Koninklijke Philips NV (PHG) 2006 Q3 法說會逐字稿

Good day and welcome to the Genlyte Group third quarter 2006 earnings conference call. Also, welcome to those of you listening on the webcast. At this time all the participants are in listen-only mode. As a reminder, this conference is being recorded with an audio archived copy becoming 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 third 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. At any time during the conference you may indicate (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 results may differ. We will shortly hand over to Mr. Powers.

Good morning, everyone, and welcome to our third quarter earnings release. I think it's without saying that we were pleased with the results of our quarter. Our core businesses remained reasonably strong and then with the additions of the acquisitions, we had a very strong quarter in overall sales. I'm going to comment in a few minutes about our acquisitions, but those of you who follow our industry may have noticed that several of our competitors in their releases recently talked about one or more companies in our industry choosing to lower prices as the way to grow market share. And then they also stated that they weren't going to allow this to continue to happen, that they were also, if necessary, going to reduce their prices in order to protect market share and/or gain additional market share.

I just wanted to make a comment that it certainly is not Genlyte's strategy in any way to be the low-priced person out there on the street. We have no intentions whatsoever of reducing our pricing in order to grow our market share. We believe that we can better do that by introducing innovative new products, doing all that we can to improve the productivity and efficiencies in our factories and then provide excellent service to our customers. That basically has been our strategy, and will continue to be our strategy going forward.

Just a comment a little bit on our recent acquisitions, JJI was the first company that we acquired this year, back in May, and they continue to do reasonably well. We still have a long ways to go to get them fully acclimated to our way of doing business. We're working with them, everything from insurance to their management incentive programs to pricing to purchasing to whatever. They certainly are moving in the right direction; we're encouraged by some actions that they have taken, and you will see over the next year or so the plans unfold, and they will continue to become more Genlyte-ized, as we call it. We think that as a result of doing that, that we will continue to improve their profitability and continue to grow their sales. So that's moving along quite nicely.

One of the companies that we acquired recently out of bankruptcy, a company called Strand Lighting. For those of you who are not familiar with that company, it's a company that is primarily in the theatrical dimming and lighting business. I'm very excited about this acquisition because I just think it's going to be an excellent company for us. They have been around for approximately 90 years, they have an excellent name in the marketplace. It's kind of gotten tainted in the last couple of years because they got in trouble financially, they weren't able to pay their vendors, they weren't developing as many innovative new products as they should and all of that -- those common problems that cause a company to get in trouble and ultimately ends up in bankruptcy.

However, having said that, we believe with our acquisition of the company and revitalizing that name and introducing more new products and getting them back in a position where they can really service, then we're going to be able to grow that business very nicely.

As you know, we did not buy the European portion of that business, but we have plans to very quickly move back into Europe in a very big way. That was -- a significant amount of their sales were coming out of Europe, and we have continued to do some business in Europe during this time since we have acquired them. But that has been done primarily just being able to quote and sell a few products here in the United States. We have plans to go back in there and open up a distribution sales operation in Europe to really service that country, where Strand is very well-known, and we think that will be an excellent addition to us.

They also have a very good operation in Hong Kong, which we think will help us to penetrate further the Asian market. We are doing a pretty nice job both in Europe and in Asia with Vari-Lite, which is another division of our controls business. But with the addition of Strand and Vari-Lite together, we think we will heavily penetrate those two markets and then continue to do well here in the United States. So I think it's one of those companies that opportunistically we acquired out of bankruptcy and it's going to be an excellent addition to our product line.

The most recent acquisition that we made is a small little company called Carsonite located down in South Carolina. They were opportunistic primarily as that they were in the pultrusion business, fiberglass pultrusion. Our Shakespeare division, which is located also in South Carolina, could use some additional capacity. There were some synergies between these two companies in the utility and municipal markets. Carsonite primarily provides all types of markers, pultrusion markers and that for utilities, municipalities, that type of market. There's a lot of synergies between them and Shakespeare. So we think that will be a nice little addition.

There's not a lot of sales there, but fortunately we acquired both of these companies out of bankruptcy. We bought both of them right, so there is very little downside potential, which I always like when I make an acquisition, and quite a lot of upside potential, particularly for Strand -- much more for Strand, actually, than Carsonite, although Carsonite is a nice company and I think we will continue to improve them and do fairly well with them also.

I also wanted to comment. As you know, last year at this time we were talking about some of the difficulties and challenges we had at our new facility that we opened in San Marcus, Texas, our new HID outdoor facility down there. I am happy to report, as of this time we've made excellent progress there. They're starting to ship their products pretty much on time, and cost are continuing to come down as they gain experience and the efficiencies improve, and we have really made nice progress there.

We're really proud of that facility. It's a beautiful facility with an outstanding training center and, really, a laboratory for outdoor lightings. We have got lots of testing facilities there, and it's just an outstanding facility, and we think that we're going to get our payback many, many times over as a result of that.

So, having said all that, with our sales and earnings having been very strong in the third quarter, I just kind of look out into the future and tell you kind of what we see from here. Assuming that the market stays kind of at or near its current level, we should finish the year with another reasonably good fourth quarter. We have just finished October in our sales, and earnings continue to be reasonably strong.

We do have concerns, as we stated in our release, about these material cost increases. We have just received rumors -- actually, more than rumors, some of the ballast companies have already started calling our people. I actually received a call myself last week notifying us that we're going to see some additional price increases in ballast. We're seeing other commodities continue to go up.

The concern that I have is that if these commodities go up, at what point does that actually start putting a damper on commercial construction? It's been good. It remains pretty active and seems to be moving forward pretty good at the present time. But there's some point at where you have to look and say, how long can these price increases continue?

We have plans on the pricing front to increase prices on many of our products the first of the year, particularly HID products, which we have been notified of recently that we're going to have prices on HID ballast and there's also some hinting now that fluorescent ballast prices are probably also going to go up on the electronics side also. If that continues in that, then we will also need price increases. We're prepared to initiate price increases in order to protect our margins and continue to improve. But again, as I stated earlier, I do have some concerns as to what level of price increases can the overall construction market bear before it starts having a hamper on the commercial construction.

The other comment I would make -- residential, as you can see and I think we all know that residential construction has definitely slowed, and so it hasn't had that much impact. Our residential divisions are -- their business is flat, down slightly in some of our companies. But overall it doesn't have that much impact on our Company.

But the concern that I have going forward is that residential does have a tremendous impact on what we refer to as the light commercial market. It's strip shopping malls, it's banks, it's the hotels, restaurants and that, that all are being built in areas as a result of the boom in residential construction. Because if residential construction stays soft, as some people are predicting it is for some time, then at some point it's going to have an adverse effect on some of these light commercial jobs, too. It also relates to schools, to hospitals.

There's hardly anything in the commercial construction business that isn't in some way somewhat tied to residential. Office space is not quite as tied to it, but certainly these strip shopping malls, branch banks, fast food restaurants, all types of things are fairly closely aligned with residential. If residential stays down for an extended period of time, at some point it definitely will have an impact on the commercial business.

Again, having said all that, the commercial business remains relatively healthy at the present time. I look for the fourth quarter to be reasonably strong, but I would like to point out -- and I think Bill will talk a little more about this -- but a little bit of caution in that we're not going to continue to see the same kind of increases quarter over quarter that we saw in the third quarter going forward.

We just had an exceptionally strong quarter. Bill is going to talk to you about some of the reasons that that quarter was as strong as it was. We obviously are very pleased with the quarter, but I don't think that we can expect that kind of improvement year over year, going forward into the fourth quarter.

So with that I'm going to turn it over to Bill and let him talk to you, and then we will be happy to answer any questions that you might have. Bill?

Thank you, Larry, and good morning, everybody. As you saw from our release, our third quarter sales of $410.4 million are 26% over the $325.6 million we reported last year. The recent acquisitions of JJI and Strand accounted for approximately half of that increase. Excluding the acquisition, sales would have increased 12.1%. Of that 12% increase, approximately half was related to price increases and half was related to volume or unit increases. The foreign exchange impact of translating our Canadian sales at stronger Canadian currency rates as compared to last year accounted for 1.1% of the increase in our sales.

Orders during the quarter were 19.3% higher than last year. Of course, a good part of that is related to the recent acquisitions of Strand and JJI. Excluding those, orders would have been about 12.5% or 12.4% higher than last year.

Backlog actually decreased slightly from the second quarter of 2006 by about $25 million. The third quarter, going into the fourth quarter -- typically, there is a reduction in backlog. If you will recall, in the second quarter we had a fairly large increase in backlog attributed to price increases. So going into the third quarter, we had a lot of activity, a lot of pent-up demand, if you would, in the form of backlog, whereas going into the fourth quarter, as is typical with the seasonality in our business, the business tends to slow down going into the winter construction season.

Year-to-date sales are $1.1 billion, 17.2% higher than last year. Recent acquisitions account for approximately 6.5% of the overall increase. Foreign currency impact translating the Canadian sales at the stronger Canadian rate accounts for approximately 1.5% of the overall sales increase.

Third quarter operating profit of $61.7 million is 50.8% higher than 2004. The operating margin increased to an even 15% compared to 12.6% last year, primarily due to effective price increases, mix and the selling, as Larry indicated earlier, of higher value-added products with higher average selling prices.

Our gross margin during the third quarter increased to 40.4% compared to 37% in the third quarter of 2005. Again, this is primarily due to price increases, mix and acquisitions having higher average margins, as well.

In addition, one of the things that happened during the more recent quarter is that -- as you will recall, we had our price increases that were announced in May and effective in June. Cost increases are working their way through, however. Many of our supply agreements, whether it's ballast or steel or aluminum or paint or even sockets -- we have supply agreements that are anywhere between three months to a year, often three to six months. Many of those rolled off or are rolling off. And so they'll be, as we go forward, eating into or eroding into the overall margin improvements that we've seen.

And thus, in fact, there's even more price increases coming. So we have some visibility, much of it is related to ballast, which is one of our more higher-cost items. As we see these cost increases coming, as Larry indicated, we anticipate additional price increases just to cover those cost increases that we see that will be hitting us probably three months from now.

In addition, other costs have increased as well. As a percentage of sales, our freight expenses increased, our selling and commission expenses have increased. In fact, our operating expenses are 24.9% of sales, which is 60 basis points higher than the comparable quarter for 2005. So, even on a higher volume, our operating expenses for certain areas such as freight related to energy cost increases have increased fairly significantly.

Year-to-date, our operating profit of $156.5 million is 41.5% higher than 2005. The operating margin has increased to 14.2% compared to 11.7% last year. In the net income area, third quarter net income was $38 million, an increase of 73.6% from the $21.9 million that we reported in the third quarter of 2005.

Some of the notable items from the third quarter of 2005 that were unusual or accounted for the percentage increase, in any case, were that during the third quarter of 2005 we had an income tax expense of $3.2 million related to the foreign earnings repatriation of $60 million of earnings that we repatriated and have unusual tax of $3.2 million related to that. Also, in 2005 we had a fairly significant currency translation loss of $2.4 million. Then we had selling and administrative expenses of just under $500,000 and inefficiencies of $1.3 million that were related to the startup of the new San Marcos plant and the consolidation of San Marcos and San Leandro facilities. So that was approximately $2 million worth of extra costs that occurred just related to that restructuring project, which we didn't have this year.

So third quarter, if you take all of that out, would be 41% higher than the third quarter of 2005 on a pro forma, if you would, basis. Our third quarter net interest expense of $2.7 million versus $1.6 million last year -- of course, the three acquisitions that we closed during the period from May until September account for the increased borrowing and increased interest expense as well as an overall increase in interest rate levels.

Our third quarter effective tax rate was 35.6% compared to 44.4% last year. As I indicated earlier, the third quarter of last year included this $3.2 million tax expense related to the foreign earnings repatriation. The third quarter of this year there is some tax true-ups that typically occur during the quarter when we file our annual tax returns.

Our year-to-date net income of $122.5 million increased 99.4% over last year. If you will recall, earlier this year we had some unusual items. The year-to-date net income increased by $24.7 million due to a one-time tax provision benefit related to the change in Genlyte's tax status from Genlyte Thomas Group's tax status, from partnership status to [The] Corporation. Then we had a $4.4 million currency exchange gain related to a return of capital from Canada. So, excluding these items, net income would have been $89.1 million or 45.1% higher than last year.

On an earnings per share basis, then, third quarter earnings per share is $1.32 compared to $0.77 last year, 71.4% higher. Year-to-date earnings per share is $4.26 compared to $2.17 last year, again, 96% higher, with the acquisitions and these tax issues I talked about earlier having a fairly significant impact.

Year-to-date EPS includes the $24.7 million tax provision or $0.86 per share benefit, and a $4.4 million foreign currency gain, which is about a $0.15 per share benefit. Then again, the recent acquisitions are helping EPS as well.

Cash generation -- third quarter cash flow from operations net of capital expenditures was $40.3 million compared to $40.4 million last year, so approximately even. Our third quarter working capital, operational working capital, which excludes cash, cash equivalents and short-term investments and debts, increased 17.6% to $224 million from just under $191 million last year. The increase is primarily due to the JJI acquisition.

As a percentage of sales, working capital actually decreased to 13.7% from 14.6% in 2005. Some of the individual elements -- Accounts Receivable with $245.8 million, which is $35.6 million higher than the third quarter of 2005. However, as a percentage of sales, it's 15% compared to 16.1% last year. So we did a really good job in managing Accounts Receivable with the increased sales that we had this year. Acquisitions resulted in increasing accounts receivable by about $24.5 million.

Inventory increased about $38.6 million to $195 million compared to last year. Again, as a percentage of sales, it decreased to 11.9% compared to 12% last year. So, good improvement in managing inventory as well, from all of our operating people. Acquisitions resulted in increasing inventory by $30.8 million.

One area that we still have opportunity to improve in on an Accounts Payable -- Genlyte seems to pay its vendors a lot better than all of our competitors. Hopefully, our vendors appreciate that with maybe some break on some of the purchase prices that we get from them.

Our third quarter capital expenditures are $6.5 million or $4.7 million lower than the $11.2 million that we incurred last year. You will recall last year we were wrapping up the San Marcos factory project and paying some of those bills, so this is more of a normal rate that we had this quarter. Year-to-date capital expenditures are $17.7 million compared to $32.4 million last year.

In the area of debt, September of 2006 we closed with net debt, which we defined as debt less cash, short-term investments, and the net debt position was $154.5 million compared to a net debt position of $130.5 million in September of 2005, or an increase of about $24 million. Total debt was $191 million compared to $175.6 million in the third quarter of last year.

In the third quarter we have -- of course, in the acquisitions we acquired Strand and Carsonite for a combined purchase price or acquisition price of $14.4 million, which resulted in some of the debt increase in addition to the overall working capital to support the increased sales levels. Year-to-date our acquisition investments totaled $131.8 million including the May 2006 acquisition of JJI.

So with that I will -- that's the end of my formal comments, and I will open the line up for additional questions.

(OPERATOR INSTRUCTIONS). Peter Lisnic, Robert W. Baird.

Just on your initial comments, Larry, about the pricing and picking up share at the beginning of the call, can you give us a sense as to whether or not you have seen any share shrinkage in terms of your business from what is going on in the industry and then maybe give us some color as to what markets some of that aggressive pricing might be happening in?

I don't think that we have seen any significant deterioration as a result of the pricing. We have seen people in spot markets that are out there being very aggressive. I'm assuming it's to take marketshare because they -- people do it for all types of reasons. In some cases it's because they have a weak rep in a territory and they're trying to buy business, or they want to try to penetrate a market that they have never been strong in; there's a variety of reasons.

The major markets that give us the [fits] and usually are created by that are the high-volume fluorescent business related primarily to the commercial office construction and that; that's always been a very pricey business, which we have never understood why people want to sell that business at very low margins.

The other one is the industrial market, where there has been quite a shift in recent years from the typical HID high base over to some fluorescent T-5 high base in the marketplace. Some people have, I think, lost some marketshare and have gotten very aggressive trying to go after that.

Then there's this continual battle at the low-end of the downlighting business, where we have got a lot of foreign competition coming in and everybody's trying to battle it out. We think there's a lot of junky products; we're not interested. We have actually had some of our distributors who have now made a decision to go source some of these products directly themselves from China; in fact, some of them we have met with recently. They would like for us to do it, but we tell them we have no interest in doing it; we think it's counterproductive.

First of all, what we want to do is go out there and convince the consumer and the contractors and the owners of buildings and property that lighting is a great medium and it provides and enhances the quality of people's lives. We want to show people how to sell better lighting and use better products, which are more energy efficient, they are more reliable long-term and they just do a better job.

We think it's foolish -- we're in an industry that requires a lot of capital equipment, particularly in the fluorescent and some of the downlighting business, where we have spent a lot of, you know, millions of dollars to buy presses, millions of dollars to tool for these new products, and we go into the marketplace -- instead of trying to sell the value and that, and stress the importance of good lighting and quality lighting and all that, we go in the marketplace and allow the market to beat us down in pricing and sell on price. So we don't think that's very smart to do that.

I think it's indicative, if you look at the earnings of most of our competitors recently -- everybody has been doing better. Usually, what happens when the market is good then people have a tendency to keep the pricing up a little. Then if you are not doing good, you have a tendency to be the one that drives the prices down. That's what we've seen; the companies that are kind of the weakest amongst the big lighting companies are the ones that we see are, I think, the most desperate and out there trying to drive pricing down in order to get orders.

But the takeaway is not causing you too much heartburn?

It hasn't yet. Now, it may cause us more heartburn, obviously, if the market softens and the business gets tighter. That's when it usually causes you more heartburn. But right now it hasn't caused us a great deal.

You mentioned the industrial business. We were pleasantly surprised at the margin that you put up in the quarter in that business. Can you give us a sense as to how you go from a sub-12% run rate in the first half to near 25% in the third quarter?

Let me talk about that. We're still working on the segment numbers. One of the issues that we're dealing with this quarter, again, are these three acquisitions, the JJI, the Strand and the Carsonite. It's the other category in there, particularly in the theatrical lighting business, that can be classified as commercial and it can be classified as other. So we're working on the categorization of that; in fact, we may even have some changes.

There's a few million dollars there that can move kind of either direction. So I would hold off on drawing too many forward-looking conclusions from those numbers and let us work with them a little bit longer and try to get -- make some sense of comparability there.

Well, I mean even if you just look at the total operating income line, then, I guess if we take the question that way, your operating profit for the quarter was well above our expectation. You talked a little bit about how you might be -- I don't know, I guess at this point getting some excess recovery, if you will, because the contracts from your material suppliers haven't necessarily repriced. Do you have any sense as to how much that might be adding to your bottom-line?

It's difficult to say that, but we know for a fact that that's true because what happened is, is that we got these announcements of price increases on materials and that from our vendors. So, as we went ahead and were proactive and announced price increases -- but some of this because of timing and that, these higher costs have not kicked in. But we just had our [Exec-Com] a week before last, and several of our general managers commented that they were a little concerned about the fourth quarter because they are now seeing cost increases that are going to kick in. Even if we announced the price increase now, our price increases wouldn't be in effect quick enough to offset that. Now, exactly what percentage that is and what, we don't have a handle on that at the present time.

Matt McCall, BB&T Capital Markets.

Bill, could you -- I was a little surprised at the upside on that acquisition revenue. Can you bring down JJI's revenue? I know you've given us some more color on that in the past?

Well, for competitive reasons I would rather not break all of it out individually. If you will recall, as we indicated earlier, JJI in total was roughly $130 million company at the time that we acquired it. It's growing in line with the rest of our businesses.

We had a full quarter's worth of sales from the JJI acquisition, which took place at the end of May, and we had almost a full quarter's worth of sales from the Strand acquisition, which took place in the middle of July.

Now, the Carsonite deal, which took place at the very end of September, we had virtually -- it's almost nonexistent sales during the quarter; it's just getting started up at the end of the quarter. But it's a pretty small business. It was a $10 million to $15 million business even before we brought it.

Well, and I think the thing that we would say, I think, is the total, because if you look at the two acquisitions we made, ongoing, the business we bought from Strand was about a $30 million business, and JJI is about $130 million. So if you looked at it, you'd say, it's $160 million. Now, is it going to continue to get better or worse? We're not sure of that.

But I think the Strand business will definitely, over time will improve from that rate. They had approximately $20 million worth of business in Europe that we basically said we don't have at this point; we are going to go back there. How quickly we're able to get that powered back up and take advantage of that, we're not sure. But we're hoping not too long.

And as Bill said, the JJI business has continued to move along fairly nicely. They haven't grown quite as fast as our systemic growth within our companies, but they have been doing reasonably well. So if you just look at the two of them, you are roughly talking $150 million to $160 million worth of volume, which would be like, what, a 10% to 12% increase in our sales year-over-year.

About $40 million a quarter, roughly.

But it was a little better than that in Q3, correct?

It was a little better than that, yes. They actually exceeded or slightly exceeded our expectation. The whole industry is doing better.

Well, you guys exceeded mine, so that's why I'm trying to figure out why. You commented last quarter about the profitability in the EPS impact from those acquisitions. Can you give us any idea what that was this quarter?

I can give you kind of a bottom-line impact. Let's see. One of the issues -- it's a little dangerous to do that, and we will break out more of that in the 10-Q for you. Let's see. The impact from all of the acquisitions was approximately $5.7 million. However, included in there is a step-up or the expense of a step-up from the amortization of backlog and profit that's in inventory at the time of the acquisition. So that all got burned off. We had one month of that, during the month of June, for JJI; it's about a three-month burn-off. So that also took place during July and August. Then for Strand we had a little bit; it wasn't too much inventory or profit in inventory when we did that deal. So those step-up amortization costs will be -- they're behind us now and we won't have that impact going forward.

So the impact, can you give us an idea of what that was? Is that 5.7?

It was a little under $2 million. No, I think it was about $1.5 million.

You mentioned San Marcos. Was it still a hit to profitability? So, like it was a lot better but was there still a hit there?

0h, no. There wasn't a hit. It did very, very well. I mean they --

Relative, I guess, to the Company? I mean it was not at company levels; right?

Well, it's at company levels. What happened was is that we took a company that, in Gardco, that was producing products in San Leandro, California. If you know anything about -- particularly Northern California and all that -- and now we've got them in a much more efficient, much lower cost facility. Their earnings -- Wide-Lite was already down there, so it didn't really have that much impact on them, but the improvement had a significant improvement in regard to them.

But there's the inefficiencies, the year-over-year inefficiencies that we had during the first half of this year. I mean we've recovered most of them and there's still a learning curve. I've been through a lot of these factory startups and it seems like it takes two years before everybody is at the peak of their performance.

But relative to -- again, they started out at a pretty bad level, too, but in California, and separated. So I think we've recovered the inefficiencies, and there's probably still some room for improvement. But it's marginal room for improvement at this point compared to the leap step type of improvements that we've seen over the last few months.

Last year one of the things where we got hit really bad is where our service is so bad we couldn't ship. Then we had all this new overhead in that we were hiring all these new people and all the inefficiencies and that. On top of that, we couldn't ship. So you get kind of a double whammy. Whereas this year, we're shipping at a much higher level, and now we've got the people.

Like Bill said, we've still got some inefficiencies. We're still having some turnover of people, we don't think we have all the right people in the right jobs at the present. But they've made substantial progress there.

And Larry, one more question with a follow-up on your residential comment. I wanted to make sure I was square on what you were saying. It didn't look like there were declines yet showing up on the topline residential, yet you're saying going into -- I guess, just kind of repeat and go over what your outlook is for your residential segment, in Q4 and then into next year.

What has happened is, is that residential and particularly the decorative products that we sell into residential, which is a significant amount of our residential business, is very late in the cycle. So a lot of these homes -- everybody has talked about this year the residential market turning down, and it definitely has. But our residential business as far as shipments each quarter has gone down a little bit, but still, up until this last quarter, I think it was still slightly over prior year but at a declining rate.

Now, going into the fourth quarter is probably the first time we'll actually see our residential shipments below prior-year. Our order input has definitely been below prior-year for the last two quarters in that. So we're going to start seeing an increased impact on that.

But again, you have to realize that we don't have -- the majority of our businesses is commercial, it's not residential. So we're going to have some impact from that, but it's not going to be a dramatic impact on that.

The biggest impact on it probably will be in some of our residential downlighting business, where we do have a pretty nice position in certain markets, and we have definitely seen that slow. Our commercial downlighting business, on the other hand, has been very good and offset that so far. Now, when will those two cross over? I'm not sure. But so far the commercial has been very, very good.

And the declines -- obviously, if you look at housing starts, it's been pretty ugly. What kind of declines are you anticipating year-over-year?

Well, when you say what kind are we anticipating, you don't know me very well, but I never anticipate any decline.

I had to ask.

Right. And I certainly don't ever tell my [debatients] that they can decline. But if you look at the housing starts, there's no question that housing next year is going to be down substantially. It's already down this year and probably going to decline somewhat further next year. Now, it's still at a reasonably high level. Of course, what we say to our people is we've got to go get a larger market share and be smarter and sell the higher-quality, better products. We're hoping not to have a big decline in that. Now, realistically, we're going to see some decline.

One thing to keep in mind and we've talked about this in the past, I just want to remind you, that the lighting as opposed to other building products is not as cyclical. If you are in the concrete or cement business or the drywall business or the building steel business or roofing materials, brick, glass, whatever, you're going to be very much tied to new construction.

Lighting clearly is tied, but the refurbishment activity is there as well. So even when buildings are discontinuing being built -- new buildings -- there's still a certain amount of people doing remodeling and refurbishment activity.

Now there's more so in commercial because people are moving from one building to the other as their leases expire, but there's still a certain amount of refurbishment activity in residential as well. So we will continue to see some of that.

And then, in addition, in residential, there's shifts between single-family and multifamily. There's other things going on as well. Then again, some of the residential moves into commercial and vice versa, as those markets move in certain markets were projects that were residential properties, as the commercial market picks up, turn into small offices for startup companies and that type of thing. So there's some substitution factors going on as well.

Alex Rygiel, Friedman Billings Ramsey.

Gentlemen, another great quarter. Two questions. First, with regards to the tax rate in the quarter, Bill, you mentioned that there were some tax true-ups. Did they help or hurt the quarter?

They helped the quarter. Typically, with the new rules for the way that we account for taxes, the rules require that we, during the fourth quarter, first quarter and second quarter, we accrued taxes to what our estimate of what the exposures are. As the statutory provisions fall off or returns that were filed four years ago, whatever, and there's issues that get resolved. When the statutory expires, we then reduce reserves or release reserves, whatever, for those tax positions, during the quarter that the statutory rules expire.

So unfortunately, we can't smooth it out or even it out as the new rules require that it's higher in three quarters and higher or lower, depending on how things work out, in the quarter that you file the returns.

With regards to San Marcos, it sounds like that's up and running full speed or almost full speed. Do you have plans for a San Marcos Act II?

If you recall, since we did the Genlyte Thomas merger in 1998, we have consolidated or merged at least one factory or one operation every year. Now, with the more recent JJI acquisition, that gives us some opportunities to look for additional combinations of facilities. We're very rational and careful. The number one thing we try to do is maintain customer service and do it as seamlessly as possible from a customer service perspective. But it takes us some time.

But yes; the short answer is yes. We have -- I think there's over 35 factories now, and there's plenty of opportunities. There may be some in San Marcos. There's some opportunity for some other -- some of the old facilities in San Marcos that we could use for other manufacturing operations. But there's a lot of other factories out there, as well, that we could do some cost synergies with.

One of those right now is in San Marcos. We took the old main facility, as we called it, that Wide-Lite had, that they moved out of, and Hadco has a small operation across the street, but they don't have a paint facility. It's kind of small, we can't expand it much. We're expanding that right now. That's a minimal cost, but that will be a productivity improvement.

We're looking to potentially do some things, more things, in Mexico and possibly even do something in China a little more aggressively than we have been. These are all things that we have out there that we're exploring. With the JJI acquisition and the Strand acquisition both, we will continually look for facilities. Those facilities that aren't -- most of the JJI facilities aren't up to what we would call our standards of manufacturing. Those ones that we keep we will look to modernize, make more efficient, improve, whatever. And then if we're not going to keep them long-term, we will look to decide where we're going to put that production and at new and better facilities.

Christopher Glynn, CIBC World Markets.

Last quarter you commented a little bit, Larry, on the market emerging a little more for the sale of energy efficiency products and some of the retrofitting based on the Energy Policy Act tax incentives and the general return on investment. Can you comment on the further development of that market?

Yes, it's moving forward. We have several of our divisions now that have put out brochures and are really going -- particularly after some of the government type businesses. If you look at the largest owners of commercial real estate in this country, it's our federal government. They supposedly have committed to doing, in a lot of these retrofits, a lot of the federal courthouses and places that are still using a lot of inefficient lighting. We're on a campaign and I think we're starting to see some benefits from that. I can't say that they are overwhelming, but we're hoping that we'll see some nice benefits from that next year.

The important thing for that bill -- I happen to be on the NEMA Board of Directors, and we're going to be having, in fact, an annual meeting for NEMA -- that's the National Electrical Manufacturers Association -- meeting is in Washington, D.C. next week. It's going to be critical, I think, that we try to get that bill extended because if that bill expires at the end of 2007, then I think the momentum for that is just going to get up and kind of get going. Hopefully, we can get the government to extend that. With all the things going on in politics today, who knows how successful we're going to be.

But if we are able to do that, I think it can have some big impact over the longer-term on this retrofit. In the short-term it's having some positive benefit, not anything big and outstanding. But we're definitely seeing some business as a result of that, and it is giving our salespeople and that a lot to talk about, a lot of things to promote to people under this new Energy Act.

So what you're seeing out there now with some activity in the short-term, and that's differentiated from just the market of an improving mix of newer energy-efficient products into new construction. You were speaking to the retrofit activity?

That's correct. We're seeing some people get more serious. And then I think there's a lot of emphasis coming, again, from the federal government and from big companies and people looking at it and saying, look, we want to have green buildings, we want to be environmentally correct. So we need to take a look at the opportunities to upgrade our lighting.

There's still a lot of lighting fixtures -- we estimate, we don't know the exact number but somewhere between 600 million or 1 billion old, magnetic ballasted fluorescent fixtures that's a nice opportunity for somebody to retrofit that whole market over the next several years.

In terms of the tax incentive from the Energy Policy Act, would like to see that extended. But what about just in terms of the energy cost savings? I've heard that is actually a bigger economic incentive. Can you talk about what the payback is also just in terms of the energy savings to taking out some of those older fixtures and putting in some of the newer ones?

Yes, it's still, if you look at it, you take a typical company and what you'd love to be able to do -- we've always felt that if we could ever get it to where we could show people like a two-year payback, it would be a fantastic sell and you could really get everybody excited. It's still not quite to that level yet; it's getting better all the time. It really depends on the building and what lighting you're using and how you're -- it's just hard to generalize on the opportunities. But there are opportunities to get some decent payback. The problem is getting people to want to pay the upfront costs to go in and do all the work in the retrofit and that. But you're talking three to four-year paybacks on a lot of this stuff.

(OPERATOR INSTRUCTIONS). Justin Maurer, Lord Abbett.

Bill, would you mind, as it relates to price increases, just kind of walking us through what you guys have done year-to-date? I know the last was June; correct?

Yes.

And just kind of get a sense -- I know, to Larry's earlier comments about kind of fourth quarter visibility, to what it's been so far this year, maybe a little bit dimmer if the costs keep going up on you, but I just kind of want to get a sense of magnitude there.

The price increase that we had -- well, we had a price increase in June of this year that was announced in like May or so, that was anywhere between 5% and 15%. Some of the products, the magnetic ballasted products, were in the 15% range and other more commodity-like products were at the 5% range. As I indicated earlier, year-to-date about half of our sales increase including acquisitions or about 6% is from price and then 6% is from unit. So, does that --?

Yes, I'm just trying to get a sense of fourth quarter. I mean, is that 6% -- can you (multiple speakers) --?

Yes, it's fully [eroded]. So it's going to erode; it's about as good as it gets, in other words. The price increase that we got in June was just that. But to these cost increases that we have talked about, from ballast and steel and paint and things -- the supply agreements that we had, that we put in place maybe a year ago or six months ago, have eroded off. Many of those materials, as we get the new agreements, have gone up in price.

So now we'll be paying higher costs for those materials. Now, hopefully, we get some additional material usage synergies and labor synergies and things like that going forward. That's one of our goals, is to always try to offset the cost increases with productivity improvement. But that's not always -- especially when costs are going up -- like, for example, in freight, where we've had these huge fuel surcharges, it's almost impossible to offset them. The costs keep going up and our price increases are kind of lumpy.

As we indicated before, we are seeing more fairly sizable cost increases coming, particularly in the magnetic ballast area. For example, our composites business that uses a lot of resin, which is a hydrocarbon, petroleum-based material inputs -- those businesses have seen some fairly significant cost increases. So they need additional price increases going into the first part of next year. We will announce them, we'll let our customers know, give them a visibility. Then they will be effective probably with the beginning of next year.

It may not be across all of our products, we haven't figured it all out yet. But there are certain products that, clearly, the costs are going up a lot faster than the price protection that we have been able to achieve.

Just piggy-backing off that, though, to Larry's point about maybe being a little bit concerned that you don't want to push -- meaning you as an industry don't want to push it too hard to the extent you could stifle some demand. Are you taking maybe a little bit more cautionary approach?

We're going to be competitive. Obviously, you can't be that -- especially on the commodity type products, you can't be the highest guy out there or no one is going to buy from you. We will monitor it market by market and we monitor it competitor by competitor and make sure that we're competitive.

On the other hand, what we hear from our vendors is they are increasing their costs or the price we pay for materials not just to us but to all of our competitors as well. So I presume everybody is in the same boat.

The difference -- I just want to add something to what Bill said -- is that we don't go out there and drive and push for those commodity products and try to stay down in that low-end market. What we do is we try to get our people to sell better lighting, a better mix of products, the higher-quality stuff. So it doesn't really have quite as much impact, I think, on us as it does some people that really, they just lead with price. That's where they go every day.

I think one of the competitors today not mentioned on one of the calls this quarter that they are seeing some signs maybe a little bit of price competitiveness creeping back in. But maybe that is on that low-end?

Well, it is, and it's by a company that I think is struggling in certain markets, so they get aggressive in pricing. We just think that's a foolish way to lead, with pricing. In the long run, unless you have got a huge cost advantage -- and if you look at our industry, nobody -- we all buy ballast, we all buy steel, we all buy aluminum. There's no one company, in my opinion, that has a huge -- and when I say huge, I'm talking about a 15% kind of cost advantage. You can't win a price battle and be a good company over time unless you have a huge cost advantage. I don't think people in our industry have a huge cost advantage; it's just the nature of what we buy. We're not prime suppliers of most -- we all buy steel and aluminum and ballast and lamps and those commodities and so there's not that much difference in the pricing.

And just lastly, in SG&A, how much of the increase was the transportation? Was it the majority of the year-over-year increase, Bill?

It was fairly evenly split between the transportation cost and the commission cost and selling expense cost. Again, with the higher -- one of the ways that our commission structure works is, as our salespeople or reps sell products at higher margins, the commission levels tend to be higher. So, and with the focus on the higher value-added products and the higher-margin products, the commissioned rate, if you would, it's higher than it is for the commodity, stock-and-flow, type of products that would be out there.

How about bonus accruals?

That's part of it, too. That goes up along ratably with the increase in profitability.

Thanks, guys. Great job.

Peter Lisnic, Robert W. Baird.

Bill, the fourth quarter tax rate -- or not the fourth quarter, but it looks like you trued-up to around a 36% tax rate. Is that a reasonable guess for next year?

No; I think you need to probably be higher than that.

Back to 38% or 39%?

I'd go back to 38% or 39%.

One of the things that we do, one advantage that Genlyte has is that we have this fairly significant presence in the United States for service. Our Company tends to be more of a project type business where service is extremely critical. So we have our manufacturing footprint relatively close to where our customers are, and we can meet demand for short-order turns, et cetera.

Well, with that goes the benefit of IRS Section 199 manufacturing tax deduction. So we get an increasing benefit every year for the next couple of years related to the manufacturing deduction for having this presence in the United States, especially relative to some of our competitors. So that's a good thing from two perspectives; number one, customer service but number two, also getting that manufacturing deduction.

So that should help a little bit. On the other hand, there's some of our competitors that are headquartered offshore from a tax perspective, so they get some fairly significant benefits from being Bermuda-based or whatever. So we pay higher taxes, because we are a U.S. entity.

On your commentary regarding price increases that are coming, can you give us a sense as to what you're hearing or seeing in terms of price increases coming your way? What are the ballast guys telling you? I'm just trying to get a sense of the magnitude that might be coming.

We're really don't know much yet. There's just kind of feelers out there. We're just hearing rumblings of a 5% to 10% on some of the HID ballasts and that. But I don't think we know enough yet. I just wanted to be sure that we made everybody aware that we are hearing rumblings and there are some discussions about it.

We also were just told last week that there's probably even going to be some increases on the electronic side, which we haven't seen for some time because there's not much steel [and] aluminum net in the electronics. I was somewhat surprised myself that the market -- but I think people are looking to do what they can while the market is reasonably strong.

[George Mellis], Lord Abbett.

I have a follow-up on a previous question on the margin in the industrial and other category. Is this just a matter of reclassification or classification between different divisions?

Yes. It would be classification between the commercial and the other.

So there's no one-time thing in there?

No, well, I mean it's a classification issue. Not like the earnings are going to go away, it would just move from one bucket into the other.

And then I have a follow-up on the material cost increases -- I'm not quite sure how to ask that question, but if you include ballast, steel, aluminum, all these sort of material things that you buy from the outside, and of course, that your peers buy also from the outside, how much of the cost of goods sold is that, roughly?

It varies by product line significantly, but 65% to 70% of our costs.

So 65% to 70% of your costs is basically purchased products, purchased goods?

Well, materials that -- yes. We buy -- none of us produce our own steel. None of us -- there are some people that produce some of their own ballasts. We all do it differently. We're probably as fully integrated and in some of our businesses more fully integrated manufacturing than many of our competitors; it's all over the place. But for us you can figure -- it's kind of, on average, it really varies. It goes all the way up to 80%, down to not that much percent, depending on what product. But probably a good average would be, I would think, wouldn't you, Ron, in the 65% to 70% range, somewhere in that neighborhood?

On the contracts you have for those materials, is any of those contracts longer than a year?

Very seldom are they longer than a year. Many of them are for a year, but many of them are even shorter term than that. What usually happens when people start seeing inflation and commodity prices going up, everybody shortens that cycle.

Like on our lamps, there's a lot of things that we basically don't have any long-term contract. They're usually reasonably good at giving us a little bit of time, although that has been shortening too, when they announce a price increase. They usually give us a little bit of time to implement the price increase. But again, we've noticed that that time cycle has been shortening also.

And gentlemen, I am showing no further questions at this time. This concludes the question-and-answer session. We will shortly hand over to Mr. Powers for closing remarks.

I just, again, thank all of you for participating in our conference call today. We appreciate your support and hope to do everything we can to keep our sales and earnings growing. So again, thank you very much.

Ladies and gentlemen, thank you for your participation in today's event. As a reminder, this conference has been recorded with an audio archive copy becoming available in approximately three hours on Genlyte Group's web site at www.Genlyte.com. Thank you for your participation and have a great day.