Good morning, and my name is Savannah, and I will be your conference call operator today. At this time, I'd like to welcome everyone to the Watts Water Technologies Fourth Quarter 2021 Earnings Call. All lines have been placed on mute to prevent any background noise, and after the speakers remarks there’ll be a question-and-answer session. [Operator Instructions]. Thank you. And Tim MacPhee, you may begin your conference. Please stand by for some technical difficulties. Please go ahead.

Good morning, everyone. Welcome to our fourth quarter and full year 2021 earnings conference call. Joining me today are Bob Pagano, President and CEO; our CFO, Shashank Patel; and Diane McClintock, VP of Financial Planning and Analysis. Bob will provide an overview of this past year, review Watts' 2022 priorities as well as update you on our market expectations for this year. Shashank will provide a detailed analysis of our fourth quarter and full year financial results and discuss our outlook for Q1 in the full year 2022. Following our prepared remarks, we will address questions related to the information covered during the call. Today's webcast is accompanied by a slide presentation, which can be found in the Investors section of our website. We will refer to these slides throughout our prepared remarks. Any reference to non-GAAP financial information is reconciled in relevant GAAP measures in the appendix to the presentation. 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 via publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether because of new information, future events or otherwise. On a personal note, this will be my last earnings call. I have decided to retire effective March 31. While I have worked with so many great people at Watts over the last 18 years, I'm excited and looking forward to the next chapter. I am also excited to inform you that Diane McClintock, our VP of Financial Planning and Analysis, will be assuming my Investor Relations duties. Diane has over 10 years of increasing financial responsibilities within Watts as well as experience in financial roles with other companies. You will find Diane to be very knowledgeable, energetic and personable. I fully expect you will enjoy working with Diane as much as I have. I've also enjoyed working with you, the investor and analyst community, over the last 9 years. I've appreciated your continued interest in our company, and I wish you all the best, both personally and professionally. With that, I will turn the call over to Bob.

Thank you, Tim, and good morning, everyone. Before beginning the presentation, I'd like to comment on Tim's personal announcement. Tim has been a respected member of the Watts team for 18 years. As Corporate Controller, Chief Accounting Officer, Treasurer and our Investor Relations lead, he has been involved in all aspects of finance. Tim has worked closely with several CEOs and CFOs during his tenure at Watts and all have appreciated his work and counsel. I want to thank Tim for all his services to Watts and wish him all the best in his retirement.

Thank you, Bob.

Now please turn to Slide 3 in the earnings presentation, and I'll provide a recap of our 2021 efforts and some initial thoughts regarding 2022. Entering 2021, general expectations were that the pandemic's negative global impacts would wane as the year progressed. Instead, new virus variants emerged, supply chain disruptions became more frequent, across-the-board inflation became more prevalent and our personal lives continue to be affected. As the economy recovered, we saw strong market demand. Also, earlier in the year, severe winter weather in the Southeastern United States drove additional unexpected demand. Throughout another challenging year, the entire Watts global team worked tirelessly to meet customer demands despite all the adversities. I must thank everyone for their outstanding performance. The team remained close to our customers, dealt with many complex supply chain disruption, enhanced our digital platforms to promote remote work collaboration and continue to drive a safety-first mindset. We diligently addressed inflationary pressures through market-leading pricing programs and with productivity initiatives. In addition, we expanded our product offering in leak detection systems and solutions with the purchase of Sentinel Hydrosolutions. We have advanced our efforts to further embed environmental, social and governance or ESG tenets into our culture. In 2021, our General Counsel also became the Chief Sustainability Officer and is providing quarterly updates on our ESG efforts to the Board. We performed a materiality assessment to help guide us in determining the ESC touch points most critical to our future success in our ESG journey. We participated in the Water Council's Water Stewardship Accelerator program, which allowed us to better understand how we affect water resources, both upstream and downstream at eight of our worldwide facilities. We continue to encourage the expansion of our employee resource groups and now have six groups focusing on various constituencies within our…

Thank you, Bob, and good morning, everyone. Before beginning, I also want to thank Tim for his meaningful contributions to the company. He has been very helpful to me in understanding Watts' long history, what is top of mind with our investor base and how we address those concerns in a concise, timely and transparent manner. Tim has been a great sounding board for me and I've always appreciated his thoughtful input on a variety of subjects. Thank you, Tim, for your efforts and wish you a long and healthy retirement. I look forward to working with Diane in her new role and introducing her to our shareholders and analysts. Please now turn to Slide 5, which highlights our fourth quarter results. Reported sales of $474 million were up 18% year-over-year. Organic sales were up 18% as well with the impacts of acquisitions and foreign exchange movements mostly offsetting one another. Sales were stronger than we had anticipated with double-digit growth in all regions. I will review regional performance momentarily. Adjusted operating profit of $64 million, a 16% increase, translated into an adjusted operating margin of 13.4%, down 20 basis points versus last year. Benefits from volume, price and productivity savings were more than offset by inflation, incentives, cost normalization and incremental investments of $7 million. Adjusted earnings per share of $1.42 increased 23% versus last year. Earnings per share growth was driven primarily from operations up $0.22 and, to a lesser extent, by $0.05 from a combination of lower interest expense and a lower adjusted effective tax rate, partially offset by unfavorable foreign exchange movements. The adjusted effective tax rate in the quarter was 22.8%. The rate declined as compared to last year due to the benefits from higher R&D credits. For GAAP purposes, we took a $1.1 million…

Thanks, Shashank. Please turn to Slide 10 and let me summarize our discussion. The team delivered record results in 2021 while navigating many challenges throughout the year. We continued our ESG journey, embracing more of its concepts and educating our workforce to make it part of how we do business. Our smart and connected product portfolio and pipeline continue to grow. The original 2023 target remains our goal, but COVID and supply chain issues may delay those ambitions. Markets are expected to grow with growth moderating when compared to 2021 levels. In 2022, we expect moderate revenue and margin expansion, and we'll continue investing for the future. As always, we remain disciplined in our capital deployment, prioritizing reinvestment in acquisitions that strengthen our core, further expand our geographic reach and add technology to build scale. We'll be closely monitoring how future virus variants materialize and how they may impact customer sentiment in the construction markets. I want to again thank the entire team for delivering an exceptionally strong year in 2021. I'm very confident our experienced team will continue to work through the many virus-related supply chain and labor issues and execute again in 2022, while still focusing on our long-term growth strategy. With that, operator, please open the lines for questions.

[Operator Instructions] We will take our first question from Nathan Jones with Stifel. Please go ahead.

Yes, good morning. This is Adam Farley on for Nathan. In your presentation, you called out price as being a favorable tailwind in your 2022 planning framework. Could you give a little more granular detail on what you expect price cost to be in 2022? Do you expect it to be price cost neutral to positive?

Yes. So just to -- going back to 2021, overall price was, on average, about 5% price realization and price and productivity more than offset cost inflation. And in 2022, we see the same dynamic where price and productivity will more than offset cost inflation. Clearly, there's a carryover from the price increases we did in '21. And then we have price increases in the first quarter of 2022. So with that dynamic, we will -- again, with price and productivity, it will exceed inflation.

Okay. Thanks for that. And then shifting over to the supply chain more broadly. Is having your own foundries reducing the impact to Watts versus your competitors? Do you think this is resulting in any share gains? And do you think these share gains will likely be permanent or transitory? Thanks.

Well, the way we look at it, look at our foundry and our -- our overall strategy of manufacturing where we sell our products is, I believe, a strong strategy, and that has benefited us greatly in 2021 because we've been able to control our own destiny. So we believe it's a competitive advantage, and our goal is to keep all the share we've gained this year and then gain some more. So that's our focus and that's our team's efforts on that.

Thanks for taking my questions.

Our next question will come from Jeffrey Hammond with KeyBanc Capital. Please go ahead.

Hey, good morning. This is David Tarantino on for Jeff. Just starting out, like given all the puts and takes we've seen with supply chain broadly, could you give us some color on what you're seeing get better or worse in terms of input availability and pricing in 4Q?

Listen, I would say, in general, we saw some of our supply chain get better, but it's like whack-a-mole, right? Some things get better and some things get worse. So I think the Omicron, which happened late in the fourth quarter and carried over into the first quarter, really impacted not only us but our suppliers' labor force. And some of the shutdowns in China, obviously, impacted our China facility. So in general, I think things are starting to get better, but this Omicron was an issue that caused more problems, but our teams are working hard. And as we said in our prepared remarks, we believe it's going to continuously get better. But like I said, one step forward, two steps back, and we keep on going. So the team is holding their own, but we still think it's going to be difficult, especially in the first quarter. And as we go into the latter part of the year, we believe it will get better.

And then just as a follow-up to clear up on price. Was the 5% what was realized in 4Q? And also, what do you expect price contribution to the 2022 sales guidance to be?

Yes, that 5% number was for the full year 2021. Obviously, we announced almost three increases globally. So the price realization ramped up as we went through the year. And some of that is a tailwind into 2022, along with the first quarter of 2022 price increases. At this point, it's hard to estimate what the price realization will be for 2022. Obviously, we'll be reporting on it when we do the next earnings call as we get to the realization of Q1 price increases.

Great. Thank you.

Our next question will come from Ryan Connors with Boenning and Scattergood. Please go ahead.

Great. Thanks for taking my question. And congratulations to Tim and Munish, both been very helpful to us over the years. I wanted to talk about price from a different angle. It's amazing how the things have evolved in the last year. And now we're obviously at the hinge point where the Fed is going to be raising rates and their goal, I guess, is to tamp down inflation. So theoretically, by the end of the year, some of the raw material cost challenges will start to cool off. What are your thoughts on the ability and strategy around trying to hold price, looking past the next quarter or two out into the tail end of '22 into '23? Any thoughts on that side of things?

Ryan, I think when you look at the inflationary economy right now, I don't think it's going to abate anytime soon, right? So I think we'll have to watch that. And then when you look at any portfolio, the more commoditized you are, the more susceptible you're going to be towards those type of potential drops into the future. So as you know, we pruned a lot of our commoditized products early several years ago. And we are spending a lot of time and effort to focus on value provided to our customers with our smart and connected products. So look, inflation is different. Wage inflation is not going to go away. Once you provide that, it's going to stay. And costs like insurance, that's going to stay. So whether raw materials move, that will be an area we'll focus on, but we're going to continue to build products that differentiate and add value, and we're going to keep as much price as we can. So that's our focus. But I think the more commoditized you are, the more difficult it's going to be to keep price.

Got it. Okay. That's clear and helpful. The other one I wanted to chat about was sort of the channel inventory type situation and where you think that stands. Obviously, when you've got so many different pricing actions going out, presumably, your channel partners are trying to navigate around that to their own benefit. I mean where does that stand? And is there any volatility we can expect related to that the next few quarters?

Yes. So we watch that very closely. We don't have full visibility. The interesting thing we're seeing now is that the channels, whether it be a contractor, are starting to store inventory where they haven't in the past. So it's interesting to see. We're seeing general increases. People are trying to get in front of price increases, but volume repair and replacement has been robust. So that's been driving some of the demand for that inventory. So we're watching that very closely. We're a book-and-ship business, and that's why we're very careful as we watch, especially in the second half of this year, because of supply chain gets better, lead times come down and people can rely on manufacturing in general. I think the tendency will be for them to look at potentially reducing their inventory. So we watch that very closely.

Okay, great. Thanks for your time this morning.

And our next question will come from Walt Liptak from Seaport Research. Please go ahead.

Hi, thanks. Good morning everyone. And Tim, it's been great working with you, too. So good luck with everything in the future.

Thanks, Walt.

I wanted to ask about -- maybe a follow-on to that last question about the channel. And I wonder if you could talk about the timing of the 2022 price increases and if you think there's maybe a fourth quarter pre buy at all ahead of that price increase?

Yes. I would say, look, our price increases varied through the first quarter based on our notice and timing. So do I believe a bunch of orders came in to beat the price increase? Yes, it will be shipping. Some of them we shipped in the fourth quarter. It's very difficult to gauge that. I probably saw more of it in Europe, where we could see some stocking happening, in particular, Shashank called out in our Drains business. We saw some stocking at the wholesale level in Europe. But difficult to figure, but maybe one or two points, but again, it's very difficult to figure out.

Okay. Great. And then you commented that the first quarter is going to be impacted by, I guess, some Omicron-related absenteeism and supply chain, more so than the rest of the year. I wonder if you could talk about it. That seems to be having peaked in coming back. I wonder if you can give us any insight into are things getting better now or do we have to wait until second quarter for some of those pandemic-related issues to start dissipating.

Yes. We saw a peak in January with absenteeism being the highest. We've actually in the last, and I'm knocking on wood, couple of weeks we've seen that get much better and trend down. Still higher than our normal absenteeism, but like half the rate it was in January, which is much better. So teams are working hard. We're -- again, all the safety protocols are in there. We take it very serious, and we're working overtime to make up for what we missed in the first month of the year.

Okay. Okay. And then maybe a last one for me. Just wondering about the EU government programs. You seem to have gotten a nice benefit from that last year. Are some of those government programs still in place? And similarly, you mentioned that there's going to be more restructuring savings. Does it accelerate from last year? Or is it about the same?

Yes. So when you look at -- I'll let Shashank answer the productivity. So you want to answer the productivity?

Yes. So on the productivity side. So that's the facility in Mery, France that we complete the restructuring this year. So there's incremental savings, roughly an incremental $2 million that we'll get in 2022.

Okay, great. Thanks Shashank.

Yes, Walter, I think you also asked a question on the government incentive programs in Germany and in Italy that we benefited from in 2021. Those programs will continue into 2022. But the subsidies are at a lower rate, but those subsidies will continue.

Okay, great. Thank you.

And our next question will come from Brian Lee with Goldman Sachs. Please go ahead.

Hi, everyone. This is Miguel on for Brian Lee. I think most of my questions have been answered, but I just wanted to touch back on the supply chain real quick. We're hearing more and more about electronic shortages, especially on chips. Could you just level set us on your supply of electronic components? Is there a certain kind of chip or component that's become more constrained recently? Or in general, are you seeing incrementally more constraints on those specific components? And then also, is there a region that might be most impacted by those -- by the shortages either because of a higher mix of smart and connected sales? Thanks.

Yes. So in general, I would say we are seeing chip shortages go out. But as I said in my prepared remarks, it's nice to have your own electronics team inside your organization who looks at when products become obsolete or have difficulty. We look at what we can do, what we can reengineer, what we can requalify from a customer point of view and we ship to different chips and stuff. So I would say it's general across the board. Primarily from smart and connected, Americas is most impacted by that. That's where we have the most smart and connected products, and then Europe would be second. But again, I still indicate it's global. It's great to have a team of engineers and your own internal capabilities to help you mitigate all these issues. So watching it very closely. We get daily and weekly reports on where the shortages are and what we're doing to correct it. So the team is doing a great job with that.

Great, thank you very much. I’ll pass it on.

Our next question will come from Michael Anasagio [ph] with Cowen. Please go ahead.

Hey, good morning guys. How you’re doing?

Good morning.

Great. I'm sorry, I joined late here. Previously, you mentioned there was a 25% target for the connected products for 2023 and it looks like we might be pushing out to 2024. Can you provide any color here if this is more due to chip shortages or other COVID headwinds?

Yes. So in my prepared remarks, we talked about that. Look, our goal is still -- the team's goal is to get to 25% by 2023. But given the chip shortages and what I just discussed with Walt, we've been shifting our internal resources to just upgrade our current chips for our current products. So we've been able to shift that, which allowed us to really take advantage of our existing products and continue to get them out the door. So again, we're not letting off. There is chip shortages, but when you had -- we diverted about 30% of our key engineers in the second half of this year to work on existing products and to look at chip shortages. So this may delay. I'm only saying may because internally, we're still shooting for 25%. It all depends on how fast the chip shortages go away and how quickly the supply chain issues all around the industry start going. So again, still the focus is on 25%.

Great. Thanks for the color. And just a follow-up to that, and then apologies if this was answered prior. But can you just provide a little bit more of a framework towards your procurement strategy and -- for these types of inputs and such?

Well, we have two electronics companies: one in Canada, one in France and a low-cost manufacturing in Tunisia. So we have a lot more scale than most traditional companies in our space. So we have the ability to have -- get supply chain capabilities around the world. So we look at this, we monitor it. We have long-term agreements in place. So the team continues to watch that and then also look for potential obsolescence from some of our older products and then look at upgrading those chips to more current chips that are becoming more available. So again, the team is all over it.

Great. Thank you for the color.

Our next question will come from Mike Halloran with Baird. Please go ahead.

Good morning, everyone. And also congratulations, I guess. Congrats, Tim, in the retirement, Munish as well. And congrats, Diane, with the new responsibilities. So two questions here. First, just from a competitive landscape environment, obviously, it's challenging from the supply chain shortages, et cetera, perspective. How do you think you're faring relative to peers competitively? What do you think shares shifting qualitatively across some of the product lines? And how much of a benefit do you think having your scale in broader manufacturing base is helping right now?

Yes. Well, our product lines are massive and there's multiple competitors here. But again, I think our results speak for themselves, up 17%, yes, 18% in the quarter. And I think we've been doing a good job getting our customers' product. And as a result, certainly, that I believe we've gained some share here. So we'll continue to look at that and I think that's on a global basis. So we'll continue to focus on that. And I think product availability is key right now. And I think as we talked earlier, that having our current manufacturing strategy, where we have products in the local region where we manufacture to serve our local customer is an advantage for us.

And I know you guys touched on this in a few spots, but I just want to hear kind of a cohesive message around it. Just when you go to guidance and the cadence you've assumed for the year, could you just touch on the seasonal cadence that you're expecting for the revenue line as well as the margin line? And maybe how that compares to what a typical seasonal curve might look like for you?

Well, Mike, I'll start off and Shashank can do it. If you look at our comparisons, I mean, we grew 20% over the last 9 months of 2021. We had an easier compare in Q1 of last year. We only had about 4% growth. So I think as you look at it from a cadence point of view, it's easier comparison in Q1. And certainly, Q1 of last year's income, all the price increases we had in the second half of 2021. So I think just the pricing impact has changed some of the seasonality. First quarter will be stronger just because of that year-over-year comparison. And again, don't forget that there was pent-up demand inside of -- when you look up at the global supply chain related to everything being locked down in 2020 and now things open back up in early 2021, especially after the shot started hitting everybody, and people got vaccinated. So I think things started opening up in the second, third and fourth quarter. So I think we're going to have tougher comps in those -- the back half, including the second quarter. And don't forget, we had two points of overall growth freeze last year. So we're comping against that. The biggest impact was in the second quarter, but we also had an impact in the first quarter.

Yes. No, I certainly appreciate all that. I'm more thinking on a sequential basis, Bob. So if I'm thinking about how you're expecting the revenue to continue in few years and work through the year, is it a more normal year? Or given some of the supply chain challenges, shortage challenges, maybe a little bit more of a ramp through the year? Maybe you could address that?

Yes. So look, I mean, historically, if you go pre-pandemic, our seasonality, second quarter and the third quarter used to be a little bit higher than Q1 and Q4 just because of new construction in the summer and springtime. And with -- obviously, post-pandemic, it all depends on the activity by quarter, which does change in the prior year comps. So if you think about this year, a point Bob made on Q1 is very relevant. And then as we go into the out quarters, it's more of a seasonal pattern, assuming that we don't have greater supply chain disruptions or assuming there's no new variance of the variant. So those are the risks that are out there that would disrupt a more normal pattern.

Thank you. That makes lot of sense. Appreciated.

And we do have a follow-up from Nathan Jones with Stifel. Please go ahead.

Good morning, everyone. Just following up on that -- on some commentary there, Bob. You talked about reopening, and I understand as things got reopened, there was some repair and replace work that you would have to do. Do you think that has passed through now? Or do you think there's some continuing benefit from that in 2022?

I think given projects have been delayed, Nathan, in general because of labor shortages and then it continued in the latter half of 2021 with the Omicron and then into the first quarter. I don't think all of that has come through. I think it will be -- most of that will come through in the first and second quarters and as supply chain stabilize and job sites stabilize, I think that's going to be past us and we'll look at normal growth. But I think the first half is where you're going to see that finally come through.

And then a question on interest rates. The new construction side of your business could potentially slow down if the Fed actually does follow through with raising interest rates. It's been a long time since we've had a rising interest rate environment. Just any comments you could make on the expectation of how that might impact your business? I wouldn't imagine you think it has any impact in 2022, but maybe '23 and beyond?

Yes. It also depends on what inflation is also. So if they raise interest rates, and again, interest rates, if you really look at it, are still historically low. They're up -- could go up significantly, but you're only talking a point or 2. But if inflation starts coming back down, especially on the commodity side, I think that somewhat balances off. So again, we're cautiously optimistic, and we've not seen the commercial market fully open up. I think the interest rates you're talking about really impact single-family homes and more so and versus some of the longer term on the commercial side. But again, something we're watching very carefully. But let's -- if you think about it, interest rates are still very low, even if they do increases.

Still very low, I agree. I just want to ask a follow-up on the increased growth investments going up by $20 million in 2022, which I think is the highest level of incremental growth in investments that you've had over the last few years. Have you -- what kind of ROI are you seeing on those investments currently? What do you think the long-term ROI is likely to be on these growth investments?

Well, Nathan, the way I look at it is our whole portfolio is going to move towards smart and connected. So I think it's -- we'll have no sales because we're driving the future to smart and connected. So the majority of our portfolio long term is going to get smart and connected. But we've been continuing to improve our ROIC every single year and has bounced up significantly last year to this year. And so in general, I would say every project that we look at from a return point of view, but we also know if our products add value and differentiate and allows us to increase our price and our margins on it from a standard margin point of view. So we'll continue to focus on that. And you can watch our overall ROIC, which I think really answers your question.

Great. Thanks for taking my questions. And congratulations to Tim.

Thank you.

And that will conclude our question-and-answer session for today. I would like to turn the call back to Bob Pagano 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 look forward to speaking with you during our first quarter earnings call in May. Have a great day, and stay safe.

And this will conclude today’s conference. Thank you for your participation and you may now disconnect.