Q3 2022 Zurn Elkay Water Solutions Corp Earnings Call
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Good morning, and welcome to the Saar in L. K water Solutions Corporation third 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 Collie Vice President.
Mr Relations for Zurn L K water solutions.
This call is being recorded and will be available for one week.
The phone number for the replay can be found in the earnings release the company filed in an 8-K with the SEC yesterday October 25th.
At this time for opening remarks, and introduction I'll turn the call over to Dave Wally.
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 SEC filings contain additional.
Information about these non-GAAP measures why we use them and why we believe they're helpful to investors and contain reconciliations to the corresponding GAAP information.
System 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 with that I'll turn the call over to Todd Adams, Chairman and CEO of Zurn allocate water solutions.
Dave and good morning, everyone and really appreciate everyone, taking the time on the call. This morning.
The earnings release that we issued last night contains some perspective on the approach we're taking with respect to the fourth quarter outlook and we will go through that in some detail in just a bit. We'll also spend time, taking everyone through the significant progress we've made on the integration of LK over the first 90 days.
And finally provide some color on how we're thinking about 2023.
There are obviously, a number of moving parts as we bring <unk> into the fold, but in the end the view and perspective will be sharing this morning is essentially aligned with the view that we had from the beginning which.
Which was to bring these two amazing businesses together.
Dreamliner and simplifying the businesses into two significant product categories that from a performance perspective, we're very zurn like we've done the work and the path is now clear and well share what that looks like this morning.
As it relates to the third quarter. Our results were very much in line with our expectations heading into the quarter solid core growth. The first quarter of LTE on track and solid margins and free cash flow our leverage ended the quarter at one five times and we expect further a further reduction in December ending the year between one two and one.
Three times.
Mark will provide some additional color and unpack the growth for both the third quarter as well as the outlook in just a few minutes if you could move on to page four.
The reality is that it's not even four months since we closed the <unk> transaction, but the amount of progress. Our team has made is significant and in doing so it really sets us up to start 2023 as a single integrated business.
Wrapping up our first integrated strategic plan over the next several weeks, which will fully embed all of the growth and synergy expectations into our normal business cadence as opposed to developing a plan for <unk> plus a plan for LKQ.
We start 2023, as one business and we have one plan that we're executing.
In the first 90 days, we've completed all of our planned third party Rep changes, which is a huge undertaking because we're asking independent business organizations to change or change significant portions of their agencies from competitive lines to the new zurn L shape, while learning new or different products transacting in floating in different systems, while harmonizing around a set of <unk>.
Common commercial practices, having that behind US 90 days in with the quality of the third party representation. We don't have is a huge thing and will create a lager to leverage as we head into 2023.
The other significant change we've made is with the organization.
Already have a single sales organization across the entire business a single marketing organization across the entire business as well as organizations around supply chain and distribution, we've established general manager roles over drinking water.
With engineering and product management align with these categories essentially mirroring the zurn model to organize align and focus the business on profitable growth.
Without question the single most impactful thing we've done in the first four months is a rigorous deployment of 820 <unk>.
The thing to remember is that as a privately owned business had its own rationale for doing the way things the way they did whether it was serving certain channels our customers are being in certain product lines or skus. It made sense for them at a point in time.
As we went as we came together we went through a very detailed and much needed fact based 80 <unk> review.
To put ourselves in a position to evaluate where we wanted to focus and deploy resources to drive profitable growth and where we needed to do something different or simply not to do it at all.
I'll go on to say that the details I'll share didn't end up deferring all that much from our initial tops down assessment.
But getting the teams to engage with the data and the details and then framing it all to allow us to understand all of the downstream implications of our simplification work took a little bit of time.
Whether it was customer employee or supply chain related we needed to make sure that we got it right. So that we can make decisions and move forward with the conviction and confidence it takes $800000. It takes to do 2020, the right way, which is a relentless prioritization around profitable growth.
And on the integration is that it is quickly becoming a single core business as we head into 2023, which bode well, which bodes well in terms of realizing the expected synergies and even more importantly, being in a spot to leverage our unrivaled product portfolio and solutions to drive better long term growth and profitability by only focusing on what's core to US Please turn to.
Page five.
Okay.
To ground everyone on this page when we closed the transaction and announced Q2 earnings.
We talked about okay for the full year of 2022 and again. This is for the full year not to have that will end up consolidating having about $600 million of revenues and EBITDA margins in the 14% to 15% range.
And our detailed work over the past 90 days, we went through each of the primary category, specifically drinking water commercial.
In residential <unk> access to accessories customer by customer SKU by SKU.
He then had the internal debates conversations with customers and evaluation of our competitive position and long term strategy along with the detailed understanding of any collateral impact from our conclusions.
This page highlights is that basically inside the $600 million revenue business is a growing and profitable $485 million base business with real sustainable competitive advantages and that as we execute our simplification and rationalization initiatives.
More profitable at $485 million than it is at $600 million.
And then there are synergies on top of this run rate.
The core zurn, LK will be drinking water and commercial six in both cases, we're the clear market leader with above average with above market growth and terrific margins will be selective in where and how we play in residential but it will be niche areas, where it supports our overall strategy.
I want to be clear about the portions of the residential market that we are exiting and also whats left.
The pieces, we're exiting really have no strategic value and a zurn LK context, none of it conveys anything or carry the <unk> brand or sold through our current set of wholesalers and reps. It's made up of private label White label sourcing and accessories are all different types of materials and finally products done for other Oems sold through home centers.
That makes no sense for us to continue to support.
The slices of residential thinks will stay in call. It roughly $70 million will be LK branded sold through our existing channels represent wholesalers, where we believe we do have strategic relationships and products that when paired with our commercial lines make a ton of sense in the market.
The other thing to highlight is.
This isn't going to all happen overnight, we've got some contractual obligations, we have to fulfill and we also want to maximize the value will be assets and inventory associated with the exit but this is the core of what we're going to build around and it's our best estimate that we can exit this level of business and start at this run rate some time in the quarter second quarter of 2023.
Hi.
Hopefully, it's also more clear that the drinking water and commercial synced product area categories share the same characteristics and looked like the core zurn business from a growth profitability and returns point of view if.
If you turn to page six I'll sure.
Share a view of how we think the pro forma mix of the business looks after the rationalization.
On the left you'll see we're still aligned around the four highly profitable categories of specified water solutions that we have real competitive advantages in <unk> significant market shares in <unk>.
On the right we have a nice balanced between new construction and retrofit replace with significant U S institutional and commercial construction exposure with institutional and sub verticals of education and healthcare being our largest exposure.
We have residential comprising only 15% of the pro forma revenues and leverage primarily through our <unk> product offering.
We have a tightly focused strategy and are leveraged to mature the material substitution trend in both residential and commercial.
All in all not wildly different than before but we do think that by focusing 100% of our time on the strategic parts of our business will serve us well when you look at this over 95% of our revenues come from a number one or number two position. The reality is that being a number five or six in residential sinks sold through home centers are online isn't.
That we built our business case around I'll turn it over to Mark to walk through the third quarter and the fourth quarter outlook. Thanks, Todd Schuster.
Slide number seven.
On a year over year basis, our third quarter sales increased 82% to $418 million.
The recently completed merger with <unk> in the prior year Whey drained acquisition contributed 67% year over year growth in our core business drove 16% growth with pricing price realization contributing high single digit growth year over year and the balance of the core sales growth coming from our nonresidential markets and our strategic share capture initiatives.
This growth was partially offset by softening residential market.
While our safety and control hygienic and environmental and flow control product categories. All contributed to the core sales growth.
Currency translation reduced sales by about 100 basis points.
With respect to LK I'll provide some color on the third quarter.
Non residential business, which is comprised of drinking water and commercial things grew low double digits on a year over year basis, driven by solid market demand in both product categories and improving price realization as we quickly implemented Z Ebs price realizations standard work across all product categories within the <unk> product groups.
Our residential zinc product group declined mid single digits in the quarter as we improved price realization was more than offset by the overall softening in the residential market as well as the $5 million of product line exits as we started our 80 20 simplification actions in the quarter and began to exit certain residential commodity private label and OEM zinc skus as Todd just.
Yes.
Turning to profitability, our adjusted EBITDA, excluding corporate costs totaled $91 million in the quarter and adjusted EBITDA margin was at the high end of our expectations for the quarter at 21, 7% as.
As Todd discussed earlier on the call we moved quickly to integrate these two businesses into one.
Said, we can only provide directional color on margins between the legacy Zurn business and <unk> at the cost structures are quickly becoming one.
Starting with the legacy Zurn business margins did decline approximately 100 to 150 basis points year over year as we anticipate as we anticipated as the benefits of the sales growth inclusive of price realization. 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 LK margin saw a substantial improvement from low double digits in the prior year's third quarter to mid teens in the 2022 third quarter driven by the accelerating price realization I discussed earlier as well as some early benefits from our integration actions, partially offset by some investments needed in the business as well as the adverse impact of material and transportation weighted inflation.
<unk>.
With respect to corporate costs, they totaled 7 million in the quarter as we had expected.
Please turn to slide eight and I'll touch on some balance sheet and leverage highlights.
Our net debt leverage ended the quarter in line with our expectations at one five times.
So pharma for the adjusted annual expense run rate of approximately $27 million and inclusive inclusion of cash utilization to pay off of legacy term loan at close as well as transaction costs related to the combination.
As a result of the leverage reduction we did trigger at 25 basis point reduction in our base term loan rate that goes into effect during the fourth quarter.
As we look to the end of the year, we continue to anticipate ending the year at one two to one three times net debt leverage.
Please turn to slide nine and I'll cover some of the highlights of our outlook for the fourth quarter.
For the fourth quarter of 2022, we are projecting consolidated observe LK sales in the range of $350 million to $365 million and our consolidated adjusted EBITDA margin to be between 20% and 21% in the quarter inclusive of our corporate costs, which we expect to be approximately $7 million in the quarter.
I'll come back to some of the details on page nine lets move to page 10 and cover some of the items that.
On the walk of our third quarter sales to our fourth quarter outlook.
As you know our fourth quarter traditionally has fewer shipping days as well as a seasonal slowdown in non risk construction activity as we enter the fall and early winter season in certain regions of the country.
The seasonality primarily impacts the legacy zurn side of the business given the product categories and to a lesser degree the LTI product groups know that.
Last year was unusual yearend zurn is approximately $10 million scheduled third quarter shipments shifted to the fourth quarter due to certain container delays, but if you adjust the prior year third quarter and fourth quarter for that timing issue. The usual Q3 to Q4 declined did take place.
As both Tom and I have discussed earlier in the call we've accelerated our 80 20 simplification actions.
Over the past 90 days, we've been able to thoroughly review the <unk> sales volume at a SKU level and customer level and are finalized our plan to simplify the business to focus on better growth better margins and better returns on invested capital.
In late July we have line of sight to at least $10 million to $20 million of exits in the second half of 2022.
Completion of our analysis, we will be exiting at $25 million in the second half of 2022 with $5 million already taking place in the third quarter and $20 million occurring in the fourth quarter for an incremental $15 million of exits on a sequential basis from Q3 to Q4.
Lastly, the residential market has softened from where we were 90 days ago in the third quarter, we experienced a low double digit decline in our served residential market. As we look ahead to the fourth quarter. We anticipate further declines in the residential market and have built that into our outlook.
The year over year contraction of approximately 20% in the fourth quarter.
It is important to note that our products that serve the residential market tend to be more of a stocked products will decline we experienced in the third quarter and our assumptions for the fourth quarter include market decline as well as destocking.
Okay.
The items I just covered work our third quarter sales of the high end of our fourth quarter outlook.
And given the fact that we are entering into the end of the calendar year and the macro environment appears to be deteriorating, we believe customer sentiment and market behavior could be more volatile and as a result, we are adding some additional conservatism into our outlook as highlighted on the right side of the slide.
Turning to profitability in the third quarter at the midpoint of our guidance range for adjusted EBITDA margin and the midpoint of our sales range. The sequential decremental margin from the third quarter or the fourth quarter is less than 20%.
Exits of lower margin skus, improving price realization in the <unk> LTE product groups.
Cost controls and our continued actions to integrate into one business are all contributing to improve margins. Despite the lower sales.
Before I turn the call over to Todd for some closing comments I'll touch on a few additional outlook items that were on page nine.
We anticipate our interest expense to be approximately $9 million are noncash stock comp expense should be about $8 million.
Depreciation and amortization will come in at around $22 million.
Our tax rate on adjusted pretax earnings will be about 27% to 28%.
And diluted shares outstanding will be approximately 179, five $480 5 million in the quarter with that I'll turn the call back to Todd on page 11.
Thanks Mark.
Before we turn it over to questions I just wanted to.
Cover a little bit about 2023, and some perspective.
Fully everyone appreciates the level of transparency, we went through this morning in an ideal scenario, we would've been able to lay out this entire simplification story last quarter or perhaps even before but the realities of the amount of work and decisions and conversations that needed to be had just took a little bit of time.
Pride ourselves on simplification and I think as we reflect on and I reflect on how the last.
Quarter wind were not happy with that and so hopefully we're providing the amount of clarity with purpose.
This morning, you can you can you can appreciate.
See the changes.
We will have a.
A huge impact not only the dollars of profit, but a dramatic impact on the margins on a pro forma basis as we exit 'twenty three and look.
Exit 'twenty, two and look to 'twenty three.
We believe we are taking an appropriately cautious view on the fourth quarter, but I wanted to spend some time.
2023 from an end market perspective, we see record levels of nonresidential construction backlog and strong confidence indicators and the contractor community.
The momentum around institutional construction continues to be very strong commercial construction as always we will be more mixed and super Hiper.
In aggregate, we think the market will still be up next year, probably more so in the first half or at least more confidently in the first half than the second so we'll continue to watch on how that develops our quotation volume. However continues to be strong and we're not seeing any material slowdown in demand whatsoever.
Presidential as Mark highlighted without question be impacted near term, we're seeing a near jerk reaction across the board a lagging impact from where mortgage rates have gotten too.
And are going is having an adverse impact on the residential side of things, but as you saw earlier, it's not only 15% of our business and inside of that multifamily should continue to see growth and we have a highly variable model inside our residential serve product lines.
So the impact on profitability is relatively muted relative to the other markets and product lines we have.
After three years of challenge I think we start 2023 with the supply chain dynamics that are a lot more stable lead times are back to normal container costs are down dramatically.
Understanding on how all of that Chinas order behavior is something to watch that we don't have all that much inventory at all sitting on shelves in wholesale and retail distribution, we're generally seeing live demand and our order rates and we'll end the year with a smaller backlog than we started but I think the net impact of all of that heading into next year is a positive, particularly when we monetize some.
The higher cost inventory, we have throughout Q4, and Q1, which means cash flow that should be very strong.
And our design procure assemble test model will benefit from lower input costs and a strong U S dollars as we procure procure through our supply chain and we're quite confident the combination of lower input prices lower freight and inventory reductions being we'll end up being a positive for the year in a scenario when markets slow we really don't have any much we don't have much in the way of fixed cost to absorb.
And the vast majority of our selling expenses tied to variable rep commissions and finally, we've got the benefit of $50 million of synergies flowing through the next two years with a great balance sheet and our ESG profile continues to improve as we focus our business on the four key pillars of water.
We're going to continue to monitor all of this over the coming months, but our takeaway is that as we look at next year, we think that the overall setup for our business is a lot more half full and half empty than a lot of other years at this point in time coupled.
Couple that with our resilient business model, the <unk> business system and a great team.
We sit here and believe we can deliver a ton of value both in the marketplace and to shareholders over the coming years with that we appreciate everyone's time on the call. This morning, and we'll open it up to your questions.
At this time I would like to inform everyone. If you would like to ask a question. Please press Star then the number one on your telephone keypad.
Your first question comes from the line of Bryan Blair with Oppenheimer.
Thank you good morning, guys.
Good morning, Brian .
I appreciate the perspectives on 2023 setup.
And I guess, if we if we can.
Yes, maybe offer a little more.
More detail on how your team is thinking about.
On the set up for growth on the nonresidential side of course interested in.
And your core verticals of education, and healthcare and how.
Those projects are progressing as we approach the new year and then on the resi side I guess the key question is yes.
How much pain is ahead after the channel and reset of Q3 Q4.
Look I think as we look at.
Nonresidential.
They are at near record levels and when you. When you think about the amount of time that it's going to take for that to roll through the build cycle. It's really all of 'twenty, three and probably part of 'twenty four.
Quotation levels are continuing to be really good.
And so we believe that the market is going to be up next year in aggregate.
Commercial construction will continue to be more mix, obviously the office segment of that is.
<unk>.
But we're seeing growth in retail for the first time in 25 years. So I think thats, a really a very hyper local game. So you might see a lot of activity in Florida, and Texas, and Southern California, and maybe not as much in the upper Midwest to the northeast so taken as a whole we think the market is up next.
Each year.
One three points I think we're going to monitor it over the course of the next four months and into next year, but I do think that the market growth.
And nonresidential is going to be there as well as in waterworks.
And so far as it relates to residential look we we took some of the pain in the third quarter, we're going to take some more in the fourth quarter as Mark highlighted but when you take a giant step back housing is still under bill.
There is going to be some level of new construction, perhaps thats not at the same level as everyone thought.
Six months ago, but the trend around multifamily, which frankly is sort of critical in the product lines that we have.
It should continue to be strong as people deep places to live and so I would say that for the next.
A quarter or two I think residential is going to be a little dodgy.
But hopefully by the time, we get to the second half next year, we're sort of on play and it's not as big of a headwind as it was in the third quarter and the fourth quarter and likely will be as we start 2023.
Okay.
I appreciate that color.
Regard to L K.
<unk> <unk> thousand 20 inch rationalization seems extremely first half weighted in terms of two.
2023 impact.
On a net basis, how should we think about it.
This earnings growth outlook cross selling synergies and.
Netting against the planned rationalization going forward.
I think we recognize Brian is that it's going to be something that we have to over communicate I think what we tried to do with this morning was basically give you a.
Pro forma look at.
2022, if we were to have accomplished this all from there what we will do prospectively is.
Take that 45 in that 92 to 95 million of EBITDA and articulate our results around that as we as we go through the quarter. We will obviously have some revenue related to this stuff, we're exiting but we'll try to isolate that.
And articulate how much is left to go what did we exited in the quarter and what Youll see I think is the margin profile for that core <unk> business.
<unk> to grow and so you will see the growth in the core core okay.
Happening real time quarter by quarter, so it won't be.
We'll try to be transparent around.
The 485, what's growing from a market standpoint, what's growing from a pricing input what's growing from our strategic initiatives and cross selling opportunity that may show up either on the <unk> side or the <unk> side, I mean, I think the.
The big takeaway.
Its starting 'twenty three is it really is just one business with two additional really really dynamite product lines that are now structured and being run like we are running Missouri business. So.
We're going to do our very best to communicate and articulate around around that kind of framework as we as we get into 2023.
Okay that detail very helpful and I guess just to level set a bit more by how much.
Your planned rationalization now exceeds the initial deal plan and.
Where on the commercial side is there some 80 20, taking place that seems mathematically.
Implied.
Sure.
When we made the announcement.
We said approximately $700 million, okay at a budget of roughly $690 million, obviously, the backlog reduction and all the noise that we talked about to get to the 600.
That sort of happened before we owned the business and obviously, what's happening in real time.
When we went to our board and we evaluated this we felt very confident that $60 million.
Revenue was stuff, we were going to walk away from and there was another call it $60 million under review and I think that the details over the last three months have given us the conviction that that 60 that was under review was really.
Something that we should walk away from so when you look at the.
The analysis and the business case, and the approvals that we went through.
When you look at year, three and year four.
Our return on invested capital is within 50 basis points of what we had using.
The base <unk> numbers and that difference really being and nothing to do with the walkaway decisions because we felt like.
We would be able to through a combination of synergies and reducing fixed costs make that a net positive.
It really has to do with that that may be lower starting point.
And then maybe the 690, so I think our business cases, very very much on track.
The the push.
He is probably less than six months when you look at the timing of when we get on the returns on return on invested capital run rates that we had anticipated initially relative to where we are today and that's with.
<unk>.
Something we've looked very carefully at because.
Is off the charts and its probably just gets even incrementally better.
When you when you strip away some of the.
So things are walking away from but I appreciate you asking the question because.
We continue to see.
The return targets very much very much in line with what we said when we did the deal.
Understood. Thanks again guys.
Your next question comes from the line of Mike Halloran with Baird.
Hey, good morning, everyone.
Just to follow up on one of the last couple of questions. There, so youre talking about $80 million or so of cold revenue, having been executed on by the end of the year and the incremental $35 million or so is what's going to be left to be executed on the front half of next year as far as the run rate goes is that.
Fair thought process.
No.
It's a little bit different than that Mike. So we think we will have gotten at $25 million.
By the end of 2022 with the remaining 90 to go.
In.
In 2020.
25% in annualized number quarterly number.
In the quarter in the quarter and the quarter.
Yes.
Okay.
So I guess I'm confused.
Why wouldn't you be able to annualize that number.
To get to the $115 million.
That's <unk>.
Question, So youre, saying in the fourth quarter, you called 2000 $25 million of revenue were $20 to 25 million of revenue right.
Is that an annualized number.
That represents the annual number or is that the revenue that is attached to that fourth quarter.
That is the revenue attached to the fourth quarter. So yeah. So 25 hours. This year by 115 in total soybean. So you've watched 22, 9% to 23 there'd be 90 more that would come out in 'twenty three if you walk year over year.
But what I guess, what I'm, saying is.
If you've got a 20 year or so run rate from the fourth quarter, you've executed on the 80 or so because thats the run rate from a full year perspective.
And then what Youre executing on for the remainder perspective is like 35 or I think I think the issue Mike is <unk> got a you've got to start at 600.
When you look at the reported revenues for the year that we thought.
<unk>.
90 days ago it was roughly.
$600 million.
From there.
From there we will walk away from out of that revenue run rate basis, we'll walk away from a 125.
So I think what Mark said is exactly right the 25% specific to the quarter.
The 90 will come next year off of that $600 million run rate.
So the numbers that we're going to be reporting we will have the absolute impact of.
<unk>.
Of the walkaway that happens in the quarter had we done we could've done in a different way of saying if you would've started.
'twenty one.
It would have booked.
Maybe more in line with the run rate that you are talking about but since we're doing it from a.
Static starting point.
The level of walkaway.
I actually think we're saying the same thing just different different phrasing I'll take I'll take it offline that it's not a big deal.
So you talked about the balance sheet being in really good shape.
The <unk> piece, you feel comfortable that you have made the right.
And the strategic decisions to be able to execute on it so what's the willingness to bring stuff in today, how does that pipeline look and has the environment changed.
What that pipeline looks like multiples or anything like that.
I think it's probably very early to say, but I think look if we look at our pipeline of opportunities.
It's pretty extensive and expensive I think that we're going through.
And understanding of okay. So how do these businesses and their outlooks get impacted by maybe what's in front of us.
There are certain things that are going to convert over the next six to 12 months because they they look exactly like what it is we do we have confidence that our standing with the market outlooks like.
So I think it's relatively unchanged I think the pace of the integration and the capacity and the team that we built and have added to over.
In the last six months gives us a lot of confidence that we can we can continue to do M&A. We think we can do it at the right levels to create great returns and.
I think things that fit really really well inside of our core and so.
I think there'll be a period of time, where.
Expectations need to get reset we really have to understand.
In terms of value.
But I think we're going to continue to do what we've been doing for a long time, which is cultivate.
Things that fit inside of our core transacted at reasonable levels and integrated well and grow from there.
I appreciate that last one just on the Destocking side based on the positive commentary in the non residential businesses. It sounds like Theres no destocking needs there if anything maybe the opposite.
Term that one way or another and then also how long do you think the destocking is going to take to get to the right normalized level of inventory in the channel perspective on the residential side.
So youre correct I mean from a from a nonresidential side there is really not that much inventory at all throughout the throughout all the various channels and so what we're seeing now is probably.
A little bit of lead times coming in people being more cautious with order patterns and a little bit of backlog reduction. We think the vast majority of that is behind us in the fourth quarter.
On the non res side.
Yes, I think that.
When you look at residential.
I think we're taking a big whack out of it in the third and fourth quarter, there may be a little bit in the first quarter, but I don't think its material.
In the Grand scheme of things, So I think we get.
Clean sell through the demand numbers.
Late Q1 and into Q2.
So I think our our business is not a push model, where we have a lot of stuff on the shelf, it's really a <unk>.
<unk> pull through so nobody is really procuring this.
Before they need it and there's really not much in the way of shelf inventory. So I think we will see this.
This channel dynamic changed dramatically the impact of lead times coming in people being more cautious.
I think thats going to be a case by case basis, but all that being said as long as we're driving specification and preference and we see this backlog continuing to be strong in the nonresidential side I think.
The growth rates that will deliver our broadly speaking real time demand.
Great really appreciate the color guys. Thanks.
Thanks, Mike Thanks, Mike.
Yes.
Your next question comes from the line of Jeff Hammond with Keybanc capital markets.
Hey, good morning, guys, Hey, Jeff and Jeff.
Just as we go back to kind of the 23 look just can you give us a sense of how youre thinking about carryover price.
As well as kind of outgrowth momentum in the core.
Okay.
Yes, Jeff from a carryover standpoint.
If you think about next year on the Zurn side, we have seen obviously well ahead of the pricing game faster.
We've made a lot of progress in healthcare in the back half so.
About pricing I would say.
Zurn type product categories.
You would probably think about a low single digit type number.
Into next year, given the comps on the <unk> side, given the fact that our back half as well as stronger first half. If you think about that as more of a mid single digit <unk> blended together, it's about low to mid single digit range from a price realization going into next year Jeff.
Okay and then after a point at this point, Jeff we don't really.
We really don't have a view on pushing a lot more price heading into 'twenty. Three we will obviously continue to evaluate it but as the world sits today with input costs coming down and everything else. We've got a I would say a sizable tailwind.
<unk>.
Lower input costs, and so we want to leave ourselves the room.
If we need to get a little bit sharper on price scenarios, we certainly have the carryover and we certainly have.
The tailwind. So if you think about March number in aggregate of call it low to mid single digit carryover.
We think that market.
On the non res side is clearly up we think rates call it down a touch.
Then some outgrowth and so you can find your way to I think.
Pretty reasonable growth over the course of 'twenty three how it shakes out by quarter.
Be impacted by some of the dynamics that we've talked about but.
It's more efficient in my comments, a little more half full than it is half empty when you look at the.
Really concentrated simplified business post some of these rationalizations and jump I missed your comment or question on market ultimately.
What we're doing strategically we feel any given year, we're trying to get two to three points, Brian on the share capture side. So that we wouldn't feel any different about that vision that we have in the prior year and our ability to execute on strategic growth initiatives.
Okay, Great and then.
It looks like the water fountain in the commercial business grew pretty well I think you said low double digits.
Talk about kind of the order and quoting activity does that align with kind of the legacy zurn commercial or just how is that trending.
Commercial things, yes, I think it looks very similar to that that element within our with our zurn business versatile product categories. I think what we've seen already the power of having both brands in our portfolio.
So I think just from a growth standpoint that category both brands.
Saw low double digit growth.
In the quarter for sure in the third quarter, we expect that to be very similar in the fourth quarter.
Okay, and then just last one.
Certainly with some of the okay resets the stock's been under considerable pressure here.
How are you thinking are you have you revisited.
Share buybacks as a use of cash.
Free cash flow generation.
We have we have.
What's the number.
Roughly $200 million 160, 860 $870 million left on our repurchase plan. We also have.
A year, a very very strong free cash flow ahead of us and so the combination of all of that you can you can work your way to a leverage number of.
Half a turn by the end of next year with obviously without doing anything and.
And so as we talked a little bit earlier, we've got some M&A that we want to do we want to keep the balance sheet.
Pretty conservative as we go through this period of uncertainty.
But share buybacks should.
Should we feel it appropriate are definitely on the table.
We are.
We're confident in our ability to execute in 'twenty, three and 'twenty four and if we see a <unk>.
<unk> that is a dislocation at least in the near term I think there's a chance that we may do something I think the other part of it is I think as we scale the business.
It will probably revert to a more balanced return of capital to shareholders through M&A dividend and stock buyback just like we did.
Prior to the to the RMT and so I think we're probably a quarter away from that in the moment, but I think that thats definitely on the table and we do have the capacity to do that with the kind of cash flow and balance sheet profile we have.
Okay, great. Thanks, guys.
Yes.
Your next question comes from the line of Nathan Jones with Stifel.
Good morning, everyone.
Good morning Nathan.
I wanted to ask a question on the stickiness of pricing.
You, obviously had a lot of inflation flowing through this year, you talked about monetizing some higher priced inventory light issue early next year, which I guess implies that you'll have some lower priced inventory.
Coming along how sticky do you think pricing is likely to be from the price increases that you've already put through now in a deflationary environment and how accretive could that <unk> margins in 2023.
Yes.
It's.
It's very sticky.
When you look at specified plumbing products.
The pricing is sticky and I don't recall a scenario in the 15 years that I've been around the business, where it has not been.
That being said project by project opportunity by opportunity you have to be aware of what's happening amongst the competitive set and we've seen a very orderly market to date, we would expect that to continue.
And so if it plays out.
Where the prices continuing to be sticky.
And we're selective where we choose not to be.
There is a sizable tailwind coming through with.
With lower input costs.
And so we've left ourselves the room.
And the way we've thought about 2023 to see in a position to do that but it's our position that the pricing is sticky and if you look at the inflation that we pass through relative to other products that go into nonresidential construction.
Anything we've fallen down the frito, because we haven't seen the doubling of prices.
In subcategories and R.
Our price increases have been really to offset.
Some of the input costs that we've managed really well, but based on our model.
Don't have the fixed costs were not buying spot commodities.
We are well positioned to capture that tailwind.
When you think about what that could mean to margins it's significant.
Even without all of that and some of it.
We see pretty strong margin accretion into next year.
On a maybe not even a double digit growth sort of level. So I think our business model is built for this kind of environment.
Thanks, a couple questions around okay.
So I wouldn't assume that the revenue that you're exiting would've been lower growth than the revenue that you are maintaining I think you'd already targeted LK over the long term to be a double digit growth kind of business does this increase the expectation other than long term outside of any 2023 market.
<unk>.
The growth profile of <unk>.
Hey.
I don't know that we would see.
Sign up to increasing that but I think when you look at the categories that really now make up and constitute the core okay. We absolutely think drinking water has a longer term secular growth trend above.
But what we have and as Mark pointed out with the relative market share we have in commercial <unk>.
We have a terrific opportunity to outgrow.
The overall market just because of the size scale presence and spec nature of that category. So I think.
Maybe the way to think about it is a much much higher degree of confidence around that kind of outgrowth.
Absolutely nothing.
The residential seeing business already she comes with a fair amount of inventory liquidation can you talk about the cash generation that you should see from the exited that business.
Yes, it will be.
It will be sizable.
Obviously, the inventory investment to support that portion of the business was not generating much of.
Any profit was outsized relative to the inventory positions in what is core and so I think it's.
At least $25 million.
As we look to liquidate those inventories.
And likely more.
Great. Thanks for taking my questions.
David.
Your next question comes from the line of Joe Ritchie with Goldman Sachs.
Hi.
This is vivek srivastava on for Joe Ritchie. Thank you for the question.
You bet.
Absolutely not to beat a dead horse here.
But the 90 million.
Exit next year.
As I think most of it is tough.
Is that the right way to think about $20 million goes away in the fourth quarter credit too and then $45 million each goes in first and second quarter of <unk>.
Sequentially, basically like $25 million higher exit and banking regulatory.
For chronic care.
I think the way the way Mike was talking about it is I think more accurate right you've got <unk> and in this quarter to $20 million impact we had five last quarters pointed out in the back half of action video annualized right. So as you think about the walk yes, as I said in the walk you got $90 million impact.
Year over year.
But a big chunk of the actions that have taken place and you start to annualize on those numbers.
Michael describing is accurate so.
The annual work as we've laid out is intact, but a lot of actions.
Taking place right now that will drive the incremental impact.
Next year.
And the really more so in the first half of next year I laid out.
Maybe to make it very simple before before any.
Market price.
Our strategic growth initiatives.
Run rating Q1 at $120 million.
In Q2, and 120 million in Q3, that's the base before we do want to correct as we as we as we walk away from this.
That's the part I talked about we're going to try to isolate that and communicate around what is that $120 million growing year over year.
How what are the margins related to that and then we'll we'll give you what we walked away from and the impact of that but that is that's really the way to think about it.
Thanks.
That's helpful.
I have a question on free cash flow I think the color you provided on inventory liquidation that is helpful anything else.
From the SKU rationalization, which will impact <unk> FC of conversion and how should we think about your free cash flow conversion longer term.
Well I think specifically as it relates to the fourth quarter, we're going to see.
Free cash flow in the 90 to call it $100 million range, if we think about 2023.
We think that the inventory reduction across the enterprise is going to be sizeable.
And so free cash flow next year should be I would say.
Outsized relative to this year and then you've obviously got that liquidation factor that is going to be permanent and so.
I don't think Theres anything unusual.
We've obviously got to pay for some of the.
The restructuring and things like that to get the $50 million of synergies that we do.
We've signed up for.
But nothing outsized other than I think free cash flow next year should be.
Very very very strong.
Thanks, and then last one on revenue synergies quickly.
Are you already starting to get some traction here and maybe just if you can provide some color on what are the opportunities on this front and any any color on timing.
Yeah, I mean, we're in the throes of it right now.
When you think about some of the Essar and her funding.
As it relates to.
Secondary post secondary education.
We're immediately adding the conversations not only around drinking water, but also around our bright shield offerings and so we've targeted 25 school districts around the country, where we are.
Doing all the work to get at some of those funding and we're seeing that convert real time.
So we're leading with drinking water and then I think we're in a position to pull through some of the other more hygienic products or vice versa, where we've had a good conversation started with some school districts around creating more hygienic spaces, we're not pulling through the drinking water.
The opportunity around filtration that we highlighted initially is significant the film.
Filtration opportunity.
Amongst the combined business over the next several years.
$50 million to $75 million of growth at very very high margins and so the commercial teams are already engaged in the field on some of these things.
Going through our strategic plan and how we deploy those but I would say that the.
The case of bringing these two businesses together.
And being able to provide even more specified content to customers.
Is working.
Okay. Thanks.
Your next question comes from the line of Brett Linzey with Mizuho.
Hi, Good morning, all good morning, Brad.
Hey, just wanted to come back to the $70 million of retained LK resi revenue that you are selling through the existing channels are these pieces closer to the corporate average or these revenue pools that are maybe still under earning or mix negative that you think you can.
Since the profitability over time, and maybe review at a future date.
I think that they come in.
Oh.
A little bit below the fleet average.
But these are with our core wholesale customers they are LK branded.
They do have.
An element of conveyance with other products. So these are in sort of professional grade plumbing showroom type.
Type of products and so.
There is just without question as we bring the two companies together the opportunity to eliminate skus.
Opportunity.
But there certainly is cost opportunity as we bring the two companies together and I think as you as you look at that consolidating manufacturing simplifying skus.
Combining the spend.
And really focusing on manufacturing all of these.
In a more efficient way.
Should should drive the margins closer.
If not to the fleet average overtime.
That was the calculus in terms of why we decided to stay.
It was branded products that have convinced that we can improve the margins on and fit with our overall.
Go to market.
Through specification third party reps wholesalers that we've that we're strategic partners with and things. Unlike the other stuff really was was totally detached in.
<unk> had a lot of resource and a lot of inventory tied up in it and it was never going to be.
It was never going to be.
The kind of returns business that we wanted to.
Create when we put these two together.
Yes, no mix makes a ton of sense and then just my follow up it sounds like Youre progressing well on the integration efforts just in terms of the phasing of some of those savings and how that might have now changed relative to earlier expectations. I mean, do you think those ramp a little bit quicker herein.
Q4 in 'twenty two early 'twenty, three and just curious if there would be a change in any of the normal seasonal margin realization than you would typically see on a quarterly basis as you pull on these synergies and maybe a little bit earlier next year and these rationalization efforts are starting to ramp up.
Yes, no I think we're going to hit the ground running in 2023 with the synergy realization as a result of.
I think the significant work we've done around.
Creating these as product lines and moving on some of the.
Costs that we had line of sight to I'll leave it to Mark and Dave to communicate I mean, obviously, you know our our seasonal patterns.
Our first quarter is generally lower than our second and third and our fourth is as well based on the.
The weather patterns in nonresidential construction, so I think they'll all be amplified from a margin perspective relative to where they've been solely because of the synergies that.
That we're going to generate but I don't know that its outsized in any one quarter relative to the next yes, that's fair.
Obviously.
To provide more colors will be closer, but right now we wouldn't say that is.
Yes, overweight back half waterway front I think as Todd said a lot of your actions.
Are occurring now we feel pretty good about being at that run rate.
Going into next year, so there isn't there isn't playing out.
<unk> overweight quarter, it'll be incremental to each quarter I think is probably the way to think about it.
I appreciate all the color best of luck.
Thanks.
And at this time there are no further questions.
Are there any closing remarks.
Yes.
Thanks, everyone for joining us on the call today. We appreciate your interest in Zurn LK water solutions, and we look forward to providing our next update when we announce our December quarter results in early February have a good day.
This concludes today's conference you may now disconnect.
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