Watts Water Technologies Inc (WTS) 2010 Q3 法說會逐字稿

Good afternoon, welcome to the Watts Water Technologies' third quarter 2010 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.

My name is Ken LePage, I'm the General Counsel of Watts Water Technologies.

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 10K for the year ended December 31, 2009 and other reports we file from time to time with the Securities and Exchange Commission, 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 other date.

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 a press release dated today's date and relating to our third quarter 2010 financial results.

A copy of which may be found in the investor relations section of our website at 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 your continuing interest in Watts Water Technologies.

I am joined today by Bill McCartney, our CFO, who will provide you with the financial highlights for the third quarter including individual sector results, after my comments.

First, let me give you a brief overview of the quarter.

I'd like to describe Q3 as a continuation of what has been a solid year-to-date performance by the company.

We have again been able to deliver double-digit operating earnings growth for the third quarter and for the first nine months of this year.

Sales grew organically for the third consecutive quarter.

In Q3, sales grew by 5%, and for every additional sales dollar generated this quarter over Q3 of last year, we delivered a 39% increase in organic operating profit.

On a year-to-date basis, we've delivered 47% in organic operating profit for each additional sales dollar.

We achieved these results primarily by maintaining our commitment to cost reduction and executing on various productivity initiatives.

We ended the quarter with $290 million in cash on our balance sheet, an increase of about $38 million from the June 2010 levels.

We continue to generate cash from operations but at lower levels than in 2009.

Although we added some inventory in the quarter to provide safety stock for various ongoing plant moves, operationally networking capital increased by only $1 million in Q3.

Our networking capital operating metrics are fairly stable and have improved on a net basis from the beginning of this year.

Our net debt to capital ratio at quarter-end is 8.7%, which we believe to be conservative, which is down from 9.9% at December 2009.

The US repair and remodeling market continues to show an upturn as we experienced growth in certain product lines which sell into this market.

As in Q2, we saw growth in the appliance area where our gas connectors and water fittings are used in oven and dishwater applications.

Existing home sales were up sequentially by 10% in September which should've helped our sales in this repair and remodeling sector.

The commercial market continues to struggle, although, during the quarter, we did see some growth in the product lines which sell substantially into this market segment.

As I discussed last quarter, there is a sense that the commercial sector has bottomed, but when this market will return to growth is up for debate.

The latest ABI, or architectural billing index, was above 50% for the first time since January 2008, so, hopefully, that's an indication that the commercial sector has begun to turn the corner.

We continue to believe we won't see any meaningful growth in the commercial marketplace until the tail end of 2011.

There continues to be a premium for fast delivery to gain and maintain market share.

We believe we are well-positioned with our inventories and other services to meet our customers' needs.

Our European performance was again solid during the quarter, excluding acquisitions in the foreign exchange effects, our OEM channel posted nice organic sales growth during the third quarter as compared to the third quarter of 2009.

We also saw growth but at lower rates in the hotel sector.

Our Blucher drain business had strong sales growth as did our German OEM and our French -based electronics business.

Our DIY sales underperformed to some degree, due to lower than expected restocking by customers after the summer holidays.

We also believe we have captured market share during the quarter with some of our alternative energy offerings, albeit in a down market.

As in the US, we see the renovation market improving and we see customers expecting short delivery lead times.

European order intake was steady during the quarter.

Regarding commodities, we continue to see a lot of variability in copper costs.

As compared to Q3 of last year, our US copper costs has increased by approximately 65%.

We also saw some higher costs in materials like stainless steel and other raw materials.

We believe we were again able to maintain equilibrium between our pricing to customers and the continually fluctuating costs of commodities.

In many instances, we offset the increased cost through production efficiencies and increased absorption.

Recall that we announced an increase in the US wholesale channel that was effective on March 1, and we have seen a portion of that price increase flow through and affect our Q3 results.

We also announced our retail channel price increase that became effective in mid-second quarter, whose effect on Q3 results was relatively minor.

Now, let me give you a brief update on our footprint consolidation effort.

The restructuring of our French operation, we believe, is ahead of plan.

We took some additional restructuring charges in Q3 for relocation and consulting costs related to this project.

At this point, we believe the project will be finalized in mid-2011, which is approximately four to six months sooner than originally anticipated.

We are not anticipating any pretax savings this year, but we estimate that we will save approximately $5 million annually, once this project is completed.

We will see the full savings materialize in 2012.

In September, we announced the closure of two manufacturing facilities in North Carolina.

Our latest incremental cost estimate is $6.9 million, which includes restructuring costs of $4.9 million.

Included in those restructuring costs are severance shutdown costs and equipment write-downs.

We also incurred -- we also think that training and preproduction setup costs of approximately $2 million are included in that $6.9 million cost estimate.

We also expect to spend about $1.2 million in capital.

During the third quarter, we recognized restructuring costs primarily for severance.

We expect a P&L savings of approximately $1.4 million annually, which should be fully realized during the second half of 2012.

We will continue to evaluate our existing global footprint to seek further operating efficiencies.

Now, I'd like to discuss our outlook.

We have recently seen a general softness in business, at least in the US.

From a micro --macro-perspective we think this is a result of the weighting effect of tax stimulus, i.e.

first-time home buyer credits, which we believe helped the market that we sell into during the first half of this year, and likely increase sales during the first half of 2010 to the detriment of the second half of this year.

Although -- another development in Q3 we observed was, which will likely continue to affect us for the remainder of 2010, is some destocking is occurring in our major retail customer accounts.

We believe our retail customers are now aligning their order levels with us to be more in-line with the customer point of sale purchases.

So, we have seen our daily order rates decrease.

Wholesalers are not destocking but are maintaining their inventories at low levels.

I think that so much macroeconomic uncertainty, i.e.

regarding unemployment, housing foreclosures, and the like will lead vote many wholesale customers to be cautious as they approach year-end.

Another point to keep in mind, which is specific to our business, is that we will have five fewer shipping days in Q4 of 2010 versus Q4 of last year.

Or compared sequentially with Q3, we will have four fewer shipping days.

So, we expect these comparisons to be relatively difficult.

Commodity prices have tended higher but we do hope to cover these increases with additional productivity and selective pricing increases.

Looking into 2011, we continue see the US commercial construction being challenged.

As mentioned earlier, the ABI index has been creeping up but it is a nine to 12 month predictor, so we don't see any near-term relief.

At best, the picture in the new home construction is muddled, as economists appear to be pushing back their expectations for a housing recovery.

There doesn't appear to be a lot of a lot of good news that is going to bolster this market in the near term.

On the positive side, as previously mentioned, our existing home sales were up 10% sequentially in September, and our recent LIRA report, which is the Leading Indicator of Remodeling Activity, is suggesting that pent-up demand will increase home improvements spending through the first half of 2011.

If correct, this would bode well for our repair and replacement business.

In Europe, we see the overall market up in the low single digits for the year.

Our concerns continues to be the financial malaise and its effect on the European economies.

This will likely result in the value of the euro could widely fluctuate, which could cause the volatility on our reported earnings and our reported results in 2011.

Lastly, let me address our acquisition program.

We were quiet on the acquisition front during the Q3, but we continue to review a number of acquisition candidates, and these candidates are in various stages of our review process.

We believe we are in an advantageous position, given our cash availability, to get a deal completed.

Now, I'll turn the call over to Bill McCartney, who will take you through the financial highlights and then we'll open the lines and let you ask any questions you may have.

Bill?

Okay, thank you, Pat.

Looking at the quarter, as we've mentioned, sales closed at $315 million.

That's an increase of about $11 million, or 4%.

The components of that increase would be an organic increase of $14.7 million, which is 5%; acquisitions of $6.4 million, which is 2%; and these gains were offset by unfavorable foreign exchange of $10 million, which is 3%; and it all nets to the $10.8 million, or 3.6%.

And, that's the consolidated numbers.

Looking at North America, sales closed at $192 million, increase of $9 million or 5%.

The components of the North American change would be organic increase of $7.6 million, or 4%, the acquisition of BRAE, which is about $0.5 million dollars, and then favorable foreign exchange in the North American market of $1 million, which is the Canadian dollar.

And, that totals $9 million, or 5%.

The average Canadian rate that we use in the Q3 2010 was about $0.96 versus $0.91 in Q3 2009.

On the wholesale side, sales at $150 million, which is an increase of $10 million, or 7% which is inside of those North American numbers that I just quoted.

And, again, as Pat mentioned earlier, some of the factors driving the increase in North America, some of our gas and water connectors had some strong results, as a result of increased appliance sales.

The discretionary repair and remodeling market has held up for us during the quarter, and I think we've done a good job on new product introductions.

We've introduced several new products during the course of the year.

We have our X65 modular water pressure regulator, a new line of trench drains, some expansion tanks, and expansion of our thermostatic regulating line and some expansion of our underfloor electric product tile warming line.

Of course, field inventories are about as low as they have been in our recent history, and we believe that a critical factor of our success in the wholesale is maintaining the strong fill and delivery rates which we have been doing for the last several quarters.

On the retail side in North America, sales closed out at $41 million, that's a decline of $2 million, or 5%.

And, again, as Pat mentioned earlier, that's primarily the result of inventory adjustments at the large home retailers.

There's too much of an inventory build in the first half, and, now, we're seeing some inventory destocking in the second half, as they even out their -- bring their inventories in line to their needs.

And, also, last year at this time we had a couple of rollouts which make the comparison a little bit more difficult, as well.

In Europe, we closed revenue at $118 million; it's an increase of $1 million, or about 1%.

The major components here, is we had an organic or an internal increase of $7 million, which is about 6%, the acquisition of Austroflex which we completed in June of this year that contributed $6 million, or 5% and Austroflex is slightly ahead of our plan for the first quarter being part of the family here.

So, we're pleased with that.

These gains were offset by some unfavorable foreign exchange of $11 million, or almost 10%.

So, the average rate we used for the euro in Q3 2010 was about $1.30 compared to last year, it was about $1.43.

So, that euro depreciated about 10% versus last year.

And, again, the environment in Europe is generally weak relative to new builds, but we did see some strong activity around the retrofitting on HVAC systems both from an under floor rating heating standpoint in some of our alternative and energy products as well as our energy conservation products, as well.

The Blucher acquisition is doing well, both in the marine industry, some of the Middle Eastern office that we've opened in sales into southern Europe, as we've leveraged the Watts distribution network for Blucher.

And, Europe is similar to the North American market where field inventories are quite tight and deliveries there are critical.

And we are doing a good job with fill and delivery rates there, so that's helping us quite a bit.

China, sales of $5 million, a slight increase versus last year, and that's just a little bit of extra sales into that Chinese domestic market.

Looking at the gross margin for the quarter, 36.2%, that's an increase of about 0.02 of a point versus Q3 last year.

What's driving that is we had an increase in the North American market of about 0.03 of a point, driven primarily by some of the volume increases which help the factory absorptions.

Last year, we were seeing an inventory decrease.

This year inventories are flat to up a little bit, so the absorption characteristics for our factories are improved and helping the margins.

We also had a bit of a mix towards the wholesale side which helps the North American margin.

In Europe, margins are up about one 1.5 points, at 35.5%, and that's primarily a result of a good product mix with heavier sales of Blucher in some of our insulated piping products.

On the SG&A, SG&A came in at $79 million, which is down 0.07 of a point as a percentage of sales, it's at 25.2%, that's an increase of about $0.5 million in total.

Looking at the components of the change, as we go from the last year's $78.8 million to this year's $79.3 million, we had an organic increase of $1.3 million, the impact of the foreign exchange rates decreased our SG&A by $2.4 million, and then the inclusion of the acquired companies of BRAE and Austroflex added $1.6 million, and that's -- that brings you to the $79.3 million of SG&A.

Coming down to operating earnings, at $31.5 million dollars, that's 10% of sales; however, if we look at the operating earnings excluding restructuring charges its $34.5 million, that's an increase of $4 million and that represents 11% of revenue.

As we look at the change from last year, operating earnings, last year, we had $30.6 million, we had an additional $5.7 million associated with the organic increases -- organic revenue increases in productivity, so the incremental margin, if you will, on the incremental revenues came in at 39% of revenue.

Then, we had an unfavorable foreign exchange which impacted us $1.2 million.

And, the acquisitions had a net loss in the quarter of $600,000 which brings us to the $34.5 million dollars, or 11% again ex-restructuring.

And, the reason for the loss on the acquisitions is just the purchase price accounting.

We're not expecting that to continue as we go forward.

We have -- in the first quarter or two, after an acquisition, you have to amortize customer lists and extra inventories, et cetera.

Looking at the tax rate of 33.8% in the quarter that's down from about 41% last year, and last year at this time, we had some losses on some equipment write-offs, that we could not tax benefit, so we had a higher tax rate, 33.8% is a little bit more representative of our anticipated rate as we go forward.

So, net income ex-restructuring 19.6% -- $19.6 million, 6.2% of revenue and that's an increase of almost 13% versus last year.

So, on a US GAAP-basis we had $0.46 from earnings-per-share, an increase of 48%, but, again, the number that we like to focus on is the earnings-per-share without the restructuring which is $0.52, about an 11% increase, and we believe that this quarter the $0.52 really is a good reflection of the run rate that we saw in the quarter.

And, just to walk you through the change of the $0.47 to the $0.52, last year we had $0.47 per share in the quarter, which is excluding restructuring and is just continuing operations.

So, as we go towards this year, then we had an unfavorable impact from the change in foreign exchange rates that's $0.03, the acquisition losses of $0.01, and then we had other income and expense increases which is primarily increase in interest expense associated with the additional debt that we took on, reduced earnings by $0.01.

So, now we have -- that takes you to $0.42, we actually earned $0.52, an increase of $0.10 and that is really the result of the improvement in the operations, both the increase in revenues in North America and Europe and the associated improvements in the gross margin in those two geographies.

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

(Operator Instructions) Our first question comes from the line of Michael Cox of Piper Jaffray.

Please proceed.

Thanks a lot and congrats on a nice quarter, guys.

My first question is on the top line, trying to embed the comments you're making around some of the softness your seeing, and then the fewer days, historically the fourth quarter has been a seasonally a little stronger than three Q.

Should we expect the quarter to be roughly flat sequentially, is that a fair assessment of the market you're seeing?

I'd say you should expect some softening, primarily for two reasons, one is because we see continued softening going into the fourth quarter from the retail accounts, and secondly because of the number of days.

Okay.

So, down sequentially is a better way to view it.

Okay, and then on some of the commodity price inflation you're seeing, should we expect a price increase in the first quarter of 2011 to offset that or will the efficiencies that you're getting fully absorb all of that?

We're expecting to have to affect the price increase early in the first quarter.

Okay, and then my last question, you had set a target earlier this year of a 12% operating margin, I believe as you're entering 2012, and is that still intact or are some of the macro issues you're seeing leading you to be a little more cautious on that objective.

I think we're still intact on that.

The issue that we're struggling with is the housing recovery and how long is it going to take before the market gets a lift, especially, on the new construction side.

Yes.

Michael, you also have to remember that we're still very dedicated to the whole concept of improving our lean manufacturing capability and we still have quite a bit of our restructuring program savings which will be coming in to the P&L, late 2011 and early 2012, so we're very focused on all that stuff, and hopefully by that time, by late '011, we'll get some help from the economy.

Okay, great.

Well, thanks a lot guys.

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

Please proceed.

Thank you.

Pat, I guess first, I'm wondering if you could say a little bit more, maybe quantify what you're seeing in the North American retail market with this new softness that you're seeing?

If you can just say a little bit more there please.

I think what we saw is that the US retailers were buying a little bit ahead of the actual sales out the door, so they were building inventories particularly during the second quarter and possibly into the third quarter, then they reversed themselves and they brought those inventories, those packing levels, down so they'd been doing these destockings throughout the third quarter and going into the fourth quarter.

So what it is, is balancing their sales to customers out the door against their purchase requirements and their inventory positions so they're bringing their inventories down.

I would expect the year-ends are generally January 31.

So I expect that they wouldn't try to take on a significant amount of inventory until early in the new year.

So you're seeing a change in their order patterns, and I thought you said that Q2 in Europe was fairly strong and still steady in Q3 is that right as it relates to Europe?

Are you talking about the retail?

I'm talking now about Europe in general.

Europe in general has been relatively strong.

We're seeing a little bit of softness in the retail sector but the other sectors have been okay.

Okay, so what I'm leading up to is how we should think about organic growth going forward.

I know you don't typically quantify any guidance there, but Europe's been leading the charge there to some extent, it sounds like that's holding up and maybe that continues to be positive over the next few quarters, but it sounds like you're suggesting that North America turns negative on an organic basis fairly quickly.

I would say you're probably right.

Yes, Kevin.

We think the environment in Europe is a little bit on the weak side relative to new builds but because of some of the programs we have there with Blucher and the alternative energy and so on we think we're outperforming the market in Europe.

Okay, so I think what you're suggesting is correct.

But we are concerned about the North American market with the continued softness on the housing and the commercial market is, we think, at the bottom but not turning up soon combined with the retailers adjusting some inventory levels.

And the wholesale is really unwilling to carry any extra inventory right now as well, so it's a very conservative atmosphere out in the field in the US market.

Got it.

Okay Bill, thank you.

Our next question comes from the line of Jeff Hammond of Keybanc Capital Markets.

Please proceed.

Hi.

Good afternoon, guys.

Could you give us the breakdown of the restructuring by segment.

How much was Europe, how much was North America?

In the quarter, we booked in North America, it was $2.1 million pretax and $1.7 million after-tax.

In Europe it was $900,000 pretax and $600,000 after-tax.

Okay.

Then just maybe to ask the Europe dynamic a little bit different.

Last year you had a big ramp 3Q to 4Q, and I just want to understand -- maybe remind me what that was, or why it would repeat not repeat.

Was it seasonal, was it a kind of a one-time bump and maybe that frames the fourth quarter this year.

I'm not recalling, Jeff, why we had a ramp up last year in the fourth quarter in Europe to be honest with you.

I don't recall anything that was unusual other than the economic recovery coming out of it a little bit maybe.

Okay.

Maybe I will follow up off-line there.

In terms of -- have you communicated any pricing actions to your customers?

If copper were to hold here, what kind of order of magnitude price increase needs to be early next year.

The team is working on that now, Jeff.

We have not communicated to customers as of yet but we're working the analysis.

With the magnitude of the cost increase we clearly cannot cover that with productivity improvements alone.

Okay and just finally, if I'm reading you right it sounds like commercial on the margin is about the same bottoming, but not better, not worse, res feels maybe a little bit weaker?

Is that fair?

Yes.

I think so.

Okay, thanks guys.

Our next question comes from the line of Todd Vencil, of Davenport, please proceed.

Hi guys, good afternoon.

Digging in on the North American remodeling a little bit, the repair and remodeling market, obviously it's clear that you are seeing some destocking, you've been pretty clear about that.

Can you tell -- can you read through the distributors and see what the end market demand looks like.

Has that fallen off a little bit or do you think because of existing home sales that's pretty stable?

Actually the remodeling market, the repair and remodeling market for the wholesale channel has been relatively strong.

Okay.

I'm sorry, I was thinking about the customer demand coming through the retail business.

In the retail its mostly a restocking.

Its destocking inventory levels down to where the sales are going out the door.

So, I guess where i'm going with that is, it sounds like you're saying that fourth-quarter, probably you're seeing a continuation of that trend to the end of the year, Bill, as you said not wanting to go into the end of the year with a lot of inventory.

Bus is the idea that, that could stabilize early next year.

That's a reasonable guess at this point

But I would say, we saw significant destocking in the retail channel during the third quarter and continuing into the fourth quarter how long that will last is anyone's guess.

Got it.

And we do expect the discretionary remodeling market is going to continue to be a good market for us for the foreseeable future, into 2011.

With people's inability to sell their homes, they're in their homes longer.

If you've been able to avoid the unemployment line, you're probably feeling a little more willing to spend some money and so on.

YOu know, we think that, that remodeling market stays pretty good through 2011.

Everything we hear right now.

Okay great.

Bill, on Cap Ex, what are you looking for, for this year?

Let me take a quick look.

I think -- So far this year, we have spent -- we have about $18 million we've spent so far, and I would say there's another $2 million in Q4.

So it's something like a $20 million number.

I would take up to about $21 million or $22 million.

And do you have any ideas about next year, is it going to step up materially?

We're going to budget somewhere around $30 million.

Okay.

And, just a couple of clean-up items really, the Austroflex revenue from acquisitions was a shade under $6 million in Europe in the quarter is that a good run rate for those guys?

Yes.

Okay.

And then final question, and this is -- if you don't have an idea on this, its no big deal but you just mentioned the impact of the day sales this fourth-quarter not insignificant sequentially.

Do you remember what it was last year?

Third quarter to fourth-quarter.

The number of days?

Yes Was last year unusually large in the fourth quarter?

No, let me see, I have it right here.

Lets see, Q4 last year we had 64 days, this year we have 59 day,s and last year in Q3 both this year and last year we had 63 days.

Got it.

Perfect.

Okay, thanks a lot.

Our next question comes from the line of Ryan Connors, of Janney Montgomery Scott.

Please proceed.

Good afternoon guys, thanks for taking the call.

I wanted to talk a little bit about your position in the value chain there and how that influences the impact of the fluctuating raw material costs.

I mean, specifically -- I know upstream you do have the foundry, is that supply a hundred percent of your production, in other words, are you buying, when we say copper are we talking about a hundred percent of that being raw copper or do you outsource any of that foundry work where presumably there might be an upstream supplier who absorbs some of the impact on that?

We outsource quite a bit of our foundry capabilities.

So we maintain -- we have one foundry that we continue to produce out of, but it's probably, Bill, I'd say, as low as 50% of our total requirements in the US.

That's right.

What we're buying too, is we're not buying pure copper, for the most part we're buying primarily bronze and brass.

And bronze is 81% copper and brass is 60% copper.

Right.

What I'm getting at I guess is that this theory, you're buying castings, so there might be some of that margin impact sometimes won't get absorbed upstream, obviously you've taken a piece of it as well but it's not a one-to-one.

That's correct.

And then, downstream, what percentage of your sales would you say go directly to an end consumer versus a BTB sale where you might have better ability to drive prices.

Is it just the DIY depot piece thats direct to consumer?

The rest of it goes -- about two thirds goes through wholesale, the other 1/3 is evenly split between OEM and DIY.

Okay.

And the DIY is the off the shelf piece.

Okay, that's helpful.

And then just a quick housekeeping, I apologize if you had mentioned it.

I might have missed it.

What's your view on the full year tax rate, Bill?

Just give one second and I can tell you.

Year-to-date we're at 32%, so I would use probably for the full year 32.5%

Super thanks again.

Our next question comes the line of David Rose of Wedbush Securities.

Please proceed.

Good afternoon.

I was hoping you could walk me through on a sequential basis, the change in SG&A, and what your expectations are for Q4 on SG&A, and then on the gross margin side, if you can walk me through as well, the expectations of when we start to see the increases in copper.

Obviously you have roughly five months of inventory, on inventory of copper or all your, your inventory is affected by the increases in copper, so I imagine we'll see more of that impact of the first quarter than we would in the fourth-quarter.

If that's fair?

If you can give some guidance whether we -- how much we see in the fourth and how much we see in the first.

Well, typically we will lag the spot market if you want to look at that as a trend by four to five months.

We don't necessarily go up at the same rate as copper because we're going out and doing spot buys with our vendors and making commitments and trying to manage it as effectively as we can.

So what we're buying in the third quarter will typically hit cost of goods during Q1.

And the price increases you expect to put in place at the beginning of Q1 or the end of Q1?

We recognize that when we're in the planning process, we're trying to lay out a price increase which will be effective early in the first quarter.

Okay, great, and then on the walk through on SG&A sequentially from Q3 to Q4?

You did a nice job year-over-year, but do we see this going forward in the fourth-quarter and how do we get there from the third quarter.

From the second quarter actually, sorry.

From the third quarter into the fourth quarter for SG&A that's the question?

Let me repeat that.

If you can walk me through the decline from Q2 to Q3 and then what our expectations are for Q4.

I don't have Q2 SG&A in front of me here.

So, you were at $84.8 million in SG&A for Q2.

Which is a substantial decline in Q3.

If you can walk me through in the same way you walked through year-over-year comparisons, acquisitions for ex and productivity improvements?

Well, I don't have that all detail in front of me to walk you through and give you a forecast on Q4 with the specific SG&A numbers.

We don't usually give that level of detail guidance on that type of thing.

Maybe could help me out, is there any -- are there any other anomalies or any reasons that we shouldn't expect the same sort of trends in -- or the same levels of SG&A in Q4 as we'd seen in Q3 barring for ex?

I would say I don't know of any reasons why there would be a significant change in direction right now.

Okay thank you.

Our next question comes from the line of Michael Gaugler of Brean Murray, Carret.

Please proceed.

Good afternoon, guys.

Again, congrats on a nice quarter.

I'll keep my questions short though.

I'd like to discuss the non- residential business a bit.

On those say $3 million to $15 million rehabs of the hotels, office buildings, et cetera I'm wondering what you're hearing and seeing in that particular end market?

In hospitality, I mean, I think hospitality has been one of our better discretionary modeling markets so far this year.

And, how about the office buildings?

I think the occupancy rates are holding that back.

Because the vacancy rates there are about 15% to 17%, I think on the office side.

All right, guys, that's all I have, my other questions were answered.

Ok, thanks Michael.

Our next question comes from the line of Wendy Caplan of SunTrust, please proceed.

Thank you.

Hello.

A couple things.

First, how much of the two price increases that you mentioned earlier in the year, how much of those stuck?

We have somewhere around 3% effective in the quarter.

Okay, and what kind of -- what is that relative to the price increase that you put to your customers?

We had --

Probably 4.5%

About 5%, but in that range.

Okay.

That's helpful, and you mentioned that during the third quarter you build some inventory in Europe as safety stock.

Do you have a sense -- usually that kind of inventory build helps the margin with absorption, do you have any sense of how much that added to the European margin?

It would have been slightly positive.

Maybe a couple tenths at the most.

Okay, thanks.

It's primarily held for restructuring programs.

Right, I understood that but sometimes when you build inventory that does help the absorption.

And can I I'm sorry I didn't get it if you said it, can you tell me why you lost money in China in the quarter?

We had a one-time charge that we took in China, was associated with a labor negotiation, so we took the charge.

It was a question around what type of benefits we want to be paying at one of our plants so we took the charge in the quarter.

Okay.

All right.

That's very helpful, thanks so much.

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

Please proceed.

Hi.

Good evening guys.

Just a question, Pat and Bill, on your overall manufacturing state of the world, at this point.

You talked a lot about lean.

You've done a lot of restructuring, how you'd characterize your processes today versus 12 to 18 months ago, and any sort of examples you might be able to provide to help us understand some of the progress you've made.

When you look at lean Six Sigma, we, like most people, view it as a continuous process.

I would say we're probably underway and getting good traction but we have a long way to go.

I would still call us relatively, we're first quartile, in terms of having identified and implemented improvements, so we have along way to go.

Okay great.

And then, I guess the incremental margins have been really strong, how sustainable do you think those are before you'd have to start making any significant investments in headcount or capacity or anything like that?

I believe those are -- those incremental margins if you will, are sustainable.

If we're to continue to be successful our productivity initiatives and close some of the factories that we've been talking about, that we have announced.

Those should be -- those sort of mid- 30% incremental margins are sustainable and hopefully we can improve upon that as we go into next year.

When we start to see some these factory closures completed.

Sure.

Okay.

Then on Blucher, the strength in the drain business, can you give us a little more detail on what's driving that?

A couple of things.

One is, we're leveraging some of the distribution capabilities of Watts, the existing Watts Europe where Blucher had strong market shares in northern Europe and we have distribution capability throughout all of Europe, so leveraging some of that.

We've also opened an office in the Middle East with Blucher, and the marine industry, which is about 20% of Blucher's revenue, has held up quite well.

Okay.

Thanks a lot that's all I had.

Our next question comes from the line of Brian Meyer of Robert W.

Baird.

Please proceed.

Hi, guys.

Nice quarter.

First off, wanted to talk a little bit about the material cost expectations for fourth-quarter relative to third-quarter, are you expecting any incremental step up there or is that more of a one Q event?

I think we'll have some headwinds from the cost of materials.

Because what we have is costs of materials continuing to climb without a commensurate price increase until early in the first quarter.

Got you.

Okay.

Then on the pricing side, you guys talked about putting a price increase in effect early in 2011 I guess, what's your thought on the likelihood of any pre-buying, particularly by the wholesalers in front of that price increase?

It would probably be -- to be honest with you, it will probably be all within 2011, you'll have the price increase and the pre-buy all in the period.

Okay, and then I guess one other one if I could.

When you look back at this quarter, the trend from 2Q to 3Q, would you characterize that as a normal, seasonal build, and then in addition to that what's -- if you look at the wholesale trends in particular, month by month in the quarter was there any noticeable variation?

Well, I'm going to say usually Q3 and Q2 are pretty close because you have the heating season in Q3 and you have irrigation and construction in Q2, but because of some of the destocking that we were talking about and the conservative attitude of some of the wholesalers we saw our decline from, in revenue from Q2 into three.

Got it.

That's all I needed thanks a lot, guys.

Our next question comes from the line Chris Wiggins of Oppenheimer.

Please proceed.

Hi, guys.

Just a couple of really quick ones, mostly clarification here.

One of the first questions you addressed, you'd mentioned that you expected revenues to decline sequentially in the fourth quarter.

I might've missed it but were you speaking about North America or was that total revenues?

Primarily North America.

Okay.

And then as far as corporate expense, any other additional expenses in the quarter, should we expect an increased bonus or any compensation expense to come through in the fourth quarter?

No, we accrued that Pro-RATA over the course of the year, so we're not expecting any significant adjustments because of something like that.

Okay.

And then the last one, if we look at the BREA acquisition and the Austroflex, the acquisitions kind of have some energy efficiency and kind of sustainability themes to it.

Is this the type of acquisition that we should expect you guys to be looking at more and more going forward and is there any color you could put around the size of the deals that you are looking at in the pipeline?

Are they similar to the Austroflex sides or any larger deals in there, or any color would help.

Let me first say that we're interested in looking at companies like BREA which has got an energy conservation, clean kind of image, so we are interested in those kind of deals.

Most of those deals though are smaller companies, so typically, for us the sweet spot is probably in the neighborhood of $75 million to $100 million in terms of a good-sized deal that comes with a good strong management team and a good strong position in its end market.

So we look at deals, I'd say with a sweet spot of $75 million to $100 million but we're probably looking at deals down to more like low side $30 million, high side probably $150 million to $200 million.

Okay great.

Thanks for your time.

(Operator Instructions) Our next question comes from the line of Garik Shmois of Longbow Research.

Please proceed.

Hi, thanks.

Just have a question, you mentioning that you're seeing some inventory destocking activity and on the other end just lack of initiative in buying here at the end of the year.

But can you talk about the competitive environment, if you're seeing some of your competitors maybe get aggressive here at the end of the year to try to take some share to generate some cash flow?

We've actually seen competitors get more aggressive here in the third and extending into the fourth quarter.

Probably because we're all scrapping for the same projects.

But you see it more in the project kind of work than you do on the day-to-day shelf goods, but we are seeing -- I think the competitive environment has increased over the last couple of years and it's pretty competitive at the moment.

Okay and you have seen it accelerate here over the last one to two quarters relative to what you've seen over the last several years?

Especially as the market starts to slow down.

Great, thank you very much.

That now concludes our question and answer session.

I would now like to turn the call back over to Pat O'Keefe.

I want to thank you for joining us today and we look forward to talking to you at the end of January or early February with the year-end results.

So thank you for your continued interest in Watts.

Good night.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.