Watts Water Technologies - Q1 2016

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Watts Water Technologies First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require operator assistance during the conference, you may press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Tim MacPhee, Treasurer, VP, Investor Relations. Mr. MacPhee, you may begin.

Timothy MacPhee (Treasurer and VP of Investor Relations)

Thank you, Nicholas. Good morning, everyone, and thank you for joining our first quarter earnings call. Joining me today are Bob Pagano, President and CEO, and Todd Trapp, our CFO. Bob and Todd will provide their perspective and analysis on Watts' First Quarter 2016 results, the current market, and will update our full-year outlook. Following our prepared remarks, we will address questions related to the information covered during the call. The earnings press release and earnings call presentation we issued last evening includes some non-GAAP financial measures, and we have included in those documents the necessary reconciliations to GAAP measures. You can find a direct link to the webcast of today's conference call on our website at www.wattswater.com. We will archive the webcast on the site for replay.

I'd like to remind everyone that in the course of this call, to give you a better understanding of our operations, we will be making certain forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Watts Water's publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Let me now turn the call over to Bob Pagano.

Robert Pagano Jr. (President and CEO)

Thanks, Tim, and good morning, everyone. Now, turning to Slide 3 in the earnings call presentation, let me briefly provide a summary for the first quarter. I'm very pleased that the first quarter results were reflective of the cumulative actions we have taken to enhance our portfolio and drive operating efficiencies throughout the organization. In Q1, we saw top-line growth, strong operating margins, and EPS expansion. This quarter included some extra shipping days relative to last year, which positively impacted sales growth and other operating metrics. However, when results are normalized for the extra days, we still delivered a solid start for 2016. Todd will review the quarter's results in more detail in a few minutes. The regional realignment announced in February is moving along well.

Munish Nanda has met with all key members of the European team and has visited most of the sites since he assumed responsibility in late February. Elie Melhem has also incorporated key members of the Middle East sales team into his Asia Pacific leadership group. Each leader has made some changes to improve regional alignment and enhance the skill set of their respective management teams. Our key initiatives are moving ahead as planned, and we continue to focus on enhancing the customer's experience with Watts. Our transformation initiatives in the Americas and in EMEA are driving results for us. In March, we began shipping from our new state-of-the-art distribution facility in Columbus, Ohio. This new center of excellence will streamline the distribution process through new management, warehouse, and scanning technology.

We expect to fill customer orders more quickly and move to a single-ship process, making it easier to do business with Watts. In early April, we announced that 2 distribution sites will be closed and phased out by the end of June. To date, this brings the number of announced site closures in the Americas to 5, helping to achieve our goal of reducing our footprint by 30%. Additional site closures are planned and will be announced in due course over the next several quarters. Cost and expected savings for phase two are still in line with our previous discussions. Our legacy restructuring actions in EMEA are progressing as planned, and we should reap the expected savings we've previously identified for 2016. I'm proud to announce that on April 20th, we celebrated the grand opening of the Watts Works Learning Center.

This new 12,000 sq ft facility is located at our corporate headquarters in North Andover and will provide customers, distributors, sales representatives, and our associates a hands-on experience with the company's products and technologies. The learning center includes configurable classrooms, demonstration labs, and working mechanical rooms that showcase Watts' products in action. We had approximately 450 guests at the grand opening, and we received very positive feedback about the new facility. We are excited to reestablish our position as a leader in training the industry. Finally, we are reaffirming the full-year outlook we provided during our February conference call. Todd will review the detailed assumptions again shortly. Moving to the current external environment, let's turn to Slide 4. Let's begin with the non-residential and residential markets in the Americas. The major indices imply that the non-residential market outlook is somewhat mixed.

The ABI has fluctuated with no major positive moves lately, while the Dodge Momentum Index was actually down in March. In the non-residential markets we serve, we expect to see uneven growth in 2016. Based on market intelligence, the non-residential market should be up in the low to mid-single digits in 2016. Longer term, the largest sub-market for us, institutional, is projected to grow more steadily over the next few years than the office and commercial sub-market. In Canada, the same sub-markets are all forecast to be negative this year. Overall, for 2016, we expect to see slow but steady growth in the non-residential end market. The latest data for the residential market is also mixed. Both housing starts and permits were down in March, and builder sentiment was little changed.

However, this data can be lumpy, and we think other macro trends, like employment levels, low mortgage rates, and continued momentum in existing home sales, should provide a tailwind. We expect solid growth in the residential housing sector for 2016. As has been the case for the last, the past few years, EMEA is a mixed bag. On a positive note, we have seen some stabilization in France, our largest market. Whether that stability is long-lasting is tough to gauge. Certain economies, like Russia, the Middle East, and certain portions of Western Europe, Europe, are directly and indirectly impacted by oil prices. Until there is more clarity on the direction of oil, these regions will continue to lag. And uncertainty over Great Britain's potential exit from the EU and subsequent repercussions is creating an overhang.

In Asia Pacific, China's economy continues to experience structural corrections in the commercial real estate sector that will drag overall growth. On the other hand, we see regions outside of China, like Indonesia and Australia, with reasonable growth prospects in 2016. Overall, the markets are playing out as we planned for 2016. Now, I'll turn it over to Todd to talk about our first quarter operating results in more detail. Todd?

Todd Trapp (CFO)

Thanks, Bob, and good morning, everyone. We're on slide 5, which highlights the first quarter financial results. We generated sales of $344 million, down about 3% quarter over quarter. This decline was driven by two factors. First, and most significantly, was the impacts from the exit of undifferentiated products in 2015, which impacted sales by about $30 million or 8%. Secondly, foreign exchange, primarily driven by the weaker euro, lowered sales by approximately $5 million or 2%. These two items were partially offset by strong organic growth of 6% across all regions, an incremental volume of about $3 million from the Apex acquisition. As Bob mentioned, sales growth and other operating metrics were positively affected by approximately 2-3 extra shipping days, depending on the region, in Q1 of 2016 as compared to last year.

When normalized for the additional shipping days, organic sales growth approximated 2% in the quarter. We thought the effect was large enough to highlight the numbers with and without the extra days. From a full year perspective, the extra days in Q1 will be offset with fewer shipping days in Q4. So no change in our full year outlook, really just a comparison issue within these two quarters. Having said that, our organic sales, operating margins, and EPS still demonstrated solid growth even after normalizing for the days. Please refer to page 17 in the appendix, where we provide details of the reconciliation by region. Continuing on. Adjusted operating profit of $37 million increased $8 million or 27%. This translated into adjusted operating margins of 10.8%, up 260 basis points versus Q1 last year.

In terms of operating margins, the 10.8 represents a first quarter record for Watts. Strong volume, favorable sales mix, including the exit of undifferentiated products and productivity, were the main drivers of the record Q1 margins. Adjusted EPS of $0.57 was approximately 27% better than last year. We estimated that the extra shipping days positively affected EPS by roughly $0.06 in the quarter. From a headwind perspective, the exit of undifferentiated products and a higher tax rate negatively impacted EPS by $0.05 and $0.04, respectively. The effective tax rate of 37.4% is over 400 basis points higher than Q1 last year. About half of the increase relates to a reserve that we booked in the quarter associated with an ongoing tax audit, and the other portion relates to earnings mix, which is more heavily weighted to the U.S.

So let's turn to the regions, and on slide 6, we'll review the Americas results for the quarter. Sales were $222 million, down 6% on a reported basis, but up 7% organically. Adjusting for the additional shipping days, Americas organic growth was about 3% in the quarter. We had strong performance from our commercial products like drains, large testable backflows, and ACVs, as well as solid growth for many of our other core products, including water quality, electronics, and gas connectors. Divested products were down about $27 million on a net basis as compared to Q1 of last year. This included a little over $3 million in sales to Sioux Chief in this quarter as we completed the transition services agreement as anticipated.

AERCO grew at a modest pace in Q1, largely due to project timing, which we expect to be temporary as the backlog remains solid. We expect AERCO sales should pick up during the traditional busier second and third quarters for AERCO. Adjusted operating profit in Americas was $33 million, an 18% increase year-over-year. Operating margin expanded 300 basis points, which was driven by volume, favorable sales mix, including the positive impact of divested products, price, and productivity, which also included the benefit from lower material costs. So overall, a good start to the year in Americas with strong margin expansion. So turning to slide 7, let's review EMEA's quarterly results, sales of $111 million were up 2% on a reported basis and up 5% organically.

Foreign exchange negatively impacted sales by $3 million or about 3%, which is less of an impact than we've seen in quite some time. Excluding the additional shipping days, organic growth was 1%. The organic increase was driven by our water and plumbing products, where we are seeing some stabilization in the French construction markets. We also saw some growth in our electronics business, aided by the timing of a large OEM order. Sales in our HVAC and drains businesses were down in the quarter, and just as a reminder, we expected that drains would be down due to the shipment of three large products in Q1 last year that did not repeat. Regionally, we saw mid-single-digit growth in some of our key countries, such as France, Scandinavia, and Italy, while the Middle East continued to be strong, with sales growth over 20% in the quarter.

By contrast, we saw softness in Germany, where we continued to experience pressure in the OEM channel, and unfortunately, Russia still remains a headwind for us. Adjusted operating profit for the quarter was $10.6 million, an increase of 31%. Operating margins of 9.6% increased 220 basis points as compared to Q1 last year. The margin expansion was driven by volume, productivity, including lower material costs and restructuring efforts, as well as some easy comps. Overall, EMEA's performance was relatively, relatively stable for the second consecutive quarter. Now, on Slide 8, let's review Asia Pacific's results. In the quarter, sales were approximately $11 million, up 11% on a reported basis and up 7% organically over the same period last year. Excluding shipping days, organic growth was 1% in the quarter, generally in line with our expectations.

We continued to experience some project delays in the valve business within China, and this is primarily due to the commercial market landscape, which has been down in recent quarters. Conversely, we saw good growth in China in underfloor heating, driven by an uptick in demand for our PEX and PERT products. Outside of China, we continue to see strong valve sales. The Apex acquisition generated about $3 million in sales during the quarter, which more than offset the $2 million of impact from the exit of undifferentiated products. Sales outside of China represented 46% of total Asia Pacific sales in Q1 versus 16% last year, driven by the addition of Apex, plus growth in our valve portfolio in countries like Australia, Indonesia, and Japan. We expect this trend to continue as we expand our business into more mature code-driven countries.

Adjusted operating profit increased $33 million to $2 million in the quarter, and adjusted operating margin increased over 300 basis points to 18.6%. The key drivers of the significant expansion were higher trade volume, favorable product mix, including higher margin Apex sales and strong productivity. So overall, a solid start to the year for Asia Pacific. On Slide 9, a few items I'd like to point out related to free cash flow for the quarter. As you know, historically, Q1 is a slower period for cash, and that played out as expected. Our free cash outflow for the quarter was $31 million, as compared to a $5 million dollar outflow in Q1 last year.

The majority of the incremental outflow relates to a planned inventory increase to support the opening of our new distribution center in Columbus and to establish buffer inventory for other Americas phase two transformation activities. This decision impacted inventory by roughly $17 million in the quarter, and we do expect the inventory balance to ramp down in the second half of the year. We also invested about $4 million more in capital in the quarter to help drive growth and productivity initiatives within our facilities. From a metric standpoint, we improved DSO and inventory turns versus the same period last year by 5% and 6%, respectively. It is also worth mentioning that including in investing activities is a cash outflow of $18 million related to the potential sale of our China entity, which produced undifferentiated products.

This is cash that we've placed in escrow, which will be returned to us when the sale of that business is finalized, which we expect to happen in the second quarter. On the balance sheet, all cash in the escrow has been classified as restricted cash. Separately, we purchased approximately 268,000 shares of our Class A common stock at a cost of about $12.5 million during the quarter. While the first quarter is seasonally slow, we fully expect our cash generation will improve as the year progresses and are focused on achieving 100% cash conversion for the year. Finally, turn to Slide 10 and the outlook on the year. We are reaffirming our full-year outlook.

We continue to expect full-year organic sales growth in the low single digits for the organization, with sales by region falling in line with our previous guidance from February. We expect operating margins should grow 100+ basis points, despite the incremental investment to support future growth initiatives. Currently, we expect to spend between $1.5 million and $2 million per quarter for the investments in the final three quarters of 2016. As I mentioned earlier, we anticipate free cash flow converting at or above 100% of net income.

Lastly, I do want to bring to your attention a minor tweak to the outlook, and that is around our global effective tax rate, which may be at the high end of the 32%-34% range for the year that we previously provided, driven by the mix of earnings weighted heavily to the U.S. and the reserve we booked in Q1 regarding the tax audit. So with that, let me turn the call over to Bob before we begin Q&A. Bob?

Robert Pagano Jr. (President and CEO)

Thanks, Todd. To summarize, the year started out on a good note. Sales grew in all three regions. We saw healthy growth in operating profits, operating margins, and EPS during the quarter. We continued to drive our various rationalization and transformation programs, which we believe should drive better margin performance going forward. And our outlook for the year remains unchanged from our February call. I want to reiterate that we expect to grow our margins in 2016 by 100+ basis points, and we should generate free cash flow at equal to or greater than net income for the year. We are excited about how 2016 has started, and we expect to make continued progress as the year unfolds as we execute on our key initiatives. So with that, Nicholas, please open the lines for questions.

Operator (participant)

Ladies and gentlemen, if you have a question at this time, please press star, then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. One moment for questions. Our first question comes from the line of Jeffrey Hammond with KeyBanc. Your line is now open. Please proceed with your question.

James Picariello (Senior Automotive Analyst)

Hey, guys, this is James Piccariello. Congrats on a nice quarter here. Regarding the, you know, the strong margin performance, even excluding the 50 basis point benefit that you guys pointed out, driven by the additional shipping days, I mean, how sustainable do you think this improvement is the rest of the year? And maybe can you just talk to, you know, what the puts and takes were in the quarter that drove the nice incrementals?

Todd Trapp (CFO)

Yeah. So, James, this is Todd. I'll jump in on this one. So, you know, listen, we had actually a nice start to the quarter, right? We're really happy with the margin performance, but there's a couple of things I think it's worth mentioning. I think first and foremost, we had strong sales aided by the extra days in the quarter, right? And this drove some favorability on the absorption line. We also had some nice benefit of some commodity tailwinds in the quarter as well. And if you think about where commodities are today, it seems to have, I would say, troughed in the January time frame.

While we expect to see some continued benefit in Q2, I think as you think about the second half of the year, it's going to be a little bit of, I would say, some tougher comps. We also saw some nice benefit on restructuring in the quarter as well. Between raw material commodity headwinds, favorable restructuring, as well as the incremental volume, that really was driving our strong margins in Q1. Now, as I think about it over the course of the remainder of the year, I do expect to see some solid margins continuing in the Americas business, as a result of the transformation initiatives going on there.

I expect to see continued benefit out of EMEA as well as in APAC, although it'll probably moderate, more moderate growth and expansions in the second and third quarter going out.

James Picariello (Senior Automotive Analyst)

Got it. Thanks.

Todd Trapp (CFO)

And then one other question just on Asia. I mean, so Asia was extremely high in the quarter. And I think if you ask us, again, besides the additional trade sales days we had and the additional margin for APAC sales, we did have higher amounts of intercompany activity from our China plant to really help support some of the Americas transformation, and this drove better factory absorption. So going forward, we think margins for Asia should normalize in the 10%-15% range, really depending on the amount of intercompany volume that we drive through that factory.

James Picariello (Senior Automotive Analyst)

Got it. Very helpful. Thank you. You guys also did mention the effective tax rate for the year is trending higher towards that 34%, and some of it is tied to an ongoing tax audit. You know, whatever color you could provide there would definitely be helpful.

Todd Trapp (CFO)

Yeah, so we had one tax charge in the quarter and approximately about $0.02 for a reserve established for, you know, an ongoing tax audit. And, you know, the remainder of the increase was really driven by worldwide earnings mix being more heavily weighted to the U.S. And so, you know, we expect the full year effective tax rate will be towards the high end of the range of 34%, really just given the reserve change plus the continued weighting of earnings in the U.S.

James Picariello (Senior Automotive Analyst)

Got it. I will get back to you. Thanks.

Operator (participant)

Our next question comes from the line of Kevin Bennett with Stifel. Your line is now open. Please proceed with your question.

Kevin Bennett (Research Analyst)

Thanks. Good morning, everybody.

Robert Pagano Jr. (President and CEO)

Morning, Kevin.

Kevin Bennett (Research Analyst)

First question, Bob, can we talk about pricing? I know Todd just mentioned the raw materials. I'm wondering, you know, what pricing was in the quarter, and then what do you think, you know, given the, I guess, recent kind of run-up in commodities, what do you think about pricing for the rest of the year?

Robert Pagano Jr. (President and CEO)

Yeah, so when I look at pricing, you know, we've had decent pricing. It's, you know, we put in a price increase in March. We expect about 1% of that to hold, and, you know, part of our growth assumptions are 0.75%-1% of growth related to pricing. So, you know, it's been able to hold. We have some contracts with some OEMs, where we do have to pass on the favorability based on the LME prices. But overall, we believe, we're holding our own on the pricing, and we believe, we can sustain that for the rest of this year.

Kevin Bennett (Research Analyst)

... Okay, great. And then I guess the next question is about your new training center that you opened up, which seems very interesting. I was curious if you could talk about, you know, what was the investment there? And I guess, what was kind of the thought behind that, and what kind of return do you think that will generate over time? Just elaborate on that a little bit.

Robert Pagano Jr. (President and CEO)

Yeah. So we spent $several million on this new training facility, and really what we're trying to do is Watts has so many brands and components, and we tried to put all the components together to show how they all work in an overall system. So what that does is allows all our people, all our customers to really look at, see all our components in one place. It's a hands-on experience, and certainly, we invite you and other investors to come and look at this because it's state-of-the-art. It really showcases our products and allows us to get voice of the customer.

As we train customers and see them, you know, try our products hands-on, put them together, taking them apart, see how they interact, we get to listen to their input on how we can better improve them or other options to do that. So it's a great new investment. You know, it's always difficult to put a value on this, but, you know, I know from past experience that, you know, getting a loyal customer, training them very well, really drives long-term commitment to your product. So we believe that's one of our key growth initiatives that will play out in the longer term for our company.

Kevin Bennett (Research Analyst)

Got you. That makes sense. Look forward to seeing that someday. Thank you, guys.

Robert Pagano Jr. (President and CEO)

Thank you.

Todd Trapp (CFO)

Thank you.

Operator (participant)

Our next question comes from the line of Kevin Maczka with BB&T. Your line is now open. Please proceed with your question.

Kevin Maczka (Managing Director and Senior Equity Research Analyst)

Thanks. Good morning.

Robert Pagano Jr. (President and CEO)

Good morning, Kevin.

Kevin Maczka (Managing Director and Senior Equity Research Analyst)

The shipping days disclosure is kind of a new topic that we haven't really had to think much about in the past. Just to be clear on that, the six cents that was a benefit this quarter, you expect a headwind of about that magnitude in Q4? Is that the way to think about this?

Robert Pagano Jr. (President and CEO)

Yeah. So Kevin, it's nothing more than just the 4-4-5, the calendar close. And so the benefit we saw in Q1, we expect to be pretty much fully offset in Q4. So, you know, 4% organic growth rate, probably 50 basis points on the operating income. I think that would be, from a modeling standpoint, the right way to think about it.

Kevin Maczka (Managing Director and Senior Equity Research Analyst)

Got it. In terms of the margins and the strength in the quarter and what's sustainable and what's not, I think you're pretty early days on the sourcing initiatives. That wasn't one of the call-outs here. Can you give an update on that, and what are your expectations as we move forward there?

Robert Pagano Jr. (President and CEO)

Yeah. So Kevin, it's Bob. The related to our productivity, when we talk productivity, we include sourcing savings. So I would tell you, our sourcing savings, both from a, let's call it commodity, but, you know, we just follow commodity, but really from our putting our buying power and leveraging global spend, you know, we're really in full force. So we started seeing the benefits of that, you know, in the second half of last year, significantly. We called out $4 million of benefits last year. Our goal is an incremental $4 million of benefits just from sourcing, unrelated to commodities. And, you know, we're on track, a million this quarter on that. So, you know, that team is working very, very well, and, we believe, you know, that will continue throughout the quarters.

As Todd earlier mentioned, the commodities, you know, they, you know, basically, we saw the lowest commodities in the first quarter as, you know, we start getting tougher comps in the second half of the year. But again, that has been a tailwind for us, and our teams are executing very well on those initiatives.

Kevin Maczka (Managing Director and Senior Equity Research Analyst)

Got it. And just finally from me, the growth investments, I think, I think it was mentioned, $1.5 million-$2 million per quarter going forward. Is that a step up from what we saw in Q1? If you gave that number, I missed it.

Robert Pagano Jr. (President and CEO)

Yeah. So, as we talked about in the fourth quarter of last year, we said we were gonna come out lower on the investments because we really wanted to see how the economy and the markets were behaving. So we purposely were lower on our investments, about $1 million in the first quarter. We expect that to ramp up to $1-$2 million or $1.5-$2 million in the second and third and fourth quarter. So again, we're ramping up. We're feeling more confident about the year and the markets based on what we saw in the first quarter. So, you know, we're, we're executing on those initiatives as we go forward.

Kevin Maczka (Managing Director and Senior Equity Research Analyst)

Okay, great. Thank you.

Robert Pagano Jr. (President and CEO)

Thank you.

Todd Trapp (CFO)

Thank you.

Operator (participant)

Our next question comes from the line of Jim Giannakouros with Oppenheimer. Your line is now open. Please proceed with your question.

Jim Giannakouros (Managing Director and Senior Analyst)

Thanks. Good morning, guys.

Robert Pagano Jr. (President and CEO)

Good morning, Jim.

Jim Giannakouros (Managing Director and Senior Analyst)

I get, I get the selling day is helping Q1 and the give back in Q4, but any areas of your business tracking better or worse than initially expected coming into the year? Just trying to understand the puts and takes, you know, between, you know, what you were seeing a few months ago versus your expectations from a, I guess, from a market perspective, or even just from a, you know, the inventory, commodity wind down, things that are trending better or worse, that you can speak to, that nets out to your, call it, you know, maintaining your original outlook.

Robert Pagano Jr. (President and CEO)

Yeah. Let's start off with some execution issues. I think the execution of our new distribution center is ahead of schedule, which has allowed us to build inventory faster, which is good in allowing us to make the transition. So I think that's, you know, that's positive. Also, EMEA, we weren't exactly sure. We thought, you know, where we're gonna be at with that. As you know, our guidance is dialed it down a little bit, and we saw in the first quarter, it was better. But I think we're taking a cautious outlook for the second half of the year with the, you know, the exit potential, you know, by the UK and the Greek exit. We just don't know the turmoil that is.

Also, you know, when we talk to our local team there, you know, they're optimistic, but we're cautiously optimistic, again, because any major issue in Europe, it tends to have an impact on the, you know, whole economy there. So we wanna wait and see there before we call it a success and potential to grow further, just because the economic uncertainty is there. So we're playing it a little cautious there in that regard. So that's probably a little better than we expected. All the other things are kind of in line with what we expected.

Jim Giannakouros (Managing Director and Senior Analyst)

Got it. That's helpful. And, specifically on North America, I haven't heard about any disruptions in your lead-free foundry. Can you update us on how that's running and at what capacity? And just a quick follow-on, can you estimate how much the milder weather benefited your 1Q?

Robert Pagano Jr. (President and CEO)

Yeah. So, continued questions on our foundry. But, so our foundry is doing well, no interruptions, and the teams continue to execute. And, we're looking really at our, you know, Franklin facility is not just a foundry. We've got a large effort to transform the whole machine shop and really looking at that whole value stream. So we're on top of it. The team's making great progress, and we'll continue to execute. Regarding your second question, you know, we looked at the weather from a weather point of view, and we estimated it was probably impacting us favorably by 1%. But if you recall, in the fourth quarter, we called about a large wholesaler order that came in that impacted us by 1%.

We kind of looked at both of those as netting out from a year-over-year comp point of view. You know, weather probably helped us by 1%, but that one large order that got moved into the fourth quarter of last year hurt us by 1%, so they netted each other out.

Todd Trapp (CFO)

Then the other thing I might add there is that the push out of that one AERCO order as well, Bob.

Robert Pagano Jr. (President and CEO)

Yeah.

Todd Trapp (CFO)

It's probably about 1 point in the quarter as well.

Robert Pagano Jr. (President and CEO)

Exactly.

Jim Giannakouros (Managing Director and Senior Analyst)

Got it. And one follow-up, if I may. AERCO, what's the growth implied there in your plan or guidance for North America in 2016?

Todd Trapp (CFO)

If for 2016?

Jim Giannakouros (Managing Director and Senior Analyst)

Yeah.

Todd Trapp (CFO)

It's 10+, I would say, would be the growth rate for AERCO in 2016.

Robert Pagano Jr. (President and CEO)

Yeah, it was on the low single digits in the first quarter, but that was timing. As you know, we had a very, very strong fourth quarter, strong double digits and growth in the fourth quarter. And as you know, that business is very project and lumpy, you know, but the team is on track to execute the growth numbers that Todd just talked about.

Jim Giannakouros (Managing Director and Senior Analyst)

Understood. Thank you.

Robert Pagano Jr. (President and CEO)

Thank you.

Operator (participant)

Our next question comes from the line of Tristan Margot with Cowen and Company. Your line is now open. Please proceed with your question.

Tristan Margot (Head of Thematic Content)

Hey, guys, good morning. I just wanted... I know this is very small, but could you address your growth in Asia, aside from China, and was this expected?

Robert Pagano Jr. (President and CEO)

Yeah. So, we've had a focus on, you know, we didn't wanna be completely relying on China, especially with all the macro things that are happening there. So we've been at a conscious effort to grow outside of China. And as Todd talked about Indonesia, Japan, Australia, those are key focus areas that we saw very nice growth in the quarter. So we're becoming, you know, certainly, China is the largest portion of that, but we're trying to expand beyond that, and, you know, that's why we bought the Apex Acquisition, which really is in New Zealand. So we're trying to broaden our Asia focus. And, you know, so China was in line with what we expected, but the other regions were strong.

Tristan Margot (Head of Thematic Content)

Okay, thanks. And could you give us some colors on your end markets, specifically in the U.S., maybe on resi? What you're seeing now and going forward?

Robert Pagano Jr. (President and CEO)

Yeah. So in my opening comments, I talked about that, you know, we feel good about, you know, the residential market. We feel that's strong. Commercial's a little lumpy, but we've seen positive growth from that point of view. So we're, you know, confident in both of those markets, this year. Also, remember that a large portion of our business is aftermarket or repair and replacement. That tends to follow GDP growth, you know? So, you know, you gotta look at, you know, 60% of our North America business really follows that, aftermarket replacement business. So the other portions are on the new construction. So anyways, we're positive on those markets.

Tristan Margot (Head of Thematic Content)

Okay, thanks. Congrats on the quarter, guys.

Todd Trapp (CFO)

Thank you.

Robert Pagano Jr. (President and CEO)

Thanks.

Operator (participant)

Our next question comes from the line of David Rose with Wedbush Securities. Your line is now open. Please proceed with your question.

David Rose (SVP of Equity Research)

Good morning. Thank you for taking my call. I just wanted-

Robert Pagano Jr. (President and CEO)

Good morning, David.

David Rose (SVP of Equity Research)

First of all, I wanted to, you know, just say thank you for, for being, you know, straightforward with the, the additional shipping days. Hats off to you for, for, the candor. Second, if we can kind of go through the, cost, or at least the benefits from reduced raw material costs, can you give us a, a percentage or a dollar figure or a margin number of the impact of that, of the lower raws?

Robert Pagano Jr. (President and CEO)

David, as you know, we don't talk about commodity costs in detail at that level just because of the competitive nature of it. But certainly, it was a tailwind for us, a strong tailwind, and we continue to drive that. Yeah, but not only that, I think, as I said earlier in one of the questions, is that our whole focus on global sourcing and how that impacts our supply chain, on-time performance, all of that is a key focus for our team. So as we look at this, you know, we'll see continued improvement in Q2. I think it's a little tougher comparison, as I said, in the second half of the year, but it's certainly positively impacting our margins.

David Rose (SVP of Equity Research)

... Okay. Then, as it relates to, you know, sort of the investment you highlighted for the remainder of the year, but how should we start to think about 2017? I mean, are you gonna continue to, you know, increase the level of spend for growth, or does it sort of flatten or does it drop off? I mean, how should we think about the long-term CapEx?

Robert Pagano Jr. (President and CEO)

Yeah, so we believe there's a-

David Rose (SVP of Equity Research)

For the next year or two.

Robert Pagano Jr. (President and CEO)

Yeah. So we believe from a capital allocation point of view, we really wanna continue to invest organically. That's the a key investment opportunity. We believe we have opportunities to invest in both growth and productivity improvements in our factories. So we'll continue to do that investment, but we also expect higher productivity as a result of some of these investments, as well as growth. So you know, I would say this year is probably a net you know cost impact from those incremental investments. But we continue to invest for the future, and we plan on growing and investing and continuing to do that. So you know, I would say we're gonna continue to invest, but we have a high you know a key threshold for return on investment and payback.

We're gonna make sure we make smart business decisions as we allocate that capital.

David Rose (SVP of Equity Research)

Okay, so we should assume that we build on the current number for this year?

Robert Pagano Jr. (President and CEO)

I don't know about build. I would say about the same, probably.

David Rose (SVP of Equity Research)

Okay. And then lastly, as it relates to capital allocation, I mean, you know, AERCO was a pretty meaningful acquisition for you last year, and you know, you mentioned that you're interested in sort of controls and technology on the water side. Can you provide us a little bit more color, you know, in terms of the verticals? Is it gonna be more on the industrial side, residential? Is there any interest in the municipal side, given the strength in muni?

Robert Pagano Jr. (President and CEO)

Yeah. So when we look at it, we look at... As you know, we can't control the timing of any acquisitions. We look at all the spectrums. I would say, you know, number one, we're gonna stay close to our core. Number two, you know, certainly more of our focus is on the commercial space. You know, municipal, not a heavy focus. I think we're looking, you know, at, you know, companies come with some municipal experience, but I wouldn't do a flat-out pure municipal acquisition just on pure municipal. But overall, you know, I think our focus is more in that, you know, residential, commercial, but probably a little more on the commercial side.

David Rose (SVP of Equity Research)

Okay, perfect. Thank you very much.

Robert Pagano Jr. (President and CEO)

Thank you.

Operator (participant)

This concludes today's Q&A session. I would now like to turn the call back over to Bob Pagano for closing remarks.

Robert Pagano Jr. (President and CEO)

Okay. Well, thank you, everyone. We appreciate your interest in Watts Water, and we look forward to updating you on our Q2 performance in early August. Thank you very much.

Operator (participant)

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day. Speakers, please stand by.