Zurn Elkay Water Solutions Corp quarterly report, Q2 FY2018

Filing summary

Entity and period: The supplied filing is Rexnord Corporation’s Form 10-Q for the fiscal quarter ended September 30, 2017 (fiscal Q2 2018), not a filing identified as Zurn Elkay Water Solutions Corp. Zurn is discussed as part of Rexnord’s Water Management platform. Financial amounts below are in U.S. dollars.

Business context and results

Rexnord operates Process & Motion Control and Water Management platforms, serving industrial, nonresidential construction, and water-infrastructure markets. Management cites its Rexnord Business System as its framework for productivity and continuous improvement.

Q2 sales grew 4.0%; gross margin was approximately 36.9% versus 35.4%, and operating margin was 12.9% versus 10.7%. For the six-month period, sales rose 3.7% and operating margin increased to 12.1% from 9.5%. Higher operating income was supported by sales growth, lower amortization, productivity and cost initiatives, and favorable Water Management project mix. Preferred-stock dividends reduced income attributable to common shareholders.

Segments and material changes

• Process & Motion Control: Q2 sales rose 4.7% to $300.4M; operating income increased 20.5% to $44.7M, with margin rising to 14.9% from 12.9%. Management reported 3% Q2 core sales growth, excluding currency effects.
• Water Management: Q2 sales rose 3.1% to $210.4M; operating income increased 25.0% to $32.5M, with margin rising to 15.4% from 12.7%. Management reported 5% Q2 core sales growth, excluding the RHF product-line exit and currency effects. Six-month reported sales declined slightly, while core sales increased 2%.
• Six-month interest expense fell to $40.2M from $46.5M, largely reflecting prior term-loan prepayments. The six-month tax provision was $23.0M versus a $1.5M tax benefit in the prior-year period; effective tax rates were 29.0% and (3.6)%, respectively.
• On October 4, 2017, after quarter-end, Rexnord acquired World Dryer Corporation for a preliminary cash purchase price of approximately $50.0M, net of cash acquired and excluding transaction costs. It is expected to join Water Management; the purchase-price allocation was not complete at filing.

Cash flow, debt, and liquidity

For the six months ended September 30, 2017, operating cash flow was $60.5M (prior year $59.0M); capital expenditures were $15.9M (prior year $28.9M). Investing activities used $14.1M, compared with $240.7M in the prior period, which included the Cambridge acquisition. Financing activities used $17.0M, including $8.2M of debt repayments and $11.6M of preferred dividends. Cash increased $41.2M to $531.3M.

At September 30, total debt was $1,615.7M, including $1,599.4M of long-term debt. Cash and cash equivalents were $531.3M. The company reported $345.8M of additional borrowing capacity across its revolving facility and receivables securitization program, net of letters of credit. The credit-agreement total net leverage ratio was 3.1x against a 6.75x maximum; the company reported compliance with applicable covenants. Adjusted EBITDA for the six months was $184.1M, a non-GAAP measure.

Outlook, risks, and unusual items

• The filing gives no quantified revenue, earnings, or cash-flow guidance. Management describes favorable demand trends across most served end markets, including nonresidential construction and water and wastewater infrastructure, but cautions that interim results are not necessarily indicative of full-year results.
• Restructuring and footprint optimization are continuing. Management expects additional workforce, facility, lease, and possible asset impairment or accelerated-depreciation costs, but says the plans are preliminary and future expenses are not yet estimable. Q2 restructuring charges were $5.1M; six-month charges were $7.8M.
• Rexnord disclosed ongoing legal and environmental matters, including asbestos claims. For certain Water Management asbestos claims, it estimated a $37.0M liability and recorded a corresponding $37.0M insurance receivable as probable of recovery. It estimated available insurance at $241.8M but warned coverage could be affected by disputes, legal changes, or insurer insolvencies; actual liability could differ and be substantial.
• Other risks include tax examinations and changes in deferred-tax valuation allowances, foreign-exchange and variable-rate interest exposure, and substantial indebtedness. The company uses currency forwards, interest-rate swaps, and caps; it reported that approximately 88% of variable-rate term loans were hedged.
• The 5.75% mandatory convertible preferred stock carries quarterly dividends and is scheduled to convert on November 15, 2019, subject to its terms. Preferred dividends were $5.8M in Q2 and $11.6M for six months.

Investor verification checklist

1. Confirm the issuer and filing: the provided 10-Q is Rexnord Corporation’s, although the request metadata names Zurn Elkay Water Solutions Corp.
2. Review whether operating-margin gains and core-sales growth persist, particularly in Water Management after the RHF exit and in light of the World Dryer acquisition.
3. Track cash conversion and working capital: inventory rose to $349.6M from $314.9M, and management cited higher trade working capital as a partial offset to profit growth.
4. Monitor debt, interest costs, leverage covenant headroom, and the terms and dividend/conversion effects of the preferred stock.
5. Assess actual restructuring costs and progress, asbestos insurance recoverability and exposure, and tax valuation-allowance or examination developments.