Regal Rexnord Corp (RRX) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Regal-Beloit Corporation fourth quarter 2006 earnings conference call. At this time, all lines are in a listen-only mode. Later, there will be a question-and-answer session and instructions will be given at that time. [OPERATOR INSTRUCTIONS] As a reminder, today's conference is being recorded. At this time, then, I would like to turn the call over to Mr. Dave Barta. Please go ahead, sir.

Thank you, Kent. And good afternoon, everyone, and welcome to the Regal-Beloit fourth quarter earnings conference call. Joining me today are Henry Knueppel, Chairman and CEO, and Mark Gliebe, President and COO. Before I turn the call over to Henry, I would like to remind you that the statements made in this conference call that are not historical in nature, are forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements. For a list of those factors that could cause actual results to differ materially from projected results, please refer to today's earnings release and our filings with the SEC. Now I'll turn the call over to Henry.

Thank you, Dave. And thank all of you for joining the call. We appreciate your interest in Regal-Beloit. We're going to follow the same agenda that we've followed in recent calls. I'll make a few overview comments, Dave will cover the financial aspects of the quarter, and Mark will provide color in our markets and operations, and then I will finish with a few comments on the first quarter and the year ahead. First of all, we would say that the quarter ended up pretty much as we had projected. It was very challenging at the top line, and perhaps a little bit more challenging than we had expected. Some of that is due to the comp to last year, when we enjoyed roughly a $30 million bubble in the HVAC business due to SEER 13 legislation. And also this time last year, the fourth quarter in our industrial business was very strong as we were ramping up out of a slower time. And we enjoyed a little bit of a bubble from hurricane Katrina.

This year, the HVAC channel is more normal in demand, perhaps a little bit slower than normal, and Mark will cover that in more detail in a few minutes. Our industrial businesses were, I would say, enjoyed normal seasonality, unlike last year, with the exception of large motors and power generation, which were both very strong. Given the top line challenges, we were extremely pleased with our earnings leverage that came from strong productivity from our operations, and continued results from new products, somewhat offset still by materials. For the year, we were extremely pleased with our 13.4% growth in sales, most of which was organic, and our 45.5% increase in fully diluted EPS. Achieving this degree of leverage this far into a business cycle is testament to the strength of our business improvement initiatives and the quality of our people. I cannot say enough about our people and their performance, day in and day out, and the energy and capability they exhibit in their actions. With that, I'm going to turn it over to Dave Barta.

Thanks, Henry. I'm going to touch on some of the financial highlights for the fourth quarter and for the year. Sales for the fourth quarter were $366.6 million, which is a 2.5% decrease as compared to the fourth quarter of 2005. And looking at this by segment, in the Electrical segment, sales were $320.6 million, a decrease of $4 million or 1.3% versus the prior year. And as Henry mentioned, you recall that in the fourth quarter of '05, we had a tremendous quarter for the HVAC business as a result of the 13 SEER legislation and the hot weather. And again, we estimated that to be about a $30 million lift in 2005 fourth quarter sales. The Sinya business we purchased in May of 2006 had an outstanding quarter, with sales of $14.6 million. We also continue to see strong sales performances in our power generation businesses, with sales increasing over 20%, and our larger industrial motor business, where sales increased over 9%. We were also impacted by another topic we've talked about, which was the transition of the GE supply agreements, with sales being reduced about $1.9 million in the quarter versus fourth quarter 2005.

Sales in the Mechanical segment decreased 10.6%. And the results in that segment were negatively impacted by the sale of the cutting tools business that we sold in the second quarter of 2006, and that reduced sales for the Mechanical segment by approximately $4.3 million. Excluding this impact, sales decreased 2.3%. And the results varied by business, with a continuing trend that we've seen earlier this year of the later cycle businesses outperforming those that we would consider earlier cycle businesses. For the year, sales finished at $1.62 billion, an increase of 13.4% in 2005. And in the full-year sales number, there was $36.5 million of sales from the Sinya business and the other impacts we've talked about, the reduction of sales in the Mechanical and the sale of Cutting Tools' Illinois Gear was $14 million. And the transition away from the GE supply agreements reduced sales in 2006 in total by $7.3 million.

Gross margins for the quarter were 24.3% as compared to the prior year fourth quarter gross margins of 22.8%. And we were not able to offset completely inflation with pricing. However, our productivity Lean Six Sigma projects continued our margin expansion that we've seen earlier and throughout the year. For the year, gross margins improved 180 basis points to 23.6%, with that improvement, again, coming from the productivity and Lean Six Sigma efforts. Operating expenses were 13.5% of sales versus 12.7% in the fourth quarter of 2005, including operating expenses of approximately $900,000 in the quarter related to [expensive] equity comp, and that amount compares to about $100,000 in the fourth quarter of 2005. And for the full year, operating expenses were 12.1% of sales versus 12.3% in 2005, reflecting leveraging from sales volume and some of the productivity efforts and redeployment of those resources.

Income from operations was $39.5 million versus $38.3 million in the fourth quarter of '05, an increase of 3.1%. As a percent of sales, income from operations was 10.8% versus 10.2% in the prior year. And again, this reflects the contributions from new products, pricing, productivity, and leveraging of SG&A. For the full year, income from operations was 12% of sales, versus 9.4% for '05. Tax rate for the quarter was 32% versus 34% in the fourth quarter of '05. The reduction was primarily due to Congress extending the R&D credit during the fourth quarter. And for the year, the tax rate was 35.5%, which was basically in line with the tax rate for all of 2005. Net income for the quarter was $23 million, an increase of 13.1% as compared to the $20.3 million reported in the fourth quarter of 2005. Fully diluted earnings per share were $0.68, which compares to $0.63 reported in the fourth quarter of '05. For the year, net income was $109.8 million, an increase of 57.9%, and fully diluted earnings per share were $3.28 as compared to $2.25 for 2005.

Turning to a few balance sheet highlights, total debt was $373.3 million, which is a decrease from 37 -- of $37.5 million from the end of the third quarter, and a reduction of 38.7 from a year ago. And this is one area where I would say we are not pleased, as we've mentioned in the past, that our cash performance in '06 was not up to what our standards are, and we're taking aggressive steps to improve our performance moving forward, with a free cash flow to net income growth goal of 100% or better. CapEx for the quarter was $14.9 million and depreciation amortization, 11.4.

A few comments on the outlook for the first quarter of '07. As Henry mentioned, the HVAC business was benefited in the fourth quarter of '05, and that carried into the first quarter of '06 because of the 13 SEER legislation. So again, it's going to provide somewhat of a tough comp for our HVAC business. And again, Mark will gives more color and details regarding that. Our EPS guidance of $0.75 to $0.83 per share reflects the strength in the power gen and large motor business, which is going to be partially offset by the impact of the tougher HVAC environment. We are expecting contributions from our corporate initiatives, which will be reflected in our operating margin performance. And just a few other details, the tax rate used in arriving at the EPS guidance was 35%. I think that's a pretty good rate assumption for the full year of 2007, as well. We're currently expecting capital spending in the area of $8 million to $12 million in the first quarter. And at this point now, I'll turn the call over to Mark.

Thanks, Dave. As Henry mentioned, the fourth quarter was pretty much what we had predicted, relative to the HVAC 13 SEER impact, and our tough year-over-year comparisons. But it was somewhat of a bigger challenge due to the warmer winter impact on furnace sales in the HVAC market, and then the decline in the housing market. Our Power Generation business continued to deliver very strong growth, up 29% in the quarter. And our other businesses returned to more normal seasonal patterns. All in all, the top line was what we thought it was going to be, and the bottom line we delivered double-digit growth. Not like the first three quarters, but not bad at all.

Today I'd like to touch on a few significant changes that we have been making during the second half of 2006. First is the change that is underway in our Power Generation business. We started up a Greenfield operation in Monterrey, Mexico, this past year, with the intention of transitioning our Lima, Ohio, manufacturing operations. This transition has been going very well, and we expect to substantially -- be substantially complete by the end of the second quarter of 2007. When the transition is complete, we will have generator manufacturing capability in the U.S., China, and now in Mexico. This all plays very well at a time when our business is growing double-digit on the top line.

As you may already know, August and December were the two year anniversaries of the acquisition of the GE businesses. For the last two years we worked very hard at disconnecting our businesses from our former parent. The single largest disconnect we had to accomplish was the transition off of GE's order-ship-bill IT systems to our own Oracle enterprise system. We chose to execute that move in the fourth quarter of 2006 when we knew that our HVAC business would be at its slowest shipping point of the year, and when we would have the least impact on our customers. While that transition was certainly a tough one, it is now substantially behind us. And today, we are operating the business 100% on our own IT systems. We have one more warehouse to move, which we plan on executing during the first quarter, and then the disconnect from GE will be completed. What's more important, however, is the direction we are headed. Our goal has been to put the entire Company on one IT platform in an effort to drive synergies across every one of our businesses. By the end of 2007, we plan to be 70% of the way there.

As we have mentioned before, Lean Six Sigma continues to be a drive throughout the Company. We feel great about the progress we made in '06, and we intend to implement Lean faster and deeper across the organization in 2007 and beyond. We will train 200 more people in Six Sigma this year, and we will implement Lean in all of our factories and offices. Lean Six Sigma has been and will continue to be a culture-changing journey for the Company, where our progress today is tomorrow's baseline for improvement. More importantly, what we have found along the way in our Lean Six Sigma journey is that the initiative is both uniting and energizing the Company. With many different businesses and brands, the Lean Six Sigma initiative has given us a common language, common problem solving tools, and a platform to share best practices. We couldn't be happier with our results so far, and we see more opportunity in the future.

Innovation is another key initiative in the Company, and this past week at the annual ASHRAE Show, we put out a press release announcing our new ECM 3.0 Blower Motor. We call the motor a ThinkTank, and it features our new patented Black Box technology for diagnosing and customizing system performance. The new motor will have the ability to talk and listen by storing motor performance data, even at the time of a failure. For consumers and contractors who service HVAC systems, a self-aware motor can communicate warnings, error reports and service requests. As an example, if a motor suddenly begins running 30 degrees hotter, it could notify the homeowner or contractor that the equipment requires attention, to avoid a costly system break down. Further, the information stored in the Black Box recorder will be made available to both Regal-Beloit and our customers, so that we can better understand the environment affecting performance, and together modify our equipment to make the systems more reliable. ThinkTank ECM is part of our ongoing effort to provide our customers with greater value that helps them to be more profitable, and we are driven to be the supplier of choice for motor technology solutions.

Looking forward, the recent drop in copper prices, while directionally favorable, still presents us with an inflationary environment. And as you know, we have a disciplined process of hedging that puts us in the position of comparing last year's blended rate with this year's blended rate. Prices would need to remain stable well into the back half of the year before we saw any real benefit. As you know, throughout the copper inflationary period, our price increases never quite caught up with the materials increase. As mentioned earlier, our HVAC business will face tough year-over-year comparisons in the first quarter of 2006, when the HVAC industry experienced unprecedented strength as a result of 13 SEER energy legislation that went into effect at the end of January, 2006. Also affecting our demand will be the impact that the housing market and the warmer winter is having on our customers. It is quite difficult to sort out how much of an impact any of these specific issues is having overall. However, we have been saying for quite some time that we do expect a sizable unit decline in the first quarter, but that we thought we would fare well overall. I think our guidance this morning reinforces what we have been saying all year. We expect that this will be the last quarter that we see an impact of the 13 SEER legislation.

In the rest of our businesses, we are seeing a return to more normal seasonal ordering patterns. In the past two years, we experienced somewhat vigorous order activity, driven by very strong economic conditions. Moving forward, we expect to return to more normal seasonal order patterns. In summary, the fourth quarter was what we expected it to be, and we fared well with the tough year-over-year comparisons. We have one more quarter where the 13 SEER pull-ahead from last year has an impact on our comparisons. We feel good about the first quarter. We're pleased that the big disconnects from GE are substantially behind us. And we are optimistic given the initiatives, energy and enthusiasm throughout the Company. I'll pass it back to Henry.

Thank you, Mark. Overall, it was absolutely a great year of achievement for the Company. And we can say definitively that our strategic initiatives are continuing to gain traction. Those initiatives include improving customer centricity, creating innovative new products and processes, implementing Lean and Six Sigma disciplines across the Company, globalizing our selling and manufacturing -- global selling efforts and manufacturing base, and digitizing our processes. Looking forward, we are optimistic about the year ahead. We recognize that the first quarter will be another challenging quarter for the same reasons that the fourth quarter was. While our order flow is currently very solid in our industrial businesses, and exceptional in the power generation business and large motor business, the HVAC channel appears to be back to normal, seasonal trends, and overall, unfortunately, is not providing a great deal of visibility. We expect to fare well due to our new products. But certainly the overall health of that market will be important.

Materials, while improving on the surface, will continue to be a headwind through the first half. We expect to see some relief in the second half of the year, but not a flood gate. As you can see from our first quarter projections, we are optimistic overall. And we expect our strategic initiatives to continue to improve the quality of our earnings. We are continuing to analyze a number of acquisition opportunities, but we will remain disciplined and patient in our approach. With that, we'll open it up for questions.

[OPERATOR INSTRUCTIONS] Michael Schneider, Robert W. Baird.

Sorry for the background noise. I guess, first, maybe you could just give us some insight to the HVAC channels. What have you noticed, I guess, for OEM orders versus the after market? And does it tell you anything about the impact of housing, which I suspect you would see in the after market of the distribution business?

Mike, it's Mark. You probably saw the ARI data was released today, showing the quarter was down -- shipments were down 33% in the quarter. That's obviously having some impact on our demand. And what we're hearing throughout the channel is that the after market's a little stronger.

So your expectation for 2007, given what we know about housing now, do you think it's still realistic, given your prior comments, that the industry overall could be flat for the year in units, even though we're starting in the hole in Q1?

Most of our customers are telling us that they see it improving after the first quarter. I'm hearing flat to up. So that's kind of what we're hearing so far.

Okay. And then as far as the HVAC pricing issue goes, now that we've got copper coming down, we've kind of swallowed most of the 13 SEER aftermath, have you started to see renewed pricing pressure from the OEMs? Or, I guess platform shifts among products? Just any insight into 2007 vis a vis the OEMs?

Well, as you know, Mike, we do have a number of our customers that we have contractual relationships with, where we adjust price up or down relative to commodities. And some of those agreements are different based on the customers. And some of them are at a quarter point, some of them are at a half year point, some of them are at a total year point. So if copper stays down, by contract, we will adjust our pricing down with those customers in that channel.

And then how about on the industrial front? And I guess more importantly the industrial distribution channel. Are you beginning to see pricing pressure there? Or at least less pricing power, if that's the way to put it, now that copper has come down? Just trying to get a sense -- I know you guys are feeling a lag effect of rising copper. But is it a case where the customer base doesn't care, and is already beginning to push back?

We announced our last price increase in the back half of 2006. That price increase so far appears to have stuck. I think Henry has said for quite some time that we thought that on the way up, there would be a lag in terms of us catching up to copper, and on the way down, there would be a lag in terms of giving it back. And so I do believe that there will be, like Henry, a lag in giving it back.

Okay.

And I would say, Mike, I would say at this point, we have not seen a lot of pressure in that specific channel.

Okay. All right. And then final question, just vis a vis the Rockwell Reliance acquisition, do you guys see an opportunity to pick up new distributors or new product channels or anything along those lines, as those two industrial companies come together?

Well, obviously they're both very strong companies, and now one strong company. There's always certain people who perhaps would say we always try to separate our buy, and now we're buying from the same company. So we would like to make sure that we have an alternative. And certainly there are some of those discussions taking place. But if you say is that a ground swell, I think the answer is no. The reality always is that it's still going to get down to who provides the best quality of service and the best product. So there's usually more talk than there is action on that front. But are there some opportunities? Sure. I think long-term, it's going to still be back to who creates the most value for the customer.

Okay. Thank you, again guys.

Alexander Paris, Barrington Research.

Congratulations on a good quarter and on Mark for joining the Board.

Thank you.

Just a couple of questions. I've seen all the economic reports that production was actually down a little bit in the fourth quarter. The ISM and the Chicago PMI, were showing contraction in January and there's clearly inventory liquidation going on in the U.S. manufacturing sector and distributors. Are you, ignoring HVAC for a minute, are you seeing any of those effects here? Are they reaching yo? Do you see customers stretching out orders, cutting inventories, things like that?

We have not seen a lot of that, Alex. In the smaller products, which are typically faster to react to those kinds of things, we saw pretty much a seasonal kind of a pattern throughout the fourth quarter, what we would have called normal in the past, but not last year, when we seeing a ramp up all the way through the quarter. So it felt like it should for that time of year. On the larger products and some of the products that are typically a little later cycle, we are still seeing very, very strong year-over-year positive demand.

But you generally, as you can recall, when you see the numbers, and people like me talking about all the bad numbers, a kind of a lag of a quarter or so before it really starts showing up -- ?

We would have expected to see it happening on some of our first end kind of products at the same time we heard it from you.

Okay. Just one other thing. Now that the GE is all shaken out, integrated, can you just give a rough idea of what percent of either your total sales or the Electrical sales is actually sensitive to housing construction?

Well, the -- we always have to kind of break this down a little bit. When you take a look at HVAC, our HVAC types of products, about, Mark, 80% is residential? And when you take a look at that portion of the residential, about 75% is really due to replacement market, and 25% is due to new home starts. So by the time you break all of that down, you get down to the total amount that is due to new home starts for us as a Company, is probably somewhere in the vicinity of about 10% of our total sales. So, hopefully that helps you.

Yes. And just one other thing. Mechanical, when you took out the Cutting Tools, it was still down for the quarter at a time when you don't see the negative effects of the slower industrial sector in the fourth quarter. Is there -- I think you maybe mentioned some things. Was there an extra strong, or difficult comparison in the Mechanical area, too?

Well, last year, during the fourth quarter, typically our Mechanical group slows down a little bit in the fourth quarter. The fourth quarter's kind of the lightest quarter that we see there. First quarter ramps up, and second and third quarters are strong. Last year it didn't. I mean, last year it ramped up straight through the fourth quarter. A little bit of that could have been aftermath of Katrina. But for the most part, it was just a very, very strong marketplace. I think we were seeing some inventory expansion in the industrial channels. And this year I think it's pretty normal. So I think it really is more -- has to do with more with the comp to the last year, than it does any other single factor.

And also, Alex, there was definitely some market differences in the business. As you know, our Mechanical business is a combination of quite a few different. And the later cycle businesses that are more in oil and gas, more infrastructure-type products, were again up double-digits. Where the softest was there was in Richmond Gear business, which is obviously impacted by consumer's habits and also the price of fuel. So that business was actually down. So there was a very stark difference between kind of the best performers and the worst performers. But fairly consistent trends with what we'd seen earlier in the year.

Okay. Thanks a lot.

[OPERATOR INSTRUCTIONS] Jeff Hammond, KeyBanc.

Was looking to get a little more granularity on the HVAC business in the quarter. Can you just give us a sense of the magnitude of the decline there? And maybe perhaps relative to what you were originally thinking. And then similarly, how would you be thinking about that same comp in the first quarter, within the context of your guidance?

Our HVAC revenues were down, roughly 25% for the quarter.

And does it continue at that run rate into the first quarter? Or we're down a little bit less?

At the moment, I think our expectation for the first quarter is that it will be down, but probably not quite as much. We think that there was some -- some of the fourth quarter had to do with the warm start to the cooling season -- or to the heating season, I should say. And that typically has less impact in the first quarter, it's more of a fourth quarter impact. And we also think that there was some inventory reduction in the channel as we went through the quarter, overall. And this time of the year, they start to build for the coming season. So we're expecting a little less impact. Won't change the fact that we won't have the bubble we had last year. But probably a little bit more normal seasonal kind of approach.

To the point of inventories, I know ARI stopped reporting inventory data. As you talk to your major OEM customers, how are they feeling about inventory levels?

I think the general sense is that they did do some adjusting in the fourth quarter. But I think that they would say overall that they're in a reasonable condition going into the season. So overall, I think inventories are in reasonably good condition.

Then back to the commodities. Is there a point, or at what point during the year based, if we consider stable copper and commodity prices from here, where you actually reach price cost parity, or actually get some net benefit?

It would appear to be about mid year that we would actually be at parity. And then if spot price stays where it is, hopefully we will start to see some improvement. Again, it's not going to be a flood gate opening and huge change because hedging the way we do, we never got to the high price of the spots that you saw at their peak.

And then, can you just reflect on international business momentum, relative to what we're seeing -- you discussed in the domestic side?

Well we continue to see very strong growth in China and in India. Those engines are almost unbelievable, I guess, by U.S. standards. But very strong growth, and we have strong momentum in both of those locations. Reasonable growth elsewhere in Southeast Asia. We are not a huge participant in Europe. So I don't think that -- what we see there is positive. But it's not a big swing factor in the Company.

Great. Thanks, guys.

Steven Hill, First Investors.

If I look at how your stock is trading, your dividend yield is a bit lower than peers, and your valuation is terrific. In fact, compared, say, to Valdor, you guys are an outright bargain. Why not consider accelerating returning some capital to shareholders this year? Either in the form of a dividend increase, just a modest bump to bring it up to peer levels. Or maybe some share repurchase activity, because I know you've been waiting on that for a while due to M&A.

Those are great questions, and we do -- the Board routinely considers those. We did increase dividends each of the last two years. And we will continue to review that on a quarterly basis. Whether or not we start to buy back stock, it is something that we do consider. And we look at that in light of the pipeline that sits there in front of us for potential acquisitions. And I think they're great questions, and things that we do and will continue to consider, to make sure that we are doing the most we can for our shareholders.

And if I could ask you a couple of follow-up questions. One is on the cash conversion cycle. You mentioned the hurdle rate you had if free cash flow to net income greater than 100%. When do you think we'll start seeing movement in that direction? Is that going to be in the second half, the latter half of this year?

Well, we've been there before. So I think that we've have -- the year before last was a pretty good cash conversion year. And this past year, as we've said, was not. And part of that was due to the level of CapEx spending. So this year, initially, the emphasis is on working capital management. And I would say that we'll start seeing progress each and every quarter. But certainly, when you're taking out inventory and doing some things, sometimes there's structural things you need to put in place to make sure you can do that and still supply your customers the way you want. And our first goal is to make sure that our customers have product when they want it and where they want it. So I would say we'll accelerate that throughout the year. We're making a lot of headway in the area of accounts payable. And that, I think, is manifesting itself, already. And you'll continue to see that. And have made some progress over the last quarter in accounts receivable. So accelerating as the year goes on.

And then one final question, although it may be too early in the season to ask. I'm wondering how motor replacement in the cooler looks to you. And I guess there was a commercial refrigeration air flow product that you may be working on. I'm wondering when you might see that product come to fruition?

Yes, you're right, there are commercial refrigeration products we're working on. And hopefully we'll be able to talk about those in the ensuing quarterly calls. That's our goal here. So hopefully everything happens the way we want it to.

And I think the other part of your question is that the replacement market really doesn't get rolling until the second quarter. So it is a little bit too premature to say whether there's any plus or minus there.

Okay, thank you.

Wendy Caplan, Wachovia.

Could we talk a little bit about your margin? The '07 operating margin was up 260 basis points versus '06. I'm sorry, '06 versus '05, sorry. Can you help us understand how much of that margin improvement was mix related, how much of it was productivity gain? And as we look toward '07 and beyond, we're still below that kind of corporate goal of 15%. As we think about '07, how should we think about that margin in terms of where the margin comes from primarily? The mix has been established, I would assume at least mostly. Is it mostly productivity? Or are there other things we should be looking at?

Wendy, I think the primary contributor has been productivity. A second major contributor would be new products and mix. Certainly this last year the mix was very strong, plus for us given the SEER 13 legislation and the new products that we brought to market. I think as we look forward to this year, we would hope to have some more new products. But on a year-over-year basis, probably be a lower percent -- percentage of gain that comes from that, and a higher percentage of the gain that's going to come from continued productivity efforts. The productivity pipeline is very, very strong, and we're expecting to have another year that would be as strong as we had last year. So I think you're going to see a bigger share of it this year that will come from productivity than there was last year.

There's a piece of it that eventually will come out, we think in materials, as Mark mentioned earlier. But predominantly it's going to be productivity, followed by new products over the next two years. And we're still -- we feel -- still feel pretty comfortable that if the economy just stays in a reasonable level, that we're on schedule to in '08 hit the mid teens operating profit level that we've talked about.

And can you say some more, Henry, about kind of some of the specifics of what some of the productivity initiatives are for '07, and where we should see some of that -- some of that gain?

Well, I'll try to. Mark can jump in here any time he wants to. But we are really pushing Lean and Six Sigma across the Company in depth. And we think that there is just a lot of opportunity there. Six Sigma efforts this year ramped up to over $10 million of contribution. And we think that they'll be higher this coming year. Lean is really -- we've been gaining from it, but we're trying to accelerate that substantially. And then in addition to that, we have a lot of capital projects and other projects that are going on throughout the Company. Mark mentioned getting everybody over onto one system. We think that there are a lot of gains that come from that, from a lot of different fronts. But I can tell you that what would amaze you, is if you saw the number of projects that we intend to complete this year, all of which will have a productivity plus to the Company.

You're talking phenomenal numbers with a lot of people engaged. And a whole bunch of singles, and a few doubles, that are involved in that. And I think that's one of the great things about the initiatives that we have going, frankly, is they're broad-based. There's just no end in sight to the kind of things that we can do and improve in our operations. And I don't think that's starting from a weak spot. That's starting from a pretty good level of performance right now, but a lot more in our line of sight. Mark, I don't know if there's any flavor you'd like to add.

I was just going to add that the thousand projects we have active right now.

Yes, it's -- they're big numbers.

Thanks very much.

Chris Bamman, Morgan Joseph.

I was wondering if you could maybe provide a little bit more color on the end markets and which ones that you're serving appear to continue to be strong. I know you talked about the power generation and some of the industrial markets. Just maybe add a little bit of color to that, if you could, please, as we work through '07.

Power generation certainly is strong, and it's strong globally. It's not just a North American or just a Southeast Asian, or any one spot in the world. It's very strong and it's very broad-based. Certainly, oil and gas and some of the big industries are contributing to that, in mining and so on. Large motors are -- continues to be very strong. And the process duty industry, which is typically a little later cycle than the rest of the economy, continues to be very strong. And we're very pleased with the kind of penetration that we're getting there.

Some of our other industries are very solid. Food, beverage industry is very solid. Mining is very solid, actually strong. The HVAC after-market we expect to continue to be very strong, because it's got some great dynamics, in the terms of number of units that are coming up for replacement. Commercial construction continues to be strong. Mark, are there others that are ringing bells?

I think you hit them.

I think those are all -- they're pretty solid. We don't see -- I think the good news is we don't see any particular industry that's really weak. Some of these, some of the industries are kind of back to a more normal cycle. We're not seeing the ramp out of a slower time. But they're very solid, and we expect to have up year-over-year kind of comparisons.

Okay. And I guess, as we're talking about -- you're talking about a more seasonal pattern, so to speak, and maybe just what kind of rates do you sort of characterize as being more seasonal, considering we had some stronger growth due to hurricanes SEER 13. Remove those factors, and what is there more -- what would you characterize to be a more seasonal growth rate for some of these products, if you can touch on that?

Well, I have to think about that one for just a minute. I think that some of the general industrial markets, we're looking this year at anywhere from 2.5% to 5%, depending upon the individual market. Home starts appear to be down. But the after-market continues to be 6% to 8% kind of growth in terms of the units that are coming up for replacement. We have to see now, given the cost of new units, how that replacement market goes this year. But the number of units that would be coming up for replacement is certainly up in that kind of percentage range. Commercial construction continues to be strong at, we would say, 3% to 5%, probably in that vicinity, maybe a little bit stronger. So mining is going to be close to double-digit, and so is oil and gas. So high single-digit kind of growth in the marketplace.

Okay. And then do you expect any sort of relief from the price of commodities to come through for the second half of the year? Is that sort of how you calculate it?

Yes. And again, we want to just caution everyone. There isn't a switch on the wall, and all of a sudden, the gates open. But we should start to see year-over-year, some favorable comparison in the second half, unless spot prices start to change again.

That's it for me. Thank you very much.

[OPERATOR INSTRUCTIONS] Holden Lewis, BB&T.

Building on Wendy's question a little while ago. I guess '06 was really marked for very strong gross margin growth. But for the year, SG&A as a percentage of sales is really pretty flat. And is that just a function of having to sort of invest to support growth? Or is there some reason why there wasn't a lot of progress made on levering SG&A? And can we expect that a lot of these productivity initiatives and such are going to improve that performance in '07? Can you just sort of comment on the SG&A dynamics a bit?

Sure, a couple things. First, recall, as you compare the SG&A line to 2005, that in 2005 we basically had very little expensing of equity comp. So there are some apples and oranges differences. So one of the increases this year because of the FAS 123R, was the expensing of equity comp, which certainly added to that base. If you're looking in terms of absolute numbers, the addition of Sinya, and net of the disposal of the Cutting Tools business, certainly had some noise. But on a percentage basis, I think we are really focussed on that number. As you can imagine, the productivity projects, we often talk about those in terms of what those mean in the manufacturing and cost of sales area. But our productivity in Lean Six Sigma projects go all the way into the SG&A area, as well.

We've got probably a majority of our projects geared around cost of sales-related projects. But there are quite a few that are in the SG&A area. And I would say that those oftentimes require a little more up front investment. Mark talked earlier about IT for example. We spent several million dollars in expense-related dollars in the IT conversions that we've made this past year to get us positioned to be able to leverage that going forward. So we'll see continued opportunities to lever that.

I think we have also been investing some of those savings back into the business, particularly in the area of R&D and product development. We've added quite a few engineering resources at our U.S. centers and we've also added resources at our India Technology Center. So initially there was some reinvestment versus dropping to the bottom line. But as we go forward, there is a full court press on taking out non-value added costs out of SG&A, and again, redeploying some of that to benefit our customers and our growth, but also dropping some of that to the bottom line. So, I think you will see some leveraging of that over time.

Okay. And can you comment also on the margin performance in the Mechanical unit? Obviously, very strong in Q4. Pretty strong in Q3, as well. Can we sort of look at the second half of '06 as being a normalized level of profitability from Mechanical? Or was there something that was inflating that? And can we sort of use those second half levels as kind of our base going forward?

I think using that as a base going forward is a pretty good proxy. The businesses that over the last two years that we have eliminated from our portfolio were well below the fleet average in Mechanical. So that's provided a permanent lift. As well as I think you're seeing the -- and you've been following the Company for quite a while, so I think you were with us in the days where every quarter there was more restructuring going on in Mechanical. And I think you're seeing the results of what was a pretty long process of -- it's pretty heavy lifting in our UK business, downsizing that or right-sizing that business. The move, several years ago, of Electric Gear business from California and combining that with our growth here. So I think you are seeing the benefits of the restructuring that was going on over a number of years.

Okay. And the second half is typically a little bit weaker on the margin in Mechanical groups? I mean, at least historically, that was the case. So these 11% to 13% margins, might that be a little bit better in the first half? Sort of how should we look at that?

Well, we're intent on improving our margins and our cost structure on all fronts. So I'd say we intend to continue to see those improve. I think that the first half in Mechanical is probably a little bit stronger than the second half as a general rule over a long period of time. Although, in total, the second and third quarters are pretty similar. The fourth quarter is typically a little weaker than the first quarter in terms of sales dollars. So first half is a little bit stronger.

Okay. And then last, I'll jump back in. But when we talk about seasonality, normal seasonality, honestly, given the 13 SEER and the acquisitions, I'm not sure what normal seasonality is for you guys any more. Can you give us some insight into what do you -- what do you envision being normal seasonality from a quarterly EPS? Is the first quarter typically 22, and the second and third quarter is X amount? Can you give us some sense of what normal seasonality is?

Well, I think you're right. It is tough with the last couple of years and the noise, and that. But generally, the second quarter is our -- has been our strongest quarter. Again, if you go way back, we were kind of taking the year and divide by four, as far as the sales distribution. That's migrated to where the second quarter is going to be our stronger quarter, probably followed by the third quarter. And then the first and the fourth being fairly similar. But again, not wildly out of bounds, I would say. Because from the weakest quarter to the strongest, it's not significant on the sales line. It's going to be a 200 basis point kind of differences. So -- .

What about on the EPS lines, as those sales differences get magnified? Same pattern, but magnified?

Yes, at this point, I would say it's not anything wildly out of bounds. Again, I think your caution is probably a good one. I don't know what normal necessarily means down to that level. But obviously, we provided only guidance for the first quarter. So -- .

Right. Okay. All right. Thank you.

[OPERATOR INSTRUCTIONS] Andrea Wirth, Robert W. Baird.

Just a question on profitability. You mentioned that the top line was essentially as you had expected. But just wondering if profitability maybe came in a little bit light? The only reason I'm asking is just wondering if the IT integration maybe caused some inefficiencies during the quarter, and maybe margins would have been a bit higher if not for that?

Well, let me just get two pieces. Actually the top line came in a little lighter than we expected when we went into the quarter. We were pretty pleased, really, with the way we leveraged the earnings, given the top line. There was some impact from that transition. But I would not rate it as overall specifically very significant to the quarter. Because it is a time when the business slows down anyway. We chose to do it when we did it because of that reason.

And then, just looking at the growth you had mentioned. The large industrial motors were up 9% in the quarter. Just wondering what the overall industrial motors business did? I'm guessing a little bit lighter than that?

Yes, if you take out the large and the HVAC, the commercial industrial motors remaining were low-single digits.

And then finally, just you had mentioned the new product, the ECM ThinkTank. Just curious what you think that the potential is for that business in rough numbers. I'm guessing it's not really kind of the home run like the X13. But kind of what do you think the potential is?

That product is all about our customer, and delivering value to them. And in most cases, replaces an existing product. There may be some further penetration that that product caused. But it's more about staying out in front, and delivering more value to that product, certainly as other people try to get into that space.

Is that primarily in the commercial HVAC market?

No, that would be in residential.

In residential. Okay. Great. Thanks, guys.

Great. Thank you. And at this time, then, I'd like to turn the call back for any closing comments from the management team.

All right. Thank you. And again, we want to thank everyone for joining the call. We really do appreciate your interest in Regal-Beloit. I think just the final closing thoughts were that overall, the quarter met expectations. Perhaps not as much as highly on the top line, but we were very pleased with our ability to leverage the earnings. The year in total was really just a terrific year in every regard. Our strategic initiatives are working, and we are very optimistic about where they're going to take us. As we look at the first quarter, we will see some of the same challenging comparison to the last year's first quarter that we saw in the fourth quarter. But we're very optimistic about the year in total, and about the future of Regal-Beloit. So with that, thank you for joining the call. Have a great day.

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thanks for your participation, and for using AT&T's Executive Teleconference. You may now disconnect.