Acuity Brands’ (AYI) CEO Vern Nagel on Q4 2014 Results – Earnings Call Transcript

Good morning everyone. Ricky and I would like to make a few comments and then we’ll answer your questions. First, let me say we are extremely pleased with our performance in 2014. We achieved record results for net sales, diluted earnings per share and cash flow generation for both the fourth quarter and the full year.

For the full year and the fourth quarter, net sales grew 15%, which was meaningfully higher than the estimated mid single-digit growth rate for the key markets we serve. In fact, this was the sixth quarter in a row where we achieved double-digit volume growth, a meaningful accomplishment in this environment. We believe these results are yet again a strong evidence our strategies to provide our customers with differentiated value-added solutions and to diversify the end markets we serve are succeeding, allowing us to extend our leadership position in North America.

These strategies include the continued aggressive introduction of innovative, energy-efficient lighting solutions, expansion in key channels and geographies, and improvements in customer service and company-wide productivity. Our profitability and cash flow for the quarter and the full year were records for Acuity, even as we continue to fund our strong sales growth and areas with significant future growth potential, including the expansion of our solid-state luminaire and lighting controls portfolio.

I know many of you have already seen our results and Ricky will provide more detail later in the call, but I would like to make a few comments on the key highlights, first for the quarter. Net sales for the fourth quarter were a quarterly record of $669 million, an increase of over 15% compared with the year-ago period. Operating profit was $90.7 million compared with $78.2 million in the year-ago period. Operating profit margin was robust 13.6%, up 10 basis points from the year-ago period. Diluted earnings per share were a record $1.26 compared with diluted EPS of $1.03 in the year-ago period, up 22%, strong quarterly results indeed.

For the full year, net sales at Acuity were a record $2.4 billion, up almost 15% from 2013. Operating profit was $1 million shy of $300 million compared with $222 million in the year-ago period, up 35%. Adjusted operating profit was $293 million or 12.2% of net sales compared with $247 million or 11.8% of net sales in the year-ago period. Diluted EPS was $4.05 compared with $2.95 per share in 2013, up 37%, while adjusted diluted EPS was $3.97 per share compared with $3.31 in the year-ago period, up 20% from 2013.

In addition, we generated $233 million in net cash provided by operating activities this year, while funding a $55 million increase in accounts receivable due to our record sales growth. As Ricky will discuss later, we meaningfully enhanced our already strong financial position in 2014 as we now have more than $550 million of cash and cash equivalents on hand, far exceeding our debt at slightly more than $350 million.

Lastly, I’m pleased to report that we once again earned much more than our cost of capital and our cash flow return on investment was a robust 29%, the second highest in our history and far in excess of most in the electrical industry. These results for the quarter and full year were significant improvements over the year-ago periods. We believe you will find our results for the quarter and the year even more impressive upon further analysis.

While net sales for the fourth quarter grew more than 15% compared with the year-ago period, we estimate our sales volume grew almost 17%, partially offset by lower price mix and to a lesser degree the impact of foreign currency. While it’s not possible to precisely determine the separate impact of price and mix changes, we believe the difference was primarily due to lower pricing on like-kind LED luminaires between periods reflecting the decline in certain LED component costs.

The increase in net sales was broad-based along most product lines, including certain specialty fixture types more closely associated with new construction as we began to see an uptick in this important market.

From a channel perspective, we continued to experience strong growth in the commercial, industrial and infrastructure. Sales growth in our largest channel, commercial and industrial, was above this quarter’s overall percentage increase as we continue to focus on projects for new construction and renovation in both the non-residential and residential markets as well as continued emphasis on selling higher value-added lighting solutions, especially LED luminaires, where sales our LED products almost doubled again this quarter compared with the year-ago period, an extraordinary achievement when one considers that sales of LED-based luminaires now account for 40% of our total sales.

Our rate of growth for LED luminaires continues to far outpace the growth rates of our largest competitors for these types of products, demonstrating our market-leading prowess. Excluding LED luminaires, we believe the puts and takes for product pricing as well as material and component costs were again fairly benign this quarter.

Looking at market conditions for the fourth quarter, we believe the North American lighting market was up mid single-digits during the quarter supported by growth in renovation as well as the residential market. This is in stark contrast compared with the growth rate of our net sales in North America, which was up more than 15%.

Lastly, we believe our channel and product diversification as well as our strategies to better serve customers with new, more innovative lighting solutions and the strength of our many sales forces have allowed us to again achieve meaningful sales growth this quarter.

Before I turn the call over to Ricky, I would like to comment on our profitability and strategic accomplishments. As we noted earlier, our fourth quarter operating profit was $90.7 million, the most in our history, and operating profit margin for the fourth quarter was a robust 13.6%. More impressive was our gross profit margin for the quarter, which came in at 42.4%, up 150 basis points compared with the year-ago quarter. The expansion of our gross profit margin was primarily due to the benefits of higher net sales, favorable sales channel mix and productivity improvements, partially offset by unfavorable changes in foreign currency exchange rates.

Next, total selling, distribution and administrative expenses were up $34 million, 21%, and the net sales increase of 15%. SDA expenses as a percentage of net sales were 28.8% in the quarter, an increase of 140 basis points from the year-ago period.

This next point is very important. The increase in our SDA expense was primarily due to higher variable cost for freight and selling commissions to support the record growth in net sales and a $15 million increase in our variable employee incentive compensation expense, which is based on our bonus program plan design that incents or rewards strong period-over-period growth.

Our performance, which is measured along three key metrics of profit growth, margin improvement and cash flow generation, this year compared with the year-ago period placed us above the 75th percentile of our benchmark industries, driving the increase in our employee incentive-based compensation expense, a positive reward for record performance.

Another way to view just how robust our fourth quarter results were is to examine our variable contribution margin, adjusting for this net increase in employee incentive compensation in order to make it comparable to the same period last year. Doing so, our variable contribution on the incremental sales of $89 million was almost 31%, strong results indeed.

The story was much the same for the full year’s record results. Net sales grew 15% this year, almost three times the estimated growth rate of our addressable market. Gross profit margin was 40.9%, up 40 basis points compared with the prior year’s adjusted gross profit margin. Adjusted operating profit was 12.2%, which included a $31 million increase in our variable employee incentive compensation expense, improved 40 basis points over 2013.

Be very clear, variable employee incentive compensation is an integral part of our business model, which is based on aggressive period-over-period improvement performance. However if one were to adjust for the net increase in our full year employee incentive compensation expense, so as to make the year-over-year comparisons meaningful, our operating profit margin increased by 130 basis points and the variable contribution margin for the incremental sales in 2014 would have been over 25%. All in all, we had a great year.

On the strategic front, we accomplished a great deal in 2014, setting the stage for what we believe will be strong growth in profitability in 2015 and beyond. Internally we’ve made great strides on a number of fronts by further accelerating the deployment of our lean business processes. For example, we improved our productivity through the organization. One measure of productivity is net sales per associate, which increased almost 11% in 2014. Another area of strong improvement was in our service to customers where late backlog declined to a historical low, while on-time delivery was at an all time high.

From a product and lighting solutions development perspective, we continued our rapid pace of new product introductions, significantly expanding our industry leading portfolio of innovative energy-efficient luminaires and lighting control solutions. To put this in perspective, we now offer our customers more than 1.7 million SKUs to choose from, more than three times as many as we had in 2008. No other lighting company offers customers more choices and more solutions than Acuity Brands.

Much of this growth in our portfolio has been driven by the expansion of our lighting controls and solid-state lighting product offering. For the full year, our LED sales more than doubled compared with 2013. This is an extraordinary achievement when you again consider that if our LED sales were measured as a standalone company, we believe it would be the fourth largest lighting luminaire company in North America, while we believe our conventional business would still be number one.

Also we continue to fund the development of holistic integrated lighting solutions for specific applications such as schools, healthcare facilities, commercial office buildings and various outdoor applications to fully leverage our award-winning portfolio of lighting fixtures, controls and components. Additionally, we continue the development of luminaires incorporating other light source technologies such as organic LEDs where we continue to expand our award-winning portfolio of these innovative products.

More impressively, our adjusted operating profit margin continued to expand this quarter and this year, while sales of LED-based solutions have become an even larger portion of our overall business. Acuity is a clear leader in providing customers with superior lighting solutions incorporating either convention or solid-state light sources.

The market has come to understand that LED as a light source is no longer a new technology, now widely accept the attention of customers is focused and how once can best control a new light source to optimize their visual environment while realizing the benefit of its long life and energy savings characteristics, because Acuity truly understands how best to fully utilize the unique capabilities of LED to optimize the visual environment and provide significant energy savings through our smart and simple solutions for virtually any application. We are growing significantly faster than virtually all of our major competitors.

At Acuity, we view the advent of LED as an enabler, affording us the opportunity to bring differentiated lighting solutions to a broad array of customers, distancing us from our competitors. Our expertise lies in the true understanding of the proper use and control of light while minimizing the use of energy. We are without equal in the design and development of fixtures and integrated lighting systems for virtually any application without a bias of the light source. Our formidable strength and innovation was on full display again in 2014 where Acuity LED lighting and control solutions as well as for our new line of organic LED products.

As I have noted before, our organization has a long and distinguished history of leading and innovating during areas of technology disruption and that is even more true today. Acuity Brands is leading the evolution to intelligent lighting solutions with its broad and deep portfolio of indoor and outdoor solid-state and traditional energy-efficient luminaires and lighting controls. And we are delivering profitable growth in strong financial returns for our shareholders while making these important investments.

These accomplishments have diversified and strengthened our foundation and will further serve as a robust platform for our future growth that is less reliant on the new commercial construction cycle. We have been able to produce these results because of the dedication and resolve of our 7,000 associates who are focused on serving, solving and supporting the needs of our customers. I will talk more about our future growth strategies and our expectations for the construction market later in the call.

I would like to now turn the call over to Ricky before I make a few comments regarding our focus for 2015. Ricky?

Ricky Reece – Executive Vice President and Chief Financial Officer

Thank you, Vern, and good morning, everyone. Vern covered the primary drivers for our fourth quarter and full year sales growth and our profitability. So I’ll not repeat these items.

The effective tax rate for the fourth quarter was 33.2% compared with 36.1% in the fourth quarter of last year. The lower income tax rate was primarily attributable to favorable adjustments to certain discrete items. In addition, the prior-year fourth quarter tax rate was unfavorably impacted by a change in UK tax laws, which resulted in a reduction of certain deferred tax assets. The effective tax rate for the full year of 33.8% was relatively flat compared with 34.0% in the prior year. We estimate the effective tax rate for fiscal year 2015 will be approximately 35.5% before any discrete items and if the rates in our taxing jurisdictions remain generally consistent throughout that year.

As Vern mentioned earlier, cash flow generated from operations for fiscal year 2014 was a very impressive $233 million, which is more than $100 million over the prior year. The significant year-over-year improvement reflects higher net income and lower working capital requirements as compared with the prior-year period.

Our operating working capital defined as account receivables plus inventory less accounts payable decreased five days to an industry-leading 33 days and represents only about 12.5% of revenue. Most of this improvement was in our management of inventory where we continue to improve our inventory turns while also improving our service levels.

In fiscal year 2014, we spent approximately 1.5% of revenue or $35.3 million on capital expenditures compared with $40.6 million in the prior year. This reduction in spending was due to some large projects in fiscal year 2013 that did not repeat and delays in certain projects this year that got pushed into fiscal year 2015. We currently expect to spend approximately 2% of revenues in capital expenditures in fiscal year 2015. This expected uptick in capital expenditures is due to the projects that were delayed from fiscal year 2014 and investments necessary to support our growth.

In fiscal year 2014, our free cash flow, which we define as cash flow from operations less capital expenditures, was $197.8 million. This is the sixth year out of the last eight years that we achieved our target of having our free cash flow exceed net income, which we believe speaks to the quality of our earnings and efficient management of our working capital and capital investments.

At August 31, 2014, we had a cash balance of $552.5 million, an increase of $193.4 million since the beginning of the fiscal year. Our total debt was $354 million. Consequently, our cash exceeded debt at the end of the fiscal year. At August 31, 2014, we had additional borrowing capacity of $243.8 million under our credit facility. During our fourth quarter, we amended and extended our credit facility, improving the pricing and terms and extended its maturity so we have five years remaining on its tenure.

We have a significant amount of cash on our balance sheet, continue to generate a lot of cash and have access to additional capital based on our extended credit facility. So you’re probably asking what are our priorities for all of this capital. Our capital allocation priorities have not changed. First, we will invest in capital expenditures for maintenance, cost savings and growth initiatives, which is expected to be around 1.5% to 2% of revenue per year.

Next, we will seek strategic acquisitions to add technology, fill product gaps and/or expand our market access. The timing of acquisitions of course are hard to predict. And quite frankly, we would have expected to have been more active this year in M&A. We remain very disciplined in our acquisition activities and will continue to seek desirable acquisitions at appropriate valuations.

Lastly, we will continue to return capital to shareholders in the form of dividends and stock buybacks. In fact, over the last decade, we have returned approximately half of our free cash flow to shareholders through dividends and share buybacks. We clearly have 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 the call back to Vern.

Vern Nagel – Chairman, President and Chief Executive Officer

Thank you, Ricky. As we look forward, we continue to see significant long-term growth opportunities that are ever changing and evolving, particularly for Acuity. Our expectations for growth of the lighting industry primarily in North America has not changed much over the last few quarters. We remain very positive. So while we don’t give earnings guidance, I would like to provide you with some observations for fiscal 2015.

First, most economists expect the economy in North America will continue to improve at a modest to increasing pace. Our forecast for industry growth rates by independent organizations continue to vary widely. The consensus estimate for the broad lighting market in North American is expected to grow mid to upper single-digit range for our fiscal 2015, reflecting the benefits of both new construction and renovation activity.

Further, we continue to see signs that give us optimism regarding the future growth of the markets we serve in our business. Leading indicators in the North American markets such as the architectural billing index, vacancy rates, office absorption, lending availability and the rebound in residential construction continue to improve. As has become the normal over the last handful of years, we are always leery of the next round of uncertainty that might come out of Washington, including potential noise around the mid-term elections as well as fiscal and foreign policy issues.

As you know, the manner in how these key issues are handled can meaningfully influence business and consumer confidence. Nonetheless, we continue to expect that overall demand in our end markets for the next 12 months will continue to improve and be more broad-based and consistent than that experienced in either 2013 or 2014. The continued favorable trend in our September order rate again seems to support this continuing level of improvement.

Second, excluding the price of certain LED components, which are expected to continue to decline, we do not anticipate significant changes in input cost over the next 12 months as some commodity costs have waned, while others continue to rise. Further, we expect employee-related costs to continue to rise due to wage inflation and the negative impact of rising healthcare cost. As you know, our employee incentive compensation programs are variable in nature and designed to incent and reward period-over-period performance based on aggressive improvement along three key shareholder-centric measures.

Put differently, our incentive compensation plan is what everyone regards as a pure pay-for-performance. In 2014, our incentive compensation was meaningfully higher than in 2013 due to our record performance. So we enter 2015 where a high performance base is already in our cost structure on which to compare future performance. Assuming similar year-over-year performance in 2015 as we achieved in 2014, the increase in incentive compensation in 2015 would then be minimal.

But again, let me be very clear, as your management team and fellow shareholders, we have every incentive in the world to outperform the record performance we delivered in 2014, which would result in an increase in incentive compensation in 2015.

Next, we continue to be leery of foreign currency exchange fluctuations, which are impossible to predict. Of course, we will continue to be vigilant in our pricing posture as well as furthering our efforts to drive productivity improvements to help offset rising cost.

Another observation, while our gross profit margin is influenced by a number of factors including sales volume, price, product and sales channel mix and innovation, we expect our annual gross profit margin to improve over time as values grow, particularly for larger new construction projects which would also benefit our mix and as we continue to realize typical gains in manufacturing efficiencies.

Our gross profit margin in the fourth quarter was a good example of our potential, but we prefer to look at our margin improvements over a 12-month period to remove quarterly anomalies like last year’s second quarter due to weather to discern proper trends. You should do the same. It’s a positive picture.

Additionally, we continue to experience some isolated pricing pressures in certain markets and sales channels. We will continue to be vigilant on pricing. As we have said before, we will defend our market position vigorously from competitors should they attempt to use price as their only point of differentiation.

Lastly and most importantly, we expect to continue to meaningfully outperform the markets we serve. Looking more specifically at our company, we are very excited by the many opportunities to enhance our already strong platform, including the introduction of holistic lighting solutions like connecting smart lighting with smartphones for retailers as well as our growing electronic component capabilities.

As we have noted in our last several conference calls, our strategies to drive profitable growth remains essentially the same. We continue to see opportunities in this environment including benefits from growing portions of the market, further expansion in underpenetrated geographies and channels and growth from the introduction of new lighting solutions. Our positive results reflect the solid execution of these strategies.

Our company-wide strategy is straightforward. Expand and leverage our industry-leading product and solutions portfolio coupled with our extensive market presence and our considerable financial strength to capitalize on market growth opportunities that will provide our customers with unmatched value and our shareholders with superior returns. So all it takes are focus and resources. We are funding these activities today, because we see great future opportunity. Through these investments, we have significantly expanded our addressable market. Our record growth supports this view.

As I have said before, we believe the lighting and lighting-related industry will experience significant growth over the next decade, particularly as energy and environmental concerns come to the forefront along with emerging opportunities for digital lighting to play a key role in the internet of things. We continue to believe the many markets we serve as part of the broader lighting industry could grow by more than 50% over the next few years, providing us with significant growth potential. As the North American market leader, we are positioned well to fully participate in this exciting industry.

Thank you and with that, we will entertain any questions that you have.

Question-and-Answer Session

Read the Full Transcript Here

 

Related Posts

• The Truth About Debt: Why 99% Rich Use It & Others Fear It – Dr. Anil Lamba (Transcript)
• Paulo Nogueira Batista: Decline of the IMF & Rise of the BRICS New Development Bank (Transcript)
• Ex-BlackRock Insider Reveals The Next 2008 Financial Crisis (Transcript)
• Transcript: CEA Dr V Anantha Nageswaran on Growwing India Podcast
• Transcript: Business Expert Natalie Dawson on DOAC Podcast