Watts Water Technologies Inc (WTS) 2005 Q1 法說會逐字稿

Good day.

Welcome to your quarter one 2005 Watts Water Technologies earnings conference call.

My name is Sheen and I will be your conference facilitator today.

At this time all lines in a listen-only mode and towards the end of the conference call we will be taking questions. [Operator Instructions] At this time I will turn the call over to your host Mr. Kenneth LePage, Assistant General Counsel.

Sir, please proceed.

Thank you.

Good afternoon.

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 Litigations 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, 2004 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.

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

Thank you, Ken.

First let me talk about the protocol for today's call.

I'm going to make some opening comments.

Following those opening comments I'm going to turn the call over to Bill McCartney our CFO who will review the results and details, then we're going to come back and I'm going to make some comments regarding the environment we are operating here as we are one third of the way through the second quarter and then we will open up the lines for questioning and we'll take all -- any questions you may have.

First of all, I just want to say that we are generally pleased with the results for the first quarter.

Like any quarter we have some areas where we need to make some improvements.

On the other hand, we have some positive developments throughout the quarter.

With regard to revenue, revenue came in at 219 million, up from 186 million the prior year, so an increase of $33 million. 17.75% which is a great showing.

With regard to net income from continuing operations we had a 1.4 million increase, increasing from 11 million in the prior year to 12.4 million this year which is 12.75%.

When you look at earnings per share from continuing operations we reported $0.37 this year, $0.34 in the prior year, so an increase of o $0.03 over the prior year.

And included in that earnings per share from continuing operations is restructuring charges equivalent to $0.02 in each year.

When you look at the shares outstanding our shares outstanding went up 483,000 shares, 1.5%.

The other issue I want to point out to you is earlier today we filed a shelf registration, a universal shelf registration where we have the ability under that shelf to issue up to $300 million worth of either debt or equity securities.

And we're going talk to you later about that.

There is nothing imminent at the moment in regard to that.

Its simply a normal registration filing being filed in anticipation of future debt and equity needs.

So there is nothing imminent and nothing immediate in terms of plans whatsoever.

Now, I would like to turn it over to Bill and Bill will walk you through the numbers and give you some of the color on the numbers throughout the quarter.

Thank you, Pat.

We'll go down to the P&L here.

First of all, revenue growth we grew $33 million or 17.7%.

Breaking net revenue growth down, organic growth was $20 million or 10.8%.

Our acquired growth was $9.3 million which is 5%.

And favorable foreign exchange of $3.6 million which is just under 2%.

And just to point out that we did complete the divestiture of Jameco International LLC, the small joint venture we had in which we held the minority interest.

That divestiture was completed during the first quarter and we were carrying that in our numbers last year as a FIN46 line item, but that has been removed from the comparison so you don't need to consider that.

It has been in last year's numbers all netted down into a discontinued operation number.

Looking at North America, North America's growth was just under 22% or $26.5 million.

Looking at the components of the growth there, of our total $20 million of internal growth in the quarter, $19 million came from North America.

So that is about 15.9% organic growth in North America.

The foreign exchange was about $750,000 so .06 point and acquired growth in North America $6.5 million or 5 .4 % for a total of 21.9.

Our retail segment did quite well in the quarter.

We grew from 33 to a little bit over $40 million or 22%.

We are very successful in the quarter in our rollouts.

We were rolling out our new EZ-Sweat pre sided copper fittings, some of our hot water connector and installation kits, our hot water recirculating pumps.

So that was one of the main contributors to the growth.

We saw our electrical tile warming products increase by a million dollars up to 3 in the quarter.

And just general volume increases overall to take us to the rest of the growth.

While we still have -- we had a very vibrant quarter there, similar to what you heard from us last year, Pat and I still feel that we are talking a 9, 10% type of growth here for the year and its just that we had a very strong rollout process, if you will, during the first quarter.

On the wholesale side, excluding the acquisitions, which impact wholesale we grew from 88 million to $100 million.

That is 14% percent organic on the wholesale.

The main contributors obviously we had backflow which grew at 18% and led by Hunter as well as a broad base of growth in all of our backflow products.

Plumbing products had a growth rate of 12%.

This is some of our more traditional regulator and temperature and safety relief valves as well as some of our more commodity orientated, but it was a broad gain across most of our product line as well as most of our wholesalers were up in that overall growth rate of between 12 and 18%.

About half of that overall growth in the wholesale is pricing.

Also rolling up into our wholesale numbers is our under-floor radiant heating business which grew at a rate of 48%, that is about $1.6 million in the quarter.

And basically our -- that is led by some of our PECs -- our water PECs program as well as our under-floor radiant heating business itself.

Canada has good performance following the same trend that we talk about in the wholesale and the retail as well.

The acquisitions in North America HF Scientific and Sea Tech both acquired in January of this year.

If we look at HF's run rate, they were up over last year.

They had a very good start with us.

Sea Tech is essentially even with last year but they are coming in just as expected.

And our program there is to focus on integrating Sea Tech both into our retail and wholesale channels as well as some of our PECs distributors as well.

The other company on the acquisition front is Orion -- contributed $4 million.

Orion was acquired in May 2004 and is very much on track.

If you recall, that in Q3 and Q4 we had a lot of purchase price amortization on Orion, most of that is behind us now so Orion did make a good contribution in the first quarter.

Looking at Europe, organic growth was $700,000 which is 1.2% foreign exchange, 2.8 million, 4.8%.

And acquired growth in Europe was 2.9 million which is 4.7%.

So our total revenue increase in Europe $6.4 million or 10.7%.

What we saw in Europe this quarter is a little different than some of the quarters we talked about last year in that we had a -- excluding acquisitions we had a slight decline in our OEM business, about 3% decline whereas the wholesale business grew at a rate of about 5%.

So in Europe we had a mix towards the wholesale.

So what is happening here is that we are seeing our -- some of our OEM customers are cutting their production levels in response to the general economic situation in Europe and at the same time we are gaining market share on the wholesale side, particularly in Germany and we have been expanding our wholesale operations into eastern Europe.

We have added some sales offices late last year and added additional sales people in eastern Europe.

We have also been successful with gaining some market share in some of the Nordic countries.

An acquisition we did a couple of years ago called Watts Electronics, which part of that deal was an electronic -- an electrical distributor and a combination electrical and plumbing distributor and we have been adding more and more of our products and gaining market share in that distribution site.

Obviously you have been hearing a lot of talk about the economy in Europe and we are finding the same things.

The economy is very stagnant there, and we will talk about that in a moment.

It has become more difficult to export out of Europe because of the exchange rate regarding the Euro and the dollar.

Looking at China.

The growth rate there from an external reporting standpoint was small at only 2.5%.

But if you look at the two major components of that growth which is some of our commodity products and our Water works products, the Waterworks Products which go into the Chinese infrastructure and the water infrastructure and the commercial market in China were up 28% which is $550,000 in the quarter.

Now, that was offset by approximately the same amount, what was it, $400,000 decline in some of the commodity orientated products.

The reason for that decline is since last year in the end of the first quarter we completed the acquisition of the other 40% of our joint venture which manufactures those commodity products.

Since that time we have been shifting a lot of those revenues into an intercompany which is then handled through the United States.

So that revenue is not that we have lost the revenue but we are handling it as an export to the United States.

Our intercompany activity in China is actually up over 100% quarter over quarter, but we don't see that because all of that revenue is eliminated before we issue external financial statements.

Looking at the gross margin on the quarter.

It is an increase from 34.9% last year to 35.3% this year.

Now, on the wholesale side in the U.S., we actually had very strong performance on the gross margin where we feel that, we have been able to cover a lot of our costs and the volume is up as well.

Now, what we have seen, though, is that some of those -- that coverage that we have gained there we have given up some of that on the retail side.

We have seen quite an increase in some of our plastic component pricing and our resin pricing during the quarter because of the increase in some of the price of oil.

And we had a lot of new product introduction, as I mentioned earlier, and we have to two go out and get some higher margins on that and that is also, those products that is also related to some of this plastic resin pricing that I just mentioned.

In Europe the gross margin was up slightly despite the mix to wholesale.

The OEM margins in Europe tend to be a little bit higher, about 5 points higher or so than the wholesale side but margins are up nonetheless.

That increase is driven by the cost reduction program and the restructuring activities that we have been implementing in Europe over the last year or so.

Increased utilization of our Tunisian facility as well as contributions from TEAM Precision Pipework which we acquired last year.

Looking at the SG&A, there is an increase there of $11 million, the increase as a percentage of sales is 24.3% last year versus 25.6% this year.

That is 1.3 or 130 basis point increase.

Looking at the dollars that are inside of that increase, we have our Sarbanes-Oxley expenses which we did not have last year in Q1.

That is about $1.2 million.

We also have the recognition of the expense for the earnout at Watts Radiant, which you will recall we had to start recording that as an expense in the fourth quarter of 2004 and now we're going to carry that as an expense for the first three quarters of 2005 and that was $700,000 in the quarter.

We also had $2.9 million of SG&A expenses for our acquired companies which were obviously zero in last year's Q1.

We also had a reversal in last year's first quarter of a million dollars for a legal case that we settled favorably and so we reversed that accrual in last year's first quarter.

That is one million.

And we have some increased selling expenses associated with our commissions of about $900,000 and some restructuring expenses of about 400.

That is about 7 million of the $11 million increase that we with just discussed.

When we look at the increase from a percentage of sales stand point, the 130 basis points we have to look at basically three issues.

One is the Sarbanes-Oxley expenses of 1.2 because we did not have them last year.

The $700,000 Radiant earnout of 700.

And then the reversal on the legal case of a million.

Those are worth $2.9 million the 1.3% 130 basis point increase is $2.8 million.

So that is the reason for the increase on the percentage of sales.

Looking at the overall operating earnings, they are up to $21.3 million versus 19.8 last year.

And the decline on the percentage of sales is really due to the SG&A items that I just discussed.

The tax rate this year 35.2% versus 37.3 so we had 190 point -- excuse me -- that's 210 point basis point reduction.

The reason for that is the strong performance of our Chinese segment and those earnings are essentially subject to a tax holiday so that was very favorable for us.

And then the way the income mix occurred inside of Europe where the German and Italian subsidiaries were not as profitable as last year, which was offset by a lot of the smaller entities that we have in Europe, but that mix of income also helped reduce the tax rate a little bit.

I think those are the highlights on the P&L and I'll turn it back to Pat for a moment for some additional overview.

Okay.

When you look at the environment we are working in in the second quarter a couple of comments I want to make.

First of all, if you remember last year in the second quarter we disclosed to you on the conference call that we had some prebuy activity which, depending on what happens with pricing, we need to -- we need to adjust some pricing in two areas.

One, to cover the raw material cost increases that are being driven by oil and gas, primarily plastic resins.

And then we also -- at this point in time the rest of the costs have already been ramped up but we need some minor adjustments in terms of specific products where we didn't fully recover those cost increases.

So last year you had a sort of had prebuying which contributed almost $900,000 pretax to the second quarter.

The other issue that will occur this year that we didn't have last year is we expect some place similar in terms of Watts Radiant earnout , something in the neighborhood of a charge of $700,000 in the second quarter.

With regard to the environment we are operating in a couple of things I want to mention.

One is that the environment in western Europe is relatively lack luster.

There are some stagflation kind of activities going on there.

We are trying to make up for that weak economy by adding additional sales people in eastern Europe and in Russia and so far in this quarter we have been able to show some gains in terms of the wholesale market as well as the eastern European market so we are hoping that that will continue into the second quarter.

With regard to retail, we have a number of rollouts that have occurred throughout the first quarter.

Some of those will continue into the second quarter as well.

However, a good part of those have been completed in the first quarter, so as we go forward the issue really in retail is making sure that we have -- that we execute against price increases to offset primarily the plastic resin costs which rose quite rapidly here over the last six months.

In terms of the commercial marketplace we are seeing a pickup in terms of the commercial construction activity and the commercial products, as Bill explained earlier, are doing well and we expect that to continue in the quarter.

So from a total point of view I think we have weaknesses in western Europe, we have some price increases that we need to execute in the retail market and the commercial marketplace continues to show steady but consistent growth.

Okay, with that , operator, I would like to open up the call for questions.

Thank you, sir. [Operator Instructions] Please hold for your first question.

We will take that from the line of Steven Weiss of Mindflow Capital Investments.

Please go ahead.

Yes, thank you.

Patrick, good job this quarter.

Thanks, Steve.

A couple of questions.

Regarding -- what I've noticed over the last couple of months in the industry your competition has recently been putting in some new strategic initiatives in terms of technology to help them reduce the sourcing costs with their suppliers, especially in this very high cost economy where raw materials are going up, and commodity prices are going up, component costs are going up, and it is real tough to make sure you keep your costs low; and they are putting these new strategic initiatives to open a better line of communication with their suppliers and collaborate in a more efficient way.

I'm interested in what you guys are doing to reduce your sourcing cost, be able to maybe possibly consolidate your supply relationships and what you can talk about as to how you plan to improve your bottom line?

Let me make some comments.

The first thing is we have been in the process of tying our computer system so we actually are operating off the same computer system in China that we are in North America.

So, one of the things that we believe is necessary is that we have to have open communication with our Chinese organization so that when we are changing forecasts here they immediately see those changes and forecasts and are reacting to them.

The other thing that we have been doing is that we are in the process of establishing initiative to put a operation in China where we consolidate products that we purchase from a wide variety of different locations, some which are our locations in China, some of which are locations of independent vendors that we utilize.

And we are consolidating those shipments and bringing them in so that we can mix and match containers, and as a result we can bring down the both the transportation costs, and the inventory carrying costs associated with bringing product across a longer logistic chain.

So I think we are continuing to make progress in that regard.

I think you know that the whole key to this whole thing is to figure out how to strength -- how to -- how to reduce costs in that channel as we bring product in.

I will think we are making pretty good progress on it.

How are you guys measuring your supplier base right now in terms of what suppliers to work with for any particular time?

Are you running optimal allocation schedule models, or what are you guys doing to achieve that?

Well, in most cases we have a pretty strong evaluation process in terms of looking at the suppliers we want to deal with.

There is a multitude of things that go into that factoring but one of them is their ability to consistently produce quality product, their ability to consistently meet production schedules and things of that nature.

So, we -- to be honest with you, we tend to tie ourselves to specific vendors and then work those vendors so that we don't have the typical problem that you have which is intermittent quality and intermittent delivery gaps.

Okay.

Great.

I really like what I'm hearing.

Continued success down the road.

Okay.

Thank you.

We'll take your next question from Andrea Wirth of Robert W. Baird.

Good afternoon, guys.

Hi, Andrea.

Hi.

Lets start on the retail side.

Obviously you posted some great numbers there.

You said a lot of it was from some rollouts.

Could you give us an idea of how much those rollouts contributed or what was gross ex those rollouts?

The rollouts were about $2.6 million of the 7.

2.6 million of the 7.

Okay.

And then do you know about how much you expect for rollouts in the second quarter?

Well, I don't have specific number Andrea, other than these products are -- we have been rolling them out now for 2 -- in some cases between two and three quarters, so we wouldn't expect that level of rollout but we are -- in this business you have to constantly be looking for new products to roll out and that hasn't stopped those efforts.

But --

Okay.

We will be introducing additional new products later in the year.

However, you know, we are viewing the retail and total for the year, as we said last year we are saying it again this year, that 9-10% range.

Oh, okay.

This year Andrea, just so you know, the rollouts are front ended this year.

Okay.

Okay.

And that simply a function of how successful we were in terms of line reviews and how successful we were in terms of getting prepared to meet the delivery schedules of our key customers so it -- it -- by coincidence it turns out to be front ended this year.

Last year it was back ended.

Oh, I see, I see.

SO then do comps get much more difficult in the second half?

I think the preponderance of rollouts -- you have to balance this thing.

When you do rollouts you have depressed margins.

When you are not doing rollouts you tend to do better in terms of your average margin because rollouts cost you money in terms of two things.

One is they cost you money in terms of inefficiencies during the rollout period as you are smoothing out that whole process and secondly you incur costs to do setups within the stores,.

Okay.

So rollouts are good thing because they drive your sales line.

They are a negative thing because you are sacrificing short-term margin and short-term and short-term marketing expenses for long-term profitable relationship.

So we like 'em and we don't.

[ LAUGHTER ] Fair enough.

Fair enough.

They come at a cost.

Okay.

Talking a little bit about pricing.

Obviously you said you are experiencing some difficulties on the plastic side.

Maybe talk a little bit about what kind of a deficit you are facing right now as far as the gap between price increases and raw materials on the retail side.

Exactly what is your plan?

I mean do you have price increases already slated to go in or are you still negotiating or where are you at in that stage?

If you look at the runup that we have experienced, you know, we would be in the range of 4 to 8% deficit versus -- prior to the price runup.

Now, that -- that is a very broad range and we just can't go out with an overall 4 to 8%, we have to work with our customers and with our vendors, but that is sort of the range we are targeting here.

And as far as actual increases do you have some slated to go in right now or still in that process?

We have specific action plans that are -- and we have a number of pricing actions taking place here, some of which have already taken place, some of which will take place.

The one thing you got to understand about the retailers is they are masters at pushing out that decision and trying to delay the process of accepting that price increase and I think that is part of the issue here that we are struggling with.

So its fair to say that you will probably still be seeing some sort of deficit in the second quarter as well?

I would expect so.

And then on Europe, I mean obviously its a very challenging region.

Just wondering if you would characterize it as actually deteriorating sequentially and could you comment as to whether it is actually below your plan that you had originally laid out in the beginning of the year.

We don't generally comment about where we are on plan, but i would say that what has happened in Europe is that Europe has had a slow economy really for the last three, maybe four years.

We really haven't had a robust environment in Europe.

The one thing that has changed in the last 12 months is the Euro going as high as it is, that it is currently $1.30 versus the U.S. dollar, has constricted their ability to export.

So the European customers that we have used to have greater opportunities to export outside of Germany or Italy or France or any of the major countries where we operate.

So I would say there is a little bit further constriction in the last 12 months than there has been over a period of, lets say the last four years.

However, there is also an opportunity which is Eastern Block where there is a tremendous buildup of infrastructure and that's where -- if you look at Europe in total that is where the growth is coming from.

Now we have added quite a few sales people and added resources that are devoted to that eastern European marketplace.

And if you look over the last, lets say three years we have gained market share in western Europe.

We have done a pretty good job of incremental growth in eastern Europe and have been able to continue to grow, while many of our competitors are really experienced very low or no growth.

So the problem you have now is that the economic stagflation in Europe has lasted for a long time so you see a lot of what I consider to be irrational behavior on behalf of some of the weaker players in the marketplace.

Now good news is that probably makes more opportunities for us to do acquisitions.

The bad news is while they are doing irrational things they push margins down and they sometimes go after orders that traditionally were your orders at ridiculously low pricing.

Sure.

So I would say there has been some additional deterioration really within the last 12 months primarily driven by the Euro.

Okay.

I just a a couple of other quick questions.

Bill, do you know what cash flow from operations was for the quarter as well as D&A and CapEx if you have got it?

Yes, hold on one second.

Net cash as consumed in operating activities was 8 million.

That was the use.

The use.

And D&A was 7.

Okay.

What was it a year ago.?

And a year ago it was -- we consumed 14 million.

So we had -- you know, we have I should just remind everyone, though, we have seasonality in our cash flows in that we expect that we will have a deficit there in Q1 and as we go forward we generate cash flow during the course of the year so that is very much a seasonal issue.

Okay.

And then I guess this is my final question is on corporate expense.

I mean obviously you guys were at about negative 5.2 million this quarter.

What kind of run rate should we expect for the rest of the year?

Does it stay about that range or does it improve or what should we be look looking at there?

I think that is the range we are looking at.

That is where we booked most of our SOX.

Not all of it, but most of it.

I think that is the range.

Okay.

Great.

Thanks, guys, good quarter.

Thank you.

We'll take your next question from Jeff Hammond of Keybanc Capital Markets.

Hi, good afternoon.

Hey, Jeff, how are you.

Hi, Jeff.

Doing well.

Wanted to look at the North American business from the wholesale side.

I mean, strong organic growth there.

Just wanted to understand the sustainability of that organic growth rate going forward giving some near term visibility.

Well, go back to my comments, I think there has been a consistent and -- growth pattern in the commercial market space and I think we are benefiting from that.

You remember there is a couple of things that we benefit from.

One is we benefit from the additional value.

Bill pointed out the product lines that are strong.

They tend to be commercial product lines that in the first quarter showed strong sales increases.

I think it is also true that those product lines in general have higher margins than our average margins.

I would expect, I don't see any reason, I have been looking at FW Dodge reports over the last few weeks and I think FW Dodge continues to report that there are a number of commercial starts underway.

You have to remember we are mid to late cycle in terms of when our products go into a construction site, so I would think that 2005 should be a pretty robust from the commercial side.

Now, I do think there is some softening in the residential side.

But -- and the higher interest rates go I think the more contraction you are going to see on that side, so we have a pretty robust commercial side offset by some weakness in the housing starts.

Okay.

And then on the -- moving to margins, if I understand correctly that the Sarbanes goes through the corporate expense.

Most of it does.

So if you look at the margins in the North American business this quarter, if you take out the earnout and the restructuring, it looks like you had 130 basis points of margin contraction and I just want to understand better what was driving that and how do we look at that going forward?

Well, a lot of that, Jeff, was driven by the mix on the retail.

I mean we, you know with that going up 22% and coupled with you know some of the plastic issues that we discussed that is the -- one of the larger drivers there is for the contraction.

And as far as going forward, well, if we are able -- if we are successful on the retail side on the pricing, you know, that will help.

And I'm not expecting that, you know, we are going see 22% quarter over quarter all year long on the retail.

Again, we are talking about, you know, 9, 10 points.

So that mix should play a little bit more in our favor.

Okay.

And then you mentioned on the new products coming in at lower margins and needing to get some better price there.

I mean is that a function of how you priced them going in, you need to kind of revisit that or those happened to be plastics based products that you are seeing increases?

How should we look at the new products?

I think is lot of that, Jeff is, that we made commitments on that, those products sort of the middle of last year and you design the program with your customers and you commit to a price and then we had the plastic runup.

So it is just that you are pricing it much earlier than, you know, the plastic runup occurred if that is answering your question.

No, no, that is helpful.

And then Sarbanes-Oxley, can you just remind us real quick what the '04 spend was and what the '05 expectation is?

If you look at what we recognized in our P&L in '04 was $6 million.

And I'm expecting a decrease of a million dollars this year.

Okay.

And then finally, going to the China business.

You had talked about directionally the local business versus the commodity business.

How long or how long do we have this transition period where your external or reported organic growth is under pressure from that JV shift to where we -- where we start to see the more notable growth that you are actually seeing in your underlying business?

Well, you potentially have two quarters of that, I would say.

That is not having a huge impact on the profitability of China because you know you are shifting that stuff through an intercompany channel.

But you still have, you know, some margin on that and what not.

But, so it is not affecting the profitability of the Company it's just how we are recognizing it.

The water infrastructure stuff seems to be going forward at a rate that we would expect.

Last year we grew 40% in China and the first quarter was 28% so those are pretty strong numbers and that domestic water/commercial markets.

But I think the comparison issue you probably have about two quarters of that issue.

Okay.

Thanks, guys.

Okay.

Thanks, Jeff.

We'll take a question from David Smith of Smith Barney.

Hi, guys.

Hey, David, how are you doing?

Good.

In terms of -- I may have missed this, but can you talk about the pricing impact on sales in North America?

Yes, in you look at the -- on the -- in North America we said that we had about 16% organic growth and we would estimate on the wholesale side which we said was 14%, probably half of that growth is pricing.

Okay that is sort of the traditional part of the business.

The retail side there is some pricing in there.

A couple -- but it is much smaller than the 14.

A couple of points worth.

Okay.

How much then if I look at as well, the 16% organic, how much of that would have come from new products being introduced to the market?

A couple of points but I don't have that number calculated right now.

Okay so I would be safe in saying like 2 to 3-ish?

Yes.

Okay.

What -- was there any net positive impact on margins in the wholesale side?

Are you talking in terms of pricing versus the commodity runup?

Yes.

No, we don't see that this quarter.

We think we're covered.

So it's kind of flattish?

Yes.

Whereas on the retail side it was negative?

Right, right.

Okay.

One reason I'm having a little trouble with is we talked quite a bit in the past about China having an impact on North America and improving margins, but we are just not seeing it in the incremental numbers.

When do you see that flowing through that we start a see a bit more incremental leverage coming out of it?

If I just take the raw numbers as they are now it looks like it was a 7% incremental operating profit.

Where do you feel you get to maybe the 20 to 30% level.

Is that doable?

From products from Chinese you are talking about?

I'm just talking more North America and looking at operating profit in terms of the getting the volume through and then getting the incremental operating profit out of it as well.

The leverage, yes.

I think when you are looking at 14% in wholesale and half of that is pricing you are losing half of your leverage right there.

Yes.

All right.

And then you have a mix going on where you are going towards the retail, so you are not getting as much leverage there.

Okay.

I think that on a leverage situation it really comes down to the strength of the commercial markets would be the biggest contributor there.

Okay.

Kind of leading on to that.

Then can you talk a bit about the order book right now as they look -- as if we, say, looked at the commercial side and the residential side?

Well, you got to remember we are a business that has only a couple of days worth of backlog because almost everything is ordered for immediate shipment.

Okay.

We still consider -- I guess when you look at these numbers going into April we haven't seen any significant change up or down.

So the cadence going into April on the commercial side, does it sound a little stronger than the residential?

Yes.

It does, okay.

Okay.

Thanks.

Okay.

Thank you.

We'll take a question from Ian Fleischer of Friedman Billings Ramsey.

Hi, good afternoon.

Hi, Ian.

Can you spend a little bit of time on your restructuring costs?

You had about $770,000 in restructuring costs in the quarter.

That's right.

Just kind of how we should think about that going forward this year and into '06 and where the consolidation is taking place?

Is it more west Europe or is it also the U.S.?

Well, if we look in the quarter we had $774,000 pretax restructuring. 398 was in the margin and 376 was in the op expenses and that was for two major projects.

One in the U.S. and one in Europe.

The one in Europe is complete with those charges and the one in the U.S. that is the approved restructuring will be complete in Q2.

So then anything that happens after that would be for any projects that would be approved or whatnot, but nothing is approved right now.

And if we have any projects that we consider to be approved restructuring where we authorize our operating guys to start to move forward we would disclose that.

We always have disclosed it.

Okay.

But I think it is -- I don't think you want to assume that we won't ever have any more restructuring charges.

Right.

And how much did you source from low cost countries in 2004?

Was it about a 100 million?

The run rate was 100 million at year end.

I think that -- It was 100 million -- Yes the run rate was 125 I think at December and the total amount was about 100, yes, that's correct.

And where do you hope to take that over the course of the year?

Well, right now our plan is to have a run rate at 175 by the end of the year.

Okay.

And if you could just touch on acquisitions a little bit.

The pipeline pricing, you know, size of the companies you are looking at, maybe some color on geography.

Yes, I think nothing has really changed since we reported last quarter.

If you look over a historical period over the last two years the multiples have gone up a little bit.

The reason they have gone up a little bit -- they have particularly gone up on the larger deals where you have the leverage buyout firms entering into the competition and are able to finance transactions with a lot more leverage than they previously did and they all raise capital so that they are out there in full force, but I think we still continue to have a pretty robust backlog of companies we are looking at.

Like always, you know, we look at, you know, 8 to 10 companies for every one we actually get closed and I think -- I don't see any change whatsoever.

I don't really see -- I think the price escalation that occurred we saw that most of the last 18 months so I don't see anything really different there.

It's just reality that the multiples that you could buy companies 24 months ago were probably at least one multiple than you can do it today.

Still pretty reasonable, though.

Great, thank you.

We'll take our next question from Mark [Grumsky] of Needham and Company.

Good afternoon.

Hey there.

Just a few quick questions.

First one regarding working cap.

Where do you see that by the end of '05.

I know you mad a little pickup here in the first quarter.

Is that just due to the strength going into the next quarters, into the second and third quarters?

Well, we had a small increase -- we had an $11 million increase in inventory in the first quarter.

That is $7 million in Europe and $4 million in North America.

We -- the increase in Europe really is the OEM business with is a working capital intensive business, if you will.

But we are working very hard with our guys here in providing some resources to improve some of the working capital management, and we are -- we are expecting that any growth in working capital would be minimal between now and the end of the year.

That is what our internal objectives are.

Okay, great.

And you might have mentioned this, but gross margins on your new products, was -- do you have that number or is that like a consolidated gross margin number or you can't --

We don't have a gross margin on that number on a consolidated basis.

Its just that they were lower than the average and that is why we are working with our guys to get increases on those.

Okay.

Great.

Great.

And then finally just looking at the domestic business on the commercial side, are you seeing any -- and the retail for that fact, any geographic -- any places where there is strength geographically, or is it just broad based across most of the continental U.S.?

What you saw, I don't usually like to talk about this but what you saw in the first quarter is some unusual weather patterns where you had major parts of the country that had excessive precipitation, and I would say that in talking to the guys here in the northeast it is a little bit sluggish.

And in other parts the southeast and the southwest it was more -- it was actually influenced more by weather.

We are hoping that what we see as they get past that -- because many of the contractors which really drive the root demand for our products if they lose days because of harsh weather products aren't installed.

So I think what you saw in the first quarter is some unusual patterns in terms of contractors losing days because of the unusual weather patterns that we experienced.

And whether we will ever make up for that is yet to be seen.

Okay.

You may have a pretty robust second and third quarter as a result of them adding staff to get those jobs completed.

Okay.

Thanks, guys.

Have a good one.

Thank you.

We'll take a question from Michael Gaugler of Boenning and Scattergood.

Good afternoon.

Hi, Michael.

Hey, Mike.

One quick question for you.

I was wondering if you had looked at any potential impact from a revaluation of the Chinese currency which has been in the news lately and appears imminent, probably within the next 12 months.

Well, our view is that a reveal is likely.

We think it going to be within a relatively tight band, you know, 3 to 5%.

That will help us in terms of translation issues on the P&L and it will hurt us from the perspective of you lose some of your cost reductions as you come across purchasing material from China.

But our focus also is partially to offset some of that it to try to be much more active in the domestic market in China because that is such a large growth opportunity for us.

That so is sort of our views on it.

Okay.

That's helpful.

Thanks, guys.

Thank you.

And we'll take a question from Jim Foung of Gabelli and Company.

Good afternoon.

Hi Jim.

How are you doing, Jimmy?

Good.

I missed your comment about the gross margins in the second quarter last year this was prebuying.

Did you say it impacted -- increased your margin by $900,000?

Yes Jimmy, if you remember in our previous conference calls I think it was probably the third quarter and fourth quarter conference calls, both of them I think we mentioned the fact when you look at the second quarter last year, you remember we had price increases announced that took effect in mid to late June.

Right.

So wholesalers anticipating that those price increases were permanent because raw materials were going up and they felt that they needed to buy additional product, so what we had last year is some prebuy in the second quarter.

We have estimated that that prebuy probably contributed $900,000 in incremental profit to the second quarter.

Okay.

Pretax.

Right.

And then the third and fourth quarter was back to normal so to speak or what did that kind of --

To be honest with you, when you look at the total year you probably borrowed from Peter to pay Paul.

Kind of smoothed out as you went through the rest of the year then?

Yes.

And then second question is regarding your material costs, the resin.

You think the market is ready to accept further price increases another 3-4%?

And if so, how soon do you think you might be able to implement that?

One of the problems you have with resin materials Jimmy, is that a lot of the products that are resin are relatively -- they are commodity oriented products.

So to get a price increase on those products is a more difficult thing to do than on traditional products that are metal based, okay.

One of the reasons resins are used is to cheapen the product where there has historically been price sensitivity, okay.

So I think it as harder -- I think it is harder for us to get price increases on the resin side than it has been over the last lets say, 18 months on the metal side.

Okay.

But you don't get what you don't ask for, Jimmy.

Okay.

So I infer that to mean its getting it from the Home Depots and the retail market more than the WDs, right?

Yes, the more difficult side of the equation for us.

Right.

And particularly in the first quarter has been on the retail side.

Okay.

Okay.

And some of that is because they find ways to defer accepting a price increase, and in some cases it is because of the fact that the product is more commodity oriented that so even your competition is scratching their head and not necessarily following as quickly as they might on the metal side.

And a question for you, Bill, is the Sarbanes-Oxley costs, how much was that in Q2 of last year?

And how much did you spend this year?

It was $1.4 million last year.

Okay.

And then.

And, you know, I mean going for the full year here, as I just mentioned, we are expressing about $5 million for the full year versus $6 million last year.

So, you know, you would expect to see --

So like 1.25.

A little bit of a decrease.

We will probably see a much more favorable decrease in the latter part of this year, much more favorable comparison in the latter part of the year because we in curd a lot of our SOX expenses late last year.

So second half of this year then you see the year-over-year swing more then?

Yes, yes.

Okay.

And then last your tax rate should we use that as your tax rate for the year?

Well, what we have said to people -- we think a normalized tax rate for us is about 36%.

36%.

That is a good number to model off the rest of the year?

Yes.

And then I guess last, are you guys ready to step up to the plate and do a big acquisition, you know, with your shelf offering? $100 million in size?

Well, Jimmy, if you can find us a good acquisition to do that is big and small I'll take the opportunity to look at it.

All right.

I'll look through my rolodex then.

Good quarter guys.

Okay.

Thank you.

We will take a question from Richard Rossi of Morgan Joseph.

Good afternoon, everybody.

Hey, Richard.

Hi, Richard.

You already covered most of my questions but just a couple of things.

First on these rollout costs just in general, how long does a new product roll out exhibit rollout costs that impact your P&L?

In other words, how long do you have to absorb the cost of setting up and getting the product to position at lower prices et cetera on average?

Probably 6 to 9 months.

Okay.

And the reason that is is because you take one of the big box retailers who have lots of stores, they typically either your capacity to roll out or their capacity to work with you on a rollout takes that long.

Got you.

Now in regards to that then, what was -- how did rollouts break out last year along the quarters?

I know everything doesn't fall exactly right in terms of counting out 6 or 9 more months.

I don't know really the answer to your question, but let me talk generally.

If you remember last year in the first quarter our retail was a very modest percentage growth.

I think -- Bill help me if I'm right -- but I think it was it was low --

6%.

Low 6%, okay.

That's right.

And then if you look at the fourth quarter it was significantly higher.

Do you know what that was, Bill?

I think it was 18 or so.

I think you are talking 18 or 19% in the fourth quarter.

We can -- while I'm talking they can pull some numbers there for me.

So what you had is you had just the opposite of what you have now.

Where you had --

21.

It was 21% in the fourth quarter.

So you had a 21% in the fourth quarter and you have a robust growth rate in the first quarter of this year, which is reflective of the fact that you were in the fourth quarter and in the first quarter running through significant rollouts.

Okay, and you saw that Richard in the margins.

Right, right.

Okay.

Now, if you look at our plan this year, we are saying that it is going to be somewhat of the inverse of what it was a year ago.

So towards the end of the year while the topline growth rate may slow, your margin should reflect the fact that those costs are relatively absent, maybe not completely but.

Yes.

Okay.

You should -- there is two things that if we are good at what we do will happen.

One is that you will have absorbed the rollout costs and the setups that go with them in the earlier part of the year.

And two, you would have effectuated some price increases where the market allows you to get them.

Okay.

And one other thing.

Building codes have always, or often have helped you in this country and in Canada.

And I'm just wondering as you look in Europe what are the comparable building code issues and I'm sure east versus west is different as well.

Yes.

That is an interesting question.

The first thing I'll talk about western Europe.

In western Europe there are very well developed codes and we have similar kind of protections because our products have satisfied those codes and therefore new competitors have difficulty becoming code acceptable, okay.

Okay.

However, the codes in France are inevitably different because of the nature of the way they think and the importance that they put on various issues, versus Germany and it is true in Italy.

If you look at Belgium and you look at Netherlands, et cetera, you will have slightly different codes, and you will have to go through the process of getting your product code approved in each one of those countries.

Got you.

So it is a complex maze of approvals.

In some cases you to add something like a tail piece to your product or an extra ring in there or something like that to comply with the codes in the various countries, but for mott the most part they are Pan-European products with some modification or you have had to go through extra effort to get approval okay.

Right.

In eastern Europe you have the opposite, which is codes are now only being developed.

In many cases they are specifying for example a German code.

You are selling products into the eastern block but they are being specified under German codes.

A lot of the more successful relationships that we have are actually our German operations with their contacts into the eastern block, okay.

And so but what is happening also is they are quickly adopting codes, most of those codes tend to be based on the Germanic codes.

Got you.

Thanks very much.

Thank you.

[Operator Instructions] And we will take a question from Stewart Scharf of Standard & Poor's.

Good afternoon.

How are you?

Good.

I was wondering if you could quantify the cost savings from China as far as your targets over the last two or three years and where that stands as far as what you were looking at over the past few years when you started up operations there?

As a rule of thumb, Stewart, we usually expect to see a cost reduction of about 25% as far as landed costs in the U.S. versus, you know, manufactured cost in the United States.

And I don't believe that that rule of thumb has really changed over the years.

You know, the issue we have if I'm reading into the question is that we don't necessarily get to keep all of that 25% and we get to -- some cases we do, but in a lot of cases we are going out to market with a more competitive product and we are looking to gain market share or maintain a leadership position et cetera.

Before the competition gives it away and you are forced to give it away as well.

Right.

But the rule of thumb usually you can usually achieve 25% and just -- part of cost reduction.

Is that answering your question?

Okay.

Yes.

And as far as inventories, I assume they are more now in line with demand though you had the absorption costs in the fourth quarter?

Yes.

And you don't see any change in that or --

Well, we are working to keep working capital in a very tight rein this year so we didn't -- in the fourth quarter we reduced inventories about $10 million.

We did have an increase of 11 this quarter.

I don't see us going on any type of an inventory reduction campaign that would hurt our absorption in a given quarter.

That is not in our plans right now.

Okay.

And can you break down the do it yourself sales for the quarter and OEM?

Percentage?

Well, the retail revenue was $40.4 million.

And the European OEM I -- I -- if you can give me a second I can look it up.

We had a decrease in the OEM revenue of 6 million -- no, 3%.

Okay.

Do you have the percentage of replacement products in wholesale?

I'm sorry, say that again?

The percentage of replacement products in the wholesale business?

Well, I mean we usually say that that is about 40%.

We don't measure that on a quarter by quarter basis.

I'm just looking up that OEM number for you, Stewart.

Okay.

I have it somewhere.

It's going to take me a minute.

Okay.

OEM revenue was 25.5 million Euros.

Okay.

Thank you very much.

Okay.

Thank you.

And there are no questions at this time.

With that then we will conclude our first quarter call.

We appreciate your time and your attention.

We look forward to talking to you at the end of the second quarter.

Thank you.

Thank you.

Ladies and gentlemen, thank you for joining us on the call.

You may now disconnect.