WATTS WATER TECHNOLOGIES INC Q2 2025 earnings call

Thank you and good morning, everyone. Welcome to our second quarter earnings conference call. Joining me today are Bob Pagano, President and CEO, Shashank Patel, our former CFO, and Ryan Lada, our new CFO. During today's call, Bob will provide an overview of the second quarter, an operational update, and an update on our outlook for 2025. Shashank will discuss the details of our second quarter performance and provide our outlook for the third quarter and for the full year. 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 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 will turn the call over to Bob.

Thank you, Diane, and good morning, everyone. Before beginning our second quarter overview, I'd like to take a moment to express my gratitude to Shashank Patel as this will be his last earnings call with Watts. I'm grateful for his seven years of impactful leadership. He has been a tremendous asset to the entire Watts team and has been a key strategic advisor to me. I wish him all the best in his retirement. Over the next two months, Shashank will help support the transition to our new CFO. On that note, I'm excited to welcome our new CFO, Ryan Lada, to his first earnings call with Watts. Ryan, would you like to say a few words?

Thank you, Bob, and good morning, everyone. I'm excited to be part of Watts and contribute to its continued success. I had the opportunity to attend the board meeting shortly after joining Watts, and I was able to spend time with the board members and the leadership team. I was incredibly impressed with the talent, engagement, and high-performance culture, and I'm thrilled to be part of the team. Over the next few months, I will focus on getting up to speed and plan to spend time traveling to our sites to learn about the operations and the team. I look forward to working with the investment community and contributing to Watts' continued growth and long-term value creation. With that, I will turn the call back to Bob.

Thank you, Ryan, and welcome to the team. Now, please turn to slide three, and I'll provide an overview of the second quarter. Our second quarter results were better than expected, with record sales, operating income, and earnings per share. Our performance is a direct result of the commitment and strong execution of the entire Watts team and their dedication to serving our customers amid a challenging environment. Organic sales increased 6% in the quarter, with favorable price, volume, and pull-forward demand more than offsetting continued weakness in Europe. We also benefited from incremental sales from our I-CON and EasyWater acquisitions and favorable foreign exchange movements. Adjusted operating margin of 21.6% exceeded expectations due to favorable price-cost dynamics, volume leverage, productivity, and cost containment. Our balance sheet remains strong and provides ample capacity to support flexibility in our capital allocation strategy.

From an operations perspective, we continue to take proactive steps to mitigate the impact of tariffs through our pricing and supply chain strategies. The tariff environment remains fluid, but as of today, our global direct tariff impact in 2025 is estimated to be approximately $40 million. We have a proven track record of successfully navigating through inflationary periods and are confident in our ability to maintain a favorable price-cost outcome. In line with our strategic approach to M&A, in June, we acquired the assets of EasyWater, a company that engineers and manufactures innovative water conditioning and filtration solutions that serve residential, commercial, and industrial markets. EasyWater's custom solutions will complement our existing water quality portfolio. We expect EasyWater to contribute approximately $5 million in sales and be neutral to adjusted EPS in 2025 after factoring in normal purchase accounting adjustments.

The integrations of Bradley, JOSAM, I-CON, and EasyWater are progressing well, and synergy realization is tracking ahead of our original estimates. The rollout of our Nexa Intelligent Water Management solution has gained traction, and we continue to build scale. We've had numerous successful installations, including a luxury multifamily condominium, hotels, and in a commercial real estate portfolio where Nexa provided remote monitoring, issue identification, and replacement component revenue. Importantly, we are partnering with customers to help them make the most of the Nexa platform through data-driven insights and comprehensive solutions for their water management challenges. We view Nexa as one of the most promising long-term opportunities and will continue to leverage our differentiated capabilities and expertise to build scale and drive growth. Nexa is delivering measurable savings and quick payback cycles for our customers within our targeted verticals, which include hospitality, multifamily, and property management companies.

Nexa's momentum is building slowly, but we expect continued expansion and growth in the coming years. Now, an update on our outlook for the remainder of the year. Due to our strong first half and our expectations for the third quarter, we are increasing our full-year sales and margin outlook. Tariff-related price increases, foreign exchange movements, strong data center growth, and our Easy Water acquisition are all favorable relative to the outlook we provided in May. However, some uncertainty still remains around the impact of tariffs, including the effect on global GDP. As a reminder, GDP is a proxy for our repair and replacement business, which represents approximately 60% of our total revenue. Now, please turn to slide four for an update on our sustainability journey.

In early June, we published our 2024 sustainability report, which highlights the accomplishments and progress we've made within our four sustainability pillars: footprint, handprint, social responsibility, and corporate governance. We are confident that our triple play of solutions addressing safety and regulation, energy efficiency, and water conservation enable our customers to manage operational pressures, comply with evolving regulations, and meaningfully advance their sustainability initiatives. We continue to make progress towards our long-term goals, including an absolute carbon emissions reduction target, which will help advance our sustainability mission while improving our operations. I'm proud of the progress our global teams have made and invite you to read more about it in our sustainability report, which can be found on our Investor Relations website. With that, let me turn the call over to Shashank, who will address our second quarter results and our third quarter and full-year outlook. Shashank?

Thank you, Bob, and good morning, everyone. Please turn to slide five, which highlights our second quarter results. Sales of $644 million were a record for Watts and were up 8% on a reported basis and 6% on an organic basis. Strong organic growth in the Americas more than offset declines in APAC and Europe. Americas organic sales were up 10% and reported sales were up 11%, both better than expected, driven by price, volume, and pull-forward demand. Sales from the I-CON acquisition added $7 million. Easy Water sales were immaterial in the quarter. Impact from our 80/20 actions in the Americas were limited, with approximately $1 million of eliminated product sales as a result of strategies aimed at improving profitability. Europe organic sales were down 8% and reported sales were down 3%, with organic declines across all geographies due to continuing OEM and market weakness.

Reported sales benefited from favorable foreign exchange. APMEA sales decreased 1% on an organic basis and 3% on a reported basis. Growth in Australia, New Zealand, and the Middle East was more than offset by a decline in China due to project timing. Compared to the prior year, adjusted EBITDA of $153 million increased 22% and adjusted EBITDA margin of 23.8% increased 280 basis points. Adjusted operating income of $139 million also increased 24% and adjusted operating margin of 21.6% was up 280 basis points and is a record for Watts. Adjusted EBITDA and operating income benefited from favorable price-cost dynamics, volume leverage in the Americas, productivity, and cost containment, which more than offset inflation, volume deleverage in Europe, and investments. Americas segment margin increased 290 basis points to 27.2%.

Europe's segment margins increased by 170 basis points to 11.7% and APMEA's segment margin was flat to prior year period at 18.9%. Adjusted earnings per share of $3.09 increased 26% versus last year, with contributions driven by operations, acquisitions, foreign exchange, and reduced interest expense. The adjusted effective tax rate in the quarter was 25.2%, which was flat compared to the second quarter of 2024. For GAAP purposes, we incurred $3.8 million of pre-tax acquisition costs and restructuring charges related to the exit of a facility in France and other actions within Europe. Our free cash flow year-to-date through the second quarter was $105 million compared to $120 million last year. The cash flow decrease was probably due to working capital timing and increased CapEx.

We expect sequential improvement in our free cash flow and are on track to achieve our full-year goal of free cash flow conversion greater than or equal to 100% of net income. The balance sheet remains strong and provides us with ample flexibility. Our net debt-to-capitalization ratio at quarter end was -10% and our net leverage is -0.4%. Our solid cash flow and healthy balance sheet continue to give us capital allocation optionality. Now on slide six, let's review our assumptions about our third quarter and full-year outlook. We are increasing our full-year sales and margin outlook due to our strong first half, incremental price, favorable foreign exchange, strengthened data centers, and our acquisition of EasyWater, which will be included in our Americas segment. We now expect organic sales growth of flat to up 3%, a two-point increase to the midpoint from our previous outlook.

Our reported sales growth is expected to be up 2% - 5%, a three-point increase from our previous outlook. We expect incremental revenue from our Easy Water acquisition and favorable foreign exchange movements, which are listed by region in the appendix. Regionally, we expect the Americas sales growth to be better and Europe to be slightly worse compared to our previous outlook. We are increasing our full-year adjusted EBITDA margin outlook to a range of up 60 basis points to up 120 basis points and an increase of 30 basis points to the midpoint of our previous outlook. We are also increasing our full-year adjusted operating margin expansion to a range of up 50 basis points to up 110 basis points and an increase of 50 basis points to the midpoint of our previous outlook.

Our updated outlook includes $40 million of estimated direct tariff costs, as previously mentioned by Bob. This is based on the tariffs in effect as of today, which includes copper tariffs as currently defined. Our free cash flow expectation remains in line with our previous outlook, as we expect to deliver a free cash flow conversion of greater than or equal to 100% of net income in 2025. Next, a few items to consider for the third quarter. On an organic basis, we expect sales growth of 2% - 5%. Regionally, we expect mid-single-digit growth in the Americas and low single-digit growth in APMEA, partly offset by high single-digit decline in Europe. The Americas' growth is sequentially lower than the second quarter due to the pull-forward demand previously discussed. We expect approximately $8 million in incremental sales in the Americas from acquisitions.

We estimate that foreign exchange in the quarter will be a tailwind of approximately $4 million, and our assumptions by region are listed in the appendix. We expect our 80/20 actions in the third quarter to be an estimated $2 million of product exits, primarily within the Americas. Third quarter EBITDA margin is expected to be in the range of 19.7% - 20.3%, or up 20 basis points - 80 basis points. Operating margin should be in the range of 17.1% - 17.7%, or flat to up 60 basis points. We expect that price and volume leverage in the Americas and APMEA will more than offset continued volume deleverage in Europe. The sequential decline in margins is due primarily to the non-recurring price-cost favorability in the second quarter, as the impact of tariffs rolls into expense plus normal seasonality.

Other key inputs for the third quarter and the full year can be found in the appendix. Before I turn the call over to Bob, I would like to express my gratitude to the entire Watts team for the opportunities I've had over the last seven years. I've also enjoyed working with you, the investor and analyst community, and wish you the best in the years to come. With that, I'll turn the call back over to Bob before moving to Q&A. Bob.

Thanks, Shashank. On slide seven, I'd like to summarize our discussion before we address your questions. Our second quarter performance was better than we anticipated, with record sales, operating income, and earnings per share due to strong performance in our Americas region, which benefited from price realization, favorable price-cost dynamics, and volume leverage. We continue to execute well amid an uncertain trade environment and expect that price, our expansive U.S. footprint, and global supply chain will enable us to navigate the current backdrop effectively. As a result of our strong first half performance and third quarter expectations, we are increasing our full-year sales and margin outlook. Our balance sheet remains strong and provides ample flexibility to support our capital allocation priorities, including M&A, factory automation, investment in new product development, our digital strategy, and returning capital to shareholders via share buybacks and dividends.

I'm confident in our team's ability to execute despite the uncertain environment and continue to create durable long-term value for our shareholders. With that, operator, please open the line for questions.