Zurn Elkay Water Solutions Corporation (ZWS) Earnings Call Transcript & Summary

Good day, and welcome the Baird conference with the Rexnord Corporation. [Operator Instructions] Please note the event is being recorded. Please refer to the events confirmation e-mail, Pulte's research website for important disclosures regarding the company's discussed during the event. I'd now like to turn the conference over to Mr. Mig Dobre, Baird senior research analyst. Please go ahead, sir.

Thank you, and good morning, everyone. My name is Mig Dobre. I'm the Baird research analyst covering diversified industrials and machinery, which also includes Rexnord Corporation. It is my pleasure to have joining us today for a call, Todd Adams, CEO of Rexnord Corporation; as well as Mark Peterson, Chief Financial Officer. With an update on the current environment, and we'll actually start with some formal remarks from Todd. So Todd, I'm going to turn it over to you, and then we're going to do some Q&A.

Thanks, Mig. And we do certainly appreciate the opportunity to stay in front of you in sort of this very unprecedented time. Before I get started, I'll refer everyone to our website and our safe harbor statements. I won't go through it and read it at this point, but I think we're all sort of very aware of those. The goal of the call, really, for us, this morning is to talk to you 3 things: First and foremost, how we're handling the situation holistically from employee and family welfare to business continuity, our overall risk management to continue to serve our customers and really, how we're addressing our response to the crisis and really to all stakeholders of the company; the second is to just give you some basic facts around our business. In any particularly difficult or disruptive time, transparency and communication seems to be the most important thing. And so we want to provide a view of reality and what we're seeing, how we're managing through it and give you the chance to look through that same lens; and finally, a plan of how we're thinking about the next 90 days and beyond. This is, obviously, a situation that we are not going to sail through, something we have to road through. And I think if we cover those 3 things today and, obviously, take some questions, hopefully, that provides a degree of clarity around a few things and lets you know how we're doing. So starting off, how we're handling this holistically, and we believe responsibly, we're balancing our passion to perform with compassion for our employees and their families and also our customers and the communities where we live and work. Our board has been active and briefed daily on all the issues and actions and responses that we're taking. We've got a terrific diverse Board that's been a source of great input for us beyond extensive China experience, manufacturing in both consumer and industrial industries, technology, commercial real estate and finally, health care. So a very valuable asset for us in these uncertain times. As we think about the crisis response and specifically in the U.S., we've had some good pilots in both China and Italy. Obviously, we're applying the appropriate sensitivities and differences in those situations to what we're seeing here, but we are leveraging that learning to how we're responding in the U.S. We've got a facility in Changzhou, China that was impacted beginning in January. We worked through the closures, the supply chain disruptions. And at this point, we're essentially running about 90% of where we were before it started, and it seems to get just a little bit better week by week. The other point that I think many of you know is we've got an extensive supply chain for Zurn in China, which is essentially operated uninterrupted. We've accomplished this through a couple of means. Significant consigned inventory in the U.S. to match what we saw future demand being with the transit times. And also really a plan for supply redundancy across multiple geographies. And the 2 points to make here is that I think are important, we had a long-term strategic view to balance that supply chain to alternate geographies, and we have made great strides. We're sourcing probably about 15% to 20% less out of China than we were just 2 years ago. And the other thing is, we've never been more in-tune with this part of our business, given the tariff environment and our ability to navigate through that very, very well. And so we feel like that was a big risk over the course of the last couple of years that we've mitigated both on the tariff side and obviously now on the virus side. If we move to Italy, we've got 2 factories in Italy, 1 in Correggio, 1 in Ferrara. These are each 100 to 125 miles southeast of Milan. Up through this past weekend, we, again, had essentially operated on an uninterrupted basis with some of the new government orders, our facility in Ferrara, which manufactures couplings for wind energy and things like that, has been required to shut for the mandatory government time. What will Correggio, the facility there serves food and beverage, and that's been mandated to be able to stay open, provide critical components to beverage manufacturing. As states have issued stay-at-home or work-at-home orders, there's only been a very few exceptions where our businesses have not been exempted, being able to work to provide products based on the critical infrastructure, essential business guidelines that have been issued state-by-state. Internally, we've had a COVID task force that meets 2 times a day, 7 days a week. We manage every day in a fact-based discipline, cross-functional way, using the Rexnord business system. And if there was ever a time where we really benefit from having a common language and really having the entire organization understand the way we do work, it's now. It's allowed us to be nimble and creative in the way we've addressed the variety of challenges that have popped up and will continue to pop up, but also allows us to leverage all that learning very quickly and apply it across different parts of the organization. Things as simple as transportation. You may have been hearing about some transportation disruptions as carriers make assessments of what they're going to pick up or what they're not going to pick up. We've quickly mobilized and been able to distribute all the proper documentation to all of our employees. So we've seen almost no disruption to our export transit. Having duplicate patterns, as we learned in China, once being shut down, it's very difficult to get started. So in Italy, where we're doing some level of injection molding, we were able to move tooling and different manufacturing equipment to different geographies, really eliminating single points of failure. And on a real-time basis, we've got a center of excellence in Italy, where we do a significant amount of engineering and IT support as well as things that support our digital initiatives. And when we saw this coming, we had the opportunity to both help people get to places where they could work from, and then obviously, create the infrastructure and connectivity to allow them to continue to work. And so when you read that the country shut down for 21 days, we've essentially been operating remotely fully productive for the course of 2 weeks based on being able to connect the dots and recognize that it was going to impact India at some point. Not surprisingly, we're following all the guidelines around CDC, World Health Organization. And we are in close contact, location by location, with the local health and governmental authorities to make sure we're connected. That's a theme you'll hear out, I think, as we have the call today. Our protocols and business continuity plans, including things like protocols for shutdowns, minimizing the number of people in our facilities, creating redundant capability, both physical and manufacturing capability and also acknowledge are things that we're leveraging incredibly well. Our enterprise risk management process identified a risk in the event of a significant inability to get to work. How do we do that? Everything from our supply chain people, to our engineering people, our customer care people can all work remotely, and we've had great success with that so far. As we look at the health and well-being of all of our team, over 2 weeks ago, we took the stance of requiring people to work from home that could do so. In our case, it's a significant number. 1/3 of our workforce is exempt and typically salaried and able to work from home in some form or fashion. And then we also launched our plans around running our facilities with as few people as possible. It's required us to be creative on the way we run our various manufacturing sales. How we staff over the course of a 24-hour period, but simple things like keeping people out of the lunch rooms, allowing the social distancing to occur while work continues to get done. The other thing that we've leveraged is an extensive environmental health and safety organization at all of our locations. We've got a Vice President of EHS and the risk management that reports to me and has reported to me. So I think we've always had a sensitivity around managing risk as well as we possibly could. And this has been critical to allow us to stay connected, provides a framework for good judgment at the point of impact. It's very difficult to mandate policies across everything. You've got to have the framework for judgment at the point of impact. And they've been terrific in coordinating our efforts around personal protection equipment, both acquisition and distribution. Acquisition and developing protocols around leveraging thermometers. So we're taking the temperature of people before they get into the building, and just overall associate well-being. And finally, extensive communication with our team globally. Trying to eliminate as much uncertainty as possible, knowing how they're going to get paid in the event of the plant shutdown, placing a priority on a level of financial health for them and engaging them to find solutions on being more productive and flexible so we really better understand what the path will be. We're going to have to make a call on future business levels, business-by-business and plant-by-plant, we will do that. But just having the people calm as much as possible and continue to engage them has really been something to watch. As we -- as you reflect on this, it's just more of a human issue than any other crisis that I think any of us have been around. It impacts everyone's life from their own well-being and health to how do I handle child care in the event of school closures, 2-income families moving to 1. And the thing that we're doing is we're using an internal social media platform called the Rexnord Connection to really stay engaged with everybody as best we possibly can. News, updates, questions they have, polls, how to work better from home, how to stay active and just recognizing that when everyone is remote, they feel less connected. And so trying to do our best to bring them together, keep them engaged and it's really helping us navigate and see around some corners that, inevitably, will come. So if you think about how we're operating, I would say, with a lot of vigilance. There's not an ounce of complacency anywhere in the organization. And for better or for worse, I think we've been tested over the course of the last 10 to 15 years across a number of things. We've got a large people -- a large group of people that know how to respond in a crisis. And fundamentally having a business system that has a common language, a lot of standard tools and processes and really a way that we do work is providing us great leverage. And first and foremost, making sure that our people and our team are safe, and we're doing our part to stem this spread of the virus. The next thing I'll talk about is some basic facts and a little bit of perspective on our business. If you look at our 2 platforms, process and motion control and water management, it's probably never been more clear than the last quarter. In process of motion control, we keep industry moving. And on the Water Management side, we provide safe, clean water for human health. And we've got a digital overlay now. We're able to connect these products, they're able to be reviewed and accessed remotely to drive productivity and uptime and reliability. And we think that becomes an even more important part of our roles in a post-COVID world. As I mentioned earlier, the vast majority of our businesses operate in support of critical and essential businesses, providing components that are fundamental to food supply and production, energy production, tissue and fabric manufacturing. And then on the water side, obviously critical water components for water supply, sanitation, and it's particularly acute and important when you think about health care and having to add capacity and keep people safe and not spread the virus. For those that know us well and have followed us in the last 3 to 4 years, we've been racing to navigate our business to a point where we could withstand a significant shock and perform well, and obviously this is never a scenario we dreamt or hoped for. But nonetheless, I think we've done a lot of things along the way that help us feel very confident about our ability to perform through this. Our supply chain optimization and footprint rationalization moves, the first one; and the second one, eliminated about 20% of our overall manufacturing square footage, eliminated fixed cost, reduced our capital expenditure requirements on a go-forward basis and made us far more variable. We are in the midst of our third phase. Once we're done towards the end of our fiscal '21, which is essentially less than 12 months from now, we will have reduced our fixed cost structure by over $60 million. And the nice thing is that the third phase is up and running. We are -- We're in the process of moving things, and you'll hear more about that as we get to our earnings call in a few weeks. We've made great strides in improving the strength of our balance sheet and our liquidity. We've divested all of our underperforming businesses. Some of the M&A we've done to migrate to more stable end markets and end markets are going to be really important. Things like food processing, more integrated water, health care and hygiene solutions are all things that we've done. And so we've been, as I said earlier, on a race to position our business to withstand a recession of some sort, obviously this one, the magnitude and the length is sort of still to be determined, but we are positioned to deal with it. The next thing I'll move to is understanding how we will perform. And then I think without trying to pick how much are we down, I'm sure that will come in the questions, we just simply decided to go to a breakeven analysis, right? And so without any countermeasures from our current level of business, our EBITDA breakeven at the Rexnord level can absorb about a 45% to 50% sales decline. Our process and motion control platform falls within that range, and again without any significant cost reductions that we would likely, obviously take in that sort of environment. And at the Zurn level, it's approaching 60%. So Zurn could absorb roughly 60% sales decline and still be breakeven. And it's really due to the fact of the advanced progress we've made on an asset-light design, procure, assemble, test model that's performed well -- extraordinarily well on the upside and we performed extraordinarily well in a slower environment. More importantly, we've run the business really for this last 16 years on a rolling 13-week cigar box cash flow basis. Having been part of private equity for the better part of 10 years, cash management is a core competency. So every dollar, every peso, every euro, we have a very good sense of cash is not a formula, cash is what shows up in the cigar box every day. To further bulletproof, I'll say, our liquidity and essentially harkening back to the days of '08, '09, we chose to convert all of our available lines of credit to cash. And coupled with our very strong Q4 cash flow as we had sort of outlined earlier, when we announced our earnings, we're going to end the year with well over $500 million of cash actually on the balance sheet. And so 100% liquid in that regard. As you look ahead, in a 1-year period, and certainly we're not underwriting this as the base case. But if you took an extreme position that EBITDA was breakeven, we believe our annual cash usage in that 1-year period would be less than $50 million. And you get there through a combination of cash interest, obviously any minimal cash taxes that you may have in certain geographies. So maintenance CapEx and some other uses for pension, our scope of 3 spending to get us to that, $20 million savings run rate and the dividend, offset by the release of working capital would essentially deliver a use of cash of less than $50 million. And on the working capital side, we're assuming that we would be less efficient than we are today. So just some perspective on how we see our business and understanding the levers and also some extreme scenarios. Specifically, as it relates to the March quarter, if that quarter ended yesterday, we'd be delivering essentially the same outlook we had from January. As this crisis unfolded over the course of the quarter, we've obviously had some blips. Inspections to sign off on products have been postponed, things like that, nothing abnormal. Those happen quarter-to-quarter, but I think some of the travel restrictions mandated that, and I expect that over the course of the next couple of days as we try to close out our fiscal year, that ends next Tuesday, there'll be some more blips. But our teams have done just an amazing job of being creative, resilient and courageous to sort of continue to perform for our customers in our key businesses. Looking ahead, we are going to have to flex our levels of employment. However, with the breakthroughs and growth investments we've made, gaining traction, we're going to make sure we keep as much of the outstanding team we have in place because there will be another side to all of this, and we want to stay on the trajectory we were on, and frankly are on even as of today. And so the irony is we're going to end up probably posting a record quarter in March. And recognizing that in at least the next 2 quarters, we're going to be faced with a pretty significant downturn, and we're going to have to navigate through that. Finally, our plan moving forward, and this really gets you to sort of think about what we're going to come back to you on in just a little bit over a month time. It is too early to talk about our outlook. But our base case is that the environment for the next 6 months is going to be very challenged. The tentacles of how this ripples through is not going to reveal itself in the next week or 2 weeks. So we're not going to speculate, but we are going to commit to being as transparent as we can and provide updates as we feel we can be credible and fact-based. That being said, the position that we're taking, which I think is the right one, is that it's going to be very disruptive. It's likely going to be uneven across some of our end markets. I think aerospace is certainly going to be different than food and beverage and health care facility construction. To that end, we are -- we have paused any share buybacks for the time being, and we'll stay on pause until further notice. It's the prudent thing to do to preserve liquidity and get a sense of where we think things are. We, obviously, continue to think that the future cash flows of the business support an equity value much higher. But I think at this point, the prudent thing to do is to manage for a lot of disruption and protect and insulate your business as best you can with cash. By mid-May, we'll provide our best look. It might be for 90 days, it might be for 180 days. But the thing we'll commit to do is to provide some detail on how we're planning by sector, by end market, by channel. And 1 thing we're not going to do is be the company that underestimates the magnitude and falls behind on how we respond. And so the -- we just got through with our first call of the day. And the first thing to do is to do our part to help this curve flatten, and we're doing everything we can internally to accommodate that while continuing to serve our customers and meet the demand that they have. So before I turn it back to Mig, just a couple of thoughts. The overarching message I hope you take away, is that our day-to-day focus over the next coming weeks is staying safe, staying connected and staying nimble. The priorities are pretty clear. Safety and well-being of our teams, business continuity and flexing our business to levels required to serve our customers. Cash, cash and cash. And there are bright spots, continuing to execute on the breakthroughs we've been making terrific progress on and be in a position when this stabilizes, accelerate out of that. And we are not going to stop some of those things. We're going to have to make some tough choices in other areas. But the things where we can differentiate and drive growth, and there are pockets of those that are going to exist, we're going to take advantage of that. So the phrase we've used for a very long time around here is control the controllable. Deal with the reality of the situation, proactively evaluate and manage our risks, recognize the fluid situation. And we're going to work through the disruption that will ultimately migrate to stabilization. It's easy to just simply keep your head down and not think of others, and I think our teams have done an amazing job of balancing that. And just a couple of examples. We've been donating some of the PPE and N95 masks to some hospitals in the communities that we live and work in. We're currently working with a consortium of manufacturers at Marquette University, leveraging 3D printing capabilities that we have across the company, along with some other manufacturers to make components for respirators. And finally, the one thing that I think we've all heard throughout this crisis is how critical handwashing is to preventing the spread of the coronavirus. And before this, and obviously, maybe a little bit fortuitous, we've been pulling together a complete suite of products, really a hygienic package that is in support of CDC guidelines on washing your hands and doing it in a touchless way, so let's scrub, rinse and dry. And last night, you may have seen that we ended up donating $1 million worth of this product to qualifying health care organizations so that they can continue to keep those first responders and those health care workers safe, keep hospitals from preventing to spread the disease. And we fully think that the combination of copper sinks, a CDC-compliant hand washing faucet, the relationship of understanding restroom usage to handwashing, handless, touchless hand dryers are all going to be things that are going to be in great, great demand post this COVID environment. The final point before I turn back to Mig is as you see a lot of these triage hospitals popping up on the coasts, we're very intimately and actively involved in supporting these things through our Zurn business, getting them up and running. And I think we feel just happy to be able to help where we can. So with that, I will turn it back over to you, Mig, and obviously let you facilitate any questions that people may have.

All right. Thank you, Todd. This was great perspective, and you're doing a lot. This is very obvious, not only in terms of mobilizing the company and the employees, but also more broadly, in the community and as a person who does live in Milwaukee, where you guys operate, I've seen that locally. So I commend you for that. As you can imagine, many of the questions that we've received from investors over the past couple of weeks have really dealt with a framework for some of the most dire of circumstances as we're kind of trying to stress test our assumptions. So I'm going to try to ask a little bit about your framework in this regard. But the place where I think we should start is with some more perspective on the balance sheet, and you provided some comment on liquidity, maybe anything that you think is useful to expand on that. Also, your thoughts on leverage and where leverage might end up being? And maybe some clarity around your existing covenants. The structure of it, if there are any springing covenants or anything that investors need to be aware of, is they're kind of running through their own modeling and assumptions. So let's start there, if we can.

Yes, Mig. I'll start, and obviously, Mark will help me out. The thing to recall is our business generates cash every day. So from a liquidity perspective, in any given month, quarter, year, we essentially have no borrowings on any revolver through the course of a normal period. And we expect to end, as I said earlier, with roughly $550 million of cash on the balance sheet, and leverage 1 9-ish. And so if you start to look through a variety of scenarios and what would happen in an EBITDA down 15%, 30%, more than that? We still -- if you use the 30% sort of number, is just to pick one, leverage would end up sub 2.5 because, obviously, we'll get the benefit of some working capital release, but our annual cash costs, if you think about cash interest, it's just a shade over 50. In that sort of scenario, cash are in the tens of millions versus closer to $100 million, with maybe what our base case was. CapEx can flex down to 1.5%. Obviously, we've got some spend to get to our scope for 3 savings that we would absolutely want to protect. But in all those scenarios, we still generate pretty significant free cash flow and leverage doesn't get in that scenario that I painted, not sub-2.5. In terms of the balance sheet, Mark, maybe outline some of our debt and obviously any covenants.

Yes. Right. So I'll just walk through the balance sheet very quickly, as a reminder. So our senior notes are not due until December of 2025, our term loan is not due until August of 2024, and our revolver isn't due until March of 2023. So the -- from a balance sheet standpoint and commitments, we don't have any near-term debt commitments at all, so a good spot there. As far as covenants, we really only have 1 financial covenant tied to our term loan. That's a net debt leverage ratio of 6.75 x to 1. So that is the only financial covenant that we have in place. And obviously, as Todd outlined in his previous comments, we're far away from that at this point in time. No concerns on the financial costs side.

Okay. That's great. That's very helpful. Also, the color on CapEx is helpful in terms of maintenance versus other uses and how you might flex that down. If we can talk a little bit about demand, and I understand that at this point, all of this is happening very rapidly, and it's quite recent. I don't know if you can provide some commentary in terms of what you're hearing from customers or what your salespeople are seeing in various end markets. And related to this, I'm particularly interested in some of the geographies that are maybe a little bit ahead of the U.S., in China and Europe. How demand for your products have trended in those regions and what are not in certain places like China, for instance, you're actually starting to see some level of bottoming out? So that will be helpful perspective on that.

Sure. Obviously, we just don't have that big of a China business. But what we did see, we saw things turn absolutely off for the better part of a month. And this is from an order and demand lens as opposed to sales. But I would say, we are probably 70% to 80% of what we were running through the November-December time frame at this point. So we've seen a reasonable snapback in a relatively short period of time. As it relates to Europe, again, I think it's still too early to say. There are a number of closures that are happening in real time. And then I guess, my suspicion would be that when people do get back to work, and take stock of their businesses without question, the base case that maybe people had been planning for is going to be less. But we haven't seen, I would tell you, cancellations in Europe. We haven't seen deferrals. Things as it relates to MRO, continues to be pretty steady. And frankly, that's what we saw in '08 and '09, relatively stable MRO demand. And obviously, going into this sort of environment with channel inventories at sort of record lows. I mean we're going to cross over our March year-end with channel inventories in both parts of our business as low as they've ever been. So the destocking element that maybe we saw in '08 and '09, it isn't there. So I'd say, it's still too early, Mig. Obviously, U.S. is all happening real time. And as I said earlier, the irony of the situation is we haven't seen much change, but we know it's coming. I would tell you that Zurn is having a terrific quarter. And we don't see a lot of it as pull ahead because it's for actual demand. That was going to happen maybe a month or 2 from now, maybe they're trying to secure product in advance of supply disruptions or the potential for supply disruptions, but these are sort of live projects. And so it's a little bit too early to tell. I think when you get through the next 2 to 4 weeks, that's going to reveal itself. And obviously, we are going to be able to provide that input when we get together in early May.

That's fair. I know we've done this, and I think many of the folks who dialed in, were in similar analysis, where we're trying to use 2009 as a benchmark. Your business is different now than it was in 2008 and '09. You talked about inventory in the channel is one of the things that's very different. But I am wondering as you've done your own stress testing here, a 2009 scenario, what would it look like for the business in terms of revenues in each segment, decremental margins? I understand the breakeven that you've given us previously. Hopefully, we never have to live through that. What would the '09 scenario look like?

Well, I'll give you what happened in '09 as the guideline, I don't think we want to -- we're not underwriting this as our guidance at this point for good or [ for bad ]. But just conceptually, I think, is maybe where you're going with this, and this is very true I think. In '08, '09, our sales were down about 22% on a consolidated basis. If you look at it on a core basis, it would have been down about 15%. And I believe our EBITDA was down about 20%. That's a combination of divesting underperforming businesses, and these are all things that have happened since then. Divesting underperforming businesses, obviously our scope for actions over the years. And so the way to think about it, I think, Mig, is over the course of a year, whatever sort of sales decline we would see at the Rexnord level, maybe 1.5x that impact to EBITDA. So if it's down 10%, down 15%. If it's down 20%, it's down 30%. And those are, I think, pretty good guidelines. It will obviously depend on the trajectory of the down because we are going to flex our business. We are going to, in that scenario, we would absolutely be taking out cost. We'd obviously be flexing spending everywhere. And the other thing to remind people of is, if you think about commodities and input costs, those are going to be coming down as well, which provides some additional benefit. And so I think that's the way I would provide the framework, recognizing that it's going to be different, as I said earlier, amongst our various end markets. And so that's the high-level view. But obviously when we look at it, we need to look at it end market by end market, and provide the best view we can. But that's how we will perform through that sort of environment.

Understood. On the cost side, you talked about SCOFR. I don't know if you maybe can update us a little bit as to what might be incremental in '21 versus '20 in terms of savings based on what you already announced? And really, a framework for any other self-help that we might -- you might be able to do that you can essentially directly control in this kind of environment to buttress margins?

The SCOFR 3 actions include closing a couple of factories in the U.S. and adding to a facility we have in Monterrey. Those actions have been announced at the facilities impacted in the U.S. The facility is being finished as we speak. And the move will take place really in a phased approach, leveraging, again, some level of manufacturing, but also some supply chain and outsourcing, really over the course of the next 9 months, in earnest. We'll go through a period of stabilization. And then the run rate savings on that is $20 million, that in a scenario of -- in a perfect scenario, beginning day 1 of our fiscal '22 or early March of '21, we'll begin run rating in the $20 million annual savings from that set of actions. You asked about flexing. I don't think it's unreasonable to think about in a sustained period of down at a relatively high level, would we be able to flex out an incremental $20 million to $40 million of cost without question? And that would be above and beyond the normal variable cost that you would expect to see come out. And so that's how you wind your way to that relationship of 1.5 is the framework. So that's -- I think it's a scenario that we've, obviously, done, and we probably did a little better than that back in '08 and '09. But I think that's how we're thinking about it. And again, it's -- I want to be very clear, it's going to be different by business. I think if some of the activity that we see in and around health care inside of Zurn and Water Management is what we believe it could be, we're not going to have to take costs out of that business. If we see things in end markets are going to be substantially more impacted, we're going to have to be a little more -- a little tougher. And so the big thing is we're going to do it in a thoughtful way. We're not going to miss it on the downside, and we're going to protect the resources that are going to give us a better trajectory coming out of this. And so that's, I think, roughly the way we're thinking about it. We're going to protect, obviously, the margins, our cash flows, but there will be another side of this. And we're not calling the end or when. But the strength of our businesses and our brands and the position and really the trajectory we were on, we're going to get back to that at some point. We're going to live through some difficult quarters, for sure, and do what we need to do to deliver solid results and not just for those particular quarters, but really over a long period of time.

Understood. Maybe also related to all of this, we're, obviously, talking about playing defense for the next, at least couple of quarters. You suspended your buyback, as you said. But from a bigger picture standpoint, when you think about capital deployment, what are your priorities coming out of this COVID crisis? Have they changed in any way? Are you really making some adjustments in the way you're thinking, even in your organic investment when you look at various end markets and geographic exposure that you have?

No. I mean, I do think that the path we have been on is adding to our water platform to be able to provide a bundle of solutions to end markets that desperately need it. I mean if you think about World Dryer and just manufacturing. Without those two, we don't have this hygienic package that is going to be, we think, the only manufacturer that can offer this period. So our continuing to build out our water business in and around the things that we do really well and also complementing the food and beverage business that we have are our 2 biggest priorities. They were the 2 biggest priorities going into this. We were, I would say, very close to converting something on the water side that we had cultivated for 5-plus years. It will still be there. We both looked at each other and said, "Look, let's not try to do something now. Let's hold on." So I think we're in a good place to pick up where we left off, and the priorities remain the same. Our views on balance sheet leverage have not changed as a result of this. I think maintaining the 2 to 3x in all environments is sort of the discipline that we outlined when we announced our capital allocation strategy in January. We didn't pay a long period of time to deploy it, but we did take advantage of it while -- for a period of time. We generated strong free cash flow in the quarter, we leveraged some of that. We paid our first dividend. In all the environments that we've talked about, our dividend is safe. The yield just happens to be a little bit higher right now. But the priorities that we laid out as part of that, including organic investment, all remain the same, and we will get back to that point.

I see. I want to talk a little bit about the segments as well. And I'm just going to bring up a couple of things -- a couple of questions that I routinely get from investors, but I think some clarity would be helpful. First, on a PMC side, in aerospace. Maybe get some updated thoughts from you as to how you see this business proceed going forward based on what you know today? Obviously, traffic is down materially and things are rapidly changing, so we understand that. But your perspective on your OE versus aftermarket, kind of how we're thinking into COVID and post-COVID for the aerospace business.

Sure. Our aerospace business is about 9% of total sales. The split between OE and aftermarket is about 70% OE and about 30% aftermarket. While we haven't seen it to date, the aftermarket is going to be very challenged for a while. As we talk to some of our partners, they're pumping the brakes, they're trying to assess what's going to happen, how long, how deep. But obviously with the shape the carriers are in and the lack of passenger miles, there's going to be a period of time where there is very limited aftermarket -- very limited aftermarket growth. That being said, it's still a small part of our business. And so while there'll be disruption, I think it could create opportunity, right? As we positioned ourselves with a much lower cost structure, much more productive, there's an opportunity to take some share inside of aftermarket, but the end market itself is going to be challenged. If you move back to the OEM side of things, we're probably slightly overweight Boeing, all things Boeing, and that's consistent with what we've communicated forever. The shuttering of the facility in Seattle is clear. The challenge is with the 737MAX. I think we had incorporated some of that into the way we were thinking about it. I think we're probably going to have to think about it a little more deeply. But as we get through this, as people start flying, as planes start to get built, the next 12 months, probably 18 months, are going to be tough for aerospace without question.

I presume it's fair to assume that this end market has higher than segment average margin. So there could be a bit of a mixed headwind for you as well?

It will be. But, the but is, the center of excellence that we have in Downers Grove allows for enough space for potentially us to do some consolidation down the road from another facility or 2. And so the margins in the business are terrific. They're not wildly ahead of the fleet average, but they are ahead. And so it would be a mixed headwind as we look out over the next 12 to maybe 18 months.

Understood. What about food and beverage? This is a bigger end market for you than it's been in prior downturns. Maybe some color as to kind of how you think about the cyclicality of this end market as well as the contribution from a margin mix standpoint?

Yes. It's our -- in our industrial -- in PMC, it's our biggest -- aside from general industrial, it's our largest single end market at 12% of sales. One of the reasons that we were so purposeful about expanding into this both organically and then through the acquisition of Cambridge 3 years ago -- 3.5 years ago was the global demand for food production as well as beverage. And so our view on this is there's going to be a little bit of disruption as plants are shut, as food and beverage manufacturers evaluate their capital spending. But that being said, the demand for packaged food, bottled water, manufacturing of food is never going to be more important than it is now. And we think the resilience is going to be very high. And so there's a -- if you look at every beer manufacturer in the world right now, they're running full tilt. If you think about having to ensure bottled water for hospitals and things like that, it's a very good time. And I think where we've been underpenetrated is Europe. And so some of our breakthroughs are around growing food in Europe. And I think this will afford us an opportunity to do it. So we feel like it's a much more stable business. It's a good margin business. It's a balanced mix between MRO to keep existing lines running. And as people add lines to support the fundamental demand, that's upside and obviously continuing to penetrate food will be our focus.

I see. Maybe switching gears here and talking about water management. There's been a lot of inbound questions we've received, vis-à-vis the potential changes in shift and construction landscape overall when we're thinking about -- when we're talking about nonresidential investment and what that might mean in the post-COVID world as well as the potential for residential to be derailed by unemployment and obviously an outright recession. So I guess, my question is this, as you're sort of putting your forecasting cap on or looking at prior cycles, how do you think about the cyclicality of your portfolio here? And is there any way to kind of parse out new construction versus retrofit?

Yes. The -- it's about 35% to maybe 40% is retrofit replaced, and the remainder is new construction. And this is a relatively new phenomenon that we've built really since the last recession, heading into '08, '09 as earns focused, and we had just made the acquisition was solely writing the new construction wave and very little to focus on either products that were readily available to be retrofitted or channels and access to the markets that serve the retrofit. So we built it to a substantial portion of the business. And we believe that, that is going to be an area that will perform far better than any sort of cycle. It proved its worth in '09 as we began to build it. It's become an important part of our business. And with some of the things we're doing around more regional partnering with wholesalers, some of the things we're doing around e-commerce, we're seeing significant opportunities really sort of untapped on the retrofit side. If you move to new construction, we've been obviously seeing a slowing in the commercial and institutional market for a while. If we were to guide -- what we were planning on doing is guiding to that continuing to be negative. It may get more negative as a result of everything you talked about. On the institutional side, our largest single end market is health care. And so while we think -- there'll be blips as construction is shut down for periods of time. I mean these are measured in weeks, hopefully, not years. The things that have been started will continue to get built out. The level of activity behind that, you certainly have to assume, is going to be less. However, the power of what we have at Zurn will, without question, allow us to outperform whatever the end market's decline. Even going back to '08, '09, the power of the brand, the breadth of the portfolio, the amount of specification. I think you can go back '08, '09, '10, every quarter, we outperformed the market somewhat significantly. As we grew our retrofit business and we really leveraged the savings that come with the Zurn package and bundle. So we'll try to get a little bit tighter on that, Mig, as we communicate, how we're seeing it. But we would have told you that heading into '21, the market would have been flattish, maybe down a little bit on a weighted average basis. So maybe it's down a little bit more. I saw some things from Dodge this morning that are projecting down in the first half 8% to 10% with a modest recovery in the back half. I think we know how reliable some of those things are, particularly trying to make a call amidst an environment when not a lot of people are working and providing input. So I think it's going to be softer. And over the course of the next month, we'll have to take a view on that.

Sure. We're almost at the top of the hour, and I want to ask my final question here. As you're preparing the business and planning the business today, are you essentially getting ready for more of a V-shape recovery at the back end of this COVID crisis or something closer to a U-like recovery?

Well, I think it's phased. I think what we've communicated this morning is, we know what an L looks like. We certainly suspect it's going to be a U. It's probably going to be a W across our different end markets. But at this point, it would be very difficult for me to think that it's going to be a V-shaped recovery. We certainly hope for that. But I think we know what an L looks like. We'll plan for a U, and it will probably be a W. And if it's a V, I think we will have -- we will come out stronger and, obviously, better than any of the comments that I've communicated today.

That sounds like a very fair way to approach it. We are reaching the top of hour, as I said. So I want to turn it over to you -- back to you, Todd, for some closing remarks. Thank you, everyone, for dialing into our call today.

Well, first and foremost, we certainly hope you found it productive. Being transparent and just hearing from us, we felt was an obligation. And we were not going to hide under a rock and not communicate as best we can. I don't know that we provided ultimate clarity on our outlook, but that really wasn't the intent of today. It was to take you through how we're managing it, see things maybe through the same lens as best as possible and recognize that we're going to commit to communicate fully. And I think as you've seen, over the last 4 or 5 years, deliver or beat what we tell you. And so that's the commitment we're going to continue to make. And we certainly hope everyone stay safe, your families and your friends, and do your part to get to the other side of this. Because there will be another side, and we will all have to deal with a new reality for some period of time. But don't lose sight of -- there will be another side of this. So we thank everyone for their time, and I certainly hope it was in some way helpful. Thanks a lot. Bye.

Thank you. Thank you, everyone.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.