RBC Bearings Incorporated
Q1 2017 Earnings Call Transcript

Published: 9 May 2017

[Operator:]

Good morning and welcome to the Regal First Quarter 2017 Earnings Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Rob Cherry, Vice President of Business Development and Investor Relations. Please go ahead.

[Robert Cherry:]

Thank you, operator. Good morning and welcome to Regal Beloit's first quarter 2017 earnings conference call. Joining me today are Mark Gliebe, Chairman and Chief Executive Officer; Jon Schlemmer, Chief Operating Officer; and Chuck Hinrichs, Vice President and Chief Financial Officer. 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 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 factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our SEC filings. On slide 3, we state that we are presenting certain non-GAAP financial measures in this presentation. We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods and in the same manner as management. Please read this slide for information regarding these non-GAAP financial measures. And please see the appendix for a reconciliation of these measures to the most comparable measures in accordance with GAAP. Now, I will turn the call over to Mark.

[Mark Joseph Gliebe:]

Thanks, Rob. Welcome, everyone, and thank you for joining our first quarter call and thank you for your interest in Regal. We'll follow our normal agenda. I'll make a few opening comments. Chuck will provide a financial update. Jon will provide color on markets, operations and the performance of our three segments. After that, I'll summarize and then we'll move to Q&A. Our first quarter adjusted earnings per share results were 12.6%, ahead of prior year and slightly ahead of our expectations. Revenues were in line and operating margin was somewhat better than we expected. It was great to see positive organic growth in the quarter. The first quarter was the fifth quarter in a row where the organic growth rate improved. At a segment level, organic growth in the Climate segment was up 3.7% with strong sales in residential HVAC partially offset by diminishing weakness in the Middle East market. In the C&I segment, organic growth was up 1.7%, with growth in most of our Asia businesses, our power generation businesses and our commercial HVAC business. Finally, in the PTS segment, organic sales were down 5% for the quarter, driven mostly by renewable energy demand patterns. From an operating profit perspective, margins improved 100 basis points year-over-year resulting from three key drivers. First was the impact of volume leverage and positive mix in Climate; second was the rightsizing of our oil and gas businesses; and third was the benefits of simplification and SG&A cost controls. We had another good quarter of working capital improvement. Cash cycle days improved by 7.6 days in the quarter. The strong working capital management helped us pay down $43.5 million in debt, bringing our debt to adjusted EBITDA ratio down to 2.9. Overall the first quarter was a strong start to the year. Looking forward, as we entered the second quarter, orders are up low single-digits across all three reporting segments. The key top line drivers affecting our total year sales include, first we expect the two-way material price formulas to continue to be a tailwind to sales. Next, we expect to anniversary last year's declines in the Middle East and in oil and gas in the second half of the year. And finally, our residential and commercial HVAC customers are predicting mid single-digit growth rates for 2017. Overall for 2017, we're now expecting low single-digit organic growth for the year. On margin performance, we are off to a great start and we are continuing to forecast margin expansion for the year resulting from volume leverage and the success of our simplification efforts. We are expecting margin pressures from commodity inflation for the rest of the year. The two-way material price formulas and recent price increases will help offset commodity inflation. However, commodity inflation is expected to slow our margin expansion efforts for the year. We have updated and increased our 2017 guidance. Our guidance now reflects total year adjusted earnings per share of $4.55 to $4.95, up 7% at the midpoint over 2016. I will now turn it over to Chuck.

[Charles A. Hinrichs:]

Thank you, Mark, and good morning, everyone. Sales in the first quarter 2017 were $813.5 million, down 0.6% from the prior year. Organic sales increased 0.7% in the first quarter of 2017 as compared to the prior year. Foreign currency translation in the quarter was a negative 0.6%, and the impact of a prior year divestiture reduced sales by 0.6%. Our adjusted operating margin in the first quarter was 9.6%, which was a 100 basis points improvement from the 8.6% in the prior year. The strong improvement in the first quarter was driven by three factors

[Jonathan J. Schlemmer:]

Thanks, Chuck, and good morning, everyone. Let's first walk through each of the segments. In Commercial and Industrial Systems, sales were $381 million with organic sales increasing 1.7% from prior year. This was in line with our expectations and represents the fourth consecutive quarter of improving organic growth rates. In the quarter we experienced strength across our Asia businesses with particularly strong demand in China. We also saw strength in our power generation businesses. The commercial HVAC and the North America pool pump markets were positive as well. The strength across these markets was partially offset by diminishing weakness in oil and gas and lower demand in agriculture. Price was essentially flat to the prior year; however, prices improved sequentially. In the quarter we had improvements in both our gross margins and our operating margins. Adjusted operating margin was 7.2% of sales, up 140 basis points from prior year. The margins improved as a result of the rightsizing of our oil and gas businesses as well as the benefits from SG&A cost savings. Partially offsetting these improvements was the negative impact of commodity inflation. Overall it was a solid start to the year for our C&I business with organic sales up and improved operating margin. In Climate Solutions, sales were $248 million with organic sales increasing 3.7% from prior year. This represents the fifth consecutive quarter of improving organic growth rates. We had another quarter with strong demand in our North America residential HVAC business with sales up mid single-digits from prior year. The strength in North America HVAC was partially offset by diminishing weakness in the Middle East. We also experienced soft demand for our heating aftermarket products due to the mild winter weather throughout much of the first quarter. Similar to C&I, price was essentially flat to prior year with pricing continuing to improve sequentially due to the two-way material price formulas. In the quarter we had improvements in both our gross margins and our operating margins. Adjusted operating margin was 13% of sales, up 220 basis points from prior year. The strong North America HVAC volumes improved product mix, and the ongoing simplification efforts and cost controls all contributed to the strong margin performance in the quarter. Overall, it was an excellent start to the year for our Climate business with organic sales up and improved operating margin. Sales in Power Transmission Solutions were $185 million. The prior year divestiture had a negative 2.6% impact on sales and organic sales were down 5% versus prior year. While still down from prior year, it was the third consecutive quarter of improving organic growth rates. The decline was impacted by project-driven demand patterns in renewable energy and diminishing weakness in the oil and gas end markets. The order rates in this segment continue to improve sequentially and are up low single-digits from prior year. Adjusted operating margins were 9.8% of sales, down 170 basis points from prior year. The decline in margins was driven by the lower volume. Overall, our PTS business performed in line with our expectations. And given our improved order rates, we are expecting organic sales growth and margin improvement in the second quarter. Now, I'd like to give you an update on a few of the topics that we discussed at our recent Investor Day back in March. We continue to make excellent progress on our simplification efforts over the past quarter. The three manufacturing projects that we announced in the fourth quarter and communicated on our last call are all underway and on schedule. One of these projects will be completed in the third quarter and the other two will be completed prior to the end of the year. During the quarter we announced a fourth manufacturing consolidation program. We announced the closure of a motor manufacturing facility in Pennsylvania, where we will be consolidating the operation into our larger manufacturing facility in Wausau, Wisconsin. We also completed another ERP conversion during the first quarter, converting our legacy Power Transmission business. This puts our PTS business on a common ERP, and by the end of the year, we'll have approximately 80% of Regal's total sales on a common platform. During the quarter our restructuring expenses totaled $3.2 million, and we are forecasting $9 million of restructuring expenses for the full year. I'll remind everyone that payback on these programs is typically two years or less. Before I leave the discussion on simplification I'd like to bring your attention to the picture at the lower right-hand corner of the slide. We've been placing a stronger focus on growing our sales to customers across Latin America, especially in Mexico. We've added to our sales organization in this region and as a result we've experienced double-digit organic sales growth over the past couple of years. This quarter, we will open a new distribution center and sales office in Monterrey, representing a significant investment to support our organic growth efforts. The new distribution center will improve service to our customers and will allow us to consolidate and simplify several third-party warehouse operations across Mexico, helping to reduce our operating expenses. We announced at Investor Day the focus we were placing on commercial excellence to help drive organic growth. We'd like to give you a quick update on the progress we've made over the past couple of months. We are actively recruiting and hiring additional sales professionals to fill gaps in our sales coverage and to increase the focus in our distribution businesses. About 25% of the new positions were filled in the first quarter and most of the remaining positions will be filled in the second quarter. We're excited to increase the resources working directly with our customers and the opportunity to bring more talent into our sales organization. We're also arming the team with common CRM tools to help increase the team's effectiveness. During the first quarter we also made very nice progress on our efforts to develop and bring rich data content to our distribution customers. This is what we're calling the digital customer experience. We're well on our way to capturing the high resolution 360-degree spin images on the 20,000 SKUs that we've targeted to complete in 2017. And as we progress through the year we'll be syndicating this data to our key distribution customers so they can improve the search and find capabilities on their websites and on our own website. We continue to receive very positive customer feedback on the direction and progress we're making in this area. I will now turn the call back over to Mark.

[Mark Joseph Gliebe:]

Thanks, Jon. Now before I summarize our first quarter results, I would like to draw your attention to the announcement we made last week, where our board voted to increase our quarterly dividend $0.02 per share, representing an 8% increase. This dividend increase is twice our normal increase and illustrates the confidence we have in our future. Now, I will like to briefly summarize our first quarter results. Adjusted earnings per share were up 12.6% as compared to prior year. Organic sales growth was up slightly and in line with our expectations. As we enter the second quarter, orders in all three segments were up low single-digits as compared to prior year. Margins were relatively strong in the quarter, up 100 basis points and we expect margin improvement for the year. We improved our cash cycle days and we paid down $43.5 million in debt. In the quarter we started the repatriation of $150 million of cash that we previously outlined for you at Investor Day. We are making very good progress on our 2017 simplification programs, which will benefit late this year and into 2018. During the quarter we began to implement a variety of commercial excellence initiatives, which we believe will help drive longer-term organic growth. And finally we raised our 2017 annual guidance $0.05 per share. Overall, the first quarter was a great start to the year. We will now take your questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. At this time, we will pause for a moment to assemble our roster. Our first question comes from Julian Mitchell with Credit Suisse. Please go ahead.

[Unknown Speaker:]

Hi, guys, good morning. This is actually Jason (20

[Mark Joseph Gliebe:]

Good morning, Jason (20

[Unknown Speaker:]

Yeah, my first question is just on your free cash flow. Could you provide a little bit of color on your full-year guidance particularly on conversion? I know this is currently in line with usual seasonality this quarter, but do you see that continuing sort of throughout the balance of the year?

[Charles A. Hinrichs:]

Well, we had given – Jason (21

[Unknown Speaker:]

Got it, thank you. And just as a quick follow-up, when you're talking about the resi and commercial HVAC markets in particular being up in the single-digits, is that something that you see sort of accelerating throughout the year, maybe sort of when going to our model overriding the sequentially tougher comps in some of your segments, or do you see that sort of just as a constant – as sort of a constant cadence throughout the year?

[Mark Joseph Gliebe:]

So, I'll take a pass at this Jason (22

[Jonathan J. Schlemmer:]

Yes, that we're expecting, I would say a more normal HVAC cooling season this summer in terms of how we forecasted the remainder of the year.

[Unknown Speaker:]

Got it. Thank you very much.

[Mark Joseph Gliebe:]

Thanks, Jason (22

[Operator:]

Our next question comes from Robert McCarthy with Stifel. Please go ahead.

[Robert McCarthy:]

Can you hear me, guys?

[Mark Joseph Gliebe:]

Yeah. Good morning, Rob.

[Robert McCarthy:]

Good morning. So, thanks for taking my questions. Number one, could you just talk a little bit about how you're thinking about the margin cadence for the year from here, and then maybe talk about a little bit of dynamics that you see the improvement of PTS?

[Mark Joseph Gliebe:]

Sure. So, I'll start off. First, as Jon mentioned, we had both gross margin and operating profit margin improvements in both our C&I and our Climate segments, and then it was weaker for us in the PTS segment. We also commented that we expect a margin expansion in the second quarter in the PTS segment as a result of the higher order rates that we're seeing in that business. Normally, our second quarter and our third quarter are our stronger operating margin net performance in our residential business just as a result of seasonality. So that should help you think it through.

[Robert McCarthy:]

Okay. And then, just thinking about, obviously you have material escalators across the portfolio, but can you talk about kind of areas where you got any outsized price just on your own, or – I mean, how do you feel good about your pricing position right now?

[Mark Joseph Gliebe:]

Sure. I'll comment then Jon can add any color. So, I'll remind folks for the benefit of everyone, 30% of the company is affected by two-way material price formula contracts in both our C&I segment as well as our Climate segment. And throughout last year and the year before we had quite a headwind as commodities were falling with a top-line headwind. As commodities were falling, we had guided for the year that those – we expected those two-way material price formulas to turn and they did, and we're starting to see that we saw that benefit in the first quarter and we're expecting that to continue in the second and third quarters. Relative to the rest of the company, our history has been that we're able to offset material inflation with price increases, we commented last call that we did raise prices back in December effective in the first quarter and those prices are now taking effect and we are seeing a benefit from them.

[Robert McCarthy:]

Hello?

[Mark Joseph Gliebe:]

Yeah, Rob.

[Robert McCarthy:]

Yeah. So thank you for that. The last question, sorry, is just longer term, if you could just talk about, obviously you raised the dividend slightly, but hopefully you get a strong free cash flow generation as a whole. And this is a company that's done a very good job though of buying very interesting assets with high visibility on costs levering up and taking that cost out and kind of as the cycle improves paying down a lot of debt and then kind of expanding the overall revenues and sales, and profitability of the company in the aggregate. Do you think that's still the strategy going forward in terms of kind of riding the cycle and levering up for M&A, and obviously you can disagree with my characterization, but – or do you think there's going to have to be a change in your long-term growth strategy going forward, just because you might have a different sense of the opportunity set for M&A?

[Mark Joseph Gliebe:]

Well, we outlined at Investor Day our enterprise strategy, and we commented that while we certainly continue to expect the company to do M&A in the future, there was a subtle shift in our thinking from acquisition-first to organic-first. So we're all about trying to drive organic growth in the company and that is absolutely our heads-up (26

[Robert McCarthy:]

Thanks for your time.

[Mark Joseph Gliebe:]

Thanks, Rob.

[Operator:]

And our next question comes from Bhupender Bohra with Jefferies. Please go ahead.

[Bhupender Bohra:]

Hey, good morning, guys.

[Mark Joseph Gliebe:]

Good morning, Bhupender.

[Bhupender Bohra:]

Hey, so I just wanted to get the first question on Climate Solution here, if you guys can talk about the product mix here within the quarter. And how you're thinking about that mix kind of contributing to the margins, especially I think Jon talked about the summer like it's going to be a normal summer this year. But it doesn't look like, when you see outside. So if you can comment on that and how we should think about the mix as we go through.

[Jonathan J. Schlemmer:]

Yes, I'll comment, Bhupender, on the mix, and also the HVAC season in terms of what we're expecting and how we're looking at the remainder of the year. So on the product mix, as I mentioned, it was one of the drivers for our margin improvement in the first quarter, we had I call it a slight mix benefit in the first quarter and then we had the other factors of just the higher volumes overall in Climate as well as the simplification and the cost control efforts that all contributed to the margin improvement in the first quarter, but mix was a positive factor for us in the first quarter. And I would say that for the remainder of the year, we would be expecting a slight mix benefit as well for the remainder of the year. On the season, we've had a pretty good start in the second quarter, similar to how we exited the first quarter and the normal seasonality. So our expectation, I would say of a normal cooling season so far is holding. Obviously it's a short-cycle business and weather can play a big role, especially early in the season. So we're watching that closely, but our expectation is that we'll have a more normal cooling season and that will have some impact on our comps as Mark mentioned earlier on both the second quarter and third quarter because of the timing that we had, the unusual timing we had in 2016.

[Bhupender Bohra:]

Okay. Got it. Just to follow-on on PTS business here. You did mention the order rates actually improved as you exited the quarter. What particular end markets do you think – if I look at the mix here, material handling and general Industrial kind of the biggest pieces here within the business, can you give us some color where that order rate is improving? Thanks.

[Mark Joseph Gliebe:]

Yeah. Sure, I'll give a sort of comment on that, Bhupender. First of all, the first quarter was affected by project business in our...

[Jonathan J. Schlemmer:]

Renewable.

[Mark Joseph Gliebe:]

... renewable energy space, sorry. Thanks. And so we expect that that's kind of choppy and volatile and we expect that to shift here in the rest of the year. So it will become favorable for us. And then next is – relative to the rest of the business, I would say we saw relatively broad improvement in our order rates. Certainly oil and gas started to improve, we're seeing that and then I would say the general Industrial business that we sell through distribution, we saw improvements in those order rates as well.

[Jonathan J. Schlemmer:]

Yeah. And I would add, Mark, that the sequential improvement we saw in orders, that was true in the fourth quarter and then with another sequential improvement in the first quarter. So we're quite pleased with how the order rates have improved sequentially and that's what gives us the confidence that we'll see organic sales growth in the second quarter in that segment.

[Bhupender Bohra:]

Okay. Got it. Thanks a lot, guys.

[Mark Joseph Gliebe:]

Thanks. Thanks, Bhupender.

[Operator:]

Our next question comes from Scott Graham with BMO Capital Markets. Please go ahead.

[Ashish Gupta:]

Hi. Good morning, gentlemen. This is Ashish Gupta on for Scott. I just wondered if you could talk a little bit more about the incredible margins. It seems like a lot of the improvement came from lower D&A, but just wondering if you could go into more of the puts and takes there.

[Mark Joseph Gliebe:]

Sure. So, we saw very nice incremental margins in both our Climate and C&I segments. They were quite strong. And then in our – in PTS segment, I would say we saw normal decremental margins in that business as the volume was down. So...

[Jonathan J. Schlemmer:]

Probably I would say the decrementals were a little better than normal and that would be some of the benefits from the cost controls and simplification and synergies, but I would agree, Mark, the decrementals and PTS were more in line with what we would expect to see in that business. And all driven by the top line volume.

[Ashish Gupta:]

Great. Thanks for that color. And then you kind of gave some more detail there on the end markets relative to the order rates in C&I. And just wondering if you could kind of give a little bit more quantification on where you saw the most improvement across the end markets, because you guys have so much exposure?

[Jonathan J. Schlemmer:]

Well, I would say....

[Mark Joseph Gliebe:]

Are you talking about a specific reporting segment, Ashish?

[Ashish Gupta:]

Across the segments?

[Mark Joseph Gliebe:]

Across all segments?

[Jonathan J. Schlemmer:]

Yeah. So I'll give you some additional color on the end markets, then Mark can add in if he has any other comments. In Climate, I would say that it was pretty straightforward. We had North America HVAC, where we had solid orders and sales performance in our Climate business. As we commented, up mid single-digit and expecting that for the year. We had in the Middle East while the comps were still a headwind for us in the quarter; the comps are diminishing because of the comparisons getting easier as we enter into the second half. From an orders rate standpoint, I would call that kind of business kind of stable from a sequential standpoint, no real change in the business, just the comparisons are getting easier as we enter the second half. Moving into C&I, I would say that the orders performance, it was really – the strength was in the markets I mentioned earlier on the C&I segment. So I – where we had strength in power generation, we had strength in Asia, particularly in our China business, which is mostly an Industrial business, and we had strength in both commercial HVAC similar to the residential HVAC market and our pool pump market was quite a strong first quarter.

[Ashish Gupta:]

And the only other particular add in that space will be data centers was quite strong for us in the quarter.

[Jonathan J. Schlemmer:]

Data centers was a nice strength impacting our generator business as well as our switchgear business. So, we've talked about that business in past calls and that continues to be a nice end market with strength for us. And PTS as Mark mentioned, it's pretty broad-based across a number of end markets when we talk about the sequential orders improvement.

[Ashish Gupta:]

Great. Thank you so much.

[Jonathan J. Schlemmer:]

Thanks, Ashish.

[Operator:]

Our next question comes from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

[James A. Picariello:]

Hey, guys. This is James Picariello. So, just a quick.... (34

[Mark Joseph Gliebe:]

Good morning.

[James A. Picariello:]

Starting out with the D&A guidance, it looks like it's roughly $7.5 million lower year-over-year. Just wondering what drove that and how that factored into prior guidance versus the one you lay out today?

[Charles A. Hinrichs:]

Sure, James. Thanks for the question. I would respond in three areas. Number one, we've seen a consistent decline in D&A expenses over the last three years. A lot of it comes from the success of our simplification initiative, where we are closing facilities and optimizing our manufacturing footprint. So our fixed costs, including depreciation would be going down as a result of the success there. Also I would add that in the first quarter of last year, we had a $2 million acceleration of depreciation expense from an ERP system that was being converted to our Oracle platform. So the year-over-year comparison is a little bit larger than it would normally be. And then thirdly on the intangible side, on the amortization side, some of the intangibles from prior acquisition have reached their accounting useful life, and therefore the amortization expense declines.

[James A. Picariello:]

I appreciate that. But how did this factor into your prior guidance last quarter? Just wondering, because, I mean it's a $0.13 year-over-year benefit.

[Charles A. Hinrichs:]

Right.

[James A. Picariello:]

So just wondering how it compared to your prior guidance?

[Charles A. Hinrichs:]

Yeah. It wasn't in our prior guidance specifically; we didn't give the D&A expense. So there's really no change from – as it impacted our guidance. The guidance improvement is due to the improvement in sales and order flow for the second, third and fourth quarters.

[James A. Picariello:]

Okay. Got it. And then just one on Climate Solutions. Obviously a really strong first quarter on margins. And there's typically a pretty sizable ramp sequentially into the selling season. How should we be thinking about it for this year, the progression for Climate given the strength in the first quarter here?

[Mark Joseph Gliebe:]

Well, I'll go back to reminding first that last year was kind of an unusual season, because we had a weaker second quarter and a stronger third quarter overall in the top line which drove our incremental margins in both quarters. So, normally our second and third quarters are our stronger top line, and therefore our stronger operating margin quarters, and we think that will be – that's the way you should think about it for this year as well.

[James A. Picariello:]

Thanks for the color.

[Mark Joseph Gliebe:]

Thanks, James.

[Operator:]

Our next question comes from Mike Halloran with Robert Baird. Please go ahead.

[Mike P. Halloran:]

Hey, you guys. Hey, guys. Good morning.

[Mark Joseph Gliebe:]

Good morning, Mike.

[Mike P. Halloran:]

So, let's have a conversation about sustainability from current levels, more on the Industrial side of the portfolio, so that PTS and everything. So it sounds like order rates are tracking the right direction, maybe you could have some conversation about one, what you think the sustainability of the Industrial side of the portfolio looks like? Two, what kind of inventory levels you're seeing in the channel today and kind of sequentials as you've seen so far the year if they've been pretty normal or a little better than expected?

[Mark Joseph Gliebe:]

So, I'll start and Jon can jump in. So, first the comment I'll make is on the bottom line, Jon commented and I commented I think as well – as a contributor from an operating margin perspective was the rightsizing that we did last year in our oil and gas businesses. Those businesses were hurt as a result of order rates and we took the appropriate actions from a rightsizing perspective, and we're seeing the benefit of that in the second quarter, and while the orders are improving, we won't need to add all that cost back. So we should see the benefit of that throughout the rest of the year. Order rates seem to be hanging in there right now. And so I would say it's early to claim victory for the year that they're going to continue. But at least as we can see through the second quarter, Jeff, right now, we see the second quarter continuing to go forward. So, that's my view on that.

[Jonathan J. Schlemmer:]

Yeah. I would agree, Mark. I think, Mike, that kind of summarizes how we see the Industrial orders. And the strength that we had – yeah, we mentioned in PTS in particular that orders are up on a year-over-year basis. And we've had similar order patterns as we've entered the second quarter that we experienced as we exited the first quarter. So at least so far, we're seeing the order strength that we experienced exiting Q1, we've seen very similar demand patterns coming into the second quarter.

[Mike P. Halloran:]

And the inventory side?

[Jonathan J. Schlemmer:]

Inventory, I would say, we do feel that the destocking that we experienced throughout 2016 has come to an end where we see that behind us. However, I wouldn't say there's been any restocking that's occurred in the channel. It seems to be we're running with more with the flow of the business now is what we're feeling.

[Mark Joseph Gliebe:]

I think a feedback on the residential HVAC side is the inventory channel is thin as well.

[Jonathan J. Schlemmer:]

We've had that feedback from a few of our customers that would indicate that in the Climate, inventories are running on the low side.

[Mike P. Halloran:]

Great. And then the follow-up, small one here. You have one last selling day in the second quarter, how should I think about that in terms of impact from a growth perspective or is it pretty negligible?

[Mark Joseph Gliebe:]

I would think it would be negligible for the quarter.

[Mike P. Halloran:]

Yeah. Appreciate it, guys.

[Mark Joseph Gliebe:]

Thanks, Mike.

[Operator:]

Our next question comes from Sam Eisner with Goldman Sachs. Please go ahead.

[Samuel H. Eisner:]

Yeah. Good morning, guys.

[Mark Joseph Gliebe:]

Good morning. Good morning, Sam.

[Samuel H. Eisner:]

Just going through the EBIT build on a year-over-year basis, just curious have you guys, this time last year gave buckets of volume, cost, price material, acquisition, FX. You were able to kind of let us know what really drove the EBIT change to the downside. Curious if you can walk through the EBIT change to the upside? We know that D&A is a kind of pretty sizable driver on the year-over-year improvement here, but wondering if you will walk through those other buckets and specifically if you can target kind of what's going on with the cost savings, how much of that was a tailwind to EBIT this quarter?

[Mark Joseph Gliebe:]

Well, I'll start off and the rest of the guys can jump in. So we did outline a little bit where some of the margin benefit came from. Jon mentioned that we saw improvement in both Climate and C&I, on both the gross margin rate as well as the operating profit margin rate. We saw a sizable benefit in SG&A and some of that came from the rightsizing of our oil and gas business, but I would say overall we saw a nice benefit in comp and ben in the quarter in SG&A and we also saw a benefit in depreciation in the quarter due to the reasons that Chuck just outlined for you. So those would be the key drivers overall.

[Jonathan J. Schlemmer:]

And I would add a headwind that we had to offset in the quarter was price costs, which we mentioned. While prices have been improving sequentially, we still experienced a headwind on price cost. I mean, look at commodity, inflation was pretty significant in the quarter. So we had the benefits that Mark mentioned around the rightsizing of the oil and gas businesses, the cost controls and then also the positive impact of volume that helped all of those as well as the lower SG&A costs more than offset the price cost headwind.

[Samuel H. Eisner:]

Is there any way to put any numbers behind that, Mark, since you gave the comp and benefits comment, how much of that was a tailwind from a dollar standpoint in the quarter?

[Mark Joseph Gliebe:]

I don't have those with me right now, Sam.

[Charles A. Hinrichs:]

Yeah. We usually don't provide that level of detail. But certainly we had comp and benefits, savings in all three of the segments. So we continue to manage our cost consistently across the businesses.

[Samuel H. Eisner:]

Got it. And then maybe just going back to the inventory comment, appreciate the color on, no more destocking. When you look at your kind of inventory position today, it looks like you've actually turned the corner and starting to build the inventories and – so I guess how much does increased absorption this quarter actually benefit the margin profile versus last year, when you're presumably destocking and how do we think about production levels over the balance of the year?

[Mark Joseph Gliebe:]

So, I think last year we talked about the headwind we had from taking out all that inventory we took out. Last year, it was 25 to 50 basis points of headwind. I think it's not unusual for us to go into the second quarter and build inventories. That is quite normal for us. Now, we're still not satisfied with our progress – we haven't arrived yet in terms of what we think we can get to on overall DIO days in inventory. So we still think there's room to move there. So, we expect continued improvement in that area as we go forward. In terms of the impact on margins, I would expect just the reverse, as we are producing, we should see the slight benefit to margins that last year was a headwind.

[Charles A. Hinrichs:]

And Sam, as we build inventory, that really is a period cost in the second quarter when we sell that inventory. So we don't really get that much of a volume impact in the first quarter from the build of inventory. We'll realize it when we sell it in the second quarter.

[Samuel H. Eisner:]

Got it. Thanks so much.

[Mark Joseph Gliebe:]

Thanks, Sam.

[Operator:]

Our next question comes from Walter Liptak with Seaport Global. Please go ahead.

[Walter Scott Liptak:]

Hi. Thanks. Good morning, guys.

[Mark Joseph Gliebe:]

Good morning, Walt.

[Walter Scott Liptak:]

I want to ask about the PTS segment, and if we can get an update on the oil and gas mix and the renewable mix, how much of the pie for that segment are those two sectors?

[Mark Joseph Gliebe:]

Yeah. So – we could speak for the whole company relative to oil and gas in total then maybe we can take the PTS segment here in a second. So, overall oil and gas in the company, I think we're down to 2% of total sales. I think when we started the oil and gas decline, we were at 8%. So, it took quite a hit over the years. So I don't have the specific number for PTS at my fingertips.

[Charles A. Hinrichs:]

For PTS, I think originally, when we acquired the company, it was about 10% of their total sales, it's obviously declined at a rate similar to what we've seen in total Regal. Of course with so much of the sales going through distribution, we wouldn't have full visibility as to the ultimate customer.

[Walter Scott Liptak:]

Okay. And what about the renewables part of this segment?

[Jonathan J. Schlemmer:]

Well, this is Jon, the renewable part of that business, it's a relatively small part of the business in total sales, I'd say in the neighborhood of a couple percent of the segment, in terms of the size of the business. And the good news is, it's all been incremental for us, that was a business that we won in 2015. It had nice growth in 2015 and into 2016. But being a project-based business, it's really choppy from quarter to quarter. So, and we've had a couple of quarters here where it's been a headwind in our sales. It will actually be a tailwind in the second quarter, with the orders that we already have on the books. It will actually be a positive for us in Q2 and for the year, it will be about similar to our 2016 revenue for our full year.

[Walter Scott Liptak:]

Oh, great. So you took in some orders this quarter and that fills out your back half. That's great in renewables.... (47

[Jonathan J. Schlemmer:]

We did, we have a pretty good visibility through the next few quarters and some assumptions we're using for the fourth quarter.

[Walter Scott Liptak:]

Okay. Do you know why that stalled out, why those projects did (47

[Mark Joseph Gliebe:]

It's just project-based, when our customer gets big orders, we tend to get big project orders in that business. It's been – since the time we won that business, that's the way it's been, it's been choppy.

[Walter Scott Liptak:]

Okay. Okay, and then similarly in oil and gas, can you talk about the streams where you've got most of the exposure, obviously oil and gas is picking up kind of across the board, but are you seeing any increased interest, order rates, quotes, things like that?

[Mark Joseph Gliebe:]

There's no question. We're definitely seeing improvements in interest levels, order rates, and quotes, all three. So, oil and gas has certainly got a lot of green shoots and we're seeing them pretty much across all of our businesses that are exposed to that space.

[Jonathan J. Schlemmer:]

No question in the upstream products, we're seeing it. I'd say that the midstream products, we've not yet seen it yet. But that business is kind of normal.

[Walter Scott Liptak:]

Okay, great. And then just one last follow-up on the D&A, not to beat a dead horse here but I think I had a higher D&A level because you guys didn't guide for 2017, when you did your first go at EPS guidance. Was the lower D&A in your original guidance you just didn't show it or in your original forecast or was this a change to your D&A that just happened?

[Charles A. Hinrichs:]

Walt, there was no change in the D&A in our earlier guidance or in our current guidance. We just didn't provide that single data point in the original guidance for 2017.

[Walter Scott Liptak:]

Okay. I understand. Okay. Thank you.

[Mark Joseph Gliebe:]

Thanks, Walt.

[Operator:]

Our next question comes from Rudy Hokanson with Barrington Research. Please go ahead.

[Rudolf Arthur Hokanson:]

Good morning.

[Mark Joseph Gliebe:]

Hi, Rudy.

[Rudolf Arthur Hokanson:]

A question on the balance sheet. You don't have it in your squares, in your financial metrics, but are you still expecting to pay down about $200 million this year and alongside of the question, could you explain the slight increase in the net interest expense for the year?

[Charles A. Hinrichs:]

Rudy, this is Chuck. Thank you for your question. Yeah. Our original outlook for $200 million of debt reduction was before we had gained confidence in our ability to repatriate the additional $150 million of cash. So we'll be increasing that debt reduction target for 2017, but as we said that will be coming in the second and possibly the third quarter. Our interest expense forecast is up a little bit consistent with the increase in interest rates and the timing that we would expect in receiving the cash repatriation.

[Rudolf Arthur Hokanson:]

Okay. So you're still expecting and I was a little confused there. You're still expecting to pay down about $200 million?

[Charles A. Hinrichs:]

$200 million from normal cash from operations and then the cash repatriation would be in addition to that, so you're targeting....

[Rudolf Arthur Hokanson:]

Okay. Yeah. I remember you saying that if you did get the cash you might apply it to further debt repayment, that's what you're saying?

[Mark Joseph Gliebe:]

That's right.

[Rudolf Arthur Hokanson:]

Great. Okay. And then the second question, could you talk a little bit more about what's going on in the Middle East or how to think about it, because not too long ago it was due to – going to different standards, I believe, in the Middle East and getting rid of inventory in the Middle East by your clients that had caused the drag. Where are you on the Middle East right now as far as the market goes? I think you said you felt it was stable right now. But I was wondering if there's a particular dynamic or something that evolved out of what you had experienced a little over a year ago, I believe?

[Jonathan J. Schlemmer:]

Rudy, you're correct. We did have that change, we had a couple of things that were impacting our Middle East business, we just had – we had the overall market down given the lower prices in oil and gas and the impact that's had on the economy there, and then we had the standards change which also put a real headwind into demand for us as the manufacturers work through inventory levels. That's behind us now. So there isn't anything unique going on in terms of any dynamic like that affecting demand. But, the Middle East, while stable, it's stable at a lower level of demand. So, we're not seeing a sequential change in demand but if you look at it compared to our historical demand levels, we are operating at a lower level of demand today.

[Mark Joseph Gliebe:]

And I'll just reemphasize that we are expecting this to turn in the back half of the year. It's been a headwind; we expect it to start to be a slight tailwind as we go into the second half.

[Rudolf Arthur Hokanson:]

Okay. Thank you. Those were my two questions.

[Mark Joseph Gliebe:]

Thank you, Rudy.

[Operator:]

We now have a follow-up question from Robert McCarthy from Stifel. Please go ahead.

[Robert McCarthy:]

Hi. This is Robert McCarthy for Robert McCarthy. How are you doing? In any event, I wanted to follow up maybe just longer-term about your IoT strategy or thinking about the connected devices with respect to motors and the kind of data that you can get, I mean, in speaking to some of the OEM GDOS (53

[Mark Joseph Gliebe:]

Well, thanks, Rob. I appreciate the question. So we did outline this for our investors at Investor Day and we talked about IoT being a long-term growth driver for the company. And so as a reminder to everybody, as more and more electric motors become energy-efficient products, especially in the smaller electric motors, you tend to use permanent magnets, and when you use permanent magnets, you tend to use electronics to make the whole thing work. Once you add electronics and integrate the electronics into the motor, all of a sudden now you add knowledge capability and communication capability into the motor. And so, we've already launched a few products that are actually IoT enabled and providing a variety of different kinds of benefits to our customer, whether it be control of the motor from a remote perspective, whether it aids our contractor in installation or provides feedback in predictive maintenance. So, from our perspective, this is not a near-term thing, we have a lot of work to do, and it's going to be a lot of work with our customers trying to find out how we can help our customers meet their own IoT goals, but I would say it's a wide-open (54

[Robert McCarthy:]

The second question is obviously the predominant amount of your sales are in the U.S., but could you just go around by geography and talk a little bit about, flavor that, and specifically could you contrast maybe a little bit of your oil and gas exposure domestically versus Canada, such as it is or anything you can provide, obviously understanding that predominantly your sales are in the U.S.?

[Mark Joseph Gliebe:]

Right. Thanks. So in the quarter, China was a nice tailwind for us, primarily related to infrastructure activity. So we saw a nice bump in demand coming out of China. India similar, both in our residential HVAC business in India as well as our larger infrastructure, larger motor infrastructure products we saw a nice boost in the performance. So those would be the two highlights. Relative to oil and gas, most of our oil and gas exposure is in the United States, a little bit in Australia. But most of it's in the United States.

[Robert McCarthy:]

Thanks for your time.

[Mark Joseph Gliebe:]

Hey. Thanks, Rob.

[Operator:]

Thank you. As there are no further questions in the queue, this now concludes our question-and-answer session. I would now like to turn the conference back over to Mark Gliebe for any closing remarks.

[Mark Joseph Gliebe:]

Yeah. We felt great about the first quarter. We appreciate everybody's interest and questions today. So thank you very much and have a great day.

[Operator:]

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