Regal Rexnord Corp (RRX) 2007 Q2 法說會逐字稿

Welcome to the second quarter 2007 earnings conference call. At this time, all participants are in a listen only mode. Later we will conduct a question and answer session, instructions will be given at that time. (OPERATOR INSTRUCTIONS)

At this time, I'd like to turn the conference over to our host, Dave Barta, please go ahead.

Thanks very much, Shannon. Good afternoon, everyone, and welcome to the Regal-Beloit's second quarter earnings conference call. Joining me on today's call are Mark Gliebe, President and COO, and Henry Knueppel, Chairman and CEO. Before turning the call over to Henry, I would like to remind you that the statements made in this conference call that are not historical in nature are forward looking statements. Forward looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward looking statements. For a list of those factors that could cause actual result to differ materially from projected results, please refer to today's earnings release in our filings with the SEC. Now I'll turn the call over to Henry.

Thank you, Dave. And thank all of you for joining us and for your interest in Regal-Beloit. As we have in the last several calls we will follow our similar agenda. I will give you a few opening comments, Dave Barta will cover the financial aspects of the quarter, Mark Gliebe will give you more detail on the markets and operations, and I will finish with some forward looking comments toward the next quarter and beyond.

With that, let me just say that we were very pleased with the quarter, it was strong due to the commercial and industrial markets that we participate in. Power generation remained very strong, the improvements-- operating improvements in our Mechanical Group and growth in Asia. The quarter highlights were very strong cash flow which Dave will cover in more detail, continued rollout of new products and more important than that is the pipeline that we have for the future. We're also very pleased to have been selected by Frost & Sullivan as the Motor Company of the Year, based on their independent research. And we would refer you to our website that will be posted within the next couple of days so that you can see the basis that they use to pick us. And then finally, last and certainly not least was the announced acquisition of FASCO, which we believe is a great business and a great brand, offers us more complete selling solutions and improves our global footprint. So with that I'm going to turn it over to Dave Barta.

All right thanks, Henry. Just quickly to go over the financial results for the quarter starting with the P&L. Sales for the second quarter were $459.8 million which is a 5.6% increase as compared to the second quarter of 2006. In the Electrical segment, sales were $405.7 million and increase of 6.1% versus the prior year. And as was the case in the first quarter, the segment growth was paced by the power generation business and experienced over 22% year-over-year growth as a result of continuing strong generator sales out of both our U.S. and China facilities. Large motors also continued the recent trend growing over 15 % for the quarter. On the other end of the spectrum was the HVAC business which was down 10.7%, and Mark will have comments regarding that business.

The Sinya business we were quite pleased with the continued progress with that business, and as you may recall we purchased that business in May of 2006. We had a strong quarter with sales of $27.3 million and that's for the entire quarter, sales for the April period if you're calculating organic growth were $11.4 million. Sales in the Mechanical segment increased 2.1% and results for this segment were negatively impact by the sale of the Cutting Tools business during the second quarter of 2006, that effectively reduced sales by approximately $1.7 million, so excluding that impact, sales would have increased 5.4%. And now both of the acquisition of Sinya and the sale of Cutting Tool business have been anniversaried, so going forward it's pretty pure.

Gross margins for the quarter were 22.6 as compared to the prior year second quarter gross margin of 23.9. The decrease was primarily a result of two factors, the first of which was inflation driven primarily by increases in copper which we were not able to offset with pricing. And the second was the impact of significant finished goods inventory. We've reduced inventory $26 million resulting in a reduction of fixed cost absorption. Our productivity and Lean Six Sigma efforts however made a noticeable contribution in the quarter. There was a decrease in operating expenses resulting primarily from productivity and cost control activities, resulting in income from operations increasing 3.8% and finishing at 13.1% of sales as compared to 13.3% in the second quarter of '06. Which I will note that the second quarter of '06 results included the gain on the sale of assets of $1.6 million on a pre-tax basis so adjusting for that fact, last year's operating margin would have been $12.9 million.

Tax rate for the quarter was 34%versus 35.9% in the second quarter of 2006, primarily as resulting from the distribution of income which was weighted to lower tax rate countries. Net income for the quarter was $36.3 million and an increase of 9% as compared to the $33.3 million reported in 2006 for the second quarter. Fully diluted earnings per share were therefore $1.06 which compares to $0.99 reported last year.

Like to turn briefly to the cash flow and the balance sheet. We had an outstanding quarter from a cash flow standpoint. Cash flow from operations in the quarter was $89.7 million. We're very pleased with the improvement in working capital management and as you would recall from the conference calls we've had earlier this year, there's been an intense focus for the Company this entire year and we're glad to see those results are materializing. Working cap with the use of cash in the first quarter, it was a source of cash in the second quarter with a flip of almost $69 million so again a very, very meaningful impact. We're successful in reducing a significant amount of inventory head lined by the $25.5 million reduction in finished goods. Accounts payable also moved in the right direction and receivables was pretty consistent on an increase in sales.

We're not done. We still feel like we have a lot of room to go in terms of payable and receivables in particular, and our focus is on cash with our goal of 100% free cash flow as a percent of net income. Other housekeeping depreciation amortization was $10.5 million. CapEx was $5.7 million and dividends were $4.4 million resulting in a free cash flow of $79.6 million in the second quarter versus $23.9 million in the second quarter of 2006. The cash flow resulted in a debt pay down. Our debts stood at the end of the quarter at $310.3 million, a decrease of $63 million from the end of the year and a decrease of $83 million from a year ago. Now I'll turn with some comments to the third quarter and let Henry expand on these later.

Our EPS guidance as you might have seen in the release this morning is $0.87 to $0.93 per share and reflects the many regards a continuation of the sales trends we have seen in these recent quarters. There are also a couple of other factors that were mentioned in the press release that are impacting our estimate. The first is commodity cost pressures, again primarily copper, which has remained an issue, effective cost increase for the third quarter over the second quarter is very significant. Additionally we announced and filed an 8K this morning regarding reaching a settlement agreement with respect to the Enron legal matter. The impact of the settlement is $1.8 million on a pre-tax basis and I think Henry has some comments of-- further comments on the agreement.

The tax rate used in arriving at our EPS guidance is 34.5 , I'd suggest using not only that rate for the third quarter but the fourth quarter as well. And we're currently expecting capital spending in the area of $10 million to $15 million in the second quarter and anticipate full year CapEx in the neighborhood of $40million to $45 million. Also I'd add that our current estimates and guidance that we provided do not include any impact for the proposed FASCO acquisition. We will not update that guidance until the closing of that transaction. I'll now turn the call over to Mark.

Thanks, Dave. This was the third consecutive quarter where our business performed well, in spite of a difficult residential housing market and we are very pleased with the execution of our team. Highlights of the second quarter were strong sales growth in our commercial and industrial motor businesses, up 10% and in our generator businesses up 22%. Across the Company, we continued our march to improve our performance through the implementation of our initiatives. During the quarter we made nice progress in repositioning our generator business as we completed the transition from our Limo, Ohio facility to Monterey, Mexico. This transition has been in progress for over a year and we are pleased that the transfer is now complete. Our new moderator generator facility is performing very well and we expect to grow this facility in the years to come.

We also made tremendous progress on cash flow as Dave had mentioned and we reduced our cash cycle by 5.5 days since the beginning of the year. We made improvements on all three working capital areas, receivables, payables and inventory. Our focus on customers and innovation is resulting in a steady stream of new products, with a strong focus on energy efficiency. With a significant portion of the energy in the United States consumed by electric motors, we are making energy saving high efficiency products a long term priority and focus.

This past quarter, we announced our new Ice ECM product. This new product is targeted for the commercial refrigeration, walk-in cooler and freezer segment and allows grocery store users to cut the evaporator motors-- motor energy consumption from walk-in coolers by up to 67%. On the product costs more than the standard motor than it replaces, it can pay for itself in the users energy savings in as little as 1.5 years. The California Energy Commission has legislated that the ECM motor is required for all new walk-in freezer installations effective January 1st 2008. The first installation of the Ice product will actually occur this coming weekend at a major grocery chain and our current sales estimate for this product in the first full year is $5 million to $10 million. In addition, as part of the Federal Energy Act, Congress is now considering legislation to require the same ECM motor in all new walk-ins nationwide. If that were to occur, we estimate the total opportunity to be in the range of three or four times our first year sales and we feel we have a great head start on our competition with the product specifically targeted for this application.

Across the Company, we are working on a number of other new ECM products. Some are focused on specific improvements and modifications requested by our customers. Other new ECM products are focused on new and different market segments where we see long term opportunities. By the end of the third quarter, we expect to talk about yet another new and exciting ECM product that we will launch in the fourth quarter.

And it's not just ECM Motors where we are working on new high efficiency products. In our Mechanical business, we launched our new high efficiency, helical based in-line and right angle gear drives. These gears are anywhere there 20% to 30% more efficient than the standard products they replace and will have torque density performance that either matches or beats the best-in-class offerings. What makes this product even more exciting for us is that we are launching the line as a Lean platform which means three day deliveries, to delight our customers and less overall inventory for us. Also, for the first time, we are launching this new product under one manufacturing and design platform but selling it under our multiple brands. Instead of different manufacturing investments for each brand, we'll invest in one platform that serves our hub city , [Glow Gear] and LEESON brands.

From a commodities perspective, copper prices continue to be a challenge, with our most recent higher cost hedge positions replacing our historical positions. Even with our disciplined hedging process, we have been unable to offset all the commodity inflation we are facing and it has been pressing our margins. We are continuing to drive offsetting productivity but unfortunately we are forced to continue to pass on some portion of the commodity increases to our customers.

In terms of the HVAC segment, the ARI and gamma data shows us that the market was down 17% year-to-date and while the month of May showed modest improvement, some of our customers took time out during the end of the second and the beginning of the third quarters to adjust their own inventory levels. In our business, our sales were down 11% for the quarter with year-over-year declines showing in both our standard and ECM products. While the HVAC industry is clearly in the midst of a slowdown it is a solid space to compete in over the long term. The fundamentals of the segment including an established replacement market, warming temperatures and the demand for technology driven comfort and energy efficiency make the HVAC segment an attractive long term market for us.

The highlight moving forward is that the rest of our businesses are continuing to perform and our initiatives are paying dividends. We continue to see strength in the industrial machinery and oil and gas motor segments. We expect continued improvements in the commercial industrial motor businesses as well as our Mechanical and power generation businesses.

In summary the second quarter was yet another data point showing that the variety in our end markets balances our Company's performance while one demand from one end market is off, the others are performing. We continue to be excited about the benefits that our new products and our initiatives are delivering to both our customers and to our businesses performance. We feel good about the third quarter. We are excited about adding the FASCO team to the Regal-Beloit family and we are looking forward to integrating our teams and finding value for our customers in the marriage of our products and services. I'll turn it back over to Henry. Thank you.

Thank you, Mark. Before we open it up for questions, I want to address our views of the third quarter and our views of the way investors should be viewing Regal-Beloit Corporation. Let's take the bigger issue first. How should investors view Regal-Beloit in the context of future growth opportunities. As all of you know our tag line for sometime has been that we are at the heart of what drives your world. That's still absolutely true, but perhaps as important, we are at the heart of what makes the world more energy efficient. It has been estimated that somewhere between 50% and 60% of all electricity generated in the United States is used by electric motors. Looking at just the U.S. usage, that's about 1.7 trillion kilowatts per year. At just $0.06 per kilowatt hour, that's $100 billion expended each year on electricity. Each 1% improvement therefore is about $1 billion and 6 to 10 million fewer tons of coal, 15 to 20 million fewer tons of carbon dioxide delivered to our environment.

Our products make a significant difference in the stewardship of energy usage. Products such as our brushless DC motors for residential HVAC applications or our [Nema] premium motors or our variable speed motors, our high efficiency generators and controls and our high efficiency gear drives. These products offer efficiency improvement from 2% to 30% over the standard products being sold today and even bigger improvements over the average of the installed base. The potential for improvement is significant. Paybacks are significant and the social responsibilities are clear. We provide technology based solutions to these social and financial issues. We have been quietly but steadily raising the bar with products such as our ECM product, our PGC 4,000 controls for generators, our X-13 motors, PMG generators, Ice 59 commercial refrigeration motors that Mark talked about earlier, and as you heard today, our new high efficiency gear drives with industry leading torque density and we have a full pipeline of products in development.

Our products are not just necessary, they also help our customers offer superior features and efficiencies. Therefore, in the bigger context of what's next, we are in a great position to help guide a mega trend wave, and we believe that we have the people, the processes and the technology to make a difference.

Looking at the third quarter specifically, we think it will be a very good quarter from a historic perspective and an excellent quarter in light of the significant headwinds that we face. The issues that we face in the next quarter are the residential HVAC market, it will continue to be a challenge, although the comparisons will be less difficult by the fourth quarter. Commodities as Mark said we are replacing lower cost hedges with higher cost hedges and spot prices have been surging again even though that we were expecting them to drop by this point in the year. Finally the Enron settlement we think is a positive for our investors. We know a number of investors and potential investors who were concerned about it. We also believe that it's good from a standpoint of time and cost moving forward as we would have moved into a heavier phase of litigation. And we will not answer more questions on that until it has been accepted by the courts.

So we expect a very solid quarter. I think the good news is that the issues that we just talked about for the third quarter will pass quickly. What won't go away is the momentum we have on our initiatives including globalization, Lean Six Sigma, customer centricity, digitization and innovation. And the other item that won't go away is the global need to improve energy efficiencies. So with that, we'll take questions.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Alexander Paris with Barrington Research. Please go ahead.

Good afternoon, good quarter.

Thank you, Alex.

Thank you. Just a few questions. I'm just trying to get my hands around Sinya. Did they in 2006, did they have about $40,000--- $40 million in sales?

For the full year?

Yes.

Close to that I believe. I don't have it in front of me but I want to say it was in the high 30s.

Okay and the second quarter was $22.3 million. That must be a lumpy business. You can't annualize that to get a run rate, can you?

Yes, it was 27.3 in the most recent quarter, so correct they're in the HVAC space as well, so there's some seasonality to their sales.

Okay, I'm just trying to figure out what run rate you're at here now, it's running well ahead of a year ago, right?

Oh, absolutely. That business is growing 25% plus a year, and I think we'll see at least that kind of growth this year.

Okay, good. And that-- the international is 10% of your businesses, is most of that Asia or what part of that is Asia?

Yes, India and China, that's the majority of that. We do very little today in Europe so it's primarily Asia or Asia Pacific.

Okay, and looking at weather, can you tell from so far in the quarter, it's been getting pretty hot lately. Can you make any adjustments as whether this is going to be good weather for HVAC in the summer, is it too early?

I'm voting right there with you, Alex. It is too early and we have not seen a response to that but I'm watching the same weather map.

The $25.5 million in inventory reduction, that was all intentional, right?

Yes.

And was it mostly in HVAC or--?

Across-the-board.

Okay, and just one other question. In FASCO, you mentioned 10% to 15% accretion in 2008, then you also mentioned you expected $15 million of the annual savings by the end of the third year. That's in addition to this accretion, those are the extra cost savings as you would expect?

Right, and the guidance we gave for next year was $0.10 to $0.15.

Right

Just to be clear, and then we identified approximately $15 million in synergies that we would realize over the three year period.

Right.

At this point, as I mentioned earlier, I'm not prepared to give anymore guidance until we've got a transaction closed and we'll obviously provide you a little more color on the impact for '07 as well as '08 and beyond.

Great. Thank you very much.

Thank you.

The next question comes from the line of Mike Schneider with Robert W. Baird. Please go ahead.

Good afternoon, guys.

Hi, Mike.

Just following up on the inventory question, you took inventory down by $25 million. Do you have an estimate of what that actually hit you in absorption for the quarter either in margin points or dollars?

Right. That was $25.5 million just in finished goods so our total inventory we actually reduced more than that, but the absorption impact it varies by business as you can expect but generally our overhead rates are 15% to 20% of COGS, so it was a fairly significant impact.

And going into Q3 now, do you level load production or do you still run it below optimal rates?

Well, we still have goals of taking out inventory. Some of our businesses are in pretty good shape and further along, we still have some that are-- they have room to go to get to the type of performance that we are expecting out of our businesses. I would be surprised if we have that type of reduction in the third quarter but I think the emphlysis is still to reduce inventories.

Okay and just to be clear the inventory reductions aren't really a call on your outlook for demand at this point. This is more you squeezing cash out of the balance sheet?

Yes. I think the last several calls, probably as many as three, we've talked about working capital and have not been happy with the performance coming out of the third quarter of last year, both in terms of receivables and inventory, our payables as we've mentioned were-- is a full court press on and trying to equalize our terms with vendors, so this is across the board push on maximizing our performance from a balance sheet perspective and improving what we do with the cash that we've now got invested in working capital.

Mike I just want to add a little bit. Some of it is because of the Lean. We've been driving Lean so that's helping some of our businesses, and the other thing that has helped is we, as you recall, we had that big Oracle implementation that we had to go through in the late fourth and early first and second quarters, and when you're going through something like that, you don't have as much control as you'd like, so now we have better reporting, better capabilities. So getting payback.

Okay, and in fact on the Oracle system, what is left yet to deploy and I guess have you been happy with the performance or outcomes?

Well, we have a lot of legs to get the entire Company reporting on that system, but the big one was last fall. I would say at this point, we are reasonably happy. I think any time you make a system conversion, it is a humongous task, I think our people did a great job of quickly getting on top of the issues but we're at the point now where the refinements are pretty meaningful and give us better clarity in operation, so I would say that right now we're probably back to reasonably close to where we were before we started the implementation, and I think the good news is theres a lot of blue sky in front of us to improve it further.

Okay and then on copper and pricing, Dave, do you have just a specific number as to what materials hit you year-over-year in 2Q and then 3Q so we can get a sense of the progression?

We've generally not provided that. I think the comment we made-- two comments, one that pricing did not offset inflation and the gap was reasonably significant in the second quarter which has definitely widened from where we've been running. We've been playing as you know catch up with materials and it increase, and then the wind going into the third quarter is again fairly significant if you look at it versus the second quarter, the third quarter I think our estimate versus the streets estimates would have been much more easy, but much of an easier comparison if it were not for copper in the third quarter.

And you guys do do a fair amount of hedging. I'm just curious because the hedges roll off in a fairly systematic manner. What-- why is it that your I guess this far short on the price cost curve and does it imply anything about industry pricing?

Well, there's a couple things, Mike. One is that I think industry pricing has been fairly good, however, just the nature of what we expect when we work with about six different experts in terms of trying to understand what's going to come in front of us in the copper market, and if you went to the end of last year, everyone was expecting it to be, the prices to be down reasonably significantly by now. Instead we've had yet another surge, so the hedge position coming into the quarter is probably a little lighter than where we've been in recent quarters, based on I think more normal expectations of the way pricing would react, so that's the main issue. In terms of the industry, I think the industry is reacting with prices but it has been the case now for the last few years. It's late in delivering the price versus when we actually see the cost.

And when do the lines cross, Henry, given the prices you've gone out with and maybe you can layout what you have gone out with and then again, where the lines cross?

Well, I think it depends, obviously depends on what happens with prices in the copper market, but if they stay reasonably consistent, we still expect them to start the downhill trend. I mean there's a lot of capacity scheduled to come on line between now and the first half of next year. There's still a backwardation in the market so the market continues to believe that prices are going to trend down. You would expect that the lines will cross some time probably in the first quarter of next year unless there's another surge in pricing.

And what price increases have you gone out with most recently ?

About a 5% increase and it will take effect at different times during this quarter and of course some of our business is under contract and will not be affected by it during this quarter.

So the fourth quarter is really when you see the almost full force of it?

Yes. It will filter in as the quarter progresses.

Okay. All right, thank you, guys.

Thanks, Mike.

Your next question comes from the line of Robert LaGaipa with CIBC World Markets. Please go ahead.

Thank you, good afternoon.

Hi, Bob.

Just had a question on Mechanical segment. Obviously, a phenomenal performance in terms of the margins, and I was just curious as to what happened between last quarter and this quarter and between this quarter and last year that created that type of margin? I mean at 16.5% here, this is the highest margin you guys have had since the late 90s so can you maybe just provide some color on that?

Well, we're very very pleased obviously with what the team has been doing there. They took on a whole series of actions and actually over the last two years there's been a lot of activity including the sale of a couple of businesses that we didn't believe were any longer appropriate or strategic to the Company. In addition to that just ongoing cost reduction efforts, the Lean in Six Sigma efforts and very heavy productivity [dex.] Mark do you want to add any additional color?

Those are the three things, we did restructuring in '05 that paid us in '06 and '07, we have the Lean Six Sigma and we had gotten rid of one of the underperforming businesses.

Anything sequentially from last quarter to this quarter because even sequentially I mean it's up 430 basis points.

Nothing out of the ordinary. There is a full court press as you can imagine in that business-- in those group of businesses just like our Electrical to improve performance and some of our businesses that have been kind of under our level of expectation have just done a pretty phenomenal job at bringing their performance up and their operations, driving their cost productivity results to the bottom line and that would add these new products. So again, that definitely begins to fuel the margin line when you can come up with the innovative new products that we're seeing out of these businesses as well.

Absolutely and I guess this is a related question and obviously you moved the Ohio facility down to Monterey, Mexico. What other changes should we look for in terms of the footprint or consolidation of facilities, et cetera say over the next few quarters? And this is of course excluding FASCO.

Well, as you can appreciate, we are constantly looking at the value equation, if you will, through our customers eyes and so we have some product line moves that we are executing. Some of those are moving products-- product shipments to either Asia or to Mexico, and at the same time of course we're bringing on a lot of new products and those I would say are not necessarily automatically going to Asia or Mexico. They're being produced in a variety of facilities, so it will be, I mean, the fine tuning will continue forever. I don't think there will ever be a time when we aren't doing a lot of fine tuning.

We have a lot of work to do as we move into the FASCO opportunities to make sure that we fine tuned all of the product offerings and that we take advantage of our size and capabilities of purchasing materials as well as manufacturing efficiencies, sharing best practices, so I think there are a lot of opportunities there. They just-- they aren't a switch on the wall. They all take work and will be awhile before we can get them implemented.

And obviously from a Lean standpoint, you're fairly early on in the adoption across the organization and I guess what struck me here, and tell me how far along you are in terms of this, with the multi-brands plat-- the multi-brands off of one platform, is this the first [forance] into that area or is there more to go here or how far along are you in terms of that process? Really consolidating the brands on to one platform but at least in the market showing the different brands?

In terms of a new product launch, this would be the first time we've done what we talked about, one manufacturing platform and multiple brands, and where we think we could do that and maintain our differentiation among our brands we will do that. It is not our first foray in terms of existing product. We have, again where we think we can maintain our differentiation in the marketplace. We are consolidating platforms and consolidating brands where it makes sense. And we'll-- that's a long term journey and we'll be doing that for quite some time.

And the reason I ask these questions across productivity initiatives and other plant consolidations, et cetera, is if I look at the CapEx being down roughly 19% to 20% versus last year, how should we take that in terms of that decline? Is it just that you're more efficient with the CapEx or how should we look at that?

I think there are probably a couple things that you could keep in mind. First of all this years CapEx is very heavily oriented toward new products and productivity, so we feel pretty good about where the money is being spent. We're doing a little less catch up, if you will, on the IT side of life. As you know last year, we had two or three major sessions of implementing the Oracle system across the GE businesses. This year that's a lighter schedule because we completed the big ones. We still have more to do but those will start to fall into next year now.

So I think that the from a standpoint of how we're spending money, I guess I would add one other thing. Lean manufacturing as we ramp up, I think you asked the question before, where are you and I'd say we're in the second or third inning, So there's a lot of game to play there and we could not be more excited about what we're accomplishing. But one of the great things that comes out of Lean is more effective utilization of your assets and so frankly, we've been able to improve our throughput in a couple of facilities pretty significantly. When I say that I'm going to talk about 40% to 50% type of throughput improvements, without having to do much CapEx. So it creates capacity in and of itself.

And last question, just quickly is when's FASCO expected to close?

Well, we're waiting for Hart-Scott-Rodino approval and we've been filed I think for roughly two weeks, so assuming that there are no additional questions that come up , you would expect it to be at the 30 day mark, so hopefully we would get approval by the end of this month and we'll close as quickly as we can get it accomplished.

Terrific. Thanks very much.

Thank you.

Our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

Good afternoon, gentlemen.

Hi, Jeff.

Just a clarification on the price increases you're going out with the 5%. How would you, I mean, what percentage of your product line would you say you're going out with, with that kind of a price increase?

It's across-the-board, in terms of our Electrical side of our business where it hits more, on the Mechanical side, copper is not as significant of an issue. So anywhere on the Electrical side, it'll cover that range and it'll be-- each product line goes out at a different time.

Now you mentioned I think the lease and price increase as of July, so is that incorporating that five or is there incremental to that?

No, that's the five we're talking about.

Okay, so and then what portion of the Electrical piece would you say is kind of tied up in longer term contracts where you'd have to wait?

It's roughly 1/2 of the Electrical piece is in longer term contracts and some of those, however, have built in agreements whereas the copper goes up in price, so does the pricing to the customer. So they aren't affected by industry changes but they are affected by the long term contract that's in place.

Okay, and then I guess Henry, as you think about your long term margin targets, I mean is-- just given the stubbornness of commodities and just the state of kind of residential HVAC, as you look to hitting those long-- I mean do you need to reassess the long term targets, is it too early to do that or are there other things you can do that maybe are an offset to some of those external challenges?

I think that's a great question, Jeff. As far as we can see, we don't believe that we need to change our long term targets. Now, could you have some move out? Yes we said from the very beginning that it was dependent upon having just reasonably solid markets, and into the commodity headwind, and we still feel the same way.

Now obviously as we bring in FASCO, they will be coming in at lower margins, but we still believe we can accomplish what we said we could accomplish on our current business, absent those special situations like a market that's down as much as the HVAC market is down this year, and we don't expect that to go into the end of next year. So we said by the end of '08 we thought we could get there, we're not giving up on that yet.

Okay, great. And then you've mentioned that the acquisition pipeline, even despite FASCO is still pretty active. Can you just talk about what you think your balance sheet capacity is in terms of doing additional deals and how you're thinking about management capacity along the same lines?

Well, balance sheet wise, we've got ample capacity and we can do a lot. Dave I don't know if you want to try to put anymore color in that or not?

Well, yes. It could do the math yourselves as well, but the-- our capacity, probably ultimate capacity even in this market is much greater than probably where we feel comfortable going. As you know we generally run the Company kind of in that 30 to 50 debt-to-cap range and even within that range, we have capacity to do quite a few things, FASCO being the first and room to do at least that much more, in either larger property or group of smaller ones. So the capacity is not certainly an issue even with the market being a little choppy for financing.

I think the other question, Jeff, you asked is do we have the Management capacity and I would say yes. We have built substantial capability over the last few years , certainly the GE acquisition has been helpful on top of what we consider to be a pretty good base that was already successfully completing the acquisition so we built some additional structure. We've added some headcount to help us become a more consistent acquirer, if you will, and to make it more something that investors can depend upon as opposed to here and there. So I think from our standpoint, we believe we're investing and we have the capable-- the capability and people to do the-- to do more acquisitions than we've done in the past.

Okay, perfect. Thanks, guys.

Our next question comes from the line of Nigel Coe with Deutsche Bank. Please go ahead.

Thanks, good afternoon, guys.

Hi Nigel.

So just wanted to return to the inventory reduction and Mark , you seem to imply that most of this was optional, but how much was-- is structural in terms of better IT systems allowing you to lower lead times and how much was due to the OEMs cutting off the order towards the end of the quarter?

Well, I'm not sure I understood your last comment there, but I mean there-- I would say some of them, well I'll just say it was braun and 1/2 of it was related to the fact that we had the tools in place to properly size our inventories and properly look at both finished and in-process inventories, so I'd attribute 1/2 of our inventory reduction to better tools.

Okay, good. And have you talked about, sorry if I missed it, but have you talked about how much production volumes are down in the quarter as a result of this inventory reduction?

Not specifically. I don't think I have the unit number.

Okay. Somewhere in the 5% to 10% range, would that be, would that be fair?

Yes. Again I don't have the production unit data to really validate that.

Okay, and on the net impact of pricing copper, if you give out the information, it might help in your negotiations with customers, so just another stab here, what would you expect the incremental delta to be on that net recovery from 2Q to 3Q?

From second quarter to third quarter?

Yes.

With this additional headwind?

Yes.

Is in several million dollars, $4 million or $5 million kind of range.

Okay, no that's helpful.

It's significant, and it's one that-- pricing I guess we feel in a lot of ways is hopefully the last option we would much rather go to a customer with a great new product to help make them successful but it's a reality as well.

Okay. Just another quick one. On the pricing you said you mentioned 5% pretty much across-the-board. Typically when you have 5%, how much of that sticks and the long term agreements you have, what's the [deration] are those locked into?

Well, first of all, the take rates probably 60% and when you announce a public price increase. And then in terms of the longevity, it's all over the board. It depends on the customer. Some of them are many many years and some of them are a single year.

Okay, great. Thanks a lot, guys.

Our next question comes from the line of Holden Lewis with BB&T Asset Management.

Good afternoon, thank you. Again, I guess on the copper question. When I look at a chart of copper it seems like really for the past 15 months with the exception of maybe a three, three and a half month period at the end of '06 and the early part of '07, copper prices have been between 3 and 380 the whole time, and so with the exception of a brief period of time it's not like copper over the past 15 months has wiggled all that much. And I could understand if you're replacing lower cost hedges to higher cost hedges, but at what point do our hedges and our spot exposure begin to fully reflect a 3 to 360 or a 3 to 380 copper price?

Yes, I think that's the same question that Mike was asking earlier, in a lot of respects probably by the end of the first quarter next year.

Okay, so by then, you think that all of your hedging and spot exposure will kind of be consistent with the current level of copper?

Yes, short of there being another surge in prices.

Fair enough.

That we can't predict.

Okay, great. And then I guess the other question I had is it looks like the SG&A from Q1 to Q2, looks like it was down about $6 million sequentially despite the fact that revenues obviously seasonally are up. That seemed like a pretty dramatic drop. Can you talk a little bit about why the SG&A dollars fell like that sequentially?

I'd have to go back and look at that a little farther and bring in all of that detail. There was no single driver. There's been a pretty big emphasis, Lean and Six Sigma don't just impact the factory floor, it impacts our entire business. Some other things that have changed is with us migrating out of GE, we are completely out of all transition services agreements so that's been a cost to the business that we're now out of, and again, we've done a lot behind the scenes to reduce as Mark fondly calls it swivel chair work and in some cases we try to redeploy that to R&D in technology but in some cases that's fallen to the bottom line.

Right, but I mean over the past-- over the proceeding five quarters, your SG&A level dollar wise had run in a pretty tight range between $48 million and $50 million, and then to drop to $44 million in Q2, I mean it almost looks like there was a switch that got flipped there. Is there anything other than sort of ongoing efforts that you can point to that would have caused such a departure from the proceeding months or proceeding quarters trends and is there anything that may not be sustainable in the quarter ?

Nothing in particular. If you, I mean look back over last year, I think you've got some, you had the transition services agreements that I mentioned that were in a full effect. I think the first half of last year, there were some pension related expenses related to some changes and assumptions with some of the pension plans that I think was in the Q last year and that was fairly sizeable, several million dollars. But there's not one thing I could point to I guess at the moment to direct you towards.

Okay, great. And then I think to sort of build on Nigel's question about production rates I think it was, was your production level in Q2 just qualitatively below where it was in Q1 and are we likely to sustain the Q2 levels? I mean directionally is that what we had been seeing within your ops?

I think the way to think about it is we're seasonal with Q1 is lower than Q2 and then Q2 is the high point and then Q3 is slightly lower than Q2. Typical seasonality is the way to think about it, so Q2 would have been higher than Q1, and Q3 will be similar to Q2, maybe a little lower.

Okay, and then the inventory draw downs that you're working through presented an additional-- and I guess that's-- I think you'd been running sort of below production optimal production because you were trying to work in the inventory and it just seems like to get the type of inventory cut you had in Q2 that you probably would have taken that suboptimal production even lower, seasonality aside is that right, or no?

Well, some of the inventory that we grew down was inventory we built up in Q1, and some of it actually probably held over from last year, so we were drawing that inventory down and some of it was related to better operating performance because we had better tools across the business to do it. Clearly the seasonality in HVAC affects that, but across the rest of the business, having better tools allowed us to perform better. And I think what Dave had mentioned is the right thing, that as we go forward, we see continued opportunities in the receivables and payables side on the cash but probably not a lot more upside in inventory in the near term.

Okay, and then last question, you mentioned Power Gen 22% , large motors grew 15%, HVAC was down 10-- 11%, can you comment how-- what the growth was for small motors and then commercial ?

Commercial industrial I made the comment when you combine commercial and industrial, and that would the industrial piece of that would be what they referred to as the large motors so when you combine them, it was up 10 in total.

Okay and the large motors at 15 plus is within that?

That's right.

Was the commercial and the small motors, did they grow because obviously they grew less than the large motors but did they grow or did they turn negative at all?

No, they grew, well when you talk small motors you got to set HVAC aside and then they definitely did grow but not at the same pace. It was high single-digits.

Okay. Great. Thank you.

Our next question comes from the line of Chris Bamman with Morgan Joseph. Please go ahead.

Good afternoon, gentlemen.

Hi, Chris.

A couple questions, real quick. When you guys purchased copper, what is the lag between purchasing the copper and actually putting the copper into the finished product? In terms of when you buy then it goes into the product?

Typically, we are hedging, we have a very disciplined hedging process and we are layering in consistently as far out as 18 months at times and so at any given point in time, you would see us probably hedged 70% to 80% in the quarter ahead , sometimes a little less than that, never more than that. And if you looked out a year you might see us in the 20% area. So we're calling that shot now for next spring so when you ask the question when does that actually get into the product, technically it never does because we're doing a hedge and so that's just a financial mechanism of protecting yourself with the price. When we actually buy the copper, it's probably the end product within 30 days.

Okay. And then you guys talked about the residential HVAC sales being down around 11%. Is there anyway you could quantify that too or what it's from?

As far as what's driving that or--?

No, like down 10.7%, do you have like an absolute number? Or can you give an absolute number?

I'm not sure I understand the question. From a sales standpoint it was down 10.7%.

Right.

Chris, can you ask us the question again? We're not quite sure we understand it.

The residential HVAC revenues were down 10.7%. What, do you have some absolute numbers behind that 10.7%?

Oh, I see. We've never-- we haven't been specifically breaking out the sales by product group.

Okay. And then I guess as you look ahead and you look at your markets, do you feel or maybe what's your take in terms of the industrial and Power Generation markets in terms of that growth being able to offset what you're seeing in terms of declines in the residential market. Essentially are the returns to the strength that you're expecting in the residential market greater than what declines you might see in the residential market as they work to offset each other or partially offset? If you know what I mean.

Yes, about 2/3 of our business is in commercial industrial marketplace, so when you think of it that way, it takes less of an increase there than it would take in a decrease to offset, so we still think that there's opportunity for further growth. We are somewhat seasonal so as you look at the third and fourth quarter, you would expect a normal decline to take place as Mark already talked about. And we, frankly as we go into the fourth quarter, we should start to face more favorable comparisons for the HVAC business, so I would say we're-- while we will see a normal decline in the fourth quarter, we do not expect to see it fall off like it did last year. It's probably too early to get prognosticating too much for the fourth quarter. Okay that's it for me. Thanks.

And the next question comes from the line of John Emerich with Iron Works Capital.

Thanks, a couple unrelated questions if I could ask them separately. Just to repeat what you said earlier in terms of the working capital improvements, receivables and payables, sustainable or even more to go, inventory you'd be looking to hold about these levels of turns?

Correct. The-- in a payables side, we as a Company our global sourcing effort, we change terms late last year, so that has been ruled out and we continue to improve our payable position from a DPO standpoint, and we'll continue to improve that going forward. And then on the receivables standpoint, we are full court press on making sure that our customers are paying for the terms that we've agreed and we think we still have room there and as Mark mentioned inventory probably in total for that performance kind of hanging where it is, but still some opportunities.

Okay and the-- could you repeat your comments about the tax rate in the next couple quarters and the implications maybe for the following year?

Sure. We haven't given anything out for '08 yet but for the third quarter and the fourth quarter, I would use 34.5%. We based our guidance for the third quarter on 34.5%.

That's my fault. Running a fair bit lower than I had in my model, is the year now looking for a full year tax rate lower than you would have thought at the beginning of the year or did I just have it wrong?

Yes, I have to go back and look at our guidance but I would say the answer is yes. I mean that's certainly below kind of our historic tax rate combination of a couple things. One of it being as we grow internationally and grow in countries with lower tax rates, that certainly benefits us and has effected as far as our structuring of our Company, we can take advantage of that so it's really a combination of those two factors that we'll continue to work on that tax rate.

Okay, so as long as your international keeps growing, there's no obvious reason why it would have to bounce back up to the 36%/37% range?

At this point, with world tax law the way it is I would say that's correct.

Last question, a questioner asked about or made a reference to your long term margin targets. Can you remind me what those are?

We said back in '05, in mid-teens which would imply a 14% to 16 % as a Company.

All right super. Thank you very much.

Thank you.

Our final question comes from the line of Mike Schneider with Robert W. Baird. Please go ahead.

Guys just some follow-ups. Mark, maybe on the ECM product rollout the refrigeration push, I guess is that a new market for you and are the revenue amounts you've been talking about incremental?

It is relatively a new market. We've had one product in that segment for about the last couple of years and we did take a stab at a new product, Mike, about a year and a half ago, and we fell short, and we got it right this time and so yes, I would say certainly this freezer segment and the bottle cooler segment, that is not a space we have been strong in the past and the dollars that I gave you are incremental to our business.

Okay, and then in the HVAC space, can you update us on where you are in the Next Generation, ECM and of the post-mortem on X-13 in the past year. And then maybe looking forward, I presume you're quoting for the Next Generation platforms or the next platforms for 2008, just what you've won and lost or what you would expect?

Yes, first on the Next Generation of ECM, we did rollout as I had mentioned in one of our previous calls, we rolled out our ECM 3.0 most recently. That like was probably six months ago is when we launched it. We do have customers now utilizing that new version of the product, and the benefits of that product are around reliability and quality improvements in the product. It also includes that Black Box technology which gives you cause of failure if the system goes down it actually works like a flight recorder. So that product is now being used by a number of customers and that's in the market and doing quite well. We're pleased with that.

In terms of X-13, it is still a great story. We're very proud of it. We do have some customers who are now adding X-13 to platforms that were tough to get it on during the 13 SEER time, when they were doing all of the redesigns of their systems. So there are a couple customers continuing to add X -13 and we're pleased with that as well. Did I get your two questions?

Yes, and then just I guess on the standard motor side, have you sensed the cannibalization of the standard motor business,? If I recall in the first year the rollout you were pleasantly surprised that it didn't cannibalize all that much but what is the update there? And then the I guess the one question I had ask that maybe didn't address is platforms for 2008, wins and losses

Okay. In terms of the cannibalization, yes. I mean every X-13 motor cannibalizes somebody's motor. There's no doubt about that and you're right, when we first launched it, we didn't see as much, we didn't see the decline in our standard motor business that we would have expected. And now-- what I can't tell you, Mike, was was that because of the market was simply so strong during the 13 SEER build up, I don't know that. But yes, every X-13 ship either cannibalizes ours or somebody else's.

In terms of '08 platforms, in terms of platforms themselves, customers design them and they typically don't change over quite often. Now I can tell you there have been some wins and some losses. We have lost some business and we have won some business going into '08.

Do you-- have you become aware of any significant competitive ECM wins?

What we have said before is that there's always a lot of talk about ECM product. We have not seen an ECM motor by competitor yet and that is not because we haven't tried. We just haven't been able to get our hands on one yet.

Okay. Thank you, again.

Thanks, Mike. Okay, again we want to thank all of you for joining the call, and for your interest in Regal-Beloit. Takeaways from our perspective are these: That number one the Company is strong and delivering despite headwinds, very strong cash flow, we are at the epicenter of energy efficiency opportunities, our new product pipeline is strong and aimed at making a difference for our customers and we have the financial latitude to support both the R&D necessary for new product development and acquisitions. Thank you, have a great day.

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