Q1 2023 Zurn Elkay Water Solutions Corporation Earnings Call
Okay.
Good morning, and welcome to discern L. K water Solutions Corporation first quarter 'twenty twenty-three earnings results Conference call with Todd Adams, Chairman and Chief Executive Officer, Mark Peterson, Senior Vice President and Chief Financial Officer, and Dave Poly, Vice President of Investor Relations Sports aren't 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 April 25th at this time for opening remarks, and introduction I'll turn the call over to Dave Poly.
Good morning, everyone and thanks for joining us on 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.
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 with that ill turn the call over to Todd Adams, Chairman and CEO of zero <unk> waterfall.
Thanks, Dave Good morning, everyone and thanks for joining the call.
When we announced our Q4 earnings in early February we talked a lot about 2023 is a euro simply executing against the plans that we had developed throughout 'twenty two.
If you look at our Q1 results that's simply a down payment on what we said we were going to do and as Youll hear from Mark for the time being we're leaving our full year outlook unchanged, but intend to take another look at it after we deliver the Q2 that we've outlined.
Pro forma core sales were up 5% and pro forma EBITDA margins were up 280 basis points over the prior year to 19, 5% as we discussed in February and we will reiterate this morning, we have high confidence that our margins will continue to ramp throughout the year based on the current cross profile, we've locked in and the benefit of the $25 million of L case synergy.
That will continue to roll into the results.
For the balance of the year, what that means the second half margins will improve at least 250 basis points relative to the first half.
Next we repurchased an additional $37 million or $1 7 million shares against our anticipated minimum $100 million of repurchases. This year and have continued to do so to begin in the second quarter.
Q1 cash flow was even in Q1, which was ahead of our expectations and gives us even further confidence in delivering our strong full year free cash flow.
Late in the quarter, we launched a national campaign to bring awareness to the problems with lead in drinking water, particularly in K through 12 schools.
And what we can do to help them solve this incredibly solvable problem.
Still early innings, but we're seeing demand for our drinking water solutions, both bottle fillers and filtration accelerate.
Taken as a whole Q1 was pretty much down the middle with lead times back to 2019 levels no supply chain constraints and all the 80 20 simplification work behind us. So we were able to work on the <unk> integration.
Integration efforts and executing on our strategic growth plan. We have developed we remain highly confident in the 2023 cost synergies from LTE reading through this year, while we continue to do the work to get the incremental $25 million benefit next year with that I'll turn it over to Mark on page four to take you through some financial details on Q1. Thanks, Todd Please turn to slide number four.
On a year over year basis, our first quarter first quarter sales increased 55% to $372 million L.
Okay merger contributed 3% year over year growth, while foreign currency translation reduced sales by 100 basis points from the prior year and core sales increased 300 basis points.
Pro forma basis, including LTE in the prior year first quarter and adjusting for the product line exits that we outlined during last quarter's earnings call core sales expanded 5% year over year breaking.
Breaking down that pro forma core growth sales to our residential end markets were a bit better than we anticipated as a mid teens year over year decline was partially offset by a few last time buys for certain skus, we exited resulting in a nonrecurring sales of approximately $7 million in the quarter.
Also our non residential end markets were also ahead of our outlook for the quarter and increased mid single digits year over year with balanced growth across wealth management and control water safety and control hygienic environmental and drinking water.
With respect to our al Qaeda related product line exit work, we completed the exits in the first quarter as planned and as Youll see on our outlook slide later in the call.
Both exits we'll have a year over year sales impact of $29 million in the second quarter and the $90 million, we have been highlighting for calendar year 2023.
Turning to profitability, our adjusted EBITDA totaled $72 million in the quarter and our adjusted EBITDA margin was at the high end of our outlook for the quarter at 19, 5%. This compares to $52 million and 21, 7% in the prior year's first quarter.
The benefits of price realization and our productivity initiatives inclusive of the cost synergies that will benefit earnings by a little over 6 million each quarter and calendar year 2023 was more than offset by the sell through of higher cost inventory purchased last year investments in our growth and supply chain initiatives as well as the impact of the <unk> merger.
Please turn to slide five and I'll touch on some balance sheet and leverage highlights.
With respect to our net debt leverage we ended the quarter with leverage at one six times inclusive of approximately $37 million of cash used to repurchase common stock in the quarter.
We have purchased another $17 million worth of stock through the first part of the second quarter, bringing our total share repurchase to just under $80 million from the fourth quarter of 2022 through yesterday.
In February our board of directors approved an increase in our share repurchase program to $500 million as we highlighted on our earnings call last quarter, we intend to utilize at least $100 million of our free cash flow in 2023 to continue to execute our share repurchase plan, while targeting a net debt leverage ratio in the one to two times range over time.
I will turn the call back to Todd.
Thanks, Mark I'm on page six over the next couple of slides I want to share a few positive developments on various legislation and other things we're doing to drive outsized growth from our safe water drinking platform.
There are no safe levels of lead in drinking water, especially when it comes to kids. We were pleased to see the Michigan Senate passed filter first water safety legislation last week. This legislation is intended to protect children from lead in drinking water by requiring all child care centers and schools to implement a drinking water management plan install filtered bottle filling stations.
Filtered forces on outlets designated for drinking water and test the filter filtered water to ensure that the filters are installed and operating properly.
Legislation now as to the Michigan State House of Representatives for consideration and as widespread support from health and environmental experts because it is more cost effective than requiring repeated testing at every school.
While we view Michigan's legislation is the gold standard there is growing awareness and more legislation developing in other states across the country, including California, Texas and Massachusetts as you can see here and this is all just within the last three months.
<unk> been actively supporting this legislation as well as others and believe the most proactive and protective solution to kids getting exposed to lead through school and child care drinking water is to place filters at the point of views and for about $2 per student per year.
Schools can accomplish that with our filtration solution.
Moving to page seven.
We're also doing our part to bring greater awareness and understanding about the importance of safer drinking water and healthy hydration through a broad awareness campaign, we started with a video series that launched across social media connected streaming and video on demand services and supported that with an entire tool kit of information and resources.
In addition, we launched a dedicated section of <unk> Dot com with information designed specifically for parents teachers administrators and facility managers. The content ranges from letters parents can send a school administrators matched indicating where water quality is most at risk for school boards and administrators curriculum for students and teachers plus.
Where to buy and how to change our filters for facility managers, we know awareness drives action and when parents teachers and the community call attention to their drinking water problems the issue cannot be ignored moving.
Moving to page eight.
Just the fact that some school districts have more resources than others. However, all children deserve clean safe water in the places where they're learning and growing every day.
Why we created our fountains for youth program in 2019, providing filtered bottle filling stations filters installation grants or a combination of all of these to schools in need.
The program assesses donation needs based on several criteria, including water quality issues and the ages of students attending the school with a preference given to schools and early education in elementary schools, where led has the greatest impact on developing minds and bodies.
Graham has benefited dozens of schools across the country with our most recent efforts focused on Los Angeles, Betten Harbor, Michigan and Milwaukee.
<unk> to roll this out to even more schools across the country. This year in places like Jackson, Mississippi and others.
Graham has just a piece of our overall ESG efforts at a nice segue to the last one for me on page nine.
We continue to make strides in our ESG efforts and clean water mission. Overall in addition to our 2022 sustainability report issued in February and our UN Global compact communication on progress that will issue next month. We also wanted to share our first quarter progress against key targets to provide additional transparency and accountability on our ESG journey.
Developing clean technology water solutions that help our customers meet their water challenges and goals is core to our sustainability strategy with 74% of our revenue coming from products with sustainable attributes during the quarter.
Our commitment to clean technology innovation and continuous improvement keeps us focused on expanding our line of products to conserve water contribute to a cleaner environment protect human health and hydration save energy and reduce the use of plastics and other non renewable resources.
Okay products save an estimated 8 billion gallons of water during the quarter and our goal is to reach 40 billion gallons of water saved annually by 2024. Additionally, okay water bottle fillers have prevented the use of more than $4 billion single use plastic water bottles, well on our way well on our way to the target of preventing 15.
Annually.
Within our own operations, we identified and are launching eight new projects to reduce our energy usage and greenhouse gas emissions and we have clearly defined path to meet targets for both collectively for the quarter, our philanthropic donations in kind gifts and associated volunteer time exceeded $1 million.
In March we announced a mctigue joined our board of directors with the addition of <unk>. Our board now has nine independent directors three of whom are women. Overall continued strong progress with our ESG efforts and now I'll turn it back over to Mark to take you through our outlook.
Thanks, Todd Please turn to slide 10, I'll cover the highlights of our outlook as.
As you saw in the press release, we issued yesterday for 2023, we're going to continue to take a view on our external outlook that encompasses a broader range of volatility when we have the past couple of years.
Our outlook for calendar year, 2023 remains unchanged with sales in the range of $1 5 billion to 155 billion and our consolidated adjusted EBITDA in a range of 325 million to $345 million, resulting in year over year margin expansion of at least 110 basis points up to 170 basis points.
Similar to last quarter to help better understand the growth trends in the business in 2023 on the right side of the chart, we presented Zurn LTE pro forma 2022 sales for the second quarter, which takes reported sales for 2022, plus <unk> sales for the second quarter of 2022, lastly year over year impact of the 80 20 product line exit.
We have executed.
For the second quarter of 2023, we are projecting sales to be in the range of 385 million to $395 million and our adjusted EBITDA margin to be in the range of 21% to 21, 5%, which is a 150 to 200 basis points step up from the first quarter.
With respect to the sales outlook you can see on the page our assumptions for year over year growth in our nonresidential and residential product groups, which are which are impacted by the timing of shipments last year. As we began working down an elevated backlog in the second quarter of 2022.
We anticipate pro forma orders in the second quarter to expand the low to mid single digits year over year with mid to high single digit growth in our non residential end markets, partially offset by a mid teens decline in our residential end market.
Turning to profitability, our second quarter margin, expanding 150 to 200 basis points sequentially from the first quarter of 2023 as the sell through of the higher cost inventory. We purchased in 2022 will be complete in the first part of the quarter.
Our margin will begin to benefit from the lower commodity and transportation costs in the back half of the second quarter and into the second half of 2023, where we anticipate another large step up from the second quarter.
Our synergy savings related to the <unk> merger will continue to deliver just over 6 million a quarter and $25 million for the full year in 2023.
Before we open the call for questions. Just a reminder, that we are included on page 10, our second quarter outlook assumptions for interest expense noncash stock comp expense depreciation and amortization, our adjusted tax rate and.
And diluted shares outstanding.
Ill open the call up for questions.
At this time, if you'd like to ask a question simply press star one on your telephone keypad. Our first question will come from the line of Bryan Blair with Oppenheimer. Please go ahead.
Yes.
Thank you good morning, guys.
Good morning, Brian .
I believe you said that.
He was down mid teens with roughly 7 million of unanticipated sales that.
While being on.
Unwound they stayed in the quarter just to clarify what was the margin on the $7 million.
The margin of 7 million was I'd say about the fleet average what we had for the quarter. So we do a little better than that given the size of last time buy is below what you had net Norway state, but it didn't materially impact the overall EBITDA margin in the quarter Brian .
Okay understood.
And maybe offer a little more color on.
At year on year backlog dynamics impacting Q2.
<unk>.
Any any additional insight you can offer there in terms of how much of a headwind that is and how we should think about the phasing.
And an extension of the progression of growth rates into the back half for.
On non res in particular.
But also your resi sales obviously easier.
Easier comps as the year progresses.
Yes, specifically as it relates to Q2, there is a sizable.
Sizable headwind in Q2 from a backlog reduction so we built backlog in Q1, it reduced it significantly in Q2 and Q3 so.
If you look at our order rates relative to the prior year in Q2, they are actually going to be up nicely. So the sales growth.
As clearly impacted.
As a result of the backlog reduction in Q2 reasonably acutely and also Q3.
So we are seeing.
The trajectory of year on year order rates continue to.
Stabilize and be positive as we go out throughout the year, but the phenomenon that you talked about Brian is impacting what.
We're talking about in terms of sales growth for the.
For the quarter, it's not what we would characterize as the underlying demand or market growth.
If you go back and look at the backlogs.
Go back to last year's Q that there was about a $60 million backlog burn last year on reserve side of the core business itself.
That's what advertisers offering too when you look at the order the sales rates you've got to take that.
Duration, let's start pointed out the order rates are are accelerated in Q2, and we think right now we see a good a good second half year over year demand.
Got it.
One last one higher level question just be great to hear your thoughts on.
On non res in general there's been a fair amount of concern regarding the cycle. That's obviously levered in the recent past.
Yes.
Consternation related to the to the banking sector I'm just wondering how your team feels about the backdrop, overall, and which end markets or product lines.
You're most confident in growing through an uncertain market and where there may be a bit more risk to zero, okay going forward.
Sure, Yes, we've heard the concerns.
I think <unk>.
Qualitatively if you look at our forecast for the remainder of the year, it's essentially unchanged.
From what we had developed.
To start the year I think that's an important piece to.
To take into consideration.
Secondly, if you look at our overall nonresidential mix, 47% of that is institutional.
Primarily health care and education.
Some water works. So you can get to over half of the overall revenue. If you look at the slice of commercial.
Obviously.
We're watching it when we entered the year we add.
We had we had obviously identified a lot of that risk in the outlook that we had provided we're not seeing anything that <unk>.
Points us to being more outsized than that at this point, but again, Brian I think.
Our forecast for the remainder of the year is essentially unchanged.
That wouldn't be reflected in sort of the consensus view of the world, but but from our standpoint.
Very little change.
In the last 90 days relative to maybe the range of outcomes that we thought could happen for the year.
Okay I appreciate all the color solid start to the year.
Your next question comes from the line of Jeff Hammond with Keybanc. Please go ahead.
Hey, good morning, guys. Good morning, good morning, Jeff.
So.
I guess just on the margin bridge first half the second half can you just kind of remind us of the moving pieces I know you've got some certainly the higher cost inventory the.
The investments.
And the safe drinking water and then kind of the synergies, but just walk us through kind of that.
You said 250 basis points first half the second half move.
Yes definitely.
Introduce play out consistently across the quarter.
So no H two versus H, one benefit really from the centers that is playing out consistent each quarter.
Yes, a bit of a modest step down in some of the investments that was a little more front end weighted but the big thing that really matters. The most.
As the inventory cost structure. So as we've said we were buying inventory in 2022 at elevated levels from a cost standpoint.
It worked its way through Q1 is going to impact us a little bit in the first part of Q2, but the big difference is the back half of Q2, and then into Q3 as well as Q4 will be at the lower commodity lower transportation costs that we've been experiencing for a period of time here impacting the P&L. So thats the really bad.
The biggest piece of the puzzle Jasper Youll really see it.
In the third quarter, because they really were not expect anything different in Q4, So youll see.
Meaningful improvement and the Q3 margin and then that margin will decline a bit in Q4, just based upon the seasonal reduction in sales in Q4 expected normal decremental margin in.
In Q4, so Q3 is that the point, where youll see that that full run rate of that lower commodity and transportation cost impact in the P&L.
Okay Perfect and then just on this clean water opportunity can you just maybe.
Size, it and what you think.
The funnel of opportunities is and just how important it is for additional states declined.
Drive regulation versus.
Just more more organic.
And what kind of penetration.
Yes, Jeff as it relates to our sort of regular way.
More new construction work.
We think that that is going to continue to accelerate and grow as it has been.
For a long period of time.
The opportunity is measured in the hundreds of millions when we look at a combination of.
Aftermarket retrofit replace in filtration and obviously we've got.
Some some pretty targeted initiatives in key states as well as this broader awareness campaign that we're going state by State School District by School District. They begin to identify where is the problem. Most acute what's installed what can we do to replace and then obviously how can we provide that Phil.
<unk> in our recurring a recurring basis and so I think the opportunity continues to.
To be there I think the awareness campaign and this legislation is just bringing it into.
Bringing it closer and closer to.
Two impact and so we're building the funnel as we speak we're obviously addressing these states, particularly.
The ones we identified.
But I think this has got a very long tail.
And we would qualify it as something measured in the hundreds of millions of dollars over the next three to four years incremental to that core business.
We continue to we continue to see nice growth from.
And then you mentioned filtration can you just kind of as you've dug in on the integration.
Maybe.
Reassess kind of aware that where you see that filtration opportunity relative to maybe what you thought initially.
Well it's.
It's not much different than we identified if you think about.
The attachment rate and you think about the.
The ability to continually.
Provide this through subscription services or other things and really drive.
The the replacement with our filters.
Was not a strategic focus that <unk> really.
Had spent a lot of time on we identified it through the size of the installed base.
The conversion from non filtered to filtered units and then obviously ensuring that we recap we would capture that replacement of that and so we think this is.
Clearly identifiable and broadly the same size, we thought but it's.
It's not crazy to think about this as a $100 million opportunity.
And the next two to three years.
Okay. Thanks, guys.
Your next question will come from the line of Mike Halloran with Baird. Please go ahead.
Hey, good morning, everyone.
Followed up on.
Brian's last question there.
When you think about the guidance for the back half of the year. So it will realize unchanged all else equal for the full year.
Are you assuming any.
What is the assumption for demand relative to normal seasonality is it just a stable backdrop on the residential side.
In the nonresidential side, when you normalize for kind of the inventory machinations and all the other things you just assuming a relatively stable demand pattern underneath or is there something different.
We are yes, we're not assuming I think if you go back 90 days ago. We thought look we think over the course of the year.
The residential end market could get modestly better in the back half sequentially.
And non res pretty stable over the course of the year I'd say modestly remote material impact that may offset a little bit of both.
Slowdown in the fourth quarter, but I think everything that we see right now and you look at contract backlogs.
Pulsing Contra.
Contractors across the regions.
Still feel reasonably good about 2023 today.
The visibility as you can appreciate it is only so far out.
But I think that we right now all the data points that we have with our contractors and reps.
<unk> pointed to some cliff coming in the back half of the year at this point in time of what everyone can see.
That makes sense and then on the inventory side, maybe just talk to how you feel about channel inventories as well as how you feel about your own inventory levels.
And how you see that working out through the year.
Yes, I think from a from a wholesale channel inventory perspective.
There is.
The right levels of inventory for the future demand that we see we don't see it elevated in really any specific categories. So taken as a whole I think we're sort of through the.
Through that right sizing more based on where our lead times are today relative to maybe where they had been over the course of 2021 and 2022, so that feels.
Very normal in terms of our inventories obviously, we've got.
And outlook on the second half, we've essentially dialed in.
The purchase requirements that we see that match that and so youll see inventory continue to come down over the course of the year.
As lead times from our suppliers have sort of normalized so taken as a whole I think the.
The jockeying of lead times and inventory.
For us and our suppliers is largely behind us so it's sort of steady state.
At much lower cost as market identified and Thats, where we see the margin methods spot rate current purchases that we've locked in we feel we've got a we've got a nice cost tailwind heading into the second half.
Thanks, I appreciate it gentlemen have a good one.
Thanks.
Your next question comes from the line of Joe Ritchie with Goldman Sachs. Please go ahead.
Hey, good morning, guys.
Good morning, So I'm just trying to I'm just trying to square your non res commentary.
Back of the envelope it looks like non res is probably up I don't know high single digits this quarter.
Now now we're expecting it to be negative modestly in the second quarter and I'm just I'm. Just wondering like is it is this mostly channel inventory dynamics were there.
Any cancellations in your backlog I'm, just trying to understand that a little bit better.
Joe I think the.
We touched on it a little bit earlier.
The sales growth.
In Q2, and Q3 would be impacted by backlog reduction last year, so not necessarily the order rates or the market. It was.
So it's a function of last year's Q2, Q3 comparable would have pretty.
Pretty significant backlog reduction from both discern and <unk> and as a result of that obviously, we're working through that headwind, but if we look at sort of daily order rates and what we're projecting for Q2 and in Q3, the order growth in non res would be positive for those two.
Orders remember last year in the first quarter.
Lead times were extended supply chains for long.
So we built backlog and then spent Q2 and Q3, reducing that so I wouldn't say that our outlook on the market as really any different from Q1 to Q2.
It's more a function of the comparable last year as we reduce backlog.
Okay got it that's helpful and I guess, maybe just as we're progressing through the year I know you've given a lot of color at this point on the on the margins improving particularly in the third quarter.
Yes.
I know that you guys typically don't get pricing, but im just curious you know youre seeing across.
The sector, some really good tailwind from price cost.
And I'm wondering if you can at least give us may be some some quantification.
But with lower cost inventories going through your P&L, but does that ultimately mean from a dollar standpoint, just trying to understand the impact that we should see in the second half.
Yes.
We're not going to get into given the actual dollars for the third quarter, we will get to the outlook at the end of or at the end of this quarter. When we report again in July .
If you think about pricing and cost.
Yes.
We've been talking about getting effectively low single digit price realization on a year over year basis. This year.
Thats been thats been sticky.
Theres been no no.
Walking back at all as we anticipated and we think that continues for the balance of the year.
Cost standpoint, we said, there's about 250 basis point headwind.
And year over year in the first quarter that most of down to close to a 100 basis points.
And in the second quarter, then obviously that headwind disappears. So the benefit really is.
We get to that lower cost structure, we have been talking about.
Yet the price stays in place in the back half and you'll see that stand out in the third quarter margin when we give our outlook 90 days from now.
Okay. Thank you.
Your next question comes from the line of Nathan Jones with Stifel. Please go ahead.
Good morning, everyone.
Good morning.
I wanted to maybe take a look a little further into the future you guys have talked about some of these new non res.
<unk> that Youre aware of you track for up to two two years before they turn into revenue, which gives you some visibility not only into 'twenty fall, but maybe even adding to 'twenty five.
Which I think is probably where people are more concerned on the.
At least the commercial side of non res construction.
Can you talk about that sales funnel that you track.
Further adding to the future and whether you're seeing much change in that more.
More distinct kind of opportunity.
Yes, I think it's way too early Nathan.
The short answer would be it would be.
Unidentifiable for us to look at 2025 and noticed a meaningful change as a result of what's happened in the last 90 days. So theres been no significant adds beyond what we would normally expect or cancellations and so taken as a whole.
The market and the level of project activity that were seeing particularly on the institutional side is not changing dramatically.
One year two year out is a function of.
Where interest rates are or.
The banking crisis I would say.
When you look at our commercial exposure.
It's a mix of retail office warehouse hospitality and other things and so.
I think it would be disingenuous to say that we've seen any change in our in our project outlook beyond qualitatively, saying, hey, it's probably not going to be as good in 'twenty four 'twenty five as a function of.
Rates are today.
But I.
I don't think that we could identify anything specific that would maybe cancer, what youre trying to get at.
Okay fair enough.
Maybe just on the share repurchase.
No.
Higher than the average for the first quarter, you talked about having done more in the second quarter here.
Is that how much you execute on.
On the share repurchasing 23 dependent on share price opportunities you find.
Other capital deployment, all bonds anything like that just any more color on where that number might end up for the year.
Well I think obviously, we we communicated.
Sure.
At a minimum of $100 million.
We're off to a very strong start on free cash flow we're executing.
Against the <unk>.
Projections that we had the stock prices has been obviously, a little bit lower than maybe we would all like.
And so I think that there is upside to that $100 million.
And we'll just continue to work at identifying.
How much we do and how we executed throughout the year.
Okay.
Hi, guys. Thanks for taking my questions.
I will now turn the call back over to Dave for any further remarks.
Thanks, everyone for joining us on our call today. We appreciate your interest in <unk> and we look forward to providing our next update when we announce our June quarter results in late July have a good day everyone.
Ladies and gentlemen that will conclude today's meeting. Thank you all for joining you may now disconnect.
Okay.
Okay.
Yeah.
Okay.
Yes.