Earnings Call Transcript - LYTS Q3 2024

Jim Galeese, CFO

Welcome, everyone, and thank you for joining. We issued a press release before the market opened this morning detailing our fiscal '24 third quarter results. In addition to this release, we also posted a conference call presentation in the Investor Relations section of our corporate website. 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. Our complete reconciliation of 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, for more details. Today's call will begin with remarks summarizing our fiscal third 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.

Jim Clark, CEO

Thank you, Jim, and good morning, all. Thank you for joining us on today's call. It's truly hard to believe, but we're closing out our third quarter of fiscal year 2024 and well into our fourth quarter as we speak today. We are just over two months away from the end of our fiscal year 2024, and we've just begun developing our operating plans for 2025. Things have been busy, and the LSI team continues to execute well. Working through the second half of the year, we are still facing some ongoing headwinds related to the current pause in our grocery vertical. Despite these challenges, total sales for the third quarter were down only 8%, while adjusted net income was up 14% on a year-over-year basis. These results demonstrate and underline the resiliency of the management team to operate the company with a continued focus on execution and earnings while being fully prepared to capitalize on developing opportunities. As you all are well aware, LSI has developed and published our strategic plan to grow the company and its earnings of $800 million in sales and 12.5% in EBITDA in 2028. This plan, which is known as our Fast Forward Plan, provides insight for our investors, employees, and customers alike to understand our goals in the path we intend to take to reach that $800 million milestone. Late last week, LSI announced the acquisition of EMI Industries. EMI is based out at Tampa, Florida, and they have a long-established history as a fixture display and food equipment manufacturer in the grocery, convenience store, and restaurant industries. EMI has been in business for more than 40 years, and they serve a well-established customer base ranging in size from regional brands with several hundred site locations to national and international brands operating thousands of sites. This acquisition fits well into our Fast Forward Plan, and we see a number of opportunities from additional goods and services that we can offer to our customers. A key component of our strategy is identifying and developing a solution set for higher-value verticals where our customers recognize the value of our products and services. This approach has served us well over the last several years, and we've advanced our position in multiple verticals. The acquisition of EMI further expands and accelerates this strategy. I mentioned in previous calls, published information regarding the significant multi-year planned investment by C-stores, QSR, and grocery industry participants as a target in-store sales growth as a means to increase profitability. An improved image and brand enhance the consumer shopping experience. The acquisition of EMI positions LSI to exploit further growth opportunities in this multi-year investment cycle. As we've discussed before, company culture and commercial synergies are always important elements to LSI when looking at any type of transaction. Our work with EMI over the last few months has shown a highly experienced management team that plans to stay onboard with EMI and LSI well into the future. In terms of commercial synergies, we see a customer base about a third, a third, and a third. In other words, while one-third of the combined company customers are new to EMI, about one-third of the combined customers are new to LSI and JSI, and about one-third of the customers are shared. As a result, we've identified substantial cross-selling opportunities across our expanded customer base. In fact, regarding common customers, we had one customer, a large quick-serve chicken restaurant chain, reach out to us already, letting us know they do business with both LSI and EMI, and they look forward to working with us as a combined entity. In their own words, they thought this was a great combination. Aside from these commercial opportunities, we see several operational and integration opportunities. It will help EMI lower costs, improve production capabilities and product quality while improving customer service and profits. We see combined technology capabilities and benefits we can offer our customers. We won't get all of these opportunities overnight, but working with the team at EMI, we are confident in our ability to work together, share capabilities, and learn from each other. EMI and JSI today provide adjacent products to our combined customer base, and in fact, they make a perfect combination, where EMI and LSI help JSI in metal fabrication and design, and JSI will help EMI in the refrigeration and cold fixture business. EMI and JSI both work in the millwork and refrigeration space, and we believe the capabilities and purchasing power will complement each other. Over the next few quarters, we'll explore these opportunities, including having JSI work with EMI in the introduction of an R290 solution, allowing EMI to offer an environmentally friendly refrigerated solution for those customers who value this offering. In the full calendar year 2023, EMI reported total revenues of $87 million and EBITDA performance of $5.5 million. EMI will be immediately accretive to LSI on an adjusted earnings per share basis. LSI has been working with EMI over the last few months as we underwent our full due diligence of the company. Our purchase price of $50 million was fully funded from our existing revolver, leaving our net debt at approximately 1.3 times. We will add about 300 employees to LSI and five additional manufacturing locations located in Florida, Georgia, New Jersey, Rhode Island, and Dallas, Texas. This acquisition helps make a meaningful step towards our $800 million goal and provides an expanded set of products, services, and solutions in our targeted vertical markets.

Jim Galeese, CFO

Thank you, Jim. In fiscal Q3, we continued our strong focus on execution and quality of earnings. For the quarter, LSI generated increased net income and earnings per share, margin rate expansion, and strong cash flow, all while continuing to invest in the business, with increased capital expenditures and other growth initiatives. Our adjusted gross margin rate improved 160 basis points versus last year, contributing to our improved net income and margin expansion. Adjusted EBITDA margin increased 80 basis points to 10.4%, while adjusted earnings per share increased $0.02 to $0.21 a share. Multiple factors drove the improvement with favorable mix, stable pricing, moderating material input costs, and factory productivity all contributing. Results were achieved in a divergent market environment with vertical performance ranging from robust activity levels to the continued pause in grocery. In refueling C-stores, for example, our recent large program wins for display solutions generated significant growth in the third quarter, as site release activity for these programs was initiated. Our site work ranged from product only to being the single-source provider of comprehensive products and services. Many of these sites specify our unique forward throw technology and Archer perimeter lighting system. This differentiation creates increased revenue per site and strengthens our importance to customers. The adoption rate continues to increase as customers recognize the value these systems provide. The refueling C-store outlook for the fiscal fourth quarter and entering fiscal '25 is strong, with high levels of site release activity for multiple programs expected to continue. Conversely, refueling C-store growth was offset by continued disruption in grocery demand levels caused by the slow progress in the proposed merger of two large industry participants. We maintain ongoing contact with our grocery customers, and plans for interior refresh programs remain, but with schedules deferred, pending more clarity on the merger. The underlying fundamentals of the grocery vertical remain solid and support multi-year investment in store refresh programs. For lighting, market performance has varied across verticals as well as project size. Overall, lighting project quote activity for fiscal Q3 was above prior year levels. However, we're also experiencing the quote to order conversion period continuing to lengthen, particularly for larger projects. Small project activity remained stable across multiple verticals, and we expect this trend to continue in the fourth quarter. Despite the lengthening quote to order conversion period, the Q3 book-to-bill ratio was above one. Lighting adjusted operating income increased 11% for the quarter on 3% lower sales. The lighting gross margin rate was 280 basis points above the prior year period, reflecting in part the healthy level of small project activity, as well as stable pricing, moderating material input costs, and factory productivity. Next, a few comments on cash and capital allocation. Free cash flow was $11 million in the quarter, with our TTM cash flow over $43 million. Solid cash flow generation reduced net debt to $9 million and lowered our ratio of adjusted EBITDA to net debt to 0.2 times as of March 31. We have been successful over the last several years with our earn to invest model, generating increased earnings and cash flow, significantly reducing debt, and positioning the business to execute on both organic and inorganic growth initiatives, as identified in our Fast Forward Strategic Plan. Last week, we announced the acquisition of EMI Industries as part of that inorganic growth plan. We expect the combined cash flows of two entities to significantly reduce outstanding debt over the next two years, supporting the cycle of investment to achieve our 2028 target. On a reporting basis, EMI will become part of LSI's display solutions segment, beginning with a partial impact starting in fiscal Q4. As part of our capital allocation and total return to shareholders, the company declared a regular cash dividend of $0.05 per share payable on May 14 to shareholders of record on May 6. In summary, our third-quarter performance reflects the diversity and durability of our business model. The last two quarters demonstrate LSI can achieve solid results while overcoming disruptions driven by interruptions to key markets. The addition of EMI will further strengthen our diversity of markets and customers and durability of performance.

Aaron Spychalla, Analyst

Yeah, good morning, Jim and Jim. Thanks for taking the questions. First for me, good to see the lighting book-to-bill above one and activity on the quotation front that you talked about. Is that pretty broad-based or are there any verticals leading that? And then, you also mentioned the order conversion period continued to lengthen. Can you just give a little bit more detail behind that on gating factors that you're seeing there?

Jim Clark, CEO

Thank you for the question, Aaron. The lighting segment we serve remains extensive across all areas. Interestingly, we're only experiencing a slight decline in lighting. It's important to note that even lighting is affected by the slowdown in grocery, which highlights some growth opportunities that could have arisen if we hadn't faced this gap caused by grocery. As for your second question, could you remind me what it was? I apologize for not recalling. Oh, the lengthening of the lighting.

Aaron Spychalla, Analyst

Yeah, just kind of the order conversion period. Just gating factors or what's going on there?

Jim Clark, CEO

Yeah, I mean, I think that we've been pointing it out for the better part of the year. We have a trend analysis that we do relative to incoming quotes from the time it takes from initial quote activity to order, and we track that, and that gives us our cycle, how long that quote to order conversion ratio takes. We just noted that if it continues to stay at an extended length over certain periods of time, particularly at the beginning here of this year, we noticed it and even added a couple more days to it. It doesn't indicate anything as though we're losing business or anything, just that the time from initial inquiry to the time to close continues to lengthen. I would say that it's only days, and then it's normalized now coming back to that extended period that we've had for the last couple of quarters, but it's just another observation that it's lumpy.

Aaron Spychalla, Analyst

Right. Okay, thanks. And then, also good to see mention of the recent program awards in C-store and QSR. Any newer large awards to note there? And I know you've had some pilots for refrigerated and C-stores and broader pilots in QSR. Can you just give an update on how those have been going and if those are turning into program awards here in the near term?

Jim Clark, CEO

From last quarter, we had a few significant wins that we discussed previously, and those are projects that will take us several years to complete. So, there were substantial project victories. I can't highlight anything particularly noteworthy from this quarter, although as you mentioned, we have several test locations and products. We are testing a range of items, including our R290 and refrigerated products, as well as various graphics and lighting products. We have a number of systems currently in testing and reconfiguration, but there aren't any significant wins this quarter to emphasize.

Sameer Joshi, Analyst

Hey. Good morning, Jim. and Jim. Thanks for taking my questions. On the EMI integration, you might have a lower EBITDA margin, so should we look at this as improving because of leverage and just higher sales? Or do you expect to incorporate any cost synergies, resources, common resources elimination?

Jim Clark, CEO

Hi Sameer, thanks for your call and question. The answer encompasses all of the aspects you've mentioned. Most participants on this call know we are disciplined operators, and we see numerous opportunities ahead. These opportunities are not just related to cost synergies or operational improvements, but rather a combination of these factors that we believe will enhance our prospects. Currently, the business operates at a lower margin, but we expect to make significant advancements within 12 to 24 months by collaborating with them to enhance efficiency, including purchasing synergies and operational improvements, as well as building commercial momentum. It's important to note that any commercial product developments typically take time; they don't materialize in just weeks or months. They often require a quarter, a year, or even longer for substantial projects. While we anticipate some individual successes from the EMI/LSI integration, I expect the major achievements to unfold over the next 6, 9, 12, or 18 months.

Sameer Joshi, Analyst

Understood. And just a quick follow-up on that. Are there possible technological synergies? I think you mentioned the EMI/JSI cooperation on the R290 solution. Are there more such technological synergies possible?

Jim Clark, CEO

Absolutely. I'll elaborate a bit more on what you just mentioned. Both EMI and JSI provide refrigerated solutions, but they are not the same and do not necessarily compete with each other. However, the underlying technology such as compressor technology and the types of refrigerants they select are common. We believe that EMI will greatly benefit from JSI's infrastructure, particularly in testing and development. We are definitely eager to take advantage of that. As it stands, EMI does not currently have an R290 solution, so we will be working to introduce that. It may take us three, six, or nine months to develop a product with that solution, but we see many opportunities ahead of us.

Sameer Joshi, Analyst

And then just switching just a little bit to the grocery merger that is in the works. I think there was recently submitted a big, updated divestiture plan, which calls for around 600 stores to be sold from this combined company if it happens. Does that present you with additional upside from just like restarting the process? And then new branding and new signage for these 600 stores?

Jim Clark, CEO

We think that nearly 600 stores will require a complete rebranding as they transition from their previous brand to a new one. This presents us with fresh store opportunities. Additionally, depending on the merger's outcome and the strategies of the involved parties, there may still be potential for co-branding, rebranding, and redesigning the other stores. So, we anticipate at least 600 new store opportunities, along with a combined rebranding effort for the other stores. There are also general updates needed for the stores that have been lagging while they navigate this process. Furthermore, our competitors are currently assessing their approach and determining who they will be up against—whether that’s a store keeping its current brand, one that will be rebranded, or one that might be sold off. We believe this situation will create significant advantages for us, potentially offering multiple opportunities depending on how everything unfolds.

Leanne Hayden, Analyst

Morning, everyone. Thanks so much for taking my question and congrats on the progress this quarter. Just to start, are you continuing to see supply and permitting constraints in the marketplace, whether this is from transformers or permits? Or has there been an improvement? Or is this kind of part of a new reality we should come to terms with?

Jim Clark, CEO

Hi, Leanne. Thanks for your question. We've been discussing for a long time now the disruptions in supply chains across various industries. Switchgear and electrical supplies remain unstable, and I would describe this as the new normal in our business landscape. While I can't say these issues have directly affected our operations, they do help clarify the longer conversion cycles we've mentioned as customers prepare to launch new projects and assess equipment and product delivery realities. This explains the increasing duration from quote to conversion as we adjust to extended lead times for some products. I believe this is our new reality for the foreseeable future, but I expect that over the next few quarters, or perhaps years, we will gradually return to pre-2020 norms in terms of delivery and related matters.

Leanne Hayden, Analyst

Got it. Okay, that makes sense. And then just a second one for me. You have a lot of your own manufacturing facilities and you've acquired several manufacturing facilities. Can you please talk about any sort of wage inflation that could impact your financials going forward?

Jim Clark, CEO

I don’t think there’s anything particularly significant to mention regarding wage inflation. We have always prioritized our employees and aim to ensure our starting wages, especially for our manufacturing staff, are competitive and attractive enough to retain them. This approach has been in place even before the wage inflation that followed COVID-19. Therefore, we don’t anticipate any major threats or changes that we will need to address. We have consistently focused on being employee-friendly. While labor is a part of our product cost, it is not a predominant factor. Hi. I just wanted to say thank you again for taking the time to dial in and continue to learn a little bit more about LSI. We're very excited about the addition of EMI to the team, we're just beginning that process. We do have our normal integration team working to bring EMI into the fold. I don't think that you can expect to see anything happen overnight in terms of the synergies we think that we have there, but we do believe we have a good path forward and a lot to capture. We believe both companies will benefit significantly. And more importantly, our customers will benefit. We are focusing on the idea of a one-stop shop in specializing in certain verticals, and EMI allows us to continue to expand that value to our customers, and we look forward to the benefit we're able to offer to our shareholders and our customers alike. So with that, I'll just say thank you for calling in, and I'll look forward to speaking to you on our next call. Take care.

Operator, Operator

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.