Acuity Brands, Inc. (AYI) Q1 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the Acuity Brands 2015 First Quarter Financial Conference Call. After today's presentation, there will be a formal question-and-answer session. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I would like to introduce Mr. Dan Smith, Senior Vice President, Treasurer and Secretary. Sir, you may begin.

Thank you. Good morning. With me -- excuse me, with me today to discuss our fiscal 2015 first 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 risk and uncertainties such that actual results may differ materially. Please refer to our most recent 10-K and 10-Q SEC filings in today's press release, which identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Now let me turn this call over to Vern Nagel.

Thank you, Dan. Good morning, everyone. Ricky and I would like to make a few comments and then we'll be happy to answer your questions. First off our results for the first quarter of 2015 were just outstanding. Our net sales grew almost 13%, while our adjusted earnings per share grew nearly 40%. On an adjusted basis, we achieved quarterly records for operating profit, operating profit margin, net income and earnings per share. In fact, this was the seventh quarter in a row where we achieved double-digit volume growth. We believe these results are yet again strong evidence of our strategies to provide our customers with differentiated, value-added solutions and to diversify the end markets we serve are succeeding, allowing us to extend our leadership position in North America. These strategies include the continued aggressive introduction of innovative, energy efficient lighting solutions, expansion in key channels and geographies and improvements in customer service and company-wide productivity. Our adjusted profitability for the quarter was a record for Acuity, even as we continue to invest in our strong sales growth and areas with significant future growth potential, including the expansion of our solid-state luminaire and lighting controls portfolio. I know many of you have already seen our results, and Ricky will provide more detail later in the call, but I would like to make a few comments on the key highlights, for the quarter. Net sales for the first quarter were $647 million, an increase of almost 13% compared with the year-ago period and the second highest quarterly sales in our history. Reported operating profit for the first quarter of 2015 was $86.7 million compared with reported operating profit of $77.4 million in the year-ago period. This quarter we recorded a special pretax charge of $10 million associated with certain streamlining actions to lower our cost structure and to reduce spending in certain areas, so we can increase investment in new opportunities with greater growth, with greater potential for future profitable growth. Also in the year-ago quarter, we received $5 million as a partial recovery for a fraud perpetrated by our former freight service provider to the company, for which we had previously recognized an expense in the third quarter of 2013. I find it helpful to add back these items to both quarter results to make them comparable. In doing so, one can see adjusted operating profit for the first quarter of 2015 was a quarterly record of $96.7 million, compared with adjusted operating profit of $72.4 million in the year-ago period. Adjusted operating profit margin for this quarter was a robust 14.9%, up 230 basis points from adjusted margin in the year-ago period. Adjusted diluted earnings per share were a record $1.32, compared with adjusted diluted EPS of $0.96 in the year-ago period, up 38%, strong quarterly results indeed. In addition, we generated almost $47 million in net cash provided by operating activities this quarter. As Ricky will discuss later, we meaningfully enhanced our already strong financial position this quarter as we now have more than $580 million of cash and cash equivalents on hand, far exceeding our debt of slightly more than $350 million. These results for the quarter were significant improvements over the year-ago period we believe you will find our results for the quarter even more impressive upon further analysis. While net sales for the first quarter grew almost 13% compared with the year-ago period, we estimate our sales volume grew more than 14%. This growth was partially offset by lower price mix and to a lesser degree of the impact of foreign currency. While it's not possible to precisely determine the separate impact of price and mix changes, we believe the difference was primarily due to lower pricing on like-kind LED luminaires between periods, reflecting the decline of certain LED components and to a lesser degree of changes in the mix of products sold. The increase in net sales was broad based along most product lines, including certain specialty fixtures as well as certain control solutions, more closely associated with new construction as this important market continues to expand. From a channel perspective, we continue to experience strong growth in commercial, industrial and infrastructure as well as games and home improvement. Our sales growth this quarter was primarily due to our continued focus on projects for new construction and renovation in both the non-residential and residential markets as well as continued emphasis on selling higher value-add lighting solutions especially LED luminaires, where sales of our LED products grew by almost 75% this quarter, compared to the year-ago period, an extraordinary achievement when one considers that sales of LED-based luminaires at Acuity now account for more than 40% of our total net sales. We believe our rate of growth for LED luminaires continues to far outpace the growth rates of our largest competitors for these types of products demonstrating our leading -- market-leading prowess. Excluding LED luminaires and components, we believe the put and takes for product pricing as well as material and component cost were again fairly benign this quarter. looking at market conditions for the first quarter, we believe that North American lighting market was up mid single digits during the quarter. This was in contrast with the growth rates of our net sales in North America, which was up more than 14%. Lastly, we believe our channel and product diversification as well as our strategies to better serve customers with new, more innovative lighting solutions and the strength of our many sales forces have allowed us to again achieve meaningful sales growth this quarter. Before I turn the call over to Ricky, I would like to comment on our profitability and strategic accomplishments for the quarter. As we noted earlier, our adjusted first quarter operating profit was $96.7 million, the most in our history and adjusted operating profit margin for the quarter was a robust 14.9%, also the highest in our history, up 230 basis points from adjusted margin in the year-ago period. Our gross profit for the quarter was 42.2%, up 90 basis points compared with the year-ago quarter. The expansion our gross profit margin was primarily due to the benefits of higher sales volume, somewhat offset by price mix and unfavorable changes in foreign currency exchange rates. Productivity improvements and lower material cost also had a small, yet favorable impact on our gross profit margin improvement this quarter. Next, total selling distribution and administrative expenses excluding the items noted earlier for each quarter were up $11.6 million, or 7%, on the net sales increase of almost 13%. Adjusted SD&A expenses as a percentage of net sales were 27.2% in the quarter, a decrease of 150 basis points from the year-ago period. The increase in adjusted SD&A expense was primarily due to higher freight and commission cost to support the increase in net sales and to a lesser degree, higher compensation cost. The improvement in adjusted SD&A expense as a percentage of net sales was primarily due to the benefit of higher sales volume, cost containment programs in certain areas and timing of certain programs and of course productivity gains. This next point is very important, another way to view just how robust our first quarter results were as to examine our variable contribution margin or adjusted operating profit on the increase in net sales. Doing so, one can see our variable contribution on the incremental sales of $73 million was almost 34%. All in all we had another great quarter. On the strategic front, we continue to make great strides, setting the stage for what we believe will be a strong growth and profitability in 2015 and beyond. During the quarter we took certain actions to further streamline our organization that will lower our cost structure and better allocate resources and investments to areas with greater potential future profitable growth. These actions included the rationalization of certain production activities as well as the elimination of certain positions with the intent of adding new positions to pursue opportunities, which require experience and skills different from those we possess today. From a product and lighting solutions development perspective, we continued our rapid pace of new product introductions, expanding our industry-leading portfolio of innovative, energy-efficient luminaires and lighting control solution. As we've noted in the past, we offer customers more than $1.7 million skews to choose from, more than three times as many as we had in 2008. No other lighting company provides customers with more choices and solutions than Acuity Brands. Much of this growth in our portfolio has been driven by the expansion of our lighting controls and solid state lighting product offering. For the first quarter, our LED sales grew approximately 75% compared with the year-ago period. This is essentially the first quarter in four years where our growth in LED fixtures did not at least double compared with the year-ago period. This is an extraordinary achievement when you again consider that if one would imagine the sales of our LED products as a standalone company. We believe that would be the fourth largest lighting luminaire company in North America, while we believe our conventional business would still be number one. Additionally, we continue the development of luminaires and corporate and other light source technologies such as organic LEDs where we continue to expand our award-winning portfolio of these innovative products. The strength of our portfolio is so significant we're evolving to an integrated tiered solutions approach, which fully leverages the benefits of our product development capabilities with the integration of our many acquisitions, including our controls portfolio. The purpose of this strategy is to leverage this incredibly diverse portfolio by offering customer solutions that best meet their needs, whether it be a single device or a complete holistic integrated lighting solution for their indoor and outdoor needs and everything in between, all with the promise and security from Acuity that you're in good hands and we have your back. This will be a compelling and powerful value proposition for customers. While we execute this strategy, we've continued to hone our organization structure to be more customer centric, leveraging our industry leading access to market and to better allocate resources along each of our tiers, creating the best solution for our customer's applications. More impressively, our adjusted operating profit margin continue to expand this quarter, while sales of LED-based solutions have become an even larger portion of our overall business. Acuity is a clear leader of providing customers with superior lighting solutions, incorporating either convention or solid state light sources. The market has come to understand that LED as a light source is no longer new, now widely accepted the attention of customers as focused on how one best can control and utilize this light source to optimize our visual environment, while realizing additional benefits including its long life and energy savings characteristics. Because Acuity truly understands how best to fully utilize the unique capabilities of LED to optimize the visual environment and provide other benefits including significant energy savings to our smart and simple solutions for virtually any application. We believe we're growing significantly faster than the markets we serve. At Acuity, we view the advent of LED as an enabler, affording us the opportunity to bring differentiated lighting solutions to a broad array of customers distancing us from our competitors. Our expertise lies in the true understanding of the proper use and control of light, while minimizing the use of energy. We are without equal in the design and development of fixtures and integrated lighting systems for virtually any application without a bias of the light source. As I've noted before, our organization has a long and distinguished history of leading and innovating during areas of technology disruption and that is even more true today. Acuity Brands is leading the evolution to intelligent lighting solutions with its broad and deep portfolio of indoor and outdoor solid-state and traditional energy-efficient luminaires and lighting controls. And we're delivering profitable growth and strong financial returns for our shareholders while making these important investments. These accomplishments have diversified and strengthened our foundation and will further serve as a robust platform for our future growth that is less reliant on the new commercial construction cycle. We've enabled to produce these results because of the dedication resolving for more than 7,000 associates who are manically focused on serving, solving, and supporting the needs of our customers. I will talk more about our future growth strategies and our expectations for the construction market later in the call. I would like to now turn the call over to Ricky before I make a few comments regarding our focus for 2015. Ricky?

Thank you, Vern, and good morning, everyone. Vern covered the primary drivers for our fourth quarter sales growth and our profitability. So I'll not repeat these items, other than to echo Vern's comment that they were truly outstanding. I’ll begin my prepared comment by discussing the special charge we took in the first quarter of 2015. We've recorded a pretax special charge of $10 million or $0.15 diluted EPS, associated with the actions to streamline the organization by realigning certain responsibilities primarily within various selling, distribution and administrative departments as well as for the consolidation of certain production activities. The special charge consisted primarily of severance and employee related cost. We currently expect to incur production transfer expense and additional cost associated with these streamlining actions totaling approximately $1 million during the next two fiscal quarters. We expect to achieve annual savings in excess of these costs, but as Vern mentioned earlier, we plan to reinvest a portion of these savings in additional growth initiatives, which will require adding new talent with different skill sets. Accordingly in fiscal year 2015, we expect to realize savings net of reinvestments approximately equal to the amount of the total restructuring cost. These net savings are expected to be realized later in this year primarily in the fourth quarter. And other expense income we reported net miscellaneous income of $0.9 million for the first quarter of fiscal 2015 compared with net miscellaneous expense $0.6 million for the same period last year. This favorable comparison of $1.5 million pre tax is due to changes in foreign currency rates. The effective tax rate for the first quarter was 35.9% compared with 35.3% in the first quarter of last year. A slightly higher income tax rate was primarily attributable to unfavorable discrete items. We still believe the effective tax rate for the full year will be approximately 35.5% before any discrete items and if the rates in our taxing jurisdictions remain generally consistent throughout the year, we should see a slight immaterial tax benefit in our second fiscal quarter of 2015, as a result of the recent passage of the so called tax extenders. As Vern mentioned earlier, cash flow generated from operations for the first quarter of fiscal 2015 was an impressive $46.7 million, which is a $3.3 million increase over the prior year, despite a much greater incentive compensation payout this year compared with last year. Our operating working capital defined as account receivables plus inventory less accounts payable, decreased six days to an industry-leading 37 days and represents only about 12.5% of annualized revenues. Most of this improvement was in our management of inventory where we continue to improve our inventory turns while also improving our service levels. In the first quarter of fiscal 2015, we spent $18.5 million on capital expenditures compared with $8.5 million in the prior year. We currently expect to spend approximately 2% of revenues in capital expenditures in fiscal year 2015. This expected uptick in capital expenditures compared with recent prior years is primarily due to projects that were delayed from fiscal year 2014 and investments necessary to support our growth. In November 30, 2014, we had a cash and cash equivalents balance of $583 million, an increase of $30.5 million since August 31, 2014. Our total debt was $354 million. Consequently our cash exceeded debt at the end of the fiscal year. At November 31, 2014, we had additional borrowing capacity of $243.8 million under our credit facility. You may have seen last month that Moody's raised our debt rating to be AA2 with a stable outlook. They based their revise rating on our leading market share, modest leverage, solid interest coverage, attractive returns on capital, consistent free cash flow and higher margins as we transitioned to higher volumes of LED lighting fixtures and controls. Moody's went on to say that Acuity’s revenues and earnings will further benefit from the structural shift to LED lighting with further upside should non-residential construction activity in North America begin to strengthen. So in the last year both Standard & Poor's and now Moody's have revised upward our credit rating with positive comments about our outlook. As you know, we have a significant amount of cash on our balance sheet. Additionally, we continue to generate strong free cash flow and an access to additional committed capital based on our credit facility. Our capital allocation priorities have not changed. First, we will invest in capital expenditures for maintenance, cost savings and growth initiatives, which is expected to be around 2% of revenue this year. Next we will continue to see strategic acquisitions to add technology, fill product gaps and/or expand our market access. The timing of acquisitions of course are hard to predict. We remain active, but disciplined. Lastly, we will continue to return capital to shareholders in the form of dividends and stock buybacks. We clearly have significant financial strength and flexibility and will continue to seek the best use of our strong cash generation to enhance shareholder value. Thank you and I’ll now turn the call back to Vern.

Thank you, Ricky. As we look forward, we continue to see significant long-term growth opportunities that are ever-changing and evolving, particularly for us. Our growth expectations for the lighting industry primarily in North America has not really changed much over the last few quarters. We remain very positive. So while we don't give earnings guidance, I would like to provide you with some observations for the balance of fiscal 2015. First, most economists expect the economy in North America will continue to improve at a modest and increasing pace. Our forecast for industry growth rates by independent organizations continue to vary widely. The consensus estimate for the broad lighting market in North American is expected to grow in the mid to upper single-digit range for our fiscal 2015, reflecting the benefits of both new construction and renovation activity. Further, we continue to see signs that give us optimism regarding the future growth of the markets we serve in our business. 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 while residential construction continues to grow nicely. As this becomes the norm over the last handful of years, we are always leery of the next round of uncertainty that might come out of Washington as well as fiscal and foreign policy issues. As you know, the manner in how these key issues are handled can meaningfully influence business and consumer confidence. Nonetheless, we continue to expect that overall demand in our end markets for 2015 will continue to improve and be more broad-based and consistent than that experienced in either 2013 or 2014. The continued favorable trend in our December order rate again seems to support this continuing level of improvement. Second, excluding the price of certain LED components, which are expected to continue to decline, we do not anticipate significant changes in input cost over the next 12 months as some commodity cost have waned while others continue to rise. Further we expect employee related cost to continue to rise primarily due to wage inflation and the negative impact of rising healthcare cost. Next we continue to be leery of foreign currency exchange rate fluctuations, which are impossible to predict. Of course we will continue to be vigilant in our pricing posture as well as furthering efforts to drive productivity improvements. Another observation, while our gross profit margin is influenced by a number of factors including sales volume, price, product and sales channel mix and innovation, we expect our annual growth profit margin to improve over time as volumes grows particularly for larger new construction projects, which should also benefit our mix and as we continue to realize typical gains and manufacturing efficiencies. Our gross profit margin in the first quarter was a good example of our potential, but we prefer to look at our marginal improvement over a 12-month period to remove quarterly anomalies like year’s second quarter due to weather or the seasonality of the second quarter in general to discern proper trends. You should do the same, it is a positive picture. Additionally, we continue to experience some isolated pricing pressures in certain markets and sales channels. We will continue to be vigilant on pricing. As we have said before, we will defend our market position vigorously from competitors, should they intend to use prices as their only point of differentiation. Lastly and most importantly, we expect to continue to meaningfully outperform the markets we serve. Looking more specifically at our company we're very excited by the many opportunities to enhance our already strong platform including the introduction of holistic lighting solutions like connecting smart lighting with smartphones for retailers as well as our growing of electronic component capabilities. As we have noted in our last several conference calls, while our strategies to drive profitable growth remain essentially the same, the implementation of our integrated tiered solution strategy is really the next step in the advancement of our overall growth strategy. Additionally we continue to see opportunities in this environment including benefits from growing portions of the market, further expansion in underpenetrated geographies and channels and growth from the introduction of new lighting solution. Our positive results reflect a solid execution of these strategies by our associates. Our company-wide strategy is straightforward. Expand and leverage our industrial-leading product and solutions portfolio, coupled with our extensive market presence and our considerable financial strength to capital 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're realigning certain resources and continuing to make additional investments in certain areas today because we see great future opportunity. Through these investments we will have significantly expanded our addressable market, our record growth supports this view. As I've said before, we believe the lightening and lightening related industry will experience significant growth over the next decade, particularly as energy and environmental concerns come to the forefront along with emerging opportunities for digital lighting to play a key role in the internet of things. We continue to believe that the many markets we serve as part of the broader lighting industry could grow by more than 50% over the next few years, providing us with significant growth potential. As the North American market leader, we're positioned well to fully participate in this exciting industry. Thank you. And with that, we will entertain any questions that you have.

[Operator Instructions] Thank you. Our first question comes from Winnie Clark of UBS, your line is open.

Good morning and congratulations on another outstanding result. Maybe to start with -- hello, can you hear me?

Yes we can, please.

Oh, sorry. So maybe to start with volume growth. Another quarter of impressive volume growth, despite the fact you were facing a pretty difficult comp. Given it sounds like you expect the underlying end-market to continue to improve as the year progresses, your comps also ease a bit, should we expect your volume growth to accelerate from here on a year-on-year basis?

So Winnie when we look at the various leading market indicators, if you will whether its employment, whether it’s delinquency and commercial loans, you're looking at absorption, vacancy rates, office rents, all of these signs are signaling positive momentum. Our expectation for the balance of 2015 and really into 2016 is that all of these will contribute to the growth of the overall market, which again we're expecting to be mid to upper single digit range. And so I am personally optimistic that assuming no exogenous event that the markets will continue to show favorable signs and allow us to continue to grow at very positive rates. Our expectation is that we will outperform the growth rates of the markets that we serve. This is the seventh quarter in a row where we've had double digit of volume gains against the backdrop of kind of mid single digit growth in the overall market. So we continue to be optimistic about what the markets and the opportunities in front of Acuity continue to be.

And then maybe just on LEDs. You highlight again prices coming down on these products and that means that the value proposition gets increasingly more attractive. I am curious how adoption rates are trending across your various markets. I know outdoor is largely converted, but how are adoption rates trending in some of your other channels? Any notable bright spots or laggards?

Well when we say outdoor has converted I would say that outdoor has converted primarily for new types of insulations. There is a tremendous installed base of conventional light sources for outdoor for example, so when we look at the market, we kind of look at it in two buckets if you will, sort of the new construction bucket and then the renovation bucket. I would submit to you that the renovation bucket is still largely untapped from a if you will a digital lighting source, So our view is that the opportunities in that installed base to continue to renovate and convert will provide great growth opportunities for Acuity and the industry for a long time to come. New construction for sure in many applications, whether it be indoor or outdoor is now really quiet accessible for electronic type lighting and when you particularly couple that with lighting solutions that integrate controls as well as LED lighting it provides an opportunity for Acuity to create exceptional value prepositions for customers, whether its school, healthcare facilities, commercial office building, industrial spaces, parking garages and so on and so forth because of the value that can be had by controlling these lights in a way that takes advantage of daylight harvesting, takes advantage of dimming if you will. So we see quite bit of growth in front of us both in terms of the new constructions as well as the renovation. I would say that when you look at which areas are tipping faster or say slower than the others, I will submit to you that they're all moving fairly quickly. Again I would also remind folks the beauty of Acuity is that we listen to our customers. We provide to them solutions that make the most sense for them and we're almost agnostic to the light source. And conventional lightening, florescent is still a very viable value proposition today. I believe that the industry trend all of the prognosticator say that by 2020, the industry could be 80% LED. I have no qualms around that at all. But in the meantime, we want to continue to make sure that we're providing our customers with the solutions that make the most sense for them.

Great. Thanks so much and congratulations again.

Thank you.

Thank you. Our next question is Rich Kwas of Wells Fargo Securities

Hi. Good morning. Just a question, Vern, on incremental shares. So very strong this quarter; you're taking some actions on the SG&A front. Ricky, you mentioned that you are going to spend away some of that, but the 33% this quarter really excluded all the streamlining activities, I would think. So how should one think about what happened this quarter and try to translate that on a go-forward basis, given your comments about the end markets?

Sure, the 33% does contemplate if you will the adjusted -- the incremental adjusted operating profit dollars on the incremental sales. We have typically said that our target is kind of in that mid 20s, mid to upper 20% variable contribution rate because we do expect to continue to reinvest back into our business as we see growth opportunity that LED is enabling Acuity to provide. As we had mentioned earlier our tiered solutions approach really is taking if you will discrete components and now bringing these things together so that you can provide customers with holistic solutions for whatever application they need. Our belief is that we will continue to drive productivity into our business. We will continue to see volume growth. So all of those should have very favorable impact on both our variable contribution, margin, as well as our gross profit margin on a go-forward basis. But we feel comfortable in that sort of mid to upper mid 20% range because it is our expectation to continue to invest back into our business for skills and capabilities to really allow us to get after more of what if you will digital lighting can allow a company like Acuity to do. It was a great quarter. And we've had other quarters, by the way where our variable contribution margin has been in the 30s. So it's not unusual for it to happen, but I think when you look at over a 12-month trend we would be more comfortable in the mid to upper 20% range because of the investments that we continue to make.

Yes. that’s what I was getting at because the numbers -- you've had some very strong quarters followed by some quarters that have been relatively low, so they have been -- there's been some volatility. So that's kind of the crux of my question.

So Rich, we would encourage you to not look at just quarterly numbers, but instead to look at it over a longer period of time where I think the quarters are tough to precisely predict spending in investment and the things that you're doing. But when you look over a 12-month, I think you really get a good sense of what we're capable of doing.

Okay, yes. No, I appreciate that. And then on the fixed versus SD&A for the quarter, what were the numbers on SD&A? Do have the range because I know that number, the fixed number, was going up? And I know last quarter you had some incentive comp that hit -- that make it go up more significantly and there sounded like there were some incentive comp this quarter, but you were --. I think, Vern, you were talking about 105 is a good run rate. Were you at that level this quarter?

So, Ricky admonishes me from calling it fixed because it has a variable element in there. But the number that you're referring to is roughly in the sort of $95 million to $100 million range. Some of that had to do with the timing of expenses. Our incentive compensation this quarter versus the year ago quarter was about the same. We did have some wage inflation, but we offset that with some productive improvements and some opportunities of just lower spending in some other areas. The spending in some of the areas probably had more to do with a bit of timing. We're not uncomfortable with again that $105 million kind of number, but it really depends on each quarter. If you look at that spend over the course of the year, the number I think last year averaged about $95 million maybe a little bit more than that. So this year my expectations will probably be in that lower $100 million and $105 million range.

Okay, that's helpful. Then last one from me on the mix. The business is a lot more weighted toward renovation at this point. But, Vern, over the last couple of quarters you've been more positive about what you are seeing on the new construction side or the early stages of that. In the quarter and then going forward, do you sense that the new construction piece is going to reverse course and increase a bit on a percentage of sales basis over the course of 2015 and into 2016? Should we think about that, because that obviously helps mix a bit? So I wanted to get your thoughts there.

So when you think about new construction you actually have to think about vertical applications, schools, healthcare, facilities, commercial office buildings, religious facility, so on and so forth. And Dodge provides and there are a number of groups that provide great information around this. What you're seeing is a larger trend because of the earlier statistics and things that I quoted earlier starting to improve and so this tide is lifting all loads. Healthcare facilities right now are lagging a little bit. Schools K-12 tend to lag a little bit, but the other aspects of the economy again whether it's commercial office buildings, industrial facilities, outdoor all of these things are starting to find their stride and they're improving and they're improving on a more consistent basis. The thing I would say about new construction is that there is a specification element that requires a timeframe. So if someone says, I am going to build a building today by the time lighting finds its way and to say a fairly large structure, it could be 12 to 24 months later. Smaller projects, sure lightings will find its way into that sooner, but we're starting to see greater quotations, again architecture billing index, office absorption, office rental rates are improving. All these sings I think what give the prognosticators, the Dodges of the world confidence that will be the kind of growth that both has been and the incremental growth that they're calling for.

But are you worried about oil and gas at this point with -- on your business specifically, given CapEx reductions and what not?

Sure I think that there is a great debate out there about where you have some folks who are operating drilling machines and so on and so forth. How does that flow back? Personally, our business is so diversified geographically that the consumer getting that huge extra cash in their pocket because of longer gas prices, we think has a stimulating effect more broadly around the North American market, which I personally think will be favorable.

Okay. Great. Thank you.

Thank you. Next question is Jed Dorsheimer of Canaccord Genuity.

Hi, thanks and congratulations on another fantastic quarter here guys.

Thanks Jed.

First question, I guess you touched on volumes in terms of driving margins and clearly LEDs are neutral to the overall business as they are now 42% of sales. But I'm curious if you could help a little bit on solution versus discrete or systems versus discrete as you've added the controls aspect into the business. Could we put a percentage or how should we look at what portion of your business is going to a systems solution, which I would assume carries higher margin and certainly carries higher ASPs as we think about that going forward? And then I have a follow-up.

Sure, so Jed in our product selection guide, we articulate on one of the first few pages are sought of tiered solutions approach. If I had to tell you where we are in that game, I would say that the managers are still at home played exchanging a line of cards. So the bulk of what we sell today is device discrete capability when you look at our total volume, but the growth rates in what we call Tier 2 and Tier 3 where you're adding more capability to luminarie or the Tier 3 where you're offering a holistic solution where it all works together. Those growth rates are quite significant on a very small base. So the percentage is great. The dollars are smaller relative to the total. Our margin profile tends to be greater in the Tier 2 and Tier 3 area, but it's still very early for us to say what will that difference be on a go-forwards basis. We certainly have an expectation that we can add more value when we bring together a holistic solution for our customers and that value to them allows them to really again do more things energy savings so on and so forth. But it's no longer just energy savings and if you look at our visible light communication system for the retail space, we're just -- we're so early in that, but the opportunity for margin and enhancement for both our customers, which is just extraordinary as well as for Acuity sharing and that we're still like I say so early in the game. It's not had a meaningful impact yet on our overall margin performance.

Okay, great. And then just as a follow-up: I got the fixed component of SD&A correct based on your previous comment, but I guess I was too conservative with respect to variable component of SD&A, which looks like it took a big drop down quarter over quarter. I know we should look at the longer-term trends, but is there something that is driving that that I should be more aware of? Or is this sort of the normal level and then we should just expect as volumes change that would be the only driving factor of the variable component of SD&A? Thank you.

So let me answer your question a couple of different ways. The piece that we call that is truly variable freight and commissions those numbers as a percentage have been fairly consistent over the last several, several quarters and it can isolate 10 bips to 20 bips one way or the other, but it's pretty consistent around that 11.6%. All the rest of our SDA, which we -- some folks have referred to is fix and I guess someone had started that, so shame on me, Ricky punishes me for that, but that portion, that can vary a little bit and some of the spending obviously on salaries and wages and healthcare cost, but it's also marketing. It's travel, its product development and also it's incentive compensation. The incentive compensation this quarter compared to the year-ago period was fairly flat. It was up, but not by a huge amount. So we had some puts and takes in there and we always will. That's why I think if you look at it over the course of the year, our sense is, is that you get a better average. That doesn’t mean one quarter to next won't be higher or lower. This quarter may have been just slightly lower due to the timing of some spending. Our two sense around this and the best way to get at it is through the variable contribution margin on incremental sales, particularly when you have consistent incentive compensation year-over-year. Again I want to remind everyone, our incentive compensation is totally pay for performance and it's based on period over period improvement. So our variable contribution rate this quarter was 34%, very robust and we're always looking to drive that, but we feel a little bit more comfortable in sort of that mid 20 to upper 20% variable contrition rate because we will continue to make investments in our business and it's not always -- we're not able to precisely estimate when that's going to occur.

Great. Thank you.

Thank you.

Thank you. Our next question is Kathryn Thompson of Thompson Research Group.

Hi thanks for taking my questions today. What if any impact has the drop in oil prices had on the piece of your business and your planning? And I guess trying to string little bit further, have you see any change in bid activity over the past couple of months?

Ricky, could you answer the first?

Yes, first on the oil price Kathryn, as we mentioned in the 10-K, we consume about four million gallons each year of diesel fuel. Of course we have seen a reduction in diesel fuel not to the extent that you’ve seen in the price of a barrel of oil, but we have seen a reduction and people are projecting further. So far it has not been material. You're talking a few hundred thousand dollars of benefit as Vern said our variable cost, which includes freight and commission was pretty consistent, so a little bit of benefit, not much. Obviously if diesel continues to drop, you could be getting into a few millions of dollars. You can do the math on four million gallons and whatever you think, diesel is going to drop. We should see a benefit in the freight cost we do as I say have it there. Beyond freight we're really not seeing it much in other areas. Obviously petroleum based goes into some of the lenses and plastics that we use, but so forth it's not had a material impact on the cost of those products.

And Kathryn, with regard to the bid activity, I would remind everyone that our second quarter is seasonally our softest quarter simply because of weather. It's December, January and February. Having said that, our bid activity is up over the year ago period and our expectation based on what we see from folks, things that haven’t yet turned it a bit, but just activity, particularly driven around things like the architectural billing index is a good example of that. Our folks are busy and so our expectation is that, as I said earlier non-residential construction on the new construction site will continue to show a positive rebound and we will particularly see that in the second half.

Thank you. And then maybe touching point string a little bit more on that comment, if you what specifics or even some general issue can get around your projections for new construction versus renovation or retrofit growth projections in 2015 and also when thinking about what's the difference today versus it was a year ago in terms of the end markets. What end markets or segments are doing better this year and we've seen maybe perhaps more of a turnaround just to give you some perspective for us. Thank you.

Sure and so on the end markets if you will and if you look at the market and separated by verticals, you look at commercial office buildings, which are starting to ramp up and what's exciting for us about that is when a commercial office building based on construction put in place starts to uptick, we know that ultimately will be putting luminaire and lighting controls into those buildings. So I'll say commercial office buildings, industrial spaces, outdoor continues to be favorable area infrastructure all of these things are up-ticking. Healthcare is still lagging a tad as it is K-12. So we expect that as the economy moves up, as people continue to go back to work, as they pay taxes, the demographics are such at that that the K-12 market, we need more schools and so our expectation is that over the next 1,000 days, you'll start to see that market tick up. But let's be clear, from a new construction standpoint employment people going back to work are the most critical factor and building buildings, we really -- we see absorption occurring at very healthy clip. So markets are starting to tighten up. You're seeing rental rates for any type of space whether it's a commercial office building or even industrial spaces starting to tick up. All those suggest that the rebirth if you will of investment that will occur in the non-residential construction real estate market and we view that as a very favorable sign obviously for Acuity. And then you couple on that by the way the ability to sell more value ad per square foot in the old days we would have sold the luminaire. Today we're selling not only a quality of life, but we're selling energy solutions for these folks as well. So it's quite an opportunity for Acuity going forward.

If you take a stab just in terms of general thoughts on new construction versus retrofit in the commercial market in 2015?

I would say that new construction will be accretive. What will be the exact percentage put of our business between new construction and renovation has not to guess that right now because I don't have the precise data that's always kind of a rear view mirror activity. We're positioned uniquely well to serve both and we're aggressively going after all opportunities in both.

Okay. Great. Thank you very much.

Thank you.

Thank you. Our next question is Glen Wortman of Sidoti & Company.

Yes, good morning, everyone.

Good morning.

Yes and I am sorry to beat the dead horse here, but I missed earlier, does the $100 million to $105 million per quarter that you're expecting this year in the sixth piece of SG&A, does that include incentive-based comp?

That would yes.

Okay. Okay. And then on non-res construction, I am sorry if I missed this too earlier, but did you say how much that up in the quarter?

I am sorry, say that again.

Yes, your sales derived from non-res construction in the quarter, do you know how much that was up year-over-year?

No.

Okay. All right. Thank you for taking my questions.

Thank you.

Thank you. Our next question is Josh Chan of Robert W. Baird.

Hi, good morning guys. Great quarter. on your streamlining actions and investments, could you give us little bit more color on what particularly you are restructuring out of your cost structure and then also where you're making those incremental investment?

Sure Ricky.

Yes, first on the cost reduction, most of it is in salary cost and related benefits. As we mentioned, it's an SD&A and then we're consolidating some production activities. So you will see a portion of the cost as well as the savings up in gross margin category. Areas of reinvestment will largely be in SD&A and engineering as we continue to build out our capabilities and skill sets to service the solution offerings. It will be in sales and marketing areas as we get the training and the marketing for these broader solutions and capabilities that are out there as well as the collateral and so forth. And then pre-imposed sales support area in the sales and marketing to be able to service these broader solution offerings both in the design phase, commissioning stage as well as in the final post sales when you go back and help with any final commissioning and set up or issues that may come in. So mainly in SD&A, in engineering, sales and marketing is where we would reinvest and then in engineering for product development and service capabilities.

Okay. Great. And then you guys have previously talked about learning to fish better in the renovation pool. I was just wondering if your market share in renovation is what that would be compared to your market share in new construction and where you're traditionally stronger or have you closed that gap over the last couple of years.

Again it's -- we use estimates, it's impossible for us to predict. We sell products through 14 different channels and not often or not all of the channels are we able to discern exactly where that product is going. If there was a specifier involved and it was someone redoing a K-12 school, all that's renovation. It looks like new construction to us. If that person doesn’t necessarily tell us what the materials are being used for or we don't know, so I wouldn’t be giving you good information to say I know one versus the other.

Okay. Great. Thanks for your time and congrats on the quarter.

Thank you.

Thank you. Our next question is Ryan Merkel of William Blair & Company

Thanks. The first question I had is on price competition as it relates to the large project specification business versus stock and flow. Is there a noticeable difference in price competition in those two applications today?

So Ryan, the way I'm going to answer your question is, if you take both of those compared to say prior year, I would say that bid competition it's for new construction virtually the same. The marketplace hasn’t materially changed and how it competes and so on and so forth and we haven’t seen any meaningful change there and I would say the same thing would be true for stock and flow. The way the market competes for those pieces of business are the same. On the stock and flow side, the opportunity to work with key strategic distributor partners is a major focus Acuity and we try to provide them with the fulsomeness of support, strength and project as well as the support and opportunities of working together on stock and flow. So I don't see that competition is necessarily different between those or in those markets today, but we're looking to leverage our skill and capability with our strategic partners in both of those areas.

Okay. That's helpful. And then second question, you mentioned broad-based strength in the quarter and I was wondering does this include retrofits for multi-tenant buildings and also for municipalities? Because my understanding was those two parts of the market were a little softer.

Yes, when I say broad-based, I am trying to sort of dance along the mountain tops. I think that Dodge for example tracks over 100 different vertical applications. I don't look at all of those. I know that within their schools K-12s are still soft. There are other markets that are still soft if you will. Healthcare is still soft, but broadly speaking both geographically as well as for us across a broad range of product and application, the growth was reasonably broad based. That again does not mean that smaller parts don't or haven’t experienced some still softness.

Could you comment on multi-tenant retrofits though? Is that improving a bit or is that still a bit slower?

Yes, I personally can't comment. Ricky, do you have any sense. I didn't…

I would just make one comment, in multi-tenant, a lot of that is more residential focused obviously within the apartments of the condominiums that are being built where our participation is lower. We obviously participate in the common areas, the parking garages, the outdoor lighting and so forth. They continue to build out our capability within the living spaces of multi-tenant, but it's an area that we're a little less penetrated and we would be in other commercial buildings.

Okay. Great. Thank you very much.

Thank you. Our next question is Mike Ritzenthaler of Piper Jaffray.

Yes, good morning. Just one question from me that wasn't already asked is, with LEDs now over 40% of total sales, what are some of the challenges that will be unique in going from 40% to 60% versus 10% to 40%? Or is it even useful to be thinking about growth in those terms?

Some of the challenges, I think that challenge is really our opportunities for Acuity as we continue to grow if you will LED as a larger portion of our sales. The opportunities are to incorporate those components as part of broader holistic solutions. I had mentioned in answering Jed's question earlier that this tiered solutions approach, bringing these capabilities together to instead of offering just a single device, but instead offering a holistic solution for your building whether news commercial office, your office, the hallway, the conference rooms tied into the floor, tied into the building management. All of those represent unique opportunities that weren’t necessarily available to Acuity a handful of years ago. So to us it's bringing that capability to the end customer and doing it very efficiently. So you could call that a challenge, but we look at that more as an opportunity to take advantage of, not only what we have done with our lighting portfolio, but the acquisitions that we've made to create again these types of very interesting solutions for the end customer.

That makes sense. Thanks and congrats.

Thank you. Our next question is Brian Lee of Goldman Sachs.

Hey guys. Thanks for taking the questions. I had two quick ones. First, on your commentary around digital lighting solutions, I was just curious if you guys had a sense of what percent of your business, whether it's just device or system-level solutions, is currently being sold into what you would consider the smart lighting opportunity. And then how you might expect that to evolve as a part of the mix in 2015.

Sure. Again the notion of the Tier 3 solution, which again in our power lines are holistic lighting solution today is a very small portion of our business. Now I say very small again understands against the backdrop of $2.5 million business small and still fairly large. That portion of our business would dwarf many of the lighting companies that are out there today, but again it's still very small. Our expectation is that really it's a 2016 where you'll see that Tier become a meaningful portion of our business because a lot of it has to do with new construction and get specified and it gets ramped up. So we like the trends that we're seeing in those portions of the portfolio, but I think in 2015, it will still from a financial perspective not move the needle in a huge way, but it is laying the foundation for huge growth over the next handful of years. Again we have said that we believe that our addressable market could grow by more than 50% over the next handful of years. A large portion of that growth is going to be in these Tier 2 or Tier 3 areas where we can add much more capability, add much more value to the end customer allowing us to sell these types of solutions at margins that are attractive.

Okay. Great. And then as a follow-up to that, you commented around the portfolio and you've also made a number of acquisitions, particularly on the software side, which seems to position you well for that transition in the lighting market. So I was wondering are there any tools in the portfolio that you can speak to tangibly that you are maybe more focused on for addressing in 2015. It seems like there are some M&A opportunities that you may be wanting to look at more actively here in the coming years. Thanks, guys.

Sure. The difference between saying that we have a hole in our portfolio versus that we see opportunities through acquisitions to add to our portfolio, I would like to say we're at the latter. We don't see any holes in what we're doing. It doesn’t -- again we don't do everything for everybody. That doesn’t mean that we can't do more, but from an acquisition standpoint, we see opportunities to be accretive and add to the value proposition of what we're doing and that really is a primary focus of our acquisition strategy. How can we take advantage of this technology to add even more value to the end customer because every location needs to have a light source in it, whether it's outdoor lighting and it has a light pool or whether it's indoor lighting and there is a luminaire in every type of building space. These things can become communication devices that can be data collection devices and that is hugely powerful in terms of where the world is going and lighting can be right at the epicenter of all that and Acuity is working hard to really lead in that area. So I don't see holes in our portfolio. I see opportunities for us to continue to expand our capabilities.

Okay, thanks. Very helpful.

Thank you. Our last question comes from Brent Thielman of D.A. Davidson.

Yes, thank you. Just real quickly, a few quarters ago you talk about investments in some of these electronic components for LEDs and that would create some headwind for gross margins in subsequent quarters. Was that negligible this quarter or did you still face a little headwind there?

We have continued to improve our profitability in those areas. I wouldn’t say that it was as much of a headwind this quarter as it has been in the past, but again I want to be clear, your question tees up something very important. We took a special charge to again streamline our organization because we want -- we are de-investing certain areas of if you will older technologies, so that we can further our investment in some of these areas going forward. As questions were asked earlier about what is that area of our SDA that is not greater commissions? Last year in 2014, that number averaged about 102 million a quarter, so when I think about where that number is, folks had asked us earlier where do you see that number. As of today, I said $100 million, $105 million we will continue to invest, but we're also looking to de-invest. Do we have the right precise alchemy? One, we don't give guidance, what I would like to do is again direct people back towards our variable contribution margin. We're looking to get every penny we can. This quarter was a fantastic quarter and we push ourselves to deliver these kinds of results, but we will continue to make investment back in our business and you cannot precisely predict that pace. So when I said that, that portion of our SDA that is not directly greater commissions, will operate between $100 million, $105 million. There could be quarters where it will be even above that, but when we try to look at the average over a year, the better way to look at our company is not through fix. This portion of the SDA is looking at our variable contribution margins. Again as I've said earlier, our incentive compensation is based period-over-period improvement. Our objective is to continue to knock the ball out of the park and so therefore our incentive compensation will grow. It's in that number that is not in the freighter commission portion of SDA. So we don't give guidance and so it's a little bit of a difficult thing to predict our variable compensation. You guys in your own models can do this yourselves. If we keep knocking the ball out of the park, our incentive compensation will be higher than what it is right now. So we will drive that number higher. So anyway that's just my true sense on how I think you ought to look at that.

Okay. I understand that. You talked a bit about the overall pipeline is up. I was just curious; does it feel as though there's more urgency among customers to secure Acuity's solutions? And I guess I'm thinking from the context of when you provide a customer a quote and when that translates into an order.

There is more activity out there. There is no doubt about that. And so to say urgency, people are building and people are renovating and the notion of how they do that, people -- building owners are becoming very comfortable with the notion that I can put in a solution that gives me a payback because of energy savings. And so I don't know if I had used the work urgency, but acceptance and the desire to want to drive that to put their capital work to get cost savings, it's a return on investment story in that market. Yes, it's happening and when you look at folks who are building buildings, those things are coming out of the ground in the normal course and they're going about it the right way. I would say that as absorption occurs, landlords when they finally find someone to consumer some space, the market has always been that I have someone. You need to provide me with 30 days and I want these folks in. That hasn’t changed except for the fact that there is more of it happening. So I wouldn’t say that the urgency has changed. The business activity has really started to pick up, which is favorable.

Okay. So it doesn't sound like the quote to order timelines have materially changed, it's just more activity in general.

I would say it's correct.

Okay. Thank you very much.

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

Thank you for your time this morning. Again we strongly believe we're focusing on the right objectives deploying the proper strategies and driving the organization to succeed in critical areas that will over the longer term to continue to deliver strong returns to our key stakeholders. Our future is very bright and thank you for your support.