Watts Water Technologies Inc (WTS) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2009 Watts Water Technology earnings conference call.

My name is Chris, 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 toward the end of this conference.

(Operator Instructions).

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

Kenneth Lepage of the General Counsel.

Please proceed.

Thank you.

Good afternoon and welcome to the Watts Water Techniques third quarter 2009 earnings conference call.

On the call with me today are Pat O'Keefe, our President and Chief Executive Officer, and Bill McCartney, our Chief Financial Officer.

Please be aware that any remarks we may make during today's call 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 the December 31, 2008, and other reports we file from time to time with the SEC.

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

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

During this call we may refer to non-GAAP financial measures.

These measures are not prepared in accordance with generally accepted accounting principles.

A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release dated today's date, relating to our third quarter 2009 financial results, a copy of which may be found in the Investor Relations section of our website, www.WattsWater.com under the heading "Press Releases."

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

Thank you, Ken, and good afternoon, everyone.

Welcome to our third quarter conference call and thank you for joining us today.

After my opening remarks, Bill McCartney, our CFO, will provide you with the financial highlights for the quarter.

He will also discuss the individual sector results.

Then we will address your questions.

First, I must mention the outstanding job our employees have achieved in maximizing cash flow, not only year-to-date, but especially during the third quarter.

In the first six months of 2009, we generated 74.5 million in cash from operating activities.

In the third quarter alone, we almost matched that, generating 73.2 million in cash from operating activity.

Our cumulative year-to-date total cash generation by operations is 147.8 million which is 63% more than the 90.4 million of cash generated from operating activity in the first nine months of 2008.

We achieved this despite a 37% reduction in year-to-date income from continuing operations due to our continued focus on working capital management, our cost-saving initiatives and lower commodity costs.

Our free cash flow for the first nine months of this year approximated 132.5 million, an 89% increase over 2008 comparable free cash of 70.2 million, again as a result of working capital management and also closely managing our capital spend.

Cash flow generation, as we talked about before, remains a key driver for our Company.

As a result of our efforts to maximize cash, we expanded our liquidity through the third quarter.

As of September 27, 2009, our net debt to capital ratio was 12.2% which compares favorably to the 22.8% at December 31, 2008.

We had approximately $233 million of cash on hand versus 166 million at December 31st.

Our cash position has increased even though we paid down debt of approximately 61 million during 2009 including completely paying down our line of credit, and we maintained our dividend consistent with the prior year, paying 12.2 million in dividends through September.

We believe the added liquidity provides us with the flexibility that we need to ride out this recession.

Now, I'd like to talk briefly about our results for Q3, and let me address a couple of large one-time charges that affected our P&L during the quarter.

First, included in our restructuring and other charges is a 5.5 million non-cash, pretax write-down of land and building at one of our facilities.

This facility is included in the Manufacturing Footprint Consolidation Program we announced earlier this year.

We are moving part of the operation of this facility to an existing manufacturing location and the remaining manufacturing operations will either be moved or outsourced.

We are currently negotiating to sell the facility to a potential suitor.

As part of that negotiation, we have determined that the net book value assigned for the land and building are no longer supported by their expected future cash flow, which is primarily proceeds from the sale.

Therefore, we recognized the impairment of those assets in this quarter.

The other large adjustment relates to the charge of [8.2] million of which 5.9 million is non-cash taken to discontinue operations in the quarter.

This charge is primarily for the operating loss and estimated loss on the disposal of Watts Changsha or CWV.

CWV is a Chinese manufacturer of large-diameter butterfly valves used primarily in China's various infrastructure and water markets, including hydropower, thermal and nuclear power.

We discovered during the past quarter that CWV's sales methods may be in violation of the Foreign Corrupt Practices Act, FCPA.

You may recall we disclosed this issue in the second quarter 10-Q.

An investigation by our outside counsel of CWV's sales practices is ongoing.

We are currently marketing the company through an investment banker and hope to finalize a sale within the next six to nine months.

Our operating results prior to restructuring charges exceeded our own internal expectations.

Sales were in line with our expectations and we delivered solid gross margin performance in Q3, slightly better than we had anticipated.

Gross margins were 310 basis points higher than Q3 of 2008 and sequentially were 60 basis points greater than Q2 of 2009.

Although pricing pressure remains a constant issue in our markets, price erosion was not a major factor during this quarter.

Operationally, gross margins were higher versus Q3 of last year due to lower raw material costs, lower reset costs and efficiencies in our operations both in China and in Europe.

Further, our gross margin increased due to the sale of TWT which was in our results through mid-October of 2008 and in addition, acquisition charges related to Blucher negatively impacted last year's margins.

These margin enhancements were partially offset by overheads that were not fully absorbed due to reduced sales volume, especially in the commercial sector.

The sequential margin increase from Q2 was mainly due to lower raw materials cost.

Operating margins for Q3 of 2009 were fairly consistent with the same period in 2008, declining by 10 basis points to 8%.

Restructuring costs reduced margins by 210 basis points and 20 basis points in 2009 and 2008 respectively.

Currency swings from year to year negatively impacted operating earnings by $0.01, but this swing was less than we had anticipated, as the Euro has been steadily gaining ground against the US dollar.

At current FX rates, we expect the Euro will have a positive effect on earnings in the fourth quarter of this year in relation to the fourth quarter of 2008.

Looking at our major end markets, the US commercial market remains depressed.

Sales into the US wholesale channel in Q3 declined 21% organically against Q3 of 2008.

We had experienced 18% declines in wholesale sales versus comparable prior year periods in both Q1 and Q2, so the market is far from recovering at this point.

While we believe the majority of the destocking with wholesalers has subsided, they still remain cautious in terms of rebuilding their inventories.

The American Billing Index, ABI, was 43.1 in September.

Although activity has picked up since this year -- earlier this year when the Index stood at 33.3, this predictor indicates that the commercial construction will remain depressed throughout at least the next nine months.

As mentioned by the American Institute of Architects in a September press release, factors such as tight bank credit, requirements for bigger developer equity stakes and conservative appraisals had made project financing very difficult.

So our near term outlook for the commercial sector has not changed.

We expect to see continued deterioration in the commercial marketplace at least through the first half of 2010.

Our organic US retail sales in Q3 were 6.6% higher than the Q3 of 2008 and sequentially flat with Q2 and Q1 of this year.

Part of the increase was due to the timing of product [release] as performed in Q3 of last year and the remainder is due to the increase in volume of new product introductions and market share gains.

Consistent with our discussions last quarter, we think that our retail business will remain stable and our retail -- and that substantially, retail destocking has ended.

In Europe, our organic sales decline of 7 -- our organic sales declined by 17% in Q3 which was in line with Q2.

As mentioned last quarter, more customers are seeking slower orders with faster turnaround.

Organically, OEM sales were [up] 26% from Q3 of last year which compares to a 24% reduction in the second quarter.

Our perception currently is that wholesale and OEM inventories are at very low levels, so we believe that their destocking activity has subsided, or we think OEMs will continue to manage inventories very closely in order to conserve cash as the year end approaches.

Sales to wholesalers are down approximately 10.6% organically in the quarter versus 9% in Q2.

Sales into Eastern Europe have remained depressed due to the poor economic conditions.

Some currencies in Eastern Europe are beginning to show recovery against the Euro, but customer credit risk remains a major issue.

In our major geographical markets of Germany, Italy, France, we believe the economies have touched bottom and have stabilized.

We are currently flexing our workforce as needed to expected production levels.

Now, I'd like to discuss our outlook both for the remainder of 2009 and how in general, we see 2010 shaping up.

For Q4, we expect the rate of sales decline will be between 10 and 15% versus Q4 of 2008 which is lower than the 15 to 20% we have experienced year-to-date.

This reduction in sales is signaling an up -- is not necessarily signaling an uptick in business, so much as Q4 of 2008 was the first quarter we started to experience a decline in US sales.

So comparables are more in line with the previous quarters.

We now believe Q3's gross margins levels will remain throughout -- excuse me.

We now believe that Q3 gross margins levels will be maintained through Q4.

We had previously expected to lose the benefit of lower copper as Q4 progressed, but higher priced metals are not affecting our P&L as anticipated.

The increases in Q4 due to higher priced commodities will likely be offset by better absorption and other production efficiencies.

We estimate that 1.2 million of FCPA costs will be charged to operating results in Q4 which is about 700,000 more than we recorded in Q3.

Now, looking into 2010, in general, we expect the first half of the year to be very challenging as the US commercial market tries to find a bottom and the US retail and the European markets slowly begin to crawl out of a recession.

Overall, we see year-on-year reductions in commercial sales of 10 to 15% with more of that reduction weighted in the first half of the year.

We see US retail as stable, with growth anywhere from flat to up 3%.

We see overall European markets up 3% for the year with most of the growth in the European markets registered in the later half of 2010.

With regard to gross margins, please realize 36% of sales as we did in the Q3 is an historical very high level for us.

In 2010, we expect gross margins will be affected by higher commodity costs, especially copper-based products.

We are making plans to increase prices in certain product lines to offset commodity increases.

We hope that we can be effective in passing along commodity costs as we've done in the past, but at the same time, I want you to realize the sustainability of any price increase will be market-driven.

We also believe our margins will be impacted by exposure to the commercial market downturns.

In the commercial end markets which are expected to be off 10 to 15%, we are currently predicting that we will have a mix in volume issue which will negatively affect our 2010 gross margins.

On the plus side, we expect to receive some benefit starting in late Q2 from our Footprint Consolidation Initiatives which I'll discuss with you in a moment.

Just one note regarding liquidity.

Next year, $50 million of our private placement is coming due in May of 2010.

We presently expect to fund this payment through operations.

Now, let's talk for a moment about our restructuring initiatives.

The PEX production relocation project which was mentioned last quarter is moving along as anticipated.

This initiative will allow us to rationalize our PEX manufacturing, drive process efficiencies and provide a central location for distribution throughout the US and Canada.

We are still estimating a total cost of 2.7 million, including severance costs, shutdown costs, moving costs and setup costs.

In addition, we expect to spend approximately 1.9 million in capital to outfit the new production site.

We anticipate the move will be completed in the latter part of the second quarter of 2010 with annualized savings of approximately 1.5 million.

As mentioned earlier, we took a non-cash charge of 5.5 million for a manufacturing facility that is part of our Footprint Consolidation exercise.

We expect to announce our intentions to close this facility to all the affected employees during the fourth quarter.

To date, we have taken a pretax restructuring charge of 1.3 million relating to this project for both severance and moving costs.

Once the project is finalized, which we estimate to be during the second quarter of next year, we anticipate annual savings of approximately 1.5 million.

Last, let me address the acquisition program.

As you know, it's been a quiet year on the acquisition front.

We presently are reviewing a number of acquisition candidates, are in various stages of review and due diligence.

As always, we continue to look at potential deals and as previously discussed, we believe we are in an advantageous position, given our cash availability to get a deal completed.

With that, I'll close off my comments and turn it over to Bill McCartney, who will take you through the financial highlights.

Bill?

Thank you, Pat.

As Pat mentioned, revenue closed at just under $304 million which is a decline of 68 million or 18%.

The factors there on the 18%, first of all, organically, we were down 61 million which is 16%.

Foreign exchange adversely impacted us to the tune of 5 million or 1% and then the disposal of PWT last year was a reduction of $2 million of revenue there for half a point.

We look at the earnings per share of $0.09 on a GAAP basis and then we have -- I think the way we look at it is we would add back in our discontinued operations charge of $8 million which is $0.22, and then we would add back in our restructuring charge of $5.8 million after-tax, which is $0.16.

And when you adjust for those items, we believe we had an operating quarter of $0.47 per share.

That would compare to last year at $0.46 a share when we had again $68 million of incremental revenue.

The restructuring charge of 5.8 million was reported in SG&A and is primarily the result of marking to market the assets which are in China which are going to be sold.

Now, just looking at some of the segments, North America at 182 million, almost $183 million, was down 16%.

The biggest chunk of that was wholesale which closed at $140 million which is down 21% versus last year and that's without the foreign exchange.

With the FX, we closed at $139 million and that's down about $14 million versus Q2 which about half of that is the normal seasonal change and half of that is the result of some of the commercial markets starting to slide.

And again, as Pat mentioned, we continue to see softness in the residential and the commercial are starting to slide; really, no restocking is seen yet and no meaningful uptick on residential at this point in time.

On the retail, $43 million which is an increase of 6% or about 2.7 -- or $2.5 million, primarily the result of some new product introductions, as well as picking up some additional shelf space in the retail space.

In Europe, we closed at $116 million which is a decline of 19% or $28 million.

The factors there are a decline organically of $24 million which is about 17% and then the change in the foreign exchange rates [resulted] in Europe's revenue declining by $4 million or 2.8%.

This year, our average translation rate for the Euro in the third quarter was 1.43 versus last year at 1.48.

I think you have to remember when we're looking at Europe on a comparative basis, last year we had very strong energy quarters and we had some channel fill as well.

This year, the result of the impact of the bad economy, we saw a decline particularly on the OEM side and that was reflected across most of our European countries.

Germany was down about 20%; Italy, 25 and France, 15.

We continue to see softness in Eastern Europe and Northern Europe as well.

China closed at $4.8 million, a decline of 4.1 million.

Of that 4.1 million, 2.1 is a decline from an organic standpoint and that's primarily the result of lower exports from China to the European market.

And we also have a decline of $2 million because of the sale of TWT last year.

And just as a reminder, now that we are treating Changsha as a discontinued operation, their numbers are no longer included in our China segment.

The gross margin at 36%, that's an increase of 310 basis points versus last year, an increase of 60 basis points versus Q2 of this year.

The increase from Q2 was really the result of lower metal running through cost of goods sold and as Pat mentioned earlier, the improvement versus last year is a result of several things.

One is the sale of TWT [in teams], so those lower gross margin companies are no longer in our numbers.

We are no longer amortizing the purchase price of Blucher, which we were in the third quarter of last year.

We have seen some significant improvements in operating efficiencies in one of our Chinese companies versus last year and we continue to see the impact of some of our lean projects and resulting in labor efficiency.

Now, we obviously have lower cost metal running through the P&L this quarter versus last year.

However, that benefit is primarily offset through the overhead absorption variances that we see as a result of the lower volume.

And as Pat mentioned, we expect to see some of the higher priced copper running through the P&L early in 2010.

We're looking at price increases to offset that.

The SG&A at $78.8 million is a decline of $12.6 million or almost 14% and that's down a couple of million dollars versus Q2 when we recorded 81 million of SG&A.

So our cost-reduction programs continue to be effective [here], but when you look at the decline from last year, 91 to $70 million this year, organically, we're down $10 million which is a result of cost reductions and lower variable selling expenses.

Foreign exchange declined SG&A by about 1 million and then the disposal of TWT results in a decline of $1 million as well.

Bringing us down to operating earnings, again, if we exclude the restructuring charges that we recorded, we would show operating earnings of $30.6 million.

That's compared to last year at $31 million, so we're approximately the same operating earnings ex-restructuring which reflects a 180-basis point improvement versus last year.

And again, if you compare us to Q2, on a sequential basis, we were up about $1.5 million in operating earnings ex-restructuring and that's reflective of about $10 million less in sales with improved operating earnings as a result.

Below the line, we went from 6.6 to $4.7 million versus Q3 last year, primarily the result of lower debt and the lower interest rates on that effective debt.

The tax rate (inaudible) almost 41% in the quarter compared to 31% last year.

The increase is really due to the fact that when we took the restructuring charge of -- almost $4.5 million of that was an item that we could not tax benefit.

So if you remove that item from the calculations, our tax rate would have been closer to 33%.

The impact of 41% is really because of that item that we did not tax benefit.

So again, the net income ex-restructuring, 17.4 million, about a $500,000 increase versus last year and again, we believe we had a $0.47 earnings per share from an operating standpoint ex-restructuring.

And just one note before we open up for questions -- our depreciation and amortization on a year-to-date basis is $34.4 million and our cap ex at $15.3 million.

And with that, we'd like to open it up to any questions you might have.

(Operator Instructions).

Our first question comes from the line of Kevin Maczka of BB&T Capital Markets.

Please proceed.

Hi, Pat, Bill.

Hi, Kevin.

Hello.

I guess my first question is on pricing.

You made some comments there that price erosion has not been a major issue so far.

It sounds like with raw materials ticking back up, you're looking to go back to the market for more price.

So I guess can you just comment with the top-line outlook you gave for Q4 and 2010, what kind of assumptions are you making there?

And what does the market look like?

Does it look to be receptive to price increases right now?

I'd say it's too early to tell with regard to receptivity.

We all are affected by the same raw material escalation that we anticipated coming.

We're seeing it already in terms of purchase orders that we're placing into the market.

With regard to what happened in the third quarter, we really saw pricing being relatively stable and even throughout the quarter, consistent with what we saw in the second quarter.

And we anticipate, to be honest with you, in the fourth quarter of 2009 for it to be consistent as well.

The other point I'd like to make there, Kevin, is that just reading the transcripts of some of the companies that have released, quite a few of them have mentioned price increases coming early in 2010 as well.

So we're not alone in this regard.

Okay.

And Bill, what's your view on the channel inventory now?

We went through such destocking for so many quarters and maybe we're ready to see some restocking now.

What's the channel look like?

Our belief is that the channels are pretty skinny at the moment.

Yes, we don't think that there's going to be any restocking here in the fourth quarter because people are going to play their cards pretty close to their chest with regard to balance sheets at December 31st.

Sure.

We see no restocking whatsoever in the fourth quarter.

Okay.

And then just quickly on the market share gains, you referenced that retail.

Can you put any numbers to that or more color, maybe who you're taking share from?

Well, we have the normal competitors out there, Kevin, that we always talk about, but these is some of the larger chains where we've picked up some additional shelf space.

Okay.

That's all I had.

Thank you.

Okay.

Thanks, Kevin.

Our next question comes from the line of Richard Paget of Morgan Joseph.

Please proceed.

Hey, guys.

Hi, Richard.

I just wondered if -- I mean, you already commented on your market share gains, but in terms of new products, can you give us a little bit more information on what you're rolling out now and what's selling on the retail side?

Well, one of the ones we had the most success with was a new dishwasher (inaudible) assembly that was sold into retail.

It was this quarter and it was well received.

That was one of the bigger impacts that we had in the quarter.

Okay.

Are you starting to see any of the energy-efficient type products start to pick up, given some of the initiatives to "greenify" buildings and save water and/or energy?

Not really.

I mean, we think it's a little bit too early for that.

You have to remember what drives that is a couple of things.

One is higher energy costs, which we really haven't hit those levels yet, and secondly, would be a much more vibrant construction market and we certainly don't have that at the moment.

And we do think that long-term in the US that that is a very good growth market for us, but in the current environment, we don't really [audio drop].

Okay.

So even with some of the tax incentives and some of the government mandates on the commercial side with some of the institutional buildings, that still hasn't really come into effect?

We see it here and there, like on some of the federal buildings and Army bases where they're rehabbing that and bringing things up to more current standards, [you can see it], but it's not enough to really move the needle in a meaningful way.

Okay.

And then on the charges, any way you could break that down between the operating segments?

Sure.

On a pretax basis, we booked 6.3 million of restructuring of which 5.2 was China, 400,000 was in Europe, 700,000 was in North America and then we took a $.5 million tax benefit at the corporate level for that.

And the discontinued operations charge was all in China.

Okay, great.

Thanks.

I'll get back in queue.

Okay.

Thank you.

Our next question comes from Mike Schneider of Robert W.

Baird.

Please proceed.

Good evening, guys.

Michael.

Maybe we can just talk about volume trends within the quarter.

I'm curious, we've heard a number of residential products companies state that their comparison is -- even in very difficult areas like pools have turned positive in the months of August and September.

Did you see a sequential strengthening or any change in trends by market?

Not really, Mike.

I mean, we normally have a stronger September than we do a July and August [audio drop] start of heating [audio drop] and also Europe is very, very quiet in August for us.

So our September was stronger than our July and August, but we just view that as normal trends, but I don't think we're at a point where we're really starting to see any meaningful pickup in residential.

Okay.

And then in Europe, I'm just curious if there was a distinction between the OEM performance and the wholesale performance in that market.

Yes, I can give you that figure.

The wholesale was down about 11%; the OEM was down about 26%.

And is OEM down that much simply against a tougher comparison to last year when some of the energy-efficiency products were selling [hot]?

That's right.

I mean, you have to remember in Q2, Q3 and to a certain extent, Q4, energy -- we had big energy quarters in Europe.

Yep.

And I think we also -- as we learned in Q1 of this year, there was a little bit of channel filling going on as well because there was so much excitement that they got -- some of the OEMs got a little bit ahead of themselves.

And are there any initiatives now proposed or pending that would drive similar type sales for solar products or furnace or heat-pump products, whatever they are?

One of the things that we're seeing which is a proposal, which we don't know if it's going to pass, but we're optimistic about it, is in Germany, they're looking at standards to be set around heat loss in a structure.

That would specifically address standards for pipes, windows and etc.

So if that were to pass, we would be the beneficiary of that and if it were to pass, we think that would probably spread to other European countries [audio drop].

That's one of the more interesting things that are being considered at the moment.

It's not passed yet.

Okay.

And then gross margins, it's seeming to me to be probably the single biggest swing factor to what you earn in 2010.

Can you give us a sense -- if you look at copper at $3 right now and some of the steel and components, where they are today, it strikes me though that you're still flat right now year-over-year, probably on an average basis, if you look at 2009 versus 2008.

So is it a case where you don't really see raw -- an average cost of raw materials rising in the P&L as we enter 2010?

If you were to look at the average for the year, that's probably -- I haven't done that analysis for the whole year.

We kind of focus on things more on a quarter-on-quarter trending, but it's not an unreasonable assumption.

Well, and the reason I ask is that -- if indeed we don't see an absolute increase in raw material costs in 2010 for you, gross margins, while there will be an adverse hit because of the lower commercial mix, you get the benefit of additional cost-saving actions and lean initiatives.

It strikes me that the 36 is sustainable in 2010, barring a significant change in volumes.

I think you should have a bias downward, Mike.

Really?

Yes.

Okay.

I think copper -- I think (inaudible) costs are a bigger factor than you (inaudible).

Okay.

And then I guess I'll ask the pricing question maybe a different way which is if you look at your, I guess, position today versus even two years ago when you were going out with price increases, is there something different competitively in any of your key markets or positions with the retailers or mix that would inhibit or constrain your ability to go out with price right now, other than just weak markets?

I'd say weak markets is the biggest concern.

It's more difficult to get a price increase to stick in a difficult market like we're in.

And final question on just the cash.

So you pay off the 50 million private placement.

What's the rate on that?

And then I guess do you start to consider buying back stock here, just given that it doesn't strike me (inaudible) multiples have come down all that much -- in fact, may have risen.

Just curious if you've kind of updated your priority list there for the use of cash.

The rate on that private placement is about 5% (inaudible) quarter of a point and we are back looking and talking to companies, but (inaudible) have very similar screening processes we've always had and the same disciplines.

Because we're talking to people doesn't mean we're going to rush in and do a deal.

I don't know if I'm answering your question or not, but we feel more comfortable that we won't have a big double-dip in the economy and that we'll be able to continue to generate reasonable cash flows, and that we still think we can have the science to do a deal.

Yes, I would say, Mike, that acquisitions are in our [DNA].

Right.

Okay.

Thank you.

I'll get back in line.

Thank you.

Our next question comes from Christopher Glynn of Oppenheimer.

Please proceed.

Thanks.

Getting back to some of the margin drivers, Pat, did you say that the under-absorbed overhead would become less of an issue in the fourth quarter?

To a certain extent.

We see margins -- what I said is I see margins being consistent in the fourth quarter with what we achieved in the third quarter, mostly because of the fact that we had previously been talking and thinking that we'd see higher raw materials hitting our P&L and hitting us during the fourth quarter.

And we now revised our forecast as to when they'll hit us.

They're going to hit us more in the first quarter than they would in the fourth, so that's the [key] driver.

Okay.

And where do you see your inventory position right now?

Comfortable with that?

Do you have a target?

We're on an effort to reduce inventories and improve customer service delivery as measured by on-time deliveries and fill rates, and we still think we have opportunities to squeeze additional unnecessary working capital off of our balance sheet.

Okay.

Is there a longer term turns target that you could articulate?

Well, Chris, if I just jump in here, I mean, right now, our turns are about 2.7 which is -- we consider that to be quite low.

And there's no reason we can't significantly improve that over a couple of year period.

That's part of the whole thinking behind lean and all the other things we're doing, sales and operational planning and moving our IT systems and so on.

Reduction of manufacture.

Yes, reduction of our manufacturing footprint is another big contributor to (inaudible) inventory reduction.

So we're far from satisfied with our inventory position, but it's a multi-year task to get it up to significantly higher turnover.

But we're thinking that inventory should be a source of cash for the foreseeable future.

Okay.

And then just lastly, on the kind of SG&A run rate that you've had this year been pretty consistent.

If we think about next year, it sounds like maybe some variable factors, different mix in markets, but how much of that is really the kind of unsustainable belt-tightening furloughs, etc., or what are we thinking trend-line for the SG&A dollar levels?

Well, if you look at our number in the quarter, barring any FX changes, just looking at organic changes, we're about $79 million and to me, that feels pretty reasonable.

I mean, I think we're in a very (inaudible) range that -- we're going to try to keep it in a very tight range around that number.

Understood.

Thank you.

Okay.

Our next question comes from Jeff Hammond of Keybank Capital Markets.

Please proceed.

Hi, good afternoon, guys.

Hi, Jeff.

I was just -- you talked about some of the individual restructuring programs.

I just wanted -- if you could kind of boil it down to what did you get this year for temporary cost savings?

What are you getting this year from restructuring savings?

And just based on what you've done, what's the incremental cost saves into 2010?

Well, remember now, this year, we did our [riff] and we already told everyone that that was just 10 million alone in the US.

We also have --

Is that savings this year?

Yes.

Okay.

We have several million dollars additional in Europe from the kind of reductions.

We have a couple million dollars in the US based on salary reductions.

We have things we've announced and we also have an ongoing program with our lean programs, if you will, where we're pushing all of our plant managers for productivity.

So we're looking for a couple of points net productivity as we move forward to come out of our cost of goods sold.

Now, that's not necessarily a promise, but that's the objective that we've set and we have programs in place and people in place, etc., to focus on that.

We also have, as Pat mentioned in his opening remarks, there's a couple of factory closures that we're going to see the benefit from next year which there's several million dollars there that will start to come through the P&L as well.

And we have some other programs, footprint issues that we're looking at that we haven't announced, but we won't really see a benefit of those in 2010, but (inaudible) probably will be work -- we will be working on those in 2010 to get a benefit in 2011.

So if you picked a facility closure in just this lean productivity, what do you think your all-in incremental cost saves in '10 would be?

Well, I haven't put pen to paper yet.

We're working on that right now with our 2010 plan, but just the plant closures is $3 million alone and a couple of points, advantage points, cost of goods sold is our objective.

Okay.

And then just looking at how your raw material costs would be coming through your P&L, when do you need to start capturing these price increases you're talking about?

Probably within the first quarter.

Okay.

And then finally, do you have an estimate for corporate expense for the fourth quarter and how should we think about that line item into '10?

Corporate expense in the fourth quarter, I don't see why it would be that much different than it is now.

We'll have a little bit, maybe $.5 million -- I think we said $700,000 (inaudible) SG&A expenses.

Other than that, it should be flat.

And then as you go into '10, the FCPA expenses should go away.

Okay.

So like a normal run rate would be kind of 7, 7.5 million a quarter?

7.5.

Okay.

Okay.

Thanks, guys.

Okay.

Thanks, Jeff.

Our next question comes from Scott Graham of Ladenberg Thalmann.

Please proceed.

Hey, good afternoon.

Good afternoon.

I really don't have too many questions.

They're really just some logistical stuff.

I was just wondering, do you think you can keep your capital expenditure level on a quarterly basis kind of where you're at right now, number one.

And number two is that there's a -- I know you guys typically carry a lot of cash on the books, so I guess in preparation for acquisitions and what-have-you, but are you close to the finish line on a couple of things than you were in the second quarter?

Are you closing in on anything, would you say?

We typically don't discuss that, where we are, because as soon as we discuss it, it spooks the story and we get a delay, but we have an active pipeline, although in this environment, it is more difficult to work through due diligence.

And there's always more contentious issues to negotiate through the negotiation process, but I would say that we sort of at this point in time have several active deals.

Whether they'll come to fruition or not is yet to be seen.

Are these normal Watts-size deals, the historical norm?

Are they below the norm or do you think that maybe there's a couple of opportunities above the norm?

They're pretty much down the strike zone.

Okay.

What you've seen us do in the past.

And the cap ex number, I know it's been pretty flat.

I mean, it's just -- you're driving tremendous free cash flow off of a very low cap ex number.

Do you guys keep that the same?

I assume you can with a lower facility count, right?

Probably figure 75% of depreciation and amortization.

Very good.

Thanks a lot.

Thank you.

Our next question comes from Todd Vencil of Davenport.

Please proceed.

Hi, guys.

Thanks for taking the questions.

Bill, what were the sales associated with discontinued operations in the quarter?

Sales on the disc ops?

Yes.

It would be about $3 million, Todd.

I don't have an exact figure, but that's a rough estimate.

Okay.

That's fine.

Alluding to a question that was asked earlier, have you guys seen -- with regard to M&A and multiples and seller expectations, have you guys actually seen a move up or a move in any direction that you would be able to sort of get the signal from the [noise] on?

We haven't closed any deals and finalized them, but we made offers that are lower in the range than we would have made a year ago or two years ago, but we're also seeing resistance from sellers in terms of accepting those offers.

Got it.

And any -- on any level -- I guess final question and a pretty broad question.

Are there any sort of regional differences in the US in terms of demand trends that you're seeing either on the resi side or the commercial side or anything at all?

Well, you can imagine that the big states like Florida and California, where the economy has hit them the hardest, are showing substantial more deterioration than some of the areas like New England.

Okay.

It's the kind of stuff you read everyday in the newspaper as to the markets that have been most hit by housing starts and housing pricing.

What's your outlook on how those states come back?

Do you think California and Florida lag the recovery?

I would anticipate they will, yes.

Okay.

All right.

Thanks a lot, guys.

Okay.

Our next question comes from Ryan Connors of Boenning & Scattergood.

Please proceed.

Afternoon.

Most of my detailed questions have kind of been answered, so I guess kind of a bigger picture issue, Pat and Bill.

There's a lot of talk about the cost-cutting into next year and the impact of that on the income statement, but from a longer term perspective, I wonder if you could talk about just where you are strategically in terms of restructuring and entering the next upturn on the top-line whenever that comes -- obviously, not necessarily next year, but do you view yourselves now as a leaner, more profitable entity into the next upturn?

If so, in what magnitude?

And really, I guess the core of the question is how much of the cost cuts are really permanent per se and how much of them will kind of come back, those costs, as the top-line recovers, whenever that is?

If you look at our numbers, our operating earnings, on a historical basis, you can pretty much figure we're in the sort of 10% range.

And when we come out of this, our objective is to come in more like a 12.5, a 13% or so from an operating earnings basis.

So we think that there are some of the cost reductions that are temporary and they'll be given back as the economy starts improving, but there's an awful lot of footprint and there's an awful lot of driving unnecessary costs out of the business and things of that nature that will be permanent.

Okay.

Well, that's great color.

Thanks, Pat.

Thanks for your time tonight.

Our next question comes from Jamie Sullivan of RBC Capital Markets.

Please proceed.

Hi, good evening.

Most of my questions have been answered.

I guess just a quick one on the tax rate, what we should be expecting going forward.

A normalized tax rate for us would be more in the 33 to 33.5 range.

Okay, great.

That's it for me.

Thank you.

Okay.

There are no -- oh, our final question comes from the line of Michael Coleman of Watts Water Technologies (sic).

Please proceed.

That's Sterne Agee.

Thanks.

Good afternoon.

How are you?

(Inaudible).

You mentioned previously just on the previous quarter, or the call, or question, 12.5, 13.5% operating margin.

What are you assuming in terms of an organic growth backdrop to hit that kind of margin?

We need to see some -- we don't have to get all the way back to where we were prior to the downturn, but we need to see positive growth, 5, 6% organic growth to start hitting those kind of numbers.

And we need to finish up some of the restructuring programs that we're in the middle of right now.

There are two major assumptions in that number, but that is -- as Pat said, that is our focus in -- if you look at all the things we've been doing over the past year or so where we've been trimming the portfolio, disposing of companies that aren't as profitable, who don't fit the core, trying to reduce the footprint so that we have a company that has a better mix in the portfolio, a better margin mix, and a company that has a lot more operating leverage.

That's what we're really focusing on, as we -- so when we come out of this thing, we're [leaner-meaner].

Okay.

Kind of looking at 2010, you gave kind of an outlook for commercial to be down 10 to 15% with greater weight toward the first half of the year.

Just so we're clear on this, is that your expectation -- that's not your expectation for Watts overall, is it?

No, because we gave you the other pieces as well.

Okay.

Okay.

What, in terms of an FX impact or -- what are you thinking just the components on an organic or FX in terms of 2010?

Foreign exchange basis?

Yes.

Well, I mean, it's difficult to forecast, Mike.

I mean, if you look at the Bureau -- let's see, the average rate for the year for us so far has been $1.36, okay?

And I know the Euro, I think yesterday, was about $1.50, $1.49, somewhere in that range.

I mean, the -- if the Euro stays where it is, it's very favorable to us in 2010, but we're not in the game of forecasting that right now.

Just tell you what it is today and what our -- favorable right now.

Okay.

Thank you.

It'll be favorable in the fourth quarter.

Yes.

Mr.

O'Keefe, there are no further questions.

I want to just thank everyone for joining us today.

I think this has been a good quarter for us and we're proud to have these kind of results and we look forward to talking to you at the fourth quarter conference call which will be held probably in early February.

Thank you, everyone.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.