Acuity Brands, Inc. (AYI) Q1 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the Acuity Brands Fiscal 2016 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 today to discuss our fiscal 2016 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 Web site 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 actual results to differ materially from those contained in our projections or forward-looking statements. Now let me turn this call over to Vern Nagel.

Thank you, Dan. Good morning, everyone. Ricky and I would like to make a few comments and then we will answer your questions. First off, our results for the first quarter of 2016 were outstanding. Our net sales grew 14% while our adjusted earnings per share grew 25%. On an adjusted basis, we achieved quarterly records for operating profit, operating profit margin, net income, and earnings per share. In fact, this was our 11th 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 accretive acquisitions, the continued aggressive introduction of innovative, energy-efficient lighting and building automation 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 in areas with significant future growth potential including the expansion of our solid-state luminaire and lighting controls portfolio as well as our building automation and Internet of Things solutions. 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 $737 million, first quarter record representing an increase of 14% compared with the year-ago period and the second highest quarterly sales in our history. Reported operating profit for the first quarter of 2016 was a $112.4 million compared with reported operating profit of $86.7 million in the year-ago period. We recorded special charge -- pre-tax charges of $400,000 this quarter and $10 million in the year-ago quarter associated with certain streamlining actions to lower our cost structure in certain areas so we can accelerate investment in new opportunities with greater potential for profitable growth. Also our reported operating profit included expenses associated with the acquisition of Juno and certain purchase accounting adjustments including among others, increased amortization expense for intangibles associated with the acquisition of Distech Controls which was completed on September 1st of this quarter. I find it helpful to adjust both quarters’ results by adding back these items to make them comparable. Doing so, one can see adjusted operating profit for the first quarter of 2016 was a quarterly record of $117.1 million, compared with adjusted operating profit of $96.7 million in the year-ago period. Adjusted operating profit margin for this quarter was a record 15.9%, up 100 basis points from adjusted margin in the year-ago period. Adjusted diluted earnings per share were quarterly record of $1.65, compared with adjusted diluted EPS of $1.32 in the year-ago period, up 25%; strong quarterly results indeed. In addition, we generated a robust $51 million in net cash provided by operating activities this quarter. We closed the quarter with $560 million of cash on hand after investing $239 million for the acquisition of Distech Controls and $23 million for capital expenditures. As you know, we completed the acquisition of the Juno Lighting Group on December 10th for approximately $380 million leaving us with plenty financial firepower to execute our strategy. Our 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 14% compared with year-ago period, we estimate our sales volume grew by the same 14%. The addition of Distech added three points of growth, which was offset by two points of foreign currency fluctuation, primarily for the weakening Canadian dollar and one point for changes in price mix. 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 in certain LED component costs and to a lesser degree changes in the mix of products sold. The increase in net sales was broad-based along most product lines and sales channels. Sales of LED products grew by 41% this quarter compared with the year-ago period, an extraordinary achievement when one considers that sales of LED-based luminaires at Acuity now account for more than half of our total sales, which as you know, also includes non-fixture related products as well. We believe our rate of growth for LED luminaires continues to far outpace the growth rates of our largest competitors for these types of products, demonstrating our market leading prowess. Lastly, we believe our channel, product diversification, as well as our strategies to better serve customers with new, more innovative and holistic 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 $117 million, the most in our history. And adjusted operating profit for the quarter was a record 15.9%, up 100 basis points from the adjusted margin in the year-ago period. Our gross profit margin for the quarter was a record 43.4%, up 120 basis points compared with the year-ago quarter. The expansion of our gross profit margin was primarily due to the benefits of higher net sales, somewhat offset by price mix and unfavorable changes in foreign currency exchange rates. Productivity improvements and lower material costs also had a favorable impact on our gross profit margin this quarter. Next, total selling, distribution, and administrative expenses excluding the adjustments noted earlier for each quarter were up $26.6 million or 15%. Adjusted SD&A expenses as a percentage of net sales were 27.5% in the quarter, an increase of 20 basis points from the year-ago period. The increase in adjusted SD&A expense was primarily due to higher freight and commission costs to support the increase in net sales, the addition of Distech and to a lesser degree higher compensation costs. The increase in compensation costs was primarily due to additional headcount to support and drive our tiered solutions strategy. Next point is very important. Another way to view just how robust our first quarter results were is to examine our variable contribution margin for adjusted operating profit on the increase in net sales excluding the acquired performance of Distech. Our variable contribution margin was 24%, consistent with our expectations. 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 strong growth and profitability in 2016 and beyond. Internally, we continue to accelerate the deployment of our lean business processes, driving greater productivity and enhanced customer service. From a product and lighting solutions development perspective, we continued our rapid pace of new introductions, expanding our industry-leading portfolio of innovative, energy-efficient luminaires and lighting-control solutions. As we have noted in the past, we offer customers more than 1.7 million SKUs to choose from, more than three times as many as we had in 2008. To our knowledge, no other lighting company provides customers with more choices and solutions than Acuity Brands. Much of this growth in our portfolio has been driven by the expansion of our Digital Lighting Solutions portfolio, including controls and now building automation systems and IoT applications. The addition of Juno and its very talented associates will meaningfully enhance our industry-leading capabilities and solutions portfolio. We continue to invest in and expand our capabilities to drive our integrated, tiered solutions strategy which consists of four tier levels. The purpose of this strategy is to leverage our incredibly diverse and growing portfolio by offering customers solutions that best meet their needs, whether it would be a single device which we identify as Tier 1 or a complete holistic integrated building automation and lighting solution, which we refer to as Tier 3 for their indoor and outdoor needs, and everything in between, all with the promise and security from Acuity that these solutions are smart and simple, both to install and to use. These are compelling and powerful value propositions for customers and a huge competitive advantage for Acuity. While sales information 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 again up more than 40% this quarter over the year-ago period. Tier 3 solutions can be enabled to provide data collection and to support connectivity to the Internet of Things, affording Acuity additional revenue streams which we identify as Tier 4. To fully execute our holistic tiered solution strategy, we have continued to hone our organization structure to be more customer-centric, leveraging our industry-leading access to market and to better allocate resources among each of our tiers, creating the best solutions for our customers’ applications. We’ve added enormous capabilities over the last year including the acquisitions of Distech Controls, the Juno Lighting Group and Geometri as well as increasing our salaried headcount to support the growth in our tiered solutions strategy. Additionally, now that LED is widely accepted, the attention of customers is focused on how they can best control and utilize this light source to optimize their visual environment, while realizing additional benefits including energy savings and the opportunity to have a smart connected platform to enable the Internet of Things. Because Acuity truly understands how best to fully utilize the unique capabilities of digital lighting through our smart and simple solutions for virtually any application, we believe we are uniquely positioned to grow much faster than the markets we serve. At Acuity, we are not just talking Internet of Things, we are doing it. Today, we have converted over 10 million square feet of space for customers, utilizing over 150,000 Beacon enabled lighting fixtures that can collect data and enable applications to provide users with actionable information. We believe this level of capability and deployment is unmatched in our industry. The addition of Geometri will only add to this industry-leading solution from Acuity. At Acuity Brands, we continue to build on our legacy of excellence, innovation and profitable growth. We are focused on rapidly developing new technologies and aggressively expanding our industry-leading portfolio with intelligent solutions that represent significant advancements over traditional technologies and easily network with other systems, creating lighting and building automation solutions that deliver superior quality, energy efficiency and performance, including a robust enabler for the Internet of Things. As I’ve noted before, our organization has a long and distinguished history of leading and innovating during eras of technology disruption and that is even more true today. As part of our tiered solutions strategy, Acuity Brands is a leader in evolution to smart buildings and smart cities. We are very pleased that Distech Controls and its very talented team officially joined the Acuity family on September 1st. Distech Controls as well as our other strategic partnerships will help drive our tiered solutions strategy, particularly as it relates to our holistic approach towards the advancement of smart buildings and smart cities. We expect the combination of Acuity with our broad industry-leading solid state lighting portfolio, innovative control technologies and integrated digital solutions and Distech to contribute to our tiered solutions strategy by offering true end-to-end optimization of all aspects of the building, including enhanced occupant experience, quality visual environment, seamless operational energy efficiency and cost reductions, as well as an increased digital functionality due to a unique capability to collect vast amounts of data to better enable the Internet of Things for building owners. We expect strategic opportunities such as these, coupled with our internal efforts to allow us to continue to diversify and strengthen our foundation and further serve as a robust platform for our future growth that is less reliant on the new non-residential construction cycle. We have been able to produce these results because of the dedication and resolve of our associates who are maniacally focused on serving, solving and supporting the needs of our customers. With the addition of Juno, we’ll now be almost 9,000 associates strong. I will talk more about Juno and 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 2016 and beyond. Ricky?

Thank you, Vern and good morning everyone. Vern covered the primary drivers for our first quarter sales growth and our profitability, so I will not repeat these items. I will provide a bit more color on our record first quarter results and our financial position, as well as our acquisitions of Distech Controls, Juno Lighting Group and Geometri. As Vern mentioned earlier, we had some adjustments to the GAAP results in the first quarter of fiscal 2016 and 2015 which we find useful to add back in order for the quarterly results to be more comparable. In the first quarter of fiscal 2016, we added back various items that are a consequence of applying purchase accounting to the Distech results. These acquisition-related adjustments include pre-tax $0.6 million or $0.01 per diluted EPS for the acquired profit in inventory; pre-tax $1.1 million or $0.02 per diluted EPS for acquisition-related professional fees associated with the Distech and the Juno acquisitions; pre-tax $2.1 million or $0.03 per diluted share for the amortization of the acquired intangible assets of Distech; and $0.5 million or $0.01 per diluted EPS for the stock-based expense related to initial restricted stock unit grants to certain key employees of Distech. In addition to the acquisition-related items, we also adjusted our GAAP results for the special charge in the first quarter of 2016 of $0.4 million or $0.01 per diluted EPS. We also adjusted the prior year results for the special charge of $10 million or $0.15 per diluted EPS. These adjustments to our GAAP earnings resulted in an adjusted diluted EPS of a $1.65 for the first quarter of fiscal year 2016, which is a 25% increase compared with a $1.32 adjusted diluted EPS in the year-ago period. These adjusted results should provide a proper comparison to our expected results. As a consequence of the recent acquisitions of Distech, Juno and Geometri along with our intent to make additional strategic acquisitions, we will have a fair bit of noise in our GAAP numbers in the future, primarily due to U.S. GAAP purchase accounting requirements and the expected increase in stock-based compensation, largely as a result of our strategy to further align the interest of the senior leadership of our acquired businesses as well as our associates with our shareholders as we drive and enhance our entrepreneurial culture. Therefore, beginning this quarter, we intend to further adjust our GAAP financial results for each quarter and full year by adding back the full impact of these items to our results in order for them to be comparable between periods. And we encourage you to adjust your financial models for Acuity to reflect these adjustments. We typically adjust for these items in our internal reviews of the performance and use these non-GAAP measures for baseline comparative operational analysis, decision making and other activities. Specifically, we believe these non-GAAP measures provide greater comparability and enhanced visibility into our results of operation. We think you will find this transparency very helpful in your analysis of our performance. In addition, many of our peer companies make these same adjustments, so it will help as you compare our performance to other public companies in our industry. In our earnings release and form 10-Q we provided a detailed reconciliation of non-GAAP measures. We also provided in the Form 8-K filed today the quarterly historical amounts for acquisition-related amortization and stock-based compensation, so you can revise previous periods’ GAAP results to reflect these adjustments which you can then compare with the adjusted results we will use going forward. Since Vern’s previous discussion and analysis was primarily on the adjusted results excluding the add-back of all the amortization of acquired intangibles and stock-based compensation, I will provide a few key performance items for the first quarter of 2016 with these additional adjustments. These, as further adjusted results, will provide a baseline as we continue reporting this information in the future as further adjusted operating profit for the first quarter of 2016 including these additional adjustments was a $125.9 million compared with a $103.7 million in the prior year; as further adjusted operating profit margin was 17.1% in this quarter, an increase of a 110 basis points compared with the prior year; as further adjusted diluted EPS with these additional items added back for the first quarter of fiscal 2016 was a $1.77, the comparable prior year amount was a $1.43 which is an increase of 24%. The effective tax rate for the first quarter was 35% compared with 35.9% in the first quarter of last year. The prior year effective tax rate was impacted by unfavorable discreet items which did not recur in the current year. We expect the effective tax rate for fiscal year 2016 to be 35.5% before any discreet items and if the rates in our taxing jurisdictions we remain generally consistent throughout the year. Cash flow generated from operations for the first quarter of fiscal year 2016 was $51.1 million, an increase of $4.4 million compared with the prior year. We did an excellent job of managing our operating working capital defined as receivable plus inventory less payables this quarter as our operating working capital days decreased by four days compared with last year to 32 days, which we believe is industry-leading. In the first quarter of fiscal year 2016, we spent $23.1 million on capital expenditures, compared with $18.5 million in the prior year. This uptick in capital expenditures is primarily due to investments necessary to support our growth, including tooling for new products, expansion in our electronics capacity, and the build out of our innovation and technology center in metro Atlanta, which we moved into last month. We currently expect to spend approximately 2.5% of revenues in capital expenditures in fiscal year 2016. At November 30, 2015, we had cash and cash equivalent balance of $560.2 million, a decrease of $196.6 million since August 31st. We spent almost $240 million on acquisitions in the first quarter. Our total debt was $352.4 million at the end of the fiscal quarter. At November 30, 2015, we had additional borrowing capacity of $243.9 million under our credit facility, which does not expire until August 2019. So even though, we have spent over $618 million net of cash acquired in the last four months on acquisitions, we clearly still have significant financial strength and flexibility, and we’ll continue to seek the best use of our strong cash generation to enhance shareholder value. I will conclude with some additional comments on the Distech Controls, Juno Lighting Group and Geometri acquisitions. On September 1, 2015, we completed the acquisition of all of the outstanding capital stock of Distech Controls for approximately 318 million Canadian dollars net of cash acquired, or approximately US$240 million which we use cash on-hand. Distech Controls generated net sales in access of 80 million Canadian dollars during the fiscal year ended August 31, 2015 and enjoyed a five-year annual growth rate of over 25%. The operating profit margin of Distech Controls is similar to Acuity excluding U.S. GAAP required purchase accounting adjustments. We expect Distech Controls will be modestly accretive to our fiscal 2016 consolidated financial results. The Juno Lighting Group acquisition closed on December 10, 2015, subsequent to quarter-end. We acquired all of the equity interest in Juno using cash on hand for approximately $380 million. Juno was a leading provider of down lighting and track lighting fixtures for both residential and commercial applications. Their annual sales was approximately $250 million for the last 12 months with EBITDA margins in the low-teens. We are very excited to add Juno to our portfolio and expect them to be accretive to our fiscal 2016 consolidated financial results. The Geometri acquisition closed on December 9, 2015, subsequent to the quarter-end. Geometri is a provider of software and a service platform for mapping, navigation and analytics. While financially this acquisition is currently immaterial to our results, it is very important strategically as it adds advanced indoor mapping, navigation and analytics capability to our indoor positioning technology solutions. 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 in a positive direction, particularly for us. Our growth expectations for the North American lighting industry -- primarily North American, has not really changed much over last several quarters, in spite of the noise of the contrary. We remain very positive. So, while we don’t give earnings guidance, I would like to reiterate our observations for fiscal 2016. First, most economists expect the economy in North America will continue to improve at a modest, but increasing pace. While forecast for industry growth rates by independent organizations continue to vary widely, the consensus estimate for the broad lighting market in North America is expected to grow mid to upper single-digit range for our fiscal 2016, reflecting the benefits of both new construction and renovation activity. Again, the continued favorable trend in our December order rate seems to support this continued level of improvement. Further, we continue to see signs that give us the 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 and lending availability and favorable employment trends continue to improve at varying paces, while residential construction continues to grow nicely. Excluding the price of certain LED components which are expected to continue to decline, we do not anticipate significant changes in input costs over the next 12 months. Further, we expect employee-related cost to continue to rise primarily due to increases in associate headcount, 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. Another observation, while our gross profit margin is influenced by a number of factors including sales volume, price, product and sales channel mix and innovation, we expect our annual gross profit margin to improve over time as volumes grow, particularly for larger new construction projects, which should also benefit our mix and as we continue to realize typical gains in manufacturing efficiencies. Our record gross profit margin in the first quarter was a good example of our potential but we prefer to look at our margin improvement over a 12-month period to remove quarterly anomalies like last 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, while we always experience some isolated pricing pressures in various markets and sales channels, we continue to be vigilant on pricing. As we have said before, we will defend our market position vigorously from competitors, should they attempt to use price as their only point of differentiation. Lastly and most importantly, we expect to continue to meaningfully outperform the markets we serve. Looking more specifically at our Company, we are very excited by our many opportunities to enhance our already strong platform including the expansion of our Tier 3 and 4 holistic lighting and building automation solutions that for example connect smart lighting with smartphones for retailers, as well as our growing electronic component and software 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 solutions strategy and our opportunities to meaningfully participate in the interconnected world is really a continuation in the advancement of our overall growth strategy. This includes expected benefits from the acquisition of Distech, which we believe will meaningfully expand our addressable market and add much greater opportunities to offer customers even more broad-based holistic solutions to optimize the performance of their facilities. Further, as you know, we completed the acquisitions of the Juno Lighting Group and Geometri in December. We expect the addition of Juno to meaningfully expand and strengthen our lighting solutions portfolio, including both down and track lighting as well as enhance our presence in the residential and corporate account sales channels. As we noted in our press release, Juno had revenues of approximately $215 million in the trailing 12 months. We are extremely bullish on the long-term growth potential of the Juno Lighting Group. However, we do anticipate some modest short-term impact on the revenue growth rate, as we integrate certain overlapping sales forces. This is a common phenomenon in our industry when acquisitions occur, due to the nature of the specification construction cycle for commercial projects. Lastly, the addition of Geometri, a small yet fast growing business intelligence company, will enhance our growing business analytics capabilities as part of our software solutions portfolio to support retailers and other building users’ need for actionable data. The addition of Geometri will meaningfully enhance our Tier 4 solutions offering. Our company-wide strategy is straight forward, 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’re investing to enhance and expand our core competencies to excel in our fast changing industry because we see great future opportunity. Through these investments, we have significantly expanded our addressable market; our record growth supports this view. As I’ve said before, we believe the lighting and lighting related industry as well as the building automation systems market will experience significant growth over the next decade, particularly as energy and environmental concerns continue to come to the forefront along with emerging opportunities for digital lighting to play a key role in the internet of Things. We continue to believe the many markets we serve as part of the broader lighting and building automation industries, some of which to grow by more than 50% over the next few years will provide us with significant growth potential. As a North American market leader in lighting solutions and a technology leader in building automation, we are positioned well to fully participate in these exciting and growing industries. Thank you. And with that, we will entertain any questions that you have.

[Operator Instructions] The first question is from Mr. Brian Lee of Goldman Sachs. Sir, your line is open.

Thanks for taking my questions. I had two of them actually; maybe first Ricky on the accounting adjustment, just from a housekeeping perspective. It looks like it’s a $0.20 impact to adjusted EPS this quarter, about 13%. Is that the run rate we should expect going forward? And then, can you outline why you guys have decided to make this shift as it’s done?

Sure. That amount’s approximately correct; again today with the 8-K we filed will give you three-year trend by quarter of what those amounts are, so you can get the trend and this recent quarter now we will have a little bit more restrictive stock that we’ll be issuing with these new acquisitions that would increase that a little bit. The reason we went to this is variety of reasons, one as we’ve indicated, we’ve made three acquisitions in the last four months, two of which are fairly sizeable. The purchase accounting required by U.S. GAAP increases non-cash amortization pretty significantly around trade names, around customers, around technology and so forth that can really distort the historical and underlying performance of the business we believe if someone’s really looking at how the business is performing versus these non-cash items that you have to allocate the purchase price to that increase the amortization. And we’re acquisitive and think we’ll continue to do this. And then on the stock compensation, similarly we issue stock many times to the key executives when we acquire a business to get their interest aligned with our, since they’re our employees, you have to expense that; you can’t put that as part of the purchase price. And so that’s caused an increase. And then as we become more entrepreneurial and technology focused, internally we’re using that as a mechanism to incentivize and align employees’ interest with shareholders. Lastly, I’d say when we looked at most of our public peer companies they were making those same type of adjustments. And so, we’ve figured as we’re comparing our results to now with Philips or spin out as their lighting business or OSRAM or go on down the list, they were adding back these items. So, we thought it would be helpful to have us have an adjusted number on a comparable basis to what many of the other people in our industry are doing.

Second question was just around business trends. I know there’s a lot of noise out there sometimes, as you’ve mentioned Vern around macro data but some of the data we track which show that new construction trends are actually [indiscernible] for growth here very recently. So, I know you’re reiterating the mid to high single digits -- and lighting is late cycle but just wondering what might be driving a delta in your view versus some of the uptick in trends that we might have seen recently here?

I’m going to apologize; you broke out right, when you made the most significant word in your comment about spread. [Ph] So, if you could just repeat that; you see trends as what again?

Yes. It seems like some of the grand and there’s a lot of noise in some of these trends but the data we track has shown some of the new construction trends are into the teens percentages for growth, year-on-year. So relative to the mid, high single digit view that you guys have stuck with and then continue to reiterate, wondering if there’s any sort of delta or maybe potential upside to the view here, acknowledging that lighting is late cycles, so maybe you see those trends later?

Again, we’re not economists, so we use a number of different groups, whether it’s Dodge or Global Insights or NEMA data or other data to accumulate and consolidate the view. We’re also looking at the broad market, not just specifics around whether it would be a vertical like schools or vertical like commercial office buildings. So, we comment on mid to upper single digit; we’re looking at the broad overall market. Our expectation is that certain verticals will continue to show a very, very nice growth, well above those the overall average. But then there’re other areas which tend to bring that down a little bit. So, listen, we’re responding to the marketplace in a very aggressive way. And we believe that our growth rates continue to outpace the overall growth rates in the market. You’re absolutely correct, given the specification cycle, the timeframe, we tend to be -- we tend to lag what we -- what the say orders put in place or words by anywhere from six to nine months. So, we like to see the kinds of things that you just discussed. And if we see that coming in, we will upgrade what we believe will be our view of the future opportunities for the lighting industry. NEMA data came out here just the other day and you’re right it was bullish. I believe on a year-over-year basis it was up like four points or something for the third quarter. So, we continue to be bullish, not only on those types of drivers but we see the opportunity to add additional value as we bring more holistic solutions to bear on the marketplace which is what we call Tier 3 type solutions, So, yes, I believe all of this continues to be a very favorable trend.

Thank you. The next question is from Mr. Jeff Osborne of Cowen & Company.

Just two questions on my end. I was wondering on Juno, if you can just touch on the product overlap with Lithonia [ph] and some of the other brands that you have with the 250 million that front rate that they’ve been trending at?

Juno is an absolutely perfect combination with Acuity. The overlap is almost like a jigsaw puzzle coming together perfectly. The areas where they have strength, we actually have a need. And so when you think about our broad down lighting capability, they only enhance it. If you think about our track capability, we do track but what they do on track is really -- it adds a better, best capability to our good capability. So, we view from a product solution perspective, a perfect combination. There is very little in the way of duplicity or an overlap. When it comes to our presence in channels, they are very strong in the residential channel. This gives us really an opportunity to be the market leader in that channel now. When you look at how they handle corporate accounts, they bring a unique capability. In fact, when we look at the customer base, there is very, very little overlap. So both of us are now going to be able to take the other one’s product solutions portfolio to the -- first that we call on. So, it’s really a very opportunistic situation. And then when you look at the commercial markets, the ability to now have these portfolios be available through superior selling forces, we think gives us a real opportunity. The Juno acquisition, yes, there will be certainly cost synergies, purchasing for example, maybe some duplicate warehousing, whatever. But this is really about growth synergies. The opportunity for both Juno and Acuity to attack the markets together will give us great strength, markets where neither one of us really participated as well as we could. I look at the residential market where we both have strength, but now together it really gives us an opportunity to participate and what I believe will be a decade plus long growth in overall residential construction. It’s interesting to me that when we look at residential construction on an inflation adjusted basis that U.S. residential construction market still up almost 50% from its peak in 2006. So, when you think about population growth over that last decade of probably 2% plus per annum, there is a whole lot of inventory that needs to be built to handle these changing trends. And so, we are just very bullish around the whole opportunity of what Juno will bring. And you’ll start to see those benefits manifest themselves over the next 12 months to 18 months.

It’s great to hear. Just quick follow-up, Vern, I was wondering if you could just address what during the quarter was a biggest area of upside surprise and likewise unanticipated weakness, whether it’s a particular vertical or geography would be helpful.

So, we said in our prepared remarks that our growth was really pretty broad-based. We continue to grow in the infrastructure side; we continue to grow through the home improvement channel; we continue to grow on the commercial side. On the surprise side, you always see ebbing and flowing in certain geographies and things of that nature. There is some dislocation that’s going on, that’s caused by the changes in oil price. But for the most part, Acuity is extremely diversified. Our renovation capabilities are pretty robust. So, we continue to see opportunities, both in new construction and renovation. And it’s that diversification that has given us the ability to, if you will, write out small little geographical nuances or issues and overall deliver growth that is really quite robust. The lighting market and the non-residential construction market for awards and construction put in place, as I mentioned earlier, do have a lag. So to the extent that we actually see this uptick as was described earlier on by I think the person from Goldman Sachs, that’s just additional opportunity for Acuity to continue to outperform the growth rates of the markets we serve. So, we’re very excited about that future opportunity.

Thank you. The next question is from Sven Eenmaa of Stifel. Sir, your line is open.

Yes, thanks for taking my questions. The first one, I wanted to ask about your view in next year in terms of mix on retrofit activity versus new construction, you probably have a longer lead time or some of the projects and have longer term visibility.

Well, if markets play out as this conversation is suggesting, this uptick in new construction, then Acuity is uniquely positioned to participate in that. We have great access to market. But I would say that renovation continues to be a huge opportunity. Based on some of the data that we’ve seen that’s maybe a little bit old now, but if you look at outdoor lighting, the market is only 10% converted. If you look at indoor lighting, it’s only 3% converted. So, we see the renovation opportunity to continue to be very interesting to us given our access to market, our ability to create products that fit the needs of those markets. And as those prices come down in fixtures and solution sets, the ability to sell those products in the markets where they have lower energy costs, now you can get the payback. So you will -- we just believe that that conversion over the next decade is going to be a robust opportunity, particularly for us. And so then when you add new construction on top of that it’s like getting two scoops of ice cream. What will our mix be? I don’t have a good crystal ball around that. We’re marching to a $5 billion business over the next handful of years. And we can see the opportunities of serving both of those markets in an aggressive way. So, we’re pretty excited about both, if you will.

And just a quick follow-up on that. So, when you look at the new construction versus retrofit activity, are the pricing and dynamics you see on both of those markets are materially different or how would you characterize them?

I think it very much depends on the project. To say overall, this is the direction of pricing and how does it compare one to the other. It just depends absolutely on the project; it depends on the vertical; it depends on the size of the capability; it depends on what someone’s trying to do. If a big box retailer is converting a store from conventional lighting technology to digital lighting, the fixtures are primarily the same; they are very ubiquitous. So, pricing is very, very aggressive. If someone is converting their law office and it’s a very high end for conventional, usually they’re choosing luminaries and solution sets that are very sophisticated to many things and are generally more expensive. The margin dynamics for Acuity are very exciting for both because the cost structure just happens to be different. The cost to serve is different. So when you look at the expansion of our margins, I believe it’s because of two things: One, we’re growing our top line in areas that are very important, both new construction as well as not renovation but we continue to drive a great deal of productivity, cost out with the types of engineering capabilities and we’re bringing new solution sets that add value. So, I think you will continue to see us improve our margins. And from a pricing perspective, it’s really about how we bring value-add. Pricing in the marketplace has been consistent and how it approaches it for a long time. So, we don’t see any meaningful changes in how the market competes, if you will.

Thank you. The next question is from Mr. Ken Wise [ph] of Baird. Sir, your line is open.

Just I guess a quick question on the gross margins. I think in your prepared remarks, you noted that component cost were tailwind to margins. I was just wondering if there is a chance that you can break out what that might have contributed on a year-over-year basis to gross margins and how we should think about that as we go through fiscal ‘16.

From my perspective, when we look at our cost structure that makes us ability to drive gross margin, there are many influences there. And so the notion of material cost and how we engineer products to cost out things and how we improve our productivity, FX to a degree, the mix change, I would say that the market, it has been fairly benign on a cost basis. We’ve seen some significant improvements in some areas, owing to see increases in cost, not necessarily commodity or material base cost or component cost in other areas. So, I think you will continue to see us improve our margin but mix obviously has a big influence on that; sales volume has a big influence. We’re not expecting any significant changes in material cost. We do think that healthcare cost will continue to rise. So, we’re always looking for ways to use our internal AVS process, our ability to improve productivity as ways as to help offset some of those things because again as you all know, we operate in a big business environment. So, I would say that as you think about margins going forward, it really is more about our ability to drive volume, our ability to continue to drive productivity than would be on any one given commodity cost component.

And I would just add that in some of the component cost decreases we’re seeing, such as in the LED area that chips and so forth, the industry today for the most part is passing a lot of that on, as we’re continuing to enhance the conversion metrics on ROI and so forth. So, while we’re seeing some benefit in that and speak to that, we are having to share some of that with the customer base.

Okay. And then just as we think about the institutional part of the market, we’ve seen anecdotes that that market is starting to improve. And I’m just curious with education, with schools, with hospitals and government buildings, how -- what is your order book like -- order books look like in those verticals; and are you starting to see projects get released more specifically in institutional?

Yes, verticals are all very different. And it depends on again geography as well. So, yes, we are seeing improvements in what we call the educational market. And we would expect that to continue -- this is like -- and we say that we believe that over the longer term the growth rates of our overall markets will continue to be very favorable, at least for the foreseeable future. Because of the commentary that we’ve heard on this call, you all are starting to see the uptick in some of these areas on certain verticals. And Acuity is well positioned to participate in that. So, we’re bullish about the long-term growth rates of our market. There is a lag for any type of what we call larger type -- medium to larger type project, simply because of the specification cycle to the construction cycle. There is a lot of opportunity to further renovate large spaces with digital lighting, particularly our digital lighting, particularly our digital lighting that has the ability to really act as a digital pipe to enhance the notion of data collection and participation of the Internet of Things. So, we do see not only growth trends that are being driven by macro but then our ability to provide differentiated value added solutions that should allow us to continue to capture market share.

Thank you. The next question is from Mr. Jed Dorsheimer of Canaccord. Sir, tour line is open.

I guess first question just with respect to sales channel and mix, sometimes there can be -- I think you’ve noted before, Ricky and Vern that there is -- there can be some mix shifts within your -- the agent channel. And I was wondering, based on size of or deal size, I was wondering if you looked at this quarter, was this pretty normal or were there any specific shifts in that. I think it’s like 60% of that business, sort of that agenting side of the business in that contribution that led to the more favorable or was it primarily product mix shift driven on the Tier 3 solutions?

So, I would say Jed that this quarter was pretty normal. We’ve had about one point of price mix; we attributed most of that price mix to, as Ricky pointed out, just change in component cost, primarily for LED. We didn’t see a lot of shifting going on that was different, if you will, between the channels and the verticals that we sell to. Our ability to drive an improvement in margin was again unit volume growth but also we are good at improving productivity within our facilities; we are good at looking to improve cost outs of products that we have introduced because we have excellent engineering talent. So, you’re seeing Acuity at its best doing what it does best and that is growing its top line and continuing to look at every area of this business to improve its productivity while investing. We just opened up a new facility down in Mexico because we ran out of space. So, we’re absorbing that and we’re driving productivity there. We’re just darnedably pleased, as Ricky pointed out. We moved into our new technology and innovation center in Decatur where we repurposed an old factory that we had. And it’s just an outstanding facility that will help us to not only retain our top talent but to attract new talent as we continue to drive things. So, this quarter from a mix perspective and all that I think was fairly consistent; there was no new news there, but what you saw is Acuity just executing well.

And then just on my follow-up, maybe sticking with sales channel but a little bit of a different question as we look at the Distech solutions that they offer; it seems to be more on the building management. And historically, you’ve been very strong with that agent side of the business in the lighting. And the sales, if you compare sort of a building management solution and a lighting solution can come at different points in the process on the commercial build in dealing with different people. What have you seen so far in terms of the cross-pollinization of lighting products to the Distech agents and the building automation to your lighting agents?

Distech brings to us about a handful of new sales channels. The primary sales channel that they sell through is the system integrator. The system integrator, you’re absolutely right, they’re very good at both new construction as well as renovation. We see a very, very complementary opportunity going forward to have our local agents and that local system integrator, working ways to create a very strong specification for the combined capability of building automation systems of which lighting and lighting controls are a part. Bringing these things together so that they are extremely smart and extremely simple to use and simple to install, we believe is a powerful, powerful value proposition for customers. So, the ability to begin targeting specification for whether it’s new construction or renovation together, we think is a huge opportunity. And just to tell you where we are in this, I mean to use baseball analogy; the managers are walking up the whole play to exchange their line-up cards. So, we are just now getting after this. But the enthusiasm in certain markets between both agents and system integrators is really very, very interesting. And by the way, Geometri brings a sales channel to us that we had not participated in the past and that’s these value-added resellers. Their connectivity into large projects is quite robust. And so, when you start to think about Acuity bringing in that holistic total building solution and you now add on top of that the ability to drive and collect business analytics because again we believe between Distech and Acuity’s lighting control system that combination, we can collect north of 85% of all the data that’s being created in a building. And now when you start to put the analytics behind it, both what we have today and we’ll be at the Retail Federation Show here in mid-January, demonstrating again the robustness of our ByteLight Visible Light Communication System, which is that indoor positioning to robust combination. And now when you put on top of that Geometri’s ability to drive analytics off of that, I’ll tell you Jed, it’s a powerful combination and we’re just obviously starting this fresh.

Our next question is from John Walsh of Vertical Research Partners. Sir, your line is open.

I was curious given the recent tax extender legislation at the end of last year, a few changes here on section 179D with energy efficiency and raising the requirements, obviously the new requirements are more of focus on controls and lighting. I want to know if you’re hearing customers talk about that or is it kind of something you guys see as being exciting to the market?

We believe that those types of legislations that bring energy efficiency, both from an awareness perspective as well as a mandate are extremely positive. If you look at what’s happening in California around Title 24, we believe that those types of requirements will only become more robust in more states, more opportunities. So all of those kinds of things are just another macro driver for the things we’re doing. Ricky?

Yes, we were generally very pleased with the passage of that and making some of the items permanent. You mentioned one element that’s very helpful. They also renewed the tax, accelerated tax benefit that someone can get from putting in more energy efficient lighting controls as well as other energy-efficient areas. That had expired a year plus ago and they reinstated that. And then reinstating and making permanent the R&D tax credit, which is now as we’re continuing to do more and more in the technology space is a positive for us. So, all the way around, we were very pleased with the passage of the tax extender and particularly the fact that they made some of these permanent.

Great. And then, so my second question around the incremental, so the as adjusted or further adjusted incremental, I was calculating out to be about 25 which I think you guys have said you’re comfortable with the mid to upper 20s. One, I was kind of curious, what are some of the things that will drive us towards the upper end of that range from here; and then wanted if there was kind of any impact from kind of this remaining vigilant on pricing, if there was anything that kind of changed quarter sequential in terms of competitive dynamic?

So, I’ll answer the last part first. The competitive dynamics were again consistent with what we’ve seen. There is nothing that I would say would be noteworthy in terms of the pricing dynamics that would be outside the norm, if you will. That doesn’t mean that we don’t experience -- we’re a bid business that we don’t experience some competitive pressures, but I wouldn’t call that out. On the variable contribution folks, what you have to understand is that we are making investments in our business, we’ve done this for a long time, and it depends on the timing of some of these things. So, this quarter, the hiring that we did, we’ve added some tremendous capability that will drive revenues. And so those revenues will flow through without us having to add additional capabilities to garner those. And so you will see this ebbing and flowing in our variable contribution margin. That’s why we said mid to upper single -- or mid to upper 20s as a sort of a target. But ultimately as the investment that we make and the investment base becomes pretty solid, we expect that the growth rates in our top line will meaningfully impact those variable contributions because we have the core competencies in place. And we’re now driving great revenues over that, if you will, new fixed base. Having said that, I think over the course of the year, you will continue to see very favorable variable contribution margins. This quarter was smack dab consistent to what we expected. And the things that are happening that represent future growth opportunities, we’re starting to see the benefit of those; we’re starting to see the revenues rolling through. Our Tier 3 solutions which again are off a very small base, growth rate there is robust. And our margins, while we’re trying to make sure we understand them, they are contributory; they are accretive to what we’re doing overall. And again just a final comment, the reason Ricky is now trying to give you a base to understand what our real margins are is because we do expect to continue to be acquisitive in driving our business and the purchase accounting adjustments that we have to make off of the businesses that we have acquired. For example, just take Distech, their margins were very consistent with ours, but once you do purchase accounting, all of a sudden, in those margins change rather dramatically. The way we look at the business and the way you look at the business is without some of those if you will U.S. GAAP purchase adjustments for these non-cash items. The tax was already spent due to the purchase price. So, we’re trying to give everyone a real apples-to-apples picture and it is positive. When you compare our 17 plus percent adjusted, further adjusted OP percentage number to our competitors on that same basis, it’s a wow. And that’s why we want to make sure that you, all of you see these kinds of things because it’s really a positive picture.

I’d now like to turn the call back over to Mr. Vernon Nagel for closing remarks.

Folks, thank you for your time this morning. 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 continue to deliver strong returns to our key stakeholders. The market reaction to our result is notwithstanding. Believe me, our future is very bright. Thank you for your support.