Q3 2024 Watts Water Technologies Inc Earnings Call

Thank you, Diane. Good morning, everyone. Please turn aside three and I'll provide an overview of the quarter.

We are pleased with our third quarter results, which exceeds expectations.

During the quarter, organic sales were down 4%.

Strong Growth in Atmya was offset by declines in the Americas and Europe. The decline in the Americas was partly due to project timing and inventory safety stock reductions within our wholesale channel. Europe was weaker than expected as a result of continued heat pump-to-stopking in our OEM channel.

Adjusted Operating March in a 17.1% exceeded our expectations, primarily driven by productivity and cost controls, which more than offset European volume, deliberate.

The Justice Authority margin was down 90 basis points compared to last year. Primarily due to acquisition delusion in Europe, volume, and the leverage.

Year to date, free cash flow continues to be solid and we expect to generate seasonally strong free cash flow through year end. The balance sheet remains healthy and we have ample flexibility in our discipline capital allocation strategy.

Strategic M&A, High ROI CapEx, Competitive dividends in steady share by-back remain our top capital allocation priorities.

Moving operations, the integrations of our Bradley, Joe Sam, and N.Ware acquisitions remain ahead of schedule with solid synergy savings being realized largely due to the strong execution by our global operations in sourcing teams.

We recently announced a project regarding the closure of a manufacturing plant in France. As we currently are consulting with the appropriate French Works Council and local government authorities, the timing for making a final decision to close the plant and related costs have yet to be determined or approved.

If the project is approved, our plan would be to move the production from this plant to existing plants and plants and other locations.

In addition, we have initiated other cost reduction actions to further optimize our cost structure. We expect to begin realizing these savings toward the end of 2024. Now, a few comments on our end markets.

Global GDP remains positive and will continue to support repair and replacement activity, which represents approximately 60% of our business.

Europe's residential and non-residential new construction markets continue to weaken.

The Reduce Energy and Center Programs continue to unfavorably impact OEM volume and drive despocking activity, especially in the heat pump market.

In the Americas, single-family new construction remains muted, and multi-family new construction indicators have been bound double digits since the end of last year. On a positive note, America's institutional and light industrial new construction continues to be solid.

Global Mega Projects, including data centers, continued provided Talwyns and are growing in a double digit pace. We believe our strategic account teams in each region are well positioned to participate in this growing market.

Now, in update on our outlook for the fourth quarter in the full year. As a reminder, due to our fiscal year calendarization in 2024, we had extra shipping days in the first quarter, and we'll now have fewer shipping days in the fourth quarter compared to the prior year.

As a result, we expect organic sales to be down mid to high single digits in the fourth quarter, with an estimated 5% of that decrease, attributable to fewer shipping days.

We also anticipate a sequential decline in operating margins due to normal seasonality, incremental investments, volume, and the delusive impact of our Bradley acquisition.

While we expect the Q4 to be softer, we're increasing the midpoint of our full year adjusted operating and EBITDA margin outlook.

Due to our solid year-to-date performance.

Improve the acquisition profitability and the benefit of cost actions initiated at the end of the third quarter.

which we expect will more than offset further weakness in Europe and new construction.

and Lower OEM volume from the reduced energy incentives in heat pump peace stocking.

We continue to monitor the geopolitical uncertainty in the U.S. Europe and the Middle East, and we believe we are positioned to proactively address any developments that may impact our operations.

Moving on to slide four, I'd like to talk about the next phase of our smart and connected journey.

Over the last five years we have made the digitalization of our business and solutions of strategic priority. We have reached critical milestones, including achieving our goal of 25% of total sales being comprised of smart and connected and enabled products by 2023.

We have continuously increased usage of our digital solutions and remain focused on growing user adoption across our entire customer base. Today, I'm thrilled to talk about what's next in this journey and excited to share details about next up our intelligent water management solution.

We've been field testing nexa for over a year and are very excited about its unique potential to address critical trends within our industry, including skilled talent shortages and the facilities and plumbing spaces, the rise of smart building technologies and concerned around aging water infrastructure.

Additionally, Nexus' purposes directly align with our long-term strategy, which focuses on water conservation, energy efficiency, and safety and regulation.

Next up, uniquely integrate sensing hardware, smart and connected equipment, a legacy of plumbing and hydronic systems expertise, and cutting edge software until powerful offering for customers in the commercial building space.

This new solution provides unprecedented insight into water systems and unlocks significant value in the on-site operations and water risk management while supporting sustainability targets.

We're able to provide this solution while continuously improving what our industry professionals care about most, the experience of the occupants in their buildings.

If we turn this slide by, we can see what next are offers.

At its core, next-to-help protect properties against a costly impact of water damages, saves teams' time in the effort associated with managing water assets, facilitates addressing water-related compliance needs, and provides critical insight to meet our customer sustainability goals.

It is a modular solution that can be deployed in any commercial property and is already empowering customers to address a wide spectrum of operational challenges, including water usage measurement, leak risk management, and mechanical room performance tracking.

Next, we can either view the Sun at its own to optimize building water systems or as a complement to existing building management solutions.

It is easy to deploy in new builds or is a retrofit. Intuitive to use, compatible with key water-related equipment, and comes with expert support that walks as uniquely positioned to provide.

It unlocked actionable value for users, managers, and owners of commercial properties and systems that have historically been complex and hard to monitor and automate.

Next up is a pivotal step in our goal to build new business models geared toward services and reoccurring revenue.

It will be monetized through an ongoing subscription fee for active customers, while its adoption will increasingly create value for watts by reinforcing our core business of equipment in solution sales.

Based on feedback from customers, Nexa is an undeniably valuable tool, yielding many powerful examples of value creation and commercial properties, such as multinational hotel brands, educational campuses, and French I-Brestron chains.

From early detection of risk to solving complex system balancing issues that is delivered immediate results for nearly every property deployment. We encourage you to visit nexaplatform.com to find out more about the valuable water management solution we have created.

Speaker Change: Before I turn the call over to Shashank to discuss our financial results, I want to take a moment to comment on our CFO transition.

Speaker Change: We announced yesterday that Shashank will be retiring on March 15, 2025, although he will continue a CFO until a successor is named to ensure a smooth transition.

Speaker Change: We have begun a comprehensive search to identify a successor, which will include both internal and external candidates.

Speaker Change: The Board, the Executive Leadership Team, and I are incredibly grateful for Shashank's leadership during his more than six years as a CFO of Watt. He's been an invaluable partner and has made significant contributions to our success.

Speaker Change: With that, I'll turn the call over to Shashank, who address your third quarter results in discuss our fourth quarter in full year outlook. Shashank.

Shashank: Thanks Bob and good morning everyone.

Shashank: Please turn this light six and I will review the third quarters consolidated results.

Shashank: Sales of $544 million were up 8% on a reported basis and down 4% organically.

Shashank: Solent Organic Growth in Appnea was offset by another challenging corner in Europe and a decline in the Americas where we are unfavorably impacted by project timing and inventory safety stock reductions within our wholesale channel.

Shashank: The acquisitions of Bradley and Joe Sam contributed approximately $59 million or 12% and far and exchange increased sales by approximately $1 million versus the third quarter of 2023.

Shashank: Compend to the prior year, adjusted operating profit of $93 million increased 2% and adjusted operating margin of 17.1% was down 90 basis points.

Shashank: I adjusted EBITDA of $16 million increased 5% and adjusted EBITDA margin of 20% was down 50 basis points.

Shashank: Adjusted operating and EBITDA margin benefited from price, productivity, favorable mix and cost controls, which were more than offset by inflation, volume D-lavage, acquisition delusion of approximately 70 basis points, and incremental investments of $6 million.

Shashank: adjusted earnings per share of 2,000 pre-sense more slightly down versus last year, with benefits from acquisitions, offset by decline in operational contribution and incremental interest expense.

Shashank: The adjusted effective tax rate was 25.2%, down 20 basis points compared to the year period.

Shashank: For gap purposes, we incurred approximately $7.4 million in restructuring and acquisition-related charges.

Shashank: These charges were more than offset by $7.8 million on recurring gains on the settlement of the terminated Bradley pension plan.

Shashank: By either day free cash flow was 200 and 4 million dollars, up from $182 million dollars in the comparable period last year, primarily due to the contribution from our acquisitions.

Shashank: We expect the season-leaf strong V-cash flow to continue in the fourth quarter and consequently, we are increasing our full-year V-cash flow conversion target to 100% or more of net income from the 90% conversion previously communicated.

Shashank: The balance sheet remains robust and provides us with ample capital flexibility.

Shashank: Our net debt to capitalization ratio at quarter end was negative 6% and our net leverage was negative 0.2. A strong cash flow, healthy balance sheet, and available credit continue to give us capital allocation of reality.

Shashank: Please turn this light seven and I'll provide a few comments on the regional results.

Shashank: America's organic sales were down 3% and reported sales were up 14% year over year.

Shashank: Organic sales declined partly due to the previously communicated project timing between the second and third quarters and inventory safety stock reductions within our wholesale channel driven by our normal bodies the lead times.

Shashank: The acquisition is a Bradley and Joe Sam at $59 million or $17 per cent to America sales in the quarter.

Shashank: Adjusted operating income increased 2% while adjusted operating margins decreased during the 16 basis points.

Shashank: The operating margin decline was primarily driven by acquisition delusion, inflation, volume de-laborage and incremental investments which more than offset price and productivity.

Shashank: Europe Organic Sales were down 12% and reported sales were down 11% which included a 1% favorable impact from foreign exchange movements.

Shashank: Double-digit growth in our dreams business was more than offset by declines in our wholesale plumbing sales in France, Ben O'Lux and Scandinavia, as well as our only business in Germany and Italy, where he from destocking had a significant negative impact.

Shashank: Adjusted operating income decreased 10% while adjusted operating margins increased 20 basis points.

Shashank: Price, Naval will make some productivity offset inflation, volume-delabbage, and incremental investments.

Shashank: At meal organic sales were up 8% and reported sales grew 10% due to healthy demand and a 2% benefit from favorable foreign exchange movements.

Shashank: We saw strong growth across China, New Zealand and the Middle East, growth in China was driven by demand in data centers

Shashank: A justed operating income increased 18% and adjusted operating margin increased 130 basis points as volume and productivity more than offset inflation, incremental investments and the deluded effect of the NRA acquisition.

Shashank: Slide 8 provides our assumptions about our fourth quarter and full year outlook.

Shashank: First, let's cover the fourth quarter outlook.

Shashank: On a reported basis, we expect sales to range between negative 4% to flat.

Shashank: We expect organic sales to decrease between 5 and 9%.

Shashank: As a reminder, we have fuel shipping days in the fourth quarter due to a fiscal year calendarization, which will result in approximately 5% of decline versus last year.

Shashank: Organic sales are expected to be down mid-Singled digits in the Americas and down low-double digits in Europe, partially offset by apnea which is expected to be up low-Single digits.

Shashank: In addition to fewer shipping days, we anticipate continuous softness in multi-family and non-residential reconstruction in the Americas, and weaker urban markets partly due to continued heat pump and related product destocking.

Shashank: We expect incremental sales in the Americas from acquisitions to be between 20 and 25 million dollars.

Shashank: Fourth quarter adjusted EBITDA margins are expected to be in the range of 18.6 to 19.2% or up 70 basis points to 130 basis points.

Shashank: Ford-Corder adjusted operating margin should be in the range of 16% to 16.6% or up 2280 basis points.

Shashank: The increased versus the prior year is due to price favorable mixed in productivity that are more than offsetting the reduced volume and incremental investments of approximately $4 million and approximately 30 basis points of delusion from the Bradley acquisition.

The sequential decline in operating margin from Q3 is driven primarily by the impact of seasonal volume, delivery and incremental investments.

We are estimating a 1.0-8-year-old U.S. dollar exchange rate for the fourth quarter versus the average rate of U.S. 1.07 in the fourth quarter of 2023.

Shashank: This equates to an increase of approximately $1 million in sales and less than 1 cent in EPS versus the prior year. Now, let's cover the full year outlook. For full year 2024, we are narrowing our sales outlook range and expect reported sales to increase by 9 to 10%.

We expect organic sales to decline between 1 and 2 percent with the midpoint consistent with our previous guidance of minus 4 percent to plus 1 percent.

Shashank: for a year incremental acquired sales for Bradley and Joe Sam should be between 25 to 210 million dollars.

We are increasing our full-year adjusted EBITDA margin outlook to range of up 10 basis points to up 30 basis points.

We are also increasing our full-year adjusted operating margin expansion to a range of down 10 basis points to down 30 basis points.

Both represent an increase of 20 basis points to the midpoint of our previous guidance.

The solid results of Father's year along with our fourth quarter expectations are anticipated to more than offset weakening in Europe and acquisition delusion of 60 basis points.

We are also increasing our freecastle conversion target to 100% or more of net income from the 90% conversion previous team communicated.

Shashank: for a year.

We are assuming a 1.09 average real estate fixed rate, versus the average rate of 1.08 in 2023.

Shashank: This would imply an increase of 1% year over year and would equate to an increase of $5 million in sales and 2 cents per share in EPS for the full year versus the prior year. Other key inputs for the fourth quarter and the full year can be found in the appendix.

With regards to my announcement requirement for the past six years it has been a privilege to be a part of the WhatsApp leadership team.

While I'm looking forward to my retirement, I'm pleased to support the process to identify our next year-fold and ensure a smooth transition.

Shashank: I'm confident that our global team will continue to fulfill our mission and successfully execute our long-term strategy.

Now, let me turn the call back over the Bob before we begin to read. Bob.

Thanks, Ashank. On Flight 9, I'd like to summarize our discussion before we address your questions.

Our third quarter of performance exceeded expectations due to better than expected performance in our America's and apnea regions.

We are proud of the progress in our smart and connected journey. It looks forward to additional success with Nexah, the newest solution in our digital evolution.

Food are strong year-to-date performance, we're increasing the midpoint of our full year adjusted operating in Ebaton, March and Outlook.

We have taken proactive measures to optimize our cost structure through planned footprint reductions in other cost actions across our regions, which will contribute to long-term margin expansion.

Our strong free cash flow generation in balance sheet continue to provide flexibility to execute our discipline capital allocation strategy.

We continue to successfully navigate near-term challenges in softening economic conditions by controlling costs and delivering customer excellence to capture demand.

Our long-term strategy continues to be on investing for the future and positioning ourselves to capitalize on long-term market opportunities from favorable secular trends, including water conservation, safety and regulation, and energy efficiency.

With that, operator, please open the lines for questions.

Speaker Change: Thank you. Okay, this time I would like to remind everyone in order to ask a question, press star, then the number one on your telephone keypad. And your first question comes to the line of Jeff Hammond with Keybank. Your line is open.

Speaker Change: Take you more, guess?

Good morning.

Jeff Hammond: Just maybe an update on...

Where do you think we are in the bottom for heat pump, destock and just inventory adjustments in the US? And maybe just speak in North America where you're specifically seeing the destocking.

Speaker Change: Yeah, so let's start off with the Heat Pump is mainly in Europe and as we talked about on the last call, we believe that's going to continue through the first, at least the first quarter of next year because of the inventory build, etc.

Back to the North America.

On the last call we talked about, we saw a de-stocking in the wholesale channel at the beginning of Q3.

We believe for the most part that's over at this point in time.

and your final part of your question is in regard to construction. I mean, most of all, the markets are similar to Q2, except...

We were expecting a multi-family to start seeing softness and that's exactly what we started seeing in Q3. So that's the only area I would say, you know, it's different than Q2. We started seeing that softness rolling through in Q3.

Speaker Change: OK, and then you know, a lot of moving pieces to the demand environment, just any kind of early thoughts and where you might see positive negative reflections as you look into in the 25th.

Well, we haven't given guidance yet, but in general I always go back to

60% of our businesses repair a place that should follow GDP.

and certainly once we get the presidential election, some of the uncertainty out there, as well as the continued falling rates.

I think there's just a lot of pause and new construction right now waiting for some of these uncertainties unfold and play it out. And that's how we're looking at it.

Okay, thanks for sharing, congrats on the retirement, best of luck.

Speaker Change: Thank you very much.

Here next question comes from the line of Ryan Conner's with North Coast research. Your line is open.

Ryan Conner: Good morning and sounds like we'll have one more call with Shashank Patel. I'm a decision to retire.

Thank you. I wanted to actually just talk about Europe for a second, a couple of aspects. First, just tactically, it seemed like that drains business was strong there and that really seems to be bucking the trend and kind of preventing things from being a little worse. I mean, can you talk about what's.

and I'm going to be a very good, very good, very good.

Yeah, our drain business in Europe is really around stainless steel drains and they play a lot in the marine market, cruise ships, military as well as food processing.

and that has come back and I was just over in Denmark at that location a few weeks ago meeting with the entire leadership team in sales team and they feel confident.

and those markets. So it's a nice offset to some of the softness in Europe, which really is around new construction. There's so much uncertainty right now, new construction and then the heat pump in overstock as well as the

I would call the incentives that are out there of people are still waiting for them to be finalized.

Got it. Okay. And then staying on Europe for a second, one more as well. But obviously this wouldn't be your first.

Significant Restructuring Action in Europe if this one does move ahead and France. Can you just talk about the European footprint from a street teagig?

Perspective, I mean, do we still have kind of a structural issue there given that the headwinds over the last few years, or should we look at this as more of a surgical kind of a move?

I think we're always looking to optimize our footprint there. It, you know, we're always looking when we can to adjust our footprint in our cost rest.

and Structure based on market demand. You know, like you said, we're working through the Workers Council, no agreement has been set at this point in time, so we're working that process, and we'll continue to always review our footprint, not only in Europe, but North America and all over the world.

Speaker Change: and then on this next step, thanks for the great interesting update there. But can you talk about the go-to-market strategy for that? Sounds real interesting. I assume the distributors will play a central role in actually bringing that to market you.

Can you confirm that and talk about the training aspect of getting them up to speed and how long it will really take to get the channel partners ready to really move the needle with that.

Yeah, we're using a multi-facitor approach, so we're using our channel partners.

We're using our strategic accounts as well as we're using the direct sales for it.

Speaker Change: So, you know, it's unique, it's different, but it really is a way of pulling all.

Speaker Change: are smart and connected products into an overall ecosystem and tying it together to solve some of the most critical issues inside of a building. So we're excited about it early innings, but it's something we've been working on for a long time.

Yeah, sounds interesting, good luck with that, thanks guys. Thank you.

Your next question comes from the line of Mike coloring with beard, the line is open.

and everybody this is Pazam for Mike. I wanted to ask on a next scene, like a very exciting announcement. Can you maybe talk about the sales process for that? I would imagine that the sales process is pretty different than some of your existing products.

and just given that it's more of a SaaS platform. And then maybe talk about how you think about customer adoption and receptivity.

Yeah, so you're right, it is different than what we traditionally sold, but we have a lot of relationships with our strategic account and customers to solve issues.

and that's where we're really pinpointing it when customers have issues or problem locations where leveraging this capability and a lot of training along the way. So, you know, this industry is slow to move to technology as we all know.

but as you're providing value, like we have in our test pilots with this stuff. We've had this out for over a year now, so we've learned a lot and pretty much every single property that has had less than one year pay back on this thing. So the way we go to market is we sell the original equipment.

to connect it and then put a SAS model on top of that.

That's super helpful and then as you've been in the field passing and as you're learning

Speaker Change: and more about the capabilities. As that opened up maybe new areas of interest.

Speaker Change: for future investment, whether that's internal organic investment or potential MNA. Is there anything that maybe has become more interesting as you kind of gone down this path and gotten more insight into your customers and their problems?

Yeah, it really has. I mean, we spend a lot of time getting voice accustomer for our new product development. This just gives us another avenue in what we're learning is we go to multiple locations. There's a lot of similar issues.

that we're learning and putting in our system and our database. So yes, it's helpful not to get any specifics, but teams are learning a lot, as well as it helps.

and sell our core products when they have issues inside of the facilities. And we've been able to tie the leak detection platforms we have in commercial buildings and residential del Unis from that we've been able to tie to this product as well.

Speaker Change: Great, that's super helpful. I will pass on.

Thank you.

Speaker Change: The next question comes from Walt Lip Pack with Seapork Global, as you're lying in a dough bin.

Speaker Change: I think, a great quarter guys and Shashank congratulations on your decision too.

Thank you. I wanted to ask about, um...

2 things. One, the European heat pump, one of your competitors talked about, you know, just tell.

is difficult to make. So I wonder if you could provide us with some more details to the size, how much it's declined. And they were also calling for a vitamin.

and then you know, kind of right around now or maybe in the first quarter. So I wonder if you can talk a little bit about 2025 and if you're thinking this market can recover off the low base in 2025.

Yeah, I share the comments you just said and we talked about that in an earlier question, but yes.

We do believe it's a tough market and a lot of it depends on the incentives that the...

Speaker Change: the local government's put in place to move that product. We can't control that, we look at what we can control, so we'll provide...

Further guided during our February call as we, you know, we'll see how much of that destocking has happened, what happened some of the...

and the elections will impact that certainly. So we're watching that closely and you know but things hopefully will begin bottoming out in the first half of next year.

and then involved on the incentives, right? Germany is in the process of finalizing their incentives on heat pumps and obviously at least finalize it a little rate about a year ago. And obviously, you know, next year we will be comping weak, weak pumps so that weak pumps do help, but we'll just have to see how it pans out as far as the destocking.

Speaker Change: Okay great. And then on the consolidation in France, I just wanted to get to clarity on the...

We made a comment that there's more consolidation moves that are coming out. Are we relating that to France specifically? Or are you thinking more globally about optimizing some of the flip prints?

I'm not saying we're doing another plank consolidation at all. We continue to always look at our footprint productivity everywhere at every one of our sites and drive.

Speaker Change: and Productivity. So, you know, this is the only one that's on the plate at this point in time and we're working with the local workers' counsel to bring this to fruition.

Okay, got that, sir, right there, thank you.

Speaker Change: Thanks.

Your next question comes to the line of Adam Farlay with Steve O'Neill and his open.

Adam Farlay: Yeah, thanks. It's not a follow-up on the naked Jones. What's on at Mia? To see solid double-duty growth there, strong man in China with through data centers business. Is that necessarily being driven by the data centers business?

Yes, you know, the large growth is both the dab centers in China as well as our growth in the Middle East, which has been strong.

Okay, and looking at America's highlighted strength and institutional, my industrial movement instruction, you know what's kind of driving that, and given the expectations going forward on on.

Adam Farlay: on his mark is what's going on.

Well, institutional has usually been very study for us over the many years we've been in it. They're spending in schools and hospitals continues. So we expect that to continue. It's not as volatile as the other parts of the market. So we'll continue to watch that, but that's been a long standing trend.

Okay, thank you for joining my course in spring.

Adam Farlay: Thank you.

Speaker Change: and your next question comes from the line of Joe Gerdano with Co-Anne Company. Your line is open.

Adam Farlay: i

Speaker Change: Hi, good morning. This is Jane on Perjillo. I just wanted to check how you guys are doing. Good morning. How are you getting this to get about these two some building cycle? Do you think it's maybe a long day? It is more versus previous cycle. It was up for so long and now moving depending on the wrong direction.

Speaker Change: Are you concerned about how long the disc can be given how far up we've come?

When you say institutional, we just talked about it in the last call. Institutional is held steady and it's growing and it goes up and down space on projects. But in general, we feel institutional will continue to grow.

Speaker Change: OK, thank you, I'm just just generally more on the market side in terms of like the broader building cycle. Do you guys envision that changing in any way in terms of the cycle went?

Speaker Change: I think you refering to the non-intitutional, right? So all the non-resident, national, new construction that is not institutional, is that what you're asking about?

Yes, sorry, yet non-institutional sorry.

Right, and then that is looking when you look at the ABI indicated for the last 18 months they've been below 50 right. So there's certainly a challenge in the third quarter and we expect that to continue. Obviously we'll give guide for next year but the leading indicators are up to 10 softness for some time.

Speaker Change: The End

Speaker Change: Okay, thank you for that, I'll pass it along.

Thank you.

Speaker Change: and the next episode.

Speaker Change: The National Security Council.

Speaker Change: The End

Speaker Change: i

and there are no more questions at this time. I will turn it back over to Bob Pagano, President and CEO 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 during our fourth quarter of earnings call. Have a good day and stay safe.

Thank you, this does conclude today's conference. You may now disconnect.