Zurn Elkay Water Solutions Corp quarterly report, Q2 FY2016

Filing identity and reporting period

The supplied filing is Rexnord Corporation’s Form 10-Q for the fiscal quarter ended September 30, 2015 (second quarter of fiscal 2016), not a filing identified as Zurn Elkay Water Solutions Corp. Verify the issuer before relying on this summary. Rexnord reported two platforms: Process & Motion Control and Water Management.

Key financial results

For the six months ended September 30, 2015, sales were $971.0 million versus $1,034.6 million; operating income was $108.7 million versus $135.6 million; net income attributable to Rexnord was $43.9 million versus $49.3 million; and diluted EPS was $0.42 versus $0.47.

Six-month operating cash flow was $67.0 million, down from $78.5 million. Capital expenditures were $16.7 million, yielding operating cash flow less capital expenditures of $50.3 million (versus $57.3 million in the prior-year period). Cash was $374.7 million at September 30, 2015. Total debt was $1,932.7 million; additional reported borrowing capacity was $342.5 million. The company reported a 4.1x first-lien leverage ratio, below its 7.75x covenant limit, and compliance with applicable covenants.

Material changes and operating drivers

• Q2 sales fell 8.5%. Process & Motion Control sales declined 11.8%, with management citing weak industrial-process demand, distributor destocking, and adverse currency translation; aerospace and food-and-beverage strength partly offset declines. Its operating margin fell to 12.6% from 18.6%.
• Water Management sales declined 4.0% reported, but core sales rose 1% excluding a 5% foreign-exchange headwind. Its operating margin improved to 13.2% from 13.1%, reflecting cost savings.
• For the six-month period, Process & Motion Control core sales fell 9% after excluding acquisitions and currency; Water Management core sales increased 5% excluding currency.
• Six-month operating cash flow declined mainly with lower operating profit, partly offset by working-capital management. Financing cash use included $40.0 million of share repurchases; $160.0 million of repurchase authorization remained at quarter-end.

Outlook, risks, and unusual items

• Management said distributor destocking was expected to diminish in the second half of fiscal 2016. It also expected further restructuring actions, but the plans were preliminary and costs were not yet estimable. No numerical full-year earnings or sales guidance is provided in the supplied filing text.
• Restructuring charges were $2.7 million in Q2 and $4.6 million for six months. The company had discontinued its Mill Products business in fiscal 2015; no such operating activity was reported in the current periods.
• Foreign currency was a material headwind: about 32% of Q2 sales originated outside the United States. A hypothetical 10% U.S. dollar strengthening would reduce equity by an estimated $51.7 million, according to the filing.
• About 73% of variable-rate term loans were hedged with swaps and caps. Management estimated that a 100-basis-point interest-rate increase would add approximately $3.4 million of annual term-loan interest expense under the stated market-rate assumptions.
• Asbestos-related claims remain a contingency. The company estimated $35.0 million of potential liability for claims through the next ten years and recorded a $35.0 million insurance receivable; it cautioned that actual liabilities and insurance recovery could differ. Other ordinary-course legal matters were not expected by management to materially adversely affect results, cash flow, or financial position.
• Six-month adjusted EBITDA was $174.5 million, a non-GAAP, credit-agreement measure; the filing cautions it is not a substitute for GAAP results or cash flow.

Important facts for investors to verify

• Confirm that Rexnord Corporation, rather than Zurn Elkay Water Solutions Corp, is the intended issuer and that the fiscal-period mapping is correct.
• Review the reasons for the sharp Process & Motion Control margin decline and whether management’s expected reduction in destocking occurred.
• Assess debt service and interest-rate exposure alongside cash, revolving-credit availability, and the leverage covenant.
• Check subsequent disclosures on asbestos claims, insurance coverage, restructuring costs, and the remaining Mill Products asset sale.
• Reconcile non-GAAP adjusted EBITDA to GAAP results and operating cash flow when evaluating debt capacity and liquidity.