Good morning and welcome to the Acuity Brands' Fiscal 2019 Third Quarter Financial Conference Call. After today's presentation, there will be a formal question-and-answer session. [Operator Instructions] 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.

Thank you and good morning. With me today to discuss our fiscal 2019 third quarter results are Vern Nagel, our Chairman, President and Chief Executive Officer; and Ricky Reece, 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 risks 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 Vern Nagel.

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 third quarter were very solid despite continuing inflationary cost pressures, the impact of tariffs and further uncertainties caused by U.S trade policies. We implemented several programs to address these cost issues including additional price increases, product and freight cost reductions and further actions to improve productivity. We believe our top line growth this past quarter was negatively impacted by the pull forward of orders from customers into the first half of the year as they acted to avoid announced price increases as well as reduced shipments in the retail channel due to efforts initiated this year to eliminate products within our portfolio that do not meet our profitability hurdles, primarily in the retail channel. I will provide greater detail on our sales mix later in the call. Additionally, we’re pleased that our adjusted gross profit margin exceeded 40% for the first time in a year and improved sequentially for the third quarter in a row. Our adjusted diluted earnings per share of $2.53 was a third quarter record. I know many of you’ve 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 third quarter of 2019. Net sales were $948 million, a slight increase over the year-ago period. Reported operating profit was $120.3 million compared with $107.4 million in the year ago period. Reported diluted earnings per share was $2.22 compared with a $1.80 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…

Thank you, Vern, and good morning, everyone. As Vern mentioned earlier, we had some adjustments to the GAAP results in the third 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 10-Q, we provide a detailed reconciliation of non-GAAP measures for the third quarter and first nine 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 the closure of a facility, excess inventory adjustments, 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. In the third quarter of the prior fiscal year, we recorded a pre-tax special charge of $9.9 million, primarily with actions to streamline the organization. We expect to continue to incur additional costs in future periods associated with these actions initiated last year. The additional costs will consist primarily of early lease termination and moving cost associated with the closing of certain facilities. During the third quarter of this fiscal year, we reversed $100,000, a previously recorded special charges due to updated estimates. The effective tax rate for the third quarter of fiscal 2019 was 20.9% compared with 26.4% in the prior year quarter. The decline in the current fiscal tax rate reflects a lower federal statutory rate and certain research and development costs tax credits, including claims for prior periods recognized during the third quarter of fiscal 2019.…

Thank you, Ricky. While current market conditions in the lighting industry continued 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 companywide 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 profitable growth potential over the long-term. Our above market sales growth, significant cash flow and robust return on invested capital through the first nine months 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 industry and items influencing costs have not really changed over the last few quarters. So let me reiterate a few of those key items that could influence our performance in the fourth quarter and for the balance of the calendar 2019. Many independent third-party forecasts continue to suggest the overall growth rate for the North American construction market as measured in dollars will be in the low to mid single-digit range. We still believe the lighting industry will lag the overall growth rate of the construction market, primarily due to continued product substitution to lower-priced alternatives for certain products sold through certain channels, while recent industry pricing action should have a favorable impact on growth as measured in dollars. Additionally, we expect that labor shortages in certain markets will continue to dampen growth rates for both construction and lighting. The U.S government increased tariffs on certain imported Chinese made finished goods to 25% from 10% in May. This action resulted in many lighting companies including Acuity implementing a price increase in late May. The U.S has threatened to increase…

Thank you. [Operator Instructions] And our first question comes from the line of Tim Wojs with Baird. Your line is now open.

Hey, gentlemen. Good morning.

Good morning.

Good morning.

So maybe just -- again going back to your last comments there, Vern, just on the profitability improvement that you’re expecting in the fourth quarter. You mentioned that you expect EBIT to be -- EBIT margins to be up year-over-year in sequentially. Should we think the same for gross profit, just there was that headwind from the load-in on the sales line, but I also think there was a headwind not only from that load-in, but also just some negative operating costs that hit the gross profit line, the COGS line in the fourth quarter last year. So any commentary you can give us and just gross margins being higher year-over-year in the fourth quarter, that would be helpful.

Sure. So you saw that this quarter our gross profit margin improved well sequentially to 40.5% was the first time in, I believe, the last three quarters that we have exceeded 40% the gross profit margin level, the key indicator for all of you and for us internally as well. We would expect to see improvement in Q4 as well. As you know and we mentioned in the last couple of quarters because of some of the intra channel mix, customer mix within the retail channel and how we serve those customers, it is having an influence that lowers, if you will, based on historical standards our gross profit margin, but it is made up in lower SDA. We estimate that in the third quarter that impact lessened our gross profit margin by approximately 30 basis points compared with the year-ago period. So we are expecting improvements in Q4, particularly as we look at various products and product categories within our portfolio that really don't meet our margin hurdles or return on investment hurdles, so we’re looking to prune that back, which I've used a very favorable activity. And so what that should do in Q4 little bit of noise going on, it will contribute to most likely lower sales in Q4, but a higher margin profile. And as Ricky and I said in our prepared remarks, we are expecting that to result in constant or consistent operating profit dollars.

Okay. And then I guess just to be clear, you would expect gross margins to be up year-over-year in Q4 or sequentially as well?

I would expect them to be up sequentially. The headwind -- well, excuse me, for the year-ago period, we would expect them to be up pretty meaningfully above the year ago period.

Okay, great. And then maybe just -- switching over to kind of the tariffs, what have you heard from your customer base in terms of the move from no tariffs to 10% and then just the increment move from 10% to 25%, have your customers or your channel partners being able to pass that on to customers? Is that what you've heard or have you heard any sort of pushback on that move to 25%?

So we sell-through 14 different sales channels, and so I will just comment on some of the broader ones. Certainly the move from 10% to 25% that was the situation I believe where the industry, not only the lighting industry but anybody who has product that’s coming from China, that was a move too large for anyone to absorb or for the fluctuation in foreign currency to give some argument that you could absorb that. So the price increases I think are real and the end channels are passing those along to end customers because they can absorb that either. I was very pleased with our price capture in Q3. We've implemented more pricing and we expect that to continue to benefit our results. And when I say benefit our results to offset the significant tariff increases. I will remind everyone that if you go back to early September, mid-September that price increase had more to do with the cost dynamics in our industry, less to do with tariffs on finished goods. We then put in additional price increases, including the most recent price increase in May reflective of the significant increase in tariffs on Asian made finished goods.

Okay. Okay, great. And then just kind of sneak last one in. We noticed you didn't buy any stock back in the quarter. Any thoughts on just stock down 11% here today, how you think about buybacks opportunistically would be helpful. Thanks.

Sure. So I'll take a stab at this at first, and then Ricky can comment. First of all, our stock being done 11% today is ridiculous. I mean the value of the business and the things that we're doing were enhancing the value of that. It's all good things. We are really generating a lot of cash. We are doing great things within the key markets that we serve. We are looking to prune some of the things within our business that don't really provide the kinds of returns that we expect. We have a significantly high return on invested capital, cash flow return on investment, those are important metrics to us. So we are looking to make sure that we are a better business and a growing business. You might imagine that with $334 million of cash, we are looking at all alternatives, the pipeline that Ricky has from acquisitions and strategic investments is robust. And we would expect to execute on those where we see really interesting opportunities to enhance our return. So as we’ve always said in the past, if you look at how we have used our capital, our free cash flow, a third of it has gone to acquisitions, a third of it has gone to stock buybacks and the other third has been split between CapEx and dividend. So I would expect us to continue to operate in that kind of environment. Ricky?

Yes, I will just add a few more comments on that. As Vern said, our first priority is acquisitions. We think that provides the greatest longer term value creation for shareholders. The pipeline is very long and very active, both for outright acquisitions as well as opportunities to invest in complementary technologies and operations. You saw after the end of the quarter, the small acquisition of WhiteOptics, but strategically that will be very important to us as we continue to advance the optics capability in some of the new form factors that are going to the market today taking advantage of the LED. So very excited about that, but clearly share buyback is on the table. We have the authorization from the Board and that’s certainly an opportunity we will take good care of.

Great. Well good luck on the rest of the year and have a happy 4th.

Thank you.

Thank you. And our next question comes from the line of John Walsh with Credit Suisse. Your line is now open.

Hi. Good morning.

Good morning.

I guess, the first question around pricing and I think you’ve articulated that there's the general inflationary price increases and then the price increases that are related to the tariffs. But I’m just curious, if we were to see the tariffs disappear, what kind of industry discipline has been instilled or do you think customers would allow you to continue to capture that non-tariff inflation just because historically it has been a price down market?

Yes, my observation around that is that the industry has been for the bulk of the industry, I won't say for some of these lesser featured type products where they’re subject to a bit more of global competition. I would say that the industry has generally been and I would expect it to continue to be disciplined around larger projects or what I will call specification driven projects where you're adding value by selling not only product feature differences, but you are selling service and support differences and we are seeing that. We are raising prices on some of our controls platform, primarily because there's value there and we’ve experienced some cost. And I think that the industry recognizes that value and our competitors also recognize their own value. So I would expect that those types of price increases to stay in place, frankly.

I would just add, historically, we’ve seen the ability to pass on commodity price increases. So for a lot of the price degradation we’ve experienced over the last eight, nine years was because we were seeing declines in LED cost, efficacy of LED and so forth and the market again was passing that on. So I would just reiterate, I do think the market is pretty rational when it comes to these kind of common commodity costs, both when they go up as well as when they goes down.

And John, I would also comment that one of the reasons that we’ve aggressively relaunched our Contractor Select portfolio where we’ve revamped the product portfolio, if you will, based on features and benefits, but also has been maniacally focused on the cost structure within that, and that is to effectively compete in that portion of the market where to the extent that tariffs go away, we still have a strong competitive advantage, not only in the product portfolio set, but in the service set. We are modifying or service platforms, making our transactional capabilities far more frictionless and easy to do business with to compete in that world and it's an important element for us, because I don't know that pricing, while we seem to debate somewhat, particularly on product substitutions, we’d expect to continue to thrive in that marketplace, even without tariffs.

Got you. And then maybe a follow-on here about the installed base opportunity. I mean, I feel like we've always talked about LED penetration rates through the installed base, but given the very public field failure with Detroit that everyone was speaking about at LIGHTFAIR, you've seen kind of an increased amount of marketing around product quality, whether it's from yourself, your channel partners or competitors. Is there a potential to see an acceleration of, call it Contractor Selector, this kind of Tier 1 refocused product as some of this earlier imported lights fell in the field, is that a big opportunity or is that something people talk about, but you don't actually think it's going to amount to an increased installed based opportunity?

John, that's a great question. We, Acuity, have been and are increasing our aggressiveness in communicating to our customer base both through electrical distribution to the end customer that there's a huge difference, just because something looks the same and they both say LED and they both say 5-year warranty, they're not the same. I call it internally selling the difference. And more and more, we are becoming even more aggressive at selling the difference. And this happened in the analog world. If you go back almost a decade ago, imports coming in, they didn't meet some of the standards and when you had failures that were highly publicized and more and more these failures are -- I will just call them, larger projects like the City of Detroit, that goes like wildfire through the industry. And now we are able to sell our difference, but also sell the fact that Acuity is maniacally focused solely on lighting, lighting controls, building management capability and it's our quality that we sell and our ability to support those kinds of things. So we do see it as an emerging opportunity to really sell the difference and create greater sales and greater profitability for Acuity.

Thank you.

Thank you.

Thank you. [Operator Instructions] And our next question comes from the line of Jeff Osborne with Cowen and Company. Your line is now open.

Hey, good morning, guys. I was wondering if you could just put in perspective the pruning of the portfolio. You mentioned it was $12 million year-over-year. If you annualize that, is that a good number of what you've done so far and is there more room to go in terms of what you're looking to prune?

I would say that there is. The decline in our Retail segment of $12 million, that's a portion of the pruning activity, that's not all of it, it's not all in the retail channel, it's looking at various products. Just a little historical perspective. We got into some of these products by really doing a service and accommodation to certain customers sets so on and so forth. It wasn't really core to our business, but the customers were core to us. And so leveraging some of that capability and saying, yep, we will do it, it wasn't really consistent with some of the value propositions of the brands that we have. So this pruning is really, it's been a long time coming, but it's an appropriate thing to do. My guess is that it will continue to influence the next couple of quarters, particularly as we do year-over-year type comparisons and we will continue to give more insight on that. While we say it's modest, it could be two or three points of our top line, depending on how aggressively we pursue some of these things and look at alternatives. It's not just that we are going to stop doing some things, but do we want to commit resources to reengineer or engineer some new products in this area that, again, may or may not be consistent with the value proposition of brands. So we are still evaluating those types of things. But again, I want to reemphasize really important that we expect at the operating profit level for these things to be fairly neutral in terms of the actions. That's reflective of the fact that we're not making really any money on doing some of these accommodated type things and there's no reason to burn up our factories, or our balance sheet, or our people servicing that portion of the business, that is not accretive to what we're doing. So there's still I think more effort that we will be putting into this. And while it will create a little bit of noise on the top line, we think that shareholders will appreciate the benefit on the bottom line and on how we return capital to shareholders.

Makes sense. And my second question, the last one is just on the Atrius. Can you just touch on how you're capturing the value for that, in terms of any metrics that you can give in terms of price premium that you’ve for the product either in a per unit or square footage basis? You’ve just been somewhat elusive on sort of the revenue model for Tier 3 and 4 in the past, and so it would be helpful just to understand how is that 20% of retail square footage evolves over time with the awards you have, what the financial ramifications of that are?

You know, Jeff, I don't know, if we’ve been elusive on Tier 3, we apologize and that must be miscommunication. Our growth in the corporate account world for us or that enterprise solution world has been really quite positive. We are gaining share, if you will, in that space as we convert these retailers. That’s why we wanted to give you all a sense that our actions to date where we say, we believe that in the big box world, more than 20% of that square footage in the U.S is under Atrius-enabled luminaires. So we earn that business and we sold those luminaires. Now what we are doing is working with these customers to really help them drive the Ferrari that they bought in terms of what it can do to their business model. And that's really been the Tier 4 opportunity for us to generate more SaaS revenues. They are, again, we're operating off the small base. But the reason that these retailers and other verticals are putting in our Atrius-based luminaires is because they are -- they believe in the future opportunity of the IoT-enabled capabilities. And so they're now experimenting with these apps. I think that if I had a learning that I would share with the group and I think Ricky and I would have said, boy, when someone transforms a single store, they are now going to start using it and putting absent, that's just not how things work. We were wrong in that premise. People want to get critical mass. Think of airports. These transformation of these airports are years in the making. While if they redo one terminal and you're a passenger going from that terminal to another terminal and its Atrius-enabled in the one terminal and then they lose you going to the other, they've created a horrible customer experience. So they are buying these luminaires, future proofing because they know that over the course of, I will call it, whatever their renovation cycle is, they're going to have that platform in place. So the Tier 4 revenues, the SaaS revenues, have been slower incoming relative to what our assumptions were three or four years ago, but we believe that the reason that they’re buying these solutions, the fixtures themselves and the controls platform and all of this is because they believe strongly in the opportunity of what the Atrius IoT-enabled capability will allow them and that’s why we are selling a lot of luminaires into that space.

And I would just add, our business model will enable us to capture that value over time, as Vern said, as they start driving that Ferrari or adding more and more applications and capability to it. Yes, we get a premium when we sell the hardware, but the further opportunity is once they start using the data that we are able to collect or collect additional data as we build out greater capability, or other sensors, or other companies want to use our network to transfer data and run applications and gather information that they can use to enhance the business or the productivity of the customer. So our business model allows us to continue to capture that along the way and grow the SaaS revenue and enhance their revenue on that network that we put on as they continue to use it more and more.

I appreciate it. Thanks guys.

Thank you. And our next question comes from the line of Jeff Sprague with Vertical Research Partners. Your line is now open.

Yes, good morning. Thank you, guys. Hey.

Good morning.

Just a couple things from me. Good morning. Just back on the whole idea of kind of the influence of tariffs and pricing on buyers behavior. So first, do you have a sense of what the pull forward actually was in the first half of your year? And secondly, I would have thought perhaps that this move to 10% to 25% may have actually created some sort of pull forward in the current period and it seems like that didn't happen. So maybe just a little bit of additional color there would be helpful?

Sure. It's interesting and unfortunately to have precise data to answer your question, we don't have. But I have been to a number of industry events talking with distributors, contractors, different customer set. And in that dialogue with them and I will just pick distributors here for one second, they’ve said, we’ve been inundated at bringing in projects now and having to consume more and more of our floor space actually having to add space to house these projects that will be delivered over a more likely period of time. I believe that the move to 25%, while that may have created some pull forward, I think, you saw a lot of the pull forward kind of in that first half of the year. I think what you could actually see is projects on the 25% side potentially being delayed. And the truth of the matter is that for a lot of the product that was hit by the 25% tariff, that actually is on the more smaller, more stock flow type projects. Usually, larger projects that require more sophisticated type luminaire, we are manufacturing those types of products in our North American footprint and so we are able to through different types of sourcing so on and so forth, sell those luminaires without necessarily the pressure of -- the fulsome pressure of the tariffs. So I think, there you didn't see more pull forward of those types of things. And then on the stock flow side, I believe that folks are sitting back saying, well, how long is this going to stay. A lot of distributors, they already have enough inventory. They're not going to pull forward more when they're running out of space. So we did not see the same type of pull forward activity on the May increase, even though it was a significant increase. So it's just an interesting dynamic that's going on. It's -- and I wish, I could give you real statistics, but we just don't have them and lot of our distributor customers are struggling with what is actually happening in their business. Yes, they continue to be reasonably optimistic around their backlogs are healthy, they see some of these projects, but they too are concerned about larger projects. This is just simply taking long and I think that have more to do with steel, which fortunately has abated somewhat here. So we will see how that plays out frankly.

Yes, so just maybe an additional color on large projects. So is it your view that it's just inflationary pressures, or there's something going on with the end demand picture or some other dynamic that’s kind of leading this kind of extended drawing out, for lack of a better term in some of those large project activity?

Yes, it's a great question. No doubt that there are changes afloat on how people use space, use space differently so on and so forth. But I think that a lot of it has been influenced by, I hate to say this, and I -- at first, I do really accept that the notion of labor shortages were having an influence, but I think more and more a lot of these contractors, they are comfortable with their backlogs, they are comfortable with their project and their activity, as it currently is and they are saying I will get to that project later. And so I think the delay has a lot to do with just the availability of labor and to a lesser degree than expectations. Dan, as you pointed out earlier, folks maybe saying, well, if I wait, maybe these tariffs go away and the pricing will come down back to pre-tariff levels and therefore, my project looks better. We hear that anecdotally, but we don't really have good evidence around that yet.

Great, thank you for the thoughts.

Thank you.

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

Hey, thanks. So first off on the low single-digit price capture. Has this been neutral to the profit line as it relates to the quarter? And then any reason this should change positive or negatively in the future?

So low digit capture, we are spreading across the whole portfolio. We would say that it has been slight positive, but we’ve had to really work hard to take cost out of cost components that we can control, not just componentry that's coming in from Asia and/or finished goods. There's still, I think more to come on the finished good side. Again, price increases just put in place in late May. We still see input coming in at a favorable rate, positive rate for those types of smaller, medium projects, but maybe that's slowed down just a tad. But I would expect that these types of activities to continue to be positive so long as they don't ultimately end up impacting overall demand. I think the bigger issue and I will let Ricky comment, I think the bigger issue still continues to be just the volatility caused by all of the rhetoric that's in the marketplace. I think that, that we see people who are busy, but they're not really actually shipping product. I think people are, again, taking a bit of wait and see approach. Ricky, your perspective on ...

Yes, I think for the low single-digit in the quarter for the most part offset the tariff increases we have. Of course, the last tariff increase came in very late in the quarter in mid May. We announced the price increase extremely quickly, but we do protect certain backlog. We had certain customers, we had to negotiate the final amount with that are under a different scenario than just distributor or someone who places an order on a daily basis. So I think, for the most part, we captured it in the third quarter, but I think there will be further margin opportunity to capture more and then maybe go beyond here in the other quarters as we don't have to protect certain projects that had already been quoted and all once we get past that.

Okay. Yes, that makes sense. And then just to follow-up on the fourth quarter sales, so down modestly. If I were to rank sort of the pieces there, would it be first the retail comparison that's pretty tough, I think it was 500 basis points of growth last year, I think, that's what you quantified? And then secondly, eliminating some products maybe 2% to 3% negative impact and then would the last piece just be the pull forward into the first half?

I would say that the first two are directionally correct. I would say that when you get into our fourth quarter and then imagine where projects pull forward all the way from the fourth quarter into the first half, I would say probably not as much. I don't know that I would influence that. We are still trying to handicap, as Ricky pointed out in answering the previous question, what impact is the May price increase having. Right now, we are not seeing that it's having a huge pull forward impact. So I would say as you think about the Q4, the first two were directionally correct, and again, I'd like to really emphasize because this is going to be important for how all of you write your reports. Our expectation is that we are going to continue to see our profit measures improve and we will go a long way to offsetting some of that top line decline because of just the mix of it. So it's important that everyone understand that as it create some of their models.

Very helpful. Thanks.

Thank you. And that does conclude today’s question-and-answer session. I would now like to turn the call back to Mr. Vernon Nagel for any further remarks.

Thank you everyone for your time this morning. I realize that some of the questions around top line for Q4 very important as you think about your models. But again, we are really focused on not only growing our business, but profitably growing our business and making sure that we are doing it in areas that provide us with the kinds of return on capital and the margin improvements that we are after. So please understand that, know that we are focused on it. I think as you do your models you find it to be a very favorable outcome. Any way, 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 long-term to deliver strong returns to our key stakeholders. Again, our future is bright. Thank you for your support.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect and everyone have a great day.