Regal Rexnord Corp (RRX) 2008 Q2 法說會逐字稿

Good afternoon. My name is Kiara, and I will be your conference operator today. At this time, I would like to welcome everyone to the Regal-Beloit second quarter earnings conference call. All lines have been placed on mute to prevent any back ground noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). Thank you. I would now like to turn the conference over to your host, Mr. David Barta, Chief Financial Officer. Sir, you may begin.

All right. Thank you. Good afternoon, everyone. Welcome to the Regal-Beloit second quarter earnings conference call. Joining me today are Henry Knueppel, Chairman and CEO, and Mark Gliebe, President and COO.

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 results to differ materially from projected results, please refer to today's earnings release released in our filings with the SEC. Now I'll turn the call over to Henry.

Thank, Dave and thank you everyone for joining us in this call, and for your interest in Regal-Beloit. We will follow our normal agenda. I will make some opening comments, Dave will cover the financial aspects of the quarter, Mark will give you some color on products, markets, and operations, and then we'll talk a little bit about the third quarter, and take questions.

First of all, let me just say that we were extremely pleased to announce yet another record quarter, in spite of the strong headwinds in the residential HVAC market, and then unprecedented rise in raw material costs. Our largest market, residential HVAC was down approximately 12% for the quarter. We fared better than the market due to our first mover advantage, and continued success in introducing high efficiency, and more intelligent products. Mark will share more on that in a moment.

Concerning materials, steel has doubled since the beginning of the year. Copper continues to escalate. And energy costs in general are up across the board. While we continue to hedge some of our commodity exposure such as with copper, we have been forced to replace lower priced hedges, with higher priced hedges. We have raised prices on all product lines, but the reality is that with the combination of timing, and the difficult HVAC market, we were still in deficit for the quarter, as we projected. We will continue to closely monitor the situation, and will continue to act prudently and decisively, to manage our margins going forward.

Fortunately, we are benefiting from some strong tail winds as well. Our industrial motor, power generation, and industrial businesses, our international businesses have all remained strong. Our acquisitions since 2007 continue to be accretive to our financial performance, and importantly have added strategic value as we have expanded our manufacturing and commercial footprint in high growth areas, such as China, India, and Southeast Asia, and bolstered our portfolio of energy efficient solutions.

Our productivity programs are delivering across the board. Our people are doing an incredible job at every level in this corporation. They've kept their energy and focus on improving every aspect of the business, and they're a pleasure to work with. In summary, we feel very good about our recent performance, but we are even more excited about the future.

Let me take a few minutes and get away from the quarter, and talk about a gathering strength within our company. That strength is innovation. Four years ago we started focusing our R&D on what we considered to be the three mega-trends in our business. These include energy efficiency, variable speed technology, and embedded intelligence. Since that time, we have doubled our R&D spending on game changing products, resulting in more than 30 product launches over the past two years. Today, we are generating significant revenue from revolutionary products. We are continuing to launch new products at a record pace, and we have a robust product pipeline.

This level of innovation is positioning us to benefit from these mega-trends, as customer adoption continues to ram. Many of these new products are revolutionary, and bring new value to existing applications, such as lower energy consumption, enhanced process quality, reduced maintenance costs, and improved operational control. While these products hold the most promise, they also take the longest to gain traction. Frequently they require customers to make fundamental changes in their designs, to take full advantage of of our product capabilities. Such was the case with our ECM motors. However, with the cost of energy skyrocketing, and the real threat of greenhouse consequences becoming a reality, there are both economic and civic responsibilities that will drive increased demand for these products. We will be the beneficiaries of these important developments for the foreseeable future.

We have seen steadily accelerating interest and growth in higher efficiency products, and we expect this growth to continue, and adopt and to accelerate further as a result of new legislation. For example, we believe that the 410A coolant requirement legislated to go into effect in January of 2010, could create some acceleration in HVAC sales in 2009 and 2010, and a better replacement market in the years that follow. The commercial refrigeration motor legislation now in effect in California, and coming federally, will also create greater demand for our products.

In addition, we see further benefits from the pool motor legislation in California, which we believe other states will follow. The new large motor energy requirements going into effect in December of 2010, will require significant change in buying patterns in industrial motors. And new rules in China in effect this year, will require the move to higher efficiency motors over the next few years. All of these changes, and more, are going to be good for motor industry in general, and for Regal-Beloit specifically. The strength of this tidal wave is difficult to estimate. But like a tidal wave, we believe the impact will be far greater and longer lasting, than the seemingly gentle but steady set of waves that we see coming at us today.

Importantly, our innovation is expanding our addressable market opportunity. Today, we are actively involved in applications involving solar power, wind power, emission reducing drive systems, mechtronic drive trains on vehicles, and energy efficiency improvements in virtually every market we participate in, and in virtually every country where we do business. It is an exciting time to be in our spot at the epicenter of where energy is converted to useful power, to make life better. We believe that the future belongs to those who provide solutions, and we are distinguishing ourselves as the solutions provider for energy efficient motion control applications. With that, I'm going to turn it over to Dave Barta.

I'd like to review the results for the second quarter. Then we'll discuss the outlook for the third quarter. This morning's release, if you didn't see it, you can find it on our website. Sales for the second quarter were $606.3 million, which is a 31.9% increase as compared to the second quarter of 2007, included in our sales results were those results for the five acquisitions completed over the prior year, which total $131.8 million. The impact of foreign currency also added about 2.3% to our sales growth as well. Electrical segment, sales were $548.9 million, an increase of 36.3% versus the second quarter of 2007. And includes the impact of the acquired businesses which all roll up in this segment.

Segment growth in electrical segment was paced by the power generation business that experienced 40.2% year-over-year growth, as we continue to see strong worldwide demand for our generator products. Commercial industrial motor sales in North America increased 4.6%, which compares to a 1.4% increase in the first quarter of this year. Sales for the HVAC business as Henry mentioned, fared much better than the overall market, as a result of the improved mix of high efficiency products. Sales for the business however, were still down 3.6%. Sales in the mechanical segment increased 0.6%. I should add that we did reclass approximately $2.9 million of sales from the electrical group, to the mechanical group, for the second quarter of 2007, as a result of transfer of certain product sales to the mechanical segment from electrical segment.

From a geographic standpoint, our sales outside the US were 27% of total sales, versus 22.8% for the second quarter of 2007. Excluding the acquired sales, we saw pretty good sales growth throughout the world. In Europe our sales increased 10.3%, Canada 5.6%, Asia was down 1.3%, and I'll explain that in a minute, and the rest of the world increased 9%. Sales in Asia as I said were down 1.3%, were impacted by one particular business, which was our Sinya business. Where our customer who has internal motor manufacturing capabilities, moved some volume inside to address absorption and cost issues, as we continue to raise prices on these products. Excluding the Sinya business, Asia sales would have increased 13%.

We also began reporting high efficiency product sales in this morning's release. High efficiency product sales increased 9.2% to 12.9% of total sales. This supports our view that there is tremendous growth opportunity, in energy efficient products, both in terms of the growth rate and the overall opportunity for RBC.

Summarizing the sales performance, we saw strong sales volume results in many business, which was obviously aided by favorable pricing, and the impact of currency, which was somewhat countered by volume challenges at Sinya and HVAC. Without going through all of the math, volume excluding Sinya and HVAC was overall up almost mid single digits. Gross margins for the quarter were 21.6%, as compared to the prior year second quarter of 22.6%. Exclude the impact of the acquisitions, the gross margin would have been $107.8 million, or 22.7% of sales. This result is in line with our expectations, and included inflation that exceeded the price impact by approximately $8.5 million. We continue to be very committed to eliminating this gap through improved pricing across all business units.

Operating expenses were $63.7 million, including $13.2 million from the acquired businesses. Operating expenses for the legacy businesses increased due to several factors. Some of those relating to last year, some of those relating to this year. Last year we did see favorable healthcare cost across the mechanical segment, which did not repeat this year. We also had a year-over-year increase in AR reserves, and increased selling and engineering costs. These factors increase operating expenses on a year-over-year basis by approximately $5 million. Income from operations was $67.5 million or 11.1% of sales. This compared to $60.1 million or 13.1% of sales, reported for the second quarter of 2007. Excluding the impact of the acquisitions, income from operations would have been $57.4 million or 12.1% of sales.

The tax rate for the quarter was 35.4%, the increase over the guidance we gave for the second quarter is a result of the distribution of income between certain foreign-based businesses versus the US. And versus the second quarter of last year, the increase is a result of the distribution of income, some foreign statutory rate increases, and the impact of the expiration of the United States research and engineering tax credit, which at this time has not been extended for 2008. The increase in the tax rate was about $0.01 unfavorable to our guidance. I'll also point out that minority interest was double over the prior quarter and our guidance, another $0.02 a share, primarily as a result of the strength of the generator JV business in China. Net income for the quarter was $38.1 million, as compared to $36.3 million reported last year. Fully diluted earnings per share were then $1.14, a 7.5% increase as compared to the $1.06 recorded in the second quarter of 2007.

Now I'll turn to the balance sheet and cash flow. We're very pleased that our teams continue to make significant improvements in working capital, particularly the teams involved in inventory, management, and accounts payable. Cash from operations was $81.4 million, versus $89.7 million the second quarter of last year. If you recall, the second quarter of 2007, was really the point where our working capital reduction efforts gained significant traction. So even though working capital was a source of cash this quarter of $25.8 million, working capital as a source of cash last year $44.5 million. Depreciation and amortization was $16.1 million, and capital spending for the quarter was $14.5 million.

As mentioned in this morning's press release, we completed a $165 million term loan during the quarter as well. The proceeds from the loan were used to pay off the entire balance on our revolving credit facility. So we ended the quarter with total debt of $568.2 million, or $480.5 million net of cash. Versus the year end level of $564.3 million or $521.7 million net of cash. Our net debt to total cap is 34.2, which is well within our comfort zone to consider any and all opportunities to create added shareholder value.

Turning to the forecast for the third quarter, our EPS guidance as presented in this morning's release is $1.06 to $1.13 per share. The guidance is based on a very similar view of the sales environment that we experienced in the second quarter. Sales contribution from the acquired businesses is expected to be approximately $150 million to $155 million in the third quarter, and I'll note that we'll have the full quarter impact of the Hwada business that we only saw for two months of the second quarter.

We're expecting to make progress in reducing the inflation of the price gap with the pricing actions that have, and are being taken. Based on our current view of the results of the pricing actions, and our view of material costs for the quarter, we see that gap between $3 million and $5 million, so about half the level it was for the second quarter. As mentioned in this morning's release, we're expecting a one-time tax benefit of approximately $0.07 per share, resulting from the repatriation of foreign earnings from one of our subsidiaries. A slightly higher base tax rate of 36% will be netted with this one-time tax benefit, resulting in a tax rate for the third quarter of 32.6%. And I would say a rate closer to the 35%, 35.3% rate for the fourth quarter is probably in line, given that benefit will not repeat. We are forecasting capital spending of approximately $10 million to $15 million in the third quarter, and continue to estimate full year capital spending of approximately $60 million, and full year D&A to be in a range of $60 million to $65 million. With that I'll turn the call over to Mark.

Thanks, Dave. During the second quarter, we continued to see growth in segments not tied to the residential housing market, most notably increased demand in our global generator business. In spite of both the unprecedented inflationary environment and the difficult housing segment, the majority of our businesses continued to perform well, and we are very pleased with the execution of our team.

During the quarter we saw sales growth in our commercial and industrial motor businesses, up 4%, and very strong growth in our global generator businesses, up 40%. We saw strength in our generator business, both in China and in North America. In China, the robust demand was driven by the devastating earthquakes that hit China earlier in the year, causing a strong increase in demand for emergency power. That increase in demand was on top of the surge in demand we saw in the first quarter, which was driven by the severe snowstorms. We expect to see continued strong demand in China, well into the third quarter.

Our North American generator business also delivered solid growth during the quarter, driven by three primary factors. First, we are seeing an increase in demand from the US Department of Defense where our generators are being used to provide power for military operations. Second, we are seeing an increase in the demand for the new generators we launched last year for the rail industry. These generators are being used to power refurbished locomotives to ensure they meet more stringent air emissions regulations. The third factor impacting our North American generator demand was an increase in export sales. These three positive trends supported our second quarter North American generator sales, and are expected to continue into the third quarter as well.

In HVAC, our sales were down a modest 3.6% for the quarter. Obviously, we do not like any performance that is down year over year, but given the continued challenges of the residential housing industry, we felt pretty good about our HVAC performance in the quarter. Energy efficiency and home comfort continues to play an important role in offsetting weaknesses in this segment. For example, we benefited from a shift in mix to our energy saving motors, as our customers are utilizing ECM technology to sell a better mix of their energy saving high comfort HVAC systems.

During the second quarter, we spent a considerable amount of time analyzing trends in raw material inflation in an effort to remain globally cost competitive, particularly as it relates to our input costs, such as steel, copper, and aluminum. By the end of the quarter we either raised prices, or announced price increases, effective in every part of our business. Most of the latest round of price increases will be in effect in the July/August time frame. We continue to aggressively drive productivity in all of our manufacturing facilities, and we have been reducing spending appropriately.

As you know, we have been working diligently to maintain and expand our leadership in innovative energy efficient products, for over a year now. During each quarterly call, we have announced new products that were recently launched in the marketplace. During the April call, we told you about our new Empower motor, which utilizes ECM technology to deliver energy efficiencies in variable speed capabilities in a pool pump application. The intelligent motor will first be utilized in the Australian pool market. We also announced our new Evergreen motor, which is targeted for the HVAC after-market. This line of motors will provide HVAC contractors a solution for homeowners who want to improve the energy efficiency and comfort of their existing HVAC systems.

As part of our long range planning process which we recently completed, each business was required to present its strategy for new products over the next three years. For two weeks we dug into every brand, and identified the product and technology needs for the future. The sessions were both exciting and promising. These planning sessions have been quite successful in the past, yielding some of our latest energy efficiency products. In fact, our sales of energy saving products on a year-to-date basis, grew two to three times faster than our standard products, and when you combine the sales of our evolutionary and revolutionary new products introduced in the last three years, new product sales now make up 28% of our total revenues. We will continue to invest in people and technology to deliver our customers energy saving alternatives for their products.

From an operations perspective, we are continuing to deliver significant improvements in our factories. From design platform consolidations, to product transitions, to lower cost facilities, to the implementation of lean in every facility, we are benefiting from the improvements in both our balance sheet, and income statement. For example, our Reynosa, Mexico facility has been on a two year lean journey, with the goal of reducing their order to delivery cycle time from 15 days to five days. The results have been impressive. The team has freed up a third of its factory floor space, and improved inventory turns by over a half turn, while improving their on time deliveries.

Our Wausau, Wisconsin facility where we produce generators and larger motors, has also been leaning out its facility with a goal of reducing lead times and achieving zero late deliveries to its customers. The team has restructured the compensation of its work force, implemented single piece flow, and reorganized their manufacturing line to eliminate bottlenecks. The team has achieved outstanding improvements in reduced lead times, and improved deliveries, and our customers are benefiting. We are expecting further improvements from our Wausau facility in the third and fourth quarters.

The efforts to continuously improve through lean implementation is paying dividends. Our customers are seeing the benefit through improved on-time delivery, and our shareholders are seeing the benefits in improved inventories, and stronger cash flow performance.

In summary, we are pleased with our execution in the second quarter. For the past several years, our focus has been to drive a culture of innovation and operational excellence, throughout our organization. Our teams have done a great job of implementing these strategies as our record demonstrates, both in this quarter, and in the last several quarters. And finally, as we move into the third quarter, we are optimistic that it will be another opportunity for the RBC team to prove to you that we can consistently perform, and deliver to your expectations. Thank you, and now back to Henry.

Thanks, Mark. Taking a look at the quarter ahead, we believe that we will achieve another record quarter. It will look much the same as the second quarter, with similar headwinds and tailwinds. Clearly, we would love to paint a rosier near term picture. We would love to be able to say that the residential markets are turning. They are not yet. We would love to be able to say that margin expansion will come from material costs holding steady, allowing our productivity improvements to flow through to our margins. We can't yet. Those things will happen. Not in the next quarter.

What we can say is that we are delivering despite these historic headwinds. We can say that our general industry and Regal-Beloit especially, will benefit from the energy and environmental requirements of our future. We can say that we expect it to be in a strong position to take advantage of the opportunities globally, and we believe that we can fairly say, that the market is not yet properly valuing what we are achieving today, much less the outlook for our future. We continue to be excited about what lies ahead. We have a strong balance sheet, strong cash flow, and a solid pipeline of acquisition opportunities. We are in an industry that is critical to energy and to environmental stewardship. With that, we will open it up for questions.

(OPERATOR INSTRUCTIONS) . Your first question comes from the line of Alexander Paris.

Good afternoon. Nice quarter.

Thank you, Alex.

Just a couple questions. Could I get a little better feel for your international scope? You did 27% outside the United States. Could you have a rough percentage of like Europe, Japan, and so forth, a breakdown?

Yes, the way we look at that is Asia, kind of a broad scale versus-- I have it by country. I actually don't have those with me. But the bulk of what we do is in the Asia-- would be in the Asia region, which would include China, and India, as well as Thailand. But again, I don't have those numbers in front of me in the room.

Okay. But Japan, as you look at separately, I'm trying to get-- how big is Europe?

Europe for us is not large. Annualized basis, somewhere in the neighborhood of, say, $50 million currently, and probably actually a little above that. The Hwada business that we bought during the quarter, has a fairly good sized customer in Europe. So it's probably between $50 million and $75 million now.

Okay. And just looking at HVAC and residential, you've also got big housing problems in Spain, the UK, Australia, and Europe. So it sounds like that, that's not as big an impact for you as it is in the United States. Is that correct?

That's correct. Our HVAC business, we do supply some of the US based customers that are located in Europe. It's fairly small volumes.

Okay. Just one other question. Could you give us a rough idea of-- you gave us the sales-- incremental sales from the acquisition, but a rough idea of the accretion in the second quarter, what you expect in the second half?

Well, I don't think our overall view has changed from the guidance that we've given previously for a true EPS accretion. And again, what I have with me is the op income from the business was approximately 7.7% or $10 million in op income.

Could you repeat the guidance that you gave earlier on those four acquisitions? Accretion for 2008, wasn't it something like $0.35 or something like that?

If you take the midpoint of the range, I think it was $0.34.

And there was no accretion from the latest one in China, but there will be some in the second half?

In the second half, for sure. The Hwada acquisition which was in the results for two months, because of the amortization of the inventory step-up, was basically neutral to earnings. I think it was actually a slight loss, but again, immaterial. We'll have a little bit of carry over of some of that amortization in the third quarter, but we should be past the one-time purchase accounting after the third quarter. So we'll see that more in a normal performance base, certainly in the fourth quarter, but obviously step-up in performance in the third quarter as well.

You expect the 2009 tax rate to be more like your normal 35% or so?

I think that's a good-- we are a couple months away from our financial plans, so until we get to that point, I think that's a pretty good assumption.

Thank you very much.

Thank you.

Your next question comes from the line of Mike Schneider.

Good afternoon, guys.

Hello, Mike.

Maybe first we could just talk about trends through the quarter. Could you give us a sense of what orders and demand look like, maybe industrial versus HVAC, as you progress through the quarter, and maybe in the July, now that it's almost over?

Yes, in terms of HVAC, I would say that was relatively steady throughout the quarter. May have ramped up just a little bit with some of the summer heat, but I would say it was reasonably steady. Industrially, we saw some slack in demand in the second half of June. Fortunately, July is back to the pattern, and kind of order rates that we were seeing before that, but I would say the last half of June for whatever reason, was slower than it had been during the rest of the quarter.

Okay. And then just distributor inventories, to get a sense of whether they're restocking, destocking or no change, as we've gone through the middle part of the year here?

Mark, do you have any view there?

No, I don't have specifics on that. I mean, there's been no specific input provided to me on that.

And pricing in HVAC, have you been able to garner as much, or as much as you need in the HVAC channel in pricing, for the second half? I've seen the 8% increases that went out on industrial, but maybe on HVAC, update?

Well, there's two piece to the puzzle, Mike. Some of our customers have-- we have material price contracts, for the price goes up along with the material. And then in others where we don't, there's obviously a tough time for them and they've been pushing back, but we've been rather diligent in our response.

Okay. And then just margins on the high efficiency portion of the business, it's growing as a percent of the mix. I presume the margins are higher than segment average. Could you give us an order of magnitude, so we could understand what the mix looks like going forward, as the secular trend continues?

I think what we've said, we've never got very specific, Mike, as you know. What we've said is that it's significant, and it follows what you would expect if you're providing higher efficiency product, costs are higher but the selling price is higher, and overall the margins would be better than our standard products.

Again, a different mix question. North American, commercial and industrial. Commercial was down hard last quarter. Wonder if you could give us some sense of what the growth rates looked like, industrial versus commercial this quarter, and just what you read in, in terms of price and unit growth as well.

Sure. And we have gone to a slightly different presentation, and I'll explain that. The former GE commercial AC business, we have moved in, and is part of one of the industrial businesses, so we'll gradually lose visibility in what was the old GE CAC business. We've gone to this presentation that you saw today, which will probably be the consistent presentation going forward.

Even at this point, because of that change that we made earlier this year, really took effect in the quarter, I couldn't tell you exactly the GE business, because some of those orders are going through the industrial businesses now. But directionally, where that business was down mid-teens in the first quarter, it was down only, I would say single digit rate in the quarter, and again, that's probably an overstatement of how far down they were, given that some of their orders are now showing up in the marathon brand. It was an improvement, and that was something that we did know would happen.

And that implies that the pure industrial portion of the business, Mark, actually decelerated a bit in the second quarter, versus first quarter?

Yes. To some degree. Mike, I think as we said, as the second half of June is when we saw that, and as would you expect, we've been watching it very closely in July, and it's rebounded back to the levels that we were seeing before. So it's a hard one to call.

Okay. And strange question, but just the shutdowns around the Olympics now, having been through your facilities in Beijing, and around there, has anything changed in terms of the length of the shutdowns, or your expect of the impact on the business in the third quarter?

We don't have anything that's affecting us directly. We have no facilities that fall into that area. We've done a pretty exhaustive view of our supply chain, and don't believe that we have any issues. We do have a few who were shut down, but we were able to put inventory in place, or plans for storage of inventory.

Thank you, guys.

Thank you.

Your next question comes from the line of Steve [Fender].

Good afternoon.

Hello, Steve.

First, a follow-up on the pricing side. You talked about some pretty aggressive price increases last quarter. Just the timing on when you implemented those, and then looking at the July, August price increases, order of magnitude relative to what you talked about last quarter?

Mark, you want to deal with that?

We announced the price increases in the second quarter and they went into effect in-- either in July, early July, or early August. And so that-- those were the -- that's the same information we gave you in the second quarter, that we were at that point in time.

Okay. Thanks. And then Dave, a follow-up on your comment about Sinya. Is this an issue going forward? Was it a short-term problem? Can you just amplify those comments a little bit?

Sure, we have one customer as I mentioned, has in-house motor capability, and this is a customer primarily in residential HVAC, and it's again, a different type of HVAC system there, so it's a fairly small, more inexpensive motor than what you would think about when you think about our US HVAC business. And again, they have always had an in-house motor capability, and have used outside companies, such as Sinya to be one of their suppliers. And this is a product that was a big part of what Sinya did when we bought it. We have had an effort under way to bring other higher value add products to Sinya on the commercial side and the industrial side of their business, to ultimately diversify what they do somewhat, knowing that you are always-- could be impacted by a customer such as this. With the rising costs, we have put the disciplines in place not only at Sinya, but at Hwada, and our other outside the US businesses to recover the costs of material inflation, and I think that certainly factors into this decision, by their customer quite a bit, that they don't like these increases, and we're going to go ahead and push those.

So I think long-term, our solution is that we have to bring other value added products there, and diversify ourselves around some of what was their core products, when we bought the business. And these aren't good margins. It's something that the price increase is there to cover costs, but we needed to move the margins up anyways, so we were going to do that through mix. I think it will be a short-term, short-term being we've got some work to do there, in our third quarter guidance we have Sinya off quite a bit as well, again.

So it's going to take a little while to get the products and some of the things that we want to get done there, done. But we've got a new leader for that business that I think is very focused, and our China leadership, the country leadership team is very focused on doing the right things with that business, and I think rallying the resources around what we need to do to get Sinya back on track ultimately.

Okay. And then on the high efficiency product growth and percent of sales that you gave us this quarter, can you just provide a little bit more detail on the primary buckets there, how you're defining it?

Well, included in that would be any high efficiency energy saving product. Some of the ones that you would probably be most familiar with that, factor into that there, out of our HVAC business the ECM product line, the X motor, some of the products Mark talked about in commercial refrigeration, whether they be internal generated ones or through the Morrill acquisition, and the industrial side, the NEMA premium high efficiency industrial products, would be included in that, as well as in our gearing business, some of the high efficiency gearings. I don't think we're going to into the details on any one of those groups in particular going forward, but that would be the total-- sum total of the products that are adding up to that.

And then final question, Henry, you mentioned some favorable regulatory changes on the motor side in China. Can you just give us some additional details there?

This year they create a system whereby they actually have now created five different energy efficiency levels within the country, and products like motors and lighting and some of the other-- I think there were 10 different items that were placed into this grid, and by the-- by this time next year, the lowest efficiency can no longer be produced, and then three years later the second lowest efficiency can no longer be produced. They're just going to-- typical pragmatic way, go about forcing the efficiencies up.

Okay. Thanks very much.

Your next question comes from the line of Chris Bamman.

Good afternoon, gentlemen.

Hello, Chris.

Just seemed to be a little unclear. You, Henry, had mentioned that HVAC was down 12% in the quarter, and yet in the press release it says 3.6 in motor sales. Could you sort of clarify those two for me.

The 12% was market.

Okay.

That would come from the ARI and other data as far as market unit performance for the quarter.

We fared better than the market is the point.

Okay. And what did you say that the tax rate, that you used for your guidance for the third quarter, was?

Let's see. I think it was 30. Let me take a quick look. 32.6.

And that would be with the $0.07?

Correct.

And if you took that out?

I think around 36.3.

36.3. Okay. That's terrific. Actually, most of my questions have been answered so that's all I have for right now. Thank you.

Next question comes from the line of Jeff Hammond.

Hello, good afternoon, guys.

Hello, Jeff.

I jumped on late so I apologize if this is a repeat. Can you give us overall price contribution in the quarter, and then specific to res HVAC what you thought price mix would have contributed versus the unit dynamic?

You didn't miss anything because I didn't specifically give that. Kind of keeping with our tradition and that of many of our competitors. Effective pricing year-over-year I would say characterized as low to mid single digits, and a little bit less than that currently in HVAC. But with the price increases Mark mentioned, we should see both of those accelerate.

Okay. And then in the first half of the year, you were kind of-- you put up 1.5% organic growth, 1Q, 3% 2Q, and yet you're expecting an acceleration in price. Do you expect that trend to change materially, as we move into the back half, or is that a reasonable run rate on a go-forward basis?

Yes, Jeff, you're asking the magic question. And what's going to happen in our markets. I mean, our view is HVAC market's going to stay relatively like it is for the back half of the year. I mean, it's going to have its normal seasonal twists and turns, but those are embedded in the numbers every year. Industrially, we're still seeing very solid demand. There's-- I still think that we're getting a nice boost from exports. Our customers' exports in particular, equipment due to the dollar, and certainly nothing has changed materially in that regard from the last call. So we're continuing to see solid markets.

Okay. And then just in terms of the acquisitions, would you expect-- with Hwada coming in, how do you expect the trend, or what do you expect the trend to look like in terms of these acquired operating margins? Does this press down the margins near term? How should we think about that relative to that revenue contribution?

Well, I would say the businesses that we have in China are lower margin businesses. They typically are faster growth, so we can create good returns, and over time we would expect that the markets there are going to improve as they rationalize. But currently, they still provide a good return on invested capital, and provides us access to markets that we feel we need to be in, to do what we need to do for customers here, as well as there. So overall, yes, those are going to be lower margins, I think for the foreseeable future, lower than what we would see elsewhere.

The acquisitions we did in 2007, we said that we thought would take us about three years to get those up to our other averages, and we still are on schedule for that, or slightly ahead of that schedule, feel very good about it. Regards to China specifically, I think you have to look at it as being good return on invested capital coming predominately from growth, and not from margins.

Okay, that's good color, thanks guys.

Your next question comes from the line of Nigel Coe.

Thanks, good afternoon. Based on what you know now in terms of the announced price increases, and (inaudible) commodity remain where they are, how does that net price commodity look in 4Q?

Fourth quarter?

Yeah.

You know, our whole intention behind the pricing efforts, which as you mentioned are very tough, and it's not our preferred route, but just necessary, is with an eye towards eliminating that inflation price gap. In the fourth quarter, as I mentioned, that's more in the neighborhood of $3 million to $5 million, so we've cut that gap in half. As Mark mentioned, there was pricing that went into effect first part of July, with pricing going into effect August, and many of our brands know that if steel continues to-- if it accelerates from here there will potentially be another round of pricing later in the year. I guess it's a little early to predict. I would tell you if everything holds flat, we'll have obviously some gain in pricing, based on the time phasing of what we're doing this quarter, so we should see that gap probably decrease further, again, our intent is to try to eliminate that by the fourth quarter.

Okay.

But again, I would say it's early for us to make that claim. We've got some more work to do to make that happen.

Yes, I would agree with that. And how rational is the market right now? Obviously we see some of the larger metal players are pushing through similar price increases. How rational is the market? Do you have any players out there who are trying to gain market share?

Certainly in the industrial marketplace it's been very rational. And I think that's true globally, by the way. We've seen price increases coming out of competitors in China, and India, and other locations as well. So I think that is behaving rationally. You see spot issues at time, but I wouldn't say those are significant at this point, and without question, globally the costs have gone up, and the prices have gone up.

Okay. And then on the higher efficiency side, I mean we're seeing higher energy costs coming through, we're seeing higher electricity costs through into factories. Are you starting to see, maybe even anecdotally greater interest in replacing older motors, with high efficiency motors? Is that gathering momentum? Are you starting to see that tidal wave coming through?

We see it literally every day at this point. You know, it doesn't feel like a tidal wave that you saw against the shores a few years ago on TV yet. There's just one wave after another that keeps coming. A lot of that is being driven in small motors by legislation, and large motors, economics, because typically large motors are used by businesses who are paying more attention to it. We're see just a continual move toward it, and I think we're just really now starting to see the tipping point on some of the electricity costs around the country. They held steady for a little longer than you might have estimated, but we're seeing those move, and as those move, they'll pick up speed.

Okay. And then what's the kind of the typical payback periods now for a typical high efficiency motor, versus a standard motor, what would be the payback period now versus maybe two years ago.

Well, obviously it's getting better, but you have to kind of look at it in a couple different buckets. A lot of it has to do with how much you are using process duty companies, where they are running 24/7, have understood the equation for a long time, pulp and paper, and chemicals, and some of those industries that are process duty, have been buying high efficiency motors for years. What's happening is, as prices go up, it moves it down the chain to where people who are using it less than 24/7, it starts to make sense for.

For example, commercial refrigeration, we talked about some of the new products we introduced there. We had paybacks for replacing a perfectly good motor that were anywhere from as little as a year or less, maybe 10 months, to as much as 18 months, but very good paybacks. As you look out at other motors, when you get up to a large motor, typically the payback would be great, I would say less than a year, or a year to a year and-a-half, if you were going to replace the motor anyway. But if you were just going to replace a perfectly good motor, the payback might be three to five years.

Okay. Very helpful. Thanks.

Your next question comes from the line of Bill Dezellem.

We had a couple of questions, first of all, would you please give us your perspective on the economic activity levels in China, and India, separately, and we ask the question because as you have I'm sure seen commentary in the popular press, that implies some slowdown taking place there?

Certainly what we've seen in China, it's kind of an interesting time, given the cost of transportation costs, and the cost of materials, and some of the escalation in inflation in China. You can see some of the edge coming off in terms of product that's produced there, to bring back North America for cost purposes only. As we said all along, we're there, number one, to be there as part of a growing market, and number two is to be there for customers who have global operations and need to us be there, and number three would be for cost purposes when it makes sense. So the cost equation is changing.

That said, that economy is still from everything we see today, still remains pretty dog gone strong. As Dave said, without the situation with Sinya, we were up 13% or 14% year-over-year. So still very strong performance. Maybe not as strong as last year at this time, when it was 25% to 30%. But still very solid. India continues to be a growing market for us, Middle East continues to be a growing market for us out of India, shipping out of India. So I don't think there's been an appreciable change. We haven't seen an appreciable change year-over-year there.

And entirely different topic, if you said this, I apologize, but what percentage of your sales are represented by products that you had put under the energy savings category?

In the quarter, it ended up being 12.9% currently.

Great. Thank you both.

Thank you.

Your next question comes from the line of Christopher Glynn.

Hello. Thank you. Little more on the price cost, just wondering what kind of scale in the cost increases you're looking at year-over-year in the third quarter versus the second? And then the incremental pricing, if you could kind of size that versus the second quarter?

I actually don't have the pieces put out in front of me in the room, but what I can tell you that is both of them are up substantially. What we're seeing just directionally is that inflation is accelerating from the first quarter to the second, and then second to the third, and fourth, and that's primarily driven by the pricing formulas we have for steel, we're on an indexed based formula, which somewhat uses history as the forward price. So the big run up you've seen in the steel markets hit us hard in the third quarter, and into the fourth quarter, so both of them are up you substantially, third and fourth quarter, to leave us with the gap that we talked about.

Okay. And then the gap you talked about is a nice narrowing from the second quarter, so just wondering if maybe you see it a little on the timing of the second quarter, to increase the stickiness going forward?.

We're going after the pricing just as quick as we can, but you've got obviously a customer, we're very sensitive, although maybe it doesn't sound that way at all times, but we're very sensitive to understanding their needs. So we are trying to implement pricing. The pricing we need as quickly as we can, again understanding that certain customers do need some time to react and deal with it, with their outlet, and their outlet being to their customer base. But beyond that, we're putting pricing in place, just as quickly as we can.

Okay. Thank you. And then just finally, are there any major OEM contracts that are coming up for renewal in the near future?

I mean, the answer is yes, because there are always some that are coming up. But nothing in the-- nothing out of the normal.

Okay. Thanks very much.

The line of Holden Louis with BB&T.

Good afternoon, thank you. You had made mention about the new products, and could you just clarify, I think you said it's 28% of sales, is that on a three or a five year sort of definition?

What we were talking about-- you're talking about the energy efficient?

No, he's talking about--

Dave, I made the comment that it was 28% on a three year.

On a three year. Okay.

Right.

Can you talk about what that might have been, maybe two years ago, and kind of what you connect expect that to be maybe two years out? And then talk also that 28% of sales, what's the margin on that sort of pool of business versus the rest, just trying to get a sense of how this fits in strategically?

Mark, do you-- ?

We started capturing the data about a year ago. So there hasn't -- there's been a slight change upward from a year ago, and the margins on the newer products are better than the margins on the older products.

Materially so or-- ?

By a few points.

Okay. All right. Thank you.

And there are no further questions.

Okay. Well, we want to thank all of you for joining the call, and for your interest in Regal-Beloit. We leave you with two thoughts. First of all, we are delivering in a very difficult environment, and I think the better news is that we are positioned for a great future. Thank you and have a great day.

Thank you for participating in today's Regal-Beloit second quarter earnings conference call. You may now disconnect.