Q1 2020 Earnings Call

It's certainly causing enormous disruption around the globe the speed of which the pandemic has affected our lives in commerce has been unprecedented.

Our company is reacted with decisiveness and urgency focusing on our people safety, our customers' needs and being fiscally responsible to changing market demand.

With our experienced management team, we have recalibrated, our cost structure to help navigate through these turbulent times.

While cobot 19, uncertainties make predicting the future more difficult we will continue to monitor developments daily and proactively take necessary measures based upon underlying market conditions.

The company is well capitalized and well positioned to make it through these challenging economic conditions.

We are taking actions to optimize our cash flow to further enhance our strong balance sheet.

Finally, we are a market leader.

We know we must address the many near term challenges, but we won't lose focus on our long term strategy by continuing to invest for the future, especially in our smart and connected product portfolio.

We expect to come out the other end of this crisis a stronger company.

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

Thank you as a reminder to ask a question you will need to press star one on your telephone to withdraw your question press the pound our hashed Keith Please standby, while we come how they came in a roster.

Your first question comes from Jeff Hammond with Keybanc. Your line is open.

[laughter].

Can you Gary.

Yes, we can do we can now okay great.

Just you gave the really good color in your presentation, you gave the 25% to 30% expectations can you just talk about what you actually saw on your April sales run rates and.

If theres any big disparities between North America in Europe.

Yes, when you look at.

Quarter to date, we've seen about 30% reduction in the Americas and about 40% in Europe, and Asia Pacific about 30% over inside of Asia, Pacific's number actually China was up 2%, which is good However, New Zealand in Middle East where basically close.

For the month, so that's what brought down the overall appia number. So you can see a little worse in Europe and stake they hit the virus.

It hit them harder so I think thats why were seeing that activity.

Okay and then.

Just on the Decrementals living if you kind of run the math, it's in that what 30, 30% range. Just as you start to go through the years that kind of the right detrimental to think about two to you and beyond.

Yes, right in that 30% to 35% range in the second quarter is closer to that 35% arrangement as the year progresses.

Hopefully to volume declines are less it's closer to that 30% decrement range.

Okay, Great and then just finally can you just talk about what you're seeing in terms of deferrals b b on mandatory work stoppages or any cancellations in your.

Kind of order book on the Nonres side.

Yes, we've not seen cancellations, what we've seen as deferrals push outs I think a lot of uncertainties out there just because of the social distancing requirements that is happening out there and as you know places like the northeast in the West Coast, We're basically shut down from a new construction point of view.

Best kind of the activity, we're seeing in the marketplace.

Okay. Thanks, so much guys.

Thanks, Jeff Thank you.

Your next question comes from Nathan Jones of Stifel.

Your line is open.

Good morning, everyone.

Hi, gentlemen.

I apologize if I asked something you covered in your opening comments about a little bit like getting on.

Yes, So you guys have.

Yes, yes, 30 odd percent decline here in the second quarter is there any color you can give us on what you think the display it is between inventory de stocking in the channel that declining replacement revenue and the decline in new construction revenue.

Yeah, that's really difficult to see because you know we saw a lot of activity I think again when you look at our portfolio, 65% is repair replace when we talk to local plumbers et cetera, and our channels. The discussion is emergency work is continuing.

So Andrew on a repair replacement, but a lot of the farmers as well as people in multifamily homes. They don't want anybody in there unless there's a.

A materially or you know a big issue going on right now so I think given the shock to the system. That's why we're seeing this uncertainty, but we can tell especially from our smaller wholesalers you know, they're smaller older ordering less and less so again I think it's pretty much across the board at this point in time, and we think the de stocking.

Will end in May so we're seeing it in April and May will come out of the other end to that and in June once everybody starts opening up all these construction markets.

Okay, I guess part of my point here is on the replacement market I mean, we they caused the level of revenues decline and given that two thirds of the portfolios replacement that to be a fairly significant decline in replacement revenue here I would think that snapped back snaps back fairly quickly once we get the economy.

It's been again and things running again at a more normalized right is that a reasonable expectation.

Yeah, I think it is I I mean look at you can only put off repair and maintenance for so long and whether Oh, a building has one occupant or a hotel is 95% full you still need to make sure. They have good plumbing encode driven is going to be even more important right now so again I.

Your assumption is accurate.

And did you quantify what the cost out.

Number is bullet to 13, Q and going forward.

So the total year is approximately $55 million a piece of that is obviously you know the design reductions we talked about which entered into Q3. So there's a larger portion of that 55 million that happens in the second quarter.

Okay. Thanks, very much I'll pass it off.

Thank you.

Your next question comes from Ryan Connors of Boenning and Scattergood.

Your line is open.

Great. Thanks for taking my question hope everyone as well.

One of the kind of follow on what that prior question on repair replace.

And just kind of clarify and better understand the buckets here, so you're talking about new construction.

Being a third and then sort of repair replace being the remainder where does sort of remodeling fit into all that where you've got.

A restaurant or hotel or even a and into the household you know they're not it's not a new construction, but it's not a replay of emergency repair at some sort of remodeling, which bucket would that fall in and have you seen.

That type of business impacted.

Yeah. So again, it's early on right, but you know with.

April just being you know just you know happening here, we sought across the board, but just if you look strategically inside of that that would fall under depending on if it's a brand. New addition, maybe in the new construction repair replacement if its fixed so it's a combination of both of those but if you. If you just look at some of the.

Markets that we think that are probably more apt to get hit you know restaurants or you know some hotels in the short term and let's call. It just office buildings I mean, that's less than 10% of our business, but still as I said earlier, the you know they'll still need to be repaired it does it.

Codes are going to be more force than ever before and I think theres an opportunity you know for people to continue to upgrade so when you look at our core strategic themes of safety and regulation energy efficiency in water quality and conservation all of those are going to be critical in this new world. So as we go forward also you know I also look at our connect.

Good product strategy, how important that's going to be because you know monitoring and making sure. There's you know what I call less people requirements to determine whether there's issues in the system right. So that's going to be really important going forward. So again, that's where we're looking at and we're watching very close.

Absolutely.

Yes, just on that point, Bob you talked about the connected strategy.

I guess, there's been a lot of talk about reopening these buildings offices, and then hotels and whatnot and then if the if the water has been stagnant in those systems that there's been talk about legionnaires concerns and things like that I know that is part of the connected strategy.

Got a monitoring for some of those things Legionnaires in particular is that is that I mean, that's we could spend that as a positive but as that is that just a longer term thing are you seeing more demand for those type of things even now.

Well, we're doing a lot of seminars exactly on that with our customers engineers et cetera. So you know how to startup buildings et cetera, and we believe you know when you know building sit idle for a while in restaurants and everything else once they start up.

They're gonna have some issues and they need to do with the proper way to prevent you know legionella and other diseases in <unk> in their pipes and system. So again that could be an opportunity for us, but again, we're monitoring it very closely.

Got it then one last one for me if I could you you made a comment in the press release about.

Sort of renegotiating materials contracts can you elaborate on that as the mechanics of that essentially Ken.

Yeah. The actual Chevron is shanksville on as we all know commodities have gone down right, especially comp a little bit stainless and we typically go long on those so we got contracts over the next I'd say 369 months.

And also the challenge we have is the volume is going down it's harder to negotiate price decreases with volume production.

That's in fact, when a unique place so we're going back and we are having some luck in negotiating lower prices as we go forward on those Latino contact contracts as well as even on some freight contracts as well because of the low prices on oil.

Got it okay. Thanks for your time.

Thank you.

Your next question comes from Brian Blair.

With Oppenheimer. Your line is open.

Good morning, everyone hope, you're staying safe and good morning.

Thank you Brian Thanks.

Thank you.

Following up on your second quarter.

Mid to high single digit margin guide.

Can you break that out by by region, what we should expect across your second.

So the margin performance on you know we are up 20 basis points on Americas was the strongest of the region. So we had good and relatively good price performance, there as well and some of the actions we were proactive in our cost actions. So that helped to the first quarter as well so that drove the margin expansion.

Because in Europe, we were actually soft.

In the first quarter and then obviously the talked at the end and then we got affected in ACMI and now as we think about the second quarter, though.

Yeah, we basically said mid to mid to high single digits on the operating margin.

But the volume declines were talking about 25% to 30%, we expect to see margin decline across all regions.

APMEA will be the most affected because their volumes going down as well as they get affected with the intercompany volume piece, but the margin declined a little pretty much be similar in the Americas and in Europe.

Yeah.

And any additional color you can offer on expected cost savings by by region I get said 55 million city year in total and also the.

Variable or structural break out there would be helpful.

Yeah, just to take the second piece first on the structural piece is about 15% of the total approximately $55 million we talked about.

The structural piece, which is you know headcount.

It does have a annual savings related then what we realized in 2020.

As far as the regional split on the cost savings actions.

For the most part you know we everywhere.

Yes about 75% of that's gonna be in the Americas, and then about 20% in Europe and the other 5% in apnea rough rough split we do get a little bit more savings in the Americas versus Europe.

Okay, and what are the key metrics, you're tracking to determine if additional actions needed and what would come next is further actions warranted as we move through to keep going into the back half.

Well, we certainly watch orders or you know, we watch that daily and we continue to look for leading indicators talking to our channel partners understanding you know permits and all the normal things that we've all been looking at for a while I think what's more important as we see this country come back up and running just.

See whether there's some surge of pent up demand et cetera, but you know we're looking at ever all our cost every single piece, we're asking our teams to review every single thing and every single region. So it's across the board were continuing to look we went aggressive right out of the gate and a we have detailed contingency plans when we start the year we trigger.

For those immediately and we'll continue to watch these leading indicators in most importantly, as the these shutdowns come back online we want to see how quickly they syncon.

Got it I appreciate the color.

Thanks, Ryan Thank you.

Your next question comes from Mike Halloran with R.W. Baird. Your line is open.

Hi, good morning, guys.

Funding. So so its kind of a twofold question here you know you've got very strong market leadership and some fragmentation, obviously some sizable scale advantages.

Quitting isn't very good spot strong balance sheet. So <unk> twofold question is one how are you thinking about the potential to widen that disparity versus some of the comp group with how you're thinking about your R&D spend.

The connected politics et cetera, and the second piece of it is how are you guys balancing the need for short term management was continuing to invest in and playoffs and see how should we think about and all those things wrapped together.

Well, Mike as you know we've been investing a lot over the last several years and I think as I said earlier, what what we've been doing is focusing our time and attention on new products with safety and regulation energy efficiency water quality and conservation all of those are going to be really important in this new economy in like.

You said, the smart and connected products are gonna be even more critical because we just need to monitor things and not rely on people and maintenance organizations to really react. So as we look at our investments in R&D, we're going to slightly ratchet down our investments we had a plan of about.

30 million were very aggressive on that and Ah, but when you take that down we're probably going to cut that by 40% ER and really that's where we're cutting is areas like emerging markets right. Now, it's probably not you know we need the emerging markets to come back on that but our smart and connected product. It we are.

Not cutting any costs at all on that because that's more important than ever. So you know that's how I look at that from an overall strategic point of view and just a note on the R&D as you all know what do you know R&D spend in 2019 was 2.5% in the first quarter, we actually had not seen present to it continuing that focus on the Spartan connected site.

Thank you.

Thanks, Mike.

There are no further questions at this time I will now turn the call back over to Bob Pagano for closing remarks.

Thank you for taking the time to join US today. We appreciate your continued interest in Watson look forward to speaking with you again at our second quarter earnings call. In early August have a great day, and stay safe and healthy take care.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.

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