Acuity Inc. (AYI) Earnings Call Transcript & Summary

Good afternoon, everybody. This is Deepa Raghavan, Senior Analyst, Electrical and Industrial, here at Wells Fargo Securities. We have Acuity Brands with us today: CEO, Neil Ashe; CFO, Karen Holcom; and IR, Pete Shannin. First off, thanks very much, Neil, Karen and Pete, for joining us via this new virtual platform, which somehow feels pretty apt, considering Neil's focus is all about digital transformation today, a focused topic. And as for the format of this call, Neil will first present and talk through a couple of slides, and then we'll move on to Q&A. Investors joining us today have already been sent a copy of the slide presentation. But if you don't have it handy, it's also available on Acuity's website. With that, Neil, why don't you kick off.

Deepa, thank you for having us. It's a pleasure to be with you all virtually. And I will prepare you in advance, there's some good news, bad news. You might hear some construction in the background as I am in Northern California right now and the Bay Area turned on construction again as of Monday. So again, good news and bad news. And just quick clarification. The slides you have are pure background slides with a little bit of information about our company. And Deepa, we appreciate the opportunity to be with you today to talk through where we are with Acuity Brands and for you to ask us questions. So I will give a very brief introduction. And then I'll turn it back to you, and we can guide the conversation where people would really like it. As you all know, I started as CEO of Acuity on January 31. I couldn't be more excited to get involved with the company. As I came to Acuity, what I saw was a combination of some really attractive elements. The first is a market position and a technology -- collection of technology products which give us strategic access to some very interesting parts of the ecosystem. So the company, as you know, led the transformation really to LED through their luminaire advancements, the technology in the luminaires and as well as through how the company did it, through the efficiency and the productivity of the company's operations. We have an outstanding collection of lighting controls products, which are really value add, as you know, in the energy sector and are providing ways that people can do new and different things with their lights than they realize. With this tech, we have an open business -- building management system, which is a really attractive platform to integrate a lot of future activities as we go forward. And then finally, with Atrius, we have a location aware -- the potential to build location-aware applications and some interesting budding partnerships. Beyond that, we've got 2 things which I think are absolutely essential to success. The first is an outstanding team of talented and dedicated associates. When I first got here, someone described the associates at Acuity, which I'm going to shamelessly steal their description, which is that they're "can do, will do, thank you people." And so it's as good a group of people as you can imagine to really embark on this. Beyond that, I always look for 2 things in people, which are I look for integrity, which is binary and Acuity has that in spades; and I look for curiosity. Curiosity because a curiosity among your folks will give them the ability to imagine doing new things and doing them in different ways. And I found that in spades at Acuity also. And finally, as you know, we have a very efficient financial model and business model for the enterprise. So in good times and, as we're finding now, in bad times, the company is a highly efficient cash generator with essentially no leverage. And so as we think about kind of where we can go forward, obviously, as Deepa mentioned, I've had experience with digital transformation. Those digital transformations have been at CNET, which was one of the original Internet companies; then CBS; then Walmart. And what all of those have in common is really kind of 2 things. One is that the core business has gotten stronger. This is not about building other things. It's about making the core business stronger and better and then adding and growing from there. The second thing that each of these has observed, as I've kind of broken it down, is that there are kind of 4 key elements of what are a digital transformation. The first is a transformative customer experience. So what -- the context of the environment we're in right now is what really is -- has changed is the expectations of the consumer. And so business models have had to change and operating models have had to change. And we can get into that in a little bit more detail later, if you'd like. And the second is a transformative business model, understanding the full value chain and how we participate in that, how we evolve that and how we advantage ourselves as a result of that. The third is that -- is what I think most people think of for digital transformations, which is using technology to automate processes and create efficiencies. And that's, of course, piece of the puzzle, but it's really just a piece of the puzzle. And then the last one which is the most amorphous and potentially the most significant is that you operate a company like a digital company, so taking on the methods and the manner to execute in a digital manner. And taken together, those are the digital -- those are the elements of the digital transformation. I see an outstanding opportunity to do that here at Acuity. I think it's a platform of interesting strategic positioning from a product and market opportunity perspective, a collection of both outstanding product asset -- technology assets in our luminaires and our controls and our building management system and our -- and the opportunity in location-aware applications, a collection of great people who are curious and capable and are the foundation to go do new and different things and a highly efficient business model which gives us the ability to generate cash in significant amounts and the opportunity to redeploy that cash for growth. So that collection of -- is Acuity Brands today. And our vision is to, as I said, complete that digital transformation, expand our technology businesses, start to realize the opportunities that we have in these location-aware applications, and then use our available financial health to continue to grow both our current businesses as well as add new ones. So with that, Deepa, I will turn it back to you, and you can guide the conversation whichever direction you'd like to go.

Okay. Thanks, Neil. That was helpful introduction, but I need some help understanding some portions of it. So Neil, when we think about Acuity's digital offering, we think about it in terms of Atrius, we think about it in terms of control, Tier 3, Tier 4. So all the digital transformation that you talked about, what does it mean to Tier 3/4 offering? That's currently 15% to 20%. And then there is this huge Atrius installed base that's awaiting conversion. Are you able to provide any initial thoughts what that could mean to growth or any numbers to help us understand the concepts that you've laid out now?

Yes, sure. Let me first start -- let me split your question, if you'll allow me, into 2 parts. So there's the what we do and then there's the how we do it. And so as you talked about for our lighting controls and the opportunity with Atrius, I'd describe that as what we do. And so let's start at kind of Atrius and work our way backwards, which is that the company has done a very good job, as you identified, of providing this infrastructure to a number of different, mostly retail sites. This gives us an option in the way I described it to expand the application -- the location-aware applications, which generate significant value for our customers there. I also said earlier that there's -- it's a truism of technology that the impact is generally overestimated in the short term and underestimated in the long term, and I feel that way about Atrius. I think we've got work to do to make it right, and I'll explain a little bit of that in a second. And -- but long term, I think the opportunity may be even larger than we expected. It's just going to take a little bit longer to get there. And so when I say kind of make it right, what do I mean? Basically, I mean the following, which is that technology in my experience is bought for its benefits, not for the technology. So what we're in the process of doing now is honing down the specific applications which are of significant value in our Atrius portfolio and focusing on those. And that focus will take us -- it's a little bit go slow to go fast, hopefully, which is that we will core down our focus. And so the impact on, say, this year's revenue will not be as impactful as maybe we had hoped, but the impact on the revenue 2 years from now, hopefully, will be significantly more impactful than we hope. And the second, what you and -- I think what the company has historically described as Tier 3 are really around the lighting controls and building management systems, and that's where we have, as you know, a very interesting position in the marketplace. Our nLight platform is clearly a market-leading platform in the marketplace, and Distech is clearly the open alternative in the building management systems marketplace. And the opportunities for growth for both of those, we are very confident about. So those are currently, call them, collectively about a little over -- a little less rather than 1/3 of our business, and they're going to grow for -- they're going to outgrow the luminaires business. And the second piece I wanted to highlight on digital transformation is around how we do, what we do. And that's where we feel like there's a real opportunity in our core lighting and controls business to execute on this digital transformation. What does that mean? At the end of this, Deepa, I would -- you can expect our building -- our lighting and controls business to be better, smarter and faster, quite simply put. So there's a real opportunity for us to reinvent ourselves from the inside out, so all of our business processes, all the technology that powers our business processes. And that's the work that we're underway with now. And obviously, this -- there are a lot of negatives to the step back in the business, but it also gives us more time to focus on this, and hopefully accelerate it. So that will be the focus for our lighting business over the next year to 2 years.

Got it. As you view Acuity via your digital and technology background, what are the -- some of the differentiating features that Acuity does well on versus peers here in North American lighting market? And where do you think improvements can be made? You laid out some on the digital front, but just curious, is it -- are there any products -- is it only a product improvement? Is it also cost efficiencies? I mean, generally, just talk through how your -- how Acuity is placed versus peers from your vantage point.

Yes. So as you know, I'm used to competing with Amazon, Google and Facebook and other kind of technology companies like that. And so there's a pace of competition that, I believe, Acuity can rise to, which is inconsistent from the pace of competition in the current marketplace, which is not to discredit any of our competitors. They're outstanding companies, and I view competition as a gift. The opportunity that we have, though, is we should be able to significantly increase our efficiency and our pace and, as a result, our service to the marketplace and so -- on the core lighting business, which I think is a huge opportunity and one that we're, as I said, embarking on. And beyond that, we have, I think, the opportunity for significant growth in the intermediate to medium term around the continued development of our controls and building management systems and -- businesses as well as the option that I set around Atrius with where we start to identify what those real true value-add applications are and really hone in on the ones that matter the most and scale via those.

Got it. So it looks like you've already set into motion some action items at your end even with these COVID headlines. When do you think we should start to see some of your initiatives bear fruit? Is it a little bit more longer term? Or is it -- should we start to expect it pretty soon by end of the year? Or does it take a little longer? And we can understand if it takes a little longer just given the COVID, but just trying to understand where the setup is at this point in time?

Yes. Deepa, let me just address the COVID piece for a second because I believe that -- what we've said to our company is the following, which is that we need to execute effectively through this event, whatever it is. And to prepare, we've prioritized very purposely the health and well-being of our associates first; and then second, business challenges and opportunities that result from that. And we've been very purposeful about that order. As a result, we've really had to improve our operations in a very rapid manner. We took what were good operations, and we've really kind of stepped it up a notch, if you will. And so I feel really good about the fact that our entire supply chain has basically been up and running throughout this entire process that we've been able to manage through the supply shocks from the Asian shutdown largely and that we've continued to manufacture effectively and distribute effectively throughout our North American operations. That's allowed us to be a really good partner to -- both to our channel as well as to our customers, especially in light of the significant uncertainties that all of the others are -- that the entire industry is facing. And so I feel really good about our ability to be a trusted partner to all of these folks and operate effectively through this. And I view that as kind of the foundation of market leadership. So when things are challenging, you need -- we, as market leaders, need to step up, and we're doing that. So I feel really good about that. The second is we've been a constant presence in the marketplace. So we've already changed the relationship -- communication relationship with our agents. So things like our national sales meeting, which, obviously, couldn't happen in person, we've created an entirely digital version of that, where we brought all of the agents along with us in what we call a virtual expand. And we've dramatically improved the efficiency of the communications with our agent network. And so they have direct access to our product folks who are continuing to, even in these times, launch new products and satisfy customer needs. So we feel really good about operating effectively through this process. And then all of the -- and also importantly, we've contributed to the relief efforts through this process. So our -- Steve Lydecker who's one of our great product folks has -- and his team created fixtures for field hospitals that have rolled out. We've supplied the Army Corps of Engineers in a number of different locations for those. So we feel like we continue to operate effectively. We've been a constant presence in the marketplace, and we've contributed where we can to the relief efforts. So that probably, to be transparent, is what we're going to have to be doing for the foreseeable future. We're going to have to continue to just execute, meat and potatoes, in an effective manner so that we can and hopefully through that process, we will be taking share. The other thing that we've said to our company is that -- and we expect to come out of this better than we did going into it. So that's where we're starting to accelerate some of these transformation efforts, which are going to impact next year and the year after and the year after that and in perpetuity. But -- so we feel good about executing right now and then also the transformation efforts will take us forward into the future.

That's good to hear. I have to ask you a very current question. Are you able to share how April played out for you so far, I mean, as the economy started to open up in phases towards end of the month?

Yes. I mean, as you know, Deepa, we don't give guidance so I'll try and answer your questions directly as I can and obtusely as possible. But I would say that we have -- obviously, we've seen a dip in the business, and you highlight that effectively as certain parts of the country shut down. And what we haven't seen though is the precipitous drop-off that we modeled. So we've done a number of stress tests to the business. And we are -- we have and we are prepared for any potential precipitous drop-off. We haven't seen that precipitous drop-off. That doesn't mean we haven't seen a material one, but we haven't seen a precipitous drop-off. And we're cautiously optimistic, as you point out. So the -- Northern California is starting to open back up, and we expect other construction markets to open back up. And that's where our ability to continue to operate throughout this process has positioned us well to support them. So the short answer to your question is yes, we've seen a drop-off in April, but we haven't seen a precipitous drop-off that we were -- that we are prepared for and we're cautiously optimistic about as things open up that maybe we're plateauing instead of -- at least plateauing instead of continuing to fall down.

That's good to hear. Can you talk about your liquidity position? Have you -- you mentioned you ran some stress-tested scenarios. I'm just curious how you are thinking about balance sheet preservation, granted we are -- things are probably stabilizing here but we're still not out of the woods. So if you or Karen could talk about your balance sheet position, that's -- that would be helpful.

Yes, sure. Karen, I'll start, and then if you want to add anything, please jump in. So as we pointed out, that the first place we started as we did our stress test was cash. And it's important to note that even through this process, we're a cash generator. So we're going to continue to be generating cash. As you look at our -- or we expect to be unless there's something precipitous, and it would have to be precipitous for that not to happen. As you look at our balance sheet, we're basically net debt at 0. We have about, round numbers, $400 million of cash and $400 million of term loans. So we feel like we're in a very strong position with our balance sheet. And our focus is on getting through this first. Karen, is there anything you want to add to that?

Yes. I think the only thing I would add to that, Neil, is that across the business, we're just managing our expenses wisely, so keeping an eye out for excess spending, cutting back where it makes sense. A lot of it happens naturally when people aren't traveling, when conferences become virtual versus in person, but still trying to be mindful of our spending as -- during this time.

Got it. Are you seeing any role of green policies? Any regulations in the building efficiency standards, et cetera, that actually could help propel demand near term that could benefit Acuity?

Yes, yes. I don't think we've seen anything immediately that's changed. I think the -- if you -- taking a step back, and again, as a person new to the business, obviously, I think that those trends are going to be our friends for a long time. So energy efficiency, the ability of our controls and building management systems and software technology to manage a better and more efficient experience in a number of different buildings is a long-term positive trend for us. And as you know, that it can be accelerated in some areas through regulation, but our view is that if we deliver the benefits that are identifiable to people, then we're going to be successful whether there's additional regulation or not. But generally, long term, we believe that, that trend is our friend.

Got it. Can you talk about profitability across your channels? I mean just give us an idea which one's operating above your corporate average, which one's below?

Yes. I'll touch on that as an outline because I kind of do this evaluation, as you know, as an outsider coming into the business. The -- obviously, our -- if we were to talk from our kind of our least profitable forwards, we choose to be in different channels to reach different types of customers and to reach different applications. So as you know kind of through our results over the course of the last, I don't know, however many quarters or so, we've had an evolving strategy in the home center channel, which is -- and that continues as we start -- as we continue to sort through that. And that's impacted us both on the top line and as well as that's a lower-margin collection of business for us. Beyond that, as you get into kind of our independent sales channel and start to target the applications that are -- that they go after, we've really done a nice bit of work in our product organizations to increase the profitability of our products there. So as I came in, one of the things that I wanted to determine was, can we compete effectively at the low, medium and high portions of the luminaire market, recognizing that there's been industry deflation. And I'm -- based on the work that I've done so far -- we've done so far, I'm confident that we can compete effectively in the -- in each of the different market tranches. And then going forward, obviously, hopefully, our -- the technology businesses which we've built are going to have the business profile of higher margin, cash generation, et cetera, of technology businesses. So that's kind of the general architecture of where we are right now.

That's nice. As you think about capital deployment, Neil, you're one of the few companies that is pretty close to net cash or has very low net debt-to-EBITDA in my space, which is a positive thing. But given what you have right now in your balance sheet, and as you think through some of the capital deployment opportunities, how are you thinking about M&A? And are there any white spaces that are pretty glaring from -- as you build out your technology vision that you'd like to buy or acquire?

Yes. I mean obviously, we feel very good about the financial flexibility that we have. And as we continue to generate cash, that's only going to continue. Our first priority is to use that cash to grow the company. So we believe that a combination of revenue growth and return on invested capital is the way for us to accumulate value for our shareholders. And so that's our priority. We purposely are focused on our existing operations first and going through a lot of the evolution that I have described so far, Deepa. And then we'll identify if we want to go redeploy that capital into adjacencies and such. So it's a little early for us to answer that question. And -- but that work will be evolving over the next 6, 12, 18 months.

Got it. That's fair. Regarding this COVID situation that we're in, do you see competitors responding any differently, maybe be a little bit more competitive on the price or just come up with much lower value-differentiated products? Are you seeing any competitive response that probably could eat into your share? Or is this -- or on the flip side, is this an opportunity for Acuity to gain more share through this downturn?

Yes. Those are great questions, Deepa. Our operating mode right now is that if we operate as effectively, efficiently, reliably and consistently as possible through this -- through these uncertain times, we will take share by being the partner that's in the marketplace. And as I alluded to earlier, we've largely kept our supply chain open and effective throughout this to meet demand. I don't think that's true of the industry in general, including some of our component suppliers who we've helped to try and bring through the process when they've had to -- had interruptions in their production. So I think that kind of step 1 is we execute effectively through this process. And as a result, we were market-leading because a lot of people knew that they could count on us. And I -- but I believe that we've only advanced that expectation among people that they can count on us through this process. Who knows, A, when we come out of this; and B, kind of how we come out of this? And we fully expect that people will become more aggressive or attempt to become more aggressive coming out of this. But we think that the work that we're doing now to be effective, to be efficient only benefits us even more if people try and crank up the competition with us going forward. So in summary, as we kind of are -- is -- we have a market leadership position in our luminaires business and in our lighting controls business. And we're operating effectively through these incredibly uncertain times, and our belief is that the market will notice and remember that going forward.

Got it. We are almost close to the end of the call, so I'll just end with a big-picture question here for you, Neil. Just based on your prior experiences, how long has it been -- maybe in other organizations based on your experience, how long does it take to be meaningfully digitally optimized or transformed, however, you want to term it?

Yes, I always get asked this question, and I used to say kind of in a former life that this isn't a project, it's the company. So it's going to take as long as it takes, and it's going to take all that we've got to get it done. The realistic answer to that, Deepa, is that you start to see real impacts over the course of 1, 2 and 3 years. And then you own those in perpetuity, those improvements. And you can see that in places I've been before, where Walmart is today, where CBS is today, et cetera. So they continue to be super successful now. So it's an iterative process. So there's no "ta-da, it happened, and we're done," but it takes 1 to 3 years probably to start to realize the real benefits.

Got it. That's it. We're end of time. Thank you so much, Neil, Karen, Pete. Thank you for your time. Appreciate your insights and sharing your strategy with us today. Thank you so much. I hope you're all safe.

Deepa, it's great to be with you. Yes. It's great to be with you and all of your partners here on the call. So thanks for making time for us. And we look forward to being together with all of you at some point in the future. Thank you for your interest in Acuity.

Thank you very much.