Acuity Brands, Inc. (NYSE:AYI) Q2 2024 Earnings Call Transcript

Acuity Brands, Inc. (NYSE:AYI) Q2 2024 Earnings Call Transcript April 3, 2024

Acuity Brands, Inc. misses on earnings expectations. Reported EPS is $2.84 EPS, expectations were $3.11. Acuity Brands, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the Acuity Brands Fiscal 2024 Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, the company will conduct a question-and-answer session. Please be advised that, today’s conference is being recorded. I would now like to hand the conference over to Charlotte McLaughlin, Vice President of Investor Relations. Charlotte, please go ahead.

Charlotte McLaughlin: Good morning, and welcome to the Acuity Brands fiscal 2024 second quarter earnings call. On the call this morning is Neil Ashe, our Chairman, President and Chief Executive Officer; and Karen Holcom, our Senior Vice President and Chief Financial Officer. Today’s call will include updates on our strategic progress, and on our fiscal 2024 second quarter performance. There will be an opportunity for Q&A at the end of this call. As a reminder, some of our comments today may be forward looking statements. We intend these forward looking statements to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as detailed on Slide 2 of the accompanying presentation. Reconciliations of certain non-GAAP financial metrics with their corresponding GAAP measures are available in our 2024 second quarter earnings release and supplemental presentation, both of which are available on our Investor Relations website at www.investors.acuitybrands.com.

Thank you for your interest in Acuity Brands. I will now turn the call over to Neil Ashe.

Neil Ashe: Thank you, Charlotte, and thank you all for joining us this morning. Our fiscal 2024 second quarter was another quarter of solid execution. We increased our adjusted operating profit, adjusted operating profit margin and adjusted diluted earnings per share. We generated strong free cash flow, and we allocated capital effectively to drive value. Both our lighting and our intelligent spaces businesses delivered strong financial performance. In ABL, we increased adjusted operating profit by $3 million on $47 million less sales and increased the adjusted operating profit margin 120 basis points to 16.2%. This performance is is the cumulative result of the changes that we have made to the business over the last four years.

We have made the business more predictable, repeatable and scalable by executing on our strategy to increase product vitality, elevate service levels, use technology to improve and differentiate both our products and how we operate the business and by driving productivity. During the second quarter, we continue to make progress on our strategy. By focusing on the needs of our customers, we are elevating our service through our differentiated portfolios. Contractor Select is about 300 of our most popular products that are used in common everyday lighting applications. These products are designed to be resold and are in stock at retailers and electrical distributors. Through high levels of product vitality, we have been able to create a portfolio that offers quality products that our customers want at competitive prices, while at the same time, allowing our distributor partners to carry less inventory.

Design Select is comprised of products that are configurable and allow customers to easily select the products needed for their projects. We are less than a year into launching the first wave of Design Select, and we are continuing to expand the product families and configurations available. The reception so far has been positive. A recent project in California is a great example, where a customer needed indoor fixtures, outdoor fixtures and lighting controls. Using options from the Design Select portfolio, we were able to meet the unique product combination of the project, ensure it was there when the customer needed it, and then it was easy for the contractor to install. The remainder of our product portfolio is made to order. These are specialty products or solutions made for specific applications, such as national accounts that satisfy all of the wants and needs of the Lyon design community.

At the same time, we continue to make investments for future growth. In the second quarter, we expanded our horticulture product solutions. We add the Arize family of products to our existing Verjure line in order to take advantage of a growing market. Arize is a collection of professional grade LED horticulture luminaires, that are compatible with our in-line air wireless controls and are used in commercial greenhouses, indoor cultivation and vertical farming. This small investment accelerates our product portfolio efforts in this attractive vertical. This approach to investment in ABL is the right one, as evidenced by the value being realized in our OPTOTRONIC driver and component business. We acquired OPTOTRONIC in 2021 in order to control more of the technology in our luminaires to expand our OEM channel and to take greater control of our electronic supply chain.

Today, we are one of the top driver suppliers to the lighting industry and to ourselves as we manufacture the majority of our drivers for our own products. This control not only offers us a financial benefit but also offers us greater engineering flexibility during the design and development process that is core to our product vitality efforts. This quarter, we introduced the IVO family of shallow recessed downlights from Gotham which is a new platform from a vendor downlights that have a compact design for use in confined spaces that replace the traditional canned recess lighting fixtures. IVO can be used in most nonresidential settings in both new construction and renovation. The compact design and high efficiency options deliver real value for our customers, while the use of less steel, less aluminum and less plastic drives margin for us.

Finally, this quarter, several of our brands were recognized by the industry. Our Aculux, Eureka, Hydrel, Luminis and Peerless brands were awarded 9 good design awards from the Chicago Athenaeum Museum of Architecture and Design. We were awarded 11, 2023 product innovation awards by Architectural Products Magazine for impressive innovation in terms of form, functionality and sustainability. And 14 of our luminaires were selected across multiple product categories by the lift design awards for exemplifying outstanding creativity and innovation. Now moving to our Intelligence Spaces Group. Our mission in our Intelligence Spaces business is to make spaces smarter, safer and greener through our strategy of connecting the edge to the cloud. Distech has the best edge control devices on the market, while Atrius will be the best in cloud applications.

At Distech, we are focused on expanding our addressable market in 2 ways. The first is geographic and the second is increasing what we can control in a build space. As part of our geographic expansion, this quarter we added additional systems integrator capacity in Australia, and we released Atrius Sustainability and Atrius Energy in France. Our independent SIs are key to the organic expansion of our spaces business. We partner with the best SIs in specific geographies to sell our full suite of Distech and Atrius product portfolios. Our Atrius applications are making a difference for our customers. Atrius sustainability is an automation tool that captures, categorizes and reports on carbon emissions, while Atrius Energy facilitates the reduction of energy and carbon usage by allowing facilities teams to benchmark their usage and prepare for upcoming reporting obligations.

Our Atrius energy and sustainability applications are gaining recognition. Commercial Property Executive magazine named Atrius and innovative technology winner in its annual influence awards. And CRE tech selected Atrius as a finalist in its real estate tech awards that on our technology vendors that are advancing solutions for commercial buildings. Now turning to the outlook for the remainder of the year. We are performing well. We are satisfying customers, expanding margins and generating strong free cash flow. The order rates in both our Lighting business and our Spaces business are growing year-over-year. In our lighting business, we are back to typical lead times and absent the impact of sales from excess backlog last year, we would be experiencing sales growth.

In our lighting and lighting controls business, our strategy drives strong execution, and we are focused on returning the business to growth in a normalized environment, while leveraging our fixed costs and generating strong cash flow. In our Spaces business, we will continue to grow geographically and by adding to what we can control in a build space. Karen will outline what that means for our second half outlook after giving you an update on our second quarter performance. Karen?

Karen Holcom: Thank you, Neil, and good morning to everyone on the call. As Neil said, we continue to execute well. In our fiscal second quarter, we increased our adjusted operating profit, improved our adjusted operating profit margin and increased our adjusted diluted earnings per share while generating strong cash flow. We continue to allocate capital effectively while making progress on our strategic priorities. For total AYI, we generated net sales in the second quarter of $906 million, which was $38 million or 4% lower than the prior year as a result of the lower net sales in our ABL business. This was partially offset by continued growth in the ISG business of 17% in the quarter. We continue to deliver year-over-year margin improvement.

During the quarter, our adjusted operating profit increased by $8 million on lower net sales, and we expanded adjusted operating profit margin to 15.5% an increase of approximately 150 basis points from the prior year. This increase was driven largely by the significant year-over-year improvement in our gross profit margin as we continue to execute our strategy and drive margins through product vitality, the management of price and cost and productivity improvements. During the quarter, our adjusted diluted earnings per share of $3.38 increased $0.32 or 11% over the prior year, primarily a result of higher net income and to a lesser extent, lower shares outstanding due to share repurchases. In ABL, net sales were $844 million in the quarter.

A decrease of around 5% compared with the prior year, driven by declines across all of our channels. As Neil mentioned previously, our order rate in ABL continues to grow year-over-year meaning absent the sales last year from the excess backlog, ABL would have experienced sales growth. ABL’s adjusted operating profit increased 2% to $136 million on lower net sales. While we delivered adjusted operating profit margin of 16.2%, a 120 basis point improvement over the prior year. ISG’s net sales for the second quarter were $68 million, an increase of 17% as Distech continued to grow and KE2 Therm performed as we expected. ISG’s adjusted operating profit was $14 million with the adjusted operating profit margin at 21%, a 240 basis point improvement over the prior year.

Now turning to our year-to-date cash flow performance. We generated $293 million of cash flow from operating activities in the first half of the year, down slightly from the same period last year. We continue to allocate capital consistent with our priorities. Year-to-date, we invested $29 million in capital expenditures. We acquired the assets of Arize Horticulture Lighting, we increased our dividend per share 15% and allocated approximately $68 million to repurchase over 370,000 shares. In January, our Board of Directors authorized the additional repurchase of up to 3 million shares of common stock, bringing the outstanding authorization to approximately 4 million shares. Since the beginning of the fourth quarter of fiscal 2020, we have repurchased approximately 9.5 million shares at an average price of about $145 per share, which was funded by organic cash flow.

This amounts to about 24% of the then shares outstanding. We had a strong first half performance. We delivered improved margins and increased adjusted diluted earnings per share. We generated strong cash flow from operations and continue to allocate capital effectively. While it is not our practice to address our outlook during the year, our performance in the first half was very strong and we are raising our full year expectations for EPS. We now expect our 2024 adjusted diluted earnings per share range to be between $14.75 and $15.50. Thank you for joining us today. I will now pass you over to the operator to take your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Joe O’Dea with Wells Fargo.

Joe O’Dea: So first question, I’ll group kind of 2 in 1, but I wanted to ask about infrastructure and SD&A. And really, the angle is, are you seeing evidence that some of the changes in the commissions that you implemented last year are translating to better wins at this point. You can talk about the infrastructure pipeline a little bit. As well as just when you see where SD&A is as a percent of sales, opportunities that you see there, either volume leverage or cost down.

Neil Ashe: Okay. Great. Joe, thank you. So first of all, on infrastructure, we’re feeling good about our positioning for the larger projects that are coming down the pipe. I think everyone is recognizing that they are coming down on a longer-term basis than anyone would like. We’d like them to be here today, but orders are strong, but shipments and sales will be spread out over the next year or two. So there will be a continued impact from infrastructure and we’re confident we’ll get at least our fair share, and we’re working to get a disproportionate share. So we feel like that’s a good opportunity for us going forward. We also feel, to your question, we positioned ourselves well from an execution perspective. So first, around products for — that are necessary to win those projects.

And then the combination and the interrelationship between our direct sales network and our independent sales network as we approach those. So we feel good about those. As it relates to specific SD&A spending, obviously, we’re in a position this year where we are — our performance is — appears different than it would normally and the reason for that is the excess sales from backlog in last year. So we’re confident that, number 1, we’ll return the lighting business to growth. And that number 2, when we do that, the combination of the increased margin performance we’ve demonstrated at the gross margin level, as well as our ability to leverage SD&A costs going forward, we’ll continue to expand margins in that business. So it’s not insignificant achievement to expand margins on lower sales, obviously.

And so we’re looking forward to that business being — returning to normalized growth.

Joe O’Dea: I appreciate it. And then also just wanted to touch on cash and deployment. The cash balance at this point is approaching $600 million. And how you’re thinking about sort of repurchase activity, any revisions to that within the guidance framework as well as with the higher cash balance, just what we should interpret within that and perhaps strength of the M&A kind of pipeline if you’re seeing more opportunities out there?

Karen Holcom: Yes, Joe, thanks for that. Overall, we are really pleased with our cash flow performance this quarter or this year-to-date period, we’ve generated $263 million of free cash flow. So really strong cash flow performance. It’s driven a lot by our margin performance, which is contributing to the higher net income versus — despite the lower sales. So overall, really pleased with that. When we look at our capital allocation priorities, we’ve been really clear over time that it’s first to invest in the business for growth, second to invest in M&A, which we’ve done over the past few years, we’ve made some small but relatively small but strategic acquisitions with OPTOTRONIC with KE2 Therm and now with the Arize horticulture assets.

So really pleased with the progress we’ve made there. Maybe you noticed we did increase our dividend by 15% this quarter. So excited to see that increase. And then finally, share repurchases. We’ve demonstrated when the share price is high, we buy less. And when the share price is low, we buy a lot more. So this quarter, we’ve repurchased cumulative 24% of our shares outstanding. And this year-to-date period, it’s been at about $180 a share. So feel really good about where we are from our capital allocation priorities.

Neil Ashe: Karen, I’ll build on that just for a second. So we feel really good about the — our ability to generate value through capital allocation. So First, on the M&A pipeline, we — our focus continues to be on expanding the Intelligence Spaces group. We have a good pipeline of both small, medium and large-sized acquisitions. As Karen mentioned, we’ve done really well with the acquisitions that we’ve made to date, and we’re patient. So we don’t feel an obligation to move until we find the right opportunity that is going to have the right impact at the right valuation. Second, as Karen mentioned, we increased the dividend. We did that because we can. We can continue to — we can afford to pay the dividend at a higher rate and achieve the strategic opportunities that we perceive.

And finally, we’ve demonstrated on our repurchase of almost 1/4 of the company at very attractive prices. As Karen mentioned, that when the stock price is lower, we’ll buy more and when the stock price is less, we’ll buy higher. So when you put it all back together, we view capital allocation as a strategic lever for us to generate value, and we feel really good about our progress on that so far.

Operator: Our next question comes from the line of Ryan Merkel with William Blair.

Ryan Merkel: First on the new EPS guide. What does it assume for sales for the full year? Neil, you mentioned orders are growing and you expect to return the lighting business to growth in the second half you just talk about that a little bit more?

Neil Ashe: Sure. I — so first of all, we’re really pleased with our performance so far this year. It’s — as you know, it’s not our practice to address guidance other than in the beginning of the year. It’s our preference to define an outlook at the beginning of the year and then to execute against it. Our first quarter performance, obviously that was really strong, largely driven by the margin performance. As we look forward for the remainder of the year, we — obviously, we planned conservatively, given all of the uncertainties going on in the world. So we were appropriately conservative in our plan, and we’re adjusting our performance as we perform for the rest of the year. The lighting business will perform as we expect going forward, I would extend that line to be more than just the back half of the year.

But as we return that to growth over a normalized period. So the rest of this year, next year, and beyond. So we feel really good about how we’re going to do that as well. It will take a minute for us to continue to work through kind of the inflated sales from last year. But when you look at the performance over a longer period of time on a multiyear stack or where we are in the lighting business, we feel really good about that. So — we did not change the revenue guidance. So we feel confident we’re in that range, and we’re really pleased with our performance from a profitability perspective.

Ryan Merkel: Got it. All right. And then I wanted to ask on ISG, really nice growth. Just high level, are you seeing a lot more interest in controls? And are there any drivers of that, that may be new?

Neil Ashe: Yes. So thanks for that question, and I’m going to use it as an opportunity to kind of explain 2 things, if you’ll allow me, Ryan. First is that we have a very strong control business in the lighting business. Acuity is a brand lighting is 1 of the largest, if not the largest control player for lighting control, specifically. And Distech is OEM provider to Acuity brand lighting for those controls. Specifically now as it relates to our performance on ISG, we feel really good about our strategy there of growth. We’re expanding the addressable market for Distech and we’re seeing disproportionate demand there for 2 reasons. One is I think it’s fair to say our controls in sensors at Distech are perceived to be the highest quality in the marketplace.

So they’re very attractive to building owners and facilities managers because it gives them more flexibility than many other solutions. So they have — because they’re open protocol, and because we have open SI distribution, they have the opportunity to be confident that, that investment will carry them forward in an attractive way. We also feel really good about our ability to add more things that we can control, so KE2 Therm is a great example where we acquired effectively products which fit into the Distech portfolio, work within the broader Distech ecosystem and open up additional verticals like retail, convenience stores, et cetera, that have high refrigeration needs. So we feel good about that strategy going forward. So Distech has been taking share in each of the markets which it competes in.

And now we have the opportunity to expand the market. It competes in, number 1 and expand the number of things that it controls. And then finally, when you connect the edge to the cloud, which is the Atrius data layer that we have been building, it allows us to take the data that all of those sensors and controls generate and present it to the cloud in a manner in which applications can be built, which make a difference in those build spaces. So we feel really good about the business that we’re building there. We think we’re building a really valuable technology business.

Operator: Our next question comes from the line of Christopher Glynn with Oppenheimer & Company.

Christopher Glynn: I wanted to dive into some of the implications for Contractor Select and Design Select. That manner of product management or categorization internally. Would you consider that the backbone of your productivity momentum?

Neil Ashe: I think it’s a big part of it, Chris. So — and to spend just another minute on Contractor Select. So our strategy with Contractor Select is to make it the brand of choice for retail and electrical distribution with high product vitality at appropriate prices with high service levels, largely for distributors. And as I mentioned, it’s built to be stocked and resold. So designed to be stocked and resold. And we — it’s a very constrained number of SKUs. The — what that’s allowed us to do is to build a very consistent relationship with the distribution and retail community. And what that has done is provided us with a foundation and easy for them to choose. And it’s worth noting that there’s a lot in it for them, too, because we’ve created a portfolio that allows them to have less inventory on hand and satisfy the needs of their customers at an appropriate price.

They’re able to drive significantly higher returns on investment in the execution of their business. So at the same margins, they’re making significantly more money as a result. So yes, it’s been a really important part of that product portfolio. The second thing is we’ve raised the margin portfolio of that, we’ve raised the margin of that portfolio, excuse me, to much more consistent levels with where we are now. So that’s driven some of our margin performance. With Design Select, we’re really just getting started. So where Contractor Select is designed to be resold, contract — or Design Select is designed such that options can be chosen so that you can, a specifier has the opportunity to choose from options to configure the products and the projects that they need.

As we mentioned in the script, we’re at the early days of this. So this will be a multiyear process, but it is changing how both specifiers think about our portfolio and how we think about the execution of that portfolio. The majority of our business though remains made to order. And so that made to order — its made to order for a reason, so the specifiers can make the choices that they need so that they can satisfy large projects. We can satisfy national accounts. We can — there are a lot of different pieces of that puzzle. We asked — Joe asked about infrastructure earlier. We won the relight of the city of Philadelphia. That’s a good example of a made-to-order projects. We made some changes to our product portfolio to satisfy some of their specific needs, and we can roll those out.

So when you take those all together, then we’re — everything is operating at a higher margin profile and it’s set and it’s doing a much better job of satisfying very specific end user needs in the marketplace.

Christopher Glynn: The extension of that question, you’ve talked a lot about ability to choose and select the projects you want to be on considering all the productivity you’re generating that you just elaborated on. Do you see a consistent widening of the aperture moving ahead in terms of what’s attractive to you to select within the overall lighting market.

Neil Ashe: Well, we feel very good about how we’re positioned competitively. So we — obviously, we pay close attention to our competitors to the — and we generally think about this from a windshield perspective. As you indicated, like which projects we want to select. So we’re obviously competitive on the Contractor Select side. We’re doing really well there. We’ve been competitive on the project side. So there are a handful of examples where we’ve passed on projects because we don’t like the margin profile, and we’re happy for our competitors to execute on those at a lower margin profile, and especially given that their margin profiles are already lower than ours. So when we do not select those projects, that means someone else has selected those projects, and they’re executing them at a lower margin than we have and at a lower margin than we would accept.

So as we look going forward, we still see the opportunity then to build on that to grow, both on the business that we already have as well as when we add and we add new verticals. So horticulture is a great example. As you know, there was 2 or 3 years ago, there was a rush to invest in that vertical. And people invested a significant amount of money multiple companies did to try and pursue that vertical. We identified that vertical then as an attractive vertical. We just didn’t think it was worth the level of investment that would — that the market was asking for at that time. So what we did instead was we started organically. We built a product portfolio from scratch organically designed from scratch, built from the ground up. And now we’ve started with the Arize portfolio to add to that and to add to the distribution of that, which gives us a green light opportunity to grow in a vertical that, over the long term, we think will be attractive and with a measured level of investment.

So when you put that all together, we’re choosing where we want to compete in the marketplace. We are demonstrating the ability to do that through product and service innovation as well as through our management of price and margin.

Operator: Our next question comes from the line of Jeffrey Sprague with Vertical Research.

Jeffrey Sprague: Maybe just address a little bit more kind of the geographic expansion how you’re — which geographies you’re choosing to target the bandwidth of the company to kind of execute on that? And — is this something where we could see a higher level of activity from this point forward?

Neil Ashe: Yes. Thanks, Jeff. So our geographic expansion is focused on the Intelligence Spaces Group. So it’s worth pointing out that the standards are mostly global for the Distech product portfolio and the edge to cloud opportunity, the application for Atrius are global. So that gives us the opportunity to expand without having to create new product portfolios with some small exceptions, which are not available to us like Germany, for example. As a result, we are building on the strength there to roll that out. So we have strength in North America. Obviously, that’s our home market. We are probably half penetrated where we think we can be in the U.S. And so obviously, the bigger markets will invest for growth there. We’re also successful in France.

I think in the last quarter, we identified we have really high market share in France. We’re now expanding into more of Europe, so — and well through the U.K. and other markets. And then we’re focused on markets that look like that. So Australia, we added SI capacity. We’ll be looking for ways over the course of kind of the next 6 to 12 months to figure out how to accelerate that expansion for ISG geographically. Our aspiration for that business unit is that it is a global unit that makes spaces smarter, safer and greener through a combination of edge to cloud, edge controls and sensors devices and the cloud or applications that do something with the data that those sensors and controls generate. So — so yes, you can expect us to be focused on expanding that business globally.

And we’re basically in North America and France at this point. So there’s a big opportunity there.

Jeffrey Sprague: Great. And then perhaps for Karen, Neil, you can take it too, of course, just we’ve gotten this far in the Q&A without any real discussion of price. I know you’re not going to talk about price specifically, but — maybe just give us a little bit of update on kind of the tone of the market, what you’re doing there. And transportation costs were a big topic to the good last quarter. Are you seeing any significant changes there with kind of the chaos and global shipping, everything that’s going on?

Neil Ashe: Chaos is a good word, Karen. Why don’t you address pricing?

Karen Holcom: I’ll address some of the pricing. So Jeff, overall, we continue to be really pleased with our gross profit performance. And that really is resulting from what we’ve talked about on the call already is the strategic management of price and being able to get the value for our products that they deserve in the marketplace. While at the same time, we are working on input costs with our suppliers. We’ve seen some benefits this quarter in steel and electronics. So that’s helping us. And then freight is continuing to benefit year-over-year. So overall, we feel the focus on our portfolio segmentation that we talked about with Contractor Select, Design Select and made to order, helps us on strategically price the products and get the value that they deserve in the marketplace.

Operator: Our next question comes from the line of Bobby Schultz with Baird.

Bobby Schultz: I’ve been I think, 3 quarters now where you’ve posted 45% plus gross margins. How should we think about the sustainability of those margins into the second half year and then looking into 2025?

Neil Ashe: Yes. Thanks, Bobby. So as I mentioned when we were talking about our adjustment to our EPS guidance, we feel really good about our performance. And I’ll build on Karen’s answer to Jeff’s question about price and margin, which is that we are managing our pricing such that we’re realizing the value for — that our products are providing in the marketplace. And on the input cost, we’re doing 2 things. One is our product vitality efforts are changing the amount of content that is in each of our products and how we ship those products. So more products can be shipped on the same pallet. So I mentioned the IVO in my opening comments, that’s a really innovative product in the marketplace because it’s roughly half the size or less of what it is replacing, number 1, which obviously means there’s a lot less content.