RBC Bearings Incorporated
Q2 2015 Earnings Call Transcript

Published: 4 Aug 2015

[Operator:]

Good day and welcome to the Regal Beloit Second Quarter 2015 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 call over to Mr. John Perino, Vice President of Investor Relations. Mr. Perino, the floor is yours, sir.

[John M. Perino:]

Thank you, Mike. Good morning and welcome to the Regal Beloit's second quarter 2015 earnings conference call. Joining me today are Mark J. Gliebe, Chairman and CEO; Jon Schlemmer, COO; and Chuck Hinrichs, Vice President and CFO. Before turning the call over to Mark, I'd 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. Also we mention that we're presenting certain non-GAAP financial measures. We believe these are useful financial measures for providing you with additional insight into our operating performance and for helping investors understand and compare our results across accounting periods and in the same manner as management. Please read the slide for information regarding these non-GAAP financial measures and please see the appendix where you can find reconciliations of these measures to the most comparable measures in accordance with GAAP. Now I'll turn the call over to Mark.

[Mark Joseph Gliebe:]

Thank you, John. Welcome, everyone, and thank you for joining our second quarter call and thank you for your interest in Regal. Today I'll make a few opening comments, Chuck Hinrichs will give our financial update and Jon Schlemmer will give color on markets, operations and performance of our legacy segments, and then I'll do the same on our PTS segment. After that I'll summarize and we'll move to Q&A. Let me start with the second quarter highlights. Regal grew revenues 11%, and we increased adjusted operating margins to 11.9% representing 120 basis-point improvement over prior-year. We increased our adjusted earnings 19% and delivered free cash flow of 151% of net income and we used the free cash to pay down $54 million of debt in the quarter. While revenues for the quarter were up 11% year-over-year, acquisitions represented 19% of the growth and organic sales were down 5.5%. Currency was a $20 million drag in the quarter or 2.4% of sales. The headwinds in declining oil and gas markets, weaker sales in China and the SEER 13 pre-build weighed on our top line. In the Climate segment organic sales were down 4% driven by the impact of the SEER 13 pre-build and weaker sales in the furnace applications as compared to a very strong 2014. We believe that the SEER 13 pre-build is now behind us. However, as expected, we still face difficult comparisons in the back half of 2015 resulting from the pre-build. In the Commercial and Industrial Systems segment organic sales were down 7%. The decline was driven by a steep reduction in oil and gas orders and weak demand in China. In the Power Transmission Solutions segment our recently acquired PTS business contributed $149 million of sales, or 217% growth in this segment. Organic sales in our legacy business were off 1.7%, with strength in the renewable energy market helping to offset weakness in oil and gas. Speaking of PTS, the integration of the business into Regal is on track. We expect the integration of the 26 sites to be substantially complete in the early part of the fourth quarter. After that the only key item left will be the integration of our ERP systems, which we expect to complete by the end of the third quarter in 2016. On synergies we are making great progress, and we expect to exceed our year one $7 million synergy target with the benefits coming from operation integration, procurement, logistics, cross selling, and tax. Customer feedback on the acquisition continues to be positive, and we're listening to our customers to find ways to take advantage of our combination that could help us both grow. And we have already made key changes to the PTS go-to-market model based on the customers' feedback. We have strengthened our sales organization with additional resources, we have improved our on-time deliveries, and we have made changes to our customer service model that improves our responsiveness. I'd like to share with you a recent revenue synergy success. You can see the picture of the renewable energy farm. Our combined PTS business recently landed an $8 million order supplying an innovative new product that assists in tracking the sun at this installation. It's an order that neither company would have won on its own, and it's an example of how our combined teams are working together to grow. As we look forward, it's important to take a closer look at the four key headwinds that are a drag on our revenue growth. First is FX. We expect currency to continue to be a drag through the year, but comparisons should begin to improve towards the end of the fourth quarter. Next is SEER 13. As we mentioned before, the strong prebuild demand in residential HVAC that we experienced in the third or fourth quarters of 2014 created an air pocket in both the first and second quarters of 2015 and will represent tough comparisons in the back half of 2015. As we move into 2016 we expect the SEER 13 headwind to turn into a tailwind with better comparisons and a slight mix benefit. Next is China. Demand for industrial motors in China was weak in the second quarter, and we expect the weakness to continue through the remainder of the year. It is not clear where the China market goes in 2016, however, with our major China plant transitions behind us we are in a good position to capitalize when the market stabilizes. Finally, let's dig into the oil and gas markets. Our businesses were hit very hard in the second quarter with orders in some businesses off as much as 60%. For the quarter, sales were down an estimated $25 million to $30 million, and for the year we estimate sales to be down up to $100 million. These declines impact our Commercial and Industrial systems and Power Transmission Solutions segments. Recall that our Oil and Gas sales represent 7% of the company sales, about two-thirds of which is upstream. While it's too early for us to predict the bottom of our Oil and Gas businesses, we expect that by the end of the first quarter of 2016 the comparisons will improve. In summary, the difficult comparisons from SEER 13 should be behind us as we exit 2015, and we are taking all the appropriate cost actions in our China-based and Oil and Gas-related businesses to position us well when these markets recover. Even with these top line headwinds, our 2015 guidance represents a 25% to 30% year-over-year adjusted EPS increase, reflecting progress on the two key objectives that we laid out for the year, margin improvements in our legacy business and a successful integration of the recently-acquired PTS business. I will now turn it over to Chuck.

[Charles A. Hinrichs:]

Thank you, Mark, and good morning, everyone. Sales in the second quarter 2015 were $942 million, an increase of 11% from the prior year. We had net acquisition growth of 19%. Foreign currency translation in the quarter was a negative 2.4%. Organic sales declined 5.5%, reflecting the market headwinds we faced in Oil and Gas, China and the SEER 13 impact. Our adjusted operating profit margin in the first quarter was 11.9%, an improvement of 120 basis points from the prior year. The improvement came from the benefits of the simplification initiative, cost controls and the accretion from the PTS acquisition. Our adjusted earnings per share in the second quarter were $1.53, up $0.24 or a 19% increase over the prior year. Overall, we had a clean quarter. I will walk through the adjustments from our second quarter 2015 GAAP EPS of $1.39 per share to the adjusted EPS of $1.53 per share. The adjustments are detailed on the lower half of the slide. The first item is inventory purchase accounting adjustments for the acquired PTS business, charged to cost of goods sold of $7.1 million or $0.11 per share. The next adjustment to our EPS was restructuring charges totaling $2.1 million or $0.03 per share related to our simplification initiative. These adjustments totaled $9.2 million or $0.14 per share in the second quarter. The adjusted EPS for the second quarter 2015 was $1.53 per share. Now I will summarize some key financial metrics for the second quarter 2015. Our capital expenditures in the second quarter were $24 million and $45 million for the first half of 2015. We are forecasting capital expenditures of $95 million for the full year 2015. In the upper right quadrant we show our effective tax rate in the second quarter as 26%. We expect to maintain this 26% ETR in 2015. The ETR includes the PTS acquisition and the $5 million of tax synergies. In the lower left quadrant we provide data on our second quarter balance sheet. Our total debt was $1.893 billion and our net debt was $1.645 billion. In the second quarter we reduced our total debt by $54 million and our net debt by $72 million. As we have mentioned before, Regal has a long history of taking on additional debt to fund transformational acquisitions and then using our strong free cash flow to reduce the debt. Our progress in reducing our debt in the second quarter supports this point. In the lower right quadrant we present information on our free cash flow. We generated $95 million of free cash flow in the second quarter. Free cash flow in the quarter represented 151% of net income for the quarter. Our continuing goal is to generate free cash flow in excess of 100% of net income, and we expect to perform well against this goal in the future. Our updated full-year 2015 GAAP earnings per share guidance is $4.76 to $4.96. To calculate our adjusted earnings per share we add back the $0.47 per share of inventory purchase accounting adjustments and transaction costs for PTS, the estimated $0.15 per share of restructuring charges and the $0.02 per share for the Venezuelan devaluation. These adjustments total $0.64 on an earnings per share basis. The adjustments for the purchase accounting and transaction costs and the Venezuelan devaluation were already recognized in the first half of 2015. The adjustment for the restructuring charges includes the $0.05 per share adjustment already recognized in the first half of 2015 and the estimated $9 million or $0.10 per share to be recognized in the second half of 2015. Adding the $0.64 per share in total adjustments to our GAAP earnings per share results in our full-year 2015 adjusted EPS guidance of $5.40 to $5.60 per share. Let me speak to two of the key assumptions in our 2015 guidance. Number one, we expect continued sales headwinds, as Mark earlier outlined. And number two, our guidance does not assume a refinancing of a portion of the PTS bank financing, although we continue to evaluate this opportunity. Future credit market conditions will drive that decision and the impact on our interest expense. In summary, our guidance for our 2015 adjusted earnings per share of $5.40 to $5.60 is an increase of 25% to 30% over our 2014 results. Now I'll turn the call over to Jon Schlemmer.

[Jonathan J. Schlemmer:]

Thanks, Chuck, and good morning, everyone. Before I discuss segment performance I'd like to give you an update on two topics. First, the recent customer survey feedback and second, progress on our simplification initiative and the resulting operating profit margin improvements. Late in the second quarter we completed our annual customer survey. Over the past few years we've made considerable progress improving performance on all the key metrics, including the net promoter score, responsiveness, innovation and overall value. The picture on the left is a screenshot showing how we delivered the survey to all of our customers. We delivered a short message by video explaining to our customers why we conduct the survey each year and how we've been using their feedback to make improvements. The charts are the same ones that we showed in December at Investor Day, updated with the 2015 actual results. I'm pleased to report that once again we made incremental improvement on each of the key metrics. We continue to believe that driving improvements for our customers ultimately increases shareholder value. During the quarter we made significant progress on our margin improvement efforts. In spite of the currency headwind and a weaker top line, our adjusted operating profit margin was 11.9%, an increase of 120 basis points for the quarter. Our simplification initiative, our cost control efforts and the PTS acquisition all contributed to the improved performance. The improvement in the quarter is certainly encouraging. For our announced restructuring programs, we're estimating $9 million of restructuring expenses to be incurred in the second half of this year. All three segments are evaluating additional restructuring and simplification programs given the challenges on the top line. We're now evaluating what can be pulled ahead into the second half of this year from our 2015 programs. For the remainder of this year, we expect to continue to show year-over-year margin rate improvement. As we look beyond 2015, we expect to show continued but more gradual improvements. As we look at our progress through the first half of this year, adjusted operating margins have improved by 80 basis points, and we're running slightly ahead of the margin improvement goal that we communicated in December. Now, let's go ahead and get into the segments, and I'll start with Commercial and Industrial Systems. Sales were $441 million, a decrease of 8% from the prior year. Foreign currency negatively impacted sales by approximately $14 million, and acquisition growth increased sales by $9 million. We clearly were not pleased with the organic sales decrease of $33 million, or 7% of sales. I'll describe what we experienced in the quarter. The headwinds in the quarter included the decline in Oil and Gas, slowing in China and slowness in Power Gen and Distribution. We sized the estimated impact of Oil and Gas in China showing that $27 million of the $33 million was driven by these two end markets. We did experience growth in a number of the end markets, including Commercial HVAC, Industrial Pump and Pool Pump. We would expect that the comparisons will improve in Oil and Gas as we exit the first quarter in 2016. Even with headwinds on the top line, adjusted operating margin was 9.9% of sales, which is the same as the prior year. The impact of just Oil and Gas in China create -combined create an estimated 150 basis point headwind on our margin, so clearly the self-help efforts had an offsetting impact on our margins. During the quarter, we made a lot of progress rightsizing our businesses exposed to oil and gas, and we also completed the consolidation and closure of the two facilities in Australia and Japan. The largest program is the restructuring of our Kentucky-based motor parts making operations, and we're on track to substantially complete this transition by the end of the third quarter. Sales in our Climate Solutions segment decreased approximately 6% in the quarter. Foreign currency negatively impacted sales by $5 million and organic sales declined by $13 million or 4% of sales. Recall that we will be disconnected from the market in 2015 as a result of the SEER 13. Listed here are the three key factors for the organic sales decline, the SEER 13 pre-build, the impact of the lower commodity cost on our two-way material price formulas and lower demand on furnace products compared to the strong demand we experienced in the first half of 2014. The SEER 13 pre-build and the two-way material price formulas alone account for nearly the entire decline in organic sales. Offsetting these headwinds, we saw growth in the North America HVAC, India and Middle East markets. And as we've entered the third quarter, we're seeing increased demand from our HVAC aftermarket customers as a result of the hot weather across most of the country, and we've factored this into our guidance. Adjusted operating margin in the Climate Solution segment was 15.2% of sales, an increase of 330 basis points from the prior year. Much of the benefit can be attributed to our simplification initiative and overall cost reduction efforts. Some of the year-over-year improvement comes from the inefficiencies that we experienced last year when we were transitioning our factories. We've made excellent progress on the fourth of our five design simplification programs, the small motor platform. We expect this program to be substantially complete as we exit the third quarter. We're quite pleased with the margin improvement in this segment and we're not finished with the simplification improvements. I'll now turn it back over to Mark to cover the PTS segment and wrap up. Thank you.

[Mark Joseph Gliebe:]

Thanks, Jon. Sales in our Power Transmission Solution segment were $215 million, up 217% in the quarter. The FX impact from our legacy PTS business was $1 million. Looking at the end markets of the combined segment, the Oil and Gas and Agricultural Equipment markets were a drag on the top line while Distribution sales were flat. As mentioned earlier we got a nice lift in Renewable Energy as we began shipping this new business in the second quarter. Additionally, we saw growth in both Food and Beverage and Material Handling. Margins in the PTS segment improved 60 basis points as compared to prior-year, driven by both our simplification initiative and as a result of the acquisition. We expect that synergies from the acquisition begin to help in the back half of 2015 and to continue into 2016. Overall, our new Power Transmission segment is in great shape, and we continue to be optimistic about the future of these combined businesses. Now, I would like to summarize. While sales were up 11% for the quarter, the growth came primarily from acquisitions. FX, SEER 13, oil and gas, and weakness in China weighed heavily on revenues. Even with the weaker revenues, margins improved 120 basis points. Our cash flow to net income was 151% and we used the free cash flow to pay down $54 million in debt. While we cannot predict the timing of attractive deals, our primary focus remains on debt reduction. The PTS integration and the associated synergies are on track and customer feedback continues to be quite positive. Finally, our full-year guidance reflects a 25% to 30% increase in adjusted EPS on a year-over-year basis. We will now take your questions.

[Operator:]

Thank you, sir. At this time, we'll just pause momentarily to assemble our roster. The first question we have comes from Christopher Glynn of Oppenheimer. Please go ahead.

[Christopher D. Glynn:]

Thank you. Good morning.

[Mark Joseph Gliebe:]

Good morning, Chris.

[Christopher D. Glynn:]

Mark, just tremendous gains in the margin at Climate Solutions. I'm wondering what the takeaway is there, what to extrapolate? Was there any – was part of it LIFO or anything like that?

[Mark Joseph Gliebe:]

So as we outlined in the call, certainly a big chunk of it was related to our simplification initiative. We also – we've been having quite tight cost controls on the business. There was a small LIFO benefit that was – that came into the quarter and Chuck can outline more to come as we go to the end of the year. But the key drivers were the ones we outlined.

[Charles A. Hinrichs:]

Hey, Chris. The LIFO benefit was about $1 million, and I'll remind you that we had a $8 million net benefit from LIFO and other inventory reserves that we took in the fourth quarter of last year. So as we look forward to the second half of this year, we will see some LIFO benefit but it will be a lesser amount than what we had posted last year. The LIFO decline, the LIFO benefit comes from the decline in commodity costs, principally copper. And also with that we'll – our two-way material price formulas will also ratchet down in the second half of the year. Both of those, both the LIFO benefit and the pressure on price are reflected in our guidance for the year.

[Christopher D. Glynn:]

Okay. And then on the C&I organic top line, I'm wondering if you think you weathered any de-stock in the quarter or if the 7% organic is kind of a clean read on the trends for that segment?

[Jonathan J. Schlemmer:]

Chris, this is Jon. I do think that had some impact on our organic sales in the quarter. I mentioned both Power Gen and Distribution being down and in Distribution in particular we would say that there was some impact of de-stocking in the quarter. And I think we – I think, Mark, we'd say we saw that not only in C&I Systems but in Power Transmission as well.

[Mark Joseph Gliebe:]

Yeah. You're absolutely right, Jon. But that weren't – that was not the biggest drivers, as you outlined...

[Jonathan J. Schlemmer:]

Correct.

[Mark Joseph Gliebe:]

...because the big drivers were related to the oil and gas and...

[Jonathan J. Schlemmer:]

China.

[Mark Joseph Gliebe:]

...and China weakness. And the other is more commentary than a big driver to our organic growth in the quarter.

[Christopher D. Glynn:]

Thanks. Congrats on the strong quarter.

[Mark Joseph Gliebe:]

Thanks, Chris.

[John M. Perino:]

Thanks, Chris.

[Operator:]

The next question we have comes from Mike Halloran of Robert Baird.

[Michael P. Halloran:]

Morning, guys.

[Mark Joseph Gliebe:]

Good morning, Mike.

[Michael P. Halloran:]

So sticking on the margin side, again, great to see these things starting to hit, particularly when the revenue challenges are coming through here. Anything in the quarter that you don't think is sustainable relative to the revenue levels? It feels like the commentary is supportive of these margin levels on a forward basis, adding in the restructuring that's going to come down the line and things like that. Is that fair?

[Mark Joseph Gliebe:]

Yeah. I mean, Mike, what I would say is if you look at the first half, and I hate to look at any one particular quarter part, but if you look at the first half, we had an 80 basis point improvement for the half. And if you think back to how we talked about this at Investor Day relative to our legacy businesses, we thought that 70 basis point – roughly 70 basis points each year for the next three years was our best view. And we hold to that. That's still kind of our outlook. Now, that didn't include the 50 basis points we said we'd get with the PTS acquisition over a three-year period as the synergies comes in, but as you think about our legacy businesses, 70 basis points a year for three years beginning 2015 is the way to think about it.

[Michael P. Halloran:]

Okay. Then the – go ahead. Sorry.

[Jonathan J. Schlemmer:]

Yeah, Mike. Sorry. This is Jon. I was going to add when you were asking too about the sales level in Q2. The only thing I would say, I think you're right in terms of how we're thinking about the headwinds that we experienced and how we see that in the second half. There'd probably be one exception, which would be just the normal seasonality in our North America HVAC business. Q2 and Q3 are stronger quarters, so that would certainly be factored into our guidance as well, especially when you think about the fourth quarter.

[Michael P. Halloran:]

No. That makes a lot of sense, and I assumed it would've been. Speaking on kind of the guidance on a forward basis, as you think about what's embedded on the revenue line in the guidance, other than kind of normalizing HVAC on some level sequentially as you work through the year now that the pre-buy is behind you – still tough comps there – but when you look at the other markets, are you assuming – what are you assuming from a sequential pattern as you look forward here, pre-normal seasonality from current levels? Are you assuming any improvement in the end markets as you work through the back half of the year? A little more color there would be great.

[Mark Joseph Gliebe:]

Yeah, I'm going to go to oil and gas since that's been the big driver. I'll ask Jon and Chuck to make sure I get this right, but I think in our comments here, we just said that for the total year it would be roughly $100 million impact. And in the quarter we had a $25 million to $35 million headwind coming from oil and gas, so that kind of tells you how we see the back half of the year. The first quarter, the oil and gas impact was relatively small because we had some carryover in our order backlog. So the incremental headwind that we'll have will be related to oil and gas. I would say all other markets I would view them as normal seasonality that we've experienced in the past.

[Charles A. Hinrichs:]

Yeah, Mike. Mike, I'll add that the FX will continue to be a headwind for us. We could seem following a first half FX impact of a negative $46 million, we could see a number that might approach $40 million in the second half. So that will also be a tough headwind for us in 2015.

[Michael P. Halloran:]

Great. I appreciate the time, guys. Thank you.

[Mark Joseph Gliebe:]

Thank you, Mike.

[John M. Perino:]

Thanks, Mike.

[Operator:]

Julian Mitchell, Credit Suisse. Julian C. H. Mitchell - Credit Suisse Securities (USA) LLC (Broker) Hi. Thank you.

[Unknown Speaker:]

Good morning, Julian. Julian C. H. Mitchell - Credit Suisse Securities (USA) LLC (Broker) Good morning. Yeah, I just wanted to follow up on the organic sales growth guide. I just wondered what figure is embedded at the midpoint of your EPS guidance for the year as a whole in terms of organic sales year-on-year?

[Mark Joseph Gliebe:]

Yeah, well, as you probably know, we don't guide on the revenue line, but I think we've given you pretty good color, Julian, on what happened to us in the first half and how we're expecting the second half to play through.

[Jonathan J. Schlemmer:]

I mean, Julian, as we look at the second half, too, and the businesses. The order rates that we experienced in the second quarter and the impact on revenue, other than the seasonality in our business, like North America HVAC, is pretty much what we're expecting to experience again in the second half. We're not looking for an uptick in the C&I markets, for example, but we're also not assuming any further deterioration in those markets. Julian C. H. Mitchell - Credit Suisse Securities (USA) LLC (Broker) That's helpful. Thank you. And then maybe just if you could give a sense of the – as you enter next year from what the run rate of kind of aggregate savings from all the – it sounds like maybe some restructuring has been pulled forward. So assuming that, what's the run rate of savings going into 2016?

[Charles A. Hinrichs:]

I think that that's the way to characterize it is the way I answered the earlier question, which is we know what the year-over-year margin rate improvement expectations and I think we still believe that 70 basis point year-over-year improvement is the right way to think about it. As you know, it's coming from a variety of places, as we laid out on Investor Day. But as we described today the benefit was coming from simplification, year-over-year cost advantages as well as from the PTS acquisition. So we still think that's the right way to think about it. Julian C. H. Mitchell - Credit Suisse Securities (USA) LLC (Broker) Thanks. And lastly, very quickly, has there been any change in pricing trends outside of Climate Solutions? So just focused on C&I and Power Transmission.

[Mark Joseph Gliebe:]

Well, no question that as the markets are tougher. People are certainly asking for more. Obviously we're doing everything we can to push back and for the most part I think we've been successful. As we think about cost price for the year I would it's probably in our favor at this point through the first half. Julian C. H. Mitchell - Credit Suisse Securities (USA) LLC (Broker) Perfect. Thank you.

[Mark Joseph Gliebe:]

Thank you.

[Operator:]

Next, Jeff Hammond, KeyBanc Capital Markets.

[Jeffrey D. Hammond:]

Hey. Good morning, guys.

[Mark Joseph Gliebe:]

Morning, Jeff.

[Jeffrey D. Hammond:]

Hey, just on PTS I guess I was modeling a steeping margin trajectory, just trying to understand better what the margin mix is up in that segment from PTS. And then can you just maybe remind us what the old synergy number was for this year versus what you think you're going to ultimately get?

[Mark Joseph Gliebe:]

Well, I'll start at first question first. We had targeted $7 million in year one, and at this point we think we'll exceed that number. I don't exactly have the new number for this year off the top of my head, but we believe we'll exceed the first year number. We also said there'd be $30 million over four years and I would say the good news is we think we're still on that schedule, but we're probably ahead of schedule. We're on that target, but we're ahead of schedule. And so that's the way I would characterize that. Jeff, I'm not sure I understood your question about the steeper margin. Can you please re-ask that question?

[Jeffrey D. Hammond:]

Yeah. I mean how much margin – I mean you did 11.3% in Power Transmission last year. I mean where is – what should the margins pro forma just on bringing in a higher margin PTS business?

[Mark Joseph Gliebe:]

Okay. So we had suggested that we'd have a 50 basis point improvement in the total company as a result of the PTS acquisition. That comes from two primary areas, one is the actual accretion, just year-over-year, the mix-up, and then point two would be from the synergies that we'd get over the three-year – three or four-year period. So those would be the two contributing factors.

[Jeffrey D. Hammond:]

Okay. That's helpful. Now, if I go back to the earlier questions, and I know you don't give revenue guidance, but if you say the trends that you saw 2Q continue, it seems like you need a lot more than that 70, 80 basis points margin improvement to hit your guidance. So I mean what am I missing here? I just want to make sure I don't – the assumptions for top line aren't too optimistic or we're being conservative on the margin side.

[Mark Joseph Gliebe:]

Yeah. Well, remember the 70 to – 70 to 80 basis point kind of number is for the year so you've got to look at all four quarters. I think, as Jon laid out, we have the sales headwinds that we've talked about in oil and gas and SEER 13 still facing into us. Jon commented that the heat is helping a little bit right now. We figured that into our guidance. There is a slight mix benefit as a result of the SEER 13 as we had predicted, the pre-build. Now that that's behind us, we should start to see a slight mix benefit.

[Jonathan J. Schlemmer:]

And I would, Jeff, one I would add also that will help the margin also comparisons in the second half versus what we already experienced the 80 basis point in the first half is in the fourth quarter, if you recall, we had the bad debt issue with Venezuela that impacted our fourth quarter margin. So we'll see that improvement, if you will, on a year-over-year basis as well in the second half.

[Mark Joseph Gliebe:]

Yeah, that was a $10 million hit to the fourth quarter. That was not adjusted out, Jeff.

[Jeffrey D. Hammond:]

Okay. Thanks, guys.

[Mark Joseph Gliebe:]

Thank you, Jeff.

[Operator:]

Next, we have a question from the location of Nigel Coe with Morgan Stanley.

[Nigel Coe:]

Thanks, guys. Good morning.

[Mark Joseph Gliebe:]

Good morning, Nigel.

[Nigel Coe:]

Yeah. I just wanted to go back to the margin question. That was obviously the real highlight of the quarter. To what extent is the cost base benefiting from the Mexican peso devaluation? We've seen a 25% devaluation on the peso over the last 12 months, and that has to have some impact. I'm just wondering if that had a material impact this quarter?

[Charles A. Hinrichs:]

Nigel, this is Chuck. It has benefited us as the peso value has come down, and that would be flowing through our results as well as our guidance of course. We're hedging over the future, so that benefit is somewhat smoothed as we execute on those hedges.

[Mark Joseph Gliebe:]

Yeah. We hedge two to three years out on the peso, and we've been hedged. So as Chuck mentioned, the benefit is smoothed over a longer period of time.

[Nigel Coe:]

Okay. So two to three years of rolling hedges, so what that implies is the benefit of the 2016 handle on the peso comes through more in 2016, 2017?

[Charles A. Hinrichs:]

Well, I think we've seen some of the decline in the price – the peso value over the last year and so some of it flows through. And then the rest as we layer in peso hedges for the next two to three years will be deferred into future periods. So we're seeing some in 2015, and we should see some in 2016 and 2017.

[Nigel Coe:]

Okay. Great. Thank you, perfect. And another big trend is we've seen comp prices at multi- year lows, and so you highlighted the material pricing formulas with the BOEMs. Can you just remind us roughly how much of the swings in copper are passed along to the end customers and how much of a lag is there between the commodity price changes and the price formulas kicking in?

[Mark Joseph Gliebe:]

So about 30% of the legacy business is on two-way material price formulas, and that falls roughly even between our HVAC business and our Commercial and Industrial Commercial Industrial Systems segment. So it's split between those two areas. So and they are two-way material price formulas so as the price of copper goes down, the price of our product goes down and when it comes back up it goes back up. So that is impacting our top line. It's a drag on our top line. It's not necessarily a drag on our margins but it is a drag on the top line.

[Jonathan J. Schlemmer:]

And Nigel, I'd say that the agreements vary by customer in terms of the timing, the lag, your part of the question on the lag. Typically one quarter is how it – how I think you should think about those in terms of how they're executed and then...

[Mark Joseph Gliebe:]

It could be – it could be as far out as two quarters but typically one quarter.

[Jonathan J. Schlemmer:]

Right. And for the most part I would say that those agreements are built so that the majority of the impact of inflation or deflation is reflected in the price.

[Nigel Coe:]

Okay. Great. And that's very helpful. And just one final question, you mentioned you took the decision on whether or not to refinance a portion of the PTS debt depending on credit market conditions. We've got record low short rates. It would be 10 years still very reasonable rates. It looks like the Fed is going to start tightening in the back half of the year. What would cause you to refinance that debt in the back half of the year? < A – [0028RN-E Charles Hinrichs]>

[Nigel Coe:]

Okay. I'll follow up offline. Thanks, guys.

[Charles A. Hinrichs:]

Thank you.

[Mark Joseph Gliebe:]

Thank you, Nigel.

[Operator:]

The next question we have comes from Scott Graham of Jefferies.

[R. Scott Graham:]

Hey, good morning.

[Mark Joseph Gliebe:]

Good morning, Scott.

[R. Scott Graham:]

I was wondering, and this might be a tougher one, if you were able to take the HVAC vagaries and the Oil and Gas vagaries out of the equation and maybe just speak to some of more of your general industrial markets' order rates as the quarter progressed?

[Mark Joseph Gliebe:]

Well, I'll go back and then I'll invite Jon to help out here. But I'll go back to the beginning of the year. As we entered the year, Scott, we actually used the term robust order rates to describe our demand coming out of our Commercial and Industrial business. And then as we went through the first quarter and into the second quarter, order rates overall slowed, and that's not just related to the SEER 13 situation or related to this Commercial and Industrial situation. I would say overall order rates have slowed. Jon described Distribution as being flat. I think that's the right way to characterize it overall. Certainly puts and takes, but overall I think that's the right way to talk about it. We did see a little improvement in certain markets that I've described. Jon talked about Commercial HVAC. I talked about Food and Beverage and Material Handling, but generally speaking it was – it weakened through the quarter.

[Jonathan J. Schlemmer:]

(40

[Mark Joseph Gliebe:]

Right. It hasn't gotten any worse.

[Jonathan J. Schlemmer:]

It hasn't gotten worse, and then there's some upside, like Mark said. Commercial HVAC has actually strengthened, and so that's been good to see. But there's been some others that I would say probably offset some of that. So overall it's been kind of constant.

[R. Scott Graham:]

Okay. That's exactly what I was looking for. Thank you. The other question I had is about simplification. Now that it's starting to wring through the P&L, to what extent can we now take simplification maybe a little bit further in some of the businesses, particularly PTS, which I know that you have synergy targets there. But I'm not sure how much of an overlap that is with what you would consider simplification taking place at Regal? Could you talk about maybe the advancement of simplification given your successes?

[Mark Joseph Gliebe:]

Sure. So the – first of all I'll say that we still have a ways to go. Chuck outlined the $9 million we plan on spending in the back half of this year and there'll be more in 2016. We don't expect it to go on forever, but certainly for the next year and a half we have things that we're going to go do, and I would say primarily in our legacy businesses. So we have legs left to go execute. Nothing as big as perhaps the Springfield move or the Kentucky transitions that we're going through right now, but still beneficial and important to the company. With regards to PTS, I'll remind you it was a very well run business. They had gone through their own efforts on simplification prior to our purchase of them. However, whenever you put two businesses together there are definitely opportunities. And we are mining those opportunities now and we have them included in our synergy targets which, as you know, is $30 million over a four-year period. And some of the things are similar to what we do in simplifications, in terms of consolidating product platforms, consolidating ERP systems and factories and supply base, et cetera, et cetera. So it's a kind of similar headset.

[R. Scott Graham:]

Thank you.

[Mark Joseph Gliebe:]

Thanks, Scott.

[Operator:]

Next we have Josh Pokrzywinski with Buckingham Research.

[Joshua Pokrzywinski:]

Hi. Good morning, guys.

[Mark Joseph Gliebe:]

Morning, Josh.

[Joshua Pokrzywinski:]

So a lot of questions here on the margins so maybe just to ask some of them in a different way, what do you think your incremental or decremental margins are just on pure volume these days? So I think it's easier to maybe parse out some of these discrete headwinds or tailwinds and that's helpful, but to the extent that there are volume swings how should we think about the EBIT change on that?

[Charles A. Hinrichs:]

Josh, thanks for your question. It will depend on both the business and the region that we're operating in, but I would say generally the decrementals could be 10% to 20%-ish percent.

[Joshua Pokrzywinski:]

Okay. So pretty low, actually? So to the extent that volumes come in weaker, not as big of a hit relative to maybe some of the other internal actions you're taking?

[Charles A. Hinrichs:]

Yeah. I guess I'm thinking more about on the Climate side. The C&I side would be higher and then our Power Transmission Solutions segment would probably have the highest decrementals because of the higher fixed costs.

[Joshua Pokrzywinski:]

Okay. And then on the seasonality in Climate, I mean obviously this year is maybe not a good example for what seasonality looks like, how should we think about the tough comp from last on the pre-build? So obviously you're up mid- to high-singles in the third and fourth quarter last year. If I backed out pre-buy would those have been down? And should we think about 500 basis points of tough comp? Or is there – should we look at it sequentially from 2Q? Just trying to get a handle on what normal looks like given that there are a lot of moving pieces this year.

[Mark Joseph Gliebe:]

Yeah. Josh, what we've communicated, and I think the best way to do it, is think about $15 million that was pulled into 2014 that came out of the first half of 2015. Quarter points are tough, exactly which quarter it all happened. We just spread it roughly evenly across those four quarters. That's the way we think about it.

[Joshua Pokrzywinski:]

Got you. That's very helpful. And then I guess just one last one here, as this – as price cost continues to go in your favor here, should we think about that as being more of a third or fourth quarter ramp just based on the timing of hedges and any kind of price escalators that you have with your customers?

[Mark Joseph Gliebe:]

Yeah. Well, I'll remind you that the two-way price formulas actually work against us on that but overall...

[Joshua Pokrzywinski:]

I know. I meant kind of the netting process of how that – how that looked.

[Mark Joseph Gliebe:]

Yeah. Yeah. The netting – I mean, we've been seeing some of this in the first half of this year. We'll see more of it in the back half of this year. I'll remind you that we are – we hedged copper and aluminum and that we're five quarter hedged out on the declining stair-step basis. So it is smooth so it happens more gradually.

[Joshua Pokrzywinski:]

Got you. Thank you very much.

[Mark Joseph Gliebe:]

Thank you, Josh.

[Operator:]

Well, at this time, we're showing no further questions. We'll then conclude our question-and-answer session. I would now like to turn the conference call back over to Mr. Mark Gliebe for any closing remarks. Sir?

[Mark Joseph Gliebe:]

Thank you, everyone, for you questions and for your interest in Regal. At the beginning of the year, we told our investors that in 2015 we would be laser-focused on two objectives, number one, improve our operating margins, and number two, successfully integrate the PTS business. Through the first half we made great progress on both, and we expect more to come. Thank you, and have a great day.

[Operator:]

And we thank you, sir, and to the rest of the management team for your time also today. The conference call is now concluded. At this time, you may disconnect your lines. Again, we thank you for your participation. Have a great day.