Good morning. And welcome to the Acuity Brands' Fiscal 2019 Fourth 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 2019 fourth quarter and full year results are Vern Nagel, our Chairman, President, and Chief Executive Officer; and Karen Holcom, our Senior Vice President and Chief Financial Officer. We are webcasting today's conference 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. We had a solid fourth quarter given market conditions and look forward to providing you with further analysis of our results in a moment. However, before I start, I would like to introduce to you Karen Holcom as our new Chief Financial Officer. Karen is a 21 year veteran at Acuity and knows our business and strategy exceedingly well. More importantly, she is focused on helping to execute our strategy to optimize value for our key stakeholders. Please join me in welcoming Karen to her new role. Karen succeeds Ricky Reece, CFO, who was recently promoted to President of Acuity. We will leverage Ricky’s experience and knowledge of our business with his primary focus to drive our commercial growth plans. So, with those announcements complete, Karen and I would like to make a few comments, and then we will be happy to answer your questions. 2019 was one of the most challenging years we've experienced at Acuity. The markets we serve were in a constant state of flux throughout much of the year. Inflationary pressures at the beginning of the year were exacerbated by the number of market shocks, including the addition of significant tariffs placed on Chinese made components and finished goods, uncertainty created by the threat of further trade actions, and labor shortages in key markets. These issues and more created great economic uncertainty, tempering demand for lighting products in both the residential and non-residential construction markets. Further, we and our many channel partners had to deal with multiple price increases due to rising costs and tariffs which further whipsawed demand creating great stress and uncertainty for our supply chain. Obviously, these issues pose many significant challenges for us to manage, yet we feel our performance was strong given this environment. We…

Thank you, Vern, and good morning, everyone. I'm happy to be on the call with you today. As Vern mentioned earlier, we had a few adjustments to the GAAP results in the fourth quarter and for the full year of fiscal 2019 and 2018 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 for the fourth quarter and full year of fiscal 2019 and 2018. Adjusted results exclude the impact of amortization expense for acquired intangible assets, share based payment expense, manufacturing inefficiencies and excess inventory adjustments directly related to the closure of a facility. Acquisition related items, special charges for streamlining activities, a gain on the sale of our former Spanish lighting business and an income tax 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 operation. We think you will find this transparency very helpful in your analysis of our performance. Recall that during the fourth quarter of fiscal 2018, we reversed pre-tax special charges of $5 million, a certain previously planned streamlining activities were no longer expected to occur primarily because we were successful in selling our former Spanish lighting business for a gain during the quarter. During the fourth quarter of this fiscal year, we recorded net pre-tax special charges of $0.5 million related primarily to certain streamlining activities. Additionally in the fourth quarter of fiscal 2019, we incurred $1.3 million of expenses related to acquisition and investment activities. The effective tax rate for the fourth quarter of fiscal 2019 was 20.2%, compared with 21.1% in the year ago period. The decline in the…

Thank you, Karen. This is probably the most important portion of this call. Our outlook and our focus for 2020. While current market conditions in the overall lighting industry continue to be challenging, we are optimistic regarding our long-term future and that of our key markets. We believe our many actions to improve our market reach, enhance our customer solutions and capabilities and 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 profitable growth potential over the long term. That notwithstanding, we believe current market demand for lighting is sluggish. We believe the catalysts for these tepid conditions are primarily due to continued concerns over key economic issues including global trade policies and the potential for future tariffs. We expect these market conditions to continue for the foreseeable future and until such time as there is more clarity and certainty regarding these key economic issues. In addition, we believe there are a few other factors that will continue to influence the lighting market, including continued product substitution to lower price alternatives for certain products sold through certain channels, labor shortages in certain markets and continued cost increases, particularly for imported electronic, electrical components and finished goods, freight and wages. The recent pricing action should help to mitigate some of these factors. Given this market environment, we can only focus on those areas within our control and react to the best of our abilities to those influences beyond our control. We believe the maniacal focus on a few key areas coupled with precise execution of our plans will afford us the best opportunity to produce favorable results for our key stakeholders. So in 2020, our primary focus will be on two key areas.…

[Operator Instructions] Our first question comes from Christopher Glynn with Oppenheimer. Your line is now open.

Thank you. Good morning and Karen welcome to the call., So just curious about maybe a big picture on some of the structural channel shifts, Vern, in the context of the topline pressure reported. Just curious from a couple perspectives about your base run rates in the channel mix evident in the fourth quarter versus go forward. Is there any way to kind of define what you and the Board are talking about both the right size of your run rates relative to the volumes, because clearly you're trimming some areas of the portfolio. And in particular, is pruning still the right word or are you doing something a little beyond what that word suggests?

So, Chris, I think pruning is the right word. When these tariffs came through, they really created a great deal of turmoil within global supply chains, and so many of us in the industry had to evaluate where we played and why we put forth price increases. To help offset that, we took other actions to mitigate component cost increases to mitigate finished goods price increases. But to the extent that we were able or unable to get full capture on pricing in some channels, we made the decision to review that portfolio and understand where we needed to play and why. As I pointed out, our Contractor Select portfolio grew very, very nicely in Q4. And it's targeted directly at what we'll call a competition for that basic, lesser featured end of the market which is an important market to us. But there are certain channels where we feel we did not realize the type of financial profile that we're after. So we began to, if you will prune those products and assess which products we could mutually benefit both our customers as well as our shareholders in terms of profit margin. So when we think about our business going forward, the turmoil that has been created in two ways, the price increases have created pull forwards almost illogical [ph] distortions of the market, of people trying to avoid those price increases. So it's going to make it very difficult. It made it very difficult in 2019 to really understand period-over-period growth what was truly happening in the market. And we think that 2020, at least for the first half will be exacerbated by the same types of things. We also have a little bit of noise around the fact that we had a load in of certain customers…

Yes. Congrats on the gross margin, and the free cash flow improvement noted as well. Just building up the last comments of the margin, you did build some momentum through the year on margins, but clearly most pronounced in the fourth quarter here, seemingly a springboard as the components of it seem to be from structural shifts as you've evolved a few things during the year. So, is that a pretty clear setup for favorable tailwind full-year margins fiscal 2020 comparing to the year just ended?

I think we should. We expect that we will see favorable margin comparisons in 2020 to 2019, but we expect that to be for the full year. So, if I could encourage everyone to not obsess over each quarter, we expect that the full year will be favorable. It's also very interesting to note, and I just wanted to point out again that the un-absorption or the under absorption of fixed manufacturing this quarter was almost $10 million. In the year ago period, the under absorption was almost $5 million. So, when we think about how we're structuring our business and how we're managing that, we did a great job this year in managing our inventory levels down, improving our service, and you saw that in our tremendous cash flow. Part of that tremendous cash flow was the collection of receivables for the load end of the year ago period. But we've done a great job managing our balance sheet, and I expect that we will continue to see positive margin improvement in 2020 over 2019.

Our next question comes from Deepa Raghavan with Wells Fargo Securities. Your line is now open.

Hey, good morning. Vern, Karen, welcome. Just dovetailing on that margin improvement question. Vern, can you talk about the drivers to the margin improvement in fiscal 2020? I mean you mentioned all these actions which I guess it's pretty comprehensive, but can these actions lead you to say, I'm just throwing a number out there, 41% gross margin improvement for the full year irrespective of volume performance. I guess that's the big question for me. How do we think about your resiliency in a weak volume environment? And on the flip side, how do I think about pricing? Because that was a big help to margins this time. If tariff were to ease, I mean will import competition pick back up and start to pressure margins again? So, yes, two sides of the coin sorry, if you will, I'd appreciate.

Sure. Channel mix was a significant driver to our improvement in margin. So as we ramped up or as our sales through our independent sales network primarily the C&I market that became a larger percentage of the total sales in Q4 relative to the total percentage that retail or sales through the retail sales channel were. So that shift in channel mix had a meaningful improvement on the gross profit margin. I would like to point out and I think it's really important, if you were to look at again the change in our operating profit between periods excluding the unabsorbed overhead, it was a decline of $5 million on a drop of almost $123 million of sales. So I think what shareholders should take from Acuity is that we are managing our business and our portfolio well to both optimize our profit, but also to optimize our profitability and to return back that cash ,if you will, in the form of great cash flow. Because we have de-levered some of our exposure into some of those markets. From a growth perspective going forward from a margin perspective, I'm not going to prognosticate or give guidance around that. What I will say is that we expect the mix of our business to continue to a degree as it is or as we reported in Q4. And that should have a favorable impact on gross profit margins. The notion of the volume and demand in the marketplace to your question is really important. We still expect that the first quarter or market conditions which will impact our first quarter to still be sluggish. Order rates I think in the near term continue to be a challenge. I think there's a lot of economic uncertainty out there. So we're looking to not…

Got it. Thanks for the color. I think a follow-up to the same question that we're talking about it. So let's just say the tariffs rate to ease a little bit here. When do you expect kind of bulk of these projects that we're talking about that are on the sidelines come back online pretty quickly? And I mean generally how do we think about election year actually throwing in some uncertainty on top of it. I appreciate that and that will be my last question for the call. Thank you.

Sure. Thank you. So our many sales forces continue to see an experience, if you will, record backlogs which is their projects aren't releasing. And I think because of uncertainty around cost many of these projects are --they're years in the making. They're not one month and so therefore when they decide that they're going to build a commercial office building that's going to take two years from start to finish to come into place, they're trying to project their cost. So the uncertainty of tariffs has a meaningful impact on when they say go. I think as we get clarity around those things, you're going to see more of those projects come to fruition. Architects and engineers even though the architectural billing index has softened up a little bit here continue to be very busy. We don't hear of anyone laying people off. So we still think that there's good activity out there. To the extent that our price capture has really gone mostly to offset the tariff increase, so to the extent that tariffs start to abate for whatever reason. I think that you might see some of the pricing readjust. But in our perspective, it's been a -- it's been kind of a cost neutral. So I wouldn't expect us to see any significant profit profile change because of that. Other than we would expect to see volume growth which is hugely beneficial for Acuity because we have a very solid variable contribution margins on an incremental sales dollar of growth.

Our next question comes from Brian Lee with Goldman Sachs. Your line is now open.

Hey, guys. Good morning. Welcome, Karen. Thanks for taking the questions. First one, maybe just on the volume growth, maybe drilling down a little bit, I know there's a lot of moving parts here heading into 2020, Vern, but on new construction volumes, can you kind of give us a sense of where you think those are tracking at? I know in past quarters seem like you guys have been mentioning sort of down low single digits. So, if you could maybe update us as to how the trend in that particular vertical is looking right now?

Sure. So, again, we're not economists, but when we look at information, I think the US Census Bureau does it well. On inflation adjusted basis, seasonally adjusted, the overall market for electrical lighting equipment, it's been down like eight of the last nine quarters. On inflation adjusted basis, when we look at some of the other items, non-resi has kind of been on the decline here, whereas non-residential -- I'm sorry, I meant to say resi, has been down, non-residential has been flattish to slightly down. I think what's been propping up a lot of stuff has been public non-residential. So we continue to see an environment that is, again, I'll call it sluggish, with a lot of larger projects remaining on the sidelines in people's backlogs not being released. One positive thing that I think is important is the fact that when we look at the Dodge Momentum Index, while it was declining, starting in kind of middle 2018, it seems to have flattened out. So I think that when we look at the overall market, we continue to see new construction on an inflation adjusted basis to be flat to slightly down for those folks in that portion of the industry that have non -- say, deflationary items, unlike the lighting industry, they're probably actually showing some growth.

Okay. Now that's fair enough. Helpful. And then, just second question here, and I'll pass it on. I know you've done this in past quarters as well, clearly some company specific issues for you guys are doing the compare here. But how would you say you compare to the industry growth rate during the quarter? And then, I know you traditionally don't give the guidance but you're giving guidance if you want, what are you expecting kind of the baseline to be for that quarter? And really the reason I ask is, there has been a few quarters here now where you've under-performed the market it would seem, so trying to gauge when you think in fiscal 2020, you sort of get back to the historical trend of being able to outgrow the market.

Yes. So if I look at the overall growth rate of the market, as I just commented, the market for the last, again, seven, eight quarters has been down anywhere from 1.5 to almost 4 points on an inflation adjusted basis. So Acuity's growth during each of those quarters or performance against that still has outperformed the overall growth rate of the market. I think we've had a couple of things here that are specific to Acuity. When we decided to again look at our portfolio and determine the profitability of those items relative to what our expectations are. Yes, we did take some actions that were specific to Acuity around those products in certain channels. But when I look at overall C&I, which is the non-residential portion of our world, sold through agents commercial and industrial, I would say that our performance there is still positive relative to the market. Some of the lumpiness that we've seen in our corporate accounts world has been more due to the timing of releases. As you know, Acuity was the vendor of choice to relight all of the target locations, and we've completed that. And we have expanded our customer base to now add many, many additional customers, not all of whom have moved as quickly or as large as Target. So we're having, if you will, some lumpiness, it's what I call it. But yet our expansion and the amount of footprint that we cover with our connected lighting Atrius-enabled solutions continue to grow at a formidable rate. And now, we're expanding that capability into other verticals. So when I look at Acuity's growth and I compare it to the market, I'm looking at various channels and I'm looking at various segments of the market. And where we have participated in the same way, we continue to believe that we are either maintaining or growing market share. When we look individually, for example, at our lighting controls solutions, we believe we are gaining significant market share. When we look at Contractor Select, it went from being really a very small portfolio less than 18 months ago to now almost 10% of our total revenues. And we like the profit margin capabilities off of that. That growth has come in the C&I channel primarily. So I think we are well balanced, positioned well to continue to outperform the growth rates of the markets we serve, and to the extent that there is business out there that we feel is not mutually beneficial. We're not afraid to look for other channels to serve.

Our next question comes from Joseph Osha with JMP Securities. Your line is now open.

Hello. Thanks and welcome, Karen. I have two questions. First, when we think about this free cash flow, which is formidable, and if we were to look forward 12 months and maybe sort of think about how that pie is segmented between additional acquisitions and buybacks, I'm wondering how you're thinking about that free cash flow deployment. And secondly, not to harp on, I think the point everyone has been harping on, but it seems to me that you could have grown this business more and taken, call it, a 40% gross margin in the fall through to the operating line probably would have been better. At what point does that top-line growth begin to become more important than moving this gross margin higher than where it is now?

Sure. So, Karen, maybe you take the first question on cash flow, and then I'll answer the second.

Sure. Historically, we have spent about a third on acquisitions, a third on share purchases and a third on CapEx and dividends. So I think we're always looking for ways to optimize shareholder value, and surely share repurchases and acquisitions and dividends and CapEx are part of that. So I think that's where you'll see the use of our cash flow over the next year.

So no change really in terms of that?

Correct, no change. Yes.

And I would say that we continue to be opportunistic. We have a very robust pipeline of acquisitions. We just completed the acquisition of The Luminaires Group. We continue to look at not only traditional lighting businesses to complement our portfolio, but also really interesting technologies to complement our connected lighting Atrius-enabled solutions. So I want to tell everyone, we are making really solid progress in implementing our strategy around Atrius in the connected lighting space. I wish that the SaaS revenues could start to meaningfully move the top-line that has a $3.7 billion business. It's still in its early stages, but it's really encouraging. To your second question on top-line growth and letting the margins flow through, I really think it's important that when you do your analysis of Acuity's results that you consider again the $123 million change in year-over-year growth or decline in top-line and yet on an adjusted basis, excluding the unabsorbed overhead in both periods, it impacted our profitability by a drop of only $5 million. So I think Acuity is really focused on growing its top-line to in fact grow its bottom line and improve our profitability. But the news and the actions that we've taken to adjust our portfolio, I think, are really in the best interest of our shareholders and that free cash flow was really powerful, and it shows you the power of Acuity. So we balance off how do we have profitable growth in the definition around that. And we define profitable growth at Acuity based on the returns. Our return on invested capital this year was 18%, 800 bps greater than our weighted average cost to capital. We look at other things like cash flow return on investment. It was almost 35% this year. Our returns are robustly huge. Having said that, we are about growth, and I think 2020 to get growth, it's going to be about market share gains in every channel that we focus on.

Our next question comes from John Walsh with Credit Suisse. Your line is now open.

Hi. Good morning. Maybe following on that market share gains question, some of the levers there that are going to allow you to do that, obviously the DLC, very important for kind of incentive programs at utilities, I think they're coming out now or just talked about higher, more stringent qualifications to get those. And the terms they're using are controllability and quality of light, which should fit very well with your product portfolio. Is that something that can actually be meaningful? Is that a help to kind of the Tier 1 domestic OEMs versus the imports coming from overseas?

I think it's a huge impact or can have a huge impact. DLC is very important in terms of what they require. And so companies that are really focused on quality of light, who have invested significantly in understanding what controls mean. It's not just saying, I can dim a light or turn a light on or off, it's really how does it work in space? And too often these lesser quality suppliers, people experience tremendous flicker. And so the experience that one has in that space is not good. As DLC points, there are significant influence toward quality of light as well as competitive cost. I think it's going to benefit those manufacturers that have really invested in quality of life. So, yes, I do -- I think it will have an impact.

And then maybe just another question around the free cash flow, and just thinking about the inventory dynamics. I mean, last year you missed kind of that 100% conversion that we typically use as a benchmark. This year, you kind of over-drove that. I mean, how should we think about the free cash flow conversion rate going forward? Is there still any kind of working capital goodness as we think about our next year free cash flow number?

Yes, it's a great question. So our objective is to, as you point out, have free cash flow in excess of net income. This year, coming up may be a slight challenge, I think as Karen pointed out, we're expecting to spend between 1.7% and 1.8% on CapEx. That's slightly higher than our depreciation. So -- but just note that as a fact, I think from an operating working capital perspective, we're probably right now doing this from memory about 13% of sales, maybe even slightly higher than that. I think our total days -- our net days are about 56 or 57 days. We brought our payables down probably a little bit further than what we normally would expect. So I would think that our total days will come down from an operating, working capital perspective. We're at about 56 or 57 days for inventory. We have areas to improve there. Our teams are doing a great job. It really depends on what percentage of our business is coming from offshore into North America as we look to really drive the performance of our supply chain here in the North American market. We see opportunities to improve our inventory days. So I think you should expect from Acuity a continuation of attempting to meet that goal of 100% conversion of net income to cash flow.

Our next question comes from line of Tim Wojs with Baird. Your line is open.

Hey, guys. Good morning. Two quick ones for me. I guess first on the under-absorption, Vern, would you expect that to continue into the first quarter, just given the revenue guidance? That's one. And then second, how should we think of just leverage of SD&A in fiscal 2020? I think you did leverage SD&A a little bit in fiscal 2019, if you expect modest growth in the top-line in 2020, should we expect SD&A to grow similarly or can it actually maybe be flat to down?

So, on the absorption issue, we would expect there to be probably some negative or under-absorption in Q1 versus the year ago period. I haven't done any analysis to know how much that will be. It really depends on the order rate and our ability. We know we can service your order, right. But how is that order rate going to manifest itself. Orders continue to be somewhat sluggish, so we do see some bright spots. And we hear encouraging words. Words don't mean much, orders mean everything. So, we'll focus on that. But yes, I think you will see a bit of unobserved overhead, not to the significance of what was in Q4, where that number was $10 million in the year ago period of Q4, it was $5 million. I think you'll see a smaller number less than both of those, but I don't know that factually. On your SDA question, so here's the challenge, as you might imagine. We're trying to manage SDA and all costs, not just SDA, but all costs, all of our spend in a way that allows us to be consistent with what the demand is in the current period, but also holding out knowing that we have an expectation that there'll be future improvements in demand. So we're trying to balance off all of those things. As I mentioned, we have a couple of warehouses that we were able to shut down and consolidate, so we could reduce our cost. But we continue to look at all aspects of our business to drive further leverage. We prefer to get the leverage because we have top-line growth, but we will manage our fixed cost structure and our variable cost structure based on the environment that we find ourselves in. Our headcount is down approximately 9% on a year-over-year basis. So we've had to manage our business while experiencing these huge spikes, and then -- in orders because of people trying to avoid price increases and then boom. The volume or the business falls off. So it's been quite a challenge to manage, but our expectation is to further leverage our SDA. Our costs are up because of wage inflation. It's been a tight labor market out there. And so, we'll continue to experience those. We have made some investments in some areas, but we've also de-invested in some other areas. So, we will -- I think, Dan, we finished the quarter at about 26.5% SDA as a -- I have it here some place.

Yes. Correct.

So 26.5%, but I think the bigger or the more important aspect of it is what will the spend dollars be. We could see a little bit of an increase. It just depends on what the drop off in volume is going to be in Q1, knowing that we have -- we're carrying a little bit more expense from Q4 into this coming Q1 compared to what occurred last year. So probably have a little bit of a challenge there in Q1, but I think for the full year, we will -- you will see leverage in our total fixed cost opportunities. End of Q&A

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

Ladies and Gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.