Zurn Elkay Water Solutions Corp annual report, FY2014

Business context and reporting period

Important issuer mismatch: The supplied filing is Rexnord Corporation’s Form 10-K, not a filing by Zurn Elkay Water Solutions Corp. It covers fiscal 2014, the year ended March 31, 2014, and includes unaudited quarterly results; it is not a standalone 2013 Q4 filing. Rexnord operated Process & Motion Control and Water Management businesses, including Zurn products.

Financial performance and liquidity

Amounts are in millions of dollars except per-share data. Fiscal 2014 compared with fiscal 2013:

MetricFY2014FY2013
Net sales$2,082.0$2,005.1
Gross profit / margin$763.6 / 36.7%$731.4 / 36.5%
Operating income / margin$279.6 / 13.4%$255.4 / 12.7%
Net income attributable to Rexnord$30.2$50.1
Diluted EPS attributable to Rexnord$0.30$0.50
Operating cash flow$190.8$144.5
Capital expenditures$52.2$60.1
Cash and cash equivalents at year-end$339.0$524.1
Total debt at year-end$1,972.0$2,131.6

Fiscal 2014 Q4 net sales were $569.7 million and net income attributable to Rexnord was $40.0 million, versus $540.3 million and $23.9 million, respectively, in fiscal 2013 Q4. Fiscal 2014 Q2 included a $52.3 million quarterly net loss, driven largely by debt-extinguishment charges.

Year-end working capital was $671.3 million. The company reported $335.9 million of additional borrowing capacity, including $235.9 million under its revolving facility and $100.0 million under its receivables program. Its first-lien leverage ratio was 3.98x, and it reported compliance with applicable debt covenants. Adjusted EBITDA, a non-GAAP measure, was $413.0 million; the filing cautions that it does not reflect items such as capital spending, working-capital needs, taxes, or debt service.

Material changes versus the prior comparable period

  • Sales rose 3.8%. Process & Motion Control sales increased 1.6%; Water Management sales increased 7.7%. Management attributed Water Management growth to market-share gains and alternative-market sales, partly offset by severe Q4 weather.
  • Operating income increased 9.5%; operating margin improved 0.7 percentage points. Process & Motion Control margin rose to 19.0%, while Water Management margin was broadly flat at 9.1%.
  • Net income attributable to Rexnord declined to $30.2 million from $50.1 million, despite higher operating income. The main unusual charge was a $133.2 million loss on extinguishment of debt; lower net interest expense ($109.1 million versus $153.3 million) partly offset it.
  • Operating cash flow increased by $46.3 million, which management primarily attributed to working-capital management and higher sales. Cash declined by $185.1 million during the year, with acquisition spending and financing transactions affecting the change.
  • Acquisitions completed during the year included Precision Gear, Micro Precision, L.W. Gemmell, and Klamflex. The company also issued 3 million shares, receiving $73.8 million net proceeds.

Outlook, risks, contingencies, and unusual items

  • No quantified revenue or earnings guidance is provided. Management expected further restructuring and facility-rationalization costs, but said the related plans and expenses were not yet estimable.
  • After year-end, Rexnord acquired Green Turtle for $27.7 million. Its fiscal 2015 results would include the business after April 15, 2014. The board also began reviewing strategic alternatives, potentially including an exit or sale, for the non-core Mill Products line; outcomes were not yet determinable.
  • Key risks include substantial leverage and floating-rate exposure, cyclical industrial and construction demand, raw-material costs, reliance on distributors and significant customers, weather, foreign-exchange exposure, acquisition integration, and potential environmental, product-liability, and asbestos claims.
  • About 97% of debt was variable-rate; a 100-basis-point rate increase was estimated to raise annual interest expense by approximately $2.9 million, considering the LIBOR floor. Swaps covering $650 million of term loans were scheduled to become effective in September 2015.
  • Zurn brass-fitting litigation was resolved through a court-approved settlement with a claims fund capped at $20 million over seven years; plaintiffs’ attorneys’ fees and expenses of $8.5 million were paid in fiscal 2014. Zurn-related asbestos liabilities were estimated at $36.0 million, with a corresponding insurance receivable recorded; actual claims and insurance recovery remain uncertain. A patent-infringement trial involving a Zurn flush valve was scheduled for September 2014.
  • Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls were effective.

Important facts for investors to verify

  • Confirm the intended issuer and period: this source is Rexnord Corporation FY2014, not Zurn Elkay Water Solutions Corp. or a 2013 Q4 filing.
  • Review the debt-refinancing terms, maturities, covenant headroom, and the reconciliation of reported earnings to adjusted EBITDA.
  • Assess whether sales growth and margin trends persisted after fiscal 2014, particularly in Water Management and the weather-affected markets.
  • Check subsequent disclosures on the Mill Products strategic review, Green Turtle integration, restructuring charges, and litigation and insurance recoveries.
  • Reconcile the reported Q4 results with the quarterly financial statements and note that fiscal-year net income includes a large, unusual debt-extinguishment loss.