Watts Water Technologies Inc (WTS) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Watts Water Technologies fourth quarter 2015 earnings conference call.

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

(Operator Instructions) As a reminder, this conference may be recorded.

I will now turn the call over to your host, Timothy MacPhee, Treasurer and Vice President, Investor Relations.

Please go ahead.

Thank you, Stephanie.

Good morning, everyone, and thank you for joining our fourth-quarter and full-year 2015 earnings call.

Joining me today are Bob Pagano, President and CEO; and Todd Trapp, our CFO.

Bob will provide his overview for the year and address certain items related to EMEA.

He will then discuss current market conditions.

Todd will present the financial results for the fourth quarter and full year and offer our initial outlook for 2016.

Finally, Bob will update you on our key organizational initiatives and then we will open the call up to your questions.

The earnings press release and earnings call presentation we issued last evening include some non-GAAP financial measures and we have included in those documents the necessary reconciliations to GAAP measures.

You can find a direct link to the webcast of today's conference call on our website at www.Wattswater.com.

We will archive the webcast on the site for replay.

I'd like to remind everyone that in the course of this call to give you a better understanding of our operations, we will be making certain forward-looking statements.

These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements.

For information concerning these risks and uncertainties, see Watts Water's publicly available filings with the SEC.

The Company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.

Now let me turn the call over to Bob Pagano.

Thanks, Tim, and good morning, everyone.

Please turn to slide 3 in the earnings call presentation and I'll provide an overview of this past year and my initial thoughts on 2016.

As we have said before, 2015 was a transition year for Watts and I'm really proud of the progress we made on several initiatives that we identified as crucial to our future success.

I'll touch upon these initiatives in just a moment, but first, let me briefly comment on the fourth-quarter results.

I was very pleased with our efforts and the adjusted results we delivered as we ended 2015.

In the fourth quarter, we saw solid organic growth in the Americas driven by accelerated growth in our base business and continued strong performance out of AERCO.

We saw signs, some signs of stabilization in EMEA and continued softness in Asia-Pacific business, given the uncertain macro backdrop in that region.

Margins expanded nicely in the quarter, driven by our focus on profitable growth and continued cost savings initiatives.

Cash flow continues to be a very good story for Watts and Todd will provide more color on the financial results in just a few moments.

One of our key initiatives is to reshape our portfolio and we made significant strides in 2015.

During the year, we divested almost $165 million in noncore lower margin products and effectively used our strong free cash flow to add higher growth, higher margin businesses like AERCO and Apex, our recent acquisition in New Zealand.

We were able to monetize a portion of divested products through a sale that netted us $33 million and last fall we entered into an agreement in principle to sell our manufacturing location in China, dedicated to noncore products.

We expect this sale to be finalized in the first half of 2016.

The AERCO acquisition was successfully integrated into Watts during 2015.

We realize the synergies we had expected during our first year of ownership.

Internally, we shared some best practices and we were able to capitalize from the commercial markets' continued migration toward high-efficiency condensing boilers and tankless water heater solutions.

2015 was a record sales year for AERCO and the business also provided strong profits and cash flows.

We expect that trend to continue in 2016.

As an update on our restructuring efforts, we realize the savings in EMEA and in the US that we expected.

In the third quarter we announced phase 2 of the Americas transformation, which addresses our infrastructure requirements to support the newly streamlined product portfolio.

We expect to reduce our net operating footprint by approximately 30%.

When completed in 2017 we expect our phase 2 efforts to reduce working capital, improve our planning process, realize savings from redundancy and improve our customers' overall experience.

We will continue to drive new and existing programs in 2016 and beyond to generate further operational efficiencies.

We settled some legacy liabilities in 2015, including eliminating our pension obligation during the third quarter.

The transfer of the liability to a third party reduces potential volatility in our future results.

We expect that we will save approximately $3 million in annual pension cost beginning this year.

We have also resolved two matters related to legacy product liability claims.

First, we reached an agreement in principle to settle two class-action lawsuits.

The suits relate to water heater connectors and flood safe connectors, two undifferentiated products that we have exited.

The total settlement amount is $14 million, of which Watts is expected to pay approximately $4 million as our portion of the settlement.

We recorded a $3.5 million pretax charge on the fourth-quarter results.

The second, separate legal matter involving other legacy product liability claims related to undifferentiated products has also been resolved.

We have taken a charge of approximately $2.5 million to cover these legacy costs.

In total, the charge for both matters totals $6 million and both charges were recorded as special items in the fourth-quarter results.

Finally, we have reenergized the Company's commitment to the front end of the business, what you have heard me refer to as commercial excellence.

In 2015 we focused on the voice of the customer, to understand what their wants and needs are and how we can better service them.

We tested price elasticity in the marketplace, which is giving us feedback on potential product line profitability and helps us understand which products the markets perceive as value added.

In addition, we have launched a streamlined new product development process across the globe that we expect will drive innovation and to the market -- be more efficient in the market.

Investing in growth will drive top line performance and we are focused on enhancing our marketing, R&D, training and customer engagement.

We look forward to providing updates as we progress on this front.

As you saw in our press release yesterday, we announced senior-level organizational changes related to the ongoing EMEA restructuring.

So if we move to slide 4, let me talk about that in greater detail.

Yesterday we announced a new restructuring effort in EMEA.

Our infrastructure cost in certain locations now outpace the market, which saw continued declines in 2015.

We will be working through the proposed to social plans with the Works Council over the next several months with the goal of rightsizing the affected operations by the fourth quarter.

Finalization and implementations of plan is subject to completion of all legal requirements including consultation with and receipt of advisory opinions from the relevant work service councils.

We expect the cost could approximate $8 million and we should realize annual savings of approximately $3.5 million in 2017.

Savings this year will be minimal, given the time expected to obtain the needed approvals.

Todd will talk more about the goodwill impairment charge we took in EMEA.

I have asked Munish Nanda and Elie Melham, our respective Presidents for the America and Asia-Pacific, to also assume oversight for EMEA.

Mario Sanchez, our prior EMEA President, will be leaving the Company to explore new opportunities, and we all wish him well.

Munish will oversee Europe, including Eastern Europe, while Elie will assume responsibilities for the Middle East and Africa.

We believe these changes will simplify our organization and allow us to take a more global business view.

We are driving a One Watts mindset with a focus externally on voice of the customer, promoting global new product development and initiating more cross-selling opportunities, both within EMEA and around the world.

We're concentrating on better product, channel and account management to help drive top line for Watts.

Now onto the markets, so please turn to slide 5. Let me share some macro data for 2015 and 2016.

First, we expect to see continued macro growth in the US, although at a more moderate pace.

GDP is forecast to grow at approximately 2.7%, about the same as 2015.

We think GDP is a proxy for growth in our repair and replacement business.

Based on information we derive from IHS, total residential spend in 2016 is forecast to increase high single digits and commercial, office and institutional structure spend are forecast to increase in the low to mid-single digits.

In the eurozone, the overall outlook is stable with GDP growing at about 1.9%, nominally higher than 2015.

IHS is forecasting flat or low single digit growth for both residential and commercial construction spending in our larger markets.

So, we are hopeful that the long-awaited stabilization is realized in Europe during 2016.

Emerging markets will remain mixed with GDP and construction spending in Russia, both forecasted to be negative, although not as bad as in 2015.

Overall, GDP in the Middle East is expected to grow nominally in 2016.

Notably, we have seen recent project delays due to the continuing oil saga, and that will likely continue to have an impact on both the Middle East and Russia as 2016 progresses.

In China, GDP declined in 2015 and is expected to decelerate again this year at 6.3%.

Residential spending is expected to be negative again in 2016 with low single-digit growth predicted for commercial construction spending.

Regionally, Asia-Pacific GDP growth, which includes China, is expected to accelerate modestly in 2016.

Overall, the macro data suggests our markets will remain mixed and somewhat uncertain.

I will now turn the call over to Todd, who will review our results for the quarter and full year and offer our initial outlook for 2016.

Todd?

Thank you, Bob, and good morning, everyone.

I'm on slide 6, which shows the fourth-quarter results.

Overall, I would say that we were pleased with the topline performance in the quarter as we delivered sales of $358 million, which was up 4% organically, our strongest growth quarter this quarter.

On a reported basis our top line declined by about 5%, which was really driven by two factors.

First was foreign exchange, mainly related to the weaker euro which negatively impacted sales quarter over quarter by roughly $18 million or 5%.

The second factor was the negative impact from the exit of undifferentiated products, a result of our focus on reshaping our portfolio, which reduced sales by roughly $30 million or 8%.

These two headwinds were offset to some degree by the addition of AERCO as well as organic growth and Americas.

Regionally, organic sales increased 7% in Americas, 1% in EMEA and were down about 6% in Asia-Pacific.

And I will provide more color on the regional performance in a few minutes.

Adjusted operating profit of $35 million increased a little over 1%, which translated into an adjusted operating margin of 9.9%, up 60 basis points versus Q4 of last year.

Favorable sales mix and continued benefit from productivity and restructuring actions more than offset incremental SG&A investments.

As we've communicated, our SG&A costs are high due to the addition of AERCO and increases in stock compensation, pension, compliance and other cost.

Overall I would say we were pleased with the margin performance in the quarter.

Adjusted EPS of $0.59 was about 2% better than prior year.

Adjusted EPS included a negative impact of $0.05 in the quarter from foreign exchange and a $0.06 headwind associated with the exit of undifferentiated products, which more than offset the 3% positive contribution from AERCO.

The effective tax rate in the quarter was 33.2%, which is up over 400 basis points from the prior year, primarily due to the mix of earnings in the quarter being more heavily weighted to the US.

The impact of the higher tax rate was mostly offset by below-the-line favorability from FX transactional gains during the quarter.

So net-net, a minimal impact on EPS.

On a separate note, in the quarter we booked a non-cash impairment charge of $130 million in the EMEA reporting unit.

As you know, our EMEA business has struggled of late, given the tough macroeconomic environment.

Given that as a backdrop, we took a prudent view of prospects for the reporting unit as part of our annual strategic planning process in Q4.

The projected cash flows did not support the overall goodwill valuation, therefore the reason for the charge in the quarter.

This charge does not affect our liquidity, any of our bank covenants nor our ongoing EMEA strategy.

So let's move to slide 11 and the America results.

Sales for the fourth quarter were $233 million, down 2% on a reported basis but up 7% on an organic basis.

In Q4 we continued to provide transition services to Sioux Chief, resulting in approximately $9 million of revenue associated with the exit of undifferentiated products, which was incremental to our previous guidance.

We expect to finalize the transition services by mid-Q1 of 2016.

Excluding AERCO, our organic sales for the base America business -- it grew 4% during the quarter.

I think it is important to note that we did receive a sizable stocking order in December from one of our larger customers that equates to roughly 1 point of growth in the quarter.

With that said, we did see growth accelerate in the second half of 2015, as we expected, and feel good about how we exited the year.

We saw organic growth in the wholesale channel, driven by backflow and drains products.

We also saw growth in our specialty channels, including instrumentation products and products that we sell into the food service end markets.

AERCO continues to perform well, delivering another quarter of double-digit growth, driven by strength in boilers, water heaters and its aftermarket business as it continues to execute well in the commercial marketplace.

Adjusted operating profit for the quarter was $33 million, a 16% increase year over year.

Operating margin expanded 220 basis points to 14.3%.

The margin expansion was due to favorable mix, including the impact from the exit of undifferentiated products and continued strong productivity.

Partially offsetting these positive factors was higher anticipated SG&A expenses including personnel, product liability and compliance cost.

This is the second consecutive quarter that the Americas delivered strong operating results.

Now, turning to slide 8, let's review EMEA's results.

Sales for the fourth quarter were $113 million, down $14 million or 11% on a reported basis but up 1% on a constant currency basis.

Foreign exchange accounted for $15 million of the sales decline.

We saw growth in water and plumbing, driven by stronger Middle East sales, which more than offset some softness in our drains product business.

As you know, the product business can be quite lumpy and we've encountered some delays, especially in the Nordic region relating to offshore activities and related funding for construction projects in this area.

Geographically, we saw some stabilization in our major markets with growth in France and Italy, while sales into Germany were flat for the quarter.

We continue to see declines in Eastern Europe, which was down 23% in total, driven primarily by continued weakness in the Russian market, which was down over [50%] in the quarter for us.

Middle East sales were up 13% in the fourth quarter and 37% for the year, driven by valves and water quality products.

As we progressed over the course of the year, we did see some slowdown in this region, which we attribute to the declines in oil prices, which are delaying some projects.

This is something we will watch closely as we enter into 2016.

Adjusted operating profit for the quarter was $10 million, a decrease of $3 million or 20%, which translated into an adjusted operating margin rate of approximately 9%.

Approximately half the operating profit decreased was due to foreign exchange headwinds.

Sales mix and some pricing headwinds more than offset the benefits from our prior transformation and restructuring efforts.

And as Bob mentioned, we've announced additional restructuring activities that will better rightsize our cost structure to current market conditions.

Moving to slide 9, let's take a look at Asia-Pacific's results for the fourth quarter.

Asia-Pacific sales were $12 million, a 6% decline over the prior year.

We saw a decline in valve sales in China as we continued to see project delays and fewer larger-size orders.

We are seeing distributors ordering smaller quantities, more on a just-in-time basis, as concerns over the general state of the construction markets in China are weighing heavily on customer decisions.

We have continued to see strong growth outside of China, roughly 9%, driven by demand for our water and plumbing products in areas such as Australia and Southeast Asia.

Sales from Apex contributed roughly $1 million in the quarter.

Adjusted operating profit of $0.7 million was down about $1 million versus last year, which translated into adjusted operating margins of 6%.

A few items were driving the year-over-year margin reduction.

First, and consistent with last quarter, due to the product rationalization in the US, intercompany sales declined by close to $20 million or 15% as compared to last year as our China operations lost the benefit of the intercompany profit and plant absorption.

Secondly, we have maintained our leadership infrastructure within Asia-Pacific to support our future growth opportunities in this region.

So in summary, we experienced a lower-than-expected topline for Asia, given uncertainty in the China market and resultant delays.

Our margins, as expected, trended down.

So now I am on slide 10, and let me speak briefly about the full-year results.

Sales for the full year were $1.47 billion, down $46 million or 3% on a reported basis and up 1% organically.

Foreign exchange, driven by the euro and Canadian dollar, accounted for approximately $100 million or 6% of the sales decline.

The net positive impact from the acquisition of AERCO, offset by the exit of undifferentiated products, accounted for an incremental $40 million or 3% of growth.

Organically, Americas and Asia-Pacific sales increased approximately 3% and 7%, respectively, which more than offset EMEA's 3% decline.

Also, you said note that AERCO was up double digits for the year.

Operating margins for 2015 were flat at 10.1%.

Lower volume and incremental SG&A headwind were offset by favorable product mix, strong productivity and continued rationalization and restructuring savings in both the Americas and EMEA.

Adjusted full-year EPS of $2.41 was down about $0.10 or 4% versus prior year.

Headwinds from foreign-exchange and the exit of undifferentiated products negatively impacted full-year earnings by $0.42.

These two significant headwinds more than offset the positive impacts from AERCO, which contributed approximately $0.26 for the year.

Free cash flow continues to be a great story for Watts, and I will provide more color on that topic now as I turn to slide 11.

Adjusted free cash flow was up 17% on a year-over-year basis.

A big driver of the improvement is strong working capital performance.

We increased inventory turns 6% in 2015, which led to an operating reduction in inventory of over $20 million.

We also had a decrease in our accounts receivables days outstanding, which drove $13 million of cash inflow into 2015.

So we continue to make strides in working capital management and we see further opportunities ahead.

CapEx increased 18% in 2015, mostly related to the addition of AERCO as well as some incremental investment opportunities in our plans to support our growth and productivity initiatives.

Asset sale proceeds from Sioux Chief was $33 million, which helped fund the pension settlement in Q3.

We also spent approximately $21 million to purchase 80% of Apex in the fourth quarter of 2015.

Our stock buyback program remains on track as we repurchased 229,000 shares in the quarter at a cost of $12.6 million.

For the full year we've purchased 813,000 shares for $44.6 million.

I also wanted to mention that, last week, we restructured our existing credit agreement in anticipation of paying off private placement debt that is coming due in April.

The new agreement consists of a $300 million term loan that matures in 2021 and a new $500 million revolver that is committed also through 2021.

This new facility provides us ample liquidity and flexibility as we prioritize capital allocation in the future.

So in summary, free cash flow continues to be a bright spot for the organization and we expect that trend to continue going forward.

Finally, turning to slide 12, I'd like to discuss our 2016 outlook.

Starting with our sales forecast for the year, we estimate that Americas will grow in the low to mid-single digits, as we expect many of our traditional and markets, including commercial and residential, to continue to grow, albeit at a slower -- slightly slower pace versus 2015.

For EMEA, we are forecasting sales to be flat to slightly down.

We saw some stabilization in Q4.

However, we remain cautious, given the broader macros.

And Eastern Europe, mainly Russia, still remains a concern for us.

The business environment is challenging and we will continue to be deliberate and focused on profitable growth.

In Asia-Pacific, we expect organic sales to be up high single digits this coming year.

We expect that the uncertainty we are experiencing now in the markets may continue through the first half of the year with more growth in the back half as we introduce new products in the China market place.

Overall, Watts sales are estimated to grow low single digits for 2016.

A couple of other items worth mentioning: we expect sales will be reduced by approximately $100 million from 2015 levels related to the product rationalization.

The dropthrough on these loss sales should be mid-single digits.

The reduction in sales should be more pronounced in the first three quarters, approximately $30 million per quarter, and then less in Q4.

Apex should provide approximately $11 million of incremental sales for the Asia-Pacific business at midteens operating margins.

Conversely, as communicated, Asia-Pacific's margins should be impacted in 2016 by lost volume from intercompany sales due to the product rationalization.

We expect incremental transformation and restructuring savings in 2016 of approximately $10 million, half realized in the Americas and the other half realized in EMEA.

And consistent with our prior communication, we plan on taking some of the restructuring savings and reinvest it back into the business in the areas of selling and marketing, training, R&D and systems, to help accelerate our growth trajectory.

We are targeting investments in the $5 million to $7 million range for the year.

We are also expecting to have approximately $3 million of stock comp headwinds associated with new leader [ship] replacement awards and the change in the grant date of our annual stock awards from Q3 to Q1 to more closely align to our strategic plan and our compensation strategy.

There is also a future tax benefit associated with this grant date change.

Despite these headwinds, we expect to deliver strong margin expansion in 2016.

And finally, a few more maintenance items.

We expect capital expense in the year of between $35 million and $40 million and we look to invest in our manufacturing and training facilities, which will help support future growth and productivity.

Depreciation and amortization should range from $52 million to $55 million.

The effective tax rate should be between 32% and 34% for the year.

And finally, share buybacks are estimated to be in the $40 million to $50 million range, executed ratably over the year.

And now let me turn the call over to Bob before moving to Q&A.

Bob?

Thanks, Todd.

Please turn to slide 13 and let me update you on our scorecard of top priorities for the organization.

First, we have addressed key positions around the globe.

Certainly, the skill set of the management team has been broadened over the last year and a half.

We have added experienced people from ITT, Danaher, Honeywell and Johnson Controls.

We have realigned responsibilities when we believed it was best for the organization.

Talent evaluation is an ongoing process, so we are always looking to improve our overall skill set.

We are expanding our review to the next levels in the Company to ensure we have the needed bench strength to support and carry out our strategic goals.

The EMEA transformation and restructuring initiatives are on track.

The team has made steady progress in driving savings throughout Europe, realizing $8 million in savings in 2015.

Unfortunately, their effects have been more than offset by the overall market downturn.

We continue to assess our infrastructure, as evidenced by our announcement of the additional restructuring actions we will undertake this year.

Phase 1 of the Americas-Asia-Pacific transformation effort has gone very well.

We finalized the sale of the US assets, identified and executed on sourcing initiatives, and we expect to complete the sale of our China manufacturing plant in the first half of 2016.

Completing phase 1 will allow our key commercial resources to focus on a more profitable customer and profit portfolio that will drive innovation and is more solutions-oriented.

Phase 2 is focusing on consolidating and optimizing our Americas operational footprint to better support the needs of our customers and improve our cost structure.

We have announced the closure of three facilities already and we expect other site closures to be announced as the year progresses.

We are opening a new state-of-the-art distribution facility with the goal of meeting and exceeding our customers' delivery expectations while streamlining the distribution process and saving costs.

We plan on making incremental investments in reinvigorating customer training, R&D and our new product development pipeline.

We are also investing in a new state-of-the-art training center in our North Andover headquarters, which we expect will be in service during the first half of this year.

We will use the facility to train reps, distributors, customers, engineers and employees on our latest product offering and educate them on how our products can work together.

Finally, we will continue to look for every opportunity to continuously improve the performance in our Company.

We are increasingly working together as one organization between businesses, countries and regions to provide our customers with value-added products and solutions.

We have our strategic priorities as an organization and we are on track to complete what we said we would do.

We continue to build momentum within the organization.

So, let me briefly summarize.

2015 was a transition year for Watts.

We started making the people, process and cultural changes necessary to achieve our long-term strategic goals.

We did what we said we would do in 2015, delivering on the commitments and building a foundation for future growth.

And longer term, we expect to reap the benefits of our efforts through profitable growth and delivering on the mid-teen operating margins that we aspire to within the next five years.

So with that, operator, please open the line for questions.

(Operator Instructions) Ryan Connors, Boenning and Scattergood.

Thank you for taking my question.

I've got a couple.

First off, just wanted to clarify housekeeping, Todd, on the revenue outlook for 2016.

You've got the low single-digit organic growth assumption in there but yet the $100 million in portfolio realignment.

So just to clarify, that does mean we are expecting on absolute terms another down year on the topline for 2016?

Am I reading that appropriately?

Yes, you are.

Okay, okay.

And then the other thing, Bob, you mentioned some adjustments in the innovation program.

And that caught my ear.

Can you talk a little bit about the state of the R&D program right now at Watts and what the changes are going to be made there and what they are intended to accomplish in terms of the innovation and whether or not you intend to issue any metrics like a vitality index or something like that to help us measure that progress?

Yes, so -- yes, let me update you on that.

So, first of all, we surveyed and looked, and we had multiple, many new product development process.

In the fourth quarter we rolled out a consistent one process throughout Watts, so it's a One Watts process.

And I would say our product pipeline is mixed.

I think there are certain areas where it's very rich and robust.

And AERCO, I would say, is the prime example of that.

But there's other areas, honestly, where we have been milking some of the businesses, and we really need to focus on that.

So internally we have put in product vitality indexes.

We've revamped everything in a key focus, including a once-a-month growth day that we have that we are talking to each of the businesses and looking at their metrics, etc.

So we will begin looking at providing additional information on that.

But it was an area that I felt we needed to reinvigorate.

I think in most of our processes we are acquiring new product development versus internally developing it ourselves.

So, also, a lot of our new product development focus was on converting when we went to the unleaded product.

So now we are freeing up our resources to really focus on what I call voice of the customer R&D versus engineering-developed R&D.

So it's a shift in mindset there.

So we are very excited about the opportunities.

And our team is really excited about it.

Great, that's helpful.

Thanks for your time this morning.

David Rose, Wedbush Securities.

Just a couple quick ones -- the product rationalization in Q4, guidance was $40 million to $45 million in Q3 versus the $29 million number.

Can you just go over briefly what changed?

Were there fewer products or was it a function of timing?

So I'll say sales from the undifferentiated products in Q4 were down $30 million versus prior year, which was a little bit better than what we had previously guided.

And I think there's two main reasons for the difference.

First is Sioux Chief requested that we continue to support the customer transition through the quarter.

And I think the second thing is that the burn down of certain DIY products just have taken a little bit longer than we anticipated.

So both these transitions we expect to be completed in Q1 of 2016.

So we expect to have approximately I'd say, roughly $3 million to $5 million more of undifferentiated sales in Q1 that were not planned.

So the $30 million per quarter -- that will probably be weighted a little bit more in the first quarter by that $3 million?

Is that fair?

That's fair.

Okay.

And then as we start to rationalize footprint a bit more and you also talk about an additional distribution center, does that imply that you are going to need a little bit more inventory as a buffer?

And what does that imply in terms of progress on free cash flow conversion next year?

Yes.

So as we indicated, we were going to build inventories.

We are building right now.

Our focus is on customer service and not losing any market share during the training.

So we believe we will be adding about $20 million over the year but then bringing that down in the second half of the year.

So the inventory build is focused, let's call it, on the first half of the year.

And we bleed it down as we start implementing this.

So really, the focus is on keeping our customers and optimizing our performances there.

David, we still believe that we can get to 100% conversion.

Okay, that's helpful.

And then lastly, and I'll go back in the queue, given the free cash flow is still very healthy, you've talked about M&A, certainly adding higher margin products, is there any interest in -- you highlighted the stronger performers in the group, instrumentation and food and beverage.

Is there an interest in moving in that direction versus traditional plumbing?

David, we look at all opportunities.

So we don't specify -- because, as we know, we never know when acquisitions are going to happen and what's available.

So we continue to look in a disciplined way, looking at opportunities and understanding how strategically overall they fit.

We also look at where their strength is, where they are located, what areas of the countries -- there are certain areas that we don't want to participate.

So again, I think we take all of that into consideration and we are not afraid of looking at small adjacencies.

So everything is [hope and gain].

Okay, that's fair.

Thank you, Bob.

Kevin Maczka, BB&T Capital Markets.

So, strong organic in the Americas in Q4.

I have a question about the guidance here and what the scenario is whereby we get to the high end of that mid-single-digit outlook because if commercial is moderating I think you characterize that as improving last quarter.

To get up to that high end, do we have to see that we accelerate again?

Or, Bob, does some of these new product and commercial excellence initiatives get us there?

I think the commercial excellence helps us get there.

I think we've done a nice job of understanding where our strength is, where our opportunities are and our account management, our understanding of customer share of wallet and what our fair share is.

I think we've done a nice job of really understanding the market and where we are at.

So we are cautiously optimistic and our teams are driving for us.

Got it.

And shifting over to price, it looks like you've called that out as helping a bit in the Americas, hurting a bit in EMEA.

The elasticity testing that you did, Bob, can you just talk a little bit more about what that means and what have you modeled in that organic growth outlook for price?

Yes, so each region is differently.

But certainly, we've continued to rationalize our product portfolio.

We had over 50,000 products in North America.

We got rid of about 12,000 of them and we still have opportunity to, let's call it, reduce our broad portfolio and make sure we test price elasticity.

So we believe that was about a 0.5% negative tailwind for us in the first quarter.

We will continue to do that.

That effort was really -- we saw a lot of it in Q3 and some in Q4.

So we will see some of that in Q1 and Q2 of next year, probably in the half a point range.

When I look at price, price inside of North America was probably about 1%.

But when you look in Europe, pricing is not good.

It's a lot of pressure on pricing.

The same in China right now, a lot of pressure on pricing right now.

So we are assuming basically flat pricing in that and we will see some moderate pricing in North America, but not significant pricing as we saw this year as we aggressively tested price elasticity.

Got it.

And just finally, to be clear on the restructuring, the $10 million incremental savings in 2016 is a gross number, not a net number.

But is the net number closer to $6 million?

I think it's actually -- no, the $10 million number is gross.

Right, but there's some offsetting spend that you net against that; correct?

Other than the investments, what we are taking some of the savings and investing, as Todd talked about, when we gave guidance in his last slide.

So that's -- we are taking all of the savings that we have been generating, about $10 million of savings incremental this year, in 2015 to 2016, and investing a portion of that for the long term in our business.

Got it.

And just finally, on the restructuring in general, I think this is maybe the sixth phase of restructuring we've talked about.

There has been two others in EMEA in 2013 and in 2015.

I know the plan sort of evolves as you continue and make progress.

But should we be expecting further iterations of this or have we done the big structural things now with this new phase that you intend to do?

So Kevin, let's go back.

And in particular I think you are talking about the EMEA restructuring.

But really, when you look at it, the major restructuring we had done prior to this was really before what I call the geopolitical things happened, in particular Russia, Ukraine, Greece, all of that.

So there was always an assumption that the business would grow.

And now we don't believe that's the case.

So when we have been flat -- I think in the last eight quarters, only two of those quarters had organic growth, and the last one here was minimal.

So we're going to continue to look at our cost structure.

When you look at that overall, I believe -- I think there's opportunities.

But remember it's difficult and very costly to restructure facilities in Europe.

So it always has to make sense and from an overall return on invested capital point of view.

So we will be monitoring that.

But I never say never, but we will continue to monitor and do the best thing we can for our business.

Okay, thank you.

Jim Giannakouros, Oppenheimer.

In North America that operating margin of 14.3% -- very impressive.

You guys had a strong base business and, obviously, AERCO growth.

Despite the seasonally softer period, can you just get into a more granular conversation as to exactly what drove that?

Was that the unwinding of non-core costing less given the pace of wind down or just getting better price than expected?

Or was it that large stocking order that Todd mentioned earlier?

So Jim, as you can imagine, there's a lot of puts and takes.

I would say the exit of the undifferentiated products probably drove about a little over 100 basis points of margin expansion in Q4 in the Americas year over year.

But as Bob mentioned, they are seeing some nice pricing that's helping drive some of that margin as well as just continued performance on productivity.

So, sourcing and plant and [VAVC agents].

They are just seeing some of that.

So I'd say it's a combination of the exit of the undifferentiated products, unfavorable pricing, obviously good stuff on productivity as well as volume.

We are seeing the volume.

We are seeing, as I mentioned, 4% organic volume growth.

If you back out that one order, 3%, so it's a combination, I would say, of those four factors.

Okay, thanks.

And does that elevated margin -- does that hold into 1Q and then improve from there during 2016?

I'm sorry, Todd; I missed the impacts from the wind down you -- to be factored in 2016 that you mentioned (multiple speakers) margin.

I believe that the margin rates as we had in 2016 will continue to hold at these levels.

Okay.

And then as far as your growth expectations -- I'm sorry if Kevin covered this in his question right before; I may have missed it.

But can you differentiate between what you are seeing in residential versus nonresidential as far as just trying to think about how your growth expectations, all in, for this year are any lower than what you saw in 2015?

Yes.

When you look at it, I think you have to take all the different things.

We are still doing the product portfolio rationalization in the products that we are still staying in.

I also look at -- when I look at residential and commercial, as I said earlier, I think they are going to be positive for us.

We gained some momentum in the second half of this year.

We hope to keep it.

Our overall focus on gaining market share and driving increased share of wallet is real important on this.

So I think there's opportunities.

I like the markets of both residential and commercial in North America.

I think where the softness in residential is really in the EMEA, that is a headwind.

Got it.

And one last one, if I may, just on [some of the below the line items] probably for Todd or Tim.

Can you give us some guidance on quarterly or annual interest expense that we should be modeling for 2016 and that other income line?

That seems to bounce around a bit.

Yes.

I would say in terms of on the interest line I would say we will probably see a little bit of a slight benefit, maybe a couple hundred thousand dollars on a year-over-year basis on the interest line.

And then I believe the other line -- we did see some favorable foreign-exchange gains in 2015 of approximately $2 million related to affiliated loans in US-denominated accounts.

And so, I think we will potentially see a little bit in 2016 but just not to that level.

So I think that's a little bit of a headwind as we head into 2016.

Thank you.

Jeff Hammond, KeyBanc.

So, just wanted to come back to Europe.

It just seems like, given the sales decline and yet the $8 million of savings, that the decrementals are still pretty ugly.

And I'm just trying to understand a little bit better how FX transaction plays in and how bad pricing really is and do we see any stabilization of some of those headwinds into 2016.

Yes, so let me try to take that.

So when we look at that, I think pricing is difficult, especially in the OEM channel.

I think with some of the commodity price decreases, they are all looking for those savings.

And the volume is short.

We did a large business in Russia that was a very profitable part of our business.

And that's -- as Todd says, it was down 50% in the quarter.

So we are starting to get into what I call easier comps because overall Russia was down significantly.

We believe it will probably continue to go down as we -- you know, into 2016 but certainly not at the magnitude that we saw from 2014 to 2015.

So I think we have a mix there.

The other thing is our drains business in Europe is very profitable.

And in the first half, we had a nice backlog of projects that shipped in the first and second quarter of 2015, and that backlog started to drop.

And we didn't have that in Q3 and Q4.

As we enter 2016 we don't have that strong backlog because offshore oil platforms and construction related to the countries where oil is predominantly causing spending has slowed down.

So we've seen, in our drain business, that project business has come down quite a bit.

So that mix of business really impacted our overall profitability in those regions.

So that's really what was driving it.

We believe we will see some stabilization in some of these areas.

Out of the gate, if I look in what we are seeing in January, it's right in line with our expectations here, so no surprises there.

But I think it's an opportunity for us to also begin refocusing on growth in that region.

And I think that's some of the initiatives.

We are going to share some of our best practices that we have been doing inside of North America and leverage that inside of EMEA.

I think we are more internally focused in EMEA, executing all these restructuring and principal company initiatives.

And I really want us to look at how do we drive growth, in particular in the drains and our electronics businesses, which are our stronger businesses.

So that's how I look at EMEA.

Okay.

So it sounds like the drains headwinds continue, Russia continues.

Do you see an end to the pricing pressure?

Is some of the lower commodity inputs now built in?

I think we are going to see some pricing issues in the first.

We are assuming flat, so we are going to try to get price where we can.

But net-net, our assumptions are flat pricing.

Okay.

And then I just want to go back to -- so transformation spending, I think you said $10 million, $5 million in Europe, $5 million in North America.

And then, Todd, did you say $5 million to $7 million of investments as an offset?

Correct, yes, $5 million to $7 million.

(Multiple speakers)

Okay, so you are reinvesting roughly half of that?

Correct.

Okay.

How should we think about pension savings and the corporate expense line, given some of the investments?

Yes, so I'd say the overall expense corporate line I would say is relatively flat on a year-over-year basis.

So, we are seeing some benefit from the pension in there; but we're also seeing some higher stock comp hitting that corporate line as well as some of our investments and something like in Hyperion would be hitting that line as well.

So I think corporate costs from a year-over-year perspective are relatively flat.

Okay.

And then just to sneak one more in here, Asia margins -- they were running in the teens, and this quarter was 6%.

You did mention the drop-down.

Given the new structure of that business, what's the right run rate into 2016 on margins and what's maybe the longer term in the margin run rate for that business?

Thanks.

I would say from an Asia-Pacific -- I would say that the way I'd look at it is I'd say high single-digit margins to maybe low double-digit margins would be the way I'd look at it and model it going forward.

But I think in 2016 it would be more that high single-digit margins.

Yes.

Remember, Jeff, that they had all the benefits of the intercompany markup and we really didn't start exiting on differentiated products until the third and fourth quarters.

So that's where you started seeing the heavy hit on margins.

So when you look at Q1 and Q2 compared to last year, it's going to be a big shift downward, more in the Q4 type range.

And we are maintaining our management infrastructure there.

Exactly, exactly.

Thanks, guys.

Kevin Bennett, Sterne Agee.

Bob, first question: you mentioned in the slides that you saw some softness in industrial in the Americas, and I was wondering if you could elaborate on that a little bit.

I don't remember saying softness in the industrial.

What we did see is in EMEA we saw some timing of projects related to the oil and gas sector, related to our drains business.

So, that project was lumpy.

We also saw some softness in projects in EMEA related to, let's call, our normal Russian business, where some projects are slowing down, and in the Middle East.

So those were the let's call it more industrial-ish type markets that we play in.

But it's not a significant amount but it's concerning because the orders that we were getting in the Middle East were big and they were driven by let's call it oil and gas funding.

And now that that's slowed down a little bit, we are seeing that project activity just get pushed out.

And so, delays in the projects, they are pushing them out, they are not canceled but they are just moving them out.

Got you, okay.

And then in the Americas, I know a couple of people asked about this with regards to your outlook for 2016, and I'm wondering -- you talked about growth, I guess, in both resi and non-res moderating -- I'm speaking to the Americas here -- moderating in 2016.

And I'm wondering if that's just based on overall market forecast, or are you guys seeing that in your order patterns?

Or what makes you think that we are going to see that in 2016?

It's more the market.

It's the discussion in the market that it is slowing down.

But I think we will gain more than our fair share of growth in those markets.

Got it, okay.

And then last question for me -- just wondering about what was the rationale behind the management changes in EMEA?

And is this a permanent change for these two guys or are you looking for a new head of EMEA or what are you thinking about there?

No, it's a permanent change.

Really, as we continue to look at driving a One Watts culture -- we make similar products around the world.

When we had our growth innovation meeting earlier this year, it really opened my eyes to we are just not sharing knowledge and technology.

And I think we've done a nice job of breaking down the silos inside of Europe but we've really just got to break down the silos around the world.

So it's really focused on how do we get the teams to work together, how do we have more global platforms and how do we drive synergies and share best practices.

And the best way to do that is to have overall similar leadership, get everybody working on the same plans together and just working together more.

So that's really the focus.

And given the low-growth environment in Europe, we just couldn't support the infrastructure cost.

We needed to do something different.

Got you, that makes sense.

All right, thank you.

Jim Foung, Gabelli and Company.

Good morning, guys, good quarter.

I just wanted to just pick up on that last question on EMEA.

So as you dismantled the infrastructure there, will we see like cost savings as you eliminate the back office and supporting staff?

Jim, it's too early.

We just made that decision.

But a lot of the infrastructure we put in the principal Company is for shared services function.

So we've already had that in our overall European transformation.

So really there's just one individual here, and that has been baked into our overall outlook that we talked about earlier.

Okay.

And you guys now have a good portfolio of leadfree products.

And just curious with the situation in Flint, Michigan, are you seeing any demand pickup from municipalities regarding lead-free products over this concern?

We are quoting a lot of products, in particular our water quality.

The lead-free discussion -- we continue to promote our products and availability there.

But I wouldn't see a massive increase in business as a result of this but it allows us to continue to promote our safe products.

So I think it's a nice opportunity for everybody to understand the importance of clean water.

And I think it's waking everyone up in this issue.

And we are glad this issue is coming up.

We are not happy about what happened to the people.

But really, the concern over safe drinking water is really important.

Okay.

And then when you began the transformation in North America, you talked about getting a 125-basis-point improvement in your margin this year.

Now that you've completed phase 1, could you just update us?

Should we see an adjustment in the margin up or downward for this year and next year?

What we committed to is that it was going to be about 100-basis-point-plus margin improvement.

And I think that's -- what we are seeing now, and that's what we are forecasting for 2016.

Okay, so there's no change to the target?

No, no change in that.

Okay, very good.

I look forward to seeing you guys next week.

Ryan Cassil, Seaport Global Securities.

If I could just go back to EMEA, I think you've talked about the incremental investments and the transformation savings there.

Will you be timing the investments with the savings?

Or could you just give a little color on the cadence of those investments?

Yes.

So if you think about the $5 million to $7 million that we referenced, I would say probably half of that is committed right now and the other half is something that we will be -- being very prudent, we will be watching it very closely to make sure that we see top line growth before we actually make that incremental investment.

So it's something that we are going to be very smart about as we head into 2016.

Okay, great.

And the last one from me -- you guys have talked about 30% net footprint reduction across the business.

And I think there have been some investments that have maybe offset that.

Could you perhaps talk about what the gross footprint reduction would look like and then maybe take a swing at what the net footprint reduction will be, once you take some of these actions in the EMEA region that you've got planned so far?

Thanks.

The 30% in the Americas is the net.

That is the net reduction we plan, based on the results of all our transformation efforts.

So yes, we will be having an incremental distribution center.

But that was factored in our overall 30% square footage.

As we look in EMEA, really the latest restructuring -- it's not the closure of a plan, it's just a reduction of some workforce inside the business.

So it's not adjusting any square footage.

So that was done in the prior EMEA restructuring plan.

So really, the 30% is the net footprint reduction in North America when we are all said and done, with phase 2 here coming up here.

Got it, thanks.

Joe Giordano, Cowen & Company.

I wanted to start just talking about management bandwidth.

So you have some people taking on increasing responsibility in areas that are taking on incremental restructuring projects and things like that.

So maybe you could talk about bandwidth there and if that has any implications on the ability to take on new M&A?

Yes.

So no, listen, Joe, I'm not concerned about the bandwidth.

I think the heavy lifting on phase 1 and phase 2 took a lot of our management time and effort earlier in the year.

We are well along.

Phase 1, we are pretty much done.

Phase 2, we are well along with the heavy lifting and all the planning and all the things that are happening right now.

So I wouldn't have made the change if I was worried about band width.

So our team is ready for it and we are willing to take on that challenge.

In addition, we've added a lot of strong people inside the organization from where we were even a year ago.

So the bandwidth not only at the leadership level but at the next levels down in the organization has been substantially improved.

And we will continue to improve that.

So I feel good about that and it should have no impact on any of the restructuring plans or any future M&A.

Great, thanks for that.

And then just last, I wanted to talk about visibility a little bit and what you are seeing into distributor inventory levels, what you think that implies for forward expectations.

I know you talked about moderating commercial and we've seen some of the other players in that space, we've seen that kind of change in expectations reflected in their shares.

So just talk about the inventory levels and visibility into what you are seeing there outside of that restocking order that you just got.

Yes, so I feel pretty good about North America levels.

I've not seeing any major shifts from that point of view.

Where I did see -- we saw various destocking in EMEA and maybe some stocking orders we saw in the fourth quarter a little bit there.

Really, the big shift in inventory that we are seeing is probably in China.

That's where we were getting a lot of big stocking orders and those stocking orders have been cut in half now and it's more hand to mouth.

I think they're just keeping their inventories low, and that's what we saw in Q3 and Q4, that they are not just placing the big inventories.

It's more about what they are seeing and they want to be just in time in pressuring our lead times, which is fine.

So I don't see a big shift in our larger markets, in particular in North America.

I think it's fairly steady at this point in time.

Great, thank you.

That does conclude the Q&A session.

I will now turn the call back over to Bob Pagano, President and CEO, for closing remarks.

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

We appreciate your continuing interest in Watts Water Technologies.

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

So thank you very much.

Thank you.

Ladies and gentlemen, that does conclude today's conference.

You may all disconnect and everyone have a great day.