Watts Water Technologies Inc (WTS) 2004 Q2 法說會逐字稿

Welcome to the second-quarter 2004 Watts Water Technologies earnings conference call.

My name is Amanda and I will be your coordinator for today.

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

We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) At this time I'd like to hand the conference over to your host for today's call, Mr. Ken LePage, Assistant General Counsel.

Before Pat and Bill begin their presentation I want to inform you that various remarks they may make about the Company's future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those discussed under the heading "certain factors affecting future results" in our annual report on Form 10-K for the year ended December 31, 2003 which has been filed with the Securities and Exchange Commission and other reports we file from time to time with the Securities and Exchange Commission.

In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date.

While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our estimates change and, therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

I will now turn the presentation over to Pat and Bill.

Thank you, Ken.

This is Patrick O'Keefe speaking.

The way we're going to run the conference today is I'm going to make some opening comments and walk you through the top-level numbers; then I'll turn it over to bill who will give you some of the color and detail behind the financial numbers and then I will come back on line and talk about some general comments that are nonquantifiable issues impacting the business.

The first issue I want to talk about is the revenue numbers.

We ended the quarter with sales of 212,700,000 which is up 23 percent from the prior year or 39.2 million.

If you look at the numbers for the year-to-date we came in at 403 which is up 64 million or 19 percent from the prior year.

When you look at the gross margins, we had a very strong period in terms of gross margin performance.

Gross margins increased 210 basis points from 33.8 percent last year to 35.9 percent this year.

If you look at the same figures on a year-to-date, we have an increase of 160 basis points, up from 33.7 a year ago to 35.3 at this year.

When you look at the operating earnings you see a similar kind of performance.

A 210 basis point improvement, operating earnings going from 9.4 percent a year ago to 11.5 percent this year in the current quarter.

On a year-to-date basis operating earnings increased to 11 percent from 9.5, so 150 basis points on a year-to-date basis.

When you look at the earnings from continuing operations, they come in at 14 million, up from 8.7 a year ago, so a 5.3 percent increase in operating earnings which represents a 62 percent increase over the prior quarter a year ago.

On a year-to-date basis operating earnings came in at 25 million, up from 17.6 in the prior year-to-date or an increase of 7.4 which is a 42 percent increase over last year's performance on a 6 month basis.

In terms of earnings per share, a very strong quarter with 43 cents earnings per share from continuing operations; that compares to 32 cents a year ago.

And on a year-to-date basis we came in at 77 cents compared to 65 cents a year ago.

So a very, very strong performance.

Now I'm going to turn the microphone over to Bill McCartney who will take you behind the numbers and give you some of the color.

Thanks, Pat.

Looking at the components of revenue on a consolidated basis, I'd just like to run through the 4 major reasons for the change.

First of all, our internal growth was 11 percent, that's $19,069,000 and we'll talk about that by segment and the various reasons for it.

Again, on a consolidated basis the foreign exchange increased revenues by $3,074,000, predominantly the euro, a little bit of strength from the Canadian dollar.

Our acquired revenue was $11,299,000 and then the rest of it is the inclusion of Jameco International which is our 49 percent owned entity which we are now consolidating because of the new FIN 46 accounting rules and that is $5,740,000.

If you add all that up and our total growth rate in the quarter was 22.6 percent.

Looking at the revenue on a segment basis, North America went from 144.5 million -- from 118.2 million, so that's an increase of 26.4.

Our European sales, 61 million from 50.2 million, an increase of 10.8.

And then China went from last year 5.1 to this year 7.2, so an increase of $2.1 million.

That's the breakout of the increase of 39 million.

If we look at North America, the increase was 26.4 million, as I said.

North America had an increase from organic growth of 14.3 million, so that's 8.3 percent organic growth in North America during the quarter.

The foreign exchange was $200,000, that's the Canadian dollar.

Acquired revenue in the quarter was $6.1 million increase and then the 5,740,000 from the FIN 46 rule.

That's again, a total of $26.4 million increase in the quarter for North America.

When we look at the numbers inside of North America, the retail grew at 11 percent in the quarter.

What we've seen there is watch (ph) brass and tubular line has restored itself back to normal ordering patterns.

If you recall in the first-quarter our retail was down slightly on the quarter; it was the first time we had actually had an unfavorable comparison in -- actually the first time ever.

And right now we see that our customers are replenishing their inventories and the ordering patterns there are back to normal.

We also saw our Sun Touched (ph) productline increase by 59 percent in the quarter, this is our electrical under the floor tile warming system.

It's been a very successful product.

It is shipped out of our Watts Radiant facility.

Those 2 productlines were the major contributors to the growth on our retail in the quarter.

As you recall at the end of the first quarter, Pat and I were forecasting that we felt that high single digits were achievable for the full year in retail, and we still feel that that is a good forecast and we are standing by that for the year.

Looking at our wholesale business in the quarter, we were up 13 percent in North America.

This is the largest increase from an organic standpoint that we have seen in the history of the Company, so we're very strong on the wholesale side.

When we look at the productline inside of the wholesale, almost all productlines were up.

Our backflow line was up 19 percent and all lines inside of backflow were up.

We had a good performance from our Hunter which we sold $3 million of that in the quarter.

We're about 5.5 million on Hunter year-to-date and that's twice or a 100 percent increase from the run rate of last year.

The productlines that serve the residential market were very strong in the quarter and the commercial lines were either stable to up slightly.

So we saw a very strong performance when you put all of this together for the wholesale market.

On a year-to-date basis that puts our retail up at 5 percent and the wholesale up 9 percent organically.

And in North America the 2 acquisition that are included in our numbers are Orion -- or McCoy Enterprises which will go into market under the trade name of Orion and Flowmatic -- and Orion, excuse me, we acquired in the middle of May.

And Flowmatic, our reverse osmosis filtration company that we purchased the first week in January called Flowmatic; those are on target for the quarter and for the year-to-date in the case of Flowmatic.

So we're pleased with the performance of those 2 acquisitions at this point.

Looking at Europe for a moment, again the total revenue was up by 10.8 million.

The organic increase was 2.7 million, so Europe grew 5.4 percent organically in the quarter.

The foreign exchange was 2.9 million and the acquisitions in Europe contributed $5.2 million for a total again of $10.8 million.

The European market is still a difficult one for us.

Our European managers would describe the market in near recession conditions.

That applies to our major trading areas of Italy, Germany and France.

So what we're seeing in our performances is that we're gaining market share both in wholesale and on the OEM market.

We have some new sales management in Germany which is making progress with the large wholesales in which we're gaining market share in that German market.

We're also being successful in increasing some of our exports out of Germany into Eastern Europe.

We also had in Europe the acquisition of TEAM which we acquired at the very beginning of the second quarter and that performed as expected.

When we look at China the revenues are up $2.1 million.

If you recall last year in the second quarter we had some difficult accounting issues that we worked through and we took a charge at the revenue line last year's second quarter of 2.1 -- or actually $2.2 million.

So from an operating standpoint the revenue in China was flat, but what we are seeing in China is that our incoming order rates are quiet strong, particularly at our joint venture, TWT, where we have a very large backlog compared to historical perspectives.

So we are, we feel, doing well in China from a top line standpoint even though that has not all come through the P&L yet.

So when you look at all that, the next thing to talk about, I guess, is the earnings.

Pat mentioned the performance on the operating earnings line for the quarter being up 210 basis point at 11.5 percent of sales.

This improvement was driven by improvement in the gross margin.

In the quarter our consolidated gross margin came in at 35.9 percent compared to 33.8 percent last year.

What's driving that is, first of all, we had a -- the increase in the wholesale market in North America of 13 percent was a significant contributor to the performance.

We had a significantly improved mix and those of you who follow the company know that this wholesale -- North American wholesale market is the most profitable part of the business.

That was a large contributor to the performance.

Additionally if you look at our wholly-owned enterprise, Woofie (ph) in China, that broke even this quarter.

As you will recall, we were telling all of you at the end of last year that we expected to see continual gradual improvement in the performance of that.

And last quarter we had some improvement and this quarter we are now breaking even there.

We have been experiencing a lot of startup expenses and, because we've been able to increase the production levels there, that factory is now absorbing all of its manufacturing expenses.

And we are quite satisfied with the level of production and we will be looking to go to Phase II of that facility and start to transfer more or additional productlines into that facility.

Some other factors impacting the margin is our cost reduction program where we're trying to shift more of our production to third party off shore facilities as well as some of our wholly-owned facilities as well.

So we're seeing some of that come through.

The restructuring programs, particularly the ones we implemented in Europe last year, have come through and helped the gross margin in Europe.

You might recall that last year we closed a foundry in France.

We've been able to increase the amount of sourcing coming through our Tunisian facility.

We redesigned our temperature and pressure safety relief unit in Europe and we are now sourcing that through our Tunisian facility so we're seeing some improvements there.

And our European managers have also gone through several of the facilities and rationalized the productline.

So what we're seeing there is even though we had lower organic growth in Europe, we did cut back on several million dollars of low gross margin productlines and we were able to have organic growth and replace those products with higher gross margin productlines -- gross margin percentages, so that culling of the productline has also contributed to the improved margin as well.

One of the issues we've talked extensively about with you in the first quarter was our raw material cost increases.

We've seen significant increases in the cost of brass, bronze, stainless and cast iron and we believe that we have covered those cost increases with price increases for the entire second quarter.

The other thing that's impacting the performance in the margin is the leverage.

Our large factories in the United States were able to hold their fixed expenses constant so we were able to create some operating leverage in the second quarter.

So those are the major factors driving the performance on the earnings.

When we look at the SG&A expenses we had to record $1.4 million of expense in our SG&A for implementation of the Sarbanes-Oxley requirements.

We're anticipating that will be approximately $3.5 million for the full year.

We have expensed 1.9 million of that amount through the end of June.

We also brought online two additional distribution centers this year in the United States which increased our expenses and the SG&A by 600,000 in the quarter and $1 million year-to-date.

We now have our regional distribution system set up where we -- over the last 18 months we've established 5 regional distribution centers in the U.S. and 2 in Canada and we are at a steady state in terms of we will not be adding any additional distribution centers, but we now can reach all of our North American customer base within a day to a day and a half depending on where they are.

So the idea is to improve our delivery to our customers there.

The other consideration in improved performance on the earnings is the tax rate in the quarter.

We decreased our tax rate from 37.5 percent last year in the quarter to 36 percent this year second quarter.

Two major reasons why the tax rate has decreased.

One is the fact that -- of the mix.

Our European entities were more profitable this year than last and the effective tax rate in Europe is about 32.5 percent, so we have a favorable mix situation occurring there.

And because China is profitable in the quarter and we have tax holidays in China and we are also utilizing a net operating loss carryforward in China, which was generated last year, we are able to bring forward those earnings without having to tax affect them.

So utilization of the NOL in China is the second reason for the improvement on the tax rate.

The tax rate year-to-date has dropped about 3/10 of a point to 36.6.

So those are the financial highlights in the quarter and I'll turn it over to Pat for some additional comments.

I'd like to make a couple of comments.

The first one which everyone is interested in is what has happened in terms of issues with regard to legal issues and litigation.

There's 2 issues that were resolved in the quarter, both very favorable.

The first is that we received a favorable judgment in an action which was a class-action certification issue and the class was denied so that we were positively influenced in that case by the fact that that case, although it's appealable, it will be very difficult for the plaintiff's lawyer to exert a class-action type of a suit.

The second issue is in the Watts versus Zürich Insurance.

We received a favorable judgment where the court gave us a summary judgment and is entitling us to collect $11 million from Zürich Insurance Company for the indemnity cost that we paid in settling the Phase I in the lawsuit regarding James Jones.

So both legal issues are very favorable in the quarter.

Just so everyone understands with regard to the $11 million, that is recorded as a liability on our balance sheet.

It was expensed in a prior period until such time as all the appeals are heard.

We are leaving that as an expense item and as a liability on our balance sheet.

So both positive developments in terms of legal.

The second issue I want to point out is that we did declare a dividend of 7 cents a share of shareholders of record as of September 10th.

The third issue I want to talk about is the issue of pricing.

Bill mentioned this earlier.

We have been successful year-to-date in not only covering our cost increases but maintaining our margins on those products where we had substantial cost increases coming through due to a precipitous increase in raw material.

There is one area that I am concerned about as we go forward which is now we have oil prices moving.

We're concerned about those raw materials that are driven by oil prices, particularly plastic resins and things of that nature.

So we're in the process now of planning what pricing action will have to be taken in order to make sure that we maintain our margins with regard to some of those components.

The third issue I want to go back to is, again, the retail marketplace.

I think we feel pretty confident that the retail marketplace, although we experienced a soft quarter in the first quarter, we're back on track with regard to the retail market.

I think you saw the growth that we experienced in the second quarter; we feel fairly confident that we will achieve high single growth in the retail market for the entire year.

The other thing I want to point out is my perspective in terms of the wholesale market.

The wholesale market -- we had an exceptionally strong quarter in the wholesale market.

My expectations are and I think what we're seeing is the commercial marketplace is slowly but surely recovering from what has been a 3 year decline.

We don't see it picking up precipitously, but we see it increasing on a steady basis and we feel pretty positive going forward that we won't see a substantial reversal of the improvement that we're seeing in the commercial marketplace so that bodes well for our future.

And the last issue is I think in looking at the quarter I think we've created for ourselves a tough comparison as we go forward.

There are a couple reasons why I think that's true.

One is that it will be very difficult to replicate the 13 percent growth that we saw on the wholesale market during that quarter.

I think you could see that the 200 basis point improvement that we saw in gross margins, most of that was a favorable mix in terms of a shift away from lower margin products toward higher margin products, primarily wholesale related product.

The other is that we were beneficiaries of some additional volume.

One of the decisions we made in the quarter is actually to defer the closure of a facility that was planned for discontinuance later in the year.

We needed the capacity to fulfill our customer requirement, so we in essence extended that decision in terms of looking at shutting that facility down maybe a year from now versus 6 months from now.

The other thing I think that we saw in the quarter was that we saw some buying in anticipation of 2 events.

One is we saw some buying in Europe in anticipation of their vacation season which typically takes place during July and August and the second is we saw some buying in anticipation of price increases.

You'll remember we announced a price increase in mid-May.

Most of those price increases were implemented between the period of mid-May and mid-June and we saw some people who came in and gave us some impact orders trying to hedge their purchasing in anticipation of getting ahead of those price increases.

So for all those reasons I think what we have here is sort of an exceptional quarter, one which will make it difficult for us in terms of forward comparisons.

With that I'd like to open up the lines and let you ask any questions you may have.

(OPERATOR INSTRUCTIONS) Ned Armstrong, FBR.

I had a couple questions regarding some balance sheet and cash flow items.

I noticed that your inventories increased quite a bit and I'm sure a lot of that is due to acquisitions.

But I was wondering if going forward you expect them to stay at the approximate levels where they are?

Well, we had an impact from acquisitions on inventory, but we've also, because of the higher costs that we're running or we're incurring now, we had to write up our inventories about $7 million in the quarter because of the higher copper and steel content of our products.

We've also made some delivery management decisions here to increase inventories in certain productlines and we extend our supply chains to China in particular and we're increasing our production levels there, as we mentioned earlier.

So there's been certain decisions there which we are trying to make sure we protect the delivery and fill rates for our customers.

That being said, we recognize that the inventory is a little too high -- a little higher than we want it and it is going to be a focus area for us.

We're not in a position now to make a forecast on what our inventory will be at the end of the year because the business conditions have been relatively strong, but we will be looking at that or are looking at it for improvement.

Okay.

With regard to cash flow, do you have numbers for depreciation and amortization, cap spending and cash flow from operations?

Yes, I can give those to you.

Let's see.

Depreciation on the 6 months is 13.5; amortization is 0.7, capital spending 11.5.

And that's for the 6 months?

Yes, sir.

And then cash flow from operations?

It was -11.9.

Great.

And then -- I calculated acquisition spending for the quarter of $44.3 million, does that sound right?

We have -- I don't have it for the quarter.

Year-to-date it's 70.3.

Great.

That helps.

Thank you very much.

Michael Schneider, Robert W. Baird.

First, I guess just on the impact of the European pre-buy and some of these other items that set yourselves up for a tough 3Q comparison, can you guys give us a sense of what in revenue you think you benefited during the quarter by?

From the pre-buy because of the price increase?

Yes, and just the culmination that the pre-buy on the vacations, price increase, etc.

All of the factors Pat mentioned?

It's almost impossible to quantify, Mike.

We know it's happening but we haven't been able to quantify it.

The primary one though, the big driver was the U.S. buying in anticipation of price increases.

The European one was not of the same magnitude.

I asked because you beat me to the punch about the third-quarter comparison.

Historically you're flat to up in the third quarter in revenue and with the surge this quarter it's tough for me to see how you can match this quarter at about 212.

Can you give us any sense of what you're looking for in the third quarter in rough numbers?

You know we don't forecast.

I know you don't.

I'm asking you to.

There are people out there who are smarter than Bill & I. Some of which are on the line.

Fair enough.

And I guess gross margins, with that in mind I have been impressed and I congratulate you on the leverage you guys have demonstrated over the last three quarters.

Can you give us a sense of the gross margin outlook given that commodities prices are still rising especially in July?

And offsetting that are obviously the high production rates you have.

Any insights you can give us on gross margins?

Mike, if there's anything that sort of bothers me or keeps me awake it is this issue and it's been an issue that we've struggled with all year long.

We met as late as an hour and a half ago with regard to what actions we need to take with regard to those components of our products that are being influenced by the current rise in oil prices.

And we don't have a plan completely laid out, but we have a rough plan laid out.

Our intention is to maintain our gross margin on each of these product categories and I think year-to-date we have been successful in doing that.

Now the one thing I'd want to say is that some of the price increases that we implemented back in May are now just taking effect because some of your very largest wholesales or some of your very largest retailers, they argue with you, they procrastinate, they do everything possible to push that deadline up so that you can't affect that price increase until 45-60 days after you've actually announced it.

So we have an action plan where we have a number of larger accounts that are now -- we're now seeing that the actual effect of prices are taking place.

So we believe, Mike, that we will be able to maintain our margin.

The increase that you saw, the 200 basis points in that quarter, I attribute the majority of that not to the pricing actions we'd taken in order to maintain our margins, but the positive shift in mix from a very strong mix of products primarily those sold through the wholesale and our ability to cost reduce products for both the retail and the wholesale channel.

So I guess, Mike, if I were to make a forecast at the moment I think our objective is to maintain margins at the level that we're achieving and the kind of level that we achieved during the second quarter.

Okay, great.

That's very helpful.

And then on that pricing issue, Pat, can you give us a sense of what you are able to get through these large retailers because they're notoriously tough and resistant to any price increases?

Have you basically made it all up on the wholesale side?

No, we've actually -- we've had price increases on both the wholesale and the retail side.

Of equal magnitude?

Of equal magnitude in terms of -- proportionate to the cost increases that we've experienced.

So for example, where we have metal based products going into the retail we effected price increases to those retailers.

If there was an issue, Mike, it has not been that we have not been able to get them, except it's been a year-to-date battle.

So they're late in coming, okay?

But quite honestly at the end of the day we've taken the position we don't have any alternative.

With the kind of increases in raw material that we experienced this year, we basically keep on going back and fight the battle and we've been successful in covering our cost but not increasing our margin nor decreasing our margin in the retail.

And Bill, maybe following up on this gross margin question in pricing, to past points that maybe you haven't realized all of the pricing increases yet just given the delays.

Is it also the case, though, where you haven't really run through the cost increases as well through the inventory?

That's right.

We still had some of the low-cost inventory that traveled through cost of goods sold in Q2.

So that -- we will see some higher priced material on average going through cost of goods sold in Q3 and Q4, but we have some additional price increases that we're going to be realizing as well.

So it's -- we're looking, Mike, at -- some of the analysis that we've done would indicate that on a year-to-date basis the cost increases have increased our cost of goods sold by 3 percent.

And that's a mixture of everything.

We think that our prices have -- our price increases have covered that, but we still have -- it's a real moving target because copper went up and it came down a little.

As Pat says, a lot of timing issues particularly on the retail guys.

The larger customers you have to negotiate price increases; you don't put it out as part of the general price increase.

So it's a lot of variables and -- that are constantly moving on you.

You're right though, Mike.

There have been -- in the second quarter we were the beneficiaries of our first-in first-out accounting such that the older costs were running through the P&L during the second quarter.

Knowing that, that's why we're following up in making sure that these price increases -- we're watching the timing of when these price increases become effective because we're now seeing those higher costs roll through our P&L as we enter the third quarter.

And if you don't have the pricing up there you're going to see degradation in terms of your gross margin.

That's what we're guarding against.

One other comment, Mike, for you is that the way Pat is managing the salesforce, he's trying to make sure that each of these individual SKUs were maintaining our margins on that stuff in terms of cost and sale prices.

But what could affect our overall gross margin is the mix because what we're seeing is the retail -- to get to 7 percent for the year the retail could grow faster than the wholesale which is possible, we don't know that, but if it does that could affect the overall margin percentage.

But the individual business units, the gross margin would be comparable.

So you have a mix thing that could affect this a little bit.

Thank you.

I'll get back in line.

David Kurzman, Needham & Co.

A question in terms of DSO's and obviously inventory turns are going to be a little difficult to look at trailing.

But how do you intend to drive the DSO's lower and the inventory turns higher given the new mix of product?

If you look at our DSO, Dave, in the quarter -- it went down a little bit from this time last year and that's really the impact of acquisitions.

If you strip the acquisitions out of there the DSO is flat with December and this time last year.

So the accounts receivable increase you're going to see on the cash flow really is due to the timing of sales.

The end of December is typically a much quieter period than the end of June so you have some timing issues on that and we tend to get that back when you look at a cash flow from 12/31 to 12/31.

So am I right to assume then that the pre-buy came so close to the end of the second quarter that you probably collected the cash by now and DSO's will look a little bit better after the third quarter?

We don't really measure -- the way we measure DSOs here is we compare ourselves to industry averages and as long as we're close we feel comfortable with that.

Right now, if you look at our European DSO -- and we break it out by geography because it has different meanings in different geographies -- it's very close to industry averages.

So I don't view it as we need to drive down our DSO.

We need to be competitive so we don't lose any market share in terms of granting terms to our customers.

That being said, though, I do think we have opportunity on the inventory in terms of improved turnover.

One of the ways we measure the Company is we look at working capital as a percentage of sales.

And you could back out cash and changes in current portion of debt.

And on that basis we've gone from 20.5 percent to about 22.5 percent versus December to June.

What's your target trade working capital as a percentage of revenue?

Our objective is to decrease it every year and we've decreased it 5 years in a row, okay?

We have increased it from December to June.

Yes, but -- that would make sense given the higher cost of materials and the pre buy.

That's right.

And you have certain timing issues where people are getting ready for heating season.

To go from December to June is -- we measure it because we want to know.

However, it's not a perfect comparison.

Our objective would be to have improvement year-over-year at the end of December and to show that we are utilizing our working capital more efficiently.

On a separate subject, are you guys still looking for about $6 million of restructuring cost this year?

No, we've decreased that by about $1.2 million in the year and that is because we had to extend the useful life of certain of our manufacturing because we had a surge in business.

Right, right.

Okay, so now it's about 4.8?

That's correct.

And then two very quick ones.

How much more NOLs in China can you benefit from?

Is it meaningful?

It'll be through the remainder of this year at a minimum.

At a minimum?

Okay, good.

And finally, on the last call you guys talked about some sort of pickup in your acquisition opportunities.

Any more you can give us on that?

Well, we have a good pipeline; we have several that are in process.

We don't predict whether they're going to close or not; we don't have that assurance because anything can go wrong with a deal that's anywhere along the process.

But I think we feel pretty good that there are in number of opportunities out there that are synergistic and that would fit with our business and be accretive to our earnings.

Thanks a lot.

Jeff Hammond, Key McDonald.

I guess first housekeeping, can you give us the operating profit by segment or by region and then corporate expense?

One second.

Okay, operating profit for the quarter in North America 22,186;

Europe 7,992;

China 457; corporate -6,129 for a total of 24,506.

Okay.

And then the jump in corporate was largely Sarbanes-Oxley?

That's almost all it, yes.

Okay.

I guess on the raw material issue, you seem to have managed the metals base increases pretty well year-to-date with price increases, etc.

You brought up the plastic resins increases related to oil.

Can you give us some context -- order of magnitude what your exposure is on the plastics side versus what your exposure is on the metals side?

So far what we have seen -- and this is literally over the last 60 days -- you're seeing cost increases on the basic resins ranging from anywhere from on the low side 5 to the high side maybe 12 or 13 percent.

You've got to remember, on a product -- most of our products what you see is some internal parts that are made from plastic resins.

We also have some products that are entirely made of plastic resins.

So we're now in the process of evaluating what kind of a price increase we need on various product categories to cover that.

But you're talking someplace low side 5, high side 13 and that's all within I'd say the last 60 to 90 days.

Okay.

I guess what I was getting to is if you purchased say $100 the metals based product, what multiple of that would you be purchasing of say plastic residents?

I guess my understanding was that that was a much smaller --.

It's a fraction of what we buy in metals.

So you're talking less than 20 percent of the impact that we had with metals.

Metals was 80 percent of our issue, plastics is 20 percent of our issue -- or less.

Okay.

And then on the pre buy, I guess you said some of the price increases were going through mid-May, mid-June time frame.

So I guess here we stand in early August; do you have any sense of -- have you seen any drop-off because of that pre buy?

We can't talk to what's happening in the third quarter.

We have to pass on that one.

Okay.

And then I guess finally going back to commercial construction, in the 13 percent internal growth wholesale can you give us a sense -- how much of that 13 percent was residential strength, how much was commercial strength, how much was market share?

You're correct in assuming that there was some of each and let me explain.

One of the things that we experienced during the second quarter is several of our competitors had difficulty delivering and, as a result, we were able to gain market share against them.

So the second issue is that we had been extremely successful in terms of gaining market share in the backflow prevention market where we continue to grow at quite rapid rates.

We've also experienced some pretty good gains -- a good portion of which is actually the expansion of the market in our under the floor radiant heating business.

So you're right in that what we're seeing is a slight pick up in the commercial marketplace, market share gains as a result of our superiority in our backflow prevention business and then market share gains from the introduction of a number of new under the floor heating products.

And then on top of that you're seeing a pretty good pickup I think in terms of just general economy as economic conditions in the second quarter were relatively favorable.

I would say it's a combination of all three.

I'm not actually able to precisely give you the pieces.

Okay.

And then finally, if you look at the 4 acquisitions you've closed year-to-date, can you give us some sense -- were they accretive in the quarter collectively and what might be an estimation of what those might be collectively accretive in '04 or say '05?

If you look at the deals that we considered to be acquired in the quarter, which would be TEAM, McCoy, Flowmatic, and then Anello which was done last year, they contributed 4 cents in the quarter and that's after you (indiscernible) cost of money.

And now Anello drops off because we did that last July, so you have 3 deals going forward.

We believe that the 3 deals are going to contribute 2 to 3 cents a quarter.

Okay, great.

Thanks, guys.

Brendan Hartman (ph), Kramer Rosenthal (ph).

Just a follow-up I guess from the last quarterly call.

Bill, I think you talked about some new products being introduced at retail as well as some line reviews that are kind of standard operating procedure but you're always at risk of losing some business.

Can you give us an update there?

Has that taken place already?

Yes, we talked about the introduction of the presorted copper fittings line, which is -- we still expect that for the second half of the year.

We're procuring -- in beginning the process of procuring the inventory, etc.

We talked about the hot water heater recirculating pump and that has just started to ship.

So that's underway.

Those were the 2 large ones.

And there's been no change to your expectations for the new store growth?

I think last quarter you said 340 new stores, a 14 percent increase.

No change.

The other thing I want to say is there are a number of line reviews that we're actually in preparation for now.

But we don't have any ability to forecast what will happen during those line reviews.

When it comes to the water heater line review that we just went through, we actually picked up volume.

And we lost a couple of SKUs but they tended to be the very lowest margins SKUs we had and we picked up other products where we can enjoy higher margins.

This increased product, does that happen once a year, Pat, and is it staggered or is there a seasonality to the line reviews?

They're all staggered and it's interesting because they don't typically happen every year; they happen every 2 to 3 years.

But remember, we're in 18 separate categories, so at any given time you probably had 1 or 2 coming and it really depends on the workload of the buyer at the various retailers.

And then can we just go back to -- not to beat a dead horse, but the nice question on the price increases?

It seems to me you guys feel -- you talked about the oil prices being a concern now and the plastic resins and whatnot, but it seems you're less worried about copper, bronze, nickel, brass, stuff like that.

Am I correct in -- is that what I'm hearing?

(indiscernible) There was a scare and there was a shortage and you saw opportunists come into the market and try to horde things.

And I think that really sort of scared everybody because you had the increase that was greeted by demand and then you had the increase created by speculators.

And this is a little different.

Oil prices -- it's a straight driven -- it's pretty straightforward mathematically.

So a little bit easier to get your hands around.

So back to the 7 percent price increase you talked about in the last call effecting the second week in May.

You would say you realized most of that and you have not announced any other price increases except for stuff related to the plastics resins?

I wouldn’t say we realized all of it because I went through a list this line with the sales and marketing team of accounts where it's not fully implemented, but there are agreements in place in terms of effective dates.

So I'd say we're well on our way.

We have implemented enough to offset the cost increases and maintain our margins.

But we have not announced a price increase on -- due to plastics yet.

Okay.

That's still --.

Great, thanks a lot, guys.

Stewart Scharf, Standard & Poor's Equity.

Could you provide a little more color on the China operations and your cost savings there?

Are they on target with your goals?

Let me just say a couple things.

I took a trip here in June to China and spent quite a bit of time in China reviewing our operations.

You have to remember a couple of things that we have done in the last year to bring you up to date.

One is that we have a joint venture called TWT and that was the joint venture where we experienced some problems a year ago.

In resolving the problems we had a year ago, what we have done is in essence renegotiated our joint venture agreement so that we have managerial control in addition to being a 60 percent holder.

So our joint venture partner has gone from being an active manager in the business to being a passive investor.

And I think we're now seeing some significant improvements in that operation.

One of the things we are seeing, for example, is that we've been able to reorganize our selling efforts in China and are experiencing a higher level of incoming orders at that joint venture.

The second major change we made is that we bought out the minority interest in our joint venture in southern China which we refer to as Shida.

And we have seen substantial improvement there over the last several months as well in terms of incoming order rates.

And I think Bill said it earlier, the wholly-owned operation, which is essentially a machining operations in Tianjin.

We're now fully absorbing our overhead.

We have been successful in procuring 95 or 90 percent of the volume of the first major productline that we moved in there.

We're now in the second phase which is to move additional productlines into that facility.

So we saw some substantial improvement over -- year-over-year, quarter-over-quarter and we expect that that will continue throughout the rest of the year.

I think that the more we see in China -- we've made a major upgrade to the management staff there -- the more opportunities we continue to see.

We're much more actively involved in managing that operation than we were a year ago, working through and with our new managers.

Our incoming order rate at our joint venture is significantly higher.

The Chinese government is initiating a lot of water infrastructure projects as the population moves towards the East Coast.

We still have plenty of capacity left at our wholly-owned subsidiary in Tianjin and the one down in Southern China that we just acquired the remaining interest in.

So we have a lot of room to grow there as well.

So we're looking at moving more and more of our production to China and taking advantage of that capacity and taking advantage of the opportunities in the Chinese market.

Right now we're estimating that our purchases from China will be somewhere around $80 million in 2004 and increasing next year as well.

So it's a very exciting time for us in China.

Okay.

And could you explain why you (indiscernible) to maybe ahead of the curve with the plastic resins price hikes given the fact that oil prices have been high and rising for a while now?

Why would you wait?

I guess the answer is the only reason we were waiting quite honestly is to see what would happen and see if we could stabilize them.

We have not seen any of our competitors make any moves, but that's not unusual because we generally are the leaders.

So we're in the final stages of deciding exactly what to do and what to implement.

I guess, Stewart -- I guess the question is they're not as significant I guess as metal so we tended to react quicker with metal than we did with the plastic materials.

But I think you're right, the timing has come; it's time for somebody to provide leadership in the industry and it generally has to come from us.

Okay, thank you very much.

Ned Armstrong, FBR.

I just wanted to revisit the corporate expenses that you eluded to for the quarter.

I think you mentioned they were approximately 6.2 million.

6,129,000.

What portion of that related to extra legal expenses and what portion related to Sarbanes-Oxley?

Sarbanes-Oxley is $1.4 million.

Okay, and that's just for the second quarter?

Yes. 1.9 million on a year-to-date basis and in terms of legal, I don't think we really had anything we would classify as extraordinary in terms of legal expenses.

Okay.

And then the Sarbanes-Oxley for the remainder of the year you said you expected to be what again?

We're expecting that for the full year we're estimating about 3.5 million, so we're looking to go from 1.9 to 3.5 the remainder of the year.

Got it.

Thank you.

(OPERATOR INSTRUCTIONS) Michael Schneider, Robert W. Baird.

Could you guys talk about what you saw in the second quarter in terms of rollouts at Home Depot and the other retailers just given that you guys were up 11 percent organically?

It seems like there must have been some form of roll out going on?

As far as the rollouts go, Mike, we didn't have a major impact on the numbers from rollouts.

We're in the process of starting rollouts now.

We're starting the copper fittings which we probably won't have any series revenue from that until the fourth quarter.

The hot water heater recirculating pumps started a couple of weeks ago, so that will start.

Now the access panels which we mentioned, we have rolled those out earlier in the year and I'm not sure of the exact revenue there, but I know that it has been a successful product for us, but it's -- I would venture several hundred thousand dollars for access panels.

And then the other one we talked about was the water heater accessory program which we've picked up additional business there.

We are estimating it to be about a $4.5 to $5 million a year pickup in business which we're estimating we will see about 2 million of that in the second half of the year.

So in the second quarter not that much impact from the rollouts.

It's really just the reestablishment, if you will, of traditional ordering patterns on our brass and tubular line and just the continued success of the electrical product, the tile warming product.

Okay.

And you mentioned line reviews at existing customers, but have you got any sense about potential opportunities say with some of the other retailers and their line reviews in the fall?

I don't think there's -- nothing really serious to report there, Mike.

Fair enough.

I believe that is it.

Thank you.

That does conclude your questions.

Thank you very much.

We obviously had a pretty strong quarter and we look forward to talking to you about the results of the third quarter.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference.

This does conclude your program.

Have a wonderful day.