SEC Form 10-Q filed by Zurn Elkay Water Solutions Corporation
$ZWS
Industrial Machinery/Components
Industrials
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
_________________________________________________
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||
For the quarter ended September 30, 2024
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||
For the transition period from to
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| (Exact name of registrant as specified in its charter) | ||
| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | ||||||||||
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Registrant’s telephone number, including area code: (855 ) 480-5050
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Trading Symbol(s) | Name of Each Exchange on Which Registered | ||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by checkmark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| ☒ | Accelerated filer | ☐ | |||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | |||||||||
| Emerging growth company | |||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
| Class | Outstanding at October 25, 2024 | |||||||
| Zurn Elkay Water Solutions Corporation Common Stock, $0.01 par value per share | ||||||||
TABLE OF CONTENTS
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Private Securities Litigation Reform Act Safe Harbor Statement
Our disclosure and analysis in this report concerning our operations, cash flows and financial position, including, in particular, the likelihood of our success in developing and expanding our business and the realization of sales from our backlog, include forward-looking statements. Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates” and similar expressions are forward-looking statements. Although these statements are based upon reasonable assumptions, including projections of orders, sales, operating margins, earnings, cash flows, research and development costs, working capital and capital expenditures, they are subject to risks and uncertainties that are described more fully herein and in our Annual Report on Form 10-K for the year ended December 31, 2023, in Part I, Item 1A, “Risk Factors” and in Part I under the heading "Cautionary Notice Regarding Forward-Looking Statements", as well as in our other filings with the Securities and Exchange Commission. Accordingly, we can give no assurance that we will achieve the results anticipated or implied by our forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Zurn Elkay Water Solutions Corporation and Subsidiaries
Condensed Consolidated Balance Sheets
(in Millions, except share amounts)
| (Unaudited) | ||||||||||||||
| September 30, 2024 | December 31, 2023 | |||||||||||||
| Assets | ||||||||||||||
| Current assets: | ||||||||||||||
| Cash and cash equivalents | $ | $ | ||||||||||||
| Receivables, net | ||||||||||||||
| Inventories, net | ||||||||||||||
| Income taxes receivable | ||||||||||||||
| Other current assets | ||||||||||||||
| Total current assets | ||||||||||||||
| Property, plant and equipment, net | ||||||||||||||
| Intangible assets, net | ||||||||||||||
| Goodwill | ||||||||||||||
| Other assets | ||||||||||||||
| Total assets | $ | $ | ||||||||||||
| Liabilities and stockholders' equity | ||||||||||||||
| Current liabilities: | ||||||||||||||
| Current maturities of debt | $ | $ | ||||||||||||
| Trade payables | ||||||||||||||
| Compensation and benefits | ||||||||||||||
| Current portion of pension and postretirement benefit obligations | ||||||||||||||
| Other current liabilities | ||||||||||||||
| Total current liabilities | ||||||||||||||
| Long-term debt | ||||||||||||||
| Pension and postretirement benefit obligations | ||||||||||||||
| Deferred income taxes | ||||||||||||||
| Operating lease liability | ||||||||||||||
| Other liabilities | ||||||||||||||
| Total liabilities | ||||||||||||||
| Stockholders' equity: | ||||||||||||||
Common stock, $ | ||||||||||||||
| Additional paid-in capital | ||||||||||||||
| Retained deficit | ( | ( | ||||||||||||
| Accumulated other comprehensive loss | ( | ( | ||||||||||||
| Total stockholders' equity | ||||||||||||||
| Total liabilities and stockholders' equity | $ | $ | ||||||||||||
See notes to the condensed consolidated financial statements.
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Condensed Consolidated Statements of Operations
(in Millions, except share and per share amounts)
(Unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | September 30, 2024 | September 30, 2023 | |||||||||||||||||||||||
| Net sales | $ | $ | $ | $ | ||||||||||||||||||||||
| Cost of sales | ||||||||||||||||||||||||||
| Gross profit | ||||||||||||||||||||||||||
| Selling, general and administrative expenses | ||||||||||||||||||||||||||
| Restructuring and other similar charges | ||||||||||||||||||||||||||
| Amortization of intangible assets | ||||||||||||||||||||||||||
| Income from operations | ||||||||||||||||||||||||||
| Non-operating expense: | ||||||||||||||||||||||||||
| Interest expense, net | ( | ( | ( | ( | ||||||||||||||||||||||
| Other expense, net | ( | ( | ( | ( | ||||||||||||||||||||||
| Income before income taxes | ||||||||||||||||||||||||||
| Provision for income taxes | ( | ( | ( | ( | ||||||||||||||||||||||
| Net income from continuing operations | ||||||||||||||||||||||||||
| Income from discontinued operations, net of tax | ||||||||||||||||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||||||||||||
| Basic net income per share: | ||||||||||||||||||||||||||
| Continuing operations | $ | $ | $ | $ | ||||||||||||||||||||||
| Discontinued operations | $ | $ | $ | $ | ||||||||||||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||||||||||||
| Diluted net income per share: | ||||||||||||||||||||||||||
| Continuing operations | $ | $ | $ | $ | ||||||||||||||||||||||
| Discontinued operations | $ | $ | $ | $ | ||||||||||||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||||||||||||
| Weighted-average number of shares outstanding (in thousands): | ||||||||||||||||||||||||||
| Basic | ||||||||||||||||||||||||||
| Effect of dilutive equity awards | ||||||||||||||||||||||||||
| Diluted | ||||||||||||||||||||||||||
See notes to the condensed consolidated financial statements.
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income
(in Millions)
(Unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | September 30, 2024 | September 30, 2023 | |||||||||||||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||||||||||||
| Other comprehensive income (loss): | ||||||||||||||||||||||||||
| Foreign currency translation adjustments | ( | ( | ||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | ( | ( | ||||||||||||||||||||||||
| Total comprehensive income | $ | $ | $ | $ | ||||||||||||||||||||||
See notes to the condensed consolidated financial statements.
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in Millions)
(Unaudited)
| Nine Months Ended | ||||||||||||||
| September 30, 2024 | September 30, 2023 | |||||||||||||
| Operating activities | ||||||||||||||
| Net income | $ | $ | ||||||||||||
| Adjustments to reconcile net income to cash provided by operating activities: | ||||||||||||||
| Depreciation | ||||||||||||||
| Amortization of intangible assets | ||||||||||||||
| Non-cash restructuring charges | ||||||||||||||
| Loss on dispositions of long-lived assets | ||||||||||||||
| Deferred income taxes | ( | ( | ||||||||||||
| Other non-cash expenses | ||||||||||||||
| Stock-based compensation expense | ||||||||||||||
| Changes in operating assets and liabilities: | ||||||||||||||
| Receivables, net | ( | ( | ||||||||||||
| Inventories, net | ( | |||||||||||||
| Other assets | ||||||||||||||
| Accounts payable | ( | |||||||||||||
| Accruals and other | ( | |||||||||||||
| Cash provided by operating activities | ||||||||||||||
| Investing activities | ||||||||||||||
| Expenditures for property, plant and equipment | ( | ( | ||||||||||||
| Proceeds from dispositions of long-lived assets | ||||||||||||||
| Proceeds from insurance claims | ||||||||||||||
| Cash used for investing activities | ( | ( | ||||||||||||
| Financing activities | ||||||||||||||
| Proceeds from borrowings of debt | ||||||||||||||
| Repayments of debt | ( | ( | ||||||||||||
| Proceeds from exercise of stock options and ESPP contributions | ||||||||||||||
| Taxes withheld and paid on employees' share-based payment awards | ( | ( | ||||||||||||
| Repurchase of common stock | ( | ( | ||||||||||||
| Payment of common stock dividends | ( | ( | ||||||||||||
| Cash used for financing activities | ( | ( | ||||||||||||
| Effect of exchange rate changes on cash, cash equivalents and restricted cash | ( | |||||||||||||
| Increase in cash, cash equivalents and restricted cash | ||||||||||||||
| Cash, cash equivalents and restricted cash at beginning of period | ||||||||||||||
| Cash, cash equivalents and restricted cash at end of period | $ | $ | ||||||||||||
See notes to the condensed consolidated financial statements.
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
September 30, 2024
(Unaudited)
1. Basis of Presentation and Significant Accounting Policies
The unaudited condensed consolidated financial statements included herein have been prepared by Zurn Elkay Water Solutions Corporation (“Zurn Elkay” or the “Company”) in accordance with accounting principles generally accepted in the United States ("GAAP") pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.
In the opinion of management, the condensed consolidated financial statements include all adjustments necessary for a fair presentation of the results of operations for the interim periods. Results for the interim periods are not necessarily indicative of results that may be expected for the year ending December 31, 2024. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2023.
Divestiture of Asbestos Liabilities and Certain Assets
On December 15, 2023, Zurn Holdings, Inc. (“Holdings”) sold all of the equity interests of its direct subsidiary Zurn Industries, LLC (“Zurn Industries”), together with Zurn Industries’ direct and indirect subsidiaries that primarily held asbestos liabilities, certain assets and cash, in a stock sale transaction to an unaffiliated buyer (“Sale Transaction”). As a result of the Sale Transaction, all asbestos obligations and liabilities, related insurance assets and associated deferred taxes, and other assets sold to the buyer, have been removed from the Company’s consolidated balance sheet effective December 15, 2023 and the Company no longer has any obligation with respect to pending and future asbestos claims related to the divested entities. A loss on the divestiture of asbestos liabilities and certain assets of $11.4 million was recognized in the consolidated statements of operations for the twelve months ended December 31, 2023. See Note 15, Commitments and Contingencies, for additional information on the Sale Transaction.
Elkay Merger
On July 1, 2022, Zurn Water Solutions Corporation ("Zurn") completed its combination with Elkay Manufacturing Company (“Elkay”) through the Merger of Elkay with and into a newly created subsidiary of the Company, with Elkay surviving as a wholly owned subsidiary of Zurn Elkay (the “Merger” or "Elkay Transaction"). The Company's results of operations include the acquired operations subsequent to July 1, 2022. See Note 2, Acquisition, for additional information on the Elkay Transaction.
The Company
Zurn Elkay is a growth-oriented, pure-play water management business that designs, procures, manufactures, and markets what the Company believes to be the broadest sustainable product portfolio of specification-driven water management solutions to improve health, hydration, human safety and the environment. The Company's product portfolio includes professional grade water safety and control products, flow systems products, hygienic and environmental products, and filtered drinking water products for public and private spaces that deliver superior value to building owners, positively impact the environment and human hygiene and reduce product installation time. The Company's heritage of innovation and specification has allowed it to provide highly-engineered, mission-critical solutions to customers for decades and affords it the privilege of having long-term, valued relationships with market leaders. The Company operates in a disciplined way and the Zurn Elkay Business System (“ZEBS”) is its operating philosophy. Grounded in the spirit of continuous improvement, ZEBS 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 its business.
Recent Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board or other standard setting bodies that may have an impact on the Company’s accounting and reporting. The Company believes that such recently issued accounting pronouncements and other authoritative guidance for which the effective date is in the future either will not have an impact on its accounting or reporting or that such impact will not be material to its consolidated balance sheets, consolidated statements of operations, and consolidated statements of cash flows when implemented.
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2. Acquisition
Elkay Merger
On July 1, 2022, the Company completed the Elkay Merger for a purchase price (after final purchase price adjustments) of $1,457.8 million. Elkay, a market leader of drinking water solutions and commercial sinks, complements the Company's existing product portfolio. The purchase price includes $1,411.9 million of Zurn's common stock based on Zurn's closing stock price of $27.48 on July 1, 2022, and $45.9 million of net cash payments for the repayment of Elkay's term loan and Elkay's transaction related costs outstanding that were in excess of Elkay's cash and cash equivalents at the time of closing. Pursuant to the terms of the merger agreement, the Company issued 51,564,524 shares of its common stock, which represented approximately 29 % of outstanding shares immediately following the Merger. During the first quarter of 2023, we completed the final price adjustments and the adjusted purchase price is reflected in the purchase price amounts above, following the return of 186,020 of the shares issued at closing to the Company as a result of lower working capital and cash balances at closing compared to targets stipulated in the merger agreement. The shares returned to the Company were canceled upon receipt.
In accordance with the merger agreement, at closing the Company increased the size of its Board of Directors to eleven members and appointed two directors designated by Elkay. As of September 30, 2024, the Board of Directors consisted of ten members, including one director designated by Elkay. Zurn senior management immediately prior to the consummation of the Elkay Merger remained as the executive officers of the Company immediately after the Elkay Merger. The Company's management determined that the Company is the accounting acquirer in the Elkay Merger based on the facts and circumstances noted within this section and other relevant factors. As such, the Company applied the acquisition method of accounting to the identifiable assets and liabilities of the Elkay business, which were measured at estimated fair value as of the date of the business combination. The excess of the purchase price over the fair value assigned to the assets acquired and liabilities assumed was recorded as goodwill, which is not deductible for tax purposes.
Elkay’s assets and liabilities were measured at estimated fair values at July 1, 2022, primarily using Level 3 inputs. Estimates of fair value represent management’s best estimate of assumptions about future events and uncertainties, including significant judgments related to future cash flows, discount rates, competitive trends, margin and revenue growth assumptions including royalty rates and customer attrition rates and others. Inputs used were generally obtained from historical data supplemented by current and anticipated market conditions and growth rates expected as of the Merger date.
As of June 30, 2023, the valuation process to determine the fair values of the net assets acquired during the measurement period was complete. The final fair value of the assets acquired and liabilities assumed were as follows (in millions):
| As Reported June 30, 2023 | ||||||||
| Assets acquired: | ||||||||
| Receivables, net | $ | |||||||
| Inventories | ||||||||
| Other current assets | ||||||||
| Property, plant and equipment, net | ||||||||
| Intangible assets, net | ||||||||
| Goodwill | ||||||||
| Other assets | ||||||||
| Total assets acquired | ||||||||
| Liabilities assumed: | ||||||||
| Trade payables | ||||||||
| Compensation and benefits | ||||||||
| Current portion of pension and postretirement benefit obligations | ||||||||
| Other current liabilities | ||||||||
| Operating lease liability | ||||||||
| Pension and postretirement benefit obligations | ||||||||
| Deferred income taxes | ||||||||
| Other liabilities | ||||||||
| Total liabilities assumed | ||||||||
| Total purchase price | $ | |||||||
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3. Restructuring and Other Similar Charges
During the three and nine months ended September 30, 2024, the Company continued to execute various restructuring actions. These initiatives were implemented to drive efficiencies and reduce operating costs while also modifying the Company's footprint to reflect changes in the markets it serves, the impact of mergers and acquisitions, including Elkay, on the Company's overall manufacturing capacity and the refinement of its overall product portfolio. These restructuring actions primarily resulted in workforce reductions, lease termination costs and other facility rationalization costs. Management expects to continue executing similar initiatives to optimize the Company's operating margin and manufacturing footprint. As such, the Company expects further expenses related to workforce reductions, potential impairment or accelerated depreciation of assets, lease termination costs and other facility rationalization costs. The Company's restructuring plans are preliminary and the full extent of related expenses are not yet estimable.
The following table summarizes the Company's restructuring and other similar charges during the three and nine months ended September 30, 2024 and September 30, 2023, (in millions):
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | September 30, 2024 | September 30, 2023 | |||||||||||||||||||||||
| Employee termination benefits | $ | $ | $ | $ | ||||||||||||||||||||||
| Contract termination and other associated costs | ||||||||||||||||||||||||||
| Total restructuring and other similar charges | $ | $ | $ | $ | ||||||||||||||||||||||
The following table summarizes the activity in the Company's restructuring accrual for the nine months ended September 30, 2024 (in millions):
| Employee termination benefits | Contract termination and other associated costs | Total | ||||||||||||||||||
| Accrued restructuring costs, December 31, 2023 (1) | $ | $ | $ | |||||||||||||||||
| Charges | ||||||||||||||||||||
| Cash payments | ( | ( | ( | |||||||||||||||||
| Non-cash charges (2) | ( | ( | ||||||||||||||||||
| Accrued restructuring costs, September 30, 2024 (1) | $ | $ | $ | |||||||||||||||||
(1)As of September 30, 2024 and December 31, 2023, the restructuring accrual is included in other current liabilities in the condensed consolidated balance sheets.
(2)Non-cash charges consist primarily of asset impairments based on Level 3 inputs.
4. Discontinued Operations
On October 4, 2021, the Company completed a Reverse Morris Trust tax-free spin-off transaction (the “Spin-Off Transaction”) in which (i) substantially all the assets and liabilities of the Company's Process & Motion Control ("PMC") business were transferred to a newly created subsidiary, Land Newco, Inc. (“Land”), (ii) the shares of Land were distributed to the Company's stockholders pro rata, and (iii) Land was merged with a subsidiary of Regal Rexnord Corporation (formerly known as Regal Beloit Corporation), in which the stock of Land was converted into a specified number of shares of Regal Rexnord Corporation in accordance with the exchange ratio. The operating results of PMC are reported as discontinued operations in the consolidated statements of operations for all periods presented, as the Spin-Off Transaction of PMC represented a strategic shift that had a major impact on operations and financial results. The condensed consolidated statements of cash flows for the nine months ended September 30, 2024 and September 30, 2023 have not been adjusted to separately disclose cash flows related to the discontinued operations.
The major components of the Income from discontinued operations, net of tax presented in the condensed consolidated statements of operations for the three and nine months ended September 30, 2024 and September 30, 2023, are as follows (in millions):
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| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | September 30, 2024 | September 30, 2023 | |||||||||||||||||||||||
| Selling, general and administrative income (1) | $ | $ | $ | $ | ||||||||||||||||||||||
| Income from discontinued operations before income tax | ||||||||||||||||||||||||||
| Income tax (expense) benefit | ( | ( | ||||||||||||||||||||||||
| Income from discontinued operations, net of tax | $ | $ | $ | $ | ||||||||||||||||||||||
(1)Selling, general and administrative income includes the reversal of certain accruals as a result of costs the Company will no longer incur related to the Spin-Off Transaction.
5. Revenue Recognition
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers. A contract’s transaction price is allocated to each distinct performance obligation and revenue is recognized when obligations under the terms of a contract with the customer are satisfied. For the majority of the Company's product sales, revenue is recognized at a point-in-time when control of the product is transferred to the customer, which generally occurs when the product is shipped from the Company's manufacturing facility to the customer. When contracts include multiple products to be delivered to the customer, generally each product is separately priced and is determined to be distinct within the context of the contract. Other than a standard assurance-type warranty that the product will conform to agreed-upon specifications, there are generally no other significant post-shipment obligations. The expected costs associated with standard warranties continue to be recognized as an expense when the products are sold.
When the contract provides the customer the right to return eligible products or when the customer is part of a sales rebate program, the Company reduces revenue at the point of sale using current facts and historical experience by using an estimate for expected product returns and rebates associated with the transaction. The Company adjusts these estimates at the earlier of when the most likely amount of consideration that is expected to be received changes or when the consideration becomes fixed. Accordingly, an increase or decrease to revenue is recognized at that time.
Sales and other taxes collected concurrent with revenue-producing activities are excluded from revenue. The Company has elected to recognize the cost for freight and shipping when control of products has transferred to the customer as a component of cost of sales in the consolidated statements of operations. The Company classifies shipping and handling fees billed to customers as net sales and the corresponding costs are classified as cost of sales in the condensed consolidated statements of operations.
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Revenue by Category
The Company designs, procures, manufactures, and markets a comprehensive portfolio of water management solutions. The Company disaggregates its sales by customer type and geographic location, which the Company believes best depicts how the nature, amount, timing and uncertainty of its revenue and cash flows may be impacted differently by certain economic factors. The following tables present revenue disaggregated by customer type and the geographic region of the end customer (in millions):
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||
| Customer Type | September 30, 2024 | September 30, 2023 | September 30, 2024 | September 30, 2023 | ||||||||||||||||||||||
| Institutional | $ | $ | $ | $ | ||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||||
| All other | ||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||
| Geography | September 30, 2024 | September 30, 2023 | September 30, 2024 | September 30, 2023 | ||||||||||||||||||||||
| United States | $ | $ | $ | $ | ||||||||||||||||||||||
| Canada | ||||||||||||||||||||||||||
| Rest of world | ||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
Contract Balances
For substantially all of the Company's product sales, the customer is billed 100 % of the contract value when the product ships and payment is generally due 30 days from shipment. Certain contracts include longer payment periods; however, the Company has elected to utilize the practical expedient in which the Company will only recognize a financing component to the sale if payment is due more than one year from the date of shipment.
Backlog
The Company had backlog of $46.7 million as of September 30, 2024, which represents the most likely amount of consideration expected to be received in satisfying the remaining backlog under open contracts. The Company utilizes the optional exemption provided by ASC 606-10-50-14A for variable consideration, and has not included estimated rebates in the amount of unsatisfied performance obligations. The Company expects to recognize approximately 95 % of the backlog in the remaining three months of the year ending December 31, 2024, and the remaining approximately 5 % in 2025 and beyond.
Timing of Performance Obligations Satisfied at a Point in Time
The Company determined that the customer is able to control the product when it is delivered to them; thus, depending on the shipping terms, control will transfer at different points between the Company's manufacturing facility or warehouse and the customer’s location. The Company considers control to have transferred upon shipment or delivery because the Company has a present right to payment at that time, the customer has legal title to the asset, the Company has transferred physical possession of the asset and the customer has significant risks and rewards of ownership of the asset.
Variable Consideration
The Company provides volume-based rebates and the right to return product to certain customers, which are accrued for based on current facts and historical experience. Rebates are paid either on an annual or quarterly basis. There are no other significant variable consideration elements included in the Company's contracts with customers.
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Contract Costs
Allowance for Credit Losses
The Company assesses the collectability of customer receivables based on the credit worthiness of a customer as determined by credit checks and analysis, as well as the customer’s payment history. In determining the allowance for credit losses, the Company also considers various factors, including the aging of customer accounts and historical write-offs. In addition, the Company monitors other risk factors, including forward-looking information when establishing allowances for credit losses, which reflects the current estimate of credit losses expected to be incurred over the life of the receivables.
6. Income Taxes
The provision for income taxes for all periods presented is based on an estimated effective income tax rate for the respective fiscal years. The estimated annual effective income tax rate is determined excluding the effect of significant discrete items or items that are reported net of their related tax effects. The tax effect of significant discrete items is reflected in the period in which they occur. The Company's income tax expense is impacted by a number of factors, including the amount of taxable earnings derived in foreign jurisdictions with tax rates that are generally higher than the U.S. federal statutory rate, state tax rates in the jurisdictions where the Company does business and the Company's ability to utilize various tax credits, capital loss and net operating loss (“NOL”) carryforwards.
In October 2021, more than 130 countries agreed to implement Pillar 2, a plan introduced by the Organization for Economic Co-operation and Development (“OECD”) providing for a global minimum tax rate of 15% (calculated on a country-by-country basis) for those companies having consolidated revenue of at least €750 million. The implementation of the Pillar 2 global minimum tax rules is intended to apply for tax years beginning in 2024. The main purpose of such rules is to minimize tax base erosion and profit shifting from higher tax jurisdictions to lower tax jurisdictions by multi-national companies. On December 20, 2022, the OECD issued various administrative guidance including transitional safe harbor rules available in conjunction with the implementation of the Pillar 2 global minimum tax. On February 1, 2023, the Financial Accounting Standards Board indicated that they view the minimum tax (“Top-Up Tax”) imposed under Pillar 2 as an alternative minimum tax, and as such, it should be recognized in the period incurred versus recognizing or adjusting deferred tax assets and liabilities. Based upon the current OECD rules and administrative guidance, the Company does not anticipate being subject to material Top-Up Taxes as various tax jurisdictions begin enacting such legislation. The Company is continuing to monitor the potential impact of the Pillar 2 proposals and developments on our consolidated financial statements and related disclosures, including eligibility for any transitional safe harbor rules. As of September 30, 2024, the Company has determined that no accrual is currently required for Top-Up Taxes.
The Company regularly reviews its deferred tax assets for recoverability and valuation allowances are established based on historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences, as deemed appropriate. In addition, all other available positive and negative evidence is taken into consideration for the purpose of determining the proper balances of such valuation allowances. As a result of this review, the Company continues to maintain a full valuation allowance against U.S. federal and state capital loss carryforwards, as well as certain foreign NOL carryforwards and related deferred tax assets and continues to maintain a partial valuation allowance against certain U.S. state NOL and tax credit carryforwards. Future changes to the balances of these valuation allowances, as a result of this continued review and analysis by the Company, could impact the financial statements for such period of change.
The income tax provision was $16.9 million for the three months ended September 30, 2024, compared to $12.5 million for the three months ended September 30, 2023. The effective income tax rate for the three months ended September 30, 2024 was 28.0 % versus 26.2 % for the three months ended September 30, 2023. The effective income tax rate for the three months ended September 30, 2024 and the three months ended September 30, 2023 was above the U.S. federal statutory rate of 21% primarily due to the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code, the accrual of various state income taxes and the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, partially offset by the recognition of income tax benefits associated with share-based payments.
The income tax provision was $42.4 million for the nine months ended September 30, 2024, compared to $34.8 million for the nine months ended September 30, 2023. The effective income tax rate for the nine months ended September 30, 2024 was 25.7 % versus 27.7 % for the nine months ended September 30, 2023. The effective income tax rate for
13
the nine months ended September 30, 2024 was above the U.S. federal statutory rate of 21% primarily due to the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code, the accrual of various state income taxes and the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, partially offset by the recognition of certain previously unrecognized tax benefits due to the lapse of the applicable statutes of limitations and income tax benefits associated with share-based payments. The effective income tax rate for the nine months ended September 30, 2023 was above the U.S. federal statutory rate of 21% primarily due to the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code, the accrual of various state income taxes and the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, partially offset by the recognition of income tax benefits associated with share-based payments.
The Company’s total liability for net unrecognized tax benefits as of September 30, 2024 and December 31, 2023 was $3.6 million and $5.6 million, respectively. The Company recognizes accrued interest and penalties related to unrecognized income tax benefits in income tax expense. As of September 30, 2024 and December 31, 2023, the total amount of unrecognized tax benefits includes gross accrued interest and penalties of $0.9 million and $1.1 million, respectively. The Company recognized $(0.1 ) million and $0.3 million of net interest and penalties as income tax (benefit) expense during the nine months ended September 30, 2024 and September 30, 2023, respectively.
The Company conducts business in multiple locations within and outside the U.S. Consequently, the Company is subject to periodic income tax examinations by domestic and foreign income tax authorities. In accordance with the terms of the sale agreement relating to a group of certain previously owned legal entities (the parent of which was VAG Holding GbmH, “VAG”), the Company is required to indemnify the purchaser for any future income tax liabilities associated with all open tax years ended prior to, and including, the short period ended on the date of the Company's sale of VAG. VAG was notified by the German tax authorities of its intention to conduct an income tax examination of the VAG German entities’ corporate income and trade tax returns for the tax years ended March 31, 2014 through 2020. Similarly, in accordance with the Spin-Off Transaction, the Company is required to indemnify Regal Rexnord Corporation for any future income tax liabilities associated with PMC entities relating to all open tax years ended prior to, and including, the short period ended on the date of the Spin-Off. There are currently a number of ongoing tax examinations being conducted by the applicable tax authorities in Germany with respect to certain PMC entities. It appears reasonably possible that the amounts of unrecognized income tax benefits and indemnification liabilities could change in the next twelve months upon conclusion of the current ongoing examinations; however, any potential payments of income tax, interest and penalties are not expected to be significant to the Company's consolidated financial statements. With certain exceptions, the Company is no longer subject to U.S. federal income tax examinations for tax years ended prior to December 31, 2020, state and local income tax examinations for years ended prior to March 31, 2020 or significant foreign income tax examinations for years ended prior to March 31, 2019.
7. Earnings per Share
Basic net income per share from continuing and discontinued operations is computed by dividing net income from continuing operations and income from discontinued operations, respectively, by the corresponding weighted average number of common shares outstanding for the period. Diluted net income per share from continuing and discontinued operations is computed based on the weighted average number of common shares outstanding, increased by the number of incremental shares that would have been outstanding if the potential dilutive shares were issued through the exercise of outstanding stock options to purchase common shares, except when the effect would be anti-dilutive.
14
8. Stockholders' Equity
Stockholders' equity consists of the following (in millions):
| Common stock (1) | Additional paid-in capital | Retained deficit | Accumulated other comprehensive loss | Total stockholders’ equity | |||||||||||||||||||||||||
| Balance at December 31, 2022 | $ | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||
| Total comprehensive income | — | — | ( | ||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Proceeds from exercise of stock options | — | — | — | ||||||||||||||||||||||||||
| Repurchase of common stock | — | — | ( | — | ( | ||||||||||||||||||||||||
| Elkay Merger (2) | — | ( | — | — | ( | ||||||||||||||||||||||||
| Common stock issued to fund defined contribution plans | — | — | — | ||||||||||||||||||||||||||
Common stock dividends ($ | — | ( | — | — | ( | ||||||||||||||||||||||||
| Balance at March 31, 2023 | $ | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||
| Total comprehensive income | — | — | |||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Proceeds from exercise of stock options | — | — | — | ||||||||||||||||||||||||||
| Repurchase of common stock | ( | — | ( | — | ( | ||||||||||||||||||||||||
Common stock dividends ($ | — | ( | — | — | ( | ||||||||||||||||||||||||
| Balance at June 30, 2023 | $ | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||
| Total comprehensive income | — | — | ( | ||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Proceeds from exercise of stock options | — | — | — | ||||||||||||||||||||||||||
| Taxes withheld and paid on employees' share-based payment awards | — | ( | — | — | ( | ||||||||||||||||||||||||
| Repurchase of common stock | — | — | ( | — | ( | ||||||||||||||||||||||||
Common stock dividends ($ | — | ( | — | — | ( | ||||||||||||||||||||||||
| Balance at September 30, 2023 | $ | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||
| Common stock (1) | Additional paid-in capital | Retained deficit | Accumulated other comprehensive loss | Total stockholders’ equity | |||||||||||||||||||||||||
| Balance at December 31, 2023 | $ | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||
| Total comprehensive income | — | — | ( | ||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Proceeds from exercise of stock options | — | — | — | ||||||||||||||||||||||||||
| Repurchase of common stock | — | — | ( | — | ( | ||||||||||||||||||||||||
Common stock dividends ($ | — | ( | — | — | ( | ||||||||||||||||||||||||
| Balance at March 31, 2024 | $ | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||
| Total comprehensive income | — | — | ( | ||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Proceeds from exercise of stock options | — | — | — | ||||||||||||||||||||||||||
| Repurchase of common stock | — | — | ( | — | ( | ||||||||||||||||||||||||
Common stock dividends ($ | — | ( | — | — | ( | ||||||||||||||||||||||||
| Balance at June 30, 2024 | $ | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||
| Total comprehensive income | — | — | |||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Proceeds from exercise of stock options and ESPP contributions | — | — | — | ||||||||||||||||||||||||||
| Taxes withheld and paid on employees' share-based payment awards | — | ( | — | — | ( | ||||||||||||||||||||||||
| Repurchase of common stock | — | — | ( | — | ( | ||||||||||||||||||||||||
Common stock dividends ($ | — | ( | — | — | ( | ||||||||||||||||||||||||
| Balance at September 30, 2024 | $ | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||
15
____________________
(1)During the three and nine months ended September 30, 2024, the Company issued 1,300,020 and 2,698,413 shares of common stock, upon the exercise of stock options, vesting of restricted stock units and performance stock units, and for other common stock issuances, respectively. During the three and nine months ended September 30, 2023, the Company issued 135,502 and 462,738 shares of common stock, upon the exercise of stock options, vesting of restricted stock units, and for other common stock issuances, respectively.
(2)During the nine months ended September 30, 2023, 186,020 of the shares issued at closing of the Elkay Merger were returned to the Company as a result of lower working capital and cash balances at closing compared to targets stipulated in the Merger Agreement. The shares returned to the Company were canceled upon receipt. Refer to Note 2, Acquisition for additional information.
Share Repurchase Program
During fiscal 2015, the Company's Board of Directors approved a common stock repurchase program (the "Repurchase Program") authorizing the repurchase of up to $200.0 million of the Company's common stock from time to time on the open market or in privately negotiated transactions. On January 27, 2020, the Company's Board of Directors approved increasing the remaining share repurchase authority under the Repurchase Program to $300.0 million. On February 8, 2023, the Company's Board of Directors approved increasing the remaining share repurchase authority under the Repurchase Program to $500.0 million. The Repurchase Program does not require the Company to acquire any particular amount of common stock and does not specify the timing of purchases or the prices to be paid; however, the program will continue until the maximum amount of dollars authorized have been expended or until it is modified or terminated by the Board of Directors. During the three months ended September 30, 2024, the Company repurchased 1,622,895 shares of common stock at a total cost of $50.0 million at an average price of $30.81 per share. During the nine months ended September 30, 2024, the Company repurchased 4,185,755 shares of common stock at a total cost of $129.9 million at an average price of $31.02 per share. During the three months ended September 30, 2023, the Company repurchased 444,606 shares of common stock at a total cost of $13.0 million at an average price of $29.24 per share. During the nine months ended September 30, 2023, the Company repurchased 4,434,475 shares of common stock at a total cost of $100.1 million at an average price of $22.55 per share. The repurchased shares were canceled by the Company upon receipt. Approximately $260.6 million of the existing authority remained under the Repurchase Program at September 30, 2024.
9. Accumulated Other Comprehensive Loss
The changes in accumulated other comprehensive loss, net of tax, for the nine months ended September 30, 2024, are as follows (in millions):
| Foreign Currency Translation and Other | Pension and Postretirement Plans | Total | ||||||||||||||||||
| Balance at December 31, 2023 | $ | ( | $ | $ | ( | |||||||||||||||
| Other comprehensive loss before reclassifications | ( | ( | ||||||||||||||||||
| Net current period other comprehensive loss | ( | ( | ||||||||||||||||||
| Balance at September 30, 2024 | $ | ( | $ | $ | ( | |||||||||||||||
There were no
10. Inventories
The major classes of inventories are summarized as follows (in millions):
| September 30, 2024 | December 31, 2023 | |||||||||||||
| Finished goods | $ | $ | ||||||||||||
| Work in progress | ||||||||||||||
| Raw materials | ||||||||||||||
| Inventories at First-in, First-Out ("FIFO") cost | ||||||||||||||
| Adjustment to state inventories at Last-in, First-Out ("LIFO") cost | ( | ( | ||||||||||||
| $ | $ | |||||||||||||
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11. Goodwill and Intangible Assets
The changes in the net carrying value of goodwill for the nine months ended September 30, 2024, are presented below (in millions):
| Net carrying amount as of December 31, 2023 | $ | |||||||
| Currency translation adjustments | ||||||||
| Net carrying amount as of September 30, 2024 | $ | |||||||
The gross carrying amount and accumulated amortization for each major class of identifiable intangible assets as of September 30, 2024 and December 31, 2023 are as follows (in millions):
| September 30, 2024 | ||||||||||||||||||||||||||
| Weighted Average Useful Life | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||||||||||
| Intangible assets subject to amortization: | ||||||||||||||||||||||||||
| Patents | $ | $ | ( | $ | ||||||||||||||||||||||
| Customer relationships (including distribution network) | ( | |||||||||||||||||||||||||
| Tradenames | ( | |||||||||||||||||||||||||
| Intangible assets not subject to amortization - trademarks and tradenames | — | |||||||||||||||||||||||||
| Total intangible assets, net | $ | $ | ( | $ | ||||||||||||||||||||||
| December 31, 2023 | ||||||||||||||||||||||||||
| Weighted Average Useful Life | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||||||||||
| Intangible assets subject to amortization: | ||||||||||||||||||||||||||
| Patents | $ | $ | ( | $ | ||||||||||||||||||||||
| Customer relationships (including distribution network) | ( | |||||||||||||||||||||||||
| Tradenames | ( | |||||||||||||||||||||||||
| Intangible assets not subject to amortization - trademarks and tradenames | — | |||||||||||||||||||||||||
| Total intangible assets, net | $ | $ | ( | $ | ||||||||||||||||||||||
Intangible asset amortization expense totaled $14.8 million and $14.7 million for the three months ended September 30, 2024 and September 30, 2023, respectively. Intangible asset amortization expense totaled $44.3 million and $44.0 million for the nine months ended September 30, 2024 and September 30, 2023, respectively.
The Company expects to recognize amortization expense on the intangible assets subject to amortization of $59.2 million in the year ending December 31, 2024 (inclusive of the $44.3 million of amortization expense recognized in the nine months ended September 30, 2024), $58.7 million in 2025, $58.5 million in 2026, $58.5 million in 2027, $58.5 million in 2028 and $58.5 million in 2029.
17
12. Other Current Liabilities
Other current liabilities are summarized as follows (in millions):
| September 30, 2024 | December 31, 2023 | |||||||||||||
| Commissions | $ | $ | ||||||||||||
| Income taxes payable | ||||||||||||||
| Professional fees | ||||||||||||||
| Product warranty (1) | ||||||||||||||
| Restructuring and other similar charges (2) | ||||||||||||||
| Risk management (3) | ||||||||||||||
| Sales rebates | ||||||||||||||
| Tax indemnities | ||||||||||||||
| Taxes, other than income taxes | ||||||||||||||
| Other | ||||||||||||||
| $ | $ | |||||||||||||
____________________
(1)See more information related to the product warranty obligations balance within Note 15, Commitments and Contingencies.
(2)See more information related to the restructuring obligations balance within Note 3, Restructuring and Other Similar Charges.
(3)Includes projected liabilities related to losses arising from automobile, general, environmental, worker's compensation, and product liability claims.
13. Long-Term Debt
Long-term debt is summarized as follows (in millions):
| September 30, 2024 | December 31, 2023 | |||||||||||||
| Term loan (1) | $ | $ | ||||||||||||
| Finance leases | ||||||||||||||
| Total | ||||||||||||||
| Less current maturities | ||||||||||||||
| Long-term debt | $ | $ | ||||||||||||
____________________
(1)Includes unamortized debt issuance costs of $5.7 million and $6.8 million at September 30, 2024 and December 31, 2023, respectively.
Senior Secured Credit Facility
On October 4, 2021, ZBS Global, Inc. (“Holdings”), Zurn Holdings, Inc., Zurn LLC (together, the “Original Borrowers”), the lenders from time to time party thereto, and Credit Suisse AG, Cayman Islands Branch, as administrative agent for the lenders (in such capacity, the “Administrative Agent”) entered into a Fourth Amended and Restated First Lien Credit Agreement as amended by that certain Amendment No. 1 to Fourth Amended and Restated First Lien Credit Agreement dated as of July 1, 2022 (the "Amendment") (as so amended, the “Credit Agreement”). Pursuant to the Amendment, Elkay joined the Credit Agreement as a borrower (Elkay and the Original Borrowers, collectively, the "Borrowers"). The Credit Agreement is funded by a syndicate of banks and other financial institutions and provides for (i) a $550.0 million term loan facility (the “Term Loan”) and (ii) a $200.0 million revolving credit facility (the “Revolving Credit Facility”).
The obligations under the Credit Agreement and related documents are secured by liens on substantially all of the assets of Holdings, the Borrowers, and certain subsidiaries of the Borrowers pursuant to a Third Amended and Restated Guarantee and Collateral Agreement, dated as of October 4, 2021, among Holdings, the Borrowers, the subsidiaries of the Borrowers party thereto, and the Administrative Agent, as supplemented pursuant to that certain Supplement No. 1 dated as of July 1, 2022, executed by Elkay and its domestic subsidiaries, and certain other collateral documents.
The Credit Agreement contains representations, warranties, covenants and events of default, including, without limitation, a financial covenant under which the Borrowers are, if certain conditions are met, obligated to maintain on a consolidated basis, as of the end of each fiscal quarter, a certain maximum Net First Lien Leverage Ratio (as defined in the
18
Credit Agreement). As of September 30, 2024, the Borrowers were in compliance with all applicable covenants under the Credit Agreement.
Term Debt
The Credit Agreement provides for the issuance of a term loan facility in an aggregate principal amount of $550.0 million. The proceeds of the Term Loan were, together with the dividend received by the Company in connection with the Spin-Off Transaction and cash on hand, used to (i) repay in full a $625 million term loan, together with accrued interest thereon, (ii) redeem the $500 million of outstanding principal amount of the 4.875 % notes, and (iii) pay related fees and expenses.
In October 2023, the Company made a voluntary prepayment on its Term Loan of $60.0 million. In connection with this prepayment, the Company recognized a $0.9 million loss on debt extinguishment to write off a portion of the unamortized debt issuance costs. The Term Loan has a maturity date of October 4, 2028. In connection with the voluntary prepayment of $60.0 million, quarterly principal payments are no longer required.
For purposes of the Term Loan, effective July 1, 2023, the secured overnight financing rate ("SOFR") replaced LIBOR, and accordingly, beginning July 1, 2023 the Term Loan bears interest at the Borrowers' option, by reference to a base rate or a rate based on Term SOFR, plus a Term SOFR adjustment of 0.115 %, 0.262 %, or 0.428 % for interest periods of one month, three months, and six months, respectively, plus an applicable margin based on the Borrowers' Net First Lien Leverage Ratio as of the last day of each fiscal quarter. If the Net First Lien Leverage Ratio is greater than 1.80 to 1.00, the applicable margin shall equal 1.25 % in the case of base rate borrowings and 2.25 % in the case of SOFR borrowings. In the event the Borrowers’ Net First Lien Leverage Ratio is less than or equal to 1.80 to 1.00, the applicable margin on both base rate and SOFR borrowings would decrease by 0.25 %. The Borrowers’ Net First Lien Leverage Ratio was 0.89 to 1.00 as of September 30, 2024, and therefore the applicable margin is 2.00 %.
Prior to July 1, 2023, the Term Loan bore interest at the Borrowers’ option, by reference to a base rate or a rate based on LIBOR, in either case plus an applicable margin determined quarterly based on the Borrowers’ Net First Lien Leverage Ratio as of the last day of each fiscal quarter as illustrated above.
At September 30, 2024 and for the nine months then ended, the borrowings under the Term Loan had weighted-average effective interest rates of 6.71 % and 7.43 %, respectively.
Revolving Credit Facility
The Credit Agreement includes a $200.0 million revolving credit facility that has a maturity date of October 2, 2026. Similar to the Term Loan, effective July 1, 2023, the SOFR replaced LIBOR, and accordingly, beginning July 1, 2023 the Revolving Credit Facility bears interest by reference to a base rate or a rate based on Term SOFR, plus a Term SOFR adjustment of 0.115 %, 0.262 %, or 0.428 % for interest periods of one month, three months, and six months, respectively, plus an applicable margin based on the Borrowers' Net First Lien Leverage Ratio as of the last day of each fiscal quarter. If the Net First Lien Leverage Ratio is greater than 2.00 to 1.00, the applicable margin shall equal 1.00 % in the case of base rate borrowings and 2.00 % in the case of SOFR borrowings. In the event the Borrowers' Net First Lien Leverage Ratio is less than or equal to 2.00 to 1.00, the applicable margin on both base rate and SOFR borrowings would decrease by 0.25 %. The Borrowers’ Net First Lien Leverage Ratio was 0.89 to 1.00 as of September 30, 2024. The Borrowers are also required to pay a quarterly commitment fee on the average daily unused portion of the Revolving Credit Facility for each fiscal quarter and fees in connection with the issuance of letters of credit. If the Net First Lien Leverage Ratio is greater than 2.00 to 1.00, the commitment fee shall equal 0.50 %, and if the Company's Net First Lien Leverage Ratio is less than or equal to 2.00 to 1.00, the commitment fee shall equal 0.375 %.
Prior to July 1, 2023, borrowings under the Revolving Credit Facility bore interest at the Borrowers’ option, by reference to a base rate or a rate based on LIBOR, in either case, plus an applicable margin determined quarterly based on the Borrowers’ Net First Lien Leverage Ratio as of the last day of each fiscal quarter as illustrated above.
At September 30, 2024 and December 31, 2023, there were no 11.3 million and $11.0 million, respectively, of the Revolving Credit Facility was considered utilized in connection with outstanding letters of credit.
Finance Leases
19
14. Fair Value Measurements
ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. ASC 820 also specifies a fair value hierarchy based upon the observability of inputs used in valuation techniques. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed assumptions about the assumptions a market participant would use.
In accordance with ASC 820, fair value measurements are classified under the following hierarchy:
•Level 1 - Quoted prices for identical instruments in active markets.
•Level 2 - Quoted prices for similar instruments; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs or significant value-drivers are observable.
•Level 3 - Model-derived valuations in which one or more inputs or value-drivers are both significant to the fair value measurement and unobservable.
If applicable, the Company uses quoted market prices in active markets to determine fair value, and therefore classifies such measurements within Level 1. In some cases where market prices are not available, the Company makes use of observable market-based inputs to calculate fair value, in which case the measurements are classified within Level 2. If quoted or observable market prices are not available, fair value is based upon internally developed models that use, where possible, current market-based parameters. These measurements are classified within Level 3 if they use significant unobservable inputs.
Fair Value of Financial Instruments
The Company has a nonqualified deferred compensation plan where assets are invested in mutual funds and corporate-owned life insurance contracts held in a Rabbi Trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for the mutual funds, which are measured using quoted prices of identical instruments in active markets categorized as Level 1. Corporate-owned life insurance contracts are recorded at cash surrender value, which is provided by a third party and reflects the net asset value of the underlying publicly traded mutual funds categorized as Level 2. The deferred compensation plan assets are classified within other assets on the condensed consolidated balance sheets. Deferred compensation plan liabilities are measured at fair value based on quoted prices of identical instruments to the investment vehicles selected by the participants categorized as Level 1. Deferred compensation plan liabilities are classified within other liabilities on the condensed consolidated balance sheets.
The following table provides a summary of the Company's assets and liabilities that were recognized at fair value on a recurring basis as of September 30, 2024 and December 31, 2023 (in millions):
| Fair Value as of September 30, 2024 | ||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||
| Deferred compensation plan assets | $ | $ | $ | $ | ||||||||||||||||||||||
| Deferred compensation plan liabilities | ||||||||||||||||||||||||||
| Fair Value as of December 31, 2023 | ||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||
| Deferred compensation plan assets | $ | $ | $ | $ | ||||||||||||||||||||||
| Deferred compensation plan liabilities | ||||||||||||||||||||||||||
There were no transfers of assets between levels at September 30, 2024 and December 31, 2023, respectively.
Fair Value of Non-Derivative Financial Instruments
The carrying amounts of cash, receivables, payables and accrued liabilities approximated fair value at September 30, 2024 and December 31, 2023, due to the short-term nature of those instruments. The fair value of long-term debt as of September 30, 2024 and December 31, 2023, was approximately $504.4 million and $503.9 million, respectively. The fair value is based on quoted market prices for the same instruments.
20
15. Commitments and Contingencies
Warranties:
The Company offers warranties on the sales of certain of its products and records an accrual for estimated future claims. Such accruals are based upon historical experience and management’s estimate of the level of future claims. The following table presents changes in the Company’s product warranty liability (in millions):
| Nine Months Ended | ||||||||||||||
| September 30, 2024 | September 30, 2023 | |||||||||||||
| Balance at beginning of period | $ | $ | ||||||||||||
| Charged to operations | ||||||||||||||
| Claims settled | ( | ( | ||||||||||||
| Balance at end of period | $ | $ | ||||||||||||
Contingencies:
The Company's subsidiaries are involved in various unresolved legal actions, administrative proceedings and claims in the ordinary course of business involving, among other things, product liability, commercial, employment, workers' compensation, intellectual property claims and environmental matters. The Company establishes accruals in a manner that is consistent with accounting principles generally accepted in the United States for costs associated with such matters when a liability is probable and those costs are capable of being reasonably estimated. Although it is not possible to predict with certainty the outcome of these unresolved legal actions or the range of possible loss or recovery, based upon current information, management believes the eventual outcome of these unresolved legal actions, either individually or in the aggregate, will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
On December 15, 2023, Zurn Holdings, Inc. sold all of the equity interests of its direct subsidiary Zurn Industries, together with Zurn Industries’ direct and indirect subsidiaries that primarily held asbestos liabilities, certain assets and cash, in a stock sale transaction to an unaffiliated buyer. In accordance with the terms of the stock sale agreement, a subsidiary of the Company will indemnify the buyer for breaches of representations or warranties, breaches of covenants, and certain other liabilities as long as such liabilities are entirely unrelated to asbestos liabilities or assets. In addition, the buyer will indemnify the Company and its affiliates for breaches of representations or warranties, breaches of covenants, liabilities related to the operation of Zurn Industries’ and buyer’s operations post-closing and all claims arising out of asbestos liabilities and related insurance coverage.
As a result of the transaction, all asbestos obligations and liabilities, related insurance assets and associated deferred taxes, and other assets sold to the buyer, have been removed from the Company’s consolidated balance sheet effective December 15, 2023 and the Company no longer has any obligation with respect to pending and future asbestos claims related to the divested entities. As such, the divested entities have been deconsolidated from our 2023 financial results as the Company no longer owns or controls such entities. Therefore, for the period ended December 31, 2023, all asbestos obligations and liabilities, related insurance assets and associated deferred taxes, and other assets of the divested subsidiaries are no longer reported on the consolidated balance sheet. The Company recorded a loss on the divestiture of asbestos liabilities and certain assets of $11.4 million in the fourth quarter of 2023, including transaction expenses of $2.1 million.
Prior to the stock sale transaction, certain Company subsidiaries were subject to asbestos litigation. As of December 31, 2022, certain Company subsidiaries and numerous other unrelated companies were defendants in approximately 6,000 asbestos related lawsuits representing approximately 7,000 claims. Plaintiffs' claims alleged personal injuries caused by exposure to asbestos used primarily in industrial boilers formerly manufactured by a segment of Zurn Elkay's subsidiaries. Those subsidiaries did not manufacture asbestos or asbestos components. Instead, they were purchased from suppliers. These claims were handled pursuant to a defense strategy funded by insurers.
In prior years, the asbestos liability was developed based on actuarial studies and represented the projected indemnity payout for current and future claims. There were inherent uncertainties involved in estimating the number of future asbestos claims, future settlement costs, and the effectiveness of defense strategies and settlement initiatives. As of December 31, 2022, the estimated potential liability for the asbestos-related claims described above, as well as the claims expected to be filed in the next ten years , was approximately $79.0 million which was recorded in the reserve for asbestos claims within the consolidated balance sheets.
In prior years, the Company also recorded a receivable from its insurance carriers, which corresponded to the amount of this potential asbestos liability that was covered by available insurance and was determined to be probable of recovery. However, there was no assurance the Company's insurance coverage would ultimately be available or that this asbestos liability would not ultimately exceed the coverage limits. Factors that could cause a decrease in the amount of available coverage or
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create gaps in coverage include: changes in law governing the policies, potential disputes and settlements with the carriers regarding the scope of coverage, and insolvencies of one or more of the Company's carriers. As of December 31, 2022, management estimated that the available insurance to cover the ten-year estimated potential asbestos-related liabilities was $72.1 million. During the year ended December 31, 2022, the Company recorded $6.9 million for the amount that the estimated potential liability exceeded a gap in the Company's estimated available insurance coverage. This expense was recorded in other income (expense), net within the consolidated statements of operations.
16. Retirement Benefits
The components of net periodic cost are as follows (in millions):
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | September 30, 2024 | September 30, 2023 | |||||||||||||||||||||||
| Pension Benefits: | ||||||||||||||||||||||||||
| Service cost | $ | $ | $ | $ | ||||||||||||||||||||||
| Interest cost | $ | $ | $ | $ | ||||||||||||||||||||||
| Expected return on plan assets | ( | ( | ( | ( | ||||||||||||||||||||||
| Net periodic cost | $ | $ | $ | $ | ||||||||||||||||||||||
| Other Postretirement Benefits: | ||||||||||||||||||||||||||
| Interest cost | $ | $ | $ | $ | ||||||||||||||||||||||
| Net periodic cost | $ | $ | $ | $ | ||||||||||||||||||||||
The service cost component of net periodic cost is presented within Cost of sales and Selling, general and administrative expenses in the condensed consolidated statements of operations, while the other components of net periodic cost are presented within Other expense, net. The Company recognizes the net actuarial gains or losses in excess of the corridor in operating results during the final quarter of each fiscal year (or upon any required re-measurement event).
During the nine months ended September 30, 2024, the Company did not make any contributions to its U.S. qualified pension plan trusts. During the nine months ended September 30, 2023, the Company made contributions of $0.2 million to its U.S. qualified pension plan trusts.
See Note 15, Retirement Benefits, to the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2023 for further information regarding retirement benefits.
17. Stock-Based Compensation
The Zurn Elkay Water Solutions Corporation Performance Incentive Plan (the "Plan") is utilized to provide performance incentives to the Company's officers, employees, directors and certain others by permitting grants of equity awards (for common stock), as well as performance-based cash awards, to such persons to encourage them to maximize the Company's performance and create value for the Company's stockholders. For the three months ended September 30, 2024 and September 30, 2023, the Company recognized $9.8 million and $10.0 million of stock-based compensation expense, respectively. For the nine months ended September 30, 2024 and September 30, 2023, the Company recognized $29.2 million and $30.5 million of stock-based compensation expense, respectively.
During the nine months ended September 30, 2024, the Company granted the following stock options, restricted stock units, performance stock units, and common stock to directors, executive officers, and certain other employees:
| Award Type | Number of Awards | Weighted Average Grant-Date Fair Value | ||||||||||||
| Stock options | $ | |||||||||||||
| Restricted stock units | $ | |||||||||||||
| Performance stock units | $ | |||||||||||||
| Common stock | $ | |||||||||||||
Employee Stock Purchase Plan
In May 2024, the Company’s stockholders approved the adoption of the Zurn Elkay Water Solutions Corporation Employee Stock Purchase Plan (the “ESPP"). The number of shares of Company common stock available for purchase under the ESPP is 2,000,000 shares, subject to adjustment in the event of a change in capitalization.
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During the three months ended September 30, 2024, the Company issued 29,389 shares of common stock. As of September 30, 2024, 1,970,611 shares remained available for future issuance. During the three months ended September 30, 2024, the Company recognized $0.2 million of stock-based compensation expense related to the ESPP.
See Note 14, Stock-Based Compensation, to the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2023, for further information regarding stock-based compensation.
18. Subsequent Events
On October 23, 2024, the Company's Board of Directors declared a quarterly cash dividend on the Company's common stock of $0.09 per-share to be paid on December 6, 2024, to stockholders of record as of November 20, 2024.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
On July 1, 2022, we completed our combination with Elkay Manufacturing Company (“Elkay”) through the Merger of Elkay with and into a newly created subsidiary of Zurn, with Elkay surviving as a wholly owned subsidiary of Zurn Elkay (the “Merger” or "Elkay Transaction"). In conjunction with the Merger, we changed our name from Zurn Water Solutions Corporation to Zurn Elkay Water Solutions Corporation. Our results of operations include the acquired operations subsequent to July 1, 2022. See Item 1, Note 2, Acquisition, for additional information on the Elkay Merger.
Zurn Elkay Water Solutions Corporation is a growth-oriented, pure-play water management business that designs, procures, manufactures, and markets what we believe to be the broadest sustainable product portfolio of specification-driven water management solutions to improve health, hydration, human safety and the environment. Our product portfolio includes professional grade water safety and control products, flow systems products, hygienic and environmental products, and filtered drinking water products for public and private spaces that deliver superior value to building owners, positively impact the environment and human hygiene and reduce product installation time. Zurn Elkay's heritage of innovation and specification has 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 in a disciplined way and the Zurn Elkay Business System (“ZEBS”) is our operating philosophy. Grounded in the spirit of continuous improvement, ZEBS 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 audited consolidated financial statements and notes thereto, along with Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), in our Annual Report on Form 10-K for the year ended December 31, 2023.
Critical Accounting Policies and Estimates
The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"), 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, MD&A, of our Annual Report on Form 10-K for the year ended December 31, 2023 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 30, 2024, and during the period from January 1, 2024 through September 30, 2024, there has been no material change to this information.
Recent Accounting Pronouncements
See Item 1, Note 1, Basis of Presentation and Significant Accounting Policies regarding recent accounting pronouncements.
Divestiture of Asbestos Liabilities and Certain Assets
On December 15, 2023, Zurn Holdings, Inc. (“Holdings”) sold all of the equity interests of its direct subsidiary Zurn Industries, LLC (“Zurn Industries”), together with Zurn Industries’ direct and indirect subsidiaries that primarily held asbestos liabilities, certain assets and cash, in a stock sale transaction to an unaffiliated buyer (“Sale Transaction”). As a result of the Sale Transaction, all asbestos obligations and liabilities, related insurance assets and associated deferred taxes, and other assets sold to the buyer, have been removed from the Company’s consolidated balance sheet effective December 15, 2023 and the Company no longer has any obligation with respect to pending and future asbestos claims related to the divested entities. A loss on the divestiture of asbestos liabilities and certain assets of $11.4 million was recognized in the consolidated statements of operations for the twelve months ended December 31, 2023. See Item 1, Note 15, Commitments and Contingencies for additional information on this divestiture.
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Acquisitions
On July 1, 2022, we completed the Elkay Merger for a purchase price (after final purchase price adjustments) of $1,457.8 million. Elkay, a market leader of drinking water solutions and commercial sinks, complements our existing product portfolio. The purchase price includes $1,411.9 million of Zurn's common stock based on Zurn's closing stock price of $27.48 on July 1, 2022, and $45.9 million of net cash payments for the repayment of Elkay's term loan and Elkay's transaction related costs outstanding that were in excess of Elkay's cash and cash equivalents at the time of closing. Pursuant to the terms of the merger agreement, we issued 51,564,524 shares of common stock, which represented approximately 29% of outstanding shares immediately following the Merger. During the first quarter of 2023, we completed the final price adjustments and the adjusted purchase price is reflected in the purchase price amounts above, following the return of 186,020 of the shares we issued at closing as a result of lower working capital and cash balances at closing compared to targets stipulated in the merger agreement. The shares returned were canceled upon receipt. As of June 30, 2023, the measurement period was complete. Our results of operations include Elkay subsequent to the Merger date. See Item 1, Note 2, Acquisition for additional information on the Elkay Merger.
Spin-Off of Process & Motion Control Segment
On October 4, 2021, the Company completed a Reverse Morris Trust tax-free spin-off transaction (the “Spin-Off Transaction”) in which (i) substantially all the assets and liabilities of the Company's Process & Motion Control ("PMC") business were transferred to a newly created subsidiary, Land Newco, Inc. (“Land”), (ii) the shares of Land were distributed to the Company's stockholders pro rata, and (iii) Land was merged with a subsidiary of Regal Rexnord Corporation (formerly known as Regal Beloit Corporation), in which the stock of Land was converted into a specified number of shares of Regal Rexnord Corporation in accordance with the exchange ratio. The operating results of PMC are reported as discontinued operations in our condensed consolidated statements of operations for all periods presented. The condensed consolidated statements of cash flows for the nine months ended September 30, 2024 and September 30, 2023 have not been adjusted to separately disclose cash flows related to the discontinued operations.
The major components of the Income from discontinued operations, net of tax presented in the condensed consolidated statements of operations for the three and nine months ended September 30, 2024 and September 30, 2023, are as follows (in millions):
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | September 30, 2024 | September 30, 2023 | |||||||||||||||||||||||
| Selling, general and administrative income (1) | $ | — | $ | 6.6 | $ | 0.7 | $ | 8.4 | ||||||||||||||||||
| Income from discontinued operations before income tax | — | 6.6 | 0.7 | 8.4 | ||||||||||||||||||||||
| Income tax (expense) benefit | — | (0.4) | 0.3 | (0.3) | ||||||||||||||||||||||
| Income from discontinued operations, net of tax | $ | — | $ | 6.2 | $ | 1.0 | $ | 8.1 | ||||||||||||||||||
(1)Selling, general and administrative income includes the reversal of certain accruals as a result of costs the Company will no longer incur related to the Spin-Off Transaction.
See Item 1, Note 4, Discontinued Operations for additional information.
Restructuring and Other Similar Charges
During the three and nine months ended September 30, 2024, the Company continued to execute various restructuring actions. These initiatives were implemented to drive efficiencies and reduce operating costs while also modifying the Company's footprint to reflect changes in the markets it serves, the impact of mergers and acquisitions, including Elkay, on the Company's overall manufacturing capacity and the refinement of its overall product portfolio. These restructuring actions primarily resulted in workforce reductions, lease termination costs and other facility rationalization costs. Management expects to continue executing similar initiatives to optimize the Company's operating margin and manufacturing footprint. As such, the Company expects further expenses related to workforce reductions, potential impairment or accelerated depreciation of assets, lease termination costs and other facility rationalization costs. For the three and nine months ended September 30, 2024, restructuring charges totaled $2.7 million and $9.7 million, respectively. For the three and nine months ended September 30, 2023, restructuring charges totaled $2.2 million and $11.9 million, respectively. Refer to Item 1, Note 3, Restructuring and Other Similar Charges for further information.
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Results of Operations
Three Months Ended September 30, 2024 compared with the Three Months Ended September 30, 2023:
Net sales
(Dollars in Millions)
| Three Months Ended | |||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | Change | % Change | ||||||||||||||||||||
| Net sales | $ | 410.0 | $ | 398.4 | $ | 11.6 | 2.9 | % | |||||||||||||||
Net sales were $410.0 million and $398.4 million during the three months ended September 30, 2024 and September 30, 2023, respectively, an increase of 3% year over year. Core sales growth of 3%, including growth in all product categories, was offset by a 100 basis point impact from the planned exit of certain residential sink products.
Income from operations
(Dollars in Millions)
| Three Months Ended | |||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | Change | % Change | ||||||||||||||||||||
| Income from operations | $ | 70.2 | $ | 60.1 | $ | 10.1 | 16.8 | % | |||||||||||||||
| % of net sales | 17.1 | % | 15.1 | % | 2.0 | % | |||||||||||||||||
During the three months ended September 30, 2024, income from operations was $70.2 million compared to $60.1 million during the three months ended September 30, 2023. Income from operations as a percentage of net sales increased by 200 basis points year over year due to the benefits from delivering the synergies related to the Elkay Merger, as well as lower material costs.
Interest expense, net
Interest expense, net was $8.3 million for the three months ended September 30, 2024, compared to $9.9 million for the three months ended September 30, 2023. The decrease in interest expense, net as compared to the prior year period is due to interest earned on higher cash balances and reduced interest expense due to the prior year prepayment of $60 million.
Other expense, net
Other expense, net for the three months ended September 30, 2024 and 2023, was $1.5 million and $2.5 million, respectively. Other expense, net consists primarily of foreign currency transaction gains and losses, the non-service cost components associated with our defined benefit plans and other non-operational gains and losses. The year-over-year change is primarily driven by lower defined benefit plan costs in the current year and increased accruals for estimated environmental remediation costs in the prior year.
Provision for income taxes
The income tax provision was $16.9 million for the three months ended September 30, 2024, compared to $12.5 million for the three months ended September 30, 2023. The effective income tax rate for the three months ended September 30, 2024 was 28.0% versus 26.2% for the three months ended September 30, 2023. The effective income tax rate for the three months ended September 30, 2024 and the three months ended September 30, 2023 was above the U.S. federal statutory rate of 21% primarily due to the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code, the accrual of various state income taxes and the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, partially offset by the recognition of income tax benefits associated with share-based payments.
On a quarterly basis, we review and analyze our valuation allowances associated with deferred tax assets relating to certain foreign and state net operating loss carryforwards as well as U.S. federal and state capital loss carryforwards. In conjunction with this analysis, we weigh both positive and negative evidence for purposes of determining the proper balances of such valuation allowances. Future changes to the balances of these valuation allowances, as a result of our continued review and analysis, could impact the financial statements for such period of change.
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Net income
Net income for the three months ended September 30, 2024, was $43.5 million compared to net income of $41.4 million for the three months ended September 30, 2023. Diluted net income per share for the three months ended September 30, 2024 and September 30, 2023, was $0.25 and $0.24, respectively. The year-over-year change is the result of the factors described above. Net loss from discontinued operations, net of tax, was $0.0 million for the three months ended September 30, 2024 compared to net income from discontinued operations, net of tax, of $6.2 million for the three months ended September 30, 2023. Diluted net income per share from discontinued operations for the three months ended September 30, 2024 and September 30, 2023, was $0.00 and $0.04, respectively.
Nine Months Ended September 30, 2024 compared with the Nine Months Ended September 30, 2023:
Net sales
(Dollars in Millions)
| Nine Months Ended | |||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | Change | % Change | ||||||||||||||||||||
| Net sales | $ | 1,195.8 | $ | 1,173.7 | $ | 22.1 | 1.9 | % | |||||||||||||||
Net sales were $1,195.8 million during the nine months ended September 30, 2024, an increase of 2% year-over-year. The 2% core sales growth across nearly all product categories was offset by the 200 basis point impact from the planned exit of certain residential sink products.
Income from operations
(Dollars in Millions)
| Nine Months Ended | |||||||||||||||||||||||
| September 30, 2024 | September 30, 2023 | Change | % Change | ||||||||||||||||||||
| Income from operations | 195.3 | 158.6 | 36.7 | 23.1 | % | ||||||||||||||||||
| % of net sales | 16.3 | % | 13.5 | % | 2.8 | % | |||||||||||||||||
Income from operations during the nine months ended September 30, 2024 was $195.3 million compared to $158.6 million during the nine months ended September 30, 2023. Income from operations as a percentage of net sales increased by 280 basis points year over year due to the benefits resulting from productivity synergies and restructuring actions related to the Elkay Merger, as well as lower material and restructuring costs.
Interest expense, net
Interest expense, net was $25.6 million during the nine months ended September 30, 2024, compared to $29.8 million during the nine months ended September 30, 2023. The decrease in interest expense, net as compared to the prior year period is due to interest earned on higher cash balances and reduced interest expense due to the prior year prepayment of $60 million.
Other expense, net
Other expense, net during the nine months ended September 30, 2024 was $4.5 million compared to $3.3 million during the nine months ended September 30, 2023. Other expense, net consists primarily of foreign currency transaction gains and losses, the non-service cost components associated with our defined benefit plans and other non-operational gains and losses. The year-over-year change is primarily driven by income recognized in connection with an insurance settlement in the prior year, partly offset by accruals for estimated environmental remediation costs in the prior year and lower defined benefit plan costs in the current year.
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Provision for income taxes
The income tax provision was $42.4 million for the nine months ended September 30, 2024, compared to $34.8 million for the nine months ended September 30, 2023. The effective income tax rate for the nine months ended September 30, 2024 was 25.7% versus 27.7% for the nine months ended September 30, 2023. The effective income tax rate for the nine months ended September 30, 2024 was above the U.S. federal statutory rate of 21% primarily due to the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code, the accrual of various state income taxes and the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, partially offset by the recognition of certain previously unrecognized tax benefits due to the lapse of the applicable statutes of limitations and income tax benefits associated with share-based payments. The effective income tax rate for the nine months ended September 30, 2023 was above the U.S. federal statutory rate of 21% primarily due to the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code, the accrual of various state income taxes and the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, partially offset by the recognition of income tax benefits associated with share-based payments.
Net income
Net income for the nine months ended September 30, 2024, was $123.8 million compared to $98.8 million for the nine months ended September 30, 2023. Diluted net income per share for the nine months ended September 30, 2024 and September 30, 2023, was $0.71 and $0.56, respectively. Net income from discontinued operations, net of tax, was $1.0 million for the nine months ended September 30, 2024 compared to $8.1 million for the nine months ended September 30, 2023. Diluted net income per share from discontinued operations for the nine months ended September 30, 2024 and September 30, 2023, was $0.01 and $0.05, respectively.
Non-GAAP Financial Measures
Non-GAAP financial measures are intended to supplement and not replace financial measures prepared in accordance with GAAP. The following non-GAAP financial measures are utilized by management in comparing our operating performance on a consistent basis. We believe that these financial measures are appropriate to enhance an overall understanding of our underlying operating performance trends compared to historical and prospective periods and our peers. Management also believes that these measures are useful to investors in their analysis of our results of operations and provide improved comparability between fiscal periods as well as insight into the compliance with our debt covenants. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information calculated in accordance with GAAP. Investors are encouraged to review the reconciliation of these non-GAAP measures to their most directly comparable GAAP financial measures.
Core sales
Core sales excludes the impact of mergers, acquisitions, divestitures and foreign currency translation. Management believes that core sales facilitates easier and more meaningful comparisons of our net sales performance with prior and future periods and to our peers. We exclude the effect of mergers, acquisitions and divestitures because the nature, size and number 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.
EBITDA
EBITDA represents earnings before interest and other debt related activities, taxes, depreciation and amortization. EBITDA is presented because it is an important supplemental measure of performance and it is frequently used by analysts, investors and other interested parties in the evaluation of companies in our industry. EBITDA is also presented and compared by analysts and investors in evaluating our ability to meet debt service obligations. Other companies in our industry may calculate EBITDA differently. EBITDA is not a measurement of financial performance under GAAP and should not be considered as an alternative to cash flow from operating activities or as a measure of liquidity or an alternative to net income as indicators of operating performance or any other measures of performance derived in accordance with GAAP. Because EBITDA is calculated before recurring cash charges, including interest expense and taxes, and is not adjusted for capital expenditures or other recurring cash requirements of the business, it should not be considered as a measure of discretionary cash available to invest in the growth of the business.
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Adjusted EBITDA
Adjusted EBITDA is an important measure because, under our credit agreement, 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). "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 in the "Covenant Compliance" section. 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. It is also provided to aid investors in understanding our compliance with our debt covenants. 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 should not be considered 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; or (f) 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 added back in calculating Adjusted EBITDA can represent the reduction of cash that could be used for other corporate purposes. Further, although not included in the calculation of Adjusted EBITDA in the "Covenant Compliance" section below, the measure may at times allow us to add estimated cost savings and operating synergies related to operational changes ranging from mergers, acquisitions or dispositions to restructuring, and/or exclude one-time transition expenditures that we anticipate incurring to realize cost savings before such savings have occurred.
The calculation of Adjusted EBITDA under our credit agreement as of September 30, 2024, is presented in the table in the "Covenant Compliance" section below. However, the results of such calculation could differ in the future based on the different types of adjustments that may be included in such respective calculations at the time. For the nine months ended September 30, 2024, we reported net income of $123.8 million and Adjusted EBITDA for the same period of $299.3 million. See "Covenant Compliance" for a reconciliation of Adjusted EBITDA to GAAP net income.
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 a maximum total Net First Lien Leverage Ratio (consolidated indebtedness to Adjusted EBITDA) of 5.00 to 1.00 as of the end of each fiscal quarter. As of September 30, 2024, our Net First Lien Leverage Ratio was 0.89 to 1.00. Failure to comply with these covenants could limit our long-term growth prospects by hindering our ability to borrow under the revolver, to obtain future debt and/or to make acquisitions.
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Set forth below is a reconciliation of net income to Adjusted EBITDA for the periods indicated below.
| (in millions) | Nine months ended September 30, 2023 | Twelve months ended December 31, 2023 | Nine months ended September 30, 2024 | Twelve months ended September 30, 2024 | |||||||||||||||||||
| Net income | $ | 98.8 | $ | 112.7 | $ | 123.8 | $ | 137.7 | |||||||||||||||
| Income from discontinued operations, net of tax (1) | (8.1) | (8.5) | (1.0) | (1.4) | |||||||||||||||||||
| Provision for income taxes | 34.8 | 42.6 | 42.4 | 50.2 | |||||||||||||||||||
| Actuarial gain on pension and postretirement benefit obligations | — | (2.0) | — | (2.0) | |||||||||||||||||||
| Other expense, net (2) | 3.3 | 7.2 | 4.5 | 8.4 | |||||||||||||||||||
| Loss on the extinguishment of debt | — | 0.9 | — | 0.9 | |||||||||||||||||||
| Interest expense | 29.8 | 38.5 | 25.6 | 34.3 | |||||||||||||||||||
| Depreciation and amortization | 66.3 | 87.9 | 65.2 | 86.8 | |||||||||||||||||||
| EBITDA | 224.9 | 279.3 | 260.5 | 314.9 | |||||||||||||||||||
| Adjustments to EBITDA | |||||||||||||||||||||||
| Restructuring and other similar charges (3) | 11.9 | 15.3 | 9.7 | 13.1 | |||||||||||||||||||
| Stock-based compensation expense | 30.5 | 40.0 | 29.2 | 38.7 | |||||||||||||||||||
| Last-in first-out ("LIFO") adjustments (4) | (11.9) | (6.5) | (0.5) | 4.9 | |||||||||||||||||||
| Loss on divestiture of asbestos liabilities and certain assets (5) | — | 11.4 | — | 11.4 | |||||||||||||||||||
| Other, net (6) | — | — | 0.4 | 0.4 | |||||||||||||||||||
| Subtotal of adjustments to EBITDA | 30.5 | 60.2 | 38.8 | 68.5 | |||||||||||||||||||
| Adjusted EBITDA | $ | 255.4 | $ | 339.5 | $ | 299.3 | $ | 383.4 | |||||||||||||||
| Consolidated indebtedness (7) | $ | 340.6 | |||||||||||||||||||||
| Net First Lien Leverage Ratio (8) | 0.89 | ||||||||||||||||||||||
__________________________________
(1)Income from discontinued operations, net of tax is not included in Adjusted EBITDA in accordance with the terms of our credit agreement.
(2)Other expense, net consists primarily of gains and losses from foreign currency transactions, the non-service cost components of net periodic benefit costs associated with our defined benefit plans and other non-operational gains and losses as defined in our credit agreement.
(3)In accordance with the terms in our credit agreement, restructuring and other similar charges is comprised of costs associated with workforce reductions, asset impairments, lease termination costs, and other facility rationalization costs. See Item 1, Note 3, Restructuring and Other Similar Charges for more information.
(4)Last-in first-out (LIFO) inventory adjustments are excluded in calculating Adjusted EBITDA as defined in our credit agreement.
(5)Loss on divestiture of asbestos liabilities and certain assets are excluded in calculating Adjusted EBITDA as defined in our credit agreement.
(6)Other, net consists of gains and losses on the disposition of long-lived assets per the credit agreement.
(7)Our credit agreement defines our consolidated indebtedness as the sum of all indebtedness (other than letters of credit or bank guarantees, to the extent undrawn) consisting of indebtedness for borrowed money and capitalized lease obligations, less unrestricted cash, which was $155.1 million (as defined by the credit agreement) at September 30, 2024.
(8)Our credit agreement defines the Net First Lien Leverage Ratio as the ratio of consolidated indebtedness (as described above) to Adjusted EBITDA for the trailing four fiscal quarters.
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Liquidity and Capital Resources
Our primary sources of liquidity are available cash and cash equivalents, cash flow from operations, and borrowing availability of up to $200.0 million under our revolving credit facility.
As of September 30, 2024, we had $187.9 million of cash and cash equivalents and $188.7 million of additional borrowing capacity under our revolving credit facility. As of September 30, 2024, the available borrowings under our credit facility were reduced by $11.3 million due to outstanding letters of credit. As of December 31, 2023, we had $136.7 million of cash and cash equivalents and $189.0 million of additional borrowing capacity under our revolving credit facility. As of December 31, 2023, the available borrowings under our credit facility were reduced by $11.0 million due to outstanding letters of credit.
Our revolving credit facility is available to fund our working capital requirements, capital expenditures and other general corporate purposes. We believe this resource is adequate for our expected short-term and long-term needs.
Cash Flows
Net cash provided by operating activities was $229.9 million and $195.7 million during the nine months ended September 30, 2024 and 2023, respectively. The change in year-over-year operating cash flows was primarily the result of an increase in net income, a lower use of cash for trade working capital, and the timing of accrued expenses during the nine months ended September 30, 2024.
Cash used for investing activities was $11.1 million during the nine months ended September 30, 2024 and $6.6 million during the nine months ended September 30, 2023. Investing activities during the nine months ended September 30, 2024, consisted of $12.7 million of capital expenditures, which were partially offset by $1.6 million from the sale of certain long-lived assets. Investing activities during the nine months ended September 30, 2023, consisted of $15.9 million of capital expenditures, which were partially offset by the receipt of $9.0 million in connection with an insurance settlement and $0.3 million from the sale of certain long-lived assets.
Cash used for financing activities was $165.8 million during the nine months ended September 30, 2024, compared to $141.5 million during the nine months ended September 30, 2023. During the nine months ended September 30, 2024, we utilized $0.6 million of cash for payments on finance leases, $129.9 million to repurchase outstanding shares of our common stock, and $41.3 million for the payment of common stock dividends, which was partially offset by $6.0 million of proceeds from the exercise of stock options and ESPP contributions, net of taxes withheld and paid on employees' share-based awards. During the nine months ended September 30, 2023, we utilized a net $4.7 million of cash for payments on outstanding debt, $100.2 million to repurchase outstanding shares of our common stock, and $36.6 million for the payment of common stock dividends.
Indebtedness
As of September 30, 2024, we had $495.6 million of total indebtedness outstanding as follows (in millions):
Total Debt at September 30, 2024 | Current Maturities of Debt | Long-term Portion | ||||||||||||||||||
| Term loan (1) | $ | 474.6 | $ | — | $ | 474.6 | ||||||||||||||
| Finance leases | 21.0 | 0.9 | 20.1 | |||||||||||||||||
| Total | $ | 495.6 | $ | 0.9 | $ | 494.7 | ||||||||||||||
___________________________________________
(1)Includes unamortized original issue discount and debt issuance costs of $5.7 million at September 30, 2024.
See Item 1, Note 13, Long-Term Debt for a description of our outstanding indebtedness.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk during the normal course of business from changes in foreign currency exchange rates and interest rates. The exposure to these risks is managed through a combination of normal operating and financing activities and at times derivative financial instruments in the form of foreign currency forward contracts to cover certain known foreign currency transactional risks. We also have historically entered into interest rate derivatives to manage interest rate fluctuations.
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ITEM 4. CONTROLS AND PROCEDURES
We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
We carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 of the Exchange Act. Based on that evaluation as of September 30, 2024, the Chief Executive Officer and Chief Financial Officer concluded that, as of such date, the Company's disclosure controls and procedures are adequate and effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and that such information is accumulated and communicated to the Company's management, including the Chief Executive Officer and Chief Financial Officer, in a manner allowing timely decisions regarding required disclosure. As such, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the period covered by this report.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of the changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
There have been no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See the information under the heading "Commitments and Contingencies" in Note 15 to the condensed consolidated financial statements contained in Part I, Item 1 of this report, which is incorporated in this Part II, Item 1 by reference.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In fiscal 2015, the Company's Board of Directors approved a stock repurchase program (the "Repurchase Program") authorizing the repurchase of up to $200.0 million of the Company's common stock from time to time on the open market or in privately negotiated transactions. On January 27, 2020, the Company's Board of Directors approved increasing the remaining share repurchase authority under the Repurchase Program to $300.0 million. On February 8, 2023, the Company's Board of Directors approved increasing the remaining share repurchase authority under the Repurchase Program to $500.0 million. The Repurchase Program does not require the Company to acquire any particular amount of common stock and does not specify the timing of purchases or the prices to be paid; however, the program will continue until the maximum amount of dollars authorized have been expended or until it is modified or terminated by the Board of Directors. During the three months ended September 30, 2024, the Company repurchased 1,622,895 shares of common stock at a total cost of $50.0 million at an average price of $30.81 per share. The repurchased shares were canceled by the Company upon receipt. The remaining repurchase authority under the Repurchase Program at September 30, 2024 was $260.6 million.
| ISSUER PURCHASES OF EQUITY SECURITIES | |||||||||||||||||||||||
| Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Approximate Dollar Value that may yet be Purchased Under the Plans or Programs | ||||||||||||||||||||
| Period | |||||||||||||||||||||||
| July 1 - July 31, 2024 | 428,536 | $ | 30.33 | 428,536 | $ | 297,578,687 | |||||||||||||||||
| August 1 - August 31, 2024 | 858,387 | $ | 30.66 | 858,387 | $ | 271,239,283 | |||||||||||||||||
| September 1 - September 30, 2024 | 335,972 | $ | 31.79 | 335,972 | $ | 260,551,251 | |||||||||||||||||
| Total/Average | 1,622,895 | $ | 30.81 | 1,622,895 | |||||||||||||||||||
ITEM 5. OTHER INFORMATION
During the three months ended September 30, 2024, no director or officer of the Company adopted terminated
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ITEM 6. EXHIBITS
| Exhibit No. | Description | Filed Herewith | ||||||||||||
| 31.1 | X | |||||||||||||
| 31.2 | X | |||||||||||||
| 32.1 | X | |||||||||||||
| 101.INS | Inline XBRL Instance Document (The instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document.) | X | ||||||||||||
| 101.SCH | Inline XBRL Taxonomy Extension Schema Document | X | ||||||||||||
| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document | X | ||||||||||||
| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document | X | ||||||||||||
| 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document | X | ||||||||||||
| 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document | X | ||||||||||||
| 104 | Cover Page Inline XBRL data (contained in Exhibit 101) | X | ||||||||||||
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, Zurn Elkay Water Solutions Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| ZURN ELKAY WATER SOLUTIONS CORPORATION | ||||||||||||||
| Date: | October 29, 2024 | By: | /S/ DAVID J. PAULI | |||||||||||
| Name: | David J. Pauli | |||||||||||||
| Title: | Chief Financial Officer | |||||||||||||
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