Good morning, and welcome to the Zurn Elkay Water Solutions Corporation Second Quarter 2022 Earnings Results Conference Call with Todd Adams, Chairman and Chief Executive Officer; Mark Peterson, Senior Vice President and Chief Financial Officer; and Dave Pauli Vice President of Investor Relations for Zurn Elkay Water Solutions.

This call is being recorded and will be available for one week. The phone numbers for the replay can be found in the earnings release the company filed in the 8-K with the SEC yesterday, July 26. At time for opening remarks and introductions, I will turn the call over to Dave Pauli..

Good morning, everyone and thanks for joining the call today. Before we begin, I'd like to remind everyone that this call contains certain forward-looking statements that are subject to the Safe Harbor language contained in the press release that we issued yesterday afternoon, as well as in our filings with the SEC.

In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures, why we use them, and why we believe they are helpful to investors and contain reconciliations to the corresponding GAAP information.

Consistent with prior quarters, we will speak to certain non-GAAP metrics as we feel they provide a better understanding of our operating results. These measures are not a substitute for GAAP and we encourage you to review the GAAP information in our earnings release and in our SEC filings.

One final reminder, we closed the Elkay transaction on July 1. So our second quarter results that we will be walking through today do not include the impact from Elkay. We will start reporting a combined Zurn Elkay with our third quarter results. With that, I'll turn the call over to Todd Adams, Chairman and CEO of Zurn Elkay Water Solutions..

Thanks, Dave, and for everyone out there, just recognize Dave is a brand new dad three weeks ago. His wife Laura had a new son Nolan. So when you call him be sure to congratulate him, he's burning both ends of the candle here. So, thanks Dave for everything and congratulations. So, well, good morning, everyone.

And hopefully everyone had a chance to read through the earnings release last night. And we do certainly appreciate everyone taking the time to join the call this morning. As Dave said, the merger was completed on 7:1. And we've been working really, really closely together in the last few months in preparation of bringing these two businesses together.

The strategic logic around the transaction continues to be exceptional. Complementary North American water quality, safety flow control, conservation and hydration products and solutions serving the same end markets and the same customers with both significant operational and commercial synergies.

I'm really pleased where we are with respect to the integration, probably three to six months ahead of where I thought we'd be at this point, because we've got a lot of important things already behind us in the few short weeks since we've closed.

We’ve aligned the sales and marketing organizations into a single team just last week and we've already made or decided upon essentially all of the third-party rep changes that we want as a single business.

In doing so we've established a single go to market and we'll be leveraging our proven demand creation capability which is super important and doing it right away will help us build the kind of momentum we want heading into fiscal year ’23, as opposed to dealing with that much change to start our full fiscal year as a combined business that maybe we contemplated originally.

We're also working through the change curve with the legacy Elkay team teaching and fostering a common language we're going to use to run our business, the Zurn Elkay Business System. In many, many ways this transaction reminds me of when the old Rexnord combined with the Zurn Business.

We found a business with tremendous people, a great culture, fantastic products that could be better and go faster that even the Zurn team at that time thought.

A really important difference is, we've got 15 more years of experience leveraging the Business System to develop and deploy a strategy, significantly more talent across the board to execute and an even clearer vision of what we can turn the combined business into.

Because the only thing we're focused on is being the very best pure-play water solutions business in the market, and one that's a monster in both the marketplace and produces superior financial results. In terms of the second quarter, which as Dave said, will be the last standalone quarter for the legacy Zurn Business in short, was really good.

Sales growth of 17%, with 50% core growth and segment margins of 25.1%. Free cash flow was $41 million and leverage debt to $1.9 million. And when you look ahead to the end of ‘22 and to start fiscal year ‘23 leverage will be just above one times.

We also announced an increase to the dividend last week to $0.07 a quarter, consistent with what we communicated back in February with the announcement of the Elkay transaction. Before I turn it over to Mark, I want to touch on everyone's favorite topic of conversation in the last 24 months, supply chain.

Taken as a whole, we've manage the unprecedented environment extraordinarily well, really for some time dating back to the onset of tariffs through the pandemic disruption and then the follow-on freight and logistics challenges that we've all dealt with. And doing all of that while growing at a double-digit topline rate.

Consistent with what we said in the last three quarters, we're continuing to see our supply chain normalizing back to 2019 levels. Just for some context, from the time we order things to the time we receive, convert and ship them, it used to take about 70 to 80 days.

Obviously, just a proxy for the total, but think of it as our end-to-end supply chain loop. Then you have to back that into best-in-class availability and lead times with share gain driven double-digit growth and some seasonality. Our supply chain ballooned to about 160 days to 170 days over the last 12 months to 18 months.

But through a bunch of effort and strategic changes to our supply chain sourcing and processes along with some 80:20 work we've been doing, what we're seeing today is that, that's back into 80 day to 90 day range with further improvements through the fourth quarter and into fiscal year ’23.

The punch line is that, you should expect to see a sizable inventory reduction for us over the second half of the year. And also what looks like a more favorable and freight -- favorable commodity and freight cost environment as we start fiscal year ‘23.

With that, Mark is going to take you through some financial details and I'll come back and cover a few details on the integration..

Thanks, Todd. Let's turn to slide number four. On a year-over-year basis our second quarter sales increased 17% to $284 million.

On November '21, Wade Drains acquisition accounted for 2% of the year-over-year growth and the core business drove 15% of growth with generally balanced core sales growth across our water safety and control, hygienic and environmental and flow control product categories.

With respect to profitability, our adjusted EBITDA, excluding corporate costs totaled $71 million in the quarter and our adjusted EBITDA margin was just over the high end of our expectations for the quarter at 25.1% and improved 60 basis points sequentially from our first quarter of 2022.

On a year-over-year basis, about the benefits of the sales growth, inclusive of price realization and our productivity actions was partially offset by the increase in material and transportation costs as well as our investments in our growth and supply chain initiatives.

With respect to our corporate costs, it totaled $7 million in the quarter as we had expected and it should remain at that approximate level per quarter for the balance of the year. Please turn to slide number five, and I'll touch on some of the balance sheet and leverage highlights.

With respect to our net debt leverage, we ended the quarter in line with our expectations at 1.9 times pro forma for the adjusted annual corporate expense run rate I just discussed.

When it includes Elkay, our leverage will continue to decline, and by the end of the third quarter will be at a level that will trigger a 25 basis point reduction in our base term loan rates. As we look to the end of the year, we continue to anticipate and in the year in the low 1 times range.

With that, I'll turn the call back the Todd to cover some highlights from the Zurn Elkay combination..

Thanks, Mark. I think I'm on slide six. So on this page, this is what constitutes Zurn Elkay in terms of the sectors of the water solutions market we serve. In drinking water, the legacy Elkay brand is the gold standard for providing clean drinking water in public and private spaces.

In terms of relative market share and specification rates, nobody comes close. The fundamental growth drivers in drinking water is really twofold, access to clean filter drinking water coupled with the sustainability aspect of eliminating plastic bottles into landfills, where we see billions of water bottles annually.

The second growth driver is the retrofit replace market of the traditional drinking fountain. With over 8 million of these installed and only about 1.4 million bottle fillers installed, we see significant runway as we drive conversion in key institutional end markets, while building an even larger installed base.

We also see path to add-on and build the filtration aspect of the product and category, leveraging our connected capabilities for seamless monitoring and also signaling the replacement of that.

In water and safety control, where we've seen significant share gains in the last several years, we provide back flow prevention, pressure relief valves, irrigation valves, as well as all the valves required in a quench fire protection system.

Superior flow curves, ease of installation and by far the lowest total cost of ownership, puts us in the driver seat from an industry perspective trend. As labor savings and availability become huge factors in decisions the customers make.

The amount of patented third-party approved innovation in this category is critical and we believe that we have the number one single brand in the back flow.

The hygienic and environmental sector is essentially everything required to create a safe hygienic space inside of a commercial restroom, along with the connected capabilities to improve maintenance effectiveness, eliminate outages and damage to building during flood or leak events.

Touch sensor product, sinks for restrooms, labs, health care facilities and food processing along with partitions and hand dryers.

In this category we're leveraging our unparalleled solution set under the bright shield umbrella to provide real value to high traffic institutional and commercial customers who are migrating their environments to meet the well 2.0 standard. And finally in flow systems, this is where we have the most comprehensive product portfolio in the industry.

Essentially, providing a solution everywhere water needs to be controlled and moved efficiently and effectively throughout a building. Whether that's a rough floor, runway, highway or even internal to the building the Zurn spec rate is exceptional and we compounded that with also owning the weight brand of drainage products.

At a high level, 55% of the business is new construction and 45% is combination of retrofit replace along with repair parts that happen as part of a regular MRO event. And this is true across essentially every core category with the exception of flow system, which is primarily new construction.

From an end market perspective, we're over 70% institutional and commercial. Within that 70% our largest single exposures are within the top end markets of healthcare and education. Two end markets that continue to perform nicely and where we continue to exert growth. Elkay only increases our exposure to these two end markets.

The (ph) Momentum Index is an indicator of the strength of our end markets. As of June the Momentum Index was at a 14 year high, indicating that there are a lot of economic pressures and uncertainties right now, but the non-residential construction market continues to remain strong.

Our residential exposure is primarily on the Elkay side and this is a category that we're still digging into and evaluating. And it's my sense that as we work through the integration you'll see us leverage our 80:20 methodology to do a little pairing or trimming in areas where we don't see the opportunity to create a competitive advantage.

We're delighted to have roughly 98% of our revenues in North America. A large mobile population, highly specified with code variations across every city, town and municipality and over 95% of our revenues come from either a number one or number two market share position.

What I hope you take away from this is, we’ve built a significant sustainable competitive advantage in a served market that's over $9 billion today, and we see opportunities for growth within both our served market, as well as room to continue to grow our served market as we enter into new categories.

If you could move ahead just one page to slide seven.

Given the highly complementary nature of the combination, products also sold to the same customer, same end markets with the same go-to-market approach, we thought there to be a significant opportunity over time to leverage the Zurn Elkay Business System to drive a broad amount of synergies initially targeted at $50 million across SG&A, manufacturing and supply chain and finally 80:20.

As we've developed our integration plans and phasing we placed a high priority on aligning the sales and marketing organization, so that we can quickly present ourselves as one place to the marketplace and to our customers.

We'll also look to combine our functional areas where it makes sense, leveraging one corporate structure and team and then begin to work on our purchasing, logistics, distribution and supply chain work streams to capture the synergies of nearly $1.7 billion business today with growth into the future.

I talked earlier about 80:20, but the opportunity here is significant. The discipline of segmenting products and customers, simplifying the business is something that is new to the legacy Elkay business.

As we found in Zurn, this takes a little time, but once completed and executed the benefits will be dramatic and will allow us to focus on the critical few things and eliminate all the waste and the complexity that can build up over decades.

I think the way to think about the synergy, the combination at this point is that we're highly confident in the $50 million we've outlined, and we've got a growing funnel of opportunities that will identify, develop, communicate and execute over time. If you can move to page eight.

Having a well-established approach to how we run our business has been a true game changer for us.

For us, it's a common language and approach to the key pillars of people, plant, process and performance, that engages prioritize and aligns everyone around the most important things with clearly defined resources and accountability at the point of impact.

Our strategy deployment process deploys our long long-term strategy into action plans, KPIs and work that happens every day with complete transparency and we reinforce that by paying for performance.

As we become a pure play water business and now an even larger pure play water business, we recognized and embraced our role in water stewardship sustainability and helping the environment. We believe in it strongly enough and actually included purpose as one of the core principles of ZBS.

ESG isn’t something we just talk about or report on once a year, it's integrated into the way we think about and develop our long-term strategies.

How we engage our associates and understanding what we do matters, to save water, provides clean drinking water and we realized that we have an obligation to play a role in tackling some of the world's most pressing water challenges. What’s also important is that, purpose really matters to our people.

It aligns everyone around the same goals, everyone in Zurn Elkay is on an annual incentive plan. Everyone at Zurn Elkay has equity in the company. Everyone gets 20 hours of paid volunteers that helps us attract, retain, develop and promote highly -- highly engaged workforce and that's really what makes the difference.

Our associates have access to our wave social impact fund where we cultivate fund and deploy solutions that advance our efforts around the environment. And we're also having a meaningful positive impact in the areas we live and work. The last one for me is on page nine.

We strongly believe that part of creating a high performing business and culture is clarity. This page takes what we try to -- what we're trying to accomplish, really down just a one-page.

First is focus, pure play water and categories where we can build a sustainable competitive advantage and we work every day to build a bigger and bigger moat around our business. Next is the how and what. Leveraging ZBS to drive growth, margins and cash flow, both within our core business as well as with smart acquisitions.

And finally, driving measured performance for our customers, shareholders, associates and the environment. With that, I'll turn it over to Mark for the outlook..

Thanks, Todd. Please turn to slide 10 and I'll cover some of the highlights of our outlook for the third quarter. For the third quarter of 2022, we are projecting Zurn sales to increase year-over-year by a high-teens percentage and we anticipate Elkay related sales to be between $145 million and $155 million.

With respect to margins, we expect our Zurn Elkay adjusted EBITDA margin, excluding corporate costs to be between 21% and 22% in the quarter, which result in 100 basis point to 200 basis point expansion year-over-year when you pro forma the third quarter of 2021 for Elkay.

We anticipate corporate costs in terms of adjusted EBITDA to be approximately $7 million in the quarter.

Before we open the call for questions a few comments on our interest expense, stock comp expense, depreciation and amortization, tax rate and diluted shares outstanding for the September quarter that will include the preliminary estimated impact of purchase accounting, as well as the new shares issued with the merger.

Please note, the depreciation and amortization will most likely change as we finalize the purchase accounting over the coming quarters. But as of now, these are our best estimates. We do not expect a material deviation.

We anticipate interest expense to be approximately $8 million, our non-cash stock comp expense to be about $8 million, depreciation and amortization will come in around $22 million, which consist of approximately $8 million of depreciation and approximately, $14 million in amortization.

Our tax rate and adjusted pre-tax earnings to be between 27% and 28%, and diluted shares outstanding will be approximately $179.5 million to $180.5 million in the quarter. So, before we turn it over to questions, I'll just make a few final comments. Number one, I'm sure there are a lot of questions with respect to what's Elkay, what’s Zurn.

I'll tell you, the businesses are coming together incredibly fast. And so, I think we're going to stick with our convention of guiding one quarter forward with one segment, but I'll try to give you a little color in terms of how to think about both the third quarter and the full year.

With respect to the third quarter, and specifically around the Elkay numbers. Number one, I think we're trying to be a bit conservative. This is a new acquisition, it’s significant, there is a lot of change and moving parts, as I talked about in my earlier comments with respect to both the sales organization, as well as all of our third-party reps.

Some color there really would be, we had roughly 40 reps between the two of us, we've migrated that down to about 30. Half of those there was really no change, where we actually shared third-party representation.

The remaining half, three quarters of that were Elkay reps that are now becoming Zurn Elkay reps and the remaining quarter, a combination of Zurn reps or Elkay reps that are taking on the Zurn line and some changes, so a lot of moving parts. The other thing to contemplating and consider is, we're also getting after 80:20 right away.

This number, obviously, assume some level of revenue in it. And so I think it's probably a little bit inaccurate to think about this as the true underlying run rate.

But nonetheless, we think if we can make the changes we've made around the sales and marketing organization to get that moving at a nice clip, make the rep changes, as well as get some of the 80:20 done. We think the third quarter is in a great spot and puts us on the right trajectory heading into '23.

With respect to the full year for Elkay, which we'll never report when we report at second half, but fundamentally the way to think about the first half of the year was that, it was a little bit behind maybe what we would have hoped for. I think there is a handful of reasons.

Number one, I think the legacy Elkay business was probably just a little bit behind implement and holding the pricing that was necessary in the market, given the inflationary environment. Number two, I think the team, both internally and along with all the third-party reps that we're going through a bit of uncertainty were just a touch distracted.

And finally, as we dig into it post pandemic and throughout '21 they saw a combination of demand spikes and some capacity constraints, lead times extended, the backlog grew, when the backlog grows people placed more orders. The team did everything they could to bring that backlog down and in-line to where it has been historically and sits today.

As a function of that, the order rates really towards the end of '21 and first half of '22 were just a touch behind. All that being said, the Elkay business is growing, when you adjust the backlog reduction last year relative to second half, we are seeing the double-digit growth that we thought.

And from an EBITDA perspective, the run rate in the second half looks to be in the range of 85 to 90. And I'll also remind everyone that, as we think about the synergies in '23 and '24, we've got a growing funnel of opportunity there. And so, before we turn it over to your questions, I wanted to provide that kind of color.

And with that we will take your questions..

Thank you. .