Q3 2023 Zurn Elkay Water Solutions Corp Earnings Call

Good morning, and welcome to discern L. K water Solutions Corporation third quarter 2023 earnings results Conference call.

But Todd Adams, Chairman and Chief Executive Officer, Mark Peterson, Senior Vice President and Chief Financial Officer, and Dave Poly, Vice President of Investor Relations for Zurich L. K water solutions.

This call is being recorded and will be available for one week the phone numbers for the replay can be found in the earnings release. The company filed in an 8-K with the SEC Yesterday October 31st at this time for opening remarks, and introduction I'll turn it over to Dave Poly.

Good morning, everyone. Thanks for joining us on the call today.

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 in our filings with the SEC.

<unk> 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 and contain reconciliations to the corresponding GAAP information consistent.

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 I will turn the call over to Todd Adams, Chairman and CEO of <unk>.

Thanks, Dave and good morning, everyone. Thanks for taking the time to join US This morning.

I'm proud to it we had a really strong Q3 operating performance margins improved to 24, 1% up 410 basis points over the prior year. We also delivered record free cash flow in the quarter of almost 100 million bought back another 445000 shares and increased our dividend 14%.

As we highlighted in our earnings release, one year into the Okay. Sure. Okay combination, we're really hitting our stride in terms of the benefits from the transaction both from a synergy savings as well as capturing the enormous secular growth opportunity, we see in clean filter drinking water.

Over the next 12 months, we will be introducing more new products in the drinking water category than at any point since LK develop the category just over a decade ago. This is both on the filler side as well as the filtration side and all of this is happening as we see continued positive momentum on the legislative front as well as traction from the significant internal investments we have.

Made to drive growth to grow the overall category.

One year and we've accelerated the growth rate of drinking water and now expect mid teens organic growth for drinking water in 2023.

In terms of the underlying market, while we grew in line with our Q3 guidance, we were expecting a little better internally after a pretty good start to July and August which was offset by a so so September <unk>.

I'll dive into what we're seeing from a market perspective, a little bit later, but as we look at how the year has unfolded, it's not hard to see from all the external data as well as our internal data that the market is more uncertainty in it than at any point over the last year.

Also covers we don't believe that this is some sort of apocalyptic issue for 24 and 25 now I'll turn it over to Mark.

Thanks, Scott Please turn to slide number four.

Our third quarter sales were $398 million and on a pro forma basis increased 100 basis points year over year.

As we discussed during our last quarter, our year over year third quarter core sales growth was impacted by the timing of orders and shipments in the prior year as we were working down on elevated backlog in the third quarter of 2022 breaking.

Breaking down our pro forma core sales growth percentage a bit a mid single digit increase in core sales growth through our non residential end markets was partially offset by a mid teens decline in sales drove our non residential end market.

Respect to orders our pro forma orders increased high single digits year over year Nonresidential order growth was above the fleet average with balanced growth across drinking water flow control water safety and control and hygienic environmental while year over year order growth in our residential end market was below the fleet average.

Turning to profitability, our third quarter adjusted EBITDA increased 15% from the prior year third quarter to $96 million and our adjusted EBITDA margin expanded 410 basis points year over year to 24, 1% in the quarter.

Looking at our margins sequentially, we stepped up 250 basis points from the second quarter of 2023, and as we had been discussing all year the benefits of our price realization and our productivity initiatives inclusive of the cost synergies at a little over $6 million each quarter in calendar year 2023.

We read through in the third quarter with the impact of the sell through of higher cost inventory completely behind us.

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 two times inclusive of deploying $100 million of cash to repurchase common stock during the first nine months of 2023.

Early October we paid down 60 million of our term loan eliminating all future required principle payments and generating approximately $4 5 million of annual interest expense savings going forward.

Given the balance sheet position and a strong free cash flow generation with good capital allocation Optionality going forward I'll turn the call back to Todd.

Thanks, Mark and I'm on page six are.

Our ability to deliver tangible results that have an impact on the environment continues to compound as we execute our fundamental business strategy, which happens to have amazing symmetry with what our customer's goals are to do the right thing for the environment as well as human health and safety.

It's like 14 billion single use plastic water bottles avoided through the use of our LK bottled fillers that is up 8% over the past year and will easily be up double digits next year as well as 23 billion gallons of water saved through our <unk> products like low flow flushes fixtures and sensors.

The rating agencies around sustainability have also taken notice of the meaningful improvements and it shows in their most recent ratings of our overall profile.

Sustainability ranked zurn LK sustainability program and the top 3% of our industry and the top 7% of the more than 15000 companies. They rank each year with MSCI, we have a double a rating which puts us in the top 10% of our industry and lastly, S&P Global has created has rated us the top 8% of our industry.

When you step back from it the one thing to take away from all of this is that our core or in this case, 84% of our total revenues is that we really attack that climate risk of water scarcity, whether thats low water consumption valves will providing point of view is filter drinking water our products protect conserve and manage the water we all depend on.

The world faces, an array of climate and water related crises, including flooding and drought events, driven and exasperated by exasperated by climate change water pollution and its impact on biodiversity in human health and aging infrastructure that can contaminate water supplies are continued investment in engineering and R&D.

Allows us to focus on addressing these crises, which are central to sustainability and an essential part of how we drive our business forward.

I'll move to page seven.

We're seeing serious momentum on the filtration side of our business as our installed base of filtered enabled drinking water dispensers continues to grow as customers shift more and more to filter solutions combined with an increase in filter replacement rates as awareness around the dangers of led and other harmful contaminants in drinking water continues to build coupled with led.

<unk> and regulatory requirements that are beginning to be implemented.

Not only are we seeing legislation passed in Michigan related to filter first we're launching new products that continue to increase to increase the contaminants are filters are certified to reduce ultimately protecting students patients and the overall public against ingesting more potentially harmful contaminants by providing continuous safe clean drinking water.

With our filtration solutions.

Today, we are announcing the launch of our very first <unk> filter on the market, that's integrated into bottom fillers and drinking water dispensers.

Filter will continue to do what our filters do today and filtering out lead and other contaminants, but now as the two most prevalent <unk> contaminants to what it effectively filters.

Fast consumption has been linked to a number of serious health concerns, which makes effective filtration from drinking water a big deal and something we're excited about to be the first to market and offering our customers and users are solutions. Our solution utilizes highly engineered activated carbon which absorbs. These contaminants. This technology is the most water.

<unk> solution and effectively filtering Paphos and has done an lk's proprietary filler footprint, which is the smallest footprint on the market to give you some sense of how difficult. It is to launch a filter like this these filters have to reduce the <unk> chemicals down to a concentration that is 250 times less than with led.

We expect regulations will continue to evolve as the public learns more about DFAST, but by being first in providing effective and certified filtration against these two most prevalent <unk> chemicals. We believe we provided a great upgrade to schools universities and even homes in our never ending pursuit to provide us provide the safest cleanest drinking water for everyone.

The <unk> the LK filtration line of products is truly market, leading with the longest lasting led filler on the led filter on the market certified to 6000 gallons along with the most comprehensive contaminants claims on the market. The beauty of our filtration business is that it will continue to compound well into the future as we continue to build the installed.

Base, while capturing an increasing level of replacement.

I'll move on to page eight.

There's been a lot of discussion throughout the year related to the nonresidential construction market and its imminent demise, I'm joking a bit but I think it's important to understand a little bit of how we look at look at it in total beyond the headline numbers.

On this chart on the upper left as actual and projected institutional starts in a square on a square footage basis below is the same for commercial starts a couple of things to point out roughly 50% of our total business is leveraged to the institutional end markets and verticals, specifically education and health care generally institutional starts average.

Somewhere in the neighborhood of 80 to 90 million square feet per quarter over the past five years. Another thing to point out is that generally speaking this segment hasnt been particularly interest rate sensitive at least historically.

What's been driving a lot of the headlines in the commercial part of nonresidential construction, which by order of magnitude from a square footage perspective is three to four times bigger than institutional but represents only about 30% of our business. What's happening here is the massive build out of warehouse space and some automotive expansion is creating large downdrafts in the overall actual.

Projected starts on a square footage basis throughout 2023 and into 2024.

And aside our best estimate is that warehouse represents less than 5% of our overall sales meeting we have not really benefited much from that massive buildup nor will it be devastating if it's down a bunch again not the greatest of news, but the downside is capped and we have plenty of areas to find growth.

On the upper right is the average nonresidential backlog or.

Nonresidential construction backlog for only the commercial and institutional end markets excludes infrastructure, which can skew the backlog significantly.

And as you see the backlog for commercial and institutional has been relatively steady in terms of months at about $9 and below is the Dodge momentum index, which is a monthly measure in dollars of the initial report of nonresidential building projects in planning and is a leading indicator for construction spending approximately one year out.

The reason to take everyone through this is to highlight there are a ton of facets to understand the underlying nonresidential construction market in the U S. On top of this we also have access to and leverage internal bid and buy Ford information across our own portfolio as well as some of our large wholesale partners. Finally, I think is incredibly important to understand how hyper low.

That is what's happening or not happening in the bay area can be totally different than what's happening in the Carolinas, particularly when the build cycle typically spreads over the course of 12 to 18 months lastly, it's important to recognize that new construction represents about 55% of our overall business with 45% happening outside of what we see.

On this page in a somewhat orderly retrofit replacement and break fixed market.

The vast vast majority of the questions. We've got over the course of the year have been about the market our exposures and what it means to growth going forward. We're not trying to guide for 2024 at this point, but we wanted to provide a little bit more context, as we all sort through how to think about the economy and where its headed before I turn it over to Marc I'll make just a few quick points.

On page nine.

Taking into account everything I, just talked about here's a look at our 10 year core growth profile at 6% compounded.

Also point out that over the course of the last 51 quarters, that's 12 years and three quarters. We've only had four negative core growth quarters with a largest coming in June of 2020, which was down 5%.

With all the bumps in the road and challenges over the past 10 years, hopefully you can see how the mosaic of the realities of the end market dynamics I went through on the prior slide coupled with our historical growth algorithm of market plus price plus share translate into a more resilient scenario than meets the eye and this back test it against our results that you see.

Here.

That doesn't mean the scenario, we face today with interest rates and the types of uncertainties that are out there are exactly the same as any point in the last 10 years, but will also is different.

Is that our growth algorithm now foods market price share and category growth and drinking water and filtration, which is something we saw in <unk> and it's why we've attack the opportunity so aggressively over the past year.

Last couple of points for me are on <unk>, and our fundamental business model from a business perspective, we're in a terrific place, we see a clear path to profit and margin expansion in an uncertain environment with the incremental $25 million of synergies will be delivering throughout 2024.

The momentum around filter drinking water breakthroughs will only gain momentum over the next 12 months and it provides an idiosyncratic growth driver that is new to us and still very early in its runway our business system and relentless focus on simplification and continuous improvement gives us a ton of confidence that we can continue to create margins and cash flow to.

Invest back into growth and finally, we've cultivated and created a business model built to be agile with our highly variable cost structure low capex that generates consistently high free cash flow year end and year out that coupled with a great balance sheet gives us considerable optionality to drive shareholder value over the coming years and with that I'll turn it back to me.

Mike.

Thanks Todd.

Please turn to slide number 10, I will cover the highlights of our outlook for the fourth quarter.

The fourth quarter of 2023, we are projecting sales to be around $351 million, which gets you to the midpoint of our initial outlook for the year at $1 $5 5 billion.

We anticipate our adjusted EBIT margin to be in the range of 23% to 23, 5% for the quarter, which translates to approximately 336 million to $338 million for the year.

With respect to free cash flow, we are increasing our full year outlook to approximately $230 million in the $250 million of highlighted 90 days ago.

Highlights related to our outlook first.

Our fourth quarter outlook reflects our best cut at the market based on what we saw later in the third quarter and into October as well as the traditional seasonal decline in sales in the fourth quarter and fewer shipping days in the fourth quarter compared to the third quarter.

Next we recently completed a product line review, where the residential same customer after extensive negotiations a level of profitability was not going to be acceptable to us. So we decided to phase out our supply of certain whether its a thanks to this customer as a result, our fourth quarter sales will be impacted by approximately $3 million to $4 million with really no impact on our earnings.

Finally, given the momentum we have with our filter drinking water growth initiatives, coupled with the launch of our new <unk> filter and the recent passing of the Michigan filter first legislation, which requires all K through 12 schools and childcare facilities in Michigan to provide filter drinking water to students. We've accelerated a few million dollars of drinking water growth investments into our fourth.

<unk>.

Before we open the call for questions. Just a reminder, that we are included on page 10, our fourth quarter outlook assumptions for sales growth for nonresidential and residential product categories.

Interest expense noncash stock compensation expense depreciation and amortization adjusted tax rate.

And diluted shares outstanding will now open the call up for questions.

Yes.

And if you would like to ask a question Press Star then the number one on your telephone keypad.

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

Thank you good morning, guys.

Hey, Brian and Brian.

Yes.

Hi, it's encouraging to hear about the mid teens.

Core growth in drinking water for the year.

As we look to 'twenty four and the less certain market environment. Overall is there anything youre seeing that would prevent continued growth there.

And given.

The growth that you have achieved this year I assume momentum into next year.

Our favorable cost position what is the run rate margin.

And water and as we look forward.

And include the ramp of filtration sales in France, and will be margin accretive enzyme.

Where should that margin profile over the coming months.

Yes, I mean too.

To sort of take it piece by piece.

I don't think that there is anything that we see that wood.

Arrest or slowdown the growth and drinking water in fact.

Think that.

All the work we've done and the investments we're making give.

Give us high confidence that we can continue to grow it at a very high clip.

And drinking water next year.

Obviously, the algorithm around more units higher attachment rate.

That's all beneficial and compounds over time, Brian So that that is one that we feel really good about as it relates to the margins obviously above the fleet average.

We're not going to.

Decipher exactly what that is but above the fleet average and I don't think that.

We see any any challenge or risk to that either so I think we feel really good about the last 12 months as I mentioned, we've got a pipeline of new products over the next 12 months.

That is going to dwarf.

Anything that we've ever done from an introduction standpoint, so that's where we've spent the last year and I think it's it's reading out in the first year nicely and I think that we have.

We have strong momentum heading into 'twenty four and beyond.

That's helpful. Thank you.

And you walked through your portfolio exposures and the resilience you've had historically.

We have confidence looking forward.

I was hoping that you could offer a little.

A little more detail some finer points on.

How youre thinking about the puts and takes.

And institutional versus non commercial nonresident measures of resi positioning price cost follow on synergies.

As we think about 2024 and this pattern.

And the prospects for earnings growth.

Yeah, I mean, we've highlighted I think.

Compelling case around the drinking water growth for next year at very high margins, we have 25 million of synergies that will read through.

I think in terms of.

Commercial.

I think it's clear to us that it is going to be down a little bit we don't think that it's huge but it will be down.

That's on the new construction side.

Break fix we think is sort of plus or minus.

Little bit.

Because a lot of that is actually planned retrofit replace <unk> just simply break fix.

And then I'm guessing, we probably thought that <unk> was going to inflect a little bit earlier this year than it has it's not getting worse, but it hasnt improved a whole lot. So I think we probably transitioned to flattish into next year and then.

We will see around waterworks, which is only 7% 8% but.

I think there is a path to growth for sure.

And our path for significant margin expansion again, as we look at as.

As we look at 'twenty four but.

<unk>.

As we look at the market September while still growing was less than what we thought.

October was probably a bit ahead of what we baked into our quarter.

But I think there is room for some uncertainty as you head into November and December and in January. So I think we're trying to be cautious with the way, we're providing the outlook, but I think the profitability.

And the cash flows are going to be exceptional and I think the resilience of the portfolio.

<unk> has proven itself over time.

<unk>.

And we just have to continue to invest in our key breakthroughs I mean, that's really the the game. So I think we feel pretty good about where we're at one year into the combination.

<unk>.

We will see what 24 looks like when we get there but.

Taken as a whole I think we feel pretty good about where we're at.

Okay very helpful color I will leave it there thanks.

And the next question comes from the line of Jeffrey Hammond with Keybanc capital markets. Your line is open.

Hey, good morning, everyone. Good morning, Jeff.

Hey, just maybe maybe in September.

Coming in below where maybe unpack that a little more and where youre seeing maybe some softness relative to what you thought.

Yes, I think.

I think when we look at it we look at it a number of different ways, Jeff, but I think if I had to distill it down.

It was probably more of the flow business.

Sort of the retrofit replace ordinary course break fixed stuff.

Specifically in the northwest and a little bit across new England, and I think when we look at that.

Aggregate was probably three to 5 million bucks less than maybe what we had targeted.

Heading into the quarter.

And obviously I think we had a view that.

We started to see resi deteriorate towards the end of last year, and we sort of had assumed that that would begin to inflect up a little bit it really hasnt inflicted up.

Maybe to the degree that we had we had thought given how sharply it fell last year, but I would say that I think taken as all none of these things are.

Falling knives by any stretch of imagination and the reality is when you look at our Q4.

We're seeing 6%.

Pro forma core organic growth, so maybe just a little bit less than what we were assuming but taken as a whole is still pretty good.

Okay, that's great color.

Just on the puts and takes on the profit side into.

24, I guess, you feel pretty good about the 25 incremental synergies I think you've got $10 million to $15 million absence of kind of higher cost inventory.

The other two.

<unk> or headwinds to think about as you think about that profit bridge, obviously outside of <unk>.

What the growth might be.

No I think that when you take a look at the overall model is highly variable. So we're capturing all the benefit of lower input costs.

We only have 2441 employee so from a wage inflation perspective, we're well insulated.

10 to 24 back to neutral.

I don't know if it's a big tailwind needed 24, I, just think that our our working capital.

You know, we'll we'll continue to be very efficient you know I think that.

Some of the costs save that that I highlighted in twenty-five comes with incremental benefit to working capital by collapsing the length of the overall supply chain. So you know I think will continue to be efficient users there.

But again, you know I think that.

You know from where lead times are where service levels are.

Where cost is where freight and transportation costs are I think we're really well positioned to turn in you know another really really strong cash flow year in 2004, and frankly sorta like we always do I mean, I think when you look over time, you know the cash flow you're in you're out sort of always shows up just primarily because of the business.

Operator: Good morning and welcome to the Zurn LK Water Solutions Corporation, 3rd quarter, 2023, earnings result conference call. With Todd Adams, Chairman and Chief Executive Officer, Mark Peterson, Senior Vice President and Chief Financial Officer, and Dave Pauli, Vice President of Investor Relations for Zurn LK Water Solutions. This call is being recorded and will be available for one week. The phone numbers for the replay can be found in the earnings release the company filed in an 8K with the SEC yesterday October 31st.

Yeah. So if there's one more one number we're not particularly concerned about is our ability to generate really really good free cash flow and whatever the environment.

Great I appreciate the color.

Yep.

Dave Pauli: At this time for opening remarks and introduction, I'll turn it over to Dave Pauli. Good morning everyone. Thanks for joining us on the call today.

And the next question comes from the line at Andrew around Gotcha Bank. Your line is open.

Hey, Thanks, Good morning, everyone Wonder I got started back to like all the new products I'm, sorry can you quantify at all maybe like how much of a tailwind you think that might be you know for 2024 or just in kind of a medium term and how that compares to the prior run right.

Dave Pauli: 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, well as in our filings with the SEC. In addition, some comparisons will refer to non-gap measures. Our earnings release and SEC filings contain additional information about these non-gap measures, why we use them and why we believe they're helpful to investors and contain reconciliation to the corresponding gap information.

And then if you're measuring other things like you know you got new product vitality index.

Yeah, I mean, I think the way to think about it Andrew is where.

We've gone out over the course of the last year and done a ton of work on understanding what are the unmet needs of our customers.

Dave Pauli: Consistent with prior quarters, we will speak to certain non-gap metrics as we feel they provide a better understanding of our operating results. These measures are not a substitute for gap and we encourage you to review the gap information in our earnings release and in our SEC filings.

An enormous.

Mount of voice of the customer and that's you know at a lot of levels you know whether that what what are the elementary schools looking for water was higher Ed looking for and and all of those cases, it's leading us to a lot of ideas that will only enhance the penetration rate.

Todd Adams: With that, I'll turn the call over to Todd Adams, Chairman and CEO of Zernelkay. Thanks Dave and good morning everyone. Thanks for taking the time to join us this morning. To jump right to it, we had a really strong Q3 operating performance. Margin's improved to 24.1% of 410 basis points over the prior year. We also delivered record-free cash for in the quarter of almost 100 million, bought back another 445,000 shares and increased our dividend 14%.

And an increase the points of us we hope.

So I don't know that we can quantify it exactly other than to say you know these these new product launches are gonna be really spot on from what the market is wanting you know it's a category that's really developed over the past 10 years, but I think the next the next.

Todd Adams: As we highlighted in our earnings release, one year into the Zernelkay combination, we're really hitting our stride in terms of the benefits from the transaction, both from its energy savings, as well as capturing the enormous secular growth opportunity we see in clean filtered drinking water. Over the next 12 months, we will be introducing more new products in the drinking water category than at any point since LK developed the category just over a decade ago.

Evolution of this is going to be very much targeted at <unk>.

[noise] what people have learned how the adoption of point of views and bottle fillers is really gotta be evolving based on the needs of what customers want. So I don't know that we were going to quantify for you I think it's embedded in this notion of having a very high share in a category that's grown.

Todd Adams: This is both on the filler side as well as the filtration side. And all this is happening as we see continued positive momentum on the legislative front as well as traction from the significant internal investments we've made to drive growth to grow the overall category. One year in, we've accelerated the growth rate of drinking water and now expect mid-teens organic growth for drinking water in 2023. In terms of the underlying market, while we grew in line with our Q3 guidance, we were expecting a little better internally after a pretty good start to July and August, which was offset by a so-so September.

And we're gonna continue to create opportunities for ourselves to to go with that installed base and when you do that obviously the filtration thumbs right behind it and and it's also things like you know improving the access and the ability to change filters and change filters more frequently.

So those are all things that are.

Part of the overall trajectory and growth that we see going forward.

Okay, Great and then my follow up just on the investments called out for the fourth quarter. Just can you give a little more detail on what those were I guess I can you confirm or are they confined to the fourth quarter and I'm like any benefits you expect from them.

Todd Adams: I'll dive into what we're seeing from a market perspective a little bit later, but as we look at how the years unfolded, it's not hard to see from all the external data, as well as our internal data, that the market has more uncertainty in it than any point in over the last year. What I'll also cover is we don't believe that this is some sort of apocalyptic issue for 24 and 25.

Yeah, I think when we looked at what we were going to invest in whether that's personnel channel. Some of the some of the marketing work some of the until it over the next year.

Mark Peterson: Now I'll turn it over to Mark. Thanks, Todd. Please turn to slide number four. Our third quarter sales were 390 million and on a pro-forma basis increased 100 basis points year-to-year. As we discussed during our last quarter, our year-to-year third quarter sales growth was impacted by the timing of orders and shipments in the prior year as we were working down an elevated backlog in the third quarter of 2022. Breaking down our pro-forma core sales growth percentage a bit, a mid-single digit increase in core sales growth through our non-residential end markets was partially offset by a mid-teens decline in sales growth through our non-residential end markets.

We just took a look at it and said well, let's pull Sullivan forward. You know, we we really are growing at the rate. We are in and believe we can continue to expand upon that let's pull out some of that into the fourth quarter. So that we get the benefits sooner. The order of magnitude is plus or minus 3 million Bucks.

So not crazy, but it's really more of a pull forward than it is anything else. So you know, we we would expect to.

Perhaps spend $3 million less next year, but over the 15 months you know roughly the same amount of money.

Mark Peterson: With respect to orders, our pro-forma orders increased high single digits year-to-year. Non-residential order growth was above the fleet average with balance growth across drinking water, low control, water safety, control, and hygienic environmental, while year-to-year order growth in our residential end market was below the fleet average.

Alright, thank you.

Yep.

And your next question comes from the line of my <unk>. Your line is open.

Okay. Good morning, everyone thinks for the time so a.

Mark Peterson: Turning to profitability, our third quarter adjusted EBITDA increased 15% in the prior year third quarter to 96 million and our adjusted EBITDA margin expanded 410 basis points year-to-year to 24.1% in the quarter. Looking at our margins sequentially, we set up 250 basis points in the second quarter of 2023, and as we have been discussing all year, the benefits of our price realization and our productivity initiatives inclusive of the cost energies that are little over 6 million each quarter in calendar year 2023 fully read through in the third quarter with the impact of the sell through of higher cost inventory completely behind us.

A couple of questions here first time, I'm <unk> I'm <unk>.

Create the context and the color there could you put in context, what the typical leg is for you.

It's on the institutional side on the commercial side versus those start numbers in other words, you know how far out does it take for your content to get in and when we look back historically, what what's the risk profile bins for cancellations I'm guessing not that high on the institutional side.

It'd be a little more variable on the commercial side, but any help would be great.

It's a it's a good question like I I I think when you think about you know what's embedded in an institutional start it's a it's a school. It's a university building, it's a hospitals health care facility and so the build cycle from.

Mark Peterson: 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 1.2 times inclusive of deploying 100 million of cash to repurchase common stock during the first nine months of 2023.

From start to finish Iraqi occupancy somewhere on average 12 to 18 months, maybe some you.

Mark Peterson: In early October, we paid down 60 million of our terminal and eliminating all future required principal payments, and generating approximately 4.5 million of annual interest expense savings going forward. Given the balance sheet position and our strong free cashless generation, we have good capital allocation optionality going forward.

Complicated hospitals or universities take a little bit longer, but I think 12 to 18 months is the right way to think about it.

And are content is spread almost randomly a third a third a third so what do you think about when you think about that we really participate over that 12 month bill cycle somewhat randomly. So if we're gonna spend it if it's $100 of content into that.

Todd Adams: Turn the call back to Todd. Thanks Mark, and I'm on page 6. Our ability to deliver tangible results that have an impact on the environment continues to compound as we execute our fundamental business strategy, which happens to have amazing symmetry with what our customers' goals are to do the right thing for the environment as well as human health and safety.

You know a third will come in the first three to four months a third will come in the second three to four months and the remainder will come towards the end so it's fairly <unk>.

Todd Adams: Benefits like 14 billion single-use plastic water bottles avoided to the use of our LK bottle fillers. This is up 8% over the past year, and we'll easily be up double digits next year, as well as 23 billion gallons of water-safe through our zern products like low flow foshits, fixtures, and sensors. The rating agencies around sustainability have also taken notice of the meaningful improvements, and it shows in their most recent ratings of our overall profile.

<unk> over the course of that that Bill the 12 to 18 months Bill cycle.

And then and then the cancellation risk pretty low right I mean, it's too yeah commercial alyssa yeah.

Yeah, I mean again when when you think about these things, particularly.

Education is a is a perfect example, you know that's that's usually some sort of referendum.

Todd Adams: Sustainability ranks zern LK sustainability program in the top 3% of our industry, and the top 7% of the more than 15,000 companies that they rank each year. With MSCI, we have a AA rating, which puts us in the top 10% of our industry, and lastly, S&P Global has rated us in the top 8% of our industry. When you step back from it, the one thing to take away from all of this is that our core, or in this case 84% of our total revenues, is that we really attack the climate risk of water scarcity. Whether that's low water consumption valves or providing point abuse filter drinking water, our products protect, conserve, and manage the water, we all depend on.

That you know virtually never.

Never gets games same as same same is true with health care health care facilities hospitals things in life. So you know I'd be lying to say that I can recall, a scenario where something like that has been <unk>.

Cancelled once once it's.

Work this way through the restart process.

Mmm is just so good cashflow, obviously strunk balance sheet.

How are you thinking about.

[noise] willingness to be more aggressive there he's got a large authorization on the buyback side.

Todd Adams: The world faces an array of climate and water-related crises, including flooding and drought events driven and exasperated by climate change, water pollution and its impact on biodiversity and human health and aging infrastructure that can contaminate water supplies. Our continued investment in engineering and R&D allows us to focus on addressing these crises which are central to sustainability and an essential part of how we drive our business forward. We're seeing serious momentum on the filtration side of our business as our installed base of filtered-enabled drinking water dispensers continues to grow as customers shift more and more to filtered solutions, combined with an increase in filter replacement rates as awareness around the dangers of lead and other harmful contaminants and drinking water continues to build, coupled with legislation and regulatory requirements that are beginning to be implemented.

What are your thoughts on moving in on that a little bit more as you look in the next year and then any thoughts on how you look at the M&A finals.

<unk> yeah.

Yeah, I mean Ah hit M&A first obviously, we continue to cultivate proprietary ideas.

We continue to think that we'll see some conversion over.

Over the course of the next 12 months.

And some things in categories that were.

We're very close to and as it relates to the buyback look I think you know.

We take a pretty for dramatic approach, we take a look at what we think the intrinsic value of.

Our projections are and look at where the stock prices you know and we'll be more aggressive if we think that there's any sort of dislocation.

You know that.

We want to take advantage of and and obviously, we have this cash flow and the confidence of the cash would do that as well as the balance sheet. So you know, we'll we'll see I think we've been.

Todd Adams: Not only are we seeing legislation pass and Michigan related to filter first, we're launching new products that continue to increase to increase the contaminants our filters are certified to reduce, ultimately protecting students, patients, and the overall public against ingesting more potentially harmful contaminants by providing continuous safe, clean drinking water with our filtration solutions. Today we're announcing the launch of our very first PFAS filter on the market that's integrated into bottle fillers and drinking water dispensers.

You know.

If you look at pattern recognition you know when when the stock was 21 to 22, you know we bought a lot when it was 29 or 30, we bought some but we've got a little bit less and so I think you know we we absolutely will continue to follow that.

That philosophy going forward.

Thank you I really appreciate the context.

[laughter].

And your next question comes from the line from Jones, what stifle your line is open.

Todd Adams: This filter will continue to do what our filters do today in filtering out lead and other contaminants, but now adds the two most prevalent PFAS contaminants to what it effectively filters. PFAS consumption has been linked to a number of serious health concerns which makes effective filtration from drinking water a big deal, and something we're excited about to be the first to market in offering our customers in the market. Our solution utilizes highly engineered activated carbon which absorbs these contaminants.

Good morning, everyone.

One of them to Nathan.

I'd like to talk a little bit more about the business model.

Todd Adams: This technology is the most water efficient solution in effectively filtering PFAS and is done in LK's proprietary footprint, which is the smallest footprint on the market. To give you some sense of how difficult it is to launch a filter like this, these filters have to reduce the PFAS chemicals down to a concentration that is 250 times less than with lead. We expect regulations will continue to evolve as the public learns more about PFAS, but by being first and providing effective and certified filtration against these two most prevalent PFAS chemicals.

And how that is likely to protect the margin I think the best that I, probably used to more heavy manufacturing companies and your business model is it different here with the design source.

Kind of <unk> could you talk about.

The potential for a downtown let's say revenue is down more than expected in 2024, what kind of variable margins, what kind of detrimental margins. We should expect on that just given that that business model is more flexible for ya.

Yeah I think.

So in terms of.

You know as you point out our model is highly variable.

From an employee standpoint, you know we have 2441 employees.

Todd Adams: We believe we've provided a great upgrade to schools, universities and even homes in our never-ending pursuit to provide the safest and cleanest drinking water for everyone. The LK filtration line of products is truly market leading with the longest lasting lead filler on the lead filter on the market, certified to 6000 gallons along with the most comprehensive contaminants claims on the market. The beauty of our filtration business is that we'll continue to compound well into the future as we continue to build the installed base while capturing an increasing level of replacement.

Which is about I think $625000 per employee plus or minus.

So very productive and efficient you know we go to market through third party reps that are 100 per cent Commission based so to the degree you know we see.

Sales decline.

The the flex on our selling expenses perfect Hum and obviously you know I think when we when we see you know capacity requirements on the growth side, we're not spending a penny on capital and the same is true on the downside, we're not having to flex out a whole bunch of fixed costs. So I think by <unk>.

Todd Adams: I'll move on to page 8. There's been a lot of discussion throughout the year related to the non-residential construction market and its imminent demise. I'm joking a bit, but I think it's important to understand a little bit of how we look at it in total beyond the headline numbers.

<unk> you know the the the agility that we've created and cultivated in the business model.

Todd Adams: On this chart on the upper left is actual and projected institutional starts on a square footage base. The low is the same for commercial starts. A couple things to point out. Roughly 50% of our total business is leveraged to the institutional end markets and verticals, specifically education and healthcare. Generally, institutional starts average somewhere in the neighborhood of 80 to 90 million square feet per quarter over the past five years. Another thing to point out is that generally speaking, this segment hasn't been particularly interest rate sensitive, at least historically.

As bill for a little bit of uncertainty on the upside and the downside.

[noise] are detrimental margins and again they'll depend on the product category.

You know will will be very let's.

Let's just say efficient on.

On the downside, we obviously have high margins you know so that that that's not.

That's not something that you know.

We can avoid [laughter], but you know I think it'll be very efficient in.

In this scenario, where we see.

Todd Adams: What's been grabbing a lot of the headlines in the commercial part of non residential construction, which by order of magnitude from a square footage perspective is three to four times bigger than institutional, but represents only about 30% of our business. What's happening here is the massive build out of warehouse space and some automotive expansions is creating large down drafts in the overall actual and projected starts on a square footage basis throughout 2023 and into 2024.

Declines.

And that's.

Without question.

Yeah, I think that's important point to <unk> and then I'd like to follow up on the comment you made about supply chain savings of up to $10 million into 2025.

There's some <unk> moved to Mexico, some reassuring a supply trying if you could provide some color on on what you're looking at doing there and how those the savings or to be generated.

Todd Adams: As an aside, our best estimate is that warehouse represents less than 5% of our overall sales, meaning we've not really benefited much from that massive build up, nor will it be devastating if it's down a bunch. Again, not the greatest of news, but the downside is capped, and we have plenty of areas to find growth.

Yeah, I mean, we've been working at it now for probably six to nine months and we are in a position today to see the benefit you know in excess of $10 million from a run rate perspective, beginning in twenty-five that's a combination of some incremental level of outsourcing in categories that we.

Todd Adams: On the upper right is the average non residential backlog, not no residential construction backlog, for only the commercial and institutional end markets. This excludes infrastructure, which can skew the backlog significantly. And as you see, the backlog for commercial and institutional has been relatively steady in terms of months at about nine. And below is the Dodge Momentum index, which is a monthly measure in dollars of the initial report of non residential building projects and planning and as a leading indicator for construction spending approximately one year out.

We currently are more vertically integrated in.

As well as some repositioning of certain suppliers two regions that.

Perhaps are a little bit closer from a lead time perspective, as well as favorable from a terrorist perspective. So those are you know I think relatively large digital things that we see.

Then again just go into building more resilience into you know our business model. So those are things that you know we are well underway on there's a chance we get some of it at the end of 2004, but I think the way to think about it as you know, we've got $25 million synergies rolling through and.

Todd Adams: The reason to take everyone through this is to highlight there are a ton of facets to understand the underlying non residential construction market in the U.S. On top of this, we also have access to and leverage internal bid and buy quote information across our own portfolio, as well as some of our large wholesale partners.

2024, and we've got an incremental 10, plus coming from this supply chain activity in 2025.

Todd Adams: Finally, I think is incredibly important to understand how hyper local it is. What's happening or not happening in the Bay Area can be totally different than what's happening in the Carolinas, particularly when the build cycle typically spreads over the course of 12 to 18 months. Lastly, it's important to recognize that new construction represents about 55% of our overall business with 45% happening outside of what we see on this page in the somewhat orderly retrofit replacement and break fixed market. The vast majority of questions we've got over the course of the year have been about the market, our exposures and what it means to growth going forward.

Great. Thanks for taking my questions.

Yep.

And your next question comes from the line of January came with Goldman Sachs. Your line is open.

Thanks for the money and run.

Mourning mourning.

Can we maybe just touch on the the ski rationalization for a second so it looks like it's gonna be about three to four point impact in the fourth quarter, you kind of think about 2024, what what's kind of the right framework for that.

<unk>, you know impacting potentially organic growth and.

Todd Adams: We're not trying to guide for 2024 at this point, but we wanted to provide a little bit more context as we all sort through how to think about the economy and where it's at it.

In 2024.

Yeah, Joseph Mark you know I think the the impact and next year will be modest you said three to four this quarter next year isn't that night at 12 million dollar range next year. So think about it is you know sort of a quarter of it hitting this year and three quarters of an extra yourself you know overall about under under a point of growth and back next year.

Todd Adams: Before I turn it over to Mark, I'll make just a few quick points on page nine. Taking into account everything I just talked about, here's a look at our 10 year core growth profile at 6% compounded. I'll also point out that over the course of the last 51 quarters, that's 12 years and three quarters, we've only had four negative core growth quarters with the largest coming in June of 2020, which was down 5%.

Okay, Alright, great. Thank you and then I can just my quick follow up question. So clearly it seems like the water business. It is been growing at a at a nice clip for you I think you guys are you sound pretty happy regarding the date the al Qaeda Grayson at this point I guess can you kind of help level set for L. K, what's what's the <unk>.

Todd Adams: With all the bumps in the road and challenges over the past 10 years, hopefully you can see how the mosaic of the realities of the end market dynamics I went through on the prior slide. Couple with our historical growth algorithm of market plus price plus share translate into a more resilient scenario than meets the eye and this back tested against our results that you see, here. That doesn't mean the scenario we face today with interest rates and the types of uncertainties that are out there are exactly the same as any point in the last ten years.

Todd Adams: But what also is different is that our growth algorithm now includes market, price, share and category growth in drinking water and filtration, which is something we saw in LK and it's why we've attacked the opportunity so aggressively over the past year.

Yeah, what's kind of the revenue baseline exiting 2023, and then hire you guys kind of thinking about again kind of the growth framework for L. K 2024.

Yeah, I mean, we're obviously well past the the point of being able to or frankly wanting to discreetly identify what was OK what was legacies earn in part because we've already done a ton of integration, particularly around the commercials sink.

Business going forward, but suffice it to say that.

The margins of the L.

Todd Adams: Last couple of points for me are on ZEBS and our fundamental business model. From a business perspective, we're in a terrific place. We see a clear path to profit and margin expansion in an uncertain environment with the incremental 25 million of synergies will be delivering throughout 2024.

Okay piece on a standalone basis or at or above.

That fleet average today on the backs of highly profitable drinking water business and.

Todd Adams: The momentum around filtered drinking water breakthroughs will only gain momentum over the next 12 months and it provides an idiosyncratic growth driver that is new to us and still very early in its runway. Our business system and relentless focus on simplification and continuous improvement give us a ton of confidence that we can continue to create margins and cash flow to invest back into growth.

And which is a.

Massive change from the roughly 13 per cent business that it was in 21. So when you think about you know and and essentially 12 months.

Of owning the business you know we've taken a business that was running somewhere in the 13 per cent range on a on a true organic basis and turned it into something that's 24 plus with.

Todd Adams: And finally, we've cultivated and created a business model built to the agile. With a highly variable cost structure, low cap X, the generates consistently high free cash flow year in and year out. That coupled with the great balance, it gives us considerable optionality to drive shareholder value over the coming years.

I would say, an even better growth profile as a result of the exits and the investments we've made a drinking water and the benefit of all the synergy work that we've been doing so.

You know I I don't think it shouldn't be lost that anybody that you know the.

Mark Peterson: And with that, I'll turn it back to Mark. Thanks, Todd.

Mark Peterson: Please start a slide number 10. I'll cover the highlights of our outlook for the fourth quarter. The fourth quarter of 2023, we're projecting sales to be around $351 million, which gets you to the end point of our initial outlook for the year at 1.525 billion. We anticipate our dose of EBIT margin to be in the range of 23 to 23.5 percent for the quarter, which translates to approximately $336 million to $338 million for the year. So, with respect to free cash flow, we're increasing our full year outlook to approximate $230 million and the $215 million we highlighted 90 days ago.

The acquisition at the time or the merger at the time.

You know was was good but it's for environments like this when you have the drinking water franchise that we have and the opportunity for secular growth in category growth.

That's going to protect the overall top line in a way that I don't think people fully realize at this point and that's why we've been so aggressive in getting out of the things that we don't want to invest in investing in things that can grow this category and grow our business in a in a in a meaningful way over time so.

Mark Peterson: A few highlights of the lid to our outlook. First, our fourth quarter outlook reflects our best cut at the market based on what we saw later in the third quarter and into October, as well as the traditional seasonal decline in sales in the fourth quarter, and fewer shipping days in the fourth quarter compared to the third quarter. Next, we recently completed a product line review with a residential sting customer. After extensive negotiations, the level of profitability was not going to be acceptable to us.

Didn't answer your question, specifically, but I think we feel really good about it.

Okay. No. That's that's super helpful. If you don't mind I'm Gonna try to sneak one worried here just just you know in this in the context of what can be a bit of a slower growth environment.

Mark Peterson: So, we decided to phase out our supply of certain residential things to this customer. As a result, our fourth quarter sales would be impacted by approximately $3 to $4 million with really no impact on our earnings. Finally, given the momentum we have with our filter drinking water growth initiative, coupled with the launch of our new PFAS filter and the recent passing of the Michigan filter first legislation, which requires all K-12 schools and child care facilities in Michigan to provide filter drinking water to students. We have accelerated a few million dollars of drinking water growth investments into our fourth quarter.

One of the questions, we get a lot.

And you know potentially negative volume environment like what what is pricing do for your business next year, given given what you already know you know and where you.

Raw material costs are today would you expect to get some pricing in 2024.

You know I think that there are opportunities that we will see some price.

Particularly we have strong specifications, leading shares innovation, new products and things like that I.

I don't know if there'll be a ton there'll be some.

Mark Peterson: Before we open the call for questions, just to remind that we have included on page 10, our fourth quarter outlook assumptions for sales growth for a non-residential and residential product categories, interest expense, non-cast.comization expense, depreciation and memorization, adjusted tax rate, and deluded shares outstanding.

And I don't see a scenario, where we are giving back price I I think that you know when you look at the overall increases that we.

We passed along overtime they were relatively small in the Grand scheme of things and you know so if anything our pricing you know.

Operator: We'll now open the call up for questions. And if you would like to ask a question, press star then the number one on your telephone keypad.

From a market standpoint is is in a good place. We obviously have leadership positions in high specifications and some unique value props that are gonna allow us to take some modest price.

Bryan Blair: Our first question comes from the line of Brian Blair with Openheimer, your line is open. Thank you, good morning, I guess. Hey Brian, we're in Brian. It's encouraging to hear about the mid-teens core growth and drinking water for the year. As we looked at 24 and the less certain market environment overall, is there anything you're seeing that would prevent continued growth there? And given the growth that you have achieved this year, I assume momentum into next year.

But I don't see a scenario, where we're giving back price. So you know I think it's.

It's a unique environment [laughter] for sure.

But I think we feel good about where we are with some incremental opportunity into 2020.

Got it thank you.

There are no further questions at this time, both poly I'll turn the call back over to you.

Thanks to everyone for joining us on the call of the day. We appreciate your interest in his earn L. K and look forward to providing our next update when we announce our fourth quarter results in early February have a good day.

Bryan Blair: More favorable cost position. What does the run rate margin for drinking water and as we look forward and include the ramp of filtration sales, which I assume will be margin accreted in time? Where should that margin profile be over the coming months? Yeah, to sort of take the piece by piece, I don't think that there is anything that we see that would arrest or slow down the growth in drinking water. In fact, I think that all the work we've done in the investments we're making give us high confidence that we can continue to grow at a very high clip in drinking water next year.

And this concludes today's conference call you may now disconnect.

[music].

Bryan Blair: Obviously, the algorithm around more units, higher attachment rate, that's all beneficial and compounds over time, Brian. So that is one that we feel really good about. As it relates to the margins, obviously above the fleet average, we're not going to decipher exactly what that is, but above the fleet average. And I don't think that we see any challenge or risk to that either. So I think we feel really good about the last 12 months.

Bryan Blair: As I mentioned, we've got a pipeline of new products over the next 12 months that is going to dwarf anything that we've ever done from an introduction standpoint. So that's where we've spent the last year, and I think it's reading out in the first year nicely, and I think that we have all strong momentum netting into 24 and beyond. That's helpful. Thank you.

Bryan Blair: And you walked through your portfolio of exposures and the resilience you've had historically. You know, confidence looking forward.

Bryan Blair: I was hoping that you could offer a little more detail, some finer points on, you know, how your team is thinking about the puts and takes is institutional versus non-commercial on-res exposures, residue positioning, price cost, fall on synergies. As we think about 2024 and the prospects for our next round. Yeah. I mean, you know, we've highlighted, I think, a compelling case around the drinking water growth for next year at very high margins.

Bryan Blair: We have 25 million of synergies that we'll read through. You know, I think in terms of commercial, I think it's clear to us that it's going to be down a little bit. We don't think that it's huge, but it'll be down. You know, that's on the new construction side. Breakfix, we think is, you know, sort of plus or minus a little bit. Because a lot of that is actually planned retrofit replace and or just simply breakfix, and then, you know, I'm guessing, you know, we probably thought that Resi was going to inflict a little bit earlier this year than it has.

Bryan Blair: It's not getting worse, but it hasn't improved a whole lot. So I think we probably transition to flatish into next year. And then, you know, we'll see around water works, which is only seven or eight percent. But, you know, I think there is a path to growth for sure. And a path for significant margin expansion. Again, as we look at, as we look at, we've got 24, but, you know, I think as we look at the market, you know, September, while still growing was less than what we thought, October, you know, it's probably a bit ahead of what we baked into our quarter.

Bryan Blair: But I think there's room for some uncertainty as you head into November and December and January. So I think we're trying to be cautious with the way we're providing, you know, the outlook. But I think the profitability. And the cash flows are going to be exceptional. And I think the resilience of the portfolio has proven itself over time. And we just have to continue to invest in our key breakthroughs. I mean, that's really the game.

Bryan Blair: So I think we feel pretty good about where we're at one year into the combination. And we'll see what 24 looks like when we get there. But, you know, taking as a whole, I think we feel pretty good about where we're at. Again, very helpful color.

Bryan Blair: I will leave it there. Thanks.

Jeffrey Hammond: And the next question comes from the line of Jeffrey Hammond with key bank capital market. Your line is open.

Jeffrey Hammond: Good morning, everyone. Good morning, Jeff. He just done maybe maybe on September, you know, coming in below where, you know, maybe unpack that a little more and where you're seeing maybe some softness relative to what you thought. Yeah, I think, you know, I think we look at it, we look at it, you know, a number of different ways, Jeff. But I think if I had to distill it down, it was probably more of the flow business, you know, sort of the retrofit replace ordinary course break thick stuff.

Jeffrey Hammond: Specifically in the northwest and a little bit across New England. And I think when we look at that, you know, in aggregate was probably, you know, three to five million bucks less than maybe what we had targeted. You know, heading into the court. And obviously, you know, I think we had a view that we started to see resi deteriorate, you know, towards the end of last year. And we sort of had to assume that, you know, that would begin to inflect up a little bit.

Jeffrey Hammond: It really hasn't inflected up. Maybe to the degree that we had we had thought given how sharply it fell last year. But I would say that, you know, I think taken as old none of these things are falling knives by any stretchy imagination. And the reality is when you look at our Q4, you know, we're seeing 6% pro form of core organic growth. So maybe just a little bit less than what we were assuming, but taken as a whole. That's still pretty good.

Jeffrey Hammond: Okay, that's a good color. Just on the puts and takes on the profit side into, you know, 24, I guess you feel pretty good about the 25 incremental synergies. I think he got 10 to 15 million absence of kind of higher cost inventory. Any, you know, other, you know, tailwinds or headwinds to think about as you think about that profit bridge, you know, obviously outside of what the growth might be. No, I think that, you know, we can take a look at the overall model.

Jeffrey Hammond: It's highly variable. So we're capturing all the benefit of lower input costs. We only have 2004 and 41 employees. So from a wage inflation perspective, we're well insulated. And so, you know, I think that we're in a great place. We'll capture, you know, any sort of deflation. We think that there is some modest price opportunities in certain categories, specifically in and around drinking water. And so no big, big moving parts in 24 as it relates to our cost structure.

Jeffrey Hammond: I think that one that, you know, is emerging is, you know, we see some significant supply chain opportunities that will be working on over the course of 24 that are probably worth, you know, in excess of 10 million dollars into 25. So I think that, you know, we've got a, we've got a good path for margin expansion in 24. And we've got some follow on that, you know, gives us a little more tailwind into 25. So nothing, nothing unusual in terms of tailwinds or headwinds beyond what we've talked about.

Jeffrey Hammond: OK, last one, you know, cash was great. You know, I know it was supply chain kind of working capital was a big, you know, use, you know, kind of through that, you know, supply chain tightness and it seems to be coming back in balance. But I'm just wondering kind of where you think working capital is in terms of, you know, quote, normal and whether you see that as, you know, another big tailwind into 24.

Jeffrey Hammond: I don't know that it's a big tailwind into 24. I just think that our working capital, you know, will continue to be very efficient. You know, I think that some of the costs saved that I highlight in 25 comes with incremental benefit to working capital by collapsing, you know, the length of the overall supply chain. So, you know, I think we'll continue to be efficient users there. But again, you know, I think that, you know, from where lead times are, where service levels are, where costs is, where freight and transportation costs are, I think we're really well positioned to turn in, you know, another really, really strong cash flow year in 24.

Jeffrey Hammond: And frankly, sort of like we always do. I mean, I think when you look over time, you know, the cash flow year in, year out, sort of always shows up just primarily because of the business model we have. So, if there's one number, we're not particularly concerned about its our ability to generate really, really good pre cash flow in whatever.

Jeffrey Hammond: Thank you so much for the environment. Great. Appreciate the color. Thanks, Tom.

Andrew Aryl: And the next question comes from the line of Andrew Aryl with Dojay Bank. Your line is open. Hey, thanks.

Andrew Aryl: Good morning, everyone. I got sort of back to all the new products. I was like, can you quantify it all? Maybe like how much of a tailwind you think that might be for 2024? Or just in, you know, kind of a medium term and how that compares, you know, to the prior run rate. And then if you're measuring it with things like, you know, you know, new product mentality index. Yeah, I mean, I think the way to think about it, Andrew is we're, you know, we've gone out over the course of the last year and done a ton of work on understanding, you know, what are the unmet needs of our customers.

Andrew Aryl: You know, and done an enormous amount of voice of the customer. And that's, you know, at a lot of levels, you know, whether what are elementary schools looking for what are what's higher ed looking for. And in all those cases, you know, it's leading us to, you know, a lot of ideas that will only enhance the penetration rate. And increase, you know, the points of use we hope. And so I don't know that we can quantify it exactly other than to say, you know, these, these new product launches are going to be really spot on from what the market is wanting.

Andrew Aryl: You know, it's a category that's really developed over the past 10 years. But I think the next, the next evolution of this is going to be very much targeted at, you know, what people have learned how the adoption of point of use and bottle fillers is really going to be evolving based on the needs of what customers want. So I don't know that we're going to quantify it for you. I think it's embedded in this notion of having a very high share in a category that's growing and we're going to continue to create opportunities for ourselves to grow that installed base.

Andrew Aryl: And when you do that, obviously the filtration comes right behind it. And it's also things like, you know, improving the access and the ability to change filters and change filters more frequently. So those are all things that are part of the overall trajectory and growth that we see going forward.

Andrew Aryl: Okay, great. And then my follow up just on the investments called out for the fourth quarter just can give a little more detail on what those were. I just can you confirm are they confined to the fourth quarter and then again, you know, benefits you expect from them. Thanks. Yeah, I think when we looked at, you know, what we were going to invest in, whether that's personnel channel. Some of the some of the marketing work, some of the intel, you know, over the next year, we just took a look at it and said, well, let's pull some of it forward.

Andrew Aryl: You know, if we really are growing at the rate we are and believe we can continue to expand upon that, let's pull some of that into the fourth quarter so that we get the benefits sooner. The order of magnitude is, you know, plus or minus 3 million bucks. So not crazy. But it's really more of a pull forward than it is anything else. So, you know, we would expect to. You know, perhaps spend 3 million less next year, but over the 15 months, you know, roughly the same amount of money.

Andrew Aryl: All right. Thank you.

Mike Halloran: Yeah. And your next question comes from the line of Mike Halloran with Baird. Your line is open. Hey, morning, everyone. Thanks for the time. So a couple questions here. First time on side eight. I really appreciate the context and the color there.

Mike Halloran: Could you put in context, what the typical leg is for you, both on the institutional side and the commercial side versus those start numbers and others, you know, how far out of the take for your content to get in. And when you look back historically, what's the risk profile been for cancellation? I'm guessing not that high on the institutional side. Maybe a little more variable on the commercial side, but any help would be great.

Mike Halloran: It's a good question. Mike, I think when you think about, you know, what's embedded in an institutional start. It's a school. It's a university building. It's a hospital. It's a healthcare facility. And so the build cycle from start to finish or occupancy is somewhere on average 12 to 18 months, right? Maybe some, you know, complicated hospitals or universities take a little bit longer, but I think 12 to 18 months is the right way to think about it.

Mike Halloran: And our content is spread almost radically, a third and third. So when you think about, when you think about that, we really participate over that 12 month build cycle somewhat radically. So if we're going to spend, if it's $100 of content into that, you know, a third will come in the first three to four months, a third will come in the second three to four months. And the remainder will come towards the end. So it's fairly radical over the course of that that build that 12 to 18 month build cycle. And then the cancellation risk pretty low, right?

Mike Halloran: I need to do commercial. Yeah, I mean, again, when, when you think about these things, you know, particularly in education is a perfect example, you know, that's that's usually some sort of referendum that, you know, virtually never, never gets kids. Same is same, same is true with, with healthcare, health facilities, hospitals, things that alike. So, you know, I'd be lying to say that I can recall a scenario where something like that has been, you know, canceled once, once it's sort of worked this way through the start process. You know, it's just that good cash flow, obviously, strong balance sheet.

Mike Halloran: How are you thinking about, you know, willingness to be more aggressive there? You've got a large authorization to buy back side. What are your thoughts on leading in on that a little bit more is looking in next year and then any thoughts on how you look at the M&A funnel and how actionable it is. Yeah, I mean, I'll hit M&A first, obviously, we're continuing to cultivate proprietary ideas. We continue to think that, you know, we'll see some conversion, you know, over the course of the next 12 months and some things and categories that we're, we're very close to.

Mike Halloran: And as it relates to buy back look, I think, you know, we take a pretty pragmatic approach, we take a look at what we think the intrinsic value of our projections are. And look at where the stock price is, you know, and we'll be more aggressive if we think that there's any sort of dislocation that, you know, that we want to take advantage of and obviously we have this cash flow and the confidence in the cash flow to do that as well as the balance sheet.

Mike Halloran: So, you know, what we'll see, I think we've been. You know, if you look at pattern recognition, you know, when the stock was 21 to 22, you know, we bought a lot. When it was 29 or 30, we bought some, but we bought a little bit less. And so I think, you know, we absolutely will continue to follow that, you know, that that philosophy going forward.

Mike Halloran: Thank you. Really appreciate the context.

Nathan Jones: And your next question comes from the line of Nathan Jones with Faithful. Your line is open.

Nathan Jones: Good morning, everyone. I'd like to tell a little bit more about the business model and how that's likely to protect the margins. I think most of us are probably used to more heavy manufacturing companies, and your business model is a fairly different view with the design source, kind of business model. So could you talk about, you know, in the potential for a downturn, let's say revenue is down more than expected in 2024.

Nathan Jones: What kind of variable margins, what kind of decremental margins we should expect on that, just given that that business model is more flexible for you. Yeah, I think so in terms of, you know, as you point out, our model is highly variable. From an employee standpoint, you know, we have 2,441 employees, which is about, I think, $625,000 per employee plus or minus. So very productive and efficient. You know, we go to market through third party reps that are 100% commission based.

Nathan Jones: So to the degree, you know, we see a sales decline, you know, the deflects on our selling expenses perfect. And obviously, you know, I think when we see, you know, capacity requirements on the growth side, we're not spending a penny on capital. And the same is true on the downside, we're not having to flex out a whole bunch of fixed costs. So I think by design, you know, the agility that we've created and cultivated in the business model, you know, is built for a little bit of uncertainty on the upside and the downside.

Nathan Jones: And so I think our decremental margins, and again, they'll depend on the product category. You know, we'll be very, let's just say efficient on the downside. We obviously have high margins, you know, so that's not something that, you know, we can avoid. But, you know, I think it'll be very efficient in the scenario where we see declines.

Nathan Jones: So that's with our question. Yeah, I think that's an important point to make.

Nathan Jones: And then I'd like to follow up on the comment you made about supply chain savings of up to $10 million into 2025. Maybe there's some move to Mexico, some reassuring supply chain if you could, you know, provide some color on what you're looking at doing there and how those, those savings are to be generated. Yeah, I mean, we've been working at it now for, you know, probably six to nine months and we're in a position today to see the benefit, you know, in excess of $10 million from a run rate perspective beginning in 25.

Nathan Jones: That's a combination of some incremental level of outsourcing and categories that we currently are more vertically integrated in as well as some repositioning of certain suppliers. To regions that, you know, perhaps are a little bit closer from a lead time perspective as well as favorable from a tariff perspective. So those are, you know, I think relatively large digital things that we see that again, just go into building, you know, more resilience into, you know, our business model.

Nathan Jones: So those are things that, you know, we are well underway on. There's a chance we get some of it at the end of 24, but I think the way to think about it is, you know, we've got 25 million of synergies rolling through in 2024. And we've got an incremental 10 plus coming from the supply chain activity in 2025.

Nathan Jones: Great. Thanks for taking my questions.

Joe Richie: And your next question comes from the line of Joe Richie with Goldman Sachs. Your line is open. Thanks.

Joe Richie: Good morning, everyone. Good morning. Can we maybe just touch on the ski rationalization for a second? So it looks like it's going to be about a three to four point impact in the fourth quarter. Is you kind of think about 2024? What's what's kind of the right framework for, you know, that piece, you know, impacting potentially organic growth in in 2024? Yeah, Joseph, Mark, you know, I think the impact in next year will be modest.

Joe Richie: We said three to four this quarter, you know, what next year? It's not $9 to $12 million range next year. So think about it as, you know, sort of a quarter of it hitting this year and three quarters of it next year. So, you know, overall about under, under a point of growth impact next year. Okay. All right. Great. Thank you. And then I get just my quick follow up question. So clearly, it seems like the water business is been growing at a nice clip for you.

Joe Richie: I think you guys are, you sound pretty happy regarding the, the LK integration at this point. I guess, can you kind of help level set for LK? What's the business, you know, what's kind of the revenue baseline, you know, exiting 2023. And then how are you guys kind of thinking about again, kind of the growth framework for LK in 2024? Yeah, I mean, we're obviously well past the, the point of being able, or frankly wanting to discreetly identify, you know, what was okay, what was legacy, ZERN in part because, you know, we've already done a ton of integration, particularly around the commercial sink business going forward.

Joe Richie: But suffice it to say that, you know, the margins of the LK piece on a standalone basis are at or above, you know, that fleet average today on the backs of, you know, a highly profitable drinking water business, and which is a, you know, a massive change from, you know, the roughly 13% business that it was in 21. So when you think about, you know, in essentially 12 months of owning the business, you know, we've taken a business that was running somewhere in the 13% range on a true organic basis and turned it into something that's 24 plus with, I would say an even better growth profile as a result of the exits and the investments we've made in drinking water and the benefit of all the centers you work that we've been doing.

Joe Richie: So, you know, I don't think it, I shouldn't be lost on anybody that, you know, the, the acquisition at the time or the merger at the time, you know, was, was good, but it's for environments like this when you have the drinking water franchise that we have and the opportunity for secular growth and category growth that's going to, that's going to protect, you know, the overall top line in a way that I don't think people fully realize at this point and that's why we've been so aggressive in getting out of the things that we don't want to invest in and investing in things that can grow this category and grow our business in a, in a meaningful way over time. So, didn't answer your questions specifically, but I think we feel really good about it.

Joe Richie: Okay, no, that's, that's super helpful. If you mind, I'm going to try to sneak one more in here, just, you know, in the context of what could be a bit of a slower growth environment, one of the questions we get a lot on, you know, potentially a negative volume environment, like, what, what is pricing do for your business next year, given, given what you already know. So, you know, and where, you know, the raw material costs are today, would you expect to get some pricing in 2024?

Joe Richie: You know, I think that there are opportunities that we will see some price, particularly we have strong specifications, leading shares, innovation, new products, things like that. I don't know that it'll be a ton, that it'll be some, and I don't see a scenario where we are giving back price. I think that, you know, when you look at the overall increases that, you know, we passed along over time, they were relatively small in the grand scheme of things.

Joe Richie: And, you know, so if anything, our pricing, you know, from a market standpoint is, is in a good place. We obviously have leadership positions and high specifications and some unique value props that are going to allow us to take some modest price, but I don't see a scenario where we're giving back price. So, you know, I think it's a, it's a unique environment for sure, but I think we feel good about where we are with some incremental opportunity in the 2024. Thank you. There are no further questions at this time.

Dave Pauli: Dave Polly, I'll turn the call back over to you. Thanks everyone for joining us on the call today. We appreciate your interest in ZERN LK and look forward to providing our next update when we announce our fourth quarter results in early February. Have a good day.

Operator: And this concludes today's conference call. You may now disconnect .