Watts Water Technologies Inc (WTS) 2010 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the fourth quarter 2010 Watts Water Technologies earning call.

(Operator Instructions)I would now like to turn the conference over to your host for today, Mr.

Ken Lepage General Counsel.

Please proceed .

Thank you.

Good morning.

Welcome to the Watts Water Technologies fourth quarter 2010 earnings conference call.

On the call with me today are David Coghlan, President and Chief Executive Officer, and Bill McCartney, our Chief Financial Officer.

Please be aware that any remarks we may make during today's call 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 10K for the year ended December 31, 2009, and other reports we file from time to time with the SEC .

In addition, forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any future date.

While we may elect to update these forward-looking statements we disclaim any obligation to do so, and you should not rely on the statements as representing our views as of any other date.

During this call we may refer to non-GAAP financial measures.

These measures are not prepared in accordance with generally accepted accounting principles.

A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release dates February 24th, relating to our fourth quarter 2010 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 David

Good morning ladies and gentlemen and thanks for your interest in our company.

And thanks for taking the time to join our fourth quarter call.

I would like to start by recognizing Pat O'Keefe, who, as many of you know, retired as our CEO at year end.

Over Pat's eight years at Watts the sales of our company doubled from about $600 million to about $1.3 billion, and our stock price increase significantly.

So we would like to thank Pat for all his contributions to our company and wish him well in his retirement.

Moving on to our fourth quarter performance.

We were frankly a little bit disappointed with the results in Q4.

We were buffeted significantly by many of the headwinds that we talked about in our Q3 call .

For instance, construction trends in Q4 were amongst the worst in history.

US retailers continued to destock in the quarter just as we saw them do in Q3.

And in Europe, our OEM customers slowed down there orders due to a reduction in government subsidies, and to a reluctance to hold inventory at year end.

As a result our sales in Q4 came in at about 2% below prior-year.

Gross margins were a little below most recent quarters, but pretty solid at 35.6%.

And adjusted net income per diluted share was $0.40 versus $0.44 prior-year.

As we reflect on the full year, we feel pretty good about our progress despite a tough economic environment.

In the US, residential construction was at an all-time low.

Commercial markets remain very weak, and retail market momentum declined as the year progressed.

In Europe we saw concerns over government deficits, debt levels and overall economic activity create uncertainty for much of the year.

And throughout the year, very volatile commodity markets, particularly in copper and stainless steel, challenged our ability to manage our margins.

However, despite these issues we do think we delivered a year of solid performance in 2010.

Our full-year sales were up 4% versus 2009.

Our gross margins were up by about 100 basis points versus prior year, at about 36.6%, and we delivered a 27% increase in adjusted net income per diluted share of 1.97 versus at 1.55 in 2009 .

Let's talk a little bit about the fourth quarter in more detail.

We experienced 2% organic sales growth in North America, offset by about a 5% reduction in Europe.In our Q3 call, we talked about see in general business softening in the US, and that softening continued into Q4.

We also talked in our Q3 call about the fact that retailers had destocked through the quarter and we saw that continue into Q4.

In Europe, our drains business was also hit by shipping delays because of severe weather in northern and central Europe.

And as I mentioned earlier, our OEM customers in Europe were very reluctant to take on inventory towards year end.

On the gross margin front, we were hurt by plant absorption in Europe because of the volume shortfalls.

We were also hurt a little bit by some inefficiencies due to our ongoing restructurings, particularly in France.

And we experienced an unusual amount of reset costs in our retail business in Europe.

Bill will provide more details on these factors a little bit later in the call .

I would also like to spend a couple of minutes on our key areas of focus in 2010.

During the year we focused our efforts on three areas.

Number one, growing our business, both organically and through acquisitions.

Number two, driving for continuous improvement and operational excellence throughout the organization.

And number three, strengthening our balance sheet to facilitate future growth On the growth front, despite a particularly difficult market environment, we managed to deliver organic sales growth of 4% for the year overall, driven by wholesale sales growth in the US of 6%, retail growth in the US at 2.5%, and wholesale growth in Europe of 5%.

We estimate that about half of that growth was price, and about half of it was volume.

During the year we put a lot of work into looking for opportunities for growth in a soft market, and we recorded some nice wins in targeted accounts and targeted products.

We also had some nice success in leveraging products between our geographies.

For example, in taking BLUCHER stainless steel drains from Europe into North America.

On the acquisitions front, we also made some nice progress in 2010.

In June, we announced the acquisition of Austroflex, which expanded our HVAC conveyance offering in Europe by broadening the product line, and also expanding our geographic presence.

In the US we announced the acquisition of a rain water harvesting company, BRAE, which further expands our presence, in what we might call green markets.

Recently, we were particularly pleased to announce our intention to acquire Danfoss Socla.

Ken Lepage will provide some background on this acquisition shortly, but we see this acquisition as a great strategic fit.

We think it will significantly strengthen our position in the European plumbing marketplace, both in terms of product offerings and geographic reach, and we are very excited about this deal.

Our second area of focus during 2010 was continuous improvement and operational excellence.

During the year we successfully closed seven locations; five plants; two distribution sites.

And we are making good progress on our other announced restructuring efforts.

We continued our expansion into low cost manufacturing locations, we completed an expansion of our Tunisian plant, where we assemble controls for our European business, and we are in the midst of establishing a new manufacturing plant in Nogales, Mexico, which we expect to be in operation in the second quarter of 2011.

We also saw significant productivity savings coming from our Lean Six Sigma initiatives, and that's evident in the gross margin expansion that we saw come through during the year.

Our gross margins expanded by about 100 basis points year-over-year, and we estimate that for every incremental organic sales dollar that we generated in 2010 about $0.39 talked to operating profits.

Looking forward, we think about a 30% to 35% drop-through is sustainable in 2011.

On the working capital, Lean Six Sigma also helped us, and we improved inventory turns by about 6% and delivered 144% cash conversion rate.

Our third area of focus was strengthening the balance sheet to facilitate future growth and giving us flexibility into the future.

We generated $91 million in free cash in 2010 .

We also worked to refinance our revolving line of credit, $300 million for five years, and we refinanced one trench of our long-term debt, paying off $50 million and replacing it with $75 million due in 10 years.

We ended the year with just about $330 million in cash on hand and a reported net debt level of $50 million.

That leaves us with a reported net debt to capitalization ratio of 5.2%.

And should Socla close, our net debt to cap ratio would approximate 19%, still very conservative.

So we think we exited 2010 with a balance sheet which gives us a lot of flexibility for growth in the future.

Now I'd like to turn it over to Ken Lepage to talk in a little bit more detail about

Thank you, david.

As you know we have announced our intention to acquire Danfoss's water controls business through the intended purchase of Danfoss Socla and other related business assets.

It is important to note that we have not yet reached a final agreement with Danfoss on the terms for the purchase of the business and the acquisition remains subject to the signing of a definitive purchase agreement and certain other regulatory approvals.

To explain why we made this announcement now, prior to having a final agreement with Danfoss, is because German merger control authorities had publicly disclosed that we had made a regulatory filing with them related to the acquisition.

That filing identified both Watts and the target company, so we thought it was important to make this information public.

Danfoss Socla is a leading European manufacturer of backflow preventers, check valves, pressure-reducing valves, and other products which are very similar to our core product lines in the United States, so these are product lines that we have a lot of familiarity and experience with.

The company is based in France and has a strong market presence in France, Germany and Eastern Europe.

Watts currently has two strong platforms in Europe, consisting of our drains business and our heating business.

If this acquisition is successful it will provide us with a third strong platform in Europe in the plumbing and flow control areas.

We still expect the purchase price to be between EUR115 million and EUR120 million.

We expect to pay for the acquisition cost with a combination of cash on hand and borrowings under our line of credit.

At this point we are hoping that we will be able to sign a definitive purchase agreement by the end of the first quarter, and if that occurs we expect closing to occur within a few weeks after that.

We understand that there is a lot of interest in this potential transaction, but we are prevented by contractual and legal obligations from providing any further information about Socla or the acquisition at this time.

We will make a public announcement if and when we sign a definitive agreement to acquire this business, and we will be able to provide you with more comprehensive information after we have closed the transaction.

Bill will now give us a financial overview.

Thank you Ken.

At this time I would just like to walk through some of the details of the fourth quarter and year-to-date performance .

As we look at the quarter, revenue closed out at $317 million.

That's a decline of 2% versus last year's Q4.

The major components there would be a decline in organic or internal growth of $4 million or 1%.

Unfavorable foreign exchange impact of $8 million, which is 2%.

And then the inclusion of the sales of Austroflex, acquired in the June of 2010, that contributed $5 million or1.5%.

So, that totals a decline of $6.5 million or 2%, primarily driven by the FX rates.

As we mentioned earlier, the bottom line earnings per share of $0.30 .

We would like to characterize the quarter as a $0.40 run rate.

The difference between the $0.30 in the $0.40 is primarily our restructuring charges.

If you look at the last exhibit on our press release, we do give a very roll forward of that, but essentially we have $0.10 of restructuring charges in the quarter.

The items we detailed in the press release in that table, the operating items, we had some favorable results from our product liability reserves, offset by expenses incurred for the due diligence of the Danfoss Socla deal and a small impairment, but those items essentially offset.

So, to go from the $0.30 into the $0.40 is essentially the restructuring charges.

Now I know I had some inquiries on some -- if I could provide some detail relative to the restructuring.

So when we look at the restructuring charges, $5.4 million pre-tax, $3.3 million after tax.

And just to give you those figures by segment, in North America we had $1.2 million pre-tax, and $400,000 after-tax.

Europe was $3.7 million pre-tax, $2.4 million after-tax, and China was $500,000 pre- and post-tax.

The restructuring charges are primarily associated with our French restructuring, where we had to book severance and related costs.

And in North America, we wrote down the one of our buildings which we have recently exited.

Looking at some of the segment information now.

In North America we closed out our revenue at $189 million, an increase of $5 million versus Q4 last year or 3%.

Again the major factors there, are our $4 million organic increase, which is 2%, some favorable foreign exchange of about $800,000, which is the Canadian dollar.

And then the inclusion of the BRAE acquisition, which we did earlier this year, of about $300,000, so that comes to just shy of $5 million.

Now breaking that between wholesale and retail.

Wholesale, excluding foreign exchange and acquisitions, was up $6 million or 4% in the quarter.

Now we think that is fairly good performance, as David mentioned in his remarks, in a very weak environment.

Housing remains at an all-time low.

Our starts in Q4 were the lowest since it's been recorded, And we take a hit there as well because the high end homes in that market took a bit of a harder hit, we believe, and that impacts some of our higher end products such as is under-floor radiant heating and so on.

On the commercial side, obviously it's still, we believe, in the trough.

Some of our food service products were flat in the quarter .

New restaurant and store openings and so on were flat.

White goods were very very soft as well.

On the more positive side inside the wholesale though -- I mean the discretionary remodeling market we believe remains vibrant, primarily led by a good solid market for sales of existing homes.

We continue to get the pricing we need relative to the higher copper costs.

And the team is doing a very nice job of introducing the BLUCHER product line in North America.

So a good performance on the wholesale side despite a very difficult environment.

On the retail side, sales at-- again excluding any impact from foreign exchange and whatnot-- $40 million, a decline of $2 million or 5% versus last year.

And again as we discussed in our third quarter call, what we expected to see and what we did see was the continued destocking at the retail stores during the fourth quarter.

We do believe now that those are in equilibrium, where the order rates and sell through are in parity.

But, besides the destocking we also saw the impact of the very soft white goods market impact some of our retail sales relative to gas connectors, water connectors, and so on.

In Europe, sales of $122 million.

This is a decline of almost $11 million or 8% versus Q4 last year.

The major components impacting that decline would be a decrease of $7 million from an organic standpoint, that's 5% decline.The unfavorable impact from the decrease in the foreign exchange rate versus last year, so that's $9 million or 7%.

The average Euro exchange rate for us in Q4 was $1.36 versus last year at $1.48, and Q3 was $1.29, but then we also had the inclusion of the sales of Austroflex which is almost $5 million or 3.5%.

So, Europe down at $11 million, hard hit by the FX rate and the organic growth rate.

Now that organic growth rate, the decline there, was primarily due to the soft OEM business in Germany during the fourth quarter.

What we saw was that the large OEMs that we do business with were very reluctant to hold inventory at year-end, both for our year-end reporting purposes and a certain amount of uncertainty in the market there as a result of some of the changing incentives.

So that's the major driver in Europe.

China sales have a slight decline of $0.5 million, primarily associated with declining exports into the European market.

Looking at the gross margin, on the quarter of 35.6% , that's a decline from last year of 1.4% , but it is fairly close to our year-to-date run rate of 36.2%.

Looking at the year, we saw a nice improvement of 100 basis points at 36.5% for the full year.

And again that's a result of some of the actions that David was discussing around productivity, and in some of our restructuring and so on.

Looking at the gross margin a little bit deeper.

North America, the margin was consistent with Q3 and year-to-date at 37%.

We did see a nice increase in the North America ,margins; an increase of 1.5% versus 2009.

So full year, nice improvement in North America, again, also seated with productivity.

Europe is where we did struggle with the margin.

In the quarter, European margins were 32.5%.

That's a decline of 3.7% versus last year, and it's a decline of two points off of the year-to-date run rate for Europe.

The major factors impacting that were lower absorption in Germany associated with the decline in OEM sales out of the German manufacturing plant that we have there.

Those OEM revenues were down about 15%, and had an adverse impact on absorption.

The other issue we faced in the quarter was inefficiencies in our French manufacturing plants.

We are in the middle of moving those plants.

We saw significant inefficiencies and we took a hit on the margin there, and we also saw some impact there in the SG&A as well.So really when we look at the corporate margins for the quarter, the impact is from Europe because of lower OEMs and struggling in France associated with the restructuring program.

Looking at the SG&A, $84 million is flat with last year.

When we look at the components there, we saw a decrease versus last year of about $700,000 from an organic standpoint.

The FX rates versus last year caused a decline of $2 million.

Then the inclusion of the acquisitions had an increase of about $2 million.

So the whole thing nets to something that is flat.

When we look at the SG&A compared to the third quarter, we did see an increase of about $5 million.

The main components of that $5 million would be $1.5 million of foreign exchange, $1.5 million of expenses associated with conducting the due diligence for that Danfoss Socla deal.

And $1 million associated with inefficiencies in France where we added temporary workers.

And we wanted to make sure that we were meeting our customers' delivery and service needs, which we did do, but we did have to pay some extra SG&A to accomplish that by increasing our workforce on a temporary basis.

So looking, that brings us over to our operating earnings, $23 million in the quarter.

If we look at it on as-adjusted basis, excluding the restructuring and whatnot, that brings us to a $30 million run rate on the quarter which is a decline of a 4% versus this time last year.

Below the line expenses, $5 million, flat with last year consistent with the run rate.

Nothing unusual there.

We also had an issue with our tax rate in the quarter.

Tax rate at 37.9% versus a 33% year-to-date run rate.

The issue there again that was in Europe where typically our European tax rate was about 27% to 28%, and in the quarter it ran at almost 44% .

We did book and adjustment in the tax rate there for a FIN 48 tax exposure associated with some transfer pricing and tax audits that we're going though.

It's a non-cash charge, but nonetheless we took a conservative position.

So that increased tax rate had an impact of about $0.03 in the quarter.

As we look forward into 2011 we would expect that tax rate to be in the 33% range.

So that brings us down to the bottom line of $0.30 earnings from a GAAP standpoint, and again of $0.40 on an as-adjusted basis.

If I could just make a couple comments on the year that you might be interested in.

When we step back and look at our year-to-date performance, we generated $176 million of EBITDA for the full year.

That represents about a 10% increase from '09 which is $160 million, and we even had an increase versus 2008 before the sort of pre-recession levels of EBITDA of $168 million.

So, again that improvement is all associated with some of the improved sales volumes and opening up of the gross margins.

On an earnings per share basis, just about $2.00 per share if we look at it without restructuring.

Again that's an increase from 2008 of $1.80, and that last year at $1.66.

So again nice improvement on earnings line.

If we look at the earnings just on a pure GAAP basis, including the restructuring and so on, from '08 to 2010, we've gone $1.23, $1.10 and now $1.69.

So, again progress.

We think we've made progress on an all-inclusive basis as well.

The days of working capital is up from the end of '07 when we started our continuous improvement program.

At that point we had 130 days of working capital, as we close out the year of 2010 we are at 104.

So, that 26 day improvement represents $130 million we've taken out of working capital.That $130 million has contributed very nicely to the position we have on the balance sheet that David mentioned earlier.

At year-end we are at a 5% net debt-to-cap.

If you look over the last couple of years, the way that has trended, at the end of '07 we had a 13% net debt to cap.

Then in '08 we did the BLUCHER deal, and it increased to 24%.

Then we went from 10% and now down to 5%.

So, you can see those positive cash flows of reducing our working capital and having free cash in excess of our net income exceeding 100% for three years in a row.

All that contributes to that very strong balance sheet.

Also contributing to the solid cash flow in 2010, our D&A was $45 million, and we only needed to spend $22 million on CapEx.

Again, the reduced CapEx needs are a reflection of the work we're doing on continuous improvement, where we are becoming more efficient with our asset base and our need to spend on CapEx.

As we look into 2011 we have budgeted $30 million for CapEx, and we are expecting working capital to continue to be a source of cash flow.

So with that, I'd like to turn it back

Thank you, Bill.

I'd like to spend a couple of minutes on the operating environment.

Starting with 2010, and then talking a little bit about our sense for 2011.

2010 in our view was a very challenging year.

As you all know, US residential construction levels hit bottom at where what historical lows.

New home construction starts were approximately 550,000 in 2010.

On a commercial side McGraw-Hill tells is that commercial construction was down 17% in 2010 versus 2009.

And then on the retail side we saw some tail winds in the first half of the year, but then our retail business saw some headwinds in the second half of the year as our customers destocked.As Bill said earlier, we are now pretty comfortable that point-of-sale data tells us their order rates from us and they're out sales raised are pretty much in balance.

The one area that was a positive for us in 2010 was repair/replace/upgrade.

That market had a decent comeback in 2010 driven by consumer confidence , driven by nice sales of existing homes.

In Europe, we saw markets being sluggish throughout 2010.

The OEM market was soft, and it certainly got a lot softer in the fourth quarter.

In Q4, as I mentioned earlier, BLUCHER was also was soft.

It's a product that is affected by weather, and we saw a slowdown, particularly in northern Europe.

And then from a DIY perspective, the top three big box retailers in France had a 10% reduction in sales per square meter throughout the year.

So overall it was a challenging year.

The other area that we put a lot of work into was price cost.

We think we came out of the year balancing our pricing to customers with the commodity costs that we saw coming through our supply chain.

And towards the end of the year we and our wholesale competitors in North America and Europe announced price increases in Q4.

Those increases are generally effective in January and February of 2011, they'll range from anywhere from 4% to 10%, and we were right in the middle of those sorts of increases.

If we look out to 2011, we think the first half of the year is going to be tepid, and we are hopeful for a little bit of a pick up in the second half of the year.

If we look at the first half, the markets are going to need a little bit of time to react to the price increases across the industry.

However, we are confident that enough of our recent price increases will stick to cover that commodity cost that are currently moving through our supply chain.

But, if current copper costs stay as they are, they will require the industry to put through some more price increases in Q2, and we are repairing for that.

Our price increases went through based on about $3.90 copper, and it's now running at about $4.30.

Commercial markets, the indicators for 2011, point to a gradual upturn in the second half.

The architectural billing index is at 50 in January.

We do not see any dramatic improvement in the first half in residential.

We do expect some pickup in the second half .

Again we expect the repair/replace/upgrade market to perform pretty well.

We look at the LIRA report from Harvard, and it's pretty upbeat about a strong 2011.

In addition, existing wholesales of about 5.4 million units give us a pretty solid base for potential demand, and sales of existing homes were up 3% in January.

A couple of other things with respect to Europe.

We are seeing an increase in building permits in Germany, and we are hopeful that will come through and help our business.

And our alternative energy business in Europe, which is largely our OEM business, is heavily influenced by energy costs.

And as oil goes up, if they stay up, we're hopeful that might drive some additional demands.

A couple of other key points as we look at 2011 that you should take into account.

We do expect to take a $6.1 million, pre- tax charge for separation costs for Pat O'Keefe in the first quarter.

And if we close the Danfoss Socla deal, we would expect that deal to be a drag on earnings in Q2 and Q3, because of the cost of integration and because of purchase price accounting.

However, we do expect that Socla will enhance our EBITDA margins pretty quickly.

Now, stepping back a little bit and talking about the acquisition market generally for 2011, we are seeing an active acquisition market and we are looking at a number of perspective deals.

As EBITDA levels increased coming out of that trough in 2009, we are seeing more business owners looking to market their companies, and we and many other companies with cash are increasingly looking at increasing their acquisition pace.

So summing up in terms of 2011, we are not planning for a much of a tailwind from the market, particularly in the first half of the year.

And so our focus in 2011 is going to be to continue to keep a tight rein on spending, to work very hard at managing the relationship between commodity costs and price, and to keep the momentum going to with respect to continuous improvement and operational excellence.

So with that, let's open it up to questions.

Modesta, can you line up our first

(Operator Instructions)

Your first question today comes from the line of Michael Cox with Piper Jaffray.

Please proceed.

Thank you and thanks for all the detail on the call this morning.

My first question is on the OEM business in Europe.

I was just curious what your outlook or thoughts were as to you approach 2011given the slow finish that you saw at the end of 2010.

I think, first of all thank you for the question.

I think there was a lot of uncertainty in the OEM market in Europe particularly in Germany in the fourth quarter.

There's been some choppiness with respect to subsidies, and also OEMs were very cautious about keeping inventory on their books.

We did see some positive momentum in orders coming out of the end of the year and we are cautiously optimistic, particularly as we look at oil prices going into 2011.

Okay, that's helpful.

And on the facility closure side, or restructuring, aside from what you are doing in France, assuming that market conditions of stay as they are right now, would that require any additional facility closures?

There are no more facility closures -- at this point in time.

Okay.

Thank you very much.

Thank you.

Your next question today comes from the line of Wendy Caplan with SunTrust.

Please proceed.

Thank you.

Good morning.

David, this is your first call as CEO, and it might be too early to answer this, but could you talk about -- a bit about what we should expect, whether there any kind of nuances that we might see in terms of the strategic shift or any change in emphasis versus what Pat had laid out?

Wendy, thank you for your question.

The way I would answer that I think is that the strategic plan which we put together over the last couple of years was put together as a leadership team.

And so, the majority of that leadership team still is here, and we are still committed to the same strategic plan.

I think the key thing for us to focus on is not to look at rethinking our strategic plan, but to keep a very strong focus on executing the plan that we have, and that's going to be our focus for the next couple of years.

Now obviously the one thing that is a huge a variable in anybody's strategic plan these days, is when are we going to see upturn come back.

And as we all know, with new residential construction for example running at 550,000 starts, and a long-term trend of 1.2 million to 1.4 million the biggest variable that could have a huge impact on our performance is going to be when the construction markets come back.

And so, we're going to keep focused on the things that we can control.

Were going to drive very hard in terms of innovation.

Were going to work very hard in terms of account management.

Were going to continue our focus on continuous improvement and operational excellence.

And we're ramping back up our focus on acquisitions as we see an increases pipeline come through.

And so that's going to be our focus for the next couple of years.

So no real change Wendy, just a real tight focus on execution.

Thank you, that's very helpful.

And just a quick update on Austroflex in terms of, if it is performing in the way the you had anticipated?

Austroflex again is a product that tends to go in, in the outside, and so the weather in Western Europe in the fourth quarter certainly lead to some disappointing results.

But we are very pleased with the enhanced product line that Austroflex adds to our existing Microflex business and we are also -- we also see some promising opportunities because of the geographic reach it gives us.

So while I think we had a little bit of a slowdown in the fourth quarter because of weather, we are still excited about the opportunities that that acquisition gives us.

Okay, and one last question.

Think I know the answer, but I have to ask.

The unrest, the geopolitical issues in the Middle East and Northern Africa.

Any impact for you all?

Not a huge impact.

One thing that I would mention is that one of the initiatives we worked hard on, as part of our low-cost country efforts, was to significantly expand our manufacturing presence in Tunisia.

And as you know Tunisia had some geopolitical up unrest in the fourth quarter and into the first quarter.

We had about half a day shutdown and about an impact on production for another two half-days .

So at the end of effectively three days that we were right back in our production plan.

Our on materials are flowing normally through the ports, and our finished products are flowing out through the ports normally.

So, that specific impact was negligible.

Beyond that, we are early in the process of building up our markets in the Middle East, and most of our sales quite frankly are going into the Emirates, which are not heavily

Thank you very much, David.

Thank you, Wendy.

Our next question comes from the line of Garik Shmois with Longbow Research.

Please proceed.

Hi.

Thank you.

Good morning First question is if you could remind us how big piece OEM business is in Europe right now, that would be helpful.

It represents about 40 -- pre-Socla, it represents about 40% of our revenue in Europe.

Okay.

And just on the price increases that you have announced.

Did you see -- it might be too early to say -- but did you see any pre-buying ahead of the price increase, and if so, how did that compare to the pre-buying ahead of the price increases you announced and 2010?

We saw modest levels of pre-buying in the fourth quarter, very little, and again all of our customers be they wholesale or retail, are keeping an extremely tight rein on inventory, and inventory levels are very low, So the impact was very negligible.

And certainly no greater than in prior periods.

Okay.

Thank you.

And just one more question.

You indicated, David, 30% to 35% incremental margin in 2011, down about 400 basis points from 2010.

Is that mainly a function of the copper cost inflation that you are anticipating to flow through, or are there other items in there?

Copper is in there, but we are probably also just being a little bit cautious.

You've got significant mix changes that can occur in our business, so we're trying to be a little bit careful.

Okay.

Thank you very much.

Your next question comes from the line of Chris Wiggins with Oppenheimer Funds.

Please proceed.

Hello, good morning.

On the issue of price cost again, if I could, I think you said in the past that you typically have about a four month lag for the copper spot price.

So is the right way to think about this is, that if copper stays up here, that you're okay maybe through the first quarter, but then it's going to be an issue in the second quarter?

Or can you frame that a little bit better for me?

Yes, Chris, you're right .

Three to four months is about the right time to think about how copper moves through our supply chain.

So we put our price increases at between -- based on $3.85, $3.90 copper .

As you know it's spiked up since then to about $4.60, and it's now down to about $4.30 or so the last time I looked.

So that's going to take three or four months to cycle through our supply chain.

And so you'd look forward and say we should be in decent shape in the first quarter, but if copper prices stay up around the $4.30 level or so, we and the industry are going to need to look at more price increases going into the

And do you think the industry will be receptive to another one?

Basically with one coming in January and another one possibly coming in April?

Will the industry , I understand that copper is higher and everyone is dealing with it, but are the chances are being able to get a similar level -- will it be more

It's always difficult getting price increases, but that's an important part of our job, and we will certainly be very focused on it.

As to the industry and its conditioning, if you look at another part of the industry manufacturers of copper pipe, literally adjust their prices everyday based on spot.

So we have a ways to go before we need to match that.

Okay, great.

And just one last one if I could on the inefficiencies out of France.

Can you talk about how -- is that behind you now, or did those continue into the first quarter?

Any color on kind of how temporary we should view that?

I would view it as temporary in the fourth quarter.

For example, one area of inefficiency was caused as we moved product from distribution centers into a centralized, significantly expanded distribution center.

That product has now been moved.

Bill talked about some temporary labor to relieve some bottlenecks.

The processes within that distribution center have settled down, and we're pretty comfortable with its operation moving forward.

A lot of the equipment, virtually all of the equipment that needed to move between our manufacturing plants and France, has now moved.

We're looking forward to wrapping up the French restructuring program in the first quarter.

Great, thank you very much.

Thank you.

Our next question comes from the line of Brad Lindsey with KeyBanc Capital Markets.

Please proceed.

Good morning, Brad.

Hi.

Good morning.

Could you give a little more color regarding the OEM the customer demand for some of the energies -- excuse me some alternative products.

Thinking about that business, and it's a sizable portion of the European business.

With subsidies been reduced, and how should we think about that business going forward?

Is this sort of a resetting of the base -- could you add a little color there?

That's a pretty volatile business over the last couple of years.

We've had some swings and roundabouts.

Some of the swings have been very positive for us.

I think the industry needed a little bit of time to settle back and just think about the consequences of change in the incentive levels of.

But there still is a big drive in Europe it towards the use of alternative energy.

And the tail winds that we are seeing for increasing fuel prices at make us feel cautiously optimistic about the business going forward.

So, is there any fundamental shift?

We don't believe so.

And the other thing that impacts that also, is that like in Germany, they are getting away from incentives, but they are moving towards that legislation that requires installation.

So, we believe , that, as we say, it's shifting and people are trying to understand how to meet the requirements of the legislation.

There are certain minimum percentages you have to supply though alternative energy and so on.

So, as the price of energy increases, it's a fundamentally long-term sound business, it's just going through a little bit of a transition right now I

So, for example, just add a little bit of color to what Bill just mentioned, in Germany there now is legislation with respect to heat metering, for example.

That it's required in new buildings.

So past incentives might have driven that type of product, now it's legislation.

And so there's a bit of choppiness as people sit back and take account of what's going on, but we still feel cautiously optimistic about the prospects of that business.

Okay, great.

That's helpful.

And then in terms of the wholesale channel, as you speak with customers, have you seen a change in tone?

Or are they still cautious on holding any extra inventory at this point?

If we separate the facts from the emotion, our wholesale customers are being very careful with their inventory levels.

Inventory levels in the wholesale channel are at what I guess you would say our historic lows, or at least of lows that people haven't seen for many years.

On the other hand, though, we are seeing a more optimistic tone amongst our wholesale customers.

They're starting to feel that 2011 will be a better year than 2010.

They're starting to see that we've hit trough in both residential and commercial, and that there is some prospect for bouncing off at the bottom.

So yes, there's a marked change in tone , but in terms of facts are still being very cautious and what inventory they are

Okay, great.

That's all I have.

Thank you.

Your next question comes from the line of a Ryan Connors with Janney Scott.

Please proceed.

Morning, Ryan.

Good morning.

Super .

Thank you.

I want to shift gears a little bit away from the some of the cyclical drivers and just get an update on a couple of the code related growth drivers that you talked about in past calls.

First off, can you give us an update on where we stand with the new national plumbing codes relative to fire protection on the residential side?

I know you said in the past , Bill, you expected about half the states to download that code.

Is that still your expectation and if so, what impact do you think that will have on your business in '11 and especially in the near term quarters here

Where we stand, as of January of this year that is in the national code for new home construction in the United States.

It requires residential fire protection systems to be included in those new starts.

So what's happening now, Ryan, is it going to go through a multi-year period where each state will be looking at this, and over a several year period they will each make a decision on whether to adopt or not to adopt to those codes.

At the same time, each municipality in the United States, which is where plumbing codes are enforced, they also have the right to adopt those codes.

For instance in the town where we live in North Andover, Massachusetts, they recently pulled down that fire protection code.

And what we are seeing is that it's early on, but several states have adopted and several states have said they are not going to adopt.

So when we talk about half the states, that's really just a rough guess.

We don't really know yet.

There's a lot of lobbying going on behind the scenes relative to the insurance companies and the manufacturing companies want to see that code pulled down, and some other factions are fighting against it.

It's going to be a multi-year, drawn out process but at the end of the day, it will be a nice opportunity for growth for Watts, where there will be more plumbing content required in a new structure.

And maybe a couple of other points, just add on to give color around the debate that's going on within the industry.

If you look at the cost of putting in a residential fire protection system in a $200,000 home, it's roughly about 2 to 2.5 percentage points of the purchase price.

If you look at how copper and other commodity costs are moving, you're looking at similar cost movements relative to putting in a such a system.

On the other hand, roughly 3,000 people die as a result of home fires every year, and so there's an interesting discussion going on about whether to add 2, to 2.5 points to the cost of a $200,000 or $250,000 home, versus the amount of lives that could be impacted.

So we believe that over time this legislation will spread across the US, and it's going to be an attractive opportunity for us in the industry .

Interesting.

And then the other one I want to get an up date on is the lead-free tubing, particularly in California.

Just a couple of items there.

Number one on the plus side I know you were an early mover there.

Is that enabling you to pick up any share?

And on the flip side, I know that the lead-free tubing has a higher copper content, so does that present an incrementally higher margin risk as that product line grows?

Two thing, Firstly, lead-free did get implemented at the beginning of last year in California and Vermont, but in the fourth quarter a federal law was passed, which said that by 2014, January 1, this is now going to be a nationwide requirement.

And so the industry is now preparing for the next phase of the legislation, which is to go nationwide.

You are right.

For products with lead free, the commodity costs do go up.

And so that is an issue for the industry.

It does require higher prices.

It also has impact in other areas though, which could be positive from a Watts perspective.

For example, if you take California, they have now allowed HEX as an alternative material to copper pipe.

And as copper goes up and as the lead-free legislation comes in, that will speed up the conversion to alternative materials such as PEX, which is a good thing for us.

Hopefully that answers your question.

It does.

Thanks for the color this morning guys.

Thank you.

(Operator Instructions)

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

Please proceed.

Good morning, Todd.

Good morning.

Good morning fellas.

David, congratulations, welcome to the call.

Thank you.

I just have a couple questions.

Obviously, and as you pointed out, cash flow has been very good and the balance sheet is in excellent shape.

How do you think about the amount of -- or how should we think about the amount of dry powder you feel like you have to do acquisitions?

Or maybe another way to come at it is if you were to find a lot of deals that you really likes and felt like you could integrate, overtime what level of the leverage it would you be comfortable going to?

If you look at our year-end balance sheet, we have a revolving line of credit, $300 million that's untapped.

We do have some letters of credit against that, but theoretically we could draw that down by about $200 million for an acquisition, and that would leave us a $50 million to $60 million working capital management once you -- we have adjust for the lines of credit .

And then on top of that, we had $330 million of cash on hand at year end.

So, we have the ability, just for the dry powder, as you define it, of say somewhere north of a $500 million.

So the Danfoss Socla deal is EUR115 million to EUR120 million, so we still have at least north of $300 million available, after that, assuming that we close that deal.

But when we think about the philosophy of how we manage our balance sheet, we have a rule of thumb that we go by in saying we'd be willing to go up to about 40% net debt to cap if we were investing in a company, an acquisition, that had solid and very predictive of cash flows.

So we don't want to over extend the balance sheet, but we do recognize that we have been under-levered, but we don't feel that we need to go out and pressure ourselves and spend the money just to get levered.

We want to spend the money in a smart way on companies that provide growth and that provide consistent, predictable cash flows.

Now, relative to that point, though, is that if we were to go out, and we would be willing to do a larger deal if it made a lot of sense, but if we significantly were to exceed that 40%.

We would probably be looking to raise

Got it .

And does that 40% -- would that be a peak number that you are looking to back off to a sustainable level or is the 40% you think , if you saw the deal and it made sense could you get 40% and be happy to

Again, we'd be happy to stay there if we felt that what we were spending or investing in gave us a solid predictable cash flows.

Got it.

Okay.

And then, I guess relatedly, I understand completely the concept that the biggest variable in anybody's business plan, what the outlook for growth in market demand looks like, and how fast that comes back.

But that having been said, do you have any thoughts about long-term, how should we be thinking about growth out of Watts, and maybe if you want to think about that both in terms of organic growth and growth through acquisitions.

If you can think through that cycle if that's even possible anymore.

Todd, if you take a long history of Watts, and we have grown organically in units at GDP plus two or three, over a cycle.

Not every year, but over a cycle, over multiple cycles if you will.

We can do that because of a strong brand, new product introductions, the continued evolution of plumbing and building codes and a little bit of a geographic expansion, okay?

When we think about our longer term goals, what we are trying to do here, we would like to see our organic growth rate pick up by a point or two over that, over the next few years by just being more effective with innovation, new products.

And the code environment right now, driven by fire protection, energy conservation, use of alternative energy, and so on, including rainwater housing, water conservation.

The new code environment has never been more richer or more vibrant and presented more opportunities for us.

So we combine our desire to do a better job on new products, leveraging our R&D capability, that's a goal we have over the next couple of years is to pick up organic growth rate.

To that effect we've made some investments in R&D.

We're opening an R&D center in Asia and so on.

Now, when it comes to the acquisition side of it, we believe that with the cash flows that we generate, we can double our growth through acquisitions.

So that we would want to grow in total in the 12% to 14% range combining organic and acquired.

And we think we can do that without having a serious a stretch on the balance sheet.

Now, the issue is, there is that acquisitions by definition at opportunistic.

We do have a very disciplined well thought out strategy.

We have a long list of companies that we like that we talk to and so on.

But, you just never know when they come up.

So these kind of growth objectives that were talking about are really a thought process over a cycle over many years.

Some years we will do better and some years we will do worse.

That's absolutely perfect, Bill.

Thanks for that.

Final question for me.

Just a housekeeping issue if you can.

Can you tell me the absolute levels of sales in North America split between wholesale and retail, in the fourth quarter?

In the fourth quarter?

Yes.

Our wholesale sales were round numbers, $148 million/$149 million, and our retail sales were $40 million.

Perfect.

Thank you.

Okay, Todd.

Our next question for today comes from the line of Joe Gagan with Atlantic Equity Research.

Please proceed.

I just a couple of questions.

You mentioned earlier about a favorable product liability reserve, I guess reversal on earnings.

How much was that for?

In the quarter it was $2.2 million.

Okay.

And there's been some other home product or building product companies that have talked about a softening in sales for January, through the first few weeks in February.

Where sales kind of took a ratchet down from the fourth quarter.

Did you see the same thing?

Not noticeably.

No.

I mean, there are -- I read some articles in the journal recently that are saying that the housing market is off to a slow start relative to last year.

But last year was a spiked up because of the housing credit.

So, we're not reading too much into that right now.

Okay.

And then you mentioned about -- the gross margins you're giving a range saying it's going to be 30% to 35% this year ?

Did I hear that

That was are drop-through on incremental volume.

Okay.

All right.

Good.

Thanks a lot.

Thank you .

Our final question today comes from the line of the Jamie Sullivan with RBC Capital.

Please proceed.

Good morning, Jamie.

Hi.

Good morning.

Thanks for taking the questions.

So as we -- just to put the takes on the European OEM trends in 4Q, you mentioned that you seen a little bit of pick up there, and there is the balance between the incentives and the new legislation in energy.

So if we just take it all together, is kind of a low single digit growth out of Europe reasonable this year?

Yes.

Okay.

Great.

And then on the retail side, what are some of the trends that you are seeing so far after some of the restock for their fiscal year end?

You said it's in balance, but are your orders are starting to grow again?

We are encouraged by some of the recent data that we've seen from our retail customers.

For instance, a couple of them, Home Depot has been talking about expansion order ticket.

They've talked about expansion in large order tickets, which again supports what we are seeing in terms of people spending money on upgrades the.

There also seeing expansion in overall order tickets, so we think that's positive.

We also like the fact that particularly Lowe's and Home Depot are becoming a lot more active in the first quarter with what they call Spring Black Fridays.

And so we're hopeful that that will have an impact in areas like appliances, which pull through both gas and water connectors.

And so there seems to be cautious optimism on their part.

You may have noticed that there is a slight uptick in the temporary associates that lows and home depot how are planning to hire in the spring.

We're looking at that was a little bit of cautious optimism.

But again I think the industry learned a little bit from last year, and they're going to be very prudent in terms of the inventory that they hold.

Okay, thanks.

And Bill, sorry if I missed this, but can you tell me again the comps that you saw in the US residential and US commercial wholesale side in the fourth quarter?

We saw the start environment I'm pretty sure was 349,000, which was the lowest in recorded history.

And I think for the year, start environment was 589,000.

I'm sorry.

I meant for Watts.

Your comps in the resi and commercial side.

In terms of what I residential --?

Yes, I think you mentioned wholesale was 4% -- I was just curious

Okay.

Yes, I'm with you now, sorry.

Wholesale was up 4%, which was $6 million, and the retail was down 5% which is $2 million.

Okay.

Thanks.

I'm sorry, go ahead.

No, that's it.

On the repair/replace a side of things, do you have a sense of how much of that side of the business was up in 2010?

It's a difficult number to measure because our products can go into new, they can go into non-discretionary pairs, or discretionary remodeling.

So we feel comfortable in saying that that market is doing well because of the various factors that we've mentioned.

New home sales and big-ticket items at Depot are doing well and so on.

We don't have that discrete level of data to give you that answer.

Right.

Okay.

No problem.

And just the last one, on Danfoss Socla.

Nothing specific on the deal, but just wondering in terms of the market in Europe versus the US for plumbing.

Are there any major differences or advantages between the geographies that you see?

I guess the one thing that we point out is that the market in Europe is pretty disaggregated, and that while the US market is a common market in the sense of that a backflow preventer in California is the same as a backflow preventer used in New Jersey, the technologies that are used drug Europe are slightly different.

And so, you could look at that as adding a little bit of complexity to your business but it also adds a little bit of extra code compliance requirements, which favors us.

Sure.

Okay.

Thanks a lot for taking all my questions.

All right, Jamie.

Thank you.

I would now like to turn the conference back over to David Coghlan for closing remarks.

Please proceed.

So, we would just like to thank all of you were joining us on the call today.

I guess if we just sum up we'd say that the fourth quarter was a challenging quarter for us.

We're looking forward to focusing again in 2011 on the things that we can control.

And as I mentioned earlier, we're not really planning for an awful lot of tail winds from the market, so we'll continue to focus hard on continuous improvement, operational excellence.

We will be working very hard on managing pricing relative to commodities spent, and we'll be focusing hard on managing our acquisitions pipeline.

Most notably in terms of closing and moving forward with the Danfoss Socla deal.

So we look forward to talking to you again at the end of the first quarter, and thanks for taking the time to join us .

Thank you.

Ladies and gentlemen that concludes today's conference.

Thank you for your participation.

You may now disconnect.

Have a great day.