Earnings Call Transcript - AYI Q4 2022

Operator, Operator

Good morning, and welcome to the Acuity Brands Fiscal 2022 Fourth Quarter and Full-Year Earnings Call. 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.

Charlotte McLaughlin, Vice President of Investor Relations

Thank you, Liz. Good morning, and welcome to the Acuity Brands fiscal 2022 fourth quarter and full-year 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 our 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 our 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 measures are available in our 2022 fourth quarter and full-year earnings release, which is available on our Investor Relations website. With me this morning is Neil Ashe, our Chairman, President and CEO, who will provide an update on our strategy and highlights from the last quarter and full year, and Karen Holcom, our Senior Vice President and CFO, who will walk us through our fourth quarter and full-year performance, as well as provide an outlook for our full fiscal year 2023. There will be an opportunity for Q&A at the end of this call. We are webcasting today's conference call 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. Good morning, and thank you to everyone joining us on the call. We continue to deliver strong results in the fourth quarter, concluding what has been a very good fiscal 2022. We had strong demand across our end markets, and we demonstrated the ability to capture price and drive volume through product vitality and service in both our Lighting and Spaces businesses throughout this fiscal year. We delivered solid operating profit and EPS growth, and we again created permanent shareholder value through share repurchases. Both our Lighting and Spaces businesses have delivered strong results throughout 2022. Starting with ABL, our team made good progress on product vitality and service initiatives. Our product vitality efforts are the combination of new product introductions and improvements to our existing portfolio to ensure that our products are more valuable to our customers and more profitable for us. These product vitality efforts are being recognized. We won awards across our portfolio for design and innovation, including several Red Dot Design Awards for architectural lighting; EC&M magazine recognized our Contractor Select STACK Pack as a category award winner for Product of the Year; and we received a Bright Star Award for software and controls from LED Magazine. Our service initiatives are also being recognized by the industry. We were named Supplier of the Year by each of the two largest buying groups in the industry, IMARK and AD. Throughout 2022, we've been focused on satisfying customer demand. To do that through the global supply chain conditions, we've continued to prioritize three key activities: first, investing in supplier relationships; second, empowering our teams to secure components in the open market; and third, reengineering products to available components. While these challenges have continued, our focus has remained the same. In the fourth quarter, when our ABL business encountered sourcing interruptions with a few electronic components, we were able to leverage our strong supplier relationships to finish the quarter with a strong August. I'd now like to highlight two other important aspects of our business. The first is Contractor Select. Contractor Select is a collection of the most important everyday lighting and lighting control products. We have done and we continue to do significant work on product vitality in this portfolio. This work allows us to be competitive from a value perspective and the results have been impressive. Contractor Select is growing faster than our broader portfolio and provides a consistent foundational relationship with electrical distributors. Second, as we passed the one-year anniversary of our acquisition of the Osram DS business, I want to update you on our progress. We have successfully integrated the business with our go-to-market product and supply chain efforts. We have rebranded the product portfolio to OPTOTRONIC as part of our eldoLED product family. We have begun to integrate more OPTOTRONIC drivers in our luminaire portfolio. We have grown our OEM sales and we have successfully integrated the production facility into our Mexico operations. The acquisition is delivering on our expectations to grow more of the technology in our luminaires, expand our OEM channel and take greater control over electronic supply chain. Now moving to our Intelligent Spaces Group. The Spaces team also had a very solid quarter, delivering net sales growth and expanding profit as we continue to make Spaces smarter, safer and greener. Distech had strong sales in the fourth quarter, notably in the sales of our ECLYPSE controller, which uses open protocol technology to control and monitor systems and buildings, including heating, ventilation, lighting and other functions, essentially acting like the brain of the building. The data generated is then used to optimize energy consumption and occupancy comfort in a building or space. Atrius continues to roll out new and improved applications. In the fourth quarter, we launched product improvements to our Atrius Locator, which enables customers to track high-value assets within their spaces and Atrius vision that can improve customer experiences by managing traffic in a space. Now I want to spend a minute on capital allocation. Our capital allocation priorities remain the same. Our priorities are to invest for growth in our current businesses, invest in acquisitions, maintain our dividend and allocate capital for share repurchases when we perceive there is an opportunity to create permanent value for shareholders. Earlier this month, we announced Philippe Brzusczak as Senior Vice President of Corporate Development and Strategy. Philippe reports to me and will be responsible for evaluating mergers and acquisitions and building strategic relationships. As I reflect on our fiscal ‘22, we've had a good year. We have successfully repositioned the company at the intersection of sustainability and technology. Our businesses developed the technology that saves our customers' energy and reduces their carbon emissions. We are positioned for long-term growth by taking advantage of two of the most important megatrends, minimizing the impacts of climate change and maximizing the impacts of technology. Acuity Brands Lighting is the largest lighting and lighting control company in North America. We have dramatically improved our product vitality, and we have demonstrated that we could serve business when others could not. Our Intelligent Spaces Group has differentiated technology and building controls and management systems with Distech, and with Atrius, we are beginning to effectively demonstrate the benefits of connecting the edge to the cloud. We've changed how the company works with the introduction of our better, smarter, faster operating system. Better, smarter, faster is the combination of processes, tools, and ways of working that spans from strategy to people, to operating rhythms, to problem-solving. It is unique to our organization and allows us to drive strategic alignment, manage change and deliver results. At the same time, we have purposely transitioned the company to be a values-driven organization. We have seven shared values. Some of our values like integrity, owner’s mindset and community are fairly common. Others like time and curiosity are more distinctive to Acuity. Collectively, they serve as the decision-making framework that empowers our associates. The combination of better, smarter, faster and our shared values allows us to operate more efficiently with greater distribution of responsibility and accountability throughout the company. It is how we will continue to improve our business, respond quickly and effectively in changing economic environments and successfully operate additional businesses in the future. Our organization is clear on how we create value. We create value by growing net sales, turning those sales into cash and not growing the balance sheet as fast. We have overhauled our total rewards framework so that everyone in the organization is aligned with this. We've also demonstrated that we are effective capital allocators. We have made investments in our current businesses, we have successfully made and integrated acquisitions, and we have repurchased almost 20% of our company, creating permanent shareholder value. Now looking to our fiscal 2023 and beyond, we're excited about how far we have come and our prospects for the future. While we expect 2023 to continue to be a dynamic environment, we are confident in our ability to execute. We are well positioned in a variety of end markets, we are continuing to invest in product vitality and service, and we have developed a culture that supports change and is committed to improving. Now, I'll turn the call over to Karen, who will update you on our 2022 performance and provide a more specific outlook for 2023.

Karen Holcom, Senior Vice President and CFO

Thank you, Neil. 2022 was a strong year for Acuity. For the first time, we crossed over $4 billion in annual net sales. Our gross profit margin was 41.8%. Our operating profit increased by $82 million year-over-year, and we grew diluted EPS 32% to $11.08 for fiscal 2022. We continue to allocate capital effectively through the repurchase of approximately $3 million of our outstanding shares. In the fourth quarter, we continue to have strong net sales growth. Net sales of $1.1 billion were 12% higher than the prior year, with both the ABL and ISG business segments contributing to the growth. As Neil mentioned, we've now had OPTOTRONIC for a full year, and the incremental sales impact of that acquisition was only 1% in the fourth quarter. We delivered a gross profit margin of 41.7%, despite the lower production levels at the beginning of the fourth quarter. Operating profit in the fourth quarter was $150 million and adjusted operating profit was $170 million. Finally, we continued to grow earnings per share. Our diluted earnings per share of $3.48 was an increase of $0.76 or 28% year-over-year, while our adjusted diluted earnings per share of $3.95 increased $0.68 or 21% over the prior year. Share repurchases made throughout fiscal 2022 favorably impacted adjusted diluted EPS by $0.30 during the fourth quarter. I now want to expand on our segment performance. Net sales at ABL increased to just over $1 billion, an increase of 11% compared with the prior year, driven largely by strong performance within the independent sales network, which grew 11% and the direct sales network, which grew 13%. ABL's operating profit was $151 million, an increase of $2 million versus the prior year. This quarter operating profit was impacted by three key factors: first, higher cost of inventory; second, increased cost for transportation to deliver our products to the customer; and finally, higher commission rates for certain project business. Now moving onto ISG. The Spaces segment also had a very strong year and improved both net sales and operating profit. Sales in the fourth quarter of 2022 were $61 million, an increase of $11 million or 22% versus the prior year. ISG's operating performance also improved, while we continue to invest in the business. Operating profit in the fourth quarter of 2022 increased $8 million to $10 million. Moving to cash flow. We generated $316 million of cash flow from operating activities for the full-year of fiscal 2022. This was down $92 million from the prior year, primarily because we invested in working capital, particularly inventory to support our growth. I am pleased with our progress in the fourth quarter, during which we decreased inventory by $95 million. We invested $57 million or 1.4% of net sales in capital expenditures during the full-year fiscal 2022. Finally, we invested $107 million to repurchase approximately 600,000 shares during the fourth quarter, which means that for the full-year of fiscal 2022, we have invested around $512 million in repurchasing approximately 3 million shares. I would now like to spend a few minutes to talk through our 2023 outlook. After the call, you will find this outlook in the supplemental deck that will be available on our website. We are going to provide annual guidance anchored around net sales and adjusted diluted EPS. We will also provide other assumptions to help you with the construction of your models. For full-year fiscal 2023, our expectation is that net sales will be within the range of $4.1 billion and $4.3 billion for total AYI. This is based on the assumptions that ABL will generate sales growth in the low to mid single-digits and ISG will generate sales growth in the low to mid-teens. As Neil mentioned, we expect that fiscal 2023 will continue to be a dynamic environment. As we move from 2022 to 2023, our level of sales growth is returning to more normal levels. We are focused on any changes in the economic outlook and we are prepared to react as necessary in the future. Our expectation is that annual adjusted diluted earnings per share will be within the range of $13 and $14.50 for total AYI. You will recall that last year, we focused our framework on net sales and also on gross margin as we focused on product vitality and demonstrating our ability to manage the price cost relationship. We are pleased with our performance on these metrics and for fiscal 2023, our outlook will use the more traditional metrics of net sales and adjusted diluted EPS as I've described. The supplementary deck I mentioned will detail other key assumptions that should help you get to adjusted operating profit and adjusted EBITDA. We will not be providing quarterly guidance. I also want to provide you with some qualitative context for these numbers. As you know, our quarters have historically been subject to seasonality, and we expect that we will be largely consistent during fiscal 2023. We are continuing to deal with the global supply chain challenges, particularly around component shortages, and we are continuing to work through some of the higher-cost inventory. This could result in margins that are a little lower in the first part of the year, as compared to later in the year. Our capital allocation strategy in 2023 is unchanged. We will continue to generate cash and allocate capital effectively, prioritizing investments for growth in our current businesses, investing in acquisitions, maintaining our dividends and allocating capital for share repurchases. Just before I turn the call to the operator for questions, I want to leave you with this. We are very pleased with our performance in fiscal 2022. We exceeded $4 billion in net sales. We've made improvements to the business and we increased our profitability. We continue to allocate capital effectively and deliver permanent value for our shareholders. Thank you for joining us today. I will now pass you over to the operator to take your questions.

Operator, Operator

Thank you. Our first question comes from Tim Wojs with Baird. Tim, your line is now open.

Tim Wojs, Analyst

Hey, good morning. I think it's me. Nice job, guys.

Neil Ashe, Chairman, President and CEO

Thanks, Tim.

Tim Wojs, Analyst

I have a question regarding business demand and a broader question as well. If we enter a situation where there is less inflation, does that affect how Acuity approaches the market? In other words, will you modify your strategies regarding product vitality and service in a different inflationary environment?

Neil Ashe, Chairman, President and CEO

Tim, that's a great question, and I appreciate you bringing it up. The simple answer is no. We believe that product vitality and enhanced service levels are crucial for our long-term success, and they have certainly benefited us in an inflationary context. I think they will be just as vital in a more normalized environment. It's essential for us to offer products that provide value to customers while generating higher profits for us. We've made significant strides in product vitality, and there is still considerable opportunity for improvement in our service as we navigate ongoing component challenges and strive for more normalized lead times. These elements are fundamental to how we differentiate ourselves in the Lighting industry.

Tim Wojs, Analyst

Okay, good. Is there any way to kind of put numbers around vitality? I don't know if it's percentage of sales or how you kind of frame that, maybe what the margin is going to generally look like on a new product versus what it's replacing?

Neil Ashe, Chairman, President and CEO

I want to emphasize a couple of points regarding product vitality. When we refer to product vitality, we mean the combination of new product introductions and enhancements to our existing portfolio. We are actively working on both aspects and generally aim to address 20% to 30% of our product portfolio each year through these efforts, which is significantly higher than what we would have achieved three, four, or five years ago.

Tim Wojs, Analyst

Okay, good. And then maybe just a bigger picture question on the agent channel. So, over the last, I'd say, six months, we've seen just kind of higher agent consolidation in the industry and some changes. I guess it's probably driven by some of the OEM consolidation that we've seen. But, I guess as you look at the agent channel, do you see a trend towards more consolidation? And if that is the trend, is that positive for the industry in Acuity?

Neil Ashe, Chairman, President and CEO

We are quite optimistic about our independent sales network and our team of agents. We are currently enhancing our representatives in various markets, which gives us confidence. I tell our agents that our success is interconnected; they rely on us, and we depend on them. If their business thrives with us, we also benefit. The landscape is evolving, and we aim to advance together. Consequently, the top agents in local markets are increasingly drawn to align with the strongest players. I expect this trend to persist. There is considerable change happening among other independent sales agents, which presents an opportunity for us and our local agents as we move forward.

Tim Wojs, Analyst

Okay, good. Nice job on this year and good luck on next.

Neil Ashe, Chairman, President and CEO

Thanks, Tim.

Operator, Operator

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

John Walsh, Analyst

Hi, good morning, everyone.

Neil Ashe, Chairman, President and CEO

Hey, John.

John Walsh, Analyst

Hey, a lot of very interesting things happening, but maybe we can just dive into some questions on the guidance. So just looking at the $4.1 billion to $4.3 billion, just wondering if you could talk about the visibility into that number? I'm thinking if there is price carryover, if there's any kind of stimulus carryover from infrastructure and JOBS Acts or maybe even the IRA? And then, obviously, you're not really a backlog business, but you have been carrying some backlog through fiscal 2022. So just anything around that touching on those things, the confidence on that revenue number? Thank you.

Neil Ashe, Chairman, President and CEO

Thank you, John. As mentioned in our prepared remarks, we anticipate that fiscal 2023 will present a dynamic environment. I've advised our team that our strategy should be based on our ability to forecast the economic landscape better than others. Much of our current work aims to enhance our organization’s adaptability to respond to future developments. Regarding our net sales guidance, as Karen outlined, there's a distinction between ABL and ISG. On the ABL side, we are still managing a higher than usual backlog, and as I noted last quarter, the situation remains relatively stable. Our expectations for ABL suggest continued growth in the low to mid-teens as we capture market share, particularly in controls, and ramp up our Atrius software. While we can't predict the future with certainty, we are confident in our execution capabilities, and this represents our best estimate for the year’s performance.

John Walsh, Analyst

Great. And then maybe another one for you, Neil. You highlighted your business development higher. Obviously, your balance sheet is very strong. You've bought back shares during fiscal 2022. Obviously, the market is very choppy right now. But as you look at the world, what are the expectations you would set for us around balance sheet deployment and usage over, I don't know, the next six to 12 months?

Neil Ashe, Chairman, President and CEO

Yes. Let me broaden the perspective a bit beyond six to twelve months and consider the next couple of years. We have been very consistent with our priorities. We plan to invest in our current businesses, pursue mergers and acquisitions, maintain our dividend, and engage in share repurchases when opportunities arise. This framework will continue. Regarding acquisitions, I believe that in the next year or two, we will be in a better position to execute, integrate, and manage additional businesses due to all the improvements we have made in the company. As you mentioned, the market is somewhat unpredictable, which has affected valuations. Therefore, we anticipate that mergers and acquisitions will play a more significant role in our capital allocation over the next couple of years.

John Walsh, Analyst

Great. Well, a good end to the year and good luck on ‘23. Thank you.

Neil Ashe, Chairman, President and CEO

Thanks, John.

Operator, Operator

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

Chris Snyder, Analyst

Thank you. So I also wanted to ask about the guide, and some back-of-the-envelope math. If I take the mid-point, it seems like margins next year are down year-on-year at the mid-point of EPS and sales. So I guess, correct me if that thinking is wrong, but if it's right, can you just maybe talk about what are the margin headwinds next year? Is it on the price cost side? Is it more on the SG&A investment in the Spaces Group? Any color there would be helpful. Thank you.

Neil Ashe, Chairman, President and CEO

Yes, Chris, good morning. Karen and Charlotte will follow up with you and assist you in building the model after the call. Earnings per share are growing year-on-year, and we've discussed the net sales guidance. As we break that down, it does not suggest margin degradation. As Karen mentioned, we anticipate dealing with some inconsistencies in component availability early next year, which affects our ability to manage factory loads. Additionally, there are higher-cost inventory issues related to elevated historical container costs. However, we feel confident about our direction for next year.

Chris Snyder, Analyst

Thank you. I appreciate that. Does the guidance take into account any additional buybacks next year or any mergers and acquisitions that we should consider as we plan for that? Thank you.

Karen Holcom, Senior Vice President and CFO

Yes, Chris. When you see the deck that we'll post to our website after the call, you will see we're giving an estimate of share repurchases for next year in the range of $125 million to $150 million. So that's assumed in our assumptions for 2023, but we have not built anything in for M&A.

Chris Snyder, Analyst

Thank you. Appreciate that.

Karen Holcom, Senior Vice President and CFO

Thank you.

Operator, Operator

Our next question comes from the line of Christopher Glynn with Oppenheimer. Your line is now open.

Christopher Glynn, Analyst

Thanks. Good morning, Karen, Neil, Charlotte. So, kind of, interesting you spent a little more emphasis on Atrius this quarter. ISG has been largely defined by Distech, but I think with Atrius, you mentioned a couple of functionality improvements. And I think it's been a story of active piloting the last few years. So, wondering what sort of transition and inflections you're anticipating for the ability to scale the software piece there?

Neil Ashe, Chairman, President and CEO

Yes. Thanks for the question. On Atrius, you're exactly accurate. We've really been focused on improving the product and adding additional functionality to it, largely with an emphasis on the impact on buildings. So you'll see it, that's why we've been talking about Building Insights, and you'll see some of the work that the new product introduction that we talked about, an improvement that we talked about with Locator and ENVYSION are really all about those spaces. We don't feel like we're yet at an inflection point with Atrius and we don't assume that, but we're confident in the work that we've been doing. And it's worth taking a second to talk about the edge-to-cloud opportunity. So when we talk about the edge, that's obviously with Distech, we have powerful edge computing inside spaces that control those spaces and generate the data that can be used as we mentioned to control everything that happens in that space. And then the data creates options to increase additional functionality in those spaces, some of which currently exist and some of which we're building towards the future. So, no, I don't think we've turned to an inflection point yet on Atrius. But we are excited about the possibility of edge-to-cloud, and we're excited about our ability to compete effectively in the developing market around edge-to-cloud.

Christopher Glynn, Analyst

Great, thanks. And the other one was on the ABL margins in the quarter, down a bit sequentially, a little more year-over-year pressure than in the earlier quarters. You did mention the discrete kind of call out on some supplier relationships in the quarter and some make good in August, but are those two connected?

Neil Ashe, Chairman, President and CEO

Karen?

Karen Holcom, Senior Vice President and CFO

Yes. Chris, there are a couple of things going on in the ABL margins that we've highlighted. So, first as Neil mentioned, we are working through some of that higher-cost inventory related to the increased container cost from earlier in the year. That was one factor that impacted it. Definitely, the component shortages that we've experienced had some impact on our ability to level load our facilities, particularly earlier in the first couple of months of the quarter. And then we did see costs for freight to our customers. So the outbound freight to the customer is also increased in addition to the higher commissions that I mentioned. So, that really kind of impacted the margins at ABL this quarter.

Christopher Glynn, Analyst

Okay. The commission rate is stable, right? Or did the rate adjust?

Karen Holcom, Senior Vice President and CFO

The commission rate went up slightly, because of the project work and some higher rates on that project business.

Christopher Glynn, Analyst

Great. Thank you, guys.

Karen Holcom, Senior Vice President and CFO

Yes. Thank you.

Operator, Operator

Our next question comes from Joe O'Dea with Wells Fargo. Your line is now open.

Joe O'Dea, Analyst

Hi, good morning. Just wanted to expand on the ABL question for the quarter, if you could. Can you size what the revenue and margin impact was from some sourcing interruptions? And then when you talk about higher cost of inventory, can you give any sense of how much of that still needs to kind of flush out through the P&L? What kind of a margin headwind we're looking out there?

Karen Holcom, Senior Vice President and CFO

Yes. Joe, so looking at the size and impact of ABL, we're not going to break out the different pieces of how much that impact was. Yes, we talked about the OPTOTRONIC had a 1% impact. So you can look at the rest of that and know that in the quarter, because of the sudden price increases that we've had, we were a little bit more priced this quarter than what we've historically seen earlier in the year, just to give you some idea of the ABL size impact. And then on the question for the margins, we talked about working through some of the higher-cost inventory at the beginning of the year, as well as some of the component shortages. So for the balance of the year, you'd probably see a little bit lighter in the first part than you would in the second part of the year.

Operator, Operator

Thank you. Our next question comes from Adam Thomas with Redburn. Adam, your line is now open.

Adam Thomas, Analyst

Thank you. Good morning, everyone. Neil, the first question I have for you is just on the level of backlog you currently have. Have you seen any changes in the order trend versus pre-pandemic levels? And more specifically, how does the backlog position look for you as we head into 2023?

Neil Ashe, Chairman, President and CEO

Yes. Backlog remains strong as we enter the new fiscal year, and we are experiencing healthy demand across most product lines. While we are not seeing significant order cancellations, we are monitoring the situation closely as the macroeconomic environment evolves. We believe we are well positioned to capitalize on our backlog and follow-through with strong operational execution. We are preparing ourselves for any potential shifts in the market dynamics and adjusting our strategy as necessary.

Operator, Operator

Thank you. 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, Liz, and thank you all for joining us this morning. We are pleased with our strong results in the fourth quarter and throughout 2022, and we're excited about how far we've come and our prospects for the future. While we expect 2023 as we've said, through the questions and the construct of our expectation to be a dynamic environment, we're really confident about our ability to execute. We're well positioned in a variety of end markets. We're continuing to invest in product vitality and in service, and we developed most importantly a culture that supports change and is committed to improving. So thank you for your interest in our company, and we look forward to talking to you again real soon.

Operator, Operator

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