Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
On April 30, 2007, the Company amended its revolving credit facility (“Facility”). The committed amount of the Facility increased from $475.0 million to $500.0 million. The conditional commitment, subject to certain approvals and covenants, increased from $75.0 million to $200.0 million. The Facility permits the Company to borrow at interest rates (5.5% at September 29, 2007) based upon a margin above LIBOR, which margin varies with the ratio of total funded debt to EBITDA . These interest rates also vary as LIBOR varies. We pay a commitment fee on the unused amount of the Facility, which also varies with the ratio of our total debt to our EBITDA as defined in the Facility.
The Notes and the Facility require us to meet specified financial ratios and to satisfy certain financial condition tests. We were in compliance with all debt covenants as of September 29, 2007.
The estimated net actuarial loss and prior service cost for defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost during the 2007 fiscal year is $1.0 million and $0.1 million, respectively.
In the third quarter of 2007, the Company contributed $2.6 million to defined benefit pension plans. Contributions to defined benefit pension plans for the nine months ended September 29, 2007 and September 30, 2006 were $2.8 million and $2.6 million, respectively. The Company expects to contribute an additional $0.2 million, for total contributions of $3.0 million in 2007. The Company contributed a total of $3.0 million in 2006. 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 Annual Report on Form 10-K filed on February 28, 2007.
The Company recognized approximately $0.9 million and $0.8 million in share-based compensation expense during the third quarter of 2007 and 2006, respectively. Share-based compensation expense for the nine months ended September 29, 2007 and September 30, 2006 was $2.8 million and $2.7 million, respectively. The total income tax benefit recognized relating to share-based compensation for the nine months ended September 29, 2007 and September 30, 2006 was approximately $6.7 and $2.0 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 recipient. As of September 29, 2007, total unrecognized compensation cost related to share-based compensation awards was approximately $10.2 million, net of estimated forfeitures, which the Company expects to recognize over a weighted average period of approximately 2.8 years.
On April 20, 2007, shareholders approved the 2007 Regal Beloit Corporation 2007 Equity Incentive Plan (“2007 Plan”), which authorized an additional 2.5 million shares for issuance under the 2007 Plan. Under the 2007 Plan and the Company’s 2003 and 1998 stock plans, the Company was authorized as of September 29, 2007 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 2.8 million shares were available for future grant or payment under the various plans at September 29, 2007.
On April 20, 2007, the Company’s shareholders approved an amendment to the Company’s Articles of Incorporation that increased the number of shares of common stock that the Company is authorized to issue from 50 million shares to 100 million shares. Each authorized share is accompanied by one Common Stock Purchase Right as described in our Annual Report on Form 10-K filed on February 28, 2007.
The Company uses several forms of share-based incentive awards, including non-qualified stock options, incentive stock options and stock appreciation rights (SAR’s). 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 majority of the Company’s annual option and SAR 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, 2007 annual grant was $16.68. The fair value of the awards is estimated on the date of the grant using the Black-Scholes pricing model and the following assumptions: risk-free interest rate of 4.7%, expected dividend yield of 1.2%, expected volatility of 32.0% and an estimated life of 7 years.
A summary of share-based awards (options and SAR’s) as of September 29, 2007 is as follows:
The Company also granted a total of 31,500 restricted stock awards to certain employees during the nine-months ended September 29, 2007. Restrictions generally lapse three years after the date of grant. The Company values restricted stock awards at the closing market value of its common stock on the date of grant.
As of the adoption date at the beginning of the fiscal year, the Company had approximately $6.9 million of unrecognized tax benefits, $3.3 million of which would affect its effective tax rate if recognized. As of September 29, 2007, the Company had approximately $7.6 million of unrecognized tax benefits, $4.0 million 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 2003 through 2006 and various state tax returns from 2001 through 2006 remain subject to income tax examinations by tax authorities. The Company estimates that the unrecognized tax benefits will not change significantly within the next year.
An action (the “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 Contractors, 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 (the “Court”) 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, Enron Wind has asserted various claims relating to the alleged failures and/or degradations of performance of about 564 generators sold by Marathon to Enron Wind from 1997 to 1999.
In the Action, Enron Wind was seeking to recover the purchase price of the generators and transportation costs totaling about $21 million and consequential, incidental and punitive damages incurred by it and by its customers totaling an additional $100 million.
On July 30, 2007, Marathon entered into a settlement agreement with Enron Wind to resolve all matters alleged by Enron Wind in the Action, subject to approval by the Court. On September 21, 2007, the Court approved the settlement agreement. Under the terms of the settlement agreement, Enron Wind has fully released and discharged Marathon from all claims relating to the Action and, in exchange, Enron Wind received a monetary payment. After contributions from other involved parties, the after-tax impact of Marathon’s portion of the payment under the settlement agreement is approximately $1.15 million.
On April 26, 2007, the Company received notice that the U.S. Environmental Protection Agency (“U.S. EPA”) has filed an action against the Company in the United States District Court for the Northern District of Illinois seeking reimbursement of the U.S. EPA’s unreimbursed past and future remediation costs incurred in cleaning up an environmental site located near a former manufacturing facility of the Company in Illinois. In 1999, the Company and other parties identified as potentially responsible parties (“PRPs”) reached an agreement with the U.S. EPA to partially fund the costs of certain response actions taken with respect to this site. In 2004, the Company received communications from the U.S. EPA indicating that the Company was identified as one of three PRPs regarding additional remedial actions to be taken by the U.S. EPA at this site. In response, the Company provided to the U.S. EPA its environmental expert’s assessment of the site in 2004. The Company believes that it is not a PRP with respect to the site in question and intends to defend vigorously the associated claim. As of September 29, 2007 amounts that have been recorded in the Company’s financial statements related to this contingency are immaterial.
The Company is, from time to time, party to other lawsuits arising from its normal business operations. It is believed that the outcome of these lawsuits will have no material effect on the Company’s financial position or its results of operations.
15. DERIVATIVE INSTRUMENTS
The Company periodically enters into commodity futures and options hedging transactions to reduce the impact of changing prices for certain commodities, such as copper and aluminum, based upon certain firm commitments to purchase such commodities. These transactions are designated as cash flow hedges and the contract terms of commodity hedge instruments generally mirror those of the hedged item, providing a high degree of risk reduction and correlation. Derivative commodity assets of $7.4 million and $1.7 million are recorded in current assets as of September 29, 2007 and December 30, 2006, respectively. The unrealized gain on the effective portion of the contracts of $4.5 million net of tax and $1.0 million net of tax, as of September 29, 2007 and December 30, 2006, was recorded in accumulated other comprehensive income (“AOCI”).
The Company uses a cash flow hedging strategy to protect against an increase in the cost of forecasted foreign currency denominated transactions. As of September 29, 2007, derivative currency assets of $2.7 million and $0.6 million are recorded in other current assets and other non-current assets, respectively. At December 30, 2006, derivative currency assets of $2.2 million and $1.0 million were recorded in other current assets and other non-current assets, respectively. The unrealized gain on the effective portion of the contracts of $2.0 million net of tax as of September 29, 2007 and December 30, 2006, was recorded in AOCI.
The Company has LIBOR-based floating rate borrowings, which expose the Company to variability in interest payments due to changes in interest rates. During the third quarter of 2007, the Company entered into pay fixed/receive LIBOR-based floating interest rate swaps to manage fluctuations in cash flows resulting from interest rate risk. These interest rate swaps have been designated as cash flow hedges against forecasted LIBOR-based interest payments. As of September 29, 2007, an interest rate swap liability of $5.8 million was included in other non-current liabilities. The unrealized loss on the effective portion of the contracts of $3.7 million net of tax as of September 29, 2007 was recorded in AOCI.
The net AOCI balance of $2.8 million at September 29, 2007 is comprised of $6.0 million of current deferred gains expected to be realized in the next year, and $3.2 of non-current deferred losses. The impact of hedge ineffectiveness was immaterial for all periods included in this report.
16. SUBSEQUENT EVENTS
On October 12, 2007 the Company acquired Morrill Motors. The acquired business is a leading designer and manufacturer of fractional horsepower motors and components for the commercial refrigeration and freezer markets. Included in the motor offering are technology based-variable speed products. The business will be reported as part of the Company’s Electrical Segment. The purchase price was paid in cash, subject to final working capital and other customary post close adjustments.
On November 2, 2007 the Company announced the acquisition of Alstom’s motors and fans business in India. The business is located in Kolkata, India and manufactures and markets a full range of low and medium voltage industrial motors and fans for the industrial and process markets in India. Alstom is noted for high quality process duty motors with a full range from 1 to 3500 hp. The business will be reported as part of the Company’s Electrical Segment. The purchase price was paid in cash.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
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
Excluding HVAC, the end markets for the Company’s products continued to show strength during the third quarter of 2007. Net sales increased 7.2% to $449.4 million from $419.3 million in the third quarter of 2006. Third quarter 2007 sales included $28.3 million of sales related to the acquired Fasco and Jakel businesses.
Net income increased 5.0% to $31.2 million in the third quarter of 2007 as compared to $29.7 million in the comparable period last year. Diluted earnings per share increased 3.4% to $0.92 in the third quarter of 2007 as compared to $0.89 for the comparable period of 2006.
RESULTS OF OPERATIONS
Third Quarter 2007 versus Third Quarter 2006
Sales for the quarter were $449.4 million, a 7.2% increase over the $419.3 million reported for the third quarter of 2006. Third quarter 2007 sales included $28.3 million of sales related to the acquired Fasco and Jakel businesses.
In the Electrical Segment, sales increased 7.7%. The soft housing market and a comparison to a strong 2006 that was favorably impacted by the SEER 13 legislation impacted sales in the HVAC business, which decreased 16.8%. The sales for the remainder of the motor businesses increased 8.9%. Sales for the power generation businesses increased 33.6%. Sales in the Mechanical Segment for the quarter ended September 29, 2007 were 3.5% above the equivalent period of 2006.
Gross margin for the quarter was 23.7%, compared to 24.6% in the third quarter of 2006. Material costs, including copper and aluminum, continued to increase and had a significant impact on our gross margins during the quarter. These costs were partially offset by new products, productivity, pricing actions and positive product mix resulting in a net 0.9% decrease in gross margin.
Operating expenses were $53.3 million (11.9% of sales) in the third quarter of 2007 versus $50.0 million (11.9% of sales) in third quarter of 2006. Third quarter 2007 operating expenses included a $1.8 million expense to settle the Company’s litigation with Enron Wind. Income from operations was $53.4 million versus $53.0 million in the third quarter of 2006. As a percent of sales, income from operations was 11.9% in the third quarter of 2007 versus 12.7% for the third quarter of 2006. This decrease reflected increased raw material costs partially offset by contributions from new products, pricing actions, productivity, and the leveraging of fixed costs.
Net interest expense was $4.8 million versus $4.9 million in the third quarter of 2006. The decrease reflected lower levels of average debt outstanding, which was partially offset by higher interest rates.
The tax rate for the quarter was 34.2% versus 36.6% in the prior year period. The tax rate was impacted by the distribution of income, which was weighted more to lower tax rate countries than during the comparable period of 2006.
Net income for the third quarter of 2007 was $31.2 million, an increase of 5.0% versus the $29.7 million reported in same period of 2006. Fully diluted earnings per share was $0.92 as compared to $0.89 per share reported in the third quarter of 2006. The average number of diluted shares was 34,104,123 during the third quarter of 2007 as compared to 33,440,015 during the comparable period last year.
Nine Months Ended September 29, 2007 versus Nine Months Ended September 30, 2006
Sales for the nine months ended September 29, 2007 were $1,327.8 million, which is a 6.0% increase over the $1,252.9 million reported for the comparable period of 2006. The Fasco and Jakel businesses that were acquired on August 31, 2007 added $28.3 million to sales for the nine months ended September 29, 2007 versus the prior year comparable period. The sale of substantially all of the assets of the Company’s cutting tool business (completed May 2006) reduced 2007 sales by approximately $7.1 million. The Sinya motor business reported sales of $60.3 million for the nine months ending September 29, 2007, as compared to $21.9 million from the acquisition date of May 1, 2006 through September 30, 2006.
Excluding our HVAC business, we saw strong demand for our products throughout the first nine months of 2007, driven by strong end market activity. Electrical Segment sales increased 6.7% as compared to the first nine months of 2006. Sales for this segment showed strength in all product lines except HVAC, which has been affected by a soft housing market in 2007 and comparisons with a strong 2006 that was favorably impacted by the SEER 13 legislation. The Fasco and Jakel businesses that were acquired on August 31, 2007 added $28.3 million to Electrical Segment sales for the nine months ended September 29, 2007 versus the prior year comparable period. Mechanical Segment sales for the first nine months of 2007 were comparable to sales for the first nine months of the prior year; however sales for the nine months ended September 30, 2006 included $7.1 million of sales related to the Company’s cutting tools business. Substantially all of the assets of the Company’s cutting tools business were sold in May, 2006.
Gross margin for the nine months ended September 29, 2007 was 23.2%, which is 0.8% points lower than the comparable period of 2006. Material costs had a significant impact on the first nine months of 2007, partially offset by the contribution from new products, productivity efforts, pricing actions and positive product mix across our entire business. The raw material cost increases resulted primarily from increases in the costs of copper and aluminum.
Operating expenses were $147.1 million (11.1% of sales) versus $145.8 million (11.6% of sales) in the comparable period of 2006. Third quarter 2007 operating expenses included a $1.8 million expense to settle the Company’s litigation with Enron Wind. Included in operating expenses in the first nine months of 2006 was a $1.6 million gain resulting from the sale of real property in the Mechanical Segment. Operating expenses for the first nine months of 2006 also included $2.0 million of incremental expense related to the Regal Beloit Supplemental Executive Retirement Plan resulting from a change in assumptions associated with retirement benefits for certain key executives. Income from operations was $160.8 million versus $154.5 million in the comparable period of 2006, an increase of 4.1%. As a percent of sales, income from operations was 12.1% for the nine months ended September 29, 2007 versus 12.3% in the prior year.
Net interest expense was $13.9 million versus $14.9 million in the comparable period of 2006. This decrease was driven by an average lower level of debt outstanding, partially offset by an increase in interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital was $385.7 million at September 29, 2007, a 21.8% increase from $316.6 million at year-end 2006. The $69.1 million increase was driven by a $47.7 million working capital increase from the Fasco and Jakel acquisitions. The ratio of our current assets to our current liabilities (“current ratio”) was 2.2:1 at September 29, 2007 and December 30, 2006.
Net cash provided by operating activities was $168.3 million for the nine months ended September 29, 2007 as compared to $52.8 million in the comparable period of 2006. Net cash used in investing activities was $276.9 million in the first nine months of 2007 as compared to the $38.9 million used in the prior year. The increase was driven by the acquisitions of Fasco and Jakel in the third quarter of 2007. Additions to property, plant and equipment were $23.8 million in the first nine months of 2007, which was $13.9 million less than the comparable period of 2006. Our cash provided by financing activities was $126.1 million during the first nine months of 2007 versus $6.4 million used in the comparable period of 2006. The increase in cash provided by financing activities is driven by a $250.0 million increase in by long-term debt during the nine months ended September 29, 2007 as compared to the first nine months of 2006. Offsetting this increase was an additional $124.3 million of commercial paper and revolving credit facility that were repaid during the nine months ended September 29, 2007 as compared to the comparable period of 2006.
Our outstanding long-term debt increased from $323.9 million at December 30, 2006 to $497.3 million at September 29, 2007. Of our total long-term debt, $121.0 million was outstanding under our $500.0 million unsecured revolving credit facility that expires on April 30, 2012 (the “Facility”). The Facility permits the Company to borrow at interest rates based upon a margin above the London Inter-Bank Offered Rate (“LIBOR”), which margin varies with the ratio of total funded debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”) as defined in the Facility. These interest rates also vary as LIBOR varies. We pay a commitment fee on the unused amount of the Facility, which also varies with the ratio of our total debt to our EBITDA.
During the third quarter of 2007, in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended, the Company issued and sold $250.0 million of senior notes (the “Notes”). 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 LIBOR, which margin varies with the ratio of the Company’s consolidated debt to consolidated 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.
The Notes and the Facility require us to meet specified financial ratios and to satisfy certain financial condition tests. We were in compliance with all debt covenants as of September 29, 2007.
In addition to the Facility and the Notes, at September 29, 2007, we also had $115.0 million of convertible senior subordinated debt outstanding at a fixed interest rate of 2.75%, and $19.8 million of other debt. At September 29, 2007, our borrowing availability under the Facility was $373.3 million based on the Facility’s credit limit.
As of September 29, 2007, a foreign subsidiary of the Company had outstanding $8.2 million denominated in U.S. dollars. The borrowings were made under a $15.0 million unsecured credit facility which expires in December 2008. The notes are all short term and bear interest at a margin over LIBOR.
CRITICAL ACCOUNTING POLICIES
We recognized revenue when all of the following have occurred: an agreement of sale exists; pricing is determinable; collection is reasonably assured; and product has been delivered and acceptance has occurred according to contract terms.
We use contracts and customer purchase orders to determine the existence of an agreement of sale. We use shipping documents and customer acceptance, when applicable, to verify delivery. We assess whether the sale price is subject to refund or adjustment, and we assess collectibility based on the creditworthiness of the customer as well as the customer’s payment history.
Returns, Rebates and Incentives
Our primary incentive program provides distributors with cash rebates or account credits based on agreed amounts that vary depending on the end user or original equipment manufacturing (OEM) customer to whom our distributor ultimately sells the product. We also offer various other incentive programs that provide distributors and direct sale customers with cash rebates, account credits or additional products and services based on meeting specified program criteria. Certain distributors are offered a right to return product, subject to contractual limitations.
We record accruals for customer returns, rebates and incentives at the time of revenue recognition based primarily on historical experience. Adjustments to the accrual may be required if actual returns, rebates and incentives differ from historical experience or if there are changes to other assumptions used to estimate the accrual.
Impairment of Long-Lived Assets or Goodwill and Other Intangibles
We evaluate the recoverability of the carrying amount of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable through future cash flows. We evaluate the recoverability of goodwill and other intangible assets with indefinite useful lives annually or more frequently if events or circumstances indicate that an asset might be impaired. We use judgment when applying the impairment rules to determine when an impairment is necessary. Factors that could trigger an impairment review include significant underperformance relative to historical or forecasted operating results, a significant decrease in the market value of an asset or significant negative industry or economic trends. We perform our annual impairment test in accordance with SFAS 142, “Goodwill and Other Intangible Assets.”
Approximately half of our domestic employees are covered by defined benefit pension plans with the remaining employees covered by defined contribution plans. Most of our foreign employees are covered by government sponsored plans in the countries in which they are employed. Our obligations under our domestic defined benefit plans are determined with the assistance of actuarial firms. The actuaries provide us with information and recommendations 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 8.5% and an average discount rate at 5.9% for our defined benefit plans as of December 30, 2006.
We operate in numerous taxing jurisdictions and are subject to regular examinations by various U.S. Federal, state, and foreign jurisdictions for various tax periods. Our income tax positions are based on research and interpretations of the income tax laws and rulings in each of the jurisdictions in which we do business. Due to the subjectivity of interpretations of laws and rulings in each jurisdiction, the differences and interplay in tax laws between those jurisdictions as well as the inherent uncertainty in estimating the final resolution of complex tax audit matters, our estimates of income tax liabilities may differ from actual payments or assessments.
Use of Estimates and Assumptions
The preparation of our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires the use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
New Accounting Pronouncements
In February 2007, Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (SFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items generally on an instrument-by-instrument basis at fair value that are not currently required to be measured at fair value. SFAS 159 is intended to provide entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for the Company on January 1, 2008, although early adoption is permitted. If the Company elects to adopt SFAS 159 early, it would need to concurrently early adopt the provisions of Statement of Financial Accounting Standard No. 157, Fair Value Measurements (“SFAS 157”), which is described below. The Corporation is evaluating the provisions of SFAS 159.
In September 2006, the FASB issued SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS 158”). SFAS 158 requires that companies prospectively recognize through Accumulated Other Comprehensive Income the over funded or under funded status of their defined benefit plans as an asset or liability in their balance sheets. The Company adopted SFAS 158 as of December 30, 2006.
In September 2006, the FASB issued SFAS 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 will be effective beginning in fiscal 2008. We are evaluating the new standard to determine the effect on our financial statements and related disclosures.
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted FIN 48 in the first quarter of 2007. See Note 12 to the condensed consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are 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. We manage the exposure to these risks through a combination of normal operating and financing activities and derivative financial instruments such as interest rate swaps, 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 our operations and acquisitions. At September 29, 2007, we had $123.8 million of fixed rate debt and $382.0 million of variable rate debt, the latter subject to interest rate risk. As a result, interest rate changes impact future earnings and cash flow assuming other factors are constant. The Company utilizes interest rate swaps to manage fluctuations in cash flows resulting from exposure to interest rate risk on forecasted variable rate interest payments. Details regarding the instruments, as of September 29, 2007, are as follows:
Instrument | Notional Amount | Maturity | | Rate Paid | | | Rate Received | Fair Value Gain (Loss) |
| Swap | $150.0 million | August 23, 2014 | | | 5.3 | % | | LIBOR (3 month) | $(3.2) million |
| Swap | $100.0 million | August 23, 2017 | | | 5.4 | % | | LIBOR (3 month) | $(2.6) million |
A hypothetical 10% change in our weighted average borrowing rate on outstanding variable rate debt at September 29, 2007, would result in a change in after-tax annualized earnings of approximately $0.4 million.
The Company periodically enters into commodity futures and options hedging transactions to reduce the impact of changing prices for certain commodities, such as copper and aluminum. Contract terms of commodity hedge instruments generally mirror those of the hedged item, providing a high degree of risk reduction and correlation.
We are also exposed to foreign currency risks that arise from normal business operations. These risks include the translation of local currency balances of foreign subsidiaries, intercompany loans with foreign subsidiaries and transactions denominated in foreign currencies. Our objective is to minimize our exposure to these risks through a combination of normal operating activities and the utilization of foreign currency contracts to manage our exposure on the transactions denominated in currencies other than the applicable functional currency. Contracts are executed with creditworthy banks and are denominated in currencies of major industrial countries. It is our policy not to enter into derivative financial instruments for speculative purposes. We do not hedge our exposure to the translation of reported results of foreign subsidiaries from local currency to United States dollars.
All hedges are recorded on the balance sheet at fair value and are accounted for as cash flow hedges, with changes in fair value recorded in accumulated other comprehensive income (“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. The impact due to ineffectiveness was immaterial for all periods included in this report.
Derivative commodity assets of $7.4 million and $1.7 million are recorded in current assets as of September 29, 2007, and December 30, 2006, respectively. The unrealized gain on the effective portion of the contracts of $4.5 million net of tax and $1.0 million net of tax, as of September 29, 2007 and December 30, 2006, was recorded in accumulated other comprehensive income.
The Company uses a cash flow hedging strategy to protect against an increase in the cost of forecasted foreign currency denominated transactions. As of September 29, 2007, derivative currency assets of $2.7 million and $0.6 million are recorded in other current assets and other non-current assets, respectively. At December 30, 2006, derivative currency assets of $2.2 million and $1.0 million were recorded in other current assets and other non-current assets, respectively. The unrealized gain on the effective portion of the contracts of $2.0 million net of tax as of September 29, 2007, and December 30, 2006 was recorded in AOCI.
In the third quarter of 2007, the Company entered into pay fixed/receive LIBOR-based floating interest rate swaps to manage fluctuations in cash flows resulting from interest rate risk. As of September 29, 2007, a interest rate swap liability of $5.8 million was included in other non-current liabilities. The unrealized loss on the effective portion of the contracts of $3.7 million net of tax as of September 29, 2007 was recorded in AOCI.
The net AOCI balance of $2.8 million at September 29, 2007 is comprised of $6.0 million of current deferred gains expected to be realized in the next year, and $3.2 of non-current deferred losses. The impact of hedge ineffectiveness was immaterial for all periods included in this report.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’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 Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
Internal Control Over Financial Reporting. There were no changes in the Company’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 Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
Items 3 and 5 are inapplicable and have been omitted.
ITEM 1. LEGAL PROCEEDINGS
An action (the “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 Contractors, 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 (the “Court”) 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, Enron Wind has asserted various claims relating to the alleged failures and/or degradations of performance of about 564 generators sold by Marathon to Enron Wind from 1997 to 1999.
In the Action, Enron Wind was seeking to recover the purchase price of the generators and transportation costs totaling about $21 million and consequential, incidental and punitive damages incurred by it and by its customers totaling an additional $100 million.
On July 30, 2007, Marathon entered into a settlement agreement with Enron Wind to resolve all matters alleged by Enron Wind in the Action, subject to approval by the Court. On September 21, 2007, the Court approved the settlement agreement. Under the terms of the settlement agreement, Enron Wind has fully released and discharged Marathon from all claims relating to the Action and, in exchange, Enron Wind received a monetary payment. After contributions from other involved parties, the after-tax impact of Marathon’s portion of the payment under the settlement agreement is approximately $1.15 million.
On April 26, 2007, the Company received notice that the U.S. Environmental Protection Agency (“U.S. EPA”) has filed an action against the Company in the United States District Court for the Northern District of Illinois seeking reimbursement of the U.S. EPA’s unreimbursed past and future remediation costs incurred in cleaning up an environmental site located near a former manufacturing facility of the Company in Illinois. In 1999, the Company and other parties identified as potentially responsible parties (“PRPs”) reached an agreement with the U.S. EPA to partially fund the costs of certain response actions taken with respect to this site. In 2004, the Company received communications from the U.S. EPA indicating that the Company was identified as one of three PRPs regarding additional remedial actions to be taken by the U.S. EPA at this site. In response, the Company provided to the U.S. EPA its environmental expert’s assessment of the site in 2004. The Company believes that it is not a PRP with respect to the site in question and intends to defend vigorously the associated claim. As of September 29, 2007 amounts that have been recorded in the Company’s financial statements related to this contingency are immaterial.
The Company is, from time to time, party to other lawsuits arising from its normal business operations. It is believed that the outcome of these other lawsuits will have no material effect on the Company’s financial position or its results of operations.
The business and financial results of the Company are subject to numerous risks and uncertainties. The risks and uncertainties have not changed materially from those reported in the 2006 Annual Report on Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table contains detail related to the repurchase of common stock based on the date of trade during the quarter ended September 29, 2007.
2007 Fiscal Month | | Total Number of Shares Purchased | | | Average Price Paid per Share | | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | | Maximum Number of Shares that May Be Purchased Under the Plan or Programs | |
| July 1, 2007 to August 4, 2007 | | | - | | | $ | - | | | | - | | | | 1,225,900 | |
| | | | | | | | | | | | | | | | | |
| August 5, 2007 to September 1, 2007 | | | - | | | $ | - | | | | - | | | | 1,225,900 | |
| | | | | | | | | | | | | | | | | |
| September 2, 2007 to September 29, 2007 | | | - | | | $ | - | | | | - | | | | 1,225,900 | |
| | | | | | | | | | | | | | | | | |
| Total | | | - | | | | | | | | - | | | | | |
Under the Company’s equity incentive plans, participants may pay the exercise price or satisfy all or a portion of the federal, state and local withholding tax obligations arising in connection with plan awards by electing to (a) have the Company withhold shares of common stock otherwise issuable under the award, (b) tender back shares received in connection with such award or (c) deliver other previously owned shares of common stock, in each case having a value equal to the exercise price or the amount to be withheld. During the third quarter of 2007, there were no shares acquired.
| Exhibit Number | | Exhibit Description |
| | | |
| 4.1 | | Note Purchase Agreement, dated as of August 23, 2007, by and among Regal Beloit Corporation and Purchasers listed in Schedule A attached thereto. [Incorporated by reference to Exhibit 4.1 to Regal Beloit Corporation’s Current Report on Form 8-K filed on August 24, 2007] |
| | | |
| 4.2 | | Subsidiary Guaranty Agreement, dated as of August 23, 2007, from certain subsidiaries of Regal Beloit Corporation. [Incorporated by reference to Exhibit 4.2 to Regal Beloit Corporation’s Current Report on Form 8-K filed on August 24, 2007] |
| | | |
| 4.3 | | First Amendment, dated as of August 23, 2007, to the Second Amended and Restated Credit Agreement, dated as of April 30, 2007, by and among Regal Beloit Corporation, various financial institutions and Bank of America, N.A., as Administrative Agent. [Incorporated by reference to Exhibit 4.3 to Regal Beloit Corporation’s Current Report on Form 8-K filed on August 24, 2007] |
| | | |
| 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. |
| | | |
| 32.1 | | Certifications of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 |
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.
| | REGAL BELOIT CORPORATION (Registrant) | |
| | | | |
Date: November 6, 2007 | By: | /s/ David A. Barta | |
| | | David A. Barta | |
| | | Vice President and Chief Financial Officer (Principal Accounting and Financial Officer) | |
| | | | |
INDEX TO EXHIBITS
Exhibit Number | | Exhibit Description |
| | | |
| 2.1 | | Purchase Agreement, dated as of July 3, 2007, by and among Regal Beloit Corporation, Tecumseh Products Company, Fasco Industries, Inc. and Motores Fasco de Mexico, S. de R.L. de C.V. [Incorporated by reference to Exhibit 2.1 to Regal Beloit Corporation’s Current Report on Form 8-K filed on September 7, 2007] |
| | | |
| 4.1 | | Note Purchase Agreement, dated as of August 23, 2007, by and among Regal Beloit Corporation and Purchasers listed in Schedule A attached thereto. [Incorporated by reference to Exhibit 4.1 to Regal Beloit Corporation’s Current Report on Form 8-K filed on August 24, 2007] |
| | | |
| 4.2 | | Subsidiary Guaranty Agreement, dated as of August 23, 2007, from certain subsidiaries of Regal Beloit Corporation. [Incorporated by reference to Exhibit 4.2 to Regal Beloit Corporation’s Current Report on Form 8-K filed on August 24, 2007] |
| | | |
| 4.3 | | First Amendment, dated as of August 23, 2007, to the Second Amended and Restated Credit Agreement, dated as of April 30, 2007, by and among Regal Beloit Corporation, various financial institutions and Bank of America, N.A., as Administrative Agent. [Incorporated by reference to Exhibit 4.3 to Regal Beloit Corporation’s Current Report on Form 8-K filed on August 24, 2007] |
| | | |
| 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. |
| | | |
| 32.1 | | Certifications of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350. |
