Thank you for standing by. Hello, and welcome to Watts Water Technologies Second Quarter 2025 Earnings Conference Call. Please note that this call is being recorded. I would now like to turn the call over to Diane McClintock, Senior Vice President, FP&A and Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Welcome to our second quarter earnings conference call. Joining me today are Bob Pagano, President and CEO; Shashank Patel, our former CFO; and Ryan Lada, our new CFO. During today's call, Bob will provide an overview of the second quarter, an operational update and an update on our outlook for 2025. Shashank will discuss the details of our second quarter performance and provide our outlook for the third 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 this 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. Before beginning our second quarter overview, I'd like to take a moment to express my gratitude to Shashank Patel as this will be his last earnings call with Watts. I'm grateful for his 7 years of impactful leadership. He has been a tremendous asset to the entire Watts team and has been a key strategic adviser to me. I wish him all the best in his retirement. Over the next 2 months, Shashank will help support the transition to our new CFO. On that note, I'm excited to welcome our new CFO, Ryan Lada, to his first earnings call with Watts. Ryan, would you like to say a few words?

Thank you, Bob, and good morning, everyone. I'm excited to be part of Watts and contribute to its continued success. I had the opportunity to attend the Board meeting shortly after joining Watts, and I was able to spend time with the Board members and the leadership team. I was incredibly impressed with the talent, engagement and high-performance culture, and I'm thrilled to be part of the team. Over the next few months, I will focus on getting up to speed and plan to spend time traveling to our sites to learn about the operations and the team. I look forward to working with the investment community and contributing to Watts continued growth and long-term value creation. With that, I will turn the call back to Bob.

Thank you, Ryan, and welcome to the team. Now please turn to Slide 3, and I'll provide an overview of the second quarter. Our second quarter results were better than expected with record sales, operating income and earnings per share. Our performance is a direct result of the commitment and strong execution of the entire Watts team and their dedication to serving our customers amid a challenging environment. Organic sales increased 6% in the quarter with favorable price, volume and pull-forward demand more than offsetting continued weakness in Europe. We also benefited from incremental sales from our I-CON and EasyWater acquisitions and favorable foreign exchange movements. Adjusted operating margin of 21.6% exceeded expectations due to favorable price/cost dynamic, volume leverage, productivity and cost containment. Our balance sheet remains strong and provides ample capacity to support flexibility in our capital allocation strategy. From an operations perspective, we continue to take proactive steps to mitigate the impact of tariffs through our pricing and supply chain strategies. The tariff environment remains fluid. But as of today, our global direct tariff impact in 2025 is estimated to be approximately $40 million. We have a proven track record of successfully navigating through inflationary periods and are confident in our ability to maintain a favorable price/cost outcome. In line with our strategic approach to M&A, in June, we acquired the assets of EasyWater, a company that engineers and manufactures innovative water conditioning and filtration solutions that serve residential, commercial and industrial markets. EasyWater's custom solutions will complement our existing water quality portfolio. We expect EasyWater to contribute approximately $5 million in sales and be neutral to adjusted EPS in 2025 after factoring in normal purchase accounting adjustments. The integrations of Bradley, Josam, I-CON and EasyWater are progressing well and synergy realization is tracking ahead of our…

Thank you, Bob, and good morning, everyone. Please turn to Slide 5, which highlights our second quarter results. Sales of $644 million were a record for Watts and were up 8% on a reported basis and 6% on an organic basis. Strong organic growth in the Americas more than offset declines in APMEA and Europe. Americas organic sales were up 10% and reported sales were up 11%, both better than expected, driven by price, volume and pull-forward demand. Sales from the I-CON acquisition added $7 million. EasyWater sales were immaterial in the quarter. Impact from our 80/20 actions in the Americas were limited with approximately $1 million of eliminated product sales as a result of strategies aimed at improving profitability. Europe organic sales were down 8% and reported sales were down 3%, with organic declines across all geographies due to continuing OEM and market weakness. Reported sales benefited from favorable foreign exchange. APMEA sales decreased 1% on an organic basis and 3% on a reported basis. Growth in Australia, New Zealand and the Middle East was more than offset by a decline in China due to project timing. Compared to the prior year, adjusted EBITDA of $153 million increased 22% and adjusted EBITDA margin of 23.8% increased 280 basis points. Adjusted operating income of $139 million also increased 24% and adjusted operating margin of 21.6% was up 280 basis points and is a record for Watts. Adjusted EBITDA and operating income benefited from favorable price/cost dynamic, volume leverage in the Americas, productivity and cost containment, which more than offset inflation, volume deleverage in Europe and investments. Americas segment margin increased 290 basis points to 27.2%. Europe segment margins increased by 170 basis points to 11.7% and APMEA segment margin was flat to prior year period at 18.9%. Adjusted earnings per…

Thanks, Shashank. On Slide 7, I'd like to summarize our discussion before we address your questions. Our second quarter performance was better than we anticipated with record sales, operating income and earnings per share due to strong performance in our Americas region, which benefited from price realization, favorable price/cost dynamic and volume leverage. We continue to execute well amid an uncertain trade environment and expect that price, our expansive U.S. footprint and global supply chain will enable us to navigate the current backdrop effectively. As a result of our strong first half performance and third quarter expectations, we are increasing our full year sales and margin outlook. Our balance sheet remains strong and provides ample flexibility to support our capital allocation priorities, including M&A, factory automation, investment in new product development and our digital strategy and returning capital to shareholders via share buybacks and dividends. I'm confident in our team's ability to execute despite the uncertain environment and continue to create durable long-term value for our shareholders. With that, operator, please open the line for questions.

[Operator Instructions] Our first question comes from the line of Ryan Connors from Northcoast Research.

Congratulations, Shank, and welcome, Ryan. So my first question was just -- you mentioned in the press release, in addition to the other things here, this idea of a dynamic of a pull forward in the quarter. Is there any quantification you can put on that in terms of the impact of volume of that pull-forward effect you mentioned in the press release?

Yes, Ryan, this is -- it was approximately $20 million of sales pull forward pre-price increase that we shipped in the quarter.

Okay. And then in terms of the price increase, you cite the favorable price cost. You mentioned the $40 million headwind. But can you just kind of dive in a little deeper into the price dynamics? Obviously, you got lots of different products, lots of different magnitudes of price increases. The copper tariffs are kind of brand new. I mean, what's the dynamic in terms of pricing? Have you accomplished what you need to do? Are there certain products that are leading or lagging on that? Just any deep dive you can give us on the pricing dynamics would be helpful.

Yes. So specifically, in the second quarter, we talked about price/cost favorability, and that's where we implemented price increases, but based on having lower cost inventory, we had some favorability, approximately $6 million. The price increases we've announced, you're right, there's been multiple rounds of tariffs. So they have staggered between the March 31 date all the way to the June 2 date, and they're in the range of 5% to 15% of price increases. We'll see the full realization of those in the second half.

Yes. Ryan, as you know, we are -- yes, we're constantly analyzing our cost inputs, especially with the recently announced tariffs and are looking for all options, including price increases in the future. So like we've done in the past. So we'll update you on our pricing as we roll into the next quarter.

Yes. Yes. And then lastly, just on the gross margin, I mean, really impressive to see a number above 50%. What should we be thinking about intermediate term kind of run rate? I mean it's -- obviously, that might be a little elevated here, but you've made strides in terms of internal improvement and other things. So what should be kind of the -- what do you consider a base normalized level for the company over the intermediate term?

So that 50% certainly benefited from about 100 basis points on the price/cost dynamic I talked about, which was onetime, right? And it also benefited to a certain extent from volume leverage. We got significant volume leverage in the second quarter. So as you recall, prior year, we're in that 47% margin range. The goal this year was to get to that 48% level as part of our continuous improvement priorities, productivity driven primarily, as you noted. So going forward, I think in that 48% range.

Our next question comes from the line of Nathan Jones from Stifel.

Shashank, congratulations on getting Bob to finally let you retire and Ryan, welcome to the team. I guess I'll ask first about the competitive positioning and the footprint, your more domestic footprint and the advantage that gives you. Obviously, evolving, I'm sure customers are talking about those kinds of things. But any update you can give us on what kind of benefit you think you'll see -- you'll be able to realize from that versus particularly some of the smaller competitors who maybe source a lot more out of China or other places internationally. Just how you think you can use that to gain market share?

Well, listen, Nathan, we always believe that our overall strategy of -- basically producing products in the countries we sell is a positive strategy, especially in this uncertain market environment where the tariffs keep on changing. So just that uncertainty it has helped. But certainly, we do source, as we indicated, globally to diversify our product and our production capabilities. But again, we believe it's a positive for us in this current environment, and we'll continue to capitalize on that going forward.

Do you think there are any opportunities to maybe manufacture more domestically? I mean you did say you source globally. It certainly does seem that there's going to be some level of tariffs that are permanent here. And just how you think about the breakpoints of whether you would continue to source internationally for some of the products or whether you would reshore some of that production for yourself?

Yes. I think our supply chain teams and our manufacturing teams are constantly looking at that. And where it makes financial sense to bring it here, we'll do that. I think we talked on the last call that we have capacity by adding third shifts in most of our locations. So we're open to those ideas and just looking at overall what the competitive opportunities are by country, by place, et cetera. So again, constantly evolving, but we have a great supply chain team, and they're doing a great job in this environment.

And I guess I'll just ask one on the European business, I guess, with the focus on the heat pump market in Germany. I think the belief was that, that was kind of going to bottom out midyear, destocking it might be done midyear. It sounds like maybe that's not the case. So just an update on your expectations there?

Yes. From a heat pump perspective, for the most part, we're starting to see it. It varies by each one of the customers based on their distribution channels and inventory. But like we thought, that has come down, the destocking has come down. And we're believing Q3 is probably the end of that. However, it's just the general construction market is soft in Europe, and it continues to be. And as you know, I'm cautious on Europe. I always have been. And until I start seeing the order rates pick up, we're going to continue to be cautious.

Our next question comes from the line of Jeff Hammond from KeyBanc.

Congrats to Shashank. Ryan, welcome aboard. Bob, good to still have you with us. I want to go back to the tariffs. So I think you originally said $60 million and most of it or maybe $50 million of the $60 million was China. I know we had a big reset there. So I would have thought that, that number would have gone down more. I think you said $40 million is kind of the new baseline. So maybe just walk me through the puts and takes in that $60 million to $40 million change.

Yes. So you're right. The China tariff did come down significantly. But since that happened, there's been other tariffs, including copper tariffs. Tariffs on Europe are now set at 15%. So there's been quite a bit of change. And so we factored all of that change into coming up with the $40 million from the previous $60 million number on direct cost.

Okay. And then is there a way to quantify what price you got in the quarter and what you think you get for price in the second half?

So in the quarter across Watts, our price realization was approximately 3%. If you recall, in Q1, it was 1%. So it stepped up to 3%. Our expectation is with the full impact of price realization in the second half, we're probably going to be in the mid-single digits.

Okay. And this pull forward, I assume it all comes out of 3Q?

Yes, that's our current assumption, yes.

And then just last one. It sounds like all your deals are integrating well. Can you just maybe talk about what's going better and whether it's cost, margin improvement, revenue synergies, any -- where the upside surprises are, that would be great.

Yes, I think it's across the Board and each one of them is different. But the nice thing is all 4 of them are green, which we track, as you know, judiciously on a monthly basis and stuff. So costs are certainly the key focus. And as you know, we're doing the 80-20 on most of these businesses. And so the top line is important, but we are seeing synergies definitely on the top line, but we're also -- as Shashank earlier said, we continue to look at making money. And so we don't want -- we're getting rid of some of the bad business that we've had in the past.

Our next question comes from the line of Mike Halloran from Baird.

It's Pez on for Mike and Shashank, congratulations. I want to take a moment just to circle back on the 80-20 comments. Bob, should we consider most of the 80/20 actions that are being discussed going on in the acquired businesses? Or is there a chunk of that going on in some of the legacy business as well?

It's always -- it's constantly going on. For the most part, we continue to talk about big ones that -- especially with some of the acquisitions that we've pointed out, that's the biggest pieces. But we're always doing 80-20, right? We don't necessarily call it 80-20, but it's the conceptual concept that we go through our organization and are always evaluating that. So again, my team knows that our goal is to drive profitable growth.

Right. All right. That's helpful. And then we're 2 years post Bradley close. Are there areas where you've been able to maybe step on the gas in terms of investments where maybe the previous ownership had -- maybe not identified opportunities as well as you had? And then additionally, are you seeing Bradley as an opportunity to be another platform to bolt on future acquisitions?

Yes. So the answer is yes. We've been investing capital to lean out the organization, streamline the business and invest in new product development. So we had the fortunate opportunity to have our Board there on Monday and Tuesday of this week, and the Board got to see firsthand all the improvements and the great strides the teams are making. So -- and yes, Bradley has been front of the wall. I think it's a nice start, and we purchased I-CON as we talked about before. So that continues to expand our front-of-the-wall capabilities. So nice platform, doing exactly what we thought it was, and we're ahead of schedule on our integration and synergies.

Awesome. And last one for me. Bob, some really helpful comments on the Nexa platform. Obviously, some encouraging opportunities with the luxury condos and hospitality. Maybe talk a little bit about how you're approaching the targeted verticals. Is it kind of going pilot programs in certain verticals and then looking to expand? Maybe just provide us a little bit more color about how you're thinking about expanding the offering for Nexa and the approach to go-to-market?

Yes. So we're leveraging our complete sales force, whether we have some direct capabilities, strategic accounts and leveraging distribution. The process is a long process. It's a long sell process where we pilot and then the pilot -- they get to look at it for a while, then they have to put it in their budget. And then once they put it in their budget, they go forward. So it could be anyways from a year to 2-year selling cycle. So it takes a while to get this. But we're happy to say that every installation has been a great success, and we're seeing the benefit of all. So again, it continues to move forward. It's never as fast as I would want it to be, but it's moving in the right direction. And I think we've also talked about that we're migrating all our previously smart and connected products that had individual apps into the Nexa platform. So it's all centered on one overall application for all the Watch products. So for the most part, that will be done by the end of the year and early into next year.

Awesome. I know I said that was my last question, but I'm going to follow up on one of your points there. As we get further down the road and as you run more and more pilots would you expect -- and I'm not talking about necessarily this year, next year, maybe not even the year after that, but would you expect the sales time on Nexa to shorten as proof points build and your ability to demonstrate returns to customers, kind of your Rolodex of wins and pilots gets bigger, would you expect that sales cycle to slow? Or is that just more of how the customers are able to integrate the technology into their current assets?

We would expect it to grow, but certainly, you raised the concern again. But yes, the answer is we expect it to accelerate as more people have it and really realize the benefit. And I think this property group is when we get that fully installed by the end of this year, that would be a great asset for people to see and understand how to manage their portfolios across the U.S.

Our next question comes from the line of Andrew Krill from Deutsche Bank.

Congrats again, Shashank, and welcome, Ryan. I want to go back to the 3Q margin guidance as it implies a very steep about 400 basis points or so sequential decline in the EBIT margin. I know 2Q is an elevated starting point to compare it against. But just can you talk through, again, like any of the moving pieces here? Like was it really all pull forward and price cost related? Or was some of this more structural? And I thought that could have persisted more into the back half. So maybe just touch on that and like if there's any conservatism at play, please?

Yes. So Andrew, there's 3 pieces of that, right? First was the price/cost dynamic, which I quantified at approximately $6 million. So that's about 100 basis points. The second element is usually is the typical seasonality we see between Q2 to Q3, which is about 170 basis points. And then the balance is basically volume deleverage, right? So certainly, the volume in Q2 volume growth is higher than the volume growth in Q3, especially when you strip out price. So it's those 3 elements that contribute to that approximately 400 basis point decline in op income margins.

Okay. Great. That's helpful. And then for sales in the back half, can you maybe speak to what you're assuming for end market demand? The price clearly, I think, is going up. So do you have any cushion for volume destruction related to that? Or are you assuming more kind of a status quo current run rate?

Yes. So for the most part, there's still a lot of uncertainty, especially in the far back, the fourth quarter, in particular. But we're basically the same -- the markets haven't changed significantly. If anything, residential is down a little bit more than we expected. But overall, we had to pull forward. That's going to play out against Q3 and then the markets will continue. And we're having strength in data centers. That's been a great win for the team this year, and we're continuing to see the benefit going forward. So we'll see what Q4 looks like when it's there, but we're going to watch what the markets do, how the reaction to these recent tariffs and some of the uncertainty, how it unplays out in the market.

Our next question comes from the line of Joe Giordano from TD Cowen.

Shashank, just that $6 million on the price cost, like I just want to make sure I understand, that's just you're getting the price capture plus what you're selling is just flowing through inventory that was acquired at a lower price point that didn't include the tariffs. Is that what we're -- and then that ultimately goes away. Is that what we're talking about?

Absolutely. That's correct.

Okay. Great. On data center, like how large do you think that's going to be now this year? You mentioned it a couple of times already this call.

Yes. We're not going to give the specifics. But as we've talked about in the past, last year it was about 2% of sales, and I would say it's growing high double digits at this point in time. So again, it's offsetting the residential softness we're seeing in the market, and the team is doing a great job to continue to grow in that area. So nice story.

Yes. That makes sense. And last for me on Nexa, what is like the pay terms on this? Is this like a subscription base? Like how -- and what is it based on?

Yes. So there's a cost for installation of the various products, and we're flexible with the customer based on what OpEx or whether -- how they want to do it inside. They want to pay by the month, we'll incorporate the cost inside of it. And yes, it does have a future annual fee that we charge to customers to continue to monitor and measure and keep the upgrades in the system and have access to our experts. So yes, it's the combination of both of those.

How big do you think your whole like software type revenue base is now?

Yes. We don't provide that information, but it's certainly growing. It's small, right? But it's growing -- growing high percentage basis on a low number, but we'll continue to grow it. And when it gets big enough, we'll begin talking about that. But we're accelerating that, and we believe Nexa is one of the best platforms to do that with.

Our next question comes from the line of Brian Lee from Goldman Sachs.

This is Nick Cash on for Brian Lee. Just kind of a question going into, again, the end of the year. I mean, we've had pull forward kind of expecting a step down in margins heading into 3Q and then probably another one heading into 4Q. But do you guys have any additional shipping days in 4Q that you expect to see and realize some incremental volume? Or just kind of talk to the puts and takes that you're expecting in the back half of the year on margins?

There's a couple of days impact in Q4. If you recall, in Q1, we talked about lower shipping days. We picked those up at the back end of the year.

Okay. But then I guess, I think the guide implies another step down in adjusted operating margins in, what, 4Q. Is that mostly due to, again, additional volume deleveraging off of 3Q in the Americas segment?

Yes, that's correct. Yes. The volumes in Q4 are lower than Q3. So you had volume deleverage that's impacting margins in Q4.

There are no further questions. That concludes the question-and-answer session. I will now turn the call back to Bob Pagano 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 third quarter earnings call in early November. Have a great day and stay safe.

The meeting has now concluded. Thank you all for joining. You may now disconnect.