Watts Water Technologies - Q2 2018

Transcript

Operator (participant)

Good morning. My name is Amanda, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2Q18 Watts Water Technologies, Inc. earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's prepared remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question at any point, you may press the pound key. Thank you. At this time, I would like to turn the call over to your host, Mr. Tim MacPhee, Treasurer and VP Investor Relations. Please go ahead, sir.

Timothy MacPhee (VP of Investor Relations)

Thank you, and good morning, everyone, and welcome to our second quarter 2018 earnings conference call. Joining me today are Bob Pagano, President and CEO, and Shashank Patel, our CFO. Bob will provide his perspective on our second quarter results before turning the call over to Shashank, who will address the results in more detail and offer our latest outlook for the second half of this year. Following the prepared 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 Investors section of our website. We will reference these slides throughout our prepared remarks. Any reference to non-GAAP financial information is reconciled in the appendix of the presentation.

Before we begin, I'd like to remind everyone that during the course of this call, to give you a better understanding of our operations, we may 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' 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. Now, let me turn the call over to Bob Pagano.

Robert Pagano (CEO)

Thanks, Tim, and good morning, everyone. Before I speak to the quarter, I'd like to welcome Shashank Patel to the Watts team. He began on July second as CFO and brings a strong financial skill set and wealth of experience from a long tenure at Xylem and ITT. I've known Shashank for over 21 years and believe he will be instrumental in driving our near-term productivity efforts and our long-term strategy. Now, please turn to slide 3 in the presentation, and I'll provide some commentary on the second quarter. The team delivered another strong quarter, including record sales, adjusted operating margin, and EPS. We topped $400 million in quarterly sales for the first time, expanded adjusted operating margin and surpassed $1 in quarterly EPS. The results reflect our commitment to driving profitable top-line growth through commercial and operational excellence, as well as favorable benefits from tax reform.

The Americas delivered strong organic sales growth and solid operating margin expansion during the quarter. The sales increase is partially attributed to the pre-buy impact of our July price increases, but the underlying growth was impressive. APMEA, driven by the Middle East and other regions outside of China, delivered solid organic growth. In Europe, we experienced top-line softness within our Fluid Solutions platform, which in turn drove a margin reduction year-over-year. We have seen limited growth in this platform, along with pricing pressures and the impact of continued inflation. Therefore, we have decided to reduce that platform's cost structure. We are currently finalizing a restructuring plan primarily focused on headcount reductions. The cost will be recognized in our third quarter results and highlighted as a special item. Now, let me quickly mention our view on the markets. Overall, the markets are performing as anticipated.

In the Americas, growth expectations are still solid in both the non-residential and residential end markets, despite some weakness noted in the recent June housing starts and permits. The U.S. repair and replacement market is also seeing continued growth. For Europe, end market growth has moderated since the first quarter, and we've seen softness in the French wholesale market recently due to destocking. In APMEA, we expect growth in most regions will continue, with a caveat some markets may be hindered by ongoing trade pressures. Further, we continue to see softness in the residential market in China, which has been soft for a number of quarters. As discussed in April, we announced price increases that went into effect at the beginning of July to address inflation and the impact of enacted tariffs. As the third quarter progresses, we'll be able to assess the market reaction to these price increases.

However, given the existing cost pressures and potential incremental tariffs, we believe the market will accept the price increase. We'll continue to monitor this very fluid tariff situation. During the second quarter, we invested approximately $4 million for growth initiatives at the high end of the range we provided back in May. We are comfortable with the added investment due to our strong second quarter top line and operational performance. And because we expect that performance to continue, we're increasing our expected full-year investment spending to $13 million, $3 million more than our original outlook. Much of the incremental spend will be made in the Americas and focused on growth and productivity improvements. Finally, we are raising our full-year organic sales growth for 2018, which Shashank will review momentarily.

We expect solid organic growth in the second half of the year, moderating slightly in the Americas as compared to the first half, given the impact of pre-buy sales and, in general, some tougher second half comps. We expect our operating margin for the full year should expand by approximately 50 basis points. Now, I'll turn the call over to Shashank to talk about our second quarter operating performance and provide more detail on our second half outlook. Shashank?

Shashank Patel (CFO)

Thanks, Bob, and good morning, everyone. First, I'd like to say how excited I am to be joining the Watts team. My first impressions are very positive, and I look forward to working with our investor community over the coming months and years. With that said, please turn to slide 4, and let me walk you through the second quarter results. Reported sales of $408 million were up 8% and represented an all-time quarterly sales record for Watts. Organically, sales were up 5%, with strength in the Americas and Asia Pacific being partially offset by softness in Europe. Foreign exchange, mainly driven by a stronger euro, increased sales by $10 million, or 3% year-over-year. As planned, product rationalization was approximately $2 million, representing a 50 basis points headwind in the quarter.

Adjusted operating profit was $52 million, an increase of $5 million or 10%. This translated into an adjusted operating margin of 12.8%, up 30 basis points versus last year and a record for the company. This was achieved while continuing to invest approximately $4 million in our growth initiatives. Volume, price, and productivity were the main drivers of the record margin performance, more than offsetting general inflation, including higher commodity and transportation costs. Adjusted EPS of $1.05 was 27% better than last year and also represented a new all-time record for Watts. Operations drove eight cents of the increase, while tax reform, lower non-operating expenses, and foreign exchange provided 14 cents in total.

The effective tax rate in the quarter was 27.6%, or 450 basis points lower than the prior year, mainly due to the benefits of tax reform. Year to date, free cash outflow was $14 million, as compared to a $2 million outflow during the first half of 2017. The incremental outlays related primarily to inventory, tax payments, and additional capital spending. We made progress in the second quarter, and consistent with our historic seasonal patterns, we expect that cash generation should improve in the second half. During the second quarter, we repatriated approximately $39 million in cash. Year to date, we have repatriated about $110 million, using a majority of that to pay down debt.

In the second quarter, we purchased approximately 59,000 shares of our common stock at a cost of $4.5 million. Year to date, we've returned a total of $25 million to shareholders in dividends and share repurchases as part of our balanced capital deployment strategy. Overall, we are very pleased with our second quarter performance, as we set new highs in sales, adjusted operating margin, and earnings per share. Turning to the regions, on slide five, let's review Americas results for the quarter. Sales of $272 million were up about 9% on a reported basis and up 8% organically. Similar to the first quarter, we saw broad strength across a number of product lines, including plumbing, water quality, and electronics. Our heating and hot water platform had double-digit growth, with both AERCO and PVI product lines performing well.

We also benefited from favorable comps versus prior year. We estimate that about 2 points of our second quarter organic growth was driven by customers pre-buying ahead of our announced July price increases. Strong price realization drove approximately 1 point of growth in the quarter. Adjusted operating profit in the Americas was $46.7 million, a 13% increase year-over-year. Operating margin expanded by 70 basis points to 17.2%. Volume, price, and productivity offset increased inflation, commodity and transportation costs, and incremental growth investments. In summary, a continued strong operating performance for the Americas in the second quarter. Let's turn to Europe's results on slide 6. Sales of $117 million were up 6% on a reported basis, but down 2% organically.

Foreign exchange, primarily the euro, positively affected sales by about $9 million or 8% in the quarter. We saw continued solid growth in our Drains platform, which was driven by products sold into the marine end markets. Regionally, Drains saw strong growth in the Nordics. In the Fluid Solutions platform, sales were down, mainly due to the softness in our water, plumbing, and HVAC products. By region, Fluid Solutions sales into France, Germany, and Italy were down in the quarter. In France, the decline was driven by product exits and a slower wholesale market due to customer destocking. Germany's softness was driven by a slowdown with OEM customers and some softness in the wholesale channel. Italy saw continued headwinds related to heat metering products and the exit of a product line.

Adjusted operating profit for Europe in the quarter was $12.9 million, which translated into operating margin of 11%, a decrease of 80 basis points versus the second quarter of last year. The margin degradation was driven by reduced volume, unfavorable sales mix, inflation, and incremental investments being only partially offset by productivity and price. Overall, a soft quarter in Europe, and as Bob mentioned, we are taking actions to reduce fixed costs within our Fluid Solutions platform. We are in the process of finalizing the action plan. We believe that the sales downturn in the second quarter is a timing issue, but we are addressing this proactively should that not be the case. Moving to Slide 7, let's review Asia Pacific, Middle East, and Africa results.

In the quarter, sales were approximately $19 million, up 9% on a reported basis and up 5% organically over the same period last year. Excluding product rationalization, organic sales were up 11%. As we saw in the first quarter, sales outside of China more than offset softness within China. Sales outside of China increased organically by 26%. We saw strength in the Middle East, New Zealand, and Australia from higher demand for our plumbing and HVAC products due to our broad channel expansion. China sales, excluding product rationalization, decreased 12% as continued demand for our commercial valves sold into data centers and semiconductor markets was more than offset by softness in our residential underfloor heating products.

Adjusted operating profit in the quarter for Asia Pacific decreased 27% to $1.6 million, which translated into adjusted operating margin of 8.3%. The key drivers of the margin reduction included transactional FX headwinds and incremental investments. As expected, Asia Pacific, Middle East, and Africa's top-line growth gained some momentum in the second quarter. We expect growth to continue into the second half of 2018, fueled by our growth investments in Middle East and Africa. Finally, turning to Slide 8 and our outlook for the second half of the year. On a consolidated basis, we expect continued solid organic sales growth in the second half, with overall second half growth of between 4% and 5%.

By region, the Americas should see consistent growth from relatively healthy end markets and pricing, offset partially by tougher second half comps and the pre-buy impact mentioned earlier. In Europe, we expect sales should be flat to up marginally. And in Asia Pacific, sales should pick up in the back half of the year as our business outside China continues to expand and China returns to growth driven by easier comps. Our consolidated adjusted operating margins grew by 40 basis points to 12.2% in the first half of 2018. We expect better year-over-year margin expansion in the second half due to higher price realization, partially offset by the impact of higher commodity inflation driven by the impact of tariffs. We expect full-year operating margin to be approximately 12.4%.

This margin expansion includes an increase in our growth investments during the second half. As Bob mentioned, we have increased our total expected investment spend this year from $10 million to approximately $13 million. We now expect about $7 million of spend in the second half for growth investments, and we are forecasting strong cash flow generation in the second half, consistent with our performance over the past several years. We are still focused on achieving 100% free cash flow conversion for the year. Before I turn the call back over to Bob, a few items to keep in mind regarding the third quarter. We are expecting consolidated organic growth in the third quarter to be in line with our second half expectations, with the Americas at the lower end of our growth outlook, given the second quarter pre-buy impact and some tougher third quarter comps.

Product rationalization should be approximately $1.5 million in the third quarter, of which $1.3 million is in Europe and $200,000 is in Asia Pacific. Consolidated operating margin expansion in the third quarter may be slightly below our full-year expectations. This is primarily due to an increase of expected investments during the quarter. We expect price to more than offset net inflationary costs. Regarding investments, we anticipate incremental investments of $4 million in the third quarter, $3 million in the Americas, $1 million in Europe, and $300,000 in Asia Pacific. These investments should be partially offset by approximately $1 million in incremental restructuring savings, about $500,000 each in the Americas and Europe. We expect our third quarter effective tax rate to be in line with our full-year outlook of 28%.

Finally, based on current foreign exchange rates, the translation impact should be fairly neutral when compared to the third quarter of last year. With that, I'll turn the call back over to Bob before we begin Q&A. Bob?

Robert Pagano (CEO)

Thanks, Shashank. To summarize, the business delivered record sales, adjusted operating margin, and earnings per share in the second quarter. Much of the upside was driven by the Americas, which continued to deliver a strong operating performance. Europe came in softer than expected, and we are taking actions to address that. APMEA growth picked up in the second quarter, and we expect that to continue into the second half. And we are raising our full-year sales outlook based on a strong first half and our most recent expectations for the second half. So with that, operator, please open the lines for questions.

Shashank Patel (CFO)

At this time, I would like to remind everyone, in order to ask a question today, you may press star, then the number one on your telephone keypad. If you would like to withdraw your question, you may press the pound key. I'll pause for just a moment to compile the Q&A roster.

Operator (participant)

...Your first question comes from the line of Nathan Jones from Stifel. Nathan, your line is open.

Nathan Jones (MD and Senior Equity Analyst)

Good morning, everyone.

Robert Pagano (CEO)

Good morning, Nathan.

Nathan Jones (MD and Senior Equity Analyst)

Bob, I'd like to just start off on the increased growth investments. Clearly, some strong top line here gives you the opportunity to invest a little more. Can you talk about what kinds of things those investments are targeted on? How should we think about the growth investments next year? Do you think they maintain at this kind of level? Do they go up even further? Do they come down? Just how we should be thinking about that.

Robert Pagano (CEO)

Yeah. So, the incremental $3 million investment are gonna be focused on connected products, channel expansion, primarily in the Middle East and Latin America, training, and continuous improvement through the Watts Performance System. So we believe those are actions are, you know, gonna help us as we go. A lot of time, these investments take 3-6 months to realize, so more seeds are being planted to look outwards on that. From an investment point of view into the future, we really look at, you know, we're in the midst of our strategic planning process right now, and with, you know, continued growth, you know, we hope to continue to invest more for the future. So a little early for that.

You know, some of these are one-time in nature, but a lot of them will continue into the future and support our growth going forward.

Nathan Jones (MD and Senior Equity Analyst)

No color on whether it should be up, down, or the same in 2019 yet?

Robert Pagano (CEO)

Not yet. You know, but I hope to be able to spend equal or more based on, you know, where we're seeing volumes and what's happening in the business because we're seeing great return on our investments. And, you know, in this environment where acquisitions are at high multiples, I think it's prudent to invest in organic growth.

Nathan Jones (MD and Senior Equity Analyst)

Organic investments always have the best return. On the price-cost front, so you talked about implementing price increases in July. If there's any color you can give on how the market has accepted those in the first month they've been out there, any color you can give on where you were on the price-cost equation in the first half, and how you think that the price increases in July impact where you are on price-cost in the second half?

Robert Pagano (CEO)

Yeah. So, you know, price costs, I think, we held our own in the second or the first half of the year. I think, you know, we talked about realizing about 1% price that more than offset the inflationary price-cost that we saw. When we look at the second half, we believe we're gonna get another incremental 1 point of price, particularly in the Americas. So that's giving us confidence. And, you know, in July, early indications are positive that we're getting the price. So it's still too early to say, but, you know, right now, given the inflationary pressures that are out there and that everybody's seeing, we believe it's gonna stick.

Nathan Jones (MD and Senior Equity Analyst)

Do you? You said you could see another point of price in the second half. Does that correspond with another point of inflation that you're seeing? So you remain about the same, or are you seeing more or less than a point of inflation? Just how are you relative to the first half overall?

Robert Pagano (CEO)

We think that the incremental 1% will at least cover inflation. So, you know, it should be maybe a little bit positive.

Nathan Jones (MD and Senior Equity Analyst)

Great. That helps a lot. Thanks very much.

Robert Pagano (CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Ryan Connors from Boenning & Scattergood. Ryan, your line is open.

Ryan Connors (MD)

Great, thanks. I just wanted to follow up there on the Nathan's question there regarding price. I mean, obviously, price-cost, it's been volatile in copper and brass. I mean, we had a huge run-up earlier in the year, but now lately, all you read about is the big decline in copper. So, I mean, how does that impact not just your own cost structure, but you know, the tenor of you know, discussions around price? I mean, those are the headlines are kind of out there going the other way now.

Robert Pagano (CEO)

Well, copper's been very volatile. You know, it's going up and down. It all depends on what you read about whether China's slowing or accelerating and how much, investment is going into China. So, right now, we believe, you know, we can still hold our price. And, you know, the big wild card that we're all looking at right now is these proposed new China tariffs, and that's still out there. And, the more we heard that it's gonna go from 10 to 25%, we'll be looking at that, and, if that does go through, we're gonna pass on even a further price increase.

Ryan Connors (MD)

Got it. Okay. My other one was regards to, you know, you mentioned 2% contribution of this pre-buying effect to the growth in Americas in 2Q. Can you just talk about whether that was channel stuffing relative to actual, you know, demand pull-through on the end customer side, and how that leaves the channel inventory situation for third quarter, and what your near-term outlook is for volumes on that basis?

Robert Pagano (CEO)

Yeah. So I think people were trying to buy and fill the channel. On the flip side, you know, July started out pretty strong also, so that would tell us that the overall demand is still in the market. So we're cautiously optimistic right now, in particular in the Americas, in what we're seeing in the growth. The pipeline's full, the quoting's high, and we feel pretty good about North America.

Ryan Connors (MD)

Great. And one last one. On this European restructuring initiative that you're gonna embark on here, I mean, correct me if I'm wrong, but, but we've had, over the last, you know, number of years, several rounds of restructuring in Europe. I mean, are we at the point where... I mean, I'm surprised there's that much left to do, I guess. So what... Can you just comment on that? I mean, what, what, what was left on the table from the last few rounds or last couple of rounds, and, and whether we might not be, you know, at risk of cutting into bone?

Robert Pagano (CEO)

Yeah. No, we're looking at this, and we're very careful about cutting into bone and stuff. I mean, we're looking at overhead, we're looking at productivity, and yes, you know, we've done, you know, recent restructuring. But if you think about it, Europe has not been growing as originally planned in many of our forecasts and our past forecasts. So, you know, I keep on looking for productivity. We're driving productivity, and we're investing, in particular, in our European platforms of Drains and Electronics, which are growing globally. So this is more of the Fluid Solutions business, and as you know, in Germany, we're more tied to OEM business, and we're at the mercy of some of the OEMs on some of this, where they can take back some of the work internally.

We're rightsizing our business for the volume we see, as well as driving productivity.

Ryan Connors (MD)

Great. Well, that's helpful. Thanks for your time this morning.

Robert Pagano (CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Mike Halloran from Baird. Mike, your line is open.

Michael Halloran (Senior Research Analyst and Associate Director of Research)

Thank you. Morning, everyone.

Robert Pagano (CEO)

Morning, Mike.

Michael Halloran (Senior Research Analyst and Associate Director of Research)

So what—could you talk a little bit about what you're seeing on the hot water side, PVI, AERCO, obviously, a couple good quarters in a row here after, you know, some choppiness before that. How are you looking at the landscape on a forward basis? How sustainable do you think the progress you've seen over the last couple of quarters is, and what's the competitive dynamic right now?

Robert Pagano (CEO)

Yeah. So, Mike, we're seeing, you know, we said double-digit growth in that platform, and we're seeing robust product demand. And I think a lot of it is with our new product development, et cetera, in there. Some of the smaller competitors that were very aggressive in price on last year, we're seeing them come, you know, they're not as strong. We're still seeing pricing pressure, but our new products development and our new products that we're launching are grabbing, you know, taking back some share from that, from that point of view, from the smaller ones. So again, we feel pretty confident. The team, the pipeline is active, and overall, we feel that'll continue through the rest of this year.

Michael Halloran (Senior Research Analyst and Associate Director of Research)

I know that makes sense. And then on the M&A side, capital deployment side, you know, you alluded earlier that multiples are still pretty high. You know, you obviously, your balance sheet's in good shape. You know, talk a little bit about what the market looks like on the M&A side from a pipeline and actionability, and what, what your alternatives are if you, if you aren't able to push forward any, any accretive on a returns basis acquisition.

Robert Pagano (CEO)

Yeah, Mike. So, you know, we really believe in a balanced capital deployment strategy, and, you know, our pipeline is full. We're continuing to cultivate relationships, but, you know, we're gonna be disciplined in that. And, you never know when a potential M&A opportunity will come up, so you keep cultivating, but we're gonna be disciplined. And, as we said earlier, you know, some of our internal investments are really paying off, so we've made a strategic decision to go faster and forward with some of those, given the current environment out there.

Michael Halloran (Senior Research Analyst and Associate Director of Research)

Appreciate the time. Thank you.

Robert Pagano (CEO)

Thanks, Mike.

Operator (participant)

Your next question comes from the line of Brian Lee from Goldman Sachs. Brian, your line is open.

Brian Lee (MD andHead of Clean Energy, Renewables Research)

Hey, guys. Thanks for taking the questions. Good morning. I guess another question on pricing. This is an off-cycle price increase. Have you guys seen your peers take similar actions? Just wondering if there is any reason to have guarded optimism around price sticking here as you move through the year.

Robert Pagano (CEO)

Yeah. Yes, this is off cycle, and we have seen competitors follow through just right, you know, with us or behind us. So yes, they're also in, from our intelligence, increasing price also.

Brian Lee (MD andHead of Clean Energy, Renewables Research)

Okay, great. And the second question, just, I may have missed this, but on the outlook, last quarter, you guys provided a bit of a region-by-region margin view, in addition to the organic growth views. Those were all for positive margin expansion across each of the regions. Wondering, you know, where you stand on the margin outlook here by region? And if you could speak to maybe some of the drivers around the 50 basis point margin expansion view, which I think is in line with what you said before, 50 to 70 basis points, but I guess is down a smidge at the lower end, even on a higher revenue growth outlook.

I don't know if that's just related to the mix of the regions here or the incremental growth investments you're making, but any color on that would be helpful.

Robert Pagano (CEO)

Yeah. So in total, it's impacted by the incremental $3 million of investments that we're doing. So that's part of the story. Certainly, Europe is probably a little softer on the margin improvement that we were expecting, but North America should offset that. So in general, you know, as Shashank commented in his comments in the second half, you know, we look at the second half is going to increase approximately what the full year margin improvement is gonna be, you know? So I take a look at that, you know, America is a little higher, Europe a little lower, and Asia Pacific will continue to grow.

Brian Lee (MD andHead of Clean Energy, Renewables Research)

Okay, thanks, guys.

Robert Pagano (CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Jeff Hammond from KeyBanc Capital Markets. Jeff, your line is open.

Bradley Thomas (MD and Senior Equity Research Analyst)

Hey, guys. This is Brad, filling in for Jeff. Just one-

Robert Pagano (CEO)

Hi, Brad.

Bradley Thomas (MD and Senior Equity Research Analyst)

Just had one on price costs and specifically the cost side of the equation. You know, I think you're expecting somewhere in the neighborhood of $10 million of price in the second half of the year. Can you bucket out the costs, whereas as it relates to, you know, commodities, transport, and tariffs as you see it? If you've done that type of granularity, that'd be helpful.

Robert Pagano (CEO)

... Yeah, we've not done that in the past, and so we're gonna stay away from that. But in general, you know, with transportations, we've seen about a 10% increase, you know, with all the trade headwinds and stuff. We're seeing some of that from some of our products that we do get from China and Europe, particularly on the steel and aluminum. But, you know, in detail, we believe the price and cost equation, that our pricing will more than offset, equal or more than offset, the inflationary impacts.

Bradley Thomas (MD and Senior Equity Research Analyst)

All right. Thank you. That's all for me.

Robert Pagano (CEO)

Thanks.

Operator (participant)

Your next question comes again from the line of Nathan Jones from Stifel. Nathan, your line is open again.

Nathan Jones (MD and Senior Equity Analyst)

Hi again.

Robert Pagano (CEO)

Hi, Nathan.

Nathan Jones (MD and Senior Equity Analyst)

Could you guys give us any color on what the expected run rate savings are from the restructuring that you're gonna do in Europe, if I missed it?

Robert Pagano (CEO)

Yeah, we didn't provide it. It's still early on, and you know, we think it's gonna approximate $5 million, the restructuring, and have about a 3-year payback. We think about $500,000 of favorability in the fourth quarter. So that's rough estimates at this point in time. Teams are still working it, and but that's kind of the early indications.

Nathan Jones (MD and Senior Equity Analyst)

Gotta love those payback periods on Europe restructuring, don't you?

Robert Pagano (CEO)

I understand. That's the question.

Nathan Jones (MD and Senior Equity Analyst)

So just on the European softness, you talked about French destocking, and you also said some lower wholesale in Germany, so maybe some destocking there as well. Plus, you talked about you know the Americas pre-buying ahead of price increases. I would assume that would normally be what you would have expected in some of those channels in Europe as well, which would imply that, you know, maybe the underlying markets are even a little softer there than they appear. Talk about what the underlying demand drivers are that are leading to this destocking in the channel over in Europe.

Robert Pagano (CEO)

Yeah. So, our pricing increase in Europe was more in the April timeframe, so I don't think there's any dynamics inside of that. So, in moving the pricing, the July increase was in the Americas to offset the tariff impact that was in there. Regarding the equation here, again, French destocking, I think in the second quarter, if you recall, there was a lot of uncertainty with the Italian elections, a lot of discussions on trade. So I think people just laid low a little bit to, you know, determine what was happening here. Now, as I said earlier, July looked like a small rebound right now. But again, you know, the market's down in Europe today and elsewhere, just because of trade uncertainties. Everybody's thinking that Asia might be slowing, and obviously, Europe does a lot of transactions in there.

So again, we're playing a cautious outlook in Europe. You know I've always done that because I'm just concerned about that and the high cost structure. So we always, always are looking at how we're gonna reduce costs, improve productivity, be conservative there, and if we get the incremental volume, that would be great, but let's not plan on it. So that's kind of our color in Europe.

Nathan Jones (MD and Senior Equity Analyst)

Okay, that's helpful. So not really any deterioration in the underlying markets necessarily, just customers being cautious, worried about some of those impacts?

Robert Pagano (CEO)

Right. It's a question of, you know, when new construction's happening, people slow down based on uncertainty, and the same with the repair and replacement market. I think, you know, I think some of the, you know, customers are just a wait and see attitude, and we hope that'll bounce back in the third quarter. But again, my team knows that hope is not a strategy.

Nathan Jones (MD and Senior Equity Analyst)

Okay.

Robert Pagano (CEO)

We're gonna be cautious.

Nathan Jones (MD and Senior Equity Analyst)

Okay. Thanks very much.

Robert Pagano (CEO)

Thank you.

Operator (participant)

Ladies and gentlemen, again, if you would like to ask a question, you may press star, then the number one on your cell phone keypad. Your next question comes from the line of Joe Giordano from Cowen. Your line is open, Joe.

Joseph Giordano (MD and Senior Equity Research Analyst)

Hey, guys. Good morning.

Robert Pagano (CEO)

Morning.

Joseph Giordano (MD and Senior Equity Research Analyst)

In Europe, do you, do you feel like you're, you're losing share? I guess, like, if you look at some of the headline numbers, at least from the residential side, in, like, France and Germany, they look okay. So is this, do you think this is a product problem?

Robert Pagano (CEO)

I don't believe in France, in particular, that's the case, because, again, we get wholesale reports, and it looks like it was a destocking, in particular, in May, when they have many, many holidays in year-over-year. So that's not what we believe. I do believe in Germany, that we talked about, which is merely OEM. You know, a large portion of our business in Germany is OEM related, and we do see some of our OEMs pulling back some work that they've outsourced to us, given probably some of the softness they saw in the second quarter. So again, that's a timing. We get it, they pull it back, and we have to adjust our labor as a result of that. So we don't feel a significant market share loss from those point of view.

Again, we're being cautious in our outlook in Europe.

Joseph Giordano (MD and Senior Equity Research Analyst)

In the Americas, you know, what kind of indicators are you looking at, kind of on the fringes for potential, like, inflection points? I know, like, on the resi side, something like existing home sales on a trailing twelve months has been negative the last couple of months now for the first time in a while. So I'm just curious as to what you're seeing in terms of, like, kind of incoming conversations there.

Robert Pagano (CEO)

Yeah. So remember, 65% of our business in North America is repair and replace.

Joseph Giordano (MD and Senior Equity Research Analyst)

Right.

Robert Pagano (CEO)

You know, remodeling is up. We're seeing, you know, the Dodge Momentum Index is up, you know, the ABI. Those things continue to show activity, and we're seeing more remodeling in the residential side. Our residential is 35% of our business, and 14% of that 35%, so a really low number, is tied to new construction. So, you know, we're not-

Joseph Giordano (MD and Senior Equity Research Analyst)

No, I'm talking existing homes, existing home sales, right? Would that be a better proxy-

Robert Pagano (CEO)

Yeah.

Joseph Giordano (MD and Senior Equity Research Analyst)

for renovation spend?

Robert Pagano (CEO)

Yeah, it's a piece of that, but again, a new report came out this morning talking about, you know, there's still a belief that the housing is still gonna, you know, go up and then still be fairly healthy. So we're not seeing the residential, you know, falloff that, you know, you would look at from a new construction point of view. So, we're still seeing that part of our market is performing very well.

Joseph Giordano (MD and Senior Equity Research Analyst)

Okay, thanks, guys.

Robert Pagano (CEO)

Thank you.

Operator (participant)

Your final question comes from the line of Walter Liptak from Seaport Global. Walter, your line is open.

Steven Freedberg (Portfolio Manager and Director of Research)

Hi, this is Steve Friedberg filling in for Walt.

Robert Pagano (CEO)

Hi, Steve.

Steven Freedberg (Portfolio Manager and Director of Research)

Hi. Yeah, I had a tariff-related question. How much of the product manufacturing actually comes out of the Asia segment?

Robert Pagano (CEO)

What we produce in America? I mean, again, we, you know, our Asia factory, about 40% of their output supports, let's call it, some of the US products. Now, in the US, we import products from China, but also remember, there's an indirect impact of some of our suppliers that give us products that they get products from China. However, as you know, we have our own foundry here in North America that does a lot of our work here. So, compared to some of our competitors who outsource a lot of their products to China, we're gonna be less impacted with this new potential tariff that's out there. So again, you know, we're looking at all angles in the tariffs. We're looking at alternative supply chains and, accelerating inventory buys, et cetera, to minimize the impact of this.

You know, we're all waiting and seeing on this next round.

Steven Freedberg (Portfolio Manager and Director of Research)

Okay, good. That's what we were thinking. And a follow-up to that thought, since you know, you guys have more, you know, North American, you know, manufacturing than, let's say, a competitor, you know, are you guys able to increase prices, you know, dollar for dollar versus them? Or maybe a better way of asking it is, is there an advantage? I guess, how or I guess, how much is the pricing advantage, you know, do you get from, you know, being North American-based?

Robert Pagano (CEO)

I'm not gonna comment about pricing in general. I just believe that, you know, as leaders, leaders lead in pricing, and, you know, we're putting out prices that we believe that will equal or more than offset any inflationary pressure. So, you know, each individually, I don't comment about us versus our competitors' pricing.

Steven Freedberg (Portfolio Manager and Director of Research)

All right, thanks.

Robert Pagano (CEO)

Thank you.

Operator (participant)

At this time, I would like to turn the call back to Bob Pagano for closing remarks.

Robert Pagano (CEO)

Thank you for taking the time to join us today for our second quarter earnings call. We appreciate your continued interest in Watts, and we look forward to speaking with you again in our third quarter earnings call in early November. Take care and enjoy the rest of your summer.

Operator (participant)

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may now disconnect.