Watts Water Technologies Inc (WTS) 2014 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the third quarter 2014 Watts water technology earnings conference call.

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

(Operator Instructions)

Please be aware that remarks made during today's call about the Company's future expectations, plans, and prospects constitute forward looking statements under 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 the Company's annual report on form 10-K for the year ended, December 31, 2013 and other reports the company files from time to time with the securities and exchange commission.

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

While the company may elect to update these forward-looking statements, it disclaims any obligation to do so.

During this call the speakers 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 Tuesday, October 28, 2014, relating to the companies third-quarter 2014 financial results.

A copy of which may be found in the investor relations section of the company's website at www.wattswater.com under the heading, press releases.

And now I'd like to turn the call over to Tim MacPhee, vice president, investor relations and treasurer.

Please proceed, Sir.

Thank you, Adrian.

Good morning everyone, and thank you for joining our third-quarter earnings call.

Joining me today are Bob Pagano, our president and CEO; Ken Lepage, our general counselor; and Ken Korotkin, our corporate controller and chief accounting officer.

Bob will begin by providing some comments concerning third-quarter results.

Then he's going to update you on his assessment of the Americas.

Bob will also give your latest view on the market dynamics in each of our regions.

I will then our financial performance for the quarter in more detail, provide an update on our full-year sales outlook, Q4 forecast observations, and an update on our various European initiatives.

Bob will briefly summarize, and then we will open up the call to your questions.

With that, let me turn the call over to Bob.

Thanks, Tim, and good morning everyone.

Turning to slide 3, let me briefly provide an overview of the quarter.

We delivered solid operating profits, and our operating margins expanded nicely in both North America and EMEA in Q3 versus last year.

The Americas margin expansion was driven by incremental sales due to volume and cost controls in both manufacturing and operating costs.

We continued to execute on our various restructuring and transformation initiatives in EMEA, which helped to offset a broad sales reduction during the quarter.

Asia-Pacific operating profits were marginally lower and affected by lower affiliate sales, volume, and some charges during the quarter.

Overall, I was pleased with our operating profit performance.

Our bottom line and adjusted EPS were impacted in the quarter by higher FX costs and a higher effective tax rate.

Tim will provide more color on the financials in a few minutes.

We did see sequential sales slow during the quarter as compared to Q2 and consolidated organic growth year on year was nominal.

If you recall, during the second quarter earnings call, we mentioned that July orders in North America were basically flat, and EMEA orders in July were softer than previous years.

Certainly the general economic uncertainty in Europe, potential deflation, Eastern European unrest, and high unemployment is driving caution in our broad EMEA end markets.

In the Americas, we had hoped that the July order rate was an anomaly, as the month is usually a poor gauge for the quarter.

And we did have some pre-by sales in June, due to the wholesale price increase, which affected July orders as well.

But order rates remained sluggish throughout the quarter in North America, with the quarter up about 3%.

We exited September about 2.5% of ahead of last September.

Order rates in EMEA for the quarter were down about 6.5% and down about 4.5% exiting September.

Order rates in Asia Pacific remain solid for the quarter, up 14% compared to Q3 last year, although down about 9% from Q2 orders.

We exited September with order rates in Asia Pacific up a strong 27% compared to last year.

Sales in order comparisons to Q3 last year for North America were also tough, because in Q3 2013, we started loading in lead free into our wholesale channels, which, obviously, did not reoccur this year.

Finally, we experienced fairly stable performance from our lead free foundry during the quarter.

Cost inefficiencies declined.

Output and scrap issues were better than Q2 and a little better than we anticipated.

We are encouraged by the progress the team made during Q3.

Our current expectations are we will likely be running at the operating levels we exited in September.

Meaning some inefficiency will remain, and we expect to nominally improve our cost structure in the foundry as we move through the remainder of this year and through 2015.

Now, if you turn to slide 4, I'd like to provide you some feedback on my preliminary assessment of the Americas business and areas we'll be focused on going forward.

Some of the initiatives, as you will see, are also global in scope.

As we mentioned during the second quarter earnings call, I wanted to initiate an assessment of our Americas business platform in order to explore different commercial and operational improvements that could be made to drive both near-term and long-term shareholder value.

We began that review in September, and at this point, the data is still being analyzed and validated, and no firm decisions have been made.

The following items are some key takeaway's that we expect may result in future actions being undertaken in the Americas and globally.

We want to drive the front end of our business with the commercial excellence mindset.

By that, I mean we want to invest in product innovation that meets the wants and needs of our customers and our end markets.

From my discussions with customers, they want us to do more for them.

We don't want a lot of me-too products but, instead, want to focus on differentiated products that will provide greater opportunity for us to distinguish ourselves in the marketplace.

We want to initiate a portfolio rationalization effort as we've begun in Europe to identify products that are not value added by the markets and, in turn, don't add value to our operation margins.

We also want to educate our sales force and incentivize their efforts based on mantra of profitable growth as opposed to growth for growth's sake.

Next, we want to continue our operational excellence journey with both a global and regional focus on supply chain initiatives.

We want to implement global sourcing with goals of targeted savings and other key internal performance metrics like supplier rationalization.

We also want to clearly define and implement external supplier metrics for quality, on-time delivery lead times, inventory management, and cost savings.

Consistent with our efforts in Europe, we want to review the number of manufacturing facilities and distribution locations we currently employ in the Americas with the hope that we can consolidate manufacturing and eliminate some of the complexity in our network.

The goal will be a more efficient production and distribution operation, which will be more responsive to our customers needs.

We also want to ensure our lead free foundry continues to make progress in becoming a dependable lean-driven facility, which consistently drives for incremental productivity.

And we will continue to strive for incremental productivity through Lean and our other manufacturing operations as well.

We want to introduce to the Americas and to the entire organization the concept of a one Watts performance management system.

We need to build a performance culture to drive the transformation.

We will set aggressive plans that cascade across the organization and gauge our employees performance with tracking metrics and a robust review process.

Our teams should be held accountable to deliver consistent results.

We want to develop the talents and skills of our managers and our employees through ongoing training.

We should be striving to create a one-Watts concept by aligning our businesses globally around a common culture and common business vocabulary.

We need to review our IT systems, with a goal to standardize where possible in order to provide robust data analytics for decision-making.

We plan to implement a disciplined M&A approach that identifies only those targets that will pass our strategic criteria and provide a consistent integration approach for all acquisitions.

Finally, we want to focus our efforts in geographies that may offer the most attractive returns.

That means penetrating deeper into markets where we are already established and pinpointing some countries like the UK, Australia, Japan, Hong Kong, and Korea where we don't have a strong presence.

These countries are structurally attractive to us because they have established plumbing codes and require more advanced systems and solutions in the marketplace.

These broad initiatives will take time, investment, and talent and will likely be multi-year endeavors.

We expect that during the Q4 earnings call in February to be able to provide you an update on our road map to implement these actions.

Moving to the markets, let's turn to slide 5. First, let's talk about the Americas.

We continue to be encouraged by the general residential construction market.

Recent housing starts were positive, and mortgage borrowing rates have retreated recently to below 4%.

We see a broader positive sign in the general longer term outlook of the residential construction market, as the most recent Wells Fargo industry forecast expects housing starts to grow by 6.3% in 2014 and 13% next year.

Existing home sales in, 2014 are expected to be down about 4% and then rise by about 4% next year.

We are also encouraged that the NAHB Wells Fargo builder sentiment Index remains positive through September and that the LIRA index continues to project solid full-year growth in the remodeling market in 2014, with some moderation expected next year.

So we expect overall longer-term positive improvement in the US residential construction markets.

The commercial end market has become more of an enigma for us.

We have not yet seen a comprehensive broad-based pickup in our commercial end markets.

We have seen a couple of our Bellwether early cycle commercial application show solid growth.

Our customers are seeing quoting on commercial projects pick up as well.

But overall, our commercial business remains flat.

From a macro perspective, the Dodge Momentum Index trended down in Q3 after a strong first half.

The ABI index has been in mostly positive territory during the last 12 months, and commercial lending appears to be heading in a better direction.

So we are hopeful that a broader-based commercial construction uptick may occur in the near future, but now that seems more like a 2015 event.

Now let's turn our attention to the EMEA markets.

We believe overall markets in EMEA have taken a step backwards during the last three months.

We saw it in our sales and orders, and the macro data has not improved.

GDP is expected to still be positive in 2014 for the first time in three years.

But the growth has been reduced by a nominal 0.7%.

PMI has been consistently positive for the past 15 months, but it's trended down in September.

Unemployment is inching lower, although still at a high level.

As we mentioned last quarter, some of our customers were becoming cautious about the markets, and we saw that concern translate in our orders and sales for the quarter.

France's outlook was recently downgraded by S&P to negative, and we've seen articles that Italy may be experiencing deflation, and that the German engine may be sputtering.

We believe EMEA emerging markets will continue to be a good source of growth as infrastructure investment in the Middle East and Eastern Europe continue to grow.

However, near-term we are seeing some softness in Eastern Europe driven by political unrest, as is evident daily with headlines concerning Russia and the Ukraine.

The Middle East is project driven, so we are seeing lumpy growth, but we have seen a pickup in activity toward the end of the quarter.

Finally, let's discuss Asia-Pacific.

China reported GDP growth of 7.3% during the third quarter, as compared to the same period last year and down slightly from Q2.

However, government sanctions are having an effect on real estate, especially newly built homes with sales down 9% in August.

Projects are being delayed, and market prices actually declined in September by 1.1%, the first decline since December 2012.

The government recently stated they would start easing controls over real estate sales to encourage growth again.

Although down from Q2, our order intake was strong as we exited Q3 with good order bookings on valves and heating products.

Our market strategy has not changed.

We continue to see demand in China for our localized products but also for our more highly engineered European and US manufactured products.

Now I'll turn it over to Tim to talk about the results in more detail.

Tim?

Thanks, Bob.

Moving to the financial highlights of the quarter, I will be speaking to the information noted on slides 6 to 11.

First on slides 6 and 7, on a consolidated basis revenues for the third quarter increased 1.1% over the prior year.

Organic growth was 1.2%, with increases in the Americas and Asia-Pacific being substantially offset by a reduction in EMEA.

Foreign-exchange year on year was negligible.

Adjusted operating profit for the quarter was $43.8 million, a 25.5% increase over the same period a year ago.

As percentage of sales, I consolidated adjusted operating margins of 11.6% with 220 basis points higher compared to the prior year.

Now if you turn to slide 8, we've tried to normalize adjusted earnings quarter to quarter, by region, and in total.

Included in adjusted operating income in Q3 2013 were two significant adjustments, a product liability charge of $3.5 million and lead free cost of 2.5 million.

Further, approximately $2 million in rebate charges were excluded from last year's Q3 results and, subsequently, recognized in Q4 last year.

So adjusting 2013 for these three items, our normalized adjusted operating margin expanded by 110 ten basis points over Q3 last year from 10.5% to 11.6%.

The Americas and EMEA both expanded their margins and were offset partially by lower operating margins in Asia-Pacific and higher corporate cost.

Moving to slide 9. During the quarter, the Americas saw organic sales growth of 4.1%, primarily due to the year-over-year increase in the wholesale sale channel of 3.8%, with retail growing by 5.2%.

The wholesale increase was muted to some extent from a tough comp with Q3 last year when we were doing a number of load-ins with customers of lead free product.

And this year some sales were accelerated to Q2 in anticipation of the wholesale price increase that took effect in the second half of this year.

And as mentioned, sales we're impacted this year by about $2 million for rebates that were not adjusted for until fourth quarter last year.

Pricing was positive in the quarter in wholesale but offset with the retail channel.

Increased sales in our residential and commercial flow control products and water quality products were the primary driver for the growth.

The Americas adjusted operating margin of 14.6% in Q3 increased in absolute terms by 430 basis points.

Now referring back to slide 8, when excluding the items mentioned previously, the Americas adjusted margins expanded by 240 basis points.

The expansion was due to sales volume increase, better manufacturing performance, and other cost initiatives.

The Americas had a few one-off adjustments totaling approximately 80 basis points to 100 basis points in the quarter, which positively impacted the P&L.

These adjustments included reserve changes for incentives and bonuses and other subjective reserves, which we trued up in the quarter based on year-to-date performance.

On slide 10, EMEA for the quarter had an organic sales decline of 5.1%, driven by a German sales decline of almost 14%.

And our plumbing and HVAC sales in France were down approximately 6%.

Emerging-market sales were down overall by about 3% with a reduction in Eastern Europe, partially offset by an increase in the Middle East.

On the positive side, drain sales were up 3.3% during the quarter.

Despite the sales volume reduction, EMEA's adjusted operating margins expanded 40 basis points over last year to 11.9%.

EMEA continues to reap the benefits of its restructuring and cost containment efforts.

We will continue to drive our productivity efforts in EMEA through both the restructuring and transformation initiatives.

Now on slide 11, Asia Pacific's double-digit organic revenue growth continued in Q3, growing approximately 28% in the quarter over prior year.

The region benefited from continued strong order book, which was up 14% for the quarter and approximately 27% exiting September.

Adjusted operating margins were 15.5% versus 23.3% last year, the decrease due primarily due to lower inter-segment sales volume and charges in the quarter for bad debt and a stock compensation charge that is now allocated to Asia-Pacific from the corporate.

A few more items to finish the quarter, so back on slide 6 summary, the consolidated adjusted tax rate in Q3 of 34.2% was 350 basis points higher than the prior year.

The increase was primarily due to global earnings mix where more taxable profits were booked in North America this year.

And within North America, profits were more heavily weighted to the US than Canada, as compared to last year.

Adjusted EPS was 70% increased $0.12 or 21% versus the prior year.

Backing out the noise in Q3 for product liability, lead free costs, and rebates, Q3 adjusted EPS for 2013 would have been $0.64, equating to approximately 9.5% increase in adjusted EPS year over year.

Our operating drop-through in the quarter was solid.

EPS expansion was tempered due to higher below the line FX charges, primarily related to the Canadian dollar -- that's about $0.02 -- and the higher effective tax rate that I just discussed.

GAAP earnings in the quarter included approximately $1.1 million per cost in EMEA for the restructuring and transformation efforts.

And the tax line included $1.3 million in tax expense for ongoing audits of prior year's European tax returns.

We have treated both of these charges as special items in the quarter.

Moving to slide 12, primary working capital at September month end was flat with September 2013 and down into percent for sales.

Accounts receivable is down from better collection efforts, and our inventory levels have decreased nominally since last year.

We are continuing to focus on inventory reductions through the remainder of this year.

On slide 13, two items of note from cash flow perspective.

First, year-to-date free cash flow was $57.8 million, an increase of $11.3 million over last year, driven by higher profits and reduced capital spending.

We are striving to achieve a cash conversion rate to net income of 100% or more for the full year.

Secondly, we repurchased approximately $9.1 million of our stock in the open market during the third quarter, in line with their existing repurchase program.

Year to date, we've repurchased $29.1 million in stock.

The net effect of the current share buyback program was minimal during this quarter and year-to-date adjusted EPS by about a $0.01.

If we move to slide 14, I provide you an updated view of our revenue outlook by segment for the full year.

We have revised our full year expectations of growth in the Americas.

We are now projecting a full-year sales increase of 5% to 6%, reducing the bottom end of the range by 1% and the top end of the range by 2% from what we guided last quarter.

To guiding EMEA, we expect sales to be down between 2% and 3%, a refinement of our previous expectations of being down 1% to 2%.

We've added some downside to our previous expectations as we have seen our order rates decrease through Q3.

We do expect the Asia-Pacific team will continue to execute for the full year against our operating objectives and deliver a growth rate of approximately 20%, which is on the high-end of our previous range.

Let me give you some items to consider as you think about Q4 and the full-year forecast.

Please turn to slide 15.

We continue to drive our various cost initiatives and expect to realize those realizations to continue through Q4.

As Bob mentioned, our lead free foundry was fairly stable in Q3.

And we are not anticipating foundry inefficiencies to exceed those experiences past quarter.

But the foundry operation can be volatile quarter to quarter, so we are hopeful yet cautious on that outlook.

FX will be a headwind in Q4, assuming the euro continues to trade lower against the US dollar.

We think that could be approximately $0.02 in the quarter.

We expect corporate cost to increase sequentially from Q3, as the result of expected recruiting and salary costs to new hires and other costs like audit and [sots] that seasonally increase during the fourth quarter.

We had previously guided that our consolidated second half adjusted operating margins may expand by 90 basis points to 110 basis points over the second half adjusted operating margins from last year.

Given the stronger results in Q3, we may be at the top end of that range if not a little bit above.

One item I'd like to mention regarding 2015.

We've previously announced that we anticipate settling our pension liability.

Hopefully with the settlement occurring in the fourth quarter of 2015.

Since we have made that decision, for accounting purposes we need to take a more conservative position on the various actuarial assumptions we've used that determine our normal yearly pension expense.

Our actuaries have provided an estimate that the incremental charge may be approximately $3 million more than this year's pension charge.

So now let me just give you a brief update regarding our European initiatives.

Please turn to slide 16.

Regarding the transformation project, our 2014 full-year savings are pretty much in line with expectations, having increased slightly a savings related to sourcing and product rationalization that materialized quicker than we anticipated.

We have increased the expected operational savings for 2015 by $2 million to $12 million, which includes a larger tax benefit in 2015, where previously we had not expected a tax savings next year.

2014 ongoing costs are in line with our discussion from last quarter.

Expected 2015 nonrecurring costs and recurring costs are expected to increase by approximately $5.3 million and $1.3 million respectfully.

The increases are due to some actions being pushed from 2014 into 2015, some scope changes on certain projects, and a little more infrastructure spend.

So overall the program is moving ahead and more savings are being identified and realized faster than we originally anticipated.

So the restructuring program costs for 2014 and 2015 have been reduced by about $500,000 this year and $3.8 million next year.

Savings for 2014 are in line with previous estimates.

But total savings in 2015 have been reduced about $600,000 to $7.1 million.

Capital spending is expected to be on target for the projects with most spend occurring by year-end 2014.

You can see the detailed numbers in the appendix for both initiatives.

With that, I'll turn it back over to Bob.

Thanks, Tim.

So to summarize, we were able to deliver strong operating profits and enhanced operating margins during the third quarter, despite nominal sales growth.

We did this through increased sales volumes in the Americas, through more stable production in the foundry, and cost savings driven by the various initiatives and EMEA and general operating cost controls.

So with that, Adrian, can you open the lines for questions?

Thank you.

(Operator Instructions)

Please stand by for your first question, which comes from the line of Jeff Hammond of KeyBanc Capital Markets.

Please go ahead.

Hey, good morning, guys.

Hi, Jeff.

I wanted to focus on your Americas assessment -- a lot of good color there.

Just wondering: One, when do you expect to be able to quantify some of this opportunity?

I know the earlier discussion was to start quantifying some of the supply chain opportunities.

And then, if you look more broadly, maybe just size or the opportunity relative to what you've already announced and are doing in Europe?

Yes, so, Jeff, first of all, we're right in the middle of it.

And as you can imagine, we have a large infrastructure and capabilities inside the Americas.

And we're looking at each one of those items, the broad breadth of product lines, and we're analyzing our profitability by line, by product, by customer.

So, very deep analysis -- it's enlightening; we're not there yet.

But you can see some opportunities for us, as we talked about, and very similar to what we saw in our European product rationalization efforts.

So, the impact of that is not fully drawn.

All that combined, you have to take into consideration, because certainly if we're exiting a product line, it impacts our purchasing of components of that.

So, I don't want to double count, and we want to make sure we have all the numbers aligned properly.

So, that's why we're waiting to finalize the effort.

And we believe during the year-end call in February that we'll provide all the details.

Okay.

And then, just shifting gears to non-res -- it sounds like you're still seeing a mixed -- have you seen any kind of deterioration or slowdown from commercial?

Or is it just that the pick-up has been slower?

It's just been slower.

We're seeing our early indicators, like our drains are growing strong, which is usually an early indicator of that.

And as we've said before, we're seeing a strong -- you know, a lot of quotation activities.

We just need to see them in orders.

So, that's why we said it's been very strange for us.

We've expected a pick-up.

But the early signs are in there, and we're just being cautious and saying: You know what, we're not expecting any meaningful improvement till next year.

Where are you still seeing weakness within the commercial portfolio?

I just think it's on our base products.

We're just not seeing the growth.

They're basically flattish.

So, it's not broad -- it's actually broad-based inside all the product components.

Okay.

Thanks, guys.

Thank you.

Your next question comes from the line of Jim Giannakouros of Oppenheimer.

Please go ahead.

Good morning, Bob, Tim.

Good morning.

How you doing?

To tack on that, or ask it a little differently, as far as -- I know that you said the weakness is broad-based currently.

But is there anything in your product suite that you don't think is going to be able to leverage a resurgence in non-res in 2015?

I'm just trying to think about whether all the arrows pointing to non-res, growing 2015, if you're going to be a relative laggard?

Or how should I be thinking about your exposure specifically?

Well, we're usually a laggard when it starts coming up.

We usually are -- our drains business, because you need to put the drains in early on when the concrete -- when you're building it, and that's up.

So, that's usually our early indicator.

But the timing of when they input all the construction, and purchase our equipment, is in the later stages of that right now.

So, it's just how far along construction, how fast construction is going, is where we see it.

But the early indicators, which is our drains, is positive.

So, that's usually a good sign for us in the future.

Sure, agreed.

If I can ask something on the foundry, you said that the performance there is slightly better than expected.

Could you remind us how much product, as a percent of revenue, runs through that lead-free foundry?

And can you speak to, Tim, where you're at from a capacity utilization perspective?

And when you think you'll be running it at capacity?

I'll try to take some of that.

I'm not sure I have all the detailed answers there, but I would say that we're running you -- I would say about 60% capacity at this point in time; not where we want to be long term.

But the thing, as we said before, is we had to stabilize the process.

We really saw the best stabilization in the month of September, where we didn't see variation of production.

And you have to be very careful with the foundry.

As you ramp up, you've got to make sure all those variables stay in sync, and as you expand our capabilities there.

So, we're pleased that we've stabilized.

We started seeing improvement, and we expected to see improvement, and that's what we saw.

So, as we continue to ramp up as we move into next year -- we're just taking a cautious outlook on this, because we've been burnt before on the foundry.

We're not going to be burned again.

And we're just going to ramp it up slowly.

But in the long term, we believe having that foundry in North America is a competitive edge from a lead-time point of view.

And any disruption around the world, we'd have the capabilities to perform here.

Understood.

And one follow-up, if I may, on your order book in EMEA -- you said it was down 6.5%.

Is that organic?

Or does that include an FX hit as well?

The 6.5%, Jim, would be organic.

And within that, there's probably 1 percentage point there relating to the product rationalization effort that they're doing over there.

Okay, and anything that you can call out on that -- on the Germany sales being down 14%?

Is there anything one-time-ish there, or tough comps, or a specific product suite that -- ?

It's a couple of things.

It's some tough comps, if you recall.

We had a good Q3 in Germany last year because they had some huge floods at the end of the second quarter that really helped our Business in Q3, from a wholesale perspective.

So, that helped our Business.

And, quite honestly, this year, the OEMs have not been buying as much as we expected because of the weather.

They've had a mild fall in Germany and in parts of Europe.

Therefore, the OEM sales -- they just haven't been there yet.

So, we're hoping that's just a timing thing.

But that's kind of how it read out during the third quarter.

Got it, thanks for taking my questions.

Thanks.

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

Please go ahead.

Thanks, good morning.

Good morning, Kevin.

Bob -- well, I guess, first question: Your CFO left the Company about two weeks ago.

I'm a bit surprised that you didn't have any comment on that front on your prepared remarks.

Can you just address that situation?

Sure.

To reiterate a couple of key points made in our public disclosure, Dean's departure was not the result of any accounting or financial irregularities, or any internal control concerns.

Nor was it the result of a major disagreement with me about how we are shaping the future of the Business.

Dean was dismissed without cause due to a personnel matter, and I really can't elaborate beyond that.

Can you elaborate at all about how long you think the search will take for his replacement?

Yes, so, we're aggressively looking, at this point in time, recruiting is under way.

And we're going to replace that as soon as possible.

But I think, realistically, three to four months -- somewhere around that time frame.

Okay.

Shifting over to EMEA and piggy-backing on a prior question, with Germany down 14%, and with total orders down 6.5%, why shouldn't we think that that becomes the revenue run rate over the next few quarters, if that's a region, as a whole, that's been slowing?

Well, let me take that.

You know, as Tim just talked about some of the anomalies we had on a year-over-year basis, we looked at the October order rates, and they're up about 1%.

So, we're seeing a little comeback in October, which makes us feel cautiously optimistic.

But I think it is only fair, given what we've seen in EMEA, the year-to-date performance, and just the economic environment in Europe -- we all ought to be cautious, and that's what we're doing internally.

We're being cautious about growth.

We're focusing on our restructure efforts, and not assuming a lot of growth at all.

Okay.

And if I could just ask one on margins?

I'm interested in your comments on sustainability of these strong North American margins.

And just to be clear, in terms of the guidance, if you're calling out the high end of up 110 bps in the second half -- 110 compared to what?

Because the Q3 was up 220, but 110 excluding items.

Can you just clarify that?

Up 110 compared to what, in the fourth quarter?

It's the second half versus second half, Kevin.

So, last year, adjusted operating margin was 9.6%.

So, it's 110 additive to the 9.6%.

Okay, you're using 9.6% as your basis for the second half.

Second half versus second half.

But, again, if we were up 220, using that as a basis in Q3 -- if we are only up 110 for the entire second half, that's not suggesting much margin lift at all year over year in Q4.

Am I reading that right?

Q4 to Q4?

Yes.

I think one thing you have to keep in mind is: Q4 last year, we had some decent production, where we were still building a lot of lead-free product.

Where, this quarter, we're expecting to go down in terms of production.

We have a lot of inventory still as of the end of Q3.

And we're going to try to burn off some of that inventory.

What that means is we're not going to be producing as much.

So, we'll probably have some underabsorption in Q4 this year that we didn't have in Q4 last year.

As I mentioned, too, we expect some higher corporate costs in Q4, relatively speaking.

So, the combination of those may take the margins down just a tick.

Okay.

But, again, and I know you're not specifically guiding Q4, but we've got Q3 now, and you're giving a full-year guide.

But it sounds like, if we were up 220 in Q3, you're suggesting it'll be maybe down more than just a tick, maybe even closer to flat in Q4.

Again, am I off on that?

When you look at it -- the way I look at it right now is: When we look in Q3, when we look at the mix and the backlog and the European -- you saw the order softness in what we see flowing through into Q4.

We talked also about the 100 basis points of unusual stuff in Q3 related to some of the inputs inside of North America, and the incremental costs, including recruiting, which includes CFO costs, et cetera.

So, all of that inside of Q4 is built into that number that Tim just talked about.

Okay.

And then, again, I know you're not ready to guide 2015.

But this strong North American margin we just saw in Q3 -- when you get beyond some of the puts and takes we just talked about in Q4, does that become a new normal here in 2015?

At this point, we're not guiding our guidance right now because we're just starting to pull together our plans for next year.

I think Q3 was a nice, favorable mix inside of North America, and a lot of things went well.

Normally that doesn't happen for us, so it's an opportunity.

But again, we want to see more consistent results, as well as seeing it flow through to the bottom line.

So, we'll give you more guidance on margins in February, and we'll tie that together with some of the restructuring initiatives that we're going to talk about in the Americas.

I think we've got to look at that all collectively, together, as well as the performance in the foundry in the first half of this year versus next year.

All of that put together -- I think we've got a lot of math to do right now.

Okay, thank you.

Thank you.

Your next question comes from the line of Kevin Bennett from Sterne, Agee.

Please go ahead.

Hey, guys, good morning.

Good morning, Kevin.

Following up on the other Kevin's last questions, if we think about sustainability of margins in EMEA, can you guys just talk to that?

We had a best margin in a long time here, absent what happens with revenues.

How sustainable do you think this close-to-12% level is going forward?

We think, absent reduction in the top line, that we should be able to sustain the margins that we've been producing over the last couple of quarters.

Got you, okay.

And then, Tim, is there a way you can quantify the AsiaPac margins -- you know, 15.5% this quarter?

Is there a way you can quantify some of those one-time items?

We had a bad debt charge of about $400,000 in the quarter, which, obviously, was unexpected; it just happened.

And the stock comp cost -- it's about $200,000, $250,000 in the quarter.

We'll have the same effect in Q4.

Got you.

Okay, cool.

And then, Bob, thinking ahead to next year on the top line, I guess we all know currency's going to be a fairly significant headwind, at least in the first three quarters.

Is there anything else that we should be thinking about for next year, in terms of either tailwinds or headwinds?

Well, we're still putting together our plans for next year.

I guess a couple of items -- I think Tim talked about the pension headwind that we're seeing.

Some of the things -- we've got some lapping on bonuses.

We didn't perform to our expectations this year, year over year, and we haven't, actually, performed in the last several years.

So, as we look at truing up bonuses, and I'm making the assumption that we're going to perform next year and hit our plan, that's about a $4-million headwind, when we bring bonuses back up to 100% level.

And I guess, last, if I'm getting into this level of detail, I might as well get it out there.

Our incentive stock plan, as we move into next year, the difference between David's forfeiture of his incentive comp and my incentive comp from an options point of view is a $2-million headwind.

And then just our stock incentive by itself, based on the earnings, or our price of our stock has gone up, and that's another $2-million headwind.

So, we're working hard as an Organization to offset all these headwinds.

And certainly, some of the transformation items that we've talked about and our restructuring are looking to offset some of those headwinds.

Got you.

And I assume that $8 million you just talked about -- that's all going to be in the corporate line for next year?

Assuming you hit your plan?

When we hit our plan.

It's going to be corporate and some of the other North America businesses in particular.

Fair enough.

Kevin, just wanted to add to that, just from an EPS perspective.

You mentioned it a little bit, is that we do see the headwinds ahead of us regarding the euro versus the US dollar.

That could be anywhere -- based on current rates, that could be anywhere from $0.06 to $0.08 next year, a hit, if you compare that to 2014.

Got you.

Okay, thank you, guys.

Thank you.

The next question comes from the line of Joe Giordano of Cowen.

Please go ahead.

Hi, guys.

Thanks for taking my call.

I just wanted to get back quickly on the Americas margins, just make sure I'm looking at this correct.

So, I have in my notes that you guys were going to get savings in the quarter, incremental versus last year, around [$2.5 million] from lead free, [$3.5 million] from product liability, and then partially offset from about $2 million of incremental rebate charges this quarter, and about $1.5 million from foundry absorption issues, based on the commentary from last quarter.

Is that about right?

I think the $1.5 million is a little high.

It's more like $1 million, somewhere -- a little favorable --

Round numbers, those are right, Joe.

Okay, so, what would you attribute -- is the expansion in excess of those incremental savings, which are, call it, [$3.5 million] or maybe [$3 million] or something like that?

Is that all absorption and mix?

Because that's a pretty big number.

I just want to make sure I'm looking at that the right way.

In the quarter, right -- I think we said in the last call, we're expecting about a $2.5-million headwind in the second half of the year, based on our production capabilities.

Because when we started the year, we assumed a very optimized goal that unfortunately we weren't able to achieve, and we had some rocky starts.

We're starting to stabilize.

There's probably another headwind of about $1 million in the next quarter, that we're continuing.

That would tie basically to our $2.5-million guidance.

We're on target to what we plan to do and what we said we were going to do inside the foundry.

Really, the pick up, I think, Joe, with top-line growth, the foundry performing pretty well, and other cost savings initiatives -- remember, we had about $1 million savings this quarter versus Q3 last year relating to the --

Restructuring, yes.

And did you mention that there was 100 basis points in the quarter of one-off type stuff?

Was that 100 basis points of -- that boosted margins about 100 basis points?

Yes.

(multiple speakers) 100 basis points --

Inside the Americas.

Okay.

So, of non-recurring there, a little bit?

Right.

(multiple speakers)

Okay.

And then, I think someone asked earlier, I'm not sure if I caught the answer.

How big is the lead-free foundry as like a percent of America sales?

I would say about -- lead free?

That's probably, I don't know, 30%, 35%, somewhere around there.

Okay, perfect.

That does it for me, thanks, guys.

Thank you.

Sir, you have no more questions at this time.

I'd now like to turn the call over to Bob for closing remarks.

Thanks, Adrian.

In closing, I'd like to thank you for taking the time to join us today for our Q3 earnings call.

And we very much appreciate your continued interest in Watts Water.

We look forward to speaking with you again during our Q4 earnings call in February 2015.

Thank you very much.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a good day.