Acuity Brand's (AYI) CEO Vernon Nagel on Q3 2014 Results - Earnings Call Transcript

Jul. 1.14 | About: Acuity Brands, (AYI)

Acuity Brands, Inc. (NYSE:AYI)

Q3 2014 Earnings Conference Call

July 01, 2014 10:00 AM ET

Executives

C. Dan Smith, Jr. - Senior Vice President, Treasurer, Secretary

Vernon J. Nagel - Chairman, President and Chief Executive Officer

Richard K. Reece - Executive Vice President and Chief Financial Officer

Analysts

Christopher Glynn - Oppenheimer.

Brent Thielman - D.A. Davidson

Thomas Daniels - Goldman Sachs

Matt McCall - BB&T Capital Markets

Mike Ritzenthaler - Piper Jaffray

Tim Weiss - Robert W. Baird

Colin Rusch - Northland Capital Markets

Winnie Clark - UBS

Operator

Good morning and welcome to the Acuity Brands 2014 Third Quarter Financial Conference call. After today’s presentation, there will be a formal question and answer session. To ask a question, press star, one and record your name. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now I would like to introduce Mr. Dan Smith, Senior Vice President, Treasurer and Secretary. Sir, you may begin.

C. Dan Smith, Jr.

Thank you. Good morning. With me today to discuss our third quarter results are Vern Nagel, our Chairman, President and Chief Executive Officer, and Ricky Reece, our Executive Vice President and Chief Financial Officer. We are webcasting today's conference call at www.acuitybrands.com.

I would like to remind everyone that during this call, we may make projections or forward-looking statements regarding future events or future financial performance of the company. Such statements involve risks and uncertainties such that actual results may differ materially. Please refer to our most recent 10-K and 10-Q SEC filings and today's press release, which identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

Now let me turn this call over to Vern Nagel.

Vernon J. Nagel

Thank you, Dan. Good morning everyone. Ricky and I would like to make a few comments and then we’ll be happy to answer your questions.

Our results for the third quarter of 2014 were very solid. Our net sales increased almost 12% this quarter exceeding $600 million in the quarter for the first time in our history while we earned $1 per share. In fact, this was the fifth quarter in a row where we achieved double-digit sales volume growth. In addition we continued to make excellent progress with a number of strategic initiatives as I will mention later in the call. Also noteworthy, sales of LED-based lighting solutions now make up more than a third of our total sales.

We believe this level of growth is yet again positive evidence our strategies to provide customers with differentiated value propositions to diversify the end markets we serve are succeeding, allowing us to extend our leadership position in North America. These strategies include the continued aggressive introduction of innovative, energy-efficient lighting solutions, expansion in key channels and improvements in customer service and company-wide productivity.

Our profitability and cash flow for the quarter were again strong, even as we continued to fund our robust sales growth as well as other areas with significant future growth potential, including the rapid expansion of our lighting solutions and components portfolios. I know many of you have already seen our results, and Ricky will provide in more detail later, but I would like to make a few comments on the key highlights for the quarter; however, before doing so, I would like to comment on two abnormal items impacting this quarter.

First, with regard to the warranty issue we noted last quarter due to a design defect in an older, incandescent emergency lighting product, we took an additional pretax charge of $2.1 million this quarter based on additional facts and information that became available to us this quarter.

As you will recall, we took a charge last quarter related to this issue noting at that time it was our best estimate of the cost to resolve the issue. We further noted those estimates were subject to potential additional facts and information. While this is still true, we believe the charge this quarter plus the charge taken in the second quarter reflects the total costs necessary to resolve this matter.

Second, the impact of foreign currency primarily due to a weakening Canadian dollar reduced our gross profit this quarter by approximately $2.1 million. As Ricky will explain later, the level of foreign currency impact we have experienced the last two quarters is abnormal for us. We believe these two items reduced our gross profit and operating profit margins in the quarter by approximately 70 basis points. The total impact of these items reduced diluted EPS this quarter by approximately $0.06. We have taken appropriate actions in the second and third quarters to address the design issue. We of course remain somewhat exposed to currency fluctuations as they are very difficult to forecast.

Now let us review our reported results for the quarter. Net sales for the quarter were $604 million, an increase of 11.5% compared with the year-ago period. Reported operating profit for the quarter was $72.6 million compared with $50 million reported in the year-ago period. In the year-ago period, we took a special charge and incurred temporary manufacturing efficiencies associated with the plant closure as well as a charge for a fraud committed by a freight vendor, which in total reduced operating profit by $16.1 million. I do find it helpful to add back these items to the year-ago period’s results to make them comparable. Doing so, one can see that operating profit for the current quarter compared with the adjusted operating profit in the year-ago period increased approximately 10% while operating profit margin decreased about 20 basis points. Again, remember we are not adjusting the current quarter’s results for the access warranty and foreign currency impact, which lowered both gross profit and operating profit margin by approximately 70 basis points.

Diluted earnings per share for the third quarter were $1.01 while adjusted diluted EPS for the year-ago period was $0.97, an increase of about 4%. Again, our results this quarter were impacted by approximately $0.06 for the two items I previously mentioned -- still very strong results indeed.

The results for the quarter were improvements over the year-ago period. We believe you will find them even more impressive upon further analysis. While net sales grew 11.5% compared with a year ago, we estimate sales volume grew approximately 13% this quarter. This level of growth is particularly noteworthy given we believe the overall market we serve was up mid-single digits over the year-ago period. Second, the impact of price changes and the mix of products sold as well as foreign currency reduced net sales by approximately 1.5%.

Overall, our growth in net sales was broad-based along virtually all major product lines, while certain specialty fixtures more closely associated with new construction continued to lag the overall average due to the still somewhat tepid environment for new, larger non-residential construction projects. Interestingly, orders for these types of products continued to improve suggesting the rebound of our commercial projects in the U.S. is well underway.

From a sales channel perspective, we continued to experience strong growth in the commercial, industrial, and infrastructure channels for both indoor and outdoor applications as well as continued growth for renovation projects. Again, sales of LED based lighting solutions nearly doubled compared with the year-ago period. The sale of LED-based fixtures at Acuity now accounts for more than one third of our total revenues. We believe our level of growth at LED-based lighting solutions is far outpacing the growth rates of our largest competitors for these types of products further demonstrating our formidable capabilities in product development and our leadership in market access.

Let me again put this in perspective for you. If the sales of our LED-based luminaires were measured as a separate business today, we believe it would easily be the fourth largest lighting company in North America; and remember, it is still only one third of our total business, (inaudible) results indeed.

Overall, we continued to experience growth in most geographies and sales channels in North America, all of which is very encouraging. Excluding LED components, we believe material and component costs were again fairly benign this quarter. With regard to the impact of product pricing and the mix of products sold and net sales, while it is impossible to precisely predict price versus mix, we believe most of the impact was due to the mix of products sold and to a lesser degree the mix of products sold by channels. Market pricing action seemed to be consistent with past practices. Folks we are having a – I hear a horn go off here, so I apologize, we will continue to go forward, but I apologize for the problem. Let me [indiscernible].

Anyway, looking at our overall market conditions for the third quarter, we believe spending in the U.S. non-residential construction market in which we participate was up low-to-mid-single digits compared with a year ago, while residential construction was up almost 20%. Therefore while complete market data for the quarter is not yet available, we believe the overall lighting market grew in the mid-single digit range during the quarter supported by continued growth in renovation as well as the residential market. This is in stark contrast compared with our net sales growth, which was up almost 12%. Also, we believe there is little, if any, carryover effect this quarter due to the harsh winter conditions which impacted the second quarter.

Lastly, we believe our sales channel product diversification, as well as our strategies to better serve customers with new, more innovative lighting solutions and the strength of our many sales forces have allowed us again to achieve meaningful sales growth this quarter.

Before I turn the call over to Ricky, I would like to comment on our profitability and some key strategic accomplishments in the quarter. Operating profit margin for the third quarter was a solid 12%, down 20 bps compared with adjusted margin in the year-ago period. Again, the access warranty and foreign currency issues I noted earlier reduced the operating profit margin this quarter by approximately 70 basis points.

Our margin strength is particularly noteworthy given that the sales of LED-based lighting solutions are more than a third of our total net sales and we are making investments in new areas of opportunities as I will describe in a moment. Further, as Ricky will discuss later in the call, while gross profit margin declined by 70 basis points to 40.3% from the prior year’s adjusted gross profit margin, the margin decline was primarily due to the abnormal items I noted earlier, and the mix of products sold. This was partially offset by benefits from higher sales volume, productivity gains, and previous restructuring actions. Another area impacting gross profit margin was certain inefficiencies associated with the ramp up of our electronic component capabilities primarily from the acquisition of eldoLAB our programmable LED-driver platform, while it is difficult to predict start up inefficiencies, it is not at all unusual to experience higher cost due to learning [curves] and the inability to absorb cost and to a unit volumes at a more meaningful level.

Overall, we believe these cost reduced our gross profit margin by approximately 20 basis points this quarter. We are significantly accelerating our investment and capabilities to produce electronic components including programmable dimmable drivers for LED lighting applications that require superior functionality and quality, as well as consistent delivery in order to capitalize on this growing market potential.

In addition to the acquisition of eldoLAB itself, we have invested almost $10 million for additional machinery and equipment as well as funding meaningful increases in [solid] and our associates to support our growing internal requirements as well as those of our expanding list of OEM customers for these components. We expect these inefficiencies to impact our margins somewhat over the next few quarters as we ramp up our volumes of these components.

Next, total adjusted selling, distribution and administrative expenses were up almost 10% and a sales increase of approximately 12%. The increase in total SDA expense was due primarily to higher variable cost for commissions and freight to support the growth in net sales, as well as higher employee-related costs, including incentive compensation partially offset by benefits from previously implemented restructuring programs. SDA expenses as a percentage of net sales were 28.3% in the quarter compared with adjusted SDA expense of 28.8% in the year-ago period, an improvement of approximately 50 basis points – all in all, a strong third quarter for Acuity.

On the strategic front, we’ve accomplished a great deal this quarter which will have future benefit. First we continued our rapid pace of introductions of new products, significantly expanding our industry-leading portfolio of innovative, energy-efficient luminaires and lighting control solutions. For example, in May we introduced four new product families of organic LED-based luminaries making us one of the largest sellers of all LED fixtures in the world. As I mentioned earlier, our solid state lighting portfolio continues to expand rapidly, as are the sales of these luminaires, and we continue to fund the development of more holistic lighting and energy saving solutions for specific applications such as schools, healthcare facilities, commercial office buildings, and various outdoor applications to fully leverage our award-winning portfolio of lighting fixtures, controls and components.

As we have noted before, Acuity is a clear leader in digital lighting solutions world. Our expertise lies in the true understanding of the proper use and control of light in the ends vertical applications while minimizing the use of energy. We believe we are without equal in the design and development of fixtures and integrated lighting systems for virtually any indoor and outdoor application without a bias of light source. Our innovation progress was our full display of this years light fair in Las Vegas, a couple of example. Acuity won the highly coveted award, most innovative product of the year for the luminary known as Open introduced under our peerless brand.

Another extraordinary example of our ability to innovate Acuity demonstrated visible like communication technology of light there using Lumicast technology from Qualcomm, Acuity brands smart LED lighting technology roll out retailers to engage with customers and mobile devices based on their location in the store. This system showcases the ability of our commercial available eldoLED driver platform to deliver both illumination and visible like communication providing retailers with an opportunity to significantly increase their sales to customers. This capability will be tested in a proof of concept installation with the major retailer this summer and is unmatched in terms of accuracy and speed. The market potential for this system is enormous adding billions of dollars of potential future growth for Acuity and its partners.

Another area of huge growth potential for Acuity is our electronic components capabilities which are ramping up at a blistering pace. For example, we produced almost 1 million light engine boards in the month of May alone. And industry demand for eldoLED programmable dimming LED driver is growing worldwide as the superior functionality and quality of these products are highly covered by specificiers from our key projects. To put this opportunity in perspective, we believe the market for quality LED drivers could be a billion dollar market within the next 10 or 12 years.

We have been able to produce these robust results because of the dedication and resolve or our more than 6,800 associates to deliver superior value to our customers as well as driving improvements and the efficiency throughout the company to provide superior returns for our shareholders. I will talk more about our future growth strategies and our expectations for the lighting market later in the call. I would like to now turn the call over to Ricky before I make a few of our comments regarding our focus through the balance of calendar 2014. Ricky?

Richard K. Reece

Thank you Vern and good morning everyone. I’ll highlight a few items regarding our income statement. I then will discuss our cash flow and financial condition before turning the call back to Vern. Vern covered the primary drivers for our sales growth and our profitability, so I will not repeat these items; but I will provide a bit more color on certain aspects of our first quarter results.

Our gross profit margin for our third fiscal quarter of 40.3% decreased 70 basis points compared with the adjusted year-ago period. As Vern mentioned earlier, the benefits of the 11.5% increase in net sales, and an improved productivity were offset by the 70 basis point impact of the additional cost due to the product design issue and unfavorable currency impact.

In addition, gross margins were negative impacted by price mix and the inefficiencies of renting up our electronic component manufacturing capability as Vern discussed earlier. The Company and the U.S. consumer product safety commission announced a recall of certain incandescent emergency lighting fixtures on May 28, 2014. As Vern mentione4d earlier, we’ve recorded during the third quarter $2.1 million of additional cost related to this product design issue which brings the total estimated pre tax expense for this matter to $4.5 million. The additional estimated cost recorded this period is primarily due to the highest revised estimates related to the product cost and labor to properly handle this issue. While it is possible that there could be additional cost associated with the ultimate resolution of this issue, we do not currently believe they will be material and the amount recorded is our best estimate of the total cost based on what we currently know.

The unfavorable currency impact was primarily due to the Canadian dollar which weakened by 7% year-over-year relative to the U.S. dollar. As a result, we experienced approximately $2.1 million negative impact on our gross profits. We, as well as certain other industry participants have announced price increases in Canada which should help to dampen this impact going forward. In addition, the Canadian dollar has recently experienced a modest appreciation.

The effective tax rate for the third quarter was 32.2% compared with 29.9% in the third quarter of last year. Both periods were favorably impacted by a reduction and a certain income tax reserves. We estimate the effective tax rate for the fiscal year 2014 will be approximately 35.5% before any discrete items, and if the rates in our taxing jurisdictions remain generally consistent throughout the remainder of the year.

Cash flow generated from operations for the first nine months of fiscal year 2014 was an impressive $128.8 million compared with $67.8 million in the prior year period. This significant year-over-year improvement reflects higher net income, and lower working capital requirement as compared with the prior year period.

In the first nine months of fiscal year 2014, we spent $24.8 million on capital expenditures compared with $31.4 million in the prior year period. We currently expect to spend approximately $45 million in capital expenditures in fiscal year 2014.

At May 31, 2014, we had a cash balance of $467.3 million, an increase of $108.2 million since the beginning of the fiscal year. Our total debt was $354 million; consequently, our cash exceeded debt at the end of the first quarter. At May 31, 2014, we had additional borrowing capacity of $243.8 million under our credit facility that does not mature until January 2017, so we continue to maintain a significant amount of financial flexibility.

Thank you, and I’ll now turn the call back to Vern.

Vernon J. Nagel

Thank you, Ricky. As we look forward, we continue to see significant long-term growth opportunities. With regard to our expectation for the balance of calendar 2014, our view has not changed. We remain very positive. So while we don’t give earnings guidance, I would like to reiterate what we’ve previously mentioned regarding our expectations for the rest of 2014.

First, most economists expect the economy in North America will continue to improve at a modest but increasing pace. Our forecast for industry growth rates by independent organizations continue to vary widely, the consensus estimate is the broad lighting market in North America is expected to grow in the mid to upper single digit range for the rest of 2014 and accelerating into 2015 reflecting the benefits of both new construction and renovation activity. Further, we continue to see other signs that give us optimism regarding the future growth of the markets we serve in our business.

Leading indicators in the North American market such as the Architectural Building Index, vacancy rates, office absorption, lending availability, and the rebound in residential construction continued to improve. As has become the norm over the last handful of years, we are always leery of the next round of uncertainty that might come out of Washington regarding fiscal issues as well as foreign policy. As you know, the manner and how these key issues are handled can meaningfully influence business and consumer confidence.

Nonetheless, we continue to expect that the overall demand in our end markets for the balance of calendar 2014 will continue to improve and be more broad-based and consistent than experienced in 2013. The continued favorable trend in our June order rate again seems to support this continuing level of improvement.

Second, excluding certain LED components which are expected to continue to experience price declines we do not anticipate significant changes in input costs for the balance of our 2014 as some commodity costs have waned while others continue to rise. Further, we expect employee-related costs to continue to rise due to wage inflation, the negative impact of rising healthcare costs, and higher incentive compensation due to our positive performance. Of course, we will continue to be vigilant in our pricing posture as well as furthering our efforts to drive productivity improvements to help offset rising costs, as evidenced by the benefits realized in fiscal year 2014 from streamlining actions we took in the second half of fiscal 2013.

Next, while our gross profit margin is influenced by a number of factors, including sales volume as well as product and sales channel mix, we expect our gross profit margin to improve over time as volume grows, particularly for larger new construction projects, which should also benefit our mix, and as we continue to realize typical gains in manufacturing efficiencies. Well as we noted earlier, we expect margins to be somewhat constraint over the next few quarters until we achieve improvements in volumes and – inefficiencies in our electronic components capabilities. Also we expect margins over the longer term to benefit from the sale of higher value-added integrated lighting solutions with differentiated features and benefits.

Additionally, while we continue to experience some isolated pricing pressures in certain markets and sales channels such as home improvement, we will continue to be vigilant in our pricing. As we have said before, we will defend our market position vigorously from competitors should they attempt to use price as their only point of differentiation.

Lastly, we expect to continue to meaningfully outperform the markets we serve. Looking more specifically at our company, we are very excited by the many opportunities to enhance our already strong platform, including the introduction of holistic lighting solutions that are connecting smart lighting with our smart phones for retailers as well as our growing electronic component capabilities. As we have noted in our last several conference calls, our strategies to drive profitable growth remain essentially the same. We continue to see opportunities in this environment, including benefits from growing portions of the market, further expansion in under-penetrated geographies and channels, and growth from the introduction of new lighting solutions. Our positive results reflect the solid execution of these strategies by our associates.

Our company-wide strategy is straightforward – expand and leverage our industry-leading portfolio and solutions, coupled with our extensive market presence and our considerable financial strength, to capitalize on market growth opportunities that will provide our customers with unmatched value and our shareholders with superior returns.

This of course all takes focus and resources. We are funding these activities today because we see great future opportunity. Through these investments, we have significantly expanded our addressable market our record growth supports this view. As I have said before, we believe the lighting and lighting-related industry will experience significant growth over the next decade, particularly as energy and environmental concerns come to the forefront. We continue to believe the many markets we serve as part of the broader lighting industry could grow by more than 50% over the next few years, providing us with significant growth potential. As the North American market leader, we are positioned well to full participate in this exciting industry.

Thank you, and with that we will entertain any questions that you have. And the great news is that the fire drill is now over, so we can actually hear you, hopefully you can hear us.

Question-and-Answer Session

Operator

(Operator Instructions). The first question is from Christopher Glynn from Oppenheimer.

Christopher Glynn – Oppenheimer

Thanks, good morning.

Richard K. Reece

Good morning.

Christopher Glynn – Oppenheimer

The Fire drill wasn’t so bad on our end.

Richard K. Reece

It was pretty bad, and that’s it.

Christopher Glynn – Oppenheimer

I bet. Just wondering what your view is on how much cash is needed to run the business, and you know what outlets you are seeing for using some of the excess cash?

Richard K. Reece

Yeah, Chris, as far a normal working capital needs in the $50 million to $75 million, generally will support our ongoing working capital fluctuations and capital spending ebbs and flows, so as you can tell, we do have quite a bit of dry powder in the cash that we have. Consistent with previous comments, our first priority is to invest in the business in organic growth and then second would be acquisitions, and we do see quite a bit of opportunity on the M&A side, and we’ll continue to look at that and then absent that, we certainly have used our excess cash to repurchase shares as well as continuing to pay our standard dividend.

Vernon J. Nagel

Chris, we expect to continue to generate very very solid cash flow growth. As Ricky pointed out, it takes us about $0.10 or $0.11 of operating working capital to support every dollar of increase, and we are working our inventories back down to more normal levels as we learn how to manage both LED luminaires and the production of conventional luminaires. I think on the CapEx side, Ricky, we’re between 1.5% and 2% of revenues. We will be probably investing a little bit more next year in terms of building out just the ability to house our growing staff. And as we go from $2 billion to $4 billion and $5 billion of revenues, we will drive productivity throughout the business, but it’s pretty obvious that we’ll be growing our salaried head count, and so frankly, we’re out of capacity, so we are looking at ways to resolve that. But we still should be able to operate reasonably well within that 1.5% to 2% of sales from our capital investment perspective.

Christopher Glynn – Oppenheimer

Okay. Thanks for that. And on the acquisition pipeline, that’s – is there a good range in breadth of different size type deals?

Vernon J. Nagel

I would say that there is, I mean again as we’ve pointed out, we are looking for really three capabilities, one to enhance our technology capability, number two to enhance the product portfolio capability maybe from a design perspective. We’re also looking at the opportunities for geography expansions, and as you know, we look to continue to build out our residential platform. So from – there’s nothing out there where it’s a must have, but the opportunity for items and acquisitions that can help accelerate our capabilities in these areas, Ricky and his team are very, very busy. In the range of sizes, it’s interesting from very small, take Adura for example, a few items that are larger but when we say larger, we are talking hundreds of millions of dollars; we are not talking merely larger than that.

Christopher Glynn – Oppenheimer

Great, thanks for that color. And then just a housekeeping, the 35.5% tax rate for the year, I think that sort of implies a record high in the upper 30s in the fourth quarter, is that appropriate?

Richard K. Reece

Might be not quite that high, it again depends on any changes, but it will probably be a little less than that, probably closer to that 35.5% to 36% for the full quarter.

Christopher Glynn – Oppenheimer

Okay. Thank you.

Operator

The next question is from Brent Thielman from D.A. Davidson

Brent Thielman - D.A. Davidson

Hi, good morning. On the price mix headwind, does that reflect a specific channel, a change in markets within non-res that you are serving or kind of a change in the broader product portfolio?

Vernon J. Nagel

No, Brent, it was interesting this quarter. We were hopeful if you will for a more rich mix of products sold, absolutely impossible to predict the way the mix plays out, but when we look at it, it really was certain products migrating, just simply products moving from one type to another and more in our conventional light source products, it was just interesting to us. I believe that this product mix shift that we experienced this quarter is more of a temporary activity again impossible to predict. When we look at mix over the full 12 months, I think that that will be a more representative mix, if you will. And to us, we still fluctuate between channels, different channels have different margin profiles, but they also have different if you will return on investment profiles. So when we looked at the mix this quarter, and when we passed all the noise, I mean the way I’d looked at it, our adjusted gross profit margins were 41.2%, and that’s kind of getting us in the range. If the mix had been a little bit more traditional around the product side, we would have enjoyed even a higher margin expectation. So, we’ll just have to wait to see.

When we are in that 41% to 42% gross profit range where we are today, we feel that we’re hitting our stride. We have to get past -- we’ve gotten past we believe the warranty issue. FX, there’s not really a lot that we can do to forecast that, and we are ramping up our capabilities in the electronic components space, which will provide us with several things; one, features and benefits that are of a very high quality if you have a electronic component capability, assured delivery and ultimately we believe a significant cost advantage. So, all of these things that were kind of impacting this quarter, our expectation is that though it will either go away or that will yield future benefits as we go forward.

Brent Thielman - D.A. Davidson

Okay. And then just second when you look at kind of the entire construction you know retrofit in market landscape, are there specific sectors in the market that you are choosing to avoid because it doesn’t meet your parameters for margin returns maybe it’s too crowded or the opportunity for product per square footage isn’t as appealing.

Vernon J. Nagel

Well when we look the way we attack if you will the renovation markets we have a number of sales forces, we have a number of channel partners. So what we are looking to do is to support them in their focus to their end customer base. And given our size and scale and the way we – the product portfolio that we have there really aren’t too many areas of opportunity that we won’t explore or aggressively go after. Obviously much of our business is a bid business, there are at times folks that will bid projects at price points that we don’t feel are really prudent. So we’ll either not play or we’ll work hard to differentiate our portfolio in a different way. So I would say the answer to your question is no, there’s no one or two areas that we would deploy but we look to aggressively go after business opportunities and then use our sourcing capabilities and the great strength of our many associates to drive cost out to make it a profitable venture for our shareholders.

Brent Thielman - D.A. Davidson

Thank you.

Operator

The next question is from Brian Lee from Goldman Sachs

Thomas Daniels – Goldman Sachs

Hi, guys, this is Tom Daniels on for Brian. Thanks for taking my question. First, you know maybe for Vern, I was wondering if you could kind of dive into a little bit of the market share gains clearly for many quarters here you guys are outpacing the overall market and your LED lighting sales are significantly outpacing competitors. And my question is you know as the lighting gets more and more kind of technologically improved, is this a long term market share gain for Acuity and do you think the dynamics in the offshore market can change pretty meaningfully over the next decade as LEDs become such important part of the portfolio?

Vernon J. Nagel

We do see opportunities to take advantage of what technology means coming into our space. For us LED and the notion of solid state lighting is really an enabler for future opportunity. Again, you saw that in our press release, we commented on the notion of visible light communication technology. This is really in conjunction with Qualcomm and Lumicast our opportunity to deliver to the retailing space just as an example a value proposition that is not just about quality of light and energy savings, represents a huge potential market for Acuity and in our partners to really drive that kind of value. So when we think about the investments that we are making today in terms of eldoLED, in terms of our electronic component capability, it’s really so that we can bring more value to those end applications. Our view around the market place continues to evolve. So, we call this a tiered approach to lighting solutions.

If you imagine in the first year, it’s for simply product features and benefits price points. But then you start to migrate along peers where you are able to add more capability into a more holistic solution, we think that that brings even more value through its healthcare facilities, commercial office buildings, industrial spaces, outdoor and by doing so it really changes if you will to paradigm shift between just providing light into its space that now providing of light and other information that can come of off these LED luminaires which are really also communication devices. So for Acuity, we see the opportunity to significantly expand our addressable market since the acquisitions that we’ve made of companies like Renaissance and Adura and eldoLED Pathway Horizon these are all creating a capability within our portfolio to provide intelligent, holistic lighting solutions to these applications in a way that they have never had before.

So you couple our supply chain with our great technologist and our access to market, I do think that it gives Acuity the opportunity to participate more meaningfully in a very rapidly growing market place over the next decade and beyond.

Thomas Daniels – Goldman Sachs

Thanks for that color, Vern, appreciate it. Just my one other follow up, can you remind us in prior cycles as we start seeing on res construction I noted lackluster today, as we start seeing those construction numbers improve is there a lag effect for when Acuity actually starts seeing the unit volumes increase, I thought it might to six to twelve months, but just wondering if you could comment on that? Thanks.

Vernon J. Nagel

Ricky, we do have some pretty good data that shows going back to the kind of middle [age] is that cycle and how this cycle works maybe you want to comment a little bit on it.

Richard K. Reece

Yeah, clearly there is a cycle around the specification when a building, it’s designed and in the specification it’s got to come out of the ground, you got to get tenants in it and lighting is one of the last things to come in. And you’re right, it tends to be six or twelve months we use nine months as kind of an average on many other construction put in place type of data that we look at, if you look at the architectural building index, the lag is even longer, cause there you are actually just designing it. But there is our construction cycle lag, I would say is renovation becomes a bigger part of our total mix, now roughly half of our mix there the lag is much less, typically in a renovation situation once they decide to renovate it can move quickly, on other times though they all want to do an audit and study it for a year or longer so that six to twelve months is a broad range of what I would think is reasonable lag to most of the major indicators that you would see out there.

Vernon J. Nagel

And Tom, just to add to Ricky’s comment, we know that on an inflation adjusted basis in the U.S. non-residential construction is off 25% from it’s peak and yet Acuity this year will that’s the number the analyst all have $2.4 billion of revenue. We are 20% above in terms of total revenues where we were at the peak in 2008. And to Ricky’s point, it’s because we’ve really diversified the end markets that we serve and we are not as directly tied to new construction because of the expansion of our product portfolio and how we have altered our access to market to participate more wholesomely and the renovation work.

Thomas Daniels – Goldman Sachs

That makes a lot of sense. Thank you very much guys.

Operator

The next question is from Matt McCall from BB&T.

Matt McCall - BB&T Capital Markets

Good morning, guys. So on the electronic components investment, Vernon you mentioned two things. You mentioned the $1 billion market opportunity and then you mentioned the cost advantage. Can you, is it more of a cost advantage to kind of vertically integrate that or is it more of a revenue opportunity and then how do we – how would you recommend that we model that billion dollar market potential over the next so many years.

Vernon J. Nagel

So Matt, our investment in eldoLED was really made because we saw the opportunity of eldoLEDs superior functionality and the quality of the driver. Their ability to dim the dark in unmatched in the industry today. And so, as LED continues to portrait and of course it will, we felt strongly that having the ability to have a superior LED driver that’s programmable and then expand its portfolio so that it has also cost features and benefits and in a tiered sort of capability was going to be very valuable to Acuity. We also felt that the opportunity available led more of an industry standard. We are making eldoLED available to the industry, so all those this is a trending strategy, so others have access to the eldoLED capability for their designs and their products. So our view was that this is a great capability. You saw from the announcement and that [indiscernible] you had liked there but you saw that the Lumicast technology of that lead introduced in conjunction with Qualcomm, and light there is really enhanced because of eldoLEDs internal capabilities to do so many things and do those so well.

So the Lumicast technology that’s being made available and will be tested here shortly provides a superior mobile device retailing experience with accuracy and speed that’s unmatched by others that have potentially for claiming potentially similar type programs. So eldoLED was a growth strategy and now as we look at it the opportunity for us to continue to drive cost and to give cost and our OEM customers a cost advantage is there. We certainly won’t make every LED driver, we will have a broad supply chain as we do, but this is a capability that allows us in our tiered solution approach to offer more features and benefits that have great quality.

Matt McCall - BB&T Capital Markets

Okay. That’s helpful, thanks Vernon. And then my other question. You talked about variable comp, freight expenses, higher employee cost as being or increasing your SG&A is – does the math change there you talked about that $95 million of fixed cost and then the variable component varying at about 11.5% rate with sales. Is that still the right number to use, do we expect and then CapEx is projected to increase a little bit in Q4, is there going to be some more seasonality with it, some more investment that’s going to take that higher, how do we look at OpEx as over the near end and out in the next year?

Vernon J. Nagel

So Matt, let me be clear, was that one question or 50?

Matt McCall - BB&T Capital Markets

One question with many parts, thank you.

Vernon J. Nagel

Okay, let me start and I’ll start a little bit. This particular quarter, our freight commissions expand were slightly higher than what we would normally expect to probably 30 bips higher. Usually we are in that 11.5% to 11.6% of total revenues; again we were 30 bips higher. I think that that was a little bit of an abnormality so we would expect overtime that to find it’s average again, 11.5% to 11.6%. When it comes to the fixed cost and obviously it’s not completely fixed because we have incentive compensation and other items that are somewhat like that in there, our view is that we are increasing that fixed base and again, I want to be very clear about this. We are investing in things like eldoLED; we are investing in capabilities like partnering with Qualcomm and Lumicast. These are outside of if you will to traditional or historical businesses that Acuity was focused on. And the reason we are doing is because again we see great future potential that really is expanding what we would consider our addressable market and the future opportunities that are out there. How quickly some of those were rolled in, you know time will tell and we’ll provide more information as we know more information. But we see such huge potential we want to continue and invest. So that brings me all the way back then to your question around fixed, sort of that fixed piece.

We were averaging about $95 per quarter. My guess is that you’ll see – you ought to see that ramp up. I think this quarter were close to $100 million, $99.3 million sort of exact numbers. My guess is that based on our headcount, we’ve added about 50 to 60 folks here over the last quarter and a half, we are going to continue to invest to get up to some of these other areas. So it wouldn’t surprise me if that number you know migrates to kind of the 105 range. What I really like as a way for your models you know if you look at our total headcount, we are now sitting with about 2100 and 60 salaried folks. In total we have about 6800 people. But on average to deliver the consensus top line number which I don’t have in front of me, but saves 2.4 billion what you will see is that Acuity is continuing to drive headcount productivity and when we look a the salaries we are also driving salary productivity. So the growth is there and it’s happening. But we are investing outside of if you will out traditional business because we see potential there.

Let me add a bit of comment here and I think this will help you. You know we look at our variable contributions, that they fluctuate and it’s difficult to precisely predict because of mix and some of the investments that we are making exactly what is going to happen. But let me give you all an example. If I compare the third quarter to our previous second quarter and I take away the noise around FX and around the warranty issue and I adjust for a little bit of the inefficiencies as we ramp up the components business, when I look at that change in top line and I look at the variable contribution after that, we were roughly 24% variable contribution. So I feel like we are delivering in a good range while continuing to invest in the business. Now it’s unfortunate that we have a little bit of this noise around the abnormality – warranty and FX but those will go away and you will continue to see I think a reasonable contribution coming off those incremental sales, which is important for both your models and your returns.

Lastly, I would point out that if you look at our cash flow return on investment on a trailing four quarters, we are now at 27% cash flow return on investment and that’s pretty extraordinary for a manufacturing company.

Matt McCall - BB&T Capital Markets

All right, thank you Vernon very helpful.

Vernon J. Nagel

Thank you.

Operator

The next question is from Mike Ritzenthaler from Piper Jaffray

Mike Ritzenthaler - Piper Jaffray

Yes, good morning. My first question is a follow up to a previous one on the pockets of strength within C&I, particularly as it relates to public sector projects. I was curious if its accelerated bidding activity generally speaking there and can you remind us of the relative importance of public projects in Acuity C&I portfolio?

Vernon J. Nagel

Yes, you know from a bid perspective and I won’t single out just public sector bids, but if I look at our overall quoting activity, quoting activity continues to be up nicely and obviously our bid rates continues to improve and see a notion of market share gains. When we look at the end markets, our roadway business continues to be very strong and that was building out the portfolio three and four years ago that really altered the competitiveness and I think we had meaningfully gained share and we were loosing share for a while there because we were slower on the uptake within the LED world and that no longer is true. Acuity is again leading not only from a technology perspective but we are the largest outdoor lighting manufacturer company in North America. When we look at schools and that type of works, yes it’s the budgets in many of these states and these local municipalities continue to improve. We are starting to see an improvement in what’s happening in schools but lets be clear, schools is still a fairly soft market based on historical standards. And we truly believe that there is a lot of pent up demand because populations continue to grow at roughly at 2% per annum and yet schools have probably had a three year hiatus in terms of their developments.

So eventually that breaks. Roadway, there’s a lot of again opportunity as people continue to look at the benefits of LED luminaires versus particularly as we introduce controls into those LED luminaires that can do many more things other than just monitor the luminair.

Mike Ritzenthaler - Piper Jaffray

Got it. Excellent, thanks for that. And then a follow up question on the warranty issue and whether the current situation with the emergency signs will change or modify in some way the normal accounting mechanics going forward of the percent of sales reserve for warranty or if it’s kind of a temporary blip?

Vernon J. Nagel

Ricky, this particular incidence would not adjust necessary our process of accruing for warranty because this is a recall situation which thankfully is extremely rare for us to experience some thing like that. But we have you know continued to adjust our normal warranty accrual based on the typical experience that we have and with the newer technologies in the broader portfolio we have been monitoring that very closely and have seen a modest increase in the percentage of our normal warranty accrual as a result of the more solid state and the longer periods of warranty five years for example that we typically would offer for an LED warranty versus a shorter period that was normal or incandescent plus now we would trend more of that warranty than we did in the past. So a modest increase, nothing significant but we are monitoring that closely and making the appropriate adjustments in our accrual processes.

Mike Ritzenthaler - Piper Jaffray

That makes sense. Thanks guys.

Operator

The next question is from Tim Weiss from Baird.

Tim Weiss – Robert W. Baird

Yeah good morning guys. I guess just on the mid-to-high single digit market growth that you guys talked about, what do you think gets the market to the lower end and the upper end of that range?

Vernon J. Nagel

So for us we are not economist, but what we do is we try to triangulate amongst the whole bunch of data points. We use [NEMA] we look at what their prognostications, so they are pretty consistent around the growth of the lively market. We look at all of the other industries that I had mentioned whether it’s ABI, a whole notion of absorption, population growth that’s happening with for example rental rates on and so forth. And a lot of these signs continue to flash nice green, there is not a lot of yellow out there, so I believe that given how long we have and in the sort of doldrums of non-residential construction it makes sense to us that this cycle begins to build on. And so I won’t be political here, but this recovery has been the slowest recovery on record. So it’s not – this is not abnormal to see this type of generation flow into certain markets around the country and you see that space has been well absorbed so now they are into the new construction phase out in California. Northern California for example you know two years ago there were few cranes in San Francisco today there are many. Same thing is true to the northeast. So all of these signs are giving us I think a positive feeling that the trend that we have prognosticated is alive and well. I believe that as business conditions continue to improve we actually can see a shortage of certain types of real estate and so therefore it will attract capital, it will then create investments and will spur us on.

As Ricky pointed our earlier the renovation world for us is a huge market. It’s we’d estimate north of $300 billion installed base 70% of which was put in place before 1990 converting very slowly. So how folks get after this market as that market will also I think slice this too and we expect that renovation will continue for quite a long time to be a meaningful part of our business or then say it was in 2008.

Tim Weiss – Robert W. Baird

Okay, that’s helpful. And I guess you raised the market outlook last quarter, is there anything over the last three to four months that you have seen just talking with people by [fair] and some of your agents that gives you more confidence in that range relative to last quarter and as you look into 2015?

Vernon J. Nagel

I believe that there is a – there’s enthusiasm for the broad market in general so you could talk to any of my competitors or other industry participants and I think they would tell you that broad electrical industry and then more narrowly define the lighting industry will be a very solid place to play over the next decade particularly as more technology comes into place. But when we look at Acuity, we get quite excited about our future and our future meaning our long term future because we see the opportunity not only to provide discrete products which we are good at, but also now the opportunity to provide varying levels of holistic lighting solutions that incorporate not only the Luminary itself but now sensing technology, control technology so folks can do so much more with that solution. Again, we are very excited about the whole notion of how we are delivering sort of our visible light communication technology in partnership with Qualcomm. We think that these retailers will be very excited to not only have quality of life, tremendous energy savings, but its an additional revenue source so we are very excited to continue to invest in ways that where technology is an enabler to us to expand our adjustable market.

It wouldn’t surprise me that if over the next 12 months we redefine our addressable market to be much larger than what it is today.

Tim Weiss – Robert W. Baird

Great. Thank you.

Operator

Colin Rusch from Northland Capital Markets, your line is open.

Colin Rusch - Northland Capital Markets

Thanks so much. So just following up on that point about the addressable market, obviously if you got these control systems in place is a significant software or a software as a service opportunity for you guys to potentially address, can you talk a little bit about you know the direction of these partnerships are going you know the part of this question. And the second part, you mentioned the 24% return on invested capital you’ve been very I think disciplined as investors over the course of the years. Could you talk about expectations for return on investment with these partnerships?

Vernon J. Nagel

These relationships that we have, we have been working on for really sometime and they come in all forms. We have strong relationships with our supply base, and so how we work with suppliers, some of whom are even competitors, but how we work with those folks to bring value has always been one of the hallmarks of Acuity and really understanding the end market and then being able to bring the best players to really solve that problem I think that is a great skill that we have. As solid state or electronics come into our world, it’s allowing us really to take a blank sheet of paper and think very differently. It’s almost a world of apple, how do you bring apps, how do you take advantage of what technology is allowing you to do. What’s truly amazing here is if you take eldoLED which is a programmable dimmable driver that provides really no stroboscopic effects on luminaires. Some of our competitors and other component suppliers actually can’t make that claim. It allows us to provide quality of light into its space, but also now be a communication device and a clean communication device.

So to us, this is fantastically interesting. So -- we can do many things, we certainly can’t do everything so we are in conversations with many folks, not only suppliers but also potential other access points to market channels if you will that we have never really traditionally talked to before, now we are able to bring I think a very differentiated capability. Every building and every street need to have a light of some type. It’s now a communication device. So how we take advantage of providing superior quality of life, energy savings and now other potential revenue streams from that communication device is a unique capability. Our luminaires now have sensing devices in them, comes from one of our acquisitions that we made about four years ago Ricky was with Renaissance. So all of these pieces in parts are now really starting to come together in a way that will allow us to provide tiered solutions to folks in these end applications as they warrant and it’s opening up a whole new world for us in terms of who should we align with and how and generally speaking you are getting the best players coming together. There are other folks that are out there offering some type of mobile device into the retail space; we believe very strongly that when the market really sees the combination of Qualcomm’s Lumicast technology with our superior lighting we have really a very very robust offering that would be hard to match.

Colin Rusch - Northland Capital Markets

Okay and then just changing gears a little bit. Just talk about two things, one, any change in geography in terms of end market go through within the U.S. just on a regional basis? And then if you could comment on opportunities in agricultural light space, what you are seeing there at this point?

Vernon J. Nagel

I would say from a geographical perspective we are starting to see nice growth in those markets that have LED certainly but technology and/or pick the west coast, San Francisco you’ve got LA moving up. You take the east coast, where you’ve Boston, and Washington still, all of these markets are starting to improve where job growth is occurring you are seeing nice construction activities. So I would say that from a geographical perspective we are seeing a reasonably broad based approach. We look in some of these markets where they have for shale gas and in opportunities they are on fire, I mean, because they are growing so rapidly. So where there is share growth there is opportunity, where there is political sort of intrusion or intervention, you see slower growth. Ricky.

Richard K. Reece

I would agree. Certainly seeing it in those areas where the employment is taken up which is one of the big drivers. On the agricultural question, that is not a market that is a strategic focus for that, you are seeing that a pick up for certain niche players in that markets but it has not been a strategic focus for us to participate in that agricultural growth type lighting.

Colin Rusch - Northland Capital Markets

Okay. Thanks a lot guys.

Operator

The final question comes from Winnie Clark from UBS

Winnie Clark - UBS

Good morning thanks for taking my question. I wanted to talk about mix a little bit more. You have seeing better trends in higher margin products over the last couple of quarters from an order perspective. It sounds like you thought you might have benefited from it a little bit more in 3Q, would you expect these orders to start driving and improving in the mix dynamic next quarter, is that likely to be something you see in ’15?

Vernon J. Nagel

So it’s hard to predict what next quarter looks like. We’ve seen our June order rates and so we’re favorably inclined and hence we made the comment that we think that again our order rate for the month after the quarter continues to reflect sort of the growth trend. But yes, I think as we go into 2015 our expectation is that our margin should gradually improve as we continue to sell what we call more tiered solutions. As we migrate down the value add curve, where it’s not just a single product type competing features and benefits and price is more about how does the whole system work and what are the benefits that come off of that. We believe that that will yield a higher and a more rich mix and therefore margin. With regard to the fourth quarter, we don’t really prognosticate but I think this quarter for us was just a little bit – it’s the way the mix flowed in terms of some of the projects that we had I would expect that as we continue to see volume growth and as we continue to do cost outs, as we continue to probe these markets on these various solutions our expectation is that our mix will continue to evolve in a more favorable way.

I can say when I do the puts and takes, I kind of do a back of an envelope, sort of calc, and our margins gross profit margins were 41.2% for this quarter. Again, improvement particularly improvement over the second quarter on an apples-to-apples basis and so I would hope that that trend continues and that the headwin that we faced this quarter from a mix perspective does abate somewhat. And the other point that I made earlier is our freight cost and our commission cost at combination was a little bit higher than what we typically have experienced and hoped we would see a little bit of regression act of – for more among that as well.

Winnie Clark - UBS

Okay. Thank you. Last quarter while you noted it was hard to quantify you thought whether it could have been as much as a 3% headwin I think you said you don’t think you saw any weather catch up in the current quarter. Is that something you still think you could recapture you know during the peak season?

Vernon J. Nagel

It’s a great question. Interesting to us we all speculated is it would be something that we would [recoup] and I think you saw lots of industrial companies come out afterwards and make commentarial round how the weather impacted their business. We did not see in the channels that we particularly watch a rebound and we try to watch certain projects and those projects simply just played out the way they were going to play out. So we don’t really think that there was any meaningful impact and certainly there was an order here or there that flowed through and it was accelerated trying to benefit or meet time deadline. But in this case generally speaking we just feel that we recaptured any of that nor do I think that we’re bound to recapture. I think that everyone’s adjusted their construction cycles and they are just simply moving forward.

Winnie Clark - UBS

Great. Thank you.

Operator

I would like to turn the call back over to Mr. Vernon Nagel for closing remarks.

Vernon J. Nagel

Thank you everyone for your time this morning. We strongly believe we are focusing on the right objectives, deploying the proper strategies, and driving the organization to succeed in critical areas that will over the longer term deliver strong returns to our key stakeholders. Our future is very bright. Thank you for your support.

Operator

That concludes today’s conference. Please disconnect at this time.

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