WATTS WATER TECHNOLOGIES INC Q4 2025 earnings call

Thank you, and good morning, everyone. Joining me today is Bob Pagano, President and CEO. Before we begin, 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. 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. With that, I will turn the call over to Bob.

Thank you, Diane, and good morning, everyone. Please turn to slide three, where I'll recap 2025 and outline the key drivers for our 2026 outlook. I want to begin by expressing gratitude to the entire Watts team for their dedication and meaningful contributions, which made 2025 another outstanding year. We achieved record sales, operating margin, and earnings per share for both the fourth quarter and the full year. Organic sales rose 8%, and reported sales were up 16% this quarter. Adjusted operating margin climbed 220 basis points to 19%. For the entire year, organic sales grew 5% and adjusted operating margin improved by 190 basis points to 19.6% while we continued investing in strategic priorities.

We generated a record $356 million in free cash flow for 2025, up 7%, reaching a conversion rate of 105%. This strong cash flow supports our robust balance sheet and gives us flexibility to invest in future growth. Our capital allocation continues to focus on strategic M&A, high-return organic investments, competitive dividends, and steady share buybacks. Since our last earnings call, we completed two acquisitions. Superior Boiler, based in Hutchinson, Kansas, is a leading designer and maker of customized fire tube, water tube, and condensing boilers for commercial, institutional, and industrial uses. Superior's mission-critical heating and hot water solutions expands our customer offerings. Superior has about $60 million in annual sales. Saudi Cast, located in Riyadh, Saudi Arabia, manufactures high-quality cast iron and stainless steel drainage products for non-residential and industrial markets.

This acquisition grows our footprint in the fast-developing Middle East region. Saudi Cast's annual sales are around $20 million. Both acquisitions are expected to be accretive to Adjusted EPS in 2026 after accounting for added interest expense and normal purchase accounting adjustments. Integration efforts are already underway for both companies. As previously discussed, we regularly review our portfolio and phase out underperforming products under our 80/20 model within the One Watts Performance System. Through this ongoing evaluation, we've identified $10-15 million of European sales and $25-30 million in the Americas, mainly in lower-margin retail and OEM channels that we intend to eliminate during 2026. We anticipate these changes will be neutral or potentially margin accretive in 2026. Here's an overview of what will drive our 2026 outlook.

We expect that pricing, along with continued repair and replacement activity, will fuel further growth in 2026. Global GDP, a proxy for our repair and replacement business, remains positive within our main end markets. In the Americas, indicators for non-residential new construction present a mixed picture. The ABI remains below 50, suggesting subdued market conditions in 2026. However, the Dodge Momentum Index is slightly more optimistic, indicating potential growth in non-residential projects. Most of this growth should come from strength in institutional and data center sectors, though it could be tempered by weaker segments such as offices, retail, warehouses, and recreation. We also anticipate a soft single-family and multifamily residential construction market through 2026. Lastly, Europe's new residential and non-residential construction is expected to remain sluggish. Uncertainties surrounding inflation, trade policies, and interest rates might continue to hamper new construction projects.

Overall, we foresee market conditions similar to those experienced in 2025. We expect to benefit over $130 million in incremental revenues from the acquisitions of EasyWater, Haws, Superior, and Saudi Cast. Collectively, these additions are projected to dilute Adjusted Operating Margin by about 50 basis points in 2026 as we implement the One Watts Performance System and realize synergies. Now, let me highlight a few strategic growth initiatives, including our data center and M&A strategy. On slide four, you'll see examples of solutions we've developed for both air-cooled and liquid-cooled data centers. Our most notable product is the cooling valves that control the flow of chilled water to sustain the required temperatures in data centers. Typically, these valves and related equipment are made of iron for air cooling and stainless steel for liquid cooling.

Other important offerings include strainers, drainage, and our CoolVault thermal storage tanks, which serve as emergency backups during chiller restarts. Our data center initiative spans the globe, and we estimate the addressable market exceeds $1 billion. In 2025, sales from this sector represented just over 3% of total company sales and are growing at a double-digit rate. We'll keep investing in new products and technologies to meet evolving customer needs and believe this market will continue expanding for years. Slide five covers our acquisitions over the past three years. We finalized eight deals, deploying about $660 million in cash and adding around $450 million in annualized revenue. These acquisitions have broadened our product range, expanded channel access, and increased our geographic reach.

Just as importantly, they diversified our end market exposure and shifted our mix toward higher growth, higher margin, non-residential, institutional, and industrial segments. By leveraging the One Watts Performance System, we're driving value through successful integration, synergy realization, and improving margins. Despite the typical early-stage margin dilution from acquisitions, we've expanded adjusted operating margin by 320 basis points in three years. We're proud of our performance and pleased to add such quality brands to our portfolio. With that, I'll hand things back to Diane, who will discuss our Q4 and full year 2025 results and share the outlook for Q1 and all of 2026. Diane?

Thank you, Bob. Let us now turn to slide six, which outlines our fourth quarter results. Sales reached $625 million, reflecting a 16% increase on a reported basis and an 8% increase organically. The Americas region delivered strong organic growth of 10% and reported growth of 17%, exceeding our expectations. This performance was supported by favorable price and volume, including the benefit of 1 additional shipping day and growth from data center sales. Acquisitions accounted for an additional $27 million in sales, contributing 7 percentage points to the Americas' reported growth. In Europe, organic sales rose by 1%, while reported sales increased 10%. Organic growth stemmed from favorable pricing and the extra shipping day, while reported sales also benefited from positive foreign exchange effects.

In APMEA, organic sales grew 9%, with acquisitions adding 6% for a total reported sales growth of 15%. Adjusted EBITDA totaled $134 million, an increase of 28%, with an Adjusted EBITDA margin of 21.4%, up 210 basis points year-over-year. Adjusted operating income of $119 million increased 31%, and adjusted operating margin improved 220 basis points to 19%. These improvements were primarily driven by favorable pricing and productivity gains, more than offsetting inflationary pressures, volume deleverage in Europe, tariffs, and acquisition dilution. Segment margins were as follows: Americas increased by 150 basis points to 23.3%. Europe increased by 490 basis points to 15.1%, while APMEA decreased slightly by 20 basis points to 17.3%.

Adjusted earnings per share equaled $2.62, representing a 28% year-over-year increase, with operational performance, acquisitions, and foreign exchange gains outweighing higher tax and net interest expense. Turning to full year results, please refer to slide seven. As previously noted, we achieved record operating results for 2025. Total company sales were $2.4 billion, up 8% on a reported basis and 5% organically. Organic growth in the Americas and APMEA reached 8% and 5%, respectively, partially offset by a challenging year in Europe, where organic sales declined by 5%. Acquisitions contributed $52 million, or 2% of incremental sales growth, and favorable foreign exchange added another 1%. Adjusted EBITDA for the year was $534 million, up 18%, and Adjusted EBITDA margin improved by 180 basis points to 21.9%.

Adjusted operating income rose 19% to $477 million, resulting in 19.6 operating margin, up 190 basis points. These increases reflect the benefit of price, volume, and productivity gains, which more than compensated for inflation, European volume deleverage, tariffs, and acquisition-related dilution. Segment margin in the Americas increased to 24.5%, up 190 basis points. Europe increased to 13.3%, up 160 basis points, and APMEA remained flat at 18.3%. Adjusted EPS was $10.58, up $1.72 or 19% compared to prior year, with benefits from operations, acquisitions, favorable foreign exchange, and lower net interest expense exceeding higher tax costs. For GAAP reporting, after-tax charges of $22.3 million were recorded related to restructuring and acquisition-related costs.

Partly offset by an $8.3 million tax benefit from the reversal of a prior year tax liability. Free cash flow reached $356 million, a 7% increase from 2024, setting a new company record. This was primarily driven by higher net income, lower tax payments due to changes in U.S. tax regulations, and contributions from acquisitions, which more than offset higher inventory investment and capital expenditures. Free cash flow conversion was 105%. Our balance sheet remains strong and continues to support our disciplined approach to capital allocation. In 2025, we returned $83 million to shareholders through dividends and share repurchases, increasing our annual dividend payout by approximately 20%. On slide eight, we will review our outlook for the first quarter and full year 2026.

The outlook for 2026 is based on the anticipated market conditions discussed earlier. For the full year, we anticipate reported sales growth of 8%-12% and organic sales growth of 2%-6%. Excluding the impact of product rationalization, our organic sales growth would be approximately 2% higher. Organic sales in the Americas are expected to increase by 3%-7%, driven by price and volume, especially within data centers, more than offsetting anticipated product rationalization headwinds of $25 million-$30 million. Price contribution will be higher in the first half, particularly Q1, due to the carryover effect of prior year tariff-related price increases. In Europe, organic sales are projected to range from a 4% decline to flat, as favorable price is offset by lower volume, partly due to $10 million-$15 million in product rationalization.

APMEA is expected to achieve organic growth between 4% and 8%. Additionally, we anticipate incremental sales from acquisitions of between $110 million and $115 million in the Americas and between $18 million and $20 million in APMEA, with foreign exchange favorability estimated at $18 million. We expect adjusted EBITDA margin to be in the range of 21.5%-22.1%, and the adjusted operating margin between 19.1% and 19.7%. Margin expansion from price, volume leverage, and productivity and restructuring savings is expected to be partially offset by inflation and 50 basis points of acquisition dilution. Regionally, Americas segment margin is anticipated to decrease by 50-110 basis points, mainly due to approximately 100 basis points of acquisition dilution.

Europe's segment margin is expected to be down 30 basis points to up 30 basis points, and APMEA is estimated to increase by 30-60 basis points. This guidance assumes no changes to the current tariff environment. We expect free cash flow conversion at or above 90% of net income for 2026, reflecting planned investments in automation in our core operations and with our new acquisitions, investments in our data center capabilities, and investment in our SAP implementation. Key considerations for Q1: Reported sales are expected to increase 12%-16%, with organic sales up 4%-8%. We anticipate high single-digit growth in the Americas, low single-digit decline in Europe, and low single-digit growth in APMEA. These estimates incorporate a negative impact from product rationalization of approximately $1 million in Europe and $6 million in the Americas.

Incremental sales from acquisitions are projected at $25 million-$30 million for the Americas and around $5 million for APMEA, with a foreign exchange benefit estimated at $13 million. First quarter EBITDA margin is expected to be between 21.1% and 21.7%. Operating margin is expected to be between 18.6% to 19.2%. Price and volume leverage in the Americas and APMEA are anticipated to be offset by volume deleverage in Europe and acquisition dilution of approximately seventy basis points. Additional key assumptions for the first quarter and full year are available in the appendix of the earnings presentation. With that, I'll turn the call back over to Bob before moving to Q&A. Bob?

Thanks, Diane. Let's move to slide nine, where I'll summarize before taking questions. In 2025, we posted strong outcomes across the board, record Q4 and full year sales, operating income, EPS, and free cash flow. We continue investing in strategic growth and productivity programs, including data center solutions, our Nexa digital strategy, and factory automation for enhanced efficiency. 5 strategic acquisitions in 2025 further diversified our business and market reach. Our broad portfolio is resilient, and our teams are positioned to capitalize on growth opportunities, including institutional and data centers. Our model, driven largely by repair and replacement, ensures steady revenue and cash flow. Our balance sheet remains strong and provides flexibility to support our balanced capital strategies. The M&A pipeline is active, and we plan to pursue appealing opportunities to expand our solutions and global presence as we aim for sustainable, profitable growth.

With that, operator, please open the line for questions.