LSI Industries Inc. (LYTS) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the LSI Industries’ Third Quarter 2018 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] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Jim Galeese, Executive Vice President and CFO. Please begin.

Thank you, Victoria, and good morning, everyone. I want to remind you that today’s presentation includes forward-looking statements about our business outlook. Such statements involve risks and uncertainties and actual results could differ materially. I refer you to our Safe Harbor statement which appears in this mornings press release as well as our most recent 10-K and 10-Q. Now let me turn the call over to John Morgan. John?

Thank you, Jim, and good morning, everyone. Thank you for joining the third quarter call this morning. Let me start by addressing the news from earlier this week regarding the departure of CEO, Dennis Wells, and of course, the search plans for the new CEO. First commenting on a personal note, I've worked with Dennis in various ways for many years, and I have always enjoyed doing so. The LSI Board has asked me to assume the role of Managing Director and to represent them on the call today. Improvements were made under Dennis's leadership and specifically in the areas of progress on developing a better platform for growth. For example, much of the infrastructure of the Company has been consolidated, leading to improve productivity. The implementation of lean through the LSI business system is creating productivity and additional capacity for growth. Lead times and delivery performance have significantly improved and today represents an outstanding capability. All of these improvements represent key enablers for future growth and we appreciate the previous work in this regard by Dennis and the entire LSI team. Now as we consider the future for our industries, our lighting and graphics markets continue to transform. Developments in the application of emerging technologies, digital electronics, and smart connected solutions present exciting opportunities for the business. As was outlined in our recent press release, the CEO search will target a person with experience and success in leading businesses through market transitions and the innovation required to capitalize on growth opportunities. The development of topline growth strategies demands unique skills and adding these skills to the organization is the focus of the recruitment effort. Our new and improved platform will allow the Company to more effectively benefit from the financial leverage available as we invest in profitable growth opportunities. Now until the CEO position is filled, we are very fortunate to have two experienced business veterans joined LSI in the CEO and COO positions as we previously disclosed. This is a terrific opportunity to look forward and build upon the momentum of a changing market and the capabilities of the LSI team. Now Jim I'd like to just turn the call back to you to review the quarterly results.

Thank you, John. 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 third quarter sales were $78.8 million or 1% above Q3 prior year. Adjusted operating income increased 74% versus prior year with the operating margin improving 40 basis points to 1%. Adjusted net income was below prior year, reflecting increased interest and tax expense. As a result, adjusted earnings per diluted share for Q3 were $0.01 flat with Q3 2017. Adjusted EBITDA for Q3 was $3.3 million, an increase of 30% over prior year. Through the first three quarters of the fiscal year, sales were 4% of our prior year and adjusted operating earnings have increased 37%. Moving to reported GAAP results, the Q3 GAAP operating results reflect only very minor differences from the adjusted results. Reported operating earnings reflect $9,000 in severance charges. Our Q3 tax rate which includes several discrete items was 35%. This compares to a tax benefit in Q3 2017. As a result, the business reported GAAP net income for Q3 was $220,000 and reported earnings per share was also $0.01. In our press release, we provide a detailed reconciliation of non-GAAP measures for the third quarter and year-to-date for both 2018 and 2017. Next, let me briefly comment on performance of our two reportable segments. I'll start with lighting. Lighting sales was $61.6 million were flat to prior year. LED sales represented 92% of our lighting sales in Q3, reflecting our emphasis on LED and intentional shift away from older HID and fluorescent products. Q3 LED sales growth was 14% versus Q3 prior year, while the older HID and fluorescent product sales decreased 58%. The unfavorable sales impact to lighting of the shift away from HID and fluorescent was four points for the quarter. Lighting Q3 operating earnings were $3 million or approximately $100,000 below prior year. Adjusted EBITDA however, increased $288,000 or 6% reflecting increased amortization expense. Year-to-date sales have increased 4% and operating earnings have increased 16%. Now I’ll shift to graphics. The graphics business delivered a solid quarter with both sales and earnings above prior year. Sales increased 5% to $17.3 million. Operating earnings were $415,000 or 82% above prior year with operating margins increasing 100 basis points to 2.4%. Graphics EBITDA was $792,000 or 32% above Q3 prior year. The sales increase was led by store, our digital signage business which again generated a strong growth rate. The petroleum c-store segment maintained sales levels with prior year as Phillips 66 decreased somewhat as planned, but was offset by increasing activity with other accounts. Year-to-date graphic sales growth is 6.5% and operating earnings have increased 54%. Now let me shift to a few other business metrics. The business generated a strong cash flow in Q3, further reducing our debt level and increasing our line of credit availability. Working capital decreased sequentially in Q3 and was flat to prior year. Inventory increased modestly as expected driven by new product launch planning and several supply chain initiatives. Capital expenditures were $1 million in the quarter resulting in a CapEx to depreciation ratio of less than one. Lastly, let me address the subject of tariffs. In Q3, the present side proclamations for Section 232 tariffs on aluminum and steel. The proclamation imposes a 25% tariff on imports of steel mill products and 10% on wrought and unwrought aluminum. The tariffs were subsequently suspended until May 1 for certain countries. Also in Q3, the President signed a memorandum that imposes up to $60 billion in new tariffs on China. The tariff is not yet effective. The Treasury Department has 60 days from this memorandum signing to submit for a final list of tariffs. Management continues to analyze the developments of both actions. We currently project to realize only a minor impact in Q4 as a result of Section 232 and continue to work in developing potential alternatives to assist and offsetting any future impact. Regarding the China memorandum, we continue to analyze the 1,300 harmonized tariff codes currently identified. It's too early to provide any projections on this, but we will continue to monitor closely. With that, I'll now turn the discussion back to John.

Jim let's just simply turn it back to the moderator and open up the call for questions if there are any.

Thank you. [Operator Instructions] The first question is from Craig Irwin of ROTH Capital Partners. Your line is open.

Good morning, and thank you for taking my questions. So first, I wanted to ask about the management transition. John, it's great to have you playing a strong role in stabilizing things and positioning the Company for growth. But I was hoping you might be able to talk a little bit about the characteristics that you would look for as you execute the search for a new CEO. And I understand that Crawford Lipsey who is stepping in as Chief Operating Officer and President, actually has a good history working with the team at Acuity, maybe if you could give us a little bit of color as far as what he's been doing operationally in the past with the company, and then Ron Brown how he's been involved at the Board level and the capacities of the company?

Sure. To be very specific, when I look at this business today as compared to just handful of years ago when I came on to the Board, I really like what I see in terms of the – I’ll call it blocking and tackling work that Dennis and the team have done. They've got a much improved platform called a simplified business, the conversion to LED has gone extremely well, getting out of some of the old technologies and managing through, that's gone extremely well, last year's acquisition of Atlas has been a bright spot. So I could go on and on. There's a lot of work that’s been done and there's really terrific platform that exists for growth. And if you think about the future opportunities for the business and what shifting in the marketplace, the integrating control systems bringing connected technology, all of the things are being developed that are being touted as IoT, Internet of Things, Big Data. This capability is to distribute and control and utilize data and technology on the backs of the infrastructure of our lighting equipment and our digital signage equipment represents a great opportunity. So if you think about that going forward, we're less interested in somebody like me that just understands the old traditional lighting business. And we're much more interested in people that really understand the future of work and the integration of technologies and product lines to understand driving topline. The team here is worthy and well qualified when it comes to running the back of the house if you will. But getting out into the market and focusing on organic growth and the integration of innovation into the product line to drive that growth is the type of skill set we're really looking forward. The Crawford in the recent past – I assume you're asking about his consulting gig with LSI. He was working on a consulting basis with LSI specifically assisting them and reenergizing some of the capabilities in the oil and gas segment, and the canopy lighting and graphics that go with that, the imaging of capabilities that they are focused in that oil and gas segment. And as Jim alluded to earlier that's going extremely well. And so we were very fortunate that Crawford was available not only to continue that, but to begin to spend everyday here full time for the foreseeable future because he has deep and rich operating knowledge in the lighting industry, and has learned an awful lot about the digital signage and imaging background through his consulting work here. Ron Brown who coincidentally lives about 10 minutes from the office here was not engaged with LSI in the past, but was coincidentally going through a retirement from the company he was with the Armor Group. And just what happens he was available. Ron is from Cincinnati. Had been the Chair and CEO of Cincinnati Milacron, and is on the Board of A.O. Smith, he understands public companies. He was a CFO. He was a General Counsel. He was the Chair and CEO. When it comes to supporting Jim and [indiscernible] here at the corporate office and making certain that everything is done properly, here at this business. He is able to hit the ground running. So he's been here most of this week. You'll be here starting full time on Monday. And I have the good fortune to have known him well because he was a director on my Board of Directors when I was the Chair and CEO of Zep Chemicals. So the combination of the two of them just makes us feel mighty secure as we go through this. We've encouraged them not to let the term interim stand in their way. They along with the team here have a business to run and there's opportunity that needs to be met here. So I hope that answers your question Craig.

That's a really good answer and I think it's very important for the shareholders of LSI, so thank you for that. My next question, I guess is about the conventional fixtures. Now just stepping back, if the score card was just based on the success of your LED fixtures, I think LSI would be viewed quite differently by the market. You've obviously done a great job managing that transition growing and the distribution of LED fixtures and diversifying product portfolio. It’s the transition in the conventional fixtures, it looks like maybe it hasn't had quite the same stickiness as certain fixtures or maybe obsolete it or transitioned as far as directly pushing those into sales of LED fixtures just under $5 million in revenue in the quarter. I'm going to maybe put some words in your mouth, but it seems like that transitions mostly over and maybe we have some HID fixtures and things that you would carry, that would be legacy for people let – want to put the same thing in on the existing projects. But would you expect conventional fixtures to see much of a contraction over the next number of quarter, and now that with the growth that you seen in LED’s, would you expect the LED growth to be more of an organic reflection of sort of what's going on in the lighting segment?

Very good question. This is Jim. Let me start with that. Let me start with addressing the rationale for our intentional shift away from HID and fluorescent fixtures. Obviously, we determined that the market was transitioning and moving very rapidly to LED type solutions. We made a decision to intentionally shift away from that to do for primarily one major reason. It really allowed us to dedicate all our precious business resources and assets to the development of LED going forward. We did not want the tail florescent HID to consume or be a distraction relative to our business assets and resources. The result of that allowed us to significantly lower our breakeven point by closing the factory and transitioning away from that and reducing significant amount of fixed cost, and again focusing our commercial team and our development team and our operations teams and supply chain team solely on the LED future of the business. So with that, let me address your comment about then. Yes, this does have a bit of a tail, but I would expect by the end of the fiscal year, Craig, we will be pretty close to a comparable basis on that with LED. Of course, we’ve been all executing this through soft market conditions, which certainly hasn't helped the situation as well.

Great, thank you for that. The next question I wanted to ask is about Atlas. So last quarter, you shared with us a revenue number for Atlas. I was hoping you might be able to break that out again. And can you comment whether or not Atlas is seeing growth in the product portfolio and where you stand on the cross selling of Atlas products in the LSI channel, LSI products, and the Atlas channel and whether or not you would expect this to be a little bit of a tailwind for the company over the next year or so?

And again, I'll start. Atlas was a very strategic and important acquisition for LSI. Really allow us to compete in the distribution side of the business access to market. We are very pleased with that. Regarding specific numbers, Craig, we really don't breakout anything below the reportable segment area, so I'm not going to share any specific numbers on Atlas. But I will say this, their unit growth continues, they just like the rest of the projects side of business has some pricing pressures, but we are very pleased with the progress of the synergies. And there are two major synergies as you may recall that we talk about. One is distribution expansion continue to expand nationally the footprint of our Atlas products. We're making great progress there. And the second is the cross-branding swap as we call it and we are also on target with respect to our ambitions and objectives there.

That’s good to hear. Thank you for that. So last question if I may, about the Graphics segment and your petroleum customer, so I understand that there are two very large petroleum customers that are significant opportunities, there is competitive bids that have been happening and a lot of information that's being provided to these customers, if not already provided, we talk to one of your competitors in this market that’s optimistic that maybe they'll get a piece of one of these. Can you say whether or not you would expect petroleum to be a healthy market for LSI over the course of the next year? And how do you feel competitively as you look at some of these large projects that are coming out? Does your history executing with Phillips 66 and then the long list of other nationally recognized brands put you in a strong position to win contracts with companies like Exxon Mobil and others?

And Craig as you know the petroleum sector for graphics has been a very important part of the business and we've been very, very successful there. The work that Robin Hood and his team has done there through the years is really, really good and a great dividends to the business. As you recall several quarters ago, we were projecting we could see a bit of a downturn in the overall graphics petroleum business as the multiyear Philips 66 of a very large project started computing the end of life if you will. And as projected it is trending down a bit, although we are continuing to see some nice follow on opportunities with that. But yes, we are seeing some very nice opportunities with respect to a couple of the other very large oil companies in North America. And as far as looking forward, we remain very confident about our success in this sector. There's a lot of good activity, lot of the programs going on there right now. And of course, the oil price tailwind gives us a bit of confidence as we continue moving forward as well.

Great. Thanks again for taking my questions. I will hop back in the queue.

Thanks Craig.

Thank you. The next question is from Greg Elsen of Singular Research. Your line is open.

Thank you and good morning.

Thank you, Greg.

Hi, you mentioned earlier in the call that LED represented 92% of the sales for the quarter in that segment, the non-LED being there for 8% and the shift cost you about 4 percentage points of growth in the quarter. Could you remind us going back to last year's Q4 of fiscal 2017, what the ratio was for LED versus non-LED back then?

Well, Greg I don't have that immediately in front of me, but by inference with the 58 – [indiscernible] I believe we were at 80% LED penetration overall was 80% some of low 80% – 82% something like that. I could provide and get you that as a follow-up Greg if required.

Okay, but importantly you said that next quarter should be the last quarter of a significant headwind from the shift. Was that…

Greg, I think we may have found the information…

Yes, two things. Number one, it was 81% LED penetration in lighting end of Q3 last year. So yes, we closed the factory in Q4 of 2016. So we have cycled the anniversary day that closures. We are doing some brand labeling sourcing, but that is down to just a couple national account activity opportunities. So as a result we see that getting down to a very small figure by the end of the fiscal year.

Okay, good. My next question if I may, could you tell us if any charges you anticipate in Q4 of this year due to the CEO change?

Yes, there will be a charge in Q4, representing the separation cost we are developing that right now and working with our audit firm as to the amounts and appropriate treatment, but yes there will be a charge in Q4.

Okay, good. Understood. You have a projected timeframe for when you'd like to accomplish the new higher?

Yes, let me take that. We've just begun that search and let me just say that the experts that do this for a living have indicated that the typical search for positions such as this ranges somewhere between five and nine months. Frankly, I don't know if this is going to take a month or a year and I think because of the uncertainty about the timing that's why we frankly feel so good about the availability of both [indiscernible] during this entire time. They don't have a timeline, so they're here until that is accomplished, and I'll be on site myself as much as necessary until that's accomplished, but I would expect it to take a several months.

Got it. Jim, going back to the quarter itself, I think you said that the tax rate for the quarter was 35%, the effective rate. What do you expect – do you have an expectation for the fourth quarter and more importantly to the next fiscal year as we cycle into the full effect of the new tax rates?

Our reported applied tax rate for the quarter was 35%. It did include a couple small discrete items. Keep in mind a tax rate on smaller quarterly income figure, small adjustments kind of affect the rate rather measurably. Moving forward as we communicated previously, we look to close fiscal 2018 with the effective tax rate before discrete items right at 29% versus 34% last year. And as we look forward to 2019 where we will see the full effect of the Tax Cuts, Jobs Act we're looking at a rate between 23% and 24% effective tax rate.

Got it. I’ll let someone else go. Thank you very much.

Thank you. End of Q&A

Thank you. And at this time there are no further questions in the queue. I’d like to turn the call back over to John Morgan for closing remarks.

All right. Great, thank you. And we appreciate you being on the call this morning. We look forward to speaking with you next quarter at the end of the fiscal year and our fourth fiscal quarter. Have a great day.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day everyone.