LSI Industries Inc. (LYTS) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Q2 2018 LSI Industries Ink's, Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. I would now like to introduce your host for today's conference Mr. Dennis Wells, CEO and President. Sir, you may begin.

Welcome and good morning. This is Dennis Wells and I would like to start by saying that I'm pleased with our Q2 results that we're going to discuss this morning. I think they build nicely upon our solid Q1 results that we announced earlier. In summary we turned in what I would call a respectable, quite respectable comp and bottom line results given the continued softness in our markets. I can assure you that our sales folks, our agents, our distributors, are out there slugging a way on a daily basis to capture business. In our perspective it is certainly been difficult to grow the top line over the last 12 to 18 months. Our cost improvement efforts, however, are definitely showing up in our quarterly results, especially the second quarter. Let me step back for a minute. As we started our fiscal year on July 1, we set two primary goals for ourselves. One, grow our top line faster in the market. Two, to gain our momentum towards achieving 30% gross margin. Let me report out briefly on each of these initiatives. In regards to top line growth in our lighting segment, I'm very pleased to report that our LED sales in Q2 increased 25% versus prior year. That represents a 92% of our lighting product sales. This is a new high for us, a new best for us to achieve a 90 plus percent LED. I want to comment, our product management team led by Steven Lowe in guiding us towards this objective. We're moving every closer each quarter to achieve our ultimate goal on being a 100% LED lighting company. Our Atlas team, which participates in the stock and flow part of the business, again delivered solid performance in the quarter. The Atlas team down in Burlington, North Carolina, led by John Bagwell, continues to achieve key sales and acquisition synergy targets, including an expansion of the distribution base and select product cross branding. Next month, we will celebrate the one year anniversary of Atlas joining forces with LSI. We're very pleased with this acquisition. Our PowerPlay team led by Randy Kimmel, produced a 94% growth rate in the first half of this year. They continued to improve our position, our ability to compete in the lighting and innovation market. We are investing here in people, in products and in programs in order to participate in a stronger way in this market segment. I'm pleased with our continued investment in new technology as it relates to lighting controls and smart lighting solutions. Our Airlink and SmartVision platforms, although in early stage of adoption are showing good progress. We launched quite a few new products, LED lighting products in the quarter, which we expect to generate a positive sales impact going forward. The first one the Scottsdale Vertex is a complete redesign of our under-canopy fixture. This is launched and intended to solidify our market leading position in the petroleum and C-store vertical market. Our new high bay product that we call Alliance was launched in the quarter, designed to service the growing warehouse segment. Lastly our Mirada family, we have launched new versions of this family, it's an outdoor area lighting offering. You might remember this is the first family where we use new silicone optical system. I do want to recognize the strong efforts here by design engineering team lead by Chris Papa. Chris and Steven Lowe, both assure me that we have many more new products coming in the future yet this year, so stay tuned for us to announce more product launches. Turning to our Graphics segment, this team lead by Jeff Croskey, delivered a solid quarter, with sales increasing 12% versus prior year and generating significantly improved operating earnings. Nice job by our graphics team. The improvement was led here by the SOAR digital signage business, which again generated sales growth in excess of 100% versus prior year. A nice job to Dave Megler and his team, they've done an excellent job launching and growing this strategic platform over the last 18 months. Not to forget our traditional graphics team as well, they had a great quarter adding a number of new customers. We did invest heavily last year in some new state of the art printing equipment, that is starting to pay off, helping us to improve our lead times and abilities to service customers in the signage and graphics industry. Our second initiative as we started the year was to regain our momentum, moving towards 30% gross margin. So let me talk a minute about each of the cost of goods sold components, starting with material. We continue to be very aggressive in all areas of material management. Our productivity efforts along with certain select pricing action had so far this year offset the impact of material inflation. However, we continue to keep a watchful eye on commodity prices. As you might remember, material inflation had a very, very negative impact on our gross margin last year. We experienced some unexpected and rapid inflationary increases in steel, cardboard and polycarb. The prices have stabilized at the higher level now that certain forecasters now indicate that the market could incur additional price movement in steel and aluminum, which are utilized in the production of lighting and graphics products. We need to keep a very watchful eye on commodity prices going forward. Our LSI business system and its lean manufacturing component is becoming a way of life here at LSI. We encourage all 1,200 of our associates to engage about areas in improvements, elimination of waste. We conduct on average 100 causing events every year. These efforts by our associates along with our facility rationalization program last year are showing tremendous improvement in our labor and overhead cost, all under the leadership of Tom Palmer, our Executive Vice President of Operations. I am pleased with our gross margin for the first half of the year which advanced upwards to a 27.4%. Barring any return of rapid material inflation, we appeared to be back on track, moving towards achieving our multiyear goal of reaching 30% gross margin. I'll now turn the mike over to Jim Galeese, our CFO to discuss the financials in greater detail.

Thank you, Dennis, and good morning, everyone. I'll be providing comments on our financial performance on a non-GAAP basis for comparability purposes and then highlight the non-GAAP items which reconcile to the reported GAAP performance. Fiscal second quarter sales were $92 million or 8% above Q2 prior year. Adjusted operating income increased 31% versus prior year with the operating margin improving 90 basis points to 5%. Adjusted net income increased by similar levels. This resulted in adjusted earnings per diluted share for Q2 of $0.12 compared to $0.10 in Q2 2017. In addition, a statistic that I give more visibility to throughout year is adjusted EBITDA. Q2 adjusted EBITDA was $7.2 million versus $5.3 million prior year, an increase of 35%. First half adjusted EBITDA was $12.9 million, a 37% increase over first half 2017 of $9.4 million. Moving to reported GAAP results. The Q2 GAAP results reflect required tax charge as a result of the tax cut and Job Act legislation. The $4.7 million charge reflects the loss in value of differed tax assets held on the balance sheet. The value of these assets against future taxes declined because of the reduction in the corporate tax rate from 35% to 21%. Q2 GAAP results also include a small restructuring adjustment with a net income impact of $59,000. As a result, the business reported a GAAP net loss of $1.5 million and earnings per share loss of $0.06. In our press release, we provide a detailed reconciliation of non-GAAP measures for the second quarter above 2018 and 2017. Next, let me briefly comment on performance for our two reportable segments, I'll start with lighting. Lighting sales in earnings both improved versus prior year. Sales increased 6% to $69 million. Dennis mentioned the LED sales represented 92% of all lighting sales in Q2 reflecting our emphasis on LED, an intentional shift away from conventional technology. Q2 LED sales growth was 25% versus Q2 prior year. Lighting adjusted operating income for Q2 was 25% above prior year with the operating margin increasing 110 basis points to 7.6%. The lighting gross margin rate improved to 170 basis point. The margin rate improvement was driven by a higher quality, richer mix of sales and a strong productivity across all cost categories which offset material inflation and price erosion. Now I'll shift to graphics. The graphics business also delivered a solid quarter with both sales and earnings above prior year. Sales increased 12% to $23 million. Operating earnings increased 58% with operating margins increasing 280 basis points to 9.7%. The sales increase was led by SOAR, our digital signage business which again generating a 100% plus grow rate. The Phillips 66 business is entering its last phase of activity and as a result declined in Q2 in the first half as projected. However, we're successful in obtaining significant new sales activity in both petroleum and non- petroleum business compensating for the Phillips 66. Shifting to select other business metrics, the business generated positive cash flow in Q2 and has considerable availability in our line of credit. Working capital increased by approximately 6 million in Q2, drive by accounts receivable related to specific growth initiatives and timing. Capital expenditures were $700,000 in the second quarter resulting in a CapEx to depreciation ratio of less than 1. Inventory has decreased marginally since the end of fiscal 2017 and we continue to manage our inventory day interns closely to ensure line that with margin demand. Let me return to the subject of taxes. In December, the President signed a Tax Cut & Job Act, TCJA into law. Management is thinking this tax cut will stimulate investment and generate growth in both in new and retrofit non-residential construction generating increase demand for lighting products. In addition, as a result of the reduction in the federal corporation tax rate from 35% to 21%, we expect TCJA to favorably impact future LSI net income, earnings per share and cash flow. For full year fiscal 2018, we forecast that the company's blended consolidated effective income tax rate will be approximately 29% before discrete items as compared to approximately 34% for fiscal 2017. The full year impact of TCJA will be realized in fiscal 2019 with our effective rate currently estimated at 24%. With that I'll now turn the discussion back to Dennis.

Thank you, Jim. I would now like to make a few comments on the markets in which we participate and a bit of a look forward. Both our markets, the lighting market and the signing graphics market are very large and over the longer term period, our expected sale growth in the 2% to 3% range annually. However both markets are susceptible to economic and political factors which can cause the market to expand or contract during any given short term period. At the moment, both markets appeared to us to be contracted. In the past, I've used the term soft to describe the situation. What I mean by soft is a flat to down single-digit contraction. This is based upon market information that we have available. Much of this information is delayed by several months; it's difficult, it's not impossible for us to have perfect knowledge, real time knowledge about our markets. We do continue to develop and expand a quite sizable log here at LSI which sometimes it's called as a pre-PL pipeline. This is our CRM system at work. We log all of our codes into our CRM system and we're able to metrics around those codes. One of those internal metrics shows that the normal time period by which a code progresses through the sales cycle to become IPO has extended significantly over the last year. I sometimes internally call at the log jam. The primary reason for this log jam as we talk to our agents, as we talk to distributors, as we talk to end customers, appears to us to be a temporary pause on capital spending for a number of reasons by our end customers. Another thing that we have noticed is that we call the small to medium size projects serviced under the LSI brand are the slowest moving codes. Our larger projects those greater than 150,000 and our stock and flow business under the Atlas brand have not seen or been impacted as much as the smaller and medium size projects. In summary, the markets we participate in are soft at the moment. However, we are starting to see signs of a positive rebound. Recent market indicters such as the DAJ index and the ISA index are trending upwards. As Jim mentioned, we are hopeful that the newly enacted tax legislation will help to break the log jam. There are customers and customers will be motivated to move forward with their capital spending as it relates to lighting and signage projects. I do want to be clear, I do want to point out that these potential developments will not have a significant influence on our fiscal Q3, but more likely will impact us later in calendar year 2018. With that being said, we as a management team are going to continue to work diligently and focus on the priorities that I outlined earlier. Number one, focus on growing faster than the market which includes investment in new products and new technology and number two continue to drive productivity and cost control initiatives. I am confident that we stay focused. Our business will be positioned to capitalize on improving market conditions as they materialize. Our second quarter results do indicate, our team is working on the right priorities. These efforts are generating a positive impact in our results, even in a soft market environment. As I conclude I want to give a special thanks to Ron Stowell who retired December 31. Ron was our CFO for the last 25 years and has been an invaluable partner to me since I joined the company in 2014, thank you Ron. Also, I want to welcome Ron Newbold to the executive team, he is the President now of our LSI Lighting Business. Ron has quite an extensive background in lighting and has already made a difference during his short tenure with us. So, welcome to the team Ron. I will now turn the mike back to our moderator and we can open up the Q&A session.

[Operator Instructions] And our first question comes from the line of John Quealy with Canaccord Genuity. Your line is now open.

Hey, good morning folks. And first congrats on the quarter and thanks for opening up the conference call. So the first question, if you could in graphics - that was pretty good improvement, it's been a lumpier business obviously with some different cadence going on in the convenient store gas channel. Dennis can you talk about in the quarter, was it just backlog coming through, or what happened in the quarter end? I think you already gave some color on the outlook for that segment?

Right. Good morning John. We do use the same CRM system in our graphics business, so we have been working on some projects for, takes some number of months to move through the sales cycle. As Jim mentioned, as Phillips 66 is starting to wane, we've been blessed with couple other nice petroleum projects and then some non-petroleum projects coming in. So, our sales force there in graphics is out working the opportunity hard. We're also pleased with SOAR, made some difference here; some nice projects in our short business shift and were installed during the quarter.

Okay great, and then on the Q1 report or right there about, we were talking about Atlas suffered some softness in the stock inflows out of the portfolio. Sounds like that's alleviated or can you comment specifically underneath riding on the different factors that you are experiencing and you expect?

So, Atlas, as you know is services the stock and flow business, they've required by a spec, February, almost a year ago. Q1 has appeared little soft, but, very nice quarter by Atlas, second quarter, Jeff Gender and John Bagwell down there are really leading their team in the right direction.

Dennis your comment around tax reform driving, hopefully some capital expenditure and retro fit and new build activity, that's been echoed by other peers in lighting. If you could talk to us about your sales tracking CRM system, are you starting to get elevated hits or more hits around projects or obviously it makes sense that we need time to get into the Q3, Q4 probably Q4, Q1 time frame to see that hit the PNL. But, can you talk about conversations you've had already with the distribution base?

Sure, we had a sales meeting the other day and we ask all of our sales people to go back do the CRM and make a very specific call and remind those customers, if they have money left over from their tax cuts, the LED is a great place to invest, with its ROI that comes with it. So, that's a type of thing we are doing. I am following up on each and every group.

Okay, great. I'll hop back in, thanks again guys.

Thank you. [Operator Instructions] And our next question comes from the line of Craig Irwin with ROTH Capital Partners. Your line is now open.

Good morning, and thanks for taking my questions.

Good morning, Craig.

Dennis, the one thing I wanted to ask about that I found pretty encouraging is gross margins. Obviously, it's an area where you've been really focused over the last number of quarters, couple of years now. And, there's a quite a lot availability there over the next number of quarters. Can you maybe talk about what's going right on the margin side, how pricing is working for you, what the relative factors are contravening to the gains resting there? And, what we should look for over the next couple of quarters to understand how margins are likely to progress?

It's a great question. I'm a huge believer in the LSI business system. This is where we engage all 1,300 of our employees, we want them to be engaged, involved. So there is a big lean component to that. I am very proud of our workforce, the culture is changing, people are participating more. I give them all the credit for this improvement. We manufacture most of our products in the USA, we are very proud of that. But, with that comes the responsibility that we must be competitive. And we see that 30% gross margin as a competitive point that we need to hit. We won't be able to deliver overnight, but we think we continue to work in that fashion. So, inflation last year, kind of knocked us off a little bit, but I'm proud of our sourcing group here in the last 12 months and our product design guys. We've found ways around steel, how to use more plastic, how to use less cardboard, things like this, trying to find our way around those. Prices have not come down, they get stabilizes at higher price. But, we are out there every day looking for new ways to improve our gross margin and sure that we're competitive when we make products in the USA.

Craig, James here. Couple of things I'll add to that. In addition to our internal productivity initiatives around the value add, we mentioned quite a bit about new products. Our new products are not only enhanced from a feature functionality perspective, but also represent a measurable cost reduction to our sales as we go to the market. And, so these cost refreshes and cost downs on both our existing, as well as our new design products are really important part of our business equation and we really have a high level of activity going on in that area right now.

Great, thank you both for that. The next question I have is very high level. So, last year after the election of President Trump, when there was some plodding in January sort of in the press between Trump and Schumer discussing trillion dollar stimulus program, the lighting market went on ice. It was very similar in character to what we saw, eight years prior, when Obama was first elected and started talking about turning out subsidies. It seems that we are seeing a little bit more rational behavior in the market now, that I guess the last couple of weeks they drafted the stimulus program has been released and we're seeing maybe a little bit more commentary out of the lighthouse regarding the stimulus program and good potential for that to actually see some action this year. Can you comment about, whether or not you are seeing that as a short term headwind. And, can you maybe frame out for us, what you think this would like? Is it likelier to be a similar dose to what we saw many years ago in the backend of the stimulus dollars that were beneficial lighting back in the 2009-2010 time frame?

It's a great question. I used to word log jam, quotes are not the issue for us here, there's a lot of great projects that we've quoted that have on ROI, especially when it comes to talking about LED lighting here. I am hopeful this stimulus will cause our end customers to not pause anymore but pick those CapEx and start signing them and moving them forward. So, I am very more tactical focused there and hoping to believe that that will happen. I just don't know the timing of that at this point. But, Jim do you have something more you want to add there?

Yeah, if there is any type of infrastructure bill that comes at a high level that would - we view it as a positive thing for both construction industry and for all and of course ourselves, as the account takes down.

Are people pausing and waiting on that?

No, I actually think the tax bill is actually a better influence and any activity that could be coming relative to infrastructure. So, I look forward to seeing any momentum build from the tax structure and if something comes from an infrastructure bill, on top of that, that would even just create a more favorable environment.

Great and then another very high level question. There's a lot of turbulence out there in the market. You had the largest participant post the worst performance they've had since the great recession in their quarter just a couple of weeks ago. And this kind of turbulence very often creates opportunity. You have a sharp eye and sharp understanding of your industry. And couple of years back you were able to identify some real opportunity from the change in ownership at Juno and I'm sure there was a real benefit for LSI against the market volatility, it made it harder for us external observers to really see. But do you see any specific opportunities, maybe that you would want to discuss with us or maybe if you can say that you see opportunities that hopefully you'll be able to tell us about in the next couple of quarters that are coming to a position because of this volatility we are seeing in the market.

My response is peer and LSI were focused on our business, our top two objectives for the year, every day we're out there scrapping for businesses available. I read about the danger of talking about as well, but here we're just focused on undermining our plan and turning this company around and providing a good return for our shareholders.

Great. Well, congratulations on a strong quarter. Thanks for taking my questions.

Thanks Craig.

Thank you. And I'm showing no further questions in the queue. I'd like to return the call to Mr. Dennis Wells for any further remarks.

Thanks for joining the call and have a great day.