ITEM 1. BUSINESS.
RBS Global, Inc. (RBS Global), a Delaware corporation, is the parent company of Rexnord LLC (a Delaware limited liability company), a holding company, which owns several domestic and foreign subsidiaries. RBS Global was formed by certain affiliates of our prior equity sponsor and incorporated in Delaware on November 4, 2002. On May 24, 2006, RBS Global entered into an Agreement and Plan of Merger pursuant to which affiliates of the private equity firm Apollo Management, L.P. (“Apollo”) and certain members of management agreed to purchase the Company from private equity firm The Carlyle Group, the predecessor equity sponsor, through the merger of Chase Merger Sub, Inc., a wholly-owned subsidiary of an Apollo affiliate, with and into the Company (the “Merger”). On July 21, 2006 (the “Merger Date”), the Merger occurred and the Company became a direct wholly-owned subsidiary of Chase Acquisition, Inc. Chase Acquisition, Inc. is 100% owned by our ultimate parent company Rexnord Holdings, Inc (“Rexnord Holdings”).
The consolidated financial statements in this Annual Report on Form 10-K include the accounts of RBS Global and its subsidiaries. Unless otherwise noted, references to the Company, Rexnord, we, us and our, refer to RBS Global, and its subsidiary Rexnord LLC and its subsidiaries. Throughout this Form 10-K, we will also refer to the financial statements of RBS Global, Inc. and subsidiaries prior to the Merger Date collectively as the “Predecessor” for comparative purposes.
Our fiscal year is the year ending March 31 of the corresponding calendar year. For example, our fiscal year 2007, or fiscal 2007, means the period from April 1, 2006 to March 31, 2007. This report includes references to financial data for the fiscal year ended March 31, 2007, which combines our results from July 22, 2006 through March 31, 2007 with the Predecessor results for the period from April 1, 2006 through July 21, 2006. This combined financial information is the result of merely adding the predecessor and successor results and does not include any pro forma assumptions or adjustments.
On February 7, 2007 we acquired the plumbing products business (“Zurn”) of Jacuzzi Brands, Inc. from an affiliate of Apollo Management, L.P. for a cash purchase price of $942.5 million, including transaction costs (the Zurn acquisition). The acquisition of Zurn establishes the Water Management platform within Rexnord. We believe Zurn is a leader in the multi-billion dollar non-residential construction and replacement market for plumbing fixtures and fittings. It designs and manufactures plumbing products used in commercial and industrial construction, renovation and facilities maintenance markets in North America. The results of operations of Zurn are included from February 8, 2007 through March 31, 2007.
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 Securities and Exchange Commission (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.
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.
Our Company
We believe we are a leading diversified, multi-platform industrial company strategically well positioned within the markets and industries we serve. With the completion of the Zurn acquisition on February 7, 2007, our business is comprised of two strategic platforms: (i) our existing Power Transmission (PT) platform and (ii) a new Water Management (WM) platform based on the acquired Zurn operations. We believe that we have the broadest portfolio of highly engineered, mission and project critical PT products in the industrial and aerospace end markets. Our PT products include gears, couplings, industrial bearings, flattop, aerospace bearings and seals, special components and industrial chain. With the Zurn acquisition, our Water Management platform is a leader in the multi-billion dollar, specification-driven, non-residential construction market for water management products. The Zurn acquisition added specification drainage, PEX, water control and commercial brass products to our highly engineered product portfolio.
We are led by an experienced, high-caliber management team that employs a proven operating system, Rexnord Business System, or RBS, modeled after the Danaher Business System, to drive performance at every level of the organization. We operate 29 PT manufacturing and four PT repair facilities located around the world and 18 WM manufacturing and warehouse facilities in North America. As of March 31, 2007, we had approximately 7,100 employees. For the year ended March 31, 2007, we generated net sales of $1,255.7 million and a net loss of $36.7 million.
We sell our PT products in a diverse group of attractive end-market industries, which include aerospace, agri-farm, air handling, cement and aggregates, chemicals, construction equipment, energy, food and beverages, forest and wood products, marine, material and package handling, mining, natural resource extraction and petrochemical. The Zurn acquisition and the creation of our Water Management platform further diversified our end-market mix by providing us with a presence in the commercial and institutional construction, civil and public water works markets. Sales to our largest customer, Motion Industries Inc., accounted for approximately 10.7%, 11.8% and 9.0% of our total net sales for the years ended March 31, 2007, 2006 and 2005, respectively.
Key Strategic Platforms:
Power Transmission (PT)
We believe we have the broadest product portfolio in the PT industry. Our PT products are highly engineered and, we believe, are critical components in the machinery or plant in which they operate. These products include gears, couplings, industrial bearings, flattop, aerospace bearings and seals, special components and industrial chain. Through the Falk acquisition in May 2005, we increased our market penetration and expanded our product portfolio in gears and couplings.
Over the past century, we have established long-term relationships with original equipment manufacturers, or OEMs, and end users serving a wide variety of industries. As a result of incorporating our components into their products, sales to OEMs and end users have created a significant installed base for our products, which are consumed in use and have a relatively predictable replacement cycle. This replacement dynamic drives recurring aftermarket sales, which we estimate have historically accounted for approximately 60% of our North American PT sales. These aftermarket sales in turn create a recurring revenue stream from our extensive distribution network, consisting of over 400 distributors nationwide that operate through 1,900 branches.
We sell our PT products to a diverse group of end-market industries, including aerospace, agri-farm, air handling, cement and aggregates, chemicals, construction equipment, energy, food and beverages, forest and wood products, marine, material and package handling, mining, natural resource extraction and petrochemical. We believe we have been able to maintain leadership positions within these markets as a result of our extensive offering of quality products, positive brand perception, highly engineered product lines, extensive specification work, market experience and focus on customer satisfaction. In addition, we serve industry-leading customers across all of our markets. Our end-market and customer diversification, coupled with high aftermarket revenues, help reduce our exposure to any specific industry.
Most of our products are critical components in large scale manufacturing processes, where the cost of component failure and resulting downtime is high. We believe our reputation for superior quality products and our ability to meet lead times as short as one day are highly valued by our customers, as demonstrated by their strong preference to replace their worn Rexnord products with new Rexnord products. Our customers’ preference to replace “like-for-like” products, combined with our significant installed base, enables us to achieve premium pricing, generates a source of recurring revenue and provides us a competitive advantage. Our products are marketed globally under brands such as Rex®, Falk® and Link-Belt®, using both direct and indirect channels. We believe the majority of our products are purchased by customers as part of their regular maintenance budgets and do not represent significant capital expenditures.
Our key PT product offerings include:
Gears
We are a leading manufacturer of gear drives and large gear sets for the heavy duty industrial market, with the number one position in the North American market for parallel shaft, right angle, and inline drives along with mill gear sets. Gear drives and gear sets reduce the output speed and increase the torque from an electronic motor or engine to the level required to drive a particular piece of equipment. Our gear drives, service and gear sets are used in a number of heavy duty industries. These primary industries include the natural resource extraction, steel, pulp and paper, chemical, forest and wood products. We manufacture a wide range of heavy duty, medium and light duty gear drives used for bulk material handling, mixing, pumping and general gearing applications. We also operate a gear service and repair business through our Product Service group (Prager™ and Falk Renew®). We believe we are the number one provider of gear repair, replacement parts and onsite services in the US. Generally, our gear drives and gear sets have an average replacement cycle of 5 to 20 years. We estimate that our aftermarket sales of gears comprise half of our overall gear sales. Our gear products are manufactured in our facilities in Wisconsin, Louisiana, Pennsylvania, Texas, Virginia, Australia, Canada, China and Germany. Our gear products are sold under the Falk™, Rex®, Link-Belt®, Stephan™ and Prager™ brand names. We categorize our gear products and services as follows.
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Heavy duty gear drives. Heavy duty gear drives are generally sold in either parallel shaft or right angle configurations with torque ratings up to 15 million inch pounds. Heavy duty gear drives are typically used to power bulk material handling and conveying systems in the cement, coal and mining industries, as well as crushing, mixing, hoisting and marine applications.
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Medium and light duty gear drives. Medium and light duty gear drives perform the same function as heavy duty gear drives, but with a maximum torque rating of 3 million inch pounds, and are typically used in medium and light duty material handling, mixing and pumping applications. Products include speed reducers, gearmotors, shaft mounts and mixer drives. We also buy and resell a range of private label products including worm drives, gearmotors and backstops.
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General gearing. General gearing includes ring gears and pinions used in the hard rock mining, cement and power generation industries for large crushing and milling applications such as ball mills, SAG mills and cement kilns. Other products include outside heavy section castings (i.e., automotive die blocks) and large contract manufacturing.
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Gear service and Repair. Falk Renew and Prager are our gearbox service and repair companies, servicing the largest installed base of geared products in the Americas. The service repair business is operated from facilities in Louisiana, Pennsylvania, Texas, Wisconsin, Canada, Australia, Brazil and Mexico.
Market. We believe we are the leading producer of gears in North America, and we sell our gear products to a variety of customers within numerous end markets. Market competition in the heavy duty gear industry is based primarily on quality, lead times, reputation for quality and cost. We estimate the global gear market to be approximately $4.5 billion. The global market is both competitive and fragmented, with a few significant competitors and none that dominate.
Couplings
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. Our couplings are sold to a variety of end markets, including the petrochemical and refining, wood processing, chemical, power generation and natural resources industries. We estimate that our aftermarket sales of couplings comprise half of our overall coupling sales. Our couplings are manufactured in our facilities in Alabama, Nebraska, Texas, Wisconsin, France and Germany.
Couplings are comprised of the grid, flexible disc, elastomeric and gear product lines and are sold under the Steelflex®, Thomas®, Omega®, Rex® Viva®, Wrapflex®, Lifelign®, True Torque® and Addax® brand names.
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Grid. Grid couplings are lubricated couplings that offer simpler initial installation than gear couplings and the ability to replace in place. Our grid couplings are sold under the Steelflex® brand.
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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®, Freedom™ and ModulFlex® brands.
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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®, Rex® Viva® and Wrapflex® brands.
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Gear. Gear couplings are lubricated couplings that are typically more torque dense than other coupling types. Our gear couplings are sold under the Lifelign® brand.
Market. The global couplings market is estimated at approximately $1 billion in annual sales and generally follows the investment cycles of the industries it supplies. We sell our couplings to a variety of customers in several end markets, including the petrochemical and refining, wood processing, chemical, power generation and natural resources industries. Global demand for couplings is split approximately equally among North America, Europe and the rest of the world. The couplings market is split between dry couplings and wet couplings and is fragmented, with numerous manufacturers.
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 mining, aggregate, forest and wood 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 3 to 5 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:
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Spherical Roller Bearings. Self-aligning and self-contained spherical roller bearings provide high capacity for heavy-duty and high-precision applications. They are used extensively on earth-moving equipment, vibrating screens, steel mill and paper mill equipment, embossing rolls, printing presses, and torque converters.
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Ball Bearings. Ball bearings provide a versatility of application arrangements for carrying shafts with radial or combination radial and thrust loads. They are designed for general purpose industrial machinery, conveyors, chain and belt drives, fans and blowers, power transmission, and many other applications.
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Cylindrical Roller Bearings. Metric series cylindrical roller bearings are manufactured to ABMA boundary dimensions. These bearings require minimum space and provide maximum rate capacity. Various configurations including separable inner and outer ring combinations offer ample application flexibility.
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Filament and Sleeve Bearings. 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. Rigid sleeve bearings provide compact and reliable usage in applications where continuous operation and uninterrupted service are required. Because bearing material wears gradually, sudden breakdowns and costly maintenance are minimized. Sleeve bearings can handle a wide variety of applications such as log decks, sewage treatment equipment, furnaces and ovens, and fans and blowers.
Market. We believe we are one of the leading producers of mounted bearings in North America. We sell our industrial bearings products to a variety of customers within numerous end markets. Market competition in the bearings industry is based primarily on cost, quality, on-time delivery and market access.
Flattop
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 4 to 5 years on average. We manufacture our flattop chain products in our manufacturing facilities in Wisconsin, Italy and the Netherlands. Our primary flattop chain products include:
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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.
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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 beverages and other unit handling industries.
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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. We market our flattop chain products directly to end users and market and sell these products to both OEMs and distributors. 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 beverages 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.
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 accessories, engine controls, engine mounts, flight control systems, gearboxes, landing gear and rotor pitch controls. The majority of our sales are to engine and airframe OEMs that specify our PT 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.
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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.
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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 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.
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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. These relatively small markets are subject to stringent regulatory approvals, quality requirements and certification processes.
Special Components
Our special components products are comprised of three primary product lines: electric motor brakes, miniature PT components and security devices for utility companies. These products are manufactured by our three stand-alone niche businesses: Stearns, W.M. Berg and Highfield.
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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.
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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.
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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.
Stearns has a network of over 900 distributor branches servicing customers in numerous industries, including material handling, cranes, servomotors and actuators, conveyors and single-phase motor manufacturers. Approximately 80% of W.M. Berg’s sales are made to OEMs with the remaining sales generally going through distributors. For fiscal 2007, the majority of Highfield’s sales were made to wholesalers, utilities and installers.
We compete against a wide variety of niche manufacturers in each of our respective markets. The competition is generally local or regional in nature.
Industrial Chain
Our industrial chain products are manufactured in our facilities in Wisconsin, Germany, China and Brazil. These products are used in various applications in numerous industries, including food and food processing, beverage and container, mining, construction and agricultural equipment, hydrocarbon processing and cement and metals processing. Our primary industrial chain products include:
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Engineered steel chain. Our engineered steel chain products, which are sold under the Link-Belt® and Rexnord® 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 and mining equipment and conveyors, and they are supplied to the cement and aggregate, energy, food and beverage, and forest and wood products industries.
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Roller chain. 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. Largely because this product is late in its product life cycle, we no longer manufacture roller chain. However, because of the strength of our brands, we are able to maintain a level of sales to certain market segments at premium pricing with outsourced brand-labeled chain. Our roller chain product line, which is marketed under the Rexnord® and Link-Belt® brand names, is supplied to a variety of industries primarily for conveyor and mechanical drive applications.
Market. We market and sell our industrial chain products directly to OEMs, end users, and through industrial distributors. The roller chain market is principally comprised of commodity products, manufactured to industry standard specifications that are available from numerous sources. We believe we have a leading position in the North American market for engineered steel chain.
Water Management (WM)
We believe our Water Management platform is one of the leading suppliers of professional grade specification plumbing products serving the commercial, institutional, civil and public water works construction markets. Zurn’s products are project-critical, high value-add and typically are a low percentage of overall project cost. We believe the combination of these features creates a high level of end-user loyalty. We also believe Zurn has one of the leading market shares in the majority of its product lines. Zurn’s end markets are principally specification-driven, and many of its product lines require stringent, third-party approvals prior to commercialization.
Over the last 106 years, Zurn has established itself as a leading designer, manufacturer and distributor of highly engineered water management products for the multi-billion dollar commercial and institutional construction, civil and public water works markets and, to a lesser extent, the residential construction and remodeling markets. Zurn has an extensive network of approximately 400 independent sales representatives across approximately 120 sales agencies in North America who work with local engineers, contractors, builders and architects to specify, or “spec-in,” Zurn’s products for use in construction projects. Once Zurn’s products are specified, these products will generally be used in future project designs. These specifications, combined with Zurn’s ability to innovate, engineer and deliver products and systems that save time and money for engineers, contractors, builders and architects, result in growing demand for Zurn products.
Zurn’s products are marketed through its widely recognized brand names, including ZURN®, WILKINS®, AQUAFLUSH®, AQUASENSE®, AQUAVANTAGE®, ZURN ONE SYSTEMS®, ECOVANTAGE®, AQUASPEC® and Zurn PEX. Through the strength of these brands and the ability to leverage the breadth of the product line, Zurn has maintained its leadership position in the industry.
Our key WM product offerings include:
Specification Drainage
Specification drainage products are used to control storm water, process water and potable water in various commercial, industrial, civil and irrigation applications. This product line includes point drains (such as roof drains and floor drains), linear drainage systems, interceptors, hydrants, fixture carrier systems, chemical drainage systems and light commercial drainage products.
Our specification drainage products include:
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Point Drains. Roof and floor drains, sold under the ZURN® brand name, are installed in various applications to control storm water or process water. These drains range in size from 2” to 12” in thousands of different configurations, including many specialty drains, and are designed for specific applications in roof and floor construction in commercial office buildings, schools, manufacturing facilities, restaurants, parking garages, stadiums and most any other facility where control of water is required. All of our point drain products have various options that allow the engineer to configure and specify the right drain for the specific application. Included in this product line are many labor-saving devices that are designed to make the installation of the drains much faster and easier for the contractor.
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Linear Drainage Systems. Linear drainage systems are sold under the Flo-Thru® brand and are designed to control large amounts of water in outdoor applications such as shipping ports, airports, commercial buildings and highways. Our linear drains are manufactured from various materials including stainless steel, fiberglass and high density polyethylene and range from 2 to 10 feet in length and from 4” to 26” in width. Our Hi-Cap high capacity drains are 80” long with throat dimensions from 12” to 23” wide. Hi-Cap drains are used primarily in roadside drainage applications. We also manufacture specialty linear drainage products designed for applications such as fountains, football fields and running tracks.
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Interceptors. We offer a complete line of grease, solids and oil interceptors, which are designed to prevent harmful or undesirable substances from entering wastewater control systems. Grease interceptors are used primarily in restraints to keep grease from entering wastewater systems and creating damaging clogs. Solid interceptors are used in various applications to remove any type of solid from the waste stream, including hair, lint and sand. Oil interceptors are used in applications such as filling stations, where oil could otherwise potentially mix with storm water or waste water.
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Hydrants. We manufacture a complete line of hydrants, which provide potable water sources in various locations throughout commercial and industrial facilities. Our hydrants are designed to be installed on the exterior of facilities and will prevent freezing of water lines in cold climates. Various configurations of the hydrants, including wall hydrants, ground hydrants, post hydrants and yard hydrants, are manufactured with hose connections of various sizes, depending on the desired water flow rate.
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Fixture Carrier Systems. Zurn fixture carrier systems are the mechanisms by which toilets, urinals and lavatories are retained to the wall. These products are manufactured from steel and cast iron for standard duty, heavy duty, extra heavy duty and bariatric applications, with load ratings ranging from 300 to 1,000 pounds.
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Chemical Drainage Systems. Zurn’s chemical drainage systems include the pipe and fittings required to handle corrosive waste streams from pharmaceutical, food processing and laboratory facilities. These products are manufactured from polypropylene and PVDF (polyvinylidene fluoride) and in sizes from 1 1/2” to 4” in diameter, with special fabrications of up to 10” in diameter.
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Light Commercial. Zurn’s light commercial product line offers a complete selection of PVC (poly-vinyl-chloride), ABS (acrylonitrile-butadiene-styrene), brass and cast iron drainage products to wholesalers serving the light commercial and residential end user. Our light commercial offerings include many non-specification variations of our other specification drainage products described above.
PEX
PEX is our product line manufactured out of cross-linked polyethylene into tubing. PEX is essentially polyethylene (PE) material (a thermoplastic that consists of a series of ethylene hydrocarbon chains) which has undergone a chemical or physical reaction that causes the molecular structure of the PE chains to link together. This reaction creates a three dimensional structure which has superior resistance to high temperature and pressure. Properly manufactured PEX tubing demonstrates superior characteristics at elevated temperatures and pressures (as compared to uncross-linked polyethylene) in the areas of tensile strength, resistance to deformation, resistance to corrosion and mineral build-up, creep resistance, abrasion resistance, impact strength and chemical resistance. This makes PEX a perfect product for high temperature and pressure fluid distribution piping.
Our PEX products include complete lines of pipe, fittings, valves and installation tools for both potable water and radiant heating systems. These systems are engineered in our facilities in Commerce, Texas, Elkhart, Indiana and Erie, Pennsylvania, to meet stringent NSF requirements.
Our PEX products include:
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PEX Plumbing Systems. Our PEX plumbing line includes brass and polymer insert and crimp fittings, a proprietary line of crimp rings, valves and manifolds and PEX tube in sizes from 1/4” to 1 1/4” in diameter. These plumbing systems are used by residential and commercial builders in place of traditional copper piping systems.
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PEX Radiant Heating Systems. Our PEX radiant heating line includes the manifolds, control valves, fittings and PEX tube necessary to install a radiant heating system. Radiant heating systems, in which PEX tube is installed in the floor to transfer heat from circulated hot water into a building, are used in place of traditional forced air heating systems.
Water Control
Our water control products are sold under the Wilkins brand name and encompass a wide variety of valves, including backflow preventers, fire system valves, pressure reducing valves and thermostatic mixing valves. These products are designed to meet the stringent requirements of independent test labs, such as the Foundation for Cross Connection Control and Hydraulic Research at the University of Southern California (“USC”) and the National Sanitation Foundation (“NSF”), and are sold into the commercial and industrial construction end markets as well as the fire protection, waterworks and irrigation end markets.
Our water control products include:
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Backflow Preventers. We offer a complete line of backflow prevention valves, which are designed to protect potable water systems from cross-connection with contaminated liquids, gases or other unsafe substances by stopping the unwanted reverse flow of water. Our backflow preventers accommodate a range of pipe sizes from 1/4” to 12” and cover a wide variety of specific applications in the plumbing, irrigation, municipal, fire protection and industrial end-markets. All backflow preventers are highly engineered and specified to exceed rigorous industry approvals and standards.
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Fire System Valves. Zurn provides control valves for commercial fire hose and fire sprinkler systems under the Pressure-Tru and Wilkins brand names. These products are designed to regulate the pressure of water in fire prevention systems in high-rise buildings, as well as opening and closing flow in pipe sizes standard to the industry.
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Relief Valves. Wilkins relief valves are designed to lower water pressure to safe and manageable levels for commercial, residential, industrial and irrigation applications in a wide variety of pipe sizes. These valves also promote water conservation. Inlet pressures as high as 400 psi are accommodated with both direct acting and pilot operated valves.
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Thermostatic Mixing Valves. Zurn’s Aqua-Guard valves thermostatically balance the hot and cold water mix in commercial and residential hot water and hydronic heating systems. The valves provide protection against hot water scalding, help prevent the growth of bacteria in hot water systems and promote energy conservation.
Commercial Brass
Zurn’s commercial brass products include manual and sensor operated flush valves marketed under the AQUAFLUSH®, AQUASENSE® and AQUAVANTAGE® brand names and heavy duty commercial faucets marketed under the AQUASPEC® brand name. Innovative water conserving fixtures are marketed under the ECOVANTAGE® and Zurn One® brand names. These products are commonly used in office buildings, schools, hospitals, airports, sports facilities, convention centers, shopping malls, restaurants and industrial production buildings. The Zurn One Systems® integrates commercial brass and fixtures into complete, easily customizable plumbing systems, and thus provide a valuable time- and cost-saving means of delivering commercial and institutional bathroom fixtures.
Our Industries
Through our two strategic platforms, we manufacture and distribute highly engineered, mission critical products to the power transmission and water management industries. These industries span a broad and diverse array of commercial and industrial end markets with fundamental long-term growth characteristics.
Power Transmission Industry
According to Industrial Market Information, Inc., the domestic PT industry accounts for approximately $84 billion in sales per year. Of this overall estimated PT industry, the relevant domestic market for our current product offerings is approximately $5 billion, which includes all product categories in all industries in which we currently compete. The PT industry is fragmented with most participants having limited product lines and serving specific geographic markets. While there are numerous competitors with limited product offerings, there are only a few national and international competitors of a size comparable to us, including the Emerson Power Transmission division of Emerson Electric and the Dodge Manufacturing division of Baldor Electric. The industry’s customer base is broadly diversified across many sectors of the economy. We believe that growth in the PT industry is closely tied to overall growth in industrial production, which we believe to have significant long-term growth fundamentals.
PT products are generally critical components in the 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 costs associated with product failure to the end user can be substantial, we believe end users in most of the markets we serve focus on products with superior quality, reliability and availability, rather than considering price alone, when making a purchasing decision. We believe that the key to success in our industry is to develop a reputation for quality and reliability, as well as an extensive distribution network to maintain attractive margins on products and gain market share.
The PT industry is also characterized by the need for significant start-up capital expenditures, experience with sophisticated engineering requirements, the ability to produce a broad number of niche products with very little lead time and long-standing customer relationships. In addition, we believe there is an industry trend of customers increasingly consolidating their vendor bases, which we expect should allow suppliers with broader product offerings to capture additional market share. We believe entry into our markets by competitors with lower labor costs, including foreign competitors, will be limited due to the fact that we manufacture highly specialized niche products that are mission critical components in large scale manufacturing processes, where the cost of component failure and resulting downtime is high.
Water Management Industry
According to the U.S. Census Bureau, U.S. nonresidential construction expenditures were approximately $586.0 billion in 2006. We estimate that the relevant market within nonresidential construction for Zurn’s current product offerings is approximately $4.0 billion. We believe the segment in which Zurn participates is relatively fragmented and that most competitors offer limited product lines. Although Zurn competes against numerous competitors with limited products or scale, one competitor, Watts Water Technologies, competes with Zurn across several lines on a nationwide basis. Zurn also competes against Sloan Valve Company in flush valves, Uponor (formerly Wirsbo) in PEX piping and Geberit in commercial faucets.
We believe the segment of the water management industry in which Zurn competes is closely tied to growth in commercial and industrial construction, which we believe to have significant long-term growth fundamentals. Historically, the commercial and institutional construction industry has been more stable and less vulnerable to down-cycles than the residential construction industry. Compared to residential construction cycles, downturns in commercial and institutional construction have been shorter and less severe, and upturns have lasted longer and had higher peaks.
Water management products tend to be project-critical and high value-add and typically are a low percentage of overall project cost. We believe the combination of these features creates a high level of end-user loyalty. Demand for these products is influenced by regulatory, building and plumbing code requirements. Many water management products must be tested and approved by USC or NSF before they may be sold. In addition, many of these products must meet detailed specifications set by water management engineers, contractors, builders and architects. As a result, these products are highly engineered to meet these precise specifications and stringent regulatory requirements.
The industry’s specification-driven end markets require manufacturers to work closely with engineers, contractors, builders and architects in local markets across the United States, to design specific applications on a project-by-project basis. Accordingly, flexibility in design and product innovation is critical to compete effectively. Also important are relationships with local engineers, contractors, builders and architects who specify or “spec-in” products for use in construction projects. Companies with a strong network of such relationships have a competitive advantage, in that once an engineer, contractor, builder or architect has specified a company’s product with satisfactory results, he or she will generally continue to use that company’s products in future projects.
Acquisitions
The Zurn Acquisition
On February 7, 2007 we acquired Zurn from an affiliate of Apollo for a cash purchase price of $942.5 million, including transaction costs. The purchase price was financed through an equity investment by Apollo and its affiliates of approximately $282.0 million and debt financing of approximately $669.3 million. This acquisition created a new strategic water management platform for the Company. Zurn is a leader in the multi-billion dollar non-residential construction and replacement market for plumbing fixtures and fittings. It designs and manufactures plumbing products used in commercial and industrial construction, renovation and facilities maintenance markets in North America, and holds a leading market position across most of its businesses. Zurn is included in our results of operations from February 8, 2007 through March 31, 2007.
The Apollo Transaction
On July 21, 2006, certain affiliates of Apollo and certain members of management purchased the Company from The Carlyle Group for approximately $1.825 billion, excluding transaction fees, through the merger of Chase Merger Sub, Inc., an entity formed and controlled by Apollo, with and into RBS Global, Inc. (the “Merger”). The Merger was financed with (i) $485.0 million of 9.50% senior notes due 2014, (ii) $300.0 million of 11.75% senior subordinated notes due 2016, (iii) $645.7 million of borrowings under new senior secured credit facilities (consisting of a seven-year $610.0 million term loan facility and $35.7 million of borrowings under a six-year $150.0 million revolving credit facility) and (iv) $475.0 million of equity contributions (consisting of a $438.0 million cash contribution from Apollo and $37.0 million of rollover stock and stock options held by management participants). The proceeds from the Apollo cash contribution and the new financing arrangements, net of related debt issuance costs, were used to (i) purchase the Company from its then existing shareholders for $1,018.4 million, including transaction costs; (ii) repay all outstanding borrowings under our previously existing credit agreement as of the Merger Date, including accrued interest; (iii) repurchase substantially all $225.0 million of our 10.125% senior subordinated notes outstanding as of the Merger Date pursuant to a tender offer, including accrued interest and tender premium; and (iv) pay certain seller-related transaction costs.
The Merger has been accounted for using the purchase method of accounting and, accordingly, resulted in a new basis of accounting for the Company. The purchase price was allocated to identifiable assets acquired and liabilities assumed based upon their estimated fair values, which are preliminary and based upon currently available information. The Company is still in the process of finalizing third-party appraisals of the acquired property, plant and equipment and certain identifiable intangible assets. In addition, management is still finalizing its strategic assessment of the business, which may give rise to additional purchase liabilities. Accordingly, final adjustments to the purchase price allocation may be required. The Company expects to finalize the purchase price allocation within one year from the date of the Merger.
The Falk Acquisition
On May 16, 2005, we acquired the Falk Corporation (“Falk”) from Hamilton Sundstrand, a division of United Technologies Corporation, for $301.3 million ($306.2 million purchase price including related expenses, net of cash acquired of $4.9 million) and the assumption of certain liabilities. Falk is a manufacturer of gears and lubricated couplings and is a recognized leader in the gear and coupling markets. The Falk acquisition significantly enhanced our position as a leading manufacturer of highly engineered PT products. By combining our leadership positions in flattop chain, industrial bearings, non-lubricated couplings and industrial chain with Falk’s complementary leadership positions in gears and lubricated couplings, as well as a growing gear repair business, the Falk acquisition resulted in a comprehensive, market-leading product portfolio that we believe to be one of the broadest in the PT industry. Falk is included in our results of operations from May 16, 2005.
Customers
Power Transmission Customers
Our PT components are either incorporated into products sold by OEMs or sold to end users through industrial distributors as aftermarket products. With over 1,900 distributor locations worldwide, we have one of the most extensive distribution networks in the industry. One of our industrial distributors accounted for 10.7%, 11.8% and 9.0% of net sales during the years ended March 31, 2007, 2006 and 2005, respectively.
Rather than serving as passive conduits for delivery of product, our industrial distributors participate in the overall competitive dynamic in the PT industry. Industrial distributors play a role in determining which of our PT 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 PT products both to OEMs and directly to end users to cultivate an end-user preference for our PT products. We believe this customer preference is important in differentiating our PT products from our competitors’ products and preserves our ability to influence distributors to recommend Rexnord products to OEMs and end users. 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 PT products and stock them for the end user. We believe our extensive product portfolio positions us to benefit from the trend towards rationalizaing suppliers by industrial distributors.
Our PT products are moving, wearing components that are consumed in use and require regular replacement. This gives rise to an on-going aftermarket opportunity.
Water Management Customers
Our WM products are branded under the Zurn tradename and distributed through independent sales representatives; wholesalers such as Ferguson, Hughes, and Hajoca; home centers such as The Home Depot and Lowe’s; and industry-specific distributors in the food service, industrial, janitorial and sanitation industries. Independent sales representatives work with wholesalers to assess and meet the needs of building contractors. They also combine knowledge of Zurn’s products, installation and delivery with knowledge of the local markets to provide contractors with value added service. We use several hundred independent sales representatives nationwide, along with a network of approximately 70 third-party warehouses, to provide its customers with 24-hour service and quick response times.
In addition to our domestic WM manufacturing facilities, we have maintained a global network of independent sources that manufacture high quality, lower cost component parts for our commercial and institutional products. These sources fabricate parts to our specifications using our proprietary designs, which enables us to focus on product engineering, assembly, testing and quality control. By closely monitoring these sources and through extensive product testing, we are able to maintain product quality and be a low-cost producer of commercial and institutional products.
Product Development
In both of our PT and WM platforms, we have demonstrated a commitment to developing technologically advanced products within the industries we serve. In the PT platform, we had 148 active U.S. patents and 572 foreign patents as of March 31, 2007. In addition, we thoroughly test our PT 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 PT solutions. In our WM platform, we had 27 and 43 active U.S. and foreign patents, respectively as of March 31, 2007. Product innovation is crucial in the commercial and institutional plumbing products markets because new products must continually be developed to meet specifications and regulatory demands. Zurn’s plumbing products are known in the industry for such innovation.
The majority of our new product development begins with discussions and feedback from our customers. We have a team of approximately 200 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.
Rexnord Business System
The goal of RBS is to deliver the highest level of customer satisfaction through 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. RBS is based on three basic tenets: People, Plan and Process, and focuses on the development of industry-leading talent, a rigorous strategic planning process and deployment of a lean process necessary to achieve the strategic plan. Implementation of RBS is focused on accelerating growth, improving quality and delivery and reducing costs. RBS encompasses a lean enterprise strategy, the goals of which include improvement of inventory management, customer delivery, plant utilization and a lower cost structure.
Suppliers and Raw Materials
The principal materials used in our PT manufacturing processes are commodities 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 and benchmarking clauses to ensure competitive pricing.
Within our WM platform, we purchase a broad range of materials and components throughout the world in connection with our manufacturing activities. Major raw materials and components include bar steel, brass, castings, copper, forgings, high-performance engineered plastic, plate steel, resin, sheet plastic and zinc. Our policy is to maintain alternate sources of supply for our important materials and components wherever possible. Historically, we have been able to successfully apply this policy, and consequently are not dependent on a single source for any raw material or component. The materials and components required for our WM manufacturing operations have been readily available, and we do not foresee any significant shortages.
Backlog
Our backlog of unshipped PT orders was $405.0 million and $307.0 million at March 31, 2007 and 2006, respectively. Our WM segment operates with minimal backlog based upon the nature of the markets and customers it serves and currently has a backlog of unshipped orders of approximately $19.0 million as of March 31, 2007, which is comparable to where it historically has been.
Geographic Areas
For financial information about geographic areas, see Note 19 of the Notes to Consolidated Financial Statements in this Form 10-K.
Seasonality
We do not experience significant seasonality of demand for our PT products, 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. Our end markets also do not experience significant seasonality of demand.
Demand for our WM products is primarily driven by non-residential construction activity, remodeling and home starts. Accordingly, many external factors affect our WM business, including weather and the impact of the broader economy on our end markets. Weather is an important variable as it significantly impacts construction. Spring and summer months in the United States and Europe represent the main construction season for new housing starts and remodeling, as well as increased construction in the commercial and institutional markets. As a result, sales generally decrease slightly in the third and fourth fiscal quarters as compared to the first two quarters of the fiscal year. The autumn and winter months generally impede construction and installation activity.
Employees
As of March 31, 2007, we had approximately 7,100 employees, of whom approximately 5,100 were employed in the United States. Approximately 13.4% of our North American employees are represented by labor unions. The seven U.S. collective bargaining agreements to which we are a party will expire in May 2008, August 2008, February 2009, December 2009, August 2010, September 2010 and October 2010, respectively. Additionally, approximately 15.8% of our workforce is employed in Europe, where trade union membership is common. We believe we have a satisfactory relationship with our employees, including those represented by labor unions.
Environmental Matters
Our operations and facilities are subject to extensive federal, state, local and foreign laws and regulations related to pollution and the protection of the environment, health and safety, including those governing, among other things, emissions to air, discharges to water, the generation, handling, storage, treatment and disposal of hazardous wastes and other materials, and the remediation of contaminated sites. We have incurred and expect to continue to incur significant costs to maintain or achieve compliance with these requirements. We believe that our business, operations and facilities are being operated in material compliance with applicable environmental, health and safety laws and regulations. However, the operation of manufacturing plants entails risks in these areas, and a failure by us to comply with applicable environmental laws, regulations or the permits required for our operations, could result in civil or criminal fines, penalties, enforcement actions, third party claims for property damage and personal injury, requirements to clean up property or to pay for the capital or operating costs of cleanup, regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, including the installation of pollution control equipment or remedial actions. Moreover, if applicable environmental, health and safety laws and regulations, or the interpretation or enforcement thereof, become more stringent in the future, we could incur capital or operating costs beyond those currently anticipated.
Some environmental laws and regulations, including the federal Superfund law, impose liability to investigate and remediate contamination on present and former owners and operators of facilities and sites, and on potentially responsible parties, or PRPs, for sites to which such parties may have sent waste for disposal. Such liability can be imposed without regard to fault and, under certain circumstances, may be joint and several resulting in one PRP being held responsible for the entire obligation. Liability may also include damages to natural resources. We are currently conducting investigations and/or cleanup of known or potential contamination at several of our current or former facilities, and have been named as a PRP at several third party Superfund sites. See “Legal Proceedings-Power Transmission” for a discussion regarding our Downers Grove, Illinois facility and the Ellsworth Industrial Park Site. The discovery of additional contamination, or the imposition of more stringent cleanup requirements, could require us to make
significant expenditures in excess of current reserves and/or available indemnification. In addition, we occasionally evaluate various alternatives with respect to our facilities, including possible dispositions or closures. Investigations undertaken in connection with these activities may lead to discoveries of contamination that must be remediated, and closures of facilities may trigger remediation requirements that are not applicable to operating facilities. We also may face liability for alleged personal injury or property damage due to exposure to hazardous substances used or disposed of by us, that may be contained within our current or former products, or that are present in the soil or ground water at our current or former facilities.
Zurn is investigating and/or remediating known or potential contamination at a number of present and former operating or disposal sites, including closure or post-closure obligations under the Resource Conservation and Recovery Act, or RCRA, and it has been named as a PRP at a number of sites under the Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA or comparable state statutes. The discovery of additional contamination or the imposition of more stringent cleanup requirements could require Zurn to make significant expenditures in excess of current reserves and/or available insurance coverage. Zurn also may face liability for alleged personal injury or property damage claims due to exposure to hazardous substances used or disposed of by Zurn, that may be contained within its current or former products, or that are present in the soil or ground water at its current or former facilities.
ITEM 1A.
ITEM 1A. RISK FACTORS.
We have identified the following material risks to our business. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or those we currently view to be immaterial may also materially and adversely affect our business, financial condition or results of operations. If any of the following risks materialize, our business, financial condition or results of operations could be materially and adversely affected.
Our substantial indebtedness could adversely affect our business.
We are a highly leveraged company. Our ability to generate sufficient cash flow from operations to make scheduled payments on our debt will depend on a range of economic, competitive and business factors, many of which are outside our control. Our business may not generate sufficient cash flow from operations to meet our debt service and other obligations, and currently anticipated cost savings and operating improvements may not be realized on schedule, or at all. If we are unable to meet our expenses and debt service and other obligations, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets or raise equity. We may not be able to refinance any of our indebtedness, sell assets or raise equity on commercially reasonable terms or at all, which could cause us to default on our obligations and impair our liquidity. Our inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our obligations on commercially reasonable terms, would have a material adverse effect on our business, financial condition and results of operations.
Our substantial indebtedness could also have other important consequences with respect to our ability to manage our business successfully, including the following:
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it may limit our ability to borrow money for our working capital, capital expenditures, debt service requirements, strategic initiatives or other purposes;
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it may make it more difficult for us to satisfy our obligations with respect to our indebtedness, and any failure to comply with the obligations of any of our debt instruments, including restrictive covenants and borrowing conditions, could result in an event of default under the indentures governing our senior notes, senior subordinated notes and our other indebtedness;
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a substantial portion of our cash flow from operations will be dedicated to the repayment of our indebtedness and so will not be available for other purposes;
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it may limit our flexibility in planning for, or reacting to, changes in our operations or business;
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we will be more highly leveraged than some of our competitors, which may place us at a competitive disadvantage;
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it may make us more vulnerable to downturns in our business or the economy;
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it may restrict us from making strategic acquisitions, introducing new technologies or exploiting business opportunities; and
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it may limit, along with the financial and other restrictive covenants in our indebtedness, among other things, our ability to borrow additional funds or dispose of assets.
Furthermore, our interest expense could increase if interest rates increase because a portion of the debt under our senior secured credit facilities is unhedged variable-rate debt. Also, we may still incur significantly more debt, which could intensify the risks described above.
The markets in which we sell our products are highly competitive.
We operate in highly fragmented markets within the PT industry. As a result, we compete against numerous different companies. Some of our competitors have achieved substantially more market penetration in certain of the markets in which we operate, and some of our competitors have greater financial and other resources than we do. Competition in our business lines is based on a number of considerations including product performance, cost of transportation in the distribution of our PT products, brand reputation, quality of client service and support, product availability and price. Additionally, some of our larger, more sophisticated customers are attempting to reduce the number of vendors from which they purchase in order to increase their efficiency. If we are not selected to become one of these preferred providers, we may lose access to certain sections of the end markets in which we compete. Our customers increasingly demand a broad product range and we must continue to develop our expertise in order to manufacture and market these products successfully. To remain competitive, we will need to invest continuously in manufacturing, customer service and support, marketing and our distribution networks. We may also have to adjust the prices of some of our PT products to stay competitive. We cannot assure you that we will have sufficient resources to continue to make these investments or that we will maintain our competitive position within each of the markets we serve.
Within the WM platform, we compete against both large international and national rivals, as well as many regional competitors. Some of our competitors have greater resources than we do. Significant competition in any of our given markets can result in substantial pressure on its pricing and profit margins, thereby adversely affecting its financial results. As a result of pricing pressures, we may in the future experience reductions in profit margins. We cannot provide assurance that we will be able to maintain or increase the current market share of its products successfully in the future.
Our business depends upon general economic conditions and other market factors beyond our control, and we serve customers in cyclical industries. As a result, our operating results could be negatively affected during economic downturns.
Our financial performance depends, in large part, on conditions in the markets that we serve and in the U.S. and global economies generally. Some of the industries we serve are highly cyclical, such as the aerospace, energy and industrial equipment industries. While we are currently experiencing an upturn in the economic environment, it is uncertain how long this upturn will continue. We have undertaken cost reduction programs as well as diversified the end markets served to mitigate the effect of a downturn in economic conditions; however, such programs may be unsuccessful in the event a downturn occurs. Any sustained weakness in demand or downturn or uncertainty in the economy generally would reduce our sales and profitability.
The demand in the water management industry is influenced by new construction activity and the level of repair and remodeling activity. The level of new construction and repair and remodeling activity is affected by a number of factors beyond our control, including the overall strength of the U.S. economy (including confidence in the U.S. economy by our customers), the strength of the residential and commercial real estate markets, institutional building activity, the age of existing housing stock, unemployment rates and interest rates. Any declines in commercial, institutional or residential construction starts or demand for replacement building and home improvement products may adversely impact us, and there can be no assurance that any such adverse effects would not be material and would not continue for a prolonged period of time.
Increases in the cost of our raw materials, in particular bar steel, brass, castings, copper, forgings, high-performance engineered plastic, plate steel, resin, sheet steel and zinc, or the loss of a substantial number of our suppliers could adversely affect our financial health.
We depend on third parties for the raw materials used in our manufacturing processes. We generally purchase our raw materials on the open market on a purchase order basis. In the past, these contracts generally have had one-to-five year terms and have contained competitive and benchmarking clauses intended to ensure competitive pricing. While we currently maintain alternative sources for raw materials, our business is subject to the risk of price fluctuations and delays in the delivery of our raw materials. Any such price fluctuations or delays, if material, could harm our profitability or operations. In addition, the loss of a substantial number of suppliers could result in material cost increases or reduce our production capacity. We are also significantly affected by the cost of natural gas used for fuel and the cost of electricity. Natural gas and electricity prices have historically been volatile, particularly in California where we have a significant manufacturing presence.
We do not typically enter into hedge transactions to reduce our exposure to price risks and cannot assure you that we would be successful in passing on any attendant costs if these risks were to materialize. In addition, if we are unable to continue to purchase our required quantities of raw materials on commercially reasonable terms, or at all, or if we are unable to maintain or enter into our purchasing contracts for our larger commodities, our business operations could be disrupted and our profitability could be adversely impacted.
We rely on independent distributors. Termination of one or more of our relationships with any of those independent distributors or an increase in the distributors’ sales of our competitors’ products could have a material adverse effect on our business, financial condition or results of operations.
In addition to our own direct sales force, we depend on the services of independent distributors to sell our PT products and provide service and aftermarket support to our customers. We rely on an extensive distribution network, with over 1,900 distributor locations nationwide. Rather than serving as passive conduits for delivery of product, our industrial distributors are active participants in the overall competitive dynamic in the PT industry. Industrial distributors play a significant role in determining which of our PT products are stocked at the branch locations, and hence are most readily accessible to aftermarket buyers, and the price at which these products are sold. Almost all of the distributors with whom we transact business offer competitors’ products and services to our customers. In addition, the distribution agreements we have are typically cancelable by the distributor after a short notice period. The loss of one of our key distributors or of a substantial number of our other distributors or an increase in the distributors’ sales of our competitors’ products to our customers could materially and adversely affect our business, financial condition or results of operations. Within WM, we depend on a network of several hundred independent sales representatives and approximately 70 third-party warehouses to distribute its products and is subject to similar risks.
We are subject to risks associated with changing technology and manufacturing techniques, which could place us at a competitive disadvantage.
The successful implementation of our business strategy requires us to continuously evolve our existing products and introduce new products to meet customers’ needs in the industries we serve and want to serve. Our products are characterized by stringent performance and specification requirements that mandate a high degree of manufacturing and engineering expertise. If we fail to meet these requirements, our business could be at risk. We believe that our customers rigorously evaluate their suppliers on the basis of a number of factors, including product quality, price competitiveness, technical and manufacturing expertise, development and product design capability, new product innovation, reliability and timeliness of delivery, operational flexibility, customer service and overall management. Our success will depend on our ability to continue to meet our customers’ changing specifications with respect to these criteria. We cannot assure you that we will be able to address technological advances or introduce new products that may be necessary to remain competitive within our businesses. Furthermore, we cannot assure you that we can adequately protect any of our own technological developments to produce a sustainable competitive advantage.
If we lose certain of our key sales, marketing or engineering personnel, our business may be adversely affected.
Our success depends on our ability to recruit, retain and motivate highly-skilled sales, marketing and engineering personnel. Competition for these persons in our industry is intense, and we may not be able to successfully recruit, train or retain qualified personnel. If we fail to retain and recruit the necessary personnel, our business and our ability to obtain new customers, develop new products and provide acceptable levels of customer service could suffer. In addition, we cannot assure you that these individuals will stay with us. If any of these key personnel were to leave our company, it could be difficult to replace them, and our business could be harmed.
We may incur significant costs for environmental compliance and/or to address liabilities under environmental laws and regulations.
Our operations and facilities are subject to extensive laws and regulations related to pollution and the protection of the environment, health and safety, including those governing, among other things, emissions to air, discharges to water, the generation, handling, storage, treatment and disposal of hazardous wastes and other materials, and the remediation of contaminated sites. A failure by us to comply with applicable requirements or the permits required for our operations could result in civil or criminal fines, penalties, enforcement actions, third party claims for property damage and personal injury, requirements to clean up property or to pay for the costs of cleanup or regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, including the installation of pollution control equipment or remedial actions. Moreover, if applicable environmental, health and safety laws and regulations, or the interpretation or enforcement thereof, become more stringent in the future, we could incur capital or operating costs beyond those currently anticipated.
Some environmental laws and regulations, including the federal Superfund law, impose requirements to investigate and remediate contamination on present and former owners and operators of facilities and sites, and on potentially responsible parties, or PRPs, for sites to which such parties may have sent waste for disposal. Such liability can be imposed without regard to fault and, under certain circumstances, may be joint and several, resulting in one PRP being held responsible for the entire obligation. Liability may also include damages to natural resources. We are currently conducting investigations and/or cleanup of known or potential contamination at several of our current and former facilities, and have been named as a PRP at several third party Superfund sites. The discovery of additional contamination at these sites, or the imposition of more stringent cleanup requirements, could require significant expenditures by us in excess of our current reserves. In addition, we occasionally evaluate various alternatives with respect to our facilities, including possible dispositions or closures. Investigations undertaken in connection with these activities may lead to discoveries of contamination that must be remediated, and closures of facilities may trigger remediation requirements that are not currently applicable to our operating facilities. We may also face liability for alleged personal injury or property damage due to exposure to hazardous substances used or disposed of by us, that may be contained within our current or former products, or that are present in the soil or groundwater at our current or former facilities. Significant costs could be incurred in connection with such liabilities.
We believe that, subject to various terms and conditions, we have certain indemnification protection from Invensys plc (“Invensys”) with respect to certain environmental liabilities that may have occurred prior to the acquisition by Carlyle (the “Carlyle acquisition”) of the capital stock of 16 entities comprising the Rexnord Group of Invensys, including certain liabilities associated with our Downers Grove, Illinois facility and with personal injury claims for alleged exposure to hazardous materials. We also believe that, subject to various terms and conditions, we have certain indemnification protection from Hamilton Sundstrand Corporation, or Hamilton Sundstrand, with respect to certain environmental liabilities that may have arisen from events occurring at Falk facilities prior to the Falk acquisition, including certain liabilities associated with personal injury claims for alleged exposure to hazardous materials. If Invensys or Hamilton Sundstrand becomes unable to, or otherwise does not, comply with their respective indemnity obligations, or if certain contamination or other liability for which we are obligated is not subject to such indemnities or historic insurance coverage, we could incur significant unanticipated costs. As a result, it is possible that we will not be able to recover pursuant to these indemnities a substantial portion, if any, of the costs that we may incur.
Zurn is investigating and remediating contamination at a number of present and former operating or disposal sites and it has been named as a PRP at a number of Superfund sites pursuant to CERCLA or comparable state statutes. Zurn’s actual costs to clean up
these sites may exceed its current estimates due to factors beyond its control, such as the discovery of presently unknown environmental conditions, the imposition of more stringent cleanup standards, disputes with insurers or the insolvency of other responsible parties at the sites at which it is involved.
We are not yet able to determine the full effect of the accident at our Canal Street facility on our financial condition or operations.
On December 6, 2006, we experienced an explosion at our primary gear manufacturing facility (“Canal Street”), in which three employees lost their lives and approximately 45 employees were injured. The explosion destroyed approximately 80,000 square feet of warehouse, storage and non-production buildings, and damaged portions of other production areas. The Canal Street facility manufactures portions of our gear product line and, to a lesser extent, our coupling product line. Our core production capabilities were substantially unaffected by the accident.
To date, we have not experienced any material customer losses or order cancellations as a result of our temporary inability to produce and deliver products from Canal Street. As of March 31, 2007, shipments have recommenced and all Canal Street employees have been recalled and are working at the facility in their pre-accident roles and/or assisting in the restoration process. While as of March 31, 2007, the majority of our production capability has been regained, the full extent of the damage and the impact on future production and sales is not yet fully determinable. We may experience a delay, and as a result a potential decline, in our gear products shipments, and to a lesser extent in coupling shipments, due to this temporary loss of production capacity in this facility. A prolonged delay could lead to a loss of customers for these products, and possibly for some of our other products. We may experience difficulties in procuring replacement machinery and tooling for equipment that was damaged in the explosion, and we therefore cannot assure you when the facility will be operating at full capacity. Due to a possible delay in obtaining component parts with long lead times, we also cannot assure you as to when the facility will return to shipping product in the same volumes as prior to the accident.
There also can be no assurance that our insurance coverage will cover all of our losses from this incident, or that we will not have to engage in protracted litigation to recover under our insurance policies. Even if the insurance carriers acknowledge broad coverage, the facility reconstruction and insurance claim process may take an extended period of time to complete. In addition, we may face workers’ compensation, personal injury, or other tort claims for injury or property damage allegedly caused by the incident. It is also possible that we may be subject to civil penalties. We may not be successful in defending such claims, and the resulting liability could be substantial and may not be fully covered by insurance. As a result of the foregoing and other matters relating to or resulting from this event, there can be no assurance as to the long term effect this incident will have on us or our financial condition.
We are subject to numerous asbestos claims.
We are a co-defendant in approximately 5,200 personal injury lawsuits involving approximately 46,200 plaintiffs pending as of March 31, 2007, in various courts in the United States primarily related to alleged exposure to asbestos contained in industrial boilers formerly manufactured by a segment of Zurn. Our potential liability for asbestos-related claims currently pending against us as well as the claims expected to be filed through 2016 is estimated at approximately $136.0 million, of which $102.0 million is expected to be paid by 2016. These claims are handled by our insurers pursuant to a coordinated defense strategy and, to date, all defense and settlement costs have been paid by our insurers. In the event any such carriers become insolvent in the future, or the actual number or value of asbestos-related claims differs materially from our existing estimates, we could incur material costs that could have an adverse impact on our business, financial condition or results of operations.
Weather could adversely affect the demand for WM’s products and decrease its net sales.
Demand for our WM products is primarily driven by commercial, institutional and residential construction activity. Weather is an important variable affecting its financial performance as it significantly impacts construction activity. Spring and summer months in the United States and Europe represent the main construction seasons. Adverse weather conditions, such as prolonged periods of cold or rain, blizzards, hurricanes and other severe weather patterns, could delay or halt construction and remodeling activity. For example, an unusually severe winter can lead to reduced construction activity and magnify the seasonal decline in Zurn’s net sales and earnings during the winter months. In addition, a prolonged winter season can delay construction and remodeling plans and hamper the seasonal increase in its net sales and earnings during the spring months.
Our international operations are subject to uncertainties, which could adversely affect our operating results.
Our business is subject to certain risks associated with doing business internationally. Accordingly, our future results could be harmed by a variety of factors, including:
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fluctuations in currency exchange rates, particularly fluctuations in the Euro against the U.S. dollar;
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exchange controls;
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compliance with U.S. Department of Commerce export controls;
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tariffs or other trade protection measures and import or export licensing requirements;
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changes in tax laws;
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interest rates;
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changes in regulatory requirements;
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differing labor regulations;
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requirements relating to withholding taxes on remittances and other payments by subsidiaries;
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restrictions on our ability to own or operate subsidiaries, make investments or acquire new businesses in these jurisdictions;
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restrictions on our ability to repatriate dividends from our subsidiaries; and
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exposure to liabilities under the Foreign Corrupt Practices Act.
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 materially and adversely affect our international operations and, consequently, our business, financial condition and results of operations.
We may be unable to make necessary capital expenditures.
We periodically make capital investments to, among other things, maintain and upgrade our facilities and enhance our products’ processes. As we grow our businesses, we may have to incur significant capital expenditures. We believe that we will be able to fund these expenditures through cash flow from operations and borrowings under our senior secured credit facilities. However, our senior secured credit facilities, the indentures governing our senior notes and the indenture governing our senior subordinated notes contain limitations that could affect our ability to fund our future capital expenditures and other capital requirements. We cannot assure you that we will have, or be able to obtain, adequate funds to make all necessary capital expenditures when required, or that the amount of future capital expenditures will not be materially in excess of our anticipated or current expenditures. If we are unable to make necessary capital expenditures, our product line may become dated, our productivity may be decreased and the quality of our products may be adversely affected, which, in turn, could reduce our sales and profitability.
We rely on intellectual property that may be misappropriated or subject to claims of infringement.
We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret protection, as well as licensing agreements and third-party nondisclosure and assignment agreements. We cannot assure you that any of our applications for protection of our intellectual property rights will be approved or that others will not infringe on or challenge our intellectual property rights. We also rely on unpatented proprietary technology. It is possible that others will independently develop the same or similar technology or otherwise obtain access to our unpatented technology. To protect our trade secrets and other proprietary information, we require employees, consultants and advisors to enter into confidentiality agreements. We cannot assure you that these agreements will provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure. If we are unable to maintain the proprietary nature of our technologies, our ability to sustain margins on some or all of our products may be affected, which could materially and adversely affect our business, financial condition or results of operations. In addition, in the ordinary course of our operations, from time to time we pursue and are pursued in potential litigation relating to the protection of certain intellectual property rights, including some of our more profitable products, such as flattop chain. An adverse ruling in any such litigation could have a material and adverse affect on our business, financial condition or results of operations. Similar risk also applies to Zurn’s U.S. and foreign patents, patent applications, registered trademarks and other proprietary rights, which we believe are important to its success, potential growth and competitive position.
We could face potential product liability claims relating to products we manufacture or distribute.
We may be subject to product liability claims in the event that the use of our products, or the exposure to our products or their raw materials is alleged to have resulted in injury or other adverse effects. We currently maintain product liability insurance coverage, but we cannot assure you that we will be able to obtain such insurance on acceptable terms in the future, if at all, or that any such insurance will provide adequate coverage against potential claims. Product liability claims can be expensive to defend and can divert the attention of management and other personnel for long periods of time, regardless of the ultimate outcome. An unsuccessful product liability defense could have a material and adverse effect on our business, financial condition or results of operations. In addition, our business depends on the strong brand reputation we have developed. In the event that this reputation is damaged as a result of a product liability claim, we may face difficulty in maintaining our pricing positions and market share with respect to some of our products, which could materially and adversely affect our business, financial condition or results of operations.
We, our customers and our shippers have unionized employees that may stage work stoppages, which could seriously impact the profitability of our business.
As of March 31, 2007, we had approximately 7,100 employees, of whom approximately 5,100 were employed in the United States. Approximately 13.4% of our North American employees are represented by labor unions. The seven U.S. collective bargaining agreements to which we are a party will expire in May 2008, August 2008, February 2009, December 2009, August 2010, September 2010 and October 2010, respectively. Additionally, approximately 15.8% of our workforce is employed in Europe, where trade union membership is common. Although we believe that our relations with our employees are currently satisfactory, if our unionized workers were to engage in a strike, work stoppage or other slowdown in the future, we could experience a significant disruption of our operations, which could interfere with our ability to deliver products on a timely basis and could have other negative effects, such as decreased productivity and increased labor costs. Such negative effects could materially and adversely affect our business, financial condition or results of operations. In addition, if a greater percentage of our workforce becomes unionized, our business, financial condition or results of operations could be materially and adversely affected. Many of our direct and indirect customers have unionized workforces. Strikes, work stoppages or slowdowns experienced by these customers or their suppliers could result in slowdowns or closures of assembly plants where our products are used. In addition, organizations responsible for shipping our products may be impacted by occasional strikes staged by the International Brotherhood of Teamsters or Teamsters Union. Any interruption in the delivery of our products could reduce demand for our products and could have a material and adverse effect on our business, financial condition or results of operations.
Although we expect the Zurn acquisition to be beneficial, its expected benefits may not be realized, in the time frame anticipated or at all, because of integration and other challenges.
Achieving the expected benefits of the Zurn acquisition will depend on the timely and efficient integration of Zurn’s technology, operations, business culture and personnel into our Company. The integration may not be completed as quickly as expected, and if we fail to effectively integrate the companies or the integration takes longer than expected, we may not achieve the expected benefits of the acquisition. The challenges involved in this integration include, among others:
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potential disruption of our ongoing business and distraction of management;
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unexpected loss of key employees or customers of Zurn;
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conforming Zurn’s standards, processes, procedures and controls with our operations;
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coordinating new product and process development;
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hiring additional management and other critical personnel; and
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increasing the scope, geographic diversity and complexity of our operations.
The Zurn acquisition may not be successfully received by our or Zurn’s customers, distributors or suppliers. In addition, we may encounter unforeseen obstacles or costs in the integration of the Zurn acquisition. Furthermore, the presence of one or more material liabilities of the Zurn business that were unknown to us at the time of acquisition may have a material adverse effect on our business.
We may be unable to successfully realize all of the intended benefits from our past acquisitions, and we may be unable to identify or realize the intended benefits of other potential acquisition candidates.
We acquired Falk on May 16, 2005 and, although we believe that the integration of Falk into our business is substantially complete, we may be unable to realize all of the intended benefits of this acquisition. As part of our business strategy, we will also evaluate other potential acquisitions, some of which could be material, and engage in discussions with acquisition candidates. We cannot assure you that suitable acquisition candidates will be identified and acquired in the future, that the financing of any such acquisition will be available on satisfactory terms, that we will be able to complete any such acquisition or that we will be able to accomplish our strategic objectives as a result of any such acquisition. Nor can we assure you that our acquisition strategies will be successfully received by customers or achieve their intended benefits. Often acquisitions are undertaken to improve the operating results of either or both of the acquiror and the acquired company and we cannot assure you that we will be successful in this regard. We will encounter various risks in acquiring other companies, including the possible inability to integrate an acquired business into our operations, diversion of management’s attention and unanticipated problems or liabilities, some or all of which could materially and adversely affect our business, financial condition or results of operations.
Our future required cash contributions to our pension plans may increase.
Congress recently passed legislation (which was signed into law by President Bush) to reform funding requirements for underfunded pension plans. The legislation, among other things, increases the percentage funding target from 90% to 100% and requires the use of a more current mortality table in the calculation of minimum yearly funding requirements. Our future required cash contributions to our U.S. defined benefit pension plans may increase based on the funding reform provisions that were enacted into law. In addition, if the performance of assets in our pension plans does not meet our expectations, if the Pension Benefit Guaranty Corporation, or PBGC, requires additional contributions to such plans as a result of the recent acquisitions, or if other actuarial assumptions are modified, our future required cash contributions could increase. Any such increases could have a material and adverse effect on our business, financial condition or results of operations.
The need to make these cash contributions may reduce the cash available to meet our other obligations, including our debt obligations with respect to our Senior Secured Credit Facility, our Senior Notes and our Senior Secured Notes, or to meet the needs of our business. In addition, the PBGC may terminate our defined benefit pension plans under limited circumstances, including in the event the PBGC concludes that its risk may increase unreasonably if such plans continue. In the event a plan is terminated for any reason while it is underfunded, we could be required to make an immediate payment to the PBGC of all or a substantial portion of such plan’s underfunding, as calculated by the PBGC based on its own assumptions (which might result in a larger pension obligation than that based on the assumptions we have used to fund such plan), and the PBGC could assert a lien on material amounts of our assets.
Our historical financial information is not comparable to our current financial condition and results of operations because of our use of purchase accounting in connection with the Zurn, Apollo and Falk acquisitions and due to the different basis of accounting used by Invensys and its affiliates prior to the Carlyle acquisition.
It may be difficult for you to compare both our historical and future results. The Falk acquisition was accounted for utilizing purchase accounting, which resulted in a new valuation for the assets and liabilities of Falk to their fair values. This new basis of accounting began on the date of the consummation of the Falk acquisition. The Apollo acquisition also was accounted for using the purchase method of accounting, causing our assets and liabilities to be revalued to their fair values on the closing date of the Apollo acquisition. The allocation of the excess purchase price over the book value of the net assets acquired in the Apollo acquisition was based, in part, on preliminary information which will continue to be subject to adjustment upon obtaining complete valuation information.
In addition, as a result of the Carlyle acquisition, we were subject to a different basis of accounting after November 25, 2002. Accordingly, our historical operating results for periods prior to such date may be of limited use in evaluating our historical performance and comparing it to other periods.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2.
ITEM 2. PROPERTIES.
Within PT we have 29 manufacturing and four repair facilities, 22 of which are located in North America, six in Europe, one in Australia, one in South America and three 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 our PT facilities throughout the United States and in several foreign countries. Listed below are the locations of our principal PT manufacturing and repair facilities:
Our Water Management facilities are principally located in the U.S. and Canada, as set forth below:
In addition, we lease sales office space in Taipei, R.O.C. and an engineering and sourcing center in Zhuhai, China. We also currently lease approximately 15,134 square feet of office space that had previously been the Jacuzzi Brands, Inc. corporate headquarters in West Palm Beach, Florida.
We believe our PT and Water Management properties are sufficient for our current and future needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Legal Proceedings-Power Transmission
Our PT entities 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 adverse effect on the financial position, results of operations or cash flows of the Company.
In connection with the Carlyle acquisition, Invensys has provided us with indemnification against certain contingent liabilities, including certain pre-closing environmental liabilities. We believe that, pursuant to such indemnity obligations, Invensys is obligated to defend and indemnify us with respect to the matters described below relating to the Ellsworth Industrial Park Site and to various asbestos claims. The indemnity obligations relating to the matters described below are not subject to any time limitations and are subject to an overall dollar cap equal to the purchase price, which is an amount in excess of $900.0 million. The following paragraphs summarize the most significant actions and proceedings:
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In 2002, we were named as a PRP, together with at least ten other companies, at the Ellsworth Industrial Park Site, Downers Grove, DuPage County, Illinois (the Site), by the United States Environmental Protection Agency, or USEPA, and the Illinois Environmental Protection Agency, or IEPA. Our Downers Grove property is situated within the Ellsworth Industrial Complex. The USEPA and IEPA allege there have been one or more releases or threatened releases of chlorinated solvents and other hazardous substances, pollutants or contaminants, allegedly including but not limited to a release or threatened release on or from our property, at the Site. The relief sought by the USEPA and IEPA includes
further investigation and potential remediation of the Site. In support of the USEPA and IEPA, in July 2004 the Illinois Attorney General filed a lawsuit (State of Illinois v. Precision et al.) in the Circuit Court of DuPage County, Illinois against us and the other PRP companies seeking an injunction, the provision of potable water to approximately 800 homes, further investigation of the alleged contamination, reimbursement of certain costs incurred by the state and assessment of a monetary penalty. In August 2003, several PRPs, including us, entered into an Administrative Order by Consent, or AOC, with the USEPA, IEPA and State of Illinois et al. that required the PRPs to pay $4.275 million to fund the hook-up of about 800 homes to municipal water and to undertake continuing investigation of the Site. We agreed to pay $306,500 of that fund under an interim allocation. The AOC is expected to resolve a significant portion of the State of Illinois lawsuit. Subsequently, we were notified by the USEPA that an expanded Site investigation will be required. Our allocated share of future costs related to the site, including for investigation and/or remediation, could be significant.
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We are also a defendant in a pending lawsuit alleging personal injury stemming from contamination that allegedly, in whole or in part, originated from the Ellsworth Industrial Park Site. The lawsuit entitled Jana Bendik v. Precision Brand Products et al. v. Rexnord Corporation et al. was filed in April 2004 by an individual plaintiff in the Circuit Court of Cook County, Illinois and seeks monetary relief. Two other suits allegedly related to the Ellsworth Industrial Park Site were recently settled: Kevin Pote, et al. v. Ames Supply Co. et al. was filed in December 2004 by an individual plaintiff in the Circuit Court of Cook County, Illinois. The complaint sought compensatory and punitive damages recoverable under the Illinois Wrongful Death and Survival Statute and the costs of the suit. A sealed, global settlement of all claims was reached with all Pote defendants in March, 2007. Muniz et al. v. Rexnord Corporation et al., was a class action filed in April 2004 in the United States District Court for the Northern District of Illinois. A global settlement was reached in late 2006 with the plaintiffs in the Muniz matter. The Muniz settlement covers past and future costs related to property damage incurred by the plaintiffs as well as certain damages for injuries, but does not release defendants from any potential future claims for non-property damages. The settlement amounts originally allocated to, and paid by, us are subject to further reallocation through a binding arbitration process. The ultimate outcome of the Ellsworth investigation and related litigation cannot presently be determined; however, we believe we have meritorious defenses to these matters. Pursuant to its indemnity obligation, Invensys is defending us in these matters and has paid 100% of our related costs to date. To provide additional protection, we have sued our insurance companies for a declaration of coverage as to these matters.
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We have been named as a defendant in over 630 lawsuits (with approximately 6,800 claimants) pending in state or federal court in numerous jurisdictions relating to alleged personal injuries due to the alleged presence of asbestos in certain brakes and clutches previously manufactured by our Stearns division. Invensys and FMC, the prior owner of the Stearns business, have paid 100% of the costs to date related to the Stearns lawsuits. Similarly, our Prager subsidiary has been named as a defendant in two pending multi-defendant lawsuits relating to alleged personal injuries due to the alleged presence of asbestos in a product allegedly manufactured by Prager. There are approximately 3,600 claimants in the Prager lawsuits. The ultimate outcome of these lawsuits cannot presently be determined. To date, Invensys has paid 100% of the costs related to the Prager lawsuits, and we believe that we also have insurance coverage for our legal defense costs related to such suits.
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The Kimberly St. Cin, Individually and as surviving spouse of Robert St. Cin, decedent v. The Falk Corporation, et al., wrongful death claim against Falk was settled and such settlement approved by the court on October 23, 2006. Our settlement contribution was within reserves previously established by us.
In connection with the Falk acquisition, Hamilton Sundstrand has provided us with indemnification against certain contingent liabilities, including coverage for certain pre-closing environmental liabilities. We believe that, pursuant to such indemnity obligations, Hamilton Sundstrand is obligated to defend and indemnify us with respect to the asbestos claims described below, and that, with respect to these claims, such indemnity obligations are not subject to any time or dollar limitations. The following paragraph summarizes the most significant actions and proceedings for which Hamilton Sundstrand has accepted responsibility:
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Falk is a defendant in over 140 lawsuits pending in state or federal court in numerous jurisdictions relating to alleged personal injuries due to the alleged presence of asbestos in certain clutches and drives previously manufactured by Falk. There are approximately 4,100 claimants in these suits. The ultimate outcome of these lawsuits cannot presently be determined. Hamilton Sundstrand is defending Falk in these lawsuits pursuant to its indemnity obligations and has paid 100% of the costs to date.
In addition to the foregoing litigation, Falk is a defendant in other lawsuits. 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 will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
Legal Proceedings-Water Management
Our Water Management group entities are party to legal proceedings that we believe to be either ordinary, routine litigation incidental to the business of present and former operations or immaterial to its financial condition, results of operations or cash flows.
As of March 31, 2007, we and an average of 80 other unrelated companies were defendants in approximately 5,200 asbestos related lawsuits representing approximately 46,200 claims. The suits allege damages in an aggregate amount of approximately $11.8 billion against all defendants. Plaintiffs’ claims against us allege personal injuries caused by exposure to asbestos used primarily in industrial boilers formerly manufactured by a segment of Zurn. Zurn did not manufacture asbestos or asbestos components. Instead, Zurn purchased them from suppliers. These claims are being handled pursuant to a defense strategy funded by our insurers.
We use an independent economic consulting firm with substantial experience in asbestos liability valuations to assist in the estimation of Zurn’s potential asbestos liability. Based on this firm's analysis, we currently estimate that Zurn’s potential liability for asbestos claims pending against it and for claims estimated to be filed through 2016 is approximately $136.0 million, of which we expect to pay approximately $102.0 million through 2016 on such claims, with the balance of the estimated liability being paid in subsequent years. However, there are inherent uncertainties involved in estimating the number of future asbestos claims, future settlement costs, and the effectiveness of our defense strategies and settlement initiatives. As a result, our actual liability could differ from our estimate described herein. Further, while our current asbestos liability is based on an estimate of claims through 2016, such liability may continue beyond 2016, and such liability could be substantial.
We estimate that our available insurance to cover our potential asbestos liability as of March 31, 2007, is approximately $287.0 million, and we believe that all current claims are covered by this insurance. However, principally as a result of the past insolvency of certain of our insurance carriers, certain coverage gaps will exist if and after our other carriers have paid the first $211.0 million of aggregate liabilities. In order for the next $51.0 million of insurance coverage from solvent carriers to apply, we estimate that we would need to satisfy $14.0 million of asbestos claims. Layered within the final $25.0 million of the total $287.0 million of coverage, we estimate that we would need to satisfy an additional $80 million of asbestos claims. If we are required to pay any such amounts, we could pursue recovery against the insolvent carriers, but it is not currently possible to determine the likelihood or amount of any such recoveries, if any.
As of March 31, 2007, we recorded a receivable from our insurance carriers of $136.0 million, which corresponds to the amount of our potential asbestos liability that is covered by available insurance and is currently determined to be probable of recovery. However, there is no assurance that $287.0 million of insurance coverage will ultimately be available or that Zurn’s asbestos liabilities will not ultimately exceed $287.0 million. Factors that could cause a decrease in the amount of available coverage include changes in law governing the policies, potential disputes with the carriers on the scope of coverage, and insolvencies of one or more of our carriers.
Although it is not possible to predict with certainty the outcome of these unresolved legal actions, based upon current information we believe that the eventual outcome of these actions will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
ITEM 4.
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, 2007.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
No established public trading market for RBS Global, Inc. common stock or Rexnord LLC membership units currently exists.
Dividends
RBS Global, Inc. and Rexnord LLC did not pay dividends during the years ended March 31, 2007, 2006 and 2005 on their common stock or membership interests, and it is our current policy to retain earnings to repay debt and finance our operations. In addition, our senior credit facility and outstanding notes significantly restrict the payment of dividends on our common stock and membership interests.
Holders
As of May 24, 2007, the common stock of RBS Global, Inc. was wholly owned by our indirect parent company Rexnord Holdings. RBS Global, Inc. is the sole member of Rexnord.
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 Form 10-K.
Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities
No securities were sold during the fourth quarter ended March 31, 2007.
ITEM 6.
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 Operations, Other Data and Balance Sheet Data are derived from our audited financial statements. These financial statements do not include the accounts of Rexnord Holdings, the indirect parent company of RBS Global, Inc.
(1) Consolidated financial data as of March 31, 2007 and for the period from July 22, 2006 through March 31, 2007 reflects the estimated fair value of assets acquired and liabilities assumed in connection with the Zurn acquisition on February 7, 2007. As a result, 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 both the Apollo and Zurn acquisitions.
(2) Consolidated financial data as of and for the year ended March 31, 2006 reflects the estimated fair value of assets acquired and liabilities assumed in connection with the Falk 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 Falk acquisition.
(3) Consolidated financial data for all periods subsequent to July 21, 2006 (the date of the Apollo acquisition) reflects the fair value of assets acquired and liabilities assumed as a result of that transaction. Consolidated financial data for all periods subsequent to November 25, 2002 (the date of the Carlyle acquisition) reflect the fair value of assets acquired and liabilities assumed in connection with the Carlyle 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 Apollo and Carlyle acquisitions. 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 and its affiliates that were acquired by our indirect wholly owned subsidiary, RBS Acquisition Corporation, in the Carlyle acquisition (Predecessor Basis of Accounting), and similarly for periods prior to the Apollo acquisition.
(4) 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.
(5) 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. 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:
EBITDA for the fiscal period from July 22, 2006 through March 31, 2007 includes a $6.0 million gain on Canal Street accident, other income of $5.7 million and a $20.0 million “last-in, first-out,” or LIFO, benefit. EBITDA for the fiscal period from April 1, 2006 through July 21, 2006 includes $62.7 million of transaction related costs, other expense of $0.4 million and a $1.2 million LIFO charge. EBITDA for the fiscal year ended March 31, 2006 includes $31.1 million of restructuring charges, a $0.7 million charge to write-off excess and obsolete inventory related to certain consolidation and integration activities, other expenses of $3.8 million and a $3.0 million LIFO charge. EBITDA for the fiscal year ended March 31, 2005 includes $7.3 million of restructuring charges, a $1.6 million charge related to the write-off of excess and obsolete inventory that was on-hand on the date that the Carlyle Acquisition was consummated for which no reserves were established in purchase accounting, other expenses of $0.7 million and a $2.0 million LIFO charge. EBITDA for the fiscal year ended March 31, 2004 includes $2.6 million of restructuring charges, a $6.6 million curtailment gain related to our pension and postretirement plans, other expenses of $1.1 million and a $0.4 million LIFO benefit. EBITDA for the period from November 25, 2002 through March 31, 2003 includes other expenses of $0.5 million and a $0.3 million LIFO benefit. EBITDA for the period from April 1, 2002 through November 24, 2002 includes $7.5 million of restructuring charges, other expenses of $0.1 million, $2.3 million of income from a litigation settlement, losses of $0.7 million related to the operating results of the Hansen P4 product line which was retained by our former parent company, Invensys plc, and excludes $1.6 million of pro forma expenses related to costs that the Company would have expected to incur had the Company operated as a separate legal entity from Invensys prior to November 25, 2002.
(6) Represents total current assets less total current liabilities.
(7) Total debt represents long-term debt plus the current portion of long-term debt.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion of results of operations and financial condition covers periods prior to the consummation of both the Zurn and Apollo acquisitions. Our financial performance includes: (i) Zurn from February 8, 2007 through March 31, 2007 and (ii) the impact of the Apollo transaction from July 22, 2006 through March 31, 2007. Accordingly, the discussion and analysis of historical periods does not fully reflect the significant impact that both the Zurn and Apollo transactions have, and will have on us,
including significantly increased liquidity requirements. You should read the following discussion of our financial condition and results of operations together with Item 6, Selected Financial Data and Item 8, Financial Statements and Supplementary Data. Our fiscal year is the year ending March 31 of the corresponding calendar year. For example, our fiscal year 2007, or fiscal 2007, means the period from April 1, 2006 to March 31, 2007.
General
We believe we are a leading diversified, multi-platform industrial company strategically well positioned within the markets and industries we serve. With the completion of the Zurn acquisition, our business is comprised of two strategic platforms: (i) our existing PT platform and (ii) a new Water Management platform based on the acquired Zurn operations. We believe that we have the broadest portfolio of highly engineered, mission and project critical PT products in the industrial and aerospace end markets, including gears, couplings, industrial bearings, flattop, aerospace bearings and seals, special components and industrial chain. Our PT products are used in the plants and equipment of companies in diverse end-market industries, including aerospace, cement and aggregates, construction, energy, food and beverages and forest and wood products. Our PT products are either incorporated into products sold by OEMs or sold to end users through industrial distributors as aftermarket products. We have a significant installed base of PT products consisting primarily of components that are consumed in use and that have a predictable replacement cycle. With the Zurn acquisition, our Water Management platform is a leader in the multi-billion dollar, specification-driven, non-residential construction market for plumbing fixtures and fittings. Although our results of operations are dependent on general economic conditions, our significant installed base generates aftermarket sales that partially mitigate the impact of economic downturns on our results of operations. Due to the similarity of our products, historically we have not experienced significant changes in gross margins due to changes in sales product mix or sales channel mix.
The Zurn Acquisition
On February 7, 2007, we acquired Zurn from an affiliate of Apollo for a cash purchase price of $942.5 million, including transaction costs. The purchase price was financed through an equity investment by Apollo and its affiliates of approximately $282.0 million and debt financing of approximately $669.3 million, consisting of (i) $319.3 million of 9.50% senior notes due 2014 (including a bond issue premium of $9.3 million), (ii) $150.0 million of 8.875% senior notes due 2016 and (iii) $200.0 million of borrowings under existing senior secured credit facilities. This acquisition created a new strategic water management platform for the Company. Zurn is a leader in the multi-billion dollar non-residential construction and replacement market for plumbing fixtures and fittings. It designs and manufactures plumbing products used in commercial and industrial construction, renovation and facilities maintenance markets in North America, and holds a leading market position across most of its businesses.
The acquisition has been accounted for using the purchase method of accounting. The purchase price was allocated to identifiable assets acquired and liabilities assumed based upon their estimated fair values, which are preliminary and based upon currently available information. We are still in the process of finalizing third-party appraisals of the acquired property, plant and equipment and certain identifiable intangible assets. Accordingly, final adjustments to the purchase price allocation may be required. We expect to finalize the purchase price allocation within one year from the date of the acquisition.
The Company’s results and financial statements for the fiscal year ended March 31, 2007 include Zurn for the period from February 8, 2007 through March 31, 2007.
The Apollo Acquisition and Related Financing
On July 21, 2006, certain affiliates of Apollo purchased the Company from The Carlyle Group and management for approximately $1.825 billion, excluding transaction fees, through the merger of Chase Merger Sub, Inc., an entity formed and controlled by Apollo, with and into RBS Global, Inc. (the “Merger”). The Merger was financed with (i) $485.0 million of 9.50% senior notes due 2014, (ii) $300.0 million of 11.75% senior subordinated notes due 2016, (iii) $645.7 million of borrowings under new senior secured credit facilities (consisting of a seven-year $610.0 million term loan facility and $35.7 million of borrowings under a six-year $150.0 million revolving credit facility) and (iv) $475.0 million of equity contributions (consisting of a $438.0 million cash contribution from Apollo and $37.0 million of rollover stock and stock options held by management participants). The proceeds from the Apollo cash contribution and the new financing arrangements, net of related debt issuance costs, were used to (i) purchase the Company from its then existing shareholders for $1,018.4 million, including transaction costs; (ii) repay all outstanding borrowings under our previously existing Credit Agreement as of the Merger Date, including accrued interest; (iii) repurchase substantially all of our $225.0 million of 10.125% senior subordinated notes outstanding as of the Merger Date pursuant to a tender offer, including accrued interest and tender premium; and (iv) pay certain seller-related transaction costs.
The Merger has been accounted for using the purchase method of accounting and, accordingly, resulted in a new basis of accounting for us. The purchase price was allocated to identifiable assets acquired and liabilities assumed based upon their estimated fair values which are preliminary and based upon currently available information. We are still in the process of finalizing third-party appraisals of the acquired property, plant and equipment and certain identifiable intangible assets. In addition, we are still finalizing our strategic assessment of our business which may give rise to additional purchase liabilities. Accordingly, final adjustments to the purchase price allocation may be required. We expect to finalize the purchase price allocation within one year from the date of the Merger.
The Falk Acquisition
On May 16, 2005, the Company acquired The Falk Corporation (“Falk”) from Hamilton Sundstrand, a division of United Technologies Corporation (“UTC”), for $301.3 million ($306.2 purchase price including transaction related expenses, net of cash acquired of $4.9 million) and the assumption of certain liabilities. The acquisition of Falk was funded by a $312.0 million term loan and was accounted for using the purchase method of accounting. During fiscal 2006, the preliminary allocation of the Falk purchase price to identifiable assets acquired and liabilities assumed resulted in the recording of $95.3 million of goodwill. Final purchase accounting adjustments were recorded in fiscal 2007, resulting in an additional $1.0 million of goodwill.
Canal Street Facility Accident
On December 6, 2006, the Company experienced an explosion at its primary gear manufacturing facility (“Canal Street”), in which three employees lost their lives and approximately 45 employees were injured. Canal Street is comprised of over 1.1 million square feet among several buildings, and employed approximately 750 associates prior to the accident. The accident resulted from a leak in an underground pipe related to a backup propane gas system that was being tested. The explosion destroyed approximately 80,000 square feet of warehouse, storage and non-production buildings, and damaged portions of other production areas. The Canal Street facility manufactures portions of the Company’s gear product line and, to a lesser extent, the Company’s coupling product line. The Company’s core production capabilities were substantially unaffected by the accident.
For the period from July 22, 2006 through March 31, 2007, the Company has recorded the following (gains)/losses related to this incident (in millions):
The Company has substantial property, casualty, liability, workers’ compensation and business interruption insurance. Management believes that the limits of coverage will be in excess of the losses incurred. The property, casualty and business interruption liability insurance provides coverage of up to $2.0 billion per incident. The aggregate amount of deductibles under all insurance coverage is $1.0 million. The accident affected production and shipments from the Canal Street facility, creating a business interruption that we estimate adversely impacted fiscal 2007 sales by approximately $39.0 to $48.0 million. While difficult to determine, the Company estimates that income from operations was adversely impacted by approximately $16.0 to $22.0 million in fiscal 2007 as a result of the accident and the associated reduction in sales. Through March 31, 2007, the Company has received cash advances from its insurance carriers totaling $37.0 million of which $27.0 million has been allocated to recoveries under property and casualty insurance policies and $10.0 million of recoveries which have been allocated to recoveries under business interruption insurance policies. The net impact on operations recorded as a result of insurance proceeds and the incurrence of expenses, impairment of assets and clean-up and restoration costs results in a $6.0 million gain currently recognized in the consolidated statement of operations. The Company is actively working with its insurance carriers to determine further recoverable amounts and timing of the insurance proceeds recoverable under its property, casualty and business interruption coverage. The Company has only recorded insurance recoveries to the extent received as of March 31, 2007. Additional recoveries are expected to become recordable under GAAP in subsequent periods.
Canal Street Update
To date the Company has not experienced any material customer losses or order cancellations as a result of its temporary inability to produce and deliver products from Canal Street. Management does not believe that there will be any long-term negative implications to the Company’s gear product line as a result of the accident. The Company has not experienced, and does not expect to experience, any material adverse impact to liquidity, cash or its leverage profile as a result of the accident.
The Company has recommenced shipments and production at Canal Street. As of March 31, 2007 all Canal Street employees have been recalled and are working at the facility in their roles prior to the accident and/or assisting in the restoration process. Shipments and production at Canal Street continue to increase, and management estimates that the Company will be able to reach pre-accident shipment levels from the Canal Street facility during the first half of its fiscal 2008.
Recovery Under Continued Dumping and Subsidy Offset Act (“CDSOA”)
The U.S. government has eight antidumping duty orders in effect against certain foreign producers of ball bearings exported from six countries, tapered roller bearings from China and spherical plain bearings from France. The foreign producers of the ball bearing orders are located in France, Germany, Italy, Japan, Singapore and the United Kingdom. The Company is a producer of ball bearing products in the United States. The CDSOA provides for distribution of monies collected by Customs and Border Protection (“CBP”) from antidumping cases to qualifying producers, on a pro rata basis, where the domestic producers have continued to invest their technology, equipment and people in products that were the subject of the anti-dumping orders. As a result of providing relevant information to CBP regarding calendar 2006 and prior years’ manufacturing, personnel and development costs, the Company received $8.8 million, its pro rata share of the total CDSOA distribution, during the third quarter of fiscal 2007. This recovery was recorded within other income (expense) on the consolidated statement of operations.
In February 2006, U.S. Legislation was enacted that will end CDSOA distributions for imports covered by anti-dumping duty orders entering the U.S. after September 30, 2007. Because monies will continue to be collected by CBP until September 30, 2007 and for prior year entries, the Company may receive some additional distributions beyond fiscal 2007; however, the Company can not reasonably estimate the amount of CDSOA distributions it will receive in future years, if any.
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.
As described above, the Apollo acquisition occurred on July 21, 2006, and created a new basis of accounting for RBS Global. In this management’s discussion and analysis, our results from July 22, 2006, through March 31, 2007 are combined with Predecessor results for the period from April 1, 2006 through July 21, 2006, with the result being referred to as fiscal year ended March 31, 2007. GAAP does not allow for such a combination of predecessor and successor financial results; however, we believe the combined results provide information that is useful in evaluating our financial performance. The combined financial information is the result of merely adding the predecessor and successor results and does not include any pro forma assumptions or adjustments.
Net Sales. Net sales represent gross sales less deductions taken for sales returns and allowances and incentive rebate programs.
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 postretirement benefits, information technology costs and other manufacturing related costs.
The largest component of our cost of sales is cost of materials, which represented approximately 37% of net sales in fiscal 2007. The principal materials used in our PT 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. Within WM, we purchase a broad range of materials and components throughout the world in connection with our manufacturing activities. Major raw materials and components include bar steel, brass, castings, copper, forgings, high-performance engineered plastic, plate steel, resin, sheet plastic and zinc. 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 20% of net sales in fiscal 2007. Direct and indirect labor and related fringe benefit costs are susceptible to inflationary trends.
Selling, General and Administrative Expenses. Selling, general and administrative expenses 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 postretirement benefits, insurance, depreciation, advertising, travel and information technology costs.
Critical Accounting Estimates
The methods, estimates and judgments we use in applying our 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. Within the context of these critical accounting policies, we are not currently aware of any reasonably likely event that would result in materially different amounts being reported.
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 2007, 2006 and 2005 was less than 0.9% of net sales in each such year. Other than our standard product warranty, there are no post-shipment obligations.
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 management estimates to determine the amount of overhead variances to capitalize into inventories. We capitalize overhead variances into inventories based on estimates of related cost drivers, which are generally either raw material purchases or standard labor. Due to changes in our manufacturing processes, we re-evaluated these estimates in fiscal 2005 to ensure we were valuing our inventories at actual cost. As a result, we revised certain of these estimates which increased inventories and 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 $4.9 million, $4.9 million, and $3.1 million during fiscal 2007, 2006 and 2005, 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:
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.
Our recorded goodwill is not amortized but is tested annually for impairment using a discounted cash flow analysis. As of March 31, 2007, there was no impairment recorded for any reporting unit.
The Company expects to recognize amortization expense on the intangible assets subject to amortization of $45.0 million in the fiscal year ending March 31, 2008, $44.7 million in the fiscal year ending March 31, 2009, $44.6 million in the fiscal year ending March 31, 2010, $44.6 million in the fiscal year ending March 31, 2011 and $44.5 million in the fiscal year ending March 31, 2012.
Retirement benefits. We have significant pension and post-retirement benefit income and expense and assets/liabilities that are developed from actuarial valuations. These valuations include key assumptions regarding discount rates, expected return on plan assets, mortality rates, merit and promotion increases and the current health care cost trend rate. We consider current market conditions in selecting these assumptions. Changes in the related pension and post-retirement benefit income/costs or assets/liabilities may occur in the future due to changes in the assumptions and changes in asset values.
Future changes in the assumptions underlying our pension valuations, including those that arise as a result of declines in equity markets and interest rates, could result in reductions in pension income, which could negatively affect our consolidated results of operations in future periods.
As of March 31, 2007, we had pension plans with a combined projected benefit obligation of $583.4 million compared to plan assets of $620.6 million. While our combined domestic pension plans are over-funded, approximately $41.9 million of the above projected benefit obligation is from plans of our German subsidiaries where such plans are typically not funded.
The obligation for postretirement 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 postretirement 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. 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 relating to foreign loss carryforwards and a partial valuation allowance against our deferred tax assets relating to certain state net operating loss and foreign tax credit carryforwards.
Commitments and Contingencies. We are subject to proceedings, lawsuits and other claims related to environmental, labor, product and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. We determine the amount of reserves needed, if any, for each individual issue based on our professional knowledge and experience and discussions with legal counsel. The required reserves may change in the future due to new developments in each matter, the ultimate resolution of each matter or changes in approach, such as a change in settlement strategy, in dealing with these matters.
Through recent acquisitions, we have assumed presently recorded and potential future liabilities relating to product liability, environmental and other claims. We have recorded reserves for claims related to these obligations when appropriate and, on certain occasions, have obtained the assistance of an independent actuary in the determination of those reserves. If actual experience deviates from our estimates, we may need to record adjustments to these liabilities in future periods.
Warranty Reserves. Reserves are recorded on our consolidated balance sheets to reflect our contractual liabilities relating to warranty commitments to our customers. We provide warranty coverage of various lengths and terms to our customers depending on standard offerings and negotiated contractual agreements. We record an estimate for warranty expense at the time of sale based on historical warranty return rates and repair costs. Should future warranty experience differ materially from our historical experience, we may be required to record additional warranty reserves which could have a material adverse effect on our results of operations in the period in which these additional reserves are required.
Environmental Liabilities. We accrue an estimated liability for each environmental matter when the likelihood of an unfavorable outcome is probable and the amount of loss associated with such unfavorable outcome is reasonably estimable. We presume that a matter is probable of an unfavorable outcome if (a) litigation has commenced or a claim has been asserted or if commencement of litigation or assertion of a claim is probable and (b) if we are somehow associated with the site. In addition, if the reporting entity has been named as a Potentially Responsible Party (“PRP”), an unfavorable outcome is presumed.
Estimating environmental remediation liabilities involves an array of issues at any point in time. In the early stages of the process, cost estimates can be difficult to derive because of uncertainties about a variety of factors. For this reason, estimates developed in the early stages of remediation can vary significantly; and, in many cases, early estimates later require significant revision. The following are some of the factors that are integral to developing cost estimates:
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The extent and types of hazardous substances at a site;
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The range of technologies that can be used for remediation;
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Evolving standards of what constitutes acceptable remediation; and
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The number and financial condition of other PRPs and the extent of their responsibility for the remediation.
An estimate of the range of an environmental remediation liability typically is derived by combining estimates of various components of the liability, which themselves are likely to be ranges. At the early stages of the remediation process, particular components of the overall liability may not be reasonably estimable. This fact does not preclude our recognition of a liability. Rather, the components of the liability that can be reasonably estimated are viewed as a surrogate for the minimum in the range of our overall liability. Estimated legal and consulting fees are included as a component of our overall liability.
Asbestos Claims and Insurance for Asbestos Claims. As noted in Item 3, Legal Proceedings, of this Annual Report on Form 10-K, we have recorded a liability for pending and potential future asbestos claims, as well as a receivable for insurance coverage of such liability. The valuation of our potential asbestos liability, which was performed this year by an independent economic consulting firm with substantial experience in asbestos liability valuations, was based on the number and severity of future asbestos claims, future settlement costs, and the effectiveness of Zurn’s defense strategies and settlement initiatives.
The present estimate of our asbestos liability assumes (i) its continuous vigorous defense strategy will remain effective; (ii) new asbestos claims filed annually against it will decline modestly through 2016; (iii) the values by disease will remain consistent with past experience and (iv) its insurers will continue to pay defense costs without eroding the coverage amounts of its insurance policies. Our potential asbestos liability could be adversely affected by changes in law and other factors beyond its control. Further, while our current asbestos liability is based on an estimate of claims through 2016, such liability may continue beyond 2016, and such liability could be substantial.
We estimate that our available insurance to cover our potential asbestos liability as of the end of fiscal 2007 is greater than its potential asbestos liability. This conclusion was reached after considering our experience in asbestos litigation, the insurance payments made to date by our insurance carriers, existing insurance policies, the industry ratings of the insurers and the advice of insurance coverage counsel with respect to applicable insurance coverage law relating to the terms and conditions of those policies. We used these same considerations when evaluating the recoverability of our receivable for insurance coverage of potential asbestos claims.
Results of Operations
Year Ended March 31, 2007 Compared with the Year Ended March 31, 2006
Net Sales. Net sales in fiscal 2007 were $1,255.7 million, an increase of $174.3 million, or 16.1%, from fiscal 2006 net sales of $1,081.4 million. Approximately $25.2 million of the year over year increase was due to the inclusion of the Falk acquisition for all of fiscal 2007 compared to approximately 10.5 months in fiscal 2006. Additionally, the Zurn acquisition added $69.5 million of sales from the date of acquisition through March 31, 2007. The remaining sales increase of $79.6 million was driven primarily by strength in our power transmission products end markets of natural resource extraction, metals processing, infrastructure expansion (mining, cement, aggregates) and strong demand for our aerospace products. Foreign currency fluctuations favorably impacted sales by approximately $18.8 million during fiscal 2007, as the Euro and Canadian Dollar strengthened against the U.S. Dollar. The Canal Street accident affected production and shipments from the Canal Street facility, creating a business interruption that we estimate adversely impacted sales in fiscal 2007 by approximately $39.0 to $48.0 million.
Gross Profit. Gross profit grew 15.0% in fiscal 2007 to $389.8 million, or 31.0% of net sales, from $339.1 million, or 31.4% of net sales in fiscal 2006. The increase in gross profit in fiscal 2007 compared to fiscal 2006 was primarily driven by the incremental sales volume year over year. Our gross profit in fiscal 2007 includes $25.0 million of incremental unfavorable expenses from selling inventories that were adjusted to fair value in purchase accounting as a result of the Apollo and Zurn acquisitions, partially offset by
$18.8 million of LIFO income recorded in fiscal 2007. The net of these fair value and LIFO adjustments adversely affected gross profit margins by a combined 50 basis points in fiscal 2007. In fiscal 2006, we recorded $3.0 million of LIFO expense that adversely affected gross profit margins by 28 basis points. The remaining decline in gross margin % in fiscal 2007 compared to fiscal 2006 was driven by decreased leverage on fixed costs as a result of lost margins due to the Canal Street accident.
Selling, General and Administrative Expenses (“SG&A”). SG&A expenses increased by $34.6 million, or 18.4%, in fiscal 2007 to $222.4 million as compared to $187.8 million in fiscal 2006. As a percentage of net sales, SG&A expenses grew to 17.7% in fiscal 2007 compared to 17.4% in fiscal 2006. The increase in SG&A expenses as a percent of sales is due primarily to the impact of the Canal Street accident and resulting lower sales in fiscal 2007 as a result of the business interruption. In SG&A dollars, the Zurn and Falk acquisitions account for approximately $15.0 of the year-over-year increase in SG&A expense. Excluding acquisitions, SG&A increased as a result of the following: higher stock option expense of $5.1 million due to the adoption of SFAS No. 123R, $5.3 million of higher depreciation expense and $2.8 million of unfavorable currency impact due to the strengthening of the Euro and Canadian Dollar. The remaining increase in SG&A was driven by higher compensation costs as compared to the prior year, offset by a one-time $3.1 million benefit recorded in fiscal 2007 as a result of the change in the Company’s vacation policy.
Restructuring and Other Similar Costs. The Company has recorded no restructuring or other similar costs in fiscal 2007. We expensed $31.1 million of restructuring and other similar costs in fiscal 2006, including $6.9 million of non-cash asset impairments, related to plans we initiated in fiscal 2006 to restructure certain manufacturing operations and reduce headcount at certain locations. The non-cash asset impairments related to the closure of our flattop plant in Puerto Rico and a decision to outsource certain portions of our industrial chain manufacturing operations. We also incurred $16.5 million of plant consolidation and integration costs consisting primarily of (i) the closure of our coupling plant in Warren, Pennsylvania, (ii) the closure of our flattop plant in Puerto Rico and (iii) Falk integration costs, including the continuation of certain Falk plant consolidation efforts that had been initiated prior to the Falk acquisition. All of these consolidation and integration actions were substantially complete as of March 31, 2006. The remaining $7.7 million of restructuring and other similar costs in fiscal 2006 relate primarily to severance, relocation and recruiting expenses for certain headcount reduction and management realignment initiatives.
Gain on Canal Street accident, net We have recorded a gain of $6.0 million through March 31, 2007 as a result of the accident at our Canal Street facility on December 6, 2006. The gain is a result of recording expenses and asset impairments related to the accident, offset by cash advances from its insurance carriers totaling $37.0 million. The net impact on operations recorded as a result of the receipt of the insurance proceeds and the incurrence of expenses, impairment of assets and clean-up and restoration costs results in a $6.0 million gain recognized in the consolidated statement of operations in fiscal 2007.
Transaction-Related Costs. We expensed $62.7 million of Apollo transaction-related costs in fiscal 2007. These costs consisted of (i) $19.1 million of seller-related expenses, including investment banking fees, outside attorney fees, and other third-party fees; (ii) $23.1 million of bond tender premium related to the $225.0 million of senior subordinated notes, substantially all of which were repurchased in connection with the Merger; and (iii) a non-cash charge of $20.5 million to write-off the remaining net book value of previously-capitalized financing fees related to the term loans and senior subordinated notes that we repaid/repurchased in connection with the Merger. There were no transaction-related costs recorded in fiscal 2006.
Amortization of Intangible Assets. We amortize the cost of our intangible assets, which include patents, customer relationships (including distribution network), a covenant not to compete and software. Amortization of these intangible assets amounted to $31.9 million in fiscal 2007 and $15.7 million in fiscal 2006. The increase between years is due to the amortization of intangible assets resulting from the Apollo and Zurn acquisitions.
Interest Expense, net. Interest expense, net was $126.0 million in fiscal 2007 compared to $61.5 million in fiscal 2006. As a result of the Apollo transaction and the recent acquisition of Zurn, we have increased our overall indebtedness, and a larger portion of that debt consists of senior notes, which have higher interest rates than our term loans.
Other Income (Expense), net. Other income, net was $5.3 million for fiscal 2007 and includes $1.4 million of foreign currency transaction losses, $2.0 million of management fee expenses, and $0.1 million of other expenses offset by an $8.8 million CDSOA recovery. Other expense, net for fiscal 2006 was $3.8 million and consists of management fees of $2.0 million, attorney fees related to the refinancing of our credit agreement of $1.0 million, losses on the sale of plant, property and equipment of $0.4 million and foreign currency transaction losses of $0.4 million.
Provision (Benefit) for Income Taxes. The income tax benefit in fiscal 2007 was $5.2 million or an effective tax rate benefit of 12.4%. The benefit recorded is lower than the statutory rate primarily as a result of certain transaction and merger related expenses being deemed non-deductible for federal and state income tax purposes. The fiscal 2006 effective income tax rate was 41.6% due to certain one-time non-deductible expenses and higher foreign-related tax expense, offset in part by the realization of certain state and local income tax benefits. See Note 16 of the consolidated financial statements for more information on income taxes.
Net Income (Loss). The net loss recorded in fiscal 2007 was $36.7 million as compared to $22.9 million of net income in the prior year due to the factors described above.
Year Ended March 31, 2006 Compared with the Year Ended March 31, 2005
Net Sales. Net sales in fiscal 2006 were $1,081.4 million, an increase of $270.4 million or 33.3%, over fiscal 2005’s net sales of $811.0 million. The increase in net sales was due to the Falk acquisition and continued solid performance in our industrial products end markets of forest products, energy, construction equipment, natural resource extraction, metals processing and infrastructure expansion (mining, cement, aggregates), as well as strong demand for our aerospace products. The net impact of foreign currency fluctuations on fiscal 2006 net sales was not significant.
Gross Profit. Gross profit grew 32.9% in fiscal 2006 to $339.1 million, or 31.4% of net sales, from $255.2 million, or 31.5% of net sales in fiscal 2005 as a result of the Falk Acquisition as well as the net impact of Rexnord Business System driven productivity and cost reductions offset by historically lower gross margin of the acquired Falk business. Our fiscal 2006 gross profit margins also include a $0.7 million charge in fiscal 2006 to write-off certain excess and obsolete inventories in connection with plant consolidation and integration activities. Our fiscal 2005 gross profit margins include (i) a $7.0 million benefit due to a change in estimate regarding the capitalization of certain overhead variances into inventory, and (ii) a $1.6 million one-time charge to write-off certain excess and obsolete inventory that was on-hand at the date of the Carlyle Acquisition for which no reserves were established in purchase accounting.
Selling, General and Administrative Expenses. SG&A expenses increased by $34.2 million, or 22.3%, in fiscal 2006 to $187.8 million as compared to $153.6 million in fiscal 2005. As a percentage of net sales, SG&A expenses declined to 17.4% in fiscal 2006 compared to 18.9% in fiscal 2005. The reduction in SG&A expenses as a percent of sales was due to better operating leverage resulting from our Falk integration efforts as well as a continued focus on reducing costs and gaining efficiencies in our selling and administrative functions. The $34.2 million increase in SG&A expense in fiscal 2006 was primarily due to the Falk Acquisition.
Restructuring and Other Similar Costs. We expensed $31.1 million of restructuring and other similar costs in fiscal 2006, primarily relating to Falk integration and plant closure activities, including $6.9 million of non-cash asset impairments. The non-cash asset impairments related to the closure of our Flattop plant in Puerto Rico and a decision to outsource certain portions of our Industrial Chain manufacturing operations. We also incurred $16.5 million of Falk integration and plant closure costs consisting primarily of (i) the closure of our Coupling plant in Warren, Pennsylvania, (ii) the closure of our Flattop plant in Puerto Rico, and (iii) Falk integration costs, including the continuation of certain Falk plant consolidation efforts that had been initiated prior to our acquisition of Falk. All of these consolidation and integration actions were substantially complete as of March 31, 2006. The remaining $7.7 million of restructuring and other similar costs in fiscal 2006 relate primarily to severance, relocation and recruiting expenses for certain headcount reduction and management realignment initiatives.
During fiscal 2005, we expensed $7.3 million of restructuring and other similar costs related primarily to severance, recruiting and relocation costs incurred as part of our effort to realign management and upgrade talent.
Amortization of Intangible Assets. We amortize the cost of our intangible assets which include patents, customer relationships (including distribution network), a covenant not to compete and software. Amortization of these intangible assets amounted to $15.7 million in fiscal 2006 and $13.8 million in fiscal 2005. The increase between years was due to amortization of the acquired Falk intangible assets.
Interest Expense, net. Interest expense, net was $61.5 million in fiscal 2006 compared to $44.0 million in fiscal 2005. The $17.5 million increase in our net interest expense between years was attributable primarily to interest on the additional $312.0 million term loan used to fund the Falk acquisition and to higher interest rates year over year on our variable-rate term debt.
Other Expense, net. Other expense, net for fiscal 2006 consisted of management fees of $2.0 million, attorney fees related to the refinancing of our credit agreement of $1.0 million, losses on the sale of plant, property and equipment of $0.4 million and exchange losses of $0.4 million. 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.
Provision for Income Taxes. The effective income tax rate for fiscal 2006 of 41.6% is up slightly from our fiscal 2005 effective income tax rate of 39.7% due to certain one-time non-deductible expenses and higher foreign-related tax expense, offset in part by the realization of certain state and local income tax benefits.
Net Income. Net income in fiscal 2006 was $22.9 million as compared to $21.6 million in the prior year due to the factors described above.
Liquidity and Capital Resources
Our primary source of liquidity is available cash, cash flow from operations and borrowing availability under our revolving credit facility. As of March 31, 2007, we had $56.1 million of cash and approximately $116.4 million of additional borrowings available to us under our revolving credit facility (there were no borrowings outstanding under the facility, however, $33.6 million of the facility was utilized in connection with outstanding letters of credit). Our revolving credit facility is available to fund our working capital requirements, capital expenditures and other general corporate purposes.
As of March 31, 2007 we had $2,046.9 million of total indebtedness outstanding as follows (in millions):
In connection with the Apollo acquisition, all borrowings under our previous credit agreement and substantially all of the $225.0 million of outstanding 10.125% senior subordinated notes were repaid or repurchased on July 21, 2006. The acquisition was financed in part with (i) the issuance of 2014 and the senior subordinated notes and (ii) $645.7 million of borrowings under senior secured credit facilities (consisting of a seven-year $610.0 million term loan facility and $35.7 million of borrowings under a six-year $150.0 million revolving credit facility). Subsequent to the Apollo acquisition, we financed the Zurn acquisition with an additional $200.0 of borrowings under our senior secured term loan facility and by issuing an additional $319.3 million of 2014 senior notes (includes $9.3 million of bond premium) and $150.0 million of 2016 senior notes.
As of March 31, 2007, the Company’s borrowings under the term loan credit facility were apportioned between two primary tranches: a $610.0 million term loan B1 facility and a $200.0 million term loan B2 facility as described above, of which $590.0 million and $197.5 million were outstanding as of March 31, 2007 under the term loan B1 and B2, respectively. Borrowings under the $610.0 million term loan B1 facility accrue interest, at the Company’s option, at the following rates per annum: (i) 2.50% plus the Eurodollar Rate, or (ii) 1.50% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). Borrowings under the $200.0 million term loan B2 facility accrue interest, at the Company’s option, at the following rates per annum: (i) 2.25% plus the Eurodollar Rate, or (ii) 1.50% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). The weighted averaged interest rate on our outstanding term loans at March 31, 2007 was 7.78%. Borrowings under our $150.0 million revolving credit facility accrue interest, at our option, at the following rates per annum: (i) 2.25% plus the Eurodollar Rate, or (ii) 1.25% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). In August 2006, we entered into an interest rate collar and an interest rate swap to hedge the variability in future cash flows associated with a portion of our variable-rate term loans.
The new senior secured credit facilities limit our maximum senior secured bank leverage ratio to 4.25 to 1.00 beginning with the fiscal quarter ended December 30, 2006. The senior secured bank leverage ratio was 2.37 to 1.00 at March 31, 2007. We expect to be in compliance with this financial covenant for the foreseeable future.
Our ability to make scheduled payments of principal on our indebtedness, or to pay interest on, or to refinance, our indebtedness, including our existing 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.
Net cash provided by operating activities in fiscal 2007 was $58.3 million compared to $91.9 million in fiscal 2006 and $67.4 million in fiscal 2005. The $33.6 million reduction in cash flow from operations in fiscal 2007 compared to fiscal 2006 was driven primarily by lower income from operations of $25.7 million between fiscal years as a result of $62.7 million of transaction costs associated with the Apollo acquisition. Increases in trade working capital (receivables, inventories and trade payables) used $3.3 million of cash in fiscal 2007 to support the $174.3 million dollar year over year sales increase. The increase in cash from operations of $24.5 million in fiscal 2006 as compared to fiscal 2005 was primarily due to a $24.0 million increase in income from operations. Increases in trade working capital (receivables, inventories and trade payables) to support our year over year sales growth used only $4.1 million of operating cash flows in fiscal 2006 as we continue to focus on cash collections and effectively managing accounts payable.
Cash used for investing activities in fiscal 2007 was $1,941.2 million, an increase of $1,605.1 million compared to fiscal 2006. The year over year increase in cash used in investing activities was driven by a combination of the $1,018.4 million paid for the Apollo acquisition, the $880.1 million of paid for the Zurn acquisition and the $5.9 million paid for the DaLong acquisition compared to fiscal 2006, which included $301.3 million paid for the Falk Acquisition. Capital expenditures and proceeds from dispositions of property, plant and equipment, combined, were comparable between fiscal 2007 and 2006 and were $36.8 million and $34.8 million, respectively. The increase in cash used in investing activities in fiscal 2006 of $336.1 million compared to $19.3 million in fiscal 2005 was driven by the $301.3 million paid for the Falk acquisition as wells as capital expenditures of $37.1 million in fiscal 2006 compared to $25.7 million in fiscal 2005.
Cash provided by financing activities in fiscal 2007 was a source of $1,915.8 million compared to a source of $240.6 million in fiscal 2006. The increase in fiscal 2007 was driven by $1.6 million of cash proceeds from the issuance of common stock, $720.2 million of capital contributions and the issuance of debt to facilitate both the Apollo and Zurn acquisitions of $2,116.9 million offset by the repayment of long-term debt of $824.8 million (including $765.7 million on or prior to the Merger Date and $59.1 million subsequent to the Merger Date). During fiscal 2007, we also paid $75.0 million of financing fees and $23.1 million of bond tender premiums.
Cash provided by financing activities in fiscal 2006 included $312 million of additional term loans issued in May 2005 under our credit agreement. The proceeds from those term loans, net of $7.6 million of financing fees paid, were used to fund the Falk acquisition. Our strong performance allowed us to repay $65.0 million of debt during fiscal 2006, including $63.0 million of principal of the term loans. We also received $1.2 million of cash proceeds from the issuance of common stock during fiscal 2006.
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.
Tabular Disclosure of Contractual Obligations
As of March 31, 2007, we had no material long-term purchase obligations. Payments of interest associated with our current revolving credit facility obligations have been omitted from the table below because they are predominantly based on varying market interest rates and varying debt balances. As of March, 31, 2007 there were no outstanding obligations under the revolving credit facility.
(1) Excludes unamortized premium of $9.2 million received from the issuance of the additional 2014 notes.
(2) Based on long-term debt obligations outstanding as of March 31, 2007.
We also have long-term obligations related to our pension and postretirement benefit plans which are discussed in detail in Note 15 to the consolidated financial statements. The pension plans cover most of our employees and provide for monthly pension payments to eligible employees upon retirement. Other postretirement benefits consist of a retiree medical plan that covers a portion of employees in the United States that meet certain age and service requirements and other postretirement benefits for employees at certain foreign locations. See “Risk Factors-Our future required cash contributions to our pension plans may increase.”
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
We are exposed to market risk during the normal course of business from changes in foreign currency exchange rates and interest 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.
Foreign 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. See “Risk Factors-Our international operations are subject to uncertainties, which could adversely affect our operating results.”
Approximately 29% of our sales occur outside of the United States, with approximately 19% 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 material 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.
Fluctuations in currency exchange rates also impact the U.S. Dollar amount of our stockholders’ 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.
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.
Interest Rate Risk
We utilize a combination of short-term and long-term debt to finance our operations and are exposed to interest rate risk on these debt obligations.
As of March 31, 2007, the Company’s borrowings under the term loan credit facility were apportioned between two primary tranches: a $610.0 million term loan B1 facility and a $200.0 million term loan B2 facility, Borrowings under the $610.0 million term loan B1 facility accrue interest, at the Company’s option, at the following rates per annum: (i) 2.50% plus the Eurodollar Rate, or (ii) 1.50% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). Borrowings under the $200.0 million term loan B2 facility accrue interest, at the Company’s option, at the following rates per annum: (i) 2.25% plus the Eurodollar Rate, or (ii) 1.50% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). The weighted averaged interest rate on our outstanding term loans at March 31, 2007 was 7.78%. Borrowings under our $150.0 million revolving credit facility accrue interest, at our option, at the following rates per annum: (i) 2.25% plus the Eurodollar Rate, or (ii) 1.25% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). In August 2006, we entered into an interest rate collar and an interest rate swap to hedge the variability in future cash flows associated with a portion of our variable-rate term loans. The interest rate collar provides an interest rate floor of 4.0% plus the applicable margin and an interest rate cap of 6.065% plus the applicable margin on $262.0 million of our variable-rate term loans, while the interest rate swap converts $68.0 million of our variable-rate term loans to a fixed interest rate of 5.14% plus the applicable margin. Both the interest rate collar and the interest rate swap became effective on October 20, 2006 and have a maturity of three years. Our results of operations would likely be affected by changes in market interest rates on the un-hedged portion of these variable-rate obligations. An increase in the interest rate of 1.00% on our variable rate debt would increase our interest cost by approximately $6.4 million on an annual basis.
The senior notes and the senior subordinated notes are fixed rate long-term debt obligations. The potential loss in fair value on such fixed-rate debt obligations from a 10% increase in market interest rates would not be material to the overall fair value of the debt.
Recent Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which permits all entities to choose to measure eligible items at fair value on specified election dates. The associated unrealized gains and losses on the items for which the fair value option has been elected shall be reported in earnings. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently reviewing the requirements of SFAS 159 to determine the impact on its financial statements.
In September 2006, the FASB released SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). Under the new standard, companies must recognize a net liability or asset to report the funded status of their defined benefit pension and other postretirement benefit plans on their balance sheets. We will be required to adopt the recognition and disclosure provisions of SFAS 158 as of March 31, 2008. We are currently reviewing the requirements of SFAS 158 to determine the impact on our financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, creates a framework for measuring fair value in generally accepted accounting principles (GAAP) and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently reviewing the requirements of SFAS 157 to determine the impact on its financial statements.
In December 2004, the FASB issued the revised SFAS No. 123, Share Based Payment (“SFAS 123(R)”). SFAS 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements. Generally, compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards are remeasured each reporting period. Compensation cost is recognized over the requisite service period, generally as the awards vest. As a nonpublic entity that previously used the minimum value method for pro forma disclosure purposes under SFAS 123, we adopted SFAS 123(R) using the prospective transition method of adoption on April 1, 2006. Accordingly, the provisions of SFAS 123(R) have been applied prospectively to new awards and to awards modified, repurchased or cancelled after the adoption date.
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), was issued in July 2006. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, Accounting for Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for the recognition and measurement of a tax position taken or expected to be taken in an income tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We are required to adopt FIN 48 as of April 1, 2007 and are currently reviewing the requirements of FIN 48 to determine the impact on our financial position or results of operations.
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, the risks set forth under Item 1A, Risk Factors, of this Form 10-K. 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 or to update publicly the risk factors which the Company believes may affect the forward-looking statements except as may be required in subsequent documents filed with the SEC.
ITEM 7A.
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 Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements included in this Form 10-K include the accounts of RBS Global, Inc. and subsidiaries subsequent to the Merger (collectively, “the Company”). The financial statements of RBS Global, Inc. and subsidiaries prior to the Merger (collectively, the “Predecessor”) are presented for comparative purposes.
Index to Financial Statements
RBS Global, Inc. and Subsidiaries
Consolidated Financial Statements
For the periods from July 22, 2006 through March 31, 2007
and April 1, 2006 through July 21, 2006 and the
years ended March 31, 2006 and 2005
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of RBS Global, Inc.
We have audited the accompanying consolidated balance sheets of RBS Global, Inc. and subsidiaries (the Company) as of March 31, 2007 and the Predecessor Company as of March 31, 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the period from July 22, 2006 to March 31, 2007, and of the Predecessor Company for the period from April 1, 2006 to July 21, 2006 and the years ended March 31, 2006 and 2005. Our audits also included the financial statement schedule listed in Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule 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, 2007 and the Predecessor Company at March 31, 2006, and the consolidated results of its operations and its cash flows for the period from July 22, 2006 to March 31, 2007, and of the Predecessor Company for the period from April 1, 2006 to July 21, 2006 and the years ended March 31, 2006 and 2005, 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.
As discussed in Note 1 to the financial statements, the Company changed its method of accounting for stock-based compensation effective April 1, 2006.
/s/ Ernst & Young LLP
Milwaukee, Wisconsin
May 18, 2007
RBS Global, Inc. and Subsidiaries
Consolidated Balance Sheets
(In Millions, except share amounts)
See notes to consolidated financial statements.
RBS Global, Inc. and Subsidiaries
Consolidated Statements of Operations
(In Millions)
See notes to consolidated financial statements.
RBS Global, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(In Millions)
See notes to consolidated financial statements.
RBS Global, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In Millions)
See notes to consolidated financial statements.
RBS Global, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2007
1. Basis of Presentation and Description of Business
The Company
As further discussed in Note 3, on July 21, 2006 (the “Merger Date”), certain affiliates of Apollo Management, L.P. (“Apollo”) purchased the Company from The Carlyle Group and management. The accompanying consolidated financial statements include the accounts of RBS Global, Inc. and subsidiaries subsequent to the Merger Date (collectively, “the Company”). These financial statements do not include the accounts of Rexnord Holdings, Inc. (“Rexnord Holdings”), the indirect parent company of RBS Global, Inc. The financial statements of RBS Global, Inc. and subsidiaries prior to the Merger Date (collectively, the “Predecessor”) are presented for comparative purposes.
The Company is a manufacturer of precision motion technology products whose portfolio includes gears, industrial bearings, flattop chain and modular conveyor belts, couplings, aerospace bearings and seals, industrial chain and special components. The products are either incorporated into products sold by original equipment manufacturers (“OEMs”) or sold to end-users through industrial distributors as aftermarket products.
As a result of our recent acquisition of the Zurn Water Management business of Jacuzzi Brands, Inc. (see Note 3), the Company is also a leading supplier of professional grade specification drainage, PEX piping, water control and commercial brass products, serving the commercial and institutional construction, civil and public water works markets.
2. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform to the fiscal 2007 presentation.
Revenue Recognition
Net sales are recorded upon transfer of title of product, which occurs upon shipment to the customer. The Company estimates amounts due and records accruals for sales rebates to certain distributors 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, which are based upon the Company’s historical experience. Revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known. The value of returned goods during the period from July 22, 2006 through March 31, 2007, the period from April 1, 2006 through July 21, 2006 and the years ended March 31, 2006 and 2005 was less than 0.9% of net sales. Other than a standard product warranty, there are no post-shipment obligations.
The Company classifies shipping and handling fees billed to customers as net sales and the corresponding costs are classified as cost of sales in the consolidated statements of operations.
Compensated Absences
In the third quarter of fiscal 2007, the Company changed its domestic vacation policy for certain employees so that vacation pay is earned ratably throughout the year and must be used by year-end. The accrual for compensated absences was reduced by $6.7 million in the third quarter to eliminate vacation pay no longer required to be accrued or paid under the current policy.
Share Based Payments
In December 2004, the Financial Accounting Standards Board (“FASB”) issued the revised Statement of Financial Accounting Standards (“SFAS”) No. 123, Share Based Payment (SFAS 123(R)). SFAS 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements. Generally, compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards are re-measured each reporting period. Compensation cost is recognized over the requisite service period, generally as the awards vest. As a nonpublic entity that previously used the minimum value method for pro forma disclosure purposes under SFAS No. 123, the Company adopted SFAS 123(R) using
the prospective transition method of adoption on April 1, 2006. Accordingly, the provisions of SFAS 123(R) are applied prospectively to new awards and to awards modified, repurchased or cancelled after the adoption date. See further discussion of the Company’s stock option plans in Note 14.
Receivables
Receivables are stated net of allowances for doubtful accounts of $7.4 million at March 31, 2007 and $5.2 million at March 31, 2006. On a regular basis, the Company evaluates its receivables and establishes the allowance for doubtful accounts based on a combination of specific customer circumstances and historical write-off experience. Credit is extended to customers based upon an evaluation of their financial position. Generally, advance payment is not required. Credit losses are provided for in the consolidated financial statements and consistently have been within management’s expectations.
Inventories
Inventories are stated at the lower of cost or market. Market is determined based on estimated net realizable values. Approximately 82% of the Company’s total inventories as of March 31, 2007 and 72% of the Company’s total inventories as of March 31, 2006 were valued using the “last-in, first-out” (LIFO) method. All remaining inventories are valued using the “first-in, first-out” (FIFO) method. 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 increased inventories and reduced cost of sales by approximately $7.0 million in fiscal 2005.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is provided using the straight-line method over 13 to 50 years for buildings and improvements, 3 to 13 years for machinery and equipment and 2 to 5 years for hardware and software. Estimated residual values on machinery and equipment are used in computing depreciation expense. Maintenance and repair costs are expensed as incurred.
Goodwill and Intangible Assets
Intangible assets consist of acquired trademarks and tradenames, customer relationships (including distribution network), patents and acquired software. The customer relationships, patents and acquired software are being amortized using the straight-line method over their estimated useful lives of 10 to 15 years, 2 to 14 years and one year, respectively. Goodwill, trademarks and tradenames have indefinite lives and are not amortized but are tested annually for impairment using a discounted cash flow analysis.
Deferred Financing Costs
Other assets at March 31, 2007 and March 31, 2006 include deferred financing costs of $69.8 million and $21.6 million, respectively, net of accumulated amortization of $5.0 million and $11.7 million, respectively. These costs were incurred to obtain long-term financing and are being amortized using the effective interest method over the term of the related debt.
Impairment of Long-Lived Assets
Long-lived assets, including property, plant and equipment and amortizable intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the long-lived asset may not be recoverable. Long-lived assets held for use are reviewed for impairment by comparing the carrying amount of the long-lived asset or group of assets to the undiscounted future cash flows expected to be generated by such asset over its remaining useful life. If the long-lived asset or group of assets is considered to be impaired, an impairment charge is recognized for the amount by which the carrying amount of the asset or group of assets exceeds its fair value. Long-lived assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.
Product Warranty
The Company offers warranties on the sales of certain of its products and records an accrual for estimated future claims. Such accruals are based upon historical experience and management’s estimate of the level of future claims. The following table presents changes in the Company’s product warranty liability (in millions):
Accumulated Other Comprehensive Income (Loss)
At March 31, 2007, accumulated other comprehensive income (loss) consisted of $4.2 million of foreign currency translation adjustments, $(0.7) million of unrealized losses on derivative contracts, net of tax and $(0.2) million of additional minimum pension liability, net of tax. At March 31, 2006, accumulated other comprehensive income (loss) consisted of $14.7 million of foreign currency translation adjustments and $(5.4) million of additional minimum pension liability, net of tax.
Derivative Financial Instruments
The Company enters into foreign exchange forward contracts to mitigate exposure related to receivables and payables denominated in foreign currencies. These derivative contracts did not qualify as hedges of future cash flows and, accordingly, were adjusted to fair value at March 31, 2007 and 2006, with the gain or loss included in other non-operating income (expense) in the consolidated statements of operations. For each of the periods presented, the gain or loss recognized on these contracts was not material.
In August 2006, the Company entered into an interest rate collar and an interest rate swap to hedge the variability in future cash flows associated with a portion of the Company’s variable-rate term loans. The interest rate collar provides an interest rate floor of 4.0% plus the applicable margin and an interest rate cap of 6.065% plus the applicable margin on $262.0 million of the Company’s variable-rate term loans, while the interest rate swap converts $68.0 million of the Company’s variable-rate term loans to a fixed interest rate of 5.14% plus the applicable margin. Both the interest rate collar and the interest rate swap became effective on October 20, 2006 and have a maturity of three years. These interest rate derivatives have been accounted for as effective cash flow hedges in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. The fair value of these interest rate derivatives totaled $1.1 million at March 31, 2007 and has been recorded on the Company’s consolidated balance sheet as an other long-term liability with a corresponding decrease in accumulated other comprehensive income, net of tax.
Foreign Currency Translation
Assets and liabilities of subsidiaries operating outside of the United States with a functional currency other than the U.S. dollar are translated into U.S. dollars using exchange rates at the end of the respective period. Revenues and expenses of such entities are translated at average exchange rates in effect during the respective period. Foreign currency translation adjustments are included as a component of accumulated other comprehensive income (loss). Currency transaction gains and losses are included in other non-operating income (expense) in the consolidated statements of operations and totaled $(0.3) million, $(1.1) million, $(0.4) million and $(0.8) million for the period from July 22, 2006 through March 31, 2007, the period from April 1, 2006 through July 21, 2006 and the years ended March 31, 2006 and 2005, respectively.
Advertising Costs
Advertising costs are charged to selling, general and administrative expenses as incurred and amounted to $4.8 million, $1.4 million, $3.9 million and $3.6 million for the period from July 22, 2006 through March 31, 2007, the period from April 1, 2006 through July 21, 2006 and the years ended March 31, 2006 and 2005, respectively.
Research and Development Costs
Research and development costs are charged to selling, general and administrative expenses as incurred and amounted to $4.9 million, $1.9 million, $6.2 million and $4.4 million for the period from July 22, 2006 through March 31, 2007, the period from April 1, 2006 through July 21, 2006 and the years ended March 31, 2006 and 2005, respectively.
Significant Customer
The Company’s Power Transmission group has a customer, Motion Industries Inc. (an industrial distributor), that accounted for 10.4%, 11.4%, 11.8% and 9.0% of net sales during the period from July 22, 2006 through March 31, 2007, the period from April 1, 2006 through July 21, 2006 and the years ended March 31, 2006 and 2005, respectively. Receivables related to this industrial distributor at March 31, 2007 and 2006 were $12.2 million and $10.8 million, respectively.
Fair Value of Financial Instruments
The carrying amounts of cash, receivables, payables and accrued liabilities approximated fair value at March 31, 2007 and 2006 due to the short-term nature of those instruments. The carrying value of long-term debt approximated fair value based on market interest rates as of March 31, 2007 and 2006.
Recent Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which permits all entities to choose to measure eligible items at fair value on specified election dates. The associated unrealized gains and losses on the items for which the fair value option has been elected shall be reported in earnings. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently reviewing the requirements of SFAS 159 to determine the impact on its financial statements.
In September 2006, the FASB released SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”). Under the new standard, companies must recognize a net liability or asset to report the funded status of their defined benefit pension and other postretirement benefit plans on their balance sheets. The Company will be required to adopt the recognition and disclosure provisions of SFAS 158 as of March 31, 2008. The Company is currently reviewing the requirements of SFAS 158 to determine the impact on its financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, creates a framework for measuring fair value in generally accepted accounting principles (GAAP) and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently reviewing the requirements of SFAS 157 to determine the impact on its financial statements.
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), was issued in July 2006. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, Accounting for Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for the recognition and measurement of a tax position taken or expected to be taken in an income tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company is required to adopt FIN 48 as of April 1, 2007 and is currently reviewing the requirements of FIN 48 to determine the impact on its financial position or results of operations.
3. Acquisitions
The Zurn Acquisition
On February 7, 2007, the Company acquired the water management business (“Zurn”) of Jacuzzi Brands, Inc. from an affiliate of Apollo for a cash purchase price of $942.5 million, including transaction costs and additional deferred financing fees. The purchase price was financed through an equity investment by Apollo and its affiliates of approximately $282.0 million and debt financing of approximately $669.3 million, consisting of (i) $319.3 million of 9.50% senior notes due 2014 (including a bond issue premium of $9.3 million), (ii) $150.0 million of 8.875% senior notes due 2016 and (iii) $200.0 million of borrowings under existing senior secured credit facilities. This acquisition created a new strategic water management platform for the Company.
The acquisition has been accounted for using the purchase method of accounting. The purchase price was allocated to identifiable assets acquired and liabilities assumed based upon their estimated fair values which are preliminary and based upon
currently available information. The Company is still in the process of finalizing third-party appraisals of the acquired property, plant and equipment and certain identifiable intangible assets, as well as the tax effects of the related temporary differences. Accordingly, final adjustments to the purchase price allocation may be required. The Company expects to finalize the purchase price allocation within one year from the date of the acquisition.
The following table summarizes the estimated fair value of the acquired assets and assumed liabilities of Zurn at the date of acquisition (in millions):
The $454.1 million of acquired intangible assets consist primarily of tradenames, customer relationships and patents. The acquired customer relationships and patents are being amortized over their estimated useful lives (15 years for customer relationships and 5 to 10 years for patents). The acquired tradenames have an indefinite life and are not being amortized but are tested annually for impairment. Most of the acquired goodwill is not expected to be deductible for income tax purposes.
The Company’s results of operations for the period from July 22, 2006 through March 31, 2007 only include Zurn for the period from February 8, 2007 through March 31, 2007.
The Apollo Acquisition and Related Financing
On July 21, 2006 , certain affiliates of Apollo purchased the Company from The Carlyle Group and management for approximately $1.825 billion, excluding transaction fees, through the merger of Chase Merger Sub, Inc., an entity formed and controlled by Apollo, with and into RBS Global, Inc. (the “Merger”). The Merger was financed with (i) $485.0 million of 9.50% senior notes due 2014, (ii) $300.0 million of 11.75% senior subordinated notes due 2016, (iii) $645.7 million of borrowings under new senior secured credit facilities (consisting of a seven-year $610.0 million term loan facility and $35.7 million of borrowings under a six-year $150.0 million revolving credit facility) and (iv) $475.0 million of equity contributions (consisting of a $438.0 million cash contribution from Apollo and $37.0 million of rollover stock and stock options held by management participants). The proceeds from the Apollo cash contribution and the new financing arrangements, net of related debt issuance costs, were used to (i) purchase the Company from its then existing shareholders for $1,018.4 million, including transaction costs; (ii) repay all outstanding borrowings under the Company’s previously existing credit agreement as of the Merger Date, including accrued interest; (iii) repurchase substantially all of the Company’s $225.0 million of 10.125% senior subordinated notes outstanding as of the Merger Date pursuant to a tender offer, including accrued interest and tender premium; and (iv) pay certain seller-related transaction costs.
The Merger has been accounted for using the purchase method of accounting and, accordingly, resulted in a new basis of accounting for the Company. The purchase price was allocated to identifiable assets acquired and liabilities assumed based upon their estimated fair values, which are preliminary and based upon currently available information. The Company is still in the process of
finalizing third-party appraisals of the acquired property, plant and equipment and certain identifiable intangible assets. In addition, management is still finalizing its strategic assessment of the business, which may give rise to additional purchase liabilities. Accordingly, final adjustments to the purchase price allocation may be required. The Company expects to finalize the purchase price allocation within one year from the date of the Merger.
The following table summarizes the estimated fair values of the Company’s assets and assumed liabilities at the date of acquisition (in millions):
The $398.7 million of net assets acquired consists of Apollo’s $438.0 million cash contribution and $3.8 million of carryover basis in rollover stock, net of a $43.1 million deemed cash dividend to the selling shareholders that was required to be recognized by Emerging Issues Task Force Issue No. 88-16, Basis in Leveraged Buyout Transactions, due to the increased leverage of the Company.
The $560.5 million of acquired intangible assets consist primarily of tradenames, customer relationships, patents, a covenant not to compete and acquired software. The acquired customer relationships, patents, covenant not to compete and software are being amortized over their useful lives (10 years for customer relationships, 2 to 14 years for patents, 4 months for the covenant not to compete and one year for software). The acquired tradenames have an indefinite life and are not being amortized but are tested annually for impairment. Most of the acquired goodwill is not expected to be deductible for income tax purposes.
Acquisition of Dalong Chain Company
On July 11, 2006, the Company acquired Dalong Chain Company (“Dalong”) located in China for $5.9 million in cash plus the assumption of certain liabilities. The acquisition was financed primarily with existing cash and was accounted for using the purchase method of accounting. This acquisition did not have a material impact on the Company’s fiscal 2007 consolidated results of operations.
Acquisition of The Falk Corporation
On May 16, 2005, the Company acquired The Falk Corporation (“Falk”) from Hamilton Sundstrand, a division of United Technologies Corporation (“UTC”), for $301.3 million ($306.2 million purchase price including transaction related expenses, net of cash acquired of $4.9 million) and the assumption of certain liabilities. The acquisition of Falk was funded by a $312.0 million term loan and was accounted for using the purchase method of accounting. During fiscal 2006, the preliminary allocation of the Falk purchase price to identifiable assets acquired and liabilities assumed resulted in the recording of $95.3 million of goodwill. Final purchase accounting adjustments of $1.4 million and $(0.4) million for the periods from July 22, 2006 through March 31, 2007 and April 1, 2006 through July 21, 2006, respectively, resulted in an additional $1.0 million of goodwill being recorded in fiscal 2007.
The following table sets forth the unaudited pro forma financial information for the Company as if the Falk, Apollo, and Zurn Acquisition (and the related issuance of debt) had occurred as of the beginning of fiscal year 2006 (in millions):
4. Canal Street Facility Accident
On December 6, 2006, the Company experienced an explosion at its primary gear manufacturing facility (“Canal Street”), in which three employees lost their lives and approximately 45 employees were injured. Canal Street is comprised of over 1.1 million square feet among several buildings, and employed approximately 750 associates prior to the accident. The accident resulted from a leak in an underground pipe related to a backup propane gas system that was being tested. The explosion destroyed approximately 80,000 square feet of warehouse, storage and non-production buildings, and damaged portions of other production areas. The Canal Street facility manufactures portions of the Company’s gear product line and, to a lesser extent, the Company’s coupling product line. The Company’s core production capabilities were substantially unaffected by the accident.
For the period from July 22, 2006 through March 31, 2007, the Company has recorded the following (gains)/losses related to this incident (in millions):
The Company has substantial property, casualty, liability, workers’ compensation and business interruption insurance. Management believes that the limits of coverage will be in excess of the losses incurred. The property, casualty and business interruption liability insurance provides coverage of up to $2.0 billion per incident. The aggregate amount of deductibles under all insurance coverage is $1.0 million. Through March 31, 2007, the Company has received cash advances from its insurance carriers totaling $37.0 million of which $27.0 million has been allocated to recoveries under property and casualty insurance policies and $10.0 million of recoveries which have been allocated to recoveries under business interruption insurance policies. The net impact on operations recorded as a result of insurance proceeds and the incurrence of expenses, impairment of assets and clean-up and restoration costs results in a $6.0 million gain currently recognized in the consolidated statement of operations. The Company is actively working with its insurance carriers to determine further recoverable amounts and timing of the insurance proceeds recoverable under its property, casualty and business interruption coverage. The Company has only recorded insurance recoveries to the extent received as of March 31, 2007. Additional recoveries are expected to become recordable under GAAP in subsequent periods.
5. Restructuring and Other Similar Costs
The Company did not incur any restructuring expense in fiscal 2007. Restructuring and other similar costs totaled $31.8 million for fiscal year ended March 31, 2006 and relate to plans the Company initiated to restructure certain manufacturing operations and reduce headcount at certain locations, including the continuation of certain Falk plant consolidation activity that had been initiated prior to the Company’s acquisition of Falk.
Restructuring and other similar costs are summarized as follows (in millions):
Consolidation and Integration Costs
Consolidation and integration costs in fiscal 2006 consist primarily of (i) the closure of the Company’s Coupling plant in Warren, Pennsylvania, (ii) the closure of the Company’s Flattop plant in Puerto Rico, and (iii) Falk integration costs, including the continuation of certain Falk plant consolidation efforts that had been initiated prior to the Falk Acquisition. All of these consolidation and integration actions are complete as of March 31, 2007.
Severance, Recruiting and Relocation Costs
Severance, recruiting and relocation costs relate to certain headcount reduction and management realignment initiatives. Costs for the year ended March 31, 2006 included $6.3 million of severance, $0.6 million of relocation expenses and $0.8 million of recruiting expenses. Costs for the year ended March 31, 2005 included $4.2 million of severance, $1.9 million of relocation expenses and $1.2 million of recruiting expenses.
Non-cash Fixed Asset Impairments
Non-cash fixed asset impairments in fiscal 2006 relate primarily to the Company’s decision to close the FlatTop plant in Puerto Rico and the decision to outsource certain portions of the Company’s Industrial Chain manufacturing operations.
Excess and Obsolete Inventory
The Company recorded a charge of $0.7 million in fiscal 2006 to write-off certain excess and obsolete inventory in connection with plant consolidation and integration activities. In fiscal 2005, the Company recorded a charge of $1.6 million to write-off certain excess and obsolete inventory that was on-hand at the date of the Carlyle Acquisition for which no reserves were established in purchase accounting. These charges are included in cost of sales in the consolidated statement of operations.
Restructuring Accrual Cash Analysis
An analysis of the restructuring accrual is summarized as follows (in millions):
6. Transaction-Related Costs
The Company expensed the following transaction-related costs in connection with the Merger (in millions):
Seller-related expenses consist of investment banking fees, outside attorney fees, and other third-party fees. The bond tender premium relates to the Company’s $225.0 million of senior subordinated notes, substantially all of which were repurchased in connection with the Merger. The Company also incurred a non-cash charge of $20.5 million to write-off the remaining net book value of previously-capitalized financing fees related to the Company’s term loans and senior subordinated notes that were repaid/repurchased in connection with the Merger.
7. Recovery Under Continued Dumping and Subsidy Offset Act (“CDSOA”)
The U.S. government has eight antidumping duty orders in effect against certain foreign producers of ball bearings exported from six countries, tapered roller bearings from China and spherical plain bearings from France. The foreign producers of the ball bearing orders are located in France, Germany, Italy, Japan, Singapore and the United Kingdom. The Company is a producer of ball bearing products in the United States. The CDSOA provides for distribution of monies collected by Customs and Border Protection (“CBP”) from antidumping cases to qualifying producers, on a pro rata basis, where the domestic producers have continued to invest their technology, equipment and people in products that were the subject of the anti-dumping orders. As a result of providing relevant information to CBP regarding calendar 2006 and prior years’ manufacturing, personnel and development costs, the Company received $8.8 million, its pro rata share of the total CDSOA distribution, during the third quarter of fiscal 2007, which is included in other income (expense), net on the consolidated statement of operations.
In February 2006, U.S. Legislation was enacted that will end CDSOA distributions for imports covered by anti-dumping duty orders entering the U.S. after September 30, 2007. Because monies will continue to be collected by CBP until September 30, 2007 and for prior year entries, the Company may receive some additional distributions beyond fiscal 2007; however, the Company can not reasonably estimate the amount of CDSOA distributions it will receive in future years, if any.
8. Inventories
The major classes of inventories are summarized as follows (in millions):
The Company adjusted inventories to fair value in connection with the Merger, which increased inventories by approximately $19.6 million as of July 21, 2006. Approximately $17.2 million of this purchase accounting adjustment relates to inventories that were subsequently sold during the period from July 22, 2006 through March 31, 2007; however, the sale of those inventories also resulted in approximately $12.1 million of additional LIFO income during that same period. As a result, on a LIFO basis approximately $12.1 million of the initial purchase accounting adjustment remains in our inventories at March 31, 2007.
As a result of the Zurn acquisition, the Company acquired approximately $170.9 million of inventory on February 7, 2007. This inventory balance includes $26.8 million of purchase accounting adjustments to record inventory at its fair value at the acquisition date. On a LIFO basis, as of March 31, 2007, this entire purchase accounting adjustment remains in ending inventory.
9. Property, Plant & Equipment
Property, plant and equipment is summarized as follows (in millions):
10. Goodwill and Intangible Assets
Goodwill totaled $1,294.2 million and $670.4 million at March 31, 2007 and 2006, respectively. Goodwill at March 31, 2007 is directly attributed to the acquisitions described in Note 3.
Intangible assets are summarized as follows (dollars in millions):
The Company expects to recognize amortization expense on the intangible assets subject to amortization of $45.0 million in the fiscal year ending March 31, 2008, $44.7 million in the fiscal year ending March 31, 2009, $44.6 million in the fiscal year ending March 31, 2010, $44.6 million in the fiscal year ending March 31, 2011 and $44.5 million in the fiscal year ending March 31, 2012.
11. Other Current Liabilities
Other current liabilities are summarized as follows (in millions):
12. Long-Term Debt
Long-term debt is summarized as follows (in millions):
(1) Includes an unamortized bond issue premium of $9.2 million at March 31, 2007.
In connection with the Merger on July 21, 2006, all borrowings under the Company’s previous credit agreement and substantially all of the $225.0 million of 10.125% senior subordinated notes were repaid or repurchased on July 21, 2006. The Merger was financed in part with (i) $485.0 million of 9.50% senior notes due 2014, (ii) $300.0 million of 11.75% senior subordinated notes due 2016, and (iii) $645.7 million of borrowings under new senior secured credit facilities (consisting of a seven-year $610.0 million term loan facility and $35.7 million of borrowings under a six-year $150.0 million revolving credit facility).
On February 7, 2007, the Company completed its acquisition of the Zurn water management business. This acquisition was funded partially with debt financing of $669.3 million, consisting of (i) $319.3 million of 9.50% senior notes due 2014 (which includes a bond issue premium of $9.3 million), (ii) $150.0 million of 8.875% senior notes due 2016 and (iii) $200.0 million of incremental borrowings under the Company’s existing term loan credit facilities.
As of March 31, 2007, the Company’s borrowings under the term loan credit facility were apportioned between two primary tranches: a $610.0 million term loan B1 facility and a $200.0 million term loan B2 facility as described above. Borrowings under the $610.0 million term loan B1 facility accrue interest, at the Company’s option, at the following rates per annum: (i) 2.50% plus the Eurodollar Rate, or (ii) 1.50% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). Borrowings under the $200.0 million term loan B2 facility accrue interest, at the Company’s option, at the following rates per annum: (i) 2.25% plus the Eurodollar Rate, or (ii) 1.50% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). The outstanding principal balances of the term loan B1 and B2 credit facilities at March 31, 2007 were $590.0 million and $197.5 million, respectively. The weighted averaged interest rate on the Company’s outstanding term loans at March 31, 2007 was 7.78%.
Borrowings under the Company’s new $150.0 million revolving credit facility accrue interest, at the Company’s option, at the following rates per annum: (i) 2.25% plus the Eurodollar Rate, or (ii) 1.25% plus the Base Rate (which is defined as the higher of the Federal funds rate plus 0.5% or the Prime rate). There were no outstanding borrowings on the revolver as of March 31, 2007. Additionally, $33.6 million of the revolving credit facility was considered utilized in connection with outstanding letters of credit at March 31, 2007.
The senior notes and senior subordinated notes are unsecured obligations of the Company. The senior subordinated notes are subordinated in right of payment to all existing and future senior indebtedness. The Company’s senior secured credit facilities limit the Company’s maximum senior secured bank leverage ratio to 4.25 to 1.00. As of March 31, 2007, the senior secured bank leverage ratio was 2.37 to 1.00.
At March 31, 2007 and 2006, the Company had additional debt of $4.9 million and $4.7 million, respectively, comprised primarily of borrowings at various foreign subsidiaries.
Future maturities of debt are as follows, excluding the unamortized bond issue premium of $9.2 million (in millions):
Cash interest paid for the period from July 22, 2006 through March 31, 2007, the period from April 1, 2006 thorough July 21, 2006 and the years ended March 31, 2006 and 2005 was $70.9 million, $32.2 million, $53.1 million and $41.1 million, respectively.
13. Leases
The Company leases manufacturing and warehouse facilities and data processing and other equipment under non-cancelable operating leases which expire at various dates through 2021. Rent expense totaled $7.1 million, $2.2 million, $7.7 million and $6.0 million for the periods from July 22, 2006 through March 31, 2007, from April 1, 2006 through July 21, 2006 and the years ended March 31, 2006 and 2005, respectively.
Future minimum rental payments for operating leases with initial terms in excess of one year are as follows (in millions):
14. Stock Options
In December 2004, the Financial Accounting Standards Board (“FASB”) issued the revised Statement of Financial Accounting Standards (“SFAS”) No. 123, Share Based Payment (SFAS 123(R)). SFAS 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements. Generally, compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards are re-measured each reporting period. Compensation cost is recognized over the requisite service period, generally as the awards vest. As a nonpublic entity that previously used the minimum value method for pro forma disclosure purposes under SFAS 123, the Company adopted SFAS 123(R) using the prospective transition method of adoption on April 1, 2006. Accordingly, the provisions of SFAS 123(R) are applied prospectively to new awards and to awards modified, repurchased or cancelled after the adoption date. The Company’s outstanding stock options as of the adoption date continued to be accounted for under the provisions of Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations through July 21, 2006, the date of the Apollo transaction discussed in Note 3. The Company did not grant, repurchase, or significantly modify any stock options from April 1, 2006 through July 21, 2006. In connection with the Apollo transaction, all previously outstanding stock options became fully vested and were either cashed out or rolled into fully-vested stock options of Rexnord Holdings. On July 22, 2006, a total of 577,945 of stock options were rolled over, each with an exercise price of $7.13. As of March 31, 2007, 574,222 of these rollover stock options remain outstanding.
In connection with the Apollo transaction, the Board of Directors of Rexnord Holdings also adopted, and stockholders approved, the 2006 Stock Option Plan of Rexnord Holdings, Inc. (the “Option Plan”). Persons eligible to receive options under the Option Plan include officers, employees or directors of Rexnord Holdings or any of its subsidiaries and certain consultants and advisors to Rexnord Holdings or any of its subsidiaries. The maximum number of shares of Rexnord Holdings common stock that may be issued or transferred pursuant to options under the Option Plan equals 2,700,000. On July 22, 2006, 1,434,937 stock options were granted under the Option Plan. Through March 31, 2007, 44,585 additional options were granted and 32,299 previously outstanding options were forfeited, resulting in 1,447,223 outstanding options as of March 31, 2007. All of the options granted under the Option Plan had an initial exercise price of $47.50, the estimated fair value of the Company’s stock on the date of grant, and the term of each option is ten years. On March 2, 2007, Rexnord Holdings declared a dividend to shareholders and holders of rollover stock options in the amount of $27.56 per share/option. As a result of this transaction, the exercise price of the options previously granted under the Option Plan was amended to $19.94 per option. Approximately 50% of the options granted vest ratably over five years from the date of grant; the remaining fifty percent of the options are eligible to vest based on the Company’s achievement of earnings before interest, taxes, depreciation and amortization (“EBITDA”) targets and debt repayment targets for fiscal years 2007 through 2011.
The fair value of each option granted under the Option Plan was estimated on the date of grant using the Black-Scholes valuation model that uses the following assumptions: expected volatility of 28% based on the expected volatilities of publicly-traded companies within the Company’s industry; an expected term of 7.5 years based on the midpoint between when the options vest and when they expire; the risk free interest rate (4.5% to 5.1%) based on the U.S. Treasury yield curve in effect at the date of grant; and expected dividends of zero. The weighted average grant date fair value of options granted under the Option Plan between July 22, 2006 and March 31, 2007 was $20.68. As of March 31, 2007, there was $24.5 million of total unrecognized compensation cost related to nonvested stock options granted under the Option Plan. That cost is expected to be recognized over a weighted average period of 4.2 years.
Information relative to stock options is as follows:
(1) As a result of the Apollo Transaction, all outstanding options at July 21, 2006 became fully vested and were exercised.
(2) Includes 577,945 of rollover options.
(3) The weighted average remaining contractual life of options outstanding and exercisable at March 31, 2007 is 9.3 years.
15. Retirement Benefits
The Company sponsors pension and other postretirement benefit plans for certain of their employees. The pension plans cover most of the Company’s employees and provide for monthly pension payments to eligible employees upon retirement. Pension benefits for salaried employees generally are based on years of credited service and average earnings. Pension benefits for hourly employees generally are based on specified benefit amounts and years of service. The Company’s policy is to fund its pension obligations in conformity with the funding requirements under applicable laws and governmental regulations. Other postretirement benefits consist of a retiree medical plan that covers a portion of employees in the United States that meet certain age and service requirements.
The components of net periodic benefit cost are as follows (in millions):
The Company made contributions to its U.S. qualified pension plan trusts of $5.4 million and $8.0 million during the periods from July 22, 2006 through March 31, 2007 and from April 1, 2006 through July 21, 2006, respectively. For the twelve months ended March 31, 2006, the Company made contributions of $13.0 million to its U.S. qualified pension plan trusts.
Benefit obligations, plan assets, funded status and net liability information are summarized as follows (in millions):
(1) Included within “Other assets” on the consolidated balance sheet.
The Company uses an actuarial measurement date of December 31 to measure its pension benefit obligations and March 31 to measure its other postretirement obligations. The following table presents significant assumptions used to determine benefit obligations and net periodic benefit cost (in weighted-average percentages):
In evaluating the expected return on plan assets, consideration was given to historical long-term rates of return on plan assets, and input from the Company’s pension fund consultant on asset class return expectations, long-term inflation and current market conditions.
The Company’s weighted-average investment allocations as of March 31, 2007 and 2006, are presented in the following table.
Allocations between equity and fixed income securities are maintained within a 5% tolerance of the target allocation established by the investment committee of each plan. The Company’s defined benefit pension investment policy recognizes the long-term nature of pension liabilities, the benefits of diversification across asset classes and the effects of inflation. The diversified portfolio is designed to maximize investment returns consistent with levels of investment risk that are prudent and reasonable. All assets are managed externally according to guidelines established individually with investment managers and the Company’s investment consultant. The manager guidelines prohibit the use of any type of investment derivative without the prior approval of the investment committee. Portfolio risk is controlled by having managers comply with their established guidelines, including establishing the maximum size of any single holding in their portfolios and by using managers with different investment styles. The Company periodically undertakes asset and liability modeling studies to determine the appropriateness of the investments. The portfolio included holdings of domestic, international, and private equities, global high quality and high yield fixed income, and short-term interest bearing deposits. No equity securities of the Company are held in the portfolio.
The Company expects to contribute approximately $9.4 million during fiscal 2008 to its defined benefit plans and $4.9 million to its other postretirement benefit plans.
Expected benefit payments to be paid in each of the next five fiscal years and in the aggregate for the five fiscal years thereafter are as follows (in millions):
Pension Plans That Are Not Fully Funded
At March 31, 2007, the projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of the fair value of plan assets were $255.3 million, $245.4 million and $180.9 million, respectively. At March 31, 2006, the projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of the fair value of plan assets were $247.6 million, $236.8 million and $153.6 million, respectively.
Other Postretirement Benefits
The Company’s domestic retiree medical program provides for prescription drug benefits. On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) was signed into law. The Act introduced a prescription drug benefit under Medicare (Medicare Part D). In May 2004, the FASB issued Staff Position No. 106-2 (FSP 106-2), which provides accounting guidance to employers that offer prescription drug benefits under retiree healthcare benefit plans to Medicare eligible retirees. FSP 106-2 requires that the benefit attributable to past service be accounted for as an actuarial gain and the benefit related to current service be reported as a reduction in service cost. The adoption of FSP 106-2 reduced the Company’s accumulated postretirement benefit obligation at March 31, 2005 by approximately $2.6 million.
The other postretirement benefit obligation was determined using an assumed health care cost trend rate of 9% in fiscal 2008 grading down to 5% in fiscal 2012 and thereafter. The discount rate, compensation rate increase and health care cost trend rate assumptions are determined as of the measurement date.
Assumed health care cost trend rates have a significant effect on amounts reported for the retiree medical plans. A one-percentage point change in assumed health care cost trend rates would have the following effect (in millions):
Multi-Employer and Government-sponsored Plans
The Company participates in certain multi-employer and government-sponsored plans for eligible employees. Expense related to these plans was $0.1 million, $0.1 million, $0.2 million and $0.2 million for the periods from July 22, 2006 through March 31, 2007, from April 1, 2006 through July 21, 2006 and the years ended March 31, 2006 and 2005, respectively.
Defined Contribution Savings Plans
The Company sponsors certain defined-contribution savings plans for eligible employees. Expense related to these plans was $7.6 million, $3.0 million, $9.8 million and $5.9 million for the periods from July 22, 2006 through March 31, 2007, from April 1, 2006 through July 21, 2006 and the years ended March 31, 2006 and 2005, respectively.
16. Income Taxes
The components of the provision (benefit) for income taxes are as follows (in millions):
The provision (benefit) for income taxes was calculated based upon the following components of income (loss) before income taxes (in millions):
Deferred income taxes consist of the tax effects of the following temporary differences (in millions):
These deferred tax assets and liabilities are classified in the consolidated balance sheet based on the balance sheet classification of the related assets and liabilities.
Management believes it is more likely than not that current and long-term deferred tax assets will be realized through the reduction of future taxable income. Significant factors considered by management in this determination include the historical operating results of the Predecessor and the expectation of future earnings, including anticipated reversals of future taxable temporary differences. A valuation allowance was established at March 31, 2007 and 2006 for deferred tax assets related to state net operating loss carryforwards, foreign net operating loss carryforwards and foreign tax credit carryforwards for which utilization is uncertain. The carryforward period for the foreign tax credit is ten years. The carryforward periods for the state net operating losses range from five to twenty years. Certain foreign net operating loss carryforwards are subject to a five year expiration period, and the carryforward period for the remaining foreign net operating losses is indefinite.
The provision (benefit) for income taxes differs from the United States statutory income tax rate due to the following items (in millions):
No provision has been made for United States income taxes related to approximately $18.3 million of undistributed earnings of foreign subsidiaries considered to be permanently reinvested. It is not practicable to determine the income tax liability, if any, which would be payable if such earnings were not permanently reinvested.
The Company’s United States federal income tax return for fiscal 2002 is currently under examination. Management believes adequate provision for income taxes payable of the Company has been made for all fiscal years through 2007. The Company has been indemnified for all tax obligations related to tax years ending prior to and including November 25, 2002, by Invensys (in connection with the sale of the Predecessor to The Carlyle Group on November 25, 2002).
In conjunction with the Zurn acquisition, the Company assumed certain tax liabilities and contingencies of Jacuzzi Brands, Inc. A federal tax audit was completed for Jacuzzi Brands, Inc. for the fiscal years ended September 30, 1998 through 2002. At the conclusion of this audit, an appeal was filed with the IRS in September 2005 regarding various issues identified during the audit upon which agreement could not be reached. To date, final settlement has not been concluded. Adequate reserves have been recorded to cover any assessment if the appeals are rejected.
Cash paid for income taxes to governmental tax authorities during the periods from July 22, 2006 through March 31, 2007, from April 1, 2006 through July 21, 2006, and the years ended March 31, 2006 and 2005 was $3.6 million, $1.1 million, $10.5 million and $7.1 million, respectively.
17. Related Party Transactions
RBS Global, Inc. had a management services agreement with TC Group, L.L.C., (The Carlyle Group) for advisory and consulting services related to corporate management, finance, product strategy, investment, acquisitions and other matters relating to the business of the Predecessor. Under the terms of the agreement, the Company paid $0.5 million, plus out of pocket expenses during the period from April 1, 2006 through July 21, 2006, and $2.0 million per year, plus out of pocket expenses for both fiscal 2006 and fiscal 2005. This agreement terminated July 21, 2006 when The Carlyle Group sold the Company to Apollo.
RBS Global, Inc. has a management services agreement, effective July 22, 2006, with Apollo for advisory and consulting services related to corporate management, finance, product strategy, investment, acquisitions and other matters relating to the business of the Company. Under the terms of the agreement, the Company paid $1.4 million plus out of pocket expenses during the period from July 22, 2006 through March 31, 2007. This agreement will remain in effect until such time as Apollo or its affiliates collectively own less than 10% of the equity interest of the Company, or such earlier time as the Company and Apollo may mutually agree.
In connection with the Apollo acquisition, we entered into a management consulting agreement (the “Cypress agreement”) with Mr. Sherman and two entities controlled by Mr. Sherman, Cypress Group, LLC (“Cypress”) and Cypress Industrial Holdings, LLC (“Cypress Industrial” and, collectively with Mr. Sherman and Cypress, “Consultant”). Pursuant to the Cypress agreement, Consultant provides certain consulting services to us, Mr. Sherman serves as the non-executive Chairman of the boards of directors of Rexnord and Rexnord Holdings, and Consultant receives an annual consulting fee of $250,000 and reimbursement for reasonable out-of-pocket expenses. Under the terms of the Cypress agreement, we paid $172,500 plus out of pocket expenses during the period from July 22, 2006 through March 31, 2007; $77,500 plus out of pocket expenses for the period from April 1, 2006 through July 21, 2006; and $250,000 plus out-of-pocket expenses for fiscal 2006. Mr. Sherman also received non-qualified stock options.
Transaction costs
The Company paid a total of $0.6 million to The Carlyle Group and $21.3 million to Apollo for investment banking and other transaction related services as part of the purchase of the Company by Apollo. These payments have been accounted for as transaction fees and are included in the total cost of the Apollo Acquisition as discussed in Note 3.
The Company paid a total of $9.0 million to Apollo and $1.8 million to the Cypress Group LLC for investment banking and other transaction related services as part of the Zurn Acquisition. These payments have been accounted for as transaction fees and are included in the total cost of the Zurn Acquisition as discussed in Note 3.
During the period from July 22, 2006 through March 31, 2007 , the period from April 1, 2006 through July 21, 2006 and the year ended March 31, 2006, the Company expensed approximately $2.5 million, $0.5 million, and $1.5 million, respectively, of consulting services provided by an entity that is controlled by certain minority shareholders of the Company.
18. Commitments and Contingencies
Power Transmission (“PT”)
The Company’s PT entities are involved in various unresolved legal actions, administrative proceedings and claims in the ordinary course of its business involving, among other things, product liability, commercial, employment, workers’ compensation, intellectual property claims and environmental matters. The Company establishes 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, management believes the eventual outcome of these unresolved legal actions either individually, or in the aggregate, will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
In connection with the Carlyle acquisition in November 2002, Invensys PLC has provided the Company with indemnification against certain contingent liabilities, including certain pre-closing environmental liabilities. The Company believes that, pursuant to such indemnity obligations, Invensys is obligated to defend and indemnify the Company with respect to the matters described below relating to the Ellsworth Industrial Park Site and to various asbestos claims. The indemnity obligations relating to the matters described below are not subject to any time limitations and are subject to an overall dollar cap equal to the purchase price, which is an amount in excess of $900 million. The following paragraphs summarize the most significant actions and proceedings:
•
In 2002, the Company was named as a Potentially Responsible Party (“PRP”), together with at least ten other companies, at the Ellsworth Industrial Park Site, Downers Grove, DuPage County, Illinois (the Site), by the United States Environmental Protection Agency, or USEPA, and the Illinois Environmental Protection Agency, or IEPA. The Company’s Downers Grove property is situated within the Ellsworth Industrial Complex. The USEPA and IEPA allege there have been one or more releases or threatened releases of chlorinated solvents and other hazardous substances, pollutants or contaminants, allegedly including but not limited to a release or threatened release on or from our property, at the Site. The relief sought by the USEPA and IEPA includes further investigation and potential remediation of the Site. In support of the USEPA and IEPA, in July 2004 the Illinois Attorney General filed a lawsuit (State of Illinois v. Precision et al.) in the Circuit Court of DuPage County, Illinois against the Company and the other PRP companies seeking an injunction, the provision of potable water to approximately 800 homes, further investigation of the alleged contamination, reimbursement of certain costs incurred by the state and assessment of a monetary penalty. In August 2003, several PRPs, including the Company, entered into an Administrative Order by Consent, or AOC, with the USEPA, IEPA and State of Illinois et al. that required the PRPs to pay $4.275 million to fund the hook-up of about 800 homes to municipal water and to undertake continuing investigation of the Site. The Company agreed to pay $306,500 of that fund under an interim allocation. The AOC is expected to resolve a significant portion of the State of Illinois lawsuit. Subsequently, the Company was notified by the USEPA that an expanded Site investigation will be required. The Company’s allocated share of future costs related to the site, including for investigation and/or remediation, could be significant.
•
The Company is also a defendant in a pending lawsuit alleging personal injury stemming from contamination that allegedly, in whole or in part, originated from the Ellsworth Industrial Park Site. The lawsuit entitled Jana Bendik v. Precision Brand Products et al. v. Rexnord Corporation et al. was filed in April 2004 by an individual plaintiff in the Circuit Court of Cook County, Illinois and seeks monetary relief. Two other suits allegedly related to the Ellsworth Industrial Park Site were recently settled: Kevin Pote, et al. v. Ames Supply Co. et al. was filed in December 2004 by an individual plaintiff in the Circuit Court of Cook County, Illinois. The complaint sought compensatory and punitive damages recoverable under the Illinois Wrongful Death and Survival Statute and the costs of the suit. A sealed, global settlement of all claims was reached with all Pote defendants in March, 2007. Muniz et al. v. Rexnord Corporation et al., was a class action filed in April 2004 in the United States District Court for the Northern District of Illinois. A global settlement was reached in late 2006 with the plaintiffs in the Muniz matter. The Muniz settlement covers past and future costs related to property damage incurred by the plaintiffs as well as certain damages for injuries, but does not release defendants from any potential future claims for non-property damages. The settlement amounts originally allocated to, and paid by, the Company are subject to further reallocation through a binding arbitration process. The ultimate outcome of the Ellsworth investigation and related litigation cannot presently be determined; however, management believes the Company has meritorious defenses to these matters. Pursuant to its indemnity obligation, Invensys is defending the Company in these matters and has paid 100% of the related costs to date. To provide additional protection, the Company has sued its insurance companies for a declaration of coverage as to these matters.
•
The Company has been named as a defendant in over 630 lawsuits (with approximately 6,800 claimants) pending in state or federal court in numerous jurisdictions relating to alleged personal injuries due to the alleged presence of asbestos in certain brakes and clutches previously manufactured by the Company’s Stearns division. Invensys and FMC, the prior owner of the Stearns business, have paid 100% of the costs to date related to the Stearns lawsuits. Similarly, the Company’s Prager subsidiary has been named as a defendant in two pending multi-defendant lawsuits relating to alleged personal injuries due to the alleged presence of asbestos in a product allegedly manufactured by Prager. There are approximately 3,600 claimants in the Prager lawsuits. The ultimate outcome of these lawsuits cannot presently be determined. To date, Invensys has paid 100% of the costs related to the Prager lawsuits, and the Company believes that it also has insurance coverage for its legal defense costs related to such suits.
•
The Kimberly St. Cin, Individually and as surviving spouse of Robert St. Cin, decedent v. The Falk Corporation, et al., wrongful death claim against Falk was settled and such settlement approved by the court on October 23, 2006. The settlement contribution was within reserves previously established by the Company.
In connection with the Falk acquisition, Hamilton Sundstrand has provided the Company with indemnification against certain contingent liabilities, including coverage for certain pre-closing environmental liabilities. The Company believes that, pursuant to such indemnity obligations, Hamilton Sundstrand is obligated to defend and indemnify the Company with respect to the asbestos claims described below, and that, with respect to these claims, such indemnity obligations are not subject to any time or dollar limitations. The following paragraph summarizes the most significant actions and proceedings for which Hamilton Sundstrand has accepted responsibility:
•
Falk is a defendant in over 140 lawsuits pending in state or federal court in numerous jurisdictions relating to alleged personal injuries due to the alleged presence of asbestos in certain clutches and drives previously manufactured by Falk. There are approximately 4,100 claimants in these suits. The ultimate outcome of these lawsuits cannot presently be determined. Hamilton Sundstrand is defending Falk in these lawsuits pursuant to its indemnity obligations and has paid 100% of the costs to date.
In addition to the foregoing litigation, Falk is a defendant in other lawsuits. 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 management believes the eventual outcome of these unresolved legal actions will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
Water Management
The Company’s Water Management entities are party to legal proceedings that the Company believes to be either ordinary, routine litigation incidental to the business of present and former operations or immaterial to its financial condition, results of operations or cash flows.
As of March 31, 2007, the Company and an average of 80 other unrelated companies were defendants in approximately 5,200 asbestos related lawsuits representing approximately 46,200 claims. The suits allege damages in an aggregate amount of approximately $11.8 billion against all defendants. Plaintiffs’ claims against Zurn allege personal injuries caused by exposure to asbestos used primarily in industrial boilers formerly manufactured by a segment of Zurn. Zurn did not manufacture asbestos or asbestos components. Instead, Zurn purchased them from suppliers. These claims are being handled pursuant to a defense strategy funded by Zurn’s insurers.
The Company uses an independent economic consulting firm with substantial experience in asbestos liability valuations to assist in the estimation of Zurn’s potential asbestos liability. Based on this firm's analysis, the Company currently estimates that Zurn’s potential liability for asbestos claims pending against it and for claims estimated to be filed through 2016 is approximately $136.0 million, of which the Company expects to pay approximately $102.0 million through 2016 on such claims, with the balance of the estimated liability being paid in subsequent years. However, there are inherent uncertainties involved in estimating the number of future asbestos claims, future settlement costs, and the effectiveness of the Company’s defense strategies and settlement initiatives. As a result, the Company’s actual liability could differ from the Company’s estimate described herein. Further, while the Company’s current asbestos liability is based on an estimate of claims through 2016, such liability may continue beyond 2016, and such liability could be substantial.
Management estimates that its available insurance to cover its potential asbestos liability as of March 31, 2007, is approximately $287.0 million, and believes that all current claims are covered by this insurance. However, principally as a result of the past insolvency of certain of the Company’s insurance carriers, certain coverage gaps will exist if and after the Company’s other carriers have paid the first $211.0 million of aggregate liabilities. In order for the next $51.0 million of insurance coverage from solvent carriers to apply, management estimates that it would need to satisfy $14.0 million of asbestos claims. Layered within the final $25.0 million of the total $287.0 million of coverage, management estimates that it would need to satisfy an additional $80 million of asbestos claims. If required to pay any such amounts, the Company could pursue recovery against the insolvent carriers, but it is not currently possible to determine the likelihood or amount of any such recoveries, if any.
As of March 31, 2007, the Company recorded a receivable from its insurance carriers of $136 million, which corresponds to the amount of its potential asbestos liability that is covered by available insurance and is currently determined to be probable of recovery. However, there is no assurance that $287.0 million of insurance coverage will ultimately be available or that Zurn’s asbestos liabilities will not ultimately exceed $287.0 million. Factors that could cause a decrease in the amount of available coverage include changes in law governing the policies, potential disputes with the carriers on the scope of coverage, and insolvencies of one or more of the Company’s carriers.
Although it is not possible to predict with certainty the outcome of these unresolved legal actions, based upon current information management believes that the eventual outcome of said actions will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
19. Business Segment Information
The results of operations are reported in two business segments, consisting of the Power Transmission segment and the Water Management segment. The Power Transmission segment manufactures gears, couplings, industrial bearings, flattop chain and modular conveyer belts, special components, industrial chain and aerospace bearings and seals. This segment serves a diverse group of end market industries, including aerospace, aggregates and cement, air handling, construction equipment, chemicals, energy, food and beverage, forest and wood products, mining, material and package handling, marine, natural resource extraction and petrochemical. The Water Management segment manufactures professional grade drainage, water control, commercial brass and PEX piping products for the commercial and institutional construction, renovation and facilities maintenance markets.
The financial information of the Company’s segments is regularly evaluated by the chief operating decision makers in determining resource allocation and assessing performance and is periodically reviewed by the Company’s Board of Directors. Management evaluates the performance of each business segment based on its operating results. The same accounting policies are used throughout the organization (see Note 2).
Business Segment Information (Continued)
(in millions)
(1) Represents the period from July 22, 2006 through March 31, 2007.
(2) Represents the period from April 1, 2006 through July 21, 2006.
Net sales to third parties and long-lived assets by geographic region are as follows (in millions):
Net sales to third parties are attributed to the geographic regions based on the country in which the shipment originates. Amounts attributed to the geographic regions for long-lived assets are based on the location of the entity that holds such assets.
20. Guarantor Subsidiaries
The following schedules present condensed consolidating financial information of the Company as of March 31, 2007 and for the period from July 22, 2006 through March 31, 2007 for (a) RBS Global, Inc. and its wholly-owned subsidiary Rexnord LLC (formerly Rexnord Corporation), which together are co-issuers (the “Issuers”) of the senior notes and senior subordinated notes issued on July 21, 2006 in connection with the Merger; (b) on a combined basis, the domestic subsidiaries of the Company, all of which are wholly-owned by the Issuers (collectively, the “Guarantor Subsidiaries”); and (d) on a combined basis, the foreign subsidiaries of the Company (collectively, the “non-Guarantor Subsidiaries”). Separate financial statements of the Guarantor Subsidiaries are not presented because their guarantees of the senior notes and senior subordinated notes are full, unconditional and joint and several, and the Company believes separate financial statements and other disclosures regarding the Guarantor Subsidiaries are not material to investors.
The following schedules also present condensed consolidating financial information of the Predecessor as of March 31, 2006 and for the period from April 1, 2006 through July 21, 2006 as well as for the years ended March 31, 2006 and 2005 for (a) RBS Global, Inc., the Parent company; (b) Rexnord LLC (formerly Rexnord Corporation), a wholly-owned subsidiary of RBS Global, Inc. and the issuer of the prior senior subordinated notes, substantially all of which were repurchased on July 21, 2006 in connection with the Merger; (c) on a combined basis, the domestic subsidiaries of the Predecessor, all of which were wholly-owned by the Issuers (collectively, the “Guarantor Subsidiaries”); and (d) on a combined basis, the foreign subsidiaries of the Predecessor (collectively, the “non-Guarantor Subsidiaries”). Separate financial statements of the Guarantor Subsidiaries are not presented because their guarantees of the prior senior subordinated notes were full and unconditional and joint and several, and the Company believes separate financial statements and other disclosures regarding the Guarantor Subsidiaries are not material to investors.
Condensed Consolidating Balance Sheet
March 31, 2007
(in millions)
Condensed Consolidating Balance Sheet
Predecessor
March 31, 2006
(in millions)
Condensed Consolidating Statement of Operations
Predecessor
Period from July 22, 2006 through March 31, 2007
(in millions)
Condensed Consolidating Statement of Operations
Predecessor
Period from April 1, 2006 through July 21, 2006
(in millions)
Condensed Consolidating Statement of Operations
Predecessor
Fiscal Year Ended March 31, 2006
(in millions)
Condensed Consolidating Statement of Operations
Predecessor
Fiscal Year Ended March 31, 2005
(in millions)
Condensed Consolidating Statement of Cash Flows
Period from July 22, 2006 through March 31, 2007
(in millions)
Condensed Consolidating Statement of Cash Flows
Predecessor
Period from April 1, 2006 through July 21, 2006
(in millions)
Condensed Consolidating Statement of Cash Flows
Predecessor
Fiscal Year Ended March 31, 2006
(in millions)
Condensed Consolidating Statement of Cash Flows
Predecessor
Fiscal Year Ended March 31, 2005
(in millions)
21. Quarterly Results of Operations (unaudited)
(in millions)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 15d-15 of the Exchange Act. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the period covered by this report.
There have been no changes in our internal control over financial reporting identified in connection with the evaluation discussed above that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
This annual report on Form 10-K does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the Company’s registered public accounting firm due to a transition period established by rules of the SEC for newly public companies.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth information concerning our directors and executive officers as of the date of this Form 10-K:
Name
Age
Position(s)
George M. Sherman
Chairman of the Board of RBS Global and Rexnord LLC
Robert A. Hitt
President, Chief Executive Officer and Director of RBS Global and Rexnord LLC
George C. Moore
Executive Vice President of Finance and Chief Financial Officer of RBS Global and Rexnord LLC and Director of Rexnord LLC
Alex P. Marini
President and Chief Executive Officer, Water Management Group
Laurence M. Berg
Director, RBS Global
Peter P. Copses
Director, RBS Global
Damian Giangiacomo
Director, RBS Global
Praveen R. Jeyarajah
Director, RBS Global
Steven Martinez
Director, RBS Global
George M. Sherman has been Chairman of our board of directors since 2002. Mr. Sherman also served as the Chairman of Campbell Soup from August 2001 to November 2004, and currently serves as the chairman of Jacuzzi Brands. Prior to his appointment with Campbell Soup, Mr. Sherman was the Chief Executive Officer at Danaher Corporation, a manufacturer of process/environmental controls and tools and components, from 1990 to May 2001. Prior to joining Danaher, he was Executive Vice President at Black and Decker Corporation.
Robert A. Hitt became our President and Chief Executive Officer in April 2001 and was elected as one of our directors in connection with the Carlyle acquisition in 2002. Prior to the Carlyle acquisition, Mr. Hitt had been the Chief Operating Officer of Invensys Industrial Components and Systems Division since April 2002, Division Chief Executive of Invensys Automation Systems Division from April 2001 to March 2002 and Division Chief Executive of Invensys Industrial Drive Systems Division from October 2000 to March 2001. Mr. Hitt joined Siebe/Invensys in 1994, where he held various positions, including President of Climate Controls, from June 1997 to October 2000, and prior to June 1997, General Manager of Appliance Controls.
George C. Moore became our Executive Vice President of Finance and Chief Financial Officer in September 2006. Prior to joining the Company Mr. Moore had been the Executive Vice President and Chief Financial Officer of Maytag, a manufacturer of major appliances and household products, since 2003. Prior to that Mr. Moore served as Group Vice President of Finance at Danaher Corporation, where he was employed since 1993.
Alex P. Marini became President and Chief Executive Officer of our Water Management Group upon consummation of the Zurn acquisition. Previously, Mr. Marini was the President and Chief Executive Officer of Jacuzzi since August 2006, the President and Chief Operating Officer of Jacuzzi from August 2005 to August 2006 and the President of Zurn from 1996 to August 2006. He joined Zurn in 1969 and held a variety of financial positions, including Vice President and Group Controller. He was promoted to Vice President of Sales, Marketing and Administration in 1984, and in 1987 was named President of Wilkins, a Zurn division, a position he held until becoming President of Zurn.
Laurence M. Berg became a member of our board of directors in July 2006 upon consummation of the Apollo acquisition. Mr. Berg is a Senior Partner of Apollo Management, L.P. and its investment affiliates, where he has worked since 1992. Prior to joining Apollo, Mr. Berg was a member of the Mergers and Acquisition Group at Drexel Burnham Lambert. Mr. Berg is also a director of Educate, Goodman Global, Jacuzzi Brands, Do Something, and Connections Academy.
Peter P. Copses became a member of our board of directors in July 2006 upon the consummation of the Apollo acquisition. Mr. Copses is a Founding Partner of Apollo Management, L.P. and its investment affiliates, where he has worked since 1990. Prior to joining Apollo, Mr. Copses was an investment banker at Drexel Burnham Lambert, and subsequently at Donaldson, Lufkin & Jenrette Securities, primarily concentrating on the structuring, financing and negotiation of mergers and acquisitions. Mr. Copses is also a director of Rent-A-Center, Inc., and Linens ‘n Things, Inc.
Damian J. Giangiacomo became a member of our board of directors in October 2006. Mr. Giangiacomo is a principal at Apollo Management, L.P., where he has been employed since July 2000. Prior to joining Apollo, Mr. Giangiacomo was an investment banker at Morgan Stanley & Co. Mr. Giangiacomo is also a director of Linens N’ Things and Jacuzzi Brands.
Praveen R. Jeyarajah was first elected as one of our directors in connection with the Carlyle Acquisition in 2002 and served in that capacity until the Apollo acquisition. Mr. Jeyarajah was reappointed as a director in October 2006, and also serves as a director of Jacuzzi Brands. Mr. Jeyarajah is a Managing Director at Cypress Group, LLC. Prior to joining Cypress Group, he was a Managing Director of Carlyle from 2001 to 2006. Prior to joining Carlyle, Mr. Jeyarajah was with Saratoga Partners from 1996 to 2000. Prior to that, Mr. Jeyarajah worked at Dillon, Read & Co., Inc.
Steven Martinez became a member of our board of directors in July 2006 upon the consummation of the Apollo acquisition. Mr. Martinez is a Partner at Apollo Management, L.P. Prior to joining Apollo in 2000, he worked for Goldman Sachs & Co. and Bain and Company. Mr. Martinez also serves as a director of Oceana Cruises, Jacuzzi Brands, Goodman Global Holdings, Inc. and Allied Waste Industries, Inc.
Boards of Directors
RBS Global’s board of directors has an audit committee and a compensation committee. However, through Apollo’s control of a majority of the common stock of Rexnord Holdings, it has the power to control Rexnord Holdings’ and our affairs and policies, including the election of Rexnord Holdings’ and our directors and the appointment of Rexnord Holdings’ and our management.
Audit Committee. The duties and responsibilities of the audit committee include recommending the appointment or termination of the engagement of independent accountants, otherwise overseeing the independent auditor relationship and reviewing significant accounting policies and controls. The members of the Audit Committee are Messrs, Martinez (Chair), Giangiacomo and Jeyarajah.
Compensation Committee. The duties and responsibilities of the compensation committee include reviewing and approving the compensation of officers and directors, except that the compensation of officers serving on any such committee will be determined by the full board of directors. The members of the Compensation Committee are Messrs, Berg, Giangiacomo, Jeyarajah and Martinez (Chair) and Sherman.
Our board of directors has not evaluated whether any member of the Audit Committee is an “audit committee financial expert”, as that term is defined in Item 407(d)(5) of Regulation S-K because all of the members of our board of directors who serve on our audit committee were appointed by our 100% stockholder.
Code of Ethics
We have adopted a written code of ethics, referred to as the Rexnord Code of Business Conduct and Ethics, applicable to all directors, officers and employees, which includes provisions relating to accounting and financial matters applicable to the principal executive officer, principal financial officer and principal accounting officer and controller. The Rexnord Code of Business Conduct and Ethics is available on our corporate website at www.rexnord.com. If we make any substantive amendments to, or grant any waivers from, the code of ethics for any director or officer, we will disclose the nature of such amendment or waiver on our corporate website or in a Current Report on Form 8-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Compensation Discussion and Analysis
Overview
The Compensation Committee of our Board of Directors (the “Committee”) is principally responsible for determining the executive compensation programs for the Company, with the exception of the award of equity based compensation, which is determined by the Compensation Committee of Rexnord Holdings, Inc., our indirect 100% parent (“Holdings”), as these awards cover equity securities of Holdings. The Committee, in consultation with the Compensation Committee of Holdings (the “Holdings Compensation Committee”), has the authority to approve all matters regarding executive compensation, including salaries, bonuses, cash incentives, equity incentives and benefit programs. The members of the Committee are Messrs. Martinez (Chair), Berg, Giangiacomo, Jeyarajah and Sherman. The Holdings Compensation Committee is currently comprised of the same individuals.
The Committee, with input from the Holdings Compensation Committee and the boards of directors of Holdings and the Company, oversees our executive compensation agreements, plans and policies. The Committee seeks to ensure that the compensation and benefits provided to executives are reasonable, fair, competitive and aligned with the long and short term goals of Holdings’ Board of Directors. Based upon these criteria, the Committee, in consultation with the Holdings Compensation Committee, sets the principles and strategies that guide the design of our executive compensation program. Throughout this discussion, we refer to the executives named in the Summary Compensation Table under this Item 11 as the “Named Executive Officers.”
General Compensation Philosophy and Objectives of Executive Compensation Programs
The foundation of our executive compensation programs is to reward our executives for achieving specific annual and long-term strategic goals of the Company and to align each executive’s interest with that of our owners. We believe that rewarding executives for superior levels of achievement will result in significant long-term value creation for the Company and its owners. As a result, we believe that the compensation packages we provide to executives, including the Named Executive Officers, must include both cash-based and equity-based elements that reward performance. The Committee, with input from the Chief Executive Officer, evaluates the performance of our executives and their compensation packages to ensure that we maintain our ability to retain highly talented key employees and attract new talent, as needed, to successfully grow and lead the organization.
We have created a “pay for performance” culture that places an emphasis on value creation and subjects a substantial portion of each executive’s incentive compensation to risk depending on the performance of the Company. As such, the Committee bases its executive compensation decisions on the following philosophy:
•
The compensation program should support the business by establishing an emphasis on critical short-term objectives and long-term strategy;
•
Each executive’s total compensation should correlate to their relative contribution to the Company;
•
A significant portion of each executive’s total compensation should be based on the achievement of performance goals and objectives; and
•
Executives should be rewarded for superior performance through annual cash-based incentives and, if appropriate, the grant of equity-based awards.
Our executive compensation program is designed to focus our executives on critical business goals that translate into long-term value creation. As a result, we believe that a substantial portion of our executives’ compensation should be variable and based on overall corporate financial performance. Another element of our executive compensation program is designed to reward annual improvement in personal objectives, with target performance areas determined for each executive officer by our Chief Executive Officer (or by the Committee, in the case of our Chief Executive Officer). We refer to these target performance areas as annual improvement priorities (“AIPs”).
Setting Executive Compensation and the Role of Our Executive Officers in Compensation Decisions
The Committee annually reviews and approves all compensation decisions related to our officers, including those for our Named Executive Officers. Prior to making its annual compensation determinations for each executive officer (other than that of the Chief Executive Officer), one or more members of the Committee work together with the Chief Executive Officer to review the performance of the Company and, if applicable, the respective business group, the role of each executive in the various aspects of that performance, and the executive’s level of achievement of his or her AIPs. Based on this review, the Chief Executive Officer makes recommendations to the Committee as to the compensation of all executives other than himself. The Committee will consider these recommendations and use its discretion and judgment in accepting or modifying these recommendation in making its final determinations.
The Committee has not retained a compensation consultant to review our executive compensation policies and procedures, although the Committee may from time to time obtain compensation studies to determine the relative strengths and weaknesses of our compensation packages.
2007 Executive Compensation Components
We compensate our executives though a variety of forms of cash and non-cash compensation. Our compensation program includes:
•
Cash compensation
•
base salaries
•
annual performance based awards
•
discretionary bonuses
•
special signing bonus
•
Long-term equity incentive awards
•
Retirement benefits
•
Severance benefits
The principal components of our executive compensation program for the fiscal year ended March 31, 2007 are discussed below.
Base Salary. Base salaries are set to recognize the experience, skills, knowledge and responsibilities required of the executives in their respective roles. Available market or comparable salary data is also used. Our executives’ base salaries are generally set at or slightly above the midpoint of the base salary for each position of other comparable companies, as reported to the Company by Mercer. The Committee reviews base salaries annually and makes adjustments from time to time to realign salaries with market levels after taking into account individual responsibilities, performance and experience. Our existing employment agreements do not provide for mandatory minimum annual salary increases above the base salary amounts set forth in the employment agreements.
Annual Performance Based Awards. Cash incentives for our executive officers are principally awarded through our Management Incentive Plan, except for the cash incentive for Mr. Hitt for fiscal 2007, which is to be awarded under the Executive Bonus Plan, and the cash incentive for Mr. Marini for fiscal 2007, which is payable under the terms of his employment agreement. The terms of the Executive Bonus Plan for Mr. Hitt are the same as the terms of our Management Incentive Plan and therefore, for purposes of this discussion, we refer to both the Executive Bonus Plan and the Management Incentive Plan as the “MIP.”
The MIP is designed to provide our key officers with appropriate incentives to achieve and exceed key annual business objectives by providing performance-based cash compensation in addition to their annual base salary. Under the terms of the MIP, participants are eligible to earn cash bonuses based upon the achievement by the Company of the financial targets established by the Committee and by the achievement of each executive’s AIPs. Each participant’s target bonus amount is based upon a specified percentage of the participant’s annual salary. Each participant is entitled to his target bonus amount if 100% of the specified performance targets (“Base Targets”) are achieved. The target bonus amount for Messrs. Hitt and Moore are 75% and 50% of salary, respectively.
Base Targets under the MIP are comprised of financial performance metrics, which are similar for each executive officer, and the individual AIPs. For the 2007 and 2008 fiscal years, the financial performance metrics are based upon EBITDA and debt reduction targets. These metrics are substantially the same as those that are established for the bonus system of our other management personnel and salaried employees. The Committee, with input from the Holdings Compensation Committee, sets the financial performance metrics. The Committee is responsible for setting the AIPs for our Chief Executive Officer and our Chief Executive Officer sets the AIPs for each of the other executive officers participating in the plan. The Committee's intention in setting the Base Targets for fiscal 2007 and 2008 was that the Company would have to perform at a high level and create a certain level of value for its owners for any annual incentive to be paid and that it would require an exceptional level of performance to attain or exceed the target level.
Aggregate bonuses under the plan are weighted to include both financial metrics as well as the AIP performance. For 2007, 80% of the aggregate bonus is paid in accordance with the percentage of the EBITDA and debt repayment targets actually achieved, weighted evenly, and 20% of the aggregate bonus is paid in accordance with the achievement of the respective executive’s AIPs (although the Committee has the discretion to modify the personal performance percentage to 0%-40% of base salary). For a minimum bonus to be triggered under the financial performance metrics, the Company must reach at least 90% of the respective metric. For a minimum bonus to be triggered under the AIP metric, the Company must achieve at least 70% of the base targets. There is no maximum bonus opportunity payable with respect to the financial performance based portion of the bonus, and as a result, as the Company achieves a greater percentage of its target financial performance metrics, the percentage of base salary used to determine the participant’s performance based portion of the bonus for the year increases.
The financial metrics used in the Base Targets are based upon certain revenue, expense, cash flow, growth rate and other assumptions about the future business of the Company. Accordingly, the plan provides that in the event the Committee determines, in its sole discretion, that an adjustment to the Base Targets is appropriate to maintain eligibility or prevent dilution or enlargement of the economic benefits intended to be made available under the MIP, including as a result of an acquisition or divestiture, the Committee can adjust the financial targets in good faith and in any manner as it may deem equitable.
In accordance with the terms of Mr. Marini’s employment agreement, for the period between February 7, 2007 (the date his employment commenced with the Company) and March 31, 2007, Mr. Marini is eligible to receive a pro-rata bonus payment equal to the bonus that he would have received under the Jacuzzi Annual Performance Incentive Plan as it was in effect immediately prior to the Zurn acquisition. As is the case with the MIP, the Company believes that providing Mr. Marini with a bonus opportunity that is dependent on the performance of Zurn provides appropriate incentives to achieve and exceed key business objectives.
The table set forth below titled “Grants of Plan-Based Awards” provides information regarding aggregate threshold, target and maximum amounts that would be payable to the named Executive Officers under the MIP for the five year period comprised of our fiscal years ended March 31, 2007 through March 31, 2011 for Messrs, Hitt and Moore, and for March 31, 2008 through March 31, 2011 for Mr. Marini. The actual bonus amounts for the Named Executive Officers have not yet been determined.
The Committee expects to review the performance of the Company and the Named Executive Officers with respect to the pre-established performance goals for fiscal 2007 in the near future and approve incentive award payments based on that review. The amounts of these payments will be included in a subsequent filing by the Company with the SEC following final determination.
Discretionary Bonuses. In addition to annual incentive awards under the MIP, the Committee has the discretion to award additional performance-based compensation to our executives if the Committee determines that a particular executive has exceeded the objectives and/or goals established for such executive or made a unique contribution to the Company during the year. The Committee did not award any discretionary bonus awards for fiscal 2007.
Special Signing Bonus. The Company established the Special Signing Bonus Plan (the “Signing Bonus Plan”) effective July 21, 2006 to provide for the award of a cash bonus to certain employees, directors, consultants and other service providers of the Company and its subsidiaries who agreed to provide services to the Company following the date of its adoption (which was the date of the July 2006 Apollo acquisition). Mr. Hitt is the only Named Executive Officer who is a participant in the Signing Bonus Plan. Bonuses are payable to participants upon the earliest to occur of: (i) a change in control of the Company, (ii) the separation from service of the participant or (iii) a date specified for each participant.
Long Term Equity Incentive Awards. The Holdings Compensation Committee may, from time to time, approve the grant of equity awards to our Named Executive Officers and other officers, employees, directors and consultants. The Committee and the Holdings Compensation Committee believe that equity-based awards play an important role in creating incentives for our executives to maximize Company performance and align the interests of our executives with those of our owners. These equity awards are generally subject to time-based and performance based vesting requirements. Time-based awards function as a retention incentive, while performance-based awards encourage executives to maximize Company performance and create value for our equity owners. Equity awards are generally provided through grants of stock options to purchase shares of Holding’s common stock under the 2006 Stock Option Plan of Rexnord Holdings, Inc. (the “Option Plan”).
Among other things, the Holdings Compensation Committee decides which of our executives, employees, directors or consultants shall receive awards under the Option Plan, the exercise price, vesting terms and such other terms or conditions as the Holdings Compensation Committee may determine, in their sole discretion, provided such terms are consistent with the provisions of the Option Plan. With respect to options granted to our Named Executive Officers, 50% of the options granted to each officer under the Option Plan vest on a pro-rata basis over five years, subject to continued employment. The other 50% vest annually over five years subject to the Company meeting certain specified annual and cumulative performance targets, which currently include both annual and cumulative EBITDA and debt repayment targets. As was the case under the MIP, the Holdings Compensation Committee’s intention in setting the performance vesting targets for the options was that the Company would have to perform at a high level and create a certain level of value for its owners for any portion of the performance based options to vest. The number of options to be vested with respect to the Company's fiscal 2007 financial performance will be determined at the approximately the same time as the annual performance based awards for fiscal 2007 are determined and will be reported in a subsequent SEC filing.
As is customary in incentive plans such as the Option Plan, the performance targets established for awards are subject to adjustment appropriate to prevent dilution or enlargement of the economic benefits intended to be made available under the awards, including as a result of an acquisition or divestiture.
During the 2007 fiscal year, the Holdings Compensation Committee granted stock options to Mr. Hitt and Mr. Andrzejewski in connection with the Company’s July 2006 acquisition by Apollo and to Mr. Moore in connection with the commencement of his employment with the Company. Subsequent to the fiscal year end, the Holdings Compensation Committee granted options to Mr. Marini pursuant to the terms of his employment agreement and also made additional grants to other executive officers and non-executive personnel, including a grant of options to Messrs. Hitt and Moore. The corresponding number of stock options granted to our Named Executive Officers and the material terms of these options as of the end of our 2007 fiscal year are described below under “Description of Plan-Based Awards-Stock Options.”
We do not have any program, plan or practice in place for selecting grant dates for awards under the Option Plan in coordination with the release of material non-public information. The Holdings Compensation Committee is not prohibited from granting options at times when they are in possession of material non-public information. However, no inside information was taken into account in determining the number of options previously awarded or the exercise price for those awards, and we did not “time” the release of any material non-public information to affect the value of those awards.
Retirement Benefits. Each of our continuing Named Executive Officers participates in qualified defined-benefit and/or defined-contribution retirement plans maintained by the Company on substantially the same terms as our other participating employees. The Company adopted the Rexnord Supplemental Executive Retirement Plan ("SERP") on January 1, 2004 to provide participants with deferred compensation opportunities. Mr. Hitt, Mr. Jansen and Mr. Andrzejewski are the only participants in the SERP. Under the
plan, during the term of each participant’s active employment with the Company, each participant’s account is credited annually as of each December 31 with a percentage of his compensation and account balances are credited at an annual interest rate of 6.75%. Account balances become payable upon a termination of employment.
Under the terms of Mr. Marini’s employment agreement with the Company, Mr. Marini is entitled to receive a monthly supplemental retirement benefit commencing upon his retirement, so long as his employment is not terminated for "cause." The amount of the monthly supplemental retirement benefit is determined as of Mr. Marini's retirement date and is an amount necessary to provide Mr. Marini with a monthly 60% joint and survivor annuity during Mr. Marini's life after his retirement equal to the positive difference, if any, between $20,000 less his "existing retirement benefit” (as defined in the employment agreement). If Mr. Marini voluntarily terminates his employment with the Company for any reason other than a termination for "good reason", death or disability, he must give the Company 6 months notice of his termination order to receive the supplemental retirement benefit. If he does not give the Company the 6 months notice, Mr. Marini will be required to pay the Company an amount equal to his then current base salary. The Company believes that the benefits provided to Mr. Marini recognize the substantial past and expected future contributions to the Company (including his prior service with Zurn).
Severance Benefits. We have entered into separate employment agreements with Messrs. Hitt and Marini that, among other things, provide that the executive would be entitled to certain severance benefits in the event of a termination of employment during the term of the respective agreement if such termination is: (i) initiated by us without cause or (ii) initiated by the respective officer for good reason (each as defined in the respective agreements). The Committee has determined that it is appropriate to provide these executives with severance benefits under these circumstances in light of their positions with the Company and as part of their overall compensation package. We believe that a termination by the executive for good reason (or constructive termination) is conceptually the same as an actual termination by the Company without cause; therefore, we believe it is appropriate to provide severance benefits following such a constructive termination of the executive’s employment.
Mr. Moore is covered under a corporate severance policy that applies to our employees whose employment is involuntarily terminated under various conditions described in the plan document. The severance policy is intended to cover employees who are not entitled to severance benefits under an employment agreement. We believe that it is appropriate to provide severance benefits to employees whose employment terminates in these circumstances and that doing so helps us to attract and retain highly qualified employees.
Additional information concerning potential payments that may be made to the Named Executive Officers in connection with their termination of employment or a change in control is presented in “Potential Payments Upon a Termination or Change in Control” below.
Perquisites and Other Personal Benefits. The Company provides the Named Executive Officers with perquisites and other personal benefits that the Company and the Company's Compensation Committee believe are reasonable, competitive and consistent with the overall compensation program. The Committee periodically reviews the perquisites and other benefits provided to the Named Executive Officers. In particular, Messrs. Hitt and Moore receive travel reimbursement in connection with travel to and from their respective principal residences, which are located out-of-state, and housing reimbursement in Milwaukee, Wisconsin.
Compensation Committee Report on Executive Compensation(1)
The Company's Compensation Committee has certain duties and powers as described in its charter. The Company's Compensation Committee is currently composed of the five non-employee directors named at the end of this report. The Company's Compensation Committee has reviewed and discussed with management the disclosures contained in the above Compensation Discussion and Analysis. Based upon this review and discussion, the Company's Compensation Committee recommended to the Company's Board of Directors that the Compensation Discussion and Analysis section be included in this Annual Report on Form 10-K.
Steven Martinez (Chair)
Laurence M. Berg
Damian Giangiacomo
Praveen Jeyarajah
George M. Sherman
Unless specifically stated otherwise, this report shall not be deemed to be incorporated by reference and shall not constitute soliciting material or otherwise be considered filed under the Securities Act of 1933 or the Securities Exchange Act of 1934.
Compensation Committee Interlocks and Insider Participation
Messrs. Berg, Giangiacomo and Martinez, whose names appear on the Compensation Committee Report above, became Compensation Committee members immediately following the Apollo acquisition in July 2006. Each of these directors are partners of Apollo Management, L.P., the controlling stockholder of Holdings. In fiscal 2007 the Company entered into several significant transactions with Apollo and its affiliates, including aggregate payments of $30.3 million in connection with the Apollo and Zurn acquisitions, and the payment of an annual consulting fee, currently set at $2.0 million per year, to Apollo or one of its affiliates. In fiscal 2007 the Company also paid approximately $2.0 million in consulting fees to an entity affiliated with Mr. George Sherman, who is the Chairman of the Board of the Company and Holdings, including the $250,000 listed for Mr. Sherman in the “Director Compensation” table. Mr. Jeyarajah, whose name also appears on the above Compensation Committee Report, is a Managing Director of Cypress. None of our executive officers served as a director or a member of a compensation committee (or other committee serving an equivalent function) of any other entity, the executive officers of which served as a director or member of our Compensation Committee during the fiscal year ended March 31, 2007.
Summary Compensation Table
The following table presents information about the compensation of our Chief Executive Officer, our Chief Financial Officer and our other executive officer, and two former executive officers, whom we refer to as our Named Executive Officers, for the year ended March 31, 2007.
(1) The amounts in column (f) reflect the dollar amount recognized for financial reporting purposes for the fiscal year ended March 31, 2007, in accordance with SFAS 123(R). Assumptions used in the calculation of this amount are included in Note 14 to our Consolidated Financial Statements included herewith. Excludes options to purchase 11,535 shares granted under the Option Plan to Mr. Andrzejewski but forfeited upon his retirement, for which the Company will record no expense pursuant to SFAS 123(R). Equity based awards are denominated in shares of common stock of our indirect parent, Rexnord Holdings, Inc.
(2) The amounts in column (g) represents the amount paid under the Company's Executive Bonus Plan to Mr. Hitt for fiscal 2006 performance and amounts paid under the Management Incentive Plan to Messrs. Jansen and Andrzejewski for fiscal 2006 performance. In addition to such amounts, Messrs. Hitt, Moore and Marini are eligible to receive a performance based bonus with respect to the 2007 fiscal year covered by the Summary Compensation Table. However, these bonus amounts have not yet been determined, and such amounts will be included in a subsequent filing by the Company following final determination.
(3) The amounts in column (h) for Messrs. Hitt, Jansen and Andrzejewski represent the sum of the actuarial increase in the present value of each of their benefits under our Rexnord Non-Union Pension Plan plus interest on deferred compensation account balances under the SERP considered under SEC rules to be at above-market rates in the following amounts: for Mr. Hitt, $2,170 actuarial increase in pension value and $1,340 interest; for Mr. Jansen, $4,380 actuarial increase in pension value and $726 interest; and for Mr. Andrzejewski, $3,400 actuarial increase in pension value and $431 interest. The change in the actuarial present value of the accrued pension benefit is based on the difference of the present value of the accrued benefit as of the December 31, 2006 measurement date (used for financial statement reporting purposes) and the present value of the accrued benefit as of the December 31, 2005 measurement date (used for financial statement reporting purposes). The amount in column (h) for Mr. Marini represents the actuarial present value, calculated as of February 7, 2007 (the date his employment with the Company commenced), of the supplemental retirement benefit Mr. Marini is entitled to receive from the Company pursuant to the terms of his employment agreement. This amount was determined using the same actuarial assumptions applied for financial reporting purposes for the December 31, 2006 measurement date. Mr. Marini is also a participant under the Jacuzzi Brands Inc. Master Pension Plan, which was merged into the Rexnord Non-Union Pension Plan as of April 13, 2007. See “Pension Benefit Table” below for a description of the supplemental retirement benefit and the aggregate pension benefits to which he is entitled under the Rexnord Non-Union Pension Plan.
(4) For Mr. Hitt, column (i) includes a 401(k) matching contribution of $16,195, a 401(k) personal retirement account ("PRA") contribution of $6,600, a contribution of $825,594 to the Signing Bonus Plan, a contribution of $100,294 to the SERP, a temporary housing benefit of $24,752, commuting reimbursements of $28,213, an auto benefit of $3,677 and tax gross-ups in the aggregate of $20,486. For Mr. Moore, amounts include a 401(k) matching contribution of $1,846, a PRA contribution of $3,692, a temporary housing benefit of $5,607, commuting reimbursements of $12,907, an auto benefit of $6,023 and aggregate tax
gross-ups of $2,787. For Mr. Marini, column (i) includes club dues of $921, an auto benefit of $261, a 401(k) matching contribution of $5,035 and aggregate tax gross-ups of $414. For Mr. Jansen, amounts include a 401(k) matching contribution of $5,600, a PRA contribution of $6,600, a contribution of $45,893 to the SERP, an auto benefit of $6,983, club dues of $8,152 and aggregate tax gross-ups of $6,953, and a severance payment of $81,761, which represents the cash severance and benefits paid to him as of March 31, 2007 under his Change in Control Severance Agreement with the Company (see “Potential Payments Upon Termination or Change in Control” below for a description of Mr. Jansen’s separation agreement with the Company). For Mr. Andrzejewski, amounts include a 401(k) matching contribution of $5,696, a PRA contribution of $6,600, a contribution of $24,691 to the SERP and an auto benefit of $9,185.
(5) Mr. Moore’s date of hire was September 5, 2006.
(6) Mr. Marini, who was employed by Jacuzzi Brands, Inc. prior to the Zurn acquisition, joined the Company on February 7, 2007, the date of the Zurn acquisition. All amounts reflect compensation paid or payable by the Company for the period beginning on that date and running through fiscal year end.
(7) Mr. Jansen retired from the Company on January 21, 2007.
(8) Mr. Andrzejewski retired from the Company on November 4, 2006.
Employment Agreements. The Company has entered into employment agreements with Messrs. Hitt and Marini.
The agreement for Mr. Hitt was effective as of July 21, 2006 and provides for a five-year term, subject to automatic extension for successive one-year periods thereafter unless either party delivers notice within specified notice periods. Mr. Hitt’s initial annual salary, which may be increased by our board of directors, is $575,000, and he is eligible to receive an incentive compensation bonus under the terms of our Management Incentive Plan. The employment agreement with Mr. Marini, which was effective as of February 7, 2007, provides for an initial term of employment through August 31, 2008, subject to automatic extensions for successive one-year periods thereafter unless either party delivers notice within specified notice periods. Under the agreement, Mr. Marini’s annual base salary is $500,000, which may be increased by the Company’s Chairman or Chief Executive Officer. Mr. Marini is eligible to receive a discretionary bonus under the Company’s annual bonus plan established for each fiscal year commencing with fiscal 2008 with an annual cash target bonus opportunity for each fiscal year equal to 100% of his base salary. Mr. Marini is also entitled to receive a pro-rata bonus for the period commencing on the effective date of his employment agreement and ending on March 31, 2007. The amount of this bonus has not yet been determined. Each of the employment agreements for Mr. Hitt and Mr. Marini provide for severance payments and benefits upon a termination of employment. See the discussion following the “Pension Benefit Table” below for a description of the terms of Mr. Marini’s supplemental pension benefit.
Severance Payments to Mr. Jansen. Mr. Jansen became entitled to severance benefits upon his termination of employment with the Company on January 21, 2007 pursuant to the terms of his Change in Control Severance Agreement with the Company. See “Potential Payments Upon Termination or Change in Control” below for a description of the material terms of these payments and benefits.
Grants of Plan-Based Awards
The following table presents information about grants of plan-based awards made to our Named Executive Officers during the fiscal year ended March 31, 2007. Equity awards are denominated in shares of common stock of our indirect parent, Rexnord Holdings, Inc.
(1) For Messrs. Hitt and Moore, amounts reflect target cash incentive awards under the Management Incentive Plan for the 2007-2011 fiscal years. For Mr. Marini amounts reflect target cash incentive awards under the Management Incentive Plan for the 2008-2011 fiscal years.
(2) Represents the portion (50%) of the options granted to each Named Executive Officer under the Option Plan not subject to performance based vesting. These options vest in equal portions on the first five anniversaries of the grant date based upon continued employment.
(3) There is no minimum amount payable under the Company's Management Incentive Plan.
(4) Represents the amount payable under the Company's Management Incentive Plan if 100% of the performance and AIP measures are met for the 2007-2011 fiscal years for Messrs. Hitt and Moore and for the 2008-2011 fiscal years for Mr. Marini, assuming each executive's current annual salary, excluding any additional discretionary bonus which could be paid under the plan.
(5) The Management Incentive Plan does not set a limit on the maximum bonus opportunity payable with respect to the financial performance based portion of the bonus formula. Instead, the plan provides that the percentage of the participant’s base bonus (defined above) used to determine the participant’s financial performance based portion of the bonus for the fiscal year will increase incrementally as the level of achievement increases.
(6) Represents the minimum number of option shares that would vest under the Option Plan if the lowest performance threshold for vesting is satisfied.
(7) Represents the number of option shares that would vest under the Option Plan if 100% of the target performance for each metric under the plan is satisfied.
(8) Represents the maximum number of options that could vest under the Option Plan.
(9) On the grant date both the exercise price and the deemed fair market value were $47.50. On March 2, 2007 Holdings declared a special dividend of $27.56 per share to the holders of its common stock, and on the dividend record date the fair market value per share of Holdings common stock was reduced to reflect a corresponding deduction. Based on this reduced fair market value, the Committee, in accordance with its adjustment authority under the terms of the Option Plan, adjusted the exercise price of all of the outstanding options under the Option Plan, including those held by our Named Executive Officers, by reducing the per share exercise price to $19.94, the deemed fair market value following the special dividend.
(10) Represents options to purchase common stock of RBS Global held by Mr. Hitt which were converted into the right to purchase 115,791 shares of Holdings at a price per share of $7.13 at the time of the July 2006 Apollo acquisition. The options are 100% vested and exercisable. The $7.13 exercise price reflects the price on an as-converted basis determined to maintain the aggregate spread on the option.
(11) Mr. Andrzejewski forfeited his plan based awards as a result of his retirement from the Company prior to the completion of the 2007 fiscal year.
Narrative to Grants of Plan Based Awards
As described under “Elements of 2007 Executive Compensation Annual Performance-Based Awards,” the Management Incentive Plan provides for cash based payments based on three criteria: the achievement of personal goals, referred to as “annual improvement priorities” or AIPs, the achievement of minimum annual EBITDA targets and the reduction of the Company’s debt by predetermined minimum levels. Mr. Marini is entitled to participate in the MIP beginning with our fiscal 2008.
Under the Option Plan, the vesting criteria for 50% of all options granted to our Named Executive Officers under the Option Plan is based upon annual and cumulative EBITDA and debt reduction targets over a five year period (the other 50% of such options vest in five equal amounts based on continued employment with the Company, subject to accelerated vesting or other modifications, as determined by the Committee). As is customary in incentive plans such as the Option Plan, the performance targets established for awards are subject to adjustment appropriate to prevent dilution or enlargement of the economic benefits intended to be made available under the awards, including as a result of an acquisition or divestiture.
Outstanding Equity Awards
The following table presents information about outstanding and unexercised options held by our Named Executive Officers at March 31, 2007. Equity awards are denominated in shares of common stock of our indirect parent, Rexnord Holdings, Inc. None of our Named Executive Officers held stock awards at any time during fiscal 2007.
(1) Represents options to purchase common stock of RBS Global held by Mr. Hitt which were converted into the right to purchase 115,791 shares of Holdings at a price per share of $7.13 in connection with the Apollo acquisition (“Roll-Over Options”).
(2) Represents 50% of the aggregate options granted to the Named Executive Officer under the Option Plan, which options vest based on continued employment in equal annual amounts on the first five anniversaries of the July 21, 2006 grant date for Mr. Hitt's options and the October 25, 2006 grant date for Mr. Moore’s options.
(3) Represents 50% of the aggregate options granted to the Named Executive Officer under the Option Plan, which options are subject to performance based vesting over five years subject to the Company meeting certain specific performance targets in each of the fiscal years 2007 though 2011, which include both annual and cumulative EBITDA and debt reduction targets. As of the date of this filing no determination had been made by the Holdings Compensation Committee as to the number of options which would be deemed to have vested based upon the Company's financial performance for fiscal 2007.
(4) The option expiration date shown in column (f) above is the normal expiration date, and the latest date that the options may be exercised. The options may terminate earlier upon a termination of employment or in connection with a change in control of the Company.
Narrative to the Outstanding Equity Awards
Outstanding options currently consist of Roll-Over Options granted to Mr. Hitt in connection with the Apollo acquisition and incentive based options granted to Messrs. Hitt and Moore pursuant to the Option Plan. In both cases the options represent the right to purchase shares of common stock of Holdings, our indirect parent.
On March 2, 2007, Holdings declared a special dividend of $27.56 per share with respect to its common stock. In connection with the special dividend, Mr. Hitt received a payment of $3,191,200, which represented the per-share dividend amount multiplied by the number of shares of Holding’s common stock that were subject to Mr. Hitt’s Roll-Over Options. Additionally, and as described under footnote 9 to the “Grants of Plan Based Awards” table, the Committee adjusted the exercise price of all of the outstanding options under the Option Plan, including those held by our Named Executive Officers, by reducing the per share exercise price from $47.50 to $19.94, the deemed fair market value of the common stock following the special dividend payment.
The options granted under the Option Plan may become fully vested if there is a change in control of the Company or if Holdings experiences certain liquidity events.
Option Exercises and Stock Vested
The following table provides information regarding exercises of option awards by our Named Executive Officers during the fiscal year ended March 31, 2007. None of our Named Executive Officers held stock awards at any time during fiscal 2007.
Represents options to purchase shares of RBS Global common stock held prior to the July 2006 Apollo acquisition that were cashed out in connection with the closing of that transaction. Such amount excludes options to purchase common stock of RBS Global held by Mr. Hitt which were converted into the right to purchase 115,791 shares of Holdings at a price per share of $7.13 at the time of the Apollo acquisition.
Pension Benefits
The following table presents information regarding the present value of accumulated benefits that may become payable to each of the Named Executive Officers under our qualified and nonqualified defined-benefit pension plans as of March 31, 2007.
(1) The amounts in column (d) represent the actuarial present value of each Named Executive Officer’s accumulated pension benefit under the Rexnord Non-Union Pension Plan as of the December 31, 2006 measurement date used for financial statement reporting purposes and, for Mr. Marini, the supplemental pension benefit under his employment agreement as of February 7, 2007 (the date his employment with the Company commenced). Participants in the Rexnord Non-Union Pension Plan are assumed to retire at age 65, the plan’s earliest termination date with unreduced benefits. For a description of the material assumptions used to calculate the present value of accumulated benefits shown above, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Retirement Benefits” and Note 15 (Retirement Benefits).
(2) Mr. Marini was a participant in the Jacuzzi Brands, Inc. Master Pension Plan, which was merged into the Rexnord Non-Union Plan effective April 13, 2007. Mr. Marini’s employment with the Company commenced on February 7, 2007. Accordingly, the number of years of credited service represents former service with Jacuzzi Bands, Inc. and its affiliates.
Rexnord Non-Union Pension Plan. Each of our Named Executive Officers other than Mr. Moore participates in the Rexnord Non-Union Pension Plan. Benefit payments under this plan are generally based on final average annual compensation-including overtime pay, incentive compensation and certain other forms of compensation reportable as wages taxable for federal income tax purposes, but excluding severance payments, amounts attributable to our equity plans and any taxable fringe benefits-for the five years within the final ten years of employment prior to termination that produce the highest average. The plan’s benefits formula also integrates benefit formulas from prior plans of our former parent and Jacuzzi Brands, Inc. in which certain participants may have been entitled to participate. Benefits are generally payable as a life annuity for unmarried participants and on a 50% joint and survivor basis for married participants. The full retirement benefit is payable to participants who retire on or after age 65, and a reduced early retirement benefit is available to participants who retire on or after age 55 with 10 years of service. No offsets are made for the value of any social security benefits earned. During our 2004 fiscal year the Company froze credited service as of March 31, 2004. As such, no additional benefits are accruing under this plan. Mr. Hitt is eligible for increases in final average pay through 2014.
Supplemental Pension Benefits for Mr. Marini. Under the terms of Mr. Marini’s employment agreement with the Company that became effective February 7, 2007 in connection with the Zurn acquisition (the “Marini Employment Agreement”) Mr. Marini is entitled to receive a monthly supplemental retirement benefit in the form of a 60% joint and survivor annuity commencing upon his retirement, so long as his employment is not terminated for “cause.” The amount of the monthly supplemental retirement benefit is determined as of Mr. Marini’s retirement date and is an amount necessary to provide Mr. Marini with a monthly 60% joint and survivor annuity during Mr. Marini’s life after his retirement equal to the positive difference, if any, between $20,000 less his “existing retirement benefit.” Mr. Marini’s “existing retirement benefit” is equal to the sum of (1) the aggregate monthly benefit that he is entitled to receive under all of the tax qualified and non-tax qualified pension plans covering Mr. Marini during his employment with the Company and its affiliates and (2) the value of the lump sum payment he received under certain supplemental pension plans maintained by JBI upon the sale of JBI to affiliates of Apollo on February 7, 2007, assuming for purposes of the calculation that the amount was not paid until his retirement and was paid in the form of a 60% joint and survivor annuity rather than in a lump sum. Regardless of the form in which the existing retirement benefits would be paid under the terms of the applicable plan, for purposes of the calculation under the agreement, each benefit is determined assuming that the benefit is payable in the form of a 60% joint and survivor annuity determined using the actuarial assumptions that are used under the Company’s tax qualified defined benefit plan at the time of Mr. Marini’s retirement. If Mr. Marini voluntarily terminates his employment with the Company for any reason other than
a termination for “good reason”, death or disability, he must give the Company 6 months notice of his termination order to receive the supplemental retirement benefit. If he does not give the Company the 6 months notice, Mr. Marini will be required to pay the Company an amount equal to his then current base salary.
Nonqualified Deferred Compensation
The following table presents information on contributions to, earnings accrued under and distributions from our nonqualified defined contribution and other nonqualified deferred compensation plans during the fiscal year ended March 31, 2007.
(1) All amounts listed are included in column (h) of the Summary Compensation Table. For Mr. Hitt, represents a contribution of $825,594 under the Special Signing Bonus Plan and a contribution of $100,294 under the SERP. For Messrs. Jansen and Andrzejewski, represents a contribution under the SERP of $45,893 and $26,190, respectively.
Narrative to the Nonqualified Deferred Compensation Table
Mr. Hitt is a participant in the Rexnord Special Signing Bonus Plan (the “Signing Bonus Plan”). The Company established the Signing Bonus Plan effective July 21, 2006 to provide for an award of a cash bonus to certain employees, directors, consultants and other service providers of the Company and its subsidiaries who agreed to provide services to the Company following the date of its adoption (which was the date of the July 2006 Apollo acquisition). Bonuses become payable to participants upon the earliest to occur of: (i) a change in control of the Company, (ii) the participant’s separation from service or (iii) a date specified in the participant’s plan participation letter. Bonus amounts are not credited with interest or other earnings.
Messrs. Hitt, Jansen and Andrzejewski are the sole participants in the Rexnord Supplemental Executive Retirement Plan (“SERP”) that the Company adopted on January 1, 2003. Under the SERP, on the date the plan was adopted, each participant was credited with a specified amount to his account and during the term of each participant’s active employment with the Company thereafter, each participant’s account is credited annually as of each December 31 with a percentage of his compensation - 8.48% for Mr. Hitt, 7.97% for Mr. Jansen and 7.75% for Mr. Andrzejewski. Account balances are also credited with earnings at an annual interest rate of 6.75%. Participants are credited with a pro-rata contribution amount and interest in the year that the participant’s employment terminates. Benefits become payable upon a termination of employment, and as such, benefits for Messrs. Jansen and Andrzejewski became payable upon the termination of their employment during fiscal 2007. A “rabbi-trust” has been established to fund benefit obligations under the SERP.
Potential Payments Upon Termination or Change-in-Control
As described above in the “Compensation Discussion and Analysis - Severance Benefits”, the employment agreements of Mr. Hitt and Mr. Marini include provisions regarding certain payments to be made in the event of termination by the Company or by the executive.
Under the terms of the employment agreement for Mr. Hitt, upon termination of employment either by us without cause or by Mr. Hitt for good reason, he will be entitled to an amount equal to his stated annual base salary for a period of eighteen months and, during such severance period, continued coverage under all of our group health benefit plans in which he and any of his dependents were
entitled to participate immediately prior to termination. In addition to the foregoing, the employment agreement also provides that in the event of a termination within 18 months of a change in control (as defined in the payments and benefits agreement) by the Company without cause, or by Mr. Hitt for good reason, Mr. Hitt is also entitled to receive an amount equal to the annual bonus he would have received in the performance period in effect at the time of termination, plus 18 months of the premium amount of the basic life insurance coverage then in place for him. Mr. Hitt is prohibited from competing with us during the term of his employment and for a period of twenty four months following termination of his employment.
Under the terms of the employment agreement for Mr. Marini, in the event Mr. Marini voluntarily retires from the Company, he will be entitled to receive certain annuity benefits (described above under “Pension Benefits”), provided he gives the Company at least six months’ notice of his intention to retire, and retiree medical coverage under our retiree medical plan in effect, if any, upon his termination. If Mr. Marini’s employment is terminated on or before August 31, 2008 either by us without cause, by Mr. Marini for good reason (in each case as defined in the agreement), or because we do not extend his employment term, subject to the execution of a release of claims, he will be entitled to receive 24 monthly payments equal to his then-monthly rate of base salary and a lump sum payment equal to two times his annual target bonus amount. If a termination occurs for either of these reasons after August 31, 2008, he will be entitled to receive 12 monthly payments equal to his then-monthly rate of base salary and a lump sum payment equal to his annual target bonus amount. Additionally, if such termination occurs prior to August 31, 2008 Mr. Marini will also be entitled to continued coverage under all of our group health benefit plans in which he and any of his dependents were entitled to participate immediately prior to termination for a period of two years, or for a period of one year if such termination occurs thereafter. In either case, he will also be entitled to receive his minimum pension amount, as calculated pursuant to the agreement, retiree medical benefits for him and his spouse pursuant to the terms of the Company’s retiree medical plan covering the senior executives of the Company at the time of such termination, 12 months of accelerated vesting of his then-unvested options and any amounts then owed to Mr. Marini under the applicable benefit plans in which he is a participant, which are to be paid in accordance with the terms of such plans. Subject to certain limitations, under the agreement Mr. Marini is prohibited from competing with us or soliciting our employees, customers, suppliers or certain other persons during the term of his employment and for a period of 24 months following termination of his employment.
The following table presents the dollar value of the maximum severance benefits to which each executive would have been entitled under their respective employment agreements had a qualifying termination of employment occurred on March 31, 2007.
(1) Assumes Mr. Hitt's bonus for the year of termination equaled his target bonus of 75% of fiscal 2007 base salary.
Upon a termination of employment, Mr. Hitt would also be entitled to a distribution of the amount then credited to his account under the SERP of $298,913. In addition, upon a termination of employment or a change in control, we would have distributed to Mr. Hitt the $825,594 credited to his account under the Special Signing Bonus Plan. Upon a termination of employment, Mr. Marini would also be entitled to his minimum supplemental pension benefit as described under “Pension Plan Table” above. Additionally, in the event of a change-in-control, the Option Plan permits the Committee to take one of a series of actions, including causing outstanding option grants to be subject to accelerated vesting or repurchase by the Company.
Mr. Moore is covered under a corporate severance policy that applies to our employees whose employment is involuntarily terminated under various conditions described in the plan document. The severance policy is intended to cover employees who are not entitled to severance benefits under an employment agreement.
Mr. Jansen became entitled to severance benefits upon his termination of his employment with the Company on January 21, 2007 pursuant to the terms of his Change in Control Severance Agreement with the Company. This agreement provided Mr. Jansen with (1) severance pay in an amount equal to 12 months of his base salary payable over 12 months in accordance with the Company’s
customary payroll practices, (2) the bonus that the Mr. Jansen would have received if he remained employed through the end of the bonus performance period in which his employment terminated, (3) during the 12 month period following his termination, or until Mr. Jansen is covered by the plan of another employer, continued coverage under the Company’s group medical and dental benefit plan and (4) payments equal to 12 months of the premium cost for life insurance coverage (excluding supplemental life insurance coverage) under the Company’s life insurance plan in effect immediately prior to Mr. Jansen’s date of termination. No severance was paid in connection with the termination of Mr. Andrzejewski's employment on November 4, 2006. In accordance with their respective prior elections, final SERP distributions in the amounts of $154,430 and $94,058 were paid to Messrs. Jansen and Andrzejewski, respectively.
Director Compensation
The table below summarizes the compensation we paid to persons who were non-employee directors of the Company for the fiscal year ended March 31, 2007.
(1) The amounts in column (d) reflect the dollar amount recognized for financial reporting purposes for the fiscal year ended March 31, 2007, in accordance with SFAS 123(R), based on options granted under the Option Plan to purchase 576,765 shares of Holdings’ common stock for Mr. Sherman and options to granted under the Option Plan purchase 4,211 shares of Holdings’ common stock for Messrs. Berg, Copses, Giangiacomo and Martinez, respectively. Assumptions used in the calculation of this amount are included in Note 14 to our Consolidated Financial Statements included herewith.
(2) Service as a director initially terminated in July 2006 in connection with the Apollo acquisition. Mr. Jeyarajah was reappointed to the Board in October 2006.
(3) Service as a director terminated in July 2006 in connection with the Apollo acquisition.
Narrative to Directors’ Compensation Table
We pay our non-employee directors (excluding Messrs. Sherman and Jeyarajah) an annual cash retainer of $40,000, paid quarterly after each fiscal quarter of service, and a fee of $2,000 for each board and committee meeting attended in person. Fifty percent of the meeting fee is paid for board and committee meetings attended by teleconference. Directors who are also employees of the Company receive no additional compensation for their service as Directors. Directors are eligible to receive equity-based awards from time to time on a discretionary basis. On July 21, 2006, upon consummation of the Apollo acquisition Messrs. Berg, Copses and Martinez received options to purchase 4,211 shares of Holdings' common stock pursuant to the Option Plan. On November 28, 2006, Mr. Giangiacomo received options to purchase 4,211 shares of Holdings' common stock pursuant to the Option Plan upon his appointment to the Board. Each option has a 10 year term and becomes fully vested upon the one year anniversary of the date of grant.
On July 22, 2006, we entered into the Cypress agreement, as described above. Pursuant to the terms of the agreement, Consultant receives an annual consulting fee of $250,000. Mr. Sherman also received a grant of options to purchase 576,765 shares of Holdings’ common stock pursuant to the Option Plan. 50% of the options granted to Mr. Sherman vest based on continued service in equal annual amounts on the first five anniversaries of the July 21, 2006 grant date and the remaining 50% of the options granted to Mr. Sherman are subject to performance based vesting over five years, subject to the Company meeting certain specific performance targets in each of the fiscal years 2007 though 2011, which include both annual and cumulative EBITDA and debt reduction targets. Mr. Sherman also is entitled to reimbursement for all reasonable travel and other expenses incurred in connection with our business. Upon termination of the agreement, we must pay Mr. Sherman a pro rata portion of his consulting fee earned but not previously paid.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
RBS Global and Rexnord LLC are 100% owned (indirectly through Chase Acquisition) by Rexnord Holdings. The following table sets forth information regarding the beneficial ownership of Holding’s common stock, as of March 31, 2007, and shows the number of shares and percentage owned by each person known to beneficially own more than 5% of the common stock of Rexnord Holdings, each of our named executive officers currently with the Company; each member of the Board of Directors of RBS Global and Rexnord LLC; and all of our executive officers and members of our Boards of Directors as a group.
* Indicates less than one percent.
(1)
Each of the persons affiliated with Apollo who is also a partner or senior partner of Apollo may be deemed a beneficial owner of the shares owned by Apollo due to his or her status as an affiliate of Apollo. Each such person disclaims beneficial ownership of any such shares in which he or she does not have a pecuniary interest. The address of each such person and Apollo is c/o Apollo Management, L.P., 9 West 57th Street, New York, NY 10019.
(2) Includes options to purchase 221,012 shares held by Cypress Group LLC, over which Mr. Sherman has sole voting and dispositive power.
(3) Includes options to purchase 115,791 shares held by Mr. Hitt.
(4) Includes options to purchase 336,803 shares.
The amounts and percentages of common stock beneficially owned are reported on the basis of regulations of the SEC governing the determination of beneficial ownership of securities. Under the rules of the SEC, a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or to direct the voting of such security, or “investment power,” which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Under these rules, more than one person may be deemed a beneficial owner of the same securities and a person may be deemed a beneficial owner of securities as to which he has no economic interest. Except as otherwise indicated in the footnotes above, each of the beneficial owners has, to our knowledge, sole voting and investment power with respect to the indicated shares of common stock.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth, as of March 31, 2007, the number of securities outstanding under our equity compensation plan, the Stock Option Plan of RBS Global, Inc., the weighted-average exercise price of such securities and the number of securities available for grant under these plans:
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
RBS Global, Inc. had a management services agreement with TC Group, L.L.C., (The Carlyle Group) for advisory and consulting services related to corporate management, finance, product strategy, investment, acquisitions and other matters relating to the business of the Company. Under the terms of the agreement, the Company paid $0.5 million, plus out of pocket expenses during the period from April 1, 2006 through July 21, 2006, and $2.0 million per year, plus out of pocket expenses for both fiscal 2006 and fiscal 2005. This agreement terminated July 21, 2006 when The Carlyle Group sold the Company to Apollo.
RBS Global, Inc. has a management services agreement, effective July 22, 2006, with Apollo for advisory and consulting services related to corporate management, finance, product strategy, investment, acquisitions and other matters relating to the business of the Company. Under the terms of the indenture and the indentures governing our other notes, we are permitted to pay to Apollo an annual monitoring fee of up to the greater of $2.5 million or 1.5% of our EBITDA. At the time of the closing of the Apollo acquisition, Apollo elected to receive a $2.0 million annual monitoring fee. We have also agreed to indemnify Apollo and its affiliates and their directors, officers and representatives for losses relating to the services contemplated by the transaction fee and management agreements and the engagement of affiliates of Apollo pursuant to, and the performance by them of the services contemplated by, these agreements. Under the terms of the aforementioned agreement, the Company paid $1.4 million plus out of pocket expenses during the period from July 22, 2006 through March 31, 2007. This agreement will remain in effect until such time as Apollo or its affiliates collectively own less than 10% of the equity interest of the Company, or such earlier time as the Company and Apollo may mutually agree.
In connection with the Apollo acquisition, Rexnord Holdings, Apollo and certain other stockholders of Rexnord Holdings entered into stockholders’ agreements. The stockholders’ agreements provide for, among other things, restrictions on the transferability of each such person’s equity ownership in Rexnord Holdings, tag-along rights, drag-along rights, piggyback registration rights, repurchase rights by Rexnord Holdings in certain circumstances and certain restrictions on each management stockholder’s ability to compete with or solicit our employees or customers.
We make cash payments to Chase Acquisition to enable it to pay any (i) Federal, state or local income taxes to the extent that such income taxes are directly attributable to our and our subsidiaries’ income, (ii) franchise taxes and other fees required to maintain Chase Acquisition’s legal existence and (iii) corporate overhead expenses incurred in the ordinary course of business and salaries or other compensation of employees who perform services for both Chase Acquisition and us.
In connection with the Apollo acquisition, we entered into the Cypress agreement with Consultant. Pursuant to the Cypress agreement, Consultant provides certain consulting services to us, Mr. Sherman serves as the non-executive Chairman of the boards of directors of Rexnord and Rexnord Holdings, and Consultant receives an annual consulting fee of $250,000 and reimbursement for reasonable out-of-pocket expenses. In addition, Mr. Sherman received non-qualified stock options. Under the terms of the Cypress agreement, we paid $172,500 plus out of pocket expenses during the period from July 22, 2006 through March 31, 2007; $77,500 plus out of pocket expenses for the period from April 1, 2006 through July 21, 2006; and $250,000 plus out of pocket expenses for fiscal 2006.
Transaction Fees
The Company paid a total of $0.6 million to The Carlyle Group and $21.3 million to Apollo for investment banking and other transaction related services as part of the purchase of the Company by Apollo on July 21, 2006.
The Company also paid a total of $9.0 million to Apollo and $1.8 million to Cypress for investment banking and other transaction related services as part of the Zurn Acquisition on February 7, 2007.
Director Independence
The board of directors has not made a determination as to whether each director is “independent” because all of the members of our board have been appointed by our 100% stockholder. The Company has no securities listed for trading on a national securities exchange or in an automated inter-dealer quotation system of a national securities association, which has requirements that a majority of its board of directors be independent. The Company does not believe any of its directors would be considered independent under the New York Stock Exchange’s definition of independence.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Audit Fees
The aggregate audit fees billed, including reimbursement of actual expenses, by Ernst & Young for professional services rendered for the reviews of our quarterly reports on Form 10-Q, and for the audit of our financial statements and consents for the fiscal years ended March 31, 2007 and 2006 were $2,851,000 and $1,496,000, respectively.
Audit-Related Fees
Ernst & Young billed us $2,000 for audit-related services provided during fiscal 2007 for other consultation services not associated with the audit process. Ernst & Young billed us $15,000 for audit-related services provided during fiscal 2006 for other consultation services not associated with the audit process.
Tax Fees
The aggregate tax fees billed by Ernst & Young for tax services rendered to us during fiscal 2007 and 2006 were $313,000 and $356,000, respectively. The tax services rendered to us by Ernst & Young were for domestic tax compliance, foreign tax compliance and tax consulting.
All Other Fees
Ernst & Young billed us $770,000 for consulting services provided during fiscal 2006. These services related primarily to market studies provided by Investor Group Services, an affiliate of Ernst & Young.
Audit Committee Pre-Approval Policies and Procedures
All the services described above were approved by RBS Global, Inc.’s audit committee in advance of the services being rendered.
The Audit Committee is responsible for the appointment, compensation and oversight of the work performed by the independent auditors. The Audit Committee must pre-approve all audit (including audit related) services and permitted non-audit services provided by the independent auditors in accordance with the pre-approval policies and procedures established by the Audit Committee.
The Audit Committee annually approves the scope and fee estimates for the quarterly reviews, year-end audit, statutory audits and tax work to be performed by the Company’s independent auditors for the next fiscal year. With respect to other permitted services, management defines and presents specific projects and categories of service for which the advance approval of the Audit Committee is requested. The Audit Committee pre-approves specific engagements, projects and categories of services on a fiscal year basis, subject to individual project thresholds and annual thresholds. In assessing requests for services by the independent auditor, the Audit Committee considers whether such services are consistent with the auditor’s independence, whether the independent auditor is likely to provide the most effective and efficient service based upon their familiarity with the Company, and whether the service could enhance the Company’s ability to manage or control risk or improve audit quality. In making its recommendation to ratify the appointment of Ernst & Young LLP as our auditor for the current fiscal year, the Audit Committee has considered whether the non-audit services provided by them are compatible with maintaining their independence. At each Audit Committee meeting, the Executive VP Finance reports to the Audit Committee regarding the aggregate fees for which the independent auditor has been engaged for such engagements, projects and categories of services compared to the approved amounts.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements
The Company’s consolidated financial statements included in Item 8 hereof are for the periods from July 22, 2006 through March 31, 2007 and April 1, 2006 through July 21, 2006, and for the years ended March 31, 2006 and 2005 and consist of the following:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedules.
The Financial Statement Schedules of the Company appended hereto for the years ended March 31, 2007, 2006 and 2005 consist of the following:
Schedule II - Valuation and Qualifying Accounts
(1) Uncollectible amounts, dispositions charged against the reserve and utilization of net operating losses.
All other schedules have been omitted because they are not applicable or because the information required is included in the notes to the consolidated financial statements.
(a) (3) Exhibits.
See (b) below
(b) Exhibits.
EXHIBIT INDEX
(1) Incorporated by reference to the Form 8-K/A filed by the registrants on July 27, 2006.
(2) Incorporated by reference to the Form 10-Q filed by the registrants on November 8, 2006.
(3) Incorporated by reference to the Form S-4 Registration Statement (SEC File No. 33-10242) filed by the registrants
(4) Incorporated by reference to the Form 8-K filed by the registrants on May 19, 2005.
(5) Incorporated by reference to the S-4 Registration Statement (SEC File No. 33-140040) filed by the registrants.
(6) Incorporated by reference to the Form 10-Q filed by the registrants on August 10, 2005.
(7) Incorporated by reference to the Form 10-K filed by the registrants on June 15, 2005.
(8) Incorporated by reference to the Form 10-Q filed by the registrants on February 13, 2007.
(9) Incorporated by reference to the S-4 Registration Statement (SEC File No. 33-141121) filed by the registrants.
(10) Incorporated by reference to the Form 8-K filed by the registrants on June 19, 2006.
* Denotes management plan or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, each of the Co-Registrants has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Co-Registrant and in the capacities and on the dates indicated.
Supplemental Information to be Furnished with Reports Filed Pursuant to Section 15(d)
of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act
RBS Global, Inc. is not required to nor does it intend to furnish an Annual Report or a
Proxy Statement to security holders for its 2007 fiscal year.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, each of the Co-Registrants has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Co-Registrant and in the capacities and on the dates indicated.
Supplemental Information to be Furnished with Reports Filed Pursuant to Section 15(d)
of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act
RBS Global, Inc. is not required to nor does it intend to furnish an Annual Report or a
Proxy Statement to security holders for its 2007 fiscal year.