Business context and reporting period
This filing is a Form 10-Q for Rexnord Corporation, for the fiscal quarter ended December 31, 2017 (third quarter of fiscal 2018), with comparisons to the quarter ended December 31, 2016. Rexnord operated Process & Motion Control and Water Management platforms; the latter included Zurn-branded products. The filing is not in the name of Zurn Elkay Water Solutions Corp.
Financial performance
Dollar amounts are in millions except per-share data. Comparisons below are year over year unless otherwise stated.
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $492.3 | $451.8 | $1,490.8 | $1,414.6 |
| Gross profit | $182.9 | $153.0 | $547.2 | $492.4 |
| Income from operations | $63.2 | $32.8 | $184.2 | $123.9 |
| Net income | $81.6 | $3.2 | $137.9 | $46.7 |
| Net income attributable to common stockholders | $75.8 | $1.7 | $120.5 | $45.2 |
| Diluted EPS attributable to common stockholders | $0.67 | $0.02 | $1.13 | $0.43 |
- Q3 revenue rose 9.0%. Process & Motion Control sales increased 8.2% to $292.5; Water Management sales rose 10.1% to $199.8. Management cited stronger demand across served markets; Q3 Water Management also benefited from World Dryer and currency, while the prior-year RHF product-line exit affected comparisons.
- Q3 gross margin was approximately 37.2%, versus 33.9%; operating margin was 12.8%, versus 7.3%. Management attributed operating improvement to higher volume, productivity and footprint actions, and lower restructuring expense, partly offset by incentive compensation and investment in innovation and market expansion.
- For the nine months, revenue grew 5.4%; operating margin was 12.4%, versus 8.8%. Segment operating margins were 15.1% for Process & Motion Control and 14.1% for Water Management.
- Reported earnings benefited substantially from tax items, including a provisional $54.8 tax benefit from U.S. tax reform. Q3 income tax benefit was $50.0; therefore, reported net income growth does not solely reflect operating performance.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $121.9, essentially unchanged from $122.1 a year earlier. Management said higher profit was offset by higher trade working capital.
- Investing cash outflow was $69.6, including $50.0 for World Dryer and $25.1 of capital expenditures. Financing cash outflow was $320.2. Cash declined $255.3 to $234.8 at December 31, 2017.
- Total debt was $1,323.1, compared with $1,622.7 at March 31, 2017. The company refinanced its term loan and issued $500.0 principal of 4.875% senior notes due 2025; the reported carrying amount of the notes was $494.1. Debt refinancing generated an $11.9 loss on extinguishment.
- Available additional borrowing capacity was $348.1: $255.1 under the revolver and $93.0 under the receivables securitization program, after letters of credit. No amounts were drawn on either facility. The company reported a 3.0x total net leverage ratio against a 6.75x maximum covenant and compliance with applicable covenants.
- Preferred-stock dividends were $17.4 in the first nine months. The preferred shares are mandatorily convertible in November 2019, subject to stated conversion terms.
Outlook, changes, risks and unusual items
- No quantified sales, earnings or cash-flow guidance is provided. Management described favorable demand trends and ongoing productivity and restructuring initiatives, but stated that further restructuring actions are expected and their total costs are not yet estimable.
- Rexnord acquired World Dryer for approximately $50.0 on October 4, 2017. It also agreed to acquire Centa for approximately €118 million, subject to customary closing conditions and expected to close in fiscal Q4 2018. Management expected to use available liquidity sources to fund Centa.
- U.S. tax reform enacted in December 2017 reduced the federal corporate rate and produced a provisional $54.8 net tax benefit in the quarter: a $62.2 estimated benefit from deferred-tax remeasurement, partly offset by $7.4 of estimated tax expense related to deemed repatriated earnings, including a $3.0 one-time repatriation tax. The estimates were not final and could change during the measurement period.
- Asbestos matters remain a significant estimation and coverage risk. The company estimated approximately $37.0 of potential Zurn-related liability for current and expected claims over ten years and recorded a $37.0 insurance receivable deemed probable of recovery. It estimated $241.0 of available insurance, while disclosing potential coverage gaps and uncertainty over ultimate coverage and claim costs. Other disclosed litigation was not expected by management to have a material adverse effect.
- Interest-rate swaps and caps ceased qualifying for hedge accounting after the debt refinancing; approximately $8.2 of accumulated losses was expected to be reclassified to interest expense over the following 12 months. The company also recorded a $5.8 sale-leaseback receipt as a financing transaction, not a sale, during construction of a replacement facility.
- The company reported no impairment in its annual goodwill and indefinite-lived intangible asset review. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the issuer and reporting scope: this is Rexnord Corporation’s filing, not a filing under the Zurn Elkay Water Solutions Corp. name.
- Assess the sustainability of operating-margin gains and demand trends in both segments, separating core growth from acquisitions, currency and the RHF comparison effect.
- Evaluate earnings excluding the provisional tax-reform benefit and other discrete tax items; track subsequent revisions to tax accounting.
- Review cash conversion, working-capital needs, liquidity after the Centa transaction, and the debt covenant and leverage calculations.
- Monitor asbestos claim estimates, insurance recoverability and coverage gaps, as well as the final World Dryer purchase-price allocation and Centa closing and financing.