LSI Industries Inc (LYTS) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2018 LSI Industries Inc. Earnings Conference Call. (Operator Instructions)

And now I would like to introduce your host for today's conference, Mr. Dennis Wells, CEO and President. Sir, you may begin.

Welcome and good morning. This is Dennis Wells. And I would like to start by saying that I am pleased with our Q2 results that we're going to discuss this morning. I think they build nicely upon our solid Q1 results that we announced earlier.

In summary, we turned in what I would call a respectable, quite respectable, top and bottom line results given the continued softness in our markets. I can assure you that our sales folks, our agents, our distributors are out there slugging away on a daily basis to capture business.

In our perspective, it has certainly been difficult to grow the top line over the last 12 to 18 months. Our cost improvement efforts, however, are definitely showing up in our quarterly results, especially the second quarter.

Let me step back for a minute. As we started our fiscal year on July 1, we set 2 primary goals for ourselves. One, grow our top line faster than the market. Two, regain our momentum towards achieving 30% gross margin. Let me report out briefly on each of these initiatives.

In regards to top line growth in our Lighting segment, I'm very pleased to report that our LED sales in Q2 increased 25% versus prior year. That represents a 92% of our Lighting product sales. This is a new high for us, a new best for us to achieve a 90-plus percent LED. I want to commend our Product Management team, led by Steven Lowe, in guiding us towards this objective. We're moving ever closer each quarter to achieve our ultimate goal of being a 100% LED lighting company.

Our Atlas team, which participates in the stock and flow part of the business, again delivered solid performance in the quarter. The Atlas team, down in Burlington, North Carolina, led by John Bagwell, continues to achieve key sales and acquisition synergy targets, including an expansion of their distribution base and select product cross-branding. Next month, we will celebrate the 1-year anniversary of Atlas joining forces with LSI. We are very pleased with this acquisition.

Our PowerPlay team, led by Randy Kimmel, produced a 94% growth rate in the first half of this year. And they continue to improve our position, our ability to compete in the lighting renovation market. We are investing here in people and products and in programs in order to participate in a stronger way in this market segment.

I am pleased with our continued investment in new technology as it relates to lighting controls and smart lighting solution. Our Airlink and SmartVision platforms, although in early stage of adoption, are showing good progress. We launched quite a few new products, LED lighting products, in the quarter, which we expect to generate a positive sales impact going forward. The first one, the Scottsdale Vertex, is a complete redesign of our under-canopy fixture. This is launched and intended to solidify our market-leading position in the petroleum and C-Store vertical market. Our new High Bay product that we call Alliance was launched in the quarter, designed to service the growing warehouse segment. Lastly, our Mirada family, we have launched new versions of this family. It's an outdoor area lighting offering. You might remember, this is the first family where we used our new silicone optical system. I do want to recognize the strong efforts here by our design engineering team led by Chris Papa. Chris and Steven Lowe both assure me that we have many more new products coming in the future, yet this year. So stay tuned for us to announce more product launches.

Turning to our Graphics segment. This team, led by Jeff Croskey, delivered a solid quarter with sales increasing 12% versus prior year and generating significantly improved operating earnings. Nice job by our Graphics team. The improvement was led here by the SOAR digital signage business, which again generated sales growth in excess of 100% versus prior year. A nice job to Dave Moeglin and his team. They've done an excellent job launching and growing this strategic platform over the last 18 months.

Not to forget our traditional graphics team as well. They had a great quarter, adding a number of new customers. We did invest heavily last year in some new state-of-the-art printing equipment that is starting to pay off, helping us to improve our lead times and ability to service customers in the sign and graphics industry.

Our second initiative as we started the year was to regain our momentum moving towards 30% gross margin. So let me talk a minute about each of the cost of goods sold components, starting with material. We continue to be very aggressive in all areas of material management. Our productivity efforts along with certain select pricing action have so far this year offset the impact of material inflation. However, we continue to keep a watchful eye on commodity prices. As you might remember, material inflation had a very, very negative impact on our gross margin last year. We experienced some unexpected and rapid inflationary increases in steel, cardboard and polycarb. The prices have stabilized at the higher level now, but certain forecasters now indicate that the market could incur additional price movement in steel and aluminum, which are utilized in the production of both lighting and graphics products. We need to keep a very watchful eye on commodity prices going forward.

Our LSI Business System and its lean manufacturing component is becoming a way of life here at LSI. We encourage all 1,200 of our associates to engage around areas of improvement and elimination of waste. We conduct on average 100 Kaizen Events every year. These efforts by our associates, along with our facility rationalization program last year, are showing tremendous improvement in our labor and overhead cost, all under the leadership of Tom Palmer, our Executive Vice President of Operations.

I am pleased with our gross margin for the first half of the year, which advanced upwards to a 27.4%. Barring any return of rapid material inflation, we appear to be back on track moving towards achieving our multiyear goal of reaching 30% gross margin.

I will now turn the mic over to Jim Galeese, our CFO, to discuss the financials in greater detail.

Thank you, Dennis, and good morning, everyone. 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 the reported GAAP performance.

Fiscal second quarter sales were $92 million or 8% above Q2 prior year. Adjusted operating income increased 31% versus prior year, with the operating margin improving 90 basis points to 5%. Adjusted net income increased by similar levels. This resulted in adjusted earnings per diluted share for Q2 of $0.12 compared to $0.10 in Q2 2017.

In addition, a statistic that I will give more visibility to throughout the year is adjusted EBITDA. Q2 adjusted EBITDA was $7.2 million versus $5.3 million prior year, an increase of 35%. First half adjusted EBITDA was $12.9 million, a 37% increase over first half 2017 of $9.4 million.

Moving to reported GAAP results. The Q2 GAAP results reflect a required tax charge as a result of the Tax Cut and Job Act legislation. The $4.7 million charge reflects the loss in value of deferred tax assets out on the balance sheet. The value of these assets against future taxes declined because of the reduction in the corporate tax rate from 35% to 21%. Q2 GAAP results also include a small restructuring adjustment with a net income impact of $59,000. As a result, the business reported a GAAP net loss of $1.5 million and earnings per share loss of $0.06. In our press release, we provide a detailed reconciliation of non-GAAP measures for the second quarter of both 2018 and 2017.

Next, let me briefly comment on performance for our 2 reportable segments. I'll start with Lighting.

Lighting sales and earnings both improved versus prior year. Sales increased 6% to $69 million. Dennis mentioned the LED sales represented 92% of all lighting sales in Q2, reflecting our emphasis on LED and intentional shift away from conventional technology. Q2 LED sales growth was 25% versus Q2 prior year.

Lighting adjusted operating income for Q2 was 25% above prior year, with the operating margin increasing 110 basis points to 7.6%. The lighting gross margin rate improved 170 basis points. The margin rate improvement was driven by a higher quality, richer mix of sales and a strong productivity across all cost categories, which offset material inflation and price erosion.

Now I'll shift to Graphics. The Graphics business also delivered a solid quarter, with both sales and earnings above prior year. Sales increased 12% to $23 million. Operating earnings increased 58%, with operating margins increasing 280 basis points to 9.7%. The sales increase was led by SOAR, our digital signage business, which again generated a 100%-plus growth rate. The Phillips 66 business is entering its last phase of activity and as a result declined in Q2 and the first half as projected. However, we were successful in attaining significant new sales activity in both petroleum and nonpetroleum business compensating for the Phillips 66 decline.

Shifting to select other business metrics. The business generated positive cash flow in Q2 and has considerable availability on our line of credit. Working capital increased by approximately $6 million in Q2, driven by accounts receivable related to specific growth initiatives and timing.

Capital expenditures were $700,000 in the second quarter, resulting in a CapEx to depreciation ratio of less than 1. Inventory has decreased marginally since the end of fiscal '17, and we continue to manage our inventory days and turns closely to ensure alignment with market demand.

Let me return to the subject of taxes. In December, the President signed the Tax Cut and Job Act, TCJA, into law. Management's thinking is tax cuts will stimulate investment and generate growth in both new and retrofit nonresidential construction, generating increased demand for lighting products. In addition, as a result of the reduction in the federal corporation tax rate from 35% to 21%, we expect TCJA to favorably impact future LSI net income, earnings per share and cash flow.

For full year fiscal '18, we forecast that the company's blended consolidated effective income tax rate will be approximately 29% before discrete items as compared to approximately 34% for fiscal 2017. The full year impact of TCJA will be realized in fiscal 2019 with our effective rate currently estimated at 24%.

With that, I'll now turn the discussion back to Dennis.

Thank you, Jim. I would now like to make a few comments on the markets in which we participate and a bit of a look forward.

Both of our markets, the lighting market and the signing graphics market, are very large and over the longer-term period are expected to show growth in the 2% to 3% range annually. However, both markets are susceptible to economic and political factors, which can cause the markets to expand or contract during any given short-term period.

At the moment, both markets appear to us to be contracted. In the past, I've used the term soft to describe the situation. What I mean by soft is a flat to down single-digit contraction. This is based upon market information that we have available. Much of this information is delayed by several months. It's difficult, if not impossible, for us to have perfect knowledge -- real-time knowledge about our markets.

We do continue to develop and expand a quite sizable quote log here at LSI. We sometimes call this the pre-PO pipeline. This is our CRM system at work. We log all of our quotes into our CRM system and are able to have metrics around those quotes. One of those internal metrics shows that the normal time period by which a quote progresses through the sales cycle to become a PO has extended significantly over the last year. I sometimes internally call it the logjam. The primary reason for this logjam, as we talk to our agents, as we talk to distributors, as we talk to end customers, appears to us to be a temporary pause on capital spending for a number of reasons given by our end customers.

Another thing that we have noticed is that the -- what we call the small to medium-sized projects serviced under the LSI brand are the slowest-moving quotes. Our larger projects, those greater than $150,000 and our stock and flow business under the Atlas brand have not seen or been impacted as much as the small and medium-sized projects.

In summary, the markets we participate in are soft at the moment. However, we are starting to see signs of a possible rebound. Recent market indicators such as the Dodge index and the IFA index are trending upwards.

As Jim mentioned, we are hopeful that the newly enacted tax legislation will help to break the logjam, that our customers, end customers, will be motivated to move forward with their capital spending as it relates to lighting and signage projects. I do want to be clear, I do want to point out that these potential developments will not have a significant influence on our fiscal Q3, but more likely will impact us later in calendar year '18.

With that being said, we as a management team are going to continue to work diligently and focus on the priorities that I outlined earlier. Number one, focus on growing faster than the market, which includes investing in new products and new technology. And number two, continue to drive productivity and cost-control initiatives.

I'm confident that if we stay focused, our business will be positioned to capitalize on improving market conditions as they materialize.

Our second quarter results do indicate our team is working on the right priorities. These efforts are generating a positive impact on our results even in a soft market environment.

As I conclude, I want to give a special thanks to Ron Stowell, who retired December 31. Ron was our CFO for the last 25 years and has been an invaluable partner to me since I joined the company in 2014. Thank you, Ron. Also I want to welcome Ron Newbold to the executive team. He is the President now of our LSI Lighting business. Ron has quite an extensive background in lighting and has already made his difference during his short tenure with us. So welcome to the team, Ron.

I will now turn the mic back to our moderator, and we can open up the Q&A session.

(Operator Instructions) And our first question comes from the line John Quealy with Canaccord Genuity.

So the first question, if you could, in Graphics. That was pretty good improvement. It's been a lumpier business, obviously, with some different cadence going on in the convenience store gas channel. Dennis, can you talk about, in the quarter, was it just backlog coming through? Or what happened in the quarter? I think you already gave some color on the outlook for that segment.

Right. Good morning, John. We do use the same CRM system in our Graphics business. So we have been working on some projects where it takes a number of months for them to move through the sales cycle. As Jim mentioned, as Phillips 66 is starting to wane, we've been blessed with a couple of other nice petroleum projects and then some nonpetroleum projects coming in. So our sales force there in Graphics is out working the opportunity hard. We're also pleased with SOAR, made a difference here. Some nice projects in our SOAR business shipped and were installed during the quarter.

Okay, great. And then on the Q1 report or right thereabouts, you were talking about Atlas suffered some softness in the stock and flow side of the portfolio. It sounds like that's alleviated. Or can you comment specifically underneath lighting on the different factors that you experienced and you expect?

So Atlas, as you know, services the stock and flow business. They've -- were acquired by SPAC in February, almost a year ago. Q1, it appeared a little soft, but very nice quarter by Atlas' second quarter. Jeff Ginder, John Bagwell down there are really leading that team in the right direction.

And Dennis, your comment around tax reform driving hopefully some capital expenditure and retrofit and new build activity, that's been echoed by other peers in lighting. If you could, talk to us about your sales tracking CRM system. Are you starting to get elevated hits or more hits around projects? Or obviously it makes sense that we needed time to get into the Q3, Q4 and probably Q4, Q1 time frame to see that hit the P&L. But can you talk about conversations you've had already with the distribution base?

Sure. We had a sales meeting the other day, and we asked all of our sales people to go back through the CRM and make a very specific call and remind those customers, if they have money left over from their tax cuts that LED is a great place to invest with this ROI that comes with it. So that's a type of thing we're doing, following up on each and every quote.

(Operator Instructions) And our next question comes from the line of Craig Irwin with Roth Capital Partners.

Dennis, the one thing I wanted to ask about that I found pretty encouraging is gross margins. Obviously, it's an area where you've been really focused over the last number of quarters, couple of years now. And there is quite a lot available to you there over the next number of quarters. Can you maybe talk about what's going right on the margin side? How pricing is working for you, what the relative factors are contributing to the gains we're seeing there and what we should look for over the next couple of quarters to understand how margins are likely to progress.

It's a great question. I'm a huge believer in the LSI Business System. This is where we engage all 1,300 of our employees. We want them to be engaged, involved. Certainly, there is a big lean component to that. I'm very proud of our workforce. The culture is changing, people are participating more. I give them all the credit for this improvement. We manufacture most of our products in the U.S.A. We're very proud of that. But with that comes the responsibility that we must be competitive, and we see that 30% gross margin as a competitive point that we need to hit. We won't be able to do it overnight, but we need to continue to work in that fashion. So inflation last year kind of knocked us off a little bit, but proud of our sourcing group here in the last 12 months and our product design guys. We found ways around steel, how to use more plastic, how to use less cardboard, things like this, trying to find our way around those. The prices have not come down. They have kind of stabilized with the higher price. But we're out there every day looking for new ways to improve our gross margin and ensure that we're competitive when we make products in the U.S.A.

Craig, Galeese here. Couple of things I will add to that. In addition to our internal productivity initiatives around the value-add, we mentioned quite a bit of our new products. Our new products are not only enhanced from a feature functionality perspective, but also represent a measurable cost reduction to ourselves as we go to the market. And so these cost refreshes and cost-downs on both are existing as well as our new design products are very important part of our business equation, and we really have a high level of activity going on in that area right now.

Great, thank you both for that. The next question I have is very high level. So last year, after the election of President Trump, when there was some floating in January sort of in the press between Trump and Schumer discussing $1 trillion stimulus program. The lighting market went on ice. It was very similar in character to what we saw 8 years prior when Obama was first elected and started talking about handing out subsidies. It seems that we're seeing a little bit more rational behavior in the market now that, I guess, the last couple of weeks they drafted, the stimulus program has been released, and we have seen maybe a little bit more commentary out of the White House regarding the stimulus program and good potential for that to actually see some action this year. Can you comment about whether or not you're seeing that as a short-term headwind? And can you maybe frame out for us what you think this would look like? Is it likely to be a similar boost to what we saw many years ago in the back end of the stimulus dollars that were beneficial to lighting back in the 2009, 2010 time frame?

It's a great question. I used the word logjam. Quotes are not the issue for us here. There is lots of great projects that we've quoted that have an ROI, especially when it comes to -- talking about LED lighting here. I am hopeful the stimulus will cause our end customers to not pause anymore, but take those CapEx and start signing them and moving them forward. So I am very more tactical focus there and hoping and believe that, that will happen. I just don't know the timing of that at this point. But Jim, do you have something more you want to add there?

Yes. If there is any type of infrastructure bill that comes, at a high level that would be viewed as a positive thing for both construction industry overall and then, of course, ourselves as it cascades down. Are people pausing and waiting on that? No. Actually I think the tax bill is actually a bigger influence than any activity that could be coming relative to infrastructure. So I look forward to seeing any momentum built from the tax structure, and if something comes from an infrastructure bill on top of that, that would even just create a more favorable environment.

Great. And then another very high-level question. There is a lot of turbulence out there in the market. You had the largest participant post the worst performance they've had since the Great Recession in their quarter just a couple of weeks ago. And this kind of turbulence very often creates opportunity. You have a sharp eye and sharp understanding of your industry. And couple of years back, you were able to identify some real opportunity from the changing ownership at Juno. And I'm sure there wasn't a real benefit for LSI. I guess the market volatility made it harder for us external observers to really see. But do you see any specific opportunities maybe that you'd want to discuss with us or maybe if you can say that you see opportunities that hopefully you'll be able to tell us about in the next couple of quarters that are coming to fruition because of this volatility we're seeing in the market?

My response is, here at LSI, we're focused on our business, our top 2 objectives for the year. Every day, we're out there scrapping for business that's available. I read about the things you're talking about as well, but here, we're just focused on minding our plan and turning this company around and providing a good return for our shareholders.

And I'm showing no further questions in the queue. So I'd like to return the call to Mr. Dennis Wells for any further remarks.

Thanks for joining the call, and have a great day.

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