Regal Rexnord Corp (RRX) 2009 Q1 法說會逐字稿

Good morning. I will be your conference operator today. At this time, I'd like to welcome everyone to the first quarter 2009 earnings conference call. (Operator Instructions) Thank you. Mr. Barta, you may begin your conference.

Thanks, Eric. Good morning, everyone, and welcome to the Regal-Beloit first quarter conference call. Joining me today are Mark Gliebe, President and CEO, and Henry Knueppel, Chairman and CEO. Before turning the call over to Henry, I'd 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 for 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 in our filings with the SEC. Now I will turn the call over to Henry.

Thanks, Dave. Welcome everyone and thank you for joining the calls and for your interest in Regal-Beloit. Today we will follow our normal agenda which is that 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 I will finish up with a look at the second quarter and we will open up for Q&A. From an overview standpoint, the first quarter proved to be every bit as difficult as we projected. At the time of our fourth quarter earnings call we were generally considered pessimists giving our projections for the markets. Today, we can unfortunately say that we were pretty accurate in our view.

As has been repeatedly reported, our markets generally started out the year down and moved down broadly and significantly throughout January and February. We saw some leveling in demand in certain markets in March but at a very low level and we have not seen the normal seasonal uptick that should have begun in March. The downturn occurred in nearly every vertical market and geography. Notable exceptions for Regal-Beloit included India, Europe and high efficiency products. The most notable downturn was in North American general industrial markets and China.

Characteristic of significant downturns, bad news begets bad news. With companies and individuals pulling back, unemployment continued to rise sharply and the spiral intensified. When we started the quarter, we believed that business would actively reduce inventories in this environment. They did. That's the good news. The bad news is that we do not believe that the inventory reduction phase has completed. Rather, we believe that the demand drop was too steep to get ahead of and that we will see this activity continue strongly in the second quarter.

As we said on the fourth quarter earnings call, we do not view this downturn as short-term in nature. We believe that we are in the midst of a permanent reset. With this prognosis as the most likely scenario, we have been rapidly resharing our company to be successful in the new environment. We have aggressively reduced head count, stopped overtime, eliminated temporary and part-time help, reduced expenses at all levels and we have significantly sped up plant closings and fast pay back productivity programs. While we are cutting costs at every level and every location in the company we have not cut in the area of new product development or lean six sigma. We continue to believe that we can grow faster than our markets by fully utilizing our global geographic footprint and our front runner position on energy-efficient products. Mark will talk about additional new product introductions in a few minutes.

Further, we believe that servicing our customers' needs from world class lean production lines allows us and our customers to react from both a speed and cost position. When our customers win, we win. One of the true strategic advantages that we enjoy is that we entered this difficult time with a strong balance sheet, one that allows to us prudently invest in the future and in those programs that will allow to us differentiate ourselves as the world returns to a more normal environment. We cannot claim to have better incite into the future than anyone else, but we do believe that we have the best people with the best tools to deal with what comes at us.

While we are not optimistic about our markets in the near future and we do not see any immediate significant recovery in our global economy, we are genuinely excited about our future. We continue to believe that we will be one of the early out companies due to our residential markets and our developing economy markets. Further, we believe that we will benefit from secular trend to reduce energy dependent sea and to improving our environment. Finally, with a solid balance sheet and improving ability to successfully complete acquisitions, we believe we could be in position when the time is right to expand our scope of operations. With that, I will turn it over to Dave Barta.

All right. Thanks, Henry. Before I cover some of the financial highlights of the first quarter, I'll mention to you that our press release is posted on our website if you haven't seen it, and also we plan to file our 10(Q) shortly. As Henry mentioned, while the quarter was difficult we are pleased with many aspects of our performance. Certainly among those, the fact the quarter did come together very much as we had anticipated. The plant moves and other cost reduction are proceeding on plan. And while we were concerned about our ability to reduce the inventory that we had at year end that we knew we needed to do take out, we did achieve those intended reductions.

Henry mentioned the quarter started out on a difficult note and worsened. Sales for the quarter ended up at $443.3 million, a 17.4% decrease from the $536.3 million reported for the first quarter of 2008, but with that decrease was in the middle of the guidance range we had provided. Included in the results were $29.7 million sales for the Dutchi acquisition completed last October, the Hwada acquisition complete about a year ago and the CPT acquisition completed in the beginning of January of this year. FX impact was a reduction of sales of 2.4%.

In the electrical segment sales decreased 17.4% compared to the prior year inclusive of acquisitions, excluding impact of the acquisition sales decreased 23.7%. Breaking that down a bit further, commercial and industrial motor sales in North America decreased 23%, the global generator sales decreased 12%, and sales for the HVAC business decreased 22%. Sales in the mechanical segment decreased 17%. As mentioned in our release, our sales outside of the US were 26.7% of total sales versus 25.6% for the first quarter of 2008. And high efficiency product sales increased to 12.9% of total sales as compared to 12.2% a year ago.

Gross margin for the quarter was particularly pressured by the volume reductions. As you can imagine, the impact on plant volumes due to lower sales coupled with our inventory reduction efforts was significant. On a positive note, the operations team once again delivered positive productivity for the quarter. We also incurred expense of approximately $2.4 million related to plant moves which are underway (inaudible) and the cost of sales area.

Operating expenses decreased as compared to the first quarter of 2008 by approximately $2 million. The impact of the acquisitions was actually an increase in SG&A expense of about $5 million, meaning that we reduced our base SG&A cost by $7 million. With regard to interest expense, as discussed during our fourth quarter call the change in the accounting for the convertible notes which was effective for us beginning with this fiscal year resulted in a non-cash interest expense of $1.1 million for the first quarter of 2009. The comparable amount for the first quarter of 2008 was $1.2 million, resulting in the adjusted income that you see for the prior year on the press release, about a $0.02 impact to first quarter of 2008.

Tax rate for the quarter was 34.1% versus 35.4% for the first quarter of 2008. The favorability resulting from the distribution of income for the company on a global basis. Net income, therefore, for the quarter was $12.8 million as compared to the adjusted $31.4 million for the first quarter of 2008. On a per share basis, we finished the quarter at $0.39 as compared to the prior year adjusted EPS of $0.95.

Now turning our attention to the balance sheet, debt and cash. We ended the quarter with $587.3 million of debt which is an increase of approximately $11.9 million from the end of 2008. However, our cash balance also increased by about $17 million, meaning net debt, decreased by $5 million during the quarter. Our debt to EBITDA ratio ended at 2.18, well within our covenant levels. Depreciation amortization was $15.3 million for the quarter and CapEx was 8.1. We did bring down accounts receivable in the first quarter but that was driven primarily by the lower sales volumes. We also were successful in reducing inventory levels by $32 million, in line with the target that we set at the beginning of the year. We also again saw accounts payable decrease with the inventory reduction goals. We definitely scaled back on bringing in raw materials, so accounts payable dropped by about $50 million.

Turning to the forecast for the second quarter, our EPS guidance as presented in the release of $0.38 to $0.46 per share. In this estimate we are assuming the sales decline of 20% to 25% including the impact of acquisitions, lower production volume once again will impact our cost of sales and that's driven by the sales forecast, but also a goal of further reducing inventory levels. We have another significant goal in front of us as far as taking out yet more inventory. And we expect to incur about $3 million of costs related to the current plant closures and line moves. We also expect the impact of price of inflation to have basically a neutral impact on margins.

We expect to see SG&A costs drop slightly from the first quarter on an absolute basis as more of our cost reductions read through. The amortization of non-cash convert interest prompted by the change in the converted accounting ended in the first quarter. So interest expense will again just simply be a factor of our actual debt level times our effective interest rates. We are using a tax rate of 30% for the second quarter, which is a decrease from the first quarter, again due to the distribution of income for the company throughout the world with more of our income being in the lower cost tax locations.

We are forecasting capital spending of approximately $8 million to $12 million in the second quarter and at this point we'll keep our full year capital spending guidance of $40 million to $50 million. However, we are being very guarded with regard to spending in the CapEx area and are currently somewhat underspending that full year rate. Again, we will be making investments in productivity and new products as we move forward and we anticipate full year depreciation and amortization to be in the zone of $60 million to $65 million. Now I'll turn the call over to Mark.

Thanks, Dave. Good morning. The sales environment during the first quarter was very difficult as we experienced double-digit declines in most of our businesses. Europe and India were the exceptions. In Europe our (inaudible) team performed well actually experiencing growth in the quarter despite very tough market conditions. In India our domestic markets slowed but still showed moderate growth. As for our North American-based businesses, the slow down in orders that began for us in November of 2008 continued through the first quarter. Our sales to North America OEM customers were down 21% as manufacturers shuttered their lines to align production rates and demand while simultaneously reducing their inventories.

Our sales through North American distribution were down 18% as distributors reduced their inventories to free up cash. Material instillation continued to be a head wind in the quarter despite the downturn in commodity prices beginning in October. Steel costs were still inflationary on a year over year basis. Copper and aluminum spot prices were down versus last year. However, our hedge position which was helpful throughout the last three years voided any benefit. As we look at the second quarter while we are beginning to see minor benefit from lower steel costs, our hedge position on copper and aluminum makes commodities overall inflationary. We expect to begin to see some relief on copper and aluminum during the third quarter.

As you know, we have been working diligently to maintain and expand our leadership position in new and energy related products. During the fourth quarter call we communicated the launch of our new 460-volt energy saving ECM motor and also discussed the launch of our new 180 [frame] energy saving platform that we are producing in our new [Monterey two] facility.

During the first quarter, we launched two additional new products. First, in our Marathon Motors business in India we introduced a new line of medium and high-voltage horsepower motors from 750-kilowatt to 4 megawatt. This was a significant investment in our recently acquired India based business. In the past we did not have a product for this $150 million segment of the India market which is currently growing at 15 plus percent. We announced the product just three months ago and we already have orders for 84 motors that will be shipping in the late second or early third quarters of 2009.

Also in the first quarter our mechanical master gear business announced a new niche product for deep sea oil and gas exploration. It is a quarter turn deep sea valve actuator that is designed to operate 13,000 feet below sea level. As the oil and gas industry moves to greater and greater depths to extract fossil fuels, our customers require highly dependable components that can withstand pressure at these levels. We shipped our first order during the quarter with additional units to be delivered in the second quarter. Our end customer is the North Stream pipeline between Russia and Germany.

From an operations perspective our focus has been to serve our customers while reducing our inventories and lowering our cost. During the quarter, we reduced our inventory, as Dave mentioned, by $32 million and significantly reduced our employment levels at virtually every facility. As we reduced our inventory and down sized our factories we experienced lost productivity and a drag on our costs. As we head into the second quarter with continued pressure on revenues, our goal is to reduce inventory by another $35 million to $40 million and, as a result, we are expecting continued cost pressures.

During the first quarter we successfully completed the closure of our Neelsville, Wisconsin, facility and our Monterey, Mexico plant is now producing all of those requirements. We are now in the process of transferring a portion of our [Lebizon], Missouri, production to the same Monterey two facility. Also in the first quarter we started the transition out of our 400 person Elden, Missouri, manufacturing facility to our existing facilities in Mexico and Springfield, Missouri. By the end of the second quarter, the Elden move will be complete.

Finally, in the first quarter we announced the closure of our Brownsville, Texas, facility. Brownsville currently makes components for our generator business. We will be transferring the Brownsville production to our existing facilities in Mexico and the US. As we look at the second quarter, our orders have not significantly improved and we are not seen the normal seasonal build in our construction business or in our HVAC business; however, there are a few bright spots we'd like to highlight.

First, our HVAC segment where the recently passed stimulus billion providing consumer tax credits for new energy-efficient HVAC systems is having an impact on our business. The tax credits cover 30% of the cost up to a $1,500 cap in any of the following, a 15 SEER heat pump, a 16 SEER air conditioner and 95% efficient gas furnace or a water source heat pump. These rebates are impacting our business because our customers often use one or more of our high efficiency products to help deliver the energy efficiency levels in these HVAC systems. At the beginning of April we started to see a pronounced shift to a more energy-efficient -- to our more energy-efficient products as our customers prepare for and HVAC contractors take advantage of these new tax credits for consumers.

Finally, the latest housing data gives us hope that the residential segment will be the first out of the recession when it does emerge. Our belief is that there will be a pent up demand for HVAC systems. Typical HVAC systems have an average expected life between 13 and 15 years so the systems installed back in the mid 90s when the housing market was growing 4% to 5% annually are now beginning to fail. In the last two years consumers, as a result of their desire to save or as a result of their inability to obtain credit, have delayed the purchase of HVAC replacement systems. The past recessions have shown a strong snap back in the purchase of durable goods so we are optimistic that the HVAC industry will see improved growth rates as consumers satisfy the pent up demand. So with low channel inventory, pent up demand for HVAC equipment replacement and secular shift to improve energy efficiency, we are excited about the inevitable recovery of the HVAC segment.

In summary, the first quarter was as tough as we had predicted it to be and while we took the necessary cost actions to right size our workforce, we continued to resource the new products that will be our future. While the decline in our sales has been somewhat shocking to our team, it is absolutely shaping our business for the future. Our leadership team is determined to win in this environment, our employees overall are displaying resiliency, a sense of urgency and a willingness to sacrifice in these difficult times. I'm confident that we will come out of this recession a clear winner. Thank you and now back to Henry.

Thanks, Mark. As we look at the second quarter we expect to see continued and perhaps strengthened efforts to get inventory out of our industrial channels. At the same time, we are intensifying our own efforts to take inventory out and to reduce our operational footprint. This combination will have a detrimental effect on our earnings. When we started the year, we expected to see a second quarter seasonal push. This push traditionally begins with the HVAC business in March in preparation for home starts and continues building inventory for the heavy summer replacement market. As of this call, we have just started seeing signs of improvement to get ready for the summer and, to some extent, to get ready for possible growth due to the incentives in the stimulus package as Mark talked about.

The early season push related to home starts did not occur. Further, we normally expect to see seasonal improvements in our commercial and industrial markets though minor by comparison to the HVAC market. At this juncture we have seen some leveling but no signs of improvement in these industrial markets. Also impacting the second quarter we will experience added margin pressure as a result of costs related to plant closures, a lower run rate to more aggressively attack inventories and year over year material costs increases as we work through our hedged position. This combination of events leads to us project earnings for the second quarter to again be in the range of $0.38 to $0.46 per share.

Looking beyond the current quarter we remain very optimistic for several reasons. First, while we are not trying to call the trough specifically, we believe that we are near it. Second, we believe that the consumer is healing and that housing will recover from current levels. Further, the stimulus package offers 30% up to $1,500 in tax credits to improve home efficiencies and one of the best investments is the HVAC system. Tied to this opportunity we believe that there is pent up demand, as Mark discussed, in the replacement market that could lead -- could be unleashed with an uptick in consumer sentiment. Third, as we move into the third quarter we expect improved earnings even on flat sales due to our restructuring efforts and commodity cost relief that will begin during the quarter. Fourth, we are front runners in energy-efficient products. Our products offer meaningful paybacks in today's environment without help from the government programs. With help now available and legislation already approved, these products should experience meaningful growth. Fifth, we expect our growing presence in developing countries to pay dividends early in this global cycle. Finally, we believe that the quality of our people and our processes and our balance sheet put us in position to differentiate our company in the months ahead. With that, we will open it up for questions.

(Operator Instructions) First question, Steve Volkmann, go ahead.

Hi. Good morning. A couple of questions on inventory, I guess. First of all, how much do you think the industry is kind of underbuying whatever, I know demand levels are weak but clearly the industry is underbuying even those weak demand levels and I'm trying to think about even without a fundamental increase in activity there should be some snap back I suppose in the second half when the inventory correction kind of gets done. How should we think about that?

We are trying to make sure we understand the same thing. It isn't, there is no absolute number that we can get our hands on, as you can appreciate, but it would not surprise me to see that number be something in the vicinity of 10%.

Okay. That's helpful. Then what are we seeing with respect to pricing? I guess both with respect to your own pricing and also with respect to anything that customers, I'm sorry, competitors might be doing out there? How is that sort of holding in here?

There are a lot of different spot stories and so on, but I think overall the industry is relatively disciplined. We think that the industries that we participate in hedge similarly to the what we do. And so the pricing so far has stayed relatively disciplined. However, we've said from the -- for the last six months that there will be pricing actions that will be necessary. We have certain customers who are in material price formulas that are moving prices in relationship to commodity spot prices so there's a mixture of things happening, but it's certainly not in a run away kind of environment.

Okay. That's helpful. Thanks. I guess just the last one. In the second half it seems like the raw material costs should certainly be in your favor here and yet I think Dave mentioned that it's going to be sort of a wash for the year price versus cost. Is that just because we get back in the second half what it costs us in the first half or is that because we think that pricing probably comes under more pressure in the second half?

My comment, maybe I wasn't clear, was for the second quarter.

Okay. My mistake. So it should be somewhat positive in the second half then?

It should be, yes.

Okay. Great. Thanks, guys.

Your next question comes from Steve Sanders. Go ahead.

Good morning everyone.

Good morning, Steve.

Just a follow up on the pricing side. Any notable differences in the C&I market versus the HVAC market in terms of either what you are seeing thus far or your expectations?

We are thinking about that. No. I don't think so there's any notable differences in either market.

Okay. And then the commentary around Europe and Asia it sounds like the Dutchi value offering is holding up very well and Austin is as well. What about the outlook there, do you still expect those to stay in the positive camp or significantly outperform? How should we be thinking about that?

We are pretty positive about the new products that we are bringing online in both places. I would say in particular in India the base market itself is doing better than clearly it is in Europe. So we are pretty positive about what's going to happen at that location. Europe is a tough one to call right now because the market itself is down and we are in the battle where can we bring enough new products to the market to overcome that or not in this downturn. I would say that that answer isn't known yet.

Okay. And then on the high efficiency products I'm not sure if I did the math correctly but it looks like year over year you were down somewhere in the 8% to 10% range there. Is that correct?

Correct, on the year over year base and that differed as we break that down certainly we issued a couple of products that were actually still up year over year on the volumes but other than with the volume drop we were down.

Okay. Okay. And then all in with the various charges and facility consolidations I think you've given us all the pieces, Dave, but it feels like the 2Q gross margin is shaping up to look pretty much like 1Q. Is that fair?

Certainly in that zone.

Okay. And then final maybe for you, Henry, on the M&A side, I would assume the pipeline is pretty active as always, valuations hopefully are starting to come down a bit. But I wanted to do see if you could talk a little bit about your focus from either a geographic or product perspective and also giving the macro environment that you are seeing right now, how are you thinking about pulling the trigger on something more substantial than what we characterize as a tuck in?

Well, the pipeline, as you said, the pipeline is pretty full and there are a lot of interesting opportunities as you know, Steve. We've kind of pushed back on those because of the environment we are in and because frankly we feel like time is on our side. We do continue to believe that we will be an early out company when many companies are still feeling the pinch and that valuations will continue to come down as trailing 12-month numbers start to be more representative of the current environment versus the past environment. So we are not in -- we are certainly not in a hurry. However, we have our eyes open and our heads up. We continue to look at geography where we can bring either aligns us with faster growth base markets or where we can almost be a new entrant so to speak with products that should sell in that environment. So geography continues to be important and technology will continue to be important.

Okay. Thanks very much.

Thank you.

Your next question is from Michael Schneider. Go ahead.

Good morning, guys.

Good morning, Mike.

Maybe just to clarify, Henry. Did I hear you correctly when you said as of this call you have started to see signs of some seasonal orders or you have not?

We have.

You have. So this is just in the last seven, ten days or something?

It's just literally in the last week and a half or so we've seen some signs but don't over read that. It's not like the order book is jumping but we have seen some improvement in the HVAC market. Signs.

Talking to other major suppliers of the HVAC OEMs, it's my suspicion at least that distributors have been loathe to order any inventory ahead of the season. Do you have any indication or commentary from your customers that what was ordinarily a March, April billed could indeed just be a contemporaneous May, June season?

Not necessarily but I would say that what we've typically seen as being in March had to do with new home starts and as you know while they are better than anyone are anybody anticipated, that doesn't mean much at that lower level. I think we are just now starting to see how they feel about the summer and I do think we are seeing signs that the our customers at least have confidence in what the sell through is going to be for higher efficiency systems.

And the HVAC OEMs in particular because I believe that's your biggest OEM exposure, they have extended shutdowns in Q4 and Q1. As they come back can you talk about the activity level with them?

Mike, I would just in general first of all back on the inventory question our, the feedback we are getting from our key customers is they are selling what they are building. I mean that's kind of the way we are hearing it right now. Any of the activity we've seen in the last couple of weeks has been somewhat related to the stimulus bill and making sure that as they are seeing activity as a result of the stimulus bill.

And is that comment true, Mark, on the distribution side as well, that sell through matches their orders?

I would say here's our sense of it. There's probably some small build going on so that they have products that can meet the need of the stimulus bill. But, in general, what we are hearing is they are selling what they are getting orders for.

I think Mike is asking a question about other industrial distribution, Mike, is that the second piece?

Yes.

No, our sense there is that they are still reducing inventories, not to the extent that OEMs are but they are still in the process of coming down to today's operating levels.

Okay. And then on the 12.9% of sales that are related to high efficiency can you just drill one level deeper and kind of separate that in to high efficiency HVAC versus everything else, is the predominance of it still HVAC?

We are not going to take it down any further than this but certainly the HVAC piece is a good portion of that. But also so is the high efficiency industrial motors. Those would be probably the two biggest categories.

Okay. And as a rule of thumb, how should we think about price premiums for high efficiency motors whether it's industrial or HVAC at this point, is 30% still a good rule of thumb?

I don't know -- well, I don't know that we want to answer that specifically, Mike. We continue to be warned against talking about that. But, yes, as we've said in the past if you take a look at [NEMA] premium today versus standard efficiency for industrial motor you would be looking at something between 20% and 30% premium. As you know, the legislation that affects that starting in December of 2010 will make most of what is today standard efficiency or [E pack] efficiency going to NEMA premium and that's plus. We would expect that to condense a little bit or contract a little bit at that time. But in general today you would say that that's roughly what the range is.

Okay. Then I apologize sticking to this energy efficiency theme. If we look at the HVAC mix it's about 40% of your sales and if we take the high efficiency percentage at 12.9% and assume two-thirds of it or whatever is high efficiency, I guess I'm still amazed that that large a proportion remains the standard efficiency HVAC motors. Is it because they are going overseas or maybe just give us some sense of why 13 SEER didn't ramp that market even faster for you yet?

There are a lot of different ways to achieve 13 SEER other than to just use the motor and I think we've said that from the very beginning. You can use a standard motor to get to 13 SEER and then get there in other ways. So there is some low end of the market and in this environment, as you can imagine, the value end of the market is selling greater than the premium ends of the market. So I think that's what's driving that. And I think you're right, it is still a big portion of the total.

That leads me to my I guess really objective here about the stimulus package and the credit for $1,500. It in effect makes a 13 SEER cost equivalent to a 13 SEER for the consumer. At the 16 SEER level, what is the difference in penetration of high efficiency motors versus standard?

You need a higher efficiency motor to get there.

Got it. And I guess just on this life span issue of 13 to 15 years for HVAC, can you describe what you are seeing today in the replacement market? Is there a tendency and ability of the consumer to replace motors and then maybe relate that back to your newest motor which does go into distribution for after market HVAC.

We are seeing a slightly better performance still not -- I won't celebrate anything that has brackets around it, but we are seeing better performance in the after market in that segment than we are in the OEM market and our evergreen product is seeing some pick up. It is not a grand slam though, but it is seeing some pick up.

Okay. Final question just on the facility rationalization and head count reductions. Can you maybe go through either plant by plant or just in total what amount of savings these generate on an annualized basis and then of that what you expect to capture this year from the facility savings?

We will go through by facility starting with the Neelsville facility which was closed, as Mark mentioned, several weeks ago. That was projected to be $4 million to $5 million on an annual basis. And, again, that facility is closed so we are seeing the savings or some pay out costs that are included in the number that I gave for the second quarter, but certainly that's the early part of this quarter and then we will see the full impact of that on a quarterly basis going forward. The [Elden] closure that Mark mentioned is well under way. That was a $10 million to $11 million savings and we hope to have that facility closed around mid year. My guess, again, is there will be some slight tail-out costs into the third quarter but it should be fairly minimal so we will see the bulk of a half year of that in terms of savings. And then the other line and plant moves Mark mentioned another say $2 million to $3 million in savings, much more minor costs and again we should be through those by mid year as well. So that's on the plant side.

Okay. Very helpful. Thank you.

Thanks, Mike.

Your next question is from Jeff Hammond. Go ahead.

Hi, good morning, guys. Just to go back to the restructuring, can you give us -- it looks like it cost you $3 million or it's going to cost you $3 million in the second quarter and $2.4 this quarter. Can you just talk about what benefit, was there any benefit netting against that?

There was but it was fairly minor. The Elden closure I would say minimal, certainly nothing net. The Neelsville, minor. As you know, with these facilities you don't go from one day running 100%, the next day at zero. There's usually a kind of tailing down of the operation. So I would say in the first quarter though very, very minimal on all fronts.

Okay. So as you look to the second half do you see additional restructuring costs coming through? I mean what is that kind of $5.5 million number go to and what is the benefit kind of ramp up to?

I think it's a little early to really talk about what that might be in the third quarter. As I mentioned, there will probably be some tail off costs as you can imaging a large plant like the Elden plant you have, even once the operations moved, certainly tail out costs related to people in the building and equipment and so forth. Again, I think it will be a fairly nominal number, I hate to project it at the moment.

Okay, then on the inventory destocking, what do you think that impact was in the first quarter on your cost of goods?

We did take out the $32 million and I think on our fourth quarter call we said that would have an impact on fixed overhead absorption of around $5 million.

So that bumps up to $7.5 in the second quarter?

Yes, we have a little bigger target for the second quarter.

Then do you think by the end of the second quarter that headwind abates or --?

Yes, I think so. In this environment when your sales are off 20% and you start with the inventory number it's a pretty big number you have to take out and coming into the year we had more than what we needed. That's gone. Now we are really after the inventory that needs to come out based on the volume levels but I think so. I think most of our businesses are targeting very aggressive take outs in inventory hope to have done by June. So certainly nothing to that magnitude but we certainly always raise the bar on ourselves but, again, we don't envision at this point something near that magnitude.

Then shifting gears to the generator business which grant was down but held in better. Is that more a function that you are shipping out of backlog or is that business, the fundamentals of that business hanging in better?

It has a tendency to be a little bit more of a lag than some of the other parts of our business. So there isn't something about it at this moment we would say is going to hold up better than the general economy.

So maybe that starts to trend a little more like your other businesses going forward.

Yes.

Then China, I guess broadly on these manufacturing calls we are hearing China is kind of the one area that feels a little bit better and I think you cited it as more challenging. What are you seeing differently there and maybe more recently any signs of more stabilization?

Well, the first quarter was not a pretty picture first of all. I mean, there was a lot of drop in any portion of the business that went to export and, in addition to that, there were a couple of one-time events if you recall last year, the freak snowstorm that had tremendous demand for generators in the first quarter that didn't repeat. We see that the domestic economy in China coming back now and improving. Exports are still very challenged.

Okay. Thanks, guys.

Thank you.

Your next question is from [Dan Lang]. Go ahead.

Good afternoon. Just I think you provided the sales trends for Asia overall but could you provide details on how Europe and US did overall?

I couldn't understand what he said.

He's asking about -- did you ask about, I'm sorry, Europe and?

I think you said Asia down 24%, how did Europe and US do on the whole?

I actually don't have the pieces broke out. Obviously with Dutchi that is certainly one acquisition, so Europe obviously year over year was way up. You strip that out and I would say they were probably down.

Dutchi was actually up.

Right. I don't have just the US piece in front of me.

In terms of the your comment that you remain optimistic beyond the second quarter that you expect improving earnings trends even with flat sales, I think that's coming from some of the cost savings from the rationalization and the commodity and pricing coming out more positive, could you provide a little bit more detail kind of order of magnitude sort of benefit from the hedging wearing off and the how that might contribute in the second half?

I don't think we want to provide a ton of detail on that. I mean what we've I think said for several months is that as we get into the second -- the first half we were pretty fully hedged and what we thought might have been not fully hedged because of the downturn in the markets turned out to be fully hedge we will still have hedges that are higher than current spot markets as we go into the third quarter but considerably lower percentage. I don't think we want to get into that directly a lot more than those kind of comments. In terms of the plant closings, Dave covered that I think with a fair amount of detail and they are significant.

Right. And, finally, talked about your continued focus on investing in new products. What would you say your current -- in terms of your current sales base, what percentage of that is coming from new products that you've rolled out maybe over the last couple of years, and I would imagine that the margins on new products are sort of better than kind of the company average?

We do measure that and we look at it every year and kind of in the rear view mirror, but last year 30% of our sales came from new products and generally speaking the margins tends to be better on the newer products.

In terms of the new product focus, I mean I think you will continue to drive that more in these higher growth kind of emerging areas?

Absolutely. We are looking at new product in every space. On our overall focus is energy efficiency but in a couple of cases it will just be like we did in India, having a product to play in a space that we have not played in the past.

Great. Thank you.

Thank you.

Your next question is from Christopher Glynn. Go ahead.

Thanks. We have a number of things in the gross margin to have good visibility to some nice pop there in the second half with more favorable price cost, less under absorption and the facilities closures coming in. You did comment on the SG&A coming down sequentially, but just wondering if we could have a few more pieces to work with similar to the gross margin level of profitability. What kind of decline are you looking at maybe, and then the second half trajectory there?

Well, I think maybe the right way to think about it is just as you step that down you've got the run rate of where we are going to be in the first half and then you have obviously not that level of absorption hits and certainly in the back half of the year so there will be a pretty clear read through starting with this base, add that back and add the impact of the plant closures. On the SG&A side of things, there is nothing out in the future that's going to cause our SG&A to jump. We actually are continuing to look at opportunities to spend our money more prudently and take further costs out but we've obviously made some pretty significant cuts. So we see that SG&A, there's a piece of our SG&A related to commission sales force and so forth that does move to volume. So if (inaudible) assumptions of volume for the back half of the year there's a little bit of variable based on sales but its a fairly small part. So starting with this base, adding in the absorption hit, taking out the one-time cost related to plant moves, adding (inaudible) plant moves and the run rate for SG&A should kind of get you to why we make the comment we do that we are pretty confident the back half of the year is going to -- we are going to start to get these cost savings (inaudible) without the costs associated.

Then with the tax rate at 30% and kind of the comments on gross margin it looks like even at the low end of sales down 25 you would be pushing the high end of guidance. You are thinking about just unseen volume contingency there or -- ?

Usually just in general with our guidance range there's always that (inaudible) go into that often times that sales range is one that's pretty significant in how we set a guidance range as that reads through to EPS. But again little bit extra cost related to the restructuring, a little bit more impact from volume in the plants being down, those will certainly hit the margins. So the comment earlier about margins being fairly flat they're actually in our model slightly down in the second quarter given those two factors.

Okay.

With the tax rate do you understand it will get you to the guidance range we provided.

Then any, anything in the geographic mix that suggests that we should assume a change in the tax rate from the second quarter into the second half?

No, not at this time.

Okay. Thank you.

(Operator Instructions) Your next question comes from [Nicole] (inaudible). Go ahead.

Hi, guys most of my question have been answer you had but I have one left. I know you talked about seasonality in Q2. But if you could talk about what you expect for seasonal pattern in the back half of the year, are you expecting normal seasonality in Q3 and Q4?

We wish we knew. It's hard to call normal, anything normal this year. I would say that we are, we have some hopes. We do believe that consumers are healing a little bit because of mortgage costs coming down and gas prices being down and other costs that affect the average home being down and some signs that are coming out from the government that they are beginning to revive. And in that kind of an environment there is some upside to the replacement market versus repair in the HVAC world. The industrial markets frankly I don't think we can call that at this point. How fast will the stimulus package begin to impact them is one question, when will the inventory reduction cycle end is another. We would expect I guess that the inventory reduction cycle will start to be pretty complete by the end of the first half but there is certainly no guarantee on that. So I don't think that we have any particular great information that says that it's going to be jumping so to speak in the second half of the year.

Okay. Thanks.

Your next question comes from Holden Lewis. Go ahead.

Thank you, good afternoon. You talked a little bit about the inventory in terms of going beyond Q2 because even if I take out the $30 million, $35 million that you are looking to take out gets you down to around $295 million, year over year that puts your inventory down about 4% in revenues that are down obviously in the 20% range. So I mean it wouldn't seem to me that although you come off the peak nicely, it wouldn't seem to me that you have necessarily taken it down far enough. Am I thinking about that right and does that suggest that we are going to continue cutting inventory and impact on gross margins during the second half of the year?

I don't think there's anything magic about a particular month when it stops. I mean we are going to continue to try to drive inventories down. Some inventory is harder to get at and it takes longer. I would say the blunt force instrument so to speak that we are experiencing right now won't be that bad in the third and fourth quarters, but we are still going to be trying to work to take inventory out as we can. It just won't be as rapid a pace.

I'm wondering about the gap between if you achieve your goals in Q2 your inventories are down 4% year over year versus your revenues being down, call it 25%, 26% year over year. I mean that seems like a big gap that one can attack beyond the normal sort of day-to-day efforts to bring it down.

Holden, I think your point is well taken, believe me. We are not going to rest. However, there's a couple of things. First of all, we may be working off of a false low right now with channels being cleared and being the low point of the year normally. So you do have that piece. And then secondly, as you know, as you typically as you start to attack inventories you take the faster moving stuff first and some of the slower moving you just can't get at it quick but you can't go a whole heck of a lot faster on the fast turning items because you get to the level that is the appropriate level.

Also, Holden, I didn't check your math but if you are looking at just year over year we did not have the Dutchi business a year ago at June end and being a distributor they have more than their fair share of inventory I guess is the way to politely put it, so we do have an acquisition in there that we wouldn't have had a year ago in June.

Okay. All right. And then can you, it's a lot of talk, it's usual a smaller piece of the business, the mechanical business being down only 6% in Q1, obviously markets were down more than that and it's margin held up pretty well in light of the environment. Can you talk about what's going on in mechanical that seems to be making it somewhat resilient to the cycle both in terms of its rate of revenue contraction as well the margin?

We are checking a number here.

I think it was actually down more than that. I I think it was actually down 17% so it would have been much more in line with the company and no acquisition impacts there.

All right. Never mind, then. I will have to check my numbers from my past model. There might have been a restatement. Okay. Thank you.

Thank you.

That does conclude the questions we have in queue, ladies and gentlemen. At this time, I will go ahead and turn the call over to Mr. Knueppel for closing remarks.

Okay. Thank you and thank you for your questions. The take away from this call I think are pretty straight forward. First of all, the second quarter will continue to be pressured. There are no easy wins that we can talk about. We remain optimistic and poised to be early out company, however, and with restructuring and cost reduction restructuring cost reduction efforts that we are taking we are positioning ourselves to do well in a mediocre environment and outstanding in a good environment. We have a solid balance sheet and talented people capable of doing more if opportunity present themselves and we appreciate your interest in Regal-Beloit. Thank you. Have a great day.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.