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Edited Transcript of LYTS earnings conference call or presentation 22-Aug-19 3:00pm GMT

Q4 2019 LSI Industries Inc Earnings Call

CINCINNATI Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of LSI Industries Inc earnings conference call or presentation Thursday, August 22, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James A. Clark

LSI Industries Inc. - CEO, President & Director

* James E. Galeese

LSI Industries Inc. - CFO & Executive VP

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Conference Call Participants

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* Craig Edward Irwin

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Joseph Amil Osha

JMP Securities LLC, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Q4 2019 LSI Industries Inc. Earnings Conference Call. (Operator Instructions)

With us from the company today are Mr. Jim Clark, President and Chief Executive Officer; and Mr. Jim Galeese, Executive Vice President, Chief Financial Officer. (Operator Instructions) As a reminder, this conference call may be recorded for replay purposes.

It is now my pleasure to hand the conference over to Mr. Jim Galeese, Executive Vice President, Chief Financial Officer. Sir, you may begin.

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James E. Galeese, LSI Industries Inc. - CFO & Executive VP [2]

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Good morning, everyone. We issued a press release before the market opened this morning detailing our fourth 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.lsi-industries.com. Information contained in this presentation will be referenced throughout today's conference call.

I would like to remind you that management's commentary and responses to question on today's 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.

Today's call will begin with remarks summarizing our fourth 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 Jim Clark.

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James A. Clark, LSI Industries Inc. - CEO, President & Director [3]

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Jim, thank you. Good morning all. Let me start this morning with a few highlights. I'm encouraged by our fourth quarter results as they reflect initial impact of our management priorities and overall organizational and team focus.

Sales of $81.5 million and adjusted EBITDA of $3.3 million were just below prior year and a stair-step improvement from Q3. Our overall sales performance was down 2% to prior year; we continue to close the gap. We had a very strong order book in Q4, which was better than a 5% improvement over prior year and allowed us to exit the quarter with an increased backlog.

We had a solid balance sheet performance and execution for the quarter with free cash flow of $4.8 million as we continue to further reduce our debt by $4.3 million, bringing us under $40 million in outstanding debt. This is without the proceeds of the New Windsor facility sale, which I'll comment on in about a minute. Jim Galeese will provide more information regarding the financials overall.

With the financial overview in mind, I want to share some more specifics and provide comment on our go-forward short-term strategy. As I mentioned previously, our short-term strategy is focused on outdoor lighting in our key vertical markets, where we bring a differentiated offering and solution, including graphics and indoor lighting to our customers allowing us to enjoy a competitive position and drive higher margins.

We do prioritize our outdoor lighting and that drives a better quality of earnings, but we remain committed to bringing a full solution to our customers. It gives us a competitive advantage and differentiates us as a supplier.

Our sales team has embraced its focus on higher-value, performance-based market applications, and we are collaborating closely with our agency partners to bring these solutions to our end users. As a result of this focus, we did see some nice project activity in our key lighting verticals, including petroleum, automotive, QSR and our overall outdoor lighting in the fourth quarter. We plan to continue to capitalize on this momentum.

Turning specifically to Graphics. Our project activity in the petroleum segment remains high as we are currently managing 5 key programs involving both new and existing customers. Momentum is very positive here. Several of the programs are at their early stages of their life cycle, and they are pressing our capacity as pilot and start-up runs are disruptive, but the operation team is managing this well.

Our expansion into Mexico has slowed a bit in Q4 as the oil companies are having a difficult time keeping up with the petroleum demand at these new converted sites. They simply didn't expect such high demand, and they're not able to provide enough gasoline to these new sites. This is good news for all of us and activity is projected to increase again in fiscal Q2.

On the branded and other retail print graphics business, primarily led by grocery and pharma, we continue to evaluate the best position to be in, in this segment as it undergoes changes. A number of our current print customers are taking a closer look at digital graphics solutions as a replacement to print, and we're happy to be at the table in these discussions.

Our digital graphics business continues to perform well. It's underpinned by our position in QSR. It's small, but we do feel well about it. It's subject to swings in project demands, and we continue to learn and adapt as this vertical grows. Lastly, in the stock and flow segment, we had a reasonably good quarter again driven by improved focus on priorities, particularly in sales activities. I'm happy with the team we have in place, and I'm confident they will continue to improve their position.

Overall, I'm encouraged by our commercial efforts. We continue to invest in our sales and commercial team and remain committed to strengthen our commercial activities. With increasing training, education across all fronts, we have a full schedule and a full agenda coming into the year for training for our partners, agencies and distributors among others. This will help drive our emphasis on high-performance applications and solutions. I do want more improvement on our gross margin levels, I know we can do better. The good news is our order book is beginning to reflect the improved mix and subsequently, better margins. This won't be a quick turn, but our focus is shifting, and we can see the opportunity ahead.

Let me switch and comment on product development and engineering. I'm happy to say our focus on specific applications is rejuvenating our new product road map activity and several new projects are scheduled for release in the second half of the 2020. The engineering team has embraced a program to reduce our speed to market while improving our overall product quality. This, coupled with our strength in marketing position and product road mapping functions, will accelerate our road maps. I also want to mention that when I say second half of 2020, I mean, our fiscal half.

On the operations front, our team has completed the transfer of the New Windsor production to our Blue Ash and Independence, Kentucky locations. We proactively scheduled our lead times to be several weeks ahead in June and July to start up and help us with the start-up process. All new lines are projected to be up and running at premove levels by the end of September. The consolidation provides numerous benefits, including improved capacity utilization, lower overall base cost and annual cost savings that we've talked about on prior calls. The move did have an unfavorable impact to margins in Q4, however.

Lastly, I want to mention that our operations team is dedicating considerable time to improving our supply chain and that's reflected in overall inventory -- lower cost and inventory.

In regards to the approximately $12 million sale of our New Windsor facility, the town of New Windsor was required to approve the sale of the property before close. This process took a little bit longer than we had hoped for, however, I'm pleased to announce that the town did approve the sale on August 8, and we anticipate to close this sale by the end of September.

In summary, I'm encouraged by the evidence in progress validating our management agenda is on the right path. Fiscal year 2019 was significant change in disruption to the business, but we're exiting with a much clearer direction and set of priorities. Work remains for our business to achieve the performance expectations we defined for ourselves for 2020 and over the next several years. But momentum is building, the team is committed in achieving the balance required for successful high-performance business, and I'm encouraged with the progress we've made so far.

With that, I'll turn it back over to Jim Galeese for a deeper look at our financials.

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James E. Galeese, LSI Industries Inc. - CFO & Executive VP [4]

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Thank you, Jim. 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.

Let me start with key financial statistics. Total fourth quarter sales were $81.5 million or 2% below prior year. Adjusted EBITDA was $3.3 million versus $3.6 million for the fourth quarter 2018. Adjusted operating income of $828,000 compares to adjusted operating income of $1 million for Q4 of the prior year.

Fourth quarter GAAP reported earnings per share were $0.03 versus a loss of $0.10 a share reported last year. 2019 fourth quarter GAAP earnings per share includes a net favorable effect of $0.03, the result of the tax effect related to the expected sale of our New Windsor facility, partially offset by restructuring costs.

GAAP results contain restructuring costs of approximately $1 million for the quarter. The company exits the year in a net tax benefit position. A complete reconciliation of Q4 GAAP and non-GAAP measures is contained in our press release and 10-K.

The balance sheet continues to improve with fourth quarter free cash flow of $4.8 million and debt reduction of $4.3 million. The business exit fiscal '19 with debt under $40 million, finishing at $39.5 million. EBITDA and a sequential decrease in working capital from Q3 contributed to the $4.8 million cash flow.

Local government has approved the sale of the New Windsor facility with the closing projected to occur by the end of Q1. Proceeds of the sale are projected to be approximately $12 million. The transaction will have no tax effect in fiscal 2020 with the capital gain offset by existing long-term capital losses.

Our regular cash dividend of $0.05 per share was declared payable September 12 for shareholders of record on September 3.

Next, I'll briefly comment on the performance of our 2 reportable segments. Starting with Lighting. Sales of $57 million were 7% below last year. Sales were soft in several verticals in the project channel, while the stock and flow channel had a good quarter. Also important to note that sales were constrained by approximately 2 points due to the New Windsor production transition. A number of orders were proactively rescheduled to July to more effectively manage the transition.

Lighting gross margin was 23.4%, unfavorably impacted by lower sales volume at our higher-margin verticals and start-up costs related to the New Windsor production transition. Lighting order levels for Q4 were high single digits above prior year reflecting improved intake levels for key verticals, including petroleum and automotive. As a result, backlog for the end of Q4 is above the same period last year.

The Lighting Segment is generating positive price realization from the May price increase, offsetting any tariff impact. Lower operating costs served to offset the lower margin rate. As a result, adjusted operating earnings for the quarter were $2.7 million with adjusted EBITDA of $4.5 million or 8% of sales.

Shifting to Graphics. Graphics sales growth of 11% was driven by the petroleum segment, which increased 13% versus a good quarter last year. Momentum remained strong for the petroleum segment with a full slate of program scheduled with both existing and new customers. Graphics segment gross margin and earnings improved sequentially from Q3, but were below prior year. Earnings were impacted by project mix and the unfavorable impact of several one-off adjustments, including a write-down of capitalized software as well as end-of-program customer-specific inventory. Adjusted operating earnings were $762,000 and adjusted EBITDA was $1.2 million or 4.8% for the quarter.

I'll now return the call back to the moderator.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from the line of Craig Irwin with Roth Capital Partners.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [2]

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So Mr. Clark, your comments in the prepared remarks about backlog seem to point to potential for us to see a return to growth early in fiscal '20. Do you think it's possible we'll see the first fiscal quarter up over the prior year levels?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [3]

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Craig, yes, certainly, if you look at Q4, as I mentioned, we were down 2%, but that's quite a gap closure from looking at Q3 and kind of historic performance. I certainly anticipate it will be up in Q1, and that's our goal. Obviously, we have some seasonality to our business outdoor lighting, that type of things. So there's a number of things here to balance, but our goal is definitely to be up.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [4]

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Great. That's good to hear. Next thing I wanted to ask is about the impact of the New Windsor transition during the quarter. So you did say that the negative 7% we saw in Lighting was impacted by about 2 full points -- 2 full percentage points from this transition. Can you maybe frame out for us what it would have been sort of from a margin perspective? And would we have seen a benefit from higher utilization? And are these potentially some of your more interesting margin projects that were pushed into the first fiscal quarter?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [5]

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All right. Let me break that down into a couple of different answers. I'll kind of go backwards. New Windsor was primarily indoor lighting. So the transition relative to New Windsor was just the disruption that occurred in the -- in order to make up for that -- shutting down the factory and moving it here, we absorbed overtime and task reorganization here to get our workflows and transfers up at as quick a pace as we could. So obviously that had some impact -- overall impact on the business.

The stuff that -- the projects that we moved or the products that we moved are our lower-margin products so -- that I don't anticipate that getting those up and running is going to have a big impact on margin. And then, overall, it's mix shift, right? It's -- the more we do outdoor, the better our quality of our earnings are, the better we do. So it's really a commercial effort as opposed to the New Windsor close.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [6]

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Great. And then just to check on the $12 million in cash you mentioned previously. You would probably use that to pay down debt. Is that still the intention once you have the cash in the bank?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [7]

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Absolutely. I mean, I think that I'm very happy with what we've been able to contribute in the fourth quarter. It's nice that we've come under $40 million. Our ratio is at 2.7 now, and I anticipate that, that'll come down even -- well, obviously, mathematically, it will come down further when we apply the proceeds. But it's a key focus, and I'm very happy with the progress we're making.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [8]

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Excellent. And then another thing you mentioned that I found interesting was the progress at Atlas. The market leader did not report the same kind of positive progress in the quarter. So you guys are obviously outperforming there. Can you maybe give us a little bit more color? Is this the transfer of traditional LSI SKUs over to Atlas that's helping? Is it basic blocking and tackling? And can you maybe clarify for us, do you feel like you outperformed the market during the June quarter over at Atlas?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [9]

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Yes. So I can't comment about what the market was doing specifically in terms of competitive position against Atlas. I mean, I'm only -- I can't comment only because I wasn't really tracking that, that closely. I think that, as you know, we hired a new President down in Atlas. We've been making investment in the commercial efforts down in Atlas. And frankly, most of our progress has simply been us getting back up in front of our customers. They like the product. I think that Atlas has a good -- a brand recognition in the market. They have a good quality product and it was really the service component being out in front of them that helped us quite a bit.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [10]

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Excellent. And then last question, if I may. EBITDA margins are continuing to improve off the bottom in the last couple of quarters. How do you feel about the potential for EBITDA margins to continue to firm over the next number of quarters? Obviously, this is a focus and something that you really committed to achieve, but is this something that's going to happen in fits and starts? Should we maybe expect this in the first quarter? And do you have any internal targets for the end of the year that you might want to share with us?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [11]

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Yes. Our goal is always to make this as linear as possible and avoid those stops and starts, but market, timing, in terms of the demand seasonality with our products, all those things have an impact on it. But I mentioned in my remarks a little while ago, it's about the quality of earnings and the more we have outdoor, the better our earnings are. The more we connect our projects with Graphics, the better our earnings are. The more we leverage our digital signage with outdoor, the better our margins are.

So it's really about shifting and making sure that we have the stickiness from this -- on this strategy component, which is, "Listen, let's lead with outdoor. Let's make that our differentiated offering. Let's make our customers aware that, that's where we compete almost exclusively relative to the products that we have." We believe there is some great differentiation in those products. We believe that there's some great differentiation in the way we're able to package Lighting and Graphics together. And when our customers buy into that and when they see that value, we all benefit and it turns out that our margins and EBITDA improve.

I would just say this, Craig, that our goal is obviously to continue improving, but this is a long road. This is not -- what I want to avoid is, is that we do have a lot of those stops and starts, and I'm not pressing that change so that we have an impact to our top line, but our margins improve, but we're not able to overcome the drag because we missed on our top line. So it's a journey.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [12]

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Excellent. Well, congratulations on the progress. We look forward to watching this journey continue. Hopefully, in the right direction as it has been.

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James A. Clark, LSI Industries Inc. - CEO, President & Director [13]

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Thank you.

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Operator [14]

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And our next question will come from the line of Joseph Osha with JMP Securities.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [15]

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Following a little bit on Craig's question. You have spent your fair amount of time and this came up in LIGHTFAIR, reconfiguring your sales and your marketing, and obviously, you've made some progress there, but how should I think about what's left to show up as a result of that organizational effort?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [16]

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I think we're on the beginning of it. I mean, I think that this is a cultural change. And when you're changing the culture of the company, it happens slowly, right? You don't put too much pressure on it; you break the organization. You put -- but you do put steady and solid pressure on it. So I think we're in the beginning stages of this kind of transformation. I think there is a lot of opportunity and it extends not just on the front end, but it extends in the back end too. And we are meeting with our agencies, our partners. Those type of relationships are so critical to us. We're educating them as we go along too. And I made specific comment in my remarks, there's training programs, there's awareness campaigns, there is arming them and teaching them and educating them about what differentiates Atlas compared to the others. And as we do that, and we get -- we continue to get traction, we continue that improvement. So as I was saying to Craig, it's a journey. And it's -- I think we're at the beginning of it.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [17]

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Okay. And so let us -- following that, let's imagine that it's 2 years from now. And I'm looking at these bar graphs here on Page 5 and Page 6. And in particular, I'm looking at Lighting Segment sales and Graphics Segment sales and without putting numbers on it. How do you imagine that mix looking? And in particular within that Lighting business, how much of it is outdoor versus indoor just conventional stuff?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [18]

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Well, we don't usually -- we don't break up the indoor, outdoor. And we don't get into that specifics externally, but we certainly look at it indoor -- I mean, internally. And the message to the team is, listen, we want to be leading with the products and the solutions and in the markets that we're most differentiated. The lighting industry is very competitive and very tough industry as it is. We want every competitive advantage we can bring to the market. So generally when we are -- when we have a project that is more heavily weighted outdoor than indoor, we enjoy a benefit. When we start to get away from that balance and it becomes upside down, well, say when it's more indoor than outdoor, we lose that competitive advantage and that usually shows up in margin erosion or the quality of the earnings on that project.

But when I look at the whole thing, when I look out 2 years, 3 years, it's our mix and our focus on vertical markets that creates the biggest differentiation for us. We remain disciplined on that, we remain connected with the agents that understand that, we walk away from projects that are -- that we just don't enjoy a significant leverage in. We don't enjoy something differentiated, and then we take that time that we're creating and we move it towards those projects where we do and we put the effort into winning those. That's how we get there. I -- go ahead.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [19]

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Sorry. Would it be fair to say then and you -- I heard a comment earlier that right now you've got this problem where you can't just shut down your indoor business because you've got some fixed cost absorption within the organization that you got to cover so you can't just flip it. But over time, it kind of sounds like if you can slowly walk the business away from that segment, which isn't particularly margin accretive for you, you will do it. It's just going to take a while. Is that a fair characterization?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [20]

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Well, I want to be careful because this stuff often comes back as a sound bite. We are not abandoning our indoor business, all right? So we will -- we want to be a solution provider to the vertical markets that we have competitive advantages in. And petroleum, we reference it a lot, but I'll just speak about the petroleum market. We want to be able to provide the outdoor lighting on the canopy. We want to be able to provide the graphics across the whole canopy fixture, the pumps, everything that the customer wants. We want to bring that towards the building and have the wall packs and the outdoor lighting around the facility itself, and we want to go right indoors with that and provide the indoor lighting, interior graphics, digital signage. That's a great example. Automotive, same thing. Whether it's a car dealership or rental car or kind of a newer car sales efforts out there like CarMax or whatever it is, we want to be on the outside with our exterior lighting. We want to go right into the showroom with specific lighting that's made in conjunction or designed in conjunction with the requirements of the customer, and we want to go right back into the service bay area with the proper lighting to help them in the back whether it's paint or whether it's finishing areas or whether it's mechanical areas where undercarriage lighting, good lighting from above, all of those type of solutions. So we're definitely not abandoning lighting, but when we look at -- interior lighting rather. But when we look at a project like, let's say, a hospital -- a city hospital that has -- or an office building might be a better example, that has very limited outdoor exposure and has just floors and floors of lower-value interior lighting, it's not necessarily that if that customer's a partner of ours, we won't help provide a solution there, but I'd much rather take that same time and effort and put it into one of the vertical markets we're in or a customer that has a bigger balance of interior and exterior lighting.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [21]

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Okay. I get it. That's helpful. Just on the capital structure point. Obviously, you're delevering. That's great. You're kind of an unusual company in so far as you're delevering, but you're paying a dividend, which, I think, is great. How do you ultimately think about capital structure? Do you want to make this is a 0 debt company and convince people that the dividend's well covered? Or do you want to be maybe a little bit more efficient and continue to lever the balance sheet a bit? How do you think about what that progression should look like?

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James E. Galeese, LSI Industries Inc. - CFO & Executive VP [22]

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Joe, Jim Galeese here. We monitor and maintain various models on our capital allocation perspective, and we do value, particularly right now, the dividend as a key part of that, but it really depends, as we go forward, on certain both organic and inorganic opportunities.

Right now, the ability to pay dividend and reduce debt is also not restricting our ability to continue and invest in the business, both from a capital point of view and both from an operating expense point of view, particularly in the commercial area of the business. As we move forward, and if we see certain very large initiatives that we want to pursue, either organically or inorganically, that may change the alignment of that model a bit.

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James A. Clark, LSI Industries Inc. - CEO, President & Director [23]

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But I will say this, just for clarity. This is Jim Clark again. Part of our capital allocation model specifically address our ability to pay dividends. It's always at the Board's discretion. We meet with the management team. We have our recommendations, but I can tell you that we have very tight alignment with how our capital allocation model's laid out right now, and it does include the continued payment of dividends.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [24]

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Sure. So if I kind of hear -- take on board what I think I'm hearing it's, "Look, organically, we're going to continue to delever the business and get shareholders comfortable with the fact that this dividend's well covered. Should some opportunity on the inorganic side present itself that would might involve relevering the business, that would be okay. But that would -- that's not necessarily something that's in the plan. All other things being equal, we should expect to see the balance sheet continue to delever." Is that a fair way of saying it?

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James A. Clark, LSI Industries Inc. - CEO, President & Director [25]

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Yes. I think you're right on. Like Jim said, we're not constrained right now in the things we're looking at and the things we're doing. We're not constrained and paying the dividend doesn't put any pressure on us. But if a great opportunity came up, I inversely think every shareholder out there would say, "Hey, you know what, that's a great program. That's a great opportunity. Whatever it is, I'll forego a dividend, if that's what they think is best." But that isn't even on the table at this point.

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Operator [26]

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Ladies and gentlemen, this concludes our question-and-answer session for today. So now it is my pleasure to hand the conference back over to Mr. Jim Clark, President and Chief Executive Officer, for closing comments or remarks.

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James A. Clark, LSI Industries Inc. - CEO, President & Director [27]

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I just want to say thank you again for participating and listening to our call and having LSI on your radar. I think we're making great progress Q4. Obviously, we would like to see -- continue to do this, and that's our plan is to have additional quarters just like we did here in Q4. I mention it to all the folks we meet with on a regular basis. We're always available if you would like to come and meet with us or visit our facility, please feel free to contact us. Thank you very much for the time.

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Operator [28]

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