Good morning. And welcome to the Zurn Elkay Water Solutions Corporation Third Quarter 2023, Earnings Results Conference Call. 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 Elkay 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 31. 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. Before we begin, I would like to remind everyone that this call contains certain forward-looking statements that are subject to the safe harbor language contained in the press release that we issued yesterday afternoon, as well as in our filings with the SEC. In addition, some comparisons will refer to non-GAAP measures. Our earnings release and SEC filings contain additional information about these non-GAAP measures why we use them and why we believe they're helpful to investors and contain reconciliations to the corresponding GAAP information. Consistent with prior quarters, we will speak to certain non-GAAP metrics as we feel they provide a better understanding of our operating results. These measures are not a substitute for GAAP and we encourage you to review the GAAP information in our earnings release in our SEC filings. With that I'll turn the call over to Todd Adams, Chairman and CEO of Zurn Elkay.

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, 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 445,000 shares and increased our dividend 14%. As we highlighted in our earnings release and one year into the Zurn Elkay 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 Elkay developed the category just over a decade ago. This is both on the filter 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, 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 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, Todd. Please turn to Slide number 4. Our third quarter sales were $398 million and on a proforma 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 because we were working on an elevated backlog in the third quarter of 2022. Breaking down our proforma core sales growth percentage a bit, our mid-single digit increase in core sales growth to a non-residential end markets was partially offset by a mid-teens decline in sales growth to a residential end market. With respect to orders, our proforma orders increased high single digits’ year-over-year, non-residential order growth was above the fleet average with balanced growth across drinking water, low 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% in 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 set 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 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. Please turn to Slide 5, 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. In early October, we paid down $60 million of our term loan 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 cash flow generation, we have good capital allocation optionality going forward. Turning 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 customer’s goals are to do the right thing for the environment, as well as human health and safety. Benefits like 14 billion single use plastic water bottles avoided through the use of our Elkay bottle fillers. Which is about 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 Zurn products like low flow faucets, 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. Sustainalytics ranks Zurn Elkay sustainability program in the top 3% of our industry and the top 7% of the more than 15,000 companies 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 of views filtered 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 climate change water pollution, and its impact on biodiversity and human health and aging infrastructure that can contaminate water…

Thanks, Todd. Please turn to Slide number 10, I'll cover the highlights of our outlook for the fourth quarter. The fourth quarter of 2023, we were projecting sales to be around $351 million, which gets you to the endpoint of our initial outlook for the year at $1.5 to $5 billion. We anticipate our adjusted EBITDA 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. For the effective free cash flow, we're increasing our full-year outlook to approximately $230 million and the $250 million we highlighted 90 days ago. A few highlights led to our outlook. First, our fourth quarter outlook reflects our best cut of 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 if you are shipping days in the fourth quarter compared to the third quarter. Next, we recently completed a product line review with a residential sync customer, after extensive negotiations, a level of profitability was not going to be acceptable to us. So we decided to phase out our supply ascertain whether it's the things 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 initiative, coupled with the launch of our new PFOS filter and the recent passing of the Michigan filter first legislation, which requires all K-12 schools and childcare facilities in Michigan to provide filtered drinking water to students. We have accelerated a few million dollars of drinking water growth investments into our fourth quarter. Before we open the call for questions, just a reminder that we have included on page 10, our fourth quarter outlook assumptions for sales growth for non-residential and residential product categories, interest expense, non-cash stock compensation expense, depreciation and amortization, adjusted tax rate and diluted shares outstanding. We’ll now open the call up for questions.

[Operator Instructions] Our first question comes from the line of Bryan Blair, with Oppenheimer. Your line is open.

Thank you. Good morning, guys. It's encouraging to hear about the mid-teens core growth in drinking water for the year. As we look to '24 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, more favorable cost position? What is the run rate margin for drinking water? And as we look forward and include the ramp of filtration sales, which I assume will be marked and created in time, where should that margin profile be over the coming years?

Yes, I mean, to, to sort of take it piece by piece. I don't think that there is anything that we see that would rest or slowdown the growth in drinking water. In fact, you know, I think that, all the work we've done and the investments we're making, give us I think high confidence that we can continue to grow at a very high clip in drinking water next year. Obviously, the algorithm around more units, higher attachment rate, that's all beneficial and compounds over time, Bryan, 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 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 a strong momentum heading into '24 and beyond.

That's helpful. Thank you. I mean you walked through your portfolio exposures and the resilience you've had historically, confidence looking forward. I was hoping you could offer a little more detail some finer points on, how your team is thinking about the puts and takes of new institutional versus commercial non res exposures ready positioning price cost, follow-on synergies. As we think about 2024, in the prospects for earnings growth?

Yes, I mean, we've highlighted, I think, a 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's going to be down a little bit, we don't think that it's huge, but it'll be down. That's on the new construction, side. Break fix, we think is sort of plus or minus a little bit, because a lot of that is actually planned retrofit, replace, and or just simply break fix. And then, I'm guessing, we probably thought that resi was going to inflect, a little bit earlier this year than it has, it's not getting worse, but it hasn't improved a whole lot. So I think we probably transition to flattish into next year. And then we'll see around waterworks, which is only 7% or 8%. But, I think there is a path to growth for sure, and a path for significant margin expansion, again, as we look at '24. But, I think, 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's room for some uncertainty as you head into November, in 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 has proven itself over time. And we just have to continue to invest in our key breakthroughs. I mean, that's really the game. 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 taken as a whole, I think we feel pretty good about where we're at.

Very helpful color. I will leave it there, guys. Thanks.

And the next question comes from the line of Jeffrey Hammond, with KeyBanc Capital Market, your line is open.

Good morning, everyone. Just maybe on September, coming in below where maybe unpack that a little more, and where you're seeing maybe some softness relative to what you thought?

Yes, I think we look at it in 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, brake fix stuff, specifically in the Northwest, and a little bit across New England. And I think when we look at that, in aggregate it was probably $3 million 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 to assume that would begin to inflect up a little bit. It really hasn't inflected up maybe to the degree that that we had we had thought given how sharply it fell last year. But I would say that, I think taken as a whole none of these things are falling knives by any stretch of the 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 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 got 10 to 15 million absences, kind of higher cost inventory. Other tailwinds or headwinds to think about as you think about that profit bridge, obviously, outside of what the growth might be?

I think that, if you take a look at the overall model its 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 are well insulated. And so I think that we're in a great place, we'll capture 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 moving parts in '24 as it relates to our cost structure. I think that one that is emerging is, we see some significant supply chain opportunities that we'll be working on over the course of '24 that are probably worth in excess of $10 million into '25. So I think that we've got a good path for margin expansion in '24. And we've got some follow on that gives us a little more tailwind into '25. So, nothing unusual in terms of tailwinds or headwinds beyond what we've talked about.

Okay, last one, cash flow has been great. I know, it was supply chain kind of working capital was a big use, it's kind of through that 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 quote normal, and whether you see that as another big tailwind into '24 back to neutral.

I don't know that it's a big tailwind into '24, I just think that our working capital will continue to be very efficient. I think that some of the costs save that I highlight in '25 comes with incremental benefits of working capital, by collapsing the length of the overall supply chain. So, I think we'll continue to be efficient users there. But again, I think that 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 another really, really strong cash flow year in '24. And, frankly, sort of like we always do. I mean, I think when you look over time, the cash flow year in year out sort of always shows up, just primarily because of the business model we have. So, there's one number we're not particularly concerned about is our ability to generate really, really good free cash flow in whatever the environment.

Great, appreciate the color. Thanks, Todd.

And the next question comes from the line of Andrew Krill, with Deutsche Bank, your line is open.

Hey, thanks. Good morning, everyone. Wonder, I circle back to like all the new products. I just like, can you quantify it all maybe like how much of a tailwind you think that might be for 2024? Or just in kind of a medium term and how that compares to the prior run rate? And then if you're measuring it with things like your new product vitality index?

Yes, I mean, I think the way to think about it, Andrew, is we're -- 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, and done an enormous amount of voice of the customer. And that's, at a lot of levels, what our elementary schools looking forward, or what's higher Ed looking for. And in all those cases, it's leading us to a lot of ideas that will only enhance the penetration rate and increase the points of use, we hope. And so I don't know that we can quantify it exactly other than to say, these new product launches are going to be really spot on from what the market is wanting. It's a category that's really developed over the past 10 years. But I think the next evolution of this is going to be very much targeted at, what people have learned, how the adoption of point of views, 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 for you, I think it's embedded in this notion of having a very high share, and a category that's growing and we're going to continue to create opportunities for ourselves to grow that installed base. And when you do that, obviously, the filtration comes right behind it. And it's also things like, 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, just can you like confirm are they confined to the fourth quarter? And then like any benefits you'd expect from them? Thanks.

Yes, I think when you looked at what we were going to invest in, whether that's personnel channel, some of the marketing work, some of the Intel over the next year, we just took a look at it and said, well, let's pull some of it forward. 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 benefit 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, we would expect to perhaps spend 3 million less next year, but over the 15 months, roughly the same amount of money.

Alright, thank you.

And your next question comes from the line of Mike Halloran, with Baird, your line is open.

Good morning, everyone. Thanks for the time. So, couple of questions here. First time on slide 8, I really appreciate the context and the color there. Could you put in context, what the typical lag is for you, both on the institutional side and the commercial side versus those start numbers? In other words, how far out does it take for your content to get in? And then you look back historically, what's the risk profile been for cancellations? I'm guessing not that high on the institutional side and maybe a little more vulnerable on the commercial side. But any help would be great.

It's a good question, Mike. I think when you think about what's embedded in an institutional start, it's a school, it's a university building, it's a hospital, it's a health care facility. And so the build cycle, from start to finish, your occupancy is somewhere on average, 12 to 18 months. Maybe some 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 our content is spread almost randomly, a third, a third, a third. So when you think about that, we really participate over that 12-month build cycle somewhat ratably. So if we're going to spend -- if it's $100 of content, into that, 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 ratable over the course of that build that 12 to 18-month build cycle.

And then the cancellation risk, pretty low, right? I mean the institution [multiple speakers] less so.

Yes. I mean, again, when you think about these things, particularly in education is a perfect example. That's usually some sort of referendum that virtually never, never gets gains. Same as whoop, same is true with healthcare, healthcare, facilities, hospitals, things in the like. So, I'd be lying to say that I can recall a scenario where something like that has been canceled once, once it's sort of worked its way through the restart process.

As Jeff said, good cash flow, obviously, strong balance sheet. How are you thinking about, willingness to be more aggressive there, you've got a large authorization on the buyback side. What are your thoughts on leaning in on that a little bit more resulting in next year? And then any thoughts on how you look at the M&A funnel and how actionable it is?

Yes, I mean, I'll hit M&A first. Obviously, we're continuing to cultivate proprietary ideas. We continue to think that, we'll see some conversion over the course of the next 12 months, and some things and categories that we're very close to. And as it relates to buyback, look, I think, 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, and we'll be more aggressive if we think that there's any sort of dislocation 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. So, we'll see. I think we've been, if you look at pattern recognition, when the stock was 21 to 22, we bought a lot when it was 29 or 30. We bought some, but we bought a little bit less. And so I think, we absolutely will continue to follow that philosophy going forward.

Thank you. Really appreciate the context.

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

Good morning, everyone. I'd like to talk 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 fair bit different here with the design source kind of business model. So could you talk about in the potential for a downturn, 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 you?

Yes, I think. So in terms of as you point out, our model is highly variable. From an employee standpoint, we have 2441 employees, which is about, I think, $625,000 per employee, plus or minus, so very productive and efficient. We go to market through third party reps that are 100% commission based. So to the degree we see a sales decline the flex on our selling expensive is perfect. And, obviously, I think when we see 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, the agility that we've created and cultivated in the business model, is built for a little bit of uncertainty on the upside, and the downside, so I think, are detrimental margins. And again, they'll depend on the product category. We'll be very, let's just say efficient on the downside, we obviously have high margins, so that's not something that we can avoid. But, I think it'll be very efficient in the scenario where we see declines. And that's, without question.

Yes, I think that's important point to make. 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 moved to Mexico, some reshoring a supply chain. If you could provide some color on, on what you're looking at doing there, and how those savings are to be generated?

Yes, and we've been working at it now for probably six to nine months. And we're in a position today to see the benefit in excess of $10 million from a runway perspective, beginning in '25. 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 perhaps are a little bit closer from a lead time perspective, as well as favorable from a tariff perspective. So those are I think, relatively large digital things that we see. But again, just go into building more resilience into our business model. So those are things that 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, we've got 25 million of synergies rolling through in 2024. And we've got an incremental 10 plus coming from this supply chain activity in 2025.

Great, thanks for taking my questions.

And your next question comes from the line of Joe Ritchie, with Goldman Sachs. Your line is open.

Thanks. Good morning, everyone. Can we maybe just touch on the SKU rationalization for a second, so it looks like it's going to be about a 3 to 4-point impact in the fourth quarter? As you kind of think about 2024, what's kind of the right framework for that piece impacting potential your organic growth in 2024?

Yes, Joe, it's Mark. I think that the impact in next year will be modest. We said three to four this quarter, think about next year, it's in that $9 to $12 million range next year. So think about it as sort of quarter of it hitting this year and three quarters of a next year. So, overall about under a point of growth impact next year.

Okay. All right, great. Thank you. And then, just my quick follow up question. So clearly, it seems like the water business is been growing at a nice clip for you. I think you guys are -- you sound pretty happy regarding the Elkay integration at this point, I guess, can you kind of help level set for Elkay? What's the business, what's kind of the revenue baseline exiting 2023? And then how are you guys kind of thinking about, again, kind of the growth framework for Elkay in 2024?

Yes, I mean, we're obviously well past the point of being able, or frankly, wanting to discreetly identify, what was okay, what was legacies earn, in part, because we've already done a ton of integration, particularly around the commercial sync business going forward. But suffice it to say that, the margins of the Elkay piece on a standalone basis are at or above that fleet average today, on the backs of a highly profitable drinking water business. And -- which is a massive change from the roughly 13% business, that it was in '21. So, when you think about in essentially 12 months of owning the business, we've taken a business that was running somewhere in the 13% range, on a true organic basis, and turn it into something as 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 synergy work that we've been doing. So, I don't think I shouldn't be lost on anybody that the acquisition at the time, or the merger at the time 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 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 and investing in things that can grow this category and grow our business in a meaningful way over time. So didn't answer your question specifically. But I think we feel really good about it.

Okay, no, that's super helpful. If you don't mind, I'm going to try to sneak one more in here. Just in the context of what can be a bit of a slower growth environment. One of the questions we get a lot on potentially negative volume environment, like, what does pricing do for your business next year, given what you already know in where your raw material costs are today, would you expect to get some pricing in 2024?

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, there'll be a ton, there'll be some, and I don't see a scenario where we are giving back price. I think that when you look at the overall increases that we passed along, over time, they were relatively small in the grand scheme of things. And so if anything, our pricing from a market standpoint 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, I think it's a unique environment, for sure, but I think we feel good about where we are, with some incremental opportunity in the 2024.

Got it. Thank you.

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

Thanks, everyone, for joining us on the call today. We appreciate your interest in Zurn Elkay and look forward to providing our net next update when we announce our fourth quarter results in early February. Have a good day.

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