Watts Water Technologies Inc (WTS) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2011 Watts Water Technologies earnings conference call.

My name is Cathy, and I'll be your operator for today.

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

Later we will conduct a question-and-answer session.

(Operator instructions) I would now like to turn the conference over to your host for today's call, to Mr.

Kenneth LePage, General Counsel.

Please proceed, sir.

Thank you.

Good afternoon and welcome to the Watts Water Technologies third quarter 2011 earnings conference call.

On the call with me today are David Coghlan, our President and Chief Executive Officer and Bill McCartney, our Chief Financial Officer.

Please be aware that 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 31st, 2010, 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.

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 2011 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'll now turn the presentation over to David and Bill.

Good afternoon, everyone.

And we're very pleased you could join our third quarter earnings call.

I'll begin by providing you our latest view on market conditions, then review Socla's performance in the quarter, before moving on to talk about our third quarter performance and to give you an update on some of the key initiatives we're driving.

I'll finish up by giving you a sense for our view for the remainder of 2011, at which point Bill McCartney will review our financial performance in more detail.

After Bill's discussion, I'll summarize and then we'll open up the call to your questions.

So, first, let me give you our view on the market environment.

From a macro perspective, we see little change in the near term and end in the medium term outlooks for our key end markets.

At best, everything we look at is cloudy with regards to when a US residential and commercial recovery will commence in earnest.

The latest estimates we look at don't see a recovery in either market until late 2012 or early 2013.

The US economy continues to bump along with expected GDP growth of 2.2% for 2012.

The residential new construction market in the US continues to be soft.

New homes starts did see a bit of an uptick in September to 658,000 units.

But expectations are that 2011 will likely be flat to slightly down versus 2010, at 585,000 starts.

On a positive note, McGraw Hill is projecting a 20% increase in residential construction units in 2012, to 705,000 units driven by construction of new apartment units.

But the other forecasters we look at are expecting growth to be much more muted.

And to put any growth in historical context, in 2007, approximately 1.4 million residential units were constructed.

So, we're still a far, far away from those numbers.

Existing home sales were 4.9 million units in September and have fluctuated around the 5 million unit range for some time now.

We continue to expect existing home sales to stay steady, as the cost to buy an existing home is lower than that to buy a newly constructed home.

So, this steady market for existing homes should underpin our stable repair replace upgrade business.

On the commercial side, the US commercial market continues its slow performance during the quarter.

The ABI index, which we see as a barometer of future commercial construction, has been in negative territory for 5 of the last 6 months, with the September index diving.

That supports our sense that the near term pickup in the commercial market spase is not likely.

In Europe, market dynamics continued their year-long trend.

Nordic and Central European countries such as Germany, continue modest growth with France and Italy and other Southern European countries soft or in recession.

Sovereign debt issues in Greece, Italy, and Spain certainly are affecting the business environment throughout Europe.

And so, as we've shared with you in the past, our internal plans assume we'll receive minimal assistance in the macro environment.

So, we continue to focus on the issues that we can successfully influence, like growing the business through new product introductions, through share gain, through geographic expansion and smart disciplined acquisitions.

We focus on optimizing our margins through price management and operational excellence, and we're working to strengthen the business through initiatives like proactive talent management, deploying shared service, implementing common standard systems and processes, et cetera.

We believe this approach allows us to drive operating earnings, cash flows and revenue growth, despite a difficult operating environment.

Now let me talk briefly about the Socla acquisition.

In the third quarter, Socla continued to perform ahead of our original expectations.

For the quarter, Socla delivered $0.06 on an adjusted basis, driven by sales volume.

Eastern European sales, particularly into Russia, were strong.

And margins were in line with our expectations on an adjusted basis.

Furthermore, in terms of our integration efforts, we've made substantial progress in combining duplicative sales offices and in rationalizing the Watts Socla product offerings.

We have also initiated the move of existing Watts production into a Socla facility to gain further operating efficiencies.

So, we continue to be pleased with Socla's contribution to date.

Now let me move on to talk about our third quarter performance and address some of our key initiatives.

In the third quarter, we were able to expand our adjusted operating margins by 110 basis points through improved price cost management and further progress on our Operational Excellence journey.

A significant challenge for our business has been volatile commodity costs, particularly copper.

Approximately 65% of our COGS is material driven, with copper our main raw material component.

The average spot price of copper has moved from $3.90 in Q4 of last year to $4.37 in Q1 and $4.07 in Q3.

These changes affect our business with 120-day lag, and so effective price management continues to be a priority for us, as it has been since commodity costs became so volatile.

If you recall, we instituted a late Second Quarter price increase mainly in the wholesale market for copper-containing products to cover rising copper costs.

We were able to realize a substantial portion of that price increase in the third quarter and coupled with fairly stable copper costs flowing through our P&L, we achieved margin expansion in North America.

Positive sales mix in North America also helped our margins as we sold more higher margin wholesale products.

In Europe, and in the North American retail market, covering costs was more challenging, as has been the case for most of 2011.

In Europe, we were not able to cover all of the increased commodity costs in many of our markets.

As we've noted previously, these markets tend to be fragmented and we face competition from family-run companies that price aggressively to maintain business and to maintain employment levels.

However as lower price copper starts to hit the P&L in Q4, the price cost gap in Europe should narrow.

Germany also continued to perform well for us in Europe, especially for products sold into the radiant heating marketplace.

And we see our European drains business, [Luker] continue the upward momentum that began in the second quarter, both in its traditional Nordic region as well as in the Middle East.

In the North American retail market, our push for price has led to many line reviews where customers put an entire product line out to bid in an effort to obtain a better price or forestall an increase.

We have made progress on price in our retail channel, but we still have more work to do in this regard.

One last point on North American retail, we are seeing some evidence of some minor destocking amongst our largest customers, and we'll be watching this very carefully.

Finally, we continue to see benefits coming through from various productivity and footprint consolidation programs as part of our Operational Excellent strategy.

This also helped to contain inflationary cost pressures.

Now I'd like to briefly discuss some of our key initiatives.

First, we successfully completed our previously announced share buyback of 1 million shares of Class A common stock during the third quarter.

We returned approximately $27 million to shareholders through this plan, which will offset the dilution of our various option programs through 2012.

We found the recent low price of our stock a very compelling reason to be in the market and buying shares.

Second, I'd like to briefly discuss the reduction in force which we previously announced in the quarter and which we undertook.

As a management team, we continually examine the various macro trends in the economy and the trends more relevant to our industry and we take action accordingly.

Our conclusion was that those trends were forecasting slow growth for the foreseeable future.

In that regard, we felt compelled to realign our cost structure to our volume levels in order to successfully compete in a slower growth environment.

The result of that decision was a $1.1 million restructuring charge, taken in the third quarter to cover termination costs, which we expect to deliver annual savings of over $5 million in North America, with potentially more initiatives to follow outside of North America.

We realize this action has a serious impact on the people and the families affected.

We regret that, but we believe it's necessary, given the near term business environment.

Thirdly, I'd like to update you on our footprint consolidation program.

Our French restructuring program is now complete, and the last of the temporary workers needed for the transition have left.

The consolidation of our Spindale, North Carolina, campus is also progressing smoothly with all product moves to our New Hampshire and Mexico facilities complete, and the final moves to our Kansas City facility slated for completion in the fourth quarter.

We have also announced product moves from our Ederbach, Netherlands facility to the main Socla facility in France, as well as the elimination of small operations in Almhult, Sweden and Mossano, Italy.

Finally, I'd like to discuss some recent key hires to our leadership team.

As part of our One Watts strategy, we're trying to build our talent base with people from premier companies with global experience.

We recently announced that B.K.

Bagepalli has joined us as President of North America.

B.K.

brings a wealth of experience from his tenure at both Danaher and GE.

In addition to B.K., we've hired a new leader for Asia, a new sourcing leader, a new wholesale channel leader in North America and a new Operational Excellence leader in Europe.

These leaders bring us experience from companies such as United Technologies, Pentair, Crane, and I.T.

T., and bring us knowledge and tool kits we believe will be very important as we continue on our journey of growth, Operational Excellence and One Watts.

Now let me move on to a brief overview of how we see the fourth quarter shaping up.

To set the stage, we should review what occurred in Q3.

First, we were able to realize much of the pricing that we had targeted in the North American wholesale market and that really drove our gross margins.

Secondly, we continued to push Operational Excellence and realized further cost savings through various programs.

Third, commodity costs running through our P&Ls were fairly stable, although not quite at the levels required to match the pricing levels achieved in Europe and the North American retail market.

Finally, we ran our plants with very few absorption issues.

Now, as we look at Q4, we expect our Operational Excellence programs to continue to help mitigate cost increases.

We also expect that we will have some absorption issues as we head in to the holidays, which may drive more costs through the P&L.

We expect Europe and retail price cost dynamics to improve somewhat as lower cost copper starts to show up in the P&L.

However, we are also concerned that we will face some downward pricing pressures due to the recent decline in copper costs.

We plan to address these pricing issues on a individual customer-by -customer basis, but we cannot predict competitive behavior.

And, finally, we have some concerns that the minor destocking which we recently saw in retail might extend to wholesale towards year end, and that the economic uncertainties in Europe could effect our sales run rates.

So, in summary, we think Q4's results could be marginally below Q3.

But we are concerned about the ability of any one of the issues I described to bite us on the ankles and undermine our ability to deliver at this kind of rate.

Let me turn it over to Bill now, who will provide you with more insight into our operating performance in Q3.

Okay, thank you, David.

Well, looking at the quarter, as you can see from the press release, revenue closed out at $371 million, that's an increase of 18%.

Components of that growth are as follows.

We had an organic increase of almost $9 million, which is about 3%.

The impact of the change in foreign exchange rates, primarily the euro, increased our revenue by $12 million or 4%.

And the inclusion of the revenue of Socla, which was $36 million or 11%.

So, that total change is $56 million or just shy of 18%.

When we look at our earnings per share in the quarter, from a US GAAP standpoint, we are reporting $0.63, which is an increase of 37%.

Included in that number is $0.03 of restructuring charges, so that's $0.66, excluding restructuring.

But the way we look at the business, again, is on an adjusted run rate basis which David referred to in his commentary, and on an ongoing basis that's a $0.69 number.

That includes $0.06 contribution from Socla, and that excludes the profit inventory and the backlog amortization associated with the purchase accounting adjustments that we have to record for Socla.

So, $0.69 is the run rate.

That $0.69 represents a 33% increase in earnings per share.

But if we look at the earnings without the contribution of Socla, just the core earnings of the Company, that's $0.63.

So, that's an increase of 21% versus last year's third quarter.

Just a commentary on the restructuring charges in the quarter we did book $1.9 million pretax, $1.2 million after tax.

$900 of that pretax number was North America and $1 million was in Europe.

Looking at the segments, North America revenue at almost $206 million, an increase of 7%.

The components of that revenue increase are a $9 million increase from an organic standpoint which is about 5%, predominantly driven by pricing.

A foreign exchange of $1 million, and then the inclusion of the North American business units of Socla, which is $3 million, so that's almost 2%.

So, a total increase of almost $14 million at 7%.

The wholesale at $167 million, that's an increase of 9%.

Again, without the inclusion of the acquisition, wholesale revenue increased 6%.

In the retail, it was essentially flat on the quarter.

Iif you look at some of the product lines where we saw some of the contribution, we saw some nice contributions from our plumbing and heating product lines, as well as some of our thermostatic relief valves and some of our industrial oriented products as well.

In Europe, $159 million of revenue, that's an increase of 35%.

Components of that growth, organically we were essentially flat.

The change in the foreign exchange rates on the EURO, that contributed $10 million or 9%.

The average EURO rate we used for our P&L in the quarter was $1.40, compared to $1.30 in last year's third quarter.

Then the European revenues of Socla included in the European figures is $31 million or 27%, so that totals $41 million or 35%.

As David mentioned, we look at the product lines inside of Europe, we did see some nice contributions, particularly in Germany from our under-floor rated heating product lines.

Lucher had a nice strong quarter, with expansion into the Middle East and some of the Nordic countries and we saw some nice activity on some of our insulated piping products as well.

We had some minor pricing in Europe and -- but not as much as the US and so therefore we did see across many of our product lines some minor decreases in unit volumes.

Just as a point of interest, when we look at our mix now in Europe, with Socla in there for a full quarter, the wholesale revenue represents 63%.

Our OEM business is 32% and our retail sales now are 3%.

That's the new ongoing mix in our European business.

Revenue in our China segment, $5.9 million, an increase of $900,000, and that's entirely due to the inclusion of the Socla revenues that we have in China.

Turning to the gross margin, on a consolidated basis the margin was 36.6% for the quarter, that's an increase of about 40 basis points.

The reasons, the main contributors to that, as David has mentioned in his comments, we had improved margins in our North American business.

We had a favorable mix towards wholesale, and we also had a favorable mix within wholesale towards our heating product lines and included in the plumbing and heating, as I mentioned earlier.

The team did a very good job in terms of managing the price increase and much more affectively covering the copper increases, particularly on the wholesale side.

We did see some progress on the gross margin relative to retail.

On a sequential basis, the margins are down a little bit, but on a comparable basis to last year the margins are about flat.

In Europe, the gross margin is up a little bit from Q2.

Again, we did see some productivity coming through in France and we saw a mix with Blucher and some of the piping products we mentioned.

But we're down from last year's third quarter, again because of the increase in the copper cost that we're seeing.

The SG&A at $92 million, an increase of 17%, and that represents 25% of revenue.

When we look at the components of the change from last year, last year's third quarter we had $79 million of SG&A.

We had an increase of $2 million from an organic standpoint.

Foreign exchange rates increased our SG&A by $3 million.

And the inclusion of the SG&A of Socla was $8.5 million.

So, that change from last year $79 million, that explains the change up to $93 million.

The operating earnings from a GAAP standpoint of $41 million, that's an increase of about 31%.

If we look at it on as adjusted basis, meaning we exclude the restructuring charges and we exclude the opening book amortization for Socla, we had $45 million of operating earnings.

That's, again, an increase also of 30%.

When we look to explain the change in the GAAP operating earnings of about $10 million from last year's Q3, from an organic standpoint, we had an increase of $5 million.

The foreign exchange contributed about $1 million, the acquisition of Socla about $2.5 million.

And then we had fuel restructuring charges in this year's Q3 versus last year of about $1.1 million.

And that's how we get to a change of about $10 million.

The important point here is that if you look at it from an organic standpoint, the $5 million of improved operating earnings, that shows that our leverage on incremental revenue came through at 51%.

As we know our target, as we've explained before is 35%, so we did a little bit better than we have in our goal and that we have historically.

Below the line other income and expense at $6 million, an increase of about $600,000.

That's primarily due to the interest expense associated with the acquisition of Socla.

A tax rate at 33%, decline of 80 basis points.

That's primarily due to the income mix in that we have profitable results in China with a lower tax rate, and so on a consolidated basis it dropped our rate by 80 basis points.

Net income on an adjusted basis of $26 million, that's an increase of 33%.

When we use the shares outstanding of 37,466, that gives our $0.69.

On an ongoing basis, our share count now is about 36,800,000.

So, with that I'll turn it back to David.

Then we'll have some questions after his closing comments.

Thank you, Bill.

So, let me try and summarize the quarter.

Overall we were pretty happy with the performance we delivered in Q3.

Particularly, given the challenging business environment we're operating in.

As we said earlier, our results were driven by price realization in North America and further progress on our Operational Excellence journey.

Socla also performed better than our original expectations.

Beyond that, we also strengthened our management team by adding some key bench strength and that will help us drive further improved performance throughout the organization.

Looking forward, we're going to have to continue to deal with volatile commodity costs, and we expect that price cost on AMEX will be a challenge in Q4, given recent lower copper costs.

But despite the difficult macro environment we find ourselves in, we believe we're well positioned to provide value to our shareholders.

The programs and strategies we've been discussing with you are resulting in improved levels of profitability.

As Bill mentioned earlier, in the third quarter we realized 53% operating margin, on each incremental organic sales dollar we generated.

We also generated $54 million of EBITDA which is a 27% improvement over the third quarter in 2010.

And a 46% improvement over the EBITDA run rate for the first half of 2011.

Based on our current EBITDA levels, we're trading at a 25% discount to the companies we track as peers.

So, as we continue to drive improvements in our business, and as we expect some assistance eventually from the economy, we think we're very well positioned to generate significant value for our shareholders.

At this time, we'd like to open up the line and field any questions you might have.

Cathy, would you mind opening the line for questions, please?

Thank you, sir.

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

Hi, thanks for taking the question.

Kevin Maczka.

I guess the first question, very impressive margins this quarter.

That is obvious.

When we were talking recently about possibly getting to 12% operating margins down the road as you continued lean and volumes normalize and organic growth returns, so it's kind of remarkable to see that here in Q3.

My question is, I'm not hearing you talk about much that wasn't sustainable there, maybe around the edges there may be some holiday absorption issues or perhaps slightly less favorable pricing.

But should we be thinking about 12% going forward as a new normal for Watts?

Well, that's certainly what we're working towards, Kevin.

The thing that we did want to point out, though, is that there's a lot of volatility uncertainty out there.

And so, we may have some bumps in the road.

But that is the number that we 're aiming towards working very hard to achieve and sustain.

You mentioned destocking at wholesale, in terms of signs of uncertainty.

Are you seeing that already, or is that just being cautious that given all the headlines that perhaps we may see that at some point?

We thought our retail customers were running about as lean as they could be.

We saw some evidence of minor restocking in the third quarter.

Now, most wholesalers' fiscal years end, it's a calendar year.

So, given what we saw in retail, we're nervous that with the year end, the fiscal year end coming up, some of our wholesale customers might push hard on the cash front, and that might have an impact on the inventory levels.

Okay.

Finally from me I just wanted to touch on pricing.

You mentioned, of course, the increases that were taken in the first half, you started to realize that in the third quarter.

Has that fully kind of worked its way through the system now, or is there still a price tailwind coming from actions you've already taken?

The way I would put it, Kevin, is that on the wholesale side in North America, it's fully worked its way through.

Obviously, with copper prices retreating, the question is, what's going to happen and that's based on competitive behavior.

We still have some work to do, though, in North American retail and in Europe.

Even though reducing copper prices will help mitigate the gap, we're still working to continue to make sure that we get to equilibrium.

So, the way I put it is that we've gotten to where we need to get to, we believe, on price and wholesale.

We still have a little bit of work to do in Europe in retail.

But copper pricing is both a good guy and a bad guy -- a good guy in that it helps relieve pressure on our retail business and European business.

Potentially a bad guy, in that it may have some repercussions on the downside, depending on competitive behavior in the wholesale channel.

Got it.

Thank you.

Thanks, Kevin.

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

Please proceed.

Good evening, Jamie.

Hi, Dave, hi, Bill.

On the reductions that you talked about in the $5 million in savings, is that kind of evenly spread throughout the year starting in the fourth quarter?

Yes.

Okay.

Thanks.

Then as volume comes back, will you need to add back some of that head count, or have you found a way to keep capacity levels the same without the need to add back?

We think we can maintain headcount levels.

If there's a significant jump in volume, we may need to put some extra heads in.

But it certainly will be at a much lower rate than volume increases.

Okay.

Great.

And then wondered if you could talk a little bit about -- I know you mentioned the dynamics in the residential market, apartment or multifamily versus single family.

Wondering what the content is for Watts and how meaningful those two segments of residential are in terms of what you sell into that construction.

It's still meaningful, Jamie.

I guess the way to think about it is, if you have a multifamily building with 30, 40 families in it, if they were in individual homes each home would have a water heater.

If they were in the northeast, most homes would have a boiler.

And since they're in a multifamily home, they going to have, most likely, one large water heater for the building and one large boiler.

And so we still have a lot of content, but I guess if you thought about it in terms of content per family, it's going be a bit lighter.

Okay.

Great.

Thanks a lot.

Thank you.

Thanks Jamie.

Cathy?

Yes.

Our next question comes from the line of Jeff Hammond of Key Corp.

Hello, Jeff.

Hi.

Good afternoon, guys.

Yes, so -- not to push too much on the margin here, but the trend did bend three quarters in the 9, 9.5, and you bumped to 12.

And it seems like the message is, there's certainly some head winds, but just help us get comfortable with maybe the move from 2Q to 3Q.

Is it mostly the price cost and then maybe secondarily some of these restructuring head winds going away?

I'm just trying to get more comfortable that closer to 12 is kind of the new trend versus reverting back to what the last few quarter trend had been.

Yes, I think, Jeff, the price cost issue, obviously, had a huge impact on our performance.

We've talked many times before that in the wholesale channel, we're pretty good at getting price but there tends to be a little bit of a lag.

The team did a great job of delivering the price we needed this quarter.

Your second point about, let me call them, some restructuring challenge challenges if you like.

Yes, we eliminated a number of those, and things went much more smoothly in the receiving facilities.

So, that was also very helpful.

We also made some progress on our Operational Excellence initiatives.

We were lucky in that our plans ran pretty close to optimal absorption levels.

So, it's combination of those factors.

And then obviously the next thing on your mind is, well, what's going to happen looking forward?

And, again, as we've tried to signal, we did a great job of driving price to cover copper that was coming through our P&L.

As copper retreats, we'll be watching very carefully to see what happens in the marketplace and we'll be responding very, very carefully.

Okay.

And the last time we saw copper bump into the 4s and then roll over, what was kind of the experience around being able to hold price and how did the competition act?

In North America there were some -- there was some spottiness in terms of competitors going after some volume.

But, we were able to act on a customer-by-customer basis.

Okay.

And then just final question, you did the buyback, is that something you're considering, just given some of the progress you're making, and how you feel about the valuation on the stock?

And maybe just talk about acquisition pipeline in terms of other uses of capital.

Right now, Jeff, we're not considering another buyback.

We did the million shares.

We intended that million years shares, last quarter in this call we explained it would take over a two-year period to use that.

We did change our mind in that the stock price dropped in August when we had the big market decline, so we took advantage of that decline to use to buy the million shares back.

Our philosophy is that we want to cover the creep with buyback programs, but we don't want to use all of our cash just to reduce our flow of capital structure.

So, of our use of cash, we still intend it to be used for acquisitions.

How is the pipeline?

The pipeline is good.

There continues to be a number of opportunities.

As you know, we are very disciplined in terms of our acquisitions.

And so we're looking very carefully, we're working through them very prudently.

But it's a healthy pipeline.

Okay.

Great, thanks, guys.

Thank you.

Our next question comes from the line of Garrett [Simose], of Longbow Research.

Hi, thank you.

Good afternoon.

My question is with respect to the destocking at wholesale that you're worried that could occur here in the fourth quarter and early 2012, perhaps.

Would you say that your concern goes beyond normal seasonality at this point?

Perhaps just a little bit.

We really believed that our customers were about as lean as they could be.

So, when we saw a little bit of destocking in retail, it made us worry that wholesale might go after some more destocking and that might be a negative.

So, it's a little bit beyond normal seasonality.

But, again, we haven't seen any strong evidence, so we're not pointing out a trend.

We're pointing out that it occurred in retail, and that we have a worry that it could occur in wholesale.

So, we're watching it very carefully day by day, and we'll respond as necessary.

Okay.

Was there any remarkable inventory management behavior at wholesale in the fourth quarter of last year?

For the last couple of years, our customers have been running very, very lean.

So, remarkable would suggest a major shift and since they're so lean, no, we didn't see anything remarkable.

Okay.

That's fair.

Just a question on Socla, it looks like it's gotten off to a stronger start than you had expected.

Looking at the accretion guidance for 2012, is there some potential upside to that, given the strength in the business here in the first several months that you've had it.

As you recall, we had our initial call with the acquisition of Socla.

We indicated that next year it would be accretive $0.15 to $0.18.

Right now we feel very comfortable saying that we will at least hit the upper end of that range.

There is some upside there, but we're not going out with a specific number at this time.

Okay.

Great.

Thank you very much.

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

Good afternoon, gentlemen.

Hi, Michael.

Hi, Michael.

Congrats on a nice quarter.

Thank you.

A couple of my question have already been answered.

But kind of a follow up, I think it was to Kevin's, looking at the cash flow you're going to throw off on a go-forward basis, if business conditions remain as healthy as they are now, would you be inclined to be paying down debt aggressively with some of that cash flow?

Well, I don't think we will do that, Mike, because if you look at the debt we have out there right now, we have a small amount -- about $40 million or so on our revolving line of credit, which we will pay down as the cash becomes available in Europe.

The rest of our debt is long-term private placements which have a pretax affective rate of about 5%, 3% after tax.

And those have prepayment penalties on them, so we're very inclined to leave that sit and use our cash again for -- to grow the business.

Okay.

And then just one other thing I noticed when going through the numbers.

Your corporate expenses, they've been trending lower for the last couple of quarters and I'm wondering, is 3Q sort of the new normal?

No.

I would say the new normal is still up around $8 million.

We did have a couple of favorable adjustments around some legal accruals and so on, in the third quarter.

That's why I was saying, that the $0.69 had one or two -- couple of pennies of that sort of adjustments in it that won't recur.

Understood.

All right, guys.

Thank you.

Thank you, Michael.

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

Hello.

Kind of had a bigger picture question for you, if you can bear with me a moment while I kind of frame it.

The way we're looking at Watts, here, is that the Company has done a great job on the cost side over the last -- over the course of the downturn.

And therefore the incremental margins on organic growth should be strong going forward.

And obviously the quarter here is a very encouraging data point in that regard.

But the key is, that we at least need to have some level of organic growth going forward in order to realize the incremental.

My question is, David, you talked about doing some of the things you can control.

You talk about share gain.

You talk about new product development.

If we make the assumption that the end markets do not come back in 2012, if even if we want to get bearish and say it's even longer than that before they come back, what kind of conviction level do you have that you can deliver some kind of volume growth on an organic basis using some of those things like share gain, new product development, et cetera?

If you could just walk us through a couple of examples there and talk about that, that would be helpful.

Well, firstly what I'll tell you is that as we plan for 2012, we're planning very low revenue growth, but that's to force us to work really hard on managing the cost side of our business so we can deliver good results without volume.

However, through our strategy deployment programs, we have several initiatives that we're working hard on to actually go beyond that on the revenue side.

Some examples would be, in the third quarter we completed the launch of a line of water quality products into the wholesale channel.

We have about a little under $100 million water quality business in North America, which is quite successful through traditional water quality dealers.

But we had never really leveraged that capability into our traditional plumbing wholesale channel.

We have done so, and that's quite a considerable market.

So, if we can penetrate and leverage the relationships we have with wholesalers, leverage the Watts brand name, there's an opportunity to deliver some nice growth.

Another example, sticking with that same business platform, is to take some of their products into Home Depot's home install business, where we've been doing a number of pilots and those pilots continue to expand.

Okay.

And a specific example, any update on the residential fire protection opportunity, how many states have come on board, and what the progress is there, and whether that could be a meaningful driver?

Yes, that's one actually where we were really excited about initially, and I guess our excitement has become a little bit muted.

What we're finding is that states are slowing down their efforts to turn this [cut off].

There still are some, but not at the pace at which we expected.

And when you combine that with the continued lack of recovery in residential new construction, we've taken our expectations in the near term for that product down.

So, we still think long-term it's going to be an attractive opportunity, but the regulations are just not being put in place at the pace at which we thought they would be.

Thanks for your time.

You're welcome.

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

Hello, good afternoon, gentlemen.

I had a couple of questions; most of them have been answered.

Maybe you can, if you could, clarify the SG&A run-rate comment.

Does it -- the SG&A start to look more somewhere in between Q2 and Q3?

How much of what we saw reduced is normalized?

And then I had a follow-up question on the Middle East.

Yes, the only -- the comment on the SG&A, David, was that the corporate expenses were lower than historical run rate this quarter.

And we're just saying that that is not a sustainable run rate.

And that we should expect to see that return in Q4 to historical levels of $8 million to $8.5 million.

That's what we would expect corporate SG&A to be.

It was about $6.5 million or so in Q3.

So then the SG&A number will look more like, somewhere around the 95 range?

Is that kind of a reasonable assumption?

Yes, I think.

Then, actually, a couple initiatives -- one being the Middle East and the second on the Home Depot front.

When we had talked at AWWA, you had mentioned, David, the opportunities in the new Middle East platform.

What we saw with Blucher sales there, is, can you quantify that and maybe provide some color on the ramp up in the Middle East?

Is that something that could be incremental in 2012, or is this simply kind of on the margin?

It could be incremental in 2012.

We really only started because of a whole bunch of issues -- getting licenses, being able to get in to occupy our offices, being able to actually invoice.

We got that office into business a little bit later than we wanted to in the third quarter.

And so, certainly it will contribute next year.

We are very early in the buildup.

So, I would suspect that the contribution from the Middle East early in the next year will be -- will be modest.

But we do believe that over time the Middle East market is an attractive one for us.

And as we bring all of our products together, and offer them both North American and European, and offer them through one single face to the customer, we believe there's substantial opportunity for us there.

Okay.

Great.

And then, lastly on the other initiatives that appear to be interesting within in the Home Depot front.

Last you had commented about a couple of the pilots.

How many stores are you in now with the pilot?

We're moving into approximately 400 stores, as I recall.

And the 400 stores starts when?

We're in the process of moving into them now.

Our first test was New Jersey.

We're now moving into Florida and California.

Okay.

So we should expect to have those 400 stores complete by year end, right?

Yes, and remember, this is not putting product on the shelf.

Home Depot has a home install business which has expanded its scope from initially sidings, windows, and is now getting into a much broader range of products.

So, as we do these pilots it's educating their sales teams to go to homeowners, talk to them about the product line and then move through the selling cycle and ship the product.

What sort of sales metrics do they look for to expand?

It's going to be things like sales dollars.

Margin dollars, those types of things.

Okay.

You can't comment on any particular hurdle rates that you've achieved?

We're in the pilot phase, David, so we're still learning as we go.

We're encouraged that we're into a significant number of stores, but we're very much in the pilot stage, so we don't have a long enough run rate to really form a strong view on metrics or hurdles.

Okay, perfect.

Well, thank you very much.

You're very welcome.

(Operator Instructions) Our next question comes from the line of Fritz von Carp of Sage Asset Management, please proceed.

Yes, I was wondering on the market conditions in Europe, how did those trend through the quarter?

Were they at the same level each of the 3 months or was there a pattern, a trend?

Typically Europe is difficult to track during the summer months because in July and August it's very quiet because the holidays.

And then in our business, September starts the heating season, and September is usually a strong month.

So, for us, Europe followed that historic pattern.

Okay.

So, it was about seasonal then?

Yes.

Thank you.

Our next question comes from the line of Jeremy Hellman of Divine Capital Markets.

Hi, guys.

Good afternoon.

One question -- I know it maybe seems doomsdayish, but given what's going on in Europe these days, are you guys taking any extraordinary steps around your currency exposure with the EURO?

For us, the exposure really is just a translation.

Inside of Europe we do not really have transactional exposure.

So, our philosophy at Watts is that we hedge transactional exposure.

We do not hedge the balance sheet other than just trying to match our debt with our cash flows, but we don't hedge translation gains and losses.

Okay.

And then another unrelated question, if I might.

Just kind of going back to a prior question, regarding where you might find pockets of relative growth, are you seeing anything tied to the broader -- the net zero building movement and kind of behind that, the pace loan program that has now kind of leapt over into the commercial side.

And it's got some heavy hitters behind it with Sir Richard Branson and Barclays and Lockheed.

Is that something that you think could have any marginal pickup for some of your product lines?

It certainly -- in our European business, energy efficiency continues to be a driver of the business.

Bill mentioned earlier that our under-floor heating business in Europe grew quite nicely, and that was largely driven by energy efficiency.

In North America, we're seeing some nice activity with our rainwater harvesting business with a lot of quoting activity and its driven by similar issues.

And, likewise, people are listening and looking hard at any offerings you've got which are energy efficient, as long as the payback is acceptable.

Okay.

Thanks.

With no further questions in the queue at this time, I would like to turn the conference back over to Mr.

David Coughlan for closing remarks.

Well, in closing, I'd just like to say that we're pleased with the quarter.

We continue to focus on trying to deliver good performance for our shareholders, irrespective of the economic conditions that are out there.

So, we look forward to hearing you -- or to seeing you on our next call in a couple of months' time.

Thanks for your interest in our Company and thanks for taking the time to join the call.

Ladies and gentlemen, that concludes today's conference.

Thank you for your presentation.

You may now disconnect and have a great day.