Watts Water Technologies Inc (WTS) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2009 Watts Water Technologies Earnings Conference Call.

My name is Anita, and I will be the operator for today.

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

(Operator Instructions).

I would now like to turn the call over to Kenneth Lepage, General Counsel.

Please proceed.

Thank you.

Good afternoon and welcome to the Watts Water Techniques Second Quarter 2009 Earnings Conference Call.

On the call with me today are Pat O'Keefe, our President and Chief Executive Officer, and Bill McCartney, our Chief Financial Officer.

Please be aware that any remarks we may make during today's call about the Company's future expectations, plans, and prospects constitute forward-looking statements under the Safe Harbor Provisions of 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 the December 31, 2008, and other reports we file from time to time with the SEC.

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

While we may elect to update forward-looking statements, we disclaim any obligation to do so, and you should not rely on these statements as representing our views as of any date subsequent to today.

During this call we may refer to non-GAAP financial measures.

These measures are not prepared in accordance with generally accepted accounting principles.

A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the press release dated today's date, relating to our second quarter 2009 financial results, a copy of which may be found in the Investor Relations section of our website, www.WattsWater.com under the heading "Press Releases."

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

Thank you, Ken, and good afternoon, everyone.

Welcome to our second quarter conference call and thank you for joining us today.

After my opening remarks, Bill McCartney, our CFO, will provide you with the financial highlights for the quarter.

Bill will also discuss individual sector results.

Then we will address your questions.

As we have reported to you during the last several quarters, we continue to focus on maximizing cash flow throughout the organization.

The first half of 2009, we generated positive cash from operating activities of approximately $74.5 million, almost double the $41.8 million of cash generated from operating activities in the first half of 2008.

We achieved this despite a 43% reduction in first half income from continuing operations due to our favorable focus on working capital management and our cost savings initiatives.

Our free cash flow for the first half of the year approximated $66 million, or 140% increase over 2008's free cash flow of $27.5 million, again, as a result of working capital management and also closely managing our capital spend.

Cash flow remains a key driver for our Company as we navigate through the global recession.

We have achieved savings in the first half of 2009 through various programs and initiatives.

Since October 2008, when we first announced our reduction-in-force program, our worldwide headcount has decreased by 14%.

We have also implemented salary reductions, worker furloughs, and other cost reductions during the first half of 2009 to help us control our spend.

We continue to expand our liquidity during the second quarter.

At June 28, 2009, our net debt-to-capital ratio was 18.3%, which compares favorably to 22.8% at December 31, 2008.

We had approximately $179 million worth of cash on hand versus $166 million at December 31st.

Our cash position has increased even though we made a decision to pay down our line of credit by approximately $43 million during the first six months of 2009.

As a reminder, our next large debt payment of $50 million is not due until May of 2010.

Needless to say, I believe that liquidity is a major strength for our company.

I would now like to speak to you about the results for Q2.

Let me first address the large charge of $18.7 million taken to discontinued operations in the quarter.

This charge was primarily for the disposal of Team Precision Pipeworks in the UK, which we previously announced in May.

Team was a 2004 acquisition whose core operations were in pipe and tube assemblies primarily used in HVAC market and the automotive application.

The automotive end of the market has been quite depressed for the better part of two years, and the outlook for synergies with teams in metal-bending capabilities diminished due to certain market developments.

We explored various options to either improve or divest the company.

Finally, we determined that placing Team in the hands of an administrator, which is the UK's equivalent of bankruptcy was our most viable option.

As a result, we relinquished control of Team to the administrator in May and wrote off the net assets to discontinued operations in the second quarter.

Our operating results prior to restructuring charges exceeded our own internal expectation.

I would like to highlight that we had two product liability cases resolved during the quarter, which resulted in a one-time gain of $0.03.

From an operating perspective, we have seen pricing pressure causing reductions in certain markets but overall price erosion was not a major issue during the quarter.

We continue to experience plant under absorption, which was offset, to some extent, by our cost reduction and lean initiative.

Gross margins were 110 basis points higher than Q2 of 2008 and sequentially were 220 basis points greater than Q1.

The year-to-year margin expansion was due primarily to, one, acquisition accounting charges in 2008 for Blucher; two, incorporated Blucher in our results for the full quarter of 2009; and, three, eliminating the results of TWT, a former Chinese -- China subsidiary from this year's operating results.

The sequential growth margin expansion was due to one more plant absorption than we realized in Q1 and some lower raw material costs working their way through our inventories.

Operating margins for Q2 were consistent with the same period of 2008 at 9.1%.

Currency swings from year-to-year negatively impacted operating earnings by $0.03, but this swing was less than we anticipated as the euro has steadily gained ground this year against the US dollar.

Looking at our major end markets, the US commercial sector is still very depressed.

Sales into US wholesale channel in Q2 declined 18% organically against Q2 of 2008.

This percentage decrease was the same as we experienced in Q1.

We still see wholesalers continue to destock, but we believe that the pace of destocking has substantially lessened.

As you know, we review the ABI Index as a predictor of commercial construction markets.

Unfortunately, the June index declined to 37.7 from 43.7 in March when we last spoke.

The AIA chief economist was quoted as saying the architectural firms are concerned that the construction market conditions will not improve even as soon as next year.

So given what we are seeing in our business and the general macro information we are reviewing, our outlook for the commercial sector has not changed.

We expect to see continued deterioration in the commercial marketplace for at least the remainder of this year and likely into the first half of 2010.

Our US retail sales in Q2 were 7% below Q2 of 2008 but sequentially were flat with Q1 of 2009.

Last year's Q2 included some product rollouts to a large retail chain.

These rollouts did not recur this year to the same extent, making our comparisons relatively difficult.

Our belief is that the retail stocking has ended, and our retail business will remain stable for the remainder of this year.

In Europe we had seen organic sales decline from 13% in Q1 to 17% in Q2 as compared to the same periods last year.

Destocking was still an issue with European OEMs as more customers were seeing smaller orders with faster turnarounds.

As mentioned last quarter, we also think that the OEMs have overstocked in Q4, and we're working off their inventories throughout the first half of this year.

Organic OEM sales were off 24% from Q2 of last year.

Our perception currently is wholesale inventories are at low levels, so we believe the destocking activity with the wholesaler has subsided.

Sales to the wholesalers was down 9% organically in the quarter.

Sales into Eastern Europe has remained depressed due to poor economy conditions, customer credit risk remain a major issue in Eastern Europe.

In our major markets, we are seeing general slowness in all areas.

German OEM sales were light.

We continue to see declines in Italy driven by lower wholesale and export activity.

Approximately half of our Italian operation serves as a feeder plant to sister companies throughout Europe.

So under-absorption in those areas was an issue as demand in those plants weakened.

Lower sales in France, in general, related to wholesale and DIY channel softness.

Concerning our general outlook for the remainder of 2009, we hold our view that consolidated revenues will be lower compared to comparable prior-year quarters by 15% to 20%.

We believe the US retail business has stabilized, but there is no real upside in the near term.

Our US wholesale sales will continue to be challenged by a declining commercial sector, and our major -- our European markets are all feeling the effects of the recession.

We see the overall gross margins trending, as anticipated during our last conference call.

Under-absorption will continue to be an overriding factor for the remainder of this year.

We do see some potential margin expansion in Q3 as lower copper costs run through our P&L, but we lose some of that benefit through Q4 as higher copper prices that was recently purchased starts to bleed through our inventory.

Please recall the benefits of our footprint reductions will not be realized until 2010.

So we will continue to be challenged throughout 2009 by plant under-absorption and potential plant moving inefficiencies later in the year.

Let me update you now on recent restructuring initiatives.

As you may recall, the Board approved a program in Q1 to consolidate our manufacturing footprint in North America and China.

In mid-July we announced to our employees one of the initiatives involved in this program.

We plan to relocate our PEX production from Langley, British Columbia, and from Springfield, Missouri, into one central campus in Kansas City.

Our under-the-floor heating operations will still remain in Springfield, Missouri.

This initiative will allow us to rationalize our PEX manufacturing, drive process efficiencies, and provide central location for distribution throughout the United States and Canada.

The total cost estimate will be approximately $2.7 million, including severance costs, shutdown costs, moving, and startup costs.

In addition, we expect to spend approximately $1.9 million in capital to outfit our new production site.

We anticipate the move will be completed by Q2 of 2010 and will provide us with annual savings of approximately $1.5 million.

Other initiatives included in our overall footprint program are generally on track, but formal announcements have not been made to our employees, so I am not able to discuss the details with you at this point.

Lastly, let me address our acquisition program.

Although we continue to make inquiries and are looking at several targets, our acquisition program has been somewhat muted, given the state of the economy and our current philosophy on cash conservation.

We believe we are in an advantageous position given our cash availability to get a deal complete, and we have spoken with some interesting companies but nothing is imminent.

Now I would like to turn the call over to Bill McCartney, who will take you through the financial highlights.

Then we will answer any of your questions.

Bill?

Okay, thank you, Pat.

We'll run down some of the details here.

Looking at revenue in the quarter, we closed at $312 million.

That's a decline of $72 million, or almost 19% versus last year even though we were up $17 million from Q1.

When you look at the $72 million or 19%, 16.5% was a decline from an organic standpoint.

The foreign exchange rate, the weakening of the dollar caused us to have a negative growth of 4%.

Inclusion of Blucher for a full quarter -- as you may recall, we bought Blucher last year on June 1st, so now we have two extra months in Q2 this year.

That contributed almost 3%.

And then, as you also recall, in December of 2008, we disposed of one of our business units in China, so that was worth $3 million or about 1% decline because of that issue.

Just looking at the earnings, from a US GAAP standpoint, we reported a loss of $0.10 per share.

That includes the loss from Team, which is included in discontinued operations.

If you look at continuing ops, we were in $0.41 a share, and then when you again look at continuing ops without the restructuring charges, we earned $0.42 a share.

You compare that to last year, $0.56 a share, so on the 19% decline in revenue, our EPS declined 25%.

Of that $0.42, compared after the first quarter in which we earned $0.23.

So we've had a nice improvement from Q1 relative to the results from operations.

North America -- the revenue here, $194 million, which is a decline of about 17%.

North America is where we saw the bulk of the increased revenue from Q1.

In Q1 in North America we achieved $178 million of revenue.

But the decline in North America of 17% is a combination of 16% from an organic standpoint, and 1% from weakened foreign exchange rates.

Primarily the Canadian dollar, the average rate we used for the Canadian dollar in 2009 was $0.85 compared to $0.99 in Q2 '08.

On the wholesale side, which is where we achieved that $16 million increase, we had $152 million of revenue, which is a decline of 19%.

Compare that to Q1 of $135 million.

Again, just to reiterate some of Pat's comments, I mean, what we saw in Q2 was some destocking.

We believe that we are close to that being essentially complete.

We did have some heavier destocking in Q1, so as we go into Q2 we get some seasonality.

We believe the inventory is approaching much more of an equilibrium standpoint, but we are hearing that the wholesalers are going to be very wary of restocking but, nonetheless, we think that most of that is behind us.

So any change in the end markets, we should feel relatively quickly in our order entry rates.

Looking at the retail side, $43 million in the quarter.

That's flat with Q1 and down about $3.5 million from last year's Q2.

When we look at that, it's really -- the feeling, the pinch there primarily in the tile distributors, which are dependent on new housing starts where we sell a lot of our under-floor electrical equipment.

And last year we also, in Q2, were at the tail-end of some heavy rollouts on some of our recirculation pumping equipment.

So we're feeling it there as well.

But we also know that same-store sales from some of our larger customers -- Lowe's and Depot and whatnot -- are down between 8% to 10%.

So it's really -- the decline is primarily due to the same-store sales decline in the US.

In Europe, Q2, our revenue was $109 million, just about flat with Q1 this year and down 19% versus Q2 last year.

That 19%, we can classify at 16.7% from an organic standpoint.

The FX rates in Europe, the dollar weakened, so that contributed to additional decline of about 10%.

The average rate we used in Q2 was almost $1.36 compared to $1.56 last year.

And, again, we have the inclusion of Blucher for the full quarter, so that contributed 8%.

So all that comes together 19%.

And, again, where we saw the biggest impact in Europe was in our OEM business across all of our major markets in Europe.

We know that a lot of our customers, because of the declining economy in Europe, they had closed their factories for a good period during the quarter.

They are really focusing on inventory reduction.

They are also -- there were some strikes, as well, with some of our customer base.

So the combination of the weak economy, inventory reductions, hurt our OEM business in Europe during Q2.

Looking at China -- revenue of $9 million, down from $15 million Q2 '08, that's a decline of $6 million, or 41%.

It's really -- from an organic standpoint that explains about half the decline.

We were down $3 million organically, and that really is associated with declining sales for export sales out of China primarily into Europe because of the poor economic conditions in that end market.

When we look at our infrastructure sales in China, they were flat on the quarter versus last year.

The gross margin, Q2, 35.4%.

That's up comparatively 100 basis points and up sequentially by 220 basis points.

As Pat mentioned, the major drivers of the improved margin in Q2 -- one is the inclusion of Blucher for a full quarter as well as last year we had one month of purchase accounting issues associated with Blucher that were required to amortize some of the purchase price under the US GAAP rules.

So that's behind us.

We also have the sale of our business unit in China, which was a money loser, so that's behind us.

We also have several operating -- several of our units have operating improvements, particularly in China.

We also have our cost reductions that we've been implementing during the course of this full year.

When you look at the gross margin compared to Q1 of 221 basis points, a lot of it is due to the improved sales volume versus Q1, the operating improvements in China, and at the tail end of the quarter we started to expense some of the lower-cost material as well -- so good contribution in the quarter from the gross margin.

On the SG&A expenses, $81 million.

That's flat with Q1 and down from Q2 '08 by $15 million.

As we walk across the reasons here, last year we had $96 million from an organic standpoint.

We've decreased our expenses by $13 million.

Foreign exchange rates had a decrease of $4 million in SG&A.

The inclusion of a full quarter of Blucher increases our SG&A by $4 million, and then the disposal of our business unit in China decreases our SG&A by $2 million.

So that takes you from the $96 million down to the $81 million.

Operating earnings without the restructuring -- $29.2 million.

That's a decline of about $7 million versus last year, an increase of about $13 million from Q1.

When we look at the comparison in Q1, again, that's associated with the improved gross margin and the improved revenue.

And when we compare ourselves to last year, the $7 million really is a couple of factors here -- one is from an organic standpoint, we lost about $8 million because of decreased sales volume.

We lost about $2 million because of the change in the foreign exchange rates.

The inclusion of Blucher for the full quarter added about $1 million.

The disposal of our Chinese business unit, which was losing money, increased our op earnings by about $2 million.

Below the line, a pretty steady quarter there comparing to last year -- we were at $6.8 million.

This year, Q2, we're $5.4 million.

Basically, it's a change in interest rates that caused that.

Interest income is down $1 million, which is a function of lower interest rate and less cash on hand because we used our cash towards the end of the quarter to acquire Blucher, and then interest expense is down about $1 million, and that's a function of lower effective interest rates.

The tax rate is up 3 points at 34.2%.

The major issue here is last year the rate was a little bit low because of a change in some of the tax rules in Europe, which caused us to have a one-time credit, and we also had a favorable tax audit that settled last year as well.

So the 34.2 is a little bit more representative of a normal tax rate for us.

It's just that last year was a bit on the low side.

So we take that down to earnings per share.

Again, $0.42 ex-restructuring.

And we really look at the quarter as a $0.39 quarter from an operating standpoint because, as Pat mentioned in his remarks, we had $0.03 of favorable legal settlements, which are really one-time results for us.

So from an operating standpoint, $0.39 compared to $0.56 last year and $0.23 in Q1.

And just a couple of statistics on the cash flow side -- depreciation and amortization year-to-date, $22.8 million; capital expenditures are $8.5 million.

So I think, with that, we'd like to open it up for any questions that you might have.

(Operator Instructions) Christopher Glynn, Oppenheimer.

So the gross margin [busted] a few years, and it sounds like you're guiding up sequentially.

Did I hear that correctly?

Well, you know we don't provide guidance.

We are explaining that the margin was up and why it was up, Chris.

I mean, if you look at the reasons we talked about, you know, the inclusion of Blucher, and Blucher will be here for the foreseeable future.

We will not buy back our Chinese business unit.

We've seen operating improvements at WPT are permanent.

The guys are doing a nice job, and the cost reductions are holding.

I don't want to say we're giving guidance on that, but we are pleased with our margin performance.

Okay, and just talking about the directional trends, hopefully, this can be taken outside the spirit of asking for guidance, but directionally, from the second quarter, are you seeing seasonality?

It sounds like sequential softening in US non-res, but, you know, overall, what would you characterize the impact of the economy on seasonality you're seeing through the months?

Well, you have the impact of the non-res, which is a big negative impact.

You have the retail probably being a push from quarter-to-quarter in terms of the environment there, in terms of retail.

In Europe you probably have sequential from softness, going forward, due to the fact that Europe, in general, has trended to be one quarter behind the US.

And I'd say you also have ongoing issues with regard to absorption because we are managing for cash and, as a result, we are only building inventory when it's required.

So you're going to have continued overhead absorption issues going into the next couple of quarters.

The inventory is down nicely.

Do you have a target inventory level, assuming sort of static business levels?

Yes, we have inventory turns established for each and every one of our businesses.

You know, in terms of how they roll up, I don't have that number in front of me, but we're expecting to continue to manage inventories very constructively throughout the year.

Okay, and last one -- just the placement of the legal gain.

Should we think of that as a reduction to SG&A?

Yes, it is, yes.

Jeff Hammond, Keybanc Capital Markets.

Pat, just back to your progression on the different markets.

How should we think about this destocking impact or the abatement of destocking.

Is that outweighed by underlying deterioration in non-res or is that positive delta, 2Q to 3Q, as that goes away?

I see the non-res deterioration being a pretty strong factor as we go forward.

I also see the OEM market in Europe being -- downward pressure on the OEM market in Europe, particularly when you look at it on a comparative basis, quarter-to-quarter to last year.

Is that the progression you saw through 2Q, where as the quarter progressed the declines accelerated?

Pretty much so, yes.

In both the European OEM and the US non-res.

Okay, and then --

Let's say North American non-res.

Okay, and then just on -- you know, back to the gross margin discussion.

You talked about the two structural changes with Blucher and China, but I would imagine, you know, certainly you maybe get some additional absorption issues, but commodities sound like they're an incremental tailwind.

Can you just talk about price cost gap in 2Q and quantify maybe how much more of a tailwind it is into 3Q, 4Q?

I see the pricing being a little bit more favorable in Q3.

And then in Q4 you're going to start seeing it roll over on us again, and you're going to see late in the quarter the materials starting to rise.

So -- you know, we tend to be probably five months or so in arrears in terms of when copper and when raw materials run through our P&L.

I would say in Europe you're probably going to see similar -- you'll see some margin expansion during the third quarter and into the fourth quarter but softening as you get closer to the end of the year?

Okay.

And then just shifting gears -- the China business has kind of been bouncing around -- profitable, not profitable.

I think with this divestiture you showed a small profit.

Is that something you think is sustainable and how do you think of the long-term run rate of margins for that business?

I don't think we're done fixing China, by any means.

But I think we now have it to the point where it's more stable than it's been in the past, so I think you'll probably see some stability there in terms of going forward.

Mike Schneider, Robert W.

Baird.

Maybe first just on the under-absorption question -- I think last quarter you quantified it at about $8.5 million.

Do you have a number billed this quarter as what you think under-absorption cost you?

Yes, it's going to be somewhere in the neighborhood of 7, 7.5, Mike.

It's less than Q1 but still a meaningful number for us.

And going into Q3, I presume, as you remedy the inventory situation moreso, that number will decline again.

As more of these end markets end their destocking, they need to -- our inventories, you know, things just reach a new equilibrium, and that becomes less of an issue.

But when you have sales declines of 16%, 17%, the issue does not go away.

Sure.

All right.

So I think it's a gradual each quarter, we would expect some gradual improvement there.

Okay.

And then in Europe, the August holiday shutdowns -- can you give us a sense of do you actually expect Europe to deteriorate further based on the holiday shutdowns?

Just -- what are you hearing from your OEMs in terms of their production schedules?

You've got to remember, Mike, the holiday shutdowns are an annual thing.

So they did that last year, they'll do it this year, and they'll do it from now until the time that I'm still in business.

But, you know, typically, what you see is, you know, there's a lot of pre-buying before they go on holiday, and there's a lot of buying in anticipation where they place PO for delivery just after they return.

So we're thinking that's probably a year-over-year effect.

It will be negligible.

But I guess what I'm referring to is, like the US over Easter and Christmas, one would suspect that your OEM customers in Europe are going to take 60 days off not 30 days off this fall.

What are you hearing from them?

Well, most of the customers are on -- in Q2 were on reduced work schedules already.

So we don't see that that is going to change during Q3.

All the customers I've had contacts with, Mike, are on furlough -- have been on furlough for most of May and most of June, and the holiday season, as you know, begins here in July and August.

So I think they're probably going to use a different methodology to get hours out of the plant, but I don't think it's going to have a substantially different impact.

Okay, then, switching to US retail -- the revenue being flat sequentially, it seems to me to suggest there was no seasonality you've seen in the renovation market this spring.

Yet others are talking about, I guess, at least some seasonality in household products.

Is there something unusual about rollouts or maybe product shelf space actually coming out that would explain why the sales are actually flat sequentially?

One thing about our retail today -- we've talked about it occasionally in the past, Mike, is that we have a little bit more choppy results because we tend to do a lot of rollouts and whatnot.

So -- there is no significant shelf space or anything like that that we're losing.

But last year we had some significant rollouts in Q1 and Q2 with our hot water resurf pump, and this year we are feeling the pinch more than normal, I think, because of the lower housing starts particularly on the tile distributors -- not necessarily the big-box guys but on the tile guys.

We sell some under-floor heating equipment through that channel.

Okay, and because the sales were flat sequentially, ordinarily, retail sales, I believe, for you would be down sequentially in Q3?

I guess, what have you seen in July and what's your understanding or modeling for Q3 retail?

I think Pat mentioned earlier that we think we're sort of at a static run rate, I think was the wording he used, right, for retail.

Yes.

Even accounting for the seasonality in 3Q?

Yes.

Right.

Okay.

And then, Bill, just a final question on materials -- gross margins, as you said, were up 220 basis points sequentially.

What amount in materials contributed to that 220?

It would have been a small piece of it, Mike, because we didn't really start getting the cheaper materials -- some of the divisions had cheaper materials running into the numbers starting in June.

It wasn't one of the major contributors.

Keith Hughes, SunTrust.

I was a little confused at some of your previous comments.

If you look at your European residential-focused products, did business get sequentially worse from the first to the second quarter, in your view?

Residential in Europe?

Well, I mean, Europe, from Q1 into Q2 was flat.

We did see more of a deterioration on the OEM business, Keith, which is really -- you know, we're selling into some of that alternative energy space, and it's really, we think, a result of both the economy and this particular end market doing an awful lot of destocking, because they've just got ahead of themselves.

The wholesale side was only down about 9%, which is going to be -- well, it's residential and commercial, but -- .

Okay, all right.

And final question -- corporate expense, it's down pretty significantly year-over-year.

Besides just the cost-cutting you were working on, were there any other items in there?

That's where you see the benefit of some of the favorable legal settlements that we've discussed.

Okay, so it would be on that line?

All right, thank you.

Michael Gaugler, Brean, Murray and Carret.

Nice job on the quarter, by the way.

Pat had mentioned in his opening remarks that the pricing environment remains a bit challenging, and I've noticed that one of your key raw material cost, copper, has been steadily moving higher.

I'm wondering if you had any thoughts or perhaps any different strategies regarding copper, in particularly, going forward.

As your end markets recover, hopefully, sometime in 2010, perhaps maybe doing a little pre-buying or some type of hedging?

Because I would anticipate that the raw material costs will rise faster than your -- or come before your ability to reprice.

Yes, you're pretty much correct.

The environment right now to get price increases is not very robust.

So we -- although, in the quarter, if you remember my comment, we had downward pricing pressure but, overall, when you look at Watts on a consolidated basis, I don't think pricing pressure was a significant factor in this quarter.

Now, it's going to become a problem as you go forward, because, particularly copper has been rising for some time, and it's probably going to continue to rise.

So we do have approximately a four-month hedge in terms of our natural buying patterns, but you're going to see some pressure later in the year on our margins as that higher cost raw material starts rolling through our inventories and into our cost of goods sold.

As far as 2010 is concerned, we're taking a look at that, but we've not developed a strategy with regard to that.

Mike, historically, our habit has been that we do not do financial derivatives in future contracts and swaps and whatnot on commodities.

But we do allow our divisions to make some commitments on actual deals with vendors that make sense, and we allow them to go out an extra couple of months when it makes sense.

We're always examining that strategy because it plays an important part of our profitability, but I would imagine that strategy will probably be the same in 2010 but, as Pat says, we haven't finalized anything yet.

But we're always looking for good advice and re-examining our strategy there.

I think you're right, by the way, that you'll see pricing pressure before you see -- you're seeing cost pressure before you see pricing opportunities.

Scott Graham, Ladenburg Thalmann.

A couple of questions on the gross margin, which -- that was a really good number, and I'm just wondering -- when you read off the benefits to gross margin in the quarter -- Blucher, sale of China, operations improvements in China, and cost reductions -- should we look at that as sort of a tiering of how the most important to least important?

Or were you just putting them out there?

No, we were just putting them out there.

They're all important enough factors to mention, so we just thought we'd -- we're not suggesting that one is more important and has more of an effect than another one.

Okay.

But I'm guessing, though, that cost reductions, because most of your strategies are geared toward next year, that might be a little less than the others, or is that not right?

I would say that the operating improvements in China, the guys we've been working on, are a very important contributor, and the cost reductions would be a little bit less.

I would agree with that.

And then the sale of that business unit in China is also an important one.

Cost reductions probably are the lower of the four that we mentioned.

Right, fair enough.

And so if I look at your SG&A number, which, on a year-over-year basis, was obviously down a lot, how much would you say in SG&A was sort of structural cost versus the volume?

We have a $1.5 million net benefit because of those legal settlements that's in SG&A.

And then there would be -- a couple of million dollars would be reduced selling expenses, commissions and freight, and the remainder would be a lot of the cost reductions -- the reduction in force, the wage reductions, and so on that we've been doing.

Because I think you said that number was, like, $6 million on a year-over-year basis in the first quarter?

So that would have accelerated a little bit in the second quarter?

It's at least equal to that.

Yes, okay.

I was also wondering about some of the things that you're doing in China.

I mean, obviously, you guys are doing a great job in improving the operations.

Could you give us an idea, if we look at last year, which was a loss of, call it rounded, $3 million?

What piece was sale of the operation versus what piece was the operating improvements on a [walk-up to the million]?

The disposal of that business unit contributed $2 million to operating earnings this year versus Q2 last year.

And our operating earnings in China are, in total, improved by $3.6 million.

So -- [two of the three sixes] -- the disposal of the unit -- the rest of it is operating improvement.

Michael Coleman, Sterne Agee.

You kind of just answered this, but do you have an estimate for what that TWT lost in the third quarter or fourth quarter of last year?

I don't have that with me, but I would be -- an estimate would be approximately the same run rate as -- maybe a little bit less than we saw in Q2.

For both third and fourth quarter?

Right.

Okay, great.

And the tax rate, either for the year or for the back half of the year -- what do you think?

I would use 33.5.

Jim Foung, Gabelli & Company.

Good quarter, guys.

I guess just a couple of items -- in terms of cost reductions -- how much did you realize in the second quarter and how much, I guess, would you anticipate in the second half of this year that would be incremental to the second quarter?

I think we just -- when we were speaking with Scott, we were in that neighborhood of about $6 million.

Okay, in Q2, right?

Q2, and we're not really forecasting an increase there for Q3 and Q4, but we are working on it.

We are continuing to reduce our headcount selectively.

We have our factory managers focused on productivity and purchase guys on cost reduction for material and so on.

That's not really guiding anyone to more than we've already done, though.

Okay, but you have more restructuring actions in place, which you implement?

We are working on a lot of restructuring projects.

A lot of them have been announced, and others that we're working on that are smaller and sort of normal and ongoing in nature.

That's one of the things we do for a living, Jim, is cut costs.

We kind of do that, too, here.

In terms of Blucher, did you get all the margin improvement in Q2 in Blucher, or is there more incremental improvement coming in the second half of this year?

We think -- the issue with Blucher is we do have margin improvement there versus last year.

The issue with Blucher is that they are suffering from some decreased revenue just like the rest of our businesses.

But in terms of the margin percentage that Blucher is generating, we are pleased with that.

Could you give us that percent?

Well, their operating earnings are going to be somewhere around 15%.

15%, okay.

And then you kind of reached that target in Q2?

Yes.

You are doing that, okay.

And then, lastly, the material costs -- in the past you've given us, like, your average cost of copper because you work on kind of -- you have some --you buy sporadically or regularly.

What was your average cost in Q2 for copper, and what do you think it will be in Q3?

About $3 a pound.

$3 a pound in Q2?

Yes, and then as we get into Q2, it will be in the low $2 range.

You mean Q3, right?

Increasing in Q4.

Okay -- low $2 range in Q3 and how much is in Q4?

It would be probably close to $2.50, because copper a spot right now is $2.50.

All right.

And when do you think you'll get back to the $3 range again?

Well, you tell me when copper is going back to three bucks, and the answer is four months later.

Michael Rumberg, Boenning & Scattergood.

Congrats.

It looks like a pretty nice quarter given the environment.

On the pricing side, I want to focus on the cost of goods sold.

I want to zero in on the different channels that you guys sell to.

Have you seen any specific pricing pressure during the quarter?

Could you kind of walk us through the different channels that you sell to and give us an outlook on what you expect to see now that the price of copper has come down, whether or not that looks to be more of -- you'd expect to see more pushback from your customers.

I don't necessarily believe the cost of copper has come down.

It's starting to move back up.

One of the reasons that I said that we didn't have a significant issue with pricing in the quarter is because copper was, in essence, moving upward, and customers are recognizing that -- asking for price increases is going to be responding with a "No, we can't afford it," given the cost of copper that's coming at us.

So we really -- you know, to a certain extent, we're getting pressure from competitors who, you know, are doing things to try to get some volume in the door.

But, in general, the response from customers, in general, is that they recognize that copper is moving against all of us at this point in time.

(Operator Instructions) Jamie Sullivan, RBC Capital Markets.

I wondered if you could just remind us, with all of the restructuring that you've done, what you expect the incremental savings as you go into next year -- what you expect that to be?

What we've discussed in the past is that the restructuring programs that we've announced and that we're working on will generate $5 million after-tax savings, and those will start to come into the numbers during early 2010.

Okay, great.

And then you talked a little bit about seeing some expedited orders from customers.

Can you talk about any trends there?

Has that stayed the same as they're looking or wary of building inventory?

If you can comment on that?

I think, in general, we are seeing that both in North America, and we're seeing it in Europe as well.

The size of the orders are being reduced, and the number of times they are asking for shorter lead times -- can we meet a shorter lead time is the -- I mentioned it in my opening comments, specifically in Europe, but I think it's also been true -- we saw extensively in the second quarter in North America as well.

It's a good indication to us when we're nearing the bottom in terms of the destocking process.

That's why it's so critical, Jamie, for us to have good fill rates and delivery rates with our customers because when times are tough like this, they depend on us for quick deliveries, and, you know, we tend to get that business that way.

I think that showed up in the second quarter with the -- the -- we did better than we expected partially because of the fact that we were, from an operating point of view, delivering on a timely basis.

Okay, thanks.

And if you could just comment, I guess, on the various stimulus packages around the world -- if you are seeing any benefit in your businesses?

Well, you know, the one in the US is hard to quantify because there are so many limitations with regard to it, particularly the MakeAmerica requirements -- of that particular bill.

But we are seeing and have continued to see stimulus bills in Europe, particularly with those that are tied to energy conservation that have been -- we've taken advantage of, and we think that -- it's not stopping us from having declines in revenue, but it's probably a cushion underneath us so that we would have seen deeper declines had we not seen some of those programs in place, particularly in the OEM sector in Europe where we make a lot of products for oil manufacturers that are energy-conservation related.

Okay, and how about in China?

Are you seeing anything there?

Not really, nothing that's actually benefiting us directly.

With no further questions in queue, I would like to turn the call over to Pat O'Keefe for closing remarks.

Please proceed, sir.

I just want to take the opportunity to thank everybody for joining us today.

Needless to say, this was a pretty positive quarter, one that exceeded our expectations, and I look forward to seeing you on the call for the third quarter results in late October.

Thank you.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect and have a great day.