Zurn Elkay Water Solutions Corp (ZWS) 2014 Q1 法說會逐字稿

Good morning. My name is Tricia and I will be your operator for today's call. At this time, I would like to welcome everyone to the Rexnord first quarter fiscal year 2014 earnings result conference call with Todd Adams, President and Chief Executive Officer; and Mark Peterson, senior Vice-President and Chief Financial Officer of Rexnord.

This call is being recorded and will be available on replay for a period of two weeks. The phone numbers for the replay can be found in the earnings release in the Company files on 8-K with the SEC today, July 31, and are also posted on the Company's website at www.Rexnord.com.

At this time for opening remarks and introduction, I'll turn the call over to Mark Peterson, Senior Vice President and Chief Financial Officer of Rexnord.

Good morning. Before we get started just a brief reminder this call contains certain forward-looking statements that are subject to the Safe Harbor language contained in the press release we issued today, as well as in the filings with the SEC. In addition some comparisons refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP when and why we use them.

Today's call provide an update on our overall performance for the first quarter of our fiscal 2013, including details on our two platforms, followed by an overview of our financial statements and liquidity highlights. Afterwards, we'll open the call up for your questions.

With that, I'll turn the call over to Todd Adams, President and Chief Executive Officer of Rexnord.

Thanks, Mark, and good morning, everyone and thank you today for joining us for an overview of our fiscal 2014 first-quarter results.

Starting on page four. Our first quarter sales, profits and cash flow all slightly better than what we had anticipated heading in the quarter, with a 3% overall core growth in the quarter and a 7% increase in adjusted net income, resulting in an adjusted EPS of $0.24.

When you compare our adjusted EPS to the high end of the range we provided for the first quarter of $0.19, $0.02 of the earnings [beat] came from better core growth and operating performance, and $0.03 of the additional upside was due to a lower discrete tax rate in the quarter; a topic Mark will touch on later in the call.

Turning to the highlights for the quarter within the platforms. The momentum in Water Management continues to build, as core sales grew 8%, after having grown 11% last quarter, really all in advance of what we see as a market recovery that we should benefit from beginning in calendar year '14.

To add further color on the end markets and group performance within the platform, the growth and operating performance in Zurn continues to accelerate. Again, delivering mid-single digit core growth in the quarter, clearly outpacing the overall market growth and while cleanly navigating through the [low read] conversion issues required in the marketplace.

As far as the outlook for the non-residential construction market, we continue to see construction backlogs build in the US and Canada and positive signals from the momentum-related indices. This trend, coupled with all of the progress we made over the past few years on innovation, specification and operational execution, gives us confidence that we will disproportionately benefit from an expected market recovery over the next several years. Within VAG, we delivered double-digit sales growth in the quarter, and our book to bill ratio 1.12.

As we look at the global demand for water infrastructure, we're uniquely positioned to capture and deliver on the secular growth trend, wherever it is happening in the world, as a result of the product breadth, technical confidence and geographic capability we've established and built upon with VAG. Over the past three to six months, we have seen the global project funnel become more robust and feel good about where the order rates are trending. In the quarter, we've continued to expand our product basket and geographic reach by making a small tuck-in product acquisition in South Africa, a well as and funding in internal start-up of sales and distribution capability in France. The close on Water Management -- another solid quarter, in advance of -- in improving serve market environment.

As we've discussed, based on the end market dynamics, we look at this business in more half years versus quarter, and 90 days into the first half of fiscal 2014, we're feeling good about each group in the platform and in the aggregate for fiscal 2014 and beyond.

Moving to process and motion control. Core sales growth was flat year over year and improved sequentially from our fourth quarter, amidst an overall industrial end market was down. Our view on the overall industrial end markets and geographies isn't too different than what many others have been saying, over the course of the earnings season -- North America generally stable, with little catalyst for a pronounced second-half recovery; Europe bouncing along the bottom, still cautious, but generally with a view that there's little downside left; and China struggling through a transition to a lower growth environment.

In general, it's our view you this type of macro environment is likely a reality for the next few years. So what we worked at really hard over the past couple of years is to continue to diversify our end markets to drive strategic initiatives to better position us to capture share in our served markets to hit it straight on.

In general, we've gotten labeled, as a mining-oriented company; focused on North America and primarily coal. In reality, we've worked really hard to advance and position ourself to serve the large, more diverse end market of bulk material handling and the conveyance of all sorts of materials -- iron ore, copper, gold, [product] cement, globally. The application of conveyance is the constant rugged processing of materials and the fact that the overall process -- tons of these various material is growing, we like the long-term outlook for this market, and in the near term our outlook contemplates the challenges in the end markets.

Said another way -- we're not as heavily tied to the new CapEx trends that other companies are that serve this end market. And to keep it in perspective, it only represents 12% of Rexnord revenues, whereas water markets represent 37% of revenues.

As a follow-on point to the diversity within the platform, I'll highlight our next two largest end markets in PMC; aerospace and food and beverage, which aggregate to about 27% of PMC sales and 17% of Rexnord sales. The aerospace market, which for us is primarily large commercial aircraft programs, and a book to bill ratio of over 1.1 in the quarter and is really well positioned for the long-term growth, as a result of the increased content we've won over the past several years on the major commercial aircraft programs, as well as the [organic] growth priorities we've driven. This content growth, combined with the favorable outlook for the overall aerospace demand should be a real positive for us over the next several years.

Turning to food and beverage. Demand in North America and Europe was strong in the quarter, and we're beginning to get some good winds in adjacent markets like industrial, automated [and] geohandling and automotive that utilize similar product technology for different conveyance applications.

To summarize on process and motion control, we have pockets of solid demand, as well as pockets of weaker near in demand, as well as a somewhat sluggish overall industrial environment, based on a relatively stable level of global industrial production. Taken as a whole, it's not ideal but we do feel like the aggregate demand across the platform is stabilized, both sequentially, and compared to this time a year ago, while broadly tracking for our expectations so far this fiscal year.

Next, I'll skip around just a bit to cover our outlook for the second quarter, as well as the full year, which is on page ten of the presentation.

Looking at our second quarter, we anticipate sales to be in the range of $510 million to $520 million, with core growth of approximately about 3% at the mid point. We expect adjusted earnings per share in range of $0.23 to $0.25, inclusive of a 35% tax rate in the second quarter, which impacts the second quarter by $0.01 or $0.02, compared to our full year rate, and Mark will cover the effective tack rate in our first quarter and second quarter, shortly.

Our view on the overall market remains cautious and growth and profitability we're planning for the balance of the year is largely driven by our strategic initiatives and execution.

Based on our first quarter results and current outlook, we believe some of the downside risk we were anticipating 90 days ago has moderated. As a result we expect core growth for the year to be in the range of 2% to 4% with process and motion control growth improving only modestly in the second half. Mark will fill in the blanks for you later in the call but we are raising the low end of our adjusted earnings guidance by $0.02, resulting in a adjusted EPS for the full year of $1.12 to $1.18.

All of the numbers exclude the impact of acquisitions, which we don't predict, or include in our guidance but may likely occur over the course of the year. One final comment I'll make before turning it over to Mark.

As we outlined in the press release in mid June, our Board concluded it's review of our strategy alternative process and our majority of shareholders sold about 7.5 million shares in a marketed secondary offering in June.

As we've been on the road and spoken to shareholders, much of the discussion has been about the decision to commence the process, the decision on the conclusion of the process and the speculation as to the rationale, All of which creates a sentiment that's openly focused on the past and not on the future opportunity for value creation at Rexnord.

From our perspective, our focus has been and will remain outperforming competition and the overall growth in the served markets, which we believe overtime will generate significant shareholder value.

Without getting too far ahead of myself, we're confident that we are doing that today, and we are investing in our business to extend our competitive advantages and believe that we are truly well positioned in each of our platforms moving forward. As we look out over the next couple of years, we've seen a number of catalysts that should continue to drive and create value, including leveraging our free cash flow to delever, while investing more in M&A, as well as an opportunity for a significant refinancing event within nine months and a recovery in a number of the core end markets.

I want to thank all of our customers, suppliers and shareholders for their support during the strategic review process, and most importantly our associates for their focus and dedication to serving customers, and we all look forward to executing our strategic plan over the coming years.

With that, I'll turn it over to Mark to cover the financials.

Thanks, Todd. Consistent with prior quarters, we will speak primarily to adjusted operating profit and EBITDA, adjusted net income, and adjusted earnings per share, as we feel these non-GAAP metrics provide a better understanding of our operating results. Slide 5 of the presentation takes a reported results and reconcile to the adjusted results.

Turning to page 6, I'll discuss our operating performance highlights for the first quarter. First quarter sales increased 3% from the prior year period of $509 million, driven by core sales growth of 3%. Adjusted operating income was $65 million in the first quarter, or 12.8% of sales, and our adjusted EBITDA was $92 million, or 18.2% of sales in the first quarter.

First quarter adjusted net income increased 7% year over year to $24 million, resulting in an adjusted earnings per share of $0.24. This compares to adjusted earnings per share of $0.23 in the prior year.

Free cash flow was the use of $35 million in the quarter, an improved $17 million, or 33% over the prior year quarter.

Next, I'll take time on slide 7 to walk through the operating performance in the process and motion control platform. Sales in the first quarter were $315 million. Core sales growth improved sequentially from down 4% in our 2013 fourth quarter to flat year over year in the first quarter, as growth in sales to our food and beverage and non-US mining end markets were offset by slower global industrial demand in the majority of our remaining end markets.

Turning to profitability in PMC, adjusted EBITDA was $71 million in the quarter, or 22.5% of sales, and in line with our expectations. Our first-quarter margin reflects certain investments we have made successfully to drive our the share gain strategy in certain key geographies. Looking forward, we anticipate the PMC margin to be approximately 25% for the year.

Turning to page 8, I'll make a few comments on our Water Management platform. Water Management sales in the first quarter increased 8% from the prior year to $194 million. Core sales growth was also 8% in the quarter, driven by market share gains in our end markets and increased alternative market sales in our non-residential construction end market.

First quarter adjusted EBITDA was $30 million, and adjusted EBITDA, as a percentage of sales, was in line with our expectations at 15.33% (sic - see Press Release), which is consistent with our fourth-quarter 2013 margin, on slightly lower seasonal sales, sequentially.

Moving to slide 9, I'll touch on a few cash flow and liquidity highlights. We finished the quarter at $335 million of cash, $657 million of liquidity, and no meaningful debt maturities until 2018. Total debt at the end of the quarter was $1.958 billion, and net debt was $1.623 billion, resulting in net debt leverage ratio of 4 times.

As we discussed in our last call, we replaced our term loans in the quarter, resulting in a 75 basis point reduction in our interest rate to 275 basis points with a 1% LIBOR floor. In connection with this reprising, we also prepaid $150 million of the term loans.

As we look at the remainder of our fiscal year, we anticipate our net debt leverage to decline over the balance of year through a combination of incremental earnings and strong free cash flow generation.

Next, I'll provide a few financial metrics under our credit agreement and bond indenture. First, under the credit agreement, our senior secured leverage ratio was 1.15 times versus our covenant of 5 times, and cumulative credit basket was $619 million. Under our bond indenture, we finished the quarter with a fixed charge coverage ratio of 2.8 times, and restricted payment basked totaled $548 million, inclusive of the $25 million general basket.

Before I discuss some of the details of our outlook, I want to comment on effective tax rate. As we discussed in our last call, we anticipate an effective tax rate of 31% to 33% for the fiscal year, and that range remains unchanged. What you saw in our first quarter was the timing impact of recognizing certain discrete tax benefits in the quarter that drove the effective rate down, based on the amount of pretax income, resulting in effect of tax rate of 14%.

Because these [items] were recognized in the first quarter, we will have a higher tax rate in our second, third and fourth quarter that will ultimately blend to a 31% to 33% rate for the year.

With respect to our second quarter, our effective tax rate will be approximately 35%. When you walk our first quarter earnings per share to the mid-point of the second quarter guidance, you need to add approximately $0.04 for the expected increase in profitability but then subtract $0.04 for the change in tax rate, sequentially.

Before we turn the call back to the operator to take any questions you may have, I'll make a few final comments on our outlook.

Page 10 of the presentation reiterates the guidance that I had discussed earlier in the call, and also highlights our assumptions for interest expense, depreciation and amortization, stock option expense, effective tax rate, capital expenditures, fully diluted shares outstanding for fiscal 2014. In addition, our guidance assumes we do not incur any non-operating other income or expense, as we do not forecast realized or unrealized gains or losses from foreign currency fluctuations, gains or losses on the disposal of assets, or other items that are recorded in this P&L line item. Our guidance also excludes the impact of potential acquisitions and divestitures and future nonrecurring items, such as restructuring costs.

With that, I'll turn the call back over to the operator and open up to any questions.

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question from Mig Dobre from Robert Baird. Please, go ahead.

Good morning, gentlemen. Thank you for taking my question. First question from me would be on core growth -- a little better than what I originally anticipated here. I'm wondering can you give us an update, as to how you're thinking about core growth at segment level, both PMC and Water, and what's baked into your current outlook for the remainder of the year?

For the -- sure. Mig, when we walked into the year, we felt pretty optimistic that the water business was going to continue to accelerate, and that is clearly playing out. So when you look at the full year I would say that the guidance would have sort of mid to low, high single-digit core growth embedded in there, and when you look at processing motion control it would still be in that very low single-digit number; 1% to 2% range.

Even though arguably speaking you've done quite a bit better than originally anticipated in the first quarter?

Well, in some point, we'll probably revisit it. But I think given we've got nine months left of the fiscal year, there's still a fair amount of uncertainty.

I think we're going to take the view that the end markets and industrial side taken as a whole are still mixed. I think we're doing a really good job of taking share where we can. But in the end, I think it's prudent at the this point to keep that level of guidance, and obviously run to a higher level internally.

Sure. And then I guess my follow-up would be really on the margin side, and obviously you have spoken of incremental EBITDA margins in the [$30 million] previously, and performance in the current quarter has been a little different from that.

I'm also getting the sense that looking at your PMC incremental margin guidance for the year, you're looking at something lower than you have in the past. Can you give us a sense for how you are thinking going forward? And what are some of the puts and takes here?

Sure. I'll start by saying you know if you look at your guidance, we clearly had anticipated the margins to be where they were in the quarter; it was embedded in the guidance we provided.

I think the strategy that we've deployed is really to grow the installed base. Because if you look at the model and process in motion control, we go in and we solve complex problems in lots of systems, where the cost of down time and failure is high, and everything we make generally wears out. So by growing the installed base, you in essence, set up really [and back], so we're aggressively growing end users and OEMs.

Maybe there was a little bit of timing, in terms of projects to OEMs and end users that fell into the first quarter versus the second, and they had impacted the way the margin looks. But taken as a whole, I don't think we're walking away from the 30% incrementals but I do think that this quarter was consistent with what we thought.

So I don't think there's any change in the way we're thinking about it. In fact, I think over time, we're going to continue to accelerate the investments around growing the installed base because of the business model, and the back end is so robust. And I think this is a testament to the effectiveness of the strategy of investing to grow the core and the installed base, knowing that down the road it sets up a larger annuity for us as a company.

Same thing on the water side effectively. What we're doing there is we see a market turning and we're investing in alternative channels, we're investing in additional products to put into our basket to sell to customers globally, as well as setting up capabilities in countries and geographies, where we don't have that today. So I think it's entirely consistent with driving growth; recognizing the fact that we know that the margins are going to be there as we execute.

Great. Thanks. I'll jump back in the queue.

Our next question comes from Charley Brady from BMO Capital Market. Please go ahead.

Thanks. Good morning, guys.

Good morning there, Charles.

Good morning.

Just a question back on the margins again in this quarter. I understand that they're in line with what your expectation was but it sounds like there's some incremental spend that's going on for growth purposes is -- A, is that correct? B, what's the impact on margins going forward on those kind of growth initiatives?

I'll take it by platform. Absent a little bit of shipment mix in the quarter , relative to some end user and OEM projects, there's not a ton of incremental spend in process in motion control, meaning there's not a spend, as much as it is in targeted placement of growing the installed base in a couple places, so that process in motion control.

On the water side, there's clearly additional investment that we've put in around developing some -- further developing some alternative channels through buying groups and other things, as well as expanding in certain geographies.

So that is true spend that we feel really good about, given where the market is pointing to. So in process and motion control, I wouldn't read into the fact that we're spending a bunch of money beyond really targeted placement of growing our installed base, and in water we clearly are spending a little money to make sure that we're set up as broadly as we can be for the market recovery.

Okay. That's helpful. Thanks. And can you just -- the -- you got stock-based comp and LIFO added back into the adjusted earnings. How much stock comp and LIFO is embedded in the full year guidance?

Well, if you look fairly on that -- on the page 10 of the presentation, we laid our stock comp assumption of approximately $10 million and LIFO is (multiple speakers) --

I'm sorry. My mistake, my mistake.

Or approximately $4 million to $5 million of LIFO.

Okay, $4 million to $5 million in LIFO. Thanks.

Yes, $4 million to $5 million in LIFO for the full year. Yes.

Can you -- and you talked about market share gains in water. Can you quantify how much of that is kind of adding to I guess a baseline level of growth?

Well, I think if you would look at any I'll say readily available metrics around in place or non-res starts, et cetera, yes, you'll see that market is still contracting, and is expected to contract, and the inflection point is really towards the end of the calendar year and growth begins next year. When you look at that contrasted with the Zurn business, growing in the mid single-digits consistently over a period of time. And if you look at some of the more readily public company -- public companies we compete with growing substantially below that, I think it's pretty fair to conclude that there's a market share gain that's occurring in the non-res construction market in the US.

The same is true, when we would look at the water infrastructure market globally. We moved -- we're talking about a business is growing north of 10%, and it's not -- it's consistent by geography and it is project-based. But we know -- we feel like, based on our coverage, we've got 250 direct sellers all over the world.

We've got low-cost manufacturing, and the ability to fill really any project anywhere in the world -- we clearly feel like we've got an advantage there that we're capitalizing on by -- one, doing some tuck-in acquisitions and geographies and adding to the product basket, as well as shutting up capabilities in countries that have a reasonable amount of growth and large markets that we don't currently serve. So I would say that we're pretty confident the share gain is just based on those two things.

Thank you.

Our next question from Andy Noorigian from Vertical Research Partners. Please, go ahead.

Hi. Good morning, guys.

Good morning, Andy.

Good morning, Andy.

There's just still one quick follow-up on the water investment. When do those lapse? Or is that something that's been going on for the rest of the year and we don't see that kind of anniversary until next year?

I think it's going to be an ongoing thing for us. You know we've got two fantastic groups here in Zurn and VAG that have been I'll say substantially reconfigured and organized over the last couple of years, and we really now ready for what we feel is a strong growth market going forward.

That doesn't mean that we're not going to see the margin expansion that we would expect to see in that business over time. So EBITDA margins at [15%], we clearly see on a combined basis, up in the high teens over the next several years, and you'll see it improve sequentially and you'll see it improve for the year.

So I wouldn't say that these are one-time investments. I would say that they're recurring investments are what I make to support what is a great growth business.

Okay. And then is VAG being kind of outgrowing a couple digits? Is that mix negative on the margin there's in the business?

It would be mix negative, relative to where Zurn margins are, yes, at present.

When we look at the fundamental profile of VAG versus Zurn, it's just a different market and a different business. So there is going to be an adverse mix relative to Zurn.

However, we feel like we can get the VAG margins up to where the fleet average is today and beyond over the next several years.

Okay. And then last question. Is there any color you can provide on maybe what you saw on the PMC short cycle distributor market, especially towards the end of the quarter and may be how that continue at least anecdotally into July?

Anecdoteally -- when we would -- if you go back a couple of quarters, the sell through and distribution in December was really poor, minus 5% or 6%. It went to minus 1% or 2% in March, and it was actually plus 2% on a sell-through be basis, for our categories and our products in the June quarter.

So we're seeing it progress in line with what we had expected. I think the first week of July is sort of a tough read, just based on the holiday. But for the quarter, we don't see it contracting; we see it -- and that similar 2% sort of sell-through, when you look at our second quarter -- our second quarter.

Great. Thank you very much.

(Operator Instructions). Our next question comes from Julian Mitchell from Credit Suisse.

Hi, guys. It's Charlie for Julian. Just a quick question on the mining. I heard you guys mentioned in perception as a mining company, and I'm kind of moving away from that. Just to know for the year, I think you had mentioned a bunch but I just wanted to confirm. Just for the year, what the base was in '13 in terms of percentage sales, mining contributes to PMC, and just what your expectation for growth? Or how much growth will be down this year?

Well, if you want to -- at the Rexnord level, it's 12%. If we look at it -- what's the percentage of PMC? It was about 19% last year, which compares to 27% for aerospace and food and beverage.

When we put the -- when we walked into the year, we felt -- when we had planned that market to be down between 10% and 15%.

Okay.

So when you doing the math, I think you can see that it's circa $250 million-ish market us, which we've substantially migrated away from coal.

Coal is a big piece. Two or three years ago, it's only about a third. Today, another [hot market going] outside the US, representing the lion's share of the market. So that's -- those are the statistics around the market and everything else.

Sure. So obviously underlying growth in the rest of the business. And then just real quickly, you'd mentioned just potash -- and obviously it was in the news the last couple of days. That is still fairly -- I mean agriculture is still fairly small for you guys, right?

It is. But it's a growing -- when I -- some of the comments I made around diversifying end markets -- there's a tremendous opportunity for growth, if we look at the potash market in Canada.

So we've been working with really the end users to drive specifications of our products, and we see that as a growth market for us over the next couple of years. And that's really -- when you look at what we're trying to do it's really growth content and adjacent markets with new customers, and I think it's right down the fairway of what it is we're doing to diversify that end market to something that's fundamentally less volatile than some of the historic applications.

Great. Thanks.

And we have no further questions in the queue at this time.

Great. Thank you, everyone, for joining us on the call today. We appreciate your interest and support, and look forward to providing further updates, when we announce our fiscal 2014 results in early November. Thanks a lot.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.