Regal Rexnord Corp (RRX) 2006 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the second-quarter 2006 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Dave Barta, Vice President and Chief Financial Officer. Mr. Barta, you may begin.

Thank you, Therese, and good afternoon, everyone, and welcome to the Regal Beloit second-quarter earnings conference call. Joining me today are Henry Knueppel, Chairman and CEO; Mark Gliebe, President and COO.

Before turning the call over to Henry for some opening remarks, I'd like to remind you that the statements made in this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of those factors that could cause actual results to differ materially from those projected results, please refer to today's earnings release and our filings with the SEC. Now I'll turn the call over to Henry for opening comments.

Thank you, Dave, and thanks all of you for joining us on the call. We certainly appreciate your interest in Regal Beloit. The objective for the call is I'm going to make a few overview comments. Dave Barta, our CFO, will then cover the financial aspects of the quarter. Mark Gliebe, our President and Chief Operating Officer will cover some of the operating highlights and give you some color on the markets and materials. And then finally I'll finish up with some discussion on our key initiatives and our view for the third quarter.

With that, let me just say that simply put, it was a great, great quarter. Record sales and record profits. Sales driven by continued strong commercial and industrial markets. Extremely strong power generation sales globally with the unusual exception of China, slightly down unit volume in residential HVAC market more than offset by the [SER] 13 mix and some share gains and the strong commercial HVAC sales market.

Operating profit, which again was a record, was driven by a strong volume and mix, very strong productivity gains, still considerably restrained by materials and energy costs. Contributions came from every segment of our business. And finally it was a great quarter of progress on strategic initiatives. With that, I'm going to turn it over to Dave Barta.

Thank you, Henry. As Henry mentioned, it was record sales for the quarter. Sales were 435.3 million, which is an 18% increase over the second quarter of 2005. And this performance again was driven with strong results in our electrical segment, where sales increased over 20% and sales in this segment showed strength in almost all the product lines, including commercial, industrial, HVAC and generators. The Sinya business that we purchased in May of this quarter reported sales of 10.2 million, so those are included in those results. And we did begin to see the impact of the transition away from the GE supply agreement that we've talked about since the acquisition of the GE businesses and that reduced our sales by a little over $1 million during the quarter. So adjusting for these factors, sales on an organic basis increased 17.6%.

The sales in the mechanical business increased 2.9% on a reported basis and the results in this segment were obviously impacted by the sales of Illinois gear business that we sold in May of 2005 and the sale of the cutting tool business that we sold during this quarter. Combined impact of these two divestitures were a reduction of sales about $4 million. So excluding this impact, sales increased over 11%. Sales were positive in all divisions across the this segment with the exception of the Richmond gear and all the drive business, which continue to be impacted by high gasoline prices and the impact that has on the high-performance auto and marine end markets. Again, we saw continued strength in our later cycle businesses that are part of this segment.

Gross margins for the quarter were 23.9% as compared to 21.6 in the prior year. As Henry pointed out, material costs, particularly copper and aluminum continued to have a significant impact on margins for the quarter. However, the impact of our new products, our productivity, pricing, positive product mix across our entire business offset those pressures.

Also included in cost of sales for the quarter was $1.4 million of costs related to restructuring activities in our electrical segment.

Operating expenses were 10.6% of sales versus 11.9 in the second quarter of 2005. Included in operating expenses was about $900,000 related to expensing of equity compensation and that amount compares to about 200,000 in the prior year.

Also included as a reduction in operating expenses was a $1.6 million gain on the sale of some excess real estate and that occurred in our mechanical group.

Income from operations was 57.9 million versus 35.8 million in the second quarter of 2005, which was an increase of 61.6%. And on a percent of sales basis, income from operation improved to 13.3% versus 9.7% in the second quarter of 2005, with this increase reflective of the contributions that I've mentioned -- new products, productivity, volume and then the leveraging of SG&A costs.

The tax rate for the quarter was 35.9%. The rate was negatively impacted by our distribution of income, which was weighted to higher tax rate countries such as the United States, although we did have favorable results through some of the productivity projects.

Net income for the first quarter was 33.3 million, which is an 80.6% increase versus the second quarter of 2005 and that resulted in earnings per share of $0.99, which is compared to $0.62 reported in the second quarter of 2005. The average number of diluted shares was 33,644,909 as compared to 29 million 720.4 of last year, reflecting and this is the primary shares that we issued in the third quarter of 2005 and the added dilutive impact of the convertible.

Turning to a few balance sheet highlights, total debt was 393.2 million, which is a 27.1 million reduction from the first quarter and a reduction of 144 million from a year ago. That puts our debt to cap ratio at 35.8%. The decrease in debt was driven by the strong income performance, which was countered somewhat by an increase in working capital, again, largely as a result of accounts receivable that increased due to the strong volume and timing of payments from key customers. Gross CapEx for the quarter was 10.6 million and the proceeds from the sale of assets were 2.6 million from the sale of the real estate and we received 7.7 million from the sale of the cutting tool assets. Depreciation was 7.1 million for the quarter and amortization was 1.9 million for the quarter.

Turning to the outlook for the third quarter, as you noticed in this morning's press release, we did provide guidance of $0.78 to $0.84 per share for the third quarter. This guidance is driven by what we see as a continuing positive sales environment across the vast majority of our businesses, including continued strength in the HVAC business and continued year-over-year margin improvement. The tax rate used in arriving at this EPS guidance was 36%.

We currently expect capital spending in the range of 15 to 20 million in the third quarter and we've revised our projection for CapEx for the year up slightly to 55 million as a result of additional capacity related projects. And we have not included as a net to the CapEx the sale of any assets and we continue to have a couple more properties that are being marketed.

I will now turn the call over to Mark for additional comments on the business.

Thanks, Dave. During the second quarter, we again achieved broad-based top-line growth in almost every business unit. Revenue strength can be attributed to general economic conditions, mild share gains and the success of a number of our newer and premium products.

I would like to start off talking about the mechanical side of our business, where our revenues, as Dave mentioned were up 3% for the quarter, 12% when you consider continuing operations. And our operating profit was up 127%. Operating profits gains were driven by volume leverage as well as the restructuring we executed in 2005 and the sale of our cutting tool business this year. Our mechanical teams performed well in the quarter except that we were not totally satisfied with our progress in meeting our customers' demands in just a few of our businesses.

On the electrical side of our business, sales from our motor segments grew roughly 17% excluding acquisitions with strong sales in distribution, industrial machinery, and both commercial and residential HVAC. We saw double-digit sales growth in every motor brand. Additionally, our generator division sales were up 22% for the quarter with continued strong demand in oil and gas and international markets.

In our HVAC business, our sales continued strong despite weaker shipments throughout the quarter from our customers to their own customers. In terms of our own performance, we have continued to deliver on the strong demand for both our new X13 motor and our ECM motors and these products have continued to meet or beat our expectations on both quality and reliability.

For our standard motors, the shift in demand to our more energy-efficient models due to two SER 13 has caused us to delay deliveries for certain models and we are working very hard to address ramp-up capacity in these areas. In the end for us, it was another strong quarter for our HVAC business.

We are continuing to execute our strategy to invest in our Asian operations with significant investments in India and the acquisition of Sinya in China. Long term, we want to have the lowest cost, highest reliability of motors in the industry for these longer-term faster growing markets.

We would like to update you on a topic -- Dave mentioned it earlier -- that we discussed with you at the time of the acquisition of the two GE businesses. If you recall, there were two segments of the business where we agreed with GE to continue to sell motors to them while they relocated the production back to their own facilities. These were products that were not included in our acquisition of the business. We estimated at the time of the transaction that $23 million of sales would be shifted back to GE over a three-year period. That shift began in the second quarter and the impact on 2006 will be a reduction in sales of roughly $11 million. The rest of the top-line impact will be felt in 2007. The operating margin on these sales was below the fleet average and in the range of 7%.

As we look forward, our key challenge continues to be inflation. Copper prices peaked back in early May and we have seen only small corrections from that peak. Aluminum prices have reacted similarly. As we move through the rest of the year, our effective prices for copper and aluminum will gradually increase as our hedges are replaced with higher priced hedges. While we relentlessly work at driving productivity improvements both in our business and for our customers, we have been unable to completely offset the continued increase in these commodities. As you can imagine, customers would prefer no price increases and we are looking at all of alternatives to offset our higher costs but unfortunately we have been forced to look to our customers to offset some portion of these increases.

From a volume perspective in the third quarter, you can tell by our guidance that the quarter is somewhat stronger than we had expected. This is driven by a higher than normal backlog in a few of our key businesses and by overall economic strength. We are presently adding capacity as Dave mentioned where it makes sense in our key business units.

Looking beyond the third quarter, while we do not see any softening in our core markets, we continue to believe that we will have tougher comparisons in the fourth quarter due to last year's hot summer and the 10 SER inventory buildup. In spite of those tougher year-over-year comparisons, we are optimistic that we will fare well given the acceptance of our new products and the order strength in the rest of our industrial motors and power generation businesses.

In summary, we feel great about the second quarter. It was great to see the broad-based contributions from almost every business unit. We feel good about the third quarter and we are optimistic given the energy and enthusiasm throughout the Company. Back to Henry.

Thank you, Mark. Just to finish up the second quarter, I think the most pleasing aspects of the quarter were number one, organic growth. As Mark mentioned, we had great growth in each of our business units, double digits and strong double digits. The operating leverage despite the materials and energy costs, which certainly volume and mix played a key role, but also the fact is that all of our operating teams are executing. We are seeing some very definitive gains coming from the lean Six Sigma processes that we are implementing and we have strong productivity decks in each of our businesses. The fact is that our people delivered and we believe that we will continue to do so in the quarter ahead.

We also are very pleased with the strategic initiatives that are gaining traction in our Company. During the Company, we trued up our business profile and we improved our global reach with the sales of cutting tools -- the cutting tool division -- and the acquisition of Sinya. We achieved record production in Mexico, China and India. Our global sourcing team is full scale now and we're seeing definite benefits from their work. New product rollouts were on schedule and producing and I think the better news is that we have a full pipeline with some great innovative new products that will come out in the months ahead. Our acquisition pipeline is full and we have a laser-like focus on best people, best processes and customer centricity.

As we look to the third quarter, you can see from our guidance that we think it is a better than normal quarter for the third quarter, as driven by solid markets, HVAC inventories a little lower than we would've expected the to be at this point, carryover from the second quarter's strong demand, and share gains in commercial HVAC and power generation markets. Our enthusiasm is somewhat restrained by the expected continued material issues, including the change out of hedges for higher hedge costs as we move forward in the quarter and in the rest of this year. And the fact is that price increases have offset some of the materials costs but not complete. We're still in deficit and unless spot prices recede, more pricing will be required as the hedges turn over. We continue to be very optimistic about our markets and we will see the normal seasonal trends, but fundamentally, our markets are still positive.

With that, we'll take questions.

(OPERATOR INSTRUCTIONS). Alexander Paris, Barrington Research.

Good, afternoon. Great quarter. You guys are going to start getting bought by all the aggressive growth funds now.

That would be nice.

You have to move to San Francisco, your headquarters, I guess. Listen, just a couple of questions. Weather, was that a significant plus in the second quarter, would you say for your HVAC business?

We keep an eye on the National Weather Service. They publish cooling degree days and through the first half of the year, the National Public Weather would say that it was up 11%. That is there's 11% more cooling degree days this year over last. And while I can't say that we heard that coming from our customers, I've got to believe that weather does play a role in the delivery of product from our customers.

I was wondering, so far in the third quarter it's starting out very hot too.

Yes, (multiple speakers) up here where we are at.

But probably not enough to offset the very difficult comparison though in the fourth quarter. Would you say?

I would agree with that.

Okay. One other thing, just China. Some companies are making big moves to migrate production over there and I just -- I was struck by your comment that your goal of wanting to be the lowest cost producer in motors. Just looking at your investments in China and India, is part of that to take advantage of the domestic markets, which I think you are kind of -- I'd still call low-tech products, would be good for that developing countries over there. But also would you look to be moving manufacturing over there in order to export out of there to other places in Asia or maybe even further?

Alex, great question. We have been working in China actively since 1987 so it is not -- this isn't something new. We started out as mainly a supply base and moved a sourcing team in and then later started with joint ventures. Today we have three joint ventures and two wholly-owned enterprises. Today, we look at it much different. Our number one goal in China is to grow our sales in China and elsewhere in Southeast Asia with the base that we build there and are building there.

Secondly, we want to be able to supply global customers wherever they want to be supplied. So as our customers locate or relocate operations to Southeast Asia, whether that's China or wherever, we need to be able to supply them with the same quality of products that they expect from us at those locations.

And then today I would say our third priority really is bringing back components and/or whole products for cost improvement. However, all three of those, it is a three-legged stool.

Stated another way, do you think currently or prospectively that to be on the competitive forefront in the motor business that you have to do that?

I think so, yes. I don't think today to be competitive globally that you can ignore any opportunity to reduce costs as well as improve quality and productivity.

Can you give just a rough idea of what your volume say in China and India is now and what you would guess it would be in a couple of years? In other words just kind of the magnitude of growth that you are kind of thinking about?

Well, I will put it on two fronts. One would be the normal kind of growth that we would experience with current facilities and those facilities are growing double digits, strong double digits year over year. And short of some international phenomenon, we would expect that that will continue.

China itself is probably a $2 billion motor market growing 8 to 10% a year and changing very rapidly. Hopefully we will do things a little faster than that because we as you know are an acquisitive company and we are always looking for opportunities to strengthen our stable.

The capacity additions that you're talking about, that includes some in Asia too, right?

In India and in China.

just one other thing since you just mentioned it. I think your debt to capital ratio is back down to a comfortable level. And don't you generally -- isn't there a much bigger debt payback all things being equal in the second half of the year compared to the first half for your Company?

Generally there is, Alex; you're right.

Yes, so that puts you in a -- where maybe some money is burning a hole in your pocket again. Just in terms of the acquisition, just generally, you've trimmed down; you got out of the cutting tool business, the mechanical business, which that was a part of, is shrinking. Would you be adding more in the electrical area? Are there some significant new areas that would be compatible with the electrical business that would have a high priority and good growth for you?

At the moment, Alex, first of all, you would like to think that we don't let money burn a hole in our pocket, that we make prudent decisions and that we will continue that. But you know today, I would say that we are basically looking at opportunities to stick to our knitting and it really is in all three divisions, all three businesses we're in -- Power Transmission, Power Generation and Motors. There are some technology opportunities that we are evaluating. But I would say in general, we are looking at sticking to our knitting at this point.

Just one other quick housekeeping question. Tax rate, that 36%, is that good to use for the rest of the year and maybe in the next year?

Yes, I think at this point. We're, as I mentioned before, we're working on a lot of things to try to reduce that but I think that's a good number for right now.

Thanks very much and again, great quarter.

Mike Schneider, Robert W. Baird.

Congrats on a great quarter. Industrial Motors -- could you give us a sense -- you said generators were up -- I lost the number -- 22%. What were the industrial motors up this quarter?

I think we should have that number off the tip of our tongue, but we think it's 17 or 18%.

Okay. And in every business, there's pluses and minuses. Are there any laggards within that industrial mix?

From a motors perspective this quarter, there weren't. In the mechanical power transmission area, as Mark mentioned, our Richmond gear division was a little slower because of the -- what we believe is gas prices affecting pleasure craft marine and also the performance aftermarket.

Okay. And then just on HVAC, so with generators up 22, industrial up 17, 18, presumably HVAC is north of that. On unit volumes other than HVAC, you mentioned you were down slightly this quarter. I believe you were down call it 5 points in the first quarter. The industry at least according to ARI is down more than that, call it 8, 9%. Is that consistent with your thoughts about the kind of share you're gaining in units?

Well, Mike, back in the first quarter, I think what we had said is we were down 1 in units and we had projected to be similarly down in the second quarter. And that's kind of what Henry was alluding to and that's kind of the way it worked out.

And then remember, you are right, our customer, the ARI data would suggest our customer shipments were down 15% roughly for the quarter or tracking in that direction. And we are not seeing that on a unit side and it's for a couple of different reasons. You may have noticed that their inventory, the last set of data indicated that the inventory in the total system was not where they probably would want it to be, so they were building faster than they were shipping. There may have been some pent-up demand at our customers. So that would be the number one reason.

And then the number two reason is we are having success with some of our premium products.

Okay. And then the contribution of mix within HVAC then presumably is pushing 20 points or more given the total growth of that business?

Yes, mix definitely helps our top line, no doubt.

Okay. And then your expectation for the second half -- this is the $1 million question of course. But you had noted that the OEMs probably have slightly too much inventory but yet inventory throughout the channel was actually down. Give us your general thoughts and where you think this market shakes out for the year in units? And I guess just what you've baked into your Q3 forecast and at least your thoughts on Q4?

In the third quarter -- at this point in time, we haven't seen any real letup. And the last public set of ARI data that was out there indicated that total inventory in the system was not probably where they wanted it. And so my guess is they're going to try to rebuild some of those inventories. So that's kind of point one. And we think we are seeing that right now.

Now as I mentioned earlier in the fourth quarter, it's going to be tougher comparisons and there's not much we're going to be able to do about that simply because of the 13 SER buy I had last year and the very, very hot summer.

Do you believe your HVAC -- while units may be down in Q4 against the comparison, do you believe with the contribution of mix, you can actually grow HVAC revenue in Q4?

Mike, we don't think it's quite right for us to start projecting the fourth quarter yet.

And mechanical -- well actually back in electrical, you observed the 1.4 million restructuring this quarter. Can you give us a sense of what's coming in the second half?

Well I don't think we have any restructuring -- significant restructuring activities. We are adding a plant in Monterey, Mexico for power generation and some of the costs that you saw had to do with some of the startup costs. We don't anticipate great significance to that. We will start ramping it up as we go through this year and into mid year next year. But I think the startup costs are somewhat behind us.

Okay. So the 13% margin this quarter, cal lit 13.5 for Electrical scrubbed of the restructuring expense, do you believe that is sustainable from here or because of the seasonal peak we actually see declines in the second half in that electrical margin?

Well certainly volume played a big role in that. So it will fluctuate somewhat with the volume of the business, meaning you know, as we've said all along, we are still a somewhat seasonable business with the second quarter being the biggest; third quarter being the next biggest. But we are somewhat volume sensitive when it comes to the overall margin. We still have the issue that is difficult to call exactly what materials; spot prices do play a role. And we're not anticipating any help during the third quarter from that. And as we go forward, of course, as we have said, if we don't see some receding of the spot prices, we're going to have some more difficult decisions to make. So, I would not anticipate that the margin would necessarily stay up where it was at this kind of volume as we go into the third quarter.

Okay, final question just on price increases in electrical. I know Baldor and some others have gone out with call it late summer price increases. Have you as well?

Yes.

And comparable magnitude of 7, 8%?

Yes. And just one more comment. Most of those took place during the second quarter. So you know, began during the quarter.

Wendy Caplan, Wachovia Securities.

Can you talk about kind of the magnitude of the higher hedge costs and what that implies relative to margin going forward?

The difficulty, Wendy, is that it's a continuous accordion right now. What happens is that as you go through a period that we have gone through, we're always hedging. We're very disciplined. We're not trying to be market timers. We're trying to gain some certainty and so -- but there's always a portion and it's not an insignificant portion that stays at the spot level because you can't call your volumes that close.

And so, what happens is as we go through the rest of this year, we will see the weighted average cost. If spot prices stay where they are, our weighted average cost will continually increase. We have some price increases that went into effect during the second quarter that had some positive impact on the second quarter and we will have some positive impact on the third quarter, which is taken into account in our forward look. But at the same time, we will see -- we will continue to see this onslaught of ongoing cost increase unless the spot prices begin to decline.

At the moment, I can give you a report that would say they should and I can give you a report that says look out they're not going to and they're going to go the other way. So it's very difficult to call how that's going to actually go.

Thanks, Henry. Also, you mentioned something about the delivery delays on the lower efficiency motors. Can you say some more about what the bottlenecks are and give us some color on that?

You know, as we went to the -- on the standard product, there were still energy-efficient versions of those motors that we had to ramp up for. And when we did that, the motors tend to be slightly larger, not necessarily physically in size but in terms of the way we wind the motors, causes us a little bit longer to manufacture each motor and put pressure on our capability to get the product out. We have addressed it but we have had spot issues and we're quickly making up ground.

Okay. And finally, the share gains that you mentioned, could you give us some sense of how significant they are and anything else that might be helpful to us?

Yes, I would say that we certainly have seen some improvement on our HVAC side as a result of our premium products. At this point in time, we're the only ones that offer that product. So every time we ship one we're gaining a little bit.

And then across non HVAC, we have had wins in some of our commercial AC motor businesses in kind of the -- closer to the pump market.

Holden Lewis, BB&T.

Yesterday, the leverage in the quarter was excellent and I think if you look at the actual sort of dollar SG&A, even stripping out the benefit from the real estate sale, it looks like your dollar SG&A actually declined in the quarter despite the higher sales number. Can you talk a little bit more about sort of what's in that and what drove that? It declined sequentially by the way from Q1 despite the higher.

Yes, there's not a tremendous amount of our SG&A that's [varied] with sales. So you do get a nice leveraging; we obviously do use some commissioned sales forces so that will move with sales. But as well, again, the rest of it is pretty fixed. And I think in the first quarter, we also did say that there were a couple of items that were onetime that went the direction, dealing with some pension related to accounting. So this quarter we had a positive and first quarter, we had a negative.

But again beyond that, there's nothing I guess I would say is moving wildly. We continue to be very, very disciplined. I mean times are good, sales line is strong. But we're watching the SG&A line very, very carefully.

Our Six Sigma, our lean efforts don't stop at the plant door. We have those carrying through our SG&A areas as well and have lean Six Sigma projects underway that impact it as well. But again, nothing I could really call out as a real mover in regard to the number.

Do you know what sort of the value of those items that may have weighed on Q1 were [in collection]?

I would have to refer back to the press release. I think we did call it out [trend] but I don't have that in here with me.

Okay but it's primarily just pension?

Right, it was pension related.

Nigel Coe, Deutsche Bank.

Good afternoon and congratulations on a great quarter. I don't want to beat the hedging question too much but are you moving from hedge prices to spot prices right now or are you putting on new hedges?

I'm sorry, Nigel, could you ask that one more time?

Yes, I mean are you going from hedge prices to spot prices right now for your purchases?

No, we continue to hedge. We continue to hedge. The fact of the matter is if you look at --if you were hedging today for six months out versus a year ago at six months out, that will tell you the story.

Okay. So six month hedges is typical?

We hedge more than six months. I'm just saying on average when you look at the way hedges roll, they are rolling -- every month hedges are rolling out to their lower cost than hedges that are rolling in.

Okay. And the price increases that you talked about in the electrical segment, do you think that's going to be enough to offset the higher prices able to come through in 3Q and 4Q?

Not if spot prices stay where they are or go north.

Okay, great. Secondly, looking at Sinya, the contribution to the top line this quarter. They are better than I expected. Is there any seasonality that we need to be aware of in that business?

It matches very closely to the seasonality of our business.

Okay, so 2Q, 3Q will be the peak?

It may start a couple of months earlier and finish a couple of months earlier but overall it's reasonably close to proximity.

Okay and that's what, $30 million of sales from that business?

I think it was more like 38.

$38 million, okay, great. Just a couple of numbers questions here. Interest was a little bit higher than expected as well. Are there any one-off items in there this quarter, Dave?

No, no one-off items. Debt levels coming down. We are at the lowest level of our revolver, but obviously with the interest rates creeping up, that's really what's driving that.

The higher rates coming through there, okay. Sorry, I missed the DNA for the quarter. Can you just repeat that, Dave? Sorry.

Sure, depreciation was 7.1 million and amortization was 1.9; so in total 9 million.

Okay, great. Final question on HVAC. Just in 3Q, last year, we had OEM inventory burn during the Q3 and obviously that's not going to happen this time. So if that's going to help you, OEM shipments should be down I guess overall. So overall, what would you expect burn to be for you in 3Q?

In terms of units, we are expecting another kind of slightly down quarter as we have seen in the prior couple of quarters.

Okay, so basing it to what you saw in 2Q?

Right.

Great, thanks a lot, guys.

Mike Schneider, Robert W. Baird.

Guys, can maybe you address just the trends in industrial during the quarter? Did you notice any discernible acceleration or deceleration? And then I guess your thoughts as we head into the third quarter?

Certainly didn't see any deceleration. As we reported last quarter, some of the process industries and so on, oil and gas, chemical, paper and so on are still in our opinion accelerating and we have not seen pullback in what some of the areas that we would typically say pullback sooner as opposed to later. So we look at fundamentally the market still feels very, very strong and just -- I don't think there were -- other than this pleasure craft marine and high-performance automobile aftermarket, we just didn't see anything that was of concern.

And then in mechanical, just focusing back on the margins there. If we strip out the gain this quarter and adjust for cutting tools. Can you give us a sense of, is this margin indeed sustainable now at 10% and is that a function of just cutting tools being dropped or divested or are there other improvements that you have begun to see?

It's definitely -- the biggest single function is the restructuring efforts that we've taken on over the last couple of years now finally paying dividends. And there was a fair amount of that work done in '05 and some work done in '04. So that's the most significant. Cutting tools certainly supports a higher margin -- with it being gone supports a higher margin in total.

Okay. And just final question on CapEx. Dave, you mentioned the budget went up to 55 million for the year. Where is the additional money being spent?

Mark mentioned some capacity adds and that's exactly what is driving that.

That's primarily HVAC?

It is really HVAC as well as some of our other products (multiple speakers)-- it's power generation as well.

And India -- there's a fair mix.

And I will at least take a crack at it in Q4. I think everybody is wondering, can you actually grow earnings year over year in the fourth quarter from the $0.63 you reported last year just given the industrial momentum and I guess the gains being made in HVAC at least in terms of mix? Can you give us any directional guidance?

I guess my tendency is to say nice try. You know, it's a great question. We're very optimistic about what our initiatives are doing in the Company. We're not prepared to try to give you yet a glimpse of the fourth quarter other than to say we believe that our initiatives will continue to add value and that the markets that we're anticipating in are strong; we will see the normal seasonal kinds of changes that take place.

And as Mark has already said, from a standpoint of HVAC, there is that single drop-off that's going to come as we don't rebuild the [10's] here but we're seeing nice, hot weather and inventories in the channel are down and so we remain pretty optimistic.

Just one more if I could. Next year's HVAC picture, have you begun to already resign different platforms for your X13? Are you seeing motors for 2007 or do those negotiations have yet to occur?

Well some are annual, some aren't. I mean there are some that are multi-year. So we are at different stages with a lot of different customers. So there isn't a blanket answer that we can give you on that.

Nigel Coe, Deutsche Bank.

Well you wouldn't answer the question on 4Q so I thought I might try 2007 here. Obviously CapEx is ramping up pretty big this year. Would you expect 2007 to be lower, given that you've put in a lot of capacity this year for the volume ramp up?

If you look back to 2004, we actually were a little lighter in '04 and said there'd be carryover into '05 or '05 and '06 and we're seeing a little bit of that. And some of these capacity adds we're putting in now will likely -- some of the spending will carry over into '07.

And again, we are several months in advance of putting together our budget for '07. So I don't have a number that I could give you. But my guess is at this point that it will probably be still a little higher than normal. Because again, some of these projects will carry over but probably not quite to the level of this year.

Second question which you probably won't answer but obviously [Rockwell] are in the process of shopping around their power business. And you do cross over with them a fair bit. Is that business too large for you to consider and therefore you're looking for more bolt-on acquisitions? Or do you think it's feasible that you might kind have a look at that business?

You know, it's certainly a terrific business and businesses like that don't come around every day. So it's certainly one that if we have the right opportunity, we would look at seriously. And but within the constraints that we've always talked about, we don't like to do dilutive deals. We don't try to get overleveraged. So you'd have to take all that into account. What I would say beyond that is that we have a --the pipeline that we have today is very, very full. It's full here in North America. It's full in Asia and there are even some European opportunities that we think are somewhat interesting. So, we are not -- I wouldn't say we have all of our eggs in any given single basket.

Thanks. And just one follow-on to your comment about dilution? Obviously you like to do EPS accretive deals, but (indiscernible) of an asset, will you be prepared to see some dilution for other assets?

If we had a clear path that would get us a positive very quickly and if we believe we can get the return on capital that our shareholders deserve, we would consider it. But again we would be pretty disciplined about that.

(OPERATOR INSTRUCTIONS).

Okay. With that, then, we really appreciate your interest. Just to recap the quarter, saying it was -- again, it was just a truly great quarter. We certainly think the third quarter can be better than we would have expected it to be as we started the beginning of the year although we will see some seasonal impact that we always see. Very pleased with the progress we're making on key initiatives. We still believe that the opportunities outweigh the challenges as we look forward and we remain very optimistic about our future. So with that we want to thank you for your interest in Regal Beloit and we wish you a great afternoon.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect. Thank you, Mr. Barta.