Good morning, my name is Casey and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Watts Water Technologies Fourth Quarter 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Tim MacPhee, you may begin your conference.

Thank you and good morning everyone. Welcome to our fourth quarter and full year 2018 earnings conference call. With me today are Bob Pagano, CEO and President; Shashank Patel, our CFO. Bob will discuss our key accomplishments this past year, touch upon our 2019 focus areas in the macro markets and he will also discuss our smart and connected product strategy. Shashank will offer a detailed analysis of our fourth quarter and full year results and provide our initial outlook for 2019. Following our prepared remarks, we will address questions related to the information covered during our call. Today's webcast is accompanied by a presentation, which can be found in the Investors Relation section of our Web site. We will reference this presentation throughout our prepared remarks. And any reference to non-GAAP financial information is reconciled in the appendix of the presentation. Before we begin, I'd like to remind everyone that during the course of this call, we will 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 and uncertainties, see Watts' 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. Now, let me turn the call over to Bob Pagano.

Thank you, Tim, and good morning everyone. Starting on Slide 3 in the earnings presentation, let's review our accomplishments for this past year and I will provide some initial thoughts on 2019. I'm very pleased with the strategic progress we made in 2018. The team is focused on increasing customer intimacy and driving productivity continues to be reflected on our operating performance and financial results. Last February, we mentioned that with the transformation initiative complete, we wanted to focus on accelerating organic growth. In 2018, we achieved consolidated organic growth of 6%, our fastest pace of growth since 2006. A number of factors contributed including strong Americas end markets and driving a positive price cost dynamic despite the many input headwinds that surfaced. We also benefited from our new product development efforts like key products like Intellistation and Benchmark Platinum Boiler driving incremental sales. Fanning business into the Middle East, Africa, Australia and New Zealand also contributed to sales growth this past year. We are beginning to see the benefits of our previous year's investments and new product development and geographic expansion. Another 2018 goal was continued expansion of our adjusted operating margin. This year we increased consolidated adjusted operating margin by 40 basis points driven by price realization, volume growth and productivity initiative. Margin expansion was slightly lower than our expectations mainly due to an incremental $6 million of investment spending above our original plan. We took advantage of our strong top-line performance to accelerate funding for growth and productivity. In total, we spent an incremental $16 million for investments in 2018 to benefit the future. The investment initiatives include marketing and sales, incremental R&D and continuous improvement. We estimate about 75% of the total spend this year related to front-end commercial growth projects and 25% to lean and…

Thank you, Bob, and good morning, everyone. Please turn to Slide 8 which highlights the fourth quarter results. Sales of $388 million were up 6% on a reported basis and up 7% organically. The solid top-line result was driven mainly by the Americas with slightly positive growth in Europe. Foreign exchange mainly the euro negatively impacted sales by 1%. As expected the impact of Europe's product rationalization was minimal, totaling about $0.7 million in the quarter or a 20 basis point consolidated headwind. Adjusted operating profit of $45 million increased 9%. This translated into an adjusted operating margin of 11.7% up 30 basis points versus last year and a fourth quarter record for Watt. Benefits from price, volume, productivity and restructuring more than offset higher inflation and incremental growth investments. Adjusted earnings per share of $0.88 increased 19% versus last year, $0.88 was another fourth quarter record for the company. Earnings per share growth was driven by $0.09 from operations and $0.06 in below the line items including lower tax expense and lower interest charges. Foreign exchange was a $0.01 headwind in the quarter versus last year. The adjusted effective tax rate in the quarter was 27.5% lower than last year by 400 basis points driven by the benefits of tax reform. Free cash flow for the full year was $136 million, an increase of 7% over 2017. Adjusted free cash flow conversion was 109%. Over the course of the year, we paid down net debt of over $144 million. We invested $36 million in capital expenditures, which equates to 124% reinvestment ratio. The majority of our capital investments are high ROI projects, which will help drive growth and productivity over the next several years. During 2018, we also returned $54 million to shareholders in the forms of dividends and…

Thanks Shashank. If you would please turn to Slide 15, let me summarize our discussion. We were pleased to deliver record results for the company in 2018. We successfully grew the business especially in the Americas and by expanding geographically. We anticipate overall growth should continue in 2019, but at a reduced level to this past year. We'll be closely monitoring how potential macro headwinds impact customer sentiment and the construction markets. We plan to deliver solid margin expansion in 2019 while investing for future growth and continuing to deliver strong free cash flow. As always we'll remain disciplined in our capital deployment. Our smart and connected product strategy is gaining momentum and we expect it should help drive growth into the future. Over the last four years, we have made substantial progress in our journey to become a leaner, more customer centric organization. We intend to continue that focus and I'm confident that our team will continue to deliver on its commitments for 2019 and beyond. With that, operator please open the line for questions.

Thank you. [Operator Instructions] Thank you. And your first question comes from Nathan Jones with Stifel. Please go ahead. Your line is open.

Good morning, everyone.

Good morning, Nathan.

Thanks for all the color on the -- on the connected solutions investments and all of those kinds of things that Bob. Maybe you could talk a little bit about how you think this changes the future growth profile of the company. Any color you can give us on how much growth you think you can derive from these investments what kind of returns you're looking from these kinds of investments?

Sure Nathan. When I look at this, I look at our connected strategy really about -- it's going to be the new basis for competition. I think if we didn't do this, would it hurt us in the long run. So I think it's the future. Everybody knows the world is going to this and with our broad product portfolio, we have the opportunity to leverage our solutions. So we believe the return on investment is high. Certainly there's costs early on in the program, but as we look into the future, we believe it has a potential to increase our growth by at least a percentage point and with a higher return on investment. So again that's why we've been putting in a lot of time and effort in this and it's been a key thrust of our overall strategy.

If that's the basis you think this is where the industry is going you have to have these connected solutions to compete. Maybe you can talk about the complication and how much of the competition actually has the financial resources the R&D resources, the engineering resources to keep up with these kind of innovation? And how much of the industry kind of then falls into the commodity bucket and becomes less challenging of a competitor for you guys?

Yes. So it's difficult for us to talk about our competitors. I think I'll say in general, I think it does cost a lot to invest in this. So I think the larger competitors obviously will -- can afford it more than the smaller ones. So again, I think each competitor's different and but let's also be aware that we're also wary of these small startup companies that have new innovative technologies and we got to keep our eyes open for them too because they don't have the traditional paradigms of the industry. So we're watching that very closely, we're partnering with colleges and universities to make sure we're watching what's happening in the marketplace. But it is an exciting venture, but I just think as you look at our product portfolio and the bundling of the products, we just have a unique portfolio compared to a lot of our competitors.

Okay. You guys had targeted 14% operating margins in 2020 and I imagine that was probably absent some of the -- at least a level of growth investments that you've been putting into the company. Do you see a continued incremental growth investments going forward into 2020, where the long-term value to the company is more in funding those growth investments than it actually is hitting that 14% margin in 2020? Do you think you can still hit the 14% with the growth investments? Any color you can give on that?

Sure, Nathan. You are correct in that. We set that target before we fully understand the implications and costs of our smart and connected strategy as well as before we knew what was going to happen is we really embarked on an innovation strategy. So we've had many new ideas. We're definitely focused on the long run, but I'm still challenging my team to get to that 40% target. So we'll see, we will re-evaluate it next year. But again, we're focused on the long run and we're excited about our innovation pipeline.

I think investors should be able to clearly see the benefits of those investments they are having. So I think that's a good move. Thanks very much for the time.

Thanks Nathan.

Your next question comes from Walter Liptak with Seaport Global. Please go ahead your line is open.

Hi. Thanks. Great quarter guys. I want to ask -- some follow-on questions on the new product spending and to get to that 2023 number, the 25% it looks like the growth rate would be a little bit faster than 1%. So I wonder if you could talk about cannibalization? How do these new products just replace some of your old products?

Yes. We've looked at that and it's -- a lot of this is guesswork but as we see it, we're thinking that about 75% of it will be cannibalized. But it also depends on how we put these products together into the various systems like Intellistation, right. We used to sell the components of an Intellistation and now we have more of the system. So in general that's how we look at it, 75% is our best estimate of what the cannibalization will be.

Okay, great. Sticking with this the new products. I wonder if you could talk about where the spending is by end-market. It sounds like construction is going to be a little bit faster than -- faster growth in residential. Where were you making your investments since new products and hoping to get the benefit next year?

Yes, exactly. We're looking at really most of our investments are on the commercial side of our business. That's where we believe most of the focus is. We do have some in the residential side but from 70%, 75%, I would allocate it more towards the commercial space and looking at the bigger systems and the impact that they'll have from our customer point of view.

Okay, great. Now one last one for Shashank. Just on the FX thinking about Europe and the headwinds you are going to get this year, as a percentage of revenue, what are you thinking about for a headwind in 2019?

Yes. The total the average euro rate last year was about 1.18. We've set our budget at a 1.14 rate and each point is about $4 million in top-line revenue. So $20 million total, it's about 130 basis points of top-line revenue impact.

Okay, great. Sounds good. Thank you.

Thank you.

Your next question comes from Ryan Connors with Boenning & Scattergood. Please go ahead. Your line is open.

Great. Thanks. I wanted two -- first off congratulate you guys on a great quarter and in particular on a nice clean numbers not only for the quarter but for the year, not a lot of adjustments and very cleanly done which is a rarity these days with all these adjustments everywhere. So hopefully that's the new trend. I want to stick with this connected strategy and just kind of dive in on that a little bit on kind of margin impact of that there's been some other sectors, I can think of metering for example where counter intuitively a lot of the new technologies end-up being lower margin because there are fewer barriers to entry on the tech side and there's more competition and the legacy products tend to become more of the cash cow. So can you just talk about your outlook for the margin on the connected strategy side of things and how that plays out?

Yes. Great question, Ryan. Because as you look at it certainly the traditional cash cows you could argue have larger margins because they don't have any incremental investments. However, when you look at it we believe as you're putting these systems together versus the components that system, the benefit of putting the system together and how they interact and connect with each other drives a higher value proposition to our customers. And with the shortage of plumbers in the industry, the more we can put together and provide a greater value proposition in factory certified, I think there's a value in a premium they're willing to pay. But certainly on the upfront cost, all the security, all the -- what I would call the SG&A cost are on the front-end really important, but they're scalable in the long run. But you have to build that solid foundation for our customers.

Okay. And then, so I guess that segues into my next question which is sort of -- in terms of pricing strategy. You don't want to divulge too much about that I understand for competitive reasons, but just conceptually, I guess what you're talking about is, you're going to roll out products are going to be a premium to embed the technology and/or to the degree you're embedding the technology, or you get your pricing that product at a premium to the more legacy version without technology. I mean is that kind of a way to think about how the pricing strategy works on that?

Exactly. That's exactly the strategy.

Okay. And then, my last one was just on, you talk about scenarios relative to rolling that connected strategy out and where we are in the cycle. I mean you talked about especially in the non-resi side which I guess is where more of this would be, if we are going to go into a down cycle especially -- maybe in the scenario of a more severe one. How does that impact the timing of how you get to your goals because presumably in a down cycle maybe to be a little more price sensitivity and would be a little tougher. So any thoughts on that might be helpful.

Yes. The way I always look at it and this is, I always believe in always investing for the future. So this is one that I think is a differentiator for us and one, we're going to want to fund maybe cut it just a little bit if there was a deep recession maybe. But I also come back to 65% of our business is repair and replacement. So we've got a nice solid foundation to leverage upon as well as they'll still be building although it may not be growing and hopefully we can differentiate with our products, therefore, capturing our fair -- more than our fair share of the existing building that's going to be happening. So that's the kind of way we're looking at it right now. But we're very mindful of the economic conditions, we have contingency plans, we have triggers, we're watching it very closely and our teams are ready.

Okay. That's great stuff. Thank you for your time.

Thanks Ryan.

Your next question comes from Mike Halloran with Baird. Please go ahead. Your line is open.

Good morning guys.

Good morning, Mike.

So just staying on the connected side, a couple fold here. What's the customer response been, how do they view the value proposition from their perspective the return enhancing proposition from their side. And then, secondarily, maybe just talk about the decision on how much control you want to have or the analytics versus letting the next layer higher control that?

Good questions. Right now, the example I give on the Intellistation that our customers have been very excited because it's an issue you know that engineers specify and it has to be put together in the field while the engineers feel much more comfortable that it's coming from the factory and certified. So that's a great example of what, we feel much better assuming or knowing that a company like Watts with the credibility we have that we're going to be putting that digital mixing station and connecting it into the building management system. So they feel real good about that. They've been very positive and now instead of specing components they inspect, they spec the entire system. So it's been very positive. But as you can imagine there's certain people that are uncomfortable with is. Our job is to make it simple, easy to use and continue to leverage our trusted brand of Watts. So that's how we're focusing on it. And related to the business and data analytics, that's stuff that we're continuing to monitor and we want to invest further in that area. I think we're early innings on that. We share in particular data from our on air capabilities with our customers. It's their data. And some of them ask us to monitor the data for them. So it's a combination. But I think that's the -- as I look five years from now data analytics is going to be much a critical component of our overall strategy. But again, we're in the early innings on that Mike.

Thanks for that. And then, at a high level the rationalization is maybe not 100% done with, but certainly winding down on a global basis. The focus of this call has very much been on growth investments and how that can help the portfolio longer term. Maybe you could talk a little bit about the balance between the dollars being allocated towards the growth side versus the restructuring or the improvement side or the operational side. Whatever metric you want to use, capital dollars time, how do you think about that balance between the two from an internal focus perspective from here?

Yes. Mike we have that discussion all the time. The issue right now is with the significant ideas and innovation we have, we really have to accelerate our productivity inside of our factory. So as we look at investments, it's been about 75% growth 25% more on lean and productivity initiatives. However, on the CapEx side I would say it's more 50% on productivity, 25% growth in the rust maintenance and those are rough plus or minus 10% here and there. But again, we're very mindful of that. We're looking at it. And as I said in my earlier statement I hired a continuous improvement very experienced leader to report directly to me to accelerate our productivity initiatives to fund -- to help fund the growth initiatives and to get to our long-term margin aspirations.

Thanks for that. Appreciate the time gentlemen.

Thanks Mike.

Your next question comes from Joe Giordano with Cowen & Company. Please go ahead. Your line is open.

Yes. Good morning.

Good morning, Joe.

So I was curious -- we've heard other companies talk about fourth quarter having a little bit of pull forward from 1Q just some of their customers trying to get ahead of potentially price increases to deal with further tariff or inflation or a combination of commodities. So just curious if you saw any that in 4Q?

Yes. We believe we did about 1.5% to 2% of the North America business we believe was pulled in -- not necessarily for price, but also to leverage some of their rebates because they've had good years. So we believe that's a slight headwind as we walk into Q1.

Okay. And then, how are you guys thinking embedded in your guidance for how much is price of your expected growth? And then, as far as the commodities on the inflation side, we see iron ore going up here; copper is probably helpful in the first half maybe not in the second half, so how are kind of thinking about that?

Yes. So as we look at -- our price increases certainly we had stronger pricing in the second half of this year and that's why we think it's -- on a comp basis in the second half of the year, it's going to be tougher comps. But we look in the growth, if I look at the overall company a couple points of price is what we're probably looking at next year for the overall company. And then, on the price cost dynamics relative to commodities, the iron ore, we've just seen that given the recent dam break and that volatility. So we'll be watching that closely. But we've been very aggressive on our pricing in October when we announced our price increase. So we'll be watching that. But overall, I think our price cost -- we're ahead of the game and we're going to continue to stay ahead of the game.

And just to add a little color on the steel -- and the steel and copper, overall, when you look at copper and average price, we are slightly down. Copper has started up ticking over the last few days, but really these are on 90 day contracts et cetera. So we do expect a little softer copper. And steel went down quite a bit in the second half after all the tariffs I noted in the first half of last year. So we see a little softening on the steel side as well. So a little bit more favorable dynamics on the commodities especially steel and copper which we use a lot.

May be last from me, how is the German OEMs look I know that's been a challenging market and given what the macro data in Germany how is that kind of factored into the next year?

Well, that's why you see the 0% to 2%. I mean, certainly, I think Europe is softened and we're watching that very closely. And as you know, we're at some of their mercy with the German OEMs on that. So we watch that closely. That's why our guidance is conservative inside of Europe. And we're watching very closely so it's something more concerned about and we'll continue to monitor it.

Thanks guys.

Thank you.

Your next question comes from Andrew Cohen with the North Coast Research. Please go ahead. Your line is open.

Thanks. Great quarter. Great margins. I guess -- was hoping maybe for a little bit of color on APMEA where China's going one direction and the rest of it's going the other. Has the 5% to 7% kind of a continuation with a double-digit outside of China and still shrinkage in China or how should we be thinking about it?

So when you look at China, first of all, it's less than 2% of our overall business. And when you look at China, we really started seeing it in the back half -- the second half of 2018. So I think we're going to have tough compares on the first half of 2019. And then, it should even out. But that's been part of our long-term strategy is to diversify our Asia Pacific -- our APMEA business outside of China. And we're very pleased that the -- expansion and the things we're doing in Middle East and the other Asian countries, we're growing double digits in that area. So with lesser reliance on China and as you know, we feel more confident in our ability to grow those areas. China is a little bit difficult now, I think it's lumpy, but it's becoming less and less part of our portfolio and I think it'll stabilize in the second half of 2019.

That's helpful. Thank you. And then, on the smart connected strategy do you -- I mean, obviously, as you said it's a changing field constantly. But do you feel like you have most of what you need to go-to-market or are there holes in the portfolio that you're still looking to either fill through acquisition or research and development or how should we view all that?

I think we never feel satisfied where we are. So I think it's all of the above, right. And whether it be our M&A pipeline that we're looking for holes to fill and/or new R&D where we plan on increasing our investments. So as I said in my prepared remarks, we have a solid foundation that we've stabilized and invested a lot in. And now we can leverage that foundation as we bring in potential small little pieces from an M&A point of view like the Syncta acquisition that we did a very small startup. That's an example of grabbing a small company, plugging it in and leveraging some of our capabilities and our installed base. So we'll continue to look at that. And but we're never satisfied and we're always going to be looking for new innovation and opportunities.

All right. Thanks very much.

Thank you.

Your next question comes from Brian Lee with Goldman Sachs. Please go ahead. Your line is open.

Hey, guys. Thanks for taking the question. Just a couple here. I guess maybe on the share buybacks and set's incremental development here, any shift or does that signal any shift in priorities around the capital allocation strategy as we head into 2019.

Now, we've been fairly consistent and our strategy has always been to avoid share creep with stock options, BSEs and stuff. But when the situation does arise and we do opportunistic with our share repurchase plan, if the stock dips below over extended periods of time like it did in Q4. But overall, it's just to avoid the share creep over the next several years.

Okay. Fair enough. And then, maybe another question around the smart and connected product strategy, so the 25% target by 2023, does the $10 million you spend in 2018 is that a good annual baseline to be thinking about, or does it ramp from here? And then, Bob, there was an earlier question around data analytics and I guess some potential here for an incremental services model potentially over time. Is that something that you would contemplate needs a lot more infrastructure of CapEx to ultimately to build a strategy that can drive more monetization in that arena or how are you thinking about in a medium to longer term timeframe?

Yes. So let's start with the $10 million that includes about half CapEx and half investments. So it's a combination of both. And as I look outward that's a key area of investment. And with our new products and our focus, so yes, we'll be investing that into the future. Similar as I look into this year probably a little less CapEx because a big piece of that was our new Web site that we went forward with in 2018. But you're right, the data analytics and gathering that information, building capabilities and the infrastructure as I said in an earlier question, I think we're early innings and the teams are evaluating that and we'll be looking forward with that. So stay tuned. Again, no definitive plans on that, but it's clearly something we're investigating and looking forward to.

All right. Thanks guys.

Thank you.

And there are no further questions at this time. I would turn the call back over to Bob Pagano, CEO, for any closing remarks.

In closing, thank you again for taking the time to join us today for our fourth quarter earnings call. We appreciate your continued interest in Watts and we look forward to speaking with you during our first quarter earnings call in May. Have a great day.

And ladies and gentlemen, this concludes today's conference call. You may now disconnect.