Zurn Elkay Water Solutions Corporation — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Amounts are in millions of dollars unless stated otherwise. Elkay was acquired on July 1, 2022; reported 2022 results include Elkay only from that date, so year-over-year comparisons are not fully like-for-like. Prior-year results also include PMC discontinued operations, while 2022 results do not.
Business context and reporting period
The company designs, manufactures and markets water management products, including water control and safety, plumbing, drainage, sinks and drinking-water solutions. It operates as one reporting segment. The Elkay merger had a preliminary purchase price of $1,462.9, primarily paid in stock, and added commercial sink and drinking-water businesses.
Key financial metrics
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net sales | $417.7 | $229.7 | $941.5 | $678.6 |
| Gross profit | $140.4 | $95.8 | $356.1 | $288.0 |
| Gross margin | 33.6% | 41.7% | 37.8% | 42.4% |
| Operating income (loss) | $(10.1) | $32.5 | $87.3 | $93.8 |
| Operating margin | (2.4)% | 14.1% | 9.3% | 13.8% |
| Net income (loss) attributable to common stockholders | $(19.1) | $64.1 | $47.5 | $187.3 |
| Diluted earnings (loss) per share | $(0.11) | $0.51 | $0.33 | $1.50 |
Q3 sales increased 81.8%; management attributed 67 percentage points to Elkay and the prior Wade Drains acquisition, a 1% decline to foreign currency, and reported 16% core sales growth. Nine-month sales rose 38.7%, including a 24% acquisition contribution; core sales grew 15%.
For the nine months, operating cash flow was $12.6 versus $245.8 in 2021; capital expenditures were $4.3, implying approximate operating cash flow less capital expenditures of $8.3. The prior-year cash-flow period included discontinued operations, so the comparison is not directly comparable. Cash and cash equivalents were $71.9 at September 30, 2022, down from $96.6 at December 31, 2021.
Total debt was $537.0, including $531.3 of long-term debt. The company had no revolver borrowings and reported $192.4 of additional borrowing capacity, after letters of credit. Net first-lien leverage was 1.61x; covenant-defined Adjusted EBITDA was $200.0 for the nine months, and reported trailing-twelve-month net leverage was 1.61x. Current assets were $800.5 and current liabilities $328.7.
Material changes versus comparable periods
- Q3 operating results shifted to a loss, principally due to $33.7 of Elkay transaction costs, higher amortization and other acquisition-related costs, and $11.7 of restructuring charges. Sales growth and productivity savings partially offset these costs.
- Nine-month operating income declined 6.9%; management cited merger costs, acquisition-related amortization and restructuring, and higher transportation and material-input costs, partially offset by sales growth, pricing and productivity savings.
- Nine-month net income attributable to common stockholders fell from $187.3 to $47.5, substantially reflecting $140.6 of PMC discontinued-operations income in the 2021 comparison. Continuing-operations net income was $46.7 in both nine-month periods.
- Balance-sheet growth primarily reflects the Elkay acquisition: goodwill was $754.8 and intangible assets were $1,019.1 at September 30, 2022, versus $254.1 and $179.1, respectively, at December 31, 2021. The preliminary purchase-price allocation remains subject to adjustment.
Outlook, risks and unusual items
- No full-year revenue or earnings guidance is provided in the supplied filing text. Backlog was $65.8 at September 30; the company expected to recognize approximately 94% in the remainder of 2022.
- Management expects further restructuring costs related to workforce reductions, lease terminations and facility rationalization; amounts for potential additional actions were not yet estimable.
- Key merger risks include integration execution, realizing expected synergies and cost savings, potential disruption or loss of key employees, and possible impairment of the substantial goodwill and intangible assets recorded.
- Asbestos claims: approximately 6,000 lawsuits representing about 7,000 claims. The recorded liability and corresponding insurance receivable were each $66.0. Management estimated insurers would pay approximately $49.0 over the next ten years; actual liability and recoveries remain uncertain, including due to coverage disputes, legal changes or insurer insolvency.
- The company reported compliance with credit-agreement covenants. Its term loan is floating-rate; the effective rate was 5.39% at September 30, 2022. It is exposed to interest-rate and foreign-exchange risks.
- On October 20, 2022, the board declared a $0.07-per-share dividend payable December 7, 2022. Former Elkay stockholders’ potential share sales and registration rights may affect the stock price.
Important facts for investors to verify
- Whether core sales growth and margins persist after separating acquisition contributions, pricing and cost inflation.
- Cash conversion and working-capital needs, given the sharp decline in operating cash flow and higher receivables and inventory.
- Progress integrating Elkay, capturing synergies and completing the preliminary purchase-price allocation.
- Debt, floating-rate exposure, covenant headroom and liquidity under changing operating conditions.
- Whether asbestos insurance coverage remains available and whether claims or legal contingencies change materially.