WTS

• Overall Financial Performance

  • The quarter delivered better-than-expected results with record sales, operating income, and earnings per share. Total Q2 sales reached $763 million, up 19% year-over-year on a reported basis and 12% organically. Adjusted operating income was $160 million (up 15% YoY) with an adjusted operating margin of 21% (down 60 basis points YoY, which was better than expected). Adjusted EPS was $3.66, up 18% YoY.
  • Adjusted EBITDA totaled $177 million, up 15% YoY, with an adjusted EBITDA margin of 23.1% (down 70 basis points YoY). Margin declines stemmed from expected acquisition dilution, difficult year-over-year comparisons to prior-year one-time tariff-related price-cost benefits, and inflation, partially offset by favorable pricing, volume leverage, and productivity gains.
  • Year-to-date free cash flow was $98 million, with the company still on track to hit its full-year target of ≥90% free cash flow conversion from net income. The balance sheet remains very strong, with a net debt-to-capitalization ratio of negative 12% and net leverage of negative 0.4.

• Strategic and Operational Updates

  • The company completed 5 acquisitions in 2025 to expand its product portfolio, strengthen market reach, and increase non-residential market exposure; all acquired businesses are performing well, and the company remains on track to meet or exceed targeted synergies, with integration progressing via the One Watch performance system.
  • 60% of total company sales come from stable repair and replacement activity, creating a strong foundation across varied economic conditions. While residential and non-institutional new construction remain challenged, the company has reallocated resources to high-growth opportunities, most notably data center cooling.
  • In Q2 2026, data center sales more than tripled year-over-year, representing 8% of total sales through the first half of the year. The global served addressable market (TAM) is now estimated at $2 billion, up from a prior estimate of $1 billion, driven by expansion to global markets (previously only North America and China) and growing adoption of higher-content liquid cooling solutions. Data center sales are expected to reach mid-to-high single digits as a percentage of full-year 2026 total sales, up from 3% in 2025.
  • The company proactively managed Middle East conflict headwinds during the quarter via pricing, supply chain, and productivity initiatives; newly acquired SaudiCast's in-region business model has limited disruption exposure. The company released its 2025 sustainability report in June, making progress against second-generation environmental goals while expanding water and energy efficiency solutions.
  • The ongoing 80-20 product rationalization program continues to eliminate low-value SKUs, with a total projected year-over-year sales impact of $25-26 million in the Americas and $6-8 million in Europe for full-year 2026.

Management raised full-year 2026 guidance for sales and margins, based on stronger-than-expected first half performance and Q3 expectations, with guidance assuming no changes to the current Middle East conflict status, no additional tariff changes, and excluding potential IEPA tariff refunds:

• Full-year organic sales growth is now guided to 8% to 11%, an increase of over 5 percentage points at the midpoint of the prior outlook. Excluding 80-20 rationalization impacts, organic growth would be approximately 1 percentage point higher. Reported sales growth is now guided to 14% to 17% year-over-year.
• Regional organic growth guidance: Americas 9% to 12%, Europe 1% to 4%, APMEA 9% to 12%. Total incremental acquisition sales are expected to be $105-110 million in the Americas and $21-22 million in APMEA, with a $18 million favorable foreign exchange impact.
• Full-year adjusted EBITDA margin expansion is now guided to 20 to 80 basis points year-over-year, a 60 basis point increase at the midpoint of the prior outlook. Full-year adjusted operating margin expansion is guided to 20 to 80 basis points, a 70 basis point increase at the prior midpoint. Margins will be supported by pricing, volume leverage, and productivity that offset higher inflation and 50 basis points of acquisition dilution.
• Regional margin guidance: Americas segment margin expected to be down 20 basis points to up 40 basis points (offsetting ~100 basis points of acquisition dilution); Europe segment margin expected to increase 20 to 80 basis points; APMEA segment margin expected to increase 30 to 90 basis points.
• Full-year free cash flow guidance is maintained at ≥90% conversion of net income.
• Q3 2026 guidance: Reported sales growth 11% to 14%, organic sales growth 5% to 8%; EBITDA margin 22.2% to 22.8%; operating margin 19.8% to 20.4%. Q3 organic growth by region: high single-digit to low double-digit in the Americas (lower sequentially due to Q2 pull-forward demand), flat to low single-digit in Europe, mid to high single-digit in APMEA.

By geographic segment (all figures in USD):

1. Americas: Total sales included $28 million of incremental acquisition revenue, with 12% organic growth and 17% reported year-over-year growth. Organic growth was driven by price, volume, and data center sales, partially offset by an $8 million sales impact from the 80-20 product rationalization initiative, plus $15 million of pull-forward demand ahead of a SAP implementation. Segment adjusted operating margin decreased 150 basis points to 25.7% year-over-year.
2. Europe: 9% organic year-over-year growth and 12% reported growth, driven by favorable pricing and higher HVAC volumes, with a $1 million sales impact from 80-20 rationalization and a positive contribution from foreign exchange. Segment adjusted operating margin increased 160 basis points to 13.3% year-over-year.
3. APMEA: 31% organic year-over-year growth driven by Chinese data center sales (including $5 million of early pulled-forward project shipments) that more than offset Middle East conflict headwinds. Acquisitions added 17% to reported growth and favorable foreign exchange added 9%, resulting in 57% total reported growth. Segment adjusted operating margin increased 100 basis points to 19.9% year-over-year.

• Persistently higher inflation and commodity prices compared to early 2026, coupled with market expectations of no interest rate cuts for the remainder of 2026, have worsened macro weakness in residential and non-residential new construction markets.
• Ongoing geopolitical disruption from the Middle East conflict has created direct and indirect operating and cost headwinds for the business, though these have been partially mitigated to date.
• The global tariff environment remains fluid, with new Section 301 and 338 tariffs recently enacted, creating ongoing uncertainty for supply chain and cost dynamics.
• Data center sales are a project-based business, so quarterly sales volumes and timing are inherently more variable than the company's traditional business, driven by customer project scheduling shifts and pull-forward/delay dynamics that can create quarterly volatility.
• Softness in legacy new construction markets is expected to continue, with single-family residential markets noted as slightly weaker than the prior quarter.

Q: Why did Watts expand its data center TAM from $1 billion to $2 billion, and when will it need major manufacturing capacity expansion for this segment? / A: The updated TAM reflects a shift from only counting North America and China to a full global estimate that now includes Europe, the Middle East, and Southeast Asia. It also accounts for faster-than-expected market growth and higher product content per megawatt driven by increasing liquid cooling adoption, plus the addition of the new CoolVault thermal storage tank product line. Current capacity expansion is focused on leveraging existing facilities (including acquired sites like Superior Boiler) and adding shifts as needed, with only modest incremental CapEx planned for now rather than major new footprint expansion.

Q: Why is Watts outgrowing the overall 15-20% data center market growth rate, and what will drive full-year 2026 data center sales to the low or high end of the mid-to-high single-digit mix guidance? / A: Watts is outgrowing the market due to successful new product development (most notably the CoolVault thermal storage tank, which had no sales in 2025) and a disciplined focus on profitable growth rather than pursuing all available market share. Data center sales are inherently lumpy due to their project-based nature, so outcomes depend on project timing: Q3 visibility is clear, but Q4 visibility is lower, as customer project delays or accelerations can shift sales between quarters. Stronger-than-expected project pulls forward would push sales to the high end of the range, while widespread delays would push it to the low end.

Q: What is the current state of legacy non-data center construction markets, and what is the outlook for pricing cadence in the back half of 2026? / A: Single-family residential new construction is slightly weaker than it was last quarter, multifamily construction remains soft but stable, and institutional non-residential construction (healthcare and education) is holding up well. Outside of data centers, all other non-residential new construction segments remain soft, consistent with prior quarter trends. Q2 saw 6% year-over-year price growth, which is expected to decline sequentially in the back half of 2026. The company completed targeted global price increases to offset Middle East-related inflation, and management reports it is comfortable with its current price-cost position.

Q: What is the current geographic mix of data center sales, are there margin differences across regions, and what drives the $25,000-$100,000 per megawatt content range? / A: While China was historically the leading region for Watts data center sales, the Americas are now growing faster due to the domestic launch of the CoolVault product, with growing activity across all global regions including Europe and Southeast Asia. Management notes there is no material margin difference across geographies that would create a significant mixed impact. Content per megawatt is highest for liquid-cooled projects that include thermal storage tanks, and lower for traditional air-cooled projects; content is currently higher in the U.S. due to greater CoolVault penetration, but the wide range reflects variation across project sizes, customer requirements, and geographic markets.