Zurn Elkay Water Solutions Corporation
Q2 2022 Earnings Call Transcript

Published: 27 Jul 2022

[Operator:]

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.

[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.

[Todd Adams:]

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

[Mark Peterson:]

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.

[Todd Adams:]

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

[Mark Peterson:]

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

[Operator:]

Thank you.