Watts Water Technologies Inc (WTS) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2011 Watts Water Technologies Incorporated earnings conference call.

My name is Jonathan, and I'll be your operator for today.

(Operator instructions).

At this time, I'd like to hand the call off to Mr.

Kenneth Lepage, General Counsel.

You may proceed, sir.

Thank you.

Good afternoon and welcome to the Watts Water Technologies first quarter 2011 earnings conference call.

On the call with me today are David Coghlan, 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 10K for the year ended December 31st, 2010, 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 these forward-looking statements, we disclaim any obligation to do so.

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 a press release dated today's date relating to our first quarter 2011 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'll now turn the presentation over to David and Bill.

Good afternoon, everyone, and thank you for joining our first quarter earnings call.

I'd like to give you an update on the Danfoss Socla acquisition, our view of market conditions and touch on the key elements of our first quarter performance.

Then I'll turn the call over to Bill for a review of our financial performance before wrapping things up and opening the call to your questions.

First, let's talk a little bit about the Danfoss Socla acquisition.

We successfully completed that acquisition on Friday, April 29th.

The purchase also included Danfoss's China water control business, which we decided to purchase after finishing some final due diligence.

As we've talked about before, the Socla acquisition allows us to strengthen one of our three key product platforms in Europe, namely residential and commercial plumbing and flow control.

We paid about $176 million based on recent FX rates for shares and assets, and we anticipate that Socla will be a accretive to our earnings in 2011.

We're very excited to bring Socla into the Watts family, and Bill will provide some more financial details on the transaction a little bit later.

Now let's talk a little bit about our view of market conditions.

As we anticipated during our fourth quarter conference call, business remained tepid during the first quarter, and we experienced little improvement in most of our key markets throughout the quarter.

The US residential market continues to be soft, with new home starts below 500,000 units on a seasonally adjusted basis.

Housing inventory gluts due to foreclosure, tighter credit, high unemployment and lower housing pricing continues to dampen new construction.

The one bright spot was that new home sales increased by about 11% in March, albeit from a historically low level in February.

Overall, we see residential construction continuing to go sideways for the foreseeable future.

On the positive side, we are still seeing growth in the residential repair/replace/upgrade market.

A recent Lyra Report suggests solid growth for this market throughout 2011.

This is partially driven by an increase in existing home sales, which are up about 4% sequentially in March at an annualized rate of 5.1 million units and partially by consumers' willingness to spend some money on improving their current home since fewer of them are moving to new homes.

This provides a solid base of potential demand for us in the home improvement upgrade market.

US non-residential construction remained slow, with many project delays, particularly in the public sector, due to a lack of federal or state funding; however, the Architect Billings Index has remained in positive territory for the last several months, and we continue to hope that this means growth in the non-residential market will resume either later this year or early in 2012.

On the commercial repair/replace/upgrade front, we have seen some pick-up in select market segments.

For example, we've seen some growth in the food service industry as a result of pent-up demand to replace older equipment and/or upgrade kitchens.

Turning to Europe, our markets there also remained pretty spotty, with Germany and Scandinavia doing pretty well while a number of southern European countries, such as France and Spain, are soft.

In France, we continue to gain market share in the retail channel; however, the overall DIY market is still quite slow.

We're seeing the customers in all of our market segments are keeping inventory to an absolute minimum, and we're seeing them continue to place smaller orders on an as-needed basis with the expectation that we have the inventory available when they need it.

As we anticipated during our fourth quarter call, the German OEM market did bounce back from a pretty lackluster Q4.

In Germany, we saw solid growth in the first quarter in solar and underfloor heating packages, and we also had stronger sales into eastern Europe, particularly into Russia.

We anticipate that if higher oil prices persist, government incentives might be reinstituted to drive consumers and businesses to consider alternative energy options.

Third, let's talk about our quarterly performance.

The main thing to point to is that commodity costs continue to be a huge concern for our business and for our entire industry as the cost of key raw materials used in our products continue to escalate.

Copper costs in the first quarter of 2011 are approximately 30% higher than the first quarter of 2010, following significant escalations in Q4.

We've reacted aggressively to these commodity cost increases by working to implement the price increases which we announced in late Q4 throughout the first quarter.

In most cases we're seeing reasonable stick rates; however, in some markets, notably the North American retail market and the European OEM market, we have not been able to fully recover those commodity cost increases.

This served to reduce our adjusted operating margins in Q1, when compared to last year.

In recent weeks, we've responded to the latest commodity cost increases by announcing a second wave of price increases in the US and Europe, which will start to take effect during Q2.

As a result of the commodity squeeze on our margins, we leveraged only 20% of incremental organic sales to the operating profit line in Q1.

Our goal, which we met in some prior quarters, is to leverage at a 30% to 35% rate.

So this was disappointing.

Operating margins were also affected by some inefficiencies in Europe due to our French restructuring program.

As we talked about in Q4, we added temporary workers in both production and logistics in the latter part of 2010 to make sure that we could meet delivery commitments to our customers, and this continued to affect us into Q1.

However, much of the heavy lifting regarding plant moves and logistics consolidation in France has now been completed, and so we expect to see these inefficiencies abate in Q2, and we expect to see the benefits of the French restructuring efforts start to flow into our financials.

Last, let me talk a little bit about working capital.

We saw days of working capital improve in the quarter by about five days versus the fourth quarter due to better working capital management and to increased sales.

As some significant restructuring programs, for example, the French program, wrap up, we expect to work off the buffer inventory built up to cover the transition.

Let me now turn it over to Bill to provide you with more insight into our Q1 financials.

Okay, thanks, David.

What I'd like to do is just talk for a brief moment on Socla now that we have that deal done and then go into some of the details on the quarterly financials.

Relative to Socla, $135 million in sales with approximately $19 million of EBITDA, and that's based on us exercising our Asian option on that business.

So based on that level of EBITDA, we're paying a multiple of 9.1 times.

We used $85 million of cash on hand, and we borrowed $91 million from our revolving line of credit.

Those are -- we borrowed euros, but $91 million of euros.

And that allows us to have a better alignment of our cash flows and our debt relative to the euros.

After the acquisition, we anticipate we still have about $415 million of cash and available borrowing capacity.

The impact on the P&L this year, as we said during our Socla conference call, in the second quarter it will be dilutive to earnings $0.11 and then $0.05 in each of Q3 and Q4.

And then in 2012, again, accretive $0.15 to $0.18.

And again, we're very excited.

We have a lot of opportunity here relative to synergies, and we feel that the effective multiple will be coming down over the next couple of years as we achieve those synergies.

And, of course, as you know, at year end we had a net debt to cap ratio of 5.2% as we do at the end of the quarter, but at the post-Socla we have a net debt to cap of 19.2%.

So we can see we still have a very conservatively capitalized balance sheet with a lot of flexibility.

Okay, so now why don't we just talk about the first quarter and the P&L.

We closed the quarter at $330 million of revenue.

That's an increase of almost $11 million, a little bit over 3%.

The components of that growth would be $5.5 million of organic revenue, about 2%; $0.5 million growth because of foreign exchange; and then the inclusion of the sales of Austroflex and Bray, which were acquired in the middle of 2010.

They contributed $4.6 million in the quarter.

We look at our earnings per share from a US GAAP standpoint -- $0.29.

But when we look at it on a run rate basis or an adjusted basis, we saw we had a $0.43 quarter.

The difference between the GAAP earnings and the ongoing earnings would be there's an $0.11 charge in our SG&A for the CEO separation cost.

That's $6.3 million pre-tax in our SG&A, which half of that charge is cash and half is non-cash.

And then we have $0.02 of restructuring in there as well.

When we look at the components -- looking at the segments rather, North America -- $202 million of revenue, an increase of $4 million or 2%.

The components there -- $2.5 million of organic growth, $1 million of foreign exchange and a small contribution from Bray in the quarter.

We break out the revenue for wholesale and retail.

The retail revenue is $156 million.

That's an increase of $6 million or 4% versus last year.

And as David commented earlier, I mean, we continue to see a soft residential market in North America; however, we did have some offsets there, which helped us a bit.

We have some new back-flow codes up in Canada.

We have the introduction of BLUCHER into the United States.

We had strong performance in our water quality group.

And again, as David mentioned, the renovation market continues to contribute with the existing home sales north of 5 million units.

On the retail side -- $46 million of revenue.

That's down $2 million, a decline of about 5%.

The issue there is that, if you recall last year, the retailers were in a mode of building inventory.

They had a very, say, optimistic view of what was happening in the housing market.

And we also had a couple of product lines that we were doing rollouts with them during last year's first quarter.

So right now, though, we are in equilibrium, where what we're selling to them is what they're selling through to their customers, but it does reflect a $2 million decrease in the quarter.

Looking at Europe-- $124 million of revenue in the quarter.

That's an increase of $7.5 million or 6%.

The components of that growth -- we had almost $4 million of organic growth, 3%, a slight adverse impact from the weakening of the euro versus the dollar versus this time last year.

The average exchange rate we used in the quarter was 136.5 versus last year was 138.6.

And then we have $4.5 million of Austroflex in the quarter as well.

That comes up to $7.5 million of growth.

David really in his remarks had mentioned the reasons for the growth.

We saw a return of our German OEM market for solar packages and underfloor heating.

Our drains business performed well, with expansion into the Middle East.

The Marine market was solid as was Eastern Europe.

China business was down $0.5 million at $3.8 million.

That's really the result of lower exports into Europe.

The gross margin on a consolidated basis -- 36.7%.

That's down 40 basis points versus last year's first quarter.

It is up 110 basis points on a sequential basis.

And again, as David mentioned, the issue that we have in the gross margin really is commodity inflation.

We did not recapture all the commodity cost in the North American retail market, and we had some issues in the European OEM market as well.

We have had price increases announced in all those markets, and we're expecting to see improved pricing as we go into the second and third quarters.

SG&A at $97 million for the quarter.

It's an increase of $8.7 million.

The main driver here is the inclusion of the CEO separation cost of $6.3 million, and then we have the inclusion of the expenses of Austroflex.

When you adjust for those numbers, you would have $88.9 million of SG&A.

That $88.9 million does include about $1 million of deal costs for closing out the Socla deal, and we have about $1 million in there also for some of our French restructuring extra head count that we're carrying right now, as David mentioned again, some of those extra costs for logistics.

So we do expect that to be going down over the next couple quarters.

Operating earnings from a GAAP standpoint-- $22.9 million.

But if we look at it on an as-adjusted basis, excluding the CEO separation and restructuring-- $30.3 million, which is about a 1% increase versus last year's first quarter.

Below the line, other income and expense -- there's an increase of about $900,000.

That's all associated with the change in the capital structure we made last year, where we have $25 million of additional long-term private placement debt, and we rejigerred our revolving line of credit so we have a little bit higher fees associated with that as well.

On the tax line, the effective tax rate in the quarter was 35.6%.

It's a little higher than we would have expected.

You know, we would expect an effective tax rate of something 33% or in that range.

We did have about $1.3 million of non-deductible deal expenses in France.

Under the new US GAAP rules, we are required to expense all of our deal expenses, legal expenses and accounting expenses and so on, but in France we are not allowed to deduct those for tax purposes.

So we had a little bit higher effective tax rate in Europe because of that.

So on an adjusted basis, net income at $16.1 million -- about flat with last year -- and a $0.43 run rate.

So with that, I'd like to just turn it back over to David for a couple of comments.

Before we open it up to questions, I just wanted to summarize things from our perspective.

In many ways 2011 started off much as we anticipated.

Our top-line growth was limited by headwinds in many of our key markets and commodity costs continued to pose a challenge for us throughout the quarter; however, we think we're taking the necessary steps to mitigate any further margin erosion.

That includes the second round of price increases, which we mentioned earlier, a drive to accelerate restructuring programs wherever possible, and continuing our intense focus on continuous improvement.

Beyond that, we're also implementing some cost-containment initiatives to reduce discretionary spending levels wherever we can.

So with that, let me open it up to your questions.

Jonathan?

(Operator instructions).

Your first question is from the line of Mr.

Jeff Hammond with KeyBanc Capital Markets.

You may proceed, sir.

Hello, Jeff.

Sorry, he has withdrawn his question.

There's a question from the line of Kevin Maczka with BB&T Capital Markets.

You may proceed, sir.

Thank you.

First question on this price cost situation is it sounded like last quarter you were maybe a little more confident that you would be able to offset that in Q1, and maybe Q2 would get a little bit more concerning, but it sounds like what you're saying is this is more a function of costs continuing to elevate rather than some push-back on the pricing actions you've taken.

So I guess first is that correct and second can you say a little bit more about the magnitude of this second wave of price?

Yeah, well, I think the way you're reading it is correct.

If we look at in North America, for example, by far our biggest channel would be wholesale.

And in terms of recovering price in wholesale in the first quarter, we did pretty much what we expected.

We got the stick rates that we were hoping for; however, copper prices continued to escalate.

They got up to $4.40 at one point in the quarter, and that raises concerns about the second quarter.

We do have a couple of segments where we have to fight a lot harder than we thought we would have to for price, and that's North American retail and the OEM business in Europe.

But the major concern is the continued escalation.

So to your point about continued price increases, it's hard to pin down a single number because it very much varies by geography and by product.

So, for example, we have some products that are largely made from cast iron, and the price increases that we've announced there are quite different from those that are largely copper driven.

But our intent is to get prices out there such that with a reasonable stick rate we can try and offset the continuing commodity escalation.

Bill, anything you'd add to that?

I think that's right, David.

We had another round that we're announcing for -- they have been announced for the 1st of June in the United States, and Europe has had a series of price increases.

The dates vary by the markets, but, David, I think you described it properly.

And, David, you touched on some of the gross margin pressure, or maybe it was Bill, but you touched on that pressure.

Should we expect even more of that in Q2 before some of these -- this second wave kicks in, or do you think that we start to alleviate that right away in Q2 and see the gross margins expand a bit?

Well, Kevin, we have a whole series of price increases we put out, but copper continues to climb, so, I mean, I guess we do view ourselves as being under pressure, but we think we are reacting to it properly.

And to perhaps give you a feel for, you know, how it comes through for us, average copper in Q1 was I think about $3.91.

And so, you know, there is a lag effect.

So it's not like as copper goes up it hits us tomorrow.

We do have a little bit of a lag effect, and therefore we're hoping that we can get our June price increases in and to stick it early enough to offset the higher copper coming through in Q2.

Kevin, you also have to bear in mind, I mean, we're talking about a couple of 10ths on the margin here.

It's not as if this is a calamity.

We're up 110 basis points over Q4 because our volume returned, which we thought it would, and that happened, and we were able to get some of the French issues behind us on the gross margin side.

We still have some of those French issues on the SG&A, with the logistics temporary head count that we have.

So, you know, we saw an increase in copper, but we still had a nice sequential increase in the gross margin.

Right, I see that, Bill.

I get that point.

I'm just trying to frame the expectation for Q2 based on what you're saying.

Yeah, yeah.

Separate question, last question from me, on organic growth in general.

It stayed positive in North America.

It returned to being positive in Europe.

As we look out over the next few quarters and for the year, should we think about positive organic growth going forward and was part of the rebound in Europe related to the alternative energy business there?

Yeah.

When we looked at our European business, we definitely saw a nice rebound in our OEM business, which is largely driven by alternative energy.

There was a little bit of a pause in the market in the fourth quarter.

We anticipated that it would start to come back.

And as oil continues to stay high and as, for example, the German government continues to idle nuclear plants, we think the pressures to continue to drive alternative energy will increase, and we're hopeful that we'll continue to see decent growth in that business.

In North America, our organic growth is very modest.

It's largely driven by repair/replace/upgrade, some new product at work, and a little bit of share gain here and there.

As Bill mentioned, we're making nice progress with our BLUCHER line, introducing it into North America.

So in North America, it's more of a game of inches.

Okay, thank you.

Thank you, Kevin.

Thank you, Kevin.

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

You may proceed.

Hi.

Thank you.

Garik Shmois.

Just first question is -- is it possible to parse out how much of the revenue growth in the quarter was a function of volumes versus price?

Yeah, I mean, it's going to be, let's see, in the North American market -- North American market is going to be almost all that I would be pricing and on a net basis.

We did have unit volume growth as we mentioned in some of these areas that we talked about, Garik, but, you know, because -- that was offset by softness in the residential side.

So, again, negative unit growth on residential, positive unit growth in some of these back-flow areas, BLUCHER, water quality and so on, but on a net basis, the organic increase of $2.5 million would be all pricing.

And Europe is probably about half pricing, half units.

Okay, that's helpful.

And as you look out for the second round of price increases, does it seem like the success that you had pushing it through to the wholesale channel, is that where you would expect to secure pricing again here in the middle of the year through wholesale and a bit less in retail and OEM?

We're certainly targeting wholesale, but we're also working hard to get price up in retail.

And so we're not giving up on any area.

The one thing that is out there, as we talk to our customers, is the fact that many of their suppliers have been hitting them with many, many price increases, and there's a little bit of shell shock in the market as people deal with, you know, price increase after price increase.

But we'll be targeting all channels to get as much as we possibly can.

Okay.

That's helpful.

And if you could talk about your incremental margins going forward this year.

The quarter was in around 20% as you mentioned, David.

You'd like to be at 30% to 35%.

Would you anticipate with the pricing actions that you're taking that you could get to that 30% to 35% target in perhaps the second half of the year?

Yeah, Garik, it all depends.

As long as we are successful on covering the increased commodities of pricing, we would expect that the incremental margin on that incremental volume would be in that mid 30% range.

There's no reason to think that we will not achieve that.

If you just think about the pieces for a second, you know, we took some headwinds in the fourth and the first quarter from some costs for French restructuring.

We should see some of those benefits come in to help us in the second half.

We did take a little bit of a hiccup in terms of some of the price increases in a couple of channels.

As we continue to work that, you know, put all those pieces together, and I think returning to the 30%, 35% is feasible.

Just lastly, the costs in France from the restructuring, how much of that would you expect to go away?

Well, that $1 million that we're running in SG&A, I would say that that would go away over the next two quarters or so.

It will wean down on that one.

They're starting to prepare to ramp down on the temporary workforce now, so I agree with Bill -- over the next couple of quarters, that should go away.

Okay, great.

Thank you very much.

Okay, thank you.

Your next question is from the line of Mike Ritzenthaler with Piper Jaffray.

You may proceed, sir.

Good afternoon.

I guess my first question is on the [options] that you exercised to buy to include the Chinese controlled business in the Socla deal.

Is that something that we can start to see the impact of right away in Q2, and is that part of a larger strategy to grow Chinese revenues in general?

Well, in terms of the impact of that, the numbers that I mentioned to you earlier, the China business is included in that.

That's why we wanted to give a brief update there because when we had our Socla call, we gave the numbers excluding the China option.

Right.

Now we have it, so now you have those numbers.

So those are to roll in during Q2.

You're right.

This is definitely part of a plan.

I can let David expand on it, but it's definitely part of a plan to try to, you know, grow our China business over time here.

And to maybe just give a little bit of color on that if I may, we're starting to see the types of codes that are important for our business come into play in China, and we worked hard to get some of our product management team into the room where those codes are being written.

And so we're seeing opportunities for our traditional products in China, something that we've not really seen up until recently.

Adding Socla to that product list starts to expand our range and really position us nicely for the commercial and multifamily home in China.

So, yes, it's definitely part of a strategy, but we've got to be patient as the codes are written.

It's not a case of there's a big market that we can immediately tap into.

It's going to evolve as the codes are written and put in place.

Sure, okay, that makes sense.

And then I guess my last question is on restructuring costs.

When France is complete, are there any additional restructuring costs that are going to be incurred?

Yes, there will.

I'm afraid, you know, this is something we'll be living with for a while.

As the French restructuring program draws to a close, we did announce a couple of other restructuring programs which are ramping up.

So it will make your models a little bit complicated.

We have a large restructuring program in the United States, which is gearing up right now.

The first product moves have taken place.

Some of the next product moves are being prepared.

And that's the closure of our retro facility.

You may recall that we announced that closure and said we'd be transferring product to two North American plants and we'd be transferring product to a new plant in Mexico.

That new plant in Mexico shipped its first product about four weeks ago.

And so that restructuring program is well in process.

We're also moving through the next phase of our restructuring of our Italian footprint, and we announced the closure of a further Italian plant on April 4th.

So we're going to have more restructuring programs I'm afraid for the next while.

You know, Mike, the detail of all that is in our footnotes, if you look at the K, the 10K.

The costs are outlined there.

Okay, excellent.

Thanks, guys.

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

Hi, Jamie.

Hi.

How are you doing?

Good.

Question I guess on the retail side.

You mentioned orders have kind of evened out with those customers.

Maybe can you just give us your view on how you see the seasonal pick-up playing out this year?

Well, I think it's very much going to be unlike in prior years where retailers tended to build up inventory ahead of the season, that's not happening this year.

So that's certainly going to dampen the seasonal effect.

If you'll recall last year, our retail customers, or a number of our retail, customers built up quite heavy levels of inventory before the season and then didn't find the customers coming through their doors as they expected and ramped that down in the second half of the year.

We're seeing a much more gentle increase this year.

They're literally just ordering to replenishing their safety stocks.

We're not seeing a lift in inventory.

So our order patterns are going to be very much driven by what customers come through the door and buy.

Okay, that's helpful, thanks.

And then question on the Danfoss Socla acquisition and some of the numbers you're expecting in terms of accretion.

Does that assume a level of synergies, and maybe can you quantify that for us at all, what you see coming out in synergies?

Well, the numbers there, we spoke about a moment ago, Jamie.

There's no synergies in those right off the bat.

I mean, we're assuming we do get, when we start and get into 2012, with the $0.15, $0.18, we start to get into synergies.

So that's just really the -- what that represents is the base business, and then we include in that the amortization of the inventories and the backlog and all the things you have to take care of in your opening balance sheet according to accounting rules.

If we look at the types of synergies that we can expect, I'd put them in a couple of large buckets.

There's one group of synergies whereby we can leverage each other's customer base.

There's some customers, for instance, Pan-European Wholesalers, where we've got a very good market position and Socla does not, so we'll be able to leverage that to good effect by pulling in Socla product.

Likewise, there's a variety of wholesale customers, for instance, in France where they've got an extremely good position, and we'll be working hard to try to leverage their position.

On the back end of the business, we like the manufacturing footprint that Socla has.

They've got some nice facilities.

And we see the ability to leverage those by putting additional volume from elsewhere in our network into it.

And then secondly, as we put together our combined purchasing, we see purchasing synergies that we can achieve.

So they would be sort of the major opportunities that we see in the near term.

Okay, that's helpful.

And then I guess just last one on the tax rate, how you see that kind of trending from here after 1Q with some noise.

I would say that our expected tax rate would be in the 33% to 34% range.

Okay.

Great, thanks a lot.

Thanks, Jamie.

Your next question is from the line of David Rose with Wedbush.

You may proceed.

Good afternoon.

Hi.

Hi.

Two quick questions.

Last quarter you had mentioned that there was some effect on the drain business, that it was negatively impacted by the weather.

Did you see any benefit as those sales from either a restocking or a pull forward from Q2 into Q1 on that business?

We did see some delays from Q4 as we talked a bit on our last call, and we had a nice Q1 for our BLUCHER business.

So, yes, we did see that business start to pop back.

In terms of pull forward from Q2 into Q1, no, nothing that we noticed.

So your sense is that it's not a matter of restocking.

It's indicative of trends to come.

If you go back to Q4, a lot of projects that those products were going into were hit by severe weather conditions in Europe, and so those projects literally ground to a halt.

As they started back up in the first quarter, our shipments resumed.

So we were caught with products made for specific jobs where shipment was pushed out because the customers couldn't take it due to bad weather.

So it really wasn't a matter of inventory.

It was more a matter of project delays due to weather.

Okay, perfect.

And then on the Danfoss Socla acquisition, with respect to the commodity pressures, you're able to react with pricing initiatives in your existing business.

What do you have to do with their business and how quickly can you enact price initiatives?

Well, a lot of their products, if you look at their largest raw material, it's actually cast iron.

So the inflationary pressures there are less than our typically brass bronze based business.

So there's less of an urgent need so to speak.

Secondly, they did announce a price increase late last year, and we're seeing that start to take effect in the market.

And the early indications that we're seeing of their stick rates we would be comfortable with.

Okay, great.

Thank you very much.

Your next question is from the line of Jeff Hammond with KeyBanc.

You may proceed, sir.

Hey, guys.

Let's try this again here.

Just a clarification on the incrementals.

So as you start talking about the 35% incremental, can we be clear?

Is that incremental gross margin or incremental operating margin?

Operating.

Okay.

And so as we look at this quarter, I think, David, you mentioned 20% incrementals, and I'm kind of struggling to get there because in my model if you strip everything out, it's kind of flat to a slightly negative leverage.

Hold on, Jeff.

I don't know if it's just with one of the one-timers I'm not pulling that out.

But it just seemed like up profit flat, X items, you know, on a couple of points of organic growth.

Well, the analysis that we've done internally here, you know, we have to -- you have to back out the one-offs, which is the restructuring and the CEO separation costs, right?

And when we do that, that gets us to 20%.

Yeah.

Okay.

And then just because there seems to be two different things going on in Europe-- restructuring actions, which you pull out, and then some disruption.

Just as I step back, we've had a couple quarters now where, you know, margins have kind of dropped into the 8%, 9% range after being pretty stable, you know, in kind of the 12%, 13% range.

When do these, you know, kind of ongoing or disruption, I guess non-restructuring charges, when do those start to abate?

The biggest restructuring program we have in Europe is France.

The other ones are relatively modest.

And so that program is coming to a finish, and we should see those inefficiencies abate over the next couple of quarters.

The other point that I mentioned, Jeff, is that our largest business in Europe is our OEM business.

And, you know, we mentioned that we're struggling harder than we'd like to get the sort of price recovery that we need in that market.

Okay.

So the inefficiencies start to go away next quarter, but, you know, it's yet to be seen whether we can overcome the price cost.

Because it looks like back in '07, '08 the margins were pretty stable in Europe.

Has something changed with that customer base where it's become more difficult to get price?

The last couple of years we compete -- we sell to big customers, and we compete against a lot of relatively modest competitors.

So we've worked very hard to try to get price in that market.

It's a bit of a challenge.

Okay.

And then just finally, can you quantify your price increases that you've -- you know, these follow-on price increases that you're contemplating?

On average, the announced price increase is about 5%.

That's in North America.

But it varies quite a bit by product, largely driven by the type of material composition.

Okay.

And in Europe?

It would vary hugely in Europe.

If I had to put a number on it, and this would be sort of let me call it a weighted average, it would be more like in the 3%, 3.5%.

Okay.

Okay, thanks, guys.

Thank you.

Your next question is from the line of Chris Wiggins with Oppenheimer.

You may proceed.

Hi.

Good evening.

Hi, Chris.

Just two quick questions.

On the price increases, any signs or would you expect to see any pre-buy ahead of the next round of pricing?

And also related to that, I'm just curious if there's any risk or how you -- any risk around potential substitution away from maybe the brass bronze type products and how that would impact you.

Good question.

Pre-buys, we're not seeing an awful lot of pre-buys simply because our customers are very loathe to take on inventory.

And so we're not factoring in much if any of a pre-buy.

We might see some who decide to do a little bit of pre-buy, but I don't believe it's going to be anything significant.

The second question in terms of alternative materials, that's a great question, and it fits into a higher order discussion.

You may be aware of the fact that the federal government put out a little bit of a surprise to the industry, but put out a new law late last year that requires the implementation of the California low lead law across the country by 2014.

And so that certainly prompts a lot of questions around material substitution.

However, one of the things that we continue to find is even where we have plastic products available, for instance, PEX piping, plastic fittings, et cetera, the take-up rate of those right through this copper escalation has not changed significantly.

So we have an incumbent set of customers, plumbers, who are conservative and who are loathe to make significant changes.

I'll give one example.

We estimate that the percent of PEX usage to copper pipe usage across North America is still less than 20%.

And that evolution has been occurring over the last 30 years.

So we don't believe that we're going to see any rapid changes.

Okay, great.

And then just one final quick one.

I know it's a small part of the business, but China now, [EBIT] margins over 20% for two quarters in a row.

Is this kind of a sustainable run rate here?

Well, we've been working hard to improve our gross margins on our trade business in China and to right-set our costs.

One of the big drivers, though, that you ought to be aware of -- I guess the way I'd answer it is, it is sustainable within the year.

But remember the heavy part of our business, the bigger part of our business in China, is intercompany shipments to our locations in North America and Europe.

And as they drive their cost improvements during the year, we eventually get to the end of the year and we reset our standards.

And obviously that will have let me call it a wealth transfer effect from one piece of our business to another, if that makes sense.

Sure, great.

Thank you.

Your next question is from the line of Joe Gagan with Atlantic Equity Research.

You may proceed, sir.

I have a question in regard to the improvement in the gross margins after the acquisition set that you guys do.

So this quarter your gross margins went I think to 36.7%, which is 110 basis points above the immediately preceding quarter when you had the acquisition.

And that in '09, I know you did a pretty decent size acquisition in '08, you had a significant increase in the gross margins after that acquisition.

Can you tell me what specifically you're doing around the accounting or maybe the inventory or lay-offs or factory closing downs.

What are you doing to get these great margin improvements right after acquisitions?

Well, when you look at the impact directly after closing, it really has more to do with the mix.

What we're trying to do is acquire companies that have good solid gross margin characteristics.

But generally speaking, you know, the synergies that we have is we have the ability to hopefully put capital into our business so we can get better more efficient machine tools and tooling.

We can buy better.

We can leverage economies of scale.

We can usually get volumes up a little bit as we cross-pollinate distribution channels.

And that's why we focus on acquisitions that are in our space where we can have these types of synergies because when we look at an acquisition, we want to have 1 and 1 equal 3, and that's part of the strategy, if you will.

Okay.

You said this acquisition was only part of the quarter.

Is that right?

Right.

We just closed on it on April 29th, and that's one month into the quarter.

So it will be two months -- two-thirds of our quarter.

So in other words this acquisition wasn't even in the mix in the first quarter.

Correct, that's right.

We just closed on it on Friday.

Okay.

I thought you said earlier that some of the revenues were in the first quarter were from the acquisition, no?

No.

We had costs in the first quarter as we finished our due diligence, but we didn't have any revenues.

We did have about $4.5 million of acquired revenue from an acquisition that we did last year, but not from this Socla acquisition.

Okay.

All right, thank you very much.

Okay.

And with no further questions in queue, that closes our Q and A for today.

I would like to hand the call off to Mr.

David Coghlan for closing remarks.

Well, I'd just like to thank everybody for joining us today.

Appreciate the time and attention and the questions and very much appreciate your interest in our company.

We look forward to talking to you after the completion of our next quarter.

With that, have a great day.

Thank you.

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

The presentation has now ended.

You may now disconnect.

Have a good day.