Acuity Brands, Inc. (AYI) Q2 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the Acuity Brands Fiscal 2016 Second Quarter Financial Conference Call. After today’s presentation, there will be a formal question-and-answer session. [Operator Instructions]. This conference is being recorded. If you have any objections, you may disconnect at this time. Now, I would like to introduce Mr. Vernon Nagel, Chairman, President, and CEO. Sir, you may begin.

Good morning everyone. With me today to discuss our fiscal 2016 second quarter results is Ricky Reece, our Executive Vice President and Chief Financial Officer. Dan Smith our SVP, who is usually on the call with us is serving Jury duty this week and probably won't be back until Monday. We are webcasting today’s conference call at our website at www.acuitybrands.com. I would like to remind everyone that during the 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 will identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. First off our results for the second quarter of 2016 were simply outstanding. There is no other way to describe them. Our net sales grew 26% while our adjusted diluted earnings per share grew 53%. We achieved record quarterly results for a number of key financial metrics including net sales, and on an adjusted basis gross profit margin, operating profit, and diluted earnings per share. In fact, this was our 12th quarter in a row where we achieved double-digit volume growth, remarkable achievement. We believe these results yet again are strong evidence of strategies to provide customers with differentiated value added solutions and to diversify the end markets we serve are succeeding, allowing us to extend our leadership position. These strategies include accretive acquisitions, the continued aggressive introduction of innovative, energy-efficient lighting and building automation solutions, expansion in key channels and geographies, improvements in customer service, and company-wide productivity gain. Also in the quarter we completed the acquisitions of Juno and Geometri. These are two great companies with the extraordinarily talented associates that will meaningfully contribute to the growth of our tiered solutions strategy. Our results for the second quarter set records for Acuity even as we continued 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 as well as our building automation and Internet of Things solution. I know many of you have already seen our results and Ricky will provide more details later in the call but I would like to make a few comments on the key highlights for the quarter. Net sales for the second quarter were $778 million, an increase of 26% compared with a year ago period, and the highest quarterly sales in our history. Reported operating profit for the second quarter of 2016 was $106.7 million compared with reported operating profit of $78.6 million in the year ago period. There were some minor adjustments in both quarters for a certain special charges which Ricky will describe later in the call. Also our reported operating profit included such items as share based compensation expense, costs associated with the acquisition of Juno, the cost of early termination of certain contracts at Juno which were no longer necessary due to the acquisition, and certain purchase accounting adjustments including profit in inventory and amortization expense for acquired intangible. In order to make our quarter results comparable between periods we find it helpful to adjust both quarter's results by adding back these items. In doing so one can see adjusted operating profit for the second quarter of 2016 was a quarterly record of $127.4 million compared with adjusted operating profit of $85.8 million in the year ago period, an increase of 49%. Adjusted operating profit margin was 16.4% up 250 basis points from the adjusted margins in the year ago period. Adjusted diluted earnings per share was a quarterly record of $1.80 compared with adjusted diluted EPS of $1.18 in the year ago period up 53%. This is very compelling performance. We closed the quarter with $224 million of cash on hand after investing $614 million for acquisitions, leading -- for acquisitions this year leaving us with plenty of financial fire power to execute our growth strategies. Further we generated a $120 million from net cash provided by operations in the first half of 2016 up $44 million from the year ago period. Our record 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. Net sales for the second quarter grew 26% compared with the year ago period. We estimate our sales volume grew by an impressive 17%. The additions of Distech and Juno increased net sales another 11% or 11 points I should say. While foreign currency fluctuation primarily for the weakening Canadian dollar and changes in price mix each reduced net sales by 1 point. While it is not possible to precisely determine the separate impact of price and mix changes on net sales, we believe the difference was primarily due to lower pricing on like kind LED luminaires between periods reflecting the decline in certain LED component cost 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 over 40% 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 55% of our total net sales, which as you know, includes non-fixture related products as well. We believe our rate growth for LED solutions 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 and product diversification, as well as our strategies to better serve customers with new, more innovative and holistic lighting and building automation solutions and the strength of our many sales forces have allowed us to yet again achieve meaningful sales growth this quarter. Before I turn the call over to Ricky, I would like to comment on our profitability and strategic accomplishments for the quarter. As we noted earlier, our adjusted second quarter operating profit was $127.4 million, the most in our history. And adjusted operating profit margin for the quarter was a second quarter record of 16.4%, up 250 basis points from the adjusted margin in the year-ago period. Again this is very robust performance and historically our lowest quarter due to seasonality. Further our adjusted gross profit margin for the quarter was a record 43.5%, up 200 basis points compared with the year-ago period. The expansion of our adjusted gross profit margin was primarily due to the benefits of higher net sales volume, productivity improvement throughout the supply chain, and lower input cost partially offset by the addition of Juno which in its recent past has had lower gross profit margins than Acuity. Next, total selling, distribution, and administrative expenses excluding the adjustment items noted earlier for each quarter were up $41 million or 24%. Adjusted SD&A expenses as a percentage of net sales were 27.1% in the current quarter, a decrease of 50 basis points from the year-ago period. The increase in adjusted SD&A expense was primarily due to the higher freight and commission cost to support the increase in net sales, the impact of acquisitions, and to a lesser degree higher compensation cost. The increase in compensation cost was primarily due to additional headcount to support and drive our tiered solutions strategy. This next point is very important. Another way to view just how robust our second quarter results were is to examine our variable contribution margin excluding the impact of acquisitions. On a comparable basis, our variable contribution margin was in mid 30s as a percentage of sales well above our current target of mid to upper 20s. All in all we had another great quarter. On a strategic front, we continued to make great strides, setting the stage for what we believe will be strong growth from profitability in 2016 and beyond. Internally, we continued to accelerate the deployment of our lean business processes, driving greater productivity and enhanced customer service. We continued our rapid pace of introducing new products and solutions, expanding our industry-leading portfolio of innovative, energy-efficient luminaires and lighting-control solutions. With the addition of Juno we now offer customers more than 1.8 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. We continued 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 customer solutions that best meet their needs, whether it would be a single device which we categorize as Tier 1 or a complete holistic integrated building automation and lighting solution, which we refer to as Tier 3 for their innovative or 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 competitive advantage for Acuity. And the additions of Distech, Geometri, and Juno will meaningfully enhance our industry leading capabilities and solutions portfolio. While sales data for our tiered solutions is still imprecise and expanding off a small base, we believe sales in our Tier 3 category, encompassing our holistic integrated solutions were up more than 40% through the first half of this year over the year-ago period. Tier 3 solutions can be enabled to collect data 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 our recent acquisitions as well as increasing our salaried headcount to support the growth as part of 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 12 million square feet of space for customers, utilizing almost 200,000 Beacon enabled lighting fixtures that can collect data and enable applications to provide users with useful, actionable information. People need this level of capability and deployment is unmatched in our industry. The addition of Geometri will only add to our industry-leading capabilities. The integration of Distech which operates in its historical markets as more of a standalone company is moving along very well. Particularly among the engineering, marketing, and sales teams where we are adding new capabilities to create and market enhanced, unified building and lighting systems as well as expand our access to customers in additional channels. We expect the combination of Acuity with its broad industry leading solid state lighting portfolio innovate and control technologies in integrated digital solutions and Distech who contributes to our tiered solutions strategy by offering a holistic, unified solution that delivers true end to end optimization in all aspects of the building. These solutions are designed to enhance the occupant experience, improve the quality of the visual environment, and provide seamless operational energy efficiency and cost reductions. As well as increased digital functionality due to a unique capability to collect vast amounts of data that can better enable the Internet of Things for building owners. Through the execution of our tiered solution strategy, Acuity Brands is a leader in the evolution to smart buildings and smart cities. We expect these recent acquisitions coupled with our aggressive internal investments will 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 non-residential construction cycle. We have been able to produce these results because of the dedication and resolve of our 9000 associates who are maniacally focused on serving, solving, and supporting the needs of our customers. I will talk more about our future growth strategies and our expectations for the construction markets 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. Ricky?

Thank you, Vern and good morning everyone. As Vern noted we had a very strong second quarter performance on virtually all metrics including sales and earnings growth, profitability and cash flow. I will provide a bit more color on our second quarter results and our financial position. As Vernon mentioned earlier we had some adjustments to the GAAP results in the second quarter of fiscal 2016 and 2015 which we find useful to add back in order for the quarterly results to be comparable. In the second quarter of fiscal 2016, we added back pre-tax $8 million or $0.12 per diluted share for various acquisition related items. Pre-tax $6 million or $0.09 per diluted share for the amortization of acquired intangible assets. $6.6 million or $0.10 per diluted share for share based compensation expense and $0.1 million for special charges related to previously announced streamlining activities. We adjusted prior year results for amortization of acquired intangible assets of 2.8 million or $0.04 per diluted share, share based compensation expense of 4.3 million or $0.06 per diluted share, acquisition related fees of $7.7 million or $0.02 per diluted share, and reversal of a special charge of 0.6 million or $0.01 diluted share. These adjustments to our GAAP earnings resulted in an adjusted diluted EPS of $1.80 for the second quarter of fiscal year 2016 which is a 53% increase compared with a $1.18 adjusted diluted EPS in the year ago period. We believe these non-GAAP measures provide greater comparability and enhanced visibility into our results of operations. We think you are finding 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 provide a detailed reconciliation of non-GAAP measures. The effective tax rate for the second quarter was 34.2% essentially flat with the 34.4% in the second quarter of last year. We expect the effective tax rate for fiscal year 2016 to be 35.5% before any discrete items and if the rates in our taxing jurisdictions remain generally consistent throughout the year. Cash flow generated from operations for the first half of fiscal year 2016 was an impressive $119.5 million, an increase of $44 million compared with the prior year. We did an excellent job this past quarter of managing operating working capital defined as receivables plus inventory less payable as our working capital -- operating working capital net of the effects of acquisitions decreased by six days compared with last year to 35 days which we believe is industry leading. In the first half of fiscal year 2016 we spent $43.8 million on capital expenditures compared with $27 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 electronic capacity, and the build out of our innovation and technology center in Metro Orlando which we moved into earlier this fiscal year. We currently expect to spend approximately 2.5% of revenue in capital expenditures in fiscal year 2016. At February 29, 2016 we had a cash and cash equivalent balance of $224.3 million, a decrease of $532.5 million since August 31, 2015. The decrease was due primarily to cash used upon acquisitions of $613.7 million and capital expenditures of $43.8 million as well as to pay dividends to shareholders of $11.4 million. Our total debt outstanding was $353.7 million at February 29, 2016. The ratio of debt net of cash to total capitalization net of cash was 8% at February 29, 2016. We had additional borrowing capacity of $243.9 million at February 29, 2016 under our credit facility which does not expire until August 2019. We clearly enjoy 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 will now turn the call back to Vern.

Thank you, Ricky. As we look forward, we continue to see significant long-term growth opportunities that are ever-changing and evolving in a positive direction, particularly for Acuity. Our growth expectations for the lighting industry primarily in North America, has not really changed much over the last several quarters, in spite of the noise to 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 still expected to grow in the 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 March order rate seems to support this continued level of improvement. 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 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 wary 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, innovation and price, product and sales channel mix as well as the current dilutive impact of Juno 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 and manufacturing efficiencies. Our record adjusted gross profit margin for the half of fiscal 2016 is a good example of our potential, the positive picture. Additionally, while we always experience some isolated pricing pressures in various markets and sales channels, we will continue to be vigilant on pricing. As we have said before, many times 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 our growth rates to continue to meaningfully outperform those of the markets we serve. Looking more specifically at our company, we are very excited by the many opportunities to enhance our already strong platform including the expansion of our Tier 3 and 4 holistic lighting and building automation solutions that for example connect smart lighting with smart phones for retailers, as well as our growing electronic and software capabilities. As we have noted in our last several conference calls, 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, which has been in place for some time. 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 our customers even more broad-based holistic solutions to optimize the performance of their facilities. While we are very early in this game, we are seeing positive results in our growth rates for Tier 3, and the implementation of our IoT solutions. Further, 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 last earnings call, while we are extremely bullish on the long-term growth potential of the Juno Lighting Group, we anticipated some modest short-term impact under net sales, as we integrated certain overlapping sales forces. We are pleased to report a large portion of the integration of those sales forces has been completed and early indicators such as quote rates for Juno products are up significantly over the year ago period. This gives us optimism that much of the negative impact of the sales force integration is behind us. Additionally I would know we are ahead of our internal schedule for the integration of Juno which includes unifying our design and engineering teams as well as enhancing our expanded supply chain and streamlining our support activities. Lastly, the addition of Geometri, a small yet fast growing business intelligence company, will enhance our expanding 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 and is already paying dividends through greater customer connectivity. 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 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 could grow by 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]. Our first question comes from Jed Dorsheimer with Canaccord Genuity. Sir, your line is open.

Thanks. Congratulations, spectacular quarter guys. Just two questions from me, I guess first question, I guess the profitability on the Tier 3 and Tier 4 solution sales, has that -- are you seeing a meaningful increase as those bundled or tiered solutions are more readily adopted in the marketplace?

So, Jed as I mentioned in my prepared remarks, Tier 3 is really starting to take hold in a positive way but we are still very early in the game. Yes, we are seeing margin improvement but again it is a small contributor to what we are doing today. Obviously we have high expectations that it will be a large contributor as we continue to differentiate those capabilities in the market. From a Tier 4 perspective, we are generating revenues from business analytics and other capabilities within our Tier 4 service offering. But again that is really small compared to the overall corpus. And we are investing in that capability by adding additional software capability, headcount if you will in that area as well as the Geometri acquisition. So, profitability if we looked at it at gross profit level it would be quite high but again off a very small base. So we will be talking about this over the next or forever actually because this will be an integral part of the solutions capability that Acuity will provide its customers going forward.

And then there seems to be a bit of divergence in the marketplace between companies that are taking an approach with low voltage and possibly power over Ethernet as a solution versus others that are taking more holistic controls approach with an integrated package. And I was just curious, you have had -- you are having a lot of success, you have a established distribution channel that seems to support the more of line voltage, I was wondering if you could comment on activities on power over Ethernet or your views of that particular technology and whether or not we should see Acuity with a meaningful product offering in this particular space?

Sure, we believe that a unified solutions set is the preferred choice of most customers. If you go back and look at some of the announcements that have been made by some of our competitors, if I look at what Distech -- they were doing things like that two and three years ago. It is not really new but the capabilities we believe most customers are going to want more full some capabilities particularly as they are trying to optimize how their buildings are not only being used but how they also can collect data off of these unified systems where they work seamlessly and the future functionality of them are much broader and more robust. So early, early, early in the game but our view is that most folks will be opting for a more robust capability because the cost is really not that much different.

Great, thanks and congrats again.

Thanks, Jed.

Thank you, our next question is from Ryan Merkel with William Blair. Sir, your line is open.

Thanks, good morning everyone, and again very nice quarter. So the first question I had was, one of your competitors mentioned that there was some chop and weak conditions in January and February so I’m wondering did you see that as well and you just out-execute it or did you not see it and your view is the market is ticking along just fine?

Not familiar with who made those comments but you know I’ve been with customers pretty aggressively here over the last 90 days as we typically do, and I would say that generally speaking you hear little pockets of softness but I think that those are typically driven by a local geography and potentially a local issue. So if you imagine with the oil patch being soft you might expect in some of those areas where folks are being served that if you’re serving that type of capability sure you’ll see a little bit of softness. But in those markets as we talk to our various customers and talk to our various selling forces, they see opportunities in other areas. So I would say that generally speaking while folks were maybe a bit cautious in terms of their outlook, I believe that business activity still continued. Acuity is blessed because not only in the legacy business did we sell through 14 different channels touching the various markets in a very aggressive way, but with the additions of our recent acquisitions including Distech, Geometri they added more capabilities, more channels for us to now touch customers in the way that they want to be touched. So I tend not to get too tied up in what one person or two people or someone says about something because of again the opportunity that Acuity has to continue to touch those markets. Our order rate was strong and our shipments were strong as witnessed by our top line volume. And it was broad based throughout virtually all of the various end applications or end markets that we serve. And virtually all of our channels -- for all of our channels and all of our geographies showed growth. So I can't really comment on what others may have said.

Okay, fair enough and then my second question on incremental margin coming in at 26% I think this quarter, which you pointed out this is a seasonally weak quarter which makes it even more impressive, so I am curious in the back half of the year you know with things seasonally stronger should we expect something in the high 20s or would you just reiterate that we should be in that sort of 25% to 29% range in the second half?

So I believe that the variable contribution margin that you calculated included the acquisitions that had no -- we didn’t pro-forma their results into a prior period. So you’re just seeing what that delta difference, the operating profit off of the incremental sales. But just know that that’s not precisely how we would look at it. So you don’t have that period over period. When we look at the legacy business where we did actually have sales in the year ago period and that this is a same store sales kind of concept, that variable contribution margin came in the mid 30s and again we’ve tried to give guidance where our current target is kind of mid to upper 20s because we are investing in capabilities to really drive our tiered solutions strategy. So, you are right, our variable contribution margins were impressive and it had to do with the fact that our gross profit margins improved, our company continues to do an excellent job in driving productivity throughout the organization. So, you really started to see not only improvements in margin through the supply chain and other things that we are doing there but also the leverage on the SD&A. As these acquisitions come into fold and we have year-over-year comparability with them, we still see very positive variable contribution margins. So, I still -- we would still like to see folks think about that mid to upper 20s because it is a little bit lumpy in terms of how we are investing in the great talent that we are being able to attract that is helping to drive our growth rates. As I pointed out, our Tier 3 solution set, the growth rates there again off the small base through the first six months were up 40% and those are very telling signs of future opportunities.

Very good, thank you.

Thank you.

Thank you, our next question is from Matt McCall with BB&T Capital Markets. Sir, your line is open.

Thank you, good morning guys. So, maybe I want to just expand on the last one, Vernon, in the past you have given us some good insight into the way you see the SD&A line broken out kind of fixed and variable. I guess the question is, is there -- two parts of the question is are there are any shift or can you give us any update on the fixed variable components of that line item post these acquisitions and then as we see it sounds like mix is going to be your friend as we see mix continue to benefit your overall margin if your contribution margin remains in the mid to upper 20s, does that imply that you can actually have -- you actually have more to invest as you generate high levels of profits, hopefully that makes sense?

It does. Our expectation as we continued to expand our offerings in tiers 3 and 4 which we expect will deliver higher gross profit margins but also as we continue to develop and hone our capabilities with the legacy Acuity, Distech if you know. In tiers 1 and 2 we see that as also being a very powerful driver over the next 12 to 18 months. They obviously for different reasons expand our access to market but also expand our capabilities in those various end markets that are growing. If you look at residential for the last couple of quarters, last several quarters actually residential continues to grow in sort of that low teens area. And Juno combined with our Lithonia and other brand gives us a pretty robust offering there. So we are pretty excited about that. If we think about Distech and what it is doing, it has very strong gross profit margin. So we want to continue to invest and we are investing to expand the portfolio that Distech and Acuity can offer in terms of an unified system. But that would be a Tier 3 and we believe that, that overall system from a building management perspective gives building owners the opportunity to really drive Internet of Things which will allow us to develop a recurring revenue stream in the Tier 4 area for us. So, the answer is yes, we would expect our variable contribution margins to expand over time but right now we are in a bit of an investing mode. If you look at our salaried headcount it has increased so it is a bit difficult to precisely answer your question around the fixed variable piece. We prefer to target more as a percentage of sales if you saw us leverage this quarter. Our SD&A, we picked up about 50 basis points so that was really helpful. It is interesting as we manage our business, and I think our team is doing that very, very well. If you look at our salary and our wages as a percentage of our total revenues, it continues to show productivity there. So these investments are paying off and giving us more capability to drive more variable contribution margin as we differentiate our solution set. So, I think the way we would ask folks to look at our SD&A is more as percentage of sales and then hone in based on the last couple of questions, hone in on the variable contribution margin as we go forward. And I think that, that picture will allow folks to test their models, create their models, and measure our ability to execute against those in a very favorable way.

Okay, alright and just one follow up. There is a long cash flow, the last couple of years it has been about 200 million annually that you have increased cash on a balance sheet and you made some acquisitions this year. Just want to maybe give us any insight into what may change in the cash flow drivers post the acquisitions and specifically I noticed payable has actually ticked down as a percentage of sales in Q2, normally that goes up, was that acquisition related, is something changing with the seasonality, just any more color will be helpful?

So Ricky if you could address that.

Yes, sure. Matt, you’re right the acquisitions, primarily the acquisition of Juno. Juno historically does have more operating working capital then we traditionally have as a percentage of revenue, our returns the way you look at it and its really pretty much all three of the components or a bit opportunistic for us. Their receivable days are higher, their inventory is quite a bit higher, and their payable days are shorter. So we do see opportunity as we continue to work with them and look at ways to integrate their back office functions as well as some of the transactional areas to improve on that. So I do think you are going to continue to see us generating strong cash flow. The opportunity for the legacy business I think is still there on inventory, I feel pretty good where we are in receivable and payable days. They are the industry leading we believe not necessarily work class, there are still opportunity for improvement but certainly industry leading in our industry. But we still see some opportunities to continue to work through working capital. The other variable beyond operating working capital is CAPEX. You have seen a bit of a tick up in the last couple of years as we needed to expand our footprint if you will on office space for engineers primarily as well as a little bit in manufacturing or expanding some manufacturing capability as well. But I now also see some opportunity with the acquisitions to see how we can better get efficiencies out of that. So CAPEX at the 2.5% I think is a good number for now. That’s a little higher than we’ve historically run but I do see strong cash flow going forward as we continue to see opportunities to manage working capital particularly with the acquired businesses as well as inventory.

If I could just pile on a little bit, our team has done just an outstanding job through the first half of generating cash flow from operations. I mean if you look at $120 million up $44 million over the year ago period and yet we paid out in the first quarter probably an extra $20 million of bonus over the year ago period. So when you think about that, that cash flow performance is very robust. And as Ricky points out, this year is probably -- last year and this year we’ve spent a little bit more as a percentage of sales than we typically have. My guess is that as we look out into 2017 and 2018 that number starts to come back to a little bit more closer to our historical number. But again as we pointed out earlier, Acuity is really a human capital business and so adding the kind of skill sets and capabilities that are required to really drive our total solution set is what we’re doing. And what we’re seeing from a return off of those investments, pretty robust.

Okay, thank you guys.

Thank you. The next question is from Christopher Glynn with Oppenheimer. Sir, your line is open. You may proceed.

Thank you, good morning. Wanted to talk a little bit about the core volume acceleration from the first quarter to the second quarter and last year you noted some headwinds from weather reports, it wasn’t really evident in headline number but it was called out a little bit. I am wondering if the acceleration of 17% here reflected some benign weather or is that more kind of the building of the core base of Tier 3 into the run rates?

If we look at the legacy business it was down slightly this quarter compared to the first quarter but nowhere near what the historical change has been. Look I -- the only way we are able to determine market share is through the [indiscernible] data. We only see ours compared to the total pie. We know we are continuing to drive share but I believe that, that the bulk of that share gain well it is impossible to say precisely where it is coming from but I think that the world of renovations for Acuity is a strong contributor and so at times we continue to drive those sorts of things. It is very favorable. The weather conditions this year seemed to be a little bit more mild compared to the year ago period so potentially there is something there. When we look at our utility business, it is a outdoor business. We continued to have strong traction but we have had strong traction period over period, sequential or year-over-year growth in those areas. So, I just feel like our sales forces were executing well. Maybe weather gave us a little bit of a break but we expect to continue to build on that Tier 3 solutions. Again for the bulk of what we have those are indoor activities and so I don’t know if those would have been -- getting solid but nice growth there but it is off a pretty small base. So, it is hard to precisely say why sequentially this year over that or excuse me -- this quarter over the previous quarter. But I do really like what our selling forces are doing and how we are expanding our access and capabilities market. I am certain that, that had a contributing factor to the kinds of performance that we had in this Q2.

Okay, so if we think in terms of seasonality and run rates would it be fair if we think about the back half take the second quarter and just assume a normal kind of seasonal builds consistent with the patterns?

Yeah, I don’t see any reason why our second half which is traditionally the stronger of the two halves should continue that trend. If you look at what's happened over the last three years, I mean it is 12 quarters in a row now of double-digit growth with a market that has typically grown between mid to upper single-digits, I think we have demonstrated a pretty good track record so far as meaningfully outperforming the growth rates of the markets that we serve. We are excited by the fact that our residential construction came in at very high single-digits. I think it was almost 10% for the last couple of quarters. So, as you know lighting for new construction tends to lag so that new construction opportunity we think is robust and we continue to drive renovation opportunities in our business. So, Chris I would say absolutely that the historical trends nothing that we can see right now that would suggest that those things should be questioned.

Okay, and then more granular one on the Juno run rates, how is the channel normalization process going. I think you expected a bit of pause in their run rates as you kind of reconciled their business into yours, how do we think about the headline number you have bought it at and what the early stages will be, do you still expect to grow there?

Yes, we do. And so in fact we expect the growth to be robust and positive. What we did is we transitioned their C&I sales force to the Acuity C&I sales force, so that was a huge undertaking for which the Juno associates did just an absolutely marvelous job. And so, we believe that virtually every incidence it was upgraded to their C&I sales force. And so when you do that you have a disruption. When you have a disruption it usually creates problems within the specification cycle which as you all know can be 60 to 180 days. And so, you tend to see a lag and as I said in my prepared remarks we made the conversions very quickly, the teams did an outstanding job that is virtually behind us. And so the court activity that we are now seeing for Juno through the new selling forces in that C&I world are robustly up. And so, we are pretty excited about what that will mean in the future. Is it going to translate into a superior growth next quarter, I would say that is probably a bit premature but it will translate into growth both on projects as well as through stock inflow, as well as through various end verticals like residential, corporate accounts. So we’re expecting the Juno team and the Acuity teams to really make hay in their end markets as we combine the businesses. And understand that there was overlap of product. Some of our products will be rebranded Juno and some of Juno’s products will be rebranded into some of the Acuity brands so that we can really optimize how we are selling those products to end customers. That process still is ongoing but as I pointed out earlier we are much further ahead given our own aggressive internal integration plan. So we’re pretty excited with the entire Juno team now being part of the Acuity team means for our customers and our shareholders.

Well happy hay making, congrats.

Thank you.

Thank you. The next question is from Jamie [ph] of CLSA. Sir, your line is open.

Thanks, good morning. I wanted to ask you about pricing you made some commentary around price mix being 1% headwind in the quarter which seems very consisting with the trends we have seen in the past year or so. I am wondering if you’re seeing any change in terms of the average selling price of your products on the LED side and how that relates to the declining raw material cost?

Sure, as we pointed out in our prepared remarks we continue to see price mix impact our top line about a point. And we believe while it is impossible to precisely determine the difference between price, product, and channel mix we believe that the majority of that was pricing due to LED luminaires and their prices continuing to come down as component cost come down. And so as you know the math around that, if we are able to maintain our overall profitability and the declining price improves our margin so, our view is that there has been no real change in the trend, there has been no real change in how the competitors out there, it’s a big business from most of what we do. And so we’re competing everyday and I don’t know that we’ve seen any meaningful change in how our competitors compete. So I would say that it is still kind of more the same at this point.

Okay and when you look at your margin expansion in the quarter, the gross margin level is that price material cost gap significant contributor to the margin expansion you saw in the quarter?

I would say no. I think that typically it is not a huge amount but I would say where most of our gains have come from have been driven by us continuing to drive productivity throughout our supply chain. Us continuing to focus very aggressively on input cost and to a degree you have sometimes FX that influences that. But I think that overall we continue to manage our overall supply chain well. We’re able to handle the incremental volume without having to meaningfully increase our supply chain spending. So the variable contribution that comes off of that is quite favorable. I would say that as we price product into the marketplace that hasn’t materially changed in terms of the trend that you have seen over the last several quarters. We continue to introduce new product and new solutions specs that are similar from Tier 3 which has the influence and the positive influence of maintaining and or improving on our margins. So you are seeing a little bit of that. But again it’s off a small base. So I would say that the predominant reason for margin improvement is our supply chains capability to handle increasing volume without adding a lot of cost or ability to manage our input cost and then to a lesser degree the mix.

Thanks very much.

Thank you and the last question is from Rich Kwas with Wells Fargo Securities. Your line is open.

Hi, good morning. Nice work. I wanted to just Vern ask about the on the margin side as a follow up to Chris' question around later in the year as we move forward with normal seasonality. So mid 30s on incremental for core that would seem to imply that the Juno Distech volumes coming in the mid teens on an incremental margin basis, as we think about the next few quarters, I know there is variability in mix and what not with the legacy business but how should we think about that mid 30s holding and that mid teens incremental for the acquired revenue is getting better, it seems like you are ahead of schedule in some of the integration so seemed like there is some potential that goes higher over the balance of the year but just curious to get your thought?

Sure, you could look at it in two ways. We try to provide insight because we know that whenever you make acquisitions that are meaningful it can distort historical comparisons. So we try to provide with the legacy business what that variable contribution margin looks like and in contrast kind of what you know our target is, our near term target. Ultimately we want our variable contribution margins to be much higher than what they are, right. That’s what we get paid to do, delivering very high variable contribution margin. But we are in an investing mode here in the near-term and have been for a while. So that’s why trying to get people to understand why mid to upper 20s for the legacy business is important. When you add the acquisitions there is nothing in the prior period so you’re seeing essentially that P&L down to operating profit flow through as the variable contribution, there is nothing to leverage it. Having said all of that, our feeling is that we will continue to drive the efficiencies, the productivity throughout not only our core business but the acquisitions. It is going to be very difficult as we get into probably the fourth quarter and then into 2017. We won't really talk about what's the legacy business versus the other businesses because Juno will be just part of the whole team. And we’re doing lots of different things as I have mentioned earlier, products that Juno sold under the Juno brand. Probably will fit in other brands better within the current Acuity portfolio or the legacy portfolio and a number of the products that were in the legacy portfolio are going to fit much better under the Juno brand. So our ability to sort of track and provide what variable contribution is going to be by the separate entities I think will become clouded. And so we’ll do the best we can in the shorter term. And therefore that pushes you to look at the overall consolidated here is what the sales growth was, here is what the operating profit contribution. I am not trying to break it out by was it Distech, was it Juno, was it Acuity because they are all we are investing heavily to create these Tier 3 solutions that bring all of the capabilities of the acquisitions that we brought together. So if you do that this quarter I believe that you’ll see about a 25% variable contribution margin and that's probably a better way to look at it because we will drive productivity improvements throughout the entire business and that includes all of the businesses that we recently acquired and those teams are excited about it. Because they want to take some of that variable contribution and reinvest it back in the business for superior growth. So I like the notion of saying let's look at the whole thing and then therefore as you think about our volume going forward and our abilities to continue to outperform the markets we grow I think it gives you a pretty good opportunity to test your models and test how well we’re performing.

So it sounds like you are pretty comfortable on in all in basis in the mid 20s and maybe there is some potential for upside but it kind of just puts and takes so played out?

And again, Ricky please join in here but we’re looking at very short-term investment opportunities, I am talking about what does it look like over the next 12 months. Where we need capabilities we’re adding that capability because we see longer-term growth potential. The install base of buildings for building management systems, for lighting systems, and to create that unified capability is just huge and people will invest if they can get paybacks around energy and or get more value out of this space, out of the Internet of Things. So we see just on a longer term basis a lot of growth and the variable contribution margins of that growth in the future we think will be meaningfully higher than what we are guiding to in the shorter term.

And I would just to pile on a bit, as we continue to build out the solution for capability and then start selling that a fair amount of that not all of it, but a fair amount of that is really software. Once you have developed a software, you have developed the analytics, you have developed the visualization of those analytics to convert it into information that facility managers and customers can now use to make their businesses better. The incremental margins get very attractive. Now we’re building all of those so we’re having a fair amount of investments as we’re calling it in SG&A as we are building out that capability. But once we have more of that in the market place selling and then the repeat sales and the recurring revenue off of it that should be a good driver towards the ability to drive those incremental margins on top of the other items Vern talked about.

Okay, that’s helpful and just a quick follow up on more broadly speaking around on the non res new construction site. You know we were hearing that some projects on the institutional side that had previously been shelved for funding purposes, funding reasons and what not have start to come to fruition, I am just curious in terms of what you’re seeing on the quoting side if you are seeing something similar on the institutional side of your business at this point?

No, overall quote rates continue to be favorable activity. As we pointed out a number of different indicators give us reason for enthusiasm. Again the construction numbers that for a construction put in place for Q1 and Q2 on the non resi side we are in the middle of 9% growth range, that’s very favorable. Resi up 11%, 12%, 13% depending on which quarter you’re looking at, again year-over-year very favorable. So when someone says a project I have put on hold, sure you can pick a project but I think when you look at the broad, broad industry in North America which is what we do, we’re not -- I can't really comment on any given project or a trend because that’s not anything that we’ve seen. We see more favorability in the broad trends than commenting on whether a project or two got put on hold.

Okay, that’s helpful. Thank you.

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

Everyone 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. Our future is very bright. And thank you for your support. Good bye.

And that concludes today’s call. Thank you for your participation. You may now disconnect.