Acuity Brands Inc (AYI) 2017 Q3 法說會逐字稿

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

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

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

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

Sir, you may begin.

Thank you, and good morning.

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

We are webcasting today's conference call at 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 in today's press release, which identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

Now let me turn this call over to Vern Nagel.

Thank you, Dan.

Good morning, everyone.

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

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 third quarter of 2017.

Net sales for the third quarter were a record $892 million, an increase of 5% compared with the year-ago period.

Reported operating profit was $131.5 million compared with $121 million in the year-ago period.

Reported diluted earnings per share was $1.90 compared with $1.69 in the year-ago period.

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

And adding back these items, one can see adjusted operating profit for the third quarter of 2017 was $148.3 million compared with adjusted operating profit of $146.1 million in the year-ago period, an increase of 2%.

Adjusted operating profit margin was 16.6%, a decrease of 60 basis points compared with a record quarterly margin reported in the prior year.

Adjusted diluted earnings per share was a third quarter record of $2.15, up 4% from the year-ago period.

During the quarter, we purchased approximately 2 million shares of our common stock in the open market for -- at an average price of $179 per share, supporting our bullish view of the long-term prospects for Acuity.

We closed the quarter with $190 million of cash on hand, leaving us with plenty of financial firepower to execute our growth strategies.

Looking at the key highlights for the third quarter.

Net sales in the quarter were up 5% over the year-ago period.

Overall, net sales volume grew approximately 6%.

This was offset by approximately 1 point for changes in the price/mix of products sold and a modest unfavorable impact for fluctuations in foreign currency.

While it is not possible to precisely determine the separate impact of changes in the price and the mix of products sold, we estimate the impact of price/mix was primarily due to changes in product price, primarily for more basic, lesser-featured LED luminaires sold at certain channels.

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

Net sales in Mexico and Europe continued to be negatively impacted by political and economic issues in those regions, which collectively reduced our consolidated net sales by almost 1 point this quarter.

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

Additionally, we believe overall market demand remains soft, particularly for smaller, short-cycle projects.

To add a bit more color on this, while available market data does not line up perfectly with our quarters, recent information from various organizations, including the U.S. Census Bureau and NEMA suggests shipments of lighting fixtures in the United States grew in the low single-digit range for our third quarter, consistent with consensus industry forecast.

However, this level of demand was down considerably when compared with the overall market growth rate reported in the year-ago period.

Please recall, demand started to slow in the second half of calendar 2016.

Nonetheless, we were still able to grow our business in U.S. and Canada by more than 6% this quarter, far outpacing the growth rate of the overall lighting industry, allowing us to continue to gain market share.

I will comment more on the -- 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 non-fixture-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 salesforces have allowed us to, yet again, achieve solid sales growth this quarter, particularly against the backdrop of a soft market environment.

Our profitability measures for the third quarter were solid, but impacted by these tepid market conditions.

Adjusted operating profit for the third quarter was $148.3 million, up $2.2 million compared with the year-ago period, while adjusted operating profit margin for the quarter was 16.6%, down 60 basis points from the adjusted margin in the year-ago period.

The decline in adjusted operating profit margin was primarily due to lower adjusted gross profit margin, partially offset by lower operating expenses as a percentage of net sales.

Gross profit in the third quarter was essentially flat compared with adjusted gross profit reported in the year-ago period.

Gross profit margin for the third quarter was 42.5% compared with our quarterly record adjusted gross profit margin of 44.5% 1 year earlier, a decrease of 200 basis points.

Gross profit this quarter remained flat compared with the year-ago period on an increase in net sales of almost $40 million.

Gross profit and gross profit margin were negatively impacted by higher-than-normal supply chain cost, including quality and inbound freight expenses, and to a lesser degree, the impact of price/mix changes.

This was partially offset by lower cost for certain components and productivity improvements, primarily from previously known streamlining actions.

We are aggressively addressing these supply chain issues and recently began to adjust our production capacity for certain product families to reflect current market demand.

We are also accelerating programs to reduce costs for certain basic, less differentiated product families to maintain our competitiveness and expected profitability.

Should market demand strengthen later in the calendar year, we will flex our production capacity to support this expected uptick when it occurs.

Next, adjusted SDA expenses were down $2.1 million compared with the year-ago period.

Adjusted SDA expense as a percentage of net sales was 25.9% in the third quarter, a decrease of 140 basis points from the year-ago period.

The slight decrease in adjusted SDA expense was primarily due to lower incentive compensation expense, partially offset by higher freight and commission costs to support the increase in net sales, greater salary and healthcare costs due to continued investment in additional headcount to support and drive our tiered solution strategy.

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 performance through the first 3 quarters of this year has resulted in a much lower potential payout than we accrued in the year-ago period.

Our adjusted diluted EPS was $2.15 compared with $2.06 reported in the year-ago period.

The increase was primarily due to a 3% increase in pretax income, a lower tax rate in the quarter and lower average shares outstanding due to the stock purchases this quarter.

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

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

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

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 35% this quarter and now represent more than 13% of our total sales.

In May, we announced our new Atrius brand, encompassing our portfolio of IoT business solutions and our Atrius software platform, which as you know, has been developed over the last few years.

This software platform is a robust, scalable and secure platform that enables an array of capabilities, including indoor positioning, asset tracking, space utilization, spatial analytics and energy management.

The Atrius solution builder provides a comprehensive development environment for customers and partners to build IoT solutions leveraging the Atrius platform.

In fact, yesterday, we announced the names of some of industry-leading technology and software providers that have adopted the Atrius IoT platform and software solutions that will enhance their ability to deliver unique and valuable capabilities and solutions to their customers.

Interest in our Atrius platform is significant, and we expect to add additional user partners soon.

Through Atrius, we will continue to provide and expand our comprehensive set of IoT business solutions, leveraging intelligent luminaires, lighting and building management controls, software platform services and development tools.

These solutions deliver connectivity and intelligence to a space via an expansive network of smart LED lighting and controls and a software platform that gathers, unlocks and transforms raw data to enable a broad range of software solutions, addressing critical business challenges.

Atrius solutions have already been deployed across nearly 60 million square feet of indoor spaces, leveraging more than 1 million sensors.

Additionally, the installed base of the Acuity Brands' network lighting systems encompassing more than 1 billion square feet will now be upgraded to a more multifunctional Atrius sensory network that can supply IoT data to this robust platform.

We launched the Atrius platform at the IoT World Forum in London earlier this quarter, creating significant demand from numerous global technology leaders to partner with Acuity to leverage and expand these unique capabilities.

From a commercial perspective, we have recently received commitments and orders from both customers accelerating the expansion of their current platforms as well as customers moving beyond pilot programs to implementation, deploying the Atrius IoT platform, including our comprehensive lighting and building management solutions, that will afford them unique value-added capabilities and solutions to enhance their businesses and to potentially allowing us the opportunity to quadruple our installed base of Atrius-enabled systems over the next 12 to 18 months.

And this does not include the potential growth opportunities from new customers and partners, again, from which there is great interest in deploying our Atrius platform and solutions.

Lastly, we have added new technology -- new technologies, capabilities and analytical features to our Atrius solution platform, creating a more comprehensive, full suite of IoT solutions that are well beyond the proof-of-concept stage that we believe will continue to contribute to our accelerated growth and our Tier 3-enforced solutions.

We have been able to create these capabilities while providing industry-leading results because of the dedication and resolve of our more than 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 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 as you compare our performance to other public companies in our industry.

The effective tax rate for the third quarter was 34% compared with 34.3% in the third quarter of last year.

We expect the effective tax rate for fiscal year 2017 to be approximately 34.5% before any additional discrete items and if the rates in our taxing jurisdictions remain generally consistent throughout the year.

At May 31, 2017, we had a cash and cash equivalent balance of $189.7 million, a decrease of $223.5 million since August 31, 2016.

Our operating working capital, defined as receivables plus inventories less payables, at May 31, 2017, increased $34.4 million during the 9 months of fiscal 2017 to 51 days compared with 41 days in the prior year.

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

In the first 9 months of fiscal year 2017, we spent $55.2 million on capital expenditures compared with $61.8 million in the prior year.

This decrease in capital expenditures was primarily due to reduced spending on facility renovations.

We currently expect to spend approximately 2% of revenues in capital expenditures in fiscal year 2017.

We have finalized the acquisition accounting for all of our recent acquisitions.

As disclosed more fully in our 10-Q filed today, with the resulting changes and evaluation of intangible assets, we expect amortization expense to be approximately $28 million annually.

During the third quarter of fiscal 2017, we completed the repurchase of 2 million shares of the company's outstanding common stock for $357.9 million with an average price paid per share of just under $179.

Earlier this week, our Board of Directors authorized an additional 2 million shares for repurchase.

This new authorization provides management with the ongoing flexibility to repurchase shares in the future as appropriate.

We believe that repurchasing our shares represent a wise use of our cash flow, especially during periods of high stock price volatility and allows us to offset dilution resulting from our stock-based compensation and benefit programs.

Additionally, we believe that repurchases of the company stocks supports Acuity Brands' objective to maximize long-term shareholder value while continuing to fund investments to better serve our customers, grow our business and improve our operating and financial performance.

Our total debt outstanding was $356.7 million at May 31, 2017.

We had additional borrowing capacity of $244.7 million at May 31, 2017 under our credit facility, which does not expire until August 2019.

Our net debt to total capitalization at May 31, 2017 was a mere 9.8%.

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

Thank you, and I'll now turn it back over to Vern.

Thank you, Ricky.

At Acuity, we continue to see significant long-term growth opportunities that are ever-changing and evolving in a positive direction for our company.

Recent economic and industry data shows the end markets we serve in North America and certain markets in Europe through the first 3 quarters 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 total growth for the lighting fixture market will be up in the low single-digit range for the balance of calendar 2017, primarily driven by softness in end-user demand, particularly for certain smaller projects that have short lead times.

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

Current forecasts are calling for a rebound in luminaires sales for 2018 supported by growth in the overall economy as well as a more consistent growth rate for nonresidential and residential contract awards.

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

We continue to see signs that give us optimism regarding the future growth of the markets we serve.

Leading indicators for the North American market such as Architectural Billings 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 the calendar year 2017:

Given the information just noted, we expect the lighting market in North America, our largest market, to grow modestly in the second half of calendar 2017.

Additionally, we expect to continue to outperform the overall growth rate of the market we serve.

Next, we expect the price of certain LED components to continue to decline, though at a decelerating pace, while certain other costs, including certain components and commodity costs as well as certain employee-related costs, primarily due to further investments and associate headcount, wage inflation and healthcare cost, will increase somewhat.

We expect to mitigate some of the impact of these rising costs through certain pricing initiatives, productivity improvements and product cost reductions, though the timing of these initiatives might lag the timing of these increased costs.

Next, we continue to be leery of the impact 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 cost, market level pricing and changes in the mix of products and sales channels, we expect our annual gross profit margin to improve over time as volume grows and as we realize typical gains in manufacturing efficiencies.

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

Our current supply chain issues as well as competitive pressures for certain products sold in certain channels has influenced our profit and margin dynamics somewhat this year.

Nonetheless, we believe the actions we have put in place to reduce costs and enhance the value of our solutions as well as overall market growth will allow us to expand our margins over the long term.

I would point out that our variable contribution margin this quarter was 28% on a sequential basis over the second quarter.

Next, our adjusted SDA expense as a percentage of sales was approximately 26% year-to-date.

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 a much higher incentive compensation expense.

This means we would expect our adjusted SDA expense as a percentage of net sales be closer to our historical trend assuming market rebounds 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 towards our historical trend.

So to be very clear, our focus is 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 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 Atrius IoT platform and software solutions.

As I noted earlier, we are now converting certain customers to implementation from pilot programs, and we continue to expand the number of pilot programs with customers for these smart platforms and continue to experience strong interest from many other key customers and potential partners in multiple verticals to deploy our holistic solutions with these unique 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 our growth rates for our Tier 3 and 4 categories as well as the acceptance of our IoT-enabled smart platform solutions, particularly with the launch of our new Atrius platform.

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

This all takes focus and resources.

We are 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 have 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 continued opportunities for new construction, and more importantly, the conversion of the installed base, which is enormous in size, to more efficient and effective solutions.

As the market leader in lighting solutions and a technology leader in building automations, along with our Atrius platform, we are positioned well to fully participate in these exciting and growing industries.

Thank you.

And with that, we will entertain your questions.

(Operator Instructions) Our first question is from Vishal Shah of Deutsche Bank.

I was just wondering if you can maybe talk a little bit about your contribution margins during the quarter.

And also what you see in the stock and flow business.

It looks like the business is still soft.

What percentage of your product business today is stock and flow?

And how do you think that's going to trend over the next couple of quarters?

Sure.

With regard to our contribution margin, quite frankly, we had nice growth relative to market conditions.

We grew in our U.S. and Canadian business more than 6%.

So against the backdrop of a marketplace that we believe was up 2, that's a meaningful outperformance.

We would've expected contribution at the gross profit level much greater than what we had.

So let me just do some math for everyone.

If you imagine that we target our variable contribution margin to sort of being in the mid- to upper 20s, when you take away freight and commission expense, the rest of it would be in gross profit.

So clearly, there was a shortfall.

As we look at what's happening in our business, we continue to have challenges within our supply chain.

And we call it supply chain, but it's really more connected than that.

Some of the issues, as we continue to accelerate the introduction of new products and new solution set, the connectivity between engineering and manufacturing, and then further, our component supply base, continues to be a challenge for us.

We pride ourselves on being very, very good at this, but we have seen issues that have given rise to some quality issues that we have to address as well as the fact that we're incurring greater inbound freight as we try to better align our supplier base.

Let me give you one example around this.

We have a key supplier that has supplied us with products for quite a long time for a small subset of what we do, but an important subset of what we do.

This particular supplier has moved their manufacturing operations to a more low-cost environment.

And in their process, they have struggled.

They've struggled to keep up with the demand that we have.

So it's impacted somewhat our top line, but it's very much impacted our gross profit line because we've had to incur additional cost to help facilitate that.

I am very confident that in time, we will solve those issues.

And you will see, from a cost perspective, improvements that would be more consistent with what we have historically operated at.

So when I look at this quarter and I see that loss of variable contribution margin, it has more to do with self-inflicted wounds than it does, in our view, with overall market dynamics.

And again, as I said in the call, we are addressing that.

To the second question, with regard to stock and flow, the stock and flow business is really supporting these smaller, short cycle-type projects.

We continue just to see overall softness.

We have different pieces of data that are confirming this level of softness.

Larger projects continue to move along nicely.

Orders and quotations that we see continue to be very positive for those medium to larger projects.

On the stock and flow side, I don't have good data or information to say exactly why is this happening, but I do believe that people are taking a bit of a wait-and-see approach.

I can use Acuity as an example.

We're looking to add some additional paint capacity.

The question is where do we put that capacity as we wrestle with the some of the thoughts that are coming out of Washington about taxing policies, that will influence our decision.

So here's a company like Acuity that's delaying certain investments as it waits and see.

My guess is that flows through the marketplace as well.

But our stock and flow business is an important piece of our business, and we support it and serve it well.

So as that market rebounds, we would expect to continue to outperform in that space as well.

Our next question is from Tim Wojs of Baird.

This is Josh Chan on for Tim.

Yes, my first question is following up on some of the gross margin discussion.

Vern, you mentioned that the supply chain issues -- and then you also mentioned rising costs in other areas as well.

So just wondering, as we look forward, do these issues -- how long do these issues persist?

And how should we think about gross margin trajectory next quarter and then obviously into the next year?

So again, it's an interesting dynamic.

When I look at our labor cost within our supply chain as a percentage of sales, we continue to drive productivity.

We continue to see improvements in that area.

So at some of these exogenous areas that have more to do with, if you will, business processes and those folks that help supply us, again, if our supply chain, and I don't necessarily mean our internal capacity to assemble or to paint or to do some of the things that we have great core competencies around, it's how materials moving from suppliers into our system.

If those are not precisely connected or those folks are having issues, they're going to impact us.

We have, with this one particular example I gave you, we've seen that now for, what, probably 3 quarters in a row, Ricky?

Yes.

And we're seeing improvement, but it's slow, and these are -- this is an important supplier.

We're taking actions to help mitigate, to help support to do some of these things.

I expect that we will continue to see progress.

As I mentioned to you earlier, when we looked at our variable contribution margin, third quarter compared to the second quarter, so sequentially, we were up 28%, which is reflective of the improvements that we're making.

I would expect those to continue as we wrestle through some of these issues.

A number of the quality issues that we're experiencing really are from solutions and business processes that we -- that were a year ago, and we're now experiencing some of these.

We believe that we have addressed a number of the business processes.

What we mean by that is the handoff from engineering and product development to manufacturing and then to supply base, we think we have addressed many of those issues, but we're dealing with the lingering effects of that.

So my expectation is that we'll still see some headwinds, if you will, as we fix those things.

But again, I'm robustly positive that this is in our wheelhouse.

We're good at this stuff.

It's just that we're experiencing -- have been experiencing some issues here within the supply chain.

If we had performed, and I'm not suggesting we didn't, but if we did what we normally do, I think that the variable contribution margin that had been more in that mid to upper 20s, the growth and performance would have been more in line with the kinds of expectations in performance that we're capable of delivering.

So I'm optimistic about what the actions that we're taking.

I like how we're driving productivity.

I like our focus around these things.

But my guess is we'll still be dealing with some of the lingering, the lag effect of fixing some of those items over the next quarter or so.

All right.

And if I can switch gears to the Tiers 3 and 4 solutions that you talked about.

Obviously, there's been a lot of headlines on retail recently.

So wondering what your thoughts are on whether the online effect is impacting your opportunity set there?

And also, do you have targets for other verticals?

And are you making headway in those other verticals as well?

Yes.

So we believe that as the folks in retail, who have a massive installed base, look to adjust, enhance their business models on how they serve their customers and take advantage of their proximity and location, we think it provides a unique opportunity for the Atrius solution set to drive real value to enhance those capabilities.

I didn't mention this, but we're very excited about taking Atrius, not only from indoor, but to the outdoor opportunity so we create an entire campus capability, if you will, to provide the types of analytics and asset tracking and other things that we're able to provide that are really value-add to these types of, whether it's retailers or public spaces or healthcare, educational campuses, we see it as a unique opportunity to add value.

When we think about the base, these things take longer than most people anticipate because folks are testing these solution sets, and they're looking at do others provide capabilities and why is this capability so robust.

This quarter, I believe, was a bit of a watershed quarter because we now have customers that are moving from implementation to an accelerated implementation.

We have a number of customers who are now moving from pilot programs to implementation.

So as I mentioned in our prepared remarks, just the base that we have today and with orders and commitments that we have in hand, we would expect to quadruple the amount of space that is covered under the Atrius solution platform over the next 12 to 18 months.

And as you all probably saw here just recently, we announced partners that are now engaged in utilizing the Atrius IoT platform as embedded into their capabilities.

This is a hugely exciting opportunity for us to really drive growth, and there'll be more announcements around these types of folks because we have a robust platform.

When I think about the number of square footage and the customers that we're dealing with in multiple verticals and how these things are moving along, we still have competitors that are trying to figure out how to do it in one space.

So when you think about one space versus the thousands that we're now in, it's a huge difference.

So very excited about what that opportunity is, and it will continue, because it's a long spec cycle, to roll out, but the momentum is the building and we're excited about that.

That's why when we pointed out what we've -- our growth in our Tier 3 area was in the kind of the mid-30s, 35% growth and now represents 13% of our business for these types of solution sets.

So very exciting for us.

And we think that this is additive to our overall growth beyond just what market and some of our ability to gain shares in our local market.

Our next question is from Brian Lee of Goldman Sachs.

I guess, first off, Vern, with the new data that you're looking at suggesting a low single-digit growth for the industry moving through the rest of calendar '17, does that change your thoughts around the growth recovery?

I think in the past, you had talked about sort of exiting this year and early 2018.

So would be curious if, one, the timing of your view on growth recovery for the industry is changing.

And then, two, historically, you guys have kind of grown at close to 2x over industry growth rate.

Is that still the ratio you're sort of targeting?

I know you haven't quantified it more recently, but just wondering if anything's changed there?

Sure.

So let me answer the second question first.

The last couple of quarters, we've seen the marketplace slow down relative to the year-ago quarter, whatever that was, and kind of being this more low single-digit range.

And yet our growth this quarter, when I look at U.S.-Canada, which is -- I put Europe, which is a small piece of our business and Mexico aside, which have some political issues going on, our growth was, we believe, 3x the market.

So pretty robust.

What we target is just to meaningfully outperform.

I think that Acuity, over the last, go back 3 or 4 years, has meaningfully outperformed the growth rate of the overall market.

And so our expectation is that we will continue to do that, and we'll do that in an aggressive way.

We think that providing our Atrius platform and our Tier 3 and Tier 4 solution sets, that really bring along the quality of our lighting and building management products is an opportunity just to facilitate an even greater growth rate than the overall market growth rate.

Our competitors don't have this capability.

When we think about the growth rate of the markets, look, coming into 2017, all of the market forecasters on a consensus basis were projecting more growth, and I think that, that enthusiasm was built off of just generally improving economic activities, employment, so on and so forth.

There's bifurcation in larger projects versus smaller projects.

There's lots of speculation as to what's causing that.

I do think that folks are taking a bit more of a wait-and-see approach.

So is that causing a delay in the overall market growth?

Could be.

I don't know precisely why, but I know it's happening.

2018, our view is that -- and we're looking at the same data they're all looking at, whether it's Dodge, Global Insight, different economic forecast from differing organizations, I think people are expecting that there'll be sort of a clearing of the air around some of these clouds, whether it's tax policy or some of the other things that are overhanging people, political views around what's going to happen with NAFTA, so on and so forth.

I think as these things kind of move away and move off the table, I think that there's a lot of underlying or pent-up demand for a lot of these things, the value propositions for renovation and retrofit are really strong.

And I think that as we continue to bring even more value in terms of the Atrius platform, I think that we're going to see an acceleration of our growth, but I also believe that the underlying market growth rate will continue to improve.

Okay, great.

No, that's helpful.

The second question and I'll pass it on, is I know you guys don't necessarily think about the business in these terms, but you do break it out, so we tend to look at it this way from this outside community.

The LED segment growth, it's nothing to sneeze at in the mid-teens here, but it has derated faster than I think a lot of people would've expected here and you're now kind of back in line with what the growth rate is for peers after a long time of outgrowing peers.

Any specific drivers you can point to there?

Is this just the new normal after a period of outsized growth in that particular technology segment?

Or when you mentioned reacceleration in the business, would that be a particular area where we might see those growth rates start to tick back up, especially with Atrius embedded in those numbers?

I believe that our LED growth rate is exceeding the market growth rate, Ricky.

When we look at some of the data we have around sales relative to others, it's positive to that.

So I don't know that I completely agree with the statement or the premise that we're now at peer levels.

Mix of product is important.

A lot of folks have come at us, you didn't ask this question, but I'll look to address it a bit, what's happening with pricing in the market and certain things.

Our overall price/mix, we believe, was mostly prices for it was a point, right?

But we don't participate in every aspect of the market.

So where there is, if you will, aggressive price pressures where people are talking about that folks do certain channel check.

Acuity doesn't always participate in that.

So when we look at our growth rate and we look at what's happening in our luminaires, we participate, and always have, in a bid market.

So pricing is always competitive.

And what happens in one geography may not be happening in another for a certain set of products so on and so forth, but when I look at our overall luminaire business, and it depends on what type of product set it is, I mean, we are robustly now in full penetration.

When I look at downlighting and things of that nature, Ricky, I mean, it's a high number.

And so you're continuing to add value at different ways to bring solutions to the market that are not just based on competitive price pressures.

Again, we have said that we expect component cost to continue to decline, though we believe that it's somewhat of a decelerating rate, and some of that goes back into the marketplace.

So overall, I believe that our growth in LED continue to outpace the market, will continue to be favorable.

And unit volume for many of these products, again as component price come down, we'll have to -- will offset some of the top line effects, if you will.

How much of that is impacting the market, I still believe that when we look at our overall business, stock and flow is not an unimportant part of our business at all, but it's probably in that 20% range.

I don't know precisely what the number is.

Maybe it's slightly less than that, Ricky, when we look at the -- against the total backdrop, including total sales, building management and other sorts of things.

So again, while it's an important part piece of our business, price/mix, for us, was about 1 point, and we believe that point was primarily in the LED luminaires side, which I think is very different than others who may be participating in other type of products at that basic, less de-featured end than we are.

We participate in certain SKUs and it's an important part of our business, and that's why we're aggressively looking at our cost structures to be more competitive and maintain the profit dynamics that we have.

But again, when we looked at our results for the quarter, our gross profit impact was primarily due to some of these supply chain issues, not related to the price/mix either.

Ricky, any additional comments?

The only other thing I'd mention is, on the LED, is, as Vern said, we participate in much of that broad market, but there are segments like the lamps, the LED tubes, some of those areas, which are experiencing nice growth and some areas that are replacing incandescent and so forth, but are seeing huge price declines and challenges and all, there.

So as you look at our results and compare it to some of our peers, recognize that, that's a part of the LED market that we have strategically chosen not to participate in.

Our next question is from Christopher Glynn of Oppenheimer.

Interesting headline on the Atrius partners.

I'm wondering if you could speak to how substantive that partner engagement is versus, sure, we'll be interested in lighting.

And what the real buy-in on the notion of luminaire is a truly core edge device is?

Yes.

So the Atrius platform is a broad-based platform.

It's collecting -- it has the ability to collect data from multiple sensor sources, not just lighting.

We see lighting, and our partners, in this regard, see lighting as a very dense, ubiquitous capability to create a robust sensory network that can tie in to many other types of sensory networks.

So think of HVAC, think of other building things, literally any sensor that you can imagine, the Atrius platform has the, again, robust ability to collect that information.

And then in a very, very user friendly way, provide that data so that people, with their own SDKs, can create apps or analytics and the solution set and how they can do that through Atrius is really simple and really efficient and it's a point of significant differentiation.

So what these partners see is the ability to say, "Oh, instead of using a very less efficient data collection sensor, battery-enabled beacon of some type." I'm just using that as an example, we could collect that data.

But because we have this, again, very robust sensory network from lighting, it's a great source for many of their solution set.

So the data is now being made available to them.

Our team has done an extraordinary job of really creating sort of the API that is robust and secure and scalable, and the SDK kits are really very, very efficient.

So Chris, these partners see this as an enabling capability that makes them very, very efficient in how they then get the data to then use it in the apps where they're bringing differentiated value.

So we're very excited about this.

As you know, the investment that we've made over the years to create the Atrius platform, whether it's acquisitions of Geometri, eldoLED, DGLogik, many of these kinds of things, and then the -- our own investment of our software engineer and our various engineering teams, again, we have now hundreds of people there focused on this.

So the coming out party under the Atrius platform, various pieces and parts have been in the market today.

Now, we're full in.

It's no longer proof-of-concept.

We are engaging people to have this become, if you will, the standard within their system to be able to collect data and then they do their thing, their value-add in terms of what they're providing to that end customer.

So we're very excited about this.

There's very significant demand, and we're aggressively putting resources behind this to market these programs and solutions to these folks.

I would just say to the -- to all of the listeners here, you know, in the last quarter, if I think about how we have net added folks in our salaried workforce, probably 90% of them are focused on this type of solution set.

That is really part of the broader Atrius IoT platform and solution side.

It's a big deal.

Very interesting.

And if I could ask you speculatively, you mentioned the quadrupling of the installed base.

A couple of questions.

Is that often running or more back-end loaded as momentum follows a normal build pattern?

And is the quadruple kind of a snapshot, what you see now versus maybe that is a dynamic metric as momentum builds and we get updates the next few quarters?

Yes, I think it will be important.

Because this is all new and developing, it's spotty, right?

It's not like you can say, "Okay, here is the overall market.

It grows at this rate, and then you can gauge what we're doing." We're developing, if you will, a solution set into a marketplace that has been rudimentary.

So people are testing it.

People are working with it.

They're experimenting with it.

Those that were the early adopters are now moving more and more to a more rapid implementation because they now are using it to do things that create real value to them, and they're driving that.

Folks that were in pilot programs are now moving from pilot to implementation.

So it will go through its normal rollout.

We just want folks to understand that the significant difference that Acuity has relative to what competitors, you might view as competitors, traditional people saying, "Oh, I can do that, too." Just ask them what's their installation set look like.

And now, you have a real sense of just how far we are in this opportunity compared to our competitors.

So I think it's going to be -- it will be a little bit lumpy as we roll out, but like I said, I think over the next 12 to 18 months, off the base that we have, this is what we're expecting based on the commitments and orders that they have, we just know that this is a snapshot today, and our teams are aggressively marketing to partners, to other lighting companies, to other vertical sets.

Again, as we think about who are we targeting, retail is a great example, public spaces are a great example.

And then you think of campuses, whether it's university campus, research campuses, healthcare campuses, those are the verticals where it's really low-hanging fruit and opportunistic.

And then when you get into our traditional business, we're bringing unique solution sets into the commercial office building, into warehouses.

We're expanding Atrius and having discussions with people who are focused on that industrial warehouse manufacturing space because of the unique capabilities of this Atrius IoT platform to collect data from any source and then provide that data into a very, very effective SDK process where people can write apps against it.

It just facilitates meaningfully their ability to provide data and analytics back.

Our next question is from John Walsh of Vertical Research.

I guess a lot of ground covered, but 2 kind of quick ones.

One, as we think about the investments you're making in software and engineers over the next couple of years and what you've already been doing, are we at the point where we're starting to plateau?

Or are there still kind of significant step-ups that have to happen from the run rate we're at currently?

So let me try to address that question is really to (inaudible) kind of targeting (inaudible).

I would say that we still need to, in our view, and (inaudible) marketing sides of things, really working with customers to make sure that their solution set is being supported the way they want so that they -- it comes off without a hitch.

So we need some more capability there.

Those folks who will be both engineers as well as other skill sets, but I don't consider that to be a huge number.

I think the bulk of the investment that was necessary to get Atrius to where it is today, meaning a very viable platform that can be used in the market on a number of applications is pretty robust.

And so I think that the variable contribution margin number that we target, mid- to upper 20s, is still good for a while because we will be adding capability.

But as you all know, and I've said this before, and Ricky and Dan have said this before, our expectation is that there's a crossover point and we'd begin to really leverage this.

I think we're some quarters away from that, but we're getting closer every day.

Our excitement I would add to that is while the investment is there and we'll continue to have some ahead, we're now starting to see the return off of these several years of investments.

Early on, we had to build the platform, we had to build out the APIs, the SDKs and all before you really started seeing meaningful revenue.

Now, with the momentum that we're seeing, we're now starting to see the return come in, both on the sales of the infrastructure, but also on the recurring revenues as well.

That is enjoyable to see that we're now getting the return on these years of investment.

And Ricky, I think you would also agree that the opportunity to add solution sets to basic, lesser-featured products allows them to have more value than just trying to compete on a very deep featured, really low value-add product.

Just because something's low value or doesn't have a lot of features, it doesn't mean it doesn't reside in the space.

The real estate in that ceiling is valuable.

I think that Atrius gives us the opportunity to make those basic products more valuable, more differentiated and more competitive against folks who are simply trying to say, "Oh, I have a low price." So we're excited about what this opportunity means for our Tier 1 and our Tier 2 solution sets and Tier 3 that go through more traditional channels.

This is a value-add opportunity that can -- that will help us further differentiate.

In every situation?

No.

But in many situations, yes.

And that's a margin enhancement opportunity on what we'll call basic deep-featured-type luminaires.

Great.

And then I guess just to follow-up to that, as we think about future proofing and turning clients on potentially at a later date for services, how is the system set up for that?

Somebody might not be ready to go to a full-blown solution today, but they want to have that capability down the road.

Is that embedded in kind of some of the less smart luminaires today?

And then obviously LED, once it goes into the ceiling, you're talking about potentially 15-year plus [lights].

How do you kind of future proof?

And I'm assuming it's mostly software update, but maybe kind of talk a little bit about that.

So our nLight System is a very robust capability that has been out for a while.

We estimate -- it's an estimate.

We estimate that there's probably 1 billion square feet of space that is nLight-enabled that really now has the opportunity in a very simple way to enjoy the benefits of the Atrius IoT platform.

So we have customers that have this capability in place.

It's also through our nLight ECLYPSE system, which was created in conjunction with Distech, which is a fantastic acquisition, great team to create these capabilities.

So we have an installed base.

They have the ability through their nLight capability to upgrade or to take advantage of our Atrius IoT platform.

And as we talk to customers today, it's at the forefront of our discussion to say, "Hey, look, you're converting to LED.

You should hear the energy savings that you have.

But you should future-proof this so that it can be Atrius IoT-enabled because one day, if you're not ready today, you can use this capability to do many, many things." And we believe that's a very robust opportunity, because as you imagine, some of these other partners who are using the Atrius platform and the SDK capability to create apps that are targeted towards things, this is really our model.

We want other people who are creative as all get out writing apps that help the end customer enhance the value of their space, indoor and outdoor, enhance the productivity, enhance the use.

But it's all, if you will, paid for through the notion of energy savings, energy-efficient lighting in their space.

Our next question is from Cindy Motz of Williams Capital Group.

Congrats on the buyback and the overall growth and just the -- even reigning in some of the incentive compensation, that was great.

So -- but I just had a question on Atrius, just following up.

In general, you had a nice ramp.

Like so sales are growing now at 35% versus like 25%, like you said, I guess, a quarter ago.

That should mean good things for gross margins as well, right, because it's recurring revenue's more like software margins.

So could we -- I mean, if you get the supply chain issues in order and you also have the bump, let's say, from increased margins from Atrius, I would think that your margins, as you said, should go up.

But I mean, could we see some of that next quarter?

I'm just curious, I mean, obviously going forward.

And then I had a question just on revenues, but if you want to answer that one first.

Cindy, first of all, reigning in incentive comp is not our objective here because we are...

No, I meant I saw the decline though.

I saw that percentage come down.

So you're doing what you said you're going to do, so.

It means that we're not having the kind of period-over-period improvement that we're after to pay.

Let me answer or attempt to answer some of the questions around the margin of Atrius.

First of all, our Tier 3 solution set, recall that it is a broad-based solution set where we are tying together luminaires and building management capability in your conference room, in your floor, tied to your whole building.

Those solution sets can be enabled to do different types of things within Atrius -- the asset tracking, geospatial analytics, so on and so forth.

So Tier 3, that billion square foot of base that we believe is in place, most of those folks put that in place primarily because they were targeting energy savings.

It's just that our solution set through nLight offers them the opportunity to now upgrade that, if you will, to an Atrius solution.

So as Atrius itself begins to spice the stew and the mix within that Tier 3, and as it allows us to then generate recurring revenues to support on a subscription basis, the Atrius platform, when you look at those 2 together, that's where you, in time, will begin to see the margin lift as the mix moves -- as those businesses grow.

Our core business, our core lighting business has tremendous potential and opportunity for continued growth, and we do well there from a margin perspective.

So as one is growing at a nice, exceeding market rate, the other one is accelerating as more adoption occurs.

Yes, our expectation is that in a normal operating environment, that our margins would continue to improve.

Unfortunately right now, you have sort of 2 things working, right?

We're trying to bring clarity around what's happening operationally within our business, so we've got some things to continue to address and fix.

But then, what's happening on those incremental margins, I'm still very comfortable, I think Ricky is as well, that targeting incremental margins over the next quarters, handful, less, whatever, will probably be in that mid- to upper 20 kind of variable contribution margin, then accelerating as our investment in our core, we now are really starting to leverage that.

You're not having to add more, if you will, engineers to create.

You're adding more people to help support but at a much lower rate, getting much more leverage, if that makes sense.

Great.

No, that's a great.

And just on revenues.

So we're still -- I mean, the next quarter or this quarter that we're in and your last quarter fiscally, we usually see the seasonal bump.

So I would expect that we would still see that seasonal bump.

And the only other question I had was I saw in the Q, you said that you were going to adopt ASU 2014, Ricky, September 1. So going forward, should we expect to see anything like from -- because I know that ties cash receipt to revenues more from the project thing.

So just on revenues.

Okay.

On the seasonality of the revenues, you're correct that, historically, our fourth quarter, fourth fiscal quarter is our seasonal high, our third and fourth combined usually are 52%, 53% of the total revenues for the year.

And there's nothing new that would suggest we wouldn't see that same level of seasonality this year.

A lot of it is school season-driven, weather-driven, those types of things.

As far as the accounting, I assume you're talking about the revenue recognition standard.

That, for us, we won't have to adopt until the first quarter of our fiscal '19.

So it will be September of '18 that we adopt it, we're very much in the throes of looking at contracts and preparing for that.

You saw enhanced disclosures in the 10-Q regarding the preparedness that we are going through to adopt that.

It will have an impact on us, particularly on the Tier 4 recurring revenue, subscription-type revenue.

And you're right, that will result in a more deferred accounting for that will not necessarily match the cash flow.

So we will have upfront cash, hopefully, that we collect that may get deferred.

Warranties is another area that we will be impacted as we'll have to likely separate that out as a separate revenue component and defer the portion of the revenue that's related to the warranties side.

So it will have an impact.

I don't know that it will be nearly as material as some other industries, but it will have an impact.

But we -- we're fortunate with our fiscal year end that while most people have to adopt it January 1, '18, we have all the way until August.

So we've got a little bit more time before we'll have to adopt that standard.

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

Thank you, everyone, for your time this morning.

As you can tell, 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, and thank you for your support.