Koninklijke Philips NV (PHG) 2005 Q3 法說會逐字稿

Good day and welcome to the Genlyte Group third quarter 2005 earnings conference call. Also welcome to those of you listening on our webcast. At this time all participants are in a listen-only mode. As a reminder this conference is being recorded with an audio archive copy becoming available, approximately 3 hours after the conference on Genlyte Group's website at www.Genlyte.com.

This conference will begin with an overview of the 2005 third quarter results by Mr. Larry Powers, Chairman, President and CEO of Genlyte, and Mr. Bill Ferko, Vice President and Chief Financial Officer of Genlyte followed by a question-and-answer session.

(OPERATOR INSTRUCTIONS).

Before we begin let me remind you that today's discussion may include forward-looking statements. These statements are based on our view of the world today and, therefore, are subject to risks and uncertainties which are discussed in more detail in the Company's most recent Form 10-Q. Obviously actual future results may vary. We will shortly hand you to over to Mr. Powers.

Good morning, everyone, and welcome to our third quarter call. As I stated in the press release this morning, I was reasonably pleased with the results of our third quarter when you base it on all of the turmoil surrounding our industry. There's quite a few challenges in the construction industry right now with everything that has taken place down on the Gulf Coast and even in southern Florida.

In fact I was just in southwest Florida this week and there was still a lot of challenges to get some of these projects back on track. There's becoming a shortage of contractors in many areas. People don't really know exactly what to do but a lot of people have just picked up a gone to the Gulf Coast because they are paying higher wages. And it is creating some disruption and some real challenges for our industry in total.

So, based on all those factors, I was reasonably pleased with the quarter. I would like to have seen sales up a little more but when you take everything into consideration, we felt we did reasonably well. I was particularly pleased with our gross margin and our earnings per share as a result of the gross margin. We are continuing to see escalating costs in all types of raw materials.

Obviously this -- hurricanes have caused some real challenges as it relates to fuel charges and freight has gone up, unbelievably to us. We hope that they're going to see some of those costs start coming back down but it does concern us for the near future.

The commercial construction business has remained relatively flat. We keep getting predictions from many people. Dodge (ph) and the people at NEMA -- National Electrical Manufacturing Association -- are forecasting commercial construction to begin to pick up in the third and fourth quarters of this year and continue to accelerate as they grow into 2006.

However we have not seen a lot of this major pickup at this point. Recognizing that lighting comes very late in the cycle, our business is still relatively flat in commercial construction. The residential business has remained very strong. All of our divisions that are doing business in the residential sector, which is roughly 15 to 20% of our business, continue to do very well.

There are a couple of a little disturbing trends that bother me a little bit taking place in our industry that I thought I might just mention to you. One of our national chains and, most recently, one of the smaller regional chains have decided that they want to start purchasing materials direct from China themselves. In fact, they've actually approached some of the lighting manufacturers, some of which have assisted in which I didn't personally think was wise but in helping them secure vendors and adding to parties so they can import some materials, particularly emergency lighting at this point, direct from China and sell those products and just bypass us as manufacturers altogether.

I am obviously going to let these distributors know that I don't like this trend and that we are not going to be willing to support people if that's the direction they are going to go. We may have to look at alternate channels of distribution and how we take our products to market if in fact our good distributors are going to start buying and selling our products direct from China.

There's no reason to panic on this at this point but it is a trend that has started and I just don't want to see it continue.

I guess the other most frustrating part of our business right now is Sarbanes-Oxley and all of the issues. Our financial people were at our offices yesterday till late in the evening to get our auditors to sign off. It just seemed like there is an endless array of little what we think are nitpicking details that don't really have any real substance to them, but seem to be causing them to work right up till the last minute before they sign off.

It is very frustrating. It is very time-consuming for our people. We believe a lot of it is a waste of time and, obviously, costing us a small fortune. So we don't like to see that and we hope that this at some point starts subsiding but I am not sure what is going to happen there.

As I look forward into the fourth quarter of this year, I look forward with mixed emotions. It's really hard to get a good forecast and to really know what is taking place, particularly as it relates to these hurricane areas and the shortage of labor in certain areas. It is going to create some real challenges, I think, in the construction industry which could have a significantly negative impact on our business. We just don't know, really, right now.

Our order input has remained reasonably strong. And right now everything looks to be reasonably healthy and, hopefully, we should continue at about the pace that we have been on in the past few months. Although again with these uncertainties, we do have some reasons for concern. And I think the fourth quarter of this year and potentially the first quarter of next year are going to have some real challenges facing our whole industry and our Company specifically. And Bill will talk to you about some of the things.

We have pretty much completed although there's still a lot to be done and a lot of costs to be absorbed yet from the consolidation of our Gardco division which is located in San Leandro, California, and our White Light division -- it's located in San Marcos, Texas -- into a new facility that we purchased.

We had some real issues with some painting problems and just some of the typical startup problems. I personally have been very disappointed in the way we have handled it; and we certainly have had some disruption in our service and haven't done a good job of handling this move of these two factories into this one new facility.

Hopefully, by the first of the year we should have that fully up and running at or near our capacity that we had expected. Right now we are absorbing a lot of additional costs related to the inefficiencies and our inability to ship and just things that have gone wrong in that transfer.

So with that I think I'll turn it over to Bill at this point and let him talk to you specifically about the financial results. And then we will be happy to answer any questions that you might have.

Thank you, Larry, and good morning, everybody. As indicated in our press release, our earnings release third quarter sales of 325.6 million are 7.4% over last year. The foreign exchange impact from translating our Canadian sales at a stronger Canadian currency rate than last year resulted in increasing our sales during the quarter by $4.7 million or 1.6%.

During the quarter, our orders were 10.1% higher. However, our backlog decreased by $7.2 million from the second quarter of 2005. And that is due to -- as typical it's due to shipments of orders that were placed in advance of our June price increase and the normal seasonal pattern for nonresidential construction.

Most of the sales increase during this quarter is related to price increase. Numbers of units, if you would, and most of our commercial businesses in any case, particularly fluorescent are actually flat to slightly down from last year.

Year-to-date sales of 943.2 million are 7% higher than last year. Again most of the sales increase is related to the price increases in the foreign currency impact of translating Canadian sales at the higher Canadian dollar exchange rate increased sales by $13 million or 1.4% from last year.

We are very pleased with our operating profit from this quarter. Third quarter operating profit of $40.9 million is 39.7% higher than last year. The operating margin, which we are very pleased with, increased to 12.6% compared to 9.7% last year. This is primarily due to the effective price increases and the third quarter gross margin which increased to 37% from 35.3% in the third quarter of 2004.

And again, all of that is due to the price increases and continuing to manage costs as we have in the past. And in fact operating expenses are down 20 basis points to 24.3% of sales, down 20 basis points down from last year in the same quarter.

Cost savings were realized. In many categories we continue to manage controllable costs such is advertising expenses or management information system expenses or IT expenses continue to be managed very carefully.

We have -- as we indicated in the press release we have increased our freight minimums in an effort to control our freight cost and we continue to manage our selling and commission expenses as well.

Offsets, though, or some of the cost increases include higher audit fees of $491,000, compared to the third quarter of last year. And in the third quarter although the Canadian currency strengthened and helped our sales and earnings translation, the currency's strengthening actually adversely impacts our working capital translations where we -- the loss due to the currency Canadian working capital translations was $2.4 million, compared to a loss of $1.6 million in 2004.

The Canadian division's operating profit was actually translated at this 8.7% higher rate, which resulted in an increase of $675,000.

The working capital translations will not be as onerous in the future going forward. As we indicated in the release we repatriated $60 million of cash from Canada that was held previously in dollar-denominated investments, and -- but held by Canadian functional currency companies.

Now that that has been repatriated, the translation impacts will be less extreme than they have been in the past.

We did recognize $1.3 million of employee relocation, severance, and plant consolidation in startup and efficiencies, related to the closure of the facility in San Leandro, California, and construction of our new factory in San Marcos, Texas.

We did have increased expenses in research and development. And of course, the administrative expenses, as I indicated earlier, primarily related to the audit fees.

Year-to-date operating expenses of 110.6 million -- I'm sorry operating profit of 110.6 million is 31 -- or 36.1% higher than last year. The operating margin on a year-to-date basis has increased to 11.7%, compared to 9.2% last year, due to the same issues that I discussed -- generally the same issues that I discussed for the quarter.

Third quarter net income of 21.9 million increased 42.7% from the 15.3 million that we reported in the third quarter of 2004. One of the unique issues for the third quarter that we worked on, the accounting was a little bit different than we normally have to deal with, as this gain. On the interest rate hedge there -- the interest rate swap that we had because we paid down our debt below the amount that the hedge was in place, we had to do some speculative type accounting for the gain that we had on the hedge.

So our third quarter net interest expense was $1.6 million versus 1.7 net interest expense last year. We recognized $487,000 on this interest rate swap, because the previously hedged debt balance is now lower than the notional amount of the swap that is being accounted for as being speculative. So that is one of the swaps. We still have other swaps in place that remain effective.

The third quarter 2005 effective tax rate increased dramatically to 44.4% versus 38.1% last year, primarily due to the $2.3 million tax expense related to the foreign earnings repatriation of $60 million that we talked about in the press release. And that resulted in an EPS impact of about $0.11 per share.

Year-to-date net income of 61.4 million increased by 62.9% over last year. And the year-to-date effective tax rate is 41.1% compared to 38.6% last year.

As you saw in the release, third quarter earnings of $0.77 per share compared to third quarter last year of $0.55 which is a 40% increase. And year-to-date earnings is $2.17 compared to $1.36 which is an increase of 59.6%.

We are very pleased with cash flow during the third quarter. Third quarter cash flow from operations net of capital expenditures is 40.4 million compared to 34.1 million in the third quarter of last year. Our operational working capital -- which we define as working capital less cash, cash equivalent, short-term investments, and debt -- actually decreased by 2.5% to 190.6 million from 195.5 million in September 2004. And that is, once again, on the sales increase that we reported in the quarter. So we are very pleased with that.

As a percentage of sales, the operational working capital decreased to 14.6% of sales compared to 16% of sales. Accounts receivable, which are 210.2 million at the end of the quarter, is 12.7 million higher than the 197.5 we reported last year. However once again as a percentage of sales it's down to 16.1% or 20 basis points lower than the 16.3% of sales that we reported last year.

Inventory also decreased by $4 million to 156.5 million compared to last year and as a percentage of sales, it decreased to 12% of sales compared to 12.6. Capital expenditures are higher because of the San Marcos facility we talked about. So third quarter capital expenditures were $11.2 million, which is $4.9 million higher than the 6.3 million we reported last year. And, specifically, for the San Marcos facility, expenditures were 2.1 million and year-to-date expenditures for that facility just for capital are 14.7 million.

We expect to spend an additional 1.4 million in capital during the fourth quarter and as indicated in the earnings release, we expect an additional 4.5 million of costs related to employee relocation, plant moving costs, severance costs and startup inefficiencies that, hopefully, we will get all of that behind us during the fourth quarter.

In debt, in September 2005 we closed with net debt which we defined as debt less cash and short-term investments. So net debt was $130.5 million compared to 230.6 million in 2004, a reduction of slightly over $100 million during the past year. We are very, very proud of that.

So second quarter 2005 net debt -- I'm sorry, total debt was reduced by 115 million during the past year to 175.6 million, compared to 290.7 million in the third quarter of 2004. So some very good performance with cash flow despite some fairly significant or unusual capital expenditures related to building this new factory that we built this last year.

That is the end of my formerly prepared comments and with that I will open the line up for questions.

+++ q-and-a.

(OPERATOR INSTRUCTIONS) Craig Kennison of Robert W. Baird.

Congratulations on your quarter and on the debt reduction. First question, just going to Larry's point regarding the China sourcing issue that you raised. Why shouldn't we panicked over something like this? Maybe you could just help us understand what your value add in that supply chain actually is and why maybe direct sourcing may not work?

First of all, if you look at direct sourcing in the commercial business, there's lots of job business. You eliminate all the new products. The only thing they can source is routine commodity products. But I don't want to let people get started and think that we can take -- they can take in the commodity high-volume products and go source them direct and then come to us for all their needs on the specification work and the job work, all the innovative new products that we come out with. They obviously have no ability to go develop new products.

The foreign sources that we are talking about, they have no ability on their own to develop new products. They are pretty good at copying but we don't have any reason to think that it's a serious threat. Only that I don't want to support people who think that is the way to go. Obviously people like Home Depot had done that on a large-scale basis in some of the commodity downlighting and decorative products and certain types of products for years. And that has been a successful strategy for them.

But that is high-volume commodity stuff that is sold day in and day out. In the commercial job business there and lots of variation, lots of different lamps, different balance, and also they need a floor of innovative new products which we are out there specifying. And that is why I am going to let these distributors and people who decide they want to do that know that those are the kinds of accounts we are not going to be interested in supporting long-term and oh, by the way, if they want to start selling or buying these products direct and selling them why shouldn't we just go out and open up an operation and sell direct to their contractors?

I mean that goes two ways. And it is not something that I am overly alarmed about but the fact that we have now had 2 distributors do it bothers me to some degree. And I just want to be sure that everybody knew I wasn't in favor of it and I don't think that they are going to find it is going to be a successful strategy.

Other people have tried this in the past. And there's some direct sourcing going on and has been in our industry for years but on a very small scale.

Just so that we have a sense of proportion, could you give us a sense for the percentage of revenue that these distributors may represent to your business?

Well because I don't want to identify the distributors, one of them is a very large distributor for us -- very large. In fact one of our larger distributors. The other one is a medium-sized distributor for us. So but you have to understand. The product line that they are sourcing is a very very small percentage of our business. It is almost negligible.

Okay. That is helpful. Relative to perhaps cause, I know we have talked about RFP activity being fairly active but that has not translated into orders. Could you give opinion on the disconnects between the fairly active RFP activity and the lack of real orders coming from that? Not to overly state the case.

Quotations. You're talking about quotations, Craig?

Yes.

Yes. The quotation activity.

In our industry it is just a very common thing that every major commercial job, you are going to end up having really 4 major competitors and then a lot of smaller niche type companies and so we quote a lot of jobs. Those jobs where we get out in front of the jobs and get our products specified and then we work with the contractors, distributors, not to close those orders we have a good chance of closing those orders but there's lots of jobs that our sales reps and our own salespeople come in with -- at kind of the last minute.

And we quote against our competition or whatever. And the likelihood of us getting a lot of those jobs is not very good because we are a company that likes to sell our higher quality products. We are not a company that's just out there quoting against everybody else's specs and trying to sell the commodity high-volume items on price and deliver it.

There are some people in our industry do that that's the way they make a living. But that is not what we do or do well. So we need to rely heavily on innovative new products, getting them specified and following those products through to completion.

The other thing, Craig -- this is Bill. I just want to point out on new construction activity. The quotations that are put together as the package is being developed for financing or whatever can be several months before the lighting goes in. The quotation is done usually at the front end of the project, when they are trying to figure out just how big this project is. And the foundation goes in, the steel goes in, the concrete goes in. The walls and the glass and the roof and then, 10 to 12 months later, the interior starts to get finished out and the lighting will go in.

So there is in large projects there's quite a lag between initial quotation and the ultimate delivery. So I think you've seen the vacancy rate starting to come down in office as well as other sectors that we serve but that it takes a while.

And even though we do a quotation, the developer may not break ground right away. They may wait for a while and it may just be kind of an indication of what the cost is and so we get the feel of what kind of financing he will need to raise. So there's a lot of projects that even though they are quoted don't necessarily get started right away.

Final two questions. Could you comment on whether a temporary fuel surcharge may be in the cards and with your improved balance sheet, what your acquisition pipeline looks like? Thanks.

We have toyed with the idea just as the fuel charge but it just doesn't work in our industry. Our distributors and the contractors find it very difficult to pass it on. And it is by order and it just gets really ugly and nobody can keep up with it. So what we are doing is we are investigating the possibilities -- if the fuel charges and costs remain as high as they are now we are looking at the possibility of implementing a price increase in the fourth quarter. We will need to do that.

Hopefully those fuel field charges are going to come down. They have come down some as you know. And hopefully they'll come down further. We are just going to monitor that very careful. We just don't think a surcharge will work.

What was your other question? I forgot the other question.

Acquisitions.

We are actively looking all the time. We have got a couple of small things that we are looking at right now and we are just constantly -- I try to spend probably, I don't know. I would like to spend 25% of my time on acquisitions. I haven't been spending that much lately just because it's been increasingly difficult to find them. But we do have a couple of possibilities that we are working on right now.

We know that we've got a strong balance sheet. We don't want to buy companies just to buy them. We want to buy good companies that fit our strategy and our long-term growth plan. So, hopefully, we can find some good companies to acquire and if we do, we will do that.

Thanks again and congratulations.

Thank you.

Thank you, Craig.

Thank you very much, Sir, and this concludes our Q&A session today. We will now hand the presentation back over to Mr. Powers for closing remarks.

I'd just like to thank everyone for participating in the conference call today and just assure you that we will do our best to continue to grow our sales and earnings, even under some rather challenging times right now. But we will continue to do our very best. So thank you for your support. And have a good day.

Thank you very much, ladies and gentlemen, for your participation. As a reminder this conference is being recorded with an audio archive copy becoming available in approximately 3 hours on Genlyte Group's website at wwwGenlyte.com. Again, that is www.Genlyte.com.