Franklin Electric Co Inc (FELE) 2008 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Franklin Electric Company Incorporated second quarter 2008 earnings release. At this time, all participates are in a listen-only mode. A brief question and answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is my pleasure to introduce your host, Mr. Mike Butchko, Treasurer and Assistant Secretary for Franklin Electric. Thank you, Mr. Butchko, you may begin.

Thank you, and welcome to Franklin Electric's second quarter 2008 earnings conference call. With me today are Scott Trumbull, our Chairman and CEO, John [Hanes, our CFO and other members of Senior Management. On today's call Scott will review our second quarter results and discuss the key issues confronting our company for the balance of 2008. John will review our second quarter financials. When John is through, we will allow sometime for questions and answers.

Before we begin, let me remind you that any forward-looking statements contained here in, including those relating to the company's financial results, business goals and sales growth, involve risks and uncertainties including but not limited to, risks and uncertainties, with respect to general economic and currency conditions, various conditions specific to the company's business and industry, weather conditions, new housing starts, market demand, competitive factors changes in distribution channels, supply constraints, technology factors, litigation, government and regulatory action, the company's accounting policies, future trends, and other risks, which are detailed in the company's security and exchange commission filings included in Item 1a of Part 1 of the company's annual report on Form 10-K for the fiscal year ended December 29, 2007, Exhibit 99.1, attached thereto and item 1a of Part 2 of the company's quarterly reports on Form 10-Q. These risks and uncertainties may cause actual results to differ materially from those indicated by the forward-looking statements. All forward-looking statements made herein, are based on information currently available, and the company assumes no obligation to update any forward-looking statements.

I will now turn the call over our Chairman and CEO Scott Trumbull.

Thank you, Mike. We are pleased to report record sales and operating earnings during the second quarter and first half of the year. Our sales and earnings growth was broad based and occurred across virtually all of our global business units and geographic regions. Our water segment represented 78% of our overall sales during the quarter and grew by 31% versus prior year. Organic sales growth was 10%, this growth occurred in spite of the residential housing industry decline and weak general economic conditions, in several key geographic markets. In the United States, our sales of submersible pumps and motors, grew at a double-digit pace. We experienced strong sales growth to agricultural customers as Farmers invested to expand and upgrade their operations. We also continued to gain share in the submersible pump market.

Outside the US, we continued to achieve strong sales increases in developing regions. We now drive about one-third of our total water systems revenue in developing regions, where our sales grew Organically at a double-digit rate during the quarter. Sales in latin America, the Middle East and southeast Asia grew at a particularly robust pace. Our most significant accomplishment during the quarter, was the margin improvement we achieved in our water systems segment.

Our water systems operating margins increased by 480 basis points, versus the second quarter of 2007. This increase was generated by several factors, which included fixed cost leverage resulting from higher worldwide sales volume combined with controlled increases in the company's fixed cost base, a favorable product mix shift as we experienced strong sales of large pumps and motors to agricultural customers in a number of global markets and reduced promotional pricing activity in the United States.

Our fueling segment represented 22% of our overall sales during the quarter, and grew by 37% versus prior year. All of the sales increase was organic. The growth was led by vapor recovery systems sales in California, and sales in international markets. We estimate that at the end of the second quarter, approximately 20 to 30% of the 11,800 filling stations in California, have now purchased vapor recovery systems. And that in excess of 90% of these systems have been supplied by Franklin. We sell these systems for about $18,000 each.

So there are approximately 70 to 80% of the stations, that have yet to install systems. By regulation these systems must be installed over the next ten months. We believe that the vast majority of the remaining installations will be provided by Franklin, although our share is likely to decline from the current very high level. We estimate that only about 50% of the stations that have been installed vapor recovery system have also installed the mandated vapor monitoring system. While the vapor recovery systems are required to be installed by April 2009, station owners have until the fourth quarter of 2010, to install vapor monitoring systems, we sell these monitoring systems for about $9000 each. Because we were not first to market with this product as we were with the vapor recovery product line, our share of installed vapor monitoring systems has been significantly lower than our recovery system's share.

As a result of both vapor recovery and vapor monitoring system sales in California, we foresee a significant sales surge over the next 12 to 24 months. When the California conversion winds down, our fueling system sales will fall back to the on going sales based level. We believe that level will grow over the next few years due to a number of factors some of which include as stations worldwide install our vapor recovery system we will benefit from a ongoing hanging hardware replacement business. We estimate that replacement revenue may average $200 to $400 per station, per month. So for example, an 8000 station installed base, could result in a replacement business of $19 to $38 million per year. Other countries and municipalities worldwide are passing vapor control regulations. For example, China has regulations that require installations in major metropolitan areas, over the next five years. Korea, Spain and the UK have also recently passed vapor control regulations, our penetration in these markets may not be as high as in California since those countries are establishing less rigorous system specifications which allow for more competitors. We never the less expect significant sales opportunity. As encouraging as these factors are we are not currently forecasting that we will be able to entirely offset the end of the California sales surge, with organic growth elsewhere in our fueling segment.

Our fueling system margins improved versus prior year by 590 basis points, during the quarter. The improvement was driven primarily by leverage from rapid organic sales growth. While we are pleased with our progress in both water and fueling, we are mindful of challenges we anticipate in the second half of the year. During the first six months of the year we experienced material and freight cost increases. We believe these increases may accelerate in the back half of the year as several of our supply agreements expire and vendors implement catch up price increases.

Our plan is to offset these increases with purchasing initiatives, productivity gains and price increases of our own, but weak economic conditions in several market areas may complicate the implementation of our plans. Also during the back half, we will be transferring additional pump and motor volume to our new factory in Linares, Mexico. Anticipate incurring some cost penalties as we bring this production on line. This will include added training, installation and depreciation expense; however, our cost base will benefit in the first half of 2009 when Linares Pump Plant is fully operational and fix cost levels have been adjusted in our other North American factories. As a result, our outlook is less certain for sustaining performance improvement in the second half at the same rapid rate that we achieved in the first half.

Having said that we are increasing our over all revenue growth guidance from 25% to a range of 25 to 30%.

Now I will turn the call over the John [Hanes] who will provide some additional analysis of our financial performance during the quarter.

Thank you, Scott and thank you to all of you on the call for your time and your interest in Franklin Electric. Our sales for the quarter were a record $202 million, 49.2 million or 32% higher than the second quarter of 2007. Our organic growth 16% including the foreign exchange impact on sales, an increase of about $7 million. Our gross profit was $64.7 million, or 32.1% of sales in the quarter, up by $21.4 million, or 370 basis points from the second quarter, of 2007. Of the $21.4 million increase, about $13.6 million was a result of volume and sales mix improvements and about $8 million was attributable to the acquisitions, these improvements; however, were partially offset by higher material, freight, and warranty expenses in the quarter versus 2007.

Operating income for the consolidated ending was $26.4 million, or 13.1% of sales, up $15.3 million, or about 140% from the second quarter, 2007, as higher sales resulted in significant fixed cost leverage for the company. Our water systems segment sales improved at $157.4 million, $37.4 million or 31% higher than 2007. Organic growth in water systems was 10%. Operating income and water systems was $26.2 million, or 16.6% of sales, up $12 million or 85% from the second quarter of 2007. As Scott has described the water segment was helped by strong agricultural sales worldwide, increased pump sales in the United States, and continuing growth in developing regions.

Foreign exchange rates increased water segment sales by $6.7 million in the quarter. As we previously indicated to investors, we are committed to inventory turns during 2008. Our goal for the year is to increase total sales by 25 to 30%, with no net increase in inventories by year end. Since inventories will grow in fueling due to the California sales surge to accomplish our goal, we must have a significant reduction in water systems inventory. As a result we are operating our water plants at lower utilization rates this year.

During the second quarter, under utilization did not have a significant impact for our water systems segment because we were able to offset the under utilization with lower fixed cost spending in North America. However, as Scott pointed out in the second quarter of 2008 we will add fixed cost related to our new pump facility in Linares, Mexico. This combined with the continuing effort to lower water segment inventories will result in additional under utilization of our manufacturing capacity in the latter half of this year; however, as we move into 2009 with inventories reduced we will be able to restore utilization to normal levels.

Our fueling system segment has sales of $44.3 million, $11.8 million or 37% higher than 2007. The entire sales improvement was attributable to organic growth. Operating income in fueling systems $10.9 million, or 24.6% of sales, up $4.8 million or about 80% from the second quarter 2007. The improvement in operating margins for fueling systems is primarily driven by volume and result in fixed cost leverage realized from dramatically higher sales. Selling, general, and administrative expenses increased in the quarter by $6.5 million, or 20% from the second quarter 2007. This is primarily attributable to the new acquisitions, which together contributed $5.6 million of the increase.

Selling, general and administrative expenses for the quarter improved by about 190 basis points as a percent of sales from the same period in 2007. Fully diluted earnings per share for the company were $0.66, for the second quarter, compared to $0.28 for the second quarter of 2007. There were no restructuring charges in the second quarter of this year, versus $400,000 in 2007. Cash balances on hand were $42.8 million, at the end of the second quarter of 2008. Versus $63.8 million in cash and investments at the end of the second quarter 2007. Cash was used in the first half of 2008, as accounts receivable increased consistent with sales volume increases, inventory also increased over all during the first half of 2008, to support the increase demand in fueling and international water markets, offset by decreases in the water systems inventory, in the United States. Other primary uses of cash during the first half of 2008 were for acquisitions and capital expenditures.

The company did not repurchase any shares of common stock in second quarter 2008 and on Friday, July 25, 2008, the Board of Directors of Franklin Electric declared a $0.125 dividend payable on the outstanding shares of common stock on August 21, 2008, to those holders of record at the close of business on August 7, 2008. These comments conclude our formal remarks, we would like to now open the call up for any questions.

(OPERATOR INSTRUCTIONS). One moment please while we poll for questions. Our first question is from the line of Matt Summerville with Key Banc. Please go ahead.

Scott, I want to clarify something when you're talking about seeing the year-over-year improvement, I think operating profitability moderate you're still under the -- or should we be under the impression that you will see year-over-year margin improvement just maybe not 500 basis points? In Q3 and Q4, relative to that delta you had in second quarter? Do I have that right?

Yes.

What do you anticipate the cost penalties being associated moving the additional pump capacity to Linares and how should we think about the Q3 versus Q4?

Well, that is one of the factors that will influence margin.

Sure I'm trying to understand how much expense we should be thinking about for that relocation in Q3 and Q4. What do you anticipate the cost savings being in 2009 and will this be taken as a restructuring charge or run through the P&L straight?

Right now it is our plan to take the costs through the P&L straight. I believe that later this year we will announce Phase 3 of our manufacturing restructuring program. The details of that program have not been fully worked out and so we are really not in a position to provide a precise answer to your question, Matt, about the costs because -- at this point we haven't made a decision to proceed with Phase 3 and haven't really a formal decision to proceed. We haven't announced anything within our organization and we haven't decided on all of the details. But I would expect the implementation costs to be several million dollars. In the range of $3 or $4 million.

Just for the pump initiative putting Phase 3 aside.

Yes. I think that's $2 to $4 million is a reasonable estimate of the total cost of that move.

Okay. With respect to the fueling business, you mentioned other countries that are looking at tighter vapor management or control standards, I guess how many stations are there in those countries and what kind of costs per station are we looking at over the next several years?

Just a second. John [Hanes] may answer that question.

So Matt, the actual penetration we get in any of these countries and whats mandated by law is a pretty significant unknown, but if you look down,China, we think that there is at least 20,000 stations in China that will need to be upgraded as an example. In Korea, we think there is 3500 stations that need to be upgraded. In the UK, the same number, 3500 in total although some of those have been most likely completed. In Spain, we believe it's about 2500 stations. Then when you get in to the other nations that are a little less I guess sure about actually doing this, then the numbers get much bigger. India, Russia, and so on. But our team now is looking at all these opportunities internationally, and the countries that Scott mentioned are the more robust opportunities but there are other ones as well, it's hard as I'm sure you can appreciate to estimate what ultimately will be the legislative mandate if you want to say that, and how many stations will end up converting.

Then just another question on your inventory situation, outside of the international water business and outside of fueling, how much inventory, Scott, have you been able to take out in the areas you've been looking to reduce inventory and what is the total target on that for the year, then with the two businesses, can you talk about what actions you're taking from a pricing standpoint in both fueling and water in the second half of the year and timing on that?

Our overall inventory goal as John indicated is to reduce the inventory levels overall while picking up a 25 to 30% increase in sales. Now, as far as water goes, we are actually looking at a fueling inventories over the course of the year -- (inaudible) -- just one second. We are looking at data here. So what we got is fueling inventories up 10 and water inventories going down $11 or $12 million.

Then how much progress have you made on the water side?

Well it's seasonal, so you can't just look at the numbers and see a straight line from beginning inventory down but we are on track.

Then I guess my final question, I will get back in queue, if you look at demand in your water business, domestically and internationally, as we move through the quarter, what do the overall tempo business look like, accelerate, decelerate and out of the 25 to 30% sales increase you're looking at for the full year, can you talk about what you anticipate for water versus fueling if those expectations have changed at all?

No. Our expectations for both water and fueling, we raised modestly our guidance because not because one grew and the other shrunk but because both up modestly from what we had originally anticipated. The water business generally speaking certainly in the US and in southern Europe are residential water business was soft in the first half and there is no indication from what we can see in the second half that it is getting stronger. However, our large pump and motor business which generally goes in to agricultural applications but also municipal and industrial applications and mining, our business in that arena is quite strong and has held up very well. And that's quite honestly more than offsetting the weakness in the residential market bearing in mind that the residential market was weak last year as well. So it's a weak comparison to a weak comparison and with a nice bounce back in the AG sector and the industrial and mining arenas.

Thanks a lot.

Next question from Mike Schneider with Robert W. Baird.

Maybe first on that revenue growth range, 25 to 30, Scott, if you've done 33% growth, year to date, it would imply in the second half revenue growth rate is about 20 including acquisitions and currency. It seems like the numbers should be materially higher just given the pace of fueling and what's in store in the Q3 and Q4, why do you and presumably you expect water to decelerate from the 30% growth this quarter, leaving aside the acquisitions, what do you see ahead in the second half for water that would cause such a material deceleration in the business?

Mike, I just -- first of all the fueling assumption depends on how much of the fueling business comes at us of the conversion comes at us in the back half of this year and how much of it will occur in the first half of next year. The operating assumption that we have had is that people are going to delay installing these and that we are going to have a mad rush in the first part of the fueling business, delay installing systems and we will have a significant rush in the back half of -- first half of next year. As far as the back half of this year goes, John, I'm looking at -- that's the assumed water -- we got water at about 21% up, and I guess fueling at about 31% in the back half.

So Mike, the way we are basically coming down to about 25%. And then as we talked about, there is a fair amount of uncertainty around fueling, and where that could go and what our ultimate share ends up being, but on the other side are the questions of the head winds that are in the water space and in the US economy and the economy more broadly.

One thing, though, Mike, you got to bear in mind is in the first half of the year in water, we had the full benefit of the Pump brands acquisition, the Schneider acquisitions, and the Monarch acquisition, we will lap Monarch and Pump brands during the back half. When you're looking at the overall growth, the amount of acquisition, because we don't have baked in our plans an assumption of another acquisition we may be working on other acquisitions, but there is no assumed additional acquisition in our numbers so the lapping effect of acquisitions plays an important role as well.

The color is helpful. On margins within fueling, sequentially your incremental margin was 38% and the total for the quarter was 24.5. I'm curious now, have your production rates in fueling peaked because you're building inventory at this point such that even though we have a surge in shipments in the Q1, Q2 -- are we seeing today what I call peak absorption or do rates accelerate from here?

We have Gregg Sengstack on the call. I'm going to let Gregg answer that.

Good afternoon, Mike.

The obvious point, I'm trying to figure out with the surge ahead, are margins headed higher or are we seeing the effect of peak absorption right now.

I think one thing you need to bear in mind, is that in general the fueling business, labor rates and fixed rates are lower general than the water business. But we are for that which we are producing, ramping as the market is ramping, some of the purchases we have been doing, and purchases of raw material, that's been driving inventory growth. So the conversion is yet to be done. Converting with the market. Yes, while there could be a slight diminishes in absorption in the back half , I don't see that at this point.

So a rate of plus or minus 38% like you sequentially isn't a anomaly this quarter?

No I wouldn't say it's an anomaly. Our build has been matching production and inventory rise (inaudible) -- the whip limited labor content.

Then Greg, as long as I got you, so the other international markets China, Korea, UK, Spain, can you remind us what the efficiency minimum was for the California standard and what that looks like overseas and how that changes your presumed market share opportunity in those other markets given that I know there is a difference in efficiency rates but I'm wondering if it's meaningful enough to bring in other competitors of size of even existing US competitors?

There is a rigorous approval process, this point two approved systems in California, which has been well documented. Outside of California, many countries will say they can have a carb certified system. Not under the car regulation of carb which are 95% efficient, could be using older systems. And or two which is a European approval. Or no approval at all. So efficiencies in other countries can be 90% or 80%, expectations are lower. Then there is a design issue as well, the Healy System is designed for the US market is well excepted, well excepted in China and Europe. But not Asia.

And the 80 or 9 0% efficiency levels, like Texas where our other competitor had a meaningful penetration rate is Texas comparable to what some of these other lower efficiency standards are?

The penetration rates in Texas were probably different because first dealing in the US market where there were multiple solution, balanced solutions, three or four competitors, the other thing that you had going gon Texas at that point was that the Healy System is unique in that it's all one complete system, not interchangeable. We introduced a interchangeable product in Texas. It was later in the game. In Texas there were some people that wanted to have a interchangeable product and so they shied away from Healy for that reason.

Thank you.

Next question is from the line of Ned Borland with next generation equity research.

Just just a question on raw materials versus pricing going forward you said some contracts basically come up now, is there going to be a lag in terms of the effect of raising prices versus what the pen should be on the raw material side?

Question was asked earlier about our price increase plans in the back half. In our US and Canada water systems business we have price increase scheduled in August. We did incur some freight or some inflation in cost in the month of July, so we will have a month where we may be under water. But our - - unless inflation picks up more than anticipated we think the price increase we have in place in US and Canada will largely that combined with productivity and cost control should offset that increase going forward, the cost increases going forward. Our supply arrangements in Europe have enabled us to defer the cost increases in that arena, in the area we call [EUROPA] Europe, Middle East and Africa until later in the year. Therefore we are not raising prices in that area until later in the year but our price increases, which have been announced already for October, are scheduled to go in effect or right when our we anticipate the bulk of our cost increases to occur. And our price movements in our fueling business have been consistent with cost increases so I think we may have a little bit of slippage but not should not be a material amount. Assuming that our price actions are affective and stick in the marketplace.

We have price actions in our fueling business planned for August as well.

That's helpful. In the water business you saw a benefit from AG this quarter. I'm wondering are we going to see a seasonal effect here where as the third quarter is less AG intensive in general. I imagine and maybe pick up in the fourth?

Generally, we got Robert Stone here, who runs our water systems business in the America. I will let him answer that question.

Generally the Q3 is fairly strong in AG. Some areas are less so than others, generally the Q3 is reasonably strong depending on what the weather has done and it tails off in the fourth quarter.

Okay. Then I guess your comments about certain end markets being weak, other than housing in the US, what other end markets are giving you concern right now?

That's really it, the residential market has been off our other primary end markets, AG, industrial, which includes mining, and the municipal segments and I'm speaking globally here, have all been solid. And in some cases bouncing back from a fairly weak performance last year. In the case of AG, it's certainly in North America it was a slow year for AG last year. So we are really having a good year but it looks very good compared to because of the weak comparison.

Okay. Thank you.

Your next question is from Matt Summerville with KeyBanc.

Scott, can you quantify the price increase you're putting place in the water business in the back half of the year on average?

On average, Mat, we would say that it's between 3 and 4%.

Okay. Thank you. Then with respect to Brazil, Scott, can you talk about what sort of synergies you are seeing early on here with industrial, how much cross selling you have been able to be do or if that's still yet to come?

It's yet to come. The business in Brazil is performing very well. And we are getting nice double-digit year-on-year growth out of that business on a pro forma basis since we bought it in January. We are very pleased with it. We will be introducing in August, 4-inch submersible, Franklin 4-inch submersible pumps and motors into the Brazilian market. The company that we acquired Schneider [Motobaumbus] had a number of years ago been the distributor in Brazil for one of our major competitors, and they imported that competitor's pumps along with Franklin motors and had about 25% of the Brazilian 4-inch market, when the devaluation of the real at that time made importation no longer practical and they had to give up that business. So their distribution channel which is extensive, has good reach among the residential contractors who install 4-inch pumps and motors, we are optimistic that we will be able to reestablish at least the position they historically had in that market. In addition, our Brazilian management team is looking at a number of other products produced either by our water transfer, Little Giant division or by our pump brands company in southern Africa, to introduce those products into the Brazilian market as well. Then of course we are working with them on purchasing initiatives. to reduce their costs. But we are working with Schneider management on purchasing initiatives as well. So many of the synergies are yet to come. They've been performing well up to now but it isn't because we have implemented these initiatives, those are in the works.

Okay, speaking of the water transfer business can you talk about what kind of growth you are seeing there and how operating profitability trended since you bought Little Giant in 2006 and what kind of pricing.

Little Giant, in a nutshell has been I would say up to our expectations and performed quite well from the bottom line perspective but is -- has not been up to our expectations from a top line perspective. Driven primarily by weak overall industry demand. We have accessed through industry reporting sources to market share data and we know since we acquired Little Giant, our share in of our key products have gone up. In spite of the share gains, the overall demand at least this year has been pretty soft, now, our management team has done a great job of working with the Franklin to reduce fixed cost, to reduce direct costs through purchasing initiatives, improved productivity in the factory and able to move margins up in spite of that and our profitability is up significantly in that business this year in spite of the sluggish industry demand conditions that they face. I would say that that business is more exposed to US and Canada residential housing weakness, than any of the other businesses that we have.

Okay. Then in the fueling business, I presume you had warranty costs in the Q2, first how much was that and are you complete with that?

If you're asking about the retro fit of the valve.

That's what I'm asking.

We're affectively complete with that. Most of that money was incurred in the fourth and first quarters, fourth quarter last and first quarter this year. We have on going warranty issues as our installed on a dollar basis as the installed base gets bigger, in terms of the the retro fit that's complete.

Then just two more questions, first, with respect to [Teradyne] trying to bring the larger big motor products to market, Scott, what are you seeing at this point have you seen product in the market and have you seen any customer dislocations or any evidence of increased price competitiveness and is that a concern of yours, what full year tax rate should we be using?

The -- we have obtained our first sample of the [Teradyne] high thrust motor. I would say up to now, the impact the market impact has been close to zero. There has not been a great deal of customer exposure to the product. So the fact that it's in the market is just I would say no effect on our business. Our analysis is that the introduction of this product which is marketed the same they with 6 and 8-inch motors are marketed. That is, a high thrust motor, 6 and a 8-inch motor, all go to market as a motor only, there is no pump attached to them. And almost every distributor in the United States carries Franklin large motors and high thrust motors in the 4-inch size and also carries competitors pump lines. So in the small 4-inch where [Teradyne] has been in the market up to now those products go to market as a pump motor combination. So a contractor has to make a decision, do I stay with my as an example [PentAir or [Ghouled] pump and switch to a [Teradyne] motor or stay with a Franklin motor and switch to a Pump brand that is sold with Franklin motors. He has to make a decision in that instance. In the high thrust market and in the 6 and 8-inch motor market, the contractor doesn't need to make any decision he has always used Franklin and perhaps a [Ghouled] pump, he always bought it from a local distributor, he can still do that, that's the way the products are sold in the market. They buy the motor independent of the pump. It's a much the market dynamic is very different in this -- these large motor and pump arena and our -- we've been competing with the major pump companies in -- with that have had their line of 6 and 8-inch motors for a number of years now, and our sales of those products are up dramatically, this year, so I really think it's going to be a interesting dynamic as they introduce high thrust but I really feel that we are in a pretty strong position to defend our business base, our business base here.

Matt, the affective tax rate, 347 is where we are at through the first six months. That's a good estimate for the whole year.

Thank you.

Our final question comes from Mike Schneider with Robert W. Baird.

John, maybe I could just run through some numbers with you quick. I'm trying to back in to what water systems grew on a organic basis as defined by most other companies excluding acquisitions and currency, if I take the dollar amount in the release, organic -- -- revenue growth was 23.7 million, we back out 7 million of FX, 30 million of - - I'm sorry 4.5 million of acquired organic growth, it looks like there was about $12.2 million in organic growth in dollars and all of which came out of fueling, so am I right that the water systems business is defined by a pure organic growth definition, was less than 1%? Flat up 1%?

Well, by our calculation, as we said, we thought the total organic growth was 10%. If you're trying to dial the FX out of it, we calculate that at 5%, Mike.

Then the acquisitions contributed 4.5 million as well of that organic growth that you calculate as 10%?

That's correct.

Okay. So if you back out acquisitions and currency, water organic growth was probably less than 1%.

I can take you through the numbers separately if you like. We had water organic growth at 10%. Without foreign exchange at 4.3%. In total for water.

That included foreign exchange. Back out the foreign exchange and you're down to -- 5% or so, you back out the organic growth from the acquisitions which again Mike the reason we do that is because we have some choice about where that growth could occur.

Right.

And if we choose to put it in to monarch, then it will show up as acquisition growth not organic growth for example we choose to put it in Oklahoma City, in the -- could be organic growth. Well, we prefer to make what we think is the rational business and stick business where it belongs, and that's why we represent the organic growth of the acquisitions as part of our organic growth. But if you back that out, total water systems growth would be in the 1 to 2% range.

Okay, by geography, break apart the 1 to 2 points, was North America down.

No.

Was Europe the lager this quarter?

Europe didn't have tremendous growth, Mike. The water transfer business that we talked a little bit about earlier as Scott mentioned that revenue line or top line has been a challenge in that business given the economic head wind but the core north America business grew on a volume and a price perspective in the quarter.

We indicated that business was up by double-digit amount.

Okay. Focusing on water margins, did an exceptional job in the quarter I'm trying to understand what is sustainable here. Are you able to determine of the increase in water margins this quarter how much came out of the mix shift towards AG or larger horsepower motor, how much from acquisitions, and then really what the core business looks like so we can understand the puts and takes during the quarter?

We talked bout the key drivers. First of all, we did have some mix shift, in the larger motors, that's favorable from a margin perspective. We talked that there was less discounting this quarter than we seen in prior quarters as well. And that certainly contributed. But the biggest factor is this manufacturing utilization and leverage benefit that we got, that detriment even though we are lowering inventories in this business wasn't as significant as it was in the first quarter. So we have seen that continuing benefit and that won't all continue for sure because as we said we are adding fixed cost in the second half of the year related to the pump plant, but those were the major drivers.

Mike, we are in doing some things in the back half that will -- tantalize operating leverage that we get in the back half to quite honestly tee ourselves up for a significant improvement in operating leverage in the first part in 2009. And those include moving a significant chunk of business out of North America into Linares. During the back half, while that's occurring we are going to be training people, we will incur the depreciation on the new pump plant which will kick in in the back half of this year and we will not have gotten rid of the troops, we will not have been able to reduce our cost base in our North American facilities. However, as we go in to next -- and at the same time, we are running Linares at a reduced level to bring inventories down so that next year we get the double benefit of producing as much as we sell where this year we are producing way less than we sell. Utilization rate will go up for that reason. Plus we will have transferred a great deal of additional business into Linares, plus our over all fixed cost base, will be down because as we go into 2009, we will be able to reduce cost in our other factories in North America, while then we will be adding to Linares that whole cost structure will be in place during the fourth quarter of this year. So yes, we are going the take a possibly, possibly see some reduction in water margin in North America in particular for that reason but you're asking about sustainability, we are liking what we see from a cost structure perspective going into 2009.

And I'm just curious, when you referred in the opening comments about tighter cost controls and fixed cost controls in the second quarter, to explain the benefit in water, what were you actually able to do in such quick order on the fixed cost settlement during the second quarter?

Last year and we talked about this a good deal, last year we were introducing new pump products developing and introducing new pump products, which essentially replaced our entire product line in North America.

Okay.

That whole process was expensive.

So wasn't as though expenses were dialed back this quarter --

We basically with the few minor exceptions have got all the products developed and many of them are either launched or being launched so the development cost wasn't quite as great this - - in the second quarter this year as it was, which was in the second quarter last year where we had a awful lot of activity in that regard.

Then a more conceptual question, as you changed the business model and gone more direct to distribution, has there been any litigation that has sprung up as a result of this as we moved beyond the battleground?

We had a trademark litigation with Jacuzzi brands that we resolved and recognized in the second quarter. Other than that, no, no material litigation outside the ordinary course of business. That really wasn't, didn't involve a - - didn't have a major financial impact.

In the distribution channel same question I'm curious if there is indirect exposure as well.

We aware, this is Robert again, of a lawsuit that exists between a large distributor and another pump company. We have not been named as a party to that lawsuit as this point.

I guess the answer your question is, no.

Thank you very much, guys.

Thank you that ends our call, Good-bye.

Ladies and gentlemen, this concludes the tele conference, you may disconnect at this time. Thank you for your participation