RBC Bearings Incorporated
Q1 2016 Earnings Call Transcript

Published: 10 May 2016

[Operator:]

Good morning, and welcome to the Regal Beloit First Quarter 2016 Earnings Conference 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, Investor Relations. Please go ahead.

[Robert Cherry:]

Thank you, operator. Good morning and welcome to Regal Beloit's first quarter 2016 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 reconciliations of these measures to the most comparable measures in accordance with GAAP. Now, I will turn the call over to Mark.

[Mark Joseph Gliebe:]

Thank you, Rob, and welcome and thank you for joining our first quarter call and for your interest in Regal. We'll follow our normal agenda. I'll make a few opening comments. Chuck will give a financial update. Jon Schlemmer will provide color on markets, operations and the performance of our three segments. After that, I'll summarize and we'll move to Q&A. It was a tough first quarter from a top line's perspective. Organic sales were down in all three segments. At a macro level, there were a few key items that put significant pressure on our top line. First, sales in the oil and gas and power gen end markets were down roughly $40 million year-over-year. Second, weaker sales in our general industrial end markets in both North America and China dragged sales down another $40 million. Next, demand for Middle East, East HVAC and North American residential HVAC and water heater markets were off roughly $25 million. And finally, the impact of two-way material price formulas with our larger customers was a $12 million headwind in the quarter. From an operating profit perspective, as you can see, volume was clearly the issue in the quarter. The decline in our oil and gas and power gen businesses made up over 40% of the $37 million volume-related op profit decline. Fortunately, our ongoing investments in simplification and cost saving activities helped to offset the impact of the volume decline. And the final point, after four quarters in a row of year-over-year margin improvement, we lost ground in the first quarter and nearly all the decline can be attributed to the impact of the oil and gas and power gen businesses. Back in the late fourth quarter, we recognized the weaker outlook for our markets and started accelerating our plans to further simplify and streamline the company. Today, those plans are in the execution phase. We have numerous active simplification programs underway, aimed at further reducing costs and making it easier to transact business with our customers. We continue to aggressively right size our oil and gas-related businesses, and we expect improved performance from the oil and gas businesses in the second half, both as a result of our cost actions and as a result of the easier comparisons. Further, we are paring back SG&A costs across the company. You can see the results of our efforts beginning to show up when you compare year-over-year SG&A costs which are down roughly 6%. At our last Investor Day, near the end of 2014, we communicated that over the long term, we would exit non-core or low-margin business with sales of $150 million. At the end of April, we agreed to sell our Mastergear branded business which had revenues of $22 million to Rotork plc. Mastergear was a non-core business for Regal which no longer fit in our PTS segment and will certainly fit better with Rotork. Additionally, in the last 12 months, we exited roughly $20 million in low-margin business from customers in our Climate Solutions and C&I segments. In total, we have exited roughly $65 million of the $150 million target of non-core or low-margin business set back in late 2014. Finally, in the early part of the first quarter, we've purchased the remaining shares from our European JV partner of our commercial refrigeration, motor and blower systems business. This will allow us to further integrate and streamline this global business. We improved cash cycle by nearly eight days in the quarter by reducing inventory of $18 million. We expect to continue to improve our cash cycle throughout the year. We generated $43 million of cash in the quarter, which was 104% of net income. We used a portion of the free cash to pay down $17 million in debt. As we look forward, we are expecting the negative organic growth rate that we experienced in the first quarter to moderate throughout the rest of the year. In the second half, we are estimating modestly increased demand from our global industrial businesses as destocking slows. We do expect easier comparisons in our C&I and PTS segments as we begin to lapse the oil and gas decline, which stepped down for us in the second half of last year. And finally, for the second half, we are expecting a more normal heating season in the residential furnace market versus the warm season we experienced in 2015. We do expect margin improvements in the second half as well. The benefits of simplification and synergies and a better sales mix in our Climate Solutions segment should help improve margins on a sequential basis. With the lower sales, we are necessarily very focused on reducing our costs. However, we are continuing to invest in areas such as our sales and engineering teams that can generate long-term growth. I will now turn it over to Chuck.

[Charles A. Hinrichs:]

Thank you, Mark, and good morning, everyone. Sales in the first quarter 2016 were $818.2 million, down 10.3% from the prior year. We had net acquisition growth of 3.9%. Foreign currency translation in the quarter was a negative 1.3%. Organic sales declined 12.9% from the prior year. Our adjusted operating profit margin in the first quarter was 8.6%, a decline of 120 basis points from the prior year. The decline in sales volume pressured the operating profit margin with partial offsets from the benefit of the simplification initiative and cost controls. Our first quarter 2016 GAAP earnings per share were $0.93. The only adjustment to EPS in the first quarter was $1.4 million or $0.02 per share of restructuring and related costs due to restructuring activities in our European business. Our adjusted earnings per share were $0.95 for the quarter. There are two acquisition and disposition transactions that I want to discuss. The first is our purchase of the remaining 45% of Elco, our European JV for $19 million in the first quarter. The business sells energy-efficient motor and blower systems to the global commercial refrigeration market. The business' total operating results were already consolidated, so our current and past sales and operating profit will not be impacted, where changes will be an improvement in the minority interest line on our income statement. We estimated that this is a $0.03 per share benefit to 2016 results, and this was included in our prior 2016 earnings guidance. The key benefit of this purchase is that it enables us to further integrate and improve the performance of our global commercial refrigeration business. The second transaction is a signed contract to sell our Mastergear business to Rotork Plc for $25 million, which will close in the second quarter of 2016. Mastergear manufactures valve gearboxes for industrial applications in the U.S. and European markets. Mastergear's 2015 results were sales of $22 million and operating profit of $4 million. Assuming a closing on the sale in the second quarter, the impact on 2016 results is estimated to be a reduction in sales of $11 million and a reduction in earnings per share of $0.03. This impact on our 2016 earnings was not included in our prior 2016 guidance, but is now included in our updated end guidance. The $25 million proceeds from the sale will be used for debt reduction. I will summarize some key financial metrics for the first quarter 2016. Our capital expenditures in the first quarter were $14.9 million. We expect to spend $85 million in capital for the full-year 2016. In the upper right quadrant, we show our effective tax rate information. The ETR in the first quarter was 23% lower than our guidance due to the global distribution of income and income tax differentials. We are revising our ETR forecast for the full-year 2016 from 25% to 23%. In the lower left quadrant, we provide data on our first quarter 2016 balance sheet. Our total debt was $1.675 billion and our net debt was $1.426 billion. In the first quarter, we reduced our total debt by $17 million. Since closing on the PTS acquisition in January 2015, we have reduced our total debt by $230 million. In the lower right quadrant, we present information on our free cash flow. We generated $43 million of free cash flow in the first quarter, benefiting from our management of working capital especially our focus on balancing our inventory which declined $18 million in the quarter. Free cash flow represented 104% of net income for the quarter. We have strong free cash flow generation which is generally lower in the first quarter from the investment and working capital for the seasonal increase in sales. Now, I will update our full-year 2016 earnings guidance. Mark already summarized our outlook for the rest of 2016. We are executing on our simplification and cost savings programs to partially offset the weaker market conditions. Our guidance reflects the second half of 2016 that is stronger than the first half. The effect of FX translation will continue to be a headwind on our 2016 sales. We estimate the impact of FX to be a 1% to 2% headwind in 2016. Our restructuring programs in 2016 are expected to result in $14 million of restructuring and related expenses for the full-year 2016. This is a $4 million increase from our earlier estimate of $10 million as we accelerate some of our simplification projects. Our full-year 2016 GAAP earnings per share guidance is $4.38 to $4.78. Our full-year 2016 adjusted earnings per share guidance is $4.40 to $4.80. The adjustments to the GAAP EPS include the addition of $14 million or $0.20 per share of estimated restructuring and related expenses and the subtraction of the estimated gain on the sale of our Mastergear business of $12 million or $0.18. Now, I will turn the call over to Jon Schlemmer.

[Jonathan J. Schlemmer:]

Thanks, Chuck, and good morning, everyone. Let's start with segment performance beginning with the Commercial and Industrial Systems. Sales were $378 million, a decrease of 17% from the prior year. Organic sales declined by $69 million. The impact of oil and gas and the power generation end markets impacted sales by $30 million in the quarter. During the quarter, we experienced a decline in order rates across our oil and gas businesses, and recall that last year, we were still working off a backlog in these businesses. The general industrial end markets in both North America and China impacted sales by an additional $30 million. In the industrial markets, we experienced soft demand from many of our customers including the impact of destocking. The two-way material price formulas has impacted price, reducing sales by $5 million. We experienced strength in demand in the residential pool and data center markets. Demand was strong for both standard pool motors and high-efficiency variable speed pool motors. And in data centers, we continue to see strength in both orders and sales for our switchgear technology. With the headwinds on the top line, adjusted operating margin was 5.8% of sales. The decline in oil and gas and power gen accounted for approximately 170 basis points of the margin decrease. The simplification and cost reduction efforts are helping to offset the volume decline. We have two manufacturing transitions under way to further simplify and reduce the cost of our manufacturing footprint. And while we've taken significant cost out of our oil and gas businesses, we are planning another phase of restructuring. Sales on our Climate Solutions segment decreased approximately 14% in the quarter. Organic sales declined by $37 million. We have a strong position in the Middle East air-conditioning market. And in the past three quarters, we've experienced weakness in this market, and it was even more pronounced in the first quarter. There are two factors driving this. The first is the overall market conditions, and the second is a mandated standards change impacting our customers' products, causing them to slow down production and work off their inventories. In the U.S., industry data shows that unit shipments for residential HVAC and water heaters were down mid to high single digits. In the HVAC aftermarket, we experienced weakness in demand of our heating replacement products due to the impact of the warm winter. We did see some modest strength in unit demand for air-conditioning products from our large OEM customers. Price impacted our sales by $9 million, approximately 3% of sales. This is driven by our two-way material price formulas with our large customers. As we've entered the second quarter, we're experiencing the normal seasonal increase in demand in the U.S. air-conditioning market. And looking forward to the second half, we are expecting improved comparisons in the sales of our heating products. Adjusted operating margin was 10.8% of sales, a decline of 80 basis points from prior year. The simplification and cost reduction efforts offset the majority of the volume decline from the U.S. and Middle East markets. We have three active manufacturing transitions in this segment to help further simplify and reduce the costs of our manufacturing footprint. Sales in our Power Transmission Solutions segment were $201 million, an increase of 15%. The PTS acquisition contributed $36 million of acquisition sales, and organic sales declined $10 million approximately 5%. The decline in organic sales was primarily driven by oil and gas where the reduction in demand was very similar to what we experienced in the C&I businesses. Outside of oil and gas, we experienced weakness in the agriculture and metals end markets as well as our distribution channel. These declines were offset by strength in renewable energy, food and beverage, and unit material handling. Despite the decline in organic sales, adjusted operating margin was 11.5% of sales, an improvement of 10 basis points. Operating profit benefited approximately 90 basis points, as we finalized purchase accounting in the quarter and we aligned cost accounting practices in the acquired business. Improved mix, synergies from the acquisition and cost actions helped to offset the impact of lower volume. Before I turn it back over to Mark, I want to give an overview of our simplification and synergy initiative. In 2015, we made significant progress on our simplification initiative, exiting six of our manufacturing facilities and five warehouses. We converted five ERP systems and completed the fourth of our five design platforms. We are seeing the benefit of these efforts as the savings from these programs carry over into 2016. We now have eight active manufacturing transitions underway. The majority of these transitions take advantage of our low cost manufacturing footprint and affect all three of our segments. We will start to realize the benefits from these programs in the second half of the year. We also have two active warehousing programs that will consolidate seven of our warehouses into two larger and more efficient distribution centers. And while we make progress on these fronts, we're working to complete four more ERP conversions over the next 12 months. After those conversions, we will have nearly 80% of our business on a common ERP platform. And finally, our fifth design platform consolidation is underway, we'll start seeing the benefits in the latter part of this quarter and continuing into 2017. In total, these programs generate an annual savings of approximately $13 million. We can see the benefits of all these actions in our staffing levels. Over the past five quarters since January 2015, we've reduced our non-production head count by nearly 13%. That's a significant reduction and is enabled by the progress on simplification and the ongoing focus on cost controls. Given the challenging end markets, there's even more we will take on throughout the remainder of 2016. Restructuring and related expenses from these activities totaled $1.4 million in the first quarter and we're forecasting approximately $14 million for the full year.

[Mark Joseph Gliebe:]

Thanks, Jon. Now before we go to Q&A, I would like to summarize our first quarter performance. For the first quarter, sales were down approximately 10%. The biggest headwinds were oil and gas and power generation as well as the global industrial markers. Margins at our oil and gas and power gen businesses were hit especially hard, and most of our margin rate decline in the quarter can be attributed to these businesses, and weaker volumes negatively impacted our margins. However, our simplification programs helped offset some of the margin shortfall. We are in execution mode on many simplification and cost saving programs that should start delivering benefits in the back half of the year. Improved cash cycle by nearly eight days in the quarter mostly from reducing inventories. We expect to continue improve working capital throughout the remainder of the year, enabling further debt reduction. Our cash flow to adjusted net income was 104%, and we used a portion of the free cash to pay down $17 million in debt. Our guidance reflects a second half that is stronger than the first half. We expect to begin to see the benefits of our more recent simplification and cost saving programs, especially in oil and gas. We expect a more normal heating season and better product mix in our Climate Solutions segment. And finally, we are expecting a modest recovery in the North America and China industrial markets as destocking slows. We will now take your questions.

[Operator:]

We will now begin the question-and-answer session. The first question comes from Mike Halloran of Robert Baird. Please go ahead.

[Mike P. Halloran:]

Good morning, guys.

[Mark Joseph Gliebe:]

Good morning, Mike.

[Mike P. Halloran:]

So, let's start on the demand side. Could you just help me understand how the general industrial, so the North America and China demand, and then the oil and gas demand tracked through the first quarter and then in the April here, did you see weakening towards the back part of the quarter in those end markets?

[Mark Joseph Gliebe:]

So, Mike, as you recall from our – on our last earnings call, we commented that early in the first quarter in our industrial markets, we saw a burst of demand in North America. We commented that we weren't confident that it was sustainable, and in fact, it wasn't. So, it kind of slowed during the back half of the quarter. We saw a little pickup in April, and I would just characterize our industrial demand at this point has stabilized. We do believe that our customers are destocking, as they're reacting to the overall decline in industrial markets. And we would expect that destocking to end as we head into the back half of the year.

[Mike P. Halloran:]

And so, then the basic question, you guys are calling for some modest improvement in the industrial demand as you work through the back half of the year, are you saying the environment gets better or are you saying simply that destocking on the OE, distributor side dissipates, and so maybe the demand you guys see more accurately reflects what the environment is giving?

[Mark Joseph Gliebe:]

Yeah, I think it's tough for us to call whether or not the environment starts to improve. I would say that it's more related to the slowing of the destocking.

[Mike P. Halloran:]

And then, one last one on the margin side, just to clarify the guidance. Are you guys suggesting that margins are going to track up from 1Q to 2Q, and then up again to 3Q? Or is it just up from 1Q level?

[Mark Joseph Gliebe:]

I would say that we will see sequential improvement in Q2 and Q3 from where we were at in Q1. You normally would see some of that because Q2 is seasonally a stronger market for us in the Climate Solutions segment. But I would say that the more significant improvements in margins will happen once we enter the third quarter.

[Mike P. Halloran:]

Got it. Thanks for the time.

[Mark Joseph Gliebe:]

Yes. Thank you, Mike.

[Operator:]

The next question comes from Samuel Eisner of Goldman Sachs. Please go ahead.

[Samuel H. Eisner:]

Yeah. Good morning, everyone.

[Mark Joseph Gliebe:]

Good morning, Samuel.

[Samuel H. Eisner:]

So, on the HVAC commentary here, I wanted to better understand your Climate Solutions business. Can you talk – or your Climate business. Can you talk a little bit about market share in this market? If you look at – I know you commented that the data has been down, but if you could talk a little bit about market share, what you're seeing from OEMs. Are you seeing the move towards dual sourcing and away from single sourcing? I think that would help to color in this kind of (26

[Mark Joseph Gliebe:]

Well, I'll start at the top, on HVAC, and I'll certainly address your question. As Jon mentioned, we saw a big drop in the Middle East business for us, and it was related to some standards changes in that market, slowing down our customers' demand as well as to the overall decline in the Middle East as a result of oil prices declining. So, that was a $13 million headwind in the Climate segment for us. And then, we size for you the impact of material price formulas, it's being down $9 million. And that's driven by the fact that copper and aluminum are down 15% to 20% on a year-over-year basis, which drives our material price – two-way material price formulas with our customers down. The rest of the business, as we've discussed, Jon mentioned that unit demand from the industry data that we can see down 7% in both resi HVAC and the water heater segment, which takes up another $12 million of the decline in the quarter. Relative to market share in any given quarter, there's always wins and losses. We did not lose any significant customer, and market share was not a big driver for us in the quarter. Our big issues were the markets we were participating in.

[Samuel H. Eisner:]

Got it. That's helpful there. And then, when I think about inventory management, if I look, your inventory, current inventory as a percentage of LTM sales is around 22%, and it's kind of been in that range since the end of last year and the first quarter here now. So, can you talk a little bit about inventory management going forward? It does seem to still be elevated versus historical averages.

[Mark Joseph Gliebe:]

So, yes, you're correct. And we obviously saw that as we exited the year, probably exit – had too much inventory at the end of the year. We were – as you know, in the fourth quarter, our revenues kind of dropped organically, so we need to do adjust and we did. We took $18 million of inventory out in the first quarter. And I would remind you, the first quarter is normally a time when we are building inventory. We're building inventory because seasonally we're heading into the stronger HVAC season. So, in a time when we're normally building inventory, we took out $18 million to right size. I expect probably not as substantial as the first quarter but ongoing improvements in inventory as we move through the rest of the year.

[Samuel H. Eisner:]

And then, if I could just sneak one more in here, on the guidance update, it seems to be about a $0.40 delta at the midpoint. You called out Mastergear, which is $0.03, but the lower tax rate at about $0.12 to your prior guidance, that's a net positive $0.09. Can you talk about the moving pieces of that $0.40, I guess $0.49 now, versus your prior expectations? Thanks.

[Mark Joseph Gliebe:]

Yeah. Thanks, Samuel. So, the big drivers were in the C&I segment primarily related to oil and gas and power gen. So, that was a substantial reduction from what we have seen as the oil and gas markets further deteriorated and the power gen market further deteriorated for us in the quarter. And the second piece of it, the substantial piece of it was in our Climate segment, again as the HVAC unit shipments were down in Q1 and the Middle East was affecting.

[Samuel H. Eisner:]

Got it. Thanks.

[Mark Joseph Gliebe:]

Thank you.

[Operator:]

The next question comes from Josh Pokrzywinski of Buckingham Research Group. Please go ahead.

[Joshua Pokrzywinski:]

Hi. Good morning, guys.

[Mark Joseph Gliebe:]

Good morning, Josh.

[Joshua Pokrzywinski:]

Maybe just to talk about the C&I margins a little differently. Chuck, if you wouldn't mind helping us out with the bridge from 4Q to 1Q, it looks like revenue was up, profit down call it $13-ish million here. I get that oil and gas mix is a headwind, but you would think that material prices would actually be in your favor sequentially and that the oil and gas mix wouldn't be dramatically different from 4Q to 1Q. So, I guess, just given that move, can you maybe help with the sequential growth a bit?

[Charles A. Hinrichs:]

Sure, Josh. Thank you for your question. Certainly, the oil and gas decline in sales had a negative impact on margins, but when you consider the – you have to consider the LIFO benefit that was taken in the C&I segment in the fourth quarter. So, that would explain the largest variance.

[Joshua Pokrzywinski:]

Was there any other LIFO benefit or expense in the first quarter?

[Charles A. Hinrichs:]

No, there was not.

[Joshua Pokrzywinski:]

Okay. Got you. That's helpful. And just on the destocking front, I guess I'm a little surprised to hear that, it just seems like there hasn't been as much commentary from that elsewhere. Is it specific end markets? Is it distribution in general? How would you guys characterize destocking from your customers?

[Mark Joseph Gliebe:]

So, I'll take a shot at that, and if Jon wants to add any color, he's welcome to. But if you think about just the level of industrial decline which has been, I think, pretty widely reported around folks with industrial exposure, everybody's resizing their production lines to align themselves with the real demand. And it's going to be all the kinds of markets we've been talking about, whether it's oil and gas or power gen or just general industrial markets that are affected by oil and gas. So, Jon, do you have anything else to add to that?

[Jonathan J. Schlemmer:]

Well, I will just say we – to add to that, Mark, we definitely saw it throughout the distribution channel in both C&I and the Climate segments and PTS. So, it's pretty much across the board in distribution, and I would say it was split across the number of end markets, primarily on the industrial side.

[Joshua Pokrzywinski:]

Got you. And then, if I can just sneak one last one in. On the Middle East Climate business, I had that business as being kind of less than 5% of the overall. Certainly, rest of world, I think you've quantified in the past, as being less than 10%. Can you help us size that? I mean, I guess a 5-point drag in the quarter would suggest that business was substantially zero?

[Jonathan J. Schlemmer:]

So the business, Josh, is a little more than that. It's approximately an $80 million business for us, if you looked at all the products that we ship directly into the Middle East as well as where we have known applications where our customer ship directly to Middle East customers. So, we size that at about an $80 million business. It was down significantly in the first quarter. Now, it is a seasonal business, so there's going to be quarters that are much stronger. And normally, Q1 is one of the stronger quarters. But it was down significantly in the quarter. And the standards change, as Mark said, drove a lot of that because our customers, there – that changes take effect at the end of the second quarter. And they dramatically reduced their production rates to work off inventory because they can't sell through to any prior made product.

[Mark Joseph Gliebe:]

So, I'll just add for emphasis to Jon's point about, when we – if you just break out sales geographically, we actually will sell through a U.S. customer, but we know where the majority of their demand goes or where the percentage of their demand goes. And we have customers that sell substantially into the Middle East, and we know that they're suffering as well.

[Joshua Pokrzywinski:]

Got you. All right. Thanks, guys.

[Mark Joseph Gliebe:]

Yes. Thank you.

[Jonathan J. Schlemmer:]

Thanks, Josh.

[Operator:]

The next question comes from Scott Graham of BMO. Please go ahead.

[R. Scott Graham:]

Hey. Good morning.

[Mark Joseph Gliebe:]

Good morning, Scott.

[R. Scott Graham:]

Mark, I wanted to ask you this question because in the fourth quarter conference call, you indicated that you were still seeing some pretty slack demand and nothing had really changed. And the organic in the fourth quarter, excluding the change in number of days, was call it about minus 7. And here we are, sort of at a minus 13. So, I guess, my question is, I want to slice this a little bit differently, not exactly what were the results – what were the reasons for the decline in sales. But what from the beginning of February to the end of the quarter surprised you as a company?

[Mark Joseph Gliebe:]

Yeah. I would say, the big change for us was the further step-down in oil and gas demand. That was – it dropped further than we had thought as we went into the quarter. That was probably the single biggest change, power gen being right there with it.

[Jonathan J. Schlemmer:]

And I will add one more to that, Scott. And that was – I think that on our heating products, especially in the aftermarket, we saw softer demand than we anticipated going into the first quarter.

[R. Scott Graham:]

Okay. Great. Thank you. The other question I had is about the second quarter now. How have those markets reacted and really what are order rates looking like in the month of April? I know – thank you for your comment, Mark, that you're seeing sequential improvement was down essentially as we go forward, but could you give us a little bit more color on that for April, particularly considering that the HVAC season feels a little chilly, so far, in the Northeast and Midwest? And I'm wondering what the impact you see on HVAC for that.

[Mark Joseph Gliebe:]

So, my first comment on that would be from my experience in selling in the space, it's probably too soon to call the heating season. Usually, I start thinking about it when we get to Memorial Day...

[Jonathan J. Schlemmer:]

The cooling.

[Mark Joseph Gliebe:]

...the cooling. I'm sorry, the cooling season. But we're seeing – in the Climate space, we're seeing normal sequential build that we – seasonal build that we would see at this time of the year. It's doing what we would normally see it do in terms of our sales. So, we'll see an improvement in our revenues as a result of the seasonal build. In the Commercial and Industrial ex oil and gas and ex power gen, I would say the order rates have stabilized. And we do expect to see, as we enter into the back half of the year, a slight improvement as a result of destocking.

[R. Scott Graham:]

Would you say that that's the case or it is more stable in PTS as well?

[Mark Joseph Gliebe:]

Yes.

[R. Scott Graham:]

Great. Thanks a lot.

[Mark Joseph Gliebe:]

Yes. Thank you.

[Operator:]

The next question comes from Jeffrey Hammond of KeyBanc. Please go ahead.

[Jeffrey D. Hammond:]

Hey. Good morning, guys.

[Mark Joseph Gliebe:]

Good morning, Jeff.

[Jeffrey D. Hammond:]

Hey, just back to this – one, can you flush out what is going on in power gen and why that was so weak? And then, maybe just resize these businesses on a run rate basis? Because it seems like from my math, they were down 40%, and it seems like oil and gas would have been already seeing weakness a year ago.

[Mark Joseph Gliebe:]

So, I'll get at the power gen question first. So, our power gen business on a global basis is roughly $140 million kind of business, that was down $10 million for us in the quarter. So, one of our largest competitors in that space recently publicly made the comment their power gen business was at a 10-year low. So, that's the kind of impact we're feeling. I mean, it's down dramatically. Now, probably that's because it supplies both the oil and gas market as well as the mining market which are both down. So, I think that's why we're seeing such a significant decline in power gen. So, Jon?

[Jonathan J. Schlemmer:]

And Jeff, on the oil and gas side, I think that when you look back at Q1 last year, we did have – while orders were very low in oil and gas, that's correct, we still had a pretty good backlog to work off of in Q1. So, that comparison plus the further step-down in oil and gas demand is what we saw in the first quarter.

[Jeffrey D. Hammond:]

Okay. And then, just on the Climate business, I mean, the HVAC industry's kind of short-term share side has been going through this multiyear kind of growth period where good growth, good margin expansion, and your business just has been kind of flat to down and struggling here. So, I'm just wondering, as you look at and step back and deal with these material price formulas, how do you think about it fitting in and belonging in the portfolio on a long-term basis?

[Mark Joseph Gliebe:]

Well, the first comment I'll make is, I think we have a very healthy share position and long term will be a very healthy market. The fact that we have commodities – the volatility we've seen in commodities in the last year is, except for perhaps 2008, you'll typically see that. And so, the volatility in the commodities is impacting our material price formulas which if the commodities go the other way, it'll come back the other way. So, I still think this is a healthy space for us to be participating in, and we have, I would say, an enviable share position in the overall market, a market that we think will grow long term.

[Jeffrey D. Hammond:]

Thanks, guys.

[Mark Joseph Gliebe:]

Thank you.

[Jonathan J. Schlemmer:]

Thanks, Jeff.

[Operator:]

The next question comes from Robert McCarthy of Stifel. Please go ahead.

[Robert McCarthy:]

Good morning, everyone. Rob McCarthy here. So, I can square kind of the comments about power gen because obviously Emerson called that out on their call. The Middle East comments, definitely, UTX called out on their call, but just the severity of oil and gas is kind of surprising here, and I hate to go over that again. And could you talk about – I mean there's an old quote that says, war is God's way of teaching Americans geography. Is this downturn for oil and gas? I mean, are you learning more about your business in terms of the relative exposure, whether it's up, mid or down? Could you size the business and just could you give us a better sense of kind of what the drivers are here? Because it seems to be a material disconnect between what kind of – our expectations were for coming out of 4Q and what we're seeing now, and could you just comment on share loss again or share loss risk because the growth here is really materially underperforming the broad group?

[Mark Joseph Gliebe:]

Okay. Thanks, Rob. I appreciate the questions. So, from an oil and gas perspective, I'll start out with what we have communicated in the past. I mean in the past, I think this was in 2014, we sized the business at 8% of revenues, two-thirds of which was upstream. Today, we'd say it's roughly 4% to 5% of revenues. Now, this is just oil and gas, and it's still probably two-thirds upstream. So, when we talk about our oil and gas related businesses, we're talking about businesses that sell directly into the oil and gas space. And as we entered into – as we entered into 2015, we were carrying a backlog into 2015. So, we shipped that through, we shipped that down in the first half. And then, we started to see a downturn in the second half and then further step-down as we entered into the first quarter of 2016. As we look at the variances of our orders on a year-over-year basis, we're down 40% plus, and as I read from what all of our peers are doing in that space, it does not seem unreasonable to me that we're down in the same zip code. So, I don't know of any – we haven't lost any major customer or anything like that. Obviously, in a down market, it's hard to know exactly what's happening at every different customer level when there is this much volatility. So, we don't know of any share loss in the oil and gas space.

[Robert McCarthy:]

Okay. And then, just coming back to kind of the restructuring I think you opted for the year, could you talk about the cadence to the extent you can across the quarters of the businesses and expand upon that for us?

[Mark Joseph Gliebe:]

Sure. As we left the fourth quarter, we recognized that we were heading into a tough period and we accelerated our spending in the fourth quarter of 2015. I think we spent $4.4 million in restructuring. We're seeing some of the benefits of that now. Just from a timing perspective, we had pulled into the fourth quarter some of the things that we were planning for the first quarter. So, the first quarter was a little light. We spent $1.4 million. So, out of the $14 million left, that's roughly $12.6 million across three quarters. You could just spread that evenly across the three quarters.

[Robert McCarthy:]

I'll leave it there. Thank you.

[Mark Joseph Gliebe:]

Thank you, Rob.

[Operator:]

The next question comes from Nigel Coe of Morgan Stanley. Please go ahead.

[Nigel Coe:]

Good morning, gents.

[Mark Joseph Gliebe:]

Good morning, Nigel.

[Nigel Coe:]

Yes. So, kind of a lower ground, so I just wanted to home in, obviously the LIFO swing between 4Q and 1Q for both C&I and Climate is a big factor. I think the – Chuck, remind me, I think that the LIFO for full-year 2015 was $18 million benefit year-over-year. How much of that fell into 4Q and maybe segmented by segments?

[Charles A. Hinrichs:]

Nigel, thanks for your question. The total for 2015 was $18 million. In the fourth quarter, it was roughly $15 million which was an improvement of $10 million on a year-over-year basis. So, that's an accounting true-up, as you know, at the end of the year.

[Nigel Coe:]

Okay. And did the bulk of that come into C&I?

[Charles A. Hinrichs:]

It was a little heavier in C&I but also in Climate as well.

[Nigel Coe:]

Okay. Okay. And obviously, we spent a lot of time talking about oil and gas. But the headwinds of $30 million in C&I year-over-year is very similar to the $27 million that we saw in 4Q. So, it feels like the big (45

[Mark Joseph Gliebe:]

Okay. I think, there were – I'm going to – there were three questions there, Nigel, and I'm going to try to get to all three of them. So, the first – the last question was related – the second question was related to destocking, when do we think it will subside. Our view is that we have a number of customers who are industrial-type customers, who are seeing similar kinds of downturns that we are. They're adjusting their inventories. And I expect that to subside as we enter the second half. So, that's that piece. So, you talked about – you asked a question about the oil and gas and the difference between oil and gas demand and industrial demand. We size both of them in the C&I segment, I'm just talking about the C&I segment, both of them down roughly $30 million. And...

[Jonathan J. Schlemmer:]

And the oil and gas was oil and gas and power gen.

[Mark Joseph Gliebe:]

Right. And the oil and gas was down $20 million for us, and the power gen was down $10 million for us. So, that made up the $30 million. And then, another $30 million in global industrial demand, which includes our exposure to China as well as our exposure to North America. Did I get all your questions, Nigel?

[Nigel Coe:]

I think so. I lost count in there but I think so, yeah. And then, just finally, obviously, I think there's been a series of questions shadow boxing around the back-end loading of the guidance. Can you maybe just help us in terms of the cadence for the organic? I think we all got a little bit caught up with the 13% down this quarter. How do you see organic developing by quarter? And if you're not prepared to give us by quarter, maybe what is your framework for the full year?

[Mark Joseph Gliebe:]

Yeah. So, as I mentioned earlier, we expect it to get better sequentially quarter-to-quarter. And that's – and then, we're going to get the benefits – from a margin perspective, we're going to get the benefits once we enter the third quarter from our simplification programs. So, on an organic basis, it will improve sequentially from quarter to quarter partially because we expect the markets to be better and the markets would be – the industrial markets where we expect the destocking to end, partially because we don't think we'll have another winter, kind of an all-time warm temperature set of winter that we have, we'll have a more normal heating season, and then partially because we'll have easier comps.

[Nigel Coe:]

Okay. I'll put it offline. Thanks a lot, guys.

[Mark Joseph Gliebe:]

Thank you.

[Operator:]

The next question comes from Julian Mitchell of Credit Suisse. Please go ahead. Ronnie Weiss - Credit Suisse Securities (USA) LLC (Broker) Hey, guys. It's Ronnie Weiss, on for Julian.

[Mark Joseph Gliebe:]

Good morning, Ron. Ronnie Weiss - Credit Suisse Securities (USA) LLC (Broker) Good morning. I just want to touch on the two-way pricing, $12 million hit in the quarter. Does that remain pretty much consistent for the rest of the year as it tail off towards the end of the year? And then, on the raw mat side, what's the expectation for the full year? Any change to the benefit there as well?

[Mark Joseph Gliebe:]

I'll answer the – I'll answer the first part of the question, and then Chuck will comment on our assumptions for our capital. And Jon, you should jump in if you have anything. On the two-way material price formulas, we – the first half of the year will look pretty much the same relative to the material price formulas. It could start to turn as we head into the back half of the year, so it could be some help to the top line. But we had copper prices go up two weeks ago, and now they're back down a little bit. So, you don't really quite know what's going to happen to the spot prices of copper and aluminum. There is still inflation happening today. I'm not sure how long that will last, but there is still inflation today. So, that would also cause it to turn. So, Jon?

[Jonathan J. Schlemmer:]

And I would just add on the material price formulas. What we're forecasting, what we're expecting is that we'll still have a headwind in the second quarter (49

[Mark Joseph Gliebe:]

And there is typically a three-month delay from the time of the spot prices adjust to the time that our formulas with our customers adjust. Did that answer your question? Ronnie Weiss - Credit Suisse Securities (USA) LLC (Broker) Yes. Got it. Thank you. And then, we touched on kind of cadence for the restructuring costs. On the savings side, does everything that's kind of incrementally done get caught in the back half of the year? Does some of that ultimately spill over into 2017 as well now?

[Mark Joseph Gliebe:]

Jon mentioned that there would – from the programs that we're executing on right now, there was going to be a $13 million – roughly $13 million benefit on an annual basis, and we begin that – we believe that that will start to kick in in the second half of the year. Ronnie Weiss - Credit Suisse Securities (USA) LLC (Broker) Understood. Thanks, guys.

[Mark Joseph Gliebe:]

Yes. Thank you, Ron.

[Operator:]

The next question comes from Bhupender Bohra of Jefferies.

[Bhupender Bohra:]

Good morning, guys.

[Mark Joseph Gliebe:]

Good morning, Bhupender.

[Bhupender Bohra:]

A question on the Climate Solution business here, in your commentary, you mentioned about the weakness in natural gas or water heaters. Now, can you size that market for us, like how big that is for RBC, and what actually drove the weakness in that particular – I mean we have seen – if you look at the shipments, I mean electric water heaters had been pretty strong. And natural gas, I think there's some shift that's happening between electric and natural gas. Is that the reason why it was done or was there something else?

[Mark Joseph Gliebe:]

So, Bhupender, our business sells into natural gas water heaters. We do not sell into the electric gas water heater space. So, if I'm not mistaken, I believe the natural gas water heater business in the first quarter was down in the mid-single digits kind of number. So, we were affected by the decline in that demand.

[Bhupender Bohra:]

Okay. I'm asking whether it was due to the shift towards the electric water heater, did you see that in the channels or was it purely the demand?

[Jonathan J. Schlemmer:]

Bhupender, this is Jon. I don't think we saw any appreciable shift between electric and gas on water heaters in the quarter. If there was, that would affect us. But I think we do – there's just more overall softness in the market from a unit standpoint now to shift to gas – sorry, to electric.

[Bhupender Bohra:]

All right. I'll take that (52

[Mark Joseph Gliebe:]

Yeah. So, we sell primarily into infrastructure and industrial type markets in China. And so, that business was down for us, and I would say again, it had been down in the past. So, when we sized our total industrial exposure between the U.S. and China, I think we sized it at $40 million across the company. And certainly, China was a sizeable chunk of that.

[Jonathan J. Schlemmer:]

And overall, if you look at last year's revenues 2015, we would size – China, for us, is approximately 7% of our revenues, just size it in terms of the impact.

[Bhupender Bohra:]

Okay. And when you talk about destocking, was that one of the phenomena which is happening in China?

[Mark Joseph Gliebe:]

Yeah. I would say, same scenario. We have customers with their revenues are down rather substantially. So, they're adjusting their inventories as well.

[Bhupender Bohra:]

Got it. Thank you.

[Jonathan J. Schlemmer:]

Thank you, Bhupender.

[Mark Joseph Gliebe:]

Thank you, Bhupender.

[Operator:]

And we have a follow-up from Samuel Eisner of Goldman Sachs. Please go ahead.

[Samuel H. Eisner:]

Hey. Thanks very much for letting me hop back on. Just on the inventory question again, and in particular, manufacturing levels, can you talk about how much either under production or under absorption impacted you guys in the first quarter and how you're thinking about that throughout the course of the year, either related to the cadence of margins increasing throughout the course of the year or embedded in your updated guidance? Thanks.

[Charles A. Hinrichs:]

Thank you, Sam. This is Chuck. Yeah, it certainly had somewhat of an impact as it usually does in the first quarter with lower production. But we have all of that baked into our guidance. The slowing of production as we work down inventory is somewhat offset, too, by the benefits of our simplification projects and our cost savings projects. But all of that is in our guidance for the year.

[Jonathan J. Schlemmer:]

And Chuck, I would add, in the first quarter bridge that actually Mark talked about as we walk through the slides. That any absorption issue that we had in the first quarter, we included that with the overall savings that we saw from all the cost actions in the first quarter. So, we absolutely were able to much more than offset any impact to that in the quarter. And that will be our focus through the whole year.

[Charles A. Hinrichs:]

Right.

[Samuel H. Eisner:]

Again, maybe just a follow-up on that comment, Jon. So, the $15 million of cost savings, is there any way to break out how much under absorption negatively impacted that cost savings, if you want to talk about the individual simplification plans versus kind of SG&A reduction? Just wanted a better handle on that $15 million.

[Charles A. Hinrichs:]

Yeah. Sam, it's really – it's much more complicated than that, so I think the way we bridge it is accurate and reflective of the results in the quarter.

[Samuel H. Eisner:]

All right. I'll try that offline. Thanks, guys.

[Jonathan J. Schlemmer:]

Thanks, Sam.

[Operator:]

And we have a follow-up from Robert McCarthy of Stifel. Please go ahead.

[Robert McCarthy:]

Yeah. Could you just comment on the kind of decremental margins you're kind of seeing and how you think you're going to get restructuring to kind of combat that out? I would just – cite the O&G and power businesses with the C&I and kind of the decremental you saw there, and talk about what your expectation is from the back half and how you're going to minimize that because it seems to be a big, quite a healthy decremental there.

[Mark Joseph Gliebe:]

Well, I'll give you all the data by segment here in a second, but I would say that we did – when you take into consideration everything we mentioned relative to oil and gas and excluding the oil and gas, you can see that we offset a substantial amount of decremental to the existing simplification programs and if – so, there were certainly some positive news there relative to our execution and our ability to offset those decrementals. So, if you think about the Climate business, you ought to think about 25% to 30% decrementals. If you think about the C&I business, you ought to think about 30% to 35% decrementals. And if you think about PTS, you ought to think about 35% to 40% decrementals.

[Robert McCarthy:]

I'll follow up offline.

[Mark Joseph Gliebe:]

Thank you.

[Operator:]

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