Acuity Brands Inc (AYI) 2006 Q4 法說會逐字稿

Good morning and welcome to the Acuity Brands 2006 fourth quarter and full year results conference call.

After today's presentation, there will be a formal question and answer session. [OPERATOR INSTRUCTIONS].

Now I would like to introduce Mr. Dan Smith, Vice President and Treasurer, Acuity Brands.

Sir, you may begin.

Thank you.

Good morning.

With me today to discuss our fourth quarter and full year results are Vern Nagel, our Chairman, President and Chief Executive Officer, John Morgan, our President and CEO of Acuity Brands Lighting, Ricky Reece, our Executive 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 which could cause the 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.

Thanks, Dan.

Good morning, everyone.

I would like to to make a few comments.

Then John, Ricky and I would be happy to answer your questions.

First of all, 2006 was an outstanding year for Acuity Brands.

We sold more products and earned more income in the fourth quarter and for the full year than any other respective periods in our history.

In fact, we met or exceeded many of our longer-term financial targets in 2006.

I know that many of you have already seen our results, but the following are a few of the key financial highlights for the first quarter.

Consolidated net sales for the quarter were up, were more than $674 million, up almost 13% compared with the year-ago period.

More than half of the increase was due to volume, virtually all of that coming from the lighting company with the balance coming from increases in selling prices at both companies.

Gross profit margin was 41.6%, up 270 basis points over the year-ago period.

Consolidated operating profit margin exceeded 10% for the first time ever, reaching 10.8%, up 340 basis points in the quarter.

Diluted earnings per share was $0.93, up more than 50% from the year-ago period.

For the full year, net sales at Acuity Brands reached almost $2.4 billion, up more than 10% from 2005.

Operating profit exceeded $197 million, with operating profit margins reaching 8.2%.

Net income was almost $107 million and our full year diluted earnings per share doubled to $2.34.

We generated almost $156 million in cash flow from operations.

This is up 14% over 2005.

Our cash balance exceeded $88 million at the end of August.

Our net trade cycle days improved 15% compared with the year ago period and now stand at 44 days.

This, while funding a $220 million increase in our revenue base in 2006.

Our working capital statistics compare favorably to all of our major competitors by a wide margin.

Lastly, we repurchased 5 million shares of our common stock in the open market in 2006, investing a total of $195 million at an average purchase price of approximately $39 per share.

During the same period, employees and retirees exercised approximately 3 million options, generating $61 million for the company.

Overall, we have reduced our shares outstanding by approximately 2 million shares in 2006.

As we look at the performance of each business unit, we have made progress on a number of fronts.

First at ABL, our net sales grew almost 16% in the fourth quarter and over 12% for the full year.

Looking more closely at the full year, 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 sells at ABL was due to volume expansion and new product introductions with the balance coming from higher selling prices bander mix of products sold.

Our net sales in the second half of the year were particularly robust, as the nonresidential construction market continued to expand, fueling demand for lighting fixtures.

In addition, as we noted in our third quarter conference call, we continued 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, coupled with our various new product introductions over the last 18 months has allowed us to participate aggressively in the expansion of the nonresidential construction market in North America, where we believe the market grew between 4 and 5% on an inflation-adjusted basis in our fiscal 2006.

For the quarter, operating profit at ABL grew 77%, while margins improved 440 basis points to 12.6%.

Our performance in the quarter was due to our successful efforts, again, to enhance customer service, the introduction of new products, improved pricing and productivity, and to a lesser degree, the overall growth of the nonresidential construction market.

Operating profit at ABL for the full year grew 92%, while margins expanded 410 basis points to 9.9%, reflecting both the leverage from higher sales volume and success in our execution over strategies to improve pricing and productivity.

Our profitability in margins in 2006 grew dramatically in spite of rising costs for certain raw materials, particularly various metals and component parts such as ballast, as well as significant investments made throughout the year to improve productivity and enhance our future go to market strategies.

Lastly, our backlog at ABL as of August 31, 2006 was $176 million, up 16% from the year-ago period.

In addition, I would note that incoming orders continue at a favorable pace.

All in all, ABL had a great year in 2006.

I compliment John Morgan, his leadership team and all associates at ABL for their dedication, outstanding execution, and intense focus on the pursuit of operational excellence.

Now, looking at ASP, our net sales grew by approximately 4% in the quarter and over 3% for the full year.

Overall, the increase was due primarily to higher selling prices in the industrial and institutional channel in North America, and greater sales through-- to 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, continuing to report solid unit growth.

This mitigated most of the weakness in other markets that was caused by the impact of higher sales prices, lessening customer demand and actions by the company not to participate in low margin business.

In the fourth quarter, ASP reported operating profit of $15.6 million, or 10.4% of net sales.

This was down from the year-ago period due primarily to an $800,000 charge for a product recall and the impact of higher costs including transportation.

The recall was due to a notification from a vendor, Nampack, which is owned by BWAY Corporation of a flaw in their manufacturing process to produce containers used by for us for limited products.

We are pursuing legal means to recover those costs from the supplier.

For the full year, operating profit at ASP grew by 15% over the year-ago period, while margins expanded 90 basis points to 8.8%.

Growth in profitability and margin expansion at ASP was noteworthy, given the constant pressure on raw materials, particularly those impacted by the price of oil.

The negative impact that higher selling prices had on unit volume, and the disruption and costs associated with the product recall.

As we look at Acuity Brands in total, we are very pleased with the performance and the progress we have made in 2006 on our key annual improvement priorities, including better service to our customers and improved productivity, our ability to enhance profit margins, and our success at driving strong cash flow.

We expect this momentum to carry into 2007.

As we look forward to 2007 there are a few items which are notable.

Starting off, our issues that cause us concern.

First, we continue to experience volatility company-wide for raw material costs, particularly for resins and other oil-based materials and metals, including copper and aluminum.

Also, certain component parts continue to rise as well, particularly for ballast.

Second, inflation persists in other areas of the business, such as healthcare costs.

Third, there is the potential that rising interest rates could have a disruptive influence on the broader economy that could dampen demand in both nonresidential construction and to a lesser degree, the residential market.

And lastly, the potential for continued irrational pricing tactics by certain undisciplined competitors in key markets, is again, troubling.

While all these issues are worrisome, we continue to be very vigilant on our pricing and quotation posture throughout the company.

On the positive front, we see a number of influences 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 nonresidential construction spending in North America during each quarter in 2006 on an inflation-adjusted basis over the year-ago period.

This is noteworthy because we believe that 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 2007.

We believe other factors that influence the nonresidential construction market continue to show 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 and services.

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 continue to benefit from the newly enacted Energy Policy Act of 2005.

Lastly, we continue to make investments in programs to better train and develop our associates to further enhance our ability to service customers and improve productivity.

We have demonstrated that by investing in these programs we can improve our margins, while enjoying benefits of unit volume growth.

Overall, we believe that our results in 2006 are a prologue to a successful future.

On to that end, we anticipate that we will meet or exceed many of our longer-term financial goals, including operating profit margin expansion, earnings growth and cash flow generation in fiscal 2007.

Thank you.

And with that, we will entertain any questions that you have.

Thank you.

[OPERATOR INSTRUCTIONS] our first question comes from Peter Lisnic of Robert W Baird.

Good morning, gentlemen.

Hi, Peter.

Are you on you?

Good.

Great quarter, great year.

Thank you.

If I could just ask a couple questions on the lighting business.

First, you talked about this year kind of the excluding inflation growth being somewhere around 4 to 5%.

Reasonable expectations for next year, somewhere around that number?

Let me just provide a quick oversight and then I would like John Morgan to respond.

We've looked at the market very broadly and we use many different prognosticators to help guide our thinking a little bit and Dodge is the one that we particularly focus on, but there is the one that we particularly focus on, but there are others that are out there.

Our sense is that the overall market next year, from their perspective is looking at unit growth of roughly 3%.

More specifically, though, John, maybe you could delve a little more deeply into that.

Yeah, we would anticipate modestly outgrowing the market next year, but I would agree.

We're looking at that 3%, 4% range.

The reason we think we would modestly outgrow the market is we still have a number of new products coming online and some of that construction activity in the nonresidential area are in what, you know, for lack of a better term, I'll call it our sweet spot.

It's an area such as warehouses, offices and that type of thing.

Some of the areas that are going to be down are some of the retail space, stores, and that type of thing.

Some of the more robust construction activities are in areas such as education.

That's not quite as high a margin business as you would expect in some other areas.

So overall, we are expecting about, let's just call it 3% for the market and we would anticipate modestly outgrowing that.

Okay.

That's good on that one.

And if I, if I look at the price increases that you've implemented this year, how much of that carries over into fiscal '07?

John?

On lighting, we would anticipate that the price increase is, that we've been able to get this last year will fully carry over into '07.

That's our current thinking.

That's our current plan.

That's the way we're operating the business.

Now, I, I have to put a footnote on that, Peter and tell you that when we look at what's happening around the market, there's, there's one particular, one competitor in particular who for the last three or four months has been very aggressive on pricing on a very, sort of a selective basis and various different projects, various different territories.

Just in the last 30 to 45 days, we're seeing that competitor apparently decide to get more aggressive and essentially a ubiquitous approach to the market.

I don't know how much of that is strategy on that, on their part, how much of that is lack of discipline or don't have the facts.

You know, we just don't know.

But we see them being very, very aggressive.

So we're going to have to watch that closely over the next handful of days or weeks to see how we're going to have to react to that.

We can't let that go on forever unanswered, of course, and so we'll have to watch that closely.

But that, that one exception aside, we're anticipating and hoping to see all of that as gains over the last year continue.

And we certainly need that.

Materials increases have not, have certainly not gone the other way, as you know.

And, Peter, I would comment more broadly on Acuity Brands, including Acuity Specialty Products.

We, too, would expect that our pricing posture and the price increases that we have put in place will carry into next year.

We are expecting raw material and component part volatility next year.

We don't have baked into our plans an absolute number per se, but given how we have priced into the marketplace and, again, the internal dynamics, we will be very vigilant about our cost increases.

Now, that's one piece of our pricing strategy.

The other piece, as John mentioned from the lighting side, the same thing is true at Acuity Specialty Products.

We go through an annual review process where we-- we look at products we're introducing into the marketplace that are new products, new products and services that are incorporated different types of technology and so we look at more broadly our entire pricing strategy on a product by-product and product family, really, and market by market basis to determine the most effective and appropriate pricing.

Peter, this is Ricky.

Maybe to add a little more context as well, the last price increase lighting put in was in early June, June 5.

So you could see the carry-over impact of that in specialty chemical, the last price increase was back in January.

So that will give you some sense of annualized carry-forward of those two latest price increases.

Okay.

That's very helpful.

If I could just switch over and ask one quick question on the profitability and lighting.

Incremental operating margins, somewhere north of 35% or around 35% for the year, is that a reasonable, I guess, proxy for what the current operating model there is?

What I'm just wondering if there's more cost improvements that you're doing that could lead to even better incrementals, or is that a reasonable proxy for what we should expect, or what's inherent in the business model at this point?

Very good question.

Let me make a few comments and then I'll ask John and Ricky to also comment.

First of all, in 2005, we announced a very significant restructuring program in our business, and so we took a very large charge and we began that process.

We made a commitment internally and to the marketplace that we were expecting to realize annualized cost savings off of that of roughly $50 million.

We believe that we have achieved the running rate of $50 million, and so some of the benefit that you are seeing in that variable contribution is the benefit of that restructuring.

Number two, when you look on a year-over-year basis, in 2005, our pricing lagged the increase in raw materials, and it was rather significant.

And so in 2006 we were able to benefit from finally getting the pricing in both companies in line with the cost increases that we incurred.

So those are the two main components.

The third component, we have worked very diligently again in both businesses to improve our productivity.

In fact, at the lighting business and particularly at our Lithonia Lighting business, we improved productivity within our supply chain by roughly 12% in the year.

So when you look at all of those factors, you're seeing very, very nice pull-through.

Our typical variable contribution margin is not dissimilar from other manufacturers and as John pointed out, a lot of it depends on mix, but we're somewhere in the, you know, lower to mid 20% variable contribution margin.

As we look forward, we will continue to look to improve our productivity, not just in our supply chain, but throughout the Company.

Our commitment is to, again, aggressively search for 70 basis points of improvement on our base and then to look to, as we get incremental volume, to be consistent with something in the low 20s as we had articulated.

Okay.

Great.

Thank you very much.

Thank you.

Thank you.

Our next question comes from Robert McCarthy of Banc of America Securities.

Good morning, everyone.

Hi, Rob, how are you?

Congratulations on a great quarter.

Couple questions.

One, on, just in terms of pricing, I understand that raws continued to be volatile, but there is some sense with a relief in oil and some of the key metals that we could be in a period of what you could see summer retrenchment here and my question is, given that one of your competitors got particularly aggressive on price, what do you think about the elasticity of price, if you see an easing of costs throughout '07, do you think you'll still be able to largely be able to retain the price in the face of what could be aggressive actions by one or more competitors?

Again, make an overall comment.

Then I would like to ask John to specifically comment on lighting.

First of all, we're seeing a great deal of volatility.

While we've had some relief here in the short-term, relief only off of highs, not necessarily relief relative to what the original pricing strategy contemplated when we made those price increases.

So I'm not certain that the falloff is really going to benefit us materially.

Now, of course it does because anything that's lower in terms of your cost is a good thing, but a lot of the pricing elements that we've put in place were at times where prices were lower from all-time highs.

So our expectation at this point in time is to continue to experience volatility, not just in things that are easy to measure, like maybe steel costs.

But if you imagine all costs that are available to us, wage inflation, healthcare costs, property and casualty type insurance, many of these costs continue to rise and so we are very vigilant on looking at all elements of cost and we are working hard to use productivity to help mitigate some of those things.

But at this stage of the game, I would tell you that we are expecting volatility.

The other comment that I would make overall, if you see material and-- excuse me, meaningful changes in cost, I think that ultimately price does reflect some of those changes.

Now, having said that, I think both companies continue to do an outstanding job in their new product introduction and their new service offerings to help improve our mix of products sold and the margins that we generate off of those, simply because of of the value that those new products and services have to the customer base.

So I would expect us to continue to improve our margins as we move forward.

John, could you comment?

Rob, again, specifically on lighting, let me bifurcate, as you have done, the costs and the pricing actions side.

To Vern's point, we don't expect the same degree of inflation we've seen in the recent past in most of our raw materials.

However, we believe that they will remain high and we are anticipating some further inflation in certain categories.

Now, just as our new higher prices have now come into our backlog and to Ricky's point, are moving on into what is now our fiscal '07, it's also true that the new higher priced raw materials that the increases that we've experienced over the last several months are now coming, of course, into our new inventories.

And so clearly from a cost standpoint, we need to maintain those higher level prices.

In terms of the one competitor we're referring to, obviously if they continue to take that kind of action, we'll have to respond to it.

We can't lose share in some of our core business.

From the outside looking in, I happen to believe that this is a competitor that's very intelligent and understands their costs and understands their business and I would be surprised if they continue that.

But we'll just have to wait and see, and if they do, we'll have to respond to that and that, of course, would not be good for us.

But it's a little early to predict, Rob.

I'm sorry.

I wish I could give you a better answer than that.

No, that's very helpful.

Then just maybe switching gears, obviously you have relatively minimal exposure on the residential side, particularly versus peers, but any comments in terms of the trends, weakness you're seeing there and then maybe just a general comment about the risk you see to, you know, residential retrenchment leading potentially to nonresidential retrenchment?

You know, Rob, it's very interesting.

And, again, I'll ask John to comment as well.

But it's very interesting to me to see how interest rates are moving and the impact overall of what that's having on more of the speculative markets.

But the demographics on a longer-term basis for the residential market, I think, remains favorable.

I do think that we're seeing a correction here and how significant that correction will be remains to be seen.

We do have exposure to the resi market, but as you pointed out, nowhere near what some of the other competitors have.

To me, we will continue to bring product to the marketplace that allows us to differentiate based on those product features so.

My hope is that our exposure to that portion of the resin market will be somewhat limited.

But nonetheless it, will be there.

On a longer-term basis, how it plays out into the market and what our competitors do, it really, it remains to be seen.

I believe that we have competitors who understand their business models very well and have good diversification.

So I wouldn't see a direct correlation between what may happen in resi and then what they will do in nonresidential.

John, do you have a viewpoint on that?

No, I would agree with your characterization.

It's a relatively small part of our business.

We, of course, are watching those competitors that participate more heavily in residential, but also in the nonresidential area, and to the extent that their residential values drop off and they need to go get volumes some place else, that could impact us in the CI area and so we're watching that closely.

But I would anticipate that they will address their cost structures as their volume drops off in residential, just like we did over the last two or three years as the nonresidential dropped off.

Yeah, and then one final question.

Just in terms of the, obviously you're seeing very nice volume growth here and some perspective on volume growth going forward, given the backlogs you're seeing.

Any particular, in terms of product mix, any particular end markets in terms of whether it be commercial office, hospitality, industrial, any clear pockets of strength or relative weakness right now?

And you're referring specifically to the lighting side?

Yes.

John, could you comment?

The areas of real strength, which is good news for us, is that warehouses continue to be very strong, as you would anticipate with all the imports into the United States.

Offices have made a comeback.

Manufacturing, education have all made a pretty significant comeback.

Some of the areas that are beginning to soften a little bit are some of the retail stores, some of the healthcare in the short run.

I think that's a correction, of course.

We all know healthcare will continue to grow, so that's, I think that's a reasonably good breakdown there of, as for volume for us, I know it's been-- o our folks have done a fabulous job of establishing a service over the last year and I think that's really helped us grow a little bit of share, specifically in those areas that I just mentioned.

All right.

Well, thank you for your time, gentlemen.

Thank you.

Our next question comes from Christopher Glynn of CIBC World Markets.

Good morning.

How are you doing?.

Good morning, Chris, how are you?

Good.

Question on the backlogs.

You mentioned 16%.

Over the course of the year, you've talked about a little bit how backlogs aren't necessarily apples to apples because you've cut down on the lead times.

Wondering if you could just comment on the 16% and might actually be a little understated given that your lead times in customer service has improved.

I think that's a very good question.

Our backlog at the lighting business stands at $176 million today.

The very good news is that our light backlog, again, is at record lows.

We continue to serve our customer base more rapidly and more effectively each and every day and we're building on that.

So again, we look at incoming order rates as really the litmus test of vitality in the marketplace.

The fourth quarter was strong.

We do expect it to continue to be strong.

The orders that we have seen to date, again, are favorable relative to our expectations.

So we think that, again, if you look at what Dodge's progress is indicating, based on John's comments that he just made about the mix within the industry of where we're seeing pockets of strength, I think all of that continues to bode well for a favorable 2007.

John, any further comment on that?

I would-- very insightful.

I don't have any real good math in terms of how to-- two different back logs, but I would say you're absolutely right that the cycle time is shorter, service is stronger.

You can see it showing up in our working capital.

And that's been beneficial to us here in '06 and we would anticipate on into '07.

Okay.

Thanks.

And one other one, I was just wondering what your internal models and kind of your visibility into the projects taking place materializing out there, what are your models indicate when a real batch of incremental supply might come on the office market as opposed to just sort of slow, steady that doesn't quite keep up with declining vacancy rates?

Chris, it would be a little bit reluctant to tell you what our internal models say, but thank you for that question.

I would refer you to, again, a lot of the publicly available information, which we think directionally is correct.

And John who has much of that information literally at his fingertips was using it to, again, quote strengthen vitality.

We think directionally, all of that is very consistent with what we believe internally.

John, any--

If you look at inventory and absorption rates on offices and what in particular Dodge is forecasting, the numbers we believe in we think that the offices will remain strong on in through '07 and maybe early '08 and then by that time should probably retrench .

Great.

Thank you very much.

Thank you.

Our next question comes from Richard Glass of Morgan Stanley. [OPERATOR INSTRUCTIONS].

Hi, guys.

Nice quarter.

Hi.

Rich, how are you?

I'm good, good.

Nice performance here.

I want to ask a about looking forward, you guys mentioned CapEx stepping up fairly significantly next fiscal year, I want to know where we're spending that money, kind of what split between in televisions and what projects we're focusing on?

Sure.

I believe that the split is roughly consist went our revenue base, 75-25% split.

We're looking at roughly $40 million approximately, so 30 on one, at the lighting business, 10, slightly more than 10 at the other business, and Ricky, maybe you could add some flavor.

Yeah, I would say there aren't any huge projects in there.

There's a lot of small projects that make it up.

We are, though, making some meaningful investments in both business in IT projects.

We're continuing the ERP implementation throughout all of lighting in '07.

So we should exit fiscal year '07 with our Oracle system pretty much throughout the lighting business.

So there's several millions of dollars of investment, incremental investments, although we've been investing pretty heavily in Oracle in the lighting business in the past.

We're also doing some preparation for IT investments at the chemical business as well.

We are launching an office in New York City that John may want to comment more from a marketing standpoint, but there will be some capital dollars incremental in our '07 plan as we prepare that showroom and space there and build that out there in Manhattan.

But, again, it's a lot of smaller projects across the board.

But IT and then a little bit of expansion in New York City.

Beyond that, it's a lot of small projects, Rich.

Rich, I would comment that as we continue down, on or on our journey to become a leaner, more efficient enterprise, we continue to find ways to more effectively use the capital and the asset base that we have employed.

You see that in the working capital side, where, again, as John has mentioned, total working capital as a percent of sales is now at 14.4%, down from 15.5% a year ago.

And the same thing is true on our capital side as well.

We continue to, again, find ways to more effectively deploy and utilize our asset base.

So we are progress nos indicating that, you know, we'll spend in the $40 million range.

If you recall last year, we had anticipated kind of a similar number and yet our capital came in less than that and it has only to do with the fact that we're just, again, being more efficient in utilizing that.

It wasn't that we turned away good capital projects.

All right.

So it sounds like it's much more productivity-focused and growth-focused with the exception of the spending on the New York City office really?

That is not true.

That is not true.

Last year we invested in capital, I mean roughly $30 million in our total company grew 10%.

Now, a big chunk of that was pricing into the marketplace, but we were able to handle significant volume growth on the asset base that we had.

We are expecting to continue to meet the growth objectives that we have, with the assets that we have in place.

So please be clear on this.

I think that we are continuing to fund our growth vis-a-vis our asset base because we're just getting better and more effective at doing that.

Rich, let me just pile on, if I could, in the growth.

Our primary focus is profitable growth and to Ricky's point, a number of these investments, even in the IT area are not just pointed at productivity improvements.

They are also pointed at beg able to handle the growth that we would anticipate from the investments that we're making in new products and in the increased market access, like he referred to.

So if you-- I don't have the actual sort of pie chart, if you will, in front of me looking at the breakdown of our capital expenditures.

We looked at that quite recently and it's a very balanced approach to investment in the business, you know, sort of mandatory replacements combined with new product investments and the investments in infrastructure to support the growth.

So we're sort of piling on to what Vern had to say, we're very, very focused on profitable growth.

And the notion around productivity, to invest in capital assets that help us improve our productivity, it also, we get a significant benefit in terms of quality.

Many of these investments also enhance our ability to improve our environmental sustainability objectives that we have as a company and we are very focused on becoming a much more sustainable and environmentally friendly company.

That's the value that we sell to our customers and we believe it and we're doing it internally as well.

I do have a little bit of the math in front of me and I would say it's pretty evenly split on the estimated 40 million, with about a third of that going for some form of revenue enhancement, again, whether it's in IT or other type areas, about a third of that being in areas where we see productivity improvement, cost reductions and so forth, and then a third that's kind of mandatory spending that you do to maintain your existing capacity and existing capabilities.

So reasonably even split as we plan for next year.

All right.

Sounds good.

Keep up the good work, guys.

Thanks, Rich.

Thank you.

Our next question comes from [Mike DiBernardis] of Lazard Asset Management.

Hi, guys.

Hi, Mike.

How are you?

Good.

If I look at SG&A and strip out the $6 million charge last year, I notice SG&A as a percentage of sales was actually up year-over-year despite the pretty large increase in sales.

Can you just maybe talk a little bit about that, why that is?

I know last quarter you said there were some investments in the business and I was wondering if that was the case again this quarter or if there were some other items in there.

The increase was primarily due to incentive and stock-based compensation.

The stock price moved nicely in the quarter and as you might imagine, the fourth quarter, which was very, very robust, also drove incentive compensation for the organization.

So it was probably timing related to that.

We also incurred costs related to the product recall at Acuity Specialty Products that we had mentioned earlier and I believe we incurred additional legal fees above and beyond the prior period to help facilitate some legal actions that we're taking both against folks for this recall, as well as in other activities where we're being proactive in protecting, if you will, our rights and some other activities.

Was there any other additional productivity enhancements, as you guys termed it last quarter?

Yes, we continued to make in investments, not some, but we continue to make investments in our business to enhance our productivity initiatives, as well as some of our go-to-market strategies.

But I would say that in the quarter it wasn't necessarily materially different than it was in the year-ago period.

Ricky, do you have--

That's correct.

If you look at year-over-year in the fourth quarter, while we did make meaningful investments in that area, in training, as well as consultants and so forth, it's pretty comparable to what we spent a year ago.

So it doesn't account for the main deltas are the two items that Vern previously mentioned, incentive comp, and commissions, as well as some of these compliance-type costs that we're faced with in the product recall and some legal areas.

Can you just quantify those?

What was the incremental cost this year versus last year?

In the compliance-type area, you're looking at between 1 million and $1.5 million incremental quarter over quarter in that area, and then in incentive and share-based compensation, you're looking at well over $5 million incremental year-over-year.

Okay, thanks.

Thank you.

Thank you.

Our next question comes from Matt McCall of BB&T Capital Markets.

Hi, good morning.

This is actually Sean Connor in for Matt.

He's travelling today.

Quick question on the 70-basis point incremental margin gain bogey that you guys have out there.

Do you have any specific items or opportunities that you could share that would help address that and to get there?

Sean, we believe that it will continue to come both in our supply chain initiatives as well as our initiatives to improve our transactional flow capability.

So it's both in the gross profit area as well as in the operating expense area.

As we look at how we conduct business and the opportunities for us to eliminate waste and/or improve our overall effectiveness, we continue to see, again, opportunities to do that.

While we have made, I think, very solid strides on gaining in terms of margin relative to what our competitors continue to show, and it's both in the specialty chemical business, as well as in the lighting side, we think that there are some opportunities to do that.

This year, in 2007, both businesses have projects to address and to enhance, if you will, some of our distribution capabilities.

So we see opportunities there.

We also see opportunities, again, to improve how we produce product to become more effective and efficient there.

So I would say that you'll see it peppered throughout, if you will, the opportunity profit-- operating profit area.

Great.

Thank you.

Thank you.

Thank you.

This concludes the question and answer session.

I would like to turn the meeting back over to Mr. Vern Nagel for closing remarks.

Thank you very much for your time this morning.

We believe that very much for your time this morning.

We believe that we are focusing on the right objectives, deploying the proper strategies, and driving the organization to succeed in critical areas that deliver on the expectations of our key stake holders.

Our future is bright.

We are optimistic about 2007 and beyond, and we thank you for your support.

We'll talk to you next quarter.

Thank you.

This concludes today's conference.

You may disconnect at this time.