Watts Water Technologies Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.31.13 | About: Watts Water (WTS)

Watts Water Technologies (NYSE:WTS)

Q2 2013 Earnings Call

July 31, 2013 9:00 am ET

Executives

David J. Coghlan - Chief Executive Officer, President and Director

Dean P. Freeman - Chief Financial Officer and Executive Vice President

Analysts

Kevin R. Maczka - BB&T Capital Markets, Research Division

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Garik S. Shmois - Longbow Research LLC

John R. Moore - CL King & Associates, Inc., Research Division

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

James Giannakouros - Oppenheimer & Co. Inc., Research Division

Stewart Scharf - S&P Capital IQ Equity Research

Operator

Good day, ladies and gentlemen, and welcome to Q2 2013 Watts Water Technologies Earnings Conference Call. My name is Dulu and I will be your operator today. [Operator Instructions] Please be aware that remarks made during today's call about the company's future expectations, plans and prospects constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various factors, including those discussed under the heading Risk Factors in the company's annual report on Form 10-K for the year ended December 31, 2012, and other reports the company files from time to time with the Securities and Exchange Commission. In addition, forward-looking statements represent the company's views only as of today and should not be relied upon as representing its views as of any future date. While the company may elect to update these forward-looking statements, it disclaims any obligation to do so. During this call, the speakers may refer to non-GAAP financial measures. These measures are not prepared in accordance with Generally Accepted Accounting Principles. Reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release dated Tuesday, 30th of July 2013, relating to the company's second quarter 2013 financial results, a copy of which may be found in the Investor Relations section of the company's website at www.wattswater.com, under the heading Press Releases. I would now like to turn the call over to Mr. David Coughlan, Chief Executive Officer. Please proceed, sir.

David J. Coghlan

Dulu, thank you. Good morning, everyone. And thanks for joining our second quarter earnings call. I'll start with a brief overview of the financial and business highlights for the quarter. Then I'll give you our latest view on the market dynamics in each of our geographies and a sense for where we see those markets trending as we move further into 2013. I'll also update you on our expected segment performance from a top line perspective for 2013. Finally, I'll go through a high-level review of our realignment efforts before handing the call over to Dean Freeman to review our financial performance in more detail. After Dean's discussion, I'll try and summarize and then we'll open up the call to your questions.

So let me start with the financial highlights for the second quarter, which you'll see on Slide 2 of our conference call presentation. Consolidated sales in the second quarter were up 1.1% against the previous year. Organic sales were up 50 basis points, with increases in North America of 3% and Asia of 26.2% being substantially offset by a 4.5% organic sales decline in EMEA.

We delivered an adjusted operating margin in the second quarter of 10.1% or 70 basis points higher than our second quarter 2012 performance. And our adjusted earnings per share of $0.57 was approximately 10% ahead of the second quarter last year. The net effect of our share buyback programs was $0.01 accretive to this quarter's adjusted EPS. Dean will provide more color on the results in a moment.

With added sales volume, better product mix and continuing productivity and cost control initiatives, North America was able to deliver an adjusted operating margin of 14.1% during the quarter, 190 basis point improvement versus Q2 2012.

North America wholesale sales were up 4% in total during the quarter.

On the retail front, our sales were down almost 1% in the quarter as we continue to encounter pricing pressures resulting from customer line reviews.

The second quarter impact to North American operations of our lead-free transition program was approximately $1.4 million, driven principally by labor inefficiencies as our factories continued the lead-free transition. That means our year-to-date incremental costs totaled $2 million.

You'll recall that during our Q1 conference call we said that we expected additional lead-free-related costs in Q2 and Q3 to total $2 million to $3 million, with the majority of that cost in Q2. We now expect to incur $1 million of these costs in Q3.

EMEA's adjusted margins declined 60 basis points to 8.4% as compared to the second quarter last year, driven by volume declines in some major markets.

In France and Germany, quarterly sales were both 10% below the previous year. The French wholesale plumbing market and the German HVAC market continued to be soft. Our BLÜCHER drains business, along with export sales into the Middle East, remained strong and we saw Eastern European sales bounce back sequentially from the first quarter after a tough winter.

In Asia, we continue to build out our plumbing and HVAC capabilities and to broaden our market coverage. The overall China economic environment remains positive.

Our inter-company business was also stronger during the business -- during the quarter, which helped with plant absorption. We did see a shift in sales to more buy-sell products during the quarter, which negatively affected adjusted margins. But overall, our Asia team delivered another strong quarter.

Finally, from a cash perspective, we retired $75 million of unsecured senior notes in May using cash on hand. And we repurchased 10 million of our common stock on the open market during the second quarter as part of our most recently announced share repurchase program. Our net debt-to-cap ratio remains conservative at 11.7%. And we had approximately $182 million of cash on hand at June 30.

If you turn to Slide 3, let's review the business highlights for the quarter. Let me start with EMEA. I've already mentioned that certain core markets, like France and Germany, continue to be soft. Italy was slow as well. We did see some signs of stabilization in France as the quarter progressed and June orders picked up in Germany after a very slow start to the quarter.

The drains business continued its strong performance as they maintained their momentum on project wins. The U.S. lead-free initiative continued on track during the second quarter. As the quarter progressed, we noticed more of our wholesale customers starting their transition to lead-free products. We expect this transition to accelerate as we move through the third quarter.

Operationally, the new foundry was formally commissioned in June and will ramp up output during the third quarter, with the intention to be at normal capacity by the end of the third quarter.

North American unit volume was up 4.6% overall during the quarter. However, sales were hindered by retail pricing pressures. Sales of some key new residential construction product lines were up 7.5% on average during the quarter. And we've also started to see some minor movement upward on the nonresidential front. We also saw a sequential pickup in orders from the first quarter. But certain core product lines that we sell into nonresidential applications, like specialty drains, remain flat or down to prior year. Further, we've had some new product introductions that have promise, but have yet to gain traction in the market.

And from a customer perspective, we've noted sales at smaller wholesalers are basically flat with last year while we're seeing solid growth at large customers. This signifies to us that smaller customers are being very cautious in taking on new inventories as they begin to transition to lead-free inventory.

Finally, our efforts in emerging markets, including Asia, the Middle East and Eastern Europe continue to deliver results during the quarter.

If we turn to Slide 4, let's discuss current market dynamics. Let me start with EMEA. Macro headwinds in Europe continued and have affected some of our core businesses more deeply than in the first quarter. We still estimate French wholesale markets remain down 10% to 15% due to a softening economy. Our German business declined again during the second quarter as compared to last year and we've now seen no growth in our German business for 3 quarters as the wholesale and OEM markets in Germany have softened due to the economy. As mentioned, we did see some signs of stabilization in France and Germany as the quarter progressed. But a portion of the German uptick resulted from business we picked up due to the major flooding that occurred during the quarter. Southern Europe and especially Italy, continues to be depressed with political uncertainty in many southern countries adding to the consumers' anxiety.

On the drains front, we believe that business will remain solid as will our emerging markets in Europe. Overall, I see our European end markets with a little more risk than opportunity as 2013 progresses.

Let's now look at North America. We see the same trends in North America as we discussed in May. Residential new construction is strong and continues to trend upwards, with the latest full year housing starts estimated by Wells Fargo to grow by 27% to 990,000 starts for 2013. We expect existing home sales will be steady and the residential repair and replacement business, as tracked by the LIRA index, to remain positive.

We have seen a small pickup in some commercial vertical markets, but others are still down. The ABI Index has continued its mostly positive trend during the quarter so we expect that a more positive commercial construction uptick may occur as the second half of 2013 progresses.

Finally, let's discuss Asia. Chinese GDP was up 7.5% year-over-year in the second quarter. So the overall economy continues to grow steadily. We've discussed before our focus on high end construction markets in China, where our European and U.S. technologies are in demand and where consumers are increasingly focused on ensuring comfort and safety in their homes. And we're expanding our sales footprint into Tier 2 and Tier 3 cities within the country.

One consequence of the Chinese government's latest efforts to slow down the real estate market in major cities is that shadow banking has diminished. Shadow banks are second-tier lenders that have helped to finance many projects in the larger cities. The increase in interest rates has hurt their business and may cause a slowdown in construction in the Tier 1 cities, but we expect to maintain our overall momentum in Asia as the year progresses.

Now if we move to Slide 5, I'll provide you with our updated view of how we see 2013 shaping up. For EMEA, I think we've laid out the challenges there already. And we'll certainly endeavor to mitigate the downward market pressures wherever possible.

However, our current outlook suggests that we'll experience a 3% to 5% decline in sales for the full year of 2013 at constant FX rates. Our previous downside range was 2% to 5%, so we see marginally more risk as we look at EMEA for the balance of the year.

We see business volumes picking up in North America, with growth from residential new construction and remodeling. We still do not anticipate that commercial construction will provide much tailwind for the balance of the year. So we continue to expect core business growth in North America for all of 2013 in the 2% to 5% range. In addition, we estimate that the effect of expected lead-free sales may provide an incremental 1% to 2% to our total North American sales this year.

As regards Asia, our expectation is that the team will continue to execute its sales plans and we're maintaining our sales growth expectations of 20% to 25% for the full year.

As mentioned earlier, we still anticipate incremental costs of $1 million in Q3 for the lead-free transition. And we expect further acceleration by our customers as they transition during Q3 to lead-free product SKUs. We expect to spend approximately $37 million in CapEx for the full year of 2013, meaning a second half spend of approximately $19 million.

If we move on to Slide 6, I'd like to summarize to you our anticipated realignment efforts. The board has approved the management's plan to accelerate certain operating footprint consolidation programs and SG&A improvements that we had been contemplating. Our initial efforts will focus on Europe and we've outlined in general the expected costs and benefits of the European programs. Total costs will approximate $16 million, of which $2 million will be for capital spending. The remaining costs will include severance, relocation costs and professional fees. We expect that approximately 70% of the total spend will occur by the end of 2014. Expected annualized savings approximate $7 million, which we expect to fully realize by 2016.

Presently, we anticipate that we'll capture 50% of the savings in 2014 and 90% by the year end 2015. The timing of the costs and the related savings is somewhat fluid as we will need to engage various workers councils and various local government entities to gain plan approvals. The end result is we expect to reduce our manufacturing square footage in Europe by approximately 10%.

The board also approved the disposal of Austroflex, an Austrian-based manufacturer of pre-insulated piping products. This business has not met performance expectations since its purchase approximately 3 years ago. If you recall, we took a sizable asset write-down in 2011 for the Austroflex business. We expect to incur a loss on disposal of approximately $2 million in Q3. The sale of Austroflex will reduce our European square footage by an additional 6%.

Let me turn it over to Dean now who'll provide you with more insight into our operating performance in the second quarter.

Dean P. Freeman

Thanks, David, and good morning everybody. As usual, I'll try to keep my comments very brief. I think David hit most of the major topic points and I'll apologize in advance if I repeat anything David said, but we'll try to add some color and more detail as we go through the pack.

So I'm on Slide 9. And again, as David pointed out, on a consolidated basis for the quarter, the organic revenue was up 50 basis points. North America 3% of that, offset by EMEA, down 4.5% with solid growth in Asia, 26.2%.

A little bit more color on North America as David talked about the wholesale channel being up roughly 4% organically, and on a unit basis, 4.6%. The OEM channel was also up around 3.2%. And again, as was mentioned, the retail was down 1%.

We continue to see pricing pressure in the retail big-box end markets and they've really accelerated some highly competitive line reviews. In certain cases, we've taken selective price reductions to hold share.

I think also as was mentioned, the other dynamic we saw in the quarter is that large wholesalers are fully engaged in the lead-free inventory transition. The volume is tracking to plan. It's solid in terms of the growth.

However, we have seen a bit of an air pocket in the lead-free transition with the small wholesalers as they look to destock as much is possible with leaded products before they have to restock with lead-free products. We obviously think this is transitory, but we're watching it closely.

Looking at EMEA for the quarter, we did see, as was mentioned, 4.5% organic decline in the region, driven by Germany and France. We did see improvement in the month of June. We believe that was, in fact, driven by OEM orders as a function of the central European flooding. We think that's situational to the event and not necessarily a going forward trend. However, we do continue to be cautious on our outlook. That said, we continue to invest in the markets that continue to grow. The Drains business was up over 4%. Emerging markets was up over 20% and our electronics business was up close to 30% in the quarter. Small numbers, but solid growth in those markets that are -- that continue to grow.

And as David talked about, we are planning actions to deal with the expected revenue declines in the year and I'll talk a little bit about that later in my comments.

On a consolidated basis for the quarter, we did see 50-basis-point improvement in gross margins, driven largely by performance in North America, which improved margins by 110 basis points year-over-year on higher sales volume, supply chain productivity and lower commodity costs. This does include about $1.4 million of the expected production inefficiencies related to the lead-free transition in the second quarter. We talked a lot about that. And year-to-date, we're at about $2 million in negative impact related to the lead-free transition. And I think as David has talked about, another $1 million in the third quarter.

The adjusted operating profit for the quarter was $37.6 million. Again, as was mentioned, 70-basis-point improvement to 10.1% and largely driven by the 20% improvement in the adjusted operating income coming out of North America. They were at 14.1% of sales, offsetting the declines in EMEA, so solid performance out of North America.

The adjusted tax rate for the quarter was 34.2%. That's 110 basis points over last year. And that's largely driven by the earnings mix in North America versus EMEA versus the prior year. As David mentioned, $0.57 of EPS, $0.05 improvement over prior year, at 9.6%, and that does include $0.01 of benefit from the share repurchase program for the quarter, I think as was mentioned.

So year-to-date revenue is basically flat organically, North America up 3%, EMEA down 5%, Asia up 30%. Gross margin is up 40 basis points on a year-to-date basis. Again, largely driven by North America, and largely driven by productivity volume and SG&A controls.

Adjusted operating profit year-to-date is $68.1 million, improved 70 basis points year-over-year to 9.3% of sales. Again, as was mentioned, expanding margins at lower G&A being the key drivers.

Tax rate hasn't changed over prior year at 31.6%. Year-to-date adjusted earnings at $1.06, about 12% growth versus prior year, $0.03 of benefit from share repurchases. You can read the slides on the regional performance, so I'll just turn to Slide 17.

Primary working capital. As we've talked about several times, almost exclusively affected by the inventory build to support the lead-free conversion about $27 million of inventory.

On the next slide, free cash, again, exclusively affected by the higher capital spend on the lead-free foundry. And I think as David mentioned, $10 million in share repurchases for the quarter under our 2013 plan. We plan $13 million in the second half of the year. We used $75 million of cash to pay down debt, and we ended the quarter with $102 million in cash, again, to repeat what -- all of David's comments.

So lastly, let me just make a couple of comments regarding the board-approved realignment initiative in Europe. First, it's important to point out, and I think as David clearly pointed out in the slides that he spoke to, this still requires further review by European employee representative bodies and other outside agencies. So we're not across that hurdle quite yet. We're still very much in early stages of the rollout plan. And we'll be limited in how much detail we can talk about with regard to scope and timing, so we'll be careful about that.

However, I think as David pointed out, as we've said in the past, our approach is to be both tactical in dealing with the short-term realities of the economic situation in the region, but also to be strategic in achieving the long-term sustained improvement in growth and profitability that we're targeting over the next several years. So with that, I'll just turn it back over to David.

David J. Coghlan

Dean, thank you. So in summary, during the quarter, we gained momentum in the North America wholesale market. The lead-free project continued on track, and Asia and our other emerging market businesses performed above expectations. North America and EMEA controlled their operating costs well and consolidated adjusted operating margins expanded as North American sales increased and product mix was favorable. We expect the market in EMEA to remain soft and we expect to implement our realignment initiatives in Europe as the second half of 2014 progresses. So with that, why don't we open up the line to your questions? Lulu, can you open up the lines please?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Kevin Maczka of BB&T Capital Markets.

Kevin R. Maczka - BB&T Capital Markets, Research Division

First, if I could start on North American margins. A nice lift there year-over-year and sequentially, and it sounds like you got some pockets like retail where there's some increased price pressure. You've got a foundry that's not -- a new foundry, that's not at full capacity yet. I know you've been working on the cost side and lean, and maybe mix was favorable. But I'm just wondering if you could kind of parse through that a bit. I'm trying to get a sense for sustainability of the strong margin that we just saw there.

David J. Coghlan

Well, look, there's a couple of different drivers. So let me go through them in order as best I can. First of all, we have talked for sometime about the fact that when we get additional volume, the drop-through rate is quite positive. And so we saw some benefits from that. Second, within our cost structure, we did see some benefits coming into the P&L from the reduction of copper prices. We also had a benefit in our cost structure because of advantageous mix overall, both channel and product. Third, we've continued to drive our productivity efforts and we continue to see product. And fourth, we've been managing SG&A tightly on a global basis. And we saw the benefits of that flow through in North America as well. So they're really the drivers.

Dean P. Freeman

Kevin, let me just add a little bit more color. The impact of the commodity prices was anywhere from 30 to 50 basis points on a gross basis of the benefit that we saw. The overall general productivity that we saw on a gross basis was roughly 150 basis points. And that's all sourced from the comment that David said. That's general productivity in our supply chain. It's some manufacturing productivity and cost savings coming from ongoing initiatives in our supply chain.

Kevin R. Maczka - BB&T Capital Markets, Research Division

Okay. So of those 4 things, I mean, copper continues to work in your favor and productivity SG&A control are going to be ongoing initiatives, volume presumably would get better as the cycle improves. None of that sounds one-time in nature in any way.

David J. Coghlan

Correct.

Kevin R. Maczka - BB&T Capital Markets, Research Division

Okay. Can I just shift over and ask one more on price? You've mentioned some selective pressures like the line reviews that are ongoing. Are you seeing price pressure of -- or opportunity anywhere else? And as it relates specifically to lead, now that we're another quarter into it, what's your early experience there with being able to maintain price and margin?

David J. Coghlan

Well, obviously, there's some choppiness during the transition because at certain points in time, certain wholesalers and certain manufacturers may have differing amounts of leaded versus lead-free material, and therefore you may see, let's say, non-normal comparisons between those 2 buckets. But if we look at general trends, we said right through this transition that our objective is to maintain our gross margin percentage as we do the transition from leaded to lead-free. And we remain confident that, that's still attainable. Outside of that, are we seeing any major challenges or opportunities on the pricing front? We remain concerned about what's going on in retail. We're working it as hard as we can. But outside of that, we don't have any major concerns.

Operator

The next question is coming from the line of Jeff Hammond of KeyBanc Capital Markets.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Just to be clear on the lead-free, so your spend is kind of still in line, it's just some spending shifted from 2Q to 3Q?

David J. Coghlan

Yes.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Okay, great. And then second half, I mean it sounds like you get some growth acceleration in North America and some of that is the pricing coming in. So -- I mean, I guess you hold the gross margin percentage, but you get maybe a little bit lower incremental on that revenue growth?

Dean P. Freeman

Yes, that's the logic exactly.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Okay. Okay, good. You mentioned some pockets of optimism in commercial and some hope for second half recovery. Can you just expound on that? And what are you seeing that gives you some comfort, whether it be in the order book or anecdotally and how does that shape your view into second half and into '14?

David J. Coghlan

Well, I won't go through an exhaustive list, but as we get smarter about the key vertical markets on the commercial front in which we operate, we're seeing some trends, positive and negative. So an example of a positive trend is spending in the hospitality vertical market. We're certainly seeing some growth there. And that's coming from new construction and it's also coming from existing buildings as hotel operators refresh and upgrade their buildings after a 4- to 5-year lack of investment. On the negative side, we're seeing a slowdown in governmental buildings. And so obviously, a slowdown in construction, very few projects on the books, and also a slowdown in investment in existing buildings. And so they would sort of be bookends, and as we move across the vertical market spectrum, we're seeing some other vertical markets which have some positive trends, and others which are flat or negative. And so we're pleased to see some positive trends after a tough 4 or 5 years. And we do expect that over time, those positive trends will start to outweigh the negative, but we're not calling for any substantial commercial market rebound until later in the year or next year.

Operator

Next question is from Garik Shmois from Longbow Research.

Garik S. Shmois - Longbow Research LLC

Just a clarification question on Slide 6 on the realignment summary. Just wanted to be clear, are you spending $16 million to realize $7 million in annualized cost savings? Is that how we should be thinking about it?

David J. Coghlan

Yes.

Dean P. Freeman

Yes.

Garik S. Shmois - Longbow Research LLC

Okay, great. And is it possible to provide the breakout on the cost savings, how much you anticipate will be variable versus fixed cost savings?

David J. Coghlan

We're not prepared to do that at this point. We want to remain high level on this because there's a lot of discussions that have to take place with local government entities, with workers' councils, et cetera. So we can flesh that out later as we move further through that process.

Garik S. Shmois - Longbow Research LLC

Okay, that's fair. I guess, shifting to North American DIY, just a follow-up question on the sales trends there. You talked about pricing pressure because of the line item reviews, but I'm just wondering what you're seeing on the volume end, if you're starting to see some of the DIY spend start to come back.

David J. Coghlan

I think if you look at the plumbing aisle in the major DIY chains, they are starting to see a little bit of lift. And so there's 2 dynamics going -- well, there's 3 dynamics going on. The first dynamic is they're managing the transition to lead-free in the plumbing aisle. The second dynamic is they're certainly seeing some consumer demand lift in certain categories. And then the third one is that, by and large, there's a lot of line review activity, which means that volume is shifting in and shifting out as incumbents lose business or as players gain new business. So it's a pretty complicated set of dynamics. But overall, from our perspective, what we're saying is that volumes are remaining relatively steady as a result of the lead-free transition and the line reviews, but we have decided to take a little bit of -- a cut on price in certain areas to maintain share.

Garik S. Shmois - Longbow Research LLC

Okay. And I guess just lastly, just one more clarification question on the lead-free, with the pickup in sales to large wholesalers, or at least they're being early adopters with the lead-free products. Can you just talk a little bit more about the margins there? How stable have you been able to keep the margin percentage with the large customers who have taken on the lead-free earlier on in the process?

David J. Coghlan

Our objective was all along to maintain our gross margin percentage. And we're meeting that objective.

Operator

The next question is from John Moore of CL King.

John R. Moore - CL King & Associates, Inc., Research Division

I had a couple of questions related to the lead-free transition. And I guess, first of all, I know you were expecting a lot of the contractors to stop booking any large projects with any leaded products sometime here in the third quarter, and that the transition to marketplace would really occur much sooner than the January deadline. I'm just curious if that's playing out as you anticipated?

Dean P. Freeman

It is.

David J. Coghlan

It is. I think there's still a lot of dynamics though that go on within that. If I'm working on a small project with a completion date in the next couple of months, at which time the inspectors will sign off on the job, I have no great incentive yet to want to use lead-free. But if I'm engaged in a significant project that's going to drag on for several months or a year, the inspection will take place at the end. So I'm going to be very cautious about using leaded product on that job because the inspection will take place most likely after the end of the year. And so depending on the mix of quick-turn projects versus long-term projects, that will have an impact. Also, where my supplier, my wholesaler of choice is at in their conversion is going to have an impact. So there's a lot of variables, but it's moving forward as we expected.

John R. Moore - CL King & Associates, Inc., Research Division

Okay. I guess, do you have a sense of how many -- what the breakdown between quick-turn and long-term projects are? And -- I mean, do you think will be -- you think the industry will be fully lead-free or 90% lead-free by the fourth quarter?

David J. Coghlan

I think, John, that it's -- the key driver over the next couple of months is not going to be so much the mix of projects. That will certainly play a role, but I think the biggest driver over the next couple of months is wholesalers' plans. And so if you just go back to the comments that we mentioned a little bit earlier in the call, large wholesalers who tend to operate their own distribution centers and whose internal supply lines to the counter is therefore longer, they're already off and running in the conversion and most of them are going to be done pretty soon. And so therefore, if I do come in, looking -- if I'm a contractor and I look for a leaded product, they're probably not going to be carrying it. As we said, we are seeing smaller wholesalers manage their inventories very, very tightly so that they can get rid of as much leaded as possible before they stock up on lead-free. So our view is that the wholesalers are going to be the main driver of this. And so by the end of the third quarter, we'd be surprised if there's many wholesalers out there who have not converted.

John R. Moore - CL King & Associates, Inc., Research Division

Perfect, all right. And then I was just wondering if you had any better sense -- I know the market -- there is a significant piece of the market that's served by some lower cost providers and I know we haven't been sure whether they're going to make the switch or not. I guess, have you got any better sense at this point where that market share could go or if it could become available?

David J. Coghlan

I'm not so sure that there's going to be any existing player in the marketplace who will decide not to make the switch. Because remember, over the last 4 to 5 years, they've had to make the switch if they wanted to stay in markets like California anyway. I think the issue really becomes as we -- as this becomes a nationwide rollout, the quality that those guys were able to bring to the market, their choice of alloys, the effectiveness of their manufacturing quality control processes is something that their customers will be watching carefully and they'll be seeing good results versus bad results. And so I think that's really where the rubber will meet the road.

John R. Moore - CL King & Associates, Inc., Research Division

Got it. Okay. And one last one, just on the realignment strategy and I apologize if I missed this. But the new realignment strategy, does that primarily include headcount and facilities? Or is the ERP system consolidation that I think you've been planning included in that as well?

Dean P. Freeman

Yes, I wouldn't say there's anything related to an ERP consolidation. We're going to be careful about breaking out savings or costs with regard to the different categories as we talked about earlier. We do have to pass a certain regulatory review in the region and we're still very much in the early stages of the rollout plan, so we're going to be very careful of how we break it down.

David J. Coghlan

But John, to take it a little step further, the sort of things that we've talked about in the past remain the sort of things that we continue to be focused on. And so we are looking at our footprint. We are looking at operational efficiencies through the creation of shared services and realigning back office activities. And we're also looking at how do we do things in a more efficient and effective way throughout the SG&A line. And so it's a -- sort of an all-of-the-above type of approach.

Operator

Next question is from the line of James Sullivan of RBC Capital Markets.

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

Couple of questions on margins. I guess, first on the European side, wondering how we should think about sort of long-term potential for that segment? I know if we look back historically, the segment has been as high as 13%. I mean, is that a relevant number for the potential margin and we put that against prior peak revenues and $7 million savings? Just wondered if you could maybe directionally help us with how to think about the margin potential in Europe?

Dean P. Freeman

Well obviously the margin, Jamie, has been significantly impacted by the volumes. But I can tell you, and as David pointed out, our efforts, our planned efforts with regard to realignment, the ongoing efforts that we have with regard to productivity and supply chain, none of that has stopped, and this is all about accelerating that, creating a more efficient and effective platform. So certainly getting back to historic margins, but obviously, also looking forward to continuing to expand and grow.

David J. Coghlan

So Jamie, to add just a little bit of color to that. We talked repeatedly about the fact that our midterm objective is to get to a global 12% operating margin. And in order to get there, Europe will have to get back to its peak margins and go beyond that. And so volume and continuing declines in the market obviously are headwinds as we move that way. But that's what we're focused on. That's what we're working towards and that's what we're committed to achieving.

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

That's helpful. And then switching to North America, did you mention -- I think you mentioned mix a little bit. Can you add little color there on where you saw the mix benefit in the product side?

David J. Coghlan

Well, I mentioned 2 different sources of mix. So first of all, channel. Obviously, we saw growth in our wholesale business and a negative 1% driven by price in retail. Wholesale is a higher margin channel than retail. And so that gives us favorable mix. And then second, if we look within some of our products, we saw some nice growth in particular product segments. An example would be backflow, which are higher margin than our average. And so there were a number of positive mix developments in the product side and a switch to more wholesale on the channel side.

Dean P. Freeman

The OEM channel was also up, which is positive to the mix.

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

And then one more if I could, just on, I guess, cash flow metrics. Can you just help us think about long-term what you see as normalized working capital metrics and CapEx?

Dean P. Freeman

Well, it depends on how you define long term. But certainly we've targeted over 100% of free cash as a percentage of net income. In terms of CapEx, we have certainly not cut back. We certainly focus on projects that are accretive to our overall return on invested capital. And we'll continue to invest as is necessary in order to support the growth in the performance of the business. Obviously, lead-free was an important component of that. Obviously with our proposed plans in Europe, that will be a part of it. And in terms of working capital, as we said, I think we've done a pretty good job on sort of receivables and payables, and there's a great opportunity to continue to take down working capital from an inventory perspective. The company has done a great job I think, certainly historically, in bringing working capital down. But the inventory build to support the lead-free is obviously the investment that is needed to grow the business and support that transition, but certainly offers future opportunity for reduction.

Operator

[Operator Instructions] We move to our next question. It's from the line of James Giannakouros of Oppenheimer.

James Giannakouros - Oppenheimer & Co. Inc., Research Division

Austroflex's sales on a trailing 12-month basis and EBIT contribution, can you give us those?

Dean P. Freeman

Yes, so the revenue last year was about EUR 14 million. And yes, that's about it. EBIT was below $1 million.

James Giannakouros - Oppenheimer & Co. Inc., Research Division

Got it...

Dean P. Freeman

Or I should say -- sorry, EUR 1 million.

David J. Coghlan

EUR 1 million.

James Giannakouros - Oppenheimer & Co. Inc., Research Division

And just to revisit margins again just tacking on -- asking it a little differently than the way Jamie just did. When we look back at your last 5, 6 years, we -- I think we estimate restructuring activity has taken out about $15 million or $16 million in costs. But we know that lean initiatives in ERP consolidation have contributed to your profitability as well in North America. Can you quantify, in any way, their contributions over the past several years? And on the related topic on Europe, any targets that -- high-level targets that you might have, just on those 2 components, how they can contribute to getting to a 2016 margin along the lines of how you estimated annualized savings on the restructuring side being $7 million?

David J. Coghlan

Jim, that's a tough one. The challenge in answering that question, I think, goes back to the fact that while we were restructuring, we were not looking at a stable volume environment. And so the relationship to the amount of volume drop versus the amount of capacity you take out is going to have a huge impact on the way you think about that, right? So going forward, that whole relationship should change as markets stabilize and grow. I think maybe the best way that we can put it to you is that we've talked publicly in the past about incremental volume leveraging down at about 35% or so. And so that comes from a leaner, meaner set of processes. And it also comes from a slimmed-down footprint. And maybe that's the best way we operators can think about it.

Dean P. Freeman

You all right? Yes. No further comment.

James Giannakouros - Oppenheimer & Co. Inc., Research Division

Got it. And just a finer point. I know you don't want to give guidance, but just trying to do math around Europe. It's running in the low 8s as far as the operating margin, mid 8s so far this year. Is a 10% margin achievable next year given the announced moves and assuming no organic growth in the region, so your restructuring activity, cost saves and also, taking out Austroflex?

David J. Coghlan

Jim, we'd be reluctant to give that sort of specificity about next year.

Dean P. Freeman

Obviously, volume in Europe and anybody who's got a better view of that can chime in. But certainly volume will play a significant role in ultimately how margins perform. But I think David said it best. 12% global operating income is the target and we certainly need Europe to get back to historic levels to -- in order to achieve that.

David J. Coghlan

The difficulty about answering your question about next year is we're finding it terribly difficult to make a call on where the markets go. And so those trends are going to have a huge impact on what sort of a number we might expect to see next year. We're in the early stages of engaging with works' councils and local authorities on the restructuring efforts. And that's going to have huge impact on timing. And so you put those uncertainties together and if we threw out a number, the accuracy of that number is just going to be low.

Dean P. Freeman

But, look, Europe is still a very important market to us. It will come back one day and this is really all about positioning it for the future.

David J. Coghlan

So that's why we would say, look, it's tough to say what's exactly going to happen next year, but our long-term goal is to get to global 12%. And in order to do that, Europe needs to get back to its historic profitability rates and go a bit beyond it.

Operator

The next question is from the line of Stewart Scharf of S&P Capital IQ.

Stewart Scharf - S&P Capital IQ Equity Research

Could you talk a little about the do-it-yourself in home improvement business? I was just wondering why that's been weak although the wholesale is strong on the residential? Is it more the residential -- the commercial side than the residential? Or is it split evenly?

David J. Coghlan

I think, Stewart, we tried to answer the question on retail a little earlier. So maybe let me try it again to see if I can do better. First of all, we are seeing, within the plumbing aisle of our retail customers, some increase in customer sales. We are also seeing an increase in line reviews. And when a line review is concluded, a manufacture either wins the business or loses the business. And that means that chunks of business move in and move out of the sales line based on the win-loss ratio. And the third -- the second impact of those line reviews is that there's a price associated with that business. So what we're seeing is, effectively, 3 moving pieces: an increase in consumer demand in DIY; a movement of volume in and out as a result of line reviews; the combined effect of those 2 in our business is approximately 0%, in other words, they net out; and the result of the line reviews is a negative 1% sales decline largely due to price. If we compare retail to wholesale, you're looking at 2 very different animals, because you're looking at DIY demand largely in retail and you're looking at professional demand in wholesale. So you're not going to have a whole lot of DIYers going into a retail customer to buy product to build a new home. And you're certainly not going to find DIYers going into retail to buy a lot of product for the commercial market. And so there's a big difference between the channels. And so hopefully, that sort of answered part of the question. The last piece I just try and talk about is what's going on in wholesale. We're seeing a couple of -- we're seeing 3 different trends. First, we're seeing -- well, 4 really. We're seeing improvement in residential new construction. We're seeing steady repair replace. We're seeing a mixed picture in commercial, which means it's net-net flat. And then we're seeing a movement in demand from leaded to lead-free with a solid transition on the part of large wholesalers and some air pockets as smaller wholesaler run down inventory before they make the transition. So hopefully that's not too complicated, but that's sort of the best way I could try and explain it.

Stewart Scharf - S&P Capital IQ Equity Research

Very helpful. Also just on your -- on the M&A, where do you stand with that strategy? Has it changed at all based on your focus on the realignments in Europe? And with growth being strong in Asia and it being such a small percentage of your overall sales, are you looking to expand that percentage?

David J. Coghlan

I guess the best way of responding to that is to say that our M&A strategy remains intact. We remain a careful buyer. And so that means that we walk away from properties that might be attractive, but which are not at a multiple that we deem appropriate. We did do our last 2 largest ever acquisitions in Europe. And so that, combined with the downturn there, would make us a little bit more careful about acquisitions in Europe. But outside of that, we've got a pipeline. We're working it. But we remain a prudent buyer.

Operator

Thank you, gentlemen. You have no further question in the queue. I will now hand the call back to Mr. David Coghlan for closing remarks.

David J. Coghlan

Thanks, very much, Dulu. In closing, I'd like to thank all of you for taking the time to join us today for our second quarter call. We very much appreciate your continued interest in Watts Water, and we look forward to talking to you again during our third quarter earnings call in late October. Have a great day. All the best.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference call. You may now disconnect. Have a great day. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!