Q3 2019 Earnings Call

Hi decrease in intercompany sales volume.

Unfavorable country sales mix and additional investments, which are only partially offset by additional productivity savings.

Recall that last year, the Americas purchase additional product from our Chinese sister companies in anticipation of the higher tariffs.

In summary at me a return to growth during the quarter with solid growth continuing in China, but profits were negatively affected probably by unfavorable intercompany volume and middle East project timing.

Finally, turning to slide eight I'd like to make a few comments on the fourth quarter.

Adjusted operating margin in the fourth quarter should expand versus the prior year supported by price volume growth continued execution of our productivity and restructuring initiatives.

Partially offset by inflation.

Excluding special items anticipate total corporate costs in the quarter to be $10 million to $11 million.

But expected restructuring savings or $1 million in Europe .

Our adjusted effective tax rate should approximate 28.5% in the fourth quarter.

The FX impact should be negative as compared to the fourth quarter last year.

We are expecting strong cash flow generation in the fourth quarter consistent with our performance over the past several years.

We estimate capital spending will approximate $30 million for the year.

Finally, we anticipate incremental costs of $1 million to $2 million into fourth quarter, including additional cost to finalize the European project I discussed earlier.

With that I'll turn the call back over to Bob before we begin Kuni Bob.

Thanks for sharing.

To summarize the quarter played out as we had expected with solid earnings and margin expansion along with tempered topline growth.

We acquired the assets a backlog direct to extend our product range and meet our customers' needs.

And we expect our second half sales and margin expectations for being in line with our previous outlook.

So with that operator, please open the line for questions.

Please standby well they somehow the culinary roster.

And our first question comes on line as Nathan Jones, <unk> airline or something.

Hi, good morning poorly on for now.

Good morning wanting.

[laughter].

Yeah, that's within a very consistent with the strategy of its organic investment.

Driving growth and margin expansion somewhat a focus first on gross.

Comments on the background were helpful. I was wondering though if you could talk about you know.

Some of your strategies are penetrating some of your international markets like the Middle East.

What does that work going forward are seeing traction there and then also you're talking about some of your conducted solutions and they've been up there.

Yeah. Thanks, Adam certainly a we believe there's opportunity in growth inside the middle East region. Right. Now are quoting activity is very high we are continuing to invest there, but we're being very cautious from let's call. It a collection point of view, there's a lot of jobs out there were really tight with our terms because really important.

We remain disciplined and get our cash so lot of activity and we're seeing some projects being delayed with some of the uncertainty that I talked about previously so again, we believe in the long run, though we have low market share there and it's a huge opportunity for us to grow. So we'll continue to invest there on the connected products.

There is still remain very strong we're driving you know those are continue to grow double the rate that our existing portfolios growing and we plan on being in the double digits of as a percentage of our overall sales by the end of this year. So again, great opportunities our continued investment isn't that area.

And we believe that will be opportunities for growth in the future.

Alright, great and then just switching over to the margin side [noise] somebody was talking about a moving into 2020, there's a lot uncertainty. How you guys are a balanced growth investments and then also margin expansion. So you know were where are you guys a in the weighing transformation journey.

And then just you know any other color there would be great [laughter].

Yeah. So I'm when we look at margins next year, obviously dependent on how far the topline grows you know that will determine how far we expand but we as you know we have many opportunities for lean in our organization both in our factories and on our front end and that's really our focus because we believe we need to continue to drive productivity tool.

Allow us to invest in the future. So you know margin increases you know that's our continued gold as we've always stated we believe we have the opportunity to do that but in the face of that we've also been looking at our overall corporate investments on where you know when our global investments on where we believe we can drive overall shareholder value by in.

Testing and growth opportunities. So are we haven't done a lot of M&A and we believe investing in ourselves as the best a value for our long term for our shareholders. So again were will be reviewing that as we get closer to 2020, but I still believe we have ample opportunity to grow our margins.

Great. Thank you.

Thanks.

And our next question comes on the line of Jeff Hammond Keybanc. Your line is open.

Hey, good morning, guys.

Running running Jeff.

He just on a the Americas commentary you know outlook can you just kind of bifurcate, what you're seeing in the business specifically in terms of you know areas that might be weakening versus kind of the the high level macro data, which which might be pointing to more caution, but you know maybe you're not seen yet in the business.

Okay.

Basis is predicting our future. So you know activity sills is strong we did see in our heating and hot water. Some of our business got pushed into the fourth quarter. Some delayed funding happened a lot of quotation activities are still out there. So again, we see growth, but just probably slower growth because a lot of growth.

He has been driven by pricing increases those you know as a result of tariffs battle slow down as we go into next year and then again, our leading indicators are you know, saying that a in particular in the.

Commercial area that they should be slowing in the future, but our teams are optimistic we'll get our fair share and more of the market that's out there.

And then that this time, <unk> or I guess delays and timing issues does that.

Reverse in for Q, or where is that something is pushing into 2020.

<unk> I would say both we are seeing we have a strong backlog on the heating and hot water solutions group in into the fourth quarter. So your orders were up double digits in Q3. It just the shipping was in Q4, some educational institutions I'm just delayed the timing of the funding of the.

Those projects normally they seasonally our in Q3 and it moved out into Q4. So again, we should have a solid Q4 in that business and just to note on the heating hot water side, our lead times are longer. So those projects came and that's why I've talked about orders were good but they'll be shipping in Q4 on the other side of the business. It is book and ship business primarily.

Okay, Great and then can you give us anymore I'm back flow direct what's the the annual revenue is there a revenue contribution you to think about for Fourq, you and anything around you know kind of the multiple you paid for the business.

Yes, so Jeff they've been running at about two to two and a half million per quarter and a again weve. The owner is asked us to not talk about the details of the transaction, but you obviously could read our cash flow statement, but anyways, we believe it's a great opportunity for us in the long run from an R&D point of view it saves us about three years of device.

What meant they have unique product. That's is you know smaller and lighter than our existing products. So it feels the need a that we have in our portfolio and I think it's a in the long run will aid in our new product development. So we're really excited about this acquisition.

And then maybe one last one I <unk>.

Yeah, and you know you say you know you know we didn't restructuring and I have to them off this last year and as a result of that as well as the tax law changes within the Eurozone. We just we decided to do an assessment of our legal entity structure, and we incurred some legal and tax fees.

As we gain further insights from that effort from that analysis, we all side consultants that you do a deeper dive of our product and customer profitability by country to help guide us in future investments I think we're still in the middle of then we're going to complete that in the fourth quarter, but it will certainly help us a you know drive better investment to say.

He is as we go forward so more to come on that in the next call and Jeff just to add you know we set up the principal company inside of Amsterdam, and again, a lot of billing and centralized activity was going through that so we wanted to break that back up because we're really more focused on the countries.

At this point in time, and we believe it's a better opportunity to do that so that's why we needed to break that up in allocate the right cost of the right places.

Okay. Thanks, guys.

Thank you. Thank you.

Our next question comes on line of Brian Lee Goldman Sachs. Your line is open.

Hey has gone this is Alex on for Brian .

My other more now.

Just a quick one for me appreciate the the macro color I think in the prepared remarks, so in light of those trends that you mentioned.

Have you are there any any changes to the business model or the markets that you're targeting going into next year or is it just a bit cyclicality that you're saying.

I think it's a bit of cyclicality I mean, you know we're going to continue on our investments our new product development are connected strategy. All of that we believe will allow us to have above market growth opportunities. So you know that's really important and I always remind everybody that.

60% to 65% of our businesses repair replace that tends to follow GDP and as we all see GDP is continuing to be positive. Although slightly you know moderating, but overall you know the business model is sound will continue invest in emerging markets also because we have low market shares there, but right now there's a little political turmoil.

Oil and some of those countries that we've been investing and but again, we're in it for the long run and we believe there's opportunities in the long run.

Great appreciate that and just I'm just a follow up there.

Would you would you say those trends that you are referring to are occurring in Europe as well.

Well, yes, certainly in Europe I mean.

I think you know with the Brexit the uncertainty in that whole region, you know in and then let's call. It the trade impacts that are you know going on as a result of that so you know there was a report out yesterday that France is coming back we had a strong growth in France. So that's an opportunity for us. So again you as you followed me you know I've always.

Been very conservative in Europe , just to make sure our cost structure on alignment, but our two other businesses that are growing in their both our dreams and electronics those are global growth businesses, and we believe there's opportunities to continue to grow in those markets. The other areas I think they'll be more slower growth and we'll make sure our cost structure is aligned to that.

Excellent Thanks, a lot.

Thank you.

[noise] and our next question comes from the line of Joseph Giordano of Cowen. Your line is open.

Hey, guys. Good morning, this is frenzy screen for Gil thanks.

Francisco morning.

Good morning, So you guys called out or some of the momentum in U.S. institutional building that seems to the weakening we seem to things like the Dodge momentum index.

Slowing down are you guys seeing anything notable that that you can be calling out in that part of the business specifically.

Not really I mean, again coatings up we've seen some project delays and and that's normal right in our business. When there's uncertainty projects just get pushed out and stuff, but we've not seen any cancellations and hopefully some of this uncertainty will go buy but there we still see good spending but some of those indicators are longer leading indicators and.

I think that's what we're very cautious on so again, we're gonna be watching that carefully. We've you know talking to our sales team. They still still feel bullish, but we're also very cautious and Washington around the corner to make sure. We're prepared if there's any significant downturn, but right now steady as it goes.

And again, but remember our comparison tariffs and all that are also impacting our growth into the future.

Okay, Great and then in terms of of German Oems, how do you guys seen any positive signs on that side.

I'm not really I think it's a again and we all read about the German economy, and you know potentially they've been in recession, and and I think there's just muted spending right now I mean.

So that's something we're going to watch cautiously, it's not been horrible, but it's we've not seen growth there and that's an area. We just a will remain cautious on.

Okay, great. Thank you.

Thank you.

[noise] and there are no further questions at this time I'll turn it back over to Fasano for closing remarks.

Thank you everybody for taking the time to join US today for our third quarter earnings call and we appreciate your continued interest in watts. We look forward to speaking with you again in our fourth quarter call in February Thanks again.

This concludes today's conference call you may now disconnect have a good day.