Acuity Brands Inc (AYI) 2007 Q2 法說會逐字稿

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  • Operator

  • Good morning and welcome to Acuity Brands 2007 second-quarter results conference call.

  • After today's presentation, there will be a formal question-and-answer session.

  • (OPERATOR INSTRUCTIONS).

  • Today's conference is also being recorded.

  • If you have any objections, you must disconnect at this time.

  • I would now like to introduce Mr.

  • Dan Smith, Vice President and Treasurer, Acuity Brands.

  • Sir, you may begin when ready.

  • Dan Smith - VP & Treasurer

  • Thank you.

  • Good morning.

  • With me today to discuss our second-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 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 the future events or future financial performance of the Company.

  • Such statements involve risk 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 call over to Vern Nagel.

  • Vern Nagel - Chairman, President & CEO

  • Thank you, Dan.

  • Good morning, everyone.

  • I would like to make a few comments, and then John, Ricky and I will be happy to answer your questions.

  • On behalf of our more than 10,000 associates worldwide, I'm again pleased to announce record results.

  • We sold more products and earned more income in the second quarter of 2007 than any other second quarter in our history.

  • In fact, on a consolidated basis, we met or exceeded many of our internal financial targets for the second quarter in spite of the challenges we faced in what is historically our weakest quarter.

  • Many of you have already seen our results, but I would like to give you a brief recap of the key highlights for the second quarter.

  • Consolidated net sales were more than $575 million, up almost 5% compared with the year-ago period.

  • A large portion of the increase was due to the positive execution of our pricing strategies and a better mix of products sold with the balance coming from greater sales volume in key segments of the nonresidential lighting market and a positive uptick in chemical sales in the retail channel in Europe.

  • Gross profit margin was 41.6% compared to 39.2% in the year-ago period.

  • Consolidated operating profit margin was 7.8% in the quarter, up 230 basis points.

  • In fact, our operating profit margins had been up more than 200 basis points compared with the corresponding year-ago period in five out of our last six quarters, a wonderful achievement.

  • Net income was over $24 million, up 68% from the year-ago period, while diluted earnings per share were $0.55, up approximately 72%.

  • Included in this quarter's earnings was an additional pretax charge of $2.3 million or $0.07 per diluted share for a tentative resolution of the investigation by the U.S.

  • Department of Justice of certain environmental issues at the primary manufacturing facility of Acuity Specialty Products.

  • With regard to the DOJ investigation, I believe that we're very close to finalizing this issue.

  • We have worked proactively to resolve this matter, which has been ongoing for almost four years.

  • It is clear that we had certain nonexecutive employees at ASP who acted in a manner that was in no way consistent with the very high values and ethical standards we expect at Acuity Brands.

  • Those individuals that directed these acts are no longer associated with the Company.

  • Over the last four years, we have enhanced and fortified our many business processes, as well added additional programs to ensure that we fully comply with all environmental regulations and proactively drive our commitment to be a leader in conducting business in an environmentally conscious manner.

  • Because of the significant legal costs and the tremendous time requirements placed on the associates responding to the many inquiries by the DOJ, we felt it was in the best interest of our customers, associates and shareholders to accelerate the resolution of this matter through a plea agreement and avoid the negative impact of protracted litigation.

  • The resolution will include the payment of a $3.8 million fine as soon as this matter is finalized.

  • This tentative agreement resulted in an additional pretax charge of $2.3 million from the previous amounts estimated to resolve the matter.

  • While we will have ongoing compliance requirements as part of our agreement, we believe that the conditions of the final resolution will not materially impact the ongoing performance at ASP.

  • Moving on as we review other performance metrics in the second quarter, we are pleased to report that we generated almost $61 million in net cash provided by operating activities in the first half of 2007.

  • This was three times that produced in the year-ago period.

  • Our cash balance was more than $123 million at the end of February, the highest in our history.

  • Our net trade cycle days improved almost 18% to 51 days while funding a $26 million increase in net sales this quarter compared to the year-ago period.

  • While we repurchased no shares in the quarter, we have reduced our outstanding shares by approximately 1.9 million shares or 4% over the last 12 months.

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

  • First, let's examine ABL.

  • Our lighting company had another outstanding quarter while managing through the impact on incoming orders of sluggish demand in the nonresidential lighting market and softness in the home improvement channel, primarily due to the well-publicized decline in residential home-building in North America.

  • Orders, as expected, in the nonresidential lighting market softened somewhat in the quarter due to a slowing of new contract awards in the nonresidential market about three to six months ago, which we noted in our first-quarter conference call.

  • Nonetheless, net sales at ABL grew almost $20 million, up approximately 5% compared to the year-ago period.

  • The increase in net sales is primarily due to higher selling prices, a better mix of products sold and solid unit volume growth in the nonresidential lighting market, partially offset by a decline in year-over-year shipments to the home improvement channel.

  • Selling prices increased in the quarter as we realized much of our previously announced price increases as part of our annual price review process and other price increases driven by the need to cover rising costs.

  • Additionally, we were able to maintain our selling prices in a very challenging pricing market because of our much improved service capabilities and the desirability of our new products.

  • For the quarter, operating profit at ABL grew 44%, while margins improved 280 basis points to a second-quarter best of 10.4%, reflecting both the leverage from higher sales volume and the success in implementing strategies to increase pricing, enhance product mix and improve productivity.

  • Our results at the lighting company continue to benefit from previous investments to more effectively manage pricing, expand our presence in key channels, enhance customer service, introduce new products and improve productivity, as well as the overall growth of the nonresidential lighting market.

  • Profitability and margins in the second quarter at ABL grew dramatically in spite of rising costs for compensation, certain raw materials and component parts and while continuing to make significant investments to further improve productivity and to expand our market presence.

  • Lastly, our backlog at ABL as of February 2007 was approximately $166 million, up 7% from the year-ago period.

  • Our current backlog reflects significant improvements in our manufacturing cycle times and on-time shipments to customers, which are at a historic high.

  • All in all, ABL had a terrific second quarter resulting from the implementation of successful strategies, strong tactical execution and a continuous focus on operational excellence by its associates.

  • Now looking at ASP.

  • Our net sales grew a solid 5% in the quarter.

  • Overall, the increase was due primarily to higher selling prices in the industrial and institutional channel in North America and greater shipments through the retail channel and in Europe.

  • Volume in the I&I channel again varied by region with certain key markets continuing to report solid growth.

  • This mitigated the weakness in other markets caused by the impact of higher sales prices that lessened customer demand, difficult economic conditions in certain parts of the country and actions by the Company not to participate in lower margin business.

  • In the second quarter, ASP reported operating profit of $5.9 million or 4.5% of net sales, including the $2.3 million incremental charge for the expected resolution of the DOJ matter.

  • This was down from the year-ago period due primarily to the environmental charge and higher raw material and compensation costs partially offset by higher selling prices and greater volume in the retail channel in Europe.

  • In addition, we continue to incur greater expenses for investments to train associates on new methods to improve productivity throughout the organization.

  • Excluding the environmental charge, second-quarter results at ASP exceeded both internal expectations and those posted in the year-ago period.

  • We believe that actions taken to enhance profitability, including programs to improve pricing, productivity and to expand unit volume, will continue to favorably impact the balance of 2007.

  • As we look at Acuity Brands in total, we were very pleased with our performance in the first half of the year and believe these results support our overall positive expectations for the remainder of fiscal 2007.

  • While we expect this momentum to continue in the second half of 2007, we do have our challenges.

  • Just to note a few of these challenges.

  • First, we expect to continue to experience cost pressures for certain raw materials, component parts, including key components such as ballasts, and employee-related items.

  • Second, we continue to find ways to make up -- we need to continue to find ways to make up for costs associated with investments in programs to drive future profitable growth, including those that enhance customer service, improve productivity, expand our access to market and new product development.

  • Third, the market pricing dynamics in the nonresidential lighting market continue to be challenging.

  • Lastly, we expect the residential market to continue to be soft for the foreseeable future, somewhat impacting our shipments through the home improvement channel.

  • While these issues are worrisome, we continue to be very vigilant on our pricing and quotation posture and continue to drive programs throughout the Company to enhance our service to customers, increase our introduction of new products and services, improve productivity and lower costs.

  • Overall, we continue to be cautiously optimistic about the growth prospects of the nonresidential lighting market.

  • We see a number of influences that we believe are working in our favor.

  • For example, based on the recent rebound in nonresidential building awards and other indicators, such as the Architecture Billings Index, we expect the demand for lighting fixtures to resume its positive trend during the course of the second half of our fiscal year and into our fiscal 2008.

  • 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, the outlook for employment, which continues to look favorable and an attractive long-term interest rate environment.

  • We believe that these factors and the general positive economic outlook for North America supports a positive longer-term growth trend in the nonresidential lighting market.

  • In addition, we continue to proactively position both businesses to better leverage their market presence through investments that enhance our go-to-market programs and strengthen our geographical footprint, as well as expanding our product offering with new and innovative products.

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

  • We have demonstrated that by investing in these programs we can profitably grow our business, better serve our customers and improve our margins while investing for future profitable growth.

  • Overall, we believe that our results in the second quarter and the first half of 2007 support our view for a very successful year in 2007.

  • To that end, we anticipate that we will achieve record results in 2007 and meet or exceed many of our longer-term financial goals, including operating margin expansion, earnings growth and cash flow generation in fiscal 2007.

  • Thank you, and with that, we will entertain any questions that you have.

  • Operator

  • (OPERATOR INSTRUCTIONS) Robert McCarthy, Banc of America Securities.

  • Robert McCarthy - Analyst

  • Good morning, everyone.

  • Congratulations on some very strong results there.

  • I wanted to first talk about perhaps pricing in the quarter and the prospects for the year, but first for the quarter, if you broke down on the lighting side, how many points did you get from price in terms of the year-over-year compare?

  • Vern Nagel - Chairman, President & CEO

  • Let me take a first stab at that, and then I would like to pass it on to John.

  • Overall, and I will talk to all of Acuity Brands, we have been very proactive in our pricing posture, driven both by annual price reviews to determine the opportunities in the market, and to price those opportunities accordingly based on the products that we have to offer, as well as costs.

  • So both businesses were very vigilant and announced price increases in the year and we will continue to do that.

  • When you look at our overall price opportunity, we believe that we realized much of the pricing increases that we have put in place and also we are seeing real positive opportunities from the development or the introduction of new products, so price mix continues to be a very important issue for us.

  • We are very pleased with those results.

  • John, if you could comment on the lighting business.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Rob, if you look at the lighting business, you will recall last summer we introduced or we announced, I should say, a price increase in the neighborhood of 6% overall.

  • We said that we would capture that fully and completely.

  • We think by now we have now done that, and so if you look at our Q2 results just released, we think that in excess of half of the benefit has come from price and mix with the other portion coming from body and expansion.

  • Vern Nagel - Chairman, President & CEO

  • And John, could you also comment when you contrast that your revenues were up approximately 5%, you had some offsets to that because you had nice volume growth, you had nice price, you had nice product mix, but you also saw some decline in the home improvement channel.

  • Maybe you can comment there a little.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Yes.

  • Rob, the overall volume, of course, was up just short of 5%.

  • It was a good bit stronger than that in our nonresidential areas.

  • We were up just short of 8% in the nonresidential areas.

  • We were actually --.

  • Robert McCarthy - Analyst

  • Is that a volume number or is that a core number?

  • Vern Nagel - Chairman, President & CEO

  • 5% was total.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • 5% was total.

  • Robert McCarthy - Analyst

  • Right, but that is a price and volume number, so the 8% -- what is volume and what is price within that 8%?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Think of it as approximately half and half, but understand I am including product mix in price.

  • Robert McCarthy - Analyst

  • That's fine.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • So about half and half.

  • We've actually seen a decline in that portion of our business, which is driven more by residential, specifically that that goes through the home center.

  • So that declined -- our overall commercial was up between 7% and 8% with our residential being down.

  • Robert McCarthy - Analyst

  • And what was your residential down on the order of magnitude?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Residential was down just slightly into the double-digit categories.

  • Robert McCarthy - Analyst

  • Slightly into the double-digit categories, and remind me how much of residential approximately of your overall business mix is it.

  • Is it roughly 15%?

  • Is that right?

  • Vern Nagel - Chairman, President & CEO

  • Let's be clear.

  • What John is referring to is the sales through the home improvement channel, as well as showroom channel.

  • Robert McCarthy - Analyst

  • Right.

  • Vern Nagel - Chairman, President & CEO

  • So that business represents probably 11%, 12% of our total business.

  • Robert McCarthy - Analyst

  • Of the total company?

  • Vern Nagel - Chairman, President & CEO

  • Yes.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Total lighting.

  • Robert McCarthy - Analyst

  • Total lighting, okay.

  • Got you.

  • Now some of your competitors in the quarter went through a round of price increases, and there was some thought that there was some softness that was seen in the quarter and maybe some opportunities for you to pick up share there.

  • But do you have any comment in terms of the pricing trends you saw in the quarter since your annual price review and any of your response to competitor price increases during that period?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • You are thinking specifically of lighting, Rob?

  • Robert McCarthy - Analyst

  • On the lighting side, yes.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • We did, in this Q2, we did complete our annual price review, and we did load in to our systems price increases as well.

  • We did not have price increases across the board, but the price increases we put into our system, we would intend and expect to offset material cost increases, which would have an impact on us in our Q3 and beyond.

  • In terms of what we've seen in the marketplace, we have seen announced price increases.

  • We've seen copies of letters sitting around distributors' offices.

  • I don't know what our competitors have actually done.

  • We still believe there is one major competitor that has announced an increase, but in fact has not gotten that increase or at least it appears to us as though they have not.

  • We have not responded to that.

  • We have continued to increase our prices as material cost increases have hit us.

  • We will continue to do that.

  • Our service is awfully good right now, and we would not intend to go try to gain marketshare through price.

  • We would intend to continue to try to gain marketshare, but through expansions of market presence and through introductions of new products.

  • So I believe we will continue to see the favorable pricing that we have recently seen.

  • Robert McCarthy - Analyst

  • So you didn't expect much share gain in the quarter?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • We did not expect much share gain in the quarter, no.

  • And to the extent -- the reason for that -- to the extent that we get share gain, we are not going to do it by changing our pricing structure.

  • We are going to do it by continuing to invest in expanding our market presence and in expanding our product but that share gain of course takes longer than if you just go bomb prices, which we are just not going to do.

  • Vern Nagel - Chairman, President & CEO

  • And Rob, it is very evident when you examine the financial statements that we have been very diligent on our pricing posture.

  • We see it very clearly, the new products that we've introduced, the favorable impact that they are having.

  • And so as John has pointed out, very clearly I might add, that our pricing posture and our pricing strategy really for the last four years has been very aggressive to capture fair value for the products that we have developed and introduced to the market.

  • And our customers are responding favorably to those new products.

  • So we have been able to maintain, as I said in our comments, our pricing posture not only because of new products, but because of superior service.

  • So we have again announced price increases, as John said, and again continue to be very vigilant around costs and around opportunities to enhance our product mix through the introduction of new products.

  • And you see that clearly in the financial performance of the business.

  • Robert McCarthy - Analyst

  • Absolutely, Vern.

  • Given your incremental margins, you've got to be getting pricing.

  • My question more surrounds more of a market dynamic, whether we are starting to see some softness overall in the ability to get price rather than a deliberate change in your strategy.

  • In terms of overall end market mix, what are you seeing in terms of activity at the retail construction level, at heavier office construction, any kind of complexion in terms of change in the margin in terms of activity there?

  • Vern Nagel - Chairman, President & CEO

  • I believe that when you look at a number of the macro types of information out there, whether it is Global Insights, whether it is McGraw-Hill or governmental reporting, you are seeing some choppiness, and we commented on that in the first quarter where we saw in the nonresidential market just awards being somewhat soft about three to six months ago.

  • We believe that chop came through in our second quarter, and again I am pleased to say that we did very well managing through that sluggishness in demand.

  • But I think the other indicators that you see out there, and there are many.

  • You can pick the ones that are your favorite -- I still think bode well for the nonresidential construction market, which again, as you know, lighting tends to lag.

  • It is usually towards the end of what gets put into larger projects.

  • So we continue to see and believe that the market trends are favorable for us, and we would expect that through our fiscal 2007 and as best we can see, well into our fiscal 2008.

  • John, do you have some additional comments?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Just to peal it back a little bit, both commercial industrial and institutional continue to grow.

  • I tend to look more at the square footage that is being constructed than anything.

  • And we tend to, as Vern said, assume that lighting equipment goes later into the cycle.

  • But both commercial industrial and institutional continue to grow.

  • What we've seen recently as commercial industrial are growing at a rate slightly greater than that of institutional.

  • Within that, as you would expect, offices and hotels and things such as that continue to grow.

  • We are actually continuing to see manufacturing continue to grow in North America as well.

  • We were pleased that the U.S.

  • government extended EPAct 2005 for another year, so the tax benefits for energy retrofits will extend out another year now out through '09.

  • We are pleased to see that on the infrastructure and the institutional side, there is continued expansion and investment in not only schools, but also that which is affected by the TEA act, the Transportation Act, and so those have been the areas that have been most robust.

  • Of course, residential, which doesn't impact us as much, is down very significantly, and we expect it will continue to be down for another year.

  • Robert McCarthy - Analyst

  • And are you concerned about -- It sounds like there has been a deceleration though in the rate of overall absorption in the office market.

  • Do you have any comment there?

  • Just longer term, whether we could be seeing 2008 being the peak or any kind of sustainability to this nonres cycle from your perspective?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • First of all, office is really only 5% or so forth of the overall construction.

  • So that is only a portion of the equation.

  • It is an area where we are strong, but it is not double -- single -- excuse me -- double-digit.

  • Robert McCarthy - Analyst

  • But it is your sweet spot I would --

  • John Morgan - President & CEO, Acuity Brands Lighting

  • It is a sweet spot for our Lithonia portion of our business, which is now a little over half of our business, so it is an important area for us.

  • But the absorption rates, frankly depending upon which report you choose to read, there is mixed views about what those absorption rates are.

  • We look at the CB Richard Ellis, for example, it looks like the absorption rates continue at a similar rate to where they've been in the past.

  • In fact, let me pull it out.

  • We have it in front of us.

  • It looks like the downtown offices' vacancy rates continued to decrease in the fourth quarter of '06.

  • They are down now to something like 10.8%.

  • In suburban areas, it is down now to below 14%.

  • And so we are seeing that absorption rate continue at rates similar to what we've seen over the last 12 quarters.

  • Vern Nagel - Chairman, President & CEO

  • And Rob, I think when you, again, look at -- everyone is trying to predict the beginning of the end of the cycle.

  • I think that we are still somewhere closer to the beginning of the beginning of the uptick of the cycle.

  • The good news here is that we are not getting blistering type growth only to be followed by a blistering type decline like we saw in the late '90s and early 2000.

  • I think it is very favorable that job creation continues, that the GDP is not white hot.

  • It is moving along at a positive roughly 3% pace.

  • Long-term interest rates are very favorable.

  • And so when you look at things -- there was an article in the paper the other day about commercial rents continuing to firm, but everyone was saying at a slowing pace.

  • Nonetheless, they are firming at very high rates, and we believe that all that bodes well for, again, nonresidential construction activity and therefore impacting us favorably for a considerable time.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Rob, just one more datapoint for you since you've asked specifically about offices.

  • I have now in front of me the Dodge projections, if you will, for square footage.

  • And they, too, are continuing to project square footage expansion in specifically offices throughout calendar '07 and to the extent that might flatten out or decline somewhat, they wouldn't expect that to occur until as we get into '08, which really doesn't affect us until our '09 construction cycle.

  • So we are planning and planning products and capacities to be able to continue to ride that expansion.

  • Robert McCarthy - Analyst

  • Gentlemen, thanks for your time, and I will see you next week.

  • Operator

  • Peter Lisnic, Robert W.

  • Baird.

  • Peter Lisnic - Analyst

  • Good morning, everyone.

  • You were kind enough to give us some clarity on the top line at lighting.

  • What I am still wondering about and scratching my head is just the very impressive incremental margin you put up in that business in the quarter.

  • Can you give us a sense as to how you are driving incremental margins now that are basically twice your long-term target?

  • Vern Nagel - Chairman, President & CEO

  • Well, yes, we can, in fact.

  • As you recall, and Peter you're somewhat new to us, but Craig Kennison would recall, when we started this journey a handful of years ago, we said that one of the things we wanted to do was on our base business improve our profitability by 70 basis points or better year-over-year.

  • That is on our base business.

  • We felt that there were significant opportunities within our operations to improve our productivity, to improve our service to customers, to improve our product development capability, to improve the development of our people around various types of lean initiatives.

  • What you are seeing is the benefit of those programs coming through.

  • The opportunity to have the right products with the right level of service in a marketplace that is growing is really favorable.

  • And so you're absolutely right.

  • You are seeing, even including the environmental charge, the incremental environmental charge we took, our variable contribution on the incremental revenues at the operating level was 57% pull-through, which is quite significant.

  • So it is a combination of all of those programs, our strategies around pricing in both businesses that have really allowed us to drive growth and profitability at the margin level that you see.

  • So that is how I would answer that question, and I would answer it globally.

  • Even at Acuity Specialty Products, we are continuing to see improvements again in productivity and our service opportunities.

  • Sometimes when you do those things, they have a temporary short run negative impact on your P&L and that is when we talk about the investments that we are making.

  • It is really in these areas to continue to improve our productivity and our product development capabilities.

  • But you are seeing the benefits of those previous investments now coming through, and you are seeing it also by the way in terms of our cash flow generation.

  • Cash flow or net cash provided from operating activities through the first half was $61 million, three times that generated in the year-ago period and yet our revenues are up $75 million in the half.

  • So again, that is some pretty good work that is being done by a lot of folks, particularly at the lighting company because of those improvements in our processes.

  • Peter Lisnic - Analyst

  • I'll get back to the cash question that I have, but when you talked about a 70 basis point improvement as your base rate, well, you're running at 200 basis points.

  • So why wouldn't we expect that kind of run rate going forward in the second half of '07 and into '08?

  • Vern Nagel - Chairman, President & CEO

  • Well, I believe that as you look at our -- our objective, frankly, is to continuously improve.

  • We set out as a target the opportunity of 70 basis points or better.

  • I think that you ultimately reach a point -- we still have a ways to go to reach some of the margins that some of our larger competitors have on a consolidated basis, though their business model -- their business models are different.

  • If you look at Cooper as an example, it participates in a much broader electrical market space.

  • But nonetheless, we see opportunities to continue to drive and improve our profitability at both companies.

  • The specialty chemical business right now, which represents approximately 25% of our revenues, is roughly operating -- our expectation is roughly in the 9% operating profit margin range.

  • Well, that is weighing down, if you will, the improvements that you are seeing in the lighting business.

  • But nonetheless, the cash flow return on investment in that business is quite high and quite positive.

  • And we are making investments in that business to help improve its future profitability and its future growth.

  • So when you look at the overall margins, I would say don't get too carried away.

  • Yes, we would like to continue to drive a 200 basis point improvement on year-over-year in each quarter, but at some point in time, that probably will moderate somewhat.

  • But nonetheless, I think 2007 will be a very strong margin year for us.

  • And I would expect us to continue to improve as we get into 2008.

  • Peter Lisnic - Analyst

  • Thanks for clarity on that.

  • And then back to the point you made about the cash generation being as strong as it is.

  • At some point, the deployment question will come up.

  • I'm sure it's coming up now.

  • What are the primary uses of capital that you are looking at right now?

  • Vern Nagel - Chairman, President & CEO

  • We're very pleased with our cash flow generation, particularly because of what it means around our business processes and the productivity that we are seeing in terms of improvements.

  • We believe that there are further opportunities in our business to improve our inventory turns, to improve just again the business processes around serving our customer base.

  • So my expectation is you will continue to see positive cash flow generation.

  • The deployment of that capital is really to facilitate the driving of our strategies, both from an internal point of view to fuel and fund our internal organic growth.

  • As we have mentioned, we really are aggressively looking to expand our footprint at the lighting business, particularly in New York City where we are making some rather significant investments.

  • Capital spending, I believe that we've said that we still expect to invest between $40 million and $50 million this year.

  • Most likely, it'd be at the low end of that range.

  • And we are also, as part of our strategy deployment process, looking at very selected acquisitions, particularly -- well virtually only on the lighting side of our business right now.

  • And so you could imagine seeing at some point in time us making some acquisitions of businesses that make sense for us as part of our strategy.

  • And we would also continue to use that capital to again increase our product development capability.

  • Peter Lisnic - Analyst

  • Okay.

  • That answers it.

  • Thank you very much for your time.

  • Operator

  • Matt McCall, BB&T Capital Markets.

  • Matt McCall - Analyst

  • Good morning, everybody.

  • Let me clear up -- make sure I understand the pricing comments earlier.

  • I think you said that if you just strip out the nonres business, it is up about 8%, half and half price mix versus volume.

  • But I think in the previous point, you said that the price increase that you announced last year equated to about 6%.

  • Can you explain what I am not understanding there from the 6% versus the 4%?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Well, a couple things.

  • One, we are speaking specifically of certain markets.

  • The increase -- first of all, at the lighting business, the annual price review, as John mentioned, was recently completed.

  • Our previous price increases, I believe, John, was June, and that was a 4% to 6% range -- help me with that.

  • Yes, it was June of '06, and that is the 6% that you're referring to, and that of course related to our U.S.-based nonresidential business.

  • We've not been so granular in what we described here to get into our international exports, our European business, our home center business, so forth and so on.

  • So I think you are seeing properly that in aggregate we are seeing about half of that come from price mix.

  • And so I think that the gap, if you will, between the 4% and the 6% that you're trying to figure our just comes in the fact that we are in a number of other places other than the nonresidential U.S.

  • market.

  • We haven't really broken out each of those market segments.

  • Vern Nagel - Chairman, President & CEO

  • Primarily because they are very difficult to identify specifically, and they are generally influenced by the same overall economic trends that influence nonresidential construction and therefore nonresidential lighting demand.

  • But nonetheless, what you saw in what we call our C&I business, a very nice positive uptick in both unit volume growth, as well as price and a better mix of products sold.

  • Matt McCall - Analyst

  • Okay, that clears it up.

  • And then if you talk about -- I guess it went into place last June, so you've got -- what would you have -- another quarter plus of the previous price increase and it sounded like you just announced another price increase.

  • What type of price and you don't even have to include mix there, but just what type of price assumption should we make for the remainder of this year going into '08?

  • Vern Nagel - Chairman, President & CEO

  • John, why don't you please address that and also if you could comment on the notion of the full capture again.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Again, Matt, last year, because of our need and desire to continue to aggressively invest in new product and service platforms, as well as the very rapid expansion, if you will recall, of selected raw materials, we felt it important last year that we not only increase, but that we fully capture those price increases.

  • So we've just been very diligent about that and our folks have done a fabulous job there.

  • I believe that what we've recently experienced in terms of our pricing -- let me back up -- I would say that we now have fully captured that, which was introduced last summer.

  • So that I believe is being reflected in our current run rates, and I believe we would expect that to continue in the coming quarters.

  • In terms of that which we have recently increased, we've been a little more selective there, and what I believe is that the increases that we have recently announced, which would go into effect in the future quarters, will essentially offset material cost increases that are coming into our business as well.

  • So I would not expect to see sort of incremental expansion, if you will, of margins to any significant decree due to price, but instead a lot of diligence at making sure that we don't back up, so to speak, in that regard.

  • Does that answer your question?

  • Matt McCall - Analyst

  • It does.

  • So directionally, less than the 6% and you are basing the comment about offsetting your material costs on current price levels of your inputs or on expected price levels of your inputs?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Expected.

  • We believe that we have done a pretty good job of timing expected material increases with expected increases in pricing and so we believe that will be an offset going forward.

  • Vern Nagel - Chairman, President & CEO

  • Just a general comment.

  • Given our leadership at Acuity Brands Lighting, we are also very sensitive to our price leadership opportunities, and we have been leading that for some time.

  • It's a very important point to note that in key sectors of the nonresidential construction market, as John pointed out, we have had -- we have realized the full benefit of our pricing.

  • That hasn't been historically true in this overall industry.

  • I don't think that is necessarily true of others.

  • I don't know that factually.

  • So as we went through our annual price review, which we just did and just implemented, understand that our pricing was probably ahead of where most others were.

  • Matt McCall - Analyst

  • Okay, so by announcing a targeted or a more targeted rather than across the board price increase, it is based on need rather than the ability to -- rather than the lack of ability to get incremental price through?

  • Is that the way I should look at it?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • I think that's correct.

  • Matt McCall - Analyst

  • Okay, and then one more.

  • In the prepared comments and in the release, you talk about outperforming the overall market.

  • Just to understand what your expectations are for market growth this year, I think last quarter you were talking about that 3% to 5% range.

  • Is that still a good market growth number for commercial lighting overall?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Again, it is just our opinion based on the information that is available to all, plus what we see in terms of our own competitiveness in the marketplace.

  • We would expect the market to be in that 3% range, maybe a tick higher.

  • But our expectation really is to perform at that, but really better.

  • And frankly, we expect to perform at a higher level than the overall market because of what John and his team have been able to do in terms of new product introductions and our service capability.

  • It really is a competitive advantage, and the customers are responding very favorably to that service element and to again the full product and resource capability that Acuity Brands Lighting brings to the table.

  • Matt McCall - Analyst

  • Okay, and just to follow up on that, Vern, the 4%-ish volume improvement you saw in Q2 in the commercial lighting in the nonres lighting side, that was the result of the trends you saw -- the softening trends you saw three to six months ago, that those have improved.

  • We are assuming maybe a tick higher from that 4% range in the second half, correct?

  • Vern Nagel - Chairman, President & CEO

  • I would say that while our backlog continues to -- it is really almost a pristine backlog in that our late to customers is at a dramatic -- historical low.

  • Said differently, our service to customers is at a historical high.

  • And so our cycle times keep coming down, and yet our backlog is up 7% year-over-year, giving you some sense of both price as well as market demand.

  • Matt McCall - Analyst

  • Okay.

  • Congratulations on a great quarter, and thank you very much.

  • Operator

  • Christopher Glynn, CIBC World Markets.

  • Christopher Glynn - Analyst

  • Good morning.

  • The growth above the market that you refer to, do you think that comes more from that half of the industry that is occupied by the other well-known majors or more from smaller regional types that we wouldn't necessarily have heard of?

  • Vern Nagel - Chairman, President & CEO

  • Sure.

  • John, could you comment please?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • We do think that the four major lighting manufacturers continue to take share, if you will, in the overall lighting market at a nice, gradual, slow, modest rate.

  • It is not particularly useful for us to think about November or February, if you will, but when you think about the overall trends, we think that overall trend will continue.

  • The market that we are talking about for lighting fixtures we think is generally driven by, of course, a combination of new square footage being constructed, as well as some renovation of existing space.

  • So fundamentally the growth in the market we think is coming from both energy retrofits and retail space retrofits where merchandisers like a different look, as well as the continued expansion of square footage, as Vern said earlier, in that 3% to 5% range.

  • We really don't see and I don't think you can expect to see a dramatic shift, if you will, in the share of the four majors, but instead a continued, modest growth in share of the four majors as all four most likely continue to invest in products and services that will continue to enhance their share.

  • Christopher Glynn - Analyst

  • Okay, and then since you brought up the energy retrofits, I know you have been spending time developing that market, kind of missionizing it, so to speak.

  • Just any comments on the trajectory there?

  • Is this -- at some point, does that become a verifiable slice of the pie and a distinct marketing opportunity?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • We think it is absolutely a distinct marketing opportunity.

  • There are literally millions and millions and millions of sockets with light bulbs in them out in North America that are old technology, and we view all of those as being a significant opportunity.

  • The question simply becomes one of the rate at which building owners are willing to take out light fixtures that they think are working just fine and replace them with something that will dramatically reduce energy.

  • So we are very excited about the fact that EPAct 2005 was enacted and that has now been expanded for a year.

  • We have a reasonable level of optimism that either that or other legislation will be introduced -- expansion of that or other legislation will be introduced in the future.

  • So we think it is a pretty important driver for us.

  • We think that we are a little bit behind as a country in the use of new energy-saving technologies in the lighting area when you compare to a couple of other major regions of the world.

  • So we think that is a pretty significant opportunity.

  • Chris, I wish I could be very specific about the portion of the $10 billion lighting market that is represented by that, but I am afraid we are not that good to be able to tell you precisely what it is.

  • Christopher Glynn - Analyst

  • It is probably tiny as yet, right?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • We think there's a whole lot of headroom left.

  • Christopher Glynn - Analyst

  • Right, okay.

  • And than last one is backlogs were flat year-over-year at the end of the last quarter.

  • Now, you're 7%.

  • When did the acceleration start to kick in?

  • Do order rates still indicate that the acceleration is progressing?

  • Vern Nagel - Chairman, President & CEO

  • You are talking specifically about lighting?

  • Christopher Glynn - Analyst

  • Yes.

  • John Morgan - President & CEO, Acuity Brands Lighting

  • Our backlog has slowly expanded throughout our fiscal year, so the six months of our fiscal year.

  • It has not been any one month where it jumped up.

  • As Vern mentioned, we feel awfully good about that backlog.

  • With our cycle times continuing to come down, with our productivity improving in most of our factory locations, we feel very good about that backlog.

  • It continues to grow at a modest rate right now as well.

  • Christopher Glynn - Analyst

  • Great.

  • Thanks very much.

  • Operator

  • Zahid Siddique, Gabelli & Co.

  • Zahid Siddique - Analyst

  • Good morning, gentlemen, and congratulations.

  • I would like to pick up the phone -- just a second.

  • Is this better now?

  • Yes, two questions.

  • One, you mentioned that three to six months ago, you saw some slowdown in the nonres construction contract or contract awards, but you are seeing some impact of that in your Q2.

  • So my question is in relation to that, what are you seeing in Q2?

  • What are the contracts coming in?

  • Could you comment on that briefly?

  • John Morgan - President & CEO, Acuity Brands Lighting

  • I wouldn't make too much, if you will, of the decline in contract awards three to six months ago.

  • We go through these cycles in the construction industry where contractors manage their capacities, if you will, and of course construction projects just take natural cycles.

  • So there was a little bit of a reduction during that period of time, but overall for the entire year, we still see expansion in that 3% to 5% range, and we see a similar rate for calendar '07.

  • So where we are today, and again these are estimates, until the contracts are finally reported and occupancy is taken in the facilities and it is a look-back, we are not exactly 100% positive, but we would estimate that the activity today in our Q2 is similar to the run rate we've experienced over the last year.

  • Zahid Siddique - Analyst

  • Okay, thank you, and my second question is more on the macro front.

  • If you look at most data coming in, the GDP growth, the order data, the housing data and then also subprime, all indications -- most indications are that we will probably get into a significant slowdown.

  • In your case, if you look at more specifically at the Dodge numbers for February, for example, the construction starts were down 3%.

  • The Billings Index for February is down as well.

  • If you look at all that information, do you really realistically think that you can grow at 3% to 5%?

  • Vern Nagel - Chairman, President & CEO

  • We do.

  • Dodge is actually projecting continued expansion, albeit at a lesser rate, but continued expansion of the value of construction activity for the calendar '07 and on into '08 and our expectation is that that will continue to grow at a decreasing rate.

  • And I would point out one other thing.

  • The quote that you just made about the construction industry I believe also includes the impact of the resi business.

  • If you look at nonresidential, as John pointed out, they are -- they and they are some of the more conservative ones that are out there are calling for still a positive uptick in nonresidential construction.

  • We just saw some information this morning that suggested that February in nonresidential construction, excluding of course the resi market, was quite robust, making up for a soft January.

  • To me, it's very difficult to look at one month does not make a trend.

  • I tend to look at and we tend to look at what is happening by market and what are the longer-term macroeconomic drivers.

  • And I would suggest that those continue to look favorable at this point in time.

  • So for us to sit here and try and speculate what will happen in 2009 and 2010, I just think is really not useful for us.

  • We are working very diligently to improve again the productivity in our business so that whenever the market responds or slows down, we have the ability to continue to maintain a very high margin level and to again continue to drive capability into the market that customers value.

  • Zahid Siddique - Analyst

  • And just to follow-up on the macro question, given that the economy is slowing down to some degree, what is the incentive for companies to go out and build commercial construction projects or to undertake those projects in your opinion?

  • What is going to incentivize these various companies?

  • Vern Nagel - Chairman, President & CEO

  • Sure.

  • The fact of the matter is is that if growth is slowing, it is still growth.

  • And when you look at the impact, as John mentioned, he looks at square footage, but when you look at other things like what is happening with rents, what is happening with vacancy rates, what is happening in those specific markets, to me as long as you are continuing to see positive job creation, those folks need a place to work.

  • And whether it is a manufacturing space or it's an office space or it's a retail space, all of those things bode well.

  • You are seeing retail continuing -- certain portions of retail continuing to do well.

  • So schools, population continues to increase and all of that to me again bodes well for the types of projects that we work on.

  • And that is true of both businesses by the way.

  • Zahid Siddique - Analyst

  • Thanks so much.

  • Operator

  • (OPERATOR INSTRUCTIONS).

  • Currently, I show no questions being registered.

  • I would like to turn the call over to Mr.

  • Vern Nagel for closing remarks.

  • Vern Nagel - Chairman, President & CEO

  • Thanks for your time this morning.

  • We continue to 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 stakeholders.

  • Our future is bright.

  • Thank you for your support, and we will talk to you next quarter.

  • Thank you.

  • Operator

  • Thank you.

  • This does conclude today's conference.

  • Participants, you may disconnect at this time.