Zurn Elkay Water Solutions - Q2 2023

Transcript

Operator (participant)

Good morning, and welcome to the Zurn Elkay Water Solutions Corporation Second Quarter 2023 Earnings Results 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 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, July 24th. At this time, for opening remarks and introduction, I'll turn the call over to Dave .

Dave Pauli (VP of Investor Relations)

Good morning, everyone, and thanks for joining us on the call today. Before we begin, I'd 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 Elkay Water Solutions.

Todd Adams (Chairman and CEO)

Good morning, everyone, thank you for calling in this morning. As Dave said, we released our earnings last night, taken as a whole, they were very much in line with our internal expectations, not only for Q2, but really for the first half. It's been 12 months since the Elkay transaction, all the work we did to accelerate the integration and simplify the business is essentially behind us, we're now beginning to see the benefits, both from a growth and profitability perspective with the initiatives we've been working on. You know, sales in the quarter were ahead of our guidance and orders even more so, with high single-digit order rate growth in the quarter.

Profitability of 21.6% showed the progression we've been talking about, you know, you'll obviously see another step change over the second half that Mark will talk about a little bit later. With our supply chain and service levels now back to pre-pandemic levels and even better or shorter in many cases, our free cash flow was again very strong, and it enabled us to repurchase 4 million shares in the quarter, bringing our year-to-date repurchases to $87 million, as total leverage actually ticked down to 1.5. We also expect that to continue to decline over the second half based on a strong free cash flow expectation and end the year right around 1.2x. I'll turn it over to Mark, and he'll take you through the quarter.

Mark Peterson (SVP and CFO)

Thanks, Todd. Please turn to slide number four. On a YoY basis, our second quarter sales increased 42% and were above the high end of our outlook for the quarter at $403 million. The Elkay merger contributed 47% YoY growth, and our core sales decreased 5% from the prior year. On a pro forma basis, including Elkay in the prior year second quarter and reducing those sales for the $29 million impact from the product line exits that we have outlined, core sales decreased 1% YoY. As we discussed on our call last quarter, our YoY second quarter core sales growth was impacted by the timing of orders and shipments in the prior year, as we began working down an elevated backlog in the second quarter of 2022.

Breaking down those pro forma core sales to our residential end markets declined in the mid-teens YoY, as we'd expected, which is substantially offset by a low single-digit increase in core sales to our non-residential end markets. While pro forma core sales modestly declined, pro forma core orders increased at a high single digit rate, as we anticipated, with drinking water growth outperforming the fleet average. Turning to profitability, our Adjusted EBITDA was $87 million in the second quarter, and our Adjusted EBITDA margin was above the high end of our outlook for the quarter at 21.6%. This compares to $64 million and 22%-22.6% in the prior year second quarter.

The benefits of price realization and our productivity initiatives, inclusive of the cost synergies that are a little over $6 million each quarter in calendar year 2023, was more than offset by the sell-through of higher-cost inventory purchased last year, which was complete during the second quarter. Investments in our growth and supply chain initiatives, as well as the impact of the Elkay merger. When looking at our margins sequentially, we stepped up 210 basis points from the first quarter of 2023. We expect further margin expansion in the second half of the fiscal year. Please turn to slide five, and I'll touch on some of the balance sheet and leverage highlights.

With respect to our net debt leverage, we ended the quarter with leverage at 1.5x, inclusive of deploying $87 million of cash to repurchase common stock on the first half of 2023 and $112 million since we started repurchasing shares in the fourth quarter of 2022. With that, I'll turn the call back to Todd.

Todd Adams (Chairman and CEO)

Thanks, Mark. We continue to prioritize drinking water and filtration growth based on the massive opportunity we see in the K-12 and higher ed end markets. You know, we've been investing in an awareness campaign, adding commercial resources, top-grading our product offering for simpler installation and maintenance, and also advancing the filtration aspect of drinking water with the addition of a PFAS filter that we expect to begin selling sometime in the fourth quarter. In the last 90 days, we've spent time doing three blitzes across states that have advanced legislation that will require more access, reporting on water quality, as well as mandating filtration. K-12 is a school-by-school or district-by-district game, where we're engaging with administrators, faculty, teams, educators, and parents, and we'll continue to do that as... Hello?

We'll continue to do that as we continue to work at that. At the higher ed level, we're seeing tremendous traction as both public and private universities prioritize sustainability in their master plans. We saw our funnel for higher ed grow by over $20 million in higher ed alone. We hope we continue to see that be will be a significant growth opportunity for us, not only this year, but for several years to come. We continue to keep sustainability front and center in front of all of our stakeholders, customers, employees, suppliers, and shareholders, as well as the compounding benefits of all of the products. Sustainalytics just issued a report that rated us in the top 7% of all companies they rate.

That's over 15,000 companies, in the top 2% within our end markets. As I've said before, this isn't born out of any target to go through the motions. It's fundamental to our business, is integrated into every asset or every facet of our business and our business system, and we truly believe it's adding a competitive advantage to us in the marketplace. With that, I'll turn it back over to Mark, who will take you through our outlook.

Mark Peterson (SVP and CFO)

Thanks, Todd. Please turn to slide eight, and I'll cover the highlights of our outlook for the third quarter. For the third quarter of 2023, we are projecting sales in the range of $390 million-$400 million, and our Adjusted EBITDA margin to be in the range of 23.5%-24%. Like last quarter, to help better understand the growth trends in the business in 2023, on the right side of the chart, we have presented Zurn Elkay pro forma sales for the third quarter of last year, which takes our reported sales for the third quarter of 2022, plus the YoY impact of the 80/20 product line exits we've executed.

With respect to the sales outlook, you can see on the page our assumptions for YoY pro forma growth in our nonresidential and residential end markets, which is impacted by the timing of orders and shipments last year as we continued to work down an elevated backlog in the third quarter of 2022. We anticipate pro forma orders in the third quarter to expand in the mid to high single-digit range YoY, with nonresidential end market growth above the average and residential end market growth below the average for the quarter.

Turning to profitability, our third quarter margin is expected to expand 350 basis points-400 basis points YoY, and 190 basis points-240 basis points sequentially from the second quarter of 2023, as we begin to fully benefit from the lower commodity and transportation costs we've been experiencing. Turning to page 9. With half of the calendar year behind us, we have adjusted our full year outlook and now expect sales for calendar year 2023 to be in the range of $1.525 billion-$1.55 billion, and our consolidated Adjusted EBITDA to be in the range of $335 million-$345 million, resulting in YoY margin expansion of at least 140 basis points, up to 170 basis points.

Similar to the third quarter outlook, we have provided our expected full year pro forma sales growth for our nonresidential and residential end markets, which is calculated off the prior year reported sales, plus Elkay sales for the first half of 2022, less the impact of the 80/20 product line exits we have executed. We've increased our free cash flow outlook for the calendar year from approximately $200 million to approximately $215 million. Before we open the call for questions, just a reminder that we have included on page eight and nine our third quarter and full year outlook assumptions, respectively, for interest expense, non-cash stock comp expense, depreciation and amortization, our adjusted tax rate, and dilute shares outstanding. We'll now open the call up for questions.

Operator (participant)

The floor is now open for your questions. To ask a question this time, please press star one on your telephone keypad. If at any point you'd like to withdraw from the queue, please press star one again. We'll now take a moment to compile our roster. Our first question comes from the line of Bryan Blair from Oppenheimer. Please go ahead.

Bryan Blair (Managing Director and Senior Analyst)

Thank you. Good morning, guys. Solid quarter.

Mark Peterson (SVP and CFO)

Good morning, Bryan.

Todd Adams (Chairman and CEO)

Good morning, Bryan.

Bryan Blair (Managing Director and Senior Analyst)

With regard to your Q3 revenue guide, I was hoping you'd parse that out a little bit more. I know there's a lot of year-on-year noise, but it seems like there's a fair amount of conservatism baked in if we think about the sequential trend. You know, most difficult stacked comp in Q2, typically some seasonal lift in Q3. You noted solid pro forma order growth. I know the backlog unwind is a little more challenging year-on-year, but perhaps walk us through how you're thinking about the, you know, sequential revenue progression.

Mark Peterson (SVP and CFO)

Yeah. Well, Bryan, I think, you know, as we've kind of done all year long, you know, we've been a little more conservative with our outlook going into the, into the next 90 days, across the board. I think everything you've said is accurate. You look back historically, yes, our third quarter tends to be similar to the second quarter from a revenue standpoint. Could be a little bit up, could be a little bit down, could be on par. I think as you've seen the guide, yeah, there's a bit of conservatism that's been our, you know, our practice this year, so nothing different there. I think you're right on the order trends. You know, we'd expect those to continue like we saw in the second quarter and the third quarter.

The revenue growth, as you pointed out, clearly is impacted by the backlog, you know, work down that we had last year. I think the orders are a better proxy of what we're seeing from a demand standpoint. Yeah, I think and, you know, I think the sequential trends that you've laid out are what you historically see and, there's not anything that's imminent that we see that would change that. As you know, we've just taken more of a cautious approach to our outlook this year.

Bryan Blair (Managing Director and Senior Analyst)

Okay, understood. Perhaps provide a little more color on what your team's seeing in your key institutional verticals, and your current pace of activity, how the project pipeline has developed year to date specific to Zurn Elkay, how your commercial drinking water platform has influenced the, you know, the pipeline and your, you know, forward opportunity?

Todd Adams (Chairman and CEO)

Bryan, institutional is, you know, notionally half of our total revenues, split primarily between education and healthcare. I think, you know, from a, from a current state perspective, backlogs really across the country in those two verticals continue to be very high. If you follow some of the leading indicators in that, in the institutional end market, they've been quite positive. Obviously, you know, we continue to think that the diversity of the business, adding drinking water specifically, adding filtration, you know, into the educational vertical provides us, you know, I think a lot of comfort that, you know, this is something that we can grow sustainably for a pretty long time. You know, there's pockets of strength when you go throughout the country, obviously.

Then there's pockets of, you know, where there's just less activity, but it's nothing unusual in that, in that institutional end market, really since the beginning of the year. Very much on track. Drinking water is certainly helping our value proposition, you know, when we're talking to K-12 schools and colleges and universities. As I said in my comments, you know, sustainability at the university level is increasingly important.

K-12, we're getting solid traction with a combination of legislation, and then really just going out school by school and district by district, and communicating what we're doing, which is essentially we can provide, you know, clean drinking water to students, for $1 per student per year, which is an amazing value prop that, you know, we think is going to resonate for a really long time.

Bryan Blair (Managing Director and Senior Analyst)

Absolutely. One last one. I know you're not providing, 2024 guidance, but you had put out the $25 million in incremental synergy-.

Todd Adams (Chairman and CEO)

Yes

Bryan Blair (Managing Director and Senior Analyst)

... guide before. Is there any shift to that at this point?

Todd Adams (Chairman and CEO)

No, I think it's very much on track. I think the majority of the work is behind us. You know, there's some things that we're wrapping up over the course of the next two to three months. We have obviously announced the closure of one of our facilities and consolidation of that into two different Elkay facilities. That's primarily around sink manufacturing. That work is underway. You know, we'll hit the ground running on 1/1/2024 with another $25 million into our earnings run rate.

Bryan Blair (Managing Director and Senior Analyst)

Understood.

Operator (participant)

Our next question comes from the line of Jeff Hammond from KeyBanc. Please go ahead.

Jeffrey Hammond (Managing Director)

Hey, good morning, guys.

Todd Adams (Chairman and CEO)

Morning, Jeff.

Jeffrey Hammond (Managing Director)

Hey, it sounds like the order rates were maybe a little bit better than you expected. Can you just speak to what's coming in better? Then just within the different product categories, is it, you know, pretty broad-based, or are there, you know, outliers, good or bad?

Todd Adams (Chairman and CEO)

Yeah, I think that the two sort of outperformance areas for us were a combination of residential improving. You know, we started to see resi deteriorate a little bit in the third quarter and more into the fourth quarter. We've seen that begin to snap back. You know, I think as housing starts to begin to stabilize and improve, we're seeing a little bit of traction there. Obviously, drinking water. You know, the comparable is easy given the backlog reduction, but, you know, we're seeing significant order growth in both, you know, the bottle filling units as well as filtration. Those are the two outliers. Everything else is sort of around, you know, sort of the fleet average. You know, we saw some strength in our in our flow systems business, which is very encouraging.

We continue to do just a great job in Water Safety and Control. It was relatively broad-based, but, combination of residential and then drinking water were the two areas of, you know, sort of outperformance.

Jeffrey Hammond (Managing Director)

Okay, just on the clean water kind of initiative, can you just talk about, you know, momentum versus expectation and just what you typically see from a sales cycle, given, you know, it seems very, you know, kind of local, you know, local, regional?

Todd Adams (Chairman and CEO)

It is, particularly on the K-12 side of life. Obviously, our specification share across the country is significant. So, you know, as schools get built or retrofit, we start the game, you know, in a really good place. I think what we're trying to do is drive, you know, more access points inside of these particular schools. Obviously, getting them to understand the benefits of locking in a filtration solution over a period of time. You are correct. I mean, it is a school by school, district by district. There's not a overarching, you know, sort of mandate of when to do it and how to do it.

That's where, you know, partnering with the commercial resources we've added internally, along with our third-party reps, you know, we're able to go out and really understand where are the big school districts, what are the influencers, what's our competitive position, then how do we, you know, sort of get that work done for them over the time period that works for them? I think that is the one thing in K-12 that's a little bit unique relative to higher ed, which is, you know, students are not there in the summer, so the vast majority of the work gets planned, you know, I would say late winter into spring, so that it's done over the summer. Then it gets a little bit quiet as kids are back in school.

I think universities, you know, that's obviously sort of a living, breathing thing almost every day of the year, so that work gets done, you know, over time. I think from a school perspective, particularly on K-12, you know, I think the momentum that we're building this year will benefit us even greater into next year, right? As they begin to do some more long-range planning on what they're doing. I'd also say, Jeff, that, you know, in a case where a school district may have, you know, 500 units, you know, they're not going to replace or upgrade these all at one time. They're going to do, you know, school A, B, and C, and then they're going to do the remainder over time.

It's really one of those things where, you know, the business and the opportunity, given the 131,000 schools, it's just huge. When you get to the end, you know, we'll be ready to retrofit and replace the others. It's a longer process, but one that I think has, you know, far more durability over a really, really long period of time.

Jeffrey Hammond (Managing Director)

Okay, great. Last one on buyback. You guys, you seem to be running ahead, you know, kind of the pace for the $100 million. Just wondering if you're thinking same or different around buyback, just given the stock move. Thanks.

Mark Peterson (SVP and CFO)

Yeah, I think we're sticking to that. You know, we're sticking to that at least $100 million. We're not gonna put a new number on it at this point in time, but I think, you know, it's been, for us, the timing was really positive for us, with the first half and the opportunity to buy the stock at the prices that we did. We'll continue to keep a balanced capital allocation strategy in place over not just this year, but going to next year as well.

Jeffrey Hammond (Managing Director)

Okay. Thanks, guys.

Operator (participant)

Our next question comes from the line of Andrew Krill from Deutsche Bank. Please go ahead.

Andrew Krill (VP and Equity Analyst)

Thanks. Good morning, everyone. wanted to ask on free cash flow. I think it was, you know, nicely above what we were expecting this quarter. I wanted to see, you know, I guess, any of, like, the big drivers of that strong free cash flow. It seems like inventories helped, and maybe just how you're thinking about that for the rest of the year.

Mark Peterson (SVP and CFO)

I think for us, free cash flow is, you know, been a positive this year. The team has done a really nice job with, you know, managing the trade working capital in the business this year, working down the inventories from the elevated levels last year. I think as we look at the balance of the year, I think from a timing standpoint, it'll probably reduce a bit in the third quarter and then uptick again in the fourth quarter from a phasing standpoint, based on the timing of some payments. At the end of the day, as you know, we took our outlook up from $200 million-$215 million, good momentum.

That'll be a strong year of cash flow, and we, you know, we see a lot of good momentum going on next year as well.

Todd Adams (Chairman and CEO)

Yeah, Andrew, I think the one point to make is, you know, our overall lead times in our supply chain, you know, are roughly half of what they were a year ago. Obviously, you know, we've had a view on demand and a view on, you know, that we were going to be able to get back to that. Obviously, a function of that is then selling through that high-cost inventory that you saw us do in the first half. It all sort of works together in terms of, you know, the demand that we're seeing, sort of broadly in line with what we're expecting, maybe a little bit better. Our supply chain is back to pre-pandemic levels, notionally half of what it was 12 months ago. You know, our service levels are high.

The net effect of that is, you know, the margin progression that we communicated, you know, tracks very nicely with the cash flow. From an accounting basis, you know, our margins were, I would say, understated relative to, the, you know, the current purchases that we were making. You'll see that as Mark pointed out in the outlook, that drives the vast majority of that margin step up in the second half.

Andrew Krill (VP and Equity Analyst)

Okay, great. All makes sense. For my follow-up, just on the guidance thing, maybe more for the 2023 guide, what are some of the major puts and takes that would push you to, like, the low versus higher end of the range? Thank you.

Todd Adams (Chairman and CEO)

Well, I mean, I'll let Mark comment as well. I think it's really, you know, five months left in the year. There is always going to be a range of outcomes. I don't think there's anything specific that would push us, you know, one way or another. I think the order trends that we've seen, you know, through July here would definitely give us confidence that, you know, the range is appropriate given the length of time left in the year.

Mark Peterson (SVP and CFO)

Yeah, I would agree. We've just, you know, the approach we've taken, I said earlier, just, you know, accommodating a broader range of outcomes in the outlook. We're staying consistent with what we've been doing through the first several quarters. As Todd pointed out, you know, order rates remain in a good spot. Early in July, that is the case, and we'll, you know, be back in October to report.

Andrew Krill (VP and Equity Analyst)

Thank you.

Operator (participant)

Our next question comes from the line of Joe Ritchie from Goldman Sachs. Please go ahead.

Joe Ritchie (Managing Director)

Thanks. Good morning, everybody.

Todd Adams (Chairman and CEO)

Morning.

Mark Peterson (SVP and CFO)

Morning, Joe.

Joe Ritchie (Managing Director)

My first question, maybe just on that backlog comp issue that you guys referenced last quarter. I'm just curious, like, what kind of impact do you have baked in for the rest of the year on, you know, tougher comps in the backlog and what you experienced from a growth standpoint last year?

Mark Peterson (SVP and CFO)

Yeah. In the back, if you went back and looked at our 10-Qs last year, you know, like, the backlog reduction and the core business was, you know, over $20 million in the third quarter, then call it closer to $25 million, and about another $20 million in the, in the fourth quarter. From a sales standpoint, that's the kind of backlog reduction that we were working through last year.

Todd Adams (Chairman and CEO)

I think, Joe, that to answer maybe the question, I think our order, book-to-bill, you know, if you will, over the next six months, is always gonna be somewhere around one. I think we saw, you know, as lead times extended through, you know, through a couple of years post-pandemic, you know, that forced different order behavior. I think, you know, when you get to where we are today, the backlog sort of sits at the traditional, sort of relatively low levels. The second half would imply, you know, a book-to-bill right around one, maybe just a touch better.

Joe Ritchie (Managing Director)

Okay, great. That's helpful. You know, I heard your comments earlier around, you know, margins accelerating into the back half of the year. I was really curious around Q4 specifically, because historically, what we've experienced is a, is a sequential downtick in margins in Q4 versus Q3, but it seems like the guidance implies something better at this point. Just maybe some thoughts around that, the margin kind of exiting the year, and what's driving that?

Mark Peterson (SVP and CFO)

Yeah, Joe, I would say, I think you, we would still expect, you know, a modest margin decline in the fourth quarter versus the third, just to your point, seasonally, as those sales sequentially decline, that will put a little bit of pressure on the margin. I think you'd expect to see a detrimental margin or an earnings fall, that would be generally better than what you would normally see because of the cost environment. Yeah, but I, you know, from a modeling standpoint, I would still anticipate a modest step down in that margin from where we'll see the third quarter, just based upon the decline in sales that we always traditionally see seasonally.

Joe Ritchie (Managing Director)

Got it. Yeah, that makes sense. Maybe if I could squeeze in one more just on Elkay. It seems like, you know, clearly you guys are going through some product line simplification on that business. I'm just curious, just as you kind of now look at the what's left in Elkay and the margin profile of that business, maybe just kind of some thoughts around that profile and how that's changing with the product line exits that you guys are doing.

Todd Adams (Chairman and CEO)

Well, I think the cleanest way to observe it is really look at the gross profit margins YoY, and then obviously with what our guidance implies. In aggregate, you know, we're approaching 46%, somewhere in that range over the back half. Obviously, we've got synergies into next year. I think obviously, you know, the business has improved materially from a profitability standpoint from 12 months ago. The simplification is driving, you know, that gross profit improvement across, you know, the existing and remaining part of Elkay, which we, you know, went to great lengths to try to communicate over the course of the last year.

obviously, you know, when you look at that overall company gross profit margin at that sort of level, I think it speaks to the simplification, work that was done, is having, you know, quite a dramatic impact.

Joe Ritchie (Managing Director)

That's great to hear. Thank you.

Operator (participant)

Our next question comes from the line of Mike Halloran from Baird. Please go ahead.

Michael Halloran (Associate Director of Research and Senior Analyst)

Hey, good morning, everyone. Just a couple of questions here. First, how are you guys thinking about the M&A funnel pipeline? Obviously, you feel very comfortable with where the Elkay business is from an integration perspective, or at least, you know, getting the simplification efforts well underway. I'm guessing there's a lot of willingness to bring smaller things in. Just curious how that pipeline looks and how you think actionability looks.

Todd Adams (Chairman and CEO)

Yeah, I think, Mike, like always, I think we take the long view on M&A and spend a great deal of time cultivating things over years. I think that from a funnel standpoint, I don't think that there's anything materially new in. I don't think anything is changed from, you know, transactions that have occurred that would have taken things off the board. I think it's just a matter of continuing to develop those relationships, I think, over the course of the next 12 months, which is probably a better horizon than the remainder of the year.

Michael Halloran (Associate Director of Research and Senior Analyst)

Mm-hmm

Todd Adams (Chairman and CEO)

to think about. We certainly think that, you know, we're gonna have several opportunities to bring things in that are complementary to what we do, fill some product areas and maybe, you know, strengthen us in some of our existing categories.

Michael Halloran (Associate Director of Research and Senior Analyst)

Makes sense. In, in the prepared remarks, you briefly mentioned a PFAS filter. Just a little bit more context there. It seems a little bit more, I don't know, manageable relative to a lot of the remediation, efforts in product categories and services we've seen for PFAS so far. Just some thoughts there, please.

Todd Adams (Chairman and CEO)

Yeah. I think we've been working, you know, internally and then with some third-party partners to, you know, develop the kind of filter that can be, integrated into a bottle fill that will eliminate PFAS. You know, we've been through the pilots, you know, we're sort of ramping production, something will be beginning in the market in the fourth quarter. I think it's a, you know, it's just one of those things where, for a relatively low amount of money, if you can eliminate lead and PFAS into drinking water, for kids at school, it seems like a pretty good idea. You know, I think our team is-...

you know, I would say making great strides on the filtration side of things, and we're seeing, you know, we're seeing it resonate when you actually sit in front of administrators, facilities people, and all the things we're also doing with the product to make it easier and quicker to install, gain an understanding of the life of the filter and ensure that it's done on time. You know, are all things that are incremental value add to these schools that have, you know, a million and one things going on every day. If you can ensure that the water that the kids are drinking is lead-free and PFAS-free, it's a, you know, it's a pretty good value proposition and one we're excited to bring to the market.

Michael Halloran (Associate Director of Research and Senior Analyst)

Makes sense. Thanks, guys. Appreciate it.

Operator (participant)

Our next question comes from a line of Brett Linzey from Mizuho Americas. Please go ahead.

Brett Linzey (Head of Industrial Sector Research, Senior Industrial Equity Analyst, and Managing Director)

Hi, good morning, all. Congrats on another good quarter.

Todd Adams (Chairman and CEO)

Thanks, Brett Linzey.

Mark Peterson (SVP and CFO)

Good morning. Thank you.

Brett Linzey (Head of Industrial Sector Research, Senior Industrial Equity Analyst, and Managing Director)

Yeah. Hey, just want to come back to price. You know, curious what your assessment is on the state of pricing. Are your competitors taking actions this year? Are you on hold? Just curious what you're expecting and seeing out there in terms of price and the contribution for this year?

Mark Peterson (SVP and CFO)

I'd say the price environment's been very stable this year. There's been some modest pricing actions taken in certain pockets across the industry, but nothing remotely close to what we've seen over the past several years. I would characterize as a very stable environment back to sort of normal. I think the pricing environment has continued to stick. There's not been price give back in this environment, I think I'd call it stable. Going into next year and beyond, it kind of looks like it's getting back to more that normal range where, you know, we've always historically generated 1.5-2.5 points of price in a given year.

We think, it feels like it's back to normal trends on a go-forward basis, Brett.

Brett Linzey (Head of Industrial Sector Research, Senior Industrial Equity Analyst, and Managing Director)

Okay. Yeah, thanks for that. Maybe just shifting to the synergy cost actions. I believe originally you were looking to achieve the 50 over a two year period, but just curious how the integration has progressed relative to the original timeframe. Does sound like the consolidation efforts, or at least where's my expectation, are a little ahead of schedule, but curious your thoughts there.

Todd Adams (Chairman and CEO)

I think in aggregate, Brett Linzey, you know, when we announced the transaction a year ago, we outlined $50 million. We obviously got a running start over the back half of last year. We got $25+ this year, and, you know, we're targeting another $25. In aggregate, it'll probably end up being a little bit more than the $50 that we originally contemplated, but it's essentially on the same timeline. You know, I think the only acceleration was, you know, some of the simplification work that we did.

Brett Linzey (Head of Industrial Sector Research, Senior Industrial Equity Analyst, and Managing Director)

Mm-hmm

Todd Adams (Chairman and CEO)

... really from July through December. because, you know, we just felt like, getting that piece behind us quicker, sooner, would aid everything else, whether that was supply chain, whether that was, organization, whatever it might be, you know, we sort of got ahead of it early. Since then, we've been hitting our marks on, you know, whether it be an announcement or, internal work that needed to get done to facilitate, you know, a next set of moves. Very much on track, taken as a whole, you know, probably a little bit ahead early, the last six months of last year.

Brett Linzey (Head of Industrial Sector Research, Senior Industrial Equity Analyst, and Managing Director)

Yep, got it. Thanks a lot. Best of luck.

Todd Adams (Chairman and CEO)

Thanks.

Mark Peterson (SVP and CFO)

Thanks.

Operator (participant)

Our final question comes from the line of Nathan Jones from Stifel. Please go ahead.

Nathan Jones (Managing Director and Head of Industrials Research)

Good morning, everyone.

Todd Adams (Chairman and CEO)

Morning.

Mark Peterson (SVP and CFO)

Morning.

Nathan Jones (Managing Director and Head of Industrials Research)

Follow-up question on margins here. Guidance for the back half of the year, 23.5%+. Obviously, there's been a lot of disruptions over the last 12 months with supply chain and high-priced inventory and freight logistics and integrating Elkay and all that kind of stuff. Are we through all of those meaningful hits to cost? Are we looking at what is basically a normalized environment in the back half of the year, or are there transient costs or benefits in the back half of 2023 still there, that we should be thinking about going away in 2024?

Mark Peterson (SVP and CFO)

I don't. No, Nathan, there really is nothing that's a material transient cost. I think you are starting to see margins getting into that normalized run rate in the back half of the year. You know, as you go into next year, obviously, there's always, you know, investment in our business and things that we're doing to grow the business and invest in our supply chain initiatives as well as growth initiatives. There's nothing to point to in the back half of our year as an outsized, unusual cost that would go away next year or an outsized benefit that doesn't repeat. You know, we talked about the synergies we have next year, going into the $25 million.

I'd say no, nothing unusual, non-recurring in the back half that would impact the next year.

Todd Adams (Chairman and CEO)

I mean, Nathan, the only thing I would say is, based on what we know today.

Mark Peterson (SVP and CFO)

Yeah, right.

Todd Adams (Chairman and CEO)

... obviously, nobody, envisioned container costs going from, you know, a couple thousand dollars to $22,000, and now round trip. I think given what we see, and assuming no event-specific challenges, I think Mark's comments are right. I think the run rate is sort of the run rate. You know, we've got synergies that we have a high degree of confidence in. Obviously, it assumes sort of a muted inflationary environment, which is also reflected in a relatively muted pricing environment. You know, all things considered, I think if we can deliver the second half like we were projecting, I think it bodes well heading into 2024.

Nathan Jones (Managing Director and Head of Industrials Research)

I guess the follow-on to that question for 2024 then is, if we were expecting another $25 million of synergies next year, which is about 150 basis points on a 23.5%+, is there any reason why we should not be expecting 2024 margins to be 25%+?

Todd Adams (Chairman and CEO)

We will talk about 2024 in 2024, but I think your thesis of, you know, should we continue to see margin growth into the future? I think the answer is yes. We're obviously going to continue to make growth investments. You know, taken as a whole, that is the right sort of algorithm with obvious puts and takes, given comparables and, and whatnot, and the environment. So we're not going to guide for 2024. We're going to deliver Q3, and we'll come back and talk about Q4 in October.

Nathan Jones (Managing Director and Head of Industrials Research)

Fair enough. I just wanted to, one final one, a follow-up on one of Bryan's questions. He asked about institutional backlogs in the market conditions you're seeing there. I just wonder if you could comment on the commercial side.

Todd Adams (Chairman and CEO)

You know, I think the, it's been an interesting year. We started the year and, you know, the world was falling apart, as a function of the regional banking crisis, and the downstream or collateral impact on the commercial markets. I would tell you that, you know, the commercial, the specific commercial office end market is a very small percentage of our business. You know, embedded in there are things like retail, amusement, hospitality, and other things. I wouldn't say it's an outsized drag by any stretch of the imagination. You know, obviously, you know, it's something we continue to watch, but I think the hyperlocal nature of what we're doing, you know, sort of absorbs a lot of that risk.

Because there are pockets of activity, there are always going to be pockets of activity across the country. You know, we're not particularly worried about, you know, office vacancies in Chicago as a specific example. It's really spreading the risk, you know, across the country, across a whole bunch of different verticals. Then there's always the MRO aspect of what it is we're doing. Nothing specific to really call out there other than I think there's now a better appreciation that our business is not particularly exposed to commercial office. Therefore, you know, we'll, we'll look for the next opportunity to fill the divot, you know, if that happens.

Nathan Jones (Managing Director and Head of Industrials Research)

Thanks very much for taking my question.

Operator (participant)

I would now like to turn the call over to Dave Pauli for closing remarks.

Dave Pauli (VP of Investor Relations)

Thanks, everyone, for joining us on the call today. We appreciate your interest in Zurn Elkay Water Solutions and look forward to providing our next update when we announce our September quarter results in October. Thanks, everyone.

Operator (participant)

Thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.