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Regal Rexnord Corp
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Good morning, and welcome to the Regal Beloit Second Quarter 2018 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Rob Cherry, Vice President, Investor Relations. Please go ahead, sir.
Thank you, operator. Good morning, and welcome the Regal Beloit's Second Quarter 2018 Earnings Conference Call. Joining me today are Mark Gliebe, our Chairman and Chief Executive Officer; Jon Schlemmer, our Chief Operating Officer; and Rob Rehard, our Vice President and Chief Financial Officer.
Before turning the call over to Mark, I would like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our SEC filings.
On Slide 3, we state that we are presenting certain non-GAAP financial measures in this presentation. We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods and in the same manner as management. Please read this slide for information regarding these non-GAAP financial measures, and please see the appendix for reconciliations of these measures to the most comparable measures in accordance with GAAP.
Now, I will turn the call over to Mark.
Thanks, Rob. Welcome, everyone. Thank you for joining our second quarter call, and thank you for your interest in Regal. We'll follow our normal agenda: I'll make a few opening comments; Rob Rehard will provide a financial update; Jon Schlemmer will provide color on markets, operations and the performance of our 3 segments; after that, I'll summarize; and we'll move to Q&A.
Regal delivered a solid performance in the second quarter with organic sales up 5.7%, adjusted operating margin up 70 basis points and adjusted earnings per share up 24%. At a segment level, in commercial and industrial, organic sales were up 5.7% with broad strength from the North American commercial and industrial end markets, power generation, oil and gas and in most Asian end markets. In the climate segment, organic sales were up 2.4% with sales in our North American HVAC business up mid-single digits. Finally, in the PTS segment, organic sales were up a strong 10.4% for the quarter with robust growth in oil and gas, material handling and generally strong end markets globally.
From an operating profit perspective, the adjusted operating margin improved 70 basis points year-over-year. The operating margin benefited from strong volume, incremental price and productivity, but was held back by commodity inflation. Resulting adjusted earnings per share was up 24%. That's a $0.31 year-over-year increase, with little benefit coming as a result of the recent tax reform.
For the quarter, free cash flow to net income was 122%, and we used a portion of that cash to repurchase $46 million of our shares in the quarter. Our board has recently approved a new share repurchase authorization up to $250 million.
Overall, it was a solid quarter with strong organic sales growth and further progress on our march to improve operating margins.
Looking forward, as we enter the third quarter, we are encouraged that we continue to see year-over-year order strength. Additionally, price cost was slightly positive in the second quarter and we expect price cost to remain at least neutral for the remainder of the year. With regards to the tariffs, Jon will provide more details, however, the summary is that, with our mitigation plans, we expect to offset the impact of tariffs.
For 2018, our guidance assumes total year organic growth to be up mid-single digits. We are expecting our top line to benefit from continued growth in residential and light commercial HVAC end markets, robust commercial and industrial markets and positive incremental pricing. We continue to forecast that our second half organic growth rates will be modestly lower versus the first half simply due to the more difficult second half comparisons.
On margin performance, we continue to expect year-over-year adjusted operating margin improvement for the year. We expect to see benefits from volume leverage and our Simplification efforts for the rest of 2018.
In our earnings release, we guided that our GAAP earnings included an impairment charge for the anticipated exit of our non-core residential hermetic motor components business. Subsequent to the end of the second quarter, a customer that represents a large portion of the revenues of the business announced its intention to wind down operations. Aligned with the company's strategy to focus on the core and selectively prune non-core businesses, we're accelerating our plans to exit this business. Rob will provide financial details and how they impact our GAAP results.
We are narrowing our total year 2018 adjusted earnings per share guidance to $5.70 to $6, which at the midpoint now represents a 20% increase over 2017 adjusted earnings per share and a record year for Regal in both sales and earnings.
I will now turn it over to Rob.
Thank you, Mark, and good morning, everyone. Before I get started, I would like to remind everyone that any reference to prior period comparisons has been adjusted to reflect the adoption of the new GAAP pension accounting rules that went into effect at the beginning of this year. Please refer to the appendix in the earnings call presentation for the details.
Sales in the second quarter 2018 were $959.7 million, up 10.4% from the prior year. Acquisitions contributed 3.5% and foreign currency was a positive 1.3% in the quarter. Therefore, organic sales increased a solid 5.7% from the prior year with all 3 segments contributing. Our adjusted operating margin in the second quarter was 11.1%. Our margin was up 70 basis points compared to the prior year. Margins benefited from both volume growth and productivity improvements. Price cost was slightly positive in the quarter. In addition, we incurred $2 million in LIFO expense, which was split between the C&I and climate segments.
In summary, we have strong organic sales growth and we continue to show improvement in our adjusted operating margin in the second quarter, both sequentially and year-over-year. Our second quarter 2018 earnings per share reported on a GAAP basis were $1.50. There were 3 adjustments to GAAP EPS in the second quarter: the first adjustment was restructuring and related cost of $1.5 million or $0.03 per share; the second adjustment was purchase accounting and transaction costs related to the Nicotra Gebhardt acquisition of $5.1 million or $0.08 per share; the third adjustment was a gain on a sale of assets from a previously closed business of $0.01 per share. Net of these adjustments, the adjusted earnings per share for the second quarter were $1.60, representing a 24% increase from the prior year.
Now, I will summarize a few key financial metrics. Our capital expenditures were $21.2 million in the second quarter. We now expect capital expenditures of $80 million for the full year 2018. Our Simplification activities resulted in $1.5 million of restructuring and related costs in the second quarter. We expect restructuring and related cost of $8 million for the full year 2018.
In the upper right quadrant, we show our effective tax rate information. The ETR in the second quarter was 21.4%, just slightly above the annual guidance we provided earlier this year. We continue to expect our ETR to approximate 21% for the full year 2018. In the lower left quadrant, we present information on our second quarter 2018 balance sheet. Our total debt was $1,336,000,000, and our net debt was $1,160,000,000. Our total net debt to adjusted EBITDA ratio was 2.3 at the end of the second quarter. In the lower right quadrant, we present information on our free cash flow. We generated $80.6 million of free cash flow in the second quarter, representing 122.3% of net income for the quarter. And lastly, we repurchased just over 579,000 of our shares for $46.1 million in the second quarter.
Through the first half of 2018, we have repurchased over 930,000 of our shares for $72.1 million.
Now I'd like to provide you with a summary of the anticipated exit of the residential hermetic motor components business Mark highlighted a few minutes ago. Consistent with the company's strategy to selectively prune non-core and underperforming businesses, we previously set in motion plans to either fix, sell, or exit this business. On July 31 of this year, a customer representing a large percentage of this business announced its intent to wind down operations over the next 60 days due primarily to loss of business in the Middle East. As a result of this announcement, we accelerated our plans to exit the business.
Year-to-date 2018 sales and operating profit were $31.9 million and $900,000, respectively. This business is reported within the climate segment. While we expect to begin to ramp down operations in the second half of 2018, we will continue to operate this business for a period of time to support current customers. The total cost to exit this business are estimated to be approximately $35 million. While a large majority of these costs are noncash, we estimate approximately $3.5 million of future cash obligations associated with the exit. The impact on 2018 GAAP EPS is estimated to be approximately $0.68 per share. We are expecting no impact to adjusted EPS.
Now, I will provide an update on our full year guidance for 2018. Our guidance assumes mid-single-digit organic sales growth for the full year. We are expecting a meaningful improvement in our adjusted operating margin for the full year 2018, making this the second year of improvement. Our full year 2018 GAAP EPS guidance is $4.78 to $5.08 per share. On an adjusted EPS basis, we've narrowed our full year 2018 guidance to $5.70 to $6 per share. The expected adjustment to convert the GAAP EPS to the adjusted EPS are restructuring and related costs of $8 million or $0.14 per share, purchase accounting and transaction cost of $7 million or $0.11 per share, and a gain on the sale of assets from our previously closed business of $400,000 or $0.01 per share. And as discussed on the prior slide, impairment and exit related costs of $35 million or $0.68 per share.
In summary, at the midpoint of our revised guidance, our full year adjusted EPS is expected to be up 20% over the prior year.
Now I will turn the call over to Jon.
Thanks, Rob. Good morning, everyone. Before I cover the normal update on the segments, I'd like to walk you through how the tariffs impact our business and the actions we're taking to offset the impact. Regarding the Section 232 tariffs on steel and aluminum, most of our steel is purchased from U.S. suppliers, and while we do purchase a portion of our aluminum from suppliers outside the U.S., it has a relatively low impact. So overall, there is not a large direct impact on our business. We are experiencing overall commodity inflation on both steel and aluminum, likely resulting from the tariffs. In addition, we are seeing the secondary impact on some purchase components, which utilize imported steel or aluminum.
On the Section 301 tariffs, I'll first address the $50 billion of U.S. imports from China. These tariffs include a number of electric motor product categories, a few of the power transmission products and a number of related components used in the manufacture of our type of products. The majority of products we sell to our U.S. customers are not manufactured in China. For Regal, roughly 5% of our U.S. business is directly impacted. In addition, similar to the Section 232 tariffs, there's a secondary impact on some of our purchase components. We're also in the process of evaluating the $200 billion list of Section 301 tariffs that are being proposed by the U.S. government. There are 2 main actions we are taking to mitigate the impact: first, we are implementing price increases beyond what we already executed in April to help offset the impact of tariffs; second, we are implementing actions to allow us to manufacture some of these products in Regal facilities outside of China to negate the impact of the tariffs. We have a global manufacturing footprint and, in some cases, we can transfer the production of these products to Mexico and other Asian manufacturing facilities with a minimal investment. In addition to these mitigation actions, we are pursuing growth opportunities. There are a number of cases where our customers are impacted by the tariffs with their supply chain. We can offer them alternatives with our footprint to help them mitigate the tariff impact. While it's too early to quantify the benefit, we are already talking to some customers about our ability to serve their business. While this situation is very dynamic, we expect to offset the impact of the tariffs with our robust mitigation plans.
Now I'll walk through each of the segments and give more details on organic sales and operating margin performance. In Commercial and Industrial Systems, sales were $469 million with organic sales increasing 5.7% from prior year. In the quarter, we experienced broad-based sales strength across a number of the C&I end markets, including power generation, oil and gas, commercial HVAC and pump. Sales were up slightly in the North America C&I distribution business. Sales were down in our pool motor distribution business, but we did see demand improve as we exited the quarter and entered the third quarter. From a regional perspective, sales were strong in both Asia and Europe. As you recall, we closed on the Nicotra Gebhardt acquisition on April 10, and we're pleased with the progress the team is making on the integration. Price improved sequentially and was up over prior year. After turning neutral in the first quarter, price cost was slightly favorable in the second quarter. Adjusted operating margin was 7.7% of sales, up 40 basis points sequentially and up 100 basis points from prior year. Volume, improvements from our Simplification programs, and price all had a positive impact on our margins. Commodity inflation and mix were headwinds and partially offset these benefits.
We've undertaken a number of actions to improve the profitability of our C&I segment. It was good to see the progress in our second quarter results and we continue to expect further improvements in the second half of 2018.
In Climate Solutions, sales were $277 million, with organic sales increasing 2.4% from prior year. In North America, sales to our residential HVAC, OEM and distribution customers were up mid-single digits to prior year. Demand and distribution was particularly strong in the quarter. Sales in commercial refrigeration were relatively flat to the prior year. We experienced headwinds in both the Middle East and in the residential hermetic motor components business, where sales were down mid-teens. Price improved sequentially and was up over prior year. Price cost was slightly favorable in the quarter. Adjusted operating margin was a strong 16.1% of sales, up 350 basis points sequentially and up 90 basis points from prior year. The higher volume, productivity in our manufacturing operations, mix and foreign currency all had a positive impact on margins. This was a solid quarter for our Climate Solutions segment, with mid-single-digit growth in North America residential HVAC and strong incremental margin across the segment.
Sales in Power Transmission Solutions were $213 million, with organic sales increasing a strong 10.4% from prior year. In the quarter, we experienced strength across a number of the end markets, including material handling, food and beverage, oil and gas and aerospace. Price was up over prior year, and price cost was slightly favorable in the quarter. Adjusted operating margin was 11.8% of sales, up 10 basis points from the prior year. The higher volume, price and productivity in our manufacturing operations had a positive impact on margins, however, mix was the headwind and partially offset these benefits. Mix was a headwind because, while sales were up in both OEM and distribution, OEM was stronger. Year-to-date, adjusted operating margin is 12.4%, up 160 basis points from the prior year. We are expecting margins in the second half of 2018 to be similar to the first half. It's been a solid first half for our PTS segment, with organic sales up 9.6% and adjusted operating margin up 160 basis points.
I'll now turn the call back over to Mark.
Thanks, Jon. Now before we go to Q&A, I would like to briefly summarize our second quarter results and highlights. We had a solid second quarter and our outlook remains optimistic. Organic sales increased 5.7%; price cost was slightly positive in the quarter, and we expect price cost to remain at least neutral for the remainder of the year. Our adjusted operating margins were up 70 basis points for the quarter, and our adjusted earnings per share were up 24% as compared to prior year. The $0.31 earnings per share increase was driven almost entirely from operations with little impact from tax reform. Our free cash flow to net income was 122%, and on capital allocation, we repurchased $46 million of our shares in the quarter and we repurchased $72 million year-to-date. Additionally, our board has approved the new share repurchase authorization up to $250 million.
As we enter the third quarter, orders were up year-over-year and, generally, our markets remain strong. The tariff situation is dynamic, but we expect that our mitigation actions will offset the tariff impact. We have announced our intent to exit the residential hermetic components business, which will allow us to better focus on our core and improve our overall performance.
Finally, we narrowed our annual adjusted earnings per share guidance, which now represents a 20% increase year-over-year at the midpoint. Our total year adjusted earnings per share guidance reflects a record year for Regal in both sales and earnings. We will now take your questions.
[Operator Instructions] And our first question will come from Julian Mitchell of Barclays.
Maybe just the first question on the free cash flow expectation for the year. You've got that sort of 20% earnings growth guidance aspiration on an adjusted basis, free cash flow was flat-ish year-on-year in the first half. How much do you think you'll see free cash flow grow in the second half?
Julian, this is Rob. We do continue to expect free cash flow to exceed net income over 100% in the year. So we certainly aren't coming off of that expectation, which certainly means that your back half should be fairly strong relative to the first half.
And is there something around working capital liquidation that accelerates dramatically, or some excess buildup in the first half that you think has to unwind quickly?
Well we certainly do see trade working capital as a source of cash in the year despite the growth projections that we have. So yes, we do have programs in place to reduce inventory levels. Also, we have different programs in place to address terms for both AR and AP, and that should also drive trade working capital improvements throughout the remainder of the year.
And then just a follow-up question on the Climate Solutions business, very strong margin performance in Q2. Was there anything exceptional within that? Or do you think that, that degree of year-on-year price increase, up 90 bps, I think, in Q2, you can hold a very healthy rate of increase through the second half as well?
As you know, Julian, the second and third quarters tend to be our seasonally high quarters, and we tend to have stronger margins in those 2 quarters relative to what happens in the fourth and the first. And our expectation for the year is no different.
Okay, so we should still see margins up year-on-year in the second half in climate, probably?
Yes, I think that's fair.
And our next question will come from Scott Graham of BMO Capital Markets.
This is Katja on for Scott. Can you talk a little bit about how orders were in each of the segments?
Well, as we commented on the call, as we entered the third quarter, orders were up year-over-year for most of our businesses across the world. So we felt pretty good as we enter the third quarter, similar to the way we felt going into the second quarter, which is what drives our optimism for the back half of the year. Jon, you want to add any color?
Just a couple of things. I would say that, as we progress through the second quarter, I would characterize the orders performance as somewhat stable through the quarter. No real change sequentially as we progress through the second quarter.
Do you hear anything from your customers about demand being impacted by the tariffs?
Well, I would say, it's a very dynamic time. And there's -- our products, as Jon mentioned, are definitely impacted by the tariffs. And so, there's a lot of discussions going on with customers about both the headwinds of the tariff itself as well as the opportunities. But we're dealing with those, as we mentioned, either with price increases or with potentially taking advantage of our global footprint and relocating our production to a location that doesn't have the tariff.
And I would add that, from an order standpoint, as we enter the third quarter, as Mark said, we continue to see orders strength versus prior year. A lot of discussion about the tariffs and how that may or may not impact the end markets. But we continue to see order strength.
And our next question will come from Nigel Coe of Wolfe Research. We'll move on to the next question, which is from Jeff Hammond of KeyBanc Capital Markets.
So on HVAC, did you see any kind of material prebuy ahead of any kind of pricing actions? And then just back on the margins, can you quantify that -- the FX benefit in the quarter?
So that -- Jeff, this is Jon. On the prebuy question, I would say we don't believe we saw any material impact from a demand standpoint on getting ahead of price increases. And I think you're probably referring to price increases that would be with our customers, and whether that created a pull ahead that we would've seen?
Yes.
Yes. And that -- I would say, it's always hard for us to quantify that. But based on just the commentary in the channel, talking to our customers, we don't believe that there was any significant impact to us in terms of our demand.
Okay. And then just back on tariffs. One, can you just -- it seems like maybe some of your foreign competition might be more impacted than you guys. Any opportunities you really see to capture share or price as a result? And then just maybe speak to the complexity of moving to some of these other locations if you choose to do so?
Yes. So I'll take that one, Jeff, and then Mark can add any comments if he'd like to. I think when you look at our competition, it varies based on whether we're talking about the $50 billion list of tariffs or the $200 billion list. We have competition that are impacted in both of those product categories but to a different degree. So it'll be interesting to see what happens with the $200 billion list in terms of timing and actual impact. We do see that we have a number of cases where we have competitors that we believe have a greater impact than Regal does. While we're directly impacted, we know that we have some competitors that have what we would see as even a greater impact. And I mentioned the growth opportunities that we're pursuing. That's exactly what's creating those growth opportunities. And that's happening in the $50 billion list, and we would expect that, that would happen maybe even more so in the $200 billion list. In terms of the difficulty for us to mitigate and relocate, transfer some of this product, we're looking at that on a case-by-case basis, and I would say that the good news is, I'll take, for example, some of our larger industrial motors where we have capacity and capability in our North America operation and that's an advantage for us to be able to utilize that capacity without -- with a, I'll call it a modest investment, not a large investment. And we're watching that closely because of course, no one really knows long term what the impact of the tariffs are going to be, so we're trying to manage that appropriately in terms of how much investment we would make.
Okay, great. And then just finally on PT margins, I think, you mentioned mix, but maybe just talk about expectations into the back half, and a little more color on why it was more meaningful. I mean, it seems like you just had a really good runway, and then maybe a little bit of a hiccup here, so just talk about expectations going forward.
That is kind of how we see it. The first quarter was a really, really good quarter for the PTS business in terms of margins, and like you said, we hit a little bit of a headwind in the second quarter. We do believe it was -- the impact was because of the mix with the OEM sales strength versus sale strength in distribution, but not at the same pace. We do expect that -- our first half margins were 12.4%. That's pretty much the kind of target we're looking at for the second half. And so we're kind of seeing this more of a blend of what we saw in the first quarter and second quarter in terms of how that segment will perform in the second half.
And next, we have a question from Christopher Glynn of Oppenheimer.
On the C&I margin, continue to talk about more progress on the way. Just curious to kind of stress test that in the scenario of flatter markets in 2019, hypothetically. How'd you characterize the nonvolume-related runway for your initiatives to drive volume-neutral improvement there?
I'll take a pass at it, and Jon can add any color. If you recall, we commented a few quarters ago that we have been focusing our restructuring efforts and Simplification efforts on the C&I business in an effort to improve our margins. And that hasn't changed. And I would expect that we would continue to see benefits in that business kind of regardless of what happens to -- now obviously if the volumes were to start declining that would be different but in a flat environment, I think we would continue to see benefits.
Yes. The 3 primary actions are everything we're doing around Simplification and those efforts, what we're doing with price and what we're doing with productivity through our manufacturing operations. All 3 of those are going well, and they will contribute even without the help on volume.
Great. And then on your distribution trends, I think in the past at Investor Days you've talked about strategies around distribution, penetration runway. I think the growth was a little light there in C&I in the quarter and the mix tilted away from it in PTS. So just wanted a higher level comment on how you would issue the report card on your distribution strategies?
I would say that, in terms of the scorecard, how we're doing, we're doing well on execution. We outlined a number of strategies to drive growth in distribution. Digital was a big part of that. Our investments in commercial excellence, specifically with our sales team adding to our sales organization to strengthen our coverage and distribution, both for PTS and for climate. All those investments are ongoing and we're doing well. The -- if you look at the quarter, actually, it was a little deceiving because of the comments on mix and PTS, in particular, but we actually had good sale strength in PTS and distribution. We just happen to have had a really strong quarter for OEM that created a little bit of that mix headwind. But distribution was clearly up over prior year. Distribution was quite good in HVAC, and we did have some growth in distribution in C&I. It wasn't quite at the pace we would've liked to have seen, but we were growing in C&I as well. So I would say overall, we feel good about the progress we're making around the strategy of strengthening and growing our distribution business.
Okay. And then the last one. With the hermetic exit, what sort of diminution are you expecting to impact the climate segment in the second half, and what kind of tail should we think about for 2019 as we kind of timeframe the exit process?
So, I'll just comment on how we're thinking about it. So we outlined for you the first half revenue and operating margin for the business. So that gives you kind of a sense for the scope of that business. We're talking to our customers now, and we'll give them the opportunity -- we'll support them through the transition, and I would expect that sometime in early '19, our -- we would be out of production completely. We'll be looking at potentially using the facility for different purposes, but in terms of serving this residential hermetic business, I would expect to be out in early '19.
And I would say that the timing here in the second half is going to be very dependent on what our customers need from us in terms of transition. We're having those discussions right now. I would expect by the time we get to our third quarter earnings call, we'll have a much better handle on what that's going to look like for the remainder of 2018.
The next question comes from Michael Halloran of Baird.
So just tagging onto that, are you guys keeping that in the climate segment or you guys going to report that in disc-ops on a forward basis?
I think it's too soon to tell. As we mentioned, this just happened at the end of the month. We will call it out for sure, so you'll know exactly where it was. But whether or not it goes into discontinued ops, we haven't gotten that far yet.
Okay, makes sense. And then, cadence here for capital. Obviously, you guys upped the share repurchase program, reupped it $250 million there. You made the NG acquisition earlier this year. How are you guys thinking about balancing those going forward? What's the pipeline look like for M&A? How aggressive are you guys willing to be on buyback? Maybe just give some context around that.
Yes, so we're kind of following what we've consistently been saying, which is back in March of 2017, we commented we want to be more balanced in our capital allocation, not simply doing M&A, but doing both M&A and buybacks, and we have been actually doing that. 4 out of the last 5 quarters, we have repurchased our shares. And so we want to be balanced on [indiscernible] approach, but obviously, M&A is definitely a part of our long-term strategy, and I would characterize our pipeline as being in good shape, with some very interesting things that we're looking at.
And next, we have a question from Walter Liptak of Seaport Global.
Most of the -- some of my questions have been asked, but around the discontinued ops, the $31.9 million year-to-date, is that revenue trailing off as you look at the exit? And how much is it down year-over-year?
Well, I would say that we mentioned that in the second quarter, it was down mid-teens. So that gives you an idea of how it performed in the second quarter. I would say that, in general, what we would expect to see is it trailing off, because of the announcement from our largest customer, but the big question mark that we don't really have the answer to yet is what might the near-term demand be to support customers with a transition program. So we could see a little bit of an uptick in demand just because of that requirement. But underlying demand is declining.
Okay. And you mentioned that this is all -- this is manufactured in 1 factory, so presumably you can take out all the costs related to the product?
Yes, that's our assumption.
All right, great. And then I wanted to ask a pools question. I think some of the other OEs around the pools market and the distributors are showing -- showed higher growth. I wondered, what was it about your business that had demand down?
Yes. We had demand up on the OEM side in pool. That -- what I talked about specifically was the aftermarket. We have an aftermarket business, that's a good business, part of our pool business, that was down in Q1. It was also down in Q2, not to the same degree as Q1. And we did see demand improve. So our view is that there's a couple of factors there. Q1 and probably early Q2 was more weather-related, and also for us in particular, a bit of an inventory factor as well in the channel that impacted the demand that we saw in the second quarter. But as I said, the good news was we saw demand pick up through the second quarter and entering into the third quarter. So I think it's going to be more of a timing issue that we saw in the first half.
Okay, great. And then just 1 last follow-up for me. It seems like you guys are stepping up with the discussion about Simplification and looking at how profitable the different products are. My understanding was in C&I, the Simplification that you're doing is sort of a one-off for this year. Are you finding new programs to work on to do Simplification? Or is this going to be done by the end of the year?
As you know, we've been at Simplification here for a while. In 2017, we had a number of programs where, I'm going to say, 75% of the money we spent was focused on the C&I space. That continued into 2018, and there's still more to do. So maybe perhaps not at the same pace, but there is definitely still more to do. And so we see a continued benefit stream from our Simplification efforts moving forward.
[Operator Instructions] And our next question will come from Bhupender Bohra of Wolfe Research.
I just wanted to dig more into the Climate Solutions business here. I think Jon mentioned about the U.S., North America, resi HVAC was up mid-single. I think you guys talked about some weakness in the commercial refrigeration business. Can you just -- was there some kind of a pull-forward, or how did we see the demand actually as we entered the third quarter and the cadence with the second quarter, if you could just comment on that commercial refrigeration.
So in the quarter, you're right, North America residential HVAC was up mid-single digits. Commercial refrigeration was relatively flat in the quarter if you look at it versus prior year. Commercial refrigeration was actually down in Q1 versus prior year. So flat in Q2. The trend that we're seeing on commercial refrigeration relative to prior year performance is improving. So we're expecting growth in the second half of 2018 from commercial refrigeration, year-over-year growth.
Okay, got it, got it. And is it just the -- the first half weakness, was there anything in the underlying demand or any other concerns during the first half within that market?
In commercial refrigeration?
Yes.
I think in commercial refrigeration, based on our discussions with our customers and what they're communicating it's the demand in their market that has caused us to be down in Q1 and flat in Q2. But I think it's improving, and we'll see the benefit in the back half.
And one of the things that we're doing that will help improve sales as well is we have some really exciting new products that are coming out in commercial refrigeration, all around energy efficiency and some other improvements that will help our customers that we're seeing really strong interest there, and that's part of what we'll see in our strength in the second half.
Okay, okay. And my follow-up actually was on the price cost. I mean, if you dig into like the price actions, you did a price increase in April, you actually mentioned about some other price increases coming up. And historically, you have mentioned you have contractual customers, about like 30% of your customers are contractual, and the rest of them are actually spot. How did the passthrough actually work, like in the second quarter? I mean, I was thinking you should be a little bit more positive in the back half but it seems like you mentioned about neutral. So if you can just give some color on that?
Let me give a little bit more background on that, Bhupender. We had a -- so I'll take it back just a little bit. We entered the year expecting that we would turn price cost neutral by the second quarter. We actually we ran about a quarter ahead of that. We were neutral in the first quarter, we were slightly positive is the way I would character -- we would characterize it for the second quarter. We are expecting to remain at least neutral. Neutral to slightly favorable for the remainder of the year. If you look at from a pricing standpoint, there is incremental pricing in C&I and climate with the April price increase. There was also some incremental pricing that we'll see from the material -- two-way material price formulas, with the 30% of our business that's contracted. However, there is also some incremental inflation that we have coming at the business. So that's why we would characterize it as remaining neutral to slightly favorable for the remainder of the year.
Okay, and the price increases which you mentioned, would that be C&I and climate or all across-the-board?
When you think about how we're looking at the business, what we've done as well as the actions taking on tariffs, I would characterize it as across-the-board.
And this concludes our question-and-answer session. I would like to turn the conference over to Mark Gliebe for any closing remarks.
I just thank you, everyone, for your questions and for your interest in Regal and have a great day.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.