LSI Industries Inc. (LYTS) Q3 2021 Earnings Report, Transcript and Summary

Greetings, ladies and gentlemen, and welcome to LSI Industries' Fiscal Third Quarter 2021 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator instructions] It is now my pleasure to introduce your host, Mr. Jim Galeese. Thank you. You may begin.

Good morning, everyone and thank you for joining. We issued a press release before the market opened this morning detailing our fiscal third quarter results. In conjunction with this release, we also posted a conference call presentation in the Investor Relations portion of our corporate website at www.lsicorp.com. Information contained in this presentation will be referenced throughout today's conference call. Included are certain non-GAAP measures for improved transparency of our operating results. A complete reconciliation of third quarter GAAP and non-GAAP results is contained in our press release and 10-Q. Please note that management's commentary and responses to today's questions on the conference call may include 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. Today's call will begin with remarks summarizing our fiscal third quarter results. At the conclusion of these prepared remarks, we will open the line for questions. With that, I'll turn the call over to LSI President and Chief Executive Officer, Jim Clark.

Thanks, Jim and good morning, all. Thank you for joining us on today's call. Let me start by saying I'm very pleased with the continued progress of the LSI team in what still seems to be very uncertain market conditions. COVID and its restrictions continue to decrease on a daily basis, however, its effects on project timing, labor and supply chains are all still very present. Despite these challenges, I'm happy to report that we experienced positive year-over-year growth in net sales for the quarter and prior year. In addition, gross margins, adjusted net income, operating cash flow, and adjusted EBITDA, all improved compared to last year. Typically, our third quarter is our slowest quarter as weather conditions across the country affect our outdoor installation activities. Starting out in January and into the first part of February, conditions were a bit sluggish; however, we experienced an exponential increase in sales and order activity in the second half of the quarter. And I fully expect this momentum to continue into the fourth quarter. Although lighting sales were down approximately 7% when compared to the prior year, our quote levels continue to increase measurably and the sales gap versus prior year continues to narrow with sequential improvements each quarter. Lighting segment adjusted gross margins for the quarter were 31% showing a 530 basis point improvement over prior year with adjusted operating income for lighting more than tripled prior year levels in the third quarter. The introduction of more than 20 new LSI lighting products throughout the year have allowed our agents, partners and sales team to offer multiple solutions and price points while increasing our close rate, margins and profitability. As I spoke of last quarter, we've been focusing on our sales force and sales force effectiveness. As part of the study, our sales leader Pablo Leguina has spent most of the quarter executing a reorganization of our national accounts team in an effort to develop more organic sales leads and opportunities for our agents, our partners and our company. Early results are very encouraging and we will continue to focus on creating more value from our direct sales force efforts. Turning to our stock and flow business, Atlas introduced an entirely new product line in March called Origin. This product allowed client - allows them to have multiple price points in the market. Origin will continue to roll out over Q4, but it will allow us to capture more of the value segment of the market. We're very excited about this. In addition, I would also like to mention that Atlas introduced an entirely new product category called the wall pack, Witness in Q3. This product takes a traditional Atlas wall pack and embeds a security camera into the unit allowing customers the ability to review activity through a phone or tablet application, all for a price point only slightly higher than the original classic wall pack product line. On the graphics front, sales increased by more than 20% versus Q3 of last year. Our digital graphic programs continue to gain momentum with a growing list of customers and our project with one of the world's largest QSR companies continues to be on track and delivering excellent results to the customer and to LSI. We expect that this project will continue its current pace for at least the next 12 months, at which point we plan to transition to the already committed indoor phase. I expect that overall this project will extend well into calendar year 2023. As I noted in our press release, we've also been working on a new secure digital kiosk solution for a nationwide pharmacy retailer, in addition to prototyping a number of possible solutions for the growing grocery store segment of pickup and delivery. Switching gears, petroleum graphics continues to remain strong with activity now expanding in Mexico as COVID restrictions ease. The group did experience a bit of a challenge last quarter as we lost six work days to the Texas snowstorm and resulting power outages. No orders were lost but rescheduling and timing has put pressure on the entire graphics team to make up for the lost ground. Lastly, I'd like to mention our Adapt group. This is the group that handles our installation and project management and they've been key to our expansion in integrated lighting and graphics projects. Adapt continues to grow in both its capabilities and importance in LSI's value proposition. Fiscal year-to-date revenue has increased almost 50% when compared to last year. In the last quarter alone, we engaged in several new projects, including a site assessment project for one of the world's largest convenience store chains. If this project continues to develop as we expect it will, it will create significant opportunity for LSI well into the future. Overall, I'm pleased with our results in the third quarter and I'm confident that we will continue to execute in the fourth quarter. We are working well as a team and continuing to look for organic growth and M&A opportunities. I know these efforts will benefit our employees, customers and shareholders alike. With that, I will turn it back over to Jim Galeese for a deeper look at our financial performance for the quarter. Jim?

Thank you, Jim and good morning everyone. I'll start by highlighting key financial statistics for the fiscal third quarter and then provide additional comments on segment performance. Net sales were 72 million for the quarter, growth of 2% over prior year. Net income was 1.5 million compared to income of 1.9 million last year. It is important to know that the third quarter last year included a non-reoccurring pre-tax gain of 3.7 million resulting from the sale of the North Canton, Ohio facility. Non-GAAP or adjusted net income was 1.8 million versus a loss of 1.1 million in the prior year. Earnings per diluted share were $0.05 versus $0.07 in the prior year quarter and non-GAAP earnings per diluted share were $0.07 versus a loss of $0.04 per share last year. Adjusted EBITDA was 4.4 million compared to 1.6 million in the prior year. The company generated 10.6 million of free cash flow in the quarter or more than 230% of adjusted EBITDA, increasing our cash balance to 23.5 million, as we exit fiscal Q3. Also in the quarter, we extended the maturity of our revolving credit facility from March 2022 to March 2026, and increased total borrowing availability by 25 million to 100 million. We believe our current liquidity and access to capital will allow us to fund our current operations, as well as our growth objectives, both organic and inorganic. The company had no long-term debt at the end of the quarter. A regular cash dividend of $0.05 per share was declared payable May 11th for shareholders of record on May 3. Shifting to segment operating performance, Q3 was a quarter of fluctuating market conditions for both segments, driven by the lingering effects of COVID and adverse weather conditions. And despite the disruptions, both segments reported increased adjusted operating income versus prior year. Project quotation activity took a stair-step increase in March, contributing to a book-to-bill ratio appreciably above one for the quarter. The quotation and order activity were broad-based across multiple market verticals, geographic regions of the country and products. Specific to the graphic segment, sales increased 20% in Q3, driven by our digital solutions business, notably the $100 million program in the QSR vertical. As mentioned, sales in the petroleum/c-store vertical were adversely impacted in the quarter as inclement weather resulted in lost production at our Houston, Texas facility. We were successful in securing a new petroleum program in the quarter, which involves renovating customer locations at military bases throughout the country. Our program backlog within this vertical remains strong as our design requests for potential new programs. We continue to see increasing renovation opportunities in the grocery vertical, with customers focusing on higher end features and finishes throughout the store interior and our commercial team working to identify new ways to expand our share of business in this vertical. For lighting, sales continue to recover from the pandemic as the sales gap versus prior year continued to narrow. Lighting generated a positive book-to-bill ratio in Q3 and we're encouraged to see project quotation levels coming back in select regions of the country where construction has been severely restricted over the last 12 months. We're also beginning to see larger project opportunities, which decreased significantly during the pandemic. Key indicators, such as the ABI, Architectural Billings Index, continued to improve. The lighting gross margin rate was 31% for Q3, 530 basis points above prior year, increasing the fiscal year-to-date rate improvement to 310 basis points. We continue to focus on all components of gross margin. For this reason, multiple factors are contributing to the improvement, including higher value applications, pricing, new products, designed savings on existing products, quality and manufacturing productivity. As Jim mentioned, adjusted operating income for lighting was more than triple last year. We have been successful today in managing global supply chain challenges and continue to quickly adjust to changing conditions. Because of our planning and actions, including additional inventory of 6 million since Q1, we expect minimal disruption as we manage through the fourth quarter. Inflation continues to spread across select commodities and services. As a result, LSI recently announced additional price changes to various product categories. We expect to offset these costs in both segments through a combination of price management and product cost reduction actions. Moving forward, we intend to continue the trend of gross margin rate expansion. I will now return the call back to the moderator.

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator instructions] Our first question comes from the line of Craig Irwin with ROTH Capital Partners. Please proceed with your question.

Good morning, and thanks for taking my questions. So the first thing I wanted to ask about is revenue progression, sequential revenue progression. So, this past 18 months has been highly unusual for everyone and you guys are making solid progress with the growth year-over-year now. Typically, the fourth call - the fourth fiscal quarter, the June quarter, revenue is up quite nicely, sequentially. Should we count on similar seasonality for LSI in the June quarter? Do you expect the materials increase quarter-over-quarter? And is the right comp not really 4Q20 but maybe 4Q19 and 4Q18, as we reach back to some of the historic performance?

Craig, this is Jim Clark. Good morning and thanks for joining. So we're looking at the fourth quarter, it's kind of a - there's some pressure, the external pressure, if you will, there's two things that we're looking at. One is a labor issue external to LSI, meaning as we export it - as we sell the products and ship them out, we are hearing from a number of our customers, a number of the projects that are going on that labor to get the installations done, through the entire construction chain is struggling. So we're not quite sure what that impact is going to be but we do think there could be some pressure in terms of what actually ends up getting deployed or installed in the fourth quarter. As a matter of - as a course of business here within our business, we are anchoring everything, all our reports, all our reviews have the '19 numbers right next to the '20 numbers and the '21 so that nobody gets distracted relative to some massive improvement because of the COVID effect. But we do - we are aware of this labor issue out in the general construction market and we're also aware of kind of materials inflation issue out in the market. And it's not just the pricing side, it's availability and construction materials. So we - as we were coming out of COVID, we're very positive about that, we're very enthusiastic about that, but we're seeing these other issues that are hanging on that maybe haven't been fully resolved, again, outside the walls of LSI, but we're aware of them.

Craig, Jim Galeese here, let me just support Jim's comments. We're very encouraged by the continued increase in market activity that is going on. As we commented in our remarks, our quotation levels and our orders, our book-to-bill, we feel very good about. It is just very difficult to hone in on a specific number at this point in time and give them the what, Jim mentioned. But we do feel very good about the overall direction. And your point about fiscal year '20 Q4 being the appropriate benchmark; you are right. It's really not we will see a stair-step improvement from that level, given the opening up of the other construction industry and so forth but the level of which is what, everyone, not just ourselves, has to try to hone in on.

Understood, understood. So continued moderate progress and within the constraints of the broader environment. Is that a good way to paraphrase?

Yeah, I think that's very well said, and I will - as we mentioned in the call and on our press release, our quote activity has picked up measurably. But one thing we have noticed and now we've got kind of a broader and longer view of it is our conversion timing. So the quotes come in and we had a certain conversion timing, we could say if a quote came in, generally x percentage of that, 70% of those would turn into orders, 60% of those turn into orders within 60 days or something around those lines. What we're seeing is an extension of that conversion. The quotes don't get lost. They get re-quoted to account for materials, inflation and things like that, but the conversion rate from the initial quote to the close all those things are still seem to be in flux. And what we're seeing is better visibility to the whole construction chain where those changes or where the delays are happening.

Understood, understood. So my next my next question is really about components, chips, drivers and [inaudible], right. There's a lot of conversation out there about shortages in different areas of the semiconductor market. Can you maybe talk to us how confident you are about the availability of sufficient components for the next number of months? Is this something where you could potentially be impacted? Do you have contingency plans already in place, if one supplier is short? Can you just maybe work this out for us and help us understand where you sit?

Yeah, absolutely. So first of all, I'll just say we're not immune to anything but any of these challenges that are out there, and transportation is the other element in there, which is a wild card. But I think as we've discussed over the last few quarters, over the last year-and-a-half, we purposely set out two years ago to diversify our supply chain. We tried to do - there were three elements that we were focused on. One was diversity to prevent any single point of failure. The other was diversity in terms of competitiveness. And the last was this concept of on seeing how much we could onshore our sourcing. We're not completely onshore relative to US sourcing but through those exercises, we diversified our supply chain a lot. So I think we have a lot of redundancy and contingency built into it. And at this point, we're not - we don't anticipate any significant issues.

Yeah. And Craig, just let me add, Jim Galeese here, that we consciously made a decision over the last quarter plus to increase inventory levels, for this very reason, particularly on some of the longer lead time components and so forth. So while it is a daily battle, per se, our team's Mike Beck and the operations team, Brian Vincent, procurement and supply chain teams, have done an excellent job of navigating through this. And as Jim said, we've had minimal effects on the business and we anticipate no major effects in the business throughout Q4 and moving forward.

Understood, understood. That makes sense. So then, operationally, I just wanted to maybe understand a little bit better that the margin progression. Seasonality is, your March quarter is down from your December quarter, so there tends to be some headwinds in there. But can you maybe talk about this moderate 70 plus basis points in margin compression? Was this really just driven by revenue coverage or maybe did mix move against you? And how do you expect margins to play out in the fourth quarter? Should we see an improvement to sort of recent performance? Is there an opportunity to maybe exceed that or did the margins face moderate headwinds, given the transportation and other expenses that are cropping up?

Well there's a lot of things there. I think you just hit the nail on the head, there's a lot of elements, we're kind of battling. Overall Q3 tends to be a little bit more pressure on margin, mostly because of that mix element where we get a little less outdoor, a little bit more indoor. Our outdoor projects, particularly in the northeast, and any places that are affected by weather come under pressure, but we have been stable in what we're doing from a pricing with our partners, our agents, our customers. But we've also been fair relative to whatever our input costs are. We do buy ahead. As Jim just mentioned, we purposely made some decisions to up some of our inventories, our components and things like that. As you know, we're still a build-to-order shop, but getting those pieces and being able to be ready is important. I think that given any external factors, our margin will remain stable or will continue to move up, as we've done over the last few quarters. The third quarter is always our most pressured quarter. So, in totality, I don't have any heartburn about our performance for Q3.

No, it was strong relative to 3Q19, I mean, very strong. And 3Q20, I guess, was a different world.

Right, exactly.

So congratulations, I should say, on the new petroleum customer win. That's really healthy. That's good to hear. Can you maybe frame out for us what this customer looks like from a financial opportunity for LSI, maybe the number of locations and potential content per location? And are there others in the pipeline, you think you can potentially win over the next number of months?

Yeah, well, Craig, as you know because you've been covering us for a long time, these petroleum customers, it is one of our major customers that we've been doing business with for a while, but they accelerated the pace in a kind of a - frankly, it was a - it's a group of military based installations. And they've been - they've in the past, maybe segmented some of that business and so it's a new win for us. But it's all part of that continuing kind of refresh cycle that we talked about so often. I will mention that - I didn't mention it before but I'll mention it right now, because we were able to confirm it yesterday. But we are pretty excited about something happening in petroleum where we have a customer where we're fully engaging in the solar installation. And they've selected us to be kind of the lead on that. We look at it as something that could really be expansive for us as we move forward. And the big thing being that - there's two things - there's two elements we're looking at in terms of value to the customer and the way we're playing. One is just the whole, this transition, carbon offset being a better constituent in terms of supplier in our presence here in the US. The second being that there's a number of places where we're able to use solar as emergency power and I think that they're grasping onto that concept right now. So we're going through a confirmed installation. It will take us a better part of six months to get all the permitting and work that we need to do in the background. But I did want to mention that I wasn't able to mention it before, because we weren't able to confirm it until yesterday but that is something we're really excited about on the petroleum.

Great, well, congratulations on progress and good luck for the summer selling season.

Well, thank you, Craig. Take care.

Thank you. Our next question comes from the line of Amit Dayal with H.C. Wainwright. Please proceed with your question.

Thank you. Good morning, guys. Thank you for taking my questions. With respect to the graphic segments, you pointed out an opportunity with the pharmacy chain. Is this similar in size, potentially, to what you're doing with the QSR, the $100 million level opportunity or is it maybe a little smaller, any color on that will be helpful? Thank you.

Good morning, Amit. Thanks for the question. I'd be hesitant to comment on the size right now. We're really in a multiple prototype stage. So depending on which direction they ultimately end up going on will really determine the size of the project and the deployment schedule. I think we're going to need another quarter or so to be able to answer that question with confidence. However, I will say that based on preliminary kind of discussions, I don't know if it would quite reach the $100 million mark, but I think it could be significant. It is early. It is early to forecast on that.

Okay. And with respect to the QSR project, how much of that has been delivered?

Oh, I would say that, if I would just put it in percentage, we're still - we're just coming up to the 50% mark right now. We've got a full year left. We will be fully engaged in that through our entire fiscal '22. And we've got a second follow on which is the indoor aspect of that, that will follow in '23, our fiscal '23. But we will certainly continue to be engaged in this until into calendar year '23. And I would say - Amit, I will also say that our deployment schedule will remain fairly consistent as we're looking at it right now for at least the next 12 months.

Okay, understood. Did you face any sort of labor challenges in this past quarter or is it something that you were anticipating that might become bigger? Just trying to see if there was any impact to potential deployments because of those issues already or is this something that may be coming down in the future?

Yeah, well, I'll break that into two pieces that is kind of internal to LSI and external to LSI. The external, we just talked about it with Craig's question, and it's really through that whole construction chain out in the field, so to speak. Within LSI, we're not immune to the environment right now that's going on, as our business, any surges and things like that they require us to add labor, it is a challenge. There's no question about it. Now, with that said, we sat down with the operations team and our human resources team over four months ago and they put together some pretty innovative plans to be able to make sure we can staff up for it. We've tested it in limited testing and we're continuing to expand that. But it certainly could hit us but I believe that we have some plans in place that would mitigate that risk significantly.

Understood. The sales reorg, that is taking place, is that just for the lightning segment or is it also for the graphic segment?

It's mostly focused on the lightning segment. If you've looked at the history of things that we've done on the commercial side, we sat down on the graphic side, it was one of the first things we did, because it was part of that whole reorganization where we consolidated the operations up in Akron-Canton and created much stronger continuity between our Houston operation and our Akron operation. And as part of that, we were able to look at the commercial side back then, let's say, 18 months ago, 12 months ago. So, most of the reorganization that Pablo is leading right now is really associated with lighting. And I think it's the area we have the greatest opportunity in right now, from a commercial reorganization perspective.

Understood. Okay. Okay. You highlighted maybe some further improvements coming on the gross margin front, how much more room is there with your current sort of setup to improve margins?

Well, if we were operating in a vacuum relative to the commodity pricing and materials pricing and shortages and transportation costs, I think that we still had some ways to go. If you factor in all of these items that are happening kind of real time, I still think that we can - we have the goals in place, Amit, to make sure that we are working towards those, we have the KPIs that push the teams and us, as an organization, to get there. I believe that we can still continue to make incremental improvement but we do have headwinds that are that are kind of offsetting some of our efforts. I don't expect us to slide backwards in any regard. But so much of what we're doing, particularly as we come into this fourth quarter, with things opening up and stuff is new to us. I think it's new to all businesses that are facing this, this reemergence from COVID. So, the short answer is, is that I think we still have some room but we certainly have some challenges.

Amit, Jim Galeese here, let me just add is. As you know our goal is double-digit EBITDA and we're on a nice path of progression to attaining that. And certainly a key element of that is going to be an ongoing improvement in our gross margin rate. Now, that's going to come from multiple pieces, volumes of components are there, the quality - the higher value content of businesses is a piece of that, and then, of course, all the operational elements. That's what's allowed us to achieve our margin expansion that we've driven over the last 18 months or so. And it's going to be those same variables with the volume component that's going to continue to allow us to drive margin expansion moving forward.

Understood. Thank you, guys. That's all I had. Appreciate it.

Thank you, ladies and gentlemen, at this time, there are no further questions, I would like to turn the floor back to management for closing comments.

This is Jim Clark. I just want to say thank you again for taking the time and investment to tune into our updates and find out what our company is doing. As I mentioned in the press release, I'm very happy with the results of the third quarter, the effort that teams put in, and I'm very encouraged with the fourth quarter as a country, as we start to emerge from this COVID pressures that we've been dealing with for the last year. I just want to say thank you again and we look forward to talking to you in the next quarter. Take care.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.