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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-K
 
ANNUAL REPORT
PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
     
(Mark One)    
 
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the year ended December 31, 2006
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission file number: 001-33209
 
 
 
 
ALTRA HOLDINGS, INC.
(Exact Name of Registrant as Specified in its Charter)
 
     
Delaware   61-1478870
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
     
14 Hayward Street,
Quincy, Massachusetts
  02171
(Address of Principal Executive Offices)   (Zip Code)
 
Registrant’s telephone number, including area code:
(617) 328-3300
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
 
Common Stock, $0.001 par value
  NASDAQ Global Market
 
Securities registered pursuant to Section 12(g) of the Act:
NONE
 
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ      No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and larger accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated Filer  o     Accelerated Filer o     Non-Accelerated Filer þ
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of Exchange Act).  Yes o     No þ
 
The registrant completed the initial public offering of its common stock in December 2006. Accordingly, there was no public market for the registrant’s common stock on June 30, 2006, the last day of the registrant’s most recently completed second quarter.
 
As of March 15, 2007, there were 23,087,591 shares of Common Stock, $.001 par value per share, outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE:
 
Certain portions of the Proxy Statement for the Annual meeting of stockholders of Altra Holdings, Inc. to be held May 8, 2007, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2006, are incorporated by reference in Part III of the From 10-K.
 


 

 
TABLE OF CONTENTS
 
                 
        Page
 
PART I
  Business   3
  Risk Factors   13
  Unresolved Staff Comments   22
  Properties   23
  Legal Proceedings   24
  Submission of Matters to a Vote of Security Holders   24
 
  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Repurchases of Equity Securities   25
  Selected Financial Data   28
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   29
  Quantitative and Qualitative Disclosures about Market Risk   41
  Financial Statements and Supplementary Data   43
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   80
  Controls and Procedures   80
  Other Information   80
 
  Directors, Executive Officers and Corporate Governance   80
  Executive Compensation   80
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   80
  Certain Relationships and Related Transactions, and Director Independence   80
  Principal Accounting Fees and Services   80
 
  Exhibits and Financial Statement Schedules   81
  89
 Ex-21.1 Subsidiaries of Altra Holdings, Inc.
 Ex-23.1 Consent of Independent Registered Public Accounting Firm
 Ex-31.1 Certification of CEO
 Ex-31.2 Certification of CFO
 Ex-32.1 Certification of CEO pursuant to Section 906
 Ex-32.2 Certification of CFO pursuant to Section 906


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FORWARD-LOOKING STATEMENTS
 
We make “forward-looking statements” throughout this Form 10-K. Whenever you read a statement that is not solely a statement of historical fact, such as when we state that we “believe,” “expect,” “anticipate” or “plan” that an event will occur and other similar statements, you should understand that our expectations may not be correct, although we believe they are reasonable, and that our plans may change. We do not guarantee that the transactions and events described in this Form 10-K will happen as described or that any positive trends noted in this Form 10-K will continue. The forward-looking information contained in this Form 10-K is generally located under the headings, “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” but may be found in other locations as well. These forward-looking statements generally relate to our strategies, plans and objectives for, and potential results of, future operations and are based upon management’s current plans and beliefs or current estimates of future results or trends.
 
Forward-looking statements regarding management’s present plans or expectations for new product offerings, capital expenditures, increasing sales, cost-saving strategies and growth involve risks and uncertainties relative to among other things, return expectations, allocation of resources and changing economic or competitive conditions, and as a result, actual results could differ from present plans or expectations and such differences could be material. Similarly, forward-looking statements regarding management’s present expectations for operating results and cash flow involve risks and uncertainties relative to these and other factors, such as the ability to increase revenues and/or to achieve cost reductions, and other factors discussed under “Risk Factors” or elsewhere in this Form 10-K, which also would cause actual results to differ from present plans or expectations. Such differences could be material.
 
Item 1.   Business
 
Our Company
 
We are a leading global designer, producer and marketer of a wide range of mechanical power transmissions, or MPT, and motion control products serving customers in a diverse group of industries, including energy, general industrial, material handling, mining, transportation and turf and garden. Our product portfolio includes industrial clutches and brakes, enclosed gear drives, open gearing, couplings, engineered bearing assemblies, linear components and other related products. Our products are used in a wide variety of high-volume manufacturing processes, where the reliability and accuracy of our products are critical in both avoiding costly down time and enhancing the overall efficiency of manufacturing operations. Our products are also used in non-manufacturing applications where product quality and reliability are especially critical, such as clutches and brakes for elevators and residential and commercial lawnmowers. For the year ended December 31, 2006, we had net sales of $462.3 million, net income of $8.9 million and EBITDA of $54.8 million. For a discussion of how we calculate and utilize EBITDA and limitations on its usefulness as a measure of our performance, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
 
We market our products under well recognized and established brand names, including Warner Electric, Boston Gear, Kilian Manufacturing, Nuttall Gear, Ameridrives, Wichita Clutch, Formsprag Clutch, Bibby Transmissions, Stieber, Matrix International, Inertia Dynamics, Twiflex Limited, Industrial Clutch, Huco Dynatork, Marland Clutch, Delroyd Worm Gear, Warner Linear and Saftek. Most of these brands have been in existence for over 50 years.
 
Our products are either incorporated into products sold by original equipment manufacturers, or OEMs, sold directly to end users or sold through industrial distributors. We sell our products in over 70 countries to over 700 direct OEM customers and over 3,000 distributor outlets through our global sales and marketing network.
 
We file reports and other documents with the Securities and Exchange Commission. You may read and copy any document we file at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.


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You should call 1-800-SEC-0330 for more information on the public reference room. Our SEC filings are also available to you on the SEC’s internet site at http://www.sec.gov.
 
Our internet address is www.altramotion.com. We are not including the information contained in our website as part of, or incorporating it by reference into, this annual report on Form 10-K.
 
Our Industry
 
Based on industry data supplied by Penton Information Services, we estimate that industrial power transmission products generated sales in the United States of approximately $33.3 billion in 2006. These products are used to generate, transmit, control and transform mechanical energy. The industrial power transmission industry can be divided into three areas: MPT products; motors and generators; and adjustable speed drives. We compete primarily in the MPT area which, based on industry data, we estimate was a $16.7 billion market in the United States in 2006.
 
The global MPT market is highly fragmented, with over 1,000 small manufacturers. While smaller companies tend to focus on regional niche markets with narrow product lines, larger companies that each generate annual sales over $100 million offer a much broader range of products and have global capabilities. The industry’s customer base is broadly diversified across many sectors of the economy and typically places a premium on factors such as quality, reliability, availability and design and application engineering support. We believe the most successful industry participants are those that leverage their distribution network, their products’ reputations for quality and reliability and their service and technical support capabilities to maintain attractive margins on products and gain market share.
 
Our Strengths
 
Leading Market Shares and Brand Names.  We believe that we hold the number one or number two market position in key products across several of our core platforms. For example, under a report published by the Global Industry Analysts, Inc. in February 2005, we are one of the leading manufacturers of industrial clutches and brakes in the world. Our brands, most of which have been in existence for more than 50 years, are widely known in the MPT product markets. We believe over 50% of our sales are generated from products where, according to the most recently published Motion Systems Design magazine survey, our brands on a consolidated basis have the number one or number two brand recognition in the markets we serve.
 
Large Installed Base and Diversified OEM Customers Supporting Aftermarket Sales.  With a history dating back to 1877 with the formation of Boston Gear, we believe we benefit from one of the largest installed customers bases in the industry. Given the moving, wearing nature of our products, which require regular replacement, our large installed base of products with a diversified group of end user customers, generates significant aftermarket replacement demand which creates a recurring revenue stream. Many of our products serve critical functions, where the cost of product failure would substantially exceed any potential cost reduction benefits from using cheaper, less proven parts. This end user preference and consistently recurring replacement demand in turn help to stabilize our revenue base from the cyclical nature of the broader economy. For the year ended December 31, 2006 we estimate that approximately 43% of our revenues were derived from aftermarket sales.
 
Diversified End-Markets.  Our revenue base has balanced exposure across a diverse mix of end user industries, including energy, general industrial, material handling, mining, transportation and turf and garden, which helps mitigate the impact of business and economic cycles. No single industry represented more than 9% of our total sales, in 2006. In addition, for the year ended December 31, 2006, approximately 30% of our sales were from outside North America. Our geographic diversification is further enhanced because some of our products sold into the North American market are ultimately exported into international markets as part of the final product sold by the customer.
 
Strong Relationship with Distributors and OEMs.  We have over 700 direct OEM customers and enjoy established, long-term relationships with the leading MPT industrial distributors, critical factors that contribute to our high base of recurring aftermarket revenues. We sell our products through more than 3,000 distributor


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outlets worldwide. We believe our scale, end user preference and expansive product line make our product portfolio attractive to both large and multi-branch distributors, as well as regional and independent distributors in our industry.
 
Experienced, High-Caliber Management Team.  We are led by a highly experienced management team with over 425 years of cumulative industrial business experience and an average of 14 years with our companies. Our Chairman and CEO, Michael Hurt, has over 40 years of experience in the MPT industry, while our President and COO Carl Christenson has over 26 years of experience. Our management team has established a proven track record of execution, successfully completing and integrating major strategic acquisitions and delivering significant growth and profitability.
 
The Altra Business System(“ABS”).  We benefit from an established culture of lean management emphasizing quality, delivery and cost through ABS. ABS is at the core of our performance-driven culture and drives both our strategic development and operational improvements. We estimate that in the period from January 1, 2005 through December 31, 2006, ABS has enabled us to achieve savings of over $5 million through various initiatives, including: (a) set-up time reduction and productivity improvement, (b) finished goods inventory reduction, (c) improved quality and reduction of internal scrap, (d) on-time delivery improvement, (e) utilizing value stream mapping to minimize work in process inventory and increase productivity and (f) headcount reductions. We believe these initiatives will continue to provide us with recurring annual savings. We intend to continue to aggressively implement operational excellence initiatives by utilizing ABS tools throughout our company.
 
Proven Product Development Capabilities.  Our extensive application engineering know-how drives both new and repeat sales. Our broad portfolio of products, knowledge and expertise across various MPT applications allows us to provide our customers customized solutions to meet their specific needs. We are highly focused on developing new products in response to customer requirements. We employ approximately 170 non-manufacturing engineers involved with product development, research and development, test and technical customer support. Recent new product development examples include the Foot/ Deck Mount Kopper Kool Brake which was designed for very high heat dissipation in extremely rugged tensioning applications such as drawworks for oil and gas wells and anchoring systems for on-shore and off-shore drilling platforms.
 
Our Business Strategy
 
We intend to continue to increase our sales through organic growth, expand our geographic reach and product offering through strategic acquisitions and improve our profitability through cost reduction initiatives. We seek to achieve these objectives through the following strategies:
 
  •  Leverage Our Sales and Distribution Network.  We intend to continue to leverage our relationships with our distributors to gain shelf space, further integrate our recently acquired brands with our core brands and sell new products. We seek to capitalize on customer brand preference for our products to generate pull-through aftermarket demand from our distribution channel. We believe this strategy also allows our distributors to achieve high profit margins, further enhancing our preferred positions with them.
 
  •  Focus our Strategic Marketing on New Growth Opportunities.  We intend to expand our emphasis on strategic marketing to focus on new growth opportunities in key end-user markets. Through a systematic process that leverages our core brands and products, we seek to identify attractive markets and product niches, collect customer and market data, identify market drivers, tailor product and service solutions to specific market and customer requirements and deploy resources to gain market share and drive future sales growth.
 
  •  Accelerate New Product and Technology Development.  We are highly focused on developing new products across our business in response to customer needs in various markets. We expect new products developed by us during the past three years to generate approximately $60 million in revenues in 2007.
 
  •  Capitalize on Growth and Sourcing Opportunities in the Asia-Pacific Market.  We intend to leverage our established sales offices in China, Taiwan and Singapore, as well as add representation in Japan and


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  South Korea. We also intend to expand our manufacturing presence in Asia beyond our current plant in Shenzhen, China, to increase sales in the high-growth Asia-Pacific region. This region also offers opportunities for low-cost country sourcing of materials. During 2006, we sourced approximately 17% of our purchases from low-cost countries, resulting in average cost reductions of over 45% for these products. Within the next five year, we intend to utilize our sourcing office in Shanghai to significantly increase our current level of low-cost country sourced purchases. We may also consider opportunities to outsource some of our production from North American and Western European locations to Asia.
 
  •  Continue to Improve Operational and Manufacturing Efficiencies through ABS.  We believe we can continue to improve profitability through cost control, overhead rationalization, global process optimization, continued implementation of lean manufacturing techniques and strategic pricing initiatives. Our operating plan, based on manufacturing centers of excellence, provides additional opportunities to reduce costs by sharing best practices across geographies and business lines and by consolidating purchasing processes. We have implemented these principles with our recent acquisitions of Hay Hall Holdings Limited, or Hay Hall, and Bear Linear LLC, or Warner Linear, and intend to apply such principles to future acquisitions. We have been operating Bear Linear as a division under the name Warner Linear.
 
  •  Pursue Strategic Acquisitions that Complement our Strong Platform.  Management believes that there may be a number of attractive potential acquisition candidates in the future, in part due to the fragmented nature of the industry. We plan to continue our disciplined pursuit of strategic acquisitions to accelerate our growth, enhance our industry leadership and create value. On February 17, 2007, we entered into an agreement and plan of merger to acquire all of the issued and outstanding shares of capital stock of TB Wood’s Corporation, or TB Wood’s. With our extensive MPT and motion control products, our strong customer and distributor relationships and our know-how in implementing lean enterprise initiatives through ABS, we have an ideal platform for acquiring and successfully integrating related businesses, as evidenced through our acquisition and integration of Hay Hall and Bear Linear. We intend to cause TB Wood’s, to become a subsidiary of Altra Industrial Motion, our wholly-owned subsidiary, or Altra Industrial. We expect to finance the acquisition, in part, through the tack-on offering of Altra Industrial’s 9% senior secured notes due 2011, or the 9% senior secured notes, borrowings under our senior revolving credit facility and cash on hand. The transaction is expected to close in April 2007.
 
Products
 
We produce and market a wide variety of MPT products. Our product portfolio includes industrial clutches and brakes, open and enclosed gearing, couplings, engineered bearing assemblies and other related power transmission components which are sold across a wide variety of industries. Our products benefit from our industry leading brand names including Warner Electric, Boston Gear, Kilian Manufacturing, Nuttall Gear, Ameridrives, Wichita Clutch, Formsprag Clutch, Bibby Transmissions, Stieber, Matrix International, Inertia Dynamics, Twiflex Limited, Industrial Clutch, Huco Dynatork, Marland Clutch, Delroyd Worm Gear, Warner Linear and Saftek. Our products serve a wide variety of end markets including aerospace, energy, food processing, general industrial, material handling, mining, petrochemical, transportation and turf and garden. We primarily sell our products to OEMs and through long-standing relationships with the industry’s leading industrial distributors such as Motion Industries, Applied Industrial Technologies, Kaman Industrial Technologies and W.W. Grainger.


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Our products, principal brands and markets and sample applications are set forth below:
 
             
Products
 
Principal Brands
 
Principal Markets
 
Sample Applications
 
Clutches and Brakes
  Warner Electric, Wichita Clutch, Formsprag Clutch, Stieber Clutch, Matrix International, Inertia Dynamics, Twiflex Limited, Industrial Clutch, Marland Clutch   Aerospace, energy, material handling, metals, turf and garden, mining   Elevators, forklifts, lawn mowers, oil well drawworks, punch presses, conveyors
Gearing
  Boston Gear, Nuttall Gear, Delroyd Worm Gear   Food processing, material handling, metals, transportation   Conveyors, ethanol mixers, packaging machinery, rail car wheel drives
Engineered Couplings
  Ameridrives, Bibby Transmissions   Energy, metals, plastics   Extruders, turbines, steel strip mills
Engineered Bearing Assemblies   Kilian Manufacturing   Aerospace, material handling, transportation   Cargo rollers, steering columns, conveyors
Power Transmission
Components
  Warner Electric, Boston Gear, Huco Dynatork, Warner Linear, Matrix International, Saftek   Material handling, metals, turf and garden   Conveyors, lawn mowers, machine tools
 
Clutches and Brakes.  Clutches are devices which use mechanical, magnetic, hydraulic, pneumatic, or friction type connections used to facilitate engaging or disengaging two rotating members. Brakes are combinations of interacting parts that work to slow or stop machinery. We manufacture a variety of clutches and brakes in three main product categories: electromagnetic, overrunning and heavy duty. Our core clutch and brake manufacturing facilities are located in Indiana, Illinois, Michigan, Texas, the United Kingdom, Germany, France and China.
 
  •  Electromagnetic Clutches and Brakes.  Our industrial products include clutches and brakes with specially designed controls for material handling, forklift, elevator, medical mobility, mobile off-highway, baggage handling and plant productivity applications. We also offer a line of clutch and brake products for walk-behind mowers, residential lawn tractors and commercial mowers. While industrial applications are predominant, we also manufacture several vehicular niche applications including on-road refrigeration compressor clutches and agricultural equipment clutches. We market our electromagnetic products under the Warner Electric, Inertia Dynamics and Matrix brand names.
 
  •  Overrunning Clutches.  Specific product lines include the Formsprag and Stieber indexing and backstopping clutches. Primary industrial applications include conveyors, gear reducers, hoists and cranes, mining machinery, machine tools, paper machinery, packaging machinery, pumping equipment and other specialty machinery. We market and sell these products under the Formsprag, Marland and Stieber brand names.
 
  •  Heavy Duty Clutches and Brakes.  Our heavy duty clutch and brake product lines serve various markets including metal forming, off-shore and land-based oil and gas drilling platforms, mining material handling, marine applications and various off-highway and construction equipment segments. Our line of heavy duty pneumatic, hydraulic and caliper clutches and brakes are marketed under the Wichita Clutch and Twiflex brand names.
 
Gearing.  Gears reduce the output speed and increase the torque of an electric motor or engine to the level required to drive a particular piece of equipment. These products are used in various industrial, material handling, mixing, transportation and food processing applications. Specific product lines include vertical and


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horizontal gear drives, speed reducers and increasers, high-speed compressor drives, enclosed custom gear drives, various enclosed gear drive configurations and open gearing products such as spur, helical, worm and miter/bevel gears. We design and manufacture a broad range of gearing products under the Boston Gear, Nuttall Gear and Delroyd Worm Gear brand names. We manufacture our gearing products at our facilities in New York and North Carolina and sell to a variety of end markets.
 
Engineered Couplings.  Couplings are the interface between two shafts, which enable power to be transmitted from one shaft to the other. Because shafts are often misaligned, we designed our couplings with a measure of flexibility that accommodates various degrees of misalignment. Our coupling product line includes gear couplings, high-speed disc and diaphragm couplings, grid couplings, universal joints and spindles. Our coupling products are used in the power generation, steel and custom machinery industries. We manufacture a broad range of coupling products under the Ameridrives and Bibby brand names. Our engineered couplings are manufactured in our facilities in Pennsylvania and the United Kingdom.
 
Engineered Bearing Assemblies.  Bearings are components that support, guide and reduce friction of motion between fixed and moving machine parts. Our engineered bearing assembly product line includes ball bearings, roller bearings, thrust bearings, track rollers, stainless steel bearings, polymer assemblies, housed units and custom assemblies. We manufacture a broad range of engineered bearing products under the Kilian brand name. We sell bearing products to a wide range of end markets, including the general industrial and automotive markets, with a particularly strong OEM customer focus. We manufacture our bearing products at our facilities in New York and Canada.
 
Power Transmission Components.  Power transmission components are used in a number of industries to generate, transfer or control motion from a power source to an application requiring rotary or linear motion. Power transmission products are applicable in most industrial markets, including, but not limited to metals processing, turf and garden and material handling applications. Specific product lines include linear actuators, miniature and small precision couplings, air motors, friction materials and other various items. We manufacture or market a broad array of power transmission components under several businesses including Warner Linear, Huco Dynatork, Saftek, Boston Gear, Warner Electric and Matrix. Our core power transmission component manufacturing facilities are located in Illinois, North Carolina, the United Kingdom and China.
 
  •  Warner Linear.  Warner Linear is a designer and manufacturer of rugged service electromechanical linear actuators for off-highway vehicles, agriculture, turf care, special vehicles, medical equipment, industrial and marine applications.
 
  •  Huco Dynatork.  Huco Dynatork is a leading manufacturer and supplier of a complete range of precision couplings, universal joints, rod ends and linkages.
 
  •  Saftek.  Saftek manufactures a broad range of high quality non-asbestos friction materials for industrial, marine, construction, agricultural and vintage and classic cars and motorcycles.
 
  •  Other Accessories.  Our Boston Gear, Warner Electric and Matrix businesses make or market several other accessories such as sensors, sleeve bearings, AC/ DC motors, adjustable speed drives, shaft accessories, face tooth couplings and fluid power components that are used in numerous end markets.
 
Research and Development and Product Engineering
 
We closely integrate new product development with marketing, manufacturing and product engineering in meeting the needs of our customers. We have product engineering teams that work to enhance our existing products and develop new product applications for our growing base of customers that require custom solutions. We believe these capabilities provide a significant competitive advantage in the development of high quality industrial power transmission products. Our product engineering teams focus on:
 
  •  lowering the cost of manufacturing our existing products;
 
  •  redesigning existing product lines to increase their efficiency or enhance their performance; and
 
  •  developing new product applications.


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Our continued investment in new product development is intended to help drive customer growth as we address key customer needs. Research and developmentexpenses were $4.9 million, $4.7 million and $4.3 million for the years ended December 31, 2006, 2005 and 2004, respectively.
 
Sales and Marketing
 
We sell our products in over 70 countries to over 700 direct OEM customers and over 3,000 distributor outlets. We offer our products through our direct sales force comprised of 101 company-employed sales associates as well as independent sales representatives. Our worldwide sales and distribution presence enables us to provide timely and responsive support and service to our customers, many of which operate globally, and to capitalize on growth opportunities in both developed and emerging markets around the world.
 
We employ an integrated sales and marketing strategy concentrated on both key industries and individual product lines. We believe this dual vertical market and horizontal product approach distinguishes us in the marketplace allowing us to quickly identify trends and customer growth opportunities and deploy resources accordingly. Within our key industries, we market to OEMs, encouraging them to incorporate our products into their equipment designs, to distributors and to end users, helping to foster brand preference. With this strategy, we are able to leverage our industry experience and product breadth to sell MPT and motion control solutions for a host of industrial applications.
 
Distribution
 
Our MPT components are either incorporated into end products sold by OEMs or sold through industrial distributors as aftermarket products to end users and smaller OEMs. We operate a geographically diversified business. For the year ended December 31, 2006, 70% of our net sales were derived from customers in North America, 22% from customers in Europe and 8% from customers in Asia and the rest of the world. Our global customer base is served by an extensive global sales network comprised of our sales staff as well as our network of over 3,000 distributor outlets. Refer to note 13 of our audited financial statements included elsewhere in this Form 10-K for additional information on sales and assets by geographic location.
 
Rather than serving as passive conduits for delivery of product, our industrial distributors are active participants in influencing product purchasing decisions in the MPT industry. In addition, distributors play a critical role through stocking inventory of our products, which affects the accessibility of our products to aftermarket buyers. It is for this reason that distributor partner relationships are so critical to the success of the business. We enjoy strong established relationships with the leading distributors as well as a broad, diversified base of specialty and regional distributors.
 
Competition
 
We operate in highly fragmented and very competitive markets within the MPT market. Some of our competitors have achieved substantially more market penetration in certain of the markets in which we operate, such as helical gear drives and couplings, and some of our competitors are larger than us and have greater financial and other resources. In particular, we compete with Emerson Power Transmission Manufacturing, L.P., Regal Beloit Corporation and Baldor Electric Company. In addition, with respect to certain of our products, we compete with divisions of our OEM customers. Competition in our business lines is based on a number of considerations including quality, reliability, pricing, availability and design and application engineering support. 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 regularly in manufacturing, customer service and support, marketing, sales, research and development and intellectual property protection. We may have to adjust the prices of some of our products to stay competitive. In addition, 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. There is substantial and continuing pressure on major OEMs and larger distributors to reduce costs, including the cost of products purchased from outside suppliers such as us. As a result of cost pressures from our customers, our ability to


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compete depends in part on our ability to generate production cost savings and, in turn, find reliable, cost-effective outside component suppliers or manufacture our products.
 
Seasonality
 
We experience seasonality in our turf and garden business, which in recent years has represented approximately 10% of our net sales. As our large OEM customers prepare for the spring season, our shipments generally start increasing in December, peak in February and March, and begin to decline in April and May. This allows our customers to have inventory in place for the peak consumer purchasing periods for turf and garden products. The June-through-November period is typically the low season for us and our customers in the turf and garden market. Seasonality is also affected by weather and the level of housing starts.
 
Intellectual Property
 
We rely on a combination of patents, trademarks, copyright and trade secret laws in the United States and other jurisdictions, as well as employee and third-party non-disclosure agreements, license arrangements and domain name registrations to protect our intellectual property. We sell our products under a number of registered and unregistered trademarks, which we believe are widely recognized in the MPT industry. With the exception of Boston Gear and Warner Electric, we do not believe any single patent, trademark or trade name is material to our business as a whole. Any issued patents that cover our proprietary technology and any of our other intellectual property rights may not provide us with adequate protection or be commercially beneficial to us and, if applied for, may not be issued. The issuance of a patent is not conclusive as to its validity or its enforceability. Competitors may also be able to design around our patents. If we are unable to protect our patented technologies, our competitors could commercialize technologies or products which are substantially similar to ours.
 
With respect to proprietary know-how, we rely on trade secret laws in the United States and other jurisdictions and on confidentiality agreements. Monitoring the unauthorized use of our technology is difficult and the steps we have taken may not prevent unauthorized use of our technology. The disclosure or misappropriation of our intellectual property could harm our ability to protect our rights and our competitive position.
 
Some of our registered and unregistered trademarks include: Warner Electric, Boston Gear, Kilian Manufacturing, Nuttall Gear, Ameridrives, Wichita Clutch, Formsprag Clutch, Bibby Transmissions, Stieber, Matrix International, Inertia Dynamics, Twiflex Limited, Industrial Clutch, Huco Dynatork, Marland Clutch, Delroyd Worm Gear, Warner Linear and Saftek.
 
Backlog
 
Our backlog of unshipped orders was $128.2 million at December 31, 2006 and $102.0 million at December 31, 2005, an increase of $26.2 million. The increase in backlog was primarily due to the acquisition of Hay Hall, which accounted for approximately $16.7 million of the increase.
 
Employees
 
As of December 31, 2006, we had approximately 2,500 full-time employees, of whom approximately 57% were located in North America, 28% in Europe, and 14% in Asia. Approximately 21% of our full-time factory North American employees are represented by labor unions. In addition, approximately 60% of our employees in our facility in Scotland are represented by a labor union. The four U.S. collective bargaining agreements to which we are a party will expire on August 10, 2007, September 19, 2007, June 2, 2008 and February 1, 2009, while our agreement in Scotland expires on March 31, 2007. We are currently in negotiations with the union in Scotland. We do not expect the negotiations to have a material adverse effect on operations. Two of the four U.S. collective bargaining agreements contain provisions for additional, potentially significant lump-sum severance payments to all employees covered by the agreements who are terminated as the result of a plant closing. See Risk Factors — we may be subjected to work stoppages at our facilities or


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our customers may be subjected to work stoppages, which could seriously impact the profitability of our business.”
 
The remainder of our European facilities have employees who are generally represented by local and national social works councils which are common in Europe. Social works councils meet with employer industry associations every two to three years to discuss employee wages and working conditions. Our facilities in France and Germany often participate in such discussions and adhere to any agreements reached.
 
Suppliers and Raw Materials
 
We obtain raw materials, component parts and supplies from a variety of sources, generally from more than one supplier. Our suppliers and sources of raw materials are based in both the United States and other countries and we believe that our sources of raw materials are adequate for our needs for the foreseeable future. We do not believe the loss of any one supplier would have a material adverse effect on our business or result of operations. Our principal raw materials are steel, castings and copper. We generally purchase our materials on the open market, where certain commodities such as steel and copper have increased in price significantly in recent years. We have not experienced any significant shortage of our key materials and have not historically engaged in hedging transactions for commodity suppliers.
 
Regulation
 
We are subject to a variety of government laws and regulations that apply to companies engaged in international operations. These include compliance with the Foreign Corrupt Practices Act, U.S. Department of Commerce export controls, local government regulations and procurement policies and practices (including regulations relating to import-export control, investments, exchange controls and repatriation of earnings). We maintain controls and procedures to comply with laws and regulations associated with our international operations. In the event we are unable to remain compliant with such laws and regulations, our business may be adversely affected.
 
Environmental and Health and Safety Matters
 
We are subject to a variety of federal, state, local, foreign and provincial environmental laws and regulations, including those governing health and safety requirements, the discharge of pollutants into the air or water, the management and disposal of hazardous substances and wastes and the responsibility to investigate and cleanup contaminated sites that are or were owned, leased, operated or used by us or our predecessors. Some of these laws and regulations require us to obtain permits, which contain terms and conditions that impose limitations on our ability to emit and discharge hazardous materials into the environment and periodically may be subject to modification, renewal and revocation by issuing authorities. Fines and penalties may be imposed for non-compliance with applicable environmental laws and regulations and the failure to have or to comply with the terms and conditions of required permits. From time to time our operations may not be in full compliance with the terms and conditions of our permits. We periodically review our procedures and policies for compliance with environmental laws and requirements. We believe that our operations generally are in material compliance with applicable environmental laws and requirements and that any non-compliance would not be expected to result in us incurring material liability or cost to achieve compliance. Historically, the costs of achieving and maintaining compliance with environmental laws and requirements have not been material.
 
Certain environmental laws in the United States, such as the federal Superfund law and similar state laws, impose liability for the cost of investigation or remediation of contaminated sites upon the current or, in some cases, the former site owners or operators and upon parties who arranged for the disposal of wastes or transported or sent those wastes to an off-site facility for treatment or disposal, regardless of when the release of hazardous substances occurred or the lawfulness of the activities giving rise to the release. Such liability can be imposed without regard to fault and, under certain circumstances, can be joint and several, resulting in one party being held responsible for the entire obligation. As a practical matter, however, the costs of investigation and remediation generally are allocated among the viable responsible parties on some form of


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equitable basis. Liability also may include damages to natural resources. We have not been notified that we are potentially responsible party in connection with any sites we currently or formerly owned or operated or for liability at any off-site waste disposal facility.
 
However, there is contamination at some of our current facilities, primarily related to historical operations at those sites, for which we could be liable for the investigation and remediation under certain environmental laws. The potential for contamination also exists at other of our current or former sites, based on historical uses of those sites. We currently are not undertaking any remediation or investigations and our costs or liability in connection with potential contamination conditions at our facilities cannot be predicted at this time because the potential existence of contamination has not been investigated or not enough is known about the environmental conditions or likely remedial requirements. Currently, other parties with contractual liability are addressing or have plans or obligations to address those contamination conditions that may pose a material risk to human health, safety or the environment. In addition, while we attempt to evaluate the risk of liability at the time we acquire them, there may be environmental conditions currently unknown to us relating to our prior, existing or future sites or operations or those of predecessor companies whose liabilities we may have assumed or acquired which could have a material adverse effect on our business.
 
We are being indemnified, or expect to be indemnified by third parties subject to certain caps or limitations on the indemnification, for certain environmental costs and liabilities. Accordingly, based on the indemnification and the experience with similar sites of the environmental consultants who we have hired, we do not expect such costs and liabilities to have a material adverse effect on our business, operations or earnings. We cannot assure you, however, that these third parties will in fact satisfy their indemnification obligations. If third parties become unable to, or otherwise do not, comply with their respective indemnity obligations, or if certain contamination or other liability for which we are obligated is not subject to these indemnities, we could become subject to significant liabilities.
 
Executive Officers of Registrant
 
The following sets forth certain information with regard to our executive officers as of March 15, 2007 (ages are as of December 31, 2006):
 
Michael L. Hurt, P.E.(age 61 ) has been our Chief Executive Officer and a director since our formation in 2004. In November 2006, Mr. Hurt was elected as chairman of our board. During 2004, prior to our formation, Mr. Hurt provided consulting services to Genstar Capital, L.P. and was appointed Chairman and Chief Executive Officer of Kilian in October 2004. From January 1991 to November 2003, Mr. Hurt was the President and Chief Executive Officer of TB Wood’s Incorporated, a manufacturer of industrial power transmission products. Prior to TB Wood’s, Mr. Hurt spent 23 years in a variety of management positions at the Torrington Company, a major manufacturer of bearings and a subsidiary of Ingersoll Rand. Mr. Hurt holds a B.S. degree in Mechanical Engineering from Clemson University and an M.B.A. from Clemson-Furman University.
 
Carl R. Christenson (age 47) has been our President and Chief Operating Officer since January 2005. From 2001 to 2005, Mr. Christenson was the President of Kaydon Bearings, a manufacturer of custom-engineered bearings and a division of Kaydon Corporation. Prior to joining Kaydon, Mr. Christenson held a number of management positions at TB Wood’s Incorporated and several positions at the Torrington Company. Mr. Christenson holds a M.S. and B.S. degree in Mechanical Engineering from the University of Massachusetts and a M.B.A. from Rensselaer Polytechnic.
 
David A. Wall (age 48) has been our Chief Financial Officer since January 2005. From 2000 to 2004, Mr. Wall was the Chief Financial Officer of Berman Industries, a manufacturer and distributor of portable lighting products. From 1994 to 2000, Mr. Wall was the Chief Financial Officer of DoALL Company, a manufacturer and distributor of machine tools and industrial supplies. Mr. Wall is a Certified Public Accountant and holds a B.S. degree in Accounting from the University of Illinois and a M.B.A. in Finance from the University of Chicago.


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Gerald Ferris (age 57) has been Altra Industrial’s Vice President of Global Sales since November 2004 and held the same position with Power Transmission Holdings, LLC, our Predecessor, since March 2002. He is responsible for the worldwide sales of our broad product platform. Mr. Ferris joined our Predecessor in 1978 and since joining has held various positions. He became the Vice President of Sales for Boston Gear in 1991. Mr. Ferris holds a B.A. degree in Political Science from Stonehill College.
 
Timothy McGowan (age 50) has been Altra Industrial’s Vice President of Human Resources since November 2004 and held the same position with our Predecessor since June 2003. Prior to joining us, from 1994 to 1998 and again from 1999 to 2003 Mr. McGowan was Vice President, Human Resources for Bird Machine, part of Baker Hughes, Inc., an oil equipment manufacturing company. Before his tenure with Bird Machine, Mr. McGowan spent many years with Raytheon in various Human Resources positions. Mr. McGowan holds a B.A. degree in English from St. Francis College in Maine.
 
Edward L. Novotny (age 54) has been Altra Industrial’sVice President and General Manager of Boston Gear, Overrunning Clutch, Huco since November 2004 and held the same position with our Predecessor since May 2001. Prior to joining our Predecessor in 1999, Mr. Novotny served in a plant management role and then as the Director of Manufacturing for Stabilus Corporation, an automotive supplier, since October 1990. Prior to Stabilus, Mr. Novotny held various plant management and production control positions with Masco Industries and Rockwell International. Mr. Novotny holds a B.S. degree in Business Administration from Youngstown State University.
 
Craig Schuele (age 43) has been Altra Industrial’s Vice President of Marketing and Business Development since November 2004 and held the same position with our Predecessor since July 2004. Prior to his current position, Mr. Schuele has been Vice President of Marketing since March 2002, and previous to that he was a Director of Marketing. Mr. Schuele joined our Predecessor in 1986 and holds a B.S. degree in Management from Rhode Island College.
 
Item 1A.   Risk Factors
 
We operate in the highly competitive mechanical power transmission industry and if we are not able to compete successfully our business may be significantly harmed.
 
We operate in highly fragmented and very competitive markets in the MPT industry. Some of our competitors have achieved substantially more market penetration in certain of the markets in which we operate, such as helical gear drives and couplings, and some of our competitors are larger than us and have greater financial and other resources. With respect to certain of our products, we compete with divisions of our OEM customers. Competition in our business lines is based on a number of considerations, including quality, reliability, pricing, availability and design and application engineering support. 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 regularly in manufacturing, customer service and support, marketing, sales, research and development and intellectual property protection. In the future we may not have sufficient resources to continue to make such investments and may not be able to maintain our competitive position within each of the markets we serve. We may have to adjust the prices of some of our products to stay competitive.
 
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 market share in some of the markets in which we compete.
 
There is substantial and continuing pressure on major OEMs and larger distributors to reduce costs, including the cost of products purchased from outside suppliers such as us. As a result of cost pressures from our customers, our ability to compete depends in part on our ability to generate production cost savings and, in turn, find reliable, cost effective outside suppliers to source components or manufacture our products. If we are unable to generate sufficient cost savings in the future to offset price reductions, then our gross margin could be materially adversely affected.


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Changes in general economic conditions or the cyclical nature of our markets could harm our operations and financial performance.
 
Our financial performance depends, in large part, on conditions in the markets that we serve and on the U.S. and global economies in general. Some of the markets we serve are highly cyclical, such as the metals, mining, industrial equipment and energy markets. In addition, these markets may experience cyclical downturns. The present uncertain economic environment may result in significant quarter-to-quarter variability in our performance. Any sustained weakness in demand or continued downturn or uncertainty in the economy generally would further reduce our sales and profitability.
 
We rely on independent distributors and the loss of these distributors could adversely affect our business.
 
In addition to our direct sales force and manufacturer sales representatives, we depend on the services of independent distributors to sell our products and provide service and aftermarket support to our customers. We support an extensive distribution network, with over 3,000 distributor locations worldwide. Rather than serving as passive conduits for delivery of product, our independent distributors are active participants in the overall competitive dynamics in the MPT industry. During the year ended December 31, 2006, approximately 36% of our net sales were generated through independent distributors. In particular, sales through our largest distributor accounted for approximately 8% of our net sales for the year ended December 31, 2006. Almost all of the distributors with whom we transact business offer competitive products and services to our customers. In addition, the distribution agreements we have are typically non-exclusive and cancelable by the distributor after a short notice period. The loss of any major distributor or a substantial number of smaller distributors or an increase in the distributors’ sales of our competitors’ products to our customers could materially reduce our sales and profits.
 
We must continue to invest in new technologies and manufacturing techniques; however, our ability to develop or adapt to changing technology and manufacturing techniques is uncertain and our failure to do so could place us at a competitive disadvantage.
 
The successful implementation of our business strategy requires us to continuously invest in new technologies and manufacturing techniques to evolve our existing products and introduce new products to meet our customers’ needs in the industries we serve and want to serve. For example, motion control products offer more precise positioning and control compared to industrial clutches and brakes. If manufacturing processes are developed to make motion control products more price competitive and less complicated to operate, our customers may decrease their purchases of MPT products.
 
Our products are characterized by performance and specification requirements that mandate a high degree of manufacturing and engineering expertise. If we fail to invest in improvements to our technology and manufacturing techniques 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 and availability;
 
  •  price competitiveness;
 
  •  technical expertise and development capability;
 
  •  reliability and timeliness of delivery;
 
  •  product design capability;
 
  •  manufacturing expertise; and
 
  •  sales support and customer service.
 
Our success depends on our ability to invest in new technologies and manufacturing techniques to continue to meet our customers’ changing demands with respect to the above factors. We may not be able to make required capital expenditures and, even if we do so, we may be unsuccessful in addressing technological


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advances or introducing new products necessary to remain competitive within our markets. Furthermore, our own technological developments may not be able to produce a sustainable competitive advantage.
 
Our operations are subject to international risks that could affect our operating results.
 
Our net sales outside North America represented approximately 30% of our total net sales for the year ended December 31, 2006. In addition, we sell products to domestic customers for use in their products sold overseas. Our business is subject to risks associated with doing business internationally, and our future results could be materially adversely affected by a variety of factors, including:
 
  •  fluctuations in currency exchange rates;
 
  •  exchange rate controls;
 
  •  tariffs or other trade protection measures and import or export licensing requirements;
 
  •  potentially negative consequences from changes in tax laws;
 
  •  interest rates;
 
  •  unexpected changes in regulatory requirements;
 
  •  changes in foreign intellectual property law;
 
  •  differing labor regulations;
 
  •  requirements relating to withholding taxes on remittances and other payments by subsidiaries;
 
  •  restrictions on our ability to own or operate subsidiaries, make investments or acquire new businesses in various jurisdictions;
 
  •  potential political instability and the actions of foreign governments; and
 
  •  restrictions on our ability to repatriate dividends from our subsidiaries.
 
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 adversely affect our international operations and, consequently, our operating results.
 
Our operations depend on production facilities throughout the world, many of which are located outside the United States and are subject to increased risks of disrupted production causing delays in shipments and loss of customers and revenue.
 
We operate businesses with manufacturing facilities worldwide, many of which are located outside the United States including in Canada, China, France, Germany, and the United Kingdom. Serving a global customer base requires that we place more production in emerging markets to capitalize on market opportunities and cost efficiencies. Our international production facilities and operations could be disrupted by a natural disaster, labor strike, war, political unrest, terrorist activity or public health concerns, particularly in emerging countries that are not well-equipped to handle such occurrences.
 
Material weaknesses in our internal controls over financial reporting have been identified which could result in a decrease in the value of your investment.
 
In connection with their audit of our 2006 consolidated financial statements, our independent auditors expressed concerns that as of the date of their opinion, certain plant locations had encountered difficulty closing their books in a timely and accurate manner. The outside auditors informed senior management and the Audit Committee of the Board of Directors that they believe this is a material weakness in internal controls. We have actively taken steps to address this material weakness. These steps include standardizing the financial close process, providing greater corporate oversight and review as well as implementing other


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internal control procedures as part of our on-going Sarbanes-Oxley compliance program. We believe that with the addition of these steps we should be able to deliver financial information in a timely and accurate manner.
 
However, we cannot assure you that our efforts to correct this identified material weakness will be successful or that we will not have other weaknesses in the future. If we fail to correct the existing material weaknesses or have material weaknesses in the future, it could affect the financial results that we report or create a perception that those financial results do not accurately state our financial condition or results of operations. Either of those events could have an adverse effect on your investment.
 
If we are unable to complete our assessment as to the adequacy of our internal controls over financial reporting as of December 31, 2007 as required by Section 404 of the Sarbanes-Oxley Act of 2002, or if material weaknesses are identified and reported, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of your investment and make it more difficult for us to raise capital in the future.
 
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission, or SEC, adopted rules requiring public companies to include in their annual reports on Form 10-K a report of management on the company’s internal controls over financial reporting, including management’s assessment of the effectiveness of the company’s internal controls over financial reporting as of the company’s fiscal year end. In addition, the accounting firm auditing a public company’s financial statements must also attest to, and report on, management’s assessment of the effectiveness of the company’s internal controls over financial reporting as well as the operating effectiveness of the company’s internal controls. While we will expend significant resources in developing the necessary documentation and testing procedures, fiscal 2007 will be the first year for which we must complete the assessment and undergo the attestation process required by Section 404 and there is a risk that we may not comply with all of its requirements. If we do not timely complete our assessment or if our internal controls are not designed or operating effectively as required by Section 404, our independent auditors may either disclaim an opinion as it relates to management’s assessment of the effectiveness of its internal controls or may issue a qualified opinion on the effectiveness of our internal controls. It is possible that material weaknesses in our internal controls could be found. If we are unable to remediate any material weaknesses by December 31, 2007, our independent auditors would be required to issue an adverse opinion on our internal controls. If our independent auditors disclaim an opinion as to the effectiveness of our internal controls or if they render an adverse opinion due to material weaknesses in our internal controls, then investors may lose confidence in the reliability of our financial statements, which could cause the market price of our senior secured and senior notes to decline and make it more difficult for us to raise capital in the future.
 
We rely on estimated forecasts of our OEM customers’ needs, and inaccuracies in such forecasts could materially adversely affect our business.
 
We generally sell our products pursuant to individual purchase orders instead of under long-term purchase commitments. Therefore, we rely on estimated demand forecasts, based upon input from our customers, to determine how much material to purchase and product to manufacture. Because our sales are based on purchase orders, our customers may cancel, delay or otherwise modify their purchase commitments with little or no consequence to them and with little or no notice to us. For these reasons, we generally have limited visibility regarding our customers’ actual product needs. The quantities or timing required by our customers for our products could vary significantly. Whether in response to changes affecting the industry or a customer’s specific business pressures, any cancellation, delay or other modification in our customers’ orders could significantly reduce our revenue, impact our working capital, cause our operating results to fluctuate from period to period and make it more difficult for us to predict our revenue. In the event of a cancellation or reduction of an order, we may not have enough time to reduce operating expenses to minimize the effect of the lost revenue on our business and we may purchase too much inventory and spend more capital than expected.


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The materials used to produce our products are subject to price fluctuations that could increase costs of production and adversely affect our profitability.
 
The materials used to produce our products, especially copper and steel, are sourced on a global or regional basis and the prices of those materials are susceptible to price fluctuations due to supply and demand trends, transportation costs, government regulations and tariffs, changes in currency exchange rates, price controls, the economic climate and other unforeseen circumstances. As of the year ended December 31, 2006, approximately 57% of our cost of goods sold consisted of the purchase of raw materials required for our manufacturing processes. From the first quarter of 2004 to the end of 2006, the average price of copper and steel has increased approximately 173% and 42%, respectively. If we are unable to continue to pass a substantial portion of such price increases on to our customers on a timely basis, our future profitability may be materially and adversely affected. In addition, passing through these costs to our customers may also limit our ability to increase our prices in the future.
 
We face potential product liability claims relating to products we manufacture or distribute, which could result in our having to expend significant time and expense to defend these claims and to pay material claims or settlement amounts.
 
We face a business risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in injury or other adverse effects. We currently have several product liability claims against us with respect to our products. Although we currently maintain product liability insurance coverage, we may not be able to obtain such insurance on acceptable terms in the future, if at all, or obtain insurance that 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 adverse effect on our business, financial condition, results of operations or our ability to make payments under our debt obligations when due. In addition, we believe our business depends on the strong brand reputation we have developed. In the event that our reputation is damaged, we may face difficulty in maintaining our pricing positions with respect to some of our products, which would reduce our sales and profitability.
 
We may be subject to work stoppages at our facilities, or our customers may be subjected to work stoppages, which could seriously impact our operations and the profitability of our business.
 
As of December 31, 2006, we had approximately 2,500 full time employees, of whom approximately 47% were employed abroad. Approximately 300 of our North American employees and 45 of our employees in Scotland are represented by labor unions. In addition, our employees in Europe are generally represented by local and national social works councils that hold discussions with employer industry associations regarding wage and work issues every two to three years. Our European facilities, particularly those in France and Germany, may participate in such discussions and be subject to any agreements reached with employees.
 
Our four U.S. collective bargaining agreements will expire on August 10, 2007, September 19, 2007, June 2, 2008 and February 1, 2009. Our union agreement in Scotland expires on March 31, 2007. We are currently in negotiations with the union in Scotland. We do not expect the negotiations to have a material adverse effect on operations. We may be unable to renew these agreements on terms that are satisfactory to us, if at all. In addition, two of our four U.S. collective bargaining agreements contain provisions for additional, potentially significant, lump-sum severance payments to all employees covered by the agreements who are terminated as the result of a plant closing.
 
If our unionized workers or those represented by a works council were to engage in a strike, work stoppage or other slowdown in the future, we could experience a significant disruption of our operations. Such disruption could interfere with our ability to deliver products on a timely basis and could have other negative effects, including decreased productivity and increased labor costs. In addition, if a greater percentage of our work force becomes unionized, our business and financial results could be materially adversely affected. Many of our direct and indirect customers have unionized work forces. Strikes, work stoppages or slowdowns experienced by these customers or their suppliers could result in slowdowns or closures of assembly plants


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where our products are used and could cause cancellation of purchase orders with us or otherwise result in reduced revenues from these customers.
 
Changes in employment laws could increase our costs and may adversely affect our business.
 
Various federal, state and international labor laws govern our relationship with employees and affect operating costs. These laws include minimum wage requirements, overtime, unemployment tax rates, workers’ compensation rates paid, leaves of absence, mandated health and other benefits, and citizenship requirements. Significant additional government-imposed increases or new requirements in these areas could materially affect our business, financial condition, operating results or cash flow.
 
In the event our employee-related costs rise significantly, we may have to curtail the number of our employees or shut down certain manufacturing facilities. Any such actions would be not only costly but could also materially adversely affect our business.
 
We depend on the services of key executives, the loss of who could materially harm our business.
 
Our senior executives are important to our success because they are instrumental in setting our strategic direction, operating our business, maintaining and expanding relationships with distributors, identifying, recruiting and training key personnel, identifying expansion opportunities and arranging necessary financing. Losing the services of any of these individuals could adversely affect our business until a suitable replacement could be found. We believe that our senior executives could not easily be replaced with executives of equal experience and capabilities. Although we have entered into employment agreements with certain of our key domestic executives, we cannot prevent our key executives from terminating their employment with us. We do not maintain key person life insurance policies on any of our executives.
 
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. If certain of these key personnel were to terminate their employment with us, we may experience difficulty replacing them, and our business could be harmed.
 
We are subject to environmental laws that could impose significant costs on us and the failure to comply with such laws could subject us to sanctions and material fines and expenses.
 
We are subject to a variety of federal, state, local, foreign and provincial environmental laws and regulations, including those governing the discharge of pollutants into the air or water, the management and disposal of hazardous substances and wastes and the responsibility to investigate and cleanup contaminated sites that are or were owned, leased, operated or used by us or our predecessors. Some of these laws and regulations require us to obtain permits, which contain terms and conditions that impose limitations on our ability to emit and discharge hazardous materials into the environment and periodically may be subject to modification, renewal and revocation by issuing authorities. Fines and penalties may be imposed for non-compliance with applicable environmental laws and regulations and the failure to have or to comply with the terms and conditions of required permits. From time to time our operations may not be in full compliance with the terms and conditions of our permits. We periodically review our procedures and policies for compliance with environmental laws and requirements. We believe that our operations generally are in material compliance with applicable environmental laws, requirements and permits and that any lapses in compliance would not be expected to result in us incurring material liability or cost to achieve compliance. Historically, the costs of achieving and maintaining compliance with environmental laws, and requirements and permits have not been material; however, the operation of manufacturing plants entails risks in these areas, and a failure by us to comply with applicable environmental laws, regulations, or permits could result in civil or


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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 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.
 
Certain environmental laws in the United States, such as the federal Superfund law and similar state laws, impose liability for the cost of investigation or remediation of contaminated sites upon the current or, in some cases, the former site owners or operators and upon parties who arranged for the disposal of wastes or transported or sent those wastes to an off-site facility for treatment or disposal, regardless of when the release of hazardous substances occurred or the lawfulness of the activities giving rise to the release. Such liability can be imposed without regard to fault and, under certain circumstances, can be joint and several, resulting in one party being held responsible for the entire obligation. As a practical matter, however, the costs of investigation and remediation generally are allocated among the viable responsible parties on some form of equitable basis. Liability also may include damages to natural resources. We have not been notified that we are potentially responsible party in connection with any sites we currently or formerly owned or operated or for liability at any off-site waste disposal facility.
 
However, there is contamination at some of our current facilities, primarily related to historical operations at those sites, for which we could be liable for the investigation and remediation under certain environmental laws. The potential for contamination also exists at other of our current or former sites, based on historical uses of those sites. We currently are not undertaking any remediation or investigations and our costs or liability in connection with potential contamination conditions at our facilities cannot be predicted at this time because the potential existence of contamination has not been investigated or not enough is known about the environmental conditions or likely remedial requirements. Currently, other parties with contractual liability are addressing or have plans or obligations to address those contamination conditions that may pose a material risk to human health, safety or the environment. In addition, while we attempt to evaluate the risk of liability at the time we acquire them, there may be environmental conditions currently unknown to us relating to our prior, existing or future sites or operations or those of predecessor companies whose liabilities we may have assumed or acquired which could have a material adverse effect on our business.
 
We are being indemnified, or expect to be indemnified by third parties subject to certain caps or limitations on the indemnification, for certain environmental costs and liabilities. Accordingly, based on the indemnification and the experience with similar sites of the environmental consultants who we have hired, we do not expect such costs and liabilities to have a material adverse effect on our business, operations or earnings. We cannot assure you, however, that these third parties will in fact satisfy their indemnification obligations. If third parties become unable to, or otherwise do not, comply with their respective indemnity obligations, or if certain contamination or other liability for which we are obligated is not subject to these indemnities, we could become subject to significant liabilities.
 
We face additional costs associated with our post-retirement and post-employment obligations to employees which could have an adverse effect on our financial condition.
 
As part of the acquisition of Power Transimission Holding LLC, which we refer to as the PTH Acquisition, we agreed to assume pension plan liabilities for active U.S. employees under the Retirement Plan for Power Transmission Employees of Colfax, the Ameridrives International Pension Fund for Hourly Employees Represented by United Steelworkers of America, Local 3199-10, and the Colfax PT Pension Plan, collectively referred to as the Prior Plans. We have established a defined benefit plan, or New Plan, mirroring the benefits provided under the Prior Plans. The New Plan accepted a spinoff of assets and liabilities from the Prior Plans, in accordance with Section 414(l) of the Internal Revenue Code, or the Code, with such assets and liabilities relating to active U.S. employees as of the closing of the PTH Acquisition. Given the funded status of the Prior Plans and the asset allocation requirements of Code Section 414(l), liabilities under the New Plan greatly exceed the assets that were transferred from the Prior Plans. The accumulated benefit obligation (not including accumulated benefit obligations of non-U.S. pension plans in the amount of $3.4 million) was


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approximately $22.7 million as of December 31, 2006 while the fair value of plan assets was approximately $11.0 million as of December 31, 2006. As the New Plan has a considerable funding deficit, the cash funding requirements are expected to be substantial over the next several years, and could have a material adverse effect on our financial condition. As of December 31, 2006, funding requirements were estimated to be $3.6 million in 2007, $2.5 million in 2008 and $1.9 million annually thereafter until 2011. These amounts are based on actuarial assumptions and actual amounts could be materially different.
 
Additionally, as part of the PTH Acquisition, we agreed to assume all pension plan liabilities related to non-U.S. employees. The accumulated benefit obligations of non-U.S. pension plans were approximately $3.4 million as of December 31, 2006. There are no assets associated with these plans.
 
Finally, as part of the PTH Acquisition, we also agreed to assume all post-employment and post-retirement welfare benefit obligations with respect to active U.S. employees. The benefit obligation for post-retirement benefits, which are not funded, was approximately $3.5 million as of December 31, 2006.
 
For a description of the post-retirement and post-employment costs, see Note 9 to the audited financial statements included elsewhere in this Form 10-K.
 
Our future success depends on our ability to integrate acquired companies and manage our growth effectively.
 
Our growth through acquisitions has placed, and will continue to place, significant demands on our management, operational and financial resources. Realization of the benefits of acquisitions often requires integration of some or all of the acquired companies’ sales and marketing, distribution, manufacturing, engineering, finance and administrative organizations. Integration of companies demands substantial attention from senior management and the management of the acquired companies. In addition, we will continue to pursue new acquisitions, some of which could be material to our business if completed. We may not be able to integrate successfully our recent acquisitions or any future acquisitions, operate these acquired companies profitably, or realize the potential benefits from these acquisitions.
 
We may not be able to protect our intellectual property rights, brands or technology effectively, which could allow competitors to duplicate or replicate our technology and could adversely affect our ability to compete.
 
We rely on a combination of patent, trademark, copyright and trade secret laws in the United States and other jurisdictions, as well as on license, non-disclosure, employee and consultant assignment and other agreements and domain names registrations in order to protect our proprietary technology and rights. Applications for protection of our intellectual property rights may not be allowed, and the rights, if granted, may not be maintained. In addition, third parties may infringe or challenge our intellectual property rights. In some cases, we 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. In addition, in the ordinary course of our operations, we pursue potential claims from time to time relating to the protection of certain products and intellectual property rights, including with respect to some of our more profitable products. Such claims could be time consuming, expensive and divert resources. If we are unable to maintain the proprietary nature of our technologies or proprietary protection of our brands, our ability to market or be competitive with respect to some or all of our products may be affected, which could reduce our sales and profitability.
 
Goodwill comprises a significant portion of our total assets, and if we determine that goodwill has become impaired in the future, net income in such years may be materially and adversely affected.
 
Goodwill represents the excess of cost over the fair market value of net assets acquired in business combinations. We review goodwill and other intangibles annually for impairment and any excess in carrying value over the estimated fair value is charged to the results of operations. Reduction in net income resulting from the write down or impairment of goodwill would affect our financial results.


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Unplanned repairs or equipment outages could interrupt production and reduce income or cash flow.
 
Unplanned repairs or equipment outages, including those due to natural disasters, could result in the disruption of our manufacturing processes. Any interruption in our manufacturing processes would interrupt our production of products, reduce our income and cash flow and could result in a material adverse effect on our business and financial condition.
 
Our operations are highly dependent on information technology infrastructure and failures could significantly affect our business.
 
We depend heavily on our information technology, or IT, infrastructure in order to achieve our business objectives. If we experience a problem that impairs this infrastructure, such as a computer virus, a problem with the functioning of an important IT application, or an intentional disruption of our IT systems by a third party, the resulting disruptions could impede our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on our business in the ordinary course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to eliminate these problems and address related security concerns.
 
Our leverage could adversely affect our financial health and make us vulnerable to adverse economic and industry conditions.
 
We have incurred indebtedness that is substantial relative to our stockholders’ investment. As of December 31, 2006, we had approximately $233.7 million of indebtedness outstanding and $27.1 million available under lines of credit. We expect to incur additional indebtendness in connection with our acquisition of TB Wood’s. Our indebtedness has important consequences; for example, it could:
 
  •  make it more challenging for us to obtain additional financing to fund our business strategy and acquisitions, debt service requirements, capital expenditures and working capital;
 
  •  increase our vulnerability to interest rate changes and general adverse economic and industry conditions;
 
  •  require us to dedicate a substantial portion of our cash flow from operations to service our indebtedness, thereby reducing the availability of our cash flow to finance acquisitions and to fund working capital, capital expenditures, research and development efforts and other general corporate activities;
 
  •  make it difficult for us to fulfill our obligations under our credit and other debt agreements;
 
  •  limit our flexibility in planning for, or reacting to, changes in our business and our markets; and
 
  •  place us at a competitive disadvantage relative to our competitors that have less debt.
 
Substantially all of our assets have been pledged as collateral against any outstanding borrowings under the credit agreement governing Altra Industrial’s senior revolving credit facility, or the Credit Agreement, and the 9% senior secured notes. In addition, the Credit Agreement requires us to maintain specified financial ratios and satisfy certain financial condition tests, which may require that we take action to reduce our debt or to act in a manner contrary to our business objectives. If an event of default under the Credit Agreement occurs, then the lenders could declare all amounts outstanding under the Credit Agreement, together with accrued interest, to be immediately due and payable. In addition, the Credit Agreement and the indentures governing the 9% senior secured notes and Altra Industrial’s 111/4% senior notes due 2013, or the 111/4% senior notes, have cross-default provisions such that a default under any one would constitute an event of default in any of the others.


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We are subject to tax laws and regulations in many jurisdictions and the inability to successfully defend claims from taxing authorities related to our current or acquired businesses could adversely affect our operating results and financial position.
 
We conduct business in many countries, which requires us to interpret the income tax laws and rulings in each of those taxing jurisdictions. Due to the subjectivity of tax laws between those jurisdictions as well as the subjectivity of factual interpretations, our estimates of income tax liabilities may differ from actual payments or assessments. Claims from taxing authorities related to these differences could have an adverse impact on our operating results and financial position.
 
Genstar Capital Partners III, L.P. and Stargen III, L.P. (together, the Genstar Funds) have significant influence and may have conflicts of interest with our other stockholders in the future.
 
The Genstar Funds beneficially own 30.6% of our common stock. The Genstar Funds have significant influence over the election and removal of our directors and our corporate and management policies, including potential mergers or acquisitions, payment of dividends, asset sales and other significant corporate transactions. We cannot assure you that the interests of the Genstar Funds will coincide with your interests.
 
Item 1B.   Unresolved Staff Comments
 
None


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Item 2.   Properties
 
In addition to our leased headquarters in Quincy, Massachusetts, we maintain 23 production facilities, ten of which are located in the United States, two in Canada, ten in Europe and one in China. The following table lists all of our facilities, other than sales offices and distribution centers, as of December 31, 2006, indicating the location, principal use and whether the facilities are owned or leased.
 
                     
                    Lease
Location
 
Brand
 
Major Products
  Sq. Feet   Owned/Leased  
Expiration
 
United States
                   
South Beloit, Illinois
  Warner Electric   Electromagnetic Clutches & Brakes   104,228   Owned   N/A
Columbia City, Indiana
  Warner Electric   Electromagnetic Clutches & Brakes   76,200   Owned   N/A
Warren, Michigan
  Formsprag   Overrunning Clutches   79,000   Owned   N/A
Syracuse, New York
  Kilian Manufacturing   Engineered Bearing Assemblies   90,400   Owned   N/A
Erie, Pennsylvania
  Ameridrives   Couplings   76,200   Owned   N/A
Wichita Falls, Texas
  Wichita Clutch   Heavy Duty Clutches & Brakes   90,400   Owned   N/A
Quincy, Massachusetts(1)(2)
  Altra, Boston Gear       30,350   Leased   February 12, 2008
Niagara Falls, New York
  Nuttall Gear   Gearing   155,509   Leased   March 31, 2008
Torrington, Connecticut
  Inertia Dynamics   Electromagnetic Clutches & Brakes   32,000   Leased   May 31, 2007
Belvidere, Illinois
  Warner Electric   Linear Actuators   21,000   Leased   June 30, 2009
Charlotte, North Carolina
  Boston Gear   Gearing & Power Transmission Components   35,000   Owned   N/A
International
                   
Toronto, Canada
  Kilian Manufacturing   Engineered Bearing Assemblies   29,000   Owned   N/A
Bedford, England
  Wichita Clutch   Heavy Duty Clutches & Brakes   49,000   Owned   N/A
Allones, France
  Warner Electric   Electromagnetic Clutches & Brakes   38,751   Owned   N/A
Saint Barthelemy, France
  Warner Electric   Electromagnetic Clutches & Brakes   57,609   Owned   N/A
Toronto, Canada
  Kilian Manufacturing   Engineered Bearing Assemblies   30,120   Leased   (3)
Shenzhen, China
  Warner Electric   Electromagnetic Clutches & Precision Components   26,100   Owned   N/A
Garching, Germany
  Stieber   Overrunning Clutches   32,292   Leased   (4)
Heidelberg, Germany
  Stieber   Overrunning Clutches   57,609   Owned   N/A
Dewsbury, England
  Bibby Transmissions   Couplings   26,100   Owned   N/A
Brechin, Scotland
  Matrix International   Clutch Brakes, Couplings   52,500   Leased   February 28, 2011
Twickenham, England
  Twiflex   Heavy Duty Clutches & Brakes   27,500   Leased   September 30, 2009
Hertford, England
  Huco Dynatork   Couplings, Power Transmission Components   13,565   Leased   July 31, 2007
Telford, England
  Saftek   Friction Material   4,400   Leased   August 31, 2008
 
 
(1) Certain employees at these locations provide general and administrative services for our other locations.
 
(2) Corporate Headquarters and selective Boston Gear functions.


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(3) Month to month lease.
 
(4) Must give the lessor twelve month notice for termination.
 
Item 3.   Legal Proceedings
 
We are, from time to time, party to various legal proceedings arising out of our business. These proceedings primarily involve commercial claims, product liability claims, intellectual property claims, environmental claims, personal injury claims and workers’ compensation claims. We cannot predict the outcome of these lawsuits, legal proceedings and claims with certainty. Nevertheless, we believe that the outcome of any currently existing proceedings, even if determined adversely, would not have a material adverse effect on our business, financial condition and results of operations.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
During the fourth quarter of fiscal year 2006, there were no matters submitted to a vote of security holders.


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PART II
 
Item 5.   Market for the Registrant’s Common Equity and Related Stockholder Matters
 
Market Information
 
Our common stock trades on the NASDAQ Global Market under the symbol “AIMC”. As of March 15, 2007, the number of holders of record of our common stock was approximately 24.
 
The following table sets forth, for the periods indicated, the high and low sales price for our common stock as reported on The NASDAQ Global Market. Our common stock commenced trading on the NASDAQ Global Market on December 15, 2006.
 
                 
    High     Low  
 
Fiscal 2006:
               
Quarter Ended December 31, 2006
  $ 14.55     $ 13.75  
 
Dividends
 
We have never declared or paid any cash dividends on our common stock. We currently intend to retain any earnings for use in the operation and expansion of our business and, therefore do not anticipate paying any cash dividends in the foreseeable future. In addition, the Credit Agreement governing the senior revolving credit facility and the indentures governing the 9% senior secured notes and 111/4% senior notes limit our ability to pay dividends or other distributions on our common stock.
 
Recent Sales of Unregistered Securities
 
The Company’s Board of Directors established the 2004 Equity Incentive Plan, or the Plan, that provides for various forms of stock based compensation to independent directors, officers and senior-level employees of the Company. In connection with the establishment of this plan, the Board of Directors authorized and issued 1.7 million shares of restricted common stock to certain independent directors and employees of the Company. The restricted shares issued pursuant to the Plan are generally service time vested ratably over each of the five years from the date of grant, provided, that the vesting of the restricted shares may accelerate upon the occurrence of certain liquidity events, if approved by the Board of Directors in connection with the transactions. Common stock awarded under the 2004 Equity Incentive Plan is generally subject to restrictions on transfer, and certain other limitations. The restrictions and vesting schedule for restricted stock granted under the Plan are determined by the Compensation Committee of the Board of Directors.
 
In January 2006, we issued an aggregate of 39,000 shares of our restricted common stock to members of our management pursuant to our 2004 Equity Incentive Plan. In addition, in August 2006 we issued 203,899 shares of our restricted common stock to our Chief Executive Officer and 103,857 shares of our restricted common stock to our President and COO, in each case, pursuant to our 2004 Equity Incentive Plan.
 
The issuances of the securities described above were exempt from registration under the Securities Act in reliance on Section 4(2) of such Securities Act as transactions by an issuer not involving any public offering, or under Rule 701 under the Securities Act. The recipients of securities in each such transaction represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates issued in such transactions.
 
Use of Proceeds of Registered Securities
 
On December 15, 2007 we completed the initial public offering of 10,000,000 shares of our common stock, par value, at an offer price of $13.50 per share. Certain of our stockholders sold an aggregate of 6,666,666 shares of our common stock in connection with the offering. The aggregate net proceeds from the sale of common stock by the selling stockholders were approximately $83.7 million after deducting underwriting discounts.


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The aggregate net proceeds from the sale by us of 3,333,334 shares of our common stock, $0.001 par value, in our initial public offering were approximately $36.4 million, after deducting underwriting discounts, commissions and other expenses of $8.6 million payable by us. We did not receive any of the proceeds from the sale of shares by the selling stockholders. The managing underwriter in the offering was Merrill Lynch, Pierce, Fenner and Smith Incorporated, and the Company share of the aggregate underwriting discount was $3,150,001.
 
All of the shares of common stock sold in the offering were registered under the 1933 Act on a Registration Statement on Form S-1 (Reg. No. 333-137660), effective December 14, 2007. To date we have applied the proceeds received by us as follows. On February 27, 2007, we redeemed £11.6 million ($22.7 million, using an exchange rate of 1.963 as of February 27, 2007) aggregate principal amount of the outstanding Senior Notes, at a redemption price of 111.25% of the principal amount of the Notes, plus accrued and unpaid interest. We invested the remaining proceeds as cash and cash equivalents with Wells Fargo Bank. None of our net proceeds were paid directly or indirectly to directors, officers, persons owning ten percent or more of our equity securities, or our affiliates, except for the $3.0 million termination fee paid to Genstar.
 
Issuer Purchases of Equity Securities
 
Except as set forth above, during the quarter ended December 31, 2006, there were no repurchases made by us or on our behalf, or by any “affiliated purchasers”, of shares of our common stock.


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Performance Graph
 
The following graph compares the cumulative total stockholder return on our Common Stock since the time of our initial public offering, December 15, 2006 through December 31, 2006, with the cumulative total return on shares of companies comprising the S&P Small Cap 600 index and a special Peer Group index, in each case assuming an initial investment of $100.
 
(PERFORMANCE GRAPH)
 
                     
      December 15,
      December 31,
 
      2006       2006  
Altra Holdings, Inc. 
    $ 100       $ 104.07  
S&P Small Cap 600
    $ 100       $ 99.24  
Peer Group
    $ 100       $ 100.62  
                     
 
The Peer Group consists of the following publicly traded companies: Franklin Electric Co. Inc., RBC Bearings Inc., Regal Beloit Corp., Baldor Electric Co., and Kaydon Bearings Corp.


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Item 6.   Selected Financial Data
 
We were formed to facilitate the PTH Acquisition.  The following table contains selected historical financial data of the Company for the year ended December 31, 2006, December 31, 2005 and the period from inception (December 1, 2004) to December 31, 2004 and PTH(“the Predecessor”), for the period from January 1, 2004 through November 30, 2004 and for the years ended December 31, 2002 and 2003. Colfax Corporation did not maintain separate financial statements for PTH as a stand-alone business. At the time of the PTH Acquisition, Colfax Corporation produced historical financial statements for PTH for the fiscal years ended December 31, 2002 and 2003. The following should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes included elsewhere in this Form 10- K.
 
                                                   
                        Predecessor  
                (Period from
      (Period from
             
    Altra Year
    Altra Year
    December 1,
      January 1
             
    Ended
    Ended
    2004 Through
      Through
    Year Ended
       
    December 31,
    December 31,
    December 31,
      November 30,
    December 31,
       
    2006     2005     2004)       2004)     2003     2002  
    (Dollars in thousands)  
Income Statement Data:
                                                 
Net sales
  $ 462,285     $ 363,465     $ 28,625       $ 275,037     $ 266,863     $ 253,217  
Cost of sales
    336,836       271,952       23,847         209,253       207,941       190,465  
                                                   
Gross profit
    125,449       91,513       4,778         65,784       58,922       62,752  
Selling, general and administrative expenses
    83,276       61,579       8,973         45,321       49,513       48,303  
Research and development expenses
    4,938       4,683       378         3,947       3,455       3,103  
Restructuring charge, asset impairment and transition expenses
                        947       11,085       27,825  
Gain on curtailment of post-retirement benefit plan
    (3,838 )                                
(Gain) on sale of assets
          (99 )             (1,300 )            
                                                   
Income (loss) from operations
    41,073       25,350       (4,573 )       16,869       (5,131 )     (16,479 )
Interest expense, net
    25,479       19,514       1,612         4,294       5,368       5,489  
Other non-operating expense (income), net
    856       (17 )             148       465       (312 )
                                                   
Income (loss) before income taxes, discontinued operations and cumulative effect of change in accounting principles
    14,738       5,853       (6,185 )       12,427       (10,964 )     (21,656 )
Provision (benefit) for income taxes
    5,797       3,349       (292 )       5,532       (1,658 )     2,455  
Loss from disposal of discontinued operations, net of income taxes
                                    (700 )
                                                   
Income (loss) from operations and disposal of discontinued operations, net of income taxes
    8,941       2,504       (5,893 )       6,895       (9,306 )     (24,811 )
Cumulative effect of change in accounting principle — goodwill impairment
                                    (83,412 )
                                                   
Net income (loss)
  $ 8,941     $ 2,504     $ (5,893 )     $ 6,895     $ (9,306 )   $ (108,223 )
                                                   
Other Financial Data:
                                                 
Depreciation and amortization
  $ 14,611     $ 11,533     $ 919       $ 6,074     $ 8,653     $ 9,547  
Purchases of fixed assets
    9,408       6,199       289         3,489       5,294       5,911  
Cash flow provided by (used in):
                                                 
Operating activities
  $ 11,128       12,023       5,623         3,604       (14,289 )     21,934  
Investing activities
    (63,163 )     (5,197 )     (180,401 )       953       (1,573 )     (4,585 )
Financing activities
    83,837       (971 )     179,432         (6,696 )     12,746       (13,037 )
Weighted average shares of common stock outstanding:
                                                 
Basic
    1,183       9               n/a       n/a       n/a  
Diluted
    19,525       18,969               n/a       n/a       n/a  
Net income per share:
                                                 
Basic
  $ 7.56     $ 278.22     $         n/a       n/a       n/a  
Diluted
  $ 0.46     $ 0.13     $         n/a       n/a       n/a  
 


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    Altra
    Altra
    Altra
      Predecessor
 
    December 31,
    December 31,
    December 31,
      December 31,  
    2006     2005     2004       2003     2002  
Balance Sheet Data:
                                         
Cash and cash equivalents
  $ 42,527     $ 10,060     $ 4,729       $ 3,163     $ 5,214  
Total assets
    409,368       297,691       299,387         174,324       173,034  
Total debt
    229,128       173,760       173,851         1,888       65,035  
Convertible preferred stock and other long-term liabilities
    29,471       79,168       76,665         62,179       62,877  
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion of the financial condition and results of operations of Altra Holdings, Inc. and its Predecessor should be read together with the Selected Historical Financial Data, and the financial statements of Altra Holdings, Inc. and its Predecessor and related notes included elsewhere in this Form 10-K. The following discussion includes forward-looking statements. For a discussion of important factors that could cause actual results to differ materially from the results referred to in the forward-looking statements, see “Forward-Looking Statements” and “Risk Factors”.
 
General
 
We are a leading global designer, producer and marketer of a wide range of MPT and motion control products with a presence in over 70 countries. Our global sales and marketing network includes over 700 direct OEM customers and over 3,000 distributor outlets. Our product portfolio includes industrial clutches and brakes, enclosed gear drives, open gearing, couplings, engineered bearing assemblies, linear components and other related products. Our products serve a wide variety of end markets including energy, general industrial, material handling, mining, transportation and turf and garden. We primarily sell our products to a wide range of OEMs and through long-standing relationships with industrial distributors such as Motion Industries, Applied Industrial Technologies, Kaman Industrial Technologies and W.W. Grainger.
 
Our net sales have grown at a compound annual growth rate of approximately 20% over the last three fiscal years. We believe this growth has been a result of recent acquisitions, greater overall global demand for our products due to a strengthening economy, increased consumption in certain geographic markets such as China, expansion of our relationships with our customers and distributors and implementation of improved sales and marketing initiatives.
 
We improved our gross profit margin and operating profit margin every year from fiscal year 2002 through fiscal year 2006 by implementing strategic price increases, utilizing low-cost country sourcing of components, increasing our productivity and employing a more efficient sales and marketing strategy.
 
While the power transmission industry has undergone some consolidation, we estimate that in 2006 the top five broad-based MPT companies represented approximately 19% of the U.S. power transmission market. The remainder of the power transmission industry remains fragmented with many small and family-owned companies that cater to a specific market niche often due to their narrow product offerings. We believe that consolidation in our industry will continue because of the increasing demand for global distribution channels, broader product mixes and better brand recognition to compete in this industry.
 
Initial Public Offering
 
In December 2006, the Company completed an initial public offering. The Company offered 3,333,334 of their own shares. In addition selling stockholders offered 6,666,666 shares. Proceeds to the Company after the underwriting discount were $41.9 million. As of December 31, 2006, there are 50,000,000 shares of common stock authorized with a par value of $.001 and 21,467,500 outstanding.

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History and the Acquisitions
 
Our current business began with the acquisition by Colfax Corporation, or Colfax, of the MPT group of Zurn Technologies, Inc. in December 1996. Colfax subsequently acquired Industrial Clutch Corp. in May 1997, Nuttall Gear Corp. in July 1997 and the Boston Gear and Delroyd Worm Gear brands in August 1997 as part of Colfax’s acquisition of Imo Industries, Inc. In February 2000, Colfax acquired Warner Electric, Inc., which sold products under the Warner Electric, Formsprag Clutch, Stieber and Wichita Clutch brands. Colfax formed PTH in June 2004 to serve as a holding company for all of these power transmission businesses.
 
On November 30, 2004, we acquired our original core business through the acquisition of PTH from Colfax for $180.0 million in cash. We refer to this transaction as the PTH Acquisition.
 
On October 22, 2004, The Kilian Company, or Kilian, a company formed at the direction of Genstar Capital, the largest stockholder of Altra Holdings, acquired Kilian Manufacturing Corporation from Timken U.S. Corporation for $8.8 million in cash and the assumption of $12.2 million of debt. At the completion of the PTH Acquisition, (i) all of the outstanding shares of Kilian capital stock were exchanged for approximately $8.8 million of shares of our capital stock and Kilian and its subsidiaries were transferred to our wholly owned subsidiary, Altra Industrial and (ii) all outstanding debt of Kilian was retired with a portion of the proceeds of the sale of Altra Industrial’s 9% senior secured notes due 2011, or the 9% senior secured notes.
 
On February 10, 2006, we purchased all of the outstanding share capital of Hay Hall for $49.2 million. The purchase price is still subject to a change as a result of the finalization of a working capital adjustment in accordance with the terms of the purchase agreement. Included in the purchase price was $6.0 million paid in the form of deferred consideration. At the closing we deposited such deferred consideration into an escrow account for the benefit of the former Hay Hall shareholders. The deferred consideration is represented by a loan note. While the former Hay Hall shareholders will hold the note, their rights will be limited to receiving the amount of the deferred consideration placed in the escrow account. They will have no recourse against us unless we take action to prevent or interfere in the release of such funds from the escrow account. At closing, Hay Hall and its subsidiaries became our direct or indirect wholly owned subsidiaries. Hay Hall is a UK-based holding company established in 1996 that is focused primarily on the manufacture of couplings and clutch brakes. Hay Hall consists of five main businesses that are niche focused and have strong brand names and established reputations within their primary markets.
 
Through Hay Hall, we acquired 15 strong brands in complementary product lines, improved customer leverage and expanded geographic presence in over 11 countries. Hay Hall’s product offerings diversified our revenue base and strengthened our key product areas, such as electric clutches, brakes and couplings. Matrix International, Inertia Dynamics and Twiflex, three Hay Hall businesses, combined with Warner Electric, Wichita Clutch, Formsprag Clutch and Stieber, make the consolidated company one of the largest individual manufacturers of industrial clutches and brakes in the world.
 
On May 18, 2006, we acquired substantially all of the assets of Bear Linear for $5.0 million. Approximately $3.5 million was paid at closing and the remaining $1.5 million is payable over approximately the next two years. Bear Linear manufactures high value-added linear actuators which are electromechanical power transmission devices designed to move and position loads linearly for mobile off-highway and industrial applications. Bear Linear’s product design and engineering expertise, coupled with our sourcing alliance with a low cost country manufacturer, were critical components in our strategic expansion into the motion control market.
 
On February 17, 2007, we entered into a merger agreement to acquire all of the issued and outstanding capital stock of TB Wood’s. Pursuant to the merger agreement, Forest Acquisition Corporation, our wholly owned subsidiary, commenced a tender offer on March 5, 2007 to acquire all of the outstanding shares of common stock, par value $0.01 per share, of TB Woods at a price of $24.80 per share. If the tender offer is consummated, we are required, pursuant to the merger agreement and subject to the conditions set forth therein, to acquire, pursuant to a back-end merger, all remaining shares of TB Wood’s not tendered. We intend to cause TB Wood’s to become Altra Industrial’s wholly-owned subsidiary. We expect to finance the


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acquisition, in part, through the tack on offering of Altra Industrial’s 9% senior secured notes, borrowings under our senior revolving credit facility and cash on hand. The transaction is expected to close in April 2007.
 
Cost Savings and Productivity Enhancement Initiatives
 
Our Predecessor enacted significant cost savings programs prior to our acquisition of PTH and we subsequently enacted other cost savings programs to reduce overall cost structure and improve cash flows. Cost reduction programs included the consolidation of facilities, headcount reductions and reduction in overhead costs, which resulted in restructuring charges, asset impairment and transition expenses of $0.9 million in the eleven months ended November 30, 2004. Cash outflows related to the restructuring programs were $2.2 million in 2004. The financial effects of some of the specific cost reduction programs are listed below:
 
  •  In 2005, we re-negotiated two of our U.S. collective bargaining agreements which we estimate provide for savings of $0.8 million annually.
 
  •  In 2006, we re-negotiated one of our U.S. collective bargaining agreements which we estimate provides for savings of $2.2 million annually.
 
Critical Accounting Policies
 
The methods, estimates and judgments we use in applying our critical accounting policies have a significant impact on the results we report in our financial statements. We evaluate our estimates and judgments on an on-going basis. Our estimates are based upon historical experience and assumptions that we believe are 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 our management anticipates and different assumptions or estimates about the future could change our reported results.
 
We believe the following accounting policies are the most critical in that they are important to the financial statements and they require the most difficult, subjective or complex judgments in the preparation of the financial statements.
 
Revenue Recognition.  Product revenues are recognized, net of sales tax collected, at the time title and risk of loss pass to the customer, which generally occurs upon shipment to the customer. Service revenues are recognized as services are performed. Amounts billed for shipping and handling are recorded as revenue. Product return reserves are accrued at the time of sale based on the historical relationship between shipments and returns, and are recorded as a reduction of net sales.
 
Certain large distribution customers receive quantity discounts which are recognized net at the time the sale is recorded.
 
Inventory.  We value raw materials, work-in-progress and finished goods produced since inception at the lower of cost or market, as determined on a first-in, first-out (FIFO) basis. We periodically review the carrying value of the inventory and have at times determined that 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.
 
Retirement Benefits.  Pension obligations and other post retirement benefits are actuarially determined and are affected by several assumptions, including the discount rate, assumed annual rates of return on plan assets, and per capita cost of covered health care benefits. Changes in discount rate and differences from actual results for each assumption will affect the amounts of pension expense and other post retirement expense recognized in future periods.
 
Goodwill and Intangible Assets.  Intangible assets of our Predecessor consisted of goodwill, which represented the excess of the purchase price paid over the fair value of the net assets acquired. In connection with the PTH Acquisition, intangible assets were identified and recorded at their fair value, in accordance with Statement of Financial Accounting Standards, or SFAS No. 141, Business Combinations. We recorded


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intangible assets for customer relationships, trade names and trademarks, product technology and patents, and goodwill. In valuing the customer relationships, trade names and trademarks and product technology intangible assets, we utilized variations of the income approach. The income approach was considered the most appropriate valuation technique because the inherent value of these assets is their ability to generate current and future income. The income approach relies on historical financial and qualitative information, as well as assumptions and estimates for projected financial information. Projected information is subject to risk if our estimates are incorrect. The most significant estimate relates to our projected revenues. If we do not meet the projected revenues used in the valuation calculations then the intangible assets could be impaired. In determining the value of customer relationships, we reviewed historical customer attrition rates which were determined to be approximately 5% per year. Most of our customers tend to be long-term customers with very little turnover. While we do not typically have long-term contracts with customers, we have established long-term relationships with customers which make it difficult for competitors to displace us. Additionally, we assessed historical revenue growth within our industry and customers’ industries in determining the value of customer relationships. The value of our customer relationships intangible asset could become impaired if future results differ significantly from any of the underlying assumptions. This could include a higher customer attrition rate or a change in industry trends such as the use of long-term contracts which we may not be able to obtain successfully. Customer relationships and product technology and patents are considered finite-lived assets, with estimated lives ranging from 8 years and 12 years. The estimated lives were determined by calculating the number of years necessary to obtain 95% of the value of the discounted cash flows of the respective intangible asset. Goodwill and trade names and trademarks are considered indefinite lived assets. Trade names and trademarks were determined to be indefinite lived assets based on the criteria stated in paragraph 11 in SFAS No. 142, Goodwill and Other Intangible Assets. Other intangible assets include trade names and trademarks that identify us and differentiate us from competitors, and therefore competition does not limit the useful life of these assets. All of our brands have been in existence for over 50 years and therefore are not susceptible to obsolescence risk. Additionally, we believe that our trade names and trademarks will continue to generate product sales for an indefinite period. All indefinite lived intangible assets are reviewed at least annually to determine if an impairment exists. An impairment could be triggered by a loss of a major customer, discontinuation of a product line, or a change in any of the underlying assumptions utilized in estimating the value of the intangible assets. If an impairment is identified it will be recognized in that period.
 
In accordance with SFAS No. 142, we assess the fair value of our reporting units for impairment of intangible assets based upon a discounted cash flow methodology. Estimated future cash flows are based upon historical results and current market projections, discounted at a market comparable rate. If the carrying amount of the reporting unit exceeds the estimated fair value determined using the discounted cash flow calculation, goodwill impairment may be present. We would evaluate impairment losses based upon the fair value of the underlying assets and liabilities of the reporting unit, including any unrecognized intangible assets, and estimate the implied fair value of the intangible asset. An impairment loss would be recognized to the extent that a reporting unit’s recorded value of the intangible asset exceeded its calculated fair value.
 
We have calculated goodwill and intangible assets arising from the application of purchase accounting from our acquisitions, and have allocated these assets across our reporting units. We evaluated our intangible assets at the reporting unit level at December 31, 2006 and found no evidence of impairment at that date. If the book value of a reporting unit exceeds its fair value, the implied fair value of goodwill is compared with the carrying amount of goodwill. If the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recorded in an amount equal to that excess. The fair value of a reporting unit is estimated using the discounted cash flow approach, and is dependent on estimates and judgments related to future cash flows and discount rates. If the actual cash flows differ significantly from the estimates used by management, we may be required to record an impairment charge to write down the goodwill to its realizable value.
 
Long-lived Assets.  Long-lived assets are reviewed for impairment when events or circumstances indicate that the carrying amount of a long-lived asset may not be recovered. Long-lived assets held for use are reviewed for impairment by comparing the carrying amount of an asset to the undiscounted future cash flows expected to be generated by the asset over its remaining useful life. If an asset is considered to be impaired,


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the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value, and is charged to results of operations at that time. Assets to be disposed of are reported at the lower of the carrying amounts or fair value less cost to sell. Our management determines fair value using discounted future cash flow analysis. Determining market values based on discounted cash flows requires our management to make significant estimates and assumptions, including long-term projections of cash flows, market conditions and appropriate discount rates.
 
Income Taxes.  We record income taxes using the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and operating loss and tax credit carryforwards. We evaluate the realizability of our net deferred tax assets and assess the need for a valuation allowance on a quarterly basis. The future benefit to be derived from our deferred tax assets is dependent upon our ability to generate sufficient future taxable income to realize the assets. We record a valuation allowance to reduce our net deferred tax assets to the amount that may be more likely than not to be realized. To the extent we establish a valuation allowance, an expense will be recorded within the provision for income taxes line on the statement of operations. In periods subsequent to establishing a valuation allowance, if we were to determine that we would be able to realize our net deferred tax assets in excess of our net recorded amount, an adjustment to the valuation allowance would be recorded as a reduction to income tax expense in the period such determination was made.
 
Non-GAAP Financial Measures
 
The discussion of Results of Operations included below includes certain references to financial results on a “combined basis.” The combined results were prepared by adding our results from Inception to December 31, 2004 to those from the Predecessor for the 11 month period ending November 30, 2004. This presentation is not in accordance with generally accepted accounting principles. The primary differences between the predecessor entity and the successor entity are the inclusion of Kilian in the successor and the successor’s book basis has been stepped up to fair value, such that the successor has additional depreciation, amortization and financing costs. The results of Kilian are included in Altra for the period from December 1, 2004 through December 31, 2004 and the years ended December 31, 2006 and 2005. Management believes that this combined basis presentation provides useful information for our investors in the comparison of Predecessor trends and operating results. The combined results are not necessarily indicative of what our results of operations may have been if the acquisitions of PTH or Kilian had been consummated earlier, nor should they be construed as being a representation of our future results of operations.
 
The discussion of EBITDA (earnings before interest, income taxes, depreciation and amortization) included in the discussion of Results of Operations below is being provided because management considers EBITDA to be an important measure of financial performance. Among other things, management believes that EBITDA provides useful information for our investors because it is useful for trending, analyzing and benchmarking the performance and value of our business. Management also believes that EBITDA is useful in assessing current performance compared with the historical performance of our Predecessor because significant line items within our statements of operations such as depreciation, amortization and interest expense are significantly impacted by the PTH Acquisition. Internally, EBITDA is used as a financial measure to assess the operating performance and is an important measure in our incentive compensation plans.
 
EBITDA has important limitations, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. For example, EBITDA does not reflect:
 
  •  cash expenditures, or future requirements, for capital expenditures or contractual commitments;
 
  •  changes in, or cash requirements for, working capital needs;
 
  •  the significant interest expense, or the cash requirements necessary to service interest or principal payments, on debts;


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  •  tax distributions that would represent a reduction in cash available to us; and
 
  •  any cash requirements for assets being depreciated and amortized that may have to be replaced in the future.
 
EBITDA is not a recognized measurement under GAAP, and when analyzing our operating performance, investors should use EBITDA in addition to, and not as an alternative for, operating income (loss) and net (loss) income (each as determined in accordance with GAAP). Because not all companies use identical calculations, our presentation of EBITDA may not be comparable to similarly titled measures of other companies. The amounts shown for EBITDA also differ from the amounts calculated under similarly titled definitions in our debt instruments, which are further adjusted to reflect certain other cash and non-cash charges and are used to determine compliance with financial covenants and our ability to engage in certain activities, such as incurring additional debt and making certain restricted payments.
 
To compensate for the limitations of EBITDA we utilize several GAAP measures to review our performance. These GAAP measures include, but are not limited to, net income (loss), operating income (loss), cash provided by (used in) operations, cash provided by (used in) investing activities and cash provided by (used in) financing activities. These important GAAP measures allow our management to, among other things, review and understand our uses of cash period to period, compare our operations with competitors on a consistent basis and understand the revenues and expenses matched to each other for the applicable reporting period. We believe that the use of these GAAP measures, supplemented by the use of EBITDA, allows us to have a greater understanding of our performance and allows us to adapt to changing trends and business opportunities.
 
Results of Operations
 
                                           
                      From
         
                      Inception
      Predecessor  
                Combined 12
    (December 1,
      11 Months
 
    Year Ended
    Year Ended
    Months Ended
    2004) through
      Ended
 
    December 31,
    December 31,
    December 31,
    December 31,
      November 30,
 
    2006     2005     2004     2004       2004  
    (Unaudited)  
Net sales
    462,285     $ 363,465     $ 303,662     $ 28,625       $ 275,037  
Cost of sales
    336,836       271,952       233,100       23,847         209,253  
                                           
Gross profit
    125,449       91,513       70,562       4,778         65,784  
Gross profit percentage
    27.1 %     25.2 %     23.2 %     16.7 %       23.9 %
Selling, general and administrative expenses
    83,276       61,579       54,294       8,973         45,321  
Research and development expenses
    4,938       4,683       4,325       378         3,947  
Restructuring charge, asset impairment and transition expenses
                947               947  
Gain on curtailment of post-retirement benefit plan
    (3,838 )                          
Gain on sale of assets
          (99 )     (1,300 )             (1,300 )
                                           
Income (loss) from operations
    41,073       25,350       12,296       (4,573 )       16,869  
Interest expense, net
    25,479       19,514       5,906       1,612         4,294  
Other non-operating expense (income), net
    856       (17 )     148               148  
                                           
Income (loss) before income taxes
    14,738       5,853       6,242       (6,185 )       12,427  
Provision (benefit) for income taxes
    5,797       3,349       5,240       (292 )       5,532  
                                           
Net income (loss)
  $ 8,941     $ 2,504     $ 1,002     $ (5,893 )     $ 6,895  
                                           


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Year Ended December 31, 2006 Compared with Year Ended December 31, 2005
 
Net sales.  Net sales increased $98.8 million, or 27.2%, from $363.5 million, for the year ended December 31, 2005 to $462.3 million for the year ended December 31, 2006. Net sales increased primarily due to the inclusion of Hay Hall and Warner Linear in the results of the year ended December 31, 2006. Hay Hall net sales for the period February 10 to December 31, 2006 were $65.5 million and Warner Linear’s sales for the period May 18 to December 31, 2006 were $3.2 million. The remaining net increase was due to price increases and strong distribution sales for the aftermarket and the strength of several key markets including energy, primary metals and mining.
 
Gross profit.  Gross profit increased $33.9 million, or 37.1%, from $91.5 million (25.2% of net sales), in 2005 to $125.4 million (27.1% of net sales) in 2006. The increase includes $14.1 million from Hay Hall for the period February 10 to December 31, 2006 and $0.7 million from Warner Linear for the period May 18 to December 31, 2006. Excluding Hay Hall and Warner Linear, gross profit increased approximately $19.2 million, or 21.0%, and gross profit as a percent of sales increased to 28.1% due to price increases during the first quarter of 2006 and an increase in low cost country material sourcing and manufacturing efficiencies implemented by the new management team in the second half of 2005.
 
Selling, general and administrative expenses.  Selling, general and administrative expenses increased $21.7 million, or 35.2%, from $61.6 million in 2005 to $83.3 million in 2006. The increase in selling, general and administrative expenses is due to the inclusion of Hay Hall for the period February 10 to December 31, 2006 and Warner Linear for the period May 18 to December 31, 2006, which contributed $11.1 million and $0.6 million, respectively. Excluding Hay Hall and Warner Linear, selling, general and administrative expenses, as a percentage of net sales, increased from 16.9% in 2005 to 18.2% in 2006, primarily due to the $3.0 million termination fee paid to Genstar, $1.0 million transaction fee paid to Genstar in connection with the Hay Hall acquisition and $1.9 million stock based compensation expense offset by the cost savings initiatives.
 
Research and development expenses.  Research and development expenses increased $0.2 million, or 5.4%, from $4.7 million in 2005 to $4.9 million in 2006. The increase was primarily due to the inclusion of Hay Hall for the period February 10 to December 31, 2006.
 
EBITDA.  To reconcile net income to EBITDA for 2006, we added back to net income $5.8 million provision of income taxes, $25.5 million of interest expense and $14.6 million of depreciation and amortization expenses. To reconcile net income to EBITDA for 2005, we added back to net income $3.3 million provision of income taxes, $19.5 million of interest expense and $11.5 million of depreciation and amortization expenses. Taking into account the foregoing adjustments, our resulting EBITDA was $54.8 million for 2006 and $36.9 million for 2005.
 
Other non-operating (income) expense.  We recorded $0.9 million of non-operating expense in 2006 which was primarily due to foreign currency translation losses due to the strengthening of the British Pound Sterling and Euro.
 
Interest expense.  We recorded interest expense of $25.5 million during 2006 primarily relating to the 9% senior secured notes, 111/4% senior notes, subordinated notes and amortization of related deferred financing costs. Interest expense of $19.5 million was recorded during 2005. The increase was due to the issuance of the 111/4% senior notes during 2006 and the redemption of the subordinated notes which resulted in prepayment penalties and the write-off of the related deferred financing costs.
 
Provision for income taxes.  The provision for income taxes was $5.8 million, or 39.3%, of income before taxes, for 2006, versus a combined provision of $3.3 million, or 57.2%, of income before taxes, for 2005. The 2005 provision as a percent of income before taxes was higher than that of 2006 primarily due to the Hay Hall Acquisition and a greater proportion of taxable income in jurisdictions possessing lower statutory tax rates. For further discussion, refer to Note 8 in the audited financial statements.


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Year Ended December 31, 2005 Compared with Year Ended December 31, 2004
 
Net sales.  Net sales increased $59.8 million, or 19.7%, from $303.7 million on a combined basis, for the year ended December 31, 2004 to $363.5 million for the year ended December 31, 2005. Net sales increased primarily due to the inclusion of Kilian in the results of the year ended December 31, 2005. Kilian’s net sales for 2005 were $42.5 million. The remaining net increase was due to price increases, improving economic conditions at our customers in the steel, energy and petrochemical industries and increased sales of $4.7 million to certain transportation customers and $2.5 million in mining OEM customers, partially offset by a weakening at our turf and garden OEM customers. On a constant currency basis sales increased $58.7 million, or 19.3%, in 2005. Excluding Kilian, the constant currency increase in sales was $17.0 million, or 5.6%.
 
Gross Profit.  Gross profit increased $21.0 million, or 29.7%, from $70.6 million (23.2% of net sales) on a combined basis, in 2004 to $91.5 million (25.2% of net sales) in 2005. The increase includes $9.1 million from Kilian for 2005. Excluding Kilian, gross profit increased approximately $11.9 million, or 16.8%, and gross profit as a percent of sales increased to 25.7%. The remaining increase in gross profit is attributable to price increases during the second half of 2005, an increase in low cost country material sourcing and manufacturing efficiencies implemented by the new management team. Savings from low cost country material sourcing and manufacturing efficiencies totaled $2.63 million.
 
Selling, general and administrative expenses.  Selling, general and administrative expenses increased $7.3 million, or 13.4%, from $54.3 million on a combined basis in 2004 to $61.6 million in 2005. The increase in selling, general and administrative expenses is due to the inclusion of Kilian in 2005, which contributed $3.4 million to the increase, $3.0 million of amortization of intangibles, and $1.0 million management fee paid to Genstar Capital, L.P., offset by cost savings initiatives of $1.0 million put in place during 2005. Excluding Kilian, selling, general and administrative expenses, as a percentage of net sales, increased from 17.9% in 2004 to 18.1% in 2005, primarily due to the amortization of intangibles and the management fee paid to Genstar Capital, L.P., offset by the cost savings initiatives. On a constant currency basis, selling, general and administrative expenses increased $6.4 million, or 11.8%, from $54.3 million, on a combined basis, in 2004. Excluding Kilian, selling, general and administrative expenses, on a constant currency basis, increased $3.0 million, or 5.6%, and was 17.9% of sales.
 
Research and development expenses.  Research and development expenses increased $0.4 million, or 8.3%, from $4.3 million on a combined basis in 2004 to $4.7 million in 2005. The increase was primarily due to development projects including the Foot/ Deck Mount Kopper Kool brake, a new clutch brake for the mining industry, spot brake technology, various elevator brakes and forklift brakes.
 
Gain on sale of assets, Our Predecessor recorded a gain on sale of assets of $1.3 million during 2004 relating to the sale of surplus real estate. We recorded a gain of $0.1 million from the sale of surplus machinery during 2005.
 
Restructuring charge, asset impairment and transition expenses Restructuring charge, asset impairment and transition expenses decreased from $0.9 million on a combined basis in 2004 to zero in 2005 due to the ending of the program in 2004.
 
Interest expense, net.  We recorded interest expense of $19.5 million during 2005 primarily due to the 9% senior secured notes, the CDPQ subordinated notes and the amortization of related deferred financing costs. On a combined basis, interest expense of $5.9 million was recorded during 2004.
 
Provision for income taxes.  The provision for income taxes was $3.3 million, or 57.2%, of income before taxes, for 2005, versus a combined provision of $5.2 million, or 83.9%, of income before taxes, for 2004. The 2004 provision as a percent of income before taxes was higher than that of 2005 primarily due to the impact of non-deductible transaction expenses incurred in connection with the PTH Acquisition in 2004. For further discussion, refer to Note 8 to the audited financial statements.
 
EBITDA.  To reconcile net income to EBITDA for 2005, we added back to net income $3.3 million provision of income taxes, $19.5 million of interest expense and $11.5 million of depreciation and amortization expenses. To reconcile net income to EBITDA on a combined basis for 2004, we added back to net


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income $5.2 million provision of income taxes, $5.9 million of interest expense and $7.0 million of depreciation and amortization expenses. Taking into account the foregoing adjustments, our resulting EBITDA was $36.9 million for 2005 and $19.1 million for 2004.
 
Liquidity and Capital Resources
 
Overview
 
Historically, our Predecessor financed capital and working capital requirements through a combination of cash flows from operating activities and borrowings from financial institutions and its former parent company, Colfax. We finance our capital and working capital requirements through a combination of cash flows from operating activities and borrowings under our senior revolving credit facility. We expect that our primary ongoing requirements for cash will be for working capital, debt service, capital expenditures and pension plan funding. If additional funds are needed for strategic acquisitions or other corporate purposes, we believe we could borrow additional funds or raise funds through the issuance of equity securities.
 
Borrowings
 
In connection with the PTH Acquisition, we incurred substantial indebtedness. To partially fund the PTH acquisition, our wholly owned subsidiary (“Altra Industrial”) issued $165.0 million of 9% senior secured notes, we issued $14.0 million of subordinated notes, or the CDPQ subordinated notes, to Caisse de dépôt et placement du Québec, or CDPQ, a limited partner of Genstar Capital Partners III, L.P., and Altra Industrial entered into a $30.0 million senior revolving credit facility. All of the CDPQ subordinated notes were redeemed in 2006. In connection with our acquisition of Hay Hall in February 2006 Altra Industrial issued £33.0 million of 111/4% senior notes. Based on an exchange rate of 1.7462 U.S. Dollars to U.K. pounds sterling (as of February 8, 2006), the proceeds from these notes were approximately $57.6 million. The notes are unsecured and are due in 2013. Interest on the 111/4% senior notes is payable in U.K. pounds sterling semiannually in arrears on February 15 and August 15 of each year, commencing August 15, 2006.
 
As of December 31, 2006, Altra Industrial had outstanding $165.0 million of 9% senior secured notes, $64.6 million of 111/4% senior notes, $1.5 million in capital leases, $2.6 million in mortgages and had no outstanding borrowings and $2.9 million of outstanding letters of credit under our senior revolving credit facility. This constitutes approximately $233.7 million of total indebtedness which results in approximately $26.1 million of interest expense.
 
In February 2007, Altra Industrial redeemed £11.6 million aggregated principal amount of our outstanding 111/4% senior notes, at a redemption price of 111.25% of the principal amount of the 111/4% senior notes, plus accrued and unpaid interest to the redemption date, using a portion of the proceeds from our initial public offering. Altra Industrial intends to issue additional 9% senior secured notes pursuant to a tack-on bond offering to finance the acquisition of TB Wood’s.
 
Altra Industrial’s senior revolving credit facility provides for senior secured financing of up to $30.0 million, including $10.0 million available for letters of credit. The senior revolving credit facility requires us to comply with a minimum fixed charge coverage ratio of 1.20 for all four quarter periods when availability falls below $12.5 million.
 
Altra Industrial and all of its domestic subsidiaries are borrowers, or Borrowers, under the senior revolving credit facility. Certain of our existing and subsequently acquired or organized domestic subsidiaries which are not Borrowers do and will guarantee (on a senior secured basis) the senior revolving credit facility. Obligations of the other Borrowers under the senior revolving credit facility and the guarantees are secured by substantially all of the Borrowers’ assets and the assets of each of our existing and subsequently acquired or organized domestic subsidiaries that is a guarantor of our obligations under the senior revolving credit facility (with such subsidiaries being referred to as the “U.S. subsidiary guarantors”), including but not limited to: (a) a first-priority pledge of all the capital stock of subsidiaries held by the Borrowers or any U.S. subsidiary guarantor (which pledge, in the case of any foreign subsidiary, will be limited to 100% of any non-voting stock and 65% of the voting stock of such foreign subsidiary) and (b) perfected first-priority security interests


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in and mortgages on substantially all tangible and intangible assets of each Borrower and U.S. subsidiary guarantor, including accounts receivable, inventory, equipment, general intangibles, investment property, intellectual property, real property (other than (i) leased real property and (ii) our existing and future real property located in the State of New York), cash and proceeds of the foregoing (in each case subject to materiality thresholds and other exceptions).
 
An event of default under the senior revolving credit facility would occur in connection with a change of control if: (i) a person or group, other than Genstar Capital and our affiliates, beneficially owns more than 35% of our stock and such amount is more than the amount of shares owned by Genstar Capital and its affiliates, (ii) we cease to own or control 100% of each of its borrower subsidiaries, or (iii) a change of control occurs under the 9% senior secured notes, 111/4% senior notes or any other subordinated indebtedness.
 
An event of default under the senior revolving credit facility would occur if an event of default occurs under the indentures governing the 9% senior secured notes or the 111/4% senior notes or if there is a default under any other indebtedness any Borrower may have involving an aggregate amount of $3 million or more and such default: (i) occurs at final maturity of such debt, (ii) allows the lender there under to accelerate such debt or (iii) causes such debt to be required to be repaid prior to its stated maturity. An event of default would also occur under the senior revolving credit facility if any of the indebtedness under the senior revolving credit facility ceases to be senior in priority to any of our other contractually subordinated indebtedness, including the obligations under the 9% senior secured notes and the 111/4% senior notes.
 
Under the agreements governing Altra Industrial’s indebtedness, its subsidiaries are permitted to make dividend payments to Altra Industrial for use in its operations and to pay off its senior revolving credit facility and outstanding notes. Altra Industrial and its subsidiaries are restricted, however, from making dividend payments to us to pay off the CDPQ subordinated notes, subject to certain exceptions. During 2006, Altra Industrial pre-paid $14.0 million of the CDPQ subordinated notes on our behalf pursuant to these exceptions. The outstanding balance due under the CDPQ subordinated notes was paid in full on December 7, 2006. In addition, the first priority liens against us, its subsidiaries and their assets created by our indebtedness limits our ability to sell or transfer such subsidiaries or assets.
 
As of December 31, 2006, we were in compliance with all covenant requirements associated with all of our borrowings.
 
Net Cash
 
Cash and cash equivalents totaled $42.5 million at December 31, 2006 compared to $10.1 million at December 31, 2005. The primary source of funds for fiscal 2006 was cash provided by financing and operating activities of $83.8 million and $11.1 million, respectively. Net cash provided by operating activities for 2006 resulted mainly from net income of $8.9 million, non-cash depreciation, amortization and deferred financing costs of $15.9 million, non-cash amortization of $2.3 million for inventory step-ups recorded as part of the Hay Hall Acquisition and $1.1 million related to the loss on foreign currency which was offset by a non-cash gain on the curtailment of other post-retirement benefit plan of $3.8 million and by cash used by a net decrease in operating liabilities of $13.7 million and by cash used from a net increase in operating assets of $4.3 million.
 
Net cash used in investing activities of $63.2 million for 2006 resulted from $9.4 million of purchases of property, plant and equipment primarily for investment in manufacturing equipment and for the consolidation of our IT infrastructure and $53.8 million related to the acquisitions of Hay Hall and Bear Linear.
 
Net cash provided by financing activities of $83.8 million for 2006 consisted primarily of $57.6 million from the issuance of the 111/4% senior notes, $41.9 million from the proceeds of the initial public offering, net of the underwriters discount, $2.5 million from mortgage proceeds. These amounts are offset by the $14 million pre-payment of the subordinated debt and the $2.7 million payment of debt issuance costs associated with the 111/4% senior notes.


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Capital Expenditures
 
We made capital expenditures of approximately $9.4 million and $6.2 million in the year ended December 31, 2006 and December 31, 2005, respectively. These capital expenditures will support on-going business needs. We expect to spend approximately $10.5 million on capital expenditures in 2007.
 
Our senior revolving credit facility imposes a maximum annual limit on our capital expenditures of $11.0 million for fiscal year 2007, $10.0 million for fiscal year 2008, and $10.3 million for fiscal year 2009 and each fiscal year thereafter, provided that unspent amounts from prior periods may be used in future fiscal years.
 
Pension Plans
 
As of December 31, 2006, we had cash funding requirements associated with our pension plan which we estimated to be $3.6 million in 2007, $2.5 million in 2008 and $1.9 million annually thereafter until 2011. These amounts represent funding requirements for the previous pension benefits we provided our employees. In 2006, we eliminated pension benefits in one of our locations. These amounts are based on actuarial assumptions and actual amounts could be materially different. See Note 9 in the audited financial statements.
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements that provide liquidity, capital resources, market or credit risk support that expose us to any liability that is not reflected in our consolidated financial statements.
 
Contractual Obligations
 
The following table is a summary of our contractual cash obligations as of December 31, 2006 (in millions):
 
                                                         
    Payments Due by Period  
    2007     2008     2009     2010     2011     Thereafter     Total  
 
Senior secured notes(1)
                          $ 165.0     $     $ 165.0  
Senior notes(2)
                                $ 64.6     $ 64.6  
Operating leases
  $ 4.1     $ 2.9     $ 1.9     $ 0.9     $ 0.6     $ 1.5     $ 11.9  
Capital leases
    0.6       0.4       0.4       0.1       0.1             1.6  
Mortgage(3)
    0.1       0.1       0.1       0.1       0.1       2.1       2.6  
Senior Revolving Credit Facility(4)
                                         
                                                         
Total contractual cash obligations
  $ 4.8     $ 3.4     $ 2.4     $ 1.1     $ 165.8     $ 68.2     $ 245.7  
                                                         
 
 
(1) We have semi-annual cash interest requirements due on the 9% senior secured notes with $14.9 million payable in, 2007, 2008, 2009, 2010 and 2011. These amounts will increase in connection with the tack-on bond offering being contemplated to finance the acquisition of TB Wood’s.
 
(2) Assuming an exchange rate of 1.959, we have semi-annual cash interest requirements due on the 111/4% senior notes with $7.3 million payable in 2007, 2008, 2009, 2010, 2011 and $10.9 million thereafter. The principal balance of £33 million is due in 2013 which, assuming an exchange rate of 1.959, equals approximately $64.6 million. In February 2007, we redeemed £11.6 million aggregated principal amount of our outstanding 111/4% senior notes, at a redemption price of 111.25% of the principal amount of the 111/4% senior notes, plus accrued and unpaid interest to the redemption date, using a portion of the proceeds from our initial public offering. We intend to have Altra Industrial issue additional 9% senior secured notes pursuant to a tack-on bond offering to finance the acquisition of TB Wood’s.
 
(3) In June, 2006, our German subsidiary entered into a mortgage on its building in Heidelberg, Germany, with a local bank. The mortgage has a principal of €2.0 million, an interest rate of 5.75% and is payable in monthly installments over 15 years.


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(4) We have up to $30.0 million of borrowing capacity, through November 2009, under our senior revolving credit facility (including $10.0 million available for use for letters of credit). As of December 31, 2006, there were no outstanding borrowings and $2.9 million of outstanding letters of credit under our senior revolving credit facility.
 
Stock-based Compensation
 
In January 2005, we established the 2004 Equity Incentive Plan that provides for various forms of stock based compensation to our officers and senior level employees. We account for grants under this plan in accordance with the provisions of SFAS No. 123(R).
 
As of December 31, 2006, we had 1,620,090 shares of unvested restricted stock. The remaining compensation cost to be recognized through 2011 is $2.0 million. Based on the stock price at December 29, 2006 of $14.05 per share, the intrinsic value of these awards as of December 31, 2006 was $28.2 million, of which $5.4 million related to vested shares and $22.8 million related to unvested shares.
 
Income Taxes
 
We are subject to taxation in multiple jurisdictions throughout the world. Our effective tax rate and tax liability will be affected by a number of factors, such as the amount of taxable income in particular jurisdictions, the tax rates in such jurisdictions, tax treaties between jurisdictions, the extent to which we transfer funds between jurisdictions and repatriate income, and changes in law. Generally, the tax liability for each legal entity is determined either (a) on a non-consolidated and non-combined basis or (b) on a consolidated and combined basis only with other eligible entities subject to tax in the same jurisdiction, in either case without regard to the taxable losses of non-consolidated and non-combined affiliated entities. As a result, we may pay income taxes to some jurisdictions even though on an overall basis we incur a net loss for the period.
 
Seasonality
 
We experience seasonality in our turf and garden business, which in recent years has represented approximately 10% of our net sales. As our large OEM customers prepare for the spring season, our shipments generally start increasing in December, peak in February and March, and begin to decline in April and May. This allows our customers to have inventory in place for the peak consumer purchasing periods for turf and garden products. The June-through-November period is typically the low season for us and our customers in the turf and garden market. Seasonality is also affected by weather and the level of housing starts.
 
Inflation
 
Inflation can affect the costs of goods and services we use. The majority of the countries that are of significance to us, from either a manufacturing or sales viewpoint, have in recent years enjoyed relatively low inflation. The competitive environment in which we operate inevitably creates pressure on us to provide our customers with cost-effective products and services.
 
Recent Accounting Pronouncements
 
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 will be effective for fiscal years beginning after December 15, 2006. The provision of FIN 48 are effective January 1, 2007. The Company is currently evaluating the effect that adoption of FIN 48 will have on its financial position and results of operations.
 
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108 “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in


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Current Year Financial Statements,”. SAB No. 108 states that registrants should use both a balance sheet approach and an income statement approach when quantifying and evaluating the materiality of a misstatement. The interpretations in SAB No. 108 contain guidance on correcting errors under the dual approach as well as provide transition guidance for correcting errors. This interpretation does not change the requirements within SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB No. 20 and FASB Statement No. 3,” for the correction of an error on financial statements. The Company adopted this pronouncement during 2006, the effect of this statement was not material to the financial statements.
 
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This standard defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America, and expands disclosure about fair value measurements. This pronouncement applies under other accounting standards that require or permit fair value measurements. Accordingly, this statement does not require any new fair value measurement. This statement is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the effect to be material.
 
In September 2006, the FASB issued 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).” This pronouncement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability on its statement of financial position. SFAS No. 158 also requires an employer to recognize changes in that funded status in the year in which the changes occur through comprehensive income. On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158. The effect of adopting Statement 158 is not included on the Company’s consolidated financial condition at December 31, 2005 or 2004. SFAS No. 158’s provisions regarding the change in the measurement date of postretirement benefit plans are not applicable as the Company already uses a measurement date of December 31 for its pension plans. See Note 9 for further discussion of the effect of adopting SFAS 158 on the Company’s consolidated financial statements.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” The standard permits entities to choose to measure many financial instruments and certain other items at fair value and is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS No. 157, “Fair Value Measurements.” The Company is in the process of evaluating the impact this pronouncement may have on our results of operations and financial condition and whether to adopt the provisions of the standard for the fiscal year beginning January 1, 2007.
 
Item 7A.  Quantitative and Qualitative Information about Market Risk
 
We are exposed to various market risk factors such as fluctuating interest rates and changes in foreign currency rates. At present, we do not utilize derivative instruments to manage this risk.
 
Currency translation.  The results of operations of our foreign subsidiaries are translated into U.S. dollars at the average exchange rates for each period concerned. The balance sheets of foreign subsidiaries are translated into U.S. dollars at the exchange rates in effect at the end of each period. Any adjustments resulting from the translation are recorded as other comprehensive income. As of December 31, 2006 and 2005, the aggregate total assets (based on book value) of foreign subsidiaries were $138.3 million and $74.6 million, respectively, representing approximately 33.8% and 25.1%, respectively, of our total assets (based on book value). Our foreign currency exchange rate exposure is primarily with respect to the Euro and British Pound Sterling. The approximate exchange rates in effect at December 31, 2006 and 2005 were $1.31 and $1.19, respectively to the Euro. The approximate exchange rates in effect at December 31, 2006 and 2005 were $1.96 and $1.73, respectively to the British Pound Sterling. The result of a hypothetical 10% strengthening of the U.S. dollar against the Euro and British Pound Sterling would result in a decrease in the book value of the aggregate total assets of foreign subsidiaries of approximately $13.8 million as of December 31, 2006. The result of a hypothetical 10% strengthening of the U.S. dollar against the Euro and British Pound Sterling


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would result in a decrease in net income of our foreign subsidiaries of approximately $0.2 million for the year ended December 31, 2006.
 
Currency transaction exposure.  Currency transaction exposure arises where actual sales and purchases are made by a business or company in a currency other than its own functional currency. Any transactional differences at an international location are recorded in net income on a monthly basis.
 
Interest rate risk.  We are subject to market exposure to changes in interest rates based on our financing activities. This exposure relates to borrowings under our senior revolving credit facility that are payable at prime rate plus 1.25% in the case of prime rate loans, or LIBOR rate plus 2.50%, in the case of LIBOR rate loans. As of December 31, 2006, we had no borrowings under our senior revolving credit facility and $2.9 million of outstanding letters of credit under our senior revolving credit facility. Due to the minimal amounts of outstanding debt a hypothetical change in interest rates of 1% would not have a material effect on our near-term financial condition or results of operations.
 
The Sarbanes-Oxley Act of 2002 and Material Weakness in Internal Control
 
In connection with their audit of our 2006 consolidated financial statements, our independent auditors expressed concerns that as of the date of their opinion, certain plant locations had encountered difficulty closing their books in a timely and accurate manner. The outside auditors informed senior management and the Audit Committee of the Board of Directors that they believe this is a material weakness in internal controls. We have actively taken steps to address this material weakness. These steps include standardizing the financial close process, providing greater corporate oversight and review as well as implementing other internal control procedures as part of our on-going Sarbanes-Oxley compliance program. We believe that with the addition of these steps we should be able to deliver financial information in a timely and accurate manner.


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Item 8.   Financial Statements and Supplementary Data
 
Report of Independent Registered Public Accounting Firm
 
To the Board of Directors
Altra Holdings, Inc.
 
We have audited the accompanying consolidated balance sheets of Altra Holdings, Inc. (“the Company”), as of December 31, 2006 and 2005 and the related consolidated statements of operations and comprehensive income (loss), changes in convertible preferred stock and stockholders’ equity, and cash flows for the year ended December 31, 2006 and December 31, 2005 and the period from inception (December 1, 2004) through December 31, 2004, and the combined statements of operations and comprehensive income, stockholders’ equity and cash flows of the Predecessor for the period from January 1, 2004 through November 30, 2004. Our audits also included the financial statement schedules listed in the index at Item 15 (a). These financial statements and schedules are the responsibility of management of the Company and its Predecessor. Our responsibility is to express an opinion on these financial statements and schedules 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 Altra Holdings, Inc. at December 31, 2006 and 2005 and the consolidated results of the operations and cash flows of the Company for the years ended December 31, 2006 and 2005 and the period from inception (December 1, 2004) through December 31, 2004, and of its Predecessor for the period from January 1, 2004 through November 30, 2004 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
 
As discussed in Note 2 to the consolidated financial statements, in 2006 the Company adopted Statement of Financial Accounting Standards (“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)”.
 
/s/  
Ernst & Young LLP
 
Boston, Massachusetts
March 28, 2007


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ALTRA HOLDINGS, INC
 
Consolidated Balance Sheets
 
                 
    December  
    2006     2005  
    Dollars in thousands, except share amounts  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 42,527     $ 10,060  
Trade receivables, less allowance for doubtful accounts of $2,017 and $1,797
    61,506       46,441  
Inventories, less allowance for obsolete materials of $10,163 and $6,843
    75,769       54,654  
Deferred income taxes
    6,783       2,779  
Prepaid expenses and other
    7,532       1,973  
                 
Total current assets
    194,117       115,907  
Property, plant and equipment, net
    82,387       66,393  
Intangible assets, net
    59,662       44,751  
Goodwill
    65,397       65,345  
Deferred income taxes
    2,135        
Other assets
    5,670       5,295  
                 
Total assets
  $ 409,368     $ 297,691  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 34,053     $ 30,724  
Accrued payroll
    15,557       16,016  
Accruals and other liabilities
    15,008       6,349  
Taxes payable
    5,353       2,190  
Deferred income taxes
    1,382       33  
Current portion of long-term debt
    573       186  
                 
Total current liabilities
    71,926       55,498  
Long-term debt, less current portion and net of unaccreted discount
    228,555       173,574  
Deferred income taxes
    7,130       7,653  
Pension liabilities
    15,169       21,914  
Other post retirement benefits
    3,262       12,500  
Other long term liabilities
    3,910       1,601  
Commitments and Contingencies (see Note 15)
           
Convertible Preferred Series A stock ($0.001 par value, 0 and 40,000,000 shares authorized, 0 and 35,500,000 shares issued and outstanding at December 31, 2006 and 2005, respectively)
          35,500  
Stockholders’ equity
               
Common stock ($0.001 par value, 90,000,000 and 50,000,000 shares authorized, 21,467,502 and 52,667 issued and outstanding at December 31, 2006 and 2005, respectively)
    21        
Additional paid-in capital
    76,907       113  
Retained earnings (deficit)
    5,552       (3,389 )
Accumulated other comprehensive loss
    (3,064 )     (7,273 )
                 
      79,416       24,951  
                 
Total liabilities and stockholders’ equity
  $ 409,368     $ 297,691  
                 
 
See accompanying notes.


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ALTRA HOLDINGS, INC.
 
Consolidated Statements of Operations and Comprehensive Income (Loss)
 
                                   
                From
         
                Inception
      Predecessor
 
                (December 
      (Note 1)  
                1, 2004)
      11 Months
 
    Year-Ended
    Year-Ended
    through
      Ended
 
    December 31,
    December 31,
    December 31
      November 30,
 
    2006     2005     2004       2004  
    Dollars in thousands, except per share amounts  
Consolidated Statement of Operations
                                 
Net sales
  $ 462,285     $ 363,465     $ 28,625       $ 275,037  
Cost of sales
    336,836       271,952       23,847         209,253  
                                   
Gross profit
    125,449       91,513       4,778         65,784  
Selling, general and administrative expenses
    83,276       61,579       8,973         45,321  
Research and development expenses
    4,938       4,683       378         3,947  
Restructuring charge, asset impairment and transition expenses
                        947  
Gain on curtailment of post-retirement benefit plan
    (3,838 )                    
Gain on sale of fixed assets
          (99 )             (1,300 )
                                   
Income (loss) from operations
    41,073       25,350       (4,573 )       16,869  
Interest expense, net
    25,479       19,514       1,612         4,294  
Other non-operating expense (income), net
    856       (17 )             148  
                                   
Income (loss) before income taxes
    14,738       5,853       (6,185 )       12,427  
Provision (benefit) for income taxes
    5,797       3,349       (292 )       5,532  
                                   
Net income (loss)
    8,941       2,504       (5,893 )       6,895  
                                   
Consolidated Statement of Comprehensive Income (Loss)
                                 
Minimum pension liability adjustment
    696       (700 )     (722 )       (6,031 )
Foreign currency translation adjustment
    677       (6,400 )     549         478  
                                   
Other comprehensive income (loss)
    1,373       (7,100 )     (173 )       (5,553 )
                                   
Comprehensive income (loss)
  $ 10,314     $ (4,596 )   $ (6,066 )     $ 1,342  
                                   
Net Income per share:
                                 
Basic
  $ 7.56     $ 278.22     $         N/A  
Diluted
  $ 0.46     $ 0.13     $         N/A  
Weighted average common shares outstanding:
                                 
Basic
    1,183       9               N/A  
Diluted
    19,525       18,969               N/A  
 
See accompanying notes.


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ALTRA HOLDINGS, INC.
 
Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity
Dollars in thousands, except share amounts
 
                         
          Accumulated
       
          Other
    Net
 
    Invested
    Comprehensive
    Invested
 
    Capital     Loss     Capital  
 
For the Predecessor
                       
Balance at December 31, 2003
  $ 30,221     $ (33,225 )   $ (3,004 )
Net income
    6,895             6,895  
Contribution from affiliates
    7,922             7,922  
Other comprehensive income, net of $3,697 tax benefit
          (5,553 )     (5,553 )
                         
Balance at November 30, 2004
  $ 45,038     $ (38,778 )   $ 6,260  
                         
 
                                                                 
                                        Accumulated
       
                            Additional
    Retained
    Other
       
    Preferred
          Common
          Paid-In
    Earnings
    Comprehensive
       
    Stock     Shares     Stock     Shares     Capital     (Deficit)     Income (Loss)     Total  
 
For the Company
                                                               
Initial capital contribution
  $ 26,334       26,334     $           $     $     $     $ 26,334  
Equity issued related to acquisition
    8,766       8,766                   54                   8,820  
Net loss
                                  (5,893 )           (5,893 )
Other comprehensive loss
                                        (173 )     (173 )
                                                                 
Balance at December 31, 2004
    35,100       35,100                   54       (5,893 )     (173 )     29,088  
Issuance of preferred stock
    400       400                                     400  
Amortization of restricted stock grants
                      53       59                   59  
Net income
                                  2,504             2,504  
Other comprehensive loss, net of $1,938 tax benefit
                                        (7,100 )     (7,100 )
                                                                 
Balance at December 31, 2005
  $ 35,500       35,500             53     $ 113     $ (3,389 )   $ (7,273 )   $ 24,951  
Conversion of preferred stock into common stock
    (35,500 )     (35,500 )     18       17,750       35,482                    
Issuance of common stock, net of offering costs
                3       3,333       39,367                   39,370  
Stock based compensation and vesting of restricted stock
                      332       1,945                   1,945  
Net income
                                  8,941             8,941  
Cumulative foreign currency translation adjustment, net of $880 tax expense
                                        677       677  
Minimum pension liability adjustment and cumulative transition to SFAS No. 158, net of $2,165 tax expense
                                        3,532       3,532  
                                                                 
Balance at December 31, 2006
  $           $ 21       21,468     $ 76,907     $ 5,552     $ (3,064 )   $ 79,416  
                                                                 
 
See accompanying notes.


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ALTRA HOLDINGS, INC.
 
Consolidated Statements of Cash Flows
 
                                   
                        Predecessor
 
                From Inception
      (Note 1)  
                (December 1, 2004
      11 Months
 
    Year-Ended
    Year-Ended
    through
      Ended
 
    December 31,
    December 31,
    December 31,
      November 30,
 
    2006     2005     2004)       2004  
    Dollars in thousands  
Cash flows from operating activities:
                                 
Net income (loss)
  $ 8,941     $ 2,504     $ (5,893 )       6,895  
Adjustments to reconcile net income to cash provided by operating activities:
                                 
Depreciation
    10,821       8,574       673         6,074  
Amortization of intangible assets
    3,790       2,959       246          
Amortization of deferred loan costs
    1,255       669       53          
Accretion of debt discount
    942       942       79          
Paid-in-kind interest
                198          
Loss on foreign currency, net
    1,079                      
Amortization of inventory fair value adjustment
    2,278       1,699       1,699          
Stock based compensation
    1,945       59                
Gain on sale of fixed assets
          (99 )             (1,300 )
Gain on curtailment of post-retirement benefit obligation
    (3,838 )                    
Provision (benefit ) for deferred taxes
    1,190       225       (1,031 )       117  
Changes in operating assets and liabilities:
                                 
Trade receivables
    (330 )     (2,654 )     (324 )       (4,197 )
Inventories
    (3,973 )     (1,353 )     (412 )       (6,418 )
Accounts payable and accrued liabilities
    (11,427 )     (1,788 )     9,402         3,734  
Other current assets and liabilities
    (2,297 )     2,226       (2,126 )       1,477  
Other operating assets and liabilities
    752       (1,940 )     3,059         (2,778 )
                                   
Net cash provided by operating activities
    11,128       12,023       5,623         3,604  
Cash flows from investing activities:
                                 
Purchases of fixed assets
    (9,408 )     (6,199 )     (289 )       (3,489 )
Acquisitions, net of $775 and $2,367 of cash acquired in 2006 and 2004, respectively
    (53,755 )     1,607       (180,112 )        
Payment of additional Kilian purchase price
          (730 )              
Proceeds from sale of fixed assets
          125               4,442  
                                   
Net cash (used in) provided by investing activities
    (63,163 )     (5,197 )     (180,401 )       953  
Cash flows from financing activities:
                                 
Initial contributed capital
                26,334          
Proceeds from initial public offering
    41,850                      
Initial public offering transaction costs
    (1,176 )                    
Proceeds from issuance of senior notes
    57,625                      
Proceeds from issuance of senior subordinated notes
                158,400          
Proceeds from sale of preferred stock
          400                
Payments of debt acquired in acquisitions
                (12,178 )        
Payment of paid-in-kind interest
          (198 )              
Proceeds from issuance of subordinated notes
                14,000          
Payment of subordinated notes
    (14,000 )                    
Payment of debt issuance costs
    (2,731 )     (338 )     (7,087 )        
Proceeds from mortgages
    2,510                      
Borrowings under revolving credit agreement
    5,057       4,408       4,988          
Payments on revolving credit agreement
    (5,057 )     (4,408 )     (4,988 )        
Payment of capital leases
    (241 )     (835 )     (37 )        
Contribution from affiliates
                        7,922  
Change in affiliate debt
                        (14,618 )
                                   
Net cash (used in) provided by financing activities
    83,837       (971 )     179,432         (6,696 )
                                   
Effect of exchange rates on cash
    665       (524 )     75         159  
                                   
Increase (Decrease) in cash and cash equivalents
    32,467       5,331       4,729         (1,980 )
Cash and cash equivalents, beginning of period
    10,060       4,729               3,163  
                                   
Cash and cash equivalents, end of period
    42,527     $ 10,060     $ 4,729       $ 1,183  
                                   
Cash paid during the period for:
                                 
Interest
  $ 23,660     $ 17,458     $       $ 2,796  
Income Taxes
  $ 2,341     $ 1,761     $       $ 446  
                                   
Non-Cash Financing:
                                 
Acquisition of capital equipment under capital lease
  $ 613     $     $       $  
Accrued initial public offering costs
  $ 1,304     $     $       $  
Conversion of preferred stock
  $ 35,500     $     $       $ —   
                                   
 
See Accompany notes


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements
Dollars in thousands unless otherwise noted
 
1.   Description of Business and Summary of Significant Accounting Policies
 
Basis of Preparation and Description of Business
 
Headquartered in Quincy, Massachusetts, Altra Holdings, Inc. (“the Company”), through its wholly-owned subsidiary Altra Industrial Motion, Inc. (“Altra Industrial”) produces, designs and distributes a wide range of mechanical power transmission products, including industrial clutches and brakes, enclosed gear drives, open gearing and couplings. The Company consists of several power transmission component manufacturers including Warner Electric, Boston Gear, Formsprag Clutch, Stieber Clutch, Ameridrives Couplings, Wichita Clutch, Nuttall Gear, Kilian Manufacturing, Inertia Dynamics, Twiflex Limited, Industrial Clutch, Huco Dynatork, Matrix International, Warner Linear and Delroyd Worm Gear. The Company designs and manufactures products that serve a variety of applications in the food and beverage, material handling, printing, paper and packaging, specialty machinery, and turf and garden industries. Primary geographic markets are in North America, Western Europe and Asia.
 
The Company was formed on November 30, 2004 following acquisitions of certain subsidiaries of Colfax Corporation (“Colfax”) and The Kilian Company (“Kilian”). The consolidated financial statements of the Company include the accounts of the Company subsequent to November 30, 2004. The financial statements of “the Predecessor” include the combined historical financial statements of the Colfax entities acquired by the Company that formerly comprised the Power Transmission Group of Colfax, a privately-held industrial manufacturing company, that are presented for comparative purposes.
 
The historical financial results of Kilian, which was not related to the Predecessor, are not included in the presentation of Predecessor balances in the financial statements or the accompanying footnotes.
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of the Company, the Predecessor (where noted) and their wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
 
Reclassification
 
Certain prior period amounts have been reclassified in the consolidated financial statements to conform to the current period presentation.
 
Net Income Per Share
 
Basic earnings per share is based on the weighted average number of common shares outstanding, and diluted earnings per share is based on the weighted average number of common shares outstanding and all dilutive potential common equivalent shares outstanding. Common equivalent shares are included in the per share calculations when the effect of their inclusion would be dilutive.


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
The following is a reconciliation of basic to diluted net income per share:
 
                 
    Year Ended
    Year Ended
 
    December 31,
    December 31,
 
    2006     2005  
 
Net Income
  $ 8,941     $ 2,504  
                 
Shares used in net income per common share — basic
    1,183       9  
Effect of dilutive securities:
               
Incremental shares of unvested restricted common stock
    1,321       1,210  
Preferred Stock
    17,021       17,750  
                 
Shares used in net income per common share — diluted
    19,525       18,969  
                 
Net income per common share — basic
  $ 7.56     $ 278.22  
                 
Net income per common share — diluted
  $ 0.46     $ 0.13  
                 
 
There was no common stock outstanding for the one month period from December 1, 2004 to December 31, 2004 to establish a basic earnings per share. The company did not generate earnings for the period from December 1, 2004 to December 31, 2004, therefore, the potential common stock equivalents were anti-dilutive and excluded from dilutive earnings per share.
 
The Predecessor’s capital structure was comprised of contributions from the parent and affiliated companies. There was no common stock associated with the group of entities which comprised the Predecessor. Accordingly there is no respective earnings per share.
 
Fair Value of Financial Instruments
 
The carrying values of financial instruments, including accounts receivable, accounts payable and other accrued liabilities, approximate their fair values due to their short-term maturities. The carrying amount of the 9% Senior Secured Notes was $160.4 and $159.4 million at December 31, 2006 and 2005, respectively. The carrying amount of the 11.25% Senior Notes was $64.6 million as of December 31, 2006. The estimated fair value of the 9% Senior Secured Notes at December 31, 2006 and December 31, 2005 was $168.3 million and $160.1 million, respectively based on quoted market prices for such Notes. The estimated fair value of the 11.25% Senior Notes was approximately £36.3 million ($71.1 million) as of December 31, 2006.
 
Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the financial statements. Actual results could differ from those estimates.
 
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 are translated at average exchange rates effective during the respective period.
 
Foreign currency translation adjustments are included in accumulated other comprehensive loss as a separate component of stockholder’s equity. Net foreign currency transaction gains and losses are included in the results of operations in the period incurred.


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
Cash and Cash Equivalents
 
Cash and cash equivalents include all financial instruments purchased with an initial maturity of three months or less. Cash equivalents are stated at cost, which approximates fair value.
 
Trade Receivables
 
An allowance for doubtful accounts is recorded for estimated collection losses that will be incurred in the collection of receivables. Estimated losses are based on historical collection experience, as well as, a review by management of the status of all receivables. Collection losses have been within the Company’s expectations.
 
Inventories
 
Inventories are stated at the lower of cost or market using the first-in, first-out (“FIFO”) method. The cost of inventories acquired by the Company in its acquisitions reflect their fair values at the date of acquisition as determined by the Company based on the replacement cost of raw materials, the sales price of the finished goods less an appropriate amount representing the expected profitability from selling efforts, and for work-in-process the sales price of the finished goods less an appropriate amount representing the expected profitability from selling efforts and costs to complete.
 
The Company periodically reviews its quantities of inventories on hand and compares these amounts to the expected usage of each particular product or product line. The Company records as a charge to cost of sales any amounts required to reduce the carrying value of inventories to net realizable value.
 
Property, Plant and Equipment
 
Property, plant, and equipment are stated at cost, net of accumulated depreciation incurred since November 30, 2004.
 
Depreciation of property, plant, and equipment is provided using the straight-line method over the estimated useful life of the asset, as follows:
 
         
Buildings and improvements
    15 to 45 years  
Machinery and equipment
    2 to 15 years  
 
Improvements and replacements are capitalized to the extent that they increase the useful economic life or increase the expected economic benefit of the underlying asset. Repairs and maintenance expenditures are charged to expense as incurred.
 
Intangible Assets
 
Intangibles represent product technology and patents, tradenames and trademarks and customer relationships. Product technology, patents and customer relationships are amortized on a straight-line basis over 8 to 12 years. The tradenames and trademarks are considered indefinite-lived assets and are not being amortized. Intangibles are stated at fair value on the date of acquisition, at December 31, 2006, and 2005 intangibles are stated net of accumulated amortization incurred since the date of acquisition.
 
Goodwill
 
Goodwill represents the excess of the purchase price paid by the Company for the Predecessor, Kilian, Hay Hall and Bear Linear over the fair value of the net assets acquired in each of the acquisitions. Goodwill can be attributed to the value placed on the Company being an industry leader with a market leading position in the Power Transmission industry. The Company’s leadership position in the market was achieved by


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

developing and manufacturing innovative products and management anticipates that its leadership position and profitability will continue to expand, enhanced by cost improvement programs associated with ongoing consolidation and centralization of its operations.
 
Impairment of Goodwill and Indefinite-Lived Intangible Assets
 
The Company evaluates the recoverability of goodwill and indefinite-lived intangible assets annually, or more frequently if events or changes in circumstances, such as a decline in sales, earnings, or cash flows, or material adverse changes in the business climate, indicate that the carrying value of an asset might be impaired. Goodwill is considered to be impaired when the net book value of a reporting unit exceeds its estimated fair value. Fair values are established using a discounted cash flow methodology (specifically, the income approach). The determination of discounted cash flows is based on the Company’s strategic plans and long-range forecasts. The revenue growth rates included in the forecasts are the Company’s best estimates based on current and anticipated market conditions, and the profit margin assumptions are projected based on current and anticipated cost structures. This analysis included consideration of discounted cash flows as well as EBITDA multiples. The analysis indicated no impairment to be present as of December 31, 2006 and 2005.
 
Impairment of Long-Lived Assets Other Than Goodwill and Indefinite-Lived Intangible Assets
 
The Company assesses its long-lived assets other than goodwill and indefinite-lived intangible assets for impairment whenever facts and circumstances indicate that the carrying amounts may not be fully recoverable. To analyze recoverability, the Company projects undiscounted net future cash flows over the remaining lives of such assets. If these projected cash flows are less than the carrying amounts, an impairment loss would be recognized, resulting in a write-down of the assets with a corresponding charge to earnings. The impairment loss is measured based upon the difference between the carrying amounts and the fair values of the assets. Assets to be disposed of are reported at the lower of the carrying amounts or fair value less cost to sell. Management determines fair value using the discounted cash flow method or other accepted valuation techniques.
 
Debt Issuance Costs
 
Costs directly related to the issuance of debt are capitalized, included in other long-term assets and amortized using the effective interest method over the term of the related debt obligation. The net carrying value of debt issuance costs was approximately $5.4 million and $3.9 million at December 31, 2006 and 2005, respectively.
 
Revenue Recognition
 
Product revenues are recognized, net of sales tax collected, at the time title and risk of loss pass to the customer, which generally occurs upon shipment to the customer. Service revenues are recognized as services are performed. Amounts billed for shipping and handling are recorded as revenue. Product return reserves are accrued at the time of sale based on the historical relationship between shipments and returns, and are recorded as a reduction of net sales.
 
Certain large distribution customers receive quantity discounts which are recognized net at the time the sale is recorded.
 
Shipping and Handling Costs
 
Shipping and handling costs associated with sales are classified as a component of cost of sales.


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
Warranty Costs
 
Estimated expenses related to product warranties are accrued at the time products are sold to customers. Estimates are established using historical information as to the nature, frequency, and average costs of warranty claims.
 
Self-Insurance
 
Certain operations are self-insured up to pre-determined amounts above which third-party insurance applies, for medical claims, workers’ compensation, vehicle insurance, product liability costs and general liability exposure. The accompanying balance sheets include reserves for the estimated costs associated with these self-insured risks, based on historic experience factors and management’s estimates for known and anticipated claims. A portion of medical insurance costs are offset by charging employees a premium equivalent to group insurance rates.
 
Research and Development
 
Research and development costs are expensed as incurred.
 
Advertising
 
Advertising costs are charged to selling, general, and administrative expenses as incurred and amounted to approximately $2.4 million, $2.2 million, $0.2 million and $2.0 million, for the year ended December 31, 2006, December 31, 2005, and for the periods from December 1, 2004 through December 31, 2004 and January 1, 2004 through November 30, 2004.
 
Stock-Based Compensation
 
The Company established the 2004 Equity Incentive Plan that provides for various forms of stock based compensation to officers and senior-level employees of the Company. The Company accounts for grants under this plan in accordance with the provisions of SFAS No. 123(R). Expense associated with equity awards is recognized on a straight-line basis over the vesting period of the grant.
 
Income Taxes
 
The Company records income taxes using the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and operating loss and tax credit carryforwards. The Company evaluates the realizability of its net deferred tax assets and assesses the need for a valuation allowance in purchase price accounting and on a quarterly basis. The future benefit to be derived from its deferred tax assets is dependent upon the Company’s ability to generate sufficient future taxable income to realize the assets. The Company records a valuation allowance to reduce its net deferred tax assets to the amount that may be more likely than not to be realized. In periods subsequent to an acquisition, if the Company were able to realize net deferred tax assets in excess of their net recorded amount established in the purchase price allocation, an adjustment to the valuation allowance would be recorded as a reduction to goodwill in the period such determination was made.
 
To the extent the Company establishes a valuation allowance on net deferred assets generated from operations, an expense will be recorded within the provision for income taxes line on the statement of operations. In periods subsequent to establishing a valuation allowance on net deferred assets from operations, if the Company were to determine that it would be able to realize its net deferred tax assets in excess of their net recorded amount, an adjustment to the valuation allowance would be recorded as a reduction to income tax expense in the period such determination was made.


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

Accumulated Other Comprehensive Income (Loss)
 
The Company’s total accumulated other comprehensive income (loss) is comprised of the following:
 
                         
    Minimum
    Cumulative
       
    Pension
    Foreign
    Accumulated
 
    Liability/SFAS
    Currency
    Other
 
    No. 158
    Translation
    Comprehensive
 
    Liability     Adjustment     Income (Loss)  
 
For the Predecessor
                       
Balance at December 31, 2003
  $ (36,820 )   $ 3,595     $ (33,225 )
Minimum pension liability adjustment
    478             478  
Cumulative foreign currency translation adjustment
          (6,031 )     (6,031 )
                         
Balance at November 30, 2004
  $ (36,342 )   $ (2,436 )   $ (38,778 )
                         
For the Company
                       
Opening balance December 2004
  $     $     $  
Minimum pension liability adjustment
    (722 )           (722 )
Cumulative foreign currency translation adjustment
          549       549  
                         
Balance at December 31, 2004
    (722 )     549       (173 )
Minimum pension liability adjustment
    (700 )           (700 )
Cumulative foreign currency translation adjustment
          (6,400 )     (6,400 )
                         
Balance at December 31, 2005
    (1,422 )     (5,851 )     (7,273 )
Minimum pension liability adjustment
    696             696  
Cumulative foreign currency translation adjustment
          677       677  
Cumulative adjustment for transition to SFAS No. 158
    2,836             2,836  
                         
Balance at December 31, 2006
  $ 2,110     $ (5,174 )   $ (3,064 )
                         
 
2.   Recent Accounting Pronouncements
 
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN 48”), “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 will be effective for fiscal years beginning after December 15, 2006. The provisions of FIN 48 are effective January 1, 2007. The Company is currently evaluating the effect that the adoption of FIN 48 will have on its financial position and results of operations.
 
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108 “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements,”. SAB No. 108 states that registrants should use both a balance sheet approach and an income statement approach when quantifying and evaluating the materiality of a misstatement. The interpretations in SAB No. 108 contain guidance on correcting errors under the dual approach as well as provide transition guidance for correcting errors. This interpretation does not change the requirements within SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB No. 20 and FASB Statement No. 3,” for the correction of an error on financial statements. The Company adopted this pronouncement during 2006, the effect of this statement was not material to the financial statements.
 
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This standard defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

United States of America, and expands disclosure about fair value measurements. This pronouncement applies under other accounting standards that require or permit fair value measurements. Accordingly, this statement does not require any new fair value measurement. This statement is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the effect to be material.
 
In September 2006, the FASB issued 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).” This pronouncement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability on its statement of financial position. SFAS No. 158 also requires an employer to recognize changes in that funded status in the year in which the changes occur through comprehensive income. On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158. The effect of adopting Statement 158 is not included on the Company’s consolidated balance sheet at December 31, 2005 or 2004. SFAS No. 158’s provisions regarding the change in the measurement date of postretirement benefit plans are not applicable as the Company already uses a measurement date of December 31 for its pension plans. See Note 9 for further discussion of the effect of adopting SFAS No. 158 on the Company’s consolidated financial statements.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” The standard permits entities to choose to measure many financial instruments and certain other items at fair value and is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS No. 157, “Fair Value Measurements.” The Company is in the process of evaluating the impact this pronouncement may have on our results of operations and financial condition and whether to adopt the provisions of the standard for the fiscal year beginning January 1, 2007.
 
3.   Acquisitions
 
On February 10, 2006, the Company purchased all of the outstanding share capital of Hay Hall for $49.2 million. The purchase price is still subject to a change as a result of the finalization of a working capital adjustment in accordance with the terms of the purchase agreement. Included in the purchase price was $6.0 million paid in the form of deferred consideration. At the closing the Company deposited such deferred consideration into an escrow account for the benefit of the former Hay Hall shareholders. The deferred consideration is represented by a loan note. While the former Hay Hall shareholders will hold the note, their rights will be limited to receiving the amount of the deferred consideration placed in the escrow account. They will have no recourse against the Company unless we take action to prevent or interfere in the release of such funds from the escrow account. At closing, Hay Hall and its subsidiaries became the Company’s direct or indirect wholly owned subsidiaries. Hay Hall is a UK-based holding company established in 1996 that is focused primarily on the manufacture of couplings and clutch brakes. Hay Hall consists of five main businesses that are niche focused and have strong brand names and established reputations within their primary markets.
 
The Hay Hall acquisition has been accounted for in accordance with SFAS No. 141. The closing date of the Hay Hall acquisition was February 10, 2006, and as such, the Company’s consolidated financial statements reflect Hay Hall’s results of operations only from that date forward.
 
The Company has completed its final purchase price allocation. The value of the acquired assets, assumed liabilities and identified intangibles from the acquisition of Hay Hall, as presented below, are based upon fair value as of the date of the acquisition. The goodwill and intangibles recorded in connection with the


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

acquisition of Hay Hall have been allocated across the business units acquired. The final purchase price allocation is as follows:
 
         
Total purchase price, including closing costs of approximately $1.8 million
  $ 51,030  
         
Cash and cash equivalents
    775  
Trade receivables
    12,111  
Inventories
    17,004  
Prepaid expenses and other
    510  
Property, plant and equipment
    13,670  
Intangible assets
    16,352  
         
Total assets acquired
    60,422  
Accounts payable, accrued payroll, and accruals and other current liabilities
    12,971  
Other liabilities
    8,784  
         
Total liabilities assumed
    21,755  
         
Net assets acquired
    38,667  
         
Excess purchase price over the fair value of net assets acquired
  $ 12,363  
         
 
The excess of the purchase price over the fair value of the net assets acquired was recorded as goodwill.
 
The amounts recorded as intangible assets consist of the following:
 
         
Patents, subject to amortization
  $ 110  
Customer relationships, subject to amortization
    9,312  
Trade names and trademarks, not subject to amortization
    6,930  
         
Total intangible assets
  $ 16,352  
         
 
Customer relationships are amortized on a straight-line basis over 11 years representing the anticipated periods over which the Company estimates it will benefit from the acquired assets. The Company anticipates that substantially all of this amortization is deductible for income tax purposes. The acquisition of Hay Hall did not result in any tax deductible goodwill.
 
On May 18, 2006, the Company entered into a purchase agreement with the shareholders of Bear Linear LLC, or Bear, to purchase substantially all of the assets of the company for $5.0 million. Approximately $3.5 million was paid at closing and the remaining $1.5 million is payable over the next 2.5 years. One of Bear’s selling shareholders is a direct relative of one of the Company’s directors. Bear manufacturers high value-added linear actuators for mobile off-highway and industrial applications.
 
The Bear acquisition has been accounted for in accordance with SFAS No. 141. The closing date of the Bear acquisition was May 18, 2006, and as such, the Company’s consolidated financial statements reflect Bear’s results of operations only from that date forward.
 
Bear had approximately $0.5 million of net assets at closing consisting primarily of accounts receivable, inventory, fixed assets and accounts payable and accrued liabilities. The Company did not identify any specifically identifiable intangible assets. The Company recorded the $4.2 million excess purchase price over the fair value of the net assets acquired as goodwill. The Company has completed its final purchase price allocation.


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
The following table sets forth the unaudited pro forma results of operations of the Company for the year to date periods ended December 31, 2006 and December 31, 2005 as if the Company had acquired Hay Hall and Bear Linear as of January 1, 2005. The pro forma information contains the actual operating results of the Company, Bear Linear and Hay Hall with the results prior to May 18, 2006, for Bear Linear, and February 10, 2006, for Hay Hall, adjusted to include the pro forma impact of (i) the elimination of additional expense as a result of the fair value adjustment to inventory recorded in connection with the Hay Hall Acquisition; (ii) additional interest expense associated with debt issued on February 8, 2006; (iii) the elimination of intercompany sales between Hay Hall and the Company; (iv) additional expense as a result of estimated amortization of identifiable intangible assets; (v) and an adjustment to the tax provision for the tax effect of the above adjustments. These pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisitions occurred as of January 1, 2005 or that may be obtained in the future.
 
                 
    Year to Date
    Year to Date
 
    Ended
    Ended
 
    December 31,
    December 31,
 
(Pro Forma, Unaudited)
  2006     2005  
 
Total Revenues
  $ 471,618     $ 426,446  
Net income
  $ 10,864     $ (898 )
 
On November 30, 2004, the Company acquired the Predecessor for $180.0 million in cash and Kilian for an $8.8 million issuance of common stock plus the assumption of Kilian debt in the amount of approximately $12.2 million. The purchase price of both acquisitions has been adjusted following the completion of certain negotiations surrounding adjustments to the respective seller’s recorded working capital at the acquisition date. In 2005 Predecessor negotiations were finalized resulting in the return of approximately $1.6 million of the purchase price to the Company. Negotiations were also finalized for Kilian which resulted in a final payment by the Company of approximately $0.7 million.
 
The acquisitions have been accounted for in accordance with SFAS No. 141, “Business Combinations.” As discussed in the Basis of Presentation in Note 1, the consolidated financial statements include the results of operations for the period December 1, 2004 through December 31, 2004, and those of the Predecessor for prior periods.


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

The Company has completed its purchase price allocations. The value of the acquired assets, assumed liabilities and identified intangibles from the acquisition of the Predecessor and Kilian, as presented below, are based upon management’s estimates of fair value as of the date of the acquisition. The goodwill and intangibles recorded in connection with the acquisition of the Predecessor have been allocated across the business units acquired from the Predecessor. The purchase price allocations are as follows:
 
                         
    Predecessor     Kilian     Total  
 
Total purchase price, including closing costs of approximately $2.6 million
  $ 178,519     $ 9,594       188,113  
                         
Cash and cash equivalents
    1,183       1,184       2,367  
Trade receivables
    39,163       6,096       45,259  
Inventories
    52,761       5,108       57,869  
Prepaid expenses and other
    4,770       207       4,977  
Property, plant and equipment
    59,320       9,111       68,431  
Intangible assets
    49,004             49,004  
Deferred income taxes — long term
    8,262       104       8,366  
Other assets
    150             150  
                         
Total assets acquired
    214,613       21,810       236,423  
Accounts payable, accrued payroll, and accruals and other current liabilities
    46,422       3,125       49,547  
Bank debt
          12,178       12,178  
Pensions, other post retirement benefits and other liabilities
    34,166             34,166  
                         
Total liabilities assumed
    80,588       15,303       95,891  
                         
Net assets acquired
    134,025       6,507       140,532  
                         
Excess purchase price over the fair value of net assets acquired
  $ 44,494     $ 3,087     $ 47,581  
                         
 
The excess of the purchase price over the fair value of the net assets acquired was recorded as goodwill. The amounts recorded as identifiable intangible assets consist of the following:
 
                         
    Predecessor     Kilian     Total  
 
Customer relationships
  $ 27,802     $     $ 27,802  
Product technology and patents
    5,122             5,122  
                         
Total intangible assets subject to amortization
    32,924             32,924  
Trade names and trademarks, not subject to amortization
    16,080             16,080  
                         
Total intangible assets
  $ 49,004     $     $ 49,004  
                         
 
Customer relationships, product technology and patents, are subject to amortization over their estimated useful lives of twelve and eight years, respectively, which reflects the anticipated periods over which the Company estimates it will benefit from the acquired assets. The weighted average estimated useful life of all intangible assets subject to amortization is approximately 11.1 years. Substantially all of this amortization is deductible for income tax purposes.


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

The following table sets forth the unaudited pro forma results of operations of the Company for the period ended December 31, 2004 as if the Company had acquired the Predecessor and Kilian as of January 1, 2004. The pro forma information contains the actual combined operating results of the Company, the Predecessor and Kilian with the results prior to the December 1, 2004 adjusted to include the pro forma impact of (i) additional amortization and depreciation expense associated with the adjustment to and recognition of fair value of fixed and intangible assets; (ii) the elimination of additional expense as a result of the fair value adjustment to inventory recorded in connection with the Acquisition; (iii) additional expenses associated with new contractual commitments created at Inception; (iv) additional expenses associated with general and administrative services previously performed by the Predecessor’s parent and not charged to the Predecessor; (v) additional interest expense associated with debt issued at Inception; (vi) the elimination of previously incurred interest expense of the Predecessor and Kilian; and (vii) the elimination of expense associated with pension and OPEB obligations retained by the Predecessor. These pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisitions occurred as of January 1, 2004 or that may be obtained in the future.
 
         
(Pro Forma, Unaudited)
  2004  
 
Total Revenues
  $ 343,308  
Net loss
    (672 )
 
4.   Inventories
 
Inventories at December 31, 2006 and 2005 consisted of the following:
 
                 
    2006     2005  
 
Raw materials
  $ 29,962     $ 22,512  
Work in process
    19,112       13,876  
Finished goods
    36,858       25,109  
                 
      85,932       61,497  
Less — Allowance for excess, slow-moving and obsolete inventory
    (10,163 )     (6,843 )
                 
    $ 75,769     $ 54,654  
                 
 
5.   Property, Plant and Equipment
 
Property, plant and equipment at December 31, 2006 and 2005, consisted of the following:
 
                 
    2006     2005  
 
Land
  $ 9,599     $ 7,892  
Buildings and improvements
    19,849       16,500  
Machinery and equipment
    71,866       50,402  
                 
      101,314       74,794  
Less — Accumulated depreciation
    (18,927 )     (8,401 )
                 
    $ 82,387     $ 66,393  
                 


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

6.   Goodwill and Intangible Assets
 
Goodwill as of December 31, 2006 and 2005 consisted of the following:
 
         
Goodwill
       
Balance December 31, 2005
  $ 65,345  
Additions related to Hay Hall acquisition
    12,363  
Additions related to Bear Linear acquisition
    4,231  
Other adjustments, net
    (18,819 )
Impact of changes in foreign currency
    2,277  
         
Balance December 31, 2006
  $ 65,397  
         
 
The other adjustments primarily relate to the reversal of valuation allowances on certain deferred tax assets that had been previously established as part of purchase accounting. Goodwill was further reduced by $2.5 million for a settlement with Colfax that resulted in a return of a portion of the purchase price.
 
                                 
    December 31, 2006     December 31, 2005  
          Accumulated
          Accumulated
 
    Cost     Amortization     Cost     Amortization  
 
Other Intangibles
                               
Intangible assets not subject to amortization:
                               
Tradenames and trademarks
  $ 23,010     $     $ 16,080     $  
Intangible assets subject to amortization:
                               
Customer relationships
    37,114       5,679       27,802       2,515  
Product technology and patents
    5,232       1,316       5,122       690  
Impact of changes in foreign currency
    1,301             (1,048 )      
                                 
Total intangible assets
  $ 66,657     $ 6,995     $ 47,956     $ 3,205  
                                 
 
The Company recorded $3.8 million, $3.0 million and $0.2 million of amortization for the year-ended December 31, 2006 and December 31, 2005, and the period from inception through December 31, 2004, respectively.
 
Customer relationships, product technology and patents are amortized over their useful lives of 12 and 8 years, respectively. The weighted average estimated useful life of intangible assets subject to amortization is approximately 11 years.
 
The estimated amortization expense for intangible assets is approximately $3.9 million in each of the next five years and then $15.9 million thereafter.
 
7.   Warranty Costs
 
Estimated expenses related to product warranties are accrued at the time products are sold to customers. Estimates are established using historical information as to the nature, frequency and average costs of warranty


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Table of Contents

 
Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

claims. Changes in the carrying amount of accrued product warranty costs for the year ended December 31, 2006 and 2005 are as follows:
 
                 
    Year — Ended
    Year — Ended
 
    December 31,
    December 31,
 
    2006     2005  
 
Balance at beginning of period
  $ 1,876     $ 1,528  
Accrued warranty costs
    1,666       1,265  
Payments and adjustments
    (1,459 )     (917 )
                 
Balance at end of period
  $ 2,083     $ 1,876  
                 
 
8.   Income Taxes
 
Pre-tax income (loss) by domestic and foreign locations were as follows:
 
                                   
                        Predecessor
 
                        (Note 1)  
                December 1,
      11 Months
 
                2004 through
      Ended
 
    December 31,
    December 31,
    December 31,
      November 30,
 
    2006     2005     2004       2004  
Domestic
  $ 15,969     $ 2,127     $ (6,539 )     $ 9,125  
Foreign
    (1,231 )     3,726       354         3,302  
                                   
    $ 14,738     $ 5,853     $ (6,185 )     $ 12,427  
                                   
 
The components of the provision (benefit) for income taxes were as follows:
 
                                   
                        Predecessor
 
                        (Note 1)  
                December 1,
      11 Months
 
                2004 through
      Ended
 
    December 31,
    December 31,
    December 31,
      November 30,
 
    2006     2005     2004       2004  
Current:
                                 
Federal
  $ 2,616     $ 1,086     $ (71 )     $ 3,851  
Foreign and state
    1,991       2,038       810         1,564  
                                   
      4,607       3,124       739         5,415  
Deferred:
                                 
Federal
    998       509       (564 )       98  
Foreign and state
    192       (284 )     (467 )       19  
                                   
      1,190       225       (1,031 )       117  
                                   
Provision (benefit) for income taxes
  $ 5,797     $ 3,349     $ (292 )     $ 5,532  
                                   


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

U.S. income taxes at the statutory tax rate reconciled to the overall U.S. and foreign provision (benefit) for income taxes were as follows:
 
                                   
                        Predecessor
 
                From Inception
      (Note 1)  
                (December 1,
      11 Months
 
                2004) through
      Ended
 
    December 31,
    December 31,
    December 31,
      November 30,
 
    2006     2005     2004       2004  
Tax at U.S. federal income tax rate
  $ 5,158     $ 2,049     $ (2,165 )     $ 4,371  
State taxes, net of federal income tax effect
    674       373       (67 )       366  
Valuation allowance
                2,011         895  
Foreign taxes, net
    944                      
Interest
    (1,361 )     313       26          
Other
    382       614       (97 )       (100 )
                                   
Provision (benefit) for income taxes
  $ 5,797     $ 3,349     $ (292 )     $ 5,532  
                                   
 
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the deferred tax assets and liabilities as of December 31, 2006 and 2005 were as follows:
 
                 
    December 31,
    December 31,
 
    2006     2005  
 
Deferred tax assets:
               
Post-retirement obligations
  $ 5,247     $ 12,050  
Goodwill
    7,555       789  
Inventory
    2,036       1,217  
Expenses not currently deductible
    5,852       6,651  
Net operating loss carryover
    2,899       1,740  
Other
    557       883  
                 
Total deferred tax assets
    24,146       23,330  
Valuation allowance for deferred tax assets
    (1,252 )     (16,389 )
                 
Net deferred tax assets
    22,894       6,941  
Deferred tax liabilities:
               
Property, plant and equipment
    9,650       6,264  
Intangible assets
    11,730       5,278  
Other
    1,108       306  
                 
Total deferred tax liabilities
    22,488       11,848  
                 
Net deferred tax assets (liabilities)
  $ 406     $ (4,907 )
                 
 
At December 31, 2006 and 2005, the Company had net operating loss carryforwards primarily related to operations in France of $3.4 million and $4.3 million, respectively, and in the United Kingdom of $4.2 million and $0, respectively, which can be carried forward indefinitely.
 
The decrease in net deferred tax liabilities for the year includes a deferred tax benefit of approximately $16.4 million attributable to the release of valuation allowances initially established in purchase accounting.


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Table of Contents

 
Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

The release of the valuation allowance resulted in a reduction of book goodwill. The decrease in net deferred tax liability from the release of previously established valuation allowance was offset by additional deferred tax liabilities generated as a result of the Hay Hall acquisition of $6.4 million and approximately $4.3 million attributable to accrued pension liabilities and currency translation adjustments recorded through other comprehensive income.
 
Valuation allowances are established for a deferred tax asset that management believes may not be realized. The Company continually reviews the adequacy of the valuation allowance and recognizes tax benefits only as reassessments indicate that it is more likely than not the benefits will be realized. A valuation allowance at December 31, 2006 of $1.3 million, related to a valuation allowance established on NOL’s acquired as part of the Hay Hall acquisition, and $16.4 million as of December 31, 2005, has been recognized to offset deferred tax assets due to the uncertainty of realizing the benefits of the deferred tax assets. The decrease in the valuation allowance relates primarily to deferred tax adjustments associated with purchase price accounting and have been recorded to goodwill. The total valuation allowance existing at December 31, 2006 of approximately $1.3 million will be allocated to reduce book goodwill if and when released in subsequent periods.
 
The undistributed earnings of the Company’s foreign subsidiaries on which tax is not provided was approximately $2.3 million as of December 31, 2006, and are considered to be indefinitely reinvested. As of December 31, 2006, the Company has not recorded U.S. federal deferred income taxes on these undistributed earnings from its foreign subsidiaries. It is expected that these earnings will be permanently reinvested in operations outside the U.S. If the undistributed earnings were not reinvested in operations outside the U.S., the tax impact would be approximately $0.9 million to the Company.
 
9.   Pension and Other Employee Benefits
 
Defined Benefit (Pension) and Postretirement Benefit Plans
 
The Company sponsors various defined benefit (pension) and postretirement (medical and life insurance coverage) plans for certain, primarily unionized, active employees (those in the employment of the Company at or hired since November 30, 2004). The Predecessor sponsored similar plans that covered certain employees, former employees and eligible dependents. At November 30, 2004, the Company assumed the pension and postretirement benefit obligations of all active U.S. employees and all non-U.S. employees of the Predecessor. Additionally, the Company assumed all post-employment and post-retirement welfare benefit obligations with respect to active U.S. employees. Colfax retained all other pension and postretirement benefit obligations relating to the Predecessor’s former employees.
 
On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158. SFAS No. 158 required the Company to recognize the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations) of its pension plans and postretirement benefit plan in the December 31, 2006 balance sheet, with a corresponding adjustment to accumulated other comprehensive income (loss), net of tax. The adjustment to accumulated other comprehensive income (loss) at adoption represents the net unrecognized actuarial losses, unrecognized prior service costs, and unrecognized transition obligation remaining from the initial adoption of SFAS No. 87 Employers’ Accounting for Pensions (“SFAS No. 87”), all of which were previously netted against the plan’s funded status in the Company’s statement of financial position pursuant to the provisions of SFAS No. 87. These amounts will be subsequently recognized as net periodic pension cost pursuant to the Company’s historical accounting policy for amortizing such amounts. Further, actuarial gains and losses that arise in subsequent periods and are not recognized as net periodic pension cost in the same periods will be recognized as a component of other comprehensive income. Those amounts will be subsequently recognized as a component of net periodic pension cost on the same basis as the amounts recognized in accumulated other comprehensive income at adoption of SFAS No. 158.


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
The incremental effects of adopting the provisions of SFAS No. 158 on the Company’s balance sheet at December 31, 2006 are presented in the following table. The adoption of SFAS No. 158 had no effect on the Company’s consolidated statement of operations for the year ended December 31, 2006, or for any prior period presented, and it will not effect the Company’s operating results in future periods. Had the Company not been required to adopt SFAS No. 158 at December 31, 2006, it would have recognized an additional minimum liability pursuant to the provisions of SFAS No. 87. The effect of recognizing the additional minimum liability is included in the table below in the column labeled “Prior to Application of SFAS No. 158.”
 
                 
    Pension as of December 31, 2006  
    Prior to
    As Reported at
 
    Adopting
    December 31,
 
    SFAS No. 158     2006  
 
Plan Funded Status:
               
Benefit obligation
  $ (26,121 )   $ (26,121 )
Allowance for future salary increases
           
                 
Projected benefit obligation
    (26,121 )     (26,121 )
Fair value of assets
    10,952       10,952  
                 
Funded Status
    (15,169 )     (15,169 )
Unrecognized loss
    1,154       N/A  
Unrecognized prior service cost
    43       N/A  
                 
Accrued benefit cost
  $ (13,972 )     N/A  
                 
Balance Sheet:
               
Prepaid benefit cost
  $       N/A  
Intangible asset
    43       N/A  
Accrued benefit cost
    (15,122 )     N/A  
                 
Net liability
  $ (15,079 )   $ (15,169 )
                 
Corresponding charges to equity accounts:
               
Retained earnings
  $ 13,972     $ 13,972  
Accumulated other comprehensive loss
    1,154       1,197  
                 
Total charges to equity
  $ 15,126     $ 15,169  
                 
 


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

                 
    Post-Retirement Benefits as of December 31, 2006  
    Prior to
    As Reported at
 
    Adopting
    December 31,
 
    SFAS No. 158     2006  
 
Plan Funded Status:
               
Benefit obligation
  $ (3,549 )   $ (3,549 )
Fair value of assets
           
                 
Funded Status
    (3,549 )     (3,549 )
Unrecognized gain
    (1,016 )     N/A  
Unrecognized prior service cost
    (3,602 )     N/A  
                 
Accrued benefit cost
  $ (8,167 )     N/A  
                 
Balance Sheet:
               
Prepaid benefit cost
    N/A       N/A  
Intangible asset
    N/A       N/A  
Accrued benefit cost
    N/A       N/A  
                 
Net liability
    N/A     $ (3,549 )
                 
Corresponding charges to equity accounts:
               
Retained earnings
    N/A     $ 8,167  
Accumulated other comprehensive loss
    N/A       (4,618 )
                 
Total charges to equity
    N/A     $ 3,549  
 
Included in accumulated other comprehensive loss at December 31, 2006 are the following amounts that have not yet been recognized in net periodic pension cost: unrecognized prior service costs of $0.4 million ($0.2 net of tax) and unrecognized actuarial losses $1.5 million ($0.9 net of tax).

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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
The following tables represent the reconciliation of the benefit obligation, fair value of plan assets and funded status of the respective defined benefit (pension) and postretirement benefit plans as of December 31, 2006 and 2005:
 
                                 
    Pension Benefits     Post Retirement Benefits  
    Year Ended
    Year Ended
    Year Ended
    Year Ended
 
    December 31,
    December 31,
    December 31,
    December 31,
 
    2006     2005     2006     2005  
 
Change in benefit obligation:
                               
Obligation at beginning of period
  $ 27,697     $ 24,706     $ 10,983     $ 12,570  
Service cost
    513       591       140       295  
Interest cost
    1,491       1,362       315       549  
Amendments
    57       55       (2,564 )     (2,088 )
Curtailments
    119             (3,838 )      
Actuarial loss (gain)
    (1,188 )     1,610       (1,291 )     (218 )
Foreign exchange effect
    326       (424 )            
Benefits paid
    (2,894 )     (203 )     (196 )     (125 )
                                 
Obligation at end of period
  $ 26,121     $ 27,697     $ 3,549     $ 10,983  
                                 
Change in plan assets:
                               
Fair value of plan assets, beginning of period
  $ 5,832     $ 4,647     $     $  
Actual return on plan assets
    821       309              
Employer contribution
    7,193       961       196       125  
Benefits paid
    (2,894 )     (85 )     (196 )     (125 )
                                 
Fair value of plan assets, end of period
  $ 10,952     $ 5,832     $     $  
                                 
Funded status
  $ (15,169 )   $ (21,865 )   $ (3,549 )   $ (10,983 )
Amounts Recognized in the balance sheet consist of:
                               
Non current assets
  $     $ 49     $     $  
Current liabilities
                (287 )      
Non-current liabilities
    (15,169 )     (21,914 )     (3,262 )     (12,500 )
                                 
Total
  $ (15,169 )   $ (21,865 )   $ (3,549 )   $ (12,500 )
                                 
 
For all pension plans presented above, the accumulated and projected benefit obligations exceed the fair value of plan assets. The accumulated benefit obligation at December 31, 2006 and 2005 was $26.1 million and $27.7 million, respectively. Non-US pension liabilities recognized in the amounts presented above are $3.4 million and $2.9 million at December 31, 2006 and 2005, respectively.
 
The weighted average discount rate used in the computation of the respective benefit obligations at December 31, 2006 and 2005 presented above are as follows:
 
                 
    2006     2005  
 
Pension benefits
    5.75 %     5.5 %
Other postretirement benefits
    5.75 %     5.5 %


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Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

The following table represents the components of the net periodic benefit cost associated with the respective plans:
 
                                                                     
    Pension Benefits     Post retirement Benefits  
                From
                        From
         
                Inception
      Predecessor
                Inception
      Predecessor
 
                (December 1,
      (Note 1)                 (December 1,
      (Note 1)  
                2004)
      11 Months
                2004)
      11 Months
 
    Year Ended
    Year Ended
    through
      Ended
    Year Ended
    Year Ended
    through
      Ended
 
    December 31,
    December 31,
    December 31,
      November 30,
    December 31,
    December 31,
    December 31,
      November 30,
 
    2006     2005     2004       2004     2006     2005     2004       2004  
Service cost
  $ 513     $ 591     $ 35       $ 530     $ 140     $ 295     $ 30       $ 269  
Interest cost
    1,491       1,362       112         8,352       315       549       59         1,654  
Recognized net actuarial loss
                        2,783       (113 )                   183  
Expected return on plan assets
    (829 )     (431 )     (31 )       (9,747 )                          
Settlement/Curtailment
    119                           (3,838 )                    
Amortization
    6       72               14       (640 )     (423 )             (19 )
                                                                     
Net periodic benefit cost
  $ 1,300     $ 1,594     $ 116       $ 1,932     $ (4,136 )   $ 421     $ 89       $ 2,087  
                                                                     
 
The key economic assumptions used in the computation of the respective net periodic benefit cost for the periods presented above are as follows:
 
                                                                     
    Pension Benefits     Postretirement Benefits  
                From
                        From
         
                Inception
      Predecessor
                Inception
      Predecessor
 
                (December 1,
      (Note 1)                 (December 1,
      (Note 1)  
                2004)
      11 Months
    Year
    Year
    2004)
      11 Months
 
    Year Ended
    Year Ended
    through
      Ended
    Ended
    Ended
    through
      Ended
 
    December 31,
    December 31,
    December 31,
      November 30,
    December 31,
    December 31,
    December 31,
      November 30,
 
    2006     2005     2004       2004     2006     2005     2004       2004  
Discount rate
    5.5 %     5.5 %     6.0 %       6.2 %     5.5 %     5.5 %     6.0 %       6.3 %
Expected return on plan assets
    8.5 %     8.5 %     8.5 %       8.5 %     N/A       N/A       N/A         N/A  
Compensation rate increase
    N/A       N/A       N/A         N/A       N/A       N/A       N/A         N/A  
 
The reasonableness of the expected return on the funded pension plan assets was determined by three separate analyses: (i) review of forty years of historical data of portfolios with similar asset allocation characteristics, (ii) analysis of six years of historical performance for the Predecessor plan assuming the current portfolio mix and investment manager structure, and (iii) a projected portfolio performance, assuming the plan’s target asset allocation.
 
For measurement of the postretirement benefit obligations and net periodic benefit costs, an annual rate of increase in the per capita cost of covered health care benefits of approximately 7.5% was assumed. This rate was assumed to decrease gradually to 5% by 2008 and remain at that level thereafter. The assumed health care trends are a significant component of the postretirement benefit costs. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
 
                 
    1-Percentage-
    1-Percentage-
 
    Point
    Point
 
    Increase     Decrease  
 
Effect on service and interest cost components for the period January 1, 2006 through December 31, 2006
  $ 67     $ (51 )
Effect on the December 31, 2006 post-retirement benefit obligation
  $ 324     $ (266 )
 
In December 2003, Congress passed the “Medicare Prescription Drug Improvement and Modernization Act of 2003” (the Act) that reformed Medicare in such a way that the Company may have been eligible to receive subsidies for certain prescription drug benefits that are incurred on behalf of plan participants. There


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Table of Contents

 
Altra Holdings, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

has been no impact on the company’s plans as either prescription drug coverage is not offered past the age of 65 or we have not applied for any subsidy. Accordingly, the amounts recorded and disclosed in these financial statements do not reflect any amounts related to this Act.
 
The asset allocations for the Company’s funded retirement plan at December 31, 2006 and 2005, respectively, and the target allocation for 2006, by asset category, are as follows:
 
                         
    Allocation Percentage of Plan Assets at Year-End  
    2006
    2006
    2005
 
    Actual     Target     Actual  
 
Asset Category
                       
Equity securities
    59 %     65 %     67 %
Fixed income securities
    41 %     35 %     33 %
 
The investment strategy is to achieve a rate of return on the plan’s assets that, over the long-term, will fund the plan’s benefit payments and will provide for other required amounts in a manner that satisfies all