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Edited Transcript of LYTS earnings conference call or presentation 25-Apr-19 3:00pm GMT

Q3 2019 LSI Industries Inc Earnings Call

CINCINNATI Apr 30, 2019 (Thomson StreetEvents) -- Edited Transcript of LSI Industries Inc earnings conference call or presentation Thursday, April 25, 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

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the LSI Industries Inc. Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Also as a reminder, this conference call is being recorded.

At this time, I'd like to turn the call over to your host to Mr. Jim Clark, Chief Executive Officer and President. Please go ahead.

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James A. Clark, LSI Industries Inc. - CEO, President & Director [2]

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Operator, thank you. Good morning, and thank you for taking the time to join us on today's call. I know many of you have seen our results, but I will review the high level quickly.

For the third quarter of fiscal 2019, we reported net sales of $72.8 million or 8% below Q3 of last year and an adjusted operating loss of $1.9 million, coupled with a debt reduction of $4.6 million. Although these results were not where we would like them to be, they are not a total surprise either as we continue to move forward with our change process.

As I mentioned in our last call, LSI is going through a transformational change. Moving away from the broad market commodity supplier focus, which was adopted over the last few years, to a refocused approach as a partner and supplier in key vertical markets where LSI can bring a differentiated solution to our customers. This change, not surprisingly, is having impact on our top line and profitability as we work through this.

To help drive these changes, we've made a number of additions to LSI to help us strengthen our commercial and operational organization.

On April 1, Seth Walters joined as President of the Atlas business, strengthening our focus on our distribution stock and flow channel. The Atlas team has had several wins over the last few months, and it's just the right momentum for this group as we move into our strong outdoor season.

On the marketing and product development side, we recently filled 2 new senior positions in the marketing organization reporting to the CMO.

These positions satisfy the critical need for us to do better alignment of our product management and marketing with our vertical sales model.

Continued focus in this area will accelerate the market-driven development of new products and solutions and help us to expand our vertical focus.

We also have added a number of targeted sales positions throughout the country. The different positions required specific competencies, and I'm confident that we've hired the right individuals. Expansion of the sales team is designed to strengthen our visibility and relationship with our partners and customers, further deepening our ability to understand their requirements and provide value-add solutions, which benefit both of us.

I dedicated considerable time visiting with a number of our partners in the quarter, reaffirming our commitment to joint success and gathering feedback as to what we can and need to do better to become a better partner. Their openness, transparency and appreciation was incredibly constructive. Many had not met with a suppliers' CEO for years and just making the effort meant a lot to them. I made it clear that it meant a lot to me.

We have also stepped up our communications. A few weeks back, I sent a note to all our partners summarizing key actions the business has taken to date and those planned for the near future. This is just a first step in our plan to elevate our partner relationships and I look forward to seeing many of these folks at LIGHTFAIR, one of our industry's largest trade shows next month in Philadelphia.

Turning back towards operations, I mentioned in our last call that Mike Beck had joined LSI as Senior Vice President of Operations replacing Tom Palmer who retired. Mike has been able to dig into several of our operations initiatives, and I'm excited by his pace and the team's progress.

The previously announced New Windsor production transfer and facility closure project is proceeding on schedule and will be completed by the end of our fiscal fourth quarter. The $4 million annual project savings remains on track, and we have a definitive contract in excess of $12 million for the purchase and sale of facility as well. We expect that this will close by the end of June.

The state of Kentucky and the City of Independence Kentucky welcome the transfer and the move of our New Windsor operations and the added investment in our Kentucky facility. By that, we're benefiting from a small state-funded investment program that the City of Independence in Kentucky has offered to us.

In addition to our work at our Kentucky facility, we finalized the lease agreement to add approximately 40,000 square feet of new space in our Houston facility. This consolidates 2 off-site leases, and it puts them back in house and provides a capacity to manage the continued growth in the Graphics petroleum vertical, both domestically and in our ongoing expansion into Mexico.

Now let me give a bit more insight into our third quarter performance.

Lighting sales decline was impacted by several factors. First, no question, the changes to the sales organization and the efforts to realign our market priorities are causing a disruption in the short term. However, progress is being made, and our order book from March and April is much improved, increasing our backlog as we enter into our fiscal fourth quarter.

From an Atlas perspective, we elected not to run any broad quarter end promotional programs, to simply push products to the distribution market. These types of programs normally serve to disrupt our normal market demand patterns and requires abnormal actions for our internal supply chain and others to fulfill the orders. We elected to take a more measured approach, and I believe it was appreciated by all.

I also want to mention that we were successful in the quarter in achieving our goal of generating positive price realization, and we continue to closely manage both price and our materials input cost.

Coupling this with the previously referenced facility consolidation provides the cost structure and the flexibility to support our focused growth to profitable sales.

Lastly, our Graphics segment had significant activity occurring in the quarter, with sales increasing 16% over plan but generating an operating loss for the quarter.

Let me explain. The petroleum vertical generated double-digit sales growth in the third quarter and was successful in securing another new large customer. As a result, 2 large programs, which are in the early stages of their life cycle, represented over 60% of the petroleum graphics sales for the quarter. Margins for these early-stage programs are typically low and the high mix concentration generated a lower margin, as we work to balance and change the schedules.

The good news is, the margins will improve throughout the life cycle of the programs as the spike of these programs is better balanced.

Our petroleum market remained strong, and expansion into Mexico with our oil company partners continues, contributing to the overall petroleum growth rate both in Graphics and Lighting.

On the other side of our Graphics business, the retail graphics or branded graphics market is incurring many changing dynamics as new entrants featuring online shopping and delivery is impacting many of our traditional print graphics customers. In addition, adoption rates of digital solutions continues at an accelerated pace.

While our print graphics felt some pressure, our digital sales increased 12% for the quarter. The combination of a sales decline for certain print customers and applications coupled with select investments and onetime costs for the SOAR digital business had the largest impact to the Graphics segment result for the quarter.

Digital solutions are less asset-intensive than traditional print technology, and we are developing the plan to align our operations capacity and asset requirements for the changing mix. This will be executed over the coming quarters.

Concurrent with all these change, management activities just mentioned, we've also begun a more formal process of formalizing our thoughts on strategic aspirations and goals for the company, where and how to win and the capabilities in the management systems that will enable this path of success.

The LSI team is committed to profitable and sustainable growth, and I look forward to sharing more as the framework develops throughout the coming year.

I want to say thank you for your continued confidence in LSI. I do believe we have a strong defensible position in the market and many opportunities lie before us.

With that, I'll turn it over to Jim Galeese for additional comments on the quarter.

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James E. Galeese, LSI Industries Inc. - CFO & Executive VP [3]

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Thank you, Jim, and good morning, everyone. As a reminder, today's discussion 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.

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 third quarter sales were $73 million or 8% below prior year. The company adjusted operating loss of $1.9 million compares to operating income of $800,000 for Q3 of the prior year. Q3 adjusted EBITDA was $700,000 or 1% of sales.

Adjusted earnings per diluted share for Q3 was a loss of $0.08 compared to earnings per share of $0.01 for Q3 of fiscal '18.

Moving to reported GAAP results. A GAAP net loss of $3.2 million was reported for Q3 and reported EPS was a loss of $0.12. The GAAP results contain restructuring charges of $400,000 for the quarter, the majority related to the New Windsor facility production transfer project.

Although the company projects a federal tax benefit position in fiscal 2019, compliance with accounting standards required a tax expense to be recorded in the quarter. The fourth quarter is projected to report a tax benefit.

A complete reconciliation of Q3 GAAP and non-GAAP measures is contained in our press release and 10-Q.

Regarding the balance sheet, working capital decreased sequentially from Q2, assisting in reducing our debt level $4.6 million from the prior quarter and serving to increase our available line of credit.

A formal program to structurally reduce inventory was initiated early in the quarter and results already realized with a reduction of $2.5 million in Q3. Additional reductions are projected for Q4.

In addition, we announced a definitive agreement for the sale of the New Windsor facility, with the sale expected to close on or before June 30. Proceeds of the sale will be approximately $12 million. We project a long-term capital gain on the transaction. However, the company has a long-term capital loss carryforward. Therefore, the transaction is projected to have no tax effect.

Capital investments were $800,000 for the quarter or $200,000 below Q3 prior year. The majority of expenditures were related to the production transfer and investments and other productivity programs and tooling for new products.

Next, I'll comment briefly on the performance of our 2 reportable segments.

Starting with Lighting. Sales of $53 million were 14% below last year. Sales were lower in multiple market verticals influenced by the factors Jim described in his commentary.

Lighting gross margins declined, with both the dollar and a rate decline volume related. The business was successful in generating positive price realization for the quarter, realizing several points of the October 2018 price increase. This served to offset changes in material input costs, including the impact of China tariff activity, which was effective in late September 2018.

We've increased our efforts on design cost-reduction programs and several key programs are in process, which will be effective over the next 2 quarters. The positive Lighting book-to-bill ratio increased the backlog as we entered Q4.

Lighting adjusted operating earnings for the quarter were $1.1 million, with EBITDA of $3 million or 6% of sales.

Shifting to Graphics. Graphics sales growth of 16% was driven by the petroleum segment, which increased 27% versus last year.

We were successful in securing another project with a new customer. Sales to this customer were over $1 million for the quarter. Our expansion into Mexico continues at an accelerated pace. We have now completed over 400 petroleum sites, with over 250 being turnkey, a combination of product and installation solutions. The outlook here remains positive. Digital graphics sales increased 12%, with gross spread across several projects and customers. The decrease in Graphics margins and operating performance for the quarter reflects the impact of a combination of decisions, all positioning the business for future profitable growth. These include the start-up cost and investments for large early stage petroleum projects, one-time cost in continued forward investments in the digital business, and third, the unfavorable impact of the decline in several traditional print applications. As a result, Graphics incurred an operating loss of $900,000 in the quarter.

Total LSI operating expenses for the quarter decreased $1.7 million compared to the prior year, reflecting the cost management efforts as we balance investments in certain parts of the organization with priority-driven productivity in other areas.

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) Our first question comes from Craig Irwin from 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 first thing, I wanted to ask about is the progress with New Windsor and the closure there. Can you maybe walk us through what's left to be done at that facility to execute on the $12 million sale? And then how the savings is likely to layer into your fourth fiscal quarter and then early next fiscal year?

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

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This is Jim Clark, and thanks for the question. Let me break that into 2 pieces. In terms of just the progress of moving out, we've made -- we're wholly done. We have some liquidation auction activity going on for excess material up there this weekend, and then we anticipate that we'll be doing a walk-through and final cleanup through the month -- it will bring us into midmonth of May and then ready for transfer to the new owner.

In respect to the sale of the building, we have a definitive contract for the sale of the building. There is a need by the City Council of Windsor to meet with the new owners of the building in terms of their marketing plans and their use of the project. That is the only contingency we have on the close of the sale. I don't anticipate any problems, neither does the city or the buyer side. It's more of a formality in terms of alignment with the city's goals in how they market that as a new person coming -- a new owner coming into the city, that type of thing. So all things going -- all things -- expected, we would expect to have this closed by the first or second week of June. We don't anticipate, though, that there will be any impact in the fourth quarter in terms of savings or anything like that. That will be recognized in the first quarter of '20 -- of our fiscal 2020 starting in July.

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

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Great. So the next question I wanted to ask is about your relative growth contribution from core LSI Lighting and then Atlas in the quarter. I know pretty much everyone in the lighting markets saw this quarter, particularly March as a very difficult quarter. Did Atlas possibly outperform? Are there maybe any specific SKUs that significantly outperformed or underperformed that we should monitor from our side?

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

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Yes, well, first off, I'll break that into 2 pieces too. Generally, on -- in the whole Lighting side, meaning more on the LSI project side, we had -- there was no question March impacted us in terms of shipments, but our order bookings for March and April were much improved, where we expected them to be and better. That's on the whole for LSI Lighting. Specific to Atlas, which we normally don't break out, but I did make a comment on it, they had 2 very strong months in January and February and on a year-over-year, March wasn't exactly where it would have been last year, but we also didn't run any specials or any programs that kind of increased volume and sales out there that it tends to be more disruptive than any benefit to us. And so we made a conscious decision to not run any of those specials. And so although on a year-over-year comparison it might not have been as strong, it was still a pretty strong month and Atlas had a pretty good quarter for the third quarter.

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

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Great. So then, the improving debt position, $4.6 million, it's great to see that. It's great to see the tight management of the balance sheet. Is it possible that other than the $12.5 million payment you're expecting over the next couple of months that there is more room to squeeze this balance sheet capacity? And I know consolidation sometimes allows that, but do you see a couple of million may be coming out over the course of this quarter? And is there anything else other than the $12 million that helps to get that debt down further?

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

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Well, there may be some small incremental things that we'll continue to focus on the debt, but we also have some expenses in the fourth quarter that we traditionally wouldn't have. As an example, we have our national sales meeting coming up here, in fact it's next week. We would've typically done that back in Q3. So on a year-over-year comparison, that might -- those are small expenses, but -- there will just be little things like that. The contribution on the sale of the building may happen here in June or may get recorded in July depending on how that closeout actually works. We have -- I can't say that we have anything in the works right now that we think is going to meaningfully impact that debt. And the best thing we can do is continue on the performance side, that's the long-term plan to take that down.

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

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Great. And then last question, if I may, over the last few months, we've become aware of a private equity firm in Chicago that could have interest, specifically in the Graphics segment. Numbers I have heard kicked around are in the $60 million to $70 million range as potential valuation that they might want to put on this business, that could give you a lot of capital to go back and readdress some of these issues where maybe capital hasn't been available previously. You've always said that graphics is core, but is there any evolution here, or would you consider a serious offer core graphics only if one was to materialize?

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

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Well, I mean, specific to the sale or private equity, I don't have any comment on that, but looking at Graphics itself, there's really 2 pieces -- 3 pieces if we look at Graphics. We look at our petroleum-based graphics, our branded graphics, which would be -- you'd be more familiar in CVS or Walgreens, some quick-serve retail and then our digital graphics, which would share kind of the same customer base. The petroleum graphics are not something that we -- well, the petroleum graphics are doing very well. The branded graphics and the digital SOAR, our digital graphics are picking up quite a bit. I think we're just going through a transition from what was typically our branded graphics and -- as they move into digital graphics, we're adjusting to that. And there is some cost associated with that change, and there is some experience as we move through that process. But I feel good about all 3 components, and I don't have any plans to make any changes in the short term.

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

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Understood. But is there a potential maybe for LSI to make a more aggressive pivot towards graphics, given the consistent profitability of that business, except for when you make discretionary decisions and the interesting growth profile of that business?

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

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Yes, we're driving both businesses with the same kind of passion and commitment. And like I've said before, there is certainly a segment that really appeals to our customer base where we combine the 2 of them, and it just puts us in a differentiated spot. It really reduces the competition. And when we look at our margin performance in those combined segments, it's just -- it's compelling and we really want to look on ways where we can manage that to win even more.

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

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Congratulations for decent execution in what's obviously difficult market.

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

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Well, thank you. I appreciate the comments and the questions.

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Operator [14]

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(Operator Instructions) I show no further questions in the queue at the time. I'd like to turn the call back to Mr. Jim Clark, President and CEO for closing remarks.

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James A. Clark, LSI Industries Inc. - CEO, President & Director [15]

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Operator, thank you. I'd just like to leave everyone on the phone with a couple of thoughts. I hear a lot in the market about the lighting industry and certainly, there are a number of companies that have been impacted, but there's also a number of companies that are winning. The lighting market is not going anywhere any time soon. We have a 43-year history of competing and winning in this market and we intend to remain in this market and remain competitive for quite some time.

Our order volume coming into March and April show some of the results of our increased efforts out in the field and the operational efforts that we have going on back at the -- back within our operations are creating opportunities for us to move margin aside from good price control and good price realization.

This is a market that we can win in. The combination of our Graphics and Lighting still puts us in a unique competitive situation, which we intend to continue to leverage. I appreciate the confidence that many of you show in LSI, and we hope to reward you soon with results that prove out our strategies. Again, thank you, and good afternoon.

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Operator [16]

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Thank you, ladies and gentlemen, for attending today's conference. This concludes the program. You may all disconnect. Good day.