Good morning and welcome to Acuity Brands' Fiscal 2019 Second 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

Good morning. With me today to discuss our fiscal 2019 second quarter results are Vern Nagel, our Chairman, President and Chief Executive Officer; and Ricky Reece, our Executive Vice President and Chief Financial Officer. We are webcasting today's conference call on our 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 this call over to Vern Nagel.

Thank you, Dan. Good morning, everyone. Ricky and I would like to make a few comments and then we will answer your questions. Our results for the second quarter were very solid despite continuing inflationary cost pressures and the impact of tariffs. We implemented several actions to address these cost issues, including price increases and additional productivity improvements. We believe our topline growth this quarter was impacted by the pull forward of orders by customers into the first quarter as they acted to avoid announced price increases. Nonetheless, we grew our topline by almost 3%. Additionally, we improved our adjusted operating profit margins by 50 basis points over the year-ago period and delivered adjusted diluted earnings per share of $1.99, a second quarter record. 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 second quarter of 2019. Net sales for the second quarter were a record $854 million, an increase of almost 3% compared with the year-ago period. Reported operating profit was $95.9 million compared with $89.5 million in the year ago period. Reported diluted earnings per share was $1.67 compared with $2.33 in the year ago period. There were adjustments in both quarters for certain special items as well as certain other add-backs necessary for our results to be comparable between periods as Ricky will explain later in the call. In adding back these items, one can see adjusted operating profit for the second quarter of 2019 was $112.4 million compared with adjusted operating profit of $105.3 million in the year ago period, an increase of 7%. Adjusted operating profit margin was 13.2%, an increase of 50 basis points compared with the prior…

Thank you, Vern, and good morning, everyone. As Vern mentioned earlier, we had some adjustments to the GAAP results in the second quarter of fiscal 2019 and 2018, which we find useful to add back in order for the results to be comparable. In our earnings release and Form 10-Q, we provide a detailed reconciliation of non-GAAP measures for the second quarter and first six months of fiscal year 2019 and 2018. Adjusted results exclude the impact of amortization expense for acquired intangible assets, share-based payment expense, manufacturing inefficiencies directly related to the closure of a facility, acquisition-related items, special charges for streamlining our activities and an income tax net benefit for discrete items associated with the Tax Cuts and Jobs Act. We believe adjusting for these items and providing these non-GAAP measures, provide greater comparability and enhanced visibility into our results of operations. We think you'll find this transparency very helpful in your analysis of our performance. During the second quarter of fiscal 2019, we recognized a pre-tax special charge of $400,000 primarily related to move cost associated with the previously announced transfer of activities from a planned facility closure. In the second quarter of the prior fiscal year, we recorded a pre-tax special charge of $600,000. We expect to continue to incur additional costs, primarily attributed to early lease termination and moving cost in future periods associated with the closing of certain facilities related to the streamlining actions announced in fiscal year 2018. As a reminder, as part of adopting ASC 606 at the beginning of fiscal year 2019, we're providing in our Form 10-Q disaggregated revenues by the major sales channels of; one, independent sales network, which includes C&I agencies, infrastructure utility agencies, system integrators, and showrooms; two, direct sales network; three, retail network, which includes home…

Thank you, Ricky. While current market conditions in lighting industry continue to be challenging, we continue to be optimistic regarding our long-term future. We believe our many actions to improve our market reach, enhance our customer solutions, and capabilities and to drive company-wide productivity, will help optimize our financial performance in the future, while affording us the opportunity to continue to invest in areas we believe have high growth potential over the long-term. Our strong sales growth, significant cash flow and robust return on invested capital through the first half of the year are reflective of our very positive operating performance, despite some of these current industry headwinds. Our views on overall market demand for the lighting market and items influencing costs have not really changed over the last six months. So, let me reiterate a few of those key items that could influence our performance for the balance of our fiscal 2019. Many independent third-party forecasts continue to suggest the overall construction market, as measured in dollars, will grow in the low to mid single digit range. We still believe the lighting industry will lag the overall growth rate of construction market somewhat, primarily due to continued product substitution to lower priced alternatives for certain products, sold through certain channels, while recent industry pricing actions should have a favorable impact on growth as measured in dollars. Additionally, we expect that labor shortages in certain markets could continue to negatively impact growth rates for both construction and lighting. While the U.S. government once again delayed the implementation of increased tariffs to 25% from the current 10% for certain imported Chinese made finished goods, we believe the outcome of the entire tariff situation could have a dampening effect on overall demand due to higher component costs and finished good prices. Further,…

[Operator Instructions] Our first question comes from Joseph Osha with JMP Securities. Your line is now open.

Thank you. Good morning, everyone.

Good morning.

Two questions. First, your business continues to generate pretty solid cash flow. I'm just wondering if maybe Ricky could amplify maybe a little bit more going forward what the thoughts are about deploying net buybacks. And then also, what we might see in terms of levering the balance sheet? Then I have a follow-up.

Sure. As we've mentioned before, Joseph, our use of cash are really in three areas. One, to continue to invest in capital through capital expenditures, IT and so forth, and you see that level at the 1.5% of revenues. We've been between that and 2%. Second is, to return to shareholders in the form of dividends and share buybacks, which we've done fairly aggressively over our careers or over the last decade, I should say. And then, thirdly is acquisitions. I would say acquisitions after our normal capital CapEx spending is probably our preferred use. We see opportunities to continue to fill in areas of product gaps as well as to expand our technology, and we'll continue to look at opportunities whether it's acquiring people or partnering or minority investments. And it's an active pipeline out there. So that's an area that we continue to see opportunity, and we'll use our cash flow to create shareholder returns in that way. When the M&A activity isn't as robust or we opportunistically see a benefit to repurchase shares, we'll do that. And as you know, we have a fair amount still left under the board authorization to buy back shares. We bought back 400,000 this -- so far this year. So we'll continue to do that as well. So those are the primary plans for our use of capital.

Okay. Thank you. And just as a quick follow up, you had in the past indicated the willingness to lever the business to certain multiple of EBITDA, do you still see that kind of debt-to-EBITDA number going up over time?

You could argue we're underlevered today. So, I could see our leverage going up either through M&A or share buybacks. We do want to maintain our investment-grade rating which would suggest 2.5 turns of EBITDA or probably less. Not to say that on a great opportunity for M&A or something, we might not hit that or exceed it knowing we could quickly pay it back down. But we do want to maintain our investment grade rating and that would dictate a ceiling probably in that 2.5 turns of debt as a ceiling.

Okay.

And we continue to see an active pipeline of M&A as Ricky points out. And as you know M&A is never something that you can precisely predict. They have to be both doable and desirable at the same time, meaning from a financial perspective. So, it's again interesting in terms of technology opportunities as well as niche space lighting companies.

Thank you very much.

Thank you. And our next question comes from Brian Lee with Goldman Sachs. Your line is now open.

Hey, guys. Thanks for taking the questions. Just had a couple here. I guess first off on the mix shift here in retail, just thinking like, you would have less control on the sales channel for this part of the market, hence the lower SG&A expenses if I'm reading it correctly. How should we think about what that means for both potential and just the part of the business -- as a part of your mix that just goes in line with the industry given the competition in this channel? So, if you could just maybe help walk through the growth sort of puts and takes for that particular channel?

Okay. Brian, sounds like there's a food fight going on at Goldman Sachs. Not certain that we heard all of question, but when we think about our retail channel, we see opportunities for continued diversification and growth. But you know, again, we have to look at the trade-off in terms of are those solution sets that they are providing appropriate for returns on our own business. But we see the retail channel as an opportunity for us again to continue to diversify our customer base. We're doing that. And obviously that has some impact, because these customers all have different service requirements, which as I mentioned in my previous -- or my prepared remarks do have an influence on how we basically account for some of these things, some of the items are above the line, so they enhance gross profit some of the things such as freight. I mean this is a really simple issue. It's just depends on whether we provide freight of the material or that end customer provides freight and then the adjustment is the price. So -- but again, our view around the retail channel is continued opportunity to leverage our brand and to leverage the supply chain that we have in place for profitable growth.

Okay, great. Hopefully, it’s a little bit better. On the -- maybe second question just on channel and product mix, I know these were issues for you guys that just I guess started to materialize that you couldn’t shift in the past couple of quarters. So, wondering if it's the right assumption to anticipate that the revenue of fiscal 2019 is going to see this impact in a similar range on a year-on-year basis due to offsetting the recent price increases like you saw here in fiscal 2018? Thanks guys.

Yes, the food fight is still alive and well at Goldman Sachs. I think the question was based around sales channel mix and its impact. First of all, let me make a comment on pricing. We were very pleased with the price capture that we were able to achieve in the second quarter, and really there's still more to come as it rolls through. But just so everyone understands, while price capture for us, we believe contributed low-single digit to our growth, I understand that probably two-thirds of our business is really bid business. And I think it's very different than some of our competitors. So that one-third that is subject to price list and so on and so forth is really where the price increases were put in place. When it comes to our bid business, we are always looking to sell the value of our solutions and optimize our profitability as best we can. We're very pleased this quarter with how, again the realization of price help to offset the great deal of the cost that we had. Some of the channel mix discussion that we bring up really is the fact that this quarter had what we believe was anomaly, because of the pull forward within the C&I market as people trying to avoid price increases placing their orders early. And so therefore, in Q2, we saw a drop in sales volume in the C&I market. But when we look at our overall business, it grew over 3% sales volume. So, it was other channels that allowed us to show growth. So, again, our Distech, BMS team just knocked the ball out of the park in Q2 and they have been doing that, they're doing a great job. That's within our independent sales network, if you will,…

[Technical Difficulty]

Thank you. And our next question comes from Christopher Glynn with Oppenheimer. Your line is now open.

Yeah, thanks. Good morning. Just following up on the price topic. Just wondering, how you'd mark where you might be along the expected price capture and realization ultimately as you work through some of the big business in quote protection? You think you're kind of halfway there? A couple of quarters out from what you see is kind of steady state based on the dynamics you've addressed so far?

You know, Chris, it's a good question. And it's just – it's an educated guess. So take it for what it's worth. I would say that, we probably still have another quarter of just a little bit of noise around that, but as I said earlier, really pleased with the price capture on that portion of our business that is off of a price – based off a price sheet. I think others have said the same thing. So we'll see. On the project side, again, projects, we are always looking to differentiate our value proposition taking into account all aspects of that including costs to drive the difference.

Okay. And then, with expected continued mix pressure within the retail dynamics, can price offset that and get you to gross margin positive over the next few quarters? Or is there just too much contention there with the mix dynamic?

Yeah. So don't use the word contention. What it is, is just how different people, different customers in that channel handle different aspects. The easiest one to understand is freight. Some people provide their own freight. And so they take that off if you will the sales price. So that has a gross profit dynamic. Some people ask us to provide the freight, and therefore, it's a higher price consultant. So it's – the dynamic is really not a problematic maybe accounting treatment goes for that. We expect that dynamic to continue. So it's a reset, if you will of your – the notion of what historical margins for that channel may have been at gross profit in an operating profit. And operating profit is essentially have offset the difference. It's just that – its influence our gross profit and our SDA expense, primarily freight and commission. And you saw that this quarter as our SDA expense was down pretty significantly. And so that, as you think about your models, all of you think about your models going forward. I would say that, historically, our freight and commission is operated between say 11% and 12% of sales the way we do our accounting. You know, we'll probably be at the very low end of that range on a go forward basis. So if you're going to see overall SDA be down a little bit because of that on a go forward basis. But the margin profile will also be down as a result of that.

Okay. And then, you mentioned in the press release focus on improving mix of products and solutions. Just want to clarify exactly what that means, because I think you're kind of steadiest growth is the large enterprise solutions, customers that may in fact have the opposite effect within mix from the perspective of margins?

Yeah. So we are very excited about the growth rates that we are experiencing in our corporate accounts. Again, as I mentioned, those corporate accounts have a different -- I mean, it's all part of the same type of fixture, but they're driving the ability for us to ultimately sell an Atrius-enabled solution, more of the SaaS revenue kind of thing. So laying the track has really been a very positive thing. And it's growing our business very nicely. We're well over two billion square feet of Atrius-enabled fixtures, which is just a staggering number and continuing to grow at an unbelievable pace. While the gross profit margin profile of that is below, if you will, with the C&I channel, so when we talk about channel mix, our focus is to -- key portion of our team is to drive and improve the C&I overall mix, particularly around larger projects. Those things continue just to be sluggish in terms of their release. Backlogs continuity for these types of projects is favorable, but they're slow to release. That's what people tell us, it has to do with labor shortages in certain markets. So what people are doing is amping up their education, trying to recruit more electricians, so on and so forth. So we believe that this problem gets solved, because the overall market dynamics, employment, rising commercial rental rates and industrial rates, vacancy rates, all these things are flashing big dream size. That usually means that if there's and now an uptick coming in the build of that type of real estate, backlogs that customers will suggest that that is true. But we haven't seen the releases of some of these larger projects. So that's what we mean by improving our channel mix.

Okay, got it. Thank you.

Thank you. And ladies and gentlemen, in order to provide everyone the opportunity to ask questions, the company asks that you please limit yourself to two questions per caller. [Operator Instructions] Our next question comes from Deepa Raghavan with Wells Fargo Securities. Your line is now open.

Good morning. Vern, just some commentary on how the quarter progressed month wise? That will be helpful. And if you can talk about any improved momentum or not, well into March, now that March is under the belt?

Yes. The quarter was lumpy, in terms of orders. Again, it's always difficult to quantify exactly why. It's certainly early into the quarter, so the December month for us was influenced by the pull forward. I also believe that January was impacted into a degree by weather in key parts of the country. We had a little bit of a government shutdown, so I'm at grasping at straws to try and explain why there was this lumpiness. We are starting to see improvements in the overall order rate. And we would expect that, because, again, you're coming out of seasonally, for us, our second quarter is always our softest quarter. And then we have the build going into Q3 and Q4. So probably a little bit too early to say that, let's declare a victory and this is the way it's going to be. But we see favorability and we continue to hear favorability.

That's the commentary for March?

We don't give commentary on [Indiscernible]. I'm just saying that, what we saw as we departed Q2, we saw an improvement. We saw lumpiness in Q2 and we're now starting to see favorability relative to that lumpiness.

Understood. My second question is what are your thoughts on recent lighting industry M&A? I mean you're seeing this Cree's fixture business being sold to private family business, GEs current business going to BE and now that Ethon has announced the spin as well. What does it say about the lighting industry as such? And secondly, is there an interest for you to participate in this? Thank you.

Thank you. My comment on the lighting industry is it's not going anywhere. I mean it's a robust industry, it's growing. It brings a lot of value. I think that some of the smaller bit players like Cree, they didn't make the right investments and they miss stepped and so they didn't win. Acuity has been investing heavily for the last decade building on the controls platform, building on an IoT platform. I think that with Ethon's announcement that they're going to spin their lighting business, I think that that was the portfolio decision. Lighting was a very small part of Ethon's overall portfolio and so they made a decision. But Ethon's lighting business isn't going anywhere. It's going to become its own public company. And so I don't see the notion of people making investment decisions as somehow being indicative of a lighting industry. When Ethon came out and said, here our performance, our requirements, and our lighting business doesn't quite meet those, Acuity far exceeds those types of performance and requirements. Our operating profit margin, yes, this quarter, 13.2% improving. Our topline we continue to grow. Our controls business continues to add improvement there. Yes, we're dealing with the notion of product substitution from -- to lower-priced alternatives, so we're fighting, if you will, that trend. But we believe that we will be able to improve our margins both gross profit as well as operating profit over time. I'm bullish on the lighting industry and where it's going to go. I think that some of these competitors that again the M&A has been with relatively minor players so far. The spend of Ethon's lighting business is not an M&A event, they're alive and well.

Got it. Thank you.

Thank you. And our next question comes from Ryan Merkel with William Blair. Your line is now open.

Great. Thanks. So, first question from me, may be discussed in more detail, what products and services you're reviewing? And what the impact could be to sales and margin?

So, as part of our normal course, we look at product lifecycle management, in the past where product lifecycles have been much longer and more traditional or conventional lighting. With the LED -- the advent of LED, it's no longer a new technology, it's around -- product lifecycles have become shorter. The ability to be more innovative with form factors and how you put technology inside those luminaries. It just shortens up the product lifecycle. So, what we're doing in my view is nothing more than a normal review of product lifecycle management and making decisions around why are we going to continue to offer something that is no longer in our view effective relative to new form factors or new capabilities, I don't perceive that it's going to have a significant impact on our top line. So, any impact to us, I expect it to have a offsetting positive impact on our margins and our return on investments. So, to me, the reason we’re mentioning it, is because we want people to understand that we're doing this with the expectation is well, I don't think it will be significant on our top line. It will have some impact, but we also believe it will improve our operating profit margins, as well as our return on invested capital, which by the way, is quite robust.

Okay. That’s helpful clarification. And then secondly, when do you expect the higher margin part of the Atrius solution to begin impacting the P&L? Because it seems to me that we're still not really telling a whole lot out of the Tier 4, but maybe help us with that?

Yeah. No, it's interesting, it's a great question. Against the backdrop of Acuity Brands, which is almost a $4 billion business, it's hard to have an activity that is growing nicely spiced the stew so significantly that you say, oh my gosh, you know I can now see the difference. We are getting great growth in our corporate accounts because people want the benefit of the Atrius-enabled capability. When they buy that, they usually wait till they have enough critical mass before they start to, if you will, drive the Ferrari. But for the early adopters, we are seeing interesting activity. It is positive to what we're doing. Where we're getting the growth so far is in our corporate account, as we continue to push the technology, enhance the technology, hone the technology, all the words that you want to use, once we're able to now more specifically control and once we have the opportunity to put it in the hands of our agents and I still think we're probably 12 to 18 months out where we can actually sell solutions into various verticals through that sales force, it will be a powerful capability, profit generator for Acuity.

That’s helpful. Thanks so much.

Thank you. And our next question comes from Tim Wojs with Baird. Your line is now open.

Hey, guys. Good morning. Just two follow-ups for me. So, the first is on inflation, the last couple of quarters you had called out a headwind to gross profit, I think last quarter it was $16 million and in Q4 it was $20 million. Any color on what that was in the February quarter? And then secondly, just to put a little finer point on this mix issue. As you look forward, it's not unreasonable for us to think that all-in you should actually start to see margin improvement on an EBIT basis, despite some of the mix issues with gross margins?

Sure. You saw on an EBIT basis improvement in Q2…

Exactly, yeah.

…50 basis points, our expectation is that we will continue to drive improvement at the operating profit level. So, to me, our -- coming back to your previous question, our costs continued, but let me start to imagine that we’re getting closer to where we're anniversaring some of that costs. Those -- some -- those numbers, the difference isn't as great. But yet, you would say, okay, it has a deteriorating impact on your margin. This is where the price increase -- price increases were very helpful in helping to lessen that. And as we said, we believe that our price increases are contributed low single-digit to our overall growth, which when you then further imagine that it really applies mostly to about a third of our business, we did get pretty solid capture. So a little bit of that sales channel mix we get this quarter noise, because of the pull-forward through the C&I channel or the C&I market, I should say, because of the price increases implemented on that, that caused a bit of a distortion. We still saw a great growth in our corporate accounts, and again, just a big shout-out to our Distech BMS team, they really put some big points on the board. So and we expect that to continue. Those are – that actually is margin accretive to us. So cost was an issue, tariffs issue, price increases benefited that the mix, the channel mix had to do with the pull-forward into Q1 from the C&I side.

Okay. Great. So EBIT margins that expansion should continue going forward?

Well, we're not providing guidance. But as you might imagine that…

I try. Okay. Great. Well, good luck on the second half guys. Thanks.

Thank you. And our final question comes from Jeffrey Sprague with Vertical Research Partners. Your line is now open.

Thank you. Good morning, everyone. Hey. Just let me come back to one of your earlier questions that might have been lost about whether the lighting industry is going away, and more about, does it make sense in this environment for you guys to explore being a consolidate tour in an environment where arguably there's too much capacity or is that kind of contrary to your strategy and you'd rather just try to pull away from the path organically?

Yeah. So we continue to look at all types of M&A, whether it's technology, technology within lighting, technology within BMS, technology within Atrius as well as lighting businesses that can enhance our portfolio. The Juno acquisition was a great example of a company that fit very nicely and fill the gap with us, the Juno team, fantastic opportunity. But also look we acquired Lucid, again, a fantastic company to help us drive more of our SaaS opportunities. So we are looking at a broad playing field, businesses that – the most recent transactions that have been announced where there has been M&A that spin-out. Those businesses – there was really no reason for us to participate in that. We believe that, we have a robust portfolio, talented people, and as you point out, we would go at that and look to grow organically in the marketplace to tidy up a competitor or buy something like either of those two businesses. I think would have been really dilutive to our returns and our attention. So where we are active in the M&A world on all aspects like Ricky pointed out, but for us to drive consolidation with some of the companies that were available that would not have been a benefit to Acuity shareholders.

Thanks. And then separate question, totally understand your comment about the price increases and list price going through a-third of your business, but does that activity significantly influence your ability to capture price on bids? Is there a kind of element of some sort of priced umbrella or just kind of general tone in the market around positive price that would feed into, while you're bidding activity?

Yes. So once we bid and the bid has been accepted, this is where some of the previous jobs that have been either part of our agents' backlog are now part of our backlog, a lot of that was price protected. As we look forward, we're looking at how do we continue to differentiate our solution set. This is where our controls platform is very helpful to us, in adding differentiated value. And we are looking at what our cost structure is, but we price to the market opportunity, not to our cost structure. We look to improve our cost structure to drive margin influence, but higher cost in the marketplace does find its way into the project side of the world on future bids.

Great. Thank you.

Thank you. And ladies and gentlemen, that concludes our question-and-answer session for today's call. I would now like to turn the call back over to Mr. Vern Nagel for any closing remarks.

Thank you everyone for your time this morning. Again, we strongly believe we are focusing on the right objectives, deploying the proper strategies and driving the organization to succeed in critical areas that have the potential over the longer term to deliver strong returns to our key stakeholders. Our future is bright. And thank you for your support.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may now disconnect. Everyone, have a wonderful day.