Ladies and gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2022 Watts Water Technologies, Inc. Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you'd like to ask a question at that time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. It's now my pleasure to turn today's call over to Diane McClintock, Senior Vice President, FP&A, and Investor Relations. Please go ahead.
Thank you, and good morning, everyone. Welcome to our second quarter earnings conference call. Joining me today are Robert Pagano, President and CEO, and Shashank Patel, our CFO. During today's call, Bob will provide an overview of the second quarter and discuss the current state of the markets and our operations. He will also update you on our smart and connected product initiatives and our sustainability efforts. Shashank will discuss the details of our second quarter performance and provide our outlook for the third quarter and for the full year. 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 this presentation.
Before we begin, I'd like to remind everyone that during this call, we may 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 Watts' publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. With that, I will now turn the call over to Bob.
Thank you, Diane, and good morning, everyone. Please turn to slide three, and I'll provide an overview of our Q2 performance. Firstly, I want to thank our employees around the world who have executed through the challenges of record inflation, the effects of the Ukraine war on Europe's economy, COVID lockdowns in China, and the continuing supply chain disruptions. Our success is a result of the dedication of our team to serving our customers. We continued our strong start to the year with our second quarter results significantly better than we expected. During the quarter, we benefited from incremental sales due to our decision to invest in inventory, which allowed us to better serve our customers. Our Americas team delivered another quarter of double-digit growth despite the difficult prior year comparisons due to the impact of the freeze in the South Central U.S. in the first half of last year.
We were able to deliver mid-single digit organic growth in Europe despite the impact of the Ukraine war, the exit of Russia business, and escalating inflation. In APMEA, while lockdowns impacted several of our key markets, the team still delivered top-line growth in the quarter. Adjusted operating margin exceeded expectations supported by price, volume, and productivity, which more than offset inflation, incremental investments, and cost normalization. We benefited in the quarter from our proactive investment in inventory at lower cost in parallel with increased price. This favorable dynamic subsides in the second half of the year when the price and cost become more balanced. Year-to-date free cash flow has been seasonally slow due to additional working capital needed to meet the current demand and our investment in inventory. We anticipate sequential improvement through the second half due to normal seasonality.
Our supply chain and sourcing teams have done a great job securing components and managing cost increases. We're beginning to see some easing in our supply chain. However, electronic component availability is still challenging. We are committed to investing an incremental $20 million during 2022 to benefit our future and our smart and connected strategy. Now, I'd like to provide an update on our end markets. In the Americas, non-residential new construction indicators are mixed. The ABI and Dodge Momentum Index continue to be positive. However, they have shown recent moderation. Institutional, industrial remain positive, but there is slowing in retail, hotels, and office building subverticals. The North American repair and replacement market is currently holding up well despite downward revisions of GDP. New residential single-family construction is beginning to slow as rising interest rates and material inflation are starting to take effect.
However, multifamily starts continue to be solid as declining single-family home affordability has bolstered rental demand. In Europe, the war and rising energy costs have triggered both a reduction in GDP forecasts and concern of a potential recession. As previously communicated, we have stopped our direct shipments to Russia. The impact is estimated to be approximately $12 million annualized and $3 million in the second quarter. We anticipate that the second half of 2022 will be sequentially slower than the first half for our European business. In the Asia Pacific region, our China markets were negatively impacted by the COVID lockdowns, particularly our heating business. As the lockdowns have lifted, business activity is resuming. However, there could be some continuing impact in the third quarter as job sites are slow to reopen. Now, an update on our outlook for the third quarter and the remainder of the year.
We expect organic sales growth and margin improvements versus the prior year in the third quarter. Price and productivity should more than offset any impacts from the war in Ukraine, inflation, and incremental investments. As a result of our solid start and our third quarter expectations, we are increasing our full year outlook. We expect solid demand in the Americas could buffer against the anticipated slowing European economy driven by the impact of the war in Ukraine. On slide four, I'd like to update you on our smart and connected initiative. As part of our strategic focus to grow organically, we're investing in innovative, new smart and connected products, and I'd like to share a couple of them with you today.
During the second quarter, the percentage of smart and connected enabled product sales to total sales increased sequentially as compared to the first quarter, as well as the full year 2021. We continue to make progress towards our goal of 25% smart and connected enabled product sales by 2024. Our Leak Defense System detects water leaks in pipes and prevents significant water damage in a home or business, reducing insurance costs and providing peace of mind to property owners. The system employs a smart valve and thermodynamic sensing probes to monitor flow. The valve will close, preventing additional flow, and a notification alert is sent via the proprietary app if the preset flow parameters are exceeded. The Connected Roof System provides early detection of blockages in rooftop drainage and helps prevent potential damage resulting from flooding.
The system detects water levels and temperatures and will trigger a notification to the building management system or app if readings exceed certain levels. The temperature capabilities are also designed to detect snow or ice and send notifications to enable ice or snow melt controls. As you can see, our investments in smart and connected solutions are providing real-time problem-solving and great value to our customers. Now on slide five, I'd like to update you on our sustainability efforts. In June, we issued our 2021 sustainability report highlighting our accomplishments and establishing some longer term goals to reduce our environmental impact. During 2021, we worked to further distinguish ourselves as a responsible and committed corporate citizen, finding strategic opportunities to advance each aspect of our ESG strategy.
In early 2022, we proudly joined the United Nations Global Compact, reaffirming our commitment to incorporate the UNGC's principles and standards on human rights, labor, and environment, and anti-corruption into our strategy, culture, and operations. During the year, we improved water use intensity by 28%, greenhouse gas intensity by 30%, and hazardous waste intensity by 23%. We are also solving sustainability challenges for our customers by designing and commercializing sustainable products and solutions based on our triple play theme of safety and regulation, water conservation, and energy efficiency. We continue to focus on social responsibility. In 2021, we achieved zero recordable injuries at 13 sites, established diverse hiring targets at 12 U.S. sites, and collaborated with Planet Water to provide clean, safer drinking water to families in disadvantaged areas.
In addition, we encouraged and supported the formation of six different employee resource groups as part of our overall work to attract, retain, and inspire talent at Watts. Sustainability is core to what we do at Watts. It is a key component of our strategy and is ingrained in our culture. We look forward to continuing our sustainability journey and furthering our commitment to improving our communities. With that, let me turn the call over to Shashank, who will address our second quarter results and our third quarter and revised full year outlooks. Shashank?
Thanks, Rob, and good morning, everyone. Please turn to slide six, and I will review the second quarter's consolidated results. Sales of $527 million were up 13% on a reported basis and up 16% organically. We had a very strong quarter in the Americas and saw mid-single-digit growth in Europe. We saw double-digit growth despite the tough second quarter 2021 comps that included a 3% benefit from the freeze in the South Central United States. Foreign exchange, primarily driven by a weaker euro, reduced year-over-year sales by roughly $18 million or 4%. Acquisitions accounted for $2 million of incremental sales year over year. Adjusted operating profit was $98 million, up 40% compared to last year, and adjusted EPS was up 43% to $2.11.
Adjusted operating margin of 18.5% was up 360 basis points as price, volume, and productivity more than offset inflation, incremental investments, and normalized spend. As Bob indicated, our margins benefited in the quarter from our proactive investment in inventory at lower cost combined with higher price. The adjusted effective tax rate was 26%, 110 basis points lower than the second quarter of 2021. The decrease relates primarily to the restructuring of our Mexican supply chain operations. Our free cash flow year to date was $33 million as compared to $65 million in the second quarter of last year. The cash flow decrease was due to our proactive decision to invest in inventory, higher employee and customer incentives and restructuring payments, and higher net capital spend, which more than offset higher net income.
We expect sequential improvement in our free cash flow, and our full year goal is to drive free cash flow conversion of approximately 90% of net income. The balance sheet remains strong. Gross leverage was 0.6 times and net leverage was negative 0.1 x. Our net debt to capitalization ratio at quarter end was also negative at 2%. Year to date, we have repurchased approximately 434,000 shares of our common stock for $61 million. Please turn to slide seven, and I'll provide a few comments on the regional results. The Americas had a very strong quarter, with organic sales up approximately 22% despite a tough comp that included approximately 4%, resulting from the impact of the freeze in the South Central region of the U.S. in the second quarter of 2021.
The net growth was driven by strong price realization and underlying market demand. We saw growth in all platforms and all channels. Acquisitions added approximately $2 million or 1% to reported sales. Adjusted operating profit increased by 58% and adjusted operating margin increased by 510 basis points. The margin expansion was driven by price, volume, and productivity, which more than offset inflation, incremental investments, and the return of normalized business costs. Our proactive investment in inventory at lower costs, combined with higher price, also contributed to margin expansion. Europe had a solid quarter with organic sales up approximately 5%. Reported sales growth was negatively impacted by 12% from unfavorable foreign exchange movements. We saw organic growth in our plumbing, HVAC, and drains platforms. We saw solid growth in Germany and Italy, driven by our OEM business due to government energy incentives.
Scandinavia also saw strong growth as the food and beverage end markets continued to be robust. As mentioned by Bob, we have stopped our direct shipments to Russia, and we estimate the impact to be approximately $3 million in the second quarter. Operating margin declined 80 basis points as price and productivity were unable to fully offset rising inflation, continued investments, and normalized business expenses. APMEA grew organically by 3%. Reported sales declined 1% due to unfavorable foreign exchange movements of 4%. China's organic sales grew high single digits, primarily due to commercial valves into the data center market. Underfloor heating sales declined due to the impact of lockdowns in China in the second quarter. Organic sales outside China were up low single digits.
Adjusted operating margin decreased 200 basis points as price and productivity were unable to offset a reduction in affiliate volume, inflation, and investments. China affiliate volume was down 38%, due primarily to a tough compare from the U.S. freeze demand in the second quarter of 2021. Slide eight provides our assumptions about our third quarter and full-year operating outlook. First, let's cover the third quarter outlook. We are estimating consolidated organic sales for the third quarter to grow at 5%-10% over the third quarter of 2021. This moderation in growth rates is due to three reasons. Firstly, underlying market conditions are expected to soften in Europe, as evidenced by the declining order patterns starting in May as a direct result of the impact of the Ukraine war.
Secondly, we have more challenging comps due to the multiple price increases implemented in the first nine months of 2021. Lastly, we also expect a headwind from the direct sales loss from our decision to exit the Russia market of approximately $3 million. We expect approximately $2 million of sales from prior acquisitions. We estimate our adjusted operating margin could range from 14.5% to 15.1% for the third quarter, with the increase versus prior year driven by price and productivity and offset partially by incremental investment spending of $6 million. We estimate the incremental volume to drop to between 25% and 30% versus prior year. The sequential decline in operating margin from the second quarter is driven primarily by volume deleverage and incremental investments.
In addition, as previously mentioned, the favorable price cost dynamic normalizes in the second half as price cost becomes more balanced. Corporate costs should be approximately $13 million. Interest expense should be in line with the second quarter at approximately $2 million. The adjusted effective tax rate should approximate 24%. Currency looks to be a headwind in the second half. We are now assuming a 1.00 average euro-US dollar FX rate for the third quarter versus the average rate of EUR 1.18 in the third quarter of 2021. This implies a reduction of 15% year-over-year, which equates to a reduction of $20 million in sales and $0.06 a share in EPS versus prior year.
Now let's cover the full year outlook. For the full year 2022, we are increasing our organic sales growth outlook to 8%-11% from 3%-8%. We believe that our stronger than expected start in the first half and our expected third quarter outlook will be able to more than offset expected weakness in Europe in the second half, our exit of business in Russia, and the overall weakening of global macros. We are also increasing our full year adjusted operating margin expansion to a range of 110-160 basis points compared to our previous outlook of 20-60 basis points. We now expect our operating margins to be between 15.4%-15.9%.
We expect the increase in inflation and incremental investments will be more than offset by price and productivity. Our free cash flow expectations are anticipated to be in line with our previous outlook in April and should approximate 90% of net income. As a reminder, we expect incremental CapEx and restructuring payments in 2022 compared to 2021, and we do plan to reduce our inventory levels as supply chains begin to normalize. For the full year, we are now assuming a 1.05 average euro-US dollar FX rate versus the average rate of EUR 1.18 in 2021. This would imply a reduction of 12% year-over-year and equates to a reduction of $64 million in sales and $0.21 a share in EPS for the full year versus prior year.
Regarding other key inputs for the full year, we expect corporate costs could be approximately $49 million for the year. Interest expense should be in the range of $7 million-$8 million for the year. Our adjusted effective tax rate for 2022 should be between 24%-25%. Capital spending is expected to be in the $40 million range. Depreciation and amortization should also be approximately $40 million for the year. We expect our share count to be approximately 33.7 million for the year. Now let me turn the call back over to Bob before we begin Q&A. Bob?
Thanks, Shashank. On slide nine, I'd like to summarize our discussion before we address your questions. The second quarter was stronger than we anticipated, with double-digit organic growth and strong drop-through as a result of our proactive investment in lower cost inventory. We are staying on top of the price cost dynamic and expect tougher second half compares. We expect a solid third quarter, although sequentially down from Q2. We're increasing our full year outlook based on our strong start, which should be able to offset headwinds from the war in Ukraine and softening GDP. We are monitoring our markets and are confident in our ability to execute in this uncertain environment. We continue to execute against our strategic framework, including focusing on innovation and profitable growth by investing for the future and driving our smart and connected strategy. With that, operator, please open the line for questions.
At this time, I would like to remind everyone, in order to ask a question, press star followed by the number one on your telephone keypad. Your first question is from the line of Jeff Hammond with KeyBanc. Your line is open.
Hey, good morning, guys.
Morning, Jeff.
Morning, Jeff.
Just on this price cost gap into the second half, is the largest delta that you had some low cost inventory working through in 2Q and you won't have that? Or, you know, it seems like inputs are normalizing a bit and, you know, you continue to push price. Just more color there.
Yeah, Jeff, that was it. It's the inventory in parallel with the price we got. We had the lower cost inventory. The net amount is about $6 million-$8 million that we got the benefit of in the second quarter.
Okay, great. Just on the full year revision, can you just isolate how you're looking at EMEA and Asia, you know, differently or same, or is it just all a revision on the Americas?
Well, look at, Jeff, when you see inside of our numbers, you know, for Q3, we think North America is gonna be up double digits. We believe Europe is gonna be down low single digits and APMEA up mid-single digits. For now, in Q4, we're being cautious, really because of Europe right now. As you know, we're a short lead time business, and the visibility for Europe is a concern for us right now. Team's doing a good job of managing it, but it's something we're watching closely. You know, we're being cautious in Q4 based on that. Overall, you know, Americas is doing well and APMEA is coming back given the lockdowns.
On par, you're kind of lowering the Europe forecast.
Yes
A bit versus.
Yeah
The previous quarter. Okay.
Correct.
That's showing up in the order rates since May?
Yeah. Shashank talked about we started seeing declines in order rates in May. I think some of it is destocking of inventory, that's going on in the channels right now and, just the cautious nature because of the significant energy increases and, everybody just being cautious given there's a potential recession in front of them.
Okay. Just last one, maybe talk about inventories in the channel and need to restock or destock in North America. Thanks.
Yeah, North America is holding its own. I think there's some discussion. People are beginning to talk about inventory, so we're watching that closely. I think we benefited also in the second quarter because we did have the inventory. As you know, it's a book and ship business. Whoever has the inventory gets the order. I think we're watching that closely, but I think it's decent inventory levels in North America.
Okay. Thanks so much, guys.
Thanks.
Thank you.
Your next question is from the line of Joe Giordano with TD Cowen. Your line is open.
Hey, good morning. This is Michael on for Joe.
Morning, Michael.
Thank you on the color for the inventory build and price cost. Perhaps you can just dive into a little bit on the sustainability of the Americas margins, and if you're contemplating any volume declines in your guide for that particular segment.
Yeah. You know, in the second quarter, we talked about, and I basically said there was about $6 million-$8 million because of a lower cost inventory position. Obviously, that balances out in the second half, as well as in the Americas. You know, we got tremendous volume leverage in the second quarter. The volume leverage is less in the second half as the volumes come down. From a margin standpoint, we do have incremental investments coming through in the second half as well, versus the first half.
Great. Thank you.
Thank you.
Your next question is from Nathan Jones with Stifel. Your line is open.
Good morning, everyone.
Good morning, Nathan.
I'm gonna go back to the margin in the second quarter here because obviously it was extremely high. The $8 million would be, you know, 110-150 basis points of margin upside. You came in at 300-350 basis points, better than where you had guided the second quarter. I guess what I'm really wondering is why the guidance for the second half implies that you pretty much dropped back down to where you were guiding the second half before, which is, you know, back down more like 300-350 basis points.
If that price cost imbalance was only $130 of the $350 that you beat the quarter by, the guidance by, why would we drop back down that full $300-$350 in the back half of the year?
Part of it, Nathan, was we got tremendous volume leverage in the second quarter. That volume leverage isn't as much in the second half. As well as when you think about pricing, right? The pricing dynamic, you know, we had from a pricing perspective, the first half was best from a year-over-year comp perspective. We got, you know, approximately 10% price realization in the second quarter. Obviously, we don't talk about Q3, Q4 until it happens 'cause there's elasticity out in the marketplace. The expectation is it is tougher comps in the second half versus second half last year from a pricing perspective. We bake some of that in as well.
That's great.
The last point, the point I made earlier about investment spend is higher in the second half versus first half.
Is it higher than what you were planning previously, the investment spend in the second half?
It's about the same.
Okay. I just wanted to talk about, you know, the balance sheet and capital allocation here. You're in, you know, a slight net cash position. You know, the company hasn't executed much in the way of M&A over the last few years here. Just your outlook on what to do with the balance sheet here, if it's, you know, patience waiting for maybe some larger acquisitions or, you know, how you intend to get that cash off the balance sheet.
Well, Nathan, as you know, we always have a balanced allocation strategy, right? We you know look at dividends, CapEx, et cetera. On the M&A, we're disciplined. Our pipeline is full. We look at it, but as you know, we're disciplined. We can never predict the timing of when acquisitions will happen. We'll maintain discipline and you know that's how we look at our capital allocation strategy. We'll be patient and you know and look for what is out there.
You know, the last point, Nathan, I mean, people never talk about investment in inventory as cash allocation. Seriously, in the last year, it's been over $100 million, and that certainly helped us in the second quarter.
Okay. Thanks for taking my questions. I'll pass them on.
Thank you.
Thanks, Nathan.
Your next question comes from the line of Michael Halloran with Baird. Your line is open.
Hey, good morning.
Good morning.
Bob, you talked about some of the leading indicators, and the decks really had it on the new construction side. Maybe you could just dig into what some of those are, and you know whether that's what your customer channel is saying or just some of the kinda larger macro stuff.
Yeah. Mike, ABI, Dodge Momentum, all of those are positive. That's good. I think we're all seeing, you know, single-family housing starting to come down, but we're also seeing multi-family that's positive. As I said earlier, Europe is the biggest wild card for us right now. You know, we just don't know the impacts, the full impacts of the war and the implications of, you know, their significant energy costs, and in particular in Germany, if they shut off, you know, the gas at that point in time. That's where we're watching. I think they're mixed. Some of these signals are coming down. You know, normally, our repair and replace, which is about 60%-65% of our business, that holds up well. That ties to GDP, you know, so we're watching that.
We're also watching. You know, in general, supply chains are starting to get more balanced. So I think the fear of people having a bunch of inventory to offset supply chain issues with lead times coming down. I mean, I think we're watching all of those things and how they come together. In general, we feel positive about North America and APMEA Europe is the biggest concern for us.
Yeah, I know. That makes a lot of sense. I should have been clear. I was more curious about Americas, but you certainly touched on that. Are you actually seeing the weakness in the single-family business today? More of a perspective comment.
Yeah, we're seeing that. Like I said, we're seeing some offset in multifamily.
No, makes sense. Then from a channel partner perspective, are they seeing where their head is at? Then maybe a thought on inventory levels in your main channels and that question focused on Americas.
Yeah. When you talk to the channel, especially when you get into the contractors, they're all still busy. They're cautiously optimistic, but they're certainly, you know, hearing the same things we're all hearing, so they're more concerned about their future, you know, later on and stuff. Look, I don't think for the most part if there's a recession in North America or a downturn, nobody believes it's gonna be very long at this point. They're optimistic. Their biggest issue right now is labor. It continues to be.
Yeah
labor issues, getting the right labor to fulfill it, which I think helps extend this cycle, you know, over a longer period.
Just to comment on the inventory levels.
Inventory levels, I think, are stable inside of North America. You know, we've heard rumors of people beginning to think about that, of reducing inventories because they're seeing commodities starting to come down, and they don't want to be caught with higher inventory. We have not seen a significant shift at this point in time, but we're monitoring it.
Great. I'll, I won't ask the question about Americas margins, even though they were pretty spectacular. Thanks, guys. Really appreciate the time.
Thanks, Mike.
Thank you.
Your next question is from the line of Ryan Connors with Northcoast Research. Your line is open.
Great. Thanks for taking my question. I wanted to kinda step back and look at the margin question from a bigger picture perspective, Bob. You know, I think it's pretty remarkable. We think back just a few years ago, you were talking about an operating margin target of 12%, which I think we interpreted as, like, you know, that's the reasonable margin the market will bear for this industry. If we look at it from that perspective, I mean, do you think. You're obviously gonna try to hold price if in fact raw materials come down. Do you believe that there's been a structural upward shift in sort of the natural equilibrium cross-cycle margin for this industry or not. Do you think gradually things will revert back.
I'm just curious on your big picture perspective of what all this has done to, you know, the run rate margin for this space.
Yeah, Ryan, we've always talked about mid-teens. In our mind, it was always 14-15, not 12. It's just a question of timing. Every year, we talk about growing margins 30-50 basis points while still investing for the future. In general, I think a couple of things. You know, we've driven productivity, we've got great supply chain, and we focused on automation in our factories. I think. As you know, we're continuing our lean journey. I think all of those contributed to our ability to take out costs and drive higher margins overall. You know, we try to add value to our customers and differentiate our products, especially in the smart and connected area, which we believe commands higher margins.
All right. I mean, maybe a related follow-up to that would be, you know, you made a comment earlier that whoever has the inventory gets the order. Do you believe that there's been any market share shifts because of some companies, maybe yourselves, handling the supply chain issues more effectively and staying ahead above water and others, you know, not faring as well and maybe suffering some reputational damage in the process? Has there been any share shift over the last couple of years that you think could hold going forward?
Yeah, I think, shares bounce around, right? It depends on who has the inventory and the timing of that inventory. I think certainly our vertically integrated strategy of manufacturing, where we ship has paid off, especially in an environment like this, where lead time supply chains, you know, from overseas are much longer. I think that benefited us, and we really saw the benefit in Q2 because there was shortages of inventory in the market, and we, you know, believe we took our fair share of what was out there. You know, supply chains are coming back to levels, you know, normal levels with all our competitors. I think, you know, that great performance we have in Q2, we're going to do our best to continue that.
I think it was abnormal because we, you know, pushed it and we had the inventory and our strategic investment in inventory really paid off.
Yeah, that's clear. Hey, thanks so much for your time.
Thanks, Ryan.
Thank you.
Your next question is from the line of Brian Lee with Goldman Sachs. Your line is open.
Hey, everyone, this is Miguel on for Brian. Thanks for taking my question. I just had two questions. The first one was just I wanted to touch back on the conversation around channel inventories. Just wanted to hear a little bit more commentary on your visibility into the channel, specifically wondering
I was specifically wondering how much, like destocking do you think has occurred so far? How much inventory is out there, if there's a way to measure that in months or weeks? What are your expectations on how those channel inventories work their way through the rest of the year and next year, and if there's a way to talk about that on a regional basis if possible? Thanks.
Miguel, that's a very difficult. We have thousands of customers, right? We do not have that visibility. We have to do channel checks, et cetera. As I said earlier, I think Europe is the biggest place that we're beginning to see channel destocking, which makes sense. Especially in the smaller wholesalers, cash is king, as you can imagine, and I think that's important. I think that also holds true in North America. Again, visibility is limited from our point of view. I think a general comment would be as supply chain get better, lead times come down, I think, you know, the channels, the wholesalers, and contractors will hold less inventory because they'll be relying on, you know.
Shorter leads
The wholesalers and the manufacturers to ship it to them. Timing of that, it's difficult to predict, but in general, I would say over a longer term, you know, a year or two, I think that'll begin coming down.
Okay, thanks. That's very helpful. Second question, I'll pass it on. Just on the guidance for adjusted operating margins. The guidance suggests that Q4 is the low point on operating margins this year. Is that the right way to think about it? I know you're not guiding to 2023, but just hoping to get more commentary on how you think about the general cadence of margins beyond this year as the balance of those pricing actions and also the lower inventory costs normalize. Thanks.
Okay. We're not talking about 2023 at this point in time. I would just say in general, when you look at margins, as I stated earlier in one of the previous questions, we're being cautious about Q4 given European margins and European volume. I think the thing, as you can imagine, we've had a lot of discussion regarding we have high fixed costs in Europe, and it takes a while to take those costs out. If volume deleverages, it abnormally hurts our margins. We've been benefiting over the last two years with really strong volume inside of Europe, and we're starting to see from an order point of view, that's slowing. Again, we're cautious about that because, again, we're a book and ship business. We don't have a significant visibility to, you know, the future.
We'll update you. We'll take it a quarter at a time, and we'll update you after the next quarter and give us our, you know, better guidance into the future.
Okay, great. Thanks, v ery helpful. I'll pass it on.
Thank you.
Again, if you would like to ask a question, press star followed by the number one on your telephone keypad. Your next question is from the line of Walt Liptak with Seaport Global. Your line is open.
Hey, good morning, guys. Thanks and good quarter.
Good morning.
I wanted to ask about, you know, if you can help us with selling prices. You know, some of the commodities costs are a bit of a mixed bag. Are you still taking up prices? Did you take them up in the quarter? Like, what was the cadence of some of the price increases?
Yeah, look, Walt, as we've talked before, we do an evaluation every 90 days of our total cost inflation on all cost of goods sold. The last analysis we did, which was in the May time period, price increases before then was based on that. We'll be updating our numbers at the end of August, so we'll take a look at it again. That's something that we do routinely every 90 days.
Okay, great. That sounds good. You know, when I'm looking at some of the materials costs, you know, there are some, you know, copper and piping and things like that, they're clearly deflating. You know, others that might be up. I wonder if you could just talk about, you know, some of your inputs and, you know, and what that means for the back half.
Well, one of the things we pride ourselves on is staying in front of this. We'll see the benefit. We always stay in front of cost and, you know, price with cost. One of the things we will see the benefit of that fall through with our inventory turns, et cetera, in 2023. Look it, there's many other costs, overhead, labor, et cetera, we're still seeing inflation on. You know, overall, net-net, you know, we'll take a reading on it, but we're watching it very carefully and we'll put the appropriate pricing in, you know, as Shashank said. We're continuing to drive price, and because in this inflationary market, we need to do that.
Okay. Makes sense. Okay. Thanks very much.
Thanks, Walt.
There are no further questions at this time. I will now turn the call back over to the CEO, Mr. Robert Pagano.
Thank you for taking the time to join us today. We appreciate your continued interest in Watts and look forward to speaking with you again at our third quarter earnings call in early November. Have a good day and stay safe.
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.