Watts Water Technologies, Inc.

Good day and thank you for standing by. Welcome to the Watts Water Technologies first quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1 on your telephone. If you require any further assistance, please press star 0. I'd now like to hand the conference over to your presenter today, Timothy M. McPhee, Treasurer and Vice President, Investor Relations of Watts Water Technologies, Inc. Please go ahead.

Thank you and good morning, everyone. Welcome to our first quarter earnings conference call. Joining me today are Bob Pagano, CEO and President, and Shashank Patel, our CFO. During today's call, Bob will provide an overview of the first quarter and discuss the current state of the markets and our operations. Shashank will discuss the details of our first quarter performance. and provide our outlook for the second quarter and our revised outlook for the full year 2021. Following our remarks, we will address questions related to the information covered during the call. Today's webcast is accompanied by a presentation, which can be found in the investor relations section of our website. We will reference this presentation throughout our prepared remarks. Any reference to non-GAAP financial information is reconciled in the appendix to the presentation. Before we begin, I'd like to remind everyone that during the course of this call, we will be making certain comments that constitute forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially. For information concerning these risks, see WAAT's publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. With that, I will now turn the call over to Bob.

Thank you, Tim, and good morning, everyone. Please turn to slide three, and I'll provide an overview of the quarter. I must first thank our global organization for executing under very trying circumstances. I'd especially like to applaud our manufacturing, supply chain, and logistics teams. During the first quarter, the teams dealt with numerous issues around component availability, transportation bottlenecks, customer fulfillment needs, and the ongoing pandemic. I'm proud of how they work together to serve our global customers' demand. We had a solid start to the year. The severe winter freeze experienced in the South Central U.S. in mid-February caused widespread plumbing infrastructure problems and was an unexpected benefit that we estimate positively affected consolidated sales by about 3%. The underlying market conditions in Europe and apnea were stronger than we had anticipated. Lastly, part of the year-over-year upside was driven by an easier comp in apnea, which was heavily impacted by COVID in Q1 of 2020. Adjusted operating margin exceeded expectations supported by continued cost actions and incremental sales. We also delivered strong cash flow in the quarter. And shortly after the quarter ended, we completed the renegotiation of our credit agreement, extending the facility through March 2026 and amending terms to mirror current market conditions. We have ample capacity, which affords us a lot of flexibility. Finally, we announced a double-digit dividend increase starting in June. Shashank will review the financials in more detail momentarily. Operationally, commodity increases, especially in copper, steel, and packaging supplies, coupled with increases in logistics costs, have driven us to announce additional price increases globally. These will go into effect later in the quarter. We won't see the real benefit of that price increase until the second half of 2021. Supply chain constraints have increased significantly as well, driving potential component and product availability issues. Entering the first quarter, we maintained higher inventory levels, which allowed us to proactively meet the heavier freeze demand. However, constraints in the local and global supply chains are now resulting in higher costs. During the quarter, we continue to invest for the future. We incrementally spent approximately $2 million, of which over half was invested in our smart and connected products. We plan to increase investment spending for the full year from $13 million to $16 million, primarily to support additional growth and productivity projects. We announced a proposal to close or sell a small plant in Marie, France. We are currently consulting with the Works Councils and local government authorities so timing for making a final decision to close or sell the plant and related costs have yet to be determined or approved. Our goal is to move the MERIA operation to other existing plants in France. Our proposal impacts approximately 85 employees. On a net basis, we anticipate downsizing by approximately 50 people. Now, I'd like to provide an update on our end markets. From a macro perspective, since we last spoke in February, GDP forecasts have been revised upwards in the U.S., Canada, and parts of Asia Pacific, while other key areas in Europe, including France, Germany, and Italy, have seen GDP expectations reduced. Market expectations in the Americas for new construction in both the commercial and residential markets continue to be mixed and vary by submarkets. New residential single-family constructions continue to look steady for the year, with recent March and year-to-date housing starts positive. And multifamily residential starts, although lumpy, showed some buoyancy recently, with March starts up over 30% sequentially. We anticipate non-residential new construction growth will remain challenged at least through 2021. We still see a divergent growth prospects dependent on the end market. A recent AGC survey of about 1,500 contractors noted that 77% saw new projects either postponed or canceled in 2020, and 40% are seeing further project cancellations or postponements for the January to June 2021 period. Our drain product lines that are installed early during commercial construction projects saw continued negative sales growth in the quarter. The latest industry indicators have been more positive which may indicate new commercial construction growth as we head into 2022. For now, non-residential repair and replacement market is holding up very well, and with the positive impact of the freeze in the south central region, has offset the air pocket in new construction. As mentioned, GDP expectations for the U.S. and Canada have increased, so we expect that to continue to drive repair and replacement activity. Certainly, the south central U.S. freeze helped during Q1, and we anticipate that tailwind will continue into the second quarter. That sudden freeze demand has also caused reduced channel inventory levels, so we expect there will be channel restocking in the second quarter as well. Feedback from many contractors in the Americas that business has picked up and looked solid in Q2. In Europe, except for drains, the underlying markets look better. In our drains business, the commercial marine market is expected to continue to be challenged for the foreseeable future. Government-sponsored home energy subsidies in Germany and Italy should continue to provide support, and we see stronger wholesaler activity in France, at least in the near term. However, the second half of the year is still unclear. Strength in Italy has been driven by government-sponsored programs protecting employment that are in place through June. and successful vaccine implementation across Europe is still a concern as many countries are lagging the progress in the U.S. and the U.K. In the Asia Pacific region, our China markets have come back strong, especially in commercial valve sales. And we see growth in both the Australian and New Zealand markets where the governments have done a good job controlling the pandemic. The Middle East is still being challenged by COVID, and we expect minimal market expansion there for the balance of 2021. Regarding our outlooks for Q2 and the remainder of the year, we expect a strong year-over-year performance in the second quarter given the negative impact COVID had last year and the expected positive impact from the freeze and channel restocking. We're increasing our full-year outlook given the stronger-than-expected first half. We still have some concerns about the second half, with the main issues being supply chain and logistics disruptions, the final impact of the commercial new construction air pocket, inflation, and vaccine rollouts outside the U.S. Finally, I want to mention a few points as we continue along our ESG journey. First, we remain vigilant towards the health and safety of our employees, which remains a priority. Masks, social distancing, and sanitation protocols remain embedded in our operations. Second, We recently took part in Project 24 in partnership with the Planet Water Foundation. We sponsored the installation of an integrated water system and funded a water health and hygiene education program for more than 600 students in a small Vietnamese town. Since the beginning of our partnership with Planet Water in 2016, we've provided approximately 30,000 people in nine countries with safe, clean drinking water. Finally, we'll be issuing our annual sustainability report in June. The enhanced report will discuss our latest accomplishments and some important near-term ESG goals. With that, let me turn the call over to Shashank, who will address our first quarter results and our second quarter and advise full-year outlooks. Shashank?

Thanks, Bob, and good morning, everyone. Please turn to slide four, and I will review the first quarter's consolidated results. Sales of $413 million were up 8% on a reported basis and up 4% organically. As discussed, we had an easier compare in apnea during the quarter, and we estimate sales increased by approximately 3% because of the freeze in the south-central United States. Price was favorable in both the Americas and Europe, and Europe's organic volume was stronger than expected. Foreign exchange, primarily driven by a strong euro, increased year-over-year sales by roughly $13 million, or 3%. Acquisitions net of divestitures accounted for $4 million of incremental sales year over year. Adjusted operating profit was $60 million, up 24% compared to last year, and adjusted earnings per share were up 31% to $1.24. Adjusted operating margin of 14.5% was up 190 basis points as volume, price, productivity, and cost actions more than offset inflation and incremental investments. The adjusted effective tax rate was 28% comparable to the first quarter of 2020. Our free cash flow for the quarter was $32 million as compared to negative $8 million in the first quarter of 2020. The cash flow improvement was due to better working capital management, higher net income, and less net capital spending. Our goal is to drive free cash flow conversion at 100% or more of net income for the year. During the quarter, we repurchased approximately 31,000 shares of our common stock for $3.8 million, and as Bob mentioned, announced a double-digit increase in our dividend. Please turn to slide five and let me provide a few comments on the regional results. The Americas posted a solid quarter where organic sales up approximately 3%. This was primarily driven by the tailwind from the freeze in the south-central region of the U.S., which we estimate provided almost 4% of incremental growth. Absent the freeze impact, sales would have been in line with our first quarter expectations. We saw growth in plumbing and electronics, which was partially offset by lower heating and hot water and water quality sales. Adjusted operating profit increased by 11%, and adjusted operating margin increased by 110 basis points. The margin expansion was driven by volume, price, cost actions and productivity being only partially offset by inflation and incremental investments. Europe delivered a solid quarter with organic sales up approximately 2% and adjusted operating margin expanded by 350 basis points. Reported sales also increased by 10% from favorable foreign exchange movements. Organic sales were better than we anticipated as we saw growth in France in the wholesale plumbing channel driven by higher residential demand, and in OEM electronic products with customers pre-buying due to supply chain and inflationary concerns. In Italy, growth was driven by government heating subsidies. Sales in these regions were partially offset by lower sales in Germany and in Scandinavia, both from a continued contraction in the commercial marine business. From a platform perspective, plumbing and HVAC sales growth more than offset continued softness in drains. Adjusted operating margin expanded from volume, price, cost actions, and productivity, more than offsetting inflation. APMEA's year-over-year results was primarily driven by the easier comp to last year's soft first quarter that was negatively impacted by COVID, and to a lesser extent by stronger-than-expected growth in China. Reported sales increased by 76%, including 43% of organic growth, 23% from net acquisitions and 10% from favorable foreign exchange movement. China's organic sales grew from commercial valve sales into data centers. Organic sales outside China were flat, with growth in Australia and New Zealand being offset by continued softness in the Middle East. The AVG acquisition provided approximately $3 million of sales, which was in line with our expectations. Adjusted operating margin increased 15.5 percentage points due to higher third-party and intercompany sales volume and from cost actions and productivity offsetting inflation and investments. China intercompany activity was up 80% organically, benefiting from the U.S. freeze-driven demand. Slide 6 provides our assumptions about our second quarter operating outlook. We expect a strong year-over-year compare given COVID's major impact on Americas and Europe in the second quarter last year. Further, we anticipate an additional sales benefit of approximately 4% from the continued impact of the freeze in the U.S. and expect restocking actions in the wholesale market. As Bob mentioned, we have announced a second price increase globally to offset commodity and supply chain inflation. These become effective later in the second quarter and so will have a minimal impact. In total, we estimate consolidated sales may grow organically between 19 and 24 percent. In addition, acquired growth should approximate $4 million for the second quarter. We estimate our adjusted operating margin could range from 13.5 to 14.5 percent for the second quarter, driven by volume and offset partially by incremental investment spending of $4 million and incremental costs of $6 million related to temporary spending reductions in 2020 that we expect will return. All in, we estimate the incremental volume to drop through between 25 and 30 percent. Corporate costs should approximate $10 million. We expect interest expense should approximate $2 million in the second quarter, or about half of last year's interest charge. Under the new debt agreement, we locked in current market rates, which are lower than what we were paying under the old agreement, and we have less outstanding debt than last year as well. The adjusted effective tax rate should approximate 27%. Foreign exchange should be a tailwind when compared to the second quarter last year, given the current Euro-dollar exchange rate. Now let's turn to slide seven and let me review our revised outlook for the full year 2021. We estimate that organically, America's sales may increase in the range of 2% to 7% for 2021, driven by the freeze benefit and the second price increase, neither of which was anticipated in our February outlook, as well as stronger growth in non-residential repair and replace due to higher GDP expectations. sales should increase by about $4 million for the full year from the acquisition of the detection group. We expect adjusted operating margin in the Americas may be up versus 2020, driven by the drop-through benefits of the freeze, along with the incremental cost savings and productivity initiatives. For Europe, we are forecasting organic sales to increase between 1 and 5 percent. The increase will be driven by the second price increase as well as slight growth in underlying residential markets in France and growth in Germany and Italy due to government energy initiatives. This will more than offset expected GDP reductions. Adjusted operating margin may be up from incremental drop-through on volume, price, and cost savings initiatives. In APMIA, we now expect organic sales to grow from 10% to 15% for the year. Sales should also increase by approximately $6 million from the AVG acquisition in the first half. We anticipate adjusted operating margin for the year to be similar to 2020, if not marginally higher, depending on intercompany volume in the second half of the year. Overall, on a consolidated basis, we anticipate Watts organic sales to range from up 2% to 7% in 2021. This is approximately 7% higher than our previous outlook and is primarily driven by the impact of the freeze in the south central region of the United States, the second inflation-driven price increases, and the slightly better end market expectations in our key regions. However, we are still cautious about the second half due to the impact of the potential supply chain issues and the impact of the air pocket in new construction in the United States. Also, in Europe, there is the risk of potential shutdowns to the delays in vaccine rollouts. To date, these risks have been more than offset by the impact of the freeze and a more robust repair and retrofit market. We estimate our consolidated adjusted operating margin may be up 30 to 70 basis points for the year. This is primarily driven by the drop through from incremental volume, price, restructuring savings of $14 million, and productivity being offset partially by 2020 cost headwinds of $15 million, incremental investments of $16 million, and general cost inflation. And regarding other key inputs, we expect corporate costs will approximate $42 million for the year. Interest expense should be roughly $7 million for the year. Our estimated adjusted effective tax rate for 2021 should approximate 27.5%. Capital spending is expected to be in the $38 million range. Depreciation and amortization should approximate $46 million for the year. We expect to continue to drive free cash flow conversion equal to or greater than 100% of net income. We are now assuming a 1.19 average Euro-US dollar FX rate for the full year versus the average rate of Euro 1.14 in 2020. Please recall that for every one cent movement up or down in the Eurodollar exchange rate, our European annual sales are impacted by approximately $4 million, and our annual EPS is impacted by one cent. We expect our share count to approximate $34 million for the year. Now, let me turn the call back over to Bob before we begin Q&A. Bob.

Thanks, Shashank. On slide eight, I'd like to summarize our discussion before we address your questions. The first quarter was better than we anticipated with growth in all regions that was aided by an unexpected freeze tailwind in the U.S. and an easier compare in apnea. We expect to benefit from the freeze impact in the second quarter as well. Supply chain issues were minimal in our operations in the first quarter, but we see potential issues in Q2 and beyond that our team is managing on a daily basis. Inflation is also accelerating, and we've announced a second price increase to help offset the cost increases. We are on top of both matters in monitoring closely. We are increasing our investments for growth for 2021 while continuing to focus on cost controls. Market expectations in residential and markets are consistent with our February outlook. Near-term, the non-residential outlook is better, fueled by the freeze, channel inventory restocking, and stronger repair and replacement demand, which is overshadowing the weak new commercial construction market. We are still cautious about the second half because of supply chain constraints, the air pocket impact due to lower non-residential construction starts, and vaccine rollout progress outside the U.S. The leading indicators are suggesting we'll see growth in non-residential new construction in 2022. Watts is well capitalized. We have ample liquidity to drive our capital deployment strategy. The second quarter should be strong given the easier compared due to COVID last year and freeze benefits this year. We have increased our full year outlook given the strong start to the year while remaining prudent concerning the second half. Finally, we continue to execute on a day-to-day basis to meet our customer needs while managing through the ongoing pandemic and supply chain challenges. The company is well positioned both financially, operationally, and commercially to take advantage of market opportunities. With that, operator, please open the line for questions.

At this time, I'd like to remind everyone, in order to ask a question, please press star followed by the number one on your telephone keypad. And we'll pause for a moment while we compile the Q&A roster. And our first question comes from the line of Nathan Jones with Stiefel. Go ahead, please. Your line is open.

Good morning. This is Adam Farley on for Nathan.

Good morning. Good morning.

Related to the deep freeze in the southern U.S., you called out inventory restocking in 2Q. Do you expect that to be the final quarter of that impact, or should it carry through the rest of the year at all?

Right now we believe it's going to happen in the second quarter. Could some of it fall into the third quarter? Maybe. It just depends on how quickly they can get up and running. And right now there's a shortage of plumbers in the area. So all the, you know, bigger things are being done quickly. But our assumption is it'll be pretty much complete in the second quarter.

Okay. And then on the margin side related to that, is it concentrated in specific parts of the portfolio? And were sales of higher margin products accrued to Nick related to the deep freeze?

Yeah, we had favorability in our testable backflows. You know, it was heavy into irrigation, backflow kits, regulators, and fittings, et cetera. So, you know, on average, I would say it was slightly below our average margins. But, again, the volume from the factory point of view drove absorption. So, net-net, it was favorable.

Okay, that makes sense. Thanks for taking my questions.

Thank you. Our next question is from the line of Jake Jarnago with Baird. Go ahead, please. Your line is open.

Hey, good morning, everyone. Yep, this is Jake from my Canada teams. Good morning, Jake. Good morning, guys. Question on... you know, kind of the near-term or kind of structural versus temporary cost actions that we kind of talked about last quarter. I just want to make sure that that is still largely the same with what the results came in as today. So last I recall, it was basically about $15 million of temporary coming back this year with that largely being offset by incremental savings from 2020 structural actions. I guess where does that stand today? Thanks.

Yeah. Yeah, Jake, so it was $15 million, and out of the $15 million, we had talked about $5 million in the second quarter and about $10 million in the second half. So that is still our latest outlook. Now, the $5 million in the second quarter was, you know, part of that was travel markup. Obviously, with COVID lockdowns, it might be less than that as we go through the second quarter. And then being offset by the incremental restructuring savings we get, that number of roughly $14 million of restructuring savings offsets that.

Got it. Perfect. Thank you. And then another margin question here. So in terms of price cost then for the year, so it seems like first quarter was pretty good. Second quarter is where it seems like the timing impact would kind of hit you most. And then some catch up in third quarter, fourth quarter. So on a full year basis, are we thinking net neutral or is there potential to get kind of net positive there too?

Yeah, slightly net positive. And the reason for that is, you know, we do try to get ahead of the price-cost curve, and that's why we announced the January increases. And also, you know, we do lock in some of our commodities like brass in Europe. And in Europe, we can lock in for longer periods. But even in the U.S., we've kind of locked in for a certain, you know, for a few months and stuff. So we've kind of gotten ahead of it. And obviously now we've announced the second price increases because obviously commodities have inflated more than we had anticipated in the February time period. But overall, on a full year basis, slightly positive.

Great. Thank you. And then one more quick one here, again, on margins and kind of mixed impact. And this is kind of more around the commercial water heater and boiler business in North America. It seems like that is still kind of coming off the bottom. I would assume we're going to be starting to hit you know, easier comps here for the rest of the year? You know, I guess one, you know, kind of what's your outlook for that business? And then secondarily, from a mixed perspective, how does that relate relative to the other pieces of the America segment?

No, so, yeah, you're right. They were down, you know, overall mid-single digits in the first quarter. We expect they'll have easier compares for the rest of the year. So I think overall, though, we still believe that'll be down for the year, slightly down. when you look at a margin from an EBITDA point of view, you know, it's right on. So I think, you know, in line with all our expectations.

Great. Thank you very much.

Thank you.

Thank you. Our next question comes from the line of Ryan Connors with Boning and Scattergood. Go ahead, please. Your line is open.

Great. Thanks. First off, I just wanted to clarify something you said there, Shashank. Did I hear you say that basically the impact of southeast freeze on mix was but not really material? I think that was the first question there. Was that, did I get that basic idea right?

No, this is Bob. The question was regarding the mix and how did it impact margins. And from a standard margin, it's probably slightly lower, you know, given the mix. However, given the overall impact, P&L hit because of the absorption, it was favorable to our overall margins.

Okay. Okay. Okay. And then my other question, you know, I'm not sure if this is the right way to look at it, but if we look at pricing and price capture and sort of the delta between your resi and your non-resi commercial markets, you know, it seems like this environment would be pretty conducive to getting price in resi. I mean, if someone's putting up a housing development you know, in this kind of environment for red-hot housing that's going to sail right through any price increase, but a lot tougher in commercial. I mean, can you talk about that and how that affects price capture and how you manage that in two very different markets?

Yes, yes. So we're trying to drive price in all the markets, no matter what. Now, in some of the, let's call it retail segments, we have longer-term contracts. that we adjust. And some of our OEM contracts, we have inflationary quarterly adjustments based on materials. So, you know, all of that said, we're driving price in every one of the markets, given the supply chain issues, and most importantly, given the commodity increases we're seeing in the marketplace. So we're full speed ahead on that.

Okay. Okay. And then my last one, just real big picture, Bob. I mean, you know, and this sort of goes in line with Jake's question about the sort of cost-cutting initiatives and so forth. I mean, a year ago, we were sitting here talking about cost-cutting and headcount reductions, and then, you know, 12 months later, we've got record first-quarter sales, positive outlook, and the temptation is just sort of, you know, all systems go. But, you know, COVID was not the last black swan the world's going to ever see. And how do you strategically manage the company keep from getting back to normal too quickly where you leave yourself at risk if things turn south, the Fed or whatever happens? I mean, just walk us through your thinking on how to manage an organization at this point in the cycle.

Well, look, as you know, we tend to be conservative from a top-line point of view, so we keep our costs under control. We have detailed contingency plans based on you know, what's happening in the marketplace so we know actions we're going to take right away. So we're very careful about bringing costs back, you know, because we are still uncertain. However, right now, given the volume, given what's happening, you know, we can't control the inflation relative to commodity prices. There's labor inflation also. So again, we're balancing all of those things. But in the long run, right, we're going to continue to focus on costs and growth in our smart and connected overall strategy. So again, we're trying to do, it's the end, right? We're trying to invest in growth and keep our costs down. In particular, you know, you've heard me say many times that we have too much cost in Europe and we're looking at one facility right now in France. So we'll continue to look at that. We'll continue to manage our portfolio and our cost structure as we continue to invest for the future.

And, Ryan, you know, so this is, you know, we're a book and ship business, so we not only look at the leading indicators that you're aware of, but we're daily tracking our order input. So back to that $15 million of cost coming back, and, yes, that is the plan, but we meter that depending on how the orders come in. So we're on top of this, like, on a daily basis because we have to be.

Got it. Hey, thanks for your time.

Thank you. Thank you. Our next question comes from the line of Joe Giordano with Cohen & Company. Go ahead, please. Your line is open.

Hey, guys. Good morning. Good morning. Just curious kind of how you're triangulating the impact from, like, 2Q Texas. Is it just from, like, what you've seen through, like, today at this point? Like, how are you kind of getting your head around what that kind of impact is?

Is this the freeze you're talking about?

Yeah, exactly. Like how are you, you know, you're coming up with that 400 basis point kind of benefit in the 2Q from the freeze. Is it just kind of extrapolating out what you've seen in that kind of region through, you know, so far in this quarter?

It's a combination of all the above, right? We looked at what we did in April. We've talked to our customers. We're looking at channel inventory and our sales team's best estimate of what's happening in the marketplace there. So, Again, you know, it's a best estimate at this point in time, and, you know, that's where we're at, you know, right now.

Are you hearing anything about, like, I know you mentioned specifically the inventory channel there is now low because of this, but excluding that, like, let's talk about inventories elsewhere. Are you seeing, like, customers stocking up ahead of, you know, I'm guessing for these types of products, maybe there's not as much risk of supply. So I'm curious to see what the mindset of your customers are. So we're seeing people like kind of overstocking in other parts of the world.

Yeah, I think you raise a good point. So, you know, the freeze in the, you know, South Central really brought inventory through all the channels in almost every region because, you know, availability of products to ship, you know, was being pulled from all regions. So, You know, we watched some of that happen. The other thing is, given the concerns of the supply chain, especially chips and, you know, other products, we're seeing, you know, customers, you know, pulling in and placing orders early to get in line because they're worried about their future projects in case there's, number one, incremental pricing, and number two, just availability. So we're seeing both of those at this point in time. That's why, you know, Q2 – It's going to be interesting, and that's why we're a little concerned in the second half of this year because we don't know how much has been pulled forward into Q2 based on our latest projections. But there are supply chain concerns just like us. We're concerned, and we're ordering more right now to make sure we're ahead of the game.

So just the last for me on that point, you mentioned concern on the second half a couple of times. I definitely understand what you mean on how much is being pulled forward into now. But on the logistics side, are you kind of worried that this gets worse from here? I mean, I know everyone's already experiencing pretty tough logistics world right now. Are you thinking that this actually gets incrementally worse from here into second half?

I think we started with a strong inventory position at the beginning of the year that we've been drawing down. And I think we're trying to rebuild that quickly. And, you know, like everybody, you know, we're, we're getting allocated products in, in some of our, you know, chemical related products, plastics, et cetera. So we're, we're concerned about that. And, uh, our supply chain is very aggressive and feel good about Q2, but again, it's uncertain and, uh, You know, God forbid another thing happens in the marketplace like a tornado or something that takes out something. So, again, we're cautious because, you know, everything is real tight right now, and we don't need another potential disaster in the supply chain at this point in time.

Thanks, guys.

Thank you. Thank you. Our next question comes from the line of Jeffrey Hammond with KeyBank. Go ahead, please. Your line is open.

Hey, good morning. This is David Tarantino on for Jeff.

Good morning.

So could you dig a little bit more into the cadence of the full year guide? Maybe what dynamics are you seeing, kind of given what seems to be better dynamics in Q1?

Yeah, so if you think about the previous guide, which midpoint was minus 2.5 and now the new midpoint is 4.5, it's about a 7%. increased top line from the previous guide. Out of that seven percent the freeze impact is about a couple of points is the freeze impact which all as Bob said most of that happens in the first half. And then the balance of it is basically split between the second price increase which we had not contemplated in February but was inflation induced so to speak. And then the remaining is basically stronger underlying markets. and, you know, France and Italy and in Germany because of government incentives. And then in the United States, the higher GDP expectations versus February, that drives our, you know, repair-replace activity. And that's basically how we came up with the 7% increase in top line.

Great. Thank you. And then just as a follow-up, I know you mentioned there was – A lot of inventory drawdown from Texas, but was there any pull-forward demand ahead of price increases? And kind of how far out is that inventory rebuild? Kind of how far out does that go?

So I think a little less in the first quarter, but we're expecting probably more in the second quarter of pull-forward based on this new price increase as well as the supply chain constraints. Our goal, you know, internally we're modeling – uh that the supply chain will be caught up by the end of the third quarter so um that's our best estimate at this point in time and that's what we're hearing from our channel partners but that all you know that's just our best estimate at this point in time great thank you thank you thank you and our next question comes from the line of nathan jones with stiefel go ahead please your line is open

Yeah, thanks for the follow up. I was wondering if I could just get a little more color on the new construction in the U.S. as it relates to the air pocket. I think you called out leading indicators are a little more favorable for 2022. So, you know, what gives you confidence that that will start to come back in 2022?

Well, again, we're starting to we see the same leading indicators that you're looking at, right? Dodge momentum, ABI has now been positive for the last two months in a row. So you're starting to see the signs of, you know, some of the new construction coming back. Certainly there are headwinds and building products are, you know, skyrocketing the costs of both lumber, steel, and certainly copper and related. So those costs are going up, low interest rates. But as I sit here today, you know, versus three months ago, I feel that the tide is starting to turn and people are talking more, more quotations are happening. in that marketplace. But again, it's too soon to predict what 22 is right now. But again, it's nice to see that the leading indicators that we all track are showing a turn now, at least in the bidding part of the new construction. Starts are still down. They're down, you know, and we still have that air pocket. We saw it in Q2. Our drains are a leading indicator of that.

and uh so you know it's it's down it's just being offset by all the other momentum we talked about uh previously on the call here okay and then shifting gears um towards acquisitions uh the balance sheet is in really great shape you guys renegotiated terms on your financing um so maybe can you just describe the the prospects for accelerated m a and have you seen any increase in the willingness for sellers given the potential for capital gains tax increase? Thanks.

Yeah, so look, M&A is always hard to predict. Timing is always difficult. Our pipeline is strong. We'll continue to be disciplined because valuations are still high. Yes, some of the smaller acquisitions, ones we've recently, you know, the TDG, that was because of the tax benefit. And, you know, so that's all part of it. I think on the smaller acquisitions, size companies, you know, that's in their mindset. But again, it's always difficult to predict and valuations are still high. So we'll continue to be disciplined.

And there are no further questions in queue at this time. I'd like to turn the call back over to CEO Bob Pagano for some closing remarks.

Thank you for taking the time today to join us. We appreciate your continued interest in Watts and look forward to speaking with you again at our second quarter earnings call in early August. Have a good day and stay healthy.

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