Watts Water Technologies Inc (WTS) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter four 2007 Watts Water Technologies earnings conference call.

My name is Makeeta, and I will your coordinator for today.

At this time all participants are in listen-only mode.

We will be facilitating a question-and-answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS).

I would now like to turn the presentation over to your host for today's call, Mr.

Kenneth Lepaige, Assistant General Counsel.

Please proceed, sir.

Thank you.

Good afternoon, during today's presentation we may make various remarks about th e company's future expectation, plans and prospects which constitute forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various factors including those discussed under the heading "risk factors" in our most recent annual report on Form 10-K , filed with the Securities and Exchange Commission and other reports we file from time to time with the SEC.

Any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date.

While we may elect to update forward-looking statements at some point in the future we disclaim any obligation to do so.

During this call we may refer to non-GAAP financial measures, these non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles.

A reconciliation of the non-GAAP financial measures to the most direct comparable GAAP measures is available in the press release dated today relating to our fourth quarter 2007 financial results, a copy of which may be found in the Investor Relations section of our website at www.WattsWater.com under the heading "press releases." I will now turn the presentation over to Pat and

Thank you, Ken and good afternoon everyone.

Thank you for your continued interest in Watts Water Technologies.

Following my remarks Bill McCartney, our CFO will provide you with the financial highlights for the company in total and Bill will also discuss the individual sector results, then we will open up the forum for questions.

I would like to provide you with an update on some key initiatives we've undertaken.

First, you may recall we announced a $13 million restructuring at Q3.

Q3 charges of $4.3 million pretax related mainly to product discontinuance.

In Q4 we took an additional pretax charge of $800,000 related to severance, relocation costs and asset write-downs.

In the quarter we announced to employees the closure of a manufacturing facility on the West Coast whose operations will be absorbed into another U.S.

plant.

We expect the relocation will be completed in mid-2008.

We also announced a right-sizing of one of our Chinese plants which we concluded in the fourth quarter.

At the end of this month we will have successfully moved our Chinese joint venture operation whose physical plant was taken over through imminent domain by local Chinese government and we will right-size the operation into on e of our wholly-owned Chinese enterprises located in the same area.

The move reduced headcount and improved our manufacturing efficiencies.

As part of that relocation process we expect to receive $2 million from our joint venture partner to reimburse us for the land use rights we lost in the forced relocation.

From an accounting perspective, the receipt of that $2 million will be treated as an equity infusion.

In general, we are on target regarding the timing and implementation of these various programs, we expect nominal savings in 2008 from the restructuring exercise with most of the savings roughly $900,000 pretax, being realized in the second half of 2008.

Secondly, in December we entered into a contract to purchase the remaining 40% of our Chinese joint venture mentioned previously.

We expect that transaction will close no later than the middle of March, depending on the timing of the government approvals.

We will pay approximately 5.2 million for our partners' interest.

Having this operation fully under Watts' umbrella will allow us to control this company in the same fashion we control our other wholly-owned business units.

We will be able to realize synergies with another wholly-owned entity that has similar products and sells into the domestic Chinese infrastructure market.

The next initiative I would like to mention concerns our stock repurchase program.

On November 9th, we announced a program to repurchase up to 3 million shares of our class-A common shares.

As you may recall, at our third quarter conference call, we -- a couple of weeks prior to that we were somewhat reticent about implementing any type of stock repurchase program, subsequent to the conference call the news media continued to report on further declines in the housing market and related financial markets.

It was clear to us that the general malaise in the residential markets due to the financial crisis was continuing and would have a near-term negative effect on our stock price.

Therefore, with the Board's approval we implemented a 10-B51 plan under the SEC rule to take advantage of purchasing our stock at what we believe is a discounted price.

As of last Friday, February 8th, we had repurchased approximately 2.1 million shares in the open market, and we had invested approximately $58.1 million to repurchase those shares.

The effect on earnings per share from repurchasing the shares in Q4 is minimal.

We expect the effect on earnings per share from the repurchase program to approximate $0.12 per share in 2008 for the entire year.

We still have enough capital flexibility in the form of existing cash and through available credit lines to be opportunistic in the acquisition marketplace going forward.

Speaking of acquisitions, in November we purchased the assets of Topway Global, Inc., a California manufacturer and distributor of water softener, point of entry filter units and point of use drinking systems for the residential, commercial and industrial marketplace.

Topway has annual revenues of approximately $18 million which will expand our distribution network of independent water quality dealers, distributors and OEMs .

The purchase of Topway will allow us to extend our existing water quality platform into the southeastern part of the United States.

This area of the country we believe will continue to be a fertile area of growth for water quality and water conservation products.

To date, Global Topway has performed in line with our expectations.

Now I would like to give my observations on the acquisition landscape.

When we spoke last during third quarter conference call my overall impression was that there was a lack of good acquisition candidates and the pipeline was not as robust as it had been in the past.

My expectations at that time and what I still believe is that the acquisition marketplace will begin to pick up this year with companies coming to market with more reasonable expectations with regard to EBITDA multiples.

Our focus most recently has been on European candidates where we have been following some potentially interesting companies, both bolt-on type of acquisitions and those with complimentary product offerings.

Presently we have a high level of potential deal activity in Europe and we feel that we have the needed cash and available borrowing capacity to get these deals done.

As far as domestic U.

S.

marketplace is concerned we have seen less activity in recent months but would expect the pipeline to pick up as we move forward throughout 2008.

Finally, in China our focus in the near-term has been on operational improvements and the physical move of our joint venture operation but we'll certainly keep our eyes open for acquisitions going forward.

As far as our outlook goes for 2008, I would like to make the following observations.

Looking at the domestic residential channels, obviously much of the news has been bad and may stay that way for awhile longer.

Home construction permits were down in December 2007 by 8.1% from November of 2007, and 34.4% below December 2006.

Single-family construction starts were less that than 800,000 units, the lowest level in 16 years.

An economist for Bank of America recently forecast residential construction growth in 2008 would be anywhere from a minus 2 to a plus 2% with a turnaround beginning late in 2008.

I tend to agree with this assessment.

I believe that we are coming close to the bottom of the residential issue, and this channel will provide us with only minimal top-line growth for us in 2008.

If we turn to the commercial marketplace, we believe we have positive growth but not to the extent that we've experienced over the last two or three years.

Bank of America economist recently said they expect the commercial marketplace to increase between 3 to 7% this year.

One of the indexes that I look at is the architectural billing index leading economic indicator of nonresidential construction activity and it is published monthly by the American Institute of Architects..

The ABI index for December was 55.4, any score above 50 indicates that architectural billings have improved billings from the prior months so their billings are increasing above 50.

This score has been at 50 or above for 34 consecutive months, provides an approximate 9 to 12-month window into future nonresidential construction activities.

Basically, from the time the design takes place in the architect's office until the construction happens.

So we see continued growth albeit at lower levels in the domestic commercial marketplace for the better part of 2008.

We really don't have visibility beyond 2008 at this point and don't issue an opinion.

Remember, too, that a good portion of our business, 40 to 50% of our business, is predicated on the replacement markets which we believe will continue to be firm.

We expect that we will introduce new products into the marketplace in 2008.

We are -- further I'd like to point out we're closely involved in the plumbing code regulation and expect to see expanded growth in that area as well.

To touch on Europe for a moment, we see growth in the general economy slowing due it to the impact of reduced exports to the U.S., and to some extent the impacts of the credit crunch.

In particular, we see the German marketplace continuing to have difficulties.

We are seeing that slowness in Germany slowly creep into our business in eastern Europe as well.

In Europe, the under for our heating is becoming the preferred choice in traditional boiler manufactures are moving into renewable offerings.

We see this as a positive trend for Watts because we are well positioned to capture market share with the various packages we sell and offer to these type of applications.

We see the continued pan-European consolidation of wholesalers and larger customers as a plus to Watts as well, because as they consolidate purchasing, we expect that the breadth of our product offering and our brand preference will differentiate us from other European competitors.

Finally, in 2008, we are focused on organizational improvement and efficiency.

We have hired several experienced managers to improve our manufacturing and procurement process in both North America and China.

In China we've hired a key individual to expand our sales channels into the Chinese marketplace.

We expect 2008 to be a relatively challenging year so operational improvements and maximizing cash flow will be two of our top priorities.

You should note that we have increased our quarterly dividend by 10% to $0.11 per share for shareholders of record as of February 25, 2008.

Now at this time I would like to turn the proceedings over to Bill McCartney who will take you through the financial highlights, then we'll open the lines to questioning.

Thank you, Pat.

Providing overview on financials for the quarter, revenue on a consolidated basis was up 4%.

We closed at $345 million.

From an organics -- or looking at the factors of that growth, from an organics standpoint we were down about 1%, about $3 million.

The foreign exchange was favorable, primarily due to the strengthening of the Euro that was about 4.8% and then we had some contributions from Topway Global at about $2 million so that all comes to 4%.

When you look at the organic growth, of minus 3 million or minus 1%, the retail North American retail market was down 2 million.

The European organic revenue was down 4 million, China was down 2.

This is offset by growth in the North American wholesale market, and we'll go through those in a little bit more detail in a moment.

On the earnings side, net income on a GAAP basis was $0.55 a share that's an 8% improvement over last year's fourth quarter.

If we look at net income from continuing operations and we back out our restructuring charges, net income was $0.57, which is compared to $0.54 last year, and consensus estimates were $0.54 on the quarter, and even though we started our share buyback during the fourth quarter, we still had $0.02 of dilution in the numbers from our offering we did in November '06.

On the restructuring numbers in the quarter, we booked $800,000 pretax, mostly associated with some severance and asset write-downs.

Now I would just like to talk about some of our segments.

North America sales were up 4% in total, which is about 1% organic.

Foreign exchange was 1 and acquisitions were 1.

In total it does round to 4%, though.

But inside North America we like to break it down between our wholesale and retail markets.

Looking at wholesale, it was up 6%, which includes a contribution from Topway Global.

On an organic basis, we were up 3%, backing out the FX and the acquisitions.

So basically what we're seeing here in the residential market is similar to what Pat has mentioned on the outlook and what you're hearing from other companies.

In that we're seeing a decline in residential units of somewhere between the mid to high single-digits, offset by growth on a commercial basis, the commercial units which are up sort of high single-digits.

And then we have pricing that's coming through as well to make the whole wholesale positive.

As you recall, we had two price increases recently on the wholesale.

We had a June of 5%, and a September of about 4%.

The September one was primarily to offset some of the changes in the VAT taxes in China.

On the retail side, we're down in total about 5%.

The total revenue was $44 million there.

A few things happening here on retail.

First of all, during the course of the quarter we had different price increases that rolled in at different periods of time, ranging from 5 to 7%.

Additionally, as you recall, we discussed in prior quarters we have exited some low gross margin business in the retail sector here, and that had an impact in the quarter of about $8 million, and that was $29 million on the year.

With that, we'll become a much smaller issue as we go forward.

And at the same time, we're doing some roll-outs and picking up some market share so we think that made a contribution of about $4 million.

And then obviously the impact from what's going on tin residential marketplace had an unfavorable result of about $2 million.

So just the economy alone we think is about a 2 million or 5% impact on retail.

But in total, again, retail was off about 5%.

Looking at Europe, total revenue of $118 million.

That's an increase of 8%.

Basically we had unfavorable organic revenue there of 4 million or 4% offset by some favorable foreign exchange, and the combination of the two nets to 8%.

And again, the story here is very similar to what we've discussed with you in prior quarters.

We see continued softness in the German housing market, housing starts there down quite a bit.

And at the same time, we have a large OEM business in Europe, and we're seeing the boiler production down in Europe, depending on the manufacturer and the type of boiler, but those declines in boiler production range anywhere from 25 to 35%.

Now, we are down a fraction of that in Europe, so we believe that we are picking up market share, and that's because we're moving product line, our manufacturers in Europe have moved the product line over the last couple years more toward the systems approach, more value added in the product line, and at the same time moving towards more controls and solar and geothermal applications and away from just being a manufacturer of components.

So all things considered, we think we're doing fairly well in Europe, given the softness in the German market.

And, of course, we all know the Euro is at an all-time high, so the high Euro combined with the softness in the U.S.

housing market puts a lot of pressure on all companies in Europe relative to exports back into the U.S.

or the U.S.

housing market.

When we look at sort of the markets in Europe that we serve, we see an increase in the wholesale of 5%.

The OEM is down about 13%, and that's where we see the impact of the boiler manufacturers and the housing being down.

And then we have a nice increase in the do it yourself market of about 10%, and that's where we're starting to realize some of the synergies with the ATS acquisition that we did in May of 2006.

On a China revenue, sales of $14.6 million, that's a decline of about $1.2 million or 8%.

There's really two issues here.

Well, first of all, let's back up.

From an organic standpoint, we had a decline of $2 million, or 13% offset by some strengthening of the RMB, which offset that about 5%, so that nets to an unfavorable 8%.

But, again, looking at the reasons for that decline, first of all, if you recall, back in May of '06, we acquired Changsha Valve Works, and what we did at the end of 2006 for Changsha is we recognized four months of revenue in the quarter.

And that was because it took us a couple quarters to get their accounting system current and caught up after the acquisition.

So if you adjust for that and make a comparison without that extra month of revenue in lost in 2006's number it would say that our sales into the infrastructure market were up about 10%.

So again, that business is going along fine and we believe it it's a healthy business, and we're optimistic on that.

The other issue is our sale of exported product in China declined about $1.5 million, and that decline is the result of some production issues we had at one of our plants which prohibit us from meeting our production requirements.

The order entry rates were fine on that product line.

It was more related to some production issues.

Just to talk about the gross margin for a moment, in total, the gross margin at 35.3%, that's an increase of 200 basis points compared to last year's fourth quarter.

And I think if you recall what our discussion on the gross margin has been during the course of this year, we said that from the first quarter forward what we expected to see was sequential improvement on the gross margin throughout the year.

For the first couple of quarters, we were unfavorable relative to the prior year.

Now we've turned favorable.

And I think that's particularly impressive this quarter because we -- during the fourth quarter, we realized $30 million reduction in our inventory, so we also had to absorb during the quarter some unfavorable manufacturing overhead variances, and that happened across all three of our segments.

We look at the North American gross margin at 38.1%, that's an increase of 320 basis points.

And that's really driven by two things.

One is the price increases that we experienced in wholesale and the retail that I mentioned earlier, and then we also had a bit of a favorable mix, if you will, because the retail was soft, and we walked away from some of that lower margin business, we had a favorable mix towards the wholesale, and then inside wholesale, a little bit of favorable mix towards the commercial side.

The combination of pricing and mix in North America helped us.

On Europe, the margin was 29.8%.

That's a small improvement from last year, which was 29.5.

And again, similar to North America, we had some improved pricing as well as a little bit of a favorable mix towards the wholesale side because the sales to the OEM market had declined a little bit.

In China, the margin was 12.4%.

That's a decline of 9.7% versus last year's fourth quarter.

There is a couple things happening there.

First of all, we mentioned the production issues we had that hurt our export sales, so we did not cover all of our fixed expenses in that factory.

Also, as Pat mentioned earlier, we're in the process of moving our joint venture from one side of Taizhou Shida to the other, so we -- that factory was in a state of flux, if you will, during this quarter with all the production equipment moving, so we did not have a strong margin there.

And then one other factory also a captive machine shop that we have in Taizhou Shida as well had some absorption variances due to the lower production levels to reduce our inventory.

So in China it's really -- most of it is driven by some of the volume as well as the absorption variances.

On our SG&A, consistent at 25% of revenue, at 85.8 million, that's an increase of $4 million.

Looking at the components of that, from an organic standpoint, we had an increase of $400,000, and then the change in the foreign exchange rates, predominantly the Euro, had an impact of 3.1 million and then the SG&A of Topway Global that we included in the quarter was the difference.

So really the thing is, the SG&A increase driven by the change in the foreign exchange rates.

Operating earnings, $34.9 million that's an increase of 21% versus last year, represents 10.1% of revenue.

That's a $6 million increase.

When we look at the components of the improvement in operating earnings from an organic standpoint, $2.5 million increase, which is primarily due to the improved gross margins.

The foreign exchange contributed about 2 million.

The acquisitions, or the acquisition of Topway Global had a negative impact on operating earnings because they had a loss in the two months that we owned them, and that's the result of amortizing the purchase price accounting issues, as we go into the first quarter Topway Global will be making money, those issues are now behind us.

And then we had fewer restructuring charges during the quarter versus last year.

So $6.1 million improvement in operating earnings.

The tax rate was essential flat at 31.5%.

So net income from continuing operations at $21.7 million.

That's an increase of 20%.

So with that, I think we can open it it up for any questions that you might have.

(OPERATOR INSTRUCTIONS) .

And your first question comes from the line of Amit Daryanani of RBC Capital Markets.

Please

Quick question with production issues in China , (inaudible) Is it the same size it that we're trying to right size at this point?

And also, of those issues resolve that (inaudible) are they going to continue in

Amitt, that's a different site.

The site that we were right-sizing Taizhou Shida, where we make more of the infrastructure related valves.

.

This site that we're talking about with the production issues is down in southern China, and we've made a lot of progress on those issues.

We think they're behind

All right.

And then I just want to make sure I got this right, but last quarter you had spoken about $20 million head wind on revenues because of product line divestitures.

How would you say 29 million?

Does that many we have incrementally walked away from $9 million, or did I just hear you wrong?

I think $20 million might have been the year to date number.

I'm not sure.

But there's only one set of issues here, and this is some low growth -- unacceptably low-growth margin business we had with some of our retail customers that we chose to exit.

All right, regarding Europe you highlighted softer trends in Germany as being a pretty big head wind on the organic growth line.

Could you tell us what you're seeing in other parts, especially France, which is probably one of your bigger markets?

Yes, this is Pat.

I think what you're seeing is gene slowdown.

It's influenced by a lot of the same things that are hitting the United States which is the credit concerns and other issues.

So you are right, we'e concerned primarily about Germany but you're seeing some of that trickle down into Italy, France, and to a certain extent into the U.K.

So it's been a relatively slow quarter for Europe.

The beginning of the year was much stronger, the end of the year was much slower.

We're seeing that slowdown really sort of -- predominantly in Germany but also to a lesser extent in the other countries.

Then just my final question.

Looking at the inventory turns, they've been sub free for awhile.

(inaudible) Are there initiatives, plan in place to get those inventories -- inventory turns moving in a higher direction?

The answer is yes.

In my opening comments I made some comments about the fact that he we hired two key executives, one which is a Vice President of North American operations, and the other which is a Supply Chain Head for the North American and China operations.

So it's a major focus on that.

I don't think at this point in time, though, we're prepared to give you a specific estimate in terms of what kind of improvement, but I can assure you that if you look at operating efficiency improvements in cash flow those are two top priorities for us this year.

Thank you.

Thank you.

And your next question comes from the line of Curt Woodworth of JP Morgan.

If you adjust for the delusion of the stock offering, looks like your EPS this year was about flat where it was last year, commodity pressures earlier in the year.

So my question is in terms of framing the year, is it the right way to think about it that growth in the wholesale commercial side, basically offset all the weakness that you saw in retail and some of the DIY channels this year?

It offset softness in the DIY channel.

It really offset softness in the wholesale residential sector as well is the way I would look at it.

Okay.

You had strength in other markets but not in the residential.

I'd include most of the retail in that residential sector.

Right.

Looking to 2008, and kind of given this quarter, the first quarter, you comped positively on margins, and we're going to be lapping some of the residential comps, is your feeling that the commercial wholesale market is going to hold up and the comps get easier on the wholesale residential and DIY channels?

From a margin and earnings growth perspective, this year should shape up more favorable than 2007?

Your head wind is still going to be there for almost the entire year on the residential side, right.

I think our visibility on the commercial side says the commercial marketplace will stay strong through our visibility and through the end of the year and we think that the commercial marketplace will continue to show strength through at least the third and into the fourth quarter.

So I'd say overall I'd say it also depends a little bit, curt, in terms of if we get some stability in metal pricing, because as you know, there's always a lag between metal pricing moving and our ability to pass it on to the customer just because of the fact that they're hurting overall because they're missing out on the residential piece of the business so they tend to resist pricing more today than they did a year and a half ago.

Okay.

The margins this quarter on the growth side were very strong, so in terms of the price versus raw material Delta, do you feel like you're still behind the curve on that?

I know you had some higher cost copper that flowed through.

Maybe just talk about what you need to do in 2008 to maybe reach parity.

Curt, on the wholesale side we're probably in much better shape on that cost-price push than we are on the retail side.

It's just -- we have to -- as we look forward, we're really looking to build a lot more efficiency into the organization with some of these management upgrades.

We've been selective this year with some of the product line pruning that we've done.

So it's just -- it's more of the same, keeping your nose to the grindstone on all these issues really, but we're really -- we've met a big push over the last couple months to really bring in some fresh talent experience from bigger company, et cetera, to help us do a much more lean, more efficiency in the factory, that kind of stuff.

All right, thank you.

Thank you.

Your next question comes from the line of Steven Nisan of [Mindful] Capital Investments, please proceed ,

Thank you very much.

Congratulations on good results, Patrick.You always seem to do a good job.

You talked about one of your main priorities were operational improvement.

Can you provide a little more color on what you're doing in terms of operational improvements revolving around lean and Six Sigma and how do you expect to see more through put through out plants and the benefits to your bottom line.

Yes, we're getting quite serious about implementing lean techniques Six Sigma type of techniques in our organization.

I hired a new Vice President for Manufacturing who is well seasoned in that area.

We'll probably have to add some additional training and talent to our organization in order to get the momentum on that, so I would consider us at this point in time, Steven, to be in the infancy with regard to our development in that area.

I think down the road will you probably see some significant benefits from what we're doing.

I look at 2008 as a tough year, sort of the year that you sort of batten down your team, and you go to you get into some things and better terms you might not have approached.

So I think at the moment I still consider us to be in our infancy, but I think long-term, it's a very viable program and has long-term positive impact on the organization.

As we go into 2008 how are you guys going to measure yourself?

Looking at (inaudible) ROIC What's going to tell your company that you're ahead of the game and this is where you need to be in terms of metrics?

What are you going to be looking at?

You got it right.

We're looking more at ROIC kind of measures and return on investment type of measures.

Personally, I think I've said this a number of times, we need to squeeze a loot of cash off of our balance sheet in terms of inventory position, and I think we're dedicated to doing that.

I think it's going to take us some time to get some traction but we're disciplined about what we're trying to do, and I think you're going to see us end up with better ROIC and a better return for on equity at the end of the day.

As you start these initiatives for '08 are there certain plants around the world that concern you more than others, and how do you plan to address those first over maybe your more successful plants?

We used to go through an education process.

We have plants that are quite honestly at the top of their game and have implemented lean techniques and Six Sigma techniques and pretty much have taken it to heart.

We have others that are lagging seriously so right now we're going through that introduction phase, the training phase.

It will take us awhile before we get the engine rung.

You think probably by next quarter you might have some more updates our think it will be at least a year-long process?

I think it's going to be a gradual process as we go through the year.

Going forward, for the remainder of '08 what systems and solutions would you like to put in place to accelerate your CI initiatives to really affect your bottom line and improve on shareholder value?

I have to be careful because I don't want to divulge things in to much detail but we have a number of initiatives and each one of our plants and that's the process we are really putting in place now, so I think it's a little premature to answer that question but we will be prepared to answer it in further calls.

Okay.

Final question.

For 2008, you have some operational challenges ahead of you.

What's your number one goal as CEO of Watts Water that you want to tell the shareholders on this call that you would like to accomplish a year from now so you come back to us in February 2009 and say I promise you guys I'm going to hit this goal, I did this goal, and we're all successful because of it?

What would you like to accomplish?

I think there's sort of two initiatives.

One is to put additional improvement on improvements like lean initiatives, the other is to seriously drive in improving our cash flow.

I think those are two we can look back on a year from now and think we made some substantial progress on.

Great.

I wish you continued success through this year.

And your next question comes from the line of Keith Hughes of Robinson Humphrey.

I just wanted to make sure I got get a number right.

You had said the U.S.

was up hey single digits; is that correct?

Yes.

Did you see any change in pace in the quarter or any occupancy that was better than at one during the period?

I'd say the growth rate was a little less than we had seen in prior quarters, Keith, but this is a selective -- we're talking about selective product lines here.

These are the products that are clearly commercial only large diameter valves and whatnot.

I would say the growth rate is down a little bit from what we've been seeing earlier in the year.

Okay.

And generally object pricing, was pricing on your wholesale channel in the United States on an apples to apples basis than what you saw in the retail channel?

It's been that way quite awhile.

Not comparing the two, but I know you've been raising price.

Were you able to get more price in the wholesale channel versus retail?

Not really.

Let me explain.

The price increase that we announced and had an effective date of June of 2007, it took effect and bid in a little bit earlier, so that we saw that pricing firm up in August and September so we saw, let's call it the latter part it of third quarter.

So you had the full effect of that in the fourth quarter.

So those prices were -- the retail sector, really those prices were implemented in September, probably became effective on a realistic basis in late October, early November.

So that's what you are seeing.

I think we got price movement in both channels.

Okay.

Final question, what was the ending share count, diluted share count?

38,800.

That was the average, correct?

Sorry?

That was the average, correct?

Oh, you want the average?

Yes, because you bought back shares in the quarter.

What did we end at?

I only have the arching front of me.

Okay, I'll get it later.

Thank you.

And your next question comes from the line of Christopher Glen of Oppenheimer.

Please proceed.

Good evening.

North America margins just really strong, the best in years, I believe does that signal anything strong about the margin direction in '08 comparatively to '07 as a whole?

I think it tells you that we've worked hard and now are catchy up on raw material costs.

I think that's one thing that clearly is happening.

I think the other thing that's happening, it it says something about the mix because your residential mix is very soft and your commercial mix is relatively strong, so after you positive shift with regard to the mix and the product in that quarter as well.

Overall, given the fact that your production levels weren't at the highest levels, and you had some unabsorbed overhead, that you worked hard in terms of some other -- containing costs in other areas.

Okay.

And then in the replacement exposure that you have, how much of that -- any way to break that down versus pure replacement versus maybe remodel activity?

We don't have really good visibility on that, because you think about our product, it's going through channels where we lose the definition of where the end customer is.

We have a fairly good feel in terms of the break down between residential and the commercial, but after that we lose it.

But traditionally Watts has done very well in the replacement, repair, and remodeling market.

Even in times where housing starts were at historically low periods, we've seen that stabilize.

The primary reason I think is because when a homeowner isn't willing to move into a new home, they make decisions regarding whether they want to upgrade their existing home.

Right now I think there's probably a lot of consternation in people's minds because they're readying the bad news in the paper every day but come later this spring when they decide they're it not going to move to a new home but they are going to upgrade their existing home they may improve their lavatory or kitchen, and we would probably see a piece of that action.

So we're looking at that piece of our business which is really someplace between 40 and 50% of our business as a relatively stabilizing influence.

Are you aware of any dynamic whereby since's really tough to sell a home right now people are actually investing more in their homes to get it ready for sale?

I don't think they're doing that yet.

I think they'll probably do that year.

I think right now they're trying to figure out what's going on with the markets, and the availability of credit.

I think right now they're probably confused.

Okay.

And then without the 8 million drag from product exits, you actually had unit volume growth in the quarter, that would be correct, right?

No, we still would have had slightly negative unit volume growth even without that.

I guess -- what's the carry-over from the product exits, and then on the other side, the new roll-outs and the share into '08 relative to the total impact in '07?

We'll have a little bit of that, product exit stuff in '08, but it's mostly behind us.

Most of that is gone.

And we do have several programs that we're rolling -- we're continually rolling out new product into that -- into those retailers.

How much share we're going to get during '08 I can't say, but we're still very active with new products, new rollouts, et cetera.

Okay.

And then finally, a number of companies are talking an bout resurgent raw material increases.

Are you seeing that for the first half?

We saw copper, for example, which is our number one import, copper-based alloys, bronze, and brass, things of that nature and we saw a drop until early December and now it is going the other way, it is going back up so our best guess is that you're not going to see it abating any time soon.

Okay.

Thank you very much.

Okay.

And your next question comes from the line of Andrew DeAngelis of KeyBanc Capital Market, please proceed, sir.

Hi, guys.

A question on restructuring.

Where did that hit the segments, the 1.2 million on the consolidated sheet?

We got 800,000 is about 100,000 in -- actually 100,000 favorable in North America and 900 China.

800 pretax.

We had 100,000 favorable because some of the inventory that we disposed of we had a little bit better recovery than our estimate.

Okay.

On the income statement is, it showed a $1.2 million charge and you're saying there was another, I guess a favorable ate temperature of 400,000 embedded somewhere?

That would be in cost of goods, yes.

1.2 was SG&A, and 400,000 favorable -- about 400 to 500,000 favorable in cost of goods.

That's really helpful.

I guess, could you sequentially, maybe take us through what happened in North America?

It sounds like based on some of your prior responses that you were able to capture a little bit more price within the quarter but, I mean, clearly the margin on a sequential basis improved nettable despite the fact that you're roughly comparable on a sales basis.

I guess other than the pricing, any other notable shifts on a sequential basis that maybe we should be thinking about?

I think the main issue is really relative to the margin is much better pricing than we had in the prior quarters.

We're doing better on that cost price relationship.

The mix was a factor, because the retail was down.

That's our lowest gross margin area, and wholesale was up, and then you still have favorable mix within inside of wholesale towards the commercial side.

That was all favorable.

And that was somewhat offset by some an absorption variances because we he did lower our levels to get at some of this inventory.

Okay.

How should we be thinking about price next year?

Obviously you have carry-over of benefit from your late '07 increases, but any other additional increases planned or being accepted by the market at this point?

The market actually, interesting, when copper prices dropped in December, you actually had requests to go the other way.

So we didn't accept those because of the fact that we understand that market are volatile and metal is volatile, and it jumps up and down.

But right now we don't have anything on the schedule at this point in time.

One of the issues I think is going to be, though is where is copper go through out th year and if copper continues to go in the direction it's been going over the last 45 days we'll have to take additional action.

Okay.

That's helpful.

That's all I had.

Thanks a lot, guys.

Thank you.

And your next question comes from the line of Francesca McCann of Stanford Financial.

Please proceed.

Hello, good evening.

How are you doing?

Doing well.

I think the last part of that answer kind of, I don't know, dwindled off.

I didn't quite hear it.

But kind of getting on prices nothing planned for this coming year, and we talked a lot about what happened in '07.

Are there any areas, though, providing copper does he remain high, are there any areas that you kind of anticipate that it would be more difficult to push through price increases?

Yes, I think in general it's more difficult to push through price increases now because most of your customers, at least on the wholesale side is and on the retail side, are suffering volume restraint, okay, so they're losing their volume like we are on the residential side, so their natural tendency is to push back all price increases a little butt harder than they have in the past.

They do recognize the reality of metals, though, and they all track metals like we do, and they're all fully aware of what's happening with metals.

So if it's appropriate to move it up there and after you good argument, we've demonstrated I think over the long period of time that we can pat pricing on to the market when it's appropriate to do so.

Okay.

So despite the premium that some of the product already sell at, that can still hopefully be kind of maintained and passed through?

We've demonstrated, I think, over four years now, because the escalation in raw materials started almost four years ago.

So far we've kept our nose just above the water line.

Okay.

All right.

Back to European market, what percent of your European business is -- has eastern Europe comprised?

Of the total Europe, eastern Europe?

About 6 or 7%, I think.

It's a small but growing piece of our business.

Okay.

But you are seeing some slowdown there?

Yes, what's happening is, it seems to be exhibiting itself in the terms of some of the wholesale theirs we sell to, the and we have a lot of premium wholesale there we sell in to eastern Europe but they seem to be running into credit worthiness problems.

It might be the fact that they grew so fast they out grew their financial capacity, so it relates more to credit worthiness than does it, I think, end demand.

It's an unusual situation that's developed.

We often require these guys post letters of credit in many cases they've been struggling to do that.

Sorry, just to confirm, at 6 or 7% of the total European business, so 2% or so.

And then within Europe, the breakdown of commercial versus residential, and then replacement versus new, for each of those, if you can give that.

The mix is the sale in the U.S.

Sort of half and half residential commercial.

If anything, the replacement business might be a little heavier over there because they're more heating oriented, and heating is a big replacement business.

When we say the 40 to 50% replacement we're saying that for the whole corporation so Europe is probably at the higher end of the range.

And 40 to 50% for both commercial and residential, approximately?

Right.

Okay.

And then how is the COO search coming, or is it?

Very active.

I have candidates in here I think tomorrow, Thursday, and Friday.

Okay.

Anybody you're excited about?

I think there are some well qualified candidates in the process.

It's a process that you take seriously, and you go through it very methodically.

You want to pick somebody who is going to be able to come in and have an impact.

Okay.

So that's progressing.

Good.

All right, I think that's it for now so thank you.

Thank you, Francisca.

And your next question comes from the line of Andrea Wirth of Robert W.

Baird, please proceed.

Good evenings, guys.

If we could go back to your outlook on the housing market you definitely seem a little bit more cautious than last quarter but sounds like you're generally still feeling like we've hit a bottom.

Just curious if you have actually sort of adjusted your plans for '08 from last quarter, maybe assuming a little bit lower level of volume, or have your plans generally stayed the same?

I think if you look at our forecast for '08, I think we are cautious, because the residential side, when I say we're nearing the bottom, I'm not good enough to forecast when we're at the bottom.

If you can give me a couple of lessons in that I'd appreciate it.

But I think we're nearing the bottom here.

I think specifically one of the reasons I think we're nearing the bottom is because one of the factors I take into consideration is what wholesalers are doing with inventories.

And I think in the third quarter of last year and into the fourth quarter of last year you saw a lot of reduction in inventories that won't replicate itself.

So you're probably going to see a little bit of the market demand itself falling off but you won't see a repeat of what I call the de-inventory cycle where, they're taking inventory levels and lowering them.

So that's part of the reason I think we're close to the bottom of the cycle, is that to the -- to a certain extent what we sop last year's numbers was some of the inventory reductions that feel take place when the markets contract.

And then when you look at just specific forecasts for the new construction market and remodeling, just curious what your internal forecasts are.

Are you kind of still on the new construction side looking at a million units, or are you a little bit more optimistic than that?

We're talking -- we're thinking that 900,000 units or so will be the level we'll see in 2008.

Then the remodeling side, are you still expecting positive growth there, or do you think you will see some did he decline remodeling as well?

Probably see some softness there, but not substantial.

And then --

Remember we do better in that market than we do in the new housing market.

Right.

Then just want to get back to the North American margin.

Obviously it was a fantastic margin there.

Definitely saw some nice improvement.

Just wanted to just kind of contrast your pricing versus what actually you saw in the raw materials front, because I believe sequentially, you actually saw a tougher raw materials comparison just based on FIFO accounting and kind of the inventory coming through on copper purchases, et cetera.

I want to say that's higher this quarter.

Is that fair?

And despite that you're able to grow margins even more?

Yes, the average cost is somewhat higher in Q4 versus Q3, that's right.

You can chart copper, if you will, and lag it about five or six months, and that's sort of what flows through.

As a rule, it's a very general statement, and we try to be smart and do smart buys when we have opportunities, et cetera, but that's what we've been saying for a long time, five to six-month lag.

Actually when you go forward into the first couple quarters of '08 actually I think it should improve for you, the comparison there.

So is it fair to say that given the same level of demand you may actually see margins improve from here even further on a sequential basis, or is that a little bit too strong of a statement?

I mean, there's so many factors that affect the margin just besides copper for us, you have mix, volume, absorption, absorption issues.

Everyone loves to talk about copper, but there's a lot more things that impact our margin than just copper, even though copper is a major factor, though.

And then just in the quarter, could you guess roughly how much you benefited from mix versus price?

Was it primarily mix, or primarily price, just to get an idea roughly of where that benefit came from?

Primarily pricing.

Okay.

Thanks, guys.

And your next question comes from the line of Todd Vencil of Davenport.

Hey, guys, nice quarter.

Thank you.

Just to kind of beat this one fully to death, but I want to ask it in a little bit different way.

Basically, if I put all the pieces together, you're basically saying you had a better price - cost relationship in the fourth quarter just overall due to the price increase that went through and you feel like you've caught up on a lot of that.

A lot of the fight you were fighting was escalating raw materials costs.

My question would be, how much additional benefit from those price increases are we maybe going to see as we go into the first part of '08, and then from there, are we sort of looking at a status quo situation with regard to at least that element's impact on margins until and unless metals prices move up or down at which point will you react to those?

Yes, that's the way I see it.

Okay.

Do we have any additional incremental benefit that we're going to get this year?

Sort of as those price increases continue to roll through?

I think it's relatively small, though.

Okay.

All right, that's helpful.

And then most of my questions did get answered, but do you guys have a projection for the tax rate for the year?

We're budgeting about 33%.

Okay.

And what about CapEx and D&A?

CapEx will be approximately 35 million, and D&A is about 39, '08.

Okay.

Thanks very much.

Thank you, Todd.

And your next question comes from the line of Richard Paget of Morgan Joseph.

Good evening, everyone.

Hello, Richard, how are you doing?

Doing all right.

I know you cited the ABI as a leading indicator saying that non-residential commercial was going to hang in there.

But if I look at some other industry stats, whether it's the McGraw Hill construction starts or some of the industry forecasts, they're saying '08 could be flat to down.

What are you seeing in terms of whether its inventories or backlog of orders that would tend to make you believe you'd have a more positive outlook?

Well, for example, I spend quite a bit of time with the sales organization here in the first month of the year because we have a number of different sales meetings and things of that nature.

I deliberately go out there and spend my time with them.

The question I'm asking is what are you seeing at the architectural level, because you understand that one of the things we do as an organization is call on the architects, the contractors and the engineers.

That's an important part of specification selling.

What we're getting repeatedly back through our channels of distribution and back to our reps is that the channel is still -- there are good project out there that will be completed.

Now, the question is what's the in put now as 2008 unfolds, are new projects being delayed or are new project going to get approved and passed through and funded?

What we're seeing is the backlogs are good, solid, and what's in the engineering firms is favorable toward us in terms of the type of project that has high occupancy, high sanitary processes.

So our visibility is really probably six to nine months, something like that, on a realistic basis.

The reason I quoted the ABI, because I think it's a more accurate than my casual input from my sales organization and from channels of distribution.

Okay.

I mean, I would agree in terms of some of the engineering firms, their backlog is continuing to grow, but you also hear anecdotal evidence that some of these project are getting delayed just due to tougher financing out there, so there could be the chance of a pause, at a minimum in some cases.

That's a concern we all have.

But even if that happen, it it's going to be in the second half of the year.

Okay.

And then I figured everyone else has kind of harped on margins, but you talked about mix and the benefits of that, and pricing.

I mean, you've had some good sequential improvement throughout the year.

Is there further sequential improvement, or have we hit kind of a plateau here in terms of the gross margins?

I don't want to say a plateau , but I don't think you'll see the rate of improvement just because the pricing is a lot of the pricing is in.

We'll still get some additional pricing, but we're looking at further inventory reductions, looking to probably have some absorption variances going forward.

The rate of the margin in North America right now, that's pretty much near our high, so I don't want to predict that we're going to go higher than that.

In this environment, that would be

Right.

But I guess you don't see necessarily a significant fall-off.

Well, we're not really in the mode, Richard, of giving this level.

I know.

Okay.

Gross margins by segment.

It's difficult to predict.

Okay.

Thanks.

That's it for me.

Thanks, Richard.

Your next question comes from the line of Ryan Connors of Boenning & scattergood.

Most of my things have been covered.

It's been a comprehensive call but just a couple quickies.

On the gross margins, Bill, you mentioned quickly in your prepared remarks that the mix shift due to some of these discontinued lower margin product lines was a contributing factor.

But I haven't heard you mention that again in several kind of follow-ups in the Q and A.

I wonder, was that a meaningful contributor and if, so has that sort of run its course, or will some of that slip into the first quarter?

I don't want to overstate it it.

One of the callers asked was it mix or pricing that was predominantly the contributor to the improvement, an it definitely is pricing.

The mix helps, because we've always said the wholesale is higher than the retail, and then inside of wholesale commercial is higher than residential.

So you had a mix towards wholesale, then towards the commercial, then at the same time, with that mix , the product lines that we exited we're very low gross margin products so that accentuates that mix shift if you will, more so than just the normal movement of the business.

But all that being said pricing was the main contributor to the

Got it.

On China, obviously pretty weak, I'm wondering, you mentioned the organic growth was down quite a bit, but the order trends are strong.

Is there a snap-back sort of there?

Does some stuff sort of get pushed into the next quarter, then suddenly you see a really nice -- some real nice numbers coming out of China going out of the quarter or is that not it?

I think you have that potential but it's a small number.

You're only talking $2 million of commodity product.

So it's not something that's going to move the needle one way or the other that much.

We had a good quarter this quarter on the gross margin, and we had that unfavorableness, so when that snaps back I don't think it it's going to push us over the top.

Sure.

Just finally, in past calls you've talked a it lot about or somewhat about your pecks tubing and your plastic tubing line, how you've been getting some traction with copper where it is.

Certainly we see a lot of anecdotal evidence with that out there.

Aim wondering whether that's still the case, whether that product line is still doing well, and if so, what the impact of that is on profitability.

I'd say in general pecs is a positive growth area for us.

I think as we get better at manufacturing at our efficiencies improve as well, so our costs is coming down, I think long-term that's a positive contributor to both profitability and sales growth.

Okay, great.

Thanks for all the time, guys.

Thank you.

Once again, ladies and gentlemen, to ask a question press star 1.

And your next question comes from the line of Andrew DeAngelis of Keybanc Capital Markets.

I know this has been long call but I figured while we're on, you mentioned several European acquisition candidates that you're looking at.

Was just wondering about the size of those properties.

They range all the way from low of maybe 15 million Euros up to quite substantial, 150 million Euro type of business.

There's quite a bit of activity, interestingly enough, that just happens at the moment the more activity is happening in the European theater than is happening in North America.

I think it will take a little while before some good properties become available on the U.S.

market.

And I know you mentioned in Europe they were kind of bolt-on, some complimentary, focused, I guess, on DIY wholesale OE?

No, most of these deals that we're looking at at the moment are more wholesale oriented.

Okay.

Thanks.

Thank you.

And your final question comes from the line of Christopher Glen of Oppenheimer.

Please proceed.

I think you paid a little debt down in the quarter.

Any help on the interest line for '08?

Let's see.

I would say most of that debt we have, Chris, is fixed, and it's in the U.S.

The debt that is variable and is pre payable is in Europe, so if we're successful with this cash flow improvement, you'll see the debt go down in Europe a little bit.

So I'd say you could see interest expense go down a little bit, but not a big number.

Okay.

Thanks again.

Thank you, Chris.

There are no further questions at this time.

I would now turn the call over to Pat O'Keefe for closing comments.

Thank you.

Wanted to just thank everyone for joining us.

Thank you for your continued interest in Watts.

We look forward to talking with you here at the end of the first quarter when we cover our results for the end of the first quarter 2008.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.