Koninklijke Philips NV (PHG) 2006 Q2 法說會逐字稿

Good day and welcome to the Genlyte Group second quarter 2006 earnings conference call. Also, welcome to those who are 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 to be available approximately three hours after the conference on Genlyte Group's website at www.Genlyte.Com.

This conference will begin with an overview of the 2006 second quarter results by Mr. Larry Powers, Chairman, President, and CEO of Genlyte and Mr. Bill Ferko, Vice President and CFO 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, and 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 your call over to Mr. Powers.

Good morning, everyone, and welcome to our second quarter earnings release. I'm obviously pleased to report the excellent results we had in the second quarter and through the first half of the year. I personally continue to be impressed, and I have to tell you a little bit surprised by the strength of the commercial construction market. If I look back at last year in the fourth quarter, our business softened.

Our order input was somewhat weak, and we had some concerns coming into this year late in the year, but it's almost like January 1. Somebody flipped on a switch and there's no question that commercial construction has really improved so far this year, and we can only hope that it continues at or near these current levels. There's no question that we have recently seen a decline, or I shouldn't say a decline but a definite softening of the residential market.

We still had a relatively good second quarter in residential, although it wasn't near as strong as our commercial markets, and I think if you look around at everything you read, I happen to have a son-in-law who works for the largest home builder in this country, they're still building houses at a very rapid pace, but they are not selling like they have been selling in inventory of new homes that are building pretty rapidly, and I think we're going to continue to see some softening in the residential market.

The industrial market is also relatively strong, and that's driven I think a lot by some of the new government legislation and some of the energy efficiency programs that are under way. We're seeing a nice pick-up in some of our high bay business, related to industrial revamping to try to improve efficiencies, and reduce costs going forward.

I thought I might take just a moment and talk a little bit about a couple of the acquisitions that we originally made. We haven't had a conference call since our acquisition of JJI, and then more recently Strand. I believe that JJI is going to prove to be an excellent acquisition for our Company. These are a lot of relatively small niche-type companies that fit very well with our strategy.

There's a variety of companies that I'm not going to go through the whole list of them, but there's some outdoor companies and indoor companies and especially little niche companies, that add very nice to the specification strengths, and I have now visited all of the facilities that we have, including I actually visited the one in Germany prior to the acquisition, and one in California prior to the acquisition, and I'm actually going to be out there next week also, but we recently had somewhat of a whirlwind trip, and our corporate Management team went around and visited all of the JJI companies, and we're relatively impressed with the Management team, and we think we've got a lot of good people and a lot of the opportunities.

A lot of the facilities are older and not certainly up to our standards today, but over time we'll decide what we're going to do with these facilities, and the ones we're going to invest in, we'll be improving with new equipment and doing the things we need to make them more efficient, and in the meantime, we've certainly got them involved in our purchasing, whether it be ballast or steel or whatever, they are now on all of our contracts, and a lot of their costs will come down in that regard, and things like freight, they are able to take advantage of that.

So I think it's going to be good and in fact, I think the first month and Bill will probably talk a little bit more about it in detail when he talks to you, we had an excellent month with them, but they had we had what would be equivalent to almost a six week month so the earnings looked a little bit abnormally high for the first month that we owned them, because of this six weeks in terms of overhead and that, but they did have an excellent first month with us, and we're happy to have them on board, and I think we'll continue to grow those companies and do very well.

The most recent acquisition is Strand which is a very old Company. Strand is I believe about 90 years old and they had some challenging times. This is a Company that we have been following for several years, and we've had an interest in and they were owned by an investment group, and Management had a ownership position in the Company, or at least an opportunity to have an ownership position, and they kept wanting to refinance the Company and see if they could come up with the financing, so that Management was a little bit at odds with the group that owned the Company, and it was kind of a difficult thing for us to work through this deal, but finally they got in somewhat difficult circumstances, and we told them that we would acquire part of the Company.

We didn't acquire all of Strand. We acquired the U.S. Operations, the Asian operation, and the Canadian operation, which was in the process of being consolidated in the U.S. anyway. We did not acquire any of the European companies that Strand owned in that part of the world, but I think over time, we'll be able to work closely withstand.

They have a lot of products that fit very well with our Vari-Lite product line, and it's another Company that we acquired and ended up being an excellent acquisition for us about four or five years, ago and we couldn't be happier to own Vari-Lite now, and we're hoping we'll have the same type of results with Strand. We believe we will.

If you look at this year, it's going to take us some time because because we are going to have to improve some of their operations, some of the sourcing and some of the issues that we have with the Company, because of the splitting apart with their European operation is going to create a little bit of heartache for us for a while, but I think as we get towards the end of this year and certainly into next year once we get this thing kind of solidified it will be an excellent Company for us, and we'll continue to do very well with this, and it will help to strengthen our whole theatrical lighting and controls business, which also we use a lot of in schools and auditoriums and churches and that, and it really will add to that part of our package.

The only real concerns I have that I have to express to you are the continuing costs of raw materials. We had a price increase in most of our companies the 1st of June, which also accelerated I think our order input somewhat in this past quarter, but since then, even in the month of July, we're continuing to get raw material increases in almost all of the commodities.

We're hearing rumors of the more increases in Ballast potentially coming down the road, and potentially maybe electronic ballots increasing between now and the end of the year, and steel, copper, aluminum, you know what's happened to freight. Those costs continue to go up, and my only real concern is that if those costs continue to go up, along with the Fed continuing to raise the interest rates, at some point you wonder if this construction business can stay as strong as it is.

If it does stay strong at or near the current levels, there's no reason that we shouldn't continue to have a very strong second half of the year. I don't think there's any way that it can be as strong as the first half, but it should have a very good second half, again assuming the commercial construction stays relatively strong.

So I think with that I'll turn it over to Bill, and he will go through the finances with you, specifically and then we'll be happy to entertain any questions that you might have. Bill?

Okay, thank you, Larry and good morning, everybody. As you saw from our release, our second quarter sales of $366.1 million, are 15.8% over 2005. Of course the May 22 JJI acquisition was important, it impacted our sales by $15.8 million for the approximately six week, or 40-day month, that we had subsequent to the acquisition.

Most of the sales increase this quarter were due to normal seasonal trends. Of course second and third quarter are typically our strongest quarters of the year, and then again growth in our core commercial and industrial markets that Larry spoke about, and then partially related to the cumulative impact of the price increases, and some pre-buy in anticipation of the June 1st price increase. This year, our price increase was about two weeks earlier than the price increase that occurred in the middle of June last year, which gave us about another two weeks of additional time to get the orders shipped during the quarter this year, compared to last year.

Order input rate was 20% higher this quarter, and approximately 16% higher net of the JJI acquisition for comparable operations. The backlog going into the third quarter, or as of the end of the second quarter, is 56% higher, or $58.5 million higher than 2005, now this includes approximately $15 million of backlog benefit from the JJI acquisition. The other notable thing in sales was that converting our second quarter Canadian sales at the stronger Canadian dollar rate, increased our sales by approximately 1.6% of sales, or $6 million. And on a year-to-date basis, our sales of $695.3 million are 12.6% higher than 2005, and the impact of converting the Canadian sales at a higher foreign exchange rate had a benefit of approximately 1.3%.

In the operating profit area, second quarter operating profit of 51.3 million is 35.4% higher than 2005. The operating margin has increased to 14% versus 12% last year primarily due to the effect of price increases, increased volume, and product mix from selling higher value-added products. The JJI acquisition added approximately $2.3 million of operating income for the quarter, net of a $650,000 step-up for amortization of the backlog and finished goods inventory.

We expect to amortize an additional $1.3 million of step-up during the third quarter of this year. Purchase accounting for JJI is preliminary and we're working on the results of appraisals, and the working capital purchase price adjustments, which hopefully we'll get that finalized during the third quarter.

Second quarter gross margin increased to 39.4% from 37.3 for the second quarter of 2005, and again this is primarily due to the increased volume, premium product mix, and price increases, and continued costs and controls. As Larry indicated we're experiencing continued year-over-year cost increases in the area of freight, ballast, steel, aluminum, zinc, audit fees, and interest rates. Operating expenses, however, for the quarter remained unchanged at 25.1% of sales.

In the second quarter we had a currency loss due to translating our Canadian working capital that's invested in U.S. Dollar denominated cash and/or receivables, and that loss was $1.2 million, compared to a gain of $408,000 in the second quarter of 2005, however converting the Canadian divisions operating profit at an approximate 11% higher exchange rate, resulted in an increase in operating income of $781,000, which substantially offset the working capital translation losses.

Year-to-date operating profit of $94.8 million is 36.1% higher than 2005, the operating margin has increased to 13.6% versus 11.3% last year. In the area of net income, second quarter net income was was 35.9 million, an increase of 66.6%, compared to to the 21.5 million in 2005. Second quarter net income before taxes includes the somewhat unusual item of a $7.2 million foreign currency exchange being related to the return of capital from Canada, which was used for acquisitions. The net income impact of that $7.2 million pretax gain was $4.4 million. Excluding this gain, net income was 31.5 million which is an increase of 46.5%.

The second quarter net interest expense is 1.7 million versus 2.4 million of interest expense last year. The May 22nd JJI acquisition added approximately $760,000 of incremental interest, on the approximately approximately 121 million that we funded for the 40 days during the quarter after the closing, at an effective blended borrowing rate of 5.7%.

The second quarter effective tax rate was reduced to 36.8% compared to 39.2% last year, due to a one-time deferred tax rate adjustment to reflect, recent, this is end of June, Canadian legislation which lowered the rate, the Canadian rate, the Canadian tax rate and adjustments going in the other direction last year, so we had a one-time adjustment on our deferred tax is what really will benefit cash flow in future periods, but the accounting rules required us to recognize the benefit on our deferred taxes in the current quarter.

Going forward, we expect to consolidated rate to be approximately 38% for modeling purposes. Year-to-date net income then was $84.5 million, an increase of 113.7% over last year. Of course, during the quarter as we discussed, or in the year-to-date numbers as we discussed in our earnings release, we had a significant $24 million one-time gain which was discussed during the first quarter, and the first quarter earnings release, as well as we broke it out in the second quarter release as well.

So earnings per share for the quarter then, for the second quarter were $1.24, compared to the 2005 earnings per share of $0.76, and it's 63.2% higher, excluding the impact of the $7.2 million foreign currency gain, EPS would have been $1.09, or 43.4% higher, and the impact of the $7.2 million foreign currency gain was $0.15 per share. JJI earnings increased earnings per share by approximately $0.06 per share.

Year-to-date, and again for the quarter, well year-to-date earnings per share was $2.94 compared to $1.40 last year. It's an increase of 110%. The year-to-date EPS includes the first quarter recognition of the $24.7 million tax provision that we've talked about, the EPS impact for that tax benefit was $0.86 per share, and then we also had excluding that $24.7 million tax provision, and the $7.2 million FX gain that we recognized this quarter, EPS is up $0.53, or 37.9%, to $1.93 on a comparable basis.

In the area of cash generation, second quarter cash flow from operations net of capital expenditures is 16.3 million, compared to 13.9 million in the second quarter of 2005. Second quarter working capital less cash equivalents and short-term investments increased to 228.7 million, from 203.8 million in June of 2005. It's primarily due to the JJI acquisition. Working capital as a percentage of annualized sales actually decreased to 15.6% of sales, compared to 16.1% of sales last year.

Accounts receivable of 237.4 million is $32 million higher than the 205 million last year, and as a percentage of sales it's unchanged at 16.2%, and JJI resulted in an increase of approximately 17.4 million in accounts receivable. Inventory increased 29.4 million to 189.2 million from 159.8 last year, as a percentage of sales increased slightly to 12.9%, from 12.6% in the second quarter last year, and again most of that is due to the JJI acquisition, which increased inventory by approximately $27 million.

Second quarter capital expenditures of $6.2 million, are $4.7 million lower than the 10.9 million we recognized in second quarter of last year, again last year we were wrapping up the San Marcos factory construction, and that operation started up in third quarter of last year. Year-to-date capital expenditures are 11.2 million versus 21.2 million last year.

In the area of debt, we closed June with debt less cash and short-term investment position, or net debt of $182.4 million, compared to net debt of of 177.2 million in June of 2005. Total debt is 222.6 million versus versus 245 million in the second quarter of 2005. The second quarter cash and short-term investments balance was 40.2 million, compared to 67.9 million last year, and again we had these dividends coming back from Canada, which helped us bring that cash balance down. The ratio of debt to capitalization is 25.9% compared to 33.5% at the end of last year, so it's still a very strong balance sheet even after the JJI acquisition.

With that, I will open the line up for questions.

Thank you, Mr. Ferko. We will now poll for questions from analysts. [OPERATOR INSTRUCTIONS] Our first question comes from Matt McCall with BB&T Capital Markets. Please proceed.

Thank you, good morning everybody.

Good morning.

Larry, first, I was surprised to hear you say that you don't think the second half can be as strong as the first half, and I'd ask maybe if you could expand on that thought a little bit. Just looking back historically, it looks like the second half has actually picked up a little bit from an EPS perspective versus the first half.

I was relating it primarily to the construction markets. We know that residential construction is just not going to be as strong. I was just up in Fall River, which is one of our largest divisions this past week, and we had two very large customers in there from around the country, and they have already started seeing their true stock business starting to soften up somewhat, relating primarily to that medium small contractor business on the residential side, and that's the only issue that I have.

If commercial construction stays in all of the predictions are that commercial construction is going to stay very good through the second half, and of course well into next year, if that holds we should do very well, but just when I look at how well we did in residential the first half, our residential division, Thomas Lighting, for example, our total residential division had an outstanding first half, and I just can't see how they can replicate that in the second half, with the downturn in residential construction.

I think both industrial and commercial should remain very strong but again, and I have some concerns as I stated earlier, about these commodity prices. They are going to have an effect at some point, if these price increases, a little concerned about what's going on in the Middle East, and if we see fuel continue to get out of sight or more cost increases, I think at some point it could have an impact even on commercial construction.

I might even add to Larry's comments if you'll notice in our segment information, the year-to-date residential sales are up 6.8%, however for the second quarter they're up only 5.9%, so we're starting to see already, it's not that they aren't down, but they just aren't up as much as they were earlier in the year, so we're starting to see a little bit of softness there.

Okay so it's more related to residential and I might have misunderstood there. So from a normal seasonality perspective on the EPS line, there's nothing that I should be thinking about looking at the second half versus the first half? Historically it's gotten a little better?

Yes, normally if you just think of the construction seasonality, the schools, the retail shopping malls, all of that need to get pretty wrapped up in anticipation of the holiday selling season, so the third quarter is typically the strongest quarter of the year, second and third quarters are usually the strongest quarters, because the weather is better in the summertime for construction it's better, and then the fourth quarter is the holiday season comes on, and the schools are already in session, things start to slow down typically. So but the third quarter is often our strongest quarter.

Okay. And 200 basis points year-over-year, I guess can't go on forever. On the operating a margin line 200 basis points of expansion, at what point do we get to a more normalized level, or what is that normalized level if you want to look at it from a segment perspective, or maybe a contribution margin perspective, how should we look longer term at how the margins can improve?

Well one of the things you have to realize, those margins, the improvement in those margins have a lot to do with two things. One obviously is the increase in sales. As we absorb, we're a fully vertically integrated manufacturing company. We produce a lot of products in our factories, and then when these factories are fully loaded and we're absorbing that overhead, and the volume goes up, there's no question that our margins get better, and then the other side of that also relates to the mix of products.

When we have a good mix of products in our outdoor, and not a high percentage of our sales coming from more the commodity-type goods in HID and fluorescent, we do much better, so when you say what is the normalized, I wish I could give you a good solid answer for that. I don't see any reason for it to deteriorate, because we do focus on the mix issue, and it's our goal to introduce or continue to introduce more innovative new products, we're right now with the energy Bill that's in place, we're putting a lot of emphasis on energy-type products, and we're starting to put more and more emphasis on LEDs, I was at Lightolier this week, I was pretty impressed with some of the things I saw.

There's some new technology coming there and I think it's kind of exciting and that's the arena we play in, so if anything, I hope that our margins will stay certainly where they are, or continue to improve as we're able to sell more and more of those innovative new products, and get higher margins.

Now, on the negative side of that you have to also realize that we have a lot of people who like to knock off our products, particularly the Chinese and even U.S. companies who have Chinese vendors, they're constantly coming in here, and putting pressure on pricing, so we always have that pressure that we battle at and do we take some of this commodity business, and at what price so there's the mix. Right now with business being strong, it's easier to hold on for the higher margin business and to hold pricing up, if sales soften then it becomes more pressure from our sales people, and for everybody who wants to sell more and more of the lower margin-type products.

But I guess the 14% number doesn't sound like it's kind of a high from where you guys can see this thing going.

Well, again, as Larry indicated, it's mix. If you look at, you know we have several different brands or divisions, companies out there, some have margins that are higher than that and others have margins that are lower, and so much of it depends on which of the brands are doing better and which ones aren't, and right now the premium brands are doing a lot better, and so that's the mix thing that Larry's talking about, and that's really one of our core strategies is to emphasize the premium products, and the value of higher value-added, higher quality lighting, more energy efficient lighting that does the right job, et cetera. And that's really a good, we have a lot of our sales and marketing effort directed toward educating architects, lighting engineers, lighting specifiers, and the value of higher value-added lighting, and that drives the mix to a higher level and so, so much of it depends on our success in that area.

There's some companies out there that have a 25% operating profit margin, but we're certainly not going to, we've looked at acquisitions over the years, other companies that we compete with that have 25% operating margins, but that's not the whole, you just can't do the whole business at that level. So that's really what it comes down to.

And then one more, and I'll hop off. You talk about the profitability being benefited by the extra weeks in the quarter. Can you tell us what the EBIT margin would have looked like, I think if I calculated right it was 14.6%, and you said it added about $0.06 in EPS, without those extra weeks do you know what the normalized profitability would look like there?

When we acquired the Company it was like an 8 to 9% as I recall off the top of my head, in that proper range, and we have a goal to improve that over time but I think right now, we would probably look for that to be in the 10% range, until we're able to do more of the things that we need to do. Over time, we certainly want to take that up.

It was about a $130 million company, just to give you a rough feel there.

Right. Okay, thank you very much. Good luck.

Sure.

Our next question comes from Alex Rygiel from Friedman Billings Ramsey. Please proceed.

Thank you. Two quick questions. First, I missed your comments on the San Marcos facility. Can you update us on where that stands right now, and then secondly, I know you've mentioned on this call and in past calls, with regards to your activities in the LED marketplace. When can we anticipate a product launch, or more aggressive conversation or discussion on the LED activities?

Okay, well on San Marcos, they have made some pretty significant improvement. And we were actually fairly pleased with the second quarter. This is kind of the first quarter that we've seen significant progress. They still have a ways to go, but our belief is that they will continue to improve and it should be better in the third quarter, and hopefully a little better in the fourth quarter, and certainly by the end of the year, we should be up to at or near the levels that we had anticipated when we put this project together, so we're seeing nice progress and they're shipping more on time, and they still have a few bottlenecks, one of the problems they've run into a little bit here lately is just finding good people.

Unfortunately, there's been a lot of growth in the whole State of Texas, if you really look at it, it's a very favorable climate for manufacturers, and there's been a lot of growth in manufacturing in Texas recently, and so the unemployment areas in that county where we operate I think are down in the 2 to 3% range right now, and we're having to find it a little difficult, you can always find bodies but finding the quality of people we want, hopefully we'll continue to work on that, and we're favorably impressed, and think it will continue to do well, and just get better over the next couple of quarters. The second question was --

LEDs.

Oh, on LED's. I don't know if you missed my earlier comments but I was at Lightolier this past week, we've got several major projects we're working on, we're already in the LED products significantly with many product lines, particularly emergencies, hazard and landscape lighting, where we're starting to make some in roads and it's slow. LEDs, what everybody has to realize, I've been doing this for a long time and it's not just going to come out in overnight LEDs are going to replace all general illumination. There are lots of little niche products. It's getting better. We're impressed with some of the new LEDs we've seen, and our goal is by next year at Light fair we will have significant introductions of new LED products. We will probably introduce a fair amount of new products starting out in the first quarter of next year, and then throughout the first half of next year, you'll see significant introductions.

Now, do I believe that they are going to have significant sales impact immediately? The answer is no because the pricing on LEDs and LED products, and there still has to be a value story there to talk about. The pricing is still significantly higher than what you could get the equivalent lumens per lot out of a say, fluorescent-type products, and/or many HID sources today, so unless you have an unusual situation where you want to use LEDs and you really need that 50,000 hour lamp light, which also some of us are questioning as to whether all of that is real, but it looks like they're getting better at it on that, LEDs are going to progressively become more and more important, and it will be an integral part of our product development and design for many years to come, but I don't think it's going to take over and all of a sudden next year we'll have have $100 million in sales in LEDs. It's just not going to happen that way.

Well the other point is that the lamp or light bulb manufacturers are now talking about improved lamp lights in some of the florescent products.

Right. There's significant improvement coming around in some of the other products, which is also very interesting to us, and they are starting to get florescent lamp lights up, but they are talking about the potential in the near future of 40,000 hours in some fluorescent lamps, so that's pretty interesting also.

Very helpful. Thank you, nice quarter.

You bet.

Thanks.

Our next question comes from Peter Lisnic from Robert W. Baird. Please proceed.

Good morning, gentlemen. Good quarter.

Thank you.

I was wondering if I could ask the margin question maybe a little bit differently. If you look at the current quarter maybe back out the acquisition and the amortization step-up you had to take, it looks like the incremental in the quarter was 30%, or maybe north of 30%. Is that a reasonable proxy for incremental margins, given where you're at in terms of production capacity, or kind of where you're at in terms of your manufacturing sweet spot if you will?

Well again it depends so dang much on the mix of those products. The answer to that would be yes, if it's in our higher margin products, and we're able to sell the products that we have gross margins and we can command higher prices, the answer is no is if all of a sudden the market turns down a little bit, and the pricing gets a lot more competitive in a lot of the commodity areas, in fluorescent and down lighting and some of the higher volume HID products. So and I realize it's a little bit of an evasive answer, but it's a very difficult thing to answer directly, because we have such a wide array of product and profit margins in those products, and it also relates to as I stated earlier has a lot to do with volume.

We have a lot of factories where if we're running at current levels that that we're running at, there we're not anywhere near in 100% capacity in any facility we own right now. We still have a fair amount of capacity, which is also encouraging because if our sales continue to be strong, and we're able to grow sales, our margins should stay very good and maybe even improve some. It's so volume sensitive in a lot of these companies.

Can you give us a sense as to where you're at capacity wise?

No. We're not even close. It's basically one shift five days a week.

We have a few areas like for example, our fiberglass pole business down in Newberry, South Carolina. We have this big winding machine that this one winding machine, that winds these big fiberglass poles, and we're running that full capacity right now. In fact we're just getting ready to buy another winding machine that will double the capacity in that area, but at most of our facilities as Bill said, we're running one, and in some cases we're running two partial shifts and that, but we're not more than I would say totally 60 to 65% capacity in our Company in total, and that depends again a little bit on the divisions, it's hard to make a blanket statement, because if you really really get serious about looking at the capacity you have to start breaking it down by divisions, but all-in-all we're still in very good shape as far as capacity is concerned.

Capacity really doesn't drive our margin pricing decisions, or anything like that though. A lot of what we do is very disciplined and selective, in terms of walking away from lower margin business, and trying to again convince specifiers, the benefits of higher value-added products. So what we're literally talking about is more of the absorption thing from the factories than the mix issue, which is probably more important than the volume issue.

Okay. That's a good answer. Thank you. Now if I could ask one more. The impact of your price increases may be pulling forward some orders. Any sense as to how much may have been pulled forward?

Again we had the price increase in the second quarter last year, so this is two years, so if you're looking at year-over-year numbers, they're relatively comparable except for the two weeks we talked about, where again last year, the price increases in the middle of the month, and this year it was in the beginning of the month so we had a little bit more time to get it shipped this year than last year, but Larry can maybe --

Well, you have to also understand, so much of our business these days is project related that we don't get, it's not like a huge amount of price increase.

People will try to pull in some orders if they know prices are going to go up, and distributors who were stocking some flow good type products will try to buy ahead a little bit, but it's not a huge impact that we get from a price increase enough that we get this huge flood of orders. We will get a little orders right at the end of the month, and that's primarily just people trying to accelerate jobs, and we will have contractors and people that our sales people have gone to and say look, if you don't take this order now prices are going to go up, so they store it in a trailer and they find a warehouse or something to put it in for a short period of time.

It's more that really than it is people just buying ahead. We get just a little bit of that, but it's really quite minimal these days.

Our rules are if it's released for delivery for shipment, in this case it was June 1st, was the day of the price increase is at the old price, if it's released for delivery after that then it's at the new price, and we don't count an order as an order unless we have a release date for it, and that's what goes into our backlog.

The only exception to that might be some national accounts, which is like retail stores, where we put out a proposal for we're going to bill 30 stores for the next year at a certain price, and so we would have to honor that contract if that was negotiated earlier in the year, but that's a relatively small part of our business.

And utility is the same way. Shakespeare had a little bit of a problem with their margins during this past quarter, and that is because they really felt the increase in these fiberglass materials as a result of the petroleum industry, and they had some contracts out there for the utilities, and they got these new prices coming into effect that they kind of got hurt during the quarter, because their materials went up before they were able to initiate these price increases, but for the most part we watch that fairly carefully. This quarter is a little bit dangerous, in that we have to receive some significant potential price increases during this quarter --

Cost increases.

Yes, I mean cost increases that will be reflected in our margins right away, because a lot of the vendors we deal with, their prices are in effect immediately. Steel, aluminum, obviously freight, and those kind of things that we pay the price at the time we take the materials.

Is there maybe a way of quantifying what that incremental materials costs are or will be in the third quarter, or second half of the year?

What we've tried to do is to align our price increases for the price we sell our products with, with the cost increases on average. Now, there's obviously a little bit of a disconnect. The price increases were all effective June 1st, and there's shipments of products of the old prices during the month of June and a little bit into July probably, but then as the new prices kick in, hopefully that we sell the products at, hopefully that will offset the cost increases that have been kind of rolling in through the process too.

And ideally in a perfect world, the two offset. But if there's some mismatch, because we can't go up on price every month, so it's because it takes it awhile to get it all working, and so there are some months that it starts out a little bit higher and then the cost increases catch up as they have, and it eventually equals out, but it's hard to tell you precisely, it's not going to match up perfectly every month-type thing.

Well and the thing I notice this time just to clarify is that right after we announced our price increase, I get mad. I get all over our ballast people for not giving us warnings and that kind of thing, and for the most part they're pretty good but this year has been an anomaly, in that we have had more price increases and more often than a normal year, and I was a little irritated because right after we announced this June 1st price increase we did get some announcements of additional price increases that we hadn't counted on, and they will be reflected. Now, I can't quantify that for you right now in this quarter, but it will have a little impact on the quarter. Hopefully not a big impact.

Okay, great. That's very helpful. Thank you, both.

Thank you.

Our next question comes from Christopher Glynn from CIBC World Markets. Please proceed.

Good morning. Congratulations on JJI. Looks like it had a great start.

Thank you.

On that, it's been a part of your business for a long time, to do some bolt-on acquisitions, and this was a particularly big one, Strand looks a little bit more of the typical variety. Just wondering how sustainable over time is this aspect of your business model? In other words, how many more regional or specialty players remain out there?

Well there's still a fair amount that remain out there. Some of them aren't for sale. Some of them aren't very good companies, and some of them fit too well, but we continually look for these kinds of opportunities. The JJI one is one that we worked on, again this is about the third time this company sold, and the two other previous times we were there but we didn't pay what they wanted to pay for it.

The same thing with Strand. It was on the market then off the market, and we just look for those and I mean we're always, I try to stand maybe as much as 25% of my time in a year on acquisitions, and meeting with people and talking with people and that kind of thing, and sometimes they work out, and sometimes they don't. I mean, there still are other companies and we may have to start looking a little more globally, if we want to continue at the rate that we've been on.

There's becoming fewer and fewer companies obviously in the U.S. for sale, and particularly ones that we think add value. There's lots of little residential companies that are out there right now, some that aren't so little too by the way, but some of them that focus heavily on the DIY market which we aren't really that interested in, and lots of little companies, but we look for companies that do make sense for us, and we think that either they are financially viable or because of the markets they are in and the same markets we serve and that, that we believe we have an opportunity to turn them around very quickly, that's true of Strand.

I mean had we not had Veri-Lite, had we acquired it a few years ago, and felt there was a lot of synergies between these two companies, it's really doubtful we would have acquired Strand. Strand is performing very poorly financially, this company hasn't made money in years, but when we look at the potentials of putting it together with one of our divisions, and this good old name and the markets we serve, and a lot of the rep, just a lot of things that make it a good fit for our Company, and we just hope that we can find more of those companies.

How many are out there? I can't give you a number. There's still a fair amount of these little companies around, and we'll continue to look for them and if they make sense we'll buy them.

Thanks, that's very helpful. And with the split across the segments from JJI, is there any in the industrial segment or is that almost all commercial?

It's really all, I mean there's always some business in any commercial company that flips over a little bit of it in the residential market, and a little bit in the industrial market but if we were really classifying the company in total, this really is a commercial company. It's a very high percentage. I don't know if it's 90 or 95, but a very high percentage of JJI business would fit into the commercial, in the commercial markets.

Okay. And you mentioned industrial may have gotten a little bit of benefit from people taking advantage of the energy efficiency opportunity, and managing the cost side and industrial America. I was wondering if you have any thoughts on the prospects for the government renewing the tax incentives that I believe were included in the Energy Policy Act?

They are. I'm on the NEMA Board and the Executive Committee and very involved, that's National Electrical Manufacturer's Association, and we're very involved in government and they're headquartered in DC, very involved, and they are working very hard with the government to try to get that Bill extended, because the problem with that Bill is it's just now starting to get some teeth into it, and some things are starting to happen and as you know, it expires at the end of 2007, and in my opinion is, it's just the momentum is just going to start going, and if they don't extend it, I'm hoping they will extend it.

Now, if anybody could ever bet on our Congress and that and what they are going to do, that's a $64,000 question, but it just makes all the sense in the world to extend it because hopefully, we're going to be able to show them some momentum that we got going, and let's don't cut this thing off before it gets going, and I think some of the recent things you've been reading about again in California, some of the big metropolitan areas, New York and some of these people, are predicting some pretty significant energy problems yet this summer if it stays hot, and that, and hopefully they are going to see even more need and that, to get serious about energy conservation in this country, and that will do nothing but enhance the chances of this Bill being hopefully expanded and extended beyond it's current timeframe.

Great. And just to finish up on that. So it looks like referring to not betting on Congress doing anything but you're optimistic, the government bureaucracy thing in the past you mentioned the opportunity for courthouses to overall, but that's in the public area, so you're seeing a distinct difference in the industrial area with the tax incentives creating an opportunity, and just the return on investment?

That's correct. So far, that's where the major thrust is happening. And I'm hoping down the road that the government will get serious. As you probably know they are the largest owners of commercial buildings in this country, a lot of courthouses and a lot of people still have the old magnetic ballast at T-12, and there's a good opportunity there, and when they get serious about that, and there's little blips here and there, and there's talk about it doing. We haven't seen a big thrust in that, but hopefully somewhere down the road they get serious about that also but right now, the advantage is really by the companies taking the benefit they are going to get first of all for the tax incentives the government is putting out, and second of all the energy efficiencies that they are going to gain by relighting these facilities.

A lot of the higher efficient lighting solutions have a pretty good return on investment, even without the government incentives, but the government incentives just kind of move things along faster and get a faster return on investment or faster pay back, so we're not going to fall off the edge of the earth if all of a sudden it doesn't get done, but I think it's good for the country, and it's good for energy policy to extend the program, which we'll certainly lobby for.

Great. Thank you very much.

Our next question comes from [Sangam Sogani] from Goldman Sachs.

Hi. I had three questions. Can you tell us what is the weighted average price increase that you have implemented recently?

It's actually very difficult because it's so broad across our product lines, but I would guess it's in the neighborhood of 5 to 6%. Would you guess, Bill?

Probably.

Some goes up as high as 10 and some actually 15, and some go 2 or 3, and it depends on the volume of those items that sell, and the divisions we'll been watching that over time but right now it's hard for us here at corporate because of all of our divisions out there just knowing this mix, and what products are going to sell, but if I were looking at it, I would guess somewhere in the 5 to 6% kind of an average area.

I see. And do you do any kind of hedging of your commodity products at all?

We do not.

No. We have purchase agreements with vendors who may do their own hedging, like we'll have a 3 month or 6-month type of agreement with a vendor at a fixed price, which may be, it's really negotiated type prices, and we expect the vendors to honor those, but other than that, and presumably a lot of those vendors then are going out and hedging that agreement they have with us.

And the second question, when I look at your commercial and industrial segments, can you help us with your end industry exposure? In other words, how much of that is retail, how much of that is export?

Yes, we don't measure that. In the commercial sectors as I've explained to a lot of people there's really four subsectors within commercial. There's Office Construction which is one, Retail which is shopping malls and large chain stores like Nordstrom's or Barnes & Nobel, or the Gap, the Limited, et cetera, that's #2, and the Hospitality is #3, which is hotels, restaurants, theme parks, casinos, entertainment facilities, and then the fourth is the Institutional, which is schools, churches, museums, hospitals, nursing homes, prisons, all of that kind of thing, and they all move a little bit differently.

For the last three or four years the Institutional sector has been pretty strong, Office is just starting coming back of about a three or four year lull, but it's very difficult for us to measure each of those 4 subsectors, so it's hard to comment on. It's more -- you almost have to look at the Dodge numbers, McGraw-Hill, Edison, they have a Dodge reporting service, and they give you some feel for that kind of mix. REIS is another primarily focused on Office Construction. The CV commercial, at [Chrishman] Wakefield, they do analysis on the various markets that we serve, but we're going to move generally with the overall market, but it's difficult for us to measure the end use level.

Okay, that's fair. Third question, when I look at your, you mentioned Residential is slowing down which is fairly obvious, how could that impact your other 2 businesses? What I'm trying to understand, is how easy is it for me to move my capacity from producing residential goods, to commercial and industrial goods, if I am competing in this market?

Well, it's not very easy, because most of the products that we produce for the residential market, let me back up and restate this. If you look at Residential, it really is broken down into two major categories, one is what we refer to as decorative products, the majority of those decorative products are imported from the Far East, and then we have a couple of little factories where we do assembly and that kind of thing, and if that business goes slow, it really doesn't have anything to do with our capacity.

The other major area that does have some impact is in the area of down lighting, which a lot of recessed lighting and to a lesser degree, track lighting goes into residential and in commercial, but we have a certain segment of it that sold big time into residential, primarily the smaller wattages, small aperture, and a lot of incandescent products that go, and obviously if we aren't doing that in our factories we can do more commercial products in those same factories, so in that area it's very easy to switch one off in the other, but on the decorative side of it, which is a significant amount of our residential business, it doesn't really affect our capacity.

Almost all contract manufacturers, 10 or 15 contract manufacturers in China and Asia that we use and so there's really no direct impact there.

I see. What percentage of the residential is imported?

Oh, boy. Percentage imported?

It's a relative. Of our total business or of our residential business?

Residential.

Well of our decorative business, it's probably 80%, but again that's still a relatively small number in total, of our total business. Our decorative business, we don't break out those numbers specifically, but it's not a huge factor in our Company. It would be, it's no more than I guess, not more than like 5% of our sales at Decorative, so it's not huge.

Okay, thanks.

This concludes the Q&A session. We will shortly hand over the call to Mr. Powers foreclosing remarks.

Well, thank you everyone for participating in our conference call today, and we're very pleased with the first half, and hopefully we can do the same thing in the second half, so have a great day.

As a reminder, the conference has been recorded with an audio archive copy beginning available in approximately 3 hours on Genlyte's Group website, www.Genlyte.Com.