WATTS WATER TECHNOLOGIES INC Q1 2026 earnings call

Thank you, good morning, everyone. Welcome to our first quarter earnings conference call. 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. Good morning, everyone. Please turn to slide three and I'll provide an overview of the first quarter. We began 2026 with better-than-expected results, including record sales, operating income, operating margin, and earnings per share. I'd like to thank the entire Watts team for their impactful contributions to our results. Organic sales rose 12% in the quarter as we benefited from price and incremental volume. Adjusted operating margin of 20.1% increased 110 basis points due to better than expected price, volume, and productivity, which more than offset tariff costs, inflation, and acquisition dilution of 80 basis points. Our balance sheet remains strong and provides ample capacity to support our disciplined capital allocation strategy. This includes evaluating strategic M&A opportunities while continuing to invest in product innovation and advancing our digital strategy.

As a result of our solid start to 2026 and expected cash flows for the remainder of the year, we announced a 21% increase to our dividend beginning in June. We continue to see strong momentum in data center cooling applications, with sales more than doubling in the quarter as we deepen customer relationships and leverage our broad portfolio. To support this growth and meet our customers' needs, we're investing in our team and accelerating innovation across our product portfolio. Additionally, we're expanding capacity, including adding inventory to meet shorter lead time expectations. We're also gaining traction with our digital solutions, including the Nexa platform, our intelligent water management solution. Together, these strategic initiatives are driving growth and helping to offset softer end markets.

In 2025, we completed five acquisitions, enhancing our technology capabilities and expanding our product range, geographic reach, and exposure to high-growth non-residential end markets. These businesses are performing well, and we are successfully integrating them through our OneWatts Performance System. We're on track to achieve or exceed the targeted synergies. We are proactively working to mitigate the impact of the Middle East conflict. Our direct sales exposure to the Middle East is limited to approximately 2% of global sales, with the majority being in our APMEA region. We are implementing targeted pricing strategies as well as sourcing and productivity initiatives to mitigate both the direct and indirect impacts, including freight and energy cost increases.

Our direct Middle East exposure includes our recent acquisition, Saudi Cast, and I wanted to highlight that the Saudi Cast business is largely an in-country, for-country business model, which should help insulate it from the full impact of the conflict. The tariff environment also remains fluid, with IEEPA tariffs being eliminated but generally being offset by new tariffs under Section 122 and changes in the Section 232 rules. Additionally, the administration is considering new tariffs under Section 301. Based on the tariff structure in place as of today, we believe we are well positioned from a price-cost perspective. Our strong first quarter performance and outlook for the second quarter give us a solid start towards achieving our outlook for the full year. We continue to face an uncertain macroeconomic and geopolitical environment, including the Middle East conflict, downward revisions of global GDP forecasts, and elevated interest rates.

In light of these factors, we believe it's prudent to maintain our full year outlook, and we'll revisit in our next earnings call. With that, let me turn the call over to Diane, who will address our first quarter results and our second quarter and full year outlook. Diane?

Thank you, Bob. Good morning, everyone. Please turn to slide four, which highlights our first quarter results. Sales reached $677 million, reflecting a 21% increase on a reported basis and a 12% increase organically. This performance was supported by favorable price and volume, including the benefit of growth in data center sales. The Americas region delivered strong organic growth of 16% and reported growth of 23%, exceeding our expectations. Acquisitions accounted for an additional $31 million in sales, contributing seven points to the Americas' reported growth. In Europe, organic sales rose 1%, while reported sales increased 12%. Organic growth stemmed from favorable pricing, while reported sales also benefited from positive foreign exchange.

In APMEA, organic sales grew 3%, with acquisitions adding 19% and favorable foreign exchange contributing 7% for a total reported sales growth of 29%. Adjusted EBITDA totals $151 million, an increase of 27% with an Adjusted EBITDA margin of 22.3%, up 90 basis points year-over-year. Adjusted operating income of $136 million increased 28%, and adjusted operating margin improved 110 basis points to 20.1%. These improvements were primarily driven by favorable pricing, volume leverage, and productivity gains, more than offsetting inflationary pressure, tariffs, and acquisition dilution of 80 basis points. Segment margins were as follows: Americas increased 80 basis points to 24.2%, and APMEA increased 120 basis points to 18.7%, while Europe decreased 20 basis points to 13.7%.

Adjusted earnings per share equaled $3.04, representing a 28% year-over-year increase, with operational performance, acquisitions, tax, and foreign exchange gains outweighing higher net interest expense. The adjusted effective tax rate in the quarter was 24.2%, down 30 basis points compared to the first quarter of 2025, primarily due to a higher tax benefit from the vesting of stock compensation awards that occur in the first quarter of each year. Our free cash flow for the quarter was $7 million, compared to $46 million in the first quarter of last year. The cash flow decrease was primarily due to the increase in accounts receivable due to higher sales volume, increases in and timing of our annual customer rebate payments, and an increase in inventory related to incremental tariffs and our strategic investment in inventory.

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 90% of net income as previously communicated. We have a strong balance sheet and solid cash flow, giving us flexibility in executing our capital allocation strategy, including the announced 21% increase in our dividends that will begin in June. On slide five, we will review our outlook for the second quarter and full year 2026. We are reaffirming the full year 2026 outlook we presented in February, which reflects the market factors Bob discussed. It assumes the Middle East conflict is short-term in nature, the current tariff structure remains in place for the remainder of the year, and there are no IEEPA tariff refunds.

For the full year 2026, we are maintaining both our consolidated and regional sales outlooks. Consolidated organic sales growth is expected to be between +2% and +6%, and our reported sales growth is expected to be between +8% and +12%. We are also maintaining our full year Adjusted EBITDA and adjusted operating margin outlook. A few items to consider for the second quarter. Reported sales are expected to increase by 10%-14%, with organic sales up 4%-8%. We anticipate mid to high single-digit growth in the Americas, despite the tough compare to the second quarter last year, which included an estimated $20 million of pull-forward sales into the second quarter from the third quarter due to the timing of price increases.

We expect a low single-digit decline in Europe and low to mid single-digit growth in APMEA, with our expected data center sales offsetting the direct impact of the Middle East conflict. These estimates incorporate the negative impact from product rationalization under our 80/20 initiative of approximately $2 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. We also estimate a foreign exchange benefit of approximately $5 million. Second quarter EBITDA margin is expected to be between 22.3% and 22.9%. Operating margin is expected to be between 20% and 20.6%. Price and volume leverage in the Americas and APMEA are anticipated to be offset by acquisition dilution of approximately 70 basis points.

In addition, last year we had a non-recurring price cost benefit of approximately $6 million in the second quarter, in addition to the volume leverage on the estimated $20 million of sales pull forward that together are a 120 basis point headwind to margins in the second quarter. Additional key assumptions for the second 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. To wrap up, we had a strong start to the year with record first quarter sales and earnings. Our portfolio spans diverse end markets, and we're actively reallocating resources towards areas of strong demand, including institutional and data centers. Importantly, approximately 60% of our sales are driven by repair and replacement activity, which provides a consistent foundation for revenue and cash flow generation over time. We remain nimble and are confident in our ability to execute through dynamic market conditions. We're maintaining our full year outlook despite the macro and geopolitical uncertainty. Our balance sheet remains strong and provides ample flexibility to support our capital allocation priorities. We believe we are well-positioned to deliver on our financial commitments, create value, and drive profitable growth over the long term. With that, operator, please open the lines for questions.