Good morning, and welcome to Acuity Brands Fiscal 2020 First Quarter Financial Conference call. [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. Pete Shannin, Vice President, Investor Relations and Corporate Development. Sir, you may begin.

Good morning. With me today to discuss our fiscal 2020 first quarter results are Vern Nagel, our Chairman and Chief Executive Officer; and Karen Holcom, our Senior Vice President and Chief Financial Officer. We are webcasting today's conference call at acuitybrands.com. During this call, we will also discuss certain non-GAAP financial measures. Reconciliations to comparable GAAP financial measures can be found in our first quarter press release. I would like to remind everyone that during the 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. Further, forward-looking statements speak only as to the date that they are made, and we undertake no obligation to update publicly any of these statements in light of new information and future events. Please refer to our most recent 10-K and 10-Q SEC filings and today's press release, which identify important factors that could cause actual results to differ materially from those contained in our projections on forward-looking statements. Now let me turn this call over to Vern Nagel.

Thank you, Pete. Good morning, everyone. We have a great deal to discuss this morning, including our CEO succession plan, which I will address later in the call. But first, Karen and I would like to make a few comments regarding the quarter, and then after we will answer your questions. As you will recall from our last earnings call, we expected our net sales to be down this quarter compared with the year ago period, primarily due to the significant pull forward of orders last year as customers placed orders in advance of two announced price increases, and to a lesser degree, the impact of our efforts to improve the margin profile of our product portfolio. While the precise impact of this pull forward in the year ago period was impossible to determine, we felt it was probable our net sales would decline this quarter by mid- to upper single digit from last year. This decline played out pretty much as we expected. However, we believe the decline in our net sales this quarter was also exacerbated by additional weakness in the overall demand primarily due to continued concerns over global trade and the economic issues. Nonetheless, our results for the first quarter were solid despite these issues as witnessed by our enhanced gross profit margin profile and strong cash flow from operations. In addition, we took several actions in the quarter to better align the resources of our company to current demand and to further invest in our key strategies to drive profitable growth in the future. Some of these actions resulted in a special charge this quarter, which we will further discuss later in the call. I know many of you have already seen our results, and Karen will provide more detail later in the call, but…

Thank you, Vern, and good morning, everyone. As Vern mentioned earlier, we had some adjustments to the GAAP results in the first quarter of fiscal 2020 and 2019, 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 first quarter of fiscal 2020 and 2019. Adjusted results exclude the impact of acquisition-related items, amortization expense for acquired intangible assets, share-based payment expense and special charges for streamlining activities. 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 will find this transparency very helpful in your analysis of our performance. During the first quarter of fiscal 2020, we recognized a pretax special charge of $6.9 million in order to streamline the operations to be more in line with current market demand and to allocate resources to activities with higher profitable growth opportunities. These charges consisted primarily of severance cost and lease impairments related to planned facility closures. Additionally, we recognized relocation cost and lease asset impairment associated with the previously announced transfer of activities from planned facility closures. We expect to continue to incur additional cost in future periods related to current streamlining actions primarily attributed to moving cost associated with the closing of certain facilities. We expect that these actions to streamline our business activities will allow us to reduce spending in certain areas, while permitting continued investment in future growth initiatives, such as new products, expanded market presence and technology and innovation. We expect to achieve pretax savings in fiscal 2020 in excess of the special charge, with most of the benefit occurring in the second half of the fiscal year.…

Thank you, Karen. While current market conditions in the overall lighting industry continue to be challenging, we are optimistic regarding our long-term future in that of our markets. We believe our many actions to improve our market reach, enhance our customer solutions and capabilities and 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 profitable growth potential over the longer term. That notwithstanding, we believe current market demand for lighting will continue to be sluggish and inconsistent so long as concerns over key economic issues, including global trade policies and the potential for future tariffs remain unresolved. We are hopeful that the recent announcements regarding key global trade issues will remove these uncertainties that have negatively impacted the private nonresidential construction markets over the last several quarters. On a positive note, we are seeing some early indicators, such as the Dodge Momentum Index turning positive for the first time in a while, which could suggest an improvement in the -- in market conditions for lighting in the latter half of calendar 2020. In addition, we believe there are a few other factors that will continue to influence the lighting market, including continued product substitution to lower-priced alternatives for certain products sold through certain channels, labor shortages in certain markets and continued cost increases, particularly for imported electrical components and finished goods as well as higher freight and wages, though announced streamlining actions as well as a decline in certain input costs should help mitigate some of these factors. As we mentioned in our last earnings call, we are maniacally focused on executing our plans to grow market share, improve our margin profile and to reduce our cost structure to be more consistent…

[Operator Instructions]. Our first question comes from the line of John Walsh with Crédit Suisse.

So I guess looking back in the model, you didn't use to have that much variability around your gross profit margin line within a year, looking kind of quarter-to-quarter. Obviously, very good start beginning of the year. We do expect some volume kind of to come back towards the back end of the year. Should we be able to kind of hold this level around the gross profit margin and go back to that kind of historical pattern where one quarter to another quarter, there wasn't a lot of variability?

So our focus is to obviously continue to drive improvement in our gross profit margin. The benefit has been really from a sales channel perspective, that mix has shifted a little bit. We continue to have very aggressive programs to enhance our cost structure, both from a material perspective as well as a conversion perspective. So this level of gross profitability -- gross margin profile should be relatively consistent as we go forward. Obviously, additional volume rolling through there will also have an incremental benefit on our margin profile. So as we look to the second half, if you will, of our fiscal 2020, our expectation is that the markets should show some improvement. I'm personally excited about some of the rhetoric that we're now hearing about how we might resolve some of these tariff issues. We have our own North American trade discussions that are going on. Hopefully, they'll pass that. The Dodge Momentum Index has started to improve, that's the first time in a while. So many of those things, in my view, are positive indicators of potential. And the notion of having volume becoming a little bit more consistent, particularly for larger projects would have a favorable impact on Acuity's gross profit margin profile.

And then as we've been talking about these streamlining actions, you took some actions here in the quarter. How should we think about what the dollar value opportunity is at Acuity as you kind of take these streamlining actions going forward?

Sure. Karen, maybe you would like to address that?

Sure. As I addressed in my comments, we do expect to recover the cost of that streamlining actions and start to see benefit, particularly in the second half of the year. So you will see some improvement with some of that being reinvested back into the business. So do look for improvement, mostly focused in the second half as we recover those costs, but do continue to make investments in the business.

Well, I guess maybe just to clarify the question there. It sounds like there's more to do. I mean should we think of this as kind of a program that we should see quarter after quarter that you'll be able to find some streamlining and get associated payback with that going forward?

So we are -- this is Vern. We are always looking to continuously improve our cost structure, drive productivity and do things, but this particular charge was specifically identified around some key actions. And when you take the charge, you also have to allow for follow-on expense under GAAP accounting. So we identified these actions. We are taking those actions and our expectation is that, okay, let's complete those. In addition to that, we are always looking for ways to improve our cost structure through engineering efforts to reduce material cost, engineering efforts to change our -- how we produce these products, work within our facilities, both our factories as well as our back-office operations to improve our productivity. It's part of our ABS process to look for continuous improvement, but those typical continuous improvement items do not result in what we'll call a special charge.

Our next question comes from Josh Chan with Baird.

It was good following the company under your tenure, Vern, and best wishes in your future endeavors.

Thank you so much. It's really been exciting 15...

Yes, that's right. Yes, maybe we can start off on that. Vern, you were kind of obviously on the Board and asking you for the color on the succession planning. Could you talk a little bit more about kind of specifically what the Board saw in terms of Neil's skill set? And then also, could you also address the timing, at least from an external perspective, the transition looks kind of quick. Why not have Neil join the organization and then become CEO maybe at a designated time later? Can you just kind of go through some of those topics?

Sure. Sure, fabulous. I have been talking with the Board about just normal succession. We often have -- not often, regularly, it's part of our job as a Board to have succession planning discussions. So as we were thinking about both Ricky's plans and opportunities, the development of Karen and other leaders in our business, the timing was right to begin the process. There was no -- as I mentioned in my prepared remarks, there was -- it was not time-bound. We said, let's begin the process. And we were going to start looking really some time in 2020. But as fate would have it, we were introduced to Neil by one of our directors. And he said, Vern, you really need to meet this guy. He's fantastic. He understands business models. He understands the opportunities to transform industries, and with Atrius and the way you all have been transforming your company, bringing in new innovation, looking at new markets, our Atrius IoT capability. So Ricky and I met with Neil almost a year ago, and some of our teammates were involved with Neil in exploring ways to take advantage of what Acuity's platform is about. And so we became quite knowledgeable with Neil. And if you look at Neil's background, he is a serious player, and he has really taken businesses and transformed them. If you look at where Walmart is today. It was fantastic. The CEO of Walmart came out and said that their stores are their key points of differentiation. If you look at what Neil did is he enabled those capabilities through the development of e-commerce capability. So in every instance, as we've gotten to know Neil, what he has been able to do is transform businesses and make their core businesses even stronger and more…

That's great. And if I could ask one question on the quarter. I think you mentioned that the market was down in your estimate low to mid-single digits. And it looks like that your independent channel might be down a little bit more than that if you take out the acquisitions. So is there simply quarterly fluctuations or anything to think about there in terms of share?

Sure. So Josh, and for everyone on the call, our expectation, and it was really difficult to know precisely. If you go all the way back to last year's first quarter, we knew a pull forward was happening. It was difficult for us to really get our arms completely wrapped around that. So we guesstimated that it was probably mid- to upper single digits as the influence. My own personal bias based on some analytics is that it was probably in the high single digits that pull forward. So when we looked at our business and you look at the total amount, we also felt that what was happening, and we do have some good analytics around this is that the market this quarter, both the private nonresidential construction market was extremely soft, lighting even further, particularly for larger projects. And then we have noise around some of our stuff. That's why we tried to identify what was happening, if you will, for certain products in our product pruning focus to lessen the sale of products that really don't meet our financial profile. So you had a little bit of noise there. And then in our corporate accounts world, which is really servicing some of these larger retailers, we've always known that it's going to be a lumpy cycle. It depends on releases, it depends on their own activities. So I feel when we look at our core business, and I made that comment in my prepared remarks that what we saw in those things that were an apple to an apple, the marketplace or Acuity was not overly penalized or not overly advantaged by the market changes right now. So I don't -- the noise around the pull forward and then it being exacerbated by the softness in the market, I think created just a little bit more of a headwind than what we had originally anticipated. Again, just to be clear to everybody, we still think the markets are sluggish and will be until we get some clarity around these things. But I do take some comfort that the Dodge Momentum Index is finally starting to turn positive, which it hasn't for a while.

Our next question comes from Jeff Sprague with Vertical Research.

Just two from me. First, just thinking about the distortions that have been caused by the pull forward and the comps associated with that. Obviously, there's a big cyclical and economic overlay on top of this, but are the normal seasonal factors in play here for your business as we look forward to Q2? Or is there something else we should be thinking about as we kind of jump off this Q1 starting point?

Sure. Seasonal patterns, well, are alive and well. Our Q2 is traditionally the lowest sales number of any of our quarters, we still expect that to happen. And you all know why. It's just because of December, January, February and then construction markets, weather usually impacts those types of things. So we expect that to happen. We hope to get past all of this noise around pull forward here pretty soon. For sure, it will be in the second half that we won't have this noise. There could be still a little bit of noise around that for Q2. And then additionally, as I mentioned in my prepared remarks, we still are looking at our portfolio and still pruning a little bit, some of these product life cycles and how we position those need to be managed in an appropriate way. So there's probably still a little bit of headwind around that. Now having said that, we continue to focus on ways to drive and enhance share gain in the marketplace. We mentioned what we're doing around certain types of renovation in smaller and medium-sized capability. So yes, seasonal noise, a little bit of pruning and then expectation around how can we execute to drive some share gain.

And could you elaborate a little bit more on projects. I think we all kind of get it, the macro uncertainty just is not helpful, but are you seeing projects kind of taking outright cancellations? Is it a function of things that were in your front log that actually are not moving forward and any particular kind of additional vertical market color on the type of projects?

Sure. So on those larger projects, they're traditionally specification-driven. Our great agent partners are very, very focused on that portion of the marketplace, very skilled at that. And as I travel around the country and talk with both contractor customers as well as electrical distributor customers with our agent partners, their backlogs are robust. But these projects just are slow and have been slow to release. We hear different reasons why. In certain markets, we hear that there are labor shortages for contractors and so -- or for electricians. And so contractors are picking and choosing jobs, they're not necessarily growing larger projects. People are still wondering what's going to happen with costs. So if I wait, we'll have a lower cost potential. So we just keep hearing different anecdotal reasons why people are slowing down. They all seem to make some sense. But here's what we do now. Our agents have strong backlogs that just aren't releasing.

Our next question comes from Joseph Osha with JMP Securities.

Thank you, and again, Vern, let me add my voice to the congratulations on your long tenure.

Thank you.

Two questions for you. First, I'm wondering if we might get some comments on future plans as regards to use of cash. Obviously, this year, things skewed a little bit, but I'm curious about the balance going forward between acquisitions, buybacks and whatever else you might do with this very generous free cash flow you're generating?

So obviously, we pointed out that Neil will start January 31. He is working hypothesis around different views of strategy, both for Acuity as well as our core lighting and lighting solutions business, our BMS businesses. So we have a very, very healthy financial profile. And what I'd like to do is defer to Neil when he visits with you on the next earnings call to articulate more of that. One of the things that I believe has attracted Neil to Acuity is not only the culture of our people around driving value for our key stakeholders, but the platform that we have as well as the financial strength to really go after and attack markets by serving customers in a different way. And how he uses the balance sheet to drive this strategy, I really think that he should be the one to articulate that. I will say on behalf of the Board, Neil's initial thoughts, we are very excited about his vision and what it means for our current 12,000 associates, which I expect that number to grow. So I would just defer to him. We've had a -- he's very focused on capital allocation, very focused on return on invested capital, very focused on growth -- profitable growth. So if you'll allow us to defer to him on that to the next call.

And then, I'm going to change my second question then, because that's very interesting, obviously without tipping your hand because you don't know yet. Is it fair to say that as part of this transition, there is kind of a broader review of allocation of capital across different priorities taking place?

Yes. So again, I would say that the Board is quite excited about Neil's vision for the future. And his vision, I think is rooted quite well in his past. I think if you look at the things that he has done in his past, he has transformed different businesses and taking advantage of the opportunities in those markets. What he sees in Acuity in his glimpse into Acuity was pretty significant, when he was working with some of our Atrius folks as well as some of our lighting folks as a real platform. So I think he sees the current, if you will, platform that we have as well as our financial strength to get aftermarkets and customers that are consistent with what we do today, but thinking about how he can transform and change their businesses to become better and more effective using the capabilities that we have and potentially additional capabilities that we will add. Acuity has been a very aggressive acquirer over the last, I'll call it, 15 years, we've spent over $2 billion, done over 20 acquisitions. So you shouldn't be -- no one should be surprised about a continuation of how do we build our platform and core capabilities. And I think that Neil will continue to do that, but that is a continuation of what we've been doing. So I just am very excited about the platform that he has, the financial strength of the company that he has, coupled with his gifted mind and his really entrepreneurial spirit to do great things for our shareholders.

Our next question comes from Deepa Raghavan with Wells Fargo Securities.

Vern, my congratulations to you as well.

Thank you.

Two quick questions for me. Can you talk generally, not just for the quarter, but how the Contractor Select initiative has been performing within the retail channel, without the -- I mean without the Lowe's load-in? And also, I don't know if I missed it, what was the Tier 3 and 4 sales performance in the quarter?

So let me answer the second one first. Our sales in Tier 3 and Tier 4 combined were significantly better than the decline that we had in others because it was the others that were influenced by the pull forward. So we didn't really provide that data, but Tier 3 and Tier 4 actually -- I don't know that you should take one quarter and compare it, but our total share in that area or that percentage of our business is still favorable. It's probably north of -- well, it's definitely north of 15%. It's probably close to 17% or 18%. So we did fine there. That is also driven by larger projects to a degree. It's also driven by some of the things that we do in the corporate accounts channel. So give us another quarter where we get past all this noise to then bring that back to you, but I just want to say it was favorable. The pull forward impacted Tier 1 and Tier 2 more significantly. With respect to Contractor Select and what's happening, if you will, in the retail channel. Contractor Select is a portfolio of products that were designed to compete with, if you will, some of the lesser featured, more price-sensitive portion of the market, so limited SKU range, but it's an important element of not only how we serve the retail channel, but it's also an important element in how we serve, if you will, the C&I channel. So we are pleased with the growth rates in that business, even though some of what we're doing in the retail channel with potentially other products is managing that portfolio, if you will, down a little bit. So having said that, I think Contractor Select gives us the opportunity to further leverage and further penetrate both channels, both retail as well as the C&I sold primarily through the electrical distributor. Again, I think we're going to continue to see growth there. What I think you should all take away as a positive is that our gross profit profile continues to improve, even though that portion of the market or our business continues to grow as well.

Got it. My follow-up is on your portfolio pruning actions. Should we think about that as a low single-digit revenue headwind, not just for the upcoming fiscal Q2, but for the rest of the year as well?

Yes. My view -- and Karen, please chime in here. My view is that some of those pruning efforts should really start to abate as we get kind of through second and maybe a little bit into third quarter. We've done a good job there. And so I would expect that kind of headwind to start to abate.

Yes. I think it will be consistent in the second quarter against our [indiscernible].

Okay. Does it mean all the known headwinds from Lowe's load-in, pruning, et cetera, should all be done with by the time we get into second half. Is that a fair assessment?

It may leak into Q3 a little, but I think that we feel like it should start to tail off. We shouldn't be making big comments around this.

Our next question comes from the line of Christopher Glynn with Oppenheimer.

Vern, congratulations.

Thank you.

So I just want to go back to the gross margin, maybe try to understand that a little bit better given the magnitude. Also, in particular, it was up sequentially on $100 million lower sales. I mean some of the factors you talked about were more year-over-year driven. So wondering about that sequential resilience given the kind of reflexive thought of how much can change from 1 month to the next, maybe a bunch of higher cost work in progress rolled off. What's going on there?

Well, we have had puts and takes that have been pluses and minuses around these things. The tariffs are still a significant headwind to us. We think that our pricing strategies have countered some of that, countered most all of the tariff. The channel mix issue and including the pruning, if you will, of those lower-margin type products that are mostly impacted by tariffs has had a favorable impact on the mix. So what it's doing, Chris, is it's giving you a reflection into the profitability and the value-add that we bring into those other channels. So you're seeing that uptick. We'd love to have more volume. And so our strategies, our tactical plans are to become focused in certain portions of the market that maybe we haven't traditionally focused on. That represent opportunities for growth for Acuity. So the volume issue is kind of the wildcard, I think, for me, in Q2 I think from material inputs. We're working aggressively to continue to drive cost out of our products through our engineering efforts. We continue to really do well in our factories in terms of driving productivity. Our service is up quite nicely. So we see opportunities to try and grow our business in this challenging market by taking share.

Makes sense. And then similarly, kind of a sequential look at revenue. The seasonality has been more pronounced to the adverse side sequentially the last couple of quarters. Do you think the big mover there has been as tariff resolution gets closer that people holding on to projects and backlog gets more pronounced because they can see a yellow light at the end of the tunnel? Or alternatively, are you -- is there more impact from transitioning from larger enterprise retail Atrius rollouts taking place?

I think that the tariff -- this is just my opinion, so be careful here, I think that the tariffs and these trade discussions create a -- just a degree of uncertainty into the marketplaces. And so I think that people's enthusiasm and their money stay on the sidelines for these larger capital projects. The economy and employment is just fantastic. So you would think that with rising rents and rising in both industrial and commercial, more people working, all of those have traditionally been really positive signals for people coming off the sidelines and investing in real estate. These rising rents look where you live. I mean the cost of rents in that market are going up significantly. Typically, that would mean that people would add capacity into those things, they haven't done that yet. So our view is that, that money comes back. The governing factor around that maybe also some of these labor issues on the trade side. And it's not just electricians, all of the trades, it's a challenge. So even if that money comes back, we're going to have to figure out how to do certain things differently. And Acuity is doing that. We are aggressively looking to change how we service, how we sell, how we do certain things to that customer base, so we can make them more productive. And in turn, they buy more of our solutions.

And what about transitions from previous key supports to the revenue run rate from Atrius rollouts?

On the Atrius rollouts, we are very excited by now our expansion into these other verticals. I would have to tell the world that I think that some of the technology has taken us just a little bit longer to hone and really make it reliable. And I think that we are meaningfully ahead of anyone else in the space. And these customers who are now using these solution sets are starting to say, wow, this can -- this actually can enhance my business model. And so our applied technology team and our sales forces are starting to get into some of these other verticals with these solutions to experiment on how we can add not just quality of light energy savings, but a third element to the value proposition. And that's still going to take time. I think Neil will help accelerate that, by the way, he's a very gifted entrepreneurial. So it will not only make our customers better solution, but it will give our many sales forces more solutions to sell, changing hit rate, changing value proposition and not having to subject all these to just price as the only point of differentiation.

Thank you for participating in today's Q&A. I would now like to turn the call back over to Mr. Vernon Nagel for closing remarks.

Everyone, thank you so much, Dan and I were trying to compute, we think this is like the 72nd or 73rd time that you've heard my boring voice. It has been truly a pleasure. Neil and the team will have just a -- it's a great future. I'm so excited about our foundation. So again, thank you for your time this morning. Our future is bright. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.