Filing summary
Issuer and period mismatch: The supplied filing is Rexnord Corporation’s Form 10-Q for the quarter ended September 30, 2016 (fiscal Q2 2017), not a filing identified as Zurn Elkay Water Solutions Corp. or 2016 Q2. The figures below summarize the supplied filing.
Business context and reporting period
Rexnord is a diversified industrial company with Process & Motion Control and Water Management platforms. Its fiscal year ends March 31. The filing compares the three and six months ended September 30, 2016 with the same periods in 2015.
Financial performance
| Metric | Quarter ended Sep. 30, 2016 | Prior-year quarter | Six months ended Sep. 30, 2016 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $491.0m | $485.9m | $962.8m | $971.0m |
| Gross profit | $174.0m | $169.3m | $339.4m | $339.1m |
| Income from operations | $52.5m | $55.5m | $91.1m | $108.7m |
| Net income attributable to Rexnord | $24.6m | $22.6m | $43.5m | $43.9m |
| Diluted EPS attributable to Rexnord | $0.24 | $0.22 | $0.42 | $0.42 |
| Operating margin | 10.7% | 11.4% | 9.5% | 11.2% |
Quarterly gross margin was approximately 35.4%, versus 34.8% a year earlier; six-month gross margin was approximately 35.2% in both periods. Six-month income taxes shifted from a $20.0m provision to a $1.5m benefit, contributing to nearly unchanged net income despite lower operating income.
- Segments, quarter: Process & Motion Control sales rose 6.7% to $286.9m and operating income increased to $37.1m. Water Management sales fell 6.0% to $204.1m and operating income declined to $26.0m.
- Segments, six months: Process & Motion Control sales increased 1.9% to $550.6m, but operating income fell to $62.7m. Water Management sales fell 4.3% to $412.2m and operating income declined to $48.7m.
- Six-month operating cash flow was $59.0m, compared with $67.0m. Capital expenditures were $28.9m, versus $16.7m.
- Cash was $208.5m at September 30, down from $484.6m at March 31. Total debt was $1,822.7m, including $1,822.0m long-term. The resulting simple debt less cash measure was approximately $1,614.2m.
- Available borrowing capacity was reported as $345.5m: $245.5m under the revolver and $100.0m under the receivables securitization facility. No revolver borrowings were outstanding; $19.5m of capacity was used for letters of credit.
Material changes and unusual items
- Rexnord acquired Cambridge International Holdings on June 1, 2016 for $213.4m cash. The acquired business contributed 8% to quarterly Process & Motion Control sales growth; the six-month contribution was 5%. Purchase accounting remained preliminary.
- Six-month cash flows included $213.7m of acquisition-related investing outflow and approximately $99.9m used to prepay term-loan principal. Cash declined by $276.1m over the six months.
- The company made a voluntary $95.0m term-loan prepayment, in addition to scheduled principal payments, and thereby settled future quarterly principal repayments through the facility’s August 2020 maturity.
- Restructuring charges were $4.4m for the quarter and $10.0m for six months, compared with $2.7m and $4.6m. Management expected further footprint and product-line actions, but said the overall plan and related expenses were not yet estimable.
- The company was exiting the Rodney Hunt Fontaine flow-control gate product line. Its sales were $5.5m for the quarter and $12.0m for six months, down 36.0% and 52.9%, respectively, year over year.
- Early adoption of share-based compensation guidance produced a $4.7m six-month tax benefit and may cause effective tax-rate volatility. It also increased diluted weighted-average shares by approximately 0.5m for the six-month period.
Liquidity, debt, outlook and risks
At September 30, the first-lien leverage ratio was 4.3x, compared with a maximum covenant level of 7.75x; the company reported compliance with its covenants. Approximately 98% of total indebtedness was variable-rate, while swaps and caps hedged about 78% of variable-rate term loans. Management estimated that a 100-basis-point rate increase would add about $8.5m of annual term-loan interest expense under the stated rate-floor assumptions.
On November 2, 2016, after quarter-end, the company amended its credit agreement to reduce applicable borrowing margins by 1.0%, extend the revolving facility maturity to March 15, 2019, and revise the leverage covenant. The amendment generated approximately $2.0m of costs to be recognized as interest expense over the facility’s remaining term.
No formal numerical sales or earnings guidance is provided in the supplied text. Management cited industrial OEM and end-user demand weakness, infrastructure project-shipment timing and unfavorable Water Management project mix. It noted stable nonresidential construction demand and growth in certain distribution and consumer-facing markets. Management also warned that Brexit-related effects remained uncertain and that currency movements could affect reported results.
Legal and contingency exposures include asbestos claims, environmental matters and product claims. The company estimated its Zurn-related asbestos liability at $32.0m and recorded a corresponding $32.0m insurance receivable, but cautioned that coverage may be reduced by insurer insolvencies, coverage disputes or changes in law. Management said unresolved legal matters were not expected, based on current information, to have a material adverse effect; actual asbestos exposure and insurance recoveries remain uncertain.
Most important facts to verify
- Confirm that Rexnord’s September 30, 2016 filing is the intended document, given the company and period mismatch in the request metadata.
- Review the drivers and sustainability of declining six-month operating income and margins, particularly in both operating segments.
- Verify Cambridge’s final purchase-price allocation, integration performance and contribution to underlying growth.
- Assess cash generation, post-acquisition liquidity, debt repayment capacity, variable-rate exposure and the terms of the November 2 credit amendment.
- Monitor expected additional restructuring costs and the financial impact of the RHF product-line exit.
- Evaluate asbestos liability assumptions, insurance availability and the status of other legal and tax contingencies.