Zurn Elkay Water Solutions Corp Q3 FY2024 earnings call

• Todd Adams noted the third quarter slightly exceeded guidance, with core growth of 4% leading to 9% adjusted EBITDA growth and margin expansion of 150 basis points year-over-year. The company raised its full-year margin expansion outlook. Free cash flow was $87 million, with $50 million used for share repurchases. Dividend was raised to $0.09 per quarter.
• David Pauli discussed third quarter sales of $410 million, 4% organic core growth. Profitability: adjusted EBITDA was $105 million, margin 25.6% (up 150 basis points YOY). Year-to-date EBITDA margins at 25%, expecting 30-35% incremental margins. Balance sheet: net debt $308 million, leverage 0.8 times, with $130 million deployed to share repurchases and $41 million to dividends.
• Todd Adams spoke about sustainability impact, Michigan's Filter First regulations, and market data including Dodge Momentum Index, ABI, Construction Backlog, and vertical starts data. Emphasized over-indexed to strong institutional verticals, resilient business.
• David Pauli highlighted 51 out of 55 quarters with positive core growth, 6% CAGR over 10 years, 45% retrofit exposure, leveraging variable cost model and Zurn Elkay Business System for margins, strong cash flow, and capital allocation focus on dividends and repurchases.

Third quarter sales totaled $410 million, growing 4% organically on a pro forma core basis. Adjusted EBITDA was $105 million, with a margin of 25.6%, representing 150 basis points of margin expansion year-over-year. Through nine months, consolidated EBITDA margins sit at 25%. Free cash flow in the quarter was $87 million, with $50 million used to repurchase 1.6 million shares. Leverage fell to 0.8 times. The company raised its full-year outlook, with adjusted EBITDA margin expansion expected to be 250 basis points to 270 basis points, and free cash flow projected around $260 million for the year.

• Third quarter slightly exceeded guidance, raising full-year outlook. Core growth 4% led to 9% adjusted EBITDA growth, margins 25.6%. Raised full-year margin expansion to 250-270 basis points. Free cash flow outlook $260 million.
• Fourth quarter projected low single-digit core sales growth, adjusted EBITDA $88-90 million. Full-year low single-digit pro forma core sales growth, adjusted EBITDA margin expansion 250-270 basis points, free cash flow ~$260 million.

• Uncertainty around construction starts translating to actual sales, as starts need to occur and bid quotes convert to buy quotes. Potential delays or weather impacts on construction timelines. Tariff environment could affect supply chain repositioning benefits.

Q: Another solid quarter. Noted growth in all product categories for Q3. I guess the level set was there meaningful delta in growth rates in the quarter. And then for Q4, what are you contemplating buying major product category in the low single-digit guide that you offered?

A: David Pauli said nothing different between product categories, drinking water continues to perform well, saw double-digit growth in filtered bottle fillers, and expects similar in Q4 across product categories.

Q: Is there any reason to expect that drinking water growth rate to moderate and to what extent, if you can quantify, could Michigan’s Filter First implementation or other states following suit benefit your team over time?

A: David Pauli said nothing suggests slowdown, Michigan's legislation requires one filtered bottle filler per 100 students, with ~1.5 million occupants in K-12 schools, and legislation has a two-year adoption period, benefiting growth over time.

Q: You mentioned that normalized 30% to 35% incrementals you expect to drive going forward. I believe you’re also underway with some supply chain repositioning that should benefit EBITDA growth next year. Can you remind us of the benefit that should drop through and perhaps the phasing or the timing of that?

A: Todd Adams said supply chain repositioning benefit is ~$5M to $10M at full run rate, will articulate perfectly in February, begins to read through next year, full run rate into 2026.

Q: So the story all year has been really strong margins and this quarter, in fact, gross margins I thought were exceptional. I’m wondering if you could talk a little bit more about gross margins. But what’s driving that? How sustainable are the current levels and then what’s the long term goal from here in gross margins? Is there really a ceiling or can that just keep going higher?

A: Todd Adams said driven by Zurn Elkay Business System, productivity, waste elimination, mix favorable, incredibly sustainable, targeting 50% gross margin over time.

Q: So on those and all that information on Dodge Starts, so you mentioned more encouraging projections looking into next year, but that you need to see them actually happen. So just wondering, have you seen kind of any increase in like pauses or hesitancy with customers, to like actually push projects through the finish line right now?

A: Todd Adams said not in any pronounced way, Dodge Starts information reliable, nothing pronounced on delays or push outs from their vantage point.

Q: There is a follow up to Bryan’s earlier question on the incrementals and supply chain savings. You’ve got 30% to 35% normalized incrementals. Should we think of the supply chain savings over the next year or two as contributing to that 30% to 35% incremental or as additional to that 30% to 35% incremental?

A: David Pauli said think of supply chain savings as additional to 30-35% normalized incremental margins.

Q: Back when you guys acquired Elkay, you gave some data around, the number of water fountains in the U.S. it was like 8 million [ph]. And the penetration of bottle fillers on those was like, I think it was a 1.6 million [ph]. Is there an update you have to that? I’m just interested to see kind of how the penetration of those has evolved over the last couple of years to get kind of a better idea of how long the runway is for penetration of bottle fillers.

A: David Pauli said there’s an incremental 200,000 to 300,000 bottle fillers over the last since July 2022, still early days, category 11 years old, life cycle of bottle filler ~10 years, growing installed base by 200,000-300,000 over next five years.

Q: Hey, good slide. And I’m just trying to triangulate, the Dodge Starts in the sub-segment information with the timing that you laid out on Slide 10. It seems to me what you’re saying is there’s relative stability in your markets as we sit here today. The tailwinds from a potential spike in the education, the education and healthcare side of things. I mean that would be more the second half of next year. So the idea from your perspective, if I’m triangulating this, is pretty stable going into the front half of next year and then back prior next year in 2026. Is where the tailwind from that where that would come in? Or is it just a little early to make that assumption?

A: David Pauli said if starts occur as projected, majority of benefit accrues to 2026, 45% of business is retrofit replace (2-3% growth), residential exposure excluded, benefit shows a bit towards end of 2025, more pronounced in 2026 if projections hold.

Q: How do you think about the balance sheet usage from here? Raise the dividend, balance sheets in great shape, obviously. How’s that funnel from an M&A perspective look at this point? And how do you think about actionability?

A: Todd Adams said cultivation activity picking up, opportunities to convert in 2025, will continue to invest in dividend, share repurchases, and watch for M&A opportunities in 2025.

Q: I want to follow up on that question. It was really helpful to get some of this macro data and the kind of like the initial framework for next year. I just want to maybe understand that education and healthcare piece a little bit better because for the last few years we’ve seen a bunch of ESSER funding come through on the education side. And so I don’t know, is there maybe a little bit more color on what’s driving that expected increase in 2025 on the starts data?

A: Todd Adams said ESSER funding mostly went to salaries, safety, technology, not new school construction, driving expected outlook due to aging school infrastructure and requirements for safe/sustainable buildings.

Q: Look, it’s great to see the balance sheet position where it is today, sitting at sub, one times leverage at this point. Just give us an update if you can on your M&A pipeline priorities for the excess liquidity that you have today. And any thoughts around that would be helpful.

A: Todd Adams said will stick to core market, combination of categories and adjacencies fitting existing product lines, cultivating opportunities in core North American market.

Q: Hey, good morning all. I was wondering if you might be able to drill down on the groupings in a little more detail. So if you look at the flow systems, which does lead, are you seeing any early signs of improvement on the rate of change that might inform that things are getting better there, any granular color on some of those, those rates of change?

A: Todd Adams said qualitatively flow systems growing at decent clip, performing in line with starts data trajectory, not declaring victory yet as much can happen, but performing in line with expectations.

Q: You noted the high end of the growth achievement and was driven by growth initiatives, but you didn’t go as far as saying anything was related to share gain. Do you think you picked up a little bit of share in the quarter? And I guess is there any way to parse out what growth initiatives bridged you to the upper end versus, more market related activity?

A: Todd Adams said measuring share in a quarter is difficult, but over time, specification share is growing reliably, North Star is growing specification share, answer is yes, manifesting in long-term share gains rather than discrete quarter measurement.