Acuity Inc. (De) Q2 FY2022 Earnings Call

Good morning, and welcome to the Acuity Brands Second Quarter Earnings Call of Fiscal 2022. At this time, all participants are in a listen-only mode. After the speakers’ 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.

Thank you, Michelle. Good morning, and welcome to the Acuity Brands fiscal 2022 second quarter earnings call. As a reminder, some of our comments today may be forward-looking statements based on management's beliefs and assumptions, and information currently available to management at this time. These beliefs are subject to known and unknown risks and uncertainties, many of which may be beyond our control, including those detailed in our periodic SEC filings. Please note that the company's actual results may differ materially from those anticipated and we undertake no obligation to update these statements. Reconciliations of certain non-GAAP financial metrics with their corresponding GAAP metrics are available in our 2022 second quarter earnings release, which is available on our Investor Relations website. With me this morning is Neil Ashe, our Chairman, President and Chief Executive Officer, who will provide an update on our strategy and highlights from the last quarter; and Karen Holcom, our Senior Vice President and Chief Financial Officer, who will walk us through our earnings performance. There will be an opportunity for Q&A at the end of the call. So those participating, please limit your remarks to one question and one follow-up if necessary. We are webcasting today's conference live. Thank you for your interest in Acuity Brands. I will now turn the call over to Neil Ashe.

Thank you, Charlotte, and good morning to everyone joining us to discuss Acuity Brands. Our team delivered another strong performance in the second quarter of fiscal 2022. For the second consecutive quarter, we delivered net sales growth of 17% and we maintained our gross profit margin at 41.7%, consistent with the first quarter. And compared to last year, we increased diluted earnings per share by 22%. Despite the cost challenges, we were able to convert our sales growth into operating profit and net income by effectively leveraging operating expenses. The world remains complicated. Although our demand environment is strong, costs continue to be volatile, and we are continuously dealing with the ongoing pressures resulting from the global component shortages. In spite of this, our team continues to execute well, and this is reflected in our performance. Both ABL and Spaces are performing admirably. Our decisions to prioritize shipments by investing in electrical components and transportation are resulting in higher sales and operating profits, albeit at slightly lower margins. Now, I want to move to talk to our progress at both ABL and Spaces. First, in ABL, I'm happy to report that some things are returning to the way they used to be. In March, we hosted our first in-person sales conference in three years, NEXT 2022. It was great to be back together with our Independent Sales Network, who have performed exceptionally through the ups and downs of the last two years. We have the best agents in the industry, and it was a great opportunity to talk about our strategic vision for Acuity Brands lighting, share many new products, and engage our agency partners around EarthLIGHT initiatives. This was the first time that many of our associates and agents had seen each other in person since the pandemic started. While we have been incredibly productive working virtually with our channel, it was great to spend some quality time together in person. It was hard not to be struck by the levels of energy and enthusiasm throughout the event and the consistency of the feedback from our agents. They said Acuity is delivering. Our investments in service have allowed us to prioritize delivering for our customers when others have been unable to. At the same time, our investments and product vitality have allowed us to continue to create compelling new products that are both innovative and market-moving. As I said last quarter, we have done this by focusing on three main areas. First, by focusing on strategic supplier relationships; the current environment has reminded us all that it really matters who you do business with. Because we are the largest lighting company, we have certain advantages over our direct competitors, but those same components are also used by larger industries. Consequently, we are making investments in people, time, and resources. We have recruited a new head of strategic sourcing for ABL. We are working with our key suppliers on effective planning and allocation management, and we are investing in inventory. Second, by empowering our teams to prioritize access and speed over cost on available components, we have been able to ensure continuity of supply across many of our existing product lines, while also supporting our ongoing product vitality efforts across our product portfolio. Finally, our engineering teams continue their Herculean efforts to redesign products to the available components. At the same time, these teams have also managed to introduce around 220 new or significantly upgraded lighting and lighting control products over the last two years. We expect the challenges around access to and cost of components to continue into the foreseeable future. Our strategy around product vitality, and the dexterity of our engineering teams in flexing to the changing requirements of the component shortages has been a significant part of why we are leading in this market, and we expect to continue these efforts. Another highlight of the NEXT conference was our focus on EarthLIGHT. EarthLIGHT is an important part of our strategy. Our product vitality efforts are not just about improving the functionality of our products; it's also about redesigning products to reduce customer energy consumption, reducing packaging and waste, and improving transportation efficiency. This quarter, we announced a new initiative that brings together both technology and sustainability to significantly reduce paper use by introducing scannable QR code instructions across our products. At NEXT, we also expanded our community outreach by packing 1,000 bags of food for a local Atlanta organization together with our agents. It was one of the highlights of the event. Moving to the Intelligent Spaces Group, Spaces had another solid quarter of growth. In both Distech and Atrius, we have a strong product roadmap to make spaces smarter, safer, and greener. Distech continues to win in the building controls market against significant competition. Through the Eclipse Controller Products, Distech is at the forefront of the technology curve with a presence in key markets and recognized leadership built on open protocol technology. In the last quarter, Distech recorded significant project wins and key verticals including education, commercial, infrastructure, and data centers. Distech is now a key supplier to two of the largest cloud providers. We also continue to develop the Atrius platform, including progress on Atrius building insights, and we expect to expand the portfolio over time. We continue to add talent to this team. Finally, I want to update you on our capital allocation. Our capital allocation priorities remain the same. We expect to continue to prioritize investments for growth in our current businesses, to invest in acquisitions, to maintain our dividend, and to allocate capital to share repurchases when there is an opportunity to create permanent value for our shareholders. This quarter, the Board of Directors authorized additional capacity for share repurchases to increase our remaining authorization from 3 million to 5 million shares. Since May of 2020, we have repurchased approximately 13% of our shares outstanding. I would also like to announce the appointment of Sach Sankpal, our Senior Vice President of Growth and Transformation. Sach joins us to manage our technology organization, to deploy our better, smarter, faster company operating system, and to lead the integration efforts for future acquisitions. Sach comes to us with distinguished experience at leading companies, including Trimble and Honeywell. We're excited to have Sach on our team. As I close, I once again want to thank our team for their ongoing efforts. Each quarter, we are faced with new challenges, and our team continues to deliver. Our continued focus on service and product vitality is allowing us to take advantage of the strong demand environment. I will now turn the call over to Karen, who will take a deeper dive into our quarter performance, and I'll be back later in the call for Q&A and some closing remarks.

Thank you, Neil. I want to start by reiterating thanks to our team for their work over the last quarter. I'm so impressed by their flexibility and ability to drive results. We delivered strong performance in the second quarter of 2022. We grew net sales, we managed margins effectively despite a volatile cost environment, and we leveraged our operating expenses. Net sales were $909 million, an increase of 17% compared to the prior year. This performance was driven by our focus on service levels and product vitality, a continued recovery in the end markets of both of our business segments, and the benefits of recent price increases and acquisitions. Gross profit was $379 million, an increase of $43 million, or 13% over the prior year. This improvement was driven by revenue growth and by offsetting the significant increase in input costs through price increases and product and productivity improvements. Gross profit as a percent of sales was 41.7%, a decrease of 170 basis points from 43.4% in the prior year, but flat sequentially from the first quarter of 2022. I will talk more about the current cost environment later in the call. Reported operating profit was $102 million, an increase of $11 million or 12% over the prior year. Reported operating profit margin was 11.3% of net sales for the second quarter of fiscal 2022, a decrease of 40 basis points over the prior year. Adjusted operating profit was $123 million, an increase of $14 million or 13% over the prior year. Adjusted operating profit margin was 13.5% of net sales, a decrease of 50 basis points against the prior year. Adjusted operating profit margin was lower than the prior year as a decline in gross profit margin was partially offset by leveraging operating expenses. Finally, we saw continued improvement in diluted earnings per share for the second quarter of fiscal 2022. Diluted EPS was $2.13, an increase of $0.39 or 22% over the prior year, and adjusted diluted earnings per share of $2.57 increased $0.45, or 21% over the prior year. Our share repurchase program favorably impacted adjusted diluted EPS by $0.06. Now moving on to our Segment. During the quarter, our Lighting and Lighting Control segments saw sales increase 17% to $863 million over the prior year. This was driven by the improvements within our independent sales network, which grew approximately 12% and an increase of 5% in our direct sales network. Additionally, sales in the corporate account channel increased approximately 105% over the prior year. Recall that last year, customers had paused their renovations due to the pandemic. That activity has now restarted as you can see from the growth this quarter. We also had growth in our other channel of 83% over the prior year, due primarily to the acquisition of OSRAM. Sales in the retail channel declined approximately 2% in the current quarter. This was due to some of our inventory being delayed in transit or held up in the port, resulting in longer lead times than we anticipated. We should start to see growth in this channel in the upcoming quarters. ABL's operating profits for the second quarter of 2022 were $117 million, an increase of 14% versus the prior year, with operating margin declining 30 basis points to 13.5%. Adjusted operating profit of $127 million improved 13% versus the prior year, with adjusted operating profit margin declining 50 basis points to 14.7%. ABL has demonstrated the ability to grow sales while leveraging their operating expenses. Moving on to the results for our Intelligent Spaces Group. For the second quarter of 2022, sales in Spaces increased approximately 16% to $50 million reflecting growth in both Distech and Atrius. Spaces operating profit in the second quarter of 2022 increased approximately $400,000 to $1.2 million. Adjusted operating profit of $6 million increased approximately $1 million versus the prior year as a result of the strong sales growth and continued investment in the business. Our business model continues to be highly productive, generating $127 million of net cash flow from operating activities in the first half of fiscal 2022. This was a decrease of $85 million compared to the prior year, due primarily to an increased investment in working capital primarily related to inventory. Inventory days are up over the end of our fiscal year, with approximately half of the increase due to increased lead times on sourcing finished goods and to a slightly lesser extent increase purchases of electronic components. We are managing our inventory levels to support our growth, as well as insulate our production facilities from inconsistent supply availability. We also invested $24 million or 1.3% of net sales in capital expenditures during the first six months of fiscal 2022. Finally, we have continued to repurchase shares in the second quarter. As a result, since May of 2020 we have bought back approximately 13% of our company shares at an average price of approximately $120 per share. I would now like to spend a few minutes focusing on the remainder of the year. As Neil stated, we expect the current environment to continue for the foreseeable future with strong demand while access and cost of components will remain a challenge. Our focus throughout will continue to be on growing sales and leveraging our operating expenses. In relation to the recent instability in Europe, we have no direct sales exposure either to Russia or Ukraine. However, the conflict does add to the existing supply chain pressures. Additionally, we're experiencing increases in transportation costs driven by expected increases in oil prices. In the last 15 months, we have strategically introduced fixed price increases in addition to driving product and productivity improvements. Before I hand you over to the operator, I want to leave you with our key takeaways. We have continued to demonstrate strong sales growth and effective management of gross margin in a volatile cost environment. We have leveraged our operating expenses, and finally we have continued to allocate capital effectively.

Thank you. Our first question comes from Christopher Glynn with Oppenheimer. Your line is open.

Hi, good morning. Thank you, and nice quarter. Curious, if you're seeing any instances of encountering elasticity, as you know, the price increases take fuller effect and commentary on backlog levels versus normal.

Yes, good morning, Chris. Thanks for being with us. As Karen indicated in her commentary, we've been able to strategically introduce fixed price increases over the course of this year, way more than we expected, obviously, and the reaction has been relatively accepting of those price increases. So you've seen us have success, obviously, in the top line performance as a result of that. Demand remained strong. So as we look at backlogs in terms of committed orders, they are obviously significantly higher than they usually are at this point, which is a reflection of both the strong demand as well as the availability of components that Karen alluded to. So we're trying to work through that as effectively as we can. We expect that dynamic to continue through at least the rest of the calendar year, where demand is strong and supply chain is tight.

Okay, thanks. And just follow-up from me, the guidance slide was removed in the Outlook section in the press release, do we just retain the prior quarter’s disclosure by default?

Yes. Introducing something new to the world is quite challenging. Our initial plan for the year was to establish a financial framework, which we did not plan to update throughout the year. This framework, as you may recall, projected mid-single digit growth for ABL and included the expectation of expanding operating margins, which we are currently achieving. Our focus this year will be on communicating what we are doing, the reasons behind it, and how we are executing it, all while delivering the best results possible. We mentioned aspects like price increases and volumes, and we are concentrating on three key areas: building strong supplier relationships, prioritizing access over cost for certain components, and continuously reengineering our products to adapt to the components available. This is how we are accomplishing our goals, and the positive outcomes are clearly demonstrating that.

Thanks, Neil. Just a small point of order. You just said mid-single digits for ABL, I think you're standing metric is high single digits.

Yes, high single digits. Sorry, thank you for correcting me, Chris. I didn't mean to accidentally give the wrong numbers.

Our next question comes from Ryan Merkel at William Blair. Your line is open.

Hey, everyone. Good morning, and nice quarter.

Thanks, Ryan.

So Neil, you mentioned that fixed price increases, and it sounds like realization is pretty good given the backdrop. Just curious, when do you expect to see the full impact just given a backlog of those fixed? And then, can you give us a sense of the range of like, what price could contribute once you start seeing the full impact?

Yes. So as we kind of talk through those, one of the things we highlighted in our last quarter was that we have intentionally not repriced the backlog. So just for those who may not know, when a project gets started, we start to make quotes for that project. When those quotes are accepted, we consider that a committed order and we honor that price going forward. So all price increases are effective from that point onwards. So you see the cumulative effect of those price increases in the backlog as it starts to roll forward. The challenge with managing or matching up price and cost is obviously, those are moving independently of each other. We have realized a significant amount of price and we will continue to realize more as the cumulative impact of that rolls out through the rest of the year. Independent from that, we are buying the necessary components to manufacture those goods. So, whether it’s components or the other key materials like steel and aluminum, which are moving independently of each other, the sum of those obviously is our ability to manage price and cost. And that's how we feel like we've done a nice job of managing those margins, even though they aren’t as high as they were last year given the volatility on the cost side. We feel that we can be set up for continued performance by the same manner for the remainder of the fiscal year.

Got it. Okay, thanks for that. And then for my follow-up, just can you comment on the backlog? Did it grow sequentially just given the supply chain challenges and any cancellations or push outs? Or do you feel pretty good about the next three to six months based on what you're hearing and seeing from customers?

Yes. So as I said, Karen indicated we've seen strong demand, and that's continued. So the backlog has ticked up slightly sequentially. So there's plenty of business out there. We're just working hard to satisfy it.

Our next question comes from Chris Snyder at UBS. Your line is open.

Thank you. So I certainly understand the strategy, and also the drivers of the building inventory levels at the company. And during the - I guess this quarter and last, but could you speak to any maybe impact this has on margin, whether it be higher fixed costs absorption in the current period? Or if this inventory level wording may be normalized or right size lower? Any potential margin headwinds coming from a result of that?

Karen, you want to start?

Sure. Yes, Chris. As we've mentioned, we have intentionally increased our inventory really related to two reasons. One was the longer lead times that we're seeing on the purchase finished goods. It used to take about 20 days to get to us, and now it's taking closer to 50. So that has been some build that has happened because of those longer lead times. The second reason has been availability of our electronic components. So we have tried to secure more of those just in light of the shortages, so that we can service the demand that we're seeing. So as you know, that rolls through, you're not going to see any headwinds, as you described, other than from the increasing cost that we've been talking about, and that Neil has described on the call.

Thank you. Appreciate that. And then some follow up; I want to touch on M&A. In the past, the company has spoken to its interest in adding tech assets to build out the spaces group. But if I remember correctly, I also believe there was some commentary at the investor day around maybe even pushing into a tangential industrial vertical, could you just provide some color on the company's M&A strategy as the cash balances remain higher than what we've seen historically?

Yes, I'll take that one, Chris. I can't speak for what the acquisition strategy was before I got here. So we'll focus on what we said on the investor day, which is that our capital allocation priorities are pretty straightforward. One, we want to grow the businesses we already have; two, we want to expand the company via acquisition, both investments in our current businesses, lighting and spaces, and add additional businesses over time; the third is to maintain our dividend; and then the fourth is when we see an opportunity to create permanent value through share repurchase. We've done that and when it's been really attractive, we've been really aggressive. As we look forward to the acquisition strategy, that is absolutely a part of where we want to deploy capital going forward and we want to grow the business. As a point of fact, though, we've seen significant opportunity to generate value through our existing businesses. So that's where we focused our efforts. Obviously, the OSRAM acquisition is a great example of adding a strategic asset to an important business for us. So, as a reminder, we did that for three reasons; one was to control the technology we have in our luminaires. The second was to expand our OEM channel so that we could participate more fully in the broader market. And the third was to integrate our supply chain so that we could scale more effectively. That acquisition is performing exceptionally well from a financial perspective. As we indicated on the last quarter, it's mildly diluted from a gross margin perspective, but dollar accretive. We expect that to accelerate over time as we integrate it. We're actively looking at opportunities to expand the spaces group in businesses that are more related to Distech primarily and then we're working aggressively to demonstrate organic sales growth with Atrius products as the first step towards investing further in them. Finally, that gives us the opportunity over the next couple years to add other businesses to the portfolio. We're positioning the company both from an ability perspective, as well as talent perspective with the addition of Sach. We are also positioning well from a financial perspective. The narrative will be that over the next while we will continue to improve the businesses that we already have. Over time, we'll add businesses where we can demonstrate what we've done with ABL and spaces and in other environments where we can drive high returns for our shareholders.

Appreciate that, thank you for the time.

Our next question comes from Josh Chan at Baird. Your line is open.

Hi, good morning, Neil, Karen, Charlotte, congrats on a good quarter.

Thank you Josh.

My first question is on the supply chain, I guess. Could you update us on kind of how it has changed sequentially? If at all, anything getting better or worse? And how do you expect that to trend data in the coming months I guess?

Karen, I'll pick that one. I would say Josh, good morning. The supply chain, I can't think of a different analogy other than kind of whack a mole. It just seems to be something different each time. The big picture trends are pretty obvious. There is more demand than supply for global chips, so working through allocations and demand planning is the challenge we're trying to manage our unfair share of those. Transportation has been a problem that should hopefully get a little better in the foreseeable future absent any Long Beach strike issues. Commodity prices have changed, you can see those as well as we can. So whether it's steel or the aluminum prices changing due to the situation in Ukraine, we are playing whack a mole, which is why we've talked about how we're managing through this. Karen walked through the pricing and the costing; that's why I feel like we're delivering and we're pleased with these margins at the gross margin level. In a steady-state environment, I am confident we would be delivering higher margins. But even if they hang around at these levels for a while, we think we can be pleased with them.

Appreciate the color there. And then I guess my second question is on market share. It certainly seems like you're winning in terms of market share, given the more transactional nature of some of these projects; like what can you do? Or how are you working to retain the gains that you've secured over this time period?

Yes, Josh, our focus right now continues to be on service and product vitality. That’s really where you're seeing us able to grow our sales in the independent sales network and our direct sales network is through our ability to differentiate with service and our product portfolio. So we're just going to continue that focus as we move forward.

The only thing I’d add to that, Josh, is we’ve had a lot of success with the contractor select portfolio, which is the right product, the right place, at the right time. So, we describe it as your most important everyday lighting products. So, as long as we maintain a high product vitality, that's an interesting and important part of the portfolio going forward.

That's great. Thank you both for your time.

Thanks.

Our next question comes from Jeff Osborne at Cowen & Company. Your line is open.

Hey, good morning. A couple of questions on my end. Karen, I think on the last quarter, you had mentioned that you thought Q2 would be the low point for gross margins throughout the year, is that still the case?

I do not recall mentioning that it would be the low point for gross margins. I think what we talked about is that the second quarter is seasonally our lowest top line. So you could expect to see some seasonal decrease, which is I think we were down about $20 million from the first quarter. So, you do get a little bit of an impact from leveraging some of your fixed costs and gross profit from that perspective. Just as we've talked about before, as we look ahead, the cost and availability of components continue to be a challenge, we will prioritize servicing our customers and speed over costs. And we'll manage those costs aggressively.

Got it. And then two other quick ones: any impact to the backlog from rising interest rates on some of your larger projects? And then I was just curious about the initiatives to try to work through the backlog quicker. Would the increase in inventory help you do that?

Yes, so first, on the rates, I don't think we've seen that yet. We're obviously paying close attention to that. It's pretty obvious that projects, the value of them will have to change. Big projects, not our projects, but those we are part of will be impacted at some point by discount rates. In terms of managing through the backlog, we have initiated a significant number of activities, which I highlighted in terms of redesigning products, strategic supplier relationships, and managing to cost and access over speed. We are aggressively ramping capacity. This has been a challenge, but we've gotten labor in a good spot over time now. We are starting to crank through that backlog. The good news is that orders remain strong, so even though we continue to increase our production and our productivity, the orders keep coming in.

Thanks for the detail, Neil, appreciate it.

And our final question comes from Brian Lee at Goldman Sachs. Your line is open.

Hey, Neil. Hey, Karen. This is Miguel on for Brian. Just had a quick question to talk about inventories again. So you talked about the two impacts: the increased lead times and then also the increasing purchases. Is there a shift happening with how you're managing inventories going forward? Just as potentially at the lead times come down, would you expect to continue to hold higher inventories as a percent of revenue as you think about increasing revenues, just given all of the supply chain challenges going on?

Yes. So thank you, Miguel. As I mentioned, the two reasons, and you're right, are the extended lead times on the source finished goods and also the electronic components. How we're managing those is we're looking ahead. We're trying not to look in the rearview mirror, but really look ahead, understand where we have the demand, understand where we have the inventory we need to meet that demand, and focusing really carefully on that. So we don't expect that our days would continue to be this high. We do believe that it's necessary right now given the challenges that we're seeing with access to components and inventory, but we are managing our days very aggressively.

Okay, thank you very much. That's it for me. I'll pass it on.

Thanks, Miguel.

Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back to Neil Ashe for any closing remarks.

Thank you all for joining us this morning. We really appreciate your interest in Acuity Brands. From my perspective summary is, I believe that our team delivered a really good quarter in a really challenging environment. As we look forward, demand remains strong; supply chain remains tight and challenging. We'll continue the hard work to deliver on the results that you've seen going forward. Thank you for your interest in us, and thank you to our team and our independent sales network for their hard work delivering these results.

This concludes the program. You may now disconnect. Everyone have a great day.