Earnings Call Transcript - AYI Q1 2022

Operator, Operator

Good morning, and welcome to the Acuity Brands First Quarter Earnings Call of Fiscal 2022. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be 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, Vice President of Investor Relations

Thank you, Liz. Good morning, and welcome to the Acuity Brands fiscal 2022 first 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 first quarter earnings release, which is available on our Investor Relations website at www.investors.acuitybrands.com. With me this morning is Neil Ashe, our Chairman, President and CEO, who will provide an update on our strategy and detail 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.

Neil Ashe, Chairman, President and CEO

Thank you, Charlotte. A Happy New Year to everyone joining us this morning to discuss Acuity Brands. I'm proud of our performance in the first quarter of fiscal 2022. Our team delivered sales growth of 17%, expanded our operating profit margin by 160 basis points and increased diluted EPS by 57% despite global supply chain challenges and unpredictable market conditions. Our performance demonstrates that by prioritizing customers, we are driving sales growth and turning that into operating income, while continuing to invest in the long-term growth and transformation of the company. I want to start today's call by taking a deep dive on the current market conditions. As you are aware, this is a dynamic market with a fair share of paradoxes. Demand across our end markets remains strong. At the same time, the availability and cost of key inputs remain challenging. In short, it's the best of times and the most challenging of times. First on demand, business is strong both in ABL and in spaces. Within ABL, demand is strong across all of our channels to market except retail, which we expect to improve this calendar year. In this dynamic pricing environment, we have been prudent and successful passing on price increases while at the same time providing as much consistency as we can to our customers so that they can plan and execute their projects effectively. At the same time, input costs and availability remain unpredictable, and we expect it to continue. Obviously, everyone is dealing with this. Our strategy for managing through this has been consistent. Prioritize satisfying customer demand and ensuring the health and wellbeing of our associates. So now let me spend a minute on what we mean by satisfying our customer demand. First, we have chosen to honor pricing on all of our placed orders. As I've said before, it is important to me that we are known in the industry for doing what we say. There is a gap in time between when we receive orders and when we fulfill them in normal times, and that is even greater now. Therefore, we believe that this position will serve us well in the long-term with specific customers and with the industry. From there, we’re also doing everything that we can to fulfill these orders as quickly as we can. While we don't disclose backlog, what I will say is that it is meaningfully higher than during normal periods. This is a result of higher demand, coupled with changing component availability and the general supply chain and transportation challenges. Again, these are not unique to Acuity. To combat these, we have prioritized three key activities. First, we have focused and invested in our strategic relationships with manufacturers and suppliers to procure as much of the available components supply as possible. We benefit from being the largest and most consistent in the industry. Second, we have empowered our teams to source components in the spot market, and we have prioritized speed and access over cost. This allows us to maintain higher levels of production at the expense of some higher costs. Third, our product, engineering and manufacturing teams have been continuously redesigning and reengineering existing products based on what components are available. To give you an idea of the magnitude of that effort, our Distech engineers spent half their time in the last quarter dedicated to this type of redesign. Our ABL team made the same commitment in addition to changes and improvements in our manufacturing processes to ensure consistent production. These efforts also extend beyond our company into our broader ecosystem. We have been working with suppliers to help them find necessary components and make engineering changes in the products that they supply to us. The overall effort has been Herculean and our teams continue to remain flexible and to adapt to an ever-changing environment. The changes that we have implemented over the last two years have enhanced our ability to see across our business, work across our stakeholders, and improve our service levels. So where are we on our transformation? One of the points that I stress to our team is that transformation is a process, not a destination. In challenging times, sometimes the first reaction is to revert to what you know. In our case, we are using these times to redouble our transformation efforts. Let me start with the ABL business. Trevor and his team are focused on maintaining high product vitality, continuing to elevate industry service levels and continuing to use technology to differentiate us. During the first quarter, we launched several interesting products to drive our portfolio expansion, products like the STACK PACK and STACK Switch products. These are the next-generation of center-element LED lay-in lights for commercial indoor spaces. The STACK has a lower profile and more efficient packaging that saves on transportation costs. It also has an adjustable lumen output that can be reconfigured at any time through the STACK Switch. This means that there is no time wasted on the job site if there need to be changes to the configuration. In controls, we introduced the CLAIRITY Link. This is part of our nLight lighting controls platform that offers remote connectivity capability. The remote capabilities reduce the need for in-person visits, offering quick troubleshooting resolutions and a reduction in maintenance cost. This product fundamentally changes the way we service projects and is an important step forward for our customers. Now moving to the Intelligent Spaces Group. The mission of ISG is to use technology to solve problems in spaces in order to make them smarter, safer and greener. We do this in two ways. We collect data through hardware, for example the Distech controller; and then analyze and take action on the data through software applications powered by Atrius. Our ISG group had an eventful quarter. As I mentioned, even though the engineering team at Distech spent over half their time focused on redesigning Distech products for the available components, we continued to roll out several important products and product enhancements. The Distech ECLYPSE APEX was introduced in the first quarter and is the most advanced version of our controller for HVAC and building automation. The APEX introduced artificial intelligence to the edge and increases compute capacity in buildings, which helps customers manage energy usage more effectively. We also further expanded the availability of our Atrius Building Insights service by enabling it for additional languages and local privacy requirements. Atrius Building Insights is now available in the UK, Ireland, France, Germany, Spain and Norway. As I turn the call over to Karen, I want to take a step back. We are currently and expect to continue to be operating in unpredictable times. Input prices and availability can sometimes feel like a game of whack-a-mole, and we are dealing with Omicron, which materialized only a few months ago. As we face these challenges and new challenges, we will maintain our focus on satisfying customer demand and ensuring the health and well-being of our associates. I remain optimistic about 2022 and our ability to effectively manage in this environment. We have a great team who are executing today while also remaining focused on the long-term growth and transformation of the company. I'll now turn the call over to Karen, who will take a deeper dive into our performance. And then I'll be back for the Q&A and for some closing remarks.

Karen Holcom, Senior Vice President and Chief Financial Officer

Thank you, Neil. I want to begin by expressing my gratitude to our team for their efforts over the last quarter in this challenging environment. I continue to be impressed by their commitment to our transformational goals while we manage the daily operations of the business. We achieved a strong performance in the first quarter. Net sales reached $926 million, marking a 17% increase compared to the previous year. This growth was fueled by enhanced service levels, ongoing recovery in the end markets of our two business segments, and the advantages of recent price increases. Gross profit was $386 million, up $53 million or 16% from the previous year. This improvement resulted from revenue growth and actions taken to mitigate the significant rise in material and freight costs through price increases and product and productivity enhancements. Gross profit as a percentage of sales was 41.7%, a slight drop of 30 basis points from 42% the year prior, which is a notable achievement considering the current cost environment. The reported operating profit margin for the first quarter of fiscal 2022 was 12.4% of net sales, an increase of 160 basis points from the previous year. The adjusted operating profit margin was 14.4% of net sales, up 120 basis points from the prior year. Most of this improvement stemmed from better operating leverage as we balanced cost management with growth investments. The effective tax rate for the first quarter of fiscal 2022 was 19.6%, down from 24.7% in the same period of 2021, primarily due to favorable discrete items recognized this quarter related to excess tax benefits on share-based payments. We anticipate our tax rate for the full year of 2022 to normalize around 23% excluding these discrete items. We also saw a significant increase in diluted earnings per share for the first quarter of fiscal 2022. Diluted EPS was $2.46, up $0.89 or 57% from the previous year. Adjusted diluted earnings per share was $2.85, an increase of $0.82 or 40% year-over-year. Our share repurchase program positively affected adjusted diluted EPS by $0.07, and the tax impact was about $0.16. Now, turning to our segments. In the Lighting and Lighting Control segment, sales rose 17% to $884 million compared to the previous year. This growth was driven by improvements in our independent sales network, which increased by 14%, and our direct sales network, which grew around 12%. These increases were the result of our strong market strategies and a better demand environment, along with the positive effects of price increases. Our corporate accounts channel experienced a sales increase of about 62% compared to the prior year as large accounts resumed previously deferred maintenance and renovations. Performance in this channel can vary quarter to quarter, depending on our customers' renovation cycles. Sales in the retail channel decreased by roughly 16% in the current quarter. ABL operating profit for the first quarter of fiscal 2022 rose 30% to $128 million compared to the prior year, with the operating margin improving by 160 basis points to 12.4%. Adjusted operating profit of $138 million was up 28% compared to the previous year, with the adjusted operating margin improving by 140 basis points to 15.6%. Moving on to our Intelligent Spaces Group, sales increased around 14% to $46 million in the first quarter of 2022 compared to the previous year, reflecting strong demand primarily in our building and HVAC controls. Spaces' operating profit increased by about $2 million to $2 million compared to the prior year. Adjusted operating profit of $6 million rose approximately $2 million year-over-year due to strong sales growth. Regarding cash flow, we generated solid operating cash flows. The net cash from operating activities for the first three months of fiscal 2022 was $84 million, down $40 million or 32% from the prior year, reflecting increased investment in inventory for growth. Cash flow was also affected by the timing of income tax payments and the previous year’s deferral of withholding taxes under the CARES Act. We invested $9 million, or 1% of net sales, in capital expenditures during the first three months of fiscal 2022. During the quarter, we adhered to our capital allocation strategy, repurchasing about 300,000 shares of common stock for around $53 million at an average price of $176 per share. We have approximately 3.5 million shares remaining under our current Board authorization. Our capital allocation priorities remain unchanged. We will continue to focus on growth investments in our current businesses, pursue acquisitions, maintain our dividend, and allocate capital for share repurchases when it aligns with creating long-term value for our shareholders. Now, I would like to take a moment to address some current topics of interest. First, regarding the pricing environment, we are managing pricing strategically while balancing our relationships with customers. We announced another price increase this week that will take effect for orders placed in February. We will continue to take a careful approach to pricing. Next, I would like to update you on the integration of OSRAM. We have made considerable progress in this effort. We acquired the OSRAM North American DS business to maintain control over the technology, expand our OEM channel, and enhance our supply chain integration. The addition of OSRAM contributed over 300 basis points to our sales growth this quarter. Although there was a minor dilutive impact on gross profit margin, OSRAM overall positively contributed to our operating profit. The integration is meeting our expectations, and we are excited that the OSRAM team is now part of Acuity. Finally, you may have noticed that this quarter we included an additional metric in our earnings release. We have added EBITDA and adjusted EBITDA to our reconciliation tables to facilitate comparisons and enhance the consistency of reported adjustments. As we proceed through 2022, we will maintain our focus on serving our customers to drive sales growth and operating income. We will also continue to allocate capital in ways that promote long-term growth and create permanent value for our shareholders. Thank you for joining us today. I will now hand the call over to the operator to take your questions.

Operator, Operator

Thank you. Our first question comes from John Walsh with Credit Suisse. Your line is now open.

John Walsh, Analyst

Hi, good morning.

Neil Ashe, Chairman, President and CEO

Good morning, John.

John Walsh, Analyst

Maybe first, if we could talk a little bit about the operating profit margin performance. I appreciate the comments in the script. Looks like you were really able to leverage the fixed portion of your SD&A bucket, kind of the non-freight and commissions. Wondering if you could just give a little bit more color there. Is it kind of just the stronger sales flowing through on that? Or are you also driving some productivity on that fixed part of your SD&A cost structure. Thank you.

Neil Ashe, Chairman, President and CEO

Yes, thanks for your question. To provide some clarity, our plan has always been to focus on driving sales growth and converting that growth into operating margin. We started with our product vitality initiatives, and now we're focusing on leveraging our fixed costs. So, to answer your question, there are improvements due to higher sales figures and a smaller increase in fixed operating expenses. Additionally, there will be aspects of our transformation that will continue to enhance our leverage.

John Walsh, Analyst

Great. And then I guess, just a question on you feel strong about the sales growth going forward. Obviously very early in the year, so kind of not surprised to see no change to the guide. But can you maybe talk a little bit about what you're seeing in terms of maybe renovation and retrofit demand from energy efficiency and decarb perspective? And then maybe any color on Holophane and if you're seeing any benefit from the passed infrastructure bill yet? And then I'll pass it along. Thank you.

Neil Ashe, Chairman, President and CEO

I’ll begin, and Karen can add anything I miss. Regarding the financial framework we introduced at the end of the last fiscal year and the start of this fiscal year, our plan is not to update it frequently but to provide a stable framework. You are aware of that framework. Looking ahead for the remainder of the year from a sales standpoint, we had a strong performance this quarter, which was due to several factors, primarily robust end market demand. This strong demand is consistent and is leading to an increase in lead time for our orders, and we are managing those orders as efficiently as possible. This is in contrast to last year, where the first quarter is typically lower due to seasonality, compounded by reduced demand from the pandemic. As we move forward, our focus remains on meeting customer demand, which will lessen some of the usual seasonal effects, though not all. The upcoming second quarter will include Christmas and other factors, so it won't mirror the first quarter. We anticipate returning to normal levels sometime later this year or early next year.

Karen Holcom, Senior Vice President and Chief Financial Officer

Yes. The only other thing I would call out, John, is when you look at that corporate accounts channel, it had a really strong quarter at 62% growth year-over-year. And so that can be inconsistent quarter-to-quarter as well.

Neil Ashe, Chairman, President and CEO

And then finally, on your question about Holophane and the industrial. Holophane had a good quarter. Candidly, not a great quarter yet. We see lots of opportunity in the future as those projects start to happen. But it's going to take a minute for them to get specced, to get designed and to get funded and to get started.

John Walsh, Analyst

Great. Appreciate it. Pass it along.

Neil Ashe, Chairman, President and CEO

Thanks, John.

Operator, Operator

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

Ryan Merkel, Analyst

Hey, everyone. Good morning. Happy New Year.

Karen Holcom, Senior Vice President and Chief Financial Officer

Good morning. Same to you.

Neil Ashe, Chairman, President and CEO

Hey, Ryan.

Ryan Merkel, Analyst

So Neil, I wanted to start with supply chain, I guess, a two-part question. Do you think you're taking market share just based on how well you're managing things? And then secondly, do you feel like the worst is over? Or is it too early to say that?

Neil Ashe, Chairman, President and CEO

In response to your first question, I've mentioned this since I joined the company; it's frustrating that there's a lack of clear information about the market, making it difficult to state our position definitively. As you observe our performance compared to our competitors, it appears that we are gaining market share. This trend is based on two main factors we've identified: product vitality, which reflects our ongoing investments to ensure we have the right products, and the effectiveness of our supply chain, focused on delivering the right products in the right place, at the right price, and at the right time. I believe we've performed better than many in this regard. Regarding your second question about whether the worst is over, the short answer is we don't know. We continue to be surprised, as I mentioned earlier. No one anticipated Omicron, and we cannot predict if it will affect our labor and production capacity in the coming months. However, I want to emphasize that our supply chain's flexibility has enabled us to perform well. By flexibility, I mean that we source from various suppliers, and our team has shown remarkable adaptability. They are rethinking how they source products, plan production, and manage our factory and distribution systems. We're continuously adjusting these aspects to improve our performance. Therefore, we're preparing for uncertainties in the supply chain so that we can maintain our performance, regardless of whether conditions worsen or improve. I expect this situation to persist for a while longer.

Ryan Merkel, Analyst

Got it. Makes sense. And then on price capture, when do you think we'll see the full impact of the price increases that you've put through? And then will the realization be enough to cover your higher costs?

Neil Ashe, Chairman, President and CEO

Karen?

Karen Holcom, Senior Vice President and Chief Financial Officer

Yes. Let me start with that, Ryan. As we mentioned in our comments, there is a lag between when we have the price increase and when we see that in the results. And then also the timing of the costs, the costs come in a lot faster than the price does. So as you know, we've now, as of this week, had five price increases. And so you'll start to see benefits of that accumulate throughout the course of the year, while we also expect the cost to increase commensurately throughout the course of the year. So that being said, I think we'll still see some benefit from price and be able to offset cost, but still a bit uncertain and just monitoring what the costs are going to do, and then if we have to take actions in the future to offset some of those. And again, we're not just focused on price. We're also focused on product and productivity improvements to continue to improve our margins. Anything else to add, Neil?

Neil Ashe, Chairman, President and CEO

Yes, Ryan, I want to emphasize that we have been successful in securing price increases whenever needed. I've also mentioned earlier that we've made a significant strategic choice to honor the prices on orders already placed. This decision brings consistency to the markets that are executing projects. Additionally, as Karen noted, there is a time lag between when we establish the pricing for these orders and the actual component input costs that we face. However, as reflected in our results, this approach is contributing positively to our top line and enabling us to achieve operating profit margins.

Operator, Operator

Our next question comes from Jeff Sprague at Vertical Research.

Jeffrey Sprague, Analyst

Two for me. One maybe is just kind of housekeeping. On the comment on the guide that you don't plan to regularly update it, do you plan to, though, I guess, reevaluate if you're outside of kind of some band of materiality? Or should we expect that, regardless of what you're printing through the year here, that this framework remains exactly the same?

Neil Ashe, Chairman, President and CEO

Thank you for your question, Jeff. My philosophical view on this is that we refer to it as a framework because it represents our thinking for the year. It's more important for us to share our perspective so that we can collectively assess our performance moving forward. That's why we prefer the term framework over guidance and wish to maintain it. I also want to remind you that we anticipated this year would show higher growth than our usual expectations for the framework. If you recall our Investor Day, we provided an overarching view of our two segments, which reflects our desired approach. We aim to engage in an informed and qualitative discussion about the outlook and strive to deliver the best results possible.

Jeffrey Sprague, Analyst

Great. That's helpful, given the whole framework/guidance approach with you. Helpful, but new for all of us given prior practices. So thanks for that insight. Can we come back to kind of the retrofit/reno work? What kind of backlog of activity do you see there? And I understand it might not be in your product backlog per se given the nature of your business and how you book orders. But in terms of kind of feet on the street, people out working projects, do you see that sort of work broadly coming back at this point in time? And any color on how the peak of the season as it relates to that type of activity would be interesting.

Karen Holcom, Senior Vice President and Chief Financial Officer

Yes, we are observing improvements in various areas related to retrofit and renovation. Industrial remains a robust market for us, and we're noticing slight advancements in office space. Education is strong and fluctuates depending on the time of year. All these markets with renovations continue to perform well. Many large retailers are returning to and revitalizing their renovation programs, which is encouraging. However, the hospitality market seems to be recovering at a slower pace compared to others, and we can see that reflected in our current orders. Our agents and other channels are reporting similar trends in their respective markets.

Operator, Operator

Our next question comes from Christopher Glynn at Oppenheimer.

Christopher Glynn, Analyst

I had a question about IGS. Neil, you mentioned several product expansions into a range of international arenas. I'm curious to hear you talk about the prospects outside North America. Are they different from ABL? Because I think ABL has been sort of happenstance, not necessarily strategic. You may have some qualifiers, but to that. But materially, is there a difference in the international outlook for IGS?

Neil Ashe, Chairman, President and CEO

Thank you, Chris. I appreciate the question and the chance to elaborate on this. Before discussing the spaces group, I want to touch on ABL. The North American lighting market is distinct for various reasons compared to European and Asian markets, including differences in standards, electricity, and industry structure. Therefore, it is sensible for us to concentrate on our lighting business in North America and continue to gain market share as we have done. Now, regarding the spaces group, both Distech and the related controller technology have broader applications beyond North America. This technology is already established in Europe, where we have a strong presence, particularly in France with Distech. Thus, we see significant international opportunities for Distech outside the U.S. Additionally, I previously mentioned Atrius Building Insights. We are consolidating Atrius and developing software applications that analyze data and eventually enable action based on that data. Atrius Building Insights helps any facility understand their energy costs, what factors influence those costs, and view that information consistently. We have localized this for European markets, which will support our continued expansion of both Distech and Atrius in conjunction with Distech for future solutions.

Christopher Glynn, Analyst

Great. And I was curious about the ABL top line framework for high single digits. Just if we kind of tease out normal seasonality in the next couple of quarters, and I think you indicated second quarter might be on the heavier end of normal seasonality given the first quarter strength. But kind of backs into a flattish fourth quarter to exit the year, I think we'll attribute that to your guidance explanation rather than a ratification of that implication. Is that correct?

Neil Ashe, Chairman, President and CEO

That's correct.

Operator, Operator

Our next question comes from Brian Lee at Goldman Sachs.

Miguel De Jesus, Analyst

This is Miguel on the line for Brian. I wanted to ask about the price increases, specifically the fifth one announced this week. Regarding the four previous announcements, are their impacts fully reflected in this quarter's results, or is there still some effect left to be realized from those four prior increases? Will those also carry over into future quarters, along with the fifth one?

Karen Holcom, Senior Vice President and Chief Financial Officer

Yes. Thank you, Miguel. As we mentioned, our backlog is meaningfully higher than what we would typically see. So I think in normal times, you might see the price increases come a bit faster. But where we are today, there's still more of the price increases that would come through just in terms of the timing of when they were announced, when they were impacted and then how that backlog will flow through. As we also pointed out, we're not repricing our backlog and adjusting it. So it only reflects the prices that were implemented at the time the order was placed. So you will see a lag in some of the pricing coming through.

Miguel De Jesus, Analyst

Okay. Great. And then I had just a quick follow-up, too. It doesn't sound like it, but how are customers, I guess, responding to price increases? You mentioned that you built in a lag for when you announced the prices. And then I think in a prior call, you mentioned that there's a possibility there have been some demand pull-forward as customers maybe anticipate further price increases. But do you see any possibility of maybe a decline in customer orders if prices go up to a certain level, given if material costs and things maybe go up higher than expected?

Neil Ashe, Chairman, President and CEO

I’ll address that. First of all, higher prices are not favorable; we don't like them, and our customers don't like them either. However, everyone understands that costs are changing, which leads to the expectation of price increases. Our end markets are absorbing the price increases we are implementing. Now, regarding our pricing strategy, we aim to be careful and strategic because we believe that ultimately, it's about having the right product, which relies on product vitality, positioned effectively with our service levels, and offered at the right price. Our investment in honoring our order prices is crucial for maintaining relationships with our customers and the end markets, allowing them to anticipate and plan their projects accordingly. Input prices will fluctuate and may impact future prices, but our strategy focuses on having the right product in the right place at the right price. This approach is driving our growth, which we believe exceeds the market, while also allowing us to leverage our costs to enhance margins.

Operator, Operator

Our next question comes from Jeff Osborne at Cowen & Company.

Jeffrey Osborne, Analyst

Two questions on my end. One, Karen, I was wondering if you could just remind us on what the typical lag is from order to revenue recognition. And you mentioned that, that is stretching out. But can you just put it in perspective what that is in normalized times and what it is today?

Karen Holcom, Senior Vice President and Chief Financial Officer

Yes. Typically, we would have seen, it depends on the projects, but you would have not seen elevated backlog like we're seeing today. So it could be a few weeks, it could be a few months. But just based on kind of the availability of the components, the supply chain challenges that we've discussed with the lead times, it is stretching beyond that. So it can be upwards of 6 months or so. But these are all placed orders. They're not speculative orders. It's really just the timing of when we can ship the orders.

Jeffrey Osborne, Analyst

Got it. That's helpful. And then maybe for Neil. 18, 24 months in now, can you just give us a sense of the UVC product line? You haven't mentioned it in recent earnings calls, but has that been successful? Or any update on the product momentum and availability would be helpful.

Neil Ashe, Chairman, President and CEO

Thank you for that. We have developed a strong product line for GUV based on the expectation of consistent purchases. We're seeing some interest from larger clients who appreciate the investment's value. However, as I mentioned in previous quarters, we don't consider this a game-changer for us; rather, it’s an adjustment to the current market conditions. With each new variant, it becomes increasingly clear that we will need to invest more in creating safer spaces in the long run. We have the best portfolio of GUV products to achieve this goal. If the market shifts in our favor, we are well-prepared, but the market size isn’t as large as some anticipated.

Operator, Operator

Our next question comes from Tim Wojs at Baird.

Timothy Wojs, Analyst

Maybe just the first one, I just want to kind of run back to seasonality. Q2 is kind of typically your weakest quarter from just a gross margin perspective just kind of structurally. And I think normally, it's down 50 basis points to 100 basis points from Q1 levels. And so I know you don't want to necessarily give quarterly guidance, but just given how tough the comp is last year, would you expect kind of a similar kind of seasonal trend to play out this year, kind of Q1 to Q2? I just want to make sure we have that calibrated correctly.

Neil Ashe, Chairman, President and CEO

Tim, are you talking about on a year-on-year basis or a sequential basis?

Timothy Wojs, Analyst

Sequential.

Neil Ashe, Chairman, President and CEO

Let me address the fact that we had a significant gross margin quarter last year. We have discussed in detail what has changed between then and now. As we compare the fiscal first quarter to the second quarter, we need to consider the seasonality. In the second quarter, we have Christmas and New Year's, along with various impacts, which cause the top line to be lower than in the first quarter. This naturally puts downward pressure on gross margin on a sequential basis due to the way fixed costs are leveraged in our supply chain. That's the general outline. As noted by Karen and myself, we are focusing on addressing customer demand, and I shared a framework for how we are managing that, which will ultimately influence our gross margin.

Timothy Wojs, Analyst

Okay. Okay. So it sounds like more seasonal than last year would maybe be the framework to say. Okay. And then I guess, maybe just like big picture, when you think about the environment in terms of quoting projects and how those customers think about lighting in general. I mean, there has been a lot of deflation in the market over the last 4 years, and that's clearly flipped to inflation now. I mean, do you think this phenomenon around how people are kind of thinking about lighting and kind of speccing that in and pricing is kind of a cyclical benefit right now? Or do you think there's the potential that there's kind of a mindset change in terms of how people are thinking about lighting on a go-forward basis? I don't know if that makes sense, but hopefully, I'm just trying to understand, like, if there's kind of a conceptual difference in terms of how the end customer is thinking about lighting today than maybe 4 or 5 years ago.

Neil Ashe, Chairman, President and CEO

Yes, I believe we're at a point where our observations are more anecdotal than philosophical, as the market is evolving rapidly and people are reacting to current conditions. Regarding the potential for this change to be long-lasting for us, specifically in terms of product vitality, quality, variety, and the overall impact in the marketplace, I see it as transformative. I've previously highlighted the Compact Pro High Bay, which represents a significant advancement in value and impact. Additionally, the STACK technology I mentioned is altering how the end market interacts with our products, effectively reshaping the value chain. It reduces installation costs and offers more flexibility, resulting in permanent increases in value. This allows us to tap into new areas of value delivery, meaning if installation requires significantly less labor, the pressure on the cost of luminaires or control solutions diminishes. This is why we've focused on enhancing product quality and ensuring we provide the right product at the right place and price to maintain high service levels. I anticipate this approach will persist. As for the broader inflationary context, that remains debatable. In the past, I've mentioned that CEOs typically aren't skilled economists, so I wouldn't place too much weight on my insights on that topic. However, I do believe that the strategic changes we're implementing are positioning us effectively for both the current climate and future periods.

Operator, Operator

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

Neil Ashe, Chairman, President and CEO

Thank you. Before we break, I wanted to thank all of you for joining us and again reiterate a Happy New Year. I want to bear attention to the publication of our 2021 EarthLIGHT Report. We've made substantial progress on our ESG strategy in 2021. And I'm really pleased to say these efforts are being recognized. In December, the Carbon Disclosure Project vastly improved our rating over prior periods. It's a testament to the team for prioritizing and driving our ESG initiatives. We're really pleased with where we are. We're really pleased with where we're going, and we appreciate you investing both your time and your capital in Acuity Brands. So thanks for your interest, and we look forward to talking to you again in about 3 months.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.