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Operator
Good morning, and welcome to Acuity Brands' quarterly earnings release.
After today's presentation there will be a formal question-and-answer session. (OPERATOR INSTRUCTIONS).
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, Vice President and Treasurer of Acuity Brands.
Dan Smith - VP and Treasurer
Thank you.
Good morning.
With me today to discuss our third-quarter results are Vern Nagel, our Chairman, President and Chief Executive Officer, John Morgan, our President and CEO of Acuity Brands Lighting, Ricky Reece, our Senior Vice President and Chief Financial Officer, and other selected members of our executive team.
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.
Vern Nagel - Chairman, President and CEO
Thanks, Dan.
Good morning, everyone.
I'd like to make a few opening comments, and then John, Ricky and I will be happy to answer your questions.
We are pleased to report record quarterly results for net sales, operating profit, net income and diluted earnings per share in the third quarter of 2006.
I know that many of you have already seen our results, but the following are a few key highlights for the quarter.
Our net sales exceeded $600 million for the first time ever, up almost 11% compared with the year ago period.
More than half of the increase was due to volume, virtually all of that at the lighting company, with the balance coming from increased selling prices.
Our gross profit margin was 41.3% in the quarter, up 240 basis points.
Operating profit margin was 8.7%, up 160 basis points.
Diluted earnings per share was $0.63, up 43% compared to the year ago period.
Our cash balance exceeded $70 million at the end of May.
Our net trade cycle days improved by 10% compared with the year ago period, and now stand at 54 days, which compares very favorably to all of our major competitors.
Our year-to-date cash flow from operations was approximately $64 million ahead of the year ago period, in spite of record level of receivables required to support our strong growth in net sales.
Lastly, as of June 12th we had repurchased 4 million shares of our common stock in the open market this fiscal year, investing a total of $152 million at an average purchase price of approximately $38 per share.
During the same period, employees and retirees exercised options for approximately 2.9 million shares, generating $59 million for the Company.
Overall we have reduced our outstanding shares by approximately 1.1 million shares to date.
We had hoped to more significantly reduce our overall outstanding share count when we first announced our share buyback program; therefore, today we are pleased to announce our third buyback program this year for up to 2 million shares.
Obviously, this is a reflection of our belief in the future performance of Acuity Brands, and that this represents the best use of our cash flow at this time to create greater shareholder value.
As we look at the performance of each of our business units, we've made progress on a number of fronts.
First, let's look at Acuity Brands Lighting.
Our net sales grew at a robust pace, increasing almost 13%.
The increase was broad-based, as virtually all brands, channels, and geographies experienced unit volume growth and higher prices.
Overall, more than half of the growth in net sales at ABL was due to volume expansion and new product introductions, with the balance coming from higher selling prices and a better mix of products sold.
We expect to realize future benefits from our pricing strategies, including the price increase announced in the third quarter for products sold through the C&I channel for all new orders received after June 5th.
Said differently, that price increase does not benefit the third quarter, but we have high expectations that it will benefit the fourth quarter and beyond.
In addition, we continue to benefit from previous investments to enhance our market presence in key channels, as well as significant improvements in our levels of service to customers.
Our strong levels of service has allowed us to participate aggressively in the expansion of the nonresidential construction market in North America, where we believe the market grew by approximately 5% on an inflation-adjusted basis during the quarter.
Operating profit at ABL grew by 50% in the quarter, while margins expanded 240 basis points, reflecting both the leverage from higher sales volume and improved pricing and productivity.
Our profitability margins grew dramatically in spite of rising raw material costs, particularly for various metals and component parts such as ballast, as well as over $3 million in investments expensed in the quarter to improve productivity and to enhance our future go to market strategies.
Additionally, we made investments to increase the number of hourly associates earlier than normal to meet not only the typical seasonal demands of the nonresidential market cycle, but also to meet the customer service requirements caused by the price increase announced by ABL effective June 5th.
Lastly, I would note that our backlog at ABL as of May 31 was $198 million, up 14% from the year ago period.
In addition, I would also note that incoming orders were robust in June, both before and after the price increase effective June 5.
As we look at ASP, our net sales grew by approximately 4% in the quarter.
Overall the increase was due primarily to higher selling prices in the industrial and institutional channel in North America and greater sales through a key customer in the home improvement channel.
Volume in the I&I channel varied by region, with certain markets in the western and southern portions of the United States, as well as Canada, reporting solid unit growth, offsetting weaknesses in other markets, that were due primarily to the impact of higher sales prices and actions taken by the Company to not participate in low-margin business.
Operating profit at ASP grew by about 11% over the year ago period, while margins expanded 70 basis points, to 10.7%.
The growth in profitability and margin expansion was particularly noteworthy, given the constant pressure on raw material components, particularly those impacted by the price of oil, and the disruption in costs associated with a product recall for defective five gallon pails provided to us by a normally reliable vendor.
From an overall company-wide perspective, we are pleased with the performance and the progress we have made on a number of our annual improvement priorities and our ability to improve our margins.
Looking a little closer at our results, we believe that we are delivering on our year ago objective of improving our productivity by an annualized run rate of approximately $50 million as we ended the third quarter of 2006.
You all can see this as well.
The quick math on this is that in the current quarter we incurred almost $6 million in expenses, about half of which was due to the stock-based programs, with the remainder for those investments at ABL that I had mentioned earlier and the costs associated with the recall at ASP.
Adjusting for these items, we approximated the targeted productivity, while pulling through our expected variable contribution margin on the incremental net sales in the quarter.
To say it differently, the incremental $6 million that we invested reduced our operating profit margins by almost 100 basis points, to 8.7%.
However, we feel strongly that these investments made will further strengthen our organization in the future.
As we look forward to the fourth quarter and beyond, there are a few items which are notable.
First, we do see some issues that continue to cause us concern.
For example, raw material costs company-wide continued to rise, particularly for resins, metals, including copper, aluminum and now steel again, and other oil-based materials.
Component parts are rising as well, particularly for ballast.
Inflation in other areas such as healthcare are again troublesome.
While all this causes us some concern, we continue to be very vigilant on our pricing and quotation posture throughout the Company.
We increased prices in both organizations early in the year, including a price increase at the lighting business that went into effect again on June 5th.
We anticipate other price increases at ABL for specific products, including a recent announcement for those products which have significant copper content.
On the positive front, we see a number of items that we believe are working in our favor.
For example, we believe that we are now experiencing the long-anticipated lift in the nonresidential construction market.
We have seen meaningful increases in construction spending in North America during the past three quarters on an inflation-adjusted basis.
This is noteworthy because we believe that the installation of light fixtures lags this upward trend by approximately two quarters.
We believe that this will bode well for our lighting Company as we enter the fourth quarter and into 2007.
We believe other factors that influence the nonresidential construction market are showing positive signs, including vacancy rates for commercial space, which have been declining as the economy grows, as well as the outlook for employment, which continues to look favorable.
Strategically, we continue to position both businesses to better leverage their market presence through investments to enhance our go to market programs, as well as expanding our product offering with new and innovative products.
At ABL, for example, we have created one of the broadest, most energy-efficient and cost-effective product lines available in the industry to allow our customers to benefit from the newly-enacted Energy Policy Act of 2005.
Lastly, we continue to make investments in the training and development of our associates to further enhance our service to customers and improve our productivity.
We have demonstrated that through these programs we can improve our margins while enjoying the benefits of unit volume growth.
Overall, we anticipate that we will meet or exceed many of our long-term goals, including operating margin expansion, earnings growth and cash flow generation in fiscal 2006.
With that, I will entertain any questions that you have.
Thank you.
Operator
(OPERATOR INSTRUCTIONS).
Craig Kennison, Robert W. Baird.
Ryan Kelly - Analyst
Congratulations on a great quarter.
This is actually Ryan Kelly for Craig.
First off, with the backlog up substantially to 198 million, how much of that do you think is pre-buy versus strength in the underlying market?
Vern Nagel - Chairman, President and CEO
John, could you address that please?
John Morgan - President and CEO, Acuity Brands Lighting
It's mostly -- on the 198, it's mostly pre-buy in the third quarter.
So the kind of margins that we would anticipate in that backlog would be similar to the margins that we experienced in the third quarter.
We will get a little lift in price because there were some pricing increases that took place as part of our annual price review.
As you know, we go through two types of pricing reviews.
We have an annual price review where we look at our entire product line.
And that was done in the January timeframe.
And during that period of time, we did make some upward adjustments, in particularly some of our stock products.
In addition, when we run into an inflationary time that is unusual, such as we have recently with copper taking off, we make additional adjustments, which were announced -- I think Vern said June 5th, or the cutoff date for orders was June 5th.
So I would anticipate a little bit of lift in that backlog, but not materially.
Ryan Kelly - Analyst
Can you talk a little bit about the specialty chemicals business, especially the competitive environment, given your price increases, and then how you view ASP's business fundamentally and strategically?
Vern Nagel - Chairman, President and CEO
Sure.
First of all, I thought ASP had a very strong quarter, given the environment that they find themselves in.
First of all, on the volume side of the equation, we experienced volume growth in a number of key markets around the country, around the U.S., as well as in Canada.
We also experienced certain volume decline in markets, particularly the Midwest, where I think there are two things working.
One, you have the general economic just weakness that's in that particular region of the country.
And couple that with the price increases that the industry has put through -- and we have participated in that, obviously -- the market finds itself a bit unsettled, if you will, in terms of trying to find its footing vis-a-vis pricing.
We also have taken actions in the Midwest around certain customers where we have opted to not participate in certain bid processes where we feel that the margins are just beneath margins that we find acceptable.
So in spite of rather dramatic increases in raw material costs, I think that the ASP folks have managed their business very well and very effectively during the period.
And you saw that.
Our margins were 10.7%.
Our operating profit grew 11%.
So, I feel we're doing a very good job.
I think as oil prices stabilize and as the marketplace accepts the general price increases -- again, not just us, but the market in general -- I think you're going to see us return to growth again.
From a strategic perspective, we think that ASP has tremendous opportunity.
If you look at the various markets that they participate in -- the I&I channel, which is a $9 billion-plus market; if you look at the retail channel, the portion that we participate in is roughly a $4 billion channel; if you look at the adjacent markets, you're probably adding another 8 to $10 billion.
So, with us being one of the dominant players and having such small share, we think that there's ample opportunity for future profitable growth in our business.
And our strategies are about levering those capabilities and our brand strength and our people strength to go after that growth opportunity.
Ryan Kelly - Analyst
Vern, finally -- [Gemlite] made an acquisition a little over a month ago.
Can you talk about your appetite for acquisitions and how the market looks out there?
Vern Nagel - Chairman, President and CEO
Let me make a comment, and then I'd like to ask John to make a comment as well.
We have been very specific about what our strategies have been over the last 24 months, in terms of positioning the footprint of our business to be able to be a more cost-effective supplier, to be a more competitive supplier, to be a more efficient supplier.
And our strategies have been around, one, making that platform more efficient, and number two, getting our product development capabilities where we want.
You are starting to see the benefits of our product development capability.
When you look at products like the RT5, the I-BEAM, SuperGlass, and so on and so forth, what you're seeing is really one of the core strengths, I think, of both our solutions business as well as our commercial business at the lighting company.
Acquisitions will play a strong part in the things that we want to do on a go-forward basis, but we have done a lot of work to improve ourselves so that we have the ability to more effectively target and bring on acquisitions.
And so, I think, as we look out over the next 24 months, you'll see us in the marketplace, but you'll see us in the marketplace in a very diligent and thoughtful way.
I believe that our platform -- both businesses, actually, are improving to the point where they're near ready to be able to do that.
John, your observations?
John Morgan - President and CEO, Acuity Brands Lighting
I would agree that while a year or two ago we didn't feel at Lighting that we were prepared to integrate acquisitions, I think the organization is equipped to do so at this point.
Our real appetite, though, is for profitable growth, and not just through acquisition, but organic growth.
And if you think about the fact that we participate both in a higher-volume segment of the market, where products are highly commoditized, as well as a more specialized side of the market, where the lighting is more specialized in its design, our appetite for growth is certainly in both areas.
But I'd like to increase the participation in the Specialty Products side.
We will, of course, do that either organically or through acquisition.
There are a number of properties out there that would make a lot of sense for our portfolio of products.
We're not inclined to overpay for any of those.
If we find ourselves in a situation where we would have to overpay, then we would develop those products organically.
So we're going to look for both opportunities, but we feel we could integrate at this point in time.
Operator
Matt McCall, BB&T Capital Markets.
Matt McCall - Analyst
Great quarter.
Congratulations on the surprising, or very positive results on all lines, it looks like to me.
Referring to last quarter, you talked about Q2 '04 being more of a clean comparison from a gross margin perspective.
If that's the case, we look at Q3 and compare it to Q3 '04, still down about 50 basis points; obviously, very encouraging results year-over-year.
Is that a good way to look at the actual results here, to look at a comparison maybe two years ago?
Vern Nagel - Chairman, President and CEO
Actually, I find it to be -- and I'll let Ricky comment as well -- but I find the comparison to be, again, quite favorable.
If you look at our Q3 of '04, we're up almost 100 basis points in terms of gross profit margin.
And if you look at overall, our operating expenses are down, while incurring in the current quarter almost $6 million, approximately half of which is for the resi side of the world, and the other half -- resi -- for the stock-based compensation, and then the other half for investments that we have made to enhance our productivity.
So, I think that the comparison is pretty strong.
The other thing that I find interesting that I would point out to everyone -- if you look at our fourth quarter of 2005, what is interesting to me is our revenues are not materially different.
We're up about $6 million over the fourth quarter, but yet our gross profit is up over $17 million.
While our operating expenses are up approximately $8 million, 6 of that, again, is for the stock-based compensation, as well as the investments that we've made.
So I think you're really getting a strong sense of the opportunity on a go-forward basis of the business and the leverage capability, as well as the internal productivity improvements that we have been working through our business.
Matt McCall - Analyst
That's kind of what I'm trying to get a handle on, is if you look at Q4 last year and Q4 of '04, you had the seasonally-weakest gross margin, yet you had the seasonally-strongest topline.
So I'm trying to make sure I understand what maybe was occurring then in those quarters that won't be recurring in Q4 this year, and trying to get a better handle on where the gross margin could fall out, given the strong results in Q3 '06.
Vern Nagel - Chairman, President and CEO
Again, our objective was to add on an annualized basis 70 basis points of operating profit on a per annum basis.
If you go back to '04, where we were at [66] and 70 basis points for '05, and add another 70 basis points, you know, you're north of -- you're 8% or better in terms of what our targets are.
And I believe that we will achieve that and potentially exceed that.
Ricky, do you have an observation?
Ricky Reece - SVP and CFO
I would say another comment worth highlighting is we were beginning to see raw material cost increases in the latter part of '04, and certainly throughout '05.
Now, we were taking pricing action beginning in '05 to combat that in late '04 even.
But we were lagging that throughout that period.
So I think what you're seeing in our third quarter of '06 is us finally catching up with these raw material increases that began back there as we were lagging them, and that is showing up in our gross profit margin.
Obviously, the restructuring efforts and so forth that we took throughout '05 are beginning to take full traction, as Vern commented, on the 50 million improvement.
And then lastly, the incremental volume which we're finally getting, particularly in the lighting business, is throwing good profit to the gross profit line.
So several factors, I think, are contributing to a favorable comparison to '04.
Vern Nagel - Chairman, President and CEO
And I would expect us to continue to show the kind of robust gross profit margins that you saw here in the third quarter as we go into the fourth quarter and beyond.
When it comes down to our operating expenses, we did make some investments in the quarter.
And we made those carefully, thoughtfully, and we expect that those investments will benefit a little bit of the fourth quarter, but really benefit some of the things -- some of the strategies that we are executing over as we enter 2007.
So, while it was a small investment, you need to have clarity around that.
And I believe we've provided that to you.
Matt McCall - Analyst
One final one.
Vern, in your prepared comments in the release, you talk about, I believe, the market will continue to expand at a positive rate consistent with a variety of forecasts.
Which forecasts -- there's a pretty broad range out there from a non-res construction standpoint.
Which ones are you specifically referencing in that comment?
Vern Nagel - Chairman, President and CEO
We, like you, look at them all.
So, Dodge is the one who folks most commonly look to.
But we look at a whole host of other indicators.
In fact, in John's organization, we have just an excellent group of individuals who spend a lot of time looking at many factors to help us support our own thoughts around where the market will be.
But I think Dodge is probably the one that gives you -- is the most followed forecaster.
John, any thoughts from your perspective?
John Morgan - President and CEO, Acuity Brands Lighting
I would say Dodge is the primary one.
We both look at -- we look at both square footage as well as construction dollars, construction spending, in there.
We also look at, closer in, the construction put in place.
There is another index we follow that's a little bit more of a leading indicator in our view; it's the AIA (multiple speakers) tax billing index.
But I think Dodge is a pretty good source.
Matt McCall - Analyst
What is the Dodge projection for the next, say, few quarters?
John Morgan - President and CEO, Acuity Brands Lighting
The Dodge projection for the next, let's say, six quarters is continued expansion in the 4 to 7% range.
They further break it down by construction type; for example, healthcare, education, offices and so forth.
I guess the thing that we are optimistic about is we're seeing for the first time in a half-a-dozen years that the expansion is coming in areas where we are relatively strong; areas such as offices.
You look at the absorption rate of available office inventory, it's continuing to be absorbed.
The demand for sources schools continues to increase.
So, in those specific areas, they do break it down into those categories.
Operator
Chris Glynn, CIBC World Markets.
Chris Glynn - Analyst
I just wanted to talk about the investments a little bit.
Part of the growth was attributed to prior investments, and then this quarter you had, I think, 3 million incremental over last year.
So with the markets seemingly accelerating and getting results from prior investments, do you see this accelerating, the investments in, say, market presence and customer service?
Vern Nagel - Chairman, President and CEO
A couple of things.
One, we have been very judicious and focused on where we pick and choose to make our investments.
And we continue to invest in our market presence capability, and I'll just give you one example.
If you go back a handful of years ago, not even three years ago, our sales force -- we probably increased the sales force at Holophane by 60%.
Unidentified Company Representative
That's correct.
Vern Nagel - Chairman, President and CEO
So, when you do things like that, you take a short-term hit as these folks come on board and find their footing, if you will, in the marketplace.
So if you're enjoying the benefits in terms of growth, due to that investment in market presence, we're making currently investments in some of the things to enhance really what we think are key strategies on a go-forward basis around those markets on where we participate, how we participate.
And it's in both businesses, by the way.
This particular investment was primarily made at the lighting business, but to really hone those strategies and to hone those tactics as we go forward.
The other thing that we've done is we continue to make investments that you expense in training and development of our people around how to become more effective in terms of a more lean organization, if you will.
So we are very focused on how do we get at productivity.
A lot of it has to do with training and development, and we're seeing the benefits of that.
So while we think it's a short-term cost, we think that the longer-term benefits -- and I don't mean real long-term;
I'm talking about as we get into 2007 -- you will continue to see that.
That's one of the ways that we intend to continue to drive organically, if you will, our improvement in our operating profit margins.
So we're continuing, again, to pick and choose where and how we do these types of things.
Chris Glynn - Analyst
Right.
But with the incremental investment this quarter, because of the end-market strength and benefits from prior spending, there was no short-term hit, per se.
So in this environment, I'm just kind of wondering why -- you would seem to be able to find opportunities to maybe get that up to 6 or 8 million from 3 million over a couple of more quarters.
Vern Nagel - Chairman, President and CEO
Again, when I talk about -- when I talk about these investments, these are items where we expense those things in the current period, and they will look to enhance what we do in future periods.
And so I consider those to be incremental costs to what the true quarter was.
But I think that because we don't do these things all the time, that's why we're making note of them.
Our operating expenses did go up more than what, I think, we would have anticipated.
And if we don't explain why, because of both the stock-based compensation, as well as some of these investments that were made, you might not understand those as clearly as we would like you to.
Chris Glynn - Analyst
Just a little more on the mix of that 13% in ABL.
You said half from volume and new products, with the balance from mix and price.
What's the difference between -- you kind of differentiated new products and mix?
Vern Nagel - Chairman, President and CEO
Sure.
John, would you like to address that?
John Morgan - President and CEO, Acuity Brands Lighting
It's a little bit more than half in the area of volume.
I guess we're particularly pleased -- within the mix, some of our new products, such as RT5 and such as our I-BEAM products, those products that have focused on energy conservation have gotten traction quite quickly.
And so those are higher-margin products; they're higher-priced products.
They have helped us both in the volume and in the price side of the equation.
And related to your earlier question, we would intend to continue to invest in new product development at a similar or expanded rate.
So, we've -- as you know, we don't report specific product line sales, but we've been very pleased with the traction we've gotten out of the new products we've introduced over the last six to 12 months.
Chris Glynn - Analyst
One last one.
Honeywell just announced a little deal with a township to overhaul all their building controls and put in new lighting fixtures.
How much have you seen of that opportunity, from a town making an investment in its energy cost structure, for instance?
And what kind -- it would seem to be a huge market opportunity.
Do you have any ideas about how that might play out over the longer term?
John Morgan - President and CEO, Acuity Brands Lighting
Not in terms of specifically Honeywell, but in general.
As you know, [EPAC] 2005 offers tax incentives for a variety of energy-related improvements to facilities.
A significant portion of that is related to lighting.
In the case of government facilities, it's actually the lighting designer, for example, who can take benefit from a tax standpoint.
In private facilities, it's the facility owner that can take benefit to that.
We hope that those tax benefits are extended beyond 2007, but for now, the benefit is through 2007.
We're seeing, we think, a good bit of lift in the opportunity.
There are millions, hundreds of millions of light sockets out there of old technology that could be replaced.
And we view it to be a very significant opportunity.
Certainly in the area of new construction, there is a greater and greater trend to go towards energy-efficient products.
And that is assisting us from a product mix standpoint.
Operator
Cliff Walsh, Sidoti & Co.
Cliff Walsh - Analyst
Can you guys comment on the end-market breakdown in the quarter in terms of lighting?
We've seen a lot of strength in the non-res sector, so I just wanted to kind of get a sense as to where things stand right now.
Vern Nagel - Chairman, President and CEO
I'll just make a brief comment; then I'll ask John to make a comment.
We have seen, in the data and information that we look at, growth on an inflation-adjusted basis in the nonresidential construction market overall for the last three quarters.
We believe that that growth trend really is quite positive for us, those of us who sell lighting fixtures, because we believe we tend to lag that growth cycle.
So as the market continues to expand, we should enjoy the benefit of that for the foreseeable future.
When you look down at the specific end markets, we are seeing, as John had mentioned earlier, growth in those areas where we believe we have strong core competencies and really quite an extensive and effective product offering.
We continue to use our product development capability to bring proprietary technology and opportunities to our customer base to help them with many of the energy issues that they will be grappling with, both today and on a go-forward basis, particularly when you see oil at $70 a barrel.
So from our perspective, we are seeing the kind of growth and in the specific areas that we think really bode well for us on a go-forward basis.
John, (inaudible)?
John Morgan - President and CEO, Acuity Brands Lighting
Cliff, we -- again, we look at both the square footage that is being constructed, as well as the cost of construction.
In square footage, the overall market continues to grow substantially, in that 4 to 7% range.
The only segment that really does not appear to be growing in terms of construction is the retail space.
I don't have all those right in front of me now, but there's significant expansion in healthcare, in office and education.
We've seen over the last year and are continuing to see some expansion in North American-based manufacturing, and certainly in warehousing.
So, those are the larger markets that are also experiencing expansion, and are projected to continue for the next several quarters.
Cliff Walsh - Analyst
In terms of revenue for the quarter, can you give me a percentage basis as to how much was residential versus nonresidential?
Any general sense on that?
John Morgan - President and CEO, Acuity Brands Lighting
I don't really have that off the top of my head, but we are not very heavy in the residential side.
Our business is primarily nonresidential.
Cliff Walsh - Analyst
And in terms of raw material cost increases that you're seeing, can you quantify some of the major ones that you're seeing?
John Morgan - President and CEO, Acuity Brands Lighting
Copper is a thing -- is [pricing effect] time of delivery that has gone up some 235% in the last several months, and the steel has started to climb up somewhat.
That, of course, is affecting the transformers of the lighting ballast that we purchase.
Aluminum has continued to increase.
Any petroleum-based product, such as plastic, has continued to increase.
Those industries are well published;
I won't try to (multiple speakers) them all right here, but we're affected by all those.
I think, to the point Ricky made earlier, it had been a number of years since we really had to operate in an inflationary environment to this degree.
So last year it took us a little time to catch up with that.
At this point in time, our folks are doing a fabulous job of managing our pricing to the market in the face of inflation.
So we think we're going to be able to keep pace with it.
Vern Nagel - Chairman, President and CEO
And I would say the same thing is true for ASP, where they have done an outstanding job in a very tough environment.
They are directly impacted by the price of oil.
In the third quarter I believe that year over year the price of oil was up over 30%.
So we continue to -- and that impacts many aspects of our business.
We move product from our manufacturing hubs to our customers.
So we have many influences in terms of what raw materials and component parts mean for us.
And again, as I said earlier, we have been very vigilant in terms of understanding our quotation posture company-wide, as well as understanding our pricing strategies.
Not only do we have annual price reviews in both businesses, but we are pretty vigilant about what cost increases mean to us and how we handle those in the marketplace.
Operator
[Steve Ferrell], Conning Asset Management.
Steve Ferrell - Analyst
I was wondering, with respect to your share repurchase activities, is your goal to actually reduce your share count, or really just to offset option dilution?
Vern Nagel - Chairman, President and CEO
Ricky?
Ricky Reece - SVP and CFO
Our goal is to reduce the share count.
We had originally targeted a 2 million share net reduction; had pretty significant option activity, primarily from some retirees that we had late last calendar year that, with the stock appreciation, took advantage of that.
So the goal is to reduce the net share count net of the option exercise, and this last 2 million authorization should help us do that.
We've only really been able to reduce our share count by a little over 1 million shares, about 1.1 million shares, well short of the minimum 2 million we were targeting.
Steve Ferrell - Analyst
Would you be willing to actually incur additional borrowings to proceed with share repurchases, or are you going to limit it pretty much to your free cash flow?
Ricky Reece - SVP and CFO
At the level we've been authorized at this point, our cash flow will more than be sufficient to cover that.
So we're not looking to have to do incremental borrowings to cover that.
So it hasn't really become an issue.
Steve Ferrell - Analyst
One last question.
Your CapEx, I guess, has been coming in a little lower than I had expected.
Can you give us a sense where you think it's going to come in for this fiscal year?
Ricky Reece - SVP and CFO
Yes.
We have been bringing down our outlook for spending in the last couple of quarters.
We started at an expectation around 40 million.
We're now down to probably closer to 30 million, maybe even a little under $30 million in spending for the year, which would be a pretty heavy fourth-quarter spending, because we're nowhere near that level at this point.
But we do have some major projects that are coming in in the latter part of this year.
We had been pretty focused earlier this year on some of the moves that were made last year in being able to squeeze out more productivity out of the existing assets, and it delayed some of the IT investments that had originally been scheduled for this fiscal year into next year.
And that's what's caused us to bring it down.
We have not overtly curtailed the spending by any of the operating units in capital, and certainly are prepared to make the investments.
Vern and John both had talked about investments we're making in a variety of areas, and very prepared to do that; and would expect, as you look into next year, that we may go back more to our historical levels, although we're still in the process of putting together our plans for fiscal year '07.
But suffice to say, for this year it will probably be somewhere south of the 30 million, which is below the run rate we've been experiencing.
Vern Nagel - Chairman, President and CEO
Ricky, If I could also comment on that, I think that both organizations have really done a very effective job -- we talk about these investments that we make -- but a very effective job at understanding how to derive more utility and benefit from the assets that we have employed, and being more creative and effective at working with our supply base to understand how we bring product to market in the cost-effective way possible.
You're seeing the benefits of, again, some of the training and development of our people in this particular area.
It's just one example of how we're looking to drive our cash flow return on investment and improve that, which, by the way, if you look at year-to-date third quarter and (inaudible) third quarter of this period to third quarter a year ago, our cash flow return on investment has almost doubled in that time period.
This is an example, just one example, of how we've been able to lever our assets through some of the deployment of these programs.
Steve Ferrell - Analyst
Just one last question.
The fourth quarter typically is pretty positive from a working capital standpoint.
Any reason to expect otherwise this quarter?
Vern Nagel - Chairman, President and CEO
In fact, I would believe that in the fourth quarter, you will see us continue to further lever our asset base.
While I won't make a prognostication, I believe last year that our total working capital as a percentage of net sales was around 15.5% -- I'm recalling this.
I think you'll see meaningful improvement on that.
Again, some of the investments that we have made in inventory, we would have expected our inventory dollars to actually come down a little bit.
But we knew that we were coming into a very robust period, plus you have raw material costs that are up.
That's why, as I noted earlier, our days in total our down about 10% year over year, which is pretty significant.
And our total days at 54 days for our net trade cycle is really best in class at this stage.
Operator
[Rob Halth], Fiduciary Management.
Rob Halth - Analyst
Actually, my question was just asked.
Thanks a lot.
Operator
(OPERATOR INSTRUCTIONS).
Bruce Geller, DGHM.
Bruce Geller - Analyst
It's Dalton, Greiner.
Congratulations on a great quarter.
Vern Nagel - Chairman, President and CEO
You've been waiting for this for a long time, haven't you?
Bruce Geller - Analyst
You put up what you've been promising, so congratulations.
Just one quick question on the cash flow statement.
There's a line item called excess tax benefits from share-based payments, and it's a cash outflow of 16 million.
Could you just help me understand what that is?
Ricky Reece - SVP and CFO
That -- under FAS 123R, there was a change in how those costs are shown, or those benefits are shown in the cash flow statement.
It is offset in the financing activities portion of the cash flow statements, and these are the deductibility that the Company gets when these options are sold by the employee, short of a holding period that otherwise they would be able to get a more favorable tax treatment for.
The Company is able to deduct the cost of that, and it's now treated under FAS 123R.
Gross it up and show it as a [use] up in the operating activities and a source in the financing activity.
So that's new as a result of adopting 123R this year.
Bruce Geller - Analyst
Are you getting an earnings benefit in the -- by reduced taxes to the level of $16 million this year?
Is that what that's saying?
Ricky Reece - SVP and CFO
No, this is the cash benefit that the Company will get from being able to use that opportunity.
It's similar -- you've been getting it in the past.
Nothing has changed, other than we've added an increased amount of activity this year in exercise of options.
So nothing has changed on the income statement side as a result of 123R as it relates to these tax benefits.
It's solely how it's reflected in the statement of cash flow.
Vern Nagel - Chairman, President and CEO
I want to make sure that you and everyone else understands that.
If you look at our effective tax rate -- which is, what, 34.5%, somewhere in that range -- there is no tax benefit flowing through the P&L.
This is strictly a cash flow item.
So when you look at our effective tax rate of 34.5%, that's kind of where we are as an organization.
Does that make sense to you?
Bruce Geller - Analyst
Yes.
I'm still trying to understand exactly why it is where it is on the cash flow statement.
Ricky Reece - SVP and CFO
Again, that was a requirement under the new FASB statement that they're seeing that more as a financing type of an activity as opposed to an operating activity, would be the theory of it.
And that was a change that all companies make as they adopt 123R.
Vern Nagel - Chairman, President and CEO
They thought that would benefit you as an investor.
Operator
[Rob Halth], Fiduciary Management.
Rob Halth - Analyst
Sorry guys;
I did have a question.
In regards to -- I know that it was asked earlier, about sort of the desire to get the share count down.
And you haven't really been successful, it doesn't appear, with the share repurchase activity being offset for the most part by people issuing options.
What is the compensation, I guess, strategy going forward to potentially lower the situation as we move forward into the future?
Vern Nagel - Chairman, President and CEO
A couple of points.
One, quarter-over-quarter we added about 870,000 shares on our previous years, our shares outstanding of 44.6.
So when -- as Ricky mentioned earlier and as I mentioned earlier, we have reduced our overall share count down by about 1.1 million shares.
So we have been successful; you just haven't felt the full benefit of it yet, because we finished the most recent round, essentially, on June 12.
That's why we are reloading for another couple of million shares, or up to a couple of million, so we can in fact get that share count down.
When you look at the past compensation sort of philosophy, it was -- and, I think, appropriately so -- using options.
And if you go into our K and you look at -- if you go back a few years, you'll see that our total options outstanding was in the, depending on when you look, near 7 million shares of options outstanding.
At the end of this quarter, I believe we're now down to approximately 2.1 million options outstanding.
So the overhang has dropped rather dramatically.
For the last couple of years, the long-term incentive program, which is a performance-based program, has been paid out, generally speaking, in restricted stock.
We have issued some options for the senior management team, but they have been really fairly de minimis compared to options that were issued in the past.
Again, the program being performance-based, last year's allocation was quite modest, because our performance wasn't where we had expected.
This year, I would expect a different outcome.
So our view is is to continue to use primarily restricted shares, though the compensation committee and I will be having conversations around what is the best and most appropriate mix of shares, options, or other vehicles that have the same benefit, but potentially do not create quite the same amount of dilution on a go-forward basis.
Rob Halth - Analyst
I guess it just seems like you guys are putting up some very good results; that's very encouraging.
It seems like some of it is being chipped away by things that -- options, etcetera.
And I guess I'm just not clear on whether the $3 million investments that you talked about in terms of the quarter, which you maybe are not going to repeat -- but maybe it's recurring but nonrecurring, I guess.
Maybe you could characterize that a little bit, Vern.
It would be very helpful.
Vern Nagel - Chairman, President and CEO
Let me go back to your previous comment, though.
When 123R came rolling through we, obviously, complied.
And you can have your own view about whether that is a useful FASB or not.
I won't comment (inaudible) I have a strong view on it.
The fact of the matter is we have brought into this current quarter additional expense that would have normally found its way into footnote disclosure.
So unfortunately, it's following FASB 123.
We have been using restricted stock, but that has not had a significant impact in terms of the quarterly expense relative to prior periods.
So it has had some impact, of course, but that's not where the lion's share of this is coming through.
So, again, there's not much that we can do about it.
It's 123R.
We describe it in all of its glorious detail in our various footnotes, so you're able to get a pretty good sense of that.
Coming back to these investments, again, we have been working aggressively to train and develop people around some of our changes to our manufacturing techniques to some of our transactional techniques to become a more lean organization.
And so, to get as many people through the training and development, so that they actually can apply these tools, requires cost that we expense in the current period.
We've been accelerating that, particularly around areas where we can improve our sales and operating coordination and planning process, areas where we can, again, enhance some of the tools and techniques to become a leaner, more effective organization.
We also made some investments in the current period to improve how we process our payroll activity.
We expect to get benefits from that in terms of more efficient payroll processing, less headcount.
And we just didn't get those -- we had to make the investment upfront -- didn't get those benefits fast enough.
And then lastly, we have become -- as we have fixed, if you will, or moved the operating platform to a position where we think it is now operating more akin to what we would expect, we're now becoming more aggressive in terms of our thoughts around where we can apply some of our considerable resources in terms of product development, service capabilities beyond just product into the marketplace.
So we have been aggressively exploring these areas, and that has resulted in just an incremental cost for us to better understand our opportunities in those areas.
Rob Halth - Analyst
Great.
Thanks, and congratulations on a great quarter.
Operator
At this time I would like to turn the conference back over to Mr. Smith and Mr. Nagel for any closing remarks.
Vern Nagel - Chairman, President and CEO
Everyone, thank you very much for your time this morning.
We believe that we are focused on the right objectives, [fulfilling] the proper strategies and driving the organization to succeed in critical areas, while delivering on expectations for all of our key stakeholders.
Our future is bright, and we thank you for your support.
Talk to you next quarter.
Thanks.
Operator
Thank you for participating in today's conference call.
You may now disconnect.