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RXN > SEC Filings for RXN > Form 10-Q on 28-Oct-2013All Recent SEC Filings

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Form 10-Q for REXNORD CORP


28-Oct-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Policies and Estimates The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities on the date of the financial statements and revenues and expenses during the periods reported. Actual results could differ from those estimates. Refer to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), of our Annual Report on Form 10-K for the fiscal year ended March 31, 2013 for information with respect to our critical accounting policies, which we believe could have the most significant effect on our reported results and require subjective or complex judgments by management. Except for the items reported below, management believes that as of September 28, 2013 and during the period from April 1, 2013 through September 28, 2013, there has been no material change to this information. Recent Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board ("FASB") issued another update to Accounting Standards Codification ("ASC") No. 220, Presentation of Comprehensive Income, which requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive loss by component. In addition, an entity is required to present, either on the face of the statement where net (loss) income is presented or in the notes, certain significant amounts reclassified out of accumulated other comprehensive loss by the respective line items of net (loss) income. This guidance is effective prospectively for fiscal years and interim periods within those years beginning after December 15, 2012, with early adoption permitted. As this new guidance is related to presentation only, the implementation of this guidance in the first quarter of fiscal year 2014 did not have a material impact on our results of operations, financial position or cash flows.
In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"), which generally requires an unrecognized tax benefit, or portion of an unrecognized tax benefit, be presented as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward. However, if an applicable deferred tax asset is not available or a company does not expect to use the applicable deferred tax asset, the unrecognized tax benefit should be presented as a liability in the financial statements and should not be combined with an unrelated deferred tax asset. This guidance is effective for unrecognized tax benefits that exist at the effective date for fiscal years, and interim periods within those years, beginning after December 15, 2013, with early adoption permitted. We have elected early adoption and implemented this guidance in the second quarter of fiscal 2014 resulting in an increase in the presentation of our noncurrent deferred income tax liability and a reduction in the presentation of our unrecognized tax benefits (within other liabilities) in the amount of $7.0 million and $6.3 million at September 28, 2013 and March 31, 2013, respectively.

Fiscal Year
Our fiscal year ends on March 31. Throughout this MD&A, we refer to the period from June 30, 2013 through September 28, 2013 as the "second quarter of fiscal 2014" or the "second quarter ended September 28, 2013." Similarly, we refer to the period from July 1, 2012 through September 29, 2012 as the "second quarter of fiscal 2013" or the "second quarter ended September 29, 2012."

Results of Operations
General
Rexnord is a growth-oriented, multi-platform industrial company with what we believe are leading market shares and highly trusted brands that serve a diverse array of global end-markets. Our heritage of innovation and specification have allowed us to provide highly engineered, mission critical solutions to customers for decades and affords us the privilege of having long-term, valued relationships with market leaders. We operate our Company in a disciplined way and the Rexnord Business System ("RBS") is our operating philosophy. Grounded in the spirit of continuous improvement, RBS creates a scalable, process-based framework that focuses on driving superior customer satisfaction and financial results by targeting world-class operating performance throughout all aspects of our business.
The following information should be read in conjunction with the consolidated financial statements and notes thereto, along with Item 7 "MD&A" in our Annual Report on Form 10-K for the fiscal year ended March 31, 2013.


Table of Contents

Consolidated Overview
Net sales for the second quarter of fiscal 2014 increased 3% year-over-year to $514.5 million. Core net sales for the second quarter of fiscal 2014 increased 3% as the impact of acquisitions and foreign currency translation was negligible. Income from operations for the second quarter of fiscal 2014 increased 10% year-over-year to $72.6 million, or 14% of net sales. In the second quarter of fiscal 2014, we completed a refinancing of our term loans and a full retirement of our 8.50% senior notes due 2018 (the "8.50% Notes"). In connection with these transactions, we recorded a loss on the extinguishment of debt of $129.2 million in the second quarter of fiscal 2014 (see "Loss on extinguishment of debt" below for further information). Excluding the impact of the loss on extinguishment of debt, net income increased 40% to $28.4 million. Net sales for the first six months of fiscal 2014 increased 3% year-over-year to $1,023.2 million. Core net sales for the first six months of fiscal 2014 increased 3% as the impact of acquisitions and foreign currency translation was negligible. Income from operations for the first six months of fiscal 2014 increased 10% year-over-year to $133.6 million, or 13% of net sales. In the first six months of fiscal 2014, we completed a re-pricing of our then-outstanding term loan, as well as a subsequent refinancing of our term loan and a full retirement of our 8.50% Notes as previously discussed. In connection with these transactions, we recorded a loss on the extinguishment of debt of $133.2 million in the first six months of fiscal 2014 (see "Loss on extinguishment of debt" below for further information). Excluding the impact of the loss on extinguishment of debt, net income increased 38% to $42.0 million. Second Quarter Ended September 28, 2013 Compared with the Second Quarter Ended September 29, 2012:

Net sales
(Dollars in Millions)
                                    Quarter Ended
                          September 28,      September 29,
                               2013               2012          Change    % Change
Process & Motion Control $         311.8    $         309.1    $   2.7       0.9 %
Water Management                   202.7              190.4       12.3       6.5 %
 Consolidated            $         514.5    $         499.5    $  15.0       3.0 %

Process & Motion Control
Process & Motion Control net sales were $311.8 million in the second quarter of fiscal 2014 and $309.1 million in the second quarter of fiscal 2013. Core net sales increased 1% year-over-year as low single digit sales growth in the majority of our end-markets was partially offset by a decline in sales to our bulk material handling markets.
Water Management
Water Management net sales increased 7% from the prior year to $202.7 million in the second quarter of fiscal 2014. Excluding a 1% favorable impact from foreign currency, core net sales increased 6% year-over-year as a result of market share gains in the majority of our served markets and increased alternative market sales in our non-residential construction end-markets.
Income (loss) from operations
(Dollars in Millions)

                                   Quarter Ended
                          September 28,     September 29,
                              2013              2012          Change    % Change
Process & Motion Control $        59.4     $        56.5     $  2.9         5.1 %
  % of net sales                  19.1 %            18.3 %      0.8 %
Water Management                  21.8              18.4        3.4        18.5 %
  % of net sales                  10.8 %             9.7 %      1.1 %
Corporate                         (8.6 )            (8.8 )      0.2         2.3 %
  Consolidated           $        72.6     $        66.1     $  6.5         9.8 %
    % of net sales                14.1 %            13.2 %      0.9 %


Table of Contents

Process & Motion Control
Process & Motion Control income from operations for the second quarter of fiscal 2014 increased 5.1% from the prior year to $59.4 million. Income from operations as a percentage of net sales increased 80 basis points to 19.1% in the second quarter of fiscal 2014 as a result of lower year-over-year restructuring and depreciation expense.
Water Management
Water Management income from operations for the second quarter of fiscal 2014 increased 18.5% from the prior year to $21.8 million. Income from operations as a percentage of net sales increased 110 basis points to 10.8% in the second quarter of fiscal 2014 as increased operating leverage on higher year-over-year net sales and lower amortization related to fully amortized intangible assets from the acquisition of VAG were partially offset by investments in strategic growth initiatives.
Corporate
Corporate expenses were $8.6 million and $8.8 million in the second quarter of fiscal 2014 and fiscal 2013, respectively. Interest expense, net
Interest expense, net was $29.2 million in the second quarter of fiscal 2014 compared to $37.2 million in the second quarter of fiscal 2013. The year-over-year decrease in interest expense was primarily the result of the full retirement of our 8.50% Notes during the second quarter of fiscal 2014. As a result of the transaction, our effective interest rate on approximately $1.1 billion of our outstanding debt was reduced by approximately 450 basis points. At prevailing market rates, this transaction is expected to decrease our pre-tax annual interest expense by approximately $48.0 million. See Part I Item 1, Note 13 Long-Term Debt of the condensed consolidated financial statements for more information.
Loss on extinguishment of debt
During the second quarter of fiscal 2014, we completed a refinancing of our term loan facility and a full retirement of our 8.50% Notes. Upon completion of this transaction, we recognized a pre-tax loss of $129.2 million in accordance with ASC 470-50 Debt - Modifications and Extinguishments, which was comprised of a $109.9 million bond tender premium paid to holders and $5.3 million of fees paid to lenders, as well as a non-cash write-off of $12.4 million of unamortized deferred financing costs and $1.6 million of original issue discount associated with previously outstanding debt.
Other income, net
Other income, net for the quarter ended September 28, 2013, consists of foreign currency transaction gains of $1.5 million, $0.7 million loss on the sale of property, plant and equipment and other miscellaneous losses of $0.7 million. Other income, net for the quarter ended September 29, 2012, consists of foreign currency transaction losses of $0.1 million, a $0.1 million loss on the sale of property, plant and equipment and other miscellaneous income of $0.4 million.
(Benefit) provision for income taxes
The income tax benefit was $33.2 million in the second quarter of fiscal 2014 compared to an income tax provision of $8.8 million in the second quarter of fiscal 2013. The effective income tax rate for the second quarter of fiscal 2014 was 38.7% versus 30.2% in the second quarter of fiscal 2013. The effective income tax rate for the second quarter of fiscal 2014 was above the U.S. federal statutory rate of 35% mainly due to the accrual of a significant state tax benefit associated with the August 2013 debt refinancing (see Part I Item 1, Note 13 Long-Term Debt) and the recognition of certain, previously unrecognized tax benefits due to the lapse of the applicable statutes of limitations. The effective income tax rate for the second quarter of fiscal 2013 was below the U.S. federal statutory rate of 35% mainly due to the accrual of foreign income taxes at rates which are generally below the U.S. federal statutory rate, as well as the recognition of certain foreign related branch losses for U.S. income tax purposes.
Net (loss) income from continuing operations Our net loss from continuing operations for the second quarter of fiscal 2014 was $52.5 million, inclusive of the $129.2 million pre-tax loss on extinguishment of debt, compared to net income of $20.3 million in the second quarter of fiscal 2013 as a result of the factors described above. Diluted loss per share from continuing operations was $0.54 in the second quarter of fiscal 2014, as compared to diluted income per share of $0.20 in the second quarter of fiscal 2013.
Loss from discontinued operations
Our net loss from discontinued operations was $1.1 million in the second quarter of fiscal 2013. The loss from discontinued operations relates to the divestiture by sale in fiscal 2013 of a non-core engineered chain business located in Shanghai, China within the Process & Motion Control platform.


Table of Contents

Six Months Ended September 28, 2013 Compared with the Six Months Ended
September 29, 2012:
Net sales
(Dollars in Millions)
                                  Six Months Ended
                          September 28,      September 29,
                               2013               2012          Change    % Change
Process & Motion Control $         626.4    $         623.0    $   3.4       0.5 %
Water Management                   396.8              370.1       26.7       7.2 %
 Consolidated            $       1,023.2    $         993.1    $  30.1       3.0 %

Process & Motion Control
Process & Motion Control net sales in the first six months of fiscal 2014 were $626.4 million compared to $623.0 million in the first six months of fiscal 2013. Core net sales were relatively flat year-over-year as low single digit sales growth in the majority of our end-markets was partially offset by a decline in sales to our bulk material handling markets. Water Management
Water Management net sales in the first six months of fiscal 2014 increased 7% from the prior year to $396.8 million. Core net sales also increased 7% as a result of market share gains in the majority of our served markets and increased alternative market sales in our non-residential construction end-markets. Income (loss) from operations
(Dollars in Millions)

                                  Six Months Ended
                          September 28,      September 29,
                               2013              2012          Change     % Change
Process & Motion Control $        110.7     $       112.0     $ (1.3 )      (1 )%
  % of net sales                   17.7 %            18.0 %     (0.3 )%
Water Management                   40.5              34.9        5.6        16  %
  % of net sales                   10.2 %             9.4 %      0.8  %
Corporate                         (17.6 )           (25.8 )      8.2        32  %
  Consolidated           $        133.6     $       121.1     $ 12.5        10  %
    % of net sales                 13.1 %            12.2 %      0.9  %

Process & Motion Control
Process & Motion Control income from operations for the first six months of fiscal 2014 was $110.7 million compared to $112.0 million in the first six months of fiscal 2013. Income from operations as a percentage of net sales was 17.7% and reflects investments we have made to drive share gains in strategic geographies and targeted end-markets.
Water Management
Water Management income from operations increased 16% from the prior year to $40.5 million. Income from operations as a percent of net sales increased 80 basis points from the first six months of the prior year to 10.2% primarily resulting from increased operating leverage on higher year-over-year net sales, as well as lower year-over-year amortization and depreciation related to fully amortized intangible assets from the acquisition of VAG and the consolidation of our North American manufacturing footprint, respectively. Corporate
Corporate expenses decreased by $8.2 million from $25.8 million in the first six months of fiscal 2013 to $17.6 million in the first six months of fiscal 2014 primarily due to a $10.1 million charge recorded in the prior year related to a pending legal settlement reached in connection with ongoing litigation associated with alleged failure or anticipated failure of Zurn brass fittings. See Part I Item I, Note 16 Commitments and Contingencies for additional information. This year-over-year decrease was partially offset by increased restructuring expense in the first six months of fiscal 2014.


Table of Contents

Interest expense, net
Interest expense, net was $64.2 million in the first six months of fiscal 2014 compared to $75.5 million in the first six months of fiscal 2013. The year-over-year reduction in interest expense is primarily the result of the full retirement of our 8.50% Notes and lower outstanding borrowings on our term loans for the majority of the first six months of fiscal 2014 (as compared to fiscal 2013). See Part I Item 1, Note 13 Long-Term Debt of the condensed consolidated financial statements for more information. Loss on extinguishment of debt
During the first six months of fiscal 2014, we recorded a $133.2 million loss on extinguishment of debt resulting from two debt transactions. During the first quarter of fiscal 2014, we completed a re-pricing of the applicable margin on our then-outstanding term loan facilities and recognized a pre-tax loss of $4.0 million in accordance with ASC 470-50, which was comprised of $0.8 million of fees paid to lenders, a non-cash write-off of $2.4 million of unamortized deferred financing costs and $0.8 million of original issue discount. During the second quarter of fiscal 2014, we completed a refinancing of our term loan facilities and a full retirement of our 8.50% Notes. In connection with these transactions, we recognized a pre-tax loss of $129.2 million in accordance with ASC 470-50, which was comprised of a $109.9 million bond tender premium paid to holders, $5.3 million of fees paid to lenders, as well as a non-cash write-off of $12.4 million of unamortized deferred financing costs and $1.6 million of original issue discount associated with previously outstanding debt. During the first six months of fiscal 2013, we recorded a $21.1 million loss on extinguishment of debt as a result of our early redemption of all of the then outstanding 11.75% Notes, which primarily consisted of a $17.6 million premium related to redemption and $3.5 million of a non-cash write-off of the deferred financing costs.
Other (expense) income, net
Other expense, net for the first six months of fiscal 2014 was $6.1 million and consisted of $3.0 million of costs attributable to our Board of Directors' review of strategic alternatives, foreign currency transaction losses of $1.3 million, $1.1 million loss on the sale of property, plant and equipment and other miscellaneous losses of $0.7 million. Other income, net for the first six months of fiscal 2013 was $0.7 million and consisted of management fee expense of $15.0 million to terminate our management agreement with Apollo, foreign currency transaction losses of $4.9 million, a CDSOA recovery of $16.6 million, a $4.1 million gain on the sale of property, plant and equipment and other miscellaneous losses of $0.1 million.
(Benefit) provision for income taxes
The income tax benefit recorded in the first six months of fiscal 2014 was $31.0 million compared to an income tax provision of $5.6 million in the first six months of fiscal 2013. The effective income tax rate for the first six months of fiscal 2014 was 44.3% versus 22.2% in the first six months of fiscal 2013. The effective income tax rate for the first six months of fiscal 2014 was above the U.S. federal statutory rate of 35% mainly due to the accrual of a significant state tax benefit associated with the August 2013 debt refinancing (see Part I Item 1, Note 13 Long-Term Debt) and the recognition of certain, previously unrecognized tax benefits due to the lapse of the applicable statutes of limitations. The effective income tax rate for the first six months of fiscal 2013 was below the U.S. federal statutory rate of 35% mainly due to the accrual of foreign income taxes at rates which are generally below the U.S. federal statutory rate, the recognition of certain foreign related branch losses for U.S. income tax purposes, as well as the higher tax benefit associated with significant, discrete items compared to the overall forecasted rate in conjunction with the relatively low amount of income before income taxes. Net (loss) income from continuing operations Our net loss from continuing operations for the first six months of fiscal 2014 was $38.9 million, inclusive of the $133.2 million loss on the extinguishment of debt, compared to net income from continuing operations of $19.6 million in the first six months of fiscal 2013 due to the factors described above. Diluted loss per share from continuing operations in the first six months of fiscal 2014 was $0.40, compared to diluted net income from continuing operations per share of $0.20 in the first six months of fiscal 2013. Loss from discontinued operations
Our net loss from discontinued operations was $2.6 million for the first six months of fiscal 2013. The loss from discontinued operations relates to the divestiture by sale in fiscal 2013 of a non-core engineered chain business located in Shanghai, China within the Process & Motion Control platform.


Table of Contents

Non-GAAP Financial Measures
Core sales
Core sales excludes the impact of acquisitions, divestitures and foreign currency translation. Management believes that core sales facilitates easier comparisons of our net sales performance with prior and future periods and to our peers. We exclude the effect of acquisitions because the nature, size and number of acquisitions can vary dramatically from period to period and between us and our peers, and can also obscure underlying business trends and make comparisons of long-term performance difficult. We exclude the effect of foreign currency translation from this measure because the volatility of currency translation is not under management's control. Adjusted EBITDA
Adjusted EBITDA (as described below in "Covenant Compliance") is an important measure because, under our senior secured credit facilities, our ability to incur certain types of acquisition debt and certain types of subordinated debt, make certain types of acquisitions or asset exchanges, operate our business and make dividends or other distributions, all of which will impact our financial performance, is impacted by our Adjusted EBITDA, as our lenders measure our performance with a net first lien leverage ratio by comparing our senior secured bank indebtedness to our Adjusted EBITDA (see "Covenant Compliance" for additional discussion of this ratio, including a reconciliation to our net income). We reported Adjusted EBITDA in the six months ended September 28, 2013 of $195.5 million and net loss attributable to Rexnord for the same period of $38.5 million.
Covenant Compliance
Our credit agreement, which governs our senior secured credit facilities, contains, among other provisions, restrictive covenants regarding indebtedness, payments and distributions, mergers and acquisitions, asset sales, affiliate transactions, capital expenditures and the maintenance of certain financial ratios. Payment of borrowings under the credit agreement may be accelerated if there is an event of default. Events of default include the failure to pay principal and interest when due, a material breach of a representation or warranty, certain non-payments or defaults under other indebtedness, covenant defaults, events of bankruptcy and a change of control. Certain covenants contained in the credit agreement restrict our ability to take certain actions, such as incurring additional debt or making acquisitions, if we are unable to meet certain maximum net first lien leverage ratios and, with respect to our revolving facility, also require us to remain at or below a maximum net first lien leverage ratio of 7.75 to 1.0 as of the end of each fiscal quarter (4.26x to 1.0 at September 28, 2013). Failure to comply with this covenant could limit our long-term growth prospects by hindering our ability to obtain future debt or make acquisitions.
"Adjusted EBITDA" is the term we use to describe EBITDA as defined and adjusted in our credit agreement, which is net income, adjusted for the items summarized in the table below. Adjusted EBITDA is intended to show our unleveraged, pre-tax operating results and therefore reflects our financial performance based on operational factors, excluding non-operational, non-cash or non-recurring losses or gains. Adjusted EBITDA is not a presentation made in accordance with GAAP, and our use of the term Adjusted EBITDA varies from others in our industry. This measure should not be considered as an alternative to net income, income from operations or any other performance measures derived in accordance with GAAP. Adjusted EBITDA has important limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under GAAP. For example, Adjusted EBITDA does not reflect: (a) our capital expenditures, future requirements for capital expenditures or contractual commitments; (b) changes in, or cash requirements for, our working capital needs; (c) the significant interest expenses, or the cash requirements necessary to service interest or principal payments, on our debt; (d) tax payments that represent a reduction in cash available to us; (e) any cash requirements for the assets being depreciated and amortized that may have to be replaced in the future; (f) management fees paid to Apollo; or (g) the impact of earnings or charges resulting from matters that we and the lenders under our credit agreement may not consider indicative of our ongoing operations. In particular, our definition of Adjusted EBITDA allows us to add back certain non-cash, non-operating or non-recurring charges that are deducted in calculating net income, even though these are expenses that may recur, vary greatly and are difficult to predict and can represent the effect of long-term strategies as opposed to short-term results.
In addition, certain of these expenses can represent the reduction of cash that could be used for other corporate purposes. Further, although not included in the calculation of Adjusted EBITDA below, the measure may at times allow us to add estimated cost savings and operating synergies related to operational changes ranging from acquisitions or dispositions to restructurings, and/or exclude one-time transition expenditures that we anticipate we will need to incur to realize cost savings before such savings have occurred.

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