Acuity Brands Inc (AYI) 2011 Q2 法說會逐字稿

Good morning and welcome to the Acuity Brands 2011 second-quarter financial conference call.

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, Senior Vice President, Treasurer and Secretary of Acuity Brands.

Sir, you may begin.

Good morning.

With me today to discuss our second-quarter results are Vern Nagel, our Chairman, President and Chief Executive Officer, and Ricky Reece, our Executive Vice President and Chief Financial Officer.

We are webcasting today's conference call at www.acuitybrands.com.

I would like to remind everyone that during this call we may make projections or forward-looking statements regarding future events or future financial performance of the Company.

Such statements involve risks and uncertainties such as 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.

Thank you, Dan.

Good morning, everyone.

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

First, let me say we are very pleased with our results for the second quarter of 2011.

We performed well in spite of significant macroeconomic issues confronting our business.

This is the fourth quarter in a row where we achieved unit volume growth in an environment where nonresidential construction continued to decline.

I believe this is strong evidence the execution of our strategies to extend our leadership position in North America is succeeding.

These strategies include the continued introduction of new, energy-efficient lighting products and solutions, expansion in key channels and geographies, improvements in customer service, and completing important acquisitions.

Our profitability was similarly strong while we continue to invest heavily in a number of areas representing significant growth potential, including lighting controls and renovation.

The economic environment continues to be challenging as job growth remains anemic, lending practices for real estate continue to be restrictive, and asset values for commercial real estate continue to fall.

These factors, coupled with weak housing demand, continue to negatively impact new commercial construction.

Having said this, we believe our key markets served have either bottomed out or are on the road to recovery.

Also, in the quarter, we encountered rising commodity costs, particularly for oil and steel which increased at a torrid pace.

These higher costs reduced our operating profit by approximately $5 million in the quarter as I will explain later in the call.

I mentioned these macro factors because it provides a backdrop against which you can see the outstanding performance of our Company.

I know many of you have already seen our results, and Ricky will provide more detail later in the call, but I would like to make a few comments on the key highlights for the quarter.

First, please recall that in the year ago quarter we recorded pretax charges of $5.4 million for streamlining activities and $10.5 million for the early-retirement of certain debt.

To make the comparison of our second-quarter results between periods meaningful, I have excluded these charges from the year ago results.

So net sales for the second quarter of this year were $416.1 million, up 8.5% compared with the year ago period.

This level of growth is very significant given market conditions.

Operating profit was $37.2 million, up 12% from that reported in the same quarter last year.

Operating profit margin was a strong 8.9% in the quarter, up 20 basis points from last year.

Diluted earnings per share were $0.45, up almost 13% compared with the year ago period.

As you know, our second quarter is typically our weakest due to seasonal factors, yet our results showed significant improvement over the year ago period.

We believe this gives positive insight into the balance of 2011.

We believe you will find these results even more impressive upon further analysis.

So let us start by reviewing our net sales.

On a consolidated basis, net sales grew 8.5% compared with the year ago.

Excluding the impact of acquisitions, which added a bit more than $7 million in sales in the quarter, net sales grew over $25 million or almost 7% compared with the year ago period.

We estimate more than 5 points of the 7 percentage point increase in net sales was due to unit volume growth, primarily in our commercial and industrial channel with emphasis on renovation and small and medium-sized projects of various types through stock and flow.

From a geographical perspective, revenue growth was particularly strong in the US and Canada, partially offset by weakness in Europe.

We also saw growth from our continued expansion in certain geographies and channels in North America, which is very encouraging.

While it is impossible to precisely determine the separate impact that price and product mix changes have on our net sales, we estimate that overall price mix added about 1 point of growth in the quarter, mostly due to higher product pricing in certain channels.

Looking at all of this a bit more closely, there are some interesting points to know.

We believe nonresidential construction was down from a value perspective in the high single digits as a percentage from a year ago.

Certain portions of the market such as commercial buildings were off even more compared with the year ago period.

However, we believe the lighting market experienced growth in our second quarter in the low single-digit range.

This contrasts with our unit volume growth, which was up more than 5%, a strong accomplishment.

We believe our channel and product diversification, including lighting controls, as well as our strategies to better serve customers with new and more innovative products and the strength of our many sales forces, have allowed us to yet again gain overall marketshare.

With regard to product pricing, as you will recall, we announced price increases on those products most impacted by the significant rise in commodity costs effective at the end of February.

Therefore, we did not enjoy any benefit of this increase in the quarter just completed.

I will explain more about this later in the call.

We continue to see opportunities in certain areas such as renovation where we are growing.

We enjoy share gains in certain geographies and channels, including our stock business and to a lesser degree participate in projects funded from the government stimulus program.

We expect these areas will provide us with growth opportunities in 2011 and beyond.

I will talk more about our future growth strategies and our expectations for the construction market later in the call.

Before I turn the call over to Ricky, I would like to comment on our profitability.

Operating profit margin was 8.9%, up 20 basis points from the year ago period when excluding the impact of last year's streamlining charge.

There are a couple of key points to note.

First, acquisitions added more than $7 million in net sales with a minor impact on operating profit.

We expect these acquisitions in the aggregate to be a contributor to our profitability in the second half of 2011 and beyond.

Next, as we noted earlier in the conference call, we estimate that higher fuel, material and component costs reduced our operating profit margin by approximately $5 million in this second quarter without any offsetting pricing benefit from our announced price increase.

Also, this impact lowered our operating profit margins this quarter by approximately 120 basis points, which is huge.

Just to remind you of why we incurred these costs without the benefit of higher selling prices, consider that steel costs are according to the AMM went up about $0.15 per pound for the base metal or 45% in the second quarter alone after a long period of price stability.

Remember we use about 60 million pounds of steel each quarter.

While we endeavor to pass along these cost increases in the form of higher selling prices, we are not able to do so immediately generally due to the nature of the bid process in commercial construction.

Additionally, as we have explained in previous investor calls, our operating profit margins could have been even higher, particularly given our robust gross profit margin.

So let me explain.

Selling distribution and administrative expenses increased $7.5 million or a little over 6% this quarter on an increase in net sales of 8.5%.

As I explained on our last conference call, a little more than half of this increase was for additional headcount for technology and innovation, marketing funds for accelerating new product introductions, and increased sales commissions to support our selling efforts and for the sale of higher margin products.

The balance was due to acquisitions.

Much of this investment for headcount was put in place in the second and third quarter of 2010.

We did see the leverage of our SD&A this quarter as total operating expenses as a percentage of net sales improved approximately 70 basis points.

Excluding acquisitions, it was even more.

Even so, we continued to invest aggressively to expand into new channels such as renovation.

While our revenues in this channel were up more than 25% this quarter compared with last year, we have invested at a far faster pace than our current sales growth because of the future opportunity.

The same is true in certain other areas of our business.

Lastly, our controls platform is expanding rapidly, and we continue to invest in people and new products today to meet the expected growth opportunities in the future.

These investments are an expense on our P&L today.

Revenues are ramping up in these areas, though nowhere near expected peak sales.

We expect they will pay dividends later in 2011 and beyond.

We continue to be very pleased with our topline growth and our operating margins, particularly in this demanding and fiercely competitive environment.

We have been able to produce these results because of the dedication resolve of our 6000 associates and the progress they have made in four key areas of strategic focus -- customer service, pricing and margin management; geographical channel and product portfolio expansion, including significant additions to our stable of sustainable and energy-efficient products and solutions; and lastly, because of Companywide productivity.

On the strategic front, we, again, made excellent progress on our key initiatives.

The following are some of the more noteworthy.

We completed the acquisition of Sunoptics.

Sunoptics is a premier provider of high-performance prismatic daylighting products.

We are very pleased to welcome the Sunoptics team to our growing family of great brands.

We continued to introduce new products in lighting solutions at an accelerated pace.

Accelerating the introduction of new, more energy-efficient products and services has been a key contributor to our improved margins over the last few years is one of the cornerstones of our growth strategy going forward.

We continued our expansion into new geographies and markets such as renovation and increased our penetration of important channels such as C&I and distributor stock and flow.

Importantly, we saw meaningful increases in some of the most hard-hit markets like the Southwestern portion of the US.

This is all very encouraging.

We made great strides at providing more differentiated services to our customers and driving productivity throughout the Company.

Lastly and most importantly, we continued to enhance and expand our presence in the fast-growing lighting controls market.

These accomplishments have strengthened our foundation and will serve as a robust platform for future growth.

I will talk more about our future growth strategies and our expectations for the construction market later in the call.

I would like to now turn the call over to Ricky to make a few comments on our overall financial performance before I make some concluding remarks on our focus and efforts for the balance of 2011.

Ricky?

Thank you, Vern.

Good morning, everyone.

I will highlight a few items regarding our income statement.

I will then discuss our cash flow and financial condition, as well as a summary of the acquisition of Sunoptics before turning the call back to Vern.

Vern covered the second-quarter earnings results, so I will not repeat this information other than to highlight a few key items.

First, we enjoyed strong topline growth of 8.5%, and this is the fourth quarter in a row that we experienced unit volume growth in a very challenging market.

I believe this illustrates the return we are realizing on our investments in sales and marketing resources, as well as new products and services.

Second, we are aggressively managing the price cost relationship.

Temporarily our pricing actions are lagging the higher input costs, which we estimate negatively affected the second quarter results by about $5 million.

While we hope to be back in balance by the end of our fiscal third quarter, this imbalance will put pressure on our profitability in the third fiscal quarter.

Third, we are beginning to achieve the leverage of volume growth on our selling, distribution and administrative expenses.

These expenses as a percent of sales improved 70 basis points in our second quarter compared with prior year period.

Excluding available commission and freight costs, our SD&A costs remained relatively flat with the prior year period.

And lastly, we are pleased to post diluted EPS growth of 12.5% compared to adjusted diluted EPS last year, even after the drag on earnings caused by the temporary price cost imbalance and the short-term negative impact of recent acquisitions due to transaction costs.

Regarding the streamlining actions initiated last year, we estimate that we are now pretty much at the full annual savings run-rate of $10 million.

Interest expense net was $7.5 million for the second quarter of fiscal year 2011 compared with $8.1 million last year.

This decrease of $0.6 million is primarily due to lower average outstanding debt balances in the second quarter of fiscal 2011 compared with the year ago period.

Miscellaneous expense is due primarily to the impact of exchange rate on certain foreign currency items.

In the second quarter of fiscal 2011, we had incremental expense of $1.3 million compared with the same period last year.

The effective tax rate this quarter was 31.4%.

We expect the effective tax rate for the year to be approximately 34%.

The lower rate in this quarter from our full-year expected effective tax rate is due primarily to various discrete items regarding federal and state tax credits that were recognized in the quarter.

Now let's look at cash flow for the six months ended February 28, 2011.

Cash flow provided by operations for the quarter was $28.7 million.

Our fiscal year first half typically is a much lower cash generating period than our second half due to seasonally lower demand and payment of incentive compensation earned in the prior year.

The other primary reason for the lower level of cash provided by operations in this fiscal year first half was because of adding almost $14 million dollars of inventory, excluding the impact of acquisitions.

This increase in inventory was due primarily to increased raw material and finished good inventory.

The rise of raw materials was due primarily to inflationary cost increases and strategic purchases of certain commodity and components to better support customer service and relocation of production.

The Company expects to begin drawing down the raw material inventory in the second half of fiscal 2011 once the production moves are completed.

Additionally, in the first six months of fiscal 2011, we spent $80 million on acquisitions of businesses and $12 million on capital expenditures.

We expect to spend about $30 million this full fiscal year from capital expenditures.

We ended the second quarter of fiscal 2011 with a cash balance of $125.5 million and total debt of $353.4 million.

We also have availability under the revolving credit facility of over $243 million as of February 28, 2011.

This facility does not mature until October 2012.

I will conclude my prepared remarks with a few comments on our February 23 acquisition of Sunoptics.

Sacramento, California-based Sunoptics is a premier provider of high performance prismatic daylighting products.

Since its founding in 1978, Sunoptics has been dedicated to creating the finest daylighting environments for leading retailers such as Best Buy, Home Depot, Kroger and Wal-Mart.

The acquisition of Sunoptics allows us to manage the visual environment using natural daylight.

Their portfolio strengthens our suite of sustainable and energy-efficient solutions for retail, industrial, warehouse, education and government and office applications.

Further, there are opportunities to leverage our technology expertise and broad market access, including integration of Sunoptics products with our energy-efficient technologies such as our LED-based luminaires and intelligent lighting control solutions.

We did not disclose the terms of the transactions.

We owned Sunoptics for only four days in our second quarter, and therefore, it had an immaterial impact on our financial results.

We expect Sunoptics to be accretive to our overall operating results and margins for our fiscal year 2011 second half.

Thank you and I will now turn the call back to Vern.

Thank you, Ricky.

As we look forward, we again see considerable challenges, but more importantly huge opportunities.

First, a few comments about expected market conditions.

Our view of the market has not really changed since our last conference call.

The economic environment continues to be challenging but improving.

Key indicators for our primary market, non-residential construction, appear to be stabilizing from very depressed levels, and the overall economy is showing signs of growth, reflecting a cautionary uptick in consumer and business confidence.

But housing starts in February were at a half-century low.

This is still concerning.

Forecasts by independent organizations continue to suggest unit volume for North American construction put in place will be flat or possibly slightly down in 2011.

Though certain segments like commercial buildings are expected to again decline considerably more.

Interestingly, sales of lighting fixtures are expected by some to be up low single digits this year, maybe higher, mostly due to renovation.

Additionally we feel the controls portion of the industry will continue to significantly outpace the growth of luminaires.

It seems the significant headwinds that have prevailed in our markets over the last two years have begun to abate, though the recovery is expected to be slow and inconsistent both in North America and Europe.

Given the growth we experienced in North America in the second quarter, particularly in the C&I channel, we expect to see continued growth in the second half of our fiscal 2011.

This is consistent with our commentary of previous earnings calls and seems to be supported by our backlog and incoming order rates so far for March.

Our current backlog stands at $179 million.

Excluding acquisitions, our backlog was up over 45% from the year ago period.

While much of this increase is attributable to the announced price increase effective at the end of February, orders for March, which reflect new pricing for those products most impacted by cost increases, were favorable.

As I noted earlier, the industry is experiencing rising costs due to inflationary pressures on many commodities and components.

We have raised prices on those products sold through key channels most affected by these commodities.

While we expect the February price increase to primarily offset these rising costs, we anticipate there will be some lag due to our larger backlog, creating some margin pressure in our third quarter as well.

Looking ahead, we will continue to be vigilant in our pricing posture.

If commodity and material costs continue to rise, we will again increase selling prices to recover our costs.

Additionally, as I have said before, we will defend our market position vigorously from competitors should they attempt to use price as their only point of differentiation.

Lastly, as I noted last quarter, the global lighting industry experienced disruptions from the supply of certain electronic ballast and drivers due to a worldwide shortage of some electrical components generic to many products, including ballasts.

That situations seems to have abated.

However, the catastrophic events in Japan could once again create a disruption in the supply chain of these critical components.

We will monitor this situation very closely.

Looking more specifically at our Company, we are excited by the many opportunities to enhance our strong platform.

As I noted in our last few conference calls, our strategies to drive profitable growth remain intact.

We continue to see opportunities in this environment, including benefits from growing renovation and tenant improvement projects, further expansion in under-penetrated geographies and channels, and growth from the introduction of new products and lighting solutions.

As the clear leader in North America, we continue to work diligently to expand our relationships with key suppliers around the globe to bring greater and more unique value to our customers, including products which incorporate advanced technologies providing superior lighting quality and more sustainable energy solutions.

Our product and solutions portfolios in this area are expanding rapidly, including strategic acquisitions like Sunoptics this quarter and Winona last quarter, and we expect to make more.

Our strategy is straightforward -- expand and leverage our industry-leading products and solutions portfolio, coupled with our extensive market presence and our considerable financial strength to capitalize on market growth opportunities.

We continue to enjoy success in building our lightings control and solutions platform, deploying superior technology, enhancing our product offering and greatly expanding our access to market.

We are now starting to see the benefits and synergies of our investments in these exciting and fast growing markets.

This all takes investment and focus.

We are investing today, even though the current environment is challenging because we see great future opportunity.

We believe that continued execution of these longer-term strategies will enable us to outperform the markets we serve in 2011 and beyond.

As we look beyond the challenges of the current environment, we believe the lighting and lighting-related industry will experience significant growth over the next decade, particularly as energy and environmental concerns come to the forefront, and we are now positioned well to fully participate in this exciting industry.

Thank you.

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

Kathryn Thompson, Thompson Research Group.

The first question is, in your prepared comments and also in your press release today, you talked a bit about your backlog, and it expanded up a strong 45%.

But -- so that March is still doing decently.

How much are March shipment volumes up, and how much of the backlog increase do you think was driven by pre-orders versus real demand?

So we will answer one of those questions.

We believe that the ending backlog was up significantly because of the pull-forward of demand.

But yet when you look at our overall growth in the second quarter of almost 9%, we believe that that is indicative of some of the future opportunities that we see.

Our March orders were favorable, and that is really all that we are going to comment on with regard to that.

Would you say that your March orders are in line with the demand trends you saw in the quarter just reported?

I would say that the second quarter I think is a harbinger of favorable things for the second half.

Okay.

You have also -- (multiple speakers) -- talked a little bit more about participating in the commercial repair and remodel renovation.

When you do start seeing greater demand in your Company for commercial renovation projects?

Well, I think it has been an important part of our business.

If you go back and look at certain channels, I think that the retail channel has always viewed renovation as an opportunity to enhance quality of lighting while using energy savings to help pay for that.

What we are seeing, I believe, is an expansion of other types of -- or other building types in the marketplace looking to enhance quality of lighting while using energy savings to pay for these types of renovations.

So I would say that if you go back to 2008 where we experienced a good piece of business, I think we commented that at that time it was roughly $80 million of revenues, and then you saw the significant dip because of the economic disaster that we had in 2009 and carrying into 2010.

So we are now starting to see a rebound, if you will, in that renovation market but more broadly.

It is not just, if you will, retailers who understand, again, the notion of quality of lighting and energy savings.

Other building types are viewing that as a favorable opportunity as well.

So it is a broader market is what you are saying now than it was back in 2008 -- (multiple speakers) -- when you were seeing the demand for renovation?

Yes.

And I would add I think we are participating more broadly as we have added resources into this area both directly at sales function, as well as through our channel partners, and then have targeted more products and solutions toward that renovation market.

So the market, I believe, has gotten broader.

Plus, I believe our participation in the market has expanded since 2008.

Okay.

And two final questions.

On the renovation, how much of your business is driven by repair and remodel versus new, and what is your target going forward?

Then, finally, could we expect to see another price increase due to additional increases in raw material costs?

So the opportunity on renovation will be, I think, to continue to expand that capability.

We would expect that that market will continue to grow.

There are a number of estimates that are out there that talk about 100 billion square feet of building -- this is just indoor -- building availability, and 70% of that -- of those buildings were built before 1990.

So, as you think about that renovation market, energy costs going up dramatically and they continue to go up, and we expect that to be the case, you can see a very interesting market on a go forward basis.

So our business would expect to participate in that.

And then on the price increase, as we said in our comments, we will continue to watch the inflationary pressures that we saw in the second quarter very, very carefully.

You know, it happened very rapidly.

We had price stability in steel for the previous 12 months and truthfully in other costs as well.

And then in the second quarter alone, steel jumped 45%.

And I think for people who participate in the construction cycle as we do, not just lighting but many electrical folks, to catch up to that type of very rapid increase is a very difficult challenge.

So, as we look forward to the extent that costs continued to show increases, we will monitor that very carefully, and we will be very diligent in putting forth additional price increases as we see necessary.

(Operator Instructions).

Matt McCall, BB&T Capital Markets.

First, did you give an outlook on what the inflationary pressure is going to look like based on, I mean if we look out next quarter, maybe the next quarter if we just assume current prices?

You saw $5 million this quarter.

I think that is a little above your expectation at least as you conveyed it last quarter.

What are we looking at as we move into Q3?

So in our first-quarter conference call, we said that we estimated more than $4 million.

And the number that we actually came in was approximately $5 million or 120 basis points of impact on our margin or about $0.08 a share.

At this point in time, we have a little bit of higher backlog than what we would say typically have that we expect to roll through.

Hopefully we will be able to offset some of that increase with productivity and other measures.

As we think about what the market is going to look like on a go forward basis, in truth our crystal ball is no better than yours or anyone else's.

We are going to be, again, very vigilant on monitoring the situation, and if we need to put through another price increase or when we need to put through another price increase, we will do so.

Okay.

You mentioned lighting growth, and this is more about -- this is more of a cyclical progression question, I guess.

You saw some lighting growth this quarter.

The market was up.

And I don't have perfect data on this, but is the progression of this cycle where you actually see some unit volume from lighting pick up in advance of construction?

Are things progressing kind of the way you would expect them to progress?

I mean one of the last questions was about maybe a mix shift in the market.

But are things from a unit perspective lighting versus construction working the way -- from an industry perspective, I know you guys are doing well as a company -- but from an industry perspective, are they working the way you would have expected?

Yes.

I think that the cycle, the traditional cycle of lighting not declining as dramatically as construction put in place, is because lighting usually lags.

Lighting also has the benefit of tenant improvements.

So when some one moves out of one space and into another, the landlords typically provide incentives -- build out incentives, things of that nature.

So the lighting industry typically does not fall as far as nonresidential construction.

Having said that, we think that there are some other opportunities here through renovation where folks who are staying in their space are proactively looking to enhance the quality of their lighting environment and using energy savings to help pay for that.

So I think that the look that we have for the balance of our fiscal 2011 says kind of low single-digit growth in lighting fixtures, and I think against that backdrop, you have to look at the growth that we are providing.

I think it, again, is a strong reflection of both our portfolio indoor and outdoor and our channel diversification and our access to market, which is very diversified allows us to benefit to fully participate in wherever growth is.

That leads well into my next question.

I wanted to talk about the channel diversification.

Your contractor select business, it was part of the market.

I think you were a couple of years ago losing some share.

Are you -- I know you have been having some success there with the new product.

Are you back to your old share of that market yet, or are we still climbing uphill?

You know, truthfully I don't have that information at my fingertips.

But what I would say is that we are very aggressively expanding our product portfolio to be consistent with the kinds of value propositions that smaller and medium-sized projects would require at pricing that is available in the market.

And those products have features and benefits at price points that allow us to grow, as well as allow us to maintain and actually enhance our margin profile.

So we are continuing to see growth.

Our model is very balanced around how do we get after new products or -- excuse me, new projects, driven through specification.

But how do we also support our distribution customers in their abilities to provide better quality of lighting and better value for their customers through lighting products and lighting and control products I should say.

Okay.

And I want to sneak one more in.

I apologize.

But you mentioned the faster growth rate for controls.

Can you give us an update there, and maybe the way I want to look at it is, maybe on a hit rate basis, what percent of your luminaires project sales now includes controls?

Is there any trend we can reference and say, all right now, the new product we are getting X percent, we were getting Y percent.

We think that that can grow to Z percent.

We have not -- what we said on our controls platform when we acquired both Sensor Switch and LC&D and included that with our current portfolio, that our expectation at that point in time was to double the revenues in an 18-month timeframe, and we are ahead of that projection.

And so that is what I would like to provide there.

We are seeing -- and this is both interesting and expected -- we are seeing more and more luminaires that have, if you will, control capability embedded.

And so this is where the world of digital lighting is actually going.

The ability to provide the type of solution whether it is an industrial space, a school, a commercial office building, a healthcare facility, the ability to provide quality of lighting in the space while being able to optimize energy savings to help pay for that.

Retailers have always known the benefits of quality of lighting and then how to use energy savings to help pay for that and drive their operating costs.

I think it is becoming more broadly known in the marketplace.

So you are seeing more and more fixtures both traditional lamp ballast type fixtures with sensors and control capability.

But very clearly where the market is going with LED and/or in this world of digital lighting, controls will be a very important element to enhance lighting environment and energy savings.

I would add one of the excitements of the Sunoptics acquisition is daylighting does not save energy unless you turn the artificial lights out, and you need controls, therefore, to do that.

So we see huge opportunity in the daylighting that Sunoptics does to ensure that controls are applied and applied in a way to maximize that energy savings.

And the controls can be both for turning off the artificial lights, but also to control too much light coming in in the middle of a bright, sunny day that may blast an area with too much light, so having controls to manage the natural sunlight coming in.

So we are seeing opportunities not only to include controls in the artificial lights we sell, but now to include controls in the natural daylighting products we are selling.

Andrew Abrams, Avian Securities.

First, congratulations on doing well in a very difficult environment.

Second, I wonder if you could maybe just walk us through how the raw material impact worked its way through the quarter.

Are you on a short-term basis with your steel suppliers?

Can you adjust that as things are going during the quarter, or are you kind of locked in, and sometimes if there is a very fast move, you don't see it until a month or two later?

Maybe you could kind of walk us through how that actually impacts the quarter on a month-to-month basis.

Sure, Andrew.

We purchased commodities, steel being the primary one that we focused on, but we have fuel and others.

And each of it varies, and it varies some by the suppliers.

Generally on fuel that comes through almost immediately.

We get surcharges and so forth and, of course, buy our own diesel fuel for our vehicles.

So that would come through pretty quickly.

On steel there, again, it depends on the supplier.

Some of them we have adjustments that come in very quickly.

Others it does delay a little bit more.

But we see it pretty quickly, and then we are on a FIFO basis of inventory.

So, therefore, we will have a lag until the inventory turns.

Our inventory turns currently are around 6 times or so a year, 6, 7 times a year.

So you will see a month or two lag just based on the turn of the inventory.

So it varies, but there is a lag of at least a couple of months typically based on the turn of inventories for commodity costs less so on fuel.

That comes through much quicker.

Right.

And on the price increase, again, how does that kind of work its way through the quarter?

It does not affect all revenue lines or at least it does not sound like -- you said it was really more in the areas that needed the price increase.

So is there a way for us to understand how it falls into the quarter and how it impacts on a month-over-month basis, again kind of the same way that the materials increases due?

Andrew, it is a terrific question because you're absolutely right.

There are products that are much more impacted by steel, if you will, than other products.

And we have a very diverse portfolio of products going all the way from your traditional light goods, if you will, all the way to very, very sophisticated control devices.

And so what we attempted to do was put through those price increases on those products that were most impacted by it.

So we put through price increases in the range of 5% to 7%.

What you are struggling with in truth we have to manage very carefully is really the mix issue.

Of those products or of our total revenues, what do we expect price increases to follow through?

You know, as we said in our Q2, price increases impacting Q2 from prior price increases that was into May, I believe --

May, yeah.

We believe added about a point, and I think at that point in time we said 2 to 4, I'm trying to remember.

So probably roughly half -- and this is real rough -- probably roughly half of our products were impacted by that.

The good news is is that we have for a long time now enjoyed full capture on our price increases on those products that we have put forth the price increases on.

And so, as we think about how we are going forward, Q3 as Ricky said, we are probably going to have some lag effect.

Hoping to offset as much of that as we can through productivity, but our expectation was -- is that the price increases that we have put through would offset the cost increases that we experience.

As I also said in the call, we are monitoring the situation very, very closely because we want to try and be ahead of these kinds of things and not lag them.

The problem was that in Q2 we experienced a 45% increase in the base metal, and we just could not get the price increase in fast enough given the nature of the construction cycle.

And I believe that the electrical industry will experience that, not just the lighting companies.

Have you seen -- and I guess it is probably a little on the early side for this -- but have you seen any of your competitors using the opportunity of the price increase to gain share?

Meaning, okay, look, we are going to give you -- we are putting in a 5% or 6% price increase, the same as everybody else is.

But we are going to give you -- we are only going to put a 2% in on your product, whatever it happens to be.

Have you seen that anywhere?

Are people willing to reduce their profitability a little bit to gain marketshare, or is it just too early in this kind of rapid change cycle that we are seeing?

Andrew, I will give you two comments.

One is kind of historically.

We have thousands of competitors.

Sure the top four players in the North American lighting market probably have a bit north of 50% marketshare, but then there are many, many, many, many smaller businesses out there.

Typically pricing is a very local situation.

It depends on the job, the contractor, the distributor, the specifier, the strength of the local sales force, so on and so forth.

The issue then becomes what is happening locally.

We typically do not see national or trends that would suggest that one competitor is by strategy trying to use a price increase or your comment around someone trying to do at this time?

We are generally seeing the price increase sticking --.

So I would say that this is kind of a business as usual.

Again, very local, competitive, so on and so forth.

But we expect to get full capture on our price increases on those products that are being impacted.

And to the extent that we see someone locally attempting to use prices as their only point of differentiation, we have the size and the strength and the market-facing skill to direct a different outcome potentially.

Peter Lisnic, Robert W.

Baird.

Vern, I guess first question, in terms of March order strength that you saw, can you maybe distinguish or bifurcate between stock and flow and what you are seeing in stock channels?

Actually I have not -- I have seen the gross data.

I have not seen the individual data.

I would say that from what I am hearing, it is probably fairly consistent to some of what we have experienced.

The small project, small and medium-sized project, is -- there is private money coming into those spaces, and it depends on the geography.

This is also typically school season, so we are starting to see a buildup of that activity.

I don't think that there is anything notable about the end use application.

I'm very excited about some of the geographies that really were dormant for quite a long time.

The Southwestern portion of the US, you know we have now started to see signs of life, not in every market but in a number of them.

So that is encouraging, and it is not for us government stimulus.

This is private money coming into some of these projects.

So I think that those were favorable trends.

Okay.

And then if we switch over to verticals, if we look at the government or the education side given the pressures on budgets there, what are you seeing in terms of demand trends there?

Still pretty solid or are you seeing any sort of projects maybe get deferred or pushed out because of the budget issues?

I think that the school season is seemingly starting off in a reasonably consistent way with the past.

But your point around government budgets and their ability to spend, schools are a little different typically.

They come through millages and so on and so forth, but I think government budgets will have an impact on spending as stimulus goes away.

There are a number of people who I think lived off stimulus money.

We did not.

We saw some benefit of it.

So we actually think that as people stop getting the free handout from the government and have to actually spend their own money, that is going to work in our favor.

We have the kind of portfolio that allows a good, better, best value proposition typically for municipalities as opposed to saying, well, I will just spend on something that may be somewhat esoteric.

So more to come on this.

Actually we are monitoring it very closely, but don't have really a prognostication of how that is going to impact business going forward.

Okay.

Understood.

Then just on the commodity cost side, again, if I look at the numbers, the gross margin impact, or gross profit impact $5 million in the second quarter, about $2 million in the first.

In that backlog number, I mean you should be able to ship that -- that backlog represents maybe one third of a quarterly revenue run-rate.

So my guess is the commodity impact for the third quarter is probably in between that $2 million and $5 million.

Is that a safe way of thinking about the impact from the third quarter?

You know, again, we did not put out a prognostication because we find it very difficult in this transition.

We know that there is some amount, and potentially the range that you have provided is a good guesstimate.

But our hope and what we are focused on is, how can we move our mix?

How can we -- we are anticipating volume; we are anticipating productivity.

Our productivity in the second quarter in our facilities improved 10% on a year-over-year basis.

I mean so we continue to do very, very good stuff there.

How much can we offset?

That is really what we don't know, but we are going to endeavor to do it.

Understood.

Okay.

And then we have not talked about it, but in terms of Japan risk, I would guess it would be in the electronics and things like ballasts.

Have you identified any situations or issues in the supply chain where you may have to go out and be more aggressive buying forward or just protecting yourself given what has happened there?

We actually have done a fairly detailed sort of risk assessment, and we feel that there are -- that our supply base given the amount of time that we have, we should not see a material impact on us at this point in time.

Now who knows?

The situation there is catastrophic, tragic, I mean all the words that one can imagine to describe.

Many of our suppliers are not in that area.

We have a few components that come out of there primarily in our emergency product line, but we are looking to find alternate sources.

Our supplier is looking to use alternate factories in some of those areas.

So I think that this is a situation where the industry is going to have to obviously keep very close tabs on it.

And, at this point in time, we don't see a material impact to our business, but boy, oh, boy, it is really fluid.

So we will just have to, again, remain vigilant around that.

Understood.

Okay.

Perfect.

Thank you, again, for all of your help.

Shawn Severson, ThinkEquity.

I was wondering if you could talk a little bit more about the kinds of retrofit channel and I think you have some numbers around there.

But I'm just trying to understand how you delineate or differentiate between those that you would view as kind of energy-efficient retrofit projects versus regular sales through distribution and through your sales agencies?

So it is very difficult.

Because when products -- there are certain product types that we manufacture that are really primarily for the renovation market.

That is what they have been designed for, the retrofit kits.

So those are easy to identify.

We can put them on distributor shelves.

Distributors will then sell those, but we know what those numbers are.

In truth, as Ricky pointed out earlier in the call, as we expand our access to market through our sales forces calling on various end-users or end suppliers of energy retrofits or lighting retrofit, the plethora of product that they are buying is beyond just, if you will, control devices or retrofit kits.

They are buying product that is indistinguishable between whether it is new construction or tenant fit up.

So it makes it very difficult for us to quantify precisely how much of the growth is there.

We talked to our agents obviously on a regular basis, and we asked, where do you think these products are going?

And it is not uncommon for them to say, well, they decided in this one building that they are going to retrofit or renovate this portion, and they are going to put in new fixtures on this portion.

So I wish I could give you better insight and we want better insight, but right now it is a bit of Kentucky wind this year.

Sure.

And you spent a lot of money and time in broadening the product offering and in training the agency sales force.

I'm curious how their interaction -- do you get a sense of how their interaction is changing with the end customer?

I mean are they coming in to a contractor and a building, and are they able to put together a complete project quote per se, including an energy audit, an estimated savings and return on implementing the lighting strategy that they may have offered?

I mean do you get a sense of how many are doing that, and is that a big part of the effort now?

We believe that it is a very large part of their effort.

As new construction has declined rather precipitously, particularly for commercial office buildings, the talent that our many sales forces have are the ability to go in and knock on the doors.

Now they are knocking on new doors today for people who might do these types of projects to get access to that end customer.

But for many of the folks where they actually were the person who put in the new fixtures when that project was built, they are dusting off their files, and they are knocking on those doors, and they are saying, let us help you think through this.

This is energy savings.

This is how you can enhance the quality of your lighting.

But the connectivity that we have through our distribution partners and other channels -- I mean we are talking to a lot of the lighting management companies and the energy management companies, these [ESKOs].

So we see a broadening channel and opportunity in this marketplace.

It is just very difficult to quantify.

I believe that the marketplace is outperforming.

This is why the lighting industry is growing slightly when the new -- or, excuse me, nonresidential construction is still declining at a pretty good clip.

This is being offset.

So my view is that when we look out over the next handful of years as new construction comes back because of economic activity, employment, energy, all of these things are going to influence it, I think you are going to see a broader market opportunity for folks to participate like us because we will now have been converting over more and more of the installed base.

And, as I said earlier in the call, we guesstimate that there is 100 billion square feet of building space out there, 70% of which was built or put in place before 1990.

Now that has been converted over through tenant improvement at probably the tune of between 1% and 1.5% per annum for a long time.

We think that that is going to grow to between 2.5% and 4%.

Don't know what the exact number is going to be as energy costs continue to rise.

So we see it as a huge growth opportunity on a go forward basis.

And I guess the way that impacts you the most I assume is that through selling controls and systems, it improves the overall margin for you on those projects.

Is that fair to say?

So, as that mix shift grows and both new construction projects and more sophisticated and you have a controls offering, as well as the retrofit that on the margin side it should be -- I would think it would be more attractive for you than what we have seen in past cycles or maybe in a typical product sale of products into a retrofit instead of a solution per se?

I agree with that.

I think that over the next handful of years, just to pick something that is relatively close in, I think you are going to see as people migrate more and more -- you know, smart grid going to smart buildings, smart buildings needing intelligent lighting systems, this whole world of digital lighting is going to allow a very large company like ours to provide a complete lighting solution.

So it is about, how do I drive quality of life but pay for it through energy savings?

So I do think you are going to see more value being sold per square foot, and I think it's going to allow those folks like ourselves who have the combined capability of providing that digital lighting solution to extract more value because there is more value there.

There is more value there.

(Operator Instructions).

Christopher Glynn, Oppenheimer.

Over the past couple of years, Vern and Ricky, you've talked about how you're shortening your leadtimes through productivity improvements and such.

Do we see that -- I mean we had the backlog build us some noise from potential pull forward.

But are we seeing any re-extending now of leadtimes, and what implications might that suggest for the cycle or your business?

No.

As I said earlier in the call, our productivity from our supply chain perspective continues to improve at a robust rate.

The issues that we would have supply chain really have more to do with components having -- component issues through supply base.

But we continue to drive a service profile and a differential that we think is very exciting.

We have implemented some capabilities in our local markets to provide configuration capability, quick turnaround.

So I see Acuity continuing to drive its leadtimes down and its ability to serve its customer as a point of real differentiation.

Okay.

So relative to the current backlog, we would expect that to turn over in similar fashion to what we have been seeing?

Yes, I think Ricky commented on that earlier as well.

Yes, we would.

The notion that the backlog is up 45% -- not all of that is because of the pull-forward because of the price increase.

Our business is ramping up.

You saw in the second quarter an 8.5% improvement.

Exclude acquisitions, up almost 7%.

So you're starting to see this, and yes, we would expect that backlog to turn in Q3 virtually.

I mean there is an aging to the backlog, but that is not important.

Okay.

And then on the wireless side, again, a lot of investment.

What is the next opportunity?

I'm not sure there is much of a market for wireless currently, but that could greatly reduce the upfront costs for customers in a retrofit project.

Can you update on your wireless strategy for controls?

Well, from an outdoor perspective, we are wireless in terms of our mesh network, our ROAM system, which is gaining traction in that municipality world.

And so we are very excited about that.

On an indoor basis, many of the fixtures that are now being embedded with sensing type capabilities, those are self-controlled.

But when it comes to communicating in a broader network system to ensure true capability, to ensure true performance, that is still a wired world.

But we are doing it in a different way that allows contractors and owners to install these fixtures in a much more robust and efficient fashion if they are LED-based products.

So we see that as a real opportunity.

I think that the wireless world will come into the indoor space.

But unfortunately when you get into some of these buildings that have steel and concrete, some of the robustness and the consistency of these wireless systems just are not quite there yet.

Jed Dorsheimer, Canaccord.

Congrats on the diversification of the product portfolio.

The first question, I had not heard -- many asked about it, but on your LED product offerings.

One, I guess what percentage of the business is it?

And recognizing that it is still small but quite important, could you talk about we have seen the opposite in terms of pricing where the commodity components seem to have greater pricing pressure, which should benefit you?

I was wondering if you could elaborate on the elasticity that you're seeing in the market?

Thanks.

So that is a great question.

Our product portfolio, our revenues today from an LED perspective certainly -- I'm talking about just luminaires here -- less than 5% growing significantly.

But what is really interesting is the amount of quotations both for indoor and outdoor luminaires that are out there.

Our hit rate is improving.

You are absolutely right.

The cost of components, and let me just say primarily chips, have been coming down dramatically.

And, as you state in many of your research reports, you would expect that to happen.

We expect that to happen.

And, as a consequence, we are trying to put that into the pricing of these luminaires because we see that as an opportunity to seed the market.

And so it is still very early in terms of what is happening, but our expectation is that in the balance of 2011 into 2012, you will now start to see that less than 5% grow to well above 5%.

And the other thing I would say, our product selection guide is about an inch and a half thick.

There is probably an over 1 million different SKUs that you could go to.

So imagine any small startup company could rip a page out of that product selection guide and try and knock it off and they could say, I have LED fixtures, and their business could grow to $2 million.

I mean that is insignificant.

We are looking at really carving out meaningful parts of the interior ambient white light market and really driving our product portfolio to that.

Our outdoor portfolio is growing at a dramatic rate.

Lightfair is going to be an interesting display, and the difference for us versus these small startup businesses is that we have multiple sales forces that can sell these differentiated products.

So a customer, we can offer that a lighting solution that meets their needs both with traditional light sources, as well as the notion of digital lighting.

So exciting future, exciting opportunity for a company like Acuity because it can offer lighting solutions to enhance the visible light in this space.

Maybe just a follow-up on that, Vern, just to the extent -- could you elaborate on how much the LED business is actually contributing or if it is contributing to some of the other parts of your business?

In particular, you have some offerings there with the Gotham products, etc., that are not readily available on the marketplace.

So to what extent are you seeing your products that are specified in through your independent channel that is then locking in some of the more standard products that you offer?

Is there any way to quantify that?

With Gotham specifically, obviously that is a specified product, but it is also available through distribution.

It is the Lithonia downlight that you would see in multiple distribution channels that is available.

And that business is growing very well, but it is a small base.

So when I say that we are slightly less than 5% of our revenues today, a lot -- in truth, I don't have the exact percentage.

I would say that more than half.

I will be safe in saying that.

More than half is probably through distribution, the balance being through specification.

I would expect that as this ramps up, that you would see it be more in line with our traditional kind of 70/30 split between project and distribution.

I don't know why it would be different.

Having said that, the value of what we will call digital lighting, an entire controlled and intelligent lighting system, will sell for more value than just selling an individual luminaires or control device.

A couple of other comments I would make on here is one, when we sell, for example, an LED outdoor fixture, the odds of us selling the ROAM monitoring system and all goes way up.

So we do see greater combo sales of controls and all when you're going to LED lighting.

And then the other point I would make is Vern was talking about how exciting the quoting activity has been around LED.

A benefit we have with our broad portfolio is kind of a good, better, best in certain instances, and right now it is in a lot of instances they may quote LED initially, but then conclude for the value and the return on investment and all that they may want to go back down to florescent or a different source.

Well, we still have that solution and can still offer that other alternative to them.

So even if it did not count more sales of other traditional fixtures or controls, it may be that they first were interested because of LED, but then because of the great value that florescent still offers for many, many applications they may back off, and we would still get the sale.

It would just be for a more traditional source than LED.

That is great, guys.

Looking forward to seeing you at Lightfair.

Glenn Wortman, Sidoti & Co.

Just looking at SG&A sequentially, it fell more than one would suspect accounting for the drop in sales.

Was there anything unusual going on there, and is this a good go forward level for us to use?

Nothing unusual that went on there.

We had indicated through about this time that we thought the investments we have been making in SD&A on a fixed cost level would stay fairly flat from here on out.

And if you take out the variable commission and the variable freight, we actually were flat year over year, and obviously had some acquisitions in there.

So I think we are beginning to see a more leveling off of these investments.

We are still making the investments, but they are not incrementally growing.

They are staying at a flatter rate, and hence, the 70 basis points improvement as a percent of sales as we now can leverage those fixed costs against greater.

But nothing significant that was unusual in the quarter that drove that number.

Okay.

And then just second, Vern, I think a while back you had said that lighting sales would likely come back earlier than the broader nonresidential construction numbers given that many buildings were started but not completed over the past three years.

Is that variable still at play?

Yes and I think it will be in play for the next couple of years.

We are seeing absorption starting to improve.

We are seeing vacancy rates starting to improve.

So those vacancy rates and that absorption, those numbers have to play out before you are going to see folks putting up new structures.

Lending standards continue to be restrictive.

So there is a whole lot of space out there that needs to get absorbed through higher employment.

So it is employment, not necessarily unemployment, but employment numbers that will help drive that, and those trends are starting to turn favorable.

So I would see in this phase of the cycle our growth outperforming, say, nonresidential construction put in place.

That is why we try and provide two numbers.

Nonresidential construction is probably easier to get to compared with lighting.

You know, what is the growth in lighting fixtures?

Some of that is a bit of a guesstimate.

We used [Neiman] numbers to help us with that.

And so I think it's a fair reflection of the general trend between those two.

So I think you're going to see Lighting growth in luminaires and in controls as well that will outpace the change in nonresidential construction.

Craig Irwin, Wedbush Securities.

Quickly here, can you guys talk a little bit about the Winona acquisition and how that is tracking?

We thought the run-rate was around $50 million or so before hand, so at roughly $7 million that suggests there might be some adjustments.

Yes, no, no, no.

I don't think that the run-rate for Winona was ever $50 million, at least it has not been in their past.

My expectation is that as there wheelhouse, which is really that commercial office building, starts to revive, even through renovation that they will grow because of access through our multiple channels.

But the Winona business, roughly a $30 million business.

It had higher revenues in the past.

They are a terrific business.

We look to them to really be the product incubator for us in a number of key areas.

So exciting acquisition.

We know that this is kind of the bottom of their cycle relative to what their real niche is.

But just a terrific company with great folks.

So I think over the next handful of years, you are going to see Winona be a key contributor to our specification capabilities and how we leverage our other product sales.

Thanks.

That is good to know.

You talked a little bit about the pricing follow-through, but could you reiterate that or talk to that a little bit more what you think the potential is for the follow-through on the pricing increase?

Let me make sure I understand your question.

What specifically would you like me to comment on?

How you expect it to flow through in Q3 and Q4?

So our expectation is that, again, the price increase that we put through was on those products that were most impacted by it.

Very difficult based on mix to determine is that 60% of our portfolio, 70% or 40%?

I said earlier that if you look in the past and look at this Q2, just looking at how the price flowed because it was kind of a similar thing from the price increase that we had put forth in the previous May, we probably based on that mix yielded more than half of what the announced number was.

But, on those products, we had full capture.

So when you think about the 5% to 7% price increase, how much of that is for your model?

Will you be able to say will flow through because I don't know -- more than half would be kind of my guess as to those products that were impacted by those rising raw material costs for which we put through the price increase.

Then, of course, the backlog and you saw the big spike in backlog, and that is at the old pricing.

So when you look at third quarter versus fourth, you can certainly factor in that backlog and most all of that shipped here in the third quarter would be at the old pricing.

Any orders we are taking now here in March and all material senses are at the new pricing.

So that would give you another indicator of the lag between the third quarter going into the fourth.

And I would also say that the majority portion of the increase in backlog that we would attribute to the pull forward would be those products that are most impacted by these commodity costs.

Sure.

Thank you.

That is very helpful.

And finally, the tax rate seems a bit low compared to historics.

Is that a seasonality issue, or is there something beyond that?

Anything for the tax rate, and what do you expect for the remainder of the year?

Yes, the expectation for the full year would be 34%.

The lower rate this year was due to discrete items on some tax credits, the most significant of which was the R&D tax credit, which Congress was nice enough to pass and extend that yet again.

We are not allowed to take the benefit of that until that law is passed, and it was retroactively passed so there was a catchup here in this quarter related to the benefit we get in the R&D tax credit.

So that was the biggest reason for the decline relative to the annual effective tax rate here in this second quarter.

And Ricky, that was what, about a $0.005, wasn't it?

It wasn't that --

Maybe a little more than that.

6/10.

I think I did the calculation on that.

Does that answer your question?

That does.

Thank you very much.

(Operator Instructions).

At this time, we have no other questions in queue.

And I would like to turn the call back over to Mr.

Vern Nagel for closing remarks.

Everyone, thank you very much for your time this morning.

We strongly believe we are focusing on the right objectives, deploying the proper strategies, and driving the organization to succeed in critical areas that will over the longer term deliver on the expectations of our key stakeholders.

Our future is very bright.

Thank you for your support.

This concludes today's conference.

You may disconnect at this time.