Acuity Brands Inc (AYI) 2014 Q4 法說會逐字稿

Good morning and welcome to the Acuity Brands 2014 fourth-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.

Thank you, sir, you may begin.

Good morning.

With me today to discuss our FY14 fourth-quarter and full-year 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 in 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 will answer your questions.

First, let me say we are extremely pleased with our performance in 2014.

We achieved record results for net sales, diluted earnings per share and cash flow generation for both the fourth quarter and the full year.

For the full year in the fourth quarter net sales grew 15%, which was meaningfully higher than the estimated mid single-digit growth rates for the key markets we serve.

In fact, this was the sixth quarter in a row where we achieved double-digit volume growth, a meaningful accomplishment in this environment.

We believe these results are yet again strong evidence our strategies to provide our customers with differentiated, value-added solutions and 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 geographies, and improvements in customer service and Company-wide productivity.

Our profitability and cash flow for the quarter and the full year were records for Acuity even as we continued to fund our strong sales growth in areas with significant future growth potential, including the expansion of our solid state luminaire and lighting controls portfolio.

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.

First, for the quarter.

Net sales for the fourth quarter were a quarterly record of $669 million, an increase of over 15% compared with the year-ago period.

Operating profit was $90.7 million compared with $78.2 million in the year-ago period.

Operating profit margin was a robust 13.6%, up 10 basis points from the year-ago period.

Diluted earnings per share were a record $1.26 compared with diluted EPS of $1.03 in the year-ago period, up 22%.

Strong quarterly results, indeed.

For the full year, net sales at Acuity were a record $2.4 billion, up almost 15% from 2013.

Operating profit was $1 million shy of $300 million compared with $222 million in the year ago period, up 35%.

Adjusted operating profit was $293 million or 12.2% of net sales, compared with $247 million or 11.8% of net sales in the year-ago period.

Diluted EPS was $4.05 compared with $2.95 per share in 2013, up 37%.

While adjusted diluted EPS was $3.97 per share compared with $3.31 in the year-ago period, up 20% from 2013.

In addition, we generated $233 million in net cash provided by operating activities this year while funding a $55 million increase in accounts receivable due to our record sales growth.

As Ricky will discuss later, we meaningfully enhanced our already strong financial position in 2014, as we now have more than $550 million of cash and cash equivalents on hand, far exceeding our debt of slightly more than $350 million.

Lastly I'm pleased to report that we once again earned much more than our cost of capital.

Our cash flow return on investment was a robust 29%, the second highest in our history, and far in excess of most in the electrical industry.

These results for the quarter and full year were significant improvements over the year-ago period.

We believe you will find our results for the quarter and the year even more impressive upon further analysis.

While net sales for the fourth quarter grew more than 15% compared with the year-ago period, we estimate our sales volume grew almost 17%, partially offset by lower price mix and to a lesser degree, the impact of foreign currency.

While it is not possible to precisely determine the separate impact of price and mix changes, we believe the difference was primarily due to lower pricing on like-kind LED luminaires between periods, reflecting decline in certain LED component costs.

The increase in net sales was broad based along most product lines, including certain specialty fixture types more closely associated with new construction as we began to see an uptick in this important market.

From a channel perspective, we continued to experience strong growth in commercial, industrial and infrastructure.

Sales growth at our largest channel, commercial and industrial, was above this quarter's overall percentage increase as we continue to focus on projects for new construction and renovation in both the non-residential and residential markets, as well as continued emphasis on selling higher value-added lighting solutions.

Especially LED luminaires, where sales of our LED products almost doubled again this quarter compared with the year ago period, an extraordinary achievement when one considers that sales of LED-based luminaires now account for 40% of our total sales.

Our rate of growth for LED luminaires continues to far out pace the growth rates of our largest competitors for these types of products, demonstrating our market-leading prowess.

Excluding LED luminaires, we believe the puts and takes for product pricing, as well as material and component costs, were again fairly benign this quarter.

Looking at market conditions for the fourth quarter, we believe the North American lighting market was up mid single-digits during the quarter, supported by growth in renovation as well as the residential market.

This is in stark contrast compared with the growth rate of our net sales in North America, which was up more than 15%.

Lastly, we believe our 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 achieve meaningful sales growth this quarter.

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

As we noted earlier, our fourth-quarter operating profit was $90.7 million, the most in our history.

And operating profit margin for the fourth quarter was a robust 13.6%.

More impressive was our gross profit margin for the quarter, which came in at 42.4%, up 150 basis points compared with the year-ago quarter.

The expansion of our gross profit margin was primarily due to the benefits of higher net sales, favorable sales channel mix and productivity improvements, partially offset by unfavorable changes in foreign currency exchange rates.

Next, total selling, distribution and administrative expenses were up $34 million, or 21%, on a net sales increase of 15%.

SD&A expenses as a percentage of net sales were 28.8% in the quarter, an increase of 140 basis points from the year-ago period.

This next point is very important.

The increase in our SD&A expenses was primarily due to higher variable cost for freight and selling commissions to support the record growth in net sales and a $15 million increase in our variable employee incentive compensation expense, which is based on our bonus program plan design that incents and rewards strong period-over-period growth.

Our performance, which is measured along three key metrics of profit growth, margin improvement, and cash flow generation, this year compared with the year ago period placed us above the 75th percentile of our benchmark indices, driving the increase in our employee incentive-based compensation expense, a positive reward for record performance.

Another way to view just how robust our fourth-quarter results were is to examine our variable contribution margin, adjusting for this net increase in employee incentive compensation in order to make it comparable to the same period last year.

Doing so, our variable contribution on the incremental sales of $89 million was almost 31%.

Strong results, indeed.

The story was much the same for the full-year's record results.

Net sales grew 15% this year, almost three times the estimated growth rate of our addressable market.

Gross profit margin was 40.9%, up 40 basis points compared with the prior-year's adjusted gross profit margin.

Adjusted operating profit of 12.2%, which included a $31 million increase in our variable employee incentive compensation expense, improved 40 basis points over 2013.

To be very clear, variable employee incentive compensation is an integral part of our business model, which is based on aggressive period-over-period improvement performance.

However, if one were to adjust for the net increase in our full-year employee incentive compensation expense, so as to make the year-over-year comparisons meaningful, our operating profit margin increased by 130 basis points and the variable contribution margin for the incremental sales in 2014 would have been over 25%.

All in all, we had a great year.

On the strategic front we accomplished a great deal in 2014, setting the stage for what we believe will be strong growth and profitability in 2015 and beyond.

Internally we've made great strides on a number of fronts by further accelerating the deployment of our lean business processes.

For example, we improved our productivity throughout the organization.

One measure of productivity is net sales per associate, which increased almost 11% in 2014.

Another area of strong improvement was in our service to customers, where light backlog declined to a historical low while on-time delivery was at an all-time high.

From a product and lighting solutions development perspective, we continued our rapid pace of new product introductions, significantly expanding our industry-leading portfolio of innovative, energy-efficient luminaires and lighting control solutions.

To put this in perspective, we now offer customers more than 1.7 million SKUs to choose from, more than three times as many as we had in 2008.

No other lighting company offers customers more choices and more solutions than Acuity Brands.

Much of this growth in our portfolio has been driven by the expansion of our lighting controls and solid state lighting product offering.

For the full year, our LED sales more than doubled compared with 2013.

This is an extraordinary achievement when you again consider that if our LED sales were measured as a stand-alone Company, we believe it would be the fourth largest lighting luminaire Company in North America, while we believe our conventional business would still be number one.

Also, we continue to fund the development of holistic integrated lighting 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.

Additionally, we continued the development of luminaires incorporating other light source technologies such as organic LEDs, where we continue to expand our award-winning portfolio of these innovative products.

More impressively, our adjusted operating profit margin continued to expand this quarter and this year, while sales of LED-based solutions have become an even larger portion of our overall business.

Acuity is a clear leader in providing customers with superior lighting solutions, incorporating either convention or solid state light sources.

The market has come to understand that LED as a light source is no longer a new technology.

Now widely accepted, the attention of customers is focused on how one can best control and utilize this light source to optimize their visual environment, while realizing the benefit of its long life and energy savings characteristics.

Because Acuity truly understands how best to fully utilize the unique capabilities of LED to optimize the visual environment and provide significant energy savings through our smart and simple solutions for virtually any application, we are growing significantly faster than virtually all of our major competitors.

At Acuity, we view the advent of LED as an enabler, affording us the opportunity to bring differentiated lighting solutions to a broad array of customers, distancing us from our competitors.

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

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

Our formidable strength in innovation was on full display again in 2014 where Acuity won numerous industry awards for indoor and outdoor LED lighting and control solutions, as well as for our new line of organic LED products.

As I have noted before our organization has a long and distinguished history of leading and innovating during the eras of technology disruption, and that is even more true today.

Acuity Brands is leading the evolution to intelligent lighting solutions with its broad and deep portfolio of indoor and outdoor solid state and traditional energy-efficient luminaires and lighting controls.

And we are delivering profitable growth and strong financial returns for our shareholders while making these important investments.

These accomplishments have diversified and strengthened our foundation and will further serve as a robust platform for our future growth that is less reliant about on the new commercial construction cycle.

We have been able to produce these results because of the dedication and resolve of our 7,000 associates who are maniacally focused on serving, solving, and supporting the needs of our customers.

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 before I make a few comments regarding our focus for 2015.

Ricky?

Thank you, Vern, and good morning, everyone.

Vern covered the primary drivers for our fourth-quarter and full-year sales growth and our profitability, so I'll not repeat these items.

The effective tax rate for the fourth quarter was 33.2% compared with 36.1% in the fourth quarter of last year.

The lower income tax rate was primarily attributable to favorable adjustments to certain discrete items.

In addition, the prior-year fourth-quarter tax rate was unfavorably impacted by a change in UK tax laws, which resulted in a reduction of certain deferred tax assets.

The effective tax rate for the full year of 33.8% was relatively flat compared with 34% in the prior year.

We estimate the effective tax rate for FY15 will be approximately 35.5% before any discrete items, and that the rates in our taxing jurisdictions remain generally consistent throughout that year.

As Vern mentioned earlier, cash flow generated from operations for FY14 was a very impressive $233 million, which is more than $100 million increase over the prior year.

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

Our operating working capital, defined as account receivables plus inventory, less accounts payable, decreased five days to an industry-leading 33 days, and represents only about 12.5% of revenue.

Most of this improvement was in our management of inventory, where we continue to improve our inventory turns while also improving our service levels.

In FY14 we spent approximately 1.5% of revenue, or $35.3 million on Capital Expenditures compared with $40.6 million in the prior year.

This reduction in spending was due to some large projects in FY13 that did not repeat, and delays in certain projects this year that got pushed into FY15.

We currently expect to spend approximately 2% of revenues in capital expenditures in FY15.

This expected uptick in capital expenditures is due to the projects that were delayed from FY14 and investments necessary to support our growth.

In FY14 our free cash flow, which we define as cash flow from operations less capital expenditures, was $197.8 million.

This is the sixth year out of the last eight years that we achieved our target of having our free cash flow exceed net income, which we believe speaks to the quality of our earnings and efficient management of our working capital and capital investments.

At August 31, 2014, we had a cash balance of $552.5 million, an increase of $193.4 million since the beginning of the fiscal year.

Our total debt was $354 million; consequently our cash exceeded debt at the end of the fiscal year.

At August 31, 2014, we had additional borrowing capacity of $243.8 million under our credit facility.

During our fourth quarter we amended and extended our credit facility, improving the pricing and terms, and extended its maturity so we have five years remaining on its tenure.

We have a significant amount of cash on our balance sheet, continue to generate a lot of cash, and have access to additional capital based on our extended credit facility.

So you're probably asking what are our priorities for all of this capital?

Our capital allocation priorities have not changed.

First, we will invest in capital expenditures for maintenance, cost savings and growth initiatives, which is expected to be around 1.5% to 2% of revenue per year.

Next we will seek strategic acquisitions to add technology, fill product gaps, and/or expand our market access.

The timing of acquisitions, of course, are hard to predict and quite frankly we would have expected they'd been more active this year in M&A.

We remain very disciplined in our acquisition activities and will continue to seek desirable acquisitions at appropriate valuations.

Lastly we will continue to return capital to shareholders in the form of dividends and stock buybacks.

In fact over the last decade, we have returned approximately half of our free cash flow to shareholders through dividends and share buybacks.

We clearly have significant financial strength and flexibility and will continue to seek the best use of our strong cash generation to enhance shareholder value.

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 that are ever changing and evolving, particularly for Acuity.

Our expectations for growth of the lighting industry, primarily in North America, has not changed much over the last few quarters.

We remain very positive.

So while we don't give earnings guidance, I would like to provide you with some observations for FY15.

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 for the broad lighting market in North America is expected to grow mid to upper single-digit range for our FY15, reflecting 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 the 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 leary of the next round of uncertainty that might come out of Washington, including potential noise around the midterm elections as well as fiscal and foreign policy issues.

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 next 12 months will continue to improve and be more broad based and consistent than that experience in either 2013 or 2014.

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

Second, excluding the price of certain LED components, which are expected to continue to decline, we do not anticipate significant changes in input cost over the next 12 months, 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 and the negative impact of rising healthcare costs.

As you know, our employee incentive compensation programs are variable in nature and designed to incent and reward period-over-period performance based on aggressive improvement along three key shareholder-centric measures.

Said differently, our incentive compensation plan is what everyone regards as a pure pay for performance.

In 2014, our incentive compensation was meaningfully higher than in 2013 due to our record performance.

So, we enter 2015 where a high performance base is already in our cost structure on which to compare future performance.

Assuming similar year-over-year performance in 2015 as we achieved in 2014, the increase in incentive compensation in 2015 would then be minimal.

But again, let me be very clear.

As your management team and fellow shareholders, we have every incentive in the world to out-perform the record performance we delivered in 2014 which would result in an increase in incentive compensation in 2015.

Next, we continue to be leary of foreign currency exchange fluctuations, which are impossible to predict.

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.

Another observation, while our gross profit margin is influenced by a number of factors including sales volume, price, product and sales channel mix and innovation, we expect our annual gross profit margin to improve over time as volumes grow.

Particularly for larger new construction projects, which should also benefit our mix and as we continue to realize typical gains in manufacturing efficiencies.

Our gross profit margin in the fourth quarter was a good example of our potential.

But we prefer to look at our margin improvements over a 12-month period to remove quarterly anomalies, like last year's second quarter due to weather, to discern proper trends.

You should do the same; it's a positive picture.

Additionally, we continue to experience some isolated pricing pressures in certain markets and sales channels.

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 and most importantly, we expect to continue to meaningfully out-perform the markets we serve.

Looking more specifically at our Company, we're very excited by the many opportunities to enhance our already strong platform, including the introduction of holistic lighting solutions like connecting smart lighting with smart phones 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 under-penetrated geographies and channels and growth from the introduction of new lighting solutions.

Our positive results reflect the solid execution of these strategies.

Our Company-wide strategy is straightforward.

Expand and leverage our industry-leading product and solutions portfolio, 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 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, along with emerging opportunities for digital lighting to play a key role in the internet of things.

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 America market leader, we are positioned well to fully participate in this exciting industry.

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

(Operator Instructions)

Our first question is Rick Class of Wells Fargo securities.

Good morning, everyone.

Ricky, on the $15 million increase in incentive comp, what should we think of as a normal run rate here in a normalized year?

Because when we add back that, that's pretty significant in terms of EPS.

I assume that in a normal year, you'd incur some level of comps.

So I'm just trying to get the right comparison and the right way to think about it.

So Rick, this is Vern, if I could answer that question.

This year, we obviously had record performance.

All of our employee incentive compensation programs are really driven towards driving pay for performance.

What you saw this year was essentially us exceeding the 75th percentile along three key measurements.

Again, we said earnings growth, operating profit margin improvement and cash flow generation.

So that 75th percentile cost structure is now baked in, if you will, into our cost structure.

Obviously, we have every incentive to continue to out-perform even that level of growth.

The reason that we provided you with this notion of the comparable variable contribution margin was so that folks could understand that the incentive comp was the piece that was driving that in a way that, as we go forward, you'll see us be able to deliver that kind of variable contribution on a net adjusted basis.

Okay, so we should think of this as the new base.

And then if you happen to under-perform that, then it's a positive to earnings as we think about 2015?

Yes, and again, it's not our objective to under-perform that.

Our history over the last decade has been, typically, that we have way out-performed the markets we serve.

So our incentive compensation has really always been in a pay-for-performance environment baked into our cost structure.

2013, frankly, was a little bit of an anomaly in that we incurred some inefficiencies that was due to our management or the lack thereof.

So obviously our incentive compensation was reduced in 2013.

Now going forward, we think we're at a more of a catch-up kind of mode.

Okay that's helpful and then just two other quick ones.

In terms of fixed SD&A, Vern, did you hit the $105 million this quarter?

Actually, if we exclude incentive comp, which I don't want to, all the rest of our costs were very consistent with, say, the third quarter, for example.

Still up from the year-ago period because we've added headcount into our business.

If we look at our total salaried head count, excluding bonus, as a percentage of sales, it actually has declined on a year-over-year basis.

But if we look at the spending that we had in total bonus in the fourth quarter, our total bonus accrual in the fourth quarter was $15 million higher than what it was in the year-ago period.

In fact, what we booked in the fourth quarter was more than all of what we booked in 2013, just again, to put that in perspective.

So the run rate that I would expect on our bonus going forward is what we've baked in, or if you will, what we've earned in 2014.

Then, if I look at those other fixed costs, that number is probably in the $95 million range.

Now having said all of that, we will continue to invest in head count.

We will continue to invest in our SD&A area but what you should expect to see from Acuity is us continuing to leverage that SD&A basis, that base down.

So that as a percentage of sales, our SD&A will continue to decline as we continue to improve our revenues.

So the actual dollars that we will invest there will continue to grow.

Right.

So the $95 million, should we still think at some point in 2015 you get to $105 million a quarter?

Well again, the $95 million, let's make sure we're talking about an apple to an apple.

The $95 million right now excludes the incentive comp.

I would say that incentive comp, if we look at it for the full year, Ricky, I believe it was $40 million?

Something of that nature.

Correct.

So let's call it $10 million a quarter.

So $105 million is probably the leverageable number.

But again, what I really want to make clear is that we are improving, and we did in 2014.

We grew our net sales per head by 11%.

So while we will continue to drive productivity in our business, we will also continue to invest in our business.

And just quick last one.

Gross margin.

Was there any positive impact in terms of timing of projects this quarter that helped get you to that level?

Or was that normal mix, for lack of a better term?

Well, what we did start to see is a little bit more of a favorable mix because of some of the new construction coming back.

A couple favorable signs, our specialty businesses, a number of them which are more directly related to new construction, had nice growth in the quarter.

As we have said in past, typically when we have a large new construction project, we see a much broader base of product being selected there.

And typically there's more value add in terms of the product and the service that is provided on those types of projects.

Our expectation is that new construction will continue to rebound as we enter 2015 and beyond.

I think you started to see a little bit of what we'll call channel mix, that was favorable to us.

But the sales volume obviously was a contributor to that as well.

And productivity.

Again, I take my hat off to our team throughout the organization, where we drove great productivity.

Okay, that's helpful.

I appreciate it, thank you.

Next question is Jed Dorsheimer, Canaccord Genuity.

Thanks, and congratulations for a pretty flawless quarter.

First question.

Vern, I was wondering if you could comment, the move to LED, and we'll maybe just throw OLED in there as well.

But this analog to digital transition, with respect to gross margin, is there any metrics that you could help us with in terms of that you're tying a percentage of systems versus simply a fixture sale that you're starting to see?

Or how we could better model that on a go-forward basis?

So Jed, if you, again go back to 2008, last high watermark in non-residential construction.

And by the way, we're still down on an inflation-adjusted basis here in the US, almost 20% from that last high watermark, and yet we're still delivering record results.

If you look at our sales today, 40% of our revenues are LED-based luminaires.

And if you look at the features and benefits within those luminaires, there's control devises, they're virtually all dimmable.

So the feature and benefit set is dramatically different than the same, if you will, light fixture in the conventional side, which needs to have electronic ballast.

It needs to have other features in it to perform at the same level.

So you are seeing this migration to a more capable luminaire, and the ability to do more things with it.

We are very excited by our nLight capability.

This is our software to control luminaires in a lighting environment, a room tied into a building floor, tied into an entire building, tied into the building management system, taking advantage of daylight harvesting.

All of these systems are really in their infancy.

That's what I mean by no longer is LED considered new technology.

What's really new, what customers are asking for, is how can you help me design smart solutions that are simple for me to use?

And so they're paying for those kinds of things.

But I believe we're still in our infancy as a market in that solution cell.

And we call it a tiered solutions approach.

Where we are from a tiered solutions approach is, again, primarily we call tier one where it's devices that features and benefits at a price point.

Tier two now starts to have more control capability, dimmability.

When you think dimming, think energy savings.

A tier three solution is now tying it together holistically where multiple fixtures are working in unison as part of a program to take advantage of daylight harvesting, now being tied into building management.

We're starting to see a migration down there.

But yet it's difficult to actually put a precise number of profitability.

We do see higher profit margins as we expand down our tiered approach.

It would be our expectation to continue to see that type of margin improvement over the longer term.

But right now, giving you something that you can actually model, I think we're still a little bit too early in the game to do that.

So is it fair to say that the tier three or the total system solution, is where LED was three years ago?

And from a expectations perspective?

I would say it's a good analogy.

Whether it's precisely that time frame or not, I don't know.

Because companies, many competitors are out there with different types of solutions that are still a challenge, the notion of Acuity focusing on creating smart and simple solutions that are user friendly, we're starting to see a great deal of traction as we bring together the entire portfolio that we have.

As you know, go back a handful of years ago, we've put to work over $0.5 billion in capital through acquisitions of controls businesses, acquiring talent, and now bring these systems to market.

We're just starting to do that, and the response has been very, very favorable.

Last question for me.

There was a lot of numbers in terms of fixed versus variable, so I wanted to reconcile the variable.

I thought I heard that it was $31 million, there was a $31 million increase year over year.

Is that for the entire year?

So 2013 over 2014 was $31 million?

Or is that for Q4 over Q4?

So to be very clear, in Q4 our incentive compensation increased period over period by $15 million.

For the full year, our incentive compensation increased about $31 million year over year.

Great.

Thank you.

Next question, Winnie Clark, UBS.

Good morning.

Congratulations on a solid quarter.

You noted price continues to be neutral other than for certain LED products.

Some of your competitors recently have indicated there's been some pressure.

So I'm wondering is it your mix versus other's that maybe explains why you aren't seeing that in your business?

Again, we continue to see pricing dynamics in every channel, in every geography.

But to say that this quarter was different than a previous quarter, what we're commenting on is that it still seems to us to be pretty much the same.

In many of our channels it's bid business, and so you have to be very competitive.

But what we try to do is really sell value, features and benefits, our service capabilities.

And why that is a better value than someone else who may be out there simply offering a lower price that can't offer the type of range of value to customers.

So again, our two cents is we touch so many different channels, so many different geographies, it just didn't feel to us like there was any meaningful change that would be worth noting.

Okay, thank you.

In terms of the various channels, what are you seeing?

Anything notable among the various channels?

Particular points of strength versus weakness, et cetera?

Again, as I mentioned earlier, we continue to see strength in our commercial, industrial and infrastructure businesses, or channels if you will.

I would expect those to continue.

We have the kind of portfolio that really is value creating.

So whether it be for renovation or new construction, we're extremely competitive.

We expect that the home improvement channel will be a growth channel for us again in 2015.

We're bullish about 2015 across many channels.

I would also say that, again as I noted earlier, our specialty businesses are now on an uptick.

That generally is reflective of an improving new construction market, which again, is favorable for Acuity.

Great, thanks so much.

Next question, Tim Weiss, Baird.

Yes, hi guys, great job.

On new non-residential construction, I was wondering what you're seeing in the marketplace?

I guess there's been some false starts in the past but the sum of the data out there recently suggested a little bit more of a broader recovery that's starting now.

One, I wanted to see if you agree with that statement.

And two, if you could break it into two silos in terms of private and maybe public or institutional of what you're seeing in those specific markets, from a new non-residential construction basis.

Tim, our approach is very straightforward.

We use different analysts, different information, from whether it be Dodge, Global Insight, NEMA.

And what we then try to do is correlate that or investigate with our customer base, are they seeing same.

You look at all this data.

If you look at, again vacancy rates, the architectural billing index, if you look at absorption, credit availability, the Dodge Momentum Index is a great indicator.

All of these things have been flashing green signals.

When we talk with our end customers, whether they're electrical distributer partners or whether they're architects, engineers, lighting designers, contractors, all of them have discussed being more busy and looking to add to their human capability to support what they see as growth.

For us, all of these things, these indicators, continue to flash green.

We are certainly aggressively putting our shoulder behind efforts to really drive growth in the various channels that we serve.

It's a collage of many indicators that all seemingly are favorable right now.

Okay, that's great.

And then, Ricky, you made a comment on expecting to be a little bit more active in your prepared remarks around M&A.

Some color around what deviated versus your expectations.

Was it a function of higher multiples, less attractive assets?

Some color there would be helpful.

And then what the pipeline internally looks like right now.

Yes, sure.

As I mentioned, it's very hard to predict the timing of acquisitions.

We're very active in the market, looking at things that meet the criteria.

We're looking at technology, filling in product gaps, expanding channel access and so forth.

Extremely busy this year looking at opportunities and so forth.

But it needs to be a desirable acquisition.

And as we get into it and look back, what is it really bringing?

Is it going to bring the capabilities and the strength that we had anticipated?

We don't always have it pan out from a desire ability.

And then on some instances, certainly the valuation, as people's expectations may be a little richer than we would think is appropriate to get the kind of returns that our shareholders would expect from it.

We're very diligent.

I think if you look back at our M&A track record, we've done some dozen or more acquisitions in the last decade, virtually all of which have added very well to our EVA.

Our return on invested capital, I think, speaks to that.

As Vern said, we were second highest in our year this year after investing $0.5 billion.

So we're going to stay very diligent.

We'll be very active, but we aren't going to get emotionally attached to one and do it just because we want to get bigger or we have some emotional attachments.

It's got to be desirable.

And then it's got to be at a valuation that gets the proper return to our shareholders to justify the risks that any acquisition brings.

You should count on us to continue to be diligent but active in that market.

That's great.

Thanks for the time and good luck on FY15.

Next question, Matt McCall, BB&T Capital Markets.

Thank you.

Good morning, everybody.

Vern, the new construction commentary is pretty encouraging.

Can you help us think about what you're expecting your new construction business versus renovation retrofit mix will look like next year?

I think if you go back to 2008, again, I use that as a reference point, we guesstimate.

It's impossible to precisely know that 80% of our revenues were driven off some type of new construction, 20% some type of renovation.

Today we guesstimate that our business is split evenly, 50/50 between new and renovation.

We have learned how to really fish in that renovation pond well, and we will continue to drive our capabilities there.

But as you know, we are uniquely positioned to respond to new construction demand.

I don't have a forecast or a precise target in mind as to what that mix would be.

But suffice it to say we expect both of those types of businesses, if you will, they're not separate businesses, but both of those segments to grow quite significantly over the next handful of years.

Renovation is a huge market.

Estimates are it's a $300 billion market, 70% of which was installed before 1990 converting at a very slow pace.

So the faster that companies like Acuity can reach into that install base and convince those building owners to update their lighting and their lighting solutions capabilities with our products, it really represents, again, a growth cycle.

I'm bullish on both, if you will, our continued focus on renovation as well as the hopefully re-emerging and consistently re-emerging new construction cycle.

Okay, thank you.

And then you referenced, you talked about it before, the bigger addressable market that you have.

As we move into a better construction period, can you help us understand the concept of value per square foot?

And how your offerings have changed?

And what that should do to the value you're able to offer each new square foot of space?

If you go back into the early 2000s, 1990s, as light sources transition from T12 to T8 to T5, people always understood the notion of more efficient use of energy.

What we see now today, not just with LED-based luminaires, but how we can control them and how we can take advantage of dimming capabilities consistently while people are in their space, it really provides for quite a payback story.

I believe building owners are now well aware, again, of the features and benefits of newer technology, what it can mean for them.

So people are looking at how can I enhance my visual environment while taking advantage of what new energy savings we can get.

So we're pretty excited about how folks perceive that.

Our expectation is that that will continue to drive the markets as we go forward.

Okay, thank you, Vern.

Next question is Chris Glynn, Oppenheimer.

Thanks, good morning.

Ricky, in talking about the acquisition picture, you mentioned technologies and product gaps.

I'm wondering how you're thinking about just pure consolidation as a core part of your acquisition strategy.

Yes, certainly we will look at opportunities to gain scale, whether it be small or larger consolidations.

Obviously looking what synergies can we create to create shareholder value there.

Just getting bigger to get bigger is not necessarily our strategy.

But if there's obvious synergies, either on the cost side or on the market side, absolutely we would look at that and want to be consolidator in that space.

I wouldn't say that that is our primary focus, but it would be an area that we would certainly look at as we look at others.

Thanks.

I think everything else has been asked.

Next question, Colin Rusch, Northland Capital Markets.

Thanks so much.

Can you guys talk a little bit about expected lifetimes and potential replacement cycle?

Obviously if we're at the early stages of the technology and evolution, there's going to be an awful lot of efficiency left to be had.

So you guys stepped out three, four, five, seven years, when do you think some of these devises that are being pulled within your lifetimes might actually be the technology out there that would be cost effective to replace?

So from a product life cycle perspective, we do see product life cycles shortening, as again the efficacy of light sources continue to evolve.

I think we have tooled our organization in a way to be quite responsive to that short-cycled opportunity.

The replacement market, as we mentioned earlier, the renovation market continues to be huge.

The amount of replacement that's occurred to date has been fairly de minimis, so there's quite a bit of runway left.

Companies like Acuity that sell the value of enhancing that visual environment while getting energy savings is a unique capability.

The new construction cycle, virtually everyone whose looking to build a building today that is a total cost of ownership type person, is looking at LED technology with the ability to incorporate our smart and simple controls, where again people can use these things in a very simple fashion.

We think that there's a lot of opportunity there for that.

So while cycles for new product development will, I think again, shrink it.

Particularly as a light source LED becomes more efficacious over time, you'll continue to redesign or design your luminaires to take cost out.

But we've been doing that quite effectively.

If you go back just again, when we first started with LED just shortly after 2008, today 40% of our revenues.

And we've been almost doubling every quarter over the year-ago period, we've become very skilled at how to manage that product life cycle management and continue to bring more value.

Great.

And then when you look at your R&D spend, and look at how much of that spend is going towards hardware redesign and evolution, and then how much is going toward software, can you talk a little bit about the trajectory over the last one to two years and how you see that developing going forward?

Sure.

R&D is a little bit of a misnomer.

We spend probably $30 million, $35 million a year in pure R&D, but we spend an enormous amount of money in product and solutions development.

Those are engineers who are responding to the voice of the market around product and solutions development.

The notion of solutions to us is different today than it was five years ago.

Again as I mentioned earlier, we look at how we provide customers with solutions along a tiered approach.

Five years ago Acuity was primarily in what would be tier one, product, devices, features and benefits, price.

That's how you do it.

Today, offering customers holistic turnkey solutions, more of this, what we call, tier three, it requires us to now have a different type of skill set, a human skill set.

We have been transitioning over the last few years of saying that we're not going to do certain things in the conventional world and investing heavily in the talent to really drive that tier three approach.

I think if you look at Acuity even two short years from now, you will see us having folks that are more involved in software development connecting to this notion of internet of things.

You saw that Acuity in conjunction with Qualcomm, introduced a retail GPS system that is really second to none.

We will continue to drive those types of capabilities, because for us, they represent incremental revenue sources that are attractive because of the value they bring to our end customers.

Great.

And then I'll sneak one last one in there.

Are you seeing evolution in terms of maturation of financing mechanisms for lighting?

Obviously there's pretty compelling pay backs.

Are you seeing new sources of capital for financing?

And potentially a drive towards lower-cost of capital coming into the market to finance lighting solutions?

We do see a number of opportunities.

I'll coin the phrase, light as a service.

The opportunity to sell, if you will, a different value proposition than simply saying I have a fixture that can go into your space.

There's many more opportunities for which financing will be an integral part of that, but not the only part of it, frankly.

The service element, the quality of light, how people use the space, all of these are -- you have to do that really well.

Then you can add on some of these other attributes of a potential transaction that people will find very compelling.

Great.

Thanks a lot, guys.

Next question, Glenn Wortman of Sidoti & Company.

Good morning.

I just had one question.

Wanted to make sure I understood the moving parts on incentive-based comp.

If you were to generate similar margin earnings growth and free cash flow improvement in FY15 compared with FY14, then we shouldn't expect to see much change?

You would not expect to see much change in the period-over-period incentive compensation expense.

Okay, thanks for the clarification.

Just to put that in perspective, again, I think it's an interesting factoid.

If you look at this fourth quarter and you compare it to our previous third quarter, our revenues increased about $65 million.

The variable contribution at the operating profit level was 30%.

That includes, in this case, a $60 million increase in the variable compensation expense.

Our fourth quarter we rocked it, and the full year was a solid full year.

So we were doing a little bit of catch up in the fourth quarter compared with the previous couple of quarters around the rate of our incentive compensation.

If we were to add that back, our variable contribution, just to compare an apple to an apple, of the fourth quarter compared to the third quarter, that variable contribution on that incremental sales dollar was 55%.

What we're trying to explain to all of you is the fact that we have now baked in what we would consider to be a high-performance level of incentive compensation into our cost structure.

So that when we get into 2015, if we were to deliver the same type of incremental sales growth, you should expect to see our variable contribution margin being 25%-plus.

And you wouldn't see us explaining, as a variance, why we had more incentive compensation over the year-ago period.

I hope all of that makes sense.

But again, please realize that we have every incentive in the world to out-perform what we did this year.

So we're focused on that.

Thanks for the color.

Our last question comes from Mike Ritzenthaler, Piper Jaffray.

Yes, thanks guys.

Just one last one for me.

Based on past construction cycles, I was wondering about the effect of an improving end market on price.

I know the last couple quarters we've seen a little bit of dip on price, but volumes have been good.

One would think that as everyone in the chain gets busier, it would materially lift the price mix bucket of your revenue growth.

I'm just wondering as we look through 2015, if those end markets do improve, what could the potential lift on price be as you look with the current product mix?

I would hazard to guess on that, so I won't.

But what I will say is that we do expect to have a richer mix, if you will, from a profitability perspective as the new construction cycle comes back.

Because we will be selling a broader portfolio of our products and our services that tend to generate more margin for us.

Because of the breadth and scale and the capability of not only our portfolio, but our people.

On pricing, again my expectation is that the market is a competitive market and will always be a bid market.

We will win based on how well we differentiate our portfolio and our services.

That's how I expect us to win.

If there's an opportunity in the bid world to differentiate our value and extract more price, we do that every day.

We do that every day.

Is that going to be different when others are busy?

I don't know.

I won't guess on that.

Okay, fair enough.

Congrats on a great quarter.

Thank you.

Thank you.

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

Thank you 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, continue to deliver strong returns to our key stakeholders.

Our future is very bright.

Thank you for your support.

Thank you for your participation.

That does conclude today's conference.

You may disconnect at this time.