Lsi Industries Inc Q1 FY2021 Earnings Call

Greetings and welcome to the LSI Industries Fiscal First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Jim Galeese, Chief Financial Officer. Thank you, sir, you may begin.

Good morning, everyone. We issued a press release before the market opened this morning, detailing our fiscal first quarter results. In conjunction with this release, we also posted a conference call presentation in the Investor Relations portion of our corporate website at www.lsicorp.com. Information contained in this presentation will be referenced throughout today’s conference call. I would like to remind you that management’s commentary and responses to questions 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 and 10-Q. Today’s call will begin with remarks summarizing our fiscal first quarter results. At the conclusion of these prepared remarks, we will open the line for questions. With that, I’ll turn the call over to LSI President and Chief Executive Officer, Jim Clark.

Thank you, Jim. Good morning, all, and thank you for joining today’s call. As you have likely seen from our press release issued earlier today, we have several things to talk about, and I would like to jump right in to give you some additional details. Let me first note that despite uncertainty around the general marketplace and overall market activity, which has been hampered by COVID, we have found several ways to adjust to the conditions, while remaining competitive and committed to the transformation and ongoing improvements of our business. Employee safety remains at the forefront of our plans and actions. Although COVID is no longer new, it is something we continue to deal with daily. We remain committed to assuring a safe environment for our employees, our partners, customers, and suppliers and in finding ways to continue to be effective and adaptable. Now, jumping into the business, although lighting sales were down for the quarter, I am encouraged that we have seen little to no project cancellations. Construction activity continues to fluctuate depending on the region and various COVID challenges, which has caused some delays in our committed project book, but again, no notable cancellations. On the other side of that coin, we have seen a market increase in requests for short lead time projects and competitive conversions. Our U.S.-based manufacturing and our previous work in diversifying our supply chain over the last year is allowing us to respond to a number of these short lead time inquiries and we are working hard to convert and accommodate as many of these opportunities as possible. I would also like to note that our average daily quote activity continues to increase, along with a month-over-month sequential improvement in our order rate throughout the first quarter. We are continuing to see that pace improve in the second quarter. As we mentioned now for some time, we made a purposeful decision over a year ago to move away from price-sensitive, highly commoditized business and focus instead on markets where we can differentiate ourselves and our products. This commitment to a higher value market-based approach is demonstrated in a 290 basis point gross margin improvement for the quarter, bringing our lighting margins to our highest level in years. We have been laser-focused on key vertical markets, including petroleum, automotive, grocery, pharma, QSR, warehousing, transportation, and sports court lighting. We celebrated some notable wins in lighting in the last quarter, including two outdoor projects for the world’s largest e-retailer and several early-stage projects in our automotive vertical. Our automotive projects are focused on a whole-site approach; we are providing the complete lighting solution from lot to showroom, showroom to service area, and everything in between. In many cases, we are working directly with the auto manufacturers to develop specifications, which are then rolled out to the individual dealers assuring consistency and uniformity in their lighting. We are excited by the momentum we are gaining here and the possibilities ahead. In our stock and flow business primarily in the graphics segment, we have seen a strong recovery in Q1. Distributors that had been de-stocking in the fourth quarter and through part of the first quarter have come back strong. We are encouraged by the improved order rate and inquiries. Atlas is in the process of rolling out two additional brands and products creating a new opportunity on the value side of the business and we are excited to see where that will go. From a commercial activity standpoint and in the absence of trade shows and in-person customer and agent engagement, we are investing in several sales and marketing-related activities that develop leads for our partners and our agents and increase the overall awareness of our solutions in our target vertical markets. Just last month, we introduced a new website and populated it with a slew of case studies and collateral material for our partners. We are investing in increased advertising in our focus vertical markets, and we remain committed to the introduction of new products. In 2020, we added 20 new products and in 2021, we intend to introduce even more. Our product marketing team, along with our engineering team, has in fact shortened our standard development time by more than 30%. In the design of new products, they are assuring ease of manufacturing, maintaining quality, and looking for ease of installation and service. This is a real win for our customers, partners, and for our overall competitiveness in the marketplace. It underlines the investments we are making in the business to compete on an entirely different level. Turning our attention to graphics, I am happy to say we are near pre-pandemic levels with sales in Graphics, just 4% below the prior year. Our pipeline remains strong on the petroleum side, with several new projects in various stages of development. Our business in Mexico is recovering nicely as installation and government approvals continue to increase. We are showing growth in our grocery and pharma space, including a couple of rebranding projects and in new store openings for two large grocery chains. This business makes good use of our facilities and operational improvements in both Houston, Texas, and Akron, Ohio. I have talked previously about expanding our share of wallet in our existing verticals, and I would like to comment on the projects we are working on this quarter. Recently, we were awarded a multi-million dollar product and services contract from one of the world’s largest petroleum retailers. In Q2, we will produce, ship, and manage the installation of a digital wallet contactless pay-at-the-pump solution for approximately 11,000 U.S. locations. This project utilizes LSI’s digital print technology, logistics and project management capabilities to install an innovative near-field communication and QR Code solution allowing customers to use their smartphones to pay at the pump in a contactless fashion. This project has been in the works for some time, and we are proud to have been selected as the right partner for this program. Lastly, I want to talk about our strategy going forward. Our goal is to be a $500 million company with double-digit EBITDA by 2025. Our path forward is designed around four elements: number one, expand or increase our vertical market presence. We do better and deliver higher value when we focus; number two, change our customer engagement, that means creating a higher level of commercial awareness of our products, services and solutions and developing more qualified leads for our agents and our partners; number three, build our services business. We have a great opportunity here and we will have more success stories to share around that; and number four, accelerate our growth through acquisitions. This path forward is outlined in greater detail in our investor deck, which can be found on our website under the Investors section. If you have not seen it, I encourage you to go take a look. Despite the challenges of the current environment, I am encouraged by the momentum and energy we have been able to develop. We are in a strong financial position with nearly $85 million of immediate liquidity available. We remain focused on improving and growing our business both organically and through M&A, and I am confident our best days are ahead of us. Thank you again for your time and interest in LSI. With that, I will turn the call over to Jim Galeese for comments on our financial performance.

Thank you, Jim and good morning everyone. I will start by highlighting key financial statistics for the fiscal first quarter. Sales were $70 million, improving sequentially from Q4, but below prior year as projected. Net income was $2 million compared to net income of $4.5 million in the fiscal first quarter of last year. It’s important to note that prior year first quarter results include a non-recurring pretax gain of $4.8 million resulting from a facility sale. On a non-GAAP basis, adjusted net income increased 29% to $2.1 million versus income of $1.6 million in the same period last year. Earnings per diluted share were $0.07 versus $0.17 in the first quarter of fiscal ’20, non-GAAP earnings per diluted share were $0.08 versus $0.06 per share in Q1 last year. Adjusted EBITDA was $4.7 million, or 6.8% of sales, 90 basis points above last year. Our complete reconciliation of first-quarter GAAP and non-GAAP results is contained in our press release and 10-Q. The company generated $7.2 million of free cash flow in Q1, exiting the fiscal first quarter with a total cash balance of $9.5 million, along with $75 million availability on the company’s revolving credit facility. The company had no long-term debt at the end of the first quarter. The improved liquidity provides the capital allocation flexibility to invest in the key initiatives which support our strategic priorities. A regular cash dividend of $0.05 per share was declared payable November 17 to shareholders of record on November 9. Moving to our two reportable segments, the Graphics Segment experienced a sharp rebound in the first quarter with sales approaching pre-pandemic levels. Sales decreased 4%, strictly the result of ongoing project schedule delays. Market activity remains favorable as commitments for the six major multiyear programs with petroleum C-store companies remain in process and largely unchanged. Growth continues in Mexico with sales increasing 88% year-over-year in the first quarter. New business development activity remains high with our teams working closely with multiple companies on potential programs. Year-over-year, Graphics sales growth is projected for the next several quarters. Adjusted operating income increased significantly for the Graphics Segment with first-quarter income of $1.9 million versus $1.1 million in the prior year. Leverage generated by our improved Graphics cost structure contributed to the results. Shifting to lighting, as projected, the pandemic-driven slowdown and lower project backlog exiting the fourth quarter resulted in lower first quarter sales. Quotation and order activity increased steadily throughout the first quarter, generating an increased backlog entering Q2. Distributor stock and flow activity also increased significantly from the fourth quarter, evidence that the distributor de-stocking has stabilized and market activity is improving. Two major lighting product programs were approved in Q1, including a development program for a new architectural fixture range, representing one of the many new products to be launched in fiscal 2021. The adjusted gross margin rate trend for lighting continues to improve, increasing 290 basis points to 30.5%, a combination of the ongoing impact of our focus on higher value market applications, new products, design cost reductions, and manufacturing efficiencies. First quarter lighting adjusted operating income was $3.7 million, increasing to 8.1% of sales, an improvement of 90 basis points compared to Q1 last year. I will now turn the call back to the moderator.

Thank you. [Operator Instructions] Our first question comes from the line of Amit Dayal with HC Wainwright. Please proceed with your question.

Thank you. Good morning, everyone. Really strong results. They're better than expected. Last quarter you had commented that the fiscal first quarter could be the weakest for the year. Do you still maintain that view?

Amit, good morning, Jim Clark here and thanks for joining the call today. Yes, I think that our comments on the last call were particularly in comparison to our Q1 last year, we had a very strong quarter. We knew coming into Q1 this year that we had projects that were pushing and we’re still experiencing that as I mentioned a minute ago, they’re not canceling; there are a number of challenges, COVID flare-ups, permitting, electrical permits, inspections and just general labor on some of the construction sites on some of the projects we’ve been on have held up some of that; some of the order flow out the door at the orders have remained committed, but we just haven’t been able to get better; the customers haven’t wanted the product yet. Typically, lighting goes in later in the project cycle. So, we feel very confident that there aren’t going to be any cancellations because most of the work is normally done by the time we’re getting lighting on site, but we did feel like this Q1 was about where we thought it would be.

Understood. And then just moving on to this new digital wallet product; it seems it sounds really interesting. Is this a similar business model to your other products or do you also have maybe some recurring revenue component over here and do you believe there could be other opportunities with deployment of a similar solution for other customers or you within the same customer for more facilities?

I’m sorry. You cut out on the first part of that question, so I didn’t hear what you were referencing?

Yes, the digital wallet product.

Okay, very good. Yes, just wanted to see if that is whether it’s a one-time sale or if there’s maybe a recurring revenue component to this offering and what are the opportunities for the deployment of the solution? In our digital menu side of things, we do have a recurring revenue model associated with updates and maintenance services, etc. Recurring revenue is something that we are definitely focusing on building out. This digital wallet solution will not have any recurring revenue associated with it, but we do see it as a potential opportunity, particularly over the next year. Many of you may know, the EURO Visa Mastercard payment system or chip system in the credit cards is required by mid-April of 2021. The credit card companies get to move a lot of liability back to merchants that do not install new card readers or have multi-factor authentication systems in place. So there is an incentive for a lot of companies, particularly in the spaces we play, whether it’s grocery, pharma retail, petroleum, etc., to have alternative payment methods. We use our Graphics group in this particular case through the digital wallet to have both near-field communications capability and a QR code capability that will allow things like Apple Pay and Google Pay to support both Android and Apple phones. So, we see this demonstration of being able to roll out 11,000 locations in a fairly short amount of time. This could be something that creates opportunity for us going into the next couple of quarters. And, it’s particularly important right now where you’re getting contactless payment type options. There is no exchange of cards. There is no keypads to press. You are using your own digital product, that your mobile phone to make the payment. So, there is no recurring revenue component to it, but it could be something that we continue to deliver here over the next few quarters or longer.

Understood. Yes, I’ll take my other questions offline. Thank you so much.

Thank you. Thank you for taking the time to be on the call today.

Thank you. Our next question comes from the line of Craig Irwin with ROTH Capital Partners. Please proceed with your question.

Hi, good morning. Can you maybe talk a little bit about the specific products that are higher margin in the Lighting Segments that are driving the gross margin gains, if this couple of products or group of products and is this a continuation of what we saw in the prior quarter and we are sort of at the upward ceiling on the benefit from margin expansion; do we get to the mid-30s, any color would be helpful?

Yes. Good morning, Craig and thank you for being on the call, we always appreciate hearing your voice. The products are typically project-related and outdoor-oriented. We have a full product solution indoor and outdoor, and when we usually combine those, we do very well from a margin standpoint. I think we got lost a few years back when we focused; we started overwhelming our manufacturing with lower-priced indoor products. When we have a project that has a combination of indoor and outdoor, we can move that margin. In those products, we are looking for optical control; we’re looking for cut-off; we’re looking for things that we believe customers value, which aren’t found in the commoditized products. So, the more we are involved in those projects and the more disciplined on the very low-cost buy type projects, the better we do. I do think that the mid-30s are possible. I think that probably our improvement rate will slow slightly from a quarter-over-quarter as we start to get closer and closer to those mid-30s, but it is very happy to get into the ‘30s. I think looking back, it’s one of our best positions from a margin standpoint we have had in lighting in quite some time.

Yes. Hi, Craig. Jim Galeese here. I will comment on that as well. We’ve been working hard to move our margin rates forward. We are very pleased with where we are at. There have been multiple levers contributing to that, probably the largest being the movement to higher-margin applications, but also our 20 new products that we launched last year we have seen some nice design, cost savings, and then of course the actions we have taken to right-size our manufacturing fixed cost footprint all contributed. So, our objective is to continue to drive that continuous improvement, continue to work all those levers, and we want to keep moving the lighting gross margin rate forward continuously and looking at it on a year-over-year basis.

Excellent. Next question I wanted to ask was about the two parking lot projects you mentioned in your release that we did put the world’s largest e-tailer. I guess we can assume that’s Amazon. Did you do those directly for Amazon or we know that most of their warehouses and distribution facilities are actually under lease where Prologis is the provider of the assets, and they basically just paying rent, right. Was this done for Prologis or for Amazon, and what sort of a tempo can we expect here because you know Prologis is in the process of retrofitting a large number of prior facilities and building many more new facilities, and can you maybe just comment if you see more of an opportunity there on the new facility side or the retrofit side?

So, the answer to both of those is yes, we do see an opportunity both in the retrofit and in new facilities. These two particular projects were a combination of our partners and the property owners, but certainly a lot of input from the end-use customer. In fact, we believe it was that which influenced our ability to articulate the performance of the lights. Here is a good situation, here is a good underlying example of just kind of light cut-off, light pollution, and being able to articulate the performance of the lights, not just in terms of how we were able to light the facility in the locations, in the loading docks, and in the parking lot, but also to be a good neighbor and make sure we’re not having that kind of light lead over into other locations and that type of thing. I think there is a certain segment of customers and this customer being one of them, they can appreciate being a good neighbor and making sure that they’re getting the performance that we’re committed to delivering. So, I do think that this story will continue to resonate and it is something we’re trying to demonstrate by doing as opposed to saying and we are trying to leverage these two success stories into a bigger opportunity.

Do you have any additional business in backlog for execution in the December quarter from the same customer?

I don’t want to comment on that right now, but the backlog is up. I will say that, but just to respect the process and stuff, I don’t want to say any specifics about this customer or anything.

Okay, excellent. So then, just to circle up on the QSR, the large QSR program that you mentioned as well both in your prepared remarks and in the release, the $100 million program you announced in July. You said in the release that orders doubled or more than doubled, which is really good news; it’s nice to see the Graphics business getting some good momentum here. What is the approximate timeline for completing the full $100 million in scope there? Does this mean that the $100 million may be going a little faster, that we are really looking at a low single-digit number of years? What can you share with us for us to understand sort of how this supports LSI’s graphics business over the next few years?

Yes, right now, I mean from a schedule standpoint we are anticipating two years remaining in the schedule, but I will say that the success we have had and the traction we are getting is creating additional opportunities. It might be a little premature to say too much right now, but we believe there is a significant piece of follow-on business that we have been in discussions with for some time. We have done demos of our proposed solution and proposals in front, and we believe we have a pretty strong position. We’re in our proposal and their request, and it might be a little premature to say anything right now. But we see that just with this single customer, a two-year run on the initial project from July in likely follow-on orders, and I am sure I will be able to comment about them in the coming quarter.

Okay, excellent. And then last question if I may, there were some obvious lessons learned at LSI from the acquisition of Atlas and some of the missteps there. Now that your balance sheet isn’t just in much better condition than it has been for the last few years, it looks like you’re in a position where you could potentially move opportunistically if something was a good fit with the LSI brand and LSI group of assets. How ready are you to complete an acquisition here, and what are the basic characteristics you’re looking for in acquisition candidates today?

Okay. Well, first of all, I am not going to debate that we had some missteps initially with Atlas. But we’re very happy with Atlas and I think they’ve done a great job. I comment around a little bit, but their recovery here in Q1 has been significant and they are gaining some momentum. In fact, I will just mention that they have a refreshed product offering in their independent series and they are bringing our whole another category online, which we will talk about next quarter. Our plans are definitely to grow organically and through acquisition. As Craig, you have been in this for a long time, acquisitions, we have some things that we think would fit well, but those folks may not be ready to move. We have some things where we think that we could partner up in a way that might be different, and it’s really getting that story out and getting those folks to get on board with us. Right now, I think that what we’re doing is we are filling the top of the funnel with several different targets, and as you put a lot in the top, only a few come out the bottom. So, we do plan on being very opportunistic, and we are also not just locked into what people might consider traditional core lighting solutions. We’re looking at adjacencies. We’re looking at things where we can offer a broader solution and get a better share of wallet with the customers, where we have that domain expertise; that’s why vertical markets tend to be so important to us. We can go in and have a different conversation with our customers, then just being a manufacturer product supplier. And as you have seen too, I just mentioned that services is becoming a bigger piece of our value equation to our customers.

And just a point of clarification, am I correct in the assumption that you’re much more likely to complete an acquisition for the Lighting side of your business rather than the Graphics side, or do you kind of see equal potential for accretive growth in both of these sides of the house?

I see opportunities in both. If you look at traditional print graphics or digital graphics, probably not on our list. But if it’s things that augment that like digital signage was something that we think there is a lot of expansion in, whether it’s maybe additional structure or services, audio communications, things like that within the Graphics group are attractive to us and are things we’re looking at. And then from a lighting perspective, we want to bring on things to continue to add to our portfolio and the solution set to our customers, but we want to be careful about getting into just 'me-too' products or commoditization.

Understood. Congratulations on the progress this quarter; impressive results.

Thank you, Craig. Thanks for the time too.

Thank you. We have reached the end of our question-and-answer session. I’d like to turn the call back over to Mr. Clark for any closing remarks.

Thank you, operator. I just want to thank everyone again for taking the time. I realize it’s a busy time of the year. There is a lot going on. We are very happy with the progress we continue to make at LSI. We are always open if you have any specific questions or one-on-one that you’d like to have, please don’t hesitate to contact us. In the meantime, thank you very much and we’ll look forward to talking to you next quarter. Take care.

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.