Watts Water Technologies Inc (WTS) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Watts Water Technologies 2006 Second Quarter Earnings Conference Call. [Operator Instructions] I will now turn the presentation over to your host for today’s call, Kenneth Lepage, Assist General Counsel.

Please proceed, sir.

Thank you.

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 factors, including those discussed under the heading "Risk Factors" in our annual report on Form 10-K for the year ended December 31, 2005, which we have filed with the SEC and in other reports we file from time to time with the SEC.

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'll now turn the presentation over to Pat and Bill.

Thank you, Ken.

This is Pat O'Keefe.

I just want to remind you how we’ll conduct the call.

We’ll start out with me making some general comments about the overall operating performance of the business and then I'll turn it over to Bill McCartney, who will walk you through some of the segments and the details in terms of financial breakdown on the business.

And then we will open up the call and allow you to ask any questions you may have.

The first thing I want to say is this was an unbelievable quarter, strong performance across the board.

I'm particularly pleased by the fact that if you look at from a geographical point of view, we had an increase in sales and operating profits in North America, Europe, and China.

The second issue is that we’re very pleased with the performance of our recent acquisitions, particularly the acquisition of Core Industries and Dormont Manufacturing and most recently, with the acquisition of ATS.

I will tell you that those acquisitions are on plan, performing well, and the acquisition plans that we had put in place, in terms of integration plans, are being executed at this point pretty much on plan, with nothing but positive things to say about the way that those acquisitions fit into our program.

The other thing I want to mention here is that I know a lot of you people are concerned about our gross margin performance in light of the escalating raw material prices.

I would basically just state up front that your concerns are unfounded in the quarter.

If you look at the gross margins in total, you’ll see that we came in at 35.4% and if you look at a year ago, we came in at 34.6%.

However, if you take out the acquisitions, the actual year-over-year performance for a similar unit was actually slightly higher, coming in at 35.9%.

So we’ve done an outstanding job in terms of covering, with price increases and cost reductions, the additional costs of raw materials throughout the year.

I think this is something we continue to do and we’re dedicated to continuing into the future, so an area of concern that really just never materialized.

The other thing I want to point out is if you look at the numbers, you know when you’re hitting on seven out of eight cylinders when you have an income number in your restructuring plan.

And you can see that we have $0.11 of operating earnings coming in from our restructuring plan because of sales of a facility that was unnecessary in terms of our European operation.

So, really, at this point in time, I would say that the summation on the organization is our growth, from internal growth, is strong.

Our growth through acquisitions is strong.

The acquisitions being integrated into the organization are on schedule.

This is a broad-based increase in operating earnings and sales from across the board.

With those opening comments, I'll turn it over to Bill, who will walk you through some of the details and the numbers.

Thank you, Pat.

Looking at the quarter and the P&L, revenues were just a touch over $300 million.

That’s an increase of $72 million, almost 32%.

Bottom line, at $22.4 million, that’s an increase of 61%.

If you back out the gains that Pat just mentioned on the sale of the building in Europe, it would give us net income of $19 million, which is an increase of about 34%.

We view the quarter as $0.57, from an operating standpoint, if you, again, backing out the gains on the sale of that facility, as well as the other restructuring costs.

When we look at that restructuring in the quarter, it netted to $0.11.

We had a $0.12 gain on the sale of the building in Italy and then we had $0.01 of changes that offset that.

Those charges were for some severance costs in Europe and some accelerated depreciation in China and it nets to the $0.11.

So, from an operating standpoint, we view the quarter as $0.57.

When we look at the segments, North America, the revenue was up 32%, Europe also up 32% and China at 9.0% and we’ll go through the detail on each of those segments in a moment.

On a consolidated basis, if we reconcile the 32% growth rate, from an organic standpoint, an $18 million increase, which is 8.0% of the 32%.

The foreign exchange was slightly favorable, at $2.8 million, which is just a little bit over 1.0%.

That’s the strengthening of the Euro and the Canadian dollar.

And revenue from acquired companies contributed $51 million, which is 22.3%.

So that totals $72 million or 31.6%.

Taking a look at the North American segments, sales here, $208 million or 32%.

That’s an increase of $51 million.

Giving you the same breakout on the 32%, organically we had $9.0 million or 6.0%.

Foreign exchange was $1.0 million or about 1.0% and then acquired companies at $40 million, almost 26%.

The acquired companies at $40 million, the major contributors there, again, Core Industries and Dormont, the two major contributors.

We had some smaller contributions from the other companies.

The acquisitions in the quarter contributed $38 million to the wholesale and about $2.0 million to the retail.

I’d like to make some comments at this time now on the retail and wholesale segments within North America.

The retail in total came in at $45.5 million.

That’s an increase of $4.1 million, about 10%.

If we back out the acquisitions, we had growth of 5.0% and that acquisition is the impact of the Dormont gas connector business.

Now the 5.0% is less than what we’ve seen, but again we remind you that some of the discussions that we’ve had in the past where we do say this retail business can be choppy from quarter-to-quarter and we did some of that this quarter.

Some of the things that impacted us were an inventory reduction program and a distribution center closure that occurred at Lowe's.

So that caused a reduction in our revenue in the quarter.

We don’t view that as a permanent ongoing issue, but in the quarter that inventory reduction did affect us by a couple of points.

We also had a buyback we did on a new product rollout at Lowe's as well, on our PEX pipe program with them, so that was an adverse impact in the quarter associated with the rollout.

We also had an increase in our in-transit inventory to these customers, which is more of a timing issue.

It doesn’t really mean anything for the long-term.

But, if you sum it all up, we did have unit growth sort of in the high single-digits, offset by these onetime events in the quarter and we also achieved a couple of points on pricing, on an overall basis, in the retail.

So we still have the view that retail is kind of a high single-digit growth market for us at this time.

That view has not changed, even though we continue to remind you that this market will have some choppiness from quarter-to-quarter.

On the wholesale market, sales in total, $163 million, that’s an increase of 41%.

Now if we back out the acquisitions, the organic growth rate in wholesale was 7.0%.

A couple of the major items here.

First of all, Dormont had a quarter and Pat mentioned that they are on track and they’re meeting our expectations.

The disclosure we had when we did the acquisition of $0.08 a share, we’re still thinking that that’s a good number.

Now, Core Industries, the FEBCO product line in particular, had a very strong quarter and what happened here was that we had made the decision to increase some inventory.

We made an investment there at the beginning of the year and as a result of that, we did a very good job, in our view, of catching the irrigation season.

As you’ll recall, FEBCO has good sales into the irrigation market and the irrigation season is in the spring.

So the improved sales here helped us to have increased sales of both our large and small backflow product lines and did contribute approximately $0.03 to $0.04 in terms of our improved profitability.

Now, just to remind you, that that is a seasonal business and we will expect that in irrigation season we will do better than the other quarters.

So FEBCO is making some nice progress with that acquisition.

On our major product lines, the plumbing and heating and backflow, we had some increases of about 11% there.

We break that out at about 7.0% price, 4.0% on unit growth.

But when we look at the wholesale business in all of North America, we do feel that the commercial business is ticking along nicely.

The commercially orientated products were good in the quarter, the backflow, plastic drains business and our control valve business all did well in the quarter.

Looking at the European segments, sales of $84 million, an increase of 32%.

If we break that out into the components that we always share with you, from an organic standpoint, we had a $9.0 million increase.

That’s 14%.

We believe its -- again, now some of these numbers are a little tough to measure because it's many business units and product lines, but the 14% is approximately two-thirds pricing, one-third units.

We had favorable foreign exchange of approximately $1.0 million, or about 1.5%, and acquired revenues of $10 million or 16% and all that will total, again, the 32%.

Overall, in Europe, we see the economy as being somewhat soft, but maybe improving just a little bit, nothing dramatic.

But the trends that we’ve seen in the past quarters continue to be consistent, good sales into the under floor radiant heating market, and that’s both on the equipment and the control side.

The renewable energy market, solar and geothermal, continues to be vibrant.

Sales into Eastern Europe as well continue to grow.

So we have some of these niche markets that we’ve done well in.

The major markets in both Italy and Germany, we saw some nice growth in both of those markets.

Again, some of it is because of pricing.

But also some of the programs that our European managers are implementing, some upgraded agents that we’ve put in place and continue to sell up the value chain with packaging systems and modules and whatnot.

We continue to make market shares in the German market and these gains are offsetting what we continue to see as very soft business in the boiler market, which is some of the major market that we serve.

So, despite that boiler softness, we continue to do well in Europe.

The acquisitions in Europe, the $10 million, the major contributor there is ATS, the acquisition we did in May and began the initial performance, after six weeks is meeting our expectations.

There are no surprises there.

And Microflex and Chemsafe also made contributions in the quarter.

We are seeing growth in Europe in the wholesale, the OEM, both up, ex-acquisitions at 18 and 14% respectively.

And now, in Europe, with the acquisition of ATS, we’ll be tracking a new segment, a do-it-yourself (DIY) segment in Europe, and we had approximately $4.0 million of sales in the abbreviated quarter that we had with ATS.

Sales in the China segment, $8.0 million.

It's up 9.0%.

Breaking it out into the segments, basically from an organic standpoint, we were flat in the quarter.

Foreign exchange had a very minor impact and then the growth, really, we do attribute to the acquisition of Changsha, the valve works, which we acquired during the second quarter.

The issue we had in the quarter relative to sales into the domestic market is we’re in the process of transitioning our domestic sales team from some of the existing agents and salesmen in the Changsha distribution channel.

So we did have some transition issues there that we’re working on and that caused us to have flat sales, as opposed to the last couple of quarters where we’ve seen some growth there.

The other reason why we’re flat is that the place where we would see the Lowe's inventory reduction ultimately falls back into the Chinese segment, because a lot of that product is manufactured at our facility, Watts Plumbing Technologies, in Southern China.

Despite the flatness on the sales line here we did see a 300% increase in our operating income in China, so we still are making progress there.

If you include all the intercompany activity, which you don’t see from a U.S.

GAAP standpoint, revenue would have been up 32%, so we’re absorbing more of our capacity, if you will.

Capacity utilization is up.

We have a significant amount of cost reductions that we’ve implemented this quarter versus last year and we’ve brought in more third party manufacturing into our own facilities in China.

So, despite the flatness in the sales, we did have good results in China in the quarter.

Looking at the gross margin, 35.4%, that’s down two-tenths (0.2) of a point and if we had excluded acquisitions, as Pat had mentioned earlier, we would have been up 0.3 of a point and that’s really due to the amortization of the purchase accounting.

Usually in the first turn of the inventory of these acquired companies you have to amortize the inventory write-up.

But looking at a little bit more detail, in North America the gross margin of 35.9%, down 0.3 of a point.

In North America, the decline is really associated with the mix issue.

We had a strong quarter FEBCO and even though the margins are improving, they’re still below our corporate average, so that was a mix situation, if you will.

Additionally, we wrote off approximately $2.0 million of inventory during the second quarter.

And this inventory write-off is associated with some products that we will be -- we’re going to remove ourselves from the market on some products that we sell into the DIY market, because we’re not able to get some of the margins that we require.

So these are small product lines.

However, we wanted to recognize the loss on that product line to this quarter, so that’s about a $2.0 million hit we took.

So really, the reason for the decline in the margin in North America is the mix of FEBCO and the inventory write-off.

Looking at Europe, the margin at 31.9%, it's down about 1.0% and that’s the impact of the inventory amortization because of the size of ATS relative to the size of Europe.

It did have an impact there.

We amortized EU1.1 million in the quarter.

But if we exclude that, while the acquisitions are still even, so there’s really no impact overall, but we did have $1.0 million of amortization there.

The gross margin in China is up 3.0 points and that’s really, to reiterate the reasons that I just mentioned on the sales side, increased production capacity, utilization, cost reductions and more in-house manufacturing from third parties.

On the SG&A, it's down slightly; as a percentage of sales, 24.6% versus 24.9% last year.

And there are really no unusual items inside of the SG&A.

That brings us to the operating earnings line.

If we exclude the gain on the sale of the building, from an operating standpoint we’re at 10.8% operating earnings to sales in the quarter.

That would compare to 10.8% last year.

Again, that’s an $8.0 million increase or 32%.

This compares to Q1 at $9.8 million, so on a sequential basis we were up 100 BP.

Looking at the tax line, our tax rate was down slightly from last year, 35.8%, down about 0.6 of a point.

The reason for the decline is the mix shift in the income towards China and Europe where we have lower effective tax rates.

So overall, a very solid quarter, again, excluding the gain on the restructuring, net income at $19 million or an increase of about 34%.

And just to provide you with a couple of statistics from the balance sheet that I know people are usually interested in --

D&A on the six months is $16.7 million.

When you see our cash flows you’ll see capital expenditures of $29 million.

That’s broken down between the purchase of the building in Italy at $16 million, which we then immediately turned around and did a sale leaseback on that, so you’ll also see that in the sale of equipment.

So the normalized level of CapEx is $13 million for the six months, but again, looking at the cash flow, you’ll see $29 million --$13 million normal, $16 million from the building.

And then we disposed of $25 million of assets in the quarter or YTD - the sale of our previously occupied building in Italy and the sale-leaseback of the new Italian facility, so we sold $25 million of assets.

And I think, with that, we can open it up to some questions.

Yes.

Operator, if you would open the lines for questioning?

[Operator Instructions] First question, Jeff Hammond with Keybanc Capital Markets.

Hi, good afternoon, gentlemen.

Hey Jeff, how are you doing?

Doing well.

I wanted to know -- I mean, there’s been a lot of concern about new housing and I just wanted to get a better sense of what you’re seeing as it relates to the new housing and your business, what your expectation is?

Is that showing up at all?

Is it your expectation that that shows up, as we move forward here?

Well, I think the first thing, I'll go back and reiterate what I’ve said a number of times.

Watts is not that sensitive to an immediate reduction in housing, because, particularly, Watts does better in the commercial marketplace.

Watts does better in the high-end housing market versus the low-end tract housing.

So, really, in terms of the numbers, we haven’t seen any appreciable decline at this point in time.

And to be candid with you, we think we’re somewhat isolated from some of that impact.

Okay, great.

It sounded like you got a pretty considerable pricing traction.

Can you just talk about how, what you’re planning for the second half as it relates to the fall, on price increases?

Yes.

We’ve already announced some price increases that are taking effect here.

I think they actually, most of them are effective as of today, August 1st.

So we had some price increases, and this is by product line, but we had a number of price increases, which were effective approximately May 1st.

We have seen the cost of zinc, we’ve seen the cost of copper, we’ve seen the cost of other basic raw materials move and we’ve implemented additional price increases to cover those costs and maintain our margins, effective here at the beginning of August.

We’re also obviously very diligent about watching that situation, so to the extent that those metals continue to move, we’ll have to have additional action.

Okay and then finally I guess, given that you’re at a price close to some of the copper head winds start coming through, more notably, second half, can you just comment?

As you look into the second half, you made some comments about the gross margins this quarter, ex the acquisitions, begin up.

Is that your expectation, as we look forward, that you can continue to keep that trend going?

Yes.

Our objective is to maintain our margins at the current levels and not let the increase in raw materials show up as a deterioration in our margin performance and I think, quite honestly, we’ve been doing that now for almost, I don’t know --

Two and a half years.

-- two and a half to almost three years.

I would expect we'd continue to do the same in the future quarters.

Okay, great.

Thanks, guys.

Ned Armstrong with Friedman, Billings, Ramsey & Co.

Yes, good afternoon.

Can you talk a little bit more about the results in China and just explain again why that margin is so high, the mechanics behind it?

Well, let me just talk a little bit about China in general.

If you look at sales of total in China, including intercompany sales, they’re up substantially, I think it's 32%, if I'm correct, Bill.

That’s correct.

So we had significant positive absorption issues and things like that where we’re ramping up to bring products into the European marketplace and into the North American marketplace.

The softness that you see when you report numbers on a geographical basis, under GAAP, is the sales that are actually sold to Chinese customers within China.

So we saw some softness there.

Okay.

So the sales that are going outside of China are washing out and that has a distortive effect when you’re looking at things as whole?

That’s right.

I mean, Ned, if you include intercompany sales, which we don’t report, revenues are up 32%.

But what that shows you is that the increased level of activity, but that activity winds up coming into either the U.S. or the European market and then it's sold through one of the U.S. or European subsidiaries.

So it gives you a feel for the increased level of cost-reduced product that we’re getting.

So we’re doing a much better job in China, in terms of the production capacity utilization and also, our guys, now that they’re sort of coming off learning curves and becoming more a part of the Company, they’re focusing on cost reductions in their respective plants as well.

So that’s sort of built into that number you’re seeing.

Right.

Okay.

My second question had to do with acquisition spending for the quarter.

Do you have a number for that?

Not for the quarter.

I can give you the YTD number, Ned.

I don’t have it broken out for the quarter.

Okay.

Let’s see.

YTD we’ve spent $82 million.

$82 million YTD.

Okay, good, thank you.

Okay.

Thank you, Ned.

Mike Schneider with Robert W. Baird.

Hi guys.

Maybe you could just address the DIY adjustments that you went through, that it is a lumpy market.

I’m curious as to pricing.

You’ve been able to cover, clearly in the wholesale side.

Update us on just DIY pricing, if you could?

Well, we got about a 5.0% price increase on the copper-related products, which we implemented during Q1 and Q2, okay.

So now we sell a lot of other products besides copper-based products, though.

There’s a lot of plastics and whatnot there, so it's tough to say exactly how much of that whole growth rate is pricing, but it's a couple of the points.

Okay and what’s the update, I guess, on some of the negotiations now in the second half, as you head into kind of the re-pricing season?

And then also, maybe just an update on the effects of Home Depot's combination with Hughes?

Well, as far as the pricing goes, Pat mentioned we have a whole series of price increases.

All of our DIY customers will be receiving or have been actually given notification of price increases.

The implementation period there is a little bit longer than wholesale, so those numbers are already out and will be effective during third quarter or early fourth quarter.

So that’s out there already.

I don’t know, Pat, did you want to comment on the Hughes situation?

Yes.

We don’t see anything new in terms of the Hughes situation.

We continue to see good volume coming out of Hughes and we continue to do the same thing we’ve been doing for quite some time.

There are some programs that they’re looking at, leveraging their additional volume, but really hasn’t had an appreciable impact on us, at this point, Mike.

Okay and then what should we read into the fact that you’re writing off inventory intended for the DIY market because of the margin [inaudible - multiple speakers]?

Well --.

Is that a sign of you being more aggressive with these customers and walking away from business and is there more to come?

Well, this product line only had -- it had several million dollars of revenue associated with it.

We couldn’t achieve the required margins on that, so we are going to exit that product line, so we wrote it off down to net realizable value.

I mean, we’re not going to have negative gross margins.

We can’t do that.

I think, Mike, though in general, increasingly, as time goes on, as raw materials continue to force us to implement price increases, in some cases the DIY accounts are going through a line review and in some cases you’ll lose the business, knowing that you can’t make a normal margin on it.

So, I think there’s an ongoing process there that in some cases we’re willing to let the low volume business drop off.

Okay, well then, Pat, maybe handicap for us, with the price increases that have been issued now for Q3 and Q4 as you head into ‘07, what you view as at risk.

Given that this seems like the first, at least, installment of what might be more to come?

The best way I can answer that, Mike, is sort of the way we have, which is if you look at our sales growth in that channel.

We have gone from double-digit down to more like high single-digit and I'll be honest with you, I think there’s enough opportunities for us to gain business as well as lose business and still come in at that 7.0, 8.0, 9.0% growth year-over-year basis.

Okay and a final question, just Bill, on the acquisition accounting here of $18 million in revenue.

Maybe it's just because the list was so long, but you only mentioned the Core deal and the ATS deal and Dormont as contributing revenue.

Is it really, though, you’ve backed out all of the small deals as well?

When I give you those numbers, Mike, I’m including all of our acquisitions.

I just didn’t go through the list of [inaudible - multiple speakers].

Okay, no that’s fine.

I know this is just the first quarter and you haven’t gone through the whole list, so [inaudible - multiple speakers].

I’m happy to do it if you want to hear them all, but.

No, no.

No need at all.

Congratulations on the quarter.

Thank you, Michael.

Thank you.

David Smith with Citigroup.

Hi guys.

Can you give us a sense of with copper pricing, I guess, just touching over $4.00 a pound, what are you guys paying for copper right now?

Like during the quarter, did you spend anywhere above, say, $3.50, $3.60, $3.70?

Just a sense of what you guys are paying right now and what’s in inventory?

Well, basically, as you recall, we have a FIFO inventory, so what we pay for copper hits our COGS between four to five months later.

So we’re looking at copper in Q2 of in the mid-$2.00's, in Q3 sort of around $3.00.

But we have the -- that’s why we time our price increases, as those types of numbers come in, to COGS to offset them.

Okay and any kind of just the copper that you bought at the end of the quarter that you would -- I’m just trying to get a sense.

Were you paying $4.00 at any point?

No.

I don’t think we quite went that high.

It was probably somewhere in the range of -- highest would have been what?

No.

I don’t think the spot ever hit $4.00, but it would have been in the mid-to-high mid-$3.00's.

Okay, so mid-$3.00's is kind of the high end of what you paid?

Essentially, yes.

Okay.

And then an update, maybe, on the nonresidential market, given that its now probably 50-55% of sales.

Can you talk about what you’re seeing in that market?

Yes.

We continue to see nice growth in that marketplace.

I think if you look at the mix of products, it continues to be strong in the more heavily engineered commercial product lines.

We sort of view it as steady growth.

It hasn’t been eye opening, but it's been consistent and continues.

I think, really, if you look at the fourth quarter of last year, the first quarter of this year and the first quarter and the second quarter of this year, you’ll see consistent growth throughout that whole period.

Okay and then the outlook in the second half looks the same?

Yes.

I don’t see any reason that we would change our viewpoint on that at all.

Okay, great.

Thanks.

Mark Grzymski with Needham & Co.

Good evening, guys.

Congratulations.

Hey Mark, thank you.

Thank you.

Just curious, with the acquisitions being a pretty good contribution in your North America now.

What were they growing at in the quarter over their previous quarter, well year-over-year quarter?

Well, you would have seen pretty healthy growth at Core, I don’t have an exact figure, but it was very healthy growth.

It's the best quarter they’ve had in a couple years.

Yes, Mark, the way you’ve got to look at this -- and I just want to make some comments.

Core Industries, particularly FEBCO and Mueller, were somewhat distressed businesses.

And I think the way I look at those businesses, is Watts is one of the only parties who could have acquired those companies and what brought to bear the cost reduction efforts, brought to bear the market presence, brought to bear the guts to put inventory in stock at the right moment.

And quite honestly, we a saw substantial increase year-over-year in that business, as a result of putting what I would consider to be basic business principles to use.

So I think I’m very happy with the way our integration team has approached both FEBCO and Mueller.

I would also say the same thing for Dormont.

The integration plan at Dormont has been executed pretty much flawlessly and I would say the same thing, initially.

I met recently with the guys in France who are both the existing management team and the new management team we acquired with ATS.

I'd, quite honestly, go back and reaffirm that that’s one of our core competencies.

That we put together very carefully planned out integration plans and knock on wood we’ve been executing pretty much the plan this year.

But Core is sort of -- I think, in this quarter, you saw an organization spring back.

I’m not sure that that’s repeatable, because of the fact that the irrigation market is a very seasonal market.

But I think you saw us do a lot of right things with Core and as a result, we were rewarded with some decent volume.

Yes you’ve obviously done a great job with these acquisitions.

And now just turning to the internal growth, you saw about 6.1% in the way of contributions this quarter and last quarter, a year ago, you saw a little over 8.0% and you’ve kind of touched on it looking at the commercial markets.

But are there any differences in the market that you’re seeing now and the market you saw last year or any softness?

Or is it pretty much as you summed it up in your opening comments, you’re just kind of kicking on all cylinders here?

This is pretty broad based, I will tell you.

Even if you go country-by-country through our European operations or you go product line-by-product line in our North American operations, it was a very broad-based improvement.

And in regard to the residential market here, did you guys mention that the majority of it was volume increases or that there was -- I mean, excuse me, the breakout from between volume and pricing?

On the North American wholesale, it was seven pricing four units and in Europe its about, I think we said, two-thirds of the 14%.

It’s two-thirds price, one-third units.

Okay, great.

And Bill, what’s the current cost of your debt in the quarter?

Are you talking total interest expense?

Yes.

I’m just trying to get a flavor for what the run rate's going to look like here.

Let’s see in the quarter.

It was $4.9 million in the quarter.

Your cost, your percentage of --?

Interest, oh, well we just did the new private placements, which is $225 million at 5.85%.

And then we have our remaining private placement, $125 million at 5.23% and our revolving line of credit's out there at about 5.0%.

Okay, great.

All right.

Congratulations, great quarter.

Thanks for taking my questions.

Thank you.

Thank you.

Richard Paget with Morgan Joseph.

Good afternoon, everyone.

Good afternoon, Richard.

I just want to get back to your comments on commercial construction, looking at some of the numbers coming out recently for nonresidential construction.

I think this month it was up about 16%; last month up north of 10%.

If this keeps trending that way, are you guys kind of later cycle in this, in terms of a building gets built and then kind of plumbing and the internal parts are some of the last parts to go in?

If we keep seeing this trend, should we expect more of a pick up going forward?

Yes.

We’re generally mid-to-late cycle in the construction process, so if those numbers hold true and we don’t see a deterioration in those figures, we’ll see some pretty good volume coming at us in the next couple of quarters.

And then how will that impact your mix in terms of margins?

Well, you got to remember we’ve said this a number of times.

The mix in our commercial product lines is significantly higher than the average for the Company, the average for the Company being in the 35.5% range or something like that.

But you have a significantly higher engineering content in those product lines and in many cases, those product lines are specified so that they’re specified through the architect and engineering firms.

So it's a Watts and -- comparable companies are Watts with no equal.

So we tend to have margins that are, on average, are someplace in the neighborhood of 5.0 to 10% higher than the average for the rest of the Company there.

So the other thing I think you have to take into account is if you look at the acquisitions we’ve made over the last couple of years.

We have been making acquisitions that are slowing but surely shifting our mix towards the commercial exposure.

So you have the nature of the acquisitions we’ve been making moving us away from what we used to be, let’s say 50/50 to more like 55/45 commercial.

And then you see the uptick in the marketplace as well that are probably, on average, 8.0 to 10% higher margins than average.

Okay, great.

That’s it for me.

I'll get back in queue.

Jim Foung with Gabelli & Co.

Good afternoon, Pat, Bill.

Could you just kind of touch over this irrigation business?

You said it was kind of a seasonal business and I think in your remarks you said you’ve picked up $0.03 to $0.04 from the irrigation business, but because of the seasonality we shouldn’t expect that in the second half?

Is that correct?

Right.

I mean, FEBCO has a strong presence in the irrigation market and because of some of the things that we’ve done since we acquired them.

As Pat mentioned, we’ve put in some inventory, we also increased their inventory levels to improve delivery.

We set up a couple of key stocking locations across the country for that inventory to be readily accessible to the customer.

So our guys were very well prepared to meet the irrigation season.

So just any seasonal business you have your ups and your downs and we caught the ups and because we did a good job there, we caught an extra $0.03 or $0.04 of earnings.

Okay and so you don’t expect that to be repeated in the [inaudible - multiple speakers]?

No.

We think, with FEBCO, we have a little bit more seasonality in the number now, in the second quarter a couple pennies anyway.

Okay, good.

And then just getting back to the price increase that you’re going to implement in August or the beginning this month.

Could you just kind of give us what the amount is?

I mean, how much was the price increase kind of on an average basis?

Well, it varies quite a bit by market, but you’re talking some double-digit increases.

Double-digit increase, okay.

You’re talking mid-teens, really, because of the cost of raw materials, unavoidable.

I mean, I'll be candid with you, our intention is to maintain our margins and that’s the kind of price increases that are necessary just to do that.

Oh, okay.

Right and that’s going to be implemented by, I think you said, by third and fourth quarter, just to kind of be safe then, right?

Right.

And with that price increase, would that now put you even with the increases in copper prices?

Yes.

So you --

Assuming no further increases if the cost stabilizes.

Yes, right, [inaudible - multiple speakers].

That’s a big assumption, Jimmy.

Okay.

But it still [inaudible] captures this increase.

And then lastly, on the corporate expect side, I guess compared to the first quarter it is down a bit and I noticed at the same time last year too.

So is this kind of the run rate that we should be looking for in terms of corporate expense?

As far as the run rate goes, you can take the YTD.

I wouldn’t take the quarter.

Okay and to do that.

Okay.

All right, great.

You have -- use the YTD.

YTD number?

You have a seasonality to our business, with the beginning of the year and the end of the year trailing off and building up.

Yes.

Okay.

All right, great.

Thank you.

It was a great quarter, guys.

Thank you.

Thank you, jimmy.

Curt Woodworth with JP Morgan.

Hi, how are you guys?

Hey Curt.

Hey good.

Pat, I just want to make sure I understand the raw material dynamic correctly.

Is it right to assume that you did not see any head wind this quarter, that you were matched on price versus cost?

Yes.

We effectively offset the impact on our COGS by price increases, okay, pretty much dead on, okay.

Now you always shoot for that, but whether you accomplish it is another story.

This quarter we accomplished it.

Okay and is it for both the wholesale and retail side or did wholesale help you out maybe more?

I think the wholesale helped us out a little bit from a couple of points of view.

One is that we have a longer negotiation process in the retail than we have in the wholesale process.

So the cumulative effect, we’re moving both of them, but you see the impact on the wholesale channel more immediately than you see on the retail channel.

But overall, we’re getting it on both channels but it's a more arduous process in the retail than it is in the wholesale.

We also have been favored a little bit in that to a certain extent our mix is shifting, don’t forget, toward the commercial marketplace that’s helping us to offset some of that as well.

Right.

And it felt like even though your cost basis on copper is going up close to $3.00 in this quarter versus $2.50, you feel that the pricing increases you have in place there should be no incremental head wind there in third quarter, in terms of gross margin impact?

That’s our best-developed plan, yes.

Okay.

That’s great.

And then looking as some of the onetime items this quarter, you had the $2.0 million of warranty costs, you had the $1.1 million amortization for ATS, including the inventory issue at Lowe's, you lost some profit there.

So my best guess, adding that up, it looks like it was almost a $0.05 to $0.06 EPS head wind that was in your operating number.

Yes.

And so my question is, looking at the third quarter, which historically has been about equal to Q2, given that you have maybe $0.06 going away, the commercial market's still doing well and it looks like you’re going to be even on your raw materials also relative to Q2, it certainly appears to me that earnings should be going up sequentially.

Would you agree with that?

When you plan in that kind of gain, though, Curt, you have to also remember we just mentioned $0.03 or $0.04 on the seasonality of FEBCO that goes away.

All that goes away?

$0.03 to $0.04 of it, yes.

So there’s no real profits from irrigation in Q3?

Well there are some profits, but --

They’re $0.03 to $0.04 lower than they were in the second quarter.

Right.

Oh really, wow, okay.

Okay.

I think you got the big pieces and you need to build your model.

We can’t give you -- we don’t give guidance, so we got to be careful here.

Right, but --.

But you know the pieces in the second quarter that will be non-repeatable.

Okay.

All right.

Great, well, thank you very much and great quarter.

Thank you.

Ryan Conners with Boenning & Scattergood.

Hi guys.

Most of my questions have been answered, but you talked a little bit about acquisitions in the first half.

I wondered if you could just kind of characterize the pipeline now and talk a little bit about things going forward?

I know you had a flurry a couple months ago.

It’s been kind of quiet and I guess, specifically, obviously equity valuations have come down.

I wonder if that’s brought down seller expectations at all in the markets that you’re dealing in and whether that’s what’s impacting things.

Yes, let me just talk in general.

We haven’t seen an appreciable change in our pipeline whatsoever.

There’s still a lot of deals out there.

The process in looking at companies, unfortunately, you get hot on a company and then you find out that it’s numbers don’t hold up under scrutiny and all kinds of other things happen, so it's not a linear equation.

So I wouldn’t read anything into when our activities take place.

That’s more a function of a decent pipeline, but the vagrancies of stocking acquisition.

In terms of -- I think if you look at our approach to acquisitions, we tend to be relatively disciplined in our pricing and you can see that in the multiples we are willing to pay.

I think you’re right that there may be some opportunities coming due for a couple of reasons.

One, because the valuations are coming down, so they may be more reasonable and second, I think there are a number of acquisitions that were acquired by the LBO firms and they’re three to four years into their deal.

So they may be looking to flip those.

So we think we may actually see increased activity over the next 18 months, at fairly reasonable pricing.

Great.

Thank you.

Ladies and gentlemen, this now concludes the Q&A session.

At this time, I will turn the call over to Patrick O'Keefe for closing remarks.

Well, first of all, I want to thank everybody for joining us today.

I think this was an outstanding quarter.

We’re happy to share these kinds of results with you and we appreciate your support and we will see you on the following conference call in November.

Thank you.

Thank you for your participation in today’s conference.

Ladies and gentlemen, this concludes the presentation.

You may all disconnect and have a good day. 15