Watts Water Technologies Inc (WTS) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2008 Watts Water Technology Earnings Conference Call.

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

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

We will be facilitating a question-and-answer session 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.

Before Pat and Bill begin their presentation, I want to inform you that various remarks they may make about the company's future expectations, plans and prospects constitute forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various factors including those discussed under the heading "Risk Factors" in our annual report on Form 10-K for the year ended December 31, 2007, filed with the SEC and other reports we file from time to time with the SEC.

In addition, 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 and, therefore, you should not rely on these statements as representing our views as of any date subsequent to today.

I will now turn the presentation over to Pat and Bill.

Thank you and good afternoon, everyone.

Welcome to our Q1 conference call and thank you for your continued interest in Watts.

Following my remarks, Bill McCartney, our CFO, will provide you with the financial highlights of the company in total, and Bill will also discuss individual sector results.

Then we will address your questions.

Before we get into the quarterly results, I'd like to briefly update you on a few important items first regarding the progress on our restructuring program.

In Q1 we took an additional pretax charge of approximately $1.3 million related to severance, relocation costs, and asset writedowns.

In the quarter we announced to employees the right-sizing of our manufacturing facility in Italy.

We continued with the move of our Chinese joint venture operations whose physical plant was taken over by eminent domain while simultaneously right-sizing that operation.

This move will reduce headcount and improve our manufacturing efficiencies.

As I will discuss in more detail in a minute, this move and other events in China negatively affected our results for the quarter by about $0.07.

In general, we are on target regarding the timing and implementation of the various restructuring programs.

We expect savings in 2008 from the restructuring exercise will still approximate the $900,000 pretax amount discussed last quarter with most of the savings being realized during the second half of 2008.

We mentioned at the February conference call that we had entered into a contract to purchase the remaining 40% of the Chinese joint venture.

We had hoped for a Q1 closing, but the timing of government approvals and licenses has delayed the closing until early May.

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

Having this operation fully under the Watts umbrella will allow us to control this company in the same manner as we control other wholly owned business units.

Now a quick update on our stock repurchasing program.

As of Friday, April 25, we had repurchased approximately 2.2 million shares on the open market, and we had invested approximately $63.2 million to repurchase those shares.

The effect on earnings per share from repurchasing these shares in Q1 '08 was $0.03.

We expect the effect on earnings per share from the repurchasing program in 2008 to be approximately $0.12 for the entire year.

As mentioned last quarter, we still expect to have the capital flexibility in the form of existing cash and/or available credit lines to be opportunistic in the acquisition marketplace.

Next let me address the acquisition program for a moment.

When we last spoke, I mentioned our focus was on the European candidates where we had been following several potentially interesting companies.

As you may already know, on April 9th we announced the pending acquisition of Blucher Metals, which is located in Denmark.

Blucher is the leading provider of stainless steel drainage systems in Europe and a worldwide leader in providing stainless steel drainage products to the marine industry.

Broadly speaking, Blucher sells about 80% of its product into land-based applications and 20% into marine applications.

In terms of product lines, about one-half of Blucher's product sales are in push-fit pipes with approximately 60% of these pipe sales sold to land-based application and the remaining 40% sold into the marine market.

The remainder of sales is in drains in channels.

The drain portfolio includes light-duty drains for both residential and commercial buildings, heavy-duty drains for industrial application, and marine drains used in various types of ships.

Most residential and commercial products are sold primarily through wholesalers and contractors.

The residential marketplace is driven by price and design.

The commercial and industrial marketplace are more focused on quality and meeting specifications.

Where hygiene is a priority in the industrial space, Blucher's stainless steel products are the preferred choice.

Marine products are sold directly to shipyards where function, quality, and product safety are key.

Blucher has a number of certificates and approval within the shipbuilding industry for fire-resistant shock and vibration, which we think provide barriers to other competition.

Blucher sells push-fit pipes and marine drains used in galleys, cabins, kitchens, and on deck.

We expect the marine business will continue to grow nicely.

Based on industry reports, gross tonnage to be supplied to shipyards in 2007 through 2009 is expected to grow at an average CAGR of 22%.

Geographically, approximately 50% of Blucher's sales are concentrated in the Nordic countries with 25% located in the UK, France, and Germany, and the remaining 25% located in other countries.

The company sees geographical expansion as a major growth driver in the future.

We think that Watts' existing sales channels will facilitate and accelerate Blucher's expansion into these other areas.

At $183 million in purchase price, the Blucher acquisition is the largest acquisition Watts has made.

Blucher will offer us a new platform within our European markets.

We hope to close this acquisition in either may or June timeframe, but this will depend on the timing of government approvals.

If we finalize the Blucher acquisition in May, we expect the operating results will be dilutive to earnings by approximately $0.03 in the second quarter.

We are also exploring other potential acquisition candidates in Europe as well.

As far as the domestic U.S.

marketplace is concerned, we continue to see low levels of activity in deal volume, but we hope to see this pipeline pick up as we move forward in 2008.

In China our focus in the near term is on operational improvements.

As we discussed in our February Q4 conference call, two important goals of the company in 2008 are to maximize cash flow and promote operational efficiencies and productivity.

With regard to cash flow, I am pleased to inform you that the first quarter of 2008, we expect to generate positive cash from operating activities of approximately $14.8 million, which compares favorably to a $13.8 million use of cash from operating activities in Q1 of 2007.

The first quarter is typically a period in which we are a net user of cash.

This year, with the focus on working capital management, net cash outflows from working capital have decreased from approximately $43.5 million in Q1 of 2007 to approximately $3.5 million in the first quarter of 2008.

Regarding operational improvements -- in Q1 the organization was very active in promoting operational excellence.

Various levels of management were involved in training concerning lean and six sigma manufacturing techniques.

To date, 160 people have attended training programs in both North America and China, a lean champion and coordinator has been established for each of our major manufacturing locations, performance scorecards have been developed as well that will track our key metrics such as on-time delivery, cycle time reduction, inventory reduction, and quality improvements.

We are still in the early stages but are very committed to this endeavor.

We are planning further training for six sigma blackbelts and greenbelts, and we'll expand lean techniques to our small manufacturing locations as the year progresses.

We are also performing a search for a senior-level person to head up our lean manufacturing initiatives.

During a recent strategic review, the management team developed strategic and tactical initiatives, which we expect will be rolled out over the next two years.

These initiatives will either enable the company to perform in a more efficient manner or will ultimately drive greater cost efficiencies throughout the company.

In a challenging economic environment, we believe new product development and product expansion into new markets will be important growth drivers for growth.

We think we have a solid pipeline of products in both North America and Europe that will be introduced through the remainder of 2008 and into early 2009.

Finally, with Q1 behind us, I'd like to make the following observations regarding our outlook for the balance of 2008.

As we have discussed in February, we expected 2008 to be a challenging year.

However, given the macro developments and reflecting on our own results from Q1, our organic growth has declined for the second consecutive quarter.

The challenge may be more daunting and the recovery may be longer than we had expected.

In the U.S.

our business is working within a macroeconomic environment that includes jobless claims rising, producer prices increasing, consumer confidence sliding, inflation creeping up, foreclosure at record levels, commodity prices including oil at near-record highs in tight credit markets.

I think people in the trenches are past thinking about a potential recession, and our discussions now are about how long it will last.

Globally, it appears that the U.S.

malaise is causing other parts of the world to sneeze.

Looking at the domestic residential channels we sell into, the headline news remains downbeat.

Single-family construction starts in March of approximately 947,000 units, almost 12% below February of '08 and approximately 37% below March of 2007, and this represents the lowest level in 17 years.

Application for home permits, home building permits, which are generally considered to be a sign of future economic activity, continue to trend down.

With March adjusted units at 297,000, this is 5.8% below February of '08 and almost 41% below March of 2007.

These statistics are indicative to me that the residential housing market has not yet bottomed out.

I was more hopeful in early February that the residential construction would turn around in late 2008.

At this time, I don't think we truly see the upside in this marketplace until early in 2009.

We now are seeing the commercial market showing signs of slowing down.

As we discussed in early February, we follow architectural building index, ABI.

Through December of 2007, the index score had been 50 or above for 34 straight months, which was a positive indicator.

However, starting with January the index began to decline and as March month-end, it stands at 39.7, which is the lowest level since the survey was begun in 1995.

We also reviewed data from Dodge for expectations on square-footage growth in the commercial space.

The latest data suggests that the commercial arena will actually see a decline in square-footage construction of approximately 7.4% in 2008, with declines across almost the entire spectrum of commercial marketplace.

So from a commercial marketplace point of view, I believe I need to recalibrate my earlier outlook from growth at a slower rate in 2007 to minimum growth in 2008.

As for the U.S.

replacement market, from what I can see, this will remain relatively stable throughout the remainder of 2008.

In Europe we expect to see growth in the general economy slow due to the impact of reduced exports to the U.S.

and with some impact from the credit crunch.

In particular, we expect the German marketplace will continue to have difficulties, and we are seeing that slowness in Germany creep into our business in Eastern Europe as well.

Unfortunately, these trends have persisted.

We see the traditional boiler business throughout Europe declining and being replaced by solar and under-the-floor heating applications.

We do feel, even in this challenging environment, that we are making progress and taking market share by providing a broader product offering to our customers across Europe.

Before I discuss our outlook in China, let's spend a moment to address various issue we encountered in Q1 that negatively affected our Chinese operations.

At our TWT joint venture, the plant move has taken longer than we had hoped, which did cause shipment delays.

This move has led to plant inefficiencies, personnel turnover, and unexpected costs to be realized in Q1.

We expect to be completely moved and into our new operations by mid-June, which should begin to alleviate the moving pains we have experienced.

We expect continued improvement at this plant for the remainder of 2008.

Our WPT plant operations were impacted by misshipments and underabsorbed overhead caused by a lingering labor dispute at that plant.

Workers were protesting over compensation issues and also were concerned about their future with WPT given management's recent initiative to outsource some of the operations of this plant to domestic Chinese suppliers.

We reached a settlement with these works during April, which will allow WPT the flexibility to downsize its workforce while providing the workers with an agreed amount for overtime and severance.

Finally, our Changsha facility, which makes large-diameter hydraulic butterfly valves, the severe weather experienced in China during February affected -- halted production and shipments for the better part of the month.

The plant itself was without power for 19 days.

Going forward, we expect Changsha's shipments will pick up and help move the backlog, so we would expect that Q2 will be a decent quarter for Changsha.

We think that TWT and WPT domestic business will take another quarter to sort out.

Further, please remember that a significant portion of our China production is bound for both the U.S.

and Europe.

With these two end markets slowing, we expect the China plants will be running at less than full capacity, and we intend to control inventory levels in reaction to the slowness in the residential space.

We remain bullish on the Chinese domestic market, and we are confident that our new China general manager is the right person to accelerate sales growth as we move forward.

Now, at this time, I'd like to turn the proceedings over to Bill McCartney, who will take you through the financial highlights.

Then we will answer any and all questions you might have.

Bill?

Thank you, Pat.

Looking at the quarter, first a couple of comments on the consolidated results, then I'll go into comments on the segment.

As you see from the press release, revenue was down about $2 million at $344 million in the quarter.

When you break that apart, organically, we saw a decrease in revenue of $24 million, that's 6.9%.

The foreign exchange helped to offset that, which is a positive $17.8 million, or 5.1%, and that's primarily the euro, but we saw some favorable activity there from Canada and China as well.

And then we had $4.1 million from the acquisition of TGI, which we acquired in November '07.

We look at our earnings after taxes from continuing ops at 14.7, which is excluding restructuring charges, and that's a decrease of 27%, and that represents $0.39 a share compared to $0.52 a share last year, again, excluding the restructuring charges and, as Pat mentioned, the buyback of our stock added $0.03 because of the fewer shares outstanding.

In North America the revenue closed out at $211 million, that's a decrease of about 3% and, again, on a consolidated North American basis, organically, we were down 6%, that's $13 million.

The FX offset a little bit of that as a positive $2 million, or 1% and, again, the acquisition of TGI at $4 million, or 2%, and that brings us to a decline of $6.9 million, or 3.2%.

Now we just take a look at the wholesale and the retail, which are inside of our North American operations.

Wholesale closed out at $162 million, which -- excuse me -- $168 million, which is a decline of 2%, but if you back out the acquisitions and the foreign exchange, organically, wholesale was down about 5% overall, or just about $9 million.

What we're seeing inside of wholesale in North America is about a 10% decline in units offset by about 5% pricing overall.

When we look at the residential side inside of that number, the residential would be down higher than that, and then offset with some positive from the commercial side but not a lot.

We're seeing the commercial side very spotty in the quarter with some of those leading indicators softening, as Pat mentioned.

You know, the waterworks is down, which is tied to the residential side of the business, and commercial is flat to up slightly for those products that are geared toward strictly commercial applications.

If we look at the retail side of the business, we closed out at $43 million, which is a decline of 8.7% and, again, we look at the changes inside of there basically from an organic standpoint, we saw a decline of about 10% in units, which we, again, attribute that to the softness in the economy and what's happening in the residential space.

And we saw some offset in pricing and rollouts and, again, that positive news had a slight offset in that we have slight residue from some of the product lines that we exited last year because of some low margins that we're experiencing there.

But, basically, the important message there we think is that a decline of 10% in units because of the economy in the U.S.

and the softness in the residential space because, as you know, our residential -- I mean -- our retail market is driven primarily by activity in residential.

Looking at Europe, in total, the revenue is $122.7 million, that's an increase of $7 million or 6%.

But if we look at the components there, from an organic standpoint, we saw a decline of $7.7 million or 6.7% offset by the favorable foreign exchange in which the euro strengthened relative to the dollar.

So that's a $14.8 million contribution, or 12.8%.

Again, what we see in Europe, basically, from -- if you exclude the discussion on foreign exchange and looking at the organic activity, is an overall market that is fairly soft, and we think we're doing -- our management team in Europe is doing a pretty good job there.

We are introducing new products to offset the softness in the markets.

We are re-packaging our products in different ways in terms of bundling them with more value add, combining them into packages, introducing new products around thermal controls, energy controls, solar applications, as well as having selective price increases where we can do that in Europe.

Even though it's a soft market, and we do believe we are gaining market share in this weak market because of the new product introduction and the packaging that we've been undertaking now.

In China, total revenue closed at just shy of $10 million, which is a decline of about 19%.

When you break that into the components from an organic standpoint, we were down about $3 million, which is 25% with a slight offset from the strengthening of the RMB of 6.6%, which, again, brings you back to that 19% level.

And what's happening here is really consistent with what Pat mentioned earlier.

The relocation of our joint venture from one side of Tianjin to the other offset our ability to ship product during the quarter.

The labor dispute that we had down in Southern China and then the loss of power at our Changsha valve works plant in Changsha in Hunan Province, and we lost power for almost the entire month because of that snowstorm and, obviously, we were unable to have material delivered to the plants, et cetera.

So that plant really -- that snowstorm, rather, really caused our issues, and we're thinking that issue for Changsha is behind us at this point in time.

We have not changed our view relative to the end markets in China.

They remain strong, but we do have another quarter or so to sort out some of these operational issues at TWT and WPT.

When we look at the gross margin on a consolidated basis in the quarter at 33.2%, essentially flat with last year's first quarter.

We look at the margins by segment, though; the gross margin in North America at 34.5% is up from last year's first quarter, 1.6%, which is really the result of improved unit pricing versus last year.

Of course, the issue that we are mostly concerned about and addressing right now is the fact that we saw a margin decline in North America from the fourth quarter.

In the fourth quarter of '07, the gross margin was 38.1%.

So what we're seeing here, really, is -- it is not a deterioration in pricing so much as what we're seeing is an increase in some of our cost structure, and most of that is emanating from China where we're seeing increased foreign exchange rates, the VAT rebate has decreased, and we're starting to see -- that was effective during the summer, and now we're starting to see that come through our cost of goods in a meaningful way and, of course, we've experienced quite a bit of labor inflation in China as well because of the higher demand for professional people as well as some of the new labor laws that have recently passed in China and, as Pat mentioned, we are working on streamlining those plants through some downsizing and some lean initiatives as well.

In Europe the margin at 31.5% is essentially flat with last year's first quarter and is up slightly from the fourth quarter of '07 where we were 29.8%.

Most of our business units were very steady from any of the comparisons that we have, so there are no major issues relative to the gross margin in Europe.

And, of course, in China, the gross margin in the quarter at 8%, that's a decline of 10 points from last year's first quarter, or a decline of 4 points from the fourth quarter, and that's all related to the issues that we've just discussed with you around the labor disruption and the plant relocation and the manufacturing variances and lower trade revenue that resulted from those issues.

The SG&A -- $87 million, or 25% of revenue.

That's an increase of $3 million versus last year.

When we look at the components of that $3 million in organic standpoint we saw revenue -- I mean, the SG&A declined by $1.7 million.

The impact from the foreign exchange rates increased SG&A 3.7.

Inclusion of the SG&A from TGI acquired in November '07 added $1 million to our SG&A, and that totals the $3 million.

So there are no major issues from the business standpoint inside of our SG&A expenses during the quarter.

That brings us to our operating earnings.

If we look at it, excluding the restructuring, $27.6 million, 8% of revenue, which is a decline of about 10% versus last year's first quarter, and the issue, really, is you break it down into its components from an organic or internal standpoint, we saw a decline in our operating earnings of about $4.9 million, which, again, some of that is offset by foreign exchange rates.

And the issue, really, here is the volume decline in conjunction with the operating issues that we've seen in China during the quarter.

Below the line, other income and expense increased $2.2 million.

Two major issues here -- one is a decrease in our interest income, which is associated with lower levels of cash because of the stock buyback, and the acquisition of TGI.

So we have less cash earning interest, and we also had some foreign exchange losses below the line as well.

Our effective tax rate in the quarter -- 33.9% versus last year at 26.4%.

Where we really see the impact is in last year's first quarter, we had a favorable tax settlement in Italy in which we had approved some expense thinking that we were going to have a tax payment on some withholding issues there, and we had a favorable settlement on that, and we reversed that to -- the accrual that we had for that, we reversed it to income in the quarter, so we had a one-time artificially low tax rate in last year's first quarter.

The 33.9% is much more representative of what we are expecting as we go forward for the year, as we discussed in the past.

So the net income in the quarter excluding the restructuring on an after-tax basis, $14.7 million, which is a decline of 5.5 million, or 27%, and just one statistic -- some of you are interested, I know, in our D&A, so our depreciation and amortization in the quarter totaled $10 million, and I think, with that, we can open it up for any questions that you might have.

(Operator Instructions) Curt Woodworth, JP Morgan.

Bill, when you look at the gross margins this quarter, excluding some of the one-time issues in China, they were essentially up year-on-year, and I know it was maybe a little bit of an easier call, but given some of the negative operating leverage that you saw, is it really just price gains that was able to offset that?

Was there anything else in there?

Well, the issue, really, on the quarter, Curt, relative to the margin is too many things happening there.

One is the increased level of cost that we saw coming through because of our Chinese operations, the VAT and the foreign exchange rates and whatnot.

And then just the operating issues themselves in China that we just took as an expense in the quarter.

Those are the two issues impacting us relative to the gross margin percentage.

And we obviously had negative organic growth, so you don't have any revenue growth to offset those issues.

Yeah, that's kind of my idea, right, is that if you strip out some of those that are cost items, your North American and European businesses would have been up year-on-year despite negative operating leverage, right?

Well, if you --

Or North America, I guess.

I guess -- yeah, if you look at year-over-year you're right, but we're really focused on comparing ourselves to the fourth quarter because we -- if you look at that, we have a decline in the margin in North America, which is our major concern, and remember last year we had the first quarter, the margin was less than it had been in the prior quarters, and we told everyone that we were going to have sequential improvement throughout the year, which we did; and that's through cost reduction and managing our pricing, and so we're not so much concerned relative to the comparison to last year as we're concerned about the comparison to the fourth quarter.

The fourth quarter was an all-time high gross margin during the year.

It was probably a little bit too high.

It's maybe not sustainable, but we do have to -- we are working on improving the margin, going forward, relative to the fourth quarter with all these lean initiatives and whatnot.

So given some of the one-time cost issues this quarter, is it fair to say you think that this would be more of the trough margin rate for the year for the company?

Well, I think, as Pat mentioned in his remarks, that those issues in China is going to take us another quarter to settle them down or to see them start to improve.

So we don't want to give the impression that we're going to see a big improvement in Q2 because these issues in China just go away.

It's going to take us at least a quarter to sort them out.

These are probably trough margins but not necessarily one quarter.

Okay, understood.

In terms of the copper and resin exposure, some of the incremental costs you're seeing for that, what is your thinking around getting price increases to offset that and also can you remind us what that total spend is for you?

Yes, Curt, it's quite clear that you have a number of raw materials that are escalating.

You mentioned -- we all know where oil is, we know that copper is on the rise, we know that stainless steel is on the rise, we know that cast and (inaudible) iron is on the rise.

So we clearly have to take initiative for further price increases throughout the year to make sure we cover those escalating raw material costs.

Right, but do you feel that you'll be behind the curve near term?

Or do you feel that given these cycle through your inventory, I think it's five to six months that you'll have enough time then to get price?

So basically are there any near-term margin implications that we should be concerned about?

Well, I think that those items are going to hit us more in the third quarter -- we'll see a little bit of impact probably in the second but mostly in the third quarter by the time those higher metal prices start actually going into cost of goods sold for us.

So we will have time to address pricing issues before those hit us.

Assuming the market participants cooperate.

Yes, that's right.

Jeff Hammond, KeyBanc Capital Markets.

I really wanted to focus on these China issues.

I guess I wanted to understand -- it looks like you had about a $3 million to $4 million hit this quarter from these temporary issues.

Can you parse that out between the weather issues that go away and what lingers and then also give us your confidence level that the other two issues are, indeed, resolved by the end of the second quarter?

In terms of impact, the weather issue was the smallest.

The weather issue had more of an impact on the top line than the bottom line, because those guys -- it's a very well-run plant, and they were able to control their expenses and react to the decline in the revenue relatively quickly.

So the more severe impact on the bottom line was from the other two issues -- the plant relocation and the labor dispute.

The plant relocation would have had the most impact followed by the labor issue in Southern China.

So we think the weather is -- unless there's another major weather catastrophe, that issue probably goes away, and that helps the top line and the bottom line a little bit.

And the other two issues will take, as Pat mentioned, again, it will take the second quarter to sort through those.

Okay, so you're pretty confident that it's a two-quarter impact with the other two issues, and maybe that if it was $3.5 million this quarter, it's just nominally lower in the second quarter?

That's your forecast.

We can give guidance, but we're trying to explain to you what these --

Okay.

I guess the second question is you mentioned the big drop in the gross margin sequentially, and you've talked about some different issues -- inflation in China, value add tax, can you help me understand how much of some of the one-time issues exacerbated that, or is that a completely separate issue?

I view that as a separate issue because those are ongoing costs that we need to address versus the temporary issues, which you see in the China segment.

And why do you think that was such a huge swing in such a short period of time?

Well, it's how our cost takes five or six months to come through, and a lot of those issues were changing during the second -- during the third quarter of last year, and you also have an impact of mix where a lot of those products are wholesale products, and some of our smaller bronze devices that go into wholesale, and that -- we had a stronger mix towards wholesale in the first quarter.

So have you been taking actions to kind of resize or the cost footprint, as you've seen these coming for two quarters, or is that something you need to go on a go-forward basis, and --?

We've been doing an awful lot, I think, on the cost side, but it's going to take a while for it to come through.

We've been upgrading a lot of our manufacturing folks; we've been very, very active on the sourcing side both in China and in the U.S.; looking at the footprint issue as well, but that's something you don't turn around in a quarter.

So I guess, bigger picture, at what point do you start to maybe rethink how much you have coming from China versus what you're just sourcing in the U.S.?

Obviously, the supply chain gets stretched with the China strategy.

Some of your (inaudible) analysis are already indicating that certain products that were marginal to be manufactured in North America as cost effectively as they can in China.

So you're starting to see a reversal of some of the economics here.

Okay, and then the last question to the earlier comment, have you announced or are you contemplating any further price increases?

We have to have further price increases.

We have announced some price increases that were announced in January of this year.

We have others that are planned, but the timing of them is different depending on -- they are all driven by, really, escalating raw material costs.

So I think you're going to -- quite honestly, there's a need for additional price increases just to cover the cost increases we're seeing in the market, and we think those cost increases are sustainable.

What do you think the order of magnitude of those increases are?

Oh, you're talking anywhere, believe it or not, in cast iron and [malub] wire, and you're talking 30%-some down to teens in terms of some of the other raw materials.

And in the environment you're seeing you think that you can pass those through?

I think they're going to impact us as well as all of our competition in a similar fashion, so I think it may take a while to push them through, but I think they inevitably have to go through because they impact all of us to the same extent.

Ryan Jones, RBC Capital Markets.

Could you walk us through how Blucher is tracking today relative to where it was when management last had the conference call?

How it might be responding to a slower European economic environment?

Well, first of all, we haven't closed on Blucher, so we can't disclose financial results of an acquisition that hasn't closed.

Right, but you have to be tracking, like, the LTM results or be getting updates from the company as you finish diligence, right?

Yeah, we're getting updates from the company, but I don't think at this point in time we choose to disclose them.

Is there any material change to the growth outlook for that company as Europe slows down?

I guess we're going to have pass on answering that question.

It's a similar question to what you just asked.

A couple of housekeeping questions -- CapEx for the quarter?

Maybe I missed this.

Hold on a second, I'll get it for you -- 8.3.

All right, and then on your balance sheet, the $15 million in long-term investment securities, is that your auction rate exposure?

Yes, it is -- $15 million of option rate securities, which we have classified as a long-term investment this quarter.

Mike Schneider, Robert W.

Baird.

On the pricing issue again -- so you're going out with another round.

I wonder if you could look back to the January price increases -- what was your net realization on those, and was it lower or higher than you had been running in 2007?

Well, I think the January ones, Mike, were very selective and, to be honest, I didn't hear that they were not effective at this point in time.

So you've not noticed any particular degradation on your ability or in your ability to realize price at this point?

And I ask because the magnitude of what presumably is needed now around midyear has got to have risen significantly and couple that with a market that, by your comments, is weakening both in Europe and the United States.

I think we're trying to understand what is the efficacy of that next round of pricing going to be?

We don't really know until we go out with it, Mike.

So it would be hard to give you a forecast.

I mean, you understand the issue, which is you are going out with cost-driven price increases that are absolutely necessary in order to maintain any reasonable integrity in your margins, but you have soft environment that you're going out in, and it all depends on how the customers react to those price increases and even more importantly how your competitors are impacted by the same cost increases.

Right, so any prediction about your net realization, Pat?

You sound more cautious, but I guess in the past you guys have been extremely successfully in getting price.

Is there something new or different that you would point to to suggest that you may not be as successful this time?

Or is it just the backdrop of a weaker market?

It's basically the backdrop of a weaker market.

Okay, and when you go to some of your larger DIY customers and wholesalers have there been any additional lines or product lines that you've targeted for pruning, if you will, or were there serious discussions and disagreements over pricing, going forward?

Nothing material, Mike.

Okay, and Europe specifically -- margins flat year-over-year at 31.5% is pretty impressive and actually up sequentially even on a 7% organic decline.

Bill, maybe you can give us just some color on how you did it and what's different about Europe versus the U.S.?

Yeah, in the quarter we had a little bit of a favorable mix towards wholesale and away from OEM, but I think what's really happening there, Mike, is that the guys in Europe have done a -- I give them very high marks in terms of packaging the product.

We're not just selling widgets.

We're going upscale, we're selling a lot more control packages, there's a lot more engineering content to our products, we're bundling products together into a little bit more of a systems approach, we're focused on energy savings and conservation, et cetera.

So they've done a very nice job in repositioning the company and their product portfolio, if you will.

And the weakness that you cited in boilers, specifically in Europe, that was a source of significant growth over the last couple of years.

Is it a case where you've just taken the share -- all the share there is to take, or most of it, or is it, indeed, this energy conservation trend toward solar and other alternatives?

I think it's a longer-term trend, Mike.

And do boilers alone explain most of the 7% decline in Europe or was it fairly widespread?

It would be boilers, but I think you're also seeing some weakness in some of the end markets, particularly like in Eastern Europe as they start to feel the impacts from a soft German economy, in particular.

Okay, and then --

-- weakness and sort of a technology change, if you will.

And then in the North American wholesale market, it was down 5% organically, I believe.

The trendline through the quarter, I'm just curious, if this was a March inventory destocking or adjustment by your distributors, or did you see fundamental trends deteriorate through the quarter?

It was a pretty steady drumbeat throughout the quarter, Mike.

Kevin Maczka, BB&T Capital Markets.

Question, kind of big picture and as it relates to the top line -- I was kind of thinking that the first quarter might be your low watermark in terms of total revenues, but given your macro commentary, it sounds like it's getting worse both domestically and in Europe.

I'm wondering -- I know you don't give guidance on the top line, but can you kind of comment, might that first quarter be more of a high watermark instead of a low watermark if these macroeconomies are getting so much worse?

If you look in a normal year, the second and third quarter tend to be a little bit higher than the first and fourth just because of seasonality around agriculture and -- excuse me, irrigation and construction in the spring and then the heating season in the fall.

Whether that's going to be different this year remains to be seen, but, you know, we are concerned around some of the trends that we started to see in the first quarter.

All right, and then a question on China, if I could -- I guess I'm wondering what a more normal growth rate is in China once you ex out the weather and all the disruptions you had there.

It seems like everything in nearly every industry grows double digits in China, but you mentioned that a lot of your business is exported back to the U.S., back to Europe.

What's a more normal type growth rate for your China business?

I think if you look at the infrastructure business that we have there, you're talking growth rates that are sustainable of 20% to 25%, but we did mention that a lot of the activity comes back to the States, but that does not show up as trade revenue in China.

That's intercompany revenue, which we don't show on the segment.

But it does impact the profitability if we decrease the production levels in China because of lower demand from the states.

You wind up having absorption variances and whatnot.

But the infrastructure market in China is still very strong.

We're very committed to it, and we see that as a long-term growth opportunity, it just happens to be a small part of the business.

We're ranging in the 20%-plus kind of opportunity.

Just finally, Bill, as you look at your portfolio of products, is that kind of where you want it now or is there still some culling of underperforming products or businesses to take place yet?

Well, we don't have any plans for any major changeouts right now.

We'll periodically look at our product lines, though, and I think in an environment like we're operating in today, we probably need to go back and take a look at some of those.

Francesca McCann, Stanford Group.

A couple of quick follow-ups -- in terms of the pricing pass throughs, how successful have those been and where do you anticipate those for Europe, specifically?

Let me just start by -- if you look at the history, which has taken place over, really, the last four or so years, I'm not saying any of them are easy, but we've been effective in passing through some pretty aggressive price-based adjustments based on costs as a driver.

And I think our customer base is pretty aware of what's going on with copper, they're very aware of what's going on with oil, very aware of what's going on with stainless steel.

So I would anticipate, with the exception of the fact that your end markets are slowing down, that we would have a pretty good shot at pushing those through because, one is, everyone is aware of what the cause of them is.

We're not trying to improve our margins or anything else, we're just trying to pass through cost increases that are materially based.

And, secondly, they do impact you and your competitors about the same rate, okay?

Even if they've got a small advantage, it's temporary.

Okay, thank you.

And then also looking at some of the new products that you are introducing in Europe, can you discuss a little bit what legislation or what tax incentives support those product lines?

Francesca, it's all over the board there.

Every country is different.

Some countries are actually outlawing gas-fired boilers; some countries are providing incentives around tax rebates when you file your tax return.

It's all over the place but, generally speaking, it's a much more supportive environment than Europe than you see in the States around either legislation and/or incentives.

Okay.

So would you say, then, that all or most of your new products that are kind of directly driven by legislation or some type of tax advantage?

They're more driven by energy conservation.

Right.

Not all of our products -- we're saying that we've been successful because we've been transitioning the product line towards these conservation and more engineering content in our product line, and we've been, we think, beating the overall trends in Europe.

It doesn't mean that all of our products are like this.

We still sell some potable water products and traditional plumbing products that have nothing to do with this, but because we've been transitioning the product line, we're doing better than the general trend in Europe.

Yes, Francesca, the two trends that have helped us in terms of our new product development in Europe -- one is to package components into a system where you make the installation of a system much more easy, and you can do it with a plumber's apprentice versus a full-scaled apprentice -- a full-scaled plumber.

So one is, I would consider the theme to be ease of installation.

The other one is energy conservation, which is driven by a movement away from floor-based traditional [GITS] and oil-fired burners to alternative, under-the-floor heating systems, solar heating systems, and things like that.

So I'd say, really, the trend is ease of installation and energy conservation are the two drivers.

Okay.

And then, still on the European market, what signs do you see that show that the Northern European countries and your new market with the acquisition is somehow more resilient to the slowdown that we've seen spreading and spreading into Eastern Europe?

We've seen softness in Germany, we've seen some softness in Italy, we've seen some softness in Southern Europe, but we haven't seen the same kind of softness in the other economies.

And then share repurchase plans, moving forward?

You see that in the quarter we didn't buy very many shares back.

We basically reserved our cash for the acquisition of Blucher.

So we're sitting down now to evaluate where we're going, but our feeling is that we would reserve our stock repurchase or repurchases at more attractive prices than we've seen.

We have our program out there, but we've chosen not to buy at high levels.

Remember, our first priority is acquisitions for our use of cash.

Christopher Glen, Oppenheimer.

Just in terms of the China/North America interplay, and the reported trade revenues wouldn't be impacted in China by the North America weakness, but the margins would because the absorption in some of the products in the same factory as the domestic sales, is that right?

Yes, in some cases that's true.

We have about five factories or so in China.

Some are captive that just produce product back to the United States, and if they produce at a normalized level of capacity, then there's no manufacturing variances, but if we take them below their normalized capacity levels, according to the accounting rules, we have to expense the absorption variances.

So that would impact the margin in China when we do that.

Some of the factories are mixed where we're selling into the domestic Chinese markets and bringing it back to the States.

So you have both situations.

Okay, so the captive markets -- those absorption variances are reflected in the North American margins, I take it?

No, they would be reflected in the China segments when they occur.

Okay, so they are not really matched with the revenues then?

Well, they're matched in the segment in which they occur.

So they're not matching the North American revenues, though, you're right.

Okay, and it just looked like maybe another angle on the pricing versus the end market.

It looks like maybe price was a little stronger in the fourth quarter than it was in the first, is that fair?

I think our unit pricing basically held out from the fourth to first, for the most part.

I mean, if you're looking at changes in the margin here, it's because of these operating issues and the decline in volume.

There's a little bit of mix going on there, but --

Okay, and then lastly do you have a figure, more specific figure, on what the price was in Europe?

It's difficult for us to get around that because there are so many business units in Europe and different countries, and the price increases are very selective over there, so it's difficult to come up with a meaningful disclosure there.

Ned Armstrong, FBR Capital Markets.

I had a couple of questions.

I guess the first one dealt with -- in your introductory remarks you had mentioned a number of different operating initiatives you were pursuing.

Can you just talk a little bit about the benefits that you hope to get from those initiatives in terms of points in margin, inventory turns, and the type of timeframe that you anticipate they'll be realized over?

And I understand you can't be precise, but if you could just give us some good directional information, I think that would be helpful.

Yes, the programs you are referring to are, one, we're talking about maximizing our cash flow, and the second one is we're clearly focused on operational efficiencies and productivity improvement, trying to inoculate the organization with lean six sigma techniques.

Our gut reaction, sort of, is that these programs will probably pay for themselves in 2008, and will have ongoing benefits in 2009.

I don't have real hard numbers for you, but I think it's quite clear that we have a nice opportunity to work on these programs and improve the organization's operating efficiencies long term as well as near term.

Now, are you thinking as far as -- in terms of maybe 100 to 200 basis points over the next couple of years or something significantly more or maybe less?

If you're in a world-class manufacturing company, you should be able to get a couple of hundred basis points out of your cost of goods on an annual basis.

The question is how long will it take us to get to that level.

We don't know yet, but we're putting an awful lot of emphasis on this, and upgrading our management.

Pat is sponsoring -- requiring all of our manufacturing guys and even the administrative people and whatnot -- everyone is going to these lean training and six sigma training sessions, and we're putting a lot of resource into it as well as upgrading a lot of our strategic sourcing personnel to help us on that side as well.

So we're trying to attack it from all levels looking at sourcing, manufacturing, we're also look at our distribution expenses, how can we take cost out of that, that's a big operation for us at this point in time.

So we're upgrading all of these with new management, with additional resources, training, et cetera.

Okay, and from the acquisition perspective, clearly, it would seem that the universe of companies that you are looking at as acquisition candidates are feeling the same type of pressures that you are in the European and American markets.

Have you seen -- I guess -- one, have you seen that translate to multiples yet?

And, two, has that weakness resulted in sellers may be pulling in their horns a little bit and waiting for a recovery, whenever that may come?

Yes, in my opening comments I talked about that a little bit.

We have seen some nice properties come to market in Europe, and I think at fairly okay multiples in terms of numbers that can make sense from the economics models that we run.

We run the same economic model on every deal we do.

I think in the U.S.

you see the market -- anyone who is exposed to the residential market is probably deferring taking their property to market anytime soon.

We're hoping to see some pickup in the second half of the year, but right at the moment, there are very few properties up for sale.

Okay, and then with respect to Europe, any countries stand out as being especially resilient or particularly weak in the current environment?

I think we've said this, but we've seen softness, particularly in Germany and dropping down into Italy.

I'm a little bit concerned, too, because you also have another issue, which we're dealing with at the moment, which is the pound sterling is dropping versus the euro so that you need to -- to the extent you manufacture products in euro-based plants, you have price increases that need to take place to recover the changes in the currency in the UK.

So my gut reaction is you probably see a little bit of sluggishness in the UK, going forward.

Okay, and you haven't really seen any country that's been particularly resilient to the forces that work over there?

Not really, to be honest with you.

There's nobody standing out as being totally resistant.

I think you see a general slowing down.

Ryan Connors, Boenning & Scattergood.

I wondered if I could just get you to step back and talk about the big picture a little bit.

I mean, obviously, we're in a very difficult environment right now in terms of the point that we're at in the cycle, and given that both of you guys have been through down cycles in this industry before, I thought it would be valuable to get our perspective on how this cycle compares with past down cycles and economic cycles and construction downturns that you've been through and, in particular, are we in sort of an environment here that's a whole lot worse than what you've seen in the past or is this kind of par for the course for which you'd expect to be seen at this point in the cycle?

Well, let's just talk about when you had down cycles that were significant.

We had a cycle in the early '80s, which was quite severe.

We had another down cycle that took place in -- I call it 1990, '91, '92 kind of timeframe, probably closer to '92, and both of those were pretty severe.

You remember, in the early '80s, you had high interest rates driving housing markets down to very low levels, and so I think this is a little bit different in that this is caused by liquidity issues in terms of credit availability.

And I guess our objective is, quite honestly, when you think about the initiatives that we have already discussed in my opening comments and on the answers to some of these questions, you know, we're focused on maximizing our position in terms of driving unnecessary costs out of the business, maximizing cash flow, with the intention of coming out of this downturn a stronger company than we went into it.

So when you look at all the initiatives, that's really what they're trying to do.

You're trying to build yourself into a world-class organization despite the fact that your end markets are tough.

So a lot of our initiatives are focused on cost reduction and focused on cash generation.

There are no further questions.

I would now like to turn the presentation back over to Chief Executive Officer Pat O'Keefe.

Please proceed.

Well, thank you, everybody, for joining us today.

We look forward to talking with you at the end of our second quarter, which will probably be the end of July.

We'll have that scheduled here shortly, so thank you for joining us and thank you for your continued support of Watts.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a good day.