Earnings Call Transcript - AYI Q3 2024

Operator, Operator

Good morning, and welcome to the Acuity Brands Fiscal 2024 Third Quarter 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. Good morning, and welcome to the Acuity Brands fiscal 2024 third quarter earnings call. On the call with me this morning are Neil Ashe, our Chairman, President, and Chief Executive Officer; and Karen Holcom, our Senior Vice President and Chief Financial Officer. Today's call will include updates on our strategic progress and on our fiscal 2024 third quarter performance. There will be an opportunity for Q&A at the end of this call. As a reminder, some of our comments today may be forward-looking statements. We intend these forward-looking statements to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as detailed on Slide 2 of the accompanying presentation. Reconciliations of certain non-GAAP financial metrics with their corresponding GAAP measures are available in our 2024 third quarter earnings release and supplemental presentation, both of which are available on our Investor Relations website. 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. In our fiscal 2024 third quarter, we delivered solid results. We increased our adjusted operating profit, adjusted operating profit margin, and adjusted diluted earnings per share. We generated strong free cash flow, and we allocated capital effectively to drive value. In our Lighting and Lighting Controls business, we continue to expand profitability while we focus on returning the business to growth. In our Intelligent Spaces business, the growth rate and overall performance remains impressive. In ABL, we increased our adjusted operating profit $2 million to $162 million and increased our adjusted operating profit margin by 100 basis points to 18% on $42 million less sales. These results are being driven by our ongoing efforts 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. We define product vitality as the combination of new product introductions and improvements to our existing portfolio with the intention of making products that are more valuable for our customers and more profitable for us. A great example of this is the Lithonia FRAME, which we recently introduced to the market. This luminaire is a modern and sustainable alternative to traditional LED panels and can be used in all indoor applications, including commercial offices and K-12 schools. FRAME offers our customers value as a result of three things. The first is its flexibility of design. The FRAME comes in three different size options with switchable technology to offer different lumen outputs and color temperatures. The second is its lightweight design and patented snap connections that allow for quick assembly and ease of installation. And the third is that it costs less to package and ship as a result of its minimal sustainable packaging. I'd now like to spend a few minutes talking about our differentiated product portfolios. Made-to-Order, Design Select, and Contractor Select, and how they are creating the most effective way for our end-users and contractors to get what they need, when they need it for their specific projects. The majority of our products are Made-to-Order, which uses our entire portfolio to create limitless design options for our customers. From concept to creation, we meet their requirements. I'd like to share a few examples with you. We have been working on the restoration of the Michigan Central Station in Detroit, where we took the original lighting blueprints from 1912 and recreated them as current-generation LED fixtures. When combined with our controls, these fixtures deliver energy savings and create distinct event lighting to deliver a completely unique solution. We are also able to adapt our existing Lighting and Lighting Controls portfolio. For example, this quarter, we met the retrofit requirements of a large retail customer by using the base design of several key fixtures and combining them with our controls to create a unique tailored solution. And finally, we have specialty brands known for innovation like A-Light, Luminis, and Eureka, which meet the needs of lighting specifiers in different spaces, ranging from offices to healthcare to schools. Next, Design Select takes the limitless design options from Made-to-Order and curates them into an offering that delivers a highly productive approach to project design, with ease of selection and service predictability. Whether a customer needs their products in three weeks or three months, we are able to satisfy their timelines. We deliver highly configurable product options for superior solutions by incorporating a broad portfolio of our trusted brands and offering nLight embedded controls. And the final part of our differentiated portfolio is Contractor Select. About 300 high-volume products that are used in common everyday lighting applications designed to be stocked and resold. We have been able to create a portfolio that offers quality products that our customers want at competitive prices, while at the same time allowing our distributor partners to achieve higher returns. We also continue to make investments for future growth, prioritizing new verticals where we have not historically competed or where we are underpenetrated. We have recently entered the refueling vertical, which includes service stations, convenience stores, and quick-service restaurants. We are reimagining the customer experience using solutions specifically developed for these applications in addition to our other existing products from our Lighting and Lighting Controls portfolio. This is a vertical where we have not broadly competed, and earlier this week, we announced that we have signed one of the leading independent sales agents, positioning us well to compete in this established and growing market. This builds upon our discussion last quarter around entering the horticulture market. This is another example of a vertical where we had not historically competed and where we have long-term opportunities for growth. We continue to be recognized by the industry. This quarter, we were awarded three Red Dot Design Awards for product design, one of the most sought-after distinctions for design and quality. We won for INLINE by Luminis, which we profiled in our first quarter earnings call, Atoll by Eureka, and Mochi by Cyclone. Atoll is a high-performance ring fixture with an elevated design that produces an evenly distributed glow and is available with multiple size and mounting options for use in commercial spaces and other indoor environments. 2024 marks the 10th consecutive year that our Eureka brand has won a Red Dot Design Award, and Atoll brings its total product wins in this category to 20. Mochi is a contemporary dome streetlight that offers precision illumination for use in infrastructure projects where safety is a priority, including city, residential streets, and commercial buildings. Its innovative design offers multiple configurations in addition to a patented latch that allows for easy maintenance access without compromising security. This is the first Red Dot win for our Cyclone brand. In addition, we were awarded 21 Bright Star awards from LEDs Magazine, which acknowledges innovation in lighting, components, and controls for products across 14 of our brands, including Aculux, Hydrel, eldoLED, and nLight. Now, moving on to our Intelligent Spaces Group. Our mission in our Intelligent Spaces business is to make spaces smarter, safer and greener through our strategy of connecting the edge to the cloud. Distech has the best edge control devices in the market, while Atrius will be the best in cloud applications. In spaces, 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 continue to add systems integrator capacity in the U.K., Australia, and Asia. We partner with the best system integrators in specific geographies to sell our full suite of Distech and Atrius products. In May, we hosted our key system integrator partners and end-users at our European Connect Conference in Marseille. It was a great success, and we look forward to hosting our North American Connect Conference in Nashville later this year. At Connect, the Distech Resense Move sensor that we discussed in the first quarter continued to generate positive reviews. As a reminder, this is an advanced seven-in-one ceiling-mounted sensor that is able to detect occupancy and provide feedback on occupancy requirements in built spaces. We also showcased our refrigeration offering, which included the upgraded Distech KE2 Therm Smart Access, a personalized secure portal that provides real-time refrigeration system data that can troubleshoot system issues, prevent unnecessary site visits, and save our customer's money. The device talks to all Distech KE2 Therm sensors and controls and allows on-site and remote monitoring for one or multiple site locations. And this quarter, our Spaces products received recognition from several industry leaders. Our Distech Resense Move won best AI tech innovation for intelligent buildings at IBcon 2024 last week, having also won an Excellence Award in the 2024 Electrical Review and Data Center Review earlier in the quarter. Our Distech Controls' ECLYPSE APEX controller won a Product of the Year award at the 2024 Consulting Specifying Engineer Awards, and Atrius won Best ESG and Climate Reporting software from ESG Investing Magazine for the second consecutive year, and won Top Products of 2024 by E&E Leader. Now turning to our outlook. In our lighting business, our order rate continued to grow year-over-year in the third quarter. We built backlog as our orders exceeded our shipments. This backlog will be served in the coming quarters. As we enter the fourth quarter, the order rate trend is likely to continue and we will remain focused on returning the business to growth, while expanding margins and generating strong free cash flow. Our Spaces business continues to grow impressively and is becoming a more important part of our company. Our performance is strong, and we will continue to allocate capital to expand our addressable market. Now, I'll turn the call over to Karen, who will give you an update on our third quarter performance.

Karen Holcom, Senior Vice President and CFO

Thank you, Neil, and good morning to everyone on the call. We continue to deliver solid performance in our third quarter with both our Lighting and Spaces businesses delivering margin improvements. We increased our adjusted diluted earnings per share and generated strong year-to-date operating cash flow. We allocated capital effectively and continued to make progress on our strategic priorities. For total AYI, we generated net sales in the third quarter of $968 million, which was $32 million, or 3% below the prior year as a result of the lower net sales in our Lighting and Lighting Controls business. Our Spaces business continued to experience strong growth of 15% in the quarter. We continued to deliver year-over-year margin improvement. During the third quarter, our adjusted operating profit was up $4 million from last year on a $32 million decline in sales, and we expanded our adjusted operating profit margin to 17.3%, an increase of 100 basis points from the prior year. This increase was driven largely by the significant year-over-year improvement in our gross profit margin, as we continue to execute our strategy and drive margin through product vitality, the management of price and cost, and productivity improvements. During the quarter, our adjusted diluted earnings per share of $4.15 increased $0.40, or 11% over the prior year due to higher net income and lower shares outstanding. In ABL, net sales were $899 million, a decrease of 5%. However, as Neil said earlier in the call, our order rates are higher year-over-year. While the independent sales network was down as a result of the challenging comparables last year, this quarter was a good quarter for corporate accounts, which benefited from a large retail relight project. Adjusted operating profit increased to $162 million on lower net sales, while we delivered improved adjusted operating profit margin of 18%, a 100 basis point improvement over the prior year. Net sales in Intelligent Spaces for the third quarter were $76 million, an increase of 15% as Distech continued to grow. The integration of KE2 Therm is now complete, and KE2 Therm products are now a product line under the Distech Controls product portfolio. Adjusted operating profit in Intelligent Spaces was $17 million with the adjusted operating profit margin at 22.9%, a 340 basis point improvement over the prior year. Now turning to our cash flow performance. We generated $445 million of cash flow from operating activities year-to-date, and we are earning attractive returns on the cash that we have on our balance sheet. We continue to allocate capital consistent with our priorities. Year-to-date, we invested $41 million in capital expenditures, we acquired the assets of Arize Horticulture Lighting, we increased our dividend per share by 15%, and allocated approximately $89 million to repurchase over 454,000 shares. Since the beginning of the fourth quarter of fiscal 2020, we have repurchased approximately 9.5 million shares at an average price of about $145 per share, which was funded by our organic cash flow. This amounts to about 24% of the then outstanding shares. We continue to demonstrate solid performance. We delivered improved margins and increased adjusted diluted earnings per share. We generated strong cash flow from operations and we continue to allocate capital effectively. 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 the line of Christopher Glynn with Oppenheimer. Your line is now open.

Christopher Glynn, Analyst

Thanks. Good morning. I was curious about the continuing gross margin performance and all the execution there. I'm curious if the service model streamlining initiatives, particularly the deployment of Design Select, are pacing faster than expectations perhaps.

Neil Ashe, Chairman, President, and CEO

Hey. Good morning, Chris. Thanks for the question. So we're pleased with our performance on margin expansion. As you know, this has been a multi-year process and it's been focused really on the strategy of product vitality, increasing service levels, using our technology to differentiate how we operate the business, and then driving productivity. So this is a point on that path. I'd highlight really around product vitality and our ability, as we said in the prepared remarks, to both deliver more value to our end-users as well as make our products more profitable. So obviously, that's a number of things. Design Select is among those things. It's actually pacing where we expected. So it is not the primary driver of the improvement here, which highlights the trend that we're on and the length of the path we still have to travel. So we're pleased. I'd also highlight that you'll remember we acquired the OPTOTRONIC business from Osram, so we control more of the technology that is in our luminaires, and that gives us significant flexibility both in our design and our operations. So we're pleased with the continued margin performance, and it is attributable to multiple different things working in harmony.

Christopher Glynn, Analyst

Thanks. Appreciate all that color. And then the positive book-to-bill is notable, an interesting caveat to the revenue being a little short of estimates out there, and I think it's the third straight quarter of positive year-over-year orders. I'm curious if the patterns weekly, monthly are still pretty consistent or perhaps they're getting a little more streaky in the front month or two?

Neil Ashe, Chairman, President, and CEO

Yeah. So this quarter, as we said, our orders exceeded our shipments. The order rate has been relatively consistent throughout the year. So, as Karen mentioned in her remarks, our production targets were not met in the quarter, which is why we built backlog, so why our orders exceeded our shipments. So we're working on that. We'll sort that out obviously going forward, and we will satisfy that backlog. The big picture is that we are cautiously optimistic about the future. The power of the diversity of our portfolio is really demonstrating itself, both in this quarter and as we go forward. So I'd highlight the corporate accounts business, which is defined as streaky because we meet large customers when they're ready. It's a very attractive piece of business that we are uniquely positioned to serve in the industry. So things like that have been streaky. Things like C&I have been relatively consistent. So that builds us a strong foundation so that we can adapt to where opportunity is in the market. And then, we'll continue to invest to add new areas of competition for the lighting business specifically, and we'll talk about Spaces, I'm sure later, but there we talked about horticulture and petroleum. So the streaky place, as Karen identified was around corporate accounts, which is a very attractive piece of business for us.

Christopher Glynn, Analyst

Okay. Thank you.

Operator, Operator

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

Ryan Merkel, Analyst

Hey. Thanks for taking the questions. I wanted to ask as well on the order rate growth. Neil, can you just talk about which end-markets you're seeing positive trends and maybe by geography where things are a bit stronger?

Neil Ashe, Chairman, President, and CEO

Yeah, I'll start and Karen add color as you see fit. Let me first start by the disaggregated revenue. We've seen consistency in the C&I channel, as I said earlier. So that's our agent project business throughout the country. And that has been stronger in areas where you expect growth, like the South, obviously, again, strength in corporate accounts and the opportunities that we have there, and longer-term strength in our infrastructure. So we are taking longer-lived orders to satisfy a longer period of time than we have in the past. So we've talked about the City of Philadelphia and the Hall of Fame, for example. There are others that look and smell like that. Yes, we are not in a market where everything is up and to the right, but our diversity of opportunity is presenting us the ability to continue to have a relatively consistent order rate. Karen, anything you'd like to add?

Karen Holcom, Senior Vice President and CFO

Yeah. The only thing I would like to add, Ryan, is that when we look ahead, infrastructure continues to show positive signs. It's not landing yet, but the quoting activity is really strong. So as we look ahead, I think we have the portfolio to service that business and see that as an opportunity for us.

Ryan Merkel, Analyst

Got it. Okay. That's helpful. And then, I want to go back to the comment you made about not shipping maybe as well as you could have and you're going to address that. Can you just talk about that, and when do you think you'll solve that?

Neil Ashe, Chairman, President, and CEO

Yeah. So as we said, our orders exceeded our shipments, which means we generated backlog during the quarter. The reason is we didn't meet our daily production targets, and there are a handful of reasons for that, none of which are alarming, and we are in the process of addressing them all. So we'll sort those out over the course of this quarter and the next quarter, and we'll be back to where we want to be.

Ryan Merkel, Analyst

All right. Thanks. I'll pass it on.

Neil Ashe, Chairman, President, and CEO

Thanks, Ryan.

Operator, Operator

Thank you. Our next question comes from the line of Tim Wojs with Baird. Your line is now open.

Tim Wojs, Analyst

Hey everybody. Good morning.

Neil Ashe, Chairman, President, and CEO

Good morning, Tim.

Tim Wojs, Analyst

Hey, Neil. Just to start, just on getting into kind of the refueling and the C-store market. I guess, maybe just if you could step back and kind of talk about maybe why Acuity didn't address that market in the first place, and how maybe the unit economics of that business and kind of compare to your existing portfolio?

Neil Ashe, Chairman, President, and CEO

That's a great question, Tim. To clarify, one perception about Acuity Brands lighting, including our own, is that because we are the largest in North America, we assumed we would always be the largest here, which led us to overlook potential opportunities in areas where we weren't competing. We are now focusing on where we do compete, and we historically didn't pay enough attention to the areas where we didn't. The refueling vertical is a clear example of that. We paid some attention, but it wasn't sufficient due to various reasons. As we shift our focus to identify growth opportunities where we either aren’t competing or aren't fully engaged, we have started to uncover promising niches where we want to enter. The refueling market is a prime example; it's appealing due to the size of the market for end-users and has limited competition. Therefore, we decided to enter this business organically, as we can add significant value by building a robust operation in that sector. We developed new fixtures tailored to support canopy lighting, which match or exceed current market offerings. These fixtures also complement much of our existing product portfolio, allowing us to serve entire facilities, like EV charging stations or gas stations where retail and food are sold, areas where we have a strong track record, as shown by our corporate accounts this quarter. Combining these elements creates an attractive market for us to engage. I want to commend our teams for swiftly developing the product portfolio to meet this market need. Additionally, we can leverage this opportunity to recruit top independent sales agents to represent us. We are optimistic about successfully operating in this vertical and making it a valuable part of our portfolio moving forward.

Tim Wojs, Analyst

Okay. Great. And then maybe just a higher-level question also on SG&A. We've seen that kind of ramp now to maybe 32% of sales. I know this year has been a little wacky in terms of the sales numbers, but I guess as you look out over the next couple of years, when would you expect to start to see leverage on the heightened SG&A spend?

Neil Ashe, Chairman, President, and CEO

So I'll start, and then Karen will add actual real color to the conversation. But the big picture on SG&A, I want to highlight, it is SD&A. So there's sales and marketing and then there's the distribution that is recognized in that number. So the distribution part of that is really part of our operations, and we are addressing that going forward to improve that. But that currently generally moves in line with our volume. If we put that aside, then from an operating expense standpoint, our priority and where our investment has been has been around technology. So we have historically been underinvested in technology and realized, as a result, not as many of the benefits as we could. So our priority on the investment is to drive technology, which is helping to deliver some of the gross margin performance and will ultimately be more leverageable going forward. Karen?

Karen Holcom, Senior Vice President and CFO

Yeah, Tim. The other thing I would point out is that if you look at the dollar investment quarter-to-quarter in fiscal 2024, we've been pretty consistent. As we look to return the business to growth, I think that's where we'll have a real opportunity to leverage our current level of fixed investment.

Tim Wojs, Analyst

Okay. Great. Thanks a lot.

Neil Ashe, Chairman, President, and CEO

Thank you.

Operator, Operator

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

Joe O'Dea, Analyst

Hi. Good morning. Thanks for taking my questions.

Neil Ashe, Chairman, President, and CEO

Good morning, Joe.

Joe O'Dea, Analyst

Good morning. I wanted to start on cash now at about $700 million, and just thinking about deployment opportunities, any color on the M&A pipeline, and also the potential size of what's within that. And the stock is now down sort of double-digits from highs earlier this year, does that give you an opportunity to sort of reconsider deployment and think about re-engaging on repo a little more?

Karen Holcom, Senior Vice President and CFO

Yeah, Joe. This is Karen. I'll start, and then Neil can add more color on the M&A pipeline. Our free cash flow, we're really pleased with where we are year-to-date. We're at $404 million of free cash flow, and we continue to invest in the business. Our first priority is always to invest in our current businesses for growth. We do see us doing this through our product vitality efforts. I'm also pleased to announce, and you may have seen this on LinkedIn yesterday, we were at our Distech facility, and we are expanding those operations, both in Lyon and in Montreal to support the growth of that business. So that is our first priority is to invest in our current businesses for growth. Neil will talk more about the M&A pipeline. We did increase our dividend, if you recall, this year. So our third priority is to increase our dividend. And for the first time in January, we increased it by 15% and maintained that level of dividend for this quarter. And finally, share repurchases, as you acknowledge. We've said it before, when our share price is high, we buy less. When our share price is low, we buy more. And we have demonstrated that consistently over the past four years, allowing us to buy a significant amount of our shares back over that time. We feel really good about how we've allocated that capital to date. Neil?

Neil Ashe, Chairman, President, and CEO

Yeah. And so I'll emphasize a couple of things that Karen said. First is that we're investing for growth in our current businesses, as evidence horticulture, petroleum, the expansion at Distech, etc. So we recognize that's where we can create a ton of value with organic growth funded by our cash flow. On the M&A side, we recognize also that we can expand the portfolio and expand the company in the process. We have a robust pipeline of small and medium-sized acquisitions that fit very well with our strategy going forward. Our priority there is around the Spaces business, where you've seen us do things like KE2 Therm. There are more like that. There are opportunities for us to increase our addressable market and the things that we can control and the manner in which we can control them, so we're working on that. We also have a developing strong pipeline in the lighting business as well where we may have the opportunity to put capital to work in attractive ways. But again, we're disciplined. What we look for needs to align with our strategy; we need to understand how we can integrate and operate that; we need to understand its impact on our company and financial performance; and finally, we have to acquire it at the appropriate valuation. These things take time. I'd like to say opportunity knocks, it doesn't come when it's called. We will continue to pursue those opportunities. But we feel really good about the pipeline and where we could potentially be over the next couple of years.

Joe O'Dea, Analyst

Those are helpful details. I appreciate it. And then, I just wanted to ask on industry indicators versus demand trends you're seeing. I think headline figures show some softness, and ABL revenue wasn't all that surprising when we look at ABI and Dodge Momentum. But it sounds like that was more internally related, and the commentary on order activity is encouraging. So just when you're looking at those indicators, and you're seeing the end market, what are the disconnects between the two, such that the underlying demand that you're seeing in orders is still pretty healthy?

Neil Ashe, Chairman, President, and CEO

Yeah. I would say a couple of things on that, Joe. First is that we're the largest in the market, so obviously, we're going to be affected by the market. Our growth algorithm is straightforward, affecting the market and our ability to take share while growing new things. You're seeing all three of those in our order rate. As we mentioned, we built backlog during the quarter, so on a natural basis, sales could have been higher in this quarter, but those will be satisfied in the next quarter. As we've discussed a fair amount, I am data-focused, and I'd prefer to talk about what we know versus what we think. The regression work we do shows that we are outperforming what our historical performance would suggest. That comes from experimentation. We have not been able to convincingly predict where to use a single outside variable consistently to predict the market. So ABI, for example, is simply one of the metrics that we use, and so is Dodge's. When we consolidate those, we do this every month and we iterate to make our model better. It is getting better. The takeaway is that we're outperforming what the data suggests we should do, meaning that we're outperforming both our past and the industry metrics.

Joe O'Dea, Analyst

And then just one clarification related to the production that you talked about in the quarter. Can you just size what that revenue impact is, and do you expect to fully capture that in the fourth quarter?

Neil Ashe, Chairman, President, and CEO

Yeah. So we have orders that turn into backlog, and then we produce and ship. We do not have cancellations. So orders are orders for us. It's just a matter of when we ship. The second thing I want to highlight is that we're focused on returning the Lighting business to growth. That will happen in either this quarter or the next based on how we trend that out. So we like to focus on the longer term and our ability to grow this business. We're confident in our ability to continue to grow the Lighting business and our operating performance.

Joe O'Dea, Analyst

Got it. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Jeffrey Sprague with Vertical Research Partners.

Jeffrey Sprague, Analyst

Thank you. Good morning, everyone. I want to revisit the production situation because it’s surprising to hear this in an environment where demand is not particularly strong. It's not like you're trying to increase to a higher level. It seems there's more than one issue, not just a single problem, such as a supplier failing to meet expectations. Can you provide more details on what occurred? You mentioned that things would be resolved by the second quarter, but it’s unexpected that this issue would arise from multiple sources.

Neil Ashe, Chairman, President, and CEO

Yes, Jeff. First, I want to clarify that there's nothing alarming about the situation. We've established a consistent communication pattern and will keep you informed about our thoughts. The main issue is mild labor, as we didn't increase our labor force as quickly as necessary because we didn't anticipate needing to. We can address this issue relatively quickly and move ahead. There’s nothing concerning about this, and its future impact is manageable. We feel confident. I'll provide a preview of our internal communication that will be shared shortly, which indicates that as we enhance our company, our expectations for our performance have also increased. We are holding ourselves to a higher standard. Many companies might not highlight missing production targets for the quarter, but our performance expectations are elevated, as are those of our team. Again, there's nothing alarming here, and we will resolve this and progress forward.

Jeffrey Sprague, Analyst

And then on the other side of the equation, Neil, the gross margins continue to look impressive, which I hear may be due to a production issue affecting gross margins negatively. At one point in today's discussion, you mentioned that Design Select was not the primary driver. Can you elaborate on this? You pointed to product vitality, service levels, and productivity. Is that the main focus? Is there anything in particular that stands out regarding the gross margins? I understand that the direct price discussion is somewhat unclear, but could you provide insights on the overall price and cost dynamics?

Neil Ashe, Chairman, President, and CEO

Yeah. So let me first start with product vitality. I'll use the frame as an example. We are delivering a higher value product to the marketplace, with significantly less cost. This is literally a snap-together fixture that replaces a panel in the ceiling of an office or a K-12 school, for example. So there's significantly less content in that fixture. So obviously, our ability to drive margin with less material is much higher. Second, I would say on the pricing front, we have been strategic about how we price. Our strategy is very clear. On the Contractor Select portfolio, which is 300 high-volume products, which are designed to be stocked and resold, we are very competitive from a price perspective but not the lowest price. We are the most competitive from a value perspective. We've created an opportunity for the end user to trust those products in their projects. Third, I'd highlight the now fully integrated performance of our eldoLED and OPTOTRONIC drivers. By controlling the electronics in our luminaires and our controls, we have largely completed that vertical integration, giving us several advantages, including margin. Finally, we continue to have opportunities to increase service levels and drive productivity. So, as I mentioned earlier in the call, we’re on a path here. We’re not at a destination. Each one of those is working together, and the cumulative effect of that is what we think is really good performance.

Jeffrey Sprague, Analyst

Great. Thanks for that. I’ll leave it there.

Neil Ashe, Chairman, President, and CEO

Thanks, Jeff.

Operator, Operator

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

Neil Ashe, Chairman, President, and CEO

Thank you. We appreciate you all joining us today. As we've talked about consistently, we are focused on returning our Lighting, Light and Control business to growth while we continue to drive margins and strong cash flow. We feel that our Spaces business performance is impressive and growing, and we have opportunities to continue to grow our portfolio over time. With that, we will get back to work and deliver on the fourth quarter, and we'll talk to you soon. Hope you all have a good day.

Operator, Operator

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