Regal Rexnord Corp (RRX) 2011 Q2 法說會逐字稿

Good morning and welcome to the Regal Beloit second quarter 2011 earnings conference call. All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to John Perino. Please go ahead.

Good morning. Thank you, Sue.

Welcome to the Regal Beloit second quarter 2011 earnings conference call. Joining me today are Mark Gliebe, President and CEO, Jon Schlemmer, COO, and Chuck Hinrichs, Vice President and CFO.

Before turning the call over to Mark, I would like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees since there are our inherent difficulties in predicting future results and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of those factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our filings with the SEC.

Now, I will turn the call over to Mark.

Good morning, everyone and thank you for joining the call and for your interest in Regal Beloit.

We will follow our typical agenda. I'll make a few opening comments, Chuck will give a financial update, Jon Schlemmer will provide color on products, markets and operations and then I'll return and summarize our prepared comments and we'll move to Q&A. Overall, we felt good about our operating performance for the second quarter. Excluding the $28 million incremental warranty expense, we would have exceeded the high-end of our guidance. Given the magnitude of the incremental warranty expense, I would like to cover that topic first.

We have communicated to certain HVAC customers that we have detected a production flaw in certain standards, sleeve bearing motors produced in our Reynosa, Mexico facility. These Genteq-branded motors are used in outdoor condensing units for air conditioners and heat pumps. We estimate that there are 50,000 motors that may contain the flaw. The abnormality was caused by inadequate lubrication of the bearing shaft which may result in a early failure of the motor.

The failure of the motor presents no safety concern. We are working with customers to contain the issue and identify repair and replace the flawed motors.

This event is not characteristic of the Company, or of this facility. In fact, the last time that our Reynosa facility had a quality excursion such as this, was more than 10 years ago. Further, prior to this episode, the defect rate at our Reynosa facility measured in parts per million pieces received by our customer was excellent and continuously improving. We do understand the root cause of the problem and we have fixed it. Most importantly, we sincerely regret the inconvenience to our customers and we are determined to learn from this experience and be better and stronger forward in the future.

Now, onto a brighter note regarding the acquisition of A.O. Smith's Electric Products Division or EPC. We are pleased to report that we've made significant progress with the Department of Justice, and we believe we will close the transaction within the month under materially the same terms that we agree to with A.O. Smith back in December. This is positive news and both our teams are excited at the prospect of closing soon. In terms of our operating performance during the quarter, had it not been for the incremental warranty expense, we would have had a record quarter in terms of both revenues and EPS.

We saw strength in our top line, which benefited from the general economic recovery and a number of new products as well as the additional businesses from the acquisitions we completed in 2010. Our commercial and industrial businesses had an especially good quarter. The headwinds came from a slower than expected HVAC business and acquisition related expenses, primarily related to our pending acquisition of EPC.

The two price increases we announced in the last 10 months have now been fully implemented. In the second quarter, with a combination of the price increase in productivity, we were able to offset inflation.

Excluding the incremental warranty expenses, our margins continued to climb in the quarter, and we would expect to see further margin improvements from the acquisitions as we implement synergies and drive improvements in the businesses. As for the highlights in the quarter, first, we were pleased at the strength in our commercial and industrial, mechanical and international businesses, offset the general weakness in HVAC. Next, with the acquisitions of AFMC, or the Australian Fan and Motor Company, which Jon will speak to in a minute. The closing of our new financing arrangements, which Chuck will describe. The continuation our new energy efficient products and the progress we made with the DOJ on the EPC acquisition.

With that, I will turn it over to Chuck Hinrichs.

Thank you, Mark and good morning, everyone. We are very pleased with our results for the second quarter 2011, as we posted record quarterly sales and strong cash flow from operations.

Sales for the first quarter of 2011 were $682 million, an increase of $98 million, or 16.7% over the second quarter of 2010. Sales growth in the first quarter was due -- sales growth in the second quarter was due to the addition of $60 million of sales from the 2010 acquired companies, volume growth and realizations from price increases. Our gross profit percentage for the second quarter of 2011 was 22.1%. Cost of goods sold in the second quarter included the $28 million increase in warranty expense. Excluding the $28 million expense, our gross margin for the second quarter was 26.2%, an improvement from the 24.6% in the second quarter of 2010, and the 24.9% margin in the first quarter of 2011.

In the second quarter of 2011, we recovered the commodity cost inflation we experienced with a combination of our price increase actions and operating productivity. However, commodity inflation is still a challenge in 2011. Let me give you some data on the cost inflation on two key commodities, copper and steel. As this chart on slide six shows, spot prices for copper are stabilizing at a high level. The second quarter 2011, average spot price of $4.15 was down slightly from the first quarter of 2011. The July spot price jumped up to $4.40 per pound.

Now, let's review the steel market. Here, I am putting the index prices for cold roll steel. As seen on the chart, steel prices have spiked in the last three quarters. The average price in the second quarter was $915 per ton, an increase of $123 per ton, or 15.5% compared to the second quarter of 2010. The index price for July declined to $832 per ton, perhaps indicating that steel prices have peaked for the near-term.

Our steel purchases are based on the market index, but lagged for one quarter. So, our cost for steel increased in the second quarter of 2011, and will increase again in the third quarter of 2011, before we should benefit in the fourth quarter from the recent decline in the index price.

Slide number seven provides additional financial data. Our capital expenditures in the second quarter were $10.8 million. As we previously communicated, we have three big capital projects in 2011. The first one, which closed in the first quarter, with the purchase of our previously leased factory in Faridabad, India. In the second half of 2011 and into 2012, our capital spending will be higher as we spend on the relocations of two of our factories in China.

Our depreciation and amortization was $22 million in the second quarter, and should be a similar amount in the third quarter. As we have discussed in previous calls, we continue to experience high legal costs related to the pending acquisition of EPC. In the second quarter of 2011, we expense $3.3 million of costs, an increase of $1.3 million from the second quarter of 2010, but $3 million lower than in the first quarter of 2011.

Our effective tax rate was 28.6% in the second quarter, lower than our previous guidance for 2011 of 31% to 32%. The second quarter tax provision decreased due to the incremental warranty expense, which reduced our taxable income in the US.

Turning to the balance sheet, our second quarter end cash position was $275 million, increasing $44 million from the year-end level due to our strong cash flow from operations. Our balance sheet remains strong with excellent liquidity.

Turning to slide eight, we previously announced the closing on two important financings in the last 60 days. We were pleased with both financings as we increased our financial flexibility and arranged attractive, permanent financing for the pending EPC acquisition. First closing was on June 30, 2011, when we refinanced our $500 million unsecured revolving credit commitment for an additional five years. Second closing was a private placement of unsecured notes with an average term of 10 years, and an average interest rate of 4.74%.

On July 14, we took the initial funding of $423 million, and expect to take the final funding in August for a total new debt issue of $500 million. This financing represents the permanent financing for the pending acquisition of EPC. We were fortunate in our timing in accessing the long-term debt market, to raise this capital at a competitive interest rate. But, the timing of the financing is a few weeks ahead of the closing on the EPC acquisition. This additional financing is forecasted to increase our interest expense in the third quarter of 2011 by $4.4 million.

For the third quarter of 2011, we expect earnings to be in the range of $1.11 to $1.17 per share. Our third-quarter guidance does not include any impact from the pending EPC acquisition. In comparing our third-quarter guidance to the second quarter, we expect to see a decline in sales volume and increased commodity cost inflation, principally steel. As I highlighted on the previous slide, we will incur higher interest expense on the new long-term debt, which will reduce our third-quarter earnings by $0.07 per share.

We also expect our third-quarter income tax rate to revert to our normal effective tax rate, estimated at 31.5%. This increase in the income tax provision from the lower second-quarter tax rate will reduce our third-quarter earnings by $0.05 per share.

And lastly, we compared our third-quarter guidance to the analyst consensus. Several estimates, include an earnings contribution from EPC, that may add up to $0.05 in earnings per share to the third-quarter estimates. Again, our third-quarter guidance does not include any EPC results. When we close on the EPC acquisition, we will provide updated guidance on the EPC results.

Now, I will turn the call over to Jon Schlemmer.

Thanks, Chuck, and good morning, everyone.

During the second quarter of 2011, we experienced strong double-digit sales growth over the prior-year period in our Mechanical businesses, our North America Commercial and Industrial businesses, and also in our Asia businesses. Our Mechanical businesses, which compete in later cycle segments continued their strong rebound in the quarter, with 15% sales growth. The strength that we have seen in the prior five quarters in our North America Commercial and Industrial businesses continued through the second quarter, with sales up 20%. As expected, demand for the more energy efficient NEMA premium products increased, and now represents the majority of our interval horsepower motor sales.

Sales in our global generator business grew 34%, driven by growing demand in emerging markets, the recovery in Japan and primary power plants adding standby power for risk mitigation. Driven by strong growth in the emerging markets and our acquisition strategy, sales outside the US grew by 35%, and represented 37% of our total sales for the quarter. Sales in Asia were up 14%, driven by robust economies and new products.

In HVAC, the strong start to the year in the first quarter slowed in the second quarter. There are several factors at play here. First, the US housing market and consumer confidence continued to struggle. Second, we did experience a cool spring weather season throughout much of the US. And finally, the combination of the reduction of the federal stimulus, plus the shift back to outdoor condensers utilizing R22 refrigerant impacting both demand and also the mix of energy efficient products sold in the quarter.

As you may recall, we announced two price increases in the last nine months. With those two increases and our continued drive for productivity, we were able to offset current quarter commodity inflation. We have not yet been; however, able to offset the margin we lost to inflation in 2010.

Last quarter, I mentioned the acquisition of Ramu, Inc., a small R&D company focused on switched reluctance, or SR technology. We continue to be excited about the Ramu team and technology as an energy efficient alternative to permanent magnet motors. The first new product development using Ramu's switched reluctance technology is already underway.

During the quarter, we also closed on the acquisition of AFMC, the Australian Fan and Motor Company. AFMC designs, manufactures and distributes a wide range of blowers, fans and motors for sales in Australia and New Zealand. Combined with our motor and air moving manufacturing and technology, AFMC strengthens our ability to bring new, energy efficient products to our customers throughout the Southeast Asia Pacific region.

As you know, we continue to focus our engineering development efforts on energy efficient products. During the last call, we previewed a new permanent magnet AC motor product line and a new Genteq high-speed ECM motor. Today, I'd like to talk about two new energy efficient products.

First, our Commercial and Industrial business has expanded the permanent magnet AC product line, into the 3 to10 horsepower industrial-sized motors. These new, high efficiency industrial motors are being sold through the Marathon Motors business under the SuMAX brand, and the Lease and Motors business under the Platinum e brand. The new motors utilize permanent magnet technology and deliver energy efficiency levels that not only exceed the NEMA premium requirement, but also exceed the European IE4 efficiency levels. Other features include the capability to achieve higher torque levels and increased power density.

Our team has worked extensively to test this new product, with many of the major drive manufacturers. This robust drive compatibility allows users an option for high -performance, where extensive servo motor performance is not required. While our standard industrial motors now meet the new NEMA premium energy efficiency levels, this new product gives us the ability to help our customers achieve even higher efficiency levels. Our customers are showing strong interest in this new line of motors and in a wide range of industrial applications.

Next, are Unico team has launched yet another new product for the oil and gas industry; the Heavy Duty LRP, or Linear Rod Pump. The LRP is a great example of our strategy to develop custom-integrated solutions combining our mechanical components with electronics and application-specific software. The Heavy Duty LRP was developed and introduced for more demanding oil and gas wells. The new LRP is a scaled up version of Unico's very successful, original LRP system.

The original LRP artificial lift system was limited to wells with depths of less than 7000 feet. The new Heavy Duty LRP extends the lift capacity by 50%, and nearly doubles the stroke length, giving us the ability to handle wells up to 12,000 feet in depth. The new technology makes Unico's LRP platform capable of handling the vast majority of oil and gas wells.

Unico LRP systems have been accepted by numerous oil and gas producers, including some of the super majors, as an attractive alternative to conventional pumping units. LRP technology offers improvements in safety, aesthetics and production, as well as reductions in downhole failures, installation time and transportation logistics. The oil producers could always benefits at a significantly lower cost, and that's why our Unico business is experiencing very strong growth in demand. Our team is on pace to deliver a record year of new products with the majority focused on energy efficiency.

In terms of our outlook for the third quarter, we're anticipating that we will see continued strength from our Commercial and Industrial and Mechanical businesses, and continued softness in HVAC business. We're still hopeful that the recent heat waves will help offset some of the HVAC headwinds, but we've not yet seen a change in order patterns. And finally, we expect that the combination of price and productivity to continue to offset commodity inflation.

The real excitement for the third quarter is the prospect of closing the EPC transaction within the month. We've made great progress on preparing our functional operations for eventual integration. There is still a significant amount of commercial integration and synergy activities that we can't begin until we receive DOJ approval of the transaction. We look forward to starting that process upon closing.

We feel great about the talent we are getting with the transaction and the cultural fit seems to be right on target. From A.O. Smith's public release, you can also see that the EPC team is performing very well and that makes it even more exciting to join ranks. Our team -- our focus will be to combined our talents within our team so that we can add incremental long-term value for customers.

Overall, except for the incremental warranty expense, we had a great quarter. The balance of industries that we serve allowed us to outperform our second quarter guidance even as HVAC slowed. We feel great about the performance in the quarter of our Commercial and Industrial and International businesses.

At some point in time in the future, the residential market will return, and when it does, we believe will be well-positioned. Until it does, we believe our diversified set of businesses and our diversified footprint will continue to drive growth.

With that, I'll turn it back over to Mark.

Thanks, Tom. I'll just summarize.

Again, we want to sincerely communicate that we regret any inconvenience we caused our customers or that our customers are experiencing due to the flaw in our motors. We will learn from the event and be stronger and better for it in the future. Excluding the incremental warranty expense, we feel great about the quarter and our performance in the quarter, especially given the weakness of our residential HVAC business. Between our pricing actions and productivity actions, we were able to cover the second quarter inflation and our stream of new products continued to roll out with exciting technology for the Commercial and Industrial motors business as well as for Unico's oil and gas business.

Our third quarter guidance reflects continued softness in HVAC, and continued strength in most of our other businesses. Further, the A.O. Smith EPC transaction is not reflected in our estimate, even though the interest expense for the acquisition financing is included. And finally we have our new financing arrangement in place, and we are more optimistic than ever about the pending closing of the EPC transactions. We believe we will close the transaction within the month.

With that, we will take your questions.

We will now begin the question-and-answer session.

(Operator Instructions)

Steve Sanders, Stephens Inc.

Hey, good morning, guys.

Good morning.

Maybe just first, Chuck, I think you indicated that third-quarter sales would be below 2Q, and you've given some color on that. So, should we think about that as HVAC down sequentially, moderating growth in C & I, and the emerging markets staying fairly robust, but also maybe moderating? Can you just put a little more color on that?

Yes, I think that's a good summary, Steve.

Okay, and then what have you seen in July overall in some of your primary businesses, and specifically, in HVAC? And then, is there any way for you to quantify the dry ship impact for either the second quarter or kind of your thinking for the year?

To me, HVAC, in the third quarter is normally below our second quarter. It was an anomaly last year, because we had an especially strong season last year and we went into Q3 last year with a rather substantial backlog. So, as we go into July right now, the HVAC business has not seen the kind of demand it would have typically seen. It's somewhat softer than we had expected and that shouldn't be a surprise given the communication from the public communication from many of our customers. And, a lot of that is driven by the three or four things that Jon mentioned earlier. In terms of the specific impact of R22, there's so many things, so many variables. It's difficult for us to pinpoint exactly what contribution the R22 is having on the business.

Okay. And then, two quick ones and I will get out of the way. With the probabilities of a double dip going up, can you just talk generally about opportunities you might have to accelerate some of the margin enhancement initiatives if we do end up there? And then, the final question is just on the China facility relocation. Should we think about that as a working capital and margin headwind in the near term? And then we start to get the payback in '12, or how should we think about that?

Well certainly, there are no shortages of opportunities to mine synergies given the acquisitions that we've done. And so, we'll be aggressively pursuing those I would say somewhat regardless of what happens with the economy. So, there will be opportunities there to pursue those synergies. I'm sorry. Can you repeat the second half of that question?

Yes, just China. You are doing a facility relocation so do you need to build some inventory? And are there some inefficiency on the margin side that we'll have to absorb until we start to get some benefits next year?

While certainly any time you do a plant relocation, there are some inefficiencies that you'll experience. So, we have two of them to do and honestly, we will be spending the CapEx ahead of the transition. And I do believe when we come out on the other end, the plants will be running more efficiently.

Okay. Thanks a lot.

Jeff Hammond, KeyBanc Capital Markets.

Hi. Good morning, guys.

Good morning.

So, you guys give a lot of detail on EPC and it seems like it is a done deal. Is there any risk that it does push beyond August?

Well, you know anytime you are dealing with a situation like this, you're never 100% sure. But, obviously for us to have come out and say we are going to close within the quarter, we are feeling more optimistic than ever that we've made tremendous progress.

Okay, and then you said no material change to the original deal? Are there any changes to the original deal?

Well, I'm not going to comment on anything in specific just because we are still going through the process. But, the right way to say it is the way we have said it, which will be that there will be no material change to the transaction that we signed with A.O. Smith.

Okay, great. And then, just back on HVAC. Any indication that weather in July helped and what are your customers telling you about inventory and their production plans relative to normal into 3Q?

Jeff, good morning. This is John. I will take the question. Obviously we are seeing some heat right now. We've seen that across much of the US and it's been going on now for a couple of weeks. We are not yet seeing a change in order patterns from our customers due to that heat.

We think it is probably a couple of factors that play there. One, is the heat came rather late in the season, and it could be that distributors are using that as an opportunity to work down inventory levels. And there could also be an impact of just how much capacity there is with the contractor base to deal with the heat and replacement and repair of units. But, as of right now, we are not seeing a change in order patterns. But, obviously, in general, heat is usually good for this business.

Okay, great. Thanks, guys.

Yes.

Mike Halloran, Robert W. Baird.

Morning, guys.

Hi.

So, back to the first question just on the sequential trends that you guys are talking about, obviously down to 2Q to 3Q. When you think about that relative to say normal sequential patterns, are you guys really seeing much difference from that normal sequential pattern?

Well, I would say just normally the HVAC business is certainly less robust than we would have expected. So, that's point one. Relative to our Commercial and Industrial businesses, it doesn't have the seasonality that our HVAC business has. So, there's nothing to take note of there.

No, no, I certainly agree on he second point. I guess what I'm trying to drive to on the first point though, you saw weak trends in Q2. It sounds like, or I'm curious, if 2Q is the right base to build off of if I think about kind of a normal HVAC sequential trend. So, are you seeing weakening on the HVAC side, 2Q to Q3 relative to normal? It sounds like you're saying continued weakness at a comparable level.

Yes, I would think that that is the right way to characterize it. It's relative to Q2. It's kind of a normal seasonality. Now, the other thing to take note of, is that we do have tough comps in Q3 on a year-over-year basis simply because when you carry a backlog into Q3 that we're not carrying this year.

Absolutely, no, that makes a lot of sense. And then on the margin side, could you talk about the price cost curve? And whether -- you've got steel moving a little bit more against you in 3Q, but you've also got probably more full realization of the pricing side in 3Q. Could you talk about the price cost curve and whether it is comparable to 2Q or a little bit better than 2Q when you hit 3Q?

Mike, we think we are balanced going into the quarter. As you said, the realization of the last price increase for the full third quarter and our productivity initiatives that will continue to build momentum in the year. So, we are feeling okay going into the third quarter on that balance.

And, then, last one for me on the acquisition side. From a cost perspective, you had $3 million and change of acquisition expenses in this quarter. What are your expectations at this point with for 3Q and obviously that would be excluding a lot of the one-time oriented cost that would be associated with the actual close of EPC acquisition itself?

Yes, I guess we are seeing some reductions in third quarter versus the 2Q expense level, but until we get it over the finish line, it's kind of hard estimate that.

All right. Well, I appreciate the time, guys.

Thank you.

Mark Douglass, Longbow Research.

Hi. Good morning, gentlemen.

Good morning.

Just talking again about HVAC and your ability to get cost into this quarter. Second quarter was good. But, is there a mix shift also working against you in HVAC? On the resi side, on the dry ship side of things, is there less contact of higher efficiency motors? How is that playing into your margins right now?

Mark, good morning. This is Jon. We did, we have seen a shift in mix towards more standard efficiency products for the reasons I explained. There is a combination of factors at play here. One is the reversion back to the R22 outdoor condensers when there is a failure with the consumer and the product is replaced. And, then you combine that with the lack of consumer confidence and also the reduction in the federal stimulus. All three of those factors combined are creating a dynamic we believe that is causing a mix shift back to more standard efficiency products. Clearly, there is still demand for high-efficiency products in the business, but from a year-to-year comparison, that is a change that we are seeing in the business. Saw that as we went through the second quarter and we expect to see that in the third quarter as well.

So, right now would you say that C&I or high-efficiency motors are kind of carrying the water at this point for high-efficiency motor?

We have definitely seen an increase in high-efficiency product on a year-over-year basis in our other businesses, and C&I is a notable segment of our business where we are seeing that kind of increase and demand for high-efficiency products. Absolutely.

Sure. And from that certainly due to that having to go up to NEMA Premium. Can it be quantified how much the 20% growth in C&I was due to the shift in NEMA Premium?

We don't have the breakout of that right now, but we'll ask Chuck and John to take a look at that and provide it after-the-fact.

Okay, great and then one last question for Chuck. So what are your CapEx expectations for the year?

Mark, it's kind of hard to forecast when that spending will be on the plants. If you recall, we started with an initial estimate for 2011 of $90 million and that would probably be some $25 million -- excuse me $50 million above our normal run rate. So, those two factories are probably going to be in the $20 million to $30 million range in total.

Okay, but, it is still TBD if it has been spent in '11 or '12? Okay. Thank you.

Christopher Glynn, Oppenheimer.

Thanks. Mark, a question about the Reynosa snafu there. Are you concerned about any risk of mix shift in how the customers allocate the share?

Sure. Well, obviously customers are going to be disappointed in the fact that we have this issue. So no surprise and we are making it very clear that we regret any inconvenience. But, I would say this. We have absolutely had a sense of urgency around this issue that I think our customers have recognized. We've stepped up and stood beyond the obligations to our customers and it's evident by the announcement that we made on Wednesday. So, my hope is that our customers recognize that and also recognize the fact that not every motor manufacturer in the world could stand behind their obligations the way that we are. So, time will tell, but we certainly are doing right by the customer.

Okay. And then from the bigger picture perspective, what are your longer-term thoughts about potential for OEM risk of diversification to international suppliers?

I think there's always risk that you'll have competition from international suppliers. We've had it in every one of our businesses, but I think we're well-positioned given our own international footprint. And also, when you add EPC to the mix, we'll have an even stronger international footprint that will be able to compete with anybody, anywhere.

Okay. Thanks. And then just on the 20% C&I growth, could you break out the organic piece of that?

Well, Chris, it would be a combination of volume growth and price growth. And then we'd also of course see the shift from the standard to the NEMA Premium. And, that has a higher average selling price. So it would be those three factors. We also have a volume number.

That didn't include acquisitions?

It did not include acquisitions.

Great, thanks a lot.

Josh Pokrzywinski, MKM Partners.

Hi. Good morning, guys.

Good morning.

Just wanted to follow up on an earlier question about the acquisitions in the quarter, that $3.3 million. How does that compare to that original expectation of $7 million that you guys called out last quarter? Is there another $3.7 million somewhere else buried in the numbers not related to A.O. Smith, or was that just lower than anticipated?

The second quarter did -- I'm sorry, the first quarter did have some other projects included in that number. And then the number I quoted for second quarter was a pure EPC number. And so, we would expect to see some decline on that going into the third quarter.

Okay, but just to be clear, your guidance into -- your original Q2 guidance had $7 million in it, give or take, and you guys came in a little bit lighter than that?

Yes.

Okay. Just, looking out into the third quarter, maybe back half of the year, any changes on the recent spike in steel from your guys' perspective? Any changes that happens on the LIFO line?

LIFO was not a material change for the quarter, Josh. And, steel as I mentioned is starting to trend down a little bit, but we will start to see an increase in the third quarter. But, we've got that built into our guidance.

Okay. And then, any quantification or feedback you're getting from the channel about what this bonus depreciation is doing? Is it kind of a blip, or a non-event, or is that something that you feel like is picking up demand a little bit this year?

We have not heard anything from our sales and marketing teams that would suggest that it is any kind of a benefit to the business.

Got you. And then, one final one just on inventory, with the ISA standard and pretty strong demand on the C&I side on your term, any fits in the channel on inventory levels? Is premium inventory too low, standard inventory too high? Any dynamics there that we should be aware of?

I would just say, in general, we are well-positioned. Things are rolling out pretty much the way they thought they were and that is that over time, we would earn down any remaining [EPAC] inventory, that is the less efficient product that we had in the integral horsepower business. That's moving away over time and been replaced by the NEMA Premium product. And that's what we see happening with our other competitors as well.

Got you. Okay. Thanks a lot, guys.

Scott Graham, Jefferies.

Good morning. I was wondering if you could unbundle for us some of the strengths, the markets in particular in C&I and Electrical and Mechanical overall?

I would say, overall, Jeff, generally speaking in both the Commercial and Industrial and Mechanical and Generator businesses, those tend to be later cycle businesses. And so, we've seen overall general strength across all segments that we saw in Q2. And going forward, we are assuming that we will see that same behavior in Q3.

And, I would add to that Scott, that we've seen particular strength in ag, with industrial equipment, and also with oil and gas.

That's helpful. Would you call those three markets really the leaders in each of those businesses? Or, is it maybe a little bit of a different set for one versus the other?

No, I wouldn't call those necessarily leaders for us. We do participate with several of our businesses in each of those segments, but they are not necessarily the largest segment. Now industrial equipment is a pretty important sector for our Commercial and Industrial businesses.

Okay. Now, you guys have obviously a big leadership position in HVAC in the high-efficiency area. And, I know that you are trying to move this leadership position, leverage it more into C&I. I was just wondering if you could give us a bit of an update there on, and I see some of the new products of course, but where do you see traction? I mean motors are pretty much as ubiquitous as gas and industrial, and so it would seem to be a nicely leveraged position. So I was just wondering, are you seeing good successes there? Is it just new products? Is it distribution? Just maybe give us a good idea of how that strategy is rolling out?

Scott, sure. It's a great question. I think that we're excited about what we are seeing so far in our Commercial and Industrial businesses with our strategy to take the ECM technology, if you will, and the dynamics behind that product development and how to fit it into the Commercial and Industrial businesses. We've been on that path for a long time. And, one of the products I mentioned today is that Permanent Magnet AC industrial motors is a great example of that. Essentially, if you look at that motor is very similar to an ECM motor. It uses permanent magnet technology, offers higher efficiency levels in standard products as well as other features and benefits.

In that particular case, we've done a lot of work to make sure that product is compatible with drives that are available in the market today so customers can take advantages of those benefits. Last quarter, I mentioned a smaller frame permanent magnet motor, which is very similar technology, but that gives us the ability to take the high-efficiency technology into a wide variety of commercial and industrial applications. And, we are on just as a constant path to do that. To keep taking this type of technology, making it suitable for commercial and industrial applications, and just expanding it. So, there's a lot of excitement in the team right now and we feel very good about the path we are on.

So, we are releasing both customer content and new customer gains off of the strategy?

When we have a technology like this, one, there's an interest from our existing customers, and two, it absolutely opens the doors up for new customers. No question about that.

Very good. That's all I had. Thank you.

Wendy Caplan, SunTrust.

Hi. Good morning.

Morning.

Can we talk about working capital, Chuck? Looks like it was up. On a year-over-year basis, it was up 35% double of what your sales increase was. Inventories seem to be the biggest challenge, and is that generally related to China? Or are there other factors in terms of redundancies? Or are there other factors that would be helpful for us to know?

Wendy, probably the biggest driver would just be the seasonal change as we build up inventories that would be at the end of the second quarter.

I'll just add, Wendy, if you recall last year in the quarter, in our HVAC business saw an enormous demand surge and we brought our HVAC inventories down significantly in the second quarter of last year. This year, we have a more normal inventory position.

Okay. So, are we in the quote right inventory position at this point?

I think it is generally balanced. I think, clearly, a lot of it will be determined by future sales trends. But, we're comfortable with our working capital levels at the end of the quarter.

Okay. And, can you comment on hiring? Are you hiring? Where are you hiring? Who are you hiring? Can you give us some of that information, please?

Sure. It's going to depend very much on the specific manufacturing facilities, which is where the majority of our hiring would be obviously, at the production facilities. And so when we start talking about our generator business being up 35%, I think that was the exact number, or are C&I business being up or our Mechanical business being up, those facilities would obviously have been increasing our level of staffing in order to support the demand. And, in our HVAC business, to the extent that there is weakness, we would be removing production workers.

So, on a net basis are we kind of flat, or what would you say, Mark?

I would say, probably through the second quarter we would have been up on a year-over-year basis. Going forward, probably moderating.

Okay. And, Mark, your degree of confidence that $28 million is the right number to cover these warranty issues, and the fact that it will be corrected this quarter and we won't hear. We will be looking back on it next quarter. Can you tell us about that, please?

Sure. We've done a tremendous amount of work, analysis to get at this. We work closely with our customers and looking at every point in the distribution channel to make sure we understood it, this is after a lot of analysis. This is the correct number right now and we feel so good that we have captured it all.

Okay. Thank you. And one last question on the price cost equation. Last quarter, you talked about price increases lagging the cost and inflation. In this quarter, it's covered both on -- you said on pricing and productivity. If -- should we worry that if 3Q revenue growth is slowing in volumes, decline a bit sequentially, that productivity gains are going to be harder to get? Or, do you have a strong -- you didn't mention the kind of nature of the price increases, but should they given what you know today, should they be covering costs going forward into the third quarter?

Our guidance, right now, includes having similar performance in the third quarter that we had in the second quarter, which is that our combination of both price and productivity will allow us to offset third-quarter inflation.

Okay. Thank you very much.

You're welcome.

Bill Dezellem,Tieton Capital Management.

Thank you. We have a couple of questions. The first one, generically speaking, with EPC. If that transaction were to close in the month, would you anticipate that it would be beneficial or a drain to Q3 earnings on an operating basis, including any restructuring charges and then secondarily excluding restructuring charges?

Bill, we look forward to providing that information immediately after the closing on EPC. And, we'll schedule a conference call for that purpose.

Okay. And even just generically, directionally whether it will be favorable or unfavorable in the quarter is not something that you are prepared to talk about now?

It won't be very far off, so we'll just provide that information at that time.

Alright, thank you. And then the second question is relative to the economy. There are a number of questions out there, especially after yesterday. But, what is your sense with the North American economy, whether it is shifting backwards or not? And then would you please also address the Asian and European regions? But I am actually -- not only do we have the question about the economy, but are also interested in the implications of your answer about the economy in those three regions for acquisitions?

Opposite, the best indication for us is going to be order patterns and we've reflected our thinking in our third-quarter guidance. And, the comments that we've made is that obviously we see a weakening in HVAC, and it is kind of carrying over from second quarter. Or, in our Commercial and Industrial and our Mechanical businesses, which have tended to be later cycle businesses, we still see strength in those markets and they tend to cover many, many different industries. So far, through the third quarter, we still feel strength in those businesses. From an Asia perspective, both our Asia Pacific business, which for us includes Australia and Thailand and Singapore, still going strong. Our India business, similar, still going strong. However, we have seen a deceleration in our China orders.

And, the European market?

From a Europe standpoint, we don't have a tremendously big footprint in Europe so we may not be the best indicator, but what we are seeing is a little bit stronger in the northern part of Europe and somewhat weaker in the southern part of Europe.

And, when you put all this together, what implications, if any, do you believe this has for future acquisitions for you?

Well, you know the M&A market, as you know very well are still very strong, at least these coming of the second quarter. I would say that it's a little bit frothy relative to the valuations. In terms of our own pipeline, we continue to feel good about the pipeline that we have and we are still out looking at a number of opportunities and we will continue to do so.

Thank you both.

Jamie Sullivan, RBC Capital Markets.

Hi. Good morning.

Good morning.

Most of my questions have been answered. Just figured I would ask one on HVAC. With some of the moving parts, you had some pricing helping, mix hurting. So I'm wondering if you could talk about just unit volumes and whether there was any additional impact in that business compared to last year due to maybe some changing competitive dynamics as you go down into the lower efficiency end of the market?

Well, two comments. Number one, from a year-over-year basis, as I mentioned earlier, it was difficult comps because we had a very strong second and third quarter, particularly third quarter, but second quarter as well last year. We had surging demand. The second point I'll make is that as you go into the lower efficiency products, it tends to be more competitive.

Okay. All right. And then, are your customers -- are they saying anything about their expectations around this mix trend towards R22? Are you hearing anything about closing the loophole? Just wondering --.

There's a few of the customers who don't like the situation what's going on. And in fact I believe are pursuing -- are trying to pursue the closing of that loophole. I don't know the specifics. I don't know their chances of being successful, but some people don't like what's happening. In terms of the impact on mix, they are seeing it as well. They are seeing impact on mix as well and therefore we are seeing it.

Okay. Thanks. And, maybe for Chuck. Just wondering if you have a breakout after the price increases over the last nine months. How much did price contribute to the sales growth in the quarter, overall?

Jamie, we typically don't release that information just for competitive reasons.

Okay. Thanks. That's all I had.

Thank you.

Walt Liptak, Barrington Research.

Hi. Good morning guys.

Morning.

I realize that we'll be talking in a month, hopefully after A.O. Smith gets closed. But, I wondered if -- I think you mentioned that there is likely $0.05 in the analyst estimates and I'd put A.O. Smith in there. And, I wonder how you came up with that number? Is that based on what the other analysts came up with? Or, is it based on your own accretion model?

It is purely based on our estimate of it and looking at the different models, Walt. So there's no science to it. We could be off by $0.05 either way on that number.

Okay. A.O. Smith, their revenue and profits have been running ahead of I think what most people thought they would be doing six months ago. Have you adjusted your accretion models? I know we've got the pro forma on it. At $702 million, they are already running at $424 million in revenue. Can you talk at all about where your accretion models are?

We will be updating that on our call after the closing, Walt.

Okay, and then integration plan? You've had more time now, I guess to maybe not to dig into to A.O. Smith, but to at least consider when you are going to do. Can you give us an idea of how quickly you'll be able to get in there and start taking cost out? And basically, can you get cost out once the deal closes, like within the first month or two?

We are going to stand behind the numbers we've given before in terms of our synergy targets; still in the $30 million range. We have spent a tremendous amount of time with the team in terms of integration planning, but only on the functional side. We've not been able to discuss the commercial aspects of the integration and we are looking forward to doing that as soon as the transaction closes. But, as Jon mentioned, we feel great about the talent and we've feel great about the cultural aspect of the transaction.

Okay. Great. Thanks very much.

Holden Lewis, BB&T.

Great. Thank you. Good morning.

Good morning.

Just closing the loop on a couple of things. First, with regards to price cost curves, I guess you indicated that you felt like in Q2 you had sort of recaptured the dollars that you had lost earlier. Are we to sort of assume then that by Q4 if materials stay where they are, by then you're sort of recapturing the actual margins? So, your price cost going forward could actually begin to be a margin boon at that current level as we sort of work through the direction?

Well just to be clear, Holden, we said that we were balanced in the second quarter between price and productivity offsetting the inflation. And, that we would expect to continue that balance into the third quarter. But again, we are only speaking about the year-to-date cost inflation. And, we are still behind on recovering the 2010 cost inflation. So, of course, there would be other factors impacting the margin for the full year. The volume would have a big driver to that as well. But purely on the balance between price, productivity and cost inflation, we feel we are balanced on a year-to-date basis.

Okay, and that's really just assuming the 2011 changes when you say year-to-date?

That's correct.

Okay, such as taking Q2 as a baseline. Going forward, if raw materials stay where they are, are you getting more price to still bleed in, whether it be from more contract accounts or what have you. That means that if we have captured, recaptured the dollars through the first half, at the end of the second half you start recapturing the margins and the productivity begins to actually contribute to margin rather than just being, playing defense with that?

Yes. It's difficult to answer that question with those assumptions, because we know that we are still experiencing some cost inflation into the third quarter. Now, our prices, we'll receive full realization for the entire third quarter. So, that will benefit us.

Okay. Okay. And, I just hitting back on sort of the HVAC trend as we go through the rest of year. I guess the way that we see this play out so far is you feel like Q1 is relatively strong. Customers built up inventories and then they worked down those inventories in Q2 because of a relatively cool season. And I guess you think at least to begin Q3, they are continuing to work down those inventories, despite the heat you weren't seeing any pop-up. Have you noticed maybe some capacity issues around contractors who all seem to be saying that their demand is up pretty significantly? Does this feel like if you get it later into Q3 those inventories should be just -- rationalized enough that but they start to build? Maybe there's a capacity issue? Maybe then you have a better Q4 than is seasonally normal? I mean, does that feel like that's how it plays out, or do we feel like whatever revenues we lost in Q2 due to the weak seasonal or weak weather are just lost?

This is Jon, Holden. We certainly would hope that that dynamic would hold true. That the heat that we are expressing right now, even if we are not seeing the impact on orders today, that we would see the benefit of that as we go through the third quarter and into the fourth quarter. As I mentioned earlier, heat is generally good. It's going to drive more demand for the air-conditioning equipment. It's going to drive increased demand due to replacement products. So, that's certainly what we would hope to see. As I mentioned, at this point we haven't seen an uptick in orders, though.

Okay. And then lastly, I guess, could you give us sort of an update on SG&A? It seems like revenues were up nicely in Q2, but it seems like the overall SG&A dollars are actually down versus Q1. So volumes went up, SG&A dollars went down. Is that productivity? Is it something else? If it is productivity, what major initiatives do you have in place right now that is driving some of that?

Holden, I guess the only number that we have called out would have been the lower legal expenses related to EPC in the second quarter over the first quarter.

And how much were those, I'm sorry?

They were $3 million in the second quarter. And with respect to the EPC part of it, they were over $6 million in the first quarter.

Okay. So, even accounting for those, that can explain the $3 million, but it still kind of went down in a rising volume environment. Is that just productivity you're doing? I guess I'm also trying to get a sense of what big productivity initiatives do you have in place right now that did not only drive that result, but continues to drive result going forward?

Yes, maybe we can go over some of the specifics later, Holden, but there were no other big dollar changes, quarter to quarter. We continue to of course, focus on controlling all of our costs.

Great, thanks.

Okay. I think that is the end of questions.

Yes. That's the end of questions.

Thank you very much. Before we close, one special note. Please mark your calendars for our second annual analyst day event, which will be December 6, 2011 in New York City. Thank you for joining the call and thank you for your interest in Regal Beloit.

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