Q2 2022 Watts Water Technologies Inc Earnings Call
Our business, reducing insurance costs, and providing peace of mind to property owners.
Our system employs a smart valve thermodynamic sensing probes to monitor flow.
<unk> closed preventing additional flow and a notification alert is sent via the proprietary app if the preset flow parameters are exceeded.
The blucher connected roof drain provides early detection of blockages in rooftop drainage and helps prevent potential damage resulting from flooding.
Our system detects water levels and temperatures and will trigger a notification to the building management system or app, if readings exceed certain levels.
Temperature capabilities are also designed to detect snow or ice and send notifications to enable ice or snow melt controls.
As you can see our investments in smart and connected solutions are providing real time problem solving and great value to our customers.
Now on slide five I'd like to update you on our sustainability efforts.
In June we issued our 2021 sustainability report highlighting our accomplishments and establishing some longer term goals to reduce our environmental impact.
During 2021, we work to further distinguish ourselves as a responsible and committed corporate citizen finding strategic opportunities to advance each aspect of our ESG strategy.
In early 2022, we proudly joined the United Nations Global compact reaffirming our commitment to incorporate the <unk> principles and standards on human rights labor and environment and anti corruption into our strategy culture and operations.
During the year, we improve water use intensity by 28% greenhouse gas intensity by 30% and hazardous waste intensity by 23%.
We are also solving sustainability challenges for our customers by designing and commercializing sustainable products and solutions based on our Triple play theme of safety and regulation water conservation and energy efficiency.
We continue to focus on social responsibility in 2021, we achieved zero recordable injuries at 13 sites established diverse hiring targets at 12 U S sites and collaborated with planet water to provide clean safer drinking water to families and disadvantage areas.
In addition, we encourage and supported the formation of six different employee resource groups as part of our overall work to attract retain and inspire talents at watts.
Sustainability is core to what we do at what's it is a key component of our strategy and is ingrained in our culture we.
We look forward to continuing our sustainability journey and furthering our commitment to improving our communities.
With that let me turn the call over to Shashank, who will address our second quarter results and our third quarter and revised full year outlook Shashank.
Thanks, Bob and good morning, everyone.
Please turn to slide six and I'll review, the second quarter's consolidated results.
Sales of $527 million were up 13% on a reported basis and up 16% organically.
We had a very strong quarter in the Americas.
So mid single digit growth in Europe .
We saw double digit growth. Despite the tough second quarter of 2021 comps that included a 3% benefit from the fees and the south Central United States.
Foreign exchange, primarily driven by a weaker euro reduced year over year sales by roughly $18 million or 4%.
Acquisitions accounted for $2 million of incremental sales year over year.
Adjusted operating profit was $98 million.
Up 40% compared to last year, and adjusted EPS was up 43% to $2 11.
Adjusted operating margin of 18, 5% was up 360 basis points.
Volume and productivity more than offset inflation incremental investments and normalized spend.
As Bob indicated our margins benefited in the quarter from our proactive investment in inventory at lower cost combined with higher price.
The adjusted effective tax rate was 26% 110 basis points lower than the second quarter of 2021.
The decrease relates primarily to the restructuring of our Mexican supply chain operations.
Our free cash flow year to date was $33 million.
Compared to $65 million in the second 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 net capital spend which more than offset higher net income.
Sequential improvement in our free cash flow and our full year goal is to drive free cash flow conversion of approximately 90% of net income.
Our balance sheet remains strong.
Gross leverage was 0.6 times and net leverage was negative 0.1 times.
Our net debt to capitalization ratio at quarter end was also a negative at 2%.
Year to date, we have repurchased approximately 434000 shares of our common stock for $61 million.
Please turn to slide seven and I'll provide a few comments on the regional results.
The Americas had a very strong quarter with organic sales up approximately 22%. Despite a tough comp that included approximately 4%.
<unk> from the impact of the fees and the South Central region of the U S.
Second quarter of 2021.
Net growth was driven by strong price realization and underlying market demand.
We saw growth in all platforms and all channels.
Acquisitions added approximately $2 million or 1% to reported sales.
Adjusted operating profit increased by 58% and adjusted operating margin increased by 510 basis points.
The margin expansion was driven by price volume and productivity, which more than offset inflation incremental investments and the return of normalized business costs.
Our proactive investment in inventory at lower costs combined with higher price.
Also contributed to margin expansion.
Europe had a solid quarter with organic sales up approximately 5%.
Reported sales growth was negatively impacted by 12% from unfavorable foreign exchange movements.
We saw organic growth in our plumbing HVAC and drains platforms.
Solid growth in Germany, and Italy, driven by OEM business.
Government energy incentives.
Scandinavia also saw strong growth as the food and beverage end markets continued to be robust.
As mentioned by Bob we have stopped our direct shipments to Russia, and we estimate the impact to be approximately $3 million in the second quarter.
Operating margin declined 80 basis points.
Price and productivity were unable to fully offset rising inflation continued investments at normalized business expenses.
<unk> grew organically by 3%.
Reported sales declined 1% due to unfavorable foreign exchange movements of 4%.
China's organic sales grew high single digits, primarily due to commercial valves into the data center market.
Underfloor heating sales declined due to the impact of Lockdowns in China in the second quarter.
Organic sales outside China were up low single digits.
Adjusted operating margin decreased 220 basis points as price and productivity were unable to offset a reduction in affiliate volume inflation and investments.
China affiliate volume was down 38%.
Primarily to a tough compare from the U S <unk> demand in the second quarter of 2021.
Slide eight provides our assumptions about our third quarter and full year operating outlook.
First let's cover the third quarter outlook.
We are estimating consolidated organic sales for the third quarter to grow at 5% to 10% over the third quarter of 2021.
This moderation in growth rates is due to three reasons.
Firstly underlying market conditions are expected to soften in Europe as evidenced by the declining order pattern. Starting in May is a direct result of the impact of the Ukraine or <unk>.
Secondly, we have more challenging comps due to the multiple price increases implemented in the first nine months of 2021.
Lastly, we also expect a headwind from the direct sales loss from our decision to exit the Russia market.
Approximately $3 million.
We expect approximately $2 million of sales from prior acquisitions.
We estimate our adjusted operating margin could range from 14, 5% to 15, 1% for the third quarter with the increase versus prior year, driven by price and productivity and offset partially by incremental investment spending of $6 million.
We estimate the incremental volume to drop to between 25% to 30% versus prior year.
The sequential decline in operating margin from the second quarter is driven primarily by volume deleverage and incremental investments.
In addition, as previously mentioned the <unk>.
Favorable price cost dynamic normalizes in the second half as price cost becomes more balanced.
Corporate costs should be approximately $13 million.
Interest expense should be in line with the second quarter at approximately $2 million.
The adjusted effective tax rate should approximate 24%.
Currency looks to be a headwind in the second half. We are now assuming a 1.00 average euro U S. Dollar FX rate for the third quarter versus the average rate of euro of $1. One eight in the third quarter of 2021.
This implies a reduction of 15% year over year, which equates to a reduction of $20 million in sales at <unk> <unk> a share in EPS versus prior year.
Now, let's cover the full year outlook.
For the full year 2022.
Increasing our organic sales growth outlook to 8% to 11% from 3% to 8% we.
We believe that our stronger than expected start in the first half and our expected third quarter outlook, we will be able to more than offset expected weakness in Europe in the second half our exit of business in Russia, and the overall weakening of global macros.
We are also increasing our full year adjusted operating margin expansion to a range of 110 basis points to 160 basis points.
Third to our previous outlook of 20 to 60 basis points.
We now expect our operating margins to be between $15 four and 15, 9%.
We expect the increase in inflation and incremental investments 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 April and should approximate 90% of net income.
As a reminder, we expect incremental capex and restructuring payments in 2022 compared to 2021, and we do plan to reduce our inventory levels and supply chain to begin to normalize.
For the full year, we are now assuming a 1.0 site average Euro U S dollar FX rate.
The average rate of euro of $1 one eight in 2021.
This would imply a reduction of 12% year over year and equates to a reduction of $64 million in sales and 21, a share in EPS for the full year versus prior year.
And regarding other key inputs for the full year.
We expect corporate costs could be approximately $49 million for the year.
Interest expense should be in the range of $7 million to $8 million for the year.
Our adjusted effective tax rate for 2022 should be between 24 and 25%.
Capital spending is expected to be in the $40 million range.
<unk> and amortization should also be approximately $40 million for the year.
We expect our share count to be approximately $33 7 million.
The year.
Now, let me turn the call back over to Bob before we begin Q&A Bob.
Thanks for sharing on slide nine I'd like to summarize our discussion before we address your questions.
The second quarter was stronger than we anticipated with double digit organic growth and strong drop through as a result of our proactive investment and lower cost inventory.
We're staying on top of the price cost dynamic and expect tougher second half compares we expect a solid third quarter, although sequentially down from Q2, we are increasing our full year outlook based on our strong start which should be able to offset headwinds from the war in Ukraine and softening GDP.
We are monitoring our markets and are confident in our ability to execute in this uncertain environment.
We continue to execute against our strategic framework, including focusing on innovation and profitable growth by investing for the future and driving our smart and connected strategy with that operator. Please open the line 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 is from the line of Jeff Hammond with Keybanc. Your line is open.
Hey, good morning, guys.
Gotcha.
So just on this this price cost gap.
Into the second half as the largest delta that you had some low cost inventory working through in <unk> and you won't have that or.
It seems like inputs are normalizing a bit.
You continue to push price just just more color there.
Yes, Jeff and that that was it.
In parallel with the price we got we had the lower cost inventory. The net amount is about $6 million to $8 million that we got the benefit in the second quarter.
Okay, Great and then.
Just on the full year revision can you just isolate how.
Youre looking at EMEA.
EMEA and Asia.
You don't differently or same or is it just all the revision on the Americas.
We will look at.
Jeff when you see inside of our numbers for Q3, we think North America is going to be up double digits. We believe Europe is going to be down low single digits and mid single digits for now in Q4 were being cautious really because of Europe right. Now as you know, we're a short lead time business and the visibility.
<unk> for Europe as it is a concern for US right now so the team's doing a good job of managing it but.
We're watching closely so we're being cautious in Q4 based on that but overall Americas is doing well and Anthony is coming back given the lockdowns.
So you so on part of your kind of lower in Europe .
Forecast a bit versus previous quarter okay.
And that's showing up in the order rates since may.
Yes, yes, sure Shane talked about we started seeing declines in order rates and May I think some of it is destocking of inventory.
That's going on in the channels right now and just the cautious nature because of the significant energy increases and everybody just being cautious given there's a potential recession in front of them.
Okay, and then just last one.
Maybe talk about inventories in the channel and need to restock or Destocking in North America.
Yes, North America is holding its own I think theres some discussion.
We are beginning to talk about inventory, so we're watching that closely but.
I think we benefited also in the second quarter, because we did have the inventory and as you know so a book and ship business you whoever has the inventory gets the order so.
I think we're watching that closely but I think it's.
Decent inventory levels in North America.
Okay. Thanks, so much guys.
Thank you.
Your next question is from the line of Joe Giordano with Cowen Your line is open.
Hey, Good morning, this is Michael on for Joe.
Morning, Michael.
So we're watching that we're also watching and general supply chains are starting to get more balance. So I think the fear of people, having a bunch of inventory to offset supply chain issues with lead times coming down I mean, I think we're watching all of those things and how they come together, but in general we feel positive about North America.
And apnea is Europe is the biggest concern for us.
Yeah, no that makes a lot of sensus should've been clearer as more curious about the Americas. We've seen touched on that so are you are you actually seeing the weakness in the single family.
Business today.
It's more of a prospective comment.
Yes, we're seeing that but like I said, we're seeing some offset in multifamily.
No makes sense.
And then from a from a channel partner.
They are seeing whereas there had AD and then maybe a thought on inventory levels in your main channels in that question just on Americas.
Yes channel when you talk to the channel, especially when you get into the contractors. They are all still busy so they're cautiously optimistic but theyre certainly.
Hearing the same things, we're all hearing so they're more concerned about their future later on and stuff, but I don't think for the most part nobody believes it's going to be a potential if there's a recession in north America or a downturn nobody believes at this point is going to be very long. So there are optimistic their biggest issue right.
Now as labor it continues to be labor issues getting the right labor to fulfill it which I think helps extend the cycle.
Over a longer period.
And then just the comment on the inventory levels.
Inventory levels I think are stable inside of North America.
We've heard rumors of people beginning to think about that reducing inventories because they're seeing commodities starting to come down and they don't want to be caught with higher inventory. So it's not we have not seen a significant shift at this point in time, but we're monitoring it.
Great.
I want to ask a question.
Because margins, even though they were pretty spectacular. So thanks, guys really appreciate the time thanks.
Thank you.
Your next question is from the line of Ryan Connors with North Coast Research. Your line is open.
Great. Thanks for taking my question.
I wanted to kind of step back and look at the margin question from a bigger picture perspective, Bob and I think it's pretty remarkable we think back just a few years ago, you were talking about a margin operating margin targets of 12%, which I think we interpreted that it's like.
That's the reasonable margin the market will bear for for this industry.
So if we look at it from that perspective, I mean, do you think you're obviously going to try to hold price. If in fact raw materials come down, but do you believe that theres been a structural upward shift in sort of the natural <unk>.
Equally Abraham cross cycle margin for this industry.
D or not do you think gradually things will revert back I'm just curious on your big picture perspective of what all this is done too.
The run rate margin for this for the space.
Yeah, Ryan we've always talked about mid teens. So in our mind. It was always 14 to 15 not 12, but.
The question of timing every year, we talk about growing margins 30 to 50 basis points, while still investing for the future, but in general I think a couple of things.
We've driven productivity, we've got great supply chain and we focused on automation in our factories. So I think.
As you know, we're continuing our lean journey. So I think all of those contributed to our ability to take out costs and drive higher margins overall, but we tried to add value to our customers and differentiate our products, especially in the smart and connected area, which we believe command higher margins.
Alright.
Maybe a related follow up to that would be.
You made the comment earlier that whoever has the.
However, as the inventory gets the order do you believe that theres been any market share shifts because of.
Some companies may be yourselves handling the supply chain issues more effectively.
Head above water and others.
Not faring as well and may be suffering some reputational damage in the process.
Has there been any any share shift over the last couple of years that you think could.
Hold going forward.
Yes, I think.
Shares bounce around right. It depends on who has the inventory and the timing of that inventory I think certainly our vertical vertically integrated strategy of manufacturing.
Where we ship has paid off especially in an environment like this where lead times supply chains from overseas are much longer. So I think that benefited us and we really saw the benefit in Q2, because there was shortages of inventory in the market.
<unk>.
Believe we took our fair share of what was out there, but the supply chains are coming back to levels normal levels with all of our competitors. So I think.
Great performance, we have in Q2, we're going to do our best to continue that and but I think it was abnormal because.
We pushed it and we had the inventory in our strategic investment in inventory really paid off.
Yeah, that's clear thanks, so much for your time.
Thank you.
Yeah.
Your next question is from the line of Brian Lee with Goldman Sachs. Your line is open.
Hey, everyone. This is miguel on for Brian . Thanks for taking my question I just had two.
Two questions. The first one was just I wanted to touch back on.
The conversation around channel inventories just wanted to hear a little bit more commentary on your visibility into the channel specifically wondering.
I was specifically wondering how much destocking do you think because has occurred so far how much inventory is out there if there's a way to measure that in months or weeks and what are your expectations on how those channel inventories work their way through the rest of the year and next year and if there's a way to talk about that on a regional basis if possible. Thanks.
<unk>, that's a very difficult we have thousands of customers right and we do not have that visibility. So we have to do channel checks et cetera. As I said earlier I think Europe is the biggest place that we're seeing beginning to see channel destocking.
Which makes sense, especially in the smaller wholesalers cash is king as you can imagine and.
I think thats important I think that also holds true in North America, but again visibility is limited from our point of view I think a general comment would be is supply chain.
Better lead times come down I think.
The channels, the wholesalers and contractors will hold less inventory because there'll be relying on.
The wholesalers and the manufacturers to ship it to them so timing of that it's difficult to predict but in general I would say over a longer term a year or two I think that'll begin coming down.
Okay. Thanks, that's very helpful and then.
Second question and I'll pass it on just on.
The guidance for adjusted operating margins.
Guidance.
Suggest that <unk> was the low point on operating margins. This year is that the right way to think about it and I know youre not guiding to 2023, but just hoping to get more commentary on how you. How you think about the general cadence of margins beyond this year as the balance of.
Those pricing actions and also in the lower inventory costs normalized.
Okay, we're not talking about 2023 at this point in time, but I would just say in general when you look at margins as I stated earlier in one of the previous questions were being cautious about Q4, given European margins and.
In European volume I think the thing as you can imagine we've had a lot of discussion regarding we have high fixed costs in Europe and it takes a while to take those costs out so if volume de leverages.
Normally hurts, our margins and we've been benefiting over the last two years with really strong volume inside of Europe , and we're starting to see from an order point of view that slowing. So again, we're cautious about that because again, we're a book and ship business. We don't have a significant visibility to the <unk>.
Future. So we'll update you will take it a quarter at a time.
We will update you at the next.
Next quarter and give US you are.
Better guidance into the future.
Okay, great. Thanks, very helpful I'll pass it on.
Thank you.
Again, if you would like to ask a question press star followed by the number one on your telephone keypad.
Next question is from the line of Walter Liptak with Seaport Global Your line is open.
Hey, good morning, guys, thanks, and good quarter.
Good morning, I wanted to ask about.
If you can help us with with selling prices.
Some of the commodities cost.
It's been a mixed bag or are you still picking up prices did you pick them up in the quarter what was the cadence of some of the price increases.
Yes look so Walter <unk>.