Zurn Elkay Water Solutions Corp quarterly report, Q3 FY2013

Business context and reporting period

This is Rexnord Corporation’s unaudited Form 10-Q for its fiscal third quarter ended December 29, 2012, with comparisons to the quarter ended December 31, 2011 and the nine months ended on those dates. The filing describes Process & Motion Control and Water Management businesses, including Zurn products. The supplied filing is for Rexnord Corporation, not a company identified as Zurn Elkay Water Solutions Corp.

Financial performance and position

Metric	Fiscal Q3 2013	Fiscal Q3 2012	Nine months FY2013	Nine months FY2012
Net sales	$471.7 million	$485.9 million	$1,464.8 million	$1,404.1 million
Gross profit	$167.9 million	$164.5 million	$533.2 million	$489.8 million
Income from operations	$59.5 million	$51.1 million	$180.6 million	$174.8 million
Net income	$9.2 million	$5.6 million	$26.2 million	$21.3 million
Cash provided by operating activities	Not presented for quarter	Not presented for quarter	$49.1 million	$60.7 million

Quarterly sales fell 2.9%; management reported core sales down 2%. Operating income rose 16.4%. Operating margin was 12.6%, versus 10.5%; adjusted for restructuring and prior-year inventory fair-value effects, management reported a 13.1% margin, up 130 basis points.
For the nine-month period, sales rose 4.3%, primarily reflecting the VAG acquisition. Income from continuing operations was $31.0 million, versus $20.6 million. Management reported adjusted operating income of $197.0 million, or 13.4% of sales, after specified items.
Interest expense declined to $39.1 million for the quarter and $114.6 million for nine months, from $45.1 million and $132.3 million, respectively, mainly due to lower debt balances.
At December 29, 2012, cash was $452.5 million, total debt $2,137.3 million, and stockholders’ equity $424.6 million. Cash and debt at March 31, 2012 were $298.0 million and $2,423.7 million. Current assets were $1,155.1 million and current liabilities $413.8 million.
Available additional borrowing capacity was $320.4 million: $224.3 million under the revolving credit facility and $96.1 million under the receivables program. No revolving-credit borrowings were outstanding; $40.7 million of capacity was used for letters of credit.
Nine-month capital expenditures were $41.5 million. Cash used for investing was $63.9 million; financing provided $170.6 million, including $458.3 million of net IPO proceeds.

Material changes versus comparable periods

Process & Motion Control quarterly sales declined 4.3%; management cited North American short-cycle MRO softness, partly offset by mining and energy growth. Water Management sales were nearly flat, with core sales up 1%.
For nine months, Process & Motion Control sales declined 2.7%; Water Management sales increased 19.1%, primarily due to VAG. Management reported Water Management core sales down 3%, reflecting weaker North American municipal water shipments.
Quarterly gross profit increased despite lower sales, and management attributed margin improvement in both segments partly to productivity and cost savings. Corporate operating expenses for nine months increased $11.7 million, mainly due to the Zurn PEX charge and increased stock-based compensation.
Operating cash flow declined $11.6 million year over year, which management attributed principally to a $20.9 million working-capital investment supporting long-cycle projects and a $17.2 million cash-flow classification/use related to excess tax benefits on option exercises.
The April 2012 IPO expanded the share base and helped fund redemption of $300 million of 11.75% senior subordinated notes. The company recorded $24.0 million of debt-extinguishment losses over nine months, including redemption and term-loan repricing costs.

Outlook, commentary, risks and unusual items

The board was evaluating strategic alternatives, including a possible sale of the company, a sale of one or both platforms, or retaining the current structure. The filing gives no transaction outcome or assurance that a transaction will occur; it warns of process uncertainty, distraction, costs, relationship impacts, litigation risk and possible effects on share price.
No formal sales or earnings guidance is stated. Management expected a non-cash pension and postretirement actuarial loss of approximately $20 million in fiscal Q4, but cautioned that the estimate was highly sensitive to discount rates and asset returns.
Restructuring charges were $6.3 million for nine months; substantially all expense from these actions was expected by the end of fiscal Q1 2014. The quarter included $2.3 million of restructuring costs.
The $10.1 million Zurn PEX loss-contingency charge was recorded in the first quarter. A proposed brass-fittings settlement remained subject to final court approval, included a claims fund capped at $20 million over seven years, and provided for attorneys’ fees and expenses up to $8.5 million. The company warned additional liability beyond its reserve could be material, particularly if approval or insurance recovery is not achieved as expected.
Zurn asbestos liabilities were estimated at $42.0 million, with a corresponding $42.0 million insurance receivable recorded. Management estimated $255.1 million of available insurance but cautioned coverage may not ultimately be available in full; potential liability estimates are uncertain.
The company recorded $16.6 million of CDSOA recovery income in the first quarter. Pending litigation leaves uncertain whether further distributions will be received or previously received amounts repaid.
Goodwill and indefinite-lived intangible impairment tests found no impairment. The filing notes valuations depend on assumptions including discount rates and future cash flows.
Management stated the company was in compliance with debt covenants. The senior-secured leverage ratio was 1.27x against a 5.00x maximum; the notes’ Adjusted EBITDA-to-fixed-charges ratio was 2.64x against a 2.00x minimum. Adjusted EBITDA is a non-GAAP measure and is not a substitute for GAAP results or cash flow.

Most important facts for investors to verify

Confirm the issuer and entity scope: this historical filing is Rexnord Corporation’s 2012 Form 10-Q, despite the request’s Zurn Elkay company label.
Track the strategic-alternatives review and any subsequent transaction announcements, costs, or operational effects.
Review final court approval and opt-out claims for the Zurn PEX settlement, the adequacy of reserves, and insurance coverage and collections.
Monitor cash conversion and working capital as long-cycle mining and water-infrastructure projects are delivered.
Assess debt service, refinancing capacity, floating-rate exposure, covenant headroom, and the effect of future interest-rate changes.
Compare the projected Q4 pension actuarial loss with the final remeasurement and assess possible changes in asbestos liabilities and insurance recoverability.