UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-K

 

FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

 

(Mark one)
ý		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended March 31, 2005
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from                      to

 

Commission file number: 333-102428

 

 

Registrant’s telephone number, including area code:  (414) 643-3000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

 

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o  No ý

 

As of June 15, 2005, 3,622,031 shares of RBS Global, Inc. common stock, $0.01 par value, were outstanding.  There is no trading market for the common stock of RBS Global, Inc.

 

As of June 15, 2005, 1,000 shares of Rexnord Corporation common stock, $0.01 par value, were outstanding.  There is no trading market for the common stock of Rexnord Corporation.

 

 

TABLE OF CONTENTS

 

Part I
Item 1.		Business		2
Item 2.		Properties		11
Item 3.		Legal Proceedings		12
Item 4.		Submission of Matters to a Vote of Security Holders		13
Part II
Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		14
Item 6.		Selected Financial Data		15
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk		30
Item 8.		Financial Statements and Supplementary Data		30
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		68
Item 9A.		Controls and Procedures		68
Item 9B.		Other Information		68
Part III
Item 10.		Directors and Executive Officers of the Registrant		69
Item 11.		Executive Compensation		71
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		76
Item 13.		Certain Relationships and Related Transactions		78
Item 14.		Principal Accountant Fees and Services		79
Part IV
Item 15.		Exhibits and Financial Statement Schedules		80
		Signatures		84

 

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PART I

 

ITEM 1.                                                     BUSINESS.

 

RBS Global, Inc. (a Delaware corporation) is the parent company of Rexnord Corporation (a Delaware corporation), a holding company, which owns several domestic and foreign subsidiaries. On November 25, 2002, pursuant to a Stock Purchase Agreement between RBS Acquisition Corporation and Invensys plc (Invensys) and certain of its affiliates, RBS Acquisition Corporation acquired the net assets of the Rexnord Group (the Predecessor) for cash (the Acquisition). RBS Acquisition Corporation is a wholly owned subsidiary of Rexnord Corporation.

 

The consolidated financial statements in this Annual Report on Form 10-K include the accounts of RBS Global, Inc. and its subsidiaries (collectively, the Company) subsequent to the acquisition and also include the accounts of the Predecessor prior to the acquisition. The financial statements and financial data of the Predecessor are presented for comparative purposes and include the combined historical financial statements of the wholly owned subsidiaries and divisions of Invensys that were acquired by RBS Acquisition Corporation.

 

Unless otherwise noted, references to the Company, we, us and our, refer to RBS Global, Inc. and its subsidiary Rexnord Corporation, and its subsidiaries.  Our fiscal year is the year ending March 31 of the corresponding calendar year.  For example, our fiscal year 2005, or fiscal 2005, means the period from April 1, 2004 to March 31, 2005. As noted in Note 1 to the Consolidated Financial Statements, the Acquisition resulted in a new basis of accounting for the Company.  In some cases, for informational purposes only, financial data for the period from inception, November 25, 2002, through March 31, 2003 has been added to financial data of the Predecessor for the period from April 1, 2002 through November 24, 2002, to arrive at a 12-month combined period ended March 31, 2003.  This combined data may be referred to herein as fiscal year 2003, fiscal 2003 or 2003.

 

Although the Company is not required to file reports with the SEC under Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we voluntarily file such reports in accordance with the terms of the Indenture governing our 10 1/8% Senior Subordinated Notes due 2012, which were registered in May 2003 under the Securities Act of 1933 (Registration No. 333-102428).  As such, the Company is not deemed to be an “issuer” under the Sarbanes-Oxley Act of 2002, and is therefore not subject to certain of the requirements of that Act.

 

The address of our principal executive office is 4701 W. Greenfield Avenue, Milwaukee, Wisconsin, 53214.  Our phone number is (414) 643-3000.  Our Internet website address is www.rexnord.com.

 

We make available free of charge, on or through our Internet website, as soon as reasonably practicable after they are electronically filed or furnished to the SEC, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act.

 

Our Company

 

We are one of the leading manufacturers of highly-engineered mechanical power transmission components. Our product portfolio includes flattop chain and modular conveyer belts, industrial bearings, aerospace bearings and seals, special components, couplings and gears and industrial chain. Because of our innovative product design, premium products, brand reputation and long history of reliability, we have achieved a significant share in many of the markets we serve. Our products are used in the plants and equipment of companies in diverse industries, including food and beverage, energy, aerospace, forest products, cement and construction. We have a large installed base of products consisting primarily of moving, wearing components that are consumed in use and have a predictable replacement cycle. In addition, due to the complexity of our customers’ manufacturing operations and the high cost of process failures, our customers have demonstrated a strong preference to replace their worn Rexnord products with new Rexnord products. This replacement dynamic drives recurring replacement sales, which we refer to as aftermarket sales, that we estimate accounted for approximately 60% of our North American sales in fiscal 2005 (excluding special components).

 

We manufacture what we believe to be the broadest product portfolio of mechanical power transmission products in the industry in our 29 manufacturing facilities located around the world. Our products are either incorporated into products sold by original equipment manufacturers or sold to end-users through industrial distributors as aftermarket products.  As of March 31, 2005,

 

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we had approximately 4,800 employees, approximately 165 of whom are field sales persons who market and sell our products to over 2,000 original equipment manufacturers worldwide and to more than 400 industrial distributors. Our industrial distribution customers resell our products through over 1,900 distributor branches throughout the United States.

 

Recent Developments- Acquisition of The Falk Corporation

 

On May 16, 2005, we acquired The Falk Corporation (“Falk”) from Hamilton Sundstrand, a division of United Technologies Corporation, for $295 million in cash plus certain transaction related expenses and the assumption of certain liabilities.  Falk, which is also headquartered in Milwaukee, is a manufacturer of gears and couplings with annual revenues of approximately $200 million.  The acquisition of Falk was funded by a $312 million term loan obtained through an amendment to our existing Credit Agreement dated May 16, 2005.  See Management’s Discussion & Analysis and Notes 1 and 8 of the Notes to Consolidated Financial Statements for additional information on this acquisition and related financing.

 

With the acquisition of Falk, our annual net sales are expected to exceed $1.0 billion beginning in fiscal 2006.  Compared to March 31, 2005, we also increased our leverage profile due to the additional $312 million term loan used to finance this acquisition.  As of May 16, 2005, our total debt was approximately $819 million.   Based on our combined operations, we believe that cash flows from operations and available cash, together with available borrowings under our revolving credit facility, will be adequate to meet our future liquidity needs for the forseeable future.

 

Our Industry

 

Mechanical power transmission products are generally critical components in the end user’s machinery or plant in which they operate; yet they typically represent only a fraction of an end-user’s total production cost. However, because the cost of product failure to the end-user is substantial, we believe end-users in most of the markets we serve consider a number of factors, rather than price alone, when making a purchasing decision. We believe end-users of mechanical power transmission components place a premium on factors such as quality, reliability, availability and selection. The most successful industry participants are those that can leverage their products’ reputations for quality and reliability, as well as their distribution networks, to maintain attractive margins on products and gain market share.

 

The mechanical power transmission industry is fragmented, containing numerous participants, most with limited product lines in specific geographies. There are only a few national and international competitors of a size comparable to our own, including the Emerson Power Transmission Division of Emerson Electric, the Dodge Manufacturing Division of Rockwell Automation, Inc., Renold plc and Tsubakimoto Chain Company. The industry’s customer base is broadly diversified across many sectors of the economy. We believe that market growth in the mechanical power transmission industry is closely tied to overall growth in industrial production.

 

We operate in a single business segment and sell a single class of products, mechanical power transmission components.

 

Products

 

A description of the various types of mechanical power transmission components follows below:

 

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Flattop Chain

 

Our flattop chain is a highly-engineered conveyor chain that provides a smooth continuous conveying surface that is critical to high-speed operations such as those used to transport cans and bottles in beverage-filling operations, and is primarily sold to the food and beverage, consumer products and parts processing industries. Flattop chain products generally need to be replaced every 2 to 3 years on average. We manufacture our flattop chain products in our manufacturing facilities in Wisconsin, Puerto Rico, Italy and the Netherlands.  Our primary flattop chain products include:

 

•                  TableTop^® chain. We believe we are the leading manufacturer of unit link flattop chain, which we market as our TableTop® chain. Although unit link flattop chain was originally available only in metal, today we ship more plastic chain than metal as metal unit link flattop chain has been gradually replaced with plastic chain. We believe that we maintain the industry’s largest product portfolio of both plastic and metal unit link flattop chain.

 

•                    MatTop^® chain. MatTop^® chain is our brand of modular chain that is made completely of plastic. Modular chain has an inherent advantage over competing products such as rubber belt and roller conveyors due to its more precise functioning, lower maintenance requirements and corrosion resistance. Modular chain applications have gradually expanded to include beverage and unit handling, and we have positioned ourselves as one of the top suppliers of modular chain to the food and beverage and other unit handling industries.

 

•                  Conveyor components. We manufacture a full range of conveyor components that are sold in conjunction with our TableTop^® and MatTop^® chain products. These products, which include levelers and guide rails, enable us to offer a complete package of conveying and conveyor components.

 

 Market.  The flattop chain market has experienced and continues to undergo a shift towards plastic. We believe this trend towards plastic will continue in the flattop chain market as more food and beverage companies begin to replace their older conveyor lines and as container production continues to move away from the use of returnable glass bottles that have traditionally been conveyed on stainless steel chain. This trend has not yet significantly affected the European flattop chain market, however, as European manufacturers and processors have a propensity to use metal chains that conform to standardized designs. In addition, we believe there will be other additional growth opportunities as rubber belt and roller conveyor are replaced by newer technologies.

 

 Customers.  We market our flattop chain products directly to end-users, and market and sell these products to both original equipment manufacturers and distributors. Our key end-users include Anheuser-Busch, Coca-Cola Bottling, Nestlé, Pepsi Bottling and Procter & Gamble, and our key original equipment manufacturer customers include Sidel, KHS and Krones.

 

 Competition.  Our principal competitors include Intralox, Inc., System Plast S.p.A. and Habasit A.G. In addition, regional manufacturers with limited product offerings service portions of the remaining market.

 

Industrial Bearings

 

Industrial bearings are components that support, guide and reduce the friction of motion between fixed and moving machine parts. These products are primarily sold for use in the forest products, construction equipment, and agricultural equipment industries. Industrial bearings are sold either mounted or unmounted. We primarily produce mounted bearings, which are offered in a variety of specialized housings to suit specific industrial applications, and generally command higher margins than unmounted bearings. Bearings have an average replacement cycle of 1 to 2 years. We estimate that our aftermarket sales of industrial bearings products comprise more than half of our overall industrial bearings sales. We manufacture our industrial bearings products in our facilities in Indiana, Tennessee, Michigan and Illinois.  Our primary industrial bearings products include:

 

•                  Roller bearings. Roller bearings offer higher performance levels and can carry heavier loads than standard ball bearings. Our spherical roller bearings are technically advanced because they are self-aligning and thus do not require bearing adjustment during mounting.

 

•                  Ball bearings. Ball bearings are antifriction devices made up of hardened inner and outer rings between which hardened steel balls roll. We manufacture standard duty ball bearings used primarily in agri-farm, food processing and construction applications as well as heavy-duty ball bearings, which are desirable in applications such as high-speed air handling applications.

 

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•                  Cylindrical bearings. Cylindrical bearings contain “cylindrical” rollers that are crowned or end-relieved to reduce stress concentrations, which results in low friction and allows for high-speed applications. These bearings wear slowly, minimizing sudden breakdowns, and are known for their strength and durability.

 

•                  Filament and Sleeves. Filament bearings, sold under the Duralon^® brand name, are self-lubricating bearings that feature a woven Teflon^® fabric liner and can withstand demanding loads and speeds. Sleeve bearings, sold under the Link-Belt^® brand name, are durable as they are made of metal alloys and are typically compact in nature.

 

 Market.  We are one of the leading U.S. producers of mounted bearings. Market competition in the bearings industry is based primarily on cost, quality, on-time delivery and market access.

 

 Customers.  We sell our industrial bearings products to a variety of customers within numerous end-markets. Our principal bearings customers include Caterpillar, Eaton, Mercury Marine and Vermeer.

 

 Competition.  Competitors in the industrial bearings market include Emerson and Rockwell, and to a lesser extent, Minebea Co., Ltd., and Aktiebolegat SKF. Several multinational firms also are competitive in the unmounted bearing market including INA-Holding Schaeffler KG, Koyo Seiko Co., Ltd., NSK Ltd., NTN Bearing Corporation and Timken.

 

Aerospace Bearings and Seals

 

We supply our aerospace bearings and seals to the commercial aircraft, military aircraft and regional jet end-markets for use in door systems, engine controls, engine mounts, flight control systems, landing gear and rotor pitch control. The majority of our sales are to engine and airframe original equipment manufacturers that specify our products for their aircraft platforms. Our aerospace bearings and seals products consist of rolling element airframe bearings sold under the Shafer^® brand, slotted-entry and split-ball sliding bearings sold under the PSI^® brand name and aerospace seals that are sold under the Cartriseal^® brand name, which are primarily sold for use in both aerospace and industrial applications. Our aerospace bearings and seals products are manufactured in our facilities in Illinois and California and are supported by a direct sales organization, aerospace agents and distributors.

 

•                  Rolling element airframe bearings (Shafer^® bearing). We believe we are a leading supplier of rolling element airframe bearings. We also provide technical service, product development and testing, and have achieved a strong position in the high performance oscillating bearing market. Shafer^® roller bearings provide low friction, high load carrying capabilities and internal self-alignment and are used in landing gear, flight control systems and door systems.

 

•                  Slotted-entry and split-ball sliding bearings (PSI^® bearing). We believe we are a leading supplier of slotted-entry and split-ball sliding bearings. Slotted-entry bearings are utilized because of their reduced weight, smaller size and design flexibility, and are used primarily in landing gears, flight control systems and engine mounts. Split-ball sliding bearings are used for their unidirectional axial load capabilities, additional total bearing area, high capacity and greater stiffness, and are found in secondary control systems, such as slats and flaps, as well as applications such as landing gear retract actuators, and fixed end of flight control actuators. We also manufacture split-race bearings, used in landing gears where high load and stiffness are required, which provide equal axial load capabilities in either direction allowing more total bearing area, capacity and ease of installation and replacement.

 

•                  Aerospace seals (Cartriseal^®). We manufacture aerospace seals, turbine gearbox and accessory equipment seals, and small turbine mainshaft seals and refrigeration compressor seals. We also manufacture contacting face seals and non-contacting, or lift off, face seals, circumferential seals and specialty seals used in gas turbine engines, gearboxes, auxiliary power units, accessory equipment, refrigeration compressors, industrial turbines and compressors.

 

 Market.  The aerospace components industry is highly fragmented and consists of many small, specialized companies and a limited number of larger, well-capitalized companies. We compete in product-specific markets that we estimate have historically been under $100 million in revenues. The relatively small size of these markets, combined with the industry’s stringent regulatory approvals, quality requirements and certification processes, increase the barriers to entry for potential competitors. For example, all potential competitors must meet the certification requirements and qualification approvals required by the FAA and aircraft and engine original equipment manufacturers.

 

 Customers.  We sell our aerospace products to original equipment manufacturers, distributors and the U.S. government. The majority of our sales across these three business units are to engine and airframe original equipment manufacturers.  Our largest aerospace customers include Boeing, Airbus, GE Aerospace and Gulfstream.

 

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 Competition. Our primary competitors include Minebea, MRC Bearings, Inc., McKechnie Ltd., Kaydon Corporation and Perkin-Elmer, Inc.

 

Special Components

 

Our special components products are comprised of three primary product lines; electric motor brakes, miniature mechanical power transmission components and security devices for utility companies. These products are manufactured by three stand-alone niche businesses: Stearns, W.M. Berg and Highfield:

 

•                  Stearns. Stearns is a manufacturer of electric motor brakes, switches and clutches. These products are used in a wide variety of applications where safety or protection of people or equipment is required.

 

•                  W.M. Berg. W.M. Berg offers a complete line of miniature precision rotary and linear motion control devices in addition to a highly diverse product line consisting of gears, idlers, bearings, sprockets, cams, belts and couplings.

 

•                  Highfield. Highfield manufactures a broad range of utility company barrel lock and key systems, security hardware, specialty tools, metal-formed sealing devices, and safety valves. Its business is divided into four separate product groups, including security, oil valves, impellers and gas safety valves.

 

 Market.  Stearns’ products are used in a diverse range of applications, including steel mills, oil field equipment, pulp processing equipment, large textile machines, rubber mills, metal forming machinery and dock and pier handling equipment. W.M. Berg sells its products to a variety of markets, including semiconductor, telecommunications, medical equipment, robotics, instrumentation, office equipment, production tooling, digital imaging and printing, aerospace and automated vending. Highfield’s products are sold to a variety of markets, including electric, gas, water, telecommunications, utilities and plumbing and heating.

 

 Customers.  Stearns has a network of over 500 distributors servicing customers in numerous industries, including material handling, cranes, servomotors and actuators, conveyors, and single-phase motor manufacturers. Key Stearns customers include Baldor, General Electric, Reliance Electric Company, U.S. Electrical Motors, and W.W. Grainger, Inc. Approximately 75% of W.M. Berg’s sales are made to original equipment manufacturers with the remaining sales generally going through distributors. Key original equipment manufacturer customers include Applied Materials, Celestron, Cessna Aircraft, Cross Match Technologies, Inc. and Guidant Corporation. W.M. Berg’s primary distributors include Applied Industrial Technologies, Kaman and Motion Industries. For fiscal year 2005, the majority of Highfield’s sales were made to wholesalers, utilities and installers. Some key customers for our Special Components products include Baldor Electric, Cessna Aircraft, Consolidated Edison, the U.S. Motors division of Emerson Electric and Peoples Energy.

 

 Competition.  We compete against a wide variety of niche manufacturers in each of our respective markets. The competition is generally local or regional in nature.

 

Couplings and Gears

 

Couplings are primarily used in high-speed, high torque applications and are the interface between two shafts that permit power to be transmitted from one shaft to the other. Gearsets and gearboxes are used to reduce the output speed and increase the torque of an electric motor or engine to the level required to drive a particular piece of equipment. Our couplings and gears are sold to a variety of end-markets, including the chemical, petrochemical, food, steel, forest products and pulp and paper industries. Our couplings are manufactured in our facilities in Nebraska, Pennsylvania, Wisconsin, France and Germany. Our gear products are manufactured in our facilities in Louisiana, Pennsylvania, Texas, Virginia, China and Germany.

 

Couplings are comprised of our Flexible Disc and Elastomeric product lines and are sold under the Thomas^®, Omega^®, Rex^® Viva^®, Addax^® and ModulFlex^® brand names. Our gear products are sold under the Rex^®, Link-Belt^® and Prager™ brand names.

 

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•                  Flexible Disc. Flexible Disc couplings are non-lubricated, metal flexing couplings that are used for the transmission of torque and the accommodation of shaft misalignment. Our flexible disc couplings are sold under the Thomas^® and ModulFlex^® brands.

 

•                  Elastomeric. Elastomeric couplings are flexible couplings ideal for use in industrial applications such as pumps, compressors, blowers, mixers and many other drive applications and are marketed under the Rex Omega™ and Rex Viva^® brands.

 

•                  Gears. Our primary gear products are the S-3, Planetgear™, the Link-Belt^® Model R, the Link-Belt^® PIV and Link-Belt® shaft mount models. These products are sold primarily to the forest products and beverage industries.

 

•                  Service. Prager™ is our gearbox repair service company that has a manufacturing facility dedicated to the aftermarket.

 

 Market.  We estimate that the gear market in which we participate to be approximately $4.5 billion.  The market is both competitive and fragmented, with no dominant competitor.  In addition, industry participants are often regionally focused and produce a limited range of niche products.  The couplings market is estimated at approximately $1.0 billion in annual sales and generally follows the investment cycles of the industries it supplies. Global demand for couplings is split approximately equally between North America, Europe and the rest of the world. The couplings market is split between dry couplings and wet couplings. Although we are a supplier of coupling and gear products that are used in the infrastructure of automotive plants and facilities, we are not a supplier of automotive parts and, as a result, the mechanical power transmission industry which we primarily serve does not encompass the sale of such parts.

 

 Customers.  We sell our couplings and gearsets and gearboxes to a variety of customers in several end-markets, including the chemical, petrochemical, food, steel, forest products and pulp and paper industries. Due to the high number of customized applications in the couplings market, couplings are our only mechanical power transmission product group to have a greater percentage of sales through the original equipment manufacturer channel than in the aftermarket. Our key original equipment manufacturer customers for couplings and gearsets and gearboxes included ABB Robotics, Astec, Atlas Copco, Stamler Machine and the Carrier Division of United Technologies.

 

 Competition.  The market for couplings is fragmented with numerous manufacturers. Our primary competitors are Lovejoy, Inc., MetaStream (a unit of John Crane), TB Woods Corporation, Kop-Flex (a unit of Emerson) and, until May 2005, United Technologies’ Falk Corporation (see “Recent Developments” regarding our acquisition of The Falk Corporation in May 2005). The market for geared products is both large and fragmented. Our competitors include Flender Corporation, Rockwell and SEW.  Prior to May 2005, United Technologies’ Falk Corporation also was a significant competitor in the geared products market.

 

Industrial Chain

 

Our industrial chain products are manufactured in our facilities in Wisconsin, Germany and Brazil. These products are used in various applications in numerous industries, including food and food processing, beverage and container, construction and agricultural equipment, hydrocarbon processing and cement and metals processing. Our primary industrial chain products include:

 

•                  Engineered chain. Our engineered chain products, which are sold under the Link-Belt^® and Rex^® brand names, are designed and manufactured to meet the demands of customers’ specific applications. These products are used in many applications including cement elevators, construction equipment and conveyors, and they are supplied to the energy, forest products, cement and food and beverage processing industries.

 

•                   Roller chain. Our roller chain product line, which is marketed under the Rex^® and Link-Belt^® brand names, is supplied to a variety of industries primarily for conveyor and lifting applications. In the United States, roller chain is a product that is generally produced according to an American National Standards Institute specification. As a result, roller chain has largely become a standardized or commoditized product, with very little differentiation between product manufactured in North America and low-cost imports from China and India.

 

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Market.  The roller chain market is principally comprised of commodity products, manufactured to accommodate industry standards and specifications that are available from numerous sources. We believe we have a leading position in the North American market for engineered chain.

 

 Customers.  We market and sell our industrial chain products directly to original equipment manufacturers and distributors. In addition, we maintain a sales force that works directly with end-users, including Astec, Caterpillar, Charles Machine Works and Stamler.

 

 Competition.  Our primary competition within the North American roller chain market is Emerson Power Transmission and Tsubakimoto, while our primary competition in the North American engineered chain market is Renold and Tsubakimoto. Our primary foreign competitors for both markets include Sedis S.A., Kettenwulf and Daido.

 

Distribution

 

Our mechanical power transmission components are either incorporated into products sold by original equipment manufacturers or sold to end-users through industrial distributors as aftermarket products. With over 1,900 distributor locations in the United States, our distributors provide us with one of the most extensive distribution networks in the industry.  One of our industrial distributors accounted for 9.0%, 9.5%, 10.4%, and 12.5% of net sales during the years ended March 31, 2005 and 2004, and for the periods from November 25, 2002 through March 31, 2003 and April 1, 2002 through November 24, 2002, respectively.

 

Rather than serving as passive conduits for delivery of product, our industrial distributors participate in the overall competitive dynamic in the mechanical power transmission industry. Industrial distributors play a role in determining which of our products are stocked at their distributor centers and branch locations and, consequently, are most readily accessible to aftermarket buyers, and the price at which these products are sold.

 

We market our products both to original equipment manufacturers and directly to end-users to cultivate an end-user preference for our products. This customer preference is extremely important in differentiating our products from our competitors’ and in creating “pull-through” demand with original equipment manufacturers and distributors. In some instances, we have established a relationship with the end-user such that we, the end-user, and the end-user’s preferred distributor enter into a trilateral agreement whereby the distributor will purchase our products and stock them for the end-user. We believe our extensive product portfolio positions us to benefit from trends towards the rationalization of suppliers by industrial distributors.

 

Our products are moving, wearing components that are consumed in use and require regular replacement.  This gives rise to an on-going aftermarket opportunity.

 

Product Development

 

Throughout our history, we have demonstrated a commitment to developing technologically advanced products within the mechanical power transmission industry, resulting in 101 active U.S. patents and 350 foreign patents. In addition, we thoroughly test our products to ensure their quality, understand their wear characteristics and improve their performance. These practices have enabled us, together with our customers, to develop reliable and functional mechanical power transmission solutions.

 

The majority of our new product development begins with discussions and feedback from our customers. We have a team of approximately 150 engineers and technical employees who are organized by product line. Each of our product lines has technical staff responsible for product development and application support. If the product engineers require additional support or specialty expertise, they can call upon additional engineers and resources from Rexnord Technical Services.  Rexnord Technical Services is a group comprised of approximately 30 specialists that offers testing capability and support during the development process to all of our product lines. Our existing pipeline and continued investment in new product development are expected to drive revenue growth as we address key customer needs.

 

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Operations

 

Rexnord Business System

 

The goal of the Rexnord Business System is the elimination of unnecessary costs or waste from every business process. This operational excellence initiative has been and will continue to be implemented at all operating levels in order to reduce lead times and improve cash flow. The Rexnord Business System encompasses a lean enterprise strategy, the goals of which include improvement of inventory management, customer delivery, plant utilization and a lower cost structure. As a result of the Rexnord Business System, our operations have improved over the past three years, with a 22% inventory reduction and a 25% improvement in on-time delivery performance. In particular, we are transforming our manufacturing process from a typical batch system to a lean manufacturing system, which is based on the pursuit of the elimination of waste from every business process with the ultimate goal of providing world class quality, delivery and service to customers while maximizing the quality of earnings and return on investment. To help achieve this transformation, we have trained over 200 of our employees in selected RBS activities such as implementing value stream mapping, improving process flow and productivity, rolling out key Six Sigma initiatives and implementing electronic supplier Kanbans to improve production, lead times and reduce inventory.  Six Sigma is a process output variation of no more than plus or minus six standard deviations between the mean and the nearest specification limit. Six standard deviations equates to only 3.4 defects per million opportunities for each product or service transaction. Kanbans is a system that allows a company to manufacture a product or order supplies as needed. The system reduces production lead times, amount of inventory required, and subsequently, costs in high volume production lines.

 

In addition, as part of the Rexnord Business System, we initiated a strategic sourcing program to reduce the number of suppliers and lower the cost of purchased materials. With this program we intend to reduce significantly the number of direct and indirect suppliers we use.

 

Going forward, we expect to continue to redefine our manufacturing processes and implement our lean transformation initiatives. Our near-term goals for improvement include additional reductions of inventory, a further improvement of on-time delivery and a significant improvement in quality.

 

Suppliers and Raw Materials

 

The principal materials used in our manufacturing processes are commodities that are available from numerous sources. The key metal materials used in our manufacturing processes include: sheet, plate and bar steel, castings, forgings and a variety of components. The key non-metal materials used include high-performance engineered plastic. We believe there is a readily available supply of materials in sufficient quantity from a variety of sources. We have not experienced any significant shortage of our key materials and have not historically engaged in hedging transactions for commodity supplies.

 

We generally purchase our materials on the open market. However, in certain situations we have found it advantageous to enter into contracts for certain large commodity purchases, although currently we are not a party to any unconditional purchase obligations, including take-or-pay contracts or through-put contracts. In the past, these contracts generally have had one to five-year terms and have contained competitive clauses and benchmarking to ensure competitive pricing.

 

Trademarks and Patents

 

We rely on a combination of patents, trademarks, copyright and trade secret protection, employee and third party non-disclosure agreements, license arrangements and domain name registrations to protect our intellectual property.  No single patent, trademark or trade name is material to our business as a whole.

 

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Some of our trademarks include: Rex®, Link Belt®, MB®, Duralon®, Thomas®, Omega®, Rex® Viva®, Addax®, ModulFlex®, Shafer® Bearing, PSI® Bearing, Cartriseal®, Planetgear™ and Prager™.

 

Backlog

 

The Company’s backlog of unshipped orders was $159.7 million and $133.1 million at March 31, 2005 and 2004, respectively.

 

Financial Information about Geographic Areas

 

Refer to Note 15 of Notes to Consolidated Financial Statements for financial information about geographic areas.

 

Seasonality of Demand

 

We do not experience significant seasonality of demand, although sales generally are slightly higher during our fourth fiscal quarter as our customers spend against recently approved capital budgets and perform maintenance and repairs in advance of spring and summer activity.

 

Employees

 

As of March 31, 2005, we had approximately 4,800 employees, of whom 3,151 were employed in the United States while the remainder were employed abroad. Approximately 800 of our North American employees are represented by labor unions. The five U.S. collective bargaining agreements to which we are a party will expire in July 2005, February 2006, September 2006, August 2007 and April 2008.  Additionally, approximately 23% of our workforce is employed in Europe, where trade union membership is common. The Company believes it has a good relationship with its employees, including those represented by labor unions.

 

10

 

ITEM 2.                                                     PROPERTIES.

 

We currently maintain 29 manufacturing facilities, 21 of which are located in North America, six in Europe, one in South America and one in Asia. With the exception of one plant located in Downers Grove, Illinois each of our facilities is dedicated to the manufacture of a single product line.  All of our facilities listed below are suitable for their respective operations and provide sufficient capacity to meet reasonably foreseeable production requirements.

 

We own and lease facilities throughout the United States and in several foreign countries. Listed below are the locations of our principal manufacturing facilities:

 

 

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ITEM 3.                                                     LEGAL PROCEEDINGS.

 

We are involved in various unresolved legal actions, administrative proceedings, and claims in the ordinary course of our business involving, among other things, product liability, commercial, employment, workers’ compensation, intellectual property claims and environmental matters.  We establish reserves in a manner that is consistent with accounting principles generally accepted in the United States for costs associated with such matters when liability is probable and those costs are capable of being reasonably estimated. Although it is not possible to predict with certainty the outcome of these unresolved legal actions or the range of possible loss or recovery, based upon current information, we believe the eventual outcome of these unresolved legal actions either individually, or in the aggregate, will not have a material effect on the financial position, results of operations or cash flows of the Company.

 

In a prior year, the Predecessor initiated legal proceedings against a consulting firm for nonperformance with respect to process reengineering services the consulting firm was retained to perform for the Predecessor.  A jury trial was held in 2001, and a verdict of $2.2 million was returned in favor of the Predecessor, including an award of attorney’s fees of $0.6 million.  In May 2002, the consulting firm unsuccessfully exhausted its right of appeal at which time the Predecessor received $2.3 million, including interest of $0.1 million and recorded a gain.

 

In connection with the sale of the Predecessor, Invensys has indemnified us against certain contingent liabilities.  Invensys has also indemnified us for all preclosing environmental liabilities which individually exceed $75,000 and which in the aggregate exceed $2.0 million.

 

The following paragraphs summarize noteworthy actions and proceedings against which we have been indemnified:

 

•                  We are a defendant in a case entitled GE Transportation Systems v. Rexnord, pending in the United States District Court for the Western District of Pennsylvania. The case seeks $8.0 million for damages allegedly incurred by GE in using Rexnord bearings to retrofit GE locomotives. The ultimate outcome of this litigation cannot presently be determined; however, we believe we have meritorious defenses to the suit.

 

•                  We are a third-party defendant in two separate class action suits for alleged groundwater contamination in the United States District Court for the Northern District of Illinois: Teresa and Al LeClercq et al v. Lockformer et al v. Arrow Gear Company et al and Mejdrech et al v. Met-Coil Systems/The Lockformer Company v. Arrow Gear Company et al. The original defendant, Lockformer Company, has settled with the LeClercq plaintiffs for $10 million and with the Mejdrech plaintiffs for $12.5 million. Lockformer is now seeking contribution under various theories of alleged groundwater contamination in Lisle, Illinois from at least ten other companies, including us. The contribution claims for both suits have been combined into one suit. The outcome of this litigation cannot presently be determined; however, we believe we have not contributed to the groundwater contamination and have meritorious defenses to the suit.  We have sued and been sued by our insurance companies over coverage for the Lockformer matter.

 

•                  We are a potentially responsible party (“PRP”) at the Ellsworth Industrial Park Site, Downers Grove, DuPage County, Illinois (the Site), which is under investigation by the USEPA and IEPA. The investigation alleges there has been a release or threatened release of hazardous substances, pollutants or contaminants at the Site. Based on their proximity to the Site, we and at least ten other companies have been notified of their potential liability for the remediation of the Site. In support of USEPA/IEPA, Illinois filed a lawsuit in the Circuit Court of DuPage County, Illinois against us and the other PRP companies: State of Illinois v. Precision et al.  Subsequently, we and at least ten other companies entered into an Administrative Order by Consent (AOC) with USEPA/IEPA/Illinois et al that provides $4.275 million to fund the hook-up of about 800 homes to municipal water and provides for continuing investigation of the Site.  We have agreed to provide $273,000 of that fund under an interim allocation. Recently we were notified by the USEPA that the Site investigation is expanding.  We are a defendant in three other lawsuits stemming from the Site:   Muniz et al v. Rexnord Corporation et al, a class action pending in the United States District Court for the Northern District of Illinois; Jana Bendik v. Precision Brand Products et al v. Rexnord Corporation et al, filed by an individual plaintiff in the Circuit Court of Cook County, Illinois; and Kevin Pote, et al v. Ames Supply Co. et al., filed by an individual plaintiff in the Circuit Court of Cook County, Illinois.  The AOC is expected to resolve a significant portion of the State of Illinois and Muniz lawsuits. The ultimate outcome of the Ellsworth investigation and related litigation cannot presently be determined; however, we believe we have meritorious defenses to the suits.  We have sued and been sued by its insurance companies over coverage for the Ellsworth matters.

 

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•                     We were a defendant and cross-defendant in a case entitled Odeco Drilling Inc., et al. v. Baroid Equipment, Inc., filed in state court in Harris County, Texas.  On February 26, 2002, the Court entered a final judgment in favor of Baroid Equipment, Inc. and Varco Shaffer Co. (“Defendants/Cross-Plaintiffs”) against us in the amount of approximately $2.3 million, plus pre-judgment interest of 10% beginning October 16, 1992.  The judgment provides for a further award of attorneys’ fees to the Defendants/Cross-Plaintiffs in the event of appeals.  This judgment is currently on appeal in the Houston Court of Appeals. We vigorously dispute the claims made the basis of the judgment and intend to prosecute its appeal of the judgment.  We are indemnified against any loss by two separate parties in connection with this matter.  Accordingly, we have recorded a liability at March 31, 2005 in the amount of the judgment plus accrued interest totaling $7.6 million and a corresponding receivable in the same amount.  Both the liability and corresponding receivable are classified as a noncurrent liability and asset, respectively, in the accompanying consolidated balance sheet.

 

In addition to the foregoing litigation, The Falk Corporation, which we acquired in May 2005, is a defendant in certain lawsuits.  While we have not completed our post-acquisition review of these matters, and have not formed our own judgment about the likely outcomes of these matters, we believe that the following descriptions of the claims in each lawsuit are materially correct.  As with the matters described above, it is not possible to predict with certainty the outcome of these unresolved legal actions.  However, based upon current information we believe the eventual outcome of these unresolved legal actions either individually, or in the aggregate, will not have a material effect on the financial position, results of operations or cash flows of the Company.

 

Roanoke Cement Company v. The Falk Corporation and Hamilton Sundstrand Corporation, filed in the U.S. District Court of Virginia.  The suit alleges that a defective pinion caused cement production to shut down.  Roanoke received an insurance settlement of $1.35 million.  In July 2004, a directed verdict in favor of the defendants was granted in connection with the insurance subrogation claim.  Roanoke appealed and their appeal is pending.

 

Kimberly St. Cin, Individually and as surviving spouse of St. Robert Cin, decedent, v. The Falk Corporation, et al., filed in the Circuit Court of Cape Girardeau County, Missouri.  The suit was filed against The Falk Corporation and several other defendants for wrongful death involving an elevator bucket loader. The claim amount is for $9 million. The drive and backstop were allegedly manufactured by The Falk Corporation.

 

ITEM 4.                                                     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

No matters were submitted to a vote of security holders during the fourth quarter ended March 31, 2005.

 

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PART II

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

                              Market Information

 

No trading market for RBS Global, Inc. common stock or Rexnord Corporation common stock currently exists.

 

                              Dividends

 

RBS Global, Inc. and Rexnord Corporation did not pay dividends in the period from inception, November 24, 2002, through March 31, 2005, on their common stock, and it is our current policy to retain earnings to repay debt and finance our operations. In addition, our credit facility significantly restricts the payment of dividends on common stock.

 

                              Holders

 

As of June 15, 2005, there were 22 holders of record of the common stock of RBS Global, Inc.  RBS Global, Inc. is the sole shareholder of Rexnord Corporation’s common stock.

 

                              Securities Authorized for Issuance under Equity Compensation Plans

 

See “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” located elsewhere in this report.

 

                              Securities Sold as of June 15, 2005

 

At various times during the course of our last fiscal year, directors, employees and consultants of RBS Global, Inc., Rexnord Corporation and its subsidiaries exercised options to purchase an aggregate of 19,427 shares of RBS Global, Inc. Common Stock (“RBS Common Stock”) at a price of $100.00 per share, for total consideration of $1,942,700.  The shares were sold pursuant to exemptions available under the Securities Act of 1933, as amended (the “Securities Act”), including Rule 701 promulgated thereunder.  All options were exercised at the discretion of the option holder after they had become fully vested, in accordance with the terms of the respective option grant.

 

On May 13, 2005, an affiliate of the majority shareholder purchased 334 shares of stock at a price of $150 per share for a total consideration of $50,100.  The shares were sold pursuant to exemptions available under the Securities Act, including Regulation D.

 

From May 13, 2005 to June 1, 2005, participants in the RBS Global, Inc. Stock Purchase Plan purchased an aggregate of 6,269 shares of RBS Common Stock at a price of $150 per share, for aggregate consideration of $940,350.  Eligible participants in the Plan are employees, directors and consultants of RBS Global, Inc., Rexnord Corporation and its subsidiaries.  The shares were sold pursuant to exemptions available under the Securities Act, including Rule 701 promulgated thereunder.

 

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ITEM 6.                                                     SELECTED FINANCIAL DATA.

 

The following table of selected historical financial information is based on our consolidated financial statements included elsewhere in this Form 10-K. This data should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8, Financial Statements and Supplementary Data.  The Statement of Income Data, Other Data and Balance Sheet Data are derived from our audited financial statements.  Separate historical financial information of Rexnord Corporation is not presented because the senior subordinated notes are guaranteed by RBS Global, Inc. and all direct and indirect subsidiaries of Rexnord Corporation and RBS Global, Inc., and because RBS Global, Inc. has no significant operations or assets separate from its investment in Rexnord Corporation.

 

											Predecessor Basis of Accounting (1)
		Fiscal Year Ended March 31						Period From November 25, 2002 through March 31,			Period From April 1, 2002 through November 24,			Fiscal Year Ended March 31
(dollars in millions)		2005			2004			2003			2002			2002			2001
Statement of Income Data:
Net Sales		$	811.0		$	712.8		$	252.5		$	469.3		$	722.2		$	801.3
Cost of Sales (2)		555.8			485.4			162.1			310.5			477.1			485.9
Gross Profit		255.2			227.4			90.4			158.8			245.1			315.4
Selling, General and Administrative Expenses		153.6			148.1			52.9			103.1			146.2			157.1
Restructuring and Other Similar Costs		7.3			2.6			—			7.5			55.9			21.8
Curtailment Gain		—			(6.6		)	—			—			—			—
Income from Litigation Settlement		—			—			—			(2.3		)	—			—
Amortization of Intangible Assets		13.8			13.9			4.6			1.1			18.8			18.5
Income from Operations		80.5			69.4			32.9			49.4			24.2			118.0
Net Interest Expense		(44.0		)	(45.4		)	(16.3		)	(13.0		)	(24.0		)	(37.4		)
Other Income (Expense), Net		(0.7		)	(1.1		)	(0.5		)	(0.1		)	0.9			0.1
Income Before Income Taxes		35.8			22.9			16.1			36.3			1.1			80.7
Provision for Income Taxes		14.2			8.7			6.5			16.0			9.6			37.0
Net Income (Loss)		$	21.6		$	14.2		$	9.6		$	20.3		$	(8.5	)	$	43.7
Other Data:
EBITDA (3)		$	125.2		$	113.7		$	47.2		$	73.5		$	77.7		$	171.1
Net Cash Provided By (Used For)
Operating Activities		67.4			45.0			51.1			(27.0		)	66.0			75.6
Investing Activities		(19.3		)	(30.7		)	(920.0		)	(11.2		)	(14.6		)	(33.3		)
Financing Activities		(42.0		)	(31.2		)	906.3			16.4			(52.2		)	(49.8		)
Depreciation and Amortization		45.4			45.4			14.8			24.2			52.6			53.0
Capital Expenditures		25.7			22.1			6.9			11.8			21.7			33.7

 

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		March 31,									Predecessor Basis of Accounting (1) March 31
(dollars in millions)		2005			2004			2003			2002			2001
Balance Sheet Data:
Cash		$	26.3		$	21.8		$	37.2		$	21.6		$	22.3
Working Capital (4)		118.9			117.6			135.8			110.1			127.5
Total Assets		1,277.4			1,299.1			1,314.2			1,183.4			1,287.3
Total Debt (5)		506.7			550.8			580.5			412.9			464.2
Stockholders’ Equity		424.7			399.1			375.0			477.3			488.2

 

(1)          Consolidated financial data as of March 31, 2005, 2004 and 2003 and for fiscal 2005, 2004 and the period from November 25, 2002 (the date of the Acquisition) through March 31, 2003 reflect the fair value of assets acquired and liabilities assumed in connection with the Acquisition. The comparability of the operating results for the periods presented is affected by the revaluation of the assets acquired and liabilities assumed on the date of the Acquisition. The financial data for periods prior to November 25, 2002 have a different basis of accounting and are presented for informational purposes and consist of the combined historical financial data of the wholly-owned subsidiaries of Invensys plc and its affiliates that were acquired by RBS Acquisition Corporation and other affiliated purchasers in the Acquisition (“Predecessor Basis of Accounting”).

 

(2)          Due to rising raw material costs and changes to manufacturing processes in fiscal 2005, the Company re-evaluated its process for capitalizing overhead costs into inventory.  As a result, the Company revised certain estimates related to the capitalization of overhead variances which reduced cost of sales by $7.0 million in fiscal 2005.  During fiscal 2002, the Predecessor revised its methodology for capitalizing overhead costs into inventory which reduced cost of sales by $3.8 million in fiscal 2002.

 

(3)          EBITDA represents earnings before interest, taxes, depreciation and amortization.  EBITDA is presented because management believes it is an important supplemental measure of performance and it is frequently used by analysts, investors and other interested parties in the evaluation of companies in our industry. EBITDA is also useful to investors in evaluating the performance of issuers of “high-yield” debt securities because it is a common measure of the ability to meet debt service obligations. Other companies in our industry may calculate EBITDA differently.  EBITDA is not a measurement of financial performance under generally accepted accounting principles and should not be considered as an alternative to net income as an indicator of operating performance or any other measures of performance derived in accordance with generally accepted accounting principles.  Because EBITDA is calculated before recurring cash charges, including interest expense and taxes, and is not adjusted for capital expenditures or other recurring cash requirements of the business, it should not be considered as a measure of discretionary cash available to invest in the growth of the business.  A reconciliation of Net Income (Loss) to EBITDA is as follows:

 

											Predecessor Basis of Accounting (1)
		Fiscal Year Ended March 31						Period From November 25, 2002 through March 31,			Period From April 1, 2002 through November 24,			Fiscal Year Ended March 31
(dollars in millions)		2005			2004			2003			2002			2002			2001
Net Income (Loss)		$	21.6		$	14.2		$	9.6		$	20.3		$	(8.5	)	$	43.7
Interest Expense, net		44.0			45.4			16.3			13.0			24.0			37.4
Provision for Income Taxes		14.2			8.7			6.5			16.0			9.6			37.0
Depreciation and Amortization		45.4			45.4			14.8			24.2			52.6			53.0
EBITDA		$	125.2		$	113.7		$	47.2		$	73.5		$	77.7		$	171.1

 

EBITDA for the fiscal year ended March 31, 2005 includes $7.3 million of restructuring charges, a $2.0 million LIFO charge and a $1.6 million charge related to the write-off of excess and obsolete inventory that was on-hand at the Acquisition date for which no reserves were established in purchase accounting.  EBITDA for the fiscal year ended March 31, 2004 includes $2.6 million of restructuring charges, a $0.4 million LIFO benefit and a $6.6 million curtailment gain related to our pension and postretirement plans.  EBITDA for the twelve months ended March 31, 2003 includes $7.5 million of restructuring charges, a $0.3 million LIFO benefit and $2.3 million of income from a  litigation settlement.

 

(4)          Represents total current assets less total current liabilities.

 

(5)          Total debt includes intercompany loans in 2002 and 2001 with our former parent, net, plus long-term debt.

 

16

 

ITEM 7.                                                     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF   OPERATIONS.

 

The consolidated financial statements contained in Item 8 include the accounts of RBS Global, Inc. and subsidiaries (collectively, the Company) subsequent to the Acquisition, and also include the accounts of the Predecessor for periods prior to the Acquisition which have a different basis of accounting.  The financial statements and financial data of the Predecessor are presented for comparative purposes and include the combined historical financial statements of the wholly owned subsidiaries and divisions of Invensys that were acquired by RBS Acquisition Corporation.  The Predecessor ceased operations as of the date of acquisition.

 

The following discussion of our financial condition and results of operations should be read together with the Selected Financial Data and our consolidated financial statements and the accompanying notes included elsewhere in Item 8.  Our fiscal year is the year ending March 31 of the corresponding calendar year.  For example, our fiscal year 2005, or fiscal 2005, means the period from April 1, 2004 to March 31, 2005. As noted in Note 1 to the Consolidated Financial Statements, the Acquisition resulted in a new basis of accounting for the Company.  In some cases, for ease of comparison purposes, financial data for the period from inception, November 25, 2002, through March 31, 2003 has been added to financial data for the period from April 1, 2002 through November 24, 2002, to arrive at a 12-month combined period ended March 31, 2003.  This combined data may be referred to herein as fiscal year 2003, fiscal 2003 or 2003.

 

General

 

We believe that we are one of the leading manufacturers of highly-engineered mechanical power transmission components. We manufacture and market a very broad product portfolio, including flattop chain and modular conveyor belts, industrial bearings, aerospace bearings and seals, special components, couplings and gears and industrial chain. Our products are used in the plants and equipment of companies in diverse industries, including food and beverage, energy, aerospace, forest products, cement and construction. Our products are either incorporated into products sold by original equipment manufacturers or sold to end-users through industrial distributors as aftermarket products. We have a large installed base of products consisting primarily of moving, wearing components that are consumed in use and have a predictable replacement cycle. Although our results of operations are dependent on general economic conditions, our large installed base generates aftermarket sales that partially mitigate the impact of economic downturns on our results of operations.

 

The mechanical power transmission industry is comprised of numerous participants, most serving specific geographies with discrete product lines.  The industry’s end-user base is broadly diversified across many sectors of the economy and end-users increasingly are focusing on limiting their supplier base, creating the opportunity for companies with broader product offerings to capture additional market share.

 

The mechanical power transmission products sold by industry participants generally are critical components in the machinery or plant in which they operate and range from highly-engineered products, such as flattop conveyor chain, to products that are more commoditized in nature, such as roller chain. Regardless of the level of sophistication of the product, mechanical power transmission components typically represent only a fraction of an end-user’s total production cost. However, because the cost of product failure to the end-user is substantial, we believe end-users of mechanical power transmission components look to quality, reliability, service, availability and selection, rather than price alone, in making their purchasing decisions.

 

In recent years, we have increased our manufacturing focus on highly-engineered products, rather than lower margin commodity products or products with commodity-like qualities. On the other hand, we do continue to manufacture roller chain in Europe. We are continuing to explore outsourcing opportunities for components where high-quality, low-cost sourcing alternatives are available.

 

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Impact of the Acquisition and Related Financing Transactions

 

On November 25, 2002, pursuant to a Stock Purchase Agreement between RBS Acquisition Corporation and Invensys plc (Invensys) and certain of its affiliates, RBS Acquisition Corporation acquired the net assets of the Rexnord Group (the Predecessor) for $923.9 million, including direct costs of the acquisition of $11.8 million (the Acquisition). RBS Acquisition Corporation is a wholly owned subsidiary of Rexnord Corporation. The purchase price was financed by a $359.5 million equity investment from affiliates of The Carlyle Group and certain members of management of the Company, $360.0 million of term loans and $225.0 million of senior subordinated notes.  Accordingly, our interest expense currently is and will continue to be higher than it was prior to the Acquisition.

 

We accounted for the Acquisition using the purchase method of accounting and accordingly, the Acquisition resulted in a new basis of accounting for us. We allocated the purchase price on the basis of fair values of the underlying assets acquired and liabilities assumed. Based on a valuation by third party professionals retained by us, a significant portion of the purchase price was allocated to our trademarks and tradenames, a covenant not to compete, patents and our distribution network. We also retained third party professionals to assist in the determination of the fair value of our property, plant and equipment as well as pension and post-retirement obligations. The excess of the total purchase price over the value of our assets at closing was $575.1 million and has been allocated to goodwill, and this indefinite lived asset is subject to annual impairment review. The test for impairment was conducted in the fourth quarter of our fiscal 2005 and no impairment was found for any reporting unit.

 

Financial Statement Presentation

 

The following paragraphs provide a brief description of certain items and accounting policies that appear in our financial statements and general factors that impact these items.

 

Net Sales.  Net sales represent gross sales less deductions taken for sales returns and allowances and incentive rebate programs.

 

As discussed above, our products are industrial products that are used in a number of diverse end-markets and consist of moving, wearing components that are consumed in use. As a result of these characteristics, we believe our net sales are primarily driven by overall changes in the general economy and, specifically, changes in industrial production, the replacement cycles of our products and the maintenance and capital spending trends of the end-users of our products. In addition, the cyclicality of the industries in which our end-users operate also can affect our net sales. Our relative strength in certain end-markets, however, such as food and beverage, and our aftermarket sales through our distributors, which historically have not been as dependent on economic conditions as our sales to original equipment manufacturers, partially mitigate the impact of this market cyclicality.

 

Changes in levels of our net sales historically have lagged behind changes in the levels of overall industrial production by three to six months, both when industrial production is increasing and when it is declining. This lag is a result of order lead times and end-user budget cycles as well as levels of existing inventory at our distributors, which levels historically have been lower at the end of economic downturns. Any reduction in inventory held by our industrial distributors has a negative impact on our sales to industrial distributors during that same period. Similarly, during a rising economic environment, historically we have experienced a positive impact on our sales from both increased current direct demand from end-users as well as from the replenishment of inventory by our industrial distributors. However, in fiscal 2005 we believe this trend changed somewhat as our industrial distributor customers maintained relatively flat inventory levels while the industrial economic environment improved.  As a result, our fiscal 2005 sales growth was driven almost entirely by increased end-user demand.

 

Cost of Sales.  Cost of sales includes all costs of manufacturing required to bring a product to a ready for sale condition. Such costs include direct and indirect materials, direct and indirect labor costs, including fringe benefits, supplies, utilities, depreciation, insurance, pension and post-retirement benefits, information technology costs and other manufacturing related costs.

 

18

 

The largest component of our cost of sales is cost of materials, which represented approximately 28% of net sales in fiscal 2005.  The principal materials used in our manufacturing processes are commodities that are available from numerous sources and include sheet, plate and bar steel, castings, forgings, high-performance engineered plastics and a wide variety of other components. We have a strategic sourcing program to significantly reduce the number of direct and indirect suppliers we use and to lower the cost of purchased materials.

 

The next largest component of our cost of sales is direct and indirect labor, which represented approximately 24% of net sales in fiscal 2005. Direct and indirect labor and related fringe benefit costs are susceptible to inflationary trends. As we continue to implement the Rexnord Business System with the goal of eliminating waste from business processes at all business levels, including labor input, we expect that any productivity gains from the Rexnord Business System will help to offset inflationary price pressure on labor and benefit costs.

 

 Selling, General and Administrative Expenses.  Selling, general and administrative expense primarily includes sales and marketing, finance and administration, engineering and technical services and distribution. Our major cost elements include salary and wages, fringe benefits, pension and post-retirement benefits, insurance, depreciation, advertising, travel and information technology costs.

 

Critical Accounting Estimates

 

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our consolidated financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate and different assumptions or estimates about the future could change our reported results.

 

We believe the following accounting policies are the most critical to us in that they are important to our financial statements and they require our most difficult, subjective or complex judgments in the preparation of our consolidated financial statements.

 

Revenue recognition.  Sales are recorded upon transfer of title of product, which occurs upon shipment to the customer. Because we enter into sales rebate programs with some of our customers, which require us to make rebate payments to them from time to time, we estimate amounts due under these sales rebate programs at the time of shipment. Net sales relating to any particular shipment are based upon the amount invoiced for the shipped goods less estimated future rebate payments and sales returns. These rebates are primarily volume-based and are estimated based upon our historical experience. Revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known to us.  The value of returned goods during fiscal 2005, fiscal 2004 and for the periods from November 25, 2002 through March 31, 2003, and April 1, 2002 through November 24, 2002 was less than 0.5% of net sales.  Other than our standard one-year product warranty, there are no post-shipment obligations.

 

19

 

Inventory.  We value inventories at the lower of cost or market. Cost of certain domestic inventories are determined on a last-in, first-out (LIFO) basis. Cost of the remaining domestic inventories and all foreign inventories are determined on a first-in, first-out (FIFO) basis. The valuation of inventories includes variable and fixed overhead costs and requires significant management estimates to determine the amount of overhead variances to capitalize into inventories.  Due to rising raw material costs and changes to manufacturing processes in fiscal 2005, we re-evaluated our process for capitalizing overhead costs into inventory.  As a result, we revised certain estimates related to the capitalization of overhead variances which reduced cost of sales by $7.0 million in fiscal 2005.

 

In some cases we have determined a certain portion of our inventories are excess or obsolete. In those cases, we write down the value of those inventories to their net realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. The total write-down of inventories charged to expense was $3.1 million, $1.5 million, $0.4 million and $1.6 million during the fiscal year ended March 31, 2005 and 2004, and the periods from November 24, 2002 through March 31, 2003, and April 1, 2002 through November 24, 2002, respectively.

 

Impairment of intangible assets and tangible fixed assets.  Our intangible assets and tangible fixed assets are held at historical cost, net of depreciation and amortization, less any provision for impairment. Tangible fixed assets are depreciated to their residual values on a straight-line basis over their estimated useful lives as follows:

 

Land		No depreciation
Buildings and improvements		13 to 50 years
Machinery and equipment		3 to 13 years
Hardware and software		3 to 5 years

 

An impairment review of intangible or tangible fixed assets is performed if an indicator of impairment, such as an operating loss or cash outflow from operating activities or a significant adverse change in the business or market place, exists.  Estimates of future cash flows used to test the asset for impairment are based on current operating projections extended to the useful life of the asset group and are, by their nature, subjective.

 

As described in Note 1 to the Consolidated Financial Statements, the excess of the cost of the Company’s acquisition of the Rexnord Group over the fair value of the net tangible and intangible assets acquired of $575.1 million has been allocated to goodwill.  This goodwill is not amortized but is reviewed annually for impairment.  The test for impairment was conducted in the fourth fiscal quarter of the year ended March 31, 2005 and no impairment was found for any reporting unit.

 

The Company is expected to recognize amortization expense of $13.8 million in the fiscal year ending March 31, 2006, $10.0 million in the fiscal year ending March 31, 2007, $2.5 million in the fiscal year ending March 31, 2008, $2.4 million in the fiscal year ending March 31, 2009, and $2.4 million in the fiscal year ending March 31, 2010.

 

As a result of the Acquisition, the intangible and tangible fixed assets were adjusted to their fair value in accordance with purchase accounting as prescribed by SFAS 141.

 

 Retirement benefits.  Pension obligations are actuarially determined and are affected by assumptions including discount rate and assumed annual rate of compensation increase for plan employees, among other assumptions. Changes in discount rate and differences from actual results for each assumption as well as the actual return on plan assets compared to the expected rate of return on plan assets will affect the amount of pension expense we recognize in future periods.  As of March 31, 2005, our pension plans had benefit obligations of $237.5 million as compared to plan assets of $141.3 million. Approximately $41.3 million of the total $96.2 million of benefit obligations in excess of plan assets is related to plans of our foreign subsidiaries, principally in Germany, where such plans are typically not funded.

 

Market interest rates continued to decline during fiscal 2005 and, as a result, after consultation with our actuarial consultants, we reduced the discount rate from 6.07% at March 31, 2004 to 5.78% at March 31, 2005.  Our estimated return on plan assets was reduced from 9.0% in fiscal 2004 to 8.5% in fiscal 2005 based on historical experience.

 

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The obligation for post-retirement benefits other than pension also is actuarially determined and is affected by assumptions including the discount rate and expected future increase in per capita costs of covered post-retirement health care benefits. Changes in the discount rate and differences between actual and assumed per capita health care costs may affect the recorded amount of the expense in future periods.

 

 Income taxes.  At the end of each interim period, we estimate the effective tax rate expected to be applicable for the full fiscal year. The estimated effective tax rate contemplates the expected jurisdiction where income is earned as well as tax planning strategies. If the actual results are different from our estimates, adjustments to the effective tax rate may be required in the period such determination is made.

 

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. As a result of this review, we have established a full valuation allowance against our deferred tax assets related to foreign and certain state net operating loss carryforwards.

 

Recent Developments- Acquisition of The Falk Corporation

 

On May 16, 2005, we acquired The Falk Corporation (“Falk”) from Hamilton Sundstrand, a division of United Technologies Corporation, for $295 million in cash plus certain transaction related expenses and the assumption of certain liabilities.  Falk, which is also headquartered in Milwaukee, is a manufacturer of gears and couplings with annual revenues of approximately $200 million.  The acquisition of Falk was funded by a $312 million term loan obtained through an amendment to our existing Credit Agreement dated May 16, 2005.  Under the amended Credit Agreement, all of our term loans (which consist of the new $312 million term loan and the $275 million of pre-existing term loans) bear interest, at our option, at the following rates per annum:  (i) 2.25% plus the Eurodollar Rate, or (ii) 1.00% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate).  We are required to make semi-annual principal payments on these term loans of $2.94 million beginning in November 2005 and continuing through May 2011, with the remaining principal balance of $551.8 million due in December 2011.  See Notes 1 and 8 of the Notes to Consolidated Financial Statements for additional information on this acquisition and related financing.

 

With the acquisition of Falk, our annual net sales are expected to exceed $1.0 billion beginning in fiscal 2006.  Compared to March 31, 2005, we also increased our leverage profile due to the additional $312 million term loan used to finance this acquisition.  As of May 16, 2005, our total debt was approximately $819 million.   Based on our combined operations, we believe that cash flows from operations and available cash, together with available borrowings under our revolving credit facility, will be adequate to meet our future liquidity needs for the forseeable future.

 

The following Results of Operations does not include a discussion of Falk’s operating results because this transaction occurred subsequent to our fiscal year-end.

 

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Results of Operations

 

As described above, the Acquisition occurred on November 25, 2002, which created a new basis of accounting for the Company as compared to the Predecessor company.  For accounting purposes, the Company began operations on November 25, 2002 while operations of the Predecessor ceased at that time. In some cases, for ease of comparison purposes, financial data for the period from inception, November 25, 2002, through March 31, 2003 has been added to financial data of the Predecessor for the period from April 1, 2002 through November 24, 2002, to arrive at a 12-month combined period ended March 31, 2003.  This combined data is referred to herein as fiscal year 2003, fiscal 2003 or 2003.

 

								2003
								Company			Predecessor			Combined
		Fiscal Year Ended March 31,						From Inception (November 25, 2002) through			Period From April 1, 2002 through November 24,			Year Ended March 31,
(in millions)		2005			2004			March 31, 2003			2002			2003
Sales		$	811.0		$	712.8		$	252.5		$	469.3		$	721.8
Gross profit		255.2			227.4			90.4			158.8			249.2
Gross profit % of sales		31.5		%	31.9		%	35.8		%	33.8		%	34.5		%
Selling, general & administrative expenses		153.6			148.1			52.9			103.1			156.0
Restructuring and other similar costs		7.3			2.6			—			7.5			7.5
Curtailment gain		—			(6.6		)	—			—			—
Income from litigation settlement		—			—			—			(2.3		)	(2.3		)
Amortization of intangible assets		13.8			13.9			4.6			1.1			5.7
Income from operations		80.5			69.4			32.9			49.4			82.3
% of sales		9.9		%	9.7		%	13.0		%	10.5		%	11.4		%
Interest expense, net		(44.0		)	(45.4		)	(16.3		)	(13.0		)	(29.3		)
Other expense, net		(0.7		)	(1.1		)	(0.5		)	(0.1		)	(0.6		)
Income before income taxes		35.8			22.9			16.1			36.3			52.4
Provision for income taxes		14.2			8.7			6.5			16.0			22.5
Net income		$	21.6		$	14.2		$	9.6		$	20.3		$	29.9

 

Year Ended March 31, 2005 Compared with the Year Ended March 31, 2004

 

Net Sales.  Net sales in fiscal 2005 were $811.0 million, an increase of $98.2 million or 13.8%, from last year’s net sales of $712.8 million.  The sales growth in fiscal 2005 was led by sales of our core power transmission products, which have grown 13.5% in the aggregate, with each of the major product lines (bearing, coupling, industrial chain, gearing and flattop) posting year over year improvements.  This growth occurred in both our industrial distribution channel and our OEM customer base.  In addition to the growth in power transmission products, our aerospace and special components products have also performed well, with net sales increasing 19.9% and 9.2%, respectively, over last year.  Business conditions in the end markets where our products are utilized, including construction, mining, cement, energy, heavy duty truck and aerospace, have improved over the past year and our distribution channel partners have decreased the magnitude of inventory reductions in the channel compared to last year.  Sales in the current year were also favorably impacted by $15.5 million, or 2.2%, as a result of changes in currency rates, principally related to the Euro, from those in effect during fiscal 2004.  On a constant currency basis, sales in fiscal 2005 increased by $82.7 million or 11.6% from the prior year.  The table below reconciles net sales on a constant currency basis to the comparable GAAP net sales information:

 

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		Year Ended March 31, 2005
(in millions)		Net Sales			Currency Translation			Net Sales Excluding Currency Translation
United States		$	528.9		$	—		$	528.9
Canada		37.6			(2.0		)	35.6
Europe		201.2			(12.7		)	188.5
Rest of World		43.3			(0.8		)	42.5
		$	811.0		$	(15.5	)	$	795.5

 

Gross Profit.  Gross profit grew in fiscal 2005 to $255.2 million, or 31.5% of net sales, from $227.4 million, or 31.9% of net sales in fiscal 2004.  Gross profit margins were adversely affected in fiscal 2005 by increased raw materials prices and adverse sales mix compared to the prior year.  We have tried to mitigate the impact of rising raw material prices by implementing price increases when possible as well as negotiating with our suppliers to minimize the price increases.  We estimate the net adverse impact of rising raw material prices on our gross profit margin in fiscal 2005 to be approximately 100 basis points.  Our fiscal 2005 gross profit also includes a $2.0 million charge to appropriately reflect the valuation of our domestic inventories to the last-in, first-out (LIFO) method of inventory valuation, and a $1.6 million one-time charge to write-off certain excess and obsolete inventory that was on-hand at the date of the Acquisition for which no reserves were established in purchase accounting.  These charges adversely affected fiscal 2005 gross profit margins by approximately 40 basis points.  In fiscal 2004, we experienced a favorable LIFO benefit of $0.5 million.  These reductions in gross profit margin in fiscal 2005 were partially offset by a $7.0 million benefit due to a change in estimate regarding the capitalization of certain overhead variances into inventory.  This change in estimate resulted from a re-evaluation of our process for capitalizing overhead costs into inventory in light of rising raw material costs and changes in our manufacturing processes.

 

Selling, General and Administrative Expenses (“SG&A”).   SG&A expenses increased by $5.5 million, or 3.7%, in fiscal 2005 to $153.6 million as compared to $148.1 million in fiscal 2004.  As a percentage of net sales, SG&A declined to 18.9% in fiscal 2005 compared to 20.8% in fiscal 2004.    The reduction in SG&A expenses as a percentage of net sales is a result of positive operating leverage and the impact of restructuring actions taken over the past year to reduce overhead and administrative headcount.  These reductions in SG&A expenses were partially offset by adverse changes in currency exchange rates which had the impact of increasing SG&A expenses by $3.2 million in fiscal 2005 as compared to fiscal 2004.    Increased sales volume accounted for the remainder of the dollar increase in SG&A expenses in fiscal 2005.

 

Restructuring and Other Similar Costs.  Restructuring costs of $7.3 million were incurred during fiscal 2005 compared to $2.6 million in fiscal 2004.  The fiscal 2005 amount consisted of severance, recruiting and relocation costs incurred as part of our effort to realign management and upgrade talent.

 

Curtailment Gains.  In December 2003, we made significant modifications to our defined benefit pension plan covering certain U.S. employees by freezing credited service as of March 31, 2004.  A new discretionary Company contribution equal to 3% of pay was added to the 401(k) defined contribution plan.  The changes to the defined benefit plan resulted in a curtailment of the plan under accounting principles generally accepted in the U.S.  Accordingly, a pretax curtailment gain of $5.6 million was recorded in the third quarter of fiscal 2004.  In the fourth quarter of fiscal 2004, the Company eliminated postretirement benefits for certain active employees and recognized a curtailment gain of $1.1 million.  There were no curtailment gains in fiscal 2005.

 

Amortization of Intangible Assets.  We are amortizing the cost of intangible assets acquired in the acquisition of the Rexnord Group including patents, a distribution network and a covenant not to compete.  Amortization of these intangible assets amounted to $13.8 million in fiscal 2005 and $13.9 million in fiscal 2004.  We did not acquire any new intangible assets during fiscal 2005 or fiscal 2004.

 

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Interest Expense, net.  Interest expense (net of interest income) was $44.0 million in fiscal 2005 compared to $45.4 million in fiscal 2004.  The reduction in interest expense in fiscal 2005 is due primarily to lower overall debt levels compared to a year ago as we repaid $45 million of term loans in fiscal 2005.  Interest on the subordinated notes was 10.125% per annum in both fiscal 2005 and 2004 and interest on the term loans averaged approximately 5.0% during fiscal 2005 as compared to 5.1% during fiscal 2004.

 

Other Expense, net .  Other expense, net for fiscal 2005 consisted of gains on the sales of plant, property and equipment of $2.1 million, exchange losses of $0.8 million and management fees of $2.0 million.  Other income (expense), net for fiscal 2004 consisted of gains on the sales of plant, property and equipment of $0.9 million and management fees of $2.0 million.

 

Provision for Income Taxes. The effective income tax rate for fiscal 2005 of 39.7% is up slightly from our fiscal 2004 effective income tax rate of 38.0% due to higher state and local income taxes.

 

Net Income.  Net income in fiscal 2005 was $21.6 million as compared to $14.2 million in the prior year due to the factors described above.

 

Year Ended March 31, 2004 Compared with the Year Ended March 31, 2003

 

Net Sales.  Net sales in fiscal 2004 were $712.8 million, a decrease of $9.0 million or 1.2%, from fiscal 2003 net sales of $721.8 million.  Net sales in fiscal 2004 were favorably impacted by $34.1 million, or 4.8%, as a result of changes in currency rates, principally related to the Euro, from those in effect during fiscal 2003.  On a constant currency basis, net sales in fiscal 2004 declined by $43.1 million or 6.0% from the prior year.

 

During most of calendar 2003, the poor economic environment caused several North American industrial distributor customers to reduce the amount of inventory they hold in stock.  This reduction in inventory levels among distributors had a negative impact on our sales through that channel in the first three quarters of fiscal 2004.  Based on our own internal data and data we receive from the larger industrial distributor customers, we estimate the impact of the decline in inventory held in the distribution channel during fiscal 2004 contributed to approximately one-third of our overall sales decline of $43.1 million (on a constant currency basis) from fiscal 2003.

 

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During fiscal 2004, declines in our aerospace and industrial chain product sales represented approximately one-half of our total sales decline on a constant currency basis.  Aerospace sales declined due to the continued contraction in the commercial airframe industry and industrial chain sales declined due to our decision to discontinue the manufacture of unprofitable products as well as the continued softness in the end markets of construction, forest products, agricultural equipment and cement throughout most of the fiscal year.  For the fiscal year 2004, industrial bearing and flattop chain sales were down slightly from fiscal 2003.  Sales of our gear and coupling products declined in fiscal 2004 by approximately 5% as compared to fiscal 2003 due to softness in key end markets of forest products and energy for most of the year.  Sales of our products from our European businesses during fiscal 2004 increased over fiscal 2003 due primarily to the increase in the Euro exchange rate.  Sales of our remaining power transmission products and special components during fiscal 2004 were comparable to the prior year.

 

The economic environment began to improve during the latter half of our third fiscal quarter of fiscal 2004 and order rates began to increase in nearly all of our product lines.  This improvement continued into the fourth quarter of fiscal 2004 and resulted in sales of $207.6 million in the fourth quarter, an increase of $17.7 million or 9.3% over fourth quarter sales of $189.9 million in the prior year.  As was the case in the first three quarters of fiscal 2004, fourth quarter sales were aided by changes in exchange rates which contributed $10.6 million of the $17.7 million sales increase.  On a constant currency basis, sales in the fourth quarter of fiscal 2004 increased by $7.1 million or 3.8% from the fourth quarter of the prior year.

 

Gross Profit.  Gross profit margin in fiscal 2004 was 31.9%, down from 34.5% in fiscal 2003 and 33.9% in fiscal 2002. The decline in gross profit was largely the result of lower sales volume of $43.1 million on a currency rate adjusted basis, and unfavorable trade channel mix of products that adversely affected gross profit by approximately $3.0 million for the year.  Margins in fiscal 2003 benefited from a slightly improved product mix and, in general, the impact of inflationary price increases in labor, benefits, raw material and factory overhead costs were offset by price increases and productivity improvements.

 

Selling, General and Administrative Expenses (“SG&A”).   SG&A expenses declined by $7.9 million, or 5.1%, in fiscal 2004 to $148.1 million as compared to $156.0 million in fiscal 2003.  However, SG&A expenses were also affected by changes in currency exchange rates which had the impact of increasing SG&A expenses by $7.9 million in fiscal 2004 as compared to fiscal 2003.  On a constant currency basis, SG&A expenses declined by $15.8 million, or 10.1% in 2004.  The reduction in SG&A expense was largely the result of a reduction of approximately 165 employees in SG&A staff positions during fiscal 2004 as compared to the prior year and strict cost controls.  As a percent of sales, SG&A expense declined from 21.6% in fiscal 2003 to 20.8% in fiscal 2004.

 

Restructuring and Similar Costs.  The Predecessor’s restructuring program was completed in fiscal 2004.  Restructuring costs related to severance and other termination costs of $2.6 million were incurred during fiscal 2004 compared to $7.5 million in fiscal 2003. Restructuring costs in fiscal 2003 included $1.3 million for plant closure, $4.1 million for severance and other termination costs and $2.1 million for other restructuring and similar costs.

 

Curtailment Gains.  In December 2003, we made significant modifications to our defined benefit pension plan covering certain U.S. employees by freezing credited service as of March 31, 2004.  A new discretionary Company contribution equal to 3% of pay was added to the 401(k) defined contribution plan.  The changes to the defined benefit plan resulted in a curtailment of the plan under accounting principles generally accepted in the U.S.  Accordingly, a pretax curtailment gain of $5.6 million was recorded in the third quarter of fiscal 2004.  In the fourth quarter of fiscal 2004, the Company eliminated postretirement benefits for certain active employees and recognized a curtailment gain of $1.1 million.

 

Amortization of Intangible Assets.  We are amortizing the cost of intangible assets acquired in the acquisition of the Rexnord Group including patents, a distribution network and a covenant not to compete.  Amortization of these intangible assets amounted to $13.9 million in fiscal 2004 as compared to $5.6 million in fiscal 2003.  Amortization expense in fiscal 2003 was less than fiscal 2004 because the Acquisition occurred on November 25, 2002, the third quarter of fiscal 2003.

 

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Interest Expense, net.  Interest expense (net of interest income) was $45.4 million in fiscal 2004 compared to $29.3 million in fiscal 2003.  Interest expense subsequent to the Acquisition includes interest costs for the $225 million of senior subordinated notes and outstanding term loans and revolver borrowings under the bank credit facility.  Interest on the subordinated notes was 10.125% per annum in both fiscal 2004 and 2003 and interest on the term loans averaged approximately 5.1% during fiscal 2004 as compared to 5.5% for the period from November 25, 2002 through March 31, 2003.  Interest expense of the Predecessor was related to interest on borrowings from affiliates of our former parent company.

 

Other Income (Expense) and Income Taxes.  Other income (expense), net for fiscal 2004 consisted of gains on the sales of plant, property and equipment of $0.9 million and management fees of $2.0 million.  The effective income tax rate for fiscal 2004 was 38.0% compared to 42.9% in fiscal 2003.   The provision for income taxes decreased in fiscal 2004 primarily because of utilization of foreign net operating losses.

 

Net Income.  Net income in fiscal 2004 was $14.2 million as compared to $29.9 million in the prior year (comprised of $9.6 million for the period from November 25, 2002 through March 31, 2003 and $20.3 million for the Predecessor period April 1, 2002 through November 24, 2002) due to the factors described above.

 

Liquidity and Capital Resources

 

Our working capital at March 31, 2005 was $118.9 million, reflecting a slight increase from our prior year-end working capital of $117.6 million.  As a result of our continued efforts to reduce inventories and better manage our trade payables, we achieved greater working capital efficiency in fiscal 2005.  Working capital increased $1.3 million in fiscal 2005 in support of sales growth of $98.2 million.

 

Our primary source of liquidity is available cash, cash flow from operations and borrowings under the $75 million revolving credit facility. We had $26.3 million of cash at March 31, 2005 and had approximately $64 million of borrowings available under our revolving credit facility. At March 31, 2005, there were no borrowings outstanding under the revolving credit facility; however, approximately $10.8 million of the facility was utilized in connection with outstanding letters of credit. Borrowings under the revolving credit facility are available to fund our working capital requirements, capital expenditures and other general corporate purposes.

 

As of March 31, 2005 we had $506.7 million of total indebtedness outstanding as follows (in millions):

 

		Total Debt at March 31, 2005			Short-Term Debt and Current Maturities of Long-Term Debt			Long-Term Portion
Senior Credit Facilities – variable rate		$	275.0		$	—		$	275.0
Senior Subordinated Notes – fixed rate		225.0			—			225.0
Other Debt		6.7			3.3			3.4
		$	506.7		$	3.3		$	503.4

 

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We incurred substantial indebtedness in November 2002 in connection with the Acquisition.  As of March 31, 2005, we have repaid $85.0 million principal amount of the term loans, all of which was paid prior to scheduled maturity dates.  Subsequent to our fiscal 2005 year-end, we amended our existing Credit Agreement to obtain a $312 million loan to fund our acquisition of The Falk Corporation.  Under the amended Credit Agreement, all of our term loans (which consist of the new $312 million term loan and the $275 million of pre-existing term loans) bear interest, at our option, at the following rates per annum:  (i) 2.25% plus the Eurodollar Rate, or (ii) 1.00% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate).  We are required to make semi-annual principal payments on these term loans of $2.94 million beginning in November 2005 and continuing through May 2011, with the remaining principal balance of $551.8 million due in December 2011.  The amended Credit Agreement also contains certain revised financial covenants, including (i) a minimum consolidated interest coverage ratio of 2.25 to 1.00 through March 31, 2006; (ii) a maximum consolidated leverage ratio of 5.50 to 1.00 through September 30, 2006, and (iii) a maximum annual capital expenditures limit of $50 million.  The amended Credit Agreement is guaranteed by RBS Global, Inc. and Rexnord Corporation’s domestic subsidiaries and is secured by substantially all of the domestic guarantors’ real and personal property. The Company is required under the Credit Agreement to make mandatory prepayments of its loan facilities out of, among other things: (i) net cash proceeds received from the sales of certain assets; (ii) the issuance of capital stock or subordinated debt; and (iii) a percentage of the Company’s excess cash flow, as defined in the Credit Agreement.

 

Our ability to make scheduled payments of principal of, or to pay interest on, or to refinance, our indebtedness, including the senior subordinated notes, or to fund planned capital expenditures will depend on our ability to generate cash in the future. This is subject to general economic, competitive, legislative, regulatory and other factors that are beyond our control.  Based on our current level of operations and the expected impact of acquiring The Falk Corporation, we believe that cash flow from operations and available cash, together with available borrowings under our revolving credit facility, will be adequate to meet our future liquidity needs for the forseeable future.

 

Net cash provided by operating activities in fiscal 2005 was $67.4 million compared to $45.0 million for fiscal 2004 and $24.1 million for fiscal 2003.  The increase in cash from operations of $22.4 million in fiscal 2005 as compared to fiscal 2004 was primarily because fiscal 2004 had higher cash outflows of $14.9 million resulting from the settlement of accruals and other liabilities established in connection the Acquisition.  Other reasons for the increase in fiscal 2005 operating cash flows include higher net income of $7.4 million and a larger reduction in inventories of $8.2 million.  These improvements in operating cash flows were partially offset by a $9.6 million impact of higher trade receivables in fiscal 2005 due to sales growth, and lower year-over-year growth in trade payables of $8.2 million.

 

The increase in cash from operations of $20.9 million in fiscal 2004 as compared to fiscal 2003 was primarily the result of: (i) a $47.5 million increase in cash flow related to improved collections in fiscal 2004 and a $40.5 million cash outflow in the prior year from the termination of the Predecessor’s third party receivable factoring program immediately prior to the Acquisition; and  (ii) a $48.7 million increase in cash flow resulting from a $12.0 million increase in trade payables in fiscal 2004 as compared to a $36.7 million decline in trade payables of the Predecessor in fiscal 2003. The increase in cash from operations was offset by lower net income in fiscal 2004 caused, in part, by higher interest expense in connection with the Acquisition and a $29.9 million cash outflow in fiscal 2004 resulting from settlement of accruals and other liabilities established in connection with the Acquisition.

 

Historically, cash provided by or used in investing activities has been for capital expenditures, offset by proceeds from the disposition of property, plant and equipment. Our capital expenditure requirements are comprised primarily of equipment, molds and tooling, and computer hardware and software.  Net cash used for investing activities in fiscal 2005 was $19.3 million comprised of $25.7 million of capital expenditures, offset by $6.4 million of proceeds from the disposition of property, plant and equipment.  Net cash used for investing activities in fiscal 2004 was $30.7 million comprised primarily of $22.1 million for capital expenditures and $10.4 million in final settlement of the purchase price for the Rexnord Group.  Net cash used for investing activities in fiscal 2003 was $931.2 million (comprised of $920.0 million for the period from November 25, 2002 through March 31, 2003 and $11.2 million for the Predecessor during the period April 1, 2002 through November 24, 2002) of which $913.5 million was related to the Acquisition and $18.7 million was for capital expenditures.

 

27

 

Cash used for financing activities in fiscal 2005 was $42.0 million and consisted of repayment of debt of $44.2 million, offset by proceeds from the exercise of stock options and other common stock activity of $2.2 million.  Cash used for financing activities in fiscal 2004 was $31.2 million and consisted of repayment of debt of $30.1 million and payment of financing fees of $1.1 million.  Net cash provided from financing activities in fiscal 2003 was $922.7 million (comprised of $906.3 million for the period from November 25, 2002 through March 31, 2003 and $16.4 million for the Predecessor during the period April 1, 2002 through November 24, 2002).  Net cash provided by financing activities of $906.3 million for the period November 25, 2002 through March 31, 2003 included: (i) $585.0 million from the incurrence of long-term debt in connection with the Acquisition, comprised of $360.0 million from borrowings under the senior credit facilities and $225.0 million from the issuance of the senior subordinated notes; (ii) a capital contribution of $359.5 million from The Carlyle Group; (iii) payment of financing fees of $25.5 million related to the Acquisition; and (iv) repayments of long-term debt totaling $14.7 million.

 

Tabular Disclosure of Contractual Obligations (in millions)

 

					Payments due by period
Contractual Obligations		Total			Less than 1 year			1-3 years			3-5 years			More than 5 years
Long-term debt obligations (1)		$	506.7		$	3.3		$	10.5		$	266.7		$	226.2
Interest on long-term debt obligations (1)		243.8			38.0			75.6			68.3			61.9
Operating lease obligations		30.8			6.7			10.6			6.7			6.8
TOTAL		$	781.3		$	48.0		$	96.7		$	341.7		$	294.9

 

(1)          Long-term debt obligations and interest on long-term debt obligations are presented based on the scheduled maturities and interest rates of the respective debt instruments as of March 31, 2005.  These amounts do not include the amendment to our existing credit facility on May 16, 2005 under which we obtained an additional $312 million term loan to fund the acquisition of The Falk Corporation and changed the scheduled principal payment dates and interest rates on our $275 million of pre-existing term loans.  See Note 8 of the Notes to Consolidated Financial Statements for more information.  The Company believes it will continue to pay its long-term debt in advance of the scheduled due dates.

 

We also have long-term obligations related to our pension and postretirement benefit plans which are discussed in detail in Note 11 to the consolidated financial statements.  As of March 31, 2005, we have no material long-term purchase obligations.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet transactions, arrangements, or obligations (including contingent obligations), that would have a material effect on our financial results.

 

Quantitative and Qualitative Disclosures about Market Risk

 

The Company is exposed to market risk during the normal course of business from changes in interest rates and foreign currency exchange rates.  The exposure to these risks is managed through a combination of normal operating and financing activities and derivative financial instruments in the form of forward exchange contracts to cover known foreign exchange transactions.

 

28

 

Interest Rate Risk

 

The Company utilizes a combination of short-term and long-term debt to finance operations and is exposed to interest rate risk on these debt obligations.

 

On November 25, 2002, Rexnord Corporation entered into a seven-year bank term loan credit agreement (the Credit Agreement) under which Rexnord Corporation had outstanding borrowings of $275.0 million at March 31, 2005.  Borrowings under the Credit Agreement are secured by substantially all assets of the Company. At the option of Rexnord, borrowings under the term loans bear interest at the following rates per annum: (i) 2.00% plus the Base Rate, or (ii) 3.25% plus the Eurodollar Rate.  At March 31, 2005, $200 million of term loans bear interest at 5.23%, $10 million bear interest at 5.85% and $65 million bear interest at 5.92%.  The Company’s results of operations are affected by changes in market interest rates on these short-term obligations. An increase in the interest rate of 1.00% on our variable rate debt would have increased our annual interest cost by $2.8 million.  Subsequent to our fiscal 2005 year-end, we amended our existing Credit Agreement to obtain a $312 million loan to fund our acquisition of The Falk Corporation.  See Note 1 of the Notes to Consolidated Financial Statements for additional information on this acquisition and related financing.

 

The Company had outstanding fixed rate long-term debt obligations with carrying values of $225 million at March 31, 2005. The potential loss in fair value on such fixed-rate debt obligations from a hypothetical 10 percent increase in market interest rates would not be material to the overall fair value of the debt. The Company currently has no plans to repurchase its outstanding fixed-rate instruments and, therefore, fluctuations in market interest rates would not have an effect on the Company’s results of operations or stockholders’ equity.

 

Currency Exchange Rate Risk

 

Our exposure to foreign currency exchange rates relates primarily to our foreign operations.  For our foreign operations, exchange rates impact the U.S. Dollar value of our reported earnings, our investments in the subsidiaries and the intercompany transactions with the subsidiaries.

 

Approximately 35% of our sales occur outside of the United States, with approximately 25% generated from our European operations that use the Euro as their functional currency.  As a result, fluctuations in the value of foreign currencies against the U.S. Dollar, particularly the Euro, may have a significant impact on our reported results.  Revenues and expenses denominated in foreign currencies are translated into U.S. Dollars at the end of the fiscal period using the average exchange rates in effect during the period.  Consequently, as the value of the U.S. Dollar changes relative to the currencies of our major markets, our reported results vary.  See the discussion in Results of Operations, above.

 

Fluctuations in currency exchange rates also impact the U.S. Dollar amount of our shareholders’ equity.  The assets and liabilities of our non-U.S. subsidiaries are translated into U.S. Dollars at the exchange rates in effect at the end of the fiscal period.  The U.S. Dollar weakened relative to many foreign currencies as of March 31, 2005 compared to March 31, 2004.  Consequently, Shareholders’ equity increased by $2.2 million as a result of the change in foreign currency translation adjustments.  If the U.S. Dollar had weakened an additional 10% during fiscal 2005 resulting translation adjustments recorded in shareholders’ equity would have increased by approximately $4.6 million.

 

As we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. However, any of these factors could adversely affect our international operations and, consequently, our operating results.

 

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Cautionary Statement on Forward Looking Statements

 

The foregoing Management’s Discussion and Analysis as well as other portions of this Annual Report on Form 10-K include forward-looking statements.  Statements that describe future expectations, including revenue and earnings projections, plans, results or strategies, are considered forward-looking.  The statements that are not purely historical should be considered forward-looking statements.  Often they can be identified by the use of forward-looking words, such as “may,” “will,” “could,” “project,” “believe,” “anticipate,” “expect,” “estimate,” “continue,” “potential,” “plan,” “forecasts,” and the like. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated.  Factors that could affect actual results include, among other things, unanticipated issues related to integrating The Falk Corporation into our business, our ability to meet future debt service requirements, compliance with debt covenants, changes in raw material costs and availability, our ability to manage growth in the business, changes in customer order patterns or demand for the Company’s products and services, our ability to obtain price increases from customers, increased overseas competition, changes in operating expenses, unanticipated issues associated with the Company’s non-U.S. operations, costs of complying with the Sarbanes-Oxley Act, our ability to attract and retain key employees, unanticipated acquisition or loss of significant customer contracts or relationships, unanticipated difficulties and costs associated with the design and implementation of new information technology systems, new facts that come to light in the future course of legal and environmental matters which could affect our assessment of those matters, changes in the Company’s effective income tax rate, potential repatriation of foreign earnings, changes in foreign currency exchange rates, unanticipated weakening of the economy, and acts of war or terrorism that may disrupt our business.  These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. The forward-looking statements included herein are made as of the date of the filing of this Annual Report on Form 10-K, and the Company undertakes no obligation to update publicly such statements to reflect subsequent events or circumstances.

 

ITEM 7A.                                            QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

The information with respect to the Company’s market risk is contained under the caption “Quantitative and Qualitative Disclosures About Market Risk” in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained herein.

 

ITEM 8.                                                     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

Index to Financial Statements

 

RBS Global, Inc. and Subsidiaries

Consolidated Financial Statements

 

For the Years ended March 31, 2005 and 2004, the Period from Inception (November 25, 2002)

through March 31, 2003 and for the Predecessor, for

the Period from April 1, 2002 through November 24, 2002

 

 

 

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Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

 

The Board of Directors

 

We have audited the accompanying consolidated balance sheets of RBS Global, Inc. and Subsidiaries (the Company) as of March 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and cash flows of the Company for the years ended March 31, 2005 and 2004 and for the period from inception (November 25, 2002) through March 31, 2003 and of the Predecessor for the period from April 1, 2002 through November 24, 2002. Our audits also included the financial statement schedule listed in Item 15(a)(2). These financial statements and schedule are the responsibility of management of the Company and its Predecessor. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at March 31, 2005 and 2004, and the consolidated results of operations and cash flows of the Company for the years ended March 31, 2005 and 2004 and for the period from inception (November 25, 2002) through March 31, 2003 and of its Predecessor for the period from April 1, 2002 through November 24, 2002, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

Milwaukee, Wisconsin

May 16, 2005

 

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RBS Global, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars In Millions)

 

		March 31, 2005			March 31, 2004
Assets
Current assets:
Cash		$	26.3		$	21.8
Receivables, net		127.7			120.2
Inventories		127.7			134.7
Other current assets		18.1			14.6
Total current assets		299.8			291.3
Property, plant and equipment, net		263.9			270.2
Intangible assets, net		111.3			125.2
Goodwill		575.1			582.1
Other assets		27.3			30.3
Total assets		$	1,277.4		$	1,299.1
Liabilities and stockholders’ equity
Current liabilities:
Current portion of long-term debt		$	3.3		$	2.0
Trade payables		78.3			72.9
Income taxes payable		3.7			4.8
Deferred income taxes		12.8			6.4
Compensation and benefits		32.6			29.3
Current portion of pension obligations		13.6			10.5
Current portion of postretirement benefit obligations		5.7			5.7
Other current liabilities		30.9			42.1
Total current liabilities		180.9			173.7
Long-term debt		503.4			548.8
Pension obligations		75.8			82.2
Postretirement benefit obligations		34.2			38.2
Deferred income taxes		50.2			49.7
Other liabilities		8.2			7.4
Total liabilities		852.7			900.0
Commitments and contingent liabilities
Stockholders’ equity:
Common stock, $.01 par value; authorized 5,000,000 shares; issued and outstanding 3,615,428 shares at March 31, 2005 and 3,595,001 shares at March 31, 2004		0.1			0.1
Additional paid in capital		361.6			359.4
Retained earnings		45.4			23.8
Accumulated other comprehensive income		17.6			15.8
Total stockholders’ equity		424.7			399.1
Total liabilities and stockholders’ equity		$	1,277.4		$	1,299.1

 

See notes to consolidated financial statements.

 

32

 

RBS Global, Inc. and Subsidiaries

Consolidated Statements of Income

(In Millions)

 

											Predecessor (Note 1)
		Year ended March 31,						Period from November 25, 2002 through March 31,			Period from April 1, 2002 through November 24,
		2005			2004			2003			2002
Net sales		$	811.0		$	712.8		$	252.5		$	469.3
Cost of sales		555.8			485.4			162.1			310.5
Gross profit		255.2			227.4			90.4			158.8
Selling, general and administrative expenses		153.6			148.1			52.9			103.1
Restructuring and other similar costs		7.3			2.6			—			7.5
Curtailment gain		—			(6.6		)	—			—
Income from litigation settlement		—			—			—			(2.3		)
Amortization of intangibles		13.8			13.9			4.6			1.1
Income from operations		80.5			69.4			32.9			49.4
Non-operating income (expense):
Interest expense:
To third parties		(44.0		)	(45.4		)	(16.3		)	(3.2		)
To affiliates		—			—			—			(15.0		)
Interest income from affiliates		—			—			—			5.2
Other income (expense), net		(0.7		)	(1.1		)	(0.5		)	(0.1		)
Income before income taxes		35.8			22.9			16.1			36.3
Provision for income taxes		14.2			8.7			6.5			16.0
Net income		$	21.6		$	14.2		$	9.6		$	20.3

 

See notes to consolidated financial statements.

 

33