Watts Water (WTS) Q1 2026 Earnings Transcript

Chairman, President, and Chief Executive Officer — Robert J. Pagano

Executive Vice President and Chief Financial Officer — Diane M. McClintock

Robert J. Pagano: Thank you, Diane, and good morning, everyone. Please turn to Slide 3, and I will provide an overview of the first quarter. We began 2026 with better-than-expected results, including record sales, operating income, operating margin, and earnings per share. I would like to thank the entire Watts team for their impactful contributions to our results. Organic sales rose 12% in the quarter, as we benefited from price and incremental volume. Adjusted operating margin of 20.1% increased 110 basis points due to better-than-expected price, volume, and productivity, which more than offset tariff costs, inflation, and acquisition dilution of 80 basis points. 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 product innovation and advancing our digital strategy. As a result of our solid start to 2026 and expected cash flows for the remainder of the year, we announced a 21% increase to our dividend beginning in June. We continue to see strong momentum in data center cooling applications, with sales more than doubling in the quarter as we deepen customer relationships and leverage our broad portfolio. To support this growth and meet our customers’ needs, we are investing in our team and accelerating innovation across our product portfolio. Additionally, we are expanding capacity, including adding inventory to meet shorter lead-time expectations.

We are also gaining traction with our digital solutions, including the Nexa platform, our intelligent water management solution. Together, these strategic initiatives are driving growth and helping to offset softer end markets. In 2025, we completed five acquisitions enhancing our technology capabilities and expanding our product range, geographic reach, and exposure to high-growth nonresidential end markets. These businesses are performing well, and we are successfully integrating them through our One Watts performance system. We are on track to achieve or exceed the targeted synergies. We are proactively working to mitigate the impact of the Middle East conflict.

Our direct sales exposure to the Middle East is limited to approximately 2% of global sales, with the majority being in our APMEA region. We are implementing targeted pricing strategies as well as sourcing and productivity initiatives to mitigate both the direct and indirect impacts, including freight and energy cost increases. Our direct Middle East exposure includes our recent acquisition, Saudi Cast, and I would like to highlight that the Saudi Cast business is largely an in‑country business model, which should help insulate it from the full impact of the conflict. The tariff environment also remains fluid, with IEPA tariffs being eliminated but generally being offset by new tariffs under Section 122 and changes in the Section 232 rules.

Additionally, the administration is considering new tariffs under Section 301. Based on the tariff structure in place as of today, we believe we are well positioned from a price-cost perspective. Our strong first quarter performance and outlook for the second quarter give us a solid start toward achieving our outlook for the full year. We continue to face an uncertain macroeconomic and geopolitical environment, including the Middle East conflict, downward revisions of global GDP forecasts, and elevated interest rates. In light of these factors, we believe it is prudent to maintain our full-year outlook, and we will revisit it on our next earnings call.

With that, let me turn the call over to Diane, who will address our first quarter results and our second quarter and full-year outlook. Diane?

Diane M. McClintock: Thank you, Bob, and good morning, everyone. Please turn to Slide 4, which highlights our first quarter results. Sales reached $677 million, reflecting a 21% increase on a reported basis and a 12% increase organically. This performance was supported by favorable price and volume, including the benefit of growth in data center sales. The Americas region delivered strong organic growth of 16% and reported growth of 23%, exceeding our expectations. Acquisitions accounted for an additional $31 million in sales, contributing seven points to the Americas reported growth. In Europe, organic sales rose 1%, while reported sales increased 12%. Organic growth stemmed from favorable pricing, while reported sales also benefited from positive foreign exchange.

In APMEA, organic sales grew 3%, with acquisitions adding 19% and favorable foreign exchange contributing 7% for a total reported sales growth of 29%. Adjusted EBITDA totaled $151 million, an increase of 27%, with an adjusted EBITDA margin of 22.3%, up 90 basis points year over year. Adjusted operating income of $136 million increased 28%, and adjusted operating margin improved 110 basis points to 20.1%. These improvements were primarily driven by favorable pricing, volume leverage, and productivity gains, more than offsetting inflationary pressure, tariffs, and acquisition dilution of 80 basis points. Segment margins were as follows: Americas increased 80 basis points to 24.2%, APMEA increased 120 basis points to 18.7%, while Europe decreased 20 basis points to 13.7%.

Adjusted earnings per share equaled $3.04, representing a 28% year-over-year increase, with operational performance, acquisitions, tax, and foreign exchange gains outweighing higher net interest expense. The adjusted effective tax rate in the quarter was 24.2%, down 30 basis points compared to 2025, primarily due to a higher tax benefit from the vesting of stock compensation awards that occur in the first quarter of each year. Our free cash flow for the quarter was $7 million compared to $46 million in the first quarter of last year.

The cash flow decrease was primarily due to the increase in accounts receivable due to higher sales volume, increases in and timing of our annual customer rebate payments, and an increase in inventory related to incremental tariffs and our strategic investment in inventory. We expect sequential improvement in our free cash flow 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. We have a strong balance sheet and solid cash flow, giving us flexibility in executing our capital allocation strategy, including the announced 21% increase in our dividends that will begin in June.

On Slide 5, we will review our outlook for the second quarter and full year 2026. We are reaffirming the full year 2026 outlook we presented in February, which reflects the market factors Bob discussed. It assumes the Middle East conflict is short term in nature, the current tariff structure remains in place for the remainder of the year, and there are no IEPA tariff refunds. For the full year 2026, we are maintaining both our consolidated and regional sales outlooks. Consolidated organic sales growth is expected to be between +2% and +6% and our reported sales growth is expected to be between +8% and +12%. We are also maintaining our full-year adjusted EBITDA and adjusted operating margin outlook.

Next, a few items to consider for the second quarter. Reported sales are expected to increase by 10% to 14% with organic sales up 4% to 8%. We anticipate mid- to high-single-digit growth in the Americas, despite the tough compare to the second quarter last year, which included an estimated $20 million of pull-forward sales into the second quarter from the third quarter due to the timing of price increases. We expect a low-single-digit decline in Europe and low- to mid-single-digit growth in APMEA, with our expected data center sales offsetting the direct 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 $25 million to $30 million for the Americas and around $5 million for APMEA. We also estimate a foreign exchange benefit of approximately $5 million. Second quarter EBITDA margin is expected to be between 22.3% and 22.9%. Operating margin is expected to be between 20.0% and 20.6%. Price and volume leverage in the Americas and APMEA are anticipated to be offset by acquisition dilution of 70 basis points.

In addition, last year we had a nonrecurring price-cost benefit of approximately $6 million in the second quarter, in addition to the volume leverage on the estimated $20 million of sales pull-forward, that together are a 120 basis point headwind to margins in the second quarter. Additional key assumptions for the second quarter and full year are available in the appendix of the earnings presentation. With that, I will turn the call back over to Bob before moving to Q&A. Bob?

Robert J. Pagano: Thanks, Diane. To wrap up, we had a strong start to the year with record first quarter sales and earnings. Our portfolio spans diverse end markets, and we are actively reallocating towards areas of strong demand, including institutional and data center applications. Importantly, approximately 60% of our sales are driven by repair and replacement activity, which provides a consistent foundation for revenue and cash flow generation over time. We remain nimble and are confident in our ability to execute through dynamic market conditions. We are maintaining our full-year outlook despite the macro and geopolitical uncertainty. Our balance sheet remains strong and provides ample flexibility to support our capital allocation priorities.

We believe we are well positioned to deliver on our financial commitments, create value, and drive profitable growth over the long term. With that, operator, please open the lines for questions.

Operator: 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 1 on your telephone keypad to raise your hand and join the queue. We will go to our first question from Nathan Jones at Stifel.

Nathan Hardie Jones: Good morning, everyone. I know you said, Bob, it is only one quarter in and there is a lot going on, but you did beat the first quarter by a long way, and the second quarter guidance is a fair way ahead of consensus as well. Is there any kind of assumption in here that you are making that the MRO business slows down a little bit with global GDP? You have always said it is pretty well correlated with that. Or is there any reason to think that the second half is likely to be any weaker than you thought it was going to be three months ago, or is this just purely being conservative given the macro environment?

Robert J. Pagano: Thanks, Nathan, for the question. I think it is prudent right now. We have dialed in Q2 and we feel really confident about that. It depends on how long the war goes on at this point in time and whether it impacts future demand. If it is over quickly, I think we have opportunities in the second half. Let us talk about that in three months, and we will have a better answer for you at that point in time.

Nathan Hardie Jones: Fair enough. My second question is on data centers. You said it doubled in the first quarter. Can you talk about how big this is, the contribution to overall growth, how big the addressable market is, and how much you think you can grow it over the next few years? Is it accretive to margins?

Robert J. Pagano: Regarding data centers, it is an over $1 billion addressable market for us. We ramped up last year, so the first half of this year will have easier comps, as last year’s second half was stronger than the first half. Our goal is to deliver high double-digit increases in data center for the year, and we believe we are well on our way. The teams are doing a great job, we are innovating new products, and customers are happy with our performance. We are excited about this opportunity and doubling down on it. It is accretive to company margins at the operating income level.

There are some movements on the gross margin with lower SG&A, but overall it is accretive for Watts Water Technologies, Inc.

Operator: We will move next to Mike Halloran at Baird.

Michael Halloran: Hey, good morning, everyone. On the conservatism in the back half of the year, maybe help us understand how you are talking about margin cadence and price-cost. Guidance for the back half implies lower margins than the front half, but if this trajectory continues, there feels like there is room. How are you thinking about price-cost, particularly in the context of recent inflation, and what you are doing on pricing? And then an update on the 80/20 side of things: progress with the initiatives, expectations for drag on sales through the year, and where you are starting to see benefits so far.

Robert J. Pagano: We always stay in front of price-cost, and we believe with all the movements in tariffs and everything else, we are still ahead. Regarding the cost inflation impact from the war, our international units have put in additional price increases because they are more impacted than we are in the U.S. In the U.S., we are evaluating closely. We are watching fuel costs and are prepared to put in an additional price increase if required. Regarding margins, with second-half volume assumptions that are flattish, if there are opportunities to increase our outlook in the second half, that should provide margin opportunities. As we said earlier, about 2% of overall Watts sales is in the Middle East.

We have addressed that in the second quarter with about an $8 million sales headwind, and we are watching to see any bigger impact in the second half if the war continues.

Diane M. McClintock: From an 80/20 perspective, we expect to see that ramp up in the back half of the year, which is another piece of the decline in the second half. We had about $15 million of that total in the first half, and you will see that significantly increase in the back half. Things are going well. We started with price increases, which is always the first piece, and we are getting a good response. We expect the initiative to ramp up in the second half and then clearly wrap into the front half of 2027.

Michael Halloran: Thank you. Appreciate it.

Operator: We will go to our next question from Jeff Hammond at KeyBanc Capital Markets.

Jeffrey David Hammond: Hi. Good morning, guys.

Jeffrey David Hammond: Can you give us price/mix versus volume in the quarter for North America and how you think that is going to pace through? And then on price, you mentioned you are pushing some increases internationally. What do you need to see in North America to move forward with any incremental pricing, whether it be tariffs, copper inflation, or fuel and transportation inflation?

Robert J. Pagano: You hit all the categories we are looking at. We are watching closely. Our international units are more impacted and are seeing higher charges, so we immediately went out with increases there. The impact likely will not be seen until the third quarter by the time it flows through. Overall, price realization was just a little shy of 8% in the first quarter, which was strong and covered our costs. We stay in front of it and are preparing, if needed over the next few weeks, to implement additional price increases if this continues.

Diane M. McClintock: On your question of sequentials, we will see price realization come down sequentially across the year as we start to lap the 2025 price increases.

Jeffrey David Hammond: Okay. Great. And then on the uncertainty, if you look at the order book through the quarter and into April and May, are you seeing any pockets of slowing, or are you assuming things continue and could become more disruptive?

Robert J. Pagano: Right now, we are not seeing it. We have seen some drain business that has been lumpy and was waiting for some BABA funding, but it is not material. We are up against very difficult compares on order rates in Q2 last year because of the pull-in with price increases. Overall, the order book is in line with our Q2 forecast. Data centers are offsetting softness, particularly in the residential market.

Jeffrey David Hammond: And then last one: this inventory investment. Can you quantify what it was and how you think working capital use looks for the year? It does not seem like you are changing free cash flow guidance, but it seems like a change in tone on inventory.

Robert J. Pagano: It is really around the strategic investment for data centers. Our customers are asking for quicker lead times and adjustments, and we want to ensure inventory is on hand to support that. Net-net, by the end of the year, we believe it works its way through.

Operator: We will take our next question from Andrew Creel at Deutsche Bank.

Andrew Creel: Wanted to see if there was any meaningful impact from weather this quarter. One of your public peers called this out as a point benefit for the first quarter, and I think that continues into Q2. Historically, I think Watts has even over-indexed on this versus them. Anything you can provide?

Robert J. Pagano: It was not a huge impact—just a little under 1% in the first quarter. We are not expecting it to be meaningful in the second quarter. The freeze in the first quarter created some incremental demand, but we do not expect that to carry over into the second quarter.

Andrew Creel: Makes sense. Following up on the 2Q margin guide, it implies just a little bit of sequential expansion. You went through some of the year-over-year headwinds, but any reason we are not seeing a bigger sequential expansion? You mentioned $8 million related to the Middle East—was that a cost number or sales? Any help on why it is not a bigger jump into Q2?

Diane M. McClintock: Sequentially, first quarter to second quarter on the margin side, we will have a decline in price realization, which is a margin headwind. Also remember we had a pull-forward last year in Q2, which is a headwind for us as well. And the Middle East conflict will be about $5 million to $6 million on the margin side, which is also a headwind. It is a challenging compare.

Robert J. Pagano: The $8 million I referred to was the negative sales impact in the Middle East. We are keeping our team fully aligned there, so we will have some net negative absorption costs as a result. We believe it is timing, and we are going to ride it out because we have a great team and a growing opportunity in the Middle East.

Andrew Creel: Great. And one last quick one: you see $5 million to $6 million cost dollars and $8 million of sales. Was there anything meaningful in the first quarter on both of those metrics?

Robert J. Pagano: Not on the cost side. On the sales side, a small number—just a few million dollars. Most of the conflict’s impact did not really happen until March, so we were able to get most of our expected shipments out.

Operator: We will take our next question from James Ku at Jefferies.

James Ku: Good morning. On guidance, are you assuming the Middle East conflict continues for the remainder of the year and potentially impacts other regions like Europe, or are you assuming it ends by the first half?

Robert J. Pagano: We are not assuming a long impact in Q2. We have not made a firm assumption for the rest of the year given we do not know the duration. If the conflict ends and supply lanes open up, there are opportunities in the second half. There are too many geopolitical uncertainties to raise the outlook now. We will reassess in the next three months when we expect to have greater clarity.

James Ku: Thanks. On Europe margin, it was down a bit in the first quarter, but last quarter you had nearly 500 basis points of improvement. Why are we not seeing strong expansion like last quarter?

Diane M. McClintock: There is typical seasonality in Europe—Q4 tends to be a higher-margin quarter. Volume was down in Q1, which impacts leverage. The 80/20 initiative is also a factor. Those are contributing to the margin decline.

Robert J. Pagano: There was also a small mix issue in the first quarter. Nothing to read into. The team is doing a good job. Europe is relatively stabilized—two decent quarters in a row where it is more flat. We are not seeing the decrease we saw before. The duration of the war and knock-on effects inside Europe are the variables.

James Ku: Got it. Thanks for taking the questions.

Operator: We will move next to Jeff Reeve at RBC Capital Markets.

Jeff Reeve: Last quarter, you characterized North American and European residential construction markets as remaining soft in 2026. As you sit here today, are you seeing any meaningful change in demand trends or customer behavior relative to those expectations?

Robert J. Pagano: I would say it is a little softer than we anticipated, given uncertainty and fuel costs. People are holding back, and you can see it in starts on the residential side. Residential is a little softer, but other markets are in line with expectations.

Jeff Reeve: Within residential, is it single-family, multifamily, or repair and remodel that is tracking worse?

Robert J. Pagano: All of the above to some degree. Repair and replacement is holding up. Big remodeling is a little softer as people defer. New construction markets are still soft, and we are watching carefully. We are more than offsetting that with our data center growth.

Operator: We will go next to Joseph Giordano at TD Cowen.

Analyst: Hi. Good morning. This is Chris on for Joe. You mentioned institutional alongside data centers as showing growth. Can you elaborate on which areas within institutional are growing? And can you discuss Nexa attach rates broadly in both data center and institutional?

Robert J. Pagano: Schools and hospitals are the primary drivers within institutional and they have been holding up, along with data centers which are very strong. On Nexa, it continues to be a favorable story for us and we continue to grow it steadily. Nexa will be enabled across our main products, which helps protect our core business and allows customers to connect when they are ready. It supports higher pricing based on the value it delivers.

Analyst: Have you seen any evolution in the M&A environment over the last 90 days—any change in the attractiveness of targets or overall activity?

Robert J. Pagano: The pipeline remains strong. We are disciplined; opportunities must make strategic and financial sense based on our criteria. You can never predict timing, but we will continue to cultivate opportunities and keep you posted as we make progress.

Operator: As a reminder, if you would like to ask a question, please press 1. We will pause just a moment. And that concludes our Q&A session. I will now turn the conference back over to Robert J. Pagano for closing remarks.

Robert J. Pagano: Thank you for joining us today. We appreciate your continued interest in Watts Water Technologies, Inc., and we look forward to speaking with you again during our second quarter earnings call in early August. Have a great day and stay safe.

Operator: This concludes today’s conference call. Thank you for your participation. You may now disconnect.

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Watts Water (WTS) Q1 2026 Earnings Transcript was originally published by The Motley Fool