Watts Water Technologies, Inc.

The city margin is also partially due to a very difficult comparison the second quarter of 2023 when margins exceeded 19%. Adjusted earnings per share of 2046 cents increased 5% versus last year with growth driven by operational performance and solid contribution from our acquisitions. The adjusted effective tax rate was .2% of 50 basis points compared to the prior period, primarily due to the reduction of foreign taxes associated with the repatriation of funds that occurred in the second quarter of 2023. For gap purposes, we incurred approximately $4 million of restructuring and acquisition related charges. These charges are partially offset by a $3 million non-recurring gain on the sale of a building in the Americas. Our free cash flow year to date was $120 million compared to $89 million in the comparable period last year. The cash flow increase was probably due to higher net income, lower working capital investment, and the contribution from our acquisitions. We expect sequential improvement in our free cash flow and are on track to achieve a full year free cash flow conversion goal of greater than or equal to 90% of net income as previously communicated. The balance sheet remains robust and provides us with ample flexibility. Our net debt to capitalization ratio at quarter end was negative 1% and our net leverage was negative 0.1%. A strong cash flow, healthy balance sheet, and the recent extension of our credit facility through July 2029 continue to give us capital allocation optionality. Please turn to slide six and I'll provide a few comments on the regional results. America's organic sales are up 5% and reported sales are up 22% year over year. Organic sales are ahead of our expectations as a result of higher volume, partly due to project shipping earlier than expected. We saw solid growth in our core valve products and our heating and hot water solutions. The acquisitions of Bradley and Jo Sam added $65 million or 17% to America's sales in the quarter. Adjusted operating income increased 19% while adjusted operating margin decreased 60 basis points. The operating margin decline was primarily driven by acquisition dilution, inflation, and incremental investments which more than offset price, volume leverage, favorable mix, and productivity. Europe organic sales were down 15% which was slightly worse than we expected. Reported sales were down 16% and included a 1% unfavorable impact of foreign exchange movements. Growth in our drainage business was more than offset by declines in wholesale plumbing in France, Penelux, and Scandinavia. As well as our OEM businesses in Germany and Italy where heat pump destocking had a significant impact. Operating income decreased 48% and operating margins decreased 620 basis points. Price, favorable mix, and productivity did not offset inflation and the significant impact of volume deleverage due to our high fixed cost base in Europe. APMEA organic sales were up 18% and reported sales growth of 16% was negatively impacted by 2% from unfavorable foreign exchange movements. We saw growth across China, Australia, New Zealand, and the Middle East. Project timing contributed to the growth in China and the Middle East. Adjusted operating margins increased 70 basis points in volume and productivity, more than offset inflation, incremental investments, and the dilutive effect of the end-wear acquisition. Slide 7 provides our assumptions about our third quarter and full year outlook. First, let's cover the third quarter outlook. On a reported basis, we expect sales to increase between 5 and 8%. Organically, we expect sales to decrease between 4 and 7%. Organic sales are expected to be down low single digits in the Americas and down low double digits in Europe, partially offset by APMEA, which is expected to be up low single digits. In the Americas, we anticipate weakening in multifamily and non-residential new construction. In addition, our third quarter guidance includes the unfavorable impact of project timing in the Americas at APMEA, where we saw projects delivered in the second quarter, which was earlier than anticipated. It also includes a soft start to the quarter resulting from a reduction in safety stocks at some of our channel partners in the Americas due to our normalized lead times. Europe markets are expected to remain soft, partly due to continued heat pump and related product de-stocking. We expect incremental sales in the Americas from acquisitions to be between 60 and 62 million dollars. Third quarter adjusted EBITDA margins are expected to be in the range of 18.7 to .3% or down 70 to down 130 basis points. Third quarter adjusted operating margins should be in the range of 16.2 to .8% or down 120 basis points to down 180 basis points. Acquisition dilution of 90 basis points, incremental investments of 6 million dollars, and volume delabrage, particularly in Europe, will all have an unfavorable impact. A few other items related to the third quarter. Corporate costs should be approximately 14 million dollars and net interest expense should be approximately 2 million dollars. Digested effective tax rates should be approximately 25%. We are estimating a 1.09 euro US dollar exchange rate, which is flat compared to the third quarter of 2023. Now let's cover the full year outlook. For full year 2024, we are maintaining our outlook consistent with our previous guidance. Reported sales are expected to increase 70% to 12% and organic sales are expected to range from down 4% to up 1%. Full year incremental acquired sales from Bradley and Joe Sam should be between 210 million and 215 million dollars. Our full year adjusted EBITDA margins should be between .6% and .2% or down 30 basis points to up 30 basis points. Our full year adjusted operating margins should be between 17.1 to .7% or down 70 basis points to down 10 basis points. Our better than expected second quarter, including acquisition performance, is expected to offset second half weakening in Europe as previously mentioned. As a reminder, the operating and EBITDA margin guidance includes an increase in incremental investments of 2 million dollars and acquisition dilution of 60 basis points. Our free cash flow expectation remains in line with our previous outlook. As we expect to deliver free cash flow conversion of greater than or equal to 90% of net income in 2024. For the full year, we are assuming a 1.09 average US 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 dollars in sales and 2 cents per share in EPS for the full year versus the prior year. Other key inputs for the full year can be found in the appendix. Now, let me turn the call back over to Bob before we begin Q&A.

Bob. Thanks, Shashank. On slide eight, I'd like to summarize our discussion before we address your questions. Our second quarter performance was better than we anticipated with record sales, adjusted operating income, and earnings per share due to better than expected performance in our Americas and Appian regions. We are maintaining our full year outlook with a solid first half performance expected to offset second half weakness, especially in Europe. Our portfolio is agnostic to end markets and we are well positioned to pivot to growing subverticals as needed. Our business model includes a large repair and replacement component that provides a durable base and drives steady revenue and cash flow. The integration efforts at Bradley, JoSam, and EnWare are going well. We are pleased with the progress today and excited about their growth potential. Our balance sheet remains robust and with a proactive extension of our credit facility, provides ample flexibility to support our discipline capital allocation priorities. We are well positioned financially, operationally, and commercially, but I'm confident in our team's ability to execute despite the uncertain environment which will enable us to continue creating value for our shareholders. With that operator, please open the line for questions.

In order to ask a question, press star then the number one on your telephone keypad. Your first question comes from the line of Ryan Connors with North Coast Research. Your line is open.

Good morning. Thanks for taking my questions.

Morning Ryan.

Morning. Yeah, so I wanted to talk about this issue. You mentioned project timing as a driver behind the strength in the quarter in both America's and APME. If I think back, I don't recall project timing being something you've mentioned much in the past, except maybe around data centers a little bit and generally don't think of Watts as a project oriented company. So can you just expand on exactly what that is, what types of projects those were that were pulled forward into the second quarter?

Yeah, Ryan. So in APME, and actually the data center business five, six years ago, it was virtually nothing and we've been growing from a small base. But we've been growing at double digits. It's a significant, significant. It's a reasonable part of our business globally, quite significant in the APME region. So in the APME region, we had data centers in China and those projects were scheduled for third quarter. They got pulled into the second quarter. And in the Americas is primarily in the heating hot water solutions business, the commercial waters, but of what boiler it is. There's some large projects that customers needed in the second quarter that we shipped in the second quarter. Combination of both of those is about 78 million dollars of sales that were pulled into the second quarter.

Got it. Okay. And in America is what types of non residential construction projects or those aren't really data center related. Those are more general.

Yeah, we're starting to get into data centers in North America. So we're seeing a little bit of that. But this was mainly in the heating and hot water heat pump section of our business.

Heat pumps. Okay. And my other one was just around pricing. It's been a hot topic. Some companies out there talking about some deflation. Any update on pricing in your business there and any discounting going on on some product lines or And also, you know, any shift to as price gets more of a discussion, any shift to the online sales platforms you have like backflow direct.

Yeah, in general. So pricing was favorable about one point in the quarter, certainly on large projects. They are very competitive. So we see that and certainly our online business with backflow direct is up. We continue to drive e commerce where our customers need it. But pricing has been, like I said, up 1% in the quarter.

Good to hear. Thanks for your time. Thank you.

And your next question comes from the line of Jeff Hammond with Key Bank Capital Markets. Your line is open.

Hey, good morning, guys. Morning. Yeah. Okay, appreciate the color on the on the pull forward and quantification. I think you talked about a number of headwinds kind of two Q to three Q some D stock. Non res multifamily. Maybe just rank order, you know, those headwinds and maybe a little more color on that on that D stock impact.

Yes, Jeff on the on the D stock announced probably basically are in the wholesale channel, our customers. Because we now have normalized lead times. They've been reducing their safety stock levels. We saw that in the month of July. That's approximately seven to $8 million. So far, that's happened in the third quarter. The rest of it on the multifamily. This is what we expect with with all the construction side of it because there is a lag. We expect that to down to it in the second half, which we had factored in when we set the guidance early on and we still expect to see that. And what was the third part of the question again?

I guess it's non res in general.

Yeah, no, there is again. And that's the ABI indicators, right. They've been flashing red below 50 for over a year. And on the non residential side, you know, we've seen weaknesses. In, you know, again, office, retail, restaurants, all those other those sub segments, but strength in the strength in the institutional side. So again, we factored that into the guide as well for the second half.

Okay,

and

then Europe.

I guess one is, you know, it sounds like you're going to continue to see weakness. Can you hold double digit margins into the second half? What else is weak weakening in Europe besides the European heat pump? And then, and then finally, just any signs that we're hitting bottom or stabilizing or ending this D stock on the heat pump side?

So on the heat pump side, I'll take that first. I don't think you're going to get any clarity to the potentially end of the first quarter of next year related to heat pump. There's Our channel checks showing a bunch of heat stock or heat pump inventory. You know, in the channels and they've got to believe that off in general when we look at Europe, just think about new construction is very limited there, given the uncertainties, the economic challenges, the geopolitical Issues, etc. So that's something I've been concerned about for a while here. And we certainly saw it in Q3 and we're expecting to see it again in Q4. But some of our channel checks and everybody else once this heat pump goes through some of the, you know, easier comparison to next year, you know, they believe they're starting to bottom out as we exit this year.

And just to note, there is one area of strength right in our drains business on the commercial marine side as well as food and beverage drains actually had a good quarter in the second quarter. So we do see pockets of opportunity, albeit small. Okay,

and then, and then final one. Can you just, you mentioned data center and how it's been growing. Can you just size that business as a percentage of sales now. You know, can you speak to how you, it looks, it sounds like most of that's in Asia. How you bring that product or how you enter the North America data center market. And then finally, there seems to be this big shift to liquid cooling. You know, which requires your water, etc. In a data center versus, you know, traditional air cooling and I'm wondering if we as we move there. If there's a an incremental content opportunity for you.

Yeah, Jeff. So certainly our initiative of data centers did start in China. Several years ago, and we've been bringing that to North America and in even Europe. So these are growing opportunities, I would say in total. Less than 2% of our overall watt sales, but it went from nothing three years ago to about 2% of our sales and it, as you can imagine, it's lumpy business. As you get into, you know, liquid cooled for versus air cooled. Certainly there's more content for our valves and our products and You know, from our point of view, we're bundling our solutions. It's not just, you know, it includes leak detection backflow the whole gamut of products. So it's an opportunity to offset some of the You know softness we're seeing in the traditional markets that we've been in and something we've been flexing towards and growing, you know, very quickly on a small base.

And as you said, the market is shifting to liquid cooling. So we are developing the products for liquid cooling. We sell liquid cooling a little bit of the market in China is already there. So we're into that market.

Okay, thanks for the time. Thank you.

And your next question comes from the line of Nathan Jones with Stifle. Your line is open.

Good morning, everyone. Morning. I want to follow up on the destocking question. I'm a little just a little surprised to hear that there's still a bunch of inventory in the in the channel for certain products. At this point in the recovery, I would have thought that your lead times would have already been back to normal. So maybe any more color on on what those products are and if there's anything in your portfolio that still has extended lead times that could lead to us seeing some destocking in the future.

So, Nathan, I think it was just across the board. I think everybody's looking at reducing inventories, just like we are. And I think it's just a natural thing. It's quite interesting though, is we saw it in July and it spiked out. So I think everybody looked at their June 30th balance sheet and said, So, We're watching it carefully. Our lead times are probably the best they've ever been, even pre-COVID. So no major things there, but we're watching this closely and adjusting accordingly. So

just

something we wanted to call out because we had a softer than expected July.

Kind of a one-time reset working capital optimization.

Follow-up question on the repair and replace side of the business. I think the general expectation from the macro guys is that you're going to see a slowdown in GDP as we get towards the end of the year, the fourth quarter specifically. Can you talk about kind of what you baked into the guidance from repair and replace? I know your business is correlated to GDP. So just any color you can give us on what you're thinking there.

Yeah, it's a very low single digit range, right? You're right, Nathan, in that GDP will continue tracking softer is probably the best way to put it. And that's what we factored into our guide is lower numbers on GDP. And remember, it's going from two and a half, three percent to maybe one. It's a law of small numbers. It's not a big number,

right? Yeah, perfect. Thanks for taking my questions. Thank you. Thank you.

And as a reminder, if you'd like to ask a question, press star the number one on your telephone keypad. Your next question comes from the line of Mike Halloran with Baird. Your line is open.

Hi, morning, everyone. Good morning. Just a question on how you're thinking about the back half of the year in terms of sequentials and then also where you previously had a guy to certainly understand that the weakening comments in Europe and the OE and then the how projects can swing things either way. If you look at the underlying dynamics, let's focus on America's here. Has there been a change in your thinking at all as you move to the back half of the year? I know you already had some some concern embedded in that outlook going into the into the second quarter. I'm curious if that's changed. And then if you normalize for everything, are you just thinking kind of normal sequentials as you move to the back half?

So, so Mike, I think, you know, for the most part, Europe is a little softer than we were expecting. America's kind of in the same, maybe 1% softer based on this, you know, adjustment and de-stocking that happened in July. But when you look at overall, I just want to remind everybody we had a days issue in the first quarter of the year, right? And that will negatively impact us in the fourth quarter. So that's 6%, six points of growth in the fourth quarter. So just keep that in mind. But in general, we expected the markets to slow based on the leading indicators and, you know, we're adjusting accordingly. So it's not a major shift. It's kind of seeing some of the things that we were anticipating all along in our previous guidance.

Yeah, and at this point, Bob, when you think about some of the leading indicators you guys have seen out there that we've all seen that point to some concern, are those at the point where they would even impact this year or those things that are more relevant for next year?

Well, the multifamily, we're seeing some of that. And I think that's some of the wholesale, you know, de-stocking that's happening. We said we'd probably see that in the second half of this year. And I think that's holding true. I think in the retail, which is a very low percentage of our business, OEMs, or the retail big boxes are lowering their inventories. So in general, I think it's slowing. And as we anticipated, I think, you know, in this market, in any commercial construction markets, new construction, uncertainty always, you know, leads people to slow down projects, right, and define. So I think until the elections are over, clarity on interest rates, maybe some of the geopolitical risks, I think some of this stuff is just being held. And at this point in time, but there's a lot of shovel ready projects out there to be released at some point in time, but we are hearing projects are on hold and being deferred until next year. So we're starting to hear that and see that versus I think the first half of the year, there was a solid backlog with everybody. I think some of this stuff is just starting to catch up.

And last one on my side, thanks for that. Just how would you see in the M&A outlook? Obviously, your balance sheet's in great shape. How's that pipeline look and how actionable do you think the pipeline is at this point?

Yeah, so we continue to work the pipeline. It's a strong pipeline. As you know, we, you never can predict timing of acquisitions. And all I can assure you is we'll be disciplined like we always have been. And, but we're continuing to have discussions in the space.

Thanks. Appreciate it. Thanks, Mike.

And your next question comes from the line of Joe Gordano with TD Cohen. Your line is open.

Hi, guys. Good morning.

Hey, I mean, it's small change, but I noticed the M&A dilution is being reduced here a little bit. Can you tell us like what you're finding on the acquisitions here? Is it just better execution? You finding incremental synergies that you're able to take advantage of earlier? Just like what's driving that?

It's probably better synergies, right? If you remember for the Bradley acquisition, we had a synergy target of 12 million with about 40% realization in year one. It's running slightly ahead. So we've baked that into the guide and a little bit more on the Joe's acquisition as

well.

Better execution all around, I would say.

On the

institutional side in the US, I mean, I noticed you mentioned like it's holding in pretty well. Like if you look at some of this, like the census that at least for construction put in place for institutional, it's definitely positive, but trending down. Are you like incrementally seeing that shift? Like even if we're in positive territory, it's like getting kind of progressively worse. Is that consistent with what you're seeing on the ground?

We haven't seen that yet. We've seen institutional business is held up fairly well at this point in time. But we're watching certainly with the leading indicators just like you are, but that's a bright spot for us right now.

Thanks guys.

Thank you. And as a reminder, if you would like to ask a question, please press the star than the number one on your telephone keypad. Our next question comes from the line of Walter Littok with Seaport Research Partners. Your line is open.

Hey, good morning guys. Good morning Walter. One day, one day ask about the Europe business. You guys have been, you know, and we've been talking about the, you know, Europe, the heat pump slowing for some time. Was it below your expectations in the quarter or is the de-stocking kind of going the way that you have been thinking that it would?

So we had, you're right, right? Early in the year when we gave guidance, we expected the de-stocking to happen. Quite frankly, it now looks like it's going to be longer. As Bob said, Q1 2025 is the latest view we have. And it is worse than we anticipated. So that's why when you look at Europe, Europe did come in softer in the second quarter than we had anticipated. We recalibrated the third quarter in the balance of the year, but it is worse than we had anticipated.

Okay, great. And can you remind us, you know, the, you know, the positives around the European heat pump, I think was driven by incentives. Are those incentives, is there another round of incentives coming through or is that it, are we back to like, sort of a normal consumer market for those products?

No, so the incentives, obviously the incentive levels change, right? We had talked earlier, Italy had incentives of 110% and then last March they dropped them to 60%, but they weren't instant. They were over five year tax speed, etc. So the incentives are there, but they're different and less. Similarly with Germany and France, they've solidified their incentive program. But I think the situation was there was a huge buildup of heat pumps across Europe. And that's why we got into a situation where even today there's about a nine month inventory of heat pumps in the European market. So that's got to be bled through. And that's where that Q1 2025 number comes in. But the incentives are there, they're less, but

they're still there. Okay, great. Okay, good. Okay, thanks. I'll, I'll

take it offline from here. Thanks.

Okay,

thanks. Thank you.

And there are no further questions at this time. Bob Pagano, I turn the call back over to you.

Thank you for taking the time to join us today. We appreciate your continued interest in watch and look forward to speaking with you again during our third quarter earnings call. Have a good day and stay safe.

And this concludes today's conference call. You may now disconnect.