Watts Water Technologies, Inc. (WTS) Q4 2014 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Fourth Quarter Watts Water Technologies Earnings Conference Call. My name is Karen, and I will be your event manager for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. 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 a result of various factors, including those discussed under the heading Risk Factors in the company's Annual Report on Form 10-K for the year 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 refer 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. And now, I would like to hand over to Tim MacPhee, the Treasurer, Vice President of Investor Relations. Please go ahead, sir. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Thank you, Karen. Good morning, everyone, and thank you for joining our fourth quarter earnings call. Joining me today are 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 the 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 and restructuring efforts. Bob will then provide an overview of our expected Phase 1 actions regarding the Americas, Asia-Pacific transformation project, and I will offer initial outlook for 2015, highlighting some financial items to consider for this year. Bob will summarize and then we'll open up the call to your questions. So, let me turn the call over to Bob Pagano. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Thanks, Tim, and good morning, everyone. Turning to slide three 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 that 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 adjusted operating margins expanded by 70 basis points, again on a 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 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 in effort to help 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 balance capital deployment strategy. From a shareholder perspective, we increased the dividend payout by 16% and continue to execute in our share repurchase program, buying back almost 40 million in our Class A common stock during the year. And 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've been very pleased with the way the teams are working together. It is still very early but all indications are very positive. Moving to the markets, let's turn to slide four. 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 Eurozone GDP is forecasted to be positive for the first time in several years. We saw further contraction in France in the construction markets and marketing stabilities that affected our OEM, HVAC customers in Germany where we still are seeing wholesalers in OEM sitting on excess inventories. The science continued to be mix 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 and 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 and new housing projects declining. Despite the subdued macro-environment, our market strategy has not changed. We continue to see demand in China for our localized products and our most – our more highly engineered European and U.S. 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? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Thanks, Bob. Moving to the financial highlights for the year, please turn to slide five. 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 AERCO was 10.2% for 2014, a 70 basis point improvement over last year. The Americas operating margin increased 110 basis points on solid operating leverage from incremental sales, some net wholesale pricing and cost containment actions. EMEA's margins expanded 70 basis points over 2013 from sales – from savings derived from its continued transformation and restructuring efforts. Corporate cost increased during the year by $2.2 million as both people-related costs, compliance and professional fees increased year-over-year. The incremental increases in foundry cost 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 in table one of our press release. The bigger items include restructuring cost in EMEA and 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 the tax benefit against the goodwill charge, hence 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 statutory tax rate. Now turning to slide six, let's review some of the highlights of 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 in sales volume quarter-on-quarter from some incremental bad debts. The Americas operating margin excluding AERCO expanded by 100 basis points to 12.6% against Q4, 2013. Recall that we had a $3 million dollar rebate charge in Q4, 2013's 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 were 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 the U.S. dollar against both the euro and the Canadian dollar. Our adjusted tax rate was favorable in the quarter, as this included some benefit from the EMEA transformation along with a 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 guidance are highlighted in table 1 of our press release. The bigger items in the quarter include restructuring cost in EMEA relating mainly to a new set of initiatives, that I will discuss shortly, and the $12.9 million goodwill write-off in Asia-Pacific. And as mentioned, we could not 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 pre-tax loss in Q4. Slide seven provides a snapshot of our primary working capital 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 net working 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 eight, 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 reduced capital spending. This translates into a free cash flow conversion rate of 222.5% for 2014. Secondly, we repurchased $39.6 million of our common stock in the open markets during the year plus 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. And as Bob mentioned, we increased our dividend payout by 16% year-over-year as part of our capital allocation strategy. Finally, if you move to slide nine, 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 $1 million in 2014 for accelerated tax savings that were realized. Forecasted net savings in 2015 for both programs have been reduced by a total of $2.2 million mostly related to a weaker Europe. Recently, the EMEA team proactively initiated a series of cost saving measures to address the current market environment. Total costs 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 include $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 are small 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 costs. With that, I'll turn it back over to Bob. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Thanks, Tim. So turning to slide 10, I want to update you on the Americas and Asia-Pacific transformation efforts. 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 we'll update you at our Q1 earnings call. Recall by commercial excellence, I mean we want to invest in product innovations that meet the wants and needs of our customers and our end markets. We want to focus on differentiated products that will provide greater opportunity 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've commenced a portfolio rationalization effort focus 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 am not to go – 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 a 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 have already rationalized approximately $23 million in annualized sales to date, and we expect by the end of 2015 between $80 million to $100 million 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 costs supporting these sales will 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 the related fixed cost. We estimate that the losses from existing sales for 2015 will drop-through between 15% and 20% of sales. We anticipate that in 2016 that loss drop-through will be less in the mid-single-digit range. We will have exited the majority of those stranded 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 include severances and other transitional costs are estimated at $15 million to $20 million. Non-cash costs, which include asset impairment, accelerated depreciation, and write-downs are expected to total approximately $25 million to $35 million. We recognize $13.4 million in Q4 for the write-down of goodwill and other intangible impairments related to the transformation. The remainder of the costs both cash and non-cash are expected to be incurred in 2015. All these costs will be identified with 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 benefits and sourcing savings will be significantly offset by incremental costs to help 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 would like to now turn it back over to Tim, to give you an overview of how we see 2015 shaping up. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: 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 effect of the sales of the transformation effort and potential negative FX related to the Canadian dollar. At this point, we estimate that Canadian dollar will negatively impact overall Americas' sales between 0.5% to 1% year-over-year. In EMEA, where the markets are much more uncertain, we estimated organic reduction in sales year-over-year between 1% and 3%. We're conservatively planning for our market 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 drains platform, we expect to offset the rationalization effect. From operating 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're expecting organic top line growth of around 20% excluding the effect of any transformation exercise. We expect AERCO's 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 the year. So please keep that in mind when you're adjusting your models. And to reiterate, we anticipate eliminating between $80 million and $100 million of 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. Otherwise 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 cost. 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 the 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 U.S., 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 a 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, relocation and compliance costs we need to undertake in the first half of 2015 related to the hiring of a new CFO and to meet the 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 sell on 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 cost of $40 million to $45 million. Our best guess now is that we will recognize the accounting charge and related cash expenditures in Q4, but timing could be accelerated or delayed, it depends on when the IRS provides its approval. So, the 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. And as Bob mentioned, the net margin effect in 2015 on the product mix enhancement and sourcing savings would be more than offset by stranded cost related to the transitioning out of these products. So let me turn the call to Bob, who will provide his summary. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: 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 the 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 to significantly improve operating margins and ROIC. So with that, operator, can you open the lines for questions.

. Your first question comes from Kevin Maczka of BB&T Capital Markets. Please proceed. Kevin R. Maczka - BB&T Capital Markets: Thanks. Good morning. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Good Morning. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Hi, Kevin. Kevin R. Maczka - BB&T Capital Markets: Can I ask a couple of questions on this sales elimination. I guess first question is, you are going to do $80 million to $100 million this year. Did you say you'll be at that first – that full run rate in Q1 or is this something that gets phased in over the course of the year-on-year and it's more backend weighted? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: 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 rationalized $23 million of that already. Kevin R. Maczka - BB&T Capital Markets: Okay. And then I, I mean, 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 15% to 20% decremental on those sales which would mean this is about a $0.30 or so earnings hit this year. Can you just talk about why those – why those decrementals would be as much as 20%? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Sure. I mean, you're right that it's low margin business in the start, and we exited 100% of it immediately and all the costs associated with it, you know, it would drop much less. But what's happening is, because of the timing of when we can shed the fixed cost as well as support our existing customers during that transition, it's dropping more at the gross profit level versus the operating income level. So it's going to impact us more, but the whole goal is to transition all the costs out by the end of this year. So 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 drop. Kevin R. Maczka - BB&T Capital Markets: Okay. Got it. And then just one on the Phase I Americas and Asia-Pac. I guess is the $10.5 million savings, is that all coming on the sourcing side and the sourcing benefit that you expect in 2015 to $4 million. I mean, it doesn't seem like a huge number for a company with almost a $1 billion cost of goods line, and I would think maybe it seems like lower copper alone could give you some pretty material savings next year, can you just address that point? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Yeah. Kevin. So, we look at sourcing in three buckets, right. 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 is 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, so it takes longer to implement. So 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. Kevin R. Maczka - BB&T Capital Markets: Okay. Great. Thank you. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Thank you. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Thanks.

Thank you. Your next question comes from Jeff Hammond, KeyBanc Capital Markets. Please proceed.

Hey. Good morning guys. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Good morning Jeff. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Hey Jeff.

Hey. So just to follow on the sales transformation. Why not sell the business versus kind of exit? And, it looks like your – I was kind of just going through the math, you are losing kind of $15 million in op profit as you transition out. How do you see yourself replacing that through other means? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Well, yeah, we've looked at all alternatives, and we're continuing to look at it. It's a low margin business, and when you look over the history, we look for the last five years, and what we've seen in this business and margins continued to deteriorate. So, we made the strategic decision to take the action now. And we'll look at all alternatives, but given the disparity of the business in all the different locations, we believe that maybe difficult to do that. So 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. So, we'll continue to do that, but now is the time to exit this business where we could take control of it, make the decisions and drive the changes in our organization. And 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 in distribution channels.

Okay. Great. And then just on FX, struggling a little bit with the drop through the earnings impact. Can you just walk through what you think the revenue headwind is? And then maybe how to think about translation versus transaction? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Yeah, sure. The way we're looking at it Jeff is, from an EPS perspective, maybe it's an easy to way look at it is, with the euro, right now we think we have about a $0.20 headwind and that's a difference between – the current rate that I use was about $1.14 versus our average rate in 2014 was about $1.34. So to us, as we mentioned before, it's about – for every one rate – one point movement in the rate, it's about $0.01 to us an EPS. So it's about $0.20 on the euro. It's probably another $0.03 to $0.04 relating to the Canadian dollar year-over-year. And then finally, within the $0.25 to $0.30 is transaction effect year-over-year. We think we'll have some transaction affect to the tune of a few pennies year-over-year. So that's why we're in the $0.25 to $0.30 range from an EPS perspective.

So, what's kind of the – what do you think is the FX revenue headwind on? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Probably – from a percentage perspective, probably 13%-14% year-over-year.

On the Europe business? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Yeah, on the Europe business.

Okay. And 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 kind of the three ways you've kind of gone after sourcing? What kind of the total savings is as you kind of incorporate this new $10.5 million piece? Thanks. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Well, all in, we don't give specifics in total by each commodity in 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. But the unique thing of copper inside of our EMEA is actually a slight headwind, in that, each, the copper commodities done in U.S. dollars and with the, copper has come down but the euro has come down even further. So it's actually a small tailwind or a headwind for them. So 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 cost savings offset by the net inflation.

Okay. Thanks, guys. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Thanks. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Yeah.

Thank you. Your next question comes from the line of Joe Giordano from Cowen. Please proceed. Joseph C. Giordano - Cowen & Co. LLC: Hi, guys. Thanks for taking my question. Just one quick clarification on the one you said on euro. Is it every $0.01 of euro decline is a $0.01 of EPS or is it like 1% decline is a $0.01 of EPS? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Every $0.01 of euro decline is a $0.01 to our EPS. Joseph C. Giordano - Cowen & Co. LLC: Okay. Okay. That's what I thought. Okay, great. And then can you guys kind of talk a little bit about management bandwidth to handle? I mean there is like four programs going on now, you still – you're looking for a full time CFO. How do you guys look at handling everything that's on the plate right now? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: So 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've even relocated the project management PMO officer from EMEA to lead our North America efforts. So we're bringing in 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 has been on for almost a year now, and he's developed a new team to implement our global sourcing initiatives and/or on the world. And finally on the CFO search as Tim alluded to, we're real close to finalizing our search. We hope to have someone on board in the next couple months, and I think you guys will be pleased with the individual who we are thinking about, so stay tuned for that. So 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'll bring outside help where we need to supplement that. But right now, all the action plans are loaded and we're ready to implement beginning at 11'o clock today. Joseph C. Giordano - Cowen & Co. LLC: Okay, great. And then two kind of like housekeeping ones. One is the $13 million in incremental spend that's off like that $35 million corporate number for 2014 right? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: That's – you have to spread that out, about $6.5 million is corporate, Joe, the $5 million would be in the Americas, $1 million is in EMEA and then about $0.5 million in Asia-Pacific. Joseph C. Giordano - Cowen & Co. LLC: Okay. Great. And then lastly from me, you mentioned EMEA on the guidance for one to three of an organic decline and then I thought, I heard you mention 1% of a rationalization also. So, is that like a 1% rationalization decline on top of a 1% to 3% organic decline of the go-forward business? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Yes. Joseph C. Giordano - Cowen & Co. LLC: Okay. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Well, but offsetting that is our new product development and new innovations that have been launched. So... Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Right. Joseph C. Giordano - Cowen & Co. LLC: Would you think will offset those rationalizations? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Yeah, the two offset. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Two offset. Joseph C. Giordano - Cowen & Co. LLC: Okay. Great. That does it for me. Thanks, guys. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Thank you. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Thank you, Joe.

Thank you. Your next question comes from the line of David Rose, Wedbush Securities. Go ahead, please.

Good morning. Just couple housekeeping items. Should we expect any inventory obsolescence going forward? I mean, did you have any write-down in Q4 for the product rationalization and should some of that go into 2015? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: So, when we look it, 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've provided, but our goal is to sell all of it as much of it as we can during the process or sell it as part of a product or asset sale.

Okay. That's helpful. And then, it sounds like we're pretty much finished on the foundry, but what are the remaining challenges you have left on the foundry, shall we all talk about it anymore? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Well, I was hoping to get away again, another meeting without talking about the foundry, but I must tell you, the fourth quarter was our best performance of the year, it's 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. So, the teams are working. Now that we've stabilized the process which we've done for several months now, just we've seen the steady improvement. We can throw more volume inside of that and start leveraging it. But again, we're doing it slowly and cautiously because we don't want to disrupt what we've already accomplished. So we've stabilized that, we have backup capabilities now in all our processes and the teams moving slowly but surely, and I think that's what it's going to take. Anytime we throw large volumes in it, it disrupts the process. So we are slowly gearing it up and that's what we'll continue to do for the rest of the year. So as far as we're concerned, that's a non-issue. Let's hope at least internally for us, we're just focused on the continued improvement – more of a continuous improvement process.

Okay. And then – that's helpful. And then lastly, can I assume the byproduct for this rationalization apart from enhanced margins is better working capital? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: 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 – inventory turns is a key focus of our initiative as we drive and grow our ROIC.

So do you have a goal for us for 2015 or 2016 on that front? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Stay tuned, because I really want to talk about Phase 2 and the impact of that on it. So, certainly we have our stated goals that you're well aware of 12% and 12% operating margin and 12% ROIC on an adjusted basis, but our goals are certainly north of that.

Okay. Great. I'll stay tuned. Thank you. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Thank you.

Thank you. Your next question comes from the line of Jim Giannakouros from Oppenheimer. Please go ahead. Jim Giannakouros - Oppenheimer & Co., Inc. (Broker): Good morning. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Good morning, Jim. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Hi Jim. Jim Giannakouros - Oppenheimer & Co., Inc. (Broker): Just not to focus too much on the near-term earnings reset as you transition what appears to be primarily your retail exposure, I know you don't give guidance Bob, but can you speak to your longer-term vision whether it'd be a three-year or five-year plan as far as the sales margin, earnings, target? Basically thinking – 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 what – some of that in your Phase 1 detail? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Yeah. Well, David just asked that question in a different way, but really look at – we're a premier company, we're number one or two in most of the markets and brands we serve. And I believe we need to command a premier operating margin and ROIC. So that's our focus, that's our goal and this is a critical step. This business that we're exiting has been an anchor on us and it's been slowly eroding and it's really had – it's really deep focused our organization on our core and what makes us great. So 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, and we believe we should have the opportunity to significantly increase that going forward. So we need – 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 an AERCO, that has high EBITDA margins and that's what we're focused on. Jim Giannakouros - Oppenheimer & Co., Inc. (Broker): Okay. Understood. And just so I understand your Phase 2 correctly and that will be primarily or all on the expense side, and you've identified the sales impact predominantly in your Phase 1, is that the way to think about it? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Yeah. 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're in, and the proper distribution channels and strategies inside of that with our warehouses and distribution channels. So that's what the next step is, and before you could make that decision, we have to make the first decision to make, determine what businesses we are going to be in. Jim Giannakouros - Oppenheimer & Co., Inc. (Broker): Got it. Okay. And then one last one if I may. In Europe, you've been at it now for a couple of years on the transformation. I know that's some or many of the benefits there have been on the tax line with more to go. Could you just give us an idea of, at this point, what your tax rate is in the region versus what I imagine is a mid-30s to high-30s in North America? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Yeah. I think, right now, Jim, we're probably in the 28%, 29% range. Jim Giannakouros - Oppenheimer & Co., Inc. (Broker): Okay. Thank you. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Thank you.

Thank you. Your last question comes from the line of Kevin Bennett of Sterne, Agee. Thank you. Go ahead please. Kevin Coogan Bennett - Sterne, Agee & Leach, Inc.: Hey good morning guys. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Good morning, Kevin. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Hey Kevin. Kevin Coogan Bennett - Sterne, Agee & Leach, Inc.: 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, and I'm just wondering what gives you confidence that it will only be down 1% to 3% next year? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Well, I think because it was down 5% in Q3 and Q4, the team is really, 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 quarter and fourth quarter, which never materialized. So I think there are inventory adjustments going on. I think some of the inventory adjustments happened in Q4 in particular. So I think now that – I think we'll probably see that in Q1 again this year, but the goal really here is, we believe that there are opportunities to grow. Internally, we're assuming a 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. So 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. So, the core concern as you can imagine is Germany, Italy, and France. Those are our key areas. We're focused real tight on those areas and watching that very closely. So, all in all, we netted the pluses and minuses, and we think we will be in the 1% to 3% range considering all those things. Kevin Coogan Bennett - Sterne, Agee & Leach, Inc.: Okay, that makes sense. And then, in terms of M&A, how high would you guys be willing to go on the leverage side if another AERCO came along? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Well, we don't speculate on things like that. We certainly will look at all opportunities that come our way that makes sense to us from a strategy point of view, that's the first gate. Does it make sense, does it tie to our overall strategy in the company, does it add value added and how does it fit into the overall structure of the company? So, we'll look at any and all acquisitions, but I can assure you, we're going to be disciplined in making sure that we have the bandwidth to manage an acquisition integration, given all the things that we have going on right now. So, our key focus right now is to integrate the acquisition we have which is going very well and implement in particular this North American transformation plan, which I think has significant value to be add on that. So that's our key focus right now Kevin. Kevin Coogan Bennett - Sterne, Agee & Leach, Inc.: Okay, that makes sense. I guess, different way to ask it, I mean, in terms of debt to cap or net debt to cap, I mean, do you have a range that you like to be in or that you are comfortable with? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Right now Kevin, I think – we would like to be between 35% and 45% debt to cap. Kevin Coogan Bennett - Sterne, Agee & Leach, Inc.: Okay. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Right now it's in the high 30's. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Yes. Kevin Coogan Bennett - Sterne, Agee & Leach, Inc.: Okay. Thanks Tim. And then last question from me, on the pension settlement, how much do you guys expect to save in the future by doing this? Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: If it gets settled this year which we hope it does, we expect to save approximately $4.5 million to $5 million. Kevin Coogan Bennett - Sterne, Agee & Leach, Inc.: Is that per year or just overall? Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Yeah, our costs go down starting in 2016. Timothy M. MacPhee - Treasurer & Vice President-Investor Relations: Our costs go down in 2016, yeah, by $4.5 million. Kevin Coogan Bennett - Sterne, Agee & Leach, Inc.: Got you. Okay, perfect. Thank you guys. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: Thank you.

Thank you ladies and gentlemen. I would now like to turn the call over to Bob Pagano for closing remarks. Robert J. Pagano - President, Chief Executive Officer, CFO & Director: In closing, I'd like to thank you for taking the time to join us today for our Q4 earnings call, and 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.