A O Smith Corp (AOS) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the A.O. Smith fourth quarter 2008 earnings conference call. At this time all participants are in a listen-only mode. Later there will be an opportunity for questions, and instructions will be given at the time. (Operator instructions). As a reminder, today's conference is being recorded.

I would now like to turn the conference over to Vice President of Investor Relations and Treasurer, Ms. Patricia Ackerman. Please go ahead.

Good morning, ladies and gentlemen, and 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; John Kita, Senior Vice President of Finance; and Craig Watson, Vice President, Business Development.

Before we begin with Paul's remarks, I would like to remind you that some of the comments that will be made during this conference call including answers to your questions will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in this morning's press release. Paul?

Thank you, Pat, and good morning to all. Our operating units performed well in 2008, given the difficult conditions in the housing market, a commercial market that began softening in the fourth quarter and commodity cost volatility that was best described as a roller coaster. In spite of those difficulties, we generated sales even with last year of $2.3 billion and earnings of $2.70 per share. Adjusting for restructuring and other charges, we earned $2.89 per share.

We generated operating cash flow of $107 million and continued our efforts to preserve cash. Our balance sheet remains strong, and our debt to capital ratio is 34%.

Sales at our Water Products operation in China grew 26% to $185 million. We were rewarded by our repositioning activities in our motor business with $5 million in savings in 2008. The merger agreement with Smith Investment Company is progressing.

This morning we established 2009 earnings forecast of between $2.40 to $2.60 per share. We will expand on each of these points in our review today, but I would first like to begin by addressing the market environment currently facing A.O. Smith.

Regarding the outlook for 2009, we believe the soft housing market will continue throughout the year and the recession will continue. We believe the softening in the commercial construction market that we began to experience in the fourth quarter of last year will not abate in 2009, leading to a contracting commercial market. We expect that our growth in China will slow in 2009, but will be positive, and we expect our pension costs will increase by $6 million over 2008 costs.

Those major influences will be slightly offset by certain positive developments, as we believe our water heater prices will have a positive impact on our profitability this year. Additionally, the anticipated savings from repositioning activities in our motor business and from salaried workforce reduction programs will increase in 2009. Combining all these factors with the overall temperature of the economic environment will make 2009 a challenging year for A.O. Smith, and thus our forecast for earnings is lower than what we achieved in 2008.

Terry will now talk about our financial results in more detail. Terry?

Thank you, Paul, and good morning, ladies and gentlemen.

Full-year sales of $2.3 billion were flat compared to 2007. Reported net earnings of $81.9 million or $2.70 a share were 7% and 5% lower than last year's numbers. Adjusted for $0.19 and restructuring charges, earnings were $2.89 a share, 4% lower than the adjusted $3.02 a share in 2007.

For the fourth quarter of 2008, sales were down 11% to $509 million while net earnings declined by $10 million to $6.6 million or $0.22 a share. Fourth quarter earnings included $3 million or $0.07 a share of restructuring compared with a net $0.20 per-share for restructuring and a tax benefit in the fourth quarter of last year.

Taking a closer look at the individual segments, Water Products achieved sales of $1.45 billion, a modest increase over 2007 sales of $1.42 billion. This segment benefited from a 26% increase in China sales to $185 million. However, lower residential and commercial water heater volumes overshadowed the strong progress in China.

Despite selling price improvements to offset higher cost for raw materials, sales in the Electrical Products segment declined 4% in 2008 to $858.1 million. Unit sales were negatively impacted by the weak housing market as well as customer inventory reductions at the end of the year.

Fourth quarter sales of $346.2 million at Water Products declined 9% compared with the fourth quarter of 2007 due to double-digit declines in commercial and residential Water Heaters unit volumes, partially offset by sales growth of 11% in China. Residential Water Heater volumes in the fourth quarter fell below what we believe to be replacement levels, which should favorably impact our order rate in the near term as depleted inventories in the distribution channel are replenished.

At Electrical Products fourth quarter sales of $163.2 million were significantly lower than the same period in 2007, due to weakness in its residential market segments. Although our OEM customers pared back their production schedules in December, we expect them to begin to replenish depleted inventories in the first and second quarters, which will positively impact order volumes.

As we look at operating profits, Water Products' 2008 operating profit of $134.7 million represented a 10% decline from 2007. Earnings were negatively impacted by lower residential water heater volumes and higher cost for raw materials and components, which were not completely covered by price increases. Operating profit margin declined to 9.3% in 2008 from 10.5% last year.

In Electrical Products, operating profit for 2008 increased to $39.1 million and included a restructuring charge before taxes of $8.7 million. Operating profit was $23.1 million in 2007 and included pre-tax restructuring expense of $22.8 million, primarily associated with the 2008 closings of three manufacturing facilities. Excluding restructuring expenses, the Electrical Products Company's operating margin for 2008 was 5.6% compared with 5.1% last year. The increases in operating profit and margin were primarily the result of cost savings associated with product repositioning and pricing actions at targeted accounts.

During the fourth quarter Water Products sales declined to $29.5 million compared with $45.1 million in the fourth quarter of 2007. Lower residential and commercial water heater sales in the US more than offset an 11% increase in China water heater sales. Fourth quarter operating margin fell to 8.5% compared with 11.9% in the fourth quarter of 2007 as a result of significantly lower US volumes of higher-margin commercial Water Heaters combined with additional margin pressure due to higher steel costs.

Electrical Products recorded a $5.2 million loss in the fourth quarter, which included a $2.9 million pretax charge for restructuring. Fourth quarter operating loss in 2007 was $18 million and included $21.2 million for restructuring. Excluding restructuring charges, the operating loss at Electrical Products was $2.3 million in the fourth quarter of 2008 compared with adjusted profit of $3.2 million last year. Operating margins at Electrical Products was a negative 1.4% in the fourth quarter of 2008 compared with 1.6% in 2007. Despite savings of $2 million from repositioning activities, the steep volume declines drove margins lower.

Operating cash flow of $107 million in 2008 was below our expectations and below our record cash flow last year. In addition to higher inventory days, cash deposits associated with derivative contracts negatively impacted cash flow when compared with 2007. Looking ahead, we expect the inventory levels to normalize by the end of the first quarter. The total cash cycle days increased to 65 from 57 last year. A small contraction in accounts payable days and the expansion in inventory days more than offset a reduction in receivable days.

Depreciation and amortization totaled $66 million in 2008, and our capital spending was $66 million. Capital spending is expected to increase to a range between $75 million and $85 million in 2009, primarily due to the construction of the water heater plant in India and carryover projects in China that were approved in 2007 -- or excuse me, in 2008.

Our debt to capital ratio remained unchanged for the year at 34%. We repaid $40 million in debt during the year, but our leverage ratio was impacted negatively by charges to stockholders equity associated with higher pension liabilities and losses on derivative contracts. We continue to preserve cash and reduce our cost structure to maintain our solid financial position.

For 2009 we're projecting full-year operating cash flow of about $150 million. This projection includes a voluntary pension contribution of between $35 million and $40 million, which is more than double the $15 million voluntary contribution we made in 2008.

Now Paul will talk about the outlook for 2009, and we will open the call for questions.

As you know, our biggest end markets are residential and commercial construction. The protracted slowdown in the residential market is old news at this point, and the slowdown in the commercial market segments we serve is upon us. As you may also be aware, we sell products into fairly mature segments which have a high component of less volatile replacement demand. This is an important point to consider when you think about our volumes going forward.

As you can see, for Water Products we estimate the replacement demand to be over 70%, and for motors it's approximately 60%. To elaborate on these points, these charts on slide 15 give you some historical perspective into the stabilizing effect of the replacement market on the water heater industry. Over the last 10 years, the replacement market in the water heater industry has been consistently between 7.5 million and 8 million units. Since we have a 50% market share, that translates into a nice, solid base of sustainable demand for our product.

Our commercial business enjoys an industry with the same stability. The replacement volume in the commercial market has fluctuated between about 90,000 and 110,000 units over the last 10 years. While we expect our replacement demand will continue to provide volume stability that many companies would envy, we are not completely immune to a recession. Therefore, we expect our residential volumes and our higher-margin commercial volumes to decline in both businesses in 2009.

Also, we're projecting our pension expense will be $10 million, which is higher than 2008. That said, we also expect to benefit from several earnings enhancers in 2009. First, the results from pricing negotiations in our water heater business will fall right through. Second, we expect growth of rates above GDP in both our high-margin water heater and even higher-margin commercial hermetic motor business in China in 2009. We continue to penetrate new markets for Water Heaters in tier two cities by following our retail customers and establishing new distribution in these geographies.

In addition, at 18% we now have the largest market share for electric brand tank-type water heaters in China.

Third, our restructuring activities in motors are on track to deliver $15 million in savings in 2009, and we expect additional savings from the salaried workforce reductions program announced this month.

However, notwithstanding these bright spots, we remain cautious for 2009. The persistence of the soft housing market, a slowdown in commercial construction and global recession will continue to pressure our businesses in 2009. All of these factors will make this year a challenging year for A.O. Smith, but I am confident that our experienced team is ready for the challenge.

Accordingly, we expect earnings to range between $2.40 and $2.60 per share.

With that, we are ready to take your questions. Beverly, I'll turn it back over to you.

(Operator instructions) Michael Schneider, Robert W. Baird.

Maybe we could just start on what occurred in Q4, then what you expect in Q1. Q4, sales in Water Heaters down -- I wonder if you could give us a sense of what you think the sell-through in the market was versus what you actually experienced so we can understand at least a rough mix of what was inventory depletion by distribution in retailers and what was actually the sell-through decline.

Well, fourth quarter was actually below the sell-through decline. And, Mike, you talk about a roller coaster; October was okay, November was horrible. Our order rate dropped across the board, almost every product line in the US; very, very low order rate. And then it popped back up in December.

For the quarter, I think our number was about $61 million less volume than we thought we were going to have on November 1st, was where we ended fourth quarter. But it was just everything from customers worried about whether they would be able to get the bank financing to cover their lines of credit to everything under the sun.

But it picked back up in November. And before you ask, we are off to an expected level of volume on the order rate so far in January.

So the volume decline of 9% in Water Products during the quarter -- you're actually running better than that right now in January because of some of this, I guess, more stable inventory actions?

Yes. And the other factor we have is, this is the first time in, I think, five years we haven't had a price increase in wholesale on January 1st. So there was no pre-buy at all; matter of fact, just the opposite. So we are off to a fairly decent order rate so far.

And then on pricing and wholesale for the coming year, with no price increase, what have you seen within the channel, though, in terms of any price discounting that's occurring by you or your competitors now as we go into 2009, given what the CRU index has done?

Well, obviously, there's some downward pricing pressure. But steel in the fourth quarter was by far the highest steel cost we've ever had in this Company. It was up something like 80% over where we started the year. And so we still have steel costs today in the first quarter well ahead of where we were a year ago. And, we had more than one price increase last year. Yes, there has been some deterioration, but the first price increases held fairly well and we expect that will continue because we had to have that last year to cover the steel costs. Once again, we're off to a -- obviously, steel has come down slightly from where it was in the fourth quarter, but it is still significantly above where we were, first half of last year.

And, in your outlook comments, you said you have assumed for Water that you show volume declines in 2009. What have you assumed for pricing in 2009 as a whole? And maybe just give us some thoughts of distribution versus retail.

I can't split those out, but we have obviously assumed that overall there will be a price increase over 2008.

I guess then just final question -- on the contracts with your distribution and retail customers, can you give us a sense of what percent is actually tied and is automatically adjusted by the CRU index for [contractors]?

That's only on the motor side, and that's with our OEM customers. As of right now, we don't have any wholesale contracts with any of our customers. That's why we can have -- we had, I think, three price increases last year on the wholesale side on Water Heaters.

And, have you concluded or finalized your negotiations with your largest retail customer?

We don't comment on that.

Ned Borland, Next Generation Equity.

Just on the China mid-teen growth, I'm wondering if that includes any shipments into India from China.

Yes, it does -- not a lot, although it's more than we -- that our original plan has been. As you know, we're shipping products into India from China. It's a specifically designed product for the China market. It's actually taking off better than we expected; it's doing quite well there, which is a little bit of a -- it's a good news/bad news. And frankly, I'm pleased. The good news is, the volume is up, but the bad news is we are not making any money on those because of -- there's a 10% tariff from China into India, and the dollar versus the RMB is strengthening. The dollar versus the rupee is weakening, so we are getting a double currency hit on that, too.

But the good news is, we now have land allocation, and we are in the process of putting together the plant design. And I expect we will be breaking ground there before this quarter is over, and within a year we expect to have a facility up early 2010, in India, producing product for that market. And I think, by then, we will have established the brand name fairly well. Our distribution partner there -- relationship is great; we could not be happier with how this product launch has gone.

And then, on Electrical Products, I know the volume decline was pretty staggering. I just want to put it in the context of the roadmap initiatives, when you shut down three plants in 2008. But I'm just wondering how to think of margins in that segment on a lower level of volume going forward here in 2009.

Our gross margins have been moving up. The roadmap has been working on that side. The problem has been the volume decline.

The OEMs -- we primarily service the HVAC OEMs, and you can just go check out what they are saying, and that will tell you what we're facing. They are shutting their factories down for several weeks; it's -- in the fourth quarter. And we are off to what we would consider a shallow start to this year. Some of the factories have stayed down for the first start of the year, and they are not running anywhere near the rates that they have in the past. We are assuming housing starts for this year now to be 600,000; that's an unbelievable number, based on those of us that have been around for a few decades. But that's what our forecast is this year, and that's obviously driving the HVAC people to be very cautious.

Finally, on the salaried headcount reduction, any ballpark range of savings expected from that?

It was -- the last one that we did was about $2.6 million in savings, but that's only part of it. We have done quite a bit of reorganizing and eliminating open positions and restructuring that way. But we actually had a salaried lack of work last week that was -- will generate about $2.6 million in savings this year.

And then just one last one on the guidance. How much of a price increase is embedded in your guidance range? And, what is the low end versus the high end? What are the variables on price embedded there?

It's all over the map. But, just to give you one indication, we are going into this year with steel at about 25% above where it was this time last year, when steel was about half our cost. So you can do the arithmetic on that. That's the sort of thing that we are trying to have on year over year.

Scott Graham, Ladenburg.

Could you first, Terry, maybe walk us through this derivative impact on cash flow, if you don't mind?

We've got a number of -- we've got foreign exchange contracts, we've got interest rate swaps, we've got copper, we've got aluminum. If you look at the balance sheet, you can see the number on the balance sheet, I think, is about $73 million. Most of that is probably associated with copper, but there are a number of contracts in there.

Also, the large numbers associated with those underwater derivative contracts -- a good portion of those, as you will recall, relative to the copper contracts are specific customer contracts. So they bear the risk on those contracts; we don't bear the risk on them. And the remainder would be those to which we are exposed to on hedging contracts, which, at a point in time -- that is, the value date at the end of the year -- we're underwater. That's not to say that that may not change during the year because that's a measurement on which we make the entry on the balance sheet at the end of the year.

Alright, but it's a balance sheet entry?

It's a balance sheet entry relative to valuing contracts at the end of the year.

So I guess my follow-up question would be, why was the change in current assets and liabilities a negative this quarter, whereas historically we have sourced cash out of that line?

Well, what happened is there was a dramatic drop in the peso and the price of copper in the fourth quarter which resulted from those marked to market being moved from an asset to a liability. Again, it didn't really affect cash flow because that's a non-cash flow item in the quarter. It's a balance sheet adjustment.

And, the adjustment is made every quarter.

Right.

So, maybe I didn't ask the question right, or maybe you guys misunderstood. We had a change in operating working capital -- operating other working capital items, in the fourth quarter. It was a minus. And in the past, it has always been a plus. I was just wondering if the derivative contract settlements and marks to market and all that is largely balance sheet, which was he answer I expected, why are we negative in the fourth quarter on that line?

Well, two things really happened in the quarter. The biggest one, accounts payable, was down pretty significantly quarter over quarter. And also the margin -- we had to make some margin payments during the quarter. So those were the two biggest factors. Again, those margin payments related to the derivative contracts. So those accounts payable and margins, clearly the biggest factors on negative cash flow from what you were probably expecting.

Right, I think accounts payable is a lot of that answer, so I guess my follow-up question to that would be, why did you have to do that?

The biggest issue is, we saw volumes dramatically, as Paul said, in November-December, which resulted in purchases dropping in November-December and we had to make payments by the end of the year.

So then, would it be fair to say that if you didn't really match that up with the production, per se, should we see a nice positive cash source out of working capital in the first quarter?

I can't say the first quarter, but we definitely would hope that in 2009 we will have favorable working capital.

We usually are a cash user in the first two quarters, and a cash generator in the last two.

But it's safe to say, Scott, that we went into the year with more inventory in some of the operations than we planned to, both raw, in process and some finished goods. We will get those inventories in line in the first quarter, so that will help offset the cash usage somewhat. But I don't think we're ready to predict what our cash flow will be for the first quarter.

Okay, well that's fair. Next question has to do with the restructuring plan. I guess the loss in electrical was a little wider than what I expected. And I guess my question on that would be, is there a way to tell right now, of the $20 million in total, $15 million in '09 -- where are we at right now on run rate on that number?

On the $20 million in savings?

Yes.

We will achieve $15 million more this year. We got $5 million last year. But that's a solid number.

I don't question that; I'm just saying, are we there now? Will we be there by the end of the first half on a run rate basis?

I think you can level load it for the quarter. The plants are closed, the costs are gone.

Right, okay, so you are essentially there right now, for the most part?

Yes. The plants are closed, those costs are gone off our income statement.

Right, and additional headcount actions would be incremental to that number?

Yes.

I guess my last question would be along the lines of capital expenditures in 2009. I know you are finishing up instruction in the first quarter on the China facility. Is that a number we can -- I guess I was looking for something in the $55 million, $60 million range for '09. Is that reasonable?

If you take the '08 and '09 numbers together, what we were predicting, we are still where we were. The thing is, we have quite a bit more carryover. We did not spend as much money on capital in '08 as we planned, and that is what's driving the '09 numbers up to some in the 80's.

80's?

As always, cash is king. We are going to be monitoring those capital projects on a monthly basis as we go forward. There's a very heavy emphasis on short payback productivity and a very low emphasis on any maintenance capital right now. So the guidance that Terry gave you are numbers you can use, but you should know that it's our intent to keep our capital expenditures below that if we can.

We have the India facility, which will be all in this year. Most of it will be in this year with not only the facility but equipment. And we are finishing up the Nanjing capacity expansion this quarter, as you mentioned.

On the Electrical Products business, I know we are starting to run off some of the 80/20 rule stuff, things that you are getting out of and what have you. Is there an impact at we can look for revenue-wise on an annualized basis in that business that will come out?

It has been coming out over the last couple of years, Scott. I don't think we want to quantify what that number is because some of those discussions are still taking place. But we will see a decline in unit volume and a decline in revenue and an increase in margin, which is what we have been saying we'll have.

Very good, thanks a lot.

Paul Mammola, Sidoti & Company.

First, on the Bangalore facility, do we have a sense how many units an annual basis could come out of there and what percentage of the market that might be?

No, not yet. That's going to be a slow startup. You go back to our Nanjing facility; we did over 1.2 million units last year out of Nanjing. But you go back eight or ten years ago, it was 50,000 or less, so we'll see. We are doing the India project differently in that we are getting out front with the brand and with a solid sales and distribution network. We have quite a few employees there right now, all in marketing and sales. We are putting a healthy investment into establishing a sales and distribution network and the brand identity. When I say healthy investment, it's not only the facility, but as I mentioned earlier, we're going to be recording some small operating losses as we do that. But that's per plan, and that is going to generate a -- what we think a very, very good return for our shareholders over the next several decades.

We think it's the right decision, right now. The beauty is we've got a balance sheet that allows us to make some long-term decisions like that, and we are continuing that one per our original plan.

And then on Nanjing, I guess I didn't realize that it was going to be finished this quarter. Does that factor in positively to the guidance in '09? I guess, more clearly, do you expect that to have a positive impact, or a big positive impact?

Well, we need the capacity. The old facility had capacity for about 1.1 million, and we did 1.2 million last year. We are still forecasting growth in China; we are not forecasting another 20%-plus -- 26% growth in China this year. We had a fairly weak, relatively weak fourth quarter, and it's going to be a relatively weak first quarter.

There's a lot of things going on in China. The government's forecast is 8.5% GDP growth. We are forecasting 6% within our business, and that's what we are expecting. But we need that capacity in order to achieve the -- a 6% GDP growth will result in a higher -- we grow at well above GDP with the market niche that we serve with our products.

That capacity -- the facility will be done. We will not have it completely full with equipment. We're only putting equipment in as necessary, but we are going to stay ahead of the demand curve.

So, Paul, when does that expect to be, I guess, doubled in capacity, which I think was the original plan, (multiple speakers) the 2 million units?

It can be anytime we need it to be; we can be at 2 million units. I think, given the slowdown in the housing market in China, which I think is probably going to be a six-month event, not a multi-year event, I think we will be closing in on the 2 million within a couple years, which means -- which is why we are already planning what the next piece of capacity will be and where that will be located.

That's helpful. Terry, on the -- given those projects, is there a meaningful tick up in D&A next year? Is there an expectation for a number there?

The depreciation and amortization will be in the $70 million range next year, so there's not a significant impact.

Okay, and then given the China holidays rolling off, are we expecting a 30% tax rate in '09?

I don't think it's that high.

No, about 27.5% (multiple speakers) somewhere around there.

Ted Wheeler, Buckingham Research.

I wonder if I could just get your outlook parsed a little bit by market. If I looked at Water Products, I mean commercial/residential, could you give us a little estimate of what you think those two buckets would be? And then, in electrical, I know you do a little breakdown on air-conditioning and distribution and pumps. Maybe a little color on that would be helpful.

Well, I can give you a little but not a lot. One of the charts that we have in the presentation showed the commercial market for Water Heaters. We're expecting that total market to be off somewhere in the 10% to 15% range. I think our market assumptions are about 140,000 units, down from close to 160,000 this year -- in '08, I mean.

That's a rough estimate of what we think it will be. I'll admit it's a rather fuzzy outlook right now as to what we see. The replacement business will be there; that's another good news/bad news. It hardly ever grows, but the good news is, it's always there. Of course, right now we are very happy to have that level of replacement business.

The commercial market on the motor side, I think, will not have as big a decline. We are more global there. We ship product all over the world, and there are some places that are still doing quite well. So we have a little bit more positive outlook on the commercial market, on the motor side -- maybe not a growth element, but not as big a decline.

What about the residential water heater market? Do you think that's double-digit down?

I don't know whether it will be double-digit down, but we believe it will be down. The housing starts -- housing (multiple speakers) was 2 million units out of a $9.5 million market, and it's now going to be 600,000 units out of an $8 million market. So that's pretty significant over the last two years. We got some of that decline last year, and I am not optimistic on US residential marketplace, other than the replacement business. People still will not take a cold shower more than once, no matter what their credit card balances are.

The pricing comments you made, I guess three price increases in the wholesale water heater market. And I think you said that steel is up 25% today versus beginning of last year.

That's a rough number. We have prices all over the place, depending on the kind of steel, but that's a rough number.

Well, is that 25% a rough number, a spot number, or is that your cost?

That's our costs, which are tied to, as was mentioned earlier by Mike Schneider, our costs are tied to the trailing three-month CRU index and with adjustments from that based on our negotiations with our steel suppliers. The trailing three months is October, November, December. October was still a big number; it was over $1000 a ton. November and December obviously declined, and I think our January number was down $5 a ton on the CRU; I just got that a couple days ago.

So your costs will be, if all stays the same, will be down by the end of the year from where we are now?

Yes. The fourth quarter of 2009 will be, hopefully, a lot less than 2008.

And your pricing -- I think you indicated prices will be up. You wouldn't say how much, but prices will be up?

That's what we expect, yes.

So if that holds, certainly your water heater margins should be higher next year -- I'm sorry, '09 versus '08, I would think?

Well, it depends on the market and depends on competitive pressures, but that's certainly our expectation right now.

I guess the retail pricing negotiations -- aren't they always sort of end of February when they are concluded and finalized?

It's typically in this quarter, yes.

So you wouldn't say whether those are in your expectation or not, but you must have a pretty good idea of what's going to transpire there?

I cannot comment. We are still in discussions.

So we will get that feeling firmed up by the end of the quarter, then?

Yes.

(Operator instructions) Matt Summerville, KeyBanc Capital Markets.

I think you had originally guided to $0.25 in restructuring charges in '08. It turned out to be $0.19. Does that mean we have some spillover into 2009?

And then, alongside that, are there any meaningful restructuring expenses contemplated in the $2.40 to $2.60 guidance?

Relative to the restructuring expenses being less in '08, there is no spillover. We had overestimated what they were going to be. And, relative to 2009, there is nothing in the guidance for restructuring.

Okay. And then, Terry, can you comment on what your cash contribution to the pension will look like in 2009 and how you think about 2010 in context of the funded status of the plan, versus what that number would have been in '08?

I can tell you it will be very large, I think. In 2008 our voluntary contribution was about $15 million. We are looking at a voluntary contribution someplace between $35 million and $40 million in 2009 and a number that's much larger than that in 2010. Having said that, of course, it depends upon how the markets perform and it depends upon what will happen to the discount rates. But at least, given the knowledge that we know today, we book to -- and you can see that on the balance sheet, about a $200 million plus liability, increased liability on the balance sheet which we have to make up over this seven-year period of time.

So the required contribution to the plan next year is probably in the $7 million range. But if that is all that we would make, we would be looking at significantly higher contributions going forward. So our expectation is that, we had $15 million this year, that we will have something in the neighborhood of $35 million to $40 million next year and something that's significantly higher than that in 2011 -- 2010; excuse me.

So in your operating cash flow guidance, is that increase in cash-out-the-door pension of $20 million to $25 million, '09 versus '08, is that in your operating cash flow guidance?

Yes, it is. That's in the $150 million guidance, yes.

When I look at -- I just want to make sure I understand all the dynamics at play here. When I think about pricing, Paul, in the motor business '09 versus '08, you talk about steel a little bit. Can you put how you think pricing is going to evolve for the full year in context of not only steel and the lag you have, but also what has happened with copper? I guess I'm having a hard time being convinced that you'll see higher price realizations in motors '09 versus '08, all things considered.

Well, most of that business is contractual. So we have moved the selling price to our customers based on the same indices we buy steel at. So we essentially protect ourselves on the upside and the downside there. So as that moves, we ought to be able to maintain essentially the same margins.

Now copper, yes; we have got a lot of customers that have contracts with us, as Terry mentioned earlier, that are significantly above the spot price. And we have some exposure on our own that are above the spot price. We don't talk that much about what we do on hedging. I think it's safe to say that we have hedged over the recent -- starting last spring, when copper got up to $4 a pound, we were not doing hedging at that point, and I don't think any of our competitors were either. But as it started coming down, we have consistently implemented our hedging strategy.

We are not fully hedged for the year, thank goodness. So we will be in the spot market from time to time. And the majority of the out-of-the-money contracts we have are customer-specific, and the customer is bearing the risk of that and will be paying whatever the copper contract price is.

You mentioned, I think, in your prepared remarks that growth in the Water Heater business in China was 10%, 11% in Q4. And it sounds like embedded in your guidance is an acceleration in that growth rate. Can you talk about the logic behind that and then how much you anticipate your China Electrical Products business growing '09 versus '08?

Well, I think we're going to have a weak first-quarter in both businesses because it's still a carryover from the weakness in the China market in the fourth quarter. But our expectations -- and we've got about, I think, 12 forecasts out of China from various people that we have been massaging and looking through. We're going on the conservative side of that, and expecting a GDP growth of about 6%. We typically do -- our volume is typically, on the Water Heater side, about three times that. On the Electrical Products side, it's typically at about the GDP growth. So, year over year, those are just kind of some rough numbers that we should expect.

But it's going to be a weak first quarter. There's still an excess of available housing, but the government has got a stimulus package coming out and they have changed some of their policies relative to residential housing that are going to help us quite a bit, we believe, this year.

You commented, I think, as well that within the Water Heater business it appeared that your out-the-door sales were trailing below what the normal replacement demand would be. How would you characterize the motor business in that regard, and how would you describe overall channel inventories in the motor business as well, as we sit there right now?

I'd characterize it the same way. We had a horrible November in both businesses on an incoming order rate that was below the replacement market. I think channel inventories are in good shape. The problem is the sales out of the channel to the end users are significantly down because of the housing situation.

So we are off to, as I said, a fairly slow start by the OEM's. A lot of them -- and you can go on to their -- some of them have already come out with comments this year, publicly. You can see what they are saying, and when they keep a factory down for two or three weeks additionally, that's two or three weeks we don't ship motors into them.

That's not going to last for the rest of the year. There will be a pickup. That's why we typically build inventories in the first and second quarters, is serving the growth in HVAC and pump markets that we typically get in the springtime.

Thanks a lot, that's all I have.

It's just getting off to a slow start.

Michael Schneider, Robert W. Baird.

Maybe we can just talk about Q1 now, looking ahead based on what we have seen in Q4. For your inventory depletion efforts, would you expect the overhead hit as you reduce production days to be as great in Q1 versus Q4, or will it be lesser so?

Well, we are going to have a little bit of absorption hit, but that's good. Nobody gets in trouble for doing that because they are generating cash flow -- again, another advantage we have, to be able to take a long-term approach. Characterizing it to Q4 to Q1, I think Q1 will be better, but I don't know how much better at this point.

Terry, do you happen to have at least a rough calculation of what absorption cost you in Q4?

No. John, do you have any idea? I don't have it.

On the EPC side, my recollection is it cost $2 million to $3 million.

And Water Heaters, not as significant?

Water Heaters was not as significant.

No, no.

Okay. And then, if we can go back just to the contribution of pricing versus volumes, was the price-cost curve actually positive in motors during Q4?

Q4 was our highest-cost steel, by far. As steel shot up in July, August, September, that was a one-time event, Mike. It was not good; we had these huge steel costs at the same time markets were declining and the spot market for steel was going down significantly. We think we've got that balanced now. But Q4 was, we believe, a negative anomaly that we don't expect to see come back again.

And it was clearly negative in Water Heaters; correct?

Yes.

Okay. And then, as far as the declines in Water Products, were both commercial and residential down double digits in units, or was one down materially more than the other?

In the fourth quarter, that's true; they were. The commercial was down significantly in the fourth quarter, and we are expecting it will be weaker this year.

What was the pricing contribution in water during Q4, so we can understand the price-volume mix?

The lawyer won't let me give any of that information out. I'm sorry; I can't do that for competitive reasons.

Okay, and I believe that's it, thank you.

Scott Graham, Ladenburg.

I know that, in the Water Heaters business, particularly when it comes to the wholesale distribution side, that the number of price increases that the industry has kind of needed to jam into that channel the last couple of years has you guys thinking that there's a market share opportunity if you could maybe buck that trend. So my question simply is, my sense from speaking with you in recent months is that you would like to be able to actually take some pricing off wholesale distribution and maybe other areas. Could you talk about that for particularly -- and maybe not particularly. Conceptually, what are you guys thinking on that right now?

I don't agree with what you said at all, to be blunt. We have been on a kick to get our margins up there. We will not be utilizing price to do that. We have a major program on service and quality and features, new products, new high-efficiency products, and that's our focus to grow market share. But we are not going to use the P word to do that. It's going to be, by being a value-added supplier and somebody that they can count on, because it's our intent to continue to get margin expansion there.

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