Regal Rexnord Corp (RRX) 2010 Q1 法說會逐字稿

(Operator Instructions). I would now like to turn the conference over to John Perino. Please go ahead.

Good morning. Thank you, Amy. And welcome to the Regal Beloit first quarter 2010 earning conference call. Joining me today are Henry Knueppel, Chairman and CEO, Mark Gliebe, President and COO, and Dave Barta Vice President and CFO. Before I turn the call over to Henry, I would like to remind you that the statements made in this conference call that are not historic in nature our forward looking statements. Forward looking statements are not guarantees since they are inherit 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 today's earnings release in our filings with the FCC.

Now I will turn the call over to Henry.

Thank you, John. Welcome everyone. Thank you for joining the call and for your interest in Regal Beloit. We will follow our typical agenda. I will make some opening comments and Dave Barta will talk on financial aspects of the quarter, Mark will cover color on products markets and operations and than I will finish up with some comments on the second quarter and we will have time for q and a. So let me start off by saying that we are very pleased to be able to report both year-over-year and sequential quarterly improvement in sales. We felt good about sequentially flat fourth quarter given it is normally a weaker quarter and now with the first quarter building on the fourth quarter and with 14% improvement on a year-over-year basis. We are guardedly optimistic that the economic noise that has dominated our markets for the past 18 months is beginning to clear.

The first quarter marked the fourth consecutive quarter of relative improvements in both bookings and shipments. We are even more pleased to report our earnings improvement relative to last years first quarter. This improvement clearly illustrates the earning leverage we have gained with the difficult but permanent actions we have took over the last two years, and frankly and more importantly, the significant repositioning of the Company over the last several years. To be fair we would say the first quarter of 2009 was an unfair low in earnings as we and our customers reduced inventory severely, commodity hedges plagued our margins and LIFO cost created a temporary hedge wind. Further, as we told you in the fourth quarter earnings call, that the fourth quarter 2009 contained significant tail winds due to LIFO gains and temporary commodity help.

This quarter again contains some temporary tail winds coming from an inventory revaluation that will not repeat going forward. Stripping out all of he noise in those quarters, here's the bottom-line. Revenues in bookings are growing sequentially and we are achieving meaningful earnings leverage. Even more positive is the fact that we are now seeing bookings pick up in our mid and later cycle businesses with the exception of Europe and we are continuing to see heightened demand for high efficiency products across the entire spectrum of our businesses. Three additional highlights for the quarter were, first we had another positive cash flow quarter. This is significant in light of our 14% increase in business and the fact that our first quarter has traditionally been a negative cash flow quarter.

Second, the acquisition of CMG headquarter in Melbourne, Australia, we believe that CMG holds number one or two position in Australia, New Zealand, South Africa and Singapore in motors and number one or two in Australia and New Zealand in power transmission products. And they hold significant positions in motors in Malaysia, Indonesia and elsewhere in the Asia Pacific region. With sale of $130 million and compound annual growth rate of 23% over the last decade and an excellent leadership team we are extremely pleased to have them join our family. And we are excited about the benefits of this strategic combination. Finally, it was a pleasure to increase our dividend for the fifth time in six years, further rewarding our shareholders for their continued investment in Regal Beloit. All things considered it was an excellent quarter.

Dave.

Thanks, Henry. As indicated in last night's release we did have a very strong first quarter that even surpassed our original expectations. Overall we benefited from strong end market demand in many areas and especially in the HVAC business. Volume in our factories has greatly improved over the first quarter of 2009 and when coupled with the impact of the 2009 plant consolidations, the continued mixed shift to high efficiency products, our ongoing productivity efforts, our gross margins benefited even in light of the negative impact of the price inflation dynamics. Sales ended at $507.3 million an increase of 14.4% a percent over the first quarter of 2009, all the acquisitions have been (anniversaried) so this was a purely organic comparison.

The impact of FX was positive 1.6%. Electrical segment sales increased 16.8% as compared to the prior year. Within this segment, sales for the HVAC motor business increased 32.9%, commercial industrial motor sales in North America increased 9.8%, global generator sales decreased 9.3% and Mark will speak to this in more detail. Sales of the mechanical segment decreased 3.5% as we saw strength in the early cycle mechanical business offset by the later cycle products where demand is still building. Sales of high efficiency products were 17.7% of total sales as compared to 12.9% a year ago. The gross margins for the quarter finished at 25.8% as compared to 20.4% for the first quarter of 2009.

As I previously mentioned, we had strong productivity results including the impact from the 2009 planning consolidations and also favorably impacting margins were benefited from new products, stronger factory volumes, all of which offset the negative impact of pricing inflation in the quarter. Operating expenses were $68.2 million versus $62.4 million a year ago. Impacting operating expenses where certain variable expenses such as commissions, the accrual for incentive compensation which on a year-over-year basis added $3.4 million to the SG&A line and acquisition-related costs which are required to be expensed which totaled $1.7 million. Income from operations therefore ended at 12.4% versus 6.4% on a first quarter of 2009. We're obviously very pleased with that result. The effective tax rate for the quarter was 31.7% versus 34.1% in the prior year.

While this is a decrease for the prior year results, it's an increase from our guidance of 30% as a result of more income being generated in the United States during the quarter than what we had originally forecast. Fully diluted earnings per share was .98 versus .39 a year ago on almost 19% more shares outstanding. As Henry mentioned, operating cash was $44.4 million, positive for the quarter, as compared to $18.6 million in the first quarter of 2009. While the strong income performance was a primary driver's increase, we were nonetheless pleased that our teams have continued a strong focus on cash as volumes have begun to return. We believe this not only demonstrates the cash focus of our company but the numerous process improvements the teams have made in the past 18 months.

Turning your attention further to the balance sheet, we ended the quarter with $471.9 million of debt which is a slight decrease from the $476.5 million at year end. The condensed balance sheet, accompanying the release, reflects an increase in current debt included in other current liabilities that as a result of the notices we have received by basically the remaining convertible note holders to exercise their conversion rights in the second quarter. With regard to these notices and consistent with our prior conversions we have elected to pay the premium in shares, which because of the treasury (in audible) accounting, have been historically included in our fully diluted share count.

We expect to have no convertible notes outstanding at the end of second quarter. We ended the quarter with cash and investments totaling $405.2 million versus $380 million at the end of last year. With regard to other cash flow information, depreciation was $12.6 million, amortization was $4.4 million and capex was $11.2 million for the quarter. In summary, Q1 was a strong quarter that exceeded our initial view and the basis for our guidance in three primary areas, certainly sales volume was well above our expectations, the favorable mix of the high efficient products and the productivity results that our people are achieving in all the facilities worldwide.

Turning to the forecast for the second quarter, our EPS guidance was presented in yesterday's release was .96 to $1.04 per share. We are basing the forecast on a similar year-over-year sales increase as we experienced in the first quarter plus the added sales for the CMG business. With regard to gross margins we'll once again see the benefit of the 2009 plant consolidations and other productivity projects as well as the year-over-year benefit from higher production volumes. We're expecting to see the benefits of the price actions we have taken. However, commodity costs increase will more than offset pricing resulting in a net drag on gross margins. Additionally, the strong mix benefit we saw in Q1 will lessen significantly in Q2 as we anniversary the HVAC federal tax credit that strongly impacted the last two months of Q2 last year.

As well, we'll begin (anniversarying) the plant consolidations that took place last year. The sequential impact of this is a reduction in the contribution from those projects from first quarter and second quarter of about $3 million, so less of a tail wind. We expect operating expenses to be similar to the first quarter before inclusion of approximately $4 million for the CMG business. In our guidance we are using a tax rate of 31% consistent with the first quarter, but this again could vary on the distribution of income on a global basis.

As mentioned in the release, we will see the contribution from the recently announced CMG acquisition which we completed early this quarter. The business is expected to add approximately $30 million to the sales line, will be neutral to earnings in the second quarter as a result of the acquisition and purchase accounting related charges. We're expecting capex to be in the range of $10 million to $15 million in the second quarter, depreciation and amortization in the range of $17 million to $19 million for the quarter and for the full year we're maintaining our capex guidance at $60 million to $70 million and our DNA guidance of $65 million to $75 million.

Now I'll turn the call over to Mark.

Thanks, Dave and good morning everyone. As both Henry and Dave indicated, the first quarter of 2010 was stronger in volume than we had anticipated. The company experienced year-over-year double-digit growth in most of our business units. However, we did see continued weakness in our later cycle business such as mechanical and our North American based generator business and we also saw continued weakness in Europe. Sales in our Asia Pacific businesses improved in the quarter on a sequential business basis and were up strong when compared to prior year. Domestic sales in our China based generator business came back aggressively, driven both by the responses to support unfortunate natural disasters in the region and a robust recovering China economy.

In the HVAC segment as Dave mentioned, thin inventory levels throughout the channels caused end market demand to convert to orders quickly. We experienced strong demand across our customer base and we continue to see a shift to more energy sufficient systems. Orders in sales in our commercial and industrial businesses were better than anticipated. We experienced the demand surge in pump motors to support the needed replacements caused by the flooding that occurred on the East coast. Many of our OEMs brought their manufacturing facilities back to full schedules as a result of the flooding.

Overall in the C an I segment our OEM sales grew faster than our distributor sales. The key headwind for the quarter as Dave mentioned was material inflation, while we did announce price increases in early February, they were not in effect to materially impact the first quarter. While we do expect a positive price contribution in the second quarter it will not be enough to offset all of our inflation. The volatility and unpredictability of steel and copper will continue to challenge our industry and our customers as we attempt to minimize the impact on both our businesses and our customers.

As you know, we continue to focus our new product development on energy efficient products. The secular trend on energy efficiency continues to build momentum. Our customers are being challenged to meet increasing energy efficiency requirements at the state and national level. In 2010 we'll continue to launch a series of new energy efficient products to help our customers meet that challenge. During the fourth quarter call, we shared with you, our new line of energy efficient in power plus pool motors and we also talked about the upgrade to our 142 R outdoor ECM motors. Today, I would like to tell you about two additional new products.

First I'm excited to tell you about a new product launch in our Hub City and growth gear mechanical businesses. The new product is a high efficiency right angle gear drive or HEARA for short. HEARA is a high efficiency drop in replacement for existing right angle worm gear drive application. Without any change to their existing equipment, an end user can retrofit our new mechanical drive and see a 50% improvement in system efficiency. The pay back can be in as little as five months. As a result of the increased efficiency, the user can also down size the electric motor for even more savings. The customer interest in this product has been exceptional. And as you would expect, our teams are quite excited. We have already begun shipping products to customers.

The next innovation I'd like to talk about is a product that puts us in a new adjacent market space. While our fast growing air moving business produces small blowers that are used as draft inducer on HVAC furnaces, we have never been a supplier of the larger air-circulating bore system in HVAC equipment. These blower assemblies are large and a challenge to provide as an integrated solution. Nonetheless, during the first quarter we launched our new high efficiency blower or ATB. What is unique is that ATB is the geometrical design of the air chamber itself. Because of the geometry, our customers can gain 8% to 20% in increased efficiency. And because the blower is a drop-in replacement, our customer does not have to retool to use the product.

Further, when combined with our Genteq ECN motors the entire air circulating system delivers a 10% to 35% improvement in energy efficiency versus standard systems. A couple of our key customers have already given us orders and several others are now testing the product. As Henry mentioned during the first quarter, we announced the acquisition of Australia based CMG. CMG is $130 million manufacturer and distributor of electric motors, motor components, mechanical gear drives and air moving systems. The company sells its products in Australia, Africa and Asia, New Zealand and other countries. Except for 2009, CMG has experienced a compound annual growth rate of 23% since 2001.

The attraction to CMG was the growth rate of the company, the management team and the geographical footprint. The overlap with our existing Australian based Fasco branded business was negligible and together the CMG and Fasco businesses now represent the largest supplier of electric motors in Austria and a significant manufacturer and distributor in the Asia Pacific region. The integration of CMG into RVC is now well underway and we could not be happier with the new team. Overall we were quite pleased with our first quarter results, especially given the uncertainty of the economy as we look forward into the second quarter of 2010. We see a healthy recovery but only as compared to a very weak 2009. We are seeing this recovery in most of our businesses including our mechanical segment, however we are not yet seeing a recovery in Europe.

We continue to be concerned about commodities, in spite of the recent price increases, we do not believe we will cover all the inflation. We will, however, continue our drive to improve our operations through the further implementation of Leeson Sigma and through the execution of our productivity efforts. Our Leeson Sigma journey continues to help us improve our service to our customers and the quality of our product. In fact, we made very nice progress on both fronts in the first quarter.

With that I'll turn it back over to Henry.

Thank you, Mark. As we look at the second quarter we are pleased to be able to project another sequential improvement in sales. While perhaps not as big a seasonal swing as we have seen in past years, we believe that is due to unusual strength in the fourth and first quarters rather than any backtracking of our markets. Our outlook for earnings is more guarded due to the headwinds of commodities. Despite our announced price increases, which will be effective for most of the quarter, the soaring costs of steel and copper will effectively reduce our margins. It is, frankly, extremely frustrating to be in a position where the incredible efforts of our people to improve the value proposition for our customers get wiped out in the blink of an eye by significant swings in commodities.

All that said, it will be another solid quarter. Looking beyond the second quarter we are continuing to introduce new and exciting energy efficient and intelligent products. Our geographic diversification continues to pay dividend and our strong balance sheet positions us to take advantage of growth opportunities. We have an active pipeline of opportunities all with strategic alignment and we believe that seller and buyer expectations are beginning to converge. At the end of the day it is our people and our processes that give us the most optimism about the future. And on that basis the future has never looked brighter with. That we will open up for questions.

(Operator Instructions). Our first question comes from Steve Sanders at Stephens, Inc.

Good morning, everyone. Great quarter. Maybe first just talk a little bit about pricing and commodity trend. If we see commodities hold relatively stable can we expect you to neutralize those in the third quarter?

We would love to be talking about commodities being stable for a change. The actions we have taken so far will not cover what's happening in the second quarter and I think it's a little early to evaluate next steps, Steve.

Okay. Are there any significant competitors in kind of your key segments that are not following the lead of others on taking price increases?

You never have a perfect line up. There are certain competitors who have not taken pricing actions and I think probably it's best if we leave it at that.

Okay. And then can you talk a little bit about inventories in the HVAC channel obviously on the residential side. Do you feel like we're starting to build some inventories of POEs or how shall we think about that?

I think in the first quarter we were still in a situation where we were comparing to a very difficult 2009 first quarter. When our customers, in many cases, were not operating all of their facilities to the fullest. And so at that point in time we were not only seeing the fallen demand from our customers' perspective, but we were also seeing them not operating in facilities and that affected us strongly in 2009. So on a comparison bases in 2010, I think it was just all about them bringing their factories online. As we look at the second quarter, Dave mentioned how we're beginning to anniversary the stimulus program -- stimulus program went into effect in April but really didn't take a strong foothold, I'd say, until mid May. So you have about a month and a half of anniversary going on there. And then, also we are hearing some customers tell us that they're starting to prepare for the season and they're putting inventory in place.

Okay. Great. Thanks very much. And congratulations and good luck, Dave.

Thanks, Steve.

The next question comes from Mike Halloran at Baird.

Good morning, guys.

Good morning, Mike.

Hi, Mike.

Quick question on the sequential revenue trend. I know you said that seasonality was going to be less versus second quarter than normal. Could you just talk about some of those headwinds there and then talk a little bit about expectation for progression through the year?

I really wouldn't call it a headwind, Mike. Normally we've had the first quarter or fourth quarter and first quarters are slower. And then the second quarter starts to move up and third quarter kind of is the peak. And we're seeing a move up. And we're seeing, I think, the recovery broaden across more of our business. However, we had unusually strong fourth quarter and first quarter. And so it really just gets down to that sequential -- the sequential strength that we had in those two quarters as in many cases the sell-through was stronger than I think most of our customers thought it was going to be coming into the season. I think, if you recall, we had a very cold start to last winter and it didn't necessary keep up, but we had a cold start and that spiked ,if you will, demand for the heating side of our business. And with the stimulus in place we are seeing the replacement market improve. So we had a stronger first quarter than we would normally see.

That makes sense. Any pool head demand in the first quarter or any sort of appreciable inventory build that would impact that sequential trend?

Pull in demand? I don't believe we saw any term pull ahead demand. That would be driven by the price increase? I don't think there was anything material but nothing that was significant.

Okay. And then on the margin side I know you guys talked about a lot of puts and takes there. Is there any way to back into what would be a sustainable Q1 margin to build off of, recognizing you're going to have the second quarter headwind a little on the mix side and then on the raw materials side?

I guess I would probably try to go back and pear it back. Certainly, I guess one of the drivers as I mentioned was the volume in the factories. A year ago we were taking inventory out. This year we effectively adjusted for cost, didn't add much back. But we did probably see a roughly $3 million to $5 million absorption benefit if you look at it year-over-year. So if you consider this year to be a more normal run rate that was benefit versus prior year. Beyond that you got to make the call on price versus inflation and then the sustainability of the mix. The productivity results, we have been very clear last year, we would see pretty nice tail winds coming into the year. Obviously that's more significant the first quarter a year ago Q1, we were really booking all the costs of the consolidations. And this year the absence of the costs and then 100% of the savings. And of course, that will lessen as we go into the second quarter as I mentioned by about $3 million. And then by the end of the third quarter we'll be able to anniversary those completely.

And then you mentioned the inventory revaluation. Is that referring to what you just talked about there, the year-over-year productivity or is that something different?

It's actually above and beyond. As you know, in an environment where costs are going up, you basically ride up your inventory. That was about a $5 million benefit in the first quarter that all other things consistent or static in terms of costs is a benefit that doesn't repeat. And here forward we just have the inflation impact following through directly.

Okay. Thanks for the time.

The next question comes from Mark Douglass at Longbow Research.

Good morning, gentlemen.

Hi, Mark.

Dave, back to the material costs impacting gross margins. Is there any relative difference between how it affects electrical or mechanical, or is it kind of similar across both?

You know, I think since we use a fair amount more of copper and steel in our electric motors the impact would be more on the electrical side than on the mechanical side. You wouldn't see a real copper impact on the mechanical side, you would see more of a steel impact.

Right. But mechanical has obviously a lot of steel.

Yeah, fair enough. The inflation has been much stronger on the copper side than it has on the steel side.

Sure. Okay. And then the book to bill, I don't know if you'll even say what it is, but is it above one for all segments and products or how are we looking at the book to bill right now?

Generally speaking, the book to bill is positive across the business except in the case of Europe.

Europe. And then that's Europe whether it's mechanical or electrical?

That's correct.

Okay. And then finally, the $30 million sales you expect for CMG, how does that split between the two segments? Just kind of a modeling question.

I guess about, what is it, 15% of their business probably will end up in the mechanical just roughly.

Okay. Thank you.

Thank you, Mark.

The next question comes from Jeff Hammond at Keybanc Capital Markets.

Hi. Good morning, guys.

Good morning, Jeff.

Just to go at price costs a different way. Can you give us a sense of un-net, what price cost was in terms of headwind, in Q1 and what maybe the incremental headwind is going into Q2?

Yes. I would say that was in the neighborhood of $10 million. And I think you've got a couple things. The price was actually slightly negative in the first quarter as we came off, as you know we have some contracts tied to material price formulas. So with the low material costs at the end of last year we had some negative price there. The price turns positive this next quarter, but the inflation piece is doubled or tripled so it's a pretty significant increase. And net will be just, I would say, slightly worse.

Okay. Slightly worse. And then can you just talk to me about any of your announced price increases that have gone through and just any feedback you're getting as to whether those are sticking or if there's any push back?

Well, price increases we announced were back in February. In fact, they were the day after our last earnings call -- or the day before our last earnings call. And they ranged anywhere from 3% to 6.9%. Generally speaking we're seeing the price increases stick.

Okay. Great. And then I guess just going at the seasonal uplift a little bit differently, is it more a function that Q4, Q1 surprised you on an upside? And so as we comp versus Q1we don't see a seasonal lift or is there any concern that inventory in the channels for residential, particularly, have gotten to a healthy level and maybe you don't have as much channel fill?

Yeah. In this case, Jeff, it really is just that the Q4 and Q1 were stronger than we would have expected in that environment. So those were positive. And we are seeing some seasonal uplift here. We're not saying there's none. We're just saying it's not the normal jump that we've seen in the past. So we don't think that inventories in the channels are bloated at all. We do see some customers who are starting to build for a seasonal spike, if you will, which frankly is behind when they normally would have started. So there's work to do still to fill channel inventories.

Okay. Great. Thanks, guys.

The next question comes from Christopher Glenn at Oppenheimer.

Thanks. Good afternoon.

Hi, Chris.

So with the restocking starting a little -- or the build, the channel build starting a little later than normal, is it possible that kind of compromises the view on the seasonal lift in the second quarter?

Probably a little bit. Again, as you know, I think that whole build process has been shrinking over the last several years. And we're hoping for a warm start to the summer which would probably accelerate that. But it is likely dampening somewhat our expectations at least for the early part of the summer.

Okay. And then just a couple or one modeling one. The minority interest had a little bit more magnitude than normal. Is that a good rate to consider going forward?

No. There was probably, I would say, about roughly a million in the minority interest line that really is due to specific activity at one of our joint ventures that won't be repeating. So it should fall back to a more normal pace. The CMG business does have one of the elements, that is a joint venture deal. So I guess you will actually see that probably touch ahead of where we would have averaged last year. But not to the level you saw in the first quarter.

Okay. Thanks a lot.

The next question comes from Steven Volkmann at Jefferies & Company.

Hi, good morning. Just a quick follow-up on the high efficiency mix and your thoughts about where that is likely to go for the remainder of the year.

Yes. I think the number was 17.7% of our products in the first quarter what we would call energy efficient products. And I do believe it will continue to move up. With the announcement of -- continued stream announcement of new products that we've been launching our all around energy efficiency. So I think that is the right direction. Further, as we get later into the year we have the impact of the ISA law which comes into effect on December -- I think it's December 10th, 2010, and that will also impact the shift to a more energy efficient products.

Would you expect any kind of a pre-buy ahead of that switch over?

History says that there could be a pre-buy. It's not something we're promoting or encouraging, but it could happen. And we'll have to see. It did happen to a small degree last time.

Okay. And then finally on the high efficiency with some additional competitors kind of come in and having some new products and so forth, are you seeing any pricing issues or less-favorable pricing maybe is the way to put it?

Yes, certainly we have competition. We've said for a long time that there would be competition. And it's not clear yet how each of those products and competitors are going to position themselves. So I would say at this point there's no change. But certainly it's there now and we'll have to deal with it as we go forward.

Okay. Great. And then the final one, Henry, you mentioned the acquisition pipeline was active. And people seemed to be coming closer to see eye to eye here. It sounds like we should be expecting some additional activity from you, this year. Is there a way to kind of size what that would look like? So that we can kind of think about the impact?

I don't think. I mean, the reality is that we work on a number of things at any given point in time. We have a number of opportunities that we're working on. And they vary in size as you can appreciate, Steve, all over the map. So I don't think that there's any meaningful way that we could give you guidance that would be helpful.

Okay. Fair enough. Thank you.

The next question comes from Walt Liptak at Barrington Research.

Hi, thanks. Good morning, everyone.

Good morning, Walt.

I wanted to take another shot at the seasonality question and just ask if there was any meaningful change from January through March, if some companies saw a big pickup in March, if you could comment on that?

Well, it was -- the data out of AHRI gives you some indication of what was happening just from our customers' shipments into the market. I think January was much, much stronger than February from a customer shipment perspective. March slowed down a little bit, but then April picked back up.

That's on the HVAC side. On commercial and industrial we saw a steady progression upward as we went through the quarter. And ended actually at a very brisk pace which is continuing.

Yeah. March was relatively above February in total for the company.

Okay. Last quarter you were cautious, too, on the seasonality. And I wonder if it's just caution revenue especially given the price increase on top of the product you're selling that you came through with a stronger revenue again the second quarter.

We hope that that's the case. We try to take our best shot at what we see coming. And we were a little concerned last quarter that because of the strength of the fourth quarter and what we saw in the first quarter that the normal seasonality might not apply that's just our -- that's just our view that those were a little stronger than we would have expected. And so while we expect it to improve in the second quarter, just not the delta that we normally see.

Okay. Let me ask about the costs going up. You do copper hedges. I wonder with your outlook for continued material costs, inflation, if you put on more copper hedges.

Actually, the answer is no. We probably are a little bit lighter than we've traditionally been, which seems a little bit of an anomaly. But as we've gone through the last year the market was in a tangle. Supply exceeded demand most of the year. Very difficult given those conditions and the move up in the forward costs to convince yourself that it's the best thing to do. I would say we're more normalized today than we have been over the last four months, but still probably not back to where we were three years ago or two years ago.

Okay. And then just the last one. On the acquisition pipeline, there's been press about a very large motor manufacturer that's got assets up for sale. And I guess I'd like to know what your interest is or confidence is in doing a much larger acquisition than what we just saw.

Yeah. I'm not commenting on any specific company because we never do that and won't. You understand our balance sheet at this point. I mean, we have lots of fire power. And we are interested in finding those things that leverage and accelerate, if you will, the wealth creation capability of the company for our shareholders. So we look at a full gamut of companies and we are always seeking out what is the best combination, if you will, for creating value. But we have good capacity at this point. And hopefully we can put it to use in a way that maximizes shareholder gain.

Would you go beyond your own balance sheet? Would you go back to the capital markets to do a bigger deal?

In the right situation, sure. We've done that in the past as you know and done it successfully.

Okay. All right. Thanks, guys.

The next question comes from Nicole DeBlase at Deutsche Bank.

Good morning, guy, how are you?

Good morning.

To most of my questions have been answered, but on the mechanical margins, extremely strong this quarter. I just want to know if there's anything going on there that we need to know about.

No. A couple things. One is probably for the first time the absence of any one timers last year it seemed like every quarter we had to talk about bad things that were happening to the company. We haven't had bankruptcies or any of those kind of issues or any legal issues or anything that are new. So I think it's a pretty normal quarter. And I think you're seeing a couple things. You're seeing number one the benefit of a little bit of volume in that business. Their volume is definitely improving although their sales are still down. It was a significant improvement over where they left the fourth quarter. And I think on top of that, two more items, one as Mark mentioned earlier they're not subject to the volatile copper prices. It's more steel. And they haven't in their particular grades of steel haven't seen the type of inflation, yet, that some of the steel markets overall are seeing. And then on I guess the final thing is they've I think had a real focus given the year they went through on productivity. And I think they're doing a nice job at delivering productivity to offset a part of that volume. So we've kind of indicated that they would be returning back to a more normal margin pace pretty quickly and volume would be a big driver. I think that's happening.

Okay. So you would consider Q1 margins as sustainable, then? I mean, barring steel increases of course?

Yes. I would say they're pretty much back to that normal range and be subject to steel and to some degree certainly volume.

Okay. Got it. And then the last question I have is, on the generator business, this is still the area where trend have remained pretty weak. Are you guys seeing any signs of improvement there at all?

In our China-based business, we've seen a very nice comeback. And that actually occurred in the first quarter. Our real weakness in the first quarter was in North America. China-based business was driven by both the economy as well as the unfortunate disasters in China. In the North American-based business, orders remain quite weak. Up until just recently when -- turn up somewhat on some parts of the product line. So we're hopeful that it's just a later cycle business and starting to return.

Great. Thank you.

Our next question comes from Bill Dezellem at Tieton Capital Management.

Thank you. A couple of income statement questions. First of all, relative to the first quarter gross margin being down from the fourth quarter gross margin, even though the Q1 sales were higher, would you help us understand what the dynamics were behind that? And then secondary, operating expenses on an absolute dollar amount were lower in the first quarter than the fourth quarter, and again, even though sales were higher?

Yeah. I think on the margin side, Bill, the biggest change in the fourth quarter we had two factors impacting us. First of all, material costs. Material costs were well below the levels that we're seeing now, particularly copper. I think effectively copper at some point in this quarter was almost at a point where it's double what we saw in the fourth quarter. And also we have LIFO favorable benefit. I want to say it was about $8 million or in that neighborhood in the fourth quarter that didn't repeat. In the operating expense side, we did have a $5.2 million write down in the fourth quarter primarily related to certain properties. We had excess properties in facilities due to our consolidation. So I guess I would call that kind of a one timer, you take out and put that more back in line.

Thank you very much.

Thanks, Bill.

Our next question comes from Holden Lewis at BB and T.

Thank you. Good morning.

Good morning.

First of all can you give us some color as to why Europe seems to be acting so sluggish? I think most are reporting that Europe is looking better. You certainly look at the Euro zone, ISM, PMI indexes. There's indication that is better. Is there something special about the mix you have over there? Or is Europe small enough that maybe there's a share issue? Or what's behind weakness in that region?

The product that we sell falls into two categories. It falls into the mechanical space and it falls into the larger industrial motors. Both of those would be later-cycle businesses. So our expectation is that it will come back. It just hasn't happened yet.

Okay. Great. And then just so I'm clear, you're feeling that your high efficiency mix which I think was what 17.7 this quarter, I think I heard you that you expect that to be lower?

No. I said I indicated that I thought it would move up throughout the year.

Okay. So when you were talking about the anniversary you're just saying you're not going to see the big step ups year-over-year but the rates are going to stay the same?

That's correct.

And the same goes for the costs, the savings related to the consolidations and all that?

That's correct. It was also (anniversaried).

Okay. So the way we should be looking at your gross margin, you did 25 this quarter but there's about 100 basis points from that inventory which won't occur. So the 24.8, that's actually a decent base to you, right?

Probably plus or minus what you -- materials is the one added headwind.

Right. But you said material ins Q2 were probably going to be slightly more than the $10 million that you did in Q1. But at the same time production should likely increase, volumes should likely increase, right?

Probably slightly. Again we're not calling for big volume improvements.

Okay. And then on the high efficiency, how much can the new products move -- sort of move that needle? Are the new high efficiency products replacing old standard efficiency products? Is it obsoleting another high efficiency product? As you introduce these products to what degree can those things move the needle on high efficiency mix?

Most of the products that we are introducing are going to be replacing products that are substantially less efficient. There are some for example in our ECM technology we're on generation six and we have a couple more generations that we're in the process of working on. So those become a little bit less of a delta if you will in terms of the way to look at what the technology is doing and as a consequence any margin improvements that come from it. These aren't -- these aren't huge steps when you take a look at margins because there's lots of competition in all of these areas holding. But they are on the margin better. And so it's meaningful to us and it's meaningful -- more meaningful, frankly, from a growth perspective because we think we're, as Mark said, in the beginning of a secular trend that has a lot of legs to run, makes economic sense and matches the kind of mentality that the world is adopting.

When you introduce these new products and they sort of come in as an alternative to the lower efficiency product, do you take the lower efficiency product out of stock or out of the catalog or what have you so that really the high efficiency becomes the option and therefore it's going to push the mix-up? Or is it still a pretty heavy selling job to convince them to pay up for the higher efficiency because they do have a choice between the lower efficiency and the high efficiency still even when you introduce new products?

As you can appreciate there's a mix of all of the above. For example, with the legislation that is in place that will change the mix on integral horsepower motors at the end of the year. You have no choice there, you will deplete your inventory of current products and not continue to offer them by law. Typically, when we're introducing other products, higher efficiency products in other spaces where it's not mandated we continue to, for a while at least, carry both because customers may want one or the other based on the value proposition that they're offering their customer base.

Okay. And then just last thing on the high efficiency, what are your expectations when the stimulus incentives for HVAC fall off? Would you expect that to be adverse to mix? Sort of selling at a lower level and starting from there? Or do you think you can hold the mix in this high teens even as that falls off?

Yes. Normally you would say you would expect it to somewhat fall off. However, our view is that the thought process behind it is permanently -- has created a permanent reflection point if you will in these product lines. The fact that every installer and dealer in the world now understands the efficiency proposition and the fact that there are real pay backs and they understand the basis that they can sell and install, we think changes the way that will be looked at forever in the future. As you know, there's also regional standards that are slated to come into play over the next couple of years that could boost that again. So there a number of things. Could there be some fallback? Yeah, we don't think it will be significant.

Okay. All right. Thank you.

Our last question comes from Walt Liptak at Barington Research.

Hi. Just as a follow-up on the ISA products, how much are you expecting prices are going to be out after December 10?

Yeah, Walt, it's a great question. If you took a look at those products today you would say that the average selling price would probably be in the area of 15% to 20% higher than the EPAC level efficiencies that are called standard efficiencies in today's market. Experience would say that as the higher efficiency products become the norm, there will be efficiency gains that come from producing those products because you're producing them in higher volumes and over some period of time some of that will be passed along to the customer base. So it's not clear that they will stay sustained at their current level. But we would expect there would be an improvement over today's margins.

Okay. Great. Thank you.

Okay. With that we appreciate everyone's questions and answers. I have just a few take aways that I'd like to talk about. Before I do that I'd like to publicly thank Dave Barta for his years of service at Regal Beloit. He's been a tremendous asset at the company. As most of you know he will be moving on to other pastors. And we're in a search mode for a person to fill his big shoes. Those of you who have met Dave personally know those are big shoes. But he's been a tremendous asset for us. We're going to miss him. And we'll look forward to watching his progress somewhere else.

With that I just want to talk about the take aways from the quarter. First quarter was benefited by some tail wind, but more importantly, it proved the strengths of our strategy and execution. We are now seeing a broader-based recovery. New products continue to roll. The CMG acquisition holds great promise for our future. Our balance sheet is strong, and opportunities exist. We appreciate your interest in Regal Beloit and your time for today's call. Thank you.

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