Koninklijke Philips NV (PHG) 2007 Q2 法說會逐字稿

Good day, and welcome to the Genlyte Group Second Quarter 2007 Earnings Conference Call. Also, welcome to those of you listening over our webcast.

At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded with an audio archive copy becoming available approximately three hours after the conference on Genlyte Group's website at www.genlyte.com.

This conference will begin with an overview of the 2007 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 discussions may include forward-looking statements. These statements are based on our view of the world today and, therefore, are subject to risk and uncertainties which are discussed in more detail in the Company's most recent Form 10-Q. Obviously, actual future results may vary. We will shortly hand you over to Mr. Powers.

Good morning, everyone, and welcome to our second quarter 2007 call. As I stated in the release that we put out this morning, in our earnings release, I was reasonably pleased with our sales for the quarter and certainly for the first half, based on the tremendous downturn we've had in the residential business. And even though residential only represents I think roughly 15% of our sales, but when those sales are off 25% to 30%, as they are for us at this point in time, that means we have to do a very good job on the commercial side just to equal sales.

And then to have our sales up, I was reasonably pleased with that because it's -- the market is not that strong certainly on the residential side. And when we see even some softening of what we call the light commercial market -- strip shopping malls -- for some reason, we're not seeing the big influx this year of school business that we have seen in the past. Usually this time of year, we are getting a tremendous input for schools that will open in the fall, and that school business has been relatively soft this year.

There's still a lot of large, significant commercial projects out there. We see that business. That remains pretty active, and we believe that that's going to continue to be very active through the remainder of this year and, hopefully, well into 2008 and beyond.

What we have seen, however, as I've already stated, is some softening of these stock and flow business, the small jobs that are bought through distribution. Last year in June, we had a significant price increase, and we got a very large influx of orders last year as a result of that price increase. And that helped us to have an excellent June and also helped us to get that carried over into July, where we had a big backlog that we carried forward.

Well, this year, although we've announced a price increase ourselves, all of our competitors didn't announce when we did. In fact, they have now all announced. But it looks like the majority of this price increase that we hope to obtain will be pushed back probably until about the 1st of September because of some of our competitors and the delay in the price increase.

We do believe and we do definitely need a price increase based on what we're seeing from the materials cost increases. They are -- the materials cost increases this year are somewhat mixed. Steel is -- remains relatively flat, in fact, came down just a little bit. It's kind of bumped back up here lately just a little bit more, but it seems that steel is relatively stable. Copper is still continuing to go to new heights, and we don't see really any end in sight.

There is a tremendous amount of pressure being put on basically all the commodities by primarily China, India, some of the other nations that their economies are doing relatively well and they're trying to build their infrastructure. And I don't see that slowing down or backing off anytime in the near future.

So having said all that, we are continuing to focus, as we have in the last several years, on innovative new products. We had our semiannual -- no, our every other year LightFair, which is our big industry trade show in New York at the Javits Center back in May. And at that meeting, we got lots of accolades. We introduced numerous amounts of exciting new products.

Lightolier, one of our largest divisions, in fact, not one of our -- our largest division introduced an exciting new PL downlighting product called Uniframe that has been met with unbelievable acceptance. It's kind of one of those products that if you're in the commercial construction business, and you have a grid ceiling and you don't use this product -- if you're contractor or a general contractor -- you're making a big mistake because this is an outstanding performance product, unbelievably easy to install and very competitively priced. It is just one of those exciting new products that we hit on from time to time that we think is going to be a real home run.

And besides the new products, the other things that were doing. We just completed the renovation of a new Tech Center at our Tupelo, Mississippi, facility where Day-Brite Capri Omega, our second-largest division, is housed. We've just completed an array of meetings where we brought all of our reps in from around the country, showing them the new Tech Center and training them on a lot of the new products we've had.

And now we're starting to have visitations with lots of our major accounts. We're going to invite a lot of our major distributors, architects, engineers, lighting designers to this facility and train them on the benefits of using our high-quality products. And this is kind of an exciting new opportunity at this facility because they really haven't had an adequate training facility in the past.

Lightolier, Lightolier Canada, several of our divisions -- Gardco Wide-Lite -- have an excellent training facility down in Texas, and we do that. But that's one of our real strength is continue to train and teach people how to use and install better lighting. And I think it's particularly appropriate today with some of the new energy bills and that, that some of the new energy legislation that has come about gives us an opportunity to sell people on the opportunity to upgrade their fixtures and also save money.

A couple of other major things that are going on. We are in the process -- as you know, we have acquired particularly JJI, and we've got some major things going on there. We hope to be in there early next year. We had a little bit of delay on the lease in a facility in Luedenscheid, Germany, where Hoffmeister is located. They're in a very old multi-story plant. Very, very inefficient, and we're moving them into a -- it's not a brand-new facility, but it's a newer facility fairly close by, one-level plant.

We think we can improve a lot of productivity, significantly improve their profitability when we complete this move. That will be completed sometime early next year, certainly by the end of the first quarter. We're hoping maybe even a little earlier than that if we can get the people that are in that building to vacate a little earlier.

We also have one other major renovation that we'll be taking underway. One of the facilities that JJI owned in Shelby, North Carolina, we've made a decision to upfit that plant. It's the only facility that JJI owned, but we believe it has a lot of potential. There is a very good workforce there, very competitive wage rate and that in Shelby. It's located about 40 miles straight west of Charlotte, North Carolina, which is a great place to live.

And we think it provides a lot of opportunities for us to consolidate at least two and maybe three or four other smaller facilities into this facility once we get it up and running. So we think that's going to bring some real opportunities for us going forward over the next year to 18 months.

It's really, really hard for me to give you much of a prediction on the economy at this point. I kind of read. I know about the same, I think, as all of you know. It looks like the commercial business is going to stay relatively strong. And if it continues at the current price how it is, I think our performance will continue to be reasonably good.

I'm hoping that we are at or near our bottom as far as the residential market is concerned. We don't think it can go too much lower, although it still, still continues to deteriorate a little it seems like almost every month. But hopefully, we've seen bottom or we will see the bottom in the near future. And with the commercial construction business kind of ramping up, we hope, we should be able to continue to do reasonably well in the second half.

So with that, I think I'll turn it over to Bill and let him talk to you, some of the more specifics on our financial performance, and then we'll be happy to answer any questions you might have. Bill?

Okay. Thank you, Larry, and good morning, everybody. As you saw from our release, our second quarter sales of $408.9 million are 11.7% over 2006. Acquisitions increased our sales by $36.1 million during the second quarter. Excluding acquisitions, sales increased $6.7 million, or 1.8%.

There are three factors that you would need to look at when we dissect or reconcile the sales. Our results for the second quarter of 2006 included a spike in shipments of approximately $7.5 million, and this is just an approximation or an estimation, which is about 2% of our sales, which shipped in advance of the price increase that occur during June of 2006.

Our residential -- our comparable residential and industrial segment operations experienced a sales volume decrease of $11 million, or approximately 3% of our total Company sales. This was substantially offset by the commercial segment sales increase.

And then prices, our price increases we've estimated to account for 2.2% of our sales increase for the quarter. These numbers get a little bit difficult to reconcile because we've had four acquisitions during the previous calendar year or previous 12 months. And in addition, trying to break out things between the commercial, residential and industrial segments from a volume and price perspective, it gets very difficult to do that and I'm doing my best to give you what those numbers represent.

Our year-to-date sales of $803.3 million are 15.5% higher than 2006. And we've discussed the first quarter numbers earlier this year, and now you know the second quarter numbers.

Operating profit of $60.1 million is 17.2% higher than 2006. We're very pleased to report that the operating margin has increased to 14.7% of sales versus 14% last year. I might also point out that this includes all of our segment operating expenses and all of our corporate operating expenses for Genlyte are included in these operating margins. And this improvement in the margin is primarily due to the effective price increases, increased volume in the commercial segment and then product mix from selling higher value-added products.

During the second quarter, our gross margin increased to 40.6% from 39.4%, which was recorded in the second quarter of 2006. This is primarily due to the increased volume, premium product mix, price increase and continued cost controls. I might also point out that in the second quarter of 2006, we had a very significant gross margin improvement over the prior year. So we have some very nice year-over-year gross margin improvement two consecutive years in a row. However, we are experiencing continued year-over-year cost increases, as Larry pointed out, in aluminum, zinc and other materials, as well as in employee benefit-type costs.

Our operating expenses of 25.8% are 70 basis points higher than the second quarter of 2006. The drivers of these increased expenses are primarily acquisitions, and specifically selling expenses and commissions and foreign currency translation costs or losses related to working capital transaction losses.

Our operating expenses, actually excluding acquisitions and the foreign currency losses, were actually lower at 24.1% of sales for the second quarter of 2007 versus 24.8% in the second quarter of 2006. And hopefully, with additional time and working on acquisitions, we'll be able to bring those operating expenses lower. And with some of the restructuring activity that Larry talked about and some additional facility consolidations, we'll be able to get costs lower as well.

Our second quarter currency loss, due to translating the Canadian working capital to U.S. dollars, is $2.3 million compared to $1.1 million in the second quarter of 2006. That relates to the conversion of our Canadian divisions operating profit at a 2.2% higher average exchange rate, and that related -- I'm sorry, the conversion of the division's operating profit at a 2.2% higher exchange rate related -- resulted in an increase of $206,000. So the working capital translation resulted in a $2.3 million loss or expense, and the working operating profit translation resulted in a $200,000 benefit or a $2.1 million net swing.

Our year-to-date operating profit of $118.2 million is 24.6% higher than 2006. The operating profit margin for the year has increased to 14.7% versus 13.6% last year. Our net income of $37.4 million increased 4.1% from the $35.9 million reported in 2006.

It should be noted, as we pointed out in the press release, that the second quarter of 2006 income before taxes included a $7.2 million foreign currency exchange gain related to the return of capital or cash from Canada, which was used for acquisitions during 2006. The net income impact of this return of capital from Canada was $4.4 million. And excluding this gain, the net income actually increased 18.7% rather than the 4.1%, which includes the $7.2 million last year.

Our year-to-date net income of $72.3 million decreased $12.2 million from $84.5 million in 2006. It's important to point out that in the first quarter of last year we included a one-time net tax benefit of $24.7 million, and of course, the $7.2 million foreign currency gain that took place in the second quarter last year. Excluding these two items, net income increased 30.6%. So it's a pretty nice improvement after excluding these unusual type of items.

Our earnings per share then in the second quarter were $1.29 compared to $1.24 last year, or 4% higher. The second quarter earnings per share, excluding the impact of the $7.2 million foreign currency exchange gain, would be, on a pro forma basis, 18.3% higher.

Our year-to-date earnings per share are $2.49 compared to last year at $2.94, which is a 15.3% decrease. However, our 2007 year-to-date earnings per share, excluding the two items -- the $24.7 million tax provision, which equates to $0.86 per share, and the $7.2 million foreign currency repatriation item, which is $0.15 per share -- so, after excluding both of those, our EPS would have been 29% higher.

Cash generation, second quarter cash flow from operations net of capital expenditures is $16.4 million compared to $16.3 million in 2006. Our second quarter working capital, less cash and short-term debt, increased $245.5 million from $238.3 million in June of 2006 due to sales growth. Working capital as a percentage of annualized sales actually decreased to 15% of sales from 16.3% of sales last year.

Accounts receivable of $241.5 million is $4.1 million higher than last year. And as a percentage of sales, it has decreased to 14.8% from 16.2% in 2006. Inventory also decreased $3.1 million to $186 million. As a percentage of sales, it's decreased to 11.4% of sales from 12.9% last year.

Our second quarter capital expenditures were $8.4 million, $2.2 million higher than the $6.2 million we reported in the second quarter of last year, and our year-to-date capital expenditures are $17.7 million compared to $11.2 million last year. We closed June of 2007 with debt less capital -- less cash and short-term investment position or net debt of $77.2 million compared to net debt of $182.3 million in June of 2006 and $71.2 million in December of 2006.

I think, as many of you know, we generate a significant amount of cash during the second half of the year and actually the fourth quarter, fourth calendar quarter and our fourth quarter is a usually a pretty big cash flow quarter for the Company. Our total debt then is $143.2 million versus $222.6 million in the second quarter of 2006.

And then our second quarter cash and short-term investment balance was $66 million versus $40.2 million in the second quarter of 2006. So our balance sheet is very strong. And if you exclude these unusual items from last year in the tax and the foreign currency or foreign currency repatriation issues, we actually had a very good quarter from an earnings perspective. And of course, there are some unusual reconciling items in sales that once you understand those, I think that it looks a little bit better as well.

So with that, I will open up the line for questions and --

Thank you, Mr. Ferko. We will now poll for questions from analysts.

(OPERATOR INSTRUCTIONS)

Our first question is from Robert McCarthy from Banc of America Securities.

Good morning, everyone.

Good morning.

Good morning, Rob.

Can you hear me? First, Larry, if you could just kind of touch on your comments again about commercial construction? You're talking about this residential spilling over into light commercial? And could you just talk about educational again? I mean, how should we think about the back half of the year playing out, given what you're seeing in terms of your order intake right now?

Well, again, I wish I could give you more precise information. It's just that typically when you have large growth in residential construction -- I use Louisville, Kentucky, here where we're headquartered, as an example. Here in our corporate office buildings just east of us, we had a big boom in residential construction. It's kind of the real growth area of Louisville.

Well, as a result of that, up and down -- there's several major highways here -- the one we happen to live on here is Hurstbourne Lane. Well, they built several hotels and small strip shopping malls and restaurants and all these kinds of things. Not too far away here, they just build a new Costco store. They've got a new hospital that's going in there. There have been lots of schools and that that have been built out here as a result of that.

Well, that all happened as a direct result of this residential construction booming out here on this side of town. And if you take that and you looked out across the country, you have a six months to a year, sometimes up to 18 months lag in that. And I think what we're seeing to some degree is some softening of that what I, again, characterize as light commercial that follows that residential. Branch banks, again --

Larry, how much of your sales do you think are directly tied to this light commercial tranche?

It's very -- I mean, it's very difficult to tell because we don't -- we have no way, really, of officially breaking that out. We just see it in the quotations and that.

Right now, the encouraging part of our business, our national account business, which is primarily retail construction, and that usually -- we specialize and we have more business in a lot of the higher end. You have the Nordstrom department stores, those types of people. That business is still very strong. We're doing very well there. Major office construction, major -- some of the major hotels, that part of the business is pretty strong.

It's some of this smaller kind of day in, day out business that we've definitely seen some softening of. But it's hard for us. We get all the statistics like everybody else, we look at it. When you look at the overall commercial construction business, it still looks very strong and looks to be pretty good. And we agree with that because we see a lot of major projects that we're quoting.

And it's also somewhat regionalized. I mean, the areas that have been hit really hard by residential constructions -- the Phoenix, Arizonas; the Miamis; the Las Vegases. Although Las Vegas, because of the casino businesses, is still pretty strong and that. But a lot of the business that goes along again with the residential construction in Las Vegas, we've seen that business very softened.

But it's really hard for us to give you an exact number as to what percentage. We're a little bit surprised in the school business ourselves. We usually get a -- I mean, it's not like it's a huge percentage of our business, but we always kind of midsummer get a little blip up in business as a result of schools. And we just -- this year, we had our meeting yesterday with all of our managers, and we just talked about it. And we just don't seem to have seen the number of school projects and that that we're quoting and selling this year versus last year.

And that could be tied to that residential tail as well?

It could be, to some degree. The things that we see that are good -- health care is staying very good. One of the things we did in our Company this year, we actually created a kind of healthcare division. We got people out calling on specializing in healthcare, and we see that. That's very active, very good.

The hotel business is still pretty good, and of course, major office construction is still very good. Those areas we all see as very positive. It's just some of these other smaller, some are kind of stock and flow good business. Lightolier, which is our premier architectural line, they're doing very well. Our outdoor businesses today, which is really not affected that much by the commercial business, they're doing very well today. Landscape lighting that we do have some business with the utilities, municipalities, that business is doing relatively well.

It's just some of the smaller stock and flow type business, where a contractor walks into a distributor and buys 24 downlights and a few floodlights and whatever. We also think that the distributors may be a little cautious and may be watching their inventories very carefully and may be one of the reasons we've seen a little softening in that side of the business also.

How would you comment on pricing? I mean, obviously, some of your competitors have announced some price increases in the kind of the July timeframe. What's your approach to price right now, and maybe you could comment on your current price initiatives as well?

Right. Well, as you know, we and one of our other major competitors announced the price increase at the beginning of June. And a couple of our competitors didn't follow. I mean, in our industry, because of the way the business divides up, it's pretty hard for any one or two companies -- we can always get and we will always get selective price increases.

In fact, the reason that we think that our margins are better than some of our competitors is that we introduce more new products. Obviously, when you introduce new products and you don't really have -- and particularly, if they're innovative type products, you get -- you can command a better margin on those products until they become more generic and more of your competitors copy them.

But anyway, since -- just in the last week, we've now, all four of the major lighting companies have now announced a price increase. One of them doesn't go into effect until September. Typically, what happens is that all of us will probably kind of move our price increase back and that.

But we're looking to get -- we hope and feel confident that we'll get a 3% to 5% price increase. We need it. I mean, if we don't -- because of materials going up, as Bill stated and I stated earlier, if we don't get a price increase, it's going to be real challenge to maintain our margins. But we think that we will get that 3% to 5%. We do it -- we don't do it across the line. There are some products you get more, some you get less. But that's kind of what we're looking for is a 3% to 5%.

Do you think you'll get some pull through volume in this quarter then, as a result of the price increase, or not?

I don't know if we are going to get much. We always get some. I mean, what happens is -- particularly such a significant share of our business is job business that you have to look at and say we'll get some people, if they're able, it will pull some jobs ahead a little bit. But for the most part, I don't see the distributors really stocking up a lot or anything as a result of this price increase.

Okay. And perhaps you could talk a little bit about costs and labor right now. I mean, I think you -- one thing that you all noted is that when you saw softness or even saw the last downturn, you really started taking out capital and labor pretty quickly. And your comments just today that you're at least trimming some spending plans and really focusing on your cost take-out, could you talk about what you're doing now to react to the environment?

Right. Well, we -- one of the things that is really great, we have a tremendous financial package. We measure everything every way you can imagine. We measure comp to sales, comp to EBIT. We look at it and we measure. We went -- we had our meeting yesterday, and we really -- we are really all over our divisions. And they're pretty good themselves because they know how I react to that. The minute they see their sales start softening and that, they immediately react to costs and start taking out costs.

The direct labor in that and the factories is pretty -- it's immediate, it's easier. Sometimes if we see that the downturn or softening is going to be a little longer and that we have to start taking out some of our salaried people and that. Well, there's obviously some severance pay and that. We treat people very fairly and that to go along with that.

But we are a company that we manage those costs very well, and we're going to -- we've always done it in downturns in the past, and we will continue to do that this time and in the future. If the business is not there, we're going to take out the costs. We're going to do everything we can to maintain those EBIT percentages, our earning percentages of whatever.

Are you taking out labor cumulatively or any particular division right now?

I would say most all of our divisions have taken out some. I mean, it's not like a big, huge across-the-board layoff or anything like that. Some of our divisions are doing very well. So we are obviously not going to take it out of those divisions that are doing well.

We have got a lot of our outdoor companies -- I mean, Lightolier hasn't had any layoffs. They are doing extremely well. But some of our other divisions, it's a little softer, have already started and will continue to take out costs.

Now one final question, and then I'll turn it over. On a residential side, it looks like you had some great margins there. And thanks for the incremental disclosure on the segments. But it looks like you hit 16.9% in terms of operating margin. That was down from last year. But still, given significant amount of contract manufacturing business there, I think some low-cost country sourcing preserves that.

Given the change and some of the China tax credits on VAT, do we expect -- do you expect structurally those margins, despite the downturn, to continue or we might start to see some more detrimental margins there if the residential downturn continues?

Well, all of our -- all companies are in the same mode. And I don't think that they will -- you will see any deterioration of the margin significantly as a result of that. I think we could see and we've already seen some of our margins going down, to some degree, in residential just because of the lower volume. But I think our margins will stay relatively healthy on the residential side.

Thanks for your time.

Okay.

Next we'll hear from Peter Lisnic from Robert Baird.

Good morning, gentlemen.

Good morning.

Morning, Pete.

I'm wondering if we can talk a little bit more about the top line in the quarter. And what I'm wondering is, if I kind of look at the order comps that you've put up over the past few or several quarters, one, I'm just wondering what the order comp was for this quarter? And two, are you building backlog to any great extent? Because it doesn't look like some of that order growth that we've seen in the past few quarters has really flown through the top line yet.

Pete, one of the things that gets really difficult is this pull forward from last year of all the orders that came in under just the last day. Just right under the wire in anticipation of the price increase. And trying to reconcile that, along with all these acquisitions -- again, we did our big JJI acquisition at the end of May. And we actually had a -- it was actually a six-week May or June last year for JJI.

And trying to figure out what all the impacts were from that, it gets really difficult, and then we had these other acquisitions as well. It gets difficult to dissect exactly what the trend is in this order area. And the biggest issue is the surge of orders that we got in anticipation of the price increase. And so, I think we're not going to get a really good feel until probably August or September really what the true impact of that was because it'll impact both June and July --

Okay.

-- on a year-over-year basis. The one point that we -- obviously this residential phenomenon is pretty easy to understand, though. I mean, the residential being down as it is. And then also the industrial being down as well. We've seen, as Larry indicated, these commodity-type products, where there is not a patent or a specification or proprietary type of features, are subject to -- there is more competitive pressure as well as the markets they typically go into are the non-architectural stock and flow type markets, which are -- seem to be experiencing more of the softness that's out there.

Okay. Well, I guess at the risk of having you both throw something at me through the phone, are you at all concerned that you're losing share either in stock and flow or in the project business?

Well, I think in the project business and the kind of business we want, the answer is no. Now on the stock and flow side, we could be losing some because I think, as you guys know and we've told you many times, we work very hard at protecting our margins. And we don't get down and play in the real low end, dirty end of this market.

And we talked about it yesterday with our people and said, look, let's be sure that we're not being foolish and that we are not taking business that is good business. But on the other hand, we just have never had a desire to fill our plants up with commodity business you don't make any money on. You just churn. WE can't provide good service to our valuable customers in that. So we're really not in that.

But I wouldn't be surprised. I mean, I couldn't tell you that we are not losing some market share as a result of what's going on out there. When the market gets softer, I mean typically we do reasonably well because we go, again, after the good business that we want. We protect our margins, and we don't just drop our prices and then scramble to keep our head above water. That's just not the way we operate and that.

But at the same time, we recognize we have to remain competitive. We have to service our good distributors. I mean, we have certain accounts and people that we have if not exclusive, we have at least good working arrangements with, and we are going to keep them competitive. And if they have a job and they need us to lower the price a little bit in order to be competitive, we're going to do whatever we have to do. We are not just going to walk away. But were also don't go out and aggressively pursue that low-end commodity market.

Okay, got it. Then if I could follow up on another question for you, Bill? The currency impact on the quarter seemed to be, I don't know, a lot larger than I thought it was going to be. Can you give us -- and I know how the currency is moving and --

Yes. No, that's a good question. And to be honest, I was surprised it didn't have more of a year-over-year benefit or beneficial impact from the translation of the operating income. And so, we've been through that couple times. But the bottom line is we have two divisions in Canada that sell into the United States. That's our as our Ledalite division and our Lumec division. And they have some fairly significant working capital for their receivables that are U.S. dollar denominated.

And then, secondly, we have accumulated earnings over the past year in Canada that we have not repatriated because we're saving for other investments in Canada or other places in the world. And so this accumulated balance, as it gets translated through the quarter of receivables and of cash, the cash is denominated in U.S. dollars, held by Canadian companies that are Canadian functional currency companies, it experienced almost a surge in the Canadian dollar right during June. It was a big spike during June.

So we didn't get the benefit of that increase for the whole quarter when it came to translating our earnings. On the other hand, we got the detriment of that impact during June in translating all of that accumulated earnings that's held in the form of U.S. dollar cash and in the U.S. receivables held by Canadian companies. We don't hedge those intentionally. We look -- taking an economic perspective that we are a U.S. company. We keep these investments in U.S. dollars from an economic perspective and all our shareholders are whole.

And also, if you look at the balance sheet translation -- which doesn't show up in earnings, it shows up within the shareholders equity section in the currency translation adjustment -- we would have a fairly significant gain there. But it doesn't go into earnings. It just shows up in the shareholders equity section of the balance sheet.

So there are some offsets going on there. It doesn't work out the way you would like it to from an earnings perspective, but from an economic perspective, I think our shareholders should be pleased.

Okay. But from -- I guess from an earnings perspective or maybe I should just ask the question this way, is there anything in those Canadian operations on the balance sheet? I mean, it's in the net asset position, I assume, on the U.S. dollar front, which is why we're getting a negative number coming through --

Yes. Yes.

Is there anything in there that goes away in the third quarter, where a large portion of this hit sort of reverses? Because if you look at the --

If the U.S. dollar should strengthen again. The Canadian dollar is very much a commodity --

No. But I'm just assuming the Canadian dollar and the U.S. dollar relationship stays intact. And if that's the case, it's going to take another hit --

No, they -- that's the same --

Third quarter, correct?

They stay the same it would be zero impact.

Okay, so you're doing a quarter-to-quarter?

Well, no, we're doing a month-to-month. But --

Okay, okay.

Yes.

All right, that's good on that one. I mean, that's sort of a big impact on margin. Was there anything else that flowed through the quarter that you could kind of pull out and say this hurt us or helped us, either way? For example, last quarter you talked about some restructuring at JJI. Anything along those lines this quarter?

I think we had a pretty comparable quarter. I don't think we had any -- there wasn't anything significant that happened during the quarter. I mean, we were pleased with our gross margin improvement. If you look at going to a little over 40%, our EBIT percentage at 14.7%. I mean to us. I guess some of you guys may not think that's good, but we think that's pretty dang good.

I mean, there's probably is, as Larry discussed, I mean, some of our divisions where we've seen the sales decrease -- the residential and some of this stock and flow industrial-type business -- where we do have those decreases. Obviously, we're taking out heads. And there might be a little bit of severance related to that, but it's not material or significant. So --

Okay. All right. I will jump back in queue. Thank you.

Next we'll hear from Matt McCall from BB&T Capital Markets.

Hi, this is actually Sean Connor for Matt McCall. Good morning.

Good morning, Sean.

Morning.

Just to get a quick question on the margin in the commercial segment, it looks like there was a sequential decline in that margin despite the increase in sales. Is there anything -- any color there that you might be able to provide to see what was going on there to reflect that?

I don't know what numbers you're talking about there, sequential decline.

I've got in this quarter 14.4.

Okay.

And 14.9 in Q1.

Oh. Yes, I can't comment on that.

I mean, the only thing -- my only comment would be on that is just the strength of our and the fact that some of our divisions, particularly somebody in that light commercial business, business just wasn't strong, and their margins dropped off. But overall, I think our margins were pretty good.

Okay. How about the demand environment for the industrial segment? Any color there?

We're such a small player in the industrial market, it doesn't really have much impact on us. Anybody really today that is in the big utility and the heavy industrial business is doing very well. I mean, I'm on the NEMA, National Electrical Manufacturers Association, board and have a lot of those guys that are in the industrial business, and their companies are doing extremely well.

I think some of the things that we look at, as industrial, again is some of the smaller -- we looked at some of our companies that provide some products for warehouses, parking garages, some of these things. And it's kind of -- you could really classify them as both commercial and industrial. We are really not in the big, heavy industrial market really at all in our Company.

And then on your acquisitions, do have an update on the margins for those companies?

What we do, we don't break out and we don't tell specifically what the margins are in the individual companies just because for competitive reasons.

Sure.

But there's no question that the companies that we've acquired -- particularly JJI and Strand -- over the past year, are margins are well below our Company average. So it brings our overall Company average down somewhat. But we've got programs and that in place.

And we believe that over a period of time, once we have completed some of the consolidations and taken out some of the costs, done some of the things we want to do, introduce more new products and that, that our goal is certainly to get those up to and, in some cases, over our corporate average. Because a lot of these are niche-type companies, they have a lot of potential to be high margins. But because there are some small operations. And obviously, we acquired them, they weren't doing that well in some cases, it just takes some time to make those improvements and get those margins improved.

And I know you mentioned the JJI consolidation or they were moving to get some sort of productivity improvements in Q1. Is there a timeframe for any -- for Strand as well? When are you going to expect to get them to Genlyte-type margins?

Well, I would say Strand -- what we did when we acquired Strand, they were actually a British company. And we had to pull out of Britain. I mean, that's their headquarters and everything for the company were actually in England. And so, we actually had to pull out of there based on this bankruptcy that we went through, and now we've just re-established them. In fact, I was over there at the beginning of June and then just to re-establish them in that marketplace, and we think that's going to be exciting.

Now right now what we had to do is we had to go lease a new building. We had to hire a lot of people. We had to do a lot of things. We have zero margin on that business. But that will consistently improve in over the next six months. I would say a year from now, I would be very unhappy if Strand wasn't at or over our Company average.

JJI is very similar. It's going to take a little more time. We got out of their corporate headquarters. We took some costs in the first quarter to close down and consolidate two of their businesses together out in Santa Ana, California. We have plans to up -- retrofit a plant in North Carolina, as I stated earlier, and consign a couple of operations.

That -- the benefit of that will start happening in probably the second half of next year before we really get the benefit. And in fact, in the meantime, we actually have some costs associated with that. So it takes a little time. But in the long run, all of the companies, we feel very good about all of them that we have acquired.

And the potential Hanover Lantern, one we just acquired, is already up and over our corporate average, by the way. I might point that out. They are doing their business -- because they're somewhat heavily into the residential business, their sales are just a little bit soft. But their margins are tremendous.

Working with one of our sister companies, we are going to combine two foundries into one foundry. When that's all done, it's going to benefit both of these companies very much, and it will improve the margins at both Hanover Lantern and at Hadco also.

Okay. Great, thank you very much.

Next we'll hear from Christopher Glynn from CIBC World Markets.

Good morning.

Good morning.

Good morning, Chris.

I was just wondering with the -- all the acquisitions and some integration efforts there, is there any temporary customs service issues from some of the integrations or any channel consolidation?

Not really.

Probably just the opposite.

Our service is outstanding. I mean, really, we were not -- we haven't disrupted anything. I mean, next year when we move in Germany, could we a little bit? I'm hoping not because we've got time, if we do it right, the move to Shelby and consolidation there. I just don't see any significant disruptions.

In fact, right now, one of the things that we think is really helping our Company, we think we've got some of the best service, if not the best, in our industry right now. And we're servicing our business very, very well for the most part.

The customers, of course -- in the case of the Carsonite and the Strand business, both of which we bought out of a bankruptcy situation -- I mean, they are elated. I mean, they couldn't get anything, and anything they did get, they had problems with. So we've had a lot of heavy lifting to do to turn those businesses around, but the service is exponentially better than it was prior to when we bought them.

Okay. And with the -- I think someone referenced distributors may be turning inventory a little based on their outlook. Does that kind of swing back to you in the third quarter potentially?

Well, it does if business starts picking back up. I mean, a lot of the change, and particularly these are people that are really big on inventory turn, and they -- if their business starts slowing a little, they really cut back on their inventory. And if business starts picking back up a little bit, then you'll see them reverse that. So it's hard for us to put an exact timetable on that.

But the other thing is that the stock and flow business is not that huge a part of our total business today. I mean, it's so job oriented. And we don't know the exact numbers, but we would guess 60% to 70% of our business is job business that we make for jobs. So it doesn't have a huge impact one way or another. But when they do decide to slow, there is always a temporary lull when you kind of day in, day out business slows up a little bit.

The other thing, from a seasonality perspective, Chris, we did the price increase in June of last year, as you're aware -- June, July, August, September, October are the peak construction months with weather being better throughout the country. And so, a distributor can stock up in June in anticipation of the price increase, knowing that whatever he's buying is going to get used during July to the September period. As you get closer to the winter months and with the price increase getting closer to the winter months, there is less of an incentive to stock up for in anticipation of a price increase.

So, as Larry indicated, with a stock -- a price increase being pushed up, I mean, that will obviously help margins. But I don't think we're going to necessarily get a surge in stocking or in pre-buy related to that next round of price increases.

Okay. And with the price increasing being pushed out a little bit, could you see the third quarter being much more challenging than just the second quarter from an overall price cost perspective?

Well, again, it's really hard to tell. If I look at July right now, I would say the answer is, yes, it could be a little more difficult. But September, historically, is usually always our largest month as a company. So we usually come back -- we always run into a little lull in the summertime. A lot of vacations, a lot of things happening, even from our vendors and that. And then August usually comes back a little. And then September is usually a great big month for us.

Assuming we kind of follow our traditional pattern, I think we'll be fine. If the softness that we felt here lately and that continues, then it could be a little softer. It's just hard to predict at this point.

Okay. And then, finally, your inventory position looks the strongest it's been in a while. Took it down very nicely sequentially and even down year-over-year, despite three more bolt-on acquisitions. Seems like that should bode well for the factory throughput and overhead absorption helping the margins in the third quarter. Could you comment on that?

Well, I would agree with you. We -- one of the things I'm most pleased about our Company is our inventory turn and our ability to bring our inventory levels down and respond very quickly to our customer needs and that. I think we've done an excellent job of that. And I see no reason for that not to continue, and we just look to even get better as we go forward. But I think we are doing a very good job of managing those inventories at this time.

And our -- the thing I like is that when you don't fill your plant up with a bunch of inventory that -- you may or may have the wrong stuff is when the inventory levels are low. The ability to service usually improves because you can respond quickly to the needs of those customers on whatever items they want. So I think that our service levels will continue to be very good, and we will continue to manage that inventory very closely.

Okay. And yes, I was kind of talking to the overall inventories being down, and then just how about the mix within the inventories? Sounds like you're very pleased with that as well.

We are. We had a couple of divisions, and we always got one or two divisions that we're -- that we are watching and we worry a little bit about. But we've got, I think, a pretty good handle on it. And our large divisions, the ones that generate the most sales volume, are the ones that are doing the best in inventory turn. We've got a few smaller divisions that we continue to focus on to watch their inventory and working to continue to drive it down.

Great. Thank you very much.

Next we'll hear from Alex Rygiel from FBR.

Thank you very much, and good morning, gentlemen.

Good morning.

Morning, Alex.

One question. Your price realization has slipped over the last couple of quarters to around 2% from 4% to 6%. Do you think that is due to competitors not following along with price increases? Or is it due to customers not accepting those price increases after a couple of years of significant increase?

I don't think it really has anything to do with the customers accepting it. I mean, I think that as you get into the market and business slows a little bit, everybody seems to scramble a little bit more, puts a little bit more competitive pressure on.

And people have a tendency to lower prices a little bit. And obviously, we have to be competitive and do what we have to do to get orders. So I think, if anything, that would be the biggest reason for it is just as the business softens a little, it becomes a little more competitive.

Are you seeing competitors lower prices or are you seeing competitors not ask for price increases?

Both, actually. But we have one in particular and another one that is not quite as bad. We have one competitor that we just don't understand, that continues to think the way to gain business and to do well, I guess, as a company is to lower prices. And we are all a little bit perplexed at that. As to why they would continue to try to sell at lower prices and think that they're going to get themselves into a good position doing that. But again, that's just a philosophy that some people have, and there's not much we can do about that.

And is that shift in strategy, that one competitor, to cut prices new over the last few months?

Well, yes. It's for them to be very competitive and do whatever they have to do to go get orders, I think. And I think, again, my own perception of that is a little bit of a -- I don't know, a desperate ability to try to keep market share, to keep growing, to keep doing things, and they think the way to do that is through pricing.

And I do have one other question. A number of other industrial companies are talking about seeing an improved outlook for a very large construction projects. Do you agree with that? And how should we think about that as it relates to sort of percent of your net sales?

I do think that's true, and I don't think it has a huge impact on our net sales in that a lot of these huge projects, depending on the type of project it is -- if it is a huge project in Las Vegas, we love that. And we will go after that very aggressively, and that's in kind of our sweet spot. If it's a large industrial project, we're probably not as tuned into that as some of our competitors. That's not a kind of a sweet spot for us.

So we don't think that a lot of the large, real large projects has a huge impact on our business. Although I mean, it's always good, because we like large orders and large projects, too. But our sweet spot is the small, the medium-sized jobs in strip shopping malls and high-end retail, hospitality, that type of area.

All right. Thank you very much.

And next we'll hear from Tom Brinkmann from Davenport.

Good morning, gentlemen.

Good morning.

Just wanted to know about, given the softness in some of your end markets, like residential and even recently in industrial and other, what are your prospects for acquisitions? And obviously, you're going to have stronger balance sheet now. So are you seeing some companies out there maybe going for more reasonable prices?

Well, we are constantly looking and constantly in that market. And we've got one small one that we are working on at the present time, nothing that's imminent. And we are just -- we're always looking. There was a couple of what we thought were good companies for sale in Europe that kind of excited us until we saw the prices they went for, and we just quickly backed away.

We find that the European companies are very difficult to manage in turning the profitability around, and the multiples over there are just astronomical and compared to what we're willing to pay. So we backed away. Even though one of those companies in particular was a very renowned worldwide company that we wouldn't have minded owning, but not at the multiple at which they were sold for.

And people -- I mean, the expectations are still pretty high for some companies. We are still some people that have somewhat of a realistic view of it. And that's what were hoping and looking to find.

Okay. And if you're not able to secure a reasonably priced acquisitions, then I'm wondering what your longer-term plans are with the balance sheet. Obviously, you just brought down net debt to capital to a very low level and really strengthened the balance sheet. But what will you do in lieu of acquisitions?

Well, I mean, we would look at -- obviously we discussed with our board, and we would discuss all kinds of alternatives. But one of the things obviously we would look to do is, if we had a very healthy balance sheet and had more money than we knew what to do with, we would certainly consider repurchasing some of our stock. And having some sort of stock buyback program would be something we would certainly consider.

Okay. Last question. Any further plans about maybe a facility in China?

We are continuing to evaluate that. We've got some very good vendors. We kind of like what we're doing over there now. If we found the right thing, the right opportunity, we would do that. So far, we haven't -- we haven't been that pleased with what we have seen. And the contracts we have with some of our vendors and that are going very well, and we've kind of found it in our best interest, at this point, not to do anything. But we're still looking for that.

We also have a major facility in Mexico that we have purchased. We now own that facility. We have room for expanding that facility, and that's something that we would continue to look at also is expanding and taking some more production to Mexico. We love that facility down there. It is a lot closer. It's not quite as low-cost as China, but significantly lower cost than the U.S. and obviously more readily available to our -- geographically to our markets. So we like that very much.

Okay. Thank you very much.

Thank you.

This concludes the question and answer session. We will shortly hand over to Mr. Powers for closing remarks.

Again, just like to thank all of you for participating in our conference call and just to assure you that we're going to do everything we can to continue to grow our sales and earnings and get a good return for our shareholders. So thank you very much for your participation.

As a reminder, this conference has been recorded with an audio archive copy becoming available in approximately three hours on Genlyte's Group website at www.genlyte.com. Have a nice day.