Earnings Call Transcript - AYI Q1 2025

Operator, Operator

Good morning, and welcome to the Acuity Brands Fiscal 2025 First Quarter Earnings Call. Please be advised that today's conference is being recorded. I would now like to turn the conference over to Charlotte McLaughlin, Vice President of Investor Relations. Charlotte, please go ahead.

Charlotte McLaughlin, Vice President of Investor Relations

Thank you, operator. Good morning, and welcome to the Acuity Brands Fiscal 2025 First Quarter Earnings Call. On the call with me this morning, Neil Ashe, our Chairman, President and Chief Executive Officer; and Karen Holcom, our Senior Vice President and Chief Financial Officer. Today's call will include updates on our strategic progress and our fiscal 2025 first quarter performance. There will be an opportunity for Q&A at the end of this call. As a reminder, some of our comments today may be forward-looking statements. We intend these forward-looking statements to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 as detailed on Slide 2 of the accompanying presentation. Reconciliations of certain non-GAAP financial metrics with their corresponding GAAP measures are available in our 2025 first quarter earnings release and supplemental presentation, both of which are available on our Investor Relations website at www.investors.acuitybrands.com. Thank you for your interest in Acuity Brands. I will now turn the call over to Neil Ashe.

Neil Ashe, Chairman, President and CEO

Thank you, Charlotte, and thank you all for joining us this morning. Our fiscal 2025 first quarter performance was solid. We delivered sales growth, expanded our adjusted operating profit and adjusted operating profit margin and increased our adjusted diluted earnings per share. We're also pleased to welcome QSC to Acuity, having successfully closed the acquisition last week. Now turning to Acuity Brands Lighting. We continue to perform well, delivering sales growth in the first quarter. Our performance is more predictable, repeatable and scalable as a result of the continued actioning of our strategy to increase product vitality, elevate service levels, use technology to improve and differentiate both our products and how we operate the business and to drive productivity. Our strategy has informed the development of our differentiated product portfolios, Contractor Select, Design Select and made-to-order, enabling us to drive growth and productivity for ourselves and for our partners. With Contractor Select, we are driving growth and productivity for our electrical distributors by lowering their cost of doing business and empowering them to carry less inventory. With Design Select, we're focused on delivering productivity to architects, lighting specifiers, design build contractors and electrical contractors by enabling them to choose the right configurable products for their projects. Our portfolios are constructed with high levels of product vitality. In Contractor Select, this quarter, we launched two new products: TruWrap and the REBL Round High Bay. Both products feature switchable technology and offer multiple functionality with the end result being that distributors can carry fewer SKUs while providing more options for customers. TruWrap from Lithonia Lighting enhances the traditional wrap, offering even lighting for spaces with limited natural lighting options, like locker rooms, storage utility areas, garages and offices. It features three adjustable lumen settings and three switchable color temperature settings. The REBL Round High Bay delivers uniform illumination for large open spaces like industrial facilities and indoor sports arenas. In addition to offering an expanded lumen range with switchable color temperature options, it is manufactured to withstand harsh conditions and can be easily integrated with our SensorSwitch controls for improved energy savings. These innovations are important to our customers, and our team has once again been recognized for the value they deliver. In the first quarter, many of our lighting solutions were selected for the GRANDS PRIX DU DESIGN Awards, an international competition that celebrates the excellence and talent of creative professionals and firms. Our winners included Mochi by Cyclone, Hydrel FLAME and several Eureka products, including the Tangram family and the Frank, Joli, Elke and Marro Luminaires. Our Luminis Syrios Pro was recognized by the Architect's Newspapers Best of Product Awards, which elevates well-designed products serving the architecture and design community. The Syrios Pro family includes interior and exterior luminaires for a seamless aesthetic transition. The luminaires are compatible with our nLight controls allowing seamless control of indoor and outdoor spaces while reducing energy costs, aiding in building compliance and improving occupant comfort. Now moving on to Intelligent Spaces, which delivered another strong quarter of sales growth and margin performance. Our mission in Intelligent Spaces is to make spaces smarter, safer and greener through a strategy of connecting the edge with the cloud using disruptive technologies that leverage data interoperability. In Distech, we are focused on where we compete and what we can control to expand our addressable market. As part of our geographic expansion, this quarter, we continued to add systems integrator capacity in the U.K., Asia and Australia. Distech partners with the best SIs in specific geographies to sell our full suite of controls, sensors and applications. In October, we brought together our North American SI partners in Nashville for our Connect conference. This is a highly engaged community of the best systems integrators in the world that come together to learn more about Distech and Atrius products. During the conference, we launched new products and applications and delivered updates on the latest technology trends while also offering technical training. This year was the highest attendance since the event began and highlighted the continued strength and importance of our relationships across the building management systems industry. We are thinking about spaces differently. We're using data to maximize occupant experience and transform spaces. Last week, we closed our acquisition of QSC. Through Distech, Atrius and QSC, we can now control both how a space is managed and what happens in that space with our disruptive technologies that promote end-user satisfaction through data interoperability. Imagine a future where you walk into a room and the space intelligently adjusts, where data is used to predict how many people will be using that room, cooling or heating the room in advance for optimum occupant comfort, aligning the in-person and virtual experience by seamlessly transitioning between microphones and cameras based on who is speaking and where they are located, using data points to optimize lighting levels, lowering shades if there is an increased glare. And if a meeting is canceled, reverting a room back to its unoccupied settings to save energy and lower costs. We're excited about the addition of QSC to Intelligent Spaces as we continue to execute on our mission. Now looking forward, we are an industrial technology company with the best lighting company in North America and a larger scale Intelligent Spaces business. Our path to growth and profitability is clear in both segments. In Acuity Brands Lighting, our growth algorithm is to grow with the market, take share and enter verticals where we have either not historically competed or where we are underpenetrated. We will continue on our path to improve margins. In Intelligent Spaces through Distech, Atrius and QSC, we can now control both how a space is managed and what happens in that space with our disruptive technologies that promote end-user satisfaction through data interoperability. Our focus will be on growth and we have the opportunity to expand margins. We are creating value by growing net sales, turning profits into cash and not growing the balance sheet as fast, and we are demonstrating that we are effective capital allocators. Now I'll turn the call over to Karen, who will update you on our first quarter performance and provide more details of the expected financial impact of the QSC acquisition.

Karen Holcom, Senior Vice President and CFO

Thank you, Neil, and good morning to everyone on the call. We delivered solid performance in our first quarter of fiscal 2025. We grew sales, improved our adjusted operating profit and margin, and increased our adjusted diluted earnings per share. For total AYI, we generated net sales in the first quarter of $952 million, which was $17 million or 2% above the prior year as both Lighting and Intelligent Spaces grew. During the quarter, our adjusted operating profit was $159 million, which was up $5 million or 3% from last year, and we expanded our adjusted operating profit margin to 16.7%, an increase of 20 basis points from the prior year. This increase was largely a result of the significant year-over-year improvement in our gross profit margin driven by product vitality, the management of pricing cost and productivity improvements. We generated net interest income as a result of the cash position on our balance sheet. This quarter, our effective tax rate of 20.8% was lower than last year and lower than the expected full year rate of around 23.5% due to discrete items in the quarter. Finally, our adjusted diluted earnings per share of $3.97, increased $0.25 or 7% over the prior year. In Acuity Brands Lighting, net sales were $886 million, which was $10 million or 1% above the prior year, primarily the result of sales growth in our independent sales network and in our direct sales channel. Adjusted operating profit was $154 million, and we delivered adjusted operating profit margin of 17.3%, which was down slightly compared to the prior year. Sales in Intelligent Spaces for the first quarter were $74 million, an increase of 15% year-over-year as Distech continued to deliver impressive growth. Adjusted operating profit in Intelligent Spaces was $15 million with an adjusted operating profit margin of 21%, an improvement of 5 percentage points year-over-year. Now turning to our cash flow performance. In the first quarter of 2025, we generated $132 million of cash flow from operations. We earned attractive returns on the cash that we have on our balance sheet, and we ended the quarter with $936 million of cash. We closed the acquisition of QSC last week. We financed this acquisition with $600 million of additional debt and the remainder with cash on hand. During the quarter, we resumed our share repurchase program and allocated approximately $5 million to repurchase approximately 17,000 shares. I now want to spend a few minutes updating our outlook for 2025 for the inclusion of QSC. QSC will be reported in our results beginning in January. Our updated expectations for full year fiscal 2025 is that net sales will be within the range of $4.3 billion and $4.5 billion for total AYI, and we expect adjusted diluted earnings per share within the range of $16.50 to $18. Additionally, we now expect to have full year interest expense of between $20 million and $25 million for the full year fiscal 2025. We will incur integration expenses as well as the impact of purchase accounting adjustments throughout the year. We're pleased with our performance in the first quarter of fiscal 2025. Our Lighting business continued to perform well and our Intelligent Spaces business delivered impressive results. Thank you for joining us today. I will now pass you over to the operator to take your questions.

Operator, Operator

Our first question comes from the line of Ryan Merkel at William Blair.

Ryan Merkel, Analyst

First off, I wanted to ask on QSC and the accretion, and thanks for updating the guide. But could you give us the full 12-month accretion that you're expecting from QSC?

Neil Ashe, Chairman, President and CEO

Ryan, it's Neil. Thank you all for joining us this morning. The full year isn't particularly relevant right now, but if you consider it on a calendar basis, you could get a general sense of direction. We have about 8 months left this year, so looking ahead from 8 to 12 months is reasonable. More importantly, we are really satisfied with the acquisition. For our Intelligent Spaces group, we have a different approach. We can manage both the building and how the space is utilized, which gives us a unique advantage in data collection and its application. We're really excited about this. We've had a strong start with the team at QSC and are thrilled to have them as a part of Acuity.

Ryan Merkel, Analyst

Okay. Helpful. And then, Neil, can you just comment on order trends and if visibility has improved on the backlog and the pipeline with those projects potentially getting released?

Neil Ashe, Chairman, President and CEO

Yes, Ryan, I think you are referring to the Lighting business. On the Lighting side, we are pleased with the performance. Our team is executing consistently, and we have a clear understanding of the growth strategy. Looking ahead, we believe that 2025 will be a better year from a market perspective compared to 2024. We base this assumption on data we have and our interactions in the field. Feedback from the field indicates that our growth strategy is effective. We are the leading player in the industry, not only in size but also in performance, particularly in quality. Our Q1 numbers show that our commercial and industrial channel performed well, while our retail channel did not perform as strongly, which we see as a temporary issue. Overall, we feel confident about the rest of this year and beyond.

Ryan Merkel, Analyst

And if I could just follow up on that last point. I noticed that the corporate accounts in retail were down, but the most important segment, the independent channel was up. So is the read here that you're starting to see sort of demand recovery, demand inflection? Or is it a bit too early?

Neil Ashe, Chairman, President and CEO

Let's label that when it occurs. I believe our product segmentation strategy is truly coming to life and operating effectively in the commercial and industrial as well as the direct channel. Our corporate accounts present an inconsistent but high-quality business; we experience larger quarters alongside smaller ones depending on individual customer choices. On the retail side, we have strong relationships, although the results over the past year haven't been stellar. This reflects a bit of a catch-up, but it's just a temporary situation. While it's still early to determine a turning point, we are certainly optimistic about our trajectory heading into calendar year 2025.

Operator, Operator

And our next question coming from the line of Tim Wojs with RW Baird.

Timothy Wojs, Analyst

I guess just a first question. Just on the guide, I just want to confirm, is the guide raise solely for QSC and the core is unchanged? Or did you guys make any changes to kind of the core guidance?

Karen Holcom, Senior Vice President and CFO

Yes, the guidance is just the adjustment for QSC. We expect the base business to perform as we outlined for the fourth quarter. The increase in sales and EPS is mainly due to the impact of QSC, along with the additional interest expense.

Timothy Wojs, Analyst

Okay, great. Can you share the initial feedback from your system integrated customers regarding QSC? Also, could you provide a historical example or two of how these types of businesses work together and why it is beneficial to have them all under one roof?

Neil Ashe, Chairman, President and CEO

Yes, let me take a moment to explain. We have a different perspective compared to the rest of the industry. We believe that data is the key driver of value today, and there’s an opportunity to unify the data involved in a build space, including what happens and who is present in that space. Therefore, establishing a data and controls business represents a unique opportunity that we see. Historically, these elements haven't intersected. The initial feedback we received from the systems integrator community at Distech and QSC was a request to sell each other's products, which is precisely what we anticipated. However, we haven't moved forward with that yet. Our strategy for integrating these systems involves three key steps. First, we recognize that this is a high-quality asset and we expect it to maintain its performance. Second, we see a chance to create opportunities for end users by blending data and ensuring interoperability, which we anticipate will develop over the next 12 to 24 months. Lastly, we are confident that being part of our organization will help enhance their value. A specific example of this integration is the collaboration between Distech and QSC prior to the acquisition, where they enabled data interoperability, allowing the Q-SYS control system to manage building operations through their interface while Distech controlled audio-visual elements with ours. This combination is very natural, but it hasn't been seen in this form before.

Timothy Wojs, Analyst

Okay. That's helpful. And then just to sneak one last one in. How is Acuity and the channel in general preparing for potential tariffs? Has there been any sort of pull forward in shipments? Or how would you think about the tariff implications for Acuity and how people are managing in the channel?

Neil Ashe, Chairman, President and CEO

To summarize, there's been a lot of discussion but not much action. We've made minor, targeted adjustments in our purchasing as precautionary steps for the future. Many customers have inquired about possible price increases due to tariffs, but that conversation has since quieted. Our customers expect us to respond appropriately when the situation arises, and we've communicated to them that currently, there is nothing to address. If changes do occur, we will be ready to respond accordingly.

Operator, Operator

Our next question coming from the line of Joe O'Dea with Wells Fargo.

Joseph O'Dea, Analyst

Can you just talk about the QSC margin opportunity over time? It looks like what's embedded in the guide for '25, now including QSC, would put their revenue maybe up low double digits year-over-year. So a pretty attractive growth rate and not too dissimilar from ISG. It looks like on the margin profile, we may be looking at QSC op margins kind of mid-teens versus the 20%-ish for ISG. So when you think about that margin gap, any structural differences there? And how do you think about the timeline to narrowing that?

Neil Ashe, Chairman, President and CEO

Yes. When we announced the acquisition, we mentioned that it's an appealing opportunity to integrate. The underlying business is strong and shares a similar financial profile to our current assets in the Intelligent Spaces business. You're right about expecting mid-teens growth, which aligns with our current performance. Our primary focus is on growth, and we did not pursue this acquisition to cut costs. We have a natural chance to enhance margins over time, just as we have with Distech and the ISG business, where we've seen strong progress over the past three years. Regarding your last question, there are no structural issues that would hinder our ability to achieve this growth over time. However, I want to stress that our first priority is to enhance the growth and performance of the existing business, followed by delivering unique offerings to the market that others cannot provide.

Joseph O'Dea, Analyst

And then just on the go-to-market and you talked about sort of encouraging feedback from systems integrators. But how much overlap is there in that system integrator go-to-market today, in terms of the percentage of sort QSC and ISG revenue that will be going through the same systems integrators through separate and kind of that opportunity set to then leverage those separate paths by selling both through them?

Neil Ashe, Chairman, President and CEO

I want to take this chance to emphasize something I believe is quite significant, which is the considerable overlap among the most intelligent end-user customers who have utilized both Distech and QSC's Q-SYS platform. This overlap is noteworthy. During my time here, I've noticed that the most discerning customers of Distech share similar characteristics with those of Q-SYS and QSC. This leads to a very appealing situation for the systems integration community associated with both Distech and QSC, as they have the chance to implement the best technology and engage with the most advanced customers. In that regard, we are alike. Currently, we don't have any immediate plans for these systems integrator communities to merge in the future. However, I anticipate that we will naturally attract the most sophisticated end users for the solutions we can provide.

Operator, Operator

Our next question coming from the line of Christopher Snyder with Morgan Stanley.

Christopher Snyder, Analyst

Maybe just following up on all the questions around the strategic rationale of QSC. It does seem like there is revenue synergy potential and maybe some moderate cost synergies potential. Is any of that factored into the kind of the $0.50 accretion that you guys are calling for this year? Or is that really just kind of a continuation of the steady-state business we've seen at QSC, which is growing and kind of generating these mid-teen margins to begin with?

Neil Ashe, Chairman, President and CEO

Yes. Welcome back, Chris. Our expectation for the first year of the business is that they will continue operating as they have, while we go through the integration process. I believe that revenue synergies will manifest in the future, not immediately. As I mentioned, we do not feel the need to reduce costs in their business; instead, we want to focus on growth.

Christopher Snyder, Analyst

I appreciate that. And then, obviously, gross margin just continues to be kind of a phenomenal story for the company. And I think on the last conference call, Neil, you kind of talked about ABL continuing to grow margins in, I believe, the 50- to 100-basis-point range over the, I guess, medium to long term. It seems like that implies that you guys think gross margin can continue to push higher from these levels to drive that level of operating margin expansion. I guess is that the right takeaway and how do you see gross margin going from here? I mean it wasn't that long ago where we were wondering if you could get to 42%.

Karen Holcom, Senior Vice President and CFO

Yes. Chris, good to hear from you again. You're right. We're really pleased with our gross profit margin expansion over the course of time. We were at 47.2% this quarter, which was up 140 basis points year-over-year. Particularly at ABL, it's a reflection of the work we've done over the past few years on the strategy with product vitality, service, technology and productivity, but also the growth of Intelligent Spaces is having an impact on that gross profit margin. When you think about product vitality, you've seen it on the presentation. We're not going to stop, and we're going to have products like what we highlighted last quarter with the holiday. So where we're delivering higher value products with less material content. So to answer your question, yes, we think there's still some room there. And our comment last quarter was on the 50 to 100 basis points of margin improvement at ABL from an operating profit perspective. We do think that over the course of time, that business will continue to improve margins. We're going to make some investments. We've talked about technology investments that we need to make to power our gross profit margins. So you may see a little bit more investment in SG&A to get benefits elsewhere. But overall, we feel really good about that business continuing to perform and improve margins over time.

Operator, Operator

Our next question coming from the line of Christopher Glynn with Oppenheimer.

Christopher Glynn, Analyst

A lot of good detail on QSC, so I'll pivot to ABL a little more. You've talked about the last few quarters kind of agency activity being fairly positive input and some project delays and release times a factor there. So I'm wondering if the agency activity is still suggesting a bit of a momentum build opportunity as the year goes on? And if financing and inflation are the main pacing items for the release to coalesce?

Neil Ashe, Chairman, President and CEO

Yes, Chris, those are great questions. Overall, our agency network is continuing to perform well. The independent sales network plays a crucial role in what we do at ABL, and I previously mentioned their performance. When we analyze data to forecast our future, we consider factors such as inflation, interest rates, and ABI, among others. Collectively, these factors indicate a positive trend for 2025. However, I'm not personally sure what precisely triggers these changes, and the data we've reviewed doesn't show a consistent pattern. Nonetheless, the sentiment within our agency community remains strong. We maintain regular communication and surveys with them, and most expect a gradual improvement in performance over time. While it doesn't seem like a sudden surge is on the horizon, it appears we can expect a steady progression moving forward.

Operator, Operator

Our next question coming from the line of Jeffrey Sprague with Vertical Research.

Jeffrey Sprague, Analyst

Maybe just a couple of loose ends for me, a lot of ground cover. First, just want to touch base on ABL operating margins, which did tick down a little bit. So maybe the larger question is in terms of what's going on with SG&A and investment and the fact that the gross margin and operating margin went in different directions in the quarter?

Neil Ashe, Chairman, President and CEO

Karen?

Karen Holcom, Senior Vice President and CFO

Yes, Jeff. As I mentioned earlier, we are continuing to invest in ABL. If you look at it on a sequential dollar basis, you will notice that our expenses are more aligned with where we finished last year. The focus is really on managing those expenses, and as our sales recover in the second half, you will see the percentage of sales start to improve. We are confident in our management of these investments. We will be investing in technology, which may yield some benefits in other areas of the profit and loss. Overall, we believe there are opportunities to optimize some of our fixed operating expenses as we increase sales in the latter part of the year.

Jeffrey Sprague, Analyst

And then, Neil, this idea of sort of the smartest, most sophisticated customers using Distech, QSC, is there a common theme as it relates to that customer type in terms of, I don't know, the company or business or the vertical market or some characteristics that you'd say applies across that set of customers that you're referencing?

Neil Ashe, Chairman, President and CEO

Yes, Jeff, I would say that the consistent characteristics of those customers are that they are technology-driven, manage their operations from a central point, and aim for uniformity across their various buildings or locations. They are focused on maximizing the productivity of their space and improving how they manage these spaces. For instance, at the recent Distech conference, which was part of the Connect Conference in Nashville, we had 700 systems integrators in attendance who paid to participate. The event had a family reunion vibe mixed with technology-focused business opportunities. One of the panels featured some of our best customers from our Building Advisory Council, including a representative from Stanford University, who discussed the advantages of using Distech and how its consistent technology enhances their campus operations. Additionally, on QSC's website, there are numerous engaging case studies on Q-SYS. One particularly noteworthy example is Indiana University, which standardized the interfaces in each of their classrooms, regardless of size, to ensure a consistent experience for users, thus significantly increasing their productivity while allowing for centralized management. The overarching trend is that technology is bringing data closer to the CIO rather than just the head of facilities, which is enhancing end-user experiences and improving productivity within organizations.

Jeffrey Sprague, Analyst

Great. And maybe just one quick one for Karen. I'm sorry Karen, you mentioned purchase accounting and inventory and the like. All that's adjusted out of your construct, though, correct?

Karen Holcom, Senior Vice President and CFO

Yes, it is. All of that would not be included in our adjusted diluted earnings per share expectations, correct.

Operator, Operator

And our next question is coming from the line of Brett Castelli with Morningstar.

Brett Castelli, Analyst

I just wanted to ask on ABL and specifically on the Design Select product portfolio and just the traction you're seeing there with customers?

Neil Ashe, Chairman, President and CEO

Yes, Brett, welcome. As we have noted, our portfolio segmentation strategy is focused on enhancing growth and productivity for both ourselves and our partners. The Design Select portfolio is specifically designed to foster growth and productivity within the design community, as the name suggests, by enabling them to effectively execute their projects. We are seeing good traction in that area. We anticipate this to be a long-term journey, spanning approximately 3 to 5 years. The percentage of our sales attributed to Design Select is currently higher than we anticipated at this stage, although we are still in the early phases of the process. We are in the second or third inning of what we believe we can achieve with Design Select. The feedback from the external community has been very positive; they understand the concept and recognize the value it brings, leading them to choose our offerings. Our main focus is on gradually rolling out the products associated with Design Select as we ensure that they meet our standards. We are committed to this approach to foster long-term value.

Brett Castelli, Analyst

That's great. And then maybe for Karen, just on capital allocation for the remainder of the year. And just curious what you're thinking in terms of potential debt paydown, if any, as part of that?

Karen Holcom, Senior Vice President and CFO

Sure. First, regarding capital allocation, I want to repeat our priorities. Our focus is on investing in our existing businesses for growth, pursuing mergers and acquisitions, increasing our dividend, and conducting share repurchases. To specifically address your question, we generate substantial cash. As we mentioned during the acquisition announcement, we can pay down debt fairly quickly, giving us more options for the future. With our cash flow, we can meet all our capital allocation priorities, including debt repayment over the next 12 to 18 months. I also want to note that we resumed our share repurchase program this quarter. We were temporarily out of the market due to the announcement of QSC, but we picked up again late in the quarter, which might make it seem lighter than usual. However, we are pleased with the results of our repurchase program and anticipate it will continue.

Operator, Operator

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

Neil Ashe, Chairman, President and CEO

Thank you, operator. Thank you all for joining us this morning. We are pleased with our performance in the first quarter. As stated in the prepared remarks, we have the best lighting company in North America, and it is performing well. We have a clear strategy for growth and the opportunity to continue increasing margins. Our larger scale Intelligent Spaces business combines data and control in a unique way, providing us with differentiated opportunities and growth in the marketplace. We understand how to create value by growing net sales, converting profits into cash, and managing our balance sheet growth carefully. Thank you for joining us today, and we look forward to speaking with you again next quarter.

Operator, Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.