Timothy M. MacPhee - Vice President of Investor Relations and Treasurer Robert J. Pagano - Chief Executive Officer, President, Chief Financial Officer and Director.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division James Giannakouros - Oppenheimer & Co. Inc., Research Division Kevin R. Maczka - BB&T Capital Markets, Research Division Kevin C. Bennett - Sterne Agee & Leach Inc., Research Division Joseph Giordano - Cowen and Company, LLC, Research Division.

Good day, ladies and gentlemen, and welcome to the Third Quarter 2014 Watts Water Technologies 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 company's 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 would like to turn the call over to Tim MacPhee, Vice President of 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 Counsel; and Ken Korotkin, our Corporate Controller and Chief Accounting Officer. Bob will begin by providing some comments concerning the third quarter results.

Then he's going to update you on his assessment of the Americas. Bob will also give you our latest view on our market dynamics in each of our regions. I will then review 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. Now 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 continue 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 year. 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 prebuy 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% 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 remains 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 and 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 and efficiencies declined, output and scrap issues were better than Q2 and a little better than we anticipated. We were encouraged by the progress the team made during Q3.

Our current expectations are we likely will 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 takeaways 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 a 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 operating margins. We also want to educate our sales force and incentivize their efforts based on the mantra of profitable growth as opposed to growth for growth's sake.

Next, we want to continue our operational excellence journey with both the 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'll set aggressive plans that cascade across the organization, engage our employees' performance with tracking metrics and a robust review process. Our teams should be held accountable to look 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 allowing our -- aligning our businesses globally around a common culture and common business vocabulary. And 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 U.K., Australia, Japan, Hong Kong and Korea, where we don't have a strong presence.

These countries are structurally attracted 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 multiyear endeavors.

We expect that during the Q4 earnings call in February, to be able to provide you an update on our roadmap to implement these actions. Moving to the market, 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 U.S. 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, and 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 3 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 3 years, but the growth has been reduced by a nominal 0.7%.

PMI has been consistently positive for the past 15 months, but has 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 U.S. manufacture products.

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

Tim?.

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 3 items, our normalized adjusted operating margin expanded by 110 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 costs. 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 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 in Q2 in anticipation of the wholesale price increase that took effect in the second half of this year. And as mentioned, sales were impacted this year by about $2 million for rebates that were not adjusted for until the 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 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 plumbing and HVAC sales in France were down approximately 6%. Emerging market sales were down overall by about 3%, with the 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 the 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 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 to lower intersegment sales volume and charges in the quarter for bad debt and a stock compensation charge that's 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 U.S. than Canada as compared to last year.

Adjusted EPS of $0.70 increased to $0.12 or 21% versus the prior year. Backing up the noise in Q3 for product liability, lead-free costs and rebates, Q3 adjusted EPS in 2013 would have been $0.64, equating to approximately 9.5% increase in EPS -- 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 of 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 years’ 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 for September 2013 and down as a percent of sales.

Accounts receivable was 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, 2 items of note from a 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 our 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 $0.01.

If we move to Slide 14, I'll provide you an update -- 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. Regarding EMEA, we expect sales to be down between 2% and 3%, a refinement of our previous expectations of being down 1% to 2%.

We have 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, the lead-free foundry was fairly stable in Q3, and we are now anticipating foundry inefficiencies to exceed those experienced this past quarter. 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 U.S. dollar. We think that could be approximately $0.02 in the quarter.

We expect corporate costs to increase sequentially from Q3 as the result of expected recruiting and salary costs for new hires and other costs like audit and SOX that have seasonally -- that seasonally increased during the fourth quarter.

And we have previously guided that our consolidated second half adjusted operating margins may expand by 90 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. And one item that I'd like to mention regarding 2015.

We've previously announced that we anticipate selling 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 use that determine our normal yearly pension expense.

Our actuaries have provided an estimate that the incremental charge maybe -- may approximate $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, 2014 full year savings are pretty much in line with expectations, having increased slightly as savings related to sourcing and product rationalization have materialized quicker than we anticipated.

And we have increased the expected operational savings for 2015 by $2 million to $12 million, which includes a larger tax benefit in '15, 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 nonrecurring -- and recurring costs are expected to increase by approximately $5.3 million and $1.3 million, respectively. The increases are due to some actions being pushed from '14 into '15, 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 and so the restructuring program cost for 2014 and '15 have been reduced by about $500,000 this year and $3.8 million next year.

Savings for '14 are in line with previous estimates, but total savings for 2015 have been reduced about $600,000 to $7.1 million. Capital spending is expected to be on target for the project with the most spend occurring by year end 2014. And you could see the details -- detailed numbers in the appendix for both initiatives.

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

Thanks, Tim. So to summarize, we're able to deliver strong operating profits and enhance 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 in EMEA and general operating cost controls. So with that, Adrian, can you open the lines for questions? Thank you..

[Operator Instructions] First question comes from the line of Jeff Hammond of KeyBanc Capital Markets..

So I wanted to focus on your Americas assessment. Lot of good color there. Just wondering -- one, when do you expect to be able to maybe quantify some of this opportunity? I know the earlier discussion was to maybe 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 kind of already announced and are doing in Europe?.

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

And 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 kind of shifting gears to non-res. I mean, it sounds like you're still seeing kind of a mix.

Have you seen any kind of deterioration or slowdown from commercial? Or is it just that the pickup has been slower?.

It's just been slower. I mean, we're seeing our early indicators, like our drains are growing strong, which is usually an early indicator of that. And as we said before, we're seeing a strong -- a lot of quotation activities. We just need to see them in order. So that's why we said it's been very strange for us.

We have expected a pickup, but the early signs were in there and we're just being cautious and saying, "You know what, we're not expecting any meaningful improvement till next year.".

I mean, where are you still seeing weakness within the commercial portfolio?.

I just think it's on our base products. You're just not seeing the growth. They're basically flattish. So it's just -- it's not broad. It's actually broad-based inside all the product components..

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

To tack on that or ask 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 point 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 we'd start -- it starts coming up. I mean, we -- usually 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..

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 -- I mean, where you're at from a capacity utilization perspective? And when you think you'll be running it at capacity?.

So I'll try to take some of that. I'm not sure I have all of the detailed answered there, but I would say that we're running -- 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 have 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 a foundry. As you ramp up, you got to make sure all those variables stay in sync and as you expand in capabilities there.

So we are pleased that we 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 burnt 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, okay. And one follow-up, if I may. On your order book in EMEA, you said it was down 6.5%.

Is that organic? Or is that -- does that include an FX hit as well?.

That would -- 6.5%, Jim, would be organic. And within that, there's probably a percentage point there relating to the product rationalization effort that we're doing over there..

Okay. And anything that you can call out on that -- on the Germany sales being down 14%? Is there anything onetime-ish there or tough comps or specific product suite that....

Yes. There'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 a -- 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. The weather has been kind of -- they got a mild fall in Germany and in parts of Europe. And 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..

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

Bob, well, I guess first question, your CFO left the company about 2 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 constraints. 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 do you think the search will take for his replacement?.

Yes. So we're aggressively looking at this point in time. Recruiting is underway. And we're going to replace that as soon as possible, but I think realistically, 3 to 4 months, somewhere around that time frame..

Okay. Shifting over to EMEA and piggybacking on the prior question.

With Germany down 14% and with total orders down 6.5%, why shouldn't we think that, that kind of 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. As Tim just talked about some of the anomalies we had on the year-over-year basis, we looked at the October order rates, and they're up about 1%. So we're seeing a little come back in October, which makes us feel cautiously optimistic.

But I think it's 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 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 Q2 -- Q3, excuse me, was up 220, but 110 excluding items.

Can you just clarify that? Up 110 compared to what in the fourth quarter?.

I think it's the second half versus second half, Kevin. So last year, adjusted operating margin was 9.6%. So it's 110 added to the 9.6%..

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

Second half versus second half..

But again, if we were up 220, using that as a basis in Q3, if we're 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..

Well, 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, whereas this quarter we're expecting to go down in terms of production. We have a lot of inventory still as of 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 under absorption 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 that's -- 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 will be maybe down more than just a tick. Maybe even closer to flat in Q4.

Again, am I off on that?.

I think....

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 and what we see flowing through into Q4.

We talked also about the 100 basis points of non -- 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 '15, but the 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, is that -- does that kind of become a new normal here in 2015?.

Yes, we're not -- 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 and 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.

So I think we have to look at that all collectively together as well as the performance in the foundry and 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..

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

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, both -- we had a best margin in a long time here.

Absent what happens with revenues, how sustainable do you think this kind of close to 12% level is going forward?.

Yes, 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 Asia-Pac margins, 15.5% this quarter.

Is there a way you can quantify some of those onetime items?.

We had a bad debt charge of about 450 -- $400,000 in the quarter, which obviously was unexpected, it just happened. And the stock comp cost, it's about $250,000 in the quarter, was 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 is going to be a fairly significant headwind, at least in the first 3 quarters.

I mean, 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 we're-- as we look at truing up bonuses and assuming we're going to pay out -- 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 a 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 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. So it's going to be corporate in some of the other North America businesses, in particular..

And, Kevin, just let me add to that from an EPS perspective. You mentioned a little bit is that we do see the headwinds ahead of us regarding the euro versus the U.S. dollar. That could be anywhere -- based on current rates, that could be anywhere from $0.6 to $0.8 next year a hit, if you compare that to 2014..

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

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 are going to get savings in the quarter incremental versus last year, like 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 that -- based on like 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 then -- 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 like absorption and mix? Because it is a pretty big number, I just want to make sure I'm looking at that the right way..

Well, in the quarter, right. We're looking -- 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 the 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. So we're on target to what we plan to do and what we said we were going to do inside the foundry..

So really the pickup, I think, Joe, with top line growth, the foundry performed pretty well and other cost savings initiatives, remember, we took the -- we had about $100 million savings this quarter versus Q3 last year, relating to the recession..

Yes.

And then, did you mention that there was 100 basis points in the quarter of, like one-off type stuff? Was that 100 basis points of -- that boosted margins about 100 basis points?.

Yes. [indiscernible] 100 basis points..

Inside the Americas..

Inside the Americas..

Okay.

So of -- like nonrecurring there a little bit?.

Right..

Right, yes..

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 Americas sales?.

I would say about -- lead-free, that's probably, I don't know, 30%, 35%, somewhere around there..

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..