Zurn Elkay Water Solutions (ZWS)2024-02-06 21:15Economic and Market Risks - Economic and financial market weakness may adversely affect Zurn Elkay's financial condition and results of operations, particularly in cyclical end markets[73][74] - Sales to the construction industry are influenced by factors such as consumer confidence, employment rates, and interest rates, with potential material impacts on demand and profit margins[75] - The company's business could be adversely affected by increased frequency of severe weather events, which could delay or halt construction activity and reduce demand for its products[101] - Climate change could lead to reduced demand for certain of the company's products and alter its product sales mix in ways that reduce margins[103] - The company's business and operations could be adversely affected by future outbreaks of infectious diseases, including disruptions to global supply chains and increased compensation expenses[105] Customer and Sales Concentration - Zurn Elkay's top five customers accounted for approximately 39% of consolidated net sales in 2023, with one customer representing 20%[88] - Zurn Elkay relies on 1,055 independent sales representatives and approximately 70 third-party warehouses, with the top three distributors generating 33% of consolidated net sales in 2023[90] Supply Chain and Raw Material Risks - Raw material cost increases or availability issues, including due to tariffs or trade protection measures, could adversely affect profitability and operations[94] - Zurn Elkay does not typically hedge against raw material price risks, which could lead to disruptions in business operations[95] - Cost of materials represents approximately 37% of net sales, with strategic sourcing aimed at reducing supplier numbers and material costs[182] Operational and Integration Risks - Ongoing updates to the company's ERP systems could result in substantial business interruptions if ineffective[97] - Zurn Elkay faces risks related to the integration of acquisitions and divestitures, which could adversely affect financial condition and results of operations[83][84] - Integration challenges with Elkay's business may hinder the realization of anticipated synergies and cost savings[134] Intellectual Property and Competition - The company's intellectual property protection efforts may not prevent competitors from infringing or challenging its rights, potentially affecting product margins[92] - The company's inability to attract and retain key personnel in a highly competitive industry could materially affect its business[100] Financial and Debt Management - The company's debt levels could adversely affect its ability to raise additional capital, react to economic changes, make acquisitions, and implement its capital allocation strategy[107] - The company recently amended its credit facilities to switch from LIBOR-based loans to SOFR-based loans, which could expose future borrowings to less favorable rates[109][110] - The company's credit agreement contains various covenants that restrict its ability to incur additional debt, pay dividends, make certain investments, and engage in other business activities[112][113] - The company's required cash contributions to its pension plans may increase further, which could reduce cash available for other obligations and adversely affect its financial condition[118] - The company's Net First Lien Leverage Ratio as of December 31, 2023, was 1.2 to 1.0, well below the maximum allowed ratio of 5.0 to 1.0[224] - Total indebtedness stood at $495.3 million as of December 31, 2023, including $473.6 million in term loans and $21.7 million in finance leases[236] - The weighted-average effective interest rate on the term loan facility was 7.47% as of December 31, 2023, with a 100 basis point increase in Term SOFR potentially raising annual interest expense by $4.9 million[248][249] Technology and Cybersecurity Risks - The company's technology systems could be vulnerable to disability, failures, or unauthorized access, which could impede its ability to record or process orders, manufacture and ship products, and protect sensitive data[98] Regulatory and Compliance Risks - Compliance with government regulations and third-party certification requirements could increase operational costs and impact profitability[121] - Climate change-related regulations may impose significant costs on the company, including energy requirements and environmental monitoring[122] - Environmental compliance costs and liabilities under environmental laws may result in significant capital expenditures[125] - Potential tax changes, including the OECD's Pillar 2 global minimum tax rate of 15%, could affect the company's financial condition[124] Legal and Litigation Risks - Product liability claims and litigation could adversely affect the company's reputation and financial performance[128] - The Spin-Off Transaction may result in substantial additional taxes if it fails to qualify as a tax-free reorganization[129] Financial Performance and Liquidity - The company's backlog as of December 31, 2023, is entirely scheduled to ship during 2024[89] - The company's goodwill and intangible assets totaled $796.0 million and $952.4 million respectively as of December 31, 2023, representing a substantial portion of its assets[116] - The company recognized $2.5 million of fixed asset impairment charges during the year ended December 31, 2023, with no impairment charges in 2022 or 2021[187] - The company recorded a non-cash actuarial gain of $2.0 million, $1.9 million, and $1.2 million for the years ended December 31, 2023, 2022, and 2021, respectively, related to retirement benefit re-measurements[191] - The company's liability for unrecognized tax benefits was $5.6 million and $5.5 million as of December 31, 2023 and 2022, respectively[194] - Valuation allowances against deferred tax assets were $12.0 million and $32.2 million as of December 31, 2023 and 2022, respectively[195] - The company recognized a loss of $11.4 million on the divestiture of asbestos liabilities and certain assets during the year ended December 31, 2023[198] - The Elkay Merger was completed on July 1, 2022, for a purchase price of $1,457.8 million, including $1,411.9 million in common stock and $45.9 million in net cash payments[200] - The company received $35.0 million from Regal Rexnord Corporation in 2022 due to final working capital and cash balances exceeding targets in the PMC spin-off transaction[202] - Income from discontinued operations, net of tax, was $8.5 million, $4.7 million, and $71.2 million for the years ended December 31, 2023, 2022, and 2021, respectively[203] - The company recorded restructuring charges of $15.3 million, $15.4 million, and $3.7 million for the years ended December 31, 2023, 2022, and 2021, respectively[207] - Net sales for the year ended December 31, 2023, were $1,530.5 million, a 19.4% increase year over year, with core sales decreasing by 1% excluding the impact of the Elkay merger[208] - Income from operations for the year ended December 31, 2023, was $191.4 million, or 12.5% of net sales, a 78.7% increase year over year[209] - Interest expense, net for the year ended December 31, 2023, was $38.5 million, compared to $26.9 million for the year ended December 31, 2022[210] - Net income from continuing operations for the year ended December 31, 2023, was $104.2 million, compared to $57.0 million for the year ended December 31, 2022[215] - Net income for the year ended December 31, 2023, was $112.7 million, compared to $61.7 million for the year ended December 31, 2022[216] - Adjusted EBITDA for the year ended December 31, 2023, was $339.5 million, compared to net income of $112.7 million for the same period[223] - The company's primary sources of liquidity include available cash and cash equivalents, cash flow from operations, and borrowing availability under its $200.0 million revolving credit facility[228] - Cash and cash equivalents increased to $136.7 million as of December 31, 2023, up from $124.8 million in 2022[229] - Net cash provided by operating activities surged to $253.9 million in 2023, compared to $97.0 million in 2022[233] - Cash used for investing activities decreased to $4.6 million in 2023 from $6.6 million in 2022, with $21.3 million in capital expenditures partially offset by $9.0 million from an insurance settlement and $7.7 million from asset sales[234] - Cash used for financing activities rose to $239.2 million in 2023, up from $61.1 million in 2022, driven by $50.4 million in dividends, $125.1 million in stock repurchases, and $64.9 million in debt payments[235] - The company had $189.0 million in additional borrowing capacity under its revolving credit facility as of December 31, 2023, reduced by $11.0 million due to outstanding letters of credit[229] Foreign Exchange and International Operations - Approximately 11% of sales originated outside the U.S. in 2023, with foreign currency translation adjustments increasing stockholders' equity by $3.6 million[246] - Stockholders' equity would decrease by approximately $11.7 million if the USD strengthened by 10% as of December 31, 2023[246] - The company did not enter into foreign currency forward contracts as of December 31, 2023[247] Merger and Acquisitions - The Merger with Elkay recorded substantial goodwill and intangible assets, which could lead to future impairment charges[133] - Former Elkay stockholders holding approximately 23% of Zurn Elkay's common stock may impact the trading price if they sell shares[136]