Zurn Water Solutions Corporation
Q4 2020 Earnings Call Transcript

Published: 16 Feb 2021

[Operator:]

Good morning, and welcome to the Rexnord December Quarter 2020 Earnings Results Conference Call with Todd Adams, President and Chief Executive Officer; Mark Peterson, Senior Vice President and Chief Financial Officer; and Rob McCarthy, Vice President of Investor Relations for Rexnord. This call is being recorded and will be available on replay for a period of two weeks. The phone numbers for the replay can be found in the earnings release, the company filed in an 8-K with the SEC this morning, Feb 16. At this time, for opening remarks and introduction, I'll turn the call over to Rob McCarthy.

[Rob McCarthy:]

Thank you. Good morning, and welcome everyone. Before we get started, I need to remind you that this call contains certain forward-looking statements that are subject to the safe harbor language contained in the press release that we issued earlier this morning 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, why we believe they're helpful to investors and contain reconciliations to the corresponding GAAP data. Consistent with prior quarters, we will speak to core growth, adjusted EBITDA, adjusted earnings per share, free cash flow and return on invested capital as we feel these non-GAAP metrics provide a better understanding of our operating results. However, these measures are not a substitute for GAAP data, and we urge you to review the GAAP information in our earnings release and in our filings with the SEC. With that, I'm pleased to turn the call over to Todd Adams, President and CEO of Rexnord.

[Todd Adams:]

Thanks, Rob. We’re a little bit later than normal. We had I think a significant announcement this morning to merge our PMC business with Regal Beloit and a more stress transaction that I'm sure we'll get to. But I want to start really talking about how our business performed over the course of the fourth quarter in 2020. If you look at our fourth quarter, essentially flat year-over-year, adjusted EBITDA of $96 million and absolutely terrific cash flow, all year establishing a record of $276 million. When you look at each of the platforms, we had an incredibly strong finish to 2020. Top line of Water Management up 15% year-over-year and core up by 10, the momentum around our hygienic solutions continues to build and really the power, what we put together is something that we'll get into a little bit later in the call. And PMC despite some pretty significant headwinds in aerospace, we were able to perform well. I think the trajectory coming out of Q4 into Q1 is really positive and we're excited about the transaction and the combination, but PMC is performing at a very high level, despite some pretty tough headwinds. Finally looking at, 2020 taken as a whole, we did two acquisitions over the course of the year, just earlier in the year, and then Hadrian, which we'll talk about in a moment. And we capped off the fourth quarter with 44 million of share purchases to bring the full year to $140 million, and we exited the year, 2.1 times. So, taken as a whole 2020 was a year that I think the business performed extraordinarily well. The things that we've done and our teams have done to make it more resilient through cycles, has been demonstrated. And finally, the cash flow of $276 million was, I think, a testament to the power of all that coming together.

[Mark Peterson:]

Thanks, Todd. On Slide number 11, as you can see on a year-over-year basis our consolidated fields were flat and of course those round us 2% at a roughly 70 basis point impact from our product line simplification actions. Positive contributions from currency translation out at about a point adjustment of action in Hadrian acquisitions in our water management platform at a two points or a quarter sales growth was partially offset by a small divestiture in our PMC platform that reduced our total sales by approximately one point. With respect to profitability, our adjusted EBITDA was $96 million in the quarter, and our adjusted EBITDA margin was 19.6%. As you recall, we recorded the catch up on merit and its enough compensation expenses during the quarter probably detailed on our last call. In addition, during the quarter, we elected to add some investment spending in our water management platform, as well as being incremental and widely distributed bonus to our associates that demonstrate loss in dedication to the pandemic in both platforms, which together result in approximately $4 million of additional expense in the quarter. Adjusting to that $4 million of additional expense, our margin would have been 20.4%. Let's turn to Slide 12 and we'll review our two platforms. For the platform level, the sales in PMC moderated sequentially to 8%, declining for sales were down 8% on a year-over-year basis, net approximate 100 basis point headwind from our 80 point simplification actions. The small divestiture in a kind of business has also reduced PMC sales growth by just over 1 point was offset by about a point of positive currency translation. Breaking that down further, year-over-year sales decrease in our aerospace operations, which accounted for approximately 15% of our PMC sales in calendar 2019 was consistent with a 36% decrease we experienced in our September quarter. When you – the aerospace operations, the core sales and the balance of the PMC platform in our December quarter were down 3% on a year-over-year basis. That's inclusive of 100 basis points of headwind for maybe 20 actions with comparing them the comparable 9% decline in our September quarter. We continue to see positive trends in year-over-year sales comparisons in all of our vertical markets and geographies with positive core growth continuing in Asia and in our renewable energy and market with help to drive growth in our overall power generation sales.

[Todd Adams:]

Thanks, Mark. As long as you take any questions you had, but it's going to be a busy year as we go through the process of both working through the regulatory items to get the transaction to the finish line with Regal and then also doing the work to stand up water as a standalone public company, but we are excited about it. I think the transaction is truly transformative in a lot of different ways, both for the markets we serve and then obviously for shareholders, the best-in-class water business that we've been working at and now have everyone's attention on, we think is going to be exciting, the growth – the opportunities to grow organically as well as to continue to do M&A is something that I think is going to create a lot of value over time. So it's going to be a busy year, we'll keep you as informed as we can about the transaction and all the things that I'm sure you're going to ask, but we'll print it over your questions and answer what we can.

[Operator:]

Your first question comes from the line of Bryan Blair from Oppenheimer. Your line is open.

[Bryan Blair:]

Thanks. Good morning, guys. Great top line performance in water management and obviously touchless the trajectory there is quite exciting. Where did the touchless portfolio finished as a percentage of segment next for 2020?

[Mark Peterson:]

Touchless was roughly $95 million to $100 million in sales. So up over a 100% from where it was in 2019.

[Bryan Blair:]

Got it. And last quarter you had slated order rates that supported $140 million, $150 million for 2021. Is the – our run rate orders still supportive of that range, or has there been further accelerating?

[Mark Peterson:]

Well, I think that that's almost difficult – next year the order rates in funds right now are supportable as we had talked about last quarter as a target for next year sales.

[Bryan Blair:]

Okay. And then given the touchless and hygienic momentum and then current visibility across the remainder of the platform and other puts and takes there, but I believe you cited a low single-digit order decline in the fourth quarter outside of touchless, which is a bit better than expected. Is the expectation that water management core sales will grow in 2021, or is still early to make that call?

[Todd Adams:]

Well, February 16 was probably take it with a grain of salt, but I think we're pretty confident that we’re going to grow on a core basis this year. And I think the first 45 days of the quarter would absolutely support that for the first quarter. With the vaccine coming, construction season, starting again, we feel like that's clearly something that we're going to be able to do.

[Bryan Blair:]

That's great to hear. And then a quick one on Hadrian, mentioned that profitability is lower currently, what our run rate margins and where do you expect them to go as you scale that business?

[Todd Adams:]

That's in the lower teams. And I would expect that we will be able to March them up north of 20 – in a reasonably short period of time.

[Bryan Blair:]

Okay. Excellent. Thanks again.

[Operator:]

Your next question comes from the line of Mig Dobre from Baird. Your line is open.

[Mig Dobre:]

Thank you. Good morning, everyone; and congratulations on today's announcement, in fact, the very good way, but I’m not sure of the values. I guess my first question is, maybe Todd you – perhaps you can comment on how this transaction in order to new changes the focus of the organization, your approach or ability to deploy capital. And I'm curious if on the flip side, given the amount of work that you guys are going to have to do over the next 11, 12 months, if this perhaps precludes you from doing additional deals or capital deployment here.

[Todd Adams:]

I think I got it, you're awfully hard to hear. But look, I think, I don't think much is going to change. I think we are very focused in each of our platforms and the end markets we serve, our strategy and our deployment of that strategy is going to remain exactly as it's been. We've got some work to do to untangle some things and they have gotten tangled over time, but it does – it doesn't preclude us from doing anything from an M&A standpoint, if we think it's the right thing to do. And so no, it doesn't change any of the focus, I think it's essentially business as usual. And I think we have two terrific teams that are both locked in and are going to have a great year.

[Mig Dobre:]

Okay, I see. Hopefully you can hear me. I'm trying to speak up a bit here. Then maybe a question on RBS and SCOFR, as we're thinking about water management is a pure play. Looking back, it seems like a lot of your sculpture benefits were derived from PMC. I'm wondering how your business system really applies to water management and what investors should expect from a margin sample going forward out of this study? Thank you.

[Todd Adams:]

Well, the Rexnord Business System has been deployed in Zurn since we acquired the business in 2007. And so at that point in time, when margins I think were about 19% and now they're 27%. So the business system definitely applies, perhaps the best example of the results of the business system lie inside of Zurn. It’s extraordinarily lean, it's got terrific supply chain capabilities, and it manifests itself in growth and margins and cash flow that I think are superior to essentially anybody we can be with. And so we think the business system will continue to create opportunities for growth and future margin expansion just as it has for the last 13 years.

[Mig Dobre:]

And maybe one last follow-up for me, to your point on free cash flow, can you give us a sense for what free cash flow looks like for water management as a standalone business, either as a percentage of sales or however you want to frame this going forward? Thank you.

[Todd Adams:]

Yes, maybe I think the way to think about it is you got to look the 2022, sort of the first full year and it's probably right around $150 million plus or minus.

[Mig Dobre:]

Great. Good luck guys.

[Todd Adams:]

Thanks.

[Mark Peterson:]

Thanks, Mig.

[Operator:]

Your next question comes from the line of Brett Linzey from Vertical Research Partners. Your line is open.

[Brett Linzey:]

Hey, good morning all. First question is just on stranded cost, and I'm wondering how you're thinking about as you separate PMC. Have you sized those, and just given the time to close, you obviously have a running start here to eliminate any of those redundancies, but just trying to get a sense as to the size of potential stranded costs.

[Mark Peterson:]

Well, the corporate number is right around $40 million. And from a cost standpoint, I think we believe that water remain till – will end up in the $15 million to $20 million of corporate costs. So, combination of us just being smaller and maybe not needing some functions related to international operations and things of the like, and then also Regal will likely end up absorbing some of those costs as they add PMC to the mix. So, there's going to be some additional support, whether it's the exact same resources or different resources. That's how we're thinking about getting from 40 down to that 15 to 20.

[Brett Linzey:]

Okay, great. And then just thinking about the post-transaction leverage about two times, water obviously generates a lot of cash. What is the right leverage level and how are you thinking about your total capacity, post-transaction for water to grow that business inorganically?

[Todd Adams:]

I think we view water as a growth business. And so from a cash flow standpoint, we clearly have the ability to move leverage up two to three times, I think, is what we're going to start and stay comfortable. And then obviously, the cash flow generation year in and year out is creates more flexibility. So I don't think leverage is going to be the problem. I think it's a function of continuing to invest organically find the right kind of thing. And then obviously there are bigger, more transformative things out there that we can do with water and that wouldn't create a problem with leverage. So from our standpoint, we think we've got great flexibility on the other side of this, which will be basically 2022.

[Brett Linzey:]

Okay, great. I'll leave it there. Congrats.

[Operator:]

Next question comes from the line of Jeff Hammond from KeyBanc. Your line is open.

[Jeff Hammond:]

Hey, good morning, guys.

[Mark Peterson:]

Good morning, Jeff.

[Jeff Hammond:]

Congrats on the deal. Just on Hadrian, can you give us what the revenue is for that business, or I guess within 1Q, what's the core growth and what is the revenue from Hadrian?

[Mark Peterson:]

So revenue from Hadrian is about 60 million annually, Jeff. And it was going to be a little bit lower in Q1 just given the construction season. But we think the core growth like Q1 at this point.

[Jeff Hammond:]

Okay. And then just on – I guess, on the capital allocation than other kind of follow on, you guys said laid out, fairly recently, a balanced structure of dividend buyback and M&A. And I'm just wondering if any of that changes as you think about, scaling up, water as a standalone, more rapidly from an inorganic versus kind of returning cash to shareholders.

[Todd Adams:]

Yes. Jeff, it's something that we'll obviously spend a lot more time on, but it'd be my suspicion that the capital allocation strategy for water will be modestly different in and around perhaps things like buybacks and the dividend. But we haven't made a final determination on that, but obviously, we believe that it's a much more of a growth oriented business or retaining the flexibility to be able to do that, I think will be at a premium.

[Jeff Hammond:]

Okay. Then just last one. PMC, I think you're calling for low double-digit declines in 1Q. Just wondering what you're seeing from an order trend standpoint, Regal, I think talked about on their call, some 30% growth in January and some restocking activity, and it does seem like, the industrial side is turning the corner. So just what kind of underpins that decline in 1Q?

[Mark Peterson:]

Well, I think we’re seeing similar trajectory. I think we're just trying to be a little bit conservative here. And obviously, we still have the headwind from aerospace. And the other thing not to forget is that if you go back to March of last year, we were actually flat in the March quarter. So we were performing, we performed extraordinarily well at the onset of COVID. And so it's a modestly covered comp for us in PMC. But I think the trajectory that we've seen in 45 days is supportive of something that's probably a little bit better than that. So for the time being, we're trying to, we're trying to keep everybody focused on just executing as well as we can.

[Jeff Hammond:]

Okay, sounds very fair…

[Mark Peterson:]

The comp is more of the issue in aerospace. If you look at what order rates are, order rates in the business are supportive of returning to growth in our second quarter as we highlighted. So piggyback on that, the demand trends are different than what the sales headlines and our lead in the quarter.

[Jeff Hammond:]

Okay. That's a great color. Thanks again.

[Mark Peterson:]

You bet.

[Operator:]

Your next question comes from the line of Matthew Fields from Bank of America. Your line is open.

[Matthew Fields:]

Hey, everyone. Just want to ask about kind of the capital structure and leverage commentary. I'm definitely missing something because I know you guys are saying pro forma leverage after this transaction is expected to be down to two times by the end of the year, obviously that's year-end 2021 number. But if I just strip out the $258 million of PMC, EBITDA, based on your current kind of net debt numbers, I get more like five and a half times leverage. Is there something I'm missing? Is there a step in between here and there? Is there a pro forma EBITDA that you're going to be including, or did it just grow throughout 2021 that gets you to two times? Can you just help me bridge that gap please?

[Todd Adams:]

Sure. Not to turn this into a modeling call, but you're missing a dividend. It's going to come from Regal to RemainCo.

[Matthew Fields:]

Okay. Not just RXN shareholders, but RXN the credit group will be receiving proceeds from that dividend too.

[Todd Adams:]

That's correct, Matt.

[Matthew Fields:]

Okay. And then…

[Todd Adams:]

Rob is happy to walk you through the transaction offline and any details that you want to know.

[Matthew Fields:]

Yes. That that would be helpful. And then I know that your bonding times are obviously has limitations on restricted payments. This is a $3.7 billion spin. So is this predicated on the fact that you can do this because pro forma for that dividend and everything, you'll still be below that three times net leverage test in the RP covenant.

[Todd Adams:]

Again, I think some of these details are better offline. I can assure you that with the advisors, we've had – any advice, we have, whatever indenture or concern you have, it doesn't exist. So I'd recommend you take it up with Mark and/or Rob an effective call.

[Matthew Fields:]

All right. That's fair enough. And then lastly, given that this sort of new business is going to look vastly different than before. Did it make sense to have the current bonds in here? I mean, they're only – they're in 2025 maturity, they're callable now with a step down in December kind of coinciding, do you envision kind of terming out, does that look sort of newer longer term bonds upon closing?

[Mark Peterson:]

Yes, this is Mark. The way it works is the bond will go away. The term loan goes away, your replacement, new term loan B size just for the water business, very simple upcoming structure will downsize revolver a bit. But that's the way the capital structure will shift.

[Matthew Fields:]

Okay. So do you envision going into a new loan or only structure after this.

[Mark Peterson:]

Correct, term loan B only.

[Matthew Fields:]

Okay, great. That's very helpful. Thank you very much and good luck.

[Mark Peterson:]

Thank you.

[Operator:]

There are no further questions in…

[Todd Adams:]

So thanks to everybody that can join us on the call today. We appreciate your interest in Rexnord. And we look forward to providing the next update when we announce our March quarter results in April. So have a great day and please continue to stay safe.

[Operator:]

Thank you for joining today’s conference call. You may now disconnect.