ACUITY BRANDS, INC. The purpose of this discussion and analysis is to enhance the understanding and evaluation of the results of operations, financial position, cash flows, indebtedness, and other key financial information ofAcuity Brands, Inc. ("Acuity Brands") and its subsidiaries for the years endedAugust 31, 2020 , 2019, and 2018. The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included within this report. Overview Company Acuity Brands is the parent company ofAcuity Brands Lighting, Inc. ("ABL") and other wholly-owned subsidiaries (Acuity Brands, ABL, and such other subsidiaries are collectively referred to herein as "we," "our," "us," "the Company," or similar references). Our principal office is located inAtlanta, Georgia . We are a market-leading industrial technology company that designs, manufactures, and brings to market products and services for commercial, institutional, industrial, infrastructure, and residential applications throughoutNorth America and select international markets. Our products include building management systems, lighting, lighting controls, and location aware applications. As ofAugust 31, 2020 , we operated 18 manufacturing facilities, eight distribution facilities, and two warehouses to serve our extensive customer base. We do not consider acquisitions a critical element of our strategy but seek opportunities to expand and enhance our portfolio of solutions, including the following transactions: OnNovember 25, 2019 , using cash on hand, we acquired all of the equity interests ofLocusLabs, Inc ("LocusLabs"). The LocusLabs software platform supports navigation applications used on mobile devices, web browsers, and digital displays in airports, event centers, multi-floor office buildings, and campuses. OnSeptember 17, 2019 , using cash on hand and borrowings under available existing credit arrangements, we acquired all of the equity interests ofThe Luminaires Group ("TLG"), a leading provider of specification-grade luminaires for commercial, institutional, hospitality, and municipal markets, all of which complement our current and dynamic lighting portfolio. TLG's indoor and outdoor lighting fixtures are marketed to architects, landscape architects, interior designers, and engineers through five niche lighting brands: A-light, Cyclone, Eureka, Luminaire LED, andLuminis . OnJune 20, 2019 , using cash on hand we acquired all of the equity interests ofWhiteOptics, LLC ("WhiteOptics"). WhiteOptics manufactures advanced optical components used to reflect, diffuse, and control light for LED lighting used in commercial and institutional applications. OnMay 1, 2018 , using cash on hand and borrowings available under existing credit arrangements, we acquiredIOTA Engineering, LLC ("IOTA"). IOTA manufactures highly engineered emergency lighting products and power equipment for commercial and institutional applications both in theU.S. and internationally. OnFebruary 12, 2018 , using cash on hand, we acquiredLucid Design Group, Inc ("Lucid"). Lucid provides a data and analytics platform to make data-driven decisions to improve building efficiency and drive energy conservation and savings. Please refer to the Acquisitions footnote of the Notes to Consolidated Financial Statements for more information. Strategy Our strategy is to extend our leadership position in the North American market and certain international markets by delivering superior lighting and building technology solutions. Additionally, we continue to evolve Atrius as the intelligent building platform upon which a host of problem-solving applications can be deployed. Through the Acuity Business System, we strive to achieve customer-focused efficiencies that allow us to increase market share and deliver superior returns. We look to aggressively deploy capital to grow the business and to enter attractive new verticals. Throughout fiscal 2020, we believe we made progress towards achieving our strategic objectives, including expanding our access to the market, expanding our addressable market, introducing new lighting and building technology solutions, and enhancing our operations to create a stronger, more effective organization. Management will continue to implement programs to enhance our capabilities at providing unparalleled customer service; creating a globally competitive cost structure; improving productivity; and introducing innovative solutions and services more rapidly and cost effectively. In addition, we have invested considerable resources to teach and train associates to utilize tools and techniques that accelerate success in these key areas, as well as to create a culture that demands excellence through continuous 20
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improvement. Additionally, we promote a "pay-for-performance" culture that rewards associates for achieving various levels of year-over-year improvement, while closely monitoring appropriate risk-taking. The expected outcome of these activities will be to better position ourselves to deliver on our full potential, to provide a platform for future growth opportunities, and to achieve our long-term financial goals. See the Outlook section below for additional information. The COVID-19 Pandemic DuringMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak a pandemic. This pandemic has resulted in worldwide government restrictions on the movement of people, goods, and services resulting in increased volatility in and disruptions to global markets. However, our manufacturing operations are deemed essential and continue to operate. We remain committed to prioritizing the health and well-being of our associates and their families and ensuring that we operate effectively. We have implemented policies to screen associates, contractors, and vendors for COVID-19 symptoms upon entering our manufacturing and distribution and open office facilities inthe United States ,Mexico , and other locations as permitted by law. We have also implemented one-way traffic flows, additional cleaning requirements for common spaces, mandatory face coverings, hand sanitizer stations, socially distanced workspaces, and self-serve pay stations within our cafeterias to mitigate the spread of the virus. Additionally, we are requiring certain employees whose job functions can be performed remotely to work from home for the foreseeable future. Government-mandated and voluntary social distancing measures had an adverse impact on our results of operations. The pandemic has caused reduced construction and renovation spending during the year as well as a disruption in our supply chain for certain components, both of which negatively impacted our fiscal 2020 sales volumes. We also experienced a limited number of temporary facility shutdowns due to government-mandated closures as well as additional health and safety costs including expenditures for personal protection equipment and facility enhancements to maintain proper distancing guidelines issued by theCenters for Disease Control and Prevention . In response to our sales volume declines, we have taken actions to reduce costs, including the realignment of headcount with current volumes, a freeze on all non-essential employee travel, other efforts to decrease discretionary spending, and planned reductions in our real estate footprint. Although we have implemented significant measures to mitigate further spread of the virus, our employees, customers, suppliers, and contractors may continue to experience disruptions to business activities due to potential further government-mandated or voluntary shutdowns, general economic conditions, or other negative impacts of the COVID-19 pandemic. We are continuously monitoring the adverse effects of the pandemic and identifying steps to mitigate those effects. As the COVID-19 pandemic is continually evolving, we are uncertain of its ultimate duration and impact. See Part I, Item 1a. Risk Factors for further details regarding the potential impacts of COVID-19 to our results of operations, financial position, and cash flows. Liquidity and Capital Resources Our principal sources of liquidity are operating cash flows generated primarily from our business operations, cash on hand, and various sources of borrowings. Our ability to generate sufficient cash flow from operations or to access certain capital markets, including banks, is necessary to fund our operations and capital expenditures, pay dividends, repurchase shares, meet obligations as they become due, and maintain compliance with covenants contained in our financing agreements. In fiscal 2020, we paid$54.9 million for property, plant, and equipment, primarily for tooling, new and enhanced information technology capabilities, equipment, and facility enhancements. We currently expect to invest 1.5% of net sales on capital expenditures during fiscal 2021. InMarch 2018 , the Board of Directors (the "Board") authorized the repurchase of up to six million shares of our common stock. As ofAugust 31, 2020 , 2.1 million shares had been purchased under this authorization, of which 0.7 million were repurchased in fiscal 2020. We expect to repurchase the remaining shares available for repurchase on an opportunistic basis subject to various factors including stock price, Company performance, market conditions, and other possible uses of cash. OnOctober 23, 2020 , the Board authorized the repurchase of an additional 3.8 million shares of our common stock, bringing our total authorization back to six million shares. Refer to Part II, Item 9b. Other information for further details. Our short-term cash needs are expected to include funding operations as currently planned; making capital investments as currently anticipated; paying quarterly stockholder dividends as currently anticipated; paying principal and interest on debt as currently scheduled, including our borrowings under our unsecured delayed draw term loan facility (the "Term Loan Facility"); making required contributions to our employee benefit plans; funding possible acquisitions; and potentially repurchasing shares of our outstanding common stock. We believe that we will be able to meet our liquidity needs over the next 12 months based on our cash on hand, current projections of cash flow from operations, and 21
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borrowing availability under financing arrangements. Additionally, we believe that our cash flows from operations and sources of funding, including, but not limited to, future borrowings and borrowing capacity, will sufficiently support our long-term liquidity needs. However, as the impact of the COVID-19 pandemic on the economy and our operations evolves, we will continue to assess our liquidity needs. A continued worldwide disruption could materially affect our future access to our sources of liquidity, particularly our cash flows from operations, financial condition, capitalization, and capital investments. In the event of a sustained market deterioration, we may need additional liquidity, which would require us to evaluate available alternatives and take appropriate actions. Cash Flow We use available cash and cash flows from operations, borrowings on credit arrangements, and proceeds from the exercise of stock options to fund operations, capital expenditures, and acquisitions if any; to repurchase Company stock; and to pay dividends. Our cash position atAugust 31, 2020 was$560.7 million , an increase of$99.7 million fromAugust 31, 2019 . During the year endedAugust 31, 2020 , we generated net cash flows from operating activities of$504.8 million . Cash generated from operating activities, cash on-hand, and additional long-term debt borrowings were used during the current year primarily to repay long term debt obligations due of$350.7 million , to fund acquisitions of$303.0 million , to repurchase shares of our outstanding common stock for$69.3 million , to fund capital expenditures of$54.9 million , to pay dividends to stockholders of$20.8 million , and to pay withholding taxes on the net settlement of equity awards of$5.4 million . We generated$504.8 million of cash flows from operating activities during fiscal 2020 compared with$494.7 million in the prior-year period, an increase of$10.1 million , due primarily to lower net working capital requirements, partially offset by lower net income. Operating working capital (calculated by adding accounts receivable plus inventories and subtracting accounts payable-net of acquisitions and the impact of foreign exchange rate changes) decreased by approximately$92.9 million during fiscal 2020 compared to a decrease of$57.0 million during fiscal 2019. We believe that investing in assets and programs that will over time increase the overall return on our invested capital is a key factor in driving stockholder value. We invested$54.9 million and$53.0 million in fiscal 2020 and 2019, respectively, in property, plant, and equipment, primarily related to investments in tooling, new and enhanced information technology capabilities, equipment, and facility enhancements. 22
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Contractual Obligations The following table summarizes our contractual obligations atAugust 31, 2020 (in millions): Payments Due by Period Less than 4 to 5 After 5 Total One Year 1 to 3 Years Years Years Debt(1)$ 401.1 $ 24.3 $ 375.5 $ 0.6 $ 0.7 Interest obligations(2) 103.1 18.4 36.2 19.6
28.9
Operating leases(3) 78.8 18.5 27.2 18.7
14.4
Purchase obligations(4) 306.6 301.5 5.1 - - Other liabilities(5) 50.5 5.6 9.9 9.4 25.6 Total$ 940.1 $ 368.3 $ 453.9 $ 48.3 $ 69.6
___________________________
(1) These amounts, which represent the principal amounts of our debt
outstanding at
Sheets. See the Debt and Lines of Credit footnote for additional
information regarding debt and other matters.
(2) These amounts primarily represent our expected future interest payments on
outstanding debt held at
to our corporate-owned life insurance policies ("COLI"), which constitute
a small portion of the total contractual obligations shown. COLI-related
interest payments included in this table are estimates. These estimates
are based on various assumptions, including age at death, loan interest
rate, and tax bracket. The amounts in this table do not include
COLI-related payments after ten years due to the difficulty in calculating
a meaningful estimate that far in the future. Note that payments related
to debt and the COLI are reflected in our Consolidated Statements of Cash
Flows.
(3) Our operating lease obligations are described in the Leases footnote.
(4) Purchase obligations include commitments to purchase goods or services
that are enforceable and legally binding and that specify all significant
terms, including open purchase orders.
(5) These amounts are included in our Consolidated Balance Sheets and largely
represent liabilities for which we are obligated to make future payments
under certain long-term employee benefit programs. Estimates of the
amounts and timing of these amounts are based on various assumptions,
including interest rates and other variables. The amounts in this table do
not include amounts related to future funding obligations under the
defined benefit pension plans. The amount and timing of these future
funding obligations are subject to many variables and are also dependent
on whether or not we elect to make contributions to the pension plans in
excess of those required under Employee Retirement Income Security Act of
1974. Such voluntary contributions may reduce or defer the funding
obligations. See the Pension and Profit Sharing Plans footnote for
additional information. These amounts exclude $17.2 million of
unrecognized tax benefits as the period of cash settlement with the
respective taxing authorities cannot be reasonably estimated.
The above table does not include deferred income tax liabilities of
approximately $197.3 million as of August 31, 2020 . Refer to the Income Taxes
footnote for more information. This amount is not included in the total
contractual obligations table because we believe this presentation would not be
meaningful. Deferred income tax liabilities are calculated based on temporary
differences between the tax and book bases of assets and liabilities, which will
result in taxable amounts in future years when the liabilities are settled at
their reported financial statement amounts. The results of these calculations do
not have a direct connection with the amount of cash taxes to be paid in any
future periods. As a result, scheduling deferred income tax liabilities as
payments due by period could be misleading, because this scheduling would not
relate to liquidity needs.
Capitalization
Our current capital structure is comprised principally of borrowings under the
Term Loan Facility and equity of our stockholders. Total debt outstanding was
$401.1 million at August 31, 2020 and consisted primarily of variable-rate
obligations. At August 31, 2019 , total debt outstanding was $356.6 million and
consisted primarily of fixed-rate obligations.
On June 29, 2018 , we entered into a credit agreement ("Credit Agreement") with a
syndicate of banks that provides us with a $400.0 million five-year unsecured
revolving credit facility ("Revolving Credit Facility") and a $400.0 million
Term Loan Facility. We had no borrowings outstanding under the Revolving Credit
Facility as of August 31, 2020 or 2019. We had $395.0 million in borrowings
outstanding under the Term Loan Facility as of August 31, 2020 and no borrowings
outstanding under the Term Loan Facility as of August 31, 2019 . Based on the
repayment schedule, $375.0 million of the borrowings under the Term Loan
Facility are reflected within Long-term debt on the Consolidated Balance Sheets
as of August 31, 2020 .
In December 2019 , we borrowed the full $400.0 million available under our Term
Loan Facility. The proceeds were primarily used to repay the $350.0 million of
senior unsecured notes, which matured on December 15, 2019 , and the related
accrued interest in full. Borrowings under the Term Loan Facility amortize as
described in the Debt and Lines of Credit footnote of the Notes to Consolidated
Financial Statements. Any remaining borrowings under the Term Loan Facility are
due and payable in full on June 29, 2023 . Additionally, see the Debt and Lines
of Credit footnote for interest rates related to the Term Loan Facility.
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We were in compliance with all financial covenants under the Credit Agreement as ofAugust 31, 2020 . AtAugust 31, 2020 , we had additional borrowing capacity under the Credit Agreement of$396.2 million under the most restrictive covenant in effect at the time, which represents the full amount of the Revolving Credit Facility less the outstanding letters of credit of$3.8 million issued under the Revolving Credit Facility. As ofAugust 31, 2020 , we had outstanding letters of credit totaling$8.1 million , primarily for securing collateral requirements under our casualty insurance programs and for providing credit support for our industrial revenue bond, including$3.8 million issued under the Revolving Credit Facility. See the Debt and Lines of Credit footnote of the Notes to Consolidated Financial Statements for more information. From time to time, ABL may issue debt securities under a registration statement on Form S-3 filed with theSecurities and Exchange Commission that are fully and unconditionally guaranteed byAcuity Brands and ABL IP Holding LLC . The following tables present summarized financial information as of and during the fiscal year endedAugust 31, 2020 for Acuity Brands, ABL, andABL IP Holding LLC on a combined basis after the elimination of all intercompany balances and transactions between the combined group as well as any investments in a non-guarantor (in millions): Summarized Balance Sheet Information August 31, 2020 Current assets $ 1,152.6 Current assets due from non-guarantor affiliates 183.3 Non-current assets 1,416.0 Current liabilities 530.2 Non-current liabilities 723.8 Summarized Income Statement Information Year Ended August 31, 2020 Net sales $ 2,841.1 Gross profit 1,186.1 Equity earnings of non-guarantor subsidiaries 7.8 Net income 248.3 During fiscal 2020, our consolidated stockholders' equity increased$208.6 million to$2.13 billion atAugust 31, 2020 from$1.92 billion atAugust 31, 2019 . The increase was due primarily to net income earned in the period as well as favorable foreign currency translation and pension plan adjustments, partially offset by share repurchases and dividend payments. Our debt to total capitalization ratio (calculated by dividing total debt by the sum of total debt and total stockholders' equity) was 15.9% and 15.7% atAugust 31, 2020 and 2019, respectively. The ratio of debt, net of cash, to total capitalization, net of cash, was (8.1)% and (5.8)% atAugust 31, 2020 and 2019, respectively. Dividends We paid dividends on our common stock of$20.8 million ($0.52 per share) in fiscal 2020 and fiscal 2019, indicating a quarterly dividend rate of$0.13 per share. All decisions regarding the declaration and payment of dividends are at the discretion of the Board and are evaluated regularly in light of our financial condition, earnings, growth prospects, funding requirements, applicable law, and any other factors the Board deems relevant. 24
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Results of Operations The following is a discussion of our results of operations in fiscal 2020 compared to fiscal 2019. A discussion of our fiscal 2019 results of operations compared to fiscal 2018 can be found within Part II, Item 7. Management's Discussion and Analysis within our fiscal 2019 Annual Report on Form 10-K filed with theSecurities and Exchange Commission onOctober 29, 2019 . The following table table sets forth information comparing the components of net income for the year endedAugust 31, 2020 with the year endedAugust 31, 2019 (in millions except per share data): Year Ended August 31, Increase Percent 2020 2019 (Decrease) Change Net sales$ 3,326.3 $ 3,672.7 $ (346.4 ) (9.4 )% Cost of products sold 1,923.9 2,193.0 (269.1 ) (12.3 )% Gross profit 1,402.4 1,479.7 (77.3 ) (5.2 )% Percent of net sales 42.2 % 40.3 % 190 bps Selling, distribution, and administrative expenses 1,028.5 1,015.0 13.5 1.3 % Special charges 20.0 1.8 18.2 NM Operating profit 353.9 462.9 (109.0 ) (23.5 )% Percent of net sales 10.6 % 12.6 % (200 ) bps Other expense: Interest expense, net 23.3 33.3 (10.0 ) (30.0 )% Miscellaneous expense, net 5.9 4.7 1.2 NM Total other expense 29.2 38.0 (8.8 ) (23.2 )% Income before income taxes 324.7 424.9 (100.2 ) (23.6 )% Percent of net sales 9.8 % 11.6 % (180 ) bps Income tax expense 76.4 94.5 (18.1 ) (19.2 )% Effective tax rate 23.5 % 22.2 % Net income$ 248.3 $ 330.4 $ (82.1 ) (24.8 )% Diluted earnings per share$ 6.27 $ 8.29 $ (2.02 ) (24.4 )% NM - not meaningful Net sales decreased$346.4 million , or 9.4%, to$3.33 billion for the year endedAugust 31, 2020 compared with$3.67 billion reported for the year endedAugust 31, 2019 . For the year endedAugust 31, 2020 , we reported net income of$248.3 million compared with$330.4 million for the year endedAugust 31, 2019 , a decrease of$82.1 million , or 24.8%. For fiscal 2020, diluted earnings per share decreased 24.4% to$6.27 from$8.29 for the prior-year period. The following table reconciles certainU.S. generally accepted accounting principles ("U.S. GAAP") financial measures to the corresponding non-U.S. GAAP measures referred to in the discussion of our results of operations, which exclude the impact of acquisition-related items, certain manufacturing inefficiencies, amortization of acquired intangible assets, share-based payment expense, and special charges associated primarily with continued efforts to streamline the organization. Although the impacts of these items have been recognized in prior periods and could recur in future periods, management typically excludes these items during internal reviews of performance and uses these non-U.S. GAAP measures for baseline comparative operational analysis, decision making, and other activities. These non-U.S. GAAP financial measures, including adjusted gross profit and margin, adjusted selling, distribution, and administrative ("SD&A") expenses and adjusted SD&A expenses as a percent of net sales, adjusted operating profit and margin, adjusted net income, and adjusted diluted earnings per share, are provided to enhance the user's overall understanding of our current financial performance. Specifically, we believe these non-U.S. GAAP measures provide greater comparability and enhanced visibility into our results of operations. The non-U.S. GAAP financial measures should be considered in addition to, and not as a substitute for or superior to, results prepared in accordance withU.S. GAAP. 25
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(In millions, except per share data) Year EndedAugust 31 ,
Increase
2020 2019 (Decrease) Percent Change
Gross profit $ 1,402.4 $ 1,479.7 $ (77.3 ) (5.2 )%
Percent of net sales 42.2 % 40.3 % 190 bps
Add-back: Manufacturing
inefficiencies (1) - 0.9
Add-back: Acquisition-related
items (2) 1.2 1.2
Adjusted gross profit $ 1,403.6 $ 1,481.8 $ (78.2 ) (5.3 )%
Percent of net sales 42.2 % 40.3 % 190 bps
Selling, distribution, and
administrative expenses $ 1,028.5 $ 1,015.0 $ 13.5 1.3 %
Percent of net sales 30.9 % 27.6 % 330 bps
Less: Amortization of acquired
intangible assets (41.7 ) (30.8 )
Less: Share-based payment
expense (38.2 ) (29.2 )
Less: Acquisition-related items
(2) (1.3 ) (1.3 )
Adjusted selling, distribution,
and administrative expenses $ 947.3 $ 953.7 $ (6.4 ) (0.7)%
Percent of net sales 28.5 % 26.0 % 250 bps
Operating profit $ 353.9 $ 462.9 $ (109.0 ) (23.5 )%
Percent of net sales 10.6 % 12.6 % (200 ) bps
Add-back: Amortization of
acquired intangible assets 41.7 30.8
Add-back: Share-based payment
expense 38.2 29.2
Add-back: Manufacturing
inefficiencies (1) - 0.9
Add-back: Acquisition-related
items (2) 2.5 2.5
Add-back: Special charges 20.0 1.8
Adjusted operating profit $ 456.3 $ 528.1 $ (71.8 ) (13.6 )%
Percent of net sales 13.7 % 14.4 % (70 ) bps
Net income $ 248.3 $ 330.4 $ (82.1 ) (24.8 )%
Add-back: Amortization of
acquired intangible assets 41.7 30.8
Add-back: Share-based payment
expense 38.2 29.2
Add-back: Manufacturing
inefficiencies (1) - 0.9
Add-back: Acquisition-related
items (2) 2.5 2.5
Add-back: Special charges 20.0 1.8
Total pre-tax adjustments to net
income 102.4 65.2
Income tax effect (23.4 ) (14.2 )
Adjusted net income $ 327.3 $ 381.4 $ (54.1 ) (14.2 )%
Diluted earnings per share $ 6.27 $ 8.29 $ (2.02 ) (24.4 )%
Adjusted diluted earnings per
share $ 8.27 $ 9.57 ______________________________
(1) Incremental costs incurred due to manufacturing inefficiencies directly related to the closure of a facility. (2) Acquisition-related items include profit in inventory and professional fees.
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Net Sales Net sales for the year endedAugust 31, 2020 decreased by 9.4% compared with the prior-year period due primarily to an estimated 12% decline in sales volumes partially offset by a contribution from acquired businesses of 3%. Fiscal 2020 sales volumes decreased compared with the prior year due primarily to the negative impacts of the COVID-19 pandemic, lower activity of relight projects for certain large corporate accounts customers, and the elimination of certain products in our portfolio negatively impacted by the increases in tariffs sold primarily through the retail sales channel that did not meet our return objectives. The change in product prices and mix of products sold ("price/mix") was approximately flat year over year. Due to the changing dynamics of our product portfolio, it is not possible to precisely quantify or differentiate the individual components of volume, price, and mix. Gross Profit Gross profit for fiscal 2020 decreased$77.3 million , or 5.2%, to$1.40 billion compared with$1.48 billion for the prior year due primarily to lower net sales volumes. Despite our lower sales, gross profit margin increased to 42.2% for the year endedAugust 31, 2020 compared with 40.3% for the year endedAugust 31, 2019 . The improvement in gross profit margin was due primarily to lower costs for certain inputs and the contribution from acquisitions, partially offset by lower net sales volumes. Adjusted gross profit for fiscal 2020 decreased$78.2 million , or 5.3%, to$1.40 billion compared with$1.48 billion for the prior year. Adjusted gross profit margin increased 190 basis points to 42.2% compared to 40.3% in the prior year. Operating Profit SD&A expenses of$1.03 billion for the year endedAugust 31, 2020 increased$13.5 million , or 1.3% compared with the prior year. The increase in SD&A expenses was due primarily to higher employee costs, additional amortization of acquired intangibles, and higher commissions associated with channel mix and acquisitions. In particular, share-based payment expense increased due to changes made to the equity incentive program as part of the Company's review of its compensation programs, which resulted in the acceleration of share-based payment expense in fiscal 2020. These increases were partially offset by lower freight charges due to the lower sales volumes as well as decreased travel and other expenses in response to the COVID-19 pandemic. Compared with the prior-year period, SD&A expenses as a percent of net sales increased 330 basis points to 30.9% for fiscal 2020 from 27.6% in fiscal 2019. Adjusted SD&A expenses were$947.3 million , or 28.5% of net sales, in fiscal 2020 compared to$953.7 million , or 26.0% of net sales, in the year-ago period. During the year endedAugust 31, 2020 , we recognized pre-tax special charges of$20.0 million compared with pre-tax special charges of$1.8 million recorded during the year endedAugust 31, 2019 . Further details regarding our special charges are included in the Special Charges footnote of the Notes to Consolidated Financial Statements. Operating profit for fiscal 2020 was$353.9 million compared with$462.9 million reported for the prior-year period, a decrease of$109.0 million , or 23.5%. Operating profit margin decreased 200 basis points to 10.6% for fiscal 2020 compared with 12.6% for fiscal 2019. The decline in operating profit was due to a decrease in gross profit, an increase in SD&A expenses, and higher special charges. Adjusted operating profit decreased$71.8 million , or 13.6%, to$456.3 million compared with$528.1 million for fiscal 2019. Adjusted operating profit margin was 13.7% and 14.4% for fiscal 2020 and 2019, respectively. Other Expense Other expense consists principally of net interest expense and net miscellaneous expense, which includes non-service related components of net periodic pension cost, gains and losses associated with foreign currency-related transactions, and non-operating gains and losses. Interest expense, net, was$23.3 million and$33.3 million for the years endedAugust 31, 2020 and 2019, respectively. The decrease in interest expense was due primarily to the interest savings associated with refinancing the previously outstanding senior unsecured notes with funds under the Term Loan Facility, which are subject to lower short-term borrowing rates. We reported net miscellaneous expense of$5.9 million in fiscal 2020 compared with$4.7 million in fiscal 2019. Income Taxes and Net Income Our effective income tax rate was 23.5% and 22.2% for the years endedAugust 31, 2020 and 2019, respectively. The increase in the current fiscal tax rate was due primarily to the recognition in fiscal 2019 of certain research and development cost tax credits, including claims for prior periods, that did not recur in the current fiscal year. Further details regarding income taxes are included in the Income Taxes footnote of the Notes to Consolidated Financial 27
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Statements. We estimate that our effective tax rate for fiscal 2021 will be approximately 23% before any discrete items, assuming the rates in our taxing jurisdictions remain generally consistent throughout the year. Net income for fiscal 2020 decreased$82.1 million , or 24.8%, to$248.3 million from$330.4 million reported for the prior year. The decrease in net income resulted primarily from a decreased operating profit compared to the prior-year period partially offset by lower interest expense and income tax expense. Adjusted net income for fiscal 2020 decreased 14.2% to$327.3 million compared with$381.4 million in the year-ago period. Diluted earnings per share for fiscal 2020 was$6.27 compared with$8.29 for the prior-year period, which represented a decrease of$2.02 , or 24.4%. Adjusted diluted earnings per share for fiscal 2020 was$8.27 compared with$9.57 for the prior-year period, which represented a decrease of$1.30 , or 13.6%.
Outlook
We believe the execution of our strategy will provide attractive opportunities for profitable growth over the long term. Although we are aggressively managing our response to the recent COVID-19 pandemic, its impact on our results beyond fiscal 2020 is uncertain. We expect weakness in non-residential building activity based on current construction indicators. We believe that the most significant elements of uncertainty due to the COVID-19 pandemic are the intensity and duration of the impact on construction, renovation, pricing, and consumer spending as well as the ability of our sales channels, supply chain, manufacturing, and distribution to continue to operate with minimal disruption beyond fiscal 2020, all of which could negatively impact our financial position, results of operations, cash flows, and outlook. These risks are balanced by our efforts to increase service levels, develop innovative new products, and introduce technology to improve the operations of our business. Accounting Standards Adopted in Fiscal 2020 and Accounting Standards Yet to Be Adopted See the New Accounting Pronouncements footnote of the Notes to Consolidated Financial Statements for information on recently adopted and upcoming standards. Critical Accounting Estimates Management's Discussion and Analysis of Financial Condition and Results of Operations addresses the financial condition and results of operations as reflected in our Consolidated Financial Statements, which have been prepared in accordance withU.S. GAAP. As discussed in the Description of Business and Basis of Presentation footnote of the Notes to Consolidated Financial Statements, the preparation of financial statements in conformity withU.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expense during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition; inventory valuation; depreciation, amortization, and the recoverability of long-lived assets, including goodwill and intangible assets; share-based payment expense; medical, product warranty and recall, and other accruals; retirement benefits; and litigation. We base our estimates and judgments on our substantial historical experience and other relevant factors, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. We discuss the development of accounting estimates with our Audit Committee of the Board of Directors. See the Significant Accounting Policies footnote of the Notes to Consolidated Financial Statements for a summary of the accounting policies. We believe the following accounting topics represent our critical accounting estimates. Revenue Recognition We recognize revenue when we transfer control of goods and services to our customers. Revenue is measured as the amount of consideration we expect to receive in exchange for goods and services. In the period of revenue recognition, provisions for certain rebates, sales incentives, product returns, and discounts to customers are estimated and recorded, in most instances, as a reduction of revenue. We also maintain one-time or on-going marketing and trade-promotion programs with certain customers that require us to estimate and accrue the expected costs of such programs. Generally, these items are estimated based on customer agreements, historical trends, and expected demand. For sales with multiple deliverables, significant judgment may be required to determine which performance obligations are distinct and should be accounted for separately. We allocate the expected consideration to be collected to each distinct performance obligation based on its standalone selling price. Standalone selling price is generally estimated using a cost plus margin valuation when no observable input is available. 28
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Actual results could differ from estimates, which would require adjustments to accrued amounts. Please refer to the Revenue Recognition footnote of the Notes to Consolidated Financial Statements for additional information regarding estimates related to revenue recognition. Inventories Inventories include materials, direct labor, in-bound freight, and related manufacturing overhead and are stated at the lower of cost (on a first-in, first-out or average-cost basis) and net realizable value. We review inventory quantities on hand and record a provision for excess or obsolete inventory primarily based on estimated future demand and current market conditions. A significant change in customer demand, market conditions, or technology could render certain inventory obsolete and thus could have a material adverse impact on our operating results in the period the change occurs.Goodwill and Indefinite-Lived Intangible Assets Through multiple acquisitions, we acquired definite-lived intangible assets consisting primarily of trademarks and trade names associated with specific products, distribution networks, patented technology, non-compete agreements, and customer relationships, which are amortized over their estimated useful lives. Indefinite-lived intangible assets consist of trade names that are expected to generate cash flows indefinitely. Significant estimates and assumptions were used to both identify and determine the initial fair value of these acquired intangible assets, often with the assistance of third party valuation specialists. These assumptions include, but are not limited to, estimated future net sales and profitability, customer attrition rates, royalty rates, and discount rates.Goodwill is calculated as the residual value of an acquisition's purchase price less the value of the identifiable net assets and is thus dependent on the appropriate identification and valuation of the net assets obtained in an acquisition. We also review goodwill and indefinite-lived intangible assets for impairment on an annual basis in the fiscal fourth quarter or on an interim basis if an event occurs or circumstances change that would more likely than not indicate that the fair value of the goodwill or indefinite-lived asset is below its carrying value. An impairment loss for goodwill or an indefinite-lived intangible asset would be recognized based on the difference between the carrying value of the asset and its estimated fair value, which would be determined based on either discounted future cash flows or another appropriate fair value method. The evaluation of goodwill and indefinite-lived intangibles for impairment requires management to use significant judgments and estimates in accordance withU.S. GAAP including, but not limited to, economic, industry, and company-specific qualitative factors, projected future net sales, operating results, and cash flows. Although we currently believe that the estimates used in the evaluation of goodwill and indefinite-lived intangibles are reasonable, differences between actual and expected net sales, operating results, and cash flows and/or changes in the discount rates or theoretical royalty rates used could cause these assets to be deemed impaired. If this occurs, we are required to record a non-cash charge to earnings for the write-down in the value of such assets. Such charges could have a material adverse effect on our results of operations and financial position but not our cash flows from operations.Goodwill Our business is comprised of one reporting unit with a goodwill balance of$1.1 billion as ofAugust 31, 2020 . During fiscal 2020, we utilized a quantitative assessment of the fair value of goodwill as ofJune 1, 2020 . In determining the fair value of the Company's reporting unit, we used a discounted cash flow analysis, which requires significant assumptions about discount rates as well as short and long-term growth rates. We utilized an estimated discount rate of approximately 10.4% as ofJune 1, 2020 , based on the Capital Asset Pricing Model, which considers the risk-free interest rate, beta, and market risk premium to determine an appropriate discount rate. Short-term growth rates were based on management's forecasted financial results, which consider key business drivers such as specific revenue growth initiatives, market share changes, growth in our addressable market, and general economic factors such as macroeconomic conditions, credit availability, and interest rates. Short-term growth rates used in the fiscal 2020 impairment analysis reflected additional estimation uncertainty as a result of the COVID-19 pandemic. We calculated the discounted cash flows attributable to our one reporting unit for a 10-year discrete period with a terminal value and compared this calculation to the discounted cash flows generated over a 40-year period to ensure reasonableness. The long-term growth rate used in determining terminal value was estimated at 3.0% and was primarily based on our understanding of projections for expected long-term growth in our addressable market and historical long-term performance. The quantitative goodwill analysis did not result in an impairment charge. Any reasonably likely change in the assumptions used in the analysis, including revenue growth rates and the discount rate, would not cause the carrying value to exceed the estimated fair value for the reporting unit as determined under the goodwill impairment analysis. 29
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Indefinite-Lived Intangible Assets Our indefinite-lived intangible assets consist of 13 trade names with an aggregate carrying value of approximately$174.3 million . We utilized significant assumptions to estimate the fair value of these indefinite-lived trade names using a fair value model based on discounted future cash flows ("fair value model") in accordance with Accounting Standards Codification ("ASC") Topic 820, Fair Value Measurements and Disclosures, ("ASC 820"). Future cash flows associated with each of our indefinite-lived trade names are calculated by multiplying a theoretical royalty rate a willing third party would pay for use of the particular trade name by estimated future net sales attributable to the relevant trade name. The present value of the resulting after-tax cash flow is our current estimate of the fair value of the trade names. This fair value model requires us to make several significant assumptions, including estimated future net sales (including short and long-term growth rates), the royalty rate, and the discount rate for each trade name. Future net sales and short-term growth rates are estimated for each particular trade name based on management's financial forecasts, which consider key business drivers, such as specific revenue growth initiatives, market share changes, expected growth in our addressable market, and general economic factors, such as macroeconomic conditions, credit availability, and interest rates. Short-term growth rates used in the fiscal 2020 impairment analysis reflected additional estimation uncertainty as a result of the COVID-19 pandemic. The long-term growth rate used in determining terminal value is estimated at 3% and is based primarily on our understanding of projections for expected long-term growth within our addressable market and historical long-term performance. The theoretical royalty rate is estimated primarily using management's assumptions regarding the amount a willing third party would pay to use the particular trade name and is compared with market information for similar intellectual property within and outside of the industry. If future operating results are unfavorable compared with forecasted amounts, we may be required to reduce the theoretical royalty rate used in the fair value model. A reduction in the theoretical royalty rate would result in lower expected future after-tax cash flows in the valuation model. We utilized a range of estimated discount rates between 10% and 13% as ofJune 1, 2020 , based on the Capital Asset Pricing Model, which considers the current risk-free interest rate, beta, market risk premium, and entity specific size premium. During fiscal 2020, we performed an evaluation of the fair values of our indefinite-lived trade names. Our expected revenues were based on our fiscal 2021 projections and recent third-party lighting, controls, and building technology solutions market growth estimates for fiscal 2022 through 2025. We also included revenue growth estimates based on current initiatives expected to help improve performance. During fiscal 2020, estimated theoretical royalty rates ranged between 1% and 4%. Based on the results of the indefinite-lived intangible asset analyses, we calculated an impairment charge of$1.4 million related to one trade name, which is reflected within Selling, distribution, and administrative expenses on the Consolidated Statements of Comprehensive Income. The impairment analyses of the other 12 indefinite-lived intangible assets indicated that their fair values exceeded their carrying values. Any reasonably likely change in the assumptions used in the analyses for our trade names, including revenue growth rates, royalty rates, and discount rates, would not be material to our financial condition or results of operations. Definite-Lived Intangible Assets All long-lived assets, including definite-lived intangibles, are reviewed for impairment whenever events or circumstances indicate that the carrying amount of the related asset group may not be recoverable. We evaluate the remaining useful lives of our definite-lived intangible assets on an annual basis in the fiscal fourth quarter and on an interim basis if an event occurs or circumstances change that would warrant a revision to the remaining period of amortization. For each reporting period we consider whether an event occurred or circumstances changed that would more likely than not indicate that the fair value of the definite-lived asset is below its carrying value. We recorded no impairment charges for our definite-lived intangible assets during fiscal 2020, 2019, or 2018.Self-Insurance We self-insure, up to certain limits, traditional risks including workers' compensation, comprehensive general liability, and auto liability. A provision for claims under this self-insured program, based on our estimate of the aggregate liability for claims incurred, is revised and recorded annually. The estimate is derived from both internal and external sources including, but not limited to, our independent actuary. The actuarial estimates are subject to uncertainty from various sources including, changes in claim reporting patterns, claim settlement patterns, actual claims judicial decisions, legislation, and economic conditions, among others. Although we believe that the actuarial estimates are reasonable, significant differences related to the items noted above could materially affect our self-insurance obligations, future expense, and cash flow. We are also self-insured up to certain limits for certain other insurable risks, primarily physical loss to property and business interruptions resulting from such loss lasting two days or more in duration. Insurance coverage is maintained for catastrophic property and casualty exposures as well as those risks required to be insured by law or contract. We are fully self-insured for certain other types of liabilities, including environmental, product recall, warranty, and patent infringement. 30
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We are also self-insured for the majority of our medical benefit plans up to
certain limits. We estimate our aggregate liability for claims incurred by
applying a lag factor to our historical claims and administrative cost
experience. The appropriateness of our lag factor is evaluated and revised, if
necessary, annually. Although we believe that the current estimates are
reasonable, significant differences related to actual claims, claim reporting
patterns, plan design, legislation, and general economic conditions could
materially affect our medical benefit plan liabilities, future expense, and cash
flow.
Retirement Benefits
We sponsor domestic and international defined benefit pension plans, defined
contribution plans, and other postretirement plans. Assumptions are used to
determine the estimated fair value of plan assets, the actuarial value of plan
liabilities, and the current and projected costs for these employee benefit
plans and include, among other factors, estimated discount rates, expected
returns on the pension fund assets, estimated mortality rates, the rates of
increase in employee compensation levels, and, for one international plan,
retroactive inflationary adjustments. These assumptions are determined based on
organizational and market data and are evaluated annually as of the plans'
measurement date. See the Pensions and Defined Contribution Plans footnote of
the Notes to Consolidated Financial Statements for further information on our
plans, including the potential impact of changes to certain of these
assumptions.
Share-based Payment Expense
We recognize compensation cost relating to share-based payment transactions in
the financial statements based on the estimated grant date fair value of the
equity instrument issued. We account for stock options, restricted shares,
performance shares, and share units representing certain deferrals into the
Director Deferred Compensation Plan or the Supplemental Deferred Savings Plan
based on the grant-date fair value estimated under the provisions of ASC Topic
718, Compensation - Stock Compensation ("ASC 718"). See the Share-based Payments
footnote of the Notes to Consolidated Financial Statements for further
information on these awards.
We utilize the Black-Scholes model in deriving the fair value estimates of our
stock option awards that only have a service requirement, and we utilize the
Monte Carlo simulation model to determine grant date fair value estimates of
stock options also subject to a market condition. We recognize compensation
expense for performance awards based on the probability that the related
performance metric will be satisfied. Additionally, we estimate forfeitures of
all share-based awards at the time of grant, which are revised in subsequent
periods if actual forfeitures differ from initial estimates. Forfeitures are
estimated based on historical experience. If factors change causing different
assumptions to be made in future periods, estimated compensation expense may
differ significantly from that recorded in the current period. See the
Significant Accounting Policies and Share-based Payments footnotes of the Notes
to Consolidated Financial Statements for more information regarding the
assumptions used in estimating the fair value of our awards.
Product Warranty and Recall Costs
Our products generally have a standard warranty term of five years. We accrue
for the estimated amount of future warranty costs when the related revenue is
recognized. Estimated future warranty costs are primarily based on historical
experience of identified warranty claims. We are fully self-insured for product
warranty costs. Historical warranty costs have been within expectations.
Although we expect that historical activity will continue to be the best
indicator of future warranty costs, there can be no assurance that future
warranty costs will not exceed historical amounts. Estimated costs related to
product recalls based on a formal campaign soliciting repair or return of that
product are accrued when they are deemed to be probable and can be reasonably
estimated. If actual future warranty or recall costs exceed recorded amounts,
additional accruals may be required, which could have a material adverse impact
on our results of operations and cash flow.
We also sell certain service-type warranties that extend coverages for products
beyond their base warranties. We account for service-type warranties as distinct
performance obligations and recognize revenue for these contracts ratably over
the life of the additional warranty period. Claims related to service-type
warranties are expensed as incurred.
Litigation
We recognize expense for legal claims when payments associated with the claims
become probable and can be reasonably estimated. Due to the difficulty in
estimating costs of resolving legal claims, actual costs could have a material
adverse impact on our results of operations and cash flow.
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Cautionary Statement Regarding Forward-Looking Statements and Information This filing contains forward-looking statements within the meaning of the federal securities laws. Statements made herein that may be considered forward-looking include statements incorporating terms such as "expects," "believes," "intends," "anticipates," and similar terms that relate to future events, performance, or results of the Company. In addition, the Company, or the executive officers on the Company's behalf, may from time to time make forward-looking statements in reports and other documents we file with theU.S. Securities and Exchange Commission or in connection with oral statements made to the press, current and potential investors, or others. Forward-looking statements include, without limitation: (a) our projections regarding financial performance, liquidity, capital structure, capital expenditures, investments, share repurchases, and dividends; (b) external forecasts projecting the North American lighting and building management solutions market growth rate and growth in our addressable market; (c) expectations about the impact of any changes in demand as well as volatility and uncertainty in general economic conditions; (d) our ability to execute and realize benefits from initiatives related to streamlining our operations, capitalize on growth opportunities, and introduce new lighting and building management solutions; (e) our estimate of our fiscal 2021 effective income tax rate, results of operations, cash flows, and capital spending; (f) our estimate of future amortization expense; (g) our ability to achieve our long-term financial goals and measures and outperform the markets we serve; (h) the impact of changes in the political landscape and related policy changes, including monetary, regulatory, and trade policies; (i) our expectations related to mitigating efforts around recently imposed tariffs; (j) our expectations about the resolution of patent litigation, securities class action,IRS audits, and/or other legal matters; and (k) our expectations of the short-term and long-term impact of the current COVID-19 pandemic. You are cautioned not to place undue reliance on any forward looking statements, which speak only as of the date of this annual report. Except as required by law, we undertake no obligation to publicly update or release any revisions to these forward-looking statements to reflect any events or circumstances after the date of this annual report or to reflect the occurrence of unanticipated events. Our forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from the historical experience of the organization and management's present expectations or projections. These risks and uncertainties include, but are not limited to, customer and supplier relationships and prices; competition; ability to realize anticipated benefits from initiatives taken and timing of benefits; market demand; litigation and other contingent liabilities; and economic, political, governmental, and technological factors that have affected us as a company. Also, additional risks that could cause our actual results to differ materially from those expressed in our forward-looking statements are discussed in Part I, Item 1a. Risk Factors of this Annual Report on Form 10-K, and are specifically incorporated herein by reference. The industry and market data contained in this report are based either on management's own estimates or, where indicated, independent industry publications, reports by governmental agencies, or market research firms or other published independent sources and, in each case, are believed by our management to be reasonable estimates. However, industry and market data is subject to change and cannot always be verified with complete certainty due to limits on the availability and reliability of raw data, the voluntary nature of the data gathering process, and other limitations and uncertainties inherent in any statistical survey of market shares. We have not independently verified market and industry data from third-party sources.
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