Watts Water Technologies, Inc. Q4 2008 Earnings Call Transcript

Feb.10.09 | About: Watts Water (WTS)

Watts Water Technologies, Inc. (NYSE:WTS)

Q4 2008 Earnings Call

February 10, 2009 5:00 pm ET

Executives

Kenneth R. Lepage – General Counsel & Secretary

Patrick S. O'Keefe – Chief Executive Officer & President

William C. McCartney – Chief Financial Officer & Treasurer

Analysts

Michael Schneider – Robert W. Baird & Co. Incorporated

Keith Hughes – SunTrust Robinson Humphrey

Jeffrey Hammond – Keybanc Capital Markets

Christopher Glynn – Oppenheimer & Co. Inc.

Todd Vencil – Davenport & Company

Ryan Connor – Boenning & Scattergood

[Jay Leigh] – Jana Partners

Brian Meyer – Robert W. Baird & Co. Incorporated

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2008 Watts Water Technologies Earnings Conference Call. My name is Michelle, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session toward the end of this conference. (Operator instructions)

I would now like to turn the presentation over to your host for today’s call, Mr. Kenneth Lepage, General Counsel. Please proceed sir.

Kenneth R. Lepage

Thank you. Before Pat and Bill begin their presentation, I want to inform you that various remarks they may make about the company's future expectations, plans and prospects constitute forward-looking statements under the Safe Harbor provisions of 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 our Annual Report on Form 10-K for the year-ended December 31, 2007 filed with the SEC, and other reports we file from time to time with the SEC.

In addition, forward-looking statements represents our views only as of today and should not be relied upon as representing our views as of any subsequent date. While we may elect to update forward-looking statements in the future, we disclaim any obligation to do so and therefore you should not rely on these statements as representing our views as of any date subsequent to today.

During this call, we may refer to non-GAAP financial measures. These non-GAAP 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 today’s date relating to our fourth quarter 2008 financial results, a copy of which may be found in the Investor Relations section of our website www.wattswater.com under the heading press releases.

I’ll now turn the presentation over to Pat and Bill.

Patrick S. O'Keefe

Thank you, Ken, and good afternoon everyone. Welcome to the fourth quarter conference call, and thank you for joining us today. We will follow our usual format after my remarks, Bill McCartney; our CFO will provide you with some color on the financial highlights for the company, both for the quarter and the year. Bill will also discuss individual sector results. Then we will address your questions.

First I would like to take some time to highlight the 2008 operating initiatives that made an impact on our business in 2008 and we will continue to have a positive impact on the business as we move into 2009. I would also like to update you on new programs this year.

Our 2008 goal of maximizing cash flow and promoting operating efficiencies and productivity proceeded well. Regarding cash flow, I’m again pleased to inform you that we continue to generate positive cash flow at record levels for the company. For the entire year, we generated positive cash from operating activities of approximately $146.4 million, which compares favorably to $91.7 million of cash generated from operating activities in 2007.

Our focus on working capital management generated approximately $68 million more in cash in 2008, as compared to 2007. Our free cash flow for 2008 was approximately a $121 million, or a 120% more than 2007’s free cash of approximately $55 million. This accomplishment was a result of focus and dedication by many hundreds of people throughout the Watts organization and I would like to thank them for their effort.

We intend to continue our focus on cash management as we move into 2009. Squeezing cash from working capital has only strengthened our conservative capital structure and our liquidity position. At December 31, 2008 our net debt to capital ratio was 22.4 somewhat higher than 2007 only because of the cash we used in 2008 to purchase Blücher Metals and buyback stock through our stock repurchase program. Blücher has and we will continue to be a strong contributor and our stock repurchase program has been suspended for the time being.

At December 31, we had approximately $166 million of cash on hand. We had approximately 260 million of available credit from our bank group to fund acquisitions and operation. And our next large debt payment is not due until May of 2010. I think, we are in a solid financial position to work through what a shaping up to be a challenging 2009.

Let me now update you on various cost reduction efficiency programs and new initiatives [that was] undertaken this year. As I mentioned last quarter, we undertook a reduction in force in the U.S. during Q4, as an immediate reaction to the softness that we were seeing in the commercial and residential market. This plan was substantially completed in November resulting in a one-time severance cost of approximately $2.2 million and providing annual savings of approximately $10 million.

The second initiative we mentioned on our last conference call was a salary freeze in all U.S. location at least through September of this year, savings approximately 2 million in foregone salary increases.

In addition to the salary freeze, we’ve recently announced to employees that effective February 1, 2009 all salary employees within a Watts regulated business unit, and salaried corporate personnel including all executive will be subject to a temporary 5% reduction in base salary for the foreseeable future.

Further our direct and indirect production staff will be subject to an unpaid furlough of one to two additional days per month. This action is being undertaken in lieu of additional workforce reductions and we'd be reevaluated on a regular basis by our senior management. We expect to save approximately $200,000 per month, while the program is in effect.

Other operations not affected by the various personal decisions including our international subsidiaries, are all closely reviewing their near-term activity levels. We will have contingency plans in place to reduce personnel costs should their business outlook decline significantly from planned levels. Lastly I briefly spoke during the third quarter call about our footprint review being undertaken to further consolidate our manufacturing operations.

As you probably noted in today’s press release, our Board has approved a program to potentially remove three rooftops from their existing manufacturing footprint in North America and China. The program will involve moving operations to existing facilities or centralizing operations for particular product line into a new central location.

At this time, I am reluctant to provide you with more details on the exact locations, because employees will be affected, have not yet been fully informed. We expect the cost of these moves will be approximately $17.2 million after-tax, including severance relocation asset write-downs and one-time charges. We expect to spend approximately $4.8 million in capital to consolidate these operations. And our net after-tax annualized savings will be approximately $4.8 million.

We expect that approximately 400 positions will be eliminated by the consolidation. We anticipate that most costs will be incurred in 2009 with some overhang into 2010. We expect the timeline for completion of these projects is approximately 10 months, while savings will not be realized until 2010. We expect the projects will be self-funded through the sale of buildings and other assets being disposed. We believe these initiatives will put us in a stronger competitive position when our markets do bounce back.

Regarding ongoing operational improvements, we have and we will continue to embed Lean & Six Sigma methodology in our operation. As I mentioned last quarter, Lean leaders and steering teams have been put in place at the key sites throughout the U.S. Lean scorecards have been initiated that focus on customer satisfaction, cost savings, inventory movement and other key metrics we are trying to address through the lean process. In 2009, we hope to develop a Watts Six Sigma certification program and we remain committed to this endeavor and are pleased with our early successes.

Let’s talk about the results for the quarter. But first let me address one pending matter. We have announced that we expect to take a non-cash impairment charge for goodwill between $0 and $22 million, which will reduce our preliminary net income for the fourth quarter of 2008 and for the entire year.

The impairment was determined as part of our annual review of goodwill and intangibles, the impairment relates to reporting units that primarily sell filtration devices into the residential and light commercial marketplace.

This impairment results from lower expected growth rate of the business in general, but specifically from our business located in Southern California. Business in 2008 has declined due to loss of sales with key customers as a result of recent customer bankruptcy and to tighter credit markets reducing sales into the dealer marketplace.

Also proposed legislation, which would have been water softener products that produce salt was being proposed in California. Although the Governor of California, vetoed the proposed legislation, the results of the ongoing debate negatively impacted our sales in 2008.

Further California municipalities can unilaterally determine if they want such to ban such products, which would possibly reduce our future sales prospects. Absent, the pending goodwill charges, our results for the fourth quarter were in line with our internal expectations and generally consistent with what we experienced in the markets during the third quarter.

The macro seems that continue to affect our business were a slowdown in the commercial sector exaggerated by tighten credit markets. Residential market looking for a bottom especially in the U.S. and the European business making nice gains on the back of its alternative energy offerings.

One concern that materialized during the quarter was the softness we experienced in the U.S. wholesale channels. Sales in this channel declined 5% in the fourth quarter, whereas in the second quarter and third quarter wholesale channel sales were basically flat.

My feeling is that wholesalers were have done some destocking, but the bigger issue here is that the commercial end markets have now slowed substantially. This recent phenomena requires us to take a look and revise our internal outlook for 2009. I don’t think I need to preface my latest outlook with any dire macroeconomic statistics from reading the papers. I'm show you know that none of the trends are positive. They provide little insight into when the U.S. and the growing worldwide recession may end.

Therefore, from a consolidated perspective our best guess at this point is that our organic top line sales may decline in the low double-digit consisting with the last call, we believe our 2009 challenge in North America will continue to be in the commercial market.

Last quarter, it was anticipated the U.S. commercial activities would decline between 10 and 12% with a 5% reduction in residential activity. It's what we are seeing recently in sales activity in the wholesale channel we maybe optimistic. We now anticipated decline in organic sales volume in North America in the low to mid double-digit in 2009, as compared to 2008.

Europe was again a bright spot for the company, as the fourth quarter organic growth was approximately 8%, which was double the organic growth in the third quarter and second quarter as well. Continuing a trend of increasing sales of our products and packages sold into alternative energy marketplace. However, we recently see order rates in Q1 softening from those experienced during the second half of 2008. We expect further weakening in the European core business during 2009 as a recession spreads to all major industrial nations.

Some of this weakness will be offset by an inclusion of Blucher for the entire year, and alternative energy product growth. Another issue that impacts the fourth quarter and we expect the impact 2009 European results is the foreign currency swing. Q4 FX rates negatively affected our fourth quarter results by approximately $0.03 as compared to the fourth quarter of 2007, much of the loss was related to the weakness in the Euro against the U.S. dollar.

Based on the average 2000 exchange rate of approximately 1.46. We anticipate that the euro will decline in value against the U.S. dollar by approximately 15% in 2009.

Now, let’s talk about China. As we mentioned during our last call, one of the issues we faced in China was the underperformance of one of our facilities in Tianjin. Approximately 52% of the business related to intercompany activities with Watts US and European sister company and 48% was third-party sales into the domestic Chinese butterfly valve market.

In August, we entered into agreement to sell the domestic business to a third-party while transferring the intercompany business to another Watts facility in Tianjin. In October, we entered into a second agreement with the buyer to effectively turn control of the operation over to them immediately.

This sale significantly reduced the operating loss being recognized in our Chinese segment. During the fourth quarter, our Chinese segment realized an operating profit of approximately $900,000. As for 2009, we continue to expect moderate organic sales growth in China led by Changsha, which makes large diameter hydraulic butterfly valves used in the domestic infrastructure projects.

Order rates at Changsha remain strong. Our China companies are also exploring new markets and focusing on improving service to help grow their domestic sales. There may be some disruption in sales activity due to the manufacturing footprint issue noted previously.

We have recently hired experienced program managers to oversee the footprint project. So, we hope to keep this disruption to a minimum. I would like to address how we see the overall margin trending during the coming year. In general, we anticipate margins will be tighter during the first half of 2009, with a combination of higher copper costs and continued under-absorption in the U.S. and China plants.

As we discussed in the past, our inventory takes approximately four to five months to turn. Therefore, we expect some older and higher cost copper to affect Q1 and Q2 margins.

As discussed earlier, the benefits of our footprint reduction will not be realized into 2010. So, we will continue to be challenged throughout 2009 by plant under-absorption. But as higher cost copper, works its way through our plants, we see margins expanding during the second half of 2009 offset by continued pressure from under-absorbed plants and some inefficiencies due to plant move.

Another challenge we faced which could affect margins is pricing pressure from our customers given in the recent declines in commodities. We believe that these pricing issues are manageable and will not result in across the board reductions in our selling prices.

I believe the parties throughout the selling channel will be slow to move on price reductions. Finally, I'd like to update you on several programs that have been discussed previously. As announced last quarter, our stock repurchase program was temporarily suspended in October as a means to conserve cash.

In 2008, we invested $44.5 million in the program and since inception we have invested approximately $68.1 million to repurchase approximately $2.45 million shares of the company stock. The accretion to earnings per share from repurchasing the shares in Q4 ’08 was $0.02.

Next, let me address the acquisition program. Consistent with our discussions on the last call, we are somewhat in a holding pattern. Although, we continue to make inquiries and are looking at several specific targets. We believe that we are in an advantageous position given our cash availability to get a deal completed when the right targets or targets are identified.

Finally, regarding the progress on our 2007 restructuring program. In Q4, we took an additional pre-tax charge of approximately $600,000 related mostly to asset write-offs and relocation costs in the U.S. In general, we are on target regarding the timing and implementation of various restructuring programs in the U.S. and China. Our European restructuring program was delayed from March of 2008. It is expected that we will start this program and earnings during 2009.

Now, let me turn the call over to Bill McCartney, who will take you through the financial highlights. Then we will answer your question. Bill?

William C. McCartney

Okay, thank you Pat. As you know from reading the press release, revenue were $347 million was up just slightly about 0.5%, $1.8 million. We look at the breakout there, from an organic standpoint, we had negative growth of $1.7 million foreign exchange was unfavorable at $13.2 million, the acquired revenue of Blücher and TGI totaled $19.9 million and then the disposal of TWT reduced our revenue by $3.2 million in the quarter for a total of $1.8 million.

Our net income excluding restructuring was $15.6 million, a decline of 30%. With that results in EPS excluding restructuring of $0.43, compared to consensus estimate of $0.42.

In our restructuring in the quarter $1.7 million after-tax, primarily composed of the $2.2 million that Pat mentioned, which is a pre-tax number for the severance surrounding our reduction in force.

Moving on to North America, revenue for North America was $202 million, which is a decline of about $11 million, or 5%. Looking at the $11 million, we had negative growth of $8.3 million, negative foreign exchange unfavorable if you will of 3.3, which is the Canadian dollar, then slight offsets from TGI acquired in November of about a $1 million, which comes to about $11 million.

[As we normally do] we breakout North America we’re into both the wholesale and the retail segments for you. Wholesale in a $161.6 million is down $9 million, or 5% and that’s even down from third quarter, which wholesales of $178 million during the third quarter. I mean what we’re seeing in the wholesale, I mean pricing is steady but this is basically a decline in unit volumes and some destocking as well, and there’s an article today on Yahoo! that said the inventories due to destocking at the wholesale level or at the lowest level in many, many years. So, combination of the softness in the commercial markets starting to hit us, as well as wholesalers destocking.

On the retail side, revenue at $42 million is essentially flat with last quarter, last year’s fourth quarter and right now we’re hoping that retail is close to bottom [Inaudible] retailers where we sell our repair products for residential applications though essentially flat with last year’s fourth quarter.

On Europe $136 million for the quarter that’s an increase of $17.8 million, or 15% versus last year’s fourth quarter. Breaking out the $17 million from an organic standpoint, we increased 8%, $9.5 million offset by unfavorable foreign exchange of the euro of $10.7 million and then we include the acquisition of Blücher of $19 million. So those items totaled $17.8 or 15%.

When we look at the organic growth in Europe, the same story that we’ve been discussing with you over the last couple of quarters in that the alternative energy markets across Europe remain strong and all the Western European countries. And then somewhat offset by very soft markets in Eastern Europe we believe primarily driven by the poor economy and availability of credit in Eastern Europe.

Our acquisition of Blücher is doing well, and up to the plans in which we expected. China, $9.3 million has declined of $5 million or 36%. Looking at the factors there, organically we were down $2.9 million, or 20%, foreign exchange rates strengthen there. So, they contributed 800,000, and then the disposal of TWT reduced our revenue by $3.2 million in the quarter for the total of 5.3.

The average exchange rates we saw in China was $14.6 versus $13.5 last year. So, the one strengthen about 9% versus last year. But, when we look at the end markets themselves as Pat mentioned, the infrastructure market is still strong, we had some orders that will pushed out to customer request into the first quarter.

But the incoming order rate was fine, we have a strong backlog there, and the other market that we serve in China, are some of the commodity, plumbing markets and export markets out of China into other parts of South Eastern and Asia and Australia and what not and those markets were down as above 12%. The gross margin on the quarter, 33.8%, the margin is down versus last year’s fourth quarter of 35.3%.

What we see here is a couple of things. First of all, we have a bit of a mix towards Europe with the strong alternative energy sales and we see the softness in the U.S. commercial sales. So, as you know, commercial some of U.S. commercial, some of our higher gross margin and Europe’s margins typically run about 30 to 32. So, a little bit of an unfavorable mix.

Additionally, we reduced our production levels in the U.S. to reflect the lower volume. We had some unfavorable absorption variances. We did reduce inventory in the United States in the fourth quarter by $16 million. So, we did get some cash out of the deal, even though it did hurt us on the margin side.

The margin is up slightly from the third quarter, in which the margin was 32.7%. And there is two things really that impacted us, the one is the sale of TWT, which had very low gross margins, which we closed in October 18. And then in the third quarter, we had some purchase price amortization of Blücher with the backlog and the inventory write-offs and that is behind us, now that we come into the fourth quarter.

The SG&A at $84 million is down about $1.5 million versus last year. When we look at the components of that from an organic standpoint, we’re down $4 million, or 5%. Foreign exchange caused the reduction of $2 million, the disposal of TWT, restarts SG&A by $1 million and then the inclusion of the SG&A expenses of Blucher was $6 million. So, we are trying to leverage our SG&A with some of the cost reductions that Pat has been mentioning in his remarks and then offset with the acquired expenses of Blucher.

The operating earnings excluding the restructuring 9, 9.5% of revenue, or at $33.1 million which is a decline of $2.6 million versus last year’s fourth quarter and this is basically where we see the impact of the lower gross margin in the quarter due to the mix in the production levels partially offset by the reduced SG&A. But when you look at the $2.6 million and break it out into its components from an organic standpoint the reduced margin and reduced sales, decreased the operating earnings by $3.3 million change in the foreign exchange rates reduced by 2 million.

Blucher contributed almost $2 million, and then no long it having the losses that TWT increased our operating earnings by 800,000, and those items totaled $2.6 million.

Looking at the expense below the line for a moment, other income and expense. This year, we had $10.4 million versus last year at $3.2 that’s an increase of $7.2 million. Major components here we had reduced interest income, because of the use of the funds with acquiring Blucher and doing our stock buyback.

Interest expense decreased about 800,000, which is a function of lower interest rates. And then, we had about $2.5 million of charges associated with marking or working capital for market. And we had some copper and foreign exchange hedges, which we mark-to-market as well that had an impact of $1.8 million.

The tax rate in the quarter, down slightly versus last year at 28.9% versus last year at 31.5%. Predominately this is because of the income shift as a mix towards Europe, which has a lower tax rate then the United States. So, net income from continuing ops excluding the restructuring at $15.6 million, down about $6.5 million, or 30% which brings us down to earnings per share from continuing ops excluding restructuring at $0.43 versus last year at $0.57 declined of about 25%. And as Pat mentioned early, the $0.43 includes $0.02 of accretion from the buyback and unfavorable $0.03 because of the change in foreign exchange rates.

And then just a brief commentary on the cash flow before you open it for questions. As Pat mentioned free cash flow at $121 million, a significant improvement over the last year at $55 million. The main issue here being that working capital was a source of cash for us of $44 million, compared to last year working capital was a use of cash of 25. The improved working capital management had a $69 million swing in our cash flows for the year. Our depreciation and amortization for the year was $45 million.

So I think with that, we can open it up for any questions and Pat you can ask for either Pat or myself.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Michael Schneider with Baird. Please proceed.

Michael Schneider – Robert W. Baird & Co. Incorporated

Good afternoon guys.

Unidentified Company Representative

Hi, Michael.

Unidentified Company Representative

Hi, Michael.

Michael Schneider – Robert W. Baird & Co. Incorporated

Obviously conditions are tough. So, I guess maybe if we could just start by parsing out pricing contribution in the quarter. So we can understand what volumes are actually down maybe either by segment or by channel as well, if you have?

William C. McCartney

Well, in North America Mike the pricing was up maybe 1% or 2% versus last year. The rest of it was all units, unit declines. And I don’t have the specific breakout for Europe, but I think the answer would be something very similar where pricing was very modest. And the change really is in units. I mean, we are seeing, as Pat mentioned more pressure on pricing. So some of the price increases that we have talked about in the past are starting to be given away to remain competitive.

Michael Schneider – Robert W. Baird & Co. Incorporated

And can you give us a sense of what’s it looking like in terms of percentages, Bill. Are we talking low single-digit price declines or they are greater than that?

William C. McCartney

Well, in total it’s only a couple of point so far. It’s not a major issue and we’re trying to manage it, because we still have high cost copper in the inventory.

Michael Schneider – Robert W. Baird & Co. Incorporated

Okay. And then could you just give us a view in the January. And what the order trends look like again by segment and by channel. And then I guess just final question, if you could just comment on earnings run rate in Q1. Should we expect, I presume that sequentially, earnings will be down as they have been in the last three years. But should we also expect earnings to come in below the $0.39 of a year ago?

William C. McCartney

Yeah, I mean Mike as you can tell from Pat’s comments. I mean, the order entry rates we’re seeing a decline. So, as you know we don’t give specific guidance. But you can expect that earnings will be down in the first half, because of lower volume.

Patrick S. O’Keefe

Yeah, Mike the way I would describe it is we saw a leg down in terms of incoming order rates starting in November, continuing right through to today.

Michael Schneider – Robert W. Baird & Co. Incorporated

Okay. Thank you guys.

William C. McCartney

Okay, thanks Michael.

Operator

Your next question comes from the line of Keith Hughes with SunTrust. Please proceed.

Keith Hughes – SunTrust Robinson Humphrey

Thank you. Just first to clarify, and your comments you talked about revenue declines. At one point you said low to mid teens and then mid to high teens. Is that for 2009, and which segments were those referring too?

Patrick S. O’Keefe

Yeah. From a consolidated perspective, we’re looking at declines in the low double-digit. So, that’s consolidated worldwide. When you look at North America, okay, you’re looking at mid double-digits for 2009.

Keith Hughes – SunTrust Robinson Humphrey

Okay. And within that framework, I assume we will see destocking both in the North American retail channel, as well as in the European channels. Is that correct?

Patrick O'Keefe

Yeah. We think, we’ve seen quite a bit of destocking already in the North American channels, but we are anticipating destocking in the European channels, which has not been as brisk as it has been in North America.

Keith Hughes – SunTrust Robinson Humphrey

Okay. And any kind of pricing assumptions in those numbers, price decline assumptions?

Patrick O'Keefe

That’s what we would refer to as volume declines.

Keith Hughes – SunTrust Robinson Humphrey

Well, the outline, okay. And final question on the income statement, there’s an other category in fourth quarter of 4.8 million. Could you just briefly tell us what that is?

Patrick O'Keefe

Hold on.

Keith Hughes – SunTrust Robinson Humphrey

A lot larger than normally is?

Patrick O'Keefe

Below the line the other income and expense you mean?

Keith Hughes – SunTrust Robinson Humphrey

Yeah, after minority expense, there is an other 4.8.

Patrick O'Keefe

Yeah, that’s where we, I mention Keith that would be we will be marking our working capital to market, foreign exchange and we have some foreign exchange hedges and copper hedges that we’re marking-to-market there.

Keith Hughes – SunTrust Robinson Humphrey

All right. Thank you.

Patrick O'Keefe

Thank you.

Operator

Your next question comes from Jeff Hammond with Keybanc Capital Markets. Please proceed.

Jeffrey Hammond – Keybanc Capital Markets

Good afternoon guys.

William C. McCartney

Hi, Jeff.

Patrick S. O’Keefe

Good afternoon, Jeff.

Jeffrey Hammond – Keybanc Capital Markets

I just want to come back to price. It sounds like, just to clarify you got one to two points of price realization this quarter, is that correct?

William C. McCartney

Approximately.

Jeffrey Hammond – Keybanc Capital Markets

Okay. And would that have totally made up for your commodity inflation or will you in the whole on that still?

Patrick S. O’Keefe

Probably a break even in the quarter, it’s hard to say precisely but…

Jeffrey Hammond – Keybanc Capital Markets

Okay. And then for ’09 you’re not assuming any price good or bad…

William C. McCartney

Well, as we look into ’09 we’re expecting that unit pricing will decline. As we start to realize lower copper in the second half of the second quarter and into the third quarter we’re going to windup giving pricing back to be being competitive?

Jeffrey Hammond – Keybanc Capital Markets

And that’s captured into that low double-digit decline, all in.

William C. McCartney

We’re thinking we have unit volume decline as Pat mentioned in that range. Then you’ll have some unit pricing over and above that that shouldn’t affect profitability in the second half, that will affect profitability in the first half a little bit.

Jeffrey Hammond – Keybanc Capital Markets

Okay. How should we think about decremental margins on that volume decline? I mean before you think about the restructuring savings?

Patrick S. O’Keefe

Well, we usually use a figure here about 30%.

Jeffrey Hammond – Keybanc Capital Markets

Okay. Just shifting gears to the DIY, that business was, it looks like up in the quarter. Can you just talk about what drove that?

Patrick S. O’Keefe

It was essentially flat.

Jeffrey Hammond – Keybanc Capital Markets

Yeah, I would have thought that would have been under a lot more pressure. What do you see there that’s holding that up?

William C. McCartney

Well, our view is that market is primarily residential repair. It’s gone through a tremendous downturn already. And we’re hopeful that the retail side is being a bottom, we are not sure, but we are hopeful.

Patrick S. O’Keefe

We are also seeing and hearing from those large big box customers that our product categories in which we participate or not declining at the rate that the entire store is declining.

Jeffrey Hammond – Keybanc Capital Markets

Right. Okay, and then finally, can you just talk about order momentum in that alternative energy piece. Are you still seeing good order growth that gives you confident that grows, or is that softened up as well?

Patrick S. O’Keefe

No, we’re still seeing good growth in that marketplace. But last year, we had, what I would consider to be impact orders. Where there was orders that were given to us in order to build stock in the channel. And those impact orders have been fulfilled and they’ve gone through with sort of like a snake, swallowing its pray. I knew, we saw that go through the organization; we were a little bit behind in delivering those orders we caught up. So, now our on-time delivery rate is consistent with the incoming order rate, but it should be up overall.

Jeffrey Hammond – Keybanc Capital Markets

Okay, thanks guys.

William C. McCartney

Okay.

Operator

Your next question comes from Christopher Glynn with Oppenheimer. Please proceed.

Christopher Glynn – Oppenheimer & Co. Inc.

Thanks, good evening. On the production consolidation across North America and China. Can you talk about net production is coming back to the U.S. and quantify it to the extent possible?

William C. McCartney

Well, we're a little reluctant to be too specific right now. Because we have some plans that we’ve announced in a general way, but we have not announced specific plans internally to our employees and to the plans affected. So, we prefer to kind of weight on that, Chris.

Christopher Glynn – Oppenheimer & Co. Inc.

Okay. Just some production coming back or did you cover that, with your initial answer?

William C. McCartney

Let's consider it covered.

Christopher Glynn – Oppenheimer & Co. Inc.

That’s okay. And then just going back to Europe, Pat did you say call it a 15% change in the exchange rate or we are seeing a 15% headwind to European growth in ’09 from currency?

Patrick O'Keefe

We are seeing a 15% change in exchange rate.

Christopher Glynn – Oppenheimer & Co. Inc.

Okay. And what do you think that translates for you?

William C. McCartney

I think if you look at exchange rates, if they remain where they are right now for the rest of the year it’s probably about $0.20 headwind here.

Christopher Glynn – Oppenheimer & Co. Inc.

Okay. At segment margin basically?

William C. McCartney

Well, I'm talking earnings per share, I am sorry.

Christopher Glynn – Oppenheimer & Co. Inc.

Okay. And then I am not sure if you said – I didn't catch it the outlook for unit volume declines in Europe. Did you go into that?

William C. McCartney

Outlook for what Chris, I am sorry.

Christopher Glynn – Oppenheimer & Co. Inc.

Yeah, unit volumes in Europe

William C. McCartney

Well, I think we have mentioned that, I don’t think we said a specific number other than that. We’re seeing things starting to soften there. Yeah, so we are starting to see that the order entry rate soften in Q1 versus what we’ve been seen over the past couple of quarters.

Patrick S. O’Keefe

It’s probably more or likely to be mid single-digits.

Christopher Glynn – Oppenheimer & Co. Inc.

Okay. And last one just tax rate for ’09, place holder?

William C. McCartney

Yeah, I would say consistent with what we were for the – probably a point or two versus ’08.

Christopher Glynn – Oppenheimer & Co. Inc.

Okay. Great, thanks a lot.

William C. McCartney

Okay.

Operator

(Operator Instructions). Your next question comes from Todd Vencil with Davenport. Please proceed.

Todd Vencil – Davenport & Company

Good evening guys.

William C. McCartney

Hi, Todd.

Todd Vencil – Davenport & Company

If we think about China, thinking about that the piece that you’ve sold and leaving aside I guess the question of the footprint changes that you’re looking at I mean what’s kind of the base that we ought to be thinking about of sort of top line for going forward where I guess you’re looking for a bit of growth there but how much do we lose in that divestiture?

William C. McCartney

We lost about $12 million of revenue.

Todd Vencil – Davenport & Company

Okay.

William C. McCartney

And well, we were losing about $4 million a year at the operating line with that particular venture.

Todd Vencil – Davenport & Company

4 million up or 4 million down, now you were losing 4 million from that. Okay so, that’s sort of follows under my next question. So, if we take that, and we’re thinking about China, I mean would you expect to be just kind of given the footprint that you’ve got now and what you see in the business, I mean would you expect to kind of keep this small profitability that we’ve saw kind of in the fourth quarter?

William C. McCartney

Well, we still considered China to be not as profitable as we think it can be. Still very focused on improving the operations, we’re working with our colleagues in China on, Lean manufacturing and Six Sigma, right-sizing some of the facilities, so on. So I mean we’re not satisfied that China has completely turned the corner. We’re pleased to see that we’ve turned it profitable in the quarter. And that’s a result of selling TWT in some of the operating improvements that have been implemented. It’s a combination of both of those. But we’re going to continue to work on the operations.

Todd Vencil – Davenport & Company

So, if I take that Bill is that saying that you think you’re going to remain profitable and try to be more profitable or you’re going to be working for a little while to hold on to being profitable there?

William C. McCartney

I think we’ll see China become a little bit more profitable each quarter that’s our plan at the moment.

Todd Vencil – Davenport & Company

Got it. Thank you for that. And then kind of a one balance sheet question, and you may have covered this with some of your comments that I may not have just caught where this was falling, but you accumulated other comprehensive income that’s falling off pretty sharply in last couple of quarters on the balance sheet, what’s going on there?

William C. McCartney

That is a change in foreign exchange rates in what we wind booking for pension liability.

Todd Vencil – Davenport & Company

Got it. Okay and then on the U.S. business I thought – at first you said U.S. wholesales. Then you said for the whole U.S. you’re talking about top line declines in the low to mid double-digits, have I got that right. For all of North America?

William C. McCartney

We really I think we are talking about wholesale.

Todd Vencil – Davenport & Company

Okay, just to clarify, when you’re talking about mid double-digits that’s 50% or somewhere that would 50% is in the mid double-digit range, Is that right?

William C. McCartney

In mid teens.

Patrick S. O’Keefe

Mid teens.

Todd Vencil – Davenport & Company

Okay, that’s why I was asking that question.

William C. McCartney

A good question.

Patrick S. O’Keefe

Thank you.

Todd Vencil – Davenport & Company

That changes things a little bit, I will tell you. And then finally, a little bit of a flyer. But, reading through some of the stimulus plans are getting kicked around and goodness knows that they don’t know what it is going to look like yet, but some of the pieces that yes, Obama has talked about going all the way back to the campaign and the primaries was energy efficiency programs that sort of rehab a lot of government buildings or schools in the area of energy efficiency I mean is that something that you guys would have a particular angle on either from the standpoint of some of the things you have done in Europe or some of the things that you are doing in the U.S. do you think?

Patrick S. O’Keefe

Yeah, there is two things I'd say. One is that those units that we’re manufacturing in Europe. Some of them end up back here in North America, because we sell them to large OEMs who have a significant presence here in the North American marketplace.

Todd Vencil – Davenport & Company

Yeah.

Patrick S. O’Keefe

We also have underway plans on bringing some of those products and selling those products to those people who are in the heating in air conditioning and ventilation market here in the United States direct.

Todd Vencil – Davenport & Company

Okay.

Patrick S. O’Keefe

So the two avenues, product coming through the European channels and products being sold directly here in the U.S.

Todd Vencil – Davenport & Company

Okay. So and based on the things you’ve heard is that the kind of things that they’re thinking about with that program, as far as anybody can tell?

Patrick S. O’Keefe

That’s what they are hopefully talking about.

Todd Vencil – Davenport & Company

Okay.

Patrick S. O’Keefe

The question is, when will the money be awarded.

Todd Vencil – Davenport & Company

That’s the question across a lot of my coverage, but at least we’ve got a marker in there. Thanks a lot.

Operator

Your next question comes from the line of Ryan Connor with Boenning & Scattergood. Please proceed.

Ryan Connor – Boenning & Scattergood

Hello.

Patrick S. O’Keefe

Hi Ryan.

Ryan Connor – Boenning & Scattergood

Yeah, most of my things have been answered guys. But I wondered if you could take a minute, Bill just to talk about the balance sheet. I mean obviously on the surface things appear, very healthy given where the cash level is in particular. But I wondered if you could, if there is anything that does concern you in terms of covenants et cetera. As earnings kind of deteriorate and/or whether there is any scenario you can envision where things deteriorate to the point where financial risk does under the equation.

Patrick S. O’Keefe

I don’t think that’s a concern for Watts. I mean we’ve done a lot of analysis on this point, balance sheet I think is in really good shape. Liquidity is not an issue, we don’t have any liquidity events until May 2010 when we have to come up with $50 million. We are generating a lot of cash. We expect that we will have a good cash year coming up and even if sale decline that will slow up more cash as we reduce inventory and receivables. So from a cash standpoint I think we’re in good shape. From the convent standpoint, we have a pretty wide berth right now. So we’re not even close to having a covenant issue. So, I think we’re in an enviable position relative to liquidity based on everything we see coming out us in 2009.

Ryan Connor – Boenning & Scattergood

Okay, well thanks. That’s good to hear your update there. Thanks for the time tonight.

William C. McCartney

Okay, thank you.

Operator

Your next question comes from the line of Jeff Hammond with KeyBanc. Please proceed.

Jeff Hammond – KeyBanc Capital Markets

Hi, guys just a couple of follow-ups. Can you just, I think last quarter you said, you’re looking for $8 to $9 million of cost savings from restructuring. It sounds like you’ve done some additional restructuring, can you just update us on what you think all in the benefit is from all those actions taken in ’09?

William C. McCartney

Yeah, I mean we have the reduction force in the salary reductions and so on. We should be at least $10 million maybe to $12 million of those. And then, we have a couple of million dollars of benefit coming in from the restructuring this year that we did last year in 2008 some of the factory moves that we did. And then the factory consolidation work the Pat discussed in his remarks will have the benefit of that in 2010.

Jeff Hammond – KeyBanc Capital Markets

Okay. And then just back to the price cost gap. At what point in the year, do you think you’re at parity, where you get the lower cost copper coming in, and if you look at the whole year just given how dramatically copper is falling. I mean is there – do you expect a net benefit from [beyond] that price cost line or is that more neutral because you give some price up. How should we think that on a full year basis?

William C. McCartney

Well, I think first of all we’ll have, we should be at $61 copper in the third quarter, completely in the third quarter. We will start to see some benefit late in Q2, we’re assuming that volumes hold above where we think they’ll going to come out. And we have some benefit in second quarter. When it comes to the price volume, we’ll probably be unfavorable impact in the beginning of the year and slightly favorable as we go towards the end of the year.

Jeff Hammond – KeyBanc Capital Markets

So all in, though, about neutral?

William C. McCartney

Neutral to slightly favorable.

Jeff Hammond – KeyBanc Capital Markets

Okay. Thanks guys.

Patrick S. O’Keefe

Okay.

Operator

Your next question comes from [Jay Leigh with Jana Partners]. Please proceed.

Unidentified Analyst

Hey, guys. How are you?

William C. McCartney

Hello.

Unidentified Analyst

Hello…

William C. McCartney

Hello…

Unidentified Analyst

Hi, can you hear me?

William C. McCartney

Yes sir.

Unidentified Analyst

Okay great. I’m curious so for the fourth quarter in North America. I mean, the performance, you mentioned organically was down about 4% but you mentioned you really saw order trends shift in November. And so I’m curious the guidance that you have, sorry, not guidance but sort of the approximation for called mid double-digit or mid teens, sorry I clarify mid teens volume declines. Are you expecting a further deterioration in conditions to get to that?

William C. McCartney

We are expecting things to get a little worse than they are right now. Okay.

Unidentified Analyst

So, that’s okay, I mean that’s the pretty substantial change from where you ended up in the fourth quarter or so. I guess I am just trying to understand sort of how significantly you are expecting the end markets to shift?

William C. McCartney

Yeah, I mean volumes versus last year were down and even if you look at volumes versus the third quarter. They were down all right, I mean volumes versus the third quarter in North America were down about approximately 9%.

Unidentified Analyst

Okay. And then one other question is that you mentioned that FX if they stay at current rates right now, you would expect to have about a $0.20 impact on EPS. What kind of impact would you expected to have on the sales basis?

William C. McCartney

Yeah, top of my head I’m not sure, but the average rates for the euro was 146 for the year versus what it is now about 127.

Unidentified Analyst

Okay, and…

William C. McCartney

[We ended it] at $1.80...

Unidentified Analyst

Okay and I guess that will be on roughly 35 to 40% of your revenues?

William C. McCartney

Europe is about 38% I think.

Unidentified Analyst

Okay.

Patrick S. O’Keefe

I guess 5.

William C. McCartney

Yeah, [candid] about 5%.

Unidentified Analyst

Okay, great. Thanks a lot guys.

William C. McCartney

Okay.

Operator

The next question comes from the line of Brian Meyer with Robert W. Baird. Please proceed.

Brian Meyer – Robert W. Baird & Co. Incorporated

Hi, guys.

Unidentified Company Representative

Hello.

Brian Meyer – Robert W. Baird & Co. Incorporated

Just a few questions for you here. First on the tax rate, did you guys, you said it was up a little bit versus this year in ’09, is that right?

William C. McCartney

I would say that in ’09 I would expect it to be up a point or two versus 2008.

Brian Meyer – Robert W. Baird & Co. Incorporated

Okay, got it. And then on the getting back to the North American growth assumption, you clarify that, that double-digit - down double-digit number mid teens numbers for wholesale, I am just curious what are guys assuming for retail in ’09?

Patrick S. O’Keefe

We are hoping its flat.

Brian Meyer – Robert W. Baird & Co. Incorporated

Hoping it’s flat, okay. Got it. And then just another point of clarification, you guys talked about the decremental margins, you said that 30% was that in the operating margin decremental?

Patrick S. O’Keefe

Operating earnings.

Brian Meyer – Robert W. Baird & Co. Incorporated

Operating earnings, okay. Great and then more on the maintenance side here the restructuring charges this quarter anyway you could divide that up by segment?

William C. McCartney

Okay, China would be 100,000, North America would be 2.7.

Brian Meyer – Robert W. Baird & Co. Incorporated

2.7.

William C. McCartney

Yes.

Brian Meyer – Robert W. Baird & Co. Incorporated

So, nothing in Europe…

William C. McCartney

It is zero.

Brian Meyer – Robert W. Baird & Co. Incorporated

Okay. Got it, all right. And then we came back to that the European alternative energy demand. You can quantify maybe what obviously that’s all into the OEM channels, can you quantify what the OEM growth was in Europe versus distribution or the wholesale growth?

William C. McCartney

Quarter?

Brian Meyer – Robert W. Baird & Co. Incorporated

Yeah, for the quarter.

William C. McCartney

OEM growth in the quarter, local currency was 19%, distribution was 2.

Brian Meyer – Robert W. Baird & Co. Incorporated

Plus 2…

William C. McCartney

Yes.

Brian Meyer – Robert W. Baird & Co. Incorporated

Okay. Got it. I think, that’s it guys. Thank you very much.

William C. McCartney

Okay, thank you.

Patrick S. O’Keefe

Thank you.

Brian Meyer – Robert W. Baird & Co. Incorporated

Okay.

Operator

Your next question comes from Christopher Glynn with Oppenheimer. Please proceed.

Christopher Glynn – Oppenheimer & Co.

Yeah, just a follow-up on pension at year-over-year?

William C. McCartney

Yeah.

Christopher Glynn – Oppenheimer & Co.

What is it?

William C. McCartney

Pension expense you mean?

Christopher Glynn – Oppenheimer & Co.

Yeah, what’s the change? What’s that?

William C. McCartney

Pension expense will increase about $2 million…

Christopher Glynn – Oppenheimer & Co.

Okay, that’s it. Thanks Bill.

William C. McCartney

Okay.

Operator

At this time, we have no additional question in the queue. I would now hand the call back over to Pat O’Keefe for any further remarks. Please proceed.

Patrick S. O’Keefe

Well, I just want to thank everybody for joining us for our fourth quarter conference call. And we look forward to talking with you at the end of the first quarter sometime in April. Thank you.

William C. McCartney

Thank you.

Operator

Thank you, ladies and gentlemen for your participation in today’s conference. This conclude our presentation, you may now disconnect. And have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!