Q2 2022 Zurn Elkay Water Solutions Corp Earnings Call
Good morning, and welcome today's showing L. K water Solutions Corporation second quarter 2022 earnings results conference call without items.
And Chief Executive Officer.
Mark Peterson, Senior Vice President and Chief Financial Officer.
Polly Vice President of Investor Relations for certain allocate water solutions is.
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 an 8-K with the S. E C yesterday July 26.
At this time for opening remarks, and introduction I will turn the call over to David Polly.
Good morning, everyone and thanks for joining the call today before we begin I would 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 our SEC filings contain additional information about these non-GAAP measures why we use them and why we believe they're helpful to investors.
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 <unk> transaction on July one so our second quarter results that we will be walking through today do not include the impact from Alka, we will start reporting a combined zurn, okay with our third quarter results with that I'll turn the call over to Todd Adams, Chairman and CEO Zoran allocate water solutions, thanks, Dave and for everyone.
<unk>.
Out there just recognize Dave is a brand new dad three weeks ago, he and his wife Laura.
Neuston Nolan so when you when you call and be sure to congratulate him. He is.
He's been at both ends of the candle here. Some thanks, Dave for 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 701, and we've been working really really closely together 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 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.
We've got a lot of important things already behind us in the few short weeks since we've closed we've.
We've aligned our 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 'twenty three as opposed to as opposed to dealing with that much change to start our full fiscal year as a combined business that may be we contemplated originally.
We're also working through the change curve with the legacy <unk> team, while teacher, Inc. Teaching and fostering a common language, we're going to use to run our business the <unk> business system.
In many many ways. This transaction reminds me of when the old Rexnord combined with the <unk> business, we found a business with tremendous people a great culture fantastic products that could be better and go faster that even as earned team at that time thought.
They're really important differences, we've got 15 more years of experience leveraging the business system to develop and deploy our strategy significantly more talent across the board to execute in 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 is a monster in both the marketplace and produces superior financial results.
In terms of the second.
Second quarter, which as Steve said will be the last standalone quarter for the legacy <unk> business and short.
It was really good sales growth of 17% with 15% core growth and segment margins of 25, 1% pre.
Free cash flow was $41 million and leverage dipped to one nine and when you look ahead to the end of 'twenty, two and to start fiscal year 'twenty three leverage will be just above one times.
We also announced an increase to the dividend last week to seven a quarter consistent with what we communicated back in February with the announcement of the <unk> 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.
Doing all of that while growing at a double digit topline rate.
Consistent consistent with what we said 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 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 SIOP processes, along with some 80 20 work we've been doing what we're seeing today is that that's back in the 80 to 90 day range with firm.
Other improvements through the fourth quarter and into fiscal year 'twenty three.
<unk> 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 costs favorable commodity and freight cost environment as we start fiscal year 'twenty three with that Mark's going to take you through some financial details and I'll come back and cover a few details on the integration.
Thanks, Tom, Let's turn to slide number four.
On a year over year basis, our second quarter sales increased 17% to $284 million.
Number 21 way drains acquisition accounted for 2% of a year over year growth in the core business drove 15% growth was 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, the benefit to the sales growth inclusive of price realization and productivity actions was partially offset by the increase of material and transportation costs as well as our investments in our growth and supply chain initiatives.
With respect to our corporate costs 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 one nine times pro forma for the adjusted annual corporate expense run rate I just discussed.
With the inclusion of LK, 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.
At the end of the year, we continue to anticipate ending the year in the low one times range with that I'll turn the call back to Todd to cover some highlights on the zurn allocate combination. Thanks, Mark I think I'm on slide six.
So on this page this is what constitutes the new zero, Okay in terms of the sectors of the water solutions market we serve.
And drinking water the legacy <unk> brand is the gold standard for providing clean drinking water and public and private spaces in terms of relative market share and specification rates nobody comes close.
The fundamental growth drivers and drinking water 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 battlefield is installed we see significant runway as we drive conversion 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 it also signaling the replacement event.
And water and safety control, where we've seen significant share gains in the last several years, we provide backflow prevention pressure relief valves irrigation valves as well as all the valves required at quench fire protection system superior flow curves ease of installation and by far the lowest total cost of ownership puts us in the driver's seat from an industry perspective trend.
As labor savings and availability become huge factors in decisions 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 Bachelor market.
Yes.
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 buildings done in flood or leak events.
Touchless sensor products same store restrooms labs, healthcare facilities, and food processing, along with partitions and hand drivers 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 to point out staff.
<unk>.
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 thats a rough floor runway highway or even internal to the building. The <unk> spec rate is exceptional and we've compounded that with also.
Owning the weight brand of drainage products.
At a high level of 55% of the business is new construction and $45 a combination of retrofit replace along with repair parts that happened as part of our 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 to end markets to continue to perform nicely and where we continue with exits continue to expect growth.
Okay only increases our exposure to these two end markets.
<unk> 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 nonresidential construction market continues to remain strong our residential.
<unk> exposure is primarily on the <unk> 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 Youll see us leverage our 80 20 methodology to do a little pairing our 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 Covid 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 built a significant sustainable competitive advantage in our 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 all sold to the same customers same end markets with the same go to market approach, we thought there could be a significant opportunity over time to leverage the <unk> business system to drive a broad amount of synergies initially targeted at $50 million across SG&A.
<unk> 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 to begin to work on our purchasing logistics does.
<unk> and supply chain work streams to capture the synergies of nearly a $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 <unk> business as we found in Zurich. 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 of 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 plan process and performance that engages prioritizing aligns everyone around the most important things with clearly defined resources and accounts.
Ability at the point of impact our strategy deployment process deploys, our long stir long term strategy into action plans Kpis and work that happens every day with complete transparency and we reinforced 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 to actually included purpose is one of the core principles of GBS.
ESG is 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, we shave water provide 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 what's also important is the purpose really matters to our people. It aligns everyone around the same goals everyone. In <unk> is on an annual incentive plan everyone at zurn allocate as equity in the company everyone gets 20 hours of paid volunteerism.
Helps us attract attract retain develop and promote highly in our 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 while also having a meeting a meaningful positive impact in.
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 trying to what we're trying to accomplish really down to just a one page first is focus pure play water in 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 GBS GBS to drive growth margins and cash flow both with.
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 ill cover some of the highlights of our outlook for the third quarter.
For the third quarter of 2022, we are projecting <unk> sales to increase year over year by a high teens percentage and we anticipate <unk> related sales to be between 145 and $155 million.
With respect to margins, we expect our <unk> adjusted EBITDA margin.
Moving corporate costs to be between 21% and 22% in the quarter, which resulted in a 100 to 200 basis point expansion year over year, when you pro forma the third quarter of 2021 for LKQ.
We anticipate corporate costs in terms of adjusted EBITDA to be approximately $7 million in the quarter.
Where 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.
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 noncash stock comp expense to be about $8 million.
Depreciation and amortization will come in around $22 million.
Which consists of approximately 8 million of depreciation and approximately 14 million of amortization our tax rate on adjusted pretax earnings will be between 27% and 28% and diluted shares outstanding will be approximately 179, five 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 am sure. There are a lot of questions with respect to <unk>.
<unk> 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, specifically around the LTE 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 rep. So 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 of the remaining half.
Three quarters of that we're LK reps that are now, becoming zurn LK reps and the remaining quarter a combination of.
<unk> reps or alk reps that are taking on as are in line and some changes so a lot of moving parts. The other thing to contemplate and consider as were also getting after 2020 right away. This number obviously assumes some level of work array revenue in it and so I think it's probably a little bit and accurate to think about this is 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.
The third quarter is in a great spot and puts us on the right trajectory.
Adding into 'twenty three.
With respect to the full year for <unk>, which will never report, but we reported second half, but fundamentally the way to think about the first the first half of the year was that it was a little bit behind maybe what we would have hoped for.
I think theres a handful of reasons number one I think the legacy <unk> business was probably just a little bit behind implemented 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. We're just the touch distracted.
And finally, as we dig into it.
<unk> pandemic.
And throughout 'twenty, one they saw a combination of demand spikes in some capacity constraints lead times extended the backlog grew.
When the backlog grows people place 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 and as a function of that the order rates really towards the end of 'twenty. One in the first half of 'twenty, two or just a touch behind all of that being said.
The <unk> business is growing when you adjust the backlog reduction last year relative to the 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 million.
And I'll also remind everyone that as.
As we think about the synergies in 'twenty, three and 'twenty four 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 if you'd like to ask a question press star one on your telephone keypad to withdraw your question Press Star one again.
Your first question comes from Bryan Blair from Oppenheimer. Please go ahead.
Thank you good morning, guys.
Good morning, Brian and Brian .
So maybe to start with.
With your core growth and digging a little bit there came in ahead of our expectations in the second quarter is obviously strong momentum into Q3 are there any end markets or product lines that are.
Really outperforming the rest of the portfolio. Our exposure is now and how should we think about volume versus price and your high teens guide for Q.
Q3.
Yes.
Touch on the numbers, but fundamentally it's very consistent across really all of the sectors that we that we serve I wouldn't call. One an outlier I mean, we talked about really really strong order rates and hygienic and environmental.
Last quarter that continues.
Close systems is very good.
As water safety in control, so I wouldn't say anything is.
Outlier relative to the 15% core.
Growth in marketing cover yeah, Brian on.
The price element of it I think we've been consistent in saying, we're going to be delivering in the high single digit price.
In the year and backend back half of the year and that has not changed that's consistent with what we've expected I think some of the incremental growth.
We've just been we've done some things strategically.
Some of our initiatives I think we feel like we're doing a little bit better.
On some of that share capture.
What we were anticipating in the first half of the United States in the back half of the market probably gets a touch.
Back half as well so the combination of those is what's driving some better projected.
Topline growth in the third quarter from what we May have talked about in the first half of the year.
Okay I appreciate the detail there.
And.
Todd you mentioned that growth has been a little behind what the what the team has had it.
Hoped coming into the close of the deal can.
Can you parse out growth on the drinking water side versus thinks and sauces.
Well I think the.
The way to think about it is.
The the elements of maybe some of the.
Not at the same level of growth is really split.
Both.
I think the.
The price and holding the price and inflationary environment that really applied to both categories. The distraction risk really with both.
The internal team as well as some of the third party reps that applies to both and then obviously the lead time is probably a little bit more weighted towards the drinking water side of things.
So I wouldn't call it a meaningful difference.
Brian , but I would say the lead time and then the slight air pocket from an orders perspective was really more on the drinking water side.
Okay understood.
And I understand that 2023 guidance it is not.
Out there, yet, but yes, 2023 recession fears of gripped the market for most of this year.
Current visibility zero, Okay. As you know end market profile product mix are you seeing anything.
Specific to your business right now that concerns you without a meaningful pullback going into next year.
No.
Obviously.
We're not guiding for 'twenty, three and we're really not even guiding for the fourth quarter at this point.
So we've got some road to travel before we get there, but I do think.
Number one I think our proven demand creation opportunities in all sorts of markets.
I think gives us a ton of confidence and I don't know what the number of quarters is at this point.
<unk> 47 or <unk>.
Yes.
In the last 48 quarters <unk> has had one quarter, where we were down.
Year over year, So I think that gives us some confidence that we're going to continue to grow we think adding LK into our demand creation.
Process and system creates a ton of upside and leverage heading into 'twenty three.
And I would just say you can find your way to a double digit growth rate without much market growth. We've got some carryover price we've got some share gain initiatives and if the market and the forward look is just a touch positive I think we've got the opportunity to do another another double digit year and then we've got.
Sales synergies to really work through as we head into 'twenty three and so.
We're obviously cautious and watching it and monitoring it but in my opening.
Opening comments, we talked about the forward look and I think people are still very busy I think theres a lot of work that is going to get done.
Into 'twenty, three and so still early but I think that's the way we're thinking about it.
All helpful color. Thanks again guys.
Your next question comes from Nathan Jones from Stifel. Please go ahead.
Good morning, everyone.
Good morning, good morning.
I'm going to start off with some questions on <unk>.
Get a clarification there.
Todd did you say the EBITDA run rate in the second half looks to be in the 80 to 90 range.
No I said, 85% to 90.
85% to 90, okay.
You talked about.
Okay, Hey, when the deal was announced with 701 and so we're a little bit behind that.
Do you feel like these there are pockets, where we can where youre going to catch up back towards that run rate is.
85 to 90 on $600 million of revenue or something like that the broad base for us to look at.
From 2022 to forecast, okay going into 2023.
I think thats I think thats entirely reasonable Nathan.
I'll, just say when we announced the deal we probably sort of rounded the number to 700. Some people took the 700 and moved it to 750.
By the time, we actually aligned around a forecast.
That was probably still early in the year, we were at 665, but I think if you were to use that kind of range I think you are.
I think you are in a decent jumping off point to think about 'twenty three.
And with.
The only unknown at this point would be.
What what do we see as synergy upside from the 50 that we've sort of penciled in today and we will we will think through what that might look like over the next several months, but that's that's probably a good place to start.
Probably a bit unfair to ask about synergies above the 50, but I did want to ask about.
So just philosophically youre thoughts on revenue as seen in D. C. It would seem that having more products to market to the same customers.
As one now okay would give you an advantage in that they should be revenue synergies.
For the business here.
Can you just talk about what kind of synergy opportunities on the revenue side.
Will be how long nice things kind of kick in.
Well, we don't we haven't we haven't baked any of that.
Encourage you maybe not to bake them in yet, but I do think.
The overall pull through bundle opportunity.
There is only upside.
When you think about the prior way.
We went to market and they went to market you could have a scenario where.
Third party rep in a relationship with us.
And end user or a contractor or an engineer would have had <unk> and then another brand in another brand and now we have the opportunity to pull through really all of the other product categories.
Pending where we have stronger relationships and we think the alignment gives us a real leg up with building owners engineers architects mechanical contractors as well as with the third party reps that we leverage and wholesalers. So I.
That those are going to be pretty evident and they will happen and I think we'll have.
Our view on.
How to dimensionalize that a little bit, but suffice it to say, there's only upside from a revenue synergies.
As we as we head into 'twenty, three and 'twenty four.
And just one more on inventory and cash flow Mark any color on kind of where you think inventory or how much inventory is likely to come down and what that contribution to cash flow is going to be in the second half of the year.
Yes, I think when you look at the back half of the year as we've talked about we put a conscious effort in place to to build inventories up in the first half to assure availability and that has worked well for us.
But now we're in a great spot and I think in the back half, we're looking at I would call it ballpark $40 million plus or minus type of inventory reduction.
Within our within our core business to drive the casualty expected for the balance of the year.
Great. Thanks for taking my questions.
Thanks, David.
Your next question comes from Jeff Hammond from Keybanc. Please go ahead.
Hey, good morning, guys good.
Good morning, Jeff.
So so just finally on the kind of the reset on okay from the $6 65 to the 600.
The annual run rate is that I mean should we think about that is largely this waterfall an air pocket.
Yeah.
Im just trying to get a better sense of how much is is that issue versus real demand weakness versus 80 20.
Some of the distractions.
Well I mean, Jeff maybe the way to think about it is is the following.
If you think about $6 65 to call it 600.
A good portion of that variance is really <unk>.
First half related.
The difference.
Would be really some of the 80 20 actions that we've got dialed in in the second half that would not have been in the 665.
And so you asked about.
The.
Fundamental growth if we adjust the second half last year for some of the backlog reduction, particularly in drinking water, we're seeing clear double digit growth in drinking water in the second half. If you look at the core is earned business, which are similar products same customers same end markets, we're growing in high teens.
So from our standpoint this is really.
The dynamic that happens because we were a little bit behind on price in the first half.
As a whole bunch of moving parts with respect to the sales Rep organization. We've got this backlog drawdown in the second half of last year and lead times are back to where they need to be and so from my standpoint.
Yes, we would have liked it to run rate for a little bit higher but the second half sort of I would say very consistent with what we would've expected and we will look a lot more <unk> like in terms of its growth performance going forward. After we adjust for the sort of correction that happened really before we owned the business.
Okay, and then just you talked about kind of them being behind on price kind of what what's.
What's the process around pricing in.
Have they announced kind of additional pricing or have you got.
As announced additional pricing actions here to kind of catch some of that up.
Yes.
The dynamic of Av.
Extending lead times.
And a big backlog doesn't put you in the greatest position to implement significant price.
So I think that.
<unk>.
It was a little bit more conservative, making sure that they were reducing backlog pulling lead times and maybe a little less focused on capturing all the price that they they probably deserved.
And.
And so as that backlog has come down and lead times are back to best in class levels. We feel the timing is right for price and we've got that in and that's in the second half and then from a from a process standpoint.
We've got price and price management aligned around really one team in that sales and marketing organization that we've we've snapped together. So I don't think we'll have any.
Disparities or differences in the way, we go to market and how we price things really effective today, so I think thats sort of behind us sort of issue.
Okay, Great and then just last one.
A lot of good color on kind of supply chain I'm just wondering.
If you see any temporary risk around kind of China restart.
Kind of the supply chain getting marked up at all around that.
And just.
On the core how you think about the margin trajectory.
In the second half versus kind of how youre thinking about it 90 days ago.
Well.
From a supply chain standpoint.
Theres always the potential for things to happen.
But from what's in our control.
I think my comments.
Which support our belief that we are in a really really good shape I mean, if I look at what we've got sort of.
In flight or in process for the fourth quarter I don't think we've ever had more.
Visibility to how we deliver the second half with the supply chain, we have so that fuels.
That feels really good I think in terms of the margin progression I think it's very much on track with what we talked about 90 days ago.
Obviously as we merge these businesses together and blend everything from.
Corporate functions to <unk>.
Sales and marketing to.
<unk> and rebates and everything else.
We're already seeing.
Hundred to 200 basis point pro forma expansion in the third quarter and I would say that that really wouldn't have much if any synergy in it and so as we think about the second half.
Beginning with the third quarter into the fourth quarter and in the trajectory into 'twenty three.
We're very much.
I think we're confident that.
Prices holding theres, a likelihood the commodities and freight costs or lower into next year.
So I think from a margin perspective, it's shaping up.
I would say.
On track, maybe a little bit better than maybe what we would've thought setting up a strong 23% 90 days ago set Everglades dropped 23.
Okay. Thanks, guys.
Thanks, Jeff.
Your next question comes from Mike Halloran from Baird. Please go ahead.
Hey, good morning, everyone.
Or like first Chris on the balance sheet side, just obviously allocating how close you guys got a lot of heavy lifting there any restrictions from your perspective on.
Going out and seeing what that pipeline can bring in and maybe some thoughts on how that pipeline looks right now.
Mike.
We do have a terrific balance sheet.
And we continually cultivate things that fit into the pure play water solutions.
Sort of molds, there arent any restrictions on really what we can or can't do I think our view has always been invest the time.
Stay away from.
<unk> processes and cultivate really good ideas that we can.
Leverage and so none of that's changed I think the pipeline is.
I would say very active.
But I also think we have the opportunity to be patient.
So.
Our priorities are.
Deliver a terrific second half generate a ton of cash flow position ourselves to capture the synergy savings into 'twenty, three and beyond and hopefully that's a little bit more.
And also we do have the management capacity to do more so I think from our standpoint, nothing has changed and I would say if anything the richness of the conversations.
Really over the past.
Year, plus is far better than it had been.
So.
Sure.
We're still in the game.
Makes sense and then on the synergy side. There obviously in your prepared remarks, you talked about where the focus has been sales and marketing Rep network things like that.
Good.
When you think about the cost synergies the sourcing and the other three pieces, you've kind of laid out in that $50 million and you started to work on that or is that something that's still on the come and how are you managing kind of the cumulative process from a cadence perspective, yes, we've absolutely started.
We've.
Mapped what we're planning to do how we're going to do it when we're going to do it.
And some of those work streams are already in place so it's not.
We're going to pick it up on 123 I would say.
I'm optimistic that now that we've got a lot of the sales and marketing and corporate stuff behind us.
There is an opportunity to perhaps accelerate some of that in the back and get more done in the back half than maybe we would've contemplated so its not like were three to six months ahead, and we're going to take a break.
There's a reasonable chance that we continue to pull stuff forward.
Thanks for that appreciate it.
Thanks, Michael.
Your next question comes from Joe Ritchie from Goldman Sachs. Please go ahead.
Thanks. This is <unk> on for Joe Ritchie.
My first question is on the education vertical pretty.
Pretty big end market for you guys can you provide an update on the conversations you are having within this vertical video customers.
Especially for the additive business are you seeing some faster sales conversion, especially given lake.
Conversion going on from Fountain, Stu butter filling stations in schools have a pretty significant stimulus funding right now.
Well I think that's key.
Vertical as you know is a big vertical for us and I think the combination of this business these businesses.
That was going to be pluses for us when you think about the bottle filling stations combined with what we build on bright shield.
A big opportunity going forward. So I would say the first part of your question the richness of the conversations.
Our all in getting stronger and that's one of the reasons why we've as Todd mentioned earlier, we've really pushed hard to get the commercial front end.
Integrated as soon as possible to get alignment because one of our key growth initiatives.
A team built collectively across the organization is around the aviation vertical to drive that drive that opportunity. So I think for us we.
We feel really good about we're bullish on it and we haven't changed our stance I think over time, when we think about the sales synergies in the organization.
Huge piece of the puzzle for us and having that team aligned and really having the reps Leiden early getting people marching.
Towards that strategic initiative sooner rather than later only benefits us as we go into 'twenty three 'twenty four.
Thanks, that's helpful.
Just one more on free cash flow.
On the LTM free cash flow side.
<unk> had more time to spend.
Dean can you share some of the opportunities which are there within the LTE business in terms of free cash flow improvement and any color you can provide on the timeline of driving those improvements.
Yeah, a couple of things from a cash flow standpoint, I think.
Yes.
Over time, we will manage working capital a bit tighter.
And then how the business managed it so I think there is definitely going to be working capital opportunity.
More later part of this year and into 'twenty three it takes a little bit of time, but thats, one opportunity and biller piece of the puzzle is.
As capex.
Our more vertically integrated us obviously their capex run rate is going to be a bit higher.
As we think through it.
Things were going to do around a 20 somewhat simple simplification and just a bit of a different mindset.
Around capital, we think Theres an opportunity.
To reduce the capital intensity of the business going forward. So those would be the two areas as we looked at 'twenty, three and beyond where we see the opportunity to improve.
Cash flow run rate of the business, where it may have been for the past several years.
Great. Thank you.
Hey, Dan if you'd like to ask a question press star one on your telephone keypad and your next question comes from Brett Linzey.
Mizuho. Please go ahead.
Hey, good morning, everybody.
Good morning, Hey, just just wanted to come back to a couple of your comments Todd on the more favorable freight and cost environment.
Assume that these supply chain issues and inflation issues begin to resolve in some of the areas you talked about.
How are you thinking about those tailwind into 2003, I think you mentioned 100 to.
200 basis points in the second half is it fair.
Fair to think about a similar magnitude of.
<unk>.
As we're looking into 'twenty three here too.
Well we're not.
Wouldn't spend them, yet, but yes, I think that that's totally reasonable I mean, if you look at.
If you look at the cost of a container if you look at.
Some of the input commodities that.
Significant portions of our products, they're all down considerably over the last six months, we will see if that holds or not.
But I think my view, our view would be container.
Container costs are going to sort of moderate to levels that are where they are today or perhaps a little bit lower.
I think commodities for the most part.
Have been really volatile if they stay where they are.
There is a sizeable upside so I think don't spend it yet, but I think that theres a good chance that as we.
As we get through the fall here and into next year I think it's highly likely that we're going to see a more favorable.
Cost environment than what we've seen certainly the last two years.
Okay, great guys. Thanks, and just a follow up on the supply chain. I mean, you guys have done a lot of work could you just level set us on some of your regional concentration, China versus Mexico, Indonesia, and the LK close.
Thinking that might continue to evolve or how youre running that playbook.
I mean, the supply chain, we will absolutely continue to evolve I think we're going to end up when you look at it in aggregate in China will be less than 40%.
And so that was upwards of 75% five years ago. So I think the migration to regions and some of what you've talked about some of which didn't.
We will continue.
Really over the second half of this year as well as into 'twenty three and so on.
Sure.
Our view has been how do we create.
<unk> total cost supply chain with the most amount of flexibility and I think the work that our teams have done and now.
Combined with <unk> will continue to evolve and.
Really really really pleased with.
We sit today.
The work we've done to navigate through what's been a carlyle three or four years.
But it feels like it's much more stable resilient and.
And the risk relative to where we were a while ago.
Yeah, that's great and just one clarification on the synergies.
And there'll be cost to achieve how are you thinking about the reporting mechanics of that are you going to spike those out as nonrecurring and excluded from results.
Or are those going to be embedded.
And then if you could just size into that'd be great.
Yes.
Cost to achieve.
Primarily be spiked out so a lot of it is you can appreciate when it's when it's tied to.
Head count changes or cost if youre moving facilities and whatnot. The majority of all despite that there'll be some that will that will just be inherent to the run rate, but I think I'd call that part of material like the material component of it we will be calling out so people want to have visibility to do the numbers without that baked into it.
Got it alright, thanks for the color.
Thanks, Brett.
And there are no further question at this time I will turn the call back over to the presenters for closing remarks.
Thanks, everyone for joining us on the call today. We appreciate your interest in <unk> water solutions, and we look forward to providing our next update when we when we announce our September quarter results in late October have a good day everyone.
This concludes today's conference call you may now disconnect.
[music].
Yes.
Okay.
[music].
Sure.
Okay.