Watts Water Technologies Inc Q4 FY2024 Earnings Call

Welcome to Watts Water Technologies, Inc. Fourth Quarter and year 2024 earnings call. At the end of the presentation, we will open the line for questions. I will now turn the call over to Diane McClintock, Senior Vice President FBNA and Investor Relations. Thank you, and good morning, everyone.

Welcome to our fourth quarter and full year 2024 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 2024 as well as an update on our initiatives, and Shashank will discuss the details of our fourth quarter and full year financial results and provide our outlook for the first quarter and full year 2025. Following our remarks, we will address questions related to the information covered during the call. Today's webcast is accompanied by a presentation that 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, please 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 three and I'll provide a recap of 2024 and an overview of the key drivers for our 2025 outlook. 2024 was a momentous year for us, marking the 150th anniversary of the company and another year of record performance. I'd like to start by thanking the entire Watts Water team for their tremendous contributions to these results. We finished the year with a solid quarter that exceeded our expectations, including a record fourth-quarter adjusted operating margin and adjusted EPS. We achieved record full-year sales, operating income, earnings per share, and free cash flow. Organic sales decreased by 1%, largely driven by weakness in Europe, while adjusted EPS increased by 7%. Adjusted operating margin decreased only 10 basis points versus the prior year despite 60 basis points of acquisition dilution. Significant volume de-leverage from weakness in Europe and incremental investments in our long-term strategy were also factors. I generated record free cash flow of $332 million, an increase of 18%, with a conversion rate of 114%, well above our expectations. Our balance sheet remains strong and provides us with the flexibility to continue investing for the future. Strategic M&A, high-return investments, competitive dividends, and stable share buybacks remain our top capital allocation priorities. Moving to operations, over the course of 2024, we were able to drive significant productivity savings through investments in automation, our focus on lean initiatives, both inside and outside the factory walls, leveraging the One Watts performance system, and selective restructuring actions. These savings enabled us to mitigate the dilutive impact of acquisitions and the impact of European volume de-leverage on our operating margins. We expect to continue investing to enhance productivity in our factories and drive margin expansion. As previously announced, we closed on our acquisition of Icon Systems on January 2, 2025. Icon is a leading provider of innovative plumbing and water management solutions. This strategic acquisition will expand our digital offerings and provide growth opportunities in the correctional facilities niche of the institutional market. Integration is underway and progressing well. We expect Icon to be modestly accretive to adjusted EPS in 2025 after factoring in incremental interest expense and normal purchase accounting adjustments. Last week, our board authorized a restructuring program involving the exit from a manufacturing facility in France. We'll be moving the production from this plant to existing plants in France and other locations. This action will help to simplify our manufacturing structure and provide incremental productivity. The majority of the expected costs for this program will be recorded in the first quarter, with full-year run rate savings expected in 2026. Shashank will provide more financial details on this in a moment. As discussed in our last earnings call, we introduced our new intelligent water management solution Nexa. We continue to work on multiple go-to-market strategies and the pipeline is growing nicely. Feedback from customers has been positive, with concrete results of value creation from risk mitigation, reduced water consumption, and improved occupant comfort. We look forward to continued scaling of our ecosystem of digital solutions in 2025. As part of our One Watts performance system, we regularly assess our portfolio and phase out low-performing products under our 80/20 model. As part of this process, we have identified approximately $10 million to $15 million of sales we expect to eliminate over the course of 2025, a significant portion coming from our integration of Bradley. We expect these actions will be margin accretive in 2025. Now an overview of the drivers for our outlook for 2025. We believe that price as well as repair and replacement activity will continue to drive growth in 2025. Global GDP, a proxy for our repair and replacement business, has slowed but remains positive in our key end markets. In the Americas, non-residential new construction indicators are mixed. The ABI remains below 50, implying a slower 2025. The Dodge Momentum Index is slightly more positive, suggesting growth in non-residential products will continue into 2025, primarily supported by strength in institutional and mega projects, including data centers. However, we believe growth in institutional mega projects will be partly offset by more challenged sub-verticals, including offices, retail, warehouses, and recreation. For residential new construction, we expect single-family will be flat to slightly up, while multifamily permits have been in decline for most of 2024. With interest rates remaining elevated, we expect multifamily starts to decline by double digits throughout 2025. As a reminder, multifamily new construction accounts for less than 10% of our total sales. With the uncertainty surrounding the direction of inflation and policy under the new U.S. administration, we expect interest rates to remain higher for longer, which may delay construction projects. We expect Europe’s residential and non-residential new construction to remain weak. Additionally, we expect the heat pump destocking that has unfavorably impacted our OEM partners in Germany and Italy to continue in the first half of 2025. Reduced volume will have a more significant impact on earnings due to our higher fixed cost base in Europe. In addition to the planned closure of the manufacturing site in France, we implemented headcount restructuring actions in the fourth quarter that will help reduce the impact of volume de-leveraging. Europe sales represent approximately 20% of our business. We expect growth in the Asia Pacific region with modest growth in Australia and New Zealand. We continue to monitor U.S. policy uncertainty, including potential tariffs and geopolitical uncertainty in the Middle East and Europe. We expect to proactively address any direct or indirect impacts to our customers and supply chain. With that, let me turn the call over to Shashank, who will address our results for the fourth quarter and full year and offer our outlook for Q1 and the full year 2025.

Thank you, Bob. Good morning, everyone. Please now turn to slide four, which highlights our fourth quarter results. Sales of $540 million were down 1% on a reported basis and down 5% organically. As previously discussed, we had fewer shipping days in the fourth quarter, which unfavorably impacted our sales by approximately 5% across all regions. Americas organic sales were down 3%, and reported sales were up 3%. This was better than expected, particularly with the reduced shipping days. Some of this favorability was a result of several large projects shipping earlier than expected. Sales from our Joe, Sam, and Brandy acquisitions added $23 million. Europe organic and reported sales were down 15% with declines across all geographies due to fewer shipping days, heat pump destocking at our OEM partners in Germany and Italy, and weakness in new construction markets triggering some destocking in the wholesale channel. Apnea delivered 3% organic growth while reported sales growth of 4% was favorably impacted by 1% from foreign exchange movements. Double-digit growth in China and the Middle East was partly offset by declines in Australia and New Zealand, primarily driven by fewer shipping days. Compared to the prior year, adjusted EBITDA of $104 million increased 6%, and adjusted EBITDA margins of 19.3% increased by 140 basis points. Adjusted operating profit of $91 million increased 5%, and adjusted operating margins of 16.8% was up 100 basis points. Adjusted EBITDA and operating income benefited from price productivity, favorable mix, and cost controls, which more than offset inflation, volume de-leverage, investments, and acquisition dilution. Americas segment margins increased 160 basis points to 21.8%, while Europe segment margins decreased by 480 basis points to 10.2%. Apnea segment margins increased 480 basis points to 17.5%. Adjusted earnings per share of $2.05 increased 4% versus last year, with benefits from acquisition operational contribution and reduced interest expense more than offsetting incremental tax expense. The adjusted effective tax rate in the quarter was 24.6%, up 230 basis points compared to the fourth quarter of 2023, primarily due to the recognition of additional R&D credits in the fourth quarter of 2023. Moving to the full-year results, as Bob mentioned, we delivered record operating results for 2024. Sales were $2.25 billion, up 10% on a reported basis and down 1% organically. The organic decline was primarily driven by the challenging year in Europe. Acquisitions accounted for 11% or $215 million of incremental sales. Globally, foreign exchange had an immaterial impact. Adjusted EBITDA of $454 million increased 11%, and adjusted EBITDA margin of 20.1% increased by 20 basis points. Adjusted operating income of $400 million increased 9%, and adjusted operating margins of 17.7% decreased 10 basis points. As Bob noted, adjusted operating margin decreased only 10 basis points versus the prior year despite 60 basis points of acquisition dilution and significant volume de-leverage from weakness in Europe. Similarly, the Americas segment margin was unfavorable due to acquisition dilution. Excluding acquisitions, the Americas core business operating margin was up 100 basis points, and Apnea was up 170 basis points, showing a very strong performance by both teams. Adjusted EPS of $8.86 increased by 59 cents or 7% versus the prior year. Benefits from acquisition operational contribution and reduced interest expense more than offset incremental tax expense. For GAAP purposes, we incurred after-tax charges of $16.1 million in restructuring and acquisition-related costs. These charges were partly offset by $10.3 million of nonrecurring gains on the sale of assets, the settlement of the terminated Bradley pension plan, and other investment gains. Free cash flow for the full year was $332 million, an 18% increase compared to 2023 and was a company record. The increase was driven by higher net income, improved working capital, and cash flow generated by acquisitions. Our 2024 free cash flow conversion was 114%. We returned $73 million to shareholders in the form of dividends and share repurchases in 2024, and increased our annual dividend return by 20%. Our net debt to capitalization ratio at year-end was negative 13% compared to negative 4% in 2023. Our net leverage ratio at year-end is negative 0.4. The balance sheet continues to be in excellent shape and provides substantial flexibility to fund our capital allocation priorities. Now on slide six, let's review our outlook for the full year 2025 and our expectations for the first quarter of 2025. Our 2025 outlook reflects the market factors previously discussed by Bob. Starting with the full-year assumptions on both our reported basis and organic basis, we expect sales to range between down 3% to up 2%. Regional expectations are as follows: Americas from down 3% to up 3%, Europe from down 8% to down 2%, and Apnea from flat to up 5%. In addition, we expect approximately $25 million of incremental sales in the Americas from acquisitions to be offset by the impact of 80/20 product rationalization of between $10 million and $15 million, and the unfavorable impact of foreign exchange across all regions, which equates to a decrease of $28 million in sales and $0.11 per share in EPS versus the prior year. Adjusted EBITDA margin is expected to be in the range of 20% to 21%, or up 30 to 90 basis points. Adjusted operating margin should be in the range of 17.7% to 18.3%, or flat to up 60 basis points. From a regional perspective, the Americas segment margin is expected to be flat to up 60 basis points. We anticipate the segment margin in Europe will be down 30 basis points to up 30 basis points, while Apnea will be flat to up 60 basis points. We expect the margin improvement to be driven by price productivity and restructuring savings, which will more than offset inflation and volume de-leverage. As Bob mentioned, we have completed negotiations to exit a facility in France. Total pretax exit costs are estimated to be $22 million. We will record the majority of the cost in the first quarter and provide more detail during our first quarter earnings call. Most of the costs are severance-related and are expected to be incurred in 2025. Full-year pretax run rate savings are estimated to be $3 million, which should be fully realized in 2026. We expect about $1.5 million in savings this year, largely in the second half. We expect to deliver free cash flow conversion of greater than or equal to 100% of net income in 2025. Finally, a few items to consider for Q1. On a reported and organic basis, we expect sales to decrease between 3% and 7%. Regionally, we expect a low to mid-single-digit decline in the Americas, and a high single to low double-digit decline in Europe, partly offset by Apnea, which is expected to be flat. Based on the calendarization in 2025, we'll have fewer shipping days in the first quarter versus last year, which will unfavorably impact sales by approximately 3%. We also expect Europe to remain weak as heat pump destocking is expected to continue at least through the first quarter. We expect approximately $5 million of incremental sales in the Americas from acquisitions to be offset by the unfavorable impact of foreign exchange across all regions, which equates to a decrease of $7 million in sales and $0.03 per share in EPS versus the prior year. We do not expect a significant impact from our 80/20 actions in the first quarter. First quarter EBITDA margin is expected to be in the range of 19.4% to 20%, or down 60 to 120 basis points. Operating margin should be in the range of 16.9% to 17.5%, or down 70 to 130 basis points. This is primarily due to the volume de-leverage impact of fewer shipping days and continuing European weakness. Other key inputs for the first quarter and the full year can be found in the appendix. With that, I'll turn the call back over to Bob before moving to Q&A.

Thanks, Shashank. On slide seven, I'd like to summarize our discussion before we address your questions. We delivered a strong 2024 performance with record sales, operating income, EPS, and free cash flow. While we expect mixed global markets in 2025, our portfolio is agnostic to end markets, and our teams will pivot to the growing sub-verticals. 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 continue to invest in our digital strategy, including the recent introductions of Nexa. We look forward to growing this solution to expand our suite of offerings for our customers. We believe our highly experienced team is well-positioned to proactively navigate current market conditions, controlling costs and driving productivity through our One Watts performance system, while capturing our fair share of demand and positioning us to capitalize on long-term secular trends. Our balance sheet continues to be strong after our strategic acquisition of Icon and provides ample flexibility to support our balanced capital allocation priorities. Our acquisition pipeline remains active, and we will continue to pursue attractive opportunities to expand our solutions, geographic presence, and growth. With that operator, please open the lines for questions.

Thank you. Ladies and gentlemen, we will now begin our question and answer session. If you have dialed in and would like to ask a question, please press star followed by the number one on your telephone keypad. If you would like to withdraw your questions, simply press star one again. Thank you. Your first question comes from the line of Andrew Creel with Deutsche Bank. Please go ahead.

Hi. Thanks. Good morning, everyone. I'm going to ask about the 80/20 action, which I believe are new for the company. If you do the math, it seems they're about a percentage point of a sales drag for the company this year, which seems relatively normal with 80/20. So can you touch on the margin profile of what you're exiting? Is it fair for us to assume these could be breakeven margin businesses? And do you expect this sales drag to be done in 2025, or could this dynamic happen again in 2026? Thanks.

Good morning, Andrew. Yeah. The 80/20 method has been part of the One Watts performance system since I got here eleven years ago. So, if you remember, we exited about $175 million in undifferentiated products. So, it's in our arsenal of tools that we use. We called this out specifically because Bradley was a larger mid-sized acquisition. Part of our overall process when we do acquisitions is to really look at their profile and focus on improving margins by eliminating products that don’t generate significant profits or have low margins. We're just trying to highlight that we're exiting these niche accessory-type products because it doesn't make sense. They are basically breakeven products. There might be another incremental $5 million or $6 million of Bradley that moves into next year, but we mentioned it specifically because it was a larger item this year.

That's helpful. And I noted in the prepared remarks some sales shipped a bit earlier in Q4. Could you provide details on which segment that impacted? Thanks.

Yeah. It's probably in the Americas. This is Shashank. There was some project pull-ins that we had in our commercial business on the boiler side. Approximately $4 million is what was pulled in.

Great. Thanks, guys. Your next question comes from the line of Latham Jones with Stifel. Please go ahead.

Good morning, everyone. I guess I'll start with the topic of discussion regarding the U.S. administration imposing 25% tariffs on aluminum and steel. Watts has had a very good track record in inflationary periods over the last several years of being able to pass inflation through to customers. Maybe we're in a little bit of a weaker demand environment now. So, any color you can provide on your exposure to those tariffs, how you plan on dealing with them, and whether you think the market can bear cost increases, not just from your side but across the supply chain?

Well, Latham, it's always top of mind for us to stay ahead of these types of tariffs. We will continue to monitor them and will be raising prices as soon as we see impacts, and we'll be passing them on. Certainly, we don’t know the implications on the construction industry concerning tariffs if that eventually slows things down, but I believe we will continue with our track record and offset those costs.

So it would be your intention to fully offset any tariff impact with price?

Yes.

Okay. That's the answer I was looking for. Maybe on the product rationalization side at Bradley, could you provide more color on how you're using 80/20? You've been using these tools for ten years, but this is the first time you've specifically called out 80/20 and tied lost products to it or product exits to it. Is this something you’re looking to use more over the next few years or was it simply due to the significant amount this year that warranted calling it out?

Yeah. It was just a larger amount this time. We inherited some backlog from Bradley that we've looked through. Going forward, we will continue to do it. We're also evaluating our portfolio in Europe and considering where we can optimize, especially given the market conditions. We continuously look to improve, and we've closed a facility in France a few years ago to reduce our fixed cost base. We’ll always be on the lookout for optimizing our portfolio in the broader market context.

Can you provide insight on the Icon acquisition? You mentioned it adds to the digital capabilities of the company. It sounds like a niche market but can you share any details regarding the valuation of the business and how you can leverage Icon's technology throughout your portfolio?

We've agreed not to discuss the purchase price, but I can tell you it's EBITDA neutral for the company, clearly less than a nine multiple. We really like Icon because it's in a growing market, it’s a niche market, but they have controls on the front of wall products, and that is something we are very interested in leveraging through our Nexa system. So, it’s a growing and profitable market, making it a solid acquisition.

Thanks for taking my questions.

Thank you.

Your next question comes from the line of Brian Blair with Oppenheimer. Please go ahead.

Good morning, everyone. I wanted to circle back to Bradley and Joseph. Can you provide an update on the integration there and how the P&L contribution is tracking relative to the deal model? Additionally, could you identify which specific product lines you're exiting with the 80/20 this year?

The integrations are going really well and are exceeding our profit and synergy targets this year, which is great. In detail, we are focused on non-core safety products, lockers, and accessories. They represent niche products, but not all lockers, just some specific portions. These are the items we're looking to phase out as we want to focus on improving profitability.

Understood. I’d also like to hear more on the rollout of Nexa. I had the opportunity to view the dashboard in person yesterday, and it's quite impressive. Can you share how this impacts your digital strategy and what you're hearing from customers in these early stages of rollout? Any results you can discuss in terms of value add on the customer side? What’s your current SaaS revenue, and how should Nexa influence that going forward?

We're really excited about Nexa, and I’m glad you had the chance to take a look at it. It’s early stages; we just launched it in August. We have a lot of trials, and many customers are already seeing savings, particularly in the hospitality sector. You can find customer testimonials and case studies on our website. Like any new product, people need to test it, try it, and appreciate it. However, what's critical about this product is that it protects our core products. We're deeply involved in driving smart and connected initiatives, and all our products will be integrated into the Nexo platform by the end of this year, adding scale and capabilities. All feedback has been positive thus far, and we're looking forward to scaling it even further.

What is your current SaaS revenue?

It’s minimal at this point in time. It is a growing part of our business, with contributions from our leak detection group among other products. But overall, it's negligible at this stage, and we’ll work to grow it by leveraging the Nexa platform.

Thank you.

Your next question comes from the line of Mike Halloran with Baird. Please go ahead.

Good morning, everyone. So just on the demand outlook, nothing seems overly surprising there. This is a twofold question. First, has your thought process changed much over the last quarter? And second, what are you hearing from the channel? Is the channel saying something similar, more or less optimistic? Are there any signs that distressed markets from the channel perspective might see a turn at some point this year?

Generally, the sentiment from the last quarter has carried through into January. The ongoing uncertainty in the market has caused a pause in new construction. However, there is some optimism at this time. We're closely monitoring the situation. The multifamily segment will take longer to recover, as we saw significant impact in the latter half of the year. But institutional segments remain strong. We'll keep an eye on interest rates moving forward, which will guide our actions.

Thanks for that. Regarding European margins, once you complete the restructuring process and the mix normalizes with the heat pump situation and some OEM pressure, how should we frame the sustainable margin range for that region? Will it align back to historic ranges, or are there factors that may keep it below that? Will these restructuring moves assist in nudging it above?

As you're aware, margins in Europe have been lower than in the U.S., primarily due to a larger OEM channel there. Our goal is to regain previous margins as much as possible. The team's focus remains on enhancing our profitability and addressing our footprint, as discussed regarding the facility in France. We’ve closed a site previously, and we’re actively working towards improving our fixed cost structure. Adjusting our strategies to capture volume will help drive margin performance as well.

Appreciate it. Thanks, Bob.

Thank you.

Your next question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Hey. Good morning, guys. This is David Tarantino on for Jeff. Sticking with the margin topic, could you walk us through the factors affecting the company-level margin structure, particularly considering volumes expected to be down at the midpoint? What are the key drivers for margin improvement this year?

It's a combination of factors. There's a little bit of price in our expectations; we’ve announced price increases in January, February, and March. Thus, those increases are now baked in. Productivity improvements are another key aspect. We're driving productivity globally through sourcing savings and multiple rounds of restructuring last year. Our productivity efforts take place both inside and outside the factories, and that effectively supports investments while addressing inflation-related pressures. We also expect slight volume de-leverage at the midpoint, so it's a mix of all these aspects driving our net margin expansion.

Thanks, Shashank. Regarding the European outlook, I'm surprised by the degree of weakness projected for 2025. Could you provide insights into the negative factors anticipating the remaining pressure? How should we expect this implied weakness to progress through the year?

At least for the first half, we believe heat pump destocking will continue. There's limited new construction ongoing due to the uncertainty in the market, given the geopolitical climate and associated funding issues. I anticipate the first half could be the most challenged, and we'll look to pick up momentum in the second half. I usually take a cautious approach towards Europe, so our planning incorporates low assumptions, ensuring our cost structure is well-managed, while we’ll capture any potential upside if volumes rise.

Regarding the full-year guidance and midpoint of our guidance at minus 5%, most of that comes in the first half. In Q1, the midpoint is around minus 10%. We anticipate that as we transition into the second half, the year should ease with easier comps, considering the significant declines we faced last year.

Thanks for the clarifications.

Thank you.

Your next question comes from the line of Joe Giordano with TD Cowen. Please go ahead.

Hi. Good morning, this is Dan for Joe Giordano. I wanted to discuss tariffs again. In the event of reciprocal tariffs in Europe, would that impact your competitive positioning? I assume that's not the case since you manufacture there as well, but could you comment?

For the most part, our model is to manufacture where we sell. We do source some components from China for North America, but in Europe, we manufacture primarily within the region. Thus, if tariffs on imports from the U.S. were implemented, the impact would be minimal.

Thank you, that's very helpful. You mentioned the correctional facilities niche as a growing market. Are there any specifics regarding water products in that market that are unique?

The unique aspect is refurbishment. Many of these facilities are quite old, leading to the need for renovation of plumbing systems within the cells. It’s a distinctive product from a safety perspective that caters specifically to that market.

Appreciate the insights. Thank you.

Thank you.

Your next question comes from the line of Nick Cash with Goldman Sachs. Please go ahead.

Hi. This is Nick Cash on from Brian Lee. Can you hear me?

Yes. Please proceed.

I wanted to discuss the Icon acquisition. Will it be going through a wholesale distribution channel? If not, can you share potential cross-selling opportunities you see?

It's primarily a direct customer model. There are opportunities to leverage some of their products through our Bradley representative channels, and we're currently evaluating that. There may be small synergies, mostly focusing on cost synergies by utilizing our global sourcing capabilities.

Thank you.

Thank you.

As there are no further questions at this time, I would like to turn the call over to Bob Pagano for closing remarks.

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

That concludes today's conference call. Thank you for joining. You may now disconnect.