EdisonReport discussion with John K. Morgan

February 2, 2006

Your humble editor sat down with John Morgan, President and CEO of Acuity Brands Lighting last week. Acuity Brands Lighting is the parent organization of many well-known brands including Lithonia, Holophane, Gotham, Hydrel, Peerless, American Electric Lighting, and others. This is the first in a two-part series.

Ed: Congratulations on the great quarter. Sales were up $40M for the segment; a 9% increase in sales for Lighting. Does the current quarter look as good?

John: Demand for lighting is pretty stable in the non-residential sector. Residential continues to decline modestly, although we are not as greatly impacted by residential. Non-residential has not improved at all, but the decline has flattened out, so we may have seen the bottom of the trough. We believe the overall market will be up 4-6% which is the biggest gain in six years. We’re excited that the trend is reversed, but I don’t get too excited about single digit growth. Double digit; that’s exciting.

Ed: After not being involved day-to-day in lighting operations for several years, please comment on your return as President & CEO of Acuity Brands Lighting. What did you learn and observe spending time in other businesses?

John: From the outside looking in, the lighting industry is complex. For years, outside consultants would say they don’t see why there is anything terribly complicated about selling a light fixture, but we tend to overcomplicate the process. Furthermore, the reps provide greater value and exercise more influence than in other industries. It is a relationship business more than any other I know. Sometimes we go through times when reps or key industry leaders change alliances, it seems to me, more than in other industries. As a company, we are blessed with great leaders and great reps, a majority of whom have developed and grown with our company. Because of this, competition periodically makes a run at our best people. Of course, we don’t have much to say about this, but it will always be quietly met with a competitive response from us.

Ed: Too many channels?

John: I don’t know if we have too many channels, but we do have a lot of them. There are many decision makers deciding how a light fixture goes into a ceiling. An owner, an architect, an engineer, a lighting designer, a distributor, a contractor, and a rep can all be involved. All have influence, but it’s not clear if they all have a shared mutual interest. Their goals are not perfectly aligned. A great deal of lighting is purchased late in the construction cycle, leading to lighting decisions that are made when the project is over-budget or late. They never seem to take money out of the elevators or the concrete. There are lots of challenges because of different influences.

Ed: Is the industry doing its job getting to the owner?

John: The industry has not done a good job. Several organizations have made some headway such as the Energy Cost Savings Council (ECSC) and NEMA and there have been others who have contributed. All of the decision making influences are not necessarily aligned. We need to do a better job of getting to the owner so they can understand the value of good quality lighting.

Ed: How much of your time/energy will be spent focusing on Lithonia as opposed to the other businesses?

John: Maybe half on Lithonia. The marketplace views Acuity Brands as Lithonia and it views Lithonia as a high volume commodity manufacturer. Yet, less than half of the Acuity Brand Lighting sales are high volume fluorescent fixtures.

Ed: Wow, I had no idea.

John: When we were spun off from NSI we began building a branding strategy, a branding umbrella, to assimilate important brands in the industry. We wanted to protect the brand equity of the non-Lithonia brands. By design, we elected to focus commercially on our brands as opposed to the Acuity Brands Lighting umbrella. The consequence is that we have not educated the market about the entire brand proposition. Now that we are four years into this, it is time to begin to do a better job and have the customer understand the various different brands and how we take those brands to market. In the next five years, we’ll spend more time sharing thoughts on Acuity Brands in total, the umbrella of many successful brands.

In general, there is greater recognition of the fact that the industry is divided into two categories: high volume products that are commoditized and lower volume— more specialty in nature. We need to focus on both. In the last handful of years, we have been building capabilities in specialty areas. Many of our acquisitions, including Hydrel and Peerless— have given us the capability and platform to invest. We could not have taken a high volume mentality and applied it to a Hydrel type product line and done a good job.

With acquisitions, you end up with products and people, particularly people, who understand a different business; we invest in them to grow the platform for the specialized applications. Why do this? Because we want to focus on profitable growth. Having said that, we never lose sight of the fact that high volume is the engine that pulls the rest of the cargo.

Ed: What direction do you see your companies in 2006? We hear that the integration of the Holophane (direct) and American Electric (rep) is going quite well and that your direct sales force is working with your rep agencies in certain markets.

John: Across Acuity Brands, we have installed policies that allow collaboration or synergy between different selling organizations where there is value added. In this area of the business, customers supported by three organizations: 1) The Solutions Group Sales Organization, 2) the American Electric organization for infrastructure and 3) the traditional Holophane sales organization that can take a longer view. The product development capabilities of Holophane and American Electric can be aligned to support more specialized areas of the business. It’s going extremely well and I am very pleased. We knew it would be a challenge at the outset, but it’s going well because it started with the customer and we did what customers wanted.

Ed: How do you see price increases affecting our industry?

John: The majority of the industry, from a product perspective, is largely commoditized; in so much as most products have suitable substitutes from a variety of manufacturers. In a highly commoditized industry it is difficult to get away from cost having an impact on price. However, as a company, if we ever want to invest back into the company and the industry at rates to advance the state of Lighting, then I believe we have to be more intelligent in how we manage pricing and the price the market will bear. This is especially true if we are to fund research and development. You’ll recall that we gave over $200,000 to Hurricane Katrina relief and over $2 million of in-kind support of the world’s largest aquarium and marine life research center here in Atlanta. Last year we donated $250,000 to the NAED Education Foundation.

Yet, it remains to be seen as to whether the marketplace and customers will forever be supportive and allow us to advance the quality of lighting in North America. We see modest evidence that some Electrical Distributors are providing greater and greater support directly to the Far East. They are purchasing no-name products from companies that offer the absolute lowest cost possible; these companies have no stake in advancing the state of Lighting. If that becomes a trend, we have a decision to make. We hope that the market place sees the value for established manufacturers to make adequate margins and to advance the state of Lighting. We have all worked in lighting environments that are poor; we like to see comfortably. We don’t want headaches and shouldn’t suffer in our ability to see. If customers have no interest in the value offered by the National Lighting Bureau, IESNA, NEMA, NAED, as our legitimate competitors do, it will put real stress on us to invest and advance the art and science of lighting.

Ed: Do you see the trend increasing of bringing in components and finished goods from China?

John: I think China will continue to grow to some finite percentage of capacity. I believe that all major manufacturers will place some limitation on the percentage they are willing to risk…

Ed: I don’t follow, why is this a risk?

John: There are political issues, quality issues, etc. Political risk is the balance of trade and the financial risk. I do not believe that American politics will continue to support forever the US slowly being acquired by foreign entities. It is a high risk scheme. Major manufacturers will continue to manage their risk by diversifying throughout the world.

Ed: This year you displayed your RT5, I thought brilliantly, at Lightfair.  It reminded me of when Philips first introduced ceramic metal halide (their business manager was handcuffed to a briefcase carrying the lamp and was shadowed by security personnel.) How was Lightfair?

John: Excellent for us. I have attended Lightfair for many, many years. I believe there is continuing improvement in the presentation and education aspects of Lightfair. For example, Jim Benya, well-known and well-respected, is making presentations at Lightfair that educate others in the industry. As the quality continues to increase, it becomes a very impactful event. I don’t feel the same way about the product display aspect.

Ed: How so?

John: I think it has changed considerably and is not nearly as interesting. When Lightfair is located in New York or San Francisco, each city has large specification markets, and strong presence from the lighting design community. There is good attendance from people who want an education and see new product releases. Other venues, such as Las Vegas, are not as convenient for specifiers and logistically not as good for customers. Having Lightfair every year is not as impactful for the customer as it would be if it were spaced out every 18 to 24 months.

Ed: Last year, you were the first major company to switch to an all-Universal voltage line of fluorescent fixtures (a story which EdisonReport covered). Has that worked for you?

John: Yes, it has been a good move as it reduced product complexity and made it easier for our customers, a win-win for everyone. We’ll continue to provide this type of leadership so long as we are rewarded for it. We feel the responsibility of leadership.

Ed: Is overcapacity an issue?

John: Overcapacity will always be an issue because it is so easy to come by. We could add capacity rapidly. It’s harder to take it out, but easier to add. The industry has the attitude that we have infinite capacity—which contributes to commoditization. We will continue taking capacity out of the supply chain but not at the sacrifice of service.

Ed: How effective is the NEMA President's group at getting things done for our industry?

John: I have just recently gone on the NEMA board, so I don’t know at this time.

Ed: Is sustainability important in our industry? Is Acuity focused on this?

John: We are applying many resources to sustainability. I believe it is important because the lighting design community thinks it is important, the customer thinks it is important, and I personally believe it is important. We are giving a lot of consideration to recyclable content in our product designs. We have an incredible focus on energy and are funding a new position. This person will spend all of their time on energy related issues. I remember when we lit an area for four watts per square foot. Our new RT5 fixture is well below 1 watt per square foot.

Ed: How did your reorganization go? I think I heard on the investor conference call that you would not have changed any of the moves, but perhaps, there were some issues.

John: Our Manufacturing Network Transformation moved rapidly to consolidate facilities and to take cost out. All our people did a tremendous job. Even the people affected by the closings did an incredible job in working the closure—always mindful of safety and quality. We took on an awful lot in a short timeframe, and it created service difficulties with some customers. If we had gaited over a longer period of time, the service interruption would have been less. Maybe we tried too much too fast, but we have recovered from that interruption. Our late orders now are at a low point in the history of this company, and I can’t say enough about how strong our people were during this process.

ED: Thanks for taking time to share your views on the challenges facing the lighting industry. Do you have a closing comment?

JOHN: Many of our famous brands, Lithonia Lighting, Holophane, Gotham, and Peerless to name a few, have a rich history. For most of the last century, these businesses provided high quality lighting products that improved the quality of life at home and work. Today, our company is filled with professional, dedicated people who make our industry better by continuously setting new standards of performance. They never lose sight of the fact that helping people… customers... is how we will maintain our leadership and ensure our future success.

END OF PART ONE. Watch for Part Two next week of my interview with John K. Morgan, President and CEO of Acuity Brands Lighting. John talks candidly about the company’s new strategy targeting the New York City market.