Watts Water Technologies, Inc. (NYSE:WTS) Q4 2023 Earnings Call Transcript
Watts Water Technologies, Inc. (NYSE:WTS) Q4 2023 Earnings Call Transcript February 13, 2024
Watts Water Technologies, Inc. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: 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.
Diane McClintock: 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.
Bob Pagano: 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 accounting adjustments. I'd like to provide an update on our Smart and Connected initiative. In early 2019, we committed to an aggressive goal of having 25% of our revenues generated from Smart and Connected enabled products by year-end 2023, compared to a baseline of low single digits in 2018. I'm proud to announce that we met this goal as we exited 2023. This translated to a 600 basis point improvement over 2022, which was driven by new product introductions and expanded adoption rates.
We are excited about the progress we have made and the future of our Smart and Connected systems and digital solutions. We are well on our way to achieving our goal of being an industry leader in connecting our products to provide superior benefits to our customers. As part of our goal to solve complex water challenges around the world, we focus daily on improving sustainability outcomes for ourselves, our customers and our communities. We continue our work to reduce the water, carbon and waste footprints across our operations and create innovative products and solutions for our customers to help them protect, control and conserve critical resources. We continue to be recognized for our efforts. Watts was selected by Newsweek as one of America's most responsible companies for the fifth consecutive year and is one of America's greenest companies for our work on environmental sustainability.
And for the first time in 2023, Watts was named one of the top places to work in Massachusetts, a recognition based on employee surveys that validates the work we are doing to foster an engaged people-first organization. Last but not least, we are proud to share that 2024 is the 150th year anniversary for Watts. We want to thank all of our customers, employees, suppliers, investors and other stakeholders who have been by our side along this journey. It is only through your unwavering trust, support and partnership that we have reached this remarkable milestone in Watts history. Now I'd like to talk about our market expectations in 2024. From a macro perspective, global GDP has slowed but remains positive in our key end markets. In Europe, we do see softening driven by slowing residential and non-residential new construction markets, as well as the impact of changes to the energy incentive programs in Germany and Italy.
The Scandinavian countries remain in a recessionary environment. As a reminder, Europe represents approximately 22% of our business on a pro forma basis. After a challenging year in 2023, single-family new construction in the Americas is expected to return to very modest growth. While multifamily new construction has been resilient, leading indicators, including starts and permits, portend a decline in multifamily new construction in 2024. In the Americas, non-residential new construction indicators are mixed. The ABIs have been below 50 for several months, suggesting a slowing as the year progresses. The Dodge Momentum Index is slightly more positive, suggesting growth in non-residential projects will continue into 2024, primarily supported by institutional and data center projects.
Institutional and light industrial verticals, including mega projects, have remained resilient in 2023 and are expected to be supportive in 2024, but will be tempered by challenging sub-verticals, including retail, office and recreation. In the Asia Pacific region, China's economy is forecasted to grow in the low-single-digits in 2024. Markets in China have been significantly impacted by the real estate crisis. We expect Australia, New Zealand and the Middle East to show modest growth in 2024. We continue to monitor the geopolitical uncertainty in Europe and the Middle East and expect to proactively address any direct or indirect impacts to our customers and supply chain. Now a preview of the drivers for our outlook for 2024. Price, institutional and light industrial, America's single-family new construction and repair and replacement activity are expected to be supportive at least through the first half of the year.
We expect elevated interest rates and supply to unfavorably impact multifamily new construction. As a reminder, multifamily new construction accounts for less than 10% of our total business. With the exception of the institutional light industrial, we are also anticipating slowing in nonresidential new construction. We expect weakening in Europe as new construction slows. In addition, the reduction in energy efficiency incentives in Germany and Italy may unfavorably impact our OEM partners. The slowing volume will have a more significant impact on earnings due to our higher fixed cost base in Europe. We took additional restructuring actions at the end of the fourth quarter that will help reduce the impact of volume deleveraging. We do anticipate a decline in operating margins due to incremental investments, volume deleverage and the dilutive impact of our Bradley and Josam acquisitions as a result of customary transaction-related costs, including amortization.
Despite the expected 2024 macro backdrop, we believe we are well positioned to manage these headwinds due to our resilient business model and end market diversification. We continue to invest in strategic initiatives, including our digital strategy and new product development to fuel our growth and expand our leading market positions. We are also investing in a multiyear new SAP ERP system for our Americas region to consolidate our business systems, drive productivity and support our Smart and Connected journey. We expect full-year incremental investments of approximately $20 million. With that, let me turn the call over to Shashank, who will address our results for the fourth quarter and full-year 2023 and offer our outlook for Q1 and the full-year 2024.
Shashank?
Shashank Patel: 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. Please turn to slide five. Americas organic sales were up 1% and reported sales were up 10%. This was slightly better than we expected, especially against a tough prior year comparison. As a reminder, Americas grew 11% organically in the fourth quarter of 2022. Solid growth in our non-residential core valve products was largely offset by declines in gas connectors and commercial marine instrumentation. Americas reported sales were favorably impacted by 9% from the acquisition of Bradley, which added $33 million of sales in the quarter.
Adjusted operating profit increased by 19%, and adjusted operating margins increased by 150 basis points. The margin expansion was driven by price, favorable mix and productivity, which more than offset volume declines, inflation, incremental investments and dilution from the Bradley acquisition. Europe organic sales were down 5% as we expected. Reported sales were flat as they are positively impacted by 5% from favorable foreign exchange movements. Growth in our wholesale business in France was more than offset by declines in Germany and Italy with the reduction of government subsidies had an unfavorable impact. Operating margin increased by 220 basis points as price, favorable mix and productivity more than offset inflation, investments and volume deleverage.
APMEA delivered 4% organic growth. Reported sales growth of 40% was negatively impacted by 1% from unfavorable foreign exchange movements and favorably impacted by 37% or $9 million of acquired Enware sales. Strong growth in Australia and New Zealand were tempered by flat sales in China due to weak residential underfloor heating sales and project timing in data centers. Adjusted operating margin decreased 180 basis points due to affiliate charges, inflation, investments and the dilutive effect of the Enware acquisition, which more than offset price volume and productivity. On slide six, I will speak to the full-year results. As Bob mentioned, we delivered record operating results for 2023. Reported sales were $2.1 billion, up 4%, primarily driven by price.
Again, this was against a tough prior year comparison when we grew 13% organically in 2022 on a consolidated basis. Acquisitions accounted for 3% or $59 million of incremental sales year-over-year. Foreign exchange globally had an immaterial impact across the year. Compared to last year, adjusted operating profit of $365 million increased 13% and adjusted operating margins of 17.8% was up 140 basis points. Benefits from price, productivity and mix more than offset inflation, reduced volume and incremental investments of $24 million. The dilutive impact of acquisitions was approximately 40 basis points. Adjusted full-year earnings per share of $8.27 increased by $1.14 or 16% versus the prior year. Operating results drove approximately $0.91 of the increase, while acquisitions, lower interest expense and a lower adjusted effective tax rate combined for an additional $0.23.
Free cash flow for the full-year was $281 million, a 40% increase compared to last year and is a company record. The increase was driven by higher net income and reduced working capital investment. We invested approximately $30 million in capital spending, including investments in new product development, lean initiatives and automation. Our 2020 free cash flow conversion was 107%, and our reinvestment ratio was 99%. We repatriated approximately $64 million in cash during the fourth quarter of 2023 and approximately $118 million for the full-year of 2023. The proceeds were used to pay down revolving debt and to fund acquisitions. We returned $63 million to shareholders in the form of dividends and share repurchases in 2023 and increased our annual dividend return by 20%.
We repurchased approximately 92,000 shares of our Class A common stock at a cost of $16 million during the year. There is approximately $12 million remaining under the current stock repurchase program that was authorized in 2019 with another $150 million remaining available under the stock repurchase program authorized in July 2023. Our net debt to capitalization ratio at year-end was negative 3.5%, compared to negative 14.3% at year-end 2022. Our net leverage ratio at year-end is negative 0.1. Our balance sheet continues to be in excellent shape and provides substantial flexibility to fund our capital allocation priorities. Our team did an excellent job proactively managing the price cost dynamic, expanding margins, further strengthening our balance sheet, while continuing to invest for future growth and delivering record financial results in 2023.
Now on slide seven, let's discuss the general framework we considered in preparing our 2024 outlook. First, let's look at the expected unfavorable conditions. Elevated interest rates could further impact multifamily and nonresidential construction projects. The Europe economy continues to slow. Higher interest rates and general uncertainty may negatively impact purchasing decisions, especially in new construction and energy incentive projects in Germany and Italy. We expect Americas multifamily new construction to weaken over the course of 2024. Available data suggests a continued decline in new permits for multifamily projects and in excess of capacity currently on the market. As Bob discussed, America's nonresidential new construction indicators are mixed.
Some sub-verticals will be more challenged, including office, retail and recreation. Some leading indicators, including the ABI Index, have dipped in recent quarters portending a slowdown in 2024. We expect incremental investments to be a headwind in 2024. As Bob previously mentioned, we have commenced a multiyear implementation of a new SAP cloud-based ERP system in the Americas. This is the continuation of our efforts to reduce our global ERP instances, which grew through our many acquisitions. Over the last 10-years, we have reduced from 30 ERP systems down to 12. We'll be continuing this effort in the Americas by migrating to one SAP system, which will further reduce our ERP instances. We have established a road map for the next several years to enable us to make a smooth transition to the new platform, and we expect this investment to lead to significant efficiencies for our team and customers.
In the middle column are themes that we'll continue to monitor. Geopolitical uncertainty both in Europe and in the Middle East may impact global markets during 2024. We have been able to maintain a positive price cost dynamic during 2023. We'll continue to monitor the cost environment and respond appropriately. Global GDP has slowed but is currently expected to be positive in the U.S. and Europe. As a reminder, GDP X as a proxy for our repair and replacement business. Americas single-family new construction bottomed in 2023 and is expected to see slight growth in 2024. Now looking at potential favorable conditions. Our recent acquisitions of Bradley, Josam and Enware are expected to contribute over 10 points of revenue growth and increase our exposure to attractive institutional end markets.
Americas institutional and light industrial new construction are expected to remain favorable. We believe that the health care, education, data centers, mega projects and food and beverage sub-verticals should continue to grow. We expect incremental revenue driven by our digital product offerings and other new product introductions. Productivity and automation investments are expected to provide cost savings in 2024. In addition, our Europe and Americas segments are expected to have incremental cost savings from the restructuring activities we initiated in late 2023. As discussed, our balance sheet remains strong as we head into 2024. With that as background, let's review our outlook for the full-year 2024 and our expectations for the first quarter of 2024.
On slide eight, we have provided our major assumptions. Starting with the full-year assumptions on a reported basis, we expect sales to increase between 6% and 12%. Consolidated organic revenue is estimated to range from negative 5% to positive 1%, with regional expectations as follows, Americas from negative 3% to positive 2%, Europe from negative 9% to negative 4% and APMEA from flat to positive 6%. In addition, we expect approximately $210 million of incremental sales in the Americas and $9 million in APMEA from acquisitions. Compared to 2023, we expect the following: EBITDA margin to be in the range of 19.4% to 20% or down 50 basis points to up 10 basis points; operating margin should be in the range of 16.9% to 17.5% or down 90 basis points to down 30 basis points.
This is largely due to the expected acquisition dilution of approximately 80 basis points, mostly driven by Bradley. From a regional perspective, the Americas operating margin is expected to be down 90 basis points to 140 basis points, primarily driven by the dilutive impact of acquisitions. We anticipate Europe's adjusted operating margin will decrease 100 basis points to 160 basis points due to the impact from volume deleverage. APMEA's adjusted operating margin is expected to increase 40 basis points to 100 basis points. It is important to note that the margin guidance includes approximately $20 million in incremental investments. As for the other 2024 key inputs, we expect corporate costs to be about $55 million for the year. Net interest expense should be approximately $12 million.
Our estimated adjusted effective tax rate for 2024 should be approximately 25%. CapEx spending is expected to be approximately $50 million. Depreciation and amortization should be approximately $55 million for the year. We expect to deliver free cash flow conversion of greater than or equal to 90% of net income in 2024. We expect free cash flow to be below 100% due to the previously mentioned incremental investments related to our new ERP system. For the full-year, we are assuming a 1.09 average euro-U.S. dollar FX rate versus the average rate of 1.08 in 2023. This would imply an increase of 1% year-over-year and would equate to an increase of $5 million in sales and $0.02 a share in EPS for the full-year versus the prior year. We expect our share count to be approximately 33.5 million for the year.
Finally, a few items to consider for Q1. On a reported basis, we expect sales to increase between 15% and 19%. Organically, we expect sales to increase 1% to 5% with mid-single-digit growth in the Americas and APMEA, offset by a mid-single-digit decline in Europe. Based on the calendarization in 2024, we will benefit from four extra shipping days in the first quarter, which will be offset in the fourth quarter. In addition, we expect approximately $57 million of incremental sales in the Americas and $9 million in APMEA from acquisitions. Compared to the first quarter of 2023, we expect the following: first quarter EBITDA margin to be in the range of 19.5% to 20.1% or down 50 basis points to up 10 basis points. First quarter operating margin should be in the range of 17% to 17.6% or down 80 basis points to down 20 basis points.
This is due to the impact of acquisition dilution as well as higher investments. We expect incremental investments of approximately $6 million in Q1. Corporate costs should be approximately $13 million. Net interest expense should be approximately $3 million. The adjusted effective tax rate should be between 23% and 24%. We are estimating a 1.07 euro, dollar exchange rate, which is flat to the first quarter of 2023. With that, I'll turn the call back over to Bob to summarize our discussion before moving to Q&A. Bob?
Bob Pagano: 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.
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