Franklin Electric Co Inc (FELE) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen, welcome to the Franklin Electric fourth-quarter 2009 earnings call. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Patrick Davis, Treasurer. Sir, please go ahead.

Thank you, Karen, and welcome to Franklin Electric's fourth-quarter and full-year 2009 earnings conference call. With me today are Scott Trumbull, our Chairman and CEO; John Haines, our CFO; Robert Stone, SVP of Americas Water; and Gregg Sengstack, SVP of Fueling and International Water. On today's call, Scott will review our fourth-quarter and full-year business results, and John will review our fourth-quarter and full-year financial results. When John is through, we will have some time for questions and answers.

Before we begin, let me remind you that any forward-looking statements contained herein, including those relating to the Company's financial results, business goals and sales growth, involve risk and uncertainties. These include but are not limited to risk and uncertainties with respect to general economic and currency conditions, various conditions specific to the Company's business and industry, the weather conditions, new housing starts, market demand, competitive factors, changes in distribution channels, supply constraints, technology factors, litigation, government and regulatory actions, the Company's accounting policies and future trends and other risk which are detailed in the Company's SEC filings including in Item 1-A of part one of the Company's annual report on Form 10-K for the fiscal year ended January 3, 2009, Exhibit 99.1 attached thereto and in Item 1-A of part two of the Company's quarterly reports on Form 10-Q.

These risk and uncertainties may cause actual results to differ materially from those indicated by the forward-looking statements. All forward-looking statements made herein are based on information currently available, and the Company assumes no obligation to update any forward-looking statements.

I will now turn the call over to our Chairman and CEO. Scott?

Thanks, Patrick. We were encouraged by our earnings performance in the fourth quarter and by our cash flow performance for the full year. During the fourth quarter our earnings per share before restructuring charges increased by 62% versus the prior year. Consolidated sales for the quarter declined by 5%, which was a significant reduction in the rate of decline that we experienced during the previous three quarters. We were able to offset this sales reduction with a 210-basis-point increase in gross profit margin as we achieved reduced manufacturing and raw material costs while sustaining price levels.

We also benefited from unusually low SG&A spending due to reductions in variable compensation expenses and other administrative costs. Our free cash flow, which is our net cash flow from operating activities minus capital expenditures, was $101 million during the year, which was a record for any year in the Company's history. As a result, our net debt to equity ratio ended the year at 17% compared to 40% at the end of the prior year.

Our Water Systems segment represented about 81% of our consolidated sales during the quarter. Water Systems sales grew by 8.9% in the fourth quarter; but, excluding acquisitions and foreign exchange, they declined 4% organically. Sequentially, this decline in Water Systems sales, excluding acquisitions in foreign exchange, was significantly less than the 11%, 13% and 12% declines, respectively, in the first, second and third quarters of 2009.

Sales in the US and Canada were about half of our total Water Systems sales and declined by 7% organically compared to the fourth-quarter prior year. We believe that our major US and Canadian distributors curtailed their fourth-quarter purchases because they had little chance of reaching full-year discount targets and wanted to move volume into the first quarter so that these sales would count against their discount targets for 2010. Our relatively strong US and Canada sales performance during the first six weeks of 2010 would indicate that this was the case.

International markets represented about half of our Water Systems sales during the fourth quarter. Our organic sales in international markets were flat during the quarter compared to prior year with increases in Latin America and Asia Pacific being offset by declines in Europe. The major story for the fourth quarter was a 550-basis-point improvement in Water Systems' operating income margin compared to prior year.

While operating income increased across all of our Global Water Systems regional markets, the largest increase was in the US and Canada, where we benefited from lower raw material costs, lower manufacturing costs due to ongoing consolidation into our Linares, Mexico production complex, lower SG&A spending and firmer pricing.

Fueling Systems segment represented 19% of our consolidated sales during the quarter and declined organically by 38% compared to the fourth quarter prior year. During the prior year, our fueling sales were surging as filling station owners in California purchased vapor control equipment from us to comply with an environmental mandate in that state. As these compliance-related purchases did not repeat during the fourth quarter this year, our sales in California were off sharply, thus causing our overall sales to decline.

Our fueling international markets represent about one third of our total fueling sales and grew by 18% during the quarter. International fueling sales increased at double-digit rates in Latin America, Europe, Middle East, Africa and Asia. Our Asian sales benefited in China as station owners are purchasing our vapor control equipment to comply with environmental mandates in that country. While we reduced our fixed spending and fueling, it was not enough to offset the 38% sales reduction during the quarter. As a result, our operating income before restructuring declined by about 50% compared to the prior year.

In spite of this decline, our fueling operating income margin before restructuring was still a healthy 18.9% for the fourth quarter 2009. For the first quarter 2010, we are projecting that our fueling sales and operating income margin will be sequentially lower than the fourth quarter 2009 due to seasonality. We believe the sequential sales reduction will be 5% to 10%. I should point out that our California vapor control sales were about $16 million during the first quarter of 2009, and we are forecasting that they will be about $3 million during the first quarter of 2010. In the second, third and fourth quarters of 2009 our California vapor control sales fell off to about $6 million, $3 million and $3 million, respectively.

So the current quarter should be the last where our year-on-year comparisons are significantly distorted by the vapor control sales surge in California.

We anticipate that our Water segment year-on-year sales growth rate in the first quarter will be in the mid- to high-single digit range as our distributors stop reducing inventories and start to purchase at their sales rate. We're projecting that our first-quarter Water Systems operating margins before restructuring will also be higher than the first-quarter prior year. During the latter part of the first quarter we're planning to implement price increases in both our water and fueling segments to offset anticipated material and labor cost inflation in 2010.

So, in summary, while we believe that the major reductions in demand for our products brought on by the global recession are behind us, we have yet to see indications of any significant increases in end user demand for our products in the US, Canada and Western Europe. We were encouraged that, due to a significant margin improvement in our Water Systems business, we achieved a meaningful year-on-year earnings improvement during the fourth quarter. While we reduced fixed spending by about $20 million in 2009 compared to prior year, we increased our RD&E expenditures. As a result, we enter 2010 with an exciting backlog of new product introductions. We maintained tight control of production levels throughout the year and were able to reduce inventories across the Company by about 20%.

During 2009 we generated free cash flow of $101 million, and with a debt to equity ratio of 17%, our balance sheet is in good shape. We believe that Franklin is well-positioned to achieve significant operating leverage as our markets recover from the current depressed levels.

Now I'll turn the call over to our CFO, John Haines, who will provide some additional financial information regarding the quarter.

Thank you, Scott, and good morning. Our fully diluted earnings per share were $0.33 for the fourth quarter 2009, an increase of 120% compared to 2008 fourth-quarter earnings per share of $0.15. Earnings per share before restructuring charges were $0.34, an increase of 62% compared to the prior year.

Fourth quarter 2009 sales were $144.9 million, a decrease of 5% compared to 2008 fourth-quarter sales of $152.1 million. Full-year 2009 sales were $626 million, a decrease of 16% compared to 2008 sales of $745.6 million.

Water Systems revenues increased by $9.6 million or about 9% overall from the fourth quarter of 2008. The Water Systems organic sales decline excluding foreign currency translation and acquisitions was $4.1 million or about 4%. Internationally, Water Systems sales excluding currency translations and acquisitions were flat versus the fourth quarter of 2008. Sales improvements in both the Latin America and Asia Pacific regions were offset by declines in Europe and South Africa.

Fueling Systems sales declined by about 38% during the fourth quarter of 2009 compared to the same period in 2008. This decline was due entirely to an 81% decline of vapor recovery equipment sales in California. However, it was partially offset by an 18% increase in international sales, most significantly in Latin America and Asia Pacific. The Company's consolidated gross profit was $45.2 million for the fourth quarter of 2009, up $1 million from $44.2 million in the fourth quarter of 2008. Correspondingly, the gross profit margin increased to 31.2% for the fourth quarter of 2009 from 29.1% for the fourth quarter of 2008.

Overall, operating income before restructuring expenses was $14.5 million or 10% of sales in the fourth quarter of 2009, up 56% from the same period in 2008. During the fourth quarter 2009, SG&A expenses decreased by $3.8 million or 11%. This represents an unusually low quarterly expenditure rate due to reduced compensation and other administrative costs. Water Systems operating margin before restructuring expenses improved dramatically in the quarter as a result of the cost reduction efforts previously disclosed by the Company. Operating income before restructuring expenses increased $7.3 million or 72% in the fourth quarter 2009 versus the same period of 2008.

Operating income before restructuring expenses as a percent of sales improved to 14.8% in the fourth quarter of 2009, a 550-basis-point improvement versus the fourth quarter of 2008. Operating margin before restructuring expenses in Fueling Systems was about 19% of sales in the fourth quarter of 2009 versus 23% of sales in the fourth quarter of 2008. Despite fixed expenses being 14% lower than the fourth quarter of 2008, the reductions were not enough to offset the leverage loss from lower sales volumes.

Restructuring expenses for the fourth quarter of 2009 were approximately $0.6 million and reduced diluted earnings per share by approximately $0.01. Restructuring expenses include asset impairments, severance expenses and manufacturing equipment relocation costs. On Friday, February 12, the Company announced the final closure of our facility in Siloam Springs, Arkansas. This will result in the transfer of our final manufacturing operations in Siloam to third-party vendors and impacted about -- approximately 50 employees. As a result of this final closure decision, we have estimated that pre-tax closing costs of $3.8 million to $4.5 million will be incurred over the next three quarters, beginning with the first quarter of 2010. These changes are in addition to those previously estimated in the Company's December 9, 2008 announcement.

The major categories of the additional costs include severance and other employee assistance costs, pension curtailments, asset write-offs and equipment relocations. The charges for pension curtailment and asset write-offs, about 80% of the total, are non-cash.

The Company's tax rate for the fourth quarter of 2009 was about 30%. The global reorganization of certain entities has effectively reduced tax liabilities both in foreign countries and in the US. The full-year 2009 actual tax rate is 31.3% and is lower than the prior-year rate of 34.2% and the statutory rate, primarily due to the benefit of tax planning activity, which resulted in one-time adjustment for certain foreign tax benefits and other one-time discrete events, lowering the rate about 132 basis points.

The ongoing effective tax rate for 2010 is projected to be about 32.5%. The projected tax rate will continue to be lower than the prior year and statutory rate, primarily due to the permanent reinvestment of foreign earnings and reduced taxes on foreign and repatriated earnings under the global reorganization.

The Company continued to improve working capital and cash flow in the fourth quarter 2009. Cash flow from operations for the full year 2009 improved by $[68] million versus 2008. Cash and cash equivalents on hand at the end of 2009 were $86.9 million, a $39.9 million increase, or 85% increase, compared to the end of 2008. The Company had no borrowings outstanding on its revolving credit line at the end of the fourth quarter 2009. Inventory balances declined to $134.4 million at the end of the fourth quarter 2009, 21% lower when compared to $169.9 million at the end of 2008.

At the end of the fourth quarter the Company's ratio of gross debt divided by earnings before interest, taxes, depreciation and amortization, or EBITDA, was 1.9 versus 1.8 at the end of 2008. We believe that cash on hand, internally generated funds and existing credit arrangements provides sufficient liquidity to meet current commitments and service existing debt. As we have previously disclosed, the Company's revolving loan agreement with its bank is in place until the end of 2011, and we have no scheduled principal payments on our long-term debt until 2015.

Finally, on Friday, February 5, the Board of Directors of Franklin Electric declared a quarterly cash dividend of $0.125 per share payable February 25, 2010, to share owners of record on February 11, 2010.

This concludes our prepared remarks, and we would now like to open the call up for questions.

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

Maybe first we can focus on water margins. You comment that you expect margins to be up year-over-year and sales to be up sequentially, at least by implication, if you use the guidance. Can you talk about the puts and takes, then, sequentially on margins? Because, given that you did 14.8 this quarter on the revenue, if revenue is up sequentially, just what are the headwinds, what are the tail winds, materials, incentive comp, etc., that would put your margin in Q1 up or lower than Q4?

I guess I'll answer that by saying we expect our sales to be up versus Q4. We expect our contribution margin to be modestly lower in Q1 than it was in Q4 because, throughout the back half of the year, last year, our raw material cost as a percentage of sales declined. In the first quarter of this year we are expecting it to increase as a percentage of sales by a little less than 100 basis points. And that's just because of the inflation in raw material costs that occurred in the back half of the year that are now starting to come through. And that's why we are implementing price increases at the end of the first quarter to at least hold our contribution margins relative to raw material cost increases. But we are going to see a slight erosion in contribution margin, and our fixed costs will be up because of -- at least for now, we are accruing for bonuses. So we are -- that and other factors. We are going to reinstate our 401(k) match. We are, on June 1, going to reinstate our merit increases. We have some increase in our pension funding costs this year versus last year.

So we are expecting our fixed costs for the year to be up $10 million or so versus prior year. So, on balance, I think we would be looking at first quarter margins -- Mike, we didn't -- our guidance was, they are going to be better than prior year. And we've decided consciously not to be more specific than that just because we don't feel we've got that great of visibility, and I think this is -- the first quarter is a period when we have a price increase coming. We don't know how much pre-price buying we're going to get at the end of the quarter. So I just am hesitant to give specific guidance beyond the kind of discussion of the mechanics that we just went through.

But, in summary, the margin sequentially is likely to be lower because of the recurrence or return of a number of these variable and fixed costs?

It could be, could be modestly lower, yes.

Okay. And can you just talk about the year-end dynamics in North American Water? What's the pricing environment like? What went on in terms of pre-buy or push-out around the year-end rebate programs? And then just, what is your expectation for those variables, I guess, in early 2010?

Okay. We believe that many of our distributors -- we have, as is an industry practice, discount programs, rebate programs with our distributors which kick in if they hit an annual purchase target. And, in many years in the past, including 2008, they were close enough to their targets that they would stretch at the end of the year to hit them.

However, this year, because the recession hit industry sales by more than, much more than was anticipated at the time the rebate targets were set, few of our distributors had a realistic chance of hitting their targets. And, in that case, most distributors think the right thing to do is, at the end of the year, actually hold off on purchases, run inventories down and then buy in the first part of the next year because then those purchases will apply against their targets for the next year. And that's what we saw; that's what was happening at the end of last year.

Again, this is primarily a North American phenomenon. And as I mentioned in my comments, we've had pretty good sales in the first six weeks or so of the year. So that would indicate that that phenomenon was occurring.

Now, as we look ahead, I also mentioned that at this point -- and it's still very early in the year, and we are in a seasonal business. But at this point, we are not picking up chatter from our customer base that would indicate that we should expect a significant upturn in end use, end user demand. We are not anticipating an ongoing decline, however, either. Right now, we are waiting to see how the season will come out. But our distributors are really not telling us that they are seeing an ongoing decline, but they are not telling us they have much reason for optimism.

However, we think that, last year, there was a significant destocking in the industry. And this year, while our distributors may not have the - - a commitment to increasing inventories, just by not continuing to reduce inventories and buying at the sales rate of last year, our sales to them will increase this year. So we're counting on that.

Our market share has increased every year for the last five years, and we haven't seen -- we are counting on another, perhaps more modest but nevertheless increase in market share this year. We have some interesting new products that we're bringing out, which I think will move our sales forward.

So we are somewhat more bullish about our sales outlook as we go into the season this year than we were last year, for those reasons. But again, we don't have evidence to indicate that there's going to be a big move on end user demand. I will say that we are encouraged with the overall pricing environment. After we made our strategic change, we went through a period where there was a lot of turmoil in an industry that, quite honestly, traditionally has had pretty stable pricing. And it looks like, at least for now, our pricing environment is more benign, and we are optimistic that, as we experience raw material cost increases this year, versus the latter half of last year, that we'll be able to work around those with price increases.

And then just a little more color on international water sales. You mentioned that Europe and South Africa were down. Just what are the types of declines you're seeing there and, indeed, just with some of the European concerns about debt troubles over there, have you actually seen that market continue to deteriorate? And then also just specifically, what's going on in South Africa? I guess I'm surprised to hear that that market's down.

Okay. In Europe our sales are down modestly. And our talking about what's going on in Europe is complicated by the fact that, in Europe, we are -- continue to be an OEM supplier of motors. In Western Europe we are really -- we are not in the pump business. We are an OEM supplier of motors according to the Franklin business model that existed for many years. And those OEM customers of ours ship their pumps all over the world. And so much of their product stays in Europe. Our feeling is that the end-user demand in Europe is down. Again, this would be from word-of-mouth from our customers, but would be down mid-single digits, maybe high-single digits.

However, our sales into northern Africa and into the Middle East, their sales into those regions would be a little bit stronger than that, down but still a little bit stronger than that.

In South Africa, a lot of our business goes into the mining trade. And our mining customer base curtailed their purchases of pumping system products last year, and that hurt our sales in South Africa. And we're starting to see that come back this year. Gregg, do you have any -- ?

Yes. We've found, Mike, that we went into the recession in southern Africa, which includes our Botswanan operation, later than the rest of the world, and we are coming out of it a little bit later. But it's clear that, for example, the diamond mines in Botswana are reopening and moving back to full production rates.

And so, to Scott's point, we begin to see greater activity coming out of the Southern African region moving forward, but we've moved into the recession later, we're going to be coming out of it later. Also we've had an unusually wet summer in southern Africa, particularly in South Africa, which has put a damper on our business.

Our business in Asia-Pacific was really quite strong throughout all of the year and has continued to be strong going into this year. So that's really been our star regional performer.

And Latin America and South America have been strong.

Right; we didn't comment on Latin -- go ahead, Robert, why don't you?

Yes, Latin and South America have been strong. And you didn't hear much about that in Scott's comments, but those markets actually weathered the downturn much better than most other markets.

Ok, and then final question just longer-term and more strategically. So after we've gone through this vertical integration strategy, obviously is very severe recession, as we look forward, the water business peaked back in '08 at, call it round numbers, $560 million. As you model out this business now, with all of the restructuring and different pricing dynamics over the last couple of years, what do you believe the sustainable margin is right now, back at that prior peak? I'm not asking you when you get there. But if we assume the world goes on a slow or even moderate growth trajectory from here, at $560 million, what do you think the operating margin of this business is now?

At $560 million we would be looking at operating margins that are north of 16% to 18%, the way we account for them.

Matt Summerville, KeyBanc.

Morning. A couple of questions. First, I was curious, Gregg, can you comment on the sequential performance in fueling? I believe revenue, if I'm not mistaken, was down slightly sequentially, but you've had a little bit of improvement in operating profitability. Is that more related to cost cuts? Was there anything going on from mix? And I guess, as we move into next year, how should we think about margins for the full year in fueling relative to 2009, given the pluses and minuses?

Sure, Matt. As you identified there were a couple of factors that resulted in our margin improvement in the fourth quarter sequentially. We had a rapid ramp up in sales in the '08 and then a rapid decline of sales in '09. And so obviously it needed to be cutting costs. And that takes a little bit longer than what you would like, particularly given the precipitous falloff in sales in California.

The second thing is that, with our rather healthy inventories we had costs of -- our favorable purchases were not flowing through as quickly as they were in the water business so we began to see more favorable material costs in the fourth quarter. And those factors contributed to the fourth-quarter performance. Going forward again, we don't typically give guidance on operating income. But the business is beginning to stabilize at its new level, and I think that we are going to see some material relief still in Q1. But beyond that, as Scott has pointed out, our costs are going up across the Company. We have initiated a price increase in anticipation of that. But again, margins in the -- more like the run rate for 2009, in that kind of area or a little bit less, because we are running at a lower sales rate, is what we would expect.

When you look across Franklin Electric, Scott, I think you mentioned in your prepared remarks that you believe you achieved $20 million in fixed cost reduction. I guess, on the variable side, the net impact of the addbacks you're anticipating this year or areas of cost inflation such as pension I think John mentioned -- what do you believe is the net cost take-out number that we should be thinking about 2010 versus 2009, all things considered?

Again, and some of it depends on currency changes. But our current outlook on a currency-neutral basis is that we took out $20 million last year. Now, we absorbed an acquisition in that number; we actually took out $27 million of fixed cost. But, net-net, after the acquisition we took out $20 million of fixed spending, and we'll probably see $10 million to $11 million of that come back this year.

And then, as we think about, Scott, what you're doing from a manufacturing realignment standpoint, the latest actions you announced the other day, post completion of those activities, what will your mix of low-cost labor be in the water business, versus maybe where it was two to three years ago? And I guess, longer-term, where do you think you can take that number?

Well, I remember that in 2003 it was 13%, and this year it ended at 61%. That's the percent of headcount in low-cost regions. And probably, we'll settle out, unless we build another factory or make an acquisition in a low-cost region, around 70%.

And then, with regards to the amount of capacity you've moved to Linares over the last couple of years, I guess, how much, if you actually have -- has Franklin actually taken out production capacity as a result of these moves? Or, has your capacity actually increased because of the productivity you can get in Mexico? Help me understand that. And I guess maybe right now, if you can comment, maybe throw some numbers around how your actual utilization rates have trended over the last four quarters and where you are right now.

Okay. Well, in Linares, Linares is a 310,000-square-foot factory. And in that factory we have now moved production out of the Jonesboro plant, which we shut down several years ago; the Little Rock plant, which we shut down several years ago; and the Siloam Springs plant, which we just are in the process of closing over the next couple of months. And with that, into our 310,000-square-foot Linares factory, we will have moved production volume that in these other plants occupied 550,000, square feet of manufacturing space.

So Linares -- and having said that, we still have around 70,000 square feet of space available in Linares for additional production moves. So the Linares team has done a nice job of leaning out operations and putting a lot more production in a lot less space. We continue to operate Linares on a two-shift basis. And that's not across the entire factory, so we have the opportunity to increase production in Linares by increasing the number of shifts that we operate.

Last year, of course, our sales were down something like 16%, and our inventories went down 21%. So that approximates a 37% reduction in production levels in our facility. So last year we operated our facilities way below the sales rate and way below the 2008 production rate. So we were operating at a pretty low level of capacity utilization last year. And so we have plenty of capacity headroom, even with the shutdown of these facilities, as we go into 2010.

Our utilization rate will be up this year because we are not going to reduce inventories at the same rate that we reduced inventories last year. So we are still going to reduce inventories this year, but we are not going to reduce them at the same rate so that, even if our sales do not improve, we are going to have a higher utilization rate this year.

So, Scott, back to a question Mike raised. I think in '09 you did $505 million in water revenue, or thereabouts. You did, ex-restructuring, I think about 13.5% or so operating margin. And just to make sure I understood your right, you believe if you get roughly $60 million or so of additional revenue, that you can generate, at the midpoint, a 17% operating margin in water?

Yes. I said 16% to 18%, and I feel comfortable with 16% with $60 million-$65 million of additional sales over and above the 2009 level. I think that's realistic for us.

Ned?

I had a question here on fueling. If we look at the business, excluding California, and if we look at -- I guess we backed out all the California contribution over the last few quarters, and we get to a base business of about $100 million, a third of that international, what are the growth rates in North America in that business? How should we think of that business?

Ned, the North America's business, more specifically the US business, has been impacted by the housing decline, by the general financial challenges to the US and the economic decline in the US. The housing decline reduces new station builds in new areas. The ability -- the inability to get financing for station upgrades has been an issue. And of course, the general economy has caused marketers to be reluctant to do new builds as well.

We're beginning to see that changing. We saw a rather larger falloff in the back half of the year, obviously, in the US markets. Again, we tend to go in, because we're in construction and things were in the pipeline, we tend to slow down a little bit later. I expect we're going to recover a little bit later in the North American market. We have a headwind in that station operators need to do what's called PCI compliance. This is to make the dispensers safe for debit card transactions. That upgrade has to be completed by the middle of the year. Station owners are going to spend $20,000 or $30,000 to upgrade, so they're going to be using capital dollars to be doing that. So I expect the first half of the year that it's going to be a focus of their attention.

Longer-term in the US, we have had a stable station count. We do have marketers that are building, and they will be building in new areas as housing begins to recover. Also, there are mandates, as there always have been, government mandates, regulatory mandates, for the continuous upgrade of equipment going from, say, single-wall to double-wall containments, more tighter monitoring standards of underground tanks. And so we are well-positioned for that.

Internationally, we had done very well throughout the world, as Scott has pointed out. And, we have developed some new products, specifically, our Colibri Tank Gauge, to address emerging markets. We introduced that in the fourth quarter last year. We are very pleased that in India we secured a tender for that product line. So that will be -- it's a couple-million-dollar boost to our sales this year.

And so we are looking at our international markets as recovering faster than the US market, and they would have sequentially, I think, better growth rates, particularly early on in 2010.

Shifting over to water, you've remarked about the low level of inventories in the channel. I was just wondering, what kind of level of sales would you envision to bring channel inventories at your distributors up to normal?

Ned, this is Robert. I think we are, to tell you the truth, looking at a new normal, at least for some time, in that distributors, particularly in North America, are not anxious to build up inventories at this point. They will build up inventories for seasonal demand, but in a very short-term way and will not return to, let's say, extravagant inventory levels that they may have had in the past. But I think that's still, to what Scott said earlier, given that they've depleted inventories in 2009, if we look forward and demand is essentially the same or no worse than 2009, in 2010 we will have a higher sales rate to them, as they just simply pass product through.

But if we look at 2008 as the record year, partial recovery to that level expected maybe 2010, but what kind of magnitude should we thinking about, given the cautious level of distributors out there?

We haven't tried to give guidance on the full year, Ned, at this point.

The other thing -- this is John -- keep in mind that 2008 had a significant FX benefit running through our water businesses and that contributed a lot to the top line in 2008 because of how weak the dollar was for most of the year.

Maybe I missed it, but you commented about the low level of SG&A, and I think there was some variable compensation expenses in there. Did you ever break that out?

We didn't break it out, Ned. The point we're making is that when you look at the SG&A in the fourth quarter, you can't take that rate and multiply it by 4 and assume that's going to be 2010, is effectively what we're saying. So we had some items in the fourth quarter of 2009 like reduction of compensation accruals and other administrative costs that favorably impacted the 2009 fourth quarter that you can't just extrapolate into 2010.

Paul Mammola, Sidoti & Company.

Scott, you gave a lot of good color at the distribution level, but can you give us a sense of what sales rates were like in 2009, relative to your sales or competing sales?

I'm not sure, Paul, I understood the question.

Well, your sales are off, I think, in the water, around 8% in 2009. What were the distribution sales rates like relative to your sales?

All right. We have -- our best evidence of that is data that we get from the --

Water Systems Council.

Yes. Why don't you comment on that?

Sure. What we would say is that, in looking at the Water Systems Council numbers, they were off significantly. That's our best proxy for shipments to distribution, and they were off more significantly than our sales were. And I would say, too, if you look at the SS PMA numbers, the Water Systems council numbers are for clean water, the SS PMA numbers are for the dirty water pumps or, really, sump sewage effluent pumps.

Both of those market numbers were off more significantly than our sales declines were. So the implication is that we gained share in both of those fields of business during 2009, including in the fourth quarter. If you consider that distributors reduced inventories, obviously their sales rates were higher than our sales rate in 2009. So their out-the-door sales were higher than ours. It's difficult for us to get a complete picture of that, but we know that they did reduce inventories of our products significantly. And so their sales rates to the end market, if you will, the end market demand, was better than what the industry data would indicate.

Paul, we are confident that we gained share in our principal pump product lines in North America last year based on this industry data.

I guess I was looking for that out-the-door sales rate, but if you don't have it that's understandable. Can you give us a rough sense of how much that 31% gross margin in the quarter was driven by material, compared to your internal restructuring efforts?

When you say the 31%, are you talking about the year-on-year improvement from the 29.1% in the prior year?

Sure. I guess, just bucketing out material as compared to internal action for the gross margin improvement.

Okay. Well, in gross profit, about -- a significant two thirds of our cost is material costs. And I would say 100 basis points of the improvement, of the 210-basis-point improvement, was in a reduction in raw material cost as a percentage of sales. Does that give you a -- ?

Yes, absolutely perfect, thank you. Then there was a small product recall that was recently announced. Is there anything meaningful from an expense standpoint coming in 1Q from that? And is that considered to be an isolated event in your mind right now?

I'll address the issue with product, and then John can talk about the financial impact. It is not a significant event from a product standpoint. The issue was, we had a bad label, if you will, and we have been working with the CPSC to address that. And this is not something we anticipate -- it's really very isolated, Paul, to one product, and we are going to take care of that.

John, do you want to speak to (multiple speakers) --

Yes. Paul, we established what we believed were the necessary reserves for that recall at the end of 2009. They were not material, and we don't believe that there will be any adverse material impact, financial impact of this, in 2010.

Finally, I think this is the first January in a few years that you didn't acquire a company. How are you thinking about cash balances right now and acquisitions?

Well, we have a -- both in water and fueling, we have a list of attractive bolt-on acquisition opportunities that are either right in line or very incremental to our business, in line with our strategy of product line extension and geographic expansion within our two principal businesses. However, we are holding off on those just to get a little better visibility on the direction of our market. But we feel that we have opportunities to acquire accretively and we think the pricing of those acquisitions would be fair, at this point in time. But we are not planning to move forward with those in the near future until, as I said, we have a little better visibility on end-user demand for our products as we go through this year.

Thank you, sir. We have no further questions in queue at this time.

Thank you, Karen. We appreciate everybody participating, and have a good day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a good day. Thank you.