Zurn Water Solutions Corporation (ZWS) — Q1 2022 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2022. Following the October 2021 spin-off of its Process & Motion Control business, Zurn operates as a water-management solutions company. Elkay Manufacturing was not yet part of Zurn’s reported results; the companies had agreed to combine in a stock transaction.
Financial results and liquidity
| Metric | Q1 2022 | Q1 2021 |
|---|---|---|
| Net sales | $239.6 million | $205.2 million |
| Gross profit / gross margin | $101.9 million / 42.5% | $88.4 million / 43.1% |
| Operating income / margin | $43.9 million / 18.3% | $24.0 million / 11.7% |
| Net income from continuing operations | $29.4 million | $10.0 million |
| Net income attributable to Zurn stockholders | $30.2 million | $50.0 million |
| Diluted earnings per share | $0.24 | $0.40 |
| Cash from (used for) operating activities | $(53.9) million | $71.3 million |
| Cash and cash equivalents, quarter-end | $73.2 million | $96.6 million at Dec. 31, 2021 |
| Total debt, quarter-end | $538.5 million | $539.5 million at Dec. 31, 2021 |
- Sales rose 16.8%; management reported 15% core sales growth, excluding the prior-year acquisition contribution. Growth came across all product categories.
- Operating margin expanded 660 basis points. Management cited sales growth and price realization, productivity savings, lower stock-based compensation and amortization, and a favorable LIFO adjustment; higher material and transportation costs and growth/productivity investments partly offset these gains.
- Adjusted EBITDA, a non-GAAP measure, was $52.0 million versus $44.3 million. The company reported a 2.36x net first-lien leverage ratio, within its credit agreement covenants.
- Operating cash flow was negative, primarily reflecting increased trade working capital and payment timing for payables and accruals. Investing cash flow was positive $35.5 million, including a $35.0 million receipt related to the PMC spin-off; financing cash outflow was $5.2 million.
- The $200 million revolving facility had no borrowings; $6.1 million was utilized for letters of credit, leaving $193.9 million of available borrowing capacity. The company said available liquidity was adequate for expected needs.
- Current assets were $520.1 million and current liabilities $214.5 million at March 31, 2022. The term loan matures in 2028; its reported effective interest rate was 2.75%.
Material changes versus the prior comparable period
- Continuing-operations sales and operating income improved, while operating cash flow moved from a $71.3 million inflow to a $53.9 million outflow.
- Reported net income and EPS declined from the prior-year quarter, largely because Q1 2021 included $40.0 million of after-tax income from discontinued operations. Q1 2022 included only $0.8 million of discontinued-operations income, principally a tax benefit. Comparisons of cash flows also have a scope limitation: Q1 2021 cash flows include discontinued operations, while Q1 2022 cash flows reflect continuing operations.
- Interest expense fell to $4.8 million from $9.6 million, primarily due to lower borrowings following the spin-off refinancing.
- Cash decreased $23.4 million from year-end; inventory increased to $224.3 million from $184.5 million. Debt was broadly stable.
Outlook, risks, contingencies and unusual items
- No specific earnings or sales guidance was provided. Backlog was $100.8 million at March 31; management expected approximately 99% to be recognized during the remaining nine months of 2022.
- The Elkay merger was expected to close early in Q3 2022, subject to remaining conditions including stockholder approvals. Consideration could be up to 52.5 million newly issued Zurn shares, approximately 29% of fully diluted shares on the filing’s stated pro forma basis. The HSR waiting period had expired and the registration statement became effective April 26, 2022.
- Merger risks include failure or delay in closing, transaction and integration costs, difficulty realizing synergies, restrictions on ordinary-course business actions while pending, potential employee/customer disruption, dilution and possible share-price pressure from resale of shares issued to Elkay owners. Under certain termination circumstances, Zurn may owe Elkay a $50 million fee.
- Restructuring charges were $1.1 million, mainly employee termination benefits. Management expected further workforce, lease-termination and facility-rationalization costs, but had not estimated amounts for potential additional actions.
- Asbestos claims involved approximately 6,000 lawsuits and 7,000 claims. The company recorded a $66.0 million liability and an equal insurance receivable; it estimated insurers would pay approximately $49.0 million over the next ten years. Recovery and ultimate liability remain subject to coverage and estimation uncertainties.
- Management said ordinary-course legal matters were not expected to have a material adverse effect. It also disclosed ongoing tax examinations and possible changes in unrecognized tax benefits or indemnification liabilities, with potential payments not expected to be significant.
Important facts for investors to verify
- Merger closing status, final share consideration, required approvals, and expected dilution and integration costs.
- Whether working-capital investment unwinds and operating cash flow improves; assess cash conversion separately from the spin-off-related $35 million receipt.
- Sales, pricing, input-cost and transportation-cost trends, and whether operating-margin gains are sustainable.
- Debt, interest-rate exposure, leverage covenant headroom and liquidity after any merger-related actions.
- Backlog conversion, restructuring spending, and the adequacy and recoverability of asbestos insurance coverage.