RBC Bearings Incorporated
Q2 2008 Earnings Call Transcript

Published: 4 Aug 2008

[Operator:]

Good afternoon. My name is Keara, and I will be your conference operator today. At this time, I would like to welcome everyone to the Regal Beloit second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you. I would now like to turn the conference over to your host, Mr. David Barta, Chief Financial Officer. Sir, you may begin.

[David Barta:]

All right, thank you. Good afternoon everyone and welcome to the Regal Beloit second quarter earnings conference call. Joining me today are Henry Knueppel, Chairman and CEO, and Mark Gliebe, President and COO. Before turning the call over to Henry, 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 those factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our filings with the SEC. Now I will turn the call over to Henry.

[Henry Knueppel:]

Thanks, Dave, and thank you everyone for joining us in this call and for your interest in Regal Beloit. We will follow our normal agenda. I will make some opening comments. Dave will cover the financial aspects of the quarter. Mark will give you some color on products, markets, and operations, and then I'll talk a little bit about the third quarter and take questions. First of all, let me just say that we are extremely pleased to announce yet another record quarter in spite of the strong headwinds in the residential HVAC market and the unprecedented rise in raw material cost. Our largest market, residential HVAC was down approximately 12% for the quarter. We fared better than the markets due to our first mover advantage and continued success in introducing high efficiency and more intelligent products. Mike will share more on that in a moment. Concerning materials, steel has doubled since the beginning of the year. Copper continues to escalate and energy costs in general are up across the board. While we continue to head some of our commodity exposure such as with copper, we have been forced to replace lower priced hedges with higher priced hedges. We have raised prices in all product lines, but the reality is that with the combination of timing and a difficult HVAC market, we were still on deficit for the quarter as we projected. We will continue to closely monitor the situation and we will continue to act prudently and decisively to manage our margins going forward. Fortunately, we are benefiting from strong tailwinds as well. Our industrial motor, power generation and industrial businesses, our international businesses have all remained strong. Our acquisitions since 2007 continue to be accretive to our financial performance and importantly have added strategic value as we have expanded our manufacturing and commercial footprint in high growth areas such as China, India, and Southeast Asia, and bolstered our portfolio of energy-efficient system solutions. And our productivity programs are delivering across the board. Our people are doing an incredible job at every level in this corporation. They have kept their energy and focus on improving every aspect of the business and they are a pleasure to work with. In summary, we feel very good about our recent performance, but we are even more excited about our future. Let me take a few minutes and get away from the quarter and talk about the gathering strength within our company. That strength is innovation. Four years ago we started focusing our R&D on what we considered to be the three mega trends in our business. These include energy efficiency, variable speed technology, and embedded intelligence. Since that time, we have doubled our R&D spending on game changing products, resulting in more than 30 product launches over the past two years. Today we are generating significant revenue from revolutionary products. We are continuing to launch new products at a record pace and we have a robust product pipeline. This level of innovation is positioning us to benefit from these mega trends as customer adoption continues to ramp. Many of these new products are revolutionary and bring new value to existing applications, such as lower energy consumption, enhanced process quality, reduced maintenance cost and improved operational control. While these products the most promise, they also take the longest to gain traction. Frequently, they require customers to make fundamental changes and their designs to take full advantage of our product capability. Such was the case with our ECM motors. However, with the cost of energy skyrocketing and the real threat of greenhouse consequences becoming a reality, they are both economic and civic responsibilities that will drive increased demand for these products. We will be the beneficiaries of these important developments for the foreseeable future. We have seen steadily accelerating interest and growth in higher efficiency products and we expect this growth to continue and adoption to accelerate further as a result of new legislation. For example, we believe that the coolant requirement legislated to go into effect in January of 2010 could create some acceleration in HVAC sales in 2009 and 2010 and a better replacement market in the years that follow. The commercial refrigeration motor legislation now in effect in California, and coming federally, will also create greater demand for our products. In addition, we see further benefits from the pool motor legislation in California, which we believe other states will follow. The new large motor energy requirements going into effect in December of 2010 will require significant change in buying patters in industrial motors. A new rule in China in effect this year will require to move to higher efficiency motors over the next few years. All of these changes and more are going to be good for the motor industry in general and for Regal Beloit specifically. The strength of this tidal wave is difficult to estimate, but like a tidal wave we believe the impact will be far greater and longer lasting than the seemingly gentle but steady set of waves that we see coming at us today. Importantly, our innovation is expanding our addressing market opportunity. Today we are actively involved in applications involving solar power, wind power, emission reducing drive systems, mechtronic drive trains and vehicles, and energy efficiency improvements in virtually every market we participate in and then in virtually every country where we do business. It is an exciting time to be in our spot at the epicenter of where energy is converted to useful power, to make life better. We believe that the future belongs to those who provide solutions. And we are distinguishing ourselves as the solutions provider for energy efficient motion control application. With that, I’m going to turn over to Dave Barta.

[David Barta:]

All right. I’d like to review the results for the second quarter, then we’ll discuss the outlook for the third quarter. This morning’s release, if you didn’t see it, you can find it on our website. The sales for the second quarter were $606.3 million, which is a 31.9% increase as compared to the second quarter of 2007. Included in our sales results are those results for the five acquisitions completed over the prior year, which totaled $131.8 million. The impact of foreign currency also added about 2.3% to our total sales growth as well. In electrical segment, sales were $548.9 million, an increase of 36.3% versus the second quarter of 2007 and includes the impact of the acquired businesses, which all roll up in the segment. Segment growth in electrical segment was paced by the power generation business that experienced 40.2% year-over-year growth, as we continue to see strong worldwide demand for our generator products. Commercial and industrial motor sales in North America increased 4.6%, which compares to a 1.4% increase in the first quarter of this year. Sales for the HVAC business, as Henry mentioned, served much better than the overall market as a result of the improved mix of high efficiency products. Sales for the business, however, were still down 3.6%. Sales in mechanical segment increased 0.6%. I should add that we did re-class approximately $2.9 million of sales from the electrical group to the mechanical group for the second quarter of 2007 as a result of transfer of certain product sales to the mechanical segment from the electrical segment. From a geographic perspective, our sales outside the U.S. were 27% of total sales versus 22.8% for the second quarter of 2007. Actually in the acquired sales we saw pretty good sales growth throughout the world. In Europe, our sales increased 10.3%, Canada 5.6%, Asia was down 1.3% and I’ll explain that in a minute, and the result of the world increased 9%. Sales in Asia, as I said, were down 1.3% were impacted by one particular business, which was our Sinya business, where our customer who has motor manufacturing capabilities moved some volume inside to address absorption and cost issues as we continue to raise prices on these products. Excluding the Sinya business, Asia sales would have increased 13%. We also began reporting high efficiency product sales with this morning’s release. High efficiency product sales increased 9.2% to 12.9% of total sales. This supports our view that there is tremendous growth opportunity in energy efficient product growth in terms of the growth rate and overall opportunity for RBC. Summarizing the sales performance, we saw strong sales volume results in many business, which was obviously aided by favorable pricing and the impact of currency, which was somewhat counted by volume challenges of Sinya and HVAC. Without going through all of the math, volume excluding Sinya and HVAC was overall up almost mid-single digits. Gross margins for the quarter were 21.6% as compared to the prior year second quarter of 22%. Excluding the impact of the acquisitions, the gross margin would have been $107.8 million or 22.7% of sales. This result is in line with our expectations and included inflation that exceeded the price impact by approximately $8.5 million. We continue to be very committed to eliminating this gap to improve pricing across all business units. Operating expenses were $63.7 million, including $13.2 million from the acquired businesses. Operating expenses for the legacy businesses increased due to several factors. Some of those relating to last year, some of them related to this year. But last year we did see favorable healthcare cost across the mechanical segment, which did not repeat this year. We also had a year-over-year increase in AR reserves and increased selling and engineering costs. These factors increased operating expenses on a year-over-year basis by approximately $5 million. Income from operations of $57.5 million or 11.1% of sales as compared to $60.1 million or 15.1% of sales recorded for the second quarter of 2007. Excluding the impact of the acquisitions, income from operations would have been $57.4 million or 12.1% of sales. The tax rate for the quarter was 35.4%. The increase over the guidance we gave for the second quarter is a result of the distribution of income between certain foreign-based businesses versus the U.S., and versus the second quarter of last year, the increase as a result of the distribution of income, some foreign statutory rate increases, and the impact of the expiration of the United States research and engineering tax credit, which at this time has not been extended for 2008. The increase in the tax rate was about $0.01 unfavorable to our guidance. I'll also point out that minority interest was double over the prior quarter and our guidance, another $0.02 a share, primarily as a result of the strength of the generator JV business in China. Net income for the quarter was $38.1 million as compared to $36.3 million reported last year. Fully diluted earnings per share were $1.14, a 7.5% increase as compared to the $1.06 reported in the second quarter of 2007. Now I’ll turn to the balance sheet and cash flow. We're very pleased that our teams continue to make significant improvement in working capital, particularly the teams involved in inventory management and accounts payable. Cash from operations was $81.4 million versus $89.7 million in the second quarter of last year. We recall that second quarter of 2007 was really the point where our working capital reduction effort gained significant traction. Even though working capital was a source of cash this quarter of $25.8 million, working capital as a source of cash last year $44.5 million. Depreciation and amortization was $16.1 million and capital spending for the quarter was $14.5 million. As mentioned in this morning’s press release, we completed a $165 million term loan during the quarter as well. The proceeds from the loan we used to pay off the entire balance in our revolving credit facility. We ended the quarter with total debt of $568.2 million or $480.5 million net of cash versus the year-end level of $564.3 million or $521.7 million net of cash. Our net debt to total cap is 34.2, which is well within our comfort zone to consider any and all opportunities to create added shareholder value. Now turning to the forecast for the third quarter, our EPS guidance as presented in this morning’s release was $1.06 to $1.15 per share. The guidance is based on a very similar view of the sales environment that we experienced in the second quarter. Sales contribution from the acquired businesses is expected to be approximately $150 million to $155 million in the third quarter and I’ll note that we’ll have the full quarter impact of the Hwada business that we only saw for two quarters – two months of the second quarter. We are expecting to make progress in reducing inflation of the price gap with the pricing actions that have and are being taken. Based on our current view of the results of the pricing actions in our view of material cost for the quarter, we see that gap between $3 million and $5 million, so again about half the level it was for the second quarter. As mentioned in this morning’s release, we’re expecting a one time tax benefit of approximately $0.07 per share, resulting from the repatriation of foreign earnings from one of our subsidiaries. A slightly higher base tax rate of 36% will be netted with this one time tax benefit resulting in the tax rate for the third quarter of 32.6%. And I would say a rate closer to the 35%, 35.3% rate for the fourth quarter is probably in line given that this will not repeat. We are forecasting capital spending of approximately $10 million to $15 million in the third quarter and continue to estimate full year capital spending of approximately $60 million and full year D&A to be in the range of $60 million to $65 million. With that, I’ll turn the call over to Mark.

[Mark Gliebe:]

Thanks, Dave. During the second quarter we continued to see growth in segments not tied to the residential housing market, most notably increased demand in our global generator business. In spite of both the unprecedented inflationary environment and the difficult housing segment, the majority of businesses continue to perform well. And we are very pleased with the execution of our team. During the quarter we saw sales growth in our commercial and industrial motor businesses up 4% and very strong growth in our global generator businesses, up 40%. We saw strength in our generator business, both in China and in North America. In China the robust demand was driven by the devastating earthquake that hit China earlier in the year causing a strong increase in demand for emergency power. That increase in demand was on top of the surge in demand we saw in the first quarter, which was driven by the severe snowstorms. We expect to see continued strong demand in China well into the third quarter. Our North American generator business also delivered solid growth during the quarter, driven by three primarily factors. First, we are seeing an increase in demand from the U.S. Department of Defense where our generators are being used to provide power for military operations. Second, we are seeing an increase in the demand for the new generators we launched last year for the rail industry. These generators are being used to power refurbished locomotive to ensure they meet more stringent air emissions regulation. The third factor impacting our North American generator demand was an increase in export sales. These three positive trends supported our second quarter North American generator sales and are expected to continue into the third quarter as well. In HVAC, our sales were down a modest 3.6% for the quarter. Obviously we do not like any performance that is down year-over-year, but given the continued challenges of the residential housing industry, we felt pretty good about our HVAC performance in the quarter. Energy efficiency and home comfort continues to play an important role in offsetting weaknesses in this segment. For example, we benefited from a shift in mix to our energy saving motors as our customers are utilizing ECM technology to sell a better mix of their energy saving high comfort HVAC systems. During the second quarter we spent a considerable amount of time analyzing trends in raw material inflation in an effort to remain globally cost competitive, particularly as it relates to our input costs such as steel, copper, and aluminum. By the end of the quarter we either raised prices or announced price increases effective in every part of our business. Most of the latest round of price increases will be in effect in the July, August time frame. We continued to aggressively drive productivity in all of our manufacturing facilities and we have been reducing spending appropriately. As you know, we have been working diligently to maintain and expand our leadership in innovative energy-efficient products for over a year now. During each quarterly call we have announced new products that we recently launched in the marketplace. During the April call we told you about our new Empower motor, which utilizes ECM technology to deliver energy efficiency and variable speed capabilities in a pool pump application. The intelligent motor will first be utilized in the Australian pool market. We also announced our new Evergreen motor, which is targeted for the HVAC after-market. This line of motors will provide HVAC contractors a solution for all homeowners who want to improve the energy efficiency and comfort of their existing HVAC systems. As part of our long range planning process, which we recently completed, each business was required to present its strategy for new products over the next three years. For two weeks we dug into every brand and identified the product and technology needs for the future. The sessions were both exciting and promising. These planning sessions have been quite successful in the past yielding some of our latest energy efficiency products. In fact, our sales of energy saving products on a year-to-date basis grew two or three times faster than our standard products. And when you combine the sales of our evolutionary and revolutionary new products introduced in the last three years, new product sales now make up 28% of our total revenue. We will continue to invest in people and technology to deliver our customers energy-saving alternative for their products. From an operations perspective, we are continuing to deliver significant improvements in our factories from design platform consolidation, the product transitions, the lower cost facilities to the implementation of lean in every facility. We are benefiting from the improvements in both our balance sheet and income statement. For example, our Reynosa, Mexico facility has been on a two-year lean journey with the goal of reducing the order to delivery cycle time from 15 days to five days. The results have been impressive. The team has freed up a third of its factory floor space and improved inventory turns by over a half turn while improving their on-time deliveries. Our Wausau, Wisconsin facility where we produce generators and larger motors has also been leaning out facility with the goal of reducing lead times and achieving zero late deliveries to its customers. The team has restructured the compensation of its work force, implemented single piece flow and reorganize their manufacturing line to eliminate bottlenecks. The team has achieved outstanding improvements in reduced lead times and improved deliveries and our customers are benefiting. We are expecting further improvement from our Wausau facility in the third and fourth quarters. The efforts to continuously improve through lean implementation is paying dividend. Our customers are seeing the benefit through improved on time delivery and our shareholders are seeing the benefit in improved inventories and stronger cash flow performance. In summary, we are pleased with our execution in the second quarter. For the past several years, our focus has been to drive a culture of innovation and operational excellence throughout our organization. Our teams have done a great job of implementing these strategies as our record demonstrates both in this quarter and then the last several quarters. And finally, as we move into the third quarter, we are optimistic that it will be another opportunity for the RBC team to prove to you that we can consistently perform and deliver to your expectations. Thank you. And now back to Henry.

[Henry Knueppel:]

Thanks, Mark. Taking a look at the quarter ahead, we believe that we will achieve another record quarter. It will look much the same as the second quarter with the similar headwinds and tailwinds. Clearly we would love to paint a rosier near-term picture. We would love to be able to say that the residential markets are turning. They are not yet. We would love to be able to say that margin expansion will come from material costs holding steady allowing our incredible productivity improvements to flow through to our margins. We can’t yet. Those things will happen, but not in the next quarter. What we can say is that we are delivering despite these historic headwinds. We can say that our general industry and Regal Beloit especially will benefit from energy and environmental requirements of our future. We can say that we expect to be in a strong position to take advantage of the opportunities globally and we believe that we can fairly say that the market is not yet properly valuing what we are achieving today, much less the outlook for our future. We continue to be excited about what lies ahead. We have a strong balance sheet, strong cash flow, and a solid pipeline of acquisition opportunities. We are in an industry that is critical to energy and to environmental stewardship. With that, we will open it up for questions.

[Operator:]

(Operator instructions) Your first question comes from the line of Alexander Paris.

[Alexander Paris:]

Good afternoon. Nice quarter.

[Henry Knueppel:]

Thank you, Alex.

[Alexander Paris:]

Just a couple of questions. Could I get a little better feel for your international stock? You did 27% outside the United States. Could you have a rough percentage of like Europe, Japan, and so forth breakdown?

[David Barta:]

The way we look at that is Asia, kind of a broad scale versus – I have it by country, but – and I actually don’t have those with me. But the bulk of what we do is in the Asia, within Asia region, which would include China and India, as well as Thailand. But again I don’t have those numbers in front of me in the room.

[Alexander Paris:]

Okay. And – but Japan, as you look at separately – I’m trying to get – how big is Europe?

[David Barta:]

Europe for us is not large. We have on an annualized basis at somewhere in the neighborhood of, say, 50 million currently.

[Alexander Paris:]

Okay.

[David Barta:]

And probably actually a little above that. The Hwada business that we bought during the quarter has a fairly good size customer in Europe. So it’s probably between 50 million and 75 million now.

[Alexander Paris:]

Okay. And just looking at HVAC and residential, you’ve also got big housing problems in Spain, the UK, Australia, and Europe. So it sounds like that that’s not as big an impact for you as it is in the United States. Is that correct?

[David Barta:]

That’s correct. Our HVAC business, we do supply some of the U.S.-based customers that are located in Europe. It’s fairly small volume.

[Alexander Paris:]

Okay. Just one other question yet. Could you give us a rough idea of – you gave us the sales – incremental sales in the acquisition, but a rough idea of the accretion in the second quarter and what’s expected in the second half?

[David Barta:]

I don’t think our overall view has changed from the guidance that we’ve give previously for a true EPS accretion. And again what I have with me is the Op income for the business was approximately 7.7% or $10 million in Op income. So –

[Alexander Paris:]

Could you repeat the guidance that you gave earlier on those four acquisitions? The accretion for 2008, was it something like $0.35 or something like that?

[David Barta:]

If you take the midpoint of the range, I think it was $0.34.

[Alexander Paris:]

And there was no accretion from the latest one in China, but there will be some in the second half?

[David Barta:]

In the second half, for sure. The Hwada acquisition, which was in the results for two months, because of the amortization of the inventory step-up was basically neutral to earnings. I think it was actually a slight loss, but again immaterial. We will have a little bit carryover of some of that amortization in the third quarter, but we should be past the one-time purchase accounting after the third quarter. So we’ll see that more normal performance space certainly in the fourth quarter, but obviously step-up in performance in the third quarter as well.

[Alexander Paris:]

And you expect the 2009 tax rate to be more like your normal 35% or so?

[David Barta:]

I think that’s a good – we are a couple of months away from our financial plan, so until we get to that point, I think that’s a pretty good assumption.

[Alexander Paris:]

Okay, thank you very much.

[David Barta:]

Thank you

[Operator:]

Your next question comes from the line of Mike Schneider.

[Mike Schneider:]

Good afternoon guys.

[Henry Knueppel:]

Hi, Mike.

[Mike Schneider:]

Maybe first we can just talk about trends through the quarter. Could you give us a sense of what orders and demand look like maybe industrial versus HVAC as you progressed through the quarter and maybe in July that it’s almost over?

[Henry Knueppel:]

Yes. In terms of HVAC, I would say that that was relatively steady throughout the quarter. I don’t – we may have ramped up just a little bit with some of the summer heat, but I would say was reasonably steady. Industrially we saw some slack in demand in the second half of June. Fortunately, July is back to the pattern in kind of order rates that we were seeing before that. But I would say the last half of June for whatever reason was slower than it has been during the rest of the quarter.

[Mike Schneider:]

Okay. And then just distributor inventories, do you get a sense of whether they are restocking, de-stocking or no change as we’ve gone through the middle part of the area?

[Henry Knueppel:]

Mark, do you have any–?

[Mark Gliebe:]

No, I don’t have specifics on that. I mean, there has been no specific input provided to me on that.

[Mike Schneider:]

And pricing in HVAC, have you been able to garner as much or as much as you need in the HVAC channel and pricing for the second half? I’ve seen the 8% increase that went out on industrial, but maybe an HVAC update?

[Mark Gliebe:]

There’s two pieces for the puzzle, Mike. Some of our customers have – we have material price contracts where the price goes up along with the material, and then in others where we don’t. There is obviously a tough time for them and they have been pushing back, but we’ve been rather diligent in our response.

[Mike Schneider:]

Okay. And then just margins on the high efficiency portion of the business, it’s growing as a percent of the mix. I presume the margins are higher than segment average. Could you give us an order of magnitude so we can understand what the mix looks like going forward as the secular trend continues?

[Henry Knueppel:]

I think what we’ve said – we’ve never got very specific, Mike. As you know, what we’ve said is that it’s significant and that it follows what you would expect if you are providing higher efficiency product. Costs are higher, but the selling prices are higher, and overall the margins would be better than our standard product.

[Mike Schneider:]

Okay. And then again a different mix question. North America and commercial and industrial, commercial was down hard last quarter, I wonder if you could give us some sense of what the growth rates look like industrial versus commercial this quarter and just what you read in, in terms of price and unit growth as well?

[Mark Gliebe:]

Sure. And we have got to a slightly different presentation and I’ll explain that. The former GE commercial AC business, we have moved in and are part of one of the industrial businesses. So there is gradually a lose visibility in what was the old GE CAC business. So we've gone to this presentation that you saw today, which will probably be the consistent presentation going forward. So even at this point, because of that change that we made earlier this year really took effect in the quarter, I couldn’t tell you exactly the GE business because some of those orders are going through the industrial businesses now. But directionally where that business was down mid-teens in the first quarter, it was down only I would say single-digit rate in the quarter. And again that’s probably an overstatement of how far down they were, given that some of the orders are now showing up in the Marathon brand. It was an improvement and that was something that we didn’t know would happen.

[Mike Schneider:]

And that implies that the pure industrial portion of the business, Mark, actually decelerated a bit in the second quarter versus first quarter?

[Henry Knueppel:]

Yes, to some degree. And Mike, I think as we said, the second half of June is when we saw that. And as you would expect, we’ve been watching them very closely in July and it’s rebounded back to the level that we were seeing before. So it’s hard one to call.

[Mike Schneider:]

Okay. And strange question, but just the shutdowns around the Olympics now having been through your facilities in Beijing and around there, has anything changed in terms of the length of the shutdowns or your expect of the impact on the business in the third quarter?

[Henry Knueppel:]

We don’t have anything that’s affecting us directly. We have no facilities that fall under that area. We’ve done a pretty exhaustive view of our supply chain and I don’t believe that we have any issues. We do have a few who are set down, but we were able to put inventory on place or plans for storage of inventory.

[Mike Schneider:]

Great. Thank you guys.

[Henry Knueppel:]

Thank you.

[Operator:]

Your next question comes from the lines of Steve Sanders.

[Steve Sanders:]

Good afternoon.

[Henry Knueppel:]

Hi, Steve.

[Steve Sanders:]

First a follow-up on the pricing side. You talked about some pretty aggressive price increases last quarter. Just a timing on when you implemented those and then looking at the July/August price increases, order of magnitude relative to what you talked about last year.

[Henry Knueppel:]

Mark, you want to deal with that?

[Mark Gliebe:]

We announced the price increases in the second quarter. And they went into effect either in July – early July or early August. And so that – those were the – that’s the same information we gave in the second quarter that we were at that point in time.

[Steve Sanders:]

Okay. Okay, thanks. And then, Dave, a follow-up on your comment about Sinya. Is this an issue going forward with short-term problem? Can you just amplify those comments a little bit?

[David Barta:]

Sure. We have one customer that I mentioned that has in-house motor capability, and this is a customer primarily in residential HVAC. And it’s again a different type of HVAC system that’s a fairly small more inexpensive motor than what we would think about when you think about our U.S. HVAC business. And again they have always had an in-house motor capability and have used the outside companies such as Sinya to be one of their suppliers. And this is a product that was a big part of what Sinya did when we bought it. We have had an effort underway to bring other higher value-add products to Sinya on the commercial side and industrial side of their business to ultimately diversify what they do, somewhat knowing that you are always – could be impacted by a customer such as this. With the rising costs, we have put the disciplines in place not only at Sinya, but Hwada and other outside the U.S. businesses that recover the costs of material inflation. And I think that certainly factors into the decision by their customer quite a bit and that they don’t like these increases, and we are going to go ahead and push those. So – I think long-term our solution is that we have to bring other value-added products there and diversify ourselves around some of – what was their core products when we bought the business. And then the margins is something that price increases there to cover cost, but we needed to move the margins up anyway. So we’re going to move that through mix. So I think there will be a short-term. Short-term being, we’ve got some work to do there. In our third quarter guidance, we have Sinya off quite a bit as well again. So it’s going to get the kind of products and some of the things we want to get done there done, that we’ve got a new leader for that business that I think is very focused in our China leadership, the country leadership team is very focused on doing the right things with that business. And I think rallying the resources around what we need to do with Sinya back on track ultimately.

[Steve Sanders:]

Okay. And then on the high efficiency product growth and percent of sales that you gave us this quarter, can you just provide a little bit more detail on the primary buckets there, how you are defining it?

[David Barta:]

Included in that would be any high efficiency energy saving product. Some of the ones that you would probably the most familiar with that, factor into that there, out of our HVAC business, the ECM product line, the ex motor, some of the products Mark talked about, commercial refrigeration whether they be internal generated ones or through the Morrill acquisition. In the industrial side, the NEMA premium high efficiency industrial products would be included in that, as well as in our gearing business some of the high efficiency gearing. So I don’t think we’re going to go into the details on any one of those groups in particular going forward. But that would be the total – sum total of the products they are adding up to that.

[Steve Sanders:]

Okay. And then final question, Henry, you mentioned some favorable regulatory changes on the motor side in China. Can you just give us some additional details there?

[Henry Knueppel:]

This year they created a system where by – they actually have now created five different energy efficiency levels within the country and product like motors and lighting and some of the other – I think there are ten different items that were placed into this grid. And by this time next year, the lowest efficiency can longer be produced. And then three years later, the second lowest efficiency could no longer be produced. So they are just going to – typical China pragmatic way, go about forcing the efficiencies up.

[Steve Sanders:]

Okay. Thanks very much.

[Operator:]

For question we’ll go on to Chris Bamman.

[Chris Bamman:]

Good afternoon, gentlemen.

[Henry Knueppel:]

Hi, Chris.

[Chris Bamman:]

Just seem to be little unclear. Henry has mentioned that HVAC was down 12% in the quarter and yet in the press release it says 3.6% in motor sales. Can you just sort of clarify those two for me?

[Henry Knueppel:]

Yes, the 12% was market.

[Chris Bamman:]

Okay.

[Mark Gliebe:]

That would come from the ARI and other data as far as market unit performance for the quarter.

[Chris Bamman:]

Okay.

[Henry Knueppel:]

And we fared better than the market is the point.

[Chris Bamman:]

Okay. And what did you say that the tax rate that you used for your guidance for the third quarter was?

[David Barta:]

I think it was 32.6%.

[Chris Bamman:]

And that would be with the $0.07?

[David Barta:]

Correct.

[Chris Bamman:]

And if you take that out–?

[David Barta:]

I think around 36.3%.

[Chris Bamman:]

36.3%, okay. That’s terrific. Actually most of my questions have been answered, so that’s all I have right now. Thank you.

[David Barta:]

Thanks.

[Operator:]

The next question comes from the line of Jeff Hammond.

[Jeff Hammond:]

Hi, good afternoon guys.

[Henry Knueppel:]

Hi, Jeff.

[Jeff Hammond:]

I jumped on late, so I apologize if this is a repeat. But could you give us overall price contribution in the quarter? And then specific to res HVAC, what you thought price mix would have contributed versus the unit dynamic?

[David Barta:]

You didn’t miss anything because I didn’t specifically give that. Kind of keeping with our tradition and that of many of our competitors. But – effective pricing year-over-year I would say characterizes low-to-mid single digits. And a little bit less than that currently in HVAC. But with the price increase, as Mark mentioned, we should see both of those accelerate.

[Jeff Hammond:]

Okay. And then in the first half of the year, you were kind of – you’ve put 1.5% organic growth 1Q, 3% 2Q – I mean, and yet you are expecting acceleration in price. So, do you expect that trend to change materially as we move into the back half or is that a reasonable run rate on a go-forward basis?

[Henry Knueppel:]

Yes. Jeff, you are asking the magic question. And what’s going to happen in our markets, I mean, our view is HVAC market is going to stay relatively like it is for the back half of the year. I mean, it’s going to have its normal seasonal twists and turns. But those are impeded in the numbers every year. Industrially we are still seeing very solid demand. I still think that we are getting a nice boost from exports, our customers' exports in particular, equipment due to the dollar and certainly nothing has changed materially in that regard from the last call. So we are continuing to see solid markets.

[Jeff Hammond:]

Okay. And then just in terms of the acquisitions, would you – with Hwada coming in, how do you expect the trend – or what do you expect the trend to look like in terms of these acquired operating margins? Does that press down the margins near-term? How should we think about that relative to that revenue contribution?

[Henry Knueppel:]

I would say the businesses that we have in China are lower margin businesses. They typically are faster growth, so we can create good returns. And over time we would expect it – the markets there going to improve as they rationalize. But currently they still provide a good return on invested capital and provide this excess to market that we feel we need to be in to do what we need to do for customers here as well as there. So, overall, yes, those are going to be lower margins I think for the foreseeable future, lower than what we would see elsewhere that the acquisitions we did in 2007, we said that we thought it would take us about three years to get those up to other averages and we still are on schedule for that or slightly ahead of that schedule. We feel very good about it. Regards to China specifically, I think you have to look at it as being good return on invested capital coming predominantly from growth and not from margins.

[Jeff Hammond:]

Okay. That’s good color. Thanks guys.

[Henry Knueppel:]

Thank you.

[Operator:]

The next question is from the line of Nigel Coe.

[Nigel Coe:]

Hi, good afternoon. Based on what you know now in terms of the announced price increases, and Siemen commodity remains [ph] where they are, how does that net price commodity look in 4Q?

[David Barta:]

Fourth quarter? Our whole intention behind the pricing efforts, which as you mentioned are very tough. It’s not our preferred route, but just necessary is with an eye towards eliminating that inflation price gap. In the fourth quarter, as I mentioned, that’s more in the neighborhood of $3 million to $5 million. So we’ve cut that gap in half. And as Mark mentioned, there was pricing that went in effect July – first part of July as pricing go into effect August. And many of our brands know that the steel continues to accelerate from here. There will be potentially another round of pricing later in the year. So I guess it’s a little early to predict. I would tell you, if everything holds flat, we'll have obviously some gain in pricing based on the time phasing of what we are doing this quarter. So we should see that gap probably decrease further than our intent to try to eliminate that by the fourth quarter.

[Nigel Coe:]

Okay.

[David Barta:]

But again, I would say it’s early for us to make that claim. We’ve got some more work to do to make that happen.

[Nigel Coe:]

Yes, I agree with that. And then, how rational is the market right now? Obviously we see some of the larger metal players have been pushing through similar price increases. But how rational is the market? Do you have any players out there who trying to gain market share?

[Henry Knueppel:]

Certainly. Certainly in the industrial marketplace has been very rational. And I think it’s true globally by the way. We’ve seen price increases coming out of competitors in China and again other locations as well. So I think that that is behaving rationally. You see some spot issues at times in smaller motors, but I wouldn’t say those are significant at this point. And without question, globally the costs have gone up and prices have gone up.

[Nigel Coe:]

Okay. And then on the high efficiency side, I mean, we are seeing higher energy costs coming through, we’re seeing higher electricity costs going through into factories. Are you starting to see maybe even anecdotally just greater interest in replacing older metals with high efficiency motors? Is that gathering momentum? Are you starting to see that tidal wave coming through?

[Henry Knueppel:]

Yes, we see it – I mean, we see it literally every day at this point. It doesn’t feel like the tidal wave that you saw hit the shores a few years ago on TV yet, but it is just one wave after another that keeps coming. And a lot of that’s being driven in small motors by legislation and large motors at economic because typically large motors are used by businesses. We are paying more attention to it. We see just a continual move toward it. And I think we are just really now starting to see the tipping point on some of the electricity costs around the country. They held steady for a little longer than you might have estimated. But we are seeing those move, and as those move, they will pick up speed.

[Nigel Coe:]

Okay. What’s the kind of typical payback periods now for – a typical high efficiency motor versus a standard motor, what would be the payback period now versus maybe few years ago?

[Henry Knueppel:]

Obviously it’s getting better, but you have to kind of look at it in a couple different buckets. A lot of it has to do with how much you are using process duty companies where they are running 24/7, have understood the equation for a long time. Pulp and paper, and chemicals and some of those industries that are process duty, have been buying high efficiency motors for years. What’s happening is as the prices go up, it moves down the change to where people who are using it less than 24/7, it starts to make sense for. For example, commercial refrigeration, we’ve talked about some of the new products we’ve introduced there. We had paybacks for replacing a perfectly good motor that were anywhere from a year – as low as a year or less, maybe ten months to as much as 18 months, but very good payback. As you look out at other motors, when you get up to a large motor, typically the payback would be great. I would say less than a year or year to a year and a half if you are going to replace the motor anyway. But if you are just going to replace a perfectly good motor, the payback might be three to five years.

[Nigel Coe:]

Okay. Very helpful. Thanks.

[Operator:]

Your next question comes from the line of Bill Dezellem.

[Bill Dezellem:]

I have a couple of questions. First of all, would you please give us your perspective on the economic activity levels in China and India separately? And we ask the question because as you have I'm sure seen commentary in the popular press that implies some slowdown taking place there.

[Henry Knueppel:]

Certainly what we’ve seen in China is that it’s kind of interesting time, given the cost of transportation costs and the cost of materials and some of the escalation in inflation in China. You can see some of the edge coming off in terms of product that's produced there to bring back North America for cost purposes only. As we said all along, we are there, number one, to be there as a part of a growing market, and number two is to be there for customers who have global operations and needed to be there, and number three would be for cost purposes when it makes sense. So the cost equation is changing. That said, that economy is still – from everything we see today, it still remains pretty (inaudible) strong. As Dave said, without the situation with Sinya, we were up 15% or 14% year-over-year. So, still very strong performance, maybe not as strong as last year this time when it was 25% to 30%, but still very solid. India continues to be growing market for us. The Middle East continues to be a growing market for us out of India – shipping out of India. So I don’t there has been appreciable change. We haven’t seen an appreciable change year-over-year there.

[Bill Dezellem:]

And entirely different topic, if you’ve said this, I apologize, but what percentage of your sales are represented by products that you had put under the energy savings category?

[David Barta:]

In the quarter, it ended up being 12.9% currently.

[Bill Dezellem:]

Okay. Thank you both.

[Henry Knueppel:]

Thank you.

[Operator:]

Your next question comes from the line of Christopher Glynn.

[Christopher Glynn:]

Hi, thank you. Little more on the price cost, just wondering what kind of scale in the cost increases you are looking at year-over-year in the third quarter versus the second? And then, the incremental pricing, if you can kind of size that versus the second quarter?

[Mark Gliebe:]

I actually don’t have the pieces put out in front of me in the room, but what I can tell you is both of them were up substantially. What we are seeing just directionally is that inflation was accelerating from the first quarter to second, and then second to the third, fourth, and that’s primarily driven by the pricing formulas we have for steel. We are on an index based formula, which somewhat uses history as the forward price. So the big run-up you’ve seen in the steel markets hit us hard in the third quarter and then into the fourth quarter. So both of them were up substantially, third and fourth quarter, to leave us with the gap that we talked about.

[Christopher Glynn:]

Okay. And then, the gap you talked about is a nice narrowing from the second quarter. So just wondering if you maybe you see it little on the timing of the second quarter to, I don’t know, increase the stickiness going forward?

[Mark Gliebe:]

I think we are putting – we went after the pricing just as quick as we can, but you’ve got obviously a customer and we’re very sensitive – although maybe it doesn’t sound that way at all times. We are very sensitive to understand their needs. So we are trying to implement pricing, the pricing we need as quickly as we can again understanding that certain customers do need some time to react and deal with their outlet, and their outlet being for their customer base. But beyond that, we are putting pricing in – prices as quickly as we can.

[Christopher Glynn:]

Okay. Thank you. And then just finally, are there any major OEM contracts there coming up for renewal in the near future?

[Henry Knueppel:]

I mean, the answer is yes, because they are always some that are coming up, but nothing in the – nothing out of the normal.

[Christopher Glynn:]

Okay. Thanks very much.

[David Barta:]

Thank you.

[Operator:]

And Holden Lewis with BB&T.

[Holden Lewis:]

Good afternoon, thank you. You had made mention about the new products, and can you just clarify, I think you said 28% sales, is that on a three or a five-year sort of definition?

[David Barta:]

What we were talking about – you’re talking about the energy efficient?

[Mark Gliebe:]

Dave, I made the comment that it was 28% on a three-year.

[Holden Lewis:]

On a three-year? Okay. Can you talk about what that might have been maybe two years ago and kind of what you expect that to be maybe two years out? And then talk also the 28% of sales, I mean what’s the margin on that sort of pool the business versus the res, I’m just trying to get a sense of how this fits in strategically.

[Henry Knueppel:]

Mark, do you–?

[Mark Gliebe:]

We started capturing the data about a year ago. So there has been slight change upward from a year ago. And the margins on the newer products are better than the margins on the older products.

[Holden Lewis:]

Materially so or –?

[Mark Gliebe:]

By a few points.

[Holden Lewis:]

Okay. All right. Thank you.

[Operator:]

And there are no further questions.

[Henry Knueppel:]

Okay. We want to thank all of you for joining the call and for your interest in Regal Beloit. I’d leave you with two thoughts. First of all, we are delivering in a very difficult environment and I think the better news is that we are positioned for a great future. Thank you and have a great day.

[Operator:]

Thank you for participating in today’s Regal Beloit second quarter earnings conference call. You may now disconnect.