Watts Water Technologies Inc

NYSE:WTS

Earnings Call Analysis

Company Improves Margins Despite Flat Sales

The company reported a commendable increase in free cash flow to $182 million from the $67 million in the same period last year, indicating strong financial health due to higher net income and lower working capital investment. Sales remained steady with a slight organic growth of 1% in the Americas and flat overall, alongside a modest decline in Europe and incremental growth in APMEA, partly due to the acquisition of Enware contributing $9 million. Organic sales may dip 1-6% next quarter with varied regional performance; however, operating margins are projected to rise to 15-15.6% for the fourth quarter and an increased full year margin outlook of 120-130 basis points improvement. The acquisitions of Bradley and Enware will bolster sales by approximately $30 million and $9 million, respectively, despite their dilutive effect on margins.

Solid Performance in Third Quarter Raises Full Year Outlook

In the third quarter, the company achieved better-than-expected results, reaching record sales, operating margin, earnings per share, and free cash flow. Despite organic sales being flat compared to the previous year, because of strong performance in the previous quarter, an adjusted operating margin of 18%, exceeding expectations, was reported. This success led to an increase in the full year 2023 operating margin outlook, and the company anticipates generating solid free cash flow through year-end.

Acquisitions Expanding Market Presence and Synergies

The strategic acquisition of Bradley Corporation is underway, anticipated to expand the addressable market considerably and be accretive to the adjusted EBITDA margins by 2027. Meanwhile, the integration of Enware is progressing ahead of schedule. These acquisitions strengthen the company's position in the Americas and APMEA regions and align with the company's disciplined capital allocation strategy.

Mixed End Market Signals and Updated Regional Analysis

Positive GDP growth supports repair and replacement activities, but softening in European markets and potential slowing in multifamily new constructions are concerns as we head into 2024. The Americas region saw organic sales up 1%, while Europe reported a 1% decline in organic sales. APMEA delivered 1% organic growth, with noticeable expansion in Australia and the Middle East. Adjusted operating margins saw improvement, highlighting the company's ability to manage volume decline and inflation through pricing strategies and productivity gains.

Projected Outlook and Financial Expectations

Consolidated organic sales may witness a decline of 1% to 6% in the next quarter, while full year organic sales growth is expected to be flat. The company raised the full year adjusted operating margin expansion forecast to a range between 120 and 130 basis points, reflecting an increase of 65 basis points from previous guidance. For 2023, operating margins are projected to be between 17.6% and 17.7%. The anticipated strong year-to-date performance may help offset anticipated margin declines in the fourth quarter, and free cash flow is expected to meet or exceed 100% of net income.

Continued Share Repurchase and Strong Balance Sheet

Year-to-date, the company has repurchased shares worth $12 million and still has approximately $16 million remaining under the current stock repurchase program. An additional $150 million remains available for stock repurchases under the program authorized in July 2023. With a healthy balance sheet and strong free cash flow, the company retains ample flexibility for its capital allocation strategy. The pro forma net leverage ratio stands at a healthy 0.1x, showcasing fiscal strength post-acquisition activities.

Fourth Quarter and Full Year Financial Details

For the closing quarter, adjusted operating margin is estimated to range from 15% to 15.6%, taking into account seasonal variations and recent acquisition costs. The full year operating margin is expected to reflect an increase, and capital spending is anticipated to be around $35 million, with depreciation and amortization projected to be around $45 million. The share count is expected to be approximately 33.5 million for the year.

Prepared for Global Economic Shifts

The company is vigilant in monitoring global economic indicators and is staying engaged with customers to navigate any potential impacts. There is confidence in executing strategies effectively in the current uncertain economic climate, backed by strong free cash flow and a solid balance sheet that provides financial flexibility.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Watts Water Technologies Third Quarter 2023 Earnings 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. [Operator Instructions] Diane McClintock, Senior Vice President, Investor Relations and Financial Planning and Analysis, you may begin your conference.

[Diane McClintock, executive]

Thank you, and good morning, everyone. Welcome to our third quarter earnings conference call. Joining me today are Bob Pagano, President and CEO; and Shashank Patel, our CFO. During today's call, Bob will provide an overview of the third quarter and discuss the current state of the markets and our operations. He will also update you on our recent acquisition of Bradley Corporation. Shashank will discuss the details of our third quarter performance and provide our outlook for the fourth quarter and for the full year. Following our 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 this presentation throughout our prepared remarks. Any reference to non-GAAP financial information is reconciled in the appendix to the presentation. Before we begin, I'd like to remind everyone that during this call, we may be making certain comments that constitute forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially.For information concerning these risks, see Watts' 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. With that, I will turn the call over to Bob.

[Robert Pagano, executive]

Thank you, Diane, and good morning, everyone. Please turn to Slide 3, and I'll provide an overview of the quarter and our markets. We delivered another quarter with better-than-expected results, including record Q3 sales, operating margin, earnings per share and free cash flow. As a result, we're raising our full year 2023 operating margin outlook. Organic sales were flat to prior year as we expected due to a tough comparison to a strong third quarter in 2022, where organic sales were up 12%. Strong growth in our Americas nonresidential core valve products was offset by double-digit declines in our gas connectors, radiant heating applications and commercial marine instrumentation.Adjusted operating margin of 18% exceeded expectations and was supported by solid price realization, favorable mix and productivity, which more than offset inflation, lower volume and incremental investments. Year-to-date free cash flow has been strong, and we expect to generate solid free cash flow through year-end. Our balance sheet remains healthy post Bradley acquisition with a net leverage ratio of less than 0.1x, which affords us ongoing flexibility in our disciplined capital allocation strategy.Strategic M&A, high ROI CapEx and competitive dividends remain our top capital allocation priorities. Moving to operations. As previously announced, we closed on our acquisition of Bradley Corporation in October. This acquisition is highly strategic and expands our addressable market. Integration is underway and the teams are working collaboratively to capture synergies and market opportunities. I'll speak more about the acquisition in a minute.The integration of our Enware acquisition is going well and continues to be ahead of schedule. With this acquisition, Australia and New Zealand now represent more than half of our APMEA region. Next, I'd like to provide an update on our end markets. GDP continues to be positive in our key markets, and this supports our repair and replacement activity. In Europe, some markets remained solid in the quarter as growth continued in Germany, France and Benelux. However, we do see softening driven by a slowing residential market and nonresidential new construction and the impact of changes to the energy incentive program in Italy.In the Americas, new residential single-family construction appears to have bottomed out. However, multifamily new construction has seen recent declines in starts and permits, which may signal slowing as we head into 2024. Nonresidential new construction indicators are mixed. The ABI fell back below 50 in August and declined further to 45 in September after several months of expansion. The Dodge Momentum Index sequentially improved in September after 4 months of decline due to an uptick in institutional and industrial activity. The institutional and industrial verticals have remained supportive year-to-date.In the Asia Pacific region, China data center activity remains solid, but it's being offset by declines in residential building activity. The Australian market remains healthy despite continued interest rate increases. We saw strengthening markets in the Middle East due to continued higher oil prices. Now an update on our outlook for the fourth quarter and the full year. Due to challenging comps as a result of a strong fourth quarter in 2022, we expect our fourth quarter organic sales to be lower than prior year.We also anticipate a sequential decline in operating margins due to normal seasonality, incremental investments, volume deleverage and the dilutive impact of our Enware and Bradley acquisitions as a result of customary transaction-related costs, including amortization. While we expect difficult comps in Q4, we are increasing our full year operating margin outlook due to strong year-to-date performance and anticipated higher margins in the fourth quarter due to favorable mix.We expect America's nonresidential business to remain solid, but be offset by continuing softness in certain specialty channel products. We also anticipate Q4 to be softer in Europe due to weakening macros. Higher interest rates and lending tightening may also have an impact on new construction. Please turn to Slide 4, and I'll give you an overview of the recently acquired Bradley Corporation.Bradley is a 100-year-old plus business headquartered in Menomonee Falls, Wisconsin, with approximately 500 employees. Annual sales are approximately $200 million, split evenly between hand washing products, which include syncs and faucets, washroom specialties, which includes accessories and privacy solutions and safety products, which include eyewash stations and safety showers. The addition of Bradley to the Watts portfolio is highly complementary, enables us to offer a more comprehensive solution to our customers.It expands our total addressable market with front-of-the-wall products for commercial washrooms and industrial emergency safety applications and broadens our exposure to North America institutional and industrial markets. The acquisition leverages the combined strength of our sales network and channel relationships to accelerate growth and leverage cross-selling opportunities. It is also expected to create significant value through greater scale and the capture of cost synergies. If you turn to Slide 5, I'll share how the acquisition aligns with our M&A strategy.On the left side of the slide, you'll see our previously communicated M&A strategic criteria. The Bradley acquisition fits nicely with our stated priorities. The portfolio is comprised of code and specification-driven products that align with Watt's key long-term secular growth trends of energy efficiency, water conservation and safety and regulation. Bradley's product portfolio expands our offerings with innovative water solutions as it adds front-of-the-wall applications to our differentiated back-of-the-wall portfolio and increases our exposure to attractive institutional and industrial markets.Bradley is a market leader known for innovative, high-quality, high-value products and has tremendous brand equity. The acquisition also builds on our recent acquisition of Enware, which is a leading supplier of specialty plumbing and safety equipment used in Australian institutional, commercial and industrial end markets, with products and solutions that are highly complementary with Bradley's portfolio. We expect to realize meaningful run rate cost synergies by leveraging our One Watts performance system through commercial and operational initiatives, including global sourcing savings.We expect to reach approximately $12 million of annualized savings by the end of 2026. The acquisition is expected to be modestly accretive to adjusted EPS in 2024, factoring in incremental interest expense and normal purchase accounting adjustments. We expect adjusted EBITDA margins to be accretive by 2027. We funded the transaction with a combination of cash and borrowings on our line of credit. As previously mentioned, on a pro forma basis, including the transaction, our leverage ratio is less than 0.1x, leaving us ample flexibility to implement our capital allocation strategy. With that, let me turn the call over to Shashank, who will address our third quarter results and our fourth quarter and revised full year outlook. Shashank?

[Shashank Patel, executive]

Thanks, Bob, and good morning, everyone. Please turn to Slide 6, and I will review the third quarter's results. Sales of $504 million were up 3% on a reported basis and flat organically. Organic growth of 1% in Americas and APMEA was offset by a 1% organic decline in Europe. Foreign exchange, primarily driven by a stronger euro, increased year-over-year sales by roughly $6 million or 1%. Sales from our Inver acquisition added $9 million or 2 points and are reported within the APMEA region. Adjusted operating profit was $91 million, up 10% compared to last year and adjusted earnings per share increased 14% to $2.04.Adjusted operating margin of 18% was up 120 basis points as price, favorable mix and productivity more than offset inflation, lower volume and incremental investments. We're able to deliver 120 basis points of margin expansion despite a tough comparison to the third quarter of 2022 and the dilution of the Enware acquisition in the quarter. Interest income in the quarter exceeded interest expense and contributed an incremental $0.06 per share versus the prior year.The adjusted effective tax rate was 25.4%, 10 basis points favorable to the third quarter of 2022. Our free cash flow year-to-date was $182 million as compared to $67 million in the first 9 months of last year. The cash flow increase was primarily due to higher net income and a lower amount of working capital investment. We expect solid free cash flow in the fourth quarter and reiterate our full year goal of achieving a free cash flow conversion of 100% or more of net income as previously communicated.The balance sheet remains strong and provides us with ample flexibility. Our net debt to capitalization ratio at quarter end was negative 22%. As Bob mentioned, when adjusted for the Bradley acquisition that closed last week, the pro forma net leverage is still healthy at 0.1. During the quarter, we repurchased approximately 22,000 shares of our Class A common stock for $4 million. And year-to-date, we have repurchased approximately 69,000 shares of Class A common stock for $12 million. There is approximately $16 million remaining under the current stock repurchase program that was authorized in 2019 and $150 million remains available under the stock repurchase program authorized in July 2023.Please turn to Slide 7, and let me provide a few comments on the regional results. Americas organic sales were up 1%, slightly better than we expected due to a tough prior year comparison. As a reminder, Americas grew 13% in the third quarter of 2022. Solid growth in our nonresidential core valve products was largely offset by declines in gas connectors, rated heating applications and commercial marine instrumentation. In addition to the tough comps, weakness in single-family residential new construction was a contributing factor. Adjusted operating profit increased by 13% and adjusted operating margin increased by 260 basis points.The margin expansion was driven by price, favorable mix and productivity, which more than offset volume declines, inflation and incremental investments. Europe organic sales were down 1% as expected. Reported sales were positively impacted by 7% from favorable foreign exchange movements. Growth in our German OEM business and our wholesale business in France and Benelux was more than offset by declines in Scandinavia and Italy with a reduction of government subsidies had an unfavorable impact.Operating margin declined by 190 basis points as price and productivity were unable to fully offset inflation, investments and volume deleverage. APMEA delivered 1% organic growth. Reported sales growth of 33% was negatively impacted by 4% from unfavorable foreign exchange movements and favorably impacted by 36% or $9 million of acquired Enwave sales. Double-digit growth in Australia and the Middle East was more than offset by a double-digit decline in China due to weak residential underfloor heating sales and project timing in data centers.Adjusted operating margin increased 70 basis points due to higher affiliate volume, price and productivity, which more than offset inflation investments and the dilutive effect of the Enware acquisition. Slide 8 provides our assumptions about our fourth quarter and full year outlook. First, let's cover the fourth quarter outlook. As Bob mentioned, we'll have a tough comparison to a strong fourth quarter in 2022, where we grew organically by 11%. We estimate consolidated organic sales may be down 1% to down 6%. We expect Americas may be down low single digits and Europe down mid- to high single digits, offset partly by low single-digit growth in APMEA.This reduction in growth rates is due to the anticipated softening of underlying market conditions in Europe. As previously mentioned in the Americas, we expect continued weakness in gas connectors, radiant heating applications and commercial marine instrumentation. In APMEA, the acquisition of Enware is expected to contribute $9 million of sales. In the Americas, Bradley is expected to contribute approximately $30 million of sales as Bradley is seasonally slower in the fourth quarter.We estimate our adjusted operating margin could range from 15% to 15.6% for the fourth quarter, up 70 basis points to 130 basis points versus the prior year. The increase versus prior year is due to price, favorable mix and productivity that are more than offsetting the reduced volume, incremental investments of approximately $7 million and the approximately 90 basis points of dilution from the Enware and Bradley acquisitions. The sequential decline in operating margin from Q3 is driven primarily by the impact of volume deleverage, incremental investments, typical seasonality and acquisition dilution Note that Bradley a similar seasonality to Watts and we expect lower operating margin in the fourth quarter. We also expect customary purchase accounting expense, including incremental depreciation and amortization of approximately $2 million to $3 million. Corporate costs should be approximately $14 million. Interest expense net of interest income should be approximately $1.5 million for the quarter, including interest associated with our borrowings to fund the Bradley acquisition.The adjusted effective tax rate should be approximately 25%. We are assuming a 1.06 average euro-U.S. dollar FX rate for the fourth quarter versus the average rate of 1.01 in the fourth quarter of 2022. This implies a Q4 European increase of 5% year-over-year, which equates to an increase of approximately $6 million in sales and $0.02 a share in EPS versus the prior year. Now let's cover the updated full year outlook. For the full year 2023, we expect our organic sales growth to be flat, consistent with the midpoint of our previous guidance, which was a range of minus 2% to plus 2%.As previously mentioned, we estimate sales of approximately $30 million from Bradley. In addition, we now expect approximately $26 million of acquired sales from Enware slightly ahead of our previous guidance. We are also increasing our full year adjusted operating margin expansion to a range of 120 basis to 130 basis points compared to our previous outlook of plus 30 basis points to plus 90 basis points. This represents an increase of 65 basis points to the midpoint of our previous guidance. We now expect our 2023 operating margins to be between 17.6% and 17.7%.We expect our solid results year-to-date will partially mitigate the lower margins in the fourth quarter due to seasonality, volume deleverage, incremental investments and the approximately 40 basis points of dilution from the Enware and Bradley acquisitions. Our free cash flow expectations are anticipated to be in line with our previous outlook and should meet or exceed 100% of net income. We are assuming a 1.08 average euro-U.S. dollar FX rate for the full year versus the average rate of EUR 1.05 in 2022. This would imply an increase of 3% in Europe sales year-over-year and equates to an increase of $8 million in sales and $0.03 a share in EPS for the full year versus the prior year.Regarding other key inputs for the full year, we expect corporate cost to be approximately $54 million for the full year. Interest expense net of interest income should now be approximately $2 million for the year, including interest associated with our borrowings to fund the Bradley acquisition. Our estimated adjusted effective tax rate for 2023 should be between 24% and 25%. Capital spending is expected to be approximately $35 million. Depreciation and amortization should be approximately $45 million for the year, including the incremental depreciation and amortization from the Bradley acquisition. We expect our share count to be approximately $33.5 million for the year. Now let me turn the call back over to Bob before we begin Q&A. Bob?

[Robert Pagano, executive]

Thanks, Shashank. Please turn to Slide 9. I'd like to summarize our discussion before we address your questions. We're excited about the addition of Bradley to our family of brands. The acquisition expands our addressable market and enables us to offer front-of-the-wall solutions to our customers. Integration is well underway and progressing nicely. The third quarter was better than we anticipated with record sales, operating margin and earnings per share supported by price and favorable mix. Due to our strong year-to-date performance, we are increasing our full year operating margin outlook.We continue to monitor the slowing global economic indicators and are staying close to our customers. We are confident in our ability to execute in this uncertain environment. Our strong free cash flow generation and balance sheet continues to provide flexibility to execute our disciplined capital allocation strategy. With that, operator, please open the lines for questions.

[Operator]

Thank you. [Operator Instructions] Your first question today comes from the line of Michael Halloran with Baird.

[Michael Halloran, analyst]

So let's start on the Bradley acquisition, philosophically, my question is, you look at the product and the content, it's a little bit more in front of the wall relative to maybe core portfolio. Now I can certainly see the overlap with a lot of the maintenance room-type work you do and how much content you have in that area. But I'd be curious to understand if you're thinking more broadly about the solutions that you're offering today and how you think this complements what the existing business looks like. Basically, are you thinking more in front of the wall and then just a little more detail on how this fits with what you have already?

[Robert Pagano, executive]

Yes, Mike. So yes, certainly, we really like the acquisition with Bradley. It's specifiable products in some great markets. And yes, it expands our opportunity in front of the wall and allows us more content inside of a commercial building. So we're excited about the acquisition. Teams are well on their way, and I'm excited to have them part of our portfolio.

[Michael Halloran, analyst]

Just expanding on that a little bit, Bob, does that mean that you're widening the aperture a little bit for what you look at from an acquisition perspective relative to history? Or has this been this broadening out has been in the works for a little longer than I realized?

[Robert Pagano, executive]

No, I think we'll continue to look at expanding our portfolio. Again, it's right in our core markets, residential, commercial and light industrial related to safety. So yes, we're opening our apertures to that, but I don't think you'll see us wake up and be in the oil and gas industry. So again, more closer to the core to us.

[Michael Halloran, analyst]

Okay, thanks for that. And then second one would just be along the non-res side of the business. I'm curious to see how you think this is going to play out. Certainly recognize all the comments you made in the prepared remarks, but my question is going to be twofold. One, where do you sit in the life cycle from a project activity perspective, more early mid-late cycle within the project life? And then secondarily, when you look at that, how are you thinking about the starts and what that backlog for the newer project activity can look like as we head to next year?

[Robert Pagano, executive]

Yes, Mike. So when I look at our portfolio, we're in every segment of that from the beginning, middle end and with Bradley certainly closer to the very end on that stuff. So we're watching it. Remember, the 60% to 65% of our business is repair replace. So that's a nice steady annuity with our large installed base. But as we're looking at all this, we watch the same indicators as you have. But the other indicator that we watch her, how busy are contractors, especially in North America. And they seem to be very busy. Our product is agnostic to a particular market. So if the office is down, we shift to maybe data centers as an example. So wherever there's construction and we watch the construction backlog of our customers and understanding where that is. So in North America, that's healthy.And again, drains, which as you know, is a leading indicator. We saw some softness in that. And a little bit in September, but not really bad. So again, I think we watch just like everyone else, all these leading indicators. But right now, in particular, North America is holding up.

[Operator]

Your next question comes from the line of Nathan Jones with Stifel.

[Adam Farley, analyst]

Thank you, this is Adam Farley on for Nathan. My first question is on margins. Margin expansion has been much higher than the level in launch's long-term plan. Have we reset the bar on margins to a new level outside of a potential recession impact? And do you believe that you can deliver that long-term 30 to 50 basis point target with maybe 2023 as a rebased starting point?

[Shashank Patel, executive]

And I think you're looking at the long term, over the last 3 years, certainly, we've had a very good margin expansion over the last 3 years. And that was driven by, obviously, volume leverage. Our volume is up significantly since the 2020 pandemic year. So we had good volume leverage, and then we've had good price and productivity over cost. We've got good margin expansion from that. As we look to the future, we still make the case that over the next 5 years, we're still going to be driving 30 to 50 basis points of margin expansion. And that's again, price and productivity and volume leverage over cost inflation. That's our target.

[Adam Farley, analyst]

Okay, thank you for that. And then shifting gears. Post the acquisition of Bradley, your balance sheet is still very healthy. Is there a period where you need to focus on integration and synergy generation? Or could you potentially be right back in the M&A market immediately?

[Robert Pagano, executive]

Well, listen, we certainly have the balance sheet to do further M&A. But you never can predict the timing of M&A. I'm not afraid to do M&A. We have a great team in our side of our organization that's capable of doing more. So Bradley is just one acquisition. So we continue to nurture our pipeline and the pipeline is still full. So we'll continue to watch and monitor. But as you know, you never can predict acquisitions. So we'll keep monitoring that and we'll see what happens.

[Operator]

Your next question comes from the line of Ryan Connors with North Coast Research.

[Ryan Connors, analyst]

I wanted to talk about, go back to that question, the prior question there on gross margin, look at that from the standpoint of price and how well you've continued to do in terms of price capture and price realization, even though you're stacking multiple years of price increases on top of each other now. So it's been very impressive. Can you just give us some perspective on what's enabling that? Is the market just really that tight in terms of the supply side because it does seem like the demand side has moderated a little bit, at least in residential. Any color you can give us about how pricing has held up so well?

[Robert Pagano, executive]

Ryan, one of the things that we've really focused on, we've been investing significantly in smart and connected products, and we're having a higher value proposition to our customers. So that's one of the things that allows us to drive pricing in the marketplace is because we have a differentiated solution to our customers. So I think that's been the big focus, which is helping support that.

[Shashank Patel, executive]

And the other thing, Ryan, this year, the other thing that's benefited us is certainly on the cost inflation side, if you think about labor costs, they're still inflating. But on the commodity side, commodities have been softer than we had anticipated. Freight has also logistics has been softer than we had anticipated. That's helped the margin story as well.

[Robert Pagano, executive]

And the last thing I always want to add is, from a mix point of view, residential is lower margin than commercial. So our residential and OEM business has been down and our commercial business has held steady or up, so that we're having a favorable mix in margin. So we got to watch that as residential starts coming back.

[Ryan Connors, analyst]

Okay. That's good color. Secondly, on Bradley, just going back to that, looking at that more from the perspective of your channels to market and how Bradley differs or is similar to your existing product line? In other words, are there different set of distributors and channel partners there? Are there synergies potentially there? Or on the other hand, are there complications there with trying to integrate all that. Anything you can tell us about how these products from Bradley go to market versus your legacy portfolio?

[Shashank Patel, executive]

Well, a lot of it goes through wholesalers, which are the same wholesalers. We deal with every single day. So some of the rep channels are different, but we're maintaining those rep channels and especially on the safety side. The safety channel is different from what we've traditionally done. So again, overall, we feel this is very complementary to what we're doing. And we haven't built very much sales synergies on purpose, I don't believe in sales synergies. So if they happen, they happen, we'll hold our team accountable for them, but I don't do deals based on sales synergies. So this is driven by cost synergies.

[Ryan Connors, analyst]

That's a good prudent approach. Much appreciate it. Thanks for your time.

[Operator]

Your next question comes from the line of Jeffrey Hammond with KeyBanc.

[David Tarantino, analyst]

This is David Tarantino on for Jeff. Maybe back on Bradley and to attack it maybe a little bit of a different way. Could you talk about how it positions you guys in the front of the wall relative to what the competitive landscape looks like there and how you win in that market?

[Robert Pagano, executive]

Well, Bradley is a leading brand in that market. It's known for its high quality, innovative products and the higher end of the product, which is very similar to the Watt's portfolio. So quality, innovation is exactly what they are and a brand that's been over 100 years old. So again, a large following, and that's what we really liked about the acquisition as a leader in its prospective area.

[David Tarantino, analyst]

Great. And then maybe sticking with Bradley, could you talk a little bit more about the cost synergies and the cadence you expect them to show through and where the biggest opportunities are?

[Robert Pagano, executive]

Yes. We noted that we have about $12 million of cost synergies, we think probably 40% next year, 40% and then 20% at the very end. A lot of those are, as I said in my prepared remarks, the One Watts performance system, which is really focused on lean supply chain and our global sourcing, obviously. So those are key attributes. The teams are working them hard right now, and we have line of sight to getting to all of them.

[David Tarantino, analyst]

Great. And maybe if I could sneak one last one in. Could you maybe give a little bit more color on what you're seeing on the ground in Europe? It seems like the guide implies some moderation there. And I think the results there have been surprisingly resilient to date?

[Robert Pagano, executive]

Yes. Europe in the first half of the year was performing very well, leveraging a lot of what I call the subsidies, especially in Italy. We're seeing some of those subsidies starting to slow down. And in September and October, we saw some further softening on the new construction side of that market. So we're watching that very closely. It's held up longer than we expected it to, which has been a pleasant surprise. But we're starting to see them slow down. I think a lot is dependent on how cold a winter they're going to have. Last year, they had a mild winter. So people had excess funds to work on energy-efficient products inside their homes. And I think those incentives are tailing off, but we'll see if new incentives are put in next year. But right now, we're being cautious based on our order input, in particular, in September and October is why we're being a little cautious on Europe right now.

[Shashank Patel, executive]

And the other area, we saw strength in OEM channels in Germany, but that started softening up as well, and that's what we anticipate in our fourth quarter outlook.

[Operator]

[Operator Instructions] Your next question comes from the line of Michael Anastasiou with TD Cowen.

[Michael Anastasiou, analyst]

Just wanted to hit Bradley one more time. Just curious on how this asset fits into your smart connected strategy. I know you mentioned exposure potentially just some new distribution channels, but just specifically on the value-add front, just curious if there's any specificity you could provide there?

[Robert Pagano, executive]

On the Spartan Connected front, I think that's an opportunity for Bradley. They have smart products, obviously, with their touchless bases, et cetera. But I think what we'll bring to Bradley is our connected strategy. I think we can leverage our connected strategy with them, and we'll further their initiatives around that area. So that's a key focus area. We've already teams have been already discussing that and leveraging our capabilities on that. So I believe that's exciting and can tie into our overall ecosystem.

[Michael Anastasiou, analyst]

Great. And maybe you could just dive a little bit deeper in terms of like the end market breakdown. Are you able to provide any specifics, whether it's like industry, geography or aftermarket profile?

[Robert Pagano, executive]

Yes. So primarily North America, I would basically say half is new construction, half is repair and replacement. And as we talked about before, they're highly in institutional public works and in the industrial channels, which were all favorable, which we liked. So those are nice markets that we play nicely into.

[Michael Anastasiou, analyst]

Great. And just one more, if I may. I forgot this was covered earlier in the call, but what was price contribution for the quarter?

[Shashank Patel, executive]

It's low single digits in the third quarter.

[Operator]

Your next question comes from the line of Joseph Ahlersmeyer with Deutsche Bank.

[Joseph Ahlersmeyer, analyst]

My first one is on the commercial business. I fully appreciate your short-cycle nature here and pointing to the Dodge and the ABI, I understand that as well. But how are your conversations with your customers going at this point? Does that rhyme with what you're seeing in those indices? Just any color you could add there about further outlook into the early parts of next year?

[Robert Pagano, executive]

Yes. I think what we're hearing from our customers is, especially the GCs is they're busy. They've got a strong backlog. And although they're concerned way out, they're less concerned in the near term based on their backlogs of what they have right now. So I think the one area we're watching and I noted is the multifamily side of the business because it's been strong, a whole bunch of capacities coming online, and we're watching that very carefully.So that's probably the area we're watching, but there's still some healthy backlog, especially regionally. Again, you have to look region by region in each area but so far, so good, but we're reading the same thing. So sooner or later, we believe some of this is going to slow. I don't expect a major drop. We would see that based on backlogs and we also are watching new construction hiring, and that's also been decent. So again, we watch all those leading indicators as proxies for what it could be 3, 6, 12 months out.

[Joseph Ahlersmeyer, analyst]

Right. I appreciate you calling out the timing dynamics in multifamily. We've heard from others that it's possible even with the starts that you're seeing now that backlogs will get you through potentially most of 2024. Curious if you would maybe agree with that, particularly for some of the later stage things for multifamily? And then just a follow-up question on your costs. I think you called out inflation in the quarter. I'm just wondering if you would expect that to turn to deflation next year and if that should hit a little bit faster since your inventory turns are improving?

[Robert Pagano, executive]

I think on the multifamily front, I think there's confidence maybe into the first quarter of next year. At that point, I think everybody continues to look at what their backlogs are and whether they'll come off of a multifamily construction and go into institutional. So again, labor shifts and construction shifts to where the markets are. So again, we're not hearing directly multifamily, but they're saying it's not as robust as it was and their backlogs are coming down.

[Shashank Patel, executive]

On the inflation question, so certainly, our expectation is inflation will be lower next year as far as compensation benefits, et cetera, but there'll still be inflation out there. I think your point on deflation on commodities, I think that's highly dependent on China and other Chinese economy does, recognizing that a lot of copper and steel is used in China. So I think that's something that we don't know the answer on that. We'll just see how the markets react. But for excluding commodities, we do expect a lower level of inflation.

[Operator]

[Operator Instructions] We will pause for any loss moment questions. There are no further questions at this time. Bob Pagano, I turn the call back over to you.

[Robert Pagano, executive]

Thank you. Thanks for taking the time to join us today. We appreciate your continued interest in Watts and look forward to speaking with you again at our fourth quarter earnings call in February. Have a good day, and stay safe.

[Operator]

This concludes today's conference call.