LSI Industries Inc. (LYTS) Q4 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q4 2018 LSI Industries’ Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Following managements prepared remarks, we will host a question answer session and our instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. It is now my pleasure to turn the conference over to Ron Brown, Chief Executive Officer. Sir, you may begin.

Good morning. I’m Ron Brown and I’m pleased to participate on my first earnings conference call with investors since joining LSI as the Interim CEO in April this year. Our CFO, Jim Galeese is joining me on the call. I look forward to talking to you about my first 90 days at LSI as well as LSI going forward. But before I do that, I would like to ask Jim to comment on our fourth quarter and year-end results, and then after a few remarks by me we’ll open up the call for questions. Jim?

Thank you Ron, 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 opportunities and actual results could differ materially. I refer you to our Safe Harbor statement, which appears in this morning’s press release as well as our most recent 10-K and 10-Q. 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 reported GAAP performance. Total fiscal fourth quarter sales were $83.4 million or flat with prior year. Adjusted operating income increased 3% with the operating margin improving 10 basis points. For the quarter, adjusted net income was $32,000 below prior year reflecting a net increase in interest and tax expense. As a result, adjusted earnings per diluted share for Q4 were $0.02 flat with Q4, 2017. For fiscal year 2018 sales were $342 million or 3% above prior year, and adjusted operating earnings increased 33% to $9.6 million and adjusted EBTIDA increased to $19.8 million. Full year adjusted earnings per share were $0.22, an increase of $0.03 versus fiscal 2017. Cash flow was positive in Q4 and for the full year 2018 serving to further reduce our debt level and increase our line of credit availability. Working capital investment increased in Q4 related to investments in several key initiatives which I will refer to later in my comments. Moving to GAAP and reported results, the Q4 GAAP operating results reflect the $3.1 million charge related to the CEO transition announced earlier in the fourth quarter. As a result, the business reported GAAP net income for Q4 of a loss of $2.7 million and reported earnings per share were a loss of $0.10. In our press release we provide a detailed reconciliation of non-GAAP measures for the fourth quarter and for year-to-date of both 2018 and 2017. Gross margin for the fourth quarter was 140 basis points below prior year impacted primarily by unfavorable volume mix and lower margins on the initial pilot runs for several of our new products and customer solutions. We expect these margins to improve as we shift out of the pilot phase to normal production. Decreased operating expenses of 140 basis points offset the lower margin. Next, let me briefly comment on performance of our two reportable segments, starting with Lighting, sales of $61.5 million or 8% below last year with decreases realized in the petroleum and general C&I segments, where market conditions for both remain sluggish. As a result of the lower volume, Lighting Q4 operating earnings were $1.9 million versus $3.4 million in 2017. We spent significant time profiling the broad C&I segment and are focusing investments and resources on opportunities where our products and solutions bring value to specific customer requirements. For example, lighting fixtures equipped with wireless controls generated a growth rate of 146% in Q4 versus last year. In addition, our new product launch schedule remains strong, and we are pleased with the increasing adoption rates for our recently introduced canopy parking and other outdoor area products. For Q4, LED represents 93% of total fixture sales. For the full year, lighting sales finished at $260.6 million, an increase of 3% to prior year. Operating earnings were $15.2 million or 2% above prior year. Let me shift to graphics. The graphics business delivered a solid quarter with both sales and earnings measurably above prior year. Sales increased 33% to $22 million while operating income improved 86% to $1.5 million, with operating margins increasing 190 basis points. The sales increase was led by strong performance in the petroleum c-store segment which increased 47% over prior year. The growth was driven by multiple counts of domestic projects, and initial shipment activity into Mexico. Our key oil company customers are pursuing expansion opportunities as a result of the deregulation of the Mexico petroleum industry, and we are well-positioned to assist with their growth plans. Our digital signage business, branded SOAR, continues to generate strong interest. We were recently selected by a national quick service restaurant chain to be a significant supplier in their major image program as they implement digital technology across the brand. Products for the initial pilot size shipped in Q4 and we are preparing to accelerate production aligned with their renovation schedule. Both the Mexico and QSR initiative acquired additional Q4 working capital investment as mentioned previously. Full year graphic sales were $81.4 million or 13% above prior year. Operating income of $5.6 million was $2.1 million or 61% above last year. We’re seeing positive momentum for the graphic segment. Orders outpaced sales for Q4, generating a positive book-to-bill ratio and an increased backlog as we enter fiscal Q1, 2019. Regarding the status of tariffs, the section 232 tariffs covering steel and aluminum are in effect. This had no real effect on the business in Q4, but we will realize some cost changes in Q1. We announced a price increase on select lighting products effective with mid-June quotations, but it's too early to conclude how much of the price increase will be realized. We also have many cost savings initiatives in process to offset commodity increases. The continued uncertainty surrounding China tariffs is driving domestic manufacturers to increase inventory levels on certain important components. This, along with strong global demand is causing increased leadtimes and select shortages. Availability is manageable at this point, and we continue to take proactive actions to ensure we continue to meet customer delivery requirements. With that, I'll now turn the discussion back to Ron.

Thank you, Jim. As you probably are aware, Crawford Lipsey and I both joined LSI in late April shortly after arriving, we had the opportunity to attend LightFair, it’s the largest lighting still in North America held at McCormick center in Chicago and we saw many of our competitors there, as well as our top-notch sales team in action. Over the past few months we met with a number of our customers and sales reps towards several LSI manufacturing facilities engaged with many of our dedicated LSI team members across the country. I can assure you that everyone on the LSI team is committed to not only doing their jobs, but they are committed to doing them extremely well. This company has an incredible group of talented leaders and professionals who very much want to grow LSI. And we have a combination of capabilities and lighting graphics, digital signage control and IoT technologies that enables us to serve your customers better than anyone else in the markets we serve, and lot of key ingredients for a high performance and successful company. It sounds like a great company; well it is, so why do we need to change anything? As you are aware, the board decided back in April that our shareholders and employees deserve to be part of a growing company taking advantage of market opportunities with technologies and innovation. The Board's decision to put in place a new CEO to take LSI to the next level is certainly the right move. Having the right leadership in place is critical, and the search for the permanent CEO is progressing. But we’re not going to sit and wait before making what we feel are necessary changes to move the business forward. In order to maximize the full potential of LSI, we are putting in place a structure and aligning the organization in a way that enables us to capitalize on the market opportunities available to LSI. To move the company forward, we must combine our existing strength, with new and emerging technologies to provide innovative solutions for our customers. We have been operating as three separate businesses. I could actually argue that we've been operating as many as six different businesses if we include our incubator businesses, which have their own sales and marketing organizations. Each one was focused on providing the best products and services for their own specific customers. With this silos organization structure the value of providing a fully integrated solution, including packaging the full scope of LSI’s capabilities was not being completely realized, and probably needless to say, the efficiencies that come along with operating as one organization were also not being realized. And so, we are now organizing into one LSI, an LSI where we are experts in the markets we serve, and our customers can understand the full value we can bring to them. As you saw on this morning's announcement, we have created two new senior positions, which will help lead our transformation. One is the Chief Commercial Officer responsible for leading LSI sales organizations and market channels for all of LSI’s products, technologies and services. Jeff Croskey is at Chief Commercial Officer. As President of LSI’s graphic segment last year, his team grew sales 13% and earning 61%. And we look forward to Jeff leading all LSI’s professional sales teams and customer service resources to provide our customers with innovative solutions to enable stronger growth for LSI overall. The other key leadership position is a Chief Marketing officer. His responsibilities will be to manage LSI marketing efforts, including understanding market demands and customer need and leading LSI’s new product development. A search is currently being conducted for the Chief Marketing Officer and in the meantime, our COO Crawford Lipsey will oversee these responsibilities. A critical function under this Chief Marketing Officer is new product development. John Bagwell will become Senior Vice President of product development management for all of LSI’s product and technologies. John most recently served as President of Atlas Lighting. Prior to that, he led several of LSI’s technology businesses. We feel that John's past experiences with LSI and Atlas as well as his marketing and leadership roles in prior companies are valuable in his ability to bring together all of LSI’s product development functions. Additionally, we are organizing our sales teams around key markets where LSI’s approach to funding integrated solutions for our customers will be successful. For example, Robin Hood was been with LSI for over 20 years and is known and respected throughout the petroleum industry will be responsible for all LSI customer and sales channel development for the petroleum market. Jordan Spychala, who has served as Vice President of Niche Markets for LSI’s lighting business will now be VP of Strategic Markets for all LSI products and have a responsibility for the leaders of several other key markets. One of these key markets is the automotive market. Joanna Ducker who is highly regarded by our automotive customers will lead sales and channel development for this important legacy vertical for all LSI Technologies products and services. And all of these individuals plus several others are now part of Jeff Croskey’s sales leadership team. So we are doing a lot to structure our sales around a market-driven organization. At the same time, we are moving forward to streamline responsibilities and other areas of the business to become more responsive to changing market trends. For example, responsibilities for procurement, sourcing and logistics have been spread through multiple areas in businesses within LSI. This is all now being organized under the leadership of Sylvia Astrop, who has been promoted to Senior VP of Global Sourcing. Sylvia has been successful in effectively managing LSI’s material costs, despite market and trade pressures, and we look forward to Sylvia’s leadership in bringing together all sourcing procurement and logistics functions within LSI under one organization. We intend to move LSI forward to being a stronger company, a company where our customers value more than anyone else in the industry. While a lot of work still needs to be done, I think that you can see that we are certainly not sitting still. I would like to thank everyone on the call for your interest in LSI. I would also like to thank the entire LSI team for their commitment of serving our customers and providing better returns for our shareholders. Operator at this time, we’d like to open up the call for questions.

Thank you, sir. [Operator Instructions] And our first question will come from the line of Craig Irwin of ROTH Capital Partners. Your line is now open.

Hi, good morning and thanks for taking my questions. So Ron, my first question really is one of philosophy. Historically, investors and and maybe I should say some of the more skeptical or cynical investors looked at LSI as a company that lacks internal accountability, the perception was that any excuse was just as good as getting it done. And I fully appreciate the changes in lines of accountability that you're putting in place and the collapsing of silos and improvement of sort of cross organizational communication, but can you maybe speak on your history of driving accountability in the organization. How you choose to incentivize and motivate the people that work for you, and how you see accountability going forward at LSI?

The most important thing is to align accountability with the main objectives and in this case, it’s selling and servicing our key customer market. So it's important and Jim Galeese can speak to this that from a financial standpoint that we understand by each of these verticals, strategic markets that we are tracking revenue and certainly the margins associated with those businesses. We -- because we are sharing other resources, the support we won't have it all the way down to the bottom line, but the accountability in terms of revenue and earnings will be there and the incentives are going to be aligned with that for those that are responsible for driving that part of the business. So that’s I mean it’s the most important accountability has to be with our number one objectives. That's revenue and earnings with respect to our team market. So that's a big part of the focus.

Thank you for that. Second question, its one – most investors mind these days is with the significant commodity volatility. My back of the envelope math is, I guess, your September quarter faces about 250 basis point margin headwinds from the runs we've seen in steel and aluminum. I know that you put through some pricing there and I know you're really focused on managing the tariffs too. Can you maybe give us an approximation of how much of your price you're being able to put through recently? And do you believe that you'll be able to capture some of the inefficiencies around commodities over the last couple of quarters with the move from the very large OEMs in the market aggressively looking to solve the same problem that's impacting their P&Ls?

In terms of the price increase we're seeing about 2% of that hold, and we are considering another price increase here going forward. In terms of the -- I'm surprised that the magnitude of the margins shortfall you're talking about, but we are not seeing near – even though we are keeping track of the impact of these tariffs and some of the material cost increases. At this point we have not seen major increases in our material cost, we're are seeing some, but to the magnitude you referred to.

Hi, Craig, Jim here.

Thanks Jim.

Comment from my side. As mentioned we did not have a impact in Q4 as a result of the steel and aluminum commodities. We were well protected via hedging gains. We will see an increase in Q1. It will not be to the level of this announced tariff activity, but as a result of that we do have multitude of activities in place to offset that. So first off, steel and aluminum is not the largest component of our product cost, actually electronics are. And there number of categories of electronics where costs continue to decrease, and we're seeing that. And then with respect the steel and aluminum we have several design out projects in place for either substitution of materials and/or just cost outs relative to weight and design. Third and lastly, we continue to look at all supplier alternatives we have in order to best optimize this situation. So we're certainly managing that pricing. We certainly want to have some realization of the price increase with effective with quotations in the middle of June. So it's really too early to tell Craig as to just how much of that we're going to realize particularly on the select LED products we announced. We will certainly you'll get that on our remaining legacy products for sure.

Great. Thanks…

Sorry, Ron, I interrupted you.

I think you saw probably activity announced second price increase. And we are certainly inclined to follow with our own.

Excellent, excellent. Then if we can just talk about margin targets, historically the company was sort of looking at the 30% margin level or some that would be good to achieve over the next few quarters in a reasonable time horizon. How do you feel about 30% is an achievable gross margin target at this point. Is this something that's likely to take several quarters to achieve? Or is the mix of products and your sourcing initiatives likely to continue to deliver sort of incremental movement towards that goal over the next couple of quarters?

On the assets and continually increasing returns on the investments we're making, as oppose to necessarily setting targets on margins. Although 30% is not – I don't see that as the targets that we would be looking to achieve. Long-term, we want to achieve sort of higher margins, but right now we're trying to get the organization focus more on increasing the returns on our net investments right now in each of our major verticals.

Great. And then last question if I may. You mentioned in the release, also your prepared remarks the inefficiencies from initial production of new fixtures. I guess everybody knows when you start producing in tens or low hundreds. It's not ideal from a cost standpoint. Can you maybe quantify for us the headwind that you saw in the quarter? Any color around the potential financial impact or margin impact in the quarter. And then can you approximate for us the number of SKUs that you have launched? And what's a fair expectation for those as far as revenue production over the next year?

Thanks, Craig, Jim here again. The impact was more heavily weighted to graphics. In Q4 as we had pilot activity for two major initiatives, first the Mexico petroleum initiative. As you know we have a strong relationship and base our solutions with domestic petroleum customers, but the Mexico opportunity required new design activities certainly language along was a differential. So there was quite some cost and effort and disruption associated then with design, the pilot run and the initial production and shipment activity of those products. And similarly with the QSR activity where this is just a great result of an opportunity that was a lengthy gestation period; these type of initiatives we've been working over nine months relative to this initiatives involving complete new design for the customer, developing pilots and markups, having reviews with the customer, getting those approved and showing them the differentiating factors of our solution and how that's going to improve the consumer experience for QSR customer. So that has been a significant effort in our factories in developing those. The solution involves are enclosures, our structures, the embedded of the digital signage into those structures and then of course turnkey type installation. So in terms of the impact to the graphics business and probably had 100 basis point range type of the impact in Q4. To a lesser degree we had a lot of activity but we're more experienced with this on the lighting side with our [Indiscernible] of new products involving the outdoor areas, the garage light, the under canopy and so forth. So less so there, but we didn't have the margin challenge in lighting in Q4 as we saw in graphics. Hope that helps.

That's great. Thanks again for taking my questions. I'll hop back in the queue.

I would just add to that one of the benefits of that was their product design and product launch process and if its – it was a much streamline process and we think we can benefit from that. And it went a long ways into our thinking in terms of making John Bagwell our Senior VP of Product Development.

Thank you. [Operator Instructions] And our next question will come from Greg Elsen with Singular Research. Your line is now open.

Thanks and good morning. In the press release, yes, the press release you quoted that the LED product sales in lighting were up about 14%, yet your legacy product lines in lighting were down 58%. And this is an environment where the industry you're quoting from sources is down call it mid single-digit percent. So I'm trying to understand essentially when does the drag from exiting the legacy business line and I mean, 40% growth in the LED related lighting sales, sounds pretty darn good. Could you talk about the moving parts of what's going to continue to work in the lighting segment and what is the drag to your overall sales and the lighting segment going forward in the next quarter and a quarter after that from the legacy product lines that are going to zero essentially?

Yes. Thanks Greg. Jim here. I'll start. As we noted in the press release LED now represents 93% of our lighting fixture sales. Our remaining legacy sales really represent just several select national account activity. We still prefer that. So in support of our national accounts as they continue to look to transition, we will continue to provide them with legacy product, but we're really getting near the tail end of that right now. Outdoor literally it's almost fully converted. The remaining activity is more so just on some remaining indoor applications for a few key customers. With regards to your point about, the opportunities and challenges, LED – our focus is on providing LED solutions where our products are going to be valued where they make a difference. So we're not necessarily the volume guide, that's now our gain. Our emphasis on where customers have specific solutions in mind and we are very good at those custom applications, our ability to respond and focused and provide the value they want which will then also provide value to ourselves. Do you have anything to add?

That's well said.

Okay, okay. Well, again looking at sales going forward, from your response to the prior questions about the price increases of materials from the tariff and such, it sounds like you put in one round of price increases and you're looking at going for a second round of price increases possibly. So when we think about the top line going forward is it fair to say that those price increases won't be – if you call the 2% price increase that doesn't mean sales go up 2% automatically just from that price increase because it feathers in overtime I assume. Is that a reasonable expectation about how you implement your price increases? Trying to understand how much of your growth could come just from price increases in the next quarter?

Some of that price – I mean most of that price increase is primarily on the lighting side of the business, so it's not the entire revenue line that you would be expecting. The growth in revenue is not going to be necessarily coming price increases. The top line growth is going to be coming from a number of these opportunities that were laid out the new products that we're introducing particularly those focused on outdoor lighting that really impact the petroleum markets as well as automotive and some of the other key markets, are areas where we are seeing good growth opportunities right now. That combined with the opportunity, Jim had mentioned earlier about the large QSR project or it’s a conversion opportunity, more than an opportunity we've actually given the award for that. It's a -- but the opportunity is for over 3000 conversion sites which is significant and over which certainly gives us a lot more confidence that we should be able to see mid-single digit growth through this coming year in terms of the top line. We don't give specific guidance, but we feel that mid-single digit growth is possible for this year.

Understood, understood. Early in the call you mentioned that you have three product lines, which could even say, it might even be six product lines based upon the year. The product lines that you called incubation that you don't really show up in the top line significantly? Is it possible to therefore estimate and disclose the margin drag embedded in either gross margin or operating margin percent from those incubated product lines? Is that something you could talk about?

No. it's really what we would consider its really part of product development and R&D investments that we're making. So we continue to invest in the business and we don't necessarily determine what kind of margin drag that is necessarily on our businesses.

Greg, Jim, here. The incubated businesses, there is a margin drag, its more so having them separate -- it was not allowing us to optimize the sales growth opportunities, right. So example, having just a separate dedicated control sales force was not best way for us to optimize controls placements in the lighting marketplace, right? So having that integrated with our lighting, sales organizations now align with these verticals I think is really going to allow us to accelerate. So it's more about growth acceleration versus any type of margin activity.

Yes. But Greg, we will continue to invest in new technologies like IoT technology and there maybe an incubation period going forward for some of these new technologies and -- but for a number of these businesses that we felt we're ready to really -- that they were commercialized. We unleashed them into the market, and put them into the market channels where the sales channels can really accelerate their growth, but we're going continue to invest in new technologies -- will be incubation. So that -- but we view that as investing in the future not as a drag on margins.

Okay. Thank you very much. I'll let someone else go.

Thank you. And I'm showing no further questions in the queue at this time. So now, it's my pleasure to hand the conference back over to Ron Brown, Chief Executive Officer for some closing comments and remarks.

Well, thank you. First of all, I'd like to thank all those that ask questions and participate on the call. Appreciate your interest in LSI. We certainly intend to move LSI forward to be a stronger company, a company where our customers value us more than anyone else in the industry, and while there is still a lot of work to be done, we're accelerating our growth. Thank you very much. That concludes my remarks.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program. And you may all disconnect. Everybody have a wonderful day.