Q1 2022 Watts Water Technologies Inc Earnings Call

Commodity cost increases, especially in copper steel and energy together with increases in logistic cost have driven us to announce additional price increases globally.

Those will go into effect during the second quarter, and we should start to see the benefit of those price increases at the end of the second quarter.

Our supply chain and sourcing teams have worked diligently to facilitate component availability and to manage cost increases we are proactively built higher inventory levels, which enabled us to better meet customer demand.

During the quarter, we continued to invest for the future.

We incrementally spent approximately $4 million of which over half was invested in our smart and connected initiatives.

We plan to spend an incremental $20 million during 2022 to support additional growth smart and connected products and automation projects.

Now I'd like to provide an update on our end markets.

For now the North America repair and replacement market is holding up well.

Through the first quarter, new residential single family construction, that's been up low single digits and multifamily residential starts have continued to grow with strong demand.

And new nonresidential construction, the industry indicators, including the Abi and Dodge momentum index has been positive for several months. This would portend improvement in commercial new construction starting in late 2022 is the Abi as an indicator of future new construction starts however, we're monitoring the impact.

<unk> of rising interest rates inflation and material and labor shortages on the new construction markets in.

In Europe . The war is triggered both the reduction in GDP forecast and higher inflation driven by rising energy costs.

We have stopped our direct shipments to Russia, the impact of which we estimate to be approximately $10 million for the rest of 2022.

As a result of all these factors and our best estimate of the indirect shipments to Russia, we anticipate that the second half of 2022 could be slower than we previously thought gov.

Government sponsored home energy subsidies in Germany, and Italy should continue to provide support at least in the near term. However, the impact of the war in Ukraine, and reduce GDP expectations could be a headwind.

In the Asia Pacific region, our China markets were resilient in the first quarter. However, we anticipate the lockdowns in various cities in China could have an unfavorable impact in the second quarter, particularly on the heating business.

On a positive note the middle East is recovering nicely with a higher price of oil fueling construction spending in the region.

Now an update on our outlook for the second quarter and the remainder of the year.

We expect a solid year over year performance in the second quarter. Despite the headwinds from the freeze in 2021.

Price and productivity should more than offset the impact of the war in Ukraine inflation and incremental investments.

Due to our anticipated strong first half we are increasing our full year outlook for operating margin expansion are.

Our full year organic sales growth outlook is consistent with our guidance in February .

The strong first quarter performance and additional price increases should be able to offset headwinds in the second half, particularly around the war in Ukraine and its potential impact on the economy in Europe .

Before turning the call over to Shane Arno mentioned, we will be issuing our annual sustainability report this summer.

The enhanced report will discuss our latest accomplishments and some important ESG initiatives so stay tuned.

With that let me turn the call over to Shashank will address our first quarter results and our second quarter and revised full year outlook Shashank.

Thanks, Bob and good morning, everyone.

Turn to slide four and I will review the first quarter's consolidated results.

Sales of $463 million or up 12% on a reported basis and up 14% organically.

We saw strong demand in all regions, and we're able to drive solid price realization.

Saw double digit growth. Despite the tough first quarter 2021 comps that included a 3% benefit from the fees and the south Central United States.

Foreign exchange trading driven by a weaker euro reduced year over year sales by roughly $10 million or 2%.

Acquisitions accounted for $2 million of incremental sales year over year.

Adjusted operating profit was $73 million up 21%.

<unk> last year, and adjusted EPS was up 31% to $1 63.

Adjusted operating margin of 15, 7% was up 120 basis points as volume price and productivity more than offset inflation and incremental investments.

The adjusted effective tax rate was 22% 590 basis points lower than the first quarter of 2021.

The decrease relates primarily to a higher tax benefit resulting from divesting of stock compensation Awards geographical earnings mix, resulting from the restructuring of our Mexican manufacturing supply chain operations.

And the favorable impact of tax contingencies.

Free cash flow for the quarter was negative $8 million.

Compared to a positive cash flow of $32 million in the first quarter of last year.

The cash flow decrease was due to our proactive decision to invest in inventory.

Higher employee and customer incentives and restructuring payments and higher capital spend which more than offset higher net income.

We expect sequential improvement in our free cash flow and our full year goal is to drive free cash flow conversion at 90% or more of net income as previously communicated.

During the quarter, we repurchased approximately 293000 shares of our common stock for $43 million and as Bob mentioned announced a double digit increase in our dividend.

Please turn to slide five and let me provide a few comments on the regional results.

<unk> had a strong quarter with organic sales up approximately 14%.

Despite a volume headwind of approximately 4%, resulting from the fees impact in the south Central region of the U S. In the first quarter of 2021.

The net growth was primarily driven by strong price execution we.

We saw growth in all platforms in all channels, except for DIY, which had a tough compare due to the fees.

Acquisitions added approximately $2 million or 1% to reported sales.

Adjusted operating profit increased by 20% and adjusted operating margin increased by 70 basis points.

<unk> expansion was driven by price and productivity, which more than offset inflation incremental investments and the return of normalized business costs.

Europe also delivered a strong quarter with organic sales up approximately 14%.

Reported sales growth was impacted by 8% due to unfavorable foreign exchange movements.

From a platform perspective, plumbing, HVAC electronics and drains were all up double digits.

We saw strong growth in Germany, and Italy, driven by our OEM business and government heating subsidies.

<unk> also saw strong growth as our marine markets saw some recovery and food and beverage end markets continued to be robust.

The impact from the war in Ukraine in the first quarter was not significant.

Operating margins expanded 120 basis points from price volume and productivity more than offsetting inflation.

<unk> also had a strong quarter delivering 13% organic growth.

Reported sales growth was impacted by 3% due to unfavorable foreign exchange movements.

China's organic sales grew high single digits from commercial valves in under floor heating.

Organic sales outside China were up by double digits with growth in Australia, New Zealand and in the Middle East.

Adjusted operating margins increased 30 basis points due to higher third party sales volume price and productivity, which more than offset a reduction in affiliate volume inflation and investments.

China intercompany volume was down 13% due primarily to a tough compare from the U S feed demand in the first quarter of 2021.

Slide six provides our assumptions about our second quarter and full year operating outlook.

First lets call for the second quarter outlook.

We expect a solid year over year compare despite the headwinds related to the <unk> benefit in the second quarter of 2021 in the U S.

As Bob mentioned, we have announced an additional price increase globally to offset incremental commodity and supply chain inflation.

These are scheduled to become effective later in the second quarter and so we'll have a minimal impact on results.

In total we estimate consolidated sales may grow organically between 5% and 10%.

In addition, we expect approximately $2 million of sales from prior acquisitions.

We estimate our adjusted operating margin could range from 15, 1% to 15, 5% for the second quarter, driven by price and productivity and offset partially by incremental investment spending of $5 million and incremental costs of $3 million related to the return of normalized business costs.

All in we estimate the incremental volume to drop through between 25% and 30%.

Corporate costs should approximate $13 million.

We expect that interest expense should be approximately $2 million in the second quarter of 2022, an increase versus the first quarter due to an increase in outstanding debt and rising interest rates.

The adjusted effective tax rate should be approximately 26%.

We are now assuming a 110 average euro U S dollar FX rate for the second quarter versus the average rate of $1 two zero in the second quarter of 2021 and versus the euro of $1. One fee, we provided with our guidance in February .

This implies a reduction of 8% year over year in the second quarter, which equates to a reduction of $13 million in sales and five a share in EPS versus prior year, and a $3 million reduction in sales and a <unk> <unk> share in EPS versus our previous guidance.

Now, let's cover the full year outlook.

For the full year 2022, we are maintaining our prior outlook of 3% to 8% consolidated organic growth.

We believe that our stronger than expected start in the first quarter and the incremental price increases will be able to offset the expected weakness in Europe in the second half due to the war in Ukraine.

While we are maintaining our organic sales growth outlook, we are increasing our full year adjusted operating margin expansion to a range of 20 to 60 basis points compared to our previous outlook of flat to 40 basis points.

We now expect our operating margins to be between 14, five and 14, 9%.

We expect the increase in inflation will be more than offset by price and productivity.

Our free cash flow expectations are anticipated to be in line with our previous outlook in February and should approximate 90% of net income.

As a reminder, we expect incremental capex and restructuring payments in 2022.

We are now assuming a $1 one zero average euro U S dollar FX rate for the full year versus the average rate of $1. One eight in 2000 2021 and versus the Euro 113, we provided with our guidance in February .

This would imply a reduction of 7% in sales year over year and equates to a reduction of $39 million in sales and 14 cents a share in EPS for the full year versus prior year and a reduction of $13 million in sales and <unk> <unk> a share in EPS versus our previous guidance.

And regarding other key inputs for the full year.

We expect corporate costs could approximate $48 million for the year.

Interest expense should be roughly $7 million for the year.

Our estimated adjusted effective tax rate for 2022.

Should be approximately 25%.

Capital spending is expected to be in the $45 million range depressed.

Depreciation and amortization should also be approximately $45 million for the year.

We expect our share count to be approximately $34 million for the year.

Now, let me turn the call back over to Bob before we begin Q&A Bob.

Thanks, Shashank on slide seven I'd like to summarize our discussion before we address your questions.

The first quarter was stronger than we anticipated with double digit organic growth in all regions that was supported by price and stronger underlying demand in.

Inflation continues to accelerate and we've announced additional price increases to offset cost increases.

We are working hard to stay on top of the price cost dynamic and monitor the situation daily.

Strong North America repair replacement demand in both residential and non residential should support a good first half.

As a result, we expect a solid second quarter with strong demand and favorable price.

We are increasing our full year operating margin expansion outlook and are maintaining our full year organic growth expectations with our strong start and incremental price increases they able to offset second half headwinds from the war in Ukraine.

We plan to continue to make incremental investments in new product development to drive our smart and connected strategy and in automation to drive productivity.

We are well positioned financially operationally and commercially to take advantage of market opportunities as they arise and I am confident in our team's ability to execute in this uncertain environment.

With that operator, please open the lines for questions.

At this time I would like to remind everyone in order to ask a question press star followed by the number one on your telephone keypad.

Your first question from Jake <unk> with Baird. Your line is open.

Hey, good morning, everyone again today for my Cowen.

So first question will just I will.

I'll touch on Europe here, and not try to exceed expectations lowered there, but I guess kind of twofold question.

Are you seeing any of that weakness materialized, yet and then secondarily I know we've talked about this.

Following Europe GDP.

But any specifics I guess on how you could see it growing into impacting demand for your products, primarily non discretionary side is that where you're thinking potential weakness would come in.

Yes, good morning, Jake what we're seeing right now.

The only change we're seeing is the lack of orders and shipments to Russia that we've exited so at this point in time, we're cautiously optimistic but we're hearing feedback from our teams on the ground that things are going to begin to slow right. Now. So that's why we're being cautious right now I think it just depends on the extended the war.

And what's going to happen, if Russia shuts off gas I think that would have a dramatic impact. So we're just being cautious at this point in time until we have better visibility to what's happening in Russia, It's still early.

Yes, totally understand and then somewhat related to that.

Looking at the implied guidance here it looks like in the back half of the year margins are expected to sequentially decline relative to first half.

Primarily isolated.

Related to Europe , I think typically North America, we see margins expand in the back half of the year.

Just making sure that that logic.

Guys just thinking about it.

Yes, that's primarily a function of we have obviously in the first half we have incremental volume leverage that kind of goes away a little bit in the second half and then we have incremental investment spend.

And incrementals normalized cost in the second half versus the first half and that's why you see that margin profile you talked about.

Got it alright, great I'll jump back in the queue for now.

Thank you.

Your next question is from the line of Nathan Jones with Stifel. Your line is open.

Yes. Good morning, this is Adam Farley on for Nathan.

Following up on the revenue guide understand.

Just wanted to ask from a war in Ukraine on European growth.

Are you expecting any slowdown in APAC, given COVID-19 lockdowns in China.

Yes, Thats the second piece, we're watching very closely certainly the China Lockdowns have created uncertainty I know, our China Shanghai team has been locked in their homes for five weeks now so.

That will impact our heating business in particular, because construction is shut down in that area. So we're watching that very closely that's another one of these large uncertainties that are out there.

That we're being cautious in our outlook.

China.

Okay.

Okay.

Then youre watts is more much larger and more sophisticated than the majority of its competitors do you believe that better product availability, that's leading to market share gains in this environment.

Which products and markets do you think thats occurring.

Well certainly we've invested a lot of.

Money into inventory to make sure we have available products, we have a vertically integrated strategy as you know, where we manufacture and where we sell both in North America and Europe . So we believe that in this environment with the uncertainty and spikes in demand is certainly helps so I think we are.

Certainly holding our own and in various places taking market share. So we don't believe we're losing any market share for sure.

Alright, thanks for taking my questions.

Thank you.

Your next question is from the line of Joe Giordano with Cowen Your line is open.

Good morning, this is Michael on for Joe.

Good morning, Michael Good morning.

Yeah, as we look towards the housing market.

Pacifically multifamily how should we be thinking about.

<unk> out of the Gulf power, what's your outlook there.

Multifamily has been very positive and we like multifamily homes, because they're more code driven and have.

More larger products than single family homes, so although might be peaking in single family home market.

That is being more than offset by multifamily so we're watching that closely but.

We're very cautiously optimistic in that market.

Great. Thank you.

Again, if you would like to ask a question press star followed by the number one on your telephone keypad. Your next question comes from the line of Jeff Hammond with Keybanc capital markets. Your line is open.

Hey, guys.

It's Jeff live and in person.

Hey, Joe how are you.

Good good just wanted to get a better sense of.

What price was in the quarter. It looks like it was most of North America growth in Gist.

Kind of what.

What you've been seeing or what you've been putting out in terms of follow on pricing.

Yes, so in the first quarter just globally are approximately <unk> of our growth about 10% was in price realization.

Little bit more in the Americas, a little bit less in apnea, and then Europe kind of in the middle there.

And the expectation as we go forward.

Price increases, we announced sequentially through 2021, so the comps get harder in the second half of this year. So that's that's what we anticipate now.

As far as forecasting the future we wait till the quarter ends because it's one thing announcing the prices is another they actually realizing them. The teams have done a great job so far but in Q1, it was approximately 10% of utilization.

Yeah.

Okay, Great and then.

I noticed you guys stepped up your buyback in the quarter I Didnt know if thats a function of being opportunistic as the stock has pulled back or.

Any indication of kind of what you are seen in the in the M&A pipeline.

Yes, so I'll take I'll, let Bob talk about the M&A on the stock purchases, yes. It was an opportunistic buyback and historically, we've always said that we buy stock back stopped buybacks for offsetting dilution, we had issued equity, but I'll say, if theres an opportunity in the market and there certainly was one in the first quarter. We did go in and buy stock back.

In Q1.

And Jeff on the M&A front look at as you know, we're very disciplined from that regard. So we're watching we have a solid pipeline and but we're going to be disciplined. So we've not done any major acquisitions, you've done some small bolt ons and right now we felt that was the best allocation of cash in the quarter.

Okay.

Okay, Great and then.

It seems like commercial HVAC or I'm, sorry, commercial construction in North America steam still seems quite robust and I think most people are saying Hey, we're still building backlog in.

We're kind of being held back more by by labor, but just give us a sense of what youre seeing in the commercial landscape.

Yes, we would agree with that we're seeing similar things.

We had across the board growth in all segments and all.

Everywhere, except for retail, which we expected given that that was highly impacted by the freeze but commercial construction.

There was a large backlog of projects and the spending continues and then as we look at.

Some of the leading indicators like I talked about in my prepared comments that would indicate even further expansion, but I think you hit it right on the head they need the labor right now and I think thats the constraint our discussion with our contractors is.

There's a lot of work out there.

Just need more labor and theyre, having material shortages, which are delaying projects, causing cost overruns.

Okay.

Okay, and then just last one.

Maybe just talk about inventory in the channel I think you've said maybe over the past couple of quarters inventory has gotten better for your product, but theres still.

Maybe competitive or other other items that are that are light.

Yes, I would say.

Same the same we're seeing inventory growing in the channels I think it's spotty, where I don't think.

Wholesalers in particular have all the inventory they need from all of the suppliers they need to help the builders complete the jobs, but we believe we continue to.

Give them the products they need when they need them and we.

We have a solid backlog in regards to that and have visibility to what their needs are so we'll continue to monitor that and watch it very closely.

Okay. Thanks, so much guys.

Thanks, Jeff.

Again, if you would like to ask a question press Star one on your telephone Keypad. Your next question comes from Brian Lee with Goldman Sachs. Your line is open hi.

Thanks for taking the question this is Chris on for Brian .

I guess first question's on margin just to follow up on the previous question.

Like.

Our second half Mike your implied margin for the fourth.

Suggest that.

Second half of the year it will be.

Lower.

I guess should we expect <unk> to be the low point of the year then.

Taking it back up into <unk> or do you expect <unk> to be the low point of the year.

And also can you talk about margin by segment like I think last quarter, you indicate that Americas and Europe .

<unk>.

On margin and down.

At me.

It's still.

Do you still expect those trends.

Given the Russia, Ukraine conflict and potential operating at Neal. Thanks.

Yeah. So on your first question right. So right now basically it's the second half, which has a lower margins for the reasons I stated breaking that down between Q3 and Q4.

At this point is kind of a.

We'll update that as we get through the end of the second quarter and we look at what the third quarter looks like but I would say that that margin decline is probably of a roughly equal between Q3 and Q4 at this point, but we'll take another look at it back.

Back to your back to your first question as to the margin profile by region certainly as Bob noted the impact of the of the Ukraine War is more heavily felt in Europe and as that volume goes down and with our fixed cost structure. There the margin the margin decline will be greater in Europe , a little bit less so in <unk>, and then with North America with the strength of the <unk>.

<unk> like we talked about in commercial and multifamily the margin margin accretion should be should still be good there.

Okay understood and margin decline in Europe are you talking about like a sequential.

The sequential declines year over year decline. Thanks.

While it would be first half second half right. That's what we're talking about so it'll be from first half to second half.

Okay got it and then.

Well one last question from me and then on revenue growth.

I think.

Last quarter, you talked about.

The organic growth by segment.

Just given the Russia, Ukraine, Ukraine conflict and Lockdowns in Asia can you give us an updated view on.

Organic growth by segment.

So clearly you got the Q1 numbers in the second quarter guidance I think your question is regarding the second half and as we look at the second half, where we expect the impact of the Ukraine water impact of Europe , and you look at the second half Americas would be like in the low mid single digit growth.

Europe would probably be in the mid high single digit decline in <unk> would be relatively flattish in the second half.

I'm a growth standpoint.

Thank you I will pass it on.

Thanks.

There are no further questions at this time I will now turn the call back over to Mr. Bob Campbell.

Yes.

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

Ladies and gentlemen, thank you for your participation. This concludes today's conference call you may now disconnect.

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Okay.

Yeah.

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