Acuity Sacrifices Sales for Margin Improvement

A surprising sales outlook raised investors' ire when the lighting specialist reported third-quarter earnings on July 2.

Asit Sharma
Asit Sharma
Jul 2, 2019 at 4:51PM
Industrials

Commercial lighting, controls, and building management solutions provider Acuity Brands (NYSE:AYI) coupled flat top-line results in its fiscal Q3 2019 with a forecast for lower year-over-year sales next quarter. Below, I'll review the last three months of operations as detailed in Acuity's latest earnings report and discuss why management turned the dimmer switch on next quarter's prospects. Note that all comparative numbers in the discussion that follows are presented against the prior-year quarter.

Acuity Brands results: The raw numbers

Metric Q3 2019 Q3 2018 Change
Revenue $947.6 million $944.0 million 0.4%
Net income $88.4 million $73.0 million 21.1%
Diluted earnings per share $2.22 $1.80 23.3%

Data source: Acuity Brands. 

What happened with Acuity Brands this quarter?

  • Acuity's 0.4% sales increase was due to volume growth of roughly 1%, which was offset by foreign currency translation and the company's adoption of new accounting standard ASC 606. A recent price increase was negated by the mix of products sold during the quarter.
  • Gross margin fell 70 basis points to 40.5%. Management blamed a timing shift in key customer sales in the company's retail channel, in addition to the underabsorption of manufacturing costs as Acuity reduced inventory as part of an efficiency exercise.
  • Despite the lower gross profitability in comparison to the prior-year period, management pointed out that Q3's adjusted gross profit margin (also 40.5%) marked the third sequential quarter of improvement and the first quarter in a year that this number has cleared 40%.
  • Similar to Q2, selling, distribution, and administrative (SD&A) expenses declined compared to the prior year. Acuity incurred lower outbound freight costs due to the sales mix changes in the retail channel, and booked lower professional fees related to mergers and acquisitions. SD&A decreased roughly 3% to $263.4 million. 
  • After adjusting for a one-time $10 million special charge in the prior-year quarter, operating margin improved by roughly 30 basis points to 12.7%.
  • The company acquired Delaware-based advanced optical components manufacturer WhiteOptics in June for an undisclosed amount. Acuity will utilize WhiteOptics to enhance its commercial and institutional LED lighting solutions.
Contemporary exterior lighting on a commercial building at dusk.

Image source: Getty Images.


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An acutely disappointing fourth-quarter outlook

Despite ongoing margin pressure from import tariffs, Acuity's management believes that the demand outlook for the remainder of calendar year 2019 remains relatively benign. Still, in the company's earnings press release, CEO Vernon Nagel warned of sales weakness (though accompanied by improved profitability) in the upcoming quarter:

We believe our fiscal fourth quarter net sales could be down modestly compared with prior year's net sales, which benefited from the significant initial stocking of product in the stores of a new customer in the retail sales channel. Also, fourth quarter net sales may be negatively impacted by our efforts to enhance our margin profile as we expect to continue our program of reviewing portions of our product portfolio and services offerings with the objective of eliminating those items and activities that do not meet our return objectives. Lastly, we believe our fourth quarter adjusted operating profit margin will exceed prior-year's fourth quarter margin as well as improve on a sequential basis from the third quarter.

Acuity's guidance for a sales decline sent shares spiraling south by as much as 17% in the trading session following the earnings release, though they recovered to a relatively favorable 7% drop by midday.

The forecast unnerved investors, as Acuity has already shown some revenue vulnerability from an evolving customer and product mix in its retail channel. In addition, some customers had moved orders into the first half of the fiscal year in advance of a recently instituted price increase, and this represents another potential drag on fourth-quarter sales.

Conversely, as Nagel asserts, the company is intentionally foregoing some sales of anemic margin in order to generate higher-profit, value-added business. As I recently discussed, Acuity is investing in Internet of Things (IoT) "smart building" platforms, as well as advanced lighting and control systems, to build a healthier gross margin over time. Thus, current sales sluggishness may lead to higher earnings capacity in the long run. While skeptical today, shareholders will await illumination on this business model improvement effort in the coming quarters.