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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., Inc.

Kevin Maczka - BB&T Capital Markets

Richard Paget - Morgan Joseph & Co. Inc.

Jeffrey Hammond - Keybanc Capital Markets

Christopher Glynn - Oppenheimer & Co.

Scott Graham - Ladenburg, Thalmann & Co.

Keith Hughes - SunTrust Robinson Humphrey

Jamie Sullivan - RBC Capital Markets

Todd Vencil - Davenport & Company LLC

Ryan Connors - Boenning & Scattergood, Inc.

Michael Coleman - Sterne Agee

Watts Water Technologies, Inc. (WTS) F1Q09 Earnings Call Transcript April 28, 2009 5:00 PM ET

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 good afternoon and welcome again to the Watts Water Technologies first quarter 2009 earnings conference call. On the call with me today is Patrick S. O’Keefe our President and Chief Executive Officer and Bill McCartney our Chief Financial Officer. 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 first quarter 2009 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 first quarter conference call, and thank you for joining us today. After my opening remarks, Bill McCartney; our CFO will provide you with financial highlights for the quarter, Bill will also discuss the individual sector results. Then we will address your questions.

We continue to maximize cash flow during the first quarter as we generated positive cash from operating activities of approximately $17.4 million. This compares favorably to $14.8 million of cash generated from operating activities in the first quarter of 2008. We were able to exceed last year despite negative current operating results due to our focus on working capital managing our cost savings initiative.

As to working capital we generated approximately $11 million more in cash in Q1 of 2009 as compared to the first quarter of 2008 with much of the net increase in cash due to inventory and account receivable reduction. Our free cash flow in particular in 2009 was approximately $13.4 million or more than double Q1 of 2008 free cash flow of approximately $6.6 million.

I would again like to thank our many dedicated employees throughout the organization for their efforts. We intend to continue our focus on working capital management as 2009 progresses. As to cost savings initiative we generated $7 million in PNL savings in Q1 versus Q4 run rate based on programs initiated in 2008, in addition new programs in 2009 have been started and are being planned that involved salary reduction, workers furloughs and others cost reduction programs.

Whereas the 2008 programs primarily related to our North American operations, our new initiatives will be implemented on a world wide basis. Cost reductions will be a major focus for our organization throughout 2009 and into 2010. Our conservative working capital structure and our liquidity position have strengthened from the year end 2008. On March 29, 2009 we had net depth to-capital ratio of 22.4 which is slightly lower than the 22.8 at December 31st 2008 with approximately $170 million of cash on hand at March 29th 2009 versus a $166 million at December 31st.

We have approximately $260 million worth of available credit from our bank group to fund acquisition and operations. As a reminder our next large depth payment is not due until May of 2010. We believe our solid balance sheet will be a key in weathering the turbulent global economy.

Now let us talk about results for Q1 for a moment. Our results prior to restructuring charge were in line with our internal expectation. The first quarter is a part manufacturing footprint reduction program we recognized the one time X charge of approximately $8.3 million related to the expected tax recapture on previous tax holidays enjoyed by certain locations which will be forfeited once those operations are moved.

The Company’s operating results into a loss position for Q1. Prevalent issues during Q1 for the company included plant under absorption, rising pressure and negative foreign currency movement. We estimate that we reduced operating results by approximately $8.5 million due to under utilization of our plants throughout the world.

We were able to partially offset these costs with cost savings initiative discussed previously. Generally we have been successful in maintaining our selling prices but we continue to experience pricing pressure for price reductions from our customers. We still believe that pricing issues are manageable and will not result in across the board reduction on our selling price.

Currency movement as a result to the U.S Dollar strengthening against the Euro and the Canadian Dollar negatively impacted Q1 EPS by approximately $0.04. One note on China, bills were down 2.1 million or 21% versus Q1 of 2008. The disposal of TWT which occurred in late last October accounted for 1.6 million of that reduction. Organic sales in China were down 8% driven by volume reduction to export customers.

Regarding our major end markets, business continued to slow down in the United States commercial sector exacerbated by tight credit market. Bills in the U.S wholesale channel in Q1 declined 18% organically against Q1 2008. The wholesale channel declined 5% in Q4 of 2008 versus the prior year. although that channels sells into both residential and commercial space, we believe the accelerated pace of decline is due to the commercial market. We still see wholesalers continuing to do some restocking.

The ABI index for March was up by more than eight points from February to 43.7 but this indicator is still not indicative on an expansion in the non-residential construction market. Given in our belief that the United States commercial market lag the residential market place we expect to see continued deterioration in the commercial market place for at least the remainder of this year. The United States residential market may have bottomed out in Q1 given our retail sales were flat as compared to Q1 of 2008. Although the latest macro information seems to support that perhaps residential construction has hit a plateau..

New single family home starts in March were flat sequentially at 358,000 units. Existing home sales for March as reported last week were at the same levels as seen for the last 4 months. However given the amount of over hanging available, housing inventory continued foreclosure concerns, higher unemployment we don’t see a meaningful increase in new home constructions through 2009.

Another market place of concern for us is Europe were organically sales declined 13% versus Q1 of 2008. We mentioned during the fourth quarter conference call that we were seeing a slowing in incoming order rates and that trend has continued. In general destocking was likely an issue as European OEM may have overstocked during the fourth quarter of 2008.

Our perception currently is wholesale inventories are at low levels. We believe that destocking activities have subsided. Bills in the Eastern Europe have slowed considerably due to poor economic environment in countries like Poland, Czech Republic, and the Balkan States.

Their currencies continue to devaluate against the Euro, We are much more cognizant customer credit risks. We are currently refusing one in five potential European orders due to credit concern. In our major countries we saw higher sales in Germany in both wholesale and OEM channels due to the heavy spend on boiler repairs as result of a very cold winter and successful marketing campaigns with many of our major wholesale customers. We experienced decline in sales in Italy driven by lower wholesale and export activities and lower sales in France in general related to wholesale and DIY channel softening.

In turning our general outlook for the remainder of 2009 we anticipate that consolidated revenues will be lower versus comparable prior year’s quarter by 15% to 20%. We see sales declined being driven mainly by volume reduction and negative FX movement.

Our expectation has been lowered from the last conference call that is low to mid teens due to the acceleration in the decline of the United States commercial market and more weakening than we have anticipated in Europe. We foresee the Euro FX reduction of approximately 12 to 15 percent against prior year comparable quarters.

As for China we continue to expect moderate organic growth led by (10:41) maker of large Hydraulic diameter hydraulic butterfly valves used in the domestic infrastructure market but as mentioned last quarter there maybe some disruption in their sales activity due to the manufacturing footprint reduction effort during the latter portion of this year.

You see our overall margin tending as anticipated during the last conference call we believe the under absorption will be a factor for the entire year. Higher copper cost will affect slightly through at least the second quarter with some potential margin expansion in a later quarters as lower copper cost begins to run through our PNL. If you recall the benefits of our footprint reductions will not be realized until 2010. We will continue to be challenged throughout 2009 by planned under absorption and potential plant moving in efficiencies later in the year.

Our lean and operational excellence effort continued into 2009. In the first quarter we conducted 48 Kaizen events at our manufacturing sites, each one focused on cost reduction, productivity improvement, and inventory velocity. As of today we have trained most of 70% of our total workforce based on the basics of lean.

During Q2 2009 we will kick off our six segment certification program to further enhance the continued improvement effort. We remained committed to this endeavor and are pleased with the progress as we developed our competency to consistently deliver year over year productivity saving. Let’s update you now on a recent restructuring initiative.

As you may recall our board approved a program in Q1 to potentially remove three rooftop forms our existing manufacturing footprint in North America and China. The program will involve moving operation to existing facilities or centralizing operation from a particular product line into one central location. we expect the cost of these moves will be approximately 17.2 million after tax including severance relocation, asset writedowns and one time charges. We expect to spend approximately $4.8 million in capital to consolidate operations and our net after tax annualized savings were approximate $4.87 million.

We expected approximately 400 positions will be eliminated by the consiolidation. We anticipate most cost will be incurred in 2009 with some overhang into 2010. We expect project timelines to approximate 10 months.

Thgose savings will not be realized until 2010.We expect these projects will self fund to the sale of building and ther assets being disposed. We believe these intitatives will put us into a strongwer competitive position when the markets do bounce back.

Finally let us address our acquisition program. Consistent with our discussion on the last call, we are still cautious, although we continue to make inquiries and are looking at several and are looking at several targets. We believe we are in an advantageous position given our cash availability to get a deal completed when the right targets or targets are identified.

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

Bill McCartney

Thanks a lot, Pat. I will just run down the P&L, talk about the major factors here and then we will open it up for questions.

Revenue, we had $295 million versus $344 million, declined $49 million that is 14%. If you look at the components of the 14% in organic standpoint, revenue declined $48 million which again is 14%. Foreign exchange had an adverse impact of $16 million which is 5%. That was offset by the inclusion of the revenue of Blucher which we acquired last year that was $17 million or $0.05 contribution and then the disposal of TWT last year in the fourth quarter reduced our revenues by $1.6 million, just half of points. So that whole thing comes to the $49 million or 14%.

Net income based on our US GAAP numbers was a loss of $1 million. When you exclude the restructuring charges, we earned $8.4 million after tax. That $8.4 million X restructuring is $0.23 per share compared to a consensus estimate of $0.27 and that is decline from last year's EPS X restructuring of 41%. Just a quick note on the restructuring charges themselves, $9.3 million after tax. The $1.5 million of that is included in our SG&A and then we have a tax benefit of $0.5 million in our tax line for those expenses but then we also booked $8.3 million of tax callbacks but we see a net charge in our tax line of $7.8 million. So the $1.5 million in SG&A, $7.8 net in the tax line gives us $9.3 million after tax in the US GAAP numbers.

Just looking at some of the segment summation: North America were at $177 million of revenue, that is a decline of 16% versus last year and that is a decline in our run rate from the fourth quarter from $201 million. As Pat mentioned, the wholesale business in North America was down 18% at $138 million and we are down 15% from the run rate in the fourth quarter. Basically, again as Pat mentioned, we saw a lot of de-stocking going on we believe at the wholesale level particularly the smaller wholesalers and we know that they had a lot of objectives around significant inventory reduction at their locations.

On the retail side, the story is a little different in that essentially, retail was flat at $43 million and is up just a touch from the fourth quarter when retail revenue was $42 million. Essentially what happened is last year, we had some rollout that we did not reoccur this year but we did offset them with some increase shelf space at a couple of our customers. So, retail is flat and that is consistent with what we had discussed with you in our last call in terms, but that was our view on retail.

On Europe, revenue was $109.6 million. That is a decline of about 11% versus last year. Looking at the components there, organically in Europe we were down 13%. Foreign exchange was at the adverse impact of 11%, $13.5 million, offset by the inclusion of Blucher which was 14%. So, net bottom line for Europe was a decline of 10.7% for the revenue. Again, as Pat might have mentioned, we saw the de-stocking both at the OEM in the wholesale level in Europe and we started to see some slower sales in both the Italy and France. As we have discussed in the past, we have already seen in our numbers declines in Eastern Europe and Northern Europe and we started to see that slower performance in Italy and in France and during the first quarter.

China, revenue was $7.8 million. That is a decline of 21%, $2.1 million. Looking at the factors there in organic standpoint, revenue declined 8% which is $800,000, offset partially by strengthening of the Chinese RMB which contribute 3% or $300,000 and of course as we compare to last year, we disposed a TWT in interim so that is a decline of $1.6 million. But basically, the drivers here are the fact that our exports out of China into Europe have declined because of the slowing economy in Europe. Our sales on the infrastructure side are flat. That business is still doing well but we are seeing that some of the orders are getting pushed out there a little bit because we believe of the impact from the stimulus bill in China with some of the funding is being readjusted in terms of where it is coming from but that business from an order entry standpoint is still doing well.

The gross margin is 33% on the quarter. This is down 2/10 of a point versus last year's Q1 and down 8/10 of a point from the fourth quarter. Essentially, what is happening here is the impact of volume. Again, as Pat mentioned, we had about $8.5 million of unfavorable overhead absorption and from a gross margin standpoint, which is about 280 basis points. So we partially offset that 280 basis points with the inclusion of Blucher which made a small contribution relative to the percentage and then partially offset the difference with cost savings, obviously we did not get all of it but we did get most of the decline of the absorption grants through cost savings in spite of our cost of good sold. Again, this is the implementation of lean. It is the reduction enforced, wage controls and other productivity initiatives that we have been implementing.

On the SG&A front, we came in at $81 million. This is a reduction of $6.1 million versus last year. When we look at the components of that in organic standpoint, we were down $6.3 million and again, this is where we see the reduction enforced, wage reductions and other cost reduction programs that we are focusing on. Foreign exchange rate, primarily the euro reduced our FX by $3.4 million. The disposal of TWT, not including their SG&A reduced our SG&A by $1.8 million and the inclusion of Blucher's SG&A was $5.4 million so that total comes to $6.1 million. That brings us up to the operating earnings line from a GAAP standpoint, $14.7 million which is a reduction of 44%. We exclude the restructuring charges $16.2 million of op earnings which is a reduction of 41% and that reduction is entirely driven by the reduced volume.

Looking below the line, interest income is down $2.1 million. That is the function of the money that we spent on Blucher which is not invested. We bought Blucher last June and then lower interest rates on our interest income. Interest expense is down about $1 million and that is lower rates predominantly in Europe and then other income and expense is down from $2.2 million last year of expense to $500,000 of income this year and that is primarily less charges associated with marking our working capital to market below the line.

The tax rate from a GAAP standpoint, again 109% but again backing out the tax callbacks which is where we book those, the tax rate in the quarter would be 25.3%. This compares to about 33.6% last year and we had some favorable tax credit that we booked in France and we also had a smaller loss in China which we are not able to tax benefit that. So the combination of the smaller loss and the tax benefits dropped our effective tax rate.

So, bringing it all down to the bottom line, $0.02 loss from operations including X restructuring charges at $0.23 profit and $0.04 of that decline is associated with the change in the foreign exchange rate and just a quick note, I know that people are interested our depreciation and amortization expense during the quarter was $11.2 million and $13.4 million of free cash flow that we generated, significant improvement over last year primarily generated inventory reductions.

So, with that we would like to open it up to any questions that you might have.

Question-and-Answer Session

Operator

(Operator's instruction) Your first question comes from the line of Michael Schneider - Robert W. Baird & Co., Inc.

Michael Schneider - Robert W. Baird & Co., Inc.

Maybe first we can just start I guess with the bright spot that retail was flat as you expected. Can you possibly dissect that on a more same-store sales basis so we can understand exactly how much shelf space or additional shelf space you are gaining and benefiting from because clearly, Home Depot and Lowe and these guys are reporting a mid-single digit same store sales decline? So, it appears as though you guys are enjoying more shelf space.

Patrick S. O'Keefe

Yes, Mike, we did pick up some shelf space in a couple of different change just through some, it is not new product introduction. It is just getting some existing product to some additional shelf space and one of the things we talked about, so that is part of the answer and I think the other thing that influences it when we talked about I think last quarter on the call is that when times are tough out there, homeowners will tend to do some of the projects on their own and not call a plumber. So, homeowners are going to go into the retail change and buy that kind of product. They are not going to go, consumers are not used to going into a wholesale shop. That is where the plumbers go. But we think at this, it is a little bit more homeowner demand because the economy is difficult.

Michael Schneider - Robert W. Baird & Co., Inc.

Okay then just on product pricing, Pat, if I heard you correctly, you said you have not seen and do not expect across the board price cuts, I believe you used. Could you just elaborate on that because we are certainly hearing different feedback from the channel and the distributors were talking to especially in the plumbing space.

Patrick S. O'Keefe

The concern in the first quarter, Mike, we had a lot of inquiries concerning the pricing because it was obvious to everyone that copper had dropped dramatically over the later part of quarter and then quarter but that has subsided now as copper has moved back up. So most of our customers, there were some concessions made. There were some wants to competitive conditions made but we do not see it across the board dramatic changes but we are managing the combination of price and cost very effectively at this, in fact to continue to do that throughout the year.

Michael Schneider - Robert W. Baird & Co., Inc.

And can you give us a sense of what you think price contributed to sales this quarter either by region or by division?

Patrick S. O'Keefe

What price contributed?

Michael Schneider - Robert W. Baird & Co., Inc.

Yes, I believe you said it was 1 to 2 points last quarter.

Bill McCartney

Well to be honest, Mike, we do not have that analysis right now but we are still running expensive copper through our cost of goods so we do not really think that there is a lot of type of release margin if that is what you are trying to get at.

Michael Schneider - Robert W. Baird & Co., Inc.

Okay and then I guess final question just on the sequential developments within the quarter, you have lowered your revenue forecast as you mentioned to the US commercial and Europe generally speaking. Did you see, is my understanding of your business that late March is kind of the pivotal, seasonal acceleration that would expect? Can you describe what you have seen in late March and April versus the earlier part of the quarter?

Patrick S. O'Keefe

What we are starting to see, Mike, if you think now during the later part of the quarter, we started seeing that few things were happening. One is that we were starting to see a slowdown in de-stocking efforts going on in the market. People are having a more difficult time trying to get lower stocking level and I think we saw that de-stocking sort of ease off a little bit. However, it was not done, okay? I think there are still some de-stocking actually sort of ease off a little bit although it was not done. I think there is still some de-stocking actually taking place even today on slow-moving items.

The other thing I think, Mike, is that we saw that we are starting to see the flow through of the real demand without the de-stocking. So, what we did not see which you typically see is a stocking program goes in place at particular to wholesale channel where they stock up in anticipation of the season. We did not see that at the end of the first quarter.

Michael Schneider - Robert W. Baird & Co., Inc.

Have you seen any seasonal ramp at all in April?

Patrick S. O'Keefe

Not considerably. We are very reluctant to carry in it.

Michael Schneider - Robert W. Baird & Co., Inc.

And you mentioned that de-stocking seems to be fading. Have you witnessed that in your level of expedited orders?

Patrick S. O'Keefe

Yes, the information that we collect, Mike, is people takes order but the question is what percentage of the orders. Well, you typically going to move around two to three days as for delivery and one to two days and that percentage has risen. So, we think that people are respectively at this point in time probably both at the bottom in terms of de-stocking.

Operator

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

Kevin Maczka - BB&T Capital Markets

I guess first I would like to just clarify two things I thought I heard. First on your organic and your total revenue comments down low to midteens organically 15% to 20% total. Is that total business or was that in regards to Europe?

Bill McCartney

The 15% to 20% is the total business.

Patrick S. O'Keefe

That is consolidated sales.

Bill McCartney

Yes, that is our outlook if you will for next couple of quarters.

Kevin Maczka - BB&T Capital Markets

Okay, that is the outlook for total revenue for the year for the total business, okay. And then just to clarify on the de-stocking, are you seeing that is subsiding in Europe as well because I would think if Europe is rolling over and maybe everyone except Germany has rolled and maybe Germany is yet to roll that might be accelerating, not subsiding.

Patrick S. O'Keefe

We are taking that into consideration in terms of the estimates that we have over 15% to 20% overall decline in revenue.

Kevin Maczka - BB&T Capital Markets

Okay, but on the, you are seeing it subside, the de-stocking subside as well across Europe?

Patrick S. O'Keefe

In Europe, we thought considerable de-stocking at the OEM level. We believe that that is starting to subside, yes.

Kevin Maczka - BB&T Capital Markets

And then just finally on the gross margins, Bill, I guess it held up fairly well I thought given the double digit revenue decline but I guess if you expect more significant volume declines going forward, that ought to be a negative and maybe lower copper as you get into the back half ought to be a positive. Can you just talk about kind of your outlook given your lowered revenue growth outlook, do you think gross margins can still hold in this 33% level?

Bill McCartney

The thing that is going to influence that, Kevin, obviously is going to be the reduced volume but at the same time, we still aggressively reducing inventories and despite the large inventory reduction that we had, we still maintain the margin there. I think as we go forward in the year, some things that will impact it in a positive standpoint would be the price cost push. That is an opportunity and then also as we go further in the year, hopefully as things settle down, we are thinking things will settle down in this lower 15% to 20% range, the inventories later in the year coming to parity where we might not have to have as much of the reduction in our production schedule. We will do a little bit more better job in terms of absorption but that will be a positive contributor I think.

And then we are seeing as we go to the course of the year here, we can do a little bit better job in lean as we go more and more time with lean. We should have a little bit help from improved productivity. So, I think there are some things as we go into the year that will help us sustain the margin but the big thing obviously is going to be what happens with the top line. That is the biggest driver but I think we are doing everything we can as the management team in terms of what things can we manage, I think all those things are being managed; productivity, cost reduction, pulling of production schedule and maintain new cost price relationship and so on.

Operator

Your next question comes from the line of Richard Paget - Morgan Joseph & Co. Inc.

Richard Paget - Morgan Joseph & Co. Inc.

So, there has been a lot of talk in the stimulus package and whether the GSA retrofitting some of their federal buildings to make them more efficient and greenify them and then there are some tax provisions for home owners to make their houses more energy and water efficient. I mean, is that something that you guys that could at least a positive catalyst within the next couple of quarters or in the back half of the year?

Patrick S. O'Keefe

Anytime you change the hot water tank or a boiler or a heating source or anything of that, we benefit because we do not make a boilers and we do not make hot water tank but we do make all the components and all the controls that go around them. So, we typically would be an indirect beneficiary of that purchase pattern.

Richard Paget - Morgan Joseph & Co. Inc.

Okay, but did you have, is there any way to quantify that in terms of percentage of your products that might fit into that category?

Patrick S. O'Keefe

We have not been able to do that.

Bill McCartney

Rich, the thing is most of our products in the US, you generate lead points by installing them. They have high percentage focused around efficiency as well as safety and so on. We also have, I think this will be a beneficiary of this will be meaningful in the longer term because when the economy starts to improve, people start to spend money on solar, geothermal net. Those kinds of alternative energies partially spurred on by tax incentives that have recently passed, partially spurred on by wanting to save money, be good citizens, we have a good opportunity there but that opportunity really is we still a need a little economy to become more of a tailwind. But it is a good opportunity for us and it has already been a fantastic opportunity with Europe over the last several years. Now, we are starting to follow that European model and there are some good opportunities.

Richard Paget - Morgan Joseph & Co. Inc.

Okay and then looking at your competition, do you get a sense that any are in a distress mode which might either A, create an opportunity for acquisitions or B, just once thing has turn around, there will be just be one left competitor out there for you guys?

Patrick S. O'Keefe

I think the answer is that we are seeing some, on occasion some erratic pricing coming out of competitors who appear to be really struggling and they bring some volume in the front door. But we are not aware of any of them that are financial difficulty at this time.

Richard Paget - Morgan Joseph & Co. Inc.

Okay and then in terms of your major customers or distributors, have you get any sense there either?

Patrick S. O'Keefe

We have enough a lot of people on credit watch because if they are not in trouble financially, they are slowing down their payment because they are managing their cash flow. So, I would say that we had added resources to our credit and collection effort and we are watching that very carefully although I would say that if you would do an evaluation of the credit worthiness of our accounts, they are all fine. We do not have anything unusual there.

Operator

Your next question comes from the line of Jeffrey Hammond - Keybanc Capital Markets.

Jeffrey Hammond - Keybanc Capital Markets

I think you said in the opening, you thought from cost saving actions you saved $7.5 million in the first quarter, is that right?

Bill McCartney

I think what we are talking about is the absorption variance was unfavorable about $8.5 million but we had some cost savings that offset that. I mean we reduced our SG&A about $6 million because of cost reductions and then we also had, if you look at the $8.5 million in option variances that is about 280 basis points but since we only went down about 20 basis points, there maybe half a point in it as the mix including Blucher that we had a fair amount of cost savings inside of cost of good sold to offset that.

Jeffrey Hammond - Keybanc Capital Markets

I guess what I am trying to get to is it sounds like your facility rationalization, the cost saving comes in 2010 but as you just look at cost control and just cutting discretionary cost, do you see any up tick in the level of savings there as you progress through 2009?

Bill McCartney

Definitely, I mean even though we have had a couple of larger programs that were dramatic and we have announced those and talk to you about them like the reduction force which was I think that was between $10 million and $11 million. We had another couple of million dollars because of 5% pay reduction here in the state but we are continuing to focus on cost at every level. Every month we sit with every plant manage, go through their productivity initiatives, their cost reduction initiatives. We are looking at, we are working with the purchasing people relative to material and to cost reductions. So, I mean just a continued implementation of lean, I mean every quarter theoretically you have another set of kaizen events that you have done and you have more opportunities there to lower your cost and improve productivity.

So, that is the long answer. The short answer is yes, we should see improve cost goals as we go out through the year.

Jeffrey Hammond - Keybanc Capital Markets

Okay and then you mentioned that the down 15 to 20 sales assumption for the next couple of quarters, I just kind of a finder point question, second quarter to last year as you recall had a nice bump up. I think you positively preannounce it. Have you incorporated that tough comparing to that 15% to 20% decline or was it maybe a little bit heavier in 2Q because of that?

Bill McCartney

We are thinking that we are down 20% versus the run rate to the full year. I mean we do have a little bit of a tougher comparison in Q2. You are absolutely right.

Jeffrey Hammond - Keybanc Capital Markets

Okay and then just a couple of housekeeping, how should we think about the tax rate for the rest of the year and…go ahead.

Bill McCartney

I would say about 33%.

Jeffrey Hammond - Keybanc Capital Markets

Okay and then corporate expense jumped up in the first quarter, what was behind that and how should we think of corporate for the year?

Bill McCartney

We had a little bit higher legal expense in the quarter. I would think that, I will just the run rate for the corporate there that you see.

Jeffrey Hammond - Keybanc Capital Markets

So you think the 87 is kind of what you see for the rest of the year.

Bill McCartney

I do not think it will be more than that.

Operator

Your next question comes from the line of Christopher Glynn - Oppenheimer & Co.

Christopher Glynn - Oppenheimer & Co.

Just following up on the corporate, I think that Jeff started to say the run rate and you acknowledge was higher than it had been sequentially assuming that is a little bit of a opportunity going forward, maybe the first quarter with the higher run rate?

Bill McCartney

Yes, I mean we had some a little bit higher legal expenses, Chris and those will probably persist for another quarter or two.

Christopher Glynn - Oppenheimer & Co.

Okay and then the SG&A level again, if we can think of it maybe in terms of a dollar sort of run rate, would that can be stable there or maybe trend down a little just dollar wise or is that just to cut the call.

Bill McCartney

It will not be going up and the tendency here will be for to trend down as we do more cost reductions go further and further into the year.

Christopher Glynn - Oppenheimer & Co.

In absolute dollar terms, that is right?

Bill McCartney

Yes, I mean you have to remember though, our SG&A if you just for the sake of discussion call it 25% of sales, endpoint is purely variable with revenue and the other is what you call fixed to semi-fixed that management has to do something very proactive to reduce those expenses in which working on.

Christopher Glynn - Oppenheimer & Co.

Okay, so about 40% of…

Bill McCartney

To give you the answer, I am assuming the revenue was in a tight range to what we are talking about here.

Christopher Glynn - Oppenheimer & Co.

Right. Okay and then just lastly, the North America detrimental margins were really not so bad at all. Europe is roughly double with North America. Were there any obvious differences there between the two segments just on the negative contribution margins?

Bill McCartney

We had the same kind of math in both ways so it is just how much absorption variances do you have and how much SG&A can we cut. It is a little bit more absorption impact in the margin in North America and the European did a little better job on SG&A I think but there is nothing major there that we can talk about in my opinion.

Christopher Glynn - Oppenheimer & Co.

Okay and then just lastly, the sequential softening be a little stiffer with the North American wholesale or the Europe, do you think in terms of the year-over-year is getting a little more severe?

Bill McCartney

Probably Europe is a little bit more severe just think because they are earlier into their downturn than we are in the states and the de-stocking is probably not quite as after the system.

Christopher Glynn - Oppenheimer & Co.

Okay and there were no one-times in the margin there that push the margin down a little further in Europe in the first quarter?

Bill McCartney

No.

Operator

Your next question comes from the line of Scott Graham - Ladenburg, Thalmann & Co.

Scott Graham - Ladenburg, Thalmann & Co.

I just have a two questions for you. The first one is on kind of scorecard of the restructuring. The $1.5 million that is the line item of P&L, now that counts toward the $11.7 projected for the full year, is that correct?

Bill McCartney

Yes, it does, yes.

Scott Graham - Ladenburg, Thalmann & Co.

Okay and how did that hit the geographic segments, the $1.5? I know it is a small number but still.

Bill McCartney

That would be $0.5 million in North America and $1 million in Europe.

Scott Graham - Ladenburg, Thalmann & Co.

Okay, great. Further to the previous question is my second question and that would be if North American wholesale sales declines, I think you say in your press release about 18% organically, it would suggest to me that the commercial market was down in the order of maybe 25ish? Is that sound about right and if so, is that a number that could actually get worse going forward because commercial construction spending is still weakening?

Bill McCartney

Well commercial was probably was down in that range that you just mentioned but again, we are looking at the guidance that was applied of that 15 to 20. That includes the whole book of business. I think retail was flat and so on. So, is that answering your question?

Scott Graham - Ladenburg, Thalmann & Co.

Yes, kind of. I mean, I guess it kind of leads to the ultimate question here would be that since I think your commercial businesses in North America or higher margin than your residential businesses, there seemed to be in your descriptions of the changes in the gross margin an absence of the mix effect which seems to have been pretty starkly negative this quarter. So, I am just wondering how that fits into the gross margin discussion.

Bill McCartney

Again, we have a lot of cost savings that are helping to offset some of those mix situations. Inside of it, it does not mean that we are talking at a very high level here, Scott. We also had some favorable mix inside of our wholesale and what not with some product line even though they are considered commercial doing well. Sales into lavatories and things like those kind of end markets which have good margin characteristics still had a decent quarter.

Scott Graham - Ladenburg, Thalmann & Co.

Okay, I guess the last question and I said two but analyst prerogative maybe, third question, it looks like obviously the year-over-year change in SG&A which you are largely attributing to declines and costs yet the numbers that you guys had been talking about on an annualized basis for each restructuring if you will, the last one and then the one announced two months ago, they were to the tune of $4 million to $5 million of savings each. So, what you are talking about here are not those savings. You are talking about pure block and tackle, Toyota-lean manufacturing savings here, yes?

Bill McCartney

That is correct.

Operator

Your next question comes from the line of Keith Hughes - SunTrust Robinson Humphrey.

Keith Hughes - SunTrust Robinson Humphrey

You were talking earlier about not seeing a season so far in the order pattern on a wholesale. Is that a comment on the residential or non-residential or both at this point?

Patrick S. O'Keefe

Typically what we see at some place between March 15th and April 5th that you see wholesalers particularly thinking on inventory the anticipation of a building season. This year, they are reluctant to do that and we did some survey work in the middle of the month of March and what we were determining from that survey work that we did is our wholesale base but still de-stocking and had very little interest whatsoever in terms of taking an inventory position going into the quarter.

Now, what we are seeing in the quarter is a lot of expediting. So, people are calling up and say, can you expedite this order and ship it in one day or two days which is telling me that they actually have an order in hand and they are trying to expedite the product because they have no inventory. Well, you are seeing expediting going on but you are not seeing a substantial build in anticipation of a building season.

Operator

Your next question comes from the line of Jamie Sullivan - RBC Capital Markets.

Jamie Sullivan - RBC Capital Markets

Most of my questions have been answered by I wanted to ask about the three planning consolidations that you have going on throughout 2009. I am wondering if the timing is similar for all three or those staggered at all over the next 10 months.

Bill McCartney

There will probably be one that is finished in the fall and the other two would be take in the entire year to complete.

Patrick S. O'Keefe

Yes, maybe they have moved in.

Jamie Sullivan - RBC Capital Markets

I am sorry, what was the last comment? I missed the…

Bill McCartney

Pat mentioned that one of them might actually take us into little ways into 2010 as well. We have always characterized it that the benefit that the reduction program would provide is a 2010 benefit so we are not varying off of that because one of the projects would give us a little benefit late in the year but the other one will take a little longer so it is still, it is a 2010 benefit for the most.

Jamie Sullivan - RBC Capital Markets

Okay and on your own inventory reduction efforts, how much can that contribute to your cash flows this year and how much left do you think? How much room do you think there is to go?

Bill McCartney

We think there is a lot of room in working capital and that we view it as multiyear program. We think that our inventory turnover ratio can move dramatically from where it is and we still view it as a likely scenario that working capital is a source of cash for the year.

Patrick S. O'Keefe

And we think the disciplines we put in place are multiyear disciplines that will provide benefits to you for the next several years.

Jamie Sullivan - RBC Capital Markets

Okay, do you have a target for turns?

Bill McCartney

Well, I think, it has benchmarked us against industry average thinking that we could have a turn of 4 to 5 over a multiyear period, I think that that is reasonable but it will takes us quite a while to get there.

Operator

Your next question comes from the line of Todd Vencil - Davenport & Company LLC.

Todd Vencil - Davenport & Company LLC

Just circling around on the Europe comments and just on the fact that the year-over-year decline is maybe a little worse in the US because they are just still go to the de-stocking phase. You guys are also anniversarying Blucher during the second quarter. Am I remembering that correctly?

Patrick S. O'Keefe

That is correct.

Todd Vencil - Davenport & Company LLC

Okay so that presumably have an impact as well, right?

Patrick S. O'Keefe

Yes.

Todd Vencil - Davenport & Company LLC

Okay and in the US where you guys said that you were looking at flat year-over-year comps in the retail space, is there any discernable patterns sort of geographically or any places that will be doing better for you guys or worse?

Patrick S. O'Keefe

Not that we can discern now.

Todd Vencil - Davenport & Company LLC

Okay.

Operator

Your next question comes from the line of Ryan Connors - Boenning & Scattergood, Inc.

Ryan Connors - Boenning & Scattergood, Inc.

Most of my questions have been answered as well but I do want to touch on this other income line. Bill, you talked about it a little bit but it really has been jumping around quite a bit and it is not immaterial. I am showing it as a $0.25 expense last year and now a couple of penny gain in the first quarter this year. So, what is the outlook there? Are there, should that normalize back to a gain? If so, at what magnitude? Are there more of these impacts that you have in the first quarter where that should need to be a gain? Just whatever your outlook there will be helpful.

Bill McCartney

Last year, the biggest impact in here was the change in foreign exchange rates because as you know, we have to mark our working capital to market in terms of what your current liability such that you have to mark those to market and you charge that into other income and expense. So, if exchange rates are stable, that number will not change too much from what you are seeing in first quarter of 2009. Once exchange rate start to becoming volatile or as volatile as they were last year, the number could jump around.

Ryan Connors - Boenning & Scattergood, Inc.

Okay, however if you assume the flat exchange rate scenario you basically you should run at that run rate you were in the first quarter or does that mean assuming flat exchange rate just to go to zero?

Bill McCartney

Well, flat exchange rate is sort of an sequential basis, right? I mean whatever we can charge there in June will be based on the change in the March. So, as long as the exchange rates are relatively stable during the course of the year, that number does not jump around too much on it.

Operator

You have a follow up question from the line of Michael Schneider - Robert W. Baird & Co., Inc.

Michael Schneider - Robert W. Baird & Co., Inc.

I guess I wonder if you could just circle back to the revenue forecast for the Europe being down 15% to 20%, have you assumed just based on our prior discussion of pricing that pricing changes plus or minus from here within that forecast?

Patrick S. O'Keefe

We have some deterioration in some pricing but offset by it. If we look at the cost plus price relationship, the answer is probably we can [distorted].

Michael Schneider - Robert W. Baird & Co., Inc.

It will be a benefit, I am sorry, Pat?

Bill McCartney

What we are saying Michael that there is going to be some price degradation as we go to the year, built that into a model. We are also building in other factors as well. I mean the biggest thing is the economy.

Michael Schneider - Robert W. Baird & Co., Inc.

Sure.

Bill McCartney

And then we are also considering we are introducing some new products. We have a big pushing on that and put that all into the crystal ball, a very hazy 15% to 20%.

Michael Schneider - Robert W. Baird & Co., Inc.

Fair enough and then in retail, your forecasting should remain flat for the year. Do you have a sense of just what additional program or product rollouts you have got or store penetration that is yet to come that would offset what still seems to be some double digit declines in new housing?

Patrick S. O'Keefe

We have analysis, Mike. We run that demonstrates that the number of line reviews that are coming up on product lines where we are currently the incumbent on the shelf is offset pretty much one for one by the opportunities that we have to be successful where we are not the incumbent. So it is a sort of a breakeven analysis.

Michael Schneider - Robert W. Baird & Co., Inc.

Did you guys have a housing assumption for the year that you have used?

Patrick S. O'Keefe

We are assuming that it is going to stay where it has been.

Bill McCartney

Just a quick follow on that, Mike is that this part of the business really is not driven much by housing stuffs. This is homeowners doing their thing in small plumbing repair shops doing some shopping in Home Depot. It is really not driven by starts.

Michael Schneider - Robert W. Baird & Co., Inc.

Fair enough and then on the sequential savings, we have touched on a several times but I think what we are trying to determine and begin to try to model going forward now is what level of savings other than restructuring actions you took back in Q4 that you realized in Q1 and then just even if you can just talk about Q2 alone, what level of incremental savings you should realize in Q2 versus Q1 out of the researching you did this quarter and then you need to back to Q4.

Bill McCartney

In the restructuring that we talked about in Q4, the program that we announced is a major restructuring that we really will not receive any benefit for that until 2010. This is closing couple of plans. Those plans are still up and operating today. We are spending money, time and efforts on those projects right now. So, what we are talking about with these cost reductions that are seeing, some of them come to the P&L, I think that someone asked early, this is sort of just blocking and tackling it. It is getting improved productivity in all of our plans with the reduction in force that we have done and since we had the major announcements, we have seen our headcounts continue to decline. It is cutting wages. It is anything down on discretionary spending. It is working with purchasing and the vendors to cut our material cost. It is all of those items.

Michael Schneider - Robert W. Baird & Co., Inc.

And that number if I recall was $10 million to $12 million annualized savings?

Bill McCartney

That was just the RIF and the wage cuts.

Michael Schneider - Robert W. Baird & Co., Inc.

And was that amount fully realized on a run rate basis in Q1 or is there incremental savings in Q2?

Bill McCartney

The 25% of that RIF and the wage cuts we will realize plus a bunch of other projects that I just mentioned.

Michael Schneider - Robert W. Baird & Co., Inc.

Okay and then just one question on the impairment, where was that specifically in the income statement?

Bill McCartney

Impairment?

Michael Schneider - Robert W. Baird & Co., Inc.

The impairment charge.

Bill McCartney

In the restructuring there is a, I think what you are talking now, there is a $300,000 payment of the trademark that we put in there because it is one-time, one-off charge in the SG&A.

Michael Schneider - Robert W. Baird & Co., Inc.

Okay, there will be within North America?

Bill McCartney

Europe.

Michael Schneider - Robert W. Baird & Co., Inc.

Europe, okay.

Operator

Your next question comes from the line of [Mark Lada Arliah] - Sterne Agee.

Michael Coleman - Sterne Agee

It is Mike Coleman. I am just wondering, to what extent does the increase in expedited orders kind of the urgency helped you maintain price in the year or is that not really consideration?

Patrick S. O'Keefe

Clearly, one of the things we have going to our is the very high fill rates, so our on time deliveries performance in our fill rates are extremely high at the moment. We are intending to keep them that way with the idea that it is an opportunity to have customers who are not willing to carry inventory rely on us and potentially gain some share so I think it is a positive. We are seeing people calling knowing so well then we have the inventory.

Operator

I will now turn the call over to Mr. Patrick O'Keefe for closing remarks.

Patrick S. O'Keefe

I just want to thank everybody for joining us on the call today and we appreciate your continued support. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.

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Source: Watts Water Technologies, Inc. Q1 2009 Earnings Call Transcript
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