A O Smith Corp (AOS) 2006 Q4 法說會逐字稿

Welcome to the A.O. Smith's fourth quarter 2006 earnings call. [OPERATOR INSTRUCTIONS] As a reminder today's call is being recorded. I would now like to turn the conference over to the Vice President of Investor Relations, Mr. Craig Watson. Please go ahead, sir.

Good morning, ladies and gentlemen. Thank you for joining us on this conference call. With me this morning participating in the call are Paul Jones, Chairman and Chief Executive Officer; Terry Murphy, Chief Financial Officer; and John Kita, Controller and Senior Vice President of Finance. Before we begin with Paul's remarks I would like to remind you that some of the comments that will be made during this call including answers to your questions will constitute forward-looking statements. These statements are subject to risks that could cause actual results to be materially different. Those risks include among others matters that we've described in this morning's press release. Paul.

Thank you, Craig. Good morning, ladies and gentlemen. This morning we're pleased to announce solid fourth quarter performance and record sales and earnings in 2006. Sales in the fourth quarter increased to $544 million including $125 million from GSW, and this compares with $434 million in the fourth quarter of 2005. Net earnings increased to $18.9 million or $0.61 per share compared with $16.1 million or $0.52 per share the previous year. These earnings included a tax rate benefit of approximately $0.05 a share that Terry will discuss in more detail later.

Sales increased to almost $2.2 billion in 2006 including $361 million from GSW. This compares with $1.7 million in 2005. Net earnings increased to $76.5 million or $2.47 per share compared with $46.5 million or $1.54 per share last year. We also established our 2007 earnings forecast this morning of $2.75 to $2.95 per share. I will come back to talk about the forecast later, but first Terry will talk about financial results in a little more depth. Terry.

Thank you, Paul. Fourth quarter sales at Water Products increased $115 million with the addition of GSW's $125 million of sales more than offset the 5% decline in the legacy water heater business. We expected softer sales in the fourth quarter as a result of the prebuy we saw in the third quarter of 2006. Both the residential and commercial markets declined at double-digit rates during the fourth quarter. The decline in our U.S. residential and commercial sales was mitigated by higher pricing and approximately 20% sales growth in the Chinese operation.

At Electrical Products sales declined a modest 3% as double-digit declines in HVAC and pump motor sales more than offset improved pricing and the incremental sales from the Yueyang November 2005 acquisition. Earnings before interest and taxes in the fourth quarter increased 7.2 million or 29% as a result of the nearly $9 million increase at Water Products and a modest decline in corporate expense partially offset by a $3 million decline in Electrical Products. The improvement in operating product at Water Products was the result of the incremental GSW earnings and higher earnings from China which more than offset a decline in the U.S.-based residential and commercial water heating operations. Margin was 9.9% in the fourth quarter compared with 11.1% last year which -- and the 11.1% included a $3 million LIFO benefit. Given the residential nature of the GSW business, we're encouraged by the margins we've maintained in this business.

At Electrical Products operating profit declined as a result of the lower unit volumes and an increase in restructuring charges due to plant closings. The decline was partially offset by an improvement in price and the incremental earnings from Yueyang. Margin declined to 4.6% compared to 5.8% last year.

Looking at the full year, sales increased $472 million to a record $2.2 billion in 2006. Sales increased 428 million at Water Products as a result of the $361 million contribution from GSW and a $66 million or 8% increase in the legacy water heater business. The increase in the legacy business was a result of a $35 million or 40% increase in China as well as mid-single digit improvements in both commercial and residential operations. At Electrical Products sales increased 5% to 906 million as improved pricing and the acquisition of Yueyang were partially offset by a unit volume decline in the underlying business.

For the full year earnings before interest and taxes increased 59% or $48 million to approximately $130 million. At Water Products operating profit improved 54% to 122.4 million reflecting a profit margin of 9.7% compared to 9.5% last year. The increase in profit was primarily due to the acquisition of GSW but was also the result of $35 million increase in sales in China and improved performance in mix and the legacy business. At Electrical Products full year operating profit increased $6 million primarily as the result of lower year-over-year restructuring charges. Restructuring charges in 2006 totaled $8.9 million compared with $12.6 million last year. The Yueyang acquisition also contributed to the higher profit. Operating margin was 5.3% compared to 4.9% last year.

Our tax rate declined in the fourth quarter to 23% from our forecast at the end of the third quarter, the 23% rate resulted from proportionately higher income from foreign operations like China and Mexico where tax rates are significantly lower than in the Company's U.S. operations. The tax rate for 2006 totaled 27.3% compared with our forecast of 29.25% at the end of the third quarter. In addition to higher foreign income the lower tax rate for the full year resulted from the inclusion of R&D tax credits. For 2007 we're projecting a tax rate of approximately 28%.

Operating cash flow totaled $129 million in 2006 compared with our third quarter projection of $100 million. The improvement was largely the result of better than projected working capital performance. Day sales outstanding declined to 63 days from 66 in the third quarter. However, cash cycle days were actually up to 65 days compared to 63 in 2005 primarily the result of increased inventories. As a result of the strong cash flow in the fourth quarter, our debt to capital ratio declined to 39.1% from 42.8% at the end of the third quarter. Other cash flow highlights include capital spending in 2006 of $68 million compared with depreciation and amortization of $61 million. Capital spending and depreciation totaled $51 million and $53 million respectively in 2005.

In addition to GSW, the higher level of capital spending in 2006 was attributable to the Company's businesses in China. For 2007 we're projecting stronger operating cash flow resulting from the improvement in earnings and a continued emphasis on better working capital management. Capital spending and depreciation are expected to total 78 million and 70 million respectively in 2007. Now, Paul is going to talk about the outlook for 2007 and then we will open the call for questions. Paul?

Thanks, Terry. As I mentioned at the outset in 2007 we're projecting a full year earnings rage of between $2.75 and $2.95 per share, an increase of between 12% and 20% compared with 2006. Water products will benefit from the year-over-year addition of first quarter sales and earnings from the GSW acquisition and additional synergy savings, and China is expected to grow another 25%. However, the current outlook for the legacy business is flat primarily because of the cooling housing market and potentially tough comparisons for the commercial water heating segment. We are expecting the legacy business to be softer in the earlier part of the year and to strengthen as the year progresses.

The China water heater operation continues to post impressive results and is expected to continue along that path in 2007. In 2005 we undertook a project to double their capacity, and the second phase of that project will be completed in the early part of the second quarter. Sales at Electrical Products are also projected to be similar to last year as the slowdown in new housing construction is expected to offset the benefit of improved pricing. On the upside, the HVAC market should recover somewhat after the sharp sell-off during the last three quarters of 2006.

So putting these pieces together, we expect to obtain earnings of between $2.75 and $2.95 per share. We expect to start out slow and strengthen during the year. First-quarter earnings are expected to be similar to last year as the accretion from GSW is offset by softer residential markets and restructuring charges we will take related to repositioning and severance at Electrical Products. These initiatives are expected to generate early returns and benefit earnings as the year progresses.

So with respect to the forecast, we do still have some concerns about sales and cost headwinds near term, but we expect the outlook to improve as we get deeper into the year. At the end of 2006 we launched a series of strategic initiatives in both businesses. I want to take this opportunity to share those initiatives with you. At Water Products we believe there are great savings opportunities to standardize components and processes by sharing best practices between the integrated water heater operations. Secondly, our operating companies are looking at our product offerings and our markets served and are examining ways to optimize our investment in these businesses to provide a greater return to our shareholders. Third, we enhanced our efforts to improve operational efficiencies and opportunities embedded in SG&A and fixed over head costs. Finally, considering the energy consuming markets we serve, we have elevated the importance of energy efficiency in all of our product offerings. Teams have been formed and goals set for each of these initiatives, and each initiative will be reviewed at the highest levels on a regular basis throughout the year.

Lastly, this chart captures the mission that these strategic initiatives are aimed at. We're focused on operational and profitability improvement first and foremost. Over the last ten years we've redefined the core of our business by divesting from automotive products, the storage business, and the fiberglass pipe businesses. While building the water heater and motors platforms through acquisitions. The acquisition activity has been substantial and in some cases the integration is incomplete. We believe until we have firmly established ourselves on a performance footing we cannot effectively obtain or capitalize on top line growth. Our first objective is to improve the process and the operation, or as stated in the slide, optimize the core so that in the long run we can grow from a position of strength. That concludes our opening comments and we're ready for your questions. John?

[OPERATOR INSTRUCTIONS] Our first question is from the line of Michael Schneider with Robert W. Baird. Please go ahead.

Good morning, guys.

Good morning, Mike.

Paul, maybe just first more strategic, your initiatives you discussed at the close of the call was near development. Can you describe why the change in, I guess in mind set because I guess for several years now since you've arrived it has been a growth focus. It sounds like now you've switched to certainly a margin focus for the business. What drove that? What's new or different that you see today that that drives that change in mind set?

Well, Mike, I am not happy with the margins right now, and we do still have some growth initiatives. I mentioned the energy efficiency. We have some areas that we have some exciting products coming out. We're still excited in motors on the ECM, the E-mod, and the pump market, but we really need to get very focused on getting our margins. We've talked for years about for years about having a 12% operating margin goal in the businesses. Electrical Products is a 5% we look at that, we've got a lot of opportunities of standardizing, reducing the variability, and getting those margins up, and we're very driven to get that done, and we just thought we owed it to the shareholders to let you know that that is a primary focus we're going to have for at least the next year, and we think it will give us a shot in the arm at getting our margins up, and it doesn't mean we don't still have the isolated areas. When you look at the strategy for Water Products, we still mention growth, but right now the strategy at Electrical Products is to get the costs out. We think we're in some cases at a cost disadvantage, and we see that as an opportunity.

Paul, I guess where do the opportunities lie in Electrical Products? You made the comment somewhat obtusely about optimizing the investment. Is that more about just reducing SKU count and standardizing designs or is this the old 80/20 rule in effect?

It is the SKU count and reducing the designs, primarily, Mike. We have a lot of acquisitions we've made, and we've not done as good a job on standardizing form those acquisitions. We tend to have more product variability than our competitors based on a lot of analysis we've done. We're not going to implement the ITW80/20 thing. That's not what we're talking about here. We're try to make sure if anything that we optimize the mix going forward and do the efforts on the cost side. We have more laminate designs than our competitors for example. A year from now that won't be the case. Those are examples of some of the things that we're doing.

Terry, you mentioned that the guidance assumes or your expectation is for motors to be flat in 2007? With this complexity reduction or SKU count reduction, is it possible, though, that sales are actually down in motors in 2007?

No, we don't believe sales will be down in 2007 in motors, and a lot of what we're doing as I mentioned, the SG&A and the fixed costs, there is some up-front charges to get those things done. We announced a plant closing last week, for example, and we had some other things. We have been accelerating the repositioning and the eliminating of some fixed costs in some under utilized facilities, and we're continuing to accelerate that and do that faster than the original plan. That's a little bit of what you're seeing, is a little bit of up front costs related to that as well as -- but I want to reiterate we will get those costs covered before this year is out. It is just a little bit front-end skewed as they usually are when you close a plant or have a reduction in your salaried force. You have some costs up front, and those savings come later on in the year. We will be neutral to positive on these actions that we're taking right now by the time the year ends.

Terry, just separately on raw materials, maybe you could address copper and steel separately. With copper at 2.55 where do you view your average costs as it lies today with your hedging and unhedged position and what does it imply for your cost of goods sold in 2007, and then the same question really for steel.

This is Paul. I am going to go ahead and answer that one, Mike. We traditionally have give out more information than our competitors. As I've said, we hedge, our competitors hedge, and we're just not going to talk about where we are. We work with our customers and our partners there. We did see steel declined a little bit towards the end of the year. It's picked back up now. It is going to continue to fluctuate as will copper. All I can say is that we're pleased with the actions we've taken over the last several years, and my expectation is when this year is over we'll be pleased with the decisions we made there too, but we're not going to try to speculate on what the cost of goods sold will look like based on those positions.

Maybe a different way to attack the question is to just talk about pricing actions. Have you gone out with pricing since the first of the year, and would you expect to do so beyond just low single digits at any point here in either business in the near future?

We had a major effort on costs, on pricing towards the end of last year going into this year, especially at the motor site. We just had to have it. It is not a surprise. I think it is true of all of our competitors while copper may have moved down now, copper now is at less than we were paying for it last year because of the hedges we put in place well before that. We're still seeing a copper increase on a year-over-year basis. That's just one example of what we've done, but pricing has been vital. We had a lot of things we had to do on the pricing side.

It is not just copper and steel. It is zinc, it is freight, it is health care costs, it is pension. Also, we've seen some pretty unusual things on some components lately, so pricing has been a vital portion of our strategy now for three years as we've been seeing some absolutely unpredicted increases in our costs. I think we've done a pretty good job at keeping our margins up and getting some price, but it is continuing to be a major focus of ours and frankly has to be for everybody in the industry. We're going to continue if commodity prices or components go up, we will be back out to the market with another price increase, not because we want to. It is not something we want to do, but if we're forced to do it, we've certainly learned how the last three years. Steel companies and the freight companies and the raw material commodities have really taught us that we have to get out and learn how to get the costs up and get our prices up when the costs shoot through the roof like they did.

We still have productivity programs, very aggressive ones. I am pleased at what we're doing on the standardization and optimization of the product. I am they pleased with plant operations, the efficiencies, Johnson City the new acquisition is still continuing to improve from the level they were at before we acquired them. Our Ashland City facility where hopefully we'll see you in April for a shareholders meeting, very, very pleased with what's happened there on getting the productivity up, but when you get your productivity up and save yourself 4 or $5 million ad steel goes up $100 million, you have to get out there and get some price.

In short, Paul, it doesn't sound like you have price increases planned near term unless commodities rise further?

That is true.

Okay. Thank you.

Our next question is from Scott Graham with Bear Stearns. Please go ahead.

Good morning.

Good morning, Scott.

I have a couple of questions, and I will tell you one of them was just generated because the answer to Michael's question that you just provided very much surprised me on the pricing front, but nevertheless let me hit on the water heater side first. If I X out pricing and I X out China, it looks like that business' volumes were down double-digit carry. Is that what you referred to when you said resin and comp were both down double digit? I thought you might have said that was what the market was down. Is that -- you were down as well?

The market was down.

The market was down. We weren't down double-digits, but the market was down double-digits.

You weren't down double-digit, but you got pricing, and China probably added 5% to the total. You said the core was down 5. Why weren't -- so volumes had to be pretty close to down double-digit, right?

Scott, I will talk in general. This is Paul. We've had a market share decline since the state acquisition. We have turned that around based on the latest market share data, and that's been primarily some building programs, some contractor programs that we've done to go out and get some business at reasonable margins. Our water heater market share has increased especially during the latter part of last year. It was a really tough market. We had some inventory issues. Among other things I am proud of we took our backlog down over 100,000 units over the last year simply because of a quality service initiatives that we've had there, so there is a lot of moving parts in this thing, but we're pretty pleased with the service level and what we're doing to serve that market right now. Terry, you got some numbers for him?

Just residential is down more than commercial, but in total it was not quite double-digit margins.

My estimate was pretty close to the mark, and that's why I wanted to ask you that. This is going to have some ebbs and flows, and I understand that, but we talked, I think, you and I, Paul, recently about how the prebuy in the third quarter, it was not as significant as -- it should not have been an earth shattering impact on the fourth quarter, yet it looks like it did have a much greater impact, so I guess this is just more of a open-ended question. There is nothing going on there market share wise that's troubling you, right.

No. The third and fourth quarter, actually, our water heater business came in about the way we expected them to.

That's fine. As far as the price increase answer that you gave Michael a moment ago, I was of the understanding that we were kind of waiting for the GSW acquisition to anniversary, so this kind of puts a year behind you and doesn't get you into any questionable situations with your wielding your large market share axe in the marketplace. I was of the impression that you were going to increase prices at retail in the first part of this year.

We did. We did.

You did already?

Yes. We increased price. We had to. We had to increase prices. Our margins are low acceptable level right now in the residential side where the margins on commercial side where we have a technical and service advantage are higher, but we had to due to a lot of components, a lot of other reasons. We increased prices through the fourth quarter and up to now throughout the marketplace. We're keeping everybody at the right level. This is not a pick on one group versus another. Our objective is to have acceptable margins in the residential water heater business through wholesale and retail, and we have increased prices through those channels last year.

Last year?

Last year. We just concluded it. It is going into first part of this year.

Okay. That's a little it different than I thought what we had talked about. I was under the impression that the increase in prices at the shelf that we were seeing at Lowe's were in fact Lowe's initiated and that that was giving you optimism that you would be able to get a price increase, in call it February of this year, so you changed that?

I don't remember the conversation, but retail prices have been moving up through the last few weeks and months at all the retailers, and our partners there have been moving their prices up as they should, and we've been moving our prices up as we should based on the agreement that we have with each of our retail customers.

I think, Scott, when we were talking before, we had a price increase in the fourth quarter in the legacy water products business, but we had said that the Lowe's contract I think was up in February of '07. I think that's what we might have said. There weren't any increases in the legacy business early on after the acquisition. I think Dream raised prices late in the third quarter, early in the fourth quarter. We followed that price increase in the fourth quarter, but it did not impact Lowe's who is the biggest customer because their contract wasn't up until February.

I didn't think I was going crazy. Then furthermore, then, what would you say right now is that very important price gap between resale and wholesale in the channel? Is it 15 still or is it still hovering around 10 pending the realization of these price increases at retail?

It is closer to the lower number, and that's really about all we want to say relative to pricing to the channel.

That was not the contributor, that lesser gap in pricing was not a contributor in your view, Paul, to your double-digit decline in volumes in the business this quarter?

No, no.

Okay. Last question. On motors, and this is more of a market question, one of the things that you shared was the situation where you might actually investigate acquisitions in the motors business, and I am wondering now with this more margin oriented tone which I applaud, by the way, is there any reason to do a motors acquisition when you might have more opportunity within?

Well, if the acquisition opportunity is to get scale, the odds are we're probably not going to pursue it unless we can buy it real cheap. But if we can get a technology and an innovation -- give you an example. Yueyang, that we acquired in November of '05, we're preparing the one-year summary of that for our Board in a couple of weeks, and the bottom line is we knocked the ball out of the park. That thing is upper teens operating earnings. It grew faster than we thought it would, and the margins went up more than we thought it would, and we see another couple of things out there that we're investigating similar to that. The only problem with yueyang, it was so small, about a $20 million revenue basis. It gave us high voltage hermetic product, something we didn't have before.

If we see something like that out there that we can acquire and integrate and as you know, we're pretty good at acquiring businesses in China and integrating them, and we're looking at some other things like that, so I would not say that we're on the shelf relative to acquisitions, we're just not going to do it to get scale. We're not going to do it to get some me-too acquisitions. It needs to bring something to the party on the Electrical Products side, and on the Water Products side there is always the opportunity of additional products as well as additional geographies, so our corporate development people are not sitting on their hands. They've got a lot they are working on right now.

That's very helpful. Thank you very much.

Next to the line of Matt Summerville with Keybanc. Please go ahead.

Good morning. A couple questions first. Paul, can you describe how you feel in-channel inventories are in both of your businesses right now, water heaters and motors?

Well, they're better than they were, Matt. This was the problem throughout last year, but we feel the inventory things on the air conditioning market just got so screwy that finally they quit publishing the data because nobody was believing it. We have been out lately talking to every one of our customers for two reasons--one is getting a handle on the inventory. The other is what do you think is going to happen with housing, and we're kind of cautiously optimistic that we think housing will pick up starting in the second quarter, and that's based on -- that's not just a wish or a hope, that's based on a lot of conversations with everybody that participates closer to that market than we do. The water heater side we think -- there was a blip in the third quarter as I mentioned earlier to Scott we were not -- I think the water heater third and fourth quarters came in about like we expected them to, and we continue to think that this year is going to be just like that, about like we expect, and I don't think the inventories are out of line anywhere right now. As a matter of fact, they're probably more in line now than they've been in the last two or three years.

Okay. Then, Terry, what's your pension expense assumption for '07 compared to '06?

We have an '06 pension expense, about 11.8 million and our expectation for '07 is about 12.5.

Then with respect to the restructuring in the motor business, you mentioned that the costs you incur you should kind of be neutral relative to the costs you incur in terms of savings in 2007. Does that just relate to what's going on in the first quarter or does that also take into account the savings that you should be getting from the actions you've taken in 2006?

That was just a first quarter comment.

Okay. How much cost savings do you anticipate in '07 compared to '06 based on actions you've already taken, things that were done in '06?

It is John Kita. I don't have the exact number in front of me, but the plan that we closed in the last half of the year we expected significant savings, so I think it is realistic to say 5 to $6 million benefit from those closings that we did in the third and fourth quarter of '06 will get the benefit '07.

And as you look at your geographic mix in terms of manufacturing and your motor business right now, Paul, how much is U.S. versus Mexico versus China?

Well, the U.S. has been declining significantly. Just for everybody's benefit, we had moved the assembly operations out of the U.S. a few years ago. What we've been doing in the last three years is the fabrications side. We would have a plant -- I will use Owasso, Michigan, for example. Where we just had a stamping operation, stamping laminates and some in-frames where we're using 20, 25% of that facility, so we not only got the benefit of some reduced labor even though there wasn't a big labor savings from moving that stamping net operation some place else, where we really got the savings was the fixed factory overhead that went away by closing the plant.

We have been closing two or three plants a year in the U.S. and relocating that equipment to other places where it can be more efficient, and we had one very large one that we did at the end of last year. It actually will cease production at the end of this month at the plant in Tennessee that's going to 5 or 6 million benefit that we'll get this year. In addition we announced a closing last week, and we will be doing some others. We've struggled with how do we -- do we want to put all these restructuring and everything in. We'd just rather do it as part of the day-to-day business and get on with it and just mention after the fact that oh, by the way, we eliminated another high-cost facility and moved that production to a low-cost location.

Just as a follow-up to that. From a geographic standpoint how much more optimization is there in your motor business?

We still have another year to year-and-a-half of improvements that we can make in that business.

Okay. Thank you.

Next question is from Andrea Sharkey with Sidoti and Company. Please go ahead.

Good morning, everyone.

Good morning, Andrea.

I guess maybe to follow-on the last question about opportunities on the motor side, I guess in terms of you're saying there is still another year, year-and-a-half of work to be done, can you quantify that maybe in more of a number figure, a cost savings figure? What the potential could be?

Not at this point, Andrea. There is one that we're looking at that's a substantial cost, 8 to 10 million as well as 8 to 10 million of savings in that year. That's one that we could be doing sometime this year. It would be -- it still requires a little bit more planning, and analysis, and I should mention that one is not necessarily in the U.S., so I don't want all of our employees in U.S. operations to think that they've got a target on their backs because we have some very efficient, very productive operations all over the world. We are continuing as my manufacturer is to look at ways that we can be more productive, and we're going to continue to do that.

Okay. Thank you. Then talking about the restructuring charges side of it, the restructuring was up a little bit higher this quarter, and is that kind of going to be -- when you say the first quarter of this year, it is going to be high, would you say it would be in the same magnitude as this fourth quarter or even more than that in terms of restructuring?

Well, we've done some rather substantial things within the last three or four weeks, and that's the reason we're saying that. As I mentioned, we have a facility, fairly small one stamping operation that we announced the closing of last week, and we also have some other overhead costs primarily in the SG&A area where we're taking some severance charges early in the year that we'll get those savings back as the year goes on. Those actions for the large part have been done within the last two or three weeks, and that's what we're talking about.

We would not expect it to be as high as what the fourth quarter would be.

No. It will not be as high as the fourth quarter. The fourth quarter was the one facility in Tennessee that was a substantial charge and also a substantial savings as John mentioned.

That's helpful. Thank you. In terms of looking at the demand outlook, I don't know if you can break down a little bit within the quarter if you saw any trend on a month to month basis? Are things staying kind of the same? Are they getting better, are they getting worse on both sides of the business?

Well, we're off to an okay start to the year. If that's what your question is. We've -- we're still seeing some weakness on the hermetics side tied to the air conditioner inventories getting in line. A lot of our HVAC customers have been taking some substantial time off. I think I mentioned that in the last call in the fourth quarter, and some of it spilling over into the early part of the year. Pump, also, where we had a huge inventory situation a year ago, that now seems to have gotten itself in line. It is just a matter of whether the housing market picks up in the April/May time period which we're expecting it will.

Commercial actually held pretty strong last year and I will mention to everybody we still do half of our HVAC business just through the commercial side of the business. If you will allow me a quick aside, we have a fairly substantial ECM implementation going in right now in which we're participating in the complete revamping of the HVAC facilities for the Watergate complex in Washington, D.C., and that's going to have all of our motors in it when that's done. That's an example of a commercial application that we continue to go after and have some success. Overall long-winded answer we think the -- we're okay and off to an okay start, a little weakness on hermetic. We're starting to go see the pump pick up a little bit and the water heater business continues to move along as we expected it would.

Okay. Then I noticed margins although they're down year-over-year they did increase sequentially on both the motors and the water heaters, and I was wondering if you could maybe clarify where that was coming from? Was that -- how much of that was related to the lower copper, steel and freight costs you might have seen this quarter and how much potential is there for that to be -- aside for '07?

Well, a little bit of it on the steel side, copper was not -- again, we had hedged our copper for the fourth quarter a year previously or more. But the -- I would say probably as much as anything in some of the mix improvements we had had as well as the ongoing productivity everything contributing, and we really are pretty excited about some of the productivity things that are being done. We've implemented a version of the Danaher business system within our plan, our operations, not just plants, headquarters also. We've had a good start for the first year. We're into our second year of that of really focusing on the big things that we need to get returns to shareholders up. We like the way the businesses are performing right now, still have challenges as does everybody else, but we're starting to see some -- get some things behind us and get some things done.

Okay. Great. Then one just last question and I am not sure if you will want to get this granular on it, but looking at the 2007 guidance that you've given, what are kind of your assumptions looking at margins on both sides of the businesses of what the goal is to get to maybe by the end of the year?

Well, we do have some substantial goals within the businesses, and I would like to defer that to maybe our quarter or two out when I think we'll be prepared. We don't want to talk about it. We've talked in the past and gotten some expectations out, and then we didn't quite come through. As you're seeing, we're being a little conservative, but we're not getting an expectation level out on earnings or margins unless we're fairly confident we can achieve it. We're -- internally we're quite proud of the fact that our earnings last year came in on the guidance we gave everybody in January, and that's something about the culture we want to have around here of not getting something out there until we're sure or reasonably sure that we're going to be able to achieve it.

Andrea, I wanted to -- maybe it is a good point to clarify something that Paul had said earlier, too. When he had talked about guidance for the first quarter being similar to last year, recall that last year's guidance included a $0.10 hit for a currency adjustment that was a hit in the first quarter, and we got the benefit in the second quarter. We're talking about similar. We're talking similar with not including that -- I think it was about a $0.10 hit last year. I think that that needs to be clarified for everybody on the call.

Sure. Great. Thanks. I guess that's about it. Thank you very much for your answers.

Thanks, Andrea.

Next to the line of Ned Borland with Next Generation Equity Research. Please go ahead.

Hi, guys.

Hi, Ned.

Most of my questions have been answered, but just one quick question as regards to GSW. Can you tell me what GSW did in the quarter versus a year ago before you closed it?

I don't know the quarter number. I know that we got around $0.37 for the year which is what we -- we had anticipated $0.35 we did a little bit better. On a day in and day out base there is still a lot of work being done on the synergy lift. We will be doing that throughout this year and into next year on not only procurement but standardized designs and a lot of other things, so we're pretty excited about some of the things going on there. Give you an example, we had, I think 22 designs for small, the minis we call them, under 20-gallon water heaters. We now have 5. Those are some of the things we've done. That was a seven-figure savings we go got from it. It is just some of the initiatives the teams are doing there.

We're still anticipating that the first full year of GSW will be $0.50 accretive, and we're on target to get that and I think that number will go up as the year goes on as we continue to get additional synergies implemented across the businesses. At the same time we're constantly watching the raw materials side and the components side which continue to every once in awhile raise their ugly heads.

What I can say is from a volumes standpoint where we have been talking about the residential industry being down close to 15% is what we're estimating fourth quarter this year compared to last year, they were down single digits. Their volumes held very well in a difficult industry environment.

GSW's volumes.

Yes.

That's what I was getting at. More like the sales from that brand year-over-year. And then if we look at the outlook for '07, I know that you are going to have more GSW in this first quarter than you did last year because it closed late in the quarter, but can we assume that GSW will be better off than a legacy businesses X the quarter over quarter in the first quarter?

GSW margins are typically a little lower than the overall legacy business because the legacy business has a very large portion of commercial water heaters in it. GSW had a very small offering on the commercial side, so to say that it will be better than the legacy, I am not sure that that's going to be the case.

I mean I guess I was just talking from a sales perspective.

Our guess right now would be the legacy may be down a little bit more because it's impacted more by new housing starts. I think that's a realistic assumption is the legacy in the first quarter could be down more than GSW because of that issue. Again, we're forecasting the industry in the first quarter to be down from last year's first quarter part of which is this housing start issue as it feeds through the system. Whether that will happen or not, it is a projection.

Okay. That's all I had. Thanks.

Next to the line of [Mike Marbrid] with Ramsey Asset Management.

Hi, guys, most of my questions were answered also. Just one quick comment on -- given Goodman's recent blessing of Broad Ocean have you seen the intensity of competition from the Chinese manufacturers increase on the electrical motors side?

I wouldn't say we've seen it increase. It has been there for some time. There's a couple of other Chinese manufacturers that have been moving some product in, but I think it is about the same, and we'll just see what happens out there. We would prefer not to participate frankly, in as much of the day-to-day commodity side. We see some opportunities where we can differentiate ourselves, and that's where we're trying go. That being said we're going to ship 70,000 motors out of China ourselves today, and I think it is safe to say that a majority of those would be right in the -- down the sweet swot of a commodity type product where we're trying to participate in that market to some extent, but we see some opportunities to maybe change the mix a little bit.

Proportionally, 70 out of about what, roughly.

We do about 4 million motors a year -- 40 million motors a year.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] We have a follow-up from Michael Schneider. Please go ahead.

Guys, could you just comment on commercial overall? It has been somewhat hinted at throughout the call, but can you give us a sense of what your expectations are for the folks at commercial water heater and the commercial business within the electrical products segment, '07 versus '06 and what the trends you've seen late in the year?

Yes, Mike, good question. Commercial held up throughout all last year which is one of the reasons that we ended up at the higher end of our range for the year, so I would say commercial probably came in in '06 a little above what we thought both motors and water heaters. We're a little cautious, not optimistic. We're a little cautious going into this year wondering if there will be a decline. Again, our commercial is primarily light commercial. This is small office buildings, grocery stores, retail outlets, things like that is where we are participating and participating fairly well in both businesses. We're a little cautious, and maybe that will start to slow down, and maybe we've seen a little bit of it lately, but it is quite possible we'll be surprised on the upside again because there is still a very important piece of our business.

When you say that market would be down, you are just saying the growth rate would slow down or you actually expect unit decline to fall.

We're expecting units to be about flat this year after some rather substantial improvements last year.

Same question really just on the distribution motor business or quasi industrial business, what have the trends been there?

Well, we're continuing to get wins on the distribution side, so that element of our motor business continued to grow, and it is growing as we speak.

Okay. And then just specific to restructuring charges, what were the expenses in Q4 and then what have you included in the guidance for Q1 in dollars if you would?

In '04 in the fourth quarter we have restructuring of 3-point -- about 3.5 million.

We would expect the first quarter to be less than that as we said.

It will be less. We don't have a specific number, Mike, because we haven't go announcement dates, we haven't got specificity yet but it would be less than that 3.5 million.

Presumably seven figures of some sort.

Oh, yes, yes, I would say that.

Okay. Then really for the balance of the year, what do you have included in the guidance range you've issued? Just the Q1 structuring or additional through the year?

We have some -- it is likely we will have some more during the year. Again, we don't have all of that quantified at this point.

That would not be in the guidance range, Terry.

Yes, it is in the guidance range.

It is in the guidance range?

It is in the guidance range in a, I guess in kind of some format of what we think might be the totals without any specificity.

Would you be willing to share that number.

No, not yet.

Okay. Thank you.

We have a follow-up from Scott Graham. Please go ahead.

It wasn't clear from the slides though I think you may have said it, Terry, are you expecting organic sales in the water heater business to be flat in '07? Did I hear you say that?

Yes, we're maybe being a little conservative there. We're going to have growth in China, we're not forecasting another 40% growth in China. But as we look at the -- because we think we're off to a slower start, we're being a little conservative in forecasting that to be about flat for the year.

Then here is a question. I think you managed this very well this quarter, but the question for 2007 would be is we're expecting price positive in both businesses. We're here to have the specific from China. We're essentially -- looks like we're forecasting volume negative for the year, which I don't think any of us would disagree with given the markets and hopefully they'll get better. But the question is, this quarter we didn't see that much of it because you did a good job and you had some pricing, but the volume variance is in the factories. How do you see that playing out in the margins next year?

We're forecasting -- it is our belief that the units will be about flat for the year. Pricing is contingent upon the competitive situation as well as what happens on the raw materials and components side. Our projections right now for 2007 hopefully it is conservative on the legacy business is about flat.

On the volumes.

On the volumes.

So to your point, Scott, sales would be up a little bit because price is up year-over-year.

Yes.

We're calling volumes to be flat to about slightly, but the pricing benefit that we had in September and early this year will flow through, yes.

So our core sale -- is your forecast for core sales in 2007 for clarity purposes flat or up slightly because now that's kind of contracts with flat?

Units flat, dollars up except for China where you've got both dollars and units.

Thanks very much.

Any other questions.

No further questions.

Well, we appreciate everybody's interest in the Company, and appreciate your faith and confidence in us in that we're going to go out and earn it again.

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