Watts Water Technologies Inc Q3 FY2025 Earnings Call

Thank you for joining us. I would like to welcome everyone to the Watts Water Technologies Earnings Call for the Third Quarter of 2025. Now, I will hand the call over to Diane McClintock, Senior Vice President of Investor Relations. Diane?

Thank you, and good morning, everyone. Welcome to our third quarter earnings conference call. Joining me today are Bob Pagano, President and CEO; and Ryan Lada, our CFO. During today's call, Bob will provide an overview of the third quarter, a business update and an update on our outlook for 2025. Ryan 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 statements, 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 3, and I'll provide an overview of the quarter. We are pleased with our strong third quarter results, which exceeded expectations. Watts' multiyear track record of success would not be possible without the dedication, collaboration and support of our team members and business partners, and I'd like to express my sincere gratitude. Organic sales increased 9% in the quarter, with favorable price in the Americas, volume and pull-forward demand more than offsetting the decline in Europe. We also benefited from incremental sales from our I-CON and EasyWater acquisitions and favorable foreign exchange movements. Adjusted operating margin of 18.5% was better than anticipated due to favorable price, volume leverage, productivity and mix. Year-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 to support our disciplined capital allocation strategy. On that note, we're excited to have acquired Haws Corporation, a leading global brand providing emergency, safety and hydration solutions for use in industrial, institutional and nonresidential end markets for more than 120 years. The addition of Haws' innovative specified product portfolio enhances our value proposition and broadens our capabilities. Haws has annual sales of approximately $60 million and is expected to be modestly dilutive to margins for the first year while we integrate and realize the benefits of synergies leveraging the One Watts performance system. I'm also pleased with the integrations of Bradley, Josam, I-CON and EasyWater, which are progressing well and synergy realization is tracking ahead of our original estimates. We continue to proactively manage tariff-related challenges through strategic pricing and supply chain optimization. The tariff environment remains uncertain, but based on tariffs in effect as of today, our global direct tariff impact in 2025 is estimated to be $40 million, consistent with our guidance at the last earnings call. We have successfully handled the cost impact so far in 2025 and plan to continue doing so. Now an update on our outlook for the remainder of the year. Due to our strong third quarter performance and our expectations for the fourth quarter, we are increasing our full year sales and margin outlook. Tariff-related price increases, foreign exchange movements, strong data center sales and the acquisition of Haws are all favorable relative to the sales outlook we provided in August. However, there's ongoing uncertainty around the impact of supply chain disruptions and tariffs including the effect on new construction and global GDP, as well as around the impact of the U.S. government shutdown. As a reminder, GDP is a proxy for our repair and replacement business, which represents approximately 60% of total revenue. With that, let me turn the call over to Ryan, who will address our third quarter results and our fourth quarter and full year outlook in more detail. Ryan?

Thank you, Bob, and good morning, everyone. Please turn to Slide 4, which highlights our third quarter results. Sales reached $612 million, setting a third quarter record for Watts. This reflects growth of 13% on a reported basis and 9% on an organic basis. Strong organic growth in the Americas more than offset a decline in Europe and a flat quarter in APMEA. In the Americas, reported sales were up 16% and organic sales were up 13%, exceeding expectations. Growth was driven by favorable price, volume and approximately $11 million of pull-forward demand. Sales from the I-CON and EasyWater acquisitions added another $11 million or 3 points to America's reported growth. Europe reported sales were up 4%, while organic sales were down 2% as market weakness more than offset price. Reported sales in Europe benefited from favorable foreign exchange. APMEA sales decreased 1% on a reported basis and were flat on an organic basis. Growth in Australia and the Middle East was offset by declines in China and New Zealand. Compared to the prior year, adjusted EBITDA of $128 million increased 21% and adjusted EBITDA margin of 20.9% increased 140 basis points. Adjusted operating income of $113 million increased 22% and adjusted operating margin of 18.5% was up 140 basis points. Adjusted EBITDA and operating income were supported by favorable price, leverage in the Americas and productivity. These benefits more than offset inflation, volume deleverage in Europe, tariffs and investments. Our Americas segment margin increased 180 basis points to 23.7%. Europe segment margin increased 160 basis points to 12.2%, and APMEA segment margin increased 90 basis points to 19.4%. Adjusted earnings per share of $2.50 were up 23% compared to the prior year with contributions from operations, acquisitions, foreign exchange and reduced interest expense. The adjusted effective tax rate in the quarter was 25.8%, an increase of 60 basis points relative to the third quarter of 2024. This increase was primarily due to the recent changes in U.S. tax regulations related to the One Big Beautiful Bill act. For GAAP purposes, we incurred $1.9 million of pretax restructuring charges related to the exit of a facility in France and other actions within Europe. Our free cash flow year-to-date through the third quarter was $216 million compared to $204 million last year. The cash flow increase was driven by higher net income and lower tax payments resulting from the change in U.S. tax regulations, which more than offset inventory investment and increased CapEx. We expect seasonally strong free cash flow in the fourth quarter and are on track to achieve our full year goal of free cash flow conversion greater than or equal to 100% of net income. The balance sheet remains strong. Our quarter end net debt to capitalization ratio was negative 15% and our net leverage is negative 0.5x. Our solid cash flow and healthy balance sheet continue to give us capital allocation optionality. Now on Slide 5, let's review our assumptions about our fourth quarter and full year outlook. As Bob mentioned, we are raising our full year sales and margin outlook. This is driven by a strong third quarter, incremental price, favorable foreign exchange, and strong sales in data centers. We are also benefiting from incremental sales of approximately $10 million related to the acquisition of Haws Corporation, which will be included in our Americas segment. We now anticipate organic sales growth of 4% to 5%, a 3-point increase to the midpoint from our previous outlook. Our reported sales growth is expected to be up 7% to 8%, a 4-point increase from our previous outlook. This reflects incremental revenue from the Haws acquisition and favorable foreign exchange impacts detailed by region in the appendix. Regionally, we anticipate stronger sales growth in the Americas and Europe while APMEA is projected to be slightly below our previous outlook. We are raising our full year adjusted EBITDA margin outlook to a range of 140 to 150 basis points, an increase of 55 basis points from the midpoint of our previous outlook. We are also raising our full year adjusted operating margin expansion to a range of up 140 to 150 basis points, an increase of 65 basis points from the midpoint of our previous outlook. Our updated outlook includes 10 basis points of dilution from the Haws acquisition. It also assumes $40 million in estimated direct tariff costs, consistent with our previous guidance. This is based on tariffs in effect as of today. Our free cash flow expectation remains in line with our previous outlook. 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 fourth quarter. On an organic basis, we expect sales growth of 4% to 8%. Regionally, we expect high single-digit growth in the Americas, low single-digit growth in APMEA and slight declines in Europe. The sequential slowdown in the Americas reflects the pull-forward demand discussed earlier. We expect approximately $20 million in incremental sales in the Americas from the I-CON, EasyWater and Haws acquisitions. Additionally, we estimate a foreign exchange tailwind of approximately $10 million in the quarter. Regional assumptions are detailed in the appendix. Fourth quarter adjusted EBITDA margin is expected to be in the range of 19.6% to 20.1%, an increase of 30 to 80 basis points. Adjusted operating margin is projected to be between 17% and 17.5% or up 20 to 70 basis points. Price and volume leverage in the Americas should more than offset volume deleverage in Europe and dilution from the Haws acquisition. The sequential margin decline reflects normal seasonality and the impact of the Haws acquisition. Other key inputs for the fourth quarter and full year can become in the appendix. And with that, I'll turn the call back over to Bob before we move to Q&A. Bob?

Thanks, Ryan. On Slide 6, I'd like to summarize our comments before we address your questions. Our third quarter performance was better than anticipated with record third quarter sales, operating income and earnings per share, driven by strong performance in our Americas region and better-than-expected results in Europe. We continue to execute well amid an uncertain trade environment, and we expect that price and our global supply chain strategy will enable us to continue navigating effectively. As a result of our strong third quarter performance and fourth quarter expectations, we are increasing our full year sales and margin outlook. We successfully closed on the acquisition of Haws Corporation earlier this week and look forward to welcoming them to the Watts family of brands. Our balance sheet remains strong and provides ample flexibility to support our capital allocation priorities. I'm confident in the resilience of our business and our team's ability to execute despite the uncertain environment as we continue to create durable, long-term value for our shareholders. With that, operator, please open the line for questions.

It looks like our first question today comes from Nathan Jones with Stifel.

Maybe just starting on the $11 million of demand pull forward into the third quarter. I assume that's probably ahead of price increases related to the increase in copper tariffs. And so that would then lead me to the question of, can you talk about what the price contribution was in 3Q? And then I assume the price contribution in Americas in 4Q will be somewhat higher due to those tariffs?

Correct, it was $11 million, as we talked about, and about 6% was our price.

That's in 3Q. Do you have an expectation for 4Q? I assume there's been more price to cover that tariffs.

Slightly higher than that.

I wanted to ask about the Haws acquisition, particularly regarding the drinking water business. We've seen strong growth from one of your competitors in that market, although they have a significant market share. In contrast, Haws has relatively low market share. How do you plan to compete with the LK business in the drinking water sector and increase your market share?

Well, Nathan, as we talked about it, Haws is a $60 million sales company, about 20% of its business is in the hydration market. Look it's a company that's been around a long time, 120 years, great brand, known for their quality and customer service. So they're niche in their hydration area, mainly on the West Coast. So we'll be evaluating that, but we primarily bought that business for their safety product, which complements our Bradley business.

Maybe then just as a final question, you could talk about how it complements the Bradley business. I did notice that and whether or not you can kind of marry those two together to generate revenue synergies out of those businesses.

Yes. Yes, so they make bigger sizes of safety showers and equipment and other products that we don't have. So it's complementary with some of the gaps that we have and gives us the full portfolio to leverage in our portfolio. So we believe it's a nice growing market and something we can leverage going forward.

And our next question comes from the line of Mike Halloran with R.W. Baird.

Could you just dig into how you're looking at the end markets here today and how you're thinking about the trajectory next year? I think primary focus for the question would be on the non-res, res pieces and how you see those playing out over to next year in North America as well as maybe generic comment on Europe as well?

Yes. In Q3, we observed similar market conditions to those in Q2. We will be monitoring multifamily and residential sectors, noting that single-family growth remains slow. We expect this trend to continue into next year, although it is too early to provide specifics. We are all closely watching leading indicators such as ABI and Dodge Momentum. It seems that 2026 will likely experience slow growth, akin to what we anticipate for 2025. Regarding Europe, it is encouraging to see the market approaching a bottom, with a reported organic decline of 2% against easier comparisons. However, I don't expect significant growth in new construction in Europe until the situation surrounding the war in Ukraine stabilizes, along with governments clarifying their financial commitments. Therefore, we are projecting continued slow growth in Europe.

And then secondary question, just maybe the puts and takes that drove the sequential margin improvement in Europe, but if you look at the guide for Europe margins up substantially. I guess the primary question, though is, is that the right run rate to think about sort of going into next year? The EBITDA margin implied for the European segment for the fourth quarter. In other words, are you back at the previous run rate now that you've gotten a chunk of that restructuring done and hopefully, a little bit more normal mix?

Yes, that's the goal, Mike. I mean certainly, the team has been doing a great job of getting through the restructuring and closing of the site. We're now complete, adjusting their cost structure to the current market environment. And the team is doubling down and relooking on an 80-20 basis, the markets because they've shifted so much over the last couple of years. So team's really looking at that. We'll provide a little more guidance as we move into 2026.

And our next question comes from the line of Jeff Hammond with KeyBanc.

You talked about kind of pricing through Q4. I'm just wondering, as we look forward into '26, what you think carryover prices at least into the first half? And then as you contemplate your normal course pricing for '26, is that a more normal kind of view? Or does it continue to be elevated with inflation, tariffs, et cetera?

Most of the price increases occurred starting in April. There will be some carryover because we've had multiple price increases throughout the year. Tariff adjustments are fluid, and we will continue to monitor them as we head into next year. We expect to see favorable pricing in the first quarter as we transition away from some of those increases. Additionally, we had prebuys in the second and third quarters of this year. We will provide more information in 2026, but some carryover will affect next year.

Okay. Regarding the data center business, which is clearly thriving, could you provide an estimate for its size in 2025? Additionally, how do you envision its growth in the next few years? Historically, you had significant exposure in Asia, but a lot of the current demand is in the U.S. I'm curious about your success in expanding your presence in the North American market.

Yes, Jeff. I would say our North America team is going to surpass Asia Pacific this year. We've been growing very quickly in North America. We'll size it at the end of this year, but I can say that it's growing high double digits, and it's one of our fastest-growing markets in North America and in Asia Pacific. So we'll continue to double down on that. It's offsetting some of the softness in the residential side of our markets and it's nice, complementary to what we're doing, and you're seeing it come through our results in Q3.

Okay. And then just last one, multifamily, just update there. It seems like maybe some bottoming and things getting better. And I guess it depends on where you are in the build process, but just an update there.

Yes, the multifamily market has been soft overall. While some regions are thriving, we still face challenges in the single housing sector due to a lack of homes and affordability issues. There are indeed multifamily projects underway, and many are close to completion. Developers appear to be holding off until they gain more clarity on tariffs and hope for lower interest rates. We believe the market may be nearing its lowest point and will monitor the situation closely. Although it hasn't been strong, we are optimistic for improvement as interest rates potentially decline next year.

And our next question comes from Ryan Connors with Northcoast Research.

Most of my questions have been answered. You've been thorough here. However, I noticed your tone regarding tariffs and the increased uncertainty. It seems you're hinting at the Supreme Court case, which I don't closely follow, but it appears it didn't go well and there's a possibility that the entire matter could be dismissed. Such an outcome would clearly be very disruptive considering all the price adjustments you've made related to tariffs. So, without going into too much detail, if we were to hypothetically consider a scenario where tariffs are eliminated and the Supreme Court decides against them, what would that look like? Would you maintain the price increases you've implemented, or would you reduce them? I'm just curious about how you would approach that kind of situation conceptually.

Yes, Ryan, that's a great question. Fundamentally, I have a hard time believing that the government is going to give anything back to any of us and even if they lose the case, it will be interesting to see the appeals and the potential adjustments. So we're watching it carefully. It would be very complicated, as you can imagine, because our pricing has not just been because of tariffs. Copper prices have been up double digits, general inflation has been high, labor, et cetera. So it's a very complicated item, and we're watching this very closely and we'll adjust based on what the market does at this point in time. But it's very complicated, as you said. And I think a lot of people are trying to figure this out, and we'll just have to wait and see how it plays out.

Yes. Just to follow up on that, would it be unreasonable to think that the price you've set in the market has been accepted? It seems to be established, and you might be able to maintain that. Even without any retroactive credits, could it be possible that this situation could actually lead to positive margins moving forward? Am I completely off base here?

It's a challenging question, Ryan, and there are many different factors to consider. We'll need to wait and see and look at various scenarios to better understand market pricing and the developments in this area. So, let's keep an eye on it, as we're all monitoring the situation closely.

And our next question comes from the line of Joe Giordano with TD Cowen.

This is Chris on for Joe. You had mentioned the uncertainty surrounding the government shutdown. Just wondering if you could elaborate on what parts of the business that you are seeing or expect to potentially see impact from that shutdown?

It's primarily on the residential side, right? Any time there's uncertainty, people withhold and slow down things. So I think it's just one of those things. Just an added variable, we're watching very carefully. Nothing big to report on at this point in time, but something that's certainly out there, and it's just normal process, people pull back when they're uncertain. And we'll see how that goes through. Hopefully, they'll get that resolved very soon.

Great. And with Haws, is there any difference in how they go to market versus your predominant channels and any opportunity to sell through your existing channels?

It's very similar to our current process through wholesalers and distributions. And so yes, no, it's very similar. We can leverage our channels. The nice thing about Haws is they have more international exposure than we have, so that's an opportunity for us to leverage.

And our next question is from Andrew Krill with Deutsche Bank.

Want to ask another one on Haws. Just can you provide like any sense of the historical growth rates there? What do you expect looking forward? And then on margins for the business, and I guess, if we do the math on the dilution, is it correct, it's around like 10% EBIT margins initially as you integrate the business? And then like over time, any reason this can't be a lot to average or better margin business?

Yes. So in general, I would say they're similar to the institutional growth, which is above, let's call it, growth of our traditional portfolio that includes residential. I would say their EBITDA is in the mid- to high single digits right now. And we certainly believe over the next several years, we'll be able to get them to the Watts' overall margin. So teams are on it really early at this point. Team, we're making out, great brand, great quality and great people. So we're excited to leverage that going forward.

Great. Switching back to Europe, the margin improvement is encouraging and shows a nice inflection. In the medium term, the previous high watermark was around a 16% EBIT margin. Can you reach that level if volumes remain sluggish, or are the new initiatives you’ve implemented going to help us get there? Is it feasible, and will you need volume leverage to achieve it?

Well, certainly, volume leverage would help. And certainly, we're taking cost structure. I think the team is relooking, as I said earlier, at the 80-20 because the markets have changed significantly since we did a very detailed 80-20 on that. We're reshuffling that, and we'll provide more guidance, but that should help our margins going forward, but it takes a while to unravel some of the contracts we have with customers. But team's on it. We're looking at it. I would say, our aspirations are to get back up to those levels. But as you know, I'm always cautious on Europe at this point in time given the market dynamics and given the uncertainty with the conflict in Ukraine that's having an impact on local incentives, et cetera. So watching it very closely. The team's on it, but it's nice to see. I think we're starting to hit that bottoming out at this point in time.

And there are no further questions at this time, so I will now turn the call back over to Bob Pagano for closing remarks. Bob?

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 in early February. Have a good day, and stay safe.

Thank you. And this concludes today's conference call. You may now disconnect. Have a great day, everyone.