Acuity Delivers? Electrical Distribution Declines?

Last week Acuity released its latest quarterly report (covering Q2 2018 time period.) At the headline number the business met the feedback we received from distributors in our Q2 Pulse of Lighting study (or here to purchase the report for $19) and performed well.

But we saw / got some feedback from analysts of:

• “Weird exchange on the AYI call”
• Quarter Is Less Bad, But Price/Mix Worse Again and Price Pressure Expected to Continue

Which piqued interest as started to review the analyst call.

Some headline numbers:

• Revenue rose 5% in Q3, due to ~10% increase in volume and a combined 1% favorable impact from acquisitions and foreign exchange rate changes. (Tthe difference is price erosion which mimics what we heard from manufacturers in our quarterly report. Sales were slightly behind … on the surface)
• Sales of LED-based products represented two-third of total net sales.
• Gross margin rate down 90 bps to 41.6%.
• Adjusted SD&A expense rate improved 130 bps to 27.2%.
• Adjusted operating margin rate squeezed 220 bps 14.4%.
• The Company entered into a new credit agreement with a syndicate of banks that increased the Company’s borrowing capacity under such agreement to $800M from $250M. (interesting increased borrowing capacity so much. Why? Acquisition? Anticipation of need to build more inventory? Other investments or for “dry powder”? Buy back stock?)

And the transcript, and company, says:

• Performance solid particularly against the backdrop of current market conditions which continue to be soft (depends upon definition of “soft”)
• Net sales $944M, up about 6%
• Operating profit was down about $25-26M
• Adjusted operating margin down about $12-13M (so, sales are up, profit & operating margin are down)
• Sales through C&I channel (distributors) were down slightly vs prior year (not good since our report shows distributors up 6.1%. Continuing to lose share in the channel?)
  • Had sales growth in “most channels and geographies” (so, in other ways that Acuity goes to market … other types of distributors as well as direct.)
  • Sales driven by “greater shipments of Artius-based luminaires to certain customers and growth in infrastructure and utility channels (utilities and municipality projects … roadway / street lighting … one time projects? Lower margin? No / limited distributor involvement?) and some high-volume luminaries for applications for smaller projects (possibly distributor load of their new Contractor Care offering?)
• Sales impacted by unfavorable mix and price
• Continued “increased competition” from more basic, lesser-featured products (while lesser-featured, still meeting customer expectations / needs which means that the more robust, full-featured products are not needed / understood by customers. Is this an Acuity marketing challenge or sales organization / lighting agent challenge or a distributor issue? Distributors – how do you view Acuity’s marketing efforts to create demand or is it left to the lighting agent and/or yourself?)
• Relaunched Contractor Select offering in the quarter (in a company of brands, this is the best name for an expansion of their product portfolio?)
• Feel Tier 3 and 4 sales growth was 40% and is now more than 15% of total net sales (distributors, are you / Acuity segmenting your Acuity business by tier? Are you participating in this growth? If not, is it an opportunity? And if not, what do you need training-wise or resource-wise to participate in this … or is your market not ready yet?)
  • Have accelerated number of Atrius-enabled deployments and increased activity with several US-based retailers and other key verticals / types of public buildings (diversification is good as having much of one’s sales eggs in Target in the face of Amazon and WalMart growth doesn’t sound like a winning formula or a validating marquee case study.)
  • Expect Atrius sales to be “lumpy” at times due to customer renovation and construction cycle
  • Company is betting big on Atrius. Challenge is the pace of adoption. Vern reiterated “we believe the lighting and lighting-related industry as well as the building management systems market have the potential to experience significant growth over the next decade because of the 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. (Question is, how many are thinking “next decade” and have the vision today?)
• Introduced next generation, “industry leading” lighting control system and feel Acuity has “most comprehensive and feature-rich wired and wireless lighting control system available. (never heard of that company in Coopersburg, PA … Lutron? … but definition of “industry leading” is in the eyes of the customer / specifier.)
• Continue to state that they are becoming “more of a technology company”
• Benefited from a 7.5% favorable difference in tax rate
• Increase in inventory due to customer expansion in the home center / showroom channel, new product launches (probably primarily Contractor Select – 200+ product families) and to support corporate accounts (direct sales)
• According to Vern Nagle “Current market conditions in the lighting industry continues to create a challenging environment for management to drive short-term financial performance while continuing to invest in attractive long-term opportunities.” (Challenges of selling in a project driven environment where lighting agents, and Acuity, are really good at generating specifications for larger projects but continued growth is in the small and mid-sized projects were product features may be less valued and the lighting agents have less visibility. This is also a challenge as the change to LED has generated less “stock and flow” business for distributors and lower distributor inventory due to product changes. Lighting today is a different business model for manufacturers.)
• Distributor backlogs are favorable (which is also indicated in our Q2 Pulse of Lighting Study (synopsis). Click here for the report.)
• Expect lesser-featured sales to continue and will pressure sales performance (sell more units, not necessarily at the same rate as sales, but Contractor Select to help retain sales for Acuity)

Feedback to analyst questions during the call?

• Acuity looks at Tier 3 / 4 and Atrius as an annual model vs quarterly due to the nature of the large project sales process and the implementation process.
• Hoping to continue to generate utility / infrastructure sales as these entities bid large projects. (From the transcript it appears that Acuity is using its own, direct, salesforce to pursue this market and perhaps not lighting agents or distributors as the primary vehicle.)
• Acuity thinks it picked up a couple of points of share in the segment that competes with Contractor Select offerings, the small to mid-sized market. Reportedly Acuity says it is “altering how support customers” with this new offering to help manage Acuity’s margins.
• C&I channel represented 56-57% of sales for the quarter. Decline from 60% due to slowdown in large projects through the C&I channel.
• Acuity feels its stock and flow / smaller-project business is up
• 75% of lighting business is project based

Some analyst comments:

• Our work found some improvements in the cash flow and balance sheet but fundamentally still flaws. The company chatted up Atrius but then said going forward those sales would be “lumpy.” It almost seems as though they got that big infrastructure / utility deal(s) at the lowest margin possible to beat revenue. The big question is how sustainable is any of this and is the worst ending? We’ll know more in another quarter!
• Large commercial projects remain weak despite a broader construction market that is performing well.
• The outlook commentary was a little better calling for “modest improvement” in growth, but we have heard this before and been ultimately disappointed.
• Our fear is that sustained average selling price declines on tier 1-2 (~50% of sales) due to pricing pressures and product mix, combined with slow adoption of tier 3-4 (15% of sales) could lead to gross margin falling to 40% in 2019.

So …

• Sales are up
• Electrical distribution as a % of Acuity sales declines from 60% to 56/57% for the quarter
• Atrius / Tier 3 and 4 sales accelerate by 40%
• Contractor Select line is launched to combat “lesser featured” product offerings from other companies
• Some “one-off” wins in utility and infrastructure

Distributors … how is Acuity performing for you? What do they need to do to earn more of your business?

Competitors … are you seeing the same landscape?