Acuity Brands Inc (AYI) 2017 Q2 法說會逐字稿

Good morning, and welcome to Acuity Brands Fiscal 2017 Second Quarter Financial Conference Call.

(Operator Instructions) Today's conference is being recorded.

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

Now I would like to introduce Mr. Dan Smith, Senior Vice President, Treasurer and Secretary.

Sir, you may begin.

Thank you.

With me today to discuss our fiscal 2017 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 on our website 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 risks and uncertainties such that actual results may differ materially.

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

Now let me turn this call over to Vernon Nagel.

Thank you, Dan.

Good morning, everyone.

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

Our financial results for the second quarter reflect, in large part, the impact of continued softness in demand for certain short-cycle, small lighting projects.

As I will comment later, we believe this softness for these types of projects is temporary and will rebound.

I know many of you have already seen our results and Ricky will provide more detail later in the call, but I would like to make a few comments on the key highlights for the second quarter of 2017.

Net sales for the quarter were $805 million, an increase of almost 4% compared with the year-ago period.

Reported operating profit was $108 million compared with $106.7 million in the year-ago period.

Reported diluted earnings per share was $1.53 compared with $1.49 in the year-ago period.

There were adjustments in the year-ago quarter for certain special items as well as certain add-backs made in both quarters for our results to be comparable between periods, as Ricky will explain later in the call.

In adding back these items, we can see adjusted operating profit for the second quarter of 2017 was $123.9 million compared with an adjusted operating profit of $127.4 million in the year-ago period, a decrease of 3%.

Adjusted operating profit margin was 15.4%, a decrease of 100 basis points compared with the prior year.

Adjusted diluted earnings per share was $1.77, down 2% from the year-ago period.

We closed the quarter with $463 million of cash on hand, leaving us with plenty of financial firepower to execute our growth strategies.

Looking at the key highlights for the second quarter.

Net sales in the second quarter were up almost 4% over the year-ago period.

Overall, net sales volume grew 4%, while the addition of Juno added another 1 point growth.

This was offset by a 1 point decrease in net sales due to changes in the price and mix of products sold.

The impact of foreign currency on net sales this quarter was less than 1 point.

While it's not possible to precisely determine the separate impact of price and mix changes on net sales, we believe the difference was primarily due to lower pricing on luminaires, largely because of lower component cost of LED fixtures.

A few additional points on the makeup of net sales this quarter.

Net sales in Mexico and Europe were negatively impacted by political and economic issues in those regions, reducing our consolidated net sales by almost 1 point this quarter.

Further, the increase in net sales was broad based along key product lines and sales channels in the U.S. and Canada.

However, we believe overall market demand remained weaker than most forecasters originally anticipated, particularly for smaller projects.

Nonetheless, we believe we still meaningfully outperformed the growth rate of the overall market, allowing us to continue to gain market share.

To add a bit more color on this, while available market data does not line up perfectly with our quarters, we have recent information from various organizations, including U.S. Census Bureau and NEMA, which suggests construction put in place for the quarter was again softer than anticipated while actual data for shipments of lighting fixtures in the last 2 quarters of calendar 2016 showed the lighting market was slightly down compared with periods 1 year earlier.

Nonetheless, we were still able to grow our legacy business in the U.S. and Canada by 5% this quarter, far outpacing the growth of the overall lighting industry.

I will comment more on our expectations for the balance of 2017 later in the call.

Sales of LED products grew robustly this quarter and account for 2/3 of our total net sales, which as you know, includes the sale of nonfixture-related products and solutions as well.

Lastly, we believe our channel and product diversification as well as our strategies to better serve customers with new, more innovative and holistic lighting and building management solutions and the strength of our many sales forces have allowed us to yet again achieve solid sales growth this quarter, particularly against the backdrop of a softer-than-expected market environment.

Our profitability measures for the second quarter were solid but very much impacted by these tepid market conditions.

Our adjusted operating profit for the second quarter was $123.9 million, down $3.5 million compared with the year-ago period, while adjusted operating profit for the March -- for the quarter was 15.4%, down 100 basis points from the adjusted margin in the year-ago period.

The decline in adjusted operating profit was primarily due to lower adjusted gross profit.

Gross profit in the second quarter was essentially flat compared with the year-ago period while adjusted gross profit declined $2.5 million.

Gross profit margin for the second quarter was 41.7% compared with adjusted gross profit margin of 43.5% one year earlier, a decrease of 180 basis points.

The modest decline in gross profit this quarter compared with the adjusted gross profit reported in the year-ago period was primarily due to higher manufacturing costs and a rise in quality cost, partially offset by the increase in net sales, lower component costs and productivity improvements, primarily from previously announced streamlining actions.

In addition to the factors just noted, adjusted gross profit margin was also impacted by the mix of products sold through certain sales channels.

Like last quarter, we carried a higher manufacturing cost structure into the quarter in anticipation of servicing a greater level of demand than actually occurred, impacting both gross profit and gross profit margin.

As I will point out later in the call, we believe the weakness in demand, particularly for certain smaller short-cycle projects will rebound and therefore, by strategy, we are maintaining our capabilities and organization structure.

But to be very clear, we understand that this strategy is having the impact on our short-term profitability metrics.

Next, adjusted SD&A expenses were up $1 million over the year-ago period.

Adjusted SD&A expense as a percentage of net sales was 26.3% in the second quarter, a decrease of 80 basis points from the year-ago period.

The slight increase in adjusted SD&A expense was primarily due to higher freight and commission costs to support the increase in net sales, the inclusion of Juno and continued investment in additional headcount to support and drive our tiered solution strategy.

This was mostly offset by lower incentive compensation expense.

Our incentive compensation program is based on period-over-period improvement in our key financial metrics, which are an integral part of our pay-for-performance culture.

Our first half performance this year has resulted in a much lower potential payout than we accrued in the year-ago period.

Our adjusted diluted EPS was $1.77 compared with $1.80 reported in the year-ago period.

The decline was primarily due to lower adjusted operating profit, partially offset by our lower tax rate this quarter.

Before I turn the call over to Ricky, I would like to comment on a few important strategic accomplishments.

On the strategic front, we continue to make great strides, setting the stage for what we believe will be strong growth and profitability over the long term.

We've continued our rapid pace of introducing new products and solutions, expanding our industry-leading portfolio of innovative, energy-efficient luminaires and lighting controls solutions as well as our building management platform.

Many of these solutions are connected to our IoT software platform as innovation continues to be at the forefront of our tiered solution strategy.

While sales data for our tiered solutions is still imprecise and expanding off a small base, we believe sales in our Tier 3 category encompassing our holistic integrated solutions were up 25% this quarter and now represent more than 12% of our total net sales.

Furthermore, our Tier 3 solutions can be enabled to collect data and to support connectivity to the Internet of Things, affording Acuity additional recurring revenue streams, which we identified as Tier 4 solutions.

To fully execute our holistic tiered solution strategy, we have added enormous capabilities over the last 1.5 years, including recent acquisitions as well as increased salaried headcount.

In fact, excluding the impact of acquisitions, our salaried headcount is up almost 200 associates or over 6% from one year earlier.

We continue to make these investments despite the current softness in demand because we see tremendous opportunities for future profitable growth in these areas.

A few of our competitors, if any, have been able to make these investments while [ delivering ] solid financial performance like Acuity.

At Acuity, we're not just talking Internet of Things, we're doing it.

We continue to increase the scale and scope of our solutions, having recently upgraded our nearly 50 million-square foot lighting beacon network to encompass additional ambient intelligence.

This smart solutions infrastructure, using digital lighting and building management systems as its backbone, creates an advanced sensory network made even more capable through connections to the Acuity IoT software platform.

This platform enables endless possibilities for our customers to enhance the utilization of their space through better human interaction and greater asset and employee productivity.

Building out a foundation of indoor positioning solutions, including wayfinding, we have upgraded our networks to include Bluetooth tag-based asset tracking and more robust geospatial and other valuable analytics.

Today, this platform encompasses more than 0.5 million LED light fixtures, each enabled with multiple sensing devices to form a broad sensory network, collecting data and enabling applications that provide users with superior lighting and energy performance as well as useful, actionable information.

These data and enabling applications are now providing Acuity with a recurring cloud-based service revenue stream.

Importantly, we expect the installed base of these smart lighting solutions to meaningfully expand as the benefit of these capabilities become more known by end users in several key verticals.

We believe this level of capability and deployment continues to be unmatched in our industry.

We have been able to create these capabilities while providing industry-leading results because of the dedication resolve of our 12,000 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 the balance of 2017.

Ricky?

Thank you, Vern, and good morning, everyone.

As Vern mentioned earlier, we had some adjustments to the GAAP results in fiscal 2017 and 2016, which we find useful to add back for the results to be comparable.

In our earnings release, we provide a detailed reconciliation of non-GAAP measures.

Primarily due to the impact of the 4 acquisitions completed in fiscal year 2016, we experienced noticeable increases in amortization of acquired intangible assets; share-based compensation expense, since we used restricted stock as a tool to improve retention and to align the interest of key leaders of acquired businesses with those of the shareholders; acquisition-related costs; special charges; manufacturing inefficiencies related to the closing of a facility; and a gain on the sale of an investment in an unconsolidated affiliate.

We believe adjusting for these items and providing these non-GAAP measures provide greater comparability and enhanced visibility into our results of operations.

We think you'll find this transparency very helpful in your analysis of our performance.

In addition, many of our peer companies, especially as we become more of a technology company, make these same adjustments, so it will help you as you compare our performance to other public companies in our industry.

The effective tax rate for the second quarter was 32.3% compared with 34.2% in the second quarter of last year.

The decrease in the effective income tax rate was due primarily to the tax impact of a discrete nonrecurring item related to the issuance of the new IRS regulations during the current quarter related to taxation of foreign currency translation gains and losses on intercompany accounts.

We expect the effective tax rate for fiscal year 2017 to be approximately 35% before any additional discrete items and if the rates in our taxing jurisdictions remain generally consistent throughout the year.

During the second quarter of fiscal year 2017, we finalized the purchase accounting allocation for Juno Lighting.

As a result, the provisional amounts recognized at the acquisition date were adjusted to reflect the finalization of the valuation of customer relationships and certain acquired -- accrued liabilities.

These adjustments resulted in an $81 million increase in intangible assets, a decrease in goodwill of $50 million and an increase to deferred income tax liabilities of $30 million and a decrease to net operating working capital of $1 million as of February 28, 2017.

In addition, we recorded a cumulative addition to amortization expense of approximately $2 million in the current quarter.

With these changes, amortization expense is expected to be approximately $25 million annually.

At February 28, 2017, we had a cash and cash equivalent balance of $463.2 million, an increase of $50 million since August 31, 2016.

Our operating working capital, defined as receivable plus inventory, less payables, at February 28, 2017, increased to 54 days compared with 45 days in the prior year.

The increase was due primarily to the increased inventory to support expected higher sales and to improve delivery performance.

In the second quarter of fiscal year 2017, we spent $35.8 million on capital expenditures compared with $43.8 million in the prior year.

The decrease in capital expenditures is primarily due to the reduced spending on facility renovations.

We currently expect to spend approximately between $2 million and $2.5 million of revenue in capital expenditures in fiscal year 2017.

Our total debt outstanding was $356 million at February 28, 2017.

We had more cash than debt at February 28, 2017.

We had additional borrowing capacity of $243.9 million at the end of the quarter under our credit facility, which does not expire until August 2019.

We clearly enjoy significant financial strength and flexibility, and we'll continue to seek the best use of our strong cash generation to enhance shareholder value.

Thank you, and I'll turn the call back to Vern.

Thank you, Ricky.

Just to be clear, I think what -- Rick, we intend to spend between 2% and 2.5% of sales in fiscal 2017 on CapEx, not between $2 million and $2.5 million.

Yes.

Thank you.

While market conditions in the first half of fiscal 2017 were much softer than most had anticipated, we continue to see significant long-term growth opportunities that are ever-changing and evolving at a positive direction for Acuity.

Recent economic and industry data shows the end markets we serve in North America and certain markets in Europe through the first half of our year moved along at a much slower, more inconsistent pace than was originally anticipated by various forecasting organizations.

In fact, it now appears from various data sources we collect that the slowdown in market demand started in the third quarter of calendar 2016.

While there is much speculation as to what precipitated the slowdown, many of our end customers infer this year's presidential election in the U.S. and certain political events in Europe created uncertainty and volatility, which tempered end user demand, particularly for certain smaller projects that had short lead times and to a lesser degree, residential construction.

Additionally, we continue to hear from customers that labor shortages at certain markets continues to cause delays in larger projects.

How much have all this directly impacted our shipments in the first half of fiscal 2017 is difficult to precisely quantify, but we anticipated and planned for a greater shipments than actually occurred.

While we believe the softness in demand experienced in the first half of fiscal 2017 is temporary, the same conditions could potentially linger into the second half of 2017.

Nonetheless, we believe the long-term fundamental drivers of the markets we serve are still positive and intact.

As we noted in our last 10-K, based on third-party market forecast for the lighting industry, we expect that the broad end markets that we serve in North America, which represents about 97% of our total net sales, would grow in the mid- to upper single-digit range in fiscal 2017.

Given the actual market data which shows that lighting sales in our first half were slightly down compared with the year-ago period's, many market forecasters now believe the market will be flat to slightly positive in the second half of fiscal 2017, followed by stronger growth in fiscal 2018.

This notwithstanding, we remain bullish regarding the company's long-term prospects for profitable growth, particularly as we bring more value-added solutions to the market for both new construction and the conversion of the installed base.

We continue to see signs that give us more optimism regarding the future growth of the markets we serve than third-party forecast.

Leading indicators for the North American market, such as Architectural Billing Index, vacancy rates, office absorption, lending availability and favorable employment trends continue to improve at varying paces.

So the following are a few of our key assumptions as we focus on the second half of fiscal 2017.

Given the information I just noted above, we expect the lighting market in North America, our largest market, to grow in the low single digits in the second half of fiscal 2017.

Next, we expect the price of certain LED components to continue to decline, while certain other costs, including steel and certain other commodity costs as well as certain employee-related costs, primarily due to further investments in associate headcount, wage inflation and health care costs, will increase somewhat.

We expect to offset the impact of these rising costs through certain pricing initiatives, productivity improvements and product cost reductions.

Next, we continue to be leery of foreign currency exchange rate fluctuations, which are unpredictable.

Next, while our gross profit margin is influenced by several factors, including sales volume, innovation, components and commodity costs, and mix changes for prices, products and sales channels, we expect our annual gross profit margin to improve over time as volumes grows and as we realize typical gains in the manufacturing efficiencies, including cost savings related to recent acquisitions and new product introductions.

We continue to target a current variable contribution margin on an incremental dollar of sales in the mid to upper 20% range over a full year period, knowing that it is not possible to predict with precision what the rate will be by quarter.

Obviously, given our results in the first half, this target range will be a challenge for us to achieve for the full year fiscal 2017.

Next, our adjusted SD&A expense as a percentage of sales was 26% this half.

This is below our recent trend primarily due to much lower incentive compensation expense.

Trust me, we are motivated to drive strong period-over-period growth, which is at the core of our pay-for-performance culture, which would result in much higher incentive compensation expense.

This means we would expect our adjusted SD&A expense as a percentage of net sales to be closer to our historical trend, assuming markets rebound somewhat as we noted earlier, and we continue to meaningfully outpace the growth rates of the markets we serve.

This further assumes we execute, as we have in the past, regarding our supply chain performance and can move gross margins toward our historical trend.

So to be very clear, our key assumptions are to garner additional top line growth driven primarily by our ability to outperform the growth rates of the markets we serve and to leverage our infrastructure, achieving targeted incremental margins to improve our overall profitability.

Looking more specifically at our company, we are very excited by and focused on the many opportunities to enhance our already strong platform, including the expansion of our Tier 3 and 4 holistic lighting, building management and our IoT smart platform solutions.

We continue to expand the number of pilot programs and customers for these smart platforms and experience strong interest from many other key customers in multiple verticals for our holistic solutions with these capabilities and more.

As we have noted in our last several conference calls, the implementation of our integrated tiered solution strategy and opportunities to meaningfully participate in the interconnected world is an integral part of our overall growth strategy to meaningfully expand our addressable market by adding significantly greater, broad-based holistic solutions that will allow our customers to optimize the performance of their facilities.

As we noted earlier, while we are very early in this game, we are seeing positive results in growth rates for our Tier 3 and Tier 4 categories as well as the acceptance of our IoT-enabled smart platform solutions.

Our company-wide strategy is straightforward, expanding the leverage of 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 investing today to enhance and expand our core competencies, affording us the opportunity to excel in our fast-changing industry because we see great future opportunity.

Through these investments, we are significantly expanding our addressable market.

Our strong growth record supports this view.

As I've said before, we believe the lighting and lighting-related industry as well as the building management systems market will experience significant growth over the next decade because of the continued opportunities for new construction, more importantly, the conversion of the installed base, which is enormous in size to more efficient and effective solutions.

We believe this is particularly compelling as energy and environmental concerns continue to 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 building management industries, some of which could grow very significantly over the next few years, will provide us with significant growth potential.

As the market leader in the lighting solutions and a technology leader in building automation, we are positioned well to fully participate in these exciting and growing industries.

Thank you.

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

(Operator Instructions) Our first question is coming from the line of Mr. Rich Kwas from Wells Fargo Securities.

Just, Vern, can you give us some color around the quarter as it relates to project activity, project growth and short-cycle activity?

You talked qualitatively about it last quarter.

You gave some round estimates around what you thought those markets did.

Could you update us on that?

And then what's the assumption for each of those areas for the back half of the fiscal year?

Sure.

So what we think about our business, between 70%, 75%, it's -- those are rough numbers, we consider project-type business.

The other 25% will be stock-oriented business.

Within the project side, you have multiple-sized projects, the small, medium and large.

We think that the larger project business continue to move along nicely.

Quotation rates were solid.

Shipments were solid.

In fact, these were in a sort of a mid-double digit range or mid-teens, I should say, in terms of growth.

It was that smaller project that's more of the stock and flow, more flow-type projects, smaller in nature, short cycle in nature, that seemingly was under duress, if you will, somewhat tepid in the market.

I spend a lot of time with our electrical distributor customers, with contractors, different channels trying to understand where is their industry and what do they see.

And truthfully, it feels to us, and this is why we slightly disagree with some of the third-party forecasters regarding the overall trend for the balance of 2000 -- our fiscal 2017, calendar 2017 and then in '18, we are more optimistic about the opportunities because what you're seeing is, in these larger projects, you're seeing great quote activity, contract awards.

You're seeing a lot of positive activity.

So we're not seeing a slowdown there.

This is why on the smaller short-cycle projects, it doesn't really make a lot of sense that these things are going to continue to remain tepid and soft while larger projects continue to remain very favorable.

So our view is, is that based on customer or consumer confidence, business confidence, those short-cycle things can ebb and flow.

When we think about the key demand drivers in our business, whether it's employment, employment participation is favorable, housing starts, they took a little dip.

I think October was about 1.3 million starts, November was 1.1 million, maybe slightly less than that.

Our expectation is that based on demographics and employment, you're going to continue to see a more favorable trend.

C&I loans continue to be up mid-single digits.

The Architectural Billing Index, while it's been a little bit up and down, it's been mostly up and we expect that trend to continue.

The Dodge Momentum Index, which is a favorable leading indicator for us, while it has its fits and starts, continues to be very favorable.

And then lastly, when you think about office vacancy rates and you think about net absorption, all of those continue to be favorable.

So it feels to us like for whatever is causing this sort of short-cycle, temporary, tepid demand, that fixes itself because we just see the longer-term fundamental drivers as being favorable.

And as you know, we have carried additional manufacturing cost structure in place because we believe in this, and so we're going to continue to do that.

Until the trends start to flash a much more serious signal or a negative signal, we believe that the market opportunities are there.

And as we continue to drive innovation and greater solutions, we think we can capture that share.

You didn't ask, but I'm going to say, my guess is, is that we carried probably an extra $12 million of cost into the quarter, which, from a gross profit perspective, is probably 150 basis points of investment that we're not going to get a return for.

And we know that our strategy right now is having a short-term impact on our financial results, but we're just not going to give up the capabilities that we have.

We're going to continue to attack the market and differentiate to drive this growth, which we expect to turn around.

Just as a follow-up, my follow-up, around your comments around mid-teens and then kind of flattish or maybe down slightly for small projects, I mean, the math suggests something worse than that on the smaller projects side.

So if the large projects are up mid-teens, small projects would seem to be down something in the neighborhood of 20% to get to your blended number.

So can you help me on that?

And then secondary question, real quick, is there something more structural going on, the short-cycle stuff?

Because some channel partners have talked about increased competition from imports and maybe distributors stocking less than they've used to around short-cycle contractor-type products.

I don't know if you have any color on that.

Sure.

So again, when I say larger projects, I'm talking about large projects, and these things are -- pick your number, $0.5 million and above.

Those types of things continue to move along, and so those represent a smaller portion, I won't give you any exact number.

But when you get into those small projects, those represent -- of the 70% to 75%, they represent a much smaller percentage.

So you're right, it's tempting to do that math, but that's not the right mix number.

So I wouldn't go there.

I'm not going to provide exact breakouts because it's a bit of a challenge to precisely quantify what is small, medium and large.

We have an internal way of looking at that, but it's not precise math.

So I would say to you that those larger projects continue to move along at a favorable rate, and so our overall mix of that 70% to 75% is less than sort of the mid-teens because the small short-cycle projects pull that down.

Stock and flow also continues to be somewhat flattish.

I don't think it's a structural thing within the electrical distributor world.

What they try to do is obviously manage their inventories to what demand is.

I think as demand slowed, what a number of our electrical distributor customers told us is that they were looking to balance their inventories to meet or to be more consistent with sales.

Now having said that, many of them are bullish about the second half of their calendar 2017 year.

And they're -- and where they derive their optimism is from what contractors are telling them around the broad base of projects, whether it be stock for them or small flow projects, medium or larger projects, where you have specification involved.

So we are getting more positive signals than, if you will, what market forecasters have called for.

They're the same people that called for a mid- to upper single-digit growth and the markets obviously turned.

So we're betting more on the fact that folks who are right next to the customer and who are dealing with demand and capabilities everyday, I think have a better sense of what's happening.

And many of you folks who do channel checks, I think you can confirm that, that they said markets were soft for here recently, but their backlogs and some of the things that they're looking at are more bullish.

I don't believe that there is a huge structural shift, but it doesn't mean that distributors aren't focused around their inventories, where things have the opportunity, through new technology, to be somewhat advanced.

But guess what, they get paid to have inventory on-hand to serve the needs of their customers, and we feel that our connectivity with those electrical distributors through our supply chain, which is very robust, gives them the opportunity to meet the kind of customer service requirements that they have and to not get caught, if you will, with inventory on hand.

We've also heard that people are somewhat concerned about other types of technology, not technology, but tubes and other things that might be coming in from foreign markets.

We see that, but I just don't feel that, that is a major shift in what folks are doing.

I just -- we see it all the time, that type of competition from foreign folks.

It's not new.

I don't see it increasing or being any more intent than it has been in the past.

So I just don't feel, Rich, to your last question that there's been a technology or a fundamental structural shift in how distributors are -- have always managed their business.

The next question is coming from the line of Jeff Osborne from Cowen and Company.

Just to follow up on the weakness on the short-cycle business.

Vern, I was wondering, is there any regional commentary that you can share?

And then also, just the second question I had, is there any thoughts on the buyback here?

From a regional perspective, I'm trying to think.

We have a few markets that were a little bit softer in terms of our shipments than other markets that we tend to see that it's ebbing and flowing.

I don't think I could call out any one that was demonstrably different than the other.

I guess what I was getting at is I wasn't sure if there's any notable weakness in historically more democratic states than republicans, or assuming it's just more widespread.

That's an interesting question.

We have not put up a red and blue calendar and measured that.

I would say that it still is a bit more by geography to a degree, California and those markets where you have high cost of energy continue to move along.

Markets where the cost of energy may not be as high.

Some of those areas may tend to say, "I'll wait and see." It's impossible to quantify business sentiment and what drives exactly that or consumer sentiment.

I still think that as homes -- home values improve through the home improvement channel and certain portions of the electrical distribution channel, they're providing value to people who want to do those things.

But even if you look at housing starts, those things slow down a little bit.

Why?

Weather was fantastic in most parts of the country.

So again, we think that, that's a temporary situation.

Ricky, with regard to stock buybacks...

Yes, we do have, as you're aware, an authorization from our board to repurchase 2 million shares.

We've repurchased a de minimis amount this last quarter, so we do have that there.

We will continue to look at the most appropriate use of our cash and our capital allocation to enhance shareholder value, with acquisitions being our primary choice.

But if the acquisitions don't provide the opportunity that we think is appropriate, then, certainly, share buybacks is something we have used in the past and are something that we could use in the future.

One other element to your question earlier around geography, I would say that when we look at our business in Mexico, normally, when you come near an election cycle, you tend to see a little bit of inconsistent demand shipments.

I think it's being exacerbated by some of the rhetoric that's going on in terms of the negotiations between Mexico and the U.S. Our capabilities in Mexico are fantastic.

The market there, we think, has long-term growth potential.

Interestingly, the peso has strengthened here recently.

Spain, where we have operations, they similarly can be influenced by a local election cycle that's occurring right now.

But I think that there are broader structural things that are going on, where people are still taking the wait-and-see approach.

Our business in the U.K, it's a nice little business, got a great little company there.

But they're being influenced by the whipsawing of what's going on with Brexit.

So when we look at those markets, it was another point of growth that kind of went away.

We expect there to be, once there's clarity for those markets to rebound, but that was a point of growth.

That's why we made the point in our overall comments that Canada and the U.S. markets showed kind of that mid-single-digit growth rates, 5%, in terms of sales volume.

So that was favorable to us.

Our next question is coming from the line of Mr. Ryan Merkel from William Blair.

So Vern, first question from me is what was the order intake in March?

And if the industry outlook is for flat in 2017, can you take market share and still grow sales low single digits in the second half of 2017?

Well, I think we have had a long history of outperforming the growth rates of the markets that we serve.

I mean, the spread between what our growth rate is and what the market growth rate is has been pretty consistently big.

And so our expectations, based on the product portfolio, our access to market, bringing more solutions to the market, we would expect to continue to outperform the growth rates, and quite frankly, look to even add to that spread as we go forward.

So that is a strong focus of our team.

And as we look at various verticals, how can we continue to grow and add value there, that is our -- very much our focus.

When we look at our order rates for the month of March, truthfully, we're looking at more of a sequential basis because March a year ago had some anomalies in it.

So when we look at sequential growth rates in our order rates, we see favorability.

Our backlog is up compared to the year-ago period, going into the fourth quarter backlog, not hugely important to us because it represents probably 3 weeks worth of revenues.

But it was up 7% or 8%, coming off again a fairly tepid environment.

Our expectation is that these growth rates will continue to pick up, particularly as we enter the spring cycle, which for us is a very positive cycle.

Spring and summer, as you know, are our busiest months, and we're feeling, if you will, bullish around the favorability of some of the end markets.

So we'll see.

I mean, we were -- as you know, we carried a higher cost structure into both the first quarter and the second quarter, so we're going to continue to do that because, again, the long-term drivers of our business continue to flash green and positive signals for us.

But it sounds like based on what you're seeing in March, things are stable and you continue to take -- you would continue to expect to take market share in the second half of the year?

Correct.

Okay.

And then the other big question everyone's sort of asking is, are there any signs that price competition is heating up as competitors look to protect share?

Obviously, with price only down 1% in the quarter, it looks like it's not an issue yet, but any commentary there I think would be helpful.

Sure.

Again, part of -- and I think a large part of Acuity's ability to gain share is that we reach into that installed base, that renovation market, where the competition is primarily the act of doing nothing.

I do believe that some of the tepidness that we [ felt ] in demand was because of folks saying I'm going to take a little bit of a wait-and-see approach.

The returns are compelling for folks to do renovation of their existing space using energy-efficient lighting, use -- taking advantage of building management capabilities, taking advantage of some of these IoT solutions set.

But if your confidence, for whatever reason, is somewhat shaking, you tend to say, "I'm going to wait and see." I believe that our ability to continue to gain share will be as the markets -- or excuse me, as business and consumer sentiment start to come back, and I think it is.

I mean, I think you're seeing, for the most part, businesses are massively favorable about what they expect to have happen in terms of tax reform, regulatory reform.

But if you're a smaller, short-cycle person, you may say, "I'm going to keep my cash for a little while and see what happens." I believe that folks are starting to say, "Okay, the sky didn't fall, how do I get back to doing my business?" And I believe that you're going to start to see the uptick of those things.

So where we are expecting to gain share is not just on our traditional business of new construction, whether it's small, medium, large or supporting our strategic electrical distributors with great products and solution.

But we also expect to drive a difference and have been driving a difference, hence, the spread between the overall rates of the market and what our growth rate has been because we are reaching into that installed base.

So I would expect us to continue to do that.

Next question is from John Quealy, Canaccord Genuity.

First question, in terms of the additional $20 million, I guess, of carrying cost that we're carrying here, I guess, you continue to do that for the next few quarters, wait for what fiscal '18 has in store.

And then, I guess, Vern and Ricky, what would you need to see to change that or take those costs out from a third-party data point perspective?

I just have one quick follow-up.

Sure.

First, I believe the number is more $12 million, not $20 million, just to put it in perspective.

I mean, it's still a significant number, it's just extra people.

But again, when we think about the various types of both verticals that we serve, the size of projects that we serve, whether it's indoor or outdoor, again, we're just -- the data is strong, supporting that we -- that there was a slowdown in luminaire shipments, second half of 2016, first quarter, so far, of 2017.

But again, when we look at -- and there is pretty strong correlation to these longer-term drivers of our business that I've mentioned earlier.

And those things are favorable and business is usually a positive.

So to me, it's not only are these things flashing positive signals, but as we continue to enhance our capabilities to get after that renovation and as we continue to enhance our capabilities around our IoT software platform, as more and more people are becoming confident with their test pilots and things that they're doing, we just see positive growth.

And so we're going to continue to do that.

I think that it was a statistic that I read, one economist who has a pretty good track record said that 2016 was the weakest economy or economic environment that we've had since 2013.

I don't -- I'm not an economist, so we sort of follow these things, but we listen very intently to our customers.

At the end markets, things were softening, so electrical distributors, just to pick on stock and flow, were looking to balance, rebalance inventories.

I still feel that the positive signals are going to allow us and them to continue to invest and make sure that we are supporting construction activity that we believe is going to be there.

When we talk to electrical contractors, essentially, they're saying that their backlogs are strong, but it depends on who they are.

It depends on what type of projects that they're working on.

The folks that are in that medium to larger type project, those folks, I think, feel pretty bullish, and that's pretty consistent around the country.

Some of them are talking about the notion of having challenges finding enough electricians to do jobs, so what they're looking to do is pick and choose the jobs that they do to optimize their profitability.

But again, I think that over the long term, that, that situation, that imbalance heals itself as more people come back into the work environment and do those things.

So we would look to these indicators that say to us that we think things are going to get soft here.

And if you look over our last 15-year track record, we've been pretty aggressive when we see markets that are not -- that are turning, to structure our business appropriately to continue to protect our profitability as best as we can.

We would look to do that, we just don't feel right now is the time.

I know it's painful in the short term.

We're carrying these costs, but we believe that this is still the right thing to do to continue to capture profitable market share.

Okay.

And then a quick follow-up.

In terms of Tier 4 solutions, I know many of us are looking for a target-type announcement, and maybe that's a false expectation.

How do you think we should look for development in the market, especially as your Tier 4 solution takes off in the next couple of quarters?

What's a good benchmark to look to?

Sure.

First of all, we have a large installation going on with a leading -- a world-leading retailer.

We did not mention names, so we're not going to mention names, but that project continues to move along with that particular retailer, whose name we didn't mention, in a favorable way.

We believe that these solutions that they are starting to realize are very valuable.

When I think about our overall smart solution platform and the focus that we have, we now have well over 20 strong engagements, with 6 different verticals.

We have almost 2 handful of pilots going on.

And what we think about rollouts, we're actually rolling out in 3 different verticals, retail being one of them, but other projects that are now robust.

Many of these folks that we're dealing with, they want to get their installed base up and operating, and then they will make announcements about how they want to have the marketplace perceive these things.

And I think that as they do that, as -- you can pick any particular vertical.

As they're installing this strong or smart solutions platform, they want to get it up and running, and then, to make the big splash.

Those will be the kinds of things that you'll see.

We are very pleased with where we are to date.

Again, we have north of 50 million square feet providing a strong, ambient, technical capability to them, collecting data; over 0.5 million LED luminaires; probably well north of 1 million sensors because many of these luminaires have multiple sensors, the ability to now really use the capabilities to track assets, we're really honing that capability.

And so the level of interest that we have from multiple verticals, multiple institutions, is really positive.

And you'll continue to see us report out square footage and things of this nature.

But just know it's lumpy, but the lumpiness is only, I think, a temporary thing as more and more folks become aware of these capabilities.

Our teams were just at the NRF Show as well as Shoptalk, and the fanfare around what many of these CEOs, CMOs, CIOs, CFOs saw in our solution set were robustly positive.

And so we're expecting these things to really continue to drive great value, and we'll keep people posted as we do.

To the extent that we are able to announce names as part of these programs, we'll do it.

But right now, we're not able to do that.

The next question comes from the line of Mr. Matt McCall of Seaport Global.

So Vern, you talked about the kind of a full year target for your contribution margins, and I think you said that -- you talked about returning to the historical trend for both SD&A and gross margin.

Can you kind of flesh it out a little bit more?

When I look at gross margin, you're kind of there, other than -- I think this year, I guess where consensus was, you're kind of there in that 43% range in SD&A.

Is 27% closer to that historical trend?

I was just trying to figure out what your -- what trend you were pointing to.

Sure.

So our adjusted gross profit this quarter was what, 41.8%, 41.7%, something like that.

Yes.

The notion of what we were carrying, what we believe we're carrying as incremental cost, a little bit of quality issue in there too, but I believe that's extraordinarily temporary, you're right, gets us into that sort of mid 43% range.

We think our potential is higher than that.

You saw what we did in the third quarter of last year.

I think we were in the mid 44% range.

SD&A is -- we've added investment with people.

So that's why I wanted to make the point that we've probably added close to 200 associates on a year-over-year basis, salaried associates.

So we're carrying that cost.

Obviously, we need those revenues and that variable contribution to cover those incremental salaries.

Today, we are funding those incremental folks with little -- incentive compensation.

So we're funding our own growth, if you will, but we believe in it strongly, so we're willing to do that.

I believe that the SD&A number, probably in the nearer term, is more of a 26% to 27% range, but this is why we bring people back to variable contribution.

Normally, we're able to do that.

This quarter, we didn't have variable contribution.

It was negative, and that's not something that we have done in probably 5 years, again, reflecting both the tepid environment for certain project as well as the increased investment, both in SD&A and gross profit.

So we're targeting, again, gross profit in that above 43% and SD&A probably in the mid-26% range in the nearer term.

But again, our goal is to continue to drive beyond that.

I do like the fact that typically, our variable contribution margin should be in that mid- to upper 20% range at least in the nearer term.

We're still investing in people, so we have to carry that cost, if you will, and that's what's keeping that range there.

As our mix changes, as we continue to grow Tier 3 and add Tier 4-type revenues, we would expect our gross profit margin to continue to improve.

Okay.

Okay, so if I think about the kind of the components that you called out, so the $12 million of cost you're carrying in excess of maybe what you need near term, incentive comp, you also talked about higher manufacturing costs and higher quality costs.

Can you quantify, I don't know if you quantified the incentive comps, can you quantify the manufacturing costs and then the quality costs, what were the impacts?

Yes.

So that's the $12 million number that is in the gross profit side.

We believe that, that infrastructure cost in our gross profit line, probably a $12 million number in its totality.

Okay.

And the incentive comp is -- did you quantify that number?

Or is that in that $12 million as well?

But incentive comp was lower, so did you quantify the benefit?

Yes, the incentive comp is in SD&A.

You've seen what we have been able to do.

We delivered 26%.

We told you that we're up about a -- almost 200 folks.

You could probably back into the year-ago period by taking Q2, making the guess on 200 folks, what that would cost you, you then could back into what the SD&A difference is.

We don't provide that number for incentive comp, but I think you could probably get there.

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

Thank you, everyone.

Thank you for your time this morning.

We again 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, and I really want to emphasize that.

It is very bright.

Thank you for your support.

Thank you.

And that concludes today's conference call.

Thank you all for participating.

You may now disconnect.