Acuity Brands, Inc. (AYI) Q1 2017 Earnings Report, Transcript and Summary

Good morning and welcome to Acuity Brands Fiscal 2017 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 and good morning. With me today to discuss our fiscal 2017 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 at our website at acuitybrands.com. I would like to remind everyone that during this call, we may make projections or forward-looking statements regarding future events or future financial performance of the Company. Such statements involve risks and uncertainties such that actual results may differ materially. Please refer to our most recent 10-K and 10-Q SEC filings 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 the call over to Vern Nagel.

Thank you, Dan. Good morning to everyone. Ricky and I would like to make a few comments and then we'll answer your questions. First, let me say we are pleased with our results for the first quarter of 2017 given market conditions. Net sales were up 16% while diluted earnings per share grew almost 19% both first quarter records. In fact, this was the 15th quarter in a row where we achieved double digit volume growth, remarkable achievement that few companies can claim. We believe these results are yet again strong evidence of our strategies to deliver superior returns to shareholders, provide customers with differentiated value-added solutions and diversify the end markets we serve are succeeding allowing us to expand our leadership position. We achieved record profits for the first quarter even as we continued to invest in areas to support our strong sales growth as well as opportunities for the significant future growth potential, including the aggressive introduction, innovative energy efficient lighting and building management solutions portfolio as well as the expansion of our Internet of Things software platform. 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 first quarter of 2017. Net sales were up, first quarter record of $851 million, an increase of 16% compared with the year ago period. Reported operating profit was 126.6 million compared with a 112.4 million in the year ago period. Reported diluted earnings per share was a $1.86, a first quarter record compared with the $1.57 in the year ago period. There were adjustments in both quarters for certain special items as well as certain add backs in order to make our results comparable between periods as Ricky will explain later in the call. In adding back these items, one can see adjusted operating profit for the first quarter of 2017 was $143.2 million compared with adjusted operating profit of $125.9 million in the year ago period, an increase of 14%. Adjusted operating profit margin was 16.8%, a decrease of 30 basis points compared with the prior year. Adjusted diluted earnings per share was $2, up 13% from the year ago period. We closed the quarter with $451 million of cash on hand leaving us with plenty of financial firepower to execute our growth strategies. While our results for the quarter were solid improvements over the year ago period despite weak demand in the quarter. We would like to provide you with more color on our results for the quarter. While net sales grew 16% compared with the year ago period, we estimate that sales value from our legacy business grew by a strong 10%. The addition of Juno increased net sales another nine points while changes in price mix and foreign currency reduced net sales by approximately two points and one point respectively. While it is not possible to precisely determine the separate impact of price mix changes on net sales, we believe the difference was primarily due to changes in the mix of products sold and to a lesser degree lower pricing on like kind LED luminaires between periods reflecting a decline in certain component cost for these products. Next point is important, while the increase in net sales was broad based along most product lines and sales channels, we anticipated and planned for a greater growth in the quarter. Demand softened in the back half of the quarter particularly for smaller projects, apparently due to what many of our customers are telling us, the election jitters, and to a much lesser degree delays in certain larger projects due to more pronounced labor shortages at contractors in certain areas. To add a bit more color on this while available market data does not lineup perfectly with our quarters, we've recent information from organizations including U.S. Census Bureau and NIMA which suggests construction put in place for September and October were very sluggish while shipments of lighting fixtures were actually flat to slightly down in the third calendar quarter. Nonetheless, we were still able to grow our legacy business by 10% far outpacing the growth of the overall lighting industry. While we expect some of these market conditions to carry over into our second quarter, we also expect demand to improve as elections concern subside particularly for smaller projects which generally have short lead times compared with larger projects. I will comment on our expectations for the balance of 2017 later in the call. Sales of LED products grew robustly this quarter and now account for two thirds of our total net sales which as you know includes the sale of non-fixture related products and solutions as well. Lastly, we believe our channel and product diversification as well as our strategies to better serve customers with new more innovated and holistic lighting and building management 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 in a few strategic accomplishments. Our profitability measures for the first quarter were solid but somewhat disappointing for us. Our adjusted first quarter operating profit was a $143.2 million, the third highest in our history while adjusted operating profit margin for the quarter was 16.8%, down 30 basis points from the adjusted margin in the year ago period. Adjusted gross profit increased $41.2 million with 13% this quarter over the year ago period primarily due to the increase in net sales, lower component cost and productivity improvements primarily from previously announced streamlining actions. This was partially offset by higher manufacturing cost primarily related to short-term production challenges mostly related to new product introductions and product transfers, a rising quality cost and expected increases in certain hourly employee wages and benefits. Our adjusted gross profit margin for the quarter was 42.4%, down a 100 basis points compared with the year ago period, and well below our potential. The decline in our adjusted gross profit margin was primarily due to less than anticipated variable contribution margin, caused by weaker than expected net sales volume this quarter, and to a lesser degree of the impact of the other items noted above. Another way to say this, as we carried a higher manufacturing cost structure into the quarter in anticipation of servicing a higher level of demand and actually occurred, we are in the process of aligning our supply chain cost structure to meet current demand as well as enhancing the execution of certain new product introductions. Next, adjusted SD&A expenses were up $23.9 million or 12%. The increase in SD&A expense was primarily due to higher freight and commission costs to support the increase in net sales, the inclusion of acquisitions and the continued investment in addition of headcount to support and drive our tired solutions strategy. This was partially offset by a lower incentive compensation expense, as our period-over-period improvement on our key metrics as part of our pay for performance culture resulted in a much lower potential payout than the year ago period. Adjusted SD&A expenses as a percentage of net sales were 25.6% in the current quarter, a decrease of 80 basis points from the year ago period. Excluding the impact of acquisitions, our variable contribution margin as a percentage of net sales was approximately 20% below our current annual target of mid to upper 20s primarily due to the impact of less than anticipated net sales and to a lesser degree, the continued investment and additional headcount to support our Tier 3 and Tier 4 solutions partially offset by less variable incentive compensation expense. All-in all we had a solid quarter given market conditions. On the strategic front, we continue to make great strives setting the stage for what we believe will be a strong growth and profitability in 2017 and beyond. We continued our rapid pace of introducing new products and solutions, expanding our industry-leading portfolio of innovative energy-efficient luminaires and lighting controls, as well as our building management platform. While the rapid rate of new product introductions is hugely positive for our long-term growth potential, it did put some strain and added cost on our supply chain mostly around component sourcing and production start up issues for those products. Much of this growth in our portfolio has been driven by the expansion of our digital lighting solutions portfolio including controls that support building management system and our and IoT software platform, as innovation continues to be at the forefront of our strategy. Additionally, we continue to invest in and expand our capabilities to drive our integrated tiered solutions strategies which consist of four tier levels. As we have noted before, the purpose of this strategy is to leverage our incredibly diverse and growing portfolio by offering customers lighting, building management and IoT solutions that best meet their needs. These solutions are compelling and powerful value prepositions for customers and true competitive advantage for Acuity. 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 40% again this quarter, and now represent more than 12% of our total sales. Furthermore, our Tier 3 solutions can be enabled to collect data and to support connectivity to the Internet of Things affording Acuity additional recurring revenue streams which we identify as Tier 4 solutions. To fully execute our holistic tiered solution strategy, we have continued to hone our organizational 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 have added enormous capabilities over the last year including our recent acquisitions, as well as increased salary headcount to support the growth as part of this overall tiered solutions strategy. In fact, our salaried headcount including acquisitions is up almost 700 associates or over 30% from one year earlier. Few of our competitors, if any have been able to make this kind of investment while delivering upper cortile financial performance like Acuity. At Acuity, we are not just talking Internet of Things, we are actually doing it. As of the end of the quarter, we have converted almost 40 million square feet of space for customers including leading global retailers and certain other customers to a smart lighting solutions infrastructure. This digital lighting infrastructure is connected to the Acuity IoT software platform which allows our customers to deploy indoor positioning solutions including way finding, asset tracking and geospatial analytics. As part of their smart lighting platform, we have approximately 700,000 maintenance free LED light enabled beacon that are performing superbly, collecting data and enabling applications that provide users with superior lighting and energy performance as well as useful actionable information while providing Acuity with their recurring Q4 revenues stream. Importantly, we expect the installed base of these smart lighting solutions to meaningfully expand by the end of calendar 2017. We believe this level of capability and employment continues to be unmatched in our industry. Further, we expect that our recent strategic acquisitions coupled with our aggressive internal investments will allow us to continue to deliver and strengthen our foundation and further serve as a robust platform for 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 now almost 12,000 associates who are maniacally focused on serving, solving and supporting needs of our customers. I’ll talk more about our future gross 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 the balance of 2017. Ricky?

Thank you, Vern, and good morning everyone. As Vern noted, we had a solid first quarter performance. I will add insight to our financial performance and not repeat the information already provided by Vern. As Vern mentioned earlier, we had some adjustments to the GAAP results in fiscal 2017 and 2016 which we find useful to add back in order for the results to be comparable. In our earnings release, we provide a detailed reconciliation of non-GAAP measures. Primarily, due to the impact of the four acquisitions completed in fiscal year 2016, we experienced noticeable increases in amortization of acquired intangible assets, share-based compensation expense since we used restricted stock as a tool to improve retention and to align the interests of key leaders of acquired businesses with those of the shareholders. Acquisition related cost including profit at inventory and professional fees, special charges and manufacturing inefficiencies because we streamlined and integrated recent acquisitions and gain on the sale of investment in a non-consolidated affiliate. We believe adjustments for these items and providing these non-GAAP measures provide greater comp ability and enhance visibility into our results of operations. We think you will find this transparency very helpful in your analysis of our performance. In addition, many of our peer companies especially as we become more of a technology company make these same adjustments. So, it will help as you compare our performance to other public companies in our industry. During the first quarter of fiscal 2017, the Company recorded a modest pretax special charge of $1.2 million as we complete the previously announced actions initiated to streamline the organization, including the integration of recent acquisitions. These streamlining activities included the consolidation of selected production activities and realignment of certain responsibilities primarily within various selling, distribution and administrative departments. We realized net savings of approximately $5 million in the first quarter of fiscal year 2017 and expect to achieve annual savings of almost twice the amount of the cumulative special charge or approximately $25 million, and we believe will be at this run rate by the end of the second quarter of fiscal year 2017. We are reinvesting these savings in additional headcount to support and drive our tiered solutions strategy. We anticipate incurring additional cost associated with further integration activities of recent acquisitions later in fiscal year 2017, although the amount and exact timing has not yet been determined. The effective tax rate for the first quarter was 35.3% compared with 35% in the first quarter of last year. We expect the effective tax rate for fiscal year 2017 to once again be 35.5% before any discrete items and if the rates in our taxing jurisdictions remain generally consistent throughout the year. Our operating working capital defined as receivables plus inventory less payables at November 30, 2016 increased to 45 days compared with 32 days in the prior year. This increase was due primarily to more stocking of faster moving items to improve delivery service and greater receivables due to timing of shipments. In the first quarter of fiscal year 2017, we spent $19.5 million on capital expenditures, compared with 23.1 million in the prior year. This decrease in capital expenditures is primarily due to reduce spending on facility enhancements, as the prior year included expansions in our electronic and panning capacity and the build out of our innovation and technology center and a new production facility. We currently expect to spend approximately 2.5% of revenues in capital expenditures is fiscal year 2017. At November 30, 2016, we had a cash and cash equivalent balance of $451.2 million, an increase of $38 million since August 31, 2016. This increase was due primarily the greater net income, lower capital expenditures and proceeds from sale of assets and investments partially offset by increases in working capital and payment of dividends. Our total debt outstanding was $356 million at November 30, 2016. We had more cash than debt at November 30, 2016. We also had additional borrowing capacity of $243.9 million under our credit facility which does not expire until August 2019. We clearly enjoyed significant financial strength and flexibility and will continue to see the best use of our strong cash generation to enhance shareholder value. Thank you and I’ll now turn 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 for Acuity. Now, we provided explanations for our first quarter performance, we would like to be very clear on our key assumptions going forward. While we do not give financial guidance, we hope the following will help you better understand our current assumptions. It is reasonably clear that the end markets we serve in North America and certain markets we serve in Europe this quarter moved along at a slower and more in consistent pace than in previous quarters. Many of our end customers and for this year’s election -- this year’s Presidential Election in the U.S. and certain political events in Europe created uncertainty and volatility over the last several months. We believe this uncertainty and volatility negatively impacted demand particularly for certain smaller projects, which have shortly timed and to a lesser degree residential construction. Additionally, we were told that labor shortages in certain markets cause delays in larger projects. How much all of this directly impacted our shipments this quarter difficult to precisely quantify, but we clearly anticipate a greater shipment in the quarter then actually occurred. This notwithstanding, we remained bullish regarding the Company’s prospects for continued profitable growth. We believe, the softness and demand, over the last quarter or so was due to temporary circumstances, some of which could potentially linger into second quarter. However, it seems the long-term fundamental drivers of the markets we serve are still positive and intact. Therefore, as we noted in our last 10-K, we still expect to broaden markets that we serve in North America which represents 97% of our total net sales will grow in the mid to upper single digit range in fiscal 2017. We continue to see signs that give us optimism regarding the future growth of that markets we serve in our business. Leading indicators for the North America market such as architectural building index, vacancy rates, office absorption, lending availability and favorable employment trends continue to improve that varying paces. Forecast from independent third parties continue to project positive growth rates for the residential and non-residential constructions markets in our fiscal 2017. So, key assumption number one is positive growth for the key markets we serve in our fiscal 2017. Key assumption number 2, excluding the price of certain LED component which are expected to continue to decline and steel costs which have risen recently, we do not anticipate significant changes in other material and component cost over the next 12 months. We expect to offset the impact of rising steel prices through certain pricing initiatives and product cost reductions. 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. Also, we continue to be leery at foreign currency exchange rate fluctuations which are always unpredictable. Key assumption number three, while the gross profit margins influenced by a number of factors including sales volume, innovation and price and product and sales channel mix, we expect our annual gross profit margin to improve overtime as volume grows and as we realized typical gains in manufacturing efficiencies including cost savings related to recent acquisitions and new product introductions. We continue to target a current variable contribution margin on an incremental dollar sale in the mid to upper 20% range over the course of fiscal 2017, knowing that it is not possible to predict with precision what the rate will be by quarter. Key assumption number four, our adjusted SDA expenses or percentages of sales was 25.6% this quarter. This is below our recent trend primarily due to much lower incentive compensation expense due to lower year-over-year financial performance improvement. Trust me, we are motivated to drive strong period over period growth which is at the core of our pay for performance culture, which would result in much higher incentive compensation expense. This means, we expect our adjusted SDA expenses or percentage of net sales to be closer to our historical trend, assuming markets rebound, and we continue to meaningfully outpace the growth rates of the markets we serve. This further assumes, we execute as we have in the past regarding our supply chain performance and are able to move gross margins toward our historical trend. This would suggest that our variable contribution margin over the back half of the year will be higher than our target noted above. So, to be very clear, our key assumptions for additional top line growth driven primarily by stronger market dynamics and better internal execution within our supply chain; lastly and most importantly, to add to the point on the top line growth above, we expect our overall growth rate 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 two and three or four holistic lighting, building management and IoT platform solutions. We continue to experience strong interest from many of our key customers for our holistic solutions with these capabilities and more. We have meaningfully expanded number of pilot tests with customers as well as garnered strong interest in new prospects. As we have noted in our last several conference calls, the implementation of our integrated tiered solution 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 our acquisitions of eldoLED, Distech, Geometri and DGLogik, which we believe will allow us to continue to meaningfully expand our addressable market and add significantly greater broad-based holistic solutions allowing customers to optimize the performance of their facilities. As we noted earlier while we are very early in this game, we are seeing positive results in growth rates for our Tier three and Tier four categories as well as the implementation of our IoT platform solutions. One last point on current market dynamics, the election process in the U.S. has produced a great deal of rhetoric and debate regarding a wide range of policy options with respect to monetary, regulatory tax and trade amongst others that may be pursued by the new administration. Any policy changes implemented could have a positive or negative consequence on our financial performance depending on how they influence many factors, including business and consumer sentiment. While we are proactively identifying an evaluated potential contingency option under various policy scenarios, we believe it is just too early to speculate which policy options will win the day and how they'll be enacted. We will monitor the situation closely and work with our many points of contact to make sure our government officials understand how certain policies could impact the stakeholders of our company and our industry. As such, it is just too early for us to comment or speculate at this time on the potential ramification of these endless scenarios. We'll comment when it becomes clear. Our companywide strategy is straight forward, expand and leverage our industry leading product and solutions portfolio, couple with our extensive market presence and our considerable financial strength to capitalize on market growth opportunities that'll provide our customers with unmatched value and our shareholders with superior returns. This all takes focus and resource, we're investing to enhance and expand our core competencies to excel in our fast changing industry because we see great future opportunities. Through these investments, we've significantly expanded our addressable market, our strong growth record supports this view. As I've said before we believe the lighting and lighting related industry as well as the building management systems market will experience significant growth over the next decade because of continued opportunities for new construction and more importantly the conversion of the installed base which is enormous in size to more efficient and effective solutions. We believe this is particularly compelling as energy and environmental concerns continue to come to the forefront along with the merging opportunities for digital lighting to play a key role in the Internet of Things. We continue to believe many markets we serve is part of the broader lighting and building management industries, some of which could grow by 50% or more over the next few years, will provide us with significant growth potential. As the market leader in lighting solutions and a technology leader in building automation we're positioned well to fully participate in these exciting and growing industries. Thank you, and with that, we'll entertain any questions that you have.

[Operator Instructions] The first question comes from Tim Wojs from Baird. Your line is open.

I guess just maybe could you just add a little bit of color, Vern, just on maybe what you are seeing from a quoting perspective that gives you confidence that just some of the slower trends you have seen are more temporary?

If you look at, if we separate our business between larger type projects and smaller type projects, what we saw the follow up in frankly, and it was precipitous was in the smaller projects side of the world. Frankly, it just went flat, and truthfully, if you look at the NIMA data around lighting and we just received this data, just a little while ago for the calendar year of third quarter, the shipment of light fixtures and NIMA participants was actually negative for the third calendar quarter. We believe that this carried into our, if you'll fourth quarter, and it's just -- it was very-very interesting to us. So, our quote rate was fine until we've kind of got into the middle part of our fourth quarter and the quote rate for those smaller projects went just flat. For larger projects the quote rate continues to be very favorable and you might imagine why, right, because those things have a long lead time. Small projects could be influenced by sentiment very-very quickly. And we heard from a number of different customer constituencies whether it's electrical distributors or whether it's contractors, that the marketplace people were just jittery. And why were they jittery? It's very difficult for us to say. I believe that we've seen this two years ago, we saw it four years ago and we saw the market rebound. So, I will tell you that the things that we see both in our quote rates not necessarily rebounding yet for the smaller projects but the larger projects continue to be robust but all of the key longer term drivers that drive our business continue to flash positive signs. So while many of you did channel checks it was just interesting to us, we saw something fairly different than that and actually experienced from customer visit, something that was different in that. So, our view is that while there may be some lingering impact coming into our Q2, because that is essentially December, January; our expectations that the markets will continue to rebound as people get past these things and move back to business. The value prepositions that we have that our available on compelling in terms of paybacks, and so I think businesses are going to get back to business as usual. I also believe that there is a favorable carryover from the election in terms within the business community where I think business leaders are going to be more favorable; so, our expectation is that, we will see this rebound particularly on the smaller project side, and as we continue to introduce new products.

Great. That's helpful. Then just on the incremental margins, should we think of maybe fiscal Q1 as being a low point and that variable contribution margin accelerating through the year as volumes come back?

The answer is yes. I mean quite frankly, our first quarter the variable contribution margins were impacted by two things. First, in order of magnitude, just simply the lack of shipments, I mean our expectations were and we our supply chain was ready to deliver against much stronger growth. We're very pleased with the fact that our legacy business grew 10% against the back drop of what arguably was a flat environment. Obviously, we don’t have NIMA data and won't have NIMA data on the fourth calendar quarter until probably what late January would be my guess, but I'm quite certain we're going to see flattish environment. So, our contribution margin was influence by the lack of volume, sales volume coming through, and then to a lesser degree just some issues that we had within the supply chain different than the issues that we have in the fourth quarter. I mean more because of new product introductions and some product transfers that we just continue to struggle with to absorb those into the facilities where they went. I believe that those are temporary situations will have to address than we are addressing them very aggressively it has been. Our supply chain capabilities have been the hallmark of what we are really good at, so I believe that those two are temporary so they are still I think have some carryover to Q2. So, an answer to your question, our expectation is that our variable contribution margin will get back to the annual target that we have for 2017 and most likely assuming as I pointed out that the markets particularly over the smaller projects come back and we continue to gain share as we have for a long time, we should enjoy the benefits of that volume and we should see more efficient productions of that products, partially offset by an increase in incentive compensation expense as we improve our year-over-year performance and drive greater incentive compensation.

The next question comes from Brian Lee from Goldman Sachs. Your line is open.

I guess first off Verne. I wanted to ask on, if you could maybe give us a bit more quantification around some of the temporary disturbances you are talking about. Last quarter you guys pointed to a $25 million pretty precise top-line impact due to the one-time issues. Can you do something similar for this quarter, maybe even Q2? How would you quantify the revenue you missed out on based on some of the election jitters and labor shortage issues you mentioned in your prepared remarks?

So let me separate those let me answer the second one first. The labor issues in Q4 of last year, we believe that we resolve those, we took a number of steps in terms of attracting folks we actually imply to increase some benefits and some wages not materially we absorb those this quarter we anticipated that. So the labor issues we think are behind us the issues that we experience this quarter had more to do with that we carried that labor into the quarter with the anticipation of higher volumes. You see that our finished goods inventory ticked up. I mean that's primarily because we were producing at a steady rate in anticipation off. We still believe that those orders would come back. I mean precisely when our expectation is just that over the second quarter we should start to see positive trends, what are the indicators that we have it's the longer-term indicators that I pointed to you earlier architectural billing index employment interest rates even interest rates taking up a little bit we're still historically very-very well. So, all of those things continue to give all third party forecasters, as well as customers that we serve architectural engineers lighting designers confidence that things are there. Our quoting activity on larger projects continues to be very, very positive, and that’s a very positive trend about the overall health of the industry. Projects that are short term in nature, they can move with sentiment, that’s why we comment on that type of thing. And they did. It appears that they moved fairly significantly. We think that we moved beyond that, because the indicators of broad business are favorable. When we think about the temporary disruptions in the fourth quarter, they’re very different than what we experienced here. Our fourth quarter ended August 31st, some of the NEMA data, which is just interesting to us, again for the calendar year quarter went through September 30th, showing that the markets were flat. I believe, Ricky, there are volume growth in our Q4 was what 13 to 14 points?

Right.

14, I believe. In this quarter, they were up 10. Well, we’re expecting bigger numbers than that. So where we were influenced is by the short-term stock and flow type projects. When I look at the U.S. senses bureau data around non-residential and residential and look at November on a year-over-year basis, October-September, all these numbers were somewhat weak. Though, November is now starting to show a fairly strong rebound. So, we’re trying to put all this together. We’re talking to our customers. The enthusiasm amongst our electrical contractors is still very positive, particularly for larger projects. Though, they do have some concern that labor shortages in certain markets will continue to influence just how much business they are able to take on. We don’t know right now what that exactly means. Longer term, labor, electricians, and people coming into the market, are a critical issue, and may have some impact on the overall growth rate of the industry. But right now, we’re looking at the smaller type projects and how do we get pass that. And again, our view is favorable. Though, it may linger into Q2.

And then same question just maybe a bit more of a bigger picture one. With LEDs, now two thirds of the mix, I am just curious. How do you guys think about the impacts, the mix shift has on growth potential, particularly in retrofit as some of these products have much longer lifetimes, and will push out the replacement cycle on sockets. And then maybe just related to that, whether the sustainability of the growth you’re seeing in the LED side of the business. How much of that depends on earlier gen LEDs being replaced with some on the newer Tier 3-4 solutions that you’re increasingly emphasizing? Thank you.

So the last portion of your question, first. I would say that the replacement of older LED is probably pretty nascent at this point in time. The board is quite pleased probably with what they have. So, when we think about the overall install base, we still think that the marketplace is $500 billion to $600 billion market, where outdoor is probably 10% or 11%, converted indoor is less than 5%. So, the solution sets that we are bringing into the market place, literally as we speak, whether it's nLight AIR, nLight ECLYPSE, whether it's our sub-metering capabilities, all of these things are new solutions that are directed towards primarily the huge install base. Where I see on some of these small projects, both new and renovation, we’ve sensed and we believe that people just took a break. I mean they were, for whatever reason, why this happens I don’t know. We think we saw it two years ago. We think we saw it four years ago during the political election process, where people just stopped, larger projects you can't do that, because you put in place a while ago. So, our expectation is that because of the size of the installed base, because of the solution set, because of the energy savings, which are significant; paybacks are significant and now that you add our IoT software platform on top of that, it's a very compelling value proposition in its totality. So we expect, over the longer term, marketplace to really continue to raise and absorb these types of solution sets. And others will have competing solution sets. And we want that. We want more and more people to be evangelizing proper solution sets. Unfortunately, right now, there are too many people out there that are saying they’re going to do things, and they really haven't. So, it creates a little bit of a noise out there. But in and of itself that’s not a problem over the longer term.

And I just want to comment, this is Ricky, I’ll lead it. Brian, we’ve never really participated in the replacements of lamps and ballast in the past. So the fact that LED is last a lot longer, the fixtures in the past, whether they were for S8 or HID or other forms of incandescent, the fixtures lasted a long time is well. So the conversion LED doesn’t have as much of an impact to us on that replacement cycle. The opportunity, as Vern said, is converting that install base to the more energy efficient and better quality of light than LED value proposition where it’s a great play breaking. The other thing I would say is that, while LED luminaries make-up two-thirds, may be a little bit more of our revenues today. Understand that, we sell a lot of other product, and those products are growing rapidly as well. So, the percentage of what our LED is to what our fixture portion of our business would be probably is significantly higher than the two-thirds. And the other pieces of the business continue to grow nicely, lighting controls as well as building management controls, and now our IoT software platform.

The next question comes from Christopher Glynn from Oppenheimer. Your line is open.

I’m interested in the significant headcount expansion last year. And I believe that to be a reflection on how you see the breadth of the Tier 3 projects moving from germination stages into real momentum during fiscal ‘17. Can you update on that overall process and conviction that those investments drive the acceleration in territory in the visibility there?

Sure. First off, as we pointed out in our comments, our Tier 3 solution-set, again grew 40% this quarter over the year ago period. So, that’s very, very robust. And it now represents about 12% of our total business. So, obviously, these solution sets are being received very favorably by the market. And so we continue to see opportunities to invest there. Our software technology group and our IT platform growth now consist of north of 140 people that’s where most of our investment is being going. These are engineering folks of various types. So when we look at our salary headcount on a year-over-year basis, like I said, we’re up about 700 folks. The bulk of that is through acquisitions, the acquisition of Juno, as well as DGLogik, Geometri, for example. If I look at what we’ve been doing over the last quarter or two, we’ve added at a slower pace. I mean, if I go back to say the May quarter, we’ve added probably in the neighborhood of 30 folks on the salaried side. But if we look at, just picking last May, we go back to last May, we’ve added probably close to 15% on the hourly side. And again, that add was primarily due to expected continued growth. We did get growth. We got 10% growth on our core legacy business. So that was very, very favorable given market conditions. But it was clear that we had anticipated and planned for more. So, you didn’t ask about the hourly headcount, but I wanted to provide that color. The Tier 3 solution set, we’re very optimistic and we are rolling out, again starting last quarter where we introduced nLight Air, nLight ECLYPSE, those products are now being specified into the marketplace. We’re very excited about those. We’re introducing some new products this quarter that will target the commercial office market in terms of renovation, which is really an untapped market at this point in time. Ricky pointed out early, most of that was being service by people changing out lamps, which we think are very inefficient solution given all of the other opportunities going forward. So, we’re managing our headcount growth to be very specific. We’re honing it, as Ricky mentioned earlier. We’ve taken some streamlining actions where we’ve invested in areas, so we can continue to investment in these higher growth, higher margin opportunities. We’re very excited about what we’ve been able to accomplish in the quarter on putting in Tier 3/ Tier 4 solutions sets. As I noted, we’re almost up to 40 million square-feet of these IoT oriented solutions sets, which is really, really robust. And the enthusiasm around that continues to be very, very strong. And I would also say that, don’t take it lightly that someone has been able to now implement near 40 million take it lightly that someone has been able to now implement near 40 million square-feet of these IoT enabled solutions; the learning curve and the ability to do that is really hard, and we really good at it and getting better at it every day. So this is what gives us optimism about 2017, and the customers that we're engaging, the breadth of customers that we're engaging is increasing at very-very rapid pace. So we're very optimistic about Tier 3 and Tier 4 as we go forward.

And then could you give the current estimates on LED energy savings, or the payback time period, and then also an update on the status of the share repurchase authorization?

Chris, you're only supposed to get two questions, I think you just lit in one more, but anyway. Ricky, why don't you go ahead and talk about share authorization, and I'll take the other one.

On the share authorization we have 2 million, share authorization the Board has out for quite a while. We've only repurchased a minimal amount as you saw in this quarter under that. So we've got plenty of firepower, or firepower, if that's not the right word, but the buyback shares.

And, Chris, I would say on the paybacks, again, as LED -- prices of LED luminaries, many of you focus on that, that's not really the big issue. It's as we continue to proliferate different capabilities of LED luminaries, in other words a good, better, best solution scenario. As those prices become more interesting to customers, we think that that increases the opportunity for payback. And it depends on cost of energy. As you might imagine, some areas where the cost of energy is $0.20 a KWH, the paybacks are very short. Those areas are also expensive labor areas to actually do the install. But they also have incentives to do that. So I think that paybacks are continuing to improve. And as a result, I think that customers, again, this is where small projects as well as medium sized projects are very important. Customers are listening to these types of solution sets. They just think that they took a hiatus last quarter because of the jitters that we saw. So, we see paybacks continuing to improve. We see solutions that are not just based on energy paybacks but now have IoT capabilities that are providing even more, if you will, payback opportunities because of value in addition to energy.

The next question coming from Mr. John Walsh from Vertical Research, your line is open.

So, I had a question, we won't get any numbers around some of the potential policy changes. But just wanted to know if there's additional capacity in any of your U.S. manufacturing facilities, or the ability to add capacity? And then maybe just the idea of what it actually costs to set-up a factory, same policy does go into effect.

So, let me just take a brief stab, and then I'm going to turn it over to Ricky. We have a very strong U.S. manufacturing capability. And the difficulty in all of these scenarios is who knows which one. But what we are thinking through is how we, under different scenarios, would leverage our U.S. capabilities. We are looking, as Ricky pointed out, we're targeting about 2.5% cap of sales CapEx investment this year. Some of that investment may find its way into different locations, if it was probably going to anyway. We like to do a lot of our own painting of our materials as we have moved product around. We have actually had to incur, both expediting of component cost outside processing for painting, just as an example. These are some of the inefficiencies that flowed through this quarter. So, as we think about our future investments and our future supply chain capabilities, we may actually adjust some of the locations, and just how we may make some of those investments. So instead of putting in a large paint system as we did in Guadalupe, Mexico to support our growth, we actually have been thinking about more micro-paint systems in different areas really to provide much more speed to the market and much more flexibility. So these are the kinds of things that we would consider to help facilitate, whatever changes may occur, so that we can really serve our customers in a much more efficient way. So, while we may have to do certain things, we're optimistic overall about what the positive business trends could be. So, I'm not as nervous about that. We're thinking through those. But Ricky maybe you might want to comment on the rest.

On the facilities, we do have excess capacity as you might appreciate, with the acquisitions we made that gives us opportunity to consolidate and integrate even though we've done some of that already. We do have excess capacity. We also have ability in distribution centers where we do light assembly, and in some cases do more heavy manufacturing that we can expand at there. And there's opportunity within our supply base to source more of that domestically dependant on how all of the regulations as Vern said, it's just too many options to speculate. Rest assured, we're looking at almost all of those and planning our contingencies around them. And when it becomes clearer, we can provide better clarity.

And then just a quick one here, do you -- can you provide what kind of volume growth you were actually expecting in the quarter?

Well, I believe that some of the consensus forecasts for top line were not outside of our realm of expectation. I think for folks, this is a hint, to look at our growth in finished goods, probably is a reflection of what we were expecting. And now that's at the cost level. And so you can then do your own math from there. I believe that the lack of demand probably was 100 basis points hit on our gross profit margin, not just a guess, in some of the inefficiencies that we had probably added another 50-60 basis points. But that's all speculation at this point in time. We know what our actual results were. We know what we were anticipating. And so we're now aligning our supply chain structure against current demand. Here's the point that I would make to everybody. Current demand is both what the market is plus what we believe we could grow beyond the market. We have had a long track record of outperforming the market. This quarter was no different. We guess the market was flattish, and yet we were able to grow our core business 10%, as a pretty robust performance relative to the market. So, as you know, we have experienced larger organic growth, volume growth, in previous quarters. So, we were probably more akin to that than what we actually experienced.

The next question comes from Vishal Shah from Deutsche Bank. Your line is open.

Wouldn’t the retrofit market, you guys have introduced some spec cycle products recently. Can you talk about the feedback you're getting from real customers on those products? And also, have you -- can you talk about what Tier 3, Tier 4 segment would look like as a percentage of mix, exiting 2017? Thank you.

So, first off the response from customers and understand that many of these products are spec oriented products, so they go into larger projects. So, the introduction of those products have been the architects, engineers, lighting designers, and the solution sets and the way they have examined and the way they feel about what the features and benefits can be, has been very-very positive. So, it's a spec cycle. These things have to get spec-ed in, and that's how they'll probably ramp-up over the next 120 to 180 days, kind of thing. Some of the products that we've introduced are also now directed towards what we’d call the more stock and flow that renovation project that's very quick. We were seeing very positive response to that. But yet those things need to translate into orders that then flow through the system. So, our second quarter, we are expecting that we will see the ramp-up of those products and those solution sets, more getting after untapped market as opposed to necessarily displacing other products within our portfolio. So, we're optimistic about what those products will mean for our growth. We've had good demand and good input so far. We have not specifically provided a target for Tier 3 and Tier 4 solution sets. Other than to say, we expect outsized performance and growth in those things, and we’re seeing that. So we're trying to really get our base established and then to continue to provide you with insight as of the growth in those two segments. Tier 4 revenues improved nicely. But it's off of very-very small base. And relative to our revenues, it's still very small. But yet, it's part of a broader package of solutions that we’re bringing to customers. So we're seeing larger or more significant pilot programs roll-out, we’re seeing a broader base of customers expressing deep interest, and we're expanding that customer base, in terms of our dialogue. So, again, we are very optimistic about what Tier 3 and Tier 4 look like over the next, say 1,000 days, for Acuity.

The next question comes from Cindy Motz from William Capital. Your line is open.

I just wanted to clarify, so the second quarter, you had said in the press release that it was still like a seasonally slow quarter. But just based on some of the new products and what you are mentioning in the ramp. Do you think that you’re still going to see a mid to upper single digit kind of growth in revenues there? And then just specific with the uncertainty surrounding some of the smaller projects with Trump and everything, were they worried about anything like specific, or do you think it was just the overall reaction that, I guess, a lot of us had like uncertainty and then now it's calm down? Thanks.

Cindy, the last question first, because that's one I can answer. It's just interesting to us. I mean, we’re citizens too and we watch all of this, as well as being business people. We saw it two years ago. We saw it four years ago. Why, it makes no sense to us as business people. But yet, we believe that that slowdown was real, and we’ve turned it in many geographies, in many different customer sets. And most are sometimes looking for reasons why that they are going to just delay. I believe that they are going to realize it's guide in ’12 and they’re going to get back the business as usual and they’re going to look back to hey this is a great investment, a payback that's very short and it provides operating benefits, it provides commercial benefits. So, it's a bit of a wait and see, large projects continue to move along, the quote rates are positive. We’re seeing positive activity in the precursor of those larger projects, architect, engineers, lighting designers, being busy. The smaller folks or really the smaller contractors; as they go back to their electrical distributor partners and pick-up products and take it to jobs, and then those electrical distributors replenish, that's when we’re going to know the cycle is moving back. Our expectation is that that happens. We’re waiting to see that that happens. Obviously, we’re way early in January. So we’ll wait and see on that. When it comes to giving a forecast, I just I am reluctant to go there. I will give you by way of anecdotal information. We always -- lesser revenues in Q2 relative to Q1, but in Q1, we always see lesser revenues than the Q3. And yet Q3 and Q1 revenues, Q3 from last year and Q1 revenues this year were the same. What's interesting about that is for us is that typically they would be a little less than Q1. But more importantly the difference in mix between Q3 and Q1 was a significant drop in the C&I world, which is where these small projects are. So we're actually being supportive around that. We continue to believe that we’ll see solid growth in Q2. But also remember that in Q2 we essentially have anniversary all of our acquisitions. So we’ll be back to our real year-over-year growth in terms of real volume, not just acquisition activity.

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

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

That concludes today's call. Thank you for your participation. All participants may disconnect at this time.