Acuity Brands Inc (AYI) 2005 Q1 法說會逐字稿

Good afternoon and welcome to the Acuity Brands first quarter for 2005 earnings release.

After today's presentation there will be a formal question and answer session. [Caller Instructions].

Now I would like to introduce Mr. Dan Smith, VP, Treasurer of Acuity Brands.

Sir, you may begin.

Thank you.

Good afternoon.

With me today to discuss our 2005 first quarter results are Vern Nagel, our Chairman and Chief Executive Officer;

John Morgan, our President and Chief Development Officer;

Karen Holcom, our VP, controller, and interim Chief Financial Officer; and other selected members of our executive team.

We are webcasting today's conference 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 in today's press release, which identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

Now let me turn this over to Vern Nagel.

Thanks, Dan.

I'm going to make a few comments and then what I'd like to do is open it up for questions.

In summarizing our first quarter results our, earnings were in line with our expectations in spite of numerous challenges; most particularly on the cost front.

We also experienced a bit of softness in the marketplace early in the period but did see some nice rebound later in the quarter.

Overall sales increased 1.5% to $525 million.

Their increase resulted from favorable pricing and greater shipments within certain channels in the commercial industrial portions of our businesses, partially offset by lower shipments in the retail channel.

We saw favorable signs of increased demand in the nonresidential construction market as orders began to strengthen.

The backlog at ABL increased to approximately $159 million at the end of the quarter, up considerably from last year.

I believe that last year our backlog was roughly $123 million at the same time.

Consolidated gross profit margins increased slightly to 41.7% from 41.5% in the prior year.

This improvement was achieved in spite of the significantly higher cost for raw materials and other components.

For example, steel and aluminum alone increased our steel--our costs over $8 million from the previous year.

We made significant progress in improving our productivity and service capabilities which did help us overcome these cost increases.

On a consolidated basis our operating profit margins were 5.4% consistent with last year.

In addition to the raw material costs, our consolidated operating profit margin was negatively impacted by greater expense for stock based incentive programs, which increased largely as a result of the stock appreciation during the quarter; which I believe was up-- what was it up in the quarter?

Any way, we'll come back to that.

Net income was up 2% overall to $13.2 million from 12.9 last year.

Diluted earnings per share was 30 cents per share.

That was consistent with the prior year period.

Our effective tax rate was approximately 31-- or 35.1% in the period compared to 36% last year.

At this time we expect that our tax rate-- our effective tax rate will approximate 35% for the remainder of the year.

Our debt balance increased $18 million during the quarter as a result of higher working capital requirements.

Those working capital requirements were due primarily to the timing of payables.

Also receivables were up rather significantly as shipments late in the quarter were rather substantial.

We anticipate that the second quarter will be another challenging one.

We expect to make meaningful progress in terms of the full year.

We still are holding to our objectives of making meaningful progress on growing EPS by 15% or better for the full year, but we do expect that the second quarter will continue to be a challenge due to rising raw material costs.

Overall I think that we really executed reasonably well in the quarter.

We are very pleased to see some activity in the nonresidential construction market that does give us hope and expectations that the balance of the year will be stronger.

If that in fact plays out that way, and there are many forecasters that are calling for that, it would be the first time in the last four and a half years that we have actually experienced a positive uptick in the nonresidential construction market.

So we believe that the actions that we've taken over the last six months in terms of profit improvement programs are really starting to show the benefits of those efforts.

Number two, price increases that we have put in place in both businesses should begin to show some positive signs--have actually in the first quarter, but the second price increase that we put in in both businesses we hope will impact our second quarter and beyond.

So as we all look out we are reasonably optimistic that we will, again, make meaningful progress in achieving our long-term financial goals.

Having said that what I'd like to do is open it up now for questions and respond to questions as we see them.

[Caller Instructions].

Cliff Walsh, Sidoti & Company.

Can you talk a little bit about specialty products and what's being done to kind of kick start that business?

Growth seems to have slowed a little bit and margins were somewhat weaker year-over-year.

Good question.

Specialty chemical business actually had a pretty good quarter.

Their raw material increases were quite dramatic that they experienced in the first quarter.

We, in fact, have put in a price increase for both chemical and nonchemical products that is effective January 1.

So the business actually absorbed rising raw material costs and the price increase, unfortunately, is not effective until January 1.

So our expectation is that those increases will more than offset or go to offset, if you will, our rising raw material cost.

From a growth point of view, actually the core INI business, both domestically as well as internationally, continues to be reasonably robust.

What we actually experienced in terms of the overall product mix was a bit of a softening on the retail side primarily as we look to improve and enhance our product offering capability.

So I think that you're going to continue to see or will see ASP post rather consistent improvements in their operating profit margins as we go throughout the balance of the year.

The other thing that we incurred in terms of some incremental cost, we continued to invest in enhancements to our IT systems at ASP.

That expense came into this quarter and it wasn't, obviously, there will in the year ago period.

So I think all in all the ASP business, I think, will show a good 2005.

How significant was the IT system expense?

We didn't report that number but-- and my guess is that it was probably in the couple, $300,000 range.

Okay.

In terms of what would you say-- the major raw material increases you've seen, what are the major products?

Cliff, for the Acuity specialty products business it would have been raw materials that are coming into the business that help them make their various solvents.

It also was rising fuel costs, both fuel in terms of how we manufacture our product, but also distributing our product throughout our vast distribution network.

And then lastly, of course, our packaging.

We use a great deal of steel and aluminum in various sizes to package the product, whether it be the aerosol cans or 55-gallon drums.

So all of those costs had a rather significant impact on their business.

For the Company overall, including the lighting business we absorbed, like we said, an incremental $8 million of year-over-year cost.

And, as we said in our press release, it was about $3.5 million more than we had originally anticipated.

Okay.

And moving over to lighting, can you comment on how the mid-November price increases are holding up.

Well, let me make two comments and I would like to ask John Morgan to comment as well.

One, the price increase that was put in place essentially in the middle of the summer of last year, those price increases finally started to kick in.

As you know, we operate with a bit of a backlog there.

So we did start to see the benefit of those price increases in the first quarter.

Unfortunately again, the increase in raw material costs, and it was not just steel aluminum but it was component parts as well, outstripped that price increase.

Therefore, in the middle of November we put forth another price increase.

That price increase was in the range of 8 to 10% depending on the product capability--or excuse me the product offering.

Those price increases are really just now starting to trickle in.

As you know people have backlogs and people have orders already in place where there has been price protection.

So my sense is we'll start to see some of the benefit of that as we get into late in the second quarter, but it should have a very meaningful impact as we look at the second half of our fiscal year.

John, any further thoughts on that?

Just if you break out business there, lighting, into the stock business that sold to distributors for speculative resale compared to the project business where we ship to job sites, Cliff; the products that are sold into distributor stock, much of which are commodity oriented, we would expect to see those increases take effect now as we get on into calendar '05 with the new programs.

Projects, to Vern's point, take 90 to 120 days to begin to roll through our backlogs.

The combination of the fact that these raw material increases are very real for us and we assume for our competition as well-- as well as the fact that we expect '05, '06 and beyond to be a more robust economic environment in terms of new construction activity.

We expect those price increases to hold up.

Okay.

Great.

Can you comment on your comfort level with debt right now and kind of where you see acquisitions fitting in?

I am comfortable with our full year debt projections.

We are not satisfied with our current debt level.

That had to-- our current debt level had to with inventories that we put in place in the '04 period for which, to help alleviate some of the service issues that we had as we consolidated our manufacturing facilities, particularly within lighting; those inventories helped but they didn't help in all areas.

Therefore, as those payables came due we paid those in the first quarter.

So, therefore, our payable balance and the relationship between our inventory balance and our accounts payable drifted a little differently than what we would normally expect.

So my expectation and our expectation is that as those inventories convert through the conversion cycle from inventory to receivables, that cash will come back to us most likely in the third quarter.

But our expectation is to meet and/or exceed our cash projections for the full year.

I still feel very comfortable with that.

So, having said that, I believe that our financial flexibility remains quite strong.

From an acquisition point of view we continue to be very focused on making our business a better business in terms of our internal capabilities both for customers and our cost, our cost capabilities.

I believe that we're making good progress there.

We are continuing to look at opportunities in the marketplace that make sense for us and, over time, I believe that we will be an acquirer.

There are many opportunities for us and I feel that we will, like I say, be an acquirer.

John Morgan is leading some of those discussions for us and, John, I'd like you to comment; but my sense is that you'll see us in the marketplace over the next 12 to 24 months, probably looking to add to our portfolio capability.

John, any thoughts?

Really, Vern, I don't think I have anything to add to that at this time.

There are a number of opportunities out there and we look forward to participating in them.

Rob Health, Fiduciary Management.

Just a couple of general questions.

I'm just curious, could you guys maybe talk about the one, two or three things that, you know, really the important things internally what you're focusing on in terms of profitability?

I know you talked sort of generally about consolidating the number of facilities you have, but maybe when I compare your cost structure with other companies out there what would be the take away things that you are really striving to do to improve the overall efficiency and the profitability of the Company?

That would be great if you could go through that.

Rob, that's a great question.

We are very focused on doing essentially two things.

One, improving the service capabilities that our customers see and feel in both businesses.

Doing what we say, doing what we say each and every time, doing it error free are key opportunities for us in terms of how our customers see and feel that.

Taking out inefficiencies and waste in the process is key to us.

So if you imagine that you have a process such as the order fulfillment process our opportunities to work better and more effectively are quite, quite extensive.

We are looking at using process improvement type programs, without getting too deeply into them, that allow us to improve the efficiencies of those things and, therefore, get really two bites at the apple.

As you improve your efficiencies, your cost structure on a per transaction basis will go down.

Your service to your customers will go up.

So our feeling is that as we look at our various business processes there is a great deal of opportunity for improvement.

When you look at things like our supply chain, again, robust opportunities to improve efficiencies as well as productivity.

And there's an intense focus around those items.

Also, as we think about our product mix in terms of our various businesses we see ample opportunity there to continue to improve that.

One, through product innovation bringing new products and service to bear to our customers and doing that in a way that allows us to both get margin as well as improve the differentiation between us and our competitors.

That's really helpful.

And then, if you can go through the whole pricing scheme of the industry, perhaps.

I'm just curious, here we're dealing with a time of rapid inflation in raw materials.

Excluding sort of this time, what's happened in the past year, obviously it seems like there's been more price degradation in the marketplace.

What would be the thing that maybe keeps the industry from going back to those ways?

Assuming that we get some, you know, back off in this inflationary environment in your costs, what are the things that sort of separate or allow you to maybe keep that pricing at least stable if that can happen?

That would be great.

Sure.

I guess, Rob, this is John.

Sure.

Let's be Frank.

We are not 100% certain we can make that happen.

Okay.

But here's what we believe.

Here's what we believe and here's the bet we're making.

It's important that we be able to operate at sufficient margins to fund appropriate R&D efforts, to develop new products and new services that are important to our clients.

One of the things that's very important to us not only from the standpoint of rising raw material costs but also from the standpoint of needing sufficient margins to be able to do that, is to maintain the kind of pricing structure that allows us to reinvest in the business and bring added value back to our customers.

We hope, like the dickens that others in the industry try to do similar things.

We know that our customers care about those kinds of things.

We know that our customers care about us being more directly integrated with them in terms of supply chain kinds of activities that are good for them and for us.

We know that they care about higher quality products.

And we know that if we bring more efficient products, more energy-efficient products, more effective products to the space that people are willing pay for that.

So I think it's incumbent upon us to maintain our pricing, generate those margins necessary to invest a portion of that back into development to bring higher value propositions to our customers.

And that's where we've begun to place our bets.

Would it be fair to say both John and Vern that historically in the industry, excluding these recent times that there was a fairly reasonable size portion of the customer base that was willing maybe not to go after the more innovative products and to play the pricing game a little bit.

And you guys maybe were involved in that but now the strategy more focuses on innovation and trying to move that to, at least for you guys hopefully the industry as well, into more of an innovation and, you know, a partnership with the customer base and energy-efficient, those kinds of things?

Rob, I think that's a fair characterization of both the industry and of us and your perceptions about us in the past and what we're attempting to do in the future.

Craig Kennison, Robert W. Baird.

I'd like to address the 70 basis point margin expansion potential you've identified for the year, 2005.

Really it must imply, first of all, a very strong second half and what gives you that confidence that you indeed are going to have that strong second half?

Craig, very good question.

As we look at a combination of the, one, the somewhat seasonality that we have in our business, so volume does have a positive impact on our business; as we look at the mix of product that we have; as we look at the programs that we have in place, the profit improvement initiatives that are in fact working.

The manufacturing network transformation that we went through at lighting has had a very significant and positive impact.

Those things have helped us offset rapidly rising raw material costs before the price increases were in place and able to help ameliorate those.

So our feeling is that as costs which are very high, but they seemingly have reached, at least at this moment in time, somewhat of a high point.

We feel that those price increases ought to catch up too a little bit.

So you're going to get the benefit of volume in the second half, product mix in the second half, product innovation coming to the marketplace in the second half.

You're going to get the benefit of price increases now that have been put in place coming through.

So our feeling is that we will have a strong second half consistent with what our long-term financial goals are.

Vern, in your mind what type of sales growth is necessary to at least achieve the minimum of that 70 basis points in margin expansion?

Well, our opportunity is to continue to, as John was articulating earlier, with product innovation, service capabilities, to bring the kinds of product services that our customers demand.

I actually think that we have the potential to grow quite rapidly.

We want to grow--we want to have positive and profitable growth, so we're trying to manage that mix.

I believe that the growth projections that you'll ultimately see for the year will be north of what we've posted here in the first quarter.

But are they going to be materially different?

I think it depends, Craig, on just how quickly the nonresidential construction market rolls out.

But we are very excited about our product mix.

We're very excited about the product offerings that we have going forward.

John, would you care to comment?

The thing I would add, Vern, as you know, Craig, we watch Dodge construction contract awards and just to kind of frame our thinking, if we go back to 2000, 2001, 2003, in the commercial and industrial segment, as reported by Dodge, spending was about 90 billion, then down to 80 billion, then down to 65, another year at 65.

Projection for 2005 are to come back to almost $80 billion.

And the thing we're optimistic about is that the biggest increases come in the areas of offices and manufacturing.

And those really fall into our sweet spot in terms of our capabilities, and to Vern's point about mix earlier, the kind of products that we provide.

There are some other categories that are up that are not as beneficial to us as they are to others.

But we feel good about those projected increases.

We, of course, are like everybody always waiting to see that materialize, but we do have some degree of optimism because of the length of time that it's been since that market has cycled back up.

And, Craig, I would say one other thing and I've said this before and so I want to repeat it.

The 70 basis points that we believe we can improve our business has a lot to do with the things that we're doing internally in terms of our productivity, in terms of our profit improvement programs.

The uptick that John talks about that others are prognosticating, and we do see some signs, and I think that we see some favorable signs that that has a chance of materializing; we should see benefit on top of that.

Let me ask it this way, is the Dodge forecast that you see implicit in your forecast for the margin improvement?

Or could you achieve that margin improvement at something below the Dodge forecast.

We would expect to achieve that margin improvement at something below the Dodge forecast.

If I could shift to stock compensation expense which will be an expense you'll have to overcome to achieve that 70 basis points.

It's a number that's growing in part because your stock is appreciating in value.

What kind of assumptions are you making for that line item for the year to get you comfortable again with the 70 basis points.

Well, are you asking me to prognosticate our stock price?

I'm just wondering what you have internally in your head?

Is it a $10 million number for the year?

And if it were much more than that you might feel less confident in the 70 basis points?

No, your question's a good one.

My guess is that non--programs that are not associated with the change in our stock price, okay.

So in other words, we have our long-term incentive programs that are funded using restricted stock that vest over a period of time.

Those programs are generally fixed accounting.

So once that occurs, you know what that is going to be.

Our expectation is that that number will probably be a couple of million dollars more in the '05 period relative to the '04 period.

That has nothing to do with, by the way, the change in our stock price, and if you're asking me do I believe that our stock price will continue to increase; yes, I do.

But I'm not going to forecast that.

In the first quarter, as you might imagine, some of the increase-- and it was rather significant, in our corporate expense was due to programs that are based on our stock price.

For example, we allow employees to defer some of their compensation.

They can choose to do that and it's related to stock.

We compensate our directors.

They're able to defer some of their programs into stock-based programs.

So as those, as the stock price moves it has an impact on our expense.

Thank you.

And then relative to interest expense, in '04 was approximately 35 million and given your plans to reduce debt but also the reality that interest rates are headed higher; what would you expect that number to be in '05, is it a higher number than '04, or could it be lower?

Well, a couple of comments there, one, approximately 372 million, Dan.

We got 360 in senior notes that are due in '09, '10 and then we have another 11 or 12 million in IRBs.

So let's just roughly call it 370 million of our debt or so is fixed.

The difference is subject to floating rates.

You can have your own view as to what you think's going to happen with rates over time and be able to get some-- you'll be able to make your own calculation of that.

I would expect that our interest expense line continues to be flat to down as we go forward.

And then just relative to your overall debt target, I know it's somewhat programmatic based on what you have left to pay, but what is your target again for the end of the year?

Dan, I believe that we said that we would generate, we talked about cash flow generation.

Yes, I don't think we gave any specifics, but we definitely noted that we would reach 40%.

We expect to a reach 40% debt to cap.

Again, we have about 372 million in long-term debt that's not going to go away.

The excess will go to cash.

Final question has to do with the tax rate it was a tick lower than I expected in Q1.

What should we think about for '05?

Craig, as I mentioned earlier, our current prognostication is that a 35% effective tax rate for the full year is probably a pretty reasonable number.

[Caller Instructions].

Richard Glass, Morgan Stanley.

Can you guys give us a little more understanding of the AR and the inventory and payables issue and thus the cash flow?

Sure.

A couple of comments with regard to that.

For us our AR balance was approximately $336 million at the end of November, up about $6 million from August.

But up approximately $24 million from the year ago period.

A lot of that has to do with the timing of product based on customer needs.

As the first quarter unfolded a great deal of product went out in really the last month, month and a half, for which on basic normal terms just wouldn't be collected.

A lot of that had to with the timing of customer needs.

So I would expect that our AR balance, which typically would be in the 55 day range, probably is going to stay around that.

So depending on what happens with volume, you should continue to see that.

Our mix of business really shouldn't change materially between the home improvement channel versus other channels, though that business is growing.

But I would expect our other portions to continue to grow similarly.

So 54ish days, 55 days, somewhere in there on the AR balance.

From an inventory point of view, we put inventory into the system late-- not late but in our fourth quarter of last year, particularly at our lighting business, to help--theoretically to help alleviate some service issues that we were having.

The problem is, is that the inventory that we built into the system was inventory that we could bill, the service issues were around inventory that we were unable to bill.

It's kind of obvious, actually.

The fact of the matter is, is that that inventory will take awhile to burn off.

It represents approximately four or five day's worth of production.

So my feeling and our feeling is, is that as these business processes continue to take hold and they are, what you're going to see is the amount of inventory that we need to service our base of business will continue back on its track of declining.

The plant consolidations that we had targeted in '04 are really now kind of well along in that process.

So the business processes are improving at a fairly dramatic rate.

So, I think you can expect over the next quarter or two to see that inventory balance come down.

Because we built inventory into the system late in the fourth quarter, our payable balance was higher at the end of the fourth quarter.

That inventory normally would have converted to sales and then into receivables and then into cash.

The payable-- because it did not, the payable balance of those vendors, they obviously got paid.

So the relationship of AP to inventory was not as robust at the end of the first quarter as we would normally expect.

Frankly the inventory balance was too high.

It wasn't that the AP balance was too low.

So I would expect that as we get into the second quarter and maybe actually into the third quarter you'll see that ratio that we typically run come back to normal.

Our days payable typically ought to be in the 47 to 50 day range.

I believe at year end it was up a little bit above that.

So again to me that's not an atypical number for us.

Ken Mortensen with Thrivent Investment.

Just a couple of questions.

First of all I'm wondering about the competitive response to pricing; whether the competition seems to be coming along on that, and I think if I remember historically Cooper has not been raising prices as much as the rest of the industry.

That would be the first question.

And second question is just relates to, you know, you had talked about the Dodge numbers improving.

But specifically kind of where you're seeing improvements and on the office side, as an example, are you seeing some greenfield business there or is it really kind of renovation for new tenants that's happening?

Why don't I take the last portion first and then I'll let John address the first portion last.

The tenant improvement business is starting to come back and it's market specific as you might imagine, especially where you have had deep vacancy rates, West Coast, that type of thing.

So we are seeing opportunities there and our agency network is really seeing a fair amount of activity.

Our feeling also is, is that on the commercial office space you're starting to see vacancy rates improve and as unemployment rates start to drift down, those people need to find themselves back into offices and/or into factories; wherever they may be.

Those all have a positive impact on the things that we're doing.

Our core CNI business on the lighting side actually had a relatively nice quarter.

And that had to do a lot with price.

It had a lot to do with mix.

But our folks see the activity out there in the marketplace picking up.

So while we can't confirm that Dodge's prognostication is right, we can say that we are seeing some of the positive signs that would indicate that that activity is there.

And, frankly, our backlog being up at the end of November going into the second quarter, which is historically our softest, is I think a favorable sign reflecting that trend.

John, could you comment?

Just let me pile on to that for just a moment and then come back to your question about price increases.

We look at Dodge's projections for the completion of 2004 as well as going into '05.

They prognosticate contract values as well as contract awards, values being dollars and awards being square footage.

The square footage, of course, can give you some indication of new construction, if you will, sometimes on existing sites.

Values, '04, '05, '06, for example in the commercial and industrial segment projected to be up 10, 10, and 11%, respectively, while square footage is projected to be up 5, 7 and 6%, respectively.

Some of the difference between those two, of course, would be inflation; but it is good to see that some new construction activity is coming back.

Let me frame that for you.

If you go back to '01, '02, '03, and look at new square footage, it was minus 16%, minus 19%, minus 2%.

Now we're talking about '04, '05, '06 being plus 5, plus 7, plus 6.

So there does appear to be new construction activity.

It's also good to see when you travel, as I'm sure you do, you get off the plane and drive around the city and look at construction cranes starting to pop up again so it is beginning to turn.

On pricing I would say that we haven't seen anybody, systemically across the country, appear to be maintaining old lower prices that existed prior to some of these raw materials come up as you would expect.

And I really don't want to talk about each competitor name by name, of course, but there are some that in selected areas of the country don't appear to need the price increase. but as a rule, we don't see anybody that has systemically failed to increase prices as materials have gone up.

The only other comment I would make and then maybe John would like to follow on this.

Really a lot of the improvement that Dodge is prognosticating for '04 because they haven't finalized their '04 is really late in '04.

Our--the first several months of calendar year '04, which was primarily our fiscal year '04 were still actually soft to down.

So the uptick is really coming late in calendar year '04 and then on into '05, calendar year- wise.

Yeah I guess, Vern, to that point, you'll probably recall from our conference calls last summer, six months or so ago, we were sharing sort of feedback from our sales force, from the field, about an increase in activity of design taking place at that point in time.

Our hall of fame sales force, our Lithonia sales force and so forth who works with architects and engineers were reporting a significant increase in activity in supporting the design efforts of the design community.

And that's something we expected to convert to construction as we began to get into this period of time.

So there, that adds I guess to some of our optimism about that.

And John, also, many of our customers who are involved in the entire aspect of construction have not only seen the early signs, but their revenues, because they're earlier in the cycle, have actually started to increase rather dramatically.

Lighting is usually later in the cycle as that begins to tick up.

So, again for us, seeing supply houses and construction activity or construction companies, their activity picking up, their revenue starting to generate increases is really, I think, a strong indicator of what it will mean for us as we go forward.

That's a good point.

I would now like to turn the conference back to Mr. Vern Nagel for closing remarks.

Thank you, everyone, for joining us.

Again, the first quarter, I think, if you look at it in its totality, we had a number of challenges and I think we've met those challenges.

We expected to be flattish.

I'm quite pleased that we were flat, especially given the fact that, again, costs were about $3.5 million higher than what we had expected.

So I think it gives you some strong sense of what have our profit improvement programs are meaning to our business.

We still expect the second quarter to be difficult.

But yet we, we believe that there is significant opportunity for us in 2005 to make again meaningful progress on our longer term financial goals.

We appreciate your support and we look forward to-- we look forward to talking to you at the end of the second quarter.

Thank you very much.

Thank you for participating in today's teleconference call.

You may now disconnect.