Watts Water Technologies - Q3 2018

Transcript

Operator (participant)

Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Watts Water Q3 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you'd like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. Thank you, Tim MacPhee, Treasurer and VP of Investor Relations. You may begin your conference.

Timothy MacPhee (Treasurer and VP of Investor Relations)

Thank you, and good morning, everyone. Welcome to our Q3 2018 Earnings Conference Call. On the call with me today are Bob Pagano, President and CEO, and Shashank Patel, our CFO. Bob will provide his perspective on our Q3 results in the global markets. Before turning the call over to Shashank, we'll review our results in more detail and offer our latest outlook for the remainder of 2018. Following our prepared remarks, we will address questions related to the information covered during our 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, we will be making comments that constitute forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties that could cause actual results to differ materially. 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. Let me now turn the call over to Bob Pagano.

Bob Pagano (President and CEO)

Thanks, Tim, and good morning, everyone. Please turn to Slide three in the presentation, where I'll provide an overview of the quarter. Overall, I was very pleased with our performance in the Q3. The team again delivered a record quarterly performance in sales, adjusted operating margin, and earnings per share. Organic sales grew at levels we have not seen in any quarter since 2007. Consistent with our first half performance, that growth was led by the Americas. We also maintained the earnings momentum from the first half. Operating margin was an all-time record for Watts, and adjusted EPS was a record for Q3, with another quarter of double-digit growth. These results reflect the continued execution of key strategic initiatives, including our commitment to profitable growth, delivering customer value, and driving continuous improvement.

Given our strong performance, we're increasing our projected investment spending from $13 million to $15 million for the full year. We spent approximately $5 million in the Q3 for investments, about $1 million more than was originally contemplated, and we plan to increase our Q4 spend by an additional $1 million to $4 million. We are aggressively funding projects that we believe will help future growth and productivity. Now, let me make a few comments about the regions. In the Americas, we delivered double-digit organic sales growth, driven by price and volume expansion in many of our key plumbing, drains, and boiler and water heater product lines. Looking at the end markets, U.S. non-residential markets remain healthy. We see steady growth continuing, especially in the institutional vertical, which is our strength.

U.S. residential market indicators, including permits, housing starts, remodeling activity, and higher interest rates, all lead us to be a little more cautious regarding the residential end market going forward. Regarding the Americas' inflationary costs, which include freight and raw materials, we have announced an additional price increase in the Americas that went into effect in mid-October to address the latest tariff increases. We'll continue to gauge market reaction and address any further tariff adjustments as they get enacted. In Europe, top-line growth was relatively strong, but operating margin declined due to competitive pricing pressure, unfavorable sales mix, and incremental investments. As we announced in August, a restructuring action was initiated in Q3 to rightsize our cost structure. We took a restructuring charge to GAAP earnings in Q3, with some benefit realized in the quarter. We expect a payback from this effort of a little over one year.

Shashank will provide more color in just a few moments. Recent European market forecasts predict overall economic growth easing over the next 12 months, and we have seen a similar slowdown in residential and non-residential growth expectations in many of the regions we serve. In general, we remain cautious regarding Europe. In APMEA, we see a continued mixed bag. China's residential construction market has slowed. The commercial market also saw some softness this past quarter, where we are seeing flattish end markets and competitive pricing. GDP in China is still solid, but trade concerns could impede the country's growth. Outside China, we see commercial markets broadly growing in the Middle East and Africa and other parts of Southeast Asia as a result of our geographic expansion strategy.

During the Q3, Asia Pacific top-line performance included double-digit growth outside China, being partially offset by a double-digit sales decline in China. Now, I'd like to take a moment to inform you of an important development regarding our global drains platform. We're expanding our stainless steel drains manufacturing capabilities in two locations. First, we're investing in additional plant capacity for manufacturing and training at our Denmark location, which makes our BLÜCHER branded stainless steel drain products. We have invested in new equipment for our Fort Worth, Texas, facility, where we already have expertise working with stainless steel in making our PVI-branded hot water heaters. We have already commenced production of BLÜCHER stainless steel trench drains in Fort Worth for consumption in the North American market. The Denmark addition will be completed in mid-2019, and will support both European and global markets.

These investments should drive a One Watts global solution and provides us the flexibility to meet customer delivery requirements in a project-based, custom-driven marketplace, and the additions should aid in our future growth. Finally, with two months remaining, we are confident in our ability to close the year on a positive note. Given our Q3 performance, we now expect to beat the sales growth outlook we provided back in August. At a consolidated level, we expect the second half top line growth should be in the 6%-7% range, with some puts and takes at the regional level. We now expect adjusted operating margin for the full year should approximate 12.3%, marginally lower than our August outlook, due to the incremental investments I mentioned earlier and additional corporate costs.

This would be a record-adjusted margin for the company, and our goal for free cash flow is consistent to convert 100% of net income for the year. Now, I'll turn the call over to Shashank to talk about our Q3 operating performance and provide more color on our Q4 outlook. Shashank?

Shashank Patel (CFO)

Thanks, Bob, and good morning, everyone. Please turn to slide four, and we'll discuss the Q3 results. Reported sales of $391 million were up 7%, driven by strong organic growth of 8%. Foreign exchange was a $3 million headwind, or 1%, during the quarter. The overdrive in organic growth, as compared to our August outlook in the Americas, and to a lesser extent in Europe, was due to strength in underlying markets. As expected, the impact of product rationalization was minimal, totaling about $1 million in the quarter, or a 30 basis point headwind, primarily in Europe. I will talk more about our regional performance in a few minutes. Adjusted operating profit was $50 million, an increase of 10%.

This translated into an adjusted operating margin of 12.9%, up 30 basis points versus last year and an all-time record for the company. We attained this margin while continuing to expand our investments in growth and productivity initiatives. Price, volume, productivity, and restructuring, partially offset by higher commodity and logistics inflation, were the main drivers of the record margin performance. Adjusted earnings per share of $0.99 was a 24% improvement over last year and a new Q3 record for the company. The earnings per share increase was driven equally by strong operational performance and benefits from lower below-the-line costs, including a lower income tax charge and lower non-operating costs. Foreign exchange was a $0.01 headwind in the Q3 as compared to the same period last year.

The effective tax rate in the quarter was 28.4%, 450 basis points below last year, driven by the benefits of tax reform. Turning to cash, on a year-to-date basis, free cash flow was $43 million, a 25% decrease as compared to the same period last year. The decrease was mainly due to increased inventory build to support higher organic growth and to minimize the tariffs impact, incremental tax payments due to new tax law changes, and additional capital spending. Historically, Q4 is a strong cash flow quarter for the company, and we expect that trend to continue this year as well. As Bob mentioned, our goal is to attain 100% free cash flow conversion. During the Q3, we repatriated approximately $11 million in cash.

Year to date, we have repatriated about $121 million, using a majority of that to pay down debt. In the Q3, we purchased approximately 57,000 shares of our common stock at a cost of $4.7 million. Year to date, we've returned a total of approximately $37 million to shareholders in dividends and share repurchases as part of our balanced capital deployment strategy. To reiterate Bob's comments, we are pleased with our Q3 performance, setting new highs in sales, adjusted operating margin, and adjusted earnings per share, while continuing to invest for the future. Now to the regions. On slide five, let's review Americas' results for the quarter. Sales of $263 million were up 10%, both on a reported and organic basis.

The strong organic growth was driven by strong price realization and broad volume increase in plumbing valves, drains, water quality, and heating and hot water products. Geographically, both the U.S. and Canada delivered a strong sales performance during the quarter. We are also seeing strong growth in Latin America, albeit of a very small base. As we mentioned in August, the impact of the Q2 customer pre-buys ahead of the price increase approximated $4 million, or about 2% of sales. Our best estimate of the Q3 pre-buy prior to the October price increase approximates $2 million. So on a net basis, sales were negatively impacted by about $2 million in the Q3, and the pre-buy should negatively impact Q4 America's sales by approximately $2 million. Adjusted operating profit in the Americas was $45 million, an 11% increase year-over-year.

Operating margin increased 20 basis points to 17.1%. The margin increase was driven by pricing, higher volume and productivity, which more than offset incremental growth investments, materials inflation, and logistics costs. To summarize, a very good quarter for the Americas on both the sales and operating profit lines. Moving to Europe, please turn to Slide six. Sales of $112 million were up 2% on a reported basis and up 4% organically. Foreign exchange, mainly the euro, was a headwind of about $2 million or 2% in the quarter. The sales increase was driven by solid growth within our drains platform and in electronics within the fluid solutions platform. Drain sales into marine applications continued strong, partially due to project timing, and electronics experienced strong OEM demand. We also saw strength in export markets.

By geography, we saw strength in Germany, the Nordic, and Benelux regions. Germany was driven by drain products sold into the marine market, along with better OEM and electronic demand. In the Nordic region, drains, OEM, and the wholesale channel drove stronger performance. And in Benelux, OEM and export sales all increased. Sales in France were slightly down, but flat, excluding product rationalization. Finally, Italy volume was flat for the quarter. Adjusted operating profit for Europe in the quarter was approximately $13 million, an 8% decrease as compared to last year. Operating margin of 11.5% decreased 130 basis points versus Q3 last year. The benefits of incremental volume, price, productivity, and restructuring were more than offset by unfavorable sales mix, incremental investments, and higher commodity costs.

Regarding the Europe restructuring program that we discussed in August, we expect total cost to be approximately $5.4 million. In the Q3 for U.S. GAAP reporting, we took a $4.4 million pre-tax charge, primarily related to severance costs. We expect the remaining costs will be fully incurred within the next 6-12 months. Annual pre-tax savings are estimated at approximately $5 million. We expect to realize about $1.5 million in pre-tax savings in the second half of 2018, including about $500,000 already recognized in the Q3 and approximately $1 million of expected benefit in the Q4, with a balance in 2019. The program principally involves a rightsizing of personnel across various locations in Europe. The payback approximates 1.2 years.

Total restructuring expense noted in our income statement for the quarter was $3.4 million, as we adjusted the accrual balances for previous restructuring programs. So for Europe, a solid top line with a weak operating margin performance. We are taking actions to minimize margin erosion through restructuring and other cost actions. On slide seven, let's review APMEA's results. In the quarter, sales of approximately $17 million were flat on a reported basis and up 3% organically. Excluding product rationalization, organic sales were up 4%. This should be the final quarterly impact of product rationalization on APMEA. Q3 was a continuation of APMEA's first half performance, with strong growth outside China offsetting weakness within China. Sales outside of China were up double digits organically, mainly driven by the Middle East and Africa, Australia, and Korea.

China sales declined double digits, with weakness seen in both commercial valve products and residential underfloor heating products. Adjusted operating profit and adjusted operating margin were positively affected by a significant increase in intercompany volume, favorable country mix, additional productivity savings, and favorable foreign exchange, offset partially by material inflation and incremental growth investments. In summary, a muted top line in APMEA during the quarter, with solid growth outside of China and good profit drop through favorable intercompany volume and productivity. Finally, turning to slide eight, I'd like to make a few comments on Q4. On a consolidated basis, we expect year-over-year Q4 organic sales growth should be in the range of 5%-6%. Growth rates should decline sequentially in the Americas and Europe from Q3, while APMEA's growth should increase as compared to Q3.

Product rationalization in the Q4 should be approximately $1 million and relates entirely to Europe. As mentioned, the expected sales impact of pre-buys in Q4 should be approximately $2 million. Adjusted operating margin in the Q4 should expand versus the prior year, supported by volume growth, continued execution of our productivity and restructuring initiatives, partially offset by higher inflation. We expect incremental growth investments of approximately $4 million in the Q4 versus last year, which is $1 million more than we had originally forecasted. We now anticipate total corporate costs in the quarter will approximate $12 million, an increase from our previous run rate due to incentive true-ups and the timing of other costs. Partially offsetting these margin headwinds are expected restructuring savings of $1 million in Europe.

Adjusted operating margin of approximately 12.3% is expected for the full year, a slight reduction from our last outlook, driven by additional investment spending and incremental corporate costs. We are expecting strong cash flow generation in Q4, consistent with our performance over the past several years. We now estimate capital spend will range from $31 million to $34 million for the full year. Our effective tax rate should approximate 28% in the Q4. The FX impact should be negative as compared to the Q4 last year, given current foreign exchange rates. With that, I'll turn the call back over to Bob before we begin Q&A. Bob?

Bob Pagano (President and CEO)

Thanks, Shashank. To summarize, the positive momentum from our many initiatives continued as we delivered another record quarter. We increased sales, expanded operating margin, and drove double-digit earnings growth while continuing to invest in new products and technologies and in new geographies. The investments will help drive our future performance in 2019 and beyond. With that, operator, please open the lines for questions.

Operator (participant)

Ladies and gentlemen, to ask a question, please press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Nathan Jones with Stifel. Your line is open.

Nathan Jones (Senior Equity Analyst)

Good morning, everyone.

Bob Pagano (President and CEO)

Good morning, Nathan.

Nathan Jones (Senior Equity Analyst)

I'd like to start with a couple questions on the Europe market here. You guys have seen, and this is Americas first. You guys have seen a tremendous ramp-up in organic growth in the Americas this year. You've made a ton of investments to drive that growth. I think we can safely say that the underlying markets haven't ramped up like your revenue has, which would imply that you're taking some market share there, but the Europe growth has stayed, you know, pretty flat. Can you talk about the potential for you to start gaining some market share in Europe the way you have in the Americas?

I know you're still doing some repairs in the European market, but maybe a year or two out, are we looking at a similar situation where all of these kind of investments could drive the same kind of outgrowth in Europe that you've seen this year in the Americas?

Bob Pagano (President and CEO)

Yeah, so when we look at Europe, we've got to break down our businesses into two parts. A third of our business is electronics as well as drains business, and as I said in my prepared remarks, we're expanding our drains capabilities in Europe. So we feel good about how we're performing in those two businesses in particular, because we do those businesses are growing and we believe growing faster than the market. Regarding the other two-thirds of the business, that's a little bit more difficult because a third of that is OEM related, and we're sometimes at the mercy of those OEMs at that point in time. So, you know, we are having you know, additional new product developments in those sectors, but not as near as much as in those other markets.

So those tend to follow more of a GDP growth market inside of Europe. So we're investing more in the electronics and drain side, and that's where we believe our growth is gonna be.

Nathan Jones (Senior Equity Analyst)

Just sticking with Europe, you were +4 organically this quarter versus -2 in 2Q18. Can you talk about, you know, geographically or by product, what drove the turnaround there? You're still sounding pretty cautious on the, on the Europe market, which I guess is typical for you, Bob. But maybe just a little more color on what drove the increase and, and what, what, where the caution is going forward.

Bob Pagano (President and CEO)

Yeah, so we had nice growth, like I said, in the electronics and the drains business, but we saw an OEM bounce back in the Q3 from our German business. And if you really look at their Q3 performance and the Q2, it was basically flattish, because we were negative in Q2. And, you know, our OEM margins are lower margins, so we saw that bounce back. But, you know, Italy was basically flat, Germany was up, you know, so, and France was basically flat. So again, these markets are. We're cautious, and again, when you look at some of the leading indicators, I still think there's caution out there. So you are correct, I am cautious because I wanna make sure our spending is proper in those, and then we rightsize the business accordingly.

With most of our focus in new product development is in the other two platforms of electronics and drains.

Nathan Jones (Senior Equity Analyst)

On the restructuring in Europe, should you be at that annual $5 million savings run rate by the end of 2019?

Shashank Patel (CFO)

Yeah. Yeah, so, as we said, I think, in the second half of 2018, it's $1.5 million, and then in 2019, we'll see the full $5 million or close to the $5 million run rate.

Bob Pagano (President and CEO)

Yeah, but that will be an incremental $3 million over 2018 savings, which is about $2 million.

Nathan Jones (Senior Equity Analyst)

Got it. Thanks very much. I'll jump back in the queue.

Bob Pagano (President and CEO)

Thank you.

Operator (participant)

Your next question comes from Jeff Hammond with KeyBanc Capital Markets. Your line is open.

Jeff Hammond (Managing Director)

Hey, good morning, guys.

Bob Pagano (President and CEO)

Good morning.

Shashank Patel (CFO)

Good morning.

Jeff Hammond (Managing Director)

So just, I mean, it looks like we're getting some crosscurrents, Europe, China, new res. Just as you kind of look out into 2019, how do you think things shape up? And just on the new res comment, are you just reacting to some of the macro data, or are you actually seeing slowing that spread?

Bob Pagano (President and CEO)

Yeah. So 2019 is a little early, Jeff. We're going through our operating plan reviews in the upcoming weeks, so we'll inform you in February. Regarding residential, you know, it's more about what we're hearing right now, and I think we should break up our residential a little bit so everybody understands that. As you know, 60% of our business is commercial, 40% is residential. But when you break up that residential piece, two-thirds of that is multifamily, and then a third is single-family homes. And if you look at it, our exposure, 65% is repair and replacement. So if you look at single-family new construction, we're not significantly exposed. But we are cautious in hearing the same things that everybody else is reading about, but we're not dependent on, you know, North America single resi expansion and new construction fully.

Jeff Hammond (Managing Director)

Okay, great. And then, Bob, on the, on the latest price increase, does that include Section 301, List 3, and the 25% step-up, or do you have to contemplate additional pricing? And then just talk to me about any changes you're contemplating to your supply chain as a result of some of these tariffs.

Bob Pagano (President and CEO)

Yeah-

Shashank Patel (CFO)

Yeah.

Bob Pagano (President and CEO)

Go ahead, Shashank.

Shashank Patel (CFO)

Yeah, on the price increases, and, and you're right, that's, that, that third phase, our price increase includes that and contemplates... As you know, it was 10% that kicked in in September, and then there's another - they're going up to 25% on January 1. That 25% is up in the air at the present moment, but our price increase contemplated those.

Bob Pagano (President and CEO)

Yeah, and from a supply chain point of view, we're actively working our suppliers based on, you know, the stronger dollar, as well as looking, you know, in many other places, including our North America capabilities of producing locally. As you know, you know, we have our large foundry here in North America, and you know, we can produce more here.

Jeff Hammond (Managing Director)

Okay, good. And then just one, one more. Can you just talk about the market opportunity on the stainless drain market in North America? What's the size? What's the competitive landscape? How do you, you know, plan on kind of going to market and, and penetrating that opportunity? And I'll get back in queue.

Bob Pagano (President and CEO)

Yes. Yeah, so it's a decent-sized market. I'm not gonna get into the market specifics, but what I would tell you is that market is primarily a lot of local players in the local regions that do customized stainless steel. And we believe we have the ability, leveraging our PVI facility, that is an expert in stainless steel welding and capabilities, where we can automate that as well as standardize it for larger customers. So when we look at that opportunity, we've already been importing products from Denmark, and we've done really well in the craft brewery market, and we believe we can continue to expand beyond, you know, that, really with a food and beverage-type focus on that market.

And there's other, you know, stuff in the lighter industrial, but our focus right now is more on the food and beverage as we ramp up. So again, we tested it by bringing stuff in from Denmark, and now we're comfortable, and we've been growing nicely in that, so we now are gonna build local capabilities at our PVI facility.

Jeff Hammond (Managing Director)

Okay, thanks, Bob.

Bob Pagano (President and CEO)

Thank you.

Operator (participant)

Your next question comes from Brian Lee with Goldman Sachs. Your line is open.

Brian Lee (Analyst)

Hey, guys, good morning. Thanks for taking the questions.

Shashank Patel (CFO)

Morning.

Bob Pagano (President and CEO)

Good morning, Brian.

Brian Lee (Analyst)

Morning. Hey, Bob, on the China slowing, you know, this has been kind of a trend here for the past several quarters. You've called it out, and I think this quarter seems to be a low watermark, if I read into the double digits relative to the way you've characterized it in the past few quarters. So, and I know it's not a huge market for you, but can you level set us a bit on where your exposure stands there now and how you're thinking about this? Is this somewhat share related, or is this broader weakness? And then just maybe the outlook for some recovery there.

Yeah. So, when you look inside of our China business—first of all, our APMEA business is about 60% outside of China and 40% inside of China. So when I first started, we were 90% in China, and I felt we were too exposed to China. So our strategy has been to expand outside of China, given the political things that are happening in China, we wanted to be careful, as well as its lower margins inside of China. So when you look at it, you then have to break the market down by two different pieces. The first piece is the residential piece, which is really the underfloor heating. And we talked, I think, several quarters ago, how there was a shift from individuals purchasing to more of a contractor purchasing for the whole building.

That shift is handled, or has changed, which has really changed our market because it's very low margin in some of that. So we've really, you know, we're in it, but we're in it, let's call it, on the high end of that marketplace versus, let's call it, the average. So that's competitive, and by definition, we would be losing market share. But, you know, when I'm looking at profitable growth, that's really the focus. The commercial side of that business is more lumpy. That's project-related. We had a lot of data centers, and we saw some competition start to buy some jobs in the quarter. So we again, we tried to remain disciplined in that area. It's still a focus for us.

Our teams are focused on growing that market, and we believe, you know, we'll probably see something similar in Q4, maybe a little more growth in or less of a decrease out of China and then, or flattish somewhere in that m- range. But we'll, you know, be mid-single digits to, high, low, you know, somewhere in the 5%-7%, we believe, in APMEA in that region. Again, our focus is on profitable growth, and we're finding more profitable growth outside of China.

Okay, great. No, that's helpful. The second question was just on, you know, everyone's topic these days: price cost. Just how should we be thinking about the trend here going forward? Are we sort of seeing peak realization, or do you think there's, you know, more of a spread you can capture here? And then, I guess, how should we be thinking about the operating margins in that context? I know you've down-ticked them about 10 basis points on the year, but that seems to be related more to your own investments as opposed to the price cost dynamic. But if you could speak to that a bit. Thank you.

Bob Pagano (President and CEO)

Yeah, Brian, I think, the price cost, we've seen a lot of inflation. Tariffs have been minimal. I think, really, when you'll see the tariff impact to us based on our inventory terms, is really heading into next year. So we've been proud that we've been in front of this thing, getting price, in advance, and that's why we've invested more, again, to set us up to grow for the future. So we believe, you know, between our price, our supply chain, and our productivity, that's allowed us to stay in front of this thing, and that's why we're increasing our investment. So that's been the focus. I think, when you look at price now, I think you'll probably see more price as some of these 301 tariffs start hitting and everybody increasing price.

I think as you get into next year, you're gonna lap some of those bigger price increases that everybody saw in Q3 and Q4 of this year.

Brian Lee (Analyst)

Okay, fair enough. And then, maybe one last housekeeping one. I might have missed this, but there was some other income of around $900K in the quarter. Could you elaborate on what that was and if that line item persists into the future?

Shashank Patel (CFO)

I think the bulk of it is FX. So as we saw with the Chinese currency getting lower, almost at the 6.9 level, so we had favorable foreign exchange that happened in the quarter. We had a similar situation in the Q2 as well on a foreign exchange from a transaction perspective, but it's primarily driven by the Chinese currency.

Brian Lee (Analyst)

Okay, thank you.

Bob Pagano (President and CEO)

Thank you.

Operator (participant)

Your next question comes from Joseph Giordano with Cowen and Company. Your line is open.

Speaker 9

Hey, good morning. This is Rob in for Joe. I just wondered if you could give us some color about your distributor inventory levels, and how much steam you see left in the North American, commercial, market in terms of growth? Thank you.

Bob Pagano (President and CEO)

Yeah. So from a channel perspective, I think it's healthy. I, I think it's probably slightly above average as the channel buys in front of this inflationary tariff environment. However, I also believe the commercial market, based on our backlog, our quotation activity, as well as our discussions with our field, that it's, you know, still pretty decent out there. So we feel good about the commercial market heading into 2019, and the teams are gonna get more than our fair share of that business.

Speaker 9

Great. Thank you.

Operator (participant)

Again, to ask a question, please press star one on your telephone keypad. Your next question comes from Walter Liptak with Seaport Global. Your line is open.

Walter Liptak (Managing Director and Senior Financial Analyst)

Hi. Good morning, guys.

Shashank Patel (CFO)

Morning.

Bob Pagano (President and CEO)

Good morning.

Walter Liptak (Managing Director and Senior Financial Analyst)

Wanted to ask about volumes versus price and, you know, maybe to think about the Americas. You know, in the quarter, how much did price contribute to that 10% organic?

Bob Pagano (President and CEO)

A little over 3%, Walt.

Walter Liptak (Managing Director and Senior Financial Analyst)

Okay. All right, and then turning to just some follow-ups on Europe. You know, the cautious comments that you made, you know, I wonder if, if as you went through the quarter, there were things that changed. I know Q3 tends to have some, you know, some longer holidays and things. But I wonder if there was something in the Europe numbers that, you know, caused you to think a little bit more carefully about how the trend would look in the Q4.

Bob Pagano (President and CEO)

Yeah. So the way we looked at it, in the Q2 of Europe, we were down a couple%, but we're up 4%. And then if you look at last year, our Q4 for Europe was up, you know, 5%. So we got a difficult compare next year, so that's why we're thinking modest growth in the Q4. So that's how, you know, we are framing it, Walt.

Walter Liptak (Managing Director and Senior Financial Analyst)

Okay, great. And you know, kind of along the same lines with China during the quarter, were you able to see a month-on-month change in China?

Bob Pagano (President and CEO)

Again, China, the residential market has been soft. It's continued to be soft, so no real change there. Maybe a little bit of an uptick, but the commercial market is very project-oriented and lumpy and sensitive. So again, it's hard to see any trend there. We do believe they're spending on the commercial side of that market, and our teams are focused on that. But again, our focus is on profitable, profitable growth, and we're not going to go after projects that lose money. So that's clearly our focus.

Walter Liptak (Managing Director and Senior Financial Analyst)

Okay. All right, makes sense. Okay, thank you.

Bob Pagano (President and CEO)

Thank you.

Operator (participant)

Your next question comes from Mike Halloran with Baird. Your line is open.

Mike Halloran (Associate Director of Research and Senior Analyst)

Good morning, guys.

Bob Pagano (President and CEO)

Morning.

Shashank Patel (CFO)

Morning, Mike.

Mike Halloran (Associate Director of Research and Senior Analyst)

Two clarifications, well, one clarification, one question. The first clarification is just on the China and the APMEA growth rate that you're expecting Q4. Was that a 5%-7% all in organic number, or was that inclusive of an FX number that you threw out there, Bob?

Shashank Patel (CFO)

It was, it was organic.

Mike Halloran (Associate Director of Research and Senior Analyst)

Okay. And then second, can you just help rightsize where those APMEA margins are tracking? Obviously, really strong in this quarter. That can move around quite a bit, depending on intercompany transfers and other factors. How should we think about that for the Q4, and then what's a good run rate to think about for next year?

Shashank Patel (CFO)

Yeah, the APMEA margins in the Q3, as you saw, we had a very solid Q3, and that was driven by higher intercompany volumes. So we did some buys ahead of the tariffs. That helped drive productivity in our factory in China, as well as, you know, some transfer pricing margins, which aren't that significant, quite frankly. And then we had some foreign exchange favorability. So what happens in the Q4 is, you know, as long as the FX rate, FX rates hold up, we'll still get the foreign exchange favorability, but the intercompany volume does come down in the Q4 versus the Q3. So still healthy margins in the Q4, but slightly lower than the Q3 on a sequential basis.

Mike Halloran (Associate Director of Research and Senior Analyst)

Great. Thank you for the time. Appreciate it.

Bob Pagano (President and CEO)

Thanks, Mike.

Operator (participant)

There are no more further questions queued up at this time. I'll turn the call back over to Bob Pagano for final comments.

Bob Pagano (President and CEO)

Okay, thank you for taking the time to join us today for our Q3 earnings call, and we appreciate your continued interest in Watts. We look forward to speaking with you again at our Q4 call in February. Thanks again.

Operator (participant)

This concludes today's Conference call. You may now disconnect.