Zurn Elkay Water Solutions Corp quarterly report, Q2 FY2013

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Filing identity and reporting period

Important identification discrepancy: The supplied filing is Rexnord Corporation’s Form 10-Q, not a filing identified as Zurn Elkay Water Solutions Corp. It covers the fiscal quarter ended September 29, 2012 (Rexnord fiscal Q2 2013) and the six months ended that date; comparisons are with the quarter and six months ended October 1, 2011. Rexnord reported two platforms: Process & Motion Control and Water Management.

Financial performance

  • Revenue: Q2 net sales were $499.5 million, up 11% year over year; management said core sales increased 2%, excluding acquisitions, divestitures, and currency. Six-month sales were $993.1 million, up 8%.
  • Segment trends: Q2 Process & Motion Control sales were $309.1 million, roughly flat, with core sales up 3%. Water Management sales were $190.4 million, up 38%, primarily reflecting VAG; core sales were flat. For six months, Water Management core sales declined 5%, partly reflecting lower North American municipal shipments.
  • Profit and margins: Q2 gross profit was $186.6 million (37.3% of sales), versus $159.4 million (35.5%). Operating income was $66.1 million (13.2% margin), versus $61.1 million (13.6%); Q2 included $2.4 million of restructuring charges. Net income was $19.2 million versus $4.5 million; continuing-operations net income was $20.3 million versus $4.2 million. Diluted EPS from continuing operations was $0.20 versus $0.06.
  • Six-month results: Operating income was $121.1 million (12.2% margin) versus $123.7 million (13.5%); the current period included $4.0 million restructuring charges and a $10.1 million Zurn PEX litigation charge. Net income was $17.0 million versus $15.7 million. Diluted continuing-operations EPS was $0.20 versus $0.21.
  • Cash flow and investment: Six-month operating cash flow was $8.5 million, down from $36.1 million. Capital expenditures were $32.5 million, making operating cash flow less capital expenditures approximately negative $24.0 million. Management cited working-capital cash use, restructuring payments, and the presentation of a $14.6 million excess tax benefit as drivers. Cash ended at $440.2 million, up from $298.0 million at March 31, 2012.
  • Debt and liquidity: Total debt was $2,138.7 million, down from $2,423.7 million at March 31; cash less total debt was approximately $1,698.5 million. Available additional borrowing capacity was $319.0 million, including $219.0 million under the revolver (after letters of credit) and $100.0 million under the receivables program. The company reported covenant compliance and a 1.32x senior secured bank leverage ratio, versus a 5.00x maximum.
  • Margins and interest: Q2 net interest expense declined to $37.2 million from $42.8 million; six-month expense was $75.5 million versus $87.2 million. An October 4, 2012 amendment cut the term-loan rate by 50 basis points, with a related approximately $3.0 million expense expected in fiscal Q3.

Material changes and unusual items

  • The April 2012 IPO generated $458.3 million net proceeds. The company used part of the proceeds to redeem $300.0 million principal of 11.75% notes for $325.0 million including accrued interest and premium, recording a $21.1 million extinguishment loss. It also paid Apollo $15.0 million to terminate the management agreement.
  • A $16.6 million first-quarter recovery under the Continued Dumping and Subsidy Offset Act contributed to six-month other income. Further recoveries, and any possible repayment obligation, were uncertain because of pending litigation.
  • The board approved a sale of a non-core Shanghai engineered-chain business; management expected completion within 12 months and did not expect a material financial impact. Assets of $6.8 million and liabilities of $4.3 million were classified as held for sale.
  • VAG, acquired in October 2011, contributed to Water Management’s reported sales growth. No acquisition was completed in the reported six months.

Outlook, risks, and contingencies

  • The filing gives no quantified revenue, earnings, or cash-flow guidance. Management described growth in selected Process & Motion Control end markets, while citing lower municipal water shipments and acquisition-related mix pressures in Water Management. It cautioned that interim results are not necessarily indicative of full-year results.
  • Zurn PEX brass fittings: A proposed national settlement remained subject to court approval and opt-outs. Its claims fund is capped at $20 million over seven years; plaintiffs’ fees and expenses are capped at $8.5 million, plus administrative costs. The company had recorded a $10.1 million charge in Q1. Insurance coverage is disputed, and the filing warns that liability beyond the reserve could be material.
  • Asbestos and environmental matters: The filing reports a $42.0 million estimated Zurn asbestos liability and a matching insurance receivable, while noting uncertainty about future claims, coverage, carrier solvency, and potential coverage gaps. Rexnord also described environmental and other litigation, including the Ellsworth Industrial Park site; management said the overall outcome of unresolved matters was not expected to materially adversely affect the company, but outcomes remain uncertain.
  • Other exposures: About 32% of six-month sales originated outside the United States. Management estimated that a hypothetical 10% U.S. dollar strengthening would reduce equity by about $40.4 million; a 10% adverse currency move would reduce the fair value of forward contracts by about $1.2 million. A 100-basis-point interest-rate increase was estimated to increase annual interest expense by approximately $2.1 million.
  • The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Most important facts for investors to verify

  1. Confirm the registrant and period: this text is Rexnord Corporation’s fiscal Q2 2013 10-Q, not a filing in the name supplied in the request.
  2. Track final court approval, opt-outs, insurance recovery, and any reserve revisions for the Zurn PEX settlement.
  3. Assess whether Water Management’s core-sales weakness and VAG-related margin mix persist, and whether Process & Motion Control core growth continues.
  4. Monitor operating cash generation and working capital relative to capital spending, alongside the substantial debt burden and interest-rate exposure.
  5. Verify completion and proceeds of the Shanghai business sale, and any developments affecting asbestos insurance or CDSOA recoveries.