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00:04 Good morning, and welcome to the Zurn Water Solutions Corporation Fourth Quarter 2021 Earnings Release 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 Water Solutions. This call is being recorded and will be available on replay for a period of two weeks. The phone numbers for the replay can be found in earnings release the company filed in an 8-K with the SEC yesterday February 1st.
00:37 At this time for opening remarks and introduction, I will turn the call over to Dave Pauli.
00:43 Good morning everyone. I'd like to remind you 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.
01:15 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 our SEC filings.
01:31 With that, I will turn the call over to Todd Adams, Chairman and CEO of Zurn Water Solutions.
1:35 Thanks Dave, and good morning. I hope everyone had a chance to read through the release last night, as I thought Dave was going to mention, this is the quarter where you'll see the former Rexnord PMC results presented as discontinued operations. Now there is a fair amount of moving parts when you go through one of these complex transactions, but from our view, there were no surprises as to how everything shook out as we went through all the transactional accounting. Other than a lot of work for Mark and Dave and our [indiscernible] team, but no surprises.
02:06 We're really pleased with our fourth quarter results and frankly the whole year of 2021. We drove terrific results and executed a very high level amidst both the complexities of the RMT transaction and separation work as well as the supply chain and logistics dynamic that when you step back from it, believe we managed exceptionally well.
02:26 As far as the quarter, sales were up 23% year-over-year, 16% organically and this is against the fourth quarter last year where we grew 15% and 10% organically. As we communicated last quarter, we successfully worked through some of the temporary logistics constraints we saw in the fall and continue to see a gradually improving market around transportation with respect to availability and costs. And expect that we take it back towards more normal levels as we go throughout 2022.
02:57 Our segment margins were 24% in the quarter, very much in line to slightly ahead of our expectations. Free cash flow of $26 million drove our pro forma leverage to 2.1 times at the end of December. You can see for the year record results across the board and we start 2022 with a lot of positive organic momentum along with the market outlook that is clearly better than we've seen in the past several years. Our team is energized about the future for Zurn Water Solutions, and anticipate 2023 will be another record year for us.
03:28 I'll quickly move to Slide 4. I've mentioned in the past that one of the big decisions around the timing of the RMT was ensuring the trajectory for a standalone business was really strong. And with the benefit of another year of strong execution and visibility into the next level -- into the next year's level of activity that's happening in our markets, along with organic investments reading through and even more in the early stages, we really see incredible runway for growth over the next 3 years to 5 years.
03:58 Every year we do a detailed three-year strategic plan, something we've been doing for the last 15 plus years. It's the absolute foundation of the Rexnord Business System and creates a roadmap for our strategic deployment of breakthrough growth or margin opportunities, prioritizes resources towards our biggest opportunities, and takes big three year objectives, and makes them come to life every day with tangible objectives and accountability.
04:23 It creates the framework and alignment throughout the organization that is matured, continues to improve and most importantly, measures performance and progress. At any point in time, everyone knows the priorities, why they're important and how we're doing. It's relentless in providing clarity on why, what we're doing today, next week and next month helps us 3 years from now.
04:44 This year's plan is something we call the next wave, because it really does build off of prior year's successes and course corrections, and capitalizes and compounds on unique competitive advantages we've created. We also benefit from the opportunity to focus on Zurn and only Zurn and we see a path of substantial increase in the size of Zurn organically with really the same financial characteristics that we have today. While optimistically seeing M&A opportunities convert over the planning horizon, allowing us to double the business over the coming years.
05:15 To the right you'll see the strategic framework we've consistently used to evaluate our performance for the strategic planning. Starting with getting into the right markets where we can build real, sustainable competitive advantage and then leverage the Zurn Business System to develop plans that will drive above market growth, strong incremental margins and superior free cash flow to continue to invest in our business and create capacity for M&A, while returning cash to shareholders.
05:42 In order to do all of that, our teams have to be incredibly engaged and delight our customers. We're not going to get ahead of ourselves, but it's clear to me that as we execute the next wave, Zurn Water Solutions can be a much larger company with a consistent financial profile, while continuing to build up the business very much focused on the types of things we do today.
06:03 I'll move to Page 5. One of the things that we've made tremendous progress over the last three years on is ESG leadership. I truly believe it's a critical pillar in creating superior shareholder value moving forward. The progress over that time has included things like establishing Board double committee over sight -- oversee our ESG efforts, as well as an internal steering committee. Streamline reporting by adopting the SASB framework and enhancing our CDP disclosures.
06:33 Implemented and refined policies reflect our commitments in the areas including diversity and inclusion, human rights, environmental stewardship and sustainability, product safety and supplier diversity. We have integrated ESG into our strategic planning process, which includes evaluating how climate-related issues impact our business strategy and financial planning. We were recently named one of America's Most Responsible Companies by Newsweek for the second year in a row.
07:02 In December, we joined the UN Global Compact to reaffirm our commitment to universal principles on human rights, labor, anti-corruption and the environment. Our entire business aligns incredibly well with the UN goal to ensure availability and sustainable management of water and sanitation for all. And just this week we're launching an employee-led social impact fund to provide financing, support, and resources for social ideas that advance our ESG efforts. We know that the best and most innovative ideas come from our teams and we're ready to fund those ideas.
07:39 In mid-February we will be issuing the inaugural Zurn Sustainability Report. In that you'll see that we have established ESG related targets, including commitments to reduce greenhouse gas emissions and energy use and goals for diversity among leadership and suppliers. We have provided 1% of company time for employee volunteerism and renewed our philanthropic commitment including setting a $5 million giving target by 2024. We will remain aligned with industry-specific Sustainable Accounting Standards Board metrics from the Value Reporting Foundation and we will expand our ESG reporting to measure and disclose our performance on issues that affect people and the plan.
08:23 You will see an expanded ESG content index adding multiple new metrics from GRI and from other SASB sectors that apply to our business operations. And we're also adding a table in the report that cross references ESG topics covered within our report and our other published documents with the corresponding SASB sustainable industry classification system code and GRI.
08:46 Operating as a pure play water management company presents new opportunities to embed ESG principles and practices into every aspect of our business. We're committed to continually evaluating our approach to ensure that we're committed to the targets that matter, discussing our progress transparently and always improving. So look for that in just a couple of weeks.
09:08 So with that, I'll turn it over to Mark to walk through some of the additional details on our performance and provide some color on our Q1 outlook.
09:15 Thanks Todd. Please turn to Slide number 6. On a year-over-year basis our fourth quarter sales increased 23% to $232 million. The combination of the December 2020 Hadrian acquisition and the December 2021 Wade Drains acquisition drove 7% of the year-over-year growth, with the remaining 16% of growth coming from the core business as core sales grew year-over-year across nearly all of the product categories.
09:41 With respect to profitability, our adjusted EBITDA, excluding corporate costs increased 21% from the prior year fourth quarter to [$56 million] (ph) and our adjusted EBITDA margin [indiscernible] expectations at 24%. In our core business and adjusting for the impact of the temporary cost reduction actions we have in place in the fourth quarter of 2020 due to the COVID-19 pandemic actions we took, our adjusted EBITDA margin expanded by approximately 20 basis points year-over-year.
10:11 With respect to corporate costs, they were in line with our expectations for the quarter and as we've communicated over the past few quarters with the close of the RMT transaction and our transition to a standalone pure-play water business, we will be reducing our annual corporate expenses to approximately $20 million in terms of adjusted EBITDA. And we remain on track to achieve that annualized run rate in our second quarter of 2022.
10:35 Please turn to Slide number 7. And I'll touch on some balance sheet and leverage highlights. I'll start with a quick reminder for everyone that in conjunction with the close of the RMT transaction on October 4th, we paid off all the debt that was on our balance sheet at September 30th and put in place our new capital structure that includes a $550 million term loan B with a $200 million revolver that is currently undrawn. Our new seven-year term loan has an interest rate of 2.25% with a 50 basis point LIBOR floor and [postponing] (ph) debt maturities out to 2028.
11:08 With respect to our net debt leverage, we anticipate closing -- closing out the year at a 2 times to 2.1 times, we've pro forma our adjusted EBITDA for the $20 million of annual corporate expenses on a go-forward basis. As you can see, we ended up below on that range on December 31st.
11:26 Please turn to Slide number 8, I'll make a few comments on our outlook for the first quarter of 2022 as well as the full year. For the first quarter 2022 we are projecting total sales to increase year-over-year by a high-teens percentage. With respect to margins, we expect our adjusted EBITDA margin, excluding corporate costs to be between 24% and 24.5% in the quarter. We anticipate corporate [indiscernible] in terms of adjusted EBITDA be approximately $7 million in the quarter as we work our way down to approximate $20 million annual run rate I discussed earlier.
12:03 For the 2022 fiscal year, we remain confident in delivering double-digit reported and core growth year-over-year. With respect to profitability, we believe our adjusted EBITDA margin excluding corporate costs will be consistent with our margins in fiscal year 2021 and will generally improve each quarter as the year progresses. Our corporate expenses will be approximately $22 million for the year.
12:25 Before we open the call for questions, just a few comments about our interest expense, stock comp expense, depreciation and amortization, tax rate and [indiscernible] for the quarter and the year. We anticipate our interest expense for the March quarter to be approximately $5 million and approximately $21 million for the fiscal year. Our non-cash stock compensation expense should be about $5 million in the March quarter and approximately $70 million for the fiscal year.
12:52 Depreciation and amortization will come in around $6 million in the March quarter and approximately $18 million for the fiscal year. Our tax rate on an adjusted pre-tax earnings basis will be between 26.5% and 27.5% for the March quarter as well as the full fiscal year. And diluted shares outstanding updated to reflect the conversion of restaurant equity grants and Zurn equity grants as a result of RMT transaction will be approximately $130 million to $131 million for each quarter of fiscal 2022.
13:26 With that, we'll open the call up for your questions.
13:29 [Operator Instructions] And your first question comes from the line of Brian Blair from Oppenheimer. Your line is open.
13:49 Thanks guys. Strong finish to the year.
13:51 Thanks Brian.
13:52 Good morning, Brian.
13:55 To start with your double-digit core growth outlook. I'm just wondering if anything over the last 90 days with Omicron spread, continued supply chain tightness, any of the headline risks of the day has meaningfully concerned your team in maintaining that guide? And if possible, it would be great to hear what you're currently contemplating for underlying market growth, price realization and Zurn out-performance or share capture within that framework?
14:25 Yeah, you bet. A lot of headline news, Brian, but I would call it not a whole lot different than really the last two years in terms of things changing day to day. But underlying that fundamentally we're very much committed to that double-digit growth for the year. I think it incorporates sort of a low to mid-single digit market growth outlook, very similar from a price perspective, maybe a touch more and then 2 points of market outgrowth.
15:00 And so, you can see your way to something, 10 plus. And I think we're sort of starting the year maybe a little cautious. But I think our underlying confidence in delivering that is relatively high and virtually unchanged from 90 days ago.
15:19 That's great to hear. Any further color or detail you can offer us on project pipeline in your key education and healthcare verticals? Just wondering if you can offer any directional insights on market outlook specific to those spaces, Zurn's positioning and how that influences your 2022-23 prospects and confidence in continued growth trajectory.
15:47 I think the level of activity we're seeing in those verticals is very, very strong. I think you're seeing funds flow to state and local governments and ultimately to school districts. And there is a high priority on hygiene amongst other things, including technology and things of the like. But building upgrades is a big part of it. And so, I think the level of activity is very good. As we track our funnels, they continue to grow and be robust. And I think it supports the market outlook that we've got very clearly. And I think when you think about things like BrightShield and connected products, it only reinforces our ability to drive some health growth in those categories and in those verticals.
16:36 So, I think the positive outlook for those two remains, and I think now we're starting to see that next phase of money actually getting to school districts we will be able to invest in infrastructure and hygiene and upgrades for students. So it's a good dynamic.
16:57 Sounds like solid momentum there. And maybe offer some quick color on early stage wage integration and what your team is expecting for year one revenue? Where current margins are? And where do you expect to drive profitability over time?
17:14 So Wade Drains is very complementary to our core Zurn drain business, very high relative spec share, strong regionally. And I think we see the opportunity to implement the Zurn Business System drive 80-20. And really create an even stronger position within our specs and even more so regionally.
17:42 From a revenue standpoint, it's relatively small today, circa $15 million and the margins would come in at below the fleet average. And I think we've got a very solid plan to convert the business to the model that we have and drive some additional simplification. So I would say towards the end of '22, you can see that at or near the fleet average and with a solid growth outlook.
18:10 So it was tuck-in for us, not huge, but I think strategically important when you think about the importance of spec share in our business. And then our ability to drive the efficiencies through the Zurn Business System. And what can be for our portfolio over time.
18:29 Understood. Thanks again.
18:31 You bet.
18:33 Your next question comes from the line of Jeff Hammond from Keybanc. Your line is open.
18:39 Hey, good morning guys.
18:41 Good morning, Jeff.
18:43 So, Mark, you mentioned margins should progress and improve like through the year and I'm just wondering what the big drivers of that are and maybe you can speak within that? How you see price cost playing out as you move through and maybe an update on what is getting better, or stabilizing on the supply chain side?
19:06 Sure. Yes, Jeff, I think a couple of things driving the margin improvement. As the year progresses, we'll continue to make headway on the integration of both the acquisitions, the Hadrian deal we did over a year ago as well the Wade acquisition Todd just talked about. As the year progresses and our integration plans move forward, we will see margin improvement in both of those M&A deals that we've done over the past monts and the past year.
19:34 But one piece of it. From a price cost standpoint that equation for us will get better as the year progresses as everyone can appreciate, first half of the year, the overall [indiscernible] a little bit tougher when you look at that equation given the environment we're in today versus what we were a year ago. So things that we're doing in our productivity initiatives and cost reduction initiatives progressed as the year moves forward. That equation gets better for us.
19:58 And I'd say we've been putting some -- we talked about it in the latter part of '21 and here in the early part of '22, a little bit out-sized growth investment as well as investment around some of the near-shoring initiatives we've been putting in place. We start kind of -- again, as we get in the back half of '22, we start comping again [indiscernible] started that investment in '21. So I think those are probably the three big buckets, Jeff, that are going to allow that margin as the year progresses, that will steadily improve.
20:30 Okay. And then just on supply chain, I think your biggest issue maybe last quarter was really some freight dynamics. Just maybe update us on what's going on there?
20:41 Yes, you're right, last quarter was the timing issues, right? Just getting things you know over here into the U.S. into our plans and ultimately in a timely fashion and we've had some timing issues with that. As you can see on the result this quarter that didn't impact us at all. So I think some of things that we've done from a econometric standpoint in the third quarter to get in front of it definitely helped. We talked about from an inventory standpoint, carrying little more inventory to assure availability, those actions started this last quarter, you'll see some of that in the first half of next year.
21:15 So again in that we've done to try to kind of cover that initial issue we had in the third quarter definitely paid dividends in this quarter's due to the numbers and we'll expect all same actions if we do link with spot. So right now, Jeff, we don't have any significant concerns about an air pocket like we experienced in the third quarter. Never say never, obviously, but [indiscernible] things we put in place on econometric, some of that we feel pretty good about where we are with inventory levels and availability of our products.
21:48 Okay. And then just last one, just any differentiation in the growth between the different business groups either in the fourth quarter kind of within the outlook or is it pretty broad based?
22:02 I think it's pretty broad based, Jeff. I wouldn't say there is a material differentiation if you think about sort of the two sub sectors [indiscernible] as we look forward into '22. Right now we see a path where all those factors are growing in that double-digit type category we've been talking about. Good momentum in the funnel around all those categories. I think ultimately the one that could standout and give a little difference, especially with some of the school projects and education about which Todd talked about earlier will be the hygienic environmental sector could be a tad above the other two. But again I'd say overall broad-based across all three of those sectors, yeah.
22:48 Okay, great color. Thanks guys.
22:53 [Operator Instructions] Your next question comes from Joe Ritchie from Goldman Sachs. Your line is open.
23:05 Thank you. Good morning everyone.
23:07 Good morning, Joe.
23:10 Maybe just staying on margins for a second and just thinking about the 1Q margin guide. It looks like you're expecting a little bit more revenue sequentially, but the margins kind of like in line with 4Q. Just maybe talk a little bit about the puts and takes on the margins for Q1? I know that you kind of already answered the progression throughout the year.
23:34 Yeah, I feel -- if you kind of look at it sequentially, Joe, if you're in the higher end of that range, you're sequentially looking at -- and the margin is going to be close to what we would expect with our incrementals or decrementals sequentially. So I think kind of look at where we are in this number, we expect they're going to be in the similar range. The difference would be, I think if you just look at the overall sort of timing and power price volume, how the material cost is rolling in, this is the margin, this is the quarter where that overall dynamic is [indiscernible] for us.
24:10 So it's really just the timing function of some of our pricing actions, some of the costs that we're seeing and how that's going to roll through in the quarter. So that really is the reason why that margin makes generally from a stable standpoint Q4 into Q1. And then as I mentioned earlier and [indiscernible] we get into Q3 and Q4 you see that margin progress. Other thing to is that Wade acquisition in the first quarter and we really haven't started a lot of our integration actions that benefit out first quarter margins, that does put a little bit of a mix impact in Q1 as well, that new acquisition [indiscernible] as the year progresses.
24:48 Got it. That's helpful. As you kind of think about like that margin progression then throughout the year and you think about the swing factors, it seems like you guys are pretty confident in the growth outlook, things are looking good there, your price actions are coming through. Would you say that like, freight, logistics is probably the biggest swing factor. I'm just curious how you're thinking about it on what can push the margins higher or lower throughout the year?
25:20 Yeah. Joe, I think a big part of it is, when you think about the Zurn business, it really follows the construction season in North America. So the Q4, Q1 are the relative low points in terms of top line throughout the year. And Q2, Q3 is more. So it's really just that tremendous operating leverage on the asset-light model as you go through the middle part of the year, I think is the biggest thing.
25:51 I mean obviously freight and logistics are a piece of it. But I wouldn't call it the swing factor by any means based on the assumptions that we've given you. I think it's just more of that core operating leverage that we get in the asset-light model over the course of revenue base that grows pretty significantly in the middle of the year when the level of activity is higher.
26:18 Okay. Yeah, that makes a ton of sense. Maybe one last one for me. I'd be remiss if I didn't ask you about the M&A pipeline, how you feel about things today, now that you're -- you've got the standalone business up and running like how does the pipeline look today and how you're thinking about M&A for 2022?
26:39 Yeah, I mean I think we're not going to predict it or time it, but I think we feel really good about the targets, the quality of the targets. And I think the reality is, everything we do is generally proprietary, so the timing of those is difficult to predict. But I would say the richness of the conversations and I think our anticipated conversion is pretty good on some high priority things. And we just got to keep doing the work and the cultivations, and I think there will be there over time, but I would say -- I think I'm very pleased with the quality of the funnel. And the progression of where they are in that funnel. So stay tuned I suppose, but I feel really good about our ability to convert some things over the course of 2022.
27:37 Great. Thank you all.
27:42 This concludes the Zurn Water Solutions Corporation Fourth Quarter 2021 Earnings Call. Thank you for your participation. You may now disconnect.