Watts Water Technologies Inc (WTS) 2014 Q4 法說會逐字稿

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

My name is Corrinne, and I will be your event manager for today.

(Operator Instructions)

Just as a reminder, the call is being recorded for replay purposes.

I have a Safe Harbor which the Company has asked me to read out to you.

Please be aware that remarks made during today's conference 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 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 ending December 31, 2013, 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 views only as of today and should not be relied upon as representing its views of any future date.

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

During the call the speakers may referred to non-GAAP financial measures.

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

A consolidation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release dated Tuesday, February 17, 2015, relating to the Company's fourth-quarter 2014 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 of press releases.

Now I would like to hand over to Tim MacPhee, the Treasurer and Vice President of Investor Relations.

Please go ahead, sir.

Thank you, Corrinne.

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

Joining me today is Bob Pagano, our President and CEO; Ken Lepage, our General Counsel; and Ken Korotkin, our Corporate Controller and Chief Accounting Officer.

Bob will begin by providing an overview of year and provide color on the current market conditions.

I will then discuss the financial results for both the full year and the fourth quarter.

I will also update you on EMEA's transformation restructuring efforts.

Bob will then provide an overview of our expected Phase 1 actions regarding the Americas and Asia-Pacific transformation project, and I will offer an initial outlook for 2015, highlighting some financial items to consider for this year.

Bob will summarize, and then we will open up the call to our questions.

Let me turn the call over to Bob Pagano.

Thanks, Tim, and good morning, everyone.

Turning to slide 3 in the deck, let me briefly provide an overview of this past year's performance.

First, I want to recognize that in 2014 Watts celebrated its 140th anniversary, quite an accomplishment.

I believe the Company's longevity is principally due to its people, customer focus, and history of innovation.

Those foundations will remain a cornerstone of our efforts as we move ahead for the next 140 years.

In 2014, we delivered record sales of just over $1.5 billion and record adjusted EPS, which was up 14% versus 2013 on a comparable basis excluding the AERCO acquisition.

Our adjust operating margins expanded by 70 basis points again on comparable basis, and the team delivered strong free cash flow which exceeded 2013 by 21%.

This was accomplished despite a second half sales declined in EMEA, driven by macro market forces, continuing pricing pressures both in Europe and in the Americas' DIY channel, and continued inefficiencies encountered in our lead-free foundry.

The lead-free foundry did begin to stabilize in the second half of 2014 as we've got a better handle on the many potential manufacturing variables that could affect this unique foundry operation.

We continue to execute on our various restructuring and transformation initiatives in EMEA which help to offset a broad sales reduction during the year.

The cost savings realized by these actions and efforts helped expand adjusted EMEA operating margins despite a difficult market environment.

Our EMEA team has been extremely proactive in driving for results.

In response to the recent market conditions, the team has initiated additional restructuring programs to better match our internal cost base with the external market environment.

Tim will provide more details on those initiatives in a few minutes.

As we've alluded to in our prior calls, we wanted to emulate the success of our EMEA transformation efforts in the Americas as well.

Much of the data analysis is completed, and we are now in a position to start implementing the Americas transformation plan.

This plan also affects our Asia-Pacific operations because of captive production and sourcing initiatives undertaken for the Americas.

I'll provide the highlights of this important effort in a few moments.

Finally, in 2014, we maintained a balanced capital deployment strategy.

From a shareholder perspective, we increased the dividend payout by 16% and continued executing our share repurchase program, buying back almost $40 million in our class A common stock during the year.

In December, we purchased the shares of AERCO to expand our offering to include heat sourced products, a key platform adjacency to our existing portfolio.

With respect to AERCO, integration is going very well.

We have been very pleased with the way the teams are working together.

It still very early, but all indications are very positive.

Moving to the markets, let's turn to slide 4. Let's begin with the Americas.

In general the economy looks strong.

Consumer sentiment is high, and key indicators we look at for residential like Wells Fargo data on housing starts and building sentiment look encouraging.

On the commercial side, we see positive trends in the Dodge Momentum Index, ABI, and lending activity.

In total, we saw solid growth in the Americas in 2014, and we believe this trend will continue in 2015.

Now let's turn our attention to the EMEA markets.

As we noted in our Q3 conference call we saw the markets within Europe take a step backwards, and that trend continued during the fourth quarter as well.

Although 2014 euro zone GDP is forecasted to be positive for the first time in several years, we saw further contraction in France in the construction markets and market instabilities that affected our OEM HVAC customers in Germany, where we still are seeing wholesalers and OEMs sitting on excess inventories.

The signs continued to be mixed into 2015.

Quantitative easing may help stimulate incremental activity, but instabilities in Greece, continued tensions in the Ukraine, sanctions on Russia, and falling energy prices make forecasting difficult.

We believe EMEA emerging markets will continue to be a good source of growth, as infrastructure investment in the Middle East and Eastern Europe continue to grow.

For the full year, emerging markets were down slightly with prior year driven by the softness in the Middle East and Eastern Europe.

Eastern Europe is driven by political unrest.

The Middle East is project driven, so we normally will experience lumpy growth quarter over quarter.

With recent oil and currency swings we believe there could be an impact on the project funding and the expected timing of those projects in the Middle East.

Finally, let's discuss Asia-Pacific.

We had strong growth in Asia-Pacific, albeit from a relatively small base.

This growth was through channel and territory expansion in China despite some significant headwinds in the housing market.

As everyone has observed, while China's economy has been slowing it still remains one of the most active economies in the world.

Most concerning from our standpoint is that the housing market in China appears to be contracting with both home values in new housing projects declining.

Despite the subdued macroenvironment, our market strategy has not changed.

We continue to see demand in China for our localize products, and our more highly engineered European and US manufactured products.

In addition, we see continued growth in Tier 2 cities especially in key verticals such as hotels, office space, and data centers.

We also see the heating market which for us is about 70% retrofit doing well.

Now, I'll turn it over to Tim to talk about our operating results in more detail.

Tim?

Thanks, Bob.

Moving to the financial highlights for the year, please turn to slide 5.

As Bob mentioned, consolidated revenue for the year was $1.5 billion, an increase of 2.7% over 2013.

Organic growth was 2.6% with increases in the Americas and Asia-Pacific being partially offset by a reduction in EMEA.

The effect of FX on sales year-on-year was negligible.

AERCO sales which represent only the month of December were $5.3 million.

December is seasonally a very slow period for AERCO so the December sales result does not represent a good gauge for AERCO yearly sales.

Adjusted operating profit for 2014 on a comparable basis excluding the AERCO acquisition was $153.6 million, a $13.4 million increase or 9.6% over 2013.

Adjusted operating margin again excluding the AERCO with 10.2% for 2014, a 70 basis point improvement over last year.

The Americas' operating margin increased 110 basis points on solid offering leverage from incremental sales, some net wholesale pricing, and cost containment actions.

EMEA's margins expanded 70 basis points over 2013 from savings derived from its continued transformation restructuring efforts.

Corporate costs increase during the year by $2.2 million as both people related cost, compliance, and professional fees increased year-over-year.

Incremental increases in foundry costs in 2014 were mostly offset by a reduction in product liability expenses year-over-year.

Adjusted EPS excluding AERCO for the full year 2014 was $2.52, a record, and an increase of about 14% over 2013.

The effect of the share repurchase program and the effect of FX essentially offset one another during the year.

GAAP earnings for the year included approximately $48 million in restructuring special items that reduced GAAP EPS by $1.09.

The details are highlighted highlight in Table 1 of our press release.

The bigger items include restructuring cost in EMEA, in the Americas relating to both new and legacy actions, and a $12.9 million goodwill write-off in Asia-Pacific that was triggered by the expected impact of the transformation exercise.

Please note that we cannot provide a tax benefit against goodwill charge, and it's part of the reason for the higher tax rate recorded in 2014 versus last year on a GAAP basis.

Also last year, the effective tax rate was reduced by a positive change in Denmark's statutory tax rate.

Turning to slide 6, let's review some of the highlights for the fourth quarter.

Revenue was $376.5 million, essentially flat with Q4 of 2013.

Organic growth was 2% with increases in the Americas and Asia-Pacific being substantially offset by a reduction in EMEA.

FX was negative as compared to Q4 last year by 3.2%, and AERCO acquisition was a positive 1.3% for sales.

In the Americas, quarterly wholesale sales were up 7.5%, OEM was up about 16%, and DIY was down 3.7% as compared to Q4 last year.

In EMEA, wholesale edged up 1.7% but was more than offset by an OEM decline of 12.8%.

Asia-Pacific sales were driven by valve and heating product sales.

Adjusted operating profit for 2014 for the fourth quarter excluding the AERCO acquisition was $35.5 million, a decrease of 3.3% versus last year.

Our consolidated adjusted operating margin of 9.6% was 20 basis points lower than Q4 last year.

EMEA's operating margin dropped 100 basis points to 10.1% mainly on the reduction sales volume quarter on quarter from some incremental bad debts.

The Americas' operating margin excluding AERCO expanded 100 basis points to 12.6% against Q4 2013.

Recall we had $3 million rebate charge in Q4 2013 adjusted results last year.

Excluding the rebates, Americas' operating margins would have declined quarter-on-quarter by approximately 10 basis points.

This lower margin was driven by lower plant absorption as we drove inventories down in Q4 where inventories, where actually increasing in Q4 last year, and from incremental E&O, excess and obsolete inventory charges.

Corporate costs also increased quarter over quarter.

Adjusted EPS excluding AERCO was $0.59 in Q4, a $0.02 or 3.5% increase over Q4 2013.

Foreign exchange was a $0.03 headwind this quarter related to the strengthening of US dollar against both euro and the Canadian dollar.

Our adjusted tax rate was favorable in the quarter as this included benefits from the EMEA transformation along with positive one-off benefit.

In last year, the effective tax rate included some one-off charges for a tax law change in France and various negative corporate provision adjustments.

GAAP earnings in Q4 included $34.6 million in restructuring cost and other special items which equates to $0.80 in EPS.

Again, the details of these items are highlighted in Table 1 of our press release.

The bigger items in the quarter included restructuring cost in EMEA relating mainly to a new set of initiatives that I'll discuss shortly and $12.9 million goodwill write-off in Asia-Pacific.

As mentioned, we cannot provide a tax benefit against the goodwill charge, so that is why on a GAAP basis the tax charge has been recorded despite having a pretax loss in Q4.

Slide 7 provides a snapshot of our primary working capitals compared to last year.

Please note that 2014 balances exclude AERCO to provide a comparable analysis.

Working capital as a percent of sales has decreased, and primary networking capital is down in 2014 due to better collection efforts and a concerted effort in Q4 to reduce inventories in both the Americas and Europe.

Payables decreased as a result of the inventory reductions and timing related to the purchases and CapEx.

FX fluctuations decreased net primary working capital by about $19 million year-over-year.

Now on slide 8, a few points on cash flows for the year.

First, free cash flow was approximately $112 million, a 21% increase over last year driven by lower working capital and reduce capital spending.

This translated into a free cash flow conversion rate of 222.2% for 2014.

Secondly, we repurchased $39.6 million of our common stock in the open market during the year, about 670,000 shares were repurchased.

This repurchase spend is in line with our current program.

The net effect of the share buyback program was minimal for the year.

As Bob mentioned we increased our dividend payout by 15% year-over-year as part of our capital allocation strategy.

Finally, if you move to slide 9 let me update you on our transformation and restructuring initiatives in EMEA.

For the ongoing transformation and restructuring efforts both are moving ahead as planned.

2014 savings of $4 million for the restructuring plan are in line with the expectations and all costs are now fully spent.

The transformation net savings increased about a million dollars in 2014 for accelerated tax savings that were realize.

Forecasted net savings in 2015 for both programs have been reduced by a total of $2.2 million mostly related to a weaker euro.

Recently the EMEA team proactively initiated a series of cost saving measures to address the current market environment.

Total cost for the 2015 programs will approximate $12.1 million, of which about $10.7 million are P&L charges and $1.4 million will be for capital spend.

The P&L charge includes $9 million for expected severances, and the remainder for non-cash asset impairment charges and accelerated depreciation.

When completed, the program will save approximately $4.7 million annually.

That will be in 2016.

For 2015, the savings are estimated to be about $1.2 million.

These initiatives are broad-based across Europe.

The savings is smaller this year because of the expected time required to coordinate and vet the plans with local worker councils and government agencies.

For GAAP purposes in Q4 2014 we took a $7.8 million restructuring charge for these programs mainly related to severance cost.

With that, I'll turn back over to Bob.

Thanks, Tim.

Turning to slide 10, I want to update you on the Americas and Asia-Pacific transformation effort.

As I conveyed during our last call, in September we began an assessment of our Americas business platform in order to explore different commercial and operational improvements that could be made to drive both near-term and long-term shareholder value.

This process was similar to the efforts we undertook in our EMEA transformation initiative last year.

Based on our assessment, we have now developed an action plan which will be executed in two phases.

The first phase will focus on driving both commercial excellence and global sourcing.

Phase 2 involves a broader review of our existing operational footprint in the Americas.

We are finalizing the data related to Phase 2 and will update you at our Q1 earnings call.

Recall by commercial excellence I mean we want to invest in product innovations that meets the wants and needs of our customers and our end markets.

We want to focus on differentiated products that will provide greater opportunities for us to distinguish ourselves in the marketplace and migrate away from products that we cannot add value to, and we want to strive to be a solutions provider, not merely a component supplier.

As part of the assessment, we performed an exhaustive review of our existing Americas product portfolio.

Based on that review, we have commenced a portfolio rationalization effort focused on removing products that are not considered value added by the markets, and in turn do not add value to our operating margins.

Our retail customers will be most affected by this effort.

We certainly will work with all our affected customers to ensure a smooth transition.

Given that we are just announcing this decision today, I'm not going to go into the finite details of our plans as we are now in the process of discussing this decision with our customers and our employees that are affected.

As we transition from this business, we are reviewing different strategic alternatives to minimize disruption to all of those involved.

In addition, we initiated an incremental Americas sourcing program to drive efficiencies in our supply chain.

Included in the initiative was a comprehensive review of our existing processes and resources.

The team reviewed many of our existing programs and made recommendations for purchase decisions ranging from castings to machine parts to filtration products.

On slide 11, you'll find the summary of the expected financial impact of Phase 1. We expect that between $175 million to $200 million of low margin product sales will be eliminated from our portfolio by the end of 2016.

We've already rationalized approximately $23 million in annualized sales to date, and we expect by the end of 2015 between $80 million to $100 million in sales will have been eliminated from our 2014 run rates.

We then expect an incremental $75 million to $120 million of sales will be eliminated in 2016.

Regionally, most of these sales reductions will affect the Americas.

These estimates represent our best estimate right now, and the timing of the lost sales certainly can and likely will be affected by how customers react to the news and how quickly they are able to transition.

One thing to bear in mind, the legacy fixed cost supporting these sales would take time to remove, especially since we expect to support customers through this year.

For 2015, we anticipate that losses generated from the sales reduction will be higher due to the lag in eliminating related fixed cost.

We estimate that the losses from existing sales for 2015 will drop through at between 15% and 20% of sales.

We anticipate that in 2016 that loss dropped through will be less in the mid-single digit range.

We will have exited the majority of those remaining costs by the end of 2015.

Total cost expected to be incurred regarding Phase 1 will approximate $40 million to $50 million.

Cash costs which includes severances and other transitional cost are estimated at $15 million to $20 million.

Non-cash costs which include asset impairments, accelerated depreciation, and write-downs are expected to total approximately $25 million to $30 million.

We recognized $13.4 million in Q4 for the write-down of goodwill and other intangible impairments related to the transformation.

The remainder of the cost both cash and non-cash are expected to be incurred in 2015.

All of these cost will be identified as special items when we report future results.

Global sourcing initiatives are expected to provide about $4 million in incremental savings in 2015, and incremental $4 million in 2016, and ultimately provide $10.5 million in run rate savings by 2017.

Hard savings related to the product rationalization effort is minimal.

The real effect of the rationalization exercise should change the margin profile of our businesses, helping to expand our margins by allowing our teams to focus on core products and solutions where we can bring the most value to the marketplace.

We estimate our efforts in Phase 1 by itself should expand our consolidated operating margins in 2017 by approximately 150 basis points over 2014's adjusted operating margins of 10.2%.

We expect to realize approximately 100 basis point expansion on a consolidated basis by 2016 again over 2014 consolidated adjusted margins.

Near-term, we anticipate 2015 will be a transition year.

Our expectation is that any Phase 1 product mix benefit and sourcing savings will be significantly offset by incremental costs to help to transition customers and inefficiencies in both manufacturing and distribution fixed cost.

The Phase 1 decision was critical in our overall transformation efforts.

Now that we know the businesses we're staying in, we can now move into Phase 2 which will allow us to optimize our future footprint.

I'd like to now turn it back over to Tim to give you an overview of how we see 2015 shaping up.

Thanks, Bob.

Now if you turn to slide 12, let me give you an overview of how we see 2015 going.

Looking at sales, we expect organic growth in the Americas of between 4% and 6% over 2014, excluding AERCO, and excluding the effects of the sales of the transformation effort and potential negative FX related to the Canadian dollar.

At this point we estimate the Canadian dollar will negatively impact overall Americas' sales between 0.05% to 1% year-over-year.

In EMEA, where the markets are much more uncertain, we estimate organic reduction of sales year-over-year between 1% and 3%.

We're conservatively planning for our markets to be down 1% to 3% overall, and we're also assuming approximately a 1% sales reduction due to product rationalization efforts.

With the introduction of some new products, cross-selling efforts and the expansion of our drain platform, we expect to [wash out] the rationalization effect.

From a [phase-in] perspective, we expect tougher sales comps in EMEA in half-one 2015, as half-one last year was fairly strong for the region.

In Asia-Pacific, we are expecting organic top line growth of around 20% excluding the effect of any transformation exercise.

We expect AERCO sales to increase by 10% from its 2014 run rate of approximately $100 million.

Note that AERCO's Q1 and Q4 are typically slower periods.

In fact, AERCO typically earns about 80% of its profits during the second and third quarters of year.

Please keep that in mind when you're adjusting your models.

To reiterate we anticipate eliminating between $80 million and $100 million in sales over this year as part of the transformation effort, and as Bob mentioned, we have already exited $23 million of the $80 million to $100 million in sales, all related to the Americas segment with operational impacts to Asia-Pacific.

So, that sales loss is already in the Q1 run rate of the business.

Other items to consider, FX will negatively impact our 2015 operating results.

Our current estimate is EPS will be impacted between $0.25 and $0.30, including both translation and estimated transaction costs.

Our analysis assumes current market foreign exchange rates and also assumes that those rates hold for the year.

As we have mentioned before, we estimate that every point -- that for every point movement in euro rates will affect our EPS by approximately $0.01.

We anticipate spending between $30 million and $35 million in capital in 2015, an increase over previous years which includes a broad upgrade of our existing equipment with a focus on improving productivity and supporting our strategy.

Depreciation and amortization charges are expected to be between $55 million and $60 million.

We expect our global tax rate for 2015 will be between 31% and 33% similar to 2014.

We expect tax savings from EMEA's transformation process will be offset by the mix in global earnings weighted toward the US which is a higher tax jurisdiction.

During our last call, we discussed some expected incremental costs to start compensation, pension, and bonuses that could be headwind in 2015.

Having recently completed our 2015 operating plans, we have finalized those costs.

Recall we had identified about $11 million of incremental costs to our 2014 run rate.

We have refined that number to about $13 million which includes the three components previously discussed, plus some additional recruiting, relocating, and compliance cost we need to undertake in the first half of 2015, related to the hiring of the new CFO and to meet he latest COSO and SOX requirements.

We are finalizing our CFO search process and hope to have someone on board within the next two months.

We anticipate completing our existing share repurchase program through the third quarter of 2015.

We will update our expectations about further repurchases during the Q1 conference call.

Interest expense on the AERCO acquisition debt will approximate $5.5 million to $6 million for the full year, and we hope to settle our pension liability during the latter half of 2015.

The gating factor is the final IRS approval.

Once approval is received, we have up to 120 days to liquidate our obligations.

We estimate that we will incur a one-time special P&L charge of between $55 million and $65 million with estimated cash costs of $40 million to $45 million.

Our best guess now is that we will recognize the accounting charge and related cash expenditures in Q4.

Timing could be accelerated or delayed.

It depends on when the IRS provides its approval.

Takeaway is we expect 2015 to be another good year.

However, it will be a transition year especially from a reporting perspective.

With the announcement of the Americas' transformation effort, 2015 quarterly results may fluctuate significantly.

The rate at which we lose the undifferentiated sales is intrinsically tied to the affected customers' ability to transition to other suppliers.

As Bob mentioned the net margin effect in 2015 on the product mix enhancement and sourcing savings would more than offset by stranded costs related to the transitioning out of these products.

Let me turn the call to Bob, who will provide his summary.

Thanks again, Tim.

To summarize, we were able to deliver a solid year-over-year performance.

We did this through increased sales volumes in the Americas and cost savings driven by the various initiatives in EMEA and general operating cost controls.

We completed a strategic acquisition by purchasing AERCO, which provides us a new avenue for growth and expansion.

The foundry operations started to stabilize in a second half of 2014.

Delivering a solid year is only the start.

We want to expand our product offerings, be innovative in the marketplace, and drive operational efficiencies throughout our organization.

Our key next focus will be to execute on the Americas and Asia-Pacific business transformation program.

This will reshape our business, enhance our margin profile, and focus our efforts on our core value added products.

The actions we have taken and will take this year will serve to drive shareholder value by allowing us is to significantly improve operating margins and ROIC.

With that, operator, can you open the lines for questions?

(Operator Instructions)

Kevin Maczka, BB&T Capital Markets.

Thanks.

Good morning.

Good morning.

Can ask a couple questions on this sales elimination?

I guess first question is you're going to do $80 million to $100 million this year.

Did you say you will be at that full run rate in Q1, or is this something that gets phased in over the course of the year, and it is more back-end weighted?

I think it's going to be phased throughout the year.

What we did say is of that run rate we know that we've already rationalize $23 million of that already.

Okay.

Then I would assume that these are lower margin products that you don't make much if any money on, but I think I heard you say expect a 15% to 20% decremental on those sales which would meet this is about a $0.30 or so earnings hit this year.

Can you just talk about why those decrementals would be as much as 20%?

Sure.

You're right that it's low-margin business at start.

If we exited 100% of it immediately and all the cost associated with it, it would drop much less.

What's happening is because the timing of when we can we can shed the fixed costs as well as support our existing customers during that transition, it's dropping more at the gross profit level versus the operating income level.

It's going to impact us more, but the whole goal is to transition all the costs out by the end of this year.

That's why I said as you look into the following year in 2016, you're going to see less of an impact on the operating margin dropped.

Okay.

Got it.

Then just one on the Phase 1 Americas and Asia-Pac, is the $10.5 million savings, is that all coming on the sourcing side?

The sourcing benefits that you expect in 2015, the $4 million, it doesn't seem like a huge number for a Company with almost $1 billion cost of goods line.

I would think maybe things like lower copper alone could give you some pretty material savings next year.

Can you just address that point?

Yes, Kevin, so we look at sourcing in three buckets.

We have normal sourcing that's tied to commodity prices, and that's excluded from this decision.

We've also had a transformation effort in Europe that also has included sourcing, so you're correct.

We do have a large focus on global sourcing, but this initiative all by itself was to look at consolidating our capabilities and look at different sourcing.

It takes longer to implement.

We have all three of them built inside of our numbers, but this was incremental to what we've done in the past, and hopefully that answers your question.

Okay, great.

Thank you.

Thank you.

Jeff Hammond, KeyBanc Capital Markets.

Good morning, guys.

Good morning, Jeff.

Just a follow-on the sales transformation, why not sell the business versus exit?

It looks like, just going through the math, you're losing $15 million in op profit as you transition out.

How do you see yourself replacing that through other means?

We've looked at all alternatives, and we are continuing to look at it.

It is a low-margin business, and when you look over the history, we looked for the last five years, and what we've seen in this business in margins continues to deteriorate.

We made the strategic decision to take the action now.

We'll look at all alternatives, but given the disparity of the business, and all the different locations, we believe that may be difficult to do that.

We may be selling assets at that point in time, Jeff.

When we look at replacing that, certainly through acquisition such as AERCO, as well as really focusing the team internally on organic developments and leveraging our talent to look on creating our own differentiated products which was really the core of our business.

We'll continue to do that, but now is the time to exit this business where we can take control of it, make the decisions, and drive the changes in our organization.

As I said, it was critical for us to make the strategic decision on which businesses we wanted to be in because once you do that you then can now begin optimizing your footprint and distribution channels.

Okay.

Great.

Then just on FX, I'm struggling a little bit with the drop-through, the earnings impact.

Can you walk through what you think the revenue headwind is, and then maybe how to think about translation versus transaction?

Yes, sure.

The way we're looking at it, Jeff, is from an EPS perspective, maybe it is an easy way to look at it, is with the euro right now we think we have about a $0.20 headwind.

That's the difference between the current rate that I use was about them $1.14 versus our average rate in 2014 was about $1.34.

To us, as we mentioned before, that's about for every 1 point move in the rate, it's about $0.01 to us in EPS.

That's about $0.20 on the euro.

It is probably another $0.03 to $0.04 related to the Canadian dollar year-over-year.

Finally, within the $0.25 to $0.30 is transaction effect year-over-year.

We think we will have some transaction effect to the tune of a few pennies year-over-year.

That's why we're in the $0.25 to $0.30 range from an EPS perspective.

What do you think is the FX revenue headwind, all in?

Probably from a percentage perspective probably 13%, 14%, year-over-year.

On the euro?

On the Europe business?

Yes, on the Europe business.

Okay.

Then just finally back to Kevin's question on sourcing, can you just maybe, Bob, let us know what all-in, as you look at the three ways you've gone after sourcing, what the total savings is, where as you incorporate this new $10.5 million piece?

Thanks.

All in, we don't give specifics in total by each commodity and every item because it's a net cost number.

One of the things I will tell you though that from a copper perspective, we are seeing favorability there especially in the Americas offset by steel a little bit.

The unique thing of copper inside of our EMEA it's actually a slight headwind in that the copper commodity is done in US dollars.

Copper's come down but the euro has come down even further, so it is actually a small headwind for them.

When you look at overall, we shoot for world-class purchasing savings inside our organization.

That's what our teams are driving for, and we'll continue to drive for those gross costs savings offset by the net inflation.

Okay.

Thanks, guys.

Thanks.

Joe Giordano, Cowen.

Hi, guys.

Thanks for taking my question.

Just one quick clarification on when you said on euro, is it every $0.01 of euro decline is $0.01 of EPS, or 1% decline is a penny of EPS?

Every $0.01 of euro decline is $0.01 to our EPS.

Okay, that's what I thought.

Great.

Then can you guys talk a little bit about management bandwidth to handle?

There's like four programs going on now.

You're looking for a full time CFO.

How do you guys look at handling everything that's on the plate right now?

Joe, we look at that before we start any initiative.

The EMEA team is well staffed to handle their transition and transformation.

We have strong project management capabilities.

We even relocated the project management, PMO, officer from EMEA to lead our North America efforts.

We're bringing outside help where we need it, but we believe we're fully staffed to do this.

We have brought in a new supply chain person on board.

He's been on for almost a year now, and he's developing new team to implement our global sourcing initiatives all around the world.

Finally, on the CFO search as Tim alluded to we're real close to finalizing our search.

We hope to have someone an on board in the next couple of months, and I think you guys will be pleased with the individual who we're thinking about, so stay tuned for that.

All in all, I feel confident in our ability to execute this.

Teams are focused.

They're all organized and deployed and ready to go, and we will bring outside help where we need to supplement that.

Right now, all the action plans are loaded, and we're ready to implement beginning at 11 AM today.

Okay, great.

Then two housekeeping ones, one is the $13 million in incremental spend, that's off that $35 million corporate number for 2014, right?

You have to spread that out.

About $6.5 million is corporate, Joe.

Another $5 million would be in the Americas, $1 million is in EMEA, and about $0.5 million is in Asia-Pacific.

Okay, great.

Then lastly for me you mentioned EMEA on the guidance or 1% to 3% of an organic decline.

Then I thought I heard you mention 1% of a rationalization also.

Is that a 1% rationalization decline on top of the 1% to 3% organic decline of the go-forward business?

Yes.

Offsetting that is our new product development and new innovations that have been launched.

Yes, the 2% off that.

That does it for me.

Thanks, guys.

Thank you.

David Rose, Wedbush Securities.

Good morning.

Just a couple housekeeping items, should we expect any inventory obsolescence going forward?

Did you have any write-down in Q4 for the product rationalization?

Should some of that go into 2015?

We had some small E&O write-offs inside of Q4.

I think Tim talked about that.

As we look in our overall rationalization approach, we've covered some feeling of some E&O inside of the numbers we provided.

Our goal is to sell all of it, as much as we can during the process, or sell it as part of a product or asset sale.

Okay.

That's helpful.

It sounds like we're pretty much finished on the foundry, but what are the remaining challenges you have left on the foundry, so we don't talk about it anymore?

I was hoping to get away again, another meeting without talking about the foundry.

I must tell you, the fourth quarter was our best performance of the year.

It stabilized.

I really think the next step of the foundry is really beginning to add volume and continue to drive future growth inside of there.

The teams are working.

Now that we stabilized the process which we've done for several months now, we have seen the steady improvement.

We can throw more volume inside of that and start leveraging it.

Again, we're doing it slowly and cautiously because we don't want to disrupt what we've already accomplished.

We've stabilized.

We have backup capabilities now in all our processes, and the team's moving slowly but surely.

I think that's what is going to take.

Any time we throw large volumes in it, it disrupts the process so we're slowly gearing it up, and that's what we will continue to do for the rest of year.

As far as we are concerned, that's a non-issue, let's hope at least, internally for us.

We are just focused on the continued improvement, more of a continuous improvement process.

Okay.

Then that's helpful.

Lastly, can I assume the byproduct of all this rationalization apart from the enhanced margins is better working capital?

That's all part of the whole structure.

The whole structure, again, as we move into Phase 2 that's another part of how we distribute our whole distribution strategy, and yes, inventory turns is a key focus of our initiatives as we drive and grow our ROIC.

Do you have a goal for us for 2015 or 2016 on that front?

Stay tuned because I really want to talk about Phase 2 and the impact of that on it.

Certainly, we have our stated goals that you're well aware of, 12% and 12%, 12% operating margin and 12% ROIC on an adjusted basis, but our goals are certainly north of that.

Okay, great.

I will stay tuned.

Thank you.

Jim Giannakouros, Oppenheimer.

Good morning.

Good morning, Jim.

Not to focus too much on the near-term earnings reset as you transition what appears to be from earlier retail exposure, I know you don't give guidance, Bob, but can you speak to your longer-term vision whether it be three- or five-year plan, as far as a sales margin earnings target?

Basically, I'm just trying to think about where you think the underlying earnings power of what you're trying to create at Watts will be appreciating of course that you've captured some of that in your Phase 1 detail?

Yes.

David just asked that question in a different way, but really we're a premier Company.

We're number one or two in most of the markets and brands we serve.

I believe we need to command a premier operating margin in our ROIC.

That's our focus.

That's our goal.

This is a critical step.

This business that we're exiting has been an anchor on us, and it's been slowly eroding.

It's really de-focused our organization on our core and what makes us great.

We want to refocus on that core.

I said our 12% operating margin goal that we talked about, we see that in the future very soon.

We believe we should have the opportunity to significantly increase that going forward.

It's real critical that we transform this portfolio.

We'll continue to look at doing and deploying our capital in a disciplined way and look for acquisitions such as AERCO that has as high EBITDA margins, and that's what we're focused on.

Okay, understood.

Just so I understand your Phase 2 correctly, that will be primarily or all on the expense side?

You've identified the sales impact predominantly in your Phase 1?

Is that the way to think about it?

Yes, Phase 1 is the sales and the product rationalization.

Phase 2 really gets in more about our footprint, what is the proper footprint now to serve the businesses we are in, and the proper distribution channels and strategies inside of that with our warehouses and distribution channels.

That's what the next step is.

Before you could make that decision, we had to make the first decision to determine what businesses we were going to be in.

Got it, okay.

One last one if I may, in Europe, you've been at it now for a couple years on the transformation.

I know many of the benefits there have been on the tax line with more to go.

Can you just give us an idea at this point where your tax rate is, in there region versus what I imagine is the mid to high 30% in North America?

I think right now, Jim, we are probably in the 28% to 29% range.

Okay, thank you.

Thank you.

Kevin Bennett, Sterne Agee.

Good morning, guys.

Good morning, Kevin.

Bob, first question, I want to ask about your EMEA guidance for a sales decline of 1% to 3%, we've been down 5%, I guess, the last couple of quarters.

I'm just wondering what gives you confidence that it will only be down 1% to 3% next year?

I think because it was down 5% in Q3 and Q4, the team has -- I think we're going to have a tough Q1 and Q2 comps because really what we saw at that point in time was a lot of building of inventory for an assumption of a growth inside of the third and fourth quarter which never materialized.

I think there's inventory adjustments going on.

I think some of the inventory adjustments happened in Q4 in particular.

I think now we'll probably see that in Q1 again this year.

The goal really here is we believe that there's opportunities to grow internally.

We are assuming the conservative marketplace, so we don't get our cost structure, and that's why we took the additional actions just in case it doesn't materialize.

We're watching it closely.

I'll tell you we feel good about our drains business.

That's starting to grow.

We see orders in the pipeline.

Some of our emerging markets stuff is starting to break.

The core concern, as you can imagine, is Germany, Italy, and France.

Those are our key areas.

We're focused really tight on those areas and watching that very closely.

All in all, we netted the pluses and minuses, and it looks like we'll be in 1% to 3% range, considering all those things.

Okay, that make sense.

Then in terms of M&A, how high would you guys be willing to go on the leverage side if another AERCO came along?

We don't speculate on things like that.

We certainly will look at all opportunities that come our way that make sense to us from a strategy point you.

That's the first gate.

Does it make sense?

Does it tie to our overall strategy in the Company?

Does it value add, and how does it fit into the overall structure of the Company?

We will look at any and all acquisitions, but I can assure you we're going to be disciplined and making sure that we have the bandwidth to manage an acquisition and integration, given all the things that we have going on right now.

Our key focus right now is to integrate the acquisition we have which is going very well, and implement in particular this North America transformation plan which I think has significant value to be had on that.

That's our key focus right now, Kevin.

Okay, that make sense.

A different way to ask it, in terms of, debt to cap or net debt to cap, do you have a range that you'd like to be in or that you're comfortable with?

Right now, Kevin, we'd like to be between 35% and 45%, debt to cap.

Right now, we're probably high 30%.

Okay.

Thanks, Tim.

Last question for me, on the pension settlement, how much do you expect to save in the future by doing this?

If it gets settled this year which we hope it does, we expect to save approximately $4.5 million to $5 million.

Is that per year or just overall?

Our costs go down starting in 2016.

It starts to go down in 2016, $4.5 million.

Got you.

Perfect.

Thank you, guys.

Thank you.

Thank you, ladies and gentlemen.

I would now like to turn the call over to Bob Pagano for closing remarks.

In closing, I would like to thank you for taking the time to join us today for our Q4 earnings call.

We very much appreciate your continued interest in Watts Water.

We look forward to speaking with you again during our Q1 earnings call.

Thank you very much.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect, and have a good day.