A O Smith Corp (AOS) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the first-quarter 2011 earnings call for A.O. Smith Corporation.

At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to your host Vice President, Investor Relations and Treasurer Pat Ackerman. Please go ahead.

Thank you, Ruth. Good morning, ladies and gentlemen, and thank you for joining us on our first-quarter 2011 results conference call.

With me this morning participating in the call are Paul Jones, Chairman and Chief Executive Officer; Terry Murphy, Chief Financial Officer; and John Kita, Senior Vice President of Finance.

Before we begin with Paul's remarks, I'd like to remind you that some of the comments that will be made during this conference call including answers to your question 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. Paul, I will now turn the call over to you.

Thank you, Pat, and good morning, ladies and gentlemen. The first quarter played out pretty close to what we expected as we achieved double-digit increases in sales and earnings. Earnings from continuing operations were 14% higher than last year at $24.2 million or $0.52 per share.

Sales grew 14% in the quarter to $417 million. Sales for the water products operation in China grew 51% as a result of expansion into Tier 2 cities and an increase in the number of retail and specialty stores selling the premium branded A.O. Smith products.

In addition, we estimate about one-half of the growth in China in the quarter was due to customer demand prior to an April 1 price increase and we expect our second-quarter sales in China will be somewhat dampened by this pre-buy. Sales in the US were higher as a result of new energy-efficient products which were introduced in the second quarter of 2010 and a pre-buy in the residential and commercial wholesale channel in advance of another April 1 price increase.

Our Electrical Products Company achieved a 28% increase in sales and a 77% increase in earnings. And finally as we expected, we received a second request for information from the Department of Justice associated with the sale of our Electrical Products operating segment to Regal Beloit for $875 million. I will now turn the call over to Terry to go through our first-quarter results in more detail.

Thank you, Paul. As a result of the pending sale of our Motors division, we're required to designate Electrical Products as a discontinued operation in our financial statements. I will begin with the results of our continuing operations and then finish with Electrical Products results.

Total sales in the first quarter of $417 million were 14% higher than the previous year. Earnings of $24.2 million or $0.52 per share include a $1 million after-tax non-cash charge or $0.02 per share related to the marked to market accounting rules associated with an equity hedge.

Excluding that charge, earnings were 18% higher than last year. Let me take a moment to explain our hedge.

As many of you recall, the total consideration for the sale of Electrical Products to Regal Beloit was $875 million of which $700 million is cash and $175 million is the value of 2.83 million shares of Regal Beloit stock to be received at closing. On December 12, the date of the definitive agreement, the shares were valued at $61.75 per share. Since that time, Regal's stock has appreciated and we decided to protect a portion of the appreciation by purchasing an equity collar for 50% of the expected shares.

Since the time the collar was put in place, the stock has appreciated further, resulting in the $1 million non-cash after-tax charge at the end of the quarter. The marked to market accounting will continue to occur at the end of each quarter that the collar is in place.

At Water Products, first-quarter operated profit increased 11% to $48.9 million from $43.9 million in the first quarter of 2010 primarily due to higher volumes. Operating margins were down slightly from last year as a result of higher SG&A costs to support our new renewable product introductions and the acquired North American Takagi tankless water heater business.

Cash used by operations during the quarter was $52 million in 2011 compared with $6 million used last year, a larger investment in working capital to support higher volumes and a $45 million contribution to the pension plan during the quarter were the major uses of cash. We expect to make an additional $130 million contribution to the pension plan this year and our projected cash flow for the year is $10 million to $20 million.

Cash cycle days in the quarter of 41 days were six days higher than last year primarily related to higher inventory levels to support new products and supplier changes. Our liquidity position and balance sheet remains strong.

Our debt to capital ratio was 27% compared with 23% at the end of 2010. The increase was primarily related to borrowing for the pension contribution.

Our funding sources are solid and stable as we have limited amortization of our long-term debt portfolio in the coming years and our $425 million credit facility which was renewed in November 2010 does not expire until November 2013. Capital spending during the quarter was $12.4 million. We expect capital spending for the full year to be approximately $65 million, one-third of which will support capacity expansion in China.

Our discontinued Electrical Products Company had a solid quarter. First-quarter sales were $202 million, 28% higher than last year. Hermetic and HVAC volumes have the largest gains.

Electrical Products earned $16.8 million in the first quarter, a significant improvement from the prior year as a result of higher volumes. Likewise, Electrical Products operating margins improved to 11.6% from 9.1% last year.

That concludes my comments on the financial details. Paul will provide our closing remarks before taking your questions.

Thank you, Terry. In my final remarks, I'll share our outlook for 2011 and elaborate on our acquisition activities.

First, let me share with you our thoughts underlying the 2011 guidance which is unchanged from when it was initially announced three months ago. First the good news, our China water heater business grew considerably in the first quarter.

This strong growth was due in part to customer demand ahead of the April price increase, therefore we do not expect to maintain that pace for the entire year. The pace at which we do expect to grow is higher than China's GDP as our customers continued to open new stores primarily in Tier 2 cities.

The upper middle class continues to grow and as our new energy-efficient product introductions like the heat pump and solar water heater gain traction. We have said before that we expect our China water heater business to grow at a rate of two to three times China's GDP and that is currently what we expect for 2011.

As Terry mentioned, we will use some of the proceeds from the sale of our Motors business to make a sizable contribution to our pension plan. The contribution will reduce pension expense to about $4.5 million in 2011 as compared to an $11 million charge last year.

The caution in our guidance stems from continued volatility in steel costs. As many of you are aware, this primarily impacts our wholesale water heater business.

After having stabilized early in the fourth quarter at $700 per ton, prices have maintained $1000 per ton for the past nine weeks. As a result of the higher costs which will impact us in the second quarter, we announced a wholesale price increase to be effective on commercial and retail water heaters on April 1.

As a result of all these factors, today we have confirmed full-year guidance for continuing operations of $1.90 to $2.10 per share for 2011 and this does not include the impact from future acquisitions nor the quarterly mark to market from the equity hedge. The midpoint of the range would represent a 17% increase over 2010 earnings from continuing operations.

Most of you are aware of the pending sale of our Motor business to Regal Beloit. Here is a refresher on our expected cash flow from the transaction.

Initially we will use the proceeds to pay down about $145 million in debt and pay taxes of about $170 million. As I mentioned earlier, we're planning to make a $175 million contribution to our pension plan, which equates to about $105 million after taxes. The net cash available for acquisitions as a result of the sale is approximately $455 million which equals about $10 per share.

We continue to work actively on our acquisition process. Based on our core competencies, our strategic focus for growth is simple -- hot water and clean water. We are pursuing actionable acquisitions to backfill these two areas around the world and particularly in developing and emerging geographies such as Africa, Asia and South America.

We're also pursuing acquisitions which will expand our core product line into boilers and heat pumps. We are particularly keen on energy-efficient products as this is becoming more important, even more so outside of the United States.

We are exploring new technologies for delivering hot water and clean water such as water conservation and energy-efficient technologies. And finally, we're considering water related adjacencies which can leverage our distribution and provide value to shareholders.

One final point on geographic expansion which I think is worth reiterating. We are somewhat unique given our size to operate such a strong China platform and a strengthening platform in India.

These investments made over many years have proved to be very rewarding. These two countries are by far the largest emerging and fastest growing regions in the world.

We continue to look for opportunities in these markets to leverage our brand and distribution capabilities. In addition, we're also exploring the suitability of these two platforms to serve as an export base to other smaller yet fast growing markets in Asia, Africa and the Middle East.

We have teams assigned to each of these areas. The teams have specific action plans with delivery dates.

We have actionable targets in each of these areas. The targets range from $10 million to above $500 million in price but the majority of the targets are in the $100 million to $300 million range.

As has always been the case, all of our teams regardless of focus area are preparing recommendations for investment to meet the following criteria. First we expect each investment to bring value creating opportunities.

Second the investment's return should be in excess of our cost of capital as soon as possible to certainly in the second or third calendar year. Third, we're especially interested in opportunities which expand our existing operating margins and bring higher growth. And fourth, obviously the investments must be accretive to earnings in the first year.

Finally, it's important to note that we have not set timeframes nor have we prioritized the four focus areas. We will consider acquisitions, joint ventures, or other business relationships to maximize the given opportunity and maximize the returns available to our shareholders.

This is an exciting and transformative time for our Company and the efforts to accomplish our goals in 2011 are well underway. Before turning the call over to you for questions, I would like to take this small opportunity to thank our CFO Terry Murphy who is retiring on May 1.

This is his last conference call and the 21st that he and I have had together and we have exceeded estimates 20 of those 21 quarters. Like a lot of people, we had a little problem in the third quarter of 2008.

But I want to thank Terry for everything he has done, the leadership he's brought to the Company. He brought a renewed interest on returns for shareholders with the measurements on return on invested capital and we appreciate his contributions very much. He's threatening to call in next quarter as an independent investor and I hope he does. I look forward to the call.

I would also like on this phone call to introduce you to John Kita who will be our new CFO. He brings 20 years of experience to A.O. Smith in this new assignment.

We are now finished with our somewhat prepared remarks and I'll now open the lines up for your questions. Ruth, go ahead please.

(Operator Instructions) Mike Halloran, Robert W. Baird.

Congratulations, Terry, on the upcoming retirement and good luck with the golf game.

Thank you, Mike.

So, a few questions. First, just could you give a little more color on the underlying trends you're seeing in the commercial markets in the US and the North American market on the resi side as well?

You know, I know you gave a little bit of a sense for what the magnitude of the pull forward was in the China demand. Hopefully maybe you give a little color on the magnitude of the pull forward of demand in the US as well?

Okay, Mike. I'll answer your first part.

The commercial piece remains stronger than it should be. I was just at our commercial plant in McBee, South Carolina last week or week before last and they are running six days a week.

We are seeing more demand than we thought we would. We believe it's driven by the energy efficiency products, the Cyclone product that we have that's the most efficient commercial gas water heater on the market and people are replacing it because they can get a return. They can pay for the water heater, it's just in lower energy costs.

So our commercial side is doing -- all of our indices we've used to predict that business in the past don't work anymore because frankly the business is stronger than it should be. On the resi side, obviously housing starts are still terrible. They're still running at historically low levels.

The replacement business has always been there and still is, but we're not seeing a lot of growth there. And frankly I'm not optimistic that we will for some period of time until the housing market and the overall economy gets in better shape.

And as far as the pull forward, we always try to estimate what that was. It's really hard to do but there definitely was -- when you have a double-digit price increase going into effect on a certain date, there will be a significant amount of increased inventories in the supply chain that are -- especially our wholesalers will do ahead of the date of the price increase.

But I don't know how to quantify that. It's interesting that we're doing it in China and the US at the same time. We typically will have a little bit of a different timing there but steel has just shot up, especially starting in the fourth quarter and into -- through the first quarter of this year, up in my opinion well above what it should be doing based on demand rates.

Anyway, it is what it is. It's over $1000 a ton and as always, it's been there before, and we have got to do what we know how to do which is maintain the margins for our shareholders through this cycle.

Fair enough. And then it doesn't sound like the expectations have changed a lot as far as the growth on the residential and the commercial side for the year. Is that a fair way to think about it?

Yes, especially on residential, maybe commercial is a little stronger than we thought it would be at the beginning of the year. But maybe the residential is a little weaker than we thought it would be at the beginning of the year. So yes, those probably offset.

Fair enough. And then on the cost price side, if you compare the relationship on the price cost that you saw in the first quarter to what you're thinking about in the second quarter with the price increase coming into place or already came into place on April 1, can you talk about if you're expecting it to be pretty comparable, a little bit better, a little but worse sequentially?

We do what we have always done. We have got targeted margins that give us the cash flow to number one, be able to generate shareholder returns, and also have the cash to reinvest in the future. Our Water Products business which is our continuing operations we said is 12% plus and we're still sticking with that. That is our objective.

We get it through cost reductions but when commodity prices -- steel is over half of our cost. When steel goes from $700 to $1000 per ton, we obviously have to raise prices and we do that in order to maintain the shareholder returns and keep us getting the cash we need to keep reinvesting into the business and growing.

Fair enough. Well I appreciate the time. Take care.

Ned Borland, Hudson Securities.

I just want to focus on SG&A for a little bit. You called out some items that you're spending on with Takagi and the new products, and I just want to know if it's sort of a recurring expense or is there sort of a rollout that's happening. I know there's a couple of different products, but if you could just help us think through that and maybe if you could quantify what the impact of those were in Q1?

It's a little bit of a investment ahead of us growing the demand. It is a planned orderly addition into SG&A and we expect as we roll out the energy-efficient products and adding the Takagi North American operations, it came as a little bit of SG&A (multiple speakers) a little bit higher than our normal rate. Terry (multiple speakers)

About half of that $12 million increase quarter over quarter is China and the other half is made up of Takagi and a little bit of Shanghai water treatment and a little bit of renewables. But the biggest single piece of it is China.

Okay, and just to sort of segue over to Shanghai water, I imagine that wasn't in the $88 million from China water heater sales. What was your contribution from Shanghai water in the quarter?

The main thing we focused on in the quarter was getting the operation moved to Nanjing and we now have it up and running. We are now in 360 stores I believe that we rolled out the A.O. Smith brand.

We still have the old brands that came with the acquisition, but we -- our major thrust is to roll out the A.O. Smith product to the -- not only the Suning stores but the A.O. Smith specialty stores. And we have over 300 stores selling the product now.

We are going to add another 250 in the second quarter and at least 500 in the second half. So that's building up very nicely.

Sales per store are running slightly ahead of what we originally thought. So we're off to a good start there. But the contribution to earnings is still negligible if any, probably a loss at this point.

But we still believe in the product. It's a great product and I'll tell you, the store displays that are going in are fantastic. I'm very really proud of what our market people have done and this is going to pay off for us going forward.

William Bremer, Maxim Group.

Just going back to the SG&A question, so are we going to expect that that should start to taper down now that that the investments have been made? Or should we keep that run rate pretty much the same or percentage of revenue going forward?

It will be essentially for the short-term the same run rate, but we hope the percentage drops as volume grows, but China is going to continue to grow from an SG&A standpoint as we continue to add products and outlets for our products there.

Yes, and can you give us an idea -- you put the price increase on April 1. Any backlash or can you just give us some color around that from your customers?

Well, every -- the whole industry is seeing the same price increases. We're just trying to do what we have always done.

We've been riding this steel roller coaster for -- this is our -- about seven years ago was when steel started going from $300 to $400 per ton, moving up rapidly, and we have had to change the way we do business completely because of that. And we think we have done a pretty good job of balancing the selling price and the cost relationship over that time.

Okay, and can you give us an update on India at this point?

Yes, it's going great. We will probably double our sales there, probably do more than that this year. We did about 9 million last year and we're forecasting 19 or 20 and I think that is conservative for this year.

We're getting very close to breakeven within our second year of operation of our own factory there. So really excited about how things are going.

We not only have our product in the (inaudible) stores now, but we're out into other distribution. We're growing the brand and getting it into more and more outlets every day as we roll it out across India.

Paul, can you give us an idea of how many at this point you are currently in on the distribution side, how many stores?

In India? I think it's about 75 Jaquar, but I think we're over 200 total now.

And what do you perceive that to be as we roll to, say, the end of this year?

I don't know that number like I do the China numbers but we are rolling it out.

Yes, we expect to have about 600 retail stores by the end of the year. We are currently at about 300.

Okay.

Jaquar has a lot of outlets throughout the country, so we are in many hundreds of the Jaquar.

Okay, it was 75 the last time I was -- yes, so the number right now is 300, it will be 600 at the end of the year.

And can you give us a sense of what are they purchasing? Are they purchasing the lower tier models or are they purchasing the higher tier with the better margins for you? What is the mix?

The mix is the full line and our margins are pretty good across the line. We just need more volume.

Okay, great. Thank you, Paul. Appreciate it.

Matt Summerville, KeyBanc.

Good morning, this is Joe Radigan on for Matt. Just a couple questions.

I guess I was surprised by the magnitude of the pre-buy in China because isn't it more of a consignment model there with the two large retail customers? Was that pull forward all from the independent specialty shops?

Yes, you're right about the retail. But I'll tell you, these independent specialty stores are exploding across China right now. That's obviously -- that's the traditional buy-sell relationship like US wholesalers.

And that's what's happening. The other thing is we typically don't have the announced price increases in China.

We typically -- we're constantly upgrading the product line. Several models a week get upgraded and we put a new price point on those which is a way of avoiding some big announcement.

This rapid run-up of steel going up over 40% in just a matter of 10 or 12 weeks has forced us to do an across the board price increase in China and I think that's what's driving a little bit of the pre-buy. They're not used to us doing that in China like we did.

Okay, and then historically, Q1 has been the low watermark for China. So how should we think of it sequentially?

I can understand not having 50% growth again. But in terms of a sequential rate, are we going to see improvement second quarter over first quarter or was that pre-buy so big that you think it mutes that?

I think the pre-buy was pretty big and it's certainly going to mute that. The first quarter -- we had one quarter I think a year ago where China had a tough first quarter but we typically grow every quarter.

I think last year it was an anomaly to start the year out, and of course we ended very strong. But we still say two to three times GDP.

If China's GDP is 10, we will be up 20 to 30% for the year and we're still sticking to that. That's turned out to be conservative in years past and maybe it will this year. But for right now, I would still stick with probably a 20 to 30% growth rate year over year after 2011 is wrapped up.

Okay, and then can you provide an update on customer expansion plans in China? Particularly with the recent changes at GOME I've seen speculation that the new management team there is going to be more aggressive in terms of store buildout, a little bit of a change in philosophy there. Have you heard anything in terms of them ramping up plans to expand faster than you originally thought?

Well this is another management change at GOME. We have lived through a couple recently, but GOME has been focusing on improving quality of their stores and not at adding stores. That's been over the last 18 months.

And frankly they've done a pretty good job executing on that. Our same-store sales at GOME have gone up while they have been doing that change. Suning of course is just growing like crazy and they're into the Tier 2 cities.

Every place they go, we go with them. We are benefiting from that.

If GOME gets into -- and they have said that they are going to increase their new store openings. Of course they have had very few over the last 18 months. So, if they can start adding 100 to 200 per year, that would be very positive for us.

They are talking about what they're going to do but they haven't given us any specific definitive plans at this point on what they are going to do. But right now they are building from a stronger base.

They have really cleaned up their existing store operations and they're a wonderful customer of ours as is Suning. And of course the other piece is the specialty stores, which just -- it's growing much faster than we thought it would and it's becoming a major part of the distribution channel now for getting water heaters from manufacturer to consumer in China.

Okay, and then understanding there's ramp-up costs associated with the rollout of the Shanghai water treatment product line especially as you grow it that quickly, when you look beyond that, how do margins of that product compare to the core China water heater business.

They are comparable on a gross margin basis. We just need to get more volume now.

We've got a factory with plenty of capability to handle the growth. It is an efficient factory. We're not on multiple stories in multiple buildings. We are in one building doing it the A.O. Smith way.

Right now, we are pleased with the sales efforts going on there. The other thing I only mentioned briefly in my prepared comments, but we're looking at a lot more export out of China by putting sales offices in the perimeter countries, not only for Shanghai water treatment, but also for water heaters. And I would expect that we would be rolling that out as the year unfolds.

Okay, great, thanks, Paul. Best of luck, Terry, it's been a pleasure working with you.

(inaudible) Bora, Jeffries.

This is (inaudible). I am sitting in for Scott Graham at Jefferies. First question, you guys talked about pull forward sales in China. Could you talk about like pull forward sales in US?

We announced the price increase effective April 1. We announced that price increase in February. And typical in the US especially when it's a significant one, and this was a double-digit price increase, typically especially our wholesalers will just add some inventory ahead of the price increase. It's a way for them to make more money.

Okay, so when I look at like China number which is 51% (inaudible) growth, you said like half of it came from pull forward sales, right?

About that, yes.

Okay. So taking that that into consideration, the US sales which grew like 7%, do you know -- if you guys could comment on like what was the core growth if you exclude the pull forward here?

Well, like I said, it's very difficult for us to put a number on that. But the US market is essentially not growing right now, so you can maybe assume that's what the pull forward was.

Okay, thanks for that. And the second question, if you guys can discuss on new products sell- through.

Well, we are not ready to give numbers to that at this point. But we will have to at some point in the future.

We are talking about our solar-assisted water heaters, the heat pump, we have got some new high-efficiency products of pressurized combustion which I'm excited about, the hybrid and a few other things. We will start providing some numbers on that.

I know a lot of people do and you always have to find out exactly how those numbers are calculated. But at some point in the future, we will talk about what our new energy-efficient products are doing. Right now, we are just too early in the introduction. We are still rolling it out to some locations.

Okay, because you guys mentioned on -- I believe you commented on Cyclone on the commercial side which was doing well.

That's not a new product, we have had that for some time.

Yes, I know. Okay, and the last question actually was because mentioned on the acquisition in China and India, especially on acquisition in joint ventures. Do you have any plans on capacity expansion in India?

We have a very modern facility in India that was just opened last June. It's got plenty of floor space available to handle the growth that we see.

And it also has floor space available if we want to move something else into that facility. If we acquire something somewhere and want to do a facility consolidation we have a very modern, well lit, high bay manufacturing facility that we can utilize.

Okay, the reason I was asking is like you said, it will be mostly exporting (inaudible) market like China and India. So I don't know if you have been venturing into like Southeast Asia or Far East basically where you guys want to export the products.

Like I said, we are -- the fastest growing economy in the world is Vietnam. They just have 88 million people versus the 1.3 billion in China.

So if China grows 10%, we're still better off being in China, but we want to tap into some of these other higher growth markets like Vietnam and Indonesia, Malaysia and other places in the area, Southeast Asia.

Okay, thanks a lot, that's all I have.

Ted Wheeler, Buckingham Research.

I just wanted to follow up a second on Shanghai water for just clarification. I guess you're if I add it going to have more than 1000 stores by the end of the year entering next year.

And if you think about that, what kind of sales could we expect relative to the sales of the core product kind of when we all started -- when you all started with this venture? Would the sales from A.O. Smith branded product be in the same range or more than what you started out with by that point?

It is still smaller compared to what we acquired which was a bunch of mom-and-pop storefronts which was the primary sales outlet, I think it was 2000 to 2500 stores we were originally selling in. Those are fairly small volume.

What we're rolling out now primarily with Suning and with our current storefronts, you are right, we expect it to be about 1200 stores by the end of this year. And our rate per store is running a little ahead of what we thought it was.

If I did a real rough calculation on the numbers, even at that point, it will still be less than the legacy business there. But obviously that is the fastest growing and that's one of the reasons we acquired the business was to do the rollout of the A.O. Smith brand.

Thanks, that's very helpful. And the legacy brand I guess will be flattish, downish? I know it went down quite a bit.

It went down quite a bit as we had to do a whole lot of things relative to their sales organization and marketing and a lot of work on manufacturing and quality. But it's now growing too, so maybe not as fast as we would like. But the main thing we did as I said in the first quarter was get the product line moved, got employees trained.

We had more employees go with us than we thought we would get. We did very well on the leadership by getting the executive team, especially the technical folks, to go with us going forward. So we're now in a much better position. We can focus on growth and not have a lot of the internal distractions that we had to do last year.

I guess it feels as though the earnings issues are now improving from where we were (multiple speakers)

Yes, more predictable is what I would say and improving.

Thanks for the color. One more question. On Electrical Products, was there any pull-through or any anomalies that affected the sales there?

Just the business is being run very, very well by a terrific management team there. They're doing a great job.

There wasn't any big price hedging events as in water heater?

They had price increases too. But remember, a lot of our products there especially the OEMs, we have a material escalation clause in those agreements. So those obviously kicked in and contributed some as steel moved up.

If I think about the end-markets, were they all kind of nicely double-digit strong in Electrical Products or was there one particular vertical that maybe accounted for most of the revenue growth?

Commercial hermetic is doing extremely well and that's really a global product line. We sell that product all over the world and our distribution business has done well.

Yes, thanks so much for the color.

Ned Borland, Hudson Securities.

Yes, just a follow-up on some of the puts and takes here. I mean, second quarter we're looking at kind of a pre-buy hangover. You have got a price increase, you have got some new product introductions.

Generally as I look back historically, there's a little bit of an uptick sequentially from Q1 to Q2, but you've got a little more moving parts this time around. So I'm just wondering would we see a sequential downtick in sales in Q2?

I don't think so. It's going to be tough to call because right now, we are into April and we have seen the overhang as you called it, Ned. The pre-buy has now come in.

But traditionally, historically the second quarter has been our strongest quarter. But we do need to see a pickup in volume over May and June for that to happen.

Okay, thanks.

Daniel Garofalo, Piper Jaffray.

It's Dan on for Tom this morning, congratulations on the quarter, guys. Just with regard to gross margins, a bit of a sequential decline but nonetheless, your second consecutive quarter north of 30.

Just wondering how should we think of gross margins for the year with all the noise in raw materials? Is 30% a reasonable floor or how has that segment performed historically in terms of gross margins?

Well, we have historically been working to get our margins up. We put a lot of capital investment in to be more efficient.

I have talked before about how we have been able to get more output per man hour and all the different measurements that we use. If it's at 30%, we want it to be 31. If it's at 32, we want it to be 33. And those are the things we're going to keep working at to get our gross margins up.

As the economy improves, we would expect that higher volumes will help those margins. So is 30 the right number? Ballpark 29.5, 30, 30.5, somewhere in there.

Got you. I apologize if I missed this, but could you provide us if you haven't an update on your capacity expansion plans in China?

Yes, we have land that we are starting to do the land prep for and a good -- matter of fact the biggest piece of our capital investment this year is going to be building a facility in China that will come online next year. We will be producing product out of that facility sometime in 2012.

But it is on track. We have ample capacity at our existing facility to cover the demand for this year and into next year, and we will be bringing on the new factory which will have a lot more floor space than we need initially, but will have the room for us to continue to add lines and ovens and steel processing so we can continue our two to three times GDP growth in China.

And so you think that's -- is that a first half event next year?

I'd say midyear next year we will be making product in that plant.

And just a real quick -- one last housekeeping question. You had mentioned in your prepared remarks the net cash that you will have available for acquisitions post the sale of Electrical Products.

I think you mentioned $455 million. And just to clarify, you mentioned net cash. Does that figure subtract for debt or is that just the cash that will be on the balance sheet?

We are going to pay off all of the debt except for the private placement fixed debt that we have. So it pays off all the revolving debt. We will still have another $100 million or so of debt.

And then in addition to that $455 million, we will have the capacity from our revolver which will be $425 million additional capacity I guess if you're looking at it from a dry powder perspective.

But we also currently have about $100 million of cash. So net net net that 450 will be the net cash.

Net cash position.

It will be your net cash position.

Net cash position, yep.

Very good, thanks for taking the questions.

Okay, thank you, and there are no further questions at this time. Please go ahead.

Okay, well thanks again for your interest and support in the Company. And once again, I will join with you in wishing Terry all the best as he -- Mary gets twice the husband and you have all heard the jokes. Anyway, thanks, everybody, for being on the call. Talk to you soon. Bye bye.

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