low double-digit sales growth quarter-after-quarter. Since that time, our commercial and industrial businesses have been down and been improving kind of quarter-to-quarter. This quarter, down less than 1% on a year-over-year basis when you adjust for the divested businesses. So I think it's improving there. In China, third quarter of 2011, we started to see deterioration in China. And this was the first quarter in some time that we saw growth in China and we're expecting to see it again in 20 -- I mean, in the fourth quarter. And I think the wildcards are going to be the rest of Asia, which is India and Australia, to a lesser degree, Europe. Though it appears to us that Europe is starting to stabilize and improve as well. So when you take all those things into consideration, certainly the forward look, looks better than what's in the rearview mirror.

[Operator:]

The next question comes from Samuel Eisner of Goldman Sachs.

[Samuel H. Eisner:]

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

[Mark J. Gliebe:]

Yes, it is, Samuel.

[Samuel H. Eisner:]

Okay, great. And then in terms of long-term goals for tax rate, Chuck has talked about obviously trying to move down the tax rate over time. I'm just curious if you guys kind of have a benchmark that you're trying to reach in terms of the tax rate because obviously with the first half next year being around 27%, just trying to understand where all the moving pieces are there.

[Charles A. Hinrichs:]

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

[Samuel H. Eisner:]

Got you. And on resi HVAC, x the customer loss that happened in the first quarter, what was resi HVAC in the quarter? Yes, in terms of the growth rate in resi HVAC, you guys reported that you guys were down 3.6% year-on-year, but that was inclusive of the customer loss. So I'm just curious what was that x the customer loss.

[Mark J. Gliebe:]

Yes, we answered that question with -- including the impact of our 2-way pricing formula, and we said flat to slightly up.

[Operator:]

The next question comes from Walt Liptak of Global Hunter Securities.

[Walter S. Liptak:]

You made comments about distribution improving slightly. And I wonder if is it possible to get some color around that, if there's any sectors that are getting better or any large distributors, what you're thinking about in the fourth quarter next year related to the C&I business?

[Jonathan J. Schlemmer:]

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

[Walter S. Liptak:]

Okay, got it. And if I could switch over to the leadership change and wonder if you could help us understand. So it sounds like the head of HVAC was switched out. And I wonder if you could tell us why that happened, who was put in place and what kind of expectations should we have about the new leadership with the...

[Mark J. Gliebe:]

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

[Operator:]

The next question comes from Rudy Hokanson of Barrington Research.

[Rudolf A. Hokanson:]

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

[Mark J. Gliebe:]

So Rudy, on the -- with regards to China, you should think of our lead times as typically in the 3-month range, give or take a month. That's the way to think about it. And so we can see out that far and which gives us confidence about the fourth quarter. So I would say it certainly feels better today than it has over the last 6 quarters with regards to our commercial and industrial business in China.

[Rudolf A. Hokanson:]

And what about -- I believe you mentioned briefly Latin America was looking good or South America was looking good.

[Jonathan J. Schlemmer:]

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

[Rudolf A. Hokanson:]

Okay. And is that mostly Mexico?

[Jonathan J. Schlemmer:]

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

[Rudolf A. Hokanson:]

Okay. And then on the oil and gas side and the Mechanical sales, you basically have said that first half of next year is going to be very difficult. I believe that was the time reference. And again, in terms of lead times or the type of sales or what you're hearing, is this something that you get involved with a CapEx program of a company, where they might be setting their budgets and you're negotiating with them? Or is this more of something -- are your items usually something more that will be they see the need in the field because they've completed a well, so they'll place the order and 4 weeks later you deliver?

[Jonathan J. Schlemmer:]

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

[Rudolf A. Hokanson:]

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

[Jonathan J. Schlemmer:]

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

[Operator:]

The next question comes from Liam Burke of Janney Capital Markets.

[Liam D. Burke:]

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

[Mark J. Gliebe:]

Yes, sure. Hold on. You're asking specifically about the commercial and industrial part of our business?

[Liam D. Burke:]

Yes, I'm sorry. Go ahead. Yes.

[Jonathan J. Schlemmer:]

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

[Mark J. Gliebe:]

Some of the feedback we've gotten from -- on the distribution side is you'd hear the words cautious, customers being a little bit uncertain about the environment out there.

[Liam D. Burke:]

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

[Mark J. Gliebe:]

Well, I think it represents roughly 5% to 7% of our total residential exposure. I don't have all the numbers here right in front of me, but I think they're laid out in one of our presentations. We'll make sure that John Perino gets you the data.

[Operator:]

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

[William J. Dezellem:]

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

[Mark J. Gliebe:]

Well, we tend to sell into, I would say, larger commercial -- I'm sorry, larger -- yes, commercial and industrial applications. And so you should think about infrastructure, infrastructure growth. I think that would be the best way to think about it on one piece. And another piece would be large commercial installations would be the other piece. So that's where we're seeing improvement in our orders.

[William J. Dezellem:]

And at this point, are you viewing there is some sustainability to that? Or does it appear as though it's more of an inventory channel fill? How are you looking at that?

[Mark J. Gliebe:]

No, I wouldn't think about it as inventory. You don't have the same distribution dynamics in China that you have in the U.S. So you're typically selling right to an OEM or an end user. And you're not going to get an order unless they have an order. So I don't think it's a channel fill. We feel good about the fourth quarter. Beyond that, I've seen too many ups and downs in China to talk about sustainability yet. But certainly, we feel okay about the fourth quarter.

[Jonathan J. Schlemmer:]

A bit of positive news, I'd say, Mark, is that our order rates have been more stable over the past 3 to 4 months, and we wouldn't be able to say that earlier in the year.

[Mark J. Gliebe:]

And the PMI data has been trending up, so...

[William J. Dezellem:]

That's helpful. And then one additional question. Relative to the Mechanical business, your sales were down sequentially. However, your gross margin was up nicely. And I apologize if I missed it before. But would you please discuss what you have been doing to move that close margin up in spite of softer sales?

[Mark J. Gliebe:]

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

[Operator:]

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

[Mark J. Gliebe:]

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

[Operator:]

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