Watts Water Technologies Inc (WTS) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2008 Watts Water Technologies earnings conference call.

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

We will conduct a question-and-answer session towards the end of this conference, at which time you may participate by pressing star followed by 1 on your touchtone telephone.

(OPERATOR INSTRUCTIONS)

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

Kenneth Lepage, General Counsel.

Please proceed, sir.

Thank you.

Before Pat and Bill begin their presentation, I want to inform you that various remarks that 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, 2007, 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 O'Keefe.

Thank you, Ken, and good afternoon, everyone.

Welcome to our third quarter conference call, and thank you for your continuing interest in Watts.

Following my remarks, Bill McCartney, our CFO, will provide you with financial highlights for the Company in total, and Bill will also discuss individual sector results.

Then we will address any and all of your questions.

The third quarter results were in line with our internal expectations and generally consistent with what we shared with you during the second quarter earnings call.

Bill will take you through the third quarter details in just a moment.

Obviously, the past quarter has been turbulent as the worldwide credit crisis and subsequent government intervention have caused large gyrations in the financial market.

There's a growing realization the world is headed into a recession that we think would likely persist throughout 2009.

It has certainly been apparent in our US business, where residential markets have been seriously affected.

Now we are concerned that those credit issues are affecting our domestic commercial business, as well.

Some countries in Europe have officially reported they are in recession, with others, I believe, soon to follow.

And while still expanding, the China economy is slowing down as the world is consuming fewer Chinese-made products.

Given this somewhat bleak macro view of the world's economy, let me tell you what I think our challenges and opportunities are and some of the actions we are taking to help next year's performance.

Looking ahead to 2009, our challenge in North America will be in the commercial marketplace.

Data continues to support a softer US nonresidential construction market in 2009.

A preliminary October report from McGraw-Hill Construction of expectations for nonresidential square footage suggests a 12% reduction in 2009 as compared with 2008.

The September ABI index stood at 41.4, which is negative for the eighth consecutive month, meaning business levels at the architectural firms continue to deteriorate.

A recent Manufacturing Alliance publication is forecasting a 12% decline in inflation-adjusted residential construction spending next year, with reductions expected across the entire spectrum of the construction sectors, i.e., commercial, healthcare, institutional, etc.

It is now evident that the consumer retrenchment and tightening credit will affect the consumer markets in which we now operate.

From our perspective, given the expected reductions in US commercial activities of between 10% and 12%, the continued softness in the residential markets, where we estimate a 5% market reduction and the replacement market, where we see it as effectively flat, we anticipate a decline in organic sales volume in North America in the low to mid-single digits for 2009 as compared to 2008.

In response to this business climate and to improve our leverage in North America, we recently announced to our employees a series of programs.

First, we expect to undertake a reduction in workforce that we hope we can finalize in mid-November, which targets an annual savings of $8 million to $9 million.

This is an unfortunate but necessary step in order to align our overhead cost during a prolonged economic downturn.

We are currently identifying affected employees, so final savings and severance costs are still being determined.

We expect the final net charge will be recorded in the fourth quarter.

Secondly, we have announced that all salaries are frozen for the first nine months of 2009.

At the end of nine months we will evaluate the salary freeze and take appropriate action based on the prevailing business environment.

Given our current payroll levels, we believe that the foregoing salary increases for nine months will save approximately $2 million.

Third, discretionary spending is being reviewed in detail to determine where we have room to cut back on costs.

And, finally, we are conducting a review of our worldwide manufacturing footprint to identify opportunities for further consolidation.

We expect the results of this review will be finalized and announced at the second quarter conference call next February.

I would emphasize that these projected savings will not impact our initiatives concerning continuous improvement, nor will they materially affect any of our strategic goals.

We expect that the cost savings and continued focus on lean initiatives will put us in a strong position when the economy does bounce back.

In Europe, the third quarter organic growth was approximately 4% and was in line with the second quarter organic growth, continuing the trend of increased sales of our products and packages sold into the alternative energy marketplace.

The strength of these product sales is continuing into the fourth quarter, based on the latest firm orders in our backlog.

As compared to the third quarter, we anticipate sequential sales growth in the fourth quarter on a consistent currency basis in Europe, as some weakness in our core European business will be offset by strength in Blucher sales and alternative energy products, with margins improving as a result of the lower purchase accounting charges related to the acquisition of Blucher.

As for 2009, we do not expect sales growth in Europe -- we do expect sales growth in Europe year over year, as Blucher results will be included for the full year but will be partially offset by mid-single digit reductions in our core European business.

Further, we see opportunities in expanding our market share over smaller competitors, as we have a fuller product line to offer to our customers.

Another issue that is impacting fourth quarter and we expect will impact 2009 European results is the foreign currency swings.

Current FX rates, if they continue in Q4, could negatively impact the fourth quarter results by approximately $0.02 to $0.03 as compared to the fourth quarter of 2007.

Where we may see some growth in constant currency basis next year, we expect that our translated sales and operating results will be negatively impacted by reductions in the euro against the US dollar.

Based on recent FX rates, we anticipate that on average the euro will decline in value against the US dollar by approximately 15% next year.

Now, in turning to China, we said during our Q2 conference call that we expected China would continue to underperform, with capacity issues and shipping delays through the remainder of 2008.

Our results for Q3 are in line with those expectations.

Organic sales declined approximately 10% as compared to the third quarter of 2007.

One of the issues we face in China is the underperformance of our former joint venture facility in Tianjin, which you may recall we purchased the remaining 40% of the equity in the second quarter of this year.

Approximately 52% of the business was related to intercompany activity with Watts USA and its European sister company and 48% was third-party sales into domestic Chinese butterfly valve market.

In August we entered into an agreement to sell the domestic business to a third party while transferring the intercompany business to another Watts facility in China.

We are awaiting final approval from the Chinese government for this transaction, which we anticipate will come in late November.

Year-to-date September external sales for this entity approximated $6.8 million, and the Company has generated a sizable operating loss due to unabsorbed overhead and bad debt issues.

The remaining intercompany business that we will be retaining will be run in a much more efficient manner.

This sale should significantly reduce the operating losses currently being recognized by our Chinese segment.

We are still finalizing this transaction, but we do not believe that any charge recognized on the sale will be material for our fourth quarter results.

As for 2009, we do expect to see moderate sales growth in China, led by Changsha, which makes large-diameter hydraulic butterfly valves used in the domestic infrastructure projects.

Order rates at Changsha remain strong.

Further, all of our Chinese company are exploring new markets and focusing on improving service to help grow their domestic sales.

We expect to see modest improvements in our China business as we enter 2009 and continue throughout the year.

Now I'd like to update you on a few programs we discussed previously.

Our 2008 initiative to maximize cash flow and promote operational efficiency and productivity are proceeding well.

Regarding cash flow, I am again pleased to inform you that we continue to generate positive cash flow.

For year-to-date September 2008 we generated positive cash flow from operating activities of approximately $91.5 million, which compares favorably to $21.8 million of cash generated from operating activities in the first nine months of 2007.

Our focus on working capital management has generated approximately $82 million more in cash in 2008 as compared to 2007.

We intend to continue to focus on cash management as we move into 2009.

Let me also point out that in such tough financial times our balance sheet is well positioned to help us weather the storm.

Our net debt to capital ratio at the end of September was 24.1%.

We have approximately $255 million in unused and available capital from our existing line of credit.

We do not have any debt repayment until May of 2010, when we are scheduled to repay $50 million of our private placement notes.

We believe the combination of our strong financial position and continued focus on working capital management will be an advantage to us during the next couple of years.

Let me give you an update on our stock repurchase program.

We have repurchased approximately 2.45 million shares on the open market, and we have invested approximately $68.1 million to repurchase those shares.

The accretion on earnings per share from repurchasing those shares for the third quarter of '08 was $0.02.

As another means to enhance our future cash flow during these turbulent times, we have made a decision to temporarily suspend the repurchase program.

Next let me address the acquisition program.

Again in order to preserve cash we have put the acquisition program on a slow burn, meaning over the next six to nine months we will only look seriously at bolt-on companies that can offer Watts immediate return in both operating profit and cash flows or companies that can provide a compelling platform or substantially extend our business into new geographical areas.

Nothing is currently on the horizon, although we continue to make inquiries and are looking at several targets.

Regarding operational improvements, we continue to push ahead with the Lean Six Sigma awareness training and process innovation training.

Lean leaders and steering teams have been put in place at the key sites throughout the US.

Lean scorecards have been initiated that focus on customer satisfaction, cost savings, inventory turnover and other key metrics we are trying to address through the lean process.

In 2009 we hope to develop a Watts Six Sigma certification program, and we remain committed to this endeavor and are pleased with our early results.

Finally, regarding the progress on the restructuring program, in Q3 we took additional pretax charges of approximately $900,000, related mostly to severance and relocation costs in both China and US.

In general, we are on target regarding the timing and implementation of the various restructuring programs in the US and China.

As mentioned during the last quarter call, our European restructuring program has been -- is being reviewed, which will delay both the timing of the costs being incurred as well as the savings being realized.

We still expect savings in 2008 from the restructuring program will approximate $500,000 on a pretax basis.

Now I'd like to turn the call over to Bill McCartney, who will take you through the financial highlights.

Then we will take your questions.

Bill?

Okay, thank you, Pat.

Revenue for the quarter of $379 million was up $38 million, or 11%.

Net income, at $16.7 million, represented a decline of $1.4 million, or 7.5%.

Earnings per share from continuing operations at $0.46, which was a decline of $0.01, and you compare that to consensus estimates of $0.45.

On a consolidated basis, the revenue of -- the increase of $38 million was composed of the following.

The organic growth on a consolidated basis was up $1 million, or 0.3 of a point.

The foreign exchange, mostly the euro, was up $10.5 million, or 3%.

And then contributions from acquired companies was up $27 million, or 8%.

And that totals the $38.8 million, or 11.4%.

What I'd like to do now is just, as we did last quarter, is just kind of walk you through a bridge on our earnings per share and compare it to last quarter, last year's third quarter, and then we're going to go into a more detailed discussion on the segments.

But if you recall, last year's third quarter we earned $0.47.

We have to add $0.10 to that when we eliminate, or to make it comparable to this year, $0.10 for restructuring charges.

The accretion from our stock buyback program, as Pat mentioned earlier, is $0.02.

We have acquired 2.4 million shares since this time last year.

The change in the foreign exchange rates versus last year contributed $0.02.

Last year the average rate on the euro was $1.37.

This year it was $1.48, so we picked up $0.02 there.

The inclusion of the results of Blucher had a dilutive impact of $0.01.

We were expecting, as you recall, Blucher to be dilutive about $0.04 this quarter.

So Blucher itself did a little bit better than we were expecting, and that contributed to the improvement from our anticipated results there.

The tax rate this year added $0.01 versus last year.

We had some small favorable adjustments, mostly in Europe.

And then you have another $0.01 of miscellaneous issues and rounding, which takes you to $0.62.

We compare that to this year of $0.46, and to normalize it we would add $0.02 back for restructuring, so that would save $0.48 this year's third quarter compared to last year's $0.62.

So that means we have a $0.14 decline in results from the operations of the Company.

The results, that $0.14, is composed of three segments -- North America, Europe and China.

North America, we saw a decline in operating earnings which resulted in a $0.04 impact to earnings per share, mostly attributable to some increased SG&A.

There are no major issues there, but just some increased spending.

Europe added $0.02 to the results, and that's the result of increased organic sales, with slightly improved gross margins.

And then China had a dilutive impact of $0.12, which is consistent with the issues we've been talking to you about around some delivery and bad debt issues, and we'll talk more about that in a moment.

And that brings you to the $0.14 comparing this quarter to last year's third quarter.

What I'd like to do now is just spend a moment talking about the segments, if we could.

North America closed its revenue at $218 million, which is up about 1% versus last year.

That 1% is composed of the following.

We had a decline in organic growth of about 0.5 point, which is $1.1 million.

Foreign exchange was essentially a break-even, with some slight improvement -- some slight strengthening of the Canadian dollar.

And then the acquisition of TGI last year contributed $3.7 million, or 1.7%.

So that totals $2.7 million, or 1.3%.

If we look at the wholesale sales inside of North America, they are $174 million this year compared to $174 million last year, and essentially what we saw was some unit volume declines that were offset by improved pricing.

On the retail side, we closed our revenue at $40.5 million, which was a slight decline from last year of $41.7 million.

That's a 3% decline.

And essentially what we have is this year we did some buybacks on certain products where we're resetting some shelves.

So that had a negative impact of $2 million.

And last year we were rolling out some new products on our water filtration product line.

So we have an unfavorable swing of $2 million between the buyback this year and the rollout last year, and those are the main factors impacting North American retail.

In Europe, revenue was $148 million.

That's an increase of $37 million, or 34%.

The factors there are organic growth of $4.7 million, or 4.3%; the foreign exchange is $9 million, or 8%; and then the acquisition of Blucher, the Blucher sales of $23.6 million, or 21%.

And that totals the $37.5 million, or 34%.

The average rate we used last year was $1.37 and this year is $1.48 for the euro.

Basically, what we're seeing in Europe is that overall construction levels are down, so the wholesale sales are down about 6% organically.

And that is offset by the positive situation we have of selling product into the alternative energy market, and those two essentially offset -- well, the energy more than offsets the decline in the wholesale, and that's what provides us with the organic growth of 4%.

In China, our sales, $12.8 million, which is a decline of about 10% versus last year.

There was some slight favorable foreign exchange where the RMB appreciated about 10% this year versus last year.

And organically our revenue is down about $2.6 million.

Now, if you look at the components of the $2.6 million, our sales of our more commodity-orientated plumbing products were down $2 million, and that's the result of some increased demand on our exports because of the residential decline in the world economy, and compounded with some delivery issues at one of our facilities.

But if you look at our revenue going into the domestic infrastructure market, that partially offset this decline, and that was up about $1.5 million.

So that market remains strong, and the order entry rates are strong, as well.

The gross margin, consolidated basis, we're up about 0.3 of a point, at 32.7%.

Looking at the segments, North America, the gross margin improved by 1.7 points, to 34.5%.

The main issue there is last year, you will recall, we booked a large restructuring charge.

So if you exclude the restructuring charge the margin is flat in North America from last year to this year in the quarter.

Essentially what we're seeing here in North America is that metal prices are up versus last year's third quarter, but offset with some pricing.

And at the same time we see that we have some inventory declines and some reduced production levels in North America, so the productivity issues that we're seeing around lean and other projects are helping to offset the lower absorption that we're seeing.

In Europe, the margin is up about 0.4 of a point, to 31.1%.

Blucher had a slightly negative impact there of about 0.2 of a point in the quarter because of the amortization of the purchase price, which is now behind us as we enter the fourth quarter.

And that was offset by the increased utilization because of the improved sales of the alternative energy products.

The gross margin in China at 5.5% is a decline of about 8 points versus last year.

And, again, what we see is less factory absorption because of the lower volume, which again is associated with decreased demand on the export products and some of the delivery issues.

And to ensure that we have -- are meeting our customer deliveries, we've outsourced some of our production, so that outsourcing causes some unfavorable variances, as well.

We also see the impact that the strengthening of the RMB has caused, and that's where we see it is in the margin as we're selling Chinese product and receiving US dollars in return.

On the SG&A, $92 million, which is an increase of about $13.6 million.

Looking at the components of that, organically we were up $4.3 million, which, as I mentioned earlier, about half of that, a little more than half, is in North America.

The foreign exchange, $2.2 million, and then the inclusion of the SG&A expenses of both Blucher and TGI contributed $7.1 million, which is the total of $13.6 million increase.

That brings us around to operating earnings at $30.7 million.

That's an increase of about $600,000, or 2%.

Again, when we look at the components of the change in our operating earnings, there are four basic components.

One is restructuring, so we -- last year we booked $5.1 million of restructuring charges.

We don't have that this year.

The acquisitions contributed $0.5 million of operating earnings in the quarter.

Foreign exchange was $1 million.

And then these gains were offset by the -- primarily the results in our Chinese segment.

And the whole thing nets to a $600,000 improvement.

When we look at below the line, the major component there is interest income, which is down about $2.9 million versus last year.

And that's really the result of less cash on hand because of the stock buyback and the acquisition of Blucher.

The tax rate, at 30.6%, is down 2.5 points versus last year.

When we look at the components of that, the China tax rate is down considerably versus last year.

Recall last year in the third quarter we booked a valuation allowance against the TWT facility.

So we don't have that this year.

In Europe the rate is down from 30% to 23%.

The couple of points there is associated with some one-time favorable adjustments, and also about five of those points are associated with some tax planning that we've done associated with the acquisition of Blucher.

So net income from continuing operations at $16.8 million is down $1.4 million from the third quarter of 2007.

And I'd just like to make a couple of comments to amplify on some points that Pat made around our cash flow and our balance sheet.

In the quarter ended September '08 here, we generated $71 million of free cash flow compared to negative $3 million in third quarter last year.

And that's really the result of improved working capital management.

If you look at our working capital as a percentage of revenue right now and you exclude cash, working capital to revenue is 24.7%, compared to 31% this time last year.

So you can see that we are more effectively managing working capital as we go forward with some of our lean programs.

And then a couple comments around liquidity.

Our net debt to cap is only 24.1% right now.

We have $129 million of cash on hand.

And we feel very comfortable that we have a very solid bank group that we're working with, led by Bank of America, JPMorgan, Wells Fargo and KeyBanc Capital.

But we believe that we're very well positioned around liquidity issues as we enter into this recessionary environment.

So I think with that we are ready to open it up to any questions that you might have.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Michael Schneider, with Robert Baird.

Please proceed with your question.

Good afternoon, guys.

Hi, Michael.

Hi, Michael.

Maybe first we can just talk about the wholesale channel.

I'm curious.

It sounds like the unit declines were maybe a little more steep than even the second quarter.

And is that just because you have more pricing coming through in the wholesale channel in North America?

I think what we've seen, Mike, is sort of mid-single digit declines there in terms of unit volume, offset by some pricing.

Okay.

And then you were supposed to go out with some select price increases in September.

Can you give us a sense of did those go out, and the extent they were successful?

Yes, most of the price increases, Mike, relate to -- particularly relate to iron products.

And they went out in August and were in effect, basically, by early September.

I think they're well justified based on what's happened with the cost of iron, so most of them are, at this point in time, in place and holding.

Okay.

And then as you look now into Q4 and 2009, you've been very successful in passing price along for the last two years, especially in copper products, give us a sense of what you expect in the wholesale and retail channels now that copper has been cut in half.

Well, I would expect that -- you know, let me talk about what's happened in the past.

When you had a period of rapid inflation in our industry it's been followed by a period of sort of graceful deceleration in pricing.

So you have deflationary period.

But it's been at a relatively slow pace.

The reason I attribute that to, Mike, is because all members of the channel would like to see price stability, so they're all resisting price declines and allowing those to go through.

Now, the other, I think, and I would expect that it would be -- that the pricing would -- we'd be under some pricing pressure, but I would expect that we'd hold on to a good portion of the gains that we've fought for over the last five years.

Remember, we were following cost up, so I think most of the channel members will be reluctant to pass that back down.

Okay.

They're looking more at price stability than they are at price declines, because if you give a price decline to one you're going to give it to all, and they just compete at a [no lower] level.

Okay.

And, Pat, your tone is, I guess, decidedly more cautious, and the actions you've taken, I guess, speak to it.

Are you reacting to what we've seen at least in the headlines and some of the more macro indicators, or have you seen a marked deterioration in orders just maybe even since mid-September or the first of October?

I think you're right, Mike.

I'm reacting to what I can -- I'm concerned about, which is the longer the liquidity issues remain in the marketplace the more damage you're doing to the base economy.

So we're just -- we're reacting, really, looking out at 2009.

And have you seen it in your orders yet?

Not substantially, no.

Okay.

All right.

Thank you.

You still have a good backlog of commercial projects running through.

My concern is is you can see what's happening at the architectural level.

That backlog is shrinking.

Okay.

Thank you.

Okay.

Thanks, Mike.

Your next question comes from the line of Kevin Maczka, with BB&T Capital Markets.

Please proceed with your question.

Pat, Bill, how are you?

Good, Kevin.

Fine, thank you.

You touched on the commodity issue and the fact that you may see some pricing pressure there, but when you look at the cost side of that, did you forward buy many of your big commodity purchases like copper and others so that you might not see a more immediate impact on the cost side, or should you see some cost benefit as early as Q4?

Go ahead.

We have some buys that we've done, but we were forecasting internally here that the [$2] copper would start to come into our cost of goods in the second quarter of '09, and that's typical of the lag that we see, because we always have somewhere between four to five months of material on hand, and then that's really the issue.

We have some pre-buying that we've done, but it's still within our four to five-month window.

Okay.

And then there were some of the things that, like lower commodity costs and some of the other cost-side actions that you announced tonight that you're taking and still some price increases, in the face of these volume declines that you expect in '09, do you think it's possible to maintain this 32% or so gross margin, given that some of those things ought to offset the deleveraging from lower volumes?

Well, we're still in our planning cycle right now, and it's a little early for us to say what our margins are going to be.

I mean, we're -- what we're trying to do is react to all the things that we can control, and in case the volume does -- those volume numbers do hit us, we want to be ahead of the curve.

So it's a little early to say.

Okay, and then --

We think that when you look at the -- some of the main components here of copper, which that hopefully will give us an opportunity to widen the margins a little bit, and significant reduction in our SG&A around all these salary cutbacks, there's a lot of opportunity for cost reductions which we're following up on here.

Okay.

And then two questions on Europe quickly, if I could, Bill.

Mid-single digit volume decline I think is what you're expecting in '09.

Are you expecting something similar with Blucher, as well?

And the second question is, some of the alternative energy products that were so strong last quarter, are those expected to hold up much better, given what energy prices have done lately?

Well, what we -- what -- the comments that Pat shared with us was that the core business of Europe will be down about 5 points, but we still expect Europe to hold its own, and that does not -- Blucher will not be going down by 5 points.

So the growth of Blucher offsets a lot of that, or all of it.

The two offsets you have are Blucher coming in strong and alternative energy remaining strong.

Right.

Okay.

So it's not just the addition of Blucher, but Blucher you actually expect to grow, even as a standalone unit.

Especially -- you have two factors.

It's growing on its own, but you also have the fact that we only had it for a portion of the year.

Right.

Yes, okay.

Okay, great.

Thanks, guys.

Okay.

Your next question comes from the line of Jeff Hammond, with KeyBanc Capital Markets.

Please proceed with your question.

Hi.

Good afternoon, guys.

Hi, Jeff.

Hi, Jeff.

Just back to near-term trends, it doesn't sound like you've seen a big change near term, but is there anything that you've seen over the last month or so -- we've kind of hit the pinnacle of this financial turmoil in terms of any customer segment acting particularly different, any kind of channel destocking?

Yes, the thing I worry about is the last issue, which is channel destocking, which I'm very fearful that as we approach year end you're going to see some significant destocking on top of the destocking that they've gone through year to date.

So my concern is is that you have wholesalers who are very reluctant to carry inventories across the year end.

Okay.

And --

And we have the same issue in retail.

And then, any pieces of the business over the last month or so that you have seen some marked deterioration, whether it be renovation or any subverticals?

We don't have visibility to that extent because of going through retailers, going through wholesalers.

So our visibility is a little bit blurred in the near term.

We can see trends longer term because of our discussions with our customers, but near term I think you basically have a market that's frozen.

And I don't think that's particular to one channel of distribution.

I think that's particular to the fact that homeowners are finding it difficult to get liquidity, or they're reluctant to make commitments to major purchases.

Okay.

And then, just moving over to China, I think you gave some color on '09.

You thought the business would grow modestly.

Is that excluding this Tianjin impact, or is that --

Yes, that's excluding Tianjin.

The issue with Tianjin is we have it under contract to be sold.

We're hoping that with that sale being approved here at the end of November that we put some of those -- some of the more serious operating losses behind us.

So can you give us a sense of what Tianjin on a full-year basis adds in terms of revenue contribution and operating loss that would go away?

(Inaudible) [about] $8 million to $9 million of revenue, Jeff, in there, depending on the quarter, a third to half of the operating loss.

A third to half of the operating loss that you're experiencing now?

In China.

Okay.

So when you get -- I guess when you sell that -- I mean, what's the path to kind of break even or back to profitability in China?

I mean, what's the best guess time frame?

Well, right now we're looking at continued improvement in '09, and I think we'll be well on our way midyear to late 2009.

And that's our best estimate right now.

Okay.

And then, can you give us a sense of how much copper you buy on an annual basis?

Jeff, as you know, we've been reluctant to get into being so specific on that, so I continue to be reluctant, if you don't mind.

Okay.

Great.

Thanks, guys.

Okay.

Your next question comes from the line of Curt Woodworth, with J.P.

Morgan.

Please proceed with your question.

Hi.

Good afternoon, guys.

Hi, Curt.

Hi, Curt.

I guess in terms of thinking about the low to mid-single digit number you outlined, that was a volume number, correct, Pat?

Yes.

We're talking about sort of mid-single digits.

Okay.

On volume in North America.

Right.

And, I mean, if I just took 5% of the top line off, and I know you have additional acquisition revenue coming in with the full year Blucher, but you'd be looking at a sales decline of about $74 million.

Obviously you'd have to add back some for Blucher.

Your incremental margins have kind of vacillated between 10% and 15%.

So that kind of implies an EBIT loss on the base business of roughly $7 million to $11 million.

And you've outlined -- and that's my math, obviously -- and you've outlined some of the restructuring to date that you think is going to save you about, I believe, $500,000.

Can you identify or quantify any incremental savings that you think you can get?

I know you're not comfortable maybe quantifying what you announced this quarter, but can you give us a sense of how much cost you could really take out in '09 if things did deteriorate to that degree?

We're going through that budgeting process right now, so you're a little bit premature in asking the question.

Okay.

We don't have a comprehensive view on that at the moment.

We have pretty good clarity on individual pieces --

Got it.

-- like the reduction in force and the salary freeze and some other things, but not collectively.

Okay.

And in terms of Blucher, do you still expect $0.20 of accretion in '09?

Well, we said it was $0.05 a quarter, so we're going to have $0.05 of that in fourth quarter, so you're really talking about $0.15, I think, in '09.

Okay.

We had a little bit of FX effect depending on what happens with the currency.

Okay.

And I guess just in terms of FX, you said it would be about a $0.02 to $0.03 hit to the fourth quarter.

So if it were to stay at that level into 2009, I mean, is the current thinking that would be roughly maybe a $0.10 negative impact in 2009?

It's probably $0.12 to $0.14, in that range.

Okay.

Okay.

And then this last question, for Europe, what percent of your sales are into alternative energy?

Well --

We haven't broken it out.

-- yes, we haven't really broken it out separately, Chris, but, I mean, it's half -- prior to Blucher, half our business was OEM.

Now it's probably about 40 percent.

And so it could be as much as half of that, rough estimate.

Okay, so it could --

We also get a lot of pull-through sales.

Because we're selling the alternative equipment, we get the sales on the regular equipment, as well.

So you get both.

Right.

I'm just trying to figure out a better way to model that, because you said the wholesale was down 6 points, but the alternative energy offset all of that and then some.

I think core was up 4.

So it would imply that you saw massive percentage growth in the alternative to get the whole segment that much positive.

So I'm just trying to get a little bit better handle on --

Yes, our OEM business in Europe was up 16% in the quarter, and that was -- it ended the quarter at EUR44 million, from (inaudible) EUR38 million last year.

Yes, okay.

And you think about maybe half of that would be alternative energy, roughly?

(Inaudible) it's a rough, very rough estimate.

Okay.

And then, do the margins on those product lines vary -- have much variance between your core OEM boiler-type sales?

Not really, no.

No?

Okay.

They average similar margins.

Got it.

All right, great.

Thanks a lot, guys.

Okay.

Thank you.

Your next question comes from the line of Michael [Ruberg], with Boenning & Scattergood.

Please proceed with your question.

Good afternoon, guys.

Just taking a step back -- can you hear me?

Yes.

Yes.

Just taking a step back, we've seen asset prices come down significantly, and a pretty wholesale exit from the scene of financial buyers.

I know you mentioned earlier that bolt-on acquisitions are the only things that you're looking at going forward.

Within that space, is there anything in particular, any particular type of technology or any particular type of product line that most interests you right now?

Well, we have a couple of targets we're looking at closely, and they typically fall into highly -- they're product lines where we think that there's a sustainable differentiation, where they have something that's unique, something that is somewhat price resistant and things of that nature.

But the problem we have at the moment is that there's a gap, I think, because my expectation is is that there's going to be a reset in terms of pricing on deals and the multiples will come down substantially just because the number of people who will be in a position to make offers on businesses will be substantially different six months from now than it has -- than it was six months ago.

The other thing is is that you're going to see the effects of a recession in their EBIT numbers -- in their EBITDA numbers.

So I expect that the whole -- the acquisition pricing will be readjusted here in the next six to 12 months.

Okay.

Okay.

My other questions have been answered.

Thank you.

Your next question comes from the line of Christopher Glynn, with Oppenheimer.

Please proceed with your question.

Thanks.

Good evening.

Hi, Chris.

Just, sorry if I missed it, could you mention what D&A was in the quarter?

I have that.

(Inaudible) D&A is -- year to date, Chris, it's $34 million.

I don't have the quarter here.

That's great.

And can you ballpark what the purchase accounting was at Blucher?

Inside of that D&A number?

It is all inside it, including the inventory write-up?

Yes, that is -- it's in there.

Not all of it, but, well -- in Blucher, the -- we were expecting it to be about $0.04 dilutive.

It was about $0.01 dilutive.

Okay?

The results were a little bit better than we were expecting.

Their margins were a little bit higher.

Their revenue was a touch higher, as well.

I don't have the specific D&A here with me right now on just Blucher, though.

Okay.

And the retail number just looks really good against the residential environment we're in.

Can you talk about that a little bit, and maybe a little more detail on the price would speak to that, as well, what the pricing was in North America?

You're referring to the retail sector?

Yes, and then pricing across the North America segment, perhaps.

I'll take whatever you want to give.

You know, the way I would describe pricing in the third quarter, it was relatively stable.

Now, the question, I think, that we've got to -- we're grappling with at the moment is what's going to happen on pricing going forward if copper maintains the level at which it has taken itself down?

Now, I'm a believer that the market is going to be reluctant to give that back, because it's been so hard fought to get pricing as we've gone forward.

But I don't think -- in the third quarter we didn't see anything unusual.

The pricing movement that we took in the quarter was substantially cast iron products, where the material cost was significantly higher than what our pricing was prior to the price increases, and we just simply caught up.

Okay.

And then just to the level of overall resilience, I mean, the overall sales decline in retail is just pretty minimal against the environment we're in.

Right.

Yes, it was a solid quarter in retail in the environment.

You're absolutely right.

I mean, we were down about a million bucks, and that was primarily because of timing on rollouts and buybacks and whatnot.

So I think the guys in our retail space deserve a lot of credit.

They had a solid quarter.

Okay.

And then the other solid thing, the tax rate.

It sounds like you've done some things that permanently lower your tax rate (inaudible).

What would we be thinking about as a placeholder there for '09?

It certainly sounds like it would be lower than we might have thought previously.

Well, we have -- when we did the Blucher deal we were able to do a little bit of tax planning, which, I would say, it's a little early, Chris, but maybe 0.5 a point lower than historical.

But I'm not --

Yes, Chris, I think we're going to have to give you some guidance on that in January.

Yes.

It's just a little early to say that just yet.

Okay.

Great.

Thanks for your help.

Okay.

Your next question comes from the line of Keith Hughes, with Suntrust.

Please proceed with your question.

All my questions have been answered.

Thank you.

(OPERATOR INSTRUCTIONS)

Your next question is a follow-up question from the line of Michael Schneider, with Robert Baird.

Please proceed with your question.

Pat, Bill, could you just clarify -- I think I might have crossed two different comments.

Pat, you started the call by saying you would have expected mid-single digit declines in Europe in 2009.

Again, is that unit volumes or is that revenue on the core business, and then again offset by Blucher?

It's revenue declines on the core business before offset for two things.

Blucher would be a positive offset, and the other positive offset would be the sales to the alternative energy applications.

Okay.

And then in North America did you also say you expect mid-single digit declines in '09?

Yes.

That's correct.

You do.

Okay.

And is that primarily then again the wholesale channel because of the commercial exposure, or is there something unique about the DIY comparisons or rollouts (inaudible)?

No, primarily the commercial marketplace softening up.

Okay.

That's all I have.

Thank you.

Okay.

Your next question comes from the line of Michael Coleman.

Please proceed with your question.

Good evening.

Hi, Michael.

Could you just go through kind of the unit economics of the alternative energy for the end user, what kind of payback they're getting, or what's driving, aside from high energy costs, what's driving that sales level?

Yes, there are two things that drive that sales level.

One is the fact that there is a number of subsidies across Europe, and to a certain extent those subsidies are being endorsed by other countries around the world, where they are subsidizing the installation of more energy-efficient applications, particularly solar applications, geothermal heat pump applications and things of that nature.

So a lot of this is being driven by subsidies that make it more affordable and reduce the payback on those systems.

The second issue is I think there's -- we saw this year people who were ignoring somewhat the economics of that and investing in those systems because of the noise around $100-plus oil.

Now, the question, I guess, going forward is how much is that going to relax as a result of the noise around $100-plus oil going away?

So that's the issue.

But in general you have two factors.

One is the subsidies and two is you have the movement of people to do -- to move toward green technologies and more energy-efficient technologies, even without the subsidy, or even without the short economics.

Okay.

One other thing, the $900,000 restructuring, could you just break that out between North America and China?

Let's see here.

We've got $500,000 in North America.

There's about $100,000 in Europe and about $300,000 in China.

Okay.

Thank you.

Okay.

You're welcome.

Your next question comes from the line of Christopher Glynn, with Oppenheimer.

Please proceed with your question.

Yes.

Something caught my ear on Mike Schneider's question about the alternative energy in the European next year.

And I think previously you had just expected that to kind of run solidly this year, the alternative energy.

Now it sounds like you're looking for that to continue pretty solid in '09.

Did I hear that correctly?

We don't have -- we've got to be careful, because we don't have that good a visibility in terms of what's going to happen with demand.

We have solid backlog throughout the fourth quarter.

We're starting to book some orders into the first quarter, but it's too early to tell.

Okay, but maybe you've become incrementally more positive on the sustainability of it, at any rate?

I think that's true.

Okay.

And then, just lastly, on Blucher, better than you had expected or guided in the quarter.

Should that inform our thinking about the $0.15 for next year?

I'd hold on your $0.15.

Yes.

We said earlier, you're going to have a little bit of a -- when you translate that back into US dollars, depending on what your assumption is regarding the euro-US dollar exchange rate, you have that issue to deal with.

Definitely.

Okay.

Thanks again.

Okay.

There are no further questions at this time.

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

Pat O'Keefe for closing comments.

Well, thank you very much for your continued interest in Watts Water Technologies.

We look forward to speaking with you again in our February conference call.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.