Regal Rexnord - 10-Q quarterly report FY2010 Q3

 

 

(Exact name of registrant as specified in its charter)

200 State Street, Beloit, Wisconsin 53511
(Address of principal executive office)

(608) 364-8800
Registrant’s telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES þ NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a “smaller reporting company.” See the definitions of “large accelerated filer” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

 

Certain statements made in this Quarterly Report on Form 10-Q are “forward-looking statements” intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on management’s expectations, beliefs, current assumptions and projections. When used in this press release, words such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “should,” “project” or “plan” or the negative thereof or similar words are intended to identify forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, assumptions and other factors, some of which are beyond our control, which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. Those factors include, but are not limited to:

Shareholders, potential investors, and other readers are urged to consider these factors in evaluating the forward-looking statements and cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date of this report, and we undertake no obligation to update these statements to reflect subsequent events or circumstances. Additional information regarding these and other risks and factors is included in Item 1A — Risk Factors in our Annual Report on Form 10-K filed with the SEC on March 2, 2010.

(Dollars in Thousands, Except Dividends Declared and Per Share Data)

(Dollars in Thousands, Except Shares and Per Share Data)

(Dollars in Thousands, Except Share and Per Share Data)

(Dollars in Thousands)

The accompanying (a) condensed consolidated balance sheet as of January 2, 2010, which has been derived from audited financial statements, and (b) unaudited interim condensed consolidated financial statements as of October 2, 2010, have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading.

It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s 2009 Annual Report on Form 10-K filed on March 2, 2010.

Recent accounting guidance changed the consolidation rules as they relate to variable interest entities (“VIE’s”). The guidance changed the model related to consolidating a VIE, and defines the assessment methodology for determining VIE status. The guidance was adopted by the Company as required at the beginning of fiscal 2010, and did not have an effect on the Company’s consolidated financial statements.

In the opinion of management, all adjustments considered necessary for a fair presentation of financial results have been made. Except as otherwise discussed, such adjustments consist of only those of a normal recurring nature. Operating results for the three and nine months ended October 2, 2010 are not necessarily indicative of the results that may be expected for the entire fiscal year ending January 1, 2011.

The Company operates on a 52/53 week fiscal year, and fiscal 2009 was a 53 week year with an additional week in the fiscal fourth quarter.

Cost for approximately 50% of the Company’s inventory is determined using the last-in, first-out (LIFO) inventory valuation method. The approximate percentage distribution between major classes of inventories was as follows:

Property, plant and equipment by major classification was as follows:

The results of operations for acquired businesses are included in the Condensed Consolidated Financial Statements from the dates of acquisition.

On September 1, 2010, the Company acquired Rotor B.V. (“Rotor”) headquartered in Eibergen, the Netherlands. Rotor sells electric motors to a variety of industries including the marine industry, ship building and offshore oil and gas. In addition to the Netherlands, Rotor also sells throughout Europe, the United Kingdom and Japan. The purchase price was approximately $36.4 million net of cash acquired and assumed liabilities. Rotor is reported as part of the Electrical segment.

On April 6, 2010, the Company acquired CMG Engineering Group Pty, Ltd. (“CMG”) headquartered in Melbourne, Australia. CMG manufactures and distributes fractional horsepower industrial motors, blower systems, and industrial metal products with operations in Australia, New Zealand, South Africa, Malaysia, Singapore, the United Kingdom, and the Middle East. The purchase price was $83.5 million, including $74.7 million in cash, approximately $2.7 million in assumed liabilities and 100,000 shares of Company stock with a fair market value of $6.1 million. CMG has operations in both the Mechanical and Electrical segments.

Purchase price allocations for the Rotor and CMG acquisitions included adjustments for intangible assets, property and other working capital adjustments. The excess of purchase price over fair value was assigned to goodwill.

Investments are generally short term in duration and are classified as trading securities, which are reported at fair value with gains and losses, which were insignificant for all periods presented, included in earnings. As of October 2, 2010 and January 2, 2010, the Company had $194.1 million and $117.6 million respectively, of trading securities recorded at fair value (Level 2) (see Note 16 of the Condensed Consolidated Financial Statements for description of the fair value hierarchy).

The Company’s consolidated comprehensive income for the three and nine months ended October 2, 2010 and September 26, 2009, respectively, was as follows (in thousands):

The amount of comprehensive income attributable to noncontrolling interests was $2.1 million and $5.3 million for the three and nine months ended October 2, 2010, respectively. The amount of comprehensive income attributable to noncontrolling interests was $0.5 million and $4.2 million for the three and nine months ended September 26, 2009, respectively.

Foreign currency translation adjustments, unrealized gains and losses on derivative instruments and pension liability adjustments are included in Equity under Accumulated Other Comprehensive Income (Loss). The components of the ending balances of Accumulated Other Comprehensive (Loss) are as follows (in thousands):

The Company recognizes the cost associated with its standard warranty on its products at the time of sale. The amount recognized is based on historical experience. The following is a reconciliation of the changes in accrued warranty costs for the three and nine months ended October 2, 2010 and September 26, 2009 (in thousands):

The Company has two strategic businesses that are reportable segments, Mechanical and Electrical (in thousands):

As required, we perform an annual impairment test of goodwill during the fourth quarter or more frequently if events or circumstances change that would more likely than not reduce the fair value of our reporting units below their carrying value.

At October 2, 2010, substantially all of the Company’s goodwill is attributable to the Electrical segment and the Company believes that substantially all of the goodwill is deductible for tax purposes. The following information presents changes to goodwill during the periods indicated (in thousands):

Intangible assets consisted of the following (in thousands):

Amortization expense recorded for the three and nine months ended October 2, 2010 was $5.2 million and $14.6 million, respectively. Amortization expense for the three and nine months ended September 26, 2009 was $5.2 million and $14.5 million, respectively.

The Company’s indebtedness as of October 2, 2010 and January 2, 2010 was as follows (in thousands):

At October 2, 2010, the Company has $250.0 million of Senior Notes (the “Notes”) outstanding. The Notes were sold pursuant to a Note Purchase Agreement (the “Agreement”) by and among the Company and the purchasers of the Notes. The Notes were issued and sold in two series: $150.0 million in Floating Rate Series 2007A Senior Notes, Tranche A, due August 23, 2014, and $100.0 million in Floating Rate Series 2007A Senior Notes, Tranche B, due August 23, 2017. The Notes bear interest at a margin over the London Inter-Bank Offered Rate (“LIBOR”), which margin varies with the ratio of the Company’s consolidated debt to consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) as defined in the Agreement. These interest rates also vary as LIBOR varies. The Agreement permits the Company to issue and sell additional note series, subject to certain terms and conditions described in the Agreement, up to a total of $600.0 million in combined Notes. At October 2, 2010, the interest rate of 1.0% was based on a margin over LIBOR.

The Company also has a Term Loan Agreement (“Term Loan”) with certain financial institutions, whereby the Company borrowed an aggregate principal amount of $165.0 million. The Term Loan matures in June 2013, and borrowings generally bear interest at a variable rate equal to (i) a margin over LIBOR, which margin varies depending on whether certain criteria are satisfied, or (ii) the alternate base rate as defined in the agreement. At October 2, 2010, the interest rate of 1.0% was based on a margin over LIBOR.

The Company’s $500.0 million revolving credit facility (“Facility”) matures in April 2012 and permits the Company to borrow at interest rates based upon a margin above LIBOR, which margin varies with the ratio of total funded debt to EBITDA, as defined in the Facility. These interest rates also vary as LIBOR varies. The Company pays a commitment fee on the unused amount of the Facility, which also varies with the ratio of total debt to EBITDA as defined in the Facility.

The Notes, the Term Loan, and the Facility require the Company to meet specified financial ratios and to satisfy certain financial condition tests. The Company was in compliance with all debt covenants as of October 2, 2010.

The Company has entered into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk. (See also Note 15 of Notes to Condensed Consolidated Financial Statements.)

As of October 2, 2010, the Company has no Convertible Notes that remain outstanding. The Company exercised its right to call the remaining bonds, which resulted in bondholders exercising their conversion right. As a result, bondholders received the principal amount of the notes in cash, with the balance of the conversion obligation satisfied in shares of the Company’s common stock. During the first nine months of 2010, bondholders exercised their conversion right for a total of $39.2 million of Convertible Notes. The par value was paid in cash, and 917,394 shares of common stock were issued for the conversion premium.

At October 2, 2010, other notes payable of approximately $17.9 million were outstanding with a weighted average interest rate of 5.0%.

The Company’s net periodic defined benefit pension cost is comprised of the following components (in thousands):

The estimated net actuarial loss and prior service cost for defined benefit pension plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost during the 2010 fiscal year is $2.2 million and $0.2 million, respectively.

In the third quarter of 2010 and 2009, the Company contributed $2.9 million and $8.5 million to defined benefit pension plans, respectively. The Company expects to contribute an additional $0.5 million, for total contributions of $4.3 million in 2010. The Company contributed a total of $10.1 million in 2009. The assumptions used in the valuation of the Company’s pension plans and in the target investment allocation have remained the same as those disclosed in the Company’s 2009 Annual Report on Form 10-K filed on March 2, 2010.

The Company recognized approximately $1.9 million and $1.3 million in share-based compensation expense for the three month period ended October 2, 2010 and September 26, 2009, respectively. Share-based compensation expense for the nine month period ending October 2, 2010 and September 26, 2009 was $5.0 million and $3.3 million, respectively. The total excess income tax benefit recognized relating to share-based compensation for the nine months ended October 2, 2010 and September 26, 2009 was approximately $1.6 million and $1.9 million, respectively. The Company recognizes compensation expense on grants of share-based compensation awards on a straight-line basis over the vesting period of each award. As of October 2, 2010, total unrecognized compensation cost related to share-based compensation awards was approximately $19.0 million, net of estimated forfeitures, which the Company expects to recognize over a weighted average period of approximately 3.0 years.

The Company was authorized as of October 2, 2010 to deliver up to 5.0 million shares of common stock upon exercise of non-qualified stock options or incentive stock options, or upon grant or in payment of stock appreciation rights, and restricted stock. Approximately 1.7 million shares were available for future grant or payment under the various plans at October 2, 2010.

On May 22, 2009, the Company completed the sale of 4,312,500 shares of common stock at a price of $36.25 per share to the public. Net proceeds of $150.4 million were received by the Company.

The Company uses several forms of share-based incentive awards, including non-qualified stock options, incentive stock options, and stock appreciation rights (“SARs”). All grants are made at prices equal to the fair market value of the stock on the grant dates, and expire ten years from the grant date. The Company values restricted stock awards at the closing market value of its common stock on the date of grant and restrictions generally lapse three years after the date of grant.

The majority of the Company’s annual share-based incentive awards are made in the fiscal second quarter. The per share weighted average fair value of share-based incentive awards granted in the May 2010 annual grant was $22.88. The fair market value of the awards is estimated on the date of grant using the Black-Scholes pricing model and the following assumptions: risk-free interest rate of 3.0%; expected dividend yield of 1.1%; expected volatility of 35.4%, and an estimated life of 7.0 years.

A summary of share-based awards (options and SARs) as of October 2, 2010 follows below. Forfeitures of share-based awards were immaterial.

As of October 2, 2010, the Company had 184,150 shares of restricted stock outstanding with a weighted average grant date fair value of $53.12 and a weighted average life of 2.3 years. The Company values restricted stock awards at the closing market value of its common stock on the date of grant and restrictions generally lapse three years after the date of the grant. In the first nine months of 2010 there were 105,950 shares of restricted stock granted, and 29,300 shares of restricted stock vested.

The effective tax rate for the three months ended October 2, 2010 was 30.2% versus 26.9% in the prior year period. The effective tax rate for the nine months ended October 2, 2010, was 31.2% versus 28.9% in the prior period. The changes in the effective rates are driven by changes in the global distribution of income.

As of October 2, 2010 and January 2, 2010, the Company had approximately $6.0 million and $6.6 million respectively, of unrecognized tax benefits, all of which would affect its effective tax rate if recognized. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. Federal tax returns from 2007 through 2009 and various state tax returns remain subject to income tax examinations by tax authorities.

The numerator for the calculation of basic and diluted earnings per share is Net Income Attributable to Regal Beloit Corporation. The denominator is computed as follows (in thousands):

The “Effect of dilutive securities” represents the dilution impact of equity awards and the Convertible Notes (see Note 9 of Notes to Condensed Consolidated Financial Statements). There was no dilutive effect of the Convertible Notes for the three months ended October 2, 2010. The dilutive effect of the Convertible Notes was approximately 1.8 million shares for the three months ended September 26, 2009. The dilutive effect of the Convertible Notes was approximately 0.3 million shares and 1.4 million shares of the nine month period ending October 2, 2010 and September 26, 2009 respectively.

Options for common shares where the exercise price was above the market price at October 2, 2010, and September 26, 2009 totaling approximately 0.3 million and 0.2 million shares, have been excluded from the calculation of the effect of dilutive securities as the effect of such options is anti-dilutive.

On July 30, 2009, the Company filed a response and counterclaims to an action filed by Nordyne, Inc. (“Nordyne”) in the U.S. District Court for the Eastern District of Missouri in which action Nordyne is seeking a judgment declaring that neither Nordyne’s G7 furnace systems nor its iQ Drive 23-seer air conditioning systems infringe on our ECM (electronically commutated motor) systems patents (U.S. Patent No. 5,592,058) (“the ‘058 Patent”) and/or that the ‘058 Patent is invalid. In our response and counterclaims against Nordyne we are seeking a judgment that the ‘058 Patent is valid and that Nordyne has, in fact, infringed and continues to infringe the ‘058 Patent by making, using, offering for sale and selling it G7 furnace systems and iQ Drive 23-seer air conditioning systems. We have also requested the U.S. District Court to enjoin Nordyne and all persons working in concert with Nordyne from further infringement of the ‘058 Patent and to award us compensatory and other damages caused by such infringement. We intend to defend our intellectual property vigorously against the claims asserted by Nordyne and against any infringement by Nordyne or any other person. We do not currently believe that the litigation will have a material effect on the Company’s financial position or its results of operations.

The Company is, from time to time, party to litigation that arises in the normal course of its business operations, including product warranty and liability claims, contract disputes and environmental, asbestos, employment and other litigation matters. The Company’s products are used in a variety of industrial, commercial and residential applications that subject us to claims that the use of our products is alleged to have resulted in injury or other damage. The Company accrues for anticipated costs in defending against such lawsuits in amounts that we believe are adequate, and the Company does not believe that the outcome of any such lawsuit will have a material effect on the Company’s financial position or its results of operations.

The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are commodity price risk, currency exchange, and interest rate risk. Forward contracts on certain commodities are entered into to manage the price risk associated with forecasted purchases of materials used in the Company’s manufacturing process. Forward contracts on certain currencies are entered into to manage forecasted cash flows in certain foreign currencies. Interest rate swaps are entered into to manage interest rate risk associated with the Company’s floating rate borrowings.

The Company must recognize all derivative instruments as either assets or liabilities at fair value in the statement of financial position. Accordingly, the Company designates commodity forward contracts as cash flow hedges of forecasted purchases of commodities, currency forward contracts as cash flow hedges of forecasted foreign currency cash flows and interest rate swaps as cash flow hedges of forecasted LIBOR-based interest payments. There were no significant collateral deposits on derivative financial instruments as of October 2, 2010.

For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income or loss and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or changes in market value of derivatives not designated as hedges are recognized in current earnings.

At October 2, 2010, the Company had an additional $1.6 million, net of tax, of derivative gains on closed hedge instruments in AOCI that will be realized in earnings when the hedged items impact earnings. At September 26, 2009, the Company had an additional ($0.7) million, net of tax, of derivative losses on closed hedge instruments in AOCI that was realized in earnings when the hedged items impacted earnings.

As of October 2, 2010, the Company had outstanding the following commodity forward contracts (with maturities extending through June 2012) to hedge forecasted purchases of commodities (in millions):

As of October 2, 2010, the Company had outstanding the following currency forward contracts (with maturities extending through December 2012) to hedge forecasted foreign currency cash flows (in millions):

As of October 2, 2010, the total notional amount of the Company’s receive-variable/pay-fixed interest rate swaps was $250.0 million (with maturities extending to August 2017).

Fair values of derivative instruments as of October 2, 2010 and January 2, 2010 were (in millions):

The effect of derivative instruments on the condensed consolidated statements of equity and earnings for the three and nine months ended October 2, 2010 and September 26, 2009, was (in millions):

The ineffective portion of hedging instruments recognized during the three and nine months ended October 2, 2010 was immaterial.

The net AOCI balance of ($14.0) million loss at October 2, 2010 includes $3.4 million of net current deferred gains expected to be realized in the next twelve months.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The inputs used to measure fair value are classified into the following hierarchy:

The Company uses the best available information in measuring fair value. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of October 2, 2010 and January 2, 2010 (in millions):

On November 1, 2010, the Company acquired 55% of Elco Group B.V. (“Elco”). Elco manufactures and sells motors, fans and blowers, and has manufacturing facilities in Italy, China and Brazil.

Unless the context requires otherwise, references in this Item 2 to “we”, “us,” “our” or the “Company” refer collectively to Regal Beloit Corporation and its subsidiaries.

The global economy and particularly the U.S. economy continued to show growth in the third quarter 2010. Sales of high efficiency products, particularly for HVAC and commercial refrigeration applications, continued to show strong growth rates, supported by the net economic impact to the end user and, in certain cases, by tax credits and other subsidies. During the third quarter we experienced difficulties meeting some of our demand due to supply chain disruptions. In an effort to mitigate the impact on our customers, we incurred incremental costs, including costs associated with qualifying new vendors, plant labor inefficiencies, and expedited transportation.

Net sales for the third quarter 2010 increased 27.0% to $590.8 million from $465.2 million in the third quarter 2009. Sales for the third quarter 2010 included $33.5 million of incremental sales from the Rotor and CMG businesses acquired in 2010.

Net Income Attributable to Regal Beloit Corporation increased 43.4% to $44.7 million for the third quarter 2010 compared to $31.2 million for the third quarter 2009. Diluted earnings per share increased 39.0% to $1.14 for the third quarter 2010 compared to $0.82 for the third quarter 2009.

Net sales for the third quarter 2010 were $590.8 million, a 27.0% increase compared to $465.2 million for the third quarter 2009. Sales for the third quarter 2010 included $33.5 million of incremental sales from the Rotor and CMG businesses acquired in 2010.

In the Electrical segment, sales for the third quarter 2010 increased 25.1% over the third quarter 2009. Sales for the residential HVAC motor business increased 5.3% for the third quarter 2010 compared to the third quarter 2009, driven by higher efficiency product mix which was supported by tax credits. Driven by improving end markets, commercial and industrial motor sales in North America for the third quarter 2010 increased 23.0% compared to the third quarter 2009. Global generator sales increased 34.2% for the third quarter 2010 compared to the third quarter 2009.

In the Mechanical segment, sales for the third quarter 2010 increased 45.9% compared to the third quarter 2009, including $9.5 million from the CMG acquisition and improving later cycle end markets. From a geographic perspective, Asia-based sales for the third quarter 2010 increased compared to the third quarter 2009. In total, sales to regions outside of the United States were 31.0% of total sales for the third quarter 2010 compared to 25.6% for the third quarter 2009. The impact of foreign currency exchange rates decreased total sales by (0.1%) for the third quarter 2010 compared to the third quarter 2009. Sales of high efficiency products were 18.3% of total sales for the third quarter 2010 compared to 19.3% for the third quarter 2009.

Net sales for the nine months ended October 2, 2010 were $1,682.3 million, a 23.4% increase compared to $1,363.0 million for the nine months ended September 26, 2009. Sales for the nine months ended October 2, 2010 included $61.8 million of incremental sales from the Rotor and CMG businesses acquired in 2010.

In the Electrical segment, sales for the nine months ended October 2, 2010 increased 23.5% compared to the nine months ended September 26, 2009. Sales for the residential HVAC motor business were impacted by higher efficiency product mix and low prior year comparables resulting in an 18.6% increase for the nine months ended October 2, 2010 compared to the

nine months ended September 26, 2009. Driven by improving end markets, commercial and industrial motor sales in North America for the nine months ended October 2, 2010 increased 16.5% compared to the nine months ended September 26, 2009. Global generator sales increased 13.6% for the nine months ended October 2, 2010 compared to the nine months ended September 26, 2009.

In the Mechanical segment, sales for the nine months ended October 2, 2010 increased 22.5% compared to the nine months ended September 26, 2009, including $17.3 million of sales from the CMG acquisition.

From a geographic perspective, Asia-based sales for the nine months ended October 2, 2010 increased compared to the nine months ended September 26, 2009. In total, sales to regions outside of the United States were 30.0% of total sales for the nine months ended October 2, 2010 compared to 26.3% for the nine months ended September 26, 2009. The impact of foreign currency exchange rates increased total sales by 0.7% for the nine months ended October 2, 2010 compared to the nine months ended September 26, 2009. Sales of high efficiency products were 18.1% of total sales for the nine months ended October 2, 2010 compared to 17.4% for the nine months ended September 26, 2009.