Zurn Elkay Water Solutions Corporation

Good morning, and welcome to the Zurn LK Water Solutions Corporation third quarter 2022 earnings results conference call with Todd Adams, Chairman and Chief Executive Officer, Mark Peterson, Senior Vice President and Chief Financial Officer, and Dave Pauley, 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 25th. At this time, for opening remarks and introduction, I'll turn the call over to Dave Pauley.

Good morning, everyone, and thanks for joining the call today. Before we begin, I would like to remind everyone that this call contains certain forward-looking statements that are subject to the Safe Harbor language contained in the press release that we issued yesterday afternoon as well as in our filings with the SEC. In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures, why we use them, and why we believe they are helpful to investors, and contain reconciliations to the corresponding GAAP information. Consistent with prior quarters, we will speak to certain non-GAAP metrics as we feel they provide a better understanding of our operating results. These measures are not a substitute for GAAP, and we encourage you to review the GAAP information in our earnings release and in our SEC filings. With that, I'll turn the call over to Todd Adams, Chairman and CEO of Zurn LK Water Solutions.

Thanks, Dave, and good morning, everyone, and really appreciate everyone taking the time on the call this morning. The earnings release that we issued last night contains some perspective on the approach we're taking with respect to the fourth quarter outlook, and we'll go through that in some detail in just a bit. We'll also spend time taking everyone through the significant progress we've made on the integration of Elkay over the first 90 days, and finally provide some color on how we're thinking about 2023. There are obviously a number of moving parts as we bring Elkay into the fold, but in the end, the view and perspective we'll be sharing this morning is essentially aligned with the view that we had from the beginning, which was to bring these two amazing businesses together, then streamline and simplify the businesses into two significant product categories that from a performance perspective were very Zurn-like. We've done the work, and the path is now clear, and we'll share what that looks like this morning. As it relates to the third quarter, our results were very much in line with our expectations heading into the quarter. Solid core growth, the first quarter of LK on track, and solid margins and free cash flow. Our leverage ended the quarter at 1.5 times, and we expect further reduction in December and in the year between 1.2 and 1.3 times. You'll see a chart on the right stacking our core growth for the past three years, inclusive of our fourth quarter guidance. And for 2022, this equates to 12% core growth for the year, which is in line with our expectations for the double-digit core growth we communicated and have reiterated throughout the year. Mark will provide some additional color and unpack the growth for both the third quarter as well as the outlook in just a few minutes. If you could move on to page four. The reality is that it's not even four months since we closed the LK transaction, but the amount of progress our team has made is significant. And in doing so, it really sets us up to start 2023 as a single integrated business. We'll be wrapping up our first integrated strategic plan over the next several weeks, which will fully embed all of the growth and synergy expectations into our normal business cadence, as opposed to developing a plan for Zurn plus a plan for LK. We start 2023 as one business, and we have one plan that we're executing. In the first 90 days, we've completed all of our planned third-party rep changes, which is a huge undertaking because we're asking independent business organizations to change or change significant portions of their agencies from competitive lines to the new Zurn LK, while learning new or different products, transacting and quoting in different systems, while harmonizing around a set of common commercial practices. Having that behind us 90 days in with the quality of the third party representation we now have is a huge thing and will create a lot of leverage as we head into 2023. The other significant change we made is with the organization. We already have a single sales organization across the entire business, a single marketing organization across the entire business, as well as organizations around supply chain and distribution. We've established general manager roles over drinking water and sinks with engineering and product management aligned with these categories. essentially mirroring the Zurn model to organize, align, and focus the business on profitable growth. Without question, the single most impactful thing we've done in the first four months is a rigorous deployment of 80-20. The thing to remember is that as a privately owned business, LK had its own rationale for doing things the way they did. Whether it was serving certain channels or customers or being in certain product lines or SKUs, it made sense for them at a point in time. As we came together, we went through a very detailed and much-needed fact-based 80-20 review to put ourselves in a position to evaluate where we wanted to focus and deploy resources to drive profitable growth and where we needed to do something different or simply not to do it at all. I'll go on to say that the details I'll share didn't end up differing all that much from our initial tops-down assessment, but getting the teams to engage with the data and the details and And then framing it all to allow us to understand all the downstream implications of our simple communication work took a little bit of time. Whether it was customer, employee, or supply chain related, we needed to make sure that we got it right so that we could make decisions and move forward with the conviction and confidence it takes to do 80-20 the right way, which is a relentless prioritization around profitable growth. The punchline on the integration is that it's quickly becoming a single core business as we head into 2023. which bodes well in terms of realizing the expected synergies, and even more importantly, being in a spot to leverage our unrivaled product portfolio and solutions to drive better long-term growth and profitability by only focusing on what's core to us. Please turn to page five. To ground everyone on this page, when we closed the transaction and announced Q2 earnings, we talked about okay for the full year of 2022, and again, this is for the full year, not the half that we'll end up consolidating it, having about $600 million of revenues and EBITDA margins in the 14% to 15% range. In our detailed work over the past 90 days, we went through each of the primary categories, specifically drinking water, commercial sinks, and residential sinks and accessories, customer by customer and SKU by SKU. We then had the internal debates, conversations with customers, and evaluation of our competitive position and long-term strategy. along with the detailed understanding of any collateral impact from our conclusions. What this page highlights is that basically inside this $600 million revenue business is a growing and profitable $485 million base business with real sustainable competitive advantages, and that as we execute our simplification and rationalization initiatives, it's actually more profitable at $485 million than it is at $600 million. And then there are synergies on top of this run rate. The core ZERN LK will be drinking water and commercial sinks. In both cases, we're the clear market leader with above-market growth and terrific margins. We'll be selective in where and how we play in residential, but it'll be niche areas where it supports our overall strategy. I want to be clear about the portions of the residential market that we are exiting and also what's left. The pieces we're exiting really have no strategic value in a ZERN LK context. None of it conveys anything or carries the LK brand or is sold through our current set of wholesalers and reps. It's made up of private label, white label, source sinks, and accessories of all different types of materials. And finally, products done for other OEMs sold through home centers. That makes no sense for us to continue to support. The slice of residential sinks we'll stay in, call it roughly 70 million, will be LK branded, sold through our existing channels, reps, and wholesalers, where we believe we do have strategic relationships and products. that when paired with our commercial lines make a ton of sense in the market. The other thing to highlight is this isn't going to all happen overnight. We've got some contractual obligations we have to fulfill. And we also want to maximize the value of the assets and inventory associated with the exit. But this is the core of what we're going to build around. And it's our best estimate that we can exit this level of business and start at this run rate sometime in the second quarter of 2023. It's also more clear that the drinking water and commercial sink product categories share the same characteristics and look like the core Zurn business from a growth, profitability, and returns point of view. If you turn to page six, I'll share a view of how we think the pro forma mix of the business looks after the rationalization. On the left, you'll see we're still aligned around the four highly profitable categories of specified water solutions that we have real competitive advantages and significant market shares in. On the right, we have a nice balance between new construction and retrofit replace with significant U.S. institutional and commercial construction exposure, with institutional and the sub-verticals of education and healthcare being our largest exposure. We have residential comprising only 15% of the pro forma revenues and leverage primarily to our PEX product offering, where we have a tightly focused strategy on our leverage to the material substitution trend in both residential and commercial. All in all, not wildly different than before, but we do think that by focusing 100% of our time on the strategic parts of our business will serve us well. When you look at this, over 95% of our revenues come from a number one or number two position. The reality is that being a number five or six in residential sinks, sold through home centers, or online isn't something that we built our business case around. I'll turn it over to Mark to walk through the third quarter and the fourth quarter outlook.