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spk05: Ladies and gentlemen, thank you for standing by. My name is Brent and I will be your conference operator today. At this time, I'd like to welcome everyone to the Watts Water Technologies Inc. first quarter 2023 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. Now, my pleasure to turn today's call over to Ms. Diane McClintock, Senior Vice President, FP&A and Investor Relations.
spk04: Please go ahead.
spk00: 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 the 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 turn the call over to Bob.
spk09: Thank you, Diane, and good morning, everyone. Please turn to slide three, and I'll provide an overview of the quarter. I'd like to start by recognizing our team for their continued efforts to serve our customers. Together, we delivered another better-than-expected quarter with record first quarter sales, operating margin, and earnings per share. The Americas and Europe teams expanded top line growth at a low single digit pace, primarily due to price. Both regions continued to drive organic growth despite the tough comparison to double digit growth in the first quarter of 2022. We also saw high single digit growth in apnea despite challenges in China after COVID restrictions were lifted in the impact of unprecedented flooding in New Zealand. Adjusted operating margin exceeded expectations, supported by solid price realization, favorable mix in productivity, which more than offset inflation, lower volume, and incremental investments. As a result of our strong earnings and expected cash flows for the remainder of 2023, we announced a 20% dividend increase, starting with our payment in June. Our balance sheet remains strong and provides ample capacity to afford us flexibility in our capital allocation strategy. From an operations perspective, we acquired the assets of Enware Australia in an all-cash transaction that closed at the beginning of the second quarter. Enware is a leading supplier of specialty plumbing and safety equipment with annual sales of approximately $30 million, primarily within the Australian institutional and commercial market. This acquisition broadens our product offering and channel access in a region with well-established and tightly enforced plumbing codes. a criteria that is well aligned with our strategy. We welcome our new NWARE colleagues to Watts. The integration process has started and is progressing well. NWARE will be reported in the apnea segment. On the inflation front, we continue to see cost increases across material labor, overhead, and other fixed costs. While the inflation rate has moderated from 2022 levels, it is still above normal historical levels and commodities are again beginning to rise. As a result, we continue to assess our price-cost relationship and rolled out additional price increases late in the first quarter. I also want to mention that we'll be issuing our annual sustainability report during the second quarter. Our teams have made tremendous progress advancing our ESG strategy and initiatives, and we are looking forward to sharing this with you, so stay tuned. Next, I'd like to provide an update on our end markets. From a macro perspective, global GDP, which is a proxy for our repair and replacement business, is lower than last year, but remains positive in our key markets. Europe has remained more resilient than we had anticipated as the energy subsidies continue to support our business in Germany and Italy. However, new building permits have been trending downwards and we are monitoring that closely. In the Americas, as expected, New residential single-family construction has been weak, with single-family starts down double digits. Multifamily construction is up from the annual pace in 2022, but showed a sequential decline in March, which may be an early indication of slowing in the multifamily market. In the Americas, non-residential new construction indicators are mixed. Despite the March reading slightly above 50, the ABI has been below 50 for several quarters, pretending a slowing toward the end of 2023. However, the Dodge Momentum Index continues to be an expansion territory, suggesting growth in non-residential projects will continue throughout 2023. Certain sectors have been stronger, including institutional, which encompasses healthcare and education, as well as data center projects in food and beverage. In the Asia Pacific region, China and markets were resilient in the first quarter, with data center demand remaining strong and offsetting the slowing in residential new construction and our underfloor heating business. We are seeing improving markets in the Middle East due to continued higher oil prices. However, the rising interest rates have begun to impact new construction in Australia and New Zealand. Now an update on our outlook for the second quarter and the remainder of the year. We expect our year-over-year second quarter top-line organic growth to be muted due to the very strong second quarter we had in 2022 with double-digit growth. We also anticipate declining operating margins due to the reduced volume, incremental investments, and the one-time benefit of approximately $7 million we secured in the second quarter of 2022 from our proactive investment in inventory at lower cost combined with higher price. Due to our Q1 performance and our expectations for Q2, we are increasing our full-year outlook for operating margin expansion. The solid first quarter margin performance plus favorable price and mix should mitigate expected second half market headwinds. We are maintaining our full year organic sales growth outlook consistent with our guidance in February. We remain cautious on the second half of 2023 due to the potential impact of rising interest rates, lending tightening on new construction, and persistent inflation. We expect NWARE to add approximately 20 million in sales in 2023, with very little contribution to operating margin as we work on integration and adjusting the cost structure. With that, let me turn the call over to Shashank, who will address our first quarter results and our second quarter and revised full year outlook. Shashank?
spk01: Thanks, Bob, and good morning, everyone. Please turn to slide four, and I will review the first quarter's consolidated results. Sales of $472 million were up 2% on a reported basis and up 4% organically. As Bob mentioned, we drove growth in all regions despite the tough comparison to a very strong first quarter in 2022. Foreign exchange, primarily driven by a weaker euro, reduced sales by approximately $9 million, or 2% versus 2022. Adjusted operating profit was $84 million, up 16% compared to last year, and adjusted earnings per share were up 18% to $1.92. Adjusted operating margin of 17.9% was up 220 basis points as price, mix and productivity more than offset inflation, lower volume and incremental investments. The adjusted effective tax rate was 22.5%, 40 basis points higher than the first quarter of 2022. The slight increase relates primarily to the changes in worldwide earnings mix. Our free cash flow for the quarter was $28 million, as compared to negative cash flow of $8 million in the first quarter of last year. The cash flow increase was primarily due to higher net income and lower investment in inventory. We expect sequential improvement in our free cash flow, and our full year goal is to achieve free cash flow conversion of 100% or more of net income as previously communicated. During the quarter, we repurchased approximately 22,000 shares of our common stock for $4 million And as Bob mentioned, announced a 20% increase in our dividends starting in June. Please turn to slide five and let me provide a few comments on the regional results. The Americas had a solid quarter with organic sales up approximately 3% despite a tough prior year comparison. The growth was primarily driven by price realization across the majority of our platforms and channels. As expected, we did see softening in our residential and markets which mainly impacted our OEM and specialty channels. Adjusted operating profit increased by 25%, and adjusted operating margin increased by 400 basis points. The margin expansion was driven by price, mix in productivity, which more than offset volume declines, inflation, and incremental investments. Europe demonstrated resiliency with organic sales up approximately 4%. Reported sales were negatively impacted by 5% from unfavorable foreign exchange movements. Growth was primarily due to price, with growth in Germany and Italy driven by our OEM business, and in France and Benelux through solid wholesale activity. As a reminder, we stopped our direct shipments to Russia in April 2022, and we estimate the impact of that to be approximately $2 million in the first quarter. Operating margin declined by 250 basis points, as price and productivity were unable to fully offset inflation and volume D leverage. APMIA also had a solid quarter, delivering 11% organic growth. Reported sales growth of 4% was negatively impacted by 7% from unfavorable foreign exchange movements. China's organic sales grew double digits, primarily from commercial valves sold into data centers. Organic sales outside China were up by high single digits, with growth in Australia and in the Middle East partially offset by decline in New Zealand due to historic flooding. Adjusted operating margin increased by 490 basis points due to higher third party sales volume, affiliate volume, price and productivity, which more than offset inflation. Slide six provides our assumptions about our second quarter and full year operating outlook. First, let's cover the second quarter outlook. As Bob mentioned, we have a very tough comparison to a strong second quarter in 2022. We estimate consolidated organic sales may be flat to down 4%, with low single-digit declines in the Americas and Europe offset partly by low single-digit growth in apnea. In addition, we expect approximately $7 million of sales from the acquisition of Endware. We estimate our adjusted operating margin could range from 17.2 to 17.8% for the second quarter, down 70 basis points to 130 basis points versus prior year. The decline is due to the reduced volume, incremental investments of approximately $5 million, and the one-time benefit of $7 million we spoke about in the second quarter of 2022 from our proactive investment in inventory at lower cost combined with higher price. In addition, we expect annual acquisition to be dilutive to operating margin as we work to right-size the cost structure. Corporate costs should be approximately $13 million, and interest expense should be approximately $2 million in the second quarter. The adjusted effective tax rate should be approximately 25%. We are now assuming a 1.09 average Euro-US dollar FX rate for Q2, versus the average rate of Euro 1.07 in Q2 2022. This implies an increase of 2% year-over-year in Q2, which equates to an increase of approximately $2 million in Europe sales and one cent a share in EPS versus prior year. Now let's cover the full-year outlook. For the full year 2023, we are maintaining our prior outlook of minus 5% to plus 2% consolidated organic growth. We believe that our better than expected start in the first quarter will be able to offset potential weakening in multifamily and non-residential new construction. In addition, we expect approximately $20 million of sales from the acquisition of NWARE. While we are maintaining our organic top line outlook, we are increasing our full year adjusted operating margin contraction to a range of minus 70 to minus 10 basis points compared to our previous outlook of minus 100 to minus 40 basis points. We now expect our adjusted operating margins to be between 15.7 and 16.3%. We expect our solid first quarter plus price and productivity will offset potential for the weakness in the second half and the dilutive impact of the inward acquisition. Our free cash flow expectations are anticipated to be in line with our previous outlook from February and should meet or exceed 100% of net income. We are now assuming a 1.09 average Euro-US dollar FX rate for the full year versus the average rate of Euro 1.05 in 2022. This would imply an increase of 4% in sales year over year and equates to an increase of $12 million in Europe sales and 4 cents a share in EPS for the full year versus prior year. And regarding other key inputs for the full year, we expect corporate costs to be approximately $52 million for the full year. Interest expense should be roughly $8 million for the full year. Our estimated adjusted effective tax rate for 2023 should be approximately 25%. Capital spending is expected to be in the $42 million range. Depreciation and amortization should also be approximately $42 million for the year. We expect our share count to be approximately 33.5 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 better than we anticipated with record first quarter sales, operating margin, and earnings per share supported by price and favorable mix. While we expect muted top line growth in the second quarter due to challenging prior year comparisons, we are increasing our full year operating margin expansion outlook and are maintaining our full year organic sales growth expectations. We acquired EnWare Australia and are working on integration into the Watts portfolio. We continue to stay on top of the price cost dynamic and adjust as needed. Despite the weakening macros, We'll continue to make incremental investments in new product development and to drive our smart and connected strategy and in automation to drive productivity. We are also increasing our dividends by 20%. We are well positioned financially, operationally, and commercially to take advantage of market opportunities as they arise, and I'm confident in our team's ability to execute in this uncertain environment. With that, operator, please open the line for questions.
spk05: At this time, I would like to remind everyone, in order to ask a question, press star followed by number one on your telephone keypad. Your first question is from the line of Mike Halloran with Baird. Your line is open.
spk10: Hey, good morning, everyone. Good morning, Mike. So a couple questions here. First, you know, I certainly understand the leading indicator side of things, particularly for some of the multifamily, ABI, everything like that. But when you look at the core business you have today, leaving aside the residential piece, single family, are you seeing in North America deterioration happening at this point in time or is this still perspective? And any kind of channel-oriented commentary would be great.
spk09: Yeah, Mike, I think we're really seeing it in the residential single-family side. That's where we're down. We're seeing it in the OEMs. We saw more destocking in Q1 and expecting a little more OEM destocking in Q2. So that's where we're really seeing it. I would say multifamily is holding up, and non-res is holding up also.
spk10: Any nuance on the non-res side worth mentioning? I mean, because non-res is a awfully big market with a ton of different constituents.
spk09: Yeah. Again, our product doesn't really care what market it goes into. So if office buildings are down and institutional off, it just shifts, right? So with the labor shortages in the construction market right now, the contractors are still busy and these jobs are continuing to happen. But like, as you said, we're watching the leading indicators because we're a short cycle business.
spk10: And then second one on the margins here, um, obviously the really strong performance in the first quarter, you know, North America in particular, you look back over the last four or five quarters, frankly longer, but you know, last four or five quarters, you've been hovering well, you know, in the low twenties on all in here, you look at how the guidance seems to cadence out, decel on the margins through the year. Could you just talk about the puts and takes? It seems like that's just mostly tied to the volume side of things. Obviously, there's a 2Q year-over-year comp that you mentioned with the $7 million. But anything else you would point to, Vesal, other than just caution about the environment, or is there something else in that margin profile worth mentioning?
spk01: Yeah, so there's a couple of things, right? So firstly, we did have some slightly favorable mix in the first quarter. As we sell less in single-family residential, the margins there tend to be lower. So there's some mixed favorability that helped America's. And then secondly, you know, on the price cost side, if you recall, we had price increases pretty much consistently every quarter. We start lapping those starting in the second quarter. The first quarter, we still got benefit of most of the four increases we had last year. So that helped the margin profile. And then finally, on the cost side of the equation, certainly on the inflation, as Bob noted, the inflation is moderated. We saw that in Q1 beyond commodities. In things like logistics costs, et cetera, inflation was a lot less.
spk10: Thanks, Shane. Thanks, Bob. Appreciate it. Thank you.
spk05: Your next question comes from the line of Jeff Hammond with KeyBank. Your line is open.
spk02: Hey, good morning, guys.
spk04: Good morning.
spk02: Can you just speak to what you're seeing in the channel around any – D-stocking, maybe beyond residential, just as supply chains get better, if you're seeing any of that in the channel.
spk09: Yeah, I think electronics is still spotty from a supply chain issue point of view. I would say, as I said earlier, the D-stocking is more in the OEM residential side. Wholesale, we're watching it. It's harder for us to see because we don't have a lot of visibility into it. all the wholesale channel, but it seems like it's stabilized. We're still watching that very closely. But in general, you know, it's more the softness is on the residential side.
spk02: Okay. And then just back on the margins, it seems like, you know, 2Q is always a step up from 1Q as you get the seasonal volume. But, you know, the guide is kind of suggesting margins are kind of flat to down. And, you know, it seems like You know, the price cost gap is getting wider and you're seeing some moderation in inflation. And we've had a lot of companies talk about, you know, just as supply chain friction, expedited freight, you know, hero spot buys kind of normalize. You know, you see some of that drop to the bottom line. So just don't know if there's there's something I'm missing there.
spk01: Yeah, a couple of things. So obviously, you know, we had a little bit of more volume leverage in Q1 versus Q2 because Q1, we grew the business at about 4%. And the midpoint of the guide is about a 2% decline. So there's some volume deleverage in the second quarter. And back to that pricing dynamic, as I said, you know, earlier that we had the benefit of full prices is increasing Q1. That starts fading in the second quarter. So in Q1, you know, price realization, mid to high single digits. We'll talk about the second quarter when we close out the second quarter, but our expectation is it'll be less. So that impacts the margins.
spk02: Okay. And then just back on kind of non-res, maybe can you just speak to your lead indicator products? Remind us what those are and what you're seeing there that would maybe signal or not signal a slowdown in commercial construction.
spk09: yeah in general things are holding up uh we did see a slight decrease in some of our drains but that was based on some lumpy business project business in the prior year so i think it's basically you know holding steady at this point mike i think or jeff what we're doing is um continuing to talk to our channels our contractors they continue to be busy they have a backlog of work so that's how we're watching this the leading indicators are longer term but You know, feet on the street, talking to what's happening out there is what we're really watching at this point in time. And as I said earlier, labor shortages are prolonging this. So there's a backlog of jobs. I think, as we said, as we get into the second half, that's where we're being a little cautious at this point in time to watch that. Again, we're a book and ship business.
spk02: Okay. Thanks so much.
spk09: Thanks, Josh.
spk05: Your next question comes from the line of Nathan Jones with Stiefel. Your line is open.
spk06: Good morning, everyone. Good morning. Maybe a question on the NWARE acquisition. That adds pretty significantly on a relative basis, I think, to the business in Australia. Can you talk about how you leverage that business to grow it? Do you need to make more acquisitions there to build scale? What's the strategic plan with that?
spk09: Yeah, so NWARE, look at it, it's in Sydney. It designs and engineers and manufactures specialty plumbing and safety equipment. And it fits nicely. It's quite honestly a turnaround for us. It's basically a break-even business. Team's already at work integrating that. And we like the channel access to bring our other products with it, as well as they did a lot of what I call sourcing locally. and we'll leverage our global sourcing business. But overall, it gives us scale as well as it gives us additional channel access for our existing products.
spk06: Do you need to build further scale to really leverage channels and things like that? Is that a strategic priority at this point? I know you've looked to move into developed markets that have strong plumbing codes. Do you need to build more scale in Australia or wherever else you choose to go in order to leverage those businesses properly?
spk09: Yeah, in general, I would say our whole apnea region, we want to continue to scale and leverage that. So we're looking for quality acquisitions that give us channel access. We've been building a nice position both in Australia and New Zealand. Now, a cumulative three acquisitions, it's given us... some good numbers in total, you know, it's going to be probably more than half our business now in Apnea, uh, when you add all this together. So we've been building scale, we've been building capabilities. And like you said, we want to be in code developed countries that, which is really important. The second part is that enforce codes. That's the important thing. So that's why we liked, uh, that region of the world. And again, it's more about focus, uh, in that business. It's, uh, they've tried to be everything to everyone and we're being 80, 20 focused and, uh, re-evaluating the whole product portfolio and mix and sourcing capabilities in that organization.
spk06: You just let me know when you want to take me to see that business. Just a question. I'm sure my invite's in the mail. On the Europe margins, we're down 200 bits year over year, but given the volume leverage and the high fixed cost base there, I thought a pretty good performance out of Europe. Can you maybe provide some more color on the margin profile there, the contributing factors to the pretty decent margin performance there and how we should think about that going forward?
spk01: Yeah, if you recall last year, Nathan, in the first half, we had very robust margins in Europe leveraging the volume. And then they dropped off pretty significantly in the second half as the volume came down. And we had a high fixed cost base As you recall, we took restructuring actions in Europe in Q4 and early on in January, and that's certainly helping, and that's helping the margins in Q1, as well as the fact that the volumes came in better than we had anticipated in Europe, so less volume deleveraged than we thought. And that was obviously the strength in Italy, Germany, a little bit in France and Benelux. Those regions came in better, so there was less volume deleveraged, and that's why the margin profile was better.
spk06: Great. Thanks very much for taking my questions. Thank you.
spk05: Your next question is from the line of Michael Anastasio with TD Cohen. Your line is open.
spk07: Hey, good morning, guys. Thanks for taking my question. Good morning. Good morning. You had mentioned earlier prices about high single digit in the quarter. Can you just dive into sort of the price impact expected for the remainder of the year?
spk01: Yeah, so we had said first quarter was mid to high single-digit price realization. We don't really comment on price until we close out the quarters, because now we're going on to two years plus with price increases. But the expectation, when we did our call about three months ago, we expected in the low single digits for the full year. So that does come down as we go through the year, just because we compiled price realizations last year.
spk07: Great. Thank you. And then just on the general commercial side and kind of multifamily and stuff like that, can you just comment on sort of the cadence throughout the quarter? Anything in particular that would be interesting there?
spk09: No, I commented earlier that it's been holding up. Where we're seeing the softness is single family side of the business. And I That's where most of the issues are at this point in time, as well as the OEM destocking that we're seeing.
spk05: Again, if you would like to ask a question, press star followed by the number one on your telephone keypad. Your next question is from the line of Walt Liptak with Seaport Global. Your line is open.
spk08: Hi, good morning, everyone.
spk04: Hi, Walt.
spk08: Hey, good morning. Shashank, I'm ready to go to visit NWARE, too, so just let me know. I wanted to ask a follow-on to the NWARE question. You know, it sounds like with the turnaround, I'd love to hear the 80-20 being talked about. That's great. Can you talk about what normal margins would look like for NWARE in the future, and then how long does it take to get them there?
spk09: Well, we're expecting basically break-even now, and then we'll continue to ramp up over the next three years to get it back in line with the overall apneum-type margins. So that's our goal. The teams are working aggressively and have already taken aggressive actions already. So teams on the ground making good strides.
spk08: Okay, great. And then on, you know, just kind of M&A more generally, it's good to see you guys get one done. Here is, you know, the rising interest rate environment, are you seeing more deals come into the pipeline from private equity or whoever? And are you seeing any changes in valuations?
spk09: I would say in general, I mean, M&A activity is still out there. It's hard to comment on it because it takes two people to get their minds around whether they want to sell or not. But our pipeline's full. We look at small, medium, and large acquisitions. And I would say it's about the same. We're continuing to monitor it. But I don't think the environment has changed that substantially at this point in time.
spk08: Okay. All right, great. And then, you know, I don't think I've ever asked a question about this before, you know, of any company before, but, you know, the dividend increase, I think you said was 20%. Is that, you know, par for you guys, or is there something that we should read through about, you know, the cash levels and, you know, uses for cash that, you know, I wonder if you could just comment on that.
spk01: Yeah, we tend to drive to a median yield of about 0.9%, which is kind of in line with the median for the water space. Back in the pandemic days of 2020, we didn't have any increase, so we fell a little bit behind because of that, as well as our EPS has obviously done well and our stock price has done well. So in order to try to get back to that median level of 0.9%, that's why we had the 20% increase. So beyond that, there's no need to read anything else into that.
spk08: Okay, great. Okay, thank you. Thanks.
spk05: Your next question is from the line of Brian Lee with Goldman Sachs. Your line is open.
spk03: Hey, everyone. This is Miguel on for Brian. Hey, Miguel. Just a follow-up question. Hey, everyone. Just a follow-up question on NWARE again. You said it would take about three years to sort of fully get that business up to the overall APMIA margin levels. Could you just maybe talk through specifically what are the levers to get you there? Do you need to grow that business to a certain scale? Is it a combination of that plus integrating the operations, working on cost structure? Just any additional color there would be great. Thanks.
spk09: Well, it's certainly all of the above, but I would tell you the first focus is on profitable growth, which you know our playbook. So if anything, volume is going to go down in the short term because we're going to rationalize products. Again, the 80-20 concept. of making sure we're producing and manufacturing products that make money. And then the second thing, it's about focus, right? And the team is looking, most of their product was sourced locally. We're going to leverage our global sourcing capabilities around the world, including our global plants to optimize some of the production of that material. So it's about focus. It's about right-sizing the business and potentially decreasing the sales volume to get the profitability. Again, similar to what we've done at Watts here.
spk03: Great. That's helpful. And then just a quick follow-on. Historically, can you give a sense of maybe how quickly that business had been growing in Australia? And then you're talking about maybe right-sizing in the near term. So what does that look like in terms of the near-term growth for that business then?
spk09: in general it's mid single digits uh but as i always tell anybody can give away products right and get the growth so it's about leveraging you know overall you know profitability but our goal is to get that in the mid single digit growth okay great thanks it's very clear i'll pass it on thank you again if you would like to ask a question please press star followed by the number one on your telephone keypad
spk05: There are no further questions at this time. I will now turn the call back over to Mr. Bob Pagano.
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 at our second quarter earnings call in early August. Have a good day and stay safe.
spk05: Ladies and gentlemen, this concludes today's conference call.
spk09: You may now disconnect.
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