Watts Water Technologies Inc (WTS) 0 Q0 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Watts Water Technologies earnings conference call.

My name is Shamica, and I will be your operator for today.

At this time all participants are in a listen-only mode.

We will conduct a question-and-answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS) I would now like to turn the call over to Mr.

Kenneth Lepage, Assistant General Counsel.

Please proceed, sir.

Thank you.

Before Pat and Bill begin their presentation I want to inform you that various remarks they may make about the company's future expectations, plans, and prospects constitute forward-looking statements under the Safe Harbor provisions of 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 our annual report on Form 10-K for the year ended December 31, 2006, filed with the SEC and other reports we file from time to time with the Securities and Exchange Commission.

In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date.

While we may elect to update forward-looking statements at some point in the future, we disclaim any obligation to do so, and therefore you should not rely on these statements as representing our views as of any date subsequent to today.

I will now turn the presentation over to Pat and Bill.

Thank you, Ken.

The way we'll conduct our call today is I'm going to make a couple opening statements, just general statements, with regard to the press release.

And then I'm going to make some comments with regard to how we're seeing our end markets at this point in time.

Then I'll turn the call over to Bill McCartney who will walk you through the details on the numbers, and then we'll open the lines and allow you to answer any and all questions you may have.

The first things I want to point out is sales for the third quarter of 2007 were $340.5 million, an increase of $15.4 million or 5% compared with the third quarter of 2006.

Net income for the third quarter of 2007 was $18.1 million or $0.46 per share, compared to net income of $18.2 million or $0.55 per share for the third quarter of 2006.

So you can see they're relatively flat on a dollar basis but off a little bit in terms of on a per-share basis.

2006 included a loss from discontinued operations of $3.1 million or $0.09 a share.

The results in the fourth quarter of 2007 include an after-tax charge of $4.2 million or $0.11 per share as part of our global restructuring program and covering charges for discontinued product lines.

In the third quarter we announced--in the third quarter press release we announced a major restructuring program and also the initiation of some discontinued product lines.

Bill will talk to you a little bit later and give you the details on that program.

And last but not least if you look at the issuance of shares that we did last November, that had a dilutive impact of roughly $0.03 per share for the quarter and $0.09 per share for the year.

Now, if you look over and talk about the marketplaces, if you look at the US we see a relatively weak residential marketplace.

Housing starts are off roughly 25% from a year ago.

Existing home sales are down about 20% from a year ago this time.

And the average sale price on an existing home is off about 5%.

When we're looking forward, we think that we pretty much have seen the bottom of the marketplace.

We don't see it deteriorating considerably further from this point in time, but I think that's a little bit--that prediction is based on the fact that we're not sure whether we've seen the complete fallout from the subprime market situation.

If you look at the commercial marketplace, at this point in time it remains strong.

We have a little bit of concern that if you go out and talk to the architects and engineers, there's a little bit of softness in terms of new projects entering the system, but there's plenty of backlog and plenty of jobs out there that will be going into the construction phase and into the process of completion during the upcoming quarters.

If you look at the European market, trends are sort of changing there.

We are seeing some softness in the German market, and we're concerned on a go-forward basis that that will spread to Italy and France and other major markets in Europe.

In terms of China, really sort of a pretty buoyant market and we see it remaining in that fashion for the next couple of quarters.

So when you look at--if you look at our thoughts as we look forward, we see the US, the real issue is we have a number of price increases, which Bill will talk to you about, which we've implemented.

So it's a little bit more residential softness but probably offset by some pricing that we've implemented and we'll be flowing through our P&L in the fourth quarter.

Europe we see--again I'll repeat it's a little bit of softness in Europe, and China relatively strong.

So with those opening comments I'll turn it over to Bill who will walk you through the numbers.

Okay.

Thank you, Pat.

As you can see our revenue at $340 million in the quarter is up about 5% or $15 million.

Looking at the components of that revenue growth on a consolidated basis, you would have organic growth at $4 million which is just a shade over 1%, foreign exchange of almost $10 million which is 3% and then some small contribution from some acquisitions of $1.5 million or 0.5%.

So that's $15 million or 5%.

Again on the bottom line we're down about $3 million which includes the restructuring program.

If you exclude these restructuring programs, basically the bottom line is flat at about $22.4 million.

And again excluding the restructuring we would be at $0.57 per share which includes the $0.03 of dilution that Pat mentioned earlier.

Again just a couple comments on the restructuring program itself.

We looked at it during the course of the quarter and the Board approved a plan for us to close five plants and downsize a sixth plant, and that downsizing is in progress now.

When we look at the cost of this, it's $13 million pretax or just a shade under $10 million on an after-tax basis.

The total cash requirements of the plan on an after-tax basis are just about $10 million.

That includes the after-tax cost of severance and plant relocation costs as well as capital expenditures required to complete this plant relocation program, and the sale of two of those plants.

So after-tax cash, a little over $10 million.

The savings of about $4.5 million annually once the program is fully implemented, which will be in 2009.

So therefore we have a cash payback of approximately two years.

And those savings will be phased in over the period between the beginning of '08 through the end of 2009.

Just to move on now to look at some of the segment performance.

North America at $216 million of revenue.

That's an increase of $4 million or 2%.

The components of that growth in North America would be an increase in organic revenue of $3 million or 1.5% and about $1 million from foreign exchange, to bring us to the total of $4 million.

And that's just the strengthening of the Canadian dollar versus the US.

Now, inside North America we usually look at the wholesale and retail.

So on our wholesale market sales were $174 million.

That's an increase of $7 million or about 4.5%.

And as Pat mentioned, what we see there is continued softness on the residential.

The commercial holding its own.

On a net basis we'd be down slightly overall in units with some pricing making up the difference on the wholesale side.

On the retail market, sales to our big-box retailers, revenue was $41.7 million.

That's a decline of $3.3 million or about 7.5%.

Again as we discussed in the previous calls with you, we have some low margin product lines that we've exited, so that's the major part of the decline.

And that is offset by some new product rollouts that we're doing, some new RO filters and quick-connect fittings into several of our customers, and some additional pricing as well.

So it's exiting low-margin product lines, the general softness in the residential market that we see in retail, offset by new product and price.

In Europe sales of $110 million.

That's an increase of $9 million or 9%.

Looking at the components of that growth, from an organic standpoint Europe was flat.

Just about a couple hundred thousand dollar change there.

So the bulk of the increase for us in Europe was due to foreign exchange, almost $8 million, and then a small contribution from some acquired companies of about $1.5 million, for a total of $9.1 million.

As Pat mentioned, inside of Europe what we see is the German market softening.

We have a slight decline in units with improved pricing, but that's really what's driving the performance in Europe is the soft German market.

In China sales of $14.2 million.

That's an increase of $2.5 or 19%.

What we see in China again is continued strong sales into the domestic market for our commodity-oriented products as well as exports into Europe and Australia, Southeast Asia, for our Chinese-made products.

And then strong sales of our large-diameter products going into the Chinese infrastructure market if you will.

On the gross margins, on a consolidated basis margins would be down 2.2 points to 32.4.

However if we back out our restructuring charges in the quarter, margins would be 33.7 which would be a decline from last year of 110 basis points.

Looking at the performance inside the margin, though, in the quarter, if you recall in Q2 when we had our call with you we talked about the decline in the margin.

And we had about 200 basis points of decline which we attributed primarily to the metal pricing and not recapturing some of those increased costs.

So in Q3 again without the restructuring a decline of 110 basis.

So on a sequential basis we've seen about 90 basis points of improvement.

And what we're seeing here is that in the North American market the gross margin improved very nicely with improved pricing, somewhat offset by the softness that we've seen in the European market.

Then in China the margin's down slightly, predominantly associated with the relocation of our plant in Tianjin as well as some cutbacks in our plants.

So we have some absorption variances, and so we have our inventory in line adjusting some of our production schedules to reflect the slower residential market in the US since most of these products are coming back here to the US market.

And additionally we do have some of the issues in our Chinese business units associated with lower margins associated with copper costs.

And we are seeing some of those margins move in a favorable direction with price increases that we've implemented during the quarter.

On the SG&A it's basically flat as a percentage of sales at 23.1%, an increase of $3 million overall.

Looking at the components of that change, $1.1 million is organic, foreign exchange is $1.8 and acquisitions are $300,000 for a total of $3.2 million.

There's nothing unusual in our organic increase.

On the operating earnings it's $30 million versus $36.5 million last year.

Again, backing out the charges that we took in the quarter, operating earnings would be $36.1 which is a decline of $1.6 million versus last year.

We look at the operating earnings by various segments.

I know you'll notice there was a large drop in our Chinese operating earnings; however, that is primarily due to the fact that a large portion of the charge that we took in the quarter was booked in China.

If we back out the restructuring charges, I'll share the operating earnings ex-restructuring with you by segment.

So North America we'd have $26.2 million, essentially flat with last year.

In Europe $13.9 million, up slightly from last year.

China at $3.1 million, which is down from $4.6 last year, and then the corporate expenses of $7.1 for a total of $36 million.

The decline in the Chinese operating earnings ex-restructuring is due to the factors I just discussed and the gross margin which is the absorption issues as we straighten out our inventory and move that plant as well as some of the copper issues, again which we are addressing through some price increases.

The tax rate in the quarter at 33.1% is a slight increase versus last year third quarter which was 32.3.

Basically we wrote off some deferred-tax assets in China and we had an unfavorable mix of income, whereas Chinese tax rates are generally lower and we had lower income in China on a percentage basis than we normally do.

So again that brings us to the bottom line of $18.2 million versus $21 million last year.

Ex-restructuring net income is flat on the quarter.

And just one quick comment.

I know some of the folks like to hear some cash flow information, so our capital expenditures on the quarter--or year-to-date, excuse me, are $25 million.

Depreciation and amortization is $30 million on a year-to-date basis.

We're expecting again for the year our CapEx to approximate our D&A.

So with that overview of the financials we'd like to open it up to any questions that you might have.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Michael Gaugler.

Please proceed.

Afternoon, Bill, Pat.

Hi, Michael.

Two quick questions.

First one, Bill, can you tell me what the annual sales were that were associated with the discontinued product lines?

In total it's a little bit--right now we're looking at about a little north of $20 million.

Okay.

And then--

But you have timing issues, Mike.

Some of--it's not necessarily $4 or $5 million each quarter, but in total it's a little over $20 right now.

Got it.

And also maybe you could talk about the pipeline of new opportunities in terms of acquisitions?

And as a follow-up to that, do you think the restructuring could slow your ability to consummate transactions going forward?

Yes, this is Pat.

In terms of the marketplace, right at the moment there is sort of a lack of good candidates out there in terms of I think they're a little bit concerned about whether this is the right market to put the business up for sale.

There are some deals in our pipeline but not as robust as we'd like to see them.

And to be honest with you, Mike, I don't think there's any impact on our restructuring plan on our acquisition program.

I think it's just a matter of when the buyers feel a little bit more comfortable, I think we're going to see some properties come on the market.

I'm thinking that over the course of the next two years it'll be a good market in [multiple reasonable] levels.

So I'm anticipating nice acquisition activity over the next couple of years.

All right.

Thank you, gentlemen.

Thank you.

Your next question comes from the line of Keith Hughes.

Please proceed.

Thank you.

I wanted to follow up on your commentary on commercial in the US, specifically what are you seeing and is there a specific channel within commercial that you're seeing some of these orders being delayed?

If you look at where we do well, we do well where there's heavy concentration of people in a facility.

So the best for us is something like a nursing home, doctors' offices, medical facilities, prison, things like that where there's high concentration of human beings and therefore a high use of sanitary processes.

So the thing we're starting to see is we do some channel checking and we go back and we talk to the architects and engineering firms and we ask them what kind of backlog they have, and I think there was a little bit of hesitation here in the third quarter in terms of whether they are getting funding for certain types of projects.

The projects that tend to be those that are a little bit delayed or a little bit hesitant I think are those that are not funded by government institutions but funded by commercial sponsors.

Okay.

And the comments on Germany, just can you remind us just roughly how big is Germany a country within the European segment?

I assume it kind of maps its population?

Yes, it does, Keith.

Our biggest market would be France, but a close second would be Germany.

Followed by Italy and the UK.

Yes, followed by Italy and then the UK.

It's probably about 25% of our revenue in Europe.

Okay.

Thank you.

Your next question comes from Mark Grzymski.

Please proceed.

Good afternoon.

Hi, Mark.

How are you?

Just going back to the acquisition pipeline and with your comments earlier, I'm curious, now that you have a lot of cash are you going to pursue a share buyback plan if you can't find use of that cash?

I think it's way too early to come to that conclusion because I think you're going to--we're anticipating that it will be a nice market for acquisition activity over the next couple of years, so we have not come to the conclusion that we would institute a stock buyback program at this time, no.

Okay.

But I assume you've looked at it because I think if I do the math right, just on the back of a piece of paper here, it seems pretty accretive to go out there and start buying back shares.

I think your math is probably right.

All righty.

But the engine for this company has always been a robust acquisition program.

Right.

Right.

But given the environment and if you're seeing some slowdowns in certain areas, I would assume that your evaluation methodology's got to change right now.

Well, Mark, long term we think that the most value is created by spending our cash on acquisitions.

Still, the market has changed recently.

We think it's moving in our favor.

Multiples are going to be coming down.

There should be some good residential properties that might be slightly distressed coming out in the market.

We try to think long term.

Like, what's the best use of that $350 million we have in terms of what will it do for the company three, four, five years out?

Not just this year.

And right now we're still thinking to spend the money on acquisitions, and I think a year from now my opinion would be if we see another year of quiet activity on acquisitions and we don't think these properties are going to be coming out, then we would consider a buyback.

But it's way too early, I think.

Okay.

Thank you for that.

And finally on Europe, I'm getting confused, not with what you're saying but everything that's out there on it.

There's still plenty of growth going on there, capacity being built.

And I know that doesn't necessarily tie into your business, but why are you concerned that places like Italy and France are going to slow based on what you're seeing in Germany?

And what exactly is causing concern in Germany?

Because there are certainly mixed signals out there.

Let's just talk a little bit about the products that we have in Europe.

The product which we have in Europe is heavily oriented toward eating products, and they've had a couple back-to-back winners that have been relatively mild.

So the end demand for some of our products is backed up in the channel a little bit so that the wholesalers are relatively high level inventory levels of existing product carried over from previous periods.

So it's a little bit of--if they have a rough year in terms of weather and a cold temperature winter, you'll probably see some of that product being pulled through the channel.

But right now, which is traditionally the fall months, are the big months for wholesalers stocking up on those type of products, and we're not seeing it at the same level as we saw it in previous years.

The other point, Mark, is that housing starts in Germany are off about 45% this year.

So it's a very soft market this year in Germany.

The other thing, Mark, we benefited from in the prior year was pretty robust products that were oriented toward the alternative energy market.

And one of the things that we're starting to see is that there is a slack in demand where people are waiting for additional incentives to be provided by the governmental authorities.

And the payback on an alternative energy system without some kind of subsidy is more than people are willing to pay for it.

Great.

That's it.

Thanks, Bill.

Okay.

You have a question from the line of Jeff Hammond.

Please proceed.

Hi.

Good afternoon, gentlemen.

Just in terms of the announcements, the restructuring announcements, I guess why now?

What prompted the more significant changes?

I think up until this point the product line pairing was more ad hoc and smaller.

So I just want to understand what's changed internally to prompt a more significant action?

What we did is we went through and we reviewed our manufacturing facilities and our capacity in each one of those facilities, and I think the downturn in the residential market probably prompted us to pull the trigger on a number of these moves.

We think in the long run our productivity improvements and our consolidation efforts will pay off and give us a nice payback, so we pulled the trigger on the program.

Is it fair to say that the majority of the product lines are residential and/or DIY based?

I would say quite a few of them are residentially based.

I've got to think about the idea that they're DIY.

I'm not--I don't think that's true with regard to DIY but I do think it's true with regard to residential orientations.

Okay.

And then I think you mentioned a $20 million annual run rate of discontinued product lines, but what would have been the impact on third quarter?

Were these pulled, discontinued late?

Or was there any impact--?

It was occurring during the entire quarter.

I mean, we started to see this and we talked about it in the second quarter call.

It's just that there's a bit of seasonality.

Some you have a little bit more, some less, but it's about $20 million is the run rate for the whole program.

Is that answering your question?

He wants to know what were the--?

Maybe just--I guess what I'm trying--in the first half of the year organic growth in the North America business was high single digits.

We've kind of down-stepped to nearly flat.

Same kind of story in Europe.

Second half of last year, first part of this year was high teens, and now we're kind of down to flat.

So I'm just trying to understand the moving pieces that's driving a significantly slower organic growth rate.

I mean, this particular piece of business that we're walking away from is in the quarter it's probably about $6 million, I would say.

The impact in the quarter.

That's the loss.

It's all inside of retail.

And again, though, we're not--you have to realize we're still introducing products into that market.

We're still getting price increases.

The majority of the issue I think has to do with the downturn in the residential market.

Right.

Okay.

What surprised you--or what are you seeing on the remodeling, replacement side of residential?

That softened up a little bit, and there's a couple of things that go on.

We talked about the existing home sales being down 20% and the average sale price being off 5%.

Typically when someone purchases an existing home they do make some investment in it.

Traditionally that investment will take place in the kitchen or the bathroom.

So when I look at that, and this isn't real scientific, but I think that that probably had about a 1% impact on us in the quarter in terms of a drag.

It's tough to give a very precise answer on that, Jeff, because we go through wholesale distribution on this.

You just have to look at a lot of the indicators that are out there.

Sale of existing homes is down.

New starts are down.

With the equity crunch going on it's a little bit more difficult to get home equity loans.

That type of thing.

So the market is just very soft from a number of reasons on the residential side.

So Pat's given you a best estimate, but we can't come up with--to answer that question with a lot of precision is difficult.

And then can you give us price in the quarter overall?

And then as it relates to your I guess mid-year price increase, remind us what was--what you were going out with in terms of price increase and what you think you're ultimately going to get?

I can give you an estimate.

It's going to be a very rough estimate because we have so many business units in so many markets.

But if you look at it from an organic standpoint again consolidated, we're up about 1%.

But I would give an estimate that on a unit basis we're down mid-single digits with pricing is probably 6 or 7%.

But that's a very rough estimate and you can't draw too many conclusions because you have so many markets that you're dealing with.

Right.

And then I think your price increase to wholesale was around 5%?

In the middle of June we had about a 5% increase for North America wholesale, which would have gone out to the majority of the customers.

Some of the larger customers you have to go and negotiate with them on a one-on-one basis.

And we've gotten price increases from those customers as well.

And so you'd say the preponderance of that seems to be sticking?

Yes.

We're getting pricing right now.

Okay.

And then I think you ran through this, but if you could just run through again the up profit by segment ex-restructuring?

Sure.

North America is 26.2.

Europe is 13.9.

China is 3.1.

Corporate is negative 7.1.

For a total of 36.1.

Okay.

Perfect.

Thanks, guys.

Okay, Jeff.

Your next question comes from Richard Paget.

Please proceed.

Good afternoon, everyone.

Hi.

Most of my questions have been answered, but on the Chinese revenues, sequentially they're down.

Could you remind us if there's any seasonality in there?

I don't think so.

I don't believe so.

So the drop-off from second quarter would be--?

It's really an adjustment in terms of our production levels with product coming back to the North America marketplace.

So a lot of that is absorption issue in terms of the lower demand that we're putting on those plants.

And the other thing that would be impacting there, Richard, is that if we look at our sales into the large valve market and the infrastructure, we had some orders that were pushed out this quarter and we still had an organic growth rate of 13%.

So those orders that were pushed out, those are just timing issues and those orders will ship.

But in that market we had the strongest order entry quarter we've had since we entered that market.

So sequentially we might be down, but we don't view that as an indication of any future performance for that market.

Okay.

So you're saying backlog is still strong?

We also had--someone just reminded me, in Q2 we also had a couple of our companies that we brought from a four-month to a three-month.

We had an extra month in there in Q2 because we had a lag that we were booking to and we brought that up to date.

So that's probably a good $3 million of revenue.

That was a one-time increase in revenue in second quarter.

Okay.

That makes more sense, then.

And then just to make sure that I understand the various charges, that 4.2 after-tax total, is that inclusive of the restructuring and other charges line in the income statement?

I think it's $1,596?

Well, $1,596 is included in the 4.2, but most of the 4.2 has to go to cost of goods sold under the (inaudible).

Okay.

So if I back that $0.11 out and then I think that $1,596 if you back that out, that would get you closer to 60.

The rest would come out of cost of goods sold.

Okay.

So the 4.2 and the pre-tax $1,596 are separate items?

In total if you look on a pre-tax basis in the quarter we booked $6 million pre-tax associated with this restructuring and inventory write-down.

The $6 million is $4.2 million on an after-tax basis.

The bulk of it went to cost of goods sold, except that one line-item that you're looking at.

Okay.

All right.

That's it for me.

Thanks.

Okay.

Thank you.

Your next question comes from Mike Schneider.

Please proceed.

Good afternoon, guys.

Hey, Michael.

First I guess just on the restructuring program.

Maybe you can just lay out for us, if you look at the retail market in North America, I guess for you guys it still isn't all that weak, especially when you adjust the retail numbers for some of the product line pruning you're doing.

So I'm curious as to a six-plant restructuring and a two-year restructuring program is pretty significant.

What do you see I guess coming at you in future quarters that would have prompted this?

Because it doesn't seem like there's been enough capacity created just in the recent quarters of weakness to justify the move.

No, this has been building for a while, Mike.

As we bring our capacity up in low-cost countries, you're slowly but surely building up excess capacity in your domestic plants.

So this is sort of the point where you pull the trigger and you go forward in terms of actually consolidating that capacity.

So this has been building for quite some time.

But yet most of the action just--

The trigger is--I think quite honestly the trigger is that you are seeing near-term softness and you have seen near-term softness for the last couple of quarters and probably similar kind of softness for the next couple of quarters.

Okay.

But then yet most of the actions that took place this quarter occurred in China.

So how is it that you're relocating production in China, yet you're taking charges over in China?

Well, we have a situation where one of our facilities was taken over by imminent domain, so many of those charges in China relate to that facility that we previously announced.

We are actually expanding elsewhere in China in terms of our capacity at the same time.

Okay.

And the product line pruning you mentioned at least $6 million this quarter in DIY sales.

Was most of that product coming out of China?

The $6 million referred to was the decline or the reduction in sales that we exited in the retail market because we couldn't get adequate gross margins.

And wasn't most of that produced in China, though?

It's a combination.

It's a combination, Mike, yes.

Okay.

And then when you look at the six plants that are going to be impacted, to give us a frame of reference of how large these plants are, do you have a guess as to what square footage impact this has on total Watts?

Do these six facilities [account for] 10% of the square footage?

Fifteen?

They're all smaller plants.

Yes, they're mostly smaller plants.

Okay.

And are most of these acquired plants, or are these legacy Watts?

Well, Mike, to be honest we're at a point where we can't really--some of these haven't been discussed with the employees and we can't really say.

You're making a lot of assumptions as to where these plants are, etcetera, and we're not at the point where we can--we will be making announcements shortly, but we can't answer the question.

No, I appreciate the sensitivity.

And if you can answer this, I'll ask it.

Are the plants today, do they have duplicate manufacturing overseas or are these single-product plants that need to be moved and the entire production process need to be brought up in a new plant?

Mostly redundant capability.

Mostly redundant--

(inaudible) redundancy capabilities.

Okay.

And then switching to the tone of business, so during the quarter you've laid out the German softness, maybe some of the commercial construction softness that's occurred.

Did you see any particular trend during the quarter such that these things may be gained momentum during the quarter?

I guess if you could talk through month by month it might be helpful.

Well, I think we saw--we did see a little bit of additional softness as we progressed through the quarter.

A little bit, yes.

I mean, it's tough to say because when you have in Europe during the third quarter, I mean, Europe shuts down for July and August so you don't have as much of a gauge on that, if you will.

That's why we expressed concern for the fourth quarter because the third quarter in total was soft.

But the sense of it is that Europe was starting to slow.

Okay.

And per your comments you would expect that presumably to continue into 4Q.

It wasn't a one-quarter phenomenon?

Well, you've got a couple things going on, Mike.

First of all you have housing activity in Germany way off.

Secondly you have a need for additional incentives to push the alternative energy products.

And last but not least you had several mild-weather winters.

So a lot of this could get corrected if we get a harsh winter here.

But I guess the question is are we counting on that?

The answer is no.

So we're sort of planning to say, "Gee, there's some inventory in the channels of distribution that has to get cleared out before we see substantial increases in demand."

Okay.

And then in the North America wholesale market, because that's kind of the core of the business here, so it looks like volumes were flat to down and pricing made up the four points of growth.

Can you break that down into the major product categories so we can get a sense of exactly what within that channel is softest?

And maybe what has eroded most as you went through the middle part of the year?

The decline is all in the residential product line.

What we--you have to remember our products.

Some products are particular to residential, some particular to commercial, some can go both ways.

But the products that we can gauge in each of those markets, clearly the residential ones were the ones that were affected here.

And our guys think that we have stabilized but they were lower.

Okay.

And when you say it's stabilized, if you look at housing down 25% over 50 from the peak, at least new housing, renovations down probably several points, but your business is barely down.

So I guess what gives you comfort that you're only going to suffer a minor decline and you've seen the worst when the market is already many points ahead of you and it's declining?

First of all we go through wholesale distribution, Mike.

We think our products are pretty close to the market.

We don't have a big issue of a lot of products in the distribution channel in the wholesale.

They only have a couple weeks of inventory.

And you also have to remember that a significant portion of our revenue comes from the replacement business.

So we do like a strong residential environment obviously, but we have a large installed base of product which has to be replaced on a regular basis.

Water heaters break down.

Boilers break down.

Plumbing systems get clogged up.

That's all replacement business for us.

Non-discretionary.

Okay.

Thank you for that.

I appreciate it.

And gross margins, final question, we went through a lot of machinations on the last call and you indeed did show gross margin progress sequentially of about 10 basis points.

You had indicated I think at that time you expected because copper was then rolling through at a higher cost than the P&L, Q4 should be up sequentially again but it may be tougher.

Can you give us your updated thoughts on that, especially with pricing going out right now?

Sequentially copper will be a little bit higher in the fourth quarter for us, but we're--

Should have more pricing.

We have more pricing.

So you still believe you can make some gross margin gains sequentially?

In North America, yes.

Okay.

All right, guys.

Thank you.

Okay.

Thank you, Mike.

Your next question comes from Francesca McCann.

Please proceed.

Hello there.

Hi.

Just a couple follow-ups, I guess.

In terms of backlog on the commercial side, I guess a little bit of visibility into the timing there and how far out you're able to see backlog.

If you go and talk to the architects and engineering firms, they typically have projects at least a year in advance.

But some of those projects will go, and our products will be installed in three months, six months, nine months, a year.

But typically our visibility beyond a year is pretty cloudy.

Okay.

But over the next call it three to four quarters, you do see backlog [solid]?

I'd say overall right now the commercial market's still fairly robust, and it doesn't turn down quickly.

It turns down slowly when it starts turning down.

You see a contraction in the commercial marketplace--because those projects are long-planned projects and they're almost always heavily engineered in spec, you see it coming for quite some time.

Okay.

Okay, great.

And then a question on inventory levels.

You talked a little bit about (inaudible), a little bit about Europe.

Just now you mentioned a couple weeks' worth of inventory.

I guess what else do we need to know in terms of inventory level, be it in North America on the residential or commercial, or perhaps in Europe?

Are you talking about inventory in the channel?

Yes.

In the US they're probably at low levels of inventory in the channels because the wholesalers have been very frugal given the market conditions they're operating in.

They tend to stock more products on the residential side than they do on the commercial side because those products on the commercial side are more specification-oriented.

So you typically don't see large stocks of those items.

In many cases the demand for those is well planned and planned a long time in advance.

So right now I look at the wholesale channels of distribution in North America and say that the inventory levels are relatively thin.

Although I would expect they're probably managing those inventories down as they go into the winter months, which they traditionally do.

Okay.

But that would also then imply if in commercial there tends to be relatively low inventory, that would also then be harder to gauge in terms of visibility.

I know that you just mentioned that.

Yes, you can't figure out the visibility--

Usually a slowdown comes--usually it takes time, but you also wouldn't get inventory levels as much of a gauge there.

Is that correct, then?

Yes, inventory levels aren't as good a gauge on the commercial marketplace as they are in the residential.

Residential marketplace has got much more standard product which is much more adaptable to inventory levels.

So on a commercial side you'd have to go back and talk to the architects and engineers to get a fix on what's happening.

Okay.

Great.

Turning to Europe, I know there have been several questions.

Just a couple follow-ups.

One more time, the housing starts in Germany, what did you--was the number you mentioned there?

The housing starts are off about 45% this year so far in Germany.

Okay.

And then looking at the French market which you'd mentioned that Germany could--the slowdown could spread into Italy, though France is kind of your largest market there.

What are you seeing specifically in France?

In the quarter our sales in France were fine.

We did okay.

The question is--part of the economic environment in France is the new Prime Minister who came out with a lot of new programs, created a lot of enthusiasm.

And then the other side of that you have in Germany you have a Prime Minister who's been in place for a couple of years.

The shine is coming off some of the programs that she has previously announced, and you see an economic slowdown.

But traditionally what you see is Germany's a big player in the European theater, and so goes Germany, so goes the impact on other surrounding economies.

Okay.

And then you had also mentioned that often with the alternative energy-related products, it's not until incentives are in place that you see kind of an uptick there.

What are you seeing right now related to incentives?

The incentives aren't really that strong at the moment.

Some of them--there was incentives in place.

Some of them have lapsed and they haven't been re-instituted, so there's sort of a wait and see in terms of what the government's going to do on that.

Traditionally Europe's been a little bit better than the North America economy in terms of having heavier tax on petroleum products and then turning around and incentivizing you to invest in alternative energy.

But those programs typically have a two- or three-year life, and some of those have lapsed.

And at the moment the incentives don't seem to be strong enough to initiate a strong demand, because there is a lot of that product sitting in the channel, uninstalled.

Okay.

All right.

I think that's it for now.

Thank you so much.

Thank you.

Your next question comes from the line of James Gentile.

Please proceed.

Hey.

How are you doing?

Good.

Good.

Just wanted to go over the pricing schemes that you're addressing, given your high raw material costs and the trends that you saw as the quarter progressed and what we should expect in the Q4 period.

Well, we have--we've negotiated some pricing with the big-box customers which will be coming in during the fourth quarter.

We have--the June 15 price increase continues to come in.

Certain customers that you have to negotiate with on a one-on-one basis.

Or you have a delay.

Or you have a delay.

Sure.

That's coming in.

And then we have in Europe it's kind of on a selective basis.

You have to look at each market, but we have had kind of a rifle-shot approach to pricing in Europe with selected products and/or customers.

So if you were going to size up the demand versus price dynamic going into Q4, would you say your gross margins would show further sequential improvement?

We're expecting North American margins to improve sequentially, yes.

In Europe?

I think it's a little too early to say because we're watching it closely.

Okay.

And then with regard to the Chinese restructuring, would you suggest that a return to some level of $3-plus million in EBIT would return in the Q4 period?

Well--

Given what you're working on right now?

The issue there, Jim, is going to be the production levels in those plants, and we are going to keep a low production level and have some absorption issues because we're moving one plant and we have one that's at a low level because of the residential slowdown in the US.

So where I would think that we'll see some improvement, I don't think we can sign up for what it's going to be yet.

Gotcha.

What about in the localized Asian markets?

Would you expect to see further growth in that business, in that area, organically?

Yes, that's a solid market [and it] continues to grow at good rates.

Gotcha.

All right.

Thanks.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS) You have a question from the line of Jeff Hammond.

Please proceed.

Hi, guys.

Just a couple follow-ups.

Just some housekeeping.

How should we think about effective tax rate for the fourth quarter and for '08?

And then can you give us the cash flow from operations number?

On the tax rate, Jeff, I would say somewhere around 33 the way we are.

Thirty-two to 33, in that range.

For both 4Q and '08?

Well, for 4Q.

I'm not signing up yet for '08.

But I would--I don't think it will be a dramatically different number.

We're still working on our budget, etcetera for '08.

And the operating cash flow is $22 million.

And that's for the quarter?

Nine months.

Nine months, okay.

And then I'll give this a try.

I know you guys don't give guidance, but--

(inaudible), Jeff.

Go ahead.

But as you look into '08, it seems like Europe, at least in Germany, is getting a little more challenged.

Commercial there seems to be at least some question marks.

I mean, you guys seem to think that housing's bottomed, but I think the macro view is that housing starts are at least down somewhat '08 versus '07.

And from an acquisition front it seems to be limited in terms of opportunities.

So I just wanted to get your perspective in terms of how you find growth next year.

Is it from an organic revenue standpoint?

And how much in kind of a more muted organic growth environment, how we should be thinking about margins?

Sounds to me like you're looking for a forecast.

I mean, just some qualitative color.

Jeff, we're in a difficult market but there's still plenty of opportunity in this business.

I mean, we don't want to paint an overly dire picture here.

Hey, Jeff, I would say that I don't see a precipitous drop in the commercial markets.

I see there may be some choppiness to it, but not a precipitous drop.

I see the softness in the residential market, and you may be right that we haven't seen the end of the subprime fallout.

I was reading something today that said that they expect a $250,000 to $300,000 reduction in housing starts 2008 versus 2007.

I'm not sure I believe that.

That's pretty deep from where we are because I have us now at roughly 1,250,000 starts.

And that would bring you down to a million starts.

I have a difficult time believing we're going to operate at that level.

But I think we see that we've sort of--we've seen the downsize on a residential market.

We don't think it's going to come back for some time, but we don't really--we don't think it's going to get substantially worse from where it is.

Okay.

So it's maybe a little easier comps on res.

Growth in commercial but at a lower rate.

And then just kind of annualization and price.

I mean, do you think Europe--?

Jeff, we also have new products that are coming out.

We have an excellent opportunity with our PEX and fittings line.

We still have plenty of opportunity in that big-box space for new product and rollouts.

There's an excellent relationship with those customers still.

You have the whole thing on plumbing and building codes that continues to evolve.

We have some ability, some new product capability shall I say with some projects that we're working on in China which will be able to benefit from that next year.

There's a lot of things happening despite the fact that some of these end markets are difficult right now.

Okay.

And then last question, as you look at the cost saved from this restructuring program, looks like a fair bit of activity this quarter in terms of percentage of the total charged.

What do you think the costs saved are in '08?

It'll start phasing in towards the second half of--a little bit in the beginning and then start phasing in the second half of '08 through '09.

I don't have an exact figure for you right now.

Okay.

Thanks, guys.

(inaudible) of '09 we'll have the full run rate.

Okay.

Thank you.

Okay.

There are no further questions.

I would like to turn the call back over to Mr.

Pat O'Keefe.

Please proceed, sir.

I'd like to thank everyone for joining us on our conference call today, and we look forward to talking to you in late January, early February.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.