Zurn Elkay Water Solutions Corporation — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. The company designs, manufactures and markets water-management products, including water safety and control, flow systems, hygienic and environmental, and drinking-water solutions. Elkay has been included in results since its July 1, 2022 acquisition, affecting year-to-date comparisons.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net sales | $398.4 million | $417.7 million | $1,173.7 million | $941.5 million |
| Gross profit | $169.9 million | $140.4 million | $492.2 million | $356.1 million |
| Operating income (loss) | $60.1 million | $(10.1) million | $158.6 million | $87.3 million |
| Operating margin | 15.1% | (2.4)% | 13.5% | 9.3% |
| Net income (loss) | $41.4 million | $(19.1) million | $98.8 million | $47.5 million |
| Diluted EPS | $0.24 | $(0.11) | $0.56 | $0.33 |
| Operating cash flow | Not provided separately for the quarter | Not provided separately for the quarter | $195.7 million | $12.6 million |
Q3 continuing-operations net income was $35.2 million; discontinued operations contributed $6.2 million. For the nine months, continuing-operations net income was $90.7 million and discontinued operations contributed $8.1 million. The filing does not provide a separate quarterly cash-flow statement.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $173.1 million at September 30, 2023, up from $124.8 million at December 31, 2022. Current assets were $721.3 million and current liabilities $229.8 million.
- Total debt, including finance leases, was $554.2 million: term loan of $532.4 million and finance leases of $21.8 million. No revolving-credit borrowings were outstanding; $194.2 million of revolver capacity was available after letters of credit.
- The company reported a 1.26x Net First Lien Leverage Ratio and compliance with applicable credit covenants. The term loan’s weighted-average effective interest rate was 7.43% at quarter-end. On October 11, 2023, the company voluntarily repaid $60 million of term-loan principal.
- Nine-month financing cash outflows included $100.2 million for share repurchases and $36.6 million for dividends. The company had $415.5 million of remaining repurchase authorization at September 30.
- Operating cash flow increased to $195.7 million, which management attributed primarily to improved trade working-capital use, higher net income and timing of accrued expenses. Investing cash use was $6.6 million, including $15.9 million of capital expenditures, partly offset by $9.0 million of insurance proceeds.
Material changes and management commentary
- Q3 sales fell 4.6% year over year; core sales declined 5%. Management cited softer residential demand, the planned exit of certain residential sink products and prior-year shipments associated with working down elevated backlog.
- Nine-month sales rose 24.7%, but management said the Elkay combination contributed 28% growth; core sales declined 3%. Thus, reported growth does not represent underlying organic growth.
- Q3 operating margin improved 17.5 percentage points year over year. Management cited productivity synergies and restructuring related to Elkay, lower material and transportation costs, and lower restructuring charges. Q3 2022 operating results included $33.7 million of merger costs and a $14.6 million acquisition-related fair-value adjustment.
- Nine-month operating margin increased 4.2 percentage points. Management cited productivity synergies and restructuring, partly offset by higher stock-based compensation and incremental depreciation and amortization following the Elkay acquisition.
- Interest expense increased to $9.9 million in Q3 and $29.8 million for the nine months, primarily due to higher interest rates. Nine-month other expense included higher pension-related interest costs and estimated environmental-remediation accruals, partly offset by an insurance settlement.
Outlook, risks and unusual items
- The filing provides no formal revenue or earnings guidance. Backlog was $45.8 million at September 30; management expected approximately 95% to be recognized in the remaining three months of 2023 and the balance in 2024 and beyond.
- Management expects to continue restructuring to improve margins and adjust manufacturing footprint and product portfolio. Further workforce, asset impairment or accelerated-depreciation, lease-termination and facility-rationalization costs are possible; the full amount is not yet estimable.
- Asbestos-related liability was estimated at approximately $79 million, with $72.1 million of insurance recovery recorded as probable. The filing cautions that actual claims, coverage availability and recoveries could differ materially from estimates.
- The company faces ordinary-course legal, product-liability, environmental and other claims; management did not expect their outcome, individually or collectively, to materially adversely affect financial position, results or cash flows. Ongoing tax examinations and related indemnities could change, though potential payments were not expected to be significant.
- Interest-rate and foreign-currency movements are market risks. Forward-looking statements are subject to risks and uncertainties; interim results are not necessarily indicative of full-year results.
- The board declared a quarterly dividend of $0.08 per share on October 19, 2023, payable December 7, 2023.
Important facts for investors to verify
- Whether weaker residential demand and planned product exits continue to pressure core sales and backlog conversion.
- Whether margin improvements persist after separating recurring operating gains from merger-related comparison effects, restructuring and other adjustments.
- Whether working-capital cash-flow benefits are sustainable and how management balances debt repayment, repurchases and dividends.
- Progress and cost of further restructuring, and the impact of higher interest rates and the post-quarter $60 million repayment.
- Developments in asbestos claims and insurance coverage, environmental matters and tax examinations or indemnities.