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Edited Transcript of LYTS earnings conference call or presentation 23-Jan-19 7:00pm GMT

Q2 2019 LSI Industries Inc Earnings Call

CINCINNATI Jan 26, 2019 (Thomson StreetEvents) -- Edited Transcript of LSI Industries Inc earnings conference call or presentation Wednesday, January 23, 2019 at 7:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James A. Clark

LSI Industries Inc. - President & CEO

* 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 Second Quarter 2019 LSI Industries Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this call may be recorded. I would now like to turn the conference over to Jim Clark, President and Chief Executive Officer. You may begin.

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

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Operator, thank you. Good morning, and thank you for taking the time to join us on today's call. As you know, I'm new to the organization and as we move towards the end of January, we'll be marking my third month with LSI. LSI has a rich 43-year history of innovation in the Lighting and Graphics segment, and I spent my early days focused on gaining a better understanding of the organization by visiting our facilities in Ohio, Kentucky, North Carolina, New York and Texas. I have held a number of meetings with all our employees and have traveled to meet a number of our agents, customers and suppliers.

Throughout this effort, I have attained a better understanding of our strong business foundation and the commitment of our employees and partners to further grow and improve the business. I have also been able to assess where we are in the transformation process of focusing on key market segments and to consider additional changes required to drive our business performance to the next level. Many of these items and activities are simply focused on execution, while others may be more structural and strategic in nature.

Our second quarter results reflect the position of the business as we transition and change to become more focused on key market segments and applications where our products and solutions are most valued by our customers. I want to mention that this transition is disruptive and this disruption is felt as an adverse impact on sales and margin as we realign

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in both business segments. We are not satisfied with our second quarter results, but I'm confident our changes will result in profitable growth as we move forward.

For Q2 of 2019, the Graphics segment generated sales growth of 12% versus prior year. We've been aggressive in developing solutions for the rapidly growing and changing digital market Graphics segment, securing several large projects, including a national quick service restaurant and a test platform with a national petroleum company. These solutions can be applied in many applications ranging from hundreds of thousands of locations nationwide over a multiyear project life cycle. These projects, however, are complex and competitive in nature and as we learn them, initially generate lower margins, which we will improve over time.

Another bright spot is LSI's penetration into the Mexico market, which contributed to our overall sales growth and represents a significant opportunity for us over the next several years. Our Lighting sales declined 8% for the quarter, reflecting the continued softness and competitiveness in both our project and stock and flow markets as well as the shifting emphasis to higher value-add opportunities. On the plus side, our focused approach to vertical markets has led to the award of a 2-year contract to supply outdoor lighting requirements for a large national auto retailer. This contract represents over $5 million in sales annually for locations based throughout the country.

Several key initiatives important to our transition remain on schedule. The transfer of our New Windsor, New York production facility and closure is on schedule for completion by the end of June. Projected savings of approximately $4 million are also on track. We continue to invest in sales and marketing talent, possessing the competencies required to execute our new focused commercial model. I'm happy to say that we have secured an interim Chief Marketing Officer, Scott Coleman and he is in place as we continue our search for a permanent candidate. The Chief Marketing Officer is a new position chartered to develop the plans required to navigate our evolving markets. And I'm excited by the benefit this role and the discipline it should bring us over the next several years.

Several sales resources have also been added in the second quarter to strengthen and expand our capabilities to our partners and to the entire organization as we increase our focus on customer visits over the next few quarters. I'm also happy to announce that we have recently hired a new SVP of Operations, Mike Beck. He will be replacing our retiring VP of Operations, Tom Palmer. Mike will be a key driver to assure continued improvement in our strategic corporations initiatives.

Moving forward, we will make decisions and investments to build the business to achieve profitable and sustainable growth. I plan to outline changes in critical investments needed in the coming months. This effort and vision will build momentum, which, in turn, will generate sustained success. I'm confident we can achieve our objectives, and I look forward to providing future updates on our progress.

With that, I will turn it back over to Jim Galeese for a deeper look at our numbers.

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

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Thank you, Jim, and good afternoon, 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 second quarter sales were $89.5 million or 3% below prior year. Adjusted operating income was $1.5 million compared to $4.6 million in Q2 of fiscal '18. Q2 adjusted EBITDA was $4.1 million or 4.6% of sales. Adjusted earnings per diluted share for Q2 were $0.03, Q2 of fiscal '18 was $0.12. Cash flow from operations was $5.4 million in Q2, and our debt level decreased $3.8 million versus Q2 last year, serving to increase our available line of credit.

A regular tax dividend of $0.05 was declared payable February 12.

Moving to reported GAAP results. Q2 GAAP net income was a loss of $15.8 million and reported earnings per share was a loss of $0.61. The GAAP results contain a pretax noncash goodwill impairment charge of $20.2 million and restructuring charges of $1.6 million. The goodwill impairment is a result of aligning the Lighting book carrying value to current fair market value. A complete reconciliation of Q2 GAAP and non-GAAP measures is contained in our press release and 10-Q.

Next, I'll briefly comment on the performance of our 2 reportable segments. Starting with Lighting. Sales of $63.7 million were 8% below last year, with the decline reflecting an ongoing market competitiveness and softness in several verticals where we have a strong market position. Lighting gross margin declined 3 margin points, reflecting lower volume mix and select price moves to meet competitive levels in certain product lines. Very little of the October price increase was realized in Q2 as expected as shipments include the backlog of preprice increased projects.

The effect of the October price increase will be realized more in Q3, serving to offset the incremental Chinese tariff costs. Excluding tariff activity, overall material sourcing cost continue to be approximately flat, with year-over-year increases in metals offset by savings in other categories as well as other product cost reductions. Sourcing costs are projected to continue to fluctuate in key categories, but the overall impact is expected to remain flat.

Lighting adjusted operating earnings for the quarter were $2.9 million, with EBITDA of $4.9 million or 7.7% of sales.

Shifting to Graphics. Graphics sales growth of 12% was driven by the petroleum segment, which increased 34% versus last year. Specifically, several new large projects with key national accounts, also the quick service restaurant segment, sales for a large national brand project continues to accelerate. The Graphics margin rate was lower in Q2, reflecting these projects have lower initial margins, which then improve over the project life cycle similar to the process on prior projects.

The Mexico market expansion which provides proven solutions to existing customers, large U.S. oil companies, is progressing very well. Quote and order activity for digital signage also continues at a strong pace. Graphics adjusted operating earnings for Q2 were $914,000 and adjusted EBITDA was $1.3 million or 5.1% of sales.

Total LSI operating cost decreased 1 point as a percent of sales, reflecting our management of resources and investments as we continue to transition to focusing on key market verticals.

With that, 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 of Roth Capital.

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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, first question I wanted to ask you, now that you've had a couple of months at LSI to reassess and reevaluate, do you see the Graphics business as core to the mission for LSI going forward? And are there any other potential structural changes that could possibly be on the table over the next number of quarters?

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

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Well, Craig, thanks for joining the call. Just to set the perspectives straight, it's been 62 days in seat, so there is a lot that I'm still absorbing and a lot that I am learning. As I look at the Graphics segment, obviously we've had some great successes where we've been able to pair those up, in particular, petroleum market. If you look at how our petroleum customers buy and how we supply solutions to them, you look at a classic pump station in Ireland out in front of the full -- I mean, a self-service mini mart or petroleum station, we own so many elements on that through the combination of the Graphics and Lighting. I think, in that case, you could clearly make an argument that Graphics and Lighting make a very powerful and differentiated offering to the customers. Now as you go further away from those core markets, I think that sometimes you get a bit more of a convenience buy, if you will, but I do think there's an opportunity, and I think that we need to find a way to strengthen our vertical, focus on those markets where those 2 elements, Graphics and Lighting, come into play.

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

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It's great, that's good to hear. So another question we're starting to get a little bit more often from the value-oriented investors that are looking at potentially becoming shareholders in LSI these days is the restructuring of your New York facility, so I know this was really just announced a couple of months ago, but are we seeing any loss of revenue specifically related to the transition of those products over to other facilities? Are we seeing a replay of what played out when you exited the Kansas City florescence business? Or is the market weakness and the price pressure that's showing up in Lighting delivering all of the underperformance in that business?

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

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Well, first of all, to address it specifically, we're not experiencing any disruption at the New York facility. I would mention specifically that the workforce there has truly differentiated themselves in their commitment to keeping that facility staffed. We sat down with -- as you guys may know, that's a union shop. We sat down with the local group there in the IBEW and they have really done an outstanding job of keeping our production up to both the standards of quality and in terms of total production. I think we learned a lot. The organization -- it was before my time, but the organization learnt a lot through the Kansas City exit. And I think we put good plans in place to retain the people that were there and to make sure we had a smooth transition. As far as where all the softness comes from, it's spread across multiple segments. It's not, in particular, any one. I'm not going to put my finger on it and say, it's specifically Lighting. Graphics picked up this quarter. You've been following LSI long enough, there is some cyclicality to this. And the organization has gone through a lot of disruption over the last year, so it's -- in terms of totalness it -- I can't say that it's any one market.

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

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Okay. And then on the gross margin side, it's been well telegraphed that the largest OEMs out there have had a mandate internally, don't lose any large jobs, surprising variances have been handed out literally within an hour or 2 maximum at the biggest OEMs in the market, so I understand a little bit of pricing pressure here. Can you comment about any potential strategies you have in play that you think will help preserve margins or maybe remediate margins over the next couple of quarters? Are we looking for behavioral change more than anything from the large competitors before those margins can rebound?

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

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Well, I think you hit the nail on the head. I mean, it's very hard to plan around activities such as don't lose any project at any price. We certainly don't operate like that. We want to remain profitable, so we certainly do have a point where we'll say unco. I think our biggest defense to those activities is to be present in front of the customers. We are -- we enjoy our best success when we stay vertically focused. LSI has a 43-year history. They have a great success story. They make a unique product and deliver it in a unique way. And as you brought up earlier, Craig, just the Graphics piece of it is what separates us. So the message to our organization has been, customer first and look for those and let's play in the areas where we are truly differentiated in those vertical markets So right now, at least in the short time I've been here, that's been the message to our troops and the message to our customers. I mentioned it -- I'll just follow it up with just this one last thought is, I mentioned it just a few minutes ago, but I've spent a significant amount of time traveling to our facilities, meeting our customers, spending time with the sales force. And in fact, having a number of customers visit us here at LSI, but also getting out on the road and visiting customers out in California, Nevada, Texas, and in fact, next week I'll be in St. Louis, Kansas City and Minneapolis. I think there is a lot of customers that really value the experience that LSI brings. They are willing to look beyond just the acquisition cost and understand the total cost of ownership. The expertise we bring to the verticals and the performance that the products ultimately bring and the company delivers. I think that that's where we're going to continue to differentiate ourselves and that's the field we're going to consider, that's the field we're going to compete on.

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

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That's good to hear. So a couple financial questions probably for Mr. Galeese. $700,000 lower expense for SG&A this quarter than what I've been modeling. Can you maybe comment about where things are going right for you on the SG&A side? Has there been a change in budgeting philosophy at the company? Or is this the result of the restructuring that's happened over the last couple of years?

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James E. Galeese, LSI Industries Inc. - CFO & Executive VP [9]

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Thanks, Craig. Jim Galeese here. It is a combination. You've mentioned a couple. Certainly with our current tightening of margins for a bit, we are keenly aware of our SG&A spend and make very conscious decisions around certainly our discretionary spend. But certainly, our realignment of our resources has contributed to that in the SG&A area. We look to drive productivity in all areas of our business and SG&A is one of those. Focusing on verticals and getting our resources focused there is one, so we can either eliminate or redeploy other resources where we're not seeing that level of productivity. So we stay very close to that Craig, we will continue to do so. But we're also, let me just say, not hesitant. You heard Jim mention select key investments as we're betting on the front end of the business, so that's where we're going to be successful. So we're going to make some surgical investments in the front end of our business.

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

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And last question, if I may. Free cash flows, operating cash flow is north of $5 million. Obviously, you're keeping a very tight focus on the balance sheet here. Do you think LSI could generate cash in the current quarter? What do you think about cash generation as the calendar year progresses?

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

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To your point, that's a very important statistic to the business. We do stay very close to that. You know Craig, that our fiscal Q3 is always and calendar year Q1 is historically one of the softer quarters for the industry, not just ourselves with the winter months and so forth. Our models, we project to be able to hold our own relative to the cash outlook over the next couple of quarters. We review our capital allocation model every quarter, review it with the board. And right now, we're comfortable with that model.

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Operator [12]

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And I would now like to turn the call back over to Mr. Clark for any closing remarks.

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

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Well, I'd like to say, thank you again for taking the time to spend a few minutes with LSI and learn about our business. As I mentioned in some of the questions and in my opening statements, we are really leading this from the front end of the business. I think that reenergizing our commitment to our customers and understanding the fields that we can compete on is critically important to our go-forward success. We do not want to get sucked into projects where it gets down to just solely a pricing decision, and we're making a purposeful effort to stay away from those projects. It not only keeps us focused on where we add value, but it also frees up the time for us to continue to pursue those high-value projects. It's still been a relatively short amount of time for me here in seat. I think that as we come into the next quarter and the next call, I'll have a lot more information to share. And I appreciate everyone's attention and participation and confidence in LSI, and I look forward to sharing more on our next call. Thank you.

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Operator [14]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.