Zurn Elkay Water Solutions Corporation

Good morning and welcome to the Zurn LK Water Solutions Corporation fourth quarter 2022 earnings results conference call with Todd Adams, Chairman and Chief Executive Officer, Mark Peterson, Senior Vice President and Chief Financial Officer, and Deuce 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, February 7th. At this time, for opening remarks and introduction, I'll turn the call over to Dave Pauley.

Good morning, everyone, and thanks for joining us on the call today. Before we begin, I would like to remind everyone that this call contains certain forward-looking statements that are subject to the Safe Harbor language contained in the press release that we issued yesterday afternoon, as well as in our filings with the SEC. In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures, why we use them, and why we believe they are helpful to investors, and contain certain 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 Zern Alkay Water Solutions.

Thanks, Dave, and good morning, everyone. This is what we hope is a relatively straightforward call. We'll take everyone through what we saw in the fourth quarter, along with some even more recent trends. We'll also lay out what we believe next year could look like, which is broadly reflected in the current consensus. And then we'll get back to work and execute to maximize what we're actually holding ourselves accountable to. After a couple years of big transformative transactions to completely change our business to a premier pure play water business, this upcoming year is simply about executing on what's right in front of us, and we really like our hand. It's also not lost on us. The noise of the past few quarters is not what investors expect of us. I realize the only way to do something about it is to execute at a high level, and so that's what we're going to go do. There were a lot of facets to 2022. including some real challenges and some more perception-based. The good news is that over the past six months, we've acted quickly, got to the core of what the new Zurn LK is and can be, and the overall cadence at which we've operated historically is fully embedded across the new Zurn LK to start 2023, just six months after the close of the deal. The third-party rep changes, 80-20 simplification decisions, integration planning, supply chain constraints, and extended lead times are largely all behind us. And now it's about leveraging the Zurn LK business system to drive performance and build upon our competitive advantages. As Mark will discuss, the fourth quarter was impacted by some near-end macro issues, including a weaker residential market and some wholesale inventory destocking that is also now essentially behind us. In what's been a pretty eventful last three years, I think it's important to highlight the strength of the legacy Zurn business, which has grown the top line at a compounded annual growth rate of 14% since 2019. If you could turn to page four. We've just taken our board through our three-year strategic plan, and with that as a backdrop, we decided to take the opportunity to formalize a more comprehensive and balanced capital allocation strategy as we start 2023. It's grounded in the resilience of our business, strong balance sheet, and consistently high free cash profile cash flow profile we see over the next several years, and our commitment to delivering exceptional shareholder value. Our view of the intrinsic value of the company is materially higher than it sits today, and as a result, we're integrating a significant share repurchase plan into our near to medium term capital allocation strategy. Our current dividend yield of 28 cents on an annual basis represents a current dividend yield of about 1.3%. We're committed to continuing the dividend and we'll look to review any increases to that annually. Given the fact that we just increased the dividend in our third quarter, this is something we'll look at over the course of the year and then obviously moving forward. The $500 million buyback represents about 13% of our current market cap and is sized in concert with maintaining a leverage profile between one to two times, while also accommodating macro-driven risks in the economy over the next couple years. For 2023, the minimum repurchase will be $100 million. and it's something that will be both programmatic and opportunistic about. Finally, M&A has historically been important to us to fill in product categories and enhance our competitive advantages within our portfolio at the bolt-on tuck-in level. The LK transaction was transformational and provides us multiple levers to enhance our core growth over time while we continue to cultivate other opportunities. For this year, think of us as singularly focused on delivering the value we see and saw in the combination with LK. The punchline is we believe this formalized, comprehensive approach provides even more levers to drive shareholder value. And as you see in the release, we've already been executing on it across all fronts with 25 million of shares repurchased in the fourth quarter. I'll move on to page five. I touched on our strategic plan just a minute ago, which is our 15th plan since the original Zearn acquisition in 2007. What started as a carve-out diversification play for a private equity-owned multi-industry business and part of the prior Rexnord has now become our core business. And we've taken it a step further with the LK transaction last year. As we've developed the now Zearn LK business system, one of the significant pieces of learning and change over time has been the benefit of pure focus. And when I say focus, what I really mean is an 80-20 focus. In our opinion, spending time, effort, and resources on pieces of our business, whether it's products, customers, channels, where we don't see real strategic upside is pure waste, and it comes at the expense of what really matters. It's that learning that led us to make the decisions on portions of the LK residential sink business since closing. With that behind us, our teams have gone out and executed an integration plan that puts us in a position to deliver at least $50 million of synergies over 23 and 24 years. And that's before we capture the growth benefits of what the new Zurn LK can deliver. The second significant thing to point out in our strategic planning process is the concept of deploying breakthroughs. In this three-year plan, we're over-indexing our strategy deployment process around drinking water, actually safe drinking water, focused on K-12 students and schools, which we believe is worth hundreds of millions of dollars of growth moving forward as the states and legislation are now beginning to take meaningful action to solve the issue. The business model framework we leveraged over time has gone through some modifications, but the critical piece of leveraging ZEBS is unchanged. We start 2023 in a spot that places a premium on execution, and I can't thank our team enough for all their hard work this past year, and I know we're going to do great things in the coming years as we execute like we can. If you turn to page six, I'll spend just a minute on our drinking water strategy. The reality is, in this country, over half the population drink water from lead service lines. The most vulnerable are kids, with the impact felt not only in places that you've heard of, like Flint, but very, very likely in the schools where you live, your kids, your neighbors, nieces, nephews, or grandchildren go to school. With over 131,000 K through 12 schools in the US, over 13 million kids went to school last year with elevated lead levels. There is, however, a growing awareness in legislation that's beginning to take shape, and we're investing to make sure that we're the go-to solution to address this incredibly solvable problem. It starts with having a leading market share and largest installed base of point-of-use drinking water solutions in LK. And if you turn to page 7, the inherent competitive advantage we have as a starting point is so important. The competitive moat is large and growing and one that's been built by LK over time. Now it's time to take it to another level in our approach to not only grow the category, but ensuring that the follow-on filtration business model is locked in. The category has changed over time from drinking fountains to now bottle fillers. That was the initial evolution, largely a way to improve hygiene and eliminate plastic waste. We believe the next evolution will be ensuring safe drinking water in public and private spaces with the devices and ensuring that through filtration. By improving the attachment rate and continuing to grow the installed base, We're confident that filtration can be $100 million of high-margin recurring revenue in the coming years as we expand accessibility, provide subscriptions, and embed some proprietary technology to ensure that we're getting the replacement event. Finally, both the funding and awareness is there, whether it's ESSER funding, filter-first legislation, or simply parents, teachers, community members taking some accountability to solve what, again, is a very solvable problem. This will be our why. walking the talk not only on being recognized for being an ESG-compliant company, but to actually be an ESG company, which is a nice segue to page eight. To give everyone a sense of the progress we've made in bringing these two businesses together to truly operate as one beginning in 2023, we've already fully aligned Zurn LK under a comprehensive and uniform ESG strategy, and we'll issue our first combined report later this month. As a combined organization, we made solid progress in 22 and are firmly on track with the initial set of ESG targets we announced in our 2021 report. In fact, the combination did not require us to step back from our targets. Instead, we'll be announcing seven new ESG targets in our upcoming report that are aimed at improving supplier diversity, air emissions, waste, plastic bottle elimination, engineering, and research and development stats. These new targets provide additional transparency and accountability. For the first time, we're aligning our reporting framework with the Task Force on Climate-Related Financial Disclosure Framework to guide our climate-related risk strategy and targets. We've leveraged a ZERN-LK business system and applied our core values of continuous improvement to advance our sustainability efforts. We continue to reduce our greenhouse gas emissions by completing several electricity and and natural gas reduction projects in 2022. We also launched energy audits of key facilities, which will identify significant energy reduction opportunities in our 2024 target. And finally, on page nine, here you'll see just a few highlights and statistics of the progress we've made over the last several years. Our customers care about the sustainability of their buildings and retrofit products. That's why we will soon complete our first product lifecycle analysis to document end-to-end environmental impact of our LK stainless steel sinks with plans to do more. Creating LCAs alongside environmental product declarations gives our customers additional confidence that Zurn LK products will help them achieve their own sustainability goals and earn sustainability certifications like WELL 2.0 and LEED. We simply believe that doing the right thing and we're proud of our sustainability efforts continue to be recognized. For the third consecutive year, Newsweek has named Zurn LK one of America's most responsible companies. We're continuing to build on all the work we've done and including embedding ESG into our strategic planning process efforts and hope that you'll take a look at our report later this month. With that, I'll turn it over to Mark. Thanks, Todd.