Acuity Inc.

Good morning, and welcome to Acuity Brands' fiscal 2019 second quarter financial conference call. After today's presentation, there will be a formal question and answer session. To ask a question, please press the star, then the number one key on your touch-tone telephone. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now, I would like to introduce Mr. Dan Smith, Senior Vice President, Treasurer, and Secretary. Sir, you may begin.

Good morning. With me today to discuss our fiscal 2019 second quarter results are Vern Nagel, our chairman, president, and chief executive officer, and Ricky Reese, our executive vice president and chief financial officer. We are webcasting today's conference call on our website at acuitybrands.com. I would like to remind everyone that during this call, we may make projections or forward-looking statements regarding future events or future financial performance of the company. Such statements involve risk and uncertainties, such that actual results may differ materially. Please refer to our most recent 10-K and 10-Q SEC filings in today's press release, which identify important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. Now let me turn this call over to Bernagel. Thank you, Dan.

Good morning, everyone. Ricky and I would like to make a few comments, and then we will answer your questions. Our results for the second quarter were very solid despite continuing inflationary cost pressures and the impact of tariffs. We implemented several actions to address these cost issues, including price increases and additional productivity improvements. We believe our top line growth this quarter was impacted by the pull forward of orders by customers into the first quarter as they acted to avoid announced price increases. Nonetheless, we grew our top line by almost 3%. Additionally, we improved our adjusted operating profit margins by 50 basis points over the year-ago period and delivered adjusted diluted earnings per share of $1.99, the second quarter record. I know many of you have already seen our results, and Ricky will provide more detail later in the call, but I would like to make a few comments on the key highlights for the second quarter of 2019. Net sales for the second quarter were a record $854 million, an increase of almost 3% compared with the year-ago period. Reported operating profit was $95.9 million compared with $89.5 million in the year-ago period. Reported diluted earnings per share was $1.67 compared with $2.33 in the year-ago period. There were adjustments in both quarters for certain special items as well as certain other add-backs necessary for our results to be comparable between periods, as Ricky will explain later in the call. In adding back these items, one can see adjusted operating profit for the second quarter of 2019 was $112.4 million, compared with adjusted operating profit of $105.3 million in the year-ago period, an increase of 7%. Adjusted operating profit margin was 13.2%, an increase of 50 basis points compared with the prior year. Adjusted diluted earnings per share was $1.99, the second quarter record up 5% from the year-ago period. Results from the year-ago period were significantly benefited by the adoption of the new tax law, as Ricky will explain. Net cash provided by operating activities was $188 million for the first half of this year, up nicely over the year-ago period, and our cash position at the end of the quarter grew to $232 million, even after we repurchased $49 million of the company stock during the first six months of the year, leaving us with plenty of liquidity to execute our growth strategies. Looking at some specific details for the quarter, net sales increased almost 3% over the year-ago period. Overall, net sales volume grew more than 3%, while the price mix of products sold was unfavorable by less than one point this quarter. as gains from recently announced price increases were more than offset, primarily by changes in channel mix and, to a lesser degree, changes in the mix of products sold. The small benefit of acquisitions, net of divestitures, was essentially offset by the negative impact of changes in foreign currency and the adoption of the new accounting standard, ASC 606. We believe our growth in net sales this quarter was muted by the impact of customers' primarily in the independent sales network channel, pulling forward orders into the first quarter in advance of announced price increases. While we noted this activity in our first quarter earnings call, we are unable to determine the precise impact of the sales shift between quarters. However, if we look at first-half sales compared with the year-ago period, we grew our net sales by almost 7%. Our rate of growth over this time period was far in excess of the overall growth rate of the lighting industry in North America, which we believe was up low single digits. We believe our channel and product diversification, as well as our strategies to better serve customers with new, more innovative, and holistic lighting and lighting controls and building management solutions, as well as the strength of our many sales forces, have allowed us to continue to gain overall market share in North America this quarter. Looking more closely at the details of our net sales this quarter, net sales through our independent sales network were benefited by implemented price increases and growth from our building management team at DISTEC, which knocked the ball out of the park this quarter, partially offset by a decline in C&I sales volume caused by the pull forward of customer orders into the first quarter. Additionally, net sales in our corporate accounts channel were up 10%, over the year-ago period as we continue to expand the sales of our Atrius-enabled luminaires, particularly in the retail vertical. It is interesting to note that net sales in the C&I market, which is part of our independent sales network, were up almost 5% for the first half of 2019 compared with the year-ago period. We believe measuring net sales for the first half eliminates the distortion caused by the pull forward of customer orders between quarters. The overall growth in CNI for the first half was primarily due to greater shipments of certain high-volume, more basic, lesser-featured LED fixtures, primarily for applications on smaller, mid-sized commercial projects, as well as the benefit from our implemented price increases. Additionally, net sales growth in our independent sales network for lighting was somewhat muted by prolonged weak demand for larger, non-residential lighting projects, as well as continued product substitution to lower priced alternatives for certain lighting products. With regard to the impact on net sales for changes in the price and mix of products sold, the overall net impact was negative by less than one point. While it is not possible to precisely determine the separate impact of changes in the price and mix of products sold, we estimate the impact of price increases contributed low single digits to our overall growth in the quarter. This positive price capture was more than offset by changes in channel and product mix. The change in channel and product mix this quarter was mostly influenced by changes in channel mix and, to a much lesser extent, product substitutions to lower-priced alternatives, primarily for more basic, lesser-featured LED luminaires sold in certain channels, as well as a modest decline in shipments for larger commercial projects. Our profitability measures for the second quarter were solid given overall market conditions. Our adjusted operating profit for the quarter was $112 million, up approximately 7% compared with the year-ago period, while adjusted operating profit margin for the quarter was 13.2%, up 50 basis points from the year-ago period. The increase in adjusted operating profit margin was primarily due to a decline in both SDA expense in dollars as well as in percentage of net sales, partially offset by lower adjusted gross profit margin, the dynamics of which I will explain in a moment. Adjusted gross profit margin for the second quarter was 39.2%, a decrease of 100 basis points compared with the year-ago period. Adjusted gross profit was essentially flat between periods at $335 million, as higher net sales volume The benefit of price increases and productivity improvements were offset by higher input costs, including inbound freight and tariffs on imported Chinese-made components of finished goods, as well as changes in the customer mix within the retail channel. This next point is very important to understand. Our adjusted gross profit and margin were negatively impacted by a shift in net sales between key customers within our retail channel. While our overall net sales of products sold through the retail channel were up 4% in the second quarter, net sales by key customers within this channel changed significantly. Each of our key customers in this channel have different service requirements, which impact how we account for these differences under generally accepted accounting principles. We believe the impact of this customer shift within this channel accounted for a large portion of the decline in overall adjusted gross profit margin in the second quarter compared with the year-ago period. However, it is important to note we believe this decline was largely offset with lower SDA expense. We expect this shift between gross profit and SDA expense to continue for the foreseeable future. Next, our adjusted SDA expenses were down approximately $7 million compared with the year ago period. Adjusted SDA expense as a percentage of net sales was 26% in the second quarter, a decrease of 150 basis points from the year ago period. Again, the decline in adjusted SDA expense was primarily due to lower freight and commission costs caused primarily by changes in sales channel mix, the customer shift within the retail channel, as well as certain cost containment and productivity improvements partially offset by higher expenses added from recent acquisitions. Our adjusted diluted EPS was a second quarter record of $1.99 compared with $1.89 reported in the year-ago period, an increase of 5%. The increase was primarily due to the growth in adjusted operating profit and lower average shares outstanding due to stock repurchases during the past year, all partially offset by one-time favorable impact of the new tax law enacted in the year-ago period. Before I turn the call over to Ricky, I would like to comment on a few important accomplishments this past quarter. On the strategic and technology front, we continue to make significant strides, setting the stage for what we believe will be strong growth in revenue and profitability over the long term. We continue to gain market share in many important product categories and sales channels. Our Tier 3 and 4 solutions were up over 30% again this quarter. From a commercial perspective, we continue to accelerate the number of Atrius-enabled deployments and increased active programs with several of our largest U.S.-based retailers. Our Atrius-based IoT luminaires and solutions are becoming the industry standard in the retail segment. Additionally, we continue to expand these solutions into other verticals as awareness by customers grows as they come to recognize the full benefits of these solutions, including superior visual comfort and energy savings, as well as the capabilities of our IoT solutions, providing them with the opportunity to transform their spaces from nothing more than expense items into strategic assets. As I mentioned in prior earnings calls, it is clear that certain Chinese-based lighting companies, many obviously being subsidized in some form, are influencing pricing for certain basic lesser-featured fixtures sold in certain channels. We will not yield this space for many strategic reasons. As such, we have continued to expand our contractor select portfolio to profitably compete in this portion of the market. Also, as I mentioned last quarter, we introduced in late 2018 the next generation of our industry-leading lighting control system, EnlightAir, a wireless control system with a wide range of options and functionality for which there was strong customer demand this quarter. We believe Acuity has the most comprehensive and feature-rich wired and wireless lighting control system available in the non-residential market, and importantly, they are connected to our growing BMS solutions. Our growth in these areas is significant. Lastly, we initiated many actions last year to further streamline our operations to reduce costs and improve our productivity. We believe these initiatives both enhance our performance this quarter and will continue to benefit our operating and financial performance in the future, as well as allow us to accelerate investments in areas with higher growth opportunities. Ricky will have additional comments on this in a moment. We have been able to create these capabilities while providing industry-leading results because of the dedication and resolve of our many associates who are maniacally focused on serving, solving, and supporting the needs of our customers. I will talk more about our expectations for the balance of 2019 later in the call. I would like to now turn the call over to Ricky.

Thank you, Vern, and good morning, everyone. As Vern mentioned earlier, we had some adjustments to the GAAP results in the second quarter of fiscal 2019 and 2018, which we find useful to add back in order for the results to be comparable. In our earnings release and Form 10Q report, we provide a detailed reconciliation of non-GAAP measures for the second quarter and first six months of fiscal year 2019 and 2018. Adjusted results exclude the impact of amortization expense for acquired intangible assets, share-based payment expense, manufacturing inefficiencies directly related to closure of a facility, acquisition-related items, special charges for streamlining activities, and an income tax net benefit for discrete items associated with the Tax Cuts and Jobs Act. We believe adjusting for these items and providing these non-GAAP measures provide greater comparability and enhanced visibility into our results of operations. We think you'll find this transparency very helpful in your analysis of our performance. During the second quarter of fiscal 2019, we recognized a pre-tax special charge of $400,000 primarily related to move costs associated with the previously announced transfer of activities from a planned facility closure. In the second quarter of the prior fiscal year, we recorded a pre-tax special charge of $600,000. We expect to continue to incur additional costs primarily attributed to early lease termination and moving costs in future periods associated with the closing of certain facilities related to the streamlining actions announced in fiscal year 2018. As a reminder, as part of adopting ASC 606 at the beginning of fiscal year 2019, we are providing in our Form 10Q disaggregated revenues by the major sales channels of one independent sales network, which includes CNI agencies, infrastructure utility agencies, system integrators, and showrooms, two, direct sales network, three, retail network, which includes home centers and digital retail, four, corporate accounts, and five, all other, which is primarily OEM, international, and catalog. The effective tax rate for the second quarter of fiscal 2019 was 23.1%. compared with the 23.1% tax benefit in the prior year quarter. The tax benefit in the second quarter of fiscal 2018 was due to recognizing a $31.2 million discreet tax benefit of the Tax Cuts and Jobs Act. Additionally, last year's second quarter adjusted tax rate of 17% was unusually low as it reflected a lower blended year-to-date effective rate following the passage of the Tax Cuts and Jobs Act. In other words, prior year's first quarter effective tax rate of 35.4% was lowered through an adjustment to the tax provision in the second quarter. We currently estimate that our blended effective income tax rate before discrete items will approximate 24 to 26% for fiscal 2019. We generated $188 million of net cash flow provided by operating activities during the first six months of fiscal 2019, compared with $178 million for the year-ago period. Operating working capital, defined as receivables plus inventories, less payables, decreased almost $36 million during the first six months of fiscal 2019. This decrease is largely due to reduced account receivable balance. Our operating working capital days increased 16 days to 66 days, primarily due to higher inventory days at February 28, 2019, compared to August 31, 2018. The increase in inventory is primarily due to a buildup over the last several quarters of inventory ahead of the relaunch of our broader contractor select line and customer expansion in the retail channel. We are focused on improving our inventory turns as we assimilate these newer products and customers. At February 28, 2019, we had a cash and cash equivalence balance of $232 million, an increase of $103 million since August 31, 2018. The increase was due primarily to cash flow from operations, partially offset by cash used to repurchase common stock, to invest in plant and equipment, and to pay dividends. We repurchased 400,000 shares for $49 million during the first six months of fiscal 2019. We have 4.8 million shares remaining under our current share repurchase board authorization. Our investment in capital expenditures was $25 million for the first six months of fiscal 2019, an increase of almost $4 million compared with the prior year period. We currently expect to invest approximately 1.5% of net sales and capital expenditures in fiscal year 2019. Capital expenditures for fiscal year 2019 include tooling for new products, equipment, facilities renovations, information technology, including enhancements and upgrades to our industry-leading lighting and lighting control design software visual, and our proprietary customer order portal, Agile, as well as normal ongoing property and equipment maintenance. Last year, we executed a new five-year unsecured credit agreement with a syndicate of banks that provides us with a total of $800 million of borrowing capacity, of which $795 million was available at February 28, 2019. Our total debt outstanding was $357 million at February 28, 2019. Our debt to total capitalization at February 28, 2019 was 16.5%, and net debt to capital was 6.5%. Our $350 million senior unsecured notes mature in December 2019. We intend to refinance these borrowings using availability under our $400 million unsecured delayed draw five-year term loan facility. We clearly enjoy significant financial strength and flexibility to support our growth opportunities, which may include acquisitions, and we'll continue to seek the best use of our strong cash generation to enhance shareholder value. Thank you, and I'll turn it back to Vern.

Thank you, Ricky. While current market conditions in the lighting industry continue to be challenging, we continue to be optimistic regarding our long-term future. We believe our many actions to improve our market reach, enhance our customer solutions and capabilities, and to drive company-wide productivity will help optimize our financial performance in the future while affording us the opportunity to continue to invest in areas we believe have high growth potential over the long term. Our strong sales growth, significant cash flow, and robust return on investment capital through the first half of the year are reflective of our very positive operating performance, despite some of these current industry headwinds. Our views on overall market demand for the lighting market and items influencing costs have not really changed over the last six months. So let me reiterate a few of those key items that could influence our performance for the balance of our fiscal 2019. Many independent third-party forecasts continue to suggest the overall construction market, as measured in dollars, will grow in the low to mid-single-digit range. We still believe the lighting industry will lag the overall growth rate of construction markets somewhat, primarily due to continued product substitution to lower-priced alternatives for certain products sold through certain channels, though recent industry pricing actions should have a favorable impact on growth, as measured in dollars. Additionally, we expect that labor shortages in certain markets could continue to negatively impact growth rates for both construction and lighting. While the U.S. government once again delayed the implementation of increased tariffs to 25% from the current 10% for certain imported Chinese-made finished goods, we believe the outcome of the entire tariff situation could have a dampening effect on overall demand due to higher component costs and finished good prices. Further, it is evident that the global trade issues, as well as current rhetoric regarding the potential closing of the U.S.-Mexican border, have certainly created greater volatility and demand in our various end markets, and we expect that to continue. As previously mentioned, we believe announced price increases and other actions taken will help offset the increase in costs for various items noted earlier. While increases in some input costs, such as steel, have leveled off for now, we expect other costs and expenses, such as imported electrical components and finished goods, freight and wages, will continue to rise. These potential cost increases could have a negative impact on our financial results due to the timing and nature of any mitigation efforts, including potential future price increases and other actions to reduce costs. Further, we believe that product substitutions to lower priced alternatives for certain products in certain portions of the lighting market will continue, particularly for more basic, lesser featured products sold through certain channels, potentially pressuring both top line growth and profitability. The relaunch of our contractor select portfolio and other actions taken were done to enhance our opportunities for profitable growth in those portions of the market. Foreign currency exchange rates may continue to be volatile, adding further uncertainties. Excluding the impact, if any, of those factors just noted, we remain cautiously optimistic for the balance of fiscal 2019. Our wide and varied base of customers generally remain positive about their current year growth prospects. Many customers continue to have record backlogs, though they too are concerned about the timing of releases particularly for larger projects, and the potential impact of tariffs and inflation on overall demand. However, and most importantly, we expect to continue to outperform the overall growth rate of the markets we serve, primarily in North America. Further, we believe the sales of our lighting control solutions, as well as our atrius-based luminaires, all within our Tier 3 and 4 categories, will continue to expand. though I would like to emphasize it will be lumpy at times because of the unpredictability and timing of customers' renovation and new construction schedules, as well as the volatility in demand caused by global trade and political issues. As we have noted before, our gross profit margin is influenced by several factors, including sales value, innovation, components and commodities costs, market pricing dynamics, and changes in product and sales channel mix. Additionally, we are always striving to improve our profitability through our continuous improvement efforts. However, we believe for any meaningful gross profit margin improvement to occur, we will need to continue to capture our implemented price increases, as well as experience an acceleration in market demand for more technology-enabled lighting solutions, particularly for larger commercial projects where our contribution margins are more favorable due to the complex nature of these types of projects. This illustrates the influence of product and sales channel mix on our margin profile. Also, as I noted earlier, we expect changes in net sales volume sold through certain customers in the retail channel will have a dampening effect on adjusted gross profit and margins, but we believe will be largely offset with lower freight and commission costs within SBA expense. Additionally, we have initiated a review of a small portion of our product portfolio and services offering with the objective of eliminating those items and activities that do not meet our return objectives. These efforts could modestly impact our future top line growth rate, but we expect that any actions taken in this effort will be accretive to our margins and return on invested capital. More information to come in the future on the impact, if any, from this initiative. Lastly, the implementation of our integrated tiered solution strategy, including the expansion of our tier three and four holistic lighting, building management, and our Atrius IoT platform and software solutions, and our opportunities to participate in the interconnected world is an integral part of our overall long-term profitable growth strategy to meaningfully expand our addressable market by adding broad-based holistic solutions that will allow our customers to transform their connected intelligent buildings and campuses from cost centers to strategic assets. As I've said before, we believe the lighting and lighting related industry as well as the building management systems market have the potential to experience solid growth over the next decade because of continued opportunities for new construction and more importantly the conversion of the installed base which is enormous in size to more efficient and effective solutions. As the market leader in lighting solutions and a technology leader in building automation, along with our Atrius platform, we are positioned well to fully participate in and lead these exciting and growing industries. Thank you, and with that, we will entertain any questions that you have.

Ladies and gentlemen, if you have a question at this time, please press the star, then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, that's star then one to ask a question. To prevent any background noise, may I ask that you please place your line on mute once your question has been stated. Our first question comes from Joseph Osha with JMP Security. Your line is now open.

Thank you. Good morning, everyone. Good morning. Two questions. First, your business continues to generate revenue. Pretty solid cash flow. I'm just wondering if maybe Ricky could amplify maybe a little bit more going forward what the thoughts are about deploying that in buybacks and then also what we might see in terms of levering the balance sheet, and then I have a follow-up.

Sure. As we've mentioned before, Joseph, our use of cash are really in three areas. One, to continue to invest in capital. through capital expenditures, IT, and so forth. And you see that level at the 1.5% of revenues. We've been between that and 2%. Second is to return to shareholders in the form of dividends and share buybacks, which we've done fairly aggressively over our careers, or over the last decade, I should say. And then thirdly is acquisitions. I would say acquisitions after our normal capital capex spending is probably our preferred use. We see opportunities to continue to fill in areas of product gaps as well as to expand our technology. And we'll continue to look at opportunities, whether it's acquiring people or partnering or minority investments. And it's an active pipeline out there. So that's an area that we continue to see opportunity and we'll use our cash flow to create shareholder returns in that way. When the M&A activity isn't as robust or we opportunistically see a benefit to repurchase shares, we'll do that. And as you know, we have a fair amount still left under the board authorization to buy back shares. We bought back 400,000 so far this year. So we'll continue to do that So those are the primary plans for our use of capital.

Okay. Thank you. And just as a quick follow-up, you had in the past indicated a willingness to lever the business to a certain multiple of EBITDA. Do you still see that kind of debt-to-EBITDA number going up over time?

You could argue we're under-levered today. So I could see our leverage going up either through M&A or share buybacks. We do want to maintain our investment grade rating, which would suggest, you know, two and a half turns of EBITDA are probably less. Not to say that on the great opportunity for M&A or something, we might not hit that or exceed it, knowing we could quickly pay it back down. But we do want to maintain our investment grade rating, and that would dictate a ceiling probably in that two and a half turns of debt as a ceiling.

And we continue to see an pipeline of M&A, as Ricky points out. And as you know, M&A is never something that you can precisely predict. They have to be both doable and desirable at the same time, all meaning from a financial perspective. So, again, interesting in terms of technology opportunities as well as niche-based lighting companies.

Thank you very much.

Thank you. And our next question comes from Brian Lee with Goldman Sachs.

Your line is now open.

Hey, guys. Thanks for taking the questions. I just had a couple here. I guess first off on, you know, the makeshift here in retail, this would seem like you would have less control on the sales channel for this part of the market. hence the lower end of the expenses, if I'm reading it correctly. How should we think about what that means for growth potential? Is this the part of the business, you know, the part of your mix that just grows in line with the industry, given the competition in this channel? So maybe if you could help walk through the growth sort of push and take for that particular channel.

Okay, Brian, sounds like there's a food fight going on at Goldman Sachs. Not certain that we heard all of that question, but when we think about our retail channel, we see opportunities for continued diversification and growth. But, you know, again, we have to look at the tradeoff in terms of are those solution sets that we're providing appropriate for returns on our own business. But we see the retail channel as an opportunity for us, again, to continue to diversify our our customer base. We're doing that. And obviously that has some impact because these customers all have different service requirements, which as I mentioned in my previous or my prepared remarks, do have an influence on how we basically account for some of these things. Some of the items are above the line, so they enhance gross profit. Some of the things such as freight. I mean, this is a really simple issue. It's just depends on whether we provide freight of the material or that end customer provides freight and then the adjustment is the price. So, but again, our view around the retail channel is continued opportunity to leverage our brand and to leverage the supply chain that we have in place for profitable growth.

Okay, great. Hopefully this is a little bit better. On the maybe second question, just on channel in front of me, because I know these were issues for you guys that just, I guess, started to materialize and see some shifts in the past couple of quarters. So I'm wondering if it's the right assumption to anticipate that the rest of the fiscal 2019 is going to see this impact in a similar range on a year-on-year basis, e.g., you know, sort of offsetting the recent price increases like we saw here in fiscal year. I think that's

Again, the food fight is still alive and well at Goldman Sachs. I think the question was based around sales channel mix and its impact. First of all, let me make a comment on pricing. We were very pleased with the price capture that we were able to achieve in the second quarter. And really, there's still more to come as it rolls through. But just so everyone understands, while price capture for us, we believe, contributed low single digit to our growth, understand that probably two-thirds of our business is really bid business. And I think it's very different than some of our competitors. So that one-third that is subject to price lists and so on and so forth is really where the price increases were put in place. When it comes to our bid business, we are always looking to sell the value of our solutions and optimize our profitability as best we can. We were very pleased this quarter with how, again, the realization of price helped offset a great deal of the costs that we had. Some of the channel mix discussion that we bring up really is the fact that this quarter had what we believe was a homily because of the pull forward within the C&I market of people trying to avoid price increases placing their orders early and so therefore in Q2 we saw a drop in sales volume in the C&I market but when we look at our overall business it grew over 3% sales volume so it was other channels that allowed us to show growth so again Our DISTEC VMS team just knocked the ball out of the park in Q2, and they've been doing that. They're doing a great job. That's within our independent sales network, if you will, channel. We also had growth in our infrastructure and utility. We had growth in our corporate accounts channel. So all of these have varying dynamics of both gross profit margin profile as well as then below the line, the gross profit line, the service requirements. So when we talk about all of this sales channel mix, it's alive and well for Acuity. I think the bottom line on all of this is the 50 bps of operating profit improvement that you saw in the quarter. So we're doing the right things of raising prices, differentiating our product solutions, getting after productivity improvements within our organization. Again, price increases. All of this is to drive, and I'm really pleased with how our folks drove an improvement in our operating profit margins. We didn't talk about variable contribution margin, but variable contribution margin this quarter was like over 30%. So we're focused on the right things. We're looking to improve stuff. We made a commentary that we're looking at certain portions of our portfolio. This is small, it's not big, but just to say, hey, are we getting the right kinds of returns, both on sales and on our return on investment that are appropriate with the objectives that we have. So I think you'll continue to see channel mix, but we're coming into historically our second half, which has larger volumes than the first half. Some of those mix shifts should result in some more favorability to us.

Thank you. And our next question comes from Christopher Glenn with Oppenheimer. Your line is now open.

Yeah, thanks. Good morning. Just following up on the price topic, just wondering how you'd mark where you might be along the expected price capture and realization ultimately as you work through some of the business and quote protections? Do you think you're kind of halfway there, a couple quarters out from what you see as kind of steady state based on the dynamics you've addressed so far?

You know, Chris, it's a good question, and it's just an educated guess, so take it for what it's worth. I would say that we probably still have another quarter of just a little bit of noise around that. But as I said earlier, really pleased with the price capture on that portion of our business that is off of a price based off a price sheet. I think others have said the same thing. So we'll see on the project side, again, projects We are always looking to differentiate our value proposition, taking into account all aspects of that, including costs, to drive the difference.

Okay. And with expected continued mixed pressure within the retail dynamics, can price offset that and get you to gross margin positive over the next few quarters or – Is there just too much contention there with the mix dynamic?

Yeah. So don't use the word contention. What it is is just how different people, different customers in that channel handle different aspects. The easiest one to understand is freight. Some people provide their own freight and so they take that off, if you will, the sales price. So that has a gross profit dynamic. Some people ask us to provide the freight, and therefore it's a higher price than felted. So the dynamic is really not problematic the way the accounting treatment goes for that. We expect that dynamic to continue. So it's a reset, if you will, of the notion of what historical margin is, for that channel may have been at gross profit and at operating profit. At operating profit, it essentially offset the difference. It's just that it influenced our gross profit and our SDA expense, primarily freight and commission. And you saw that this quarter as our SDA expense was down pretty significantly. And so that as you think about your models, all of you think about your models going forward, I would say that, historically, our freight and commission has operated between, say, 11% and 12% of sales the way we do our accounting. We'll probably be at the very low end of that range on a go-forward basis. So I think you're going to see overall SDA be down a little bit because of that phenomenon on a go-forward basis. But the margin profile will also be down as a result of that.

Okay, and then you mentioned in the press release focus on improving mix of products and solutions. I just want to clarify exactly what that means because I think your kind of steadiest growth is the large enterprise solutions customers that may in fact have The opposite effect within mix from the perspective of margins.

Yeah, so we are very excited about the growth rates that we are experiencing in our corporate accounts. Again, as I had mentioned, those corporate accounts have a different, I mean, it's a lot of the same type of picture, but they're driving... the ability for us to ultimately sell an Atrius-enabled solution, more of a SaaS revenue kind of thing. So laying the track has really been a very positive thing, and it's growing our business very nicely. We're well over 2 billion square feet of Atrius-enabled solutions, which is just a staggering number, and continuing to grow at an unbelievable pace. The gross profit margin profile of that is below, if you will, with the CNI channel. So when we talk about channel mix, our focus is to, by a key portion of our team, is to drive and improve the CNI overall mix, particularly around larger projects. Those things continue just to be sluggish. in terms of their release. Act laws continue to be, for these types of projects, favorable, but they're slow to release. Lots of people tell us it has to do with labor shortages in certain markets. So what people are doing is amping up their education, trying to recruit more electricians, so on and so forth. So we believe that this problem gets solved because the overall market dynamics employment, rising commercial rental rates and industrial rates, vacancy rates, all these things are flashing big green signs. That usually means that there's now an uptick coming in the build of that type of real estate. Backlogs that customers would suggest that that is true, but we haven't seen the releases of some of these larger projects. So that's what we mean by improving our channel mix. Okay, got it. Thank you.

Thank you. And ladies and gentlemen, in order to provide everyone the opportunity to ask questions, the company asks that you please limit yourself to two questions per caller. If you have further questions, please reinsert yourself back into the queue, and your additional questions will be answered as time permits. Our next question comes from Deepa Raghavan with Wells Fargo Securities. Your line is now open.

Good morning. Good morning. Just some commentary on how the quarter progressed month-wise, that would be helpful, and if you can talk about any improved momentum or not well into March, now that March is under the belt.

Yes. The quarter was lumpy in terms of orders. Again, it's always difficult to quantify exactly why. Certainly early in the quarter, so the December month for us was influenced by the pull forward. I also believe that January was impacted, and to a degree, by weather in key parts of the country. We had a little bit of a government shutdown, so I'm grasping at straws to try and explain why there was this lumpiness. We are starting to see improvements in the overall order rate. And we would expect that because, again, you're coming out of seasonally, for us, our second quarter is always our softest quarter. And then we have the build going into Q3 and Q4. So probably a little bit too early to say that, oh, you know, let's declare victory and this is the way it's going to be. But we see favorability and we continue to hear favorability.

That's the commentary for March.

Well, we don't give commentary on an individual. I'm just saying that what we saw as we departed Q2, we saw an improvement. We saw a lumpiness in Q2, and we're now starting to see favorability relative to that lumpiness.

Understood. My second question is... What are your thoughts on recent lighting industry, MMA? I mean, we've seen this Cree's fixture business being sold to a private family business, GE's current business down to a PE, and now that Eaton has announced they spend as well. What does it say about the lighting industry as such? And secondly, is there an interest for you to participate in this? Thank you.

Thank you. My comment on the lighting industry is it's not going anywhere. I mean, it's a robust industry. It's growing. It brings a lot of value. I think that some of the smaller bit players like Cree, you know, they didn't make the right investments and they misstepped. And so they didn't win. Acuity has been investing heavily for the last decade, building out a controls platform, building out an IoT platform. I think that with Eaton's announcement that they're going to spin their lighting business, I think that that was a portfolio decision. Lighting was a very small part of Eaton's overall portfolio, and so they made a decision. But Eaton's lighting business isn't going anywhere. It's going to become its own public company. And so I don't see the notion of people making investment decisions as somehow being indicative of the lighting industry. When Eaton came out and said, you know, here are our performance requirements and our lighting business doesn't quite meet those, Acuity far exceeds those types of performance requirements. Our operating profit margin, again, this quarter, 13.2% improving. Our top line, we continue to grow. Our controls business continues to add improvement there. Yes, we're dealing with the notion of product substitution to lower-priced alternatives, so we're fighting, if you will, that trend, but we believe that we will be able to improve our margins, both gross profit as well as operating profit over time. I'm bullish on the lighting industry and where it's going to go. I think that some of these competitors that are, again, The M&A has been with relatively minor players so far. The spin of Eaton's lighting business is not an M&A event. They're alive and well.

Got it. Thank you.

Thank you. And our next question comes from Ryan Merkel with William Blair. Your line is now open.

Great, thanks. So first question for me, maybe discuss in more detail what products and services you're reviewing and what the impact would be to sales and margins.

So as part of our normal course, we look at product life cycle management. In the past where product life cycles have been much longer and more traditional or conventional lighting, With the LED, the advent of LED, it's no longer a new technology. It's around product life cycles have become shorter. The ability to be more innovative with form factors and how you put technology inside those luminaires, it just shortens up the product life cycle. So what we're doing, in my view, is nothing more than a normal review of product life cycle management and making decisions around why are we going to continue to offer something that is no longer, in our view, effective relative to new form factors or new capabilities. I don't perceive that it's going to have a significant impact on our top line. But any impact it does, I expect it to have a offsetting positive impact on our margins and our return on investment. So to me, the reason we're mentioning it is because we want people to understand that we're doing this, but the expectation is Well, I don't think it will be significant on our top line. It will have some impact, but we also believe it will improve our operating profit margins as well as our return on invested capital, which, by the way, is quite robust.

Okay, that's a helpful clarification. And then secondly, when do you expect the higher margin part of the Atrius solution to begin impacting the P&L? Because it feels to me that we're still not really selling a whole lot of the Tier 4, but maybe help us with that.

Yeah, no, it's interesting. It's a great question. Against the backdrop of Acuity Brands, which is almost a $4 billion business, it's hard to have an activity that is growing nicely, spice the stew so significantly that you say, oh, my gosh, you know, I can now see the difference. We are getting great growth in our corporate accounts because people want the benefit of the Atrius-enabled capability. When they buy that, they usually wait until they have enough critical mass before they start to, if you will, drive the Ferrari. But for the early adopters, we are seeing interesting activity. It is positive to what we're doing. Where we're getting the growth so far is – As we continue to push the technology, enhance the technology, hone the technology, all the words that you want to use, once we're able to now more specifically control it and once we have the opportunity to put it in the hands of our agents, and I still think we're probably 12 to 18 months out, where we can actually sell solutions into various verticals through that sales force, it will be a powerful, powerful capability. That's helpful.

Thanks so much.

Thank you. And our next question comes from Tim Walsh with Bayard. Your line is now open.

Hey, guys. Good morning. Just two follow-ups for me. So the first is on inflation, the last couple quarters you had kind of called out a headwind. to gross profit, I think last quarter was $16 million and Q4 was $20 million. Any color on what that was in the February quarter? And then secondly, just to kind of put a little finer point on this mixed issue, as you look forward, it's not unreasonable for us to think that all in you should actually start to see margin improvement on an EBIT basis despite some of the mixed issues with gross margins.

Sure, and you saw on an EBIT basis the improvement in Q2. Exactly, yep. Our expectation is that we will continue to drive improvement at the operating profit level. So to me, coming back to your previous question, our costs continue, but when we start to imagine that we're getting closer to where we're anniversarying some of that cost, those numbers, the difference isn't as great, but yet you would say, okay, it has a deteriorating impact on your margin. This is where the price increase, price increases were very helpful in helping to lessen that. And as we said, we believe that our price increases contributed low single digit to our overall growth, which when you then further imagine that it really applies mostly to about a third of our business. We did get pretty solid capture. So a little bit of that sales channel mix. This quarter, noise because of the pull forward through the CNI channel or the CNI market, I should say, because of the price increases implemented on that. That caused a bit of a distortion. We still saw great growth in our corporate accounts. And again, just a big shout out to our... Our DISTEC BMS team, they really put some big points on the board. And we expect that to continue. That actually is margin accretive to us. So cost was an issue, tariffs issue. Price increases benefited that. The mix, the channel mix, had to do with the pull forward into Q1 from the CNI side.

Okay, great. So even margins, that expansion should continue going forward.

Well, we're not providing guidance, but as you might imagine... I try.

Okay, great. Well, good luck on second half, the guys. Thanks.

Thank you. And our final question comes from Jeffrey Sprague with Vertical Research Partners. Your line is now open.

Thank you. Good morning, everyone. Just let me come back to one of the earlier questions that might have been less about whether the lighting industry is going away and more about, you know, does it make sense in this environment for you guys to, you know, explore being, you know, a consolidator, you know, in an environment where arguably there's too much capacity? Or is that kind of contrary to your strategy and, you know, you'd rather, you know, just try to pull away from the pack organically?

Yeah, so we continue to look at all types of M&A, whether it's technology, technology within lighting, technology within BMS, technology within Atrius, as well as lighting businesses that can enhance our portfolio. The Juno acquisition was a great example of a company that fit very nicely and filled a gap with us. The Juno team Fantastic opportunity. But also, look, we acquired Lucid, you know, again, a fantastic company to help us drive more of our SaaS opportunities. So we are looking at a broad playing field. Businesses that, you know, the most recent transactions that have been announced where there's been M&A, not spin-outs, Those businesses, there was really no reason for us to participate in that. We believe that we have a robust portfolio, talented people, and as you point out, we would go at that and look to grow organically in the marketplace. To tidy up a competitor or buy something like either of those two businesses, I think would have been really dilutive to our returns and our attention. We are active in the M&A world on all aspects, like Ricky pointed out, but for us to drive consolidation with some of the companies that were available, that would not have been a benefit to Acuity shareholders.

Thanks, and then a separate question. I totally understand your comment about the you know, price increases and list price going through that third of your business. But does that activity significantly influence your ability to capture price on bids? Is there a kind of element of a, you know, some sort of price umbrella or just kind of general tone in the market around positive price that would feed into your bidding activity?

So, you know, once we bid and the bid has been accepted, This is where some of the previous jobs that have been either part of our agent's backlog or now part of our backlog, a lot of that was price protected. As we look forward, you know, we're looking at how do we continue to differentiate our solution set. This is where our controls platform is very helpful to us in adding differentiated value. And we are... looking at what our cost structure is, but we price to the market opportunity, not to our cost structure. We look to improve our cost structure to drive margin influence, but higher cost in the marketplace does find its way into the project side of the world on future bids. Great.

Thank you.

Thank you. And ladies and gentlemen, That concludes our question and answer session for today's call. I would now like to turn the call back over to Mr. Vern Nagel for any closing remarks.

Thank you, everyone, for your time this morning. Again, we strongly believe we are focusing on the right objectives, deploying the proper strategies, and driving the organization to succeed in critical areas that have the potential over the longer term to deliver strong returns to our key stakeholders. Our future is bright, and thank you for your support.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone have a wonderful day.