Watts Water Technologies Inc (WTS) 2016 Q1 法說會逐字稿

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.

(Operator Instructions).

As a reminder this conference is being recorded.

I would now like to introduce your host for today's conference, Tim MacPhee, Treasurer and VP, Investor Relations.

Mr. MacPhee, you may begin.

Thank you, Nicholas.

Good morning everyone.

Thank you for joining in 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 we 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 at www.wattswater.com.

We will archive the webcast on the site for replay.

And I would like to remind everyone during the course of the call, to give a better understanding of our operations, we will make 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 the 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 a new information, or future events, or otherwise.

Let me now turn the call over to Bob Pagano.

Thanks, Tim and good morning, everyone.

Now turning to slide three in the earnings calls presentation, let me briefly provide a summary for the first quarter.

I am very pleased that the first quarter results are reflective of the cumulative actions we have taken to enhance our portfolio and drive operation 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 metric.

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 Europan team, and visited most of the sites since he assumed responsibility in late February.

Elie Melham 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 the respective management team.

Our key initiatives are moving ahead as planned, and we continue to focus on enhancing the customers' experience with Watts.

Our transformation initiatives in the Americas and 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 two 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 five, helping to achieve our goal by 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 saving 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 previously identified in 2016.

I am proud to announce that on April 20 we celebrated the grand opening of the Watts Works Learning Center.

This new 12,000 square foot facility is located at our Corporate Headquarters at 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 configure-able classrooms, demonstration labs, and showcases 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 re-establish our position as a leader in training the industry.

Finally, we are re-affirming 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 us turn to slide four.

Let us begin with 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 movement lately, while the dodge momentum index was 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 expected to grow more steadily in the next two years than the office and commercial sub-market.

In Canada, the same sub-markets are expected 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 home sales should provide a tailwind.

We expect solid growth in the residential housing sector in 2016.

As has been the case in the past few years, the media is a mixed bag.

On a positive note, we have seen 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 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 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 will turn it over to Todd to talk about our first quarter operating results in more detail.

Todd?

Thanks, Bob.

Good morning, everyone.

We are on slide five, 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 impact of the exit of undiffrentiated projects 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 and incremental volume of $3 million from the Apex acquisition.

As Bob mentioned, sales growth and other operating metrics were positive affected by approximately two or three extra shipping days depending on the region, in Q 2016 compared to last year.

When normalized for regular shipping days, organics sales growth approximated 2% in the quarter.

We thought the effect was large enough to highlight the numbers with and without the extra dates.

From a full-year perspective, the extra date 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 dates.

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 product, 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 impacted 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 over Q1 of last year.

About half of the increase relates to a reserve we booked in the quarter associated with a ongoing tax audit and the other portion relates to earnings mix, which is more heavily weighted to the U.S.

So let us turn to the regions, and on slide six we will 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 dates, America's organic growth was 3% in the quarter.

We had strong performance from our commercial products like drains, large testable back flows, and ACVs; and solid growth from many of our other core products, including water quality, electronics, and gas connectors.

Divested projects down $27 million on a net basis 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 should pick up during the traditionally busy 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 is 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.

Overall, a good start to the year in the Americas with strong margin expansion.

So turning to slide seven, let us review our EMEA 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 than an impact than we have seen in quite some time.

Excluding additional shipping days, organic growth was 1%.

The organic increase by 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 the HVAC and drain businesses were down in the quarter.

Just as a reminder, we expected drains would be down due to the shipment of three large projects 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 continues to be strong with sales growth over 20% in the quarter.

By contrast, we saw softness in Germany where we continue 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 utility cost, and restructuring efforts as well as easy comps.

Overall, May's performance was relatively stable for the second consecutive quarter.

Now on slide eight let us 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 continue to experience some project delays in the valve business in China primarily due to the commercial market landscape which has been done in recent quarters.

Conversely, we saw big growths in underfloor heating, driven by an uptick in demand for our PEX and PERT products.

Outside of China, we continue to see strong VAL 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% of 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, co-driven countries.

Adjusted operating profit increased $33 million to $2 million in the quarter.

Adjusted operating margin increased over 300 basis point, 18.6%.

Key drivers of the significant expansion were higher trade volume, favorable product mix including higher-margin Apex sales, and strong productivity.

Overall, a solid start to the year for Asia-Pacific.

On slide nine, a few items I would 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 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 American states through transportation 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 metrics standpoint, we improved DSO in inventory terms versus same period last year by 5% and 6%, respectfully.

It is also worth mentioning that including investing activities, a cash outflow of $18 million related to the potential sale of our China entities, which produced undifferentiated products.

This is cash that we placed in escrow that 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 $12.5 million during the quarter.

While the first quarter is seasonably slow, we fully expect the cash generation will improve as the year progresses, and are focused on achieving 100% cash conversion for the year.

Finally, turn to slide ten and the outlook on the year.

We are re-affirming 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 a previous guidance from February.

We expect operating margins should grow 100-plus 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 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 affective tax rate, which may be the high end of the 32% to 34% range for the year that previously provided; driven by the mix of earnings weighted heavily for the U.S., and the reserve we booked in Q1 regarding the tax audit.

With that, let me turn the call over to Bob before we begin Q&A.

Bob?

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 continue to drive our various rationalization and transformation programs, which we believe should drive better margins going forward.

And our outlook for the year remains unchanged for our February call.

I want to reiterate that we expect to grow our margins in 2016 by 100-plus basis points and we should generate 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 our key initiatives.

With that, Nicholas, please open the lines for questions.

(Operator Instructions).

Our first question comes from the line of Jeffrey Hammond from KeyBanc.

Your line is now open, please proceed with your question.

Hey, guys, this is James Picariello.

Congratulations on a nice quarter here.

Regarding the strong margin performance, even excluding the 50-basis point benefit you pointed out driven by the additional shipping days; I mean, how sustainable do you think the improvement is for the rest of the year and maybe can you just talk to what the puts and takes were in the quarter that drove the nice incrementals?

Yeah, so, James, this is Todd.

I will jump in on this one.

We had a nice start to the quarter.

We are really happy with the margin performance, but there is a couple of things I think it is worth mentioning.

I think first and foremost we had strong sales-aided by the extra days in the quarter, right?

And this drove favorability on the absorption line.

And we also had, I think we had some nice benefit of commodity tailwinds in the quarter as well.

And if you think about where commodities are today,-- it seems to have troughed in the January time frame.

While we expect to see some continued benefit in Q2, I think as you think of the second half of the year it is going to be a little bit of I would say tougher comps.

We also so some nice benefit on restructuring in the quarter as well.

Between raw material, commodity headwinds, favorable restructuring, and as well as the increment volume that really was driving our strong margins in Q1.

As I think about it over the course of the quarter, or the remainder of the year, I do expect to see solid margins continuing in the America's business, as a result of the transformation initiatives going on there.

And I expect to see continued benefit out of EMEA as well as in APAC although it may be more moderate growth in the second and third quarter going out.

Got it.

Thanks.

And then one other question.

Just on Asia.

So Asia was extremely high in the quarter.

If you ask us, again, besides additional trade sales days we have, and additional margin for the APAC sale, we had higher margins from the China plan to help support some of the America transformation, and this drove better factory absorption.

Going forward, we think margins for Asia normalize in the 10% to 15% range, really depending on the amount of (inaudible) that we drive through the factory.

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.

Whatever color you could provide there would definitely be helpful.

Yeah, so, we had one tax charge in the quarter, it approximated $0.02 for a reserve established for an ongoing tax audit.

The remainder of the increase was driven by world-wide earnings heavily weighted by the U.S. We expect the full year effective tax rate will be toward the high end of the range, the 34%, really just given the reserve change and the continued weighting of earnings in the U.S.

Got it.

I will get back in queue.

Thanks.

Our next question from the line of Kevin Bennett of Sterne Agee.

Please proceed with your question.

Thanks.

Good morning, everybody.

Good morning, Kevin.

First question Bob, can we talk about pricing?

I know Todd mentioned the raw materials.

I am wondering what pricing was in the quarter, and then what do you think; given kind of the recent run-up in commodities, what do you think about pricing for the rest of the year?

When I look at pricing, we have had decent pricing.

We have put in a price increase in March.

We expect about 1% of that to hold.

And part of our growth assumptions are .75% to a 1% of growth related to pricing.

So it has been able to hold.

We have some contracts with some OEMs where we have to pass on the favorability based on the LME prices, but overall we believe we are holding our own on the pricing and we believe we can sustain that for the rest of this year.

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, what was the investment there, and 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.

Yeah.

So we spent several million dollars on the new training facility.

And really what we are really trying to do, is Watts has so many brands and components and we tried to put all the components together to show how they work in an overall system.

So what that does is allow all of our people, all of our customers to really look at, see all our the components in one place.

It is a hands-on experience, certainly we invite you and other investors come and look at this, because it is state of the art; it really showcases our product, and allows us to get our voice of the customer.

As we train customers and see them try our products hands-on, putting them together, taking them apart, seeing how they interact.

We get to listen to their input on how we can better improve them and other options to do that.

It is a great new investment.

It is always difficult to put a value on this, but I know from past experience that getting a loyal customer, training them very well, really drives long-term commitment to your product.

We believe that is one of our key growth initiatives that will play out longer term for our Company.

Got you.

That makes sense.

Looking forward to seeing it some day.

See you, guys.

Thank you.

Thank you.

Our next question from the line of Kevin Maczak with BB&T.

Your line is now open.

Please proceed with your question.

Thanks, good morning.

Good morning, Kevin.

The shipping days disclosure is kind of a new topic we have not had to think about much in the past.

Just to be clear on that, the $0.06 that was a benefit this quarter, you expect a headwind of about that magnitude in Q4?

Is that the way to think of this?

Yea, so Kevin, it is nothing more than just the R445 counter-close and so the benefit we saw in Q1, we expect to be pretty much fully offset in Q4.

So 4% organic growth rate, probably 50 basis points on the upper income.

I think that would be, from a modeling standpoint, the right way to think about it.

Got it.

In terms of the margins and the strength in the quarter and what is sustainable and what is not, I think your pretty early days on the sourcing initiative, that was not one of the call-outs here.

Can you give an update on that, and what are your expectations as we move forward there?

Yeah, Kevin, it is Bob.

Related to productivity, when we talk productivity we include sourcing savings.

So I would tell you our sourcing savings, both from a -- let us call it commodity -- but we just follow commodity.

But really from putting our buying power and leveraging global spend, you know we are in full force.

We started to see the benefits of that in the second half of last year significantly.

We called out $4 million in benefits last year.

Our goal is an incremental $4 million of benefits just from sourcing, unrelated to commodities.

We are on track $1 million this quarter on that.

That team is working very well, very well.

We believe that will continue throughout the quarter.

As Todd earlier mentioned, the commodities, basically we saw the lowest commodities in the first quarter as 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.

Got it.

And just finally from me, the growth investments, I think it was mentioned $1.5 million to $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.

Yeah.

As we talked about in the fourth quarter of last year we said we were going to 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 $1.5 million to $2 million in the second and third and fourth quarters.

So again, we are ramping up.

We are feeling more confident about the year and the markets based on what we saw in the first quarter.

We are executing on those initiatives as we go forward.

Okay.

Great.

Thank you.

Thank you.

Thank you.

Our next question comes from the line of Jim Giannakourous with Oppenheimer.

Your line is now open.

Please proceed with your question.

Thanks, good morning, guys.

Good morning, Jim.

I get the (inaudible) in 1Q and the giveback in 4Q.

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 between what you were seeing a few months ago versus your expectations from a, I guess from a market perspective, or even just the inventory commodity wind-down, things that are trending better or worse that you can speak to that nets out to your, call it maintaining your original outlook.

Let us start off by 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.

I think that is, you know, that is positive.

Also EMEA.

We were not exactly sure, we thought where we were going to be at with that.

As you know, our guidance is down a little bit, and we saw in the first quarter it was better.

I think we are taking a cautious outlook for the second half of the year with the exit potential by the UK and the Greek -- we just do not know the turmoil that is.

We talked to our local team there.

You know, they are optimistic.

But we are cautiously optimistic, again because any major issue in Europe tends to have an impact on the whole economy there.

So we want wait to see there before we call it a success, with potential to grow further.

Just because the economic uncertainties there.

We are playing it a little cautious there in that regard.

So that is probably a little better than we expected.

All of the other things are kind of in line with what we expected.

Got it.

That is helpful.

And specifically on North America, I have not heard of any disruptions in your lead-free foundry.

Can you update us on how that is running and at what capacity?

And just a quick follow-on; can you estimate how much the milder weather benefited your 1Q?

So I did not -- continued questions on our foundry.

But, anyways, our foundry is doing well.

No interruptions.

The teams continue to execute.

We are looking really at our Franklin Facility.

It is not just a foundry; we have got a large effort to transform the whole machine shop and really look at that whole value stream.

We are on top of it, the team is making great progress, and we will continue to execute.

Regarding your second question, we looked at the weather from the weather point of view, and we estimated it was probably impacting us favorably by 1%.

But if you recall in the first quarter, we called out a large wholesaler order that impacted by 1%.

So we kind of looked at both of those as netting out from a year over year comp point of view.

So, weather probably helped us by about 1%, but that one large order that got moved into the fourth quarter hurt us by 1%, so they netted each other out.

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

1 point in the quarter as well.

Yeah.

Exactly.

Got it.

And one follow-up, if I may; AERCO, what is the gross implied there in your plan, or guidance for North America in 2016?

For 2016?

Yes.

It is 10-plus I would say would be the growth rate for AERCO for 2016.

Yeah, it was in 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-digit growth in the fourth quarter.

And as you know, that business is very project and lumpy, but the team is on track to execute the growth numbers that Todd just talked about.

Understood.

Thank you.

Thank you.

Our next question comes from the line of Tristan Margot with Cowen and Company.

Your line is now open.

Please proceed with your question.

Hey, guys.

Good morning.

I know this is very small, but could you address your growth in Asia, aside from China, and was this expected?

Yeah, so, we have had a focus on -- we did not want to be completely reliant on China, especially with all of the macro things that are happening there.

So we have been at a conscious effort to grow outside of China.

And as Todd talked about; Indonesia, Japan, Australia, those are key focus areas where we saw very nice growth in the quarter.

So we are becoming -- certainly China is the largest portion of that, but we are trying to expand beyond that.

That is why we put the Apex acquisition which really is in New Zealand.

So we are trying to broaden our Asia focus, and so China was in line with what we expected, but the other regions were strong.

Okay.

Thanks.

Could you give us some colors on your end market, specifically in the U.S., maybe on [residential], what are you seeing now, and going forward?

Yeah.

So in my opening comments I talked about that.

We feel good about the residential market.

We feel that is strong.

Commercial is a little lumpy, but we have seen positive growth from that point of view.

So we are confident in both of those markets this year.

Also remember that a large portion of our business is aftermarket or repair and replacement, and that tends to follow GDP growth, so you have to look at 60% of our North America business really follows that aftermarket replacement business.

The other portions are on the new construction.

So anyways we are positive on those markets.

Okay, thanks.

Congratulations on the quarter, guys.

Thank you.

Thanks.

Our next question comes from the line of David Rose with Wedbush Securities.

Your line is now open.

Please proceed with your question.

Good morning.

Thank you for taking my call.

I just wanted to --

Morning, David.

First of all, I wanted to you know, just say thank you for being straightforward with the additional shipping days.

Hats off to you for the candor.

And second, if we could kind of go through the costs, at least benefits from reduced raw material costs.

Can you give us a percentage or a dollar figure or a margin number, on the impact of that as a (inaudible)?

David, as you know, we do not 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.

But not only that, I think as I said earlier on 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.

As we look at this, we will see continued improvement in Q2.

I think it is a tougher comparison, as I said, in the second half of the year, but it is certainly positively impacting our margins

Okay.

And then as it relates to sort of the investment, you highlighted for the remainder of the year, how should we start to think about 2017?

Are you going to continue to, you know, increase the level of spend for growth, or does it sort of flatten or just drop off, I mean, how should we think about the long-term Capex?

Yeah.

So we believe from a capital allocation point of view we really want to continue to invest organically.

That is a key investment opportunity.

We believe we have opportunities to invest in both growth and productivity improvement in our factories.

We will continue to do that investment, but we also expect higher productivity as a result of some of these investments as well as growth.

So I would say this year is probably a net 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.

And so, you know, I would say we are going to continue to invest.

We have a high, a key threshold for return on investment and pay back.

So we are going to make sure that you make smart business decisions as you allocate that capital

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

I do not know about build.

I would say about the same probably.

Okay.

And then lastly, as it relates to capital allocation, AERCO was a pretty meaningful acquisition for you last year.

You mentioned that your interest in, sort of controls and technology on the water side.

Can you provide us a little bit more color on the terms of the verticals?

Is it going to be more on the industrial side, residential, is there any interest in the municipal side given the strengths in muni?

When we look at it, we look at it as you know, we can not control the timing of any acquisitions.

We look at all of the spectrums.

I would say number one, we are going to stay close to the our core.

Number two, certainly more of our focus is certainly on the commercial space.

Municipal, not a heavy focus.

I think we are looking at companies come with some municipal experience, but I would not do a flat out pure municipal acquisition just on pure municipal.

But overall, you know I think our focus is more in that residential/commercial, but probably a little more on the commercial side.

Okay.

Perfect.

Thank you very much.

Thank you.

This concludes today's Q&A session.

I would like to turn the call back over to Bob Pagano for closing remarks.

Okay.

Well thank you, everyone.

We appreciate your interest in Watts Water, and we look forward to updating you in on our early Q2 performance in early August.

Thank you very much.

Ladies and gentlemen, thank you for joining today's conference.

This does conclude the program, and you may all disconnect.

Everyone have a great day.

Speakers, please stand by.