Good day, ladies and gentlemen, and welcome to the Q3 2012 Watts Water Technologies Earnings Conference Call. My name is Alex, and I will be your operator today. [Operator Instructions] Please be aware that the 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 in 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 annual report on Form 10-K for the year ending December 31, 2011, 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 on as representing our views in future dates. 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, the 30th of October 2012, related to the company's third quarter 2012 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. I would now like to turn the call over to Mr. David Coghlan, Chief Executive Officer. Go ahead, please, sir.

Good morning, everyone, and thanks for joining our third quarter earnings call. We appreciate your continued interest in Watts Water. And for those on the call who live or work in New York, New Jersey or other Mid-Atlantic states, our thoughts are with you and your families as you recover from Sandy. I'd like to begin by providing you a brief overview of the third quarter, then talk about market conditions in our key regions and give you a sense for where we see these markets going in the last quarter of 2012 and into next year. I'll then hand over to Bill McCartney, who will take you through our third quarter performance in more detail. And after Bill's discussion, I'll give you an update on our lead free initiatives, then summarize and open the call to your questions. So let me start with an overview of the quarter. We were pleased with the performance of the company in the third quarter. We were able to improve our operating results sequentially on top of a fairly solid second quarter result. And we saw organic sales growth in both Europe and Asia. As a result, we delivered adjusted earnings per share of $0.63 in Q3, compared to an adjusted earnings per share of $0.53 in Q2. Adjusted operating margins were up 1 percentage point sequentially from Q2 and 2.5 percentage points over Q1 of this year. This is consistent with the path forward we outlined earlier in the year. European sales in the quarter increased organically by about 3%, despite a challenging macroeconomic environment. If you recall, organic growth in Europe, in both Q1 and Q2, was soft, so we were quite pleased with EMEA's results in Q3. Much of the increase was related to stronger BLÜCHER drain sales, stronger sales…

Okay. Thank you, David. When we look at revenue for the quarter on a consolidated basis, we closed the quarter at $361 million. That represents a decline of almost $10 million or about 2.5% in the quarter. Looking at the components of that change, from an organic standpoint, we grew the business almost $6 million, slightly less than 2%. So that's a slight improvement over the trends we saw earlier in the year. However, the change in foreign exchange rates, primarily the euro, had an adverse impact on our revenue. So because of the FX rates, our revenue declined $18 million, almost 5%. And then the inclusion of the revenue of tekmar we acquired earlier this year increased our revenue by almost $3 million. So that all adds up to $9.6 million or a decline of 2.6% from -- again, driven by the FX rates primarily. The bottom line from a GAAP standpoint, our EPS is $0.53. However, when we look at our as adjusted numbers, we're reporting $0.63 for the quarter. That compares to $0.69 last year, so we're down $0.06. However, just as a reminder when you look at last year's third quarter, that was the strongest quarter that we've seen in the company's history, so it is a difficult comparison. And the way we discussed our performance, that we will be monitoring ourselves on a sequential basis this year and we have seen continued sequential improvement from Q1, Q2 and again, into Q3. The acquisition of tekmar contributed $0.01 to our earnings in the quarter. Just looking at some of the special and restructuring items that we used to include or calculated our as adjusted numbers. Some of the folks out there I know are interested in those numbers on a segment basis. North America, we had…

Bill, thanks very much. We though it worthwhile to spend a few minutes giving you our thoughts and expectations regarding a major shift in the plumbing industry, which is our biggest business, that being the required conversion to lead free alloys for all pipes, fittings and valves used in potable or drinking water applications. This shift is in response to the Reduction of Lead in Drinking Water Act, which will become effective in January 2014, and that law requires that the wetted surfaces of all potable water products installed after January 1, 2014, have no more than 0.25% weighted average lead content. And that's down from the current 8% limit. The January 2014 date is a hard stop, meaning the law does not allow for the sale or installation of leaded products for potable applications after that date by manufacturers, by retailers or wholesalers and by contractors. This change applies nationwide, although as many of you know, similar changes have already occurred in a small number of states, including California, Vermont and Louisiana. Our overall strategy regarding the transition to lead free is twofold. First, we believe we can use this change as a way to differentiate ourselves from other competitors who may not have the financial wherewithal or the technical and/or operational resources to successfully manage the change. We believe we have the capabilities and the resources to revamp our products, our supply chain and our manufacturing processes. And to also assist our customers to transition their businesses in a timely and effective manner. We are also working proactively with the EPA and with local authorities to ensure that the new standards are clear and that they're properly enforced to ensure that all industry participants have to meet the more stringent requirements and thereby, minimize the risks to our…

Thank you, David, I appreciate that. It's been a pleasure.

Secondly, I'd like to introduce you to Dean Freeman, who will take over as CFO on November 12, once the Q is filed. Dean has a great background and will help us a lot to move forward on our journey. We recently issued a press release giving more of Dean's background, and I'd urge you to look at that to see the pedigree that we're bringing on board. So Dean, welcome to the team.

Thank you, thrilled to be here.

So with that, why don't we open the line up to your questions. Alex, can you open the line please?

[Operator Instructions] The first question comes from the line of Garik Shmois and he's calling from Longbow Research.

I guess, my first question is on the corporate expense line. It was about $2.9 million lower in the quarter. Just wondering if you could provide a little bit more color on that, and how we should expect that to be modeled going forward.

Well, some of the things that we'd talked about on some of the earlier calls, some of the cost containment programs that we were initiating earlier in the year have come through. So we made some changes on some of our freight programs. We've continued some of our consolidation programs. In other words, we have more shared service centers, particularly, around some of our advertising and marketing areas. And now some of those savings was slightly offset by some of the investments we're making in Europe around IT. We're in the beginning of the ERP deployment in Europe. So we're making some investments there. And the other issue, you have to remember, Garik, is that earlier in the year, we did take an unusually large charge -- a true-up, if you will, from an actuarial standpoint on our product liability accrual. So that was, we believe, a onetime charge or an unusual charge. So it's -- there are some moving pieces there but we are focused on keeping that SG&A growth in check as we go forward.

Okay, thanks. And then, in the past 2 quarters you were able to quantify how much extra costs were associated with the conversion of your plans to lead free. Can you provide how much of a cost headwind it was in the third quarter and, maybe, how much is left in the 2012 program? It sounds like you're mostly done with the process, but any numbers around that would be helpful.

In the quarter, we're probably looking at rounding it probably $1 million. And looking forward, our PPAPs are essentially done, we've only a handful left so it will be insignificant in the fourth quarter.

Okay. And then, I guess just on lead free. Can you provide, maybe, a little bit more color on your mix of sales in the quarter in North America? If you're seeing any meaningful shifts into lead-free here initially in the market? Or are you anticipating, obviously, a much more sizable jump in 2013? I guess the question is, how much of your sales in the third quarter was the new lead-free product offering?

The way to think about it is that our customers are going to be cautious about shifting too far in advance because of the extra cost involved in lead-free products. And so we would say that approximately 10% of our plumbing products are currently lead-free, and that's driven by the individual states who preceded the national law, states like California, Vermont, Maryland, Louisiana. We don't anticipate that the vast bulk of our customers will start to shift before the middle part of next year.

Okay. And you're out in front with the lead-free conversion this year. Have you seen your competitors start to convert themselves? Or are they still lagging behind with the expectations of 2013 effect for them?

Well, firstly, I think the issue was much more visible for us because the Plumbing part of our business is much more significant than it is for some of the other publicly quoted companies in our space. And secondly, all of our competitors are actively working on this issue, at least, the reputable quality competitors. And we think they're going to be ready as well. The ones that we're, perhaps, a little bit more concerned about are some of the moms-and-pops, and some of the imported products from developing countries, where they may not be as sophisticated or as familiar with what the changes imply. And that's why we are focused so much on EPA, in terms of ensuring there's a level playing field through appropriate certification and testing.

Okay. And then my last question. Your measuring this year on sequential improvement. Just wondering if you could provide your view on margins in the fourth quarter relative to the third quarter? Obviously, you've made some nice progression here, sequentially, on margin. Should we anticipate that the fourth quarter margin, despite historically, I believe, being somewhat of a weaker quarter, could you see margin expansion sequentially in Q4?

Yes. I mean, obviously, we're going to remain focused on all these items. Okay? In both on a lead-free conversion, improving our noncommodity inflation on some of our material costs and so on. But there is -- so we would expect to see continued improvement there, but I want to caution you that we do have normal seasonality in our business, and fourth quarter tends to be the quietest quarter relative to revenue and so on, because once -- both the Europe and the U.S., once you get in, you're sort of tailing off heating season as you get into, sort of, early December, then you have the holidays. So it is a quiet quarter. So I just caution you, we are going to focus on all these continued improvements, but we do have some seasonality.

The next question comes from the line of Kevin Maczka. He's calling from BB&T Capital Markets.

First, on Europe. An interesting reversal there with better organic growth this time in Europe and in North America. It sounds like, maybe, with France for the first time is starting to slow a little bit, that European pace may not be entirely sustainable. But how much of the Middle East is driving that? And can you cite the Middle East portion? Because it would seem that maybe that is a more sustainable growth market right now.

Well, if you are to rank order where our growth in the third quarter came from, the first source of growth is an improvement in the win-loss rate at our BLÜCHER business. And so we would look at that business as taking share within the space it occupies, and that team is doing a great job on managing their quoting book. And secondly, we've done very well in our Heating business, which is largely based in Germany. And that business focuses on the larger Heating OEMs, and the boiler sets and underfloor heating systems that they make. And there, I think, the industry that we serve -- the customers we serve are taking share from other customers that, perhaps, we don't serve. So it's the large German OEMs who are taking share. And we've done a very good job of working with their engineering groups to, if you like, build us in to their new systems and next-generation systems. And so we've looked at that and say it's a share gain. Outside of that, the next areas would be Eastern Europe and lastly, the Middle East. And so at this point, Eastern Europe and the Middle East are a relatively smaller part of the business, but we are seeing some nice double-digit growth in those regions. And so to put it in context, the Middle East is not the primary driver. Although you are right, looking forward, it does offer some stability as does a large part of Eastern Europe.

Got it. Shifting over to the lead free, a question there. Is it fair to characterize this that this has been such a big disruption for your business in terms of preparing for this that maybe some of your teams that would have otherwise been focused on other costs or continuous improvement type of initiatives have had to be dedicated solely towards this lead-free initiative, and now that that's winding down, and when we're getting closer next year actually to launch, that maybe those folks can go back and kind of reemphasize some of the other cost initiatives? Is that a fair way to characterize that?

I think that is a fair way to characterize it, Kevin. When we talked about our Q1 underperformance, we'd -- not only did we talk about the cost of doing the PPAPs, which is running lead-free products through our manufacturing plants to check that we can manufacture them appropriately, but we also talked about the opportunity cost, which was involved by our continuous improvement teams focusing on the issue. And just to give you a simple example, for all of our suppliers, we are going in and doing detailed supplier audits to make sure that their manufacturing processes enable us to be confident to meet the requirements of lead free. And so that's time that our sourcing folks are spending doing supplier audits that they're not spending on driving sourcing productivity. So yes, as we get through that, and as we tidy up and enable our supply chain and our plants, then, we'd be able to swing back and focus on continuous improvement.

Got it. And just finally for me, to follow up on that. So going back to Bill's comment about the difficult comp and the 12% margin from a year ago, I think everyone is interested in when we may be able to see us trend back toward that level. And I guess, can you just revisit your long-term margin goals and plans with us, in terms of when we get beyond lead free. Maybe there are some lift there if you maintain those gross margins and then you continue to do the other continuous improvement initiatives you're doing. Is it reasonable to think we'll see that again in '13 or '14?

Look, we've articulated a margin goal of 12%, which we believe is achievable if we can continue to drive the, sort of, continuous improvement that we've been driving; if we continue on the path towards footprint and consolidation; and if we get some volume growth from a sustained recovery in new construction. And again, people who've modeled that out have sort of said, "Well, is that a very long pause? And is there opportunity beyond that?" And what we've traditionally said is, "Look, let us get to the 12% first, and then, we'll think about the next pause."

And Kevin, you have to remember that as we grow, and what we have seen is that organic growth comes through like 35% or so to the bottom line. So as we see some of the markets return and we focus on some of these other initiatives, the prospects are, I think, are very bright as we see that operating leverage that we've created come through.

Our next question comes from Brett Linzey from KeyBanc Capital Markets.

As you think about some of the structural challenges within the European marketplace and expectations for '13 to be, kind of, tepid activity, I mean, how do you feel about the current cost structure there, the ability to navigate some of the markets and, really, just your assessment of cost levers in a more muted growth scenario heading into next year?

Well, first of all, just to talk about the market environment. The analogy we try to use with people is to remind them that before new construction in Europe has slowed down in 2007, 2008, we might have been standing on the fifth or sixth step of the stepladder. And since then, we've been standing on the first or second step i.e., our repair/replace/upgrade business has carried us through. And so we are concerned about muted economic expectations going into 2013, particularly, with respect to France and Germany. But new construction across Europe has been soft for the last number of years anyway. As we look at our cost structure in Europe, we've continued to work that cost structure over the last several years. And so it is better than it was before this decline. We've talked about the fact that we've closed 14 to 15 rooftops over the last 4 years. A number of those had happened in Europe, and we're continuing to work on fine-tuning our footprint in Europe to make sure it's properly positioned going forward. Secondly, we've been driving productivity initiatives both Lean and Six Sigma throughout all of our facilities and we've also been ramping up our capabilities in the strategic sourcing arena. And last, but not least, the SG&A management in Europe has been very good, they've managed that very tightly and we'll continue to do so. So as Europe tightens, our focus will be on maintaining our margins and adjusting appropriately.

Okay, great. And then, I guess, just in terms of expectations for '13 on the top line. I mean, you guys gave some pretty good color just in terms of underlying growth. Could you just talk about your ability to outgrow, whether it's share gains, new products, et cetera? I know you gave a couple of examples within the German business. I mean, how should we think about that trending into next year as well?

Well, we think that in 2013, despite a lot of choppiness in some markets with Southern Europe, particularly, Italy, hurting us earlier in the year, we think if we step back and look at the market positioning, that: a, we've taken selective share; and b, we've been able to get some price realization to try to recover some of the commodity costs that hit us earlier. And so we're going to continue to focus on our strategy. We see areas where there's further opportunity for selective share gain and we also see opportunity for further growth in developing markets, including Eastern Europe and the Middle East. But that's on the plus side. The question is what's the degree of the negative? What's the degree of contraction in Germany and France, and how might that affect us? So when you put the 2 together it's, sort of, tough to look through that fog and see how it will net out.

The next question comes from Jim Foung from Gabelli & Company.

David, a just a few questions here. First, I guess, earlier you talked about new residential construction being a smaller part of your business than in the past and I'm just wondering if you could just, kind of, give us a breakout between what your exposure is to residential versus commercial constructions for both new and repair and renovation?

Well, what we've always said -- first of all, at this stage, roughly 50% of our businesses is U.S. and 50% is non-U.S. And then if you look within the U.S., what we've -- how we've classically described our business over the course of a cycle is 50% residential, 50% commercial. And then on the other side of a 2 by 2 matrix, 50% new construction and 50% repair/replace/upgrade. But if you look at the decline in the new construction markets over the last 4 to 5 years, it's tough to identify a backflow that's going into new construction versus repair/replace/upgrade, and so this is rough math. But our sense is that, probably, between 70%, 80%, 75%, 85% of our residential business is repair/replace/upgrade today.

Okay. It's a big number, then. That's like, gives you really solid support going forward.

a, I think what it does is it sort of underlines the strength of our repair/replace business; but b, it does also point to the fact that if we can get a couple of years of strong residential new construction under our belts, there's growth potential there.

Right, terrific. And then, just regarding the lead-free products. Will you be able to quantify, kind of, your market share gains from that line of Plumbing products in 2014 and beyond as you kind of convert earlier than your competitors or from mom and pops?

Well, it's very difficult to project how the share gain will play out. What we're trying to do, I think, now is by working with the EPA and with some other reputable manufacturers in the industry. We're trying to set the table, if you like, for ensuring a level playing field. And we think, by doing that, it will weed out some marginal players who struggle to make the transition and how that might play out in market share between the less sophisticated and the sophisticated players in the industry, and then amongst the sophisticated players in the industry, tough to figure that out.

Okay. And then, I guess, how big is your Plumbing products today? Because that's where the...

Well, we have -- what we're trying to say now to folks who were working the models for next year is that there's $300 million of our U.S. revenues, which are affected by this change.

The next question comes from Jamie Sullivan from RBC Capital Markets.

Just a few on the lead free and the outlook there. Do you have a sense of how much of the market is the higher quality players, like Watts, and how much is the smaller mom and pops?

You get into the whole issue about market versus served market et cetera. So if we look at it from our perspective, we would say that the -- in the served market in the plumbing industry, the market segments that we're playing in and that other reputable companies are playing in, we'd say that somewhere in the region of 80%-or-so of those market segments might be served by the top 10 or 15 players, who you could put into reputable.

Sure. Okay, that's helpful. And then, of those, I'm assuming those are many other players in the consortium you talked about in educating the customer base. Does it seem that their plans are similar to yours in terms of timing and pricing of the cutover at this point?

Well, very difficult to understand what others are going to do on areas like pricing. But in terms of changeover times, I think all good companies are going to get out and listen to their customers. And our sense is that the DIY customers will try to shift a little earlier and that the wholesale market will shift in the second quarter. And it seems to me that a lot of the sophisticated players are seeing that and are targeting some of their time frames.

Okay, great. And then, in terms of how the smaller players or less reputable players adjusted to the changes in California, Louisiana, Vermont, those areas, what did you observe when that change was made?

Well, one of the things that we've been talking to our customers about is that the California version of the EPA, about 6 months after the change, went out and did some random sampling of products from the shelf. And it was one basket of products from reputable companies, the more sophisticated players in the industry, and from that basket of goods, there was one product that didn't meet lead-free specification. So the vast majority of those products met the criteria. From the other basket, less sophisticated manufacturers, imported products, private label products, there was a 50% failure rate. And so our point is that if you impose a law, you need to enforce the law. And so if there's a solid certification and testing process, we believe that it will separate, if you like, the men from the boys. And the argument we are making with our customers is, who do you want to partner with: the sophisticated manufacturers, of which there are many a number; or the ones who are going to create risks for you?

[Operator Instructions] Our next question comes from the line of Stewart Scharf, he's calling from S&P Capital IQ.

Can you talk a little about the M&A market? And specifically, Socla, how that deal is working out, especially in light of softness in France. And you had projected about $0.18 of accretion for this year and ROI of 12% by the third year after the deal, and can you just expand on that a little bit?

Yes. Well, you're absolutely right. We talked about a range for our first year out with Socla of $0.13 to $0.18 accretion, and we overdelivered on a high end there in the first 12 months. And as we look out beyond the first year, we feel very happy with that acquisition. We think it's a great addition to portfolio and we think the integration is going well and the synergies are coming along very nicely, both at the front end of the business, as well as on the operational side. In terms of the outlook with respect to France, obviously, we're watching the market situation in France very carefully. And we are looking at our cost structures in case we have to make any changes there. But we still think that this is a good acquisition and that we'll be able to deliver on the sort of the targets that we outlined. In terms of the M&A pipeline in general, I think a lot of people will tell you that given the economic outlook in Europe, as well as fiscal cliff, changes in taxation, et cetera, that's coming down on the pike in North America, that it's a little bit more uncertain in terms of buyers and sellers out there at the moment. And we're certainly seeing that. There's a pipeline of opportunities that we've been working and looking at, but we remain conservative in terms of what we're prepared to pay and we want to make sure that we do the right deal for the future. And so that tends to take the hit rate down a little bit.

Okay. And would you say the deals are still in the 9x EBITDA range, or are they going up?

Well, I think what you're looking at is perhaps a larger spread between ask and bid than you might have seen some time ago given the sort of uncertainties that are out there at the moment.

Okay. And regarding lead free again, you said that the cost could be about 20% higher. Are you planning or you think you might be able to pass that along to customers?

Depending on the product. We put a range out of between 10% and 20%, depending on the amount of metal content in the product. And our objective is to maintain our gross margin percentage, so we'll be working very hard to do that.

We have no further questions in the queue. I would now like to hand the call back to David for closing remarks.

Okay. Well, first of all, thanks to everybody who joined us. We know, particularly, for those in the Mid-Atlantic states, there's an awful lot of things going on at the moment. Technology is not back up the where it needs to be and so we really -- there's a lot of delayed calls, so we really appreciate you taking the time to join us. And as always, we appreciate your interest in our company. We'd like to wish all of you and your families the best for the forthcoming holiday season. And we look forward to speaking with you again on our fourth quarter earnings call in February. So thanks very much, everybody. Bye-bye.

Thank you for joining today's conference. This concludes the presentation. You may now disconnect, and have a great day.