Timothy M. MacPhee - Watts Water Technologies, Inc. Robert J. Pagano, Jr. - Watts Water Technologies, Inc. Todd A. Trapp - Watts Water Technologies, Inc..

Ryan Michael Connors - Boenning & Scattergood, Inc. (Broker) Michael Halloran - Robert W. Baird & Co., Inc. (Broker) Jim Giannakouros - Oppenheimer & Co., Inc. (Broker) Ryan Curtis Cassil - Seaport Global Securities LLC James V. Foung - Gabelli & Company Tristan Margot - Cowen and Company, LLC Jeffrey Hammond - KeyBanc Capital Markets, Inc..

Good morning. My name is Tracy and I will be your conference operator today. At this time, I would like to welcome everyone to the Watts Water Technologies, Inc. Third Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

Thank you. Mr. Tim MacPhee, Treasurer and Vice President of Investor Relations, you may begin your conference..

Thank you. Good morning, everyone. And welcome to our third quarter 2016 earnings conference call. Joining me today are Bob Pagano, President and CEO; and Todd Trapp, our CFO.

Bob and Todd will provide their perspective and analysis on our third quarter results, discuss our outlook for the fourth quarter, and provide an overview of our latest acquisition, PVI Industries. Following our prepared remarks, we will address questions related to the information covered during the call.

Today's webcast is accompanied by a presentation, which can be found in the Investor Relations section of our website. We will reference these slides throughout our prepared remarks. Any reference to non-GAAP financial information is reconciled in the appendix of the presentation.

Before we begin, I'd like to remind everyone that in the course of this call, to give you a better understanding of our operations, we will be making certain forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements.

For information concerning these risks and uncertainties, see Watts Water's publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Let me now turn the call over to Bob Pagano..

Thanks, Tim, and good morning, everyone. I'm on slide three of the presentation where I'll provide some commentary on the third quarter activities. Overall, we're pleased with the progress we've made on many fronts this quarter.

We continue to reshape and upgrade our portfolio as evidenced by yesterday's announcement of our acquisition of PVI Industries and we remain focused on delivering profitable growth. Our transformation and restructuring initiatives along with our ongoing productivity focus continued to drive strong operating margin expansion.

It is important to note we delivered this margin expansion despite the incremental investments we are making to help drive future growth and productivity, and we delivered adjusted earnings per share growth, which more than offset the headwind from the exit of undifferentiated products.

Our transformation initiatives, primarily global sourcing, the right-sizing of the Americas footprint and the European restructuring are all on schedule and we are seeing the benefit of these key initiatives on our financials. We also had a strong quarter in cash flow generation and are expecting this momentum to carry through the fourth quarter.

While we continue to deliver strong margin improvement, revenue fell short of our outlook, mainly due to weakness in the Americas. The primary drivers were as follows. First, as we mentioned during the second quarter earnings call, our July orders were softer than anticipated. At the time, we expected orders would accelerate as the quarter progressed.

While we did see sequential improvement, it was not enough to offset the slow start. Second, top-line challenges in the Americas were largely driven by AERCO, which experienced some significant headwinds in the quarter.

Specifically, we encountered delays in both project construction and the timing for capital release approvals while the competitive environment proved challenging as well. As we've said before, we will continue to maintain pricing discipline, as we are committed to profitable growth.

We also anticipated the approval of AERCO product certifications in Asia, but unfortunately we're still awaiting those government approvals, which are now expected to be received within the next few quarters. Excluding AERCO, Americas organic sales were flat in the quarter.

Growth in our product lines like valves and drains were offset by weakness in our retail channel. We saw some erosion this quarter due to the residual impact from the 2015 exit of undifferentiated products. At the time of the exit, we understood there was a potential risk to future sales.

However, it took some of our customers a little longer than expected to qualify other suppliers and finally make the transition. We expect this will impact some of our retail sales over the next few quarters. But let me be clear, this development does not alter our long-term strategy, as we'll continue to drive for profitable growth.

Turning briefly to the markets, the landscape has not changed significantly since our August discussion. Some of the recent macro data such as housing starts, the ABI Index, and Dodge Momentum Index have trended down in North America. But overall, we still believe the markets are growing, but can be lumpy at times.

In EMEA, the markets generally appear to be stabilizing after the initial Brexit shock. Certainly, the UK is under some pressure and we have seen that play out a little in our business as well. And in Asia-Pacific, we see the commercial markets still driving growth both inside and outside of China.

The China residential market may be a little more subdued due to the latest restrictions being imposed on housing prices, but still growing at a moderate pace. And finally, as you saw in last night's press release, I'm very happy to announce the acquisition of PVI Industries, a leader in commercial water heating solutions.

We are very excited about this strategic acquisition and I'll provide more details about the transaction shortly. Now I'll turn the call over to Todd to talk to you about our third quarter operating performance in more detail and discuss our fourth quarter outlook.

Todd?.

Thanks, Bob, and good morning, everyone. Please turn to slide four which shows the third quarter results. Reported sales of $341 million were down 7% quarter-over-quarter. This decline was driven by the exit of undifferentiated products in 2015, which impacted sales by about $24 million or 7%.

Organically, sales were down 1%, mostly driven by the Americas. I will discuss the regional performances in more detail shortly. Adjusted operating profit of $41 million was essentially flat versus last year on lower sales of $25 million.

This translated into adjusted operating margins of 12.1%, an increase of 70 basis points versus third quarter of 2015. We attained this margin while continuing to invest in our growth and productivity initiatives as previously communicated.

Favorable sales mix including the exit of undifferentiated products and productivity were the main drivers of our strong Q3 margin performance. Adjusted EPS of $0.71 was approximately 6% better than last year.

Strong operational performance and benefits from lower interest expense and a lower tax rate more than offset a $0.05 headwind associated from the exit of undifferentiated products, so overall continued strong margin and EPS performance despite some headwinds on the top line.

Let's turn to the regions and on slide five, let's review Americas results for the quarter. Sales were $216 million, down 12% on a reported basis. This was primarily driven by the exit of undifferentiated products in 2015, which was a $23 million or 9% headwind for the region in the quarter. Organically, sales were down 3%.

The biggest driver of the variance was in AERCO, which saw a double-digit decline in sales. As Bob mentioned, AERCO's performance was attributed more to product timing, some certification delays in introducing our products into the Asian markets, and a more competitive landscape.

Keep in mind that AERCO is a project business, which can be lumpy at times, as evident in last quarter's double-digit growth rate. We do expect that AERCO's performance will improve in the fourth quarter and are excited about some of the new products AERCO will be introducing into the marketplace in the next few months.

Excluding AERCO, our base Americas business was flat versus last year. We continue to see some nice growth in our core plumbing products as well as in our drains business. However, this growth is being offset by continued softness in certain end markets and some erosion in our retail channel due to the exit of undifferentiated products.

In the quarter, we saw continued softness in our products that serve both the industrial and marine end markets and saw a decline in our Canadian business due to continued challenging construction markets. As Bob mentioned, we experienced residual impact from last year's exit of undifferentiated products.

If you recall, in early 2015, we estimated that between $175 million to $200 million of sales would be rationalized. This range included some products we planned to keep in our portfolio, but we knew were at risk given our decision to exit complementary products.

Initially, customer feedback was that they were going to maintain our supplier relationship for these product lines. So in 2015, we reduced our estimates of exited sales to approximately $165 million. Fast forward to this quarter, we were notified by a few of these customers that they were transitioning suppliers for those at-risk products.

We estimate that the impact was approximately $3 million in the quarter and we expect this development will affect our sales in Q4 and into the first half of 2017 as well. Adjusted operating profit was $36 million, a 1% increase year-over-year on $29 million lower sales.

This resulted in operating margin expansion of 210 basis points to 16.8%, another record for the Americas region. The margin improvement was driven by favorable sales mix including the positive impact from the exit of undifferentiated products and productivity, which includes the benefit from lower raw material costs.

We also benefited from favorable absorption associated with supporting our transformation initiatives. So from a margin perspective, another strong quarter performance in the Americas. Sales were below our original outlook with the expectation that some of the issues we faced will improve in the fourth quarter.

Turning to slide six, let's review EMEA's results. Sales of $110 million were down 1% on a reported basis and were flat organically. Both of our European platforms, fluid solutions and drains, were relatively flat.

Within the fluid solutions platform, our electronics business continued to benefit from successful new product introductions, which more than offset continued weakness in HVAC products sold into the OEM channel. Our drains business has continued to see project delays and push-outs due to softness in some of their end markets.

Drains also has the biggest exposure to the UK market and unfortunately they are feeling some of the Brexit impact, with UK sales down roughly 28% in the quarter. Regionally, we saw continued growth in Italy and the Middle East, while France was flat, basically in line with the French construction markets.

In Germany, sales were slightly down, as we continued to experience pressure in the OEM channel. Adjusted operating profit for EMEA for the quarter was $12.9 million, up 7% year-over-year. Operating margin of 11.8% increased 100 basis points as compared to Q3 last year.

The strong margin was driven by productivity including lower material costs and benefits from ongoing restructuring initiatives. So, for EMEA, another quarter of stabilization and continued operating margin expansion. Moving to slide seven, let's review Asia-Pacific's results. Asia-Pacific delivered strong top line performance in the quarter.

Sales were roughly $16 million, up 49% on a reported basis and up 26% organically compared to the same period last year. Our traditional China-based valve business recovered nicely during the third quarter, driven by stronger sales in the data centers, in both the office and lodging verticals.

We also saw continued strength in our under-floor heating products that serve the residential market. So, overall, China was a good story for us in the quarter. Sales outside of China continued to perform well, up 19% in the quarter, driven by strong demand for our core plumbing products in code-driven countries.

Adjusted operating profit for Asia-Pacific increased 12% to $1.9 million in the quarter, which translated into adjusted operating margin of 12.3%. The margin rate was down year-over-year mainly due to a 37% reduction in affiliate sales due to the exit of undifferentiated products in 2015.

So, in summary, Asia-Pacific continues to perform very well through better execution in China and continued growth in Southeast Asia. On slide eight, a few items I'd like to point out related to free cash flow. Year-to-date, free cash flow was $43 million as compared to $23 million last year.

Recall that last year included a $49 million cash outflow, mostly related to our pension liability settlement. We delivered a strong cash flow in Q3 of approximately $55 million, up 28% versus prior year, driven by improved working capital management.

From a capital deployment perspective, we funded about $7 million or 37% more in CapEx in the first nine months versus prior year, consistent with our plan to reinvest back in the business. Our reinvestment ratio was approximately 115%.

We continue to fund high ROI projects that will drive future growth and productivity opportunities for the organization. We also purchased approximately 74,000 shares of our Class A common stock at a cost of $4.6 million during the quarter. Year-to-date, we have purchased 433,000 shares for approximately $22 million.

So, overall a very good quarter for cash and we expect that momentum to continue into the fourth quarter. Finally, turning to slide nine, I'd like to make a few comments on Q4. First, as a reminder, we will have approximately four fewer shipping days in Q4 versus last year.

This is offsetting the extra days we had this year in Q1, as we had previously communicated. We estimate year-over-year sales and operating margins in Q4 will be impacted by about 400 basis points and 50 basis points, respectively, as a result of the fewer days.

With that said, we expect consolidated organic sales growth on a days adjusted basis to be marginally higher than Q3 of 2016, as we expect some pickup in the Americas through improved AERCO performance.

As for EMEA and Asia-Pacific, we are forecasting top line performance to be consistent with what we saw in Q3, flat in EMEA and continued strong performance out of Asia-Pacific. We do have one more quarter of headwinds associated with the 2015 exit of undifferentiated products, which should approximate $10 million in Q4.

And as mentioned earlier, we are forecasting some erosion in the retail channel in the Americas as well, similar to what we experienced in Q3, due to the residual impact of the undifferentiated product exit, roughly in the range of $2 million to $3 million.

Operating margins should expand in Q4 as compared to prior year, supported by our ongoing transformation initiatives and our strong focus on productivity. However, we do expect margins will be down sequentially compared to Q3 of 2016. PVI will be included in our results for the two months in the quarter.

We expect sales to be in the range of $7 million to $8 million. Finally, the fourth quarter is typically a good one for cash flow generation and we expect that will be the case this year as well. And with that, I will turn the call back over to Bob.

Bob?.

Thanks, Todd. Please turn to slide 10 and let me summarize the PVI acquisition. As I mentioned, PVI is a leader in commercial water heating solutions. It is strategically important for AERCO, as PVI's strong market position in commercial water heaters complements AERCO's leading position in the high-efficiency boilers.

On slide 10, you'll notice the product family pie charts provide a vivid pictorial of how the two companies' product lines complement one another.

Like AERCO, PVI is focused on differentiated product design for project-specific customer applications, and its solutions are also directed to the high-capacity marketplace with a focus on high-efficiency water heaters. PVI has been selling commercial hot water heaters for over 50 years and has a significant footprint in the U.S.

with some exposure to Canada. PVI's longevity provides a solid installed base for driving a larger repair and replacement business. PVI sales proximate $50 million and have grown roughly 10% on a compounded basis over the last five years, and its leadership team brings a wealth of experience in the water heating equipment industry.

The company has one manufacturing location, a 165,000 square foot own facility in Fort Worth, Texas, where it does all its manufacturing, engineering, design, and testing. PVI employs approximately 230 people and is a non-union site. Now, let me outline our strategic rationale for the acquisition.

First, we continue to focus on three megatrends – safety and regulation, energy efficiency, and water conservation. PVI products and solution address all three of these favorable macro trends. Secondly, the synergies with AERCO are compelling.

We think the combination of AERCO's boiler packages and PVI's hot water heating products will provide our commercial customers a total solution for their heating and hot water needs.

Further, PVI's core end markets – education, healthcare, multi-family and lodging – dovetail well into AERCO's key end markets, and both companies expect to participate in a continuing market trend to high-efficiency condensing products. Key attributes we look for in acquisition targets are brand strength and product breadth.

PVI has exceptional brand recognition, especially in the highly specified market channels, and its products encompass all major energy sources, storage capacities and BTU sizes. From a technological perspective, PVI is the only ASME-code water heater builder using duplex stainless steel.

This alloy extends the life of the water heater system as compared to the competition. Continuing, PVI has a diversified and highly respected rep network across the U.S. and Canada. The reps work with specifying engineers to communicate PVI's value proposition to the end customers such as building owners, contractors or building management.

The large geographic reach of PVI's 60 reps allows them to be close to their customers and react quickly to their needs and opportunities. Finally, let's review the transaction itself. The purchase resulted from an active auction process, which attracted a number of interested parties.

We paid approximately $78 million for the 100% of the common stock of PVI, with a final price subject to customary working capital adjustments. Assuming no synergy, we paid approximately 11 times EBITDA multiple on estimated 2016 results. We estimate annualized year three synergies ranging from $2 million to $3 million.

Those synergies would include incremental sales, material sourcing savings and G&A costs like legal, audit, et cetera. Post synergies, the multiple would be more in the 8 times range. We anticipate that the acquisition will be accretive in 2017 by approximately $0.06, excluding purchase accounting adjustments.

We are very excited about the PVI acquisition, as it allows us to expand our product breadth in the commercial water heating market. With AERCO and PVI, we can now go to market with a full complement of products that provide a complete solution for our commercial customers.

So, in summary, on page 11, we delivered solid results in the third quarter despite the top line headwinds. We are executing on our key initiatives including the Americas transformation, European restructuring, reshaping our portfolio, and expanding operating margins while simultaneously making investments to drive future growth and productivity.

We think Q4 should be another solid quarter for operating margins and the bottom line. We are maintaining our balanced capital deployment strategy. We are reinvesting in our businesses with more capital spending in high ROI projects.

We are investing in inorganic growth, as evidenced with the PVI acquisition, and we continue to drive shareholder returns through dividends and an active share repurchase program. We are excited about the progress we've made to-date in transforming the company and are even more excited about the future for Watts.

So with that, operator, please open the line for questions..

Your first question comes from the line of Ryan Connors with Boenning & Scattergood. Your line is open..

Great. Thanks for taking my question.

Wanted to discuss the issue of, I guess, the channel hiccups you discussed related to the portfolio product realignment, because I think it really cuts to the core of, I think, one of the risk factors of the product exit strategy is that maybe there was – although you didn't see value in certain products, some of your channel partners did, and that there might be some risk there in terms of creating issues or bad will that could compromise things.

So could you just discuss that development in that context, how you think it – whether that speaks to a broader risk associated with that strategy or whether you think these are isolated incidents?.

Thanks, Ryan. It's Bob. Yes. Certainly when we gave the range, we knew there was an opportunity or a potential to lose some of this business, but, again, we wanted to continue in some of this business because it was part of our overall solution and we wanted to make the product. If I look at this really, I think it's limited.

When we look on an annual basis, it's $10 million to $12 million. We saw $3 million of it approximately in the third quarter. But it doesn't change the strategic intent. When we did our planning, we honestly assumed we were going to lose some of this. So it wasn't a surprise to us.

We believe it's an isolated instance because we have other products that are very differentiated and proprietary to us. So again I think it's not a major issue. It's one that strategically we knew was a risk, but it doesn't change any of our outcome. And as you can imagine, it wasn't our highest margin product.

So, that's why you're not really seeing a big impact to it..

Got it. And so as I interpret that, you don't believe that there is risk on a follow-on basis to some of the higher margin business as a result of that..

We don't believe there's significant risk at all..

Okay.

And then a separate question, just kind of a one-off big picture question, but one of the big issues of increasing talk lately in the water sector has been the idea that the Flint, Michigan issue is going to drive cities around the country to subsidize in-home lead filtration as they work over decades on tearing out some of these leaded service lines.

They know that will take time. In the meantime, they want to do point-of-use in-home filtration and then they're going to subsidize that. There're some pretty high-profile examples of that. I know you've got a horse in that race on the filtration side with the Watts Premier product line.

Can you talk about that business and whether it's seeing any benefit of that already or whether – how you look at that opportunity, whether that's an area that you would look to focus on in M&A as that develops? Any color there would be helpful..

Sure. So first of all, we believe the Flint, Michigan developments really are focusing the whole industry in all the economies to look at safe water. So we believe overall it's a positive thing for us, albeit a very small piece of what we play in. So we've seen some uptick in that area, but it's a small piece.

And from an M&A point of view, there's a lot of people in that area. So we've got to be careful in that area. But when we look at it overall and the infrastructure spending that's going to result, this is going to take many years to resolve. That's just one case.

But again the focus on water, we think, is a good thing because we sell not only point-of-use products, but we also sell infrastructure tied to that. So, again, we believe it's positive, but we just believe it's going to be a long time..

Great. Well, thanks for your time this morning..

Thank you..

Your next question comes from the line of Mike Halloran from Robert Baird. Your line is open..

Hey, guys. Morning..

Good morning, Mike..

Good morning..

Hey. So, lot of moving pieces as you move into the fourth quarter here. I understand the retail dynamic, which you guys just talked about. I also understand the days. Maybe just talk a little bit about the core underlying trends that you're seeing, residential, non-residential as you work into the fourth quarter.

Outlook seems a little lighter on a core basis, but please correct me if I'm wrong there and just maybe highlight the trajectory as you see it, North America specific, sorry..

Yeah. No problem. What we're seeing really in the North America marketplace is lumpiness. And I would say when the Brexit happened at the end of the second quarter, you saw a lot of hesitation in July, and that's when the U.S. stock market was hit and then it came back.

And then because of the political uncertainty, I think, that's happened in the third quarter, we've just seen projects, in particular in the commercial side, just start to push out and be more lumpy in nature. So from an overall market point of view, we think that lumpiness is going to continue in the fourth quarter.

We think in particular the AERCO will bounce back a little bit because we look at that as somewhat of an anomaly in the third quarter, but we believe these markets are still growing. There's some tailwinds behind them, although lumpy from that point of view. But the key when we look at this is the projects that we're seeing are not being canceled.

They're just being pushed out. And for us, we just believe it's a bump in the road in the quarter..

Is that lumpiness confined to the project side of things? What are you seeing more in the steady-state business that you have on your traditional channels?.

Our traditional core plumbing wasn't bad, actually, in the quarter. It was in 2% to 3%, which wasn't bad at all, which was the core plumbing and drains business. It was just the products that were associated with what I would call more commercial-related projects that we just saw lumpiness in..

Okay. That makes a lot of sense. And then the North America margins were particularly impressive again. I think last two quarters were record highs for the organization. It doesn't sound like there is anything in those numbers that's not sustainable on a forward basis.

Just want to make sure that the trajectory from here makes sense relative to varying demand levels and also understand the commentary from the outlook..

Yeah, So, Michael, this is Todd. I think in my opening comments, I talked a little bit about, what I'd say, a one-time variance associated with some of the inventory build-up earlier in the year that kind of bled through the P&L, and that was about $1.5 million.

So I'd say that impacted the Americas margins from 69%, I would say, more down to 16.1%, 16.2%. So very consistent with what we saw in Q2. So I think in that range – so it's in that range 16.1%, 16.2% is probably a good number to have in your model going forward..

Yeah, makes sense. Still a healthy level. Thanks, guys. Appreciate it..

Thanks, Mike..

Your next question comes from the line of Jim Giannakouros with Oppenheimer. Your line is now open..

Hey. Good morning, guys..

Hey, Jim..

Good morning, Jim..

If I could tack on to Mike's question, there is just 500 points core incrementals in North America, when I say core, just excluding AERCO and obviously the retail exit, how should we be thinking about the core plumbing products incrementals, just given everything that you're doing on the cost side – incremental margins, that is?.

Well, I'll start with the growth side of it, and Todd can talk about the margins. I mean we expect that growth – smaller numbers – 2% to 3% of that core business growing into the fourth quarter.

So margins are similar other than what Todd talked about really related to, let's call it, the one-time favorable absorption we got from the build-up of the inventory here. It's really in our specialty channels, which are more like the HVAC, water quality related to projects in the marine side.

Those areas are the ones we saw pressure in the third quarter and we continue to believe that we'll see pressure in those markets in the fourth quarter..

Okay. Okay.

But as far as incremental margins, Todd, then how should we be thinking about that? I meant more than 4Q just on a go-forward basis, how is that running if we were to sustain that 2% to 3% core organic growth?.

I mean I think the margin rates that we saw in Q2 and Q3 ex that one-time are 16%. It's probably, again, a good run rate to use, and then from an incrementals perspective, I mean typically it's, what, 25% to 30%, I'd say, are incrementals, and so I'll allow you to do the math on that one..

Okay. Good enough. Thank you for that. AERCO, I mean that was a big swing, if we could just kind of get a little more granular as to the components, as to what drove, what we were going into the quarter or the second half thinking that double-digit growth is sustainable.

Obviously a big hiccup in 3Q that you think you're going to get back somewhat in 4Q and get on more solid footing, if I heard you right, into 2017. But you highlighted both end market project activity, but also competition. I'm curious on the competition part.

Is that new products from large players? Is that smaller guys getting aggressive on price? What exactly is going in there? And did I hear you right that this was a little bit of a speed bump in that double-digit type of growth is what we should be thinking about to be sustained over the next two years to three years or so for AERCO?.

Yeah. We certainly believe it's a speed bump in the quarter. We are seeing commercial projects push out. And because of that, when projects are lumpy, everybody is out to get those ones that are going to be done.

So we have seen aggressive pricing, especially from smaller competitors in particular, just trying to buy jobs, and we're being very disciplined. For me, it's about profitable growth. We certainly look strategically at the account, and we'll adjust pricing when it strategically makes sense, but we're not going to lose money when we ship our job.

So I look at it as a speed bump. I think that lumpiness honestly is going to continue into the fourth quarter because these projects, again, aren't being canceled, we are just seeing them push out or shipments we thought we're going to happen in 2016 have been pushed out into 2017. So I think a little lumpiness. I think we'll come back to growth.

But as I look at AERCO, 11 out of the last 15 quarters, they've grown double-digits, including last quarter. So I think when you look at this – in 13 out of the 15 quarters, they have grown greater than 8%. So when I look at it, I think this is a minor bump.

We got some new products that are being launched and I just would chalk it up to the lumpiness in the commercial marketplace..

Great. Thank you..

Thank you, Jim..

Your next question comes from the line of Ryan Cassil with Seaport Global. Your line is now open..

Thanks. Good morning..

Good morning, Ryan..

Good morning, Ryan..

Just wanted to clarify, it sounded like the Q4 outlook that organic growth in the Americas probably still negative or down maybe just less than 3%. Is that right? And if it is, could you – it sounds like maybe AERCO is still down in the fourth quarter, you think that's an air pocket that improves. I just wanted to clarify based on prior comments..

Yeah, no, I would say – Ryan, this is Todd. I would say we expect Americas growth with AERCO to be positive in Q4. So we do expect AERCO to rebound. And so, overall, I'd say that coupled with our base Americas business should show some positive growth in Q4..

The key is that excludes the exit of undifferentiated as well as we believe we have a $3 million headwind based on the retail discussion we just had..

Right. And all the things I'm talking about too, Ryan, excludes the additional – reduced days impact that we talked about in the comments as well..

Right..

But on a pure organic days adjusted basis, we expect Americas to be flat to slightly up..

Okay. On sort of fully adjustment ex the retail, it's going to be a positive organic growth in the quarter? Okay..

Yes. Yes..

Correct..

Okay.

And then just to touch on the competitive dynamics, could you just expand any certain product lines or areas where you're seeing things that are worse or is it really just that project side like you were saying sort of more broad-based and we should think about it that way?.

Well, I would say overall, I think, competition is great because of the lumpiness in particular in projects, but we're seeing it actually across the board. In the quarter, we see usually a half to three-quarters of a point in pricing, and it was flat this quarter for us.

So we're seeing general competition because of lumpiness, because of a slight slowdown based on the uncertainty I talked about earlier, I think it's price competitive out there. So again we're trying to be disciplined and we continue to test price elasticity, but we see the pricing – marketplace pretty flat versus positive in the past..

Okay. Got it. And then last one from me and congrats on the PVI deal, by the way.

Could you talk about the $2 million to $3 million of cost synergies? How much, ballpark, is cost synergies versus sale synergies there?.

Yeah, so when we look at it, we're very careful to justify acquisitions based on top line growth, but certainly that's why we give a range, $2 million to $3 million. We're looking – about a third of that sales-related and two-thirds of it cost-related.

So we do believe there's opportunities, our teams are even more excited, and the initial reaction from our teams and the industry based on the announcement, the things I have heard last night and this morning, has been taken very, very positive. So we believe it's a great opportunity. And as you saw with the pie charts, I think that says it all.

It's a nice complementary fit into that commercial marketplace. So we're excited about it, and the teams are very excited about it..

Great. Thanks very much..

Thank you..

Your next question comes from the line of Jim Foung with Gabelli & Company. Your line is now open..

Hi Bob, Todd. Good quarter..

Thanks, Jim..

Thanks, Jim..

Let me first ask you, you used to be 50% residential and 50% commercial. And now the mix is changing now as you exit the differential (sic) [undifferentiated] products, and then you acquired AERCO and PVI.

Could you just talk about where you are today in terms of your mix and then where would you like to be in like two to three years from now?.

Yeah, I think it's leaning more towards the commercial side of it. It's probably 60% now – 60%/40%, and it's probably moving up to 65% with PVI. And certainly we believe the commercial market has more margin and it allows us to be more – specify our products to the industry.

So again it allows us to showcase our differentiated products with higher margin..

Maybe we just touch a little bit – can you maybe just expand on that a little bit in terms of your vision for the commercial marketplace? I mean where else – I mean what other product lines do you need – I mean kind of where would you like to be, what kind of company would you like to be in kind of like two, three years in this commercial setting?.

Well, certainly we're looking at continuing to offer solutions to our customers. I think in the past, we have been more of a component supplier. And now we're looking more and more of how can we bundle our products together into more of a complete solution for our customers.

So as we look in that, we're going to continue to invest in electronics, tie it into the building management systems and really be a key developer of new products and innovation for that area. So it's an area we're excited about and an area we'll continue to build our portfolio around..

So, with that, I assume you go into products that you're not in right now, moving away from the home improvement, kind of appliances area?.

Well, I wouldn't characterize it as that. I think probably moving away from more commodity-type retail products and more into differentiated products that offer solutions to customers where we can bundle some of them together to offer complete solutions. So I think, really, that's the mindset change that we're trying to drive here..

Okay. Okay, great. That's all I had. Thank you..

Thanks, Jim..

Your next question comes from the line of Joe Giordano with Cowen and Group. Your line is now open..

Hi, guys. This is Tristan for Joe. Thanks for taking the question. I was just wondering with the addition of PVI, if you think there still are some holes in your water heating (40:36) treatment portfolio at this point..

Water treatment..

Yeah. Yeah. Certainly from a water treatment point of view, we're very – so much a niche player in that market. So we have products, we're nowhere near some of the big people. We focus on niche applications. Inside of that, we have anti-scaling products that we believe are very strong in that market, in particular in commercial buildings.

So when you look at that, we'll continue to develop new products in that area. But, again, I don't consider us a major water treatment player..

Okay. Thanks.

And then could you update us on your cross-selling opportunity between geographies?.

Sure. So from a cross-selling point of view, I think the biggest benefit we're seeing is the cross-selling initiatives inside of our EMEA business. When we look at that, the teams are – we've reorganized on a pan-European basis and the teams are actually – we just did a review recently where we're seeing some quicker wins.

So I think there's opportunities there. We also see opportunities in taking our North America and European products and bringing them to the Middle East. That's been an opportunity. We're still a very small player in the Middle East and we are seeing some project delays in that area, but again we have such small share in that area.

We believe there's growth opportunities. And then finally in our drains point of view, we're taking our stainless steel drains from Europe and bringing them into North America, and that's been a nice success for us.

So, again, we're seeing cross-selling opportunities, the One Watts initiative is bearing fruit and we are excited about the opportunities..

Very well. Thank you..

Thank you..

Thank you..

Your next question comes from the line of Jeffrey Hammond from KeyBanc Capital Markets. Your line is now open..

Hey, good morning, guys..

Good morning, Jeff..

Good morning, Jeff..

Hey. So there's been some mixed messages, I think, from a number of companies here during earnings on U.S. commercial construction. One of your competitors was mentioning some pockets of weakness in institutional.

Just how are you thinking about momentum there? What are you seeing near term? How are you thinking about momentum into 2017?.

Yeah, so institutional in particular is an area of strength for us. There was a lot of assumptions coming into 2016 that that would be stronger, so they revised their growth forecast down 200 basis points, but there is a feeling in general and confirmed by our channels that 2017 – the calendar year 2017 is going to be much better.

So a lot of things in schools, universities, hospitals and dorms are out there, and our channel is really looking and excited at it. So again projects I think that everybody expected in 2016, I think, just took a pause. I think someone referred to it as a hiccup. I think that's kind of what we saw and it's moving out to 2017.

So we believe there's still growth out there..

Okay. Great. And then obviously a lot of progress on the margin front showing up in North America and Europe.

Can you just update us on what you – of the stuff that you have announced, what you see as kind of year-on-year incremental savings into 2017 maybe just anything else you still really see the need to address from a restructuring or a change standpoint? Thanks..

Yeah, yeah. Thanks, Jeff. Our initiatives are all on track and in some instances ahead of schedule. So we feel good about those initiatives. We're continuing, like we said, to drive them into 2017. Our Europe, Middle East and Africa strategy, in particular in Europe we're continuing with that initiative.

We told you it was going to take most of this year and we've gotten all the approvals we need. So we're implementing in the fourth quarter, which should benefit us a little in the fourth quarter and into next year. So we're continuing with our initiatives.

Never say never because we're always looking for continuous improvement, but I would think that in particular the North America restructuring is going to slow down and we're really more – are focusing our time and attention on leaning out our existing operations.

So it's more of a focus from restructuring and closing plants to optimize our existing plants. So little more, let's call it, head count reduction coming in Europe, but more optimization in the rest of our facilities..

Great. Good color there. Thanks, Bob..

Thanks, Jeff..

There are no further questions at this time. I turn the call over to CEO, Mr. Bob Pagano, for closing remarks..

Okay. Thank you, everyone, for taking the time to join us today. We appreciate your continued interest in Watts and look forward to speaking with you again during our fourth quarter earnings call next February. Thanks again..

This concludes today's conference call. You may now disconnect..