Acuity Brands Inc (AYI) 2014 Q3 法說會逐字稿

Good morning and welcome to the Acuity Brands 2014 third-quarter financial conference call.

(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.

Sir, you may begin.

Thank you.

Good morning.

With me today to discuss our third-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 risk and uncertainties, such that actual results may differ materially.

Please refer to our most recent 10-K and 10-Q SEC filings, and today's press release, which identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

Now let me turn this call over to Vern Nagel.

Thank you, Dan.

Good morning, everyone.

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

Our results for the third quarter of 2014 were very solid.

Our net sales increased almost 12% this quarter, exceeding $600 million in the quarter for the first time in our history, while we earned $1.01 per share.

In fact, this was the fifth quarter in a row where we achieved double-digit sales volume growth.

In addition, we continued to make excellent progress on a number of strategic initiatives, as I will mention later in the call.

Also noteworthy, sales of LED-based lighting solutions now make up more than a third of our total sales.

We believe this level of growth is yet again a positive evidence our strategies to provide customers with differentiated value propositions, to diversify the end markets we serve, are succeeding, allowing us to extend our leadership position in North America.

These strategies include the continued aggressive introduction of innovative, energy-efficient lighting solutions, expansion in key channels, and improvements in customer service and Company-wide productivity.

Our profitability and cash flow for the quarter were again strong, even as we continued to fund our robust sales growth, as well as other areas with significant future growth potential, including the rapid expansion of our lighting solutions and components portfolios.

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

However, before doing so, I would like to comment on two abnormal items impacting this quarter.

First, with regard to the warranty issue we noted last quarter due to a design defect in an older, incandescent emergency lighting product, we took an additional pre-tax charge of $2.1 million this quarter, based on additional facts and information that became available to us this quarter.

As you will recall, we took a charge last quarter related to this issue, noting at the time it was our best estimate of the cost to resolve the issue.

We further noted those estimates were subject to potential additional facts and information.

While this is still true, we believe the charge this quarter, plus the charge taken in the second quarter, reflects the total cost necessary to resolve this matter.

Second, the impact of foreign currency, primarily due to a weakening Canadian dollar, reduced our gross profit this quarter by approximately $2.1 million.

As Ricky will explain later, the level of foreign currency impact we have experienced the last two quarters is abnormal for us.

We believe these two items reduced our gross profit and operating profit margins in the quarter by approximately 70 basis points.

The total impact of these items reduced diluted EPS this quarter by approximately $0.06.

We have taken appropriate actions in the second and third quarters to address the design issue.

We, of course, remain somewhat exposed to currency fluctuations, as they are very difficult to forecast.

Now, let us review our reported results for the quarter.

Net sales for the quarter were $604 million, an increase of 11.5% compared with the year-ago period.

Reported operating profit for the quarter was $72.6 million, compared with $50 million reported in the year-ago period.

In the year-ago period, we took a special charge and incurred temporary manufacturing (technical difficulty) associated with the plant closure, as well as a charge for a fraud committed by a freight vendor, which, in total, reduced operating profit by $16.1 million.

I do find it helpful to add back these items to the year-ago period's results to make them comparable.

Doing so, one can see that operating profit for the current quarter compared with the adjusted operating profit in the year-ago period increased approximately 10%, while operating profit margin decreased about 20 basis points.

Again, remember: We are not adjusting the current quarter's results for the excess warranty and foreign currency impact which lowered both gross profit and operating profit margin by approximately 70 basis points.

Diluted earnings per share for the third quarter were $1.01, while adjusted diluted EPS for the year-ago period was $0.97, an increase of about 4%.

Again, our results this quarter were impacted by approximately $0.06 for the two items I previously mentioned; still, very strong results indeed.

The results for the quarter were improvements over the year-ago period.

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

While net sales grew 11.5% compared with the year ago, we estimate sales volume grew approximately 13% this quarter.

This level of growth is particularly noteworthy, given we believe the overall market we serve was up mid-single digits over the year-ago period.

Second, the impact of price changes and the mix of products sold, as well as foreign currency, reduced net sales by approximately 1.5%.

Overall, our growth in net sales was broad based along virtually all major product lines, while certain specialty fixtures more closely associated with new construction continued to lag the overall average due to the still somewhat tepid environment for new, larger, non-residential construction projects.

Interestingly, orders for these types of products continued to improve, suggesting the rebound for commercial projects in the US is well under way.

From a sales channel perspective, we continued to experience strong growth in the commercial, industrial, and infrastructure channels for both indoor and outdoor applications, as well as continued growth for renovation projects.

Again, sales of LED-based lighting solutions nearly doubled compared with the year-ago period.

The sale of LED-based fixtures at Acuity now accounts for more than one-third of our total revenues.

We believe our level of growth of LED-based lighting solutions is far outpacing the growth rates of our largest competitors for these types of products, further demonstrating our formidable capabilities in product development and our leadership in market access.

Let me again put this in perspective for you.

If the sales of our LED-based luminaires were measured as a separate business today, we believe it would easily be the fourth largest lighting company in North America.

And remember: It's still only one-third of our total Business; [awesome] results indeed.

Overall, we continued to experience growth in most geographies and sales channels in North America, all of which is very encouraging.

Excluding LED components, we believe material and component costs were, again, fairly benign this quarter.

With regard to the impact of product pricing and the mix of products sold on net sales, while it is impossible to precisely predict price versus mix, we believe most of the impact was due to the mix of products sold, and to a lesser degree, the mix of products sold by channel.

Market pricing actions seem to be consistent with past practices.

Folks, we are having a fire alarm go off here; so, I apologize.

We will continue to go forward, but I apologize for the problem.

Anyway, looking at our overall market conditions for the third quarter, we believe spending in the US non-residential construction market in which we participate was up low- to mid-single digits compared with the year ago, while residential construction was up almost 20%.

Therefore, while complete market data for the quarter is not yet available, we believe the overall lighting market grew in the mid-single-digit range during the quarter, supported by continued growth in renovation, as well as the residential market.

This is in stark contrast compared with our net sales growth, which was up almost 12%.

Also, we believe there is little, if any, carry-over effect this quarter due to the harsh winter conditions which impacted the second quarter.

Lastly, we believe our sales channel and product diversification, as well as our strategies to better serve customers with new, more innovative lighting solutions, and the strength of our many sales forces, have allowed us to, again, to achieve meaningful sales growth this quarter.

Before I turn the call over to Ricky, I would like to comment on our profitability and some key strategic accomplishments in the quarter.

Operating profit margin for the third quarter was a solid 12%, down 20 bps compared with adjusted margin in the year-ago period.

Again, the excess warranty and foreign currency issues I noted earlier reduced operating profit margin this quarter by approximately 70 basis points.

Our margin strength is particularly noteworthy given that the sales of LED-based lighting solutions are now more than a third of our total net sales, and we are making investments in new areas of opportunities, as I will describe in a moment.

Further, as Ricky will discuss later in the call, while gross profit margin declined by 70 basis points to 40.3% from the prior year's adjusted gross profit margin, the margin decline was primarily due to the abnormal items I noted earlier, and the mix of products sold.

This was partially offset by benefits from higher sales volume, productivity gains, and previous restructuring actions.

Another area impacting gross profit margin was certain inefficiencies associated with the ramp up of our electronic component capabilities, primarily from the acquisition of eldoLED, our programmable LED driver platform.

While it is difficult to predict start-up inefficiencies, it is not at all unusual to experience higher costs due to learning curves and the inability to absorb costs until unit volumes hit a more meaningful level.

Overall, we believe these costs reduced our gross profit margin by approximately 20 basis points this quarter.

We are significantly accelerating our investment in capabilities to produce electronic components, including programmable dimmable drivers for LED-lighting applications that require superior functionality and quality, as well as consistent delivery, in order to capitalize on this growing market potential.

In addition to the acquisition of eldoLED itself, we have invested almost $10 million for additional machinery and equipment, as well as funding meaningful increases in salaried and hourly associates to support our growing internal requirements, as well as those of our expanding list of OEM customers for these components.

We expect these inefficiencies to impact our margins somewhat over the next few quarters, as we ramp up our volumes of these components.

Next, total adjusted selling, distribution and administrative expenses were up almost 10%, on a sales increase of approximately 12%.

The increase in total SDA expense was due primarily to higher variable costs for commissions and freight to support the growth in net sales, as well as higher employee-related costs, including incentive compensation, partially offset by benefits from previously implemented restructuring programs.

SDA expenses as a percentage of net sales were 28.3% in the quarter, compared with adjusted SDA expense of 28.8% in the year-ago period, an improvement of approximately 50 basis points; all in all, a strong third quarter for Acuity.

On the strategic front, we accomplished a great deal this quarter which will have future benefit.

First, we continued our rapid pace of introductions of new products, significantly expanding our industry-leading portfolio of innovative, energy-efficient luminaires and lighting control solutions.

For example, in May we introduced four new product families of organic LED-based luminaires, making us one of the largest sellers of OLED fixtures in the world.

As I mentioned earlier, our solid-state lighting portfolio continues to expand rapidly, as are the sales of these luminaires.

And we continue to fund the development of more holistic lighting and energy-saving solutions for specific applications such as schools, healthcare facilities, commercial office buildings, and various outdoor applications to fully leverage our award-winning portfolio of lighting fixtures, controls and components.

As we have noted before, Acuity is a clear leader in the digital lighting solutions world.

Our expertise lies in the true understanding of the proper use and control of light in the end vertical applications, while minimizing the use of energy.

We believe we are without equal in the design and development of fixtures and integrated lighting systems for virtually any indoor and outdoor application, without a bias of light source.

Our innovation prowess was on full display at this year's LIGHTFAIR in Las Vegas.

A couple of examples: Acuity won the highly coveted award, Most Innovative Product of the Year, for the luminaire known as Open, introduced under our Peerless brand.

Another extraordinary example of our ability to innovate, Acuity demonstrated visible light communication technology at LIGHTFAIR.

Using lumicast technology from Qualcomm, Acuity Brands' smart LED-lighting technology will allow retailers to engage with customers on mobile devices based on their location in the store.

This system showcases the ability of our commercially available eldoLED driver platform to deliver both illumination and visible light communication, providing retailers with an opportunity to significantly increase their sales to customers.

This capability will be tested in a proof-of-concept installation with a major retailer this summer, and is unmatched in terms of accuracy and speed.

The market potential for this system is enormous, adding billions of dollars of potential future growth for Acuity and its partners.

Another area of huge growth potential for Acuity is our electronic components capabilities, which are ramping up at a blistering pace.

For example, we produced almost 1 million light engine boards in the month of May alone.

And industry demand for eldoLED's programmable dimming LED driver is growing worldwide, as the superior functionality and quality of these products are highly coveted by specifiers for marquee projects.

To put this opportunity in perspective, we believe the market for quality LED drivers could be a $1-billion market within the next handful of years.

We have been able to produce these robust results because of the dedication and resolve of our more than 6,800 associates to deliver superior value to our customers, as well as driving improvements in efficiency throughout the Company to provide superior returns for our shareholders.

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

I would like to now turn the call over to Ricky, before I make a few comments regarding our focus for the balance of calendar 2014.

Ricky?

Thank you, Vern.

And good morning, everyone.

I will highlight a few items regarding our income statement.

I then will discuss our cash flow and financial condition, before turning the call back to Vern.

Vern covered the primary drivers for our sales growth and our profitability, so I will not repeat these items.

But I will provide a bit more color on certain aspects of our first-quarter results.

Our gross profit margin for our third fiscal quarter of 40.3% decreased 70 basis points compared with the adjusted year-ago period.

As Vern mentioned earlier, the benefits of the 11.5% increase in net sales, and an improved productivity, were offset by the 70-basis-point impact of the additional costs due to the product design issue and unfavorable currency impact.

In addition, gross margins were negatively impacted by price mix and the inefficiencies of ramping up our electronic component manufacturing capability, as Vern discussed earlier.

The Company and the US Consumer Product Safety Commission announced a recall of certain incandescent emergency lighting fixtures on May 28, 2014.

As Vern mentioned earlier, we recorded, during the third quarter, $2.1 million of additional costs related to this product design issue, which brings the total estimated pre-tax expense for this matter to $4.5 million.

The additional estimated cost recorded this period is primarily due to higher revised estimates related to the product cost and labor to properly handle this issue.

While it is possible that there could be additional costs associated with the ultimate resolution of this issue, we do not currently believe they will be material; and the amount recorded is our best estimate of the total cost based on what we currently know.

The unfavorable currency impact was primarily due to the Canadian dollar, which weakened by 7% year over year relative to the US dollar.

As a result, we experienced approximately $2.1 million negative impact on our gross profit.

We, as well as certain other industry participants, have announced price increases in Canada, which should help to dampen this impact going forward.

In addition, the Canadian dollar has recently experienced a modest appreciation.

The effective tax rate for the third quarter was 32.2%, compared with 29.9% in the third quarter of last year.

Both periods were favorably impacted by a reduction of certain income tax reserves.

We estimate the effective tax rate for the FY14 will be approximately 35.5% before any discrete items, and if the rates in our taxing jurisdictions remain generally consistent throughout the remainder of the year.

Cash flow generated from operations for the first nine months of FY14 was an impressive $128.8 million, compared with $67.8 million in the prior-year period.

This significant year-over-year improvement reflects higher net income and lower working capital requirement as compared with the prior-year period.

In the first nine months of FY14, we spent $24.8 million on capital expenditures, compared with $31.4 million in the prior-year period.

We currently expect to spend approximately $45 million in capital expenditures in FY14.

At May 31, 2014, we had a cash balance of $467.3 million, an increase of $108.2 million since the beginning of the fiscal year.

Our total debt was $354 million.

Consequently, our cash exceeded debt at the end of the first quarter.

At May 31, 2014, we had additional borrowing capacity of $243.8 million under our credit facility that does not mature until January 2017.

So, we continue to maintain a significant amount of financial flexibility.

Thank you.

And I'll now turn the call back to Vern.

Thank you, Ricky.

As we look forward, we continue to see significant long-term growth opportunities.

With regard to our expectations for the balance of calendar 2014, our view has not changed.

We remain very positive.

So, while we don't give earnings guidance, I would like to reiterate what we previously mentioned regarding our expectations for the rest of 2014.

First, most economists expect the economy in North America will continue to improve at a modest but increasing pace.

While forecasts for industry growth rates by independent organizations continue to vary widely, the consensus estimate is the broad lighting market in North America is expected to grow in the mid- to upper-single-digit range for the rest of 2014, and accelerating into 2015, reflecting the benefits of both new construction and renovation activity.

Further, we continue to see signs that give us optimism regarding the future growth of the markets we serve and our Business.

Leading indicators in the North American market, such as Architectural Billing Index, vacancy rates, office absorption, lending availability, and the rebound in residential construction, continue to improve.

As has become the norm over the last handful of years, we are always leery of the next round of uncertainty that might come out of Washington regarding fiscal issues, as well as foreign policy.

As you know, the manner in how these key issues are handled can meaningfully influence business and consumer confidence.

Nonetheless, we continue to expect that overall demand in our end markets for the balance of calendar 2014 will continue to improve, and be more broad based and consistent than experienced in 2013.

The continued favorable trend in our June order rate, again, seems to support this continuing level of improvement.

Second, excluding certain LED components which are expected to continue to experience price declines, we do not anticipate significant changes in input costs for the balance of our 2014, as some commodity costs have waned while others continue to rise.

Further, we expect employee-related costs to continue to rise due to wage inflation, the negative impact of rising healthcare costs, and higher incentive compensation due to our positive performance.

Of course, we will continue to be vigilant in our pricing posture, as well as furthering our efforts to drive productivity improvements, to help offset rising costs, as evidenced by the benefits realized in the FY14 from streamlining actions we took in the second half of FY13.

Next, while our gross profit margin is influenced by a number of factors, including sales volume, as well as product and sales channel mix, we expect our gross profit margin to improve over time as volume grows, particularly for larger, new construction projects, which should also benefit our mix and as we continue to realize typical gains in manufacturing efficiencies.

Though, as we noted earlier, we expect margins to be somewhat constrained over the next few quarters until we achieve improvements in volumes and efficiencies in our electronic components capabilities.

Also, we expect margins over the longer term to benefit from the sale of higher value-added integrated lighting solutions with differentiating features and benefits.

Additionally, while we continue to experience some isolated pricing pressures in certain markets and sales channels, such as home improvement, we will continue to be vigilant on pricing.

As we 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, we expect to continue to meaningfully outperform the markets we serve.

Looking more specifically at our Company, we are very excited by the many opportunities to enhance our already strong platform, including the introduction of holistic lighting solutions like connecting smart lighting with our smartphones for retailers, as well as our growing electronic component capabilities.

As we have noted in our last several conference calls, our strategies to drive profitable growth remain essentially the same.

We continue to see opportunities in this environment, including benefits from growing portions of the market, further expansion in underpenetrated geographies and channels, and growth from the introduction of new lighting solutions.

Our positive results reflect the solid execution of these strategies by our associates.

Our Company-wide strategy is straightforward: expand and leverage our industry-leading portfolio and solutions, coupled with our extensive market presence and our considerable financial strength, to capitalize on market growth opportunities that will provide our customers with unmatched value, and our shareholders with superior returns.

This, of course, all takes focus and resources.

We are funding these activities today because we see great future opportunity.

Through these investments, we have significantly expanded our addressable market.

Our record growth supports this view.

As I have said before, 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.

We continue to believe the many markets we serve as part of the broader lighting industry could grow by more than 50% over the next few years, providing us with significant growth potential.

As the North American market leader, we are positioned well to fully participate in this exciting industry.

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

And the great news is, is that the fire drill is now over, so we can actually hear you.

Hopefully you can hear us.

(Operator Instructions)

Christopher Glynn from Oppenheimer.

Thanks, good morning.

Just wondering what your view is on how much cash is needed to run the business and what outlets you're seeing for using some of the excess cash.

Chris, as far as normal working capital needs in the $50 million to $75 million generally will support our ongoing working capital fluctuations and capital spending ebbs and flows.

So, as you can tell, we do have quite a bit of dry powder in the cash that we have.

Consistent with previous comments, our first priority is to invest in the business in organic growth, and then second would be acquisitions.

We do see quite a bit of opportunity on the M&A side and we'll continue to look at that.

And then absent that, we certainly have used our excess cash to repurchase shares, as well as continuing to pay our standard dividend.

Chris, we expect to continue to generate very solid cash flow growth.

As Ricky points out, it takes us about $0.10 or $0.11 of operating working capital to support every $1 of increase.

And we're working our inventories back down to more normal levels as we learn how to manage both LED luminaires and the production of conventional luminaires.

I think on the CapEx side, Ricky, we're between 1.5% and 2% of revenues.

We'll be probably investing a little bit more next year in terms of building out just the ability to house our growing staff.

As we go from $2 billion to $4 billion and $5 billion of revenues, we will drive productivity throughout the business.

But it's pretty obvious that we'll be growing our salaried headcount.

Frankly, we're out of capacity so we're looking at ways to resolve that.

But we still should be able to operate reasonably well within that 1.5% to 2% of sales from a capital investment perspective.

Okay.

Thanks for that.

And on the acquisition pipeline that's active, is there a good range and breadth of different size type deals?

I would say that there is.

Again, as we've pointed out, we're looking for really three capabilities.

One, to enhance our technology capability.

Number two, to enhance the product portfolio capability, maybe from a design perspective.

We're also looking at the opportunities for geography expansion.

And, as you know, we look to continue to build out our residential platform.

There's nothing out there where it's a must have, but the opportunity for items and acquisitions that can help accelerate our capabilities in these areas, Ricky and his team are very busy.

The range of size is interesting, from very small -- take Adura for example -- to items that are larger.

But when we say larger we're talking hundreds of millions of dollars.

We're not talking really larger than that.

Great.

Thanks for that color.

And then just a housekeeping.

The 35.5% tax rate for the year, I think that implies a record high in the upper 30%s in the fourth quarter.

Is that appropriate?

Might be not quite that high.

Again, depends on any changes.

It will probably be a little less than that, probably closer to that 35.5% to 36% for the fourth quarter.

Okay.

Thank you.

Brent Thielman from D.A. Davidson.

Hi.

Good morning.

On the price mix headwind, does that reflect a specific channel, a change in markets within non-res that you're serving, or a change in the broader product portfolio?

Brent, it was interesting this quarter.

We were hopeful, if you will, for a more rich mix of products sold.

Absolutely impossible to predict the way the mix plays out.

But when we look at it, it really was certain products migrating, just simply products moving from one type to another.

And more in our conventional light source products.

It was just interesting to us.

I believe that this product mix shift that we experienced this quarter is more of a temporary activity.

Again, impossible to predict.

When we look at mix over the full 12 months, I think that that will be a more representative mix, if you will.

And to us, we still fluctuate between channels.

Different channels have different margin profiles but they also have different, if you will, return on investment profiles.

So, when we looked at the mix this quarter, and when you get past all the noise, the way I look at it our adjusted gross profit margins were 41.2%.

And that's getting us in the range.

If the mix had been a little bit more traditional around the product side we would have enjoyed an even higher margin expectation.

So we'll just have to wait to see.

When we're in that 41% to 42% gross profit range where we are today, we feel that we're hitting our stride.

We have to get past -- we've gotten past, we believe, the warranty issue.

FX -- there's not really a lot that we can do to forecast that.

And we're ramping up our capabilities in the electronic components space which will provide us with several things.

One, features and benefits of a very high quality -- electronic component capability, assured delivery, and ultimately, we believe, a significant cost advantage.

So, all of these things that were impacting this quarter, our expectation is that they'll either go away or they'll yield future benefits as we go forward.

Okay.

And then when you look at the entire construction retrofit end-market landscape, are there specific sectors in the market that you're choosing to avoid because it doesn't meet your parameters for margin returns, maybe it's too crowded, or the opportunity for product per square footage isn't as appealing?

The way we attack, if you will, the renovation market, we have a number of sales forces, we have a number of channel partners.

So, what we're looking to do is to support them in their focus to their end customer base.

And given our size and scale and the product portfolio that we have, there really aren't too many areas of opportunity that we won't explore or aggressively go after.

Obviously, much of our business is a bid business.

There are at times folks that will bid projects at price points that we don't feel are really prudent.

So, we'll either not play or we'll work hard to differentiate our portfolio in a different way.

So, I would say the answer to your question is no, there's no one or two areas that we would avoid.

We look to aggressively go after business opportunities and then use our sourcing capabilities and the great strength of our many associates to drive costs out to make it a profitable venture for our shareholders.

Thank you.

Brian Lee from Goldman Sachs.

Hi, guys.

This is Tom Daniels on for Brian.

Thanks for taking my question.

First, maybe for Vern, I was wondering if you could dive into a little bit of the market share gains.

Clearly, for many quarters here you guys are outpacing the overall market.

And your LED lighting sales are significantly outpacing competitors.

My question is, as lighting gets more and more technologically improved, is this a long-term market share gain for Acuity?

And do you think the dynamics in the actual market can change pretty meaningfully over the next decade as LEDs become such an important part of the portfolio?

We do see opportunities to take advantage of what technology means coming into our space.

For us, LED and the notion of solid state lighting is really an enabler for future opportunity.

Again, you saw that in our press release we commented on the notion of visible light communication technology.

This is really, in conjunction with Qualcomm and Lumicast, our opportunity to deliver to the retailing space.

Just as an example, a value proposition that is not just about quality of light and energy savings represents a huge potential market for Acuity and our partners to really drive that kind of value.

So, when we think about the investments that we are making today in terms of eldoLED, in terms of our electronic component capability, it's really so that we can bring more value to those end applications.

Our view around the marketplace continues to evolve.

We call this a tiered approach to lighting solutions.

If you imagine, in the first tier it's simply products, features and benefits, price points.

But then you start to migrate along tiers where you're able to add more capability into a more holistic solution.

We think that that brings even more value to schools, healthcare facilities, commercial office buildings, industrial spaces, outdoor.

And by doing so, it really changes, if you will, it's a paradigm shift, between just providing light into a space but now providing quality of light and other information that can come off of these LED luminaires, which are really also communication devices.

So, for Acuity, we see the opportunity to significantly expand our addressable market.

Hence the acquisitions that we've made of companies like Renaissance and Adura and eldoLED, Pathway, Horizon.

These are all creating a capability within our portfolio to provide intelligent, holistic lighting solutions to these applications in a way that they've never had before.

So, you couple our supply chain with our great technologies and our access to market, I do think that it gives Acuity the opportunity to participate more meaningfully in a very rapidly growing marketplace over the next decade and beyond.

Thanks for that color, Vern.

Appreciate it.

My one other follow-up was could you remind us in prior cycles, as we start seeing non-resi construction, I know it is lackluster today, but as we start seeing those construction numbers improve is there a lag effect for when Acuity actually starts seeing the unit volumes increase?

I thought it might be 6 to 12 months, but just wondering if you could comment on that?

Thanks.

Ricky -- we do have some pretty good data that shows, going back to the middle 1980s, just that cycle and how the cycle works -- maybe you want to comment a little bit on it?

Yes.

Clearly there is a cycle around the specification when a building gets designed and then the specification's got to come out of the ground.

You've got to get tenants in it, and lighting is one of the last things to come in.

And you're right, it tends to be 6 to 12 months.

We use 9 months as an average on many of the construction put in place type of data that we look at.

If you look at the Architectural Billing Index, the lag is even longer because there you're actually just designing it.

But there is that construction cycle lag.

I would say, as renovation becomes a bigger part of our total mix -- now roughly half of our mix -- there the lag is much less.

Typically in a renovation situation, once they decide to renovate, it can move quickly.

On other times, though, they'll want to do an audit and study it for a year or longer.

So that 6 to 12 months is a broad range of what I would think is reasonable lag to most of the major indicators that you would see out there.

And, Tom, just to add to Ricky's comment.

We know that on an inflation-adjusted basis in the US, nonresidential construction is still off 25% from its peak.

And yet, Acuity this year -- what's the number that the analysts all have?

$2.4 billion of revenue.

We're 20% above in terms of total revenues where we were at the peak in 2008.

And to Ricky's point, it's because we've really diversified the end markets that we serve, and we are not as directly tied to new construction because of the expansion of our product portfolio and how we have altered our access to market to participate more fulsomely in the renovation world.

That makes a lot of sense.

Thank you very much, guys.

Matt McCall from BB&T.

Thanks.

Good morning, guys.

On the electronic components investment, Vern, you mentioned two things.

You mentioned the $1 billion market opportunity and then you mentioned a cost advantage.

Is it more of a cost advantage to vertically integrate that or is it more of a revenue opportunity?

And then how would you recommend that we model that $1 billion market potential over the next so many years?

Matt, our investment in eldoLED was really made because we saw the opportunity of eldoLED's superior functionality and the quality of the driver.

Their ability to dim to dark is unmatched in the industry today.

And so, as LED continues to proliferate -- and of course it will -- we felt strongly that having the ability to have a superior LED driver that's programmable, and then expand its portfolio so that it has also cost features and benefits in a tiered capability, was going to be very valuable to Acuity.

We also felt that the opportunity of eldoLED to be more of an industry standard, we are making eldoLED available to the industry, so others -- this is a friending strategy -- so others have access to the eldoLED capability for their designs and their products.

Our view was that this is a great capability.

You saw from the announcement -- and, Matt, I'm not certain if you were at LIGHTFAIR, but you saw that the Lumicast technology that we introduced in conjunction with Qualcomm at LIGHTFAIR is really enhanced because of eldoLED's internal capabilities to do so many things and do them so well.

So the Lumicast technology that's being made available and will be tested here shortly provides a superior mobile device retailing experience, with accuracy and speed that's unmatched by others that have potentially -- or claiming potentially similar type programs.

So eldoLED was a growth strategy, and now as we look at it, the opportunity for us to continue to drive cost and to give us and our OEM customers a cost advantage.

We certainly won't make every LED driver.

We will have a broad supply chain, as we do.

But this is a capability that allows us in our tiered solution approach to offer more features and benefits that have great quality.

Okay, that's helpful.

Thanks, Vern.

And then my other question, you talked about variable comp, freight expenses, higher employee costs as increasing your SD&A.

Does the math change there?

You talked about that $95 million of fixed costs and then the variable component varying at about 11.5% rate with sales.

Is that still the right number to use?

I know CapEx is projected to increase a little bit in Q4.

Is there going to be some more seasonality with it, some more investment that's going to take that higher?

How do we look at OpEx over the near and then out in the next year?

Matt, let me be clear.

Was that one question or 50?

(laughter)

That was one question with many parts.

Thank you.

All right.

Let me start to dissect it a little bit.

This particular quarter our freight and commissions expense were slightly higher than what we would normally expect, probably 30 bps higher.

Usually we're in that 11.5% to 11.6% of total revenues.

Again, we were 30 bps higher.

I think that that was a little bit of an abnormality.

So we would expect over time that to find its average, again 11.5% to 11.6%.

When it comes to the fixed costs -- and obviously it's not completely fixed because we have incentive compensation and other items that are somewhat like that in there -- our view is that we are increasing that fixed base.

And, again, I want to be very clear about this.

We are investing in things like eldoLED.

We're investing in capabilities like partnering with Qualcomm and Lumicast.

These are outside of, if you will, the traditional or historical businesses that Acuity was focused on.

The reason we're doing that is because, again, we see great future potential that really is expanding what we would consider our addressable market and the future opportunities that are out there.

How quickly some of those will roll in, time will tell.

And we'll provide more information as we know more information.

But we see such huge potential, we want to continue to invest.

That brings me all the way back, then, to your question around that fixed piece.

We were averaging about $95 million per quarter.

My guess is that you'll -- you are seeing that ramp up.

I think this quarter we were close to $100 million -- $99.3 million, whatever the exact number is.

My guess is that, based on our headcount -- we've added about 50 to 60 folks here over the last quarter-and-a-half but we're going to continue to invest to get after some of these other areas -- so it wouldn't surprise me if that number migrates to the 105 range.

What I really like as a way for your models, if you look at our total headcount, we're now sitting with about 2,160 salaried folks.

In total, we have about 6,800 people.

But on average, to deliver the consensus top-line number -- which I don't have in front of me, but, say, it's $2.4 billion -- what you'll see is that Acuity is continuing to drive headcount productivity.

And when we look at the salaries, we're also driving salary productivity.

So, the growth is there and it's happening.

But we are investing outside of, if you will, our traditional business because we see potential there.

Let me add one other bit of commentary and I think this will help you.

When we look at our variable contributions, they fluctuate.

It's difficult to precisely predict because of mix sand and some of the investments that we're making exactly what is going to happen.

But let me give you all an example.

If I compare the third quarter to our previous second quarter, and I take away the noise around FX and around the warranty issue, and I adjust for a little bit of the inefficiencies as we ramp up the components business, when I look at that change in top line and I look at the variable contribution off of that, we were roughly 24% variable contribution.

So, I feel like we're delivering in a good range while continuing to invest in the business.

Now, it's unfortunate that we have a little bit of this noise around abnormal items, warranty and FX.

But those will go away.

And you'll continue to see, I think, a reasonable contribution coming off those incremental sales, which is important for both your models and your returns.

Lastly, I would point out that if you look at our cash flow return on investment on a trailing four quarters, we're now at 27% cash flow return on investment.

That's pretty extraordinary for a manufacturing Company.

All right.

Thank you, Vern.

Very helpful.

Mike Ritzenthaler from Piper Jaffray.

Yes, good morning.

My first question is a follow-up to a previous one on the pockets of strength within C&I, particularly as it relates to public sector projects.

I was curious if you're seeing accelerated bidding activity, generally speaking, there.

And can you remind us of the relative importance of public projects in Acuity's C&I portfolio?

Yes.

From a bid perspective, and I won't single out just public sector bids, but if I look at our overall quoting activity, quoting activity continues to be up nicely.

And obviously our hit rate continues to improve, hence the notion of market share gains.

When we look at the end markets, our roadway business continues to be very strong.

Again, that was building out the portfolio three, four years ago to really alter the competitiveness.

And I think we have meaningfully gained share.

We were losing share for a while there because we were slow on the uptake within the LED world.

And that no longer is true.

Acuity is, again, leading, not only from a technology perspective but we're the largest outdoor lighting manufacturer company in North America.

When we look at schools and that type of work, yes, as the budgets in many of these states and these local municipalities continue to improve, we're starting to see an improvement in what's happening in schools.

But lets be clear, schools is still a fairly soft market based on historical standards.

We truly believe that there is a lot of pent-up demand because populations continue to grow at roughly at 2% per annum, and yet schools have probably had a three-year hiatus in terms of their development.

Eventually that breaks.

Roadway, there's a lot of, again, opportunity as people continue to look at the benefits of LED luminaires versus others, particularly as we introduce controls into those LED luminaires that can do many more things other than just monitor the luminaire.

Excellent.

Thanks for that.

And then a follow-up question on the warranty issue and whether the current situation with the emergency signs will change or modify in some way the normal accounting mechanics going forward of the percent of sales reserved for warranty or if it's a temporary blip.

This particular instance would not adjust necessarily our process of accruing for warranty because this is a recall situation, which thankfully is extremely rare for us to experience something like that.

But we have continued to adjust our normal warranty accrual based on the typical experience that we have.

And with the newer technologies and the broader portfolio, we have been monitoring that very closely and have seen a modest increase in the percentage of our normal warranty accrual as a result of the more solid state and the longer periods of warranty, five years, for example, that we typically would offer for an LED warranty versus a shorter period that was normal for incandescent.

Plus now we would front more of that warranty than we did in the past.

So, a modest increase, nothing significant.

But we are monitoring that closely and making the appropriate adjustments in our accrual processes.

That makes sense.

Thanks, guys.

Tim Wojs from Baird.

Yes, good morning, guys.

Just on the mid to high single-digit market growth that you guys talked about, what gets you or what do you think gets the market to the lower end and the upper end of that range?

For us, we're not economists but what we do is we try to triangulate amongst a whole bunch of data points.

We use NEMA.

We look at what their prognostications are.

They're pretty consistent around the growth of the lighting market.

We look at all of the other indices that I had mentioned, whether it's ABI, the whole notion of absorption, population growth, what's happening with, for example, rental rates, so on and so forth.

And all of these signs continue to flash nice green.

There's not a lot of yellow out there.

So, I believe that, given how long we have been in the doldrums of nonresidential construction, it makes sense to us that this cycle begins to build on itself.

I won't be political here but this recovery has been the slowest recovery on record.

This is not abnormal to see this type of generation.

Going to certain markets around the country, you see that space has been well absorbed, so now they're into the new construction phase.

Out in California, Northern California, for example, two years ago there were few cranes in San Francisco.

Today there are many.

Same thing is true of the Northeast.

So, all of these signs are giving us, I think, a positive feeling that the trend that we've prognosticated is alive and well.

I believe that as business conditions continue to improve, we actually could see a shortage of certain types of real estate, and so, therefore, it will attract capital, it will then create investments and it will spur us on.

As Ricky pointed out earlier, the renovation world for us is a huge market.

It's, we guesstimate, north of a $300 billion installed base, 70% of which was put in place before 1990, converting very slowly.

So, how folks get after this market or that market will also I think spice the stew.

We expect that renovation will continue for quite a long time to be a meaningful part of our business, more than, say, it was in 2008.

Okay, that's helpful.

You raised the market outlook last quarter.

Is there anything over the last three to four months that you've seen, just talking with people at LIGHTFAIR and some of your agents, that gives you more confidence in that range relative to last quarter and as you look into 2015?

I believe that there's enthusiasm for the broad market in general.

So, you could talk to any of my competitors or other industry participants, and I think they would tell you that the broad electrical industry, and then, more narrowly defined, the lighting industry, will be a very solid place to play over the next decade, particularly as more technology comes into place.

But when we look at Acuity, we get quite excited about our future, and our future meaning our long-term future, because we see the opportunity not only to provide discrete products which we're darndably good at, but also, now, the opportunity to provide varying levels of holistic lighting solutions that incorporate not only the luminaire itself, but now sensing technology, control technology.

Folks can do so much more with that solution.

Again, we're very excited about the whole notion of how we're delivering our visible light communication technology in partnership with Qualcomm.

We think that these retailers will be very excited to not only have quality of light, tremendous energy savings, but now it's an additional revenue source.

So, we're very excited to continue to invest in ways where technology is an enabler to us to expand our addressable market.

It wouldn't surprise me that if over the next 12 months we redefine our addressable market to be much larger than what it is today.

Great.

Thank you.

Colin Rusch from Northland Capital Markets.

Thanks so much.

Just following up on that point about the addressable market, obviously if you've got these control systems in place there's a significant software or software-as-a-service opportunity for you guys to potentially address.

Can you talk a little bit about the direction that these partnerships are going?

That's the first part of this question.

The second part, you mentioned the 24% return on invested capital.

You've been very, I think, disciplined as investors over the course of years.

Could you talk about your expectations for return on investment with these partnerships?

Sure.

These relationships that we have, we have been working on for really some time.

And they come in all forms.

We have strong relationships with our supply base.

So, how we work with suppliers, some of whom are even competitors.

But how we work with those folks to bring value has always been one of the hallmarks of Acuity.

And really understanding the end market, and then being able to bring the best players to really solve that problem, I think that is a great skill that we have.

As solid state or electronics come into our world, it's allowing us, really, to take a blank sheet of paper and think very differently.

It's almost the world of Apple.

How do you bring apps, how do you take advantage of what technology's allowing you to do.

What's truly amazing here is if you take eldoLED, which is a programmable dimmable driver that provides really no stroboscopic effects on luminaires -- some of our competitors and other component suppliers actually can't make that claim -- it allows us to provide quality of light into a space, but also now be a communication device, and a clean communication device.

So, to us, this is fantastically interesting.

We can do many things.

We certainly can't do everything.

We're in conversations with many folks, not only suppliers but also potential other access points to market, channels, if you will, that we have never really traditionally talked to before.

Now we're able to bring, I think, a very differentiated capability.

Every building, every street needs to have a light of some type.

It's now a communication device.

So, how we take advantage of providing superior quality of light, energy savings and now other potential revenue streams from that communication device is a unique capability.

Our luminaires now have sensing devices in them from one of our acquisitions that we made -- what, four years ago, Ricky?

-- with Renaissance.

So, all of these pieces and parts are now really starting to come together in a way that will allow us to provide tiered solutions to folks in these end applications as they want.

And it's opening up a whole new world for us in terms of who should we align with and how?

And, generally speaking, you're getting the best players coming together.

There are other folks that are out there offering some type of mobile device into the retail space.

We believe very strongly that when the market really sees the combination of Qualcomm's Lumicast technology with our superior lighting, we have really a very robust offering that will be hard to match.

Okay.

Then just changing gears a little bit, just talk about two things.

One, any change in geography in terms of end market pull-through within the US, just on a regional basis?

And then if you could comment on opportunities in agricultural light space, what you're seeing there at this point.

I would say from a geographical perspective, we're starting to see nice growth in those markets that have led certainly with technology and/or -- pick the West Coast, San Francisco, you've got LA moving up; take the East Coast where you've got Boston, you have Washington still -- all of these markets are starting to improve.

Where job growth is occurring, you're seeing nice construction activity.

I would say that, from a geographical perspective, we're seeing reasonably broad-based approach.

In some of these markets where they have shale gas and opportunities, they're on fire because they're growing so rapidly.

So, where there's job growth, there is opportunity.

Where there is political intrusion or intervention, you see slower growth.

Ricky?

I would agree.

Certainly seeing it in those areas where the employment is picking up, which is one of the big drivers.

On the agricultural light question, that is not a market that is a strategic focus for that.

You are seeing a pick-up for certain niche players in that market.

But it has not been a strategic focus for us to participate in that agricultural growth type lighting.

Perfect.

Thanks a lot, guys.

Winnie Clark from UBS.

Good morning.

Thanks for taking my question.

I wanted to talk about mix a little bit more.

You have been seeing better trends in higher-margin products over the last couple quarters from an order perspective.

It sounds like you thought you might have benefited from it a little bit more in 3Q.

Would you expect these orders to start driving an improvement in the mix dynamic next quarter or is that likely to be something you'd see in 2015?

It's hard to predict what the next quarter looks like.

We've seen our June order rates and so we're favorably inclined, and hence we've made the comment that we think that, again, our order rate for the month after the quarter continues to reflect the growth trend.

But, yes, I think as we go into 2015, our expectation is that our margin should gradually improve as we continue to sell what we call more tiered solutions.

As we migrate down the value-add curve where it's not just a single product type competing features and benefits and price, it's more about how does the whole system work and what are the benefits that come off of that.

We believe that that will yield a higher and a more rich mix and, therefore, margin.

With regard to the fourth quarter, we don't really prognosticate.

But I think this quarter for us, it was just a little bit -- it's just the way the mix flowed in terms of some of the projects that we had.

I would expect that, as we continue to see volume growth, and as we continue to do cost-outs, as we continue to probe these markets on these various solutions, our expectation is that our mix will continue to evolve in a more favorable way.

Like I say, when I do the puts and takes, I do a back of an envelope sort of calc, and our margins, gross profit margins, were 41.2% for this quarter.

Again, improvement, particularly improvement over the second quarter on an apples-to-apples basis.

And, so, I would hope that that trend continues, and that the headwind that we faced this quarter from a mix perspective does abate somewhat.

And the other point that I made earlier is our freight cost and our commission cost, that combination was a little bit higher than what we typically have experienced.

So I would hope we would see a little bit of regression back to the norm on that, as well.

Okay.

Thank you.

Last quarter, while you noted it was hard to quantify, you thought weather could have been as much as a 3% sales headwind.

I think you said you don't think you saw any weather catch-up in the current quarter.

Is that something you still think you could recapture during the peak season?

It's a great question.

Interesting to us, we all speculated, would it be something that we would recoup.

And I think you saw lots of industrial companies come out afterwards and made commentary around how the weather impacted their business.

We did not see, in the channels that we particularly watch, a rebound.

We tried to watch certain projects, and those projects simply just played out the way they were going to play out.

So, we don't really think that there was any meaningful impact.

I'm certain there was an order here or there that flowed through and was accelerated, trying to benefit or meet time deadline.

But in this case, generally speaking, we just don't feel that we recaptured any of that, nor do I think that we're bound to recapture that.

I think that everyone's adjusted their construction cycles and they're just simply moving forward.

Great.

Thank you.

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

Thank you, everyone, 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 strong returns to our key stakeholders.

Our future is very bright.

Thank you for your support.

That concludes today's conference.

Please disconnect at this time.