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, Inc. Fourth Quarter 2022 Earnings Call. [Operator Instructions] It is now my pleasure to turn today's call over to Diane McClintock, Senior Vice President of Investor Relations.

Thank you, and good morning, everyone. Welcome to our fourth quarter and full year 2022 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 2022 as well as an update on our expectations for the markets in 2023. Shashank will discuss the details of our fourth quarter and full year financial results and provide our outlook for Q1 and the full year 2023. 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. 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 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. With that, I will turn the call over to Bob.

Thank you, Diane, and good morning, everyone. Please turn to slide 3 in the earnings presentation, and I'll provide a recap of 2022 and some initial thoughts regarding 2023. I'd like to start by thanking the entire Watts Water team. We've continued to execute and provide outstanding service to our customers despite escalating inflation, supply chain challenges and labor shortages. The team's collective efforts delivered another strong quarter and record full year sales, operating margin, earnings per share and free cash flow. Organically, full year 2022 sales increased by 13%. Adjusted operating margin increased by 210 basis points and adjusted EPS increased by 29%. We delivered record operating margin while still investing in an incremental $23 million for the future, including spending on our smart and connected initiatives. We generated record free cash flow in the fourth quarter to end the year at $201 million, which represents an 80% conversion rate. Our balance sheet remains strong and provides us with the flexibility to continue to invest for the future through our strategic investments in R&D, smart and connected projects, factory automation and M&A. From an M&A perspective, we have signed a definitive agreement to acquire the assets of the Enware Australia, a leading supplier of specialty plumbing and safety equipment. This acquisition will expand our presence and scale in the Australian market and further provide channel access. We expect to close the acquisition later in Q1 and we'll discuss our expectations in our Q1 earnings call. Operationally, our team did an outstanding job executing through numerous challenges. We are able to deliver meaningful margin expansion in 2022 despite unprecedented inflation in material, labor, overhead and energy costs. Our teams overcame material availability challenges, drove cost savings and realized price increases to keep in front of our cost base. We maintained…

Thank you, Bob, and good morning, everyone. Please now turn to slide 6, which highlights our fourth quarter results. Sales of $502 million were up 6% on a reported basis and up 11% organically. Foreign exchange, primarily driven by a weaker euro reduced year-over-year sales by roughly $22 million or 5%. Sales were stronger than we had anticipated with double-digit growth in the Americas and APMEA and high single-digit growth in Europe. I will review the regional performance momentarily. Adjusted operating profit of $72 million, a 12% increase, translated into an adjusted operating margin of 14.3%, up 90 basis points versus last year. Benefits from price and productivity more than offset inflation and incremental investments of $8 million. Adjusted earnings per share of $1.60 increased 13% versus last year. Earnings per share growth was driven primarily by strong operational performance, up $0.25, which was partially offset by the net impact of interest expense, income tax expense and unfavorable foreign exchange movements. The adjusted effective tax rate in the quarter was 22.4%. The rate declined by 40 basis points compared to last year, primarily due to a more favorable state tax rate. For GAAP purposes, we took a $6.2 million charge for restructuring in the quarter, largely related to the continued rightsizing of our European cost structure, along with some smaller Americas cost actions. This charge was partially offset by the gain on the sale of our plant in Méry France after its closure. We also recorded a tax benefit of $18.2 million for GAAP purposes, primarily related to the modification of the structure of our Mexican supply chain operations. In summary, the better-than-expected global top line growth drove higher operating profit, margins and earnings per share compared to the fourth quarter of 2021. Moving to the regional results, please turn…

Thanks, Sashank. On slide 11, I'd like to summarize our discussion before we address your questions. 2022 closed out on a strong note with record Q4 sales, adjusted operating margin, EPS and free cash flow. Our teams did an outstanding job delivering on our customer commitments despite the many challenges. We expect a tougher 2023 with difficult year-over-year comps from 2022 and challenging market conditions with rising interest rates and an economic slowdown. We are focused on controlling what we can and will take advantage of market opportunities as they arise. Our business model, which includes a large repair and replacement component, provides a durable revenue base that in turn drives a steady cash flow stream. We have a strong capital structure and strong cash flow capability that provides flexibility to address our capital allocation priorities to create value for our shareholders. We remain focused on executing on our long-term strategy, continuing to invest incrementally for the future and driving our smart and connected strategy. We continuously monitor economic conditions and our markets. Our experienced team is well positioned to execute throughout the economic cycle and adapt to meet our customers' needs in any environment. With that, operator, please open the line for questions.

So, just a couple of questions here. First, just on the non-res outlook, you talked about some of those leading indicators. Maybe just put it in context of the mix of business you're seeing, whether you're seeing any softness on the non-res side today, or if this is more prospective based on what those leading indicators are saying. And I know you guys referenced some concern on the office retail side, makes sense. Any other pockets where you feel particularly good about given the visibility you have? So, just some context around all those things.

Yes, the institutional market, education, health care, data centers, food and beverage side has been strong, Mike, and we expect that to continue through the rest of the year. Like you said, the-- more office buildings, retail, that has been soft, and we expect that to continue to be soft. So, that's in our assumptions for the rest of the year.

And are you seeing that today, though, Bob? Or is it the soft points from the...

Yes, that's what we're seeing, that's what our team is seeing that and feel confident that institutional education and health care, all of that will continue to be fairly even-- continue its strength through the rest of 2023.

And if you think about the sequentials that have been assumed in guidance, it feels like a more conservative back half of the year, which makes sense. Is the assumption here then that relatively normal trends into the front half of the year based on what you're seeing in 4Q and then tapers through the year with the hope that maybe the environment stays stronger, but might as well be cautious going into the back half -- is that the thought process?

Well, yes, the thought process-- I mean, the big thing we're watching is multifamily because that's been offsetting some of the single-family residential side for us. So, those indicators, we're watching closely. We expect that to soften as the second half goes-- as well as repair and replacement, Mike, has been strong all year, and repair and replacement usually follows GDP. So, with GDP coming down, we're assuming repair and replacement is likely to come down because it's been very robust in 2022.

Last one for me, if you don't mind. On the smart and connected side, when you're starting to see pockets of weakness, how are people reacting in the smart and connected adoption curve in those areas? Meaning, are you seeing people lean in as they start thinking how to manage people and cost in a weaker environment? Or you may be seeing the opposite, I'd be curious if there are any trend lines associated with that because overall, it seems like the trend line remains pretty healthy for you.

Yes. I mean when you look at smart and connected, there continues to be a shortage of plumbers as well as maintenance personnel, right? And I think anything we can do to make it simpler for the building owners to look at their systems and not have to guess is important. So, we continue to lean in on that. Our customers are taking that very positively. Especially if you have a leak or an incident, you clearly want to look at our products because if you don't, your insurance is going to go up. So, we believe, as I've said before, 10 years from now, pretty much all the products are going to be smart and connected, and we just want to lead in that journey.

Your next question is from the line of Jeff Hammond with KeyBanc Capital Markets.

This is David Tarantino on for Jeff. Maybe just starting off with Europe, I mean, organic growth in the region hasn't really shown any signs of cracks to date, which has been a positive surprise, but obviously, guidance implies a decent amount of slowing in the region. So, could you just give us a bit more color on what you're seeing on the ground in the region right now?

Yes, I mean just what I talked to Mike about just now. I mean, when you look at it, we're seeing single-family residential softening been offset by multifamily residential. We're watching that very carefully because some leading indicators are now projecting that to soften, especially in the second half of the year. As I said, GDP is slowing down -- we tend to follow GDP -- and obviously, with interest rates going up, there's some concern longer term, especially in the second half that commercial construction may slow down. So, we're watching that carefully. We feel good about the first quarter and more in the first half. We're watching how the second half unfolds at this point in time. Certainly, in Europe, with the war, there's-- we're seeing a decrease pretty much on new construction. That's where the concern is. A lot of it has been finished, they're finishing up what they started. But, I think new construction is what we're watching very carefully there, and we think that's going to continue to slow down, and that's why we've assumed that in our overall guidance for Europe.

Okay, great. Then, maybe, switching to price cost. I mean, you have that in the monitoring items, and we're starting to hear some signs of disinflation of certain commodities, but maybe could you walk us through the puts-and-takes here, especially within your own commodity basket?

Yes, look, on the price cost side, we talked about the benefit of carryover price into 2023, as well as we're announcing price increases for 2023, and that's all going to be subject to market pushback, right? But, back to your comment on disinflation, when you think about commodities -- commodities did soften. I mean our biggest commodity is copper, and it did soften in the second half of last year. Since then, it's actually picked up, and the price today is slightly higher than the average price of last year. We've assumed about a 4% inflation both for commodities and other costs like compensation, et cetera -- compensation being one of the biggest costs that we have. But it is-- there is disinflation in the market. So, inflation will be lower than prior year. Operator Your next question is from the line of Joe Giordano with Cowen.

This is Michael on for Joe. Performance in Europe was probably much higher than most were expecting, and you had mentioned earlier that price was a large contributor. Can you just give us a sense perhaps on the magnitude for the quarter and perhaps describe the volume price relationship built into the fiscal year guide?

Yes. So, look, overall, our price realization across Watts was approximately 10% in the fourth quarter, a little bit more than that in the Americas, a little bit less than that in Europe. In Europe, if you strip out price, volumes were slightly negative. Clearly, as we think about 2023 and the guide that we have, unit volumes will be negative. We talked about that when we talked about our margin expectations with the deleveraging we have with a high fixed cost base. So, that's what our expectations are, and specifically to Europe.

[Operator Instructions] Your next question comes from the line of Brian Lee with Goldman Sachs.

Brian, you there?

Sorry, everyone. This is Miguel on for Brian, I was on mute. I just wanted to follow up on that last question and the answer around Europe volumes being down for the guidance in '23. Will volumes also be down in the Americas? Then, also just looking at the Asia guidance, it looks like volumes will be up there, but I just wanted to check on volumes across the regions as well.

Yes. We did talk about Europe. If you strip out a little bit of the price we got going on, unit volumes will be down. In the Americas, if you strip out price, our expectation based on the guidance is unit volumes will be flattish to slightly down. Then, the APMEA region, unit volumes will be up a little bit, primarily driven in the Middle East-Africa market.

Okay, great. That's helpful, thanks for the clarification. Then, yes, on APMEA -- this is my last question -- on APMEA, it looks like it either will be growing in '23, but the operating margins are down. Specific to that region, what's causing the pressure on margins this year?

It was related to intercompany -- last year, in 2022-- in 2021, there was a lot of product sourced from North America. We don't put intercompany sales in that number, but it does have the intercompany profit that is made from its sales to our North America sub. So, again, it's solely due to intercompany volume.

[Operator Instructions] There are no further questions at this time. I will now turn the call back over to Mr. Bob Pagano.

Thank you for taking the time to join us today. We appreciate your continued interest in Watts and we look forward to speaking to you again in May to discuss our first quarter results. Have a good day, and stay safe.

Ladies and gentlemen, thank you for participating. This concludes today's conference call. You may now disconnect.+