FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2004
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to__________
Commission File Number: 1-7283
REGAL-BELOIT CORPORATION
(Exact name of registrant as specified in its charter)
Wisconsin
39-0875718
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification Number)
200 State Street, Beloit, Wisconsin 53511-6254
(Address of principal executive offices)
(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 x
No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuers’ classes of common stock as of the latest practicable date.
24,458,702 Shares, Common Stock, $.01 Par Value (as of November 1, 2004)
For Quarter Ended September 28, 2004
INDEX
Page No.
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets
3
Condensed Consolidated Statements of Income
4
Condensed Consolidated Statements of Cash Flows
5
Notes to Condensed Consolidated Financial Statements
6 – 9
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
9 - 13
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
13
Item 4 – Controls and Procedures
13 - 14
PART II - OTHER INFORMATION
Item 6 – Exhibits and Reports on Form 8-K
14
Signature
15
CAUTIONARY STATEMENT
The following is a cautionary statement made under the Private Securities Litigation Reform Act of 1995: With the exception of historical facts, the statements contained in Item 2. of this Form 10-Q may be forward looking statements. Actual results may differ materially from those contemplated. Forward looking statements involve risks and uncertainties, including but not limited to, the following risks: 1) cyclical downturns affecting the markets for capital goods, 2) substantial increases in interest rates that impact the cost of our outstanding debt, 3) our success in increasing sales and maintaining or improving the operating margins of our businesses, 4) the availability of or material increases in the costs of select raw materials or parts, 5) actions taken by competitors, and 6) our ability to satisfy various covenant requirements under our credit facility. Investors are directed to other documents, such as our Annual Report on Form 10-K and other Form 10-Q’s filed with the Securities and Exchange Commission.
2
PART I FINANCIAL INFORMATION REGAL-BELOIT CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands of Dollars)
Item I. Financial Statements
(Unaudited) Sept. 28, 2004
(From Audited Statements) Dec. 31, 2003
ASSETS
Current Assets:
Cash and Cash Equivalents
$
20,834
9,100
Receivables, less reserves of $1,520 in 2004 and $1,432 in 2003
124,196
85,468
Inventories
166,702
131,121
Other Current Assets
17,836
11,738
Total Current Assets
329,568
237,427
Property, Plant and Equipment at Cost
376,992
361,736
Less - Accumulated Depreciation
(203,111
)
(192,638
Net Property, Plant and Equipment
173,881
169,098
Goodwill
340,212
311,216
Other Noncurrent Assets
21,962
16,704
Total Assets
865,623
734,445
LIABILITIES AND SHAREHOLDERS’ INVESTMENT
Current Liabilities:
Accounts Payable
60,724
36,179
Federal and State Income Taxes Payable
11,987
7,546
Accrued Compensation and Employee Benefits
26,559
18,151
Other Current Liabilities
24,796
15,450
Total Current Liabilities
124,066
77,326
Long-Term Debt
275,285
195,677
Deferred Income Taxes
46,188
46,186
Other Noncurrent Liabilities
11,106
11,658
Minority Interest in Consolidated Subsidiaries
6,818
4,894
Shareholders’ Investment:
Common Stock, $.01 par value, 50,000,000 shares authorized, 25,232,552 issued in 2004 and 25,191,656 issued in 2003
252
Additional Paid-In Capital
132,971
132,313
Less – Treasury Stock, at cost, 774,100 shares in 2004 and 159,900 shares in 2003
(15,228
(2,729
Retained Earnings
285,300
270,760
Accumulated Other Comprehensive Loss
(1,135
(1,892
Total Shareholders’ Investment
402,160
398,704
Total Liabilities and Shareholders’ Investment
See accompanying notes.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars, Except Per Share Data)
(Unaudited)
Three Months Ended
Nine Months Ended
Sept. 28,2004
Sept 30,2003
Sept. 30,2003
Net Sales
193,888
159,031
534,624
467,000
Cost of Sales
150,944
122,599
412,652
356,951
Gross Profit
42,944
36,432
121,972
110,049
Operating Expenses
27,353
24,436
79,763
74,206
Income From Operations
15,591
11,996
42,209
35,843
Interest Expense
1,722
1,612
4,558
4,907
Interest Income
55
8
87
50
Income Before Taxes & Minority Interest
13,924
10,392
37,738
30,986
Provision For Income Taxes
4,435
3,667
12,996
11,390
Income Before Minority Interest
9,489
6,725
24,742
19,596
Minority Interest in Income, Net of Tax
562
215
1,326
535
Net Income
8,927
6,510
23,416
19,061
Per Share of Common Stock:
Earnings Per Share – Basic
.37
.26
.95
.76
Earnings Per Share – Assuming Dilution
.36
.94
Cash Dividends Declared
.12
Average Number of Shares Outstanding - Basic
24,456,271
25,031,756
24,647,965
25,029,364
Average Number of Shares Outstanding - Assuming Dilution
24,724,845
25,285,081
24,893,397
25,238,663
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
Sept. 28, 2004
Sept. 30, 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash provided by operating activities less effects of acquisitions:
Depreciation, amortization and deferred income taxes
16,974
16,949
Gain on sale of real estate
(1,630
—
Change in assets and liabilities:
Current assets
(30,100
(1,768
Current liabilities
28,880
5,747
Net cash provided by operating activities
37,540
39,989
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment
(10,167
(14,428
Business acquisitions, net of cash acquired
(71,786
Investment in joint venture
(1,500
Sale of property, plant and equipment
4,847
242
Other, net
(3,872
2,955
Net cash used in investing activities
(80,978
(12,731
CASH FLOWS FROM FINANCING ACTIVITIES:
Additions to long-term debt
115,000
Net repayment of long-term debt
(35,248
(16,124
Repurchase of common stock
(12,499
Dividends paid to shareholders
(8,945
(9,010
Stock issued under option plans
660
146
Financing fees
(3,801
Net cash provided by (used in) financing activities
55,167
(24,988
EFFECT OF EXCHANGE RATE ON CASH
85
Net increase in cash and cash equivalents
11,734
2,355
Cash and cash equivalents at beginning of period
5,591
Cash and cash equivalents at end of period
7,946
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest
4,529
4,845
Income taxes
6,084
3,018
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 28, 2004 (Unaudited)
1. BASIS OF PRESENTATION The condensed consolidated financial statements include the accounts of REGAL-BELOIT Corporation and its wholly owned subsidiaries and have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. All adjustments which management believes are necessary for a fair presentation of the results for the interim periods presented have been reflected and are of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested these statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest Annual Report on Form 10-K.
2. FISCAL QUARTER END In 2004, the Company changed to a fiscal monthly calendar based on 21 working days per fiscal month. A working day is defined as a weekday (as opposed to a weekend day) that is not a holiday where the Company’s plants and offices are closed. This fiscal calendar resulted in September 28, 2004 being the last day of the third fiscal quarter. In 2003, fiscal month ends were calendar months. December 31 will continue to be the year end for the Company. The third quarters of 2004 and 2003 contained 63 and 64 work days, respectively.
3. INVENTORIES Cost for approximately 69% 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 is as follows:
September 28, 2004
December 31, 2003
Raw Material
12
%
11
Work-in Process
23
20
Finished Goods
65
69
4. COMPREHENSIVE INCOME The Company’s comprehensive income which was recorded to shareholders’ investment for the third quarter and first 9 months of 2004 and 2003 is as follows:
Third Quarter Ending
Nine Months Ending
Sept.28, 2004
Net income as reported
Comprehensive income from:
Cumulative translation adjustments
1,142
107
527
2,632
Hedging activities, net of tax
220
230
Comprehensive income
1,362
757
Net comprehensive income
10,289
6,617
24,173
21,423
5. WARRANTY COSTS 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 third quarter and nine months of 2004 and 2003:
Quarter Ending
Beginning balance
3,023
3,025
2,953
3,431
Deduct: Payments
(1,255
(1,340
(3,577
(4,158
Add: Provision
1,333
1,343
3,725
3,755
Ending balance
3,101
3,028
6
6. BUSINESS SEGMENTS The Company operates two strategic businesses that are reportable segments: the Mechanical Group and the Electrical Group.
Mechanical Group
Electrical Group
ThirdQuarter
Nine Months
2004
2003
50,119
44,528
148,159
135,997
143,769
114,503
386,465
331,003
Income from Operations
5,021
3,636
11,655
10,191
10,570
8,360
30,554
25,652
Income from Operations as a% of Net Sales
10.0
8.2
7.9
7.5
7.4
7.3
7.7
Goodwill at end of period
530
339,682
312,735
As consistent with December 31, 2003 and 2002, acquired intangibles with finite lives were not material and the Company has no intangibles with indefinite lives, subject to the completion of the valuation for the recently acquired business described in Note 12.
7. STOCK-BASED COMPENSATION The Company accounts for the 2003 Equity Incentive Plan and the 1998 Stock Option Plan under APB Opinion No. 25 and has no material stock option plans that require variable accounting. Had compensation cost for these plans been determined consistent with FASB Statement No. 123 “Accounting for Stock-Based Compensation”, the Company’s net income and earnings per share would have been reduced to the following pro-forma amounts:
Third Quarter
Net Income:
As Reported
Pro-Forma
8,727
6,392
22,897
18,673
Earnings Per Share – Basic:
.93
.75
Earnings Per Share – Assuming Dilution:
.35
.25
.92
.74
7
8. PENSION PLANS The Company accounts for its defined benefit pension plans under the provisions of Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions”. The Company’s net periodic pension cost is comprised of the following components:
Service cost
366
347
1,097
1,041
Interest cost
902
837
2,706
2,511
Expected return on plan assets
(1,073
(1,179
(3,220
(3,537
Amortization of prior service cost
25
16
75
48
Amortization of net loss
240
26
720
79
Net periodic benefit cost
460
47
1,378
142
In the third quarter of 2004, the Company contributed $682,000 to defined benefit pension plans and has contributed $1.0 million in the first 9 months of 2004. In the first 9 months of 2003, the Company contributed $13,000 to defined benefit pension plans. The Company does not expect to make any further contributions in 2004. 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 2003 Annual Report on Form 10-K.
9. EARNINGS PER SHARE (EPS) The numerator for the calculation of basic and diluted earnings per share is net income. The denominator is computed as follows (in thousands):
Denominator for basic EPS – weighted average shares
24,456
25,032
24,648
25,029
Employee stock options (treasury stock method)
269
253
245
210
Denominator for diluted EPS
24,725
25,285
24,893
25,239
10. CONVERTIBLE SENIOR SUBORDINATED DEBT On April 5, 2004, the Company closed a convertible senior subordinated debt offering totaling $115 million. The notes, which are unsecured and due in 2024, bear interest at a fixed rate of 2.75% for five years, and may increase thereafter at .25% of the average trading price of a Note if certain conditions are met after five years. The Company may not call the Notes for five years, and the Note holders may only put the Notes back to the Company at approximately the 5th, 10th and 15th year anniversaries of the issuance of the Notes. After deducting fees and expenses of $3.8 million, the net proceeds recorded by the Company totaled $111.2 million. These net proceeds were used to repurchase 614,200 shares common stock totaling $12.5 million and to repay $99.3 million of long-term debt.
In October 2004, the Emerging Issues Task Force of the Financial Accounting Standards Board adopted EITF Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share” effective for fiscal periods ending after December 15, 2004. On October 28, 2004, the Company’s Board of Directors adopted a resolution directing Management to promptly change the convertible bond indenture to require that, upon conversion request, only cash be paid for the value of a bond up to the conversion stock price, removing the option the Company has had to either issue all stock, pay all cash, or a combination of both. The Company is currently in the process of changing its convertible bond indenture as consistent with the Board of Directors adopted resolution which the Company may do without the consent of the bondholders. According to EITF No. 04-8, the Company will then be required to follow the Treasury Stock method of accounting for earnings per share, which requires a company to show dilution of earnings per share only if its average stock price exceeds the stock conversion price, which is $25.56 for the Company’s outstanding convertible debt. Such dilution, if and when it would be required, would be for the calculated number of shares equivalent to the dollar value above the $25.56 conversion price.
11. CONTINGENCIES An action was filed on June 4, 2004 and amended in September 2004, against one of the Company’s subsidiaries, Marathon Electric Manufacturing Corporation (“Marathon”), by Enron Wind Energy Systems, LLC, Enron Wind Contructors, LLC and Zond Minnesota Construction Company, LLC (collectively, “Enron Wind”). The action was filed in the United States Bankruptcy Court for the Southern District of New York where each of the Enron Wind entities has consolidated its Chapter 11 bankruptcy petition as part of the Enron Corporation bankruptcy proceedings. In the action against Marathon, Enron Wind has asserted various claims relating to the alleged failures and/or degradations of performance of generators sold by Marathon to Enron Wind from 1997 to 1999. Enron Wind is seeking monetary damages, including consequential, incidental and punitive damages, and injunctive relief. The Company believes that this action is without merit and that it has meritorious defenses to the action. The Company intends to defend vigorously all of the asserted claims. The litigation is in an early discovery phase and it is difficult for the Company to predict the impact the litigation may ultimately have on the Company’s results of operations or financial condition, including the expenses the Company may incur to defend against the action. As of September 28, 2004, no amounts have been recorded in the Company’s financial statements related to this contingency.
In March 2004, the Company received notice from the U.S. Environmental Protection Agency (“U.S. EPA”) that it was identified as one of three potentially responsible parties regarding an environmental site in Illinois. The Company had previously reached a settlement in 1999 with the U.S. EPA regarding the same site. Management provided its expert’s assessment of this site to the U.S. EPA, which has not proceeded with any enforcement action. Based on the facts, the Company believes that there will be no further assessments related to this site. As of September 28, 2004, no amounts have been recorded in the Company’s financial statements related to this contingency.
12. ACQUISITIONSOn August 30, 2004, the Company acquired the GE Commercial AC motors (“CAC”) business which represented selected assets from the General Electric Company. The Company also assumed certain liabilities, including but not limited to accounts payable, certain accrued compensation and benefits and certain other accrued expenses. The purchase price paid for CAC was approximately $72.5 million in cash, subject to a working capital adjustment upon completion of and agreement on a final closing balance sheet. On a preliminary basis, approximately $43.5 million of the purchase price was allocated to the net assets acquired, and the remaining $29.0 million was recorded as goodwill, which includes values that may be reclassified to other tangible and intangible assets upon finalization of a valuation of the assets. CAC is a leading manufacturer and marketer of a full line of fractional and subfractional AC electric motors for pump, compressor, equipment and commercial HVAC applications, with expected annual sales on a normalized basis of approximately $137 million. Unaudited pro-forma results of operations for the Company for the first nine month periods of 2004 and 2003, as though CAC had been acquired as of January 1 of each of the two periods, are shown in the table below. These pro-forma amounts do not reflect any synergies, such as cost reductions or additional sales opportunities, or tax benefits that might be achieved in future years. (See also the Company’s 8K/A filed on October 12, 2004.)
Nine Months Ending September 28, 2004
Nine Months Ending September 30, 2003
Sales
633,075
575,678
25,698
21,583
Earnings per Share - Assuming Dilution
1.03
.86
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 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.
OVERVIEW The Company continued to see broad-based strength across its markets in the third quarter of 2004. Net sales in the third quarter increased 21.9% over comparable 2003 for a new quarterly record of $193.9 million. Results for the quarter include results from the acquisition of General Electric’s Commercial AC Motor (CAC) business which was completed by the Company on August 30, 2004. Excluding the results from the acquisition, sales increased 13.3% over the third quarter of 2003. Net income and earnings per share (“EPS”) in the third quarter increased to $8.9 million and $.36, improving 37.1% and 38.5%, respectively, from comparable 2003. A net gain on the sale of real estate, partially offset by the non-cash write down of certain other assets including real estate and equipment being marketed for sale, increased net income by $1.0 million. CAC had no material impact on the third quarter earnings. Higher raw material costs, particularly of copper, steel and aluminum, continued to depress our gross profit margin in 2004. Although substantial, the price increases we implemented during the first 9 months of 2004 only partially offset the 2004 raw material inflation, which accelerated in the third quarter. The Company plans to adjust pricing further in the fourth quarter of 2004. However, because of the timing of these price actions, the Company does not believe that the material inflation will be completely offset in 2004.
9
RESULTS OF OPERATIONS Net sales of the Company were $193.9 million in the third quarter of 2004. Excluding the results for the acquisition of the CAC business, sales were $180.2 million. For the nine months ended September 28, 2004, net sales were $534.6 million, a 14.5% increase from $467.0 million in comparable 2003. Excluding the results from the acquisition, year-to-date sales were $521.0 million. The Company continues to see the broad-based strength in its markets that began earlier this year. Sales for the quarter were strong in both reporting segments with increases of 12.7% and 25.6% (13.6% excluding the acquisition) for the Mechanical Group and Electrical Group, respectively. (See Note 6 to the accompanying financial statements for our business segment data.)
Gross profit increased 17.9% to $42.9 million in the third quarter of 2004 from $36.4 million in comparable 2003, and was $122.0 million for the first 9 months of 2004, 10.8% higher than the first 9 months of 2003. Our gross profit margins of 22.1% of net sales in the third quarter and 22.8% for the first 9 months of 2004, decreased from 22.9% and 23.6% in the comparable periods of 2003, respectively. Excluding the results from the acquisition, our gross margin would have been 23.1% and 23.2% for the quarter and nine months, respectively. The gross margin was impacted significantly by higher raw material costs for copper, steel and aluminum, which increased further during the quarter. Substantial price increases, which we implemented earlier in the year, only partially offset the accelerating material inflation that occurred during the quarter. The Company has announced price increases that will take effect in the fourth quarter, and in some cases, the first quarter of 2005. Because of the timing of the increases, the Company anticipates that the material inflation will not be completely offset in the fourth quarter.
Operating expenses of $27.4 million in the third quarter and $79.8 million in the first 9 months of 2004, were 11.9% and 7.5% above the comparable periods of 2003. Operating expenses grew due to normal salary increases, higher health insurance costs, and increased sales commissions, but at a rate of growth considerably below our sales growth rates. As a percentage of net sales, operating expenses decreased to 14.1% in the third quarter and 14.9% in the first 9 months of 2004 from 15.4% and 15.9% for the third quarter and nine months of 2003. Operating expenses were also impacted in the quarter by a gain on the sale of real estate located in the United Kingdom. This gain, which is reflected as a reduction of operating expense, was partially offset by the non-cash write down of certain other assets including real estate and equipment being marketed for sale, as previously discussed.
The combination of the net gain on the sale of real estate and the leveraging of our operating expenses resulted in our third quarter and first 9 months income from operations as a percentage of net sales (“operating margin”) being 8.0% and 7.9%, respectively, versus 7.5% and 7.7% from comparable 2003, despite the raw material cost increases that have reduced our gross profit margins in 2004. Income from operations increased 30.0% to $15.6 million in the third quarter of 2004 from $12.0 million in comparable 2003, while increasing 17.8% to $42.2 million from $35.8 million for the comparable first 9 months of each year.
Interest expense of $1.7 million in the third quarter and $4.6 million for the first 9 months reflected an increase of 6.8% versus the third quarter 2003 and a reduction of 7.1% versus the first 9 months of 2003. The acquisition of the CAC business increased the Company’s debt in the third quarter, however, lower interest rates paid by the Company in this year’s third quarter versus last year’s reduced the impact of the additional debt on interest expense. Our effective tax rate for the third quarter of 2004 was 31.9%. The rate was positively impacted by the United Kingdom real estate transaction, where, for tax purposes, the basis is adjusted using a published index resulting in a reduced tax liability. Excluding this impact, the tax rate would have been 35.3%. Minority interest in income, net of tax, which is our minority partners’ interest in net income of our two consolidated joint ventures in China, more than doubled to $562,000 in 2004’s third quarter and increased to $1.3 million for the first 9 months of 2004, demonstrating the continued strength of the demand for the Company’s joint venture products, particularly related to sales in Asia.
Our net income was $8.9 million in the third quarter of 2004 and $23.4 million for the first 9 months of 2004, increases of 37.1% and 22.8%, respectively, from net income of $6.5 million and $19.1 million in the comparable periods of 2003. Our earnings per share was $.36 for the third quarter and $.94 for the 9 months of 2004, as compared to $.26 and $.76 in the comparable periods last year.
10
LIQUIDITY AND CAPITAL RESOURCESOur working capital was $205.5 million at September 28, 2004, 13.9% higher than at June 29, 2004. Our current ratio decreased to 2.7:1 at the end of the third quarter from 3.0:1 at the end of the second quarter of 2004. Our cash balance at September 28, 2004 was $20.8 million versus $14.3 million at June 29, 2004.
Our cash flow from operations was $21.2 million in the third quarter of 2004, slightly above the $19.7 million in comparable 2003. For the first 9 months of 2004, our cash flow from operations was $37.5 million as compared to $40.0 million in 2003. The lower 2004 cash flow resulted primarily from additional working capital required by the increased sales volume of the Company. Capital spending was $3.5 million in the third quarter and was $10.2 million for the first 9 months of 2004. At September 28, 2004, we had $2.1 million of outstanding commitments for future capital expenditures. The acquisition of the CAC business, which was a cash transaction, was reflected as $71.8M cash used in investing activities. The cash required for the acquisition of the CAC business and for working capital needs resulted in our outstanding long-term debt increasing to $275.3 million at September 28, 2004 from $214.5 million at June 29, 2004.
On April 5, 2004, the Company closed a convertible senior subordinated debt offering totaling $115 million. The notes, which are unsecured and due in 2024, bear interest at a fixed rate of 2.75% for five years, and may increase thereafter at .25% of the average trading price of a Note if certain conditions are met after five years. The Company may not call the Notes for five years, and the Note holders may only put the Notes back to the Company at approximately the 5th, 10th and 15th year anniversaries of the issuance of the Notes. After deducting fees and expenses of $3.8 million, the net proceeds recorded by the Company totaled $111.2 million. These net proceeds were used to repurchase common stock totaling $12.5 million and to repay $99.3 million of long-term debt. With respect to the share repurchase, the Board of Directors approved in 2000 a repurchase program of up to 2,000,000 common shares of Company stock. Management was authorized to effect purchases from time to time in the open market or through privately negotiated transactions. Through December 31, 2003, the Company repurchased 159,900 shares at an average purchase price of $17.06 per share. Taking into account the current higher cost of the convertible subordinated debt in comparison to the variable rate debt from our bank credit facility, and the repurchase of 614,200 shares of the Company’s common stock on March 30, 2004, the impact on earnings per share in 2004 is projected to be neutral. (See Note 10 for further discussion regarding the impact of EITF 04-08.)
On May 5, 2004, the Company and certain of its lending banks amended and restated the existing $275 million Credit Agreement. The amended and restated revolving loan Credit Agreement (the “New Facility”) provides a borrowing limit of $225 million, is unsecured and terminates in May 2009. The New Facility, as did the original Facility, 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 earnings before interest, taxes, depreciation and amortization (“EBITDA”). These interest rates also vary as LIBOR varies. The Company also pays a commitment fee on the unused amount of the $225 million credit limit, which varies with the debt to EBITDA ratio. The New Facility includes various covenants regarding minimum net worth, permitted debt levels and minimum interest coverage. The Company was in compliance with all financial covenants as of September 28, 2004.
Under our New Facility, we had $156.0 million of debt outstanding at September 28, 2004. The increase versus the $95.2 million outstanding at the end of the second quarter is because of the cash purchase of the CAC business offset by the favorable cash flow for the quarter. Based on debt limitations created by a financial covenant of the New Facility, the Company had about $49 million of available borrowing capacity. We believe we will be able to satisfy the financial ratios and tests in the New Facility for the foreseeable future. We also believe that the combination of borrowing availability under the New Facility and our operating cash flow will provide sufficient cash availability to finance our existing operations for the foreseeable future.
CONTINGENCIES An action was filed on June 4, 2004 and amended in September 2004, against one of the Company’s subsidiaries, Marathon Electric Manufacturing Corporation (“Marathon”), by Enron Wind Energy Systems, LLC, Enron Wind Constructors, LLC and Zond Minnesota Construction Company, LLC (collectively, “Enron Wind”). The action was filed in the United States Bankruptcy Court for the Southern District of New York where each of the Enron Wind entities has consolidated its Chapter 11 bankruptcy petition as part of the Enron Corp. bankruptcy proceedings. In the action against Marathon, Enron Wind has asserted various claims relating to the alleged failures and/or degradations of performance of generators sold by Marathon to Enron Wind from 1997 to 1999. Enron Wind is seeking monetary damages, including consequential, incidental and punitive damages, and injunctive relief. The Company believes that this action is without merit and that it has meritorious defenses to the action. The Company intends to defend vigorously all of the asserted claims. The litigation is in an early discovery phase and it is difficult for the Company to predict the impact the litigation may ultimately have on the Company’s results of operations or financial condition, including the expenses the Company may incur to defend against the action. As of September 28, 2004, no amounts have been recorded in the Company’s financial statements related to this contingency.
CRITICAL ACCOUNTING POLICIES The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of our financial statements and the amounts of our revenues and expenses during the periods reported. Actual results may differ from these estimates under different assumptions or conditions. We believe the following are our critical accounting policies which could have the most significant effect on our reported results and require management’s most difficult, subjective or complex judgments.
Revenue Recognition Sales and related cost of sales are recognized upon shipment of products as this is when title and risk of ownership transfer to the customer. The pricing of our products is generally supported by customer purchase orders, and accounts receivable collection is reasonably assured at the time of shipment. Any discounts from our standard prices are recognized as a reduction of sales and the related customer receivable at the time of sale. Product returns are estimated and recorded at the time of shipment based upon historical experience. Estimated customer rebates are accrued and recognized as a reduction of sales in a systematic manner throughout the year.
Allowance for Doubtful Accounts We record allowances for doubtful accounts after customer-specific analysis and general analysis of past due balances, economic conditions and historical experience. Allowance levels change as customer-specific circumstances and the general analysis areas above change.
Excess and Obsolete Inventory Reserves Our systems track the frequency of usage of inventory by part number and reports are generated monthly. Based on these analyses of historical usage and management’s evaluation of future demand, market conditions and alternative uses for possible excess or obsolete parts, reserves are recorded and changed. Excess and obsolete inventory is periodically disposed of through sale to third parties, scrapping or other means, and the reserves appropriately reduced.
Impairment of Long-Lived Assets We review long-lived assets, which include property, plant and equipment, and other intangible assets with finite lives such as patents and trademarks, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset in our accounting records may not be fully recoverable. Additionally, we evaluate the recoverability of goodwill and other intangible assets with indefinite lives at least annually, independent of specific events. We assess these assets for impairment based on estimated future cash flows from these assets, which estimates require us to make assumptions about future demand for the Company’s products and services, future market conditions, future growth rates and the discount rate, among others. Changes to these assumptions could result in an impairment charge in future periods.
Product Warranty Reserves We maintain reserves for product warranty to cover the stated warranty periods for our products. We establish or change such reserves based on our evaluation of historical warranty experience and specific significant warranty matters when they become known and can reasonably be estimated.
Retirement Plans Approximately half of our employees are covered by defined benefit pension plans with the remaining employees covered by defined contribution plans. Our obligations under the defined benefit plans are determined with the assistance of actuarial firms. The actuaries make certain assumptions regarding such factors as withdrawal rates and mortality rates. The actuaries also provide us with information and recommendations from which management makes further assumptions on such factors as the long-term expected rate of return on plan assets, the discount rate on benefit obligations and where applicable, the rate of annual compensation increases. Based upon the assumptions made, the investments made by the plans, overall conditions and movement in financial markets, particularly the stock market, and how actual withdrawal rates, life-spans of benefit recipients and other factors differ from assumptions, annual expenses and recorded assets or liabilities of these defined benefit plans may change significantly from year to year.
Based on our annual review of actuarial assumptions as well as historical rates of return on plan assets and existing long-term bond rates, we set the long-term rate of return on plan assets at 8.75% and the discount rate at 6.25% for our defined benefit plans. Primarily as a result of the change in the discount rate, we expect pension expense to increase approximately $1.7 million in 2004 versus 2003.
Self-Insurance Liabilities Our insurance programs include health care, workers’ compensation and product liability. We self-insure from the first dollar of loss up to various specified retention levels per occurrence. Eligible losses in excess of self-insurance retention levels and up to stated liability limits are covered by policies we purchase from insurance companies, as are eligible losses when and if we purchase aggregate stop-loss policies. We estimate the annual costs and liabilities of our self-insurance programs using our Company’s claims experience and risk exposure levels for the periods being valued. Differences in actual costs of claims from estimated costs will likely result in adjustments to expenses and liabilities.
Litigation and Claims We record expenses and liabilities when we believe that an obligation of the Company on a specific matter is probable and we have a basis to reasonably estimate the value of the obligation. This methodology is used for environmental matters and legal claims that are filed against the Company from time to time. The uncertainty that is associated with such matters frequently requires adjustments to the liabilities previously recorded.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risk relating to the Company’s operations due to changes in interest rates, foreign currency exchange rates and commodity prices of purchased raw materials. The company manages the exposure to these risks through a combination of normal operating and financing activities and derivative financial instruments such as commodity cash flow hedges and foreign currency forward exchange contracts.
The Company is exposed to interest rate risk on certain of its short-term and long-term debt obligations used to finance its operations and acquisitions. At September 28, 2004, the Company had $115.9 million of fixed rate debt and $159.7 million of variable rate debt, the latter subject to interest rate risk. Ninety-eight percent of the variable rate debt is under a credit facility with an interest rate based on a margin above LIBOR. As a result, interest rate changes impact future earnings and cash flow assuming other factors are constant. A hypothetical 10% change in the Company’s weighted average borrowing rate on outstanding variable rate debt at September 28, 2004, would result in a change in after-tax annualized earnings of approximately $460,000.
The Company periodically enters into hedging transactions, primarily through commodity futures, to reduce the impact of changing copper and aluminum commodity prices. While the Company is also a large purchaser of steel, currently there is no mechanism for hedging steel purchases. Contract terms of commodity hedge instruments generally mirror those of the hedged item, providing a high degree of risk reduction and correlation.
All commodity futures hedges are recorded on the balance sheet at fair value. If the hedge is a cash flow hedge, as are all the Company’s current hedges, changes in fair value are recorded in accumulated other comprehensive income (loss) (“AOCI”) in each accounting period. An ineffective portion of the hedge’s change in fair value, if any, is recorded in earnings in the period of change. In the third quarter and first 9 months of 2004, the Company recorded $220,000 and $230,000, respectively, in AOCI. At September 28, 2004 the Company had a balance of $629,000 in other current assets and a corresponding net after tax gain of $390,000 in AOCI, representing the fair value of cash flow commodity hedges. There were no commodity hedges prior to the fourth quarter of 2003.
The Company had no foreign currency forward exchange contracts at September 28, 2004.
Item 4. Controls and Procedures
a. Disclosure Controls and Procedures. The Corporation’s management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Corporation in the reports that it files or submits under the Exchange Act.
b. Internal Control Over Financial Reporting. There have not been any changes in the Corporation’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit Number
Exhibit Description
2.1
Purchase Agreement dated as of August 10, 2004, between REGAL-BELOIT Corporation and General Electric Company. [Incorporated by reference to Exhibit 2.1 to REGAL-BELOIT Corporation’s current report on Form 8-K filed on September 3, 2004.]
2.2
Amended Purchase Agreement dated as of August 30, 2004, between REGAL-BELOIT Corporation and General Electric Company. [Incorporated by reference to Exhibit 2.2 to REGAL-BELOIT Corporation’s current report on Form 8-K filed on September 3, 2004.]
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32
Section 1350 Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K
1) On July 21, 2004, the Company filed a current report on Form 8-K containing the Company’s second quarter 2004 earnings news release.
2) On August 12, 2004, the Company filed a current report on Form 8-K containing the Company’s news release announcing the signing of a definitive agreement to acquire GE’s Commercial AC motor business.
3) On August 31, 2004, the Company filed a current report on Form 8-K containing the Company’s news release announcing the completion of the Company’s acquisition, on August 30, 2004, of GE’s Commercial AC motor business.
4) On September 3, 2004, the Company filed a current report on Form 8-K containing the Item 2.01 description of the August 30, 2004 acquisition and Item 9.01 information regarding financial statements, pro-forma financial information and exhibits.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
/S/ DAVID A. BARTA
David A. Barta Vice President - Chief Financial Officer (Principal Accounting and Financial Officer)
DATE: November 8, 2004