Acuity Inc. (AYI) Earnings Call Transcript & Summary

Good afternoon. Maybe good evening to some of you. Thank you for joining us. And I'm Tim Wojs, and I cover building products here at Baird, and we're very excited to have the management team of Acuity Brands with us at the conference today. Acuity is one of the leading manufacturers globally of lighting fixtures, lighting controls and other digital lighting technologies. From the company, we have Neil Ashe, who's President and CEO; we have Karen Holcom, SVP and CFO; and then we have Pete Shannin, who is VP of IR and Corporate Development. We're going to start off with a few kind of prepared remarks and slides from Neil, and then we'll jump into Q&A. So Neil, the floor will be yours.

Tim, thanks. It's great to be with everyone. And before we jump in, if I could ask you to spend just a copy of second on our forward-looking statements as we jump in. So with that, I'd like to take this opportunity to introduce our company to those of you who don't know us, and also to reintroduce our company to those of us who do. We're an industrial company with leading positions in lighting, lighting controls and components and intelligent building applications, as Tim mentioned. We have a very efficient business model with high cash generation. And over the last -- a little bit, we performed exceptionally well this year. We've outperformed our direct competitors in lighting. And we've done it while maintaining gross margins. And we delivered record free cash flow of over $450 million in our fiscal year, which ended in August. We're embarking on a transformation of our company through the introduction of technology and software, both in what we do and in how we do it. We're well positioned, both for the current market as well as the inevitable rebound. We expect to outgrow the lighting industry and to take share. In the near term, we expect gross margins to be around their current levels. And over time, we expect gross margins to be in the low to mid-40s, and operating margins to expand as business returns to prior levels and hopefully, beyond. We expect our Intelligent Buildings group to outgrow the end market, and we also expect for them to self-fund the lion's share of our increased investment in technology. And finally, our strong cash generation and low leverage allow us to invest in our current businesses, grow through acquisitions, maintain our dividend and create value for shareholders through share repurchase. We're building from a position of strength. Our core Lighting and Lighting Controls business, as Tim mentioned, is the market leader in North America, with leadership positions in most of the largest categories. Our portfolio of products serves a diverse collection of end users in a variety of industries: industrial; utility; commercial; office; health care; education; retail and residential. And as the market has changed over the last few quarters, we've been able to flex to where the business is. For example, we've been strong in industrials as customers have rushed to scale up in e-commerce. We had a strong summer of retail outlets as more end users invested in their homes and small offices. We had a strong summer in education as school districts took advantage of open buildings to accelerate needed renovations. At the same time, our enterprise account sales were relatively barren as those customers were so busy that they could not conduct renovations. But obviously, they'll need to get back to those in the future. And with Distech, we have a valuable company that systems integrators and building owners are realizing has the high-quality, flexible technology that allows them to solve their problems of today as well as tomorrow. As we look forward, there's a truism about technology that the impact of technology is overestimated in the short term and underestimated in the long term. And as we embark on the next-generation of Acuity, the term transformation is exciting to many and candidly scary to some. The good news is we've done this before, in Internet 1.0, in media and in commerce, at some of the largest and most important companies in the world. We are not an industrial company trying to figure out how to do technology. We are a unique combination of domain expertise in the industries that we serve and in the technology that will change them. In our core Lighting business, we are calling the transformation better, smarter, faster, which is exactly what it is. We are reevaluating our business processes with a keen focus on customers. By simplifying those processes, we can eliminate time and increase service levels. Simply put, we will be better. The simplification of our processes, combined with the power of data and machine learning, will make us smarter. We have an industry-leading path to market with an unmatched network of independent sales agents. Our work will make both us and them stronger. The end user building owners and contractors will see higher levels of service from us. We also have outstanding product development, and we will be reinvesting our savings in time and resources into improving the vitality of our products. Simply put, we will be faster. We are also refocusing our efforts at Distech and Atrius. We will be combining them into a group that we are calling Intelligent Buildings. And we expect to be the company that finally makes buildings intelligent. And here, too, we begin from a position of strength. Distech has outstanding technology that is built on open protocols and is well positioned for what buildings will need to be able to do in the future. Atrius has installed sensory networks through lighting that are capital-efficient and foundational for high-quality location-aware applications. We intend to build applications that deliver demonstrable value on top of these core building blocks. This will take time, but we are excited about the potential. So in summary, we are building from a position of strength, both in core Lightings and in Intelligent Buildings. We are a unique combination of expertise in the industries we serve and in the technology that will change them. We have an efficient business model that allows us to generate significant cash, and we have the ability to use that cash to grow our current businesses, grow our company through acquisition and create value for shareholders through share repurchase. So Tim, with that introduction, I'll turn it back to you, and we can cover any questions that you'd like to talk about.

Great, great. Thanks for the comments, Neil. [Operator Instructions] Those will be sent to me, and we'll also -- just to lever, we will have a breakout session after this to field some further questions. Maybe just to start, Neil, I mean, you've been with Acuity for -- as CEO for a little less than a year. I mean, obviously, you're on the Board before that. Just from your comments, if I can paraphrase it, it does sound like you think you have good bones in terms of the structure. What are some of the areas that you think you could really change or mold, add Acuity to really kind of take advantage of some of those things like market positioning and new product development, things that you mentioned as positive?

Yes, Tim, that's a great introduction. And I get asked this question a lot, is like kind of what are your initial observations of Acuity. And I would say that basically, it's great clay. It starts with a collection of super talented individuals who are intelligent, forward-thinking and want to change to succeed in the future. The lighting business is strategically relevant. It puts us in every building. If you look back to kind of the places that I've been in the past, the nation's largest broadcast network and the world's largest physical retailer, people don't need to watch broadcast networks anymore and they may not need to go to retail stores. But I can't imagine a scenario where anything gets built that doesn't involve lights. So that provides us a continuity of business and an introduction to different places that is obviously permanent and is a great place to build on. And it also ensures that we're going to continue to generate cash with that. And then the interesting option is the ability for us to introduce technology to how we run the core business, but also to develop the businesses around Intelligent Buildings and where those can go. So I would say, Tim, in summary, that the -- we've got great clay to build, what I hope will be a very important industrial technology company for a long time to come.

Okay, okay. Great. And you mentioned, as part of your prepared remarks that technology -- and I've heard you mentioned this on conference calls, too, that technology in the short term is kind of overestimated and in the long term is kind of underestimated. As you think about Intelligent Buildings and Atrius and some of those opportunities, where do you see the most significant opportunity within Intelligent Buildings? Because it does seem that there's a lot of focus on that from investors a few years ago, maybe didn't come through relative to expectations. And so as you kind of think about rebuilding that, where are you most excited?

I'd focus on 2 things, Tim. It's -- my experience is that companies and end users don't buy technology, they buy the benefits of technology. So what's it going to do for me is what they really want to buy. They don't want to buy speeds and feeds or widgets. And as we've assessed building technology, I would say that the existing solutions are highly vulcanized. So there's -- obviously, there have been ways to try and build around that, but they're vulcanized. And they're not consistent with the technology platforms that are being developed in other areas, so distributed networks and the applications that can be built on those distributed networks. And so when you think about -- or at least the way we think about it is we have got kind of 3 big pieces to the puzzle. We've got sensory and control networks, which is kind of the eyes, ears and muscles inside the building. So that's Atrius' location-aware applications through the luminaires, that's the Distech Controls. We have the operating system that powers that. And then we have the opportunity to build applications in the cloud, which makes those actually valuable and delivers that back to our customers. And so we think we're coming out at a different way than others have, which is not to say that what's out there isn't good so far. It's just, I think, that there's more that we can do.

Okay, okay. Great. When you think about investments, I mean, it sounds like there are going to be some incremental investments, but can you just kind of talk about, in your prepared comments, it did sound like it'd be mostly self-funded. So I'm not sure if there's a way to frame the types of investments that you need to make and maybe the source of that self-funding?

Yes. Sure. So let me start with the core Lighting business. As we've all kind of dealt with a smaller end market, we've been effective in making that business more efficient. So we've been able to maintain our gross margins through the last couple of quarters. Our operating margins have decreased some, but we've obviously maintained or done a pretty decent job, I think, of controlling costs. We're well positioned there to rebound and to grow and, I think, expand margins when we do. There's investments that we're currently making, which are embedded in these numbers in the technology, which powers that business. So the underlying technology, as I said, what we do and how we do it. On the Intelligent Building side, I think the combination of Distech and Atrius can mostly fund itself. My expectation to be transparent with you when I came was that we were going to have to take margins down to invest in that business. But I feel pretty good about our current levels of -- and our ability for that business to self-fund itself. We won't have large margins out of the gate, we'll probably have slightly negative margins, but it's not going to be a material change to the margins of the business. And then once we've done the kind of done the transformation at the core Lighting business, then we've got the tool set, the skills and the experience to go start to replicate that in other sectors.

Okay, okay. Great. A question here from the audience related to that. How does Distech compete against some of the larger kind of BMS companies like Honeywell and JCI?

I'd identify 2 key differences between Distech and those that they're competing with. First, on the technology side. They're built on open protocols, so they have always been the -- built on BACnet and the open protocols. And so there's an opportunity for scalability and doing some things differently that incorporates. And that was what I was alluding to and I mentioned kind of where things need to go. The second thing I'd identify is that they have a network of independent systems integrators around Europe and North America. So they're not dependent on their on the maintenance contracts of their own department. So those 2 things are -- make them kind of look very -- look and smell very different than, say, a Honeywell or Schneider or Siemen, somebody like that.

Okay, okay. Fair enough. And when you think about -- maybe just -- we've talked a lot about maybe some of the technology and the digital aspects. Obviously, there's been a lot of chatter about UVC and some of the agreements that you've made in that area. How do you think of the UVC market? I think there's 2 schools of thought. One is there's maybe this near-term opportunity that kind of goes away with a vaccine. And then there's another that says, hey, buildings are just going to kind of change how they think through these types of things, and there's a longer-term game here. So how would you kind of frame the UVC opportunity for Acuity?

Tim, we're thinking about it in terms of the latter as opposed to the former. Our observation out of the gate was that most of what would be launched immediately would be more slideware than actual difference maker. And so what we've tried to do is assemble through these relationships. The Ushio relationship was underway long before COVID, around 222, and then Puro around kind of the pulsed xenon technology, and there are some others in the wings. We wanted to create what we believe would be long-term solutions for people that made the decision over time that this is something that they needed to have. So we decided that whatever happened immediately out of the gate would be a short-term blip. But if we wanted to build a longer-term solution, we would need to do that. So we've assembled this network. And now we can incorporate that in our luminaires and our distribution -- our go-to-market network going forward, and both on the luminaire side and importantly as well through the HVAC side. So with Distech and the controls because basically, with all these UV solutions, they're really -- the controls element is equally as important as any of the lighting technology and [Audio Gap] So we and the industry are working through the relationship between what people are prepared to invest in that future and whether -- and obviously, you can make an ROI calculation based on the current market that you should spend whatever it costs, but we all know people aren't going to do that. So we need to meet that sweet spot.

Right, right. That's fair enough. That's fair enough. When we think about -- if we kind of step back and think about the core Lighting business, obviously, a fair amount of exposure to nonresidential construction, and that's been a little bit challenged with COVID-19 and some of the put and place numbers. How do you think about volumes from an end market perspective over the next 12 months? And what are some of the levers you can use to make sure that Acuity is at least taking share or growing above the market?