Watts Water Technologies Inc (WTS) 2010 Q1 法說會逐字稿

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  • Operator

  • Good day, ladies and gentlemen and welcome to the Q1 2010 Watts Water Technologies earnings conference call.

  • I will be your operator today.

  • (Operator Instructions).

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

  • Please proceed, sir.

  • - General Counsel

  • Thank you.

  • 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 on our annual report form 10-K for the year ended December 31, 2009 and other reports we file from time to time with the Securities and Exchange Commission.

  • 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 the forward-looking statements, we disclaim any obligations to do so, and you should not rely on these statements as representing our views as of any other date.

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

  • - CEO and President

  • Thank you, Ken, and good afternoon everyone.

  • Welcome to our first 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 first quarter, including individual sector results, and then we will address any and all of your questions.

  • Let me start out by saying I'm very much encouraged by the solid start to 2010.

  • Two comments I would like to make with regard to the first quarter, first, I'm happy to report that we grew our top line organically for the first time since 2008 with a growth rate of about 7%.

  • Secondly, excluding the effects of FX and restructuring, for each additional sales dollar generated this quarter over Q1 of last year.

  • we delivered $0.60 in organic operating profits.

  • I believe our efforts that we undertook in 2008 and 2009 and continued to push, which are continuous improvement, restructuring and other cost containment issues, have begun to bear fruit and are generating productivity improvements which will help us leverage the Company's cost base.

  • At the end of Q1, we were still blessed with cash with about $250 million of cash on our balance sheet.

  • We generated cash from operations but at a lower level than Q1 of 2009.

  • As we grew the business, we increased our customer receivables and to a some lesser extent, added some inventory.

  • However, our working capital operating metrics continued to improve as our DSO was lowered from 56 days to 54 days, and our inventory turns increased from 2.9 to 3.2 from the year-end numbers.

  • As I mentioned many times, we continue to focus on cash generation.

  • As the recession eases, we will take the opportunities to make investments in technology and people where we feel the pay back is greatest.

  • As a reminder, $50 million of our private placement debt is coming due here in mid-May.

  • We are expecting to refinance this note over the coming weeks with our net debt to capital ratio at quarter end was 10.5%, compared to 9.5% ratio at the end of the December quarter.

  • Regarding our business in general, at our last conference call, we noted that the US repair and remodeling market was showing some upturn.

  • This trend continued during the first quarter as we experienced growth in our products, such as water quality, gas connectors, radiant heating products and other products that are sold into these markets.

  • We especially saw growth in the appliance area where we saw gas connectors and water connectors, which are used in oven and dishwater applications, grow substantially.

  • We saw some minor restocking taking place both in the US wholesale and the retail channel as well.

  • Also, as mentioned during our last conference call, we introduced a full line of lead-free products which meet the new legislative standards in California and Vermont, which require almost 0% lead in piping fixtures and valves used to convey water for drinking and cooking.

  • We believe that we have successfully met our customer needs regarding this rollout and we are seen as a market leader in providing these lead-free solutions to the marketplace.

  • The commercial marketplace, as we expected, has continued to struggle during the quarter.

  • Our product offerings that focus almost exclusively on the commercial end market were down in the mid to high teens as compared to last year.

  • In Europe, the best way to describe our business is that it was stable.

  • Our European wholesale sales showed modest improvement in Q1, with OEM and retail remaining relatively flat.

  • There was a slow start to the year for products like such as boilers and solar product lines, but lately, we have seen these markets starting to pick up.

  • As in the US, the renovation market showed improvement.

  • Order intake in Europe was steady during Q1, with our backlog increasing as we progressed through the quarter.

  • Now, with regard to commodities, in 2010 we have already experienced a lot of variability in copper cost.

  • We believe that we were again able to maintain equilibrium between our pricing, the customers and the continuing fluctuating cost of these commodities.

  • In some instances, we offset increased costs through productivity and production efficiencies.

  • In other cases, we went to the market with higher prices.

  • In Q1 we announced price increases to the wholesale channel, which became effective on March 1.

  • We also announced retail channel price increases that will be effective May 1, and in some cases, later in the year.

  • As in the past, certain competitive markets we had to actually reduce price to remain a competitive force in the marketplace.

  • Now, let me give you a brief update on the footprint consolidation effort.

  • In the US, we expect our PEX operations will successfully be relocated into a new campus in Kansas City in early Q2 of this year, consolidating our manufacturing from western Canada and Springfield Missouri into one facility.

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

  • The total cost approximately is $2.7 million, including severance cost, shutdown, moving and start-up, costs plus approximately $1.9 in capital to outfit the new production site.

  • We anticipate that this project will provide us with annualized pretax savings of approximately $1.3 million, which will start in the third quarter of this year.

  • In China the relocation of our plant in (inaudible) to another Chinese plant, and partially to an operation here in the United States, was successfully completed in the first quarter.

  • Annual pretax savings are estimated to be $500,000, and we were able to reduce inventory levels because of the shorter supply line.

  • We entered into a definitive purchase and sale agreement in early April.

  • We hope to complete the sale of the [tan gen] operation before the end of the year.

  • This sale will generate approximately $6 million in cash when it is completed.

  • In Europe, two major projects are on schedule, one involving the consolidation of two plants, which support our European drain business, into one existing site.

  • Total expected outlays are $6.6 million, most of that being capital, with estimated pretax savings of $1.8 million.

  • We also expect some inventory reductions as part of this project.

  • The expected completion date will be some time in late July or early August of this year.

  • Finally, restructuring of our French operation continues.

  • The work councils have completed their voting in this, which will legally allow us to proceed with the restructuring.

  • We took some restructuring charges in Q1 for additional severance and accelerated depreciation regarding the French project.

  • We expect the project to be completed in late 2011, but we are not anticipating any pretax savings until into 2012, and those annual savings will be approximately $5 million on an annual basis.

  • Now I would like to discuss our outlook.

  • In general, we continue to believe that the first half of this year will be challenging for the US commercial markets as they try to find a bottom.

  • The ABI, the Architectural Billings Index, has been creeping up, which gives some hope for a commercial upturn later this year.

  • At this point, however, we believe our initial settlements of year-on-year reduction in commercial sales someplace in the neighborhood of 10% to 15% is still valid, with more of the reduction weighted in the first half of the year.

  • We see the US residential market slowly improving.

  • March housing starts where 626,000 units, which is up 20% from the prior year, and residential building permits were up 33% year on year, which is encouraging.

  • But I think high unemployment, tight lending will continue to serve as a drag on this market.

  • As mentioned previously, we do see some positive movement in the remodeling sector.

  • The Leading Index of Remodeling Activity, LIRA, which is published by Harvard University, is predicting a 5% growth in remodeling spending in 2010, which I believe is a reasonable assumption.

  • We see the European market up about 3%, with more of that growth registered in the latter half of 2010.

  • Our concern presently in Europe is with regard to the financial crisis in Greece, which appears to be spreading to other countries.

  • This situation could negatively affect the value of the euro, which would result in reduced reported European sales and profits for us as the year progresses.

  • It could hinder Europe's recovery from a recession.

  • As mentioned, we have seen some modest channel inventory build up, mainly in the retail channel.

  • But inventories are still being tightly controlled.

  • Quick turn-around orders from customers are still evident, especially in Europe and the US wholesale market.

  • And we have experienced strong throw rates on these orders, which may lead to market share gains because we were able to meet customer expectations on such short notice.

  • Commodity costs could be negatively impacted in our -- could negatively impact our P&L in Q2 as we expect higher priced commodity costs to be charged to our operations.

  • We hope that we can be effective in passing on these cost increases to our customers as we have been able to do in the past, but at the same time, sustainability of any price increase is market driven.

  • Beyond Q2 we are presently seeing an upward bias in commodity markets, which again could affect our ability to maintain our margins without further productivity and pricing actions.

  • Lastly, let me address our acquisition program.

  • In April, we announced the acquisition of Blue Ridge Atlantic Enterprise, BRAE, which provides engineered solutions for rainwater harvesting and commercial, industrial and residential applications.

  • We believe the acquisition of BREA enhances our water conservation and drainage product line and provides us with the expertise on national as well as local conservation codes.

  • We are presently reviewing a number of other acquisition candidates under various stages of review and due diligence.

  • As always, we will continue to look at potential deals and we believe we are at an advantageous position to close on a deal given our ability of cash to fund such deals.

  • Now, with that, I would like to turn it over to Bill McCartney who will walk you through the financial highlights and then we will take your questions.

  • - CFO and Treasurer

  • Okay.

  • Thank you, Pat.

  • We will run down the P&L, the top level as well as the segments here.

  • Revenue for the quarter closed at $319 million, that's an increase of 20 -- almost $29 million or 10%.

  • Components of that, organically, we grew at almost 7%, and the foreign exchange contributed 3%.

  • That's $20 million and $9 million respectively.

  • We are encouraged because that is the first organic increase we have seen since the third quarter of 2008.

  • On the earnings side, $0.32 a share from a GAAP standpoint.

  • When we back out our restructuring and disk ops, it brings us up to $0.44 for the quarter, which we believe is a good representation of our run rate.

  • Compare that to last year's Q1 of $0.24.

  • That's about an 80% increase in earnings per share versus last year.

  • On the restructuring, $4.2 million after tax.

  • From a segment standpoint, we had one $1.9 million in North America, $2 million in Europe and $300,000 in China.

  • We took some tax charges in North America, and most of the European charges are related to severance.

  • Very small charge in disk ops of $0.01 per share.

  • Looking at the North American results, total revenue for North America $198.5 million, that's an increase of $21 million or almost 12%.

  • Again the components of that is $18 million organically, or 10%; and about $3 million from foreign exchange, or about 2%.

  • That's just from the strengthening of the Canadian dollar.

  • The average rate in the quarter was $0.96 versus last year at $0.81.

  • Now looking at North America for both the wholesale and the retail segments inside of that north American market.

  • For wholesale, revenue was $150 million, an increase of 11%, or $15 million.

  • And as Pat mentioned earlier, the drivers really -- we have a continued soft commercial market where most of our commercial products are down in the mid teens during the quarter.

  • That commercial softness is offset by some strength on the residential side.

  • The residential products, we saw increases anywhere from 10% to 15%, versus last year's Q1.

  • These increases are driven by improvements in the remodeling market; the housing stock environment is up about 20%.

  • Existing home sales are up.

  • That helps the remodeling market as well and some very modest -- minor restocking here.

  • We do believe the channel inventories are still quite thin in the wholesale channel.

  • On the retail side North America, total revenues of $48 million, that's an increase of 15%, $6 million.

  • Again, the increases here are driven by the remodeling market.

  • A lot of remodeling is done through the retail side.

  • We introduced some new products that helped on the retail side.

  • We also gained shelf space with some existing products at existing customers.

  • And again, some minor or modest restocking with some of the larger chains that we deal with.

  • So, it is a good cross-section for reasons for growth on the retail side.

  • In Europe, we closed the quarter at $116 million.

  • That's an increase of $8 million, or about 8%.

  • The components here are $2 million, or 2%, from an organic standpoint, $6 million, or 6%, from the foreign exchange standpoint.

  • The average rate in the quarter was almost $1.39, compared to $1.32 last year.

  • Again, as Pat mentioned, we had an increase here organically of about $2 million, but we are comparing last year -- Q1 this year to Q1 last year.

  • It is a pretty good quarter last year in 2009.

  • We are up against a bit of a tougher comparison.

  • Our view in Europe as the renovation market is improving,Eastern Europe will certainly improve, and we do see it as a stable environment.

  • Those improvements were partially offset by some slower sales into the boiler and solar markets.

  • Overall, we are happy with the results in Europe.

  • Very stable.

  • On China, just some small numbers here.

  • Revenue of $4 million, down about 14%.

  • That's all organic, and that really is driven by decreased exports from our China business units into the European market.

  • It is decreased sales into the European market.

  • Looking at the gross margin, first quarter at 36.8%, very healthy.

  • If you exclude the restructuring charges that were booked against the margin, you would see the margin as 37.1% during the quarter.

  • That compares to last year at 33% in the third percent.

  • We had a healthy increase in the margin, almost 4 points.

  • So what we see here is we held our own relative to the volatility of copper with pricing and productivity and whatnot.

  • Of course, when we look at the margin, the increased sales volume helps quite a bit, not only from just generating more gross margin dollars, but it helps with the absorption characteristics in our factories.

  • And of course, last year we had to expense some of our overhead according to the SFAS 151 rules, which again, is another form of absorption variances.

  • So that volume really helps from a number of standpoints.

  • And of course, productivity continues to help us as well.

  • We are starting to really see some traction and success with some of Urolene products, and that's helping quite a bit.

  • On the SG&A, SG&A is $88 million.

  • It is an increase of $8 million versus last year's first quarter.

  • There are a couple components there to mention.

  • Of the $8 million, $2 million is from the change in the foreign exchange rates.

  • We have another $2 million, which is increased variable selling expenses, so we have freight and commissions.

  • And then we have approximately another $2 million, which is increased legal expenses associated with the wrap up, hopefully the wrap up of our SCPA investigation.

  • That he brings us down to operating earnings.

  • From a GAAP standpoint, operating earnings of $26 million; that's an increase of $10.5 million versus last year.

  • Again, if we exclude the restructuring charges, operating earnings at $30 million.

  • That's an increase of $13 million versus last year's Q1.

  • Pat mentioned this earlier, but we look at the components of the change in operating earnings.

  • If we tie back to that $10.5 million increase on the US GAAP earnings, we have an increase of almost $12 million because of the improved performance, both sales volume and productivity.

  • So, for that $19 million of organic sales, we generated about $12 million of operating earnings.

  • We are very pleased with the leverage that is occurring in the organization right now.

  • We picked up about another $1 million of op earnings because of the foreign exchange rate, and then we gave away $2.6 million because of the increased restructuring charges in the quarter.

  • Below the line, other income and expense, essentially flat with last year, and the tax rate 42.4%.

  • And we did book some tax charges associated with the closure of our facility in China.

  • If we exclude those tax charges, the tax rate would have been 35%, which is a much more normal rate.

  • It is a little high for us.

  • We are expecting a rate more in the 34% range or so.

  • The difference between 34 and 35 is really the mix of income, where we had a slight mix toward the US in the quarter, which has a little bit higher tax rate than some of our other segments.

  • Bringing it all the way down to earnings, again excluding restructuring, $16.5 million, an increase of $7 million.

  • And again, just to reiterate $0.44 earnings per share, X restructuring, which we do believe is a good representation of the operations of the Company for the quarter.

  • With that, I would like to open it up, in case you have any questions, we would be happy to answer them at this time.

  • Operator

  • (Operator Instructions).

  • The first question coming from the line of Jeff Hammond with Keybanc Capital Markets.

  • Please proceed.

  • - Analyst

  • Hi, good afternoon, guys.

  • - CEO and President

  • Hi, Jeff.

  • - Analyst

  • Bill, can you walk through this $0.09 of X items?

  • Can you give us the different pieces of that on a pretax basis?

  • - CFO and Treasurer

  • The restructuring, Jeff?

  • - Analyst

  • Yes.

  • It looks like you had the 3.1 and then maybe some additional items.

  • - CFO and Treasurer

  • On a pretax basis, it is $700,000 in North America, and on an after-tax basis in North America, it is $1.9 million because that's how we booked that tax charge associated with the shut down of our Chinese plant because they are US taxes.

  • In Europe, we had $3 million pretax, primarily associated with severance and some depreciation, so on an after tax basis that's $2 million.

  • In China, $300,000 pretax and $300,000 after tax.

  • - Analyst

  • Another -- corporate expense looked rather high.

  • Is that where the legal charge has come through?

  • - CFO and Treasurer

  • Yes, Jeff.

  • - Analyst

  • If you ex that, is it the normal run rate?

  • - CFO and Treasurer

  • Yes.

  • - Analyst

  • Then, seems to be a little bit of change of tone on the commodity side.

  • Anything really, if you compare this versus 90 days ago, anything particularly changing?

  • Do you see commodities getting a little more out of hand?

  • Are you getting a read whether your price is going to stick, not stick, et cetera?

  • - CEO and President

  • This is Pat.

  • Le me just say that the first thing you have to understand is copper is roughly at $3.25 or something of that nature, which has actually backed off here in the last week or so.

  • It was significantly higher than that and it is backing back down, so it is a lot of variability.

  • In general, what we see is if we go forward and you look at the second and third quarter, you have higher costs because of -- it has been going up on a pretty consistent basis for quite some time.

  • As it rolls through your P&L, it is increasing relative to the previous quarter.

  • There is no reason to believe that we can't recover that cost of copper.

  • We have been successful in doing it in the past.

  • We have price increases out at the moment that seem to be sticking.

  • I told you earlier we had price increases both to the wholesale and to the retail accounts at this point in time, and we believe we will have the equilibrium situation in terms of covering that additional cost.

  • - Analyst

  • Okay.

  • So looking at it from a gross margin perspective, I think in the fourth quarter you reported a 37% gross margin.

  • And I think you were warning us that as the price-cost gap closes that that would come under pressure.

  • That held up in the first quarter.

  • Where do you see gross margin settling out as soon as inflation comes through?

  • - CFO and Treasurer

  • I think, Jeff, we did have a little bit better margin than we were expecting in Q1.

  • That's true.

  • We are always a little hesitant to start promising gross margins more than 36%.

  • But what did happen is the productivity came through a little better than we were expecting, and that definitely helped us in the quarter.

  • Historically when you get up to 36%, that margin can be a little bit risky to maintain.

  • It's more than that.

  • So, we just always give you cautious advice in that regard.

  • - CEO and President

  • And the other impact on Q1 was the absorption was positive.

  • - Analyst

  • Right, but does it drop below the 36% with the commodity inflation?

  • - CFO and Treasurer

  • I think what we have said in the past is that we feel comfortable with the 36% range.

  • We are not going to sit here and promise anything more than that at this point.

  • It is too early for that.

  • Okay.

  • Thanks, guys.

  • Operator

  • Your next question comes from the line of Michael Cox with Piper Jaffray.

  • Please proceed.

  • - Analyst

  • Good afternoon.

  • Thanks for taking the questions, and nice job on the quarter.

  • - CEO and President

  • Thank you, Michael.

  • - Analyst

  • My first question is on the impact of the four extra selling days.

  • Can we roughly assume that was 4% to 5% of that 7% organic growth?

  • - CFO and Treasurer

  • About half of it.

  • Michael.

  • - Analyst

  • Okay, and from a margin standpoint, I assume you have some costs that are monthly or quarterly that are not on a per day basis.

  • So is there disproportionate benefit to margin?

  • - CFO and Treasurer

  • No, it doesn't impact that, other than you get a little bit of extra volume.

  • So, it does help you there.

  • It is not a big issue once you get below the sales line.

  • - Analyst

  • Okay.

  • On the restructuring side, could you provide us with a rough estimate of what the restructuring charges will be as the year unfolds, maybe on an aggregate 2010 basis?

  • Should 1Q be a good run rate for what we see going forward, or will they start to taper off a bit?

  • - CFO and Treasurer

  • I would expect them to taper off because project in China is done, and the project in Canada is done.

  • We will have some charges as we go through the year associated with the French restructuring.

  • I don't see it at a $4 million clip.

  • I don't see that.

  • - Analyst

  • Okay.

  • Shifting to balance sheet cash flow, on the last call you had mentioned cash flow at 100% conversion of net income.

  • Do you feel that is a realistic target for the full year?

  • And then, second question on the cash balance, now that we seem to have weathered through the worst of this economic downturn, should we expect you to be more aggressive with the cash you have, in terms of acquisitions?

  • - CFO and Treasurer

  • Yes, on the cash itself, our objective, and we believe it is achievable, was to convert at 100%.

  • That being said, that's for the full year.

  • We do have some seasonality in the business where the first quarter is usually the weakest cash quarter, and it gets better as we progress throughout the year.

  • This quarter we did have an increase in receivables.

  • It was about $19 million.

  • We did improve both our inventory turn over ratios and our DSO ratios in the quarter versus December.

  • So we did have improved (inaudible) performance, but we had a build up in accounts receivable.

  • As that evens off through the year, that should result in improved cash flows as we go through the year.

  • Then relative to the second part of your question on the cash balances, our objective here really is to use that to reinvest in the business.

  • That's both from capital spending, in terms of new products and cost-reduction projects, and acquisitions.

  • Is that what you're-- ?

  • - Analyst

  • Yes, the current acquisition pipeline or environment as you see it today.

  • - CEO and President

  • We are spending a lot more time on the acquisition front, and we're starting to see a lot of smaller deals, particularly, come available at this point in time.

  • So I think you should expect us, not necessarily in the next six months, but if you look over the next 18 months or so, to be much more aggressive.

  • - Analyst

  • Okay, great.

  • Thanks a lot, and congratulations again.

  • Operator

  • Your next question comes from the line of Garik Shmois with Longbow Research.

  • - Analyst

  • Hi.

  • Thank you.

  • Thanks for taking my question.

  • My first question is on the volumes you saw.

  • Was there any benefit that you noticed from pre-buying ahead of the price increases in the quarter?

  • - CEO and President

  • Not substantially, no.

  • What we saw though, particularly in the retail sector, is a boldness on the part of the retailers to increase their stocking levels in anticipation of an upturn in demand for them.

  • I think you have the big retailers like Home Depot and Lowes being much more aggressive in terms of restocking.

  • - Analyst

  • Okay.

  • You mentioned the dealers are still seeing rather thin inventories.

  • Would you anticipate any restocking activity on their part in the second quarter or maybe the third quarter?

  • - CEO and President

  • We haven't seen substantial restocking on the wholesale channels.

  • We see expedited orders patterns, where they want product immediately, and they are relying on us for a quick fulfillment rate.

  • We really haven't seen a breakout in terms of restocking and the wholesale channel at this point.

  • - Analyst

  • Okay.

  • Lastly, you mentioned the 60% or so incremental margins that you are generating on improved volumes.

  • Just wondering how sustainable this is and how much demand would have to increase before you start bringing costs back into the system, recognizing this may be several years out?

  • - CFO and Treasurer

  • 60% is not a sustainable number.

  • We were also comparing to a weaker quarter last year where we had several million dollars last year of these SFAS 151 (inaudible) variances, where we had to expense overhead directly to the P&L.

  • We didn't have that this quarter.

  • When we think about incremental margins, we are more the 30% to 35% range.

  • - CEO and President

  • Should be leveraging nicely over the next couple of years.

  • - Analyst

  • Absolutely.

  • Thanks for answering my questions.

  • Very nice job on the quarter.

  • Operator

  • Your next question from the line of Keith Hughes with Suntrust.

  • Please proceed.

  • - Analyst

  • Thank you.

  • Couple questions, can you seen any changes in your band in Europe in the last month given all the controversy going over there, either in the residential or commercial businesses?

  • And second question, if you look within your commercial business, can you give us an update on what you think your mix of renovation and new construction is at this point?

  • - CFO and Treasurer

  • Your first question was the -- I didn't understand it, the bend?

  • - Analyst

  • In Europe, has there been any kind of change in demand pattern in the last month, given all the controversy on the continent at this point?

  • - CFO and Treasurer

  • Not really.

  • What we saw in the quarter was a build up as the quarter went on.

  • We got stronger sales as the quarter developed ,and that has continued into the first part of the second quarter as well.

  • We haven't seen any substantial change in that pattern.

  • - Analyst

  • The second question, is if we break your commercial business down, what do you think the mix is between construction and renovation at this point?

  • - CFO and Treasurer

  • Over a full cycle, it is usually about half and half in terms of new construction and replacement market.

  • I would have to say right now with the commercial on the decline, we would definitely be more skewed toward the replacement market.

  • - Analyst

  • Thank you.

  • - CFO and Treasurer

  • It is hard to say precisely.

  • We give good faith estimates over a full business cycle.

  • - Analyst

  • Thank you.

  • Operator

  • (Operator Instructions).

  • Your next question comes from the line of Ryan Connors with Janney Montgomery Scott.

  • Please proceed.

  • - Analyst

  • Good afternoon.

  • A couple questions.

  • First off, in terms of the SG&A line, you have talked a lot about cost cutting and that a good portion of those cost cuts would ultimately be permanent.

  • Obviously, SG&A did flex back up here with the top line.

  • Part of that was this legal charge.

  • Can you give us any qualitative comments you can about how that line flexes back up as the top line seems to be starting to recover here?

  • - CFO and Treasurer

  • Our variable expenses inside of SG&A are about 10% of revenue.

  • That's freight and (technical difficulties).

  • And then the rest of it is -- we don't want to call it fixed, but it is not directly related to the change in volume.

  • - Analyst

  • Okay, that's a good rule of thumb.

  • Kind of a bigger picture question on profitability.

  • You were a 10% operating margin Company, give or take, in the last peak.

  • So looking out a couple of years as things start to get back to normalcy, where do you see, where do you envision the Company being on that kind of a metric?

  • I assume it is north of where you were in the prior peak period.

  • - CEO and President

  • Our objective is to be north of 12%.

  • - Analyst

  • How long do you think, Pat, it would take you -- is that something that could happen -- it seems here in the first quarter, anyhow, you are approaching 10 already.

  • Is that -- that's more of, I would assume, a one-year or 18 month story, not a two or three-year story.

  • - CEO and President

  • It is probably 18 months to two years, sorry.

  • - Analyst

  • Kind of following up on the earlier question on cash deployment.

  • Back in 2007, you executed a share repurchase.

  • obviously you are on the hunt for acquisitions now, but you are not the only one.

  • Presumably evaluations would come back.

  • You do have that a very large chunk of cash there.

  • Would you consider another share repurchase, and talk about the experience last time, whether ultimately, you viewed it as a good use of capital, and whether you might consider, at least with a portion of cash balance, doing some like that this time around?

  • - CEO and President

  • t this time in the economic cycle, we are trying to reserve our cash for acquisitions.

  • I don't think stock buy back immediately would be a high priority.

  • As for the previous deal, at the time we did it, we thought it made sense.

  • I still think it made sense to be buying back as many shares as we could at pretty attractive prices.

  • If I were there again, I would do it over again.

  • - Analyst

  • Thanks for your time today.

  • Operator

  • Your next question comes from the line of Scott Graham with Ladenburg.

  • Please proceed.

  • - Analyst

  • Hi, good afternoon.

  • Very simple question.

  • In China, it looks to me as if we have been kind of start and stop there.

  • I think there were high aspirations for you guys to sustainably make that a profitable business in the middle of last year.

  • And then, it looks like you had to turn around and take some more costs out.

  • When do you see China as being sustainably profitable (inaudible).

  • - CEO and President

  • We hope to achieve that later this year.

  • - Analyst

  • But could it be in a loss position then the next couple of quarters still?

  • - CFO and Treasurer

  • Your comment, Scott?

  • - Analyst

  • Sorry, I'm on a cell.

  • Could it be in a loss position for the next couple of quarters as well, or can we see that even break even next quarter?

  • - CEO and President

  • I think you will probably see us moving toward break even with break even more achievable in the second half of the year.

  • - Analyst

  • Now, the other question has to do with the commercial business where you said you saw -- you still kind of see minus 10 to minus 15 in North America, and you saw a minus mid-teens in this first quarter.

  • At the same time, commercial construction trends still appear to be weakening.

  • I'm wondering if the minus 10 to minus 15,maybe if you had to hedge your bet, would you say closer to the minus 15, or are you sticking within the middle of that range?

  • - CEO and President

  • I would probably go with the minus 15.

  • I don't think the market has found the bottom yet.

  • I think it will take us another quarter or two before it starts turning upward.

  • - Analyst

  • I would say agree.

  • That's all I had.

  • Operator

  • Your next question comes from the line of Jamie Sullivan with RBC Capital Markets.

  • - Analyst

  • Good evening.

  • Question about 2Q with some of the moving parts.

  • Wondering what your view is.

  • You mentioned that the backlog is increasing in some of the segments.

  • Are you expecting the typical seasonal uptick in 2Q?

  • - CEO and President

  • I would say it is not as robust as we saw at the peak of the cycle, but typical seasonality will take place, yes.

  • - Analyst

  • Okay, and the way the calendar shakes out for 2Q, is that impacted at all for the extra four days in 1Q?

  • - CFO and Treasurer

  • We have a couple fewer days, I think it is out in Q4.

  • - Analyst

  • And then on the -- wondering if you can talk a little more about the new products and shelf space?

  • You mentioned that contributed to growth.

  • Anyway to quantify that or give us a sense of how you were able to gain that shelf space?

  • Is it your position in the market?

  • More color there would be helpful.

  • - CFO and Treasurer

  • I would say probably around half of the growth we saw in retail was associated with new products and new shelf space.

  • And these new products are tied in with some of the appliances out there, in terms of different types of connections and fittings that makes these appliances easier to install and decreases the potential of leaks and so on, during the life of the appliance.

  • We work with the retailers and the appliance manufacturers on these products.

  • The additional shelf space, it is existing products.

  • Our sales guide is working with these retailers on developing programs and picking up the shelf space.

  • - Analyst

  • Thinking about the margin question into next year and beyond, I guess you get to 36 or so this year.

  • It could have the mix of commercial coming back a little bit stronger next year, which might suggest that the margins as we go forward in the cycle could be above the 36.

  • Am I thinking about that the right way?

  • - CFO and Treasurer

  • We have always said that the margins on the commercial side are 5 points or so higher than on the residential side, so as commercial bounces back, you have a little bit of a favorable mix that develops there.

  • - Analyst

  • Thanks.

  • One last quick one.

  • On M&A you mentioned acquisitions, don't expect anything major over the next six months or so.

  • Wondering is that partially commentary on how your pipeline is today?

  • Have deals fallen through or just slow to happen that have been in the pipeline?

  • Can you give us some color?

  • - CEO and President

  • I think what you see is medium-sized deals and not large deals that are active in the pipelines.

  • We have had our issues though with -- there is an expectation gap that still has to be completely closed with regard to what kind of earnings history should you use in terms of pricing a deal.

  • And we spend a lot of time on certain deals, only to find that we can't bridge that GAAP.

  • Operator

  • Your next question comes from the line of Michael Coleman with Sterne, Agee

  • - Analyst

  • Good afternoon.

  • Nice job.

  • - CFO and Treasurer

  • Thank you.

  • - Analyst

  • You have kind of reiterated or sticking with your commercial down 10% to 15%.

  • I think you went to the high end of that a couple of questions ago.

  • I realize you have a fair amount of replacement in your business.

  • Your North American wholesale is up 9% for the quarter.

  • If we think about over the next couple of quarters, if you are correct on the end market assumption on commercial, do we see your revenues reflect more of that, or could you actually be up even with your end markets down?

  • Or could you talk about that or maybe what went on the wholesale business in the quarter?

  • - CEO and President

  • What you are seeing in the wholesale business is essentially -- it is the renovation and replacement market that is strengthening.

  • You saw the numbers on new construction where we went from roughly new construction quarter-over-quarter from a year ago was up I think 20%.

  • - CFO and Treasurer

  • 20%, yes.

  • - CEO and President

  • But the majority of this is coming from homeowners feeling more secure in terms of making remodeling investments in their home and what you are seeing is the repair and replacement market is what is bolstering that wholesale channel.

  • - Analyst

  • Thank you.

  • Operator

  • At this time I'm showing no further questions in queue.

  • I would like to turn the call back to Pat O'Keefe for any closing remarks.

  • - CEO and President

  • I want to thank everybody for joining us today.

  • Needless to say, this was a great quarter.

  • We are happy to see the progress we are making in the first quarter of 2010, and we look forward to talking to you in late July with regard to our second quarter results.

  • Thank you for joining us.

  • Good night