Lsi Industries Inc (LYTS) Q2 2023 Earnings Call Transcript

Greetings and welcome to the LSI Industries Fiscal Second Quarter 2023 Results Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jim Galeese, Chief Financial Officer. Thank you, Jim. You may begin.

Good morning, everyone, and thank you for joining. We issued a press release before the market opened this morning, detailing our fiscal second 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. Included are certain non-GAAP measures for improved transparency of our operating results. A complete reconciliation of second quarter GAAP and non-GAAP results is contained in our press release and 10-Q. Please note 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 second quarter results. At the conclusion of these prepared remarks, we will open the line for questions. With that, I will turn the call over to LSI President and Chief Executive Officer, Jim Clark.

Thank you, Jim, and good morning, all. Thank you for joining us on today’s call. As you have likely seen from our press release, we had another strong quarter in our Q2 fiscal '23. In fact, this is our seventh consecutive quarter of double-digit organic growth. It’s quite an accomplishment given the ongoing headwinds of the general economy, ongoing supply chain challenges, and disruptions in the construction market. My hats off to the entire team at LSI along with our agents and partners. Sales for the quarter were up more than 16% year-over-year, net income up over 107%. We had strong free cash flow performance and I am happy to say our net debt sits around $60 million, which is a 1.3x net leverage ratio. We are in a good spot going into the second half of the year and Jim Galeese will provide a deeper dive of the financials in a few minutes. Our strategy around vertical markets continues to pay dividends and is reflected in our growth. While no market is recession-proof, we do believe that a good swath of our various vertical markets has provided us with some hedge against the current headwinds and have proven to be recession-resistant, creating growth opportunities that outpaced the performance of the general economy. Our refueling market continues to perform well. Although recovery in Mexico continues to lag our expectations, we have developed opportunities in other locations that are offsetting our delayed projects in Mexico. In the second quarter, we substantially completed approximately 200 site rebranding projects in Puerto Rico for a major oil retailer. This represents our first major project in Puerto Rico and demonstrates the strength of our systems and processes, which allowed us to substantially complete this major project in a new market without a hitch. We will continue to look for those types of opportunities and expand accordingly. As many of you have seen, we issued a press release a few weeks back regarding a solar installation we completed for an oil retailer in Austin, Texas midyear last year. A few months of the system running and operating, we were able to provide some interesting numbers in regards to energy savings and the payback period related to the initial investment. We see the canopy at most petroleum retail locations as an untapped opportunity, and this project is a good example of how we can turn this unused space into a real profit center for both us and our customers, not to mention the environmental impact of the clean energy production. I want to caution everyone that this is simply a first step, but it does go a long way into underlining the opportunities and possibilities of expanding products and services we can offer in our various vertical markets. Our grocery store vertical continues to deliver above expectations. In this last quarter, we were awarded another major project by one of the nation’s largest retail grocery store chains to provide approximately 1,200 to 1,500 units of refrigerated and non-refrigerated display solutions, which we will substantially complete and deliver by the end of this fiscal year. We continue to provide various print and lighting solutions to a wide group of our grocery customers, and we are experimenting with some other goods and services we can offer to this market. I hope to have some interesting news to share with you regarding these efforts next quarter. Our automotive market continues to show a number of growing opportunities and engagement of our team in a number of new projects. This week, our automotive sales team will be attending the National Association of Automotive Dealers, NADA Trade Show, and continuing to advance our position in this market. Despite several external factors affecting new and used car sales, this market continues to show good solid activity. Lastly, our sports court market has been moving along nicely with a number of larger wins recently. Our company does have some seasonality built into our normal sales cycle. With our focus on outdoor lighting solutions, it means that a good section of our sales are exposed to the realities of winter; cold weather and construction activities have slowed during winter months. Q2 and Q3 normally represent our slower months. And although I do not expect us to outsmart winter, we have been very fortunate with a record-setting third quarter last year and a very robust Q2 this year. You can be assured we will be looking for every opportunity to keep that momentum going. Next week, we will be hosting our Annual National Sales Meeting in Cincinnati. For these meetings, we bring all our sales, marketing, product development, and engineering resources together for a very full agenda. As we have done in the past, we will have a combination of workshops, sales training, and product training for our sales and marketing teams. This is a big investment that has historically paid big dividends, and we are excited to make this investment and move forward with this meeting. Immediately following our national sales meeting, we will be hosting our third annual partner and agent virtual sales and tech meeting, sharing lessons learned from our national sales meeting, along with new product introductions and best practices learned over the last year. Going into Q3, our quota activity across all sectors remains strong. We are still facing some significant headwinds, but we believe there are many more opportunities ahead of us, and we are working to improve both our top line and our bottom line. With that, I will turn the call over to Jim Galeese for a deeper look at our financials.

Thank you, Jim. Positive momentum in our business continued throughout Q2, generating double-digit sales growth, expansion in our gross and operating margins, significantly improved earnings and earnings per share, and strong cash flow. The period saw continued healthy demand levels across both reportable segments, and operational execution continued at a high level. Sales increased 16% year-over-year for the quarter, with both reportable segments attaining double-digit growth: Lighting increasing 17% and Display Solutions 15%. We continue to leverage our position in market verticals where we have a strong position and advance our position in verticals identified with profitable growth potential. Reported operating and net income were double the prior year quarter with reported diluted earnings per share of $0.22 and adjusted earnings per share of $0.26. This compares to $0.11 and $0.15 respectively last year. Adjusted EBITDA increased to $13 million, 54% above the prior year, and our adjusted EBITDA margin rate was 10.1%, our second consecutive quarter of margin exceeding 10%. The business continued to generate solid free cash flow. Second quarter cash flow of approximately $9 million increased cash flow for the first half of the fiscal year to $19 million. Our strong cash generation reduced net debt by $17 million in the first half of the fiscal year and over $25 million from the prior year period. This served to reduce the ratio of net debt to trailing 12-month adjusted EBITDA to 1.3x. Debt reduction remains a capital allocation priority and provides flexibility to pursue investments in both organic and inorganic growth initiatives. Now, a few comments on segment performance. Momentum continued in the Lighting segment as sales increased 17% and adjusted operating income improved 45%. Demand remains broad-based. Our independent sales network provided significant year-over-year growth, and our direct national account sales continued to expand, with orders received from several new customers in the quarter. We noted in the press release the substantial growth in sales for indoor applications, reflecting the progress in providing a specific complete solution set for key vertical markets which served to increase our average order size. Selling prices remained stable in the quarter, and commodity costs continued to moderate. This, combined with volume growth, was responsible for the improved earnings and margin expansion for the quarter. We reduced lighting inventory by 7% sequentially in the second quarter, reflecting ongoing supply chain stabilization. Lighting Days Inventory Outstanding remains somewhat above historical levels, and opportunities have been identified to further reduce inventory moving forward while ensuring product availability to meet projected customer demand. Project quotation levels in Q2 remained steady at a high level, and we exit the quarter with backlogs mid-single digits above last year. Moving to Display Solutions, sales increased 15%, and adjusted operating income approximately doubled to $8 million. The gross margin rate increased by 620 basis points, driven by volume leverage, improved program pricing, and favorable program mix. Jim mentioned the Puerto Rico branding program for a large oil company. I want to point out our high level of fulfillment and service performance on this and other large, highly customized display projects across the refueling C-store, quick-service restaurant, and grocery verticals as permitting issues and customer installation schedule changes continue. Our teams pivot quickly, collaborating with the customer to successfully meet the requested changes. This capability continues to be a differentiator for LSI in the market. Concept design and pilot work for prospective new programs remain very active in the Display segment, with over 20 proposals for new and existing customers in progress. To summarize, it was a solid quarter for the business, highlighted by strong financial and operational performance. We continue to effectively manage expenses while investing in programs to identify and support both short- and long-term profitable sales growth. Looking forward, quote order activity is expected to remain healthy in Q3 with sales reflecting normal seasonality. I will now return the call back to the moderator for the question-and-answer session.

Thank you. Our first question is from George Gianarikas with Canaccord Genuity. Please proceed with your question.

Hey, good morning, everyone. Thanks for taking my questions, and congratulations on continued excellent execution. So, maybe if I could start off with a question about just strategy. You’ve now brought down your debt to what seems like reasonable levels. You’re generating cash; the business is going well. So if you just think about the next 12, 24, 36 months, how do you think about the positioning of the company and how you plan to use your balance sheet as to potentially reposition and accelerate growth? Thank you.

Hey, George, thanks for joining, and thanks for the question and the compliments relative to the performance over the last quarter. Our strategy has not fundamentally changed. We are very committed to our vertical market strategy across the organization. We are looking for businesses that we think are recession-resistant, which show growth opportunity and have long legs, meaning 3, 5, or even 10 years out that we believe there is something structural to those businesses that will continue to create growth opportunities for us. So we remain very committed to that. In terms of paying down the debt and strengthening our balance sheet, there are two ways we’re going to grow. The last seven quarters, we’ve grown through organic growth, but we’ve always said that acquisitions and being able to add to our portfolio of solutions to our customers, particularly aligned with the verticals that we’re in, is going to be important for our above-market growth. So we’re going to keep executing against that. As we pay down debt, it just continues to open up the opportunities for us to look to add something else to the portfolio. We keep a very active pipeline, and it’s just a matter of the opportunity coinciding with us being in the right position and the market aligning relative to a growth opportunity, and we will be ready to execute.

Thanks. And I wasn’t necessarily the best student when it came to matrix algebra and advanced mathematics, but it doesn’t take a rocket scientist to see you’re well above what you’ve outlined for 2025 guidance in terms of $500 million in revenue and $50 million in EBITDA. So I am curious if you can help us understand what your business is capable of over the next few years. What sort of margin structure and what sort of revenue structure should we look to understand the company?

I think there is – well, let me start with this. First of all, we are looking to revisit that in this quarter and update what our goals are and what our targets are. We hope to share that widely by the end of the year, if not sooner, by the end of the fiscal year. We definitely see growth opportunities, both top line and bottom line. We do see what we believe is still a lot of runway left for us. This concentration on the vertical markets just allows us to get a greater share of wallet, and we’ve always talked about that, that the cost of sales and the cost of confidence in the customer are very high prices any company pays to get in and create a relationship with the customer. We need to make sure we’re executing on the basic commitments we make to the customers, which we do very well. Our say/do ratio still remains very high in our ability to deliver our products and the services that go along with them. We’ve been executing and firing on all cylinders on that for quite some time, and we remain committed to making sure we can continue to do that. But if we look at what the cost is relative to interfacing and dealing with the customer, it is that initial order, the ongoing orders, and the confidence the customer has. And we believe we’re in an environment where if we can continue to execute like that, maintain the confidence and trust of our customers, we can add additional offerings, whether they are products or services or a combination of both into that. So when we look at growth opportunities, I know a few years back, we caught a few people off guard with going into refrigeration with the JSI acquisition. But you can see how well that paired up. We do have synergies. We don’t elaborate on them to great length, but we’re both in there; JSI and LSI are in there as one team, as one company, and we benefit from selling across our product and solution lines to those customers. As we look forward, we want to make sure we leverage that more, both in growth. We look at it as a three-legged stool: growth in our commercial market by choosing the right verticals, growth through our organic activities, meaning we become that much better at managing margin and managing profitability. We think we have a long runway to go with that. We’re not out of ideas, and we’re not out of opportunities in that regard. Lastly, what can we add from an inorganic or acquisition standpoint? It’s those three aspects that we’re focused on, and we plan to revamp our targets. I’d also say that there were some pretty lofty goals when we sat down and penned them out in December of 2018, which we brought to the market in Q3 of 2019. There was a lot of skepticism, so we need to make sure that we’re pushing ourselves in a healthy way, while also being able to deliver. Those are the things we’re working on now, and we think we have a lot of runway beyond the $500 million and double-digit EBITDA.

Great. So you’re still a growth company, is the message, and we will hear more about that plan soon?

Yes. We’re still a growth company, and we don’t see that extinguishing any time soon – we’ve got runway.

Got it. And maybe just lastly, there has been some M&A in the supermarket channel or the proposed M&A, I should say. That was the potential for disruption, but it sounds like it’s turned into something that’s the opposite. Is that an accurate characterization of the activity you’re seeing in the marketplace in that particular channel?

But we don’t have a crystal ball, but I’d agree with what you were saying. We’ve always looked at it as an opportunity. We certainly had our planning sessions, and we looked at it if it didn’t turn the way that we anticipated it turning, but we’ve always seen this as an opportunity. It underlines what we’ve talked about for some time, which is this space is going to continue to get competitive, and little things are going to matter. That’s what we’re very good at delivering, promoting our customers' brands, and helping differentiate them. We think there is a lot of runway left specific to grocery.

Great. Thanks, guys. I will get back in queue.

Alright, George, thank you.

Thank you. Our next question is from Aaron Spychalla with Craig-Hallum. Please proceed with your question.

Yes. Good morning, Jim and Jim, it’s Aaron Spychalla. Thanks for taking the questions. First for me, good to see your commentary on the second half outlook. Can you just talk a little bit more about the increased visibility you’re getting? In the past, you’ve talked about some of the multi-site projects and refresh cycles kind of compressing. Just trying to balance that outlook with some of the puts and takes with seasonality as we look to Q3?

Yes. Well, seasonality is always something that we’ve talked about quite a bit. Our focus is in a lot of our products, which are outdoor, and they are affected in ways that we just can’t forecast or see. So any time we get into Q2 and Q3, we anticipate some seasonality. Obviously, we backed that trend last year with a very, very strong Q3, and we’re looking to do the same this year with a very strong Q2. The unforeseeable events that happen in the quarter, I don’t think structurally affect our momentum or our growth. But if you have a large snowstorm that affects construction activity for a week or two, it can slow down projects and affect timing. So Q2 and Q3 have always been a bit variable in that sense. Last year was exceptional for Q3, and Q2 this year was obviously very strong as you guys have learned. Regarding large project activity, these projects tend to work over many months or sometimes years, so the fluctuation within any given month doesn’t significantly affect commitment. Many of the projects we’ve been engaged in are these larger ones. Specifically, regarding the refresh cycle, if we go back 10 years, we saw an average refresh cycle of around 7 years; 5 years ago, it was starting to dip under 7 years. Today, we’re seeing a refresh cycle that’s solidly around 5 years or even trending lower to 3 years. This reflects the fast pace of consumer behavior, which emphasizes keeping the brand image fresh to attract customers.

Great. Thanks for the color there. And then can you discuss some of the new products launched over the last couple of years? I know you have refreshed some verticals and you called out indoor this quarter. Could you talk about how that’s helped and what areas you are focused on going forward?

If I go back 4 years ago, I remember us getting on a call and saying we were going to have almost 20 new products launched in the year. Since then, we have maintained that pace or more. These products are not necessarily game-changing technology products as much as they are incremental improvements to existing lines. Don’t get me wrong; we do have game changers. The core of it is taking our core products and making them better to serve our customers, particularly as we align ourselves around vertical markets. We aim to introduce at least 20 new products each year, and we are on track to exceed that this year. One specific game changer I’d mention is the REDiMount, which is designed to simplify installation significantly; it can cut down installation time considerably, which reduces costs for our customers and enhances maintenance efficiency. If you haven’t looked at the REDiMount, I encourage you to check it out on our website. This demonstrates our innovation not just in technical aspects but also in usability and installation ease.

That’s good color. Thank you. And I’d like to sneak one more in. I saw the grocery award and that you continue to expand wallet share there. Can you elaborate a little more on the cross-selling opportunities from JSI? Any updates on those and potential contributions?

Yes, absolutely. I also want to clarify regarding new products. In our print materials and canopy designs, we use various inks and materials, including metallic and composite types. This ongoing partnership with our suppliers helps us advise customers about what to choose based on how frequently they intend to update their look. Now, regarding JSI, we refer to this as boundary selling, where our sales teams are encouraged to discuss the breadth of our product portfolio with customers, regardless of how we initially engaged them. While it's hard to pinpoint exact statistics, we can assert that this happens constantly. It's a discipline we emphasize within our teams and will be a focus at our upcoming sales meeting. While I don’t have exact numbers to share, the potential continues to look promising. These projects often take time to mature as they may involve changing incumbents, requiring trust-building. I'm not unhappy with the pace we’re at, and I anticipate continued wins as we proceed.

Good. Appreciate all the color. Thanks. I will hop back in the queue and turn it over.

Thank you, Aaron.

Thank you. Our next question is from Amit Dayal with H.C. Wainwright. Please proceed with your question.

Thank you. Good morning guys. Solid quarter, congratulations. Just to begin with, Jim, could you provide some granularity on where the operating leverage improvements are coming from? Is it just better pricing, larger orders, or some efforts on the cost side? That would be helpful. Thank you.

Yes. Amit, thanks for joining and for your comments. It’s all of those factors. Everyone wants to pinpoint just one, but the improvements result from executing across various factors. I call it the paper clip effect, which means small incremental changes across our entire scope contribute to improvements. We have considerable room for further efficiency, and we are not operating at full capacity. Every team member recognizes these opportunities lie ahead. Pricing is one important element we’ve been disciplined with. Reliability to our customers regarding on-time delivery, means we need to operate efficiently to have a margin for error. So it’s an aggregated look at our business and our execution across all areas that drive the results. We believe there remains significant improvement potential.

Understood. Thank you, Jim. From a revenue growth perspective, are you taking market share in both the Lighting and Display segments from other players? Is this an expansion story that LSI is benefiting from or are you winning more market share due to how you've executed over the last 2 years?

I think it's definitely a market share gain. If you think we have had above-market growth now for seven consecutive quarters, there aren’t too many companies, particularly with our broad-based solutions, experiencing double-digit quarterly growth. We know the overall market isn’t growing at that rate, though we anticipate it’s possible, particularly with the verticals we’re in. Our alignment with the right verticals is a contributing factor. Despite the market not all experiencing double-digit growth, they are generally healthy and more resistant to general economic pressures. We are efficiently providing services, creating a favorable say/do ratio, and that’s earning us market share from competitors.

Thank you, Jim. That’s all I have.

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for any closing comments.

I just want to say thank you again to everyone that dialed in, called in, and follows us. I think we have a great story in front of us. As we underlined today through the Q&A, we believe we still have a lot of opportunity in front of us, and we can continue to grow like this. It is an extraordinary effort by a team, and I just want to underline and say thank you to the whole team and our partners, agents, and customers. We will continue to deliver and look for growth opportunities. I look forward to our next call. Take care.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.