A O Smith Corp (AOS) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the A. O. Smith third quarter earnings conference call. At this time, all lines are in a listen only mode. Later, we will conduct a question and answer session. Instructions will be given at that time.

(OPERATOR INSTRUCTIONS)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Director of Investor Relations, Craig Watson. Please go ahead, Sir.

Good morning, ladies and gentlemen, and thank you for joining us on this conference call. With me this morning participating in the call are Paul Jones, President and Chief Operating Officer; Ken Krueger, Chief Financial Officer and John Keeda (ph), Treasurer and Controller.

Before we begin with Paul's remarks, I'd like to remind you that some comments that will be made during this conference call, including answers to your questions, will constitute forward looking statements. These forward looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in this morning's press release. I'd also like to point out that we have posted slides on our website so feel free to follow along while we conduct the call. Paul?

Thank you, Craig. This morning we announced third quarter net earnings of $3 million, or 10 cents per share. As previously forecasted, pretax earnings were at breakeven for the quarter. The net earnings of 10 cents are primarily the result of revising the income tax rate for the year.

The tax rate has been revised due to the change in the geographic composition of the year's earnings.

Sales in the quarter increased 9 percent to $390 million as a result of a 7 percent increase at Electrical Products and a 12 percent increase at Water Systems.

Despite significant improvements in operating income resulting from our repositioning program at Motors and new product introductions at Water Systems, operating earnings were approximately breakeven during the third quarter. Operating income at Electrical Products increased primarily as a result of the higher sales and the repositioning program that was completed last year.

These positive factors more than offset higher costs for freight and raw material, particularly steel. Unfortunately, higher cost for materials and freight and operating inefficiencies at Ashland City more than offset improvements from new product introductions and higher prices at Water Systems.

However, production at our Ashland City water heater plant improved nicely during the quarter. And we are now operating at normalized efficiency levels.

One additional recent event to mention is that Chris Mapes has joined us as President of Electrical Products. Chris brings a wealth of experience and talent to this important position. And we are delighted he is on our team.

Going forward, we have adjusted our recently reduced 2004 estimate to include the revised tax rate and now project full year earnings to range between $1.05 and $1.10 per share. Fourth quarter earnings will be challenged by the raw material increases we have been experiencing all year. To offset these cost increases, we have announced substantial price increases at both of our businesses which will take effect in the first quarter of next year.

Now Ken will go over the results in more detail. Ken?

Thank you, Paul. During the third quarter, sales increased 9 percent from last year to $390 million. Sales were 12 percent higher at Water Systems and 7 percent higher at Electrical Products.

As Paul said, operating earnings were approximately breakeven in the quarter while net earnings were $3 million or 10 cents per share. An adjustment to the income tax rate accounted for 8 of the 10 cents in earnings. The reduction in earnings due to material cost increases has primarily impacted U.S. earnings, shifting a larger portion of our earnings to Mexico and China, where our income tax rates are very low. This shift caused our annual consolidated tax rate to fall from 33.5 percent to 28 percent, which improved net earnings by approximately $2.3 million.

I'd now like to discuss some of the details of third quarter performance. Our gross profit margin of 15.9 percent was lower than the 17.3 percent generated last year, primarily as a result of the higher cost of raw materials and freight. Selling, general, and administrative expenses were 14.7 percent of sales compared to 13.7 last year.

The increase resulted primarily from increased selling expenses and lower pension income.

We generated 15 million of operating cash flow during the quarter bringing year-to-date cash flow to 26 million. Working capital investment was neutral in the third quarter as receivable collections offset a modest increase in inventory and a decline in accounts payable balances. Days receivable outstanding were 63 compared with 57 last year. Inventory days were 72 versus 76 while payable days fell from 45 to 41.

Cash cycles days were 94 compared with 88 last year. In addition to increased days, receivables were higher due to increased sales volumes and improved pricing.

Capital spending was $9 million during the quarter and $30 million through the first nine months of the year. We are protecting full year capital spending to be similar to last year's level of approximately $45 million, lower then projected depreciation of approximately $51 million.

Our debt to capital ratio of 33 percent was flat compared with the second quarter and slightly higher than the year-end ratio of 32 percent.

Now I'd like to move onto a discussion of operating performance in our Electrical Products and Water Systems businesses. Sales of 216 million at Electrical Products were 7 percent higher compared to the third quarter of 2003. Sales to the pump, ventilation, general industries and Asian markets all increased by more than 15 percent while sales to the HVAC market were flat. Operating and earnings increased to 12.6 million from 9.6 million last year as contribution from the $15 million sales, increased combined with savings from the repositioning program, offset increases in cost per raw materials and freight. Relative to sales operating margin was 5.8 percent compared with 4.8 percent last year.

Order systems' third quarter sales of $174 million were 12 percent higher than the third quarter of last year. The sales increase was driven by modestly higher unit volume for residential product, as well as higher prices related to the introduction of new regulatory mandated product. Commercial sales improved more than 10 percent.

Also contributing to the sales increase was continued strong growth in China and price increases to offset higher costs for steel and freight. Sales in China increased nearly 30 percent to $14 million.

Water Systems experienced a $2 million loss, a significantly higher cost per raw materials, freight, and operating inefficiencies more then offset the benefit of the sales improvement.

As we have discussed in previous conference calls, we implemented a number of conversion programs in our Water Systems business beginning in late 2003. These programs included the conversion of residential water heater products to meet new efficiency standards, standardization of the A. O. Smith and state residential product lines, relocation of production between the Ashland City and Macbee (ph) plants and an informational systems conversion. These programs have particularly affected the Ashland City plant in Tennessee.

We typically measure the plants' efficiency by tracking man hours per unit. As a result of the disruptions from the conversion programs, this measure peaked in July. As a result of efforts to improve parts availability, production scheduling, line balancing and manning levels, man-hour per unit have improved by 30 percent and are now at normal levels in Ashland City.

Throughout the year, our businesses have faced cost pressures due to increases in the price of steel, aluminum and other materials, as well as higher freight costs. Several price increases have been implemented in an effort to offset the cost increases. Costs have continued to rise. During the third quarter, material and freight costs were approximately $23 million higher than 2003. While our price increases mitigated this impact, they didn't cover all of the cost increases.

In order to cover these costs, including anticipated increases, we are again implementing significant price increases in both of our businesses which will take effect in the first quarter. We are working our way through a very challenging time. In spite of the challenges presented by the commodity cost increase, our financial position remains strong and the benefits from our new product and process improvement initiatives have taken hold. We continue to be very enthusiastic about our longer-term prospects and we look forward to reporting on our progress in January.

That completes our opening remarks and we are now ready for your questions.

As a reminder, please limit your inquiries to one or two questions at a time so that everyone interested has an opportunity to participate. Operator.

(OPERATOR INSTRUCTIONS)

Michael Schneider from Robert W. Baird.

Just, first, obviously, on the price increases, it's a big swing factor for '05. I've learned the exact percentages and presume you don't want to talk about them, but can you -- can you tell us what they imply for margins and water heaters in 2005? You've said that you expect, after the price increases, to restore reasonable profitability. What is that number?

As you know, longer-term, what we have talked about is the target margins for both of these businesses at 12 percent EBIT kind of returns. Given the term while it has gone on in the, especially with the steel profit increases -- freight, aluminum, resins -- just many of the factors that go into making the water heaters, we have been put in a position where we need to take those cost increases and essentially pass them down the line to our customers and eventually to the end consumer.

I expect that that is going to take a little time to get back up to our normal and our target rates. I would expect that, if we could be in the 8 to 10 percent kind of EBIT range for next year, that would mark a very successful implementation of the price increases in order to offset the costs.

And that is 8 to 10 percent in water alone, right?

That is right.

(MULTIPLE SPEAKERS)

And, again, that is assuming success of the price increases from stabilization, although we do anticipate further increases on the steel costs.

And can you tell us how the market has received the price increase thus far? Because as I understand it, none of the other competitors have announced a similar price increase at all.

This is Paul. There are a couple of recent announcements that are starting to come out but it is way too early to tell, Mike.

The operations themselves. Ken, the guidance went up and end midpoints call it 7, 7.5 cents. Yet you had 8 cents or more now, I guess, looking at the fourth quarter benefit from the tax rate. So does that imply the operations are actually even slightly behind what you were discussing back in June and July?

The intent was to move the guidance up just acknowledging the tax rate improvement. The differential at 2 cents, I guess I view as de minimus. The operations as we said back a couple of weeks ago, we really expected breakeven operating results in the back half of the year here.

Basically, we are absorbing the cost increases for the last half, passing it on again to our customers, and hopefully to the end consumer beginning next year. So there is really no change in the operations, I guess. I kind of rounded it off to 2 cents.

Fair enough. And final question. Just on the productivity in Ashland City. You said man hours per unit is back to normal levels. Does that account for working Saturdays, working overtime, working doubletime, Sundays?

We are not doing any of those things anymore, Mike. We are not working overtime. We are -- the efficiency levels are moving up. We are getting the output every day on a straight 8 basis. And the manhours per unit have continued to improve. It is really a very positive story, especially over the last couple of months.

Scott Graham, Bear Stearns.

I was hoping that you guys might be able to give us a split price vs. volume of sales for each business unit in the quarter?

Yes, essentially, I would say that probably in both, it does vary a little bit. So I will go through it. The Electrical side, the increase in sales is probably about 60 percent related to price and about 40 percent other.

On the Water Products side, I guess I'm going to include the change in the product, the (indiscernible) introduction adds price. And if I do that probably close, again, about 75 percent of the sales increase is price-related.

And Ken, are you also including, in that, flammable vapor?

Well flammable vapor there was not a large impact because flammable vapor came out in July of 2003. So there was some relatively modest incremental impact for flammable vapor.

That is helpful. You guys talked about working hard with your suppliers from here to negotiate better pricing on your inputs. Could you talk to us about what, specifically, you guys are doing and success to this point?

Yes. What we talked about is making sure that we were giving competitive as good a price for our inputs as any of our competitors. Now the steel industry has been very dynamic and you've seen a lot of discussion on Wall Street Journal and other places about the shift from the contract to the spot market. Basically the steel folks, not living with the contract prices during the year, introducing surcharges, and really endeavoring to moving forward to kind of close the gap between the contract and the spot prices. And I think a lot of folks, including ourselves, are seeing that.

When we talk about it in any anticipated cost increases, it's really steel we are thinking about.

So we have -- on the input side, the biggest input, obviously, is steel. We have been doing a lot there. On the freight side, we have been doing a number of things not just with price but in making sure that we are taking and paying close attention to making sure that our trucks are fully loaded. Making sure that we have an efficient routing, both for intercompany as well as customer shipments, and doing a lot of operational things there. Trying to mitigate the actual price changes.

And as you know, we run a program for our second largest import which is copper to basically pay attention in the futures market and try to buy back smart.

Last question. The initiatives that have taken place in Water Systems and to the extent that there are still some savings left from the Motors repositioning, on a go forward basis, what would be the operating income impact now that the quarterly cost of inefficiency is now behind us? What can we expect dollarwise out of Water Systems from here from a benefit standpoint? And is there anything left to still run through the P&L in Electrical Products?

Part of the frustration of this year as we came into this year talking about things, like the repositioning savings from shifting the U.S. operations from the U.S. to Mexico. And we have achieved all of those savings. It has just fallen under this big wave of price increases so on the Motors side those cities are largely in place. What you'll see is maybe a slower increment of savings over the next year or two as we continue to move more product into China. Our Shenzhen plant to operating the sea frames is now operating at capacity levels of 40 to 50,000 units a day.

We are beginning to see coming online pump and fan motors out of our Shenzhow (ph) operations. And we are thrilled with the amount of sales that we are getting on the hermetic side out of the operations near Shanghai and Shezhou (ph).

So you'll see some incremental improvement from there. This is all over and above the normal things you do from just a day by day continuous improvement effort.

On the Water Systems side, we've said before that the plant inefficiencies and the difficulties as we went through those conversion programs was costing us in the range of $1.5 to $2 million a month. That is now behind us.

We will begin to garner some of the savings from now having the product relocated between consolidated in Ashland City on the residential side and commercial in MacBee (ph). We are now able to make and we are making some of our state branded heaters in El Paso Juarez and that allows us to better serve the West Coast. We have said before that's got about a $5 million annual savings take to it. So as we see those things start to bleed into the equation as we enter 2005.

Having said that, the big story for 2005 is going to be the price increase in place in order to offset all the commodity cost increases.

Matt Summerville from McDonald Investments.

A couple of questions, Ken. How much of the raw material related price increases that you have implemented year to date have you actually gotten? And then has the absolute level of success you have been having improved? Or has it diminished?

Yes, I think, Matt, you're focusing on the price increases to offset the raw material.

Yes.

I am not going to say we are batting 1000. But we're certainly -- the previous two price increases we put in place in both businesses, we have been largely successful. In the case of and I'll maybe take them one by one. On the Motors side as you know we put about a 3.5 percent increase way back in March, April, and one that ranged in the 5 to 8 kind of ranged in summertime.

Largely successful. What I will say is that we had contracts with some larger customers and we didn't necessarily gain all that price increase from them. So as we put the general price increase into place here in the fourth quarter, we will be going back to them. And not only for the general price increase but also the accumulative effect of the cost increases that we weren't able to pass on to them earlier in the year.

On the Water Systems side, again, some general price increases both in the spring and the summer have been largely successful. We do need -- again, those were the general price increases. There, our specific contracts are with the retailers and we do need to go back and work with them as we head into 2005.

And then if you look at the tax rate situation. Was the 28 number you cited your full year effective rate?

That is the full year effective rate at the current earnings projection. So I expect that will be largely in place for the fourth quarter.

Do you have any early thoughts on '05 as far as taxes there as well?

Our objective has been to bring the tax rate down a half-point every year. Now we got a little help with that earlier in the week with the Tax Act although I'm going to tell you I haven't quite calculated how that rolls in over the next three, four, five years. But our objective would be to have our tax rate in that 33 percent kind of range next year.

And you talked about a thing in the Water side. Can you delineate a little bit between residential and commercial volumes and then I would assume, given some of the hiccups you had at Ashland City, you maybe lost a little bit of market share, whether or not you have been able to regain that?

Yes, actually, the units were up on both sides in residential and commercial in the third quarter. Residential somewhat modestly; the commercial units, I believe, were up in over the 10 percent kind of range. We have said before as a result of some of the disruptions we had in the plant, as a result of all these programs, that we had some delivery issues and we lost some modest amounts of share in the first half. I am looking, really, for stability of share in the third quarter. I don't think we have regained any of that little bit that we lost. But I also don't think that we have lost any more.

And then lastly, can you give an update -- I know this time of year is usually around where you wrap up your copper strategy for the upcoming year. Just update in terms of where you are with that?

Yes. As you know, we typically buy copper ahead about a year so as we get to the end of a calendar year, it is pretty logical to assume that we are largely bought for next year and that would be the case.

And then any color in terms of what the kind of magnitude of increase you are looking at there?

Well as you know we don't talk about the price we hedge -- we do that to be a competitive number, but as you can see in the marketplace, copper spots this time last year was in the 80 cent range. Last week it had been -- or earlier this week, actually, it was at $1.47 a pound. It did drop 15 cents yesterday.

A big move. But it's been running in the $1.35 to $1.40 range. So you are looking at copper cost increases in the 75 percent kind of range.

Richard Gameron, from Argus Research.

You mentioned a very challenging time. Could you provide a brief, obviously, a macro outlook for the economy? Maybe your industry for the remainder of 2004 into 2005?

Yes. I'm not sure I am capable of a widespread macroeconomic view that the body would be interested in. What I was really focusing on was the commodity cost increases and how they have impacted our business. We just talked about copper being up 75 percent in the market over the last year or so. Everybody has seen what happened with cold rolled steel and scrap, again, double sometimes triple digit kind of increases. As a result of the changes in the driver laws, and the recent run-up in oil prices, freight has been a big impact on us.

Same fuel costs have also impacted our resins and plastics and I think it's going to be -- we are facing a situation, therefore, in the sort of the economic scenario where commodity cost increases have increased dramatically. We are a manufacturer of products that consume enormous amounts of basic commodities. We have absorbed a lot of that cost in the back half of this year. We simply need to get it down the channel to the end consumer. So I guess, maybe from a macroeconomic standpoint, I am a little concerned that a lot of projections that I see about consumer inflation being, again, low next year are probably optimistic. Because we have got quite a bit of costs caught up in the manufacturing channel. The manufacturing and distribution channels have been squeezed hard by the retailers and consumers for a long period of time. There is not enough margin left in those channels to be able to cover these costs.

So that is going to drive, I think, consumer inflation as we get into next year.

I think the other aspect of it is, is over and above the basic commodity increases, sort of the practices in the steel industry are going to compress any difference there used to be, historically, between contract buyers and spot buyers. And that is going to cause further pressure on our steel cost.

How about -- how problematic are health care costs? Are they impeding any hiring activity there?

They are not impeding any hiring activity. They are for us in the 12 to 13 percent range, better than it had been two or three years ago. A little worse. We had a small 9 to 10 percent kind of increase here in '04. It seems like the pace of it has picked up a little bit. To be candid, our attention has been so much focused on the commodity side that a 12 to 13 percent cost increase seems modest.

Michael Schneider. Robert W. Baird.

Ken, the price increases on the motor side. Could you give us a similar number? If all else is stable where you expect EBIT to fall or what way range EBIT to fall into as a percentage if you do indeed realize all the price increases that have been issued?

Sure. And again, as you know, long term, our target is to be in that 12 percent kind of EBIT range. But a similar kind of story, given just how quickly and how large the cost increases were to us. As we get them passed down the line, that is not going to happen instantaneously. It is not going to recover everything. And I think that same kind of 8 to 10 percent for the year, assuming the price increases go through as we anticipate them to, would be reasonable.

In January of '06, the (indiscernible) ratings or most unitary elements go from 10 to 13. Could you tell us what that means for your Motors business?

We have the capability to supply the compressor industry to meet the 13 rating now and to supply either reciprocating or scroll. So what it means for us is we need to make sure that we work with our customers to make sure that we are keeping our technology up-to-date, in order to meet their requirements for efficiency on the compressor side.

Are there higher ASPs for these motors?

I believe there will be but to be honest with you -- that's farther out than I've got visibility into right now.

A lot of the discussions we are having with our customers now on 13 C are looking at the whole systems cost not just the Motor. And there's a lot of things that can be done there, working in concert with our OEM partners to meet 13 C at a cost-effective matter. The motor being a part of the equation, but not the whole answer.

On the water heater, market, you lowered your expectations for market growth in '04 on the last call to, I think, 1 percent, is that right Ken?

Yes.

And the industry year-to-date? I've seen icing the numbers through August from Gamma is down 4.2 which means that the business has got to be up high single digits in the remaining four months. Is that really realistic, still? Or is the minus 1 percent still even optimistic?

Well, when we obviously changed the expectation from a little bit of growth to a 1 percent decline in the market, we didn't have visibility into the market numbers that you are referencing. I guess I would have to agree with you that the expectations for market growth may be even more modest than -1, given that we are through eight months of the year and we are at -4 now.

Final question on pension expense. What will it be this year and what are your early thoughts on '05?

We are expecting this year to be about $6 million credit. Next year, and as you know, there's a fair amount of variables depending on what the final discount rate is and what our actual earnings are this year. But we would expect next year to be in expense in kind of a 1 to 2 million range or so.

So roughly a $7 to $8 million swing?

That's what I am guessing it would be.

Kieran (ph) Hurston (ph), Midwest Research.

Just an outlook on the -- each AC market for the -- was flat in the third quarter. Was wondering what you see for that for the fourth quarter? And maybe if you have any visibility into '05?

The fourth quarter, typically, is the slowest market for -- slowest time of the year for HAC and I wouldn't expect to be a lot different. Sort of flattish to last year. '05, this is a GDP kind of market growth. It's about 60 percent replacement or plus. So it is kind of stable; and it is really driven by the spring season in the northern half of United States. Early hot weather tends to create a good year for the HVAC market and if we have a cool wet late spring, early summer we tend to have a poor year. So it's really weather-driven, Kieran, and I'm not sure that it is, therefore, terribly predictable.

Yes. I can appreciate that. How about the other -- the general industrial seemed to be doing pretty well. What is the outlook for that?

Generally, industrial is doing pretty well. I think it is on its third year of pretty good growth after just a terrible six or seven years, really. We don't play a lot in that market. But everything I see and read is that General Industrial continued to do okay. Maybe the growth is tempered a little bit.

Matt Summerville, McDonald Investments.

Couple of follow-ups. On the price increases in Motors, Ken, year-to-date, it looks like based on your discussion earlier in terms of how much revenue growth came from price vs. how much came from volume, it implies in the third quarter you got about 4 points of price. So should I assume the reason that that 4 isn't more like 8 or 9 alongside what you kind of talked about as putting out there on a cumulative basis relates to some of these long-term contracts? Or is that -- or is it more just general pushback?

It's more the former. I would also -- the second price increase wasn't fully effective for the entire third quarter. So those are really the two elements that take you from the 8 or 9 range down to the 5 range.

I've noticed. On the balance sheet inventories crept up for three sequential quarters. Can you talk about what's behind that and when you should start to see that reverse trend?

First of all, just preface it with, we're not at all happy with levels of the inventory. On the Water Heater side, while we talked about the disruptions of those programs and the impact it has had on the manufacturing inefficiencies, it also had a negative impact on the inventories. And, basically, we had a difficult time getting our production schedules, our manning, and our inventories in line with customer demand after having gone through all of those transitions. We do believe we have got the nature of the inventory if not the volume optimized to customer demand now. But it is at too high a level.

Similarly on the Motor side as we went through the repositioning back in late '03 and '04, part of what we did to get through that, and not disrupt customer service, was put stock in both in general and to specific customer safety stocks to make sure that we maintain supply through those transitions. And we have not burned through enough of that safety stock in that set-aside inventory to cover the transition.

What is the effective date in '05 for this next round of price increases? And should we assume that this third round -- if that is what it is -- is greater than what you've already done on an accumulative basis, at least in motors?

Yes. First of all, the effective date will be early in the first quarter. And it would be safe to assume, given our cost increases, that the last one would exceed the accumulative effect of the first two.

(OPERATOR INSTRUCTIONS)

Scott Graham. Bear Stearns.

Hi, Ken, can you give us the split between finished goods and raw materials in inventory?

Yes. Hang on. We're doing some calculator work.

It is about 60 percent to 65 percent of finished goods. With -- then the majority, then it's split by about 20, 25 percent raw and then the rest whip (ph).

I mean, all things considered for the quarter, not such a bad number. I'm sure that you're disappointed with the overall absolute number of dollars in inventory but it doesn't seem as if things got so much worse, given what went on in the quarter.

No. I don't think our inventory issue got any worse during the quarter. The disappointment was, it didn't get any better. We need to get a lot of those finished goods off-the-shelf and into the customers' hands. And you're right, Scott, it's not as though we have got a big buildup of raw or whip or anything of that nature, but we do need to get our finished goods done.

We should get cash out of working capital in the fourth quarter? Yes?

The fourth quarter will be a generator of working capital. Yes.

Here's a question that I expect you are going to have a difficult time --

Can I rephrase that. It won't generate working capital. It will generate cash out of working capital.

I'm with you. Just bringing a perspective on this. I know you can't answer this question in absolute terms. You're out there now, in the market, with announcements -- I presume announcements to your customers of at or near double, at or above double-digit price increases coming down the pike for January 1st. We have been here before. And what essentially happened in the Water Heater business was the pre buy was so massive that it disrupted, really, two quarters of your earnings. What is your perspective on buy for one of these price increases?

Well I will tell you how we are going to operate. We are not going to run overtime, we are not going to do drop ins, special deals. We are going to run our plants per the production plans, per the estimated demand that we're going to see into next year. So that we don't get in a position of overrunning the facility in the fourth quarter and then having nothing to work on in January and have much, much higher cost. As has been mentioned before, we have a lot of inventory and we will sell any of that inventory that our customers want in the fourth quarter and we will sell anything that comes off the production lines. But we are not going to be participating in the so-called prebuy type of operating mode that has been in this industry in the past.

(MULTIPLE SPEAKERS)

It seems to me that that only licks (ph) the question halfway. In that you are not going to run your factories out to meet excessive demand, which is cutting off your nose to spite your face. I'm with you. But if you sell off all of your finished goods, you walk into next year with probably about a quarter's worth or certainly at least half a quarter's worth of sales that are either going to be zero volume or could have a significant pushback on volume. Let's put it that way.

It will have an effect on the volume. There's no question about it. But I will point out that we do a shutdown at the end of the year for maintenance and facilities. We have to cover 12 days of sales during that time period. And based on looking at what's happened in years past, we think we are going to be able to get through the fourth quarter and the first quarter without having to have a significant plant shutdown or take days off or lay off or anything early next year. Time will tell. It depends on, obviously, what happens in the marketplace. Our price increase is in effect at time of shipment. And we set a date for that and that is what we're going to adhere to.

So you are driving (ph) to the fact here that this 2005 like 2004 and what we were expecting I think in 2003 before that, before we had disruption, that 2005 will be another backend loaded earnings year?

I'm not anticipating, Scott, that the prebuy even coming out of the inventory as it will in the standard manufacturing schedule is going to be that significant; that is going to shift what -- our historic pattern is for about 55 percent of our earnings to be in the first half of the year, 45 percent in the second half. We could have a prebuying impact and it may shift some from the first quarter next year into this year's fourth quarter. But I am not looking for to be of any kind of significant impact where it is going to change the calendarization of earnings for '05.

We have got the processes in place. The good news about this being the third price increase in eight months which -- while you hate to do that, we have got the prebuy process pretty well nailed down and we hope to be able to manage there.

Let's continue sort of, unfortunately, the devil's advocate side of it. What about pushback? It's not as if these are significantly value-added products. And a third round of price increases with a third one topping the accumulative of the previous two, what's been the initial customer reaction to this?

The customers, obviously, are having discussions with us. And our philosophy with them is, steel has gone up significantly this year. Copper has gone up, aluminum freight, and January 1st, we have been upfront trying to get the steel agreements, primarily, because of availability of steel. Get ourselves set up for next year. And we are going to see a significant increase of steel come the first of the year that there is going to be across the industry.

This year, we have been left holding the bag. And we are telling our customers, you don't want to be put in that position next year. That is why we're out early with a price increase to give them an opportunity to do their planning and make sure they don't go out and do -- make some sort of a deal based on one estimated price level and find out it's something different.

I've got to tell you that a lot of our customers have responded positively to those kinds of discussion. I'm not going to tell you they are happy about it. We hate the situation too. We hate being in this position, but it's a matter of facing the reality of what's going on in material prices around the world. And we are doing what we have to do for our business and our customer base, based on the discussions I've had, especially the last week or two are stepping up to do the same thing. The most popular phrase I've heard is, "Well gosh, we don't want to be left holding the bag next year in the supply chain." So they are out working with their customer base right now.

It's a very dynamic time. We are not able to give a lot more information on how we are doing because every day is a new day of information. We are obviously watching to see what happens across the competitive environment and we are going to take actions accordingly depending on what happens there. All I can really say is stay tuned.

Roman Janikov from M&A (ph) Financial Services.

I have a question about implementing the price increases on the Water Heater side. You have mentioned in the last conference call that you were looking into slightly different pricing arrangements for the pricing periods specifically looking to do it through Search Argus (ph). Is that the way you are trying to implement this latest price increase that you have announced?

To be candid, Roman, I don't remember that specific conversation. But it doesn't really matter. Going forward -- no, it's not going to be done through a surcharge. It is basically a list price, flash base price increase.

Matt Summerville, McDonald Investments.

Follow-up on steel, Ken, you mentioned a couple of times here that you anticipate your steel costs to increase further next year. Can you talk magnitude in terms of what you're thinking or at least how you guys are planning for the upcoming year? And then the follow-up to that, will that third price increase then cover everything you've encountered year-to-date? And then the amount of incremental increase you are anticipating next year?

Yes. Obviously we can't talk about a specific steel cost but I think what I mentioned earlier is that the marketplace seems to be showing that the contract buyers are moving closer towards the spot price. And that would imply a pretty significant increase. I hope we said the price increases that we have in place and that we've got announced and that we are working on do include an anticipated increase in the steel costs.

There are no further questions at this time.

Thank you, everybody. Thank you for joining us this morning. We look forward to talking you in January.

Ladies and gentlemen, this conference will be available for replay today after 10:15 AM Central through midnight. Or tomorrow at midnight. You make access AT&T Executive Replay Service at any time by dialing 800-475-6701 and entering access code 750239. International participants may dial 320-365-3844. Again, those numbers are 800-475-6701 and 320-365-3844, access code 750239.

That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.