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Welcome to Watts Water Technologies, Inc. Second Quarter 2026 Earnings Call. I will now turn the call over to Ray Nash, Vice President, Investor Relations.
Thank you, and good morning, everyone. Welcome to our second quarter earnings conference call. Before we begin, I'd like to remind everyone that during this call, we may be making certain comments that constitute forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially. For information concerning these risks, see Watts' publicly available filings with the SEC. The company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Today's webcast is accompanied by a presentation, which can be found in the Investor Relations section of our website. We will reference this presentation throughout our prepared remarks. Any reference to non-GAAP financial information is reconciled in the appendix to the presentation. With that, I will turn the call over to Bob.
Thank you, Ray, and welcome to your first earnings call with Watts. Good morning, everyone. Please turn to Slide 3, and I'll provide an overview of the second quarter. We delivered another quarter of better-than-expected results, including record sales, operating income and earnings per share. I'd like to thank the entire Watts team for their dedication and contributions which made these results possible. Organic sales rose 12% in the quarter as we benefited from strong growth in data centers and favorable price as well as pull-forward demand, partly offset by our 80/20 rationalization program. Adjusted operating margin was 21%, down 60 basis points, primarily reflecting the anticipated dilution from recent acquisitions and a difficult comparison against a one-time price/cost benefit in the prior year that we discussed last quarter. Even with those headwinds, margin performance was better than expected due to favorable price, volume leverage and productivity. Our balance sheet remains strong and provides ample capacity to support our disciplined capital allocation strategy. This includes evaluating strategic M&A opportunities while continuing to invest in productivity, product innovation and other key growth initiatives. Moving on to our business updates. We continue to make good progress integrating our recent acquisitions using the One Watts performance system. As a reminder, we completed five acquisitions in 2025 to expand our portfolio, strengthen our market reach and increase exposure to nonresidential markets. Overall, these businesses are performing well, and we remain on track to achieve or exceed our targeted synergies. We have also continued to proactively manage the impact of the Middle East conflict on our business. While it created some headwinds during the quarter, our teams have responded with pricing, supply chain and productivity initiatives to help mitigate both the direct and indirect impacts. We're also pleased with the resilience of our newly acquired Saudi Cast business as its in-country, for-country business model has limited the impact from the disruptions in the region. The tariff environment also remains fluid with new Section 301 and 338 tariffs recently announced. These are in addition to the Section 232 currently in effect and replace the Section 122 tariffs, which recently expired. Based on the tariff structures currently in place, we continue to believe we're well positioned from a price/cost standpoint. Watts offers one of the industry's broadest portfolios of water solutions. And as we discussed before, approximately 60% of our sales come from repair and replacement activity. Together, these characteristics give us a strong foundation across different economic environments. As a result, while residential and noninstitutional new construction markets remain challenged, we have continued to execute well and have been able to allocate resources toward high-growth market opportunities, including our data center initiative. We continue to see accelerated demand in data center cooling applications. And while data centers remain a relatively small part of our overall business today, we're encouraged by the momentum we're seeing. I'll provide more of an update on our data center initiatives in a few moments. We published our 2025 sustainability report in June. Our sustainability efforts continue to create value for both our customers and Watts. We've made meaningful progress against our second generation of environmental goals while expanding innovative solutions that improve safety, water conservation and energy efficiency. These efforts reinforce our commitment to solving our customers' most critical water challenges while supporting long-term growth. I'm proud of the progress our global teams have made and invite you to read more about it in the appendix of today's presentation or in our sustainability report, which can be found on our Investor Relations website. Now an update on our outlook for the remainder of the year. Due to our strong first half and our expectations for the third quarter, we are increasing our full year sales and margin outlook. Data center growth, price realization and performance in Europe and APMEA are all better than expected versus the outlook we provided in May. However, we do continue to see weakness in some of our macro indicators. Inflation measures and commodity prices are persistently higher compared to earlier this year. In addition, the market outlook for interest rates has shifted with expectations of no further rate reductions throughout the rest of the year. These factors are compounded by continued uncertainty around trade policies and geopolitical disruptions, especially the ongoing Middle East conflict. As a result, we continue to expect softness in residential and noninstitutional new construction markets. Next, please turn to Slide 4 for an update on our data center growth initiative. In the second quarter, our data center sales more than tripled compared with the prior year, reflecting continued strong demand for our cooling solutions, including our recently launched Cool Vault thermal storage tanks. Through the first six months of 2026, our data center sales represented 8% of total sales, including some of the pull forwards I mentioned earlier, which Diane will discuss in more detail. We estimate our served addressable market is approximately $2 billion. This is based on our view of the global market opportunity, including regions beyond China and North America, the double-digit growth rate of the market and also the trend towards more liquid cooling solutions. As liquid cooling adoption continues to increase, we're also seeing greater content opportunities per megawatt than the traditional air-cooled systems. Because this is a project-based business, the timing and volume of sales will be more variable than in some of our other markets. This can have an impact on our quarterly outlook as we saw with customer-driven pull forward in Q2. Our expanding global data center organization, along with investments in new product launches, have been paying off. And we feel confident in our ability to scale with our customers. We now expect data center sales for the full year to represent mid- to high-single digits as a percentage of overall company sales compared with just 3% of sales last year. We've been growing faster than the market based on our ability to serve our customers and deliver quality products while continuing to develop strong relationships with contractors, OEMs and hyperscalers. Data centers continue to represent one of our most attractive growth opportunities. With that, let me turn the call over to Diane, who will address our second quarter results and our third quarter and full year outlook. Diane?
Thank you, Bob, and good morning, everyone. Please turn to Slide 5, which highlights our second quarter results. Sales increased to $763 million, reflecting a 19% increase on a reported basis and a 12% increase organically, both better than expected. Growth was driven by price and volume, including the benefit of growth in data center sales and pull-forward sales from the third quarter, which more than offset the impact of our 80/20 rationalization initiative. The Americas region delivered strong organic growth of 12% and reported growth of 17%, both better than expected, driven mainly by price and volume, largely from data center sales. The region also saw some pull-forward demand from wholesale customers of approximately $10 million ahead of our SAP implementation at the end of June at our largest site as well as approximately $5 million of pull forward of data center project sales, which shipped earlier than planned. Our 80/20 product rationalization initiative resulted in a reduction of sales of approximately $8 million or a 1% impact on organic growth. Acquisitions accounted for $28 million in sales, contributing six points to the Americas reported growth. In Europe, organic sales rose 9%, while reported sales increased 12%. Organic growth stemmed from favorable pricing and higher volumes, particularly in our HVAC business, while reported sales also benefited from positive foreign exchange. Our 80/20 product rationalization resulted in a decline of sales of roughly $1 million or a one-point impact on organic growth. In APMEA, organic sales grew 31% driven by an increase in data center sales in China, partly resulting from approximately $5 million of pull forward of several data center projects which shipped early due to customer requirements, which more than offset the headwinds from the Middle East conflict. Acquisitions added 17% and favorable foreign exchange contributed 9% for total reported sales growth of 57%. Adjusted EBITDA totaled $177 million, an increase of 15% with an adjusted EBITDA margin of 23.1%, down 70 basis points year-over-year. Adjusted operating income of $160 million increased 15%, and adjusted operating margin decreased 60 basis points to 21%. The margin declines were primarily driven by the expected acquisition dilution of 70 basis points, the difficult comparison to the prior year tariff-related price/cost benefit and inflation. This decline was partially offset by favorable price, volume leverage and productivity gains. Segment margins were as follows. Americas decreased 150 basis points to 25.7%, while Europe increased 160 basis points to 13.3% and APMEA increased 100 basis points to 19.9%. Adjusted earnings per share were $3.66, representing 18% year-over-year growth with operational performance, acquisitions, tax and foreign exchange driving the majority of the increase. The adjusted effective tax rate in the quarter was 23.1%, favorable by 210 basis points compared to the second quarter of 2025, primarily due to a nonrecurring tax benefit from the reversal of a prior year tax liability. Our free cash flow year-to-date was $98 million compared to $105 million in the same period last year. The cash flow decrease was primarily due to an increase in accounts receivable due to higher sales and our strategic investment in inventory. We expect seasonal sequential improvement in the second half of the year and are on track to achieve our full year goal of free cash flow conversion greater than or equal to 90% of net income, as previously communicated. The balance sheet remains strong and provides us with good flexibility to execute on our capital allocation priorities. Our net debt to capitalization ratio at quarter end was negative 12%, and our net leverage is negative 0.4x. On Slide 6, we'll review our outlook for the third quarter and full year 2026. As Bob mentioned, we are raising our full year sales and margin outlook. This is based on a strong first half and our third quarter outlook. This updated guidance assumes there is no change in the current status of the Middle East conflict. We are also assuming that there are no further changes to the tariff structure that is currently in place. And we are also not including any potential IEPA tariff refunds in our outlook. Any refunds received in future periods will be treated as nonrecurring special items and will, therefore, not be included in our adjusted results. We now anticipate organic sales growth of 8% to 11%, which reflects over a five-point increase to the midpoint of our previous outlook. Excluding the impact of our ongoing 80/20 product rationalization, our organic sales growth would be approximately one point higher. Our reported sales are now expected to be up 14% to 17%. Regionally, organic sales in the Americas are now expected to increase by 9% to 12%, and driven by price and volume, especially within data centers, more than offsetting anticipated 80/20 product rationalization headwinds of $25 million to $26 million. In Europe, organic sales are now projected to increase by one to four points as favorable price and volume are partly offset by $6 million to $8 million in 80/20 product rationalization. APMEA is now expected to achieve organic growth between 9% and 12%. Incremental sales from acquisitions are expected to be between $105 million and $110 million in the Americas, a slight decline from our previous outlook as we begin to drive 80/20 actions in these businesses. We also expect between $21 million and $22 million of acquired sales in APMEA. Foreign exchange is estimated to be an $18 million favorable impact. We are raising our full year adjusted EBITDA margin outlook to a range of up 20 to up 80 basis points, which is a 60 basis point increase in the midpoint of our previous outlook. We are also raising our full year adjusted operating margin expansion to a range of up 20 to up 80 basis points, which is 70 basis points higher than the midpoint of our previous outlook. Margin expansion continues to come from price, volume leverage and productivity, which more than offset higher inflation and 50 basis points of acquisition dilution. Regionally, Americas segment margin is now anticipated to range from a decrease of 20 basis points to an increase of 40 basis points, largely overcoming approximately 100 basis points of acquisition dilution. Europe segment margin is now expected to increase 20 to 80 basis points based on strong price and productivity, which includes the expected benefits from our France restructuring program. APMEA segment margin is forecasted to increase by 30 to 90 basis points. This guidance assumes no changes to the current tariff environment. Our free cash flow expectation remains in line with our previous outlook, and we expect to deliver free cash flow conversion of greater than or equal to 90% of net income. Next, a few items to consider for the third quarter. Reported sales are expected to increase by 11% to 14% with organic sales up 5% to 8%. We anticipate high single-digit to low double-digit growth in the Americas, which is sequentially lower than the second quarter due to the pull-forward demand previously discussed and the sequential decline in price as we comp prior year price increases. We expect flat to low single-digit growth in Europe and mid- to high single-digit growth in APMEA with our expected data center sales offsetting the impact of the Middle East conflict. These estimates incorporate the negative impact from product rationalization under our 80/20 initiative of approximately $2 million in Europe and $6 million in the Americas. Incremental sales from acquisitions are projected at $30 million to $33 million for the Americas and around $5 million to $6 million for APMEA. We also estimate an unfavorable foreign exchange impact of approximately $3 million. Third quarter EBITDA margin is expected to be between 22.2% and 22.8%. Operating margin is expected to be between 19.8% and 20.4%. Across all regions, price and volume leverage are anticipated to be partly offset by higher inflation and acquisition dilution of approximately 50 basis points. Additional key assumptions for the third quarter and full year are available in the appendix of the earnings presentation. With that, I'll turn the call back over to Bob before moving to Q&A.
Thanks, Diane. To wrap up, we delivered another strong quarter with record sales, operating income and EPS. As we discussed throughout the call, data centers are an important growth opportunity and also a good example of how we are successfully targeting additional growth markets. At the same time, our diverse market exposure and significant repair and replacement business continue to provide a consistent foundation for revenue and cash flow generation across different economic conditions. Based on our strong first half performance and third quarter expectations, we are increasing our full year sales and margin outlook. We are monitoring the macro environment, including tariffs, interest rates and geopolitical developments and we believe we are well positioned to navigate those uncertainties. Our balance sheet is strong and our cash flow is healthy, and we have ample flexibility to support our disciplined capital allocation priorities. We'll continue to deploy capital to high-return opportunities that will help us deliver sustainable profitable growth and create value for our shareholders. With that, operator, please open the lines for questions.
分析師問答
Our first question comes from the line of Andrew Krill with Deutsche Bank.
I want to first ask about data centers. Could you give us more color on why the TAM expanded or doubled from the $1 billion you were saying recently to $2 billion so quickly? Does this include the opportunity in Europe? Or would that be incremental to the $2 billion? And on Europe, have you made any data center sales there, or is that in the forward look?
Yes. We've been fine-tuning that analysis which is why we increased it from $1 billion to $2 billion. We added Europe into that estimate, and we have been selling some business in Europe. In my prepared remarks, I talked about the shift toward liquid cooling, the market growth we're seeing, and our thermal storage tank, the Cool Vault. So we've refined the estimate to be a global number now versus just APMEA and North America.
That's helpful. And then, related to data centers, can you give us some color on how hard you're running your manufacturing sites? I noticed CapEx in the guide moved modestly higher. Is it fair that's related to data centers? And will there be a point where a more major footprint expansion is needed?
Yes. We did expand our CapEx, and that is directly related to additions we're making at our sites in North America and in China as we grow our global supply chain. The teams are focused on that and we're adding shifts where needed. We'll adjust CapEx as we look to the future, but we're not seeing huge incremental CapEx. We're focused on our existing facilities and some of our new acquisitions. Superior Boiler, for example, is making some of those cool tanks, and we're adjusting their capabilities to allow them to continue to expand and leverage existing capacity.
Our next question comes from the line of William Grippin with Barclays.
On data centers, growth has been stronger than maybe your internal expectations. Could you provide more color on where you're seeing the most success? How has adoption of new products been as you roll them out? Could you also give a flavor of products in development, what could be next, and how that could continue to drive growth in this customer segment?
Customers rely on quality products delivered on time, and our teams are doing exactly that. We're focused on profitable growth in this market and are selective to ensure we can meet customer requirements. The Cool Vault, which we did not have last year, has been growing as a thermal storage tank. We'll continue to expand and are developing new products, especially on the stainless steel side as applications move toward liquid cooling. We're working closely with customers and will share more as new products come online.
The guidance encompasses mid- to high-single-digit revenue mix for data centers. What drives outcomes toward the low end versus the high end of that range? What visibility do you have into the second half given project-based variability?
This is a lumpy business. As Diane mentioned, customers moved projects around; some accelerated and some delayed. We have clear visibility on construction schedules for Q3; visibility into Q4 is tougher because projects can shift. Our project management teams work closely with customers to stay on top of this. All things came together in Q2 and we shipped a lot. We monitor closely and our best visibility is for Q3 right now, and we feel comfortable with our guidance.
Our next question comes from the line of Mike Halloran with R.W. Baird.
On the legacy construction markets, non-data center, any signs of change either way in the quarter? The environment remains challenging. Within subsegments like multifamily, are you seeing any real change?
On the residential side, single-family appears slightly worse than last quarter. Multifamily is holding in but remains soft compared to prior periods. Institutional markets, including health care and education, are holding up. Other nonresidential new construction is still soft. It varies by region, but overall it's similar to last quarter, perhaps slightly worse on residential.
Regarding pricing, do you think the pricing actions you've taken position you for favorability or at least neutrality through the back half of the year? And can you help us understand the cadence of the price/cost piece in the guidance for the back half?
We saw about 6% price in the second quarter. We expect that to sequentially decline in the back half. We feel okay about our price/cost dynamic. We implemented a couple of selected price increases globally to address some inflation from the Middle East conflict and we're monitoring that closely. Overall, we feel pretty good about where we're at.
Next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.
Bob, I'd call doubling your TAM more than fine-tuning.
Well, I always said greater than $1 billion, so $2 billion is certainly greater than $1 billion.
Can we unpack that a little? How much of the expansion is Europe? What's the TAM for the thermal tank piece? And as you look at your product portfolio, including work in liquid cooling and acquisitions like Easywater, what other products or applications can you sell into that market?
There are many puts and takes. It's not only Europe; we also included the Middle East, Southeast Asia and other markets. Previously the number was largely North America and China; we've expanded it globally because we're quoting on a global basis. We were around $1.4 billion previously but rounded to $1 billion; now we're leaning toward $2 billion. For thermal tanks, they are part of the liquid cooling opportunity. Superior Boiler can make large custom boilers and large tanks, and we're leveraging their capacity and our Texas location. We've seen strong success in Q2 and are winning projects with visibility through the rest of the year.
You mentioned the market growth of 15% to 20%, which seems a bit low. How much do you think your data center business can grow relative to that market rate?
Prior to this, the Cool Vault and thermal storage tanks were not shipping; we've shipped many more this year. We're outgrowing the market due to new product development. We're focused on profitable growth and being disciplined to meet customer demand. We'll focus on the more profitable parts of the market where customers value our quality and on-time delivery.
Our next question comes from the line of Brian Lee with Goldman Sachs.
Earlier this year you mentioned Asia Pacific used to be the leader for your data center business and then America accounted for more than half of the revenue. With high growth highlighted in Q2 for China data center demand, can you update us on the geographic mix and how you expect it to evolve over the next 12 to 24 months? Are there meaningful differences in margin profile between the U.S. and China or other markets? Could a shift toward China be a tailwind or headwind to margins?
We continue to grow in China and are expanding beyond that. Americas is growing faster than China right now, primarily because of the Cool Vault which is primarily in the U.S. We are growing in all regions, including Europe, and are leveraging global capabilities to win in the market.
On margin, the Americas is growing faster than APMEA, but from a margin perspective, all of it is accretive. I do not expect a material mix issue going forward.
You disclosed content opportunity of about $25,000 to $100,000 per megawatt. What drives a project toward the high end versus the low end of that range? Is the average content per megawatt increasing over time? Is content higher in the U.S. versus other regions?
There is more content in the U.S. because we're selling the Cool Vault. Each project varies based on scope and customer needs; projects can range materially. Liquid-cooled applications with thermal storage tanks drive toward the higher end of the range. The range depends on content, customer need and region.
Next question comes from the line of James Ko with Jefferies.
Congrats on the quarter. On project visibility: some in the data center supply chain describe multi-year backlogs and design-win pipelines. Does Watts have similar longer-term visibility? Or are orders placed closer to construction with less lead time? Any color would be helpful.
The answer is both. We have longer visibility for large projects like the Cool Vault, which take longer, but for some products visibility is shorter. At the largest, we might have about five months and less for others. We stay close to customers and anticipate needs through discussions. Many projects finalize designs late, which impacts piping and valve requirements. We've combated variability by maintaining inventory across sizes and investing in inventory to handle customer variability.
How do you go to market on the data center cooling loop? Are you selling primarily through distribution, directly to mechanical contractors, or directly to hyperscalers and OEMs? At what stage of the design process do you typically get specified? Do customers sole-source or multiple-source?
It varies. Customers typically use multiple sourcing depending on the project. We involve our rep network and work closely with customers and contractors. For the Cool Vault, we often work directly with hyperscalers and contractors. We get qualified by hyperscalers and partner with channel partners throughout the process. We see the pipeline, speak with customers, and stay involved until final release.
Our next caller is Jeffrey Reive, who has temporarily disconnected. That concludes the question-and-answer session. I will now turn the call back to Ray Nash for closing remarks.
Operator, it looks like he came back into the queue.
Okay. Jeffrey Reive, your line is open.
Sorry about that. I want to go back to the data center disclosures. The $25,000 to $100,000 per megawatt range is new. Where within that range does your current mix sit and what does your pipeline look like? Should we think of the $100,000 as a data center with both air and liquid cooling, or something else?
The high end assumes a liquid-cooled data center that also has thermal storage tanks. The answer is often in between. Every project is different based on cooling type and region. We've had many inquiries over the past quarter, and we provided the range to give clarity on how we participate across different project types.
Directionally, we can assume liquid cooling growth and the related opportunity. One more on gross margin compression this quarter: SG&A improved. Is that related to the data center mix? Should we expect that to continue? Is there a natural floor in gross margins as the portfolio shifts?
On gross margin, there is some acquisition dilution and a challenging price/cost comparison to last year, which are drivers. Data centers have a little gross margin dilution, but they are accretive to operating margin because the operating expense burden is low for that business. You will see that dynamic to a degree going forward.
There are no further questions at this time. I would like to turn the call back over to Ray Nash for closing remarks.
Thank you, operator. Thank you for joining us today. We appreciate your continued interest in Watts and look forward to speaking with you again during our third quarter earnings call in early November. Have a great day, and stay safe.
Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.