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spk08: ladies and gentlemen thank you for standing by my name is brent and i will be your conference operator today at this time i would like to welcome everyone to the watts water technologies first quarter 2022 earnings conference call all lines have been placed on mute to prevent any background noise after the speaker's remarks there will be a question and answer session If you would like to ask a question at that time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. It is now my pleasure to turn today's call over to Diane McClintock, Senior Vice President of Investor Relations.
spk07: Please go ahead.
spk04: Thank you and good morning, everyone. Welcome to our first quarter earnings conference call. Joining me today are Bob Pagano, President and CEO, and Shashank Patel, our CFO. During today's call, Bob will provide an overview of the first quarter and discuss the current state of the markets and our operations. Shashank will discuss the details of our first quarter performance and provide our outlook for the second quarter and for the full year. Following our 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 this presentation throughout our prepared remarks. Any reference to non-GAAP financial information is reconciled in the appendix to this presentation. Before we begin, I'd like to remind everyone that during this call, we may be making certain comments that constitute forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially. For information concerning these risks, see Watt'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. With that, I will now turn the call over to Bob.
spk09: Thank you, Diane, and good morning, everyone. As many of you know, Tim McPhee retired last month, and Diane McClintock has assumed his responsibilities within investor relations. Diane has been with Watts for over 10 years and has been an integral part of our finance team and a key contributor to our earnings and investor communications. We are confident the transition will be seamless. Please turn to slide three, and I'll provide an overview of the quarter. We had a strong start to the year with our first quarter results better than expected with record operating margins. I want to thank the entire team for their contributions as they managed through supply chain disruptions, labor shortages, and unprecedented inflation. Demand remained strong, and our America's teams delivered double-digit growth despite the difficult prior year comparisons due to the freeze in the South Central U.S. in the first half of last year. The underlying markets in Europe held up during the quarter despite the impact of the war in Ukraine. In apnea, lockdowns impacted several of our key markets, including New Zealand and China. However, the team still delivered double-digit, top-line growth in the quarter. Adjusted operating margin exceeded expectations supported by price, volume, and productivity, which more than offset inflation, incremental investments, and cost normalization. As a result of our strong earnings and expected cash flows, we announced a 15% dividend increase starting in June. Our balance sheet remains strong. We have ample capacity, which affords us flexibility in our capital allocation strategy. Operationally, commodity cost increases, especially in copper, steel, and energy, together with increases in logistic costs, 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 have 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 has been up low single digits and multifamily residential starts have continued to grow with strong demand. In new non-residential construction, the industry indicators, including the ABI and Dodge Momentum Index, have been positive for several months. This would portend improvement in commercial new constructions starting in late 2022 as the ABI is an indicator of future new construction starts. However, we're monitoring the impact of rising interest rates, inflation, and material and labor shortages on the new construction markets. In Europe, the war has triggered both a reduction in GDP forecasts 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 indirect shipments to Russia, We anticipate that the second half of 2022 could be slower than we previously thought. 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 reduced 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 headline 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. 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 Shashank, I want to mention 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, who will address our first quarter results and our second quarter revised full-year outlooks. Shashank?
spk05: Thanks, Bob, and good morning, everyone. Please turn to slide four, and I will review the first quarter's consolidated results. Sales of $463 million were up 12% on a reported basis and up 14% organically. We saw strong demand in all regions and were able to drive solid price realization. We saw double-digit growth despite the tough first quarter 2021 comps that included a 3% benefit from the freeze in the South Central United States. Foreign exchange, primarily 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%, compared to 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 the vesting 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. Our free cash flow for the quarter was negative $8 million as compared to 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 293,000 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. The Americas had a strong quarter with organic sales up approximately 14%, despite a volume headwind of approximately 4% resulting from the freeze 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 saw growth in all platforms and all channels except for DIY, which had a tough compare due to the freeze. 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. The margin 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. Scandinavia also saw strong growth as the 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. APMIA 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 and underfloor 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 US freeze demand in the first quarter of 2021. Slide six provides our assumptions about our second quarter and full year operating outlook. First, let's cover the second quarter outlook. We expect a solid year over year compared despite the headwinds related to the freeze 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 will 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 1.10 average Euro-US dollar effects rate for the second quarter versus the average rate of 1.20 in the second quarter of 2021 and versus the Euro 1.1 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 $0.05 a share in EPS versus prior year, and a $3 million reduction in sales and a $0.01 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 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 14.5 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 1.10 average Euro-US dollar FX rate for the full year versus the average rate of 1.18 in 2020-21 and versus the Euro 1.13 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 5 cents 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. 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?
spk09: 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. 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 and 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 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'm confident
spk08: 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 jernigo with baird your line is open hey good morning everyone got jk again today for my calendar and um so first question we'll just uh
spk02: We'll touch on Europe here, not as far as I see expectations lowered there, but I guess kind of twofold question. Are you seeing any of that weakness materialize yet? And then secondarily, I know we've thought about this business as kind of following Europe GDP, but any specifics, I guess, on how you could see it rolling into impact and demand for your products? Is it primarily the non-discretionary side, or is that where you're thinking potential weakness would come in?
spk09: Yeah, good morning, Jake. What we're seeing is 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 where we're being cautious right now. I think it just depends on the extent of 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 a better visibility to what's happening in Russia. It's still early.
spk02: Yep. Totally understand. And then somewhat related to that, you know, looking at the implied guidance here, it looks like in the back half of the year, you know, margins are expected to sequentially, you know, decline relative to first half. Is this, you know, primarily isolated to Europe? You know, I think typically America, as we see margins expand in the back half of the year, Just making sure that that logic syncs with how you guys are thinking about it.
spk05: Yeah, that's probably a function of, you know, 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 incremental normalized costs in the second half versus the first half. And that's why you see that margin profile you talked about.
spk07: Got it. All right, great. I'll drop back in the queue for now. Thank you.
spk08: Your next question is from the line of Nathan Jones with Stifel. Your line is open.
spk00: Yeah, good morning. This is Adam from Nathan. Following up on the revenue guide, I understand the potential impacts from the war in Ukraine on European growth. Are you expecting any slowdown in APAC given COVID lockdowns in China?
spk09: Yeah, that's the second piece we're watching very closely. Certainly the China lockdowns has created uncertainty. I know our China Shanghai team has been locked in their homes for five weeks now. So that'll 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. And we're being cautious in our outlook in China.
spk00: Okay. And then, you know, Watts is more, much larger and more sophisticated than the majority of its competitors. Do you believe that you have better product availability that's leading to market share gains in this environment and which products and markets do you think that's occurring in?
spk09: 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 has certainly helped. So I think we're certainly holding our own and in various places taking market share. So we don't believe we're losing any market share for sure.
spk07: Thanks for taking my questions.
spk08: Thank you. Your next question is from the line of Joe Giordano with Cowan. Your line is open.
spk10: Good morning, this is Michael in Peugeot. Good morning, Michael. Good morning. Yeah, as we look towards the housing market, specifically multifamily, how should we be thinking about that on the go forward? What's your outlook there?
spk09: 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 we 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.
spk07: Great. Thank you.
spk08: 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 KeyBank Capital Markets. Your line is open.
spk01: Hey, guys. It's Jeff live and in person.
spk09: Hey, Jeff. How are you?
spk01: 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 and just kind of what you've been seeing or what you've been putting out in terms of follow-on pricing.
spk05: Yeah, so in the first quarter, just globally, approximately of our growth, about 10% was in price realization, a little bit more in the Americas, a little bit less in APMEA, and then Europe kind of in the middle there. And the expectation as we go forward, as you know, price increases, we announced sequentially through 2021. So the comps get harder in the second half of this year. So that's what we anticipate. Now, As far as forecasting the future, we wait until the quarter ends because it's one thing announcing the prices, it's another thing actually realizing them. The teams have done a great job so far, but in Q1 it was approximately 10% of realization.
spk01: Okay, great. And then I noticed you guys stepped up your buyback in the quarter. I didn't know if that's a function of being opportunistic as the stock has pulled back or any indication of kind of, what you are or aren't seeing in the M&A pipeline.
spk05: Yes, 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 buybacks for offsetting dilution with issued equity, but also if there's an opportunity in the market, and there certainly was one in the first quarter, we did go in and buy stock back in Q1.
spk09: 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. But we're going to be disciplined. So we've not done any major acquisitions. We've done some small bolt-ons. And right now we felt that was the best allocation of casts in the quarter.
spk01: Okay, great. And then it seems like, you know, commercial HVAC – or, I'm sorry, commercial construction in – North America still seems quite robust, and I think most people are saying, hey, we're still building backlog, and we're kind of being held back more by labor. But just give us a sense of what you're seeing in the commercial landscape.
spk09: Yeah, we would agree with that. We're seeing similar things. We had across-the-board growth in all segments and everywhere except for retail, which we expected, given that that was highly impacted by the freeze. But you know, commercial construction, there was a large backlog of projects and the spending continues. And then as we look at, you know, 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 that's the constraint. Our discussion with our contractors is, you know, there's a lot of work out there. They just need more labor and they're having, material shortages, which are delaying projects and causing cost overruns.
spk01: Okay, and then just last one. Maybe just talk about inventory in the channel. I think you've said maybe over the past couple quarters inventory's gotten better for your product, but they're still maybe competitive or other items that are light.
spk09: Yeah, I would say 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 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 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.
spk01: Okay. Thanks so much, guys.
spk08: Thanks, Jeff. Again, if you would like to ask a question, press star 1 on your telephone keypad. Your next question comes from Brian Lee with Goldman Sachs. Your line is open.
spk03: Hi, Tim. Thanks for taking the question. This is Grace on for Brian. I guess first questions on margins, just to follow up on the previous questions. Like your second half, your implied margin for the full year suggests that second half of the year will be lower. I guess, should we expect 3Q to be the low point of the year, then taking it back up into 4Q, or do you expect 4Q to be the low point of the year? And also, can you talk about margin by segment? Like I think last quarter you indicated America and Europe flat to up on margins and down in APMIA, do you still expect those trends given the Russia-UK conflict and potential lockdown in APMIA? Thanks.
spk05: Yes, Anya, on your first question, right? So right now, basically, it's the second half, which has the lower margins for the reasons I stated. Breaking that down between Q3 and Q4, at this point, 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 margin decline is probably roughly equal between Q3 and Q4 at this point. But we'll take another look at it. Back to your first question as to the margin profile by region. Certainly, as Bob noted, the impact 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 decline will be greater in Europe, a little bit less so in apnea. And then with North America, with the strength of the markets, like we talked about in commercial and multifamily, the margin accretion should still be good there.
spk03: Okay, understood. And the margin decline in Europe, are you talking about like sequential declines or year-over-year decline? Thanks.
spk05: Well, it'd be first half, second half, right? That's what we're talking about. So it'll be from first half to second half.
spk03: Okay, got it. And then one last question from me. And then on revenue growth, I think last quarter you talked about the organic growth by segments. Just given the Russia-Ukraine conflict and the lockdowns in Asia, can you give us an updated view on the organic growth by segments. Thanks.
spk05: So clearly you got the Q1 numbers and the second quarter guidance. I think your question is regarding the second half. And as we look at the second half, we expect the impact of the Ukraine war to impact Europe. You look at the second half, you know, America's would be like in the low, mid single digit growth. Europe would probably be in the mid high single digit decline and apnea would be relatively flattish in the second half from a growth standpoint.
spk03: Thank you. I will pass it on.
spk05: Thanks.
spk08: There are no further questions at this time. I will now turn the call back over to Mr. Bob Picano.
spk09: Thank you for taking the time to join us today. We appreciate your continued interest in Watts and look forward to speaking with you again in our second quarter earnings call in early August. Have a good day and stay safe.
spk08: Ladies and gentlemen, thank you for your participation. This concludes today's conference call. You may now disconnect.
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