Business context and reporting period
Entity mismatch: The supplied filing is Rexnord Corporation’s Form 10-Q, not a filing identified as Zurn Elkay Water Solutions Corp. The filing covers fiscal Q2 and the first six months of fiscal 2014, ended September 28, 2013; comparisons are with periods ended September 29, 2012. Rexnord reports Process & Motion Control and Water Management segments.
Financial results and liquidity
Amounts are in millions of dollars except per-share data and percentages.
| Metric | Fiscal Q2 2014 | Prior-year Q2 | First six months 2014 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $514.5 | $499.5 | $1,023.2 | $993.1 |
| Gross profit | $191.8 | $186.6 | $373.7 | $365.3 |
| Income from operations | $72.6 | $66.1 | $133.6 | $121.1 |
| Operating margin | 14.1% | 13.2% | 13.1% | 12.2% |
| Net income (loss) attributable to Rexnord | $(52.3) | $19.2 | $(38.5) | $17.0 |
| Operating cash flow | Not separately stated for the quarter | $9.1 | $8.5 |
- Q2 net loss included a $129.2 million pretax debt-extinguishment loss. Management reported net income of $28.4 million excluding that charge; the filing’s reported GAAP result remained a $52.3 million loss attributable to Rexnord.
- Q2 net sales rose 3%; core sales also rose 3%. Process & Motion Control sales increased 0.9%, while Water Management sales increased 6.5% (6% core growth, with a 1% favorable currency impact).
- Q2 gross margin was approximately 37.3%, broadly unchanged from the prior-year quarter. Process & Motion Control operating margin improved to 19.1% from 18.3%; Water Management improved to 10.8% from 9.7%.
- At September 28, cash was $206.4 million, down from $524.1 million at March 31. Total debt was $1,985.4 million, including $33.2 million current maturities; stockholders’ equity was $404.6 million.
- Six-month investing cash outflow was $53.6 million, including $19.2 million of capital expenditures and $34.4 million for acquisitions. Financing activities used $273.0 million; cash declined $317.7 million overall.
- Reported liquidity included $206.4 million cash and $323.6 million additional borrowing capacity: $223.6 million under the revolver and $100 million under the receivables program. The revolver had no borrowings outstanding; $41.4 million was utilized for letters of credit.
- Six-month Adjusted EBITDA, a non-GAAP measure, was $195.5 million. The filing reports a 4.26x net first-lien leverage ratio and compliance with applicable debt covenants.
Material changes versus the prior comparable period
- Operating income increased 9.8% in Q2 and 10% for the six-month period, while GAAP net income turned to a loss because of refinancing-related charges.
- Rexnord refinanced its debt in August, replacing the prior term loan and retiring $1.145 billion of 8.50% notes with a $1.95 billion term loan. The new term loan’s reported weighted-average effective rate was 4.00%; management estimated the note retirement would reduce annual pretax interest expense by approximately $48 million.
- Six-month net interest expense fell to $64.2 million from $75.5 million. The refinancing generated a $129.2 million Q2 extinguishment loss, in addition to a $4.0 million first-quarter charge related to repricing; the six-month total was $133.2 million.
- Water Management drove much of the sales and operating-income growth. Process & Motion Control six-month operating income declined slightly, reflecting investment in strategic geographies and end-markets.
- Prior-year comparisons included unusual items: a $16.6 million CDSOA recovery and a $10.1 million Zurn PEX loss-contingency charge. The current six-month period included $3.0 million of restructuring costs and $6.1 million of other expense, including $3.0 million for a Board review of strategic alternatives.
- Three acquisitions—Klamflex, L.W. Gemmell and Micro Precision—were completed during the first half for cash consideration; their results were included from their respective acquisition dates.
Outlook, risks, contingencies and unusual items
- The filing gives no numerical revenue or earnings guidance. Management expected announced restructuring programs to conclude by the end of fiscal 2014.
- In October 2013, after quarter-end, Rexnord entered into interest-rate swaps covering $650 million of variable-rate term loans, converting that amount to a 2.55% weighted-average fixed rate plus the applicable margin, effective September 2015 through September 2018.
- Approximately 97% of debt was variable-rate at quarter-end. Management estimated a 100-basis-point rate increase would raise annual interest expense by about $3.5 million. Foreign currency exposure is also material: about 33% of first-half sales originated outside the U.S.; a hypothetical 10% U.S. dollar strengthening was estimated to reduce equity by about $49.5 million.
- Asbestos claims remain a contingency. The estimated liability was $35.0 million, matched by a $35.0 million insurance receivable; management estimated $253.6 million of available insurance but warned coverage is not assured and actual claims may differ. Certain Water Management subsidiaries faced approximately 7,000 lawsuits representing about 26,000 claims.
- The Zurn PEX brass-fittings settlement has a claims fund capped at $20 million over seven years; $8.5 million of plaintiffs’ attorneys’ fees and expenses had been paid. Rexnord also disclosed unresolved CDSOA-related litigation, with potential future receipts or repayment not reasonably estimable.
- The filing’s Section 13(r) disclosure concerns transactions by CEVA and its subsidiaries, which Rexnord said were not Rexnord activities and had not been independently verified by Rexnord. CEVA reported small Iran-related shipments and stated it had initiated an internal investigation and notified OFAC.
Most important facts an investor should verify
- Confirm the registrant and issuer identity: this source is Rexnord Corporation, despite the request metadata naming Zurn Elkay Water Solutions Corp.
- Assess the refinancing economics against the large $129.2 million one-time Q2 extinguishment charge, the new variable-rate debt exposure and the stated prospective interest savings.
- Track cash generation and liquidity: first-half operating cash flow was only $9.1 million, and cash fell by $317.7 million, while reported undrawn facilities provide additional capacity.
- Review segment trends, particularly continued weakness in Process & Motion Control relative to Water Management’s growth, and whether growth converts into operating cash flow.
- Monitor asbestos insurance recoverability, PEX settlement claims and funding, and any developments in CDSOA litigation or the CEVA disclosure.