Acuity Brands Inc (AYI) 2015 Q2 法說會逐字稿

Good morning and welcome to the Acuity Brands 2015 second-quarter financial conference call.

(Operator Instructions)

Today's conference is being recorded.

If you have any objections you may disconnect at this time.

I would now 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 second-quarter results are Vern Nagel, our Chairman, President and Chief Executive Officer and Ricky Reece, our Executive Vice President and Chief Financial Officer.

We are webcasting today's conference call at 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 be happy to answer your questions.

First off, our results for the second quarter of 2015 were simply outstanding.

Our net sales grew almost 13% while our adjusted earnings per share grew 44%.

Net sales in our adjusted results for operating profit, operating profit margin, net income and earnings per share were all second-quarter records for Acuity.

In addition this was the eighth quarter in a row where we achieved double-digit volume growth.

We believe these results are yet again strong evidence our strategies to provide customers with differentiated value-added solutions and to diversify the end markets we serve are succeeding allowing us to further 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 adjusted profitability for the second quarter was a record for Acuity even as we continued to invest in our strong sales growth and in areas with significant future growth potential including the expansion of our solid-state luminaire lighting controls portfolio as well as our pursuit to be a critical part of the backbone for enabling the Internet of Things.

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

Net sales for the second quarter were $616 million, an increase of almost 13% compared with the year-ago period.

Adjusted operating profit for the second quarter of 2015 was $78.7 million compared with adjusted operating profit of $58.2 million in the year-ago period.

There were minor adjustments in both periods.

I find it helpful to add back these small adjustments to both quarters' results to make them comparable.

Adjusted operating profit margin for this quarter was a robust 12.8%, up 210 basis points from the adjusted margin reported in the year-ago period.

Adjusted diluted earnings per share were a second-quarter record of $1.08 compared with adjusted diluted earnings per share of $0.75 in the year-ago period, up 44%, strong quarterly results indeed.

Lastly, as Ricky will discuss later, we meaningfully enhanced our already strong financial position this quarter as we now have more than $600 million of cash and cash equivalents on hand far exceeding our debt of slightly more than $350 million.

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

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

While net sales for the second quarter grew almost 13% compared with the year-ago period we estimate our sales volume grew more than 15%.

This growth was partially offset almost equally by lower price mix and 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 the decline in certain LED component costs.

Additionally our sales volume was impacted by harsh weather conditions in certain parts of US as well as labor issues at certain ports on the West Coast.

While it is impossible to precisely quantify the impact of these events on our results, we guess that the combined impact of these items negatively impacted our shipments in the quarter by 1 to 2 percentage points.

The increase in net sales was broad-based along most product lines including sales of certain specialty fixtures as well as certain control solutions more closely associated with new construction as this important market continues to expand.

From a channel perspective we continued to experience strong growth in commercial, industrial, infrastructure as well as gains in home improvement.

Our sales growth this quarter was primarily due to our continued focus on projects for new construction and renovation in both nonresidential and residential markets as well as continued emphasis on selling higher value-added lighting solutions, especially LED luminaires where sales of our LED products grew by 60% this quarter compared with the year-ago period, an extraordinary achievement when one considers that sales of LED-based luminaires at Acuity now account for 43% of our total sales.

We believe our rate of growth for LED luminaires continues to far outpace the growth rates of our largest competitors for these types of products demonstrating our market leading prowess.

Excluding LED luminaires and components, we believe the puts and takes for product pricing were again fairly benign this quarter while overall material and component costs were slightly positive.

Looking at market conditions for the second quarter, we believe the North American lighting market was up mid single digits during the quarter.

This is in contrast with a 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 for the quarter.

As we noted earlier, our adjusted second-quarter operating profit was $78.7 million, a robust 12.8% of net sales, up 210 basis points from the adjusted margin reported in the year-ago period.

Our gross profit margin for the quarter was 41.5%, up 210 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, productivity improvements and lower material cost partially offset by price mix and unfavorable changes in foreign currency exchange rates.

Next adjusted total selling distribution and administrative expenses were up $20 million or almost 13% similar to the increase in net sales.

Adjusted SDA expenses as a percentage of net sales this quarter were flat compared with the prior year at 28.7%.

The increase in adjusted SDA expense was primarily due to higher commission costs to support the increase in net sales and higher employee-related costs including incentive compensation partially offset by productivity gains.

This next point is very important.

Another way to view just how robust our second-quarter results were is to examine our variable contribution margin or adjusted operating profit on the increase in net sales.

In doing so one can see our variable contribution on the incremental sales is $70 million was almost 30%.

All in all, we had another great quarter.

On the strategic front we continued to make great strides setting the stage for what we believe will be a strong growth and profitability for the balance of 2015 and beyond.

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

As we have noted in the past we offer customers more than 1.7 million SKUs to choose from, more than three times as many as we had in 2008.

To our knowledge no other lighting company provides customers with more choices and solutions than Acuity Brands.

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

For the second quarter our LED sales grew 60% compared with the year-ago period.

This is an extraordinary achievement when you consider that if one were to measure the sales of our LED products as a standalone company we believe it would be the fourth-largest lighting luminaire company in North America.

We continue to invest and expand our capabilities to drive our integrated tiered solution strategy.

The purpose of this strategy is to leverage our incredibly diverse portfolio by offering customer solutions that best meet their needs whether it be a single device or a complete holistic integrated lighting solution for their indoor and outdoor needs and everything in between all with the promise and security from Acuity that you are in good hands and we have your back.

This is a compelling and powerful value proposition for our customers.

While sales information for our tiered solutions is still imprecise and expanding off a small base we believe our sales were up over 50% year over year in these categories.

To fully execute this strategy we have continued to hone our organization structure to be more customer centric, leveraging our industry-leading access to market and to better allocate resources along each of our tiers creating the best solutions for our customers' applications.

More impressively our adjusted operating profit margin continued to expand this quarter compared with the year-ago period 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 conventional 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 they can best control and utilize this light source to optimize their visual environment while realizing additional benefits including its energy savings characteristics and the opportunity to have a smart connected platform for the Internet of Things.

Because Acuity truly understands how best to fully utilize the unique capabilities of LED through our smart and simple solutions for virtually any application we believe we are growing significantly faster than the markets we serve.

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

As part of our tiered solution strategy Acuity Brands is a leader in the evolution to smart buildings and smart cities.

We are leveraging our deep customer knowledge, our unmatched access to market and our broad and deep portfolio of indoor and outdoor solid-state and traditional energy-efficient luminaires and lighting controls to bring truly differentiated value to customers and we are delivering profitable growth and strong financial returns for our shareholders while making these important investments including acquisitions and strategic alliances to broaden our capabilities to serve customers.

As such we are pleased to announce this quarter the potential acquisition of Distech Controls as well as a strategic partnership with Sensity Systems, both of which have helped drive our tiered solution strategy particularly as it relates to our holistic approach towards the advancements of smart buildings and smart cities.

Just a quick comment on both opportunities.

Distech based outside Montreal, Canada is a leading provider of building automation and energy management solutions that allow for the seamless integration of lighting, HVAC, access control, closed-circuit television and related systems.

The combination of Distech and Acuity with our broad industry-leading solid-state lighting portfolio, innovative control technologies and integrated digital solutions should contribute to our tiered solution strategy to offer true end-to-end optimization of all aspects of the building for enhanced occupant experience, quality visual environment, seamless operational energy efficiency, operational cost reductions and increased digital functionality.

Distech while relatively small today with annual sales of approximately CAD70 million would enhance our tiered solution strategy going forward as we enable smart buildings.

We hope this transaction which is subject to Distech shareholders' approval as well as other customary closing conditions will close before the end of our fiscal year.

We will have more to say about this once the transaction is complete.

Our strategic partnership with Sensity, a pioneer in light sensory networks, will allow us to deliver smart lighting solutions to cities, commercial and retail facilities, airports and universities focused on improving energy conservation, public services, safety and security and a wide variety of other applications.

Additionally our joint solutions will further transform energy-efficient LED lighting into smart connected platforms for the industrial Internet of Things.

Strategic opportunities such as these coupled with our internal efforts should allow us to continue to diversify and strengthen our foundation and further serve as a robust platform for our future growth that is less reliant on the new commercial construction cycle.

We have been able to produce these results because of the dedication and resolve of our more than 7,000 associates who are maniacally focused on serving, solving and supporting the needs of 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 final comments regarding our focus for the balance of 2015.

Ricky?

Thank you, Vern, and good morning everyone.

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

I will provide a bit more color on our quarter's results and financial position as well as our recently announced potential acquisition of Distech.

I will begin my prepared comments by providing a brief update on streamlining activities.

We recorded a modest $0.6 million favorable adjustment to the special charge due to the lower-than-anticipated employee-related severance cost.

We currently expect to incur production transfer expenses and additional cost associated with these streamlining actions totaling approximately $1.4 million during the second half of fiscal 2015.

This will result in a total charge for the fiscal year of approximately $11 million.

We still expect to achieve annual savings in excess of the total estimated charge cost but as we mentioned last quarter, we plan to reinvest a portion of these savings in additional growth initiatives which will require adding new talent with different skillsets.

Accordingly in fiscal year 2015 we expect to realize savings net of reinvestments approximately equal to the amount of the total streamlining cost.

The effective tax rate for the second quarter was 34.4% compared with 35% in the second quarter of last year.

As we indicated last quarter we received a slight benefit in the second quarter due primarily to the retroactive application of the US research and development tax credit which became law during the second quarter with the passage of the tax extenders.

We still expect the effective tax rate for fiscal year 2015 to be 35.5% before any discrete items and if the rates in our taxing jurisdictions remain generally consistent throughout the year.

As Vern mentioned earlier, cash flow generated from operations for the first half of fiscal year 2015 was an impressive $75.5 million which is an $18.1 million increase over the prior year.

Our operating working capital defined as accounts receivable plus inventory less accounts payable decreased five days year over year to an industry-leading 41 days and represents only about 12% of annualized revenue.

Much of this year-over-year improvement was in our management of inventory where we continued to improve our inventory turns while also improving our service levels.

In the first half of fiscal year 2015, we spent $27 million on capital expenditures compared with $16.5 million in the prior year.

We currently expect to spend approximately 2% of revenues in capital expenditures in fiscal year 2015.

This expected uptick in capital expenditures compared with recent prior years is primarily due to projects that we delayed from fiscal year 2014 and investments necessary to support our growth including the buildout of our innovation and technology center here in Metro Atlanta.

At February 28, 2015 we had a cash and cash equivalent balance of $601.1 million, an increase of $48.6 million since August 31, 2014.

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

At February 28, 2015 we had additional borrowing capacity of $243.9 million under our credit facility.

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.

I will conclude with some additional comments on the proposed Distech acquisition.

As Vern mentioned earlier on March 9 we announced that we had entered into an agreement to acquire all of the outstanding capital stock of Distech.

The terms of the agreement reflect a cash purchase price totaling CAD318 million or approximately $250 million which we intend to fund using cash on hand.

The closing of this proposed transaction is subject to approval by certain Distech shareholders and other closing conditions.

If we're able to successfully conclude these remaining conditions we would expect to close in the next several months.

Because of significant volatility in the US and Canadian dollar exchange rate over the last year or so we thought it prudent to enter into a foreign currency forward contract in an effort to mitigate nearly all of the foreign currency exposure associated with the Canadian dollar purchase price.

Because US GAAP does not allow a hedge of a commitment to acquire a business to receive hedge accounting treatment any gain or loss incurred on the ultimate settlement of the forward contract which is based on market exchange rates at the settlement date of the forward contract will be recognized in the income statement.

Distech generated net sales in excess of CAD70 million during calendar year 2014 and enjoyed a five-year annual growth rate of over 25%.

Almost half of Distech's sales are in the US, about a third in Europe, less than 10% in Canada and the remaining spread broadly around the rest of the world.

The operating profit margin of Distech is similar to Acuity.

We will provide additional details following the completion of the transaction.

Thank you and I will 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 growth expectations for the lighting industry primarily in North America has not really changed much over the last several quarters.

We remain very positive.

So while we don't give earnings guidance I would like to provide you with some observations for the balance of fiscal 2015.

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

All 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 in the mid- to upper-single-digit range for our fiscal 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 for the North American market such as Architectural Building Index, vacancy rates, office absorption and lending availability and favorable employment trends continue to improve while residential construction continues to grow nicely.

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 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 the overall demand in our end markets for 2015 will continue to improve and be more broad-based and consistent than that experienced in either 2013 or 2014.

The continued favorable trend in our March 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 for the balance of 2015 as some commodity costs have waned while others continue to rise.

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

Next we continue to be leery of foreign currency exchange rate 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.

Another observation, while our gross profit margin is influenced by a number of factors including sales value, price product and sales channel mix and innovation we expect our annual gross profit margin to improve over time as volume grows particularly for larger new construction projects which should also benefit our mix particularly as we execute our tiered solution sales strategy and as we continue to realize typical gains and manufacturing efficiencies.

Our gross profit margin improvement in the second quarter was a good example of our potential but we prefer to look at our margin improvement over a 12-month period to remove quarterly anomalies like the impact of harsh weather conditions or the seasonality of the second quarter in general to discern proper trends.

You should do the same.

It is a positive picture.

Additionally while 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 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 that for example connect smart lighting to smart phones for retailers as well as our growing electronic component capabilities.

As we have noted in our last several conference calls while our strategies to drive profitable growth remain essentially the same the implementation of our integrated tiered solution strategy is really the next step in the advancement of our overall growth strategy.

Additionally 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 product and solutions portfolio coupled with our extensive market presence and our considerable financial strength and 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 aligning our resources and continuing to make additional investments in certain areas 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 along with the broader electrical 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 and electrical 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 that you have.

(Operator Instructions) Matt McCall, BB&T.

Thanks, good morning, guys.

So Vern in the past you've been helpful in giving us an idea of what the addressable market looks like over the next three to five years.

Can you talk about how Distech and the exposure to that I guess what amounts to be a new tier in your tiered solution strategy what it does to that addressable market and how it changes your outlook over that three- to five-year period?

Sure, Matt, that's a great question.

First of all Distech participates in the building energy management system market that's roughly what a $6 billion market, Ricky, growing at probably 7.5% or 8% per annum.

So they themselves are participating in a very interesting if you will portion of the broader electrical market and showing exceptional growth as Ricky reported.

We see the opportunity to not only participate, if you will, in that broader electrical market but to see the convergence of around key customer sets to bring unique capabilities that as we said can provide end-to-end type energy management, occupant comfort, visual environment.

So we see the opportunity to actually be accretive to the overall market growth by bringing these two businesses together.

Again it's a global business.

They have a global shareholder platform so just working through the mechanics of closing the transaction, again our guess is that it will be completed sometime before the end of our fiscal year.

So we're not really giving, if you will, additional earnings guidance for 2015 until the transaction is complete.

But we are very bullish about the combination of the two businesses.

Okay, perfect.

Thank you.

Then I guess my second question another strong contribution margin this quarter.

Did the comps seem to get a lot easier if I look at my model correctly in the back Of last year, especially in Q3.

Is there anything we need to keep in mind that would make us not assume that the incremental is thus stronger than what you've been running in the back half of this year?

Let me think about your comment.

You said the comps get easier.

Let me think about that.

We've grown by double digits for the last eight quarters in a row.

I'm sorry.

Let me clarify, Vern, the incremental margin comps.

So in the first half of last year according to my model you did about a 20% incremental margin and a 17%.

In the back half it goes to 9% and 14% and so you've been running 30% on those what amount to be tougher comps on the incremental side.

With your incrementals getting easier should your variable margin thus increase from the 30% range or is there something else to keep in mind?

Well, Matt, I'm just giving you a little bit of a hard time.

That's okay.

Our variable contribution margins in the second half of last year were impacted by the increase in incentive compensation.

This year we are performing at a very high level and so the incentive compensation should be at or slightly above where it was last year.

So therefore it should have a de minimis impact, if you will, on the contribution rates that we'll experience this year which we would expect to be higher than what they were last year.

Again through the first half our variable contribution margin rate has been very robust.

Again when you think about your models, we are investing in our business, we are investing in people and skillsets and technology so we continue to be more comfortable with a variable contribution margin that is kind of in that mid- to upper 20%s.

But again we're trying to deliver every nickel and every dime we can to the bottom line for our shareholders.

I'm very, very pleased with the team's drive around productivity not just in terms of our supply chain but throughout our organization and you saw the benefit of that this quarter.

Our gross profit margin was up by 210 basis points over the year-ago period and while we continue to invest in people and skills and capabilities to really pursue our tiered solution strategy, particularly tiers 2, 3 and 4 which we think provide great growth opportunities over the next decade.

Perfect.

Thank you, Vern.

Christopher Glynn, Oppenheimer.

Thanks, good morning everybody.

Just wondering if you could provide an update on how the market for Lumicast seems to be developing?

Sure.

As people will recall Lumicast is our visual internal light system for both retailers and other spaces.

It's a visual light guide system.

That capability and the customer response to it continues to be very favorable.

We are past certain test beta sites with certain customers and we're now moving to a broader platform and broader capability.

So we're very excited about what its future can mean and we'll provide more detail on that as those opportunities continue to roll out.

But we think that they will be a contributory part of our growth rates on a go-forward basis.

Great, and as you do lots of different things to further lighting's role in Internet of Things and your tiered solutions, and if we take the Sensity partnership, conceptually could we go into a little bit more detail how that fills in gaps around say what a Distech and Lumicast get you?

Sure.

I think Sensity again is a strategic partnership there is a great opportunity for both Acuity and Sensity to combine their disparate but consolidated skills to bring great value to cities, to people that operate large malls.

Their capability coupled with our luminaires and our control systems combined will allow us to provide a great deal of incremental opportunities for the end-user.

So if you think about President Obama came out and has an initiative I believe Ricky it's 1.5 million streetlights.

Right.

To renovate those and when you think about wherever there's people there is light.

So here's an opportunity to take advantage of the electronic aspects of LED both from Acuity and Sensity to now collect information and data that can be used for security, safety, traffic patterns.

All sorts of information where this data can be collected and then manipulated through apps to provide real-time opportunities for folks.

So think about parking structures, think about streets and cities and traffic patterns and weather patterns and so on and so forth, that kind of information can be collected from these types of polls, if you will, because of both Sensity and Acuity's capability to really provide unique value.

And I would just highlight, Chris, that Sensity is predominantly outdoor, focused on the smart city, the applications that Vern was describing.

Distech is obviously much more indoor.

We did have an offering and do have an offering in ROAM.

ROAM is still an acceptable technology for certain outdoor monitoring of lights but Sensity brings a much greater bandwidth and capability to expand our participation in this move to smart cities in the outdoor space.

Okay, thank you guys.

Jeff Osborne, Cowen and Company.

Great, congratulations on the strong results.

I just had two questions.

One I was wondering if you could give us a sense of perspective on the attach rate of tiered solutions within the LED sales was question one.

Then question two was just a bigger picture question on the Distech acquisition.

I'm trying to get a sense of where the borders or boundaries stand between what Distech would be doing and what say Johnson Controls and Honeywell and Schneider Electric would be doing in terms of the future of building automation.

Just how deeply, if you look out three to five years, do you want to get into that space?

So on the first question the attachment rate of LED to our tiered solution strategy, again overall this quarter about 43% of our revenues were LED-based luminaires.

If you think about a Tier 1 solution, which is really an individual device of some type has some functionality but then expanding all the way to say a Tier 3 solution which is a holistic fully integrated capability inside a building or in an outdoor application, the growth rate that we're seeing in kind of Tiers 2 and 3 to be particular is now north of 50%.

Our data isn't exactly precise.

It's coming off a small base and most of that capability particularly in Tier 3 would be LED-based solutions.

That's where we're integrating our controls platform into our luminaires and making it part of a holistic solution.

So again very exciting for Acuity and for our customers and we'll continue to drive that capability going forward.

If you then think about again visible light communication that we just spoke to and you think about the opportunity all the Distech, an opportunity of a Sensity coming together allowing us not only to take advantage of Tier 3?s solutions in terms of that capability in the marketplace but now offering it as a backbone to provide capability around the Internet of Things and giving us the opportunity to generate revenues in a Tier 4 capability.

So I think it's all very robust in what we're doing.

When we think about Distech, Distech supports the industry in terms of building energy management components as well as overall solutions.

And so to a degree we would be a provider of capability to those folks.

And in addition Acuity will be offering its own solution set to building owners that will attach both lighting, HVAC, building management into a more holistic approach to allow these folks a more simple, more elegant solution to managing their facilities as well as the combination of these two businesses to really get after collecting information throughout the building and facilitating that information flow into the Internet of Things to now provide that data back in real usable way or ways back to the building owner.

Think about our visible light communication capability in the retail space just as an example.

That is a huge opportunity going forward and if you tie that into the building management side it can provide even more information to the building owner.

So we're very excited about not only the opportunity to support those that are in the industry today but to create our own value proposition around key verticals and key customer sets where we think we can provide a unique value.

Great, I appreciate the detail.

Thank you.

Mike Ritzenthaler, Piper Jaffray.

Yes, good morning.

Another question on Distech and the partnership with Sensity.

I just wanted to get some additional perspective on Acuity's growing presence there in controls.

If there's a way to quantify where software and controls are now versus where they could be in one to two years, how accretive the margins could those initiatives be?

And it doesn't sound like I guess this one is a little bit more for Ricky, it doesn't sound like Distech will add any FX complexity other than the hedging program on the purchase price.

So let me attempt your first question and unfortunately you're probably not going to like the answer.

We don't -- we have a hypothesis around how controls and solutions will come together in a Tier 3 and Tier 4 opportunity and Distech and Sensity are all part of it, if you will, offering that capability in Tier 3 and Tier 4 and enhancing it.

To me it's a bit of a blank sheet of paper.

It's coming together.

We think that the world really you always have a first cost person thinking of an individual component, no issue, we want to continue to really drive capability there.

But more and more and just think about in your own personal life; a phone a decade ago was just a phone.

Because technology has advanced because microprocessing and all of that stuff has advanced your phone now does so many more things and it's really based on software and capability.

We believe that we'll see that kind of trajectory in our space and to be able to provide customers with those types of solutions both Tier 3 as the backbone and then providing additional capabilities in a Tier 4 world because that backbone is robust.

To say that today it will be this size or that size I think is a bit of a challenge.

We're trying to really get our data more precise and that's why we said earlier we're coming off a small base.

Our data is not exactly precise yet but we'll start to report out on the kinds of growth rates that we'll see in our various tiers to help answer that question more fulsomely in the future.

And on the FX question, Mike, yes it actually will help us a little bit.

As I mentioned the sales of Distech into Canada is less than 10% of their total revenue, approximately half of it into US but yet they do have a pretty large presence in the Montreal area of Canada.

They also have a presence in Europe.

So today we are very long the Canadian dollar as we sell into there but don't have any production and so forth.

Now they will help to some degree balance that out as we have a bigger cost base in there, their cost base will overshadow the revenue base there.

So it will provide us a little bit more of a natural hedge into Canada.

Again not a huge impact in the whole scheme of things but it will be slightly favorable to managing the fluctuation between the Canadian dollar and the US as it provides a bit of a natural hedge.

Sure.

I appreciate your answers on both of those.

I'm curious about on the investment side on investing in growth and how that manifests in the P&L over the coming 12 months or so.

I think Vernon I think you mentioned that ongoing pruning has already been partly reinvested.

That's going to continue.

Is Acuity temporarily over earning a little as costs are pruned out before investments are made and will future investments in the next couple say 12 months be stepwise or smooth, just in terms of expectations how should that manifest in the P&L?

That's a great question.

So two responses to it.

One the way to get at your question is really to think about our variable contribution margin rate.

And so through the first half again very favorable; do lots of good things internally.

We're investing in people at a fairly aggressive rate.

So you're seeing, if you will both investment and you're seeing our productivity improvements as well as volume gains and it is manifesting itself in a variable contribution margin that is in that upper 20%s.

We said that we're comfortable in mid- to upper 20%s so I think that's the way to really think about our business going forward.

Each quarter, quarter to quarter you are going to have some anomalies in there but for the most part we think that we're on a pretty good trajectory to talk about variable contribution margins in the mid- to upper 20%.

Fair enough.

Thank you very much.

Ryan Merkel, William Blair.

Thanks, you know when you look at your recent order trends do you see a mix towards new nonres construction?

And then secondly are you still thinking that new nonres can improve in the second half of this year?

Well we do believe that new nonresidential construction will improve in the balance of the year and well into the next couple of years.

I think all the trends that we articulated earlier, employment, availability, absorption, just availability of credit.

All of these things I think bode very well for the new construction forecast that whether it be Dodge or Global Insights or MEMA or MAPI, any of these organizations we think that there is groundswell facts that support that longer-term contention of growth.

So we do see that.

We expect to fully participate in that growth.

We are very good at new construction but I would also say we are very good at the renovation side of the world.

We have learned how to fish in that pond and we continue to play there and play there well.

So that's why I believe we can continue to outperform the growth rates of the markets we serve because of our diversification into those markets, the balance and the strength of our portfolio and our access to markets.

And then my second question I get the sense that large national industrial distributors are investing in lighting in a bigger way, hiring many more people, adding more products.

Are you seeing this as well?

Are you adding more distributors to your network and then do you think this trend could help add to growth in the future?

So we are not adding more to distribution.

We are investing heavily in our key strategic distributor partners to help them grow in the lighting space.

We see lighting both for new construction and renovation as a huge opportunity for them and us and we are picking and choosing those partners to help really drive growth by capturing more share in both new construction and in renovation.

So that's where we have been.

Again another area of significant investment for us is our relationships with our key strategic partners.

And yes we are seeing them invest and we are encouraging their investment and we are working with them to hone, train their people and to understand how to sell the benefits of lighting along a tiered solutions approach.

Great, thank you.

Tim Wojs, Baird.

Hey guys, nice job.

I guess just to go back to the end markets.

Something that we've seen in some of the data that you referenced and just anecdotally is we're starting to see an improvement in K-12 and the hospital markets.

And I guess could you talk specifically about maybe what you're seeing in quoting activity and bidding activity in those two specific end markets?

And then how we should think -- could you just remind us about how important those are to Acuity from a revenue perspective?

Sure.

Those markets have really been quite soft for the last two to three years.

In fact you've seen declines in those markets.

You're now starting to see improvements so the rate of decline has stopped, you're now starting to see a little bit of growth.

And understand K-12 and hospitals have obviously very different dynamics but in the K-12 world it's very dependent on state governments and their budgets and tax revenues, so on and so forth.

So it's as employment improves you're seeing more taxes come into these state and local municipalities.

The population continues to grow so the need for K-12 schools whether they are existing and they need to be updated or new is a growing opportunity.

We do well in the K-12 world because we just have the portfolio, we have the access to market.

We're very, very skilled at doing that.

So it is an important market.

It will contribute to our growth on a go-forward basis.

Similarly for healthcare, healthcare I think much of that industry and you'll know more about this than I will has been in kind of a status hold pattern trying to understand what does Obamacare mean and so on and so forth.

I believe that as the demographics of our population continue to evolve you just need more physical capacity to be able to handle the aging population.

So again we've made investments in our past.

Healthcare lighting for example to have an inpatient room, we do very well in hospitals.

I don't know the exact percentage of what hospitals represent to the whole market.

We have that data, I just don't have it off the top of my head.

But it, too, is an important part of our growth on a go-forward basis.

Okay, that's helpful because really that's been a piece of the nonres market that's been very sluggish.

So it?s good to hear that that's starting to turn.

And then just I guess a clarification.

You called out the 1% to 2% impact to shipments from weather and port.

I just want to clarify that's shipments.

So really have you seen an impact just has that helped -- have you seen that kind of reverse in March as some of that has normalized I guess?

From a weather perspective unfortunately I hate to use the analogy but it's like pushing snow, you just move it and it just kind of slid down.

It's rare that you recapture that sale.

To a very small degree on certain projects you may.

But if you're a person living in an area that was impacted by weather, let's call it the New England area, and you were going to do a home improvement you're simply -- you've delayed it and then you purchased it another day.

So you didn't recapture that day's worth of revenues.

On the port side again the problem there is that the slowdowns have occurred and so you're now trying to get your product out to your various customer sets and it did have an impact on us.

It had an impact in two areas, one in shipments but also we incurred a fair bit of expediting cost to help meet our customers' demands in some of these areas.

So here's almost a force majeure kind of situation and yet we're experiencing incremental cost.

We didn't spend a lot of time trying to quantify what that was but the 1% to 2% and top line, that's a reasonable estimate for the impact.

But no, I don't think you'd capture that back.

If you recall last year's second quarter we had similarly difficult weather conditions.

And it was our expectation that we would see the uptick for that in the third quarter and yet we don't believe that we did.

So we're not expecting that to happen here.

Great.

I appreciate the color, guys.

Thanks.

Jed Dorsheimer, Canaccord Genuity.

Hi, thanks for taking my question.

Just one.

Vern, I guess if we take a look at the tiered solution and where you're going with or what seems to be the direction with the recent acquisitions, most notably Distech from a controls perspective in the total solution and we look at that percentage of a Tier 3 as a percentage of your total sales.

Am I looking at this wrong that it seems very similar to where we were probably four years ago with respect to LED as a percentage of your sales.

And yet it would seem that the competitive landscape for a tiered or a total including controls solution or a value-added solution seems to be more favorable for you than what you faced from an LED perspective versus traditional lighting.

Am I missing something there or would you agree or what would you note are the differences?

Sure.

First of all we look forward to Distech becoming part of the family but that still is a little ways off.

We hope to complete it again before the end of our fiscal, so to really take advantage of that.

But Distech and our strategy around say Tier 3, a holistic solutions approach to a building owner is we think will be very powerful.

Again as technology comes in, as controls become more and more embedded into the luminaire, as software becomes more of a facilitator of how people will use their space I think that your analogy is right.

And so we are betting and investing, maybe not betting but investing heavily to deliver a comprehensive Tier 2, Tier 3 and then that will enable a Tier 4 opportunity on a go-forward basis.

It's entirely -- I mean I don't know what the percentage could be but it's going to be significant.

Because again people will want to take advantage of a holistic system and will be less enamored about having just a single device that may not tie well into the overall if you will building energy management, lighting environment type system.

So our feeling strongly is that we'll continue to see proliferation and really demand from the industry around these types of solutions particularly in key verticals like office buildings and healthcare facilities and universities and retail spaces.

It's just very exciting but we're in the early innings of all this.

One comment I would make, Jed, is while I agree with Vern that there is a lot of similarities to the LED transformation in all, one difference is in Distech and HVAC is the channels.

The lighting and all as we moved to LED was a similar channel.

There will be a need to manage and reconcile the HVAC, the controls that Distech have tend to go through a different channel than the lighting.

That is blurring and merging together as well as clearly the channel for building controls are including lighting controls and our lighting control channel partners are getting into buildings.

So that is coming together but I would just note a little bit of a difference in this move versus the transformation to LED.

And Ricky, that's a great point because both of those channels and those channel partners will continue to expand their capabilities and have great growth.

It will be around certain customers sets that you will see this combination and this capability that will occur first.

But we think that this is a migration, this isn't something that is going to happen immediately overnight.

But I do believe that both Distech's channel partners as well as Acuity's channel partners will continue to experience strong growth in Tier 2 and Tier 3 whether the combination of the value proposition it will be how that customer wants to be served that I think drives that but we see growth continuing in both channels and fairly aggressive growth too by the way.

Great, that's helpful.

That's all for me.

Thanks, guys.

Rich Kwas, Wells Fargo Securities.

Hi, good morning.

Just a question back on the incremental margin as we think about the back half of the year, I know this was asked earlier, but if the $11 million is going to be the number that's net that's a little bit better than I would've expected.

I would've thought there would have been a little more reinvestment.

So, Vern, I'm getting a sense that you're pretty comfortable with the mid- to high 20%s incremental but it sounds like ostensibly that could be -- end up being conservative.

Am I off base with my thinking?

Well, again we don't give forecasts but I would refer us all back to that mid- to upper 20%s.

We work hard every day to drive higher incremental margins but we're investing in our business.

To really capture the opportunity of Tier 3 and Tier 4 we're adding skillsets and capabilities to our business.

So yes, to the question earlier we've made decisions, streamlined actions to say we're going to de-invest here, we're going to reinvest over here.

That process is going on.

It went on in the first quarter, it went on in the second quarter.

You saw what our variable contribution margins are.

We expect it to continue to go on.

But we are looking at every opportunity to drive our incremental margins as best we can.

And as I said you can't just look at one quarter.

But I think as we think about the whole year that mid- to upper 20%s is a good number and it reflects investment back in the business.

Hopefully and hope is not a strategy but our strategy is to really start to see improvements in our incremental margins as we get into 2016 and 2017.

Because when these investments in the human capital side of our business start to pay off in terms of solutions; Tier 2, Tier 3, Tier 4 to our customers that are now paying for, if you will, those investments and giving us the return, and that return should be in the form of higher incremental margins but in the out years a bit, not in terms of 2015.

Okay, thanks.

And then second question on Distech just two separate questions that are somewhat intertwined.

I know you haven't enclosed the deal, but do you envision that you will have to make meaningful investment in educating the agent and distribution partner network that you have as well as the acquisitions, other partners in terms of their distribution, in terms of educating them on the holistic offering that you guys will be able to deliver going forward?

How does that end up working from an investment standpoint?

Then second with the meaningful presence in Europe does this potentially give you a platform to expand your business a lot more meaningfully looking out 5, 7, 10 years in the European market?

Sure.

So if you look at Acuity's current access to say the commercial industrial market, our agency network which is the best of the best, the opportunities for us to continue to drive growth and innovation around the Tier 3 approach we're going to continue down the path that we are on right now.

Similarly Distech's system integrator partners where they have robust connectivity there what we're going to do is continue to invest in those channels, invest in the education so that they can bring value to their customers.

We think that there will be some overlap where locally folks can work together but we still have an awful lot of work to do with those channel partners to figure out what is the best, the most effective value proposition for the customer and who can deliver that.

But to be clear it's going to be an accretive situation.

Both channels will continue to grow because of what they do and how they are doing it and the opportunity to work together to provide a differentiated value proposition is our goal.

But we have to get these folks together and that's why we're hopeful to close this transaction and get these people working together to figure out what's the best most effective way to do that.

We have hypotheses around that but we're not really ready to say here's exactly what we're doing with that until we get those channel partners together.

Okay.

And then Europe?

Your thoughts on the ability to expand in Europe?

As I mentioned about a third of their revenues are in Europe.

They have a presence in Lyon France that certainly is something we can build on.

We do have a presence as well, we have an operation in the UK and one in Spain.

And I think we do see opportunities.

As Vern mentioned earlier Distech does have a global offering that meets the codes in the European Union as well as around other parts of the world, Middle East, Asia and so forth and we have some of that.

So we will be in a good position I think as you point out to be patient, it will be over multiple years but an opportunity, to enhance our capabilities in Europe.

Okay, thank you.

Sven Eenmaa, Stifel.

Yes, hi thanks for taking my questions.

First I wanted to ask in terms of if you think about Acuity's M&A and acquisition activity over the next 12 months or so, what are the key areas of focus there?

Ricky, do you want to address that?

Sure.

I would put it in several buckets.

First is technology.

You've certainly have seen us continue to invest in that.

And again it could be in acquisitions or it can be in alliances in certain type of relationships as we're doing with Sensity.

So technology is an area to build out to support this tiered solution.

Having gap fillers of tuck-in bolt-on type acquisitions both in controls as well as in the luminaire area will continue to be a focus.

We've done quite a number of those and I think it's likely to see us continue to do that.

Then thirdly would be geographic expansion and it would be in that order less of a priority.

But if the right opportunities came up whether it's in Europe or in other parts of the world we would certainly look to expand geographic or our market presence in other ways.

So I'd put it in those orders of priority.

Got it.

And the last question I just wanted to clarify regarding the institutional markets.

Are you across state digital, education, healthcare are you seeing increased quoting activity there or are you actually seeing increased revenues currently?

Ricky?

More on the quoting side.

The education season is coming upon us.

They tend to do much more of their actual shipping and building in the summer months particularly K-12.

So at this stage you would expect it to be more quoting and less in the shipping area and I would say healthcare is more at this stage projects.

They've got architects involved doing design work and getting quotes but several of those projects have not been released to orders yet.

I think we're seeing some pickup in the shipments in the healthcare but it's more on the order rate.

Got it.

Thank you very much.

I would now 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.

That concludes today's conference.

Please disconnect at this time.