Watts Water Technologies Inc (WTS) 2013 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the fourth quarter 2013 Watts Water Technologies earnings conference call.

My name is Genada, and I will be your operator for today.

(Operator Instructions)

Please be aware that remarks made during today's call about the Company's future expectations, plans, and prospects constitute forward-looking statements under 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 the Company's annual report on form 10-K for the year ended December 31, 2012 and other reports the Company files from time to time with the Securities and Exchange Commission.

In addition, forward-looking statements represent the Company's view only as of today and should not be relied upon as representing its views as of any future date.

While the Company may elect to update these forward-looking statements, it disclaims any obligation to do so.

During this call, the speakers may refer to non-GAAP financial measures.

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

A reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures is available in the Press Release dated Tuesday, February 18, 2014 relating to the Company's fourth quarter 2013 financial results, a copy of which may be found in the investor relations section of the Company's website at www.wattswater.com under the heading Press Releases.

I would now like to turn the conference over to your host for today, Mr. Dean Freeman, Chief Executive Officer and Chief Financial Officer.

Please proceed.

Thank you, operator.

Good morning everybody, and thank you for joining our fourth-quarter earnings call.

We have a lot of ground to cover, and I have some help here with me.

Joining me today are Ken Lepage, our General Counsel and Chief Administrative Officer; Ken Korotkin, our Chief Accounting Officer; and Tim MacPhee, our Treasurer and VP of Investor Relations.

I will begin by providing a high-level review of our fourth-quarter results, talk briefly about the financials for the full year as well.

I will talk about market conditions in our key regions, update you on our key initiatives and give you a sense of high level of how we're viewing our expectations for 2014.

Tim will then walk us through quarterly and full year performance in more detail and some relevant financial points related to 2014, and after Tim's discussion, I will summarize it and open the call to questions.

Let me start by providing a brief overview of the fourth-quarter results just flipping to slide 3. Our sales were $376 million in the fourth quarter, 6.1% increase over Q4 2012.

Adjusted EPS was $0.57, $0.03 below our adjusted earnings for the same period last year.

I'd like to point out a couple of items that affected our adjusted earnings during the quarter.

First, rebate costs where adjusted in Q4 reflect the achievement of annual volume incentive targets for certain large customers.

$3 million of these costs related to the catch up of our rebate reserves.

The second line item related to manufacturing inefficiencies we experienced as part of our lead free conversion project.

In Q4, we incurred approximately $1.4 million of costs including furnace repairs, excess scrap, professional services, and other costs related to the new foundry.

We expect that these inefficiencies are now substantially behind us, and the two items, the rebates and the lead free cost, impacted our adjusted EPS by about $0.08.

I would like to also provide you a little more color on the Trabakoolas legal settlement.

The suit was brought for alleged failures of legacy toilet connector products as we disclosed in our 8-K filing in December.

The settlement amount totals $23 million of which Watts will be responsible for $14 million.

We have preliminary approval from the courts, and we expect we will be completed by the end of the second quarter of 2014.

As a result of the final settlement, we believe that a significant current source of volatility and variability impacting the product liability accrual will be eliminated.

The total toilet connector outstanding claims is about 40% of our total product liability claims.

Also during the fourth quarter, there are approximately $6 million of additional special items which you can see in table 1 of our Q4 Press Release.

Turning to slide 4, just looking at full year, we delivered solid top line performance during 2013 as we achieved record worldwide sales results for the Company.

This happened despite the year-on-year reduction in EMEA.

We continue to grow sequentially in Americas, and China consistently delivered double-digit growth during the year.

However, our adjusted operating profits were mixed with different economic and business dynamics in each of our key segments providing unique challenges and opportunities.

In the Americas after a slow first half, we were able to grow sales organically for the full year by 5.5% as we participated in the growing residential construction market, the solid repair and replace end market, and sales of lead free products took hold in the marketplace during the second half of the year.

As we anticipated, the Americas adjusted operating results were impacted by the ramp up of our lead free foundry operation which cause production inefficiencies for much of the year as we talked about.

We estimate that these efficiencies added up to about $5.8 million of expense to our expense base in 2013, but we do not expect the additional costs cost remaining going forward as we continue to increase our efficiencies in the foundry.

Adjusted margins were also impacted by higher than historic product liability costs as we talked about, which we estimated added approximately $3.5 million in expenses for the year.

Margin expansion was also hindered throughout the year by competitive pricing especially in the retail channel.

In EMEA, a weak pan-European economy drove year over year organic sales down by 3.6% or about $21 million.

Regionally, sales were down in our French plumbing business almost 6% for the year, but we did see stabilization starting to return in the second half of 2013 as sales were essentially flat in the second half of 2013 when compared to the same period of 2012.

German sales were down -- sales in Germany were down for the year approximately 8%, but sequentially the sales reductions moderated as the year progressed.

Overall our EMEA team was able to mitigate the effects of the sales volume reduction on adjusted operating earnings and generated adjusted operating margins that were slightly better than 2012.

This result was achieved by focusing on productivity initiatives, SG&A cost reductions, just doing an exceptional job with the overall cost structure.

EMEA also did an exceptional job in generating cash flow in 2013.

Asia Pacific, our team made great progress in building the foundation for continued growth platform based on our global plumbing and HVAC capabilities.

The Asia-Pacific team grew sales organically over 20% in 2013 on top of an 18% sales increase in 2012.

On a consolidated basis in 2013, we delivered adjusted operating margin of 9.5% or 10 basis points below 2012 performance.

And mostly driven by the net volume declines in EMEA, lower margin retail business in America, lead free conversion cost and product liability cost I talked about earlier.

Our lead free conversion and excess product liability costs reduced our adjusted operating margins by 65 basis points for the year.

Our adjusted EPS for the year of $2.22 was $0.05 higher than 2012.

Included in adjusted EPS again are the items that I talked about with regard to lead free and product liability totaling about $0.16 for the year.

The net effect of FX in share buyback resulted in $0.06 of incremental EPS in 2013 as compared to 2012.

So in summary, we expected somewhat of a choppy year given the disruptions on lead free that we thought would be created in 2013.

We were concerned about the European economy, our core business results in Europe were affected as we talked about many times the macroeconomic issues, and we're hopeful for some stabilization, and I think we actually saw that in the second half of the year.

In the Americas, we delivered solid sequential sales growth, but again, we had headwinds in margins impacted for the reasons that we previously mentioned.

We also made great strides in our target emerging markets especially in China, Eastern Europe and in [Australasia].

Now let's look at slide 5, and I will take us through some current market conditions for each of the regions.

After a 24% gain in 2013, new housing starts are expected to remain robust with 19% growth for 2014 being forecast.

Existing home sales are expected to track positively in 2014 with approximately 4% growth after gains of 9.1% in 2013.

The growth in 2014 would equate to about $5.3 million existing unit sales which is obviously helpful for our repair and replacement segment.

In the LIRA index which tracks trends and remodeling activity recently forecasted double-digit growth expectations for Q1 and Q2.

We're starting to see more constructive signs regarding commercial construction expansion.

In 2013, the commercial end markets was somewhat muted, but there is more optimism for 2014 although timing of the pickup is still somewhat opaque.

Dodge is predicting an 8% overall commercial pickup with some sectors like institutional still lagging.

But there are still verticals like hotels and office space that we participate in that are forecasted to grow by double digits this year.

We are more hopeful that a commercial construction uptick may occur in 2014, but it's just difficult to say right now what the effect on the top line will be.

Moving to slide 6. Just looking at EMEA as we mentioned during our Q3 call, we are hearing anecdotal information that our customers and markets are getting more optimistic about future expectations.

The latest expectations are that Euro area GDP will grow 1% in 2014 which would come after two consecutive years of decline, and the Euro PMI index has shown positive trends for the last six months.

During 2013, the sales shortfall against the prior-year which we saw in Q1 moderated as the year progressed so that by year-end, our EMEA sales were almost flat with Q4 2012.

This is an encouraging sign.

Still our markets continue to be uneven, and as I mentioned, French plumbing sales flattened out in the second half of 2013 again, which is positive.

Over our German business continued to decline albeit at a lower rate as the year went on.

Our drains business was steady in the second half and was more challenged with some large drains projects in the Middle East were not repeated.

And Eastern Europe showed consistent progress with nice growth in countries like Turkey and Saudi Arabia as our order rates were steady as we exited 2013.

Now let's review market conditions in Asia on slide 7. As we've consistently mentioned, we believe our long-term growth prospects in Asia-Pacific are bright.

We anticipate a significant opportunity for us to grow the domestic China marketplace, and we're making some nice progress in laying the foundations for sustained growth there.

China's economy grew by roughly 0.7% in 2013, and expectations currently are that 2014 will have similar GDP growth.

We expect to grow our heating products business in tier one cities where we are expanding middle-classes looking for more comfort.

Our focus arm will be on the higher-end markets where we expect to sell imported products, and we believe our valves business should grow in the China 50, those cities being in the tier two, tier three cities that should offer substantial construction of expansion over the next decade.

Now let me talk about two of our ongoing initiatives, so please turn to slide 8. Our lead free conversion US has been substantially completed.

As expected, we experienced downtime getting acclimated to new furnaces, new machinery processes involved in the lead free alloys as the year-end of our foundry was running at about expected capacity and downtime has been minimized.

We estimate that the production inefficiencies and related costs total about $5.8 million in 2013 as I mentioned earlier.

On the customer side, we converted most of our customers over the lead free products by year-end, and we were able to maintain our gross margin percentages despite the higher cost of the new alloys.

The restructuring program for Europe that we announced last July is proceeding as expected.

Recall we announced a plan to reduce approximately 10% of our existing European manufacturing footprint with total expected cost of $14 million plus approximately $2 million of capital spend.

Those estimates have not changed, and for 2014, we are forecasting full-year restructuring charges of approximately $5.8 million, which would bring our total charges since the project inception to approximately $10 million or about 70% of the total expected cost.

The remaining $4 million of costs we expect to incur in 2015.

Savings are on track with our original estimates, with total savings forecasted to be $7 million on a run rate basis.

We expect to realize savings in 2014 of about $4 million and to have the savings fully realized by 2015.

The plans are in various stages and have not all been finalized with works councils or government approvals, so that is still pending, but we hope that the approval process can be completed the end of 2014.

Turn to slide 9. Just to provide you a little more information related to a new initiative which has begun in Europe.

In the fourth quarter, we began a program that we refer to as a European transformation.

This program is designed to realign our European operations from country specific strategy to more pan-European operating strategy.

This program is in line with our most recent five-year strategic plan.

Under this initiative, we want to develop a more efficient and broader sales capabilities for improved product management, pan-European marketing and enhanced product cross-selling efforts and cover more emerging market opportunities.

Also as part of the transformation, we want to drive European sourcing, logistics, shared services, and IT.

We will have a focused effort on rationalizing products that deliver little incremental margin to our business.

We expect to review our business model with the express goal to drive common business processes and systems and reduce our SG&A.

And, lastly, we will align our legal and tax structure to drive significant incremental tax efficiencies.

We anticipate this effort will ultimately increase and sustain our EMEA after-tax cash flows to help drive better return on invested capital and earnings power consistent with our strategic plan.

Overall, we expect this to be a four-year effort.

We anticipate total nonrecurring spend of between $12 million and $13 million, with approximately $9 million in anticipated spend in 2014.

Total annual savings and profit enhancements are forecasted at $18 million by 2018 with approximately $3.5 million realized in 2014 and approximately $10 million realized in 2015.

We expect that we will need to eventually add about $4 million in structural costs to maintain the program.

We anticipate that we will add about $3.5 million of that in 2014.

Much of the incremental nonrecurring costs will be from one-time transitional costs, professional services, to help execute the project and get it off the ground as we build our own internal capabilities.

Finally if you turn to slide 10, I will provide a high-level overview of how we see 2014 shaping up from a top line perspective.

We see business volumes picking up in the Americas with growth from residential new construction and remodeling.

Commercial construction still needs to gain traction, but we're hopeful that by the second half of 2014 that there will be a discernible uptick.

In 2013, our America top line grew organically about 5.5%, and we anticipate that we can grow 2014 between 6% and 9% range.

Included in that range is about 1.5% of incremental top line growth due to the final rollout of lead free product sales.

In EMEA, our organic decline for 2013 was about 3.6%.

For 2014, we are assuming the European markets will slowly start to recover from the two-year recession.

The recovery may be uneven, it may be uncertain, and it will be fragile.

And as I mentioned, we expected our overall markets are choppy, and so where we see growth perhaps in one region, we see potential decline or flat performance in others.

So from a pan-European perspective, we expect flat organic sales growth for 2014.

We do expect our Middle East and Eastern European business will grow modestly, but not enough to move the EMEA sales dramatically.

And as part of the European transformation as I mentioned earlier, one of the key projects is product rationalization program with an express goal of rationalizing low margin products from our existing product portfolio.

We're going to take a deep dive into all of our product lines, and we expect to potentially rationalize as much as 3% of our total sales in Europe as a result.

Blending our organic expectations with the rationalization affect, we expect a total EMEA scales on a constant currency basis may decline by 1% to 3% in 2014.

The upside to the sales rationalization exercise that EMEA remaining sales should delever overall higher margins which has been built into the transformation savings for 2014 that I discussed previously.

We expect our growth trends in Asia will continue to 2014 and to expand geographically within China and external to China, and therefore we anticipate that we should grow our top line in that region 15% to 20% in 2014.

And, finally, we will remain active in the acquisition market.

We continue to process and progress in developing a pipeline of targets as part of our overall strategic plan.

We anticipate doubling the rate of our organic growth through acquisition over the next several years.

So now let me turn it over to Tim who will provide a little more detail on the operating performance.

Tim?

Thanks, Dean and good morning everybody.

I will start by walking through the highlights of the quarter and full year slides on slides 11 and 12 and make some general comments about 2014.

Looking at slide 11 on a consolidated basis, organic revenue for the quarter was up 4.6%.

By segment, the Americas was up 7.9%, offset partially by EMEA which added a small decline of 0.7%, and Asia had another strong quarter with organic growth up about 12.5%.

FX provided a tail wind for us in the quarter as well.

The Americas saw an organic increase in its wholesale channel of 8.7%, OEM channel was up about 4%, and retail channels up almost 7% driven primarily by increased sales in our residential commercial flow products.

As Dean pointed out we, continue to see results of strengthening trends in North American residential new construction and repair and replacement end markets.

Looking at EMEA for the quarter, organic wholesale sales declined 3.5% offset for the most part by an uptick in the OEM market of 3.7%.

While certain markets within EMEA were down to flat in the quarter, we continue to see signs of potential stabilization.

EMEA in the quarter had an adjusted operating margin of 11.1% which expanded by 90 basis over Q4 2012.

EMEA reaped some early benefits of the restructuring effort as you may have noticed on slide 8 plus other productivity and cost initiatives that have been ongoing for much of 2013.

We will continue to drive our productivity efforts through both the restructuring and transformation initiatives that Dean mentioned earlier.

Asia Pacific's strong performance in the quarter was driven largely by continued growth of plumbing and HVAC market sales.

And adjust operating profits for the quarter were $36.7 million, as a percentage of sales decreased 60 basis points to 9% year over year.

The decrease was principally driven by a 130 basis point reduction in the Americas to 12.3% as the segment incurred the customer rebate adjustment and manufacturing inefficiencies related to the lead free version as being discussed earlier.

The reduction was partially offset by EMEA's increased adjusted operating margin as I previously mentioned.

The adjusted tax rate for the quarter was that just a little over 34% versus 29% in the prior year.

The increase was primarily due to a Q4 France tax law change on interest deductibility that was retroactive to the beginning of 2013 and partially from a Q4 adjustment to true up some of our US tax provision reserves.

Adjusted EPS in the quarter of $0.57 decreased $0.03 or 5% versus the prior year and as mentioned included about $0.08 of costs related to the rebate and lead free transition costs.

We spent $3 million to repurchase our shares during the quarter which had a negligible effect on adjusted EPS versus Q4 of last year.

So can we move on to slide 12 on a full-year basis, consolidated basis, revenue was up 2.1% organically year over year with the Americas up 5.5%, and EMEA down 3.6% and Asia up a little over 20%.

Full-year adjusted operating profit was $140.2 million with adjusted operating margins declining10 basis points year over year to 9.5% of sales driven largely by the lead free transition costs and higher product liability costs that we incurred earlier in the year.

Margins were also impacted by unfavorable pricing in the retail channel throughout the year.

The full-year adjusted tax rate was 32%, about 120 basis points higher than the prior year and related again to the retroactive tax increase in France I mentioned earlier.

2013 adjusted earnings of $2.22 per share, a little over 2% growth in the year.

And since we already touched upon a lot of the regional highlights on slides13 through 18, I will just turn to slide 19 now.

We will talk about the primary working capital, and the comment I will make there is the primary working capital is mainly affected by inventory build to support the lead free conversion, and receivables are increasing in Q4 2013 as a result of higher sales in the Americas especially during November December time period.

So now if you will turn to slide 20, I will give you -- quickly discuss some of the cash highlights of 2013.

We had another strong cash year as our cash flow conversion rate was approximately 151%; that's the sixth year in a row now that we've had a cash conversion rate greater than 135% for the Company.

During 2013, we spent approximately [$24 million] to buy back [$400,000] of our own stock in the open market, and this represents approximately 25% of the $90 million buyback program that was approved by our board last year.

If you recall back in May, we repaid $75 million in private placement debt that was due, and we used available cash on hand to take care of that and to retire that debt.

So overall at the end of the year, we ended the year with $268 million in cash.

Now if you turn to slide 21, just a few points on 2014 that I would like to make you aware of.

As we announced in last night's Press Release, we have entered into a new $500 million line of credit agreement that will be used for general corporate purposes, acquisitions, and debt repayments.

The new agreement extends through February 2019, increases our available liquidity to $475 million while reducing the interest spreads we paid on any borrowed funds.

We expect to spend approximately $40 million in 2014 on our repurchase program, and that's in line with our existing plan.

We anticipate spending approximately $25 million to $30 million in capital spent for the year, most of the spend will be for maintenance-type capital.

And finally as you can see on slide 21, we put some estimates there for depreciation and amortization and also giving your range of our effective tax rate for 2014.

With that, I will turn it back over to Dean.

Thanks, Tim.

In closing, in the fourth quarter, we saw sales growth in the Americas and Asia and better sequential performance in EMEA.

As we talked about, adjusted operating profits of the quarter included a couple of items related to rebate on lead free costs which dampened our margin results.

For the year, our Asia team delivered very solid results, and EMEA worked diligently to negate some strong macro headwinds to deliver very respectable for performance in 2013, and the Americas delivered on improved top line performance and executed in a challenging lead free conversion.

Full-year adjusted operating profits again were negatively impacted by the items mentioned earlier, but we believe that uses related to lead free conversion and product liability costs have been largely mitigated with the proposed class-action settlement.

And as I mentioned earlier, we believe much of the lead free issue conversion issues are in our rearview mirror.

Looking ahead at 2014, the market dynamics are positive, and continued growth in Americas and Asia-Pacific and some emerging positive signs in Europe.

Our European team will still be busy executing both a restructuring program and the transformation process which will require incremental investment but will drive significant benefit to us both in the medium and the long-term.

Overall for 2014, we expect to deliver healthy operating profit growth through continued focus on growth, operational excellence and one lives.

So with that, why don't we open the line for questions, operator.

(Operator Instructions)

Mike Halloran, Robert W. Baird.

Just to make sure we're on the same page on the European restructuring, these are two separate initiatives, and the announcement today is incremental to the announcement that you made mid-year, correct?

That's right.

Okay.

And then, could you talk a little bit about the competitive pricing dynamics on the retail side of North America?

It doesn't sound like it's impacting the business all that much based on the growth rates the last couple of quarters.

But I wouldn't mind hearing what the win rate looks like from your perspective, and then how disciplined you guys have been from your perspective, as well.

Look, I don't think we're necessarily calling out specific win rates.

I'm not sure we've done that in the past.

But I think what we can talk about, and what we have talked about, is that we had a fair number of line reviews in the year.

Certainly, in the first half of the year, the environment got very competitive.

We continued to see a high volume of line reviews throughout the balance of the year, although they have started to moderate in the second half of the year.

And I think all we're pointing out is that we had a historically high number of line reviews, which drove pricing down in some cases, as we tried to capture market share.

So, broadly, I think that we believe that many of those line reviews are behind us.

We think that the environment continues to be tough but we have come out of it, I think, in a way that allows us to continue to be competitive but at the same time maintain discipline moving forward.

Retail continues to be tough on the wholesale side.

I think we've been very balanced in our approach, both in pricing.

In some cases, we continue to try to continue to capture market share with price; in other cases we've been able to hold price.

And, certainly, we've been fortunate that on the lead-free side we've been able to hold price consistent with our expectations.

And so, we've really tried to be very balanced about that.

And then, on the rebate side of the equation, any sense some of that was pull forward in demand?

And you got a pretty healthy outlook for North America growth into 2014.

So, I suspect you're saying not a lot but just curious.

No, none of that was necessarily related to pull forward in demand.

It was really more the basis of historical growth trends and then, obviously, the inflection point in growth that we saw in the fourth quarter.

Thank you.

Appreciate the time.

Jeff Hammond, KeyBanc Capital Markets.

Good morning, guys.

Just to walk through -- so the 5.9 lead free doesn't repeat, the $3.5 million of product liability doesn't repeat.

The rebate true-up, I guess you would have rebates next year, it would just be more smooth?

Yes.

The rebate does not affect the year.

We only called out for the quarter.

Okay.

And then, it looks like you're going to get $3 million or so of incremental savings in Europe from your first plant.

The other one's a push.

So, if we pull all those out, how should we think about maybe, one, a normal incremental, outside of those moving pieces; and then, two, any other headwinds to think about that would temper some of the margin expansion?

We still think that if there was a concern -- to answer your first question -- if there's any incremental headwinds that at least we're certainly thinking about, and I think it's exactly what we said, which is Europe.

I think that, while we're obviously all very hopeful, I think we've learned lessons about being overly optimistic with regard to any recovery.

There's news out today, as a matter fact, that I think is rattling markets a little bit.

I think it's a tenuous recovery.

I think it's fragile but, obviously, we're hopeful.

So, I think that's the one area that we're flagging with regard to concerns.

I think the numbers as you laid them out are exactly how we think about it in terms of normalizing margins for Americas and on a consolidated basis.

So I think you got the numbers right.

Okay.

And then, just real quick, what do you think of price in the 6 to 9?

And maybe just update us on the CEO search and when you think you'd have an announcement there.

What I'll say on the 6 to 9 normal pricing environment, as we've expected, I think things will continue to be competitive.

But we do see, again, healthy end markets and that should be positive for price overall.

And in that number, I think as I mentioned, there's about 1% to 1.5% of lead-free pricing in there.

Okay.

And CEO search?

CEO search, it's underway.

The committee is active.

And I think, as we've announced, it's a 4- to 6-month process.

Okay, thanks.

Kevin Maczka, BB&T Capital Markets.

Dean, it looks like lead free for the most part has played out about like you thought it would.

I'm just wondering, I know we're early in the new year, but have you been able to see any signs of any share opportunity actually materializing there?

No, not specifically that I would call out, Kevin.

Our focus has been to get the capacity in that foundry up to our own expectations, to normalize our production flows, to make sure we've got good harmonized delivery flows, both with our supply chain and with our distribution centers.

And then, obviously, ensuring that we continue to drive efficiency in the foundry.

We've been very much internally focused for now, as we get through this transition.

And, obviously, as we move forward and we get our production ramped up, we can have more thoughts on any incremental volume coming from third parties or otherwise.

Okay.

Now that we're beyond that, that was such a big initiative throughout most of 2013, you've made some strides elsewhere on productivity and cost and things like that.

I'm just wondering, to the extent that any focus was diverted away from those other things because lead free was so big in 2013, is there an even bigger productivity opportunity now, away from the restructuring that you've called out, as we look at 2014 and beyond?

I think there is.

I think you've heard us talk about -- and I think the quote is -- building up of the muscularity of the organization around lead free, both in terms of engineering capability, supply-chain capability, our manufacturing capability.

And our thinking was, as we wind down lead free, we would obviously divert those resources -- lift and shift, as I like to say -- towards enhanced productivity, enhanced supply-chain efficiencies.

And, in fact, we have a number of initiatives underway to incrementally drive productivity to other places other than what we talked about in Europe.

So, it's perfectly consistent with some of the things that we've talked about in leveraging those resources to drive more productivity across the Americas, and obviously in support of what we're doing in Europe.

Okay.

And I may have missed it but, because of all of that, is it still fair to think about a 30%-plus incremental margin on the 6 to 9 in North America?

Absolutely.

It's a great call out.

Yes, we're still in the 30% to 35% incremental flow-through.

Okay, great.

Thank you.

David Rose, Wedbush Securities.

I was wondering if you could go into the incremental cost for lead free.

I think you called out $1 million in the last quarter, and it was $1.4 million.

Is there anything operationally that stood out?

No, David.

I think it was exactly as we called it.

Obviously, through a transition like this you don't have perfect clarity on what's on the horizon and what costs may come up.

I think the one thing that we're clear about is that we see, and we have seen that, through this process -- consistent improvement, both in terms of capacity, flow rates, production efficiencies.

It's not where we want it to be yet.

Obviously, we went through a lot in the year.

But consistent improvement is certainly one of the key things that we look for, and we saw that through the fourth quarter.

Okay.

And to be clear on Q1, we're not going to hear anything about lead free.

That's what we're hoping

Okay.

And then, as we look at Asia, is the product-mix impact a trend or is it just a one-off event?

I think it's a one-off event.

I don't see it necessarily a full-year trend there, or multi-year.

Okay, great.

And then, lastly, if you could, on the European transformation, can you provide us a little bit more color in terms of the specific buckets -- how we're going to be looking at the $18 million in annual savings, how much of it is from severance, how much is it from materials and maybe back office?

I wish I could, David.

I think it's still very much in the planning stages and we haven't finalized all of that quite yet.

What we want to do is update you on a quarterly basis as we develop our plans further.

So, I'm not prepared to break that out, at this point, beyond what we've already communicated.

Okay.

I may have missed it.

Could you repeat where we're starting to see the biggest costs incurred, then, as we get through the year, in which quarters?

We haven't broken it up by quarter.

We did call out --

I can give you halves, David.

It's about $9 million of nonrecurring costs in 2014.

And, on a half-to-half basis, it's about 50/50.

Okay, thanks, Tim.

Thanks, gentlemen.

I appreciate it.

Joe Giordano with Cowen.

Just a quick question on the growth rate for revenue in the Americas.

Is that predicated on that 19% Dodge estimate for new starts?

Not necessarily.

If you look at our business, I think the mix of our business between new residential and repair/replace, we're much more weighted on the repair/replace side of [share hold], and not necessarily on the starts.

But obviously starts are a leading indicator for the overall health of the industry, so we obviously look at that very closely.

But more is, like, when you're coming up with a number, is that something that's almost plugged into the way you're looking at it?

Or is that just for our benefit to see what others are thinking in terms of the market?

Like, if that came in at 10%, for example, would you guys be basing it on 19% and then have to shift towards 10%?

Or are you using a more conservative number internally when you're coming out with your growth expectation?

I can answer the question this way.

They're not directly linked in terms of how we look at our growth.

And, secondly, but they are a key indicator of how we view the end markets.

And so, as we see changes in the health of the general construction market, obviously, we evaluate our business on the same level.

Okay.

And then, one last thing.

I think David might have hinted at this.

In terms of lead free, I know you said it's substantially behind you at this point, but is there anything left to get over?

Is there any potential -- what would you say the potential for leakage is into 2014?

It's a complex foundry with a lot of technology.

We look at the conversion costs very discretely as isolated to exactly the conversion.

But it is always possible that we continue to have productivity issues.

It's always possible that you have issues with supply chain or material cost increases, or any of the things that any normal foundry has to deal with, given the level of complexity we have there.

So, I think what we're calling out is that the discrete items related to the transition are behind us.

And we're continuing to ramp up our production and our efficiencies in the foundry on a go-forward basis.

So, there's nothing you'd call out on the efficiency side that made up that $1.4 million that stood out, any one aspect?

No.

I think it was very much similar to what we saw earlier in the year.

Okay.

Great.

Thanks, guys.

Kevin Bennett, Sterne Agee.

First off, on the non-residential market here in the US, I know we're hoping for some decent growth this year.

Can you guys dig a little deeper on what you're currently seeing?

And then maybe talk about what areas within that may be stronger than others and what may be weaker.

From a residential perspective, as I mentioned earlier, we're encouraged by the housing starts data.

We're encouraged by the overall momentum that we see in new construction.

We're encouraged by the LIRA information, which obviously points to what's more closely correlated to our growth rates, which is the repair/replace end markets, which is expected to be up about 11% next year.

From our perspective, it is about the health of the repair/remodel market, the health of the overall new construction market.

Where the opportunity lies is, as those markets get healthier, obviously small commercial, multi-family, the broader commercial verticals like hospitality and office space, also have a pull-on effect.

And that's where we see, really, the incremental opportunity in the second half of the year.

Okay, thanks.

And then, in terms of inventories in the channel, how are you feeling about those right now?

If demand has increased, and our fulfillment performance continues to improve, we had very solid fulfillment performance in the second half of the year, despite what we were going through on lead free.

We think we're fairly well balanced and we feel like we're meeting customer requirements.

At the same time, we're getting a lot more efficient on our inventory.

We obviously had to invest significantly, both in leaded and lead-free inventory, as buffer stock through the conversion.

But we think that we're getting back on track at levels that we think are normalized.

Got it.

Thanks for that, Dean.

And then, two more quick ones.

First, on the buyback, should we think about that $40 million being evenly spaced throughout the year, $10 million a quarter?

Are we going to be opportunistic?

Or how should we think about that in 2014?

Right now, Kevin, I would think about it at $10 million a quarter.

Okay, perfect.

Thanks, Tim.

And then, last question for me, on the M&A pipeline, can you just, Dean, talk about what you're seeing?

Is there anything close, or anything you can talk about?

No.

Nothing close.

All right.

(laughter)

We're seeing a lot of opportunities out there but nothing imminent.

Obviously we're working through a number of priorities here internally.

We're keeping a very healthy pipeline, and an active pipeline, but nothing imminent.

Got it.

Thanks, guys.

Appreciate it.

(Operator Instructions)

Jim Giannakouros, Oppenheimer.

As far as if you can give us any update on the timeline for achieving your previously stated 12% operating margin goal.

I know that it was formerly in the out years.

But just given the improved visibility you're getting to leverage opportunities in North America, and, obviously your cost takeout in Europe, any update there would be great.

Jim, I would be loath to call out a specific date because we hadn't done that in the past.

I think what we've talked about is in the next 2 to 3 years.

Probably closer to the 2 years, but I think the range we've talked about is 2 to 3 years, and I don't think there's a big change in that.

Okay, fair.

And I apologize if I missed it, but when you were talking about your sales rationalization in Europe, does that have more to do with duplicative SKUs in certain geographies, or just low performers?

Can you give us some specifics around where you're culling your offerings?

Yes.

Obviously, it's difficult for us to get into the specifics on that, given the early stages we are in the program.

But it is a top-to-bottom comprehensive assessment of SKUs, products, categories, and the discrete margin profiles across those categories.

And then, obviously, taking a rationalization view of -- Do we keep it, do we sell it, do we increase pricing, how do we rationalize across that portfolio to ensure that we've got the optimal product mix with the optimal margin profile that we're targeting?

Over the years, one of the issues -- if you think about the acquisitions and the integration of acquisitions over the years, there's just a lot of components, a lot of SKUs that generate low or, in many cases, no margin whatsoever.

And so, that's all a part of this effort to better integrate as we leverage our pan-European capabilities, as we try to leverage more cross selling.

Rationalizing SKUs is just a good way to effect those initiatives, but also to expand margins.

Understood.

Thank you.

At this time we have no further questions.

I would now like to turn the call back over to Mr. Dean Freeman for any closing remarks.

Okay.

Thanks, everybody.

I know that was a lot to cover.

I appreciate your interest.

Thanks for the time.

Thank you for your continued interest in Watts and we look forward to talking to you again on the first-quarter earnings call in late April.

Thanks, everybody.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect.

Have a great day.