Watts Water Technologies, Inc.

Senior Vice President of Investor Relations. Please go ahead.

Thank you and good morning, everyone. Welcome to our first quarter 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 first quarter, an operational update, and an update on our outlook for 2025. Shashank will discuss the details of our first quarter performance and provide our outlook for the second 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 what's 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'll 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 first quarter. We began 2025 with better than expected first quarter results, including record adjusted operating income, adjusted operating margin, and adjusted earnings per share. I'd like to thank the entire watch team for their significant contributions during the quarter. Organic sales declined 2% in the quarter due to fewer shipping days, which we noted on our last earnings call and continuing weakness in Europe. We benefited from incremental sales from our icon acquisition. However, the benefit was more than offset by unfavorable foreign exchange. Adjusted operating margin of 19% exceeded expectations due to better than expected volume, productivity, and cost controls. As a result of our solid start to 2025 and expected cash flows for the remainder of the year, we announced a 21% dividend increase beginning in June. Our balance sheet remains strong and provides ample capacity to support flexibility in our capital allocation strategy. From an operations perspective, we are proactively working to mitigate the impact of tariffs. We expect that our vertical integration strategy with the manufacturing close to our customers here in the US will benefit us. We have a proven track record of successfully navigating inflation and supply chain challenges and are competent in our ability to execute through the current environment. I'll talk more about tariffs in a minute. We continue to drive productivity savings through automation, lean initiatives, both inside and outside the factory walls, leveraging our one-watch performance system, and selective restructuring actions, including the previously announced exit from a manufacturing facility in France. The exit is progressing as expected and will be complete by year end. We're pleased with the progress of the integration efforts with our recent ICON acquisition, and our teams are working together to capitalize on synergies. We expect ICON to be accreted to adjusted EBITDA margins and adjusted EPS in 2025. Now, an update on our outlook for the remainder of the year. Despite the uncertainty around the trade environment and resulting demand impacts, we're maintaining our full year organic sales and adjusted operating margin outlook. We anticipate that price increases, our global sourcing actions, and accelerated on-shoring of production should offset incremental tariff costs and any potential demand reduction in the second half of 2025. There are a few positives to note. Our solid first quarter and outlook for the second quarter are supportive of our full year outlook. Mega project activity, including data centers, remain strong. We also expect to see a benefit from foreign exchange movements relative to the outlook we provided in February. Recently, global GDP forecasts have been revised downward, including a first quarter contraction in the US. Given the certain impact of tariffs on inflation, we expect interest rates to remain higher for longer. This may unfavorably impact residential and non-residential new construction in the second half of the year. We expect continued weakness in Europe due to a slowdown in new construction amid continued economic weakness. We saw ongoing heat pump de-stocking in the first quarter and anticipate this to continue in the second quarter, but current market feedback suggests potential recovery in the second half of the year. Please turn to slide four and I'll provide an overview of the cost impact of the current tariffs and the actions we're taking. The table on the left illustrates the estimated impact of currently enacted tariffs on our 2025 cost base. We source globally and expect there will be some impact on most countries we import from with the biggest impact on raw material and components sourced from China. We've been proactively working on a number of actions to offset the cost impact, including implementing price increases, relocating our supply chain by leveraging our dual source supply base, and increasing capacity across our US manufacturing footprint. We've invested in our North American footprint in supply chain diversification over many years and believe we're well positioned to mitigate the impact of tariffs on our cost base and stakeholders. One last item I'd like to mention is that our search for a new CFO is ongoing and we're making good progress. We'll inform you as soon as we have identified a candidate. In the meantime, Shashank will stay on as CFO to ensure a smooth transition. With that, let me turn the call over to Shashank who will address our first quarter results and our second quarter in full year outlook. Shashank.

Thank you, Bob, and good morning, everyone. Please now turn to slide five, which highlights our first quarter results. Sales of $558 million were down 2% on a reported and organic basis. As previously discussed, we had fewer shipping days in the first quarter, which unfavorably impacted our sales by approximately 3% across all regions. America's organic sales were down 1% and reported sales were flat. This was better than expected, particularly with the reduced shipping days. Sales from our ICON acquisition added $5 million. Europe organic sales were down 9% and reported sales were down 12% with declines across all geographies due to fewer shipping days, heat pump destocking, and weakness in new construction markets, driving destocking in the wholesale channel. ACMEA sales increased 9% on a reported basis and 13% on an organic basis. Growth in China, the Middle East, and Australia were partly offset by decline in New Zealand, primarily driven by fewer shipping days. Compared to the prior year, adjusted EBITDA of $119 million increased 1% and adjusted EBITDA margin of .4% increased 80 basis points. Adjusted operating income of $106 million increased 2% and adjusted operating margins of 19% were also up by 80 basis points and is a Q1 record for Watts. Adjusted EBITDA and operating income benefited from price, productivity, favorable mix and cost controls, which more than offset inflation, volume delaverage, and investments. America's segment margin increased 130 basis points to 23.4%, Europe segment margin decreased by 180 basis points to 13.9%, and ACMEA segment margins decreased 70 basis points to 17.5%. Adjusted earnings per share of $2.37 increased 2% versus last year with operational contribution and reduced interest expense more than offsetting incremental tax expense and foreign exchange headwinds. The adjusted effective tax rate in the quarter was 24.5%, up 70 basis points compared to the first quarter of 2024, primarily due to a lower tax benefit from the vesting of stock compensation awards that occur in the first quarter of each year. For gap purposes, we incurred $1 million of pre-tax acquisition costs and $17 million of pre-tax restructuring charges primarily related to the exit of our site in France. These charges were partially offset by a non-recurring tax benefit related to the reversal of a prior year tax liability. Our free cash flow for the quarter was $46 million compared to $37 million in the first quarter of last year. The cash flow increase was primarily due to the timing of income tax payments compared to last year. We expect sequential improvement in our free cash flow that are on track to achieve our full year goal of free cash flow conversion greater than or equal to 100% of net income as previously communicated. During the quarter, we repurchased approximately 19,000 shares of our class A common stock for $4 million. Additionally, as Bob mentioned, we announced a 21% increase in our dividends that will begin in June. The balance sheet remained strong and provides us with ample flexibility. Our net debt to capitalization ratio at quarter end was negative 9% compared to positive 3% in the prior year and our net leverage is negative 0.3. 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 second quarter and full year outlook. We are reaffirming our 2025 outlook, which reflects the market factors previously discussed by Bob and assumes that the current tariff structure remains in place for the remainder of the year. As previously mentioned, we anticipate that price increases, our global sourcing actions and accelerated on-shoring of production should offset incremental tariff costs and any potential demand reduction in the second half of 2025. For full year 2025, we are maintaining our consolidated organic sales growth outlook at a range of minus 3% to plus 2%. Our reported sales growth is increasing to a range of minus two to plus 3% due to favorable foreign exchange movements, which are listed by region in the appendix. Regionally, we expect the Americas to be slightly better, but offset by Europe, which we expect to be down a point compared to our original outlook. We are also maintaining our full year adjusted EBITDA and adjusted operating margin outlook consistent with our guidance in February. 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 100% of net income in 2025. Next, a few items to consider for the second quarter. On an organic basis, we expect organic sales growth to be flat to up 3%. Regionally, we expect low to mid single digit growth in the Americas and low single digit growth in apnea, partly offset by a high single to low double digit decline in Europe. We expect approximately $7 million of incremental sales in the Americas from acquisitions. We estimate that foreign exchange in the quarter will be neutral in total. Our assumptions by region are listed in the appendix. We expect we'll begin to see the impact from our 80-20 actions of the second quarter with an estimated $2 million of product exits primarily within the Americas. Second quarter EBITDA margin is expected to be in the range of .6% to .2% or up 50 to 110 basis points. Operating margins should be in the range of 19.1 to .7% or up 30 to 90 basis points. We expect that price and volume leverage in the Americas and apnea will more than offset continued volume deleverage in Europe. Other key inputs for the second quarter and the full year can be found in the appendix. 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 first quarter performance was better than we anticipated with record first quarter sales, adjusted operating income, adjusted operating margin and adjusted earnings per share due to a strong performance in the Americas and apnea. We're actively working to manage the current trade environment and expect that our US footprint, global supply chain and price increases will enable us to navigate it successfully. We are maintaining our full year organic sales and adjusted operating margin outlook despite the macro uncertainty and expectation of softer market conditions as the year progresses. Nonetheless, we've proven our business is resilient over the long term. Our portfolio is agnostic to end markets and our teams are pivoting to growing subverticals. Additionally, our business model includes a large repair and replacement component that provides a durable base and drives steady revenue and cashflow. Our balance sheet remains strong and provides ample flexibility to support our capital allocation priorities, including M&A and continued investment in new product development and our digital strategy. In addition, we are increasing our dividend by 21% starting in June. We believe our highly experienced team is well positioned to proactively navigate current market conditions as we have done in the past. We're competent in our ability to control costs through our one-watt performance system while capturing our fair share of demand and positioning us to capitalize on long-term secular trends. With that operator, please open the line for questions. Thank you.

We will now begin the question and answer session. If you have dialed in and would like to ask a question, please press star one on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your question, simply press star one again. Our first question comes from Nathan Jones from Stipple. Please go ahead.

Good morning, everyone. Morning, Nathan. I wanted to start off right on that last thing that you said, Bob, there about winning your fair share. I wanted to talk about winning more than your fair share. I recall in 2022 when supply chains were messed up and your competitors couldn't get product in from shop, that you guys won some additional shares, was at very good margins, you didn't have to give the typical project discounts. It would seem that the same conditions have been created again here, not necessarily because competitors can't get products, but because it's so much more expensive. So maybe just talk a little bit about where you see opportunities to gain share, to gain margin because of that advantaged manufacturing footprint that you guys have.

Thanks, Nathan. Well, sure, listen, as you know, our primary strategy has been to make products in the regions for the region. However, there are products that we source from low cost countries such as China to be competitive in the marketplace. So we don't directly talk about competitors or anything like that, but look at having our products close to the customer and in this tariff environment, that's very helpful because our cost structure with the tariffs are different or in a better position. And I think we use the example in the past of some of our gas connectors that we make in the US, our primary competition is in China, and certainly we are able to take share, as you said, during that timeframe. But look, as I said in the last comment, we're gonna get our fair share of the market. And with all these tariffs moving around, it's just a dynamic environment we're in now. So stay tuned. Like I said, we'll get our fair share and let's see how it progresses throughout the year.

Fair enough. I guess maybe if you can just talk a little bit about the pacing of the price increases that you've put through. And then, if these are all price increases rather than surcharges, obviously there's talk about the tariffs being reduced on China. If those do get reduced, what happens to your pricing structure? Do you need to give some of that back or would you hold onto it? And then I'll pass it off,

thanks. With regards to pricing, please, Nathan, we had our annual price increase in January that we talked about during the last earnings call. Since then, the tariff related price increases, there's been one at the end of March, and then there's one that takes effect May 12th. That's the latest status. And obviously we'll talk about the realization on those price increases when we have the second quarter earnings call.

Yeah, regarding pricing in the future, look at these are big tariff amounts and adjustments. So we're going to be competitive in the marketplace and with a focus on taking care of our customers. So again, stay tuned. We're watching this very carefully and we'll be competitive.

Great, thanks very much for taking my questions.

Thank

you.

Thanks, Nathan. Our next question comes from Mike Halleron from RW Bear. Please go ahead.

Good morning, guys. Good morning. So can we just, I just want to make sure I understand what you're saying with the front half versus back half margin and revenue cadence. Is it fair to say that the incremental pricing you're getting is being offset by some assumption incremental weakness from a volume perspective? The nuance I guess I'm getting at is I know there was originally some softness embedded in the guide coming in the back half of the year. Is that increased? And if so, is it prospective or is it reactive? Meaning it doesn't sound like you've seen any softening really in the business. It's been relatively stable. Obviously this quarter and what you think is going to happen next quarter, very good performance. So it's just something you've seen or you're just saying, hey, look, the environment is what it is. And we just want to take a cautious approach because the macro signals are suggesting something worse in the back half.

Yeah, I think it's the latter, Mike. It's just the uncertainty that's around there with all the tariffs. We've had a solid first quarter as well as April it has been very good. So we're watching that. Some of that is just people feeding price increases, et cetera in the marketplace. So we're just watching demand, want to make sure it's not being pulled forward too much. And then we'll watch what happens. If these big price increases like the China 145% stay in place, I believe that will certainly impact demand in the second half. Again, it's a fluid motion. And when you look at all the leading indicators and the market indicators, they've not really changed. So it didn't make sense for us to increase the second half of the year at this point in time. So we'll watch, it's only the first quarter. We'll watch and see how things flow through.

Yeah, agreed. No incentive to do that. And then just another question on the margins front half versus back half. Back half is down versus front half, probably a little more than normal. I'm sure some of that's the conservatism you just referenced. Is some of that just associated with the math behind putting an incremental pricing that is kind of more one for one on EBITDA dollars based on what you know today? Or are there anything else I should be thinking about going at the back half on the margin line?

Yeah, no, Mike, primarily it's driven. Typically we have first half margins are higher than second half margins. So it's sequential margins from a historical perspective. And then secondly, there's gonna be a piece of volume de-leverage that impacts the second half. And again, that's to be asked the thing. We'll just have to see how that goes as the quarter plays out.

But implicitly, Shank, are you saying that the pricing is not margin dilutive in the second half?

But the pricing is, we're holding our margins with the price tariff cost impact in the second half. Yeah, and it's

not only price, Mike. It's price, it's our global supply chain and our footprint adjustment. So all those together are maintaining our margin outlook.

Great, that makes a lot of sense. Thanks guys, appreciate it.

Thank you.

Thank you.

Our next question comes from Jeff Hammett from KeyBank. Please go ahead.

Hey, good morning guys.

Mike,

yes. Hey, Bob, you mentioned, you know, kind of controlling pre-buying, but what have you seen from a pre-buy ahead of these, these May 12 increases? And are you doing anything to kind of limit, you know, the impact of that?

Yeah, we saw some pre-buy impact in the first quarter at the last, at the end of the last week of the month, actually, we saw some of that flow through about $5 million in the first quarter. In the second quarter, April has been solid because people are doing that. We are controlling order input. You know, we don't want everybody to buy years full of input. So we're basing it on prior history and making sure we're looking at that. But April was solid. We're just watching that flow through. It's difficult to understand what real demand is versus how much is that price increase. But I go back to the fundamentals. The market has not changed significantly. There's just more uncertainty. And, you know, people are just trying to get in front of this right now. But as you know, we have about three months of inventory on hand, so we can, we have that. And certainly our price increases that Shashank talked about have been incrementally going through at this point in time.

Okay, and then what's informing the weaker Europe guide? It seems like we're hearing at least better news on the heat pump side, just more color there.

Yeah, I think it's really the heat pump side, just like you, we think it's going to come back in the second half of the year. It's just new construction. We saw more de-stocking than we thought was going to happen inside of this. And there's just some uncertainty, in particular in new construction. So we just believe that it's prudent at this point based on order trends and what we're seeing to be cautious with Europe at this point in time.

Okay, if I could just sneak one more in, just maybe update us on how things are going with Bradley Joe Sam Icon in terms of integration, cost revenue synergies, you know, underlying demand trends.

Yeah, all three of the businesses are doing really well and I would say all our synergy tracking is ahead of schedule, which is exciting. The integration with the teams is going well, and we're seeing the benefit clearly. Joe Sam, if you remember, also has a benefit because it has US manufacturing capabilities. And again, in this marketplace, that's a good thing.

Okay, thanks a lot.

Thank

you. Thank you.

Our next question comes from Ryan Connors from North Coast Research. Please go ahead.

Good morning. Good morning, Ryan. So I had to take a different angle on the price cost issue. I know some of the peers in the brass bronze world have talked about specific elements in raw materials being in restricted supply, for example, bismuth as a key ingredient for some of the brass products that I assume you use as well, and that that's gotten really, really tight and is precipitating some of these price increases. Is that an issue as well, or is really the main thing you're facing in terms of passing on prices that isn't really exclusively tariffs?

I think it's a little bit of the raw materials, but it's mainly the tariffs and some of the more smaller of our products that we have that we get from China to be competitive in the current marketplace. So our team has done a nice job of securing our fair share of the allocations going forward of the components of our raw material, but it's something we continue to watch daily to make sure we know where we're at. But we have a good three months of inventory as well as supply chain availability or an additional three months related to our copper and some of our ingots that we use in our foundries.

Yeah, I think, Ryan, more of the raw material restrictions have been on the rare earth metals. And in our processes, we don't use hardly any of that. Okay.

And then secondly, just conceptually on the price issue. So we have some competitors out there who source from China directly with these astronomical price increases. We've seen 60% or more. How do you look at that opportunistically? Are there cases where you'd say, look, we don't really have to raise price any more than five or 10%, but maybe we'll go for 20 or 30 just because we've got this air cover of competitors that are out there, we can undercut them amazingly with a 30% price increase. I mean, is there that, does the market allow for that kind of opportunism on price or is it gonna be more passing on what your actual tariff costs are?

Ryan, we always look at valuing in pricing to value we're providing to our customers. So, you know, we look at what competitors price, we try to be competitive in the regions and in the markets. And again, with some of these tariffs that are going in place, we don't believe they're sustainable and that they'll change in the long run. So I think it's, you gotta be careful to whipsawing. A lot of these price increases are at this price levels and it varies. There's big ranges of products where, some of the products are low single digit increases and some are in high double digit increases. But again, it depends on the component, the product, and we look at a customer region by region and making sure we're taking care of customers. So we'll be looking at that and certainly looking at getting our fair share of price in the marketplace. Got it, thanks for your time. Thank you.

Thanks, Ryan. Our next question comes from Andrew Krill from Deutsche Bank. Please go ahead.

Hi, thanks, good morning, everyone. Let me go back to, I guess your, good morning, your more US centric manufacturing, especially relative to some peers. So could you comment on like your utilization of your facilities there and trying to get a sense of, how much more capacity you have to quickly ramp up those as you shift away from other areas like China. And are you planning any further catbacks to build these out this year or is it a bit too early to expand further? Thanks.

Yeah, the good thing is we're not fully utilized on our manufacturing footprint in North America. So we do have second shifts, but we can improve our second shifts and very few of our facilities are running a third shift. So we don't have to put significant capital expenditures and we believe we have adequate footprint. We're just gonna expand shifts and capabilities as needed.

Great, that is helpful. And next for on Europe with the margins, they're pretty impressive in one queue around 14%. But for the 2Q guide, you have them stepping back pretty materially, approaching 10% or so.

Here's expand

a little on what went well in the first quarter and maybe why there's a pretty big step down for 2Q and I think implied for the rest of the year, it doesn't improve that much from there, thanks.

Yeah, looking Q1, you're right. The margin expansion, Q over Q, Q1 to Q1 was very good. Part of that was the volume driven piece of it, right? We talked about, we shipped about $10 million more than we had anticipated and some of that was pre-price increase pool and about half of it. The other half was actually data center business which was up significantly as well. As you look at sequentials, Q1 to Q2, we're still expanding margins by about 40 to 50 basis points. Q1 to Q2 and then Q2 to Q2 prior year, it's still up to about 60 basis points at the midpoint. So there's still margin expansion going on, but Q1 did benefit from some incremental volume as well as cost containment in Q1 as we saw the tariffs coming in.

Okay, great. And sorry, was that for the full company or Europe specifically?

No, that was in total. For Europe specifically, for Europe specifically, I mean, typically Q1, Q2 are the strongest quarters, but year over year with the heat pump de-stocking, the comparison become more difficult because it depends where the heat pump de-stocking started and started in the second quarter of last year. And this year, we explicitly expect that to continue the second quarter of this year.

Okay, thank you. Thank

you. Our next question comes from Joe Giordano from TD College.

Hey guys, good

morning. Morning, Blake.

And so on the America's guide for revenue, you started off the year a bit better than I think you were thinking. QQ guide is coming in plus two plus five. I'm just trying to think of how to square that with like the full year guide. Seems very conservative in light of what you expect first half performance to be on easier comps in the back end.

So part of that is the demand destruction we talked about, right? So with the incremental tariff prices, we do expect demand might be impacted in the second half. Obviously we're a short book and ship business. We have visibility into the second quarter, but we're cautious about the second half. So we've kind of baked that into the second half guide for now and we'll see how things progress over the second quarter.

Yeah, and Joe, look at a lot of people are trying to... Yeah, no, a lot of people are trying to beat the price increases and again, we're watching that. And we just want to make sure that they're not pulling the bus call the second half demand into Q2. So we're just watching that very carefully. Too many moving parts in the economy and the world right now that it would make sense to be heroes in the second half of this year until the world settles down a little bit and we understand true demand

is. That's fair. And also on the margins for America is we don't have a lot of historical precedent like the levels that you're at now, basically coming from the most lower levels in the past and through your guide for Q2 is kind of in that almost, you know, give or take 25% change. Where do you think this can go? Like from an absent additional

portfolio as you integrate these people, like what's the potential for this business on the other side? So it's different to breaking us

potentially, but we're asking margins and sustainability. We had a powerful strategy on growing 30 to 50 basis points of margin year over year and that's our target on goals while we still invest in the business. So that'll continue to be a goal. We're driving that to our organization and we do. And it's not just about the value of our new products or new market products, providing internal value to our customers.

So we're pricing it importantly. Thank you.

There are no further questions at this time. I'll turn the call back over to Bob Pagano, Watts Water Technologies CEO.

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 second quarter earnings call in early August. Have a good day and stay safe.