General Cable Corporation Q2 2010 Earnings Call Transcript

Aug. 3.10 | About: General Cable (BGC)

General Cable Corporation (NYSE:BGC)

Q2 2010 Earnings Call Transcript

August 3, 2010 8:30 am ET

Executives

Len Texter – Manager, IR

Greg Kenny – President and CEO

Brian Robinson – EVP, CFO and Treasurer

Analysts

Stuart Bush – RBC Capital Markets

Jeff Beach – Stifel Nicolaus

Jack Stemic [ph] – BB&T Capital Markets

Brent Thielman – D.A. Davidson

Michael Coleman – Sterne Agee

Shawn Harrison – Longbow Research

Richard Wesolowski – Sidoti & Company

Anthony Kure – Keybanc

Gary Farber – C.L. King

David Wachowski [ph] – Jefferies & Company

Operator

Good morning. My name is Tracy, and I will be your conference facilitator. I would like to welcome everyone to General Cable Corporation's second quarter 2010 earnings conference call. This conference call is being recorded at the request of General Cable. Should you have any objections, you may disconnect at this time. All participants have been placed on mute to prevent any background noise. (Operator instructions) Thank you. General Cable, you may begin your conference.

Len Texter

Good morning, everyone, and welcome to General Cable's second quarter 2010 earnings conference call. I'm Len Texter, Manager, Investor Relations at General Cable. Joining me this morning are Greg Kenny, our President and Chief Executive Officer; Brian Robinson, our Chief Financial Officer; and Greg Lampert, our President and Chief Executive Officer of General Cable North America.

Many of you have already seen a copy of our press release from last night. For those of you who have not, it is available on First Call and on our website at generalcable.com. I want to call your attention to our Safe Harbor provisions for forward-looking statements that can be found at the end of our press release. The Safe Harbor provision identifies risk factors that may cause actual results to differ materially from the content of our forward-looking statements. Our current reports, 10-K and other periodic filings on file with the SEC provide further detail about the risk factors related to our business.

During this call, we may refer to adjusted operating income and adjusted EBITDA, which is defined as earnings before interest, taxes, depreciation, amortization, plant rationalizations and other items. These non-GAAP company-defined measures are being provided because management believes they are useful in analyzing the operating performance and cash flow before the impact of various charges. A reconciliation of adjusted operating income and EBITDA to GAAP net income is available on the Investor Relations section of our website at generalcable.com.

The format for today's call will first be some discussion by Greg Kenny about the current business environment. Secondly, Brian Robinson will provide some financial detail about the second quarter. And finally, Greg will provide some comments on the company's third quarter 2010 outlook and business trends, followed by a question-and-answer period.

We would like to remind everyone that effective January 1, 2010, the company changed its method of valuing all of its inventories that historically used the last-in/first-out method to the average cost method. The company applied this change in accounting principle, retrospectively, to all prior comparative periods discussed here today.

With that, I will now turn the call over to Greg Kenny.

Greg Kenny

Thank you, Len, and good morning. I'm pleased to report that we delivered a solid second quarter marked by a return of seasonal demand patterns in the rest of the world and North America, volume growth year-over-year in our early cycle businesses, and the benefit of cost reduction efforts made throughout 2009. Our earnings for the second quarter were in line with our expectations despite lower than expected volumes.

Volume as measured in metal pounds sold was lower due principally to weaker than expected demand across a wide range of the company’s products in May and June, as well as the delay of certain transmission projects in the rest of the world. For the second quarter of 2010, we reported revenues of $1.2 billion and adjusted earnings per share of $0.54. These results were reduced by severance related charges of $11.1 million, as we substantially completed our negotiations with the works councils of the various operations in Spain to permanently reduce manufacturing personnel.

There were also adjustments to the research and development credits of $3.1 million in France. While the reemergence of seasonal demand patterns is encouraging, many of our businesses are still moving sideways when seasonality as we moved and we therefore remain cautious about the second half of this year as there remains a great deal of uncertainty surrounding the nature and pace of the economic recovery.

Brian will take you through the details of the financials in a bit. I thought I would spend some time talking about how I currently see our business environment. Many of the positive trends we identified in the first quarter have continued into the second quarter, particularly as it relates to the stabilizing of demand for certain products in the United States, Brazil, Southeast Asia, South Africa, and Central America.

We are encouraged by the ongoing investment and commitment to infrastructure development throughout our rest of the world segment. In addition to the massive transmission projects that are under contract in Brazil, of which we have already booked over $150 million of orders to be delivered over the next two or three years, there have been billions of dollars of investments approved in additional power distribution and power generation projects, including hydroelectric.

In Central America, Chile, Peru, Zambia and South Africa, the need for infrastructure related projects continues to gain momentum as the respect of the companies grow, in the case of Chile, rebuild. In Thailand, our high and extra high voltage business continues to perform well despite recent political unrest. And in the Philippines, a peaceful election and change in leadership coupled with expected export earnings growth are encouraging.

In the United States, there is gradual improvement or stability occurring in many sectors of the economy, with the notable exception perhaps of residential and significant sectors of non-residential construction where data continues to be mixed and inconclusive. The decelerated pace of many leading economic indicators within the last two months has generated great deal of uncertainty as to the rate and sustainability of the recovery. Overall, demand for many of our products remains at historically variable levels with our North American factories operating at the 55% to 70% utilization levels.

We are yet to see any meaningful change in demand in our electric utility business, as two years of energy usage declines coupled with weak construction and a difficult regulatory environment have not supported an increase in electric utilities spending on the distribution network, which remains at historic lows. As you know, grid reinforcement, regional interconnections, and alternative energy access for the transmission infrastructure are critical components of the investment cycle required to support energy independence, reliability and alternative energy mandates over the long-term.

Market conditions in Europe, particularly Spain, remained difficult and are expected to remain this way throughout the second half of the year. We therefore have substantially completed our negotiations with the works councils of the various operations in Spain to permanently reduce manufacturing personnel in order to align with curt and prospective future demand.

We also continue to leverage many of our vast global practices in Europe and elsewhere. For example, the sharing of best global practices in safety has enabled our European business to lower recordable incidence by more than 40% for the first half of 2010 as compared to the same period in 2009.

Despite instability in the financial markets, lingering sovereign debt concerns and tentative growth forecasts, the company believes the European Union’s commitment to renewable energy and a significant investment in infrastructure throughout the Mediterranean and Eastern European region remains a significant long-term opportunity for the company. We will continue to work to develop new regional markets for Spanish technology, know-how and production.

I will now turn the call over to Brian Robinson who will provide details on our financial performance for the second quarter. Brian?

Brian Robinson

Thank you, Greg. Volume as measured by metal pounds sold before the impact of acquired businesses was down 8% compared to the second quarter of 2009 and up 8.8% as compared to the first quarter of 2010. Volumes in the second quarter, while up sequentially, were below our expectations. In the rest of the world, volume was down 6.6% compared to the second quarter of 2009 and up 12.9% compared to the first quarter of 2010.

While the segment experienced broad-based sequential seasonal improvements in demand, volumes were less than expected principally due to lower than expected demand in Brazil. In Brazil, we have contracts in hand for major transmission projects, which are ready to begin but have been delayed as a result of the environmental permit process. These projects are expected to shift in the latter part of 2010 as well as 2011 and 2012.

Strong demand for low-voltage distribution cables for programs such as Lights for All in Brazil and the acceleration of mining projects in Zambia helps to partially offset the impact of the transmission projects delay. Lower volumes in the second quarter of 2010 compared to the second quarter of 2009 were principally due to lower demand in Venezuela where the country continues to cope with changes to its complex currency exchange rate control regulations. The new exchange rate regulations issued in January coupled with the government’s recent decision to close down the parallel currency trading market has disrupted electrical and construction projects across the country.

In North America, volume was down 9.2% compared to the second quarter of 2009 and up 13.6% compared to the first quarter of 2010. Volumes were less than expected principally due to the ongoing depressed level of spending by the electric utility companies. Excluding the impact of transmission products, volumes were flat in the second quarter of 2010 compared to the second quarter of 2009.

Looking at the early cycle products, specifically those for our MRO, OEM and networking applications, these products were up 4.8% in the second quarter of 2010 compared to the second quarter of 2009, but were flat compared to the first quarter of this year. While we were encouraged to see our early cycle businesses trend positive through the first half, we remain cautious relative to the strength and pace of the recovery in light of the fact that sequential volume changes in the early cycle businesses is flat.

In Europe, volume was down 7.8% compared to the second quarter of 2009 and was flat as compared to the first quarter of 2010. Volumes remain low in Europe principally due to the ongoing depressed domestic construction and electrical infrastructure markets in Spain coupled with larger macroeconomic issues. We do, however, expect a weaker Euro to improve our export competitiveness and reduce competition from imports to the European region.

During the second quarter, COMEX copper averaged $3.19 per pound compared to $2.15 in the second quarter of 2009, an increase of 48%, and down 3% from the first quarter average of $3.28. While the sequential quarterly movement in average copper prices appears muted, copper continues to be volatile as prices within the second quarter of 2010 recorded the high of $3.63 a pound and a low of $2.76, which exacerbate pricing and demand volatility.

Operating income in the second quarter was $59.8 million or 4.9% of revenues compared to $62.0 million in the second quarter of 2009. This result includes charges for severance, primarily in Spain, of $11.1 million and unfavorable adjustments to research and development credits in France of $3.1 million. Despite the impact of these items, operating income increased sequentially in the second quarter by $2.5 million as compared to the first quarter of 2010. The second quarter increase in operating income was due to stronger seasonal demand and the timing of project deliveries related to our business in Germany.

During the first and second quarters of 2010, the company recorded other expense of $36.5 million and $3 million respectively. Excluding the impact of the currency devaluation in Venezuela in the first quarter of $29.8 million, other expense of $3 million in the second quarter represented a decrease of 55% sequentially, primarily due to currency transaction gains in Venezuela in the second quarter.

Offsetting the Venezuela currency gains in the second quarter were losses in a handful of other countries, as currencies were volatile in the latter half of the quarter. In Venezuela, the foreign currency exchange environment continues to be complex and challenging. In addition to the previously established two-tier foreign exchange structure, the government recently closed the parallel foreign exchange market and imposed volume restrictions on trading.

During the second quarter of 2010, the company received approval at the preferential foreign exchange rate of 2.60 bolivars to US dollar for copper purchases necessary to supply products to help address Venezuela’s energy shortage challenges. The supply of copper authorized at the preferential foreign exchange rate is anticipated to be consumed over the remainder of the year. The company recorded a net foreign currency exchange gain of $1.5 million for the second quarter of 2010, which reflects copper purchased as in June at the 2.60 preferential rate and purchases of copper in April and May at the parallel rate of exchange.

The company’s effective tax rate for the second quarter was 36.1%, which includes the negative impact of non-deductible items resulting from France research and development credit adjustments and the tax impact of the foreign currency exchange control regulations in Venezuela. For these reasons, we expect our normalized effective tax rate for the year to be approximately 35%. Going forward, in 2011, we expect our effective tax rate to be more in line with our historical rate of approximately 30% to 33%.

Net debt was $635.2 million at the end of the second quarter of 2010, an increase of $128.3 million from the end of the first quarter of 2010. The increase in net debt is a result of investments in working capital, capital expenditures, and to a lesser extent, the impact on the net cash position in Europe due to the depreciation of the Euro relative to the US dollar. The company continues to maintain adequate liquidity to fund operations, which could include increased working capital requirements as a result of higher metal costs, internal growth in continuing product and geographic expansion opportunities. At the end of the second quarter, the company had well over $1 billion of excess liquidity across the globe.

During the second quarter, the company used approximately $104 million of cash flow from operating activities principally related to $146 million investment in working capital. This increase is primarily related to seasonal increases in inventory and accounts receivable balances during the second quarter of 2010, which assuming current metal prices will unwind in the second half of the year as receivables are collected and inventory levels are reduced.

Reported net interest expense in the second quarter of 2010 was $17.7 million, which includes $4.7 million of non-cash convertible debt interest expense. Net interest expense for the second quarter of 2010, excluding the non-cash convertible debt interest expense charge, was $13 million, a decrease of $200,000 compared to the first quarter of 2010.

Capital spending in the second quarter was $30.1 million, while depreciation and amortization was $25.1 million. Our ongoing capital programs are more narrowly focused on developing regions of the world coupled with an ongoing global focus on lean initiatives and continuous improvement in the areas of safety, quality, material usage and conversion costs.

For 2010, excluding the impact of any potential acquisitions or joint ventures, we are anticipating capital expenditures of approximately $100 million, which is just below expected annual depreciation and amortization. This estimate includes spending to complete development projects in India, Peru, Mexico and South Africa, as well as focused spending on a couple of projects to expand our product offering in specialty products prior to natural resource extraction.

With those comments, I’ll turn the call back to Greg for some final remarks. Greg?

Greg Kenny

Thanks, Brian. Broadly our view of 2010 has not changed from what we said six months ago in our call in February. We believe 2010 is a bottoming year. As I mentioned earlier, there are positive trends in some of our markets, but there remains a tremendous amount of excess capacity in the industry at current demand levels, and overall pricing remains very weak. Unfortunately, the global recovery that is underway has been temporary in parts of our businesses and will likely remain mix for the second half of the year.

While the reemergence of seasonal demand patterns is encouraging, the balance of the year is subject to significant uncertainty with regard to the sustainability of the economic recovery and the volatility of commodity pricing. Also recall the demand for many of our products will lag the general economy, more specifically construction starts by six to 24 months due to the late cycle nature on the majority of our product mix.

Our teams around the world, but particularly in Venezuela, Thailand, Chile and Mexico, have overcome significant social, political and natural events in the recent months. These events have and will continue to negatively impact economic growth in the near-term. We operate in promising, but very difficult and challenging locations around the world, and the effort of our associates is nothing short of extraordinary.

Overall, we expect developing economies to continue to perform relatively better than the developed economies of the world throughout the second half of the year. I am cautious optimistic that we are reaching the trough in many parts of our business. I’m encouraged as well because we’re taking out millions of dollars of cost over the last two years, and we are getting synergies across the entire company, leveraging best practices in learning.

I firmly believe that over the last 10 years we have built a very strong and well positioned company that will fully benefit from the next global expansion through our high end product lines such as submarine communications and power cable, extra high voltage energy cable, and high end audio/video products, and so on, as well as our recent development efforts in locations like India, Peru, Mexico and South Africa. We’re not discouraged and continue to see the world as opportunity rich.

That concludes our prepared remarks. I will now turn the call back over to the operator who will assist us in taking your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Stuart Bush from RBC Capital Markets. Your line is open.

Stuart Bush – RBC Capital Markets

Yes. Thanks. Hi, Greg.

Greg Kenny

Hi, Stuart.

Stuart Bush – RBC Capital Markets

It looks like there will be a huge amount of this grid work in Brazil in preparation for the Olympics and the World Cup. I would think that demand would exceed local capacity, and would you be tapping into your other North American facilities exceed that? A couple questions there. Can you quantify for us your market share and what additional opportunity beyond the contracts in hand are available in Brazil through 2012?

Greg Kenny

In Brazil, we have a strong position in overhead transmission. And we agree that there is a lot of projects that in fact have been lagged and have been held up somewhat with some environmental permitting, some of them across the rain forest. I don’t have it in front of me, but we would be among the top three manufacturers in Brazil of transmission cables and we have a great cost position. We have looked – we think overall in South America there could be a shortage of capacity as these projects roll through and they are massive. So we are looking at freight and duties to see whether we can support it from somewhere else, but the distances are great. And there is typically some tariff, things that you have to overcome. But that work is actually being looked at now.

Stuart Bush – RBC Capital Markets

Okay, great. And then just from a macro level, if you can talk about factors that will eventually drive capacity utilization rates higher, are you expecting that the oversupply will be filled by demand or do you believe that assets need to be taken out of the industry? And so, outside of Spain, what are the geographies or product lines that you believe are most oversupplied right now?

Greg Kenny

Stuart, the – if you look at history, there has been periods of under-investment in the industry. Typically there is clearly a reduction now, a great reduction in new installation of equipment. And there was a peak, particularly in Eastern Europe and in the Gulf, Mediterranean area around new lines in the ’05 to ’08 timeframe. I think the Americas have seen less capacity come in over the last cycle, and we just need a recovery of demand. Elsewhere where people built equipment or bought it, they are finding it’s tougher to operate in this environment. So I think there will be some consolidation. We also think some of these lines, which are not efficient haven’t come on line or may not come on line. So there will be some, I think, consolidation or acquisitions that occur as things haven’t grown to the sky for some of these people that want to enter these businesses. And it’s tough work there that relates to your ability to process materials and deal with fractions.

So I think there will be some consolidation. But we are seeing generally a lack of additional investment, which is consistent with all the cycles we’ve seen in the past. So we need global recovery. We are way down in – just in the US, we are running at probably off 30% from even some of the cycles in the past. So this is a tough one and tougher than anything we’ve seen. But the Americas are tighter. A lot of Chinese capacity is not really working efficiently, and it has been built but has been sitting there for years. The high voltage is people who say they can do it, but a systems work and guaranteeing the products, reliability of the network is a different task altogether. But I think we need demand to recovery. I think we will see some consolidation or the mothballing or remove of equipment. And a number of competitors, as you know, have announced restructuring efforts. Sometimes a better equipment shows up again and some of it is just capacity that comes out of the system.

Stuart Bush – RBC Capital Markets

Great. Thanks a lot, guys.

Greg Kenny

Okay.

Operator

Your next question comes from the line of Jeff Beach from Stifel Nicolaus. Your line is open.

Jeff Beach – Stifel Nicolaus

Yes. Good morning, Greg and Brian.

Greg Kenny

Hi, Jeff.

Brian Robinson

Good morning, Jeff.

Jeff Beach – Stifel Nicolaus

A couple of questions. First of all, can you quantify ahead here the timing and size of cost reductions in Spain from this restructuring?

Greg Kenny

Stuart, it’s – we've avoided getting into that, but I would expect – we're still in the middle of discussions with the union on we need flexibility on these lines and over weekends and things like that. So we are still in discussion. But Spain, as you know, over the last 10 years had virtually no unemployment and we were selling everything we could make. So we need to get rid of a portion of the workforce sadly, but we need to keep the flexibility. It’s – I would expect the pickup to be $5 million to $10 million annually.

Jeff Beach – Stifel Nicolaus

And starting about later this year or –?

Greg Kenny

Starting over the next months.

Jeff Beach – Stifel Nicolaus

Okay.

Brian Robinson

And Jeff, that’s on top of – of course, all the calls we’ve taken out in the overall company we’ve done for the last 10 years, but as you know, we took significant actions over the last 18 months in response to the economic conditions.

Greg Kenny

And we said – the ’08, ’09 actions of the company had been in the tens of millions, and we wanted not to get ahead of ourselves because we’re dealing with very tough demand and very tough pricing. So to some extent, you give back a lot of those costs out as you wind down projects and pricing tightens. And then as the economies restart, you can keep yourself as lean and keep getting leaner, you get some tremendous leverage. And we’ve also mentioned, Jeff, that we’ve got $1 billion to $2 billion depending on the product and the place of open capacity, which we flex down, which I think provides some very strong operating leverage as we use it.

Jeff Beach – Stifel Nicolaus

Second question, you mentioned a slowing in May and June in some markets. Can you talk about geographies and maybe end markets where you’ve seen some slowing?

Greg Kenny

As you know, Jeff, I think consistent with sort of the comments of other companies and the macro events, we saw – I thought we have a sharper second half May, June than we did in some of the US businesses. I thought rest of the world would be a bit stronger. But I would say my thinking was more around the US where we were up seasonally but not up as strongly. Europe was quite floppy as well during that timeframe and was a bit weaker than we had anticipated. And rest of the world was more related to Venezuela and Brazil. The rest of the rest of world seems to be getting stronger. And in fact, Brazil, I think, will also track up nicely. That was more – our business in Brazil has more tight energy transmission, and we have a smaller position in, say, construction cables and the other product lines. But I think it was related to a stronger view, primarily around the US and Europe.

Jeff Beach – Stifel Nicolaus

And which end markets in the US specifically were disappointing?

Greg Kenny

Transmission just didn’t happen at all. And then I would say the MRO business was a – we probably – we talked about in the past about people refilling their pipeline, but we just didn’t see the sell-through. So I would say some of the earlier cycle businesses were okay. Our Datacom, we’re very proud of. But some of the MRO and electronic cable, that wasn’t quite as strong as we would have anticipated. Transmission was a big disappointment, though I feel better about that for the second half of the year, as well as some of the wind projects seem to be picking up as well. So we are feeling a bit better about those segments as we look at the second half of the year.

Jeff Beach – Stifel Nicolaus

Okay. Last question, and I don’t have re-looked at the cashed inventory levels, but your June 30th inventory level at over $1.1 billion compares to I think historical level of carrying cost, but back in 2008 of little over $1 billion. So you’re at an all-time record here. Is this largely a change in accounting? And where do you feel your inventory levels are right now relative to demand and how much might we see inventory levels come off in the second half?

Brian Robinson

Jeff, the comparison to – and you just have to be careful because I believe you may have a LIFO number in front of you on the balance sheet for ’08.

Jeff Beach – Stifel Nicolaus

Yes.

Brian Robinson

So you have some old historical layers in that. But be that as it may, through the first half of the year, we – because of the return of the seasonal trends in the business and we have added call it about $170 million of inventory, much of which will come out in the second half of the year. So I would say we are managing this closely, and I would say we are about where we want to be. We are at a peak, and I think besides the North America and Europe and NRW, you see more of a – I’ll call it a seasonal trend in terms of – as you get into the fourth quarter, you’ve got the Christian holidays and a much, I would say, slower December than you see in other parts of the world. So that’s a long way. I think we will end the year – we're expecting to end the year about where we started.

Jeff Beach – Stifel Nicolaus

Okay. Thank you.

Operator

Your next question comes from the line of Matt McCall from BB&T Capital Markets. Your line is open.

Jack Stemic – BB&T Capital Markets

Good morning, everyone. This is actually Jack Stemic [ph] filling in for Matt this morning.

Greg Kenny

Okay, Jack.

Jack Stemic – BB&T Capital Markets

I just had a couple questions I guess. If you could kind of help me understand the guidance you guys gave in the release. This quarter, you guys did about $1.2 billion in top line. It looks like you’re kind of guiding to a midpoint of about $1.18 billion. So, not a ton of change there, but last quarter, for the sovereign stuff in Spain, you said there was going to be about $9 million in charges. I didn’t see anything about – related to charges. And you back out that and the R&D credit, that looked to be about $0.17. So that – guiding to a midpoint of $0.49 versus kind of backing out some of those charges from this quarter, I’m just kind of trying to figure out where that drop is coming from. If you could kind of help me there?

Brian Robinson

Sure, Jack. It’s Brian. I would say the two principal drivers there are – back to Jeff’s question, around the inventory change. So we broadly filled or added about $60 million of inventory in Q2. We are expecting to drop inventory by about $80 million in Q3. So we’ve got about $140 million swing on the inventory, of which we – there is lost absorption, which then, I’ll call it, penalizes the P&L on a relative basis. And as we head into Q3, we’ve got a seasonally slower European business partly because of the August holidays mainly in France. So sequentially, those are the two big drivers between the sequential decrease and the expected earnings.

Jack Stemic – BB&T Capital Markets

So that’s kind of coming in more on the margin side and the top line, I guess. I guess, another question, maybe this is –

Greg Kenny

We’re going to produce less. As you know, when you build something, you put an inventory at your standard cost. And if you are running your – if you’re running a factory harder, you are absorbing those costs into your inventory. So I agree. The sales are relatively the same, but the factories, we’ve taken all our shutdowns basically. Again, the factories are all scaled down from where they were, say, three years ago where you are running less lines and less over time, but we have taken – we have US facilities down one or, in some cases, two weeks in the July timeframe, and then we moved into Europe, which we have done from one to three, as well as Europe is basically not selling very much in this August timeframe. So we are under-absorbing our facilities in this third quarter relative to what we were able to do in the second quarter, and that’s related to holidays, vacation and our desire to manage inventory as close as possible. So our revenues are up. We’re selling stuff we built in the second quarter if you think about in a simplistic standpoint.

Jack Stemic – BB&T Capital Markets

Okay, that’s helpful. And I guess kind of as a follow-up to that, maybe a couple quick questions on your assumptions. So, ex this charge, I think in the note you said that operating margin would have been about 6.1%. I was just kind of curious what you kind of baked into your Q3 guidance for operating margin, and kind of same question related to maybe copper benefits you guys are seeing in Q3.

Greg Kenny

We don’t really – we don’t assume an operating margin. We kind of work it up from what we see in some cases from backlog and in some cases we’re looking at our average cost in our inventory and then trying to project demand. And then as you know, for half our business, the pricing is being set today, and then the other half, those contracts or projects are let at different times. So we are broadly assuming copper stays at the level it is today, which I think was in the $3.34-ish range. And then we work up from what we’re actually going to produce and what are we going to think we’re going to sell and what will the pricing be on those sales. We’re thinking about the value-added pricing. But we don’t start with a margin assumption.

Jack Stemic – BB&T Capital Markets

Okay. That’s it for me. Thanks.

Greg Kenny

Okay.

Brian Robinson

You’re welcome.

Operator

Your next question comes from the line of Brent Thielman from D.A. Davidson. Your line is open.

Brent Thielman – D.A. Davidson

Hi, good morning.

Greg Kenny

Good morning.

Brian Robinson

Good morning.

Brent Thielman – D.A. Davidson

Yes. Just I guess a clarification for me. I mean, when I look at the North American margins just on a sequential basis, they declined. Is that just a function of mix?

Brian Robinson

Brent, it’s probably more a function of somewhat of the lagging impact on the average cost. But as we move from Q1 to Q2, we had – and again, while the average cost for the quarter in whole, as we said, was somewhat muted. There was some pretty big volatility within the quarter.

Brent Thielman – D.A. Davidson

Okay.

Greg Kenny

And we’re dealing with copper that has been extraordinary over the last couple of years. So I think if you step back from the movement of copper and methodology the average cost, we would say that pricing is relatively similar. Meaning, it’s tough. But the conditions haven’t changed. Part of it is just again the effect of average cost into an extremely volatile metals world where we saw that quarter about $0.70 movement throughout the quarter, which changes pricing behavior in a spot market daily. It’s really that. But conditions in the US are broadly the same in terms of demand and pricing on the value-added.

Brent Thielman – D.A. Davidson

Okay. That’s helpful. And then I guess stepping aside from sort of the Spanish markets, what is your view on sort of further plant rationalization? Do you feel you’ve sort of taken all the steps you need to take at this point?

Greg Kenny

Yes. We never say we’re done. And as you know, over 10 years, we’ve always looked and said, can we do more with less and with less overhead envelopes? I think given what we see in Europe, we probably have the right facilities. And that’s not to see we don’t look at it. But these are fairly purpose-built facilities. So if there was something to be done, it’s not multiple plants. And right now, we will take the hand we’ve got and aren’t contemplating anything more specific. But that’s something we are doing. We have 48 plants around the world, but again they are a long way from each other and they are generally focused on specific products. But we are always looking at that. You will remember that we closed Moose Jaw and we also converted the Tampa plant just in the last year.

Brent Thielman – D.A. Davidson

Okay. Thanks, guys. Appreciate it.

Operator

Your next question comes from the line of Michael Coleman from Sterne Agee. Your line is open.

Michael Coleman – Sterne Agee

Good morning.

Greg Kenny

Good morning, Michael.

Michael Coleman – Sterne Agee

Brian, if I wanted to normalize your gross margin SG&A, how would the combined $11.1 million, $3.1 million charges break up between COGS and the SG&A?

Brian Robinson

The $11.1 million with respect to the severance/redundancies would be in cost of sales, Michael. The R&D credits, because they are – while they have a tax nomenclature, because they are not income tax, they are actually in the SG&A. So they are within the operating income.

Michael Coleman – Sterne Agee

Okay. In terms of your third quarter guidance of flat volume on a sequential basis, you’ve talked about Europe and seasonality as well as North America. So just kind of looking at the components there on a sequential basis. You’re looking for almost double-digit improvement in the rest of world segment to offset declines in Europe and North America. Is that kind of a correct interpretation of that?

Greg Kenny

Yes. I would say broadly, rest of world is picking up across all geographies. And it’s continuing to be ahead of the US and Europe. So the – from the second to the third quarter movement, we think North America is approximately the same. Meaning, by towns, we will ship in the third quarter about the second quarter or just slightly less. That’s actually not – given that there is seasonality, we had a weaker second quarter than we thought. And the third quarter relative to the second quarter is actually a little tighter.

So we’re getting a little bit of that back, but I would look at the North America from second to third as a pushing. Meaning, no growth, but not the decline you normally see seasonality, which probably tied to that pause we talked about in late May and June and some push-in of volume to the third quarter. Europe, we expect to be down from the second quarter primarily because of the September – I'm sorry, the August weakness. So it’s always been more profound in Europe, as Europe is much more serious about taking several weeks off as a society and not ordering. Rest of world is making up for Europe, and we would see that volume up 10% or more from the second quarter, which is I think highly encouraging.

Michael Coleman – Sterne Agee

Okay, great. One thing – on the deliveries, on submarine, cabling, as well as fiber-optic, Will the delivery in the back half of the year accelerate versus the first half of the year on the contracts for those products?

Greg Kenny

I would say these projects are very complex, have to be funded and they move around. But – I see that business, in broad terms, accelerating into 2011, more in the energy side versus communications though there are some big communications projects at large. So we don’t – I think it’s hard to say when these things get wet, but we examine backlog and then near backlog and then highly likely. But I would say generally the energy part of the submarine business is growing, and in the communications side, it depends on what projects are landed. The market hasn’t grown as rapidly as the submarine, but it’s still an important market. But yes, I’m positive on that business, and that was part of the recovery. In the second quarter, it was a stronger submarine cable business versus the first quarter relative to the project completion and project management.

Michael Coleman – Sterne Agee

Okay. Thank you.

Greg Kenny

Yes.

Brian Robinson

You’re welcome.

Operator

Your next question comes from the line of Shawn Harrison from Longbow Research. Your line is open.

Shawn Harrison – Longbow Research

Hi, good morning. A few clarifications. The aluminum pricing for the second quarter and what you’re assuming in the third quarter in your model.

Greg Kenny

Aluminum is in the mid-90s or so. It’s flat. We would assume – we would make the broad assumption that aluminum as it stands today – I don’t have that quote. I think it’s 91 or – I'm sorry, it’s up around $1.00 in the second quarter. I think it’s slightly below that now. We can get a quote for you, but it’s in the 90s and that’s what we would assume. Aluminum has been much less volatile, as you know, not without volatility. But I think we’ve seen it travel maybe to $1.40 and to $0.70 and copper has been currently sharper than that.

Shawn Harrison – Longbow Research

The second would just be in terms of, I guess, severance cost or other one-time expenditures. Is any of that included in the third quarter guidance?

Greg Kenny

It’s minimal. It’s in the hundreds of thousands.

Shawn Harrison – Longbow Research

Okay. And then looking back to the second quarter in terms of the European and Mediterranean operating margin performance, if you strip out some of the restructuring and R&D cost, you saw a nice increase in the EBIT margin in the region. If you could just elaborate in terms of what drove that? And two is, maybe the European region is where most of the inventory was built and so that’s where you’re going to see most of the margin degradation on an apples-to-apples basis heading into the September quarter.

Greg Kenny

The Europe, Spain actually, if you take out the charges, actually improved versus the first quarter. And I would say that was slightly – very slightly better domestic pricing and more export orders as the Euro weakened. Portugal was a push. It was down slightly first to second. France was around – France is more project-driven because of the high voltage, but it continued to operate at a high level. Again, I say that because (inaudible) around the world. So I should say it’s French located. The big swing was NSW, which went from a loss to earnings in the first to second quarter. And then our Algerian business improved, and that really relates again to the – there were some complicated import – raw material import regimes that we had to deal with. So broadly, we would expect the third quarter to be weaker than the second when you take out the redundancies, but we are encouraged by the cost position and the Euro has made us more competitive in the export area and has slowed down imports into the region. So Europe is weak, but maybe we’re getting around the corner here.

Shawn Harrison – Longbow Research

Okay. So I shouldn’t read that you’re going to – the inventory build wasn’t focused within Europe. It was more of kind of a global build of inventory that you will be reducing in the back half.

Greg Kenny

Yes, Europe is going to reduce as well. The strongest reduction will be in the US and Canada, followed by Europe. And on the last call, I was going through our tonnage movements. Rest of the world actually is strengthening third quarter to second quarter. So it needs – again, I’d love to have no inventory in ship perfectly, but the rest of the world is probably – will be the least contributory to the slowdown of our capacity. And the biggest adjustment is North America first, Europe second.

Shawn Harrison – Longbow Research

Okay. And just to wrap it up, you touched on pricing within Europe. It sounds like it’s a little better there. Maybe your expectation for second half given that you’ve already commented North America looks like it’s still pretty difficult in terms of pricing.

Greg Kenny

Yes. I wouldn’t go as far as, say, Europe is a little better. I mean, we are talking about Spain against very tough levels where people have to exit the business in the sense at the price levels. It’s hard to argue it gets much worse because we’ve said many times we are in some markets close to the cash contribution, cash cost of some of the least efficient producers. I think – she is bottoming. And partly as you wind through contracts, we’ve said in prior cycles the spot market – the contract market follows the spot market. So if the market for today for cables is below contracts, then the contracts will follow down, and then when the market tightens, then you’d see the spot market, if you will, or the market to distributors start to improve, then the contracts follow along. So we’ve been winding down pricing. And in a few places, we’re seeing slight improving conditions, but it’s nothing – I wouldn’t say a big trend has started.

Shawn Harrison – Longbow Research

Thank you very much for the detail.

Greg Kenny

Yes.

Operator

Your next question comes from the line of Richard Wesolowski from Sidoti & Company. Your line is open.

Richard Wesolowski – Sidoti & Company

Thanks. Good morning.

Greg Kenny

Good morning.

Richard Wesolowski – Sidoti & Company

Is the approval for the favorable FX rate on the copper purchases in Venezuela open any benefit or is there a defined window of time during which you will get that?

Greg Kenny

I would think of it as – it shows up as – in a currency account, and over the course of the year, maybe around a push. But I think of it as sort of the economic equation for the country because there are lots of issues. And when they let people go out and buy at a preferential rate, it’s because – obviously they have a currency problem, but they need to continue to run the economy. So we will benefit – they will cause you to buy in narrower windows for more than you need. So you’ll have some exposure to the metals price. But we’ll – as we get permission, we are in using that 2.60 bolivars to the dollar preference rate to acquire copper, which is priced in dollars, so that we can continue to meet demand there.

So again, I look at it as where is my economic profit from the country because we are dealing with so many variables as the government works around its own exchange controls etc. So timing should be that the third quarter benefits and then we’ll use that material on the second half of the year. The first half of the year was somewhat penalized because we were having to buy it at the spot market rate, which was very high, and then you try to sell it as much as you can to recover that, but there is also price controls for some products in Venezuela. So net-net, Venezuela still makes sense for us, and that benefit, as we buy now, we’re not buying at a linear basis. We’re buying it as soon as they give us a green light and we’re buying as much as we can.

Richard Wesolowski – Sidoti & Company

Then you would assume that they would have an incentive to continue giving that green light so long as they struggle to bring the power to the people?

Greg Kenny

Correct. They are viewing it as they had other categories, as an important commodity to their economic development. So that’s why we’ve got the green light. The other thing we are dealing with in Venezuela is, because they continue to have power issues, we also sell aluminum there. And Venezuela is a manufacturer of aluminum, but unfortunately they have cut back on their power. So we’re also having to walk through, which we think they don’t melt as much and we need a lot. So we’re also working with them on aluminum availability and importing that. So it’s a complex picture. The happy news is what we make is viewed as somewhat strategic.

Richard Wesolowski – Sidoti & Company

Was the Venezuela profit contribution to the June quarter similar to what you had reported in December and March?

Greg Kenny

We’re checking.

Brian Robinson

Yes. I would say, Rich, in the – it's more than it was in the first quarter on a pretax – if you roll all of it together on an economic basis, as we said at the end of last year, we expected 2010 to return to sort of more to normal levels. And in Q1, the pretax contribution was de minimus, in fairness. And in Q2, it’s higher than – it's a little higher than – it's back to sort of about from a global company perspective on the operating income in that 15% to 20% type range.

Richard Wesolowski – Sidoti & Company

Okay. Secondly, in the past you’ve appeared a lot more excited about the near-term opportunities in European utility networks than you have in North American T&D. Is that still the case? And if it is, when would you expect to see a pickup in your European T&D volume?

Greg Kenny

Europe, as we talked about, is the transmission linked between countries as well as the alternative energy and that we have generally found, particularly in France, that they are spending – the French have spent more on distribution and to a lesser extent, other utilities. So we continue to see Europe relatively better than the US though Spain is not strong because they don’t have houses or non-resi to hook up to the grid. But we are bidding on major interconnection projects in Europe, which we would expect would be on top of normal demand. And these are EU-funded, and there would be, say, interconnectors between France and Spain or I think it is Italy and – I lost the other connection point. But there were a number of these over-builds, which looked like they will be funded and that we would hope to start adding to our backlog, as we are successful over the next couple of years. But Europe is better than the US though I am slightly more encouraged in the second half.

Again, we’re talking about relatively low levels, but transmission in the US was, for us, only about 40% in the second quarter of where it was for most other years, including the prior year. We are feeling a bit better in the second half of the year. And the wind side also looks slightly better, we call it. There are sort of medium voltage collection systems, but it’s – we are seeing a second half of this year that looks stronger than the second half of last year, which is encouraging. Again, this is a start-stop, as they think through tax credits etc. But in the US, we are seeing improving, we believe, conditions in transmission and wind in the second half of the year, though in transmission it’s against very low levels of demand in the first half of this year.

Richard Wesolowski – Sidoti & Company

Appreciate it. Thank you.

Greg Kenny

Yes.

Brian Robinson

You’re welcome.

Operator

(Operator instructions) Your next question comes from the line of Anthony Kure from Keybanc. Your line is open.

Anthony Kure – Keybanc

Hi, guys. Just a couple quick questions. If you can maybe handicap the regulatory environment and the impact, specifically in the US here? I mean, obviously the construction markets are impacting what’s going on from a demand perspective. But if you were to – if this is a normalized demand environment, how big of an impact, if you had to guess, would hesitancy among utilities to invest be in this environment?

Greg Kenny

Well, just to give you a sense, Anthony, if I just look at my utility business over time, we were selling in a year, say, between 130 million and 145 million pounds, including in the last recession was a 130 million range. We are selling today something like 80 million.

Anthony Kure – Keybanc

That’s in the US alone is what we are talking about?

Greg Kenny

I’m talking about the US alone. And so that was a – there is 50 million pounds or hundreds of millions of dollars of demand that would come back to our business if they were – if we had a 1.1 million construction and they felt better about demand going forward in terms of the demand on the grid and then the regulators were not going to hand them out. So, tremendous upside. We have the ability to make all that. And then what we do have now, which we didn’t have in prior years, but not enough to offset is a relatively stronger wind business, but the wind is not anything close to making up that gap. But it would be great if we could get back to normalized demand with utilities and have the top dressing of wind, and then of course we also make nuclear cables and a lot of other things. So wind and solar would be great, but it’s way, way off. And I would say the market began to decline in 2006 has sort of held together in ’07 and then just began to undo itself right through last year. On that note, I would say it is relatively stable at a very low level, which says we are probably around some type of replacement or maintenance level, but it is not getting worse.

Anthony Kure – Keybanc

So I guess based on your commentary, it sounds like organic demand or organic lack of demand is really a much bigger driver than, say, hesitancy among utilities within this regulatory environment or lack of clarity on regulatory issues.

Greg Kenny

The utilities, I think they get to learn to the cap-and-trade on the new generation and it was the price of gas versus coal. And then I think there is 13 or 14 nukes. Three of them have been approved. I think the hesitancy is – don't go to your Public Utility Commission if you have – if you have a rate case right now, it’s not a great time. Your grid is not yet being loaded again, though this is a hot summer. But I think it’s more the – around wind, it’s unclear what the long-term incentive scheme is for that and solar, and it’s also unclear about the relative – what will happen in cap-and-trade. So I don’t see utilities really hitting the generation side, which generally will cause some cables to come as well.

So I think you are – I think it’s the general economy, and I think it’s the lack of a clear set of rules. There is a variety, again, of energy bills in FERC comments, one of which was quite exciting for us. There is a FERC transmission rule proposal, which is out now, I guess a 60-day common period, but it’s back to tying in wind and solar generation. They now have to look at renewable energy standards for when they do the transmission carters and then it actually has the language to spur the connection utility solar farms. And there is a couple of other bills in the Senate. So we’re watching all of those. It’s not helping. But I think the economy is probably a bigger factor.

Anthony Kure – Keybanc

Okay. And I guess just to wrap that, extending that sort of thought process into Europe, would austerity programs that are going on in the proposed spending cuts or the potential for spending cuts, is that a concern at all going forward for you, as a lot of these projects roll off?

Greg Kenny

The utilities are generally privatized in Europe though sometimes with government interest. Yes, Europe tightening its belt. I think it’s a good thing long-term, but I – there should be less governmental spending in Europe because they need to spend less. So that would have an impact. But I don’t think it really hammers the utilities. What does hammer them is what the government can afford to subsidize renewables. So you’re now having things like Germany saying, well, maybe we’ll give re-licensing of the nukes because the cost in subsidy dollars from the public for lots of North Sea wind may be a lot. So you have some of them back – they had 20% to 50% kind of goals on renewables. So I think it all gets back to the ability to pay, Anthony, unless we see oil prices at $6 to $7 a gallon. Then a lot of the stuff makes economic sense. Right now, it’s sort of a push on a lot of these renewables and they need it with the help of government, and government has to be able to pay for it.

Anthony Kure – Keybanc

Okay. That’s helpful. Thank you.

Greg Kenny

Yes.

Operator

Your next question comes from the line of Gary Farber from C.L. King. Your line is open.

Gary Farber – C.L. King

Yes, sure. Good morning. Just a couple of questions. When you’re talking about the trends in May, June, maybe into July, things being a little bit less than you thought, are you saying still stability, but stability at a low level or something different?

Greg Kenny

I think I was saying still stability, but the rate of acceleration was lower than we thought. And we are also trying to factor in the notion that there is a seasonal – that April, May and June are typically our strongest months from a physical demand standpoint. So we are – yes, I would say stability and not – we're not seeing a further deterioration.

Gary Farber – C.L. King

Okay. And as far as the tax rate, are you saying that the tax rate in Q3 and Q4 is going to be higher than Q2?

Brian Robinson

Gary, I think it will be in that same – the full year will be about 35%. So I think it will be – I'd call it 35% – in that same sort of neighborhood that we were at for the second quarter.

Gary Farber – C.L. King

Okay. And then just lastly, is there any reason to think that you will need to do anymore rightsizing of your operations anywhere?

Greg Kenny

I think the lean monitor says you’re always looking, can you do more with less. But I think we will always look and say, do we have better use of equipment somewhere else or know-how? I think at the current demand levels, we will probe at the edges, and I will say we’ll never take something down and try to keep a productive capacity under one envelope. That’s been our history, as always, always doing that when we see the chance to do it. But I think we are broadly correct for the operating environment we are in. I wish we are running more of equipment on more shares, but I think our footprint is about right. And again, we haven’t spent – we haven’t announced if we were taking factories, then we would have talked about it more specifically, but we had a continuous cost-out, accelerated over the last two years in part because volume was off more than $1 billion in real terms. And also, you always say, what else can we do that we haven’t thought of.

Gary Farber – C.L. King

Great. Okay, thanks.

Operator

Your final question comes from the line of Brett Levy from Jefferies & Company. Your line is open.

David Wachowski – Jefferies & Company

Hey, good morning, guys. It’s actually David Wachowski [ph] for Brett. Just a couple quick ones. Number one, can you give me an idea of how many projects you are actually looking in Brazil that are in the backlog or near backlog? Is that in the single digits or is that 10, 50?

Greg Kenny

We’ve got – again, we’ve got about $150 million-ish in backlog. And there appear to be more projects as well. But it’s a pretty good sized backlog.

David Wachowski – Jefferies & Company

Okay. And then, about how many of those are maybe on a percentage basis are being held up by the environmental permit cost –?

Greg Kenny

That whole amount is being – is slowed down. We thought someone would be going now. Again, there are different corridors, and without taking it through every route, broadly this is a little behind from where we though because of the complexity, as we always know about major projects across the Earth. And we see it on other project businesses. So I would expect that $150 million will go out from maybe the end of this year till 2012 and there are other projects, and we are a leader in Brazil in these types of cables.

David Wachowski – Jefferies & Company

Okay, perfect. And then just one more thing. In regards to the Spain cost, I think somebody else asked this, and I can’t tell what the answer was. Was that $5 million to $10 million per quarter in terms of cost savings? Is that on the SG&A line or is that cost –?

Greg Kenny

It’s annually – we try to avoid doing this exercise because the world is linear and price changes every day. But it’s – this is – it's expensive to take out workers in Europe. We did it, and we would expect we will, to some extent, need to continue to get flexibility around our lines, but it should be $5 million to $10 million kind of annual savings. But we’re purposely being – trying not to be set point, because we haven’t called out. And the other stuff that we’ve done over the last year-and-a-half, we simply called this one out because we actually had a talk to four unions in the government, and it was large and it wasn’t one region.

David Wachowski – Jefferies & Company

Okay. Wonderful. Thank you so much.

Greg Kenny

Yes.

Brian Robinson

You’re welcome.

Operator

At this time there are no further questions. I’ll turn the call back over to the presenters.

Len Texter

Thank you for joining us this morning. That concludes our conference call. A replay of this call will be available on our website later today. We appreciate your continued interest in general cable.

Operator

This concludes today’s conference call. You may now disconnect.

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