Hello, and welcome to the Watts Water Technologies, Inc. Fourth Quarter 2023 Earnings Call. All lines have been place on mute to reduce background noise. After the presentation there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to Diane McClintock, Senior Vice President of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Welcome to our fourth quarter and full-year 2023 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 2023 as well as an update on our expectations for the markets in 2024. Shashank will discuss the details of our fourth quarter and full-year financial results and provide our outlook for the first quarter and the full-year 2024. 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. 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 undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. With that, I'll turn the call over to Bob.

Thank you, Diane, and good morning, everyone. Please turn to Slide 3 in the earnings presentation, I'll provide a recap of 2023 and an overview of our outlook for 2024. I'd like to start by thanking the entire Watts Water team for their tremendous contributions that resulted in another record year. We closed out the year with a strong quarter, resulting in an adjusted operating margin expansion of 150 basis points. The strength of our fourth quarter drove record full-year sales, operating margin, earnings per share and free cash flow. Organically, full-year 2023 sales increased by 1%. Adjusted operating margin increased by 140 basis points and adjusted EPS increased by 16% compared to the prior year. We delivered record operating margin while continuing to invest an incremental $24 million on strategic projects, including spending on our Smart and Connected initiatives. We generated record free cash flow of $281 million, which represents 107% conversion rate. Our balance sheet remains strong and provides us with the flexibility to continue to invest for the future. High ROI CapEx, competitive dividends and strategic M&A remain our top capital allocation priorities. Moving to operations. As previously announced, we closed on our acquisition of Josam Company effective January 1, 2024. Josam is a leading provider of commercial drainage and plumbing products. This complementary acquisition broadens our existing portfolio and expands our exposure to profitable commercial, institutional and light industrial end markets. Integration is underway and the teams are working collaboratively to capture synergies and drive growth through cross-selling opportunities. The integration of our Bradley acquisition is also going very well as our cross-functional teams work together to capture cost synergies and additional growth opportunities. We expect both acquisitions to be modestly accretive to adjusted EPS in 2024 after factoring in incremental interest expense and normal purchase…

Thank you, Bob, and good morning, everyone. Please now turn to slide four, which highlights our fourth quarter results. Sales of $548 million were up 9% on a reported basis and down 1% organically. Organic growth of 1% in the Americas and 4% in APMEA were offset by a 5% organic decline in Europe. Foreign exchange, primarily driven by a stronger euro, increased year-over-year sales by roughly $6 million or 1%. Sales from our Enware and Bradley acquisitions added $42 million or 9 points and are reported within the APMEA and Americas regions, respectively. I will review the regional performance momentarily. Compared to last year, adjusted operating profit of $86 million increased 21% and adjusted operating margin of 15.8% was up 150 basis points. Benefits from price productivity and mix more than offset inflation, reduced volume and incremental investments of $9 million. The acquisitions were dilutive to operating margins by approximately 100 basis points. Adjusted earnings per share of $1.97 increased 23% versus last year. Earnings per share growth was driven primarily by strong operational performance and reduced interest expense, which was partially offset by the net impact of acquisitions and foreign exchange movements. The adjusted effective tax rate in the quarter was 22.3%, up 10 basis points, compared to the fourth quarter of 2022. For GAAP purposes, we took a $3.8 million restructuring charge in the quarter related to the continued rightsizing of our European cost structure, along with additional Americas cost actions and facility exit costs. We also incurred $6.3 million of non-recurring acquisition charges. These charges are partially offset by the reversal of an earn-out accrual from a prior acquisition. We also recorded a tax charge of $5.3 million primarily related to foreign withholding taxes associated with the repatriation of cash in 2023. Moving to regional results.…

Thanks, Shashank. On slide nine, I'd like to summarize our discussion before we address your questions. 2023 closed out on a strong note with record Q4 sales, operating margin and adjusted EPS. Our teams overcame many challenges and did an outstanding job addressing our customers' needs. We are excited about the addition of Bradley and Josam to our family of brands and solutions. We are focused on integration and ensuring a seamless transition and are pleased with the progress to date. We expect a more challenging 2024 with softer market conditions. As we've said, our portfolio is agnostic to end markets, and our teams will pivot to the growing sub-verticals as needed. We are focused on controlling what we can and will take advantage of profitable market opportunities enabled by our robust balance sheet. Our business model, which includes a large repair and replacement component, provides a durable base that drives a steady revenue and cash flow stream. We remain focused on executing on our long-term strategy, continuing to invest incrementally for the future and driving our digital strategy. Our balance sheet remains strong after our acquisitions of Bradley and Josam and provides ample flexibility to support our capital allocation priorities to create value for our customers and shareholders. Our acquisition pipeline remains strong, and we'll continue to monitor attractive opportunities that expand our solutions, geographic presence and growth. We continuously monitor economic conditions in our markets. Our highly experienced team is well positioned and has proven themselves more than capable of executing through the economic cycle and adapting to meet our customers' needs in any environment. With that, operator, please open the line for questions.

Thank you. [Operator Instructions] Your first question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is open.

Hey, good morning, everyone. Thanks for all the great detail here. Just want to jump in, I guess, a couple of areas where you cited some, maybe weakening. One, just multifamily, is this more of a concern or are you starting to see that yet? And then separately, just give us a sense of, I know the heat pump, Europe heat pump business has grown for you guys, what you think, how much pressure you see from that market? Thanks.

Good morning, Jeff. Yes, so we're not seeing multifamily decreasing yet. But given the housing, the starts, the permits, et cetera, that's where we're concerned, right? So it's -- we believe it's just a matter of time and more concern in the second-half of the year. Regarding heat pumps, we're seeing softness in our OEM business, which sells heat pumps and other ancillary equipment around there. And we saw that in Q3, and it held up in Q4, and we also saw that in January. So it's in line. There's overstock of the heat pumps for sure and then the ancillary products. A lot of that's being driven by the incentives that we talked about earlier that have -- they've slowed down those incentives. So a lot of people are waiting for those, but the OEMs are drawing down their inventories.

Okay. Very helpful. Maybe just give us a sense of what you announced on pricing, if you think pricing is back to a more normal level? And then just how to think about incremental margins, I guess, particularly for North America ex some of the acquisition dilution?

From a -- good morning, Jeff. From a pricing standpoint, we, you're right, we are back to pre-pandemic levels. And we're assuming a 1% to 1.5% price realization for this year. And that's obviously on the back of lower, much lower inflation than we've experienced over the last three years. And back to the pre-pandemic days, right, we used to focus on driving a lot of productivity. So, it was price and productivity more than offsetting inflation, incremental investments to drive the margin expansion. And I think we're back to that in 2024. Productivity, we're driving a lot on the global sourcing initiatives. We took some restructuring actions and then productivity in the plant and outside the plant as well.

And then incremental margins ex the acquisitions?

Excluding acquisitions, we're looking at 20 basis points of op margin expansion if you take the acquisitions out for the year.

Okay. Thanks, guys.

Thank you.

Your next question comes from the line of Michael Halloran with Robert W. Baird. Your line is open.

Hey, good morning, everyone.

Good morning.

So, it certainly makes a lot of sense in the prepared remarks when you think about the leading indicators you referenced and how you have some concern in specific pockets as you work through the year. What's the channel saying? And how far out does that visibility stretch as you sit here today? The leading indicators have a lot of moving pieces. There's a lot of different end markets below the hood. So, I guess I'm just a little bit more curious what the feet on the ground are specifically saying right now?

Yes. So Jeff, look we're a book and ship business, as you know. So we have very short lead times. So, we're having a lot of discussion with contractors. The larger contractors are busier. They tend to move around. So, we're watching that very closely. There is concern in general on the second half of this year, and we're watching that. But as we said earlier, we'll pivot to the areas that are growing and our products and teams will move to those areas as appropriate.

And then how, you mentioned that multiple times balance sheet capacity perfectly comfortable to pursue deals. What's that pipeline look like? And do you think that the opportunity exists to have a little bit more consistent cadence of M&A as we look forward?

Yes. So the pipeline remains full, and we continue to monitor that. You never ever can predict the timing of acquisitions. You work on these for years and then they all of a sudden pop-up. So we're watching that closely. We're continuing to develop those relationships, and we'll wait and see. But I would say, in general, the pipeline is healthy, and it's just, none of us can determine exactly the timing of any of these things at this point in time.

And then, thank you for that. And one last quick one here. Shashank, what's the percent impact of the four shipping days that you guys are assuming in the first quarter and the fourth quarter? And are those created equal, given how December can sometimes track late in the quarter?

Yes. So Q1 is about 5% to 6% of incremental revenue based on those four shipping days. This is a leap year, so you actually end up getting about three of those days back in Q4. When you look at the splits by quarter, it's about the same impact, but instead of 5% to 6%, you're probably going to see a 3% to 4% in Q4.

Got it. Appreciate it. Thanks, everyone.

Thank you.

Thank you.

Your next question comes from the line of Joe Ahlersmeyer with Deutsche Bank. Your line is open.

Hey, good morning, everybody. Thanks for taking my questions.

Good morning.

Yes. Great progress on the margin, continued here in the year. I think Slide 6 says it all, your ability to offset some of the headwinds here. Maybe if you could just talk about what you're assuming at this point for raw material inflation or deflation in 2024? And then just talk also about how some of the early pricing is going, the pricing that you put in, in the first quarter of '24?

From a raw materials standpoint, Joe, I mean we've assumed about a 2% to 3% inflation on raw materials. The biggest components for us are brass and copper. And we do, we do lock in as we talked about three months, four months ahead. So we got good visibility into the kind of April time period. And so far, that's good for the first quarter. As far as pricing, we don't talk about price until the quarter is done. And we've announced the price increases and then we'll report on what the price realization was in Q1, when we do our call in early May. For Q4, the price realization was approximately 2%.

Okay. Thanks, Shashank. And the CapEx guide, the step up, maybe if you could just give some building blocks to what that reflects. And congrats on bringing the ERPs down, as somebody that used to work in those 30 kind of makes me sweat. But is any amount of that capitalized over the coming years? Or is this going to be expensed?

No, there's a good portion that you said, there's about, there's a good portion that will be capitalized in 2024. You see the step-up in CapEx. Part of that is M&A-related, but part of that is the ERP. So there will be a good portion of the ERP that will be capitalized in 2024.

Understood. All right. Thanks a lot, guys. Good luck.

Thank you.

Thank you.

Your next question comes from the line of Joe Giordano with TD Cowen. Your line is open.

Hi. This is [Zane] (ph) on for Joe. I just wanted to ask about the sequentials you're seeing in inflation. Are you seeing the normalization sort of slow down a little bit and as inflation stayed relatively high in recent months?

So on the materials side, material started coming. I mean copper, steel, they have a different cycle, but they started coming down early last year. Quite frankly, over the last couple three months, they've gone up a little bit, but they do bounce around a little bit. On the compensation straw side, which is obviously the second biggest element of cost. We have seen a compensation side, a little bit softer, but there's still inflation out there on the compensation side across Europe and the Americas.

Thank you for that. And are you guys, are the Red Sea issues impacting you guys at all?

Yes, they are. So from a freight, yes, go ahead, Bob.

No, go ahead, Shashank. You got it.

Yes. So we do get goods in Europe from China that used to go through Red Sea and obviously, now they're going through the ports in South Africa. So there's extra time as well as the cost for container cargo. You've read about it. They've gone up, certainly not at the levels we experienced during the pricing disruptions, but they have gone up significantly over the last six, eight weeks.

Great. Thank you so much for that.

Thank you.

[Operator Instructions] Your next question comes from the line of Adam Farley with Stifel. Your line is open.

Yes. Good morning, everyone. My first questions are around European margins. Can you provide some color on what drove the positive mix in the quarter? And should we expect any positive mix impacts going forward?

So the positive mix in Q4, as Bob talked about, our OEM-driven business was down primarily because of heat pumps and ancillary equipment that tends to be lower margin, whereas our France business, which has higher margin, more on the plumbing side, that held up pretty well. So, we had favorable mix there. As well as from an op margin perspective, we did benefit from lower cost of raw materials in Q4. And that was, as I said the buys we had made early on in beginning, in the June, July time period. So, it's a combination of those two factors that drove the op margin in Europe.

Okay. Thank you for that, Shashank. And then on Americas growth, maybe just provide a little more detail on what markets are driving the continued growth in valve products? And then on the flip side, what markets drove the declines in gas connectors? Thank you.

Yes. So look, institutional, light industrial has been positive. Single-family is basically flattish. Multifamily is slight growth, and we're expecting it to temper off in the second half of 2024. And then in general, the gas connectors are in -- primarily in specialty-type applications. Some of it is destocking, and some of it is in residential niches, right? We're talking generators, we're talking gas appliances, things like that, that are moving up and down. And if you recall, we had available capacity and took a lot of share in prior years related to having our products, our gas connectors in North America produced and a lot of our competitors get them overseas. So we knew we'd give a little bit back in market share in that area, but we capitalized it in 2023.

Okay, great. Thank you.

Thank you.

There are no further questions at this time. I will turn the call back to Bob Pagano for closing remarks.

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

This concludes today's conference call. We thank you for joining. You may now disconnect your lines.