Watts Water Technologies, Inc.

Thank you and good morning, everyone. Welcome to our third quarter 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 the third quarter, our markets, and our operations. Shashank will discuss the details of our third quarter performance and provide our outlook for the fourth 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 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, see Watts publicly available filings with the SEC. The company undertakes no obligation to update or revise any forward-looking statement, 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. Please turn to slide three and I'll provide an overview of the quarter. We're pleased with our third quarter results which exceeded expectations. During the quarter, organic sales were down 4%. Strong growth in apnea was offset by declines in the Americas and Europe. The decline in the Americas was partly due to project timing and inventory safety stock reductions within our wholesale channel. Europe was weaker than expected as a result of continued heat pump to stocking in our OEM channel. Adjusted operating margin of .1% exceeded our expectations, primarily driven by productivity and cost controls, which more than offset European volume deleverage. Adjusted operating margin was down 90 basis points compared to last year, primarily due to acquisition dilution and Europe volume deleverage. -to-date free cash flow continues to be solid and we expect to generate seasonally strong free cash flow through year end. The balance sheet remains healthy and we have ample flexibility in our discipline capital allocation strategy. Strategic M&A, high ROI capbacks, competitive dividends and steady share buybacks remain our top capital allocation priorities. Moving operations, the integrations of our Bradley, Josam and NWARE acquisitions remain ahead of schedule with solid synergy savings being realized, largely due to the strong execution by our global operations and sourcing teams. We recently announced a project regarding the closure of a manufacturing plant in France. As we currently are consulting with the appropriate French Works Council and local government authorities, the timing for making a final decision to close the plant and related costs have yet to be determined or approved. If the project is approved, our plan would be to move the production from this plant to existing plants in France and other locations. In addition, we have initiated other cost reduction actions to further optimize our cost structure. We expect to begin realizing these savings toward the end of 2024. Now, a few comments on our end markets. Global GDP remains positive and will continue to support repair and replacement activity which represents approximately 60% of our business. Europe's residential and non-residential new construction markets continue to weaken. The reduced energy and center programs continue to unfavorably impact OEM volume and drive de-stocking activity, especially in the heat pump market. In the Americas, single-family new construction remains muted and multifamily new construction indicators have been down double digits since the end of last year. On a positive note, America's institutional and light industrial new construction continues to be solid. Global mega projects, including data centers, continue to provide a tailwind and are growing at a double digit pace. We believe our strategic account teams in each region are well positioned to participate in this growing market. Now, an update on our outlook for the fourth quarter in the full year. As a reminder, due to our fiscal year calendarization in 2024, we had extra shipping days in the first quarter and we'll now have fewer shipping days in the fourth quarter compared to the prior year. As a result, we expect organic sales to be down mid to high single digits in the fourth quarter with an estimated 5% of that decrease attributable to fewer shipping days. We also anticipate a sequential decline in operating margins due to normal seasonality, incremental investments, volume de-leverage, and the dilutive impact of our Bradley acquisition. While we expect Q4 to be softer, we're increasing the midpoint of our full year adjusted operating and EBITDA margin outlook due to our solid year to date performance, improved acquisition profitability, and the benefit of cost actions initiated at the end of the third quarter, which we expect will more than offset further weakness in Europe new construction and lower OEM volume from the reduced energy incentives and heat pump de-stocking. We continue to monitor the geopolitical uncertainty in the US, Europe, and the Middle East, and we believe we are positioned to proactively address any developments that may impact our operations. Moving on to slide four, I'd like to talk about the next phase of our smart and connected journey. Over the last five years, we have made the digitalization of our business and solutions a strategic priority. We have reached critical milestones, including achieving our goal of 25% of total sales being comprised of smart and connected enabled products by 2023. We have continuously increased usage of our digital solutions and remain focused on growing user adoption across our entire customer base. Today, I'm thrilled to talk about what's next in this journey and excited to share details about NEXA, our intelligent water management solution. We've been field testing NEXA for over a year and are very excited about its unique potential to address critical trends within our industry, including skilled talent shortages in the facilities and plumbing spaces, the rise of smart building technologies, and concerned around aging water infrastructure. Additionally, NEXA's purpose is directly aligned with our long-term strategy, which focuses on water conservation, energy efficiency, and safety and regulation. NEXA uniquely integrates sensing hardware, smart and connected equipment, a legacy of plumbing and hydronic systems expertise and cutting edge software into a powerful offering for customers in the commercial building space. This new solution provides unprecedented insight into water systems and unlock significant value in onsite operations and water risk management while supporting sustainability targets. We're able to provide this solution while continuously improving what our industry professionals care about most, the experience of the occupants in their buildings. If we turn to slide five, we can see what NEXA offers. At its core, NEXA helps protect properties against the costly impact of water damages, saves teams time and effort associated with managing water assets, facilitates addressing water related compliance needs, and provides critical insight to meet our customer sustainability goals. It is a modular solution that can be deployed in any commercial property and is already empowering customers to address a wide spectrum of operational challenges, including water usage measurement, leak risk management, and mechanical room performance tracking. NEXA can either be used on its own to optimize building water systems or as a compliment to existing building management solutions. It is easy to deploy in new builds or as a retrofit, intuitive to use, compatible with key water related equipment and comes with expert support that WAAS is uniquely positioned to provide. It unlocks actionable value for users, managers, and owners of commercial properties in systems that have historically been complex and hard to monitor and automate. NEXA is a pivotal step in our goal to build new business models geared towards services and reoccurring revenue. It will be monetized through an ongoing subscription fee for active customers, while its adoption will increasingly create value for WAAS by reinforcing our core business of equipment and solution sales. Based on feedback from customers, NEXA is an undeniably valuable tool, yielding many powerful examples of value creation in commercial properties, such as multinational hotel brands, educational campuses, and franchise restaurant chains. From early detection of risk to solving complex system balancing issues, it has delivered immediate results for nearly every property deploying it. We encourage you to visit nexaplatform.com to find out more about the valuable water management solution we have created. Before I turn the call over to Shashank to discuss our financial results, I wanna take a moment to comment on our CFO transition. We announced yesterday that Shashank will be retiring on March 15th, 2025, although he will continue as CFO until his successor is named to ensure a smooth transition. We have begun a comprehensive search to identify a successor, which will include both internal and external candidates. The board, the executive leadership team, and I are incredibly grateful for Shashank's leadership during his more than six years as a CFO of Watts. He has been an invaluable partner and has made significant contributions to our success. With that, I'll turn the call over to Shashank, who will address your third quarter results and discuss our fourth quarter in full year outlook. Shashank.

Thanks, Bob, and good morning, everyone. Please turn to slide six, and I will review the third quarter's consolidated results. Sales of $544 million were up 8% on a reported basis and down 4% organically. Solid organic growth in APMEA was offset by another challenging quarter in Europe and a decline in the Americas where we are unfavorably impacted by project timing and inventory safety stock reductions within our wholesale channel. The acquisitions of Bradley and Josam contributed approximately $59 million, or 12%, and foreign exchange increased sales by approximately $1 million versus the third quarter of 2023. Compared to the prior year, adjusted operating profit of $93 million increased 2%, and adjusted operating margin of .1% was down 90 basis points. Adjusted EBITDA of $106 million increased 5%, and adjusted EBITDA margin of 20% was down 50 basis points. Adjusted operating and EBITDA margin benefited from price, productivity, favorable mix and cost controls, which were more than offset by inflation, volume delaverage, acquisition dilution of approximately 70 basis points, and incremental investments of $6 million. Adjusted earnings per share of $2.03 were slightly down versus last year, with benefits from acquisitions offset by a decline in operational contribution and incremental interest expenses. The adjusted effective tax rate was 25.2%, down 20 basis points compared to the prior year period. For gap purposes, we incurred approximately $7.4 million in restructuring and acquisition-related charges. These charges were more than offset by a $7.8 million non-recurring gain on the settlement of the terminated Bradley pension plan. Our -to-date free cash flow was $204 million, up from $182 million in the comparable period last year, primarily due to the contribution from our acquisitions. We expect the seasonally strong free cash flow to continue in the fourth quarter, and consequently, we are increasing our full year free cash flow conversion target to 100% or more of net income from the 90% conversion previously communicated. The balance sheet remains robust and provides us with ample capital flexibility. Our net debt to capitalization ratio at quarter end was negative 6%, and our net leverage was negative 0.2. A strong cash flow, healthy balance sheet, and available credit continue to give us capital allocation optionality. Please turn to slide seven, and I'll provide a few comments on the regional results. America's organic sales were down 3%, and reported sales were up 14% year over year. Organic sales declined partly due to the previously communicated project timing between the second and third quarters, and inventory safety stock reductions within our wholesale channel driven by our normalized lead times. The acquisitions of Bradley and Josam added $59 million or 17% to America's sales in the quarter. Adjusted operating income increased 2%, while adjusted operating margins decreased 260 basis points. The operating margin decline was primarily driven by acquisition dilution, inflation, volume deleverage, and incremental investments, which more than offset price and productivity. Europe organic sales were down 12%, and reported sales were down 11%, which included a 1% favorable impact from foreign exchange movements. Double digit growth in our drains business was more than offset by declines in our wholesale plumbing sales in France, Benelux, and Scandinavia, as well as our OEM business in Germany and Italy, where heat pump destalking had a significant negative impact. Adjusted operating income decreased 10%, while adjusted operating margins increased 20 basis points. Price, favorable mix in productivity offset inflation, volume deleverage, and incremental investments. Atmia organic sales were up 8%, and reported sales grew 10% due to healthy demand and a 2% benefit from favorable foreign exchange movements. We saw strong growth across China, New Zealand, and the Middle East. Growth in China was driven by demand in data centers. Adjusted operating income increased 18%, and adjusted operating margin increased 130 basis points, as volume and productivity more than offset inflation, incremental investments, and the dilutive effect of the inward acquisition. Slide eight provides our assumptions about our fourth quarter and full year outlook. First, let's cover the fourth quarter outlook. On a reported basis, we expect sales to range between negative 4% to flat. We expect organic sales to decrease between five and 9%. As a reminder, we have fewer shipping days in the fourth quarter due to our fiscal year calendarization, which will result in approximately 5% of decline versus last year. Organic sales are expected to be down with single digits in the Americas, and down low double digits in Europe, partially offset by apnea, which is expected to be up low single digits. In addition to fewer shipping days, we anticipate continued softness in multifamily and non-residential new construction in the Americas, and weaker European markets, partly due to continuous heat pump and related product de-stocking. We expect incremental sales in the Americas from acquisitions to be between 20 and $25 million. Fourth quarter adjusted EBITDA margins are expected to be in the range of 18.6 to 19.2%, or up 70 basis points to 130 basis points. Fourth quarter adjusted operating margin should be in the range of 16% to 16.6%, or up 20 to 80 basis points. The increase versus the prior year is due to price favorable mix in productivity that are more than offsetting the reduced volume incremental investments of approximately $4 million and approximately 30 basis points of dilution from the Bradley acquisition. The sequential decline in operating margin from Q3 is driven primarily by the impact of seasonal volume de-leverage and incremental investments. We are estimating a 1.08 US dollar exchange rate for the fourth quarter versus the average rate of Euro 1.07 in the fourth quarter of 2023. This equates to an increase of approximately $1 million in sales and less than one cent in EPS versus the prior year. Now let's cover the full year outlook. For full year 2024, we are narrowing our sales outlook range and expect reported sales to increase by nine to 10%. We expect organic sales to decline between one and 2% with the midpoint consistent with our previous guidance of minus 4% to plus 1%. Full year incremental acquired sales for Bradley and JoSam should be between 205 to $210 million. We are increasing our full year adjusted EBITDA margin outlook to a range of up 10 basis points to up 30 basis points. We are also increasing our full year adjusted operating margin expansion to a range of down 10 basis points to down 30 basis points. Both represent an increase of 20 basis points to the midpoint of our previous guidance. The solid results so far this year, along with our fourth quarter expectations are anticipated to more than offset weakening in Europe and acquisition dilution of up 60 basis points. We are also increasing our free cashflow conversion target to 100% or more of net income from the 90% conversion previously communicated. For the full year, we are assuming a 1.09 average EOSG tax 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 in sales and $0.02 per share in EPS for the full year versus the prior year. Other key inputs for the fourth quarter and the full year can be found in the appendix. With regards to my announced retirement, for the past six years, it has been a privilege to be a part of the Watts leadership team. While I'm looking forward to my retirement, I'm pleased to support the process to identify our next CFO and ensure a smooth transition. I'm confident that our global team will continue to fulfill our mission and successfully execute our long-term strategy. Now, let me turn the call back over to Bob before we begin Q&A. Bob. Thanks, Shashank.

On slide nine, I'd like to summarize our discussion before we address your questions. Our third quarter performance exceeded expectations due to better than expected performance in our Americas and Apnea regions. We are proud of the progress in our smart and connected journey and look forward to additional success with NECFA, the newest solution in our digital evolution. Due to our strong -to-date performance, we are increasing the midpoint of our full year adjusted operating and EBITDA margin outlook. We have taken proactive measures to optimize our cost structure through planned footprint reductions and other cost actions across our regions, which will contribute to long-term margin expansion. Our strong free cashflow generation and balance sheet continue to provide flexibility to execute our disciplined capital allocation strategy. We continue to successfully navigate near-term challenges in softening economic conditions by controlling costs and delivering customer excellence to capture demand. Our long-term strategy continues to be on investing for the future and positioning ourselves to capitalize on long-term market opportunities from favorable secular trends, including water conservation, safety and regulation, and energy efficiency. With that, operator, please open the lines for questions.

Thank you. At this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. And your first question comes from the line of Jeff Hammond with KeyBank, your line is open.

Hey, good morning, guys. Good morning. Just maybe an update on where you think we are in the bottoming for heat pump, de-stock and just inventory adjustments in the US and maybe just speak in North America where specifically you're seeing the de-stocking.

Yeah, so let's start off with the heat pump is mainly in Europe. And as we talked about on the last call, we believe that's gonna continue through the first, at least the first quarter of next year because of the inventory build, et cetera. Back to the North America, on the last call, we talked about, we saw de-stocking in the wholesale channel at the beginning of Q3. We believe that for the most part, that's over at this point in time. And your final part of your question is in regard to construction. I mean, most all the markets are similar to Q2 except we were expecting multi-family to start seeing softness and that's exactly what we started seeing in Q3. So that's the only area I would say is different than Q2. We started seeing that softness rolling through in Q3.

Okay, and then a lot of moving pieces to the demand environment, just any kind of early thoughts and where you might see positive, negative inflections as you look into 25?

Well, we haven't given guidance yet, but in general, I always go back to 60% of our business is repair, replace that should follow GDP. And certainly, once we get the presidential election, some of the uncertainty out there as well as the continued falling rates, expectations. So I think there's just a lot of pause and new construction right now, waiting for some of these uncertainties to unfold and plays out. So, and that's how we're looking at it.

Okay, thanks Shashank, congrats on the retirement. Best of luck. Thank you very much,

Jeff.

Your next question comes from the line of Ryan Connors with North Coast Research. Your line is open.

Yeah, thanks, good morning. And it sounds like we'll have one more call with you Shashank, but yeah, congrats on the decision to retire.

Thank you.

Wanted to actually just talk about Europe for a second, a couple of aspects. First, just tactically, it seems like that drains business was strong there and that really seems to be bucking the trend and kind of preventing things from being a little worse. I mean, can you talk about what's exactly driving that particular product line to buck the trend like that and how sustainable that can be as we move for Q and beyond?

Yeah, our drain business in Europe is really around stainless steel drains. And they play a lot in the marine market, cruise ships, military, as well as food processing. And that has come back. And I was just over in Denmark at that location a few weeks ago, meeting with the entire leadership team and sales team, and they feel confident in those markets. So it's a nice offset to some of the softness in Europe, which really is around new construction, right? There's so much uncertainty right now, new construction and then the heat pump overstock, as well as the, I would call the incentives that are out there. People are still waiting for them to be finalized.

Got it, okay. And then staying on Europe for a second, and then I have one more as well, but obviously this wouldn't be your first significant restructuring action in Europe if this one does move ahead in France. Can you just talk about the European footprint from a strategic perspective? I mean, do we still have kind of a structural issue there, given the headwinds over the last few years, or should we look at this as more of a surgical kind of a move?

I think we're always looking to optimize our footprint there. It, you know, we're always looking, when we can, to adjust our footprint and our cost structure based on market demand. So, you know, like you said, we're working through the Workers' Council. No agreement has been set at this point in time, so we're working that process, and we'll continue to always review our footprint, not only in Europe, but North America and all over the world.

And then on this next, Bob, thanks for the great, interesting update there, but can you talk about the -to-market strategy for that? It sounds real interesting. I assume the distributors will play a central role in actually bringing that to market. Can you confirm that and talk about the training aspect of getting them up to speed, and how long it will really take to get the channel partners ready to really move the needle with that?

Yeah, we're using a multi-facet approach. So we're using our channel partners, we're using our strategic accounts, as well as we're using the direct sales for it. So, you know, it's unique, it's different, but it really is a way of pulling all our, you know, smart and connected products into an overall ecosystem and tying it together to solve some of the most critical issues inside of a building. So we're excited about it, early innings, but, you know, it's something we've been working on for a long time.

Yeah, it sounds interesting. Good luck with that. Thanks, guys. Thank you.

Your next question comes from the line of Mike Halloran with Baird. The line is open.

Hey, good morning, everybody. This is Pezzan for Mike. I wanted to ask on Nexa, seems like a very exciting announcement. Can you maybe talk about the sales process for that? I would imagine that the sales process is pretty different than some of your existing products, just given that it's more of a SaaS platform. And then maybe talk about how you think about customer adoption and receptivity.

Yeah, so you're right. It is different than what we traditionally sold, but we have a lot of relationships with our strategic account and customers to solve issues. And that's where really we're pinpointing it. When customers have issues or problem locations, we're leveraging this capability and a lot of training along the way. So, you know, this industry is slow to move to new technology, as we all know, but as you're providing value, like we have in our test pilots with this stuff, you know, we've had this out for over a year now. So we've learned a lot and pretty much every single property has had less than one year payback on this thing. So the way we go to market is we sell the original equipment to connect it and then put a SaaS model on top of that.

That's super helpful. And then as you've been in the field testing and as you're learning more about the capabilities, has that opened up maybe new areas of interest, you know, for future investment, whether that's internal organic investment or potential M&A? Is there anything that maybe has become more interesting as you've kind of gone down this path and gotten more insight into your customers and their problems?

Yeah, it really has. I mean, we spend a lot of time getting voice of customer for our new product development. This just gives us another avenue. And what we're learning is we go to multiple locations. There's a lot of similar issues that, you know, that we're learning and putting in our system and our database. So, yes, it's helpful. I'm not going to get into any specifics, but teams are learning a lot as well as it helps sell our core products when they have issues inside of the facilities.

And we've been able to tie in, you know, the leak detection platforms we have in commercial buildings and residential. The learnings from that, we've been able to tie into this product as well.

Great. That's super helpful. I will pass it on.

Thank

you. Thank you.

The next question comes from Walt Liptak with Seaport Global. Your line is open.

Hi, thanks. Great quarter, guys. And Shashank, congratulations on your decision too. Thank you. I wanted to ask about two things. One, the European heat pump, one of your competitors talked about, you know, just how difficult that market has been. So I wonder if you could provide us with some more, you know, details, the size, how much it's declined. And they were also calling for a bottoming, you know, kind of right around now or maybe in the first quarter. So I wonder if you can talk a little bit about 2025. And if you're thinking this market can, you know, recover off the low base in 2025.

Yeah, I share the comments you just said, and we talked about that in an earlier question, but yes, we do believe it's a tough market. And a lot of it depends on the incentives that the local governments put in place to, you know, move that product. So we can't control that. We look at what we can control. So we'll provide further guidance during our February call as we, you know, we'll see how much of that de-stocking has happened, what's happened. Some of the, you know, the elections will impact that, certainly. So we're watching that closely. And, you know, but things hopefully will begin bottoming out in the first half of next year.

And then, well, on the incentives, right, Germany is in the process of finalizing their incentives on heat pumps. And obviously, Italy finalized at a lower rate about a year ago. And obviously, you know, next year, we will be comping, we comps. So the we comps do help, but we'll just we'll just have to see how it pans out as far as the de-stocking.

OK, great. And then on the the the consolidation in France, I just wanted to get some clarity on the you made a comment that there's more consolidation moves that are coming. Are we relating that to to France specifically, or are you thinking more globally about, you know, optimizing some of the footprints?

No, we're not. Maybe you misinterpreted what I said. We always look at driving productivity and all around. So I'm not saying we're doing another plant consolidation at all. We continue to always look at our footprint productivity everywhere at every one of our sites and drive productivity. So, you know, this is the only one that's on the plate at this point in time. And we're working with the local workers council to bring this to fruition.

OK, got that. Sorry about that. Thank you. Thanks.

Your next question comes from the line of Adam Farley with Stiefel. Your line is open.

Yeah, thanks. Adam Farley on from Nick and Jones. We're sort of on at Mia. Good to see solid double digit growth there. Strong demand in China with with your data centers business. You know, is that is that mostly being driven by the data centers business?

Yes. You know, the large growth is both data centers in China, as well as our growth in the Middle East, which has been strong.

OK, and then looking at America's highlighted strength and institutional might industrial new construction. You know, what's what's kind of driving that? Given the expectations going forward on on how those markets will play out.

Well, institutional has usually been very steady for us over the many years we've been in it. Their spending in schools and hospitals continues. So we expect that to continue. It's not as volatile as the other parts of the market. So we'll continue to watch that. But that, you know, that's been a longstanding trend.

OK, thank you for taking my questions. Thank

you.

Your next question comes from the line of Joe Giordano with Cohen and Company. Your line is open.

Hi, good morning. This is Zane on for Joe. I just wanted to check how you guys are doing. Good morning. How are we getting you guys thinking about the institutional building cycle? Do you do you think it's maybe maybe it's elongated more versus previous cycles? It was up for so long and now moving in the wrong direction. Are you concerned about how long the dip can be given how far up we've come?

When you say institutional, we just talked about it that in the last call. Institutional is held steady and it's growing and, you know, it goes ups and downs based on projects. But in general, we feel institutional will continue to grow.

Over the next 12, 18 months.

OK, thank you. But just generally more on the market side in terms of like the broader building cycle. Do you guys envision that changing in any way in terms of the cycle went?

I think you're referring to the non-institutional, right? So all the non-residential new construction that is not institutional, is that what you're asking about?

Yes, sorry. Yes, non-institutional. Sorry.

Right. And then that is OK. When you look at the ABI indicators for the last 18 months, they've been below 50. Right. So they certainly were challenged in the third quarter, and we expect that to continue. Obviously, we'll give guide for next year, but the leading indicators pretend softness for some time.

OK, thank you for that. I'll pass it along. Thank you.

And as a reminder, if you would like to ask a question, please press star and the number one on your telephone keypad, and we will pause for a brief moment to allow questions to queue. And there are no more questions at this time. I will turn it back over to Bob Pagano, president and CEO, for closing remarks.

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

Thank you. This does conclude today's conference. You may now disconnect.