Acuity Challenged With Growth

It’s the beginning of a quarter so you now what that means … quarterly reports which gives us some insight into the overall marketplace.  Acuity conducted their call yesterday and unfortunately they missed revenue and profitability expectations. Perhaps its a case of setting expectations too high or perhaps its under performance or, as they would like everyone to believe, it’s the market.  According to one analyst, “Chief executive Vernon J. Nagel tried to put a brave face on the quarter by noting, in the earnings announcement, that Acuity wasn’t doing as badly as its rivals.”

And according to feedback from distributors we talk to, there continues to be lighting activity growth, unfortunately, due to competitiveness (from distributors, companies selling direct / customers buying direct, eCommerce) and price erosion, a portion of the lighting business is almost becoming similar to the wire commodity business … need to measure results in units vs dollars to see if you have growth.  According to one distributor, “Almost need to sell 10% more to remain even in sales dollars.”  But lighting remains 30-40% of many distributors’ business (especially if a contractor-oriented business).

The lighting market opportunity continues to grow given the continued retrofit opportunities in the commercial, lighting and municipal markets; the expected continued new construction growth (and all new construction is LED; and the anticipated growth in the controller / IoT markets. The question becomes what are the business models (and can distributors adopt them) and will competition evolve from solely price.  In a market where there is limited (perhaps no) loyalty to manufacturers within distribution, at the contractor level, at the end-user level and by them to the channel for the retrofit space, will sales growth be restrained due to price competition?

On to insights from the Acuity quarterly call:

• 

        Acuity Growth Rate

  Admitted results for quarter (their 1st quarter) were “below expectations but we continue to outperform the markets we serve.” (And an element of that is their electrical distribution channel vs other channels and feedback that we’ve heard is that they are outperforming vs Eaton Lighting, Hubbell Lighting, Cree and Philips Lighting by a significant percent, however, this is only a part of the competition. Versus others they are underperforming … and sometimes significantly.  The question becomes, can they get any of it back or should they be focused on larger projects as their core focus and nominally on the small project / “flow” business since they are today not competitive in this area?)

• Mentioned “sales declines in certain channels and markets.”
• Net sales were $843M, down 1% vs last year, with operating profit down 6% but “up about 2% in US and Canada. (Again, they say “outpacing competition” but competition is limited to 3-4 companies in many cases.)
• They have $429M in cash on hand (future acquisitions? What would be good for them? Or could be for further diversification in the building automation space … which continues to focus on their top tiers but doesn’t address where they are losing share?)
• “Net sales volume declined 1% due to price with prixe / mix due to changes in product price primarily for more basic, less featured luminaires sold in certain channels.” (for them to be down 1% due to mix in more price challenged products gives an indication of not wanting to, or can’t get to the necessary price points when distributors tell us there can be a 10-25%, sometimes more, price difference.)
• Mention that home center / showroom channel, which is 10% of sales, was down 11% do “primarily to changes in the in-house branding being deployed” (Code for someone going to a private label strategy primarily due to price considerations.  We’ve since learned the chain going private labeling is Home Depot.  This is a long-term channel / revenue loss for Acuity.  Once retailers go private label, they don’t go back except for selected SKUs / categories. And the reason they go private label is to lower their price, improve their margins and provide nominal benefits to consumers.  There are distributors, and contractors, who also buy direct for these ‘lesser feature’ SKUs.)
• “Accelerating expansion of product portfolio to compete in this channel” for the commercial pro (contractor) and DIY market. (challenge is that 1) they’ve lost the shelf space and there are only so many feet of merchandising space Home Depot will provide in-stores (online is different), 2) will pros and DYI buyers understand the benefit of the feature differences (and can Acuity market those benefits), 3) is there any brand loyalty / preference from pros and DIY and 4) what will they offer that is different given others already have “contractor value” lines in the market … Acuity may be late to the game for the lower end of the market … but they need an offering to remain a “complete line.”)
• “Believe demand continues to decline for luminaires” and that shipments for lighting fixtures were down in the low single digits for the second quarter in a row.” (Challenge with this is that the data is probably coming from NEMA data which is multi-channel, self-reported and for only a small percentage of manufacturers who sell lighting.  Our guess is that a survey of distributors would be contrary to this for the electrical channel as they are seeing across companies … it may be accurate for other Acuity channels.)
• 2/3rds of sales are LEDs
• Up almost 10% in top tiers and that it is now 15% of sales (But interesting that they continue to say that “sales data for tiered solutions is still imprecise” as they have said this for many quarters. Hard to believe that they haven’t spent some time getting more precise in this area as this is needed to validate their approach and identify if they are getting an ROI on their investment in people and technology. And it also begs the question, from an electrical distribution viewpoint, what percent of these sales / revenues involve electrical distributors and what is needed by Acuity and/or distributors (or some distributors) to participate in this reported growth segment as adoption is generated?)
• Have accelerated Atrius deployments. Key verticals appear to be retail. Some airports mentioned.
• Wants to be compared as a tech company from a financial viewpoint in making accounting adjustments. (but only 15% of sales are in this area)
• Expect tax benefit as quarterly tax rate was 35.5% … will be much lower in the future.
• Looking forward / 2018
  • Optimistic about long term
  • Reasons for lack of market growth
    • Lack of labor
    • 2017 uncertainty over tax regulations
    • Pricing pressures in certain end markets for certain less-featured products (they don’t mention increased price transparency and customers pushing for lower pricing which also infers less perceived differentiation and value proposition by “customers”)
  • Acuity customers have “guarded optimism for 2018”
  • New tax law, especially element for immediate expensing for certain investments, could help drive demand.
  • Expend second half lighting market rebound (aside from tax benefits, why different than before but, more importantly, what is Acuity going to do different, other than a low cost, less-feature line, to drive sales and capture / recapture market share? And why should their comparative metric be a few large companies and/or the NEMA metric … perhaps they need a broader barometer?)
  • Expect some component costs to further decline (while Acuity would prefer to use this decline to reduce their costs, many competitors will probably drive some of this into further lower pricing.)
  • Focused on growing Tier 3 / 4.  (With Tier 3 / 4 at 15% of sales for the quarter, about $125M, this makes this a $500M business as a combination of hardware and software. Can it be sold, deployed, monetized and replicated quick enough to make a dent in the lighting market, especially when more of these systems are being launched by manufacturers almost “daily”, thereby increasing competition for this type of offering?)

Analyst questions and responses:

• Tier 3/4 growth reduced in quarter due to retailers not wanting work in their stores after October. Makes sense but also begs the question “what other verticals need to be pursing to balance the business?”
• Acuity positioning “lesser featured / commodity products” as only in / for certain channels (very questionable as many sell direct to contractors / ESCOs or direct to end-user).
  • Feel these products are maybe 20% of what Acuity sells
  • (What could help Acuity in pursuing / re-winning this area within electrical distribution is it’s rebate strategies with distributors and involvement in AD and IMARK)
• Acuity reinforced that what they hear from distributors / others vs what they see (sales) differs.  They refer this to “the words in the music around the strength of the market”.  (Begs the question of “are they asking the right questions or are they drinking their own juice?”)
• Question –
  • Just wondering, when things kind of fell off. I think last quarter you noted pretty steady linearity lack of a plus or minus inflections month-to-month and clearly, that gave way a bit after the first month of the fiscal first quarter. So I’m just wondering what you saw there as things developed?
• Acuity answer
  • It’s interesting to me. In front of me, I have from the Census Bureau, the electrical lighting equipment U.S. total, and this is for value of shipments. Four of the last five quarters have been down. The only quarter that was up was Q3, that was 3%, all the rest of them were kind of in the mid-2% down.
  • I look against the backdrop of broader economic activity and say, this just doesn’t – this doesn’t seem like it’s sustainable. The Dodge Momentum Index, which is an index and I think that it’s reasonably accurate actually showed this downtick really in the 2017 period. And now is that the uptick that it just recently showed has meaningfully outpaced what 2017 gave back.
• Headcount down 15% since July 2017 (many types of roles with salaried headcount pretty stable)
• R&D investment is about .5% of sales … $40-50M.  Really not an R&D company as taking known technology, embedding into its system to use its sensory network (i.e. deployment into an LED chip)
• Acuity stated it is “the stock and flow leader in North America.”

Given the amount of attention to the pricing issues, it’s more than a nuisance / noise. It is creating concern and disruption. There was little discussion about projects, pipeline, impact of eCommerce, what seeing from other channels (i.e. municipality / roadway, etc) and not too positive on a go-forward strategy.

It was a challenging quarter for Acuity.  According to whom they’d like to be compared against, “better than them”, but not better than perhaps many.

Two questions:

1. What does Acuity need to do differently, or better, to get back on a much higher growth rate and to better support electrical distributors and/or their reps?
2. If you are a lighting manufacturer, or a distributor, is what they are saying representative of your business / what you are seeing in your marketplace?