Q1 2018 Earnings Call
What's water technologies first quarter 2018 earnings conference call all lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there will be a question and answer session. If you would like to ask a question during that time. Please press star and then the number one on your telephone keypad. If you would like to withdraw your question. Please press the pound key.
I would now like to turn the call over to Tim Macphee, Treasurer, and VP Investor Relations. You May begin your conference. Thank you and good morning, everyone. Welcome to our first quarter 2018 earnings Conference call with me today is Bob Pagano, CEO and president.
Bob will provide his perspective on our first quarter results offer some color on the markets.
Discuss tariff implications and update you on the CFO search.
I will provide a detailed review of our first quarter results and revisit our full year outlook.
Following our prepared remarks, we will address questions related to the information covered during the call.
Today's webcast is accompanied by a presentation, which can be found in the investor Relations section of our website.
We will reference these slides throughout our prepared remarks.
For purposes of today's call all references to key performance metrics will be on an adjusted basis, unless otherwise indicated and non-GAAP financial information and metrics have been reconciled and are included in the appendix section of the presentation.
Before we begin I would like to remind everyone that during the course of this call.
We will be making certain comments that constitute forward looking statements. These statements.
Subject to numerous risks and uncertainties that could cause actual results to differ materially.
Information concerning these risks and uncertainties see what's publicly available filings with the SEC.
The company disclaims any intention or obligation to update or revise any forward looking statements, whether as a result of new information future events or otherwise.
Let me now turn the call over to Bob Pagano.
Thanks, Tim and good morning, everyone.
Please turn to slide three and let me briefly provide a rundown of the first quarter.
We started 2018 on a strong note delivering record Q1 sales operating margin and EPS.
Organic sales growth trended favorably with all regions contributing.
We expanded adjusted operating margin by 50 basis points and adjusted EPS increased by 26% in the quarter.
Our operating financial performance is the result of executing on our strategy of delivering profitable top line growth and driving productivity and cost discipline in the organization, while continuing to invest for the future.
Regionally sales growth was mainly in line with our internal expectations. The Americas had broad growth in a number of product lines aided in part by favorable comps versus Q1 last year, especially in our boiler business.
Europe delivered a solid top line, which was slightly above our forecast and was driven by drains project timing.
Asia Pacific's growth was consistent with our internal forecast given the anticipated product rationalization headwind during the quarter.
Tim will review the quarter's results in more detail in a few minutes.
The end markets are performing in line with our expectations in the Americas much of the nonresidential construction data remains positive with anticipated <unk> in certain key nonresidential verticals.
Residential new construction data is a little lumpy, but repair and replacement indicators are healthy and we believe in total the residential markets should continue to grow at a moderate pace for the year.
Europe continues to show signs of modest growth, although some recent macro data is signaling some softness.
Asia Pacific markets are growing at moderate levels.
We continue to monitor the potential impact of tariff regulations may have on our input costs.
We believe this issue mainly affects U S purchases.
China imposed tariffs are not currently impacting our products.
And much of our intercompany activity into China is through Europe , which is not affected by the new regulations.
Regarding U S. Tariffs there are many unknowns that require clarity, including a final resolution to steel and aluminum imports and the potential impact of sanctions on China sourced products. So.
So the tariff issue is very much influx and we will react accordingly to the final import regulations.
We have already seen material inflation affect our input costs as a result of the tariff issue.
In addition, transportation costs are rising due to oil cost increases and labor shortages.
We have addressed these latest inflationary concerns by announcing price increases this week that we expect should cover the anticipated incremental costs.
The price increases become effective in July .
Turning to our full year outlook.
Given the strong Americas first quarter start and the recently announced price increases we now expect that Americas organic sales should grow at the higher end of the range. We previously provided.
Further we are reaffirming our original full year outlook for top line growth in Europe , and Asia Pacific and reaffirming margin expansion in line with the assumptions we provided in February .
Finally, a few words on our CFO transition.
First I'd like to thank Todd for his efforts over the past three years. He was a key member of our global leadership team, helping to drive our initiatives and serving as an important contact with the investment community, but we wish him the best.
As noted in the March 30 press release I have assumed the interim CFO role while the outside search for Todd's successor is conducted.
The search is well underway and we hope to have a new CFO onboard sometime in the third quarter.
Now I'll turn the call over to Tim to talk about our first quarter operating results in more detail Tim.
Thanks, Bob I'm on slide four which shows the first quarter's comparative results.
$379 million were up 9% on a reported basis and a first quarter record for watts <unk>.
Organically sales were up 4% with growth in all regions Foreign exchange, primarily driven by a stronger euro increased year over year sales by roughly $17 million or 5%.
Product rationalization as expected with approximately $2 million or 60 basis point headwind in the quarter.
Adjusted operating profit increased 14% to $44 million.
Adjusted operating margin of 11, 6% was up 50 basis points and represents a Q1 record.
Volume price and productivity more than offset $2 million of growth investment.
And inflationary pressures from commodities and transportation costs.
Foreign exchange contributed about $2 million or 5% of the profit increase year to year.
Adjusted EPS of <unk> 82 increased 26% over last year with another first quarter record for watts the increase.
It was driven by operational improvements of 11%.
A favorable tax rate of 9% and favorable FX movements of 6% as compared to last year.
The effective tax rate of 28, 2% is about 500 basis points lower than Q1 last year.
It's primarily to the benefits of tax reform.
Turning to cash as you know historically Q1 is a slower period for cash flow and that played out as expected.
Our free cash outflow for the quarter was $32 million as compared to a $50 million outflow in Q1 last year.
The majority of the incremental outflow relates to timing of working capital outlays in particular inventory and incentive payments.
Important to note while the first quarter is seasonally slow we fully expect our cash generation to improve as the year progresses.
And to achieve greater than 100% cash flow conversion for the year.
During the quarter, we repatriated approximately $71 million in cash.
The majority of that cash was used to pay down our line of credit.
In addition, we purchased approximately 80000 shares of our common stock at a cost of $6 2 million.
In total we returned approximately $13 million in Q1 to shareholders in the form of dividends and share repurchases.
Part of our balanced capital deployment strategy.
So overall a good start to 2018, we delivered record sales operating margin and EPS and we contingency organic sales growth trend positively.
Now turning to the regions on slide five let's review the Americas results for the quarter.
Sales were $241 million up 5% on both a reported and organic basis.
We saw strong performance from our core plumbing valve products like back close regulated relief valves.
Heating and hot water solution sales increased low double digits during the quarter led by echo boiler and aftermarket sales and some favorable comps.
Adjusted operating profit was $36 4 million up 8% over Q1 last year.
Operating margin was 15, 1%, a 40 basis point increase over last year, driven by volume price and productivity.
Margin expansion was partially tempered by higher commodity costs transportation costs.
Product mix and continued growth investments.
So a strong start for the Americas with growth in a number of key products and platforms.
Now onto slide six let's review Europe's results.
Sales of $123 million were up 17% on a reported basis and up 2% organically.
Foreign exchange posit positively affected sales by approximately $16 million or 15%.
From a platform perspective, we had growth in both trains and fluid solutions.
<unk> benefited from strong project sales into the hospital and industrial end markets as well as stronger marine based business sold into shipyards.
Within fluid solutions, the sales increase was driven by valve products, including <unk> and check valves offset partially by softer electronic sales and known headwinds associated with product rationalization.
Recall that we had expected Europe sales in Q1 to be at the low end of our 1% to 3% full year growth range due to fewer shipping days.
Stronger drain sales driven by project timing helped.
Helped to overdrive those expectations.
Regionally, we saw solid growth in some of our key regions, such as Scandinavia and Italy.
France, and Germany was flattish for the quarter, driven by product rationalization, France and drains project timing in Germany.
We saw continued softness in the UK, which was down double digits due to lower volumes pricing pressures and a product line exit.
Adjusted operating profit for the quarter was $14 9 million, an increase of 18%, which includes a 15% foreign exchange tailwind.
Operating margins of 12, 1% increased slightly as compared to Q1 of last year.
Margin expansion was driven by higher volume and productivity it was mostly offset by higher commodity costs.
Favorable product mix and incremental investments.
We do expect Europes margins expansion to improve as the year progresses.
Moving to slide seven let's review Asia Pacific's results.
Sales were just over $14 million in the quarter up 6% on a reported basis and up 3% organically over the same period last year excluding.
Excluding product rationalization organic sales increased 8%.
Sales outside of China, which represents over 70% of Asia Pacific sales in the quarter increased.
Increased organically by 11% the.
The increase was driven by strength in New Zealand, the middle East and Korea, due to higher demand for our plumbing and HVAC products.
China sales, excluding product rationalization, we're up 1% as continued demand for our commercial valves sold into data centers and semiconductor markets was mostly offset by softness in under floor heating products.
Adjusted operating profit was $1 $4 million in Q1, which translates to adjusted operating margin of nine 4%.
Drivers of the margin expansion will hire third party volume.
Product and country mix and cost savings, partially offset by commodities lower affiliate sales and investments.
As expected a little bit of a slow start to the year for Asia Pacific. We think it is more timing than anything else.
As growth should accelerate in the out quarters.
Now just a quick update on our full year outlook slide eight provides the details and I will highlight a few points.
As Bob discussed our current assumptions are pretty much aligned with the original outlook. We provided in February except that we now expect Americas organic sales growth should be at the higher end of the three years to 5% growth range.
Sales in the other regions are falling in line with our previous outlook.
We expect operating margins should grow between 50, and 70 basis points, which includes incremental investments to support future growth initiatives I'd like to point out that we are currently maintaining our full year effective tax rate at approximately 28%.
However, the rate in Q1 was a little bit higher at 28, 2%.
We may have to adjust the rate in the future based on further analysis as additional information and guidance on the new regulations become available.
And as I, just mentioned, we anticipate free cash flow for the year converting at or above 100% of net income.
Before I turn the call back over to Bob a few items to keep in mind regarding the second quarter.
We are expecting consolidated organic growth in the second quarter to be in line with our full year expectation.
Product rationalization should approximate $2 5 million in Q2.
$1 5 million in Europe , and $1 million in Asia Pacific.
We expect incremental investments of $3 million to $4 million in Q2, approximately $2 million in Americas.
$1 million in Europe , and approximately 500000 in Asia Pac.
The investments will be partially offset by approximately $1 million in incremental restructuring savings about $500000 each in the Americas and Europe .
Consolidated operating margin in Q2 should grow in line with our full year expectations.
Finally, foreign exchange May also be a tailwind when compared to Q2 last year given the current euro dollar exchange rate.
So with that let me turn the call over to Bob before we begin Q&A.
Bob.
Thanks, Tim I'd like to summarize before we address your questions.
The year started out on a positive note. We delivered Q1 record results in sales operating margin and adjusted EPS and we continued to see plant for the future.
We are also proactively addressing inflationary concerns.
Overall, we expect to make sustained progress and look forward to another solid year of profitable growth.
So with that operator, please open the line for questions.
At this time I would like to remind everyone in order to ask a question. Please press star and then the number one on your telephone keypad.
Your first question comes from Nathan Jones with Stifel. Your line is open.
Good morning, everyone.
Nathan Nathan.
Hey, Bob I, just wanted to start off talking a little bit about price cost.
Given all of the inflation that's out there in the market at the moment, you said you've announced price increases implemented at the start of <unk> does that mean that maybe are a little bit behind on price cost in the first half of the year you catch up in the second half of the year and margins expanded kind of in line with what you were looking for in the first.
Quarter did you make that up somewhere else just any color you can give us around that sure.
Sure Nathan we believe we've been ahead of the curve and as you know we announced a price increase in the fourth quarter of last year.
And we've been staying on top of it as we see the inflationary pressures.
Continuing amount we believe were.
We'll continue to be ahead of the game. So net net it's been positive for us through Q1, and we expect that to be continue to be positive for the rest of the year.
You also had commented.
In the press release, and a little bit in Tim's comments that you had a negative impact for mix in the quarter.
Any color you can give us on that and expectations of how mix plays out in <unk> and beyond.
Yes, so I think overall mix will play out fine as we go through the year. There's a couple of mix issues, we had during the quarter number one in Europe.
Drains was better than we expected we had a project we thought was going to ship in Q2. It shipped in Q1 and it was more in what we call the marine business, which is project related and it was lower margin than normal so that should even itself out in Q2 on the reservoir in the North America side, we talked about <unk>.
<unk> also and that was really we had some nice resident or a retail growth in North America with some small wins in stocking levels in the first quarter again that should smooth itself out into the second quarter. So again small mix issues, but not a significant impact probably 10 or 20 basis points plus or.
Minus so in the quarter, but that should clean itself up as we go into the second and third quarter.
Okay, and then just on on cash flow it was a little worse.
Seasonally than it usually is it doesn't sound like you guys think thats any more than timing can.
Can you just talk about when when we get that back.
And any expectations you have.
For growth, maybe inhibiting cash flow a little bit this year or anything like that.
Yes.
Certainly it.
Was a little less than last year, but as we look at it can progressing through the year. We still believe will converted 100% of net income certainly with growth we will have some working capital.
Concerns here, but again, we believe we'll mitigate that through our operational excellence initiatives. So I think it's a timing issue some of its ramp up or some growth initiatives that we have and we wanted to get in front of the curve on this and.
Given tariffs and future inflation, we felt it was better to be in front of us with our inventory then behind it. So net net it will smooth itself out and probably by the third quarter.
You back in alignment with where we normally are.
Okay. So a little bit of buying ahead of anticipated price increases from you there.
A little bit a lot of little pieces here Nathan it's not overall one thing it's between growth initiatives, but maybe pre buy some normal timing you had good Friday I mean, theres just a lot of moving pieces here, but nothing that we're worried about.
Okay. Thanks, I'll get back in queue.
Your next question comes from Ryan Connors with Boenning Scattergood. Your line is open.
Great. Thanks for taking my question.
Jim you might have addressed this but I apologize if I missed it but the 4% organic growth.
Did you give a breakdown of the proportion of that from volume versus the price increases that you've already achieved there.
Well, we didn't this is Bob we didn't give that detail, but we had about a about a.
A percentage point of price in the quarter. So.
So the rest was normal growth.
Okay got it okay. That's good.
And then my other one you call out in water quality.
A tailwind in the Americas is that the residential.
Water treatment business, the premier business or is that something else what exactly is that product line.
Yes, yes, that's exactly what it is is on the residential side, we had some nice wins in.
In the quarter and again that business is lumpy.
But a good early start to the team.
Got it got it and then last one for me just on.
On kind of the capital deployment side, you mentioned the buyback dividend it seems like there's a bit of a shift there.
Returning cash to shareholders is that should we read into that.
The M&A you don't like what you see in the M&A side, whether it be from valuation or just the stuff that youre seeing or or or is that reading too much into that and how do you see the M&A pipeline.
Yes, I think it's reading a little bit into that I mean, I think our dividends and share repurchases have been consistent we believe in our overall balanced capital deployment model.
Certainly we continue to look in the M&A pipeline and cultivate potential acquisitions, but as you said, there's some higher multiples out there we're going to be disciplined and do the right thing for our shareholders.
Got it alright, thanks for your time today. Thank you.
Your next question comes from Jeff Hammond with Keybanc capital Mark Your line is open.
Hey, guys. This is Brad filling in for Jeff.
Just on Americas, Hey, good morning looked like some nice growth. There can you just provide maybe a bit more detail on the growth investments and if they had any impact on the first quarter and if not when do you expect to see some some yield there.
Yes, I mean, our growth investments.
Definitely had an impact in the quarter and for the whole company. We continue to invest in new products certainly they do cannibalize existing products in some regards but between our geographical expansion and our strategic accounts and our new product initiatives.
Seeing the impact on our growth and Youre seeing the impact with our results. This is.
The largest growth we've had since my tenure here in four years and we're starting to see the impact of many of the initiatives that we started over four years ago. As we look to continue to upgrade our products and rationalize them and continuing to invest for the future.
Okay, Great and then just on back on price cost.
It seems like pushing through a midyear increase what's your confidence around the market's ability to absorb that based on what youre seeing so far from the increase back in <unk>.
Yes, I think.
Everybody understands inflation in particular with the transportation cost to everybody has seen it and I believe the market is anticipating that we've read about many companies in our industry and outside of our industry doing the same thing. So we're going to be in front of the curve on this we're going to be aggressive and we believe it's the right thing to do given.
The cost inflation that's out there.
Alright ill leave it there thanks guys. Thank.
Thank you.
Your next question comes from Brian Lee with Goldman Sachs. Your line is open.
Hey, guys. Thanks for taking the questions maybe.
Maybe first off.
It could just be.
Rounding or conservatism, but if we assume the Americas division grows it.
5% organic rate through the rest of the year.
And it seems like 4% organic in 2018 on a consolidated basis versus the three that you're sticking with is pretty achievable how would you.
Characterize.
That that Reed.
Well when you look at it.
Our full year guidance is 3% to 5% and I think in my stated comments, we're moving towards the higher end of that range. So again I think it's too early in the first quarter to change the range given all the geopolitical things that are going on but we certainly are cautiously optimistic and believe we will be at the higher end of that range. So.
Ken.
Too early to change all the numbers, but we're like I said feeling cautiously optimistic.
Okay fair enough.
Second question from me and then I'll pass it on is on the heating and hot water side.
Good.
Good growth there in the quarter I know you mentioned it was easier comps can you discern a bit between how much of it was easier comps and then just the underlying trends improving maybe if you could speak to what youre seeing there and also with respect to pricing dynamics, which I know have been an issue for that segment in the past. Thank you.
Yes, so first of all it's very competitive in that marketplace, but what we are seeing is are our backlogs are strong and.
It was easier comps, but we're also seeing the growth in the market. So you know even net of that it was very positive so again.
The <unk> team is doing a good job.
Our new products and the things we're doing are we feel good about so overall very positive and with the backlog and what we're seeing in the market we feel good about it.
Alright, Thanks, a lot. Thank you.
You.
Your next question comes from Joe Giordano with Cowen Your line is open.
Hey, guys. This is tristan in for Joe.
Good morning Hugh.
Hi can you maybe address what you're currently seeing in the Chinese housing and commercial markets and how do you expect this to evolve during the rest of the year.
Yeah, So the Chinese housing market.
Theres been a shift in the marketplace in the past.
Consumers.
Would fit out their apartments and put in there.
They are under floor heating et cetera, and that would really was strong in the retail channel based on new guidelines and recommendations that now is moving to more of a project base and the condominiums are fitted out by the developer.
So less of a retail play and more of a let's call. It a commercial builder play. So that shift is as you can imagine is becoming much more competitive in pricing and it's less about the retail side. So we're seeing a shift there that's going to probably impact us, but the Chinese market is a big market and <unk>.
Many areas, we're doing good on our valve side and in particular within the data center space as well as the chip manufacturers. So again, it's a shift in the marketplace will be watching it and we'll look at.
Moving.
More outside of that space because of the competitive nature of it we will still plan it but we're going to continue to grow in other areas.
Thanks, that's helpful and then.
I believe you mentioned in the past that drains are leading indicator for you for a full commercial growth is.
Is that what you're seeing in Europe currently.
We are the again the European market with our specialty drains blucher, which are stainless steel drains we've seen a nice pick up there a lot of it is based on our strategic account.
Focus as well as our focus overall, so we do see that as a leading indicator I would say, it's more of a leading indicator in North America I believe we're gaining share in Europe .
And then one last quick one if I can.
What percentage of your PVA sales international at this point.
It's a very low number it's a very low number but it's also an opportunity for us the increased freight costs always is difficult when you look at <unk> because you're shipping.
Big components with a lot of Aaron and I would say so the cost of transportation is a key part of that however, we believe we have one of the best commercial boilers in the marketplace or in water heaters. So both of those.
Do have some companies that want to pay that extra amount for that so but again, it's a small percentage and growing we've had some wins in Latin America, which is a little closer to us.
But we believe it's an opportunity for continued growth.
Great. Thank you guys. Thank.
Thank you.
There are no further questions at this time I will now turn the call back over to Bob Pagano for final comments.
Well, thanks, everyone for joining us today, we look forward to speaking with you on our Q2 results in early August . Thank you very much.
This concludes today's conference call you May now just.